Decision Making and Relevant Information. JOIN KHALID AZIZ FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. FRESH CLASSES OF ICMAP STAGE.

Decision Making and Relevant Information

JOIN KHALID AZIZ FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. STAGE 2 FUNDAMENTALS OF COST ACCOUNTING. STAGE 2 FUNDAMENTALS OF COST ACCOUNTING. STAGE 3 FA & APPRAISAL. STAGE 3 FA & APPRAISAL.

JOIN KHALID AZIZ FRESH CLASSES OF PIPFA FRESH CLASSES OF PIPFA FOUNDATION FOUNDATION INTERMEDIATE INTERMEDIATE FINAL FINAL 0322-3385752 0322-3385752

JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.CONTACT:0322-3385752 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.

Introduction This presentation explores the decision- making process. This presentation explores the decision- making process. It focuses on specific decisions such as accepting or rejecting a one-time-only special order, insourcing or outsourcing products or services, and replacing or keeping equipment. It focuses on specific decisions such as accepting or rejecting a one-time-only special order, insourcing or outsourcing products or services, and replacing or keeping equipment.

Learning Objectives 1 Use the five-step decision process to make decisions 2 Differentiate relevant costs and revenues from irrelevant costs and revenues in any decision situation 3 Distinguish between quantitative factors and qualitative factors in decisions

Learning Objectives 4 Identify two potential problems that should be avoided in relevant-cost analysis 5 Describe the opportunity cost concept and explain why it is used in decision making 6 Describe the key concept in choosing which among multiple products to produce when there are capacity constraints

Learning Objectives 7 Discuss the key factor managers must consider when adding or dropping customers and segments 8 Explain why the book value of equipment is irrelevant in equipment-replacement decisions 9 Explain how conflicts can arise between the decision model used by a manager and the performance model used to evaluate the manager

Learning Objective 1 Use the five-step decision process to make decisions

Information and the Decision Process A decision model is a formal method for making a choice, often involving quantitative and qualitative analysis. A decision model is a formal method for making a choice, often involving quantitative and qualitative analysis.

Five-Step Decision Process 1 Gathering information 2 Making predictions 3 Choosing an alternative 4 Implementing the decision 5 Evaluating performance

Learning Objective 2 Differentiate relevant costs and revenues from irrelevant costs and revenues in any decision situation

The Meaning of Relevance Relevant costs and relevant revenues are expected future costs and revenues that differ among alternative courses of action. Relevant costs and relevant revenues are expected future costs and revenues that differ among alternative courses of action.

The Meaning of Relevance Historical costs are irrelevant to a decision but are used as a basis for predicting future costs. Historical costs are irrelevant to a decision but are used as a basis for predicting future costs. Sunk costs are past costs which are unavoidable. Sunk costs are past costs which are unavoidable.

The Meaning of Relevance Differential income (net relevant income) is the difference in total operating income when choosing between two alternatives. Differential income (net relevant income) is the difference in total operating income when choosing between two alternatives. Differential costs (net relevant costs) are the difference in total costs between two alternatives. Differential costs (net relevant costs) are the difference in total costs between two alternatives.

Learning Objective 3 Distinguish between quantitative factors and qualitative factors in decisions Distinguish between quantitative factors and qualitative factors in decisions

Quantitative and Qualitative Relevant Information Quantitative factors are outcomes that are measured in numerical terms: Quantitative factors are outcomes that are measured in numerical terms: – Financial – Nonfinancial Qualitative factors are outcomes that cannot be measured in numerical terms. Qualitative factors are outcomes that cannot be measured in numerical terms.

One-Time-Only Special Order Gabriela & Co. manufactures fancy bath towels in Boone, North Carolina. Gabriela & Co. manufactures fancy bath towels in Boone, North Carolina. The plant has a production capacity of 44,000 towels each month. The plant has a production capacity of 44,000 towels each month. Current monthly production is 30,000 towels. Current monthly production is 30,000 towels. The assumption is made that costs can be classified as either variable with respect to units of output or fixed. The assumption is made that costs can be classified as either variable with respect to units of output or fixed.

