Suppl note re types of decisons

Suppl note re types of decisons - 1 ACCT2460 Supplementary...

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1 ACCT2460 Supplementary Notes re Chapter 7 Relevant or Incremental Costs and Special Decision Making Most businesses have to make what are called “non-routine” or special decisions on an ongoing basis. Examples: Accept v. Reject a Special Order at less than the normal selling price Keep v. Drop a product line, division, customer etc. Make inside v. Buy outside a part or component used by the business in its operations Keep v. replace a piece of equipment Sell a product as is v. process it further and then sell it These decisions typically involve two or more alternatives. The approach taken is to focus only on those costs and revenues that are relevant to the decision at hand. A cost (or revenue) is relevant to the decision if it meets the following criteria: 1. It relates to the future (i.e., the amount has not already been incurred and spent) 2. It differs among the various alterative choices. If a cost or revenue item meets both of these criteria, it is relevant to the decision and the amounts should be included in the analysis. Costs that have already been incurred and spent are called “sunk costs” and are irrelevant to the decision (but not for other purposes). Relevant costs are also called “incremental costs”, “differential costs” (the difference between two alternatives), or “avoidable costs” (costs that are avoidable under one of the alternatives). As a general rule, unless information is given to the contrary, variable costs are relevant costs (unless they are the same for both alternatives---e.g. both alternatives require paying a sales commission) and fixed costs are irrelevant (unless some addition lump sum fixed cost is required if you accept one of the alternatives---e.g., if you accept a special order, you will have to hire a night supervisor and pay an additional salary). A cost is also relevant if it can be avoided under one of the alternatives (because it then differs among the alternatives. Such avoidable costs should be added to the analysis . In the decisions we will look at, our focus is always on the alternative that differs from the status quo. Types of Special Decisions 1. Accept/Reject a Special Order Special orders are one-time orders from non-regular customers usually at a price below normal selling price. They may be orders for “generic” or no-name products.
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