Domain IV − Financial Management - Section B.3 Relevant Costs for Decision Making

Question 1

Relevant costs

Answer 1

are those future costs that change as a result of taking a particular course of action. The key term in this definition is “future”. What will be incurred in the
future, not what was spent in the past, is what affects the decision to be made.

Question 2

Relevant revenues

Answer 2

are the future revenues that change among different courses of actions.

Question 3

Marginal cost

Answer 3

is the change in total costs when an additional unit is produced.

Question 4

Marginal revenue

Answer 4

is the change in total revenue when an additional unit is sold.

Question 5

Prime costs

Answer 5

are direct material and direct labor costs that are always directly associated with output. Prime costs are typically variable and thus relevant.

Question 6

Explicit cost

Answer 6

is an actual cost incurred by the company.

Question 7

Implicit cost

Answer 7

is an economic cost that is not explicitly incurred by the company but is considered in assessing the economic success or failure of a business such as an opportunity cost.

Question 8

Opportunity cost

Answer 8

is the cost of the missed alternative or the cost of the second best alternative. Opportunity cost refers to the benefits foregone as a result of selecting one course of action rather than another.

Question 9

Economic cost

Answer 9

refers to the sum of all explicit and implicit costs of a business.

Question 10

Relevant Costs

Answer 10

that should be taken into consideration are:

i. Incremental Costs are any additional costs that the company will incur as a result of the decision made.
ii. Avoidable Fixed Costs are the fixed costs that will be eliminated as a result of the decision made.
iii. Level of Operating Capacity could affect the company’s decision. If the product is to be outsourced, then capacity will increase since the machines that were used to produce it can now be used to produce another product.

Question 11

Irrelevant Costs

Answer 11

are the unavoidable (sunk) fixed costs that the company will continue to incur irrespective of the decision made.

Question 12

Responsibility accounting

Answer 12

refers to the practice of holding managers responsible for centers that are within their management. These centers may generally be divided to:

i. Cost Center – the manager of a cost center is only held responsible for controlling costs.
ii. Revenue Center – the manager of a revenue center is only held responsible for generating revenues.
iii. Profit Center – the manager of a profit center is held responsible for a target profit that involves both generating revenues and controlling costs.
iv. Investment Center – the manager is responsible for a target return on invested assets.