Principles of Accounting: Chapter Twenty-Four

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Chapter Summary

Chapter 24 examines analytical methods and reasoning that are applicable to management decision-making activities. The chapter begins with a presentation of cost characteristics, including emphasis on the concepts of relevant and sunk costs. This is followed by the construction of a general frame of reference for decision making, which is then illustrated with examples related to outsourcing, special orders, and discontinuance of products/departments.

The chapter then turns to consideration of the evaluation of capital expenditures. Such decisions are heavily dependent upon a number of intrinsic calculations related to future and present value concepts, and the chapter provides in-depth coverage of each. Next, the chapter shows how these considerations are utilized in net present value calculations and internal rate of return calculations. Alternative capital investment evaluation tools, like the accounting rate of return and payback method, are also examined.

To aid in your understanding of this chapter, exercises with solutions are available for free download at Bookboon.com. You will find these exercises very helpful in providing models and guidelines for solving all of the problems at principlesofaccounting.com.

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Objectives: Chapter Twenty-Four

The following learning objectives for this chapter map to the curriculum design for our online university-level courses. These courses are offered through Utah State University, and result in the awarding of up to 6 hours of highly transferrable college credit. To learn more, check out the classroom link.

Cost characteristics and the impact on decisions.

What is a relevant cost, and what is a sunk cost?

Why does decision making necessarily focus on the future?

A general framework for making rational business decisions.

Describe the steps in the general approach to decision making.

In addition to quantitative factors, what else should be considered in the decision making process?

Be able to perform calculations related to outsourcing decisions ("make or buy").

Define "opportunity cost" and note its importance in the decision process.

Be able to perform calculations for special order pricing decisions.

Know why the contribution margin must be analyzed in terms of capacity constraints.

Be able to perform calculations for addition or deletion of products (or departments) in decision making.

Know the 80/20 concept.

Capital expenditure decisions.

What is a capital expenditure?

Describe the capital budgeting process.

Compound interest and present value.

What is meant by the "time value of money?"

Be able to calculate compound interest.

Understand the relationship between compound interest and present value.

Be able to calculate future value and present value of lump-sum and annuity amounts.

Tools for evaluating capital projects.

Be able to calculate the net present value of an investment, and explain the method's strengths and weaknesses.

How does depreciation impact cash flow calculations?

Explain and perform cash-flow calculations on a net-of-tax basis.

Be able to calculate the accounting rate of return for an investment, and explain the method's strengths and weaknesses.

Be able to calculate the internal rate of return for an investment, and explain the method's strengths and weaknesses.

Be able to calculate the payback period for an investment, and explain the method's strengths and weaknesses.

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