relevant costing

tactical decision making

consists of choosing among alternatives with an immediate or limited end in view

• tend to be short-run in nature

• many short-run decisions have long-run consequences

• sound tactical decision-making means not only achieving limited objective but also serves a larger purpose

• ‘least cost’ alternative chosen

relevant cost

a cost that differs between alternatives

• only relevant costs should be considered in deciding which alternative to pick

avoidable costs

a cost that can be eliminated, either in whole or in part, by choosing one alternative over another

• always relevant

• ex: direct materials, direct labor, all variable costs, some fixed costs

unavoidable costs

a cost that exists under all decision alternatives

• never relevant

• ex: some fixed elements

allocated costs

a cost that can not directly link to a product or activity, therefore assigned to the product or activity using some sort of arithmetic process

• never relevant

• ex: rent & administrative salaries

sunk costs

a cost that has been incurred and can not be recovered or ‘un-incurred’ by some future action, regardless of the alternative chosen the sunk cost can not be recovered

• never relevant

• ex: original cost of a building is a sunk cost when trying to decide to sell 5 years later

opportunity costs

a benefit given up by choosing one alternative over another

• always relevant

examples of tactical decisions

• make or buy

• keep or drop

• special orders

• sell or process further

• product mix

make or buy decision

should a component part to the company’s product or service be produced internally or should the component part be purchased from an outside supplier (outsourcing)?

make or buy decision rule

BUY: avoidable costs + opportunity costs > outside purchase price

MAKE: avoidable costs + opportunity costs < outside purchase price

keep or drop decision

the company must decide whether a segment of a business should be kept or eliminated

keep or drop decision rule

DROP: avoidable fixed costs + opportunity costs > lost contribution margin

KEEP: avoidable fixed costs + opportunity costs < lost contribution margin

special order decision

orders that are not part of a company’s regular sales, typically one-time orders usually requested at a lower selling price than regular sales

special order decision rule

ACCEPT: actual selling price of special order > minimum acceptable selling price of special order

REJECT: actual selling price of special order < minimum acceptable selling price of special order

min acceptable selling price of special order formula

variable costs per unit of the special order + contribution margin lost from ‘given up’ sales

contribution margin ‘lost’ formula

CM per unit of regular sales x units of regular sales given up / units in the special order

sell or process further decision

• joint products

• split-off point

• joint cost

joint products

2 or more products produced from the same raw material input

split-off point

the point in the manufacturing process where each joint product can be recognized as a separate product

joint costs

costs incurred upp to the split-off point

sell or process further decision rule

process further only if: (sales value from further processing - additional processing fee) > sales value at the split-off point

product mix decision

the company should produce those products that have the highest CM per unit of scarce resource

CM per unit of scarce resource formula

contribution margin per unit / scarce resource need per unit

linear programming

mathematical technique used to determine the optimal mix of products

1. define your decision variables

2. determine the objective function (always maximize CM)

3. determine the resource constraints

4. solve the linear program to determine the optimal product mix