Relevant costs:
will change if the decision is made.
Relevant costs include the following:
incremental: added if decision is made
avoidable: eliminated (in full or in part) if the decision is made.
opportunity cost: a benefit that is not received because you chose an alternative.
What are always relevant to a decision?:
-fixed costs that must be added
-fixed costs that can be avoided
-variable product costs: DM, DL, and VOH.
-opportunity costs.
-the change in contribution margin when sales change.
Irrelevant Costs:
are the same for all alternatives and are ignored.
Irrelevant costs include:
sunk costs: costs that have already been incurred and are irrevocable; cannot be recovered with any decision.
future costs: are the same for the alternatives.
What are always irrelevant to decisions?:
-depreciation: the cost was incurred when the fixed asset was bought and can not be recovered.
-day to day operations that are not specific to a product or customer and have to be incurred because the company is in business.
-sunk costs that were previous
When sales change in anyway _ will change:
contribution margin (Sales, VC and CM).
When making a decision you should do the following:
1) identify irrelevant costs and ignore them.
2)identify relevant costs and use them in the analysis.
3) a cost that is relevant to one decision may be irrelevant to another decision.
FORMULA for Make decision:
Variable product cost (per unit)
X unites to be made
=Total cost to make
plus opportunity costs/total net cost to make.
FORMULA for buy decision:
Purchase price to buy per unit
X Units to be purchased
=Total cost to buy
less fixed costs saved if you buy/total net cost to buy.
Special Orders:
a one time order that is not considered part of the normal business with a current customer. A special order is usually for reduced sales price.
*special orders do not change unavoidable fixed overhead costs.
*special orders reduce other sales if producti
FORMULA for special orders:
Sales $ per unit for special order
-all variable costs per unit related to the special order
=contribution margin per unit
X Total units of the special order
-additional total fixed costs related to the special order
=Impact on profits from the special or
What the company is already at capacity and will have to give up sales to regular customers if the special order is accepted, the____must be considered.
lost CM from not being able to sell to current customers
FORMULA for how to calculate lost CM if company is already at capacity:
Sales $ per unit to a current customer
- All variable costs per unit related to product (DM, DL, VOH, Period).
=Contribution Margin per unit
X Total units that will not be sold if the special order is accepted
=Total CM Lost.
FORMULA for determining the total impact to operating profits:
Impact on profits form special order
-Total contribution margin lost
=Total impact to profits if the special order is accepted.
joint products:
two or more products that are produced from the same manufacturing process.
split-off point:
the point in the manufacturing process that products can be distinguished as separate products.
joint costs:
costs incurred up to split off point. These costs are allocated to joint products. Joint costs are always irrelevant to decision to process further.