Management Accounting 3 Opportunity cost

A Five-step Decision Making Process in Planning & Control Identify the problem and uncertainties Obtain information Make predictions about the future Make decisions by choosing between alternatives Implement the decision, evaluate performance, and learn

Cost Classifications For Decision Making Every decision involves a choice between at least two alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. Costs and benefits that differ between alternatives are relevant in a decision.

Cost Concept Cost is a source of sacrifice to achieve specific objective.

Cost of What? Cost Unit Cost units is a unit of quantity of product, service or time in relation to which costs may be ascertained or expressed. The cost will be ascertained on the base of historical or budgeted cost regarding sacrifice relating to cost unit.

Cost of What? Cost Unit Cost unit will be determined on the base of cost-benefit approach. In ascertaining cost of a unit the benefits must be taken into consideration and useless and unnecessary cost calculations must be avoided.

For What the Cost will be Ascertained? The Goal Of Cost Calculations Cost can be calculated for different purposes. The purpose changes the approach to the cost.

For What the cost will be ascertained? The Goal of Cost Calculations Example: The cost occurred in March for ABC Furniture Manufacturing Company are as follows. While the monthly normal production capacity is 3.125 unit, company manufactured 2.500 piece of future in March. Furniture Manufacturing Company Monthly Costs Total Cost Unit Cost Steel Profile (Variable) 1.500 0,6 Wooden Materials (Variable) 1.250 0,5 Direct Labor (Variable) 2.100 0,84 Indirect Labor (Variable) 900 0,36 Utility Cost Of Factory Machinery (Variable) 800 0,32 Selling Cost (Fixed) 700 0,28 Depreciation Cost Of Factory Building And Machinery (Fixed) 1.800 0,72 Transportation Cost (Fixed) 600 0,24 Administrative Cost (Fixed) 850 0,34 10.500 4,2

For What the cost will be ascertained? The Goal of Cost Calculations Decision Production Cost? Selling Price? Selling Price For Covering Factory Costs? Selling Price For Additional Order (Additional Production) Selling Price For Additional Order (Existing Production)

Cost Concepts Relevant Cost (Geçerli, Uygun Maliyet) Costs that are affected by decisions are relevant costs. These are expected future costs, that will differ between alternatives. Future variable costs generally become relevant for decision making, while fixed costs may be irrelevant, if they do not change in total. In the same way if an item of future cost remains same for two or more alternatives, it becomes irrelevant for the decision making.

FOR ADDITIONAL ORDER Unit Cost (TL) Production Cost Normal Selling Price Selling Price That Cover Factory Costs Selling Price For Additional Production Selling Price For Existing Production Steel Profile (Variable) 0,6 Wooden Materials (Variable) 0,5 Direct Labor (Variable) 0,84 Indirect Labor (Variable) 0,36 Utility Cost Of Factory Machinery (Variable) 0,32 Selling Cost (Fixed) 0,28 - Depreciation Cost Of Factory Building And Machinery (Fixed) 0,72 Transportation Cost (Fixed) 0,24 Administrative Cost (Fixed) 0,34 Relevant Cost 3,34 4,2 3,58 2,62 Opportunity Cost*** Selling Price 5,25 3

Cost Concepts Opportunity Cost Opportunity cost (Fırsat Maliyeti) It is the value of a benefit sacrificed in favor of an alternative course of action. It is the measurable advantage foregone as a result of the rejection of best alternative uses of resources, whether of materials, labor or facilities.

Cost Concepts Opportunity Cost Opportunity cost It is the maximum available contribution to profit forgone by using limited resources of a particular purpose. This cost does not involve any cash outlay and is computed only for the purpose of comparison in the context of managerial decisions.

FOR ADDITIONAL ORDER Production Cost Normal Selling Price Selling Price That Cover Factory Costs Selling Price For Additional Production Selling Price For Existing Production Steel Profile (Variable) Wooden Materials (Variable) Direct Labor (Variable) Indirect Labor (Variable) Utility Cost Of Factory Machinery (Variable) Selling Cost (Fixed) Depreciation Cost Of Factory Building And Machinery (Fixed) Transportation Cost (Fixed) Administrative Cost (Fixed) Relevant Cost Opportunity Cost (Sacrificed Benefit) 5,25 Selling Price 3 ABC Company satisfies the demand from existing production. So the sacrificed benefit (income) will be the cost of this choice.

