Ch7-Relevant Costs

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

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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
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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.
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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
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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.
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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)
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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
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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???
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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: Heather’s sales are $200,000 per year. Fixed expenses, other than depreciation, are $70,000 per year. WHAT IS RELEVANT TO THE DECISION HERE???
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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: Heather’s sales are $200,000 per year. Fixed expenses, other than depreciation, are $70,000 per year. WHAT IS RELEVANT TO THE DECISION HERE???
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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 $
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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 $ Too many managers make decisions this way.
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