🔹 1. Identifying Relevant Costs and Benefits
- Relevant Costs:
Future costs that differ among alternatives.
- Irrelevant Costs:
Past (sunk) costs or costs that do not change with the decision.
Example:
You’re considering replacing an old machine.
|
Item |
Amount |
|
Cost of new machine |
$50,000 |
|
Trade-in value of old machine |
$5,000 |
|
Sunk cost of old machine |
Ignored |
Only the cost of the new machine and
trade-in value are relevant.
🔹 2. Different Costs for Different Purposes
- Decision:
Special order, outsourcing, discontinuation, etc.
- Costs considered:
Variable, opportunity, avoidable fixed, etc.
Example: In pricing, variable costs are relevant; in make-or-buy,
avoidable fixed costs matter.
🔹 3. Reconciling the Total and Differential Approaches
- Total approach:
Compares total future cash flows.
- Differential approach:
Focuses only on differences.
Example:
Option A yields $10,000 more in future cash flows than Option B. Only the $10,000
difference matters.
🔹 4. Why Isolate Relevant Costs?
- Prevents decision bias.
- Avoids sunk cost fallacy.
- Focuses analysis on meaningful data.
🔹 5. Adding or Dropping Product Lines and Segments
Illustration:
|
Segment |
Sales |
VC |
Traceable
FC |
Segment
Margin |
|
A |
$100k |
$40k |
$30k |
$30k |
If Segment A’s contribution is
positive after removing traceable fixed costs, keep it.
🔹 6. Comparative Format
Used to show net
advantage/disadvantage.
Example:
|
Decision |
Keep |
Drop |
|
CM |
$50k |
$0 |
|
FC Saved |
$0 |
$20k |
|
Net |
$50k |
$20k → Drop not advised |
🔹 7. Beware of Allocated Fixed Costs
Allocated overhead can distort
decision-making. Only avoidable fixed costs are relevant.
⚙️
The Make or Buy Decision
🔹 8. Make or Buy
Example:
|
Cost
Element |
Make |
Buy |
|
Direct Material |
$10 |
— |
|
Direct Labor |
$6 |
— |
|
Variable Overhead |
$4 |
— |
|
Purchase Price |
— |
$22 |
|
Avoidable FC |
$0 |
$0 |
|
Total |
$20 |
$22 → Make preferred |
🔹 9. Opportunity Cost
If using resources internally means
missing better use, the lost benefit is an opportunity cost.
Example: Internal use of a machine saves $2,000 but prevents $3,000
of outside use. Net = –$1,000.
🧾
Special Orders
🔹 10. Special Orders
Example:
Normal cost: $20/unit, Selling
price: $30
Special order: 1,000 units at $22
If fixed costs are covered and capacity
exists, accept if:
- Special price > variable cost
- Profit > 0
🔧 Utilization of Constrained Resource
🔹 11. Contribution Margin per Unit of Constraint
Example:
|
Product |
CM/unit |
Machine
hours/unit |
CM/hour |
|
A |
$10 |
2 |
$5 |
|
B |
$12 |
4 |
$3 |
Choose Product A to maximize constrained resource.
🔹 12. Managing Constraints
- Shift demand to products with higher CM/resource.
- Improve efficiency or buy more capacity.
🔹 13. Multiple Constraints
Use Linear Programming or
prioritization by CM/unit of constraint.
🧪
Joint Product Costs and the Contribution Approach
🔹 14. Sell or Process Further
Example:
|
Item |
Product
A |
|
Split-off Value |
$10,000 |
|
Further Processing Cost |
$3,000 |
|
Final Value |
$14,000 |
|
Net Benefit |
$1,000 → Process Further |
Ignore joint costs—they're sunk.
✅
Summary Table of Key Decisions and Numerical Approaches
|
Decision
Type |
Relevant
Data |
Method |
Key
Formula |
|
Add/Drop Segment |
Segment Margin |
Comparative |
CM – Traceable FC |
|
Make or Buy |
Variable Cost, Price |
Differential |
Compare Total Relevant Costs |
|
Special Order |
Variable Cost, FC |
Contribution |
SP – VC > 0 |
|
Constrained Resource |
CM per Constraint |
Ranking |
CM ÷ Constraint |
|
Joint Products |
Incremental Revenue |
Process Further |
Revenue – Processing Cost |
Here are comma-separated hashtags for a lecture on relevant costing:
#RelevantCosting, #ManagerialAccounting, #DecisionMaking, #CostAnalysis, #AccountingLecture, #RelevantCosts, #IrrelevantCosts, #AvoidableCosts, #SunkCosts, #IncrementalCosts, #OpportunityCost, #BusinessDecisions, #MakeOrBuy, #SpecialOrderDecisions, #ConstrainedResources, #FinancialEducation, #CostAccounting, #ManagementAccounting, #AccountingStudents
0 Comments