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Ch07 - Chapter 7 The Use of Cost Information in Management...

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Chapter 7 The Use of Cost Information in Management Decision Making QUESTIONS 1. These are the costs and revenues that differ between decision alternatives. 2. Sunk costs are the costs that have been incurred in prior periods. They are not incremental costs and, hence, they are not relevant in making a decision. 3. These are the costs that can be avoided if a particular action is undertaken. 4. Opportunity costs are the values of benefits foregone by selecting one decision alternative over another. Since opportunity costs differ depending upon which decision alternative is selected, they are relevant in evaluating decision alternatives. Alternatively, since opportunity costs are incurred when a decision alternative is selected, they are incremental costs related to that decision. 5. The proper (quantitative) approach to analyzing the question of dropping a product line is to calculate the change in income that will result from dropping the product line. If income will increase when the line is eliminated, the product line should be dropped; otherwise not. 6. Common costs which are incurred for the benefit of two or more products, such as the company president's salary, are not sunk because they are incurred in current and future periods. But they are still irrelevant because they usually do not differ among the decision alternatives. 7. Qualitative advantages of making rather than buying a component usually include exercising more control over the production process, quality, delivery schedules, and costs. 8. The amount of joint cost allocated to a product under relative sales value method cannot exceed the product's sales value at the split-off point. Thus, products that make a positive contribution to covering joint cost will not look unprofitable. 9. The value of time in a bottleneck department is generally quite high and equal to the contribution margin of all throughput per hour. Therefore, you don’t want to “waste it” setting up equipment. Since more set-ups are required with small batch sizes, it is generally advisable to have larger batch sizes in bottleneck departments. 10. A bottleneck department is referred to as a drum because it “beats a rhythm” that coordinates the production in other departments.
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Jiambalvo Managerial Accounting EXERCISES E1. Consider a decision to close a production facility. In this case, heat and light, which were fixed costs at the plant, would drop to zero. Thus, heat and light would be an incremental cost saving with respect to the decision. Depreciation of the facility, which is also a fixed cost, would not be an incremental cost saving. Depreciation represents a sunk cost and sunk costs are never incremental costs. E2. If Adrienne drops accessories, she will lose the contribution margin (which in this case is also the gross margin) of $31,250. The fixed costs allocated to accessories, which total $36,270, are not likely to decline. (Keep in mind that Adrienne has only two assistants. It is doubtful that she can do without either one of them simply by dropping accessories.)
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