accounting chapter 12
avoidable cost
cost that can be eliminated by choosing one alternative over another RELEVANT COST
total cost approach
includes all costs and benefits, relevant or not
decision making- 6 key concepts
1. every decision involves choosing from at least two alternatives. therefore, the first step in decision making is to define the alternatives being considered 2. once you have denied the alternatives, you need to identify the criteria for choosing among them. --relevant cost and benefits should be considered when making decisions --irrelevant costs and benefits should be ignored when making decisions 3. key to effective, decision making is differential analysis-focusing on the future costs and benefits that differ between the alternatives 4. sunk costs are always irrelevant when choosing among alternatives 5. future cost and benefits that do not differ between alternatives are irrelevant to the decision making process 6. opportunity costs also need to be considered when making decisions
3 steps in making sell process further decision
1. ignore all joint costs (cost to split off point), remain the same under both alternatives 2. determine the incremental revenue that is earned by further processing the joint product 3. take incremental revenue from step 2-incremental costs associated with processing the joint product beyond the split off point . if positive, then process further and sell for a higher price
using differential approach desirable for 2 reasons
1. only rarely will enough information be available to prepare detailed income stmts for both alternatives 2. mingling irrelevant costs with relevant costs may cause confusion and distract attention away from the information that is really crucial
split off point
Where joint products can be recognized as separate products
differential cost
a future cost that differs between any 2 alternatives ALWAYS RELEVANT
incremental cost
an increase in cost between two alternatives RELEVANT COST
constraint(bottleneck)
anything that prevents you from getting what you want. weakest part of company focus on the part that is struggling the most to fix and make the company stronger
Adding or Dropping a Product Line
be careful of fixed and common fixed cost that will not change when adding or dropping a segment if a dropping segment tallows a company to avoid more fixed cost than it looses in its contribution margin than it would be financially advantageous to eliminate the line
volume trade off decisions
companies are forced to make these when they do not have enough capacity to produce all the products and volumes demanded by their customers -in these situations, companies must trade off or sacrifice production of some products in favor of others of others to maximize profits
vertical integration disadvantages
companies may fail to take advantage of supplier who can create economies of scale advantage by pooling demand from numbers companies while the economies of scale factor can be appealing, a company must be careful to retain control over activities that are essential to maintaining its competitive position
sunk cost
costs that have already been incurred and cannot be changed regardless of what a manager decides to do
make or buy decision
depreciation and allocated general overhead are NOT relevant in making decision ---depreciation is a sunk cost on the equipment that the could not get back if they decided to buy instead of make and allocated general overhead are irrelevant because it is assumed that all these cost are common is all items produced in the factory and would be unchanged if the company decided to buy--- be aware of the space that making a product takes up. opportunity costs are NOT recorded in general ledger because they do not represent actual dollar outlays
differential approach
focuses solely on the relevant costs and benefits
what cost can be avoided by dropping a line
have to look at which parts of fixed costs are associated with line that is adding or dropping if a line is losing money that doesnt meant you have to drop it --common fixed costs that are allocated with each product line. allocating common fixed cost can make a product like look less profitable than it really is managers may Choose to keep a line that un unprofitable if it helps sell other products
special order details
one time made to order, not part of company's normal business. have to decide if its worth it to accept when analyzing a special order only the incremental costs and benefits are relevant ---fixed MOH cost would not be affected, they are not relevant should be accepted if incremental revenue exceeds incremental cost BUT need to take in consideration that the special order does not cut into normal unit sales or undercut process on normal unit sales
opportunity costs
potential benefit that is given when one alternate is selected over another
sell or process further
the decision as to whether a joint product should be sold at split off point or processed further
when companies face constraints
they must decide which product or services make the most profitable use of those limited resources -fixed costs stay the stay regardless of how a constraint resource is used-irrelevant -to maximize profits, focus on the CM PER UNIT OF CONSTRAINED RESOURCE -relaxing (elevating) the constraint-when a manager increases the capacity of the bottleneck
joint product
two or more products are produced from single raw material input
activity based costing
used to identify potentially relevant cost for decision making purposes. -improves traceability of costs by focusing on the activities caused by a product or segment -caution against reading into traceability=people assume that if a cost is traceable to a segment, then it is automatically an avoidable cost
vertical integration
when a company "makes" more in its value chain
differential rev
future rev that differs between any 2 alternatives RELEVANT BENEFITS
vertical integration advantages
smoother parts of parts and materials better quality control producing own parts realize profits from making instead of buying