Chapter 14 – Decision Making: Relevant Costs and Benefits
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CHAPTER 14
DECISION MAKING: RELEVANT COSTS AND BENEFITS
Learning Objectives
1. Describe seven steps in the decision-making process and the managerial
accountant’s role in that process.
2. Explain the relationship between quantitative and qualitative analyses in
decision making.
4. Identify relevant costs and benefits, giving proper treatment to sunk costs,
opportunity costs, and unit costs.
6. Analyze manufacturing decisions involving joint products and limited resources.
8. Formulate a linear program to solve a product-mix problem with multiple
constraints (appendix).
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Chapter Overview
I. The Management Accountant’s Role in Decision Making
A. Steps in the decision-making process
B. Quantitative versus qualitative analysis
C. Obtaining information: relevance, accuracy, and timeliness
II. Relevant Information
III. Identifying Relevant Costs and benefits
A. Sunk costs
B. Differential costs
C. Irrelevant future costs and Benefits
D. Opportunity costs
IV. Analysis of Special Decisions
A. Accept or reject a special order
B. Outsource a product or service
C. Add or drop a service, product, or department
V. Special Decisions in Manufacturing Firms
A. Joint products: sell or process further
B. Decisions involving limited resources
C. Uncertainty
VI. Activity-Based Costing and Today’s Advanced Manufacturing Environment
VII. Other Issues in Decision Making
A. Incentives for decisions makers
B. Short-run versus long-run decisions
C. Pitfalls to avoid
VIII. Appendix: Linear Programming
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Key Lecture Concepts
I. The Management Accountant’s Role in Decision Making
• The decision process consists of the seven steps that follow. In addition to
serving in an advisory capacity and being a provider of relevant
information, the managerial accountant is often a member of a cross-
functional, decision-making team.
➢ Clarify the decision problem.
➢ Specify the criterion upon which the decision will be made.
➢ Identify the alternatives.
• Although the managerial accountant collects and presents quantitative
information, the role of qualitative information should not be
underestimated. A skilled manager evaluates qualitative factors, such as
employee morale, that do not fit easily into numerical decision models.
Teaching Tip: In the late 1990s, The Wall Street Journal reported that the Board of
Directors of Delta Air Lines declined to renew Chairman Ronald Allen’s contract.
• Information that is useful in decision making must be relevant (pertinent
to the decision problem); accurate (precise); and timely (arrive in time for
the decision to be made).
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II. Relevant Information
• The information gathered should be relevant to the opportunity or
III. Identifying Relevant Costs and Benefits
• Sunk costs are past costs that have already been incurred. Such costs are
irrelevant in decision making because the amounts cannot be changed by
any of the alternatives under review.
• A differential cost is the net difference in cost between two alternatives.
• An opportunity cost is the cost of a forgone alternative.
IV. Analysis of Special Decisions
• Special orders—In this situation, a manager considers an order (often a one-
time order) at a special price. Key issues to evaluate include:
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• Outsourcing (make versus. buy)—This situation requires careful
consideration of fixed costs. The total cost per unit of a product or service
includes a unitized portion of fixed cost, a cost that may continue even if
the item or service is purchased elsewhere at a lower price.
Teaching Tip: Just about any good or service can be evaluated for outsourcing. As
an example, the North Carolina General Assembly requested that the University
of North Carolina evaluate outsourcing/privatization as a method for improving
• Add or drop a service, product, or department—Here, too, the key is the
proper handling of fixed costs and determination if such amounts are
avoidable or unavoidable. When a manager is considering dropping a
product line, he or she should isolate costs that will disappear with that
line.
➢ In many cases, fixed costs are not avoidable, particularly allocated
common costs.
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V. Special Decisions in Manufacturing Firms
• Joint products: sell or process further—A joint production process results in
the commingled manufacture of two or more products, called joint
products. The products become identifiable from each other at the split-
off point.
• Allocation of limited resources—Decisions may involve the use of limited
labor hours, limited materials, and limited machine time.
➢ When only one limited resource is present, a company should focus
on products that have the greatest amount of contribution margin
per unit of the scarce resource.
VI. Activity-Based Costing and Today’s Advanced Manufacturing Environment
• The relevant-costing concepts in an activity-based-costing environment do
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VII. Other Issues in Decision Making
• Managerial performance should be judged on the same factors that are
considered in making decisions. Unfortunately, there may be a conflict
between performance evaluation and decision making courtesy of accrual
accounting.
• The decisions in this chapter are primarily short-term in nature. Long-
term decisions should incorporate the time value of money (see Chapter
16).
• Several helpful hints in decision making:
➢ Ignore sunk costs.
VIII. Appendix: Linear Programming
• Linear programming (LP) is a powerful mathematical tool for firms that
have multiple products or services, and are constrained by more than one
resource. LP shows managers how to best allocate limited resources to
achieve either cost minimization or profit maximization.
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Teaching Overview
There is a significant amount of material in this chapter, and trying to focus on every
issue presented may be a bit overwhelming. I suggest that you pick and choose your
topics very carefully.
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Links to the Text
Homework Grid – CHAPTER 14
Item No.
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Problems:
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Item No.
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Cases:
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