ACCT 215 Ch12 Relevant cost for decision making

points

: Summary of key

Introduction :
Making decision is one of the basic functions of a manager . To be successful in
decision making , managers must be able to tell the difference between relevant
and irrelevant data and must be able to correctly use the relevant data in
analyzing alternatives
The purpose of this chapter is to develop these skills by illustrating their use in a
wide range of decision making situations
Cost concepts for decision making
A relevant cost is a cost that differs between alternatives
An avoidable cost is a cost that can be eliminated in whole or in part by selecting
one alternative over another . Avoidable cost is relevant cost and unavoidable
cost is irrelevant cost
There are 2 categories of costs that are never relevant in any decision such as :
1- A sunk cost which is a cost that has already been incurred and cannot be
avoided regardless of what a manager decides to do
2- A future cost that does not differ between alternatives is never a relevant
cost

Relevant cost analysis will have 2 steps :

1- The first step is to eliminate costs and benefits that do not differ between
alternatives (i.e sunk costs and future costs that do not differ between
alternatives )
2- The second step is to use the remaining costs and benefits that do differ
between alternatives in making the decision

Costs that are relevant in one decision may not be relevant in another context .

There are 5 business decisions to be considered in this chapter such as :

A- Make or buy decisions : Consists of making the product or part of our

product in house or buying it from an outsider . To take decisions we have to
:
List relevant costs for every decision (alternative) and to select the lowest
cost
B- A Special order : It is a one time order that is not considered part of the
companys normal ongoing business
To take decision we have to :
Incremental revenues Incremental costs
C- Utilization of a constrained resource :
When a limited resource of some type restricts the companys ability to
satisfy demand ,
the company is said to have a constraint .
To take decision we have to :
Calculate CM/unit of constrained resource ( such as CM/minute , CM/kg or CM
/pallet etc ) instead of the CM /unit and select the highest CM
D- Joint products costs ( Split off point ) :
In some industries , a number of finished products are produced from a single
raw material input . When 2 or more products are produced from a common
input these products are known as joint products . The split-off point is
the point in the manufacturing process at which the joint products can be
recognized as separate products
Joint costs are irrelevant in decisions regarding what to do with a product
from the split off point forward . Therefore these costs should not be allocated
to end products for decision making purposes
To take decision we have to :
Incremental revenues Incremental costs after the split off point
E- Dropping or retaining a segment :
This is one of the most important decision managers make is whether to add
or drop a business segment . To take a decision we have to :
To calculate the CM that would be lost and the costs that would be avoided if
the segment is dropped