Topic 23: Relevant costs for decision making Flashcards
(14 cards)
What is a Decision?
A decision involves the making of a choice among alternatives to meet a stated objective such as maximising profits or minimising losses.
How can a good decision be made?
To make a good decision, one must be able to identify factors, both quantitative and qualitative, that are relevant to the decision.
What is Relevant cost?
Relevant costs has the potential to influence a specific decision and should be considered when making decisions.
What are the fundamental characteristics of Relevant costs?
1) It is an expected future cost.
Past costs has no impact on decisions about the future. However not all future costs are relevant. If an expected future cost remains the same regardless of whether alternative A or alternative B is chosen, then it is also irrelevant (even though it is in the future).
2) It differs among alternatives.
Only costs which are different between outcomes can be used to distinguish one from the other. Costs which differ between decision alternatives are called differential costs or incremental costs.
What are Avoidable costs?
Avoidable costs are cost which need not be incurred or avoided when choosing an alternative over another. They are relevant to decision making as it differed between alternatives.
What are Opportunity costs?
Opportunity costs refers to benefits that are lost or given up due to the decision to not pursue the next best course of action.
They reflect the value, in monetary terms, of being deprived of the next best opportunity in order to pursue the particular objective.
They are relevant for decision-making.
How are Opportunity costs relevant for decision making?
Opportunity costs are relevant for decision making when the capacity of a critical resource is limited.
At full capacity, opportunity costs must be included in the analysis for the decision to be made.
What are the Quantitative information to consider in decision making?
a) Relevant costs
b) Relevant income
c) Irrelevant costs
What is Relevant income?
Relevant income are benefits arising from a particular course of action, which relates to the future and vary among alternatives.
What are Irrelevant costs?
These are costs that will not influence a decision and should not be considered when making decisions.
What are included in Irrelevant costs?
1) Sunk costs
2) Committed costs
3) Future costs
What are Sunk costs?
Sunk costs are past or historical costs that have already been incurred.
They do not affect any future cost and cannot be changed by any current decision for future action and are irrelevant to decision making.
What are Committed costs?
Committed costs arises when a irrevocable decision has been made to incur the cost, for example, in a legally binding contract, and therefore cannot be changed or recovered no matter what decision is made.
They are also not relevant for decision making.
Eg. A non-refundable deposit placed on machinery will have no impact on the decision to buy or not to buy the machine.
What are Future costs?
Future costs which do not vary with decisions are also irrelevant as regardless of the decision made, the cost has to be incurred.
