Relevant cost: Relevant costs are the costs that differ between alternatives. Sunk costs and future costs that will not differ between alternatives are irrelevant costs.
Relevant costs are used to make the following decisions
1. Make or
Buy Decisions: - Decisions about
producing a product in-house or purchase it from outside suppliers. Fixed costs of production are irrelevant
here, only variable costs of manufacturing should be considered for making such
decisions.
2. Accepting
or Rejecting Special Orders: - Decisions
about whether receiving a special order from customers or not. For making such decisions
only the costs associated with carrying the special order should be considered
and if it is considered that current sales will not be affected by choosing the
special order then the company may accept that order.
3. Adding
or Dropping a Product Line: - Decisions
about adding a new product line or dropping a losing unit. If a unit is making
loss then it does not mean that the unit should be dropped. If the
contributions from the loosing unit can contribute to the allocated fixed costs
then the unit should not be dropped.
4.
Utilization of constraint resources: - Resources are always limited so we need to use resources in a way
that will generate optimum gain. For example ABC Company produces two products,
Product X and Y. Product X require 1 machine hour per unit and product Y requires
1.5 machine hours per unit. Per machine hour product X contributes tk.2,
Product Y contributes tk.3. ABC Company has limited machine hours so it will
pay first preference for utilization of machine hours to product Y because it
contributes more than Product X per machine hour.
5.
Decisions about selling or further processing: - In some industries, a number of end products are produced from a
single raw material input. Two or more products produced from a common input
are called joint products. The point where each
joint product is recognized as separate product is called the split off point.
Some products need further processing after the split off point. If incremental
revenue is greater than the incremental costs of further processing then we
will do further processing.
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