Managerial accounting 6e jams jambalvo chapter 07

Prepared by Debby Bloom-Hill
CMA, CFM


CHAPTER
CHAPTER 77

The Use of Cost Information in Management
Decision Making

Slide 7-2


Incremental
Incremental Analysis
Analysis



Incremental analysis




All decisions involve a choice among alternative courses of action
The solution to business problems involves incremental analysis



Incremental analysis is the analysis of the incremental revenue and
incremental costs incurred when one alternative is chosen over another

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-3


Incremental
Incremental Analysis
Analysis



Incremental Revenue





Incremental Cost





Additional revenue received by selecting one alternative over another

Additional cost incurred by selecting one alternative over another

Incremental Profit



Difference between incremental revenue and incremental cost

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-4


Incremental
Incremental Analysis
Analysis





An alternative that yields an incremental profit should be selected
Incremental costs are referred to as relevant costs
Also called differential costs because they are the costs that differ
between decision alternatives

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-5


Incremental
Incremental Analysis
Analysis Example

Example



Jensen’s Rapid Copy is considering extending its hours




Alternative 1 is the status quo
Alternative 2 involved the company extending their hours from 8 pm to
midnight



The next slide shows the incremental costs and revenues associated with
choosing one alternative over another

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-6


Incremental
Incremental Analysis
Analysis Example
Example

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.

Slide 7-7


Incremental
Incremental Analysis
Analysis



Incremental Analysis can be extended to more than two alternatives




Calculate profit for each alternative
The alternative with the highest profit is the best alternative



Difference between the profit for this alternative and the profit of any
other alternative is the incremental profit

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-8


“What
“What Does
Does This

This Product
Product Cost?”
Cost?”



Answer: Why do you want to know?




No single cost number is relevant for all decisions
Must find incremental information that is applicable to the decision

 Some costs will change due to the decision, some will not
 Only costs that change are relevant

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-9


Test Your Knowledge 1
Which of the following is likely to be an incremental cost associated with increasing
planned production run of 1,000 units to 1,010 units?

a.
b.
c.
d.

Set-up costs
Depreciation of equipment
Inspection costs
Material costs

Answer: d
Material costs are variable costs and usually incremental

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-10


Analysis
Analysis of
of Decisions
Decisions Faced
Faced
by
by Managers
Managers
Three decisions that managers frequently face:

1.
2.
3.

The decision to engage in additional processing of a product
The decision to make or buy a product

The decision to drop a product line

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-11


Additional
Additional Processing
Processing Decision
Decision



Manufacturers must occasionally decide whether to:






Sell a product in a partially completed stage, or
Incur additional processing costs required to complete the product

Costs incurred to date of decision on partially complete product are not
relevant, i.e sunk costs.

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-12

Additional
Additional Processing
Processing Decision
Decision –– Bridge
Bridge Computer
Computer Example
Example
Summary of cost information

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-13


Additional
Additional Processing
Processing Decision
Decision –– Bridge
Bridge Computer
Computer Example
Example



Incremental analysis summary






Incremental revenues are $500
Incremental costs are $400
Would you spend $400 to generate an additional $500?
Answer: Yes, incremental profit is $100

Slide 7-14


Additional
Additional Processing
Processing Decision
Decision –– Bridge
Bridge Computer
Computer Example
Example
Incremental analysis summary

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-15


Additional
Additional Processing
Processing Decision
Decision

Slide 7-16

Make
Make or
or Buy
Buy Decisions
Decisions



Most manufactured goods are made up of numerous components



In some cases, a company may purchase one or more of these
components from another company or manufacture them themselves



The analysis of this decision concentrates solely on incremental costs

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-17


Make-or-Buy
Make-or-Buy Decisions
Decisions –– General
General Refrigeration

Refrigeration Example
Example

Additional information:



If purchased, cost savings include
$390,000 in supervisory salaries and all
variable costs.



Market value of production machinery is
zero

Slide 7-18


Make-or-Buy
Make-or-Buy Decisions
Decisions –– General
General Refrigeration
Refrigeration Example
Example



A key issue is to determine which of the above costs are incremental



None of the $15 million of variable manufacturing costs will be incurred if
the part is purchased



The fixed costs associated with depreciation will not be saved

 Note that not all fixed costs are irrelevant sunk costs

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-19


Make-or-Buy
Make-or-Buy Decisions
Decisions –– General
General Refrigeration
Refrigeration Example
Example



Some fixed costs are avoidable costs





Avoidable costs can be avoided if a particular action is undertaken

If the parts are purchased from an outside vendor, the salaries of 5
supervisors will be saved





The savings total $390,000 of avoidable fixed costs

It will cost the company an additional $110,000 to purchase the part

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-20


Make-or-Buy
Make-or-Buy Decisions
Decisions –– General
General Refrigeration
Refrigeration Example
Example
Incremental cost analysis – 3 column format

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-21

Make-or-Buy
Make-or-Buy Decisions
Decisions –– General
General Refrigeration
Refrigeration Example
Example

Incremental cost analysis - single column format

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-22


Test Your Knowledge 2
Which of the following is not likely to be an incremental cost for a make-or-buy decision?

a.
b.
c.
d.

Materials cost
Direct labor cost
Variable manufacturing cost
Depreciation of building

Answer: d

Depreciation of building is not likely to change no matter which alternative is chosen in a
make-or-buy decision

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-23


Opportunity
Opportunity Costs
Costs



An opportunity cost is the value of benefits foregone by selecting one
decision alternative over another



For example, if you spend $1,000 instead of investing in a certificate of
deposit, the interest that could have been earned is an opportunity cost



Since opportunity costs differ depending on the option selected, they are
incremental costs

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-24

Test Your Knowledge 3
Which of the following is true?

a.
b.

Opportunity costs are never incremental costs
Opportunity costs are always incremental costs

Answer: b
Opportunity costs are always incremental costs because they differ depending upon the
outcome selected

Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define
sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions.
Slide 7-25