Cost and management New

edition
Accounting Study Text 2019

Relevant Costing and Decision

Making Techniques

Contributors

1|Page
Mindmaplab.com
www.mcqs.club
Cost and management Accounting
Study Text

Relevant Costing and

Decision Making Techniques

Our text is designed to help you study effectively and efficiently. In this edition we:

• Highlight the most important elements

• key skills you will need

• Use overview and summary diagrams to develop understanding of interrelations

between topics

• Emphasize key points in section summaries

2|Page
Mindmaplab.com
www.mcqs.club
The mindmaplab is an educational platform where you can get the summarized/simplified
form (covering all the areas) of lengthy and complex subjects/chapters which otherwise
most of us finds difficult to absorb at the first sight.
Here on mindmaplab everything you read was written by our dedicated team who
want to help someone else.

How Mind Mapping helps make things simpler

Mind mapping a topic:

Help stop cramming: Hey book-worms there!!
Mindmaplab is here to help you to stop cramming the books all the day. It will make your
life easy by making tough subjects simple. The good thing is you will save enough time for
social life too!!
Help retain for longer term: Once a tough topic is simplified using mind mapping it will
remain fresh for longer period.
Saves time during revisions: Time management is very important during revision days.
Once a topic is mind mapped it will take substantially less time than ordinary cramming
method.

©
Mindmaplab and MCQs.club
All rights reserved. 2019

3|Page
Mindmaplab.com
www.mcqs.club
Useful links:
• Free E-books Downloads
• Practice material
• Video Lectures

4|Page
Mindmaplab.com
www.mcqs.club
 Relevant
Costing

• A relevant cost is a future cash flow that will occur as a direct

consequence of making a particular decision.
• They cannot include any cost occurred in past.
• Costs that occur whether or not a particular decision is taken are not
relevant costs.
• Relevant costs are cash flows. Notional costs such as depreciation,
interest costs and absorbed fixed cost are not relevant cost.
Examples of Relevant cost:
• Incremental cost
• Differential cost
• Avoidable costs

5|Page
Mindmaplab.com
www.mcqs.club
 Identifying
Relevant costs

Materials Labour Overheads

Material Material not • Normal rules of

• If the cost of Labour is
currently in currently in a variable cost and relevant costs
inventory inventory Labour is not in are applied i, e
restricted supply: The Relevant costs
relevant cost is its are future cash
variable cost. flows.
• If Labour is a fixed
Is material cost and there is spare
• Fixed overheads
in regular Labour time available: absorption rate
use? In this case the The relevant cost of is irrelevant.
relevant cost is using Labour is 'zero'. However, the
simply the The spare time would variable
purchase value. otherwise be paid for overhead hourly
idle time. rate is treated as
Yes No • If Labour is in relevant cost.
unlimited supply:
Relevant cost includes • The only
The relevant cost is the the opportunity cost of overhead fixed
current opportunity cost.
The relevant cost Opportunity cost is
using the Labour time costs that are
is the current higher of; for the decision instead relevant costs
Replacement • Net disposal/sales of next most profitable are the extra
cost. value/scrap value; or way. cash spending.
• Net benefit from
alternative use.

6|Page
Mindmaplab.com
www.mcqs.club
 Decision Making
Techniques

• The concept of relevant costs can be applied for both 'long term' and 'short term'
decisions.
• The application is same for both types of decisions except for long term decisions
'time value of money' should be considered.

Types of
Decisions

Joint Product
Limiting One-off Make-or-Buy Shut-down further
Factor contractual decisions Decisions processing
Decisions decisions
decisions

7|Page
Mindmaplab.com
www.mcqs.club
Types of
Decisions

• Limiting factor are the factors that 'restricts' operational capabilities,

Limiting
sales demand is normally the factor that sets a limit on volume of
Factor production. However, the availability of scarce resources such as Direct
Decisions material, skilled Labour or machine capacity could be the limiting factor.
• If the company makes just one product and a production resource is in
limited supply, profit is maximized by making as many units of product
as possible with limited resources. However, if the company produces
more than one product with same scarce resources then a budgeting
problem is to decide how many of each product to make and sell in order
to maximize Profit. In Such case select products for manufacture and
sale according to the contribution per unit. The following steps are
involved:
1. Calculate the contribution per unit of each good produced.
2. Identify scarce resources (e.g. Labour hours).
3. Calculate the amount of scarce resources used by each good
produced (e.g. 'X' no. of Labour hours). Now divide the
contribution earned by each good by scarce resources used by that
good to give the contribution per unit of scarce resources for that
good.
4. Rank each good in order of contribution per unit per scarce
resources (highest contribution is ranked 1st).
5. Construct a production plan based on ranking.
Assumptions of limiting factors:
• Profit is maximized by maximizing contribution.
• Variable costs are only the relevant costs.
• Fixed cost will be the same whatever decision is taken. Therefore, are
not relevant.

8|Page
Mindmaplab.com
www.mcqs.club
 • The contract where the Job is once only and will not be repeated in future.
• The one-off contract is under taken if extra revenue is higher than relevant costs.
• The decision is to whether agree to do the Job at a Price offered by customer or decide
One-off a selling price (base on relevant costs).
contractual • Profit = Revenue - Relevant cost
decisions
• One-off contract decisions might occur when a company has spare capacity and an
opportunity arises to earn some extra profit.

• A decision whether: to make an item internally or buy it externally. The decision

should be based on relevant cost, the preferred option from a financial view point is
the one with the lowest relevant costs.
• A financial assessment of a make or buy decision involves a comparison of:
Make- ✓ cost that would be saved; and
or- ✓ incremental cost of outsourcing
Buy • A situation may arise where entity is operating in full capacity, in order to overcome
some restrictions on its output and sales, the entity may outsource some products.
decisi
• The decision is about which item to outsource and which to retain in-house.
ons • The profit maximizing decision is to which items to outsource.
• Those items are outsourced where cost of outsourcing is least.
• To identify the Least-cost of outsourcing, it is necessary to compare:
✓ additional cost of outsourcing; with
✓ amount of resources needs to make product in-house.
Make-or-buy decision non-financial considerations
Non-financial considerations will often be relevant to make-or-buy decision:
• When work is outsourced, the entity loses some control over the work. It will rely on
the external supplier. There may be some risk that external supplier will:
✓ provide a lower quality.
✓ fail to meet delivery on said dates.
• The entity will lose some flexibility. If it needs to increase or reduce supply of the
outsourced item at short notice.
• Redundancy of employees may occur as a consequence of outsourcing affecting
relations between management and other employees.

9|Page
Mindmaplab.com
www.mcqs.club
 • A shutdown decision is whether or not to shut down a part of the
Shut-
operations of a company.
down • From a financial view an operation should be shutdown if the benefits of
Decisions shutdown exceed relevant costs.
Example of such costs
• Fixed costs may be saved, Employee redundancy cost.

• Joint products are product manufactured from a common process.

• The entity has a choice whether:
1. selling joint product as soon as it is output; or
Joint 2. processing it further before selling (at a higher price).
Product
further
• This is a short-term decision and financial assessment should be made
processing using relevant cost and revenues. The financial assessment should
decisions
compare:
1. Revenue (less) selling cost from joint product as soon as it is output.
2. The revenue that will be obtained if Joint product is processed further
(less) incremental cost of further processing.

10 | P a g e
Mindmaplab.com
www.mcqs.club
 Contact us
http://www.mindmaplab.com
http://www.mcqs.club

Contributors

11 | P a g e
Mindmaplab.com
www.mcqs.club