M6 Making Decisions Using
Relevant Information
DISCUSSION QUESTIONS
6-1.The baby sitting cost is not relevant because it failed to differ between decision alternatives. In the example, Jessica’s parents realized that the $44 charge would be assessed whether they took Jessica to EPCOT or not. Given the fact this cost was not relevant, it can be ignored in making the decision of whether to take Jessica to EPCOT or not.
6-2.Students will likely give a host of different examples of allowing irrelevant factors to affect their decision. It is likely that everyday decisions by any person are affected by factors such as ego, love, and personal vices.
6-3.Relevant quantitative factors the students should consider may include:
- the cost of the bus ticket as compared to the cost of taking the airplane
- the cost of parking at the bus station as compared to parking at the airport
- any meals that will be needed at facilities that differ (such as the airport where the cost of meals tends to be higher than meal costs elsewhere)
- the cost of meals and soft drinks needed while in transit on the bus ride that do not have to be purchased on a plane ride since airlines generally provide meals
Of course, other factors may be considered.
6-4.Relevant qualitative factors the students may identify include:
- preference of flying to driving
- ability to arrive at the destination in a timely manner
- distance and time involved to drive to the bus station as compared to the airport
- concerns for safety in parking lot at the bus station as compared to the airport
- ease of acquiring ticket for both alternatives
- concerns of sitting next to obnoxious passengers
- ability to travel without motion sickness in one versus the other
- comfort expectations of flight versus the bus ride
- food choice on both alternatives
- preference of class of passengers on an airplane as compared to those on the bus ride
- frequency of stops on each alternative
6-5.Cash is not necessarily a quantitative amount used specifically in the comparison of alternatives under the accrual basis. Nevertheless, it is an important factor that must be considered. The disposal of the old computer will generate a $10,000 cash inflow. Bill needs $76,000 to buy the new computer. Assuming the maintenance contract does not have to be acquired and paid for immediately, Bill will need $66,000 cash.
6-6.The qualitative factors that Bill should consider before making his decision may include the following:
- The knowledge of Bill’s employees in running the old versus the new computer
- The functions each computer can perform
- The learning curve associated with the new computer
- The reliability of the old and the new computers
- The availability of cash flows
- Downtime necessary for the conversion if new computer is acquired
- Employee attitude towards change
- The inconvenience of the conversion to the new system
- The emotional impact of terminating one employee (impact on both parties)
- Anticipation of a newer model arriving in two more weeks
6-7.Treating every order as a special order could make management think that profits are not impacted by fixed costs. Other orders might be accepted for less profit. If revenue is not enough to cover both fixed and variable costs, profits will decline and the company could go bankrupt. Ignoring fixed costs could be disastrous. Pose this question to your students: What if you are a manager of this company and your salary is a fixed cost that could not be paid because fixed costs were not considered when the product price was established.
6-8.If special orders cause capacity to be exceeded, some of the products may not be delivered on time causing some of the other customers to cancel their orders. In addition, new fixed costs may have to be considered. The information also shows that the company is able to handle the additional production of a special order. The accounting records from four years ago could be analyzed to see the difference in other costs that might have behaved differently than anticipated under the higher production level. This information will likely encourage Alumfloat to accept the special order.
6-9.Selling goods to one customer at a price less than all other customers may anger some of the company’s other customers that do not receive the same lower price. Sales could be lost if these customers move their business elsewhere. Although it is expected that volume discounts exist for every special or regular order, this policy should be consistent for all customers.
New fixed costs may be necessary to handle the production. This may include the rental of temporary production facilities or hiring of temporary workers who require more wages. Other factors to be considered are: quality reduction due to lack of detail in an effort to increase the rate of production; increased labor costs (fixed and variable) due to the requirement to pay overtime wages; employee loyalty to continue their present job given lack of time off; and various other qualitative factors such as these.
6-10.If the company decides to outsource the timer assemblies, the amount of overhead allocated to other products will increase because the cost must be absorbed somewhere.
