Lecture Managerial accounting: Creating value in a dynamic business environment (10th edition): Chapter 14 - Ronald W. Hilton, David E. Platt

Chapter 14 - Decision making: Relevant costs and benefits. After completing this chapter, you should be able to: Describe seven steps in the decision-making process and the managerial accountant’s role in that process; explain the relationship between quantitative and qualitative analyses in decision making; list and explain two criteria that must be satisfied by relevant information;...

Chapter 14 Decision Making: Relevant Costs and Benefits Copyright © 2014 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education The Decision-Making Process Clarify the Decision Problem Specify the Criterion Primarily the responsibility of the managerial accountant Identify the Alternatives Develop a Decision Model Collect the Data Information Information should should be: be: 1 Relevant Relevant 2 Accurate Accurate 3 Timely Timely Make a Decision 14­2 The Decision-Making Process Clarify the Decision Problem Specify the Criterion Identify the Alternatives Qualitative Qualitative Considerations Considerations Develop a Decision Model Collect the Data Make a Decision 14­3 The Decision-Making Process Relevant Relevant Pertinent to a  Pertinent to a  decision problem decision problem Clarify the Decision Problem Specify the Criterion Accurate Accurate Information must Information must be precise be precise Identify the Alternatives Timely Timely Available in time Available in time for a decision for a decision Collect the Data Develop a Decision Model Make a Decision 14­4 Relevant Information Information is relevant to a decision problem when 1 2 It It has hasa abearing bearingon onthe thefuture, future, It It differs differsamong amongcompeting competingalternatives alternatives 14­5 Identifying Relevant Costs and Benefits Sunk Sunk costs costs Costs Coststhat thathave havealready already been beenincurred incurred They They donot notaffect affect any any future futurecost costand andcannot cannotbe bechanged changedby by any any current currentor or future futureaction action Sunk costs are irrelevant to decisions 14­6 Relevant Costs Here is an analysis that includes only relevant costs: 14­7 Accept or Reject a Special Order  A travel agency offers Worldwide Airways  A travel agency offers Worldwide Airways  $150,000 for a round­trip flight from Hawaii to  $150,000 for a round­trip flight from Hawaii to  Japan on a jumbo jet Japan on a jumbo jet  Worldwide usually gets $250,000 in revenue from  Worldwide usually gets $250,000 in revenue from  this flight this flight  The airline is not currently planning to add any  The airline is not currently planning to add any  new routes and has two planes that are idle and  new routes and has two planes that are idle and  could be used to meet the needs of the agency could be used to meet the needs of the agency  The next screen shows cost data developed by  The next screen shows cost data developed by  managerial accountants at Worldwide managerial accountants at Worldwide 14­8 Accept or Reject a Special Order With excess capacity  Relevant costs will the special order usually be the variable costs associated with Without excess capacity  Same as above but opportunity cost of using the firm’s facilities for the special order are also relevant 14­9 Outsource a Product or Service A A decision decisionconcerning concerningwhether whetheran anitem itemshould shouldbe beproduced produced internally internallyor orpurchased purchasedfrom froman anoutside outsidesupplier supplieris isoften often called calledaa“make “makeor orbuy” buy”decision decision Let’s Let’slook lookat atanother anotherdecision decisionfaced facedby bythe themanagement managementof of Worldwide WorldwideAirways Airways 14­10 Add or Drop a Service, Product, or Department One Oneof of the themost mostimportant important decisions decisionsmanagers managersmake makeis is whether whetherto toadd addor ordrop dropaa product, product, service, service, or or department department Let’s Let’slook lookat athow howthe theconcept conceptof of relevant relevantcosts costsshould shouldbe beused usedin in such suchaadecision decision 14­11 Special Decisions in Manufacturing Firms Joint JointProducts: Products: Sell Sell or orProcess ProcessFurther