One-Time-Only Special Order Variable Fixed Costs Costs Per Unit Per Unit Direct materialsRs6.50 Rs -0- Direct labor.50 1.50 Manufacturing costs 1.50 3.50 Total Rs8.50Rs5.00 Variable Fixed Costs Costs Per Unit Per Unit Direct materialsRs6.50 Rs -0- Direct labor.50 1.50 Manufacturing costs 1.50 3.50 Total Rs8.50Rs5.00

One-Time-Only Special Order Total fixed direct manufacturing labor amounts to Rs45,000. Total fixed direct manufacturing labor amounts to Rs45,000. Total fixed overhead is Rs105,000. Total fixed overhead is Rs105,000. Marketing costs per unit are Rs7 (Rs5 of which is variable). Marketing costs per unit are Rs7 (Rs5 of which is variable). What is the full cost per towel? What is the full cost per towel?

One-Time-Only Special Order Variable (Rs8.50 + Rs5.00):Rs13.50 Variable (Rs8.50 + Rs5.00):Rs13.50 Fixed: 7.00 Fixed: 7.00 TotalRs20.50 TotalRs20.50 A hotel in Puerto Rico has offered to buy 5,000 towels from Gabriela & Co. at Rs11.50 per towel for a total of Rs57,500. A hotel in Puerto Rico has offered to buy 5,000 towels from Gabriela & Co. at Rs11.50 per towel for a total of Rs57,500.

One-Time-Only Special Order No marketing costs will be incurred for this one-time-only special order. No marketing costs will be incurred for this one-time-only special order. Should Gabriela & Co. accept this order? Should Gabriela & Co. accept this order? Yes! Yes! Why? Why?

One-Time-Only Special Order The relevant costs of making the towels are Rs42,500. The relevant costs of making the towels are Rs42,500. Rs8.50 × 5,000 = Rs42,500 incremental costs Rs8.50 × 5,000 = Rs42,500 incremental costs Rs57,500 – Rs42,500 = Rs15,000 incremental revenues Rs57,500 – Rs42,500 = Rs15,000 incremental revenues Rs11.50 – Rs8.50 = Rs3.00 contribution margin per towel Rs11.50 – Rs8.50 = Rs3.00 contribution margin per towel

One-Time-Only Special Order Decision criteria: Decision criteria: Accept the order if the revenue differential is greater than the cost differential. Accept the order if the revenue differential is greater than the cost differential.

Learning Objective 4 Identify two potential problems that should be avoided in relevant-cost analysis

Potential Problems in Relevant-Cost Analysis General assumptions: General assumptions: – Do not assume that all variable costs are relevant. – Do not assume that all fixed costs are irrelevant.

Potential Problems in Relevant-Cost Analysis Unit-cost data can potentially mislead decision makers: Unit-cost data can potentially mislead decision makers: – Irrelevant costs are included. – The same unit costs are used at different output levels.

Insourcing versus Outsourcing Outsourcing is the process of purchasing goods and services from outside vendors rather than producing goods or providing services within the organization, which is called insourcing. Outsourcing is the process of purchasing goods and services from outside vendors rather than producing goods or providing services within the organization, which is called insourcing.

Make-or-Buy Decisions Decisions about whether to outsource or produce within the organization are often called make-or-buy decisions. Decisions about whether to outsource or produce within the organization are often called make-or-buy decisions. The most important factors in the make- or-buy decision are quality, dependability of supplies, and costs. The most important factors in the make- or-buy decision are quality, dependability of supplies, and costs.

Make-or-Buy Decisions Gabriela & Co. also manufactures bath accessories. Gabriela & Co. also manufactures bath accessories. Management is considering producing a part it needs (#2) or using a part produced by Alec Enterprises. Management is considering producing a part it needs (#2) or using a part produced by Alec Enterprises.

