E4-relevant costs

Question 1

1. relevant costs

Answer 1

1. relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions/ change as a direct result of a decision taken.
2. management uses relevant costs in decision making, such as whether to close a business unit, whether to make or buy parts or labor and whether to accept a customer`s last minute or special orders.
3. we can calculate the total cost of the contract on a relevant cost basis and compare this to the price, if the order makes a profit on a relevant cost basis it should be accepted and , if not, it should be rejected.

Question 2

2. relevant cost

Answer 2

relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions/ change as a direct result of decision taken.
-they are future costs and revenue.
-they are incremental
-they are cash flow.
we need to consider the incremental costs which are the additional costs that will be incurred as a direct consequece of accepting the order.
the incremental costs will be the variable costs of the contract and any additional specific fixed costs incurred.

Question 2

2. relevant cost

Answer 2

relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions/ change as a direct result of decision taken.
-they are future costs and revenue.
-they are incremental
-they are cash flow.
we need to consider the incremental costs which are the additional costs that will be incurred as a direct consequece of accepting the order.
the incremental costs will be the variable costs of the contract and any additional specific fixed costs incurred.

Question 3

3. non-relevant cost

Answer 3

1. sunk costs-these are past costs or historical costs which are not relevant in decision making, for example development costs or market esearch costs which have already been paid.
2. committed costs- these are future costs that cannot be avoided, whatever decison is taken.
3. non-cash flows–these are costs which don`t involve the flow of cash.
4. net book values-these are not relevant costs because like depreciation, determined by accounting conventions rather than by future cash flows.
5. notional costs-these are costs that will not result in an outflow of cash either now or in the future, this cost will only appear in the accounts of the organization but will not result in a real cash expenditure.
6. general fixed overheads-these are usually not relevant to a decision.

Question 4

3. non-relevant cost

Answer 4

1. sunk costs-these are past costs or historical costs which are not relevant in decision making, for example development costs or market esearch costs which have already been paid.
2. committed costs- these are future costs that cannot be avoided, whatever decison is taken.
3. non-cash flows–these are costs which don`t involve the flow of cash.
4. net book values-these are not relevant costs because like depreciation, determined by accounting conventions rather than by future cash flows.
5. notional costs-these are costs that will not result in an outflow of cash either now or in the future, this cost will only appear in the accounts of the organization but will not result in a real cash expenditure.
6. general fixed overheads-these are usually not relevant to a decision.

Question 5

4. limitations of relevant costs

Answer 5

non financial / other factors
1. impact on our business:
-potential improvement of brand awareness;
-whether we have experience of doing this? if not, quality may sacrifice.
-whether we have resources (cash) of doing this?
-control system in place to make this tight
impact on employees (work overtime and impact on staff morale)
impact on customers (whether customers (dealers) feel fair when they see that our one-off price is low)

Question 6

5. one limiting factor decision

Answer 6

1. the analysis is done by comparing the contribution per unit of the limiting factor;
2. we could firstly calculate the contribution per unit of each product by taking selling price and minus its total variable costs.
3. we then divide the contribution per unit by the limiting factor.(apply to the unseen:in this case, we have a shortage of … which is limiting… each of our product guoups will require a different number of … and therefore we should maximise the contribution per … and not the contribution per unit. hence we can calculate the contribution per… by dividing the contribution per unit by the number of … required for each product group.
4. we would then need to rank the product groups on the basis of the contribution per limiting factor, the product group with the highest contribution per limiting factor would rank 1st and the product group with the second highest contribution per … would rank 2nd and so on.
5. we would then make the decision based on this ranking and the limiting factors available.

Question 7

6. limitations

Answer 7

1. the analysis is based on a single limiting factor, ie…, but if the business has more than one limiting factor such as labour hours, it may give a higher contribution per unit of labour hours and this may affect our decision.
2. the analysis is based on contributoin per unit of the limiting factor, but it may ignore the frequency of sales. this means that if an inventory which can be sold more often than others, although it has o lower contribution per unit of the limiting factor, it may be more profitable than other products.
3. customers may be upset if they can not buy certain products in our business simply because those products hace low contribution per unit of the limiting factor.
4. the analysis to calculate the contribution per unit is based on a group of items, further analysis should be done to identify the contribution and limiting factors for each individual product just based on an average figure.

