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Chapter 13 (Garrison Text) Dr. M.S. Bazaz

This document discusses relevant costs for decision making. It explains that relevant costs are those that differ between alternatives, while sunk costs that cannot be avoided are irrelevant. It also discusses opportunity costs, utilizing constrained resources, dealing with multiple constraints through linear programming, and allocating costs for joint products according to their relative sales values. Managers should focus on increasing the capacity of bottlenecks to maximize contribution margin and profit.

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73 views

Chapter 13 (Garrison Text) Dr. M.S. Bazaz

This document discusses relevant costs for decision making. It explains that relevant costs are those that differ between alternatives, while sunk costs that cannot be avoided are irrelevant. It also discusses opportunity costs, utilizing constrained resources, dealing with multiple constraints through linear programming, and allocating costs for joint products according to their relative sales values. Managers should focus on increasing the capacity of bottlenecks to maximize contribution margin and profit.

Uploaded by

Gary Alex
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Chapter 13 (Garrison Text) Dr. M.S.

Bazaz

Relevant Costs for Decision Making


 Those costs and benefits that differ in total between alternatives are called relevant costs/ benefits in a
decision.
 An avoidable cost is a cost that can be eliminated in whole or in part by choosing one alternative over
another.
 Avoidable costs are relevant costs and unavoidable costs are irrelevant costs.
 Costs that never relevant in decisions:
1. Sunk costs – those have already been incurred and that cannot be avoided regardless of what a
manager decides to do. For example: the original cost of the car in need or repair is irrelevant.
2. Future costs that do not differ between the alternatives.

 Opportunity costs – are not recorded in accounts of an organization. They do not represent actual
dollar outlays. Rather, they represent economic benefits that are foregone as a result of pursuing some
course of action.
 In general, a new project is profitable as long as the incremental revenue from the special order
exceeds the incremental costs of the order.
 Utilization of Constrained Resource
 To maximize total contribution margin, a firm should not necessarily promote those products that
have the highest unit contribution margins. Rather, promoting those products or accepting those
orders that provide the highest unit contribution margin in relation to the constrained resource will
maximize total contribution margin.
 Profit can be increased by effectively managing the organization’s constraints.
 One aspect of managing constraints is to decide how to best utilize them.
 To find the best solution, managers should look at the contribution margin per unit of the
constrained resource.
 It is often possible for a manager to effectively increase the capacity of the bottleneck, which is
called relaxing (or elevating) the constraint. The capacity can be effectively increased by:
1. Working overtime on the bottleneck
2. Subcontracting some of the processing that would be done at the bottleneck.
3. Investing in additional machines at the bottleneck.
4. Shifting workers from processes that are not bottlenecks to the process that is a bottleneck.
5. Focusing business process improvement efforts such as TQM and Business Process Re-
engineering on the bottleneck.
6. Reducing defective units. Each defective unit that is processed through the bottleneck and
subsequently scrapped takes the place of a good unit that could be sold.
 Multiple Constraints
 The proper combination or “mix” of products can be found by use of a quantitative method
known as a linear programming.
 Joint Products
 An appropriate approach to allocate the joint product costs according to their relative sales value
(NRV) of the products at the split-off point.
 It is always be profitable to continue processing a joint product after the split-off point so long as
the incremental revenue from such processing exceeds the incremental processing cost incurred
after the split-off point.
 Joint product costs that have already been incurred up to the split-off point are sunk costs, which
are always irrelevant in decisions concerning what you do from the split-off point forward.

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