Make-or-Buy Decisions Gabriela & Co. has the following costs for 150,000 units of Part #2: Gabriela & Co. has the following costs for 150,000 units of Part #2: Direct materialsRs 28,000 Direct labor 18,500 Mixed overhead 29,000 Variable overhead 15,000 Fixed overhead 30,000 TotalRs120,500 Direct materialsRs 28,000 Direct labor 18,500 Mixed overhead 29,000 Variable overhead 15,000 Fixed overhead 30,000 TotalRs120,500

Make-or-Buy Decisions Mixed overhead consists of material handling and setup costs. Mixed overhead consists of material handling and setup costs. Gabriela & Co. produces the 150,000 units in 100 batches of 1,500 units each. Gabriela & Co. produces the 150,000 units in 100 batches of 1,500 units each. Total material handling and setup costs equal fixed costs of Rs9,000 plus variable costs of Rs200 per batch. Total material handling and setup costs equal fixed costs of Rs9,000 plus variable costs of Rs200 per batch.

Make-or-Buy Decisions What is the cost per unit for Part #2? What is the cost per unit for Part #2? Rs120,500 ÷ 150,000 units = Rs0.8033/unit Rs120,500 ÷ 150,000 units = Rs0.8033/unit Alec Enterprises offers to sell the same part for Rs0.55. Alec Enterprises offers to sell the same part for Rs0.55. Should Gabriela & Co. manufacture the part or buy it from Alec Enterprises? Should Gabriela & Co. manufacture the part or buy it from Alec Enterprises?

Make-or-Buy Decisions The answer depends on the difference in expected future costs between the alternatives. The answer depends on the difference in expected future costs between the alternatives. Gabriela & Co. anticipates that next year the 150,000 units of Part #2 expected to be sold will be manufactured in 150 batches of 1,000 units each. Gabriela & Co. anticipates that next year the 150,000 units of Part #2 expected to be sold will be manufactured in 150 batches of 1,000 units each.

Make-or-Buy Decisions Variable costs per batch are expected to decrease to Rs100. Variable costs per batch are expected to decrease to Rs100. Gabriela & Co. plans to continue to produce 150,000 next year at the same variable manufacturing costs per unit as this year. Gabriela & Co. plans to continue to produce 150,000 next year at the same variable manufacturing costs per unit as this year. Fixed costs are expected to remain the same as this year. Fixed costs are expected to remain the same as this year.

Make-or-Buy Decisions What is the variable manufacturing cost per unit? What is the variable manufacturing cost per unit? Direct materialRs28,000 Direct labor 18,500 Variable overhead 15,000 TotalRs61,500 Direct materialRs28,000 Direct labor 18,500 Variable overhead 15,000 TotalRs61,500 Rs61,500 ÷ 150,000 = Rs0.41 per unit Rs61,500 ÷ 150,000 = Rs0.41 per unit

Make-or-Buy Decisions Expected relevant cost to make Part #2: Expected relevant cost to make Part #2: ManufacturingRs61,500 Material handling and setups 15,000* Total relevant cost to make Rs76,500 *150 × Rs100 = Rs15,000 ManufacturingRs61,500 Material handling and setups 15,000* Total relevant cost to make Rs76,500 *150 × Rs100 = Rs15,000 Cost to buy: (150,000 × Rs0.55) Rs82,500 Cost to buy: (150,000 × Rs0.55) Rs82,500 Gabriela & Co. will save Rs6,000 by making the part. Gabriela & Co. will save Rs6,000 by making the part.

Make-or-Buy Decisions Now assume that the Rs9,000 in fixed clerical salaries to support material handling and setup will not be incurred if Part #2 is purchased from Alec Enterprises. Now assume that the Rs9,000 in fixed clerical salaries to support material handling and setup will not be incurred if Part #2 is purchased from Alec Enterprises. Should Gabriela & Co. buy the part or make the part? Should Gabriela & Co. buy the part or make the part?

Make-or-Buy Decisions Relevant cost to make: Relevant cost to make: VariableRs76,500 Fixed 9,000 TotalRs85,500 VariableRs76,500 Fixed 9,000 TotalRs85,500 Cost to buy:Rs82,500 Cost to buy:Rs82,500 Gabriela would save Rs3,000 by buying the part. Gabriela would save Rs3,000 by buying the part.

