Chapter 13 Notes

Chapter 13 Notes - RELEVANTCOSTS

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RELEVANT COSTS Every decision involves choosing from among at least two alternatives. A relevant cost or benefit  is a cost or benefit that differs, in total,  between the alternatives. Any cost or benefit that does not differ between  the alternatives is irrelevant and can be ignored. Relevant costs and  benefits are also known as differential costs and benefits. Avoidable costs  are those costs that can be eliminated in whole or in  part by choosing one alternative over another. Avoidable costs are relevant  costs. Two broad categories of costs are never relevant in decisions: 1. Sunk costs. 2. Future costs that do not differ between alternatives. To make a decision: 1. Eliminate costs and benefits that do not differ, in total, between  alternatives. 2. Base the decision on the remaining costs and benefits.
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DROP OR RETAIN A SEGMENT EXAMPLE: Due to the declining popularity of digital watches, Sweiz  Company’s digital watch line has not reported a profit for several years. An  income statement for last year follows: Segment Income Statement—Digital Watches Sales. ................................................. $ 500,000 Variable expenses: Variable manufacturing costs. ......... $120,000 Variable shipping costs. ................... 5,000 Commissions. ..................................       75,000         200,000     Contribution margin. ........................... 300,000 Fixed expenses: General factory overhead*. .............. 60,000 Salary of product line manager. ....... 90,000 Depreciation of equipment**. ........... 50,000 Product line advertising. .................. 100,000 Rent—factory space***. ................... 70,000 General administrative expense*. ....       30,000         400,000     Net operating loss. ............................. $(100,000 ) * Allocated common costs that would be redistributed to other  product lines if digital watches were dropped. ** This equipment has no resale value and does not wear out  through use. *** The digital watches are manufactured in their own facility. Should the company retain or drop the digital watch line?
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DROP OR RETAIN A SEGMENT (continued) Approach #1: If by dropping digital watches the company is able to avoid more in fixed  costs than it loses in contribution margin, then it will be better off if the  product line is eliminated. The solution would be: Contribution margin lost if digital watches  are dropped. ........................................... $(300,000) Less fixed costs that can be avoided: Salary of the product line manager. ........ $ 90,000 Product line advertising. ......................... 100,000 Rent—factory space. ..............................     70,000         260,000    
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This document was uploaded on 10/26/2011 for the course ACC 222 at Miami University.

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Chapter 13 Notes - RELEVANTCOSTS

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