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Chapter 4

ACCY 307 Chapter Notes - Chapter 4: Insourcing, Decision Rule, Contribution Margin

Course Code
ACCY 307
Tamara Phelan

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Chapter 4: Relevant Information for Decision Making
I. Relevant Information for Decision Making
II. Process for Identifying and Analyzing Relevant Information
a. Identifying and Envisioning the Problem and Alternatives
i. Type of decision
ii. Alternatives
iii. Relevant quantitative information
iv. Relevant qualitative information
b. Identifying Relevant Quantitative Information
i. Quantitative information= numerical information that is available for addressing a problem
1. To be relevant, cash flows must (1) arise in the future and (2) vary with the action taken
c. Identifying Relevant Qualitative Information
i. Qualitative information= factors that are not valued in numerical terms
d. Performing Quantitative and/or Qualitative Analyses
e. Prioritizing Issues to Arrive at a Decision
f. Operating Decision Examples
III. Product Line and Business Segment (Keep or Drop) Decisions
a. General Rule for Keep or Drop Decisions
i. The decision rule is to drop if: Contribution margin < Relevant fixed costs + Opportunity cost
b. Customer Profitability
i. A customer should be dropped if: Customer contribution margin < Relevant fixed costs +
Opportunity cost
c. Costs of Carrying Inventory
i. Costs to process purchase orders
ii. Avoidable costs invested in the inventory, such as direct materials, direct labor, variable
overhead, or fixed overhead
iii. Opportunity cost for alternative uses of cash, such as short-term investments or reductions in debt
iv. Costs to handle, warehouse, insure, and maintain inventory
v. Opportunity cost of forgone sales from inventory shortages (stock-outs)
vi. Costs for tracking inventory and determining appropriate inventory levels
vii. Inventory shrinkage or value decline from breakage, theft, deterioration, or obsolescence
d. Qualitative and Risk Factors for Keep or Drop Decisions
IV. Insource or Outsource (Make or Buy) Decisions
a. Outsourcing= the practice of finding outside vendors to supply products and services; has become
increasingly common
b. Insourcing= the practice of providing a good or service from internal resources
c. Make or buy decisions= what outsourcing decisions are often called
i. Should the company make the product or provide the service internally, or should the company
buy it from the outside?
ii. Potential cost savings as well as organizational strategies drive such decisions
d. General Rule for Make or Buy Decisions
i. The decision rule is to outsource (i.e., buy) if:
1. Cost to outsource < Cost to insource, or
2. Cost to outsource < Relevant variable costs + Relevant fixed costs + Opportunity cost
ii. To apply this decision rule, we first separate costs into fixed and variable.
1. The variable costs are usually relevant.
2. Existing fixed costs are relevant only if they can be avoided through outsourcing.
3. The costs for insourcing also include opportunity costs.
e. Quality and Outsourcing Decisions
i. To ensure high quality, organizations typically negotiate outsourcing contracts that stipulate
specific performance criteria, such as product specifications and timeliness.
f. Summary of Information Used and Decision Rule for Make Versus Buy Decision
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