Slides 3 2 recommend a course of action in outsourcing and k

Recommend a Course of Action in Outsourcing (Relevant Cost) What will influence your decision? • Two cars: same model, same price, same engine, same features and accessories, same financing Terminal Learning Objective • Task: Recommend A Course of Action in Outsourcing and Keep or Replace Decisions • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: With at least 80% accuracy: • Explain relevant costs • Identify relevant costs in an outsourcing decision • Identify relevant costs in a keep-or-replace decision What is Relevant? • Synonyms for relevant: pertinent, applicable, related, appropriate, significant, important • We have access to more information than ever • Not every piece of information is pertinent, applicable, or related to a decision • Example: fuel economy on new car models is not pertinent to a decision about whether to pursue your Master’s degree What is Relevant? • Some pieces of information can be easily dismissed as unrelated or irrelevant • Other times it is more difficult to determine what is appropriate, significant, or important to the decision • Especially when the information is printed on an official report from the accounting system • Remember that the accounting system measures according to external requirements What is Relevant? • Relevant costs are those costs that change as a result of a decision • Identify the decision at hand • Choice between two Courses of Action (COA) • Frequently one of the options is status quo • Identify related costs • Which costs are the same for both courses of action? Which will change? Cost Definitions • Acquisition cost – all costs related to purchasing an asset and placing it into service • Operating cost – all costs related to operating an asset • Opportunity cost – the value of what is given up when choosing a particular course of action • Sunk cost – costs incurred in the past that cannot be recovered • Incremental cost – the additional cost incurred as the result of a decision Cost Definitions • Avoidable cost – cost we currently incur that would be eliminated or avoided by choosing another course of action • Unavoidable cost – cost we currently incur that would NOT be eliminated or avoided by choosing another course of action Classic Relevant Cost Problems • Outsourcing – Should we provide this service in-house or purchase from a contractor? • Keep or replace – Should we keep the equipment we have or replace with more efficient equipment? • These are the two most applicable to government entities Classic Relevant Cost Problems • Additional business at reduced price – Should we accept or reject additional business at a reduced price? • Scrap or re-work – Should we invest additional resources to bring the item up to standards or cut our losses? • While less common, these also have government applications 10 Keep or Replace Conclusions • Replacing the “old” machine will save $15,000 over the threeyear period • What else should be considered? Any qualitative factors? • What if the projected operating costs of the new machine are overly optimistic? What if the actual operating costs are $80,000 per year? $85,000? How would that change our decision? 35 Learning Check • Which costs are always irrelevant in keep or replace decisions? 36 Additional Business, Reduced Price • The dining hall can serve 200 for breakfast, but averages only 40 on weekends   • Daily fixed costs for the morning shift (three employees for four hours, plus cost of facilities) are $500, and variable costs are $2 per breakfast The regular price for breakfast is $5 • A local community service group would like to use the dining hall on Sunday mornings for their meetings They would pay $3 per person for breakfast Average attendance at meetings is 75 37 Additional Business, Reduced Price Status Quo With Additional Breakfast sales 40 @ $5 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 115 @ $2 230 (150) Fixed Costs 500 500 -0- Net Change -380 -305 75 Item $200 80 Δ 38 Additional Business, Reduced Price Status Quo With Additional Breakfast sales 40 @ $5 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 115 @ $2 230 (150) Fixed Costs 500 500 -0- Net Change -380 -305 75 Item $200 80 Δ 39 Additional Business, Reduced Price Status Quo With Additional Breakfast sales 40 @ $5 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 115 @ $2 230 (150) Fixed Costs 500 500 -0- Net Change -380 -305 75 Item $200 80 Δ 40 Additional Business, Reduced Price Status Quo With Additional Breakfast sales 40 @ $5 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 115 @ $2 230 (150) Fixed Costs 500 500 -0- Net Change -380 -305 75 Item $200 80 Δ 41 Additional Business, Reduced Price Status Quo With Additional Breakfast sales 40 @ $5 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 115 @ $2 230 (150) Fixed Costs 500 500 -0- Net Change -380 -305 75 Item $200 80 Δ 42 Additional Business, Reduced Price • Assumptions: • Excess capacity exists • Proposed business will not detract from regular business • Rules of thumb: • As long as incremental revenue exceeds incremental cost, additional business is desirable • Fixed costs are irrelevant 43 Additional Business, Reduced Price • What else should the dining hall management consider? 44 Scrap or Rework • Should we sell an inferior product as scrap or invest the necessary resources to make the product salable? • This has application to military in the area of training • Should we discharge individuals who fail basic training or retrain? 45 Discharge or Re-train Item Discharge Re-train Δ -0- X X Y Y -0- Cost of Re-training -0- Z (Z) Net Change -Y X–Y–Z X–Z Benefit of trained soldier Cost of Basic Training If X (benefit of trained soldier) is greater than Z (cost to re-train) then re-training is desirable 46 Discharge or Re-train Item Discharge Re-train Δ X X Y Y -0- Cost of Re-training -0- Z (Z) Net Change -Y X–Y–Z X–Z Cost of Basic training is a Sunk BenefitCost of and trained therefore irrelevant -0- soldier Cost of Basic Training If X (benefit of trained soldier) is greater than Z (cost to re-train) then re-training is desirable 47 Learning Check • Which costs are irrelevant in deciding whether to accept additional business at a reduced price? • What is the rule of thumb? 48 Practical Exercises 49 ... Action in Outsourcing and Keep or Replace Decisions • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational...What will influence your decision? • Two cars: same model, same price, same engine, same features and accessories, same financing Terminal Learning Objective • Task: Recommend A Course of Action. .. How are unfavorable deltas identified? 27 Keep or Replace • Your command recently purchased a machine for $50,000 The annual operating cost of the machine is $100,000 • An alternative machine