Accounting

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College of Administration and Finance Sciences
Assignment (2)
Deadline: Saturday 04/05/2024 @ 23:59
Course Name: Cost Accounting
Student’s Name:
Course Code: ACCT 301
Student’s ID Number:
Semester: Second
CRN:
Academic Year: 1445 H
For Instructor’s Use only
Instructor’s Name:Rabab Farrash
Students’ Grade:
/15
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the cover
page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students or
other resources without proper referencing will result in ZERO marks. No exceptions.
• All answers must be typed using Times New Roman (size 12, double-spaced) font.
No pictures containing text will be accepted and will be considered plagiarism.
• Submissions without this cover page will NOT be accepted.
College of Administration and Finance Sciences
Assignment Question(s):
(Marks 15)
Q1. What is the process of identifying activities in an organisation and assigning costs under the
Activity Based Costing (ABC) system? Elucidate. You will need to include the right numerical
examples to support your answer.
(2 Marks) (Chapter 7, Week 7)
Answer:
Q2. PPLC Company has two support departments, SD1 and SD2, and two operating
departments, OD1 and OD2. The company decided to use the direct method and allocate
variable SD1 dept. costs based on the number of transactions and fixed SD1 dept. costs based on
the number of employees. SD2 dept. variable costs will be allocated based on the number of
service requests, and fixed costs will be allocated based on the number of computers. The
following information is provided:
(4 Marks) (Chapter 8, Week 10)
Support Departments
Operating Departments
SD1
SD2
OD1
OD2
Total Department variable costs
18,000
19,000
51,000
35,000
Total department fixed costs
20,000
24,000
56,000
30,000
Number of transactions
30
40
200
100
Number of employees
14
18
35
30
Number of service requests
28
18
35
25
Number of computers
15
20
24
28
College of Administration and Finance Sciences
You are required to allocate variable and fixed costs using direct method.
Answer:
Q3. What are an organization’s “outsourcing decisions” and “constrained resource decisions?”
Provide a suitable numerical example of these decisions and explain how quantitative and
qualitative considerations support a company’s decision-making process.
(2 Marks) (Chapter 4, Week 9)
Note: Your answer must include suitable numerical examples. You are required to assume values
of your own, and they should not be copied from any sources.
Answer:
Q4. VBN plastic industry makes three plastic toys: T1, T2, and T3. The joint costs of the three
products in 2017 were SAR 120,000. The total number of units for each product and the selling
price per unit is given below:
(3 Marks) (Chapter 9, Week 11)
Product
Units
Selling Price per unit
T1
45,000
SAR 15
T2
26,000
SAR 14
T3
18,000
SAR 10
You are required to allocate the joint costs to each product using the physical volume method and sales
value at the split-off method.
Answer:
College of Administration and Finance Sciences
Q5. MN&M Corporation is preparing a budget for 2018. The company provides you with the
following details which will help you to prepare the budget:
(4 Marks) (Chapter 10, Week 12)
Budgeted selling price per unit
=
SAR 500 per unit
Total fixed costs
=
SAR 150,000
Variable costs
=
SAR 100 per unit
Required:
You are required to prepare a flexible budget for 1,000, 1,100, 1,200 and 1,300 units.
Answer:
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 7
Activity-Based Costing and
Management
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 7: Activity-Based Costing and
Management
Learning objectives
•
Q1: What is activity-based costing (ABC)?
•
Q2: What are activities and how are they identified?
•
Q3: What process is used to assign costs in an ABC system?
•
Q4: What is activity-based management?
•
Q5: What are GPK and RCA?
•
Q6: How does information from ABC, GPK, and RCA affect
managers’ incentives and decisions?
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Activity-Based Costing (ABC)
• ABC is a method of cost system refinement.
• Indirect costs are divided into “sub-pools” of
costs of activities.
• Activity costs are then allocated to the final cost
objects using a cost allocation base (more
commonly called cost drivers in ABC).
• Activities are measurable, making it more likely
that cost drivers can be found so that a final cost
object will absorb indirect costs in proportion to
its use of the activity.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Traditional Costing vs. ABC
Traditional costing systems:
Indirect
Costs
Indirect costs are
grouped into one (or a
small number) of cost
pools; a cost allocation
base assigns costs to
the individual products
© John Wiley & Sons, 2011
Product A
Direct Costs
Product B
Direct Costs
Product C
Direct Costs
The individual
products are
the final cost
objects.
Direct costs are
traced to the
individual
products.
