Slides 3 2 recommend a course of action in outsourcing and k

Recommend a Course of Action in Outsourcing Relevant Cost... • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awa

Recommend a Course of Action

in Outsourcing (Relevant Cost)

What will influence your decision?

• Two cars: same model, same price, same

engine, same features and accessories, same financing

Terminal Learning Objective

• Task: Recommend A Course of Action in Outsourcing

and Keep or Replace Decisions.

• Condition: You are training to become an ACE with

access to ICAM course handouts, readings, and

spreadsheet tools and awareness of Operational

Environment (OE)/Contemporary Operational

Environment (COE) variables and actors

• Standard: With at least 80% accuracy:

• Explain relevant costs

• Identify relevant costs in an outsourcing decision

• Identify relevant costs in a keep-or-replace decision

What is Relevant?

• Synonyms for relevant: pertinent, applicable,

related, appropriate, significant, important

• We have access to more information than ever

• Not every piece of information is pertinent,

applicable, or related to a decision

• Example: fuel economy on new car models is not pertinent to a decision about whether to

pursue your Master’s degree

What is Relevant?

• Some pieces of information can be easily

dismissed as unrelated or irrelevant

• Other times it is more difficult to determine what is appropriate, significant, or important

to the decision

• Especially when the information is printed on

an official report from the accounting system

• Remember that the accounting system

measures according to external requirements

What is Relevant?

• Relevant costs are those costs that change as

a result of a decision

• Identify the decision at hand

• Choice between two Courses of Action (COA)

• Frequently one of the options is status quo

• Identify related costs

• Which costs are the same for both courses of action? Which will change?

Cost Definitions

• Acquisition cost – all costs related to purchasing

an asset and placing it into service

• Operating cost – all costs related to operating an

asset

• Opportunity cost – the value of what is given up

when choosing a particular course of action

• Sunk cost – costs incurred in the past that cannot

be recovered

• Incremental cost – the additional cost incurred as

the result of a decision

Cost Definitions

• Avoidable cost – cost we currently incur that

would be eliminated or avoided by choosing another course of action

• Unavoidable cost – cost we currently incur

that would NOT be eliminated or avoided by choosing another course of action

Classic Relevant Cost Problems

• Outsourcing – Should we provide this service

in-house or purchase from a contractor?

• Keep or replace – Should we keep the

equipment we have or replace with more

efficient equipment?

• These are the two most applicable to

government entities

Classic Relevant Cost Problems

• Additional business at reduced price – Should

we accept or reject additional business at a

reduced price?

• Scrap or re-work – Should we invest

additional resources to bring the item up to

standards or cut our losses?

• While less common, these also have

government applications

A Template for Organizing the Data

• Based on the Statement of Activities

Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1

Related Cost A Cost A from COA #1 Cost A fromCOA #2 #2 - #1

Related Cost B Cost B fromCOA #1 Cost B fromCOA #2 #2 - #1

Net Change

(Rev – Cost) Rev – Costs Rev – Costs #2 - #1

A Template for Organizing the Data

• Based on the Statement of Activities

Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1

Related Cost A Cost A from COA #1 Cost A fromCOA #2 #2 - #1

Related Cost B Cost B fromCOA #1 Cost B fromCOA #2 #2 - #1

Net Change

(Rev – Cost) Rev – Costs Rev – Costs #2 - #1

COA #1 may be the

status quo

A Template for Organizing the Data

• Based on the Statement of Activities

Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1

Related Cost A Cost A from COA #1 Cost A fromCOA #2 #2 - #1

Related Cost B Cost B fromCOA #1 Cost B fromCOA #2 #2 - #1

A Template for Organizing the Data

• Based on the Statement of Activities

Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1

Related Cost A Cost A from COA #1 Cost A fromCOA #2 #2 - #1

Related Cost B Cost B fromCOA #1 Cost B fromCOA #2 #2 - #1

Net Change

(Rev – Cost) Rev – Costs Rev – Costs #2 - #1

Express Δ as Favorable

or (Unfavorable)

A Template for Organizing the Data

• Based on the Statement of Activities

Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1

Related Cost A Cost A from COA #1 Cost A fromCOA #2 #2 - #1

Related Cost B Cost B fromCOA #1 Cost B fromCOA #2 #2 - #1

Net Change

(Rev – Cost) Rev – Costs Rev – Costs #2 - #1

If the item is the same for COA #1 and COA #2

the Δ will be -0- indicating the item is irrelevant to the

decision

Learning Check

• How are relevant costs defined?

