Management Accounting 2

Relevant Costs: Future costs that differ between alternatives.
Irrelevant Costs: Include sunk costs, allocated costs, and future costs that do not differ between alternatives.

Some decision-making factors cannot be quantified monetarily, labeled as qualitative or non-financial factors.
- Example: Employee morale decline due to layoffs.
Qualitative factors must be considered alongside financial factors to avoid misguided decisions.
- Example: Buying components from a supplier might cut costs but can harm internal production and employee morale.

Refers to pricing outside the main market, often for one-time orders at lower than normal prices.
- Example: Caledonian Company has production capacity for sweaters and considers an overseas order at £20 per sweater despite its costs being £33.

Cost Components:
- Direct Labour: Fixed for the quarter.
- Manufacturing Overheads: Fixed, thus irrelevant to the decision.
- Variable Costs: Relevant; these include direct materials, variable overheads, etc.
Contribution from accepting the order calculated by relevant revenues vs. relevant costs.

In short-term scenarios, some fixed costs can be deemed irrelevant; in the long term, these costs can become relevant depending on capacity management.

Limiting Factors: Identify which resource (like skilled labour) is restricting output.
Profit maximization involves focusing on products with the highest contribution margin per limiting factor.
- Example: Ranking crops in agriculture based on contribution per square meter.

Relevance of Past Costs: Original purchase price of an asset is irrelevant for making future decisions. Only future costs and revenues are pertinent.

Outsourcing involves contracting out components or processes that were previously done internally.
Focus on Relevant Costs: Only costs that will change must be considered. Fixed costs that remain unchanged regardless of the decision are irrelevant.

When analyzing whether to discontinue a product, only the costs that will be saved should be included, excluding fixed costs that will be incurred regardless.

After-tax cash flows should be used to calculate the NPV of projects, as tax obligations can affect the cash received from investments.
The company needs to account for tax depreciation and effective rates when analyzing investment projects.

differential cash flows (incremental cash flows) : cash flows that will be affected by a decision that is to be taken
facility sustaining costs: costs to support the organization as a whole -not affected by decisions
opportunity costs: costs that measures the opportunity that is sacraficed by decision
limiting factors: scarce resources that constrain the level of output
written down value: original cost of asset minus depreciation
Relevant Costs: Future costs that will differ by decision.
Sunk Costs: Past incurred costs that cannot be recovered and should not influence current decisions.
Opportunity Cost: Financial benefits foregone by choosing one alternative over another.
Net Present Value (NPV): The present value of net cash inflows minus the initial investment outlay, used to assess project profitability.
Internal Rate of Return (IRR): The discount rate that results in an NPV of zero, indicating the project's profitability.
Payback Period: The time taken for cash inflows to repay the initial investment, ignoring the time value of money.
Accounting Rate of Return (ARR): Calculates returns by dividing average annual profits by the average investment, typically used in external financial performance evaluations.