This is an extract of our Relevant Costing Theory Top1 document, which we sell as part of our Irish Management Accounting Theory Notes collection written by the top tier of University College Cork students.
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TOPIC 1: RELEVANT COSTING.
Relevant costing is important for the short-term, it can aid in decisions such as: make or buy, adding or dropping a business segment, competitive pricing and other processing decisions.
A relevant cost for decision making needs to contain three elements:
1. Future (hasn't occurred yet)
2. Differ between the alternatives (so if the alternatives are the same then this cost is not relevant as the decision has no effect on the cost)
3. Future cash flow (depreciation, bad debts are not relevant to cash flow).
Opportunity Costs: A potential sacrifice in choosing one alternative over the other.
o Special orders are not considered to be opportunity costs because there is no giving up of any external sales to fulfil an order etc.
Incremental Cost/ Revenue: The amount with which the costs change if one decision is made over another.
Avoidable Costs: Costs which are in general avoidable and are relevant for the decision-making process, discontinuing a product, product line or business segment.
Sunk Cost: This is money already spent which cannot be recovered and these costs are irrelevant for the decision-making process.
Special Orders: will only be relevant if they incur incremental costs and benefits, if they do not affect the fixed costs then they are not incremental and thus, not relevant.
A limiting factor is something which constrains the company, and in term the company cannot fulfil its demand.
Sales demand will always be a limited factor.
Shortage or lack of skilled workers.
Shortage of materials.
Lack of SNE's Funding.
Machine Hours- bottleneck.
o Generally, where the constraint cannot be overcome in the short-term period,
it is relevant to make the most out of what the company has considering its constraint.
o Here it is advised to use the Contribution per limiting factor method, which ranks the products from highest to lowest unit contribution margin per limiting
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