#HOWTOBERELEVANTPO ?

Relevant Costing/Differential Cost Analysis

BILL JULIUS L. OCAMPO, CPA, CMA (PASSER)

OVERVIEW
• Decision Making
• Total Approach vs Differential Analysis
• Relevant cost and other cost concepts
• Types of problems encountered in relevant costing (short-term)
• Theory questions and problems
• Q&A Portion
 DECISION MAKING

1. Defining the problem – WHAT?

2. Setting of criteria - BASIS
3. Identifying the alternative courses of actions – OPTIONS
4. Determination of possible consequences of the alternatives –
ADVANTAGES/DISADVANTAGES
5. Evaluating the alternatives – ANALYZE
6. Choosing the best alternative and making the decision - DECIDE
 APPROACHES IN DECISION MAKING
(QUANTITATIVE)

• Total Approach
❖ Total revenue and total costs
❖ Regardless of relevance
❖ Advantage: less chances of omitting information
❖ Disadvantage: time-consuming, might be inefficient

• Differential Analysis
❖ Only the relevant data are considered
❖ Advantage: highlights the difference between/among alternatives
❖ Disadvantage: may be difficult to understand, hence, defeats its first advantage
 RELEVANT COST
A future cost that is to be different among alternatives.

Future Cost Differential Costs

- a cost that is yet to be - Costs which are different
incurred from sets of alternatives
OTHER COST CONCEPTS…

• Opportunity Cost
- Benefit lost by taking one action as opposed to another
- Relevant cost? YES!

• Avoidable Cost
- Cost that will be saved or not incurred when one decision is favored
- Relevant cost? YES!

• Sunk Cost
- non-recoverable cost that was incurred in the past
- Relevant cost? NO! (cost already incurred)
OTHER COST CONCEPTS…

• Join Cost
- cost that is incurred in simultaneously processing or manufacturing two or more products which are not
separately identifiable until split-off point.
- Relevant Cost? NO! (Sunk Cost)

• Allocated cost
- Cost distributed to products or department (because of benefits obtained or cause and effect)
- Service department
- Revelant Cost? NO! (if not differential e.g. will not be eliminated upon shutdown or closure
of a product line/department)
 TYPES OF PROBLEMS ENCOUNTERED IN
RELEVANT COSTING (SHORT-TERM)

• Make or Buy / Insource or outsource

• Accept or Reject a special order
• Sell or process further
• Continue or discontinue a business segment (Shutdown)
• Utilization of scarce resources
• Change in profit factors (CVP)
• Optimal product combination
CONCEPT TIME! (TRUE / FALSE)

• Sunk costs are costs that have proven to be unproductive.

FALSE
• Fixed costs are irrelevant in decisions about whether a product line should be dropped.
FALSE
• As a general guide, it is profitable to continue processing joint products after the split-off
point if their total revenues exceed the joint costs.
FALSE
CONCEPT TIME! (MULTIPLE CHOICE)

Which of the following cash flows is relevant in a decision about accepting Alternative X or
Alternative Y?
A) a cash inflow for Alternative X that is not a cash inflow for Alternative Y.
B) a cash inflow that is lost if Alternative X is accepted and is not lost if Alternative Y is
accepted.
C) a cash outflow that is avoided if Alternative X is accepted and is not avoided if
Alternative Y is accepted.
D) all of the above.
 CONCEPT TIME! (MULTIPLE CHOICE)

Consider the following statements:

I. A division's net operating income, after deducting both traceable and allocated common corporate costs, is negative.
II. The division's avoidable fixed costs exceed its contribution margin.
III. The division's traceable fixed costs plus its allocated common corporate costs exceed its contribution margin.

Which of the above statements give an economic reason for eliminating the division?
A) Only I
B) Only II
C) Only III
D) Only I and II
 MAKE OR BUY/
INSOURCE OR
OUTSOURCE

Cost of manufacturing
VS
Cost of acquiring from outside
sources
CONCEPTS TO REMEMBER:

• Avoidable Fixed Cost

• Opportunity Cost
• “Maximum cost to acquire” – cost that will be saved when you choose to acquire
from outside sources
ACCEPT OR REJECT
SPECIAL ORDER

Incremental Revenue
VS
Incremental Cost
CONCEPTS TO REMEMBER:

• Excess Capacity, Partial Excess Capacity, Full Capacity

• Forgone contribution margin – opportunity cost
• Minimum Selling Price (Incremental Cost) = variable cost + ADDITIONAL fixed
cost (if any) + forgone CM (if no sufficient excess capacity)
• MSP = Selling price to outsiders – avoidable cost
 SELL OR PROCESS
FURTHER

Incremental Revenue
VS
Incremental Cost (additional
cost to process further)
CONCEPTS TO REMEMBER:

• Joint Cost – SUNK COST!

• Incremental Revenue vs Incremental Cost
 KEEP OR DROP
(BUSINESS SEGMENT /
PRODUCT LINE)

Overall effect in total profit

of the Company
CONCEPTS TO REMEMBER:

• Relevant metric – Contribution Margin of the product line/segment

• Avoidable Fixed Cost
• Quantitative effects on other business segment or product line
• Shutdown point
SHUTDOWN POINT

• The minimum number of units you must sell to be indifferent with shutting down or
continue operating.
BREAKEVEN POINT

SHUTDOWN POINT
SCARCE RESOURCES

Overall profitability
CONCEPTS TO REMEMBER:

• Relevant Measure – Contribution Margin per SCARCE RESOURCE

• Prioritize the product with the highest CM/scarce resource