Learning Objective 5 Describe the opportunity cost concept and explain why it is used in decision making

Opportunity Costs, Outsourcing, and Constraints Assume that if Gabriela buys the part from Alec Enterprises, it can use the facilities previously used to manufacture Part #2 to produce Part #3 for Krysta’s Company. Assume that if Gabriela buys the part from Alec Enterprises, it can use the facilities previously used to manufacture Part #2 to produce Part #3 for Krysta’s Company. The expected additional future operating income is Rs18,000. The expected additional future operating income is Rs18,000. What should Gabriela & Co. do? What should Gabriela & Co. do?

Opportunity Costs, Outsourcing, and Constraints Gabriela & Co. has three options: Gabriela & Co. has three options: 1 Make Part #2 and do not make Part #3 for Krysta. 2 Buy Part #2 and do not make Part #3 for Krysta. 3 Buy the part and use the facilities to produce Part #3 for Krysta.

Opportunity Costs, Outsourcing, and Constraints Expected cost of obtaining 150,000 parts: Expected cost of obtaining 150,000 parts: Buy Part #2Buy Part #2 and do notand makeMake make Part #3Part #3Part #2 Rs82,500Rs64,500* Rs76,500 Buy Part #2Buy Part #2 and do notand makeMake make Part #3Part #3Part #2 Rs82,500Rs64,500* Rs76,500 *Rs82,500 – Rs18,000 = Rs64,500 *Rs82,500 – Rs18,000 = Rs64,500

Opportunity Costs, Outsourcing, and Constraints Opportunity cost is the contribution to income that is foregone (rejected) by not using a limited resource in its next-best alternative use. Opportunity cost is the contribution to income that is foregone (rejected) by not using a limited resource in its next-best alternative use.

Opportunity Costs, Outsourcing, and Constraints Opportunity costs are not recorded in formal accounting records since they do not generate cash outlays. Opportunity costs are not recorded in formal accounting records since they do not generate cash outlays. These costs also are not ordinarily incorporated into formal reports. These costs also are not ordinarily incorporated into formal reports.

Opportunity Costs, Outsourcing, and Constraints The opportunity cost of holding inventory is the income forgone from tying up money in inventory and not investing it elsewhere. The opportunity cost of holding inventory is the income forgone from tying up money in inventory and not investing it elsewhere.

Opportunity Costs, Outsourcing, and Constraints Carrying costs of inventory can be a significant opportunity cost and should be incorporated into decisions regarding lot purchase sizes for materials. Carrying costs of inventory can be a significant opportunity cost and should be incorporated into decisions regarding lot purchase sizes for materials.

Opportunity Costs, Outsourcing, and Constraints Assume that annual estimated Part #2 requirements for next year is 150,000. Assume that annual estimated Part #2 requirements for next year is 150,000. Cost per purchase order is Rs40. Cost per purchase order is Rs40. Cost per unit when each purchase is of 1,500 units = Rs0.55. Cost per unit when each purchase is of 1,500 units = Rs0.55. Cost per unit when each purchase is equal to or greater than 150,000 = Rs0.54. Cost per unit when each purchase is equal to or greater than 150,000 = Rs0.54.

Opportunity Costs, Outsourcing, and Constraints Average investment in inventory is either: Average investment in inventory is either: (1,500 x.55) ÷ 2 = Rs412.50 or (1,500 x.55) ÷ 2 = Rs412.50 or (150,000 x Rs0.54) = Rs40,500 (150,000 x Rs0.54) = Rs40,500 Annual interest rate for investment in government bonds is 6%. Annual interest rate for investment in government bonds is 6%. Rs412.50 ×.06 = Rs24.75 Rs412.50 ×.06 = Rs24.75 Rs40,500 ×.06 = Rs2,430 Rs40,500 ×.06 = Rs2,430

