ACYMANS: Relevant Costing

Decision Making

The process of identifying, evaluating, and choosing from at least two alternative courses of action. For business, management must choose in favor of the option most beneficial to the company in order to achieve company objectives.

Decision Making Process

1. Define the problem

2. Specify the objective and criteria

3. Identifying the alternative courses of action

4. Determining and evaluating the possible consequences of the alternatives.

5. Choosing the best alternative and making the decision.

6. Evaluating the results of the decision

Relevant Costs

Are future costs that are expected to be different among alternatives; it is oftentimes used interchangeably with terms like differential costs and avoidable costs.

Relevant Cost

A cost that differ between decision alternatives. It must be incurred in the future rather than the past.

Sunk Costs

Cost incurred in the past.

Irrelevant Costs

Are those costs that will not influence a decision.

Opportunity Costs

Income scarified or foregone when a certain alternative is chosen over another alternative. It is essentially zero when no alternative use for the productive facility is available.

Differential Costs

Increases or decreases in total cost that result from selecting one alternative instead of the other.

Avoidable Costs

Costs that will be saved or those that will not be incurred if a certain decision is made.

Sunk Costs

Costs that are already incurred and cannot be avoided regardless of what decision is made.

Out of Pocket Costs

Costs that will require expenditure of cash or incurrence of liabilities because of a management decision.

Joint Costs

Costs incurred in simultaneously manufacturing two or more products that are difficult to identify individually as separate types of products until the products reach a certain processing stage known as the split off point.

Split-Off Point

A point in the manufacturing process where some or all of joint products can be recognized as distinct and separate products.

Further Processing Costs

Costs incurred beyond the split-off point as separated joint products are to be processed further.

Bottleneck Resources

Any resource or operation where the capacity is less than the demand placed upon it.

Total Approach

Total revenues and costs are determined for each alternative, and the results are compared to serve as a basis for making decisions.

Differential Approach

Only the differences or changes in costs and revenues are considered.

Make or Buy a Part of a Product Line

Decision problem: Should a part or product be manufactured or bought from an outside supplier?

Decision: Choose the option that involves the lower cost. In most cases, fixed costs are irrelevant. Consider opportunity costs, if any.

Accept or Reject a Special Order

Decision problem: The selling price is usually lower than the regular selling price because of the special order. Is the order worth accepting? Are regular sales affected?

Decision: Accept the order when the additional revenue from the special order exceeds additional cost, provided the regular market will not be affected. In most cases, fixed costs are irrelevant. Opportunity cost is considered in case there are regular sales sacrificed in order to meet the special order.

Continue or Shutdown a Business Segment

Decision Problem: Should a business segment, which may be a product line, a department, or a branch be continued or discontinued?

Decision: Continue if avoidable revenue of the segment involved is greater than its avoidable costs; otherwise, consider shutting down the segment. Since allocated fixed cost is usually unavoidable, it is considered irrelevant.

Sell or Process Further a Product

Decision Problem: Should a product, after undergoing the joint process, be sold at the split off point or be processed further?

Decision: Process further if additional revenue from processing further is greater than further processing costs.

Product Combination

Decision Problem: Which products should be produced and sold when there are limited resources or bottleneck operations?

Decision: Identify and measure the constraint on the limited resources. Rank the products according to the higher contribution margin per unit of limited resource.

Change in Profit Factors

Decision Problem: Should any of the profit factors (selling price, unit sales, variable cost, fixed cost and sales mix) be manipulated to increase profit?

Decision: Identify the factor to change and the amount of contemplated change. Change the profit factor if it will cause an improvement on the company's overall profit position.

Make or Buy Decisions

Guideline: Compare the cost to make with the cost to buy and choose the least costly option.

Cost to Make

Avoidable VC (DM + Materials Handling + DL + VOH) + Avoidable FC + Opportunity Costs

Cost to Buy

Purchase Price + Materials Handling

Material Handling Costs

These are costs allocated to the product that passes thru the receiving department. The receiving department would check the validity of the material or product that enters the company and the costs incurred for checking would be allocated to the product.

Variable Selling and Administrative Expenses

The only variable costs that are unavoidable in a make or buy decision, thus irrelevant in relevant decision making.

Opportunity Costs

Are the income sacrificed or foregone when a certain alternative is chosen over another alternative.

Accept or Reject a Special Order

Guideline: Accept the order when the incremental revenue exceeds the incremental cost. Incremental costs would depend whether the company has excess capacity to satisfy the special order or not (the latter would incur opportunity costs).

Incremental Profit

Incremental Revenue - Incremental Costs (DM + DL + VOH + VSAE + Opportunity Costs + Additional FC)

Opportunity Cost in Accepting or Rejecting a Special Order When There is Already Maximum Capacity

The contribution margin lost on cancelled regular sales.

Continue or Shutdown a Business Segment, Product Line, or Branch

Guideline 1: Compute if avoidable revenue is greater than its avoidable cost.

Guideline 2: Look for the segment margin. If it is positive, better to continue. If the company has no choice but to drop a segment, drop the one with the least segment margin.

Avoidable Revenues

Sales Revenue + Opportunity Costs

Avoidable Costs

VC + Traceable FC + Avoidable Common FC + Other Avoidable Costs

Segment Margin

Sales - Variable Expenses = Contribution Margin - Traceable Fixed Expenses

Net Income of a Segment

Sales - Variable Expenses = Contribution Margin - Traceable Fixed Expenses = Segment Margin - Common Fixed Expenses

Sell or Process Further a Product

Guideline: Compare the additional revenue to additional costs.

Additional Revenue

Is the difference between the revenue (or selling price) after processing further while additional costs mainly pertain to the costs of processing further.

Joint Manufacturing Costs

Are irrelevant in the decision to sell or process further a product since these costs are sunk costs (incurred in the past and would not differ in the decision alternatives).

Incremental Revenue

Revenue or Selling Price After Processing Further - Revenue or Selling Price at Split-Off = Additional Revenue - Cost of Processing Further = Incremental Revenue

Product Combination

Guideline: Compute for the contribution margin per constrained resource and rank them from highest to lowest.

CM per Constrained Resource

Selling Price - Variable Cost per Unit = Contribution Margin per Unit / Constrained Resource per Unit (e.g. It takes 2 machine hours to produce 1 unit)

CM per Constrained Resource

Selling Price - Variable Cost per Unit = Contribution Margin per Unit x Number of Units Produced per Constrained Resource

Shutdown Costs

Are costs incurred even after operations temporarily stopped. Examples are, salaries of remaining executives and skeletal personnel, security, insurance, rental, interests, depreciation, property taxes, advertising, and similar unavoidable costs.

Restart-Up Costs

Include costs of rehiring and retraining personnel, refuelling, aligning, and returning machineries and equipment ,and refurbishing the plant.

True

(True or False) If continuing the operations will result to sales greater than the shut down point, it is better to continue operating and be spared or more losses from discontinuing operations.

Shutdown Point

Is the level of operations where the loss from continuing is equal to the loss from discontinuing.

Shutdown Point

Fixed Cost - Shutdown Costs / Unit Contribution Margin

Lowest Minimum Transfer Price

Variable Cost per Unit + Total Contribution Margin of Lost Sales/Total Units Transferred

Highest Maximum Price

Cost of Buying from Outside Supplier