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CHAPTER – 13

RELEVANT COSTS FOR DECISION MAKING.

GROUP MEMBERS:

NAME ID SHIFAT ARA 072-11-1804 SADIA AFREN 072-11-1816 MD SHIHAB UDDIN 072-11-1799 MD ZOBAIR ALI 072-11-1814 MD RASHED 072-11-1823

IDENTIFYING RELEVANT COST & BENEFITS:Only those costs &benefits that differ in total between

alternatives are relevant in a decision. If a cost will be the same regardless of the alternative selected, then the decision has no affect on the cost & it can be ignored.

An avoidable cost is a cost that can be eliminated in whole or in part by choosing one alternative over another. Ex: By choosing the alternative of going to the movie, the cost of renting videotape can be avoided. By choosing the alternative of renting the videotape, the cost of the movie ticket can be avoided.

Two board categories of costs are never relevant in decisions. These irrelevant costs are:

Sunk cost Future cost Future cost: that do not differ between the alternatives. Sunk cost: is a cost that has already been incurred & that cannot

be avoided regardless of what a manager decides to do.

DIFFERENT COSTS FOR DIFFERENT PURPOSE:We need to recognize from the outset of our discussion

that costs that are relevant in decision situation are not necessarily relevant another. simply put, this means that the manager needs different costs for different purposes. For one purpose, a particular group of costs may be relevant; for another purpose an entirely different groups of information can be relevant.

ISOLATE RELEVANT COSTS:Isolating relevant costs is desirable for at least two

reasons-Only rarely will enough information be available to prepare a detailed income statement. Mingling irrelevant costs with relevant costs may cause confusion & distract that an irrelevant price of data may be used improperly.Relevant cost analysis combined with the contribution approach to the income statement, provides a powerful tool for making decision.

ENVIRONMENTAL COSTS ADD UP: A decision analysis can be flawed in correctly

including irrelevant costs such as sunk costs & future costs that do not differ between alternatives. It can also be flawed by omitting future costs that do not differ between alternatives. This is a problem particularly with environmental costs that have dramatically increased in recent years.

ADDING & DROPING PRODUCT LINES 7 OTHER SEGMENTS:

Decisions relating to whether old product lines or other segments of a company should be dropped & new ones added are among the most difficult that a manager has to make. In such decisions, many qualitative & quantitative factors must be considered.

ILLUSTRATION OF COST ANALYSIS:It means illustrate the cost among all segments of an

organization, & then allocate them independently. This is one of the most powerful tools for a manager to allocate costs & then identify the possible problem then correct it properly.

We will show a problem & how to solve it later on our assignment.

MAKE OR BUY DECISION:As for example - A decision to produce specific tools

for the company or buy it from the outsider suppliers is called make or buy decision. There is some way to calculate which one is profitable. If our production cost per unit is higher than the suppliers then we will go for purchases & if it is not then we will go for production of our own.

OPPORTUNITY COST:

Opportunity cost is the potential benefit that is given up when one alternative is selected over another. Sometimes it works as important tools for management for taking appropriate decision according to the arising situation of an organization.

UTILIZATION OF A CONSTRAINED RESOURCE:

When a limited resource of some type restricts the company’s ability to satisfy demand, the company is said to have a constraint. Determine the most profitable use of a constrained resource & the value of obtaining more of the constrained resource.

MANAGING CONSTRAINTS:Profit can be increased by effectively managing the

organizations constraints. One aspect of managing constraints is to decide how to best utilize them. If the constraint is a bottleneck in the production process, the manager should select the product mix that maximizes the total contribution margin.

JOINT PRODUCT COSTS & CONTRIBUTION APPROACH:Two or more products that are produced from a

common input are known as joint products; on the other hand the split-off point is the point in the manufacturing process at which the joint products can be recognized as separate products. At this point organization prepares an analysis that shows whether joint products should be sold at the split-off point or processed further.

Exercise 13.3

R(1)-

Contribution Margin from House Keeping= 80000Less fixed costs that can be avoided:Liability Insurance =15000Program Administratiors Salary =37000 = 52000 28000(No the company should not stop the segment)

R(2)-

Revenue Total Home

Nursing

Mealson

Wheel

House

Keeping

Revenue 900000 260000 400000 240000

-V E 490000 120000 210000 160000

CM 410000 140000 190000 800000

-Fixed Expenses - - - -

Depreciation 68000 8000 40000 20000

Liability Insurance

42000 20000 7000 15000

Program Administrators Salary

115000 40000 38000 37000

Productline segment margin

185000 72000 105000 8000

-Common fixed costs

180000

NOI 5000

CONCLUSION Only those costs &benefits that differ in total between alternatives are relevant in a decision. If a cost will be the same regardless of the alternative selected, then the decision has no affect on the cost & it can be ignored.

An avoidable cost is a cost that can be eliminated in whole or in part by choosing one alternative over another. Ex: By choosing the alternative of going to the movie, the cost of renting videotape can be avoided. By choosing the alternative of renting the videotape, the cost of the movie ticket can be avoided.

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