Management Accounting & Decisions II

N12401

Lecture 7
Relevant Costing For Decisions
by Hung Woan-Ting

Learning Objectives
1.

To understand the framework of decisionmaking

2.

To understand the concept of relevant cost

(revenue)

3.

To be familiar with the different types of

decisions and apply the concept of relevant cost
(revenue) in arriving at a decision

1.0 Decision-Making Model

1. Identify objectives

process

Planning

2. Search alternative courses of action

3. Gather data about alternatives
4. Select alternative courses of action

process

Control

5. Implement the decisions

6. Compare actual & planned outcomes
7. Respond to divergences from plan

1.1 Decision Logic

Financial Accounting Logic

Decision Logic

Historical

Future

Objective

Verifiability

Relevance

Prompt

Transaction

Decision

Result

Profit

Cash Flow

Unit

Average

Marginal

Perspective

2.0 Info Relevant for Decisions

Information considered for decision-making
Financials & non-financials
Underlying assumptions
profit maximization objectives
certainty of information
known cost behaviour pattern
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2.1 Info Relevant for Decisions

Some familiar cost categorizations:
Relationship between cost item and cost object
Behaviour at different activity level
Issues faced:
Is unit cost data relevant for decision-making?
Are variable costs relevant? Always?
Are fixed costs always irrelevant? Always?
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In search of a cost categorization that support

decision making reflect cost relevance

Concept of RELEVANCE
Costs (revenues) that
will be incurred (earned)
in the future

Costs/Revenues
that are cash flows

Costs/revenues that
would differ between
alternative decisions

Opportunity costs
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Example:
You are planning to take a holiday after the MAD2
exam. Youd like to make a trip to Penang up north.

Fly??
Cat sitter $20/day
Airfare & cab $600
7 days in Penang
Hotel stay
8nights@$90/night
Food 8days@ $30/day

Drive??
Cat sitter $20/day
Petrol & Toll $200; Car
insurance $900/yr
6 days in Penang
Hotel stay
7nights@$90/night
Food 8days@ $30/day

Analyse these info and decide on your vacation plan!?

2.3 Info Relevant for Decisions

Possible categories of costs according to relevance
Future costs vs. Sunk costs
Incremental costs vs. Common costs
Avoidable costs vs. Unavoidable costs
Opportunity costs

3.0 Typical Managerial Decisions

Capital investment decisions
Pricing decisions
Adding/dropping product/segment
Choice of Product
Accept special orders
Make or buy
Joint product to further process
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3.1 Add/Drop Product Line

Example 1:
Should the business discontinue with Central?
Southern Northern

000
Sales
900
Variable costs (466)
Fixed costs
(266)
Profit/(Loss)
168

000
1000
(528)
(318)
154

Central

Total

000
000
900
2800
(598) (1592)
(358)
(942)
(56)
266

If discontinued, 250 000 of fixed costs in Central and all

of its variable costs are avoidable.
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Decision criteria:

Feasibility of the product line concerned

If continue with Central:
relevant revenues =______
relevant costs = _________
Contribution provided by Central = ______
Based solely on this, decision should be to _________
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3.2 Choice of Product

Example 2:
Should the business choose product X or Y?
$ Per unit
Product
X
Y
DM
10
20
DL
5
8
VOH
5
8
FOH
3
3
Selling Price 32
50
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Decision criteria:
Profitability of the products
$ Per
Product
X
DM
10
DL
5
VO/h
5
FO/h
3
Selling Price 32
Contribution ___

unit
Y
20
8
8
3
50
___

Based solely on this, decision should be to choose ____

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3.3 Choice of Product With Constraints

Example 3:
Machine capacity is limited. Should the business choose
product X or Y?
$ Per unit
Product
X
Y
DM
10
20
DL
5
8
VO/h
5
8
FO/h
3
3
Selling Price
32
50
Contribution
12
Machine hr p.u. 3

14
4

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Decision criteria:
Profitability of the products
in utilising the limited resources available
$ Per
Product
X
DM
10
DL
5
VO/h
5
FO/h
3
Selling Price
32
Contribution
12
Machine hr p.u.
3
Contribution/MH ___

unit
Y
20
8
8
3
50
14
4
___

Based solely on this, decision should be to choose

Product ____

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3.4 Accept Special Orders

Example 5:
There is a one-time order for the Companys existing
product. Should the order be accepted?
Company has capacity to produce 100,000 units p.a.
Total Per unit
Sales (at 100K units)
600K
6.0
Variable costs
150K
1.5
Fixed costs
250K
2.5
Net Profit
200K
2.0

The order involves 10,000 units at 3p.u, with no effect on

fixed costs.
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Decision criterion:
Incremental revenue vs.
Incremental cost of the order
Scenario 1: Regular sale level is 80K units.

Incremental revenue =
Incremental costs =
Decision should be to ______ order
Scenario 2: Regular sale level is 100K units.
Incremental revenue =
Incremental costs =
Decision should be to ______ order
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3.5 Other business decisions..

Make or Buy?
Decision-criteria:
_________ vs. __________

Joint product to further process?

Decision-criteria:
_________ vs. __________
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Readings & Exe.

1. Read the following chapters in the prescribed
textbooks
GNBCY Ch14
AHM Ch26
2. Attempt the Question Sets attached at the back of
this handout (indicative solutions in Moodle for selfchecking)
End of Lecture
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