Relevant costs and revenues for decision making

Question 1

Identify relevant cost and revenues

• The relevant costs and revenues required for ___________-____________ are ______ those that will be __________ by the _____________.

Define irrelevant cost, relevant cost and opportunity cost

Answer 1

• The relevant costs and revenues required for decision-making are only those that will be affected by the decision.

Irrelevant cost:

• sunk cost (expenses that have already been incurred and cannot be recovered), allocated common fixed costs and future costs that do not differ between alternatives.

Relevant costs:

• future costs that differ between alternatives.

Opportunity cost:

• the lost contribution to profits arising from the best alternative foregone.

Question 2

Two principles to identify relevant costs:

Answer 2

1. Future cost
2. Differentiate

Question 3

Why the book value of equipment is irrelevant when making equipment replacement decisions?

Answer 3

Past (Sunk) value cannot be changed for any alternative under consideration. Only future costs or revenues that will differ between alternatives are relevant for replacement decisions.

Question 4

Limiting factors

4 examples?

Answer 4

• A shortage of skilled labour, materials, equipment or space.
• Where limiting factors apply, profit is maximized when the greatest possible contribution to profit is obtained each time the scarce or limiting factor.
• Meaning = When resources are limited, focus on using them where they generate the most profit per unit of the scarce resource. Prioritize efficiently to maximize overall profitability.

Question 5

Key concept should be applied when limiting factors exist (2)

Answer 5

1. rank the products by the contribution per unit of the constraining or limiting factor (i.e. the scarce resource).
2. the capacity of the scarce resource should be allocated according to this ranking.

Question 6

What do special pricing decisions relatew to and what do they typically involve?

Answer 6

Special pricing decisions relate to pricing decisions outside the main market. Typically they involve one-time only orders or orders at a price below the prevailing market price.

Question 7

Outsourcing and Make or Buy Decisions

What is outsourcing?

Answer 7

Outsourcing is the process of obtaining goods or services from outside suppliers instead of producing the same goods or providing the same services within the organization.

Question 8

Discontinuation Decisions

What is PPA and what does it highlight?
What does it apply to?

Answer 8

• Periodic profitability analysis can highlight unprofitable activities that require a more detailed appraisal to ascertain whether or not they should be discontinued.
• It applies to a decision whether to discontinue a segment, a sales territory, products, services or customers.