Sessions 3-Relevant cost analysis.pdf - MANAGERIAL...

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MANAGERIAL ACCOUNTING AND DECISION MAKING ISB-2020 NOTES FOR SESSION 3 Differential Costs and Relevant Cost Analysis Chapter 6 NANDU J. NAGARAJAN 1
Relevant articles and cases Baldwin Bicycle Company case Oil Tanker Operations WSJ 2
The Right Costs For Decision Making Chapter 6-Differential Costs Several topics have an underlying common idea, which is trading off incremental costs vs. incremental benefits (for example: CVP analysis, relevant cost analysis, short-term pricing, and transfer pricing) It is important to understand what the “correct” product costs are for both short term and long-term decisions. All costs, including capacity costs are variable in the long run, and, hence, potentially controllable. However, some costs, particularly sunk or contractual fixed costs, are non- controllable and , hence, not avoidable in the short term. 3
More on the right costs for decision making If a cost is not avoidable in the short term, it is unlikely to be different across short-term alternatives For a cost to be relevant in a decision , it has to be a differential cost . A controllable cost that is not different across decision alternatives is not relevant. Relevant costs in decision making could be both fixed and variable costs 4
The Concept of Relevance Relevant cost information has two characteristics: It occurs in the future It differs among the alternative courses of action. Relevant costs are expected future costs. Relevant revenues are expected future revenues. Past costs (historical costs) are never relevant and are also called sunk costs. Both CVP analysis and Relevant Cost Analysis deal with the short-term. Note that a fundamental difference between CVP analysis and Relevant cost analysis is that CVP analysis takes account of sunk costs like depreciation in fixed production costs, but relevant cost analysis does not.

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