Relevant Costing Flashcards
What are the relevant costs in decision-making
Opportunity costs
Future outlay costs
What is an opportunity cost? Is it relevant or irrelevant to decision making?
The value being deprived of the next best opportunity in order to pursue a particular objective (when choosing betwween 2 contracts - by choosing one contract you are deprived of the other)
It is relevant to decision making. By depriving our next best option it is best to account for it when making a decision therefore it is relevant to decision making.
What is an outlay cost? Is it relevant to decision-making
Amount of money that will have to be spent to achieve a particular objective.
It is a relevant cost.
What are the criteria a cost must meet to be relevant
It must satisfy the following three:
Does the cost relate to the objectives of the business
Does the cost relate to the future
Does the cost vary with the decision
- if all yes == relevant
- if one no == irrelevant
What are the irrelevant costs
Sunk costs/past costs
Committed cost
What are sunk costs? Are they relevant or irrelevant to decision making
Sunk costs or past costs are costs that have already incurred in the past.
Irrelevant to decision making because they have already been incurred in the past and wont change regardless of the decision being made.
What is a committed cost? Is it relevant or irrelevant to decision making?
Committed cost arises where an irrevocable decision has been made to incur the cost (often because it is legally-binding, such as building rent or leasing a vehicle)
Irrelevant to decision making because it must be paid some time in the future and will not vary with the decision.
What is sunk cost fallacy? Explain why it happens
Irrational commitment to pst costs that persist because of their previous investiment of time, money, and effort.
The refusal to abandon an attachment to an irrecoverable investment is known as sunk cost fallacy.
Happens because of
- loss aversion (strong dislike of wasting resources)
- feeling of regret and failure (if investment is abandoned)
- attracts criticism (blamed for giving up too easily, or not owning up to poor decisions)
What are some non-measurable cost and benefits
These costs cannot be measured in monetary terms but tend to have a borader (less immediate) impact on the business- but likely to affect the ability of a business to achieve its objectives
- customer satisfaction
- business reputation
- product quality
- employee motivation
- demand for product/competitive state of market
- how well they delivered
- if estimates provided are accurate
What are the relevant and irrelevant costs of labour
Varies if there is full capacity or spare capacity
If there is spare labour capacity = irrelevant cost
If there is no spare labour capacity so new labour is hired = cost of additional labour
If there is no spare capacity, so existing labour diverted = opportunity cost of diverted labour