Question 8

6. limitations

Answer 8

1. the analysis is based on a single limiting factor, ie…, but if the business has more than one limiting factor such as labour hours, it may give a higher contribution per unit of labour hours and this may affect our decision.
2. the analysis is based on contributoin per unit of the limiting factor, but it may ignore the frequency of sales. this means that if an inventory which can be sold more often than others, although it has o lower contribution per unit of the limiting factor, it may be more profitable than other products.
3. customers may be upset if they can not buy certain products in our business simply because those products hace low contribution per unit of the limiting factor.
4. the analysis to calculate the contribution per unit is based on a group of items, further analysis should be done to identify the contribution and limiting factors for each individual product just based on an average figure.

Question 8

6. limitations

Answer 8

1. the analysis is based on a single limiting factor, ie…, but if the business has more than one limiting factor such as labour hours, it may give a higher contribution per unit of labour hours and this may affect our decision.
2. the analysis is based on contributoin per unit of the limiting factor, but it may ignore the frequency of sales. this means that if an inventory which can be sold more often than others, although it has o lower contribution per unit of the limiting factor, it may be more profitable than other products.
3. customers may be upset if they can not buy certain products in our business simply because those products hace low contribution per unit of the limiting factor.
4. the analysis to calculate the contribution per unit is based on a group of items, further analysis should be done to identify the contribution and limiting factors for each individual product just based on an average figure.

Question 9

7. make or buy decision

Answer 9

1. a make or buy decision is a decision made by management on whether to make our products internally or buy them from the market.
2. from a financial perspective, the relevant costs of the decision are the incremental costs resulting from making or buying the products.
3. the incremental costs of buying in the products will be the purchase price of the supplier.
4. the incremental costs of making the products will narmally be the variable costs of production on the assumption that our fixed costs will remain unchanged whether the products are manufactured inthernally or purchased externally.
5. if there is no spare capacity for making the products, the costs of making the products should also include the opportunity cost which arises from the lost benefits by not producing another type of product.

Question 10

8. make or buy

other factors to consider

Answer 10

1. why is the supplier able to offer us such a low price?
2. whether the supplier is able to supply the products to the quality standards that we require.
3. whether the supplier is able to produce the products on time.
4. does the supplier adopt similar corporate and social responsibility principles as our company?
5. whether the supplier is financially stable.
6. whether the purchase price includes delivery costs. if the supplier is based overseas these could be considerable.
7. where is the supplier based? using an overseas supplier would also potentially expose us to currency fluctuaions depending on the currency used in the purchase agreement.

Question 11

9. discontinued8/ shut down decision

Answer 11

1. we would need to consider before decicing whether to discontinue this **, what costs are avoidable ,ie the cost that will be saved if the range is discontinued. and what costs are unavoidable and will be incurred wheter the range is discontinued or not.
2. we also need to consider any future costs and revenues arising as a direct consequence of the decision.
3. the general rule is that, as long as the ** makes a positive contribution towards general fixed overhead costs it is worth continuing with the **.
4. if the contribution lost as a result of discontinuing the product/segment is greater than the fixed costs saved from this decision, we should not discontinue with the 9**. and we should discontinue the ** if the contribution lost is less than the fixed costs saved from the decision.

Question 12

10. relevant costs for pricing

Answer 12

1. in order to determine a minimum price for the new product, we need to consider the relevant costs of the product.
   - the relevant costs are the future, incremental cash flows which arise as a result of the manufacture and sale of the product.
   - any costs which have already been incurred will not be relevant and should not be included in the calculation of the minimum price.
2. suitability of a relevant cost approach
   - relevant costs are a suitable basis for pricing for a short term or one-off decision.
   - this approach would be useful in setting the minimum price where there is, for example, significant competition or spare production capacity.

Question 13

11. limitations of relevant costs

Answer 13

1. the decision is made on the basis of short-term cash flows with assumption that the decision is one-off short-term decision.
   - we will not survive if we continually accept orders on a relevant cost basis; in the longer term we need to cover all our fixed costs.
   - is this really a one-off order or will it have an impact on future orders from this and other customers? is this really a long-term decision rather than a short-term decision?
2. it is suggested that this order will give us an introduction into the ** market and result in future sales business.
   - if this future business is expected to be profitable then there may be a case for acceoting this order even if it makes a smaall loss.
   - we also need to consider what the effect of accepting this order at a low price will be on future orders because customers may not be willing to pay a higher price in the future.
3. we need to consider whether we have excess capacity to do this and whether we should get rid of the excess capactiy by doing other profitable projects.