Cost Classifications for Decision-Making

Cost Classifications for Decision-Making

Most often managers face situation that they would have to select from among at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in making the selection. This concept is explored in greater detail in the chapter on relevant costs. However, decision-making contexts crop up from time to time in the text before that chapter, so it is a good idea to familiarize yourself with relevant cost concepts.

Differential Costs

A differential cost is a cost that differs between alternatives. The cost may exist in only one of the alternatives or the total amount of the cost may differ between the alternatives. In the latter case, the differential cost would be the difference between the cost under one alternative and the cost under the other. Differential costs are also called incremental costs. Differential costs and opportunity costs should be the focus of decision-making. They are the only relevant costs and all others should be ignored.

Opportunity Costs

An opportunity cost is the potential benefit that is given up by selecting one alternative over another. The concept of an opportunity cost is rather difficult for students to understand because it is not an actual expenditure and it is rarely (if ever) shown on the accounting books of an organization. It is, however, a cost that must be considered in decisions.

Here is an example taken directly from the accountingtools web site @

http://www.accountingtools.com/questions-and-answers/what-is-a-differential-cost.html

§  Example of alternative decisions . If you have a decision to run a fully automated operation that produces 100,000 widgets per year at a cost of $1,200,000, or of using  direct labor   to manually produce the same number of widgets for $1,400,000, then the differential cost between the two alternatives is $200,000.

§  Example of change in output . A work center can produce 10,000 widgets for $29,000 or 15,000 widgets for $40,000. The differential cost of the additional 5,000 widgets is $11,000.

You can line up the revenues and expenses from one decision next to similar information for the alternative decision, and the difference between all line items in the two columns is the differential cost.

With this said:

Convenience stores are looking at more competition from supermarkets, drugstores, and membership-warehouse clubs that have added gas pumps and faster checkouts. Therefore, cost cuts are needed to increase convenience stores’ competitive edge. Some retailers have found that it is cost-effective to stock only one brand of a product. Others found that stocking particular products cost the convenience store so much that it incurred a loss on the sale of that particular product. Using accounting software takes all of these costs into consideration and shows where nonprofitable products are losing money. It helps convenience stores increase sales and decrease costs.

1. Select one of the major convenience store in your town and research the store product, and list all of the types of costs that can be associated with a product.
2. Since cutting cost are needed to increase convenience stores’ competitive edge, in your professional judgment and based on your experience, which costs can be cut without affecting daily operations of the store. Please discuss your reasons for cutting the selected costs.
3. Using accounting software takes operating costs into consideration and shows where nonprofitable products are losing money. How does this software tool help to more accurately assess an item’s profitability? Do you think that this software is beneficial for convenience stores? Why or why not?
4. Do you think this software is beneficial?
5. Can you recall a personal situation in your career in which a company that you use to or currently are working for cut unnecessary costs? How cutting costs workout?

I just need a min. answer in 250 words with refrences and in-text citation.