Relevant Costing Definition and Identifying Relevant Costs
Basics of decisions making Relevant Cost – Future cost that changes between two
alternatives
Information is essential to arrive at a sound
decision Examples of relevant Cost: (VAMOS)
Information is gathered from internal and
a. Variable Cost
external services
b. Avoidable/Incremental Cost – net increase or
Information is a combination of quantitative
decrease in Fixed cost
and qualitative decision
c. Imputed Cost – estimated cost, relevant only
More information = Much better when estimated
d. Opportunity Cost – cost of giving something up
The decision-making process
e. Savings
a. Define the problem
Note: If there is change in cost, it is relevant. Allocated
b. Obtain information
cost is completely ignored. If cost is unavoidable in the
c. Identify alternatives
long-run, it is irrelevant.
d. Determine the possible consequences of the
alternatives Irrelevant costs:
e. Choose the best alternative and implement the
a. Sunk Cost –
decision
a. Historical cost that will no longer
f. Evaluate performance
change between two alternatives
b. Examples – Joint cost in sell-as-is or
process-further, cost of obsolete
Approaches in analyzing alternatives
inventories, and cost of old equipment
Total Approach vs Differential analysis approach in replacement decisions. IF JOINT COST
AUTOMATIC IRRELEVANT
Total Approach b. Committed Cost –
Analyzes information by preparing complete set a. Cost that a company is obligated to
of financial reports for each alternative incur and can not get out of it
Reports include all revenues and expenses b. Example is Rent expense arising from
whether relevant or not contract of lease
This approach is not advisable because it tends c. Discretionary Cost –
to become misleading because of the inclusion a. Inherent to operations. It can be
of irrelevant costs delayed in the current perio d but
eventually will be incurred.
Differential Analysis b. Examples – Repairs and maintenance,
Analyzes only information that changes training, and development, advertising
between alternatives
Costs that will remain the same are executed
This method is preferred over the total
approach because it is simple and easy to
analyze
Decision Making Guide – General rule
Quantiative Approach vs Qualitative approach
Quantitative Approach –
deals with analyzing factors that are measurable
in terms of peso impact on profits. The basic
rule is choose the alternative that will increase
profits
Most quantitiatve approaches deal with short-
term costs
Qualitative Approach –
deals with analyzing non-financial factors that
will indirectly affect profitability
The guideline is to choose the alternative that
will possibly increase company profitability in
the long-run
Indifference Point
The point wherein the cost of alternatives are
the same
Under these conditions, the decision maker will
heavily rely on qualitative information to
determine the best alternative
Under what situation will I need to analyze
When analyzing alternatives, identify the
alternative that will create a change in net
income
Tactical Decision making
Make or buy (in-sourcing vs outsourcing)
Analysis of avoidable costs. If you make you will
avoid the cost of buying, and if you buy you will
avoid the cost of making. Choose the option
that involves the lowest cost.
Relevant cost to make usually includes variable
costs whether manufacturing, selling, or
administrative costs; avoidable fixed costs; and
opportunity costs. Opportunity costs arises if
ther are alternative uses of facilities used to
make the component.
Relevant cost to buy usually includes acquisition
price and incidental costs related to the
purchase such as freight-in, inspection cost, and
set-cost of the component.
Qualitative factors include employee morale if
the component was purchases and the quality
of the component if purchased.
