Unit
l i ill02 : Decision
list s in 1 Making
h
Techniques
511 i
i
11
In this chapter we focus on a number
of shortterm decisionsmadeby a
business
MakeversusBuy decisions
shutdown decisions
one off contract decisions nonrecurring
Furtherprocessing decisions
Relevant CostAnalysis
Decision making involves making a choice between 2 or more alternatives
When a business is making one
of the shortterm decisions it shouldconsider
onlyRelevant cashflows that arise as a resultof thatdecision
Relevant cashflow
if
cashposition proposal
isaccepted
cashp.gs proposal
Relevantcosts are costs related to specificmanagement decisionsrepresented
future incrementalcashflow
future mustincur in future
onlyextracashflow as a resultofdecision
unlessincremental incremental
big ignored
s houldbeignored
committedcosts cashflow onlycash flows relevant to decision
opportunitycosts beincluded
should
Opportunity cost it is thevalueofthe bestalternative foregone when
particulardecision or course ofaction is chosen It arises due to a number
ofpossibleusesofscarce resources and is relevant in decision making
Avoidable cost specificcosts an activitywhich wouldbe avoided the
of if
activity didnotexist Usuallyrelated to shutdown decisions and are relevan
Sunkcost coststhat are already incurred irrelevant in decisionmaking
Committedcost costs already committed to a particular activity or
function hence not relevant in decision making
Relevant costs Irrelevantcosts
opportunity Available
If copiited Not
I
, Notionalcosts non cashitems or accounting entries
Relevantcost materials
of
material
whenmaterial is already available frequentlyused fastmoving thecurrentpurch
aii
acaruses
wijait.ae ii
n one
price priceor replacementcost is relevantcost
whenmaterialis alreadyavailable rarelyused slowmoving NRVor opportunitycost
iii
eame.in
iri tinits
istherelevantcost
whenmaterial istobespecificallyprocured MPor outofpocketcostis relevantcost
ofa material is
in short supply the onlyway a proposal can beundertaken
would be denying anotherpartof the organisation thatresource Inthis car
relevantcost
normalmaterial cost other
qptitmut.is in
Relevantcost
oflabour
Whenthereis excesscabour alreadypaid
for itis a committedcostandthusnot a
ini k
spare
c apacity
can anitbe
relevantcost
isiiqreciiit.fi when cabouris inshortagethedecision mayrequire redirectionof
exciting labourfro
frigate tn
current
joborprocess tothenewjob Thisresults in the opportunitycostbecoming
relevant
fordecisions
Whenworkersare tobe specificallyprocured outofpocketexpensebecomes relevantto
decision
making
RelevantC ost
ofOverhead
Variableoverheads are alwaysrelevant unless they are sunkcosts
Fixed overheads are always irrelevant except in the followingcircumstances
specificallyincurred avoidable or discretionary
incremental in nature opportunity finedcost
, CostVolume Analysis
CUPanalysis is a technique used to explore the relationship between cost volume
profits It aimsto measure howvariations in these 3 components affectseachother
relies on marginalcostingprinciples forplanning
shortterm decision making
BreakEvenPoint Fixedcost BEsales or FixedCost β or
PVRatio contributionpu
Fixedcost Depreciation
cashBEP
contributionPu
Marginofsafety TotalSales BEPsales
Profit Profit
Puratio contributionPU
PVRatio contributionpu
sellingpricepu
indifferencePoint
piratio difference
difference incontribution
iiiit
shutdownpoint
Pricing decisions
TrueEconomicValue TEV alsoknown as objectivevalue measures thebenefits a
productdeliversrelativetoalternatives
TEV costofnextbestalternative
valueof performancedifferential
Pricesensitivity it measures nowcustomerbehaviourchangeswithpricevariations Sensitivit
islowerwhentheproducthas a uniquevalue highswitchingcosts orwhencostisshared
l i ill02 : Decision
list s in 1 Making
h
Techniques
511 i
i
11
In this chapter we focus on a number
of shortterm decisionsmadeby a
business
MakeversusBuy decisions
shutdown decisions
one off contract decisions nonrecurring
Furtherprocessing decisions
Relevant CostAnalysis
Decision making involves making a choice between 2 or more alternatives
When a business is making one
of the shortterm decisions it shouldconsider
onlyRelevant cashflows that arise as a resultof thatdecision
Relevant cashflow
if
cashposition proposal
isaccepted
cashp.gs proposal
Relevantcosts are costs related to specificmanagement decisionsrepresented
future incrementalcashflow
future mustincur in future
onlyextracashflow as a resultofdecision
unlessincremental incremental
big ignored
s houldbeignored
committedcosts cashflow onlycash flows relevant to decision
opportunitycosts beincluded
should
Opportunity cost it is thevalueofthe bestalternative foregone when
particulardecision or course ofaction is chosen It arises due to a number
ofpossibleusesofscarce resources and is relevant in decision making
Avoidable cost specificcosts an activitywhich wouldbe avoided the
of if
activity didnotexist Usuallyrelated to shutdown decisions and are relevan
Sunkcost coststhat are already incurred irrelevant in decisionmaking
Committedcost costs already committed to a particular activity or
function hence not relevant in decision making
Relevant costs Irrelevantcosts
opportunity Available
If copiited Not
I
, Notionalcosts non cashitems or accounting entries
Relevantcost materials
of
material
whenmaterial is already available frequentlyused fastmoving thecurrentpurch
aii
acaruses
wijait.ae ii
n one
price priceor replacementcost is relevantcost
whenmaterialis alreadyavailable rarelyused slowmoving NRVor opportunitycost
iii
eame.in
iri tinits
istherelevantcost
whenmaterial istobespecificallyprocured MPor outofpocketcostis relevantcost
ofa material is
in short supply the onlyway a proposal can beundertaken
would be denying anotherpartof the organisation thatresource Inthis car
relevantcost
normalmaterial cost other
qptitmut.is in
Relevantcost
oflabour
Whenthereis excesscabour alreadypaid
for itis a committedcostandthusnot a
ini k
spare
c apacity
can anitbe
relevantcost
isiiqreciiit.fi when cabouris inshortagethedecision mayrequire redirectionof
exciting labourfro
frigate tn
current
joborprocess tothenewjob Thisresults in the opportunitycostbecoming
relevant
fordecisions
Whenworkersare tobe specificallyprocured outofpocketexpensebecomes relevantto
decision
making
RelevantC ost
ofOverhead
Variableoverheads are alwaysrelevant unless they are sunkcosts
Fixed overheads are always irrelevant except in the followingcircumstances
specificallyincurred avoidable or discretionary
incremental in nature opportunity finedcost
, CostVolume Analysis
CUPanalysis is a technique used to explore the relationship between cost volume
profits It aimsto measure howvariations in these 3 components affectseachother
relies on marginalcostingprinciples forplanning
shortterm decision making
BreakEvenPoint Fixedcost BEsales or FixedCost β or
PVRatio contributionpu
Fixedcost Depreciation
cashBEP
contributionPu
Marginofsafety TotalSales BEPsales
Profit Profit
Puratio contributionPU
PVRatio contributionpu
sellingpricepu
indifferencePoint
piratio difference
difference incontribution
iiiit
shutdownpoint
Pricing decisions
TrueEconomicValue TEV alsoknown as objectivevalue measures thebenefits a
productdeliversrelativetoalternatives
TEV costofnextbestalternative
valueof performancedifferential
Pricesensitivity it measures nowcustomerbehaviourchangeswithpricevariations Sensitivit
islowerwhentheproducthas a uniquevalue highswitchingcosts orwhencostisshared
