chapter 14 n

The Managerial Accountants Role in Decision Making1-*Designs and implementsaccounting informationsystemCross-functional management teams who makeproduction, marketing,and finance decisionsMake substantiveeconomic decisionsaffecting operationsManagerialAccountant

The Decision-Making Process1-*1. Clarify the Decision Problem2. Specify the Criterion3. Identify the Alternatives4. Develop a Decision Model5. Collect the Data6. Make a Decision

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Learning Objective2

The Decision-Making Process1-*1. Clarify the Decision Problem2. Specify the Criterion3. Identify the Alternatives4. Develop a Decision Model5. Collect the Data6. Make a DecisionPrimarily theresponsibility of themanagerialaccountant.Information should be:1. Relevant2. Accurate3. Timely

The Decision-Making Process1-*1. Clarify the Decision Problem2. Specify the Criterion3. Identify the Alternatives4. Develop a Decision Model5. Collect the Data6. Make a DecisionQualitativeConsiderations

The Decision-Making Process1-*1. Clarify the Decision Problem2. Specify the Criterion3. Identify the Alternatives4. Develop a Decision Model5. Collect the Data6. Make a DecisionRelevantPertinent to a decision problem.AccurateInformation mustbe precise.TimelyAvailable in timefor a decision


Learning Objective3

Relevant Information1-*Information is relevant to a decision problem when . . .It has a bearing on the future, It differs among competing alternatives.


Learning Objective4

Identifying RelevantCosts and Benefits1-*Sunk costs Costs that have already been incurred. They do not affect any future cost and cannot be changed by any current or future action.Sunk costs are irrelevant to decisions.

Relevant Costs1-*Worldwide Airways is thinking about replacing a three year old loader with a new, more efficient loader.

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New loader

List price$15,000

Annual operating expenses45,000

Expected life in years1

Old loader

Original cost$100,000

Remaining book value25,000

Disposal value now5,000

Annual variable expenses80,000

Remaining life in years1

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Relevant Costs1-*If we keep the old loader, we will have depreciationcosts of $25,000. If we replace the old loader,we will write-off the $25,000 when sold. There isno difference in the cost, so it is not relevant.The new loader will be depreciated in one year.The $5,000 proceeds will only be realized if wereplace the old loader. This amount is relevant.We will only have depreciation on the new loaderif we replace the old loader. This cost is relevant.

Relevant Costs1-*The difference in operating costs is relevantto the immediate decision.

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Keep Old LoaderReplace Old LoaderDifferential Cost

Depreciation of old loader$25,000

Write-off of old loader$25,0000.0

Proceeds from sale of old loader(5,000)5,000

Depreciation of new loader15,000(15,000)

Operating costs80,00045,00035,000

Total costs$105,000$80,000$25,000

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Relevant Costs1-*Here is an analysis that includes only relevant costs:

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Relevant Cost Analysis

Savings in variable expenses provided by the new loader$35,000$1,000,0000.0

Cost of the new loader(15,000)(400,000)100,000

Disposal value of old loader5,000(350,000)0.0

Net effect$25,000$250,000$100,000

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Learning Objective5

Analysis of Special Decisions1-*Lets take a close look at some special decisions faced by many businesses.We just receiveda special order. Doyou think we shouldaccept it?

Accept or Reject a Special Order1-*A travel agency offers Worldwide Airways $150,000 for a round-trip flight from Hawaii to Japan on a jumbo jet.Worldwide usually gets $250,000 in revenue from this flight.The airline is not currently planning to add any new routes and has two planes that are idle and could be used to meet the needs of the agency.The next screen shows cost data developed by managerial accountants at Worldwide.

Accept or Reject a Special Order1-*Worldwide will save about $5,000 in reservationand ticketing costs if the charter is accepted.

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Typical Flight Between Japan and Hawaii

Revenue:

Passenger$250,000

Cargo30,000

Total$280,000

Expenses:

Variable expenses90,000

Allocated fixed expenses100,000

Total190,000

Profit$90,000

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Accept or Reject a Special Order1-*Since the charter will contribute to fixed costs and Worldwide has idle capacity, the company should accept the flight.

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Assumes excess capacity

Special price for charter$150,000

Variable cost per flight$90,000

Reservation cost savings(5,000)

Variable cost of charter85,000

Contribution from charter$65,000

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Accept or Reject a Special Order1-*What if Worldwide had no excess capacity? If Worldwide adds the charter, it will have to cut its least profitable route that currently contributes $80,000 to fixed costs and profits. Should Worldwide still accept the charter?

