Chapter 7 - Terminology Questions And Answers

Management's Decision-Making Process Considers both _____________ and ___________ information. - ANS Financial - Revenues and costs - Overall profitability Nonfinancial - Effect of decision on employee turnover - Environment - Overall image of company Incremental Analysis - ANS Process to identify financial data that change under alternative actions - Identifies probable effects of decisions on future earnings - Identify and gather the data points from Accountants, Engineers, Market Analysts, Sales Managers, Clients, Etc... Relevant Cost - ANS (1) those costs (and revenues) that are different now for each alternative, and (2) those costs and revenues that will occur in the future. Opportunity Cost - ANS In choosing one alternative, the benefit lost from some other alternative. Sunk Cost - ANS Costs that have already been incurred and will not be changed or avoided by any future alternative decision. The 6 Different Types of Incremental Analysis Scenarios - ANS 1. Accept an order at a special price 2. Make or buy component parts or finished products 3. Sell products or process further 4. Retain or replace equipment 5. Eliminate or retain an unprofitable business segment 6. Allocate limited resources Accept an Order at a Special Price - ANS Obtain additional business by making price concessions. Accept an Order at a Special Price - Assumptions - ANS - Assumes sales of the products in other markets would not be affected by special order - Assumes company is not operating at full capacity Sell or Process Further - ANS Manufacturers may have to decide, at a given point in production, whether to sell now or to process further and sell at a higher price later Sell or Process Further - Decision Rule - ANS Process further as long as the incremental revenue from such processing exceeds the incremental processing costs Joint Products - ANS Multiple end products produced from a single raw material and a common production process - Petroleum: gasoline, lubricating oil, kerosene - Meat Packing: meat, hides, bones, skin, fat Joint Costs - ANS - all costs incurred prior to split-off point - generally allocated to individual products based on relative sales value - Sunk costs!! Eliminate an Unprofitable Segment - ANS Key: Focus on relevant costs - Fixed costs allocated to the unprofitable segment must be absorbed by the other segments - Net income may decrease when an unprofitable segment is eliminated Eliminate an Unprofitable Segment - Decision Rule - ANS Retain the segment unless fixed costs eliminated exceed the contribution margin lost Allocate Limited Resources - ANS Management must decide which products to make and sell to maximize net income. Resources are always limited: - floor space for a retail firm - raw material, direct labour hours, or machine capacity for a manufacturing firm When it comes to management's decision-making, other considerations include qualitative factors. i.e. What are the potential effects of the decision on: - ANS - Employees - Product - Company - Community *When making decisions, a general rule would be...* a. fixed costs are always relevant. b. variable (unit-level) costs are always irrelevant. c. future costs and revenues are always relevant. d. future revenues and costs which differ are always relevant. - ANS d. future revenues and costs which differ are always relevant. *Of several types of decisions that involve incremental analysis, the most common are:* a. accept an order at a special price. b. make or buy component parts. c. sell products or process further. d. all of the above. - ANS d. all of the above. *In a make-or-buy decision, the relevant costs are:* a. the manufacturing costs that will be saved. b. the purchase price of the units. c. opportunity costs. d. all of the above. - ANS d. all of the above. *The decision rule in a sell or process further decision is to process further as long as the incremental revenue from processing is more than the:* a. incremental processing costs. b. variable processing costs. c. fixed processing costs. d. no correct answer given. - ANS a. incremental processing costs. *What is the salvage value of old equipment considered to be?* a. A relevant cost b. A non-incremental cost c. An opportunity cost d. A cost that is not differential - ANS a. A relevant cost *How should that portion of fixed costs that are unavoidable be handled when making a decision on whether to eliminate an unprofitable segment?* a. They should be subtracted from the contribution margin and if that results in a net loss, the segment should be eliminated. b. They should not be considered as they are not relevant. c. They should be allocated to other segments. If that causes a loss in another segment, that segment should be eliminated as well. d. Fixed costs are never relevant. - ANS b. They should not be considered as they are not relevant. *Which of the following is not a qualitative factor?* a. Employee satisfaction b. Quality control process c. Customer satisfaction d. Cost of labour per unit - ANS d. Cost of labour per unit