Chapter 10: Relevant Costs and Decision Making

Question 1

What are relevant costs and revenues?

Answer 1

Those costs and revenues that change as a direct result of a decision taken

Question 2

What are the characteristics of a relevant cost?

Answer 2

Future - we ignore sunk/historic costs
Incremental - we therefore ignore most fixed costs (unless they change because of the decision) and all committed costs
Cash Flows - we ignore accounting adjustments such as depreciation

Question 3

What is a sunk cost?

Answer 3

Expenditure that has already been incurred

Question 4

What is a committed cost?

Answer 4

Expenditure that will be incurred in the future, but as a result of decisions taken in the past that cannot now be changed

Question 5

What is a fixed cost?

Answer 5

Should be treated as a whole, and only where relevant. This means that fixed overheads that are ‘absorbed’ /’charged’ /’apportioned’ to a project should be ignored

Question 6

What is an opportunity cost?

Answer 6

The value of the benefit sacrificed when one course of action is chosen, in preference to an alternative. The opportunity costis represented by the foregone potential beefit from the best rejected course of action

Question 7

What is the relevant cost of materials if the material aren’t already in inventory?

Answer 7

Cost of purchase

Question 8

What is the relevant cost of material if the materials are in inventory and they will be replaced?

Answer 8

Replacement cost

Question 9

What is the relevant cost of materials if the material is in inventory, will not be replaced but will be used for other purposes?

Answer 9

Opportunity cost of alternative use

Question 10

What is the relevant cost of materials if the material is in inventory, will not be replaced but will not be used for other purposes?

Answer 10

Net realisable value

Question 11

What is the relevant cost of labour if there is no spare capacity?

Answer 11

Nil

Question 12

What is the relevant cost of labour if there is spare capacity?

Answer 12

Lower of:
Cost to hire labour
OR
Contribution foregone PLUS direct labour cost

Question 13

What financial factors should be considered when debating if we should discontinue?

Answer 13

The lost contribution from the area that is being closed
Savings in specific fixed costs from closure
Known penalties and other costs resulting from the closure
Any known reorganisation costs
Any known additional contribution from the alternative use for resources released.

Question 14

What are the non-financial factors to consider when deciding if we should discontinue?

Answer 14

Impact on staff
Customer reaction
Impact on the wider community
Company reputation

Question 15

What is a limiting factor?

Answer 15

Resource which prevents a company from achieving the output and sales that it would like to acheive

Question 16

If there is one limiting factor what is the rule?

Answer 16

Maximise the contribution per unit of a scarce resource

Question 17

How do you allocate the resources appropriately when we have a limiting factor.

Answer 17

Identify limiting factor
Calculate contribution per unit for each product
Calculate contribution per unit of the limiting factor for each product
Rank the products in order of contribution per limiting factor
Allocate resources using this ranking and answer the question

Question 18

What are the steps you need to take when deciding if we should make or buy with a limiting factor?

Answer 18

Saving per unit is calculated (saving = purchase price - VC to make
Divide this by the amount of scarce resource each product uses
Rank products
Once priorities have been decided, the scarce resource is allocated to the products in order of the priorities until it is fully used up.
Any products with unsatisfied demand can be satisfied by buying from the external source.

Question 19

What are the non financial factors to consider when deciding if to make or buy with a limiting factor?

Answer 19

Reliability of external supplier
Specialist skills
Impact on staff
Customer reaction