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Cost-Benefit Analysis

Horngren, Charles T., Foster, George, and Datar, Srikant M. Costs are the outlays or expenditures made in order
(2005). Cost Accounting: A Managerial Emphasis (12th ed.). to obtain a benefit. Many costs are measured monetarily,
Upper Saddle River, NJ: PrenticeHall. such as the cost of buying a new machine or of hiring an
Ijiri, Yuji (1975). Theory of Accounting Measurement. Sarasota, additional employee.
FL: American Accounting Association.
Kaplan, Robert S., and Atkinson, Anthony A. (1998). Advanced
Management Accounting (3rd ed.). Upper Saddle River, NJ: COST-BENEFIT ANALYSIS IN
BUSINESS
PrenticeHall.
Willson, James D., Colford, James P., Roehl-Anderson, Janice A cost-benefit analysis is straightforward when all costs
M., and Bragg, Steven M. (1999). Controllership: The Work of and benefits are measurable in monetary terms. Assume
the Managerial Accountant. New York: J. Wiley. that Company A must decide whether to rent an ice
cream machine for the summer for $900. The ice cream
machine will produce additional cash inflows of $1,000
Lawrence A. Klein during the summer. The benefit of additional cash inflows
Clifford Brown
($1,000) exceeds the additional cost ($900), so the proj-
ect should be undertaken. Not all cost-benefit analyses are
this simple, however. If the benefits and costs occur in dif-
ferent time periods, it may be necessary to discount the
COST-BENEFIT future cash flows to their current equivalent worth.
ANALYSIS In another example, cost savings is a benefit. Assume
Cost-benefit analysis is used for determining which alter- that Company B makes about 100,000 photocopies a
native is likely to provide the greatest return for a pro- year. Company B does not have its own copy machine and
posed investment. Sometimes referred to as currently pays 4 cents per copy, or $4,000 a year, to Copy-
cost-effectiveness analysis, it is relevant to businesses as cat Copiers. Company B can lease a copy machine for
well as to not-for-profit entities and governmental units. $2,500 a year. It must also pay 2 cents per page for paper
for the leased machine, or $2,000. In this example, the
A business might find it helpful to use cost-benefit
cost of leasing the machine and buying paper
analysis to determine if additional funds should be
($2,500+$2,000=$4,500) exceeds the benefit of saving
invested in a facility in the home country or in another
the $4,000 normally paid to Copycat Copiers. Company
country. A community not-for-profit organization that
B should continue to use Copycat Copiers for its photo-
provides a variety of programs for children might use cost-
copies. However, Company B must have a pretty good
benefit analysis to assist management in determining
estimate of the number of copies it needs to be comfort-
which activities will provide the most services for the costs
able with its decision. If Company B needs 150,000
specified. A federal governmental agency might use cost- copies this year instead of 100,000, the cost of the leasing
benefit analysis to determine which of several projects the machine and buying paper ($2,500+$3,000=$5,500)
planned for the national parks is likely to be most used by is cheaper than the $6,000 (150,000¥$0.04) savings in
interested citizens, given the costs.
fees to Copycat Copiers.
Because resources such as money and time are lim- A third example involves a project with benefits that
ited, an organization usually cannot undertake every proj- are difficult to quantify. Assume that Company C is
ect proposed. To decide whether to undertake a project, deciding whether to give a picnic costing $50,000 for its
decision makers weigh the benefits from the project employees. Company C would receive the benefit of
against the cost of the resources it requires, normally increased employee morale from the picnic. Better
approving a project when its benefits exceed its costs. employee morale might cause employees to work harder,
Cost-benefit analysis provides the structure and support increasing profits. However, the link between increased
for making such decisions. morale and increased monetary profits is tenuous. The
Benefits increase the welfare of the organization. decision maker must use his or her judgment to compare
Some benefits are monetary benefits, such as the dollar the nonmonetary benefit to the monetary cost, possibly
amount of cash inflows from additional sales of a product deciding that increased employee morale is worth the
or the saving in cash outflows that a project enables. $50,000 cost but would not be worth a $100,000 cost.
Other benefits are important but harder to quantify. For In the preceding examples, cost-benefit analysis pro-
example, a project may increase customer satisfaction; vided a framework for decision making. The range of
increased customer satisfaction may increase future sales, objectivity related to measurement of the factors is typical.
but the exact relationship between sales and satisfaction is Techniques used in business as a basis for determining
often hard to specify. costs and benefits, such as return on investment, are gen-

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