Chapter 12 notes

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Management and Organizational Studies
Management and Organizational Studies 3370A/B
Raymond Leduc

Chapter 12Relevant Costs for Decision MakingRelevant coststhose that differ among alternatives under consideration aka avoidable cost and differential costAvoidable costa cost that can be eliminated in whole or in part by choosing one alternative over another Two broad categories of costs that are never relevant in decisions o Sunk costsany cost that has already been incurred and that cannot be changed by any decision made now or in the future o Future costs that do not differ between alternatives future costs that DO differ between alternatives are relevantDifferential costany cost that differs between alternatives aka avoidable or relevant costSteps to identify costsbenefits that are relevant in a particular decision 1 Eliminate costsbenefits that do not differ between alternatives which consist of sunk costs and future costs that do not differ 2 Use remaining differentialavoidable costsbenefits to make the decisionThe concept of different costs for different purposes is fundamental to managerial accountingIsolating only relevant costs is important because o Rarely will enough info be available to prepare a detailed income statement for both alternatives o Combining irrelevant with relevant costs may distract attention from matters that are really critical irrelevant data may be used improperly resulting in an incorrect decisionA decision to drop an old segment of a company or add a new one is dependent upon the impact the decision will have on operating income o If the company can avoid more in fixed costs than it loses in contribution margin by dropping a segment then it will be better off if the line is eliminatedoverall income should improve o Even if a line shows an operating loss it doesnt mean that it should be dropped Unless another product can be found that will generate a greater segment margin than the current one the company would be better off keeping the line than dropping it Also managers may choose to retain an unprofitable line if it is necessary to the sale of other products or if it serves as a magnet to attract customersOne of the dangers in allocating common fixed costs is hat such allocations can make a product line look less profitable than it really isVertical integrationthe involvement by a company in more than one of the steps from production of basic raw materials to the manufacture and distribution of a finished product o Make or buy decisiona
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