ADMS 1500 Lecture Notes - Environmental Full-Cost Accounting, Contribution Margin, Sunk Costs
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Chapter 10: Analysis of short term decisions
Differential costs & Revenues: new orders.
The idea of cost behaviour is close to differential costs and revenues.
Differential costs and revenues change as a result of a decision
Variable costs are normally differential costs and fixed costs are normally NOT.
Making a decision that is relevant is differential to the decision.
Revenues are generally differential and behave in a variable way as sales rise or fall.
More revenue is better than less always.
Typically organizations use full cost as their way of reporting accounting information.
Financial accounts don’t split costs on the basis of behaviour (fixed/variable) instead they’re
reported functionally (materials, wages, rent).
Inventories are normally valued at full cost rather than variable.
In full cost accounting, date is used in short term decision making and the effect is inaccurate.
Suppose production overhead is a fixed cost, there’s production capacity.
Production overhead allocation is irrelevant in decision making.
When there`s issues with unused capacity there’s several choices would result in additional
contribution margin, losing the contribution margin on regular sales or to increase contribution
margin from the new order.
Potential drawback with failing to supply the regular customers with his products they normally
There`s some things more expensive than dissatisfied customers but those customers
satisfaction could not be given an accurate dollar value. So it`s omitted from the calculation.
All alternatives increase profit, the best is the first choice as it adds the greatest amount profit.
Make or buy
Costs that can be eliminated by sourcing outside are differential costs & costs that continue are
The use of full cost is likely to provide misleading information
Fringe benefits (10% x salaries & wages)
Corporate overhead (25 x $1000)
Always irrelevant is a sunk cost
Sunk cost has already happened so it`s unavoidable
Eg. Major acquisition of hardware, predominant amortization. Discontinuing the use of the
computer will not make these costs go away. They`re sunk costs