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Decision making: Six key concepts

• Key concept #1
• Every decision involves choosing from among at least two alternatives.
  • Therefore, the first step in decision-making is to __________________________ ________________________________________.
• Key concept #2
  • Once you have defined the alternatives, you need to identify the ____________ _______________________________.
    • ______________________ and ____________________ should be considered when making decisions.
    • ______________________ and ____________________ should be ignored when making decisions.
• Key concept #3
  • The key to effective decision making is ___________________________focusing on the future costs and benefits that differ between the alternatives.
    • Everything else is irrelevant and should be ignored.
      • A future cost that differs between any two alternatives is known as a _________________________ and are always relevant costs.
      • Future revenue that differs between any two alternatives is known as ________________________________.
      • An ________________________________ is an increase in cost between two alternatives.
      • An _______________________________ is a cost that can be eliminated by choosing one alternative over another.
• Key concept #4
  • ______________________ are always irrelevant when choosing among alternatives.
    • A sunk cost is a cost that has already been incurred and cannot be changed regardless of what a manager decides to do.
• Key concept #5
  • Future costs and benefits that do not differ between alternatives are ____________________ to the decision-making process.
• Key concept #6
  • Opportunity costs also need to be considered when making decisions.
    • An ______________________ is the potential benefit that is given up when one alternative is selected over another.

Adding and dropping a product line and other segments

• Ultimately, a decision to drop an old segment or add a new one is going to hinge primarily on its _________________________.
  • To assess this impact it is necessary to carefully analyze the _______________.

Sourcing decisions

• When a company is involved in more than one activity in the entire value chain, it is _____________________________.
  • A decision to carry out one of the activities in the value chain _______________, rather than to buy ____________________ from a supplier, is called a ______________________________.
  • Vertical integration provides certain advantages:
    • Some companies feel that they can ____________________________ by producing their own parts and materials.
    • Integrated companies __________________________ from the parts and materials that they choose to make instead of buy.
  • The primary disadvantage of vertical integration is that a company may fail to take advantage of suppliers who can create an ___________________________ by pooling demand from numerous companies.
    • While the economies of scale factor can be appealing, a company must be careful to retain control over activities that are essential to maintaining its _________________________________.
• Opportunity costs are not recorded in the organizations general ledger because they do not represent ______________________________.
  • Rather, they represent economic benefits that are forgone as a result of pursuing some course of action.

Special Order Pricing

• A ______________________ is a one-time order that is not considered part of the companys normal ongoing business.
• When analyzing a special order, only the _____________________________________ are relevant.
  • Since the existing fixed manufacturing overhead costs would not be affected by the order, they are not relevant.

Volume trade-off decisions

• Companies are forced to make ____________________ when they do not have enough capacity to produce all of the products and sales volumes demanded by their customers.
  • In these situations, companies must trade off, or sacrifice production of some products in favor of others in an effort to maximize profits.
• When a limited resource of some type restricts the companys ability to satisfy demand, the company is said to have a ______________.
  • The machine or process that is limiting overall output is called the __________________it is the constraint.
• Fixed costs are usually unaffected in these situations, so the product mix that maximizes the companys ___________________________________ should ordinarily be selected.
• A company should not necessarily promote those products that have the highest _________ contribution margins.
  • Rather, total contribution margin will be maximized by promoting those products or accepting those orders that provide __________________________ ______________________________________________.

Managing constraints

• It is often possible for a manager to increase the capacity of a bottleneck, which is called ______________________________________, in numerous ways such as:
  • Working _________________ on the bottleneck.
  • _______________ some of the processing that would be done at the bottleneck.
  • Investing in ___________________________ at the bottleneck.
  • _________________________ from non-bottleneck processes to the bottleneck.
  • Focusing ___________________________________________ on the bottleneck.
  • Reducing _______________________ processed through the bottleneck.

Joint product costs and sell or process further decisions

• In some industries, a number of end products are produced from a single raw material input. When two or more products are produced from a common input these products are known as ____________________.
  • The _____________________ is the point in the manufacturing process at which the joint products can be recognized as separate products.
• The term ______________ is used to describe costs incurred up to the split-off point. Joint costs are common costs incurred to simultaneously produce a variety of end products.
• Sell or process further decisions
  • Joint costs are ______________ in decisions regarding what to do with a product from the split-off point forward. Therefore, these costs should not be allocated to end products for decision-making purposes.
  • With respect to sell or process further decisions, it is profitable to continue processing a joint product after the split-off point so long as the incremental revenue from such processing exceeds the incremental processing costs incurred after the split-off point.

Activity-based costing and relevant costs

• Activity-based costing can be used to help identify ______________ relevant costs for decision-making purposes.
• However, managers should exercise caution against reading more into this _____________________ than really exists.
  • People often assume that if a cost is traceable to a segment, then the cost is automatically avoidable, which is untrue. Before making a decision, managers must decide which of the potentially relevant costs are __________________ avoidable.