Differentiate relevant from irrelevant costs and revenues in decision situation 3.. Relevant is defined as revenues and costs that occur in the future and differ among the alternative co
Trang 1CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION LEARNING OBJECTIVES
1 Use the five-step decision process to make decisions
2 Differentiate relevant from irrelevant costs and revenues in decision situation
3 Distinguish between quantitative and qualitative factors in decisions
4 Beware of two potential problems in relevant-cost analysis
5 Explain the opportunity-cost concept and why it is used in decision making
6 Know how to choose which products to produce when there are capacity constraints
7 Discuss what managers must consider when adding or discontinuing customers and segments
8 Explain why the book value of equipment is irrelevant in equipment-replacement decisions
9 Explain how conflicts can arise between the decision model used by a manager and the performance evaluation model used to evaluate the manager
CHAPTER OVERVIEW
Chapter 11 is about the decision-making process Accountants are an integral part of this process, providing information to decision makers A five-step approach to making decisions, beginning with the point in the process in which the accountants typically become involved, is described in the chapter
An extremely useful concept is presented The information needed for the decision process must be relevant to the decision Relevant is defined as revenues and costs that occur in the future and differ among the alternative courses of action available to the decision maker This definition is illustrated through various situations In this chapter the information needed for decisions of one-time-only special orders, make-or-buy, drop-or-add, and keep-or-replace are explained Several of the chapters that follow will introduce other types of decisions that use the concept of relevant revenues and costs
A major theme of the text is that information generated by the accounting system is used for the benefit of managers in making decisions The roles performed by accountants are implicit in the illustrations of relevant information gathered for decisions—problem solving, scorekeeping, and attention directing A review of those roles from Chapter 1 could be used to highlight their importance in the decision process The last step of the decision process is evaluating performance The last section of the chapter deals with conflicts between the decision model used by a manager and the performance model then used to evaluate that manager This is an important discussion
Linear programming as a tool in the decision process is described in the appendix
Trang 2CHAPTER OUTLINE
I Information and the decision process
A Define the decision under consideration
TEACHING TIP: A clear understanding of the purpose of the decision is helpful in working through the steps in the decision process By carefully and quite specifically defining the decision to be made, the determination of relevant costs and relevant revenues for each alternative is usually easier Continued emphasis on the definition of relevant cannot be overdone
Learning Objective 1:
Use the five-step decision process to make decisions
B Employ five-step decision-making process [Exhibit 11-1]
1 Obtain information
a Historical costs
b Other information
2 Make predictions
3 Choose an alternative—must have at least two
4 Implement decision
5 Evaluate performance to provide feedback
C Use feedback [Refer to Chapter 1]
1 Affect future decisions
2 Affect prediction method
3 Affect implementation of the decision
Do multiple choice 1 Assign Exercise 11-16.
II The meaning of relevance [Exhibit 11-2]
Learning Objective 2:
Differentiate relevant from irrelevant costs and revenues in decision situations
A Definition of relevant costs and revenues
1 Occur in the future
Trang 3a Past costs may be useful basis for making informed predictions of expected future costs/revenues
b Unavoidable past costs that cannot be changed are sunk costs
2 Differ among alternative courses of action (What difference does it make?)
a Same conclusion if use only that which differs and if use all data
b Pertinent data used saves time and maintains focus
Do multiple choice 2 Assign Exercise 11-18.
B Outcomes of alternatives [Exhibit 11-3]
Learning Objective 3:
Distinguish between quantitative and qualitative factors in decisions
1 Quantitative factors: outcomes measured in numerical terns
2 Qualitative factors: outcomes that cannot be measured in numerical terms
III Illustrations of relevance
A Choosing output levels—example of one-time-only special order [Exhibits 11-4 and 11-5]
1 Understand conditions of decision (obtain information)
a Decision to accept or reject one-time-only special order
b Idle capacity available
c No long-run implications of accepting the order
2 Identify relevant revenues and costs
a Income statement format—maximize income
b Full costs identified by amount and type
Do multiple choice 3 Assign Exercises 11-19.
