Chapter 6: Relevant Costs and Decision-Making

Question 1

What data will decision makers use?

Answer 1

Financial information
Management Information
Market Research
Economic Conditions

Question 2

How do short term decisions support long term decisions.

Answer 2

By often forming the building blocks of the overarching ‘long-term’ strategy.

Question 3

What is the definition of relevant costs?

Answer 3

Relevant costs and revenues are FUTURE, CASH and INCREMENTAL costs or revenues directly arising as the result of an investment decision.

Question 4

What is a sunk cost

Answer 4

A sunk cost is an expense that has already been incurred previously so it is not relevant to future decision making.

Question 5

What is a committed cost?

Answer 5

a future cash flow which will be incurred irrespective of the decision being made.

Question 6

Allocated Costs

Answer 6

These costs are incurred by the business as a whole, irrespective of whether a project proceeds or not, they are not relevant to the decision on that project.

Question 7

Non Cash Expenses

Answer 7

These a non cash flow effective so are considered irrelevant for decision making. An example would be depreciation.

Question 8

What is cost plus pricing?

Answer 8

This is a fixed mark up on top of your cost per unit.

Question 9

What is the calculation for cost plus pricing?

Answer 9

Marginal pricing (Price = Variable cost per unit x (1 + Mark-up))
Total cost pricing (Price = Total cost per unit x (1 + Mark-up))

Question 10

Give two advantages of cost plus pricing

Answer 10

-Relatively easy and cheap to use as it uses only internal
information

-Reasonable basis to set prices when there are no comparable
products

Question 11

Give two disadvantages of cost plus pricing

Answer 11

-Fails to consider external factors e.g. competition pricing
-It is not linked to costs so can be disproportionate or without an objective reason

Question 12

What is the profit margin pricing?

Answer 12

This is calculated based on a minimum required profit margin being included as part of the price along with the total costs.

Question 13

What is the calculation for profit margin pricing?

Answer 13

Price = Total costs / (1- Required Profit Margin)

Question 14

What is the calculation for targeted returns on total cost?

Answer 14

Price = (Capital invested in product x targeted rate of return) / budgeted level of production

Question 15

What is the calculation for targeted returns on revenue?

Answer 15

Price = Target rate of return on sales/ (100-Targeted rate of return on sales) * Total cost per unit