6-11.Various qualitative factors may be listed by your students. Some of these may be:
- change of current employee responsibilities
- the need for layoffs
- effects of layoffs on non-laid-off employees’ attitudes
- obsolescence of equipment not needed
- ability to accept large orders in the future with fewer employees
- availability of product from outsource vendor
- effect of layoff on trying to hire employees in the future (may create a bad employer reputation)
The point here is to get your students to think of all possibilities.
REVIEW THE FACTS
A.Relevant costing is the process of determining which dollar inflows and outflows pertain to a particular management decision.
B.A relevant cost is a dollar inflow or outflow that pertains to a particular management decision in that it has a bearing on which decision alternative is preferable.
C.A relevant cost must be a future cost and it must differ between decision alternatives.
D.A sunk cost is a past cost that cannot be changed by current or future actions.
E.Quantitative factors are factors that can be measured using numbers. Qualitative factors are factors that cannot be measured by numbers – they must be described using words.
F.The two questions that must be asked are: 1. Is the cost a future cost? and 2. Does the cost differ between alternatives?
G.Depreciation is the allocation of the asset’s original cost which is a sunk cost and is therefore irrelevant to the future decision.
H.The time value of money is the interest earning potential of cash.
I.The time value of money is important for decisions involving the purchase of long-lived assets because the inflows and outflows of cash will occur over many years and the time value of money will have an important impact on the value of these flows.
J.Sometimes acceptance of a special order will cause an increase in fixed costs because the special order is so large that it causes production to exceed the relevant range. In such an instance fixed costs will become a relevant cost because they will then meet the criteria for a relevant cost.
K.Outsourcing occurs when a company buys services, products, or components of products instead of producing them.
L.Opportunity cost is the benefit foregone or given up because one alternative is selected over another.
M.Relevant costing concepts apply to all decisions made by management where they are involved in choosing between or among alternatives. When faced with such decision management must take care to consider only information that is relevant to the decision at hand.
APPLY WHAT YOU HAVE LEARNED
6-12.
1. I The cost of the old equipment
2. R The cost of the new equipment
3. I Depreciation of the old equipment
4. I Depreciation of the new equipment
5. R Trade-in value of the old equipment
6. R Salvage value of the old equipment
7. R Salvage value of the new equipment
6-13.
a. Schedule of Portable Computer Costs:
Computer
Software
Power Supply
Internet Service
Carrying Case
b. Company’s quantitative benefits of Tom purchasing the portable computer:
Reduced long-distance phone calls
Tom’s efficiency with paper work
Increased revenue from Tom’s efficiency on the road
Reduced overtime pay for Tom
Reduced computer operating costs and internet fees
- Tom’s quantitative benefits of his purchasing the portable computer:
Increased efficiency may improve income by increasing
sales
Increased efficiency may improve chances of promotion
d. Company’s qualitative benefits of Tom’s purchasing the portable computer:
Increased customer satisfaction
More efficient operations
Increased satisfaction with Tom’s performance
- Tom's qualitative benefits of his purchasing the portable computer:
Increased job satisfaction and morale
Increased leisure time when he does not have to work at home
f. (Student answers will vary.) Perhaps Tom should pay to the extent that the computer will be used for personal work and enjoyment. The employer should pay to the extent that the computer will be used for company work. For example, if the expected use is 40% for company work and 60% personal, the cost could be shared accordingly.
6-14.
Students’ answers will vary. Below are suggestions of relevant factors to consider.
- Relevant quantitative factors:
Price of the new car
The fair value of the old car
The trade-in allowed on the old car
Maintenance costs for the old car and the new car
Anticipated repair costs on old car
Gasoline costs for both cars
Insurance and license costs for both cars
Other operating costs for both cars
- Relevant qualitative factors:
Worry about the old car operating reliably
Uncertainty about the amount and timing of the maintenance costs on the old car
Inconvenience of having the car unavailable during repairs
Pride and prestige of having a new car
Peace of mind regarding reliable transportation
Worry about making the new car payments
Satisfaction and peace of mind with having a car completely paid for
The "new car smell"
c. Students should weigh the relevant costs of buying a new car and keeping an old car. The answer depends upon the costs of each.
d. There is no "correct " answer to this question. Tina should buy the new car if she believes the relevant quantitative and qualitative factors in favor of the new car outweigh the relevant quantitative and qualitative factors in favor of keeping the new car.
