{"id":571,"date":"2018-04-18T22:53:24","date_gmt":"2018-04-18T22:53:24","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/?post_type=chapter&#038;p=571"},"modified":"2024-04-29T17:28:26","modified_gmt":"2024-04-29T17:28:26","slug":"opportunity-costs","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/chapter\/opportunity-costs\/","title":{"raw":"Opportunity Costs","rendered":"Opportunity Costs"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Identify opportunity costs<\/li>\r\n<\/ul>\r\n<\/div>\r\nWhat is an opportunity cost?\r\n\r\n<iframe src=\"\/\/plugin.3playmedia.com\/show?mf=4309242&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=TNxg1auV2AM&amp;video_target=tpm-plugin-ziyiqmug-TNxg1auV2AM\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe>\r\n\r\nYou have a part-time job while you are attending school. It is spring break and you would <strong>love<\/strong> to take a week off and lay on the beach and not do anything! However, if you take the week off, you won\u2019t get a paycheck. So what is the cost of taking that week off?\r\n\r\nThe loss of wages for that week is called an opportunity cost. It is the cost of what is lost if one decision is made over another. These costs won\u2019t show up anywhere in your accounting records, but as a manager, you need to be very aware of the missed opportunities for decisions you make!\r\n\r\nTake a look at this example:\r\n\r\nhttps:\/\/youtu.be\/pkEiHZAtoro\r\n\r\nInvestopedia defines\u00a0<strong>opportunity cost<\/strong> as follows:\r\n<blockquote>Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made.[footnote]https:\/\/www.investopedia.com\/terms\/o\/opportunitycost.asp[\/footnote]<\/blockquote>\r\nAlthough that definition relates to opportunity costs in investing, in the business operations, it has a similar meaning. \u00a0We can talk about opportunity costs when we think about making a component needed for our product as opposed to buying it from a supplier already made. Let\u2019s look at an example:\r\n\r\nHupana currently buys the soles that go on their awesome running shoes from a supplier premade and ready to attach to their shoes. The supplier is charging $5.00 per sole. Hupana wants to look at the option of making the soles in house, because they have some empty space in their building, that would be a perfect fit for the equipment needed to make the soles. Just to make this simple, let\u2019s assume Hupana already owns the equipment to make the soles.\r\n\r\nWe know that Hupana makes 2,000 pairs of shoes per year. So they pay their supplier $10,000 for the premade soles.\r\n\r\nLet\u2019s take a look.\r\n<table style=\"border-collapse: collapse; width: 100%;\" border=\"1\">\r\n<tfoot>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Difference in favor of MAKING<\/th>\r\n<td style=\"width: 33.3333%; height: 15px;\">$400<\/td>\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<\/tr>\r\n<\/tfoot>\r\n<thead>\r\n<tr>\r\n<th style=\"width: 33.3333%;\" colspan=\"3\">Hupana Make or Buy Decision<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr style=\"height: 15px;\">\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"col\">Relevant Costs:\u00a0Make<\/th>\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"col\">Relevant Costs:\u00a0Buy<\/th>\r\n<\/tr>\r\n<tr style=\"height: 30px;\">\r\n<th style=\"width: 33.3333%; height: 30px;\" scope=\"row\">Direct Materials ($2.50 per sole \u00d7 2000 soles)<\/th>\r\n<td style=\"width: 33.3333%; height: 30px;\">$5,000.00<\/td>\r\n<td style=\"width: 33.3333%; height: 30px;\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<th style=\"width: 33.3333%;\">Direct Labor (.1hr\/sole at $20\/hour)<\/th>\r\n<td style=\"width: 33.3333%;\">$4,000.00<\/td>\r\n<td style=\"width: 33.3333%;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 30px;\">\r\n<th style=\"width: 33.3333%; height: 30px;\" scope=\"row\">Variable Overhead (.1hr\/sole at $3\/hour x 2000 soles)<\/th>\r\n<td style=\"width: 33.3333%; height: 30px;\">$600.00<\/td>\r\n<td style=\"width: 33.3333%; height: 30px;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Depreciation of equipment (not relevant)<\/th>\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Allocation of