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Traditional Costing Systems
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Traditional Costing vs. ABC
Activity-based costing systems:
Activity 1
Indirect
Costs
Activity 2
Product A
Direct Costs
Product B
Direct Costs
Product C
Direct Costs
Activity 3
Indirect costs are
assigned (traced &
allocated) to various
pools of activity costs.
© John Wiley & Sons, 2011
Activity costs are
allocated to
products
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
The individual products
are the final cost objects
& direct costs are traced
to the individual products.
Slide # 6
Q1: ABC Costing Systems
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: What are Activities and How are They
Identified?
The ABC cost hierarchy includes the following activities:
• organization-sustaining – associated with overall
organization
• facility-sustaining – associated with single manufacturing
plant or service facility
• customer-sustaining – associated with a single customer
• product-sustaining – associated with product lien or
single product
• batch-level – associated with each batch of product
• unit-level – associated with each unit produced
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: ABC Cost Hierarchy Example
Some of the costs incurred by the Dewey Chargem law firm are listed
below. This firm specializes in immigration issues and family law. For each
cost, identify whether the cost most likely relates to a(n) (1) organiz-ationsustaining, (2) facility-sustaining, (3) customer-sustaining, (4) productsustaining, (5) batch-level, or (6) unit-level activity and explain your choice.
Cost
Cost Hierarchy Level
Bookkeeping software
Salary for partner in charge of family law
Office supplies
Subscription to family law update journal
Telephone charges for local calls
Long distance telephone charges
Window washing service
Salary of receptionist
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q3: What Process is Used to Assign Costs in an
ABC system?
1. Identify the relevant cost object.
2. Identify activities and group homogeneous
activities.
3. Assign costs to the activity cost pools.
4. Choose a cost driver for each activity cost
pool.
5. Calculate an allocation rate for each
activity cost pool.
6. Allocate activity costs to the final cost
object.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q3: How Are Cost Drivers Selected for
Activities?
• For each activity, determine its place
in the ABC cost hierarchy.
• Look for drivers that have a good
cause-and-effect relationship with the
activities’ costs.
• Use a reasonable driver when there is
no cause-and-effect relationship.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q3: ABC in Manufacturing Example
Alphabet Co. makes products A & B. Product A is a low-volume
specialty item and B is a high-volume item. Estimated factory- wide
overhead is $800,000, and the number of DL hours for the year is
estimated to be 50,000 hours. DL costs are $10/hour. Each product
uses 2 DL hours. Compute the traditional cost of each product if
Products A & B use $25 and $10 in direct materials, respectively.
First, compute the estimated overhead rate:
Estimated overhead rate = $800,000/50,000 hours = $16/hour.
Direct materials
Direct labor (2hrs @ $10)
Overhead (2 hrs @ $16)
© John Wiley & Sons, 2011
Product A
$25
20
32
$77
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Product B
$10
20
32
$62
Slide # 12
Q3: ABC in Manufacturing Example
Alphabet Co. is implementing an ABC system. It estimated the costs
and activity levels for the upcoming year shown below.
Estimated Estimated Activity Levels
Costs
Prod. A Prod. B
Total
Machine set-ups
$200,000 3,000 2,000 5,000
Inspections
140,000
500
300
800
Materials handling
80,000
400
400
800
Machining dep’t
320,000 12,000 28,000 40,000
Quality control dep’t
60,000
600
150
750
$800,000
Cost Driver
# set-ups
# inspections
# mat’l requistions
# machine hours
# tests
First, compute the estimated overhead rate for each activity:
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q3: ABC in Manufacturing Example
Estimated
Costs
Estimated Activity
Overhead Rate
$40
Machine set-ups
$200,000 5,000 set-ups
$40/setup
/setup
$175
Inspections
140,000
800 inspections
$175/inspection
/inspection
Materials handling
80,000
800 mat’l requistions $100
$100/requisition
/requisition
$8
Machining dep’t
320,000 40,000 machine hours
$8/mach
/machhrhr
$80
Quality control dep’t
60,000
750 tests
$80/test
/test
$800,000
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q3: ABC in Manufacturing Example
Alphabet recently completed a batch of 100 As and a batch of 100 Bs.
Direct material and labor costs were as budgeted. Information about each
batch’s use of the cost drivers is given below. Compute the overhead
allocated to each unit of A and B.
