Relevant cost refers to the incremental and avoidable cost of implementing a business decision. In managerial accounting, costs relating to decisions executives are able to make. We have seen how costing systems calculate product costs. In cost accounting, qualitative factors dont involve numbers and financial analysis. Every cost is either relevant or not with respect to a.
Relevant costs in decision making relevant to paper ii pbe management accounting and finance lee siu po, simon, the chinese university of hong kong in management accounting, you often hear the term relevant cost. The loss of profits will happen in future if production is stopped. Relevant, of course, refers to the cost and revenue that makes a difference when you make decisions. In cost accounting its necessary to connect the relevant cost and relevant revenue to the capacity planning. The change will have no effect on production costs, other than some savings in direct. Relevant costs also exclude any costs that are beyond your decision authority. Considered a key function within management accounting, the idea behind this type of cost definition is to determine how the budget will be impacted if a particular course of action is pursued. If the labour force is at full capacity then the relevant cost will be the opportunity cost of lost contribution from existing production being stopped to carry out the work on the new contract. For example, employee salaries may be a relevant cost because executives usually decide how much to pay their employees and can raise or lower them according to need and efficiency. A relevant cost is a cost that only relates to a specific management decision, and which will change in the future as a result of that decision.
The primary machine used to manufacture the action figures is the model a15 machine. Identification of relevant costs in the decision to. In order for a cost to be a relevant cost it must be. Relevant costing is often used in shortterm decisionmaking and a number of specific. They can have a longterm impact on profitability, so you need to consider them. The term relevant cost is used to describe not only changes in cost but also changes in revenue. It is often important for businesses to distinguish between relevant and irrelevant costs when analyzing alternatives because erroneously considering irrelevant costs can lead to. Relevant costs are incremental costs and it is the increase in costs and revenues that occurs as a direct result of a decision taken that is relevant. Cost or expense attributable or chargeable to one or more activities on the basis of benefits received or some other logical relationship. Consequently, it is important to formally define and document those costs that should be excluded from consideration when reaching a decision.
The classification of costs between relevant costs and irrelevant costs is important in the context of managerial decisionmaking. Relevant costs and revenues are simply cash flows that arise as the result of a decision. We now ask how the numbers generated by the accounting system should be used for decision making. Relevant costs financial definition of relevant costs. For example, if a company is deciding whether to expand its sales territory, the real estate tax and depreciation on the companys headquarters building is not relevant. Relevant costs are defined as the costs that arise in future and are different for different alternatives. You have been asked to determine the relevant cost of 600 kgs of material x to be used in a job for a customer. If numerico does 40 hours of work in a week the situation is. A current or future cost that will differ among alternatives.
These are costs which would not be incurred if the activity to which they relate did not exist. A pastry chef creates and delivers specialty desserts to local restaurants and had. In managerial accounting, this term is synonymous with avoidable cost and differential cost. It examines the relevant cost of variable costs and overheads, decisionmaking based on relevant costing principles, and includes multiple illustrations throughout. The relevant cost is the cost of loading and unloading the additional cargo, and not. Sunk costs refer to expenses that have already been incurred and arose as a result of decisions taken in the past. Relevant cost and decision making cost expense scribd. Publishers pdf, also known as version of record includes final. Fulltime employed staff working on a project would be paid whether a particular project was in place or not and so is not deemed relevant. Relevant product market 17 when defining the product market, first of all, a preliminary opinion is prepared based on the existing information or the information provided by the undertakings parties to the case. In order to properly evaluate the situation, it is necessary to look at all current costs, and. An amount that has been allocated to an income or expense, which can be adjusted to meet the actual price of what was charged by the company. Irrelevant costs are those that are not tied to a particular management decision.
Relevant costs will vary based on the context of the decision, such as an omnichannel business analysis by a multiplatform retailer. Concept, applications and limitations of relevant cost in decision making. Concept of relevant costs are used by management for making various decisions such as special or onetime order pricing, make or buy decisions, add or drop product lines, insourcing vs. Difference between sunk cost and relevant cost compare. The targetcosting method is an essential step in developing management methods established by the analysis current based on.
Relevant cost is closely linked to incremental analysis, and refers to costs which differ across decision or situation. For example, a company truck carrying some goods from city a to city b, is loaded with one more ton of goods. Chapter 11 relevant cost and decision making 238 ap2 1 wentworth toys is a manufacturer of action figures for children. An irrelevant cost is a managerial accounting term that represents a cost, either positive or negative, that does not relate to a situation requiring managements decision. Relevant costs can be defined as any cost relevant to a decision. Relevant cost is a managerial accounting term that describes avoidable costs that are incurred when making business decisions.
