Chapter 4: Decisions(Non-routine Operating Decisions) Flashcards
(9 cards)
What is needed for a decision to be considered to be relevant?
1) There must be clear differences between the options
2) The decision must be in the future.
What four things is short term decision making concerned with?
1) Keep vs Drop: Should we keep or drop the product line or service.
2) Make vs Buy: Should we make it in house, or should we outsource it from elsewhere.
3) Special order: Should we fulfill a special order request from a customer.
4) Product Mix: How many of each products should we make(occurs when there are scarce resources.
What are the key factors and relevant information that influence decision making?
-The key quantitative factors are relevant revenue, relevant costs, and opportunity costs.
-The key qualitative factors are employee morale (lay-off, rotation of position), supplier (quality of supplies), and customer relations.
-The relevant quantitative information is the expected future costs and revenue. Some strong examples include incremental contribution margin, and opportunity costs.
-The irrelevant information will be costs that won’t effect future costs, which may include sunk costs, book value of equipment, or future costs that do not differ between the options.
For keep vs drop, what are the relevant costs and benefits, irrelevant costs and benefits, and the decision rule?
-The relevant costs will be the contribution margin lost, in terms of Sales and Variable costs; the fixed costs avoided; the opportunity cost(comparing contribution margin lost or gained on other products).
-Irrelevant costs would be allocated common costs, not avoidable fixed costs, and sunk costs.
-We should keep the decision if the contribution lost due to switching> Fixed costs avoided+CM gained elsewhere
-We should drop the product/segment if CM lost due to switching <Fixed costs avoided + CM gained
For make vs buy, what are the relevant costs and benefits, irrelevant costs and benefits, and the decision rule?
-The relevant costs and benefits incldue the cost of purchase, saving on VC+Avoidable FC; and opportunity cost(measured as the contribution margin loss or gain).
-The irrelevant costs in make vs buy is allocated common costs, non avoidable fixed costs, and sunk costs.
-We make the decision if the cost of buying > cost saving + opportunity cost (represented by contribution margin loss or gain).
For special order, what are the relevant costs and benefits, irrelevant costs and benefits, and the decision rule?
-The relevant costs are incremental revenues, incremental costs, and the opportunity costs from existing order.
-Irrelevant costs include alocated common costs, non avoidable fixed costs, and sunk costs.
-We should accept the special order if incremental revenues > total relevant costs
What are the constraints preventing us from producing or selling as much as we’d like.
-The key constraint is the contribution margin per unit of the constrained resource.
-We must look at this factor when a business cannot produce everything it wants due to limited resources like machine time, labor hours, raw materials, and storage space.
-We aren’t just looking at the total contribution margin, we are looking at the relevant contribution margin.
-So CM per unit is irrelevant.
In short-term decision-making, what are the costs, benefits, and opportunity costs of dropping a product with the keep vs drop tradeoff?
1) Cost/Loss: This will be the contribution margin loss from existing sales.
2) Benefit: This will be the cost saving on avoidable fixed costs. If fixed costs can be avoided by dropping the product, you count those as benefits.
3) Opportunity Cost: If dropping this product frees up resources (like time, machines, and staff) for a more profitable product, then that gain is an opportunity benefit, because we used to incur an opportunity cost for something we no longer have an opportunity cost for. If there is no better use, the opportunity cost is 0.
In short-term decision-making, what are the costs, benefits, and opportunity costs of buying a product with the make vs buy tradeoff?
-The cost or loss of purchase is the price paid to an outside supplier if you choose to buy.
-The benefit of the purchase is the savings on variable cost of making the product, and the avoidable fixed costs that would’ve been incurred to make the product.
-The opportunity cost will be the contribution margin gain from using freed-up resources. If outsourcing frees up capacity to produce something more profitable, the gain becomes an additional benefit. If there is no better use, the opportunity cost is 0.
