Chapter 3: Relevant Cost Analysis Flashcards
Costs
Resources sacrificed to achieve a specific objective, such as manufacturing a particular product, or providing a client a service.
Different from expenses!
Sunk Costs
Cost that were incurred in the past. These are irrelevant for decisions, as they cannot be changed.
Opportunity Cost
The profit forgone by selecting one alternative over another. The net return that could be realized if a resource were put to it’s next best use. Sometimes difficult to quantify.
However: sometimes referral to the profit forgone from the next best alternative. Sometimes to the difference between the profit from the action taken and profit forgone from next best alternative.
When defined as the difference in profits then the opportunity cost can be positive or negative. Option with a negative opportunity cost is the better option.
Relevant Costs
Costs that are relevant with respect to a particular decision. A cost that changes if an alternative course of action is taken.
Sunk Costs and committed costs are not relevant.
The matching principal can obscure relevant costs. Ex: depreciation costs included in CoGS is not relevant (except for tax purposes).
Cost classifications
- According to the value chain
- According to division or business segment
- By geographic location
Value Chain
Chronological sequence of activities that adds value to a company
Committed costs
Costs that will occur in the future, but that cannot be changed. Essentially a sunk cost. (Not decision-relevant)
Excess Capacity
When new clients/sales/orders can be accomidateen without displacing current clients/sales/orders.
Typically no opportunity costs for new clients/sales etc…in this situation
Capacity constraint
When a new client/sales/order will displace existing clients/sales/orders.
Requires consideration of opportunity costs.
