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CFO Fundamentals: Your Quick Guide to Internal Controls, Financial Reporting, IFRS, Web 2.0, Cloud Computing, and More by ALLISON I. SHIM, JOEL G. SIEGEL, JAE K. SHIM

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CHAPTER ELEVEN

Short-Term Decisions

WHAT ARE THE typical short-term nonrecurring decisions that you face?

When performing the manufacturing and selling functions, management constantly faces the problem of choosing between alternative courses of action. Typical questions to be answered include what to make, how to make it, where to sell the product, and what price to charge. The CFO faces many short-term, nonroutine decisions. In a short-term situation, fixed costs are generally irrelevant to the decision at hand. CFOs must recognize two important concepts as major decision tools: relevant costs and contribution margin.

RELEVANT COSTS

In each short-term situation, the ultimate management decision rests on cost data analysis. Cost data are important in many decisions, since they are the basis for profit calculations. Cost data are classified by function, behavior patterns, and other criteria, as discussed previously.

However, not all costs are of equal importance in decision making, and CFOs must identify the costs that are relevant to a decision. Such costs are called relevant costs.

Which costs are relevant in a decision?

The relevant costs are the expected future costs (and also revenues) that differ between the decision alternatives. Therefore, the sunk costs (past and historical costs) are not considered relevant in the decision. What is relevant are the incremental or differential costs.

What is incremental analysis?

Under the concept of relevant costs, which may be called ...

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