Chapter 10:

Relevant Information for

Decision Making
Cost Accounting:
Foundations and Evolutions, 8e
Kinney Raiborn

Learning Objectives

What factors determine the relevance of information to

decision making?
What are sunk costs, and why are they not relevant in
making decisions?
What information is relevant in an outsourcing decision?
How can management achieve the highest return from
use of a scarce resource?
What variables do managers use to manipulate sales
mix?
How are special prices set, and when are they used?
How do managers determine whether a product line
should be retained or discontinued?
(Appendix) How is linear programming used to optimally
manage multiple resource constraints?

Relevant Costing

Relevant Costing focuses managerial

attention on a decisions relevant facts
Relevance

Associated with the decision under consideration

Important to the decision maker
Connected to or bearing on some future endeavor

Most variable costs are relevant

Most fixed costs are not relevant

Incremental Revenue, Cost, & Profit/Loss

Incremental Revenuethe amount of

revenue that differs across decision choices
Incremental Cost or Differential Costthe
amount of cost that varies across decision
choices
Incremental Profit or Lossthe difference
between incremental revenue and
incremental cost

Opportunity & Sunk Costs

Opportunity Costsbenefits foregone

because one course of action is chosen over
another
Sunk Costscosts incurred in the past to
acquire an asset or a resource

Not relevant because they cannot be changed

regardless of future actions
Not recoverable

SUNK COSTS ARE IRRELEVANT.

Relevant Costing & Business

Decisions

Outsourcing a product or part

Allocating scarce resources
Accepting special orders
Determining the sales/production mix

Outsourcing & Make-or-Buy Decions

Outsourcinghaving work performed for one

company by an off-site non-affiliated supplier
Offshoringsending a job formerly performed in the
home country to a foreign country
Make-or-Buy decisions compare internal production
and opportunity costs with purchase cost

Relevant information:

Strategic
Economic
Technological
Management and human resources

Most outsourcing relates to operating costs not to

strategic core competencies

Make-or-BuyQuantitative Factors
Incremental production costs per unit
Cost to purchase outside
Number of available suppliers
Production capacity available
Opportunity costs of production facilities

Space available for storage

Inventory carrying costs
Increase in throughput from buying
components

Make-or-BuyQualitative Factors

Reliability of supply sources

Ability to control quality of items purchased
outside
Nature/importance of the work to be
subcontracted
Impact on customers and markets
Future bargaining position with supplier(s)
Perceptions about future price changes
Perceptions about current product prices

Outsourcing Risk Pyramid

Outsource under
Tight Control

Outsource under
Service Levels

Never
Outsource

Strategic
Direction,
Unique Core
Competencies
Tax, Audit, Legal
Information Technology

Help Desk, Call Centers

Data Centers, Logistics

Low-Risk
Outsourcing

Facility, Network, Supply-Chain

Management, Temporary Staffing,
Payroll, Security Services, Food Services

Services Often Outsourced

Accounting and legal services

School bus programs
Medicalblood testing
Process design activities
Utilities
Engineering services
Employee health services

Scare Resources

Essential to production
activity but available only in
limited quantity

Machine hours
Skilled labor hours
Raw materials
Production capacity

Choose product or service

with highest contribution
margin per unit of scarce
resource
When there are several
limiting factors, use linear
programming to choose
product or service
Before eliminating products
or services, consider
qualitative factors

Company reputation
Impact on customer base
Market saturation
Company stagnation

Production Choices

Production and sale of some less

profitable products may be necessary to
maintain either customer satisfaction or
sales of other products
Low CM on razors may be
required to obtain high CM
on razor blades

Sales Mix Decisions

Sales Mixrelative quantities of the
products that make up the total sales of
a company
Factors affecting sales mix:

Product selling prices

Sales force compensation
Advertising expenditures

Impact of Change in Sales Price

Quantitative Factors

New contribution margin

per unit of each product
Changes in product
demand and production
volume
Best use of scarce
resources

Qualitative Factors

Customer goodwill
Customer loyalty
Response of competitors
Production of new
products

Pricing New Products

Consider the products entire life cycle (long

run)
To set prices at various stages in the
products life cycle, make assumptions about:

Consumer behavior
Competitor behavior
Pace of technology changes
Government posture
Environmental concerns
Size of potential market
Demographic changes

