Ch. 10 - Relevant Costs and Benefits Flashcards
(TERM) What is incremental revenue? What is it considered?
It represents additional revenue one alternative generates over the other. It is considered a relevant benefit
What is differential revenue?
The difference in INCREMENTAL revenues between two alternatives
(TERM) What is “Revenue lost.” What is it considered
The decrease in revenue of one alternative compared to the other.
It is considered a relevant cost (and an opportunity cost)
What is opportunity cost?
The cost (or revenue lost) as a result of picking one alternative over the other.
(TERM) What happens if two alternatives generate the same revenue?
Revenue is not considered relevant to the analysis
(TERM) What does “incremental cost” represent?
It represents the additional cost one alternative incurs over the other.
They are considered a relevant cost.
Ex. $10k incurred for maintenance for watches, compared to $0 maintenance on rings
(TERM) What does “cost saving” represent
It represents the reduction in cost of one alternative compared to the other.
It is considered a relevant benefit (and an avoidable cost).
What happens if two alternatives incur the same costs?
Costs are not considered relevant to the analysis and are referred to as “unavoidable costs”
What are unavoidable costs?
Costs that are exactly the same under all available alternatives and are therefore not relevant to an analysis
What is a differential revenue/cost?
Difference in revenue/costs between two alternatives
What happens if the costs are same under both alternatives?
Then its irrelevant to the analysis
What are costs that have already been incurred referred to as? Are they relevant to the analysis?
They are referred to as sunk costs and are irrelevant to the analysis
What is an example of an unavoidable costs?
Costs that do not change regardless of whether you do an action or not. They must be paid.
What are the two steps in performing a relevant cost and benefit analysis?
- Eliminate irrelevant costs, including unavoidable and sunk costs, and those costs and benefits that are the same across all alternatives
- Make the decision based on an analysis of relevant costs and benefits remaining
How would you go about step 2 “Make the decision based on an analysis of the relevant costs and benefits remaining”?
By categorizing remaining relevant costs as incremental or avoidable.
What are examples of avoidable costs?
Costs that you will not have to pay.
For example, if you take a vacation, avoidable costs are:
- Groceries of $1k, since you wont be eating at home, you can avoid the full amt
- Gasoline $250, since you wont be driving, therefore avoiding full amt
How do you make your decision after performing a relevant cost and benefit analysis?
Look at the analysis. If the total relevant cost is below the budget/savings available, then that alternative can be funded without any shortfall.
keeping or dropping a product or business segment: What are relevant costs?
- CM lost on discontinued thing
What are relevant benefits related to keeping or dropping a product or business segment
- Fixed costs avoided
- Contribution margin gained on other products or segments,
Keep/drop a product/business segment: What is the formula that can summarize whether it should be continued or (discontinued)
CM lost - Fixed costs avoided + CM gained elsehwere = Continue/(Discontinue)
Choosing office locations: Relevant COSTS
-Incremental costs, including variable and fixed costs, based on each location
- Opportunity costs, including any potential foregone sales as a result of relocation
choosing office locations: relevant BENEFITS
- Incremental revenue resulting from new sales in the geographical territory of the new location
- Variable and fixed costs avoided if status quo location is closed/lease terminated
How is the decision made regarding choosing locations?
Whichever decision has the most incremental increase in operating income.
Special Order: Relevant COSTS
- Incremental costs, including variable and fixed costs, of accepting the order.
- Opportunity costs of accepting the order