100 As 100 Bs
Machine set-ups
60
10
Inspections
10
2
Overhead allocated: 100 As 100 Bs
Materials handling
4
2
Machine set-ups
$2,400 $400
Machining dep’t
240
120
Inspections
1,750
350
Quality control dep’t
3
1
Materials handling
400
200
Machining dep’t
1,920
960
Quality control dep’t
240
80
Overhead for batch $6,710 $1,990
Overhead per unit
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
$67.10 $19.90
Slide # 15
Q3: ABC in Manufacturing Example
Compute the total cost of each product and compare it to the costs
computed under traditional costing.
Prod A Prod B
Direct material $25.00 $10.00
Direct labor
20.00 20.00
Overhead
67.10 19.90
$112.10 $49.90
Total
Traditional costing
assigned $77 to a unit of
Product A and $62 to a
unit of Product B.
•
The only difference between the two costing systems is that
Product A is assigned more overhead costs under ABC.
•
The additional overhead assigned to Product A reflects Product
A’s consumption of resources.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q4: Activity-Based Management (ABM)
• ABM is the process of using ABC information to
evaluate opportunities for improvements in an
organization.
• Examples include managing & monitoring
• customer profitability
• product and process design
• environmental costs
• quality
• constrained resources
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q4: ABM & Customer Profitability
• Activities can be defined so that different costs of
servicing customers are accumulated.
• Examples include
• analyzing the types of bank transactions used
by various categories of customers
• comparing the costs of servicing insurance
contracts sold to married versus single
individuals
• comparing the costs of different distribution
channels
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: ABM & Product/Process Improvements
• Activities can be defined so that the costs of stages
of production or of a business process are
accumulated.
• Examples include
• determining the costs of non-value-added
activities so the most costly can be reduced or
eliminated
• changing the steps in the accounts payable
function to reduce the number of personnel
• determining the most costly stages of product
development so that the time to market is
reduced
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: ABM & Environmental Costs
• Activities can be defined so that types of
environmental costs are accumulated.
• Examples include
• capturing the costs of contingent liabilities for
waste disposal site remediation
• comparing the cost of recycling packaging to the
cost of disposal
• computing the costs of treating different kinds of
emissions
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q4: ABM & Quality Costs
• Activities can be defined so that categories of costs
of managing quality are accumulated.
• Common categories of quality costs are
• costs of prevention activities
• costs of appraisal activities
• costs of production activities
• costs of postsales activities
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q5: What are GPK and RCA?
• Costing approaches similar to ABC because they
involve multiple pools and multiple drivers
• GPK can be described as marginal planning and
cost accounting
– Each cost is traced to a cost center (smaller than a
department) which performs a single repetitive activity,
and is the responsibility of one manager)
– Output measures tracks the volume of resource use
– Costs are segregated into proportional (change with
volume in resource use) and fixed
– Practical capacity is used for estimated allocation rate
volumes
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q5: Capacity Definitions
• Theoretical capacity – maximum assuming
continuous, uninterrupted operations 365 days/year
• Practical capacity – typical operating conditions
• Budgeted capacity – expected volume for the
upcoming time period
• Idle/excess capacity – difference between activity
capacity used and one of the above measures of
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q5: What are GPK and RCA?
• Resource Consumption Accounting (RCA)
• Builds on GPK and ABC principles
• Each cost is assigned to a resource cost pool
– Labor and machinery are often placed in different cost
pools since they are different types of resources
– RCA involves a significantly larger number of cost pools
than traditional accounting
– Like GPK, segregates proportional and fixed costs
– Utilizes theoretical rather than practical capacity for
allocating fixed costs
• More likely to focus manager attention on reducing idle and nonproductive resource time
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q5: Benefits/Drawbacks to GPK/RCA
• Benefits
– Generates multi-level internal income statements useful
for short terms decisions because it focuses on marginal
cost
– Increases cause & effect awareness among managers
– Categorizes costs (and generates profit margin) at the
product, product group, division, and company level
– Avoids arbitrary allocations of fixed costs
• Drawbacks
– Can be costly to implement
– Can result in a large number of variances to analyze
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q5: Comparison of ABC, GPK, and RCA
ABC
GPK
RCA
Character of cost
accounting system
Full costing
Marginal costing
Full and marginal
costing
Location of data
Database separate
from general ledger
Comprehensive
accounting system
Comprehensive
accounting system
Primary decision
relevance
Mid- to long-term
Short-term
Short-, Mid-, and
Long term
Allocation of
overhead based on
Activities
Cost Centers
Resources and/or
activities
Cost Drivers
Activity –Based
Resource Output
related
Resource output or
activity related
Fixed cost
allocation rate
denominator
Actual, budgeted,
or practical
capacity
Budgeted or
practical capacity
Theoretical
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q6: Decision Making with ABC, GPK, and RCA
• Benefits
• more accurate and relevant product cost information
• employees focus attention on activities
• measurement of the costs of activities and business
processes
• identify non-value-added activities and reduce costs
• Costs
• systems can be difficult to design and maintain
• more information must be captured
• decision makers may not use the information
appropriately
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Uncertainties in ABC and ABM
Implementation
• Judgment is required when determining
activities.
