Managerial Accounting: Chapter 7

Steps in the Decision Making Process

1. Identify the Decision Problem 2. Determine the Decision Alternatives 3. Evaluate the Costs and Benefits of the Alternatives 4. Make the Decision 5.Review the Results of the Decision

Using Incremental Analysis to analyze four common business decisions:

1. Special-Order Decisions 2. Make-Or-Buy Decisions 3. Keep-Or Drop Decisions 4. Sell-Or-Process Further Decisions

Avoidable Cost

Another term for relevant cost. A cost that can be avoided by choosing one decision alternative instead of another

Segment Margin

Calculated as sales revenue less all costs that are directly attributable to the segment including variable and direct fixed costs

Incremental/Differential Costs

Costs that differ between alternatives are called incremental or differential costs

Idle/Excess Capacity

If a company has idle or excess capacity, it has more than enough resources to satisfy demand. Because it has not yet reached the limit on its resources, opportunity costs are not relevant.

Bottleneck

In the short run, managers can maximize profit by prioritizing products or customers based on the amount of contribution margin generated by the most constrained resource called "bottleneck" Bottleneck limits the systems overall output and therefore determines how much contribution margin is lost due to limited resources.

Capacity

Is a measure of the limit placed on a specific resource. It could be the number of people who will fit in a restaurant or an airplane, the number of employees who are available to serve clients, the amount of machine time that is available to make a product, or the amount of shelving space that is available for merchandise.

Substitute Products

Managers must also think about the likely impact of discontinuation on other products and customers. Substitute products or products that can be used in place of one another

Direct Fixed Cost

One that can be attributed to a specific segment of the business. Example include a machine used to produce only one type of product, a supervisor who is responsible for a specific division, and advertising aimed at a specific region or product line. Even though these costs are fixed, or independent of the number of units produced or sold, they relate to only one segment and could be avoided if the segment were eliminated.

Incremental/Differential Analysis

Our main focus will be on Step 3 of the decision-making process, which involves comparing the costs and benefits of the decision alternatives identified in Step 2. The approach we use is called incremental or differential analysis because it focuses on the factors that will change, or differ between the decision alternatives.

Special-Order Decisions

Require managers to decide whether to accept or reject an order that is outside the scope of normal sales. These one-time orders, or special orders are often offered at a lower price than customers normally pay for the product or service. The decisions that managers must make is whether to accept of reject the offer. We can analyze the decision by comparing the incremental costs and benefits of accepting (versus rejecting) the special order.

Complementary Products

Sometimes firms have complementary products or products that are used together.

Constrained Resource

The constrained resource could be anything that is needed to operate the business, such as: Ex: Cash, Employees, Machines, or Facilities

Keep-Or-Drop Decisions

The next decision we consider whether to eliminate a particular division or segment of the business. Businesses can be segmented (divided) in a number of ways, such as by product line, service offering, or geographic region. If a particular business segment is not performing as well as expected, managers may decide to eliminate it. Also called Continue pr Discontinue Decisions

Make-Or-Buy Decisions

The next managerial decision we analyze is whether to perform a particular activity or function in-house or purchase it from an outside supplier. Traditionally, these decisions have been called make-or-buy decisions. Also called Insourcing versus Outsourcing Decisions.

Common Fixed Costs

Unlike direct costs that relate to specific segment, common fixed costs are shared by multiple segments and thus will be incurred even if a segment is eliminated.

Full Capacity

When a company is operating at full capacity, the limit on one or more of its resources has been reached, and making the choice to do one thing means giving up the opportunity to do something else. At full capacity, opportunity costs become relevant and should be incorporated into the analysis