Short-Run Decision Making-Using Relevant Cost and Revenue Information
SHORT-RUN TACTICAL DECISIONS
The organizations strive to earn short-run profits. In making short-run decisions, not all cost and revenue data is relevant. The cost data relevant for decision-making is referred to as relevant costs and that which is not useful for decision-making is non-relevant costs.
On the revenue side, the only relevant revenue is the incremental & differential revenue.
Relevant and Non-Relevant Costs:
1. Future Costs and Sunk Costs (IR): A future cost is that cost yet to be incurred and since the decision is in the future, future costs are relevant.
A sunk cost is a historical cost which has already been incurred and cannot be reversed hence irrelevant for decision-making.
2. Incremental Costs and Deferential Costs: An incremental cost is that which increases or decreases due to the change in the operating level in a particular decision made.
A differential cost is that which differs between alternatives. All these costs are relevant.
3. Out of Pocket Costs and Imputed Costs (Notional Costs): Out of pocket cost is an actual cash outflow and is relevant for decision-making. Imputed costs are book costs e.g. depreciation & notional rent, and are irrelevant for decision-making.
4. Committed Costs and Directly Attributable Fixed Costs: A committed cost is a contractual cost to be incurred in the future, it is irrelevant for decision-making. Directly attributable fixed costs are those fixed costs which arise because of directly engaging in a particular production line. They are relevant for decision-making.
NB: It is clear that not all future costs are relevant and also not all fixed costs are irrelevant.
5. Opportunity Cost: This is a value of second best alternative or it is the value of the best alternative foregone, it’s relevant.
6. Controllable and Avoidable Costs: A controllable cost is that which can be influenced by management decision. Avoidable cost
The organizations strive to earn short-run profits. In making short-run decisions, not all cost and revenue data is relevant. The cost data relevant for decision-making is referred to as relevant costs and that which is not useful for decision-making is non-relevant costs.
On the revenue side, the only relevant revenue is the incremental & differential revenue.
Relevant and Non-Relevant Costs:
1. Future Costs and Sunk Costs (IR): A future cost is that cost yet to be incurred and since the decision is in the future, future costs are relevant.
A sunk cost is a historical cost which has already been incurred and cannot be reversed hence irrelevant for decision-making.
2. Incremental Costs and Deferential Costs: An incremental cost is that which increases or decreases due to the change in the operating level in a particular decision made.
A differential cost is that which differs between alternatives. All these costs are relevant.
3. Out of Pocket Costs and Imputed Costs (Notional Costs): Out of pocket cost is an actual cash outflow and is relevant for decision-making. Imputed costs are book costs e.g. depreciation & notional rent, and are irrelevant for decision-making.
4. Committed Costs and Directly Attributable Fixed Costs: A committed cost is a contractual cost to be incurred in the future, it is irrelevant for decision-making. Directly attributable fixed costs are those fixed costs which arise because of directly engaging in a particular production line. They are relevant for decision-making.
NB: It is clear that not all future costs are relevant and also not all fixed costs are irrelevant.
5. Opportunity Cost: This is a value of second best alternative or it is the value of the best alternative foregone, it’s relevant.
6. Controllable and Avoidable Costs: A controllable cost is that which can be influenced by management decision. Avoidable cost
References: proposed reading list ACCA F2 Management Accounting Atkinson et. Al (1997) Management Accounting Collin Drury (1996, 2000, & 2004), Management and Cost Accounting, up to 4th Edition Hongren . T. Charles (1991-2002), Cost Accounting, Dp Publications. M. Arora (1996, 2001), Costing Principles N. a Saleemi, (2007) Cost accounting simplified (Revised 2007/08 Edition) T. Lucey (1996), Cost Accounting. DP Publications, Wilson & Chua, (1993), Managerial Accounting, Managerial Accounting, Method and meaning, Hpman Hall