Cost Concepts Relevant Cost -Illustration TL Water and Glucose Syrup (Variable) 1.500 Chemicals (Variable) 3.500 Packing Material (Variable) 500 Factory Utility Cost (Variable) 1.200 Direct Labor Cost (Variable) 2.000 General Administrative Cost (Fixed) 1.000 Factory Building Depreciation Cost (Fixed) 700 Machinery Depreciation Cost (Fixed) 800 Storing and Distributing Cost (Fixed) 900 Selling Cost (Fixed) 400 Total 12.500 Ex: ABC Co. produces 2 liters of plastic bottle soft drinks and sells them in domestic market at an unit price of 2 TL. While the company operates in full capacity in May to October (6 months) the rest months of the year works at 75 % capacity. Company has produced 1.000 bottle of soft drinks in June and the incurred costs are as follows:

For What the cost will be ascertained? The Goal of Cost Calculations Decision Company intends to gain at least 20% profit margin. Evaluate whether the selling price will meet the goal of the company? What is the minimum selling price that covers factory costs? Company received an additional order involving 200 bottles of soft drinks, priced at 10 TL. The storing and distribution costs will be undertaken by the customer. Evaluate the selling price for additional order Cause additional production? Can be supplied from existing production?

  June 100% Capacity May-October 100% Capacity October-May 75% Capacity FOR ADDITIONAL ORDER Selling Price That Cover Factory Costs Cost (TL) Unit Cost Normal Selling Price Unit Production Cost Selling Price For Additional Production October-May Selling Price For Existing Production May-October Selling Price (At 20% Profit Margin) 15  10 Water and Glucose Syrup (Variable) 1.500 1,5 Chemicals (Variable) 3.500 3,5 Packing Material (Bottles) (Variable) 500 0,5 Factory Utility Cost (Variable) 1.200 1,2 Direct Labor Cost (Variable) 2.000 2 Total Variable Cost 8.700  9,5 Factory Building Depreciation Cost (Fixed) 700 0,7 0,93 Machinery Depreciation Cost (Fixed) 800 0,8 1,07 Total Fixed Costs  1.500 General Administrative Cost (Fixed) 1.000 1 Storing and Distributing Cost (Fixed) 900 0,9 Selling Cost (Fixed) 400 0,4 Relevant Cost 12.500 12,5 11,0 11,5 14,1 12,5 x 1,2 Sacrificed benefit is selling price and storing and on the distribution cost will be benefit. Opportunity cost = 15 -0,9 =14,1 REJECT THE ORDER

Cost Concepts Opportunity Cost Ex: ABC Co. is a touristic business and would like to invest 100.000 TL cash surplus for 3 months. Company has three investment alternatives: Alternative 1: Opening a bank account at an annual interest rate of %12. A withholding tax (stopaj) shall be applied by 10%. Alternative 2: Investing to a bond yielding a return of 3% monthly. Alternative 3: By paying in cash 100.000 TL of advance for the next season’s reservation company intends to get an advantage of 10.000 TL discount from seasonal costs. Requirements : Which alternative should be selected by the company (management) and explain the reason.

Cost Concepts Opportunity Cost Decision Opening a bank account at an annual interest rate of %12? Investing to a bond yielding a return of 3% monthly? By paying in cash 100.000 TL of advance for the next season’s reservation company intends to get an advantage of 10.000 TL discount from seasonal costs?

Cost Concepts Opportunity Cost in Decision Making   Alternative 1  Alternative 2 Alternative 3  EXPECTED RETURN - Annual %12 interest rate 3.000   -  - - Monthly 3% return 9.000 - 10.000 TL discount 10.000 EXPECTED COST - 10% Withholding Tax (300) NET PROFIT 2.700 OPPORTUNITY COST (Sacrificed Benefit) (10.000) (9.000) NET ECONOMIC PROFIT/LOSS (7.300) (1.000) 1.000

Cost Concepts Opportunity Cost Ex: ABC Co. is a car rental company and would like to invest 100 TL cash surplus. Company has three investment alternatives: Alternative 1: Investing to 100 unit gold of 1 TL unit price. Company intends to sell 100 unit gold at 2,9 TL unit price for the next year. Alternative 2: Investing to a year maturity treasury bond yielding a return of 84% annually. On the other hand 3 month maturity treasury bonds are issued quarterly. The quarterly return rate of 3 month maturity treasury bonds are as follows: 1st Quarter 60% 3rd Quarter 100% 2nd Quarter 90% 4th Quarter 200% Alternative 3: Investing to US $ at a rate of 7,5TL per $ ($ 13,33 x 7,5=100) Next year the expected currency rate for the US $ is 22 TL. Requirements : Which alternative should be selected by the company (management) and explain the reason.

A Year Maturity Treasury Bond 3 Month Maturity Treasury Bonds $ Alternative 1  Alternative 2 Alternative 3   Gold  A Year Maturity Treasury Bond 3 Month Maturity Treasury Bonds $  Expected Return - Selling Price 290 -  - - Annual Interest Income 84 -Total Interest Income 164,140625 1st Quarter 15 2nd Quarter 25,875 3rd Quarter 35,21875 4th Quarter 88,046875 Exchange Income (Kur Geliri) 293 Expected Cost - Initial Investment (100) Net Profit 190 ≅164,15 193 Opportunity Cost (193) (190) Net Economic Profit/Loss (3) (109) (29) 3 100 x 0,84 100 × 3 month 0,60 12 115 × 3 month 0,90 12 140,875 × 3 month 1 12 176,09375 × 3 month 2 12