CACC406 CH09 - CACC406 CH09 RELEVANT INFORMATION AND MAKING...

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CACC406 CH09 RELEVANT INFORMATION AND MAKING PRODUCTION DECISIONS EX of Production Decisions - Make or buy - Sell at the split off point or process further - Keep or replace equipment DIFFERENTIAL AND OPPORTUNITY COSTS CONSIDER : - Maria Morales, a CA, employed by a large accounting firm at 60,000 per year - She is thinking about quitting her job to have her own practice and own business THE FOLLOWING IS A COMPARISON OF MARIA’S ALTERNATIVES CALLED A DIFFERENTIAL ANALYSIS : Remain as Open Independent Difference an Employee Practice Revenues $60,000 $200,000 $140,000 Outlay costs (operating expenses) --------- $120,000 $120,000 Income effects per year $60,000 $80,000 $20,000 Differential/Incremental Cost is the difference in total cost between the two alternatives Differential Income is the difference in total income between the two alternatives So: Differential Revenue = 140,000 Differential Cost = 120,000 Differential Income = 20,000 The annual difference of $20,000 favours Maria’s choosing independent practice, however independent practice has an opportunity cost of $60,000 – the foregone salary THE FOLLOWING IS A COMPARISON OF MARIA’S ALTERNATIVES WITH FOCUS ON OPPORTUNITY COST : Alternative Chosen: Independent practice Revenue $200,000 Expenses: Outlay costs (operating expenses) $120,000 Opportunity cost of employee salary $60,000 $180,000 Income Effects Per Year $20,000 Alternative Chosen: Remain as Employee Revenue $60,000 Expenses: Outlay costs (operating expenses) $0 Opportunity cost of indep. practice $80,000 $80,000 Income Effects Per Year $(20,000) Opportunity Cost
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CACC406 CH09 is the maximum foregone benefit (contribution to profit) by choosing to forego an alternative opportunity cost OR Is the contribution of the best alternative that is excluded from consideration DECISION: MAKE OR BUY Managers apply relevant cost analysis to a variety of make-or-buy decisions Consider: manufacturers who must often decide whether to make or buy a product Qualitative reasons for making their own parts: o Control quality o Possess special know-how Qualitative reasons for purchasing parts o Protect long-run relationships with suppliers o Avoid difficulties in obtaining needed parts during boom times, when there may be shortages of material and workers but no shortage of sales orders Qualitative considerations often dominate quantitative cost assessments – so decisions are not made exclusively on numbers alone Key factor that influences decision – Whether there are idle facilities o
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