fixed overhead (not relevant)<\/th>\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Cost of buying<\/th>\r\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\r\n<td style=\"width: 33.3333%; height: 15px;\">$10,000.00<\/td>\r\n<\/tr>\r\n<tr style=\"height: 15px;\">\r\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Total cost<\/th>\r\n<td style=\"width: 33.3333%; height: 15px;\">$9,600.00<\/td>\r\n<td style=\"width: 33.3333%; height: 15px;\">$10,000.00<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nSo if the space we would use to make the soles is sitting idle right now, then, this analysis would suggest we should start to make the soles in house, right?\r\n\r\nBut what if the space used to make the soles, could also be used to expand to add another line of shoes? And what if, that additional line of shoes would add $5000 to the net income of the company?\r\n<table style=\"border-collapse: collapse; width: 100%;\" border=\"1\">\r\n<tfoot>\r\n<tr>\r\n<th style=\"width: 33.3333%;\" scope=\"row\">Difference in FAVOR of continuing to buy from the supplier<\/th>\r\n<td style=\"width: 33.3333%;\"><\/td>\r\n<td style=\"width: 33.3333%;\">$4,600<\/td>\r\n<\/tr>\r\n<\/tfoot>\r\n<tbody>\r\n<tr>\r\n<td style=\"width: 33.3333%;\"><\/td>\r\n<th style=\"width: 33.3333%;\" scope=\"col\">Make<\/th>\r\n<th style=\"width: 33.3333%;\" scope=\"col\">Buy<\/th>\r\n<\/tr>\r\n<tr>\r\n<th style=\"width: 33.3333%;\" scope=\"row\">Total annual cost<\/th>\r\n<td style=\"width: 33.3333%;\">$9,600.00<\/td>\r\n<td style=\"width: 33.3333%;\">$10,000.00<\/td>\r\n<\/tr>\r\n<tr>\r\n<th style=\"width: 33.3333%;\" scope=\"row\">Opportunity Cost-Additional Shoe Line<\/th>\r\n<td style=\"width: 33.3333%;\">$5,000.00<\/td>\r\n<td style=\"width: 33.3333%;\"><\/td>\r\n<\/tr>\r\n<tr>\r\n<th style=\"width: 33.3333%;\" scope=\"row\">Total Cost<\/th>\r\n<td style=\"width: 33.3333%;\">$14,600.00<\/td>\r\n<td style=\"width: 33.3333%;\">$10,000.00<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nSo did that change the plan? Yes\u2014Hupana would be better off adding a shoe line, and continuing to purchase their soles from their supplier!\r\n\r\nThis opportunity cost would be <strong>lost<\/strong> if they decided to make the soles in-house. Remember, they already own the equipment to make them, but that is a sunk cost, as there is no way to recoup that cost anyway.\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Questions<\/h3>\r\nhttps:\/\/assess.lumenlearning.com\/practice\/eb761f95-ed1e-473f-9592-48b97e330a96\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Identify opportunity costs<\/li>\n<\/ul>\n<\/div>\n<p>What is an opportunity cost?<\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/plugin.3playmedia.com\/show?mf=4309242&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=TNxg1auV2AM&amp;video_target=tpm-plugin-ziyiqmug-TNxg1auV2AM\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe><\/p>\n<p>You have a part-time job while you are attending school. It is spring break and you would <strong>love<\/strong> to take a week off and lay on the beach and not do anything! However, if you take the week off, you won\u2019t get a paycheck. So what is the cost of taking that week off?<\/p>\n<p>The loss of wages for that week is called an opportunity cost. It is the cost of what is lost if one decision is made over another. These costs won\u2019t show up anywhere in your accounting records, but as a manager, you need to be very aware of the missed opportunities for decisions you make!<\/p>\n<p>Take a look at this example:<\/p>\n<p><iframe loading=\"lazy\" id=\"oembed-1\" title=\"Opportunity Cost\" width=\"500\" height=\"281\" src=\"https:\/\/www.youtube.com\/embed\/pkEiHZAtoro?feature=oembed&#38;rel=0\" frameborder=\"0\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>Investopedia defines\u00a0<strong>opportunity cost<\/strong> as follows:<\/p>\n<blockquote><p>Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made.