Clearly the variable costs are relevant if we do not

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Clearly the variable costs are relevant. If we do not do the project we will not spend the costs. The piece that is important to learn from this example, is that FIXED costs are often not relevant to the decision since they cannot be eliminated. SO will the project contribute some profit toward those fixed costs!!! Relevant costs 1. Costs that differ between the alternatives 2. Future oriented costs Relevant costs can be fixed or variable They are often context sensitive They can be estimates Sunk costs These are costs that cannot be changed so they are not relevant to future decisions Opportunity Costs These are the sacrificed costs that are incurred to obtain an alternate opportunity Differential Revenue and Avoidable Costs: If you have 2 choices, this might result in different revenue amounts. Difference between them is called differential revenue Avoidable costs – these are costs that can be eliminated under certain decisions 1. Unit level costs 2. Batch level costs 3. Product level costs 4. Facility level costs (don’t spend too much time here!!!) Using Relevant information to Make special decisions 13-2
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Chapter 13 - Relevant Information for Special Decisions Special order decisions: Should we accept or reject a special order? In these cases we really want to look at the variable costs that can be covered. The fixed costs do not matter so is the special order covering the variable costs and will it add to company profits? Compare the differential revenue and the differential cost. If the company is already operating at full capacity, any additional production increases fixed and variable manufacturing costs. Selling and administrative expenses may also increase because of the additional business. So then it is often does NOT MAKE SENSE and you must compare increase in fixed and variable costs. If the company is operating below full capacity , any additional product does not in- crease fixed manufacturing costs. In this case, the differential costs are just the vari- able mfg costs . Selling and administrative expenses may also increase because of the additional business EXAMPLE: Gooding Foods makes Goody-Goody brand peanut butter. The cost to make each jar is $2.05 and consists of the following: Direct materials $1.00 Direct labor 0.25 Variable overhead 0.30 Fixed overhead 0.50 A grocery store chain wants to purchase a generic brand peanut butter from Gooding and is willing to pay $1.50 per jar. The generic peanut butter will be made using a differ- ent recipe, lowering the direct materials cost to $0.80 per jar. Gooding can produce this special order using excess capacity; therefore, fixed costs will not increase. Use differ-
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  • Fall '12
  • Cohen
  • Pricing, relevant information, ddI, Special Decisions

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