Hope Enterprise University College

Department of Accounting & Finance

Cost & Management Accounting II

Chapter Three: Relevant Information And Special Decision

Information and the decision process
A decision model is a formal method for making a choice, frequently involving both
quantitative and qualitative analysis.
Relevant costs and Relevant Revenues
Relevant costs and relevant revenues are those expected future costs and expected
future revenues that differ among the alternative courses of action being considered.
The two key aspects to this definition are that to be relevant, (A) the costs and revenues
must occur in the future and (B) that they must differ among the alternative courses of
action. Usually, organizations focus on future because every decision deals with
selecting courses of action for the future. Nothing can be done to alter the past. Also,
the future costs and revenues must differ among the alternatives. Why? Because costs
and revenues that do not differ will not matter and hence will have no bearing on the
decision being made. The key question is always, what difference will an action make?
7 steps of the decision-making process
The most commonly steps of the decision making processes are:
1. Identify the decision
To make a decision, you must first identify the problem you need to solve or the
question you need to answer. Clearly define your decision. If you misidentify the
problem to solve, or if the problem you’ve chosen is too broad, you’ll knock the decision
train off the track before it even leaves the station.
If you need to achieve a specific goal from your decision, make it measurable and timely.
2. Gather relevant information
Once you have identified your decision, it’s time to gather the information relevant to
that choice. Do an internal assessment, seeing where your organization has succeeded
and failed in areas related to your decision. Also, seek information from external
sources, including studies, market research, and, in some cases, evaluation from paid
consultants. Keep in mind, you can become bogged down by too much information and
that might only complicate the process.
3. Identify the alternatives
With relevant information now at your fingertips, identify possible solutions to your
problem. There is usually more than one option to consider when trying to meet a goal.
For example, if your company is trying to gain more engagement on social media, your
alternatives could include paid social advertisements, a change in your organic social
media strategy, or a combination of the two.
4. Weigh the evidence
Once you have identified multiple alternatives, weigh the evidence for or against said
alternatives. See what companies have done in the past to succeed in these areas, and
take a good look at your organization’s own wins and losses. Identify potential pitfalls
for each of your alternatives, and weigh those against the possible rewards.
5. Choose among alternatives
Here is the part of the decision-making process where you actually make the decision.
Hopefully, you’ve identified and clarified what decision needs to be made, gathered all
relevant information, and developed and considered the potential paths to take. You
should be prepared to choose.
6. Take action
Once you’ve made your decision, act on it! Develop a plan to make your decision
tangible and achievable. Develop a project plan related to your decision, and then assign
tasks to your team.
7. Review your decision
After a predetermined amount of time—which you defined in step one of the decision-
making process—take an honest look back at your decision. Did you solve the problem?
Did you answer the question? Did you meet your goals?
If so, take note of what worked for future reference. If not, learn from your mistakes as
you begin the decision-making process again.
Tools for better decision-making
Depending on the decision, you might want to weigh evidence using a decision tree. The
example below shows a company trying to determine whether to perform market
testing before a product launch. The different branches record the probability of success
and estimated payout so the company can see which option will bring in more revenue.

 Past costs that are unavoidable because they cannot be changed no matter what
action is taken are called sunk cost.
Qualitative and Quantitative Relevant Information
 Qualitative factors are outcomes that cannot be measured in numerical factors
 Quantitative factors are outcomes that be measured in numerical factors. It
covers both financial and non-financial factors.
Key features of relevant information
 Past (historical) costs may be helpful as a basis for making predictions. However,
past costs themselves are always irrelevant when making decisions.
 Different alternatives can be compared by examining differences in expected total
future revenues and costs.
 Not all expected future revenues and costs are relevant. Expected future revenues
and costs that do not differ across alternatives are irrelevant and hence can be
eliminated from the analysis. The key question is always, what difference will it
make?
 Due weight must be given to qualitative factors and quantitative non-financial
factors.
An Illustration of Relevance: Choosing output levels
 One –Time-Only Special Orders
One type of decision that affects output levels involves accepting or rejecting special
orders when there is idle production capacity and where the order has no long-run
implications. This condition is described by one-time-only special orders.

Deletion or Addition of products, services or departments

Relevant Information also plays important role indecisions about adding or deleting
products, services, or departments.
Avoidable And Unavoidable Costs
Often existing business will want to expand or contract their operations to improve
profitability. How can a manufacturer decide to add or drop products? The same a
retailer decides whether to add or drop departments: by examining all the relevant cost
and revenue information.
The purpose in deciding whether to add or drop new products, services or departments
is to obtain the greatest contribution possible to pay unavoidable costs. The
unavoidable costs will remain the same regardless of any decision, so the key is picking
the alternative that will contribute the most toward paying off these costs.

Insourcing Versus Outsourcing and make or Buy Decision

Outsourcing and Idle facilities
 Outsourcing: is the process of purchasing goods and services from outside
vendors rather than producing the same goods or providing the same, service
within the organization, which is called Insourcing.
 Decisions about whether a producer of goods or services will insource or
outsource are also called make-or-buy decisions.
Product- Mix decisions under capacity constraints
Product Mix decision is the decisions about how much of each product to sell. These
decisions frequently have a sort-run focus because the level of capacity can only be
expanded in the long run.
Irrelevance of past costs and equipment-replacement decisions
1. Book-value of old machine is irrelevant. Because, it is a past cost or sunk cost.
2. Current disposable price of old machine is relevant. Because it is an expected
future benefit that defers between alternatives.
3. Gain or loss on disposal is the algebraic deference between items 1 & 2. It is a
meaningless combination blurring the distinction between the items should be
considered separately.
4. Cost of new machine is relevant. Because it is an expected future cost that will
differ between alternatives.