Slides recommend COA in outsourcing

Recommend A Course Of Action In Outsourcing And Keep Or Replace Decisions Principles of Cost Analysis and Management... • Standard: With at least 80% accuracy: • Explain relevant costs

Recommend A Course Of Action In

Outsourcing And Keep Or Replace Decisions

Principles of Cost Analysis and

Management

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 a cost advisor technician with access

to all regulations/course handouts, 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

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

What is Relevant?

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

• 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

would be eliminated or avoided by choosing another course of action

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

Classic Relevant Cost Problems

in-house or purchase from a contractor?

equipment we have or replace with more

efficient equipment?

• These are the two most applicable to

government entities

Classic Relevant Cost Problems

we accept or reject additional business at a

reduced price?

resources to bring the item up to standards or cut our losses?

• While less common, these also have

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

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

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

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

Check on Learning

• How are relevant costs defined?

• How does the table format help to identify

irrelevant costs?

• 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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

Revenue or Benefit -0- -0-

-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

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 year to operate.

• We could sell the “old” machine today for $10,000

salvage.

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Salvage of old

(benefit) -0- $10,000 $10,000

Cost of Old (Sunk) $50,000 50,000

-0-Cost of New -0- 70,000 (70,000)Operating Costs 3 yrs 300,000 225,000 75,000

Net Change -350,000 -335,000 15,000

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Salvage of old

machine (benefit) -0- $10,000 $10,000

Cost of Old (Sunk) $50,000 50,000

-0-Cost of New -0- 70,000 (70,000)Operating Costs 3 yrs 300,000 225,000 75,000

Net Change -350,000 -335,000 15,000

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Salvage of old

(benefit) -0- $10,000 $10,000

Cost of Old (Sunk) $50,000 50,000

-0-Cost of New -0- 70,000 (70,000)Operating Costs 3 yrs 300,000 225,000 75,000

Net Change -350,000 -335,000 15,000

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Salvage of old

(benefit) -0- $10,000 $10,000

Cost of Old (Sunk) $50,000 50,000

-0-Cost of New -0- 70,000 (70,000)Operating Costs 3 yrs 300,000 225,000 75,000

Net Change -350,000 -335,000 15,000

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Salvage of old

(benefit) -0- $10,000 $10,000

Cost of Old (Sunk) $50,000 50,000

-0-Cost of New -0- 70,000 (70,000)Operating Costs 3 yrs 300,000 225,000 75,000

Net Change -350,000 -335,000 15,000

Keep or Replace

• Decision: Replace Old Machine with More

Efficient New Machine?

Salvage of old

(benefit) -0- $10,000 $10,000

Cost of Old (Sunk) $50,000 50,000

-0-Cost of New -0- 70,000 (70,000)Operating Costs 3 yrs 300,000 225,000 75,000

Net Change -350,000 -335,000 15,000

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?

Check on Learning

• 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

Item Status Quo Additional With Δ

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

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

Additional Business, Reduced Price

Item Status Quo Additional With Δ

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

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

Additional Business, Reduced Price

Item Status Quo Additional With Δ

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

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

Additional Business, Reduced Price

Item Status Quo Additional With Δ

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

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

Additional Business, Reduced Price

Item Status Quo Additional With Δ

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.

Cost of Basic training is a Sunk

Cost and therefore irrelevant

Cost of Basic training is a Sunk

Cost and therefore irrelevant

Check on Learning

• Which costs are irrelevant in deciding whether

to accept additional business at a reduced

price?

• What is the rule of thumb?

Practical Exercises