Relevant Costs for Decision Making

1. Relevant Costs for Decision Making UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

2. Men Machines Major Resources Money Materials Management Major Resources M's The 5

3. Information as a Resource Information is now regarded as the sixth resource.

4. Information Anxiety Source: Information Anxiety Richard S. Wurman

5. A weekend edition of the NY Times contains more information than the average person was likely to come across in a lifetime in seventeenth-century England.

6. More new information has been produced in the last 30 years than in the previous 5,000. About 1,000 books are published internationally every day, and the total of all printed knowledge doubles every eight years.

7. In a single year . . . • The average American will read or complete 3,000 notices and forms; • Read 100 newspapers and 36 magazines; • Watch 2,463 hours of television;

8. In a single year . . . • Listen to 730 hours of radio; • Talk on the phone for 61 hours; and • Read 3 books And . . . then there's college!

9. The Challenge of Information %#@!#

10. 5,000 BC Date Method Abacus 2-4 ips Speed in ips* 1945 A.D. Computer 100 ips 1960s Computer 100,000 ips 1970s Computer 1,000,000 ips 1980s Computer 10,000,000 ips 1990s Computer 1,000,000,000 ips Computation Speed . . . *Instructions per second.

11. 4,000 BC Date Messenger Medium Speed in wpm* .01 wpm 1844 A.D. Telegraph 50 - 60 wpm 1980s Cable/Fibre 1,000,000,000 wpm 1990s Fibre 100,000,000,000 wpm Transmission Speed *Words per minute

12. 4,000 BC Date Written Medium 300 wpm Speed in wpm* Today Written 300 wpm 4,000 BC Visual 100,000,000 bpg** Today 4,000 BC Today Spoken Spoken Visual 100,000,000 bpg 120 wpm 120 wpm Human Processing Speed *Words per minute **Bits per glance

13. Information Overload The theory of bounded rationality (Simon, 1955). Humans are organisms of limited knowledge and computational capacity. Thus, simplifications (heuristics) are deliberately introduced into the choice mechanism.

14. Dealing With Information Overload HELP!

15. Information Processing • People are consistency seekers; • People are Information Processors; and • People are Cognitive Misers

16. People as Information Processors • Actively seek out information, • Observe facts, and • Reason

17. People as Cognitive Misers • Minimize cognitive efforts, and • Take shortcuts.

18. Managers as Cognitive Misers • Managers must be selective in the kinds of information they request. • The key to limiting the flow of data is to request only relevant information.

19. Information Overload • Unquestionably we need information in our lives . . . . . . however, that information must be directly relevant to our daily lives. • The real question today is, “How do we zero in on the relevant and reject the rest?”

20. Information Literacy To be information literate, a person must be able to recognize when information is needed and have the ability to locate, evaluate, and use effectively the needed information. Source: Presidential Committee on Information Literacy

21. The Need For Cost Data • Purchase new equipment; • Replace existing equipment; • Introducing new products; • Taking special orders;

22. The Need For Cost Data • Make vs. buy decisions. • Product-pricing decisions • Allocation of scarce resources.

23. Relevant Costs Are . . . • Any cost that differs among alternatives and will influence the outcome, • Any cost that is avoidable, and • Any cost that is a future cost.

24. Relevant Revenues • Any revenue that differs among alternatives; and • will influence the outcome,

25. Avoidable Costs An avoidable cost is . . . . . . a cost that can be eliminated (in whole or in part) as a result of choosing one alternative over another.

26. Avoidable Costs • All costs are considered to be avoidable, except . . . • Sunk Costs, and • Costs that are the same for each alternative.

27. When is a cost relevant? When does the cost arise? Does the cost differ between alternatives?

28. Different Costs for Different Purposes

29. Internal Value Chain Activities Design Service Develop Distribute Produce Market

30. Value-Chain Operating Traditional Product Costs Product Costs Product Costs Product Costing Definitions Research and Development Production Production Production Marketing Marketing Customer Service Customer Service Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting

31. Value-Chain Product Costs If making these types of decisions, we need to look atallcosts. Research and Development Production Marketing Customer Service Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis

32. Operating Product Costs Production Marketing Customer Service Strategic Design Decisions Tactical Profitability Analysis On the other hand, for these decisions, we might be able to ignore some of the costs.

33. For external financial reporting, we need only these costs. Value-Chain Operating Traditional Product Costs Product Costs Product Costs Product Costing Definitions Research and Development Production Production Production Marketing Marketing Customer Service Customer Service Pricing Decisions Product-Mix Decisions Strategic Profitability Analysis Strategic Design Decisions Tactical Profitability Analysis External Financial Reporting

34. Identifying Relevant Costs A Text Example

35. Identifying Relevant Costs Text pages 588-589

36. Identifying Relevant Costs Option #1 Option #2 From a financial standpoint, Cynthia would be better off taking the train to visit her friend. Some of the non-financial factor may influence her final decision.

37. Total and Differential Cost Approaches The Text Example

38. Text Example • Oak Harbor Woodworks is considering a new labor-saving machine that rents for $3,000 per year. • The machine will be used on the company’s butcher block production line. • Pertinent data are provided.

39. Text Example Text pages 591

40. Exhibit 13-1 – Total and Differential Costs

42. Adding and Dropping Product Lines and Other Segments Exercise 13-3 p. 613

43. What should Jackson do? Decision Rule Jackson County should drop the housekeeping segment only if its profit would increase. This would happen only if the fixed cost savings exceed the lost contribution margin.

44. Incremental (Differential) Analysis

45. This same solution can be obtained by using a total cost approach by preparing comparative income statements showing results with and without the Housekeeping segment.

46. The Total Cost Approach Depreciation is a sunk cost and the van has no salvage value since it would be donated to another organization. General Administrative overhead is allocated and none of it would be avoided if the program is dropped.

47. Let’s apply that concept to this problem BEWARE OF ALLOCATED FIXED COSTS! Remember the text discussion of this topic?

48. Beware of Allocated Fixed Costs

49. The Make or Buy Decision

50. The Make or Buy Decision • A decision concerning whether an item should be produced internally or purchased from an outside supplier is called a “make or buy” decision. • Exercise 13-4 – Make or Buy a Component (p. 614)