Learning Objective 4:
Beware of two potential problems in relevant-cost analysis
c Beware of two potential problems in relevant-cost analysis
i Avoid incorrect general assumptions such as all variable costs are relevant and all fixed costs are irrelevant
Trang 4ii Avoid losing sight of grand totals and focusing instead on unit costs
• Unit costs mislead when irrelevant costs are included
• Unit costs mislead when same unit costs are used at different output levels iii Require each item to be expressed as total future revenue or cost
B Insourcing-versus-outsourcing—example of make-versus-buy decisions
1 Understand conditions of decision (obtain information)
a Idle capacity available
b Qualitative factors
c If outsourcing, what use made of idled facility (new choice)
2 Identify relevant revenues and costs
a Minimize costs
b Know full costs by amount and type
i Incremental costs: additional total costs incurred for an activity
ii Differential cost: difference in cost between two alternatives
3 Use strategic and qualitative factors in choosing among alternatives [Exhibit 11-6]
a In-house to maintain control over design, quality, reliability, delivery schedules
b Outsource to be smaller and leaner organization, focusing on areas of core competencies
i Use long-run contracts to minimize risks of dependence on suppliers
ii Build partnership with suppliers
iii Allow suppliers to gain expertise and grow [VW Concepts in Action]
4 Choose best use of available facilities [Exhibit 11-7]
a Continue to make product—do not outsource
b Buy product – choice of use for idled facilities and of schedule for purchasing product
Do multiple choice 4 Assign Exercise 11-20 and Problem 11-35.
Learning Objective 5:
Explain the opportunity-cost concept and why it is used in decision making
Trang 5i Consider opportunity cost: contribution to income that is forgone by not using a
limited resource in its next-best alternative use
ii Include opportunity cost because it represents best alternative way organization may
have used its resources had it not made the decision it did [AA Concepts in Action]
Do multiple choice 5 and 6 Assign Exercise 11-21 and Problems 11-30 and 11-31.
C Product-mix decisions under capacity constraints
Learning Objective 6:
Know how to choose which products to produce when there are capacity constraints
1 Understand conditions of decision (obtain information)
a Level of capacity is a constraint—only be expanded in the long run
b Demand is a constraint
c Other constraints: availability of direct materials, components, skilled labor, financial factors, display space, etc
2 Identify relevant revenues and costs
a Maximize operating income
b Analyze individual product contribution margin
c Focus on maximizing total contribution margin by choosing products with highest contribution margin per unit of the constraining factor
Do multiple choice 7 Assign Exercises 11-22 and 11-23, Problems 11-29 and 11-32.
D Add or discontinue a product line—example of customer profitability
1 Understand conditions of decision (obtain information)
a Customer (product line) as cost object
b Activities associated with servicing customer (activity-based costing approach)
2 Identify relevant revenues and costs [Exhibit 11-8]
a Maximize profit
b Know full costs of activities and types of costs (hierarchy)
Learning Objective 7:
Discuss what managers must consider when adding or discontinuing customers and segments
Trang 6c Ignore allocated overhead costs
d Focus on how total costs differ among alternatives [Exhibit 11-9 and 11-10]
3 Choose among alternatives
a Reduce company’s costs of supporting the customer
b Charge higher prices to customer
c Discontinue the customer as an account
d Work with customer to reduce costs of supplying product
e Consider strategic factors and long-run relationship
Do multiple choice 8 Assign Exercises 11-24, 25, and 26, Problems 11-33 and 11-34.
E Keep or replace decisions—example of equipment
Learning Objective 8:
Explain why the book value of equipment is irrelevant in equipment-replacement decisions
1 Understand conditions of decision
a If keep, company has equipment because of past decision (past cost)
b Past costs, particularly book value of existing equipment, is irrelevant
2 Identify relevant revenues and costs [Exhibit 11-11]
a Minimize costs (maximize income if revenues are relevant)
b Future revenues and costs are relevant [Exhibit 11-12]
i Cash operating cost relevant
ii Disposal price of old machine relevant iii Cost of new machine relevant
Do multiple choice 9 Assign Exercises 11-27 and 11-28.
