A.Management S Decision-Making Process

LECTURE OUTLINE

A.Management’s Decision-Making Process.

1.The steps are:

a.Identify the problem and assign responsibility.

b.Determine and evaluate possible courses of action.

c.Make a decision.

d.Review the results of the decision.

2.Accounting’s contribution to the decision-making process occurs primarilyin steps (b) and (d)—evaluating possible courses of action, and reviewing results.

B.Incremental Analysis.

1.The process used to identify the financial data that change under alternative courses of action is called incremental analysis.

2.Data are relevant to the decision if they will vary in thefuture among the possible alternatives.

3.Incremental analysis sometimes involves changes that might seem contrary to your intuition. For example, sometimes:

a.Variable costs do not change under the alternative courses of
action.

b.Fixed costs do change.

4.Accept an order at a special price.

a.The relevant information is the difference between the variable manufacturing costs to produce the special order and expected revenues.

b.If other sales are affected, then the company would have to consider the lost sales in making the decision.

c.If the company is operating at full capacity, it is likely that the special order would be rejected.

5.Make or buy.

a.In a make or buy decision, the relevant costs are:

(1)The variable manufacturing costs that will be saved.

(2)The fixed manufacturing costs that can be eliminated.

(3)The purchase price.

(4)Opportunity costs: The potential benefit that may be obtained by following an alternative course of action.

6.Sell or process further.

a.Many manufacturers have the option of selling products at a given point in the production cycle or continuing to process with the
expectation of selling them at a later point at a higher price.

b.The basic decision rule is: Process further as long as the incremental revenue from such processing exceeds the incremental processing costs.

c.In many industries, a number of end-products are produced from a single raw material and a common production process. These multiple end-products are referred to as joint products.

d.All costs incurred prior to the point at which the joint products are separately identifiable (the split-off point) are called joint costs.

e.For purposes of determining the cost of each product, joint product costs must be allocated to individual products, frequently based on the relative sales value of the joint products.

f.The allocation of joint product costs is important for the determination of product cost but is irrelevant for any sell-or-process-further decisions since these joint costs are sunk costs. They have already been incurred and cannot be avoided by any subsequent decision.

7.Repair, retain or replace equipment.

a.Management often has to decide whether to continue using an asset or replace it.

b.The relevant items to be considered are:

(1)The effects on variable costs.

(2)The cost of the new equipment.

c.Any trade-in allowance or cash disposal value of the existing asset must also be considered.

d.The book value of the old asset does not affect the decision. Book value is a sunk cost, which is a cost that cannot be changed by any present or future decision.

8.Eliminate an unprofitable segment or product.

a.In deciding whether to eliminate an unprofitable segment or product, the relevant information is the contribution margin produced by the segment or product and the disposition of the segment’s or product’s fixed expenses.

b.In deciding on the future status of an unprofitable segment, management should consider the effect of elimination on remaining segments.

c.Management should also consider the effect that eliminating the segment will have on employees who may have to be discharged or retrained.

9.Qualitative issues play a role in many of the decisions presented in the chapter. Although most qualitative features not easily quantifiable, they should still be considered when making the decision.

20 MINUTE QUIZ

Circle the correct answer.

True/False

1.Determining and evaluating possible courses of action is a step in management’s
decision-making process.

TrueFalse

2.In incremental analysis fixed costs may not change under alternative courses of action, while variable costs may change.

TrueFalse

3.The relevant data to consider in accepting an order at a special price are the additional manufacturing costs incurred and expected revenues.

TrueFalse

4.The basic decision rule to sell or process further is: process further as long as the incremental revenue from such processing exceeds the incremental processing costs.

TrueFalse

5.Book value is a sunk cost and is therefore relevant in incremental analysis of retain or replace equipment.

TrueFalse

6.Fixed manufacturing costs will never be relevant in a make or buy decision.

TrueFalse

7.Opportunity costs are costs that have already been incurred and will not be avoided by any future decision.

TrueFalse

8.In deciding on the future status of an unprofitable segment, management should consider the effect of elimination on the remaining product lines.

TrueFalse

9.Joint product costs are relevant for any sell-or-process further decisions.

TrueFalse

10.Any trade-in allowance or cash disposal value of the old asset is relevant in a retain or replace equipment decision.

TrueFalse

Multiple Choice

1.Which of the following is not a step in management’s decision-making process?

a.Identify the problem and assign responsibility.

b.Determine and evaluate possible courses of action.

c.Make a decision.

d.Prepare financial statements.

2.If revenues are $315,000 under alternative A and $324,000 under alternative B, and costs are $285,000 for A and $306,000 for B, then using the basic approach in incremental analysis, incremental revenues, costs, and net income, in comparing B to A are respectively

a.$9,000, $(21,000), $(12,000).

b.$(9,000), $21,000, $12,000.

c.$9,000, $21,000, $12,000.

d.$(9,000), $(21,000), $(12,000).

3.The cost to manufacture an unfinished unit is $120 ($90 variable, $30 fixed). The selling price per unit is $150. The company has unused productive capacity and has determined that units could be finished and sold for $195 with an increase in variable costs of 40%. What is the additional net income per unit to be gained by finishing the unit?

a.$9.

b.$30.

c.$45.

d.$36.

4.The potential benefit that may be obtained from following an alternative course of action is called

a.opportunity benefit.

b.opportunity cost.

c.relevant cost.

d.sunk cost.

5.In a make or buy decision, the relevant costs include each of the following except the

a.variable manufacturing costs that will be saved.

b.fixed manufacturing costs that can be eliminated.

c.opportunity costs.

d.each of the above is a relevant cost.

ANSWERS TO QUIZ

True/False

1. True 6.False

2. True 7.False

3. True 8.True

4. True 9.False

5. False 10.True

Multiple Choice

1. d.

2. a.

3. a.

4. b.

5. d.

(For Instructor Use Only)21-1