Short Term Decisions Flashcards
What are the three criteria that must be met in order for a cost to qualify as a relevant cost?
- Future
- Cash Flow
- Incremental (specific to the decision)
Relevant costs can also be categorised as what?
- opportunity costs
2. avoidable costs
What is opportunity cost?
Opportunity cost is defined as the benefit foregone as a result of choosing one course of action over another.
What are avoidable costs?
Specific costs of an activity/sector of a business that would be avoided if the activity/sector didn’t exist.
What type of decisions are associated with avoidable costs?
Shutdown decisions
What main costs can not be classified as relevant costs?
- Sunk costs
- Committed costs
- Notional costs (non cash items i.e. accounting adjustments)
What are the 6 main decision types?
- Accept or reject
- Make or buy
- Outsource
- Shutdown
- Minimum Price of an order/job/contract
- Further processing decisions
Relevant cost of materials:
If materials are not in stock and we have to purchase more what is the relevant cost?
Current replacement cost
- i.e. market price
Relevant cost of materials:
If materials are in stock and in continual use for us we need to replace the materials we use. What is the relevant cost?
Current replacement cost
- i.e. market price
Relevant cost of materials:
If materials are in stock and we have no other use for them, we will not replace them. What is the relevant cost?
Use for free if just using for our own product
OR
Current resale/scrap value if we can sell on
OR
Nil if we can’t sell it.
Relevant cost of materials:
If materials are in stock but are scarce and we cannot replace the materials once we have taken from the stock, what is the relevant cost?
Opportunity cost
- account for lost revenue from other areas of the business.
What is the first question we should be asking when deriving the relevant cost of materials?
Whether or not the materials are in stock.
True or False: Historic costs are taken into account when deriving the relevant cost of materials.
False - we NEVER take into consideration historic costs.
Relevant cost of labour:
What is the first question we should be asking ourselves when we are assessing the relevant cost of labour?
Whether we have spare capacity or are at full capacity in our current labour force.
Relevant cost of labour:
If we have spare capacity in our labour force we can therefore undertake additional work. What is the relevant cost of labour.
Nil - we can utilise the spare time of our existing workforce.
Relevant cost of labour:
If we are at full capacity what are the two options we must consider when trying to derive the relevant cost?
Whether we can hire more staff or we cannot hire more staff.
Relevant cost of labour:
If we are at full capacity, additional work cannot be undertaken by our current workforce. If we hire more staff, what is the relevant cost?
The current rate of pay.
Relevant cost of labour:
If we are at full capacity, additional work cannot be undertaken by our existing workforce. If we cannot hire more staff, what is the relevant cost?
Opportunity cost = Variable cost + lost contribution.
What is included in the relevant cost when calculating minimum price?
Relevant cost ONLY!!
do not include apportionment of overheads or a mark u.
What are the downfalls of using the minimum price decision type?
- okay for one offs but doesn’t cover fixed costs or contribute to profit
- how would we price repeat orders? - higher price infers higher expectation of quality.
How do we make a decision under the accept or reject policy?
Accept projects with a positive return
Reject projects with a negative return
In which circumstances may we accept a project with a negative return?
- undercutting a competitor
- gaining market share
- attracting new customers
If we are not told that we can access more labour then what do we assume?
That no additional labour is available to us.
In make or buy decision making, what is the ultimate factor in the decision process?
- Which is cheaper - make or buy?
- Buy in if cost effective
What are the other key considerations in make or buy decision making?
- Quality of bought in product
- Reliability of supplier
- Becoming dependent on supplier?
- Likelihood of future price increases
- How to use spare capacity
- Confidentiality issues
- Delivery timings
- Staff morale
- Redundancies
- Feasibility if need to bring back in-house
How are further processing decisions made?
- Joint costs not relevant
- SP now vs. NRV (NRV = SP later - further costs)
- Does market exist before and after further processing?
What is the main financial factor to consider in shutdown decisions?
Lost contribution and specific fixed costs (avoidable costs)
What are the main non-financial factors to consider in shutdown decisions?
- Impact on customers
- Impact on other products
- Competitor reactions
- Impact on employees
- Impact on supplier negotiations