Accept or Reject a Special Order1-*Worldwide has no excess capacity, so it should reject the special charter.

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Assumes no excess capacity

Special price for charter$150,000

Variable cost per flight$90,000

Reservation cost savings(5,000)

Variable cost of charter85,000

Opportunity cost:

Lost contribution on route80,000165,000

Total$(15,000)

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Accept or Reject a Special Order1-*With excess capacity . . .Relevant costs will usually be the variable costs associated with the special order. Without excess capacity . . .Same as above but opportunity cost of using the firms facilities for the special order are also relevant.

Outsource a Product or Service1-*A decision concerning whether an item should be produced internally or purchased from an outside supplier is often called a make or buy decision. Lets look at another decision faced by the management of Worldwide Airways.

Outsource a Product or Service1-*An Atlanta bakery has offered to supply the in-flight desserts for 21 each.Here are Worldwides current cost for desserts:

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Variable costs:

Direct material$0.06

Direct labor0.04

Variable overhead0.04

Fixed costs:

Supervisory salaries0.04

Depreciation of equipment0.07

Total cost per dessert$0.25

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Outsource a Product or Service1-*Not all of the allocated fixed costs will be savedif Worldwide purchases from the outside bakery.

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Cost per DessertSavings from Outsourcing

Variable costs:

Direct material$0.06$0.06

Direct labor0.040.04

Variable overhead0.040.04

Fixed costs:

Supervisory salaries0.040.01

Equipment depreciation0.070.0

Total cost per dessert$0.25$0.15

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Outsource a Product or Service1-*If Worldwide purchases the dessert for 21, it will only save 15 so Worldwide will have a loss of 6 per dessert purchased.Wow, thatsno deal!

Add or Drop a Service,Product, or Department1-*One of the most important decisions managers make is whether to add or drop a product, service or department. Lets look at how the concept of relevant costs should be used in such a decision.

Add or Drop a Product1-*Worldwide Airways offers its passengers the opportunity to join its World Express Club. Club membership entitles a traveler to use the club facilities at the airport in Atlanta. Club privileges include a private lounge and restaurant, discounts on meals and beverages, and use of a small health spa.

Add or Drop a Product1-*Sales$200,000Less: Variable Costs: Food/Beverage$70,000 Personnel 40,000 Variable overhead 25,000 (135,000)Contribution Margin 65,000Less: Fixed Costs: Depreciation$30,000 Supervisor salary 20,000 Insurance 10,000 Airport fees 5,000 Allocated overhead 10,000( 75,000)Loss $ ( 10,000)

Add or Drop a Product1-* KEEP CLUB ELIMINATE DIFFERENTIALSales $200,0000 $200,000 Food/Beverage (70,000) 0 (70,000) Personnel (40,000)0 (40,000) Variable overhead (25,000)0 (25,000) Contribution Margin 65,0000 65,000Depreciation (30,000) (30,000) 0 Supervisor salary (20,000)0 (20,000) Insurance (10,000) (10,000) 0 Airport fees ( 5,000)0 ( 5,000) Allocated overhead (10,000) (10,000) 0 Loss $ (10,000) $(50,000)$ 40,000

Add or Drop a Product1-* KEEP CLUB ELIMINATE DIFFERENTIALSales $200,0000 $200,000 Food/Beverage (70,000) 0 (70,000) Personnel (40,000)0 (40,000) Variable overhead (25,000)0 (25,000) Contribution Margin 65,0000 65,000Depreciation (30,000) (30,000) 0 Supervisor salary (20,000)0 (20,000) Insurance (10,000) (10,000) 0 Airport fees ( 5,000)0 ( 5,000) Allocated overhead (10,000) (10,000) 0 Loss (10,000) (50,000) 40,000

NOTAVOIDABLEAVOIDABLEThe positive $40,000 differential amount reflects the fact that the company is $40,000 better off by keeping the club.

Add or Drop a Product1-* KEEP CLUB ELIMINATE DIFFERENTIALSales $200,0000 $200,000 Food/Beverage (70,000) 0 (70,000) Personnel (40,000)0 (40,000) Variable overhead (25,000)0 (25,000) Contribution Margin 65,0000 65,000Avoidable fixed costs Supervisor salary (20,000)0 (20,000) Airport fees ( 5,000)0 ( 5,000)Profit/Loss $ 40,000 $ 40,000

Worldwide airlines would also lose the contribution margin of $65,000. The club contributes $40,000 to Worldwides fixed costs.