6-15.
1. R The cost of traveling the 250 miles to ByLots
2. R The time she will spend on the road
3. R The time she will spend visiting with ByLots’ executives
- I The amount of time already devoted to ByLots
- R The revenue potential from ByLots
- I The cost of her last visit to ByLots
- R The probability that her visit will result in new sales
- I The cost of lunch for herself if she visits ByLots
- R The cost of the lunch she would buy for ByLots’
executives
6-16.
1. AMaintenance cost
2. B Changes in product quality
3. A Salvage value of the old equipment
4. A Cost of the new equipment
5. B Difficulty of training employees to use new equipment
6. A Salvage value of the new equipment
7. B The ill feelings due to the possible reduction in the labor force
6-17.
- The list includes such costs as:
ApartmentDormitory
RentRent
Security depositSecurity deposit
Utilities
Telephone
Food costsBoarding fees
Furniture
Appliances
Kitchenware
Transportation
ParkingParking
- All the costs listed above would be relevant to the decision.
- The qualitative factors include convenience (proximity to class and other campus activities), freedom from campus dormitory rules, quality of social life, amount of quiet time for studying, and security.
6-18.
- The list includes such costs as:
Summer SchoolEurope
TuitionTransportation
Books
Room and boardLodging and food
ClothingClothing
EntertainmentEntertainment
Spending moneySpending money
b. All the costs listed are relevant because they probably differ depending whether you are in your dorm room or in Europe.
c. Qualitative factors would include rest, relaxation, pleasure, travel experience, benefits of school (education), and self image.
6-19.
- The list includes such costs as:
Old CarNew Car
Trade-in value of carPurchase price of new car
License tagLicense tag and excise tax
Residual valueResidual value
InsuranceInsurance
Gasoline cost (mpg)Gasoline cost (mpg)
MaintenanceMaintenance
RepairsRepairs
b. All the cost listed probably differ for each alternative and would be relevant.
c. Relevant qualitative factors include:
(1)worry about the reliability of the old car
(2)concern about maintenance costs
(3)inconvenience of the unavailable car during repairs
(4)pride and prestige of having a new car
(5)peace of mind regarding reliable transportation
(6)worry about car payments
(7)satisfaction and peace of mind of having a car paid for
(8)"new car smell"
6-20.Keep old mixerBuy new mixer
Start up costs:
Cost of new system$(34,000)
Operating costs:
Old system (5 x $15,000)$(75,000)
New system (5 x $12,000) (60,000)
Shut down costs:
Sale price of old mixer
if sold now ______8,000
Total relevant costs$(75,000)$( 86,000)
Difference in relevant costs: $11,000 ($86,000 – $75,000) in favor of keeping the old mixer.
6-21. Keep old latheBuy new lathe
Start up costs:
Cost of new system$ (61,000)
Operating costs:
Old system (6 x $32,000) $(192,000)
New system (6 x $24,000) (144,000)
Shut down costs:
Sale price of old mixer
if sold now______32,000
Total relevant costs$(192,000)$(173,000)
Difference in relevant costs: $19,000 (192,000 - 173,000) in favor of buying the new lathe.
6-22. Keep old liftBuy new lift
Start up costs:
Cost of new system $(128,000)
Operating costs:
Increased contribution margin
lost by keeping old lift$(120,000)*
Shut down costs:
Residual value of old lift 10,000
Residual value of new lift 25,000
Sale price of old mixer
if sold now ______48,000
Total relevant costs $(110,000)$ (55,000)
Difference in relevant costs: $55,000 ($110,000 – $55,000) in favor of buying the new lift.
*($65,000 - $50,000) x 8 = $120,000
6-23. Keep old pressBuy new press
Start up costs:
Cost of new system $(535,000)
Operating costs:
Increased contribution margin
lost by keeping old press$(280,000)*
Shut down costs:
Residual value of old press 25,000
Residual value of new press 45,000
Sale price of old press
if sold now ______150,000
Total relevant costs $(255,000) $(340,000)
Difference in relevant costs: $85,000 ($340,000 – $255,000) in favor of keeping the old press.
