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The importance of isolating the relevant costs in a decision analysis of Nike is very significant. First, generating information is a costly process. The relevant data must be sought, and this requires time and effort. By focusing only on relevant information, Nike can simplify and shorten the data-gathering process. The second important issue is that a company like Nike can effectively use only a limited amount of information. Beyond this, the company experiences information overload, and the decision-making effectiveness declines.
By routinely providing only information about relevant costs, Nike can reduce the likelihood of information overload. In order to illustrate both relevant and non-relevant costs, the decisions recently made by Nike will be considered. First of all, sunk costs that have already been incurred by Nike will be considered. These costs do not affect any future decisions, and cannot be changed by any current or future action, so sunk costs are irrelevant costs, as the following examples show.
By 2003, Nike has had 117 3 -year-old loader trucks used to load packaged Nike tennis shoes onto the delivery trucks. The book value of one loader, defined as the asset acquisition cost less the accumulated depreciation to date, is computed as follows: Acquisition Cost Accumulated depreciation = Book Value $ 100, 000 - 75, 000 = $ 25, 000 Nike suddenly faces a decision about replacement of the loaders. The new loaders are much cheaper and cost less to operate. So the book value of the old loaders ($ 25, 000 117 = $ 2, 925, 000) is a sunk cost.
It cannot affect any future cost the company might incur. Nike buys new equipment, and so $ 2, 925, 000 cost will be incurred by the company as a write-off of the book value. Thus, the book value of the old loaders is a sunk cost and irrelevant to the replacement decision. Nevertheless, here the company also faces the relevant cost. The acquisition cost of new equipment ($ 15, 000 per item) (depreciation) is a future cost incurred only under the replace alternative. This cost meets the tests of relevant costs.
First of all, the cost relate to the future. And then, secondly, the cost differs between the alternatives. Another decision that is going to take place in the nearest future is the possibility of producing additional tennis shoe pairs. Nike's initial analysis of the relevant costs and benefits indicates that the additional revenue from the production of the tennis shoes will exceed their costs by $ 100, 000 per month. Yet, Nike currently has excess space in the companys warehouse.
Local shoe store has offered to rent the excess space in the warehouse for $ 120, 000 per month. However, if the tennis shoes are entered into production process, the additional finished goods inventory will need that extra space in the warehouse. If Nike installs the production of the tennis shoes, it will forgo the opportunity to rent the excess warehouse space. Thus, the $ 120, 000 in rent forgone is an opportunity cost of the alternative to add the new flights.
An opportunity cost is the potential benefit given up when the choice of one action precludes a different action. Although companies tend to overlook or underestimate the importance of opportunity costs, they are just as relevant as out-of-pocket costs in evaluating decision alternatives. In Nike's case, the best action is to rent the excess warehouse space to the local shoe store, rather than install additional shoes into the production process. The $ 120, 000 warehouse rental, which will be forgone if the new shoes will be installed into production process, is the relevant cost of the decision, and its important as any out-of pocket expenditure. Also future costs that are identical across all decision alternatives are not relevant. They can be ignored when making a decision.
For example, Nike is considering to change its finished product delivery route and on the way from Atlanta to Los Angeles make a stop in San Francisco. Yet, it was found that cargo revenue, and cars maintenance costs are non-relevant to the route change decision. Although this data affects future cash flows, these items do not differ between two alternatives of changing the route or staying with the present route. This data is irrelevant, and thus can be ignored. Bibliography R. Brown, (2003).
Managerial Accounting. Berkley: University of California Press. J. Weston, (2003). Nike's.
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