ConclusionKEEP THE CLUB OPEN!1-*Contribution margin from general airline operationsthat will be forgone if club is eliminated . . . . . . . . . . . $ 60,000 0 $ 60,000Profit/Loss $ 40,000 0 $ 40,000Monthly profit of KEEPING the club open $100,000 =======

Worldwide is better off by $100,000 per month by keeping their club open.The Opportunity Cost of lost contribution margin is $60,000.


Learning Objective6

Special Decisions inManufacturing Firms1-*Joint Products:Sell or Process Further A joint production process resulting in two or more products. The point in the production process where the joint products are identifiable as separate products is called the split-off point.

1-*Cocoa beanscosting $500per tonJoint Productionprocess costing$600 per tonCocoa buttersales value$750 for1,500 poundsCocoa powdersales value$500 for500 poundsSeparableprocesscosting$800Instant cocoamix sales value$2,000 for500 poundsJoint Processingof Cocoa BeanTotal joint cost:$1,100 per tonSplit-off point

Joint Products1-*Relative Sales Value Method$750 $1,250 = 60%60% $1,100 = $660

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Joint CostsJoint ProductsSales Value at Split-OffRelative ProportionAllocation of Joint Costs

$1,100Cocoa Butter$75060%$660

Cocoa Powder50040%440

$1,250100%$1,100

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Joint Products1-*Cocoa butter is sold at the end of the joint processing.Cocoa powder may be sold now or processed into instant cocoa mix. Further processing costs of $800 will be incurred if the company elects to make instant cocoa mix.

Joint Products1-*The cocoa powder should be processed into instant cocoa mix.( )

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Process Further

Sales value of instant cocoa mix$2,000

Sales value of cocoa powder500

Incremental revenue$1,500

Less: separable processing costs(800)

Net benefit of further processing$700

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Decisions Involving Limited Resources1-*Firms often face the problem of deciding how limited resources are going to be used.Usually, fixed costs are not affected by this decision, so management can focus on maximizing total contribution margin. Lets look at the Martin, Inc. example.

Limited Resources1-*Martin, Inc. produces two products and selected data is shown below:

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Products

WebsHighs

Selling price per unit$60$50

Less: variable expenses per unit3635

Contribution margin per unit$24$15

Current demand per week (units)2,0002,200

Contribution margin ratio40%30%

Processing time required

on the lathe per unit1.00min.0.50min.

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Limited Resources1-*The lathe is the scarce resource because there is excess capacity on other machines. The lathe is being used at 100% of its capacity.The lathe capacity is 2,400 minutes per week. Should Martin focus its effortson Webs or Highs?

Limited Resources1-*Lets calculate the contribution margin per unit of the scarce resource, the lathe.Highs should be emphasized. It is the more valuable use of the scarce resource the lathe, yielding a contribution margin of $30 per minute as opposed to $24 per minute for the Webs.If there are no other considerations, the best plan would be to produce to meet current demand for Highs and then use remaining capacity to make Webs.

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Products

WebsHighs


Time required to produce one unit1.00min.0.50min.

Contribution margin per minute$24min.$30min.

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Limited Resources1-*Lets see how this plan would work.Allotting the Scarce Resource The Lathe

Weekly demand for Highs2,200 unitsTime required per unit x .50 minutesTime required to make Highs1,100 minutes

Total lathe time available2,400 minutesTime used to produce Highs1,100 minutesTime available for Webs1,300 minutesTime required per unit x 1.00 minute Production of Webs1,300 units

Limited Resources1-*According to the plan, Martin will produce 2,200 Highs and 1,300 Webs. Martins contribution margin looks like this.The total contribution margin for Martin, Inc. is $64,200.Any other combination would result in less contribution.

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WebsHighs

Production and sales (units)1,3002,200


Total contribution margin$31,200$33,000

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Theory of Constraints1-*Binding constraints can limit a companys profitability.To relax constraints management can . . .OutsourceWork overtimeRetrain employeesReduce non-value-added activities

Uncertainty1-*One common technique for addressing the impact of uncertainty is sensitivity analysis - a way to determine what would happen in a decision analysis if a key prediction or assumption proved to be wrong.

Expected Values1-*From the last example, recall the the contribution margin for Webs was $24 and $15 for Highs.Due to uncertainty, assume Martin has the followingprobable contribution margins for the two products.WebsHighsMartin would use the expected value contribution margins in its decision about utilizing its limited resource - the lathe.