Impact of Change in Compensation

Commission based on fixed percentage of

gross sales dollar

Commission based on product contribution

margin

Sell highest priced product

Sell most profitable product

When considering compensation structure

Ignore fixed costs unless the fixed costs are

incremental relative to the new policy or to
changes in sales volume

Impact of Change in Advertising

Increase in advertising
costs may cause

Change in sales mix

Change in sales volume

Advertising budget
changes

Relevant costs

Increased sales revenue

Increased variable costs
Increased fixed costs

Irrelevant costs include

Original fixed costs

Contribution margin
generated by the current
sales levels

Incremental Revenues
Less: Incremental Variable Costs equals
Incremental Contribution Margin
Less: Incremental Fixed Costs equals
Incremental Benefit (or Loss)

Special Order Decisions

Special order decisions involve management
computing a reasonable sales price for products or
services not part of normal operations.

Sales price should

cover:

Variable production and

selling costs
Incremental fixed costs
Profit

Special prices can be

considered for:

Unusual quantity, delivery,

packaging, or
customization of product
One-time job such as an
overseas order that will not
affect the domestic market

Private-Label Orders, Low-Ball Bids

& Ad Hoc Discounts

Private-label order

Buyers name (not producers)

attached to the product
Accept during slack periods to
use available capacity
Fixed costs usually not
allocated
Variable selling costs often
reduced/eliminated
Sales price set to generate a
positive contribution margin

Low-ball bid

To introduce product or
service to particular market
Sales price at or below cost
Cannot be continued over
the long run

Ad Hoc Discounts

Price concessions related to

real (or imagined)
competitive pressures
rather than to the location of
the merchandising chain or
volume purchased

Special Order Decisions

Qualitative Factors

Impact on future prices and sales

Sufficient contribution margin to justify the additional
burden on workers and management
Impact on scarce resources and throughput
Keep workforce employed during slow times
Consider Robinson-Patman Act

Prohibits companies from pricing the same product at

different levels when those amounts do not reflect related
cost differences
Requires that cost differences result from actual variations
in the cost to manufacture, sell, or distribute because of
different methods of production or quantities sold

Product Line and Segment Decisions

Multiproduct Environments

Costs by product lines

Costs of divisions

Separate costs by

Product Line

Distinguish between relevant

and irrelevant information

Commingling relevant and

irrelevant information may
suggest a product line/
segment is operating at a
loss when it is actually
operating at a profit

Revenue
Variable costs
Avoidable direct fixed costs
Unavoidable direct fixed
costs

Common Costs

Unavoidable Direct Fixed

Costs and Common Costs

Will continue even if a

product line or segment is
eliminated
Are irrelevant costs when
deciding to eliminate a
product line or segment

Segment Margin
Income Statement

Use segment margin

to decide to continue
or eliminate a
segment

Sales
<Variable Expenses>
Contribution Margin
<Avoidable/Attributable Fixed Expenses>
Segment Margin
<Unavoidable Fixed Expenses>
Product Line Result
<Allocated Common Expenses>
Net Income (Loss)

Product Line Decisions Beware

Proceeds from sale of equipment are

relevant
Costs that appear to be avoidable may not
be
Depreciation on equipment is irrelevant
Eliminating a product may affect
customers

Customers seek products elsewhere due to

shrinking market assortment

AppendixLinear Programming

Linear Programming
Used to find the optimal allocation of scarce resources in a
situation involving one objective and multiple limiting factors

Resource constraints
Demand or marketing constraints
Technical product constraints
Nonnegativity constraints
Whole number constraints

Helps managers allocate scarce resources among competing

uses

One objective
Maximize contribution margin
Minimize product cost
Optimal solutionprovides best answer to allocation problem

Questions

What are some relevant financial

considerations when making an
outsourcing decision?
How are prices set for special orders?
What types of decisions require segment
margin income statements?

Potential Ethical Issues

Ignoring qualitative factors in decisions

Going offshore to exploit lax environmental and
labor standards
Making decisions based on financial earnings
impact
Using bait-and-switch advertising techniques
Setting prices that violate the Robinson-Patman
Act or other pricing regulations
Substituting materials that pose health or
environmental risks in a scarce resource situation