Week 9 chapter notes

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University of Toronto Scarborough
Financial Accounting
Liang Chen

Chapter 4 Relevant Costs for Non-Routine Operating Decisions Notes Decision Process for Non-Routine Operating Decisions Identify and Apply Relevant Quantitative Analysis Techniques N quantitative information numerical information that is available for addressing a problem N to be relevant, cash flows must (1) arise in the future and (2) vary with the action taken N relevant cash flows by analyzing the decision alternatives and then selecting cash flows that are unique to each alternative N sunk costs (i.e., costs that were incurred in the past) are always irrelevant to decisions involving cash flows that arise in future Identify and Analyze Qualitative Factors N qualitative information factors that are not valued in numerical terms N qualitative factors that might be relevant to a non-routine operating decision include the following: o whether the organization can increase or decrease capacity easily and quickly o how important quality is for a product or service o whether timeliness of delivery is an important factor o how easily customers might share price information o other potential uses for excess capacity or resources o the effects of production practices on the environment o consistency of alternatives with the organizations vision and core competencies o how non-routine operating decisions affect supplier andor customer relationships o how non-routine operating decisions affect employee morale or resistance to change Special Orders General Rule for Special Order Decisions N the general rule for special orders is that we want to be well off after accepting the order as we were before we accepted it N to make this decision, accountants need to know whether the order replaces regular businessif it does, the price should be at or above the usual price because the opportunity cost of accepting this order is at the loss of the usual contribution margin Relevant Costs and Benefits Irrelevant Costs Decision Rules N incremental revenues from the order N allocated common costs N Accept if: N incremental costs (including variableN sunk costs incremental revenues > relevant costs and fixed cost) of filling the order N Reject if: incremental revenues < relevant costs N opportunity cost of filling the order Product Line and Business Segment (Keep or Drop) Decisions N when organizations provide multiple products (goods or services), they periodically review operating results for each product, group of products (product line), or business segment and decide whether to keep or drop the product or segment General Rule for Keep or Drop Decisions N the general rule is that we discontinue a product, service, or business segment when its total contribution margin does not cover avoidable fixed costs (i.e., fixed costs that are eliminated if the product is dropped) Relevant Costs and Benefits Irrelevant Costs Decision Rules N contribution margin lost if dropped N allocated common costs N Keep if: N fixed costs avoided if dropped N sunk costs CM loss > FC avoided + CM gain on N contribution margin loss or gain on other productssegments other productssegments N Drop if: CM loss < FC avoided + CM gain on other productssegments Insource or Outsource (Make or Buy) Decisions N outsourcing the practice of hiring outside vendors to supply products and services; also called make or buy decisions N insourcing the practice of providing goods or services from internal resources; the opposite of outsourcing General Rule for Make or Buy Decisions N the general rule for make or buy decisions is to choose the option with the lowest relevant cost N managers compare the outsourcing costs with the incremental costs for insourcing N existing fixed costs are relevant only if they can be avoided through outsourcing; costs for insourcing include opportunity costs Quality and Outsourcing Decisions N product or service quality is often a major factor in outsourcing decisions N to ensure high quality, organizations typically negotiate outsourcing contracts that stipulate specific performance criteria www.notesolution.com
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