1. Relevant Information for Special Decisions Chapter 13 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 13-2 Learning Objectives 1.Identify the characteristics of relevant information. 2.Distinguish between unit-level, batch-level, product-level, and facility-level costs and understand how these costs affect decision making. 3.Make appropriate special order decisions. 4.Make appropriate outsourcing decisions. 5.Make appropriate segment elimination decisions. 6.Make appropriate asset replacement decisions.

3. 13-3 Relevant Information Two primary characteristics distinguish relevant from useless information: 1.Relevant information differs among the alternatives under consideration. 2.Relevant information is future oriented. Two primary characteristics distinguish relevant from useless information: 1.Relevant information differs among the alternatives under consideration. 2.Relevant information is future oriented.

4. 13-4 Sunk Cost A sunk cost has been incurred in a past transaction and cannot be changed, it is not relevant for making current decisions. Why are you complaining? You have two offers at or near the market value, so the $25,000 is not relevant – it’s a sunk cost. Wish I hadn’t bought that car! It cost me $25,000, and now its worth only $19,000. I really don’t want to take a loss on it but I need the cash more than I need the car!

5. 13-5 Opportunity Cost An opportunity cost is the sacrifice that is incurred in order to obtain an alternative opportunity. Your opportunity cost of ownership is $19,000 or the highest value of the available alternatives. Even though the car cost me $25,000, I can sell it to my relative for $18,000 or for $19,000 to my neighbor. So what is my opportunity cost of keeping the car rather than getting the cash?

6. 13-6 Relevance – Other Issues Relevance is context-sensitive. A particular cost that is relevant in one context may be irrelevant in another. Relevance versus Accuracy. Information need not be exact to be relevant.

7. 13-7 Quantitative vs. Qualitative Data Relevant information can have both quantitative and qualitative characteristics. Features such as company reputation, welfare of employees, and customer satisfaction Numbers or amounts used in decision making Both quantitative and qualitative data are relevant to decision making.

8. 13-8 Relevant (Avoidable) Costs Businesses seek to minimize costs. Managers avoid costs whenever possible. Relevant costs are frequently called avoidable or differential costs. They are costs managers can eliminate by making specific choices.

9. 13-9 Differential Revenue Revenue that differs between alternatives is called differential and is relevant to decision making. Peck’s Department Store sells clothes for women, men and children and is considering eliminating the children’s. The revenue from selling children’s is relevant to this decision because it differs based on alternative chosen.

10. 13-10 Cost Avoidance & Cost Hierarchy Unit-level Activities Batch-level Activities Product-level Activities Facility-level Activities Avoided by eliminating one unit of product. Avoided when a batch of work is eliminated. Avoided if a product line is eliminated. Avoided if the company is dissolved; some costs may be avoided if a business segment is eliminated.

11. 13-11 Relevant Information and Special Decisions Occasionally, a company receives an offer to sell its product at a price significantly below its normal selling price. The company must make a special order decision about whether to accept or reject the offer.

12. 13-12 Opportunity Costs The sacrifice represented by a lost opportunity is an opportunity cost. Opportunity costs that are (1) future oriented and (2) differ between the alternatives are relevant for decision making, but are extremely difficult to measure. If Premier can lease its excess capacity for $15,000 but instead uses excess capacity to make additional computers, then it foregoes the opportunity to lease the excess capacity. Sacrificing the potential leasing revenue is an opportunity cost of $15,000. It factors into the decision in the following manner.

13. 13-13 Outsourcing Decisions outsourcing Companies can sometimes purchase products needed in the manufacturing process for less than it would cost to make them. Buying goods and services from other companies rather than producing them internally is commonly called outsourcing. That test was so easy. Why is your score so low? I outsourced my homework!!

14. 13-14 Qualitative Features A company that uses vertical integration controls the full range of activities from acquiring raw materials to distributing goods and services. An oil company, like Exxon, is a good example of vertical integration. Outsourcing reduces the level of vertical integration, passing some of a company’s control over its production to outside suppliers. But is the supplier reliable? What about quality, timely delivery, future prices and other qualitative considerations? Outsourcing reduces the level of vertical integration, passing some of a company’s control over its production to outside suppliers. But is the supplier reliable? What about quality, timely delivery, future prices and other qualitative considerations?

15. 13-15

16. 13-16 End of Chapter Thirteen