L7 Relevant Costing
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Transcript of L7 Relevant Costing
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Management Accounting & Decisions II N12401
Lecture 7
Relevant Costing For Decisions
by Hung Woan-Ting
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Learning Objectives
1. To understand the framework of decision-making
2. To understand the concept of relevant cost (revenue)
3. To be familiar with the different types of decisions and apply the concept of relevant cost (revenue) in arriving at a decision
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1.0 Decision-Making Model
1. Identify objectives
2. Search alternative courses of action
3. Gather data about alternatives
4. Select alternative courses of action
5. Implement the decisions
6. Compare actual & planned outcomes
7. Respond to divergences from plan
Pla
nnin
g
pro
cess
Contr
ol
pro
cess
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1.1 Decision Logic
Financial Accounting Logic Decision Logic
Perspective Historical
Verifiability
Average
Transaction
Profit
Future
Relevance
Decision
Cash Flow
Marginal
Objective
Unit
Prompt
Result
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2.0 Info Relevant for Decisions
Information considered for decision-making
Financials & non-financials
Underlying assumptions
profit maximization objectives
certainty of information
known cost behaviour pattern
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Some familiar cost categorizations:
Relationship between cost item and cost object
Behaviour at different activity level
Issues faced:
Is unit cost data relevant for decision-making?
Are variable costs relevant? Always?
Are fixed costs always irrelevant? Always?
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2.1 Info Relevant for Decisions
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In search of a cost categorization that support
decision making reflect cost relevance
Concept of RELEVANCE
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Costs (revenues) that will be incurred (earned)
in the future
Costs/revenues that would differ between alternative decisions
Costs/Revenues that are cash flows
Opportunity costs
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Fly??
Cat sitter $20/day
Airfare & cab $600
7 days in Penang
Hotel stay 8nights@$90/night
Food 8days@ $30/day
Drive??
Cat sitter $20/day
Petrol & Toll $200; Car insurance $900/yr
6 days in Penang
Hotel stay 7nights@$90/night
Food 8days@ $30/day
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Example: You are planning to take a holiday after the MAD2 exam. Youd like to make a trip to Penang up north.
Analyse these info and decide on your vacation plan!?
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2.3 Info Relevant for Decisions
Possible categories of costs according to relevance
Future costs vs. Sunk costs
Incremental costs vs. Common costs
Avoidable costs vs. Unavoidable costs
Opportunity costs
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3.0 Typical Managerial Decisions
Capital investment decisions
Pricing decisions
Adding/dropping product/segment
Choice of Product
Accept special orders
Make or buy
Joint product to further process
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3.1 Add/Drop Product Line
Example 1:
Should the business discontinue with Central?
Southern Northern Central Total
000 000 000 000
Sales 900 1000 900 2800
Variable costs (466) (528) (598) (1592)
Fixed costs (266) (318) (358) (942)
Profit/(Loss) 168 154 (56) 266
If discontinued, 250 000 of fixed costs in Central and all of its variable costs are avoidable.
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Decision criteria:
Feasibility of the product line concerned
If continue with Central:
relevant revenues =______
relevant costs = _________
Contribution provided by Central = ______
Based solely on this, decision should be to _________
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3.2 Choice of Product
Example 2:
Should the business choose product X or Y?
$ Per unit
Product X Y
DM 10 20
DL 5 8
VOH 5 8
FOH 3 3
Selling Price 32 50
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Decision criteria:
Profitability of the products
$ Per unit
Product X Y
DM 10 20
DL 5 8
VO/h 5 8
FO/h 3 3
Selling Price 32 50
Contribution ___ ___
Based solely on this, decision should be to choose ____
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3.3 Choice of Product With Constraints
Example 3:
Machine capacity is limited. Should the business choose product X or Y?
$ Per unit
Product X Y
DM 10 20
DL 5 8
VO/h 5 8
FO/h 3 3
Selling Price 32 50
Contribution 12 14
Machine hr p.u. 3 4
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Decision criteria:
Profitability of the products in utilising the limited resources available
$ Per unit
Product X Y
DM 10 20
DL 5 8
VO/h 5 8
FO/h 3 3
Selling Price 32 50
Contribution 12 14
Machine hr p.u. 3 4
Contribution/MH ___ ___
Based solely on this, decision should be to choose Product ____
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3.4 Accept Special Orders
Example 5:
There is a one-time order for the Companys existing product. Should the order be accepted?
Company has capacity to produce 100,000 units p.a.
Total Per unit
Sales (at 100K units) 600K 6.0
Variable costs 150K 1.5
Fixed costs 250K 2.5
Net Profit 200K 2.0
The order involves 10,000 units at 3p.u, with no effect on fixed costs.
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Decision criterion:
Incremental revenue vs. Incremental cost of the order
Scenario 1: Regular sale level is 80K units. Incremental revenue = Incremental costs = Decision should be to ______ order Scenario 2: Regular sale level is 100K units. Incremental revenue = Incremental costs = Decision should be to ______ order
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Make or Buy?
Decision-criteria:
_________ vs. __________
Joint product to further process?
Decision-criteria:
_________ vs. __________
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3.5 Other business decisions..
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Readings & Exe.
1.Read the following chapters in the prescribed textbooks
GNBCY Ch14
AHM Ch26
2.Attempt the Question Sets attached at the back of
this handout (indicative solutions in Moodle for self-checking)
End of Lecture