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Chapter 9

COMM-2016EL Chapter Notes - Chapter 9: Historical Cost, Sunk Costs, Variable Cost

Commerce and Administration
Course Code
Kayla Levesque

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Chapter 9 Relevat Iforatio & Decisio
Makig: Productio Decisios
Opportunity, Outlay, and Differential Costs
Opportunity Cost the maximum available contribution to profit foregone (rejected) by using limited
resources for a particular purpose
Outlay Cost a cost that requires a cash disbursement
Differential/Incremental Cost (Savings) - the difference in total cost between 2 alternatives
Make or Buy Decisions
Sometimes qualitative factors dominate quantitative assessments of costs
Some manufacturers always make parts because they want to control quality or because they possess special
know-how (skilled labour or rare materials needed in production)
Alternatively, some companies always purchase parts to protect long-run relationships with their suppliers.
These companies may deliberately avoid the practice of making their parts during slack times to avoid
difficulties in obtaining needed parts during boom times
In these cases, there may be shortages of material and workers but no shortage of sales orders!
What factors are relevant to the decision of whether to make or buy? This depends on the situation, but a key
factor is whether there are idle facilities. Many companies make parts only when their facilities cannot be used
to better advantage
Assume the following costs reported by GE for Part No. 900
Another manufacturer offers GE the same part (No. 900) for $10. Should GE buy the part? The essential
question is the difference in expected future costs between the alternatives
If the $4 fixed OH per unit consists of costs that will continue regardless of the decision, the entire $4
becomes irrelevant (ex. depreciation, taxes, insurance, etc.)
If some of the fixed costs would be eliminated if the parts are bought instead of made, they are relevant
Let’s assume that the capacity will become idle and
$20,000 is the only fixed cost that would be saved:
The key to make-or-buy decisions is identifying the
additional costs for making (or the costs avoided by
buying) a part of subcomponent
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