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Relevant Information and Decision Making: Production Decisions

Relevant Information and Decision Making: Production Decisions. 9. Opportunity Costs. Opportunity Cost The maximum available contribution to profit foregone by using limited resources for a particular purpose Not a cost in the normal sense of the word

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Relevant Information and Decision Making: Production Decisions

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  1. Relevant Informationand Decision Making:Production Decisions 9

  2. Opportunity Costs Opportunity Cost • The maximum available contribution to profit foregone by using limited resources for a particular purpose • Not a cost in the normal sense of the word • Consider the choice between staying with your current job or returning to school; if you quit your job to return to school the wages which you would have earned had you stayed in the job are an opportunity cost of returning to school

  3. Differential Costs Differential Analysis • Differences in revenues and costs between two alternatives • Also called incremental analysis Remain Open An As An Independent Employee Practice Difference Revenues $60,000 $200,000 $140,000 Outlay costs 0120,000120,000 Income effect per year $60,000 $80,000 $ 20,000

  4. Make or Buy Decision • decision to manufacture the product or subcontract to an independent supplier (outsource) Make Buy Relevant costs: Direct material $20,000 Direct labour 80,000 Variable overhead 40,000 Fixed overhead 20,000 Cost to buy $200,000 Total cost $160,000 $200,000

  5. Joint and Separable Costs in Joint Production Processes Split-Off Point • Point in manufacturing process where products separate Joint Product Cost • A cost incurred in a production process prior to the split-off point which cannot be identified with specific intermediate or final products except in an arbitrary manner Separable Cost • A cost which related to a specific product (cost objective) Chemical X $90,000 Split-Off Point Joint Cost $100,000 Chemical Y $30,000 Separable Processing Cost $40,000 Chemical YA $80,000

  6. Sell or Process Further Decision • decision, in a joint production process, to sell product at the split-off point or process further Sell @ Split Process Further Relevant revenue: $30,000 $80,000 Relevant costs: Cost to process beyond split-off point 40,000 Total cost $30,000 $40,000

  7. Irrelevance of Past Costs • Need to irrelevant costs • Past cost are typically irrelevant e.g. obsolete inventory, book value of old equipment • Also known as “sunk” costs

  8. Conflicts Between Decision Making and Performance Evaluation • To motivate employees to make optimal decisions, methods of performance evaluation should be consistent with decision making • Sometimes there is a conflict between decision making analysis and the method used to evaluate performance • Organizations need to protect against this to avoid dysfunctional decision making

  9. Irrelevance of Future Costs? • Some future costs may be irrelevant because they are the same under all feasible alternatives • They may be safely ignored for the purposes of making a particular decision • Example: salaries of top management

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