Copyright © 2003 Pearson Education Canada Inc. Slide 11-118 Chapter 11 Decision Making and Relevant...

Copyright © 2003 Pearson Education Canada Inc. Slide 11-1

Chapter 11

Decision Making and Relevant Information


Information and the Decision Process

• A decision model is a formal method of making a choice, frequently involving quantitative analysis

5 Steps in the Decision Process

Pages 404 - 405

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db

ack

1. Gather information

5. Evaluate performance

2. Make predictions

3. Choose an alternative

4. Implement the decision


Relevant Costs and Revenues

• Relevant costs are expected future costs that differ across alternative courses of action

• Relevant revenues are expected future revenues that differ across alternative courses of action

• Every decision deals with the future

• Costs incurred in the past are irrelevant• these costs are sometimes called sunk costs• past costs are only useful in that they may help

predict costs in the future

Pages 405 - 406


Quantitative and Qualitative Information

• Quantitative factors are outcomes that are measured in numerical terms• expected costs, sales revenues and volumes

• Qualitative factors are outcomes that cannot be measured in numerical terms• employee morale, customer satisfaction

Pages 406 - 407

QuantitativeInformation

Model

QuantitativeInformation

Results Decision


Typical Relevant Costing Decisions

• One-Time-Only Special Order (Pricing)

• Make or Buy Decisions (Outsourcing)

• Opportunity Costs

• Product Mix Decisions under Capacity Constraints

• Add or Drop a Product Line or Customer

• Equipment Replacement Decisions

Pages 407 - 426


One-Time-Only Special Order

Without WithOrder Order Difference

Volume 30,000 35,000 5,000

Relevant revenues $600,000 $655,000 $55,000

Relevant costs:Variablemanufacturing (225,000) (262,500) (37,500)

Incremental income $17,500

Pages 407 - 409


Outsourcing and Make/Buy Decisions

Make Buy Difference

Relevant costs:Outside cost of parts $160,000 $160,000Direct materials $80,000 (80,000)Direct labour 10,000 (10,000)Variable overhead 40,000 (40,000)Fixed purchasing, receiving and setup overhead 20,000 (20,000)

Incremental differenceIn favour of making $10,000

Pages 410 - 413


Outsourcing and Opportunity Costs

Make Buy

Relevant cost to make $150,000

Relevant cost to buy $160,000

Opportunity cost:Profit forgone becauseCapacity cannot be usedto make another product 25,000

Total relevant costs $175,000 $160,000

Pages 413 - 417

• Opportunity cost considers the profits lost by not following the next best alternative course of action


Product Mix Decisions Under Constraint

Pages 417 - 418

Snowmobile BoatEngine

Engine

Contribution margin per unit $240 $375Machine hours required per unit 2 5Contribution margin per

machine hour $120 $75

• If machine hours are constrained, maximize income by first producing as many snowmobile engines as can be sold and then shift production to boat engines


Customer Profitability Analysis

Pages 418 - 422

Keep DropAccount Account Difference

Relevant revenue $1,200,000 $800,000 $(400,000)

Relevant costs:

Cost of goods sold 920,000 590,000 330,000

Material-handling labour 92,000 59,000 33,000

Marketing support 30,000 20,000 10,000

Order/delivery 32,000 20,000 12,000

Decline in operating incomeif drop account $(15,000)


Irrelevance of Past Costs

Pages 422 - 426

• Costs incurred in the past are sunk (irrelevant)• Only expected future costs and revenues are relevant

Example: Consider replacing an old machine with a new machine with expected lower operating costs

Keep Old Buy New DifferenceRelevant costs:Operating costs $1,600,000 $920,000 $680,000

Disposal value ofOld machine (40,000) 40,000

Cost of new machine 600,000 (600,000)

Difference $40,000


Linear Programming

• Optimization technique used to maximize total contribution margin given multiple constraints

Pages 427 - 431

Objective function:Total contribution margin = $240S + $375B

Constraints:

Assembly department 2S + 5B < 600

Testing department 1S + 0.5B < 120

Material shortage B < 110

Negative impossibility S > 0 and B > 0


FeasibleSolutions

Linear Programming Solution

Pages 427 - 431

0 50 100 150 200 250 300

Snowmobile Engines (S)

Boat Engines

(B)

250

200

150

100

50

0

Testing DepartmentConstraint

Material ShortageConstraint

Assembly DepartmentConstraint

Optimal Corner5S, 90B

Copyright © 2003 Pearson Education Canada Inc. Slide 11-118 Chapter 11 Decision Making and Relevant...

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