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Possible value of contribution marginProbabilityExpected Value

$23.0030%$6.90

24.0050%12.00

25.0020%5.00

$23.90

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Possible value of contribution marginProbabilityExpected Value

$14.0010%$1.40

15.0040%6.00

16.0050%8.00

$15.40

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Learning Objective7

Other Issues in Decision Making1-*Incentives forDecision MakersShort-RunVersusLong-RunDecisions

Other Issues in Decision Making1-*Pitfalls to AvoidSunkcosts.Unitizedfixed costs.Allocatedfixed costs.Opportunitycosts.

End of Chapter 141-*

11Chapter 14. Decision making: Relevant costs and benefits.Learning Objective 1. Describe six steps in the decision-making process and the managerial accountants role in that process.22The accountant is increasingly a part of the upper-management decision-making team. Management accountants are called to deliver relevant information to the team from their accounting information system. These teams then make decisions regarding production, marketing and financing affecting their organization. The management accountant is considered a business advisor in many organizations.33Six steps generally characterize a typical decision-making process. Defining the problem, determining the objectives of the decision, identifying alternative courses of action, determining what information is relevant, collecting information to support the decision, then selecting the appropriate alternative.Learning Objective 2. Explain the relationship between quantitative and qualitative analyses in decision making.44Accounting data is typically kept in quantitative measures, and, is important in the decisionmaking process. Managers must use their skills, their judgment and their ethics to make difficult decisions.

While involved in all stages of the decision-making process, the managerial accountants primary role is to provide quantitative data and analysis that are relevant, accurate and timely to the decision being made.77Qualitative characteristics are the factors in a decision problem that cannot be expressed effectively in numerical terms. Sometimes, a decision can be made that goes against the quantitative analysis, because the effect on the company, their employees, or their customers would be negative.44A managerial accountant might ask, What sort of information should the accountant gather? Information that is useful to a decision has some common characteristics. The information should be relevant, timely and accurate.

Relevant information means that only the information required to make the decision is presented.

Information must also be accurate in order to be useful.

The accuracy of the information is sometimes sacrificed in order to be timely. Information that is delivered after a decision has been made is of little use. If accountants had unlimited time, the information could be extremely accurate. Accuracy suffers as the time period shortens.

The management accountants job is to determine what information is relevant and provide accurate and timely data keeping a proper balance of accuracy and timeliness.

Learning Objective 3. List and explain two criteria that must be satisfied by relevant information.8Relevance has certain characteristics also. Relevant information is future oriented. To demonstrate this characteristic, you cannot make a decision on what to have for breakfast yesterday. Why? Because the decision has already been made, and, you have either already eaten or skipped yesterdays breakfast. You can make a decision on what to have for breakfast tomorrow, in the future.

Relevant information differs between the alternatives. This makes a difference in the decision. If one item costs $100, and the second item costs $100, there is no difference in the cost, and, it is not relevant to the decision. If the second item cost $115, there would be a difference, and it would be relevant to the decision.

Relevant information makes a difference in a decision.Learning Objective 4. Identify relevant costs and benefits, giving proper treatment to sunk costs, opportunity costs, and unit costs.911Sunk costs are costs that have been incurred in the past, and are not relevant to the future, and not relevant to a future decision. A decision has already been made, in the past, and that specific decision cannot be changed. A new decision can be made regarding the past decision, but, that is a new decision. Sunk costs cannot be changed.

Sunk costs are never relevant to a future decision.1117An example might help clarify relevant costs. In this example, a business is considering the replacement of a loading machine.1218Depreciation of the old loader is not relevant. The cost of the old loader was incurred in the past, and cannot be changed.

If we decide to replace the old loader, we can sell it for $5,000. This is relevant to the decision because we will only sell the loader in the future, if the decision to replace the machine is made.

The $5,000 is relevant to the decision to replace the loader.

We will only have depreciation on the new machine if we replace it. The depreciation cost of the new loader is relevant.

If we buy the new loader, there will be differences between the operating costs of the current loader and the new one. The differences in operating costs is relevant to the decision to replace the old loader.3037The final analysis of the relevant costs of purchasing the new loader shows that the new loader would have a positive effect of $25,000 to the business.

