ACCT2019 Chap.9 Relevant Costs for Short Term Decisions
Relevant Costs for Short Term Decisions
Short-term decisions use information that is both future and different between alternatives. The filter removes sunk cost and unavoidable allocation while adding opportunity cost, even when no ledger entry records it. The same logic supports special orders, outsourcing, constrained resources, keep-or-drop choices and equipment replacement.
Quantitative advantage must then be tested against capacity, quality, reliability, customers, employees and other specific consequences that can reverse the recommendation. Capacity is often the hidden pivot. A special order can be attractive with idle resources but unattractive when it displaces regular contribution.
An outsource quote must be compared with avoidable internal cost plus the best use of released capacity, not a full unit cost built from unavoidable allocations. Under a bottleneck, contribution per unit of scarce input guides the mix. Replacement work separates current disposal proceeds and future operating cash flows from the old asset's sunk book value.
Threshold analysis strengthens the recommendation by showing the supplier price, opportunity cost or lost contribution at which the preferred alternative changes. Management can then verify the decision-critical assumption rather than debate every accounting line. A concise recommendation states the measured advantage, the capacity assumption and the qualitative threshold that management must verify before committing.
What this chapter covers
- 01
Future-and-different filter
- 02
Special-order contribution
- 03
Make-or-buy comparisons
- 04
Constrained-resource ranking
- 05
Keep-or-drop analysis
- 06
Equipment replacement and book value
Worked example · free
Comparing make and buy with opportunity cost
- +1Original AskSia feedback allocation. Avoidable make cost is 6,000 x ($16 + $5) = $126,000.
- +1Opportunity cost of making is $24,000, so relevant make cost is $150,000.
- +1Buy cost is 6,000 x $24 = $144,000.
- +1Buying improves the measured result by $6,000.
- +1The $42,000 unavoidable allocation is excluded; supplier quality and reliability remain decision factors.
Key terms
- Relevant Information
- Future financial and non-financial information that differs between alternatives.
- Sunk Cost
- A past cost that cannot be changed by the current decision.
- Avoidable Cost
- A future cost eliminated when a specified alternative is chosen.
- Opportunity Cost
- The benefit forgone by using a resource for one alternative.
- Constrained Resource
- A scarce input that limits the activity or product mix available.
Relevant Costs for Short Term Decisions FAQ
Why is book value irrelevant in replacement?
Book value is the unexpired allocation of a past purchase and cannot be changed by replacing the asset. Current disposal proceeds, new purchase price, future operating cash flows and tax effects can differ and therefore enter the comparison.
How should products be ranked under a bottleneck?
Rank them by contribution margin per unit of the constrained resource, not contribution per product. Then allocate scarce capacity subject to demand and operational limits, while checking strategic commitments and secondary effects.
When is an allocated fixed cost relevant?
Only when the underlying future resource or cash flow changes between alternatives. The existence of an allocation line is not evidence of avoidability. Trace the cost to a contract, employee, facility or capacity decision before including it.
Exam move
For every scenario, create two columns for alternatives and inspect each line with the future-and-different test. Cross out sunk cost and unavoidable allocation, then add opportunity cost beside the capacity it represents. Practise the common decisions with different constraints: a special order with idle capacity and with displaced sales, outsourcing with avoidable capacity and without it, and product mix with one bottleneck.
In replacement questions, separate disposal proceeds from book value. Finish with two or three specific qualitative risks and explain how each could reverse the financial result. Avoid generic strategy language; name the supplier failure, quality threshold, customer spillover or workforce capability that matters. Create a threshold for every recommendation.
For a special order, calculate the maximum opportunity cost that keeps acceptance worthwhile. For outsourcing, find the supplier price at which make and buy are equal. Under a bottleneck, rank contribution per constrained hour and then test the effect of relaxing capacity. In keep-or-drop work, separate lost contribution from avoidable fixed cost and include any spillover on other products.
Explain why a reported segment loss can persist after closure when common cost remains. Close the practice set by taking a book-value amount, an allocation and an unrecorded opportunity cost and explaining the different treatment of each. That verbal contrast is a faster relevance test than memorising decision-specific lists.
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