Collier Chap 12

ADM 2341

COLLIER NOTES

RELEVANT COSTS FOR DECISION MAKING (CHAPTER 12)

A:

Relevant Cost Concepts (pp 527- 530)

-managers are always faced with decisions about which products to produce, whether to buy or

lease, whether to accept a special order or not, whether to drop or continue with a product line;

how to allocate constrained resources, etc;

-in order to makes these types of decisions, mangers need to know the concept of a relevant cost

and how to identify relevant versus non-relevant costs;

-a “relevant cost” is a cost that differs between alternatives under consideration and

which will be incurred in the future;

-in developing a framework for identify relevant and irrelevant costs, it is assumed that the

alternative selected will be based upon maximization of operating income;

-in the real world, other qualitative factors will also enter into the decision analysis;

-although relevant costs have an important bearing on a future decision, they do not always

determine which alternative should be chosen because they may be over-ruled by qualitative

considerations;

-qualitative considerations in a make-or-buy decision could include quality parts to be

purchased, reliability of a future supplier, impact of a decision to be made on employee

morale, impact of changing technology on a company’s own production costs, etc.

-to help identify relevant costs (and relevant benefits) when making decisions, we review four (4)

cost terms that were introduced in Chapter 2:

1:

OPPORTUN ITY COST

(page 44)

-the potential benefit given up when one alternative is chosen over another

alternative;

Examples:

(i)

(ii)

the wages foregone by choosing to come to class or going on a holiday;

the investment revenue foregone by using money to purchase land rather

than investing the money in securities.

2:

SUNK COST

(page 44)

-a cost that has already been incurred and which cannot be changed (as a

differential cost) by any decision...