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Measuring relevant costs and revenue for decision making

6 important questions on Measuring relevant costs and revenue for decision making

What are relevant financial inputs for decision-making purposes?

Future cash flows, which will differ between the various alternatives being considered. Unduly differential/incremental cash flows are taken into account.

Which costs are irrelevant for decision making?

Allocated common fixed costs, such as facility sustaining costs are irrelevant for decision making, as are sunk costs.

Special pricing decisions

Special pricing decisions relate to pricing decisions outside the main market; they typically involve one time only orders or orders at a price below the prevailing market price. It is recommended that you avoid using unit costs for decision making (since sometimes a portion of fixed cost is relevant), but instead use total cost.

Which important factors must be considered before recommending acceptance of a special order?

1. Future selling prices remain unchanged
2. The decision to accept the order prevents the company from accepting other orders
3. Fixed costs are unavoidable for the period under consideration.

What should you do, when limited factors apply?

Where limited factors (scarce resources that limit output) apply, profit is maximized when the greatest possible contribution to profit is obtained each time the limited factor is used. They way to do this is to calculate the contribution margin per limiting factor for each product and then to rank the products in order of profitability.

What do future replacement cost represent?

Where materials are taken from existing inventories the original purchase cost represents a sunk cost. However, if the materials are to be replaced then the decision to use them on an activity will result in additional accession costs compared with the situation if the materials were not used on that particular activity. Therefore, the future replacement cost represents the relevant cost of the materials.