Session Two

Any short term decisions should be approached using relevant

costing principles

Companies and government bodies have increasingly tended

Concept of to concentrate on their core competences – what they are
really good at – and turn other functions over to specialist
Relevant contractors.
Costing This is known as outsourcing or sub-contracting.

Relevant costs and revenues are:

• In the FUTURE
• CASH only
• INCREMENTAL only
Concept of Relevant Costing
Decision making should be based on relevant costs and
revenues.
3. Relevant costs are INCREMENTAL costs and it is the increase in
1. Relevant costs are FUTURE costs. costs and

A decision is about the future and it cannot alter what has been revenues that occurs as a direct result of a decision taken that is
done already. relevant.

Costs that have been incurred in the past are totally irrelevant to
any decision
that is being made 'now'.
Such costs are called past costs or sunk costs and are irrelevant.
Common costs can be ignored for the purpose of decision making.
4. Relevant costs are AVOIDABLE costs
These are costs which would not be incurred if the activity to which
they relate did

2. Relevant costs are CASHFLOWS. not exist.

Only cash flow information is required. Therefore, they are relevant to a decision.

This means that costs or charges which do not reflect additional Committed costs are future costs that cannot be avoided because of
cash spending decisions that

(such as depreciation and notional costs) should be ignored for the have already been made.
purpose of

decision making.
The responsibility centre business models

Divisionalisation

An organisation can be
structured in one of two ways:
•All activities of a similar type within a company, such as:
•production,
Functionally •sales,
•research
are under the control of the appropriate departmental head

Divisionally •Split into divisions in accordance with the products or services made or provided

Divisional managers • Responsible for all operations (production, sales and so on) relating to their product.
Advantages vs Disadvantages
of Divisionalisation
Advantages of divisionalisation
Divisionalisation can improve the quality of decisions made
because divisional
managers (those taking the decisions) know local conditions into a number of self-interested segments, each acting at
and are able to
make more informed judgments. Decisions should be
taken more quickly because information does not have to
pass along the chain of command to and from top
management.
Divisional organisation frees top management from
detailed involvement in day to- day operations and allows
them to devote more time to strategic planning.
Disadvantages of divisionalisation
A danger with divisional accounting is that the business
organisation will divide
times against the
wishes and interests of other segments.
The costs of activities that are common to all divisions, such
as running the accounting department, may be greater for
a divisionalised structure than for a centralised structure.
Top management, by delegating decision making to
divisional managers, may lose control, since they are not
aware of what is going on in the organisation as a whole.
Life-cycle costing

Life-cycle costing It enables a product’s Traditional cost

tracks and true profitability to accounting systems
accumulates be determined at the do not accumulate
the actual costs and end of the economic costs over a
revenues attributabl life. product’s entire life
e to each but focus instead on
product from (normally) twelve-
inception to month accounting
abandonment. periods. As a result,
the total profitability
of a product over its
entire life becomes
difficult to
determine.
 Every product goes through a life cycle

Development.
The product has a research and development stage where costs are incurred but no revenue is generated.
During this stage, a high level of setup costs will be incurred, including research and development, product design and
building of production facilities.
Introduction.
The product is introduced to the market. Potential customers will be unaware of the product or service, and the organisation
may have to spend further on advertising to bring the product or service to the attention of the market.
Therefore, this stage will involve extensive marketing and promotion costs. High prices may be changed to recoup these high
development costs.
Growth.
The product gains a bigger market as demand builds up. Sales revenues increase and the product begins to make a profit.
Marketing and promotion will continue through this stage.
Unit costs tend to fall as fixed costs are recovered over greater volumes. Competition also increases and the company may
need to reduce prices to remain competitive.
Maturity.
Eventually, the growth in demand for the product will slow down and it will enter a period of relative maturity.
It will continue to be profitable. However, price competition and product differentiation will start to erode profitability.
The product may be modified or improved, as a means of sustaining its demand.
Decline.
At some stage, the market will have bought enough of
the product and it will therefore reach 'saturation
point'.
Demand will start to fall and prices will also fall.
Eventually it will become a loss maker and this is the
time when the organisation should decide to stop
selling the product or service.
During this stage, the costs involved would be
environmental clean-up, disposal and
decommissioning.
Meanwhile, a replacement product will need to have
been developed, incurring new levels of research and
development and other setup costs.
The level of sales and profits earned over a life cycle
can be illustrated diagrammatically as follows.