Learning Objective 9:
Explain how conflicts can arise between the decision model used by a manager and the performance evaluation model used to evaluate the manager
IV Decisions and performance evaluation
Trang 7A Manager will favor decision alternative that looks best for performance whether decision is best for company
B Time frame for decision is longer than time frame for performance evaluation
C Accounting systems rarely track each decision separately so impacts of many different decisions are combined in a single performance report
D Managers may hesitate because of how a decision would “look” to supervisors if supervisors have
no knowledge of alternative choices
Do multiple choice 10 Assign Problems 11-37 and 11-38.
V Appendix: Linear programming [Exhibit 11-13]
A Steps in solving a linear programming problem
1 Determine the objective function: goal to be maximized (income) or minimized (costs)
2 Specify the constraints: mathematical inequality or equality that must be satisfied by the
variables in a mathematical model
3 Compute the optimal solution
a Trial-and-error approach
b Graphic approach
B Sensitivity analysis
Do multiple choice 11 through 16.
CHAPTER QUIZ SOLUTIONS: 1.c 2.b 3.a 4.d 5.b 6.a 7.c 8.d 9.c 10.b
11.b 12.a 13.d 14.b 15.c 16.d
Trang 8CHAPTER QUIZ
1 Which of the following should not be considered for every option in the decision process?
a Relevant revenues c Historical costs
2 What is always the question to ask to determine if revenues or costs are relevant?
a What is the time frame for achieving results? c Who will be responsible?
b What difference will an action make? d How much will it cost?
3 [CPA Adapted] Mikaelabelle Products sells product A at a selling price of $40 per unit
Mikaelabelle’s cost per unit based on the full capacity of 500,000 units is as follows:
Direct materials $ 6 Direct labor 3 Indirect manufacturing (60% of which is fixed) 10
$19
A one-time-only special order offering to buy 50,000 units was received from an overseas
distributor The only other costs that would be incurred on this order would be $4 per unit for shipping Mikaelabelle has sufficient existing capacity to manufacture the additional units In negotiating a price for the special order, Mikaelabelle should consider that the minimum selling price per unit should be
The following data apply to questions 4 and 5.
Troy Instruments uses ten units of Part Number S1798 each month in the production of scientific
equipment The unit cost to manufacturing one unit of S1798 is presented below
Direct materials $ 4,000 Materials handling (10% of direct materials cost) 400 Direct manufacturing labor 6,000 Indirect manufacturing (200% of direct labor) 12,000
Total manufacturing cost $22,400
Materials handling represents the direct variable costs of the Receiving Department that are applied to direct materials and purchased components on the basis of their cost This is a separate charge in addition
to indirect manufacturing cost Troy’s annual indirect manufacturing cost budget is one-fourth variable and three-fourths fixed Duncan Supply, one of Troy’s reliable vendors, has offered to supply Part Number S1798 at a unit price of $17,000
4 [CMA Adapted] If Troy purchases the S1798 units from Duncan, the capacity Troy used to
manufacture these parts would be idle Should Troy decide to purchase the parts from Duncan, the unit cost of S1798 would
a decrease by $3,700 b decrease by $5,600 c increase by $3,600 d increase by $5,300
5 [CMA Adapted] Assume that Troy Instruments does not wish to commit to a rental agreement to rent all idle capacity but could use idle capacity to manufacture another product that would contribute
$60,000 per month If Troy elects to manufacture S1798 in order to maintain quality control, Troy’s opportunity cost is
a $(53,000) b $7,000 c $(24,000) d $36,000
Trang 96 Which of the following is not a correct use of the term “opportunity cost”?
