ac102_ch11 - Revised Summer 2010 CHAPTER 11 RELEVANT COSTS...

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Revised Summer 2010 Page 1 of 19 CHAPTER 11 RELEVANT COSTS FOR DECISION MAKING Key Terms and Concepts to Know Relevance: Relevant costs and benefits are those that differ among alternatives Total approach vs. differential approach and why relevant costs must be isolated. Difference between costs that are avoidable and those that are not avoidable. Avoidable costs are those that can be eliminated (in whole or in part) by choosing one alternative over another in a decision Sunk costs, costs that has already been incurred and that cannot be changed by any decision made now or in the future, are never relevant Future revenues and costs that will not change by choosing one alternative over another in a decision are never relevant How and why some fixed costs (common fixed costs) need to be allocated, and the problems inherit in the allocation process. Constraints: Limitations under which a company must operate, such as limited available machine time or raw materials, which restricts the company’s ability to satisfy demand. Constraints or bot tlenecks limit a company’s ability to grow and limit the total output of the entire system. Opportunity Costs: Opportunity costs are not recorded in the general ledger. Opportunity costs are factors in the decision-making process because they differ among alternatives. Key Topics to Know Companies make many decisions which require relevant information on a timely basis. Some of these decisions include:
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Revised Summer 2010 Page 2 of 19 o Accepting or not accepting a special order, a one-time sales order that is not considered part of t he company’s normal ongoing business. o Dropping or retaining a product line or other business segment o Make or buy decisions, concerning whether an item should be produced internally or purchased from an outside supplier. o The most profitable use of a constrained resource to maximize the company’s total contribution margin Relevant Costs Example #1 A number of costs are listed below that may be relevant in a decision faced by the management of Birmingham Company. Birmingham normally runs at capacity and the old Model CY1000 machine is the company’s constraint. Management is considering purchasing a new machine, Model CZ4000 and the old one, CY1000 will be sold. The new machine is more efficient and can produce 20% more units than the old one. Demand for B irmingham’s product is greater than what they can supply. If the new machine is purchased, there should be a reduction in maintenance costs however the new machine is very costly and the company will need to borrow money in order to make the purchase. The increase in volume will be large enough to require increases in fixed selling expense, but general administrative expenses will remain unchanged. Required:
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ac102_ch11 - Revised Summer 2010 CHAPTER 11 RELEVANT COSTS...

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