WMBA 6050: Accounting for Management Decision Making Week 6 Weekly Briefing Welcome to Week 6! In Week 5, you studied standard costs and variances and their relationship to decision making. You analyzed the results of the direct labor and direct materials variances and discussed possible causes for the variances. All of these terms were added to your accounting vocabulary. In Week 6, you will continue to build your accounting vocabulary as you study sunk costs, opportunity costs, accounting costs, and break-even analysis. This week: In terms of the specific Learning Objectives, you will: • Analyze the impact on the organization of sunk costs, opportunity costs, and accounting costs • Determine the impact of cost decisions • Apply appropriate accounting processes to determine break-even points • Evaluate break-even points • Utilize break-even point assessment for decision making In terms of course-level Learning Outcomes, you will: • Evaluate various accounting measures and their relevance to a wide range of stakeholders • Analyze various types of budgets, strategic planning, and forecasting • Employ managerial accounting approaches and information to make effective decisions • Demonstrate effective communication skills to present accounting information to stakeholders • Assess managerial accounting tools and their usefulness to organizational leaders • Apply accounting principles ethically and appropriately to personal and professional contexts Sunk Costs, Opportunity Costs, and Accounting Costs In order to analyze sunk, opportunity, and accounting costs, you must first understand their meanings in the language of business. Sunk costs are costs that have been incurred previously and present or future decisions will not change that fact (Weygandt, Kimmel, & Kieso, 2010). They cannot be recovered. For example, a machine in your department was repaired two months ago and it cost $750. You are currently trying to decide which of two new machines you should buy to replace that machine. The $750 is a sunk cost and should not affect your decision. Even though sunk costs cannot be recovered and should not be considered in deciding between alternatives, they do have value with respect to accountability. As you studied last week, managers should be held accountable for past actions and expenditures. Opportunity costs are the benefits forgone from choosing one alternative over another (Zimmerman, 2014). If your department has a machine that is capable of making both product A and product B, and it is being used to make product A, the benefit of making product B is lost. Another example pertains to hiring an employee for $50,000. The opportunity cost is that the money is no longer available for other opportunities such as advertising, equipment purchases, etc. Accounting costs are the actual historical costs incurred for a product or service and are .

1. WMBA 6050: Accounting for Management Decision Making
Week 6 Weekly Briefing
Welcome to Week 6! In Week 5, you studied standard costs and
variances and their
relationship to decision making. You analyzed the results of the
direct labor and direct
materials variances and discussed possible causes for the
variances. All of these terms

2. were added to your accounting vocabulary.
In Week 6, you will continue to build your accounting
vocabulary as you study sunk
costs, opportunity costs, accounting costs, and break-even
analysis.
This week:
In terms of the specific Learning Objectives, you will:
• Analyze the impact on the organization of sunk costs,
opportunity costs, and
accounting costs
• Determine the impact of cost decisions
• Apply appropriate accounting processes to determine
break-even points
• Evaluate break-even points
• Utilize break-even point assessment for decision making
In terms of course-level Learning Outcomes, you will:
• Evaluate various accounting measures and their relevance
to a wide range of
stakeholders
• Analyze various types of budgets, strategic planning, and
forecasting
• Employ managerial accounting approaches and
information to make effective
decisions
• Demonstrate effective communication skills to present
accounting information to

3. stakeholders
• Assess managerial accounting tools and their usefulness to
organizational
leaders
• Apply accounting principles ethically and appropriately to
personal and
professional contexts
Sunk Costs, Opportunity Costs, and Accounting Costs
In order to analyze sunk, opportunity, and accounting costs, you
must first understand
their meanings in the language of business. Sunk costs are costs
that have been
incurred previously and present or future decisions will not
change that fact (Weygandt,
Kimmel, & Kieso, 2010). They cannot be recovered. For
example, a machine in your
department was repaired two months ago and it cost $750. You
are currently trying to
decide which of two new machines you should buy to replace
that machine. The $750 is
a sunk cost and should not affect your decision. Even though
sunk costs cannot be

4. recovered and should not be considered in deciding between
alternatives, they do have
value with respect to accountability. As you studied last week,
managers should be held
accountable for past actions and expenditures.
Opportunity costs are the benefits forgone from choosing one
alternative over another
(Zimmerman, 2014). If your department has a machine that is
capable of making both
product A and product B, and it is being used to make product
A, the benefit of making
product B is lost. Another example pertains to hiring an
employee for $50,000. The
opportunity cost is that the money is no longer available for
other opportunities such as

5. advertising, equipment purchases, etc.
Accounting costs are the actual historical costs incurred for a
product or service and are
recorded by the accounting system in monetary units
(Zimmerman, 2014). In this
course, the dollar is the unit of measure. If an organization buys
some land for
$2,000,000 with the intent of developing it, the $2,000,000 is
the accounting cost of the
land. If the organization is considering two alternative uses for
the land, the opportunity
cost will be the benefit forgone when it chooses one alternative
over the other.
Using Accounting Data to Make Decisions
Managers use accounting costs to make decisions regarding how
much it costs to make
or buy a product or produce a service, and these costs are often
used to determine the
price to charge for the product or service. For example, if the
average cost of producing
one unit of Product M for ABC Company is $200 and the
organization wants a markup
of 30%, the selling price of Product M would be $200 + ($200 x
30%) or $260. This is
termed cost-plus pricing. Many organizations use this method as
it is relatively easy to
compute (Zimmerman, 2014).
Organizations do not operate in a vacuum and consideration
must be given to the
pricing strategies of the competition. If there are many
competitors who are selling very
similar products, the market will determine the selling price of

