CHAPTER 18: RELEVANT COSTS FOR NON- DECISION MAKING UNDER RELEVANT COSTING

ROUTINE DECISION MAKING

1. Determine all cost associated with each
Decision making process, concept alternative considered
2. Drop the costs that are sunk or
It is the process of studying and evaluating two
historical
or more available alternatives leading to a final
3. Drop cost that do not differ
choice
4. Make a decision based on the
 Managers must constantly make a remaining costs.
decision ( and how each decision affects Sunk Opportuni Out of the
income) Costs ty costs pocket
 Managers must select an action that costs
MAXIMIZES expected operating income Past cost- Lost Intermedia
over the period by the decision. ( they unavoidab profit/ te or near
le economic future cash
do this by analyzing RELEVANT
benefit outlay. (
INFORMATION)
given up usually
 Relevant Information – when an variable
expected future data that differ alternativ costs)
among alternative courses of e is
action rejected
 Relevant costs- a cost that is
applicable to a particular
APPROACHES IN ANALYZING ALTERNATIVES IN
decision in the sense that it will
NON ROUTINE DECISION MAKING
have bearing on different
alternatives 2 approaches used:
Steps in Decision-making: Inremental or Total project analysis
Differential Analysis or comparative
1. Define strategies; business
or relevant cost statement analysis
goals and tactic to achieve
analysis
them Compares Shows ALL the items
2. Identify alternative choices differential revenues, of REVENUE and
3. Collect and analyze the costs and CM. ( COSTS ( whether
relevant data on the shows only the they are relevant or
choices relevant amount) not)
4. Choose the best alternative. Steps:
1. Gather all
Note: Decision making involves the costs
consideration of QUALITATIVE associated
issues. with each
alternative
2. Drop the
IDENTYFYING RELEVANT COSTS non-
differential
Relevant costs is ANY cost that is costs
AVIODABLE. 3. Select the
best
 Avoidable cost- a cost that
alternative
can be eliminated as a
result of choosing one
alternative OVER the other. SHORT RUN VS LONG RUN: OTHER FACTORS TO
CONSIDER
UNAVOIDABLE COST
For long run:
 Sunk costs
 Future costs that do  Impact on customer
not differ between  Information and reaction of
alternatives. customers
 Reaction of competitors
Relevant costs- expected future costs which
differ between decision alternatives. ( cost that TYPES OF DECISION
will be increase/ decrease because of a
A. Make or buy
decision)
 B. Add or drop a product or other segment SPECIAL SALES PRICING OR ORDER
C. Sell now or process further
Special order – a one time order that is not
D. Special sales pricing
considered part of the company’s ongoing
E. Utilization of scarce resources
business.
F. Shut down or continue operation
G. Pricing ACCEPT REJECT
 One time  No idle
MAKE OR BUY DECISION
order capacity
Management decision about whether an item  Consider idle  Will not
should be made INTERNALY or BOUGHT capacity cover
OUTSIDE.  Will not incremental
affect regular costs
sales
MAKE BUY
Cost of Cost of purchasing SHUT DOWN OR CONTINUE OPERATION
manufacturing the
part of internally  Recognize or consider that not all non-
variable cost will be eliminated by
temporary closing of the plant
ADD OR DROP A SEGMENT ( and so, shutdown cost must be made)
ADD DROP
If it produces more If operating income is SHUT DOWN CONTINUE
favorable income better without the Avoidable cost Losses on shut
segment exceeds revenue down would be
greater

SELL NOW OR PROCESS LATER Formula:

𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 𝑖𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛
SELL NOW PROCESS LATER
If there is no Incremental revenue 𝑆ℎ𝑢𝑡 𝑑𝑜𝑤𝑛 𝑝𝑜𝑖𝑛𝑡: 𝑎𝑟𝑒 𝑐𝑜𝑛𝑡𝑖𝑛𝑢𝑒𝑑 − 𝑆ℎ𝑢𝑡 𝑑𝑜𝑤𝑛 𝑐𝑜𝑠𝑡
𝐶𝑀/𝑢𝑛𝑖𝑡
incremental income exceeds the
from processing incremental cost

Joint Products – products are produced from a Note: If less than the breakeven point –
single or common raw material input ( irrelevant shutdown. Loss would be grater if continues.
– because they are sunk costs)

Split off point- point in the manufacturing

process at which joint product can be recognized
as separate products. UTILIZATION OF SCARCE RESOURCES:

 Happens when the firm have a

Incremental ( sales value @ X constraint ( scarce resource)
split off- sales
revenue from value after further  Manager must select the action
further processing) that will maximize its total
processing contribution margin
Incremental (x)
costs from Takes into consideration: CM/ Unit of
further scarce resource.
processing

Profit (loss xx
from further
processing)
PRICING PRODUCT AND SERVICES

Ways to cost a product:

TOTAL ABSORPTION CONTRIBUTION

COSTS APPROACH APPROACH
Cost based is Cost base
define as the consists of all
cost to variable costs
manufacture including SGA.
one unit and
excludes all
selling and
general
expense

TOTAL ABSORPTION CONTRIBUTION/

COST VARIABLE
Mark up:
𝐴𝑠𝑠𝑒𝑡𝑠 𝑥 𝑅𝑅 𝑅𝑒𝑡𝑢𝑟𝑛 + 𝑆𝐺𝐴𝐸 𝑅𝑒𝑡𝑢𝑟𝑛 + 𝐹𝐶
𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡𝑠 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑠
Selling Price
𝑇𝐶 𝑀𝐹𝐺 𝐶𝑜𝑠𝑡 𝑉𝐶
( )( 1 ( ) ( 1 + 𝑀𝑈) ( ) ( 1 + 𝑀𝑈)
𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑆 𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑆 𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑆
+ 𝑀𝑈)