• Judgment is required when selecting cost
drivers.
• Denominator levels for cost drivers are
estimates.
• ABC information includes unitized fixed
costs, so decision makers must use ABC
information correctly.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 1
The Role of Accounting Information in
Management Decision Making
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 1: The Role of Accounting Information in
Management Decision Making
Learning objectives
Q1 – What is the process of strategic management and
decision making?
Q2 – What types of control systems do managers use?
Q3 – What is the role of accounting information in strategic
management?
Q4 – What information is relevant for decision making?
Q5 – How does business risk affect management decision
making?
Q6 – How do biases affect management decision making?
Q7 – How can managers make higher-quality decisions?
Q8 – What is ethical decision making, and why is it
important?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Organizational Vision and Core Competencies
• The organizational vision is the core purpose and
ideology of the organization.
• Determining the organizational vision precedes all
other management decision making.
• Management must also isolate the organization’s
core competencies – its strengths relative to
competitors.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Organizational Vision and Core Competencies
Organizational
Vision
The organizational vision and the
core competencies are closely
related.
The organization’s strengths
should help shape the vision.
Core
Competencies
The vision should help locate the
organization’s strengths.
If you were starting an accounting practice, what would be your
organizational vision?
What do you think would be your core competencies?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Organizational Strategies
Organizational
Vision & Core
Competencies
Organizational strategies are the tactics
that managers use to work toward the
organizational vision while taking
advantage of the core competencies.
These strategies are long-term in nature.
Organizational
Strategies
Examples include organization structure,
financial structure, and long-term
resource allocation strategies.
If you were starting an accounting practice, what would be some of your
organizational strategies?
How do these work toward your organizational vision?
How do they take advantage of your core competencies?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Operating Plans
Organizational
Strategies
Operating
Plans
Operating plans are the short-term
implementations of the organizational
strategies.
Operating plans usually include
budgeted goals for revenues and
expenses.
Examples include schedules for
employees and procedures for daily
relationship management decisions
with suppliers.
If you were starting an accounting practice, what would be some of your
operating plans?
How do these relate to your organizational strategies?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q1: Actual Operations
Actual operations are the actions
taken and the results achieved.
Operating
Plans
Actual
Operations
The organization’s information
system measures the results of
actual operations.
Examples include number of units
sold, advertising expense, and the
wage expense for the period.
If you had an accounting practice, what would information would you
want to collect about the results of your actual operations?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q1: Monitoring and Motivating Performance
Actual
Operations
Organizational
Vision & Core
Competencies
Managers use the results of actual
operations to monitor performance and
ensure that it is in line with the
organizational vision.
Managers may find that the results of
actual operations make them re-think the
organizational vision or their view of the
organization’s core competencies.
If you had an accounting practice, can you think of an example of a
measure of actual operations and how you would use it to motivate
performance?
Can you think of an example of a measure of actual operations that
might make you redefine your organizational vision or your view of your
core competencies?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: Management Control Systems
• Belief Systems
– Vision, Mission, Core Values Statements
• Boundary Systems
– Code of Conduct, Procedure Manuals, Compliance
Actions
• Diagnostic Control Systems
– Measure, monitor, and motivate employees against
preset goals
• Interactive Control Systems
– Recurring information and reports to evaluate
performance and direct actions
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q3: Financial, Managerial, and Cost Accounting
Financial accounting
prepares reports most
frequently used by decision
makers external to the
organization.
Managerial accounting
prepares reports most
frequently used by decision
makers internal to the
organization.
Cost accounting includes both financial and nonfinancial
information and is used for both financial and managerial
accounting.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q3: Strategic Cost Management
and the Balanced Scorecard
• Strategic cost management is an approach to
reducing costs while strengthening the
organization’s strategic position.
• The balanced scorecard can be used to formalize
strategic cost management efforts by detailing
financial and nonfinancial benchmarks for all
segments of the organization.
• Examples of such benchmarks include:
• Personnel can reduce costs by completing all hiring within 20
days of initial interview.