Opportunity Costs, Outsourcing, and Constraints Option A: Make 100 purchases of 1,500 units: Option A: Make 100 purchases of 1,500 units: Purchase order costs: (100 × Rs40)Rs 4,000.00 Purchase order costs: (100 × Rs40)Rs 4,000.00 Purchase costs: (150,000 × Rs0.55) 82,500.00 Purchase costs: (150,000 × Rs0.55) 82,500.00 Annual interest income that could be earned: 24.75 Annual interest income that could be earned: 24.75 Relevant costs Rs86,524.75 Relevant costs Rs86,524.75

Opportunity Costs, Outsourcing, and Constraints Option B: Make 1 purchase of 150,000 units: Option B: Make 1 purchase of 150,000 units: Purchase order costs: (1 × Rs40)Rs 40 Purchase order costs: (1 × Rs40)Rs 40 Purchase costs: (150,000 × Rs0.54) 81,000 Purchase costs: (150,000 × Rs0.54) 81,000 Annual interest income that could be earned: 2,430 Annual interest income that could be earned: 2,430 Relevant costs:Rs83,470 Relevant costs:Rs83,470

Opportunity Costs, Outsourcing, and Constraints In this case purchasing all 150,000 units at the beginning of the year is preferred. In this case purchasing all 150,000 units at the beginning of the year is preferred. Why? Why? The higher purchase and ordering costs exceeds the lower opportunity cost of holding smaller inventory. The higher purchase and ordering costs exceeds the lower opportunity cost of holding smaller inventory.

Learning Objective 6 Describe the key concept in choosing which among multiple products to produce when there are capacity constraints

Product-Mix Decisions Under Capacity Constraints What product should be emphasized to maximize operating income in the face of capacity constraints? What product should be emphasized to maximize operating income in the face of capacity constraints? Gabriela & Co. produces Product #2 and Product #3. Gabriela & Co. produces Product #2 and Product #3. The company has 3,000 machine hours available to produce these products. The company has 3,000 machine hours available to produce these products.

Product-Mix Decisions Under Capacity Constraints Decision criteria: Aim for the highest contribution margin per unit of the constraining factor. Decision criteria: Aim for the highest contribution margin per unit of the constraining factor. When multiple constraints exist, optimization techniques such as linear programming can be used in making decisions. When multiple constraints exist, optimization techniques such as linear programming can be used in making decisions.

Product-Mix Decisions Under Capacity Constraints Per unit Product #2 Product #3 Sales priceRs2.11 Rs14.50 Variable expenses 0.41 13.90 Contribution margin Rs1.70Rs 0.60 Per unit Product #2 Product #3 Sales priceRs2.11 Rs14.50 Variable expenses 0.41 13.90 Contribution margin Rs1.70Rs 0.60 Contribution margin ratio 81% 4% Contribution margin ratio 81% 4%

Product-Mix Decisions Under Capacity Constraints One unit of Prod. #2 requires 7 machine hours. One unit of Prod. #2 requires 7 machine hours. One unit of Prod. #3 requires 2 machine hours. One unit of Prod. #3 requires 2 machine hours. What is the contribution of each product per machine hour? What is the contribution of each product per machine hour? Product #2: Rs1.70 ÷ 7 = Rs0.24 Product #2: Rs1.70 ÷ 7 = Rs0.24 Product #3: Rs0.60 ÷ 2 = Rs0.30 Product #3: Rs0.60 ÷ 2 = Rs0.30

Product-Mix Decisions Under Capacity Constraints Which product should be emphasized? Which product should be emphasized? The product with the highest contribution margin per unit of the constraining resource. The product with the highest contribution margin per unit of the constraining resource.

Learning Objective 7 Discuss the key factor managers must consider when adding or dropping customers and segments

Profitability, Activity-Based Costing, and Relevant Costs Companies must often make decisions about adding or discontinuing a product line, branch, or business segment. Companies must often make decisions about adding or discontinuing a product line, branch, or business segment. Companies must also make decisions about adding or dropping customers. Companies must also make decisions about adding or dropping customers.

