ACT1107 - STRATEGIC COST MANAGEMENT

Management Decision Making Process:

a. Identify the problem and assign responsibility
b. Determine and evaluate possible courses of action
c. Make a decision
d. Review the results of decision

Business decisions involve a choice among alternative courses of action. In making such decisions,
management ordinarily considers both financial and nonfinancial information. The process used to
identify the financial data that change under alternative course of action is called Incremental Analysis.

a. Incremental analysis involves not only identifying relevant revenues and costs, but also in
determining the probable effects of the decision on future earnings.
b. Data for incremental analysis involves estimates and uncertainty.
c. Gathering data may involve market analysts, engineers and accountants.

Note: In Incremental Analysis, both cost and revenue may change. However, in some cases (1) Variable
Costs may not change under the alternative courses of action, and (2) fixed costs may change.

The typical short-term decision-making cases may involve questions on the following:
1. Make or Buy Decisions.
2. Special Sales Pricing Decisions
3. Utilization of Scarce Resources / Best product combination
4. Shut Down Temporarily or Continue
5. Add or Drop a Segment
6. Sell or Process Further

In any of the following short-term decision making cases, the information that must be gathered should
be relevant and related to the decision making cases. Cost and Revenues are considered to be Relevant if
the expected future costs and revenues will differ among alternative courses actions.

The following are considered to be relevant:

a. Differential Costs – Cost that are present in one alternative in a decision making case, but are
absent in another alternative.

b. Avoidable Costs – Cost that can be eliminated, in whole or in part, when one alternative is chosen
over another alternative.

c. Opportunity Costs – refers to the forgone income (lost) when one action is taken over the next
best alternative course of action.

Handout for Relevant Costing

 ACT1107 - STRATEGIC COST MANAGEMENT

The following costs are considered irrelevant:

a. Sunk Cost – Cost that has already been incurred and cannot be avoided regardless of the
alternative taken
Note: Sunk Cost are always irrelevant but they may serve as a basis for making predictions

b. Future Cost that do not differ among alternative courses of actions.

In decision making cases, only the relevant factors should be considered when evaluating the alternatives.
As a general rule, the best alternative is the one that will give the highest income (lowest possible loss)
to the organization.

Handout for Relevant Costing