Relevant Costing

When making decisions, businesses should only take into account those costs and revenues which are relevant to the decision. This principle underpins virtually all of the syllabus.
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The minimum price to tender for a new contract or a piece of work. Whether to shut down a division or keep it open. The minimum price to accept from a customer who requires a product which will require transfer of resources away from more profitable uses. Whether a manufacturing company should make for itself or buy in a component used in production of a product in its product range.

A general rule can be applied when attempting relevant costing questions. General rule: Items of income or expense are only relevant to the decision if they make the business richer or poorer when the business goes ahead with the decision. For example, non-cash items are non-relevant (such as depreciation of fixed assets), since to become richer the business must receive cash as a result of their decision and to become poorer the business must spend cash. This would also help to explain the concept of opportunity cost where another opportunity is foregone if the business goes ahead with the decision under consideration. The amount by which they would be poorer is relevant and is called the opportunity cost. It is important that you know which revenues and costs are relevant and which are non-relevant:

Relevant
Cash Opportunity costs Incremental cash flows

Non-relevant
Sunk costs Committed costs Non-cash items Share of group-wide fixed overheads

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2 Exam Practice Kit: Decision Management

Questions
1.1 Which of the following phrases are characteristics of relevant costs used for decisionmaking? (i) (ii) (iii) (iv) A B C D E Unavoidable costs Past costs Incremental costs Future costs (i) and (ii) only (ii) and (iii) only (i), (ii) and (iv) only (ii), (iii) and (iv) only (iii) and (iv) only (2 marks)
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Use the following information to answer the next two questions. Shultz Ltd is about to tender for a contract.

The following information has been provided by the company accountant. Labour required Skilled (200 hours at 10/hour) Semi-skilled (60 hours at 8.50/hour) Unskilled (400 hours at 6/hour) Material required R (150 kg at 5/kg) T (250 litres at 8/litre) 2,000 510 2,400 750 2,000 7,660

Skilled labour is currently idle. However, the unskilled labour will have to be diverted from another project which currently generates contribution of 12 per unit, each unit uses four hours of unskilled labour. Semi-skilled labour will be recruited from outside the company if the contract is awarded to Shultz. The original purchase price of material R was 5 per kg. If purchased now, it will cost 8 per kg. It could be sold as scrap for 2.50 per kg. Current stock is 80 kg. Material R has not been used in the company for as long as anyone can remember. The original purchase price of material T was 8 per litre. If purchased now, it will cost 10 per litre. It could be sold as scrap for 3.50 per litre. Current stock is 50 litres and this material is in constant use. 1.2 What is the relevant cost of labour for the contract? A B C D E 1,710 3,600 3,710 4,110 4,910

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