Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fifth Edition McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 1

Relevant Costing for Managerial Decisions Chapter 23 Relevant Costing for Managerial Decisions 23-2

Conceptual Learning Objectives C1: Describe the importance of relevant costs for short-term decisions. 23-3

Analytical Learning Objectives A1: Evaluate short-term managerial decisions using relevant costs. A2: Determine product selling price based on total costs. 23-4

Procedural Learning Objectives P1: Identify relevant costs and apply them to managerial decisions 23-5

Decision Making Decision making involves five steps: Define the decision task. Identify alternative courses of action. Collect relevant information and evaluate each alternative. Select the preferred course of action. Analyze and assess decisions made. 23-6

Relevant Costs Are applicable to a particular decision. Should have a bearing on which alternative a manager selects. Are avoidable. Are future costs that differ between alternatives. 1 2 23-7

Classification by Relevance: Sunk Costs All costs incurred in the past that cannot be changed by any decision made now or in the future. Sunk costs should not be considered in decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost. 23-8

Classification by Relevance: Out-of-Pocket Costs Future outlays of cash associated with a particular decision. Out-of-Pocket-Costs ARE relative for current and future decision making. Example: Considering the decision to take a vacation or stay at home, you will have travel costs (out-of-pocket costs) only if you choose a vacation. 23-9

Classification by Relevance: Opportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year is $20,000. 23-10

Accepting Additional Business The decision to accept additional business should be based on incremental costs and incremental revenues. Incremental amounts are those that occur if the company decides to accept the new business. Management needs to know whether accepting the offer will increase net income Thanks for the offer! Let me talk to our management team and I’ll let you know tomorrow. 23-11

Make or Buy Decisions A1 Incremental costs also are important in the decision to make a component or purchase it from a supplier. The cost to produce an item must include (1) direct materials, (2) direct labor, and (3) incremental overhead. We should not use the predetermined overhead rate to determine product cost. 23-12

Scrap or Rework A1 Costs incurred in manufacturing units of product that do not meet quality standards are sunk costs and cannot be recovered. As long as rework costs are recovered through sale of the product, and rework does not interfere with normal production, we should rework rather than scrap products in process. 23-13

Sell or Process A1 Businesses are often faced with the decision to sell partially completed products or to process them to completion. As a general rule, we process further only if incremental revenues exceed incremental costs. 23-14

Sales Mix Selection A1 When a company sells a variety of products, some are likely to be more profitable than others. They are wise to concentrate sales efforts on more profitable products. How do they identify the best sales mix? To make an informed decision, management must consider . . . The contribution margin of each product The facilities required to produce each product and any constraints on the facilities The demand for each product. 23-15

Qualitative Decisions Factors Qualitative factors are involved in most all managerial decisions. For example: Quality. Delivery schedule. Supplier reputation. Employee morale. Effects on the company’s image. 23-16

Setting Product Prices A2 Relevant costs are useful to management to assist in determining prices for special short- term decisions. However, long-run pricing decisions also need to cover both variable and fixed costs, and yield a profit. There are several methods to help management in setting prices The “cost plus” method, where management adds a mark-up to the costs to reach a target price is most common. 23-17

End of Chapter 23 23-18