What are relevant costs?
Relevant costs are future costs that will change depending on the decision taken. Common relevant costs are direct materials,labour and variable overheads, avoidable fixed costs and opportunity costs.
What are sunk costs?
These are to be ignored as they are past costs that have already been incurred and cannot be changed. Such as historical training costs, assets etc.
What are opportunity costs?
Opportunity costs are the benefit foregone by choosing one option over the next best alternative. So using the labour for one product means the other product cannot use it.
What are avoidable fixed costs?
Fixed costs that stop if the activity stops.These can be eliminated if the decision is taken and they are relevant. Such as supervisor salary if department closes or machine lease that can be cancelled.
What are unavoidable fixed costs?
These will incur anyways and are not relevant such as rent or depreciation. These will be ignored.
What are variable costs?
These are usually relevant because they change with the output.
What are irrelevant costs?
These are normally
Sunk costs
Unavoidable fixed costs
Allocated overheads
Book values of assets
What is a make to buy decision?
This is where a business decides if to make a product internally OR buy it externally from a supplier. The aim is to choose the option with the LOWEST RELEVANT COST (or highest contribution)
How do you answer Make to buy questions?
IGNORE SUNK AND UNAVOIDABLE FIXED COSTS
include direct materials, direct labour, variable overheads, avoidable fixed costs, opportunity costs
Compare to relevant cost to make
Cost to buy
Choose the cheaper option
What is a special order?
This is a one off order that is offered at a lower price.
How do you answer special order questions?
Identify incremental revenue
Identify incremental costs
IGNORE EXISTING FIXED COSTS (unless avoidable)
Accept order if the revenue is greater than costs as increases overall contribution
For a special order what happens if there is no spare capacity?
Opportunity cost of lost normal sales must be considered
What is a limiting factor?
A limiting factor is anything that restricts production. The aim is to maximise contribution and produce highest contribution per limitating factor
What is dropping a product or division?
This is relating to deciding whether to stop producing a product or close a division down based on contribution. IGNORE UNAVOIDABLE FIXED COSTS.
What is the golden rule for product dropping?
A product should only be dropped if the avoidable fixed costs saved are GREATER than the contribution lost.
What is the decision rule for dropping a product?
If fixed costs saved is greater than contribution lost DROP
if contribution lost is greater than fixed costs saved KEEP
What are shutdown decisions?
These are short term decision made if a factory or product is making a loss.
How are shutdown decisions made?
If the contribution is greater than unadvoidabke fixed costs then CONTINUE
if the contribution is less than unavoidable fixed costs then SHUT DOWN TEMPORARILY
Can you name some qualitative factors that can be included in task 5?
Customer satisfaction and loyalty
Staff morale and turnover
Product reliability and defects
Brand reputation
