11 -1©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Decision Making andRelevant InformationChapter 1111 -2©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 1Use the five-step decisionprocess to make decisions.11 -3©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Information and theDecision ProcessA decision model is a formal methodfor making a choice, often involvingquantitative and qualitative analysis.11 -4©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Five-Step Decision ProcessGather InformationMake PredictionsChoose an AlternativeImplement the DecisionEvaluate PerformanceStep 1.Step 2.Step 3.Step 4.Step 5.Historical CostsOther InformationSpecific PredictionsFeedback11 -5©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 2Differentiate relevantfrom irrelevantcosts and revenues indecision situations.11 -6©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster The Meaning of RelevanceRelevant costs and relevant revenues areexpected future costs and revenues thatdiffer among alternative courses of action.Historical costsSunk costsDifferential incomeDifferential costs11 -7©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 3Distinguish between quantitativeand qualitative factors in decisions.11 -8©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Quantitative and QualitativeRelevant InformationQuantitative factorsFinancialNonfinancialQualitative factors11 -9©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster One-Time-OnlySpecial Order ExampleThe Bismark Co. manufacturing plant has aproduction capacity of 44,000 towels each month.Current monthly production is 30,000 towels.Costs can be classified as either variable or fixedwith respect to units of output.11 -10©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster One-Time-OnlySpecial Order ExampleVariable FixedCostsCostsPer UnitPer UnitDirect materials$6.50$ -0-Direct labor.501.50Manufacturing costs1.503.50Total$8.50$5.0011 -11©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster One-Time-OnlySpecial Order ExampleTotal fixed direct manufacturing labor is $45,000.Total fixed overhead is $105,000.Marketing costs per unit are $7($5 of which is variable).What is the full cost per towel?11 -12©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster One-Time-OnlySpecial Order ExampleA hotel in San Juan has offered to buy5,000 towels from Bismark Co. at$11.50/towel for a total of $57,500.No marketing costs will be incurred.Variable ($8.50 + $5.00):$13.50Fixed:7.00Total$20.5011 -13©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster One-Time-OnlySpecial Order Example$8.50 ×5,000 = $42,500 incremental costsWhat are the incremental revenues ?What are the relevant costs of making the towels ?$57,500 –$42,500 = $15,00011 -14©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 4Beware of two potentialproblems inrelevant-cost analysis.11 -15©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Two Potential Problems inRelevant-Cost AnalysisIncorrect generalassumptions:All variable costsare relevant.All fixed costsare irrelevant.12Misleadingunit-cost data:Includeirrelevant costs.Use same unitcosts at differentoutput levels.11 -16©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Outsourcing versus InsourcingOutsourcing ispurchasing goodsand services fromoutside vendors. Insourcing isproducing goodsor providing serviceswithin the organization.11 -17©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleBismark Co. also manufactures bath accessories.Management is considering producing a part itneeds (#2) or buying a part producedby Towson Co. for $0.55.11 -18©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleBismark Co. has the following costsfor 150,000 units of Part #2:Direct materials$ 28,000Direct labor18,500Mixed overhead29,000Variable overhead15,000Fixed overhead30,000Total$120,50011 -19©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleMixed overhead consists of materialhandling and setup costs.Bismark Co. produces the 150,000 unitsin 100 batches of 1,500 units each.Total material handling and setup costsequal fixed costs of $9,000 plus variablecosts of $200 per batch.11 -20©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleWhat is the cost per unit for Part #2?$120,500 ÷150,000 units = $0.8033/unitShould Bismark Co. manufacture the partor buy it from Towson Co.?11 -21©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleBismark Co. anticipates that next year the150,000 units of Part #2 expected to besold will be manufactured in 150batches of 1,000 units each.11 -22©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleVariable costs per batch are expected todecrease to $100. Bismark Co. plans to continue to produce150,000 next year at the same variablemanufacturing costs per unit as this year.Fixed costs are expected to remain thesame as this year.11 -23©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleWhat is the variable manufacturing cost per unit?$61,500 ÷150,000 = $0.41 per unitDirect material$28,000Direct labor18,500Variable overhead15,000Total$61,50011 -24©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleExpected relevant cost to make Part #2:Cost to buy: (150,000 ×$0.55) $82,500Manufacturing$61,500Material handling and setups15,000*Total relevant cost to make$76,500*150 ×$100 = $15,000Bismark Co. will save $6,000 by making the part.11 -25©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleNow assume that the $9,000 in fixed clericalsalaries to support material handling andsetup will not be incurred if Part #2 ispurchased from Towson Co..Should Bismark Co. buy the part or make the part?11 -26©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Make-or-Buy Decisions ExampleRelevant cost to make:Variable$76,500Fixed9,000Total$85,500Cost to buy:$82,500Bismark would save $3,000 by buying the part.11 -27©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 5Explain the opportunity-costconcept and why it isused in decision making.11 -28©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsAssume that if Bismark buys the part fromTowson, it can use the facilities previouslyused to manufacture Part #2 to producePart #3 for Krysta Company.The expected additional future operatingincome is $18,000.What should Bismark Co. do?11 -29©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsBismark Co. has three