Relevant Costing Flashcards
what is relevant costing?
Relevant costing (also known as marginal
analysis) can be broadly regarded as
analysis done in support of decision-making when we are trying to decide two or more possible courses of action where economic costs and benefits are the decision making criteria,
only costs that vary with the decision
should be included in the decision analysis.
what are relevant costs?
Relevant costs are those costs that relate to
the future. They are additional costs that will
be incurred from a decision
examples where relevant costing may be used
- Accepting or rejecting special orders
- Making the most efficient use of scarce resources
- Deciding whether to make or buy
- Deciding whether to close or continue a section
Accepting / rejecting special orders
In assessing a special order, it is important to
identify the entity’s available capacity
Accepting / rejecting special orders
what is a special order?
represents a request from a
customer that is different from normal sales
Accepting / rejecting special orders
what is the available capacity?
Available capacity (spare capacity)
represents the amount of capacity an entity
has available to increase output.
what is contribution margin?
A cost accounting concept that allows a company to determine the profitability of individual products.
contribution margin may also refer to
per unit measure of a product’s gross operating margin, calculated simply as the
product’s price - its total variable costs.
Consider a situation in which a business manager determines that a particular product has a 35% contribution margin, which is below that of other products in the company’s product line
what may the manager decide to do?
this figure can then be used to determine whether variable costs for that product can be reduced, or if the _price of the end product could be increased. _
If these options are unattractive, the manager may decide to drop the unprofitable product in order to produce an alternate product with a higher contribution margin.
Accepting / rejecting special orders
In undertaking this analysis, issues such as what may need to be considered?
- Is there another customer who would pay more for spare capacity rather than ‘selling it off’ cheaply
- Potential loss of customer goodwill as a result of selling the same product at different prices
- It may be better to reduce total capacity and thereby reduce fixed costs, if inability to sell full production capacity is an ongoing problem
- Accessing overseas markets may be a means of s_elling product / excess capacity_ at a different pricing structure
The most efficient use of scarce
resources
how is sales potential limited?
sales potential may be limtied when there is a limit on production capacity resulting from factors such as a shortage of
- labour
- raw materials
- space
- machinery
The most efficient use of scarce
resources
The most profitable combination of products
occurs
when the contribution per unit of the
limiting factor is maximised
Make or buy decisions
what is the question?
do you produce the product or
service you sell, or buy it from other business?
Make or buy decisions
Relevant cost of making a component or
providing a service internally is the _cost that can
be avoided_by buying the resource or service
from outside.
Unavoidable costs are not considered in the
decision
Closing or continuing a section or
department
it is common for businesses to?
It is common for businesses to account separately
for each department or section in order to assess
the relative effectiveness of each one
A department should only be replaced
where the
replacement results in an overall increase in the
sum of the contributions from all departments
