Ch7-Relevant Costs - Cost Concepts for Decision Making A...

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Unformatted text preview: Cost Concepts for Decision Making A relevant cost relevant cost is a cost that is applicable to a particular decision that should have a bearing on which alternative a manager selects. 1 2 Identifying Relevant Costs Avoidable costs are relevant costs that can be eliminated eliminated (in whole or in part) as a result of choosing one alternative over another. All costs are avoidable , except except: Sunk costs . Future costs that do not differ do not differ between the alternatives at hand. Sunk cost Sunk cost-- a cost that has already been incurred and that cannot be avoided regardless of which course of action a manager may decide to take. Identifying Relevant Costs Things that do not change as a result of a particular decision are NOT relevant to that decision. Things that do change as a result of the decision ARE relevant to that decision. New machine: List price 90,000 $ Annual variable expenses 80,000 $ Expected life in years 5 NEW MACHINE ASSUMPTIONS For example: Compare the information provided for the following analysis: (Replace an older machine with a newer, more efficient machine) Old machine: Original cost 72,000 $ Remaining book value 60,000 $ Disposal value now 15,000 $ Annual variable expenses 100,000 $ Remaining life in years 5 For example: Compare the information provided for the following analysis: (Replace an older machine with a newer, more efficient machine) OLD MACHINE ASSUMPTIONS New machine: List price 90,000 $ Annual variable expenses 80,000 $ Expected life in years 5 Old machine: Original cost 72,000 $ Remaining book value 60,000 $ Disposal value now 15,000 $ Annual variable expenses 100,000 $ Remaining life in years 5 Also Assume (although not relevant) that: Sales are $200,000 per year. Fixed expenses, other than depreciation, are $70,000 per year. WHAT IS RELEVANT TO THE DECISION HERE??? New machine: List price 90,000 $ Annual variable expenses 80,000 $ Expected life in years 5 Old machine: Original cost 72,000 $ Remaining book value 60,000 $ Disposal value now 15,000 $ Annual variable expenses 100,000 $ Remaining life in years 5 Also Assume (although not relevant) that: Heathers sales are $200,000 per year. Fixed expenses, other than depreciation, are $70,000 per year. WHAT IS RELEVANT TO THE DECISION HERE??? New machine: List price 90,000 $ Annual variable expenses 80,000 $ Expected life in years 5 Old machine: Original cost 72,000 $ Remaining book value 60,000 $ Disposal value now 15,000 $ Annual variable expenses 100,000 $ Remaining life in years 5 Also Assume (although not relevant) that: Heathers sales are $200,000 per year. Fixed expenses, other than depreciation, are $70,000 per year. WHAT IS RELEVANT TO THE DECISION HERE??? Incorrect Analysis Some mangers may recommend that the company not purchase the new machine, since disposal of the old machine would result in a bookkeeping (reported) loss: Remaining book value 60,000 $ Disposal value (15,000) Loss from disposal 45,000 $ Some mangers may recommend that the company...
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This note was uploaded on 08/04/2008 for the course ACCT 210 taught by Professor Blanchard during the Summer '08 term at University of Arizona- Tucson.

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Ch7-Relevant Costs - Cost Concepts for Decision Making A...

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