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    Relevant Costs For Decision Making

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    Mae Tndn
    1. Managers must make decisions that consider how alternatives impact operating income. Relevant information includes future expected costs and revenues that differ between alternatives. 2. A relevant cost is one that affects which alternative a manager selects. Sunk costs that cannot be avoided are never relevant. 3. The decision making process involves determining all costs for each alternative, removing sunk and identical costs, and choosing based on remaining relevant costs. Long-run factors like customer and competitor impacts must also be considered.

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    Relevant Costs For Decision Making

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    Mae Tndn
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    1. Managers must make decisions that consider how alternatives impact operating income. Relevant information includes future expected costs and revenues that differ between alternatives. 2. A relevant cost is one that affects which alternative a manager selects. Sunk costs that cannot be avoided are never relevant. 3. The decision making process involves determining all costs for each alternative, removing sunk and identical costs, and choosing based on remaining relevant costs. Long-run factors like customer and competitor impacts must also be considered.

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    1. Managers must make decisions that consider how alternatives impact operating income. Relevant information includes future expected costs and revenues that differ between alternatives. 2. A relevant cost is one that affects which alternative a manager selects. Sunk costs that cannot be avoided are never relevant. 3. The decision making process involves determining all costs for each alternative, removing sunk and identical costs, and choosing based on remaining relevant costs. Long-run factors like customer and competitor impacts must also be considered.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    124 views4 pages

    Relevant Costs For Decision Making

    Uploaded by

    Mae Tndn
    1. Managers must make decisions that consider how alternatives impact operating income. Relevant information includes future expected costs and revenues that differ between alternatives. 2. A relevant cost is one that affects which alternative a manager selects. Sunk costs that cannot be avoided are never relevant. 3. The decision making process involves determining all costs for each alternative, removing sunk and identical costs, and choosing based on remaining relevant costs. Long-run factors like customer and competitor impacts must also be considered.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 4

    MGMTACT – Prelims Relevant Costing

    Relevant Costs for Decision Making


    Management Accounting (2017 edition) E.B. Cabrera

    Managers should continually make decisions. In settling on these choices, they must gauge how
    every choice could influence operating income. The management accountant’s part in this
    procedure is to supply data on changes in expenses and incomes to encourage the decision
    making process.

    Relevant information is the expected future data that differ among alternative courses of
    action. In decision making, income and expenses are regularly the key elements. These incomes
    and expenses of one option must be looked at against incomes and expenses of different choices
    as one stage in the decision making process.

    A relevant cost can be defined as a cost that is applicable to a particular decision in the
    sense that it will have a bearing on which alternative the manager selects.

    The Decision Making Process

    Decision making is the process of studying and evaluating two or more available alternatives
    leading to a final choice.

    An organized and systematic approach may be helpful to managers in making decisions. The
    steps are outlined as follows:

    1. Define strategies: business goals and tactics to achieve them


    2. Identify the alternative choices or courses of action
    3. Collect and analyze the relevant data on the choices
    4. Choose the best alternative to achieve goals

    Identifying Relevant Costs

    Any cost that is avoidable is relevant for decision purposes. All costs are considered avoidable
    except:
    1. Sunk costs
    2. Future costs that do not differ between the alternatives at hand

    Relevant costs are future expected costs which differ between the decision alternatives.

    Decision making process involves the following analytical steps:


    1. Determine all costs associated with each alternative being considered
    2. Drop those costs that are sunk or historical
    3. Drop those costs that do not differ between alternatives
    4. Make a decision based on the remaining costs
    MGMTACT – Prelims Relevant Costing

    Sunk or historical costs are never relevant in decisions because they are not avoidable and
    therefore they must be eliminated from the manager’s decision framework.

    Opportunity costs are the profits lost by the diversion of an input factor from one use to
    another. They are the net economic benefit given up when an alternative is rejected.

    Out-of-pocket costs involve either an intermediate or near-future cash outlay; they are usually
    relevant to decisions.

    Short Run vs. Long Run: Other Factors to Consider

    In making the final decision, however, long-run factors should be such as:

    1. What will be the impact on customers?


    2. Should regular customers find out about the special price? Will they complain at paying
    more?
    3. How will competitors react?

    Types of Decisions

    1. Make or Buy
    2. Add or Drop a Product or Other Segments
    3. Sell Now or Process Further
    4. Special Sales Pricing
    5. Utilization of Scarce Resources
    6. Shut-down or Continue Operations
    7. Pricing

    Make or Buy Decision

    The make-or-buy decision is a management decision about whether an item should be


    made internally or bought from an outside supplier.

    Adding or Dropping Products/Segments

    When management is considering dropping a product line or customer group, the only
    relevant costs are those that a company would avoid by dropping the product or customer.

    Sell Now or Process Further

    Joint product costs is used to describe those manufacturing costs that are incurring is
    producing the joint products up to the split-off point. The split-off point is that point in the
    manufacturing process at which the joint product can be recognized as separate products.

    Special Sales Pricing


    MGMTACT – Prelims Relevant Costing

    A special order is a one-time order that is not considered part of the company’s ongoing
    business.

    Utilization of Scarce Resources

    When capacity becomes pressed because of a scarce resource, the firm is said to have a
    constraint. Because of the constrained scarce resource, the company cannot fully satisfy demand,
    so the manager must decide how the scarce resource should be used.

    Contribution in Relation to Scarce Resources

    A firm should not necessarily promote those products that have the highest contribution
    margins per unit. With a single constrained resource, the important measure of profitability is the
    contribution margin per unit of scarce resource used.

    Shut down or Continue Operations

    Shut down point = Fixed costs if operations are continued – Shut Down Costs
    Contribution Margin per unit
    Pricing Products and Services

    In many situations, the firm is faced with the problem of selling its own prices. The
    pricing decision can be critical because
    1. The prices charged for a firm’s products largely determine the quantities customers are
    willing to purchase and
    2. The prices should be high enough to cover all the costs of the firm

    Cost-Plus Pricing

    Target Selling Price = [ Cost + (Mark-up Percentage x Cost) ]

    Products may be cost in at least two different ways:

    1. By the absorption approach where the cost base is defined as the cost to manufacture one
    unit and therefore excludes all selling general and administrative expenses
    2. By the contribution approach where cost base consists of all the variable costs associated
    with a product including variable selling, general and administrative expenses (SGA).

    Determining the Markup Percentage

    Under the absorption approach to cost-plus pricing:

    Markup percentage = Desired return on assets employed – SGA Expenses


    Volume in units x Unit Manufacturing Costs

    Under the contribution approach to cost-plus pricing:


    MGMTACT – Prelims Relevant Costing

    Markup percentage = Desired return on assets employed – Fixed Costs


    Volume in units x Unit Variable Costs
    Target Costing

    Target Costing is the process of determining the maximum allowable cost for a new
    product and then developing a sample than can be profitably manufactured and distributed for
    that maximum target cost figure.

    Target cost = Anticipated Selling Price – Desired Profit

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