Decision making1. Recognizing the need for a decision (defining the problem)2. Identifying alternate solutions3. Evaluating the alternative solutions4. Making the decisionWhat difference does it make?Relevant Costs and Revenuesrelevant costs and revenues are future costs and revenues that will change as a result of a decisionall relevant costs and revenues should be included in an analysis for a decision because incomplete profit information could result in an incorrect decisionDetermining Relevant Costs and Revenues for a DecisionWhat activities are necessary for the company to carry out the decision?There are activities that cause all relevant costs. Thus only the costs that the company incurs as a result of performing these activities can be relevantNo cost incurred prior to making the decision is relevantFuture costs that a company will incur for activities that are not necessary to carry out the decision are not relevantBy how much will the costs and/or revenues be affected if the company undertakes the activities?A specific cost is relevant only if the total amount that the company will incur is affected by the decisionOther Cost and Revenue Concepts for Short-Term DecisionsIncremental costs: increases resulting from a higher volume of activity or from the performance of an additional activityThey are always relevant when the higher volume of activity, or the additional activity, is not necessary for the alternativeAvoidable costs: costs that a company must incur to perform an activity at a given level, but that it can avoid if the company reduces or discontinues the activityOpportunity costs: the profit impact of the disruption or lost opportunity; profits that a company forgoes by following a particular course of actionIllustration of Determining Relevant Costs and Revenues (Special Order)Step 1 and 2: either accept or reject the dealDecide which costs are relevant and which are not, eliminate what is related to activities that are not necessary to carry out the decision (Step 2)Incremental costs may be an example of shipping costsStep 3: After deciding what costs are relevant, estimate the costs and eliminate factory overhead from the analysis because although it would be a future costs incurred to support manufacturing activity, the amount would not be affected by the decisionDeciding Whether To Drop a ProductThe key to evaluating the profit effects of a company’s decision to drop a product is to determine the costs that it would incur (i.e., the avoidable costs) and the revenues that it would not earn if discontinued production and sale of the productAvoidable costs are always relevant to this evaluationThese costs are the only future costs that the company would not incur if it drops the productsA company should drop a product is the avoidable costs are more than the revenue it would lose if it dropped the productDeciding Whether to Make or Buy a PartQuality, supplier reliability, and costs advantages are go into the decisionRequires an analysis of the relevant costs for each alternativeDeciding Whether to Sell a Product or Process it FurtherConsider: difference in company’s profits between the two alternatives, whether the customers who like the product “as is” will refuse to buy the product when it is processed further, whether the further processing will have a negative affect on the environment, whether the company has access to employees….Decisions Involving Product MixDeciding how many units of each product to produce and sellInvolves two issues:A company can influence the sales volume of each of its products in many ways, such as by sales activities, promotional campaigns, and the number of sales personnel used for each productMany companies operate with limited productive capacity and, as a result, cannot produce as much of every product as they can sellDeciding How to Spend Advertising DollarsWhen the increase in fixed costs (the additional advertising money is a fixed amount) does not change between alternatives, the company earns highest profit from the alternative that produces the largest increase in contribution margin above the increase in fixed costsDeciding How Many Units to ProduceThe company earns the highest profit by using up the scare resource to manufacture the product mix that produces the highest total contribution marginCommon Element of Cost Accounting SystemsCompany systematically attaches direct labor, materials and factory overhead costs (cost of goods in process inventory, cost of finished goods inventory, cost of goods sold) to the products as it manufactures them, moving the costs with the products as they move from being gods in process to finished goods to goods soldRaw Materials CostsRaw materials include both direct and indirect materialsIndirect materials factory overheadLabor CostsDirect labor is the labor of employees that work with direct material direct laborUsually include additional payroll costs (payroll taxes, pensions, etc.) as factory overheadIndirect labor wages also included in factory overheadFactory Overhead CostsTotal cost of factory overhead items (including indirect materials and indirect labor) in the cost of the products as one of the three manufacturing costs factory overheadThe Structure of Cost Accounting SystemsClassifies the costs incurred according to activities performed and then assigns the costs to the product output of those activitiesThe Perpetual Inventory SystemRecord the costs of raw materials, goods-in-process and finished goods inventoriesINCREASES raw materials inventory account for the cost of raw materials it purchases and DECREASES the account for cost of raw materials it uses in productionINCREASES goods-in-process inventory account for the costs of the inputs (direct material, direct labor, and factory overhead) it uses in production and DECREASES this account for the cost of outputs (products it completes)INCREASES finished goods inventory account for the cost of the products it completes and DECREASES the account for the cost of the products it sellsHow Costs Flow Through the AccountsCosts enter the system as company incurs them, flowing into the goods-in-process inventory as the company uses direct materials, direct labor, and factory overhead to manufacture products. Once they are in goods-in-process, they company assigns, or applies, the costs to specific products as manufacturing takes placeJob Order CostingWhen a company manufactures one unit of a unique product