BUSN7031 · Management Accounting and Cost Analysis
Decision Making: Cost Management & Pricing Issues
Relevant-cost decision making and pricing is the Week 10 topic of BUSN7031 Management Accounting and Cost Analysis at the Australian National University, and it turns the cost numbers built in earlier chapters into a choice between alternatives. Everything rests on one filter: a cost or revenue is relevant only if it lies in the future and differs across the options, so a sunk cost such as the book value of an old machine is always ignored. The chapter drills the five recurring exam set-ups — special orders, make-or-buy, product mix under a constraint, keep-or-drop, and equipment replacement — plus the two pricing directions: market-based target costing (top-down) and cost-plus pricing (bottom-up). It is a concept-plus-short-calculation topic that supplies theory MCQs and often one worked problem in the 65% closed-book final.
What this chapter covers
- 011. The relevance filter — a cost matters only if it lies in the future AND differs between alternatives
- 022. Sunk costs and the two analysis pitfalls — book value is irrelevant, and unit-cost data mislead
- 033. Opportunity cost — the contribution forgone from the next-best use of a scarce resource
- 044. Special-order decisions — accept if incremental revenue beats incremental cost, and the minimum price
- 055. Make-or-buy (insourcing vs outsourcing) — avoidable costs plus the opportunity cost of freed capacity
- 066. Product mix under a constraint — rank by contribution margin per unit of the binding resource
- 077. Keep-or-drop and equipment replacement — decide on avoidable cash, not the allocated bottom line
- 088. Pricing — market-based target costing (top-down) vs cost-plus (bottom-up), and value engineering
Worked example: special order and the minimum acceptable price
- +1Incremental cost per panel is the variable manufacturing cost only: 12 + 6 + 4 = $22. The $3 selling cost is not incurred on this order, and the $8 fixed overhead does not change within capacity, so both are irrelevant.
- +1With idle capacity, contribution per panel = price $28 − incremental $22 = $6.
- +1Total added operating income (idle) = $6 × 4,000 = $24,000, so accept; the minimum price with idle capacity is just the incremental cost = $22.
- +1At full capacity, accepting displaces 4,000 regular sales. The contribution forgone per panel = price $40 − variable cost ($22 manufacturing + $3 selling) = $15 — this is the opportunity cost.
- +1Minimum price at full capacity = incremental cost $22 + opportunity cost $15 = $37.
- +1Compare the offer: $28 is above $22 but below $37, so accept the order only if there is idle capacity and reject it at full capacity.
Key terms
- Relevant cost
- A cost that lies in the future and differs between the alternatives under consideration; only relevant costs and revenues should drive a decision. Costs that are identical across the options cancel out and can be dropped.
- Sunk cost
- A past, unavoidable cost — such as the original cost, book value or accumulated depreciation of an old machine — that cannot be changed by any current decision and is therefore always irrelevant.
- Opportunity cost
- The contribution to operating income forgone by not putting a limited resource to its next-best use. It never appears in the ledger, yet it is relevant — for example it raises the minimum special-order price when capacity is scarce.
- Incremental (differential) cost
- The additional total cost caused by choosing one alternative over another. Decisions are best judged on total incremental costs and revenues, not on per-unit figures, because fixed cost per unit changes with volume.
- Special-order decision
- Whether to accept a one-time order at a price below the regular price. Accept if incremental revenue exceeds incremental cost; the minimum acceptable price equals incremental cost per unit plus any opportunity cost of the capacity used.
- Product-mix constraint rule
- When one resource is the binding constraint, favour the product with the highest contribution margin per unit of that scarce resource — not the highest contribution margin per unit of product.
- Target costing
- A top-down pricing approach: start from a market-set target price, subtract the required target profit, and the remainder is the target cost the product must be engineered down to, closing any gap through value engineering.
- Cost-plus pricing
- A bottom-up approach that sets price as a chosen cost base (variable, full manufacturing, or total cost) plus a mark-up, often chosen to earn a target return on investment, then tested against what the market will bear.
Decision Making: Cost Management & Pricing Issues FAQ
What makes a cost relevant to a decision in BUSN7031?
A cost or revenue is relevant only if it satisfies two tests: it must occur in the future and it must differ between the alternatives. Anything that fails either test is irrelevant — most importantly a sunk cost, which is a past amount that no current decision can change. Reject the blanket rule that all variable costs are relevant and all fixed costs are not: a fixed cost added by one alternative is relevant, and an unchanged variable cost is not. Reason on total revenues and total costs, because unit costs shift with volume and mislead.
Why is the book value of old equipment irrelevant in a replacement decision?
Because it is a sunk cost. The old machine's original cost, book value and accumulated depreciation were fixed by a past purchase and cannot be changed by deciding whether to replace it now, so they do not belong in the analysis. Any accounting loss on disposal is just that same sunk book value in another form. Only future, differential cash flows are relevant — the new machine's price, the future running-cost savings, and the current disposal proceeds of the old asset.
How do I set the minimum acceptable price for a special order?
The minimum price equals the incremental cost per unit plus any opportunity cost of the capacity the order consumes. With genuine idle capacity the opportunity cost is zero, so the floor is just the extra variable (usually manufacturing) cost, and existing fixed overhead within capacity is irrelevant. If the plant is already full, accepting the order displaces other sales, so add the contribution forgone on those bumped units — that opportunity cost can lift the minimum price well above incremental cost and flip an accept into a reject.
Under a resource constraint, which product should I make?
Rank by contribution margin per unit of the binding constraint, not per unit of product. Compute each product's contribution margin (price − variable cost), divide it by the amount of the scarce resource — machine hours, labour hours, a raw material — that the product consumes, then favour the highest per-constraint figure. A product with a larger margin per unit can still lose if it hogs the bottleneck. Allocated fixed overhead is irrelevant because it does not change with the mix.
What is the difference between target costing and cost-plus pricing?
They run in opposite directions. Target costing is top-down: the market sets a target price, you subtract the required target profit, and the remainder is the target cost you must design toward, closing any gap with value engineering. Cost-plus pricing is bottom-up: you start from a cost base and add a mark-up (often to earn a target return on investment), then test the result against the market. The exam checks that you know which way the arrow runs — a target cost is an output of the market, a cost-plus price is an output of the ledger.
Can AI help me with Decision Making: Cost Management & Pricing Issues?
Yes — ask Sia to walk through any Decision Making: Cost Management & Pricing Issues problem or concept step by step, the way Australian National University tests it. Sia is an AI tutor that explains the relevance filter, the opportunity cost, the special-order minimum price and the target-cost versus cost-plus logic so you build the understanding yourself, rather than doing your assessment for you.
Studying with AI? Sia — free AI accounting tutor works through BUSN7031 step by step.
Exam move
Treat this topic as a discipline to apply, not facts to memorise: run every line through the relevance filter (future AND differs), keep totals rather than unit costs, and never let a sunk cost or an allocated cost steer the answer. Learn the relevant and irrelevant lists for each of the five decision families — special order, make-or-buy, product mix, keep-or-drop, equipment replacement — and make opportunity cost a reflex, because it is the item students most often omit. On a worked problem, set the alternatives side by side and list only the differences so identical rows cancel; this is faster, exposes the opportunity cost, and earns method marks even if one number slips. Close with a clear decision sentence and, where it matters, the decisive qualitative factor. For pricing, remember target costing is top-down and cost-plus is bottom-up, and self-test the theory MCQs with Sia before the weeks 4, 8 and 12 quizzes.