a Opportunity costs are considered period costs rather than inventoriable costs for accounting purposes
b Opportunity costs must be considered by managers when making decisions
c Opportunity cost plus the incremental future revenues and costs equal the relevant revenues and costs of any alternative when capacity is constrained
d The opportunity cost of holding inventory is the income forgone by tying up money in inventory and not investing it elsewhere
7 Nicholas, Inc., has provided the following unit data for review:
Simple Product Advanced Product
Which product, Simple or Advanced, is most profitable for Nicholas, Inc., to manufacture?
a Both in ratio of 3 : 5 b Both in ratio of 5 : 8 c Simple d Advanced
8 RCG Services is investigating its profitability relationship with each of its customers What is the key question RCG should ask in deciding to keep or to drop a particular customer?
a Will the customer meet a specific designated gross margin percentage?
b Will the customer be willing to pay a higher price to insure RCG’s profitability?
c Will enough customers be found to replace any customers dropped for lack of profitability?
d Will expected total corporate office costs decrease if decision is to drop the customer?
9 [CPA Adapted] At December 31, 2001, Brown Co had a machine with an original cost of $90,000, accumulated depreciation of $75,000, and an estimated salvage value of zero On December 31,
2001, Brown was considering the purchase of a new machine having a five-year life, costing
$150,000, and having an estimated salvage value of $30,000 at the end of five years In its decision concerning the possible purchase of the machine, how much should Brown consider as sunk cost at December 31, 2001?
10 Which of the following is not a reason for the performance evaluation model to differ from the
decision model?
a The use of different time frames: one being an annual basis, the other a period of several years
b The accounting systems enable each decision to be tracked separately
c The accrual accounting method incorporates irrelevant costs
d Top management is rarely aware of particular desirable alternatives that were not chosen by subordinate managers
Trang 10Questions 11-16 demonstrate the use of linear programming (appendix to Chapter 11)
Belmont Company manufactures and sells two products, shirts and gloves, in its two-department plant Belmont employs linear programming to determine its optimum product mix Economic data pertaining to the two products are presented below
Shirt[S] Gloves[G]
Selling price per unit $22 $40
Cost data per unit
Variable manufacturing cost 8 12 Variable marketing cost 2 4 Fixed manufacturing cost 5 9 Fixed marketing cost 1 2
Direct Labor Data Cutting Finishing Shirt [S] 10 minutes 15 minutes
Gloves [G] 6 minutes 30 minutes
Monthly capacity 960 hours 1,920 hours
11 [CMA Adapted] The algebraic formulation of Belmont's objective function is
a. MAX TCM = 10S + 16G
b. MAX TCM = 12S + 24G
c MAX TCM = 14S + 28G
d MAX TCM = 7S + 15G
12 [CMA Adapted] The algebraic formulation of Belmont's monthly direct labor constraints is
a (1/6)S + (1/10)G ≤ 960; (1/4)S + (1/2)G ≤ 1,920
b (1/6)S + (1/4)S + (1/10)G + (1/2)G ≤ 2,880
c 10S + 6G ≤ 960; 15S + 30G ≤ 1,920
d 10S + 15S + 6G + 30G ≤ 2,880
13 [WOS] The solution where S = 0 and G = 3,000 would
a be the optimal solution
b be an infeasible solution
c. be a corner point
d. be a feasible solution
14 [WOS] A feasible solution for Belmont Company is where [to the nearest whole dollar]
a G = 0; S = 7,680 b G = 0; S = 5,760 c G = 9,600; S = 0 d G = 3,840; S = 5,760
15 [WOS] At the optimal mix, Belmont will
a have a contribution margin of $69,120
b produce 5,760 shirts
c produce 3,840 gloves
d have no excess direct labor capacity
16 [WOS] If the selling price of gloves is $34 rather than the predicted $40, what will be the cost to Belmont
of this prediction error?
a $23,040 c $8,238
a Zero, since gloves are not produced under either cost d $14,802