Relevant Costs 1

Relevant revenue

(i.e. relevant costs are merely negative relevant revenues and vice versa).

Joint product environment

1. Products are not separately identifiable until after the split-off point 2. The costs incurred up to the split-off point cannot be separated or avoided.

Types of Decisions Using Relevant Costs

1. Whether to process a product further or sell it now 2. Whether to keep or drop a product line or company segment 3. Whether to make or buy a product or component 4. Whether to accept or reject a special order

The identification of relevant costs

A critical component in many production decisions. Should we buy a component or make it ourselves? Should we process a product further or sell it now? Should we keep producing a product or drop it?

Sunk costs

A sunk cost is a cost that has already been incurred and cannot be changed. For example, when deciding whether to buy a new car or keep your current car, the price paid for the current car is irrelevant as it occurred in the past and cannot be changed. On the other hand, the market value of the current car if you sold it is relevant to the decision as it differs between the two alternatives: if you buy the new car, you can sell the current car for its market value; if you keep the current car, you forgo receiving its market value.

Opportunity Costs

Avoidable costs are ?. Unavoidable costs are not ?. ? generally include relevant costs.

Avoidable costs

Costs that can be eliminated by choosing one alternative over the other—are relevant costs. Opportunity costs—the benefits that are foregone when the selection of one course of action precludes another course of action—are also relevant costs.

Unavoidable costs

Costs that will remain the same regardless of which alternative is chosen—are irrelevant to the decision process.

Output

Fixed costs are fixed with respect to ?

Unavoidable Costs

Fixed costs are not equivalent to ?. ? cannot be changed while fixed costs can change

Future costs and benefits that do not differ between alternatives

Future costs that do not differ between alternatives tend to be fixed costs or allocated costs.

Sunk costs, Future costs and benefits that do not differ between alternatives

Irrelevant costs Categories

Incremental cost

Is the difference between two decision alternatives.

Accounting cost

These are costs that can be found in the fundamental books of record (e.g. the general ledger).

Opportunity cost

This is the benefit foregone that results from choosing one alternative course of action rather than another (generally, the next-best foregone alternative).

Marginal cost

This is the cost of producing one more unit.