financial&managerial accounting_15e williamshakabettner chap 21

8/14/2019 Financial&managerial accounting_15e williamshakabettner chap 21

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Copyright 2010 by The McGraw-Hill Companies, Inc. AllMcGraw-Hill/Irwin

Incremental AnalysisIncremental AnalysisChapter 21


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Specialorder

decisions

Productmix

decisions

Makeor buy

decisions

Jointproduct

decisions

Product markets can change quickly due to competitorprice cuts, changing customer preferences, andintroduction of new products by competitors.

Managers must make short-run decisions, with a fixedset of resources, to react to the changing market place.

The Challenge of ChangingThe Challenge of Changing

MarketsMarkets

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Important cost concepts forbusiness decisionsOpportunity costsSunk costsOut-of-pocket costs

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Relevant InformationRelevant Information

in Business Decisionsin Business DecisionsInformation that varies among the possible

courses of action being considered.

Incremental costs and revenues

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The benefit that could have been attainedby pursuing an alternative course of action.

Opportunity CostOpportunity Cost

Example: If you were not

attending college, you could beearning $20,000 per year. Youropportunity cost of attendingcollege for one year includes the$20,000.

Opportunity costs are not recorded in theaccounting records, but are relevant to

decisions because they are a real sacrifice. 21-5


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All costs incurred in the past that cannot be changedby any decision made now or in the future.

Sunk costs should not be considered in decisions.

Example: You bought an automobile that cost $10,000two years ago. The $10,000 cost is sunk becausewhether you drive it, park it, trade it, or sell it, youcannot change the $10,000 cost.

All costs incurred in the past that cannot be changedby any decision made now or in the future.

Sunk costs should not be considered in decisions.

Example: You bought an automobile that cost $10,000two years ago. The $10,000 cost is sunk becausewhether you drive it, park it, trade it, or sell it, you

cannot change the $10,000 cost.

Sunk Costs VersusSunk Costs Versus

Out-of-Pocket CostsOut-of-Pocket Costs

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Cost = $10,000two years ago

Cost = $25,000today

The dealer will trade for $20,000 plus your car.What amount is relevant to your decision,

the $10,000 sunk cost of your car or the$20,000 out-of-pocket cash differential?

The dealer will trade for $20,000 plus your car.What amount is relevant to your decision,

the $10,000 sunk cost of your car or the$20,000 out-of-pocket cash differential?

Trade ?

Sunk Costs VersusSunk Costs Versus

Out-of-Pocket CostsOut-of-Pocket Costs

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The decision to acceptadditional businessshould be based on

incremental costs andincremental revenues.

Incremental amounts are

those that occur only ifthe company decides to

acceptthe new business.

Special Order DecisionsSpecial Order Decisions

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Should Icontinue to makethe part, or should

I buy it?

I suppose Ishould compare

the outside purchaseprice with the additional

costs to manufacturethe part.

What will Ido with my

idle facilities if

I buy the part?

Make or Buy DecisionsMake or Buy Decisions

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Incremental costs also are important in thedecision to make a product or buy it from asupplier.

The cost to produce an item must include(1) direct materials, (2) direct labor and(3) incremental overhead.

We should not use the predeterminedoverhead rate to determine product cost.

Incremental costs also are important in thedecision to make a product or buy it from asupplier.

The cost to produce an item must include(1) direct materials, (2) direct labor and(3) incremental overhead.

We should not use the predeterminedoverhead rate to determine product cost.

Make or Buy DecisionsMake or Buy Decisions

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Sell, Scrap, or RebuildSell, Scrap, or Rebuild

DecisionsDecisions

As long asrebuild costs are recoveredthrough sale of the product, and

rebuilding does not interfere with normalproduction, we should rebuild.

Costs incurred in manufacturing units ofproduct that do not meet quality standardsare sunk costs and cannot be recovered.

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Product 2Joint Costs

Product 1

Product 3

Two or more products produced from acommon input are called joint products.

Two or more products produced from acommon input are calledjoint products.

The split-off point is the point in a process wherejoint products can be recognized as separate products.

Thesplit-off point is the point in a process wherejoint products can be recognized as separate products.

Joint costs arethe costs of

processing prior tothesplit-off point.

Joint Product DecisionsJoint Product Decisions

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General rule:

Process further only ifincremental revenues > incremental costs.

Businesses are often faced with thedecision to sell partially completedproducts at the split-off point or to

process them to completion.

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Joint costs are really common costs incurred tosimultaneously produce a variety of end products.

Joint costs are commonly allocated to end products onthe basis of the relative sales value of each product or

on some other basis.


Joint costs are not relevant in decisions regarding whatto do with a product after the split-off point.

As a general rule . . .It is always profitable to continue processing a jointproduct after the split-off point so long as theincremental revenue exceeds the incremental

processing costs.

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NonfinancialNonfinancial

ConsiderationsConsiderationsLegal

issues

Ethicalimplicat

ions

Reputation

Environmental

impacts

Distinguishing

fact from opinion It would be irresponsiblefor me to base my

decision entirely on revenueand cost figures.

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End of Chapter 21End of Chapter 21

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financial&managerial accounting_15e williamshakabettner chap 21

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