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Chapter 4

Chapter 4


Department
Accounting
Course Code
ACC 410
Professor
Maurizio Di Maio
Chapter
4

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Chapter 4: Relevant Costs for
Non-Routine Operating Decisions
Non-routine Operating Decisions
Routine operating decisions are made on a regular schedule
For example, budgeting is often done once a year, product prices are reviewed and set
regularly, and ongoing purchases of raw materials and other resources are commonly
made
These types of decisions arise because we want to improve processes or because
resource shortages occur or a customer wants special treatment
The following decisions are non-routine yet occur frequently in many organizations:
oCommit resources or making additional investment for a special order
oInternal resources or to outsource some activities
oDiscontinue a product line or business subunit or segment
oManage limited resources
Identify the Type of Decision Managers Must Make
We address problems more correctly and efficiently when we clarify the type of
problem before jumping into an analysis
For example, if you need to make a decision about whether to buy a new car or keep
the one you own, some costs are not relevant to the decision, such as parking fees at
the university
Identify and Apply Relevant Quantitative Analysis Techniques
Quantitative information: is numerical information that is available for
addressing a problem
To be relevant, cash flows must 1) arise in the future and 2) vary with the action
taken
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We ignore irrelevant (unavoidable) cash flows
Sunk costs (i.e. costs that were uncured in the past) are always irrelevant to
decisions involving cash flows that arise in the future
If some of the quantitative information for an analysis technique is unknown, we can
use a second technique to estimate it
For example, we often use regression analysis to estimate the fixed and variable
portions of a mixed cost
Identify and Analyze Qualitative Factors
Rarely in the business world do decision rely solely on the results of quantitative
analysis
Qualitative information: factors that are not valued in numerical terms is vital
to good decision-making
Incorporated into our analysis using judgement
In some circumstances, it might possible to calculate numerical differences, such as
pay rates or local employment levels
Consider Quantitative and Qualitative Information to Make a
Decision
Sometimes qualitative factors are more important than quantitative analysis
Sometimes we consider qualitative factors before performing quantitative analysis
For example, concerns about the reliability of a suppliers parts might lead managers
to eliminate that vendor from consideration without any analysis. The managers
would then explore alternatives such as purchasing from other vendors or
manufacturing the parts in-house
Applications of Non-routine Operating Decisions
Examples of several types of non-routine operating decisions:
oSpecial orders
oKeep or drop decisions
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oInsource or outsource (make or buy) decisions
oConstrained resources
oProduct emphasis involving multiple resource constraints and multiple
products
Special Orders
Managers need to determine whether to accept a customers special order, one that is
not part of the organizations normal operations
This type of decision has no long-term strategic impact because it involves a one-time
sale of a specified quantity of goods or services
1)General Rule for Special Order Decisions
The general rule for special orders is that we want to be as well off after accepting
the order as we were before we accepted it
To make this decision, we need to know whether the order replaces regular business
if it does, the price should be at or above the usual price because the opportunity cost
of accepting this order is the loss of the usual contribution margin
However, if idle capacity is available, the special order is acceptable if the
organization at least breaks even
Some fixed costs, such as the lease cost for a piece of equipment needed for a special
order, are relevant because they are unique to the special order
Example: Filipino bars hosting a party, reserving entire bar/restaurant during regular
business hours
EXHIBIT 4.3 Summary of Information Used and Decision Rule for Special Order
Relevant Costs and
BenefitsIrrelevant CostsDecision Rule
Incremental revenues
from the order
Incremental costs
(including variable
and fixed costs) of
filling the order
Opportunity cost of
filling the order
Allocated common
costs
Sunk costs
Accept if:
Incremental revenues > total
relevant costs
Reject if:
Incremental revenues < total
relevant costs
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