ch13 - Managerial Accounting Chapter 13 Relevant Costs and...

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Managerial Accounting Chapter 13 - Relevant Costs and Decisions
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Highlights Chapter 13 Let’s review relevant vs irrelevant costs What are sunk costs? How do we analyze keep vs replace equipment decisions? What about the analysis of dropping or retaining product lines/segments? Special orders? Scare resources? Spit products or process further?
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Costs that can be eliminated (in whole or  in  part) by choosing one alternative over  another are  avoidable costs . Avoidable costs are relevant costs. Unavoidable costs are never relevant and  include: Sunk costs. Future costs that  do not differ     between the  alternatives. Relevant Costs
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Relevant Costs Sunk Costs : a cost that has already been incurred and cannot be avoided regardless of the decision made These costs have no relevance to futures decisions and must be ignored
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Relevant Costs Future Costs & Revenues that do not differ between alternatives must be ignored Depreciation is ignored for old equipment
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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 A manager at White Co. wants to replace an old  machine with a new, more efficient machine. Relevant Costs - Example
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White’s sales are $200,000 per year. Fixed expenses, other than amortization, are  $70,000 per year. Should the manager purchase                 the  new machine? Relevant Costs - Example
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Incorrect Analysis The manager recommends that the company  not purchase     the new machine since  disposal of the old machine would result in a  loss: Remaining book value 60,000 $ Disposal value (15,000) Loss from disposal 45,000 $
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Correct Analysis For Five Years Keep Old Machine Purchase New Machine Difference Sales 1,000,000 $ 1,000,000 $ - $ Variable expenses (500,000) (400,000) 100,000 Other fixed expenses (350,000) (350,000) - Amortization - new (90,000) (90,000) Amortization - old (60,000) (60,000) - Disposal of old machine 15,000 15,000 Total net income 90,000 $ 115,000 $ 25,000 $ Look at the comparative cost and revenue                      for the next five years. Would you recommend purchasing the new machine even though we will show a $45,000 loss on the old machine?
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Relevant Cost Analysis Savings in variable expenses provided by the new machine ($20,000 × 5 yrs.) 100,000 $ Cost of the new machine (90,000) Disposal value of old machine 15,000 Net effect 25,000 Correct Analysis
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Adding or Dropping a Segment 2 methods used to analyze this situation 1) Compare CM & fixed costs of each segment. Segments should be dropped if decrease in CM < decrease in fixed costs. New segments should be taken on if increase in CM > increase in fixed costs
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Adding or Dropping a Segment 2) Calculate total Net Income under each alternative . Scenario with higher net income is selected.
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This note was uploaded on 06/20/2009 for the course ACC 406 taught by Professor Unknown during the Summer '09 term at Ryerson.

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ch13 - Managerial Accounting Chapter 13 Relevant Costs and...

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