Relevant Information
Information is relevant to a decision problem when . . .
It has a bearing on the future,
It differs among competing alternatives.
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Decision Making: Relevant Costs and BenefitsChapter 14Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.The Decision-Making Process1. 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. Timely14-2The Decision-Making Process1. Clarify the Decision Problem2. Specify the Criterion3. Identify the Alternatives4. Develop a Decision Model5. Collect the Data6. Make a DecisionQualitativeConsiderations14-3The Decision-Making Process1. 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 decision14-4Relevant InformationInformation is relevant to a decision problem when . . .It has a bearing on the future, It differs among competing alternatives.14-5Identifying RelevantCosts and BenefitsSunk costsCosts 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.14-6Relevant CostsHere is an analysis that includes only relevant costs:14-7Accept or Reject a Special OrderA 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.14-8Accept or Reject a Special OrderWith 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 firm’s facilities for the special order are also relevant.14-9Outsource a Product or ServiceA decision concerning whether an item should be produced internally or purchased from an outside supplier is often called a “make or buy” decision.Let’s look at another decision faced by the management of Worldwide Airways.14-10Add or Drop a Service,Product, or DepartmentOne of the most important decisions managers make is whether to add or drop a product, service, or department.Let’s look at how the concept of relevant costs should be used in such a decision.14-11Special Decisions inManufacturing FirmsJoint Products:Sell or Process FurtherA 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.14-12Cocoa 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 point14-13Joint ProductsRelative Sales Value Method$750 ÷ $1,250 = 60%60% × $1,100 = $66014-14Joint ProductsCocoa 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.14-15Joint ProductsThe cocoa powder should be processed into instant cocoa mix.( )14-16Decisions Involving Limited ResourcesFirms 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.Let’s look at the Martin, Inc. example.14-17Limited ResourcesMartin, Inc. produces two products and selected data are shown below:14-18Limited ResourcesThe 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?14-19Limited ResourcesLet’s 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.14-20Theory of ConstraintsBinding constraints can limit a company’s profitability.To relax constraints management can . . .OutsourceWork overtimeRetrain employeesReduce non-value-added activities14-21UncertaintyOne common technique for addressing the impact of uncertainty issensitivity analysis - a way to determine what would happen in a decision analysis if a key prediction or assumption proved to be wrong.14-22Other Issues in Decision MakingIncentives forDecision MakersShort-RunVersusLong-RunDecisions14-23Other Issues in Decision MakingPitfalls to AvoidSunkcosts.Unitizedfixed costs.Allocatedfixed costs.Opportunitycosts.14-24
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