The decision to purchase a new loader is appropriate.Learning Objective 5. Prepare analyses of various special decisions, properly identifying the relevant costs and benefits.An unexpected order arrived from a potential customer. We need to decide whether or not to accept this special order.5971A travel agency e-mails us. They want to charter one of our aircraft for a round trip flight from Japan to Hawaii. We have two airplanes that could potentially be used to fly this trip. The managerial accountant prepared some information to help the team make the decision whether or not to accept this offer.Normally, we would earn revenues of $280, and incur expenses of $190,000 on a trip such as this. However, we would not have to provide ticketing and reservation services and would save $5,000 in these costs.Since we have two airplanes that are not being used, we only need to consider our variable costs of making the trip. We would also save the ticketing costs, reducing our variable costs by $5,000.

Even though we would normally receive $250,000 for a trip such as this, we should accept the offer. The trip would contribute to paying our fixed costs, or, if our fixed costs are already paid, it would contribute this amount directly to profit.

Worldwide should accept this offer.What should we do if all of our airplanes are busy and we would have to pull our airplane from a regular route?Since we would not earn the revenues from our regular route, we would have to charge for the lost revenue of the route that was not taken, a lost opportunity. The total cost to us exceeds the amount of the offer and we should reject the special offer.The decision to accept or reject a special offer can be summed up like this. If we do have excess capacity, the relevant costs will usually be the variable costs. If we do not have extra capacity, we would have to add the opportunity cost of using our facilities.4961Sometimes the decision is whether we should produce a product, or whether we should have someone else produce that product.

This is called a make buy decision.5062We currently make our own desserts that are served on flights. Our cost summary is shown here.Our variable costs will remain in the analysis, but some of our allocated fixed costs will not be relevant to this decision. We will incur somewhat less in supervisor salaries, but will still have some since someone needs to make sure the desserts are delivered and loaded properly. Our depreciation will not change under either decision, so that cost is not relevant.

Our relevant costs are .15 per dessert.If we bought from the outside source, our cost would be 21 cents, and our relevant cost for this decision are 15 cents.

We should not accept this special offer, since we would lose 6 cents per dessert served.

Beware of Unit-Cost DataFor decision-making purposes, unitized fixed costs can be misleading.

Fixed costs often are allocated to individual units of product or service for product-costing purposes. For decision-making purposes, however, unitized fixed costs can be misleading. Remember that fixed costs are fixed in total, not on a per unit basis. Also, many fixed costs remain, regardless of a decision to outsource or to continue to produce.

3140Sometimes, managers want to drop a product or service because it appears to be unprofitable.3241Worldwide Airways offers its passengers the opportunity to join its World Express Club. Club membership entitles a traveler to use the club facilities at the airport in Atlanta. Club privileges include a private lounge and restaurant, discounts on meals and beverages, and use of a small health spa.3342The president of Worldwide Airways, is worried that the World Express Club might not be profitable. Her concern is caused by the statement of monthly operating income shown.

In her weekly staff meeting, Wing states her concern about the World Express Clubs profitability. The controller responds by pointing out that not all of the costs on the clubs income statement would be eliminated if the club were discontinued. The vice president for sales adds that the club helps Worldwide Airways attract passengers who it might otherwise lose to a competitor. As the meeting adjourns, Wing asks the controller to prepare an analysis of the relevant costs and benefits associated with the World Express Club.

3342The management accountants report contains two parts. Above, the focus is on the relevant costs and benefits of the World Express Club only, while ignoring any impact of the club on other airline operations. In the first column the accountant has listed the clubs revenues and expenses from the income statement. The second column lists the expenses that will continue if the club is eliminated.

The third column is the differential, or the difference between the two columns.3342These expenses are called unavoidable expenses. In other words, these costs will continue if the club is either kept or eliminated. Depreciation, insurance and allocated overhead costs will continue regardless of the decision, therefore Worldwide cannot avoid them.

In contrast, the expenses appearing in the first column but not the second are avoidable expenses. The airline will no longer incur these expenses if the club is eliminated. Notice that all variable costs are avoidable. In addition, supervisor salaries and airport fees will be eliminated if the club is closed.

The positive $40,000 differential amount reflects the fact that the company is $40,000 better off by keeping the club.

3342The conclusion of the first part of the controllers report is that the club should not be eliminated. If the club is closed, the airline will lose more in contribution margin, $65,000, than it saves in avoidable fixed expenses, $25,000. Thus, the clubs $65,000 contribution margin is enough to cover the avoidable fixed expenses of $25,000 and still contribute $40,000 toward covering the airlines overall fixed expenses.

4251Now consider the second part of the controllers analysis, the effect on Worldwide as a whole. As the vice president for sales pointed out, the World Express Club is an attractive feature to many travelers.

