Copyright © 2003 Pearson Education Canada Inc. Slide Chapter 11 Decision Making and Relevant Information

Copyright © 2003 Pearson Education Canada Inc. Slide Information and the Decision Process A decision model is a formal method of making a choice, frequently involving quantitative analysis 5 Steps in the Decision Process Pages Feedback 1.Gather information 5.Evaluate performance2.Make predictions 3.Choose an alternative 4.Implement the decision

Copyright © 2003 Pearson Education Canada Inc. Slide Relevant Costs and Revenues Relevant costs are expected future costs that differ across alternative courses of action Relevant revenues are expected future revenues that differ across alternative courses of action Every decision deals with the future Costs incurred in the past are irrelevant these costs are sometimes called sunk costs past costs are only useful in that they may help predict costs in the future Pages

Copyright © 2003 Pearson Education Canada Inc. Slide Quantitative and Qualitative Information Quantitative factors are outcomes that are measured in numerical terms expected costs, sales revenues and volumes Qualitative factors are outcomes that cannot be measured in numerical terms employee morale, customer satisfaction Pages Quantitative Information Model Quantitative Information ResultsDecision

Copyright © 2003 Pearson Education Canada Inc. Slide Typical Relevant Costing Decisions One-Time-Only Special Order (Pricing) Make or Buy Decisions (Outsourcing) Opportunity Costs Product Mix Decisions under Capacity Constraints Add or Drop a Product Line or Customer Equipment Replacement Decisions Pages

Copyright © 2003 Pearson Education Canada Inc. Slide One-Time-Only Special Order WithoutWith OrderOrderDifference Volume30,00035,0005,000 Relevant revenues$600,000$655,000$55,000 Relevant costs: Variable manufacturing(225,000)(262,500)(37,500) Incremental income$17,500 Pages

Copyright © 2003 Pearson Education Canada Inc. Slide Outsourcing and Make/Buy Decisions MakeBuyDifference Relevant costs: Outside cost of parts$160,000$160,000 Direct materials $80,000 (80,000) Direct labour 10,000 (10,000) Variable overhead 40,000 (40,000) Fixed purchasing, receiving and setup overhead 20,000 (20,000) Incremental difference In favour of making$10,000 Pages

Copyright © 2003 Pearson Education Canada Inc. Slide Outsourcing and Opportunity Costs MakeBuy Relevant cost to make$150,000 Relevant cost to buy$160,000 Opportunity cost: Profit forgone because Capacity cannot be used to make another product 25,000 Total relevant costs$175,000$160,000 Pages Opportunity cost considers the profits lost by not following the next best alternative course of action

Copyright © 2003 Pearson Education Canada Inc. Slide Product Mix Decisions Under Constraint Pages SnowmobileBoatEngine Contribution margin per unit$240$375 Machine hours required per unit25 Contribution margin per machine hour$120$75 If machine hours are constrained, maximize income by first producing as many snowmobile engines as can be sold and then shift production to boat engines

Copyright © 2003 Pearson Education Canada Inc. Slide Customer Profitability Analysis Pages KeepDrop AccountAccountDifference Relevant revenue$1,200,000$800,000$(400,000) Relevant costs: Cost of goods sold920,000590,000330,000 Material-handling labour92,00059,00033,000 Marketing support30,00020,00010,000 Order/delivery32,00020,00012,000 Decline in operating income if drop account$(15,000)

Copyright © 2003 Pearson Education Canada Inc. Slide Irrelevance of Past Costs Pages Costs incurred in the past are sunk (irrelevant) Only expected future costs and revenues are relevant Example: Consider replacing an old machine with a new machine with expected lower operating costs Keep OldBuy NewDifference Relevant costs: Operating costs$1,600,000$920,000$680,000 Disposal value of Old machine(40,000)40,000 Cost of new machine600,000(600,000) Difference $40,000

Copyright © 2003 Pearson Education Canada Inc. Slide Linear Programming Optimization technique used to maximize total contribution margin given multiple constraints Pages Objective function: Total contribution margin = $240S + $375B Constraints: Assembly department2S + 5B < 600 Testing department1S + 0.5B < 120 Material shortageB < 110 Negative impossibilityS > 0 and B > 0

Copyright © 2003 Pearson Education Canada Inc. Slide Feasible Solutions Linear Programming Solution Pages Snowmobile Engines (S) Boat Engines (B) Testing Department Constraint Material Shortage Constraint Assembly Department Constraint Optimal Corner 5S, 90B