Cost Accounting (14th Edition)

412 CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION
Exhibit 11-12
Cost Comparison:
Replacement of
Machine, Relevant
Items Only, for Toledo
Company
Two Years Together
Keep Replace Difference
(1) (2) (3) = (1) – (2)
Cash operating costs $1,600,000 $ 920,000 $680,000
Current disposal value of old machine — (40,000) 40,000
New machine, written off periodically
as depreciation — 600,000 (600,000)
Total relevant costs $1,600,000 $1,480,000 $120,000
Decisions and Performance Evaluation
Consider our equipment-replacement example in light of the five-step sequence in
Exhibit 11-1 (p. 392):
Step 1 Step 2 Step 3 Step 4 Step 5
Indentify
the Problem
and
Uncertainties
Obtain
Information
Make
Predictions
About the
Future
Make
Decisions
by Choosing
Among
Alternatives
Implement
the Decision,
Evaluate
Performance,
and Learn
Feedback
Learning
Objective 7
Explain how conflicts
can arise between the
decision model used by
a manager and the
performance-evaluation
model used to evaluate
the manager
. . . tell managers to
take a multiple-year
view in decision making
but judge their
performance only on
the basis of the current
year’s operating income
The decision model analysis (Step 4), which is presented in Exhibits 11-11 and 11-12, dictates
replacing the machine rather than keeping it. In the real world, however, would the
manager replace it? An important factor in replacement decisions is the manager’s perception
of whether the decision model is consistent with how the manager’s performance will
be judged after the decision is implemented (the performance-evaluation model in Step 5).
From the perspective of their own careers, it is no surprise that managers tend to
favor the alternative that makes their performance look better. If the performanceevaluation
model conflicts with the decision model, the performance-evaluation
model often prevails in influencing managers’ decisions. For example, if the promotion
or bonus of the manager at Toledo hinges on his or her first year’s operating
income performance under accrual accounting, the manager’s temptation not to
replace will be overwhelming. Why? Because the accrual accounting model for measuring
performance will show a higher first-year operating income if the old machine is
kept rather than replaced (as the following table shows):
First-Year Results: Accrual Accounting Keep Replace
Revenues $1,100,000 $1,100,000
Operating costs
Cash-operating costs $800,000 $460,000
Depreciation 200,000 300,000
Loss on disposal ƒƒƒ—ƒƒƒ ƒ360,000
Total operating costs ƒ1,000,000 ƒ1,120,000
Operating income (loss) $ƒƒ100,000 $ƒƒ(20,000)
Even though top management’s goals encompass the two-year period (consistent with the
decision model), the manager will focus on first-year results if his or her evaluation is
based on short-run measures such as the first-year’s operating income.