options regarding Krysta:1. Make Part #2 and do not make Part #3.2. Buy Part #2 and do not make Part #3.3. Buy the part and use the facilities to producePart #3.11 -30©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsExpected cost of obtaining 150,000 parts:Buy Part #2 and do not make Part #3:$82,500Buy Part #2 and make Part #3:$82,500 –$18,000 =$64,500Make Part #2:$76,50011 -31©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsOpportunity cost is the contribution to incomethat is forgone (rejected) by not using alimited resource in its next-best alternative use.11 -32©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsAssume that annual estimated Part #2requirements for next year is 150,000.Cost per purchase order is $40.Cost per unit when each purchase is1,500 units = $0.55. Cost per unit when each purchase is equalto or greater than 150,000 = $0.54.11 -33©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsAverage investment in inventory is either:(1,500 ×.55) ÷2 = $412.50 or(150,000 ×$0.54) = $40,500Annual interest rate for investment ingovernment bonds is 6%.$412.50 ×.06 = $24.75$40,500 ×.06 = $2,43011 -34©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsOption A: Make 100 purchases of 1,500 units:Purchase order costs: (100 ×$40)$ 4,000.00Purchase costs: (150,000 ×$0.55)$82,500.00Annual interest income:$ 24.75Relevant costs:$86,524.7511 -35©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Opportunity Costs,Outsourcing, and ConstraintsOption B: Make 1 purchase of 150,000 units:Purchase order costs: (1 ×$40)$ 40Purchase costs: (150,000 ×$0.54)$81,000Annual interest income:$ 2,430Relevant costs:$83,47011 -36©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 6Know how to choose whichproducts to produce when thereare capacity constraints.11 -37©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Product-Mix DecisionsUnder Capacity ConstraintsPer unit Product #2Product #3Sales price$2.11$14.50Variable expenses0.4113.90Contribution margin$1.70$ 0.60Contribution margin ratio 81% 4%Bismark Co. has 3,000 machine-hours available.11 -38©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Product-Mix DecisionsUnder Capacity ConstraintsOne unit of Prod. #2 requires 7 machine-hours.One unit of Prod. #3 requires 2 machine-hours.What is the contribution of each productper machine-hour?Product #2: $1.70 ÷7 = $0.24Product #3: $0.60 ÷2 = $0.3011 -39©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 7Discuss what managersmust consider whenadding or discontinuingcustomers and segments.11 -40©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-BasedCosting, and Relevant CostsMountain View Furniture supplies furnitureto two local retailers –Stevens and Cohen.The company has a monthly capacityof 3,000 machine-hours.Fixed costs are allocated on the basis of revenues.11 -41©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-Based Costing, and Relevant CostsStevensCohenRevenues$200,000$100,000Variable costs70,00060,000Fixed costs100,00050,000Total operating costs$170,000$110,000Operating income$ 30,000$(10,000)Machine-hours required 2,0001,00011 -42©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-Based Costing, and Relevant CostsTotalRevenues$300,000Variable costs130,000Fixed costs150,000Total operating costs$280,000Operating income$ 20,000Machine-hours required3,00011 -43©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-Based Costing, and Relevant CostsShould Mountain View Furniture drop the Cohenbusiness, assuming that dropping Cohen woulddecrease its total fixed costs by 10%?New fixed costs would be:$150,000 –$15,000 = $135,00011 -44©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-Based Costing, and Relevant CostsStevens AloneRevenues$200,000Variable costs70,000Fixed costs135,000Total operating costs$205,000Operating income$ (5,000)Machine-hours required3,00011 -45©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-Based Costing, and Relevant CostsCohen’s business is providing acontribution margin of $40,000.$40,000 decrease in contribution margin–$15,000 decrease in fixed costs= $25,000 decrease in operating income.11 -46©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Profitability, Activity-Based Costing, and Relevant CostsAssume that if Mountain View Furniture dropsCohen’s business it can lease the excess capacityto the Perez Corporation for $70,000.Fixed costs would not decrease.Should Mountain View Furniture lease to Perez?11 -47©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 8Explain why the book valueof equipment is irrelevant inequipment-replacement decisions.11 -48©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Equipment-Replacement Decisions ExampleExisting ReplacementMachineMachineOriginal cost$80,000$105,000Useful life4 years 4 yearsAccumulated depreciation$50,000Book value$30,000Disposal price$14,000Annual costs$46,000$ 10,00011 -49©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Equipment-Replacement Decisions ExampleIgnoring the time value of money andincome taxes, should the companyreplace the existing machine?The cost savings over a 4-year period will be$36,000 ×4 = $144,000.Investment = $105,000 –$14,000 = $91,000$144,000 –$91,000 = $53,000advantage of the replacement machine.11 -50©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Learning Objective 9Explain how conflicts can arisebetween the decision modelused by a manager and theperformance evaluation modelused to evaluate the manager.11 -51©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Decisions andPerformance EvaluationWhat is the journal entry to sell the existing machine?Cash14,000Accumulated Depreciation50,000Loss on Disposal16,000Machine80,00011 -52©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Decisions andPerformance EvaluationIn the real world would the managerreplace the machine?An important factor in replacement decisionsis the manager’s perceptions of whether thedecision model is consistent with how themanager’s performance is judged.11 -53©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster Decisions andPerformance EvaluationTop management faces a challenge –that is,making sure that the performance-evaluationmodel of subordinate managers is consistentwith the decision model.11 -54©2003 Prentice Hall Business Publishing, Cost Accounting11/e,Horngren/Datar/Foster End of Chapter 11