C. Short-term commercial decision-making Flashcards
What are relevant costs/revenues?
costs/revenues that change as a direct result of a decision taken
What is the CIMA definition of relevant costs/revenues?
‘costs and revenues appropriate to a specific management decision;
-they are represented by future cash flows whose magnitude will vary depending upon the outcome of the management decision made’
What are the features of relevant costs?
1) FUTURE COSTS
2) incremental/differential e.g attributable/specific fixed costs
3) they are CASH FLOWSs: not depreciation or amortisation
What are avoidable costs?
the specific costs of an activity or sector of a business which would be avoided if that activity or sector did not exist
- relevant
e. g saved due to shut down
Should variable costs be assumed as relevant costs?
yes, unless told otherwise
Are apportioned head office costs relevant?
no
- would not be saved if operation shuts down
- attributable/specific
What are examples of non-relevant costs?
sunk costs: already incurred
committed costs: past decision, cant be changed
fixed costs:if absorbed/charged/allocated/apportioned/avoidable
depreciation:not cash flow
notional costs
How are fixed costs split between relevant and non-relevant?
relevant: extra, incremental
non-relevant:absorbed, charged, allocated, apportioned, notional
What is a non-relevant cost?
costs that have already been incurred or committed
What is an opportunity cost?
the best alternative that is forgone in taking the decision
-effects of cash flows on whole organisation
What is a notional cost?
- similar to opportunity cost
e. g occupying premises instead of renting it out, if someone was willing to pay rent then it is a opp cost
What are differential/incremental costs?
difference in total cost between alternatives, calculated to assist decision making
-incremental is useful if accountant wishes to highlight the consequences of taking sequential steps in a decision
If additional labour cannot be hired for a special project, how is the relevant cost calculated?
contribution forgone + direct labour cost
What are the potential relevant costs of non-current assets?
replacements cost of machinery
if not replaced, higher of sales proceeds and net cash flow from use (NRV)
What should be maximised if there is just one limiting factor?
maximise contribution per unit of scarce resource
-the allocate to the products in order of priority
Why is contribution per unit used, not profit?
as fixed costs are unaffected by production, and are left out of contribution
What technique should be used if there is more than one limiting factor?
linear programming
In a make or buy decision, how should products be selected?
ranked highest based on savings made per usage of the scarce resource
i.e buy-in cost less incremental cost of internal production
If product is bought-in, what is the purchase cost classified as?
wholly marginal ie direct
If manufactured, what costs should be compared during buy in vs make decision?
direct materials, labour and variable factory overhead
When should a one-off order be accepted?
if selling price> relevant costs the order should be accepted
OR
compare contribution per scare resource
What is a shutdown decision?
deleting a segment of the business
-likely absorption costing will be used
When should a business be shutdown?
difference between forgone revenue < incremental cost savings from closure
When is the minimum pricing decision used?
when there is:
- a lot of competition
- surplus productive capacity
- clearance of old inventories
- getting special order
- improving market shares
What is the minimum price that should be shared?
set at incremental costs of manufacturing, plus opportunity costs
How are the incremental and joint process costs treated in relevant costing?
incremental are relevant
joint process are non-relevant as they are already sunk
What information is needed to determine whether or not joint products should be further processed?
- total cost of each of the additional processes
- unit selling price of each product
- unit selling price of each product before further processing
- % normal loss of each further process
- actual units of output of each product from the common process
What qualitative factors can affect decision making?
- state of the economy/inflation
- availability of cash
- effect of a decision on employee morale, schedules
- effect of a decision on long-term profitibility
- effect of a decision on a company’s public image and reaction of customers
- likely reaction of competitors
Why are decision making processes more concerned with the impact on cash flow rather than the impact on profits?
cash flow is more objective and harder to manipulate than profits
-decisions made may have different impact on one than other which might affect stakeholders
Why are cash and profits different in the short term?
- some cash transactions don’t affect profits e.g capital
- profits are calculated after deducting dep and NCAs. Depreciation is notional and doesn’t affect cash flow
- cash flow is affected by the need to invest in working operational working capital i.e capital needed to complete day to day
Why do cash accounting and accrual accounting produce different profit figures on an income statement?
based on different assumptions about how revenues and costs are recorded in the income statement
Why is cash accounting generally not accepted as good accounting?
as businesses enter into transactions that are legally enforceable prior to the exchange of cash but use of cash accounting does not reflect any transactions which have taken place but are not yet paid for
-don’t reflect non cash transactions
What happens to cash impact and profit impact in the long term?
they should become equal
Why might there be a conflict between decision making and performance management?
decision making:only consider relevant costs
performance: based on total controllable costs, whether relevant or not
What is ethical decision making?
making decisions that go beyond purely financial /legal considerations and instead considers a much wider scope of stakeholder perspectives
What are some ethical issues a firm should consider when decision making?
- impact on staff: redundancies, retraining
- knock on effect on morale:other areas motivation
- customers:no service, image of product/business
- local community:housing, govt investment
- reputation of firm:signalling, inconsiderate
How does acting ‘morally correct’ help a business?
- lower business risk
- make organisation attractive to customers, collabs, partners
- more attractive to employees
- less time and cost spent on regulation
- less spent on fines and damages
What are the issues involved with acting ethically?
- strategy can be copied by rivals thereby taking away advantage of differentiation
- acting ethically typically adds costs to activities
- success often relies on trial and error
- international businesses may have to adopt different ethical approached in different markets lacking consistency
What does break even mean?
cover all costs without making profit
What is Cost-Volume-Profit analysis?
study of the effects on future profit of changes in fixed cost, variable cost, sales price, quantity and mix
-what -if? analysis
CVP analysis makes use of the contribution concept to assess what measures for a single product?
- C/S ratio
- breakeven point
- margin of safety
What is another term for a variable cost?
marginal cost
Why is contribution named so?
‘contributes’ towards fixed costs and profits as it covers them and any extra is profit