6. Product M not ABC
Company. In this situation, ABC Company, which is called a
price taker, must determine
if it can still make a profit when it sells Product M at the market
price. It will need to
determine if the profit that can be realized by producing and
selling Product M at the
market price is worth the risk involved in making the product
without knowing
specifically how many units will be sold.
Another factor to be considered is market price itself. How will
changes in the market
price affect the organization? If the market price of product M
is $20.00 and the average
cost to make the product is $17.00, will ABC Company be
satisfied with a profit of $3.00
per unit? What if the market price drops to $18.00 per unit?
Will ABC Company be
satisfied with a profit of $1.00 per unit? Management must
weigh the risks associated
with production, carrying inventory, and possibly selling at a
loss when making the
decision to produce Product M.

7. Although price takers have no market power, some
organizations do have market
power. An organization has market power if no perfect
substitute exists for its products
(Zimmerman, 2014). For example, Coach, Inc. sells handbags
and other items at high
prices because it has market power. If a woman wants a Coach
handbag, there is no
perfect substitute. Coach has to make a decision concerning how
many handbags it
wants to sell each year. If it raises the price, it will sell fewer
handbags, and if it lowers
the price, it will sell more handbags. The challenge is to
determine the number of
handbags to sell and the price to charge per handbag to optimize
profitability.
Break-Even Analysis
One method that is helpful in determining profitability is break-
even analysis. At the
break-even point, sales revenue is exactly equal to total
expenses and there is no profit

8. or loss (Davis & Davis, 2012). The formula used to determine
the break-even point is:
PQ - VCQ - FC = 0 where P is a constant sales price, Q is the
output (quantity), VC are
the variable costs and FC are the fixed costs.
Before you can proceed, you need to know how to determine
which costs are variable
and which are fixed. Variable costs are costs that vary directly
with a change in the
activity level (Weygandt, et al. 2010). A variable cost remains
the same per unit at every
level of activity. For example, Dulce Company makes candy
bars and each bar requires
2 ounces of chocolate and 3 ounces of crushed peppermint. If
the company makes 10
bars, 20 ounces of chocolate and 30 ounces of peppermint will
be needed. If it makes
20 bars, 40 ounces of chocolate and 60 ounces of peppermint
will be used.
Fixed costs remain the same in total regardless of the activity
level. Examples include
rent, property taxes, supervisory salaries, and depreciation on
buildings and equipment.
If Dulce Company sells its candy bars for $2.00 each, variable
costs are $1.50 each,
and fixed costs are $50,000, how many candy bars must the
company sell to break
even? Using the break-even formula:
$2Q - $1.50Q - $50,000 = 0
$0.50Q - $50,000 = 0
$0.50Q = $50,000

9. Q = $50,000/$0.50
Q = 100,000 candy bars
Therefore, Dulce Company knows that it will not make a profit
until it sells at least
100,001 candy bars. Perhaps, Dulce Company wants to know
how many candy bars it
must sell to earn a profit of $70,000. In this case, simply
substitute $70,000 for the
break-even point.
$2Q - $1.50Q - $50,000 = $70,000
$0.50Q = $120,000
http:50,000/$0.50

10. Q = 240,000 candy bars
A very important concept in break-even analysis is contribution
margin. Contribution
margin is the amount of sales revenue left after deducting
variable expenses. It is
available to cover fixed costs and to contribute to profits. It can
be expressed in terms of
total sales revenue and total variable expenses or per unit
revenue and expenses.
Dulce Company's per unit contribution margin is $2.00 - $1.50
which is $0.50.
Contribution margin per unit is used to determine the break-
even point in units. The
formula is:
Total fixed expenses/contribution margin per unit
$50,000/$0.50 = 100,000 candy bars
The break-even point in total sales dollars can be determined
using the formula:
Total fixed costs/contribution margin ratio
The contribution margin ratio is computed by dividing the
contribution margin by sales
revenue. This can be computed by using either total amounts or
per unit amounts.
$0.50/$2.00 = .25 contribution margin ratio

11. $50,000/.25 = $200,000 in sales dollars required to break even
In summary, making decisions regarding pricing, costs, and
sales volume can be
assisted by break-even analysis, but also should take into
consideration environmental
factors, competition, tax rates, etc. Accounting measures can
provide quantifiable data,
but should be only a part of the decision making process. Good
management decisions
will include quantitative as well as qualitative information.
References
Davis, C. E., & Davis, E. (2012). Managerial Accounting.
Hoboken, NJ: John Wiley &
Sons.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010)
Managerial accounting: Tools for
decision making (5th ed.). Hoboken, NJ: John Wiley & Sons.
Zimmerman, J. L. (2014). Accounting for decision making and
control (8th ed.). New
York, NY: McGraw-Hill.
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