Chapter 7 (Jmbalvo) Flashcards
(44 cards)
What does the solution to all business problems involve?
> Incremental analysis: the analysis of the incremental revenue and the incremental costs incurred when one decision alternative is chosen over another.
What is incremental revenue?
> Incremental revenue is the additional revenue received as a result of selecting one decision alternative over another.
What is the incremental cost? What are they also referred to as?
> Incremental cost is the additional cost incurred as a result of selecting one decision alternative over another. If an alternative yields an incremental profit (the difference between incremental revenue and incremental cost), then it should be selected.
> Incremental costs sometimes are referred to as relevant costs, because they are the only costs that are relevant to consider when analyzing decision alternatives
> They are also referred to as differential costs, because they are the costs that differ between decision alternatives.
In incremental analysis, when multiple years are considered, it is generally important to consider what?
> it is generally important to consider the time value of money.
> That is, we need to take into account the fact that a dollar today is worth more than a dollar in the future.
How many alternatives can be considered in an incremental analysis?
> Incremental analysis can compare two decision alternatives
> Incremental analysis can also be extended beyond two decision alternatives.
> A third way to determine the best alternative is to calculate the profit under each of the three alternatives. In that approach, the best alternative is the one with the highest profit, and the difference between its profit and the profit of any other alternative is its incremental profit compared to the alternative.
Are gut feelings often considered in incremental analysis?
> But often there are important incremental benefits and incremental costs that are difficult, if not impossible, to quantify. Managers shouldn’t ignore them, and that’s where “gut feel” plays a role.
If you’re ever in a situation where your boss asks you how much a product or service costs, you should reply: “Why do you want to know?” While that reply may seem a bit rude, it makes an important point about incremental analysis. What is that point?
> There is no single cost number that is relevant for all decisions.
> Thus, you need to know what decision your boss is planning to make so you can identify the incremental cost information that is applicable to the decision.
In the context of incremental analysis, what are the three decisions that managers often have to face?
1) The decision to engage in additional processing of a product
2) The decision to make or buy a product
3) The decision to drop a product line
Are sunk costs incremental costs?
> Sunk costs are not incremental costs.
> Since they’ve already been incurred, they won’t increase or decrease with the choice of one alternative over another.
Most manufactured goods are made up of numerous components. In some cases, a company may purchase one or more of the components from another company. This may lead to considerable savings if the outside supplier is particularly efficient at manufacturing the component and can offer it at a reasonable price. Two decision alternatives arise in this situation:
> make or buy the component. No incremental revenues are involved.
> Therefore, the analysis of this decision concentrates solely on incremental costs.
Provide an example of an internal cost savings that is between two alternatives:
> an incremental cost saving between the two alternatives.
What are some fixed costs considered?
> Some fixed costs are avoidable costs—costs that can be avoided if a particular action is undertaken.
A cost that must be considered in decision making is what?
> A cost that must be considered in decision making is an opportunity cost. An opportunity cost is the value of benefits forgone by selecting one decision alternative over another.
Are opportunity costs incremental?
> Since opportunity costs differ depending on which decision alternative is selected, they are also incremental costs and are relevant in evaluating decision alternatives.
What is the proper approach to analyzing a the decision of dropping a product line?
> The proper approach to analyzing the problem is to calculate the change in income that will result from dropping the product line.
> If income will increase, the product line should be dropped.
> If income will decrease, the product line should be kept.
(This amounts to comparing the incremental revenues and costs that result from dropping the product line.)
What are allocated fixed costs? (in reference to product lines?)
> Allocated fixed costs are those fixed costs that are not directly traceable to an individual product line.
> These costs are also referred to as common costs because they are incurred for the common benefit of all product lines.
> An example of an allocated fixed cost is the salary of the owner/manager of the hardware store.
Are allocated common fixed costs generally avoidable?
> Allocated common fixed costs are generally not avoidable.
What should you remember when you analyze a decision involving dropping a product or service?
> Whenever you analyze a decision involving dropping a product or service, remember that common fixed costs are not incremental. This will allow you to avoid what is sometimes referred to as the cost allocation death spiral.
What happens in the “cost allocation death spiral”
> In many cases, products or services may not appear to be profitable because they receive allocations of common fixed costs.
> But what will happen to the common costs if the product or service is dropped?
- They’ll be allocated over the remaining products and services. That may result in another product or service appearing to be unprofitable.
When can costs be avoided?
> Costs that can be avoided by taking a particular course of action are always incremental costs and, therefore, relevant to the analysis of a decision.
Are sunk costs relevant in decision making?
> Costs that are sunk (i.e., already incurred and not reversible) are never incremental costs because they do not differ among the decision alternatives. Therefore, they are not relevant in making a decision.
What is a poor assumption of fixed costs?
> Students of managerial accounting often assume that fixed costs are equivalent to sunk costs and are thus irrelevant (i.e., are not incremental costs), but this is not always the case.
> Fixed costs may be sunk and, therefore, irrelevant.
> Fixed costs may not be sunk but still irrelevant.
> Finally, fixed costs may not be sunk and may be relevant.
What is the cost of depreciation on equipment already purchased considered and therefore it’s decision relevance?
> Considered a fixed cost
> Sunk and irrelevant (not incremental)
What is the cost - President’s salary, which will not change for both action A and action B - considered and therefore it’s decision relevance?
> Considered a fixed cost
> Not sunk but still irrelevant (not incremental)
