© 2007 Pearson Education Canada Slide 9-1 Relevant Information and Decision Making: Production Decisions 9

© 2007 Pearson Education Canada Slide 9-2 Opportunity Costs Opportunity Cost The maximum available contribution to profit foregone by using limited resources for a particular purpose Not a cost in the normal sense of the word Consider the choice between staying with your current job or returning to school; if you quit your job to return to school the wages which you would have earned had you stayed in the job are an opportunity cost of returning to school

© 2007 Pearson Education Canada Slide 9-3 Differential Costs Differential Analysis Differences in revenues and costs between two alternatives Also called incremental analysis RemainOpen An As AnIndependent EmployeePracticeDifference Revenues$60,000$200,000$140,000 Outlay costs 0 120, ,000 Income effect per year$60,000 $80,000 $ 20,000

© 2007 Pearson Education Canada Slide 9-4 Make or Buy Decision decision to manufacture the product or subcontract to an independent supplier (outsource) MakeBuy Relevant costs: Direct material$20,000 Direct labour80,000 Variable overhead40,000 Fixed overhead20,000 Cost to buy$200,000 Total cost$160,000$200,000

© 2007 Pearson Education Canada Slide 9-5 Joint and Separable Costs in Joint Production Processes Split-Off Point Point in manufacturing process where products separate Joint Product Cost A cost incurred in a production process prior to the split-off point which cannot be identified with specific intermediate or final products except in an arbitrary manner Separable Cost A cost which related to a specific product (cost objective) Chemical X $90,000 Separable Processing Cost $40,000 Chemical Y $30,000 Chemical YA $80,000 Joint Cost $100,000 Split-Off Point

© 2007 Pearson Education Canada Slide 9-6 Sell or Process Further Decision decision, in a joint production process, to sell product at the split-off point or process further SplitProcess Further Relevant revenue:$30,000$80,000 Relevant costs: Cost to process beyond split-off point40,000 Total cost$30,000$40,000

© 2007 Pearson Education Canada Slide 9-7 Irrelevance of Past Costs Need to irrelevant costs Past cost are typically irrelevant e.g. obsolete inventory, book value of old equipment Also known as sunk costs

© 2007 Pearson Education Canada Slide 9-8 Conflicts Between Decision Making and Performance Evaluation To motivate employees to make optimal decisions, methods of performance evaluation should be consistent with decision making Sometimes there is a conflict between decision making analysis and the method used to evaluate performance Organizations need to protect against this to avoid dysfunctional decision making

© 2007 Pearson Education Canada Slide 9-9 Irrelevance of Future Costs? Some future costs may be irrelevant because they are the same under all feasible alternatives They may be safely ignored for the purposes of making a particular decision Example: salaries of top management