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CHap 7

5 Pages

Course Code
ACC 406
George Gekas

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Relevant Costing 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 Costing 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) Some advice: 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. 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 perspective. 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 almost fixed. Pricing decisions tend to be more opportunistic and largely depend on demand. Fixed Manufacturing costs seem irrelevant as emphasis is given to variable costs. Non manufacturing costs are also irrelevant. Price must cover incremental costs including lost revenues on existing sales if price change is contemplated. In the Long run: Most costs can be changed and therefore may be considered as variable. 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
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