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Lecture Accounting for decision making and control (8/e): Chapter 2 - Jerold L. Zimmerman

Chapter 2 - The nature of costs. The topics discussed in this chapter are: Opportunity costs, cost variation, cost–volume–profit analysis, opportunity costs versus accounting costs, cost estimation, costs and the pricing decision. | The Nature of Costs Chapter Two Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Opportunity Costs - Defined Opportunity set: Set of alternative actions available to decision maker Opportunity cost: Benefits forgone by choosing one alternative from the opportunity set rather than the best non-selected alternative Example Opportunity Set = {A, B, C} Alternative Benefits Opportunity Cost A $108,000 $107,000 = Alternative B B $107,000 $108,000 = Alternative A C $106,500 $108,000 = Alternative A 2- Opportunity Costs - Characteristics Opportunity costs: include tangible and intangible benefits measured in cash equivalents rely on estimates of future benefits useful for decision making Accounting expenses: costs consumed to generate revenues rely on historical costs of resources actually expended designed to match expenses to revenues useful for control See opportunity cost examples 2- Sunk Costs and Opportunity Costs Sunk Costs: Costs which were incurred in the past and cannot be changed no matter what future action is taken. Sunk costs are totally irrelevant for decision making and are excluded from opportunity costs. Sunk costs might be useful for control purposes. 2- Relevant Costs and Opportunity Costs Often the term “relevant cost” described as “expected future costs that will differ under alternatives.” Opportunity costs is a well-defined, fundamental concept in economics that encompasses “relevant cost.” Thus only “opportunity cost” will be used in the text. 2- The Costs of SOX – the Sarbanes-Oxley Act of 2002 The Public Company Accounting Reform and Investor Protection Act Direct costs of compliance expected to grow to $8 billion in 2005 Other costs include Increases as large as 50% in director’s fees and premiums for directors and officer insurance policies Innovative projects are being abandoned due to risk and/or delayed due to time spent on compliance 2- Cost Variation – Definitions Fixed Costs: | The Nature of Costs Chapter Two Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Opportunity Costs - Defined Opportunity set: Set of alternative actions available to decision maker Opportunity cost: Benefits forgone by choosing one alternative from the opportunity set rather than the best non-selected alternative Example Opportunity Set = {A, B, C} Alternative Benefits Opportunity Cost A $108,000 $107,000 = Alternative B B $107,000 $108,000 = Alternative A C $106,500 $108,000 = Alternative A 2- Opportunity Costs - Characteristics Opportunity costs: include tangible and intangible benefits measured in cash equivalents rely on estimates of future benefits useful for decision making Accounting expenses: costs consumed to generate revenues rely on historical costs of resources actually expended designed to match expenses to revenues useful for control See opportunity cost examples 2- Sunk Costs and Opportunity Costs Sunk Costs: Costs which