Chapter 23 - Relevant Costs for Managerial Decisions

managerial decision making has 5 steps

(1) define the decision

(2) identify alternatives

(3) collect relevant info and evaluate alternatives

(4) select course of action

(5) analyze and assess decisions made

what do managers use for decision making

financial info

nonfinancial important as well but financial is more important

nonfinancial includes environmental and social data

relevant costs and benefits

future-oriented and focus on incremental effects from alternative managerial decisions

incremental revenues

additional rvenues from selecting a certain course of action over another

incremental costs

additional costs from selecting a certain course of actoin

**incremental aka differential or avoidable

incremental income

incremental revs - incremental costs

4 types of costs important in distinguising relevant costs

sunk costs

out of pocket cost

opportunity cost

avoidable cost

sunk costs

arises from a past decision, can;t be avoided or changed

**irrelevant to current and future decisions

out of pocket cost

requires future outlay of cash

relevant to decisions

opportuinty cost

potential benefit lost by taking one action instead of the other

relevant to decisions even though not included in accoutning recrods

avoidable cost

cost that can be eliminated by choosing one action vs another

ALWAYS relevant

outsourcing

buying goods or services from an external supplier

decisoin to make or buy

selec action w lower cost

decision to sell or process

select action w higher income

decision to scrap or rework

pick one that has higher income

sales mix w constrained resources

When a company sells a mix of products, and its production facilities are operating at or near capacity, management looks for the most profitable sales mix of products

When a company sells a mix of products, and its production facilities are operating at or near capacity, management looks for the most profitable sales mix of products

The company should produce the model that yields the highest contribution margin per machine hour, until market demand is satisfied.

unlimited demand

if market will buy all that the company can produce, company should deote all hours to that one product

limited demand

if demand is limited to 200/300 hours, then only produce that many then use the other 100 hours for the other product

segment elimination

segments w contribution margin < avoidable fixed costs are candidates for elimination

avoidable costs eliminated when segment is eliminated

unavoidable remain even if segment is elimijated and are allocated to remaining segments

RULE: a segment should be eliinated if income increases from elimination

keep or replace decision

replace aset if income increases

blockchain

accounting ledge that is continuously and simultaneously updated and verified

blockchain technology makes it difficult for the ledger to be modified wout a detailed record of changes

transparency of blockchain ledge means reliable info is available in real time and on demand —> accelerates and enhances managerial decisions

can also enhance supply chain transparency

price takers

strong competition

product not unique 

product not branded

low barriers to entry

**uses target pricing

price setters

weak competition

product is unique

product is branded

high barriers to entry

—> cost-plus pricing

3 normal pricing methods

cost plus

target

variable

cost plus

aka total cost method

total costs = product costs + SG&A

total cost per unit = total costs / total units expected to be produced and sold

markup per unit = total cost per unit x markup percentage

selling price per unit = total cost per unit + markup per unit

**management adds markup to cost

target cost method

target cost = expected selling price - target profit

variable cost method

detrmines price by adding markup to variable cost

markup percentage = (target profit + total fixed costs) / total variable cost

markup per unit = variable cost per unit x markup percentage

selling price per unit = vcpu + mpu

special pricing

sometimes companies receive special offers at prices lower than normal selling prices

evaluate by looking at income effects

accept special offer if income increases, reject otherwise

time and materials pricing

comapnies set price for DL and for DM, each include overhead costs and target prpfit

(1) compute time charge in $ per hour of DL, includes charge for non materials related overhead costs + target profit

(2) materials markup (%), includes overhead costs related to buying, storing, and handling materials, plus a target profit margin on materials’ cost

(3) estimate direct labor hours and costs, DM cost, and markup to get price