Cost Accounting Traditions and Innovations Barfield, Raiborn, Kinney

1. Chapter 12
Relevant Costing
Cost Accounting
Traditions and Innovations
Barfield, Raiborn, Kinney

2. Learning Objectives (1 of 2)
• List the relevant decision-making factors
• Explain how opportunity costs affect decision
making
• Define sunk costs and clarify why they are
not relevant in making decisions
• Describe the relevant financial considerations
in outsourcing
• Explain how management can make the best
use of scarce resources

3. Learning Objectives (2 of 2)
• Describe how sales mix pertains to relevant
costing problems
• Demonstrate how special prices are set and
when special prices are used
• Describe how segment margin is used to
determine whether to retain a product line
• (Appendix) Formulate a linear
programming problem

4. Relevant Costing
A process of making human
approximations of the costs of
alternative decision results

5. Relevant Costing
and Business Decisions
• Replacing an asset
• Outsourcing a product or part
• Allocating scarce resources
• Accepting special orders
• Determining the sales/production mix

6. Relevance
Focusing managerial attention on a decision’s
relevant (or pertinent) facts
1 Associated with the decision under
consideration
2 Important to the decision maker
3 Connected to or bearing on some future
endeavor

7. Relevant Costing
• Incremental Revenue - the amount of
revenue that differs across decision choices
• Incremental Cost or Differential Cost - the
amount of cost that varies across decision
choices
• Incremental Benefit - the difference
between incremental revenue and
incremental cost

8. Relevant Costing
• Most variable costs are relevant
• Most fixed costs are not relevant
• Opportunity Costs - benefits foregone
because one course of action is chosen over
another
• Sunk Cost - costs incurred in the past
SUNK COSTS ARE IRRELEVANT

9. Outsourcing
Make-or-Buy Decisions

10. Outsourcing
Make-or-Buy Decisions
Quantitative Factors
– Incremental production costs per unit
– Cost to purchase outside
– Number of available suppliers
– Production capacity available
– Opportunity costs of production facilities
• Space available for storage
• Inventory carrying costs
• Increase in throughput from buying components

11. Outsourcing
Make-or-Buy Decisions
Qualitative Factors
– Reliable supply sources
– Ability to control quality of items purchased outside
– Nature/importance of the work to be subcontracted
– Impact on customers and markets
– Future bargaining position with suppliers
– Perceptions about future price changes
– Perceptions about current product prices

12. Outsourcing Risk Pyramid
Strategic
Direction,
Unique Core
Competencies
Tax, Audit, Legal
Information Technology
Help Desk, Call Centers
Data Centers, Logistics
Facility, Network, Supply-Chain
Management, Temporary Staffing,
Payroll, Security Services, Food Services
The Yankee Group, 1995
Never
Outsource
Outsource under
Tight Control
Outsource under
Service Levels Low Risk
Outsourcing

13. Make-or-Buy Decisions:
Service Organization
Outsource
Lab Work???

14. Scarce Resources
• Choose product or service with highest
contribution margin per unit of scarce
resource
• Use linear programming when there are
several limiting factors
• Consider qualitative factors
– company reputation
– impact on customer base
– market saturation or company stagnation

15. Sales Mix Decision
• Sales Mix - relative quantities of the
products that make up the total sales of a
company
– Product selling prices
– Salesforce compensation
– Advertising expenditures

16. Impact of Change in Sales Price
Quantitative Factors
• New contribution
margin per unit of
each product
• Changes in product
demand and
production volume
• Best use of scarce
resources
Qualitative Factors
• Customer goodwill
• Customer loyalty
• Response of
competitors
• Production of new
products

17. Impact of Change in Compensation
• Commission based on
– fixed percentage of gross sales dollars
• sell highest priced product
– product contribution margin
• sell most profitable product

18. Impact of Change in Advertising
• Increase in advertising costs may cause
– Change in sales mix
– Change in sales volume

19. Special Order Decisions
• “Low-ball bid” to
introduce product or
service to particular
market
• Private-label order
• Unusual quantity,
delivery, packaging, or
customization of
product
• One-time job
• Selling price adequate
to cover
– Variable costs
– Incremental costs
– Profit

20. Special Order Decisions
Qualitative Factors
• Impact on future prices and sales
• Sufficient contribution margin to justify the
additional burden on workers and management
• Impact on scarce resources and throughput
• Workforce employed during slow times
• Robinson-Patman Act

21. Product Line Decisions
Costs by
• Product Line
– Revenue
– Variable costs
– Avoidable direct fixed costs
– Unavoidable direct fixed costs
• Common Costs

22. Segment Margin
Income Statement
Sales
<Variable Expenses>
Contribution Margin
<Avoidable Fixed Expenses>
Segment Margin
<Unavoidable Fixed Expenses>
Product Line Result
<Allocated Common Expenses>
Net Income (Loss)

23. Product Line Decisions
• Costs that appear to be avoidable may not be
• Deprecation on equipment is irrelevant
• Proceeds from sale of equipment are relevant
• Eliminating a product may affect customers

24. Linear Programming
• Typically one objective - maximize profit or
minimize some measure of performance
• Multiple limiting factors
– Resource constraints
– Demand or marketing constraints
– Technical product constraints
– Nonnegativity constraints
– Integer constraints
• Optimal solution - provides best answer to
allocation problem

25. Questions
• What are some relevant financial
considerations when making an outsourcing
decision?
• How are prices set for special orders?
• What types of decisions require segment
margin income statements?