ADMS 2510 Lecture Notes - Lecture 2: Sunk Costs, Fixed Cost, Cost Driver

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byzantiumdog699

2 Feb 2016

School

York University

Department

Administrative Studies

Course

ADMS 2510

Professor

Marcela Porporato

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ADMS 2510 Full Course Notes

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Only cost/benefits that differ between alternatives relevant in decision. Benefits forgone when one course of action chosen over another. Cost already incurred and not changeable regardless of alternative selected. Variable+fixed cost mix of variable and fixed. Total variable cost varies in direct proportion to changes in activity. Variable/fixed cost that shifts upward/ downward by certain interval/step when activity changes. Costs having both variable and fixed components. Classify each cost account as variable/fixed based on prior knowledge of account behaviour. Determine expected cost behaviour based on 1) inputs required to carry out particular activity 2) prices of those inputs. Typically used in absence of past experience. Technique to calculate change in activity and change in cost using actual observations of total cost at highest and lowest levels of activity b= cost at highest activity level cost at lowest activity level. Highest activity level lowest activity a= total cost- variable cost (variable x amount of times)

Related Questions

Tactical decision making

Tactical decision making means choosing among alternatives withan immediate or limited end in view. For example, a company mayaccept a special order for less than the normal selling price touse idle capacity. Tactical decisions tend to be short-runin nature; however, it should be emphasized that short-rundecisions often have long-run consequences. A general tacticaldecision-making model is outlined here.

1.	Recognize and define theproblem.
2.	Identify possible alternativesolutions to the problem, and eliminate any unfeasiblealternatives.
3.	Identify the costs and benefitsassociated with each feasible alternative. Eliminate the costs andbenefits that are not relevant to the decision.
4.	Compare the relevant costsand benefits for each alternative.
5.	Assess qualitative factors.
6.	Select the alternative with thegreatest overall benefit.

Identifying and comparing relevant costs and revenues is theheart of the tactical decision model. Relevant costs (revenues) arefuture costs (revenues) that differ across alternatives. (Revenuesare treated in the same way as costs, so we will simplify thediscussion by referring to costs.) All decisions relate to thefuture; so, only future costs can be relevant. In addition, thecost must differ from one alternative to another. If a future costis the same for more than one alternative, it has no effect on thedecision. Such a cost is an irrelevant cost.

Assume that Reeves Company is considering accepting a specialorder for $25 per unit when the normal selling price is $30 perunit. Reeves has enough excess capacity to make the order withoutdisplacing normal sales. The alternatives facing Reeves Company are(Select "Yes" for the statements that are applicable and "No" forthe items that do not apply):

Accept the special order.	- Select your answer -YesNoItem1
Reject the special order.	- Select your answer -YesNoItem2
Sell normal sales for $25 perunit.	- Select your answer -YesNoItem3

Choose which of the following are relevant in deciding whetheror not to accept the special order. (Select "Yes" for thestatements that are applicable and "No" for the items that do notapply)

$25 price.	- Select your answer -YesNoItem4
$30 normal price.	- Select your answer -YesNoItem5
Variable cost of making the unitsin the special order.	- Select your answer -YesNoItem6
Depreciation on factory equipmentused in making the special order units.	- Select your answer -YesNoItem7
Increased property taxes on thefactory building which are due while the special order would bemade.	- Select your answer -YesNoItem8

While cost and revenue information is important, otherinformation may be needed to make an informed decision. Thesenon-financial factors are termed qualitative and are often relevantin decision making. For example, in deciding whether to make acomponent in-house or purchase it from an outside supplier, thecompany may consider any difference in quality or in responsivenessto the company's production schedules.

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Question 29 An opportunity cost: A. Is an unavoidable cost because it remains the same regardless of the alternative chosen. B. Requires a current outlay of cash. C. Results from past managerial decisions. D. Is the potential benefit lost by choosing a specific alternative course of action among two or more. E. Is irrelevant in decision making because it occurred in the past.

Question 30 A cost that cannot be avoided or changed because it arises from a past decision, and is irrelevant to future decisions, is called a(n): A. Uncontrollable cost. B. Incremental cost. C. Opportunity cost. D. Out-of-pocket cost. E. Sunk cost.

Question 31 A company paid $200,000 ten years ago for a specialized machine that has no salvage value and is being depreciated at the rate of $10,000 per year. The company is considering using the machine in a new project that will have incremental revenues of $28,000 per year and annual cash expenses of $20,000. In analyzing the new project, the $200,000 original cost of the machine is an example of a(n): A. Incremental cost. B. Opportunity cost. C. Variable cost. D. Sunk cost. E. Out-of-pocket cost.

Question 32 Listmann Corp. processes four different products that can either be sold as is or processed further. Listed below are sales and additional cost data: Product Sales Value with no further Processing Additional Processing Costs Sales Value after further processing Premier $1,350 $900 $2,700 Deluxe 450 225 630 Super 900 450 1,800 Basic 90 45 180 Which product(s) should not be processed further? A. Premier. B. Deluxe. C. Super. D. Basic. E. Premier and Basic.

