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Chapter 13

ACC 406 Chapter 13: Chapter 13

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ACC 406
Kevin Palmer

Chapter 13 – Short-Run Decision Making: Relevant Costing SHORT-RUN DECISION MAKING The Decision Making Model  A decision model, a specific set of procedures that produces a decision, can be used to structure the decision maker’s thinking and organize the info to make a good decision.  The following is an outline of one-decision making model: Step 1: Define the Problem  Recognize and define a specific problem. Step 2: Identify the Alternatives  List and consider possible solutions. Step 3: Identify the Costs and Benefits Associated with Each Feasible Alternative  The costs and benefits associated with each feasible alternative are identified.  At this point, clearly irrelevant costs can be eliminated from consideration. Step 4: Estimate the Relevant Costs and Benefits for Each Feasible Alternative  The differential cost is the difference between the summed costs of two alternatives in a decision.  It compares the sum of each alternative’s relevant costs only. Step 5: Assess the Qualitative Factors  While the costs and revenues associated with the alternatives are important, they don’t tell the whole story.  Qualitative factors can significantly affect the manager’s decision.  Political factors, product safety, quality, reliability of supply… Step 6: Make the Decision  Once all relevant costs and benefits for each alternative have been assessed and the qualitative factors weighed, a decision can be made. RELEVANT COST DEFINED  Relevant costs possess two characteristics: they are future costs and they differ across alternatives.  If a future cost is the same for more than one alternative, it has no effect in the decision, which makes it irrelevant.  If future benefits differ across alternatives, then they are relevant and should be included in the analysis. Relevant Cost Illustrated  Opportunity cost is the benefit sacrificed or forgone when one alternative is chosen over another, which makes it a relevant cost.  While it’s never an accounting cost, because accountants don’t record the cost of what might happen in the future, it’s an important consideration in decision making.  For example, if you are deciding if or not to go to school full-time or work full-time, the opportunity cost of going to school would be the wages you sacrifice by not working. Irrelevant Past Cost Illustrated  Depreciation represents an allocation of a cost already incurred.  It’s a sunk cost, a cost that cannot be affected by any future action. They’re always the same across alternatives, therefore making them irrelevant. Irrelevant Future Cost Illustrated  Example – Company currently pays an Internet provide $5k/year to store its website on the service. Since it intends to keep the Web page no matter what, that cost is not relevant to the decision. COST BEHAVIOUR AND RELEVANT COSTS  It’s easy to fall into the trap of believing that variable costs are relevant and fixed costs aren’t, but that assumption is untrue. SOME COMMON RELEVANT COST APPLICATION  The following applications include decisions:  To outsource services or production (make or buy)  To accept a special order at less than the usual price  To keep or drop a segment or product
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