Relevant Costs and Revenues for

Decision-making
Each decision point is a unique opportunity, which
often requires relevant specialist information to back
the decision.
The primary role of the accountant in the decision-
making process is to provide this information which
may be constructed or revised to fit a specific problem.
Costs and revenues appropriate to a specific
management decision
Relevant costs and revenues as defined by CIMA Official Terminology

Historic and sunk costs

Incremental costs
Opportunity costs
Replacement costs
Cost that has been irreversibly incurred or
committed and cannot therefore be
considered relevant to a decision
Sunk cost as defined by CIMA Official Terminology
Sunk costs (machinery) should be ignored.

Food Land Limited

is 5,000 better off
by altering rather
than selling
immediately.
Incremental costs are the changes in future
costs and revenues that occur, as a result of
decisions
At first it would seem foolish to accept the deal offered by Duncan Tours.
However by accepting the tour companys offer, the fixed costs will not
change in total. Only sales and variable cost will change. Sales will
increase by 20 per bed-night taken up and variable costs will increase by
15 per bed-night taken up. These are the incremental costs and benefits.
As the benefits outweigh the costs, the offer should be accepted. The
business would lose out on extra profit of 9,750 (1,950 rooms x 5 (20 -
15)) if all the spare capacity (rooms) were not taken up by the tour
company.
The value of the benefit sacrificed when one
course of action is chosen in preference to
an alternative
Opportunity cost as defined by CIMA Official Terminology
Cost of replacing an asset
Replacement cost as defined by CIMA Official Terminology
Decision to outsource
Decision to discontinue a department
Decision for partial closure
Special pricing decisions
Decision-making with Limiting Factors
Fixed overhead will not change irrespective of the decision and is irrelevant. The
relevant costs are materials, labour and supervision amounting to 157,000.

Comparing this to the cost of outsourcing at 175,000, the hotel should retain its
cleaning department.
As the department
has a positive
contribution it
should remain
open

By closing the
baby department,
overall profit fall by
30,000 the lost
contribution from
the Baby
department
The analysis shows
that the business
should stay open
based on financial
criteria alone. The
cost of closing would
be the loss in
revenue of 25,000
with the benefits of
closing (the cost
savings) only coming
to 23,800.
At first it would seem that Monaghan Clothing should reject the order as the
offer price of 20 is 43 per cent below their normal supply price and does not
exceed the full cost price of producing the tracksuits. However focusing on the
cost estimates, the fixed overhead of 280,000 will not change and the variable
overhead will not change as a result of the order. Also direct labour is not
expected to change as the company is presently working at 70 per cent of capacity.
As these are the non-incremental costs for this order, they should be ignored in
the decision process. The only costs that are incremental are the materials cost of
5.00 and the extra adjustment costs of 1.00, thus the company should accept
the order. The relevant costs and benefits relating to the decision are as follows:
Anything which limits the activity of an
entity
Limiting factor as defined by CIMA Official Terminology

Sales demand.
Operating capacity.
Shortage of labour.
Shortage of materials.
Lack of available finance.
Limited distribution channels.
Step 1 - Establish if a constraint actually exists.
Step 2 - Establish the contribution per unit.
Step 3 - Establish the contribution per limiting
factor and rank in order of the highest
contribution per limiting factor.
Step 4 - Establish the optimum plan.
Step 5 - Calculate the profit based on this plan.
Customers
Employees
Competitors
Legal constraints
Creditors / suppliers:

Atkinson, Berry and Jarvis (1995)