ACTG 3310 - Chapter 4

1. ACTG 3310 - Chapter 4 Fundamentals of Cost Analysis for Decision Making

2. Relevant Information • Short-run: few costs change (most variable, some fixed) • Long-run: most costs change (most fixed and most variable) • Differential revenues and costs: • Revenue and costs must differ between alternatives • Comparison to total or full costs • Must be future revenues or future costs

3. Differential Cost Information • Past or “sunk” costs have already occurred and will be the same under either alternative • Opportunity costs • Benefit forgone by choosing one alternative over another one • Opportunity costs are not recorded in the accounting records but they must be considered in decision

4. Variable/Fixed Costs • Variable costs - not all variable costs are relevant; to be considered they must differ among alternatives • Fixed costs - not all fixed costs are irrelevant, if they differ among alternatives they should be considered

5. Differential Analyses • One-Time Only Special Orders • Often a proposal is made for a price that is lower than the regular price • Consider relevant costs of special order only • If relevant costs < special order price, consider accepting the special order • Check on capacity restraints • Consider long-run implications of short-run decisions

6. Special Pricing • Life-cycle product costing • Target Costing (see next slide) • Predatory Pricing • Dumping • Price Discrimination • Peak-Load Pricing • Price Fixing

7. Traditional Costing: DM +DL +OH =Total Cost +Profit Markup =Price charged Target Costing Price charged less profit markup =Target Cost (DM, DL, + OH must not be more than the target cost Traditional Cost-Plus Costing versus Target Costing

8. Differential Analyses • Make or buy decisions • Compare costs of outside bid to relevant costs to make a part or product • Lowest cost alternative appears to be the best choice • Consider opportunity costs • Consider nonfinancial considerations such as effects on employment, quality of products made elsewhere, supply of additional units, reliable delivery of units

9. Differential Analyses • Decision to Add or Drop a Product Line or Close a Business Unit • Consider differential costs of unit • Only those costs and revenues that can be eliminated if unit is dropped should be considered • Consider opportunity costs of what else could be offered • Consider effects on other units • Consider nonfinancial considerations

10. Differential Analyses • Product Choice Decisions • Use contribution margin per unit of scarce resource • Consider capacity (any idle space) • Consider demand for products

11. Theory of Constraints • Bottlenecks • Points or procedures that all goods and services must go through • The bottleneck operation limits total production • Throughput contribution • Sales dollars minus direct materials costs and other variable costs such as energy and piecework labor

12. Theory of Constraints • You are limited to how fast you can process goods and services by the bottleneck • Increase the capacity of the bottleneck and you will increase the throughput contribution