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Nonroutine Decisions
I. Overview
Incremental (differential or marginal) analysis.
The quantitative analysis emphasizes how cost and benefits vary with the chosen option.
Note: Focus is on relevant costs.
- Whether to accept special orders.
- Whether to make or buy a product.
- Pricing.
- Choosing a product mix.
- Adding or dropping product lines.
- Selling or processing units further.
- Acquiring or disposing of an organizational segment.
- Selecting a market channel.
- Special price concessions violate the price discrimination statute.
- Government contract pricing regulations apply.
- Sales to a special customer affect sakes in the firm’s regular market.
- Regular customers will learn of a special price and demand equal terms.
- Sales in other product lines will decline because a product line was discontinued.
An avoidable cost.
- No dollar outlay.
- Not recognized in the accounting records.
- Must be considered in investment decision due to it is an economical cost.
An opportunity cost.
A postponable cost.
A postponable cost.
A relevant cost.
Because sunk cost is unavoidable, expenditure has occurred or an irrevocable decision to incur the cost has been made.
II. Basic Concepts
Because it involves a future cash inflow that will not occur unless the equipment is disposed of it.
- Only those costs that among the decision options.
- All variable and fixed costs as they change with each decision alternative.
The potential effect on the decision.
Sunk cost.
Because of the inclusion of costs that may not vary among the possible choices considered.
Because the decision involves an evaluation of, among other things, demand, competitors’ actions, and desired profit margin.
In situations, expected future costs vary with the action or decision taken.
Examples: Acceptance of a special order, replacement of equipment, and addition or deletion of a product line.
Incremental cost (differential cost).
Potential cost.
Maximize the contribution margin or maximize contribution per unit times the number of units sold [(price-unit variable cost)x units sold].
Because gross profit is calculated after subtracting fixed costs, the fixed cost in the short run does not change.
III. Insourcing vs. Outsourcing (Make or Buy)
Since relevant costs are costs that can be avoidable if the total relevant costs of production are less than the cost to buy the item. The company will most likely produce in-house, and the reverse is true.
- Unit cost may be calculated based on different volumes.
- Irrelevant costs may be included in the unit amounts.
- Allocated costs may be included in the unit amounts.
When the factory has no alternative use available.
- Special technology.
- Skilled labor.
- Special material requirements.
All expected continuing costs are common to all the alternative courses of action.
Future costs that differ among the alternative courses of action plus all qualitative factors cannot be measured in numerical terms.
Maintaining a long-run relationship with suppliers is desirable.
IV. Special Order
Acceptance of the order will not affect regular sales.
The price covers variable costs.
When the additional revenue from the special order is greater than the marginal cost of producing the order.
Costs that are expensed whether or not special order is accepted.
Example: Depreciation.
V. Other Nonroutine Decisions
- Quality of the new product.
- Life of the new product.
- Customers’ relative preference for quality compared with price.
- The seller’s price is below an appropriate measure of its costs.
- It has a reasonable prospect of recovering the resulting loss through higher prices or greater market share.
Dumping.
Note: Such sale is illegal if it threatens material injury to a U.S. industry.
It involves charging different prices to different customers for essentially the same product.
- Lessen competition substantially.
- Tend to create a monopoly.
- Injury, destroy, or prevent competition.
The products with the highest contribution margin per unit of the constraining resource.