Question

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Q 4     Making a decision to process a product further is not influenced by joint cost allocation. However, it should be based on incremental costs and qualitative factors. Discuss this statement.

Answer 1

Decision making involves the at of selecting one course of action from among various feasible alternatives variable.many quantitative and qualitative factors are to be considered. The manager chooses that action which he considers to be the most effective one for acheiving goals and solving problems.

Joint cost allocation must be done for financial reporting system, to value inventory and to determine income. Joint allocation cost is not effective since it ignores the fact that all costs are directly related to physical quantities. Also it may lead to incorrect managerial decisions because high profit may be reflected from the sale of high-grade products, with low profit or lossed from the sale of low grade products,.

Now, incremental cost which is also referred as marginal cost is calculated by analysing the additional charges incurred based on the change in certain activity. Incremental costs are effective in making short term decisions or choosing between two alternatives. It is also useful in decising whether to manufacture any product or not.

Incremental costs are also called relevant costs because they encompass only the items necessary for analysis. All fixed costs are omitted from incremental cost analysis because they do not change. Therefore, fixed costs are sunk costs that should not be considered. Only variable costs such as materials or labor are considered in incremental costs.

Qualitative factors may outweigh the quantitative factors in making a decision. For example, assume management at Best Boards, Inc., believes there will be a decline in the market for wakeboards after next year. Outsourcing production makes it easier to quickly reduce costs in the face of a downturn by simply ordering fewer wakeboards from the supplier. Continuing to build the boards internally takes away this flexibility. The significant fixed costs often associated with manufacturing firms are difficult to reduce in the short run if production declines. Thus the qualitative factor of being able to reduce manufacturing costs quickly by outsourcing production may outweigh the quantitative factors