Dr. George Andrew Gekas
These notes are posted on blackboard to high light and complement certain aspects
of the topic, facilitate those students who may have missed my lecture,
balance traditional with internet based learning and overall enhance
student’s learning. The notes are not meant to suggest what may be in the
exams, replace textbook studying and/or problem solving.
Relevant costs are defined as future costs and revenues that are
Relevant to making decisions.
Relevant costs to pricing decisions include:
Expected future costs
Differential or incremental costs
Variable costs (material, labour, overhead)
Value of new Equipment
Depreciation of new equipment
Cash flows derived from disposing old equipment if a replacement
decision is made.
Irrelevant Costs to pricing decisions may include:
Historical costs (sunk Costs)
Common to all options costs
Fixed Costs (no matter what option is followed are the same)
Book value of old Equipment
Depreciation of old Equipment (It is unavoidable costs)
Using total, not unit costs, for decision making may be
advantageous. If the unit costs were developed at a different
level of activity than the one relevant for the decision in hand.
Total costs may be better.
www.notesolution.com Along run view of relative costing may be better than a short
run view. Cash flows over the entire life of an asset may be
superior to the cash flows in a given year.
Opportunity costs do not entail cash receipts or disbursements
so they are not part of pricing decisions. However, they should
be included in the calculations of examining and choosing
among alternatives, since the benefits from choosing alternative
A may be reduced by not choosing alternative B.
Fair process are a compromise between “full” costs and an
approximation of “Real” costs
Pitfalls of relevant costing
It puts too much emphasis on unit costs. Unit costs may be misleading or
irrelevant costs may be included in the unit costs as they may correspond to
different output levels.
Short /Long Term Considerations
Cost management largely depends on adopting either a short or long term
Short term perspective is considered a time frame less than a year.
Long term perspective is considered a time frame more than a year.
In the short run:
Fewer cost are relevant because they can not be altered, they are
Pricing decisions tend to be more opportunistic and largely depend on
Fixed Manufacturing costs seem irrelevant as emphasis is given to
Non manufacturing costs are also irrelevant.
Price must cover incremental costs including lost revenues on
existing sales if price change is contemplated.
www.notesolution.com In the Long run:
Most costs can be changed and therefore may be considered as
Pricing is made with a particular ROR in mind. Cost plus the required
rate of return) may determine a minimum price.
Full costs are charged to determine price.
Customers and demand of for the product is first examined before the
“right” price is determined
Prices in the long run are more stable and therefore more predictable