Making Decision o Recognize the need for a decision Defining the problem o Identify alternative solutions o Evaluate alternative solutions Accounting information is particular helpful with this step Profit impact decision is one of most important issues in step To understand managers must analyze costs and revenues it affects (relevant costs and revenues) Key question: "what difference does it make?" Company's profit is important area where decision alternatives make a difference Important to analyze costs and revenue changes caused by each decision alternative to understand profit impact of each alternative o Make the decision Choosing best alternative Relevant Costs and Revenues o Future costs and revenues that will change as a result of a decision o An important part of preparing an analysis for a decision is to identify these What activities are necessary for company to carry out decision? By how much will the costs and/or revenues be affected if company undertakes activities? o Should be included in analysis unlike costs and revenues that are not relevant o Identifying relevant costs/revenues Eliminate past costs Eliminate costs not necessary to carry out decision alternatives [unnecessary] Eliminate costs that wouldn't differ from one alternative to another Activities Necessary to Carry Out Decision o Key to identifying potentially relevant costs is to have good understanding of company's activities that are necessary to carry out decision Activities are cause of all relevant costs o No cost incurred prior to making decision is relevant Pasts costs (sunk costs) should be eliminated from consideration o Future costs company will incur for activities that aren't necessary carry to out decision are not relevant How much Costs and/or Revenues will be Affected if Company Undertakes Activities o Specific cost is relevant only if total amount the company will incur is affected by decision COSTS CONCEPTS FOR SHORT-TERM DECISIONS Incremental Costs o Cost increases resulting from a higher volume of activity or from the performance of an additional activity
o Always relevant when the higher volume of activity or additional activity is not necessary for all the alternatives Avoidable Costs o Costs that a company must incur to perform an activity at a given level but that it can avoid if it reduces (decreases its volume) or discontinues activity Opportunity Costs o Profits a company forgoes by following a particular course of action o Profit impact of disruption or lost opportunity must be included in decision analysis Commonly done by including opportunity costs among costs to be incurred Dropping a Product o Change in product mix occurs partially because a company drops a product from inventory o Several reasons company may decide to drop product Changing technology and competition No longer profitable Customer's interest in product has decreased Product is becoming obsolete(outdated) Product has poor safety record New information indicating it may harm environment o Integrated accounting system helps company's managers evaluate the profitability of the product in question of being dropped Determine costs it wouldn't incur (avoidable costs) and revenues it wouldn't earn if company discontinued production and sale of product Avoidable costs are always relevant to this evaluation Total avoidable costs > revenue it would lose if it dropped ->DROP o