Chapter 9 - Short Term Decision Making Flashcards
What are avoidable or discretionary fixed costs
These are the specific fixed costs of an activity or sector of a business which would be avoided if that activity or sector did not exist. These costs are usually associated with decisions as to whether or not to shut down a sector. If we were to shut down a sector that any contribution from the area would be lost but any avoidable fixed costs on that area would be saved.
Note that’s not all fix costs are avoidable by shutting down an area for example then maybe head office fix costs that we made payable in full even if one sector of the business were too close
What are sunk costs
These are costs that have already been incurred they are irrelevant for decision-making. The reason for this is that in any decision we will be concerned with whether or not the future benefit from the decision will outweigh the future costs and any costs already incurred will remain payable whatever decision we make
What are relevant costs
A relevant cost simply a cost that is relevant to the decision being made. A sunk cost is not a relevant cost for the reason already stated
What are opportunity costs
This is the value of a benefit sacrifice when one course of action is taken in preference to an alternative.
For example one factor that might be involved in deciding whether or not to launch a new product could be that sales of another existing product may fail. If as a result we would lose let’s say $20,000 of existing contribution for the purpose of making the decision about the new product we would consider the $20,000 as being cost of the new product. (The new product will only be worthwhile if the revenue from its covers not only any direct costs of production but also the $20,000 that we would be losing)
What are incremental costs
Incremental means extra or additional and these are any costs which would be incurred as a result of a decision and will therefore be relevant to the decision
What is a committed cost
A committed cost is one that is not yet paid but will have to pay whether or not we do the contract
What costs are relevance and irrelevance
Opportunity costs and incremental costs are relevance remember opportunity costs are the lost contribution from doing the new contract and incremental costs are the extra costs that we will need to pay.
Sunk costs are irrelevant because they have already been paid Out As well as committed costs they are also irrelevant because regardless of whether we take up the contract they are costs that we will need to pay
What are make or buy decisions
In order to overcome problems of limited resource if are made by in a product instead of making it itself.
Where incremental costs of manufacture are less than those of mine in the firm should make, assuming that there are no limited resources
Where resources are limited the firm should concentrate on making those products which gives the greatest savings over buying in per unit of the scarce resource
To decide whether a product should be made and which should be bought we calculate the saving per unit of the scarce resource for making the product rather than buying it in