• How does the table format help to identify

irrelevant costs?

• Decision: Outsource HR function for $200,000

per year or keep in-house?

• Direct labor cost = four employees @ $50,000

per employee annually

• Two would be laid off, two would be transferred to another command

• Unemployment taxes would increase $10,000 per

year due to the layoffs

• Facilities and equipment cost = $35,000 per year

• Would remain idle

• Other operating costs = $15,000 per year

• Would be eliminated

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

-0-Direct labor $200,000 -0- $200,000Cost of HR contract -0- $200,000 (200,000)Unemployment tax -0- 10,000 (10,000)Facilities/Equipment 35,000 35,000 -0-

Other operating cost 15,000 -0- 15,000

Net Change -250,000 -245,000 5,000

Outsourcing Conclusions

• Going strictly by the numbers, we would save

$5,000 by outsourcing

• What else should we consider?

• Are there non-quantifiable benefits from

keeping the function in-house? From

outsourcing?

• What if the cost of facilities and equipment

increases? Would that change our decision?

Keep or Replace

• Your command recently purchased a machine for

$50,000 The annual operating cost of the

machine is $100,000.

• An alternative machine to perform the same

function has just become available The new

machine costs $70,000 and costs $75,000 per

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Keep or Replace Conclusions

• Replacing the “old” machine will save $15,000 over the three-year period

• What else should be considered? Any

qualitative factors?

• What if the projected operating costs of the new machine are overly optimistic? What if the actual operating costs are $80,000 per

year? $85,000? How would that change our decision?

Learning Check

• Which costs are always irrelevant in keep or replace decisions?

Additional Business, Reduced Price

• The dining hall can serve 200 for breakfast, but averages only 40 on weekends

• Daily fixed costs for the morning shift (three

employees for four hours, plus cost of facilities) are $500, and variable costs are $2 per breakfast The regular price for breakfast is $5

• A local community service group would like to

use the dining hall on Sunday mornings for their meetings They would pay $3 per person for

breakfast Average attendance at meetings is 75

Additional Business, Reduced Price

Breakfast sales 40 @ $5$200 40 @ $5 + 75 @ $3$425 $225

Variable Costs 40 @ $280 115 @ $2230 (150)

Additional Business, Reduced Price

Breakfast sales 40 @ $5$200 40 @ $5 + 75 @ $3$425 $225

Variable Costs 40 @ $280 115 @ $2230 (150)

Additional Business, Reduced Price

Breakfast sales 40 @ $5$200 40 @ $5 + 75 @ $3$425 $225

Variable Costs 40 @ $280 115 @ $2230 (150)

Additional Business, Reduced Price

Breakfast sales 40 @ $5$200 40 @ $5 + 75 @ $3$425 $225

Variable Costs 40 @ $280 115 @ $2230 (150)

Additional Business, Reduced Price

Breakfast sales 40 @ $5$200 40 @ $5 + 75 @ $3$425 $225

Variable Costs 40 @ $280 115 @ $2230 (150)

• Assumptions:

• Excess capacity exists

• Proposed business will not detract from regular business

• Rules of thumb:

• As long as incremental revenue exceeds

incremental cost, additional business is desirable

• Fixed costs are irrelevant

Additional Business, Reduced Price

Additional Business, Reduced Price

• What else should the dining hall management consider?

• Should we sell an inferior product as scrap or invest the necessary resources to make the

If X (benefit of trained soldier) is greater than Z (cost

to re-train) then re-training is desirable.

If X (benefit of trained soldier) is greater than Z (cost

to re-train) then re-training is desirable.

Cost of Basic training is a Sunk

Cost and therefore irrelevant

Learning Check

• Which costs are irrelevant in deciding whether

to accept additional business at a reduced

price?

• What is the rule of thumb?

Practical Exercises