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2009 Pearson Prentice Hall. All rights reserved.

Decision Making

and

Relevant Information


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Decision ModelsA decision model is a formal method of

making a choice, often involving bothquantitative and qualitative analyses

Managers often use some variation of theFive-Ste Decision-Making !rocess


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Five-Ste Decision-Making

!rocess


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RelevanceRelevant Information has t"o characteristics#

It occurs in the future

It di$ers among the alternative courses ofaction

Relevant %osts & e'ected future costs

Relevant Revenues & e'ected future

revenues


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Relevant %ost Illustration


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Features of Relevant

Information


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Irrelevance(istorical costs are ast costs that are

irrelevant to decision making

Also called Sunk %osts


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A Starting !oint# Absortion-)ased )udgeted IncomeStatement


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*yes of Information+uantitative factors are outcomes that can be

measured in numerical terms

+ualitative factors are outcomes that aredicult to measure accurately in numericalterms, such as satisfaction

Are ust as imortant as quantitative factors

even though they are dicult to measure


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*erminologyIncremental %ost & the additional total cost

incurred for an activity

Di$erential %ost & the di$erence in total costbet"een t"o alternativesIncremental Revenue & the additional total

revenue from an activity

Di$erential Revenue & the di$erence in totalrevenue bet"een t"o alternatives


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*yes of Decisions.ne-*ime-.nly Secial .rders

Insourcing vs/ .utsourcing

Make or )uy!roduct-Mi'

%ustomer !ro0tability

)ranch 1 Segment# Adding or Discontinuing

2quiment Relacement


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.ne-*ime-.nly Secial

.rdersAcceting or reecting secial orders "hen

there is idle roduction caacity and thesecial orders has no long-run imlications

Decision Rule# does the secial ordergenerate additional oerating income3

4es & accet

5o & reect%omares relevant revenues and relevant

costs to determine ro0tability


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Secial .rder Illustration


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Make-or-)uy Illustration


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Make-or-)uy Illustration,

2'tended


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!otential !roblems "ith

Relevant-%ost AnalysisAvoid incorrect general assumtions about

information, esecially#

6All variable costs are relevant and all 0'edcosts are irrelevant7

*here are notable e'cetions for both costs


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!otential !roblems "ith

Relevant-%ost Analysis!roblems "ith using unit-cost data#

Including irrelevant costs in error

8sing the same unit-cost "ith di$erent oututlevels Fi'ed costs er unit change "ith di$erent levels of

outut


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Avoiding !otential !roblems

"ithRelevant-%ost AnalysisFocus on *otal Revenues and *otal %osts, not

their er-unit equivalents

%ontinually evaluate data to ensure that itmeets the requirements of relevantinformation


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Insourcing vs/ .utsourcingInsourcing & roducing goods or services

"ithin an organi9ation

.utsourcing & urchasing goods or servicesfrom outside vendorsAlso called the 6Make or )uy7 decision

Decision Rule# Select the that otion "illrovide the 0rm "ith the lo"est cost, andtherefore the highest ro0t/


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+ualitative Factors5on-quantitative factors may be e'tremely

imortant in an evaluation rocess, yet do notsho" u directly in calculations#

+uality Requirements

Reutation of .utsourcer

2mloyee Morale

:ogistical %onsiderations & distance from lant,etc


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.ortunity %osts.ortunity %ost is the contribution to

oerating income that is foregone by notusing a limited resource in it;s ne't-bestalternative use6(o" much ro0t did the 0rm


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!roduct-Mi' Decisions*he decisions made by a comany about

"hich roducts to sell and in "hat quantities

Decision Rule ="ith a constraint># choose theroduct that roduces the highest contributionmargin er unit of the constraining resource


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Adding or Droing

%ustomersDecision Rule# Does adding or droing a

customer add oerating income to the 0rm3

4es & add or don;t dro

5o & dro or don;t add

Decision is based on ro0tability of thecustomer, not ho" much revenue a customer

generates


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%ustomer !ro0tabilityAnalysis, Illustrated


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%ustomer !ro0tabilityAnalysis, 2'tended


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Adding or Discontinuing)ranches or SegmentsDecision Rule# Does adding or discontinuing a

branch or segment add oerating income to

the 0rm34es & add or don;t discontinue

5o & discontinue or don;t add

Decision is based on ro0tability of the branchor segment, not ho" much revenue thebranch or segment generates


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Adding1%losing .ces orSegments, Illustrated


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2quiment-Relacement

DecisionsSometimes dicult due to amount of

information at hand that is irrelevant#

%ost, Accumulated Dereciation and )ook ?alueof e'isting equiment

Any otential @ain or :oss on the transaction &a Financial Accounting henomenon only

Decision Rule# Select the alternative that "illgenerate the highest oerating income


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2quiment-Relacement

Decisions, Illustrated


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2quiment-RelacementDecisions, Illustrated =Relevant%osts .nly>


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)ehavioral ImlicationsDesite the quantitative nature of some

asects of decision making, not all managers"ill choose the best alternative for the 0rm

Managers could engage in self-servingbehavior such as delaying needed equimentmaintenance in order to meet their ersonalro0tability quotas for bonus consideration


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