CH 5: Relevant Costs and Decision Making

What are the steps in the decision making frame work

Outline prob and related unknowns
Identify suitable options and gather relative qual and quant data (make assumptions here)
Calc relevant costs and benefits
Select option with max benefits meeting required qual criteria
Implement decision

Costs that directly matter to the particular decision being made now; assist in making the decision by helping to dismiss other costs; change between alternatives

Relevant costs

What are the three characteristics of relevant costs

Differential
Avoidable
Future

type of analysis that focuses on costs and benefits that differ between alternatives; also called relevant cost approach

Differential Approach

A method of decision-making that reviews all costs and options

total cost approach

Describes decisions in which a company compares the cost and logic of manufacturing a product versus buying it from a supplier

Insource v outsource (make v buy)

What are the processes that must me considered in a make/buy decision

Core
Critical
Commodity

The company must control these processes in house and NOT outsource, perhaps because they are proprietary or confidential
ex: companies quickly outsource IT but keep technological innovation in house

Core processes

process that can potentially be outsourced to reputable, best in class vendors
ex: financial services for small companies

critical processes

Processes that can often be outsourced without losing competitive advantage
ex: payroll processes

Commodity processes

Using a service provider in another country

offshoring

Describes a decision in which managers compare the costs of keeping or dropping a product line or a business segment

Keep v drop

What are four important factors to consider in a keep v drop decision

CM lost to drop
Unavoidable FC
Are avoided FC>CM given up
Bundled Purchases

Describes decisions in which companies determine which specific products and services, and how many of each, to make, stock, or offer.

Product mix

In simple product mix decisions, managers prioritize products with the highest ___ per unit, which then maximizes the company’s total ___ and, in turn, its operating income

Contribution Margin (CM)

ratio of actual sales of each product to total sales

sales mix

For product mix decisions with a constrained resource, managers prioritize products with the highest ___ per unit of the constrained resource

CM

Sales opportunities that companies contemplate in the short term to respond to a customer’s special request

special orders

What is the guideline for special order decisions

calc the differential CM from special order - FC

stop and stay exactly as is

status quo

The costs and benefits of those paths not taken when a decision is made; potential benefits less potential costs

opportunity costs

Fixed costs that are clearly attributable to a product line, segment, or division

Direct FC

Measures the economic value each business segment provides to an organization

segment margin

Segment Margin =

Sales - VC - Direct FC

Costs of providing the factory’s capacity and/or keeping the factory itself in operation

Common FC

What are the main types of common fixed costs? (5)

Rent
Depreciation on facility
Property taxes
Insurance
Heating/AC

What are the main types of direct fixed costs (4)

Equipment
Depreciation on equipment used in product line
Supervisors salary (over product line)
Workers wages (in product line)

Fixed costs that are not differential, are not relevant to make v buy decision or keep v drop decision because are for facility and provide capacity to operate; are unavoidable

Common FC

What are the characteristics of common FCs

Not differential
Not relevant
Unavoidable

Fixed costs that can be readily assigned to a certain project, product, or business segment

Allocated FC

What are the characteristics of allocated FCs

Unavoidable
Allocated
Only eliminated by going out of business