The controller estimates that if the club were discontinued, the airline would lose $60,000 each month in forgone contribution margin from general airline operations. This loss in contribution margin would result from losing to a competing airline current passengers who are attracted to Worldwide Airways by its World Express Club. This $60,000 in forgone contribution margin is an opportunity cost of the option to close down the club.

Considering both parts of the controllers analysis, Worldwide Airways monthly profit will be greater by $100,000 if the club is kept open. Recognition of two issues is key to this conclusion. First, only the avoidable expenses of the club will be saved if it is discontinued. Second, closing the club will adversely affect the airlines other operations.

Worldwide should keep the club open.Learning Objective 6. Analyze manufacturing decisions involving joint products and limited resources.Joint production processes make two or more different products using some similar beginning process. An example of this might be a basic coffee maker. The basic coffee maker is produced, then a timer is added to the premium coffee maker.

The split-off point is where we have two differently identifiable products.Cocoa beans are processed for all finished chocolate products. When the Cocoa beans are finished, they can be used to produce two different finished products , cocoa butter and cocoa powder. The cocoa powder can then be sold as is, or, used to produce instant cocoa mix. 7898The decision to sell or produce further can be solved by using the relative sales value method. First, we determine the relative sales value at the split off point.Then we calculate the relative sales proportion of the cocoa butter.

We then allocate the joint costs to the cocoa butter.

We follow a similar procedure to allocate the joint costs to the cocoa powder. The cocoa butter is a finished product and can be sold.Cocoa powder can be sold as a finished product, or processed further into instant cocoa mix for $800.Because the benefit of further processing is positive, we should process the powder further in the instant cocoa mix. While it costs us more to produce the instant mix, we also earn more revenue from the mix.6476Organizations typically have limited resources. Limitations on floor space, machine time, labor hours, or raw materials are common. Fixed cost often continue regardless of the decision, so maximizing the contribution margin is most often the appropriate decision.

6577Martin Company produces two products with the costs shown.6678The lathe is used 100% of the time in production. It is working at its maximum capacity, and is the scarce, or limited resource. Sometimes this is known as the bottleneck.7183Webs have a contribution margin of $24 per minute.

Highs have a contribution margin of $30 per minute.

All other things being equal, and if the company can sell all the highs it can produce, the company should produce and sell all the highs it can.

Webs should only be produced when more highs cannot be sold, and they have excess capacity to produce webs.

7587The weekly demand for highs is 2,200 units and would use 1,100 minutes of lathe time. This leaves 1,300 minutes worth of lathe time to produce Webs.7688WE would have a total contribution margin of $64,000 for Martin. If we were able to sell more highs, we would increase production of highs to the maximum capacity of the lathe.A binding constraint, such as the lathe, can limit a companys profitability. A few of the ways that management can relax a constraint is by expanding the capacity of a bottleneck operation, subcontracting all or part of the bottleneck operation, invest in additional production equipment, work overtime, retrain employees and shift them to the bottleneck and eliminating any non-value-added activities at the bottleneck operation.

Sensitivity analysis is a technique for determining what would happen in a decision analysis if a key prediction or assumption proved to be wrong.

Another approach to dealing explicitly with uncertainty is to base the decision on expected values. The expected value of a random variable is equal to the sum of the possible values for the variable, each weighted by its probability.

Suppose the contribution margins per case for Webs and Highs are uncertain, in other words, there is a 30% probability that webs will have a contribution margin of $23, a 50 % chance the contribution margin will be $24, and a 20% probability that the contribution margin will be $25.

As the slide shows, the choice as to which product to produce with excess lathe time may be based on the expected value of the contribution per machine hour. Statisticians have developed many other methods for dealing with uncertainty in decision making.

Learning Objective 7. Explain the impact of an advanced manufacturing environment and activity-based costing on a relevant-cost analysis.There is an important link between decision making and managerial performance evaluation. Managers typically will make decisions that maximize their perceived performance evaluations and rewards. This is human nature. If we want managers to make optimal decisions by properly evaluating the relevant costs and benefits, then the performance evaluation system and reward structure should be consistent with that perspective.

Decision-making analysis is very similar in an ABC, or Activity Based Costing environment. The difference in the analyses lies in the superior ability of the ABC data to properly identify what the avoidable costs are. We must use caution to avoid the pitfalls of not recognizing sunk costs, allocated or shared costs, fixed costs per unit as opposed to total fixed costs, and opportunity costs which are not present in the accounting system.The decision to end chapter 14 has been made!

chapter 14 n

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