Further A A joint jointproduction productionprocess processresulting resultingin intwo twoor ormore more products products The Thepoint pointin inthe theproduction productionprocess processwhere wherethe the joint jointproducts productsare areidentifiable identifiableas asseparate separateproducts productsis is called calledthe thesplit-off split-off point point 14­12 Joint Processing of Cocoa Bean Cocoa beans costing $500 per ton Joint Production process costing $600 per ton Total joint cost: $1,100 per ton Cocoa butter sales value $750 for 1,500 pounds Split­off point Cocoa powder sales value $500 for 500 pounds Separable process costing $800 Instant cocoa mix sales value $2,000 for 500 pounds 14­13 Joint Products Relative Sales Value Method $750 $750 ÷÷ $1,250 $1,250 == 60% 60% 60% 60% ×× $1,100 $1,100 == $660 $660 14­14 Joint Products Cocoa butter is sold at the end of the joint processing Cocoa powder may be sold now or processed into instant cocoa mix Further processing costs of $800 will be incurred if the company elects to make instant cocoa mix 14­15 Joint Products (      ) The cocoa powder should be  processed into instant cocoa mix 14­16 Decisions Involving Limited Resources  Firms Firmsoften oftenface facethe theproblem problemof of deciding decidinghow howlimited limited resources resourcesare aregoing goingto tobe beused used  Usually, Usually,fixed fixedcosts costsare arenot notaffected affectedby bythis thisdecision, decision,so so management managementcan canfocus focuson onmaximizing maximizingtotal total contribution contribution margin margin Let’s Let’slook lookat atthe theMartin, Martin, Inc Inc example example 14­17 Limited Resources Martin, Inc produces two products and selected data are shown below: 14­18 Limited Resources  The Thelathe latheis isthe thescarce scarceresource resourcebecause becausethere thereis is excess excesscapacity capacityon onother other machines machines The Thelathe latheis is being beingused usedat at100% 100%of of its itscapacity capacity  The Thelathe lathecapacity capacityis is2,400 2,400minutes minutesper per week week Should ShouldMartin Martinfocus focusits itsefforts efforts on onWebs Websor or Highs? Highs? 14­19 Limited Resources Let’s calculate the contribution margin per unit of the scarce resource, the lathe Highs Highs should should be be emphasized emphasized ItIt is is the the more more valuable valuable use use of of the the scarce scarce resource, resource, the the lathe, lathe, yielding yielding aa contribution contribution margin margin of of $30 $30 per per minute minute as as opposed opposed to to $24 $24 per per minute minute for for the the Webs Webs If there are no other considerations, the best plan would be to produce to meet current  demand for Highs and then use remaining capacity to make Webs 14­20 Theory of Constraints Binding constraints can limit a company’s profitability To relax constraints management can Outsource Retrain employees Work overtime Reduce non-valueadded activities 14­21 Uncertainty One Onecommon commontechnique techniquefor foraddressing addressingthe theimpact impactof of uncertainty uncertaintyis is sensitivity sensitivityanalysis analysis aaway wayto todetermine determinewhat whatwould wouldhappen happen in inaadecision decisionanalysis analysisifif aakey keyprediction predictionor orassumption assumption proved provedto tobe bewrong wrong 14­22 Other Issues in Decision Making Incentives Incentives for for Decision Decision Makers Makers Short-Run Short-Run Versus Versus Long-Run Long-Run Decisions Decisions 14­23 Other Issues in Decision Making Pitfalls to Avoid Sunk costs Allocated fixed costs Unitized fixed costs Opportunity costs 14­24 ... demand for Highs and then use remaining capacity to make Webs 14? ?20 Theory of Constraints Binding constraints can limit a company’s profitability To relax constraints management can Outsource Retrain employees... sensitivityanalysis analysis aaway wayto todetermine determinewhat whatwould wouldhappen happen in inaadecision decisionanalysis analysisifif aakey keyprediction predictionor orassumption assumption... Timely Available? ?in? ?time Available? ?in? ?time for? ?a? ?decision for? ?a? ?decision Collect the Data Develop a Decision Model Make a Decision 14? ?4 Relevant Information Information is relevant to a decision