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Chapter 8

COMM-2016EL Chapter Notes - Chapter 8: Profit Margin, Variable Cost, Target Costing


Department
Commerce and Administration
Course Code
COMM-2016EL
Professor
Kayla Levesque
Chapter
8

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Chapter 8 Relevat Iforatio & Decisio
Makig: Marketig Decisios
The Meaning of Relevance: The Major Conceptual Lesson
What information is relevant depends on the decision being madeThe decision is based on the difference in
the effect of each alternative on future performance
Relevant Informationpredicted future costs & revenues that will differ among alternative courses of action
Historical (past) data have no direct bearing on a decision. Such data can have an indirect bearing on a decision,
because they may help in predicting the future, but past figures are irrelevant to the decision
Past figures, in themselves, are irrelevant to the decision. This is because the decision cannot affect past
data, they affect the future. Nothing can alter what has already happened!
Of the expected future data, only those that will differ from alternative to alternative are relevant to the
decision… Any item that will remain the same regardless of the alternative selected is irrelevant
ACCURACY AND RELEVANCE
In the best of all worlds, information used for decision making would be both relevant AND accurate. However,
in reality, the cost of such info often exceeds its benefit. Accountants often trade off relevance for accuracy
Relevant information must be reasonably accurate, but not precisely so
Precise but irrelevant information is worthless of decision making… On the other hand, imprecise but
relevant information can be useful
The degree to which information is relevant and/or precise often depends on the degree to which it is:
Qualitative qualitative aspects are those for which measurement in $ and cents is difficult & imprecise
o A qualitative aspect may easily carry more weight than a measurable quantitative impact in many
decisions (as relevance is more crucial than precision)
Quantitative quantitative aspects are those for which measurement is easier & more precise
o Accountants, statisticians, and mathematicians try to express as many decision factors as feasible
in quantitative terms since this approach reduces the number of qualitative factors to be judged
EXAMPLES OF RELEVANCE
EX #1. Yesterday, you noticed that one station was selling gas at $0.95 per litre, the other at $0.90 per litre.
Your car needs gasoline, and in making your choice you ASSUME that these prices have not been changed.
The relevant costs are $0.95 and $0.90, the expected future costs will differ between the alternatives
You use your past experience for predicting today’s price… The relevant costs are NOT what you paid
in the past, or what you observed yesterday, but what you EXPECT TO PAY when you get gas
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Regardless of their source, the data in Step 1 aid in the formulation of
predictions in Step 2
In Step 3, any predictions become inputs to the decision model
Decision Model any method for making a choice, sometimes requiring
elaborate quantitative procedures
In Step 4, the chosen action is implemented and the evaluation of
performance becomes a principal source of feedback. This can update
historical information and improve the prediction method, the decision
model, and the implementation of the decision
Above all, not the commonality of the relevant-information approach to the various
special decisions explored in this and the next chapter … Managers should focus on
predictions, not dwell on the past.
The Special Sales Order
The two types of income statement differ in format (contribution vs. variable). The difference in format may be
unimportant if the accompanying cost analysis leads to the same set of decisions, but they often lead to different
unit costs. For this reason, it is recommended that we convert absorption statements to contribution statements
The correct analysis employs the contribution approach and concentrates on the final OVERALL results…
Any costs that are not affected by the particular order can be safely ignored
A fixed-cost element of an identical amount that is common among all alternatives is basically irrelevant
Exhibit 8.3 represents a proper comparative predicted income statement for a potential order:
CONFUSION OF VARIABLE & FIXED COSTS
For product-costing purposes, the absorption-costing approach implies that fixed costs have a variable-cost
behaviour pattern… However, the addition or subtraction of units will not change the total fixed costs as long as
the total output is within the relevant range
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