CHAPTER 11. DECISION MAKING AND RELEVANT INFORMATION
A good decision process includes a post implementation assessment and explanation of the key causes
Decisions are made based on forecasted future revenue and cost and not on historical revenue and costs
Decision framework: choose only relevant costs
Imperfect information-> decisions- > forecast future
Sources of data: electronic/hardcopy source documents, relevant stories of past experience, expertise in
processes and outcomes, analysis from MIS , about controllable factors and expert advice and forecast.
Quantitative data: measured numerically- expressed in financial and non financial terms
Relevant data: data that changes between available choices
- Incorporate risk by quantifying risk( which helps improve mgr’s confidence and align their
interest with that of the company) and including it in the forecast.
Such measure of risk: probability
- Probabilities permit estimation of a range of predicted outcomes and identification of the
most likely to occur, the expected value, which is the sum of risk weighted outcomes
- Risk weights are measured as probabilities in decimal format while outcomes are usually
measured as financial payouts from pursuing a specific course of action.
- Fruitful discussion, less emotional
- Highly risky decisions: high probability of (near certain) loss, or small probability of a very
- High return: either a highly improbable but large upside return or near certain return.
- As circumstances change, assumptions, probability change, and negative and positive
outcomes and their magnitudes change.
- Action must be taken : or face paralysis by analysis: managers decide to wait and wait for
Relevant Vs Irrelevant costs:
- Relevant revenue: forecast future revenue that differs because of a decision
- Incremental revenue: additional total revenue from one alternative
- Differential revenue : difference between the total revenue of two or more alternatives
- Relevant cost: cost that differs due to a decision made
- Incremental cost/ out of pocket / outlay/ differential cost: difference between two
alternative relevant costs
- Net relevant cost: incremental saving – incremental cost
Additional relevant considerations: time , tax and qualitative factors - Taxes can increase due to increase in pre-tax income from one tax bracket to the next
- Qualitative factors: outcomes that cannot be measured in numerical terms: measured in
scales of eg. 1- 5 effective training, employee morale, and incorrect assumptions by top mgt.
- Quantifying the qualitative factor into a rough estimate of financial value provides relevant
information to assist in the decision making.
- Responsible management teams will go to experts outside their enterprise to help them
more clearly understand the risk and outcomes.
- Managers must give more weight to qualitative or non financial quantitative factors than to
Change output level: short and long term decisions
Short term production output decisions have no capacity management effects, such as accepting or
rejecting one time-only special . Fixed costs are irrelevant.
- Variable and throughput costing is appropriate for pricing finished goods.
- In case of idle capacity, the effect of a special order on operating income depends on the
customer accepting the contract, not on full absorption cost recovery as fixed cost is
- Fixed cost/ capacity