9E - Horngren'S Financial And Managerial Accounting

Question

Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of \(3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another \)4,500,000. Jacobs is afraid to bring this new equipment to the company president’s attention because he convinced the president to invest $3,000,000 in the machinery last year. 

Explain what is relevant and irrelevant to Jacobs’s dilemma. What should he do?

Step-by-Step Solution

Answer

The production manager must prepare an incremental analysis before making any decision. 

Step 1: Meaning of Relevant Information

Relevant information is an important requirement to draft effective decisions associated with the future activities of a business concern. Such information enables an administration to make a purchase or make decisions when an outsourcing alternative is available.

Step 2: Bifurcation of relevant and irrelevant information

The information associated with the additional cost and double production output is relevant for the business to make necessary decisions. 

Also, the cost spent by the business on the old machinery is sunk cost, which has become irrelevant information for the business entity. 

Hence, Dan Jacobs, the production manager must prepare a differential analysis to determine the annual operating income between the two machines.