Chapter8: Relevant costing Flashcards
What are relevant costs?
Future incremental cash flows & opportunity costs as a result of a decision
= the cash position if accept proposal - cash position if reject proposal (and choose next best alternative instead)
What does future mean?
only cash flows from a decision
Sunk costs (past costs) aren’t relevant
What does incremental mean
only extra cash flows from the decision are considered
Fixed costs ignored (unless there’s an incremental FC from the decision)
Committed costs (unavoidable future costs) = ignored
INCLUDE OPPORTUNITY COSTS- look at next best alternative use of resource
What is an irrelevant cost
Depreciation, sunk cost, apportioned fixed OH, financing cash flow e.g interest
What is an opportunity cost
value of next best alternative (in the past) when a particular course of action is taken
Relevant cost of materials
1) In stock or out of stock
out of stock= relevant cost (current purchase price)
2) In stock- regular use and replaced? or will not be replaced?
Will be replaced= Relevant cost (current purchase price)
Not replaced= relevant cost = opportunity cost e.g lost scrap value / lost contribution if use material here instead of elsewhere
3) If not replaced- are there alternative uses of material?
No= relevant cost= scrap/ disposal value
Yes= relevant cost= higher value in other use or scrap value
What happens if a material is in short supply
To accept that proposal would have to deny another part of the organisation that resource
Relevant cost= normal material cost + lost contribution in other department
What are the relevant costs of labour
1) Is there spare capacity or full capacity?
Spare= relevant cost= 0 (use the space reduce slack)
2) Full - hire more labour?
Yes- relevant cost= extra cost of labour e.g OT, more staff
No- relevant cost= opportunity cost of diverting labour i.e lost contribution and extra labour cost
What are the relevant costs of non - current assets ?
1) New or existing asset?
New: relevant cash flows= Purchase price/ scrap or disposal proceeds
Existing asset: relevant cost= opportunity cost- Higher of either sales proceeds or lost contribution from use in other department
What items are not relevant?
1) Depreciation
2) Profit/ loss on disposal incorporates accumulated depreciation - look at cash element only i.e scrap proceed
3) Original purchase price of existing machinery = sunk cost
4) carrying value of existing machinery= combination of original price (sunk) and accumulated depreciation (not a cash flow)
What is the minimum contract price in a one-off contract
Total net relevant cash flow associated with the contract
Comments on the minimum contract price
1) min price = break-even point
2) If contract price doesn’t cover cash flows= rejected
3) Any price higher than min= company better to accept than reject proposal
Further considerations of the minimum contract price for one off contracts
1) Price can be acceptable for 1 off contract not all contracts
2) Min price using relevant costing= lower than typical market prices- can be reluctant to accept this price if it might affect future contract prices e.g hearsay of customers demanding lower prices
3) Company may be willing to accept a loss on this contract if it increases chances of winning subsequent contracts
What is a make or buy decision
Whether a business should make components in house or buy from outside suppliers
What’s the difference between making or buying
Buy: resources brought in so purchase cost is wholly marginal (direct)
Make: direct materials & wages costs + variable factory OH
When is it uneconomic to make instead of buy
When the variable costs is greater than obtaining a similar components elsewhere
What are the 2 make vs buy decisions
1) Make or buy decisions with no limiting factors
2) Make or buy decisions with limiting factors
What is a make or buy decision with no limiting factors?
relevant costs are the differential costs between the 2 options
What is a make or buy decision with a limiting factor?
1) Calc saving per unit of each product.
Saving = purchases price- variable cost to make
2) Divide the saving by no of scarce resources each product uses = saving per unit of the limiting factor
3) rank products. 1st product to make= highest saving per unit
4) Scarce resource allocated to the product in order of priorities until used up
5) Products with unsatisfied demand can be satisfied from an external source
Other issues to consider in make vs buy
1) reliability of external supplier- meet quantity/ quality/ deliver on time/ price stability
2) Specialist skills- may not be available in house
3)Alternative use of resource- outsourcing frees up resources to be used elsewhere
4) social- does it reduce workforce? consider redundancy costs
5) legal- does it affect contractual obligations with suppliers/ employees
6) Confidentiality- risk of losing this if they provide similar work for rivals
7) Customer reaction- how they perceive products being made
Dyson examples of make vs buy:
originally said to only produce in UK to maintain competitiveness
Now produce more in Asia (cheaper)
Apple/ samsung example of make vs buy
R&D - outsource to Foxconn who manufacture
Relevant cost: cost of production
Not always a choice
w/o intellectual property apple has no value.
Foxconn has no advantage of stealing ideas as they are a manufacturer
Advantages of outsourcing
1) increased flexibility
2) Lower investment risk
3) Improved cash flow
4) concentrates on core competence
5) Enable more advanced technologies to be used without making investment- someone else takes the risk
Disadvantages of outsourcing
1) Possibility of choosing wrong supplier
2) Loss of visibility and control over process
3) Possibility of increased lead times
What are the quantifiable costs/ benefits of closure?
1) Lost contribution from the area being closed (= relevant cost of closing)
2) savings in specific FC from closure (=relevant benefit of closure), known penalties, other costs from the closure e.g redundancy, compensation to customers
3) Known reorganisation costs (= relevant costs of closure)
4) known additional contribution from the alternative use for resources released (= relevant benefit of closure)
What are the non-quantifiable costs/ benefits of closure?
1) penalties and other costs from closure e.g redundancy and customer compensation may be uncertain
2) Reorganisation costs may be uncertain
3) additional contribution from the alternative use for resources released may be uncertain
4) Knock on impact of shut down decision - e.g some stores sell products at a loss to entice into store where they buy further products at high margins
What are joint products
manufacturing 1 product inevitably results in the manufacturing of another product
Where individual profits start becoming profitable= split off point
joint costs= costs incurred before split off point and shared between the products
How to apportion joint costs
1) sales value of production ( aka market value)
2) production units
3) net realisable value
What to know about future processing decisions
aim: process further or sell after split-off only future incremental cash flow
Consider:
1) difference in revenue and extra costs
2) joint costs are sunk (not relevant) unless we’re considering the whole process (relevant)
