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ACCT 2301 (30)
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Managerial Accounting CH 6.docx

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Northeastern University
ACCT 2301
Ed Dinan

Anna Wang Managerial Accounting 6 Chapter 6 Relevant Information for Special Decisions Relevant Information - Relevant Information - differs among alternatives - is future oriented - cannot avoid a cost that has already been incurred Ex – Consider selling your car - Car is due for safety inspection, which must be completed before the car can be sold/driven - Inspection fee must be paid regardless of whether you sell the car  does not change among alternatives  not relevant in decision making - Car is due for oil change, which can be delayed until after it is sold - can avoid cost if decide to sell car and must pay for the fee if decide to keep the car  Does change among alternatives  relevant info - Future oriented means that the historic cost of car ($25,000) is not relevant. Current market price ($19,000) is relevant b/c it helps determine opportunity cost Sunk Costs - aka historic cost - Incurred in past transaction – cannot be changed and is not relevant - may be useful in predicting future Opportunity Costs - Sacrifice incurred in order to obtain an alternative opportunity - Opportunity cost of keeping the car is $19,000 - Opportunity cost of getting $19,000 is owning the car - It is the highest value of all the alternatives Relevance is an Independent Concept - Independent of cost behavior - may be fixed or variable Relevance is Context Sensitive - Salary of store manager is not relevant in deciding whether to eliminate a department at a store, but it is relevant in deciding whether to close down the whole store Relationship Between Relevance andAccuracy - Info doesn’t need to be exact in order to be relevant Ex – delay buying a computer because you know prices will fall, even if you don’t know exactly how much it will fall Quantitative vs. Qualitative Characteristics of Decision Making Computer Acosts $300 more than Computer B. Both satisfies technical requirements. Computer Alooks nicer. 1 Anna Wang Managerial Accounting 6 - Qualitative standpoint – pick computer B b/c you can avoid $300 - Qualitative standpoint – if the computer will be used in circumstances in which it needs to impress clients, pick ComputerA Differential Revenue andAvoidable Costs - Differential Revenue – revenues that are relevant to decision making b/c they differ among alternative courses of actions Ex- store sells men, women, and children clothing and is considering eliminating children dept. Revenue generated by children dept is differential/relevant b/c the store’s total revenue would be different if that dept were to be eliminated. - Avoidable Costs –relevant costs that mangers can eliminate by making specific choices Relationship of CostAvoidance to Cost Hierarchy Unit Level Costs - Relevant – can be avoided by eliminating the production of a single unit of product Batch-Level Costs - eliminating an entire batch avoids both batch-level and unit-level costs - decreasing # units in a batch avoids unit-level costs, but not batch-level costs Product-Level Costs - can be avoided by discontinuing a product line Facility-Level Costs - Segment-level facility costs can be avoided by eliminating a segment - Corporate-level facility costs cannot be avoided unless the entire corporation is eliminated Relevant Information and Special Decisions 5 types of special decisions - Special order - Outsourcing - Segment elimination - Asset replacement - Scarce resource allocation Ex – Premier expects to make and sell 2,000 printers in 10 batches of 200units/batch.Adding its markup to cost, it set the price at $360/printer. Cost/printer is $329.25 Special Order Decision Decide whether to accept a customer’s offer to buy goods at a price significantly below normal selling price. 2 Anna Wang Managerial Accounting 6 Ex – Premier receives a special order from a new customer for 200 printers. If it accepts, expected sales would go up to 2,200 printers, but the customer is only willing to pay $250/printer QuantitativeAnalysis Step 1 – Determine amt of relevant/differential revenue Premier will earn by accepting Accept  $50,000 (200 x $250) Reject  $0 Step 2 – Determine amt of relevant cost Premier will incur by accepting - will incur additional unit-level and batch-level costs Step 3 –Accept offer if relevant revenue > relevant costs Opportunity Costs Premier can consider the special offer because it has excess productive capacity. Suppose that it can lease its excess capacity for $15,000. Opportunity cost of accepting the offer is $15,000. This must be added to the other relevant costs. Accept offer if relevant revenue > total relevant costs Relevance and the Decision Context Since selling 200 printer at $250 each contributes $11,800 to profitability, can Premier reduce normal selling price to $250? No b/c it must be able to cover non-relevant costs (product-level and facility-level). Qualitative Characteristics If Premier’s regular customers learns that it is selling printers at a lower price to someone else, they will demand reduced price in future purchases At full capacity, should reject any special offers at reduced prices b/c filling those orders reduces ability to satisfy customers who are willing to pay full price Outsourcing Decisions Deciding whether to buy goods/services from other companies rather than producing them internally Ex – Premier is considering whether to outsource production of printers.Asupplier offered to sell Premier unlimited supply of printers at $240 each. Cost of making of making a printer is $329.25, so Premier should do it right? Not so fast QuantitativeAnalysis Step 1 – Determine the production costs Premier can avoid (avoidable/relevant costs) if it outsources production - can avoid unit-level, batch-level, and product level costs, but not facility level costs Step 2 – Compare the relevant production costs with the cost of buying 3 Anna Wang Managerial Accounting 6 Accept if Relevant Production Cost > Purchase Price Opportunity Cost Suppose that the space used to manufacture printers can be leased for $40,000. Opportunity cost of making printers internally is $40,000. This must be added to the relevant production cost in order to make the decision Evaluating the Effects of Growth on the Level of Production Decision to outsource would change if expected production increased from 2000 printers to 3000 printers. Some relevant costs ar
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