Chapter 02s

# We will use this approach for 1 cost volume profit

• Notes
• 38

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We will use this approach for: 1. Cost-volume-profit analysis (Chapter 5). 2. Budgeting (Chapter 8). 3. Segmented reporting of profit data (Chapter 6). 4. Special decisions such as pricing and make-or-buy analysis (Chapter 12).

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2-32 Every decision involves a choice between at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored as irrelevant. Cost Classifications for Decision  Making
2-33 Differential Cost and Revenue Costs and revenues that differ among alternatives. Example: You have a job paying \$1,500 per month in your hometown. You have a job offer in a neighboring city that pays \$2,000 per month. The commuting cost to the city is \$300 per month. Differential revenue is:   \$2,000 – \$1,500 = \$500 Differential cost is:   \$300

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2-34 Opportunity Cost The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending college, you could be earning \$15,000 per year. Your opportunity cost of attending college for one year is \$15,000.
2-35 Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. These costs should be ignored when making decisions. Example: Suppose you had purchased gold for \$400 an ounce, but now it is selling for \$250 an ounce. Should you wait for the gold to reach \$400 an ounce before selling it? You may say, “Yes” even though the \$400 purchase is a sunk costs.

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2-36 Quick Check  ü Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant.
2-37 Quick Check  ü Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant. B. No, the licensing cost is not relevant.

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2-38 Quick Check  ü Suppose that your car could be sold now for \$5,000. Is this a sunk cost? A. Yes, it is a sunk cost. B. No, it is not a sunk cost.
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• Fall '12
• StephenD.Joyce

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