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| Focusing on the costs and benefits that differ between the alternatives. |
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| Costs that differ between alternatives. |
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| Distinguishing between relevant and irrelevant costs and benefits is critical for two reasons: |
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1. Irrelevant data can be ignored--saving decision makers tremendous amounts of time and effort.
2. Bad decisions can easily result from erroneously including irrelevant costs and benefits when analyzing alternatives. |
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| Benefits that differ between alternatives. |
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| A cost that can be eliminated by choosing one alternative over another. |
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| Example of Avoidable Costs |
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| By choosing the alternative of going to the movie, the cost of renting the DVD can be avoided. By choosing the alternative of renting the DVD, the cost of the movie ticket can be avoided. |
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| A cost that has already been incurred and cannot be avoided regardless of what a manager decides to do. |
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| Suppose a used car dealer purchased a five-year-old Toyota Camry for $12,000. The amount paid for the Camry is a sunk cost because it has already been incurred and the transaction cannot be undone. |
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| If they don't differ between alternatives then they should be ignored. |
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| If you are going to buy the same pizza regardless of your choice of entertainment, the cost of the pizza is irrelevant to the choice of whether you go to the movie theater or rent a DVD. Notice, the cost of the pizza is not a sunk cost because it has not yet been incurred. Nontheless, the cost of the pizza is irrelevant to the entertainment decision because it is a future cost that does not differ between the alternatives. |
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Term
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| Costs and Benefits that differ between alternatives are relevant in a decision. |
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Term
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| Depreciation because it is spread over an amount of years(or whatever). |
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Term
| The cost of gasoline consumed by driving to New York City is what kind of Cost? |
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| The annual cost of auto insurance and license is relevant or irrelevant? (You need them annually) |
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Term
| The decline in the resale value of the car that occurs as a consequence of driving more miles is what kind of cost? |
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Term
| Why keep a product line that is showing a loss? |
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Definition
One of the great dangers in allocating common fixed costs is that such allocations can make a product line look less profitable than it really is. Dropping a product line could result in a decrease in the company's overall net operating income.
Additionally, managers may choose to retain an unprofitable product line if the line helps sell other products, or if it serves as a "magnet" to attract customers. |
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Term
| Comparative Format Approach |
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Definition
| Decisions can be represented on comparative incomes statements showing the effects of either keeping or dropping the product line. |
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Development
Production
After-Sales Service |
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| When a company is involved in more than one activity in the entire value chain. |
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| A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier. |
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| Make or Buy Decisions Involve: |
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Definition
Whether to buy a particular part or to make it internally.
Also, they also involve decisions concerning whether to outsource development tasks, after-sales service, or other activities. |
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| A one-time order that is not considered part of the company's normal ongoing business. |
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| When a limited resource of some type restricts the company's ability to satisfy demand. |
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| If some products must be cut back because of a constraint, the correct solution is: |
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Definition
| To favor the products that provide the highest contribution margin per unit of the constrained resource. |
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| The machine or process that is limiting overall output. |
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| Producing up to demand would require 15,000 minutes, but only 12,000 minutes are available. |
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| If there is a bottleneck, managers will want to know which product is less profitable by using a calculation to find the amount of money it takes to produce one unit of each. The calculation to find the contribution margin per unit of the constrained resource is: |
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Definition
| Dividing a product Contribution Margin per unit by the amount of the constrained resource required to make a unit of that product. Finding these amounts will help the managers decide which product is less profitable and which should be deemphasized. |
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Term
| Why is looking at the unit contribution margin not enough? |
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Definition
| The contribution margin must be viewed in relation to the amount of the constrained resource each product requires. |
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Term
Relaxing the Constraint
(Elevating) |
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Definition
| When a manager increases the capacity of the bottleneck. |
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| Example of Relaxing a Constraint |
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Definition
| The stitching machine operator could be asked to work overtime. |
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Term
| Capacity of a bottleneck could be effectively increased in a number of ways: |
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Definition
-Working overtime on the bottleneck
-Subcontracting some of the processing that would be done at the bottleneck
-Investing in additional machines at the bottleneck
-Shifting workers from processes that are not bottlenecks to the process that is the bottleneck
-Focusing business process improvement efforts on the bottleneck
-Reducing defective units. Each defective unit that is processed through the bottleneck and subsequently scrapped takes the place of a good unit that could have been sold. |
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Term
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| Two or more products that are produced from a common input. |
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| The point in the manufacturing process at which the joint products can be recognized as separate products. |
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Term
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| Used to describe the costs incurred up to the split-off point. |
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Term
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Definition
| Common costs that are incurred to simultaneously produce a variety of end products. These joint costs are traditionally allocated amoung the different products at the split-off point. A typical apprach is to allocate the joint costs according to the relative sales value of the end products. |
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| What kind of costs are irrelevant in decisions regarding what to do with a product from the split-off point forward? |
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Definition
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Term
| Once the split-off point is reached, what kind of costs have already been incurred and nothing can be done to avoid them? |
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Term
| Sell of Process Further Decisions |
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Definition
| It is profitable to continue processing a joint product after the split-off point so long as the incremental revenue from such processing exceeds the incremental processing cost incurred after the split-off point Joint costs that have already been incurred up to the split-off point are always irrelevant in decisions concerning what to do from the split-off point forward. |
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