ACCT2002 Chap.10 Relevant Information for Managerial Decisions
Relevant Information for Managerial Decisions
Relevant-information analysis compares future cash flows and other consequences that differ between alternatives. Historical cost, book value and unavoidable allocated common cost do not become relevant merely because they appear in an accounting report. Opportunity cost does not necessarily appear in the ledger, yet it can be decisive when scarce capacity has another use.
This chapter applies the relevance filter to insource versus outsource, special orders, constrained product mix, bottlenecks, adding or dropping customers or segments and equipment replacement.
The quantitative comparison is only one part of the decision: quality, reliability, workforce capability, strategic control and performance-evaluation incentives must be identified separately rather than forced into an invented dollar value.
What this chapter covers
- 01
Relevant and irrelevant information
- 02
Opportunity cost and avoidable cost
- 03
Insourcing and outsourcing
- 04
Special-order decisions
- 05
Product mix under a capacity constraint
- 06
Managing bottlenecks
- 07
Adding or dropping customers and business units
- 08
Equipment replacement and book value
- 09
Decision models and performance evaluation
Rank products by contribution per bottleneck hour
- 2Contribution per unit is $48 for A and $40 for B. Unit contribution alone would rank A first, but that ignores the constraint.
- 3Contribution per bottleneck hour is $48 ÷ 3 = $16 for A and $40 ÷ 2 = $20 for B, so B ranks first.
- 3Meet all demand for 700 B using 1,400 hours. The remaining 500 hours produce 166 whole units of A, using 498 hours.
- 2Total contribution is 700 × $40 + 166 × $48 = $35,968, with 2 unused hours. Fixed costs are then deducted if they are unchanged by the mix.
Key terms
- Relevant information
- Expected future information that differs between alternatives.
- Sunk cost
- A past cost that cannot be changed by the present decision.
- Opportunity cost
- The benefit sacrificed by choosing one alternative rather than the next best use of a resource.
- Avoidable cost
- A cost that will not be incurred if a particular alternative is selected.
- Bottleneck
- A resource whose limited capacity constrains output.
- Contribution per constraint unit
- Contribution margin divided by the amount of scarce resource consumed.
- Book value
- Historical asset cost less accumulated depreciation; normally irrelevant to replacement cash flows.
Relevant Information for Managerial Decisions FAQ
Why is allocated fixed cost often irrelevant?
If the total common resource and cash spending continue under both alternatives, reallocating the same amount changes reported segment profit but not the organisation's total cash flow.
When is an opportunity cost included?
When a resource used by one alternative could earn a contribution in another feasible use. It is the value of the best forgone use, not an arbitrary surcharge.
Should a special order be accepted whenever price exceeds variable cost?
Not automatically. Include incremental setup, quality, delivery and opportunity costs, and consider customer reactions, capacity and strategic effects.
Why can a manager resist an economically sound replacement?
Performance measures tied to book value or short-run accounting profit can conflict with future cash-flow benefits. The decision model and evaluation model should be aligned.
Exam move
Use a relevance table with one column per alternative and include only future differences. Put sunk and unavoidable items in a separate “excluded and why” box so they do not sneak back into the arithmetic. For constrained mix, rank by contribution per bottleneck unit and then allocate capacity subject to demand. After every numerical answer, list two qualitative factors and identify who owns the information.
Practise defending why book value is excluded without saying the asset has no economic significance.
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