Cornerstones of Managerial

Accounting 2e

Chapter Twelve
Short-Run Decision Making: Relevant
Costing and Inventory Management
Mowen/Hansen

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 Short-Run Decisions

• Small-scale actions that serve a larger purpose

• Decisions are made using a decision model
◦ Used to structure the thinking process
◦ Organizes information
• Consists of choosing among alternatives with an
immediate or limited end in view

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 Decision-Making Model
1. Define the problem
2. Identify the alternatives
3. Identify the costs and benefits associated
with each feasible alternative
4. Total the relevant costs and benefits for
each alternative
• Relevant costs are future costs that differ
across alternatives
5. Assess the qualitative factors
6. Select alternative with the greatest benefit

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 Relevant Costs

• Can consist of both variable and fixed costs

◦ Additional fixed costs associated with an
alternative are relevant
• Changes in supply and demand for resources
must be considered
◦ Costs which fluctuate with changes in supply and
demand across alternatives are relevant costs
• Also known as differential or incremental
costs
• Practical interpretation
◦ All costs that are different
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 Make-or-Buy Decisions

• Decisions involving a choice between

internal and external production
• Decision process
◦ Identify feasible alternatives
◦ Identify which costs are relevant
∙ Fixed overhead costs are most likely
irrelevant since they will not differ
◦ Compare the total relevant costs of
manufacturing with the cost of buying
◦ Make a choice
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 Special Order Decisions

• Focus on whether a specially priced order

should be accepted or rejected
• Orders can be attractive
◦ Especially when firm is operating below
maximum productive capacity

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 Keep-or-Drop Decisions

• Decision to keep or drop a segment such as

a product line
• Variable costing segment financial reports
provide information
◦ Contribution margin
◦ Segment margin
• Relevant costing provides structure to
decision making

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Further Processing of Joint Products

• Joint products
• Include both common processes and costs up
to split-off point
• Split-off point
◦ The point at which separate products become
distinguishable
• Common costs are not relevant to the
decision making

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 Product Mix Decisions
• Organizations have wide flexibility in
choosing their product mix
◦ Mix has significant impact on profitability
• Maximizing total profit is the goal
◦ Fixed cost will not change with mix, therefore
not relevant
• Focus should be on maximizing total
contribution margin
• Limitations on resources are called
“constraints”

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 Cost-Based Pricing

• Most companies start with cost to determine

price
• Formula:
◦ Price = Product cost + Markup
◦ Markup is percentage of base cost
∙ Includes:
▫ Costs not in base cost
▫ Desired profit
• Advantage – Ease of use

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 Target Costing and Pricing

• Determining price based on what

customers are willing to pay
• Company then must design and
develop product
◦ Cost must be low enough to allow for
desired profit

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 Ordering Costs

• Costs of placing and receiving an

order
• Examples:
◦ Order processing costs
◦ Cost of insurance for shipment
◦ Unloading costs

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 Carrying Costs

• Costs of carrying inventory

• Examples:
◦ Insurance
◦ Inventory taxes
◦ Obsolescence
◦ Opportunity cost of funds ties up in
inventory, handling costs, and
storage space

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 Stockout Costs
• Occur when demand is not known
• Costs of not having:
◦ Product available when demanded by a
customer
◦ Raw material available when needed for
production
• Examples:
◦ Lost sales
◦ Costs of expediting
◦ Costs of interrupted production

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Economic Order Quantity (EOQ):
The Traditional Inventory Model
• Number of units in the optimal size order
• Minimizes total inventory-related costs
• Formula:

2 x CO x D/CC

Cost of placing one order

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Economic Order Quantity (EOQ):
The Traditional Inventory Model
• Number of units in the optimal size order
• Minimizes total inventory-related costs
• Formula:

2 x CO x D/CC

Annual demand in units

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Economic Order Quantity (EOQ):
The Traditional Inventory Model
• Number of units in the optimal size order
• Minimizes total inventory-related costs
• Formula:

2 x CO x D/CC

Cost of carrying one unit in

inventory

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 Just in Time (JIT)

• Goods pushed through the system by

present demand rather than being pushed
through on a fixed schedule based on
anticipated demand
• Each operation produces only what is
necessary to satisfy the demand of the
succeeding operation
• Reduces all inventories to very low levels
• Reduces inventory carrying costs

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