ACF5955 Chap.6 Relevant Costs and Tactical Decisions
Relevant Costs and Tactical Decisions
Relevant-cost analysis compares future cash flows that differ between alternatives. This chapter removes sunk and unchanged allocated costs, includes avoidable and incremental effects, and adds opportunity cost when capacity is scarce.
It applies the filter to special orders, make-or-buy choices, outsourcing and constrained product mix, then adds quality, delivery, confidentiality and strategic consequences before making a recommendation. Differential schedules make exclusions and changing amounts visible, while reversal thresholds show how much opportunity cost an initial advantage can bear.
Students also distinguish a disappearing report allocation from a resource commitment that can truly be released. The final recommendation is conditional on capacity and identifies the operational evidence that could overturn the numerical result.
What this chapter covers
- 01
Future differential information
- 02
Sunk and unavoidable costs
- 03
Special-order decisions
- 04
Make-or-buy analysis
- 05
Opportunity cost of capacity
- 06
Product mix under a constraint
Worked example · free
Compare make with a supplier offer
- +2Relevant materials are $72,000 and labour is $40,000.
- +2Add $16,000 avoidable supervision for relevant make cost of $128,000.
- +2Buy cost is 8,000 times $17.50, which equals $140,000; continuing facility cost is excluded.
- +2Making saves $12,000 with idle capacity, subject to supplier quality and delivery effects.
Key terms
- Relevant cost
- A relevant cost is a future amount that differs between decision alternatives.
- Sunk cost
- A sunk cost has already been incurred and cannot be changed by the current decision.
- Avoidable cost
- An avoidable cost disappears when a specific alternative or activity is not chosen.
- Opportunity cost
- Opportunity cost is the benefit sacrificed by using a scarce resource in one option rather than the best alternative.
Relevant Costs and Tactical Decisions FAQ
Why is allocated fixed cost often excluded?
An allocation can disappear from a report without removing the underlying resource commitment. Include the cost only when the actual future cash flow changes between alternatives, not merely because a unit-cost statement contains it.
When can a low special-order price be accepted?
With spare capacity, compare incremental revenue with variable and order-specific costs, then assess effects on regular customers, pricing and quality. With scarce capacity, include the contribution displaced from regular work.
Why is contribution per scarce resource used for product mix?
The constraint limits how much total contribution can be earned. Ranking by contribution per machine hour, labour hour or other binding resource shows which products use that scarce capacity most profitably.
Exam move
Mark every cost as future or past, changing or unchanged, and avoidable or unavoidable. State the capacity condition before calculating because it determines opportunity cost. After the numerical difference, name the quality or strategic factor most capable of reversing the recommendation. Practise counter-cases where one fact changes and the preferred option reverses.
Build a differential schedule with one column per alternative and a final difference column. Enter only future cash flows that change. Show sunk cost as excluded once, explain why it cannot be changed, and remove it from later arithmetic. For a future fixed cost, inspect the underlying contract or resource rather than assuming that an allocation disappears when a product or activity does.
Mark exactly when the commitment can be released. Before special-order, outsourcing or product-mix calculations, write a capacity statement. With idle capacity, the opportunity cost may be zero. With a binding constraint, identify the best contribution sacrificed and add it as a real economic cost even though it is absent from the ledger.
For make-or-buy practice, calculate avoidable internal cost, supplier cost and any opportunity cost, then express the initial advantage as a reversal threshold. Change the alternative contribution and observe when the preferred choice switches. Add supplier quality, delivery, confidentiality and organisational capability to the recommendation, specifying which evidence management should obtain.
For special orders, separate variable production cost, order-specific cost and any effect on regular customers. A price below allocated full cost can add profit with spare capacity, but not if it displaces contribution or damages the main market. For scarce-resource questions, rank products by contribution per unit of the binding resource and respect demand limits. Do not rank by unit contribution alone.
If two constraints bind, explain why a single-resource ranking is inadequate rather than forcing it to answer a more complex problem. In keep-or-drop cases, reconcile the segment margin with the cost that truly disappears. A reported segment loss can improve total profit when it contributes toward unavoidable common cost.
Finish each timed answer with a conditional recommendation: quantify the financial difference, name the capacity assumption and identify the qualitative fact most likely to reverse the decision. Then create a counter-case by changing one fact only. This tests whether the logic is transferable and exposes answers that memorise a label without following the differential cash flows.
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