*($150,000 - $110,000) x 7 = $280,000
6-24.
a. The poster system would show a loss of $72 per month:
Sales revenue$1,200
Expenses:
Depreciation ($25,200 / 60)$420*
Electricity 50
Supplies 200
Wages 250
Store rent (allocated) 200
Utilities (allocated) 32
Other (allocated) 120
Total expenses 1,272 Operating income (loss) $ (72)
b. The company's overall profit increases by $280 per month:
Increased sales revenue$1,200
Increased expenses:
Depreciation420
Electricity 50
Supplies200
Wages250
Total increased expenses 920
Increased operating income$ 280
c. Start up cost:
Cost of the system$(25,700)
Operating costs:
Sales revenue ($1,200 x 60) 72,000
Electricity ($50 x 60) (3,000)
Supplies ($200 x 60) (12,000)
Wages ($250 x 60) (15,000)
Shut down costs:
Residual value 500
Total relevant costs$ 16,800
Sales revenue exceeds relevant costs by $16,800 over the 5 year (60 month) life of the system.
6-25.
a. The machine would show a loss of $34 per month:
Sales revenue$1,700
Expenses:
Depreciation ($9,240 / 60)$154*
Electricity 20
T-shirts 450
T-shirt supplies 100
Wages 250
Store rent (allocated) 425
Utilities (allocated) 85
Other (allocated) 250
Total expenses 1,734 Operating income (loss) ($34)
b. The company's overall profit would increase by $726 per month:
Increased sales revenue$1,700
Increased expenses:
Depreciation154
Electricity 20
T-shirts450
T-shirt supplies100
Wages250
Total increased expenses 974
Increased operating income$ 726
6-25. (Continued)
c. Start up cost:
Cost of the system$ (9,640)
Operating costs:
Sales revenue ($1,700 x 60) 102,000
Electricity ($20 x 60) (1,200)
T-shirts $450 x 60) (27,000)
T-shirt supplies ($100 x 60) (6,000)
Wages ($250 x 60) (15,000)
Shut down costs:
Residual value 400
Total relevant costs$ 43,560
Sales revenue exceeds relevant costs by $43,560 over the 5 year (60 month) life of the system.
6-26.
a. Relevant costs:
Cost of new forklift$17,000
Residual value of old forklift 4,000
Residual value of new forklift 7,000
Fair value of old forklift 6,000
Operating cost of old forklift 4,500 per year
Operating cost of new forklift 3,000 per year
b. Keep old forklift Buy new forklift
Start up costs:
Cost of new forklift$(17,000)
Operating costs:
Old forklift ($4,500 x 5)$(22,500)
New forklift ($3,000 x 5) (15,000)
Shut down costs:
Residual value of old forklift 4,000
Residual value of new forklift 7,000
Sale price of old press
if sold now ______6,000
Total relevant costs$(18,500) $(19,000)
Difference in relevant costs: $500 ($19,000 – $18,500) in favor of keeping the old forklift.
6-27.
a. and b.CurrentNew
machine machine
Cost of the machine $ (8,500) $(10,000)
Annual depreciation (1,000)* (1,500)**
Total depreciation (8,000) (9,000)
Annual operating cost (3,000) (1,500)
Total operating cost (18,000) (9,000)
Residual value 500 1,000
Sales price of old machine
If sold now 2,000
*($8,500 - $500)/8 = $1,000
** ($10,000 - $1,000)/6 = $1,500
c. Keep oldBuy new
Start up costs:
Cost of new machine $(10,000)
Operating costs:
Old machine ($3,000 x 6)$(18,000)
New machine ($1,500 x 6) (9,000)
Shut down costs:
Residual value of old machine 500
Residual value of new machine 1,000
Sale price of old press
if sold now ______2,000
Total relevant costs $(17,500) $(16,000)
Difference in relevant costs: $500 ($17,500 – $16,000) in favor of buying the new machine.
- Students answers will vary but their discussions might include such qualitative factors as increased efficiency of the new machine, better quality of copied material, and increased employee satisfaction/morale.
- Buy the new machine due to the lower relevant cost and probable qualitative benefits.
6-28.