Transcript Relevant Costs

Cornerstones of Managerial
Accounting 2e
Chapter Twelve
Short-Run Decision Making: Relevant
Costing and Inventory Management
Mowen/Hansen
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license.
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Short-Run Decisions
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Small-scale actions that serve a larger purpose
Decisions are made using a decision model
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Used to structure the thinking process
Organizes information
Consists of choosing among alternatives with an
immediate or limited end in view
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Decision-Making Model
1. Define the problem
2. Identify the alternatives
3. Identify the costs and benefits associated
with each feasible alternative
4. Total the relevant costs and benefits for
each alternative
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Relevant costs are future costs that differ
across alternatives
5. Assess the qualitative factors
6. Select alternative with the greatest benefit
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Relevant Costs
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Can consist of both variable and fixed costs
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Additional fixed costs associated with an
alternative are relevant
Changes in supply and demand for resources
must be considered
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Costs which fluctuate with changes in supply and
demand across alternatives are relevant costs
Also known as differential or incremental
costs
Practical interpretation
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All costs that are different
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Make-or-Buy Decisions
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Decisions involving a choice between
internal and external production
Decision process
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Identify feasible alternatives
Identify which costs are relevant
∙ Fixed overhead costs are most likely
irrelevant since they will not differ
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Compare the total relevant costs of
manufacturing with the cost of buying
Make a choice
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Special Order Decisions
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Focus on whether a specially priced order
should be accepted or rejected
Orders can be attractive
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Especially when firm is operating below
maximum productive capacity
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Keep-or-Drop Decisions
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Decision to keep or drop a segment such as
a product line
Variable costing segment financial reports
provide information
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Contribution margin
Segment margin
Relevant costing provides structure to
decision making
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Further Processing of Joint Products
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Joint products
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Split-off point
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Include both common processes and costs up
to split-off point
The point at which separate products become
distinguishable
Common costs are not relevant to the
decision making
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Product Mix Decisions
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Organizations have wide flexibility in
choosing their product mix
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Maximizing total profit is the goal
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Mix has significant impact on profitability
Fixed cost will not change with mix, therefore
not relevant
Focus should be on maximizing total
contribution margin
Limitations on resources are called
“constraints”
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Cost-Based Pricing
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Most companies start with cost to determine
price
Formula:
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Price = Product cost + Markup
Markup is percentage of base cost
∙ Includes:
▫ Costs not in base cost
▫ Desired profit
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Advantage – Ease of use
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Target Costing and Pricing
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Determining price based on what
customers are willing to pay
Company then must design and
develop product
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Cost must be low enough to allow for
desired profit
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Ordering Costs
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Costs of placing and receiving an
order
Examples:
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Order processing costs
Cost of insurance for shipment
Unloading costs
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Carrying Costs
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Costs of carrying inventory
Examples:
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Insurance
Inventory taxes
Obsolescence
Opportunity cost of funds ties up in
inventory, handling costs, and
storage space
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Stockout Costs
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Occur when demand is not known
Costs of not having:
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Product available when demanded by a
customer
Raw material available when needed for
production
Examples:
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Lost sales
Costs of expediting
Costs of interrupted production
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Economic Order Quantity (EOQ):
The Traditional Inventory Model
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Number of units in the optimal size order
Minimizes total inventory-related costs
Formula:
2 x CO x D/CC
Cost of placing one order
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Economic Order Quantity (EOQ):
The Traditional Inventory Model
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Number of units in the optimal size order
Minimizes total inventory-related costs
Formula:
2 x CO x D/CC
Annual demand in units
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Economic Order Quantity (EOQ):
The Traditional Inventory Model
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Number of units in the optimal size order
Minimizes total inventory-related costs
Formula:
2 x CO x D/CC
Cost of carrying one unit in
inventory
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Just in Time (JIT)
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Goods pushed through the system by
present demand rather than being pushed
through on a fixed schedule based on
anticipated demand
Each operation produces only what is
necessary to satisfy the demand of the
succeeding operation
Reduces all inventories to very low levels
Reduces inventory carrying costs
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