CHP 6: RELEVANT INFORMATION & DECISION MAKING



Acct 2220: Chp 6 Relevant Info for Special Decisions

H/W: E6-2A, E6-7A/E6-8A, E6-13A, P6-30A & Canvas (P6-28A)

(Omit pg 218-219 & Appendix)

We will cover three typical mgmt decision-making models:

1) Should we accept a “special order” at reduced pricing?

2) Should we outsource (make vs. buy) products or services?

3) What product lines should we modify or eliminate?

Key: What information is relevant to the decision at hand?

** Characteristics of Relevant Information (pg 206) **

Information is relevant if it:

A) Differs among the alternatives available, and

B) Is future-oriented.

Note: Historical information may be helpful to support future decision-making, but it does not differ among the alternatives as we can’t change past events or decisions.

Cost Terminology (pg 206-209):

-Sunk Cost: A cost that has been incurred and will exist regardless of any alternative chosen (i.e. always irrelevant).

-Opportunity Cost: Not a recorded cost, but the single highest “foregone benefit” lost by taking one action over another.

-Differential Revenue & Avoidable Cost: A future revenue or avoidable cost by choosing one action over another.

Relationship of Cost Avoidance to Cost Hierarchy (pg 208):

- Unit-level: Avoidable by eliminating units of product.

- Batch-level: Eliminating batch work avoids unit & batch costs.

- Product-level: Avoidable by eliminating product line.

- Facility-level: Avoidable by eliminating the facility.

Note: Relevance is “context-sensitive” (pg 207).

A particular cost (or revenue) may be relevant in one context, but irrelevant in another depending on the question at hand. Thoughtful analysis is required here.

Management Behavioral Issues:

- Short-term vs. long-term evaluations.

- Quantitative vs. Qualitative information impact.

Note: Decision-Making requires management to choose between alternative courses of action. Success often depends on the ability to correctly identify relevant information.

We will address three typical decision-making models:

1) Special Order decision (pg 209 & E6-7A, E6-8A, P6-30A, GQ#2):

-Focus on differential revenue vs. differential cost.

-Which costs are relevant in the short run?

-Impact of accepting special order on regular prices?

-Do we have the “capacity” to accept the order?

-What are the qualitative aspects of the decision?

-Apply the typical CVP (CM) format to analyze.

2) Outsourcing Decisions (pg 212 & E6-12A, E6-13A, P6-30A, GQ#2)

- Should we Make or Buy?

- What costs are relevant (i.e. avoidable) by buying?

- Idle production capacity issues:

What to do with vacated or unused factory space?

- What about qualitative considerations:

- Expertise, quality control, stable workforce issues?

3) Eliminating a Business Segment (pg 215, P6-30A, Canvas, GQ#2)

-Focus: Compare lost contribution margin to avoidable costs if the product line is dropped.

-Closely analyze fixed-cost allocation schemes here!

-Possible “Complementary Effects” of (i.e. impact on) other products?

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