RELEVANT COSTING

DECISION MAKING – is the process of making choices from at least two alternatives. It involves
identifying a problem, gathering information, and evaluating alternative
solutions. For business entities, management usually chooses the option
that maximizes company profit.
FACTORS CONSIDERED IN DECISION MAKING
1. Qualitative Factors – factors that cannot be expressed in money or other
numerical units. Examples: customer satisfaction, suppliers, and employee
morale
2. Quantitative Factors – factors that can be expressed in money or other numerical units.
The two quantitative approaches to decision making are:
✓ TOTAL approach: Total revenues and costs are determined for each alternative, and
the results are compared to serve as a basis for the decision to make.
✓ DIFFERENTIAL approach (a.k.a. incremental analysis): Only the differences or
changes in costs and revenues are considered.
TYPES of COSTS COMMONLY ASSOCIATED WITH DECISION MAKING
RELEVANT COSTS Future costs that are different among alternatives.
DIFFERENTIAL Increases or decreases in total costs resulting from choosing one option
COSTS over another.
AVOIDABLE COSTS Costs that will be saved or will not be incurred if a certain decision is
made.
OPPORTUNITY Benefit foregone or highest income sacrificed when an option is chosen
COSTS over another.
OUT-OF-POCKET Costs required for immediate or near future cash outlays based on a
COSTS particular decision.
SUNK COSTS Historical or past costs that cannot be avoided regardless of what
decision is made.

NOTE: Differential (incremental) costs, avoidable costs, opportunity costs and out-of-pocket
costs are usually considered relevant in decision making while sunk and unavoidable costs are
considered irrelevant.
TYPES of SHORT-TERM NON-ROUTINE DECISIONS
NATURE of DESCRIPTION DECISION-MAKING
ALTERNATIVES GUIDELINES
1. MAKE or BUY Should a product or material Choose the option that has the lower
a product or be internally manufactured cost. In
material (‘insource’) or bought from most cases, fixed costs are irrelevant.
(Outsourcing outside supplier Consider if there is any opportunity
Decision) (‘outsource’)? cost.
2. ACCEPT or Should a special order that Accept the order if the additional
REJECT requires a price lower than revenue
a special order the regular selling price be exceeds additional cost. In most cases,
accepted or rejected? fixed costs are irrelevant.
3. CONTINUE or Should a business segment Continue if avoidable revenue is
SHUTDOWN (e.g., product line, division, greater than its avoidable costs. Any
a business department or branch) be allocated fixed cost to the segment is
segment continued (‘keep’) or usually considered irrelevant.
discontinued (‘drop’)?
4. SELL or Should a product, after Process further if additional revenue
PROCESS undergoing the joint process, from processing further is greater than
FURTHER be sold at the split-off point further processing costs. Joint costs
a product or be processed further are considered
beyond the split-off point? sunk costs and irrelevant.
5. SCRAP or Shall be a substandard or Rework if additional revenue after
REWORK obsolete product be sold as rework is higher than rework costs.
a product scrap (‘junk’) or be reworked The original cost or carrying value is
(‘modify’)? considered irrelevant.
6. BEST PRODUCT Which product(s) should be Identify and measure constraint(s).
COMBINATION given priority in production, Allocate
(Optimal Use of given limited resources limited resources to products from
Scarcity) and/or market limitations? highest to lowest CM per unit of limited
resources.
 7. CHANGE IN Should any of the profit Change the profit factor if it will cause
PROFIT factors such as selling price, an improvement on the company’s
FACTORS unit sales, variable cost, over-all profit position.
fixed cost and sales mix be
manipulated to increase
profit?

OTHER TERMINOLOGIES ASSOCIATED WITH SHORT-TERM NON-ROUTINE DECISIONS

SHUTDOWN COSTS* Costs that will remain to be incurred even if a segment is
discontinued. [Irrelevant]
JOINT COSTS** Costs incurred in processing joint products until the split-off point.
[Irrelevant]
SPLIT-OFF POINT** The production stage where joint products are split into separate
and distinct products.
FURTHER Costs incurred in processing separate products beyond the split-
PROCESSING off point. [Relevant]
COSTS**
BOTTLENECK Any operation where the capacity is less than the demand placed
RESOURCES*** upon it.
* connected with No. 3 above ** connected with No. 4 above ***
connected with No. 6 above

Decision Making
• Making a choice from at least two alternatives
• Can be classified according to scope of the effect of decision:
o Short-term non-routine cases (Relevant Costing – Differential Approach)
o Long-term cases (Capital Budgeting)
Decision Making Process
1. Identification of necessity to make a decision
2. Identification of alternatives or decision choices
3. Determination of possible results and consequences of alternatives
 4. Evaluation of alternatives
5. Selection of best alternative and implementation

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