ACCT 102 Management Accounting Lecture 12

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ACCT 102Management AccountingLecture 12
Decision Making and Relevant Information
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Identifying Relevant Costs

• Future costs and future revenues that differ
  among decision alternatives.
• Compare to indicate how they differ under each
  alternative.
• Sunk costs are never relevant.

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Identifying Relevant Costs

• Focus on future costs and future revenues that
  differ among decision alternatives.
• Organize them in a manner that clearly indicates
  how they differ under each alternative.

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Identifying Relevant Costs
Ace Welding Company
The Model I welding machine used in the
manufacture of Mountain bicycle frames is 2 years
old and has a remaining useful life of 4 years.
It cost 90,000 when new and has an estimated
salvage value of zero dollars.
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Identifying Relevant Costs
Ace Welding Company
Management is evaluating the desirability of
replacing the Model I with a new Model II welding
machine. The new machine cost 80,000, has a
useful life of 4 years, and a predicted salvage
value of zero.
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Identifying Relevant Costs
Buy Model II
Keep Model I
Total revenue 800,000 800,000
Both options are the same, so Total revenue is
not relevant.
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Identifying Relevant Costs
Buy Model II
Keep Model I
Direct materials 120,000 120,000
Both options are the same, so Direct materials
costs are not relevant.
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000
Conversion costs are relevant
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000
Selling and distribution expenses are not
relevant.
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000 Inspection and
adjustment 6,000 20,000
Inspection and adjustment costs are relevant
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000 Inspection and
adjustment 6,000 20,000
Depreciation is not relevant.
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000 Inspection and
adjustment 6,000 20,000 Depreciation 84,000 84,00
0 Disposal value - 35,000
Disposal value of Model I is relevant
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000 Inspection and
adjustment 6,000 20,000 Depreciation 84,000 84,0
00 Disposal value - 35,000 Cost of Model
II 80,000
Cost of Model II is relevant.
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000 Inspection and
adjustment 6,000 20,000 Depreciation 84,000 84,0
00 Disposal value - 35,000 Cost of Model
II 80,000 Machine maintenance 800 9,600
Machine maintenance costs are relevant
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Identifying Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Selling and
distribution 40,000 40,000 Inspection and
adjustment 6,000 20,000 Depreciation 84,000 84,0
00 Disposal value - 35,000 Cost of Model
II 80,000 Machine maintenance 800 9,600
All other items are the same for either decision,
so they are irrelevant.
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Identifying Relevant Costs
Differential Analysis of Relevant Costs
Buy Model II
Keep Model I
Conversion 160,000 200,000 Inspection and
adjustment 6,000 20,000 Disposal value -
35,000 Cost of Model II 80,000 Machine
maintenance 800 9,600 Totals
costs 211,800 229,600
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Future Revenues
Future revenues, which are inflows of resources
from the sale of goods and services, are relevant
if they differ between alternatives
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Outlay Costs
Outlay costs are costs that require future
expenditures of cash or other resources.
Outlay costs that differ under the decision
alternatives at hand are relevant outlay costs
that do not differ are irrelevant.
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Sunk Costs
Sunk costs result from past decisions that cannot
be changed.
Aside from tax consequences, sunk costs are never
relevant.
What are sunk costs?
Note Sunk costs are never relevant!
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Sunk Costs

• Sunk costs may cause ethical dilemmas
• Although the book value of an old item has no
  economic significance (i.e. not relevant), the
  accounting treatment of past costs may make it
  difficult for managers to regard them as
  irrelevant.
• The possibility of recording an accounting loss
  may place managers in an ethical dilemma. Fearing
  the loss will lead to superiors questioning his
  or her judgment, a manager might prefer to use
  the old item, as opposed to replacing it and be
  forced to record a loss.
• Cumulative effect of many such decisions will be
  harmful to the long-run economic health of the
  organization

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Disposal and salvage values

• Disposal and Salvage Values
• Cash inflows from the disposal of assets is a
  relevant cash inflow
• Any salvage value at the end of the useful life
  of the assets will also be relevant
• A loss on disposal may have a favorable tax
  impact if the loss can be offset against taxable
  gains or taxable income

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Predicting Relevant Costs

• Analyst must know what to look out for, and this
  knowledge will help guide the search for the few
  pieces of relevant information contained in
  voluminous set of data
• Predicting relevant costs may involve an
  examination of past cost trends
• It is more difficult to predict costs when
  technology changes

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Predicting Relevant Costs
What is a cost prediction error?
It is the difference between a predicted future
cost and the actual amount of the cost when it is
incurred.
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Summary

• Under relevance costing, only costs and revenues
  that differ under each alternative should be
  considered

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Summary

• Predicting relevant costs may involve an
  examination of past cost trends
• It is more difficulty to predict costs when
  technology changes
• Apart relevant costs and revenues, other
  quantitative factors such as long-run profit
  should be considered
• Qualitative factors such as legal, ethical and
  social implications of decisions must also be
  recognized