Management Accounting

for Decision Makers

Tenth Edition

Chapter 2
Relevant costs and benefits
for decision making

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LEARNING OUTCOMES

You should be able to:

Define and distinguish between relevant costs,

outlay costs and opportunity costs

Identify and quantify the costs and benefits

that are relevant to a particular decision

Use relevant costs and benefits to make decisions

Set out relevant costs and benefits analysis in a logical

form so that the results can be clearly communicated
to managers

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 Cost-benefit analysis

Involves weighing up

Outcomes from a course of

Benefits action aimed at achieving
business objectives

against

Resources sacrificed to
Costs
achieve those objectives

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 Definition of cost

The amount of resources, usually

measured in monetary terms, sacrificed
to achieve a particular objective

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 Two types of cost

Historic cost A cost already incurred

The value of an
Opportunity
opportunity forgone
cost

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Figure 2.1 A decision flow diagram for identifying
relevant costs
Does the cost relate to the No
objectives of the business?

Yes

Does the cost relate to No

the future?

Yes

Does the cost vary with the No

decision?

Yes

Relevant cost Irrelevant cost

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A garage buys a lorry for £10,000.
It requires a new engine costing £2,500 that will take 20 hours to
fit.
The technicians will be paid £15 per hour to fit the engine.
The technicians are short of work but the garage wishes to
retain their services.
The lorry could be sold immediately for £9,000.

What is the minimum price the garage should charge

for the lorry after the engine has been fitted?

£
Opportunity cost of lorry 9,000
Cost of new engine 2,500
11,500

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A garage buys a lorry for £10,000.
It requires a new engine costing £2,500 that will take 20 hours to
fit.
The technicians will be paid £15 per hour to fit the engine.
The technicians are busy and are charged out at £50 per hour.
The lorry could be sold immediately for £9,000.

What is the minimum price the garage should charge

for the lorry after the engine has been fitted?

£
Opportunity cost of lorry 9,000
Opportunity cost of technicians’ time 1,000
Cost of new engine 2,500
12,500

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Figure 2.2 A decision flow diagram for identifying the
relevant cost of labour

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Jay Ltd is bidding for a contract that will require 800 units of Alpha.

This material is currently held and information is as follows:

Historic cost Resale value Replacement cost

£/unit £/unit £/unit

10 12 14

Alpha is no longer used by the business.

What is the minimum price for Alpha for inclusion in the

contract bid?

800 × £12 = £9,600

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Jay Ltd is bidding for a contract that will require 800 units of Alpha.

This material is currently held and information is as follows:

Historic cost Resale value Replacement cost

£/unit £/unit £/unit

10 12 14

Alpha is in regular use.

What is the minimum price for Alpha for inclusion in the

contract bid?

800 × £14 = £11,200

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Figure 2.3 A decision flow diagram for identifying the
relevant cost of materials
Are the materials held in
inventories?

YES NO

Do they need to be
replaced?

YES NO

Current Sales value Current

purchase cost or alternative use purchase cost

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 Relevant and irrelevant costs

Future costs that Costs that are the

vary with the same irrespective
decision under of which decision
consideration is made

Relevant Irrelevant
costs costs
The cost of Costs that
being deprived were incurred
of the next best Opportunity Past as a result of a
option costs costs past decision

Those that Those that

do not vary
vary with the Future outlay Future outlay
decision with the
costs costs decision

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