Question 33 Bluebird Mfg. has received a special one-time order for 15,000 bird feeders at $3 per unit. Bluebird currently produces and sells 75,000 units at $7.00 each. This level represents 80% of its capacity. Production costs for these units are $3.50 per unit, which includes $2.25 variable cost and $1.25 fixed cost. If Bluebird accepts this additional business, the effect on net income will be: A. $45,000 increase. B. $11,250 increase. C. $33,750 increase. D. $7,500 decrease. E. $33,750 decrease.

Question 34 Bannister Co. is thinking about having one of its products manufactured by a subcontractor. Currently, the cost of manufacturing 1,000 units follows: Direct material $45,000 Direct labor 30,000 Factory overhead (30% is variable) 98,000 If Bannister can buy 1,000 units from a subcontractor for $100,000, it should: A. Make the product because current factory overhead is less than $100,000. B. Make the product because the cost of direct material plus direct labor of manufacturing is less than $100,000. C. Buy the product because the total incremental costs of manufacturing are greater than $100,000. D. Buy the product because total fixed and variable manufacturing costs are greater than $100,000. E. Make the product because factory overhead is a sunk cost.

Question 35 Granfield Company has a piece of manufacturing equipment with a book value of $40,000 and a remaining useful life of four years. At the end of the four years the equipment will have a zero salvage value. The market value of the equipment is currently $22,000. Granfield can purchase a new machine for $120,000 and receive $22,000 in return for trading in its old machine. The new machine will reduce variable manufacturing costs by $19,000 per year over the four-year life of the new machine. The total increase or decrease in net income by replacing the current machine with the new machine (ignoring the time value of money) is: A. $22,000 decrease B. $76,000 increase C. $18,000 decrease D. $52,000 increase E. $22,000 increase

Question 36 A company has already incurred a $55,000 cost in partially producing its three products. Their selling prices when partially and fully processed are shown in the following table with the additional costs necessary to finish their processing. Based on this information, should any products be processed further? Product Unfinished Selling Price Finished Selling Price Further Processing Costs A $72 $108 $35 B 83 124 42 C 94 141 45 A. All of these products should be processed further. B. None of these products should be processed further. C. Products A and B should be processed further. D. Products B and C should be processed further. E. Products A and C should be processed further.

Question 37 Wheeler Company can produce a product that incurs the following costs per unit: direct materials, $10; direct labor, $24, and overhead, $16. An outside supplier has offered to sell the product to Axle for $45. If Wheeler buys from the supplier, it will still incur 45% of its overhead cost. Compute the net incremental cost or savings of buying. A. $4.00 savings per unit. B. $4.00 cost per unit. C. $2.20 cost per unit. D. $3.80 cost per unit. E. $2.20 savings per unit.

Question 38 An additional cost incurred only if a company pursues a particular course of action is a(n): A. Period cost. B. Pocket cost. C. Discount cost. D. Incremental cost. E. Sunk cost.

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FILL IN THE CORRECT TERMINOLOGIES IN THE BLANK SPACES
_____ 1.		a. A method of internal (managerial accounting) reporting that emphasizes the distinction between variable and fixed costs.

_____ 2.		b. A discounted cash flow approach to capital budgeting that computes the present value of all future cash flows.

_____ 3.		c. Determination of the maximum cost a company can spend to make a product given a set volume, selling price and desired operating profit.

_____ 4.		d. An analysis of the additional costs and benefits of a proposed alternative compared with the current situation.

_____ 5.		e. A historical cost that the company has already incurred which is irrelevant to the decision making process.

_____ 6.		f. Costs that will not continue if an ongoing operation is changed or deleted.

_____ 7.		g. An already owned production site that is not currently in use.

_____ 8.		h. The maximum available benefit foregone by using a resource for a particular purpose.

_____ 9.		i. The predicted future costs and revenues that will differ among alternative courses of action.

_____ 10.		J. The time it will take to recoup, in the form of cash inflows from operations, the initial dollars invested in a project

_____ 11.		k. Those costs of facilities and services that are shared by users

_____ 12.		l. The juncture of manufacturing where separate products developed in the same process become individually identifiable.

_____ 13.		m. A costing approach that considers all indirect manufacturing costs (both variable and fixed) to be product (inventoriable) costs.

_____ 14.		n. Purchasing products or services from a supplier outside the company.

_____ 15.		o. Capital budgeting models that focus on cash inflows and ouflows while taking into account the time value of money

_____ 16.		p. Calculation of a selling price sufficient to cover the cost of producing a product as well as desired operating income

_____ 17		q. The long-term planning for investment commitments with returns spread over multiple years

_____ 18.		r. A decision process that compares the differential revenues and costs of alternatives.

_____ 19.		s. Costs that will continue even if a company discontinues one of its current operations

_____ 20.		t. The increase in expected average annual operating income divided by the original required investment

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ADMS 2510 Lecture Notes - Lecture 2: Sunk Costs, Fixed Cost, Cost Driver

ADMS 2510 Full Course Notes

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