session7 - Session 7 Managerial Decision Making (Relevant...

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Managerial Decision Making (Relevant Costs, Incremental Analysis) Session 7
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45-701: Accounting for Decision Making and Control 2 Relevant Costs A relevant cost is a cost that is applicable to a particular decision that should have a bearing on which alternative a manager selects. Relevant cost (incremental) approach is especially helpful when Information is incomplete for detailed I/S Important impact factors need to be highlighted
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45-701: Accounting for Decision Making and Control 3 Identifying Relevant Costs Avoidable costs are relevant costs which can be eliminated (in whole or in part) as a result of choosing one alternative over another. All costs are avoidable, except: Sunk costs. Future costs that do not differ between the alternatives at hand. Fixed costs may or may not be avoidable
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45-701: Accounting for Decision Making and Control 4 Sunk Costs: Example Replacing an old machine with a new one? Sales are $200,000 per year and fixed expenses other than depreciation are $70,000 per year. 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
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45-701: Accounting for Decision Making and Control 5 Sunk Costs: Financial Accounting What would accounting profits suggest? Remaining book value Disposal value Loss from disposal Profitability on accounting books
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45-701: Accounting for Decision Making and Control 6 For Five Years Keep Old Machine Purchase New Machine Difference Sales Variable expenses Other fixed expenses Depreciation - new Depreciation - old Disposal of old machine Total net income Sunk Costs: Correct Analysis Look at the comparative cost and revenue for the next 5 years.
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45-701: Accounting for Decision Making and Control 7 Sunk Costs: A Shortcut We could prepare the analysis using only relevant costs : Relevant Cost Analysis Savings in variable expenses provided by the new machine ($20,000 × 5 yrs.) Cost of the new machine Disposal value of old machine Net effect
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45-701: Accounting for Decision Making and Control 8 Future Costs That Do Not Differ are Irrelevant Costs Any future cost that does not differ between the
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This note was uploaded on 10/07/2010 for the course ECTCS ec12947322 taught by Professor Johnathayeri during the Spring '10 term at Life.

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session7 - Session 7 Managerial Decision Making (Relevant...

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