<a class=\"footnote\" title=\"https:\/\/www.investopedia.com\/terms\/o\/opportunitycost.asp\" id=\"return-footnote-571-1\" href=\"#footnote-571-1\" aria-label=\"Footnote 1\"><sup class=\"footnote\">[1]<\/sup><\/a><\/p><\/blockquote>\n<p>Although that definition relates to opportunity costs in investing, in the business operations, it has a similar meaning. \u00a0We can talk about opportunity costs when we think about making a component needed for our product as opposed to buying it from a supplier already made. Let\u2019s look at an example:<\/p>\n<p>Hupana currently buys the soles that go on their awesome running shoes from a supplier premade and ready to attach to their shoes. The supplier is charging $5.00 per sole. Hupana wants to look at the option of making the soles in house, because they have some empty space in their building, that would be a perfect fit for the equipment needed to make the soles. Just to make this simple, let\u2019s assume Hupana already owns the equipment to make the soles.<\/p>\n<p>We know that Hupana makes 2,000 pairs of shoes per year. So they pay their supplier $10,000 for the premade soles.<\/p>\n<p>Let\u2019s take a look.<\/p>\n<table style=\"border-collapse: collapse; width: 100%;\">\n<tfoot>\n<tr style=\"height: 15px;\">\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Difference in favor of MAKING<\/th>\n<td style=\"width: 33.3333%; height: 15px;\">$400<\/td>\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<\/tr>\n<\/tfoot>\n<thead>\n<tr>\n<th style=\"width: 33.3333%;\" colspan=\"3\">Hupana Make or Buy Decision<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr style=\"height: 15px;\">\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"col\">Relevant Costs:\u00a0Make<\/th>\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"col\">Relevant Costs:\u00a0Buy<\/th>\n<\/tr>\n<tr style=\"height: 30px;\">\n<th style=\"width: 33.3333%; height: 30px;\" scope=\"row\">Direct Materials ($2.50 per sole \u00d7 2000 soles)<\/th>\n<td style=\"width: 33.3333%; height: 30px;\">$5,000.00<\/td>\n<td style=\"width: 33.3333%; height: 30px;\"><\/td>\n<\/tr>\n<tr>\n<th style=\"width: 33.3333%;\">Direct Labor (.1hr\/sole at $20\/hour)<\/th>\n<td style=\"width: 33.3333%;\">$4,000.00<\/td>\n<td style=\"width: 33.3333%;\"><\/td>\n<\/tr>\n<tr style=\"height: 30px;\">\n<th style=\"width: 33.3333%; height: 30px;\" scope=\"row\">Variable Overhead (.1hr\/sole at $3\/hour x 2000 soles)<\/th>\n<td style=\"width: 33.3333%; height: 30px;\">$600.00<\/td>\n<td style=\"width: 33.3333%; height: 30px;\"><\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Depreciation of equipment (not relevant)<\/th>\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Allocation of fixed overhead (not relevant)<\/th>\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Cost of buying<\/th>\n<td style=\"width: 33.3333%; height: 15px;\"><\/td>\n<td style=\"width: 33.3333%; height: 15px;\">$10,000.00<\/td>\n<\/tr>\n<tr style=\"height: 15px;\">\n<th style=\"width: 33.3333%; height: 15px;\" scope=\"row\">Total cost<\/th>\n<td style=\"width: 33.3333%; height: 15px;\">$9,600.00<\/td>\n<td style=\"width: 33.3333%; height: 15px;\">$10,000.00<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>So if the space we would use to make the soles is sitting idle right now, then, this analysis would suggest we should start to make the soles in house, right?<\/p>\n<p>But what if the space used to make the soles, could also be used to expand to add another line of shoes? And what if, that additional line of shoes would add $5000 to the net income of the company?<\/p>\n<table style=\"border-collapse: collapse; width: 100%;\">\n<tfoot>\n<tr>\n<th style=\"width: 33.3333%;\" scope=\"row\">Difference in FAVOR of continuing to buy from the supplier<\/th>\n<td style=\"width: 33.3333%;\"><\/td>\n<td style=\"width: 33.3333%;\">$4,600<\/td>\n<\/tr>\n<\/tfoot>\n<tbody>\n<tr>\n<td style=\"width: 33.3333%;\"><\/td>\n<th style=\"width: 33.3333%;\" scope=\"col\">Make<\/th>\n<th style=\"width: 33.3333%;\" scope=\"col\">Buy<\/th>\n<\/tr>\n<tr>\n<th style=\"width: 33.3333%;\" scope=\"row\">Total annual cost<\/th>\n<td style=\"width: 33.3333%;\">$9,600.00<\/td>\n<td style=\"width: 33.3333%;\">$10,000.00<\/td>\n<\/tr>\n<tr>\n<th style=\"width: 33.3333%;\" scope=\"row\">Opportunity Cost-Additional Shoe Line<\/th>\n<td style=\"width: 33.3333%;\">$5,000.00<\/td>\n<td style=\"width: 33.3333%;\"><\/td>\n<\/tr>\n<tr>\n<th style=\"width: 33.3333%;\" scope=\"row\">Total Cost<\/th>\n<td style=\"width: 33.3333%;\">$14,600.00<\/td>\n<td style=\"width: 33.3333%;\">$10,000.00<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>So did that change the plan? Yes\u2014Hupana would be better off adding a shoe line, and continuing to purchase their soles from their supplier!