• Production can reduce costs and improve quality if Engineering
can reduce the number of processes in the production process.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q4: What Information is Relevant
for Decision Making?
• Information is relevant if:
• Differs across the alternatives, and
• Is about the future.
• Relevant information can be quantitative or
qualitative
• Information is irrelevant if:
• Does not vary with the option chosen or action taken
Irrelevant information is NOT useful in
decision making!
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q4: Relevant Cash Flows
• Relevant cash flows are future cash flows that
differ across the alternatives.
• also called incremental cash flows
• also called avoidable cash flows
• Irrelevant cash flows are:
• non-incremental and unavoidable cash flows
• do not vary among alternatives
• Must look at the cash flow relevance to the
decision being made
• Electricity costs are relevant to the decision to open a
business or not
• Electricity costs are not relevant in the decision to
lease or buy a building for your business
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q4: What Information is Relevant
for Decision Making?
You have a small computer repair company and are deciding whether to
replace your old copy machine or repair it. In the list of information
below, identify which data are relevant to this decision and which are
irrelevant.
• The purchase price of the copy machine was $1200.
• The repair costs are $320.
• The copy machine can make 20 copies per minute.
• If you repair it, the machine will use less toner than it does now.
• You make approximately 1000 copies per month.
• The repair won’t fix the broken stapler.
• The repair carries a one-year warranty.
• The copy machine was a gift from your spouse.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q4: Relevance of Income Statement Information
• Income Statements include:
– Period costs
– Product costs (recorded as cost of goods sold)
• Many business decisions require the incremental
cost to produce a unit
• Cost per unit on the income statement includes
both fixed and variable costs
• Including fixed costs does not represent the true
incremental cost of a unit
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q5: Impact of Business Risk on Decision Making
• Business Risk is the possibility an event will occur
and interfere with the organization’s strategic goals
Economic &
Financial
People,
Legal &
Health
Political and
Social
Reputation
Weather
Criminal and
Terrorist
Informational
&
Operational
Environment
& Man Made
• The existence of business risk can cloud
management’s decision making process
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q6: Uncertainties, Biases, and Decision Quality
• Uncertainties are issues and information about
which there is doubt.
• Biases are preconceived notions adopted without
careful thought.
• Decision quality refers to the characteristics of a
decision that affect the likelihood of achieving a
positive outcome.
• Both uncertainty and bias reduce decision quality.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q6: Uncertainties and Biases in Information
• Uncertainties come from many sources and can be
exogenous or endogenous.
• The future is always uncertain.
• Managers may be uncertain that the right information
was captured in a report.
• Biases can come from many sources.
• The decision maker may be biased towards or against a
particular alternative (predisposition bias)
• The methods used to collect information could have
introduced bias (information bias)
• The decision maker may exercise an error in judgment or
processing information (cognitive bias)
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q6: Motorola’s Iridium Project
• How did uncertainties and bias effect Motorola’s
decision making process?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q6: Uncertainties, Biases, and Decision Quality
Lori loves to sew and has always made her own clothes. People often
tell her that she is the best-dressed person they’ve ever met. She can
design and sew a lovely outfit in under 2 days. She is considering
opening a store that could sell her home-made fashions. Then she could
combine her work with her hobby.
Can you identify some of the uncertainties Lori faces? Can you think of
any way she can reduce some of these uncertainties?
Can you identify any possible personal biases that Lori may have? How
could these affect her decision making process?
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q7: Characteristics of Higher-Quality Decisions
Higher quality decisions come from a
higher quality decision making process.
Such a process is thorough, unbiased,
focused, strategic, creative, and visionary.
This process requires reports that are
relevant, understandable, and available.
These reports must contain information
that is more certain, complete, relevant,
timely and valuable.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q8: Components of Ethical Decision Making
Identify
ethical
problems as
they arise
© John Wiley & Sons, 2011
Consider the
well being of
others and
society
Clarify and
apply ethical
values
Continuously
improve your
personal
ethics
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q8: The IMA’s Code of Ethics
• The Institute of Management Accountants (IMA)
has a Code of Ethics that states that IMA
members have a responsibility to:
• maintain an appropriate level of professional competence
and perform their professional duties in accordance with
laws, regulations, and standards;
• refrain from disclosing confidential information (unless
legally obligated), or using (or even appearing to use)
confidential information to illegal advantage;
• avoid actual and apparent conflicts of interest; and
• communicate information fairly and objectively, and disclose
all relevant information to decision makers.
© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision Making
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q8: Ethical Decision M