The Better Chair Company is a large furniture designer, manufacturer, and retailer headquartered in Country X.
The company has just started manufacturing a new premium lounge chair at its new production division in Country X. The company also plans to internally sell the chair to its overseas retail division in Country Y.
Additionally, the company is considering another new product, an ottoman. You have been hired as a consultant to help the new divisional management team make some decisions affecting these products by using managerial accounting information. You have also been asked to explain to them how this information can be utilized to make good managerial decisions.
You are to provide your findings and recommendations in a series of three business reports, to be submitted during the next 3 weeks.
Sunk Costs, Opportunity Costs, and Accounting Costs – Fixed and Variable After your initial meeting with the management team members and assessing their level of experience with managerial accounting, you have decided to provide some starting information on the various types of costs utilized in managerial accounting.
Your purpose for providing this information is to give the necessary context to the new management team to enable them to fully understand the accounting information and recommendations you will provide in your final report. Be sure to address the following:
1. Explain sunk cost, opportunity cost, and accounting cost, and provide three examples of each.
2. Explain how each of these costs relates to developing managerial accounting information required for decision making. 3. Summarize why a manager should understand these concepts, providing an example to support your rationale. 4. Explain the differences between fixed and variable costs and provide three examples of each type of cost. 5. Summarize the importance for managers to classify these costs correctly, including how the correct classification can inform decision making.
In business decisions, organizations often focus too much on Sunk Costs, ignoring the Opportunity Costs. Sunk Costs are explicit and appear on financial statements so it is understandable why these costs are honed in on. Opportunity Costs are implicit and unseen, so they are often overlooked. The nature of these costs generates confusion around which to consider when making business decisions.
Understanding sunk costs and opportunity costs and their relevance to your business is essential. Smarter business decisions increase savings and cut costs, setting your business up for success.
It is inevitable that businesses will incur costs in their day-to-day operations. Some of these costs are discretionary and can be identified and reduced. Managing both your direct and indirect spend with a centralized procurement software solution makes it easy to track costs and automate business procedures, eliminating nonessential spending. Understanding your business’s costs is the first step to making savings.
Managers with a solid grasp of sunk costs and opportunity costs can help achieve realized savings that match your business’s targets.
A sunk cost refers to a cost that has already occurred and has no potential for recovery in the future. Given sunk costs have already occurred, the cost will remain the same regardless of the outcome of a decision, and so they should not be considered in capital budgeting.
It is easy to get hung up on sunk costs, especially when they are explicit costs. Explicit costs are direct payments made to others in the course of running a business, such as wages, rent and, materials. Explicit costs which have already been incurred are sunk and are irrelevant to future decision-making. Explicit costs which will occur in the future, however, are relevant to business decisions as they will be direct costs to the company that could be avoided.
An Opportunity Cost is the loss of other alternatives when one option is chosen or no action is taken. Opportunity costs are unseen, not included in financial reports, and can often be forgotten about in capital budgeting. Part of the reason opportunity costs are unseen is because they consider Implicit Costs. An implicit cost is any cost that has already occurred but is not necessarily shown or reported as a separate expense. These costs are much harder to measure as they are not always quantitative. Being aware of trade-offs will allow managers to make better-educated investment decisions. The costs and benefits of every other potential alternative must be examined and weighed in order to properly calculate opportunity costs.