ACCT 2101 Chapter Notes - Chapter 7: Sunk Costs
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Tactical decision making
Tactical decision making means choosing among alternatives withan immediate or limited end in view. For example, a company mayaccept a special order for less than the normal selling price touse idle capacity. Tactical decisions tend to be short-runin nature; however, it should be emphasized that short-rundecisions often have long-run consequences. A general tacticaldecision-making model is outlined here.
| 1. | Recognize and define theproblem. |
| 2. | Identify possible alternativesolutions to the problem, and eliminate any unfeasiblealternatives. |
| 3. | Identify the costs and benefitsassociated with each feasible alternative. Eliminate the costs andbenefits that are not relevant to the decision. |
| 4. | Compare the relevant costsand benefits for each alternative. |
| 5. | Assess qualitative factors. |
| 6. | Select the alternative with thegreatest overall benefit. |
Identifying and comparing relevant costs and revenues is theheart of the tactical decision model. Relevant costs (revenues) arefuture costs (revenues) that differ across alternatives. (Revenuesare treated in the same way as costs, so we will simplify thediscussion by referring to costs.) All decisions relate to thefuture; so, only future costs can be relevant. In addition, thecost must differ from one alternative to another. If a future costis the same for more than one alternative, it has no effect on thedecision. Such a cost is an irrelevant cost.
Assume that Reeves Company is considering accepting a specialorder for $25 per unit when the normal selling price is $30 perunit. Reeves has enough excess capacity to make the order withoutdisplacing normal sales. The alternatives facing Reeves Company are(Select "Yes" for the statements that are applicable and "No" forthe items that do not apply):
| Accept the special order. | - Select your answer -YesNoItem1 |
| Reject the special order. | - Select your answer -YesNoItem2 |
| Sell normal sales for $25 perunit. | - Select your answer -YesNoItem3 |
Choose which of the following are relevant in deciding whetheror not to accept the special order. (Select "Yes" for thestatements that are applicable and "No" for the items that do notapply)
| $25 price. | - Select your answer -YesNoItem4 |
| $30 normal price. | - Select your answer -YesNoItem5 |
| Variable cost of making the unitsin the special order. | - Select your answer -YesNoItem6 |
| Depreciation on factory equipmentused in making the special order units. | - Select your answer -YesNoItem7 |
| Increased property taxes on thefactory building which are due while the special order would bemade. | - Select your answer -YesNoItem8 |
While cost and revenue information is important, otherinformation may be needed to make an informed decision. Thesenon-financial factors are termed qualitative and are often relevantin decision making. For example, in deciding whether to make acomponent in-house or purchase it from an outside supplier, thecompany may consider any difference in quality or in responsivenessto the company's production schedules.
| FILL IN THE CORRECT TERMINOLOGIES IN THE BLANK SPACES | ||
| _____ 1. | a. A method of internal (managerial accounting) reporting that emphasizes the distinction between variable and fixed costs. | |
| _____ 2. | b. A discounted cash flow approach to capital budgeting that computes the present value of all future cash flows. | |
| _____ 3. | c. Determination of the maximum cost a company can spend to make a product given a set volume, selling price and desired operating profit. | |
| _____ 4. | d. An analysis of the additional costs and benefits of a proposed alternative compared with the current situation. | |
| _____ 5. | e. A historical cost that the company has already incurred which is irrelevant to the decision making process. | |
| _____ 6. | f. Costs that will not continue if an ongoing operation is changed or deleted. | |
| _____ 7. | g. An already owned production site that is not currently in use. | |
| _____ 8. | h. The maximum available benefit foregone by using a resource for a particular purpose. | |
| _____ 9. | i. The predicted future costs and revenues that will differ among alternative courses of action. | |
| _____ 10. | J. The time it will take to recoup, in the form of cash inflows from operations, the initial dollars invested in a project | |
| _____ 11. | k. Those costs of facilities and services that are shared by users | |
| _____ 12. | l. The juncture of manufacturing where separate products developed in the same process become individually identifiable. | |
| _____ 13. | m. A costing approach that considers all indirect manufacturing costs (both variable and fixed) to be product (inventoriable) costs. | |
| _____ 14. | n. Purchasing products or services from a supplier outside the company. | |
| _____ 15. | o. Capital budgeting models that focus on cash inflows and ouflows while taking into account the time value of money | |
| _____ 16. | p. Calculation of a selling price sufficient to cover the cost of producing a product as well as desired operating income | |
| _____ 17 | q. The long-term planning for investment commitments with returns spread over multiple years | |
| _____ 18. | r. A decision process that compares the differential revenues and costs of alternatives. | |
| _____ 19. | s. Costs that will continue even if a company discontinues one of its current operations | |
| _____ 20. | t. The increase in expected average annual operating income divided by the original required investment | |
