Chapter 11
Decision Making and Relevant
Information
Copyright © 2003 Pearson Education Canada Inc.
Slide 11-118
Information and the Decision Process
•
A decision model is a formal method of making a
choice, frequently involving quantitative
analysis
1.
Gather information
2.
Make predictions
3.
Choose an alternative
4.
Implement the decision
5.
Evaluate performance
Copyright © 2003 Pearson Education Canada Inc.
Feedback
5 Steps in the Decision Process
Pages 404 - 405
Slide 11-119
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
Copyright © 2003 Pearson Education Canada Inc.
Pages 405 - 406
Slide 11-120
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
Quantitative
Information
Model
Copyright © 2003 Pearson Education Canada Inc.
Quantitative
Information
Results
Decision
Pages 406 - 407
Slide 11-121
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
Copyright © 2003 Pearson Education Canada Inc.
Pages 407 - 426
Slide 11-122
One-Time-Only Special Order
Without
Order
With
Order
Difference
30,000
35,000
5,000
Relevant revenues
$600,000
$655,000
$55,000
Relevant costs:
Variable
manufacturing
(225,000)
(262,500)
(37,500)
Volume
Incremental income
Copyright © 2003 Pearson Education Canada Inc.
$17,500
Pages 407 - 409
Slide 11-123
Outsourcing and Make/Buy Decisions
Make
Relevant costs:
Outside cost of parts
Direct materials
Direct labour
Variable overhead
Fixed purchasing,
receiving and
setup overhead
Incremental difference
In favour of making
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Buy
Difference
$160,000
$80,000
10,000
40,000
$160,000
(80,000)
(10,000)
(40,000)
20,000
(20,000)
$10,000
Pages 410 - 413
Slide 11-124
Outsourcing and Opportunity Costs
Make
Relevant cost to make
Relevant cost to buy
Opportunity cost:
Profit forgone because
Capacity cannot be used
to make another product
Total relevant costs
Buy
$150,000
$160,000
25,000
$175,000
$160,000
• Opportunity cost considers the profits lost by not
following the next best alternative course of action
Copyright © 2003 Pearson Education Canada Inc.
Pages 413 - 417
Slide 11-125
Product Mix Decisions Under Constraint
Contribution margin per unit
Machine hours required per unit
Contribution margin per
machine hour
Snowmobile
Engine
Boat
Engine
$240
2
$375
5
$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
Copyright © 2003 Pearson Education Canada Inc.
Pages 417 - 418
Slide 11-126
Customer Profitability Analysis
Keep
Account
Drop
Account Difference
Relevant revenue
$1,200,000
Relevant costs:
Cost of goods sold
920,000
Material-handling labour
92,000
Marketing support
30,000
Order/delivery
32,000
$800,000 $(400,000)
Decline in operating income
if drop account
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590,000
59,000
20,000
20,000
330,000
33,000
10,000
12,000
$(15,000)
Pages 418 - 422
Slide 11-127
Irrelevance of Past Costs
• 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
Relevant costs:
Operating costs
$1,600,000
Disposal value of
Old machine
Cost of new machine
Difference
Copyright © 2003 Pearson Education Canada Inc.
Buy New
Difference
$920,000
$680,000
(40,000)
600,000
40,000
(600,000)
$40,000
Pages 422 - 426
Slide 11-128
Linear Programming
• Optimization technique used to maximize total
contribution margin given multiple constraints
Objective function:
Total contribution margin = $240S + $375B
Constraints:
Assembly department
Testing department
Material shortage
Negative impossibility
Copyright © 2003 Pearson Education Canada Inc.
2S + 5B < 600
1S + 0.5B < 120
B < 110
S > 0 and B > 0
Pages 427 - 431
Slide 11-129
Linear Programming Solution
Testing Department
Constraint
250
Optimal Corner
5S, 90B
200
Boat
Engines
(B)
Material Shortage
Constraint
150
100
Feasible
Solutions
50
Assembly Department
Constraint
0
0
50
100 150 200 250
Snowmobile Engines (S)
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300
Pages 427 - 431
Slide 11-130