Ch.3 Using Costs in Decision Making

Sunk Costs

The costs of resources that already have been committed and cannot be changed by any current action or decision; contrast with incremental costs.

Avoidable Cost

The costs that can be eliminated when a part, product, product line, or business segment is discontinued.

Contribution Margin

The difference between total revenue and total variable cost.

Cost-volume-profit (CVP) analysis

A study of how costs and profits vary with changes in volume.

Opportunity Cost

The maximum value sacrificed when a course of action is chosen.

Relevant Cost

A cost that changes as a result of making a decision, or a cost that differs between two decision alternatives. For example, the cost of a new piece of production equipment and its operating costs are relevant costs when considering whether to replace an existing piece of equipment with the new one. When considering which of two pieces production equipment to purchase, the difference between their purchase prices and their operating costs are relevant costs.

Step Variable Costs

A cost that changes in steps as some underling volume and activity changes. For example, the cost of a train of freight cars will increase in steps as the capacity of each car is exceeded and another car gets added to the train.

Pricing

1. Organizations will use product cost information to decide whether its cost structure will allow it to compete profitably. (Market-Determined Price). 2. Organizations will often set a price that is an increment of its products cost, called cost plus pricing. (Where organization can set its price).

Mixed Cost

A cost that includes fixed and variable components. A mobile telephone bill that includes a basic fixed amount each month and a variable amount that reflects the amount of use is an example of a mixed cost to the consumer.

Make-or-buy decision

A decision in which managers must decide whether their companies should manufacture some parts and components for their products in-house or subcontract with another company to supply these parts and components.

Budgeting

Management accounting tool that projects or forecasts costs for various levels of production and sales activity. Budgeting sets the organization's direction for the budget period and provide the basis for earnings forecasts that senior executives issue to the stock market.

Performance Evaluation

Managers compare the actual results from the budget period with expectations that were reflected in the budget to assess how well the organization did in light of its expectations.

Contribution Margin Per Unit

The contribution that each unit makes to covering fixed costs and providing a profit.

Product Planning

Organizations use a tool called target costing to focus efforts in product and process design on developing a product and process design on developing a product that has a good profit potential in view of market requirements.

Manufacturing Overhead Cost

Refers to all factory costs that are not considered direct materials or direct labor. Examples of manufacturing overhead costs include depreciation on factory equipment, supervision, unities, and the cost of supplies such as lubricants.

Contracting

Reimbursement contracts organizations are reimbursed their cost plus and increment for the goods or services they provide under the contract.

Variable Cost

The cost of flexible resources. One that increases proportionally with changes in the activity level of some variable.

Direct Materials Costs

The cost of materials that can be traced reasonably and accurately to a single cost object, usually a product.

Fixed Costs

The cost that is associated with capacity related resources. The amount of fixed costs is related to the planned rather than the actual level of activities.

Increment Costs

The amount by which the total cost of production and sales increase when one additional unit of a product is produced and sold.

Contribution Margin Ratio

The ration of a product's contribution margin to its selling price. It is the fraction of each sales dollar that contributes to covering fixed cost and providing a profit.

Direct Labor Costs

Wages paid to workers whose time can be traced reasonably and accurately to a single cost object, usually a product.