Profitability, Activity-Based Costing, and Relevant Costs Blowing Rock Furniture supplies specialized furniture to two local retailers – Stevens and Cohen. Blowing Rock Furniture supplies specialized furniture to two local retailers – Stevens and Cohen. Blowing Rock Furniture has a monthly capacity of 3,000 machine hours. Blowing Rock Furniture has a monthly capacity of 3,000 machine hours. Fixed costs are allocated on the basis of revenues. Fixed costs are allocated on the basis of revenues.

Profitability, Activity-Based Costing, and Relevant Costs Stevens Cohen RevenuesRs200,000 Rs100,000 Variable costs 70,000 60,000 Fixed costs 100,000 50,000 Total operating costsRs170,000 Rs110,000 Operating incomeRs 30,000Rs (10,000) Machine-hours required 2,000 1,000 Stevens Cohen RevenuesRs200,000 Rs100,000 Variable costs 70,000 60,000 Fixed costs 100,000 50,000 Total operating costsRs170,000 Rs110,000 Operating incomeRs 30,000Rs (10,000) Machine-hours required 2,000 1,000

Profitability, Activity-Based Costing, and Relevant Costs Total RevenuesRs300,000 Variable costs 130,000 Fixed costs 150,000 Total operating costsRs280,000 Operating incomeRs 20,000 Machine-hours required 3,000 Total RevenuesRs300,000 Variable costs 130,000 Fixed costs 150,000 Total operating costsRs280,000 Operating incomeRs 20,000 Machine-hours required 3,000

Profitability, Activity-Based Costing, and Relevant Costs Should Blowing Rock Furniture drop the Cohen business, assuming that dropping Cohen would decrease its total fixed costs by 10%? Should Blowing Rock Furniture drop the Cohen business, assuming that dropping Cohen would decrease its total fixed costs by 10%? New fixed costs would be: Rs150,000 – Rs15,000 = Rs135,000 New fixed costs would be: Rs150,000 – Rs15,000 = Rs135,000

Profitability, Activity-Based Costing, and Relevant Costs Stevens Alone RevenuesRs200,000 Variable costs 70,000 Fixed costs 135,000 Total operating costsRs205,000 Operating incomeRs (5,000) Machine-hours required 3,000 Stevens Alone RevenuesRs200,000 Variable costs 70,000 Fixed costs 135,000 Total operating costsRs205,000 Operating incomeRs (5,000) Machine-hours required 3,000

Profitability, Activity-Based Costing, and Relevant Costs Cohen’s business is providing a contribution margin of Rs40,000. Cohen’s business is providing a contribution margin of Rs40,000. Rs40,000 decrease in contribution margin – Rs15,000 decrease in fixed costs = Rs25,000 decrease in operating income. Rs40,000 decrease in contribution margin – Rs15,000 decrease in fixed costs = Rs25,000 decrease in operating income.

Profitability, Activity-Based Costing, and Relevant Costs Assume that if Blowing Rock Furniture drops Cohen’s business it can lease the excess capacity to the Perez Corporation for Rs50,000. Assume that if Blowing Rock Furniture drops Cohen’s business it can lease the excess capacity to the Perez Corporation for Rs50,000. Fixed costs would not decrease. Fixed costs would not decrease. Should Blowing Rock Furniture lease to Perez? Should Blowing Rock Furniture lease to Perez?

Profitability, Activity-Based Costing, and Relevant Costs Rs50,000 would be Blowing Rock Furniture’s opportunity cost of continuing serving Cohen. Rs50,000 would be Blowing Rock Furniture’s opportunity cost of continuing serving Cohen. The Rs50,000 offsets the Rs40,000 contribution of Cohen’s business. The Rs50,000 offsets the Rs40,000 contribution of Cohen’s business.

Learning Objective 8 Explain why the book value of equipment is irrelevant in equipment- replacement decisions

Equipment-Replacement Decisions Assume that Gabriela & Co. is considering replacing a cutting machine with a newer model. Assume that Gabriela & Co. is considering replacing a cutting machine with a newer model. The new machine is more efficient than the old machine. The new machine is more efficient than the old machine. Revenues will be unaffected. Revenues will be unaffected.

