Closing down either production line would save 25% of the total fixed costs. Along the line of business, there is the production of several units. Thus, these costs increase as the production increases or drops with low production. Maintenance cost for machinery is $3,000, $2,000 for material, $2,500 for labor, and $1,500 for miscellaneous costs.
What is Relevant Cost?
These employees are difficult to recruit and the company retains a number of permanently employed staff, even if there is no work to do. There is currently 800 hours of idle time available and any additional hours would be fulfilled by temporary staff that would be paid at $14/hour. The material has no use in the company other than for the project under consideration. In business, a customer may request a one-time item from a company.
Relevant cost
The relevant costs are the costs that can be eliminated due to the closure as well as the revenue lost when the stores are closed. If the costs to be eliminated are greater than the revenue lost, the outdoor stores should be closed. A big decision for a manager is whether to close a business unit or continue to operate it, and relevant costs are the basis for the decision. Relevant costs are future potential expenses, whereas sunk costs are existing expenses that have already been made. The company is concerned about the loss that is reported by Production Line B and is considering closing down that line.
The cost of oil that will be used on the order is $1,000.The current market value of the required quantity of oil is $1,200. If oil is not used on the order, it could be used in the production of other tires. Rubber Tire Company (RTC) received a request to provide a price quote for an order for the supply of 1000 custom made tires required for industrial vehicles. RTC is facing stiff competition from its business rivals and is therefore hoping consignor and consignee to secure the order by quoting the lowest price. Incremental CostWhere different alternatives are being considered, relevant cost is the incremental or differential cost between the various alternatives being considered.
These costs will have to be compared to the contribution that can be earned by the new machine to determine if the overall investment in the asset is financially viable. Cost of machine – this is a relevant cost as $2.1m has to be paid out. A company that needs a special item can either make one on its own or outsource it. The decision to make or buy it depends on the cost-effectiveness of either alternative. If buying the item costs less than making it internally, the company opts for outsourcing it. For example, a person has to choose between vacationing and spending time with their family.
- For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
- Businesses use relevant costs in management accounting to conclude whether a new decision is economical.
- In this context, opportunity cost is the cost of the holiday and visiting new places if the person decides to go on vacation rather than stay home.
- Relevant costs stand out because they haven’t been incurred yet, can be avoided, and are only pursued if it’s believed the action will be profitable.
If the vendor can provide the component part at a lower cost, the furniture manufacturer outsources the work. Material B – The 100 units of the material already in inventory has no other use in the company, so if it is not used on the new product, then the assumption is that it would be sold for $12/unit. If the new product is made, this sale won’t happen and the cash flow is affected.
As these materials are not available in stock, these will have to be purchased at the market price which is their relevant cost. The order requires a special type of rubber.Only 25% rubber is currently available in stock. If the rubber is not used on this order, it will have to scraped at a price of $1,000.Remaining quantity shall have to be procured at the price of $7,000. Non-Cash ExpensesNon-cash expenses such as depreciation are not relevant because they shopify to xero do not affect the cash flows of a business. Opportunity CostsCash inflow that will be sacrificed as a result of a particular management decision is a relevant cost. Relevant cost, in managerial accounting, refers to the incremental and avoidable cost of implementing a business decision.
However, even long term financial decisions such as investment appraisal may use the underlying principles of relevant costing to facilitate an objective evaluation. These costs are relevant since these expenses change in the future due to the buying decision. Relevant costing attempts to determine the objective cost of a business decision. An objective measure of the cost of a business decision is the extent of cash outflows that shall result from its implementation.
What Is Another Name for a Relevant Cost?
Relevant costing focuses on just that and ignores other costs which do not affect the future cash flows. The cost effects relate to both changes in variable costs and changes in total fixed costs. A particular cost may be relevant for one situation but irrelevant for another.
However, the $1 million is an irrelevant cost, and should be excluded. Continuing the construction actually involves spending $0.5 million for a return of $1.2 million, which makes it the correct course of action. Relevant costs help to eradicate unnecessary data that can complicate a decision-making process. Management can use this concept to make cost-effective business decisions and avoid unnecessary expenses. A sunk cost is an expenditure that has already been made, and so will not change on a go-forward basis as the result of a management decision. When making a decision, you should always take relevant costs into consideration, and ignore all sunk costs.
Understanding Relevant Cost
The opposite of relevant costs is sunk cost or irrelevant costs, which refers to the expenses already incurred. Thus, incurring an expense may be avoided by deciding not to perform a certain activity. For example, assume you had been talked into buying a discount card of ABC Pizza for $50 which entitles you to a 10% discount on all future purchases.
In accounting, what is meant by relevant costs?
Therefore, the closure of Production Line B is not a good idea as the revenue lost is greater than the value of the costs saved. Relevant costs stand out because they haven’t been incurred yet, can be avoided, and are only pursued if it’s believed the action will be profitable. Companies keep track of these costs and jobs could be in jeopardy if they don’t pay off. Relevant costs are avoidable and can differ depending on which action is taken.
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