<\/p>\n<p>This opportunity cost would be <strong>lost<\/strong> if they decided to make the soles in-house. Remember, they already own the equipment to make them, but that is a sunk cost, as there is no way to recoup that cost anyway.<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Questions<\/h3>\n<p>\t<iframe id=\"assessment_practice_eb761f95-ed1e-473f-9592-48b97e330a96\" class=\"resizable\" src=\"https:\/\/assess.lumenlearning.com\/practice\/eb761f95-ed1e-473f-9592-48b97e330a96?iframe_resize_id=assessment_practice_id_eb761f95-ed1e-473f-9592-48b97e330a96\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:300px;\"><br \/>\n\t<\/iframe>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-571\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Opportunity Costs. <strong>Authored by<\/strong>: Freedom Learning Group. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">All rights reserved content<\/div><ul class=\"citation-list\"><li>Opportunity Costs (the Price of Missed Opportunities) Explained in One Minute. <strong>Authored by<\/strong>: One Minute Economics. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/www.youtube.com\/watch?v=TNxg1auV2AM&#038;feature=youtu.be\">https:\/\/www.youtube.com\/watch?v=TNxg1auV2AM&#038;feature=youtu.be<\/a>. <strong>License<\/strong>: <em>All Rights Reserved<\/em>. <strong>License Terms<\/strong>: Standard YouTube License<\/li><li>Opportunity Cost. <strong>Authored by<\/strong>: Khan Academy. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/www.youtube.com\/watch?v=pkEiHZAtoro&#038;feature=youtu.be\">https:\/\/www.youtube.com\/watch?v=pkEiHZAtoro&#038;feature=youtu.be<\/a>. <strong>License<\/strong>: <em>All Rights Reserved<\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section><hr class=\"before-footnotes clear\" \/><div class=\"footnotes\"><ol><li id=\"footnote-571-1\">https:\/\/www.investopedia.com\/terms\/o\/opportunitycost.asp <a href=\"#return-footnote-571-1\" class=\"return-footnote\" aria-label=\"Return to footnote 1\">&crarr;<\/a><\/li><\/ol><\/div>","protected":false},"author":62559,"menu_order":6,"template":"","meta":{"_candela_citation":"[{\"type\":\"copyrighted_video\",\"description\":\"Opportunity Costs (the Price of Missed Opportunities) Explained in One Minute\",\"author\":\"One Minute Economics\",\"organization\":\"\",\"url\":\"https:\/\/www.youtube.com\/watch?v=TNxg1auV2AM&feature=youtu.be\",\"project\":\"\",\"license\":\"arr\",\"license_terms\":\"Standard YouTube License\"},{\"type\":\"original\",\"description\":\"Opportunity Costs\",\"author\":\"Freedom Learning Group\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"copyrighted_video\",\"description\":\"Opportunity Cost\",\"author\":\"Khan Academy\",\"organization\":\"\",\"url\":\"https:\/\/www.youtube.com\/watch?v=pkEiHZAtoro&feature=youtu.be\",\"project\":\"\",\"license\":\"arr\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"b84d3e86-94a4-4665-be79-c010cf40ec9d, 500ce7d6-6a65-4e0d-942f-94bcbb2ea060","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-571","chapter","type-chapter","status-publish","hentry"],"part":110,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/571","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/users\/62559"}],"version-history":[{"count":14,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/571\/revisions"}],"predecessor-version":[{"id":4143,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/571\/revisions\/4143"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/parts\/110"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/571\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/media?parent=571"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapter-type?post=571"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/contributor?post=571"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/license?post=571"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}