Short Term Decisions

Question 1

What are the three criteria that must be met in order for a cost to qualify as a relevant cost?

Answer 1

1. Future
2. Cash Flow
3. Incremental (specific to the decision)

Question 2

Relevant costs can also be categorised as what?

Answer 2

1. opportunity costs

2. avoidable costs

Question 3

What is opportunity cost?

Answer 3

Opportunity cost is defined as the benefit foregone as a result of choosing one course of action over another.

Question 4

What are avoidable costs?

Answer 4

Specific costs of an activity/sector of a business that would be avoided if the activity/sector didn’t exist.

Question 5

What type of decisions are associated with avoidable costs?

Answer 5

Shutdown decisions

Question 6

What main costs can not be classified as relevant costs?

Answer 6

• Sunk costs
• Committed costs
• Notional costs (non cash items i.e. accounting adjustments)

Question 7

What are the 6 main decision types?

Answer 7

1. Accept or reject
2. Make or buy
3. Outsource
4. Shutdown
5. Minimum Price of an order/job/contract
6. Further processing decisions

Question 8

Relevant cost of materials:

If materials are not in stock and we have to purchase more what is the relevant cost?

Answer 8

Current replacement cost

- i.e. market price

Question 9

Relevant cost of materials:

If materials are in stock and in continual use for us we need to replace the materials we use. What is the relevant cost?

Answer 9

Current replacement cost

- i.e. market price

Question 10

Relevant cost of materials:

If materials are in stock and we have no other use for them, we will not replace them. What is the relevant cost?

Answer 10

Use for free if just using for our own product

OR

Current resale/scrap value if we can sell on

OR

Nil if we can’t sell it.

Question 11

Relevant cost of materials:

If materials are in stock but are scarce and we cannot replace the materials once we have taken from the stock, what is the relevant cost?

Answer 11

Opportunity cost

- account for lost revenue from other areas of the business.

Question 12

What is the first question we should be asking when deriving the relevant cost of materials?

Answer 12

Whether or not the materials are in stock.

Question 13

True or False: Historic costs are taken into account when deriving the relevant cost of materials.

Answer 13

False - we NEVER take into consideration historic costs.

Question 14

Relevant cost of labour:

What is the first question we should be asking ourselves when we are assessing the relevant cost of labour?

Answer 14

Whether we have spare capacity or are at full capacity in our current labour force.

Question 15

Relevant cost of labour:

If we have spare capacity in our labour force we can therefore undertake additional work. What is the relevant cost of labour.

Answer 15

Nil - we can utilise the spare time of our existing workforce.

Question 16

Relevant cost of labour:

If we are at full capacity what are the two options we must consider when trying to derive the relevant cost?

Answer 16

Whether we can hire more staff or we cannot hire more staff.

Question 17

Relevant cost of labour:

If we are at full capacity, additional work cannot be undertaken by our current workforce. If we hire more staff, what is the relevant cost?

Answer 17

The current rate of pay.

Question 18

Relevant cost of labour:

If we are at full capacity, additional work cannot be undertaken by our existing workforce. If we cannot hire more staff, what is the relevant cost?

Answer 18

Opportunity cost = Variable cost + lost contribution.

Question 19

What is included in the relevant cost when calculating minimum price?

Answer 19

Relevant cost ONLY!!

do not include apportionment of overheads or a mark u.

Question 20

What are the downfalls of using the minimum price decision type?

Answer 20

• okay for one offs but doesn’t cover fixed costs or contribute to profit
• how would we price repeat orders? - higher price infers higher expectation of quality.

Question 21

How do we make a decision under the accept or reject policy?

Answer 21

Accept projects with a positive return

Reject projects with a negative return

Question 22

In which circumstances may we accept a project with a negative return?

Answer 22

• undercutting a competitor
• gaining market share
• attracting new customers

Question 23

If we are not told that we can access more labour then what do we assume?

Answer 23

That no additional labour is available to us.

Question 24

In make or buy decision making, what is the ultimate factor in the decision process?

Answer 24

• Which is cheaper - make or buy?

- Buy in if cost effective

Question 25

What are the other key considerations in make or buy decision making?

Answer 25

• Quality of bought in product
• Reliability of supplier
• Becoming dependent on supplier?
• Likelihood of future price increases
• How to use spare capacity
• Confidentiality issues
• Delivery timings
• Staff morale
• Redundancies
• Feasibility if need to bring back in-house

Question 26

How are further processing decisions made?

Answer 26

1. Joint costs not relevant
2. SP now vs. NRV (NRV = SP later - further costs)
3. Does market exist before and after further processing?

Question 27

What is the main financial factor to consider in shutdown decisions?

Answer 27

Lost contribution and specific fixed costs (avoidable costs)

Question 28

What are the main non-financial factors to consider in shutdown decisions?

Answer 28

• Impact on customers
• Impact on other products
• Competitor reactions
• Impact on employees
• Impact on supplier negotiations