Relevant cost of labor is the incremental and avoidable cost of labor that is incurred as a consequence of a business decision. Meaning, expenditure which will be incurred or avoided as a result of making a decision. Definition of incremental cost an incremental cost is the difference in total costs as the result of a change in some activity. They do not change as an effect of a given management. Relevant costs for decision in an effective controlling system. Relevant costing practice question by muzzammil malik. These establish the definition of relevant costs, as well as identify synonymous. This cpe course explores relevant costs and revenues, including characteristics of relevant costs, nonrelevant costs, opportunity cost, as well as incremental revenue. Learn vocabulary, terms, and more with flashcards, games, and other study tools. Relevant costs vs irrelevant costs explanation examples. Part 1 relevant costs for decision making sunk and. Relevant costs for decision in an effective controlling system 53 accountancy in terms of advanced technologies is closer to the target cost.
Cima p2 course notes chapter 1 relevant costs and decision. In the short term, decisions are made within the given capacity limitations and the ultimate objective is to maximize shortterm profits. Basic concepts thus far, we have focused on the mechanics of cost accounting systems. They exclude costs that are already committed, contractual obligations and expenditures required by laws and regulations such as taxes. This is used to exclude sunk costs, committed costs and noncash costs from decision making as considering these costs is typically illogical. Opportunity costs revenues or profits foregone by choosing an alternate course of action. An objective measure of the cost of a business decision is the extent of cash outflows that shall result from its implementation.
Common costs can be ignored for the purpose of decision making. For example, the opportunity cost of you being here is the. Relevant costing is a management accounting term that relates to focus on only. We can also understand how opportunity costs are also relevant costs by putting the opportunity cost accepting customers order in our example against the basic three points criteria of relevant cost. Relevant costs management needs sufficient and relevant information make the correct decisions. Pdf relevant costs for decision making olamigoke alade. Relevant cost, are costs incurred at a future time that differ between each option available to the management.
Start studying ch relevant costs for decision making. However, the same cost may be relevant to a different management decision. A matter is relevant if there is a change in cash flow that is caused by the decision. For instance, staff are not always a relevant cost. If a cost is going to occur regardless of the decision being examined, it is not a relevant cost. Applicability of relevant cost concepts material requirement decision according to relevant cost concept, if material is purchased specially forthe project, the relevant cost is the purchase price. If a cash flow if unaffected by a decision then it is not relevant. Relevant and irrelevant costs for short term decision making. Incremental costs are also referred to as the differential costs and they may be the relevant costs for certain short run decisions involving two alternatives. What is opportunity cost and why is it a relevant cost as. Relevant costs are expenditures that are within your power to change in the context of a particular decision or strategy.
Relevant definition, bearing upon or connected with the matter in hand. A relevant cost also called avoidable cost or differential cost is a cost that differs between alternatives being considered. Relevant cost financial definition of relevant cost. After studying this chapter, you should be able to. In any managerial decision involving two or more alternatives, the prime focus of analysis is to find out which alternative is more profitable. Relevant cost and decision making free download as pdf file. Sunk cost vs relevant cost sunk costs and relevant costs are both expenses that result in an outflow of cash and reduce a firms income and profitability. The exact opposite of a relevant cost is an irrelevant cost.
Relevant cost definition and explanation with example. Some costs may be irrelevant under some circumstances but relevant under others. A relevant cost is a future cash cost that is relevant to a particular decision. A cost that differs between alternatives in a particular decision. The company is considering replacing the old model a15 machine with a new model b20 machine. Any costs which would be incurred whether or not the. Relevant cost is any type of cost that is subject to change, depending on what kind of decision is made. An irrelevant cost is a cost that will not change as the result of a management decision. Managerial and cost accounting kenyatta university. Relevant cost is closely linked to incremental analysis, and refers to costs which differ across decision or situation alternatives. However hiring temporary staff to work on a specific project is an incremental relevant cost of this project, so it must be included. Tweet whether in cost or managerial accounting, we need to understand what are relevant cost, criteria or nature and the benefits or usefulness of understanding relevant costs in decision making. Decisions based in part on qualitative factors are relevant, even though you cant tie specific cost or revenue numbers to them. The concept of relevant cost is used to eliminate unnecessary data.
Relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions. In management accounting, you often hear the term relevant cost. The relevant cost concept is extremely useful for eliminating extraneous information from a particular decisionmaking process. Financial statement issues that are unique to manufacturers 5. The relevant cost of labour for a new contract will therefore be dependent on whether the labour force is at full capacity or has spare capacity. Difference between relevant cost and irrelevant cost. Relevant costing is an incremental analysis which means that it considers only relevant costs i.
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