Equipment-Replacement Decisions Existing Replacement Machine Machine Original cost Rs80,000 Rs105,000 Useful life 4 years 4 years Accumulated depreciation Rs50,000 Book value Rs30,000 Disposal price Rs14,000 Annual costs Rs46,000 Rs 10,000 Existing Replacement Machine Machine Original cost Rs80,000 Rs105,000 Useful life 4 years 4 years Accumulated depreciation Rs50,000 Book value Rs30,000 Disposal price Rs14,000 Annual costs Rs46,000 Rs 10,000

Equipment-Replacement Decisions Ignoring the time value of money and income taxes, should Gabriela replace the existing machine? Ignoring the time value of money and income taxes, should Gabriela replace the existing machine? Yes! Yes! The cost savings per year are Rs36,000. The cost savings per year are Rs36,000. The cost savings over a 4-year period will be Rs36,000 × 4 = Rs144,000. The cost savings over a 4-year period will be Rs36,000 × 4 = Rs144,000.

Equipment-Replacement Decisions Investment = Rs105,000 – Rs14,000 = Rs91,000 Investment = Rs105,000 – Rs14,000 = Rs91,000 Rs144,000 – Rs91,000 = Rs53,000 advantage of the replacement machine. Rs144,000 – Rs91,000 = Rs53,000 advantage of the replacement machine.

Irrelevance of Past Costs The book value of existing equipment is irrelevant since it is neither a future cost nor does it differ among any alternatives (sunk costs never differ). The book value of existing equipment is irrelevant since it is neither a future cost nor does it differ among any alternatives (sunk costs never differ).

Irrelevance of Past Costs The disposal price of old equipment and the purchase cost of new equipment are relevant costs and revenues because... The disposal price of old equipment and the purchase cost of new equipment are relevant costs and revenues because... – they are future costs or revenues that differ between alternatives to be decided upon.

Learning Objective 9 Explain how conflicts can arise between the decision model used by a manager and the performance model used to evaluate the manager

Decisions and Performance Evaluation What is the journal entry to sell the existing machine? What is the journal entry to sell the existing machine? Cash14,000 Accumulated Depreciation50,000 Loss on disposal16,000 Machine 80,000 Cash14,000 Accumulated Depreciation50,000 Loss on disposal16,000 Machine 80,000

Decisions and Performance Evaluation In the real world would the manager replace the machine? In the real world would the manager replace the machine? An important factor in replacement decisions is the manager’s perceptions of whether the decision model is consistent with how the manager’s performance is judged. An important factor in replacement decisions is the manager’s perceptions of whether the decision model is consistent with how the manager’s performance is judged.

Decisions and Performance Evaluation Managers often behave consistent with their short-run interests and favor the alternative that yields best performance measures in the short run. Managers often behave consistent with their short-run interests and favor the alternative that yields best performance measures in the short run. When conflicting decisions are generated, managers tend to favor the performance evaluation model. When conflicting decisions are generated, managers tend to favor the performance evaluation model.

Decisions and Performance Evaluation Top management faces a challenge – that is, making sure that the performance- evaluation model of subordinate managers is consistent with the decision model. Top management faces a challenge – that is, making sure that the performance- evaluation model of subordinate managers is consistent with the decision model.

Decision Making and Relevant Information. JOIN KHALID AZIZ FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. FRESH CLASSES OF ICMAP STAGE.

Similar presentations

Presentation on theme: "Decision Making and Relevant Information. JOIN KHALID AZIZ FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. FRESH CLASSES OF ICMAP STAGE."— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Decision Making and Relevant Information. JOIN KHALID AZIZ FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. FRESH CLASSES OF ICMAP STAGE.

Similar presentations

Presentation on theme: "Decision Making and Relevant Information. JOIN KHALID AZIZ FRESH CLASSES OF ICMAP STAGE 1 FUNDAMENTALS OF FA & ECONOMICS. FRESH CLASSES OF ICMAP STAGE."— Presentation transcript:

Similar presentations

About project

Feedback