Understand What Are Relevant Costs For Short Term Decision Making

RELEVANT COSTS

Management needs sufficient and relevant information make the correct decisions. Hence, the need to understand relevant costs.

A relevant cost relates to future expected costs that will differ with each alternative used.

Because of the difference amongst alternative, hence it has a bearing on the decision to be made.

Irrelevant costs simply are costs that will not affect the decision. By analyzing these type of irrelevant costs, management will be wasting their time and efforts as these costs do not affect the decision they are going to make.

FEATURES or CRITERIA of Relevant Costs:

• Relevant cost is a cost that will be incurred in the future. Historical costs are sunk costs which has no relevancy in the decision making.
• The costs must differ between alternatives. If a cost is the same whether we choose alternative A or B then this is an irrelevant cost. A good example is factory rental which remains the same irrespective of management wanting to manufacture product A or B.
• Only CASH flow item And Incremental fixed costs are relevant. Non cash item like depreciation and absorbed fixed overheads are not relevant costs as they do not involve any additional cash flow.

AREAS OF SHORT TERM DECISIONS WHERE RELEVANT COSTS ARE APPLIED:

•  Limiting factor due to scarce resources;
•  Make or Buy decision;
• Accept or Reject special order;
• To continue or discontinue or shut down decisions;
• Pricing