Relevant Costing

Question 1

What are the features of relevant costing?

Answer 1

An aid to making short term decisions
overcomes the limitations of marginal costing; is an extension to marginal costing
used to determine the minimum price of a special project

Classifies costs and revenues as relevant or irrelevant

Advocates that managers take decisions that make the firm better off as a whole

Question 2

What are relevant costs?

Answer 2

Relevant costs and revenues are those costs and revenues that change as a direct result of a decision taken” (Management Accounting, 2017, p. 228)

Relevant costs :
	are future costs 
	are cash flows
	differ between alternatives – incremental or  
      differential

Question 3

Which items are never relevant?

Answer 3

Items never relevant:
sunk costs
   depreciation 
   overhead absorbed
   fixed overheads that will not increase or
     decrease
   committed costs

Question 4

What are relevant costs of materials?

Answer 4

The relevant cost of material to be used on a project will not be what it cost to buy in the first place
if a material that is owned by a firm is obsolete, then the relevant cost of using this material for the project is its resale value
if a material is in regular use, its relevant cost is its replacement cost

Question 5

What are relevant costs of labour?

Answer 5

The relevant cost of labour to be used on a project will not be the current wages paid to workers
if an existing worker is to be used on the project as he is presently not fully utilised, the relevant cost is zero
if a worker will be transferred from an existing project to work on a new project, resulting in new workers being recruited to work on the current project, the relevant labour cost is the salaries of the new recruits

Question 6

What are relevant costs of machinery?

Answer 6

Repair costs arising from use
Hire charges
Fall in resale value arising from use

Question 7

What are relevant costs of OH’s?

Answer 7

Specific overheads allocated to a project are a relevant cost but general overhead is treated as an irrelevant cost

Example: £30,000 general overheads of the firm have been assigned to a project. They are not specific overheads that the project would incur

Question 8

What are relevant costs of NCA’s?

Answer 8

Similar to relevant costs of materials
If plant and machinery are to be replaced at end of life then relevant costs is replacement costs
If they are not to be replaced then the relevant costs is higher of sale proceeds (if sold) and net cash inflows arising from the use of the asset (if not sold)

Question 9

Salary to be paid to market researcher who will oversee the development of a new product. The new post is created specially for the new product but the £12,000 salary is a fixed cost. Is this a relevant cost? Y

Is this statement relevant or irrelevant?

Answer 9

Yes it is relevant

Question 10

£2,500 additional monthly running cost of a new machine. The new machine will save on labour time and the fixed overhead absorbed (1)

into the product made by the machine will reduce by £100 per month. Are these costs relevant to the purchase decision? (2)

Are these statements relevant or irrelevant?

Answer 10

1. Not relevant

2. Relevant

Question 11

Expenses of £75 paid to a manager, this is to reimburse the manager for cost of travelling to a client with whom the company is currently negotiating a major contract. Is this cost relevant to continuing negotiations?

Is this relevant or not?

Answer 11

No not relevant because the expense have been paid.

Question 12

What is opportunity cost?

Answer 12

The value of the benefit sacrificed when one course of action is chosen, in preference to an alternative” (Performance Management, 2015, p. 228)

Used in decision making
Concerned with alternatives
Can be used if resources are scarce

Question 13

What are the limitations of relevant costing?

Answer 13

The context of relevant costing is much broader than that of marginal costing making it much more realistic for making decisions
However, there is the difficulty in foreseeing the indirect consequences arising from the decision in question
Qualitative factors-be aware of non-financial factors when taking decisions based on relevant costing eg impact on firm’s reputation etc

Question 14

What are the common types of decisions?

Answer 14

Limiting factor decisions;
Make or buy decisions;
Shutdown decisions (deleting a segment);
Accept or reject an order decisions;
Pricing decisions;
Joint product and further processing decisions.

Question 15

What is limiting factor?

Answer 15

This is the factor which prevents a company from achieving the required sales and output e.g. skilled labour, materials, space, equipment

Single Limiting factor:
Profit is maximised when the greatest possible contribution is obtained each time the scarce or limiting factor is used

Two or more limiting factors:
Use linear programming techniques

Question 16

What is make or buy outsourcing decision?

Answer 16

Should an organisation make a product internally or pay another organisation to supply it
Should an organisation make components for their own products or obtain them from outside suppliers

Question 17

What is accept or reject contracts?

Answer 17

Accept or reject orders or contracts on the basis that:
Selling price greater than relevant costs
There is a positive contribution

Question 18

What are some qualitative factors in decision making?

Answer 18

State of the economy
Availability of cash
Effect of decision on employee morale
Effect of decision on relationships with suppliers, shareholders, managers, environment
Effect on long term profitability
Effect on public image of the company
Reaction of competitors