Learning Objectives
7. How do managers determine whether a product line should be retained or discontinued?
RELEVANT INFORMATION FOR DECISION
MAKING
CHAPTER
10
Chapter 10: Relevant Information for Decision Making IM 2
Terminology
Ad hoc discount: a price concession made under competitive pressure (real or imagined) that does not
Common Expense: costs incurred for the benefit of the company as a whole but are allocated to
Differential cost: (see incremental cost)
Differential revenue: (see incremental revenue)
Incremental cost: the amount of cost that differs across decision choices
Mathematical programming: a variety of techniques used to allocate limited resources among activities
to achieve a specific goal or purpose
Offshoring: the practice of sending jobs formerly performed in the home country to other countries
Outsourcing decision: an analysis that compares internal production and opportunity costs with external
purchase cost and assesses the best uses of facilities
Relevant costing: a process which focuses managerial attention on a decision’s relevant (or pertinent)
information
Segment margin: the excess of revenues over direct variable expenses and avoidable fixed expenses
for a particular segment
Special order decision: a situation in which management must determine a sales price to charge for
Chapter 10: Relevant Information for Decision Making IM 3
publicly accessible website, in whole or in part.
Lecture Outline
LO.1: What factors determine the relevance of information to decision making?
A. Introduction
1. In decision making, managers should consider all relevant costs and revenues associated with
c. Step 3: The relevant costs and benefits associated with each decision alternative in step 2
are calculated.
selected.
pertinent) information.
3. This chapter introduces relevant costing by examining several recurring business decisions such
B. The Concept of Relevance
1. General
i. be associated with the decision under consideration;
2. Association with Decision
a. To be relevant, information must be associated with the decision or question under
consideration.
decision choices.
c. Incremental cost (or differential cost) is the amount of cost that varies across decision
choices.
Chapter 10: Relevant Information for Decision Making IM 4
©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
i. Incremental costs can be either variable or fixed. Most variable costs are relevant while
most fixed costs are not relevant.
d. The difference between the incremental revenue and incremental cost of a particular
i. Other factors, such as opportunity costs, may be relevant and quantifiable, but are not
captured by the accounting system.
action is chosen over another.
3. Importance to Decision Maker
management objectives.
4. Bearing on the Future
a. Information can be based on past or present data, but it can only be relevant if it pertains to a
future decision.
controllable, avoidable, and relevant.
c. Only information that has a bearing on future events is relevant in decision making.
C. Sunk Costs
any future courses of action.
transactions cannot be reversed currently.
3. Text Exhibit 10.1 (p. 394) provides data for a basic keep-or–replace decision while text Exhibit
10.2 (p. 394) presents the relevant costs that should be considered in making the decision.
Chapter 10: Relevant Information for Decision Making IM 5
publicly accessible website, in whole or in part.
ii. current resale value of the original system; and
iii. annual operating savings associated with the new system.
D. Relevant Costs for Specific Decisions
1. Managers routinely make decisions on alternative courses of action that have been identified as
feasible solutions to problems or feasible methods to use in the attainment of objectives.
a. All incremental revenues, costs, and benefits of all courses of action are measured against a
b. When evaluating alternative courses of action, managers should select the alternative that
c. The “change nothing” alternative has a zero incremental benefit since it represents current
d. Rational decision-making behavior includes a comprehensive evaluation of the quantifiable
LO.3: What information is relevant in an outsourcing decision?
E. Outsourcing Decisions
1. General
product or performing the service in-house.
b. Offshoring sends jobs formerly performed in the home country to other countries.
i. In 2010, financial services ($25.2 billion), manufacturing ($17.1 billion) and energy ($8.5
c. The outsourcing (or make–or-buy) decision is a decision that compares internal production
factors.
d. Numerous factors, such as those included in text Exhibit 10.4 (p. 397), should be considered
in making the outsourcing decision.
Factors to consider include whether:
Chapter 10: Relevant Information for Decision Making IM 6
publicly accessible website, in whole or in part.
i. a function is considered critical to the organization’s long-term viability (such as product
research and development);
g. Relevant costs, regardless of whether they are variable or fixed, are avoidable because one
decision alternative was chosen over another. In an outsourcing decision, variable production
capacity to this use.
j. Text Exhibit 10.7 (p. 399) presents the calculations relating to this decision on both a per–
i. Another opportunity cost that can be associated with insourcing is an increase in plant
the supplier) may overrule.
l. A theoretically short-run decision can have many potential long-run effects thus suggesting
need to make outsourcing decisions.
n. Outsourcing can include product and service design activities, accounting (e.g., preparation
2. Scarce Resources Decisions
a. A scarce resource is a resource that is essential to a production or service activity but is
available only in some limited quantity.
Chapter 10: Relevant Information for Decision Making IM 7
©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
i. Scarce resources create constraints on producing goods or providing services and can
include machine hours, skilled labor hours, raw materials, and production capacity.
b. Management may desire and be able to obtain a greater abundance of a scarce resource in
the long run, but management must make the best current use of the scarce resources it has
in the short run.
c. The determination of the best use of a scarce resource requires that specific company
objectives be recognized by management.
i. If an objective is to maximize company profits, a scarce resource is best used to produce
Mechanical.
At first glance, it appears that the table saw would be the most profitable of the two
However, because the table saw requires three times as many switches (the limiting
quantitative ones.
e. When one limiting factor is involved, the outcome of a scarce resource decision indicates
which single type of product should be manufactured and sold.
to achieve a specific purpose.
ii. Linear programming (LP) is one method used to find the optimal allocation of scarce
resources when there are multiple limiting factors.
3. Sales mix decisions
a. General
i. Sales mix is the relative combination of quantities of sales of the various products that
make up the total sales of a company.