Unformatted text preview: MODULE 37 NONROUTINE DECISIONS 903 NONROUTINE DECISIONS The focus of this module is nonroutine decision making, which can be broken down into two broad cate- gories, referred to here as short—term differential (relevant) cost analysis and capital budgeting decisions (or ' long—term differential cost analysis). The basic difference between these two categories is that capital budget—
ing decisions usually involve a large initial investment to be returned ever a long—term period, while short-term
differential cost decisions do not involve such an investment or such a long-term period for the returns. A. Short-Term Differential Cost Analysis
Differential cost decisions include P‘P‘F‘PP?‘ Sell or process further (see also Section 1., Module 34)
Special order '
Outsourcin g (make or buy) Closing a department or segment Sale of obsolete inventory Scarce resources These decisions would better be described as differential cost and revenue decisions, since basically
the decision maker must consider differences in costs and revenues over various alternatives. All other
things being equal, the alternative providing the greatest proﬁt (or cost savings) should be chosen. Three concepts relate to most differential cost decisions. 1. The only relevant costs or revenues are those expected future costs and revenues that differ
across alternatives. If an alternative leads to increased revenues (costs) as compared to the pres- ent method Used or other alternative considered, then these revenues (costs) are relevant (Le, a
differential cash ﬂow). ' All costs incurred in the past (sunk costs) are irrelevant, unless they have future tax ramifi- cations. Past costs include joint costs, the cost of obsolete inventory, and ﬁxed costs (in the short
run). Opportunity cost, the income obtainable from an alternative use of a resource, must be con-
sidered. If an alternative is proﬁtable and that alternative is rejected in favor of others, the bone ﬁts foregone become a “cost” to be evaluated in the decision~makiug process. To work a'relevant cost problem, you must first identify the type of decision that is involved. Once
you have identiﬁed the decision, you can determine which costs and revenues are relevant for accepting or
rejecting an alternative and in reaching a decision. For example, in a decision to sell at split-off or pro-
cess further, joint costs are irrelevant and a decision to process further is made if incremental revenue ex-
ceeds incremental cost. Finally, a decision is made based on the beneﬁt or loss that would be derived from
each alternative. . The table presented below summarizes various differential cost decisions and includes only quantita- tive factors.
Decision Descgg‘ lion Decision guideline
I. Sell or process fimher Should joint products be sold at split-off Ignore joint costs. Process further if incre-
or processed further? mental revenue exceeds incremental cost.
2. Special order Should a discount~priced order be ac- If regular sales arenot affected, accept order
cepted when there is idle capacity? when the revenue from the order exceeds the
incremental cost. Fixed production costs are
usually irrelevant—"they remain the same no
_ matter what the company does.
3. Outsourcing (make or buy) Should a part be manufactured or Choose lower cost option. Fixed costs usu-
bought from a supplier? ally are irrelevant. Often opportunity costs
4. Closing a department or segment Should a segment of the company, such Compare existing contribution margin with
as a product line. be terminated? alsematlve. Consider any changes in future
_ ﬁxed costs.
5. Sale of obsolete inventory Should obsolete inventory be reworked Cost of inventory is sunk and ignored.
or junked‘l Choose alternative with greatest excess of
future revenue over future cost.
6. Scarce resources Which products should be emphasized Determine scarce researce (cg, machine
when capacity is limited? hours). Emphasize products with greatest contribution margin per unit of scarce re-
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- Spring '08