Ch. 11 Decision Making and Relevant Information

"All future costs are relevant." Do you agree? Why?

*No-- relevant costs are defined as those expected future costs that differ among alternative courses of action being considered. Thus, future costs that do not differ among the alternatives are irrelevant to deciding which alternative to choose.

"A component part should be purchased whenever the purchase price is less than its total manufacturing cost per-unit." Do you agree? Why?

No-- -----some of the total unit costs to manufacture a product may be fixed costs, and hence, it will not differ between the make and buy alternatives -----These fixed costs are irrelevant to the make or buy decisions -----The key comparison is between purchase costs and the costs that will be saved if the company purchases the component parts from outside plus the additional benefits of using the resources freed up the next best alternative use (opportunity cost)

"Management should always maximize sales of the product with the highest contribution margin per unit." Do you agree? Why?

*No--Managers should aim to get the highest contribution margin per unit of the constraining (that is, scarce, limiting, or critical) factor ---the constraining factor is what restricts or limits the production or sale of a product (ex: availability of machine hours)

"Managers will always choose the alternative that maximizes operating income or minimizes costs in the decision model." Do you agree? Why?

*No--Managers tend to favor the alternative that makes their performance look best, so they focus on measures used in the performance-evaluation model ---If the performance-evaluation model does not emphasize maximizing operating income or minimizing costs, managers will most likely not choose the alternative that maximizes operating income or minimizes costs

"Cost written off as depreciation on equipment already purchased is always irrelevant." Do you agree? Why?

*No--cost written off as depreciation is IRRELEVANT when it pertains to past costs such as equipment already purchased The purchase cost of new equipment to be acquired in the future that will be written off as depreciation is RELEVANT --Old equipment depreciation is irrelevant --depreciation for future equipment to be purchased is relevant

"Managers should always buy inventory in quantities that result in the lowest purchase cost per unit." Do you agree? Why?

*No--deciding how much inventory to buy, managers must consider the purchase cost per unit and opportunity cost of funds invested in inventory ---ex: the purchase cost per unit may be low when the quantity of inventory purchased is large, but the benefit of the lower cost may be more than offset by the high opportunity cost of the funds invested in acquiring and holding inventory

"A branch office or business segment that shows negative operating income should be shut down." Do you agree? Why?

*No--for example, if the revenues that will be lost exceed the costs that will be saved, the branch of business segment should not be shut down. Shutting down will only increase the loss. Allocated costs and fixed costs that will not be saved are irrelevant to the shut-down decision

"Variable costs are always relevant, and fixed costs are always irrelevant." Do you agree? Why?

*No--some variable costs may not differ among the alternatives under consideration and, hence, will be irrelevant -----some fixed costs may differ among the alternatives, and hence, will be relevant

Distinguish between quantitative and qualitative factors in decision making.

*Quantitative factors = outcomes that are measured in numerical terms --some quantitative factors are financial-that is, they can be easily expressed in monetary terms. --Direct materials are an example of quantitative financial factor --Other quantitative non-financial factors (on-time flight arrivals, cannot be easily expressed in monetary terms) *Qualitative factors = outcomes that are difficult to measure accurately in numerical terms --ex: employee morale

Define relevant costs. Why are historical costs irrelevant?

*Relevant Costs= expected future costs that differ among the alternative courses of action being considered *Historical costs are irrelevant because they are past costs and, therefore, cannot differ among alternative future courses of action

Define Opportunity Cost

*The contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use

Describe 2 potential problems that should be avoided in relevant-cost analysis.

1. Assuming that all variable costs are relevant and all fixed costs are irrelevant. 2. Using unit-cost data directly

Outline the five-step sequence in a decision process.

1. Identify the problem and uncertainties 2. Obtain Information 3. Make predictions about the future 4. Make decisions by choosing among alternatives 5. Implement the decision, evaluate performance, and learn