4 steps of management's decision making process
- 1. Identify the problem and assign responsibility for the decision
- 2. Determine and evaluate possible courses of action
- 3. Make decision
- 4. Revies results of the decision
Financial infomation in making business decisions
Relates to revenue and costs and their effect on the company's overall profitability
Nonfinancial information in making business decisions
Relates to such factors as the effect of the decision on employees turnover, the environment, or the overall image of the company in the community
- The process used to identify the financial data that change under alternative courses of action, and these data
- Sometimes costs and revenue will vary
- Sometimes only costs or revenue will vary
Incremental analysis approach
Decisions involve a choice among alternative courses of action
Relevant cost concept
Those costs and revenues that differ across alternatives
Opportunity cost concept
- The potential benefit that may be obtained from following an alternative course of action
- Lost benefit
- Oftern in choosing one corse of action, the company must give up the opportunity to benefit from some other couse of action
Sunk cost concept
- A cost that cannot be changed by any present or future decision
- Costs that have already been incurred and will not be changed or avoided by any future decision
- Sunk costs are not relevan costs
Types of incremental analysis
- 1. Accept an order at a special price
- 2. Make or buy component parts or finished product
- 3. Sell product or process them further
- 4. Retain or replace equipment
- 5. Eliminate an unprofitable business segment
- 6. Allocate limited resources
Multiple end-products produced from a single raw material and a common production process
For joint products, all costs incurred prior to the point at which the two products are separately identifiable (known as the split-off point)
Theory of constraints
A specific approach used to identify and manage constraints in order to achieve the company's goals
Identify the relevant costs in accepting an order at a special price.
- The relevant costs are those that change if the order is accepted. These are typically variable manufacturing costs.
- The relevant information in accepting an order at a special price is the difference between the variable manufacturing costs to produce the special order and expected revenues.
Identify the relevant costs in a make-or-buy decision.
In a make-or-buy decision, the relevant costs are (a) the variable manufacturing costs that will be saved, (b) the purchase price, and (c) opportunity costs.
Identify the relevant costs in determining whether to sell or process materials further.
The decision rule for whether to sell or process materials further is: Process further as long as the incremental revenue from processing exceeds the incremental processing costs.
Identify the relevant costs to be considered in retaining or replacing equipment.
The relevant costs to be considered in determining whether equipment should be retained or replaced are the effects on variable costs and the cost of the new equipment. Also, any disposal value of the existing asset must be considered.
Identify the relevant costs in deciding whether to eliminate an unprofitable segment.
In deciding whether to eliminate an unprofitable segment, the relevant costs are the variable costs that drive the contribution margin, if any, produced by the segment. Disposition of the segment's fixed expenses must also be considered.
Determine sales mix when a company has limited resources.
When a company has limited resources, it is necessary to find the contribution margin per unit of limited resource. This amount is then multiplied by the units of limited resource to determine which product maximizes net income.