Relevant Costing

INCOSAC
 Relevant/Differential Costs

• Expected changes in future costs among alternative courses of action

Incremental cost Future

Current Cost / Cost /
costs?
costs? Vol / Vol /
Profit Profit

Current
costs?
Avoidable cost Future
Cost / Vol Cost / Vol
/ Profit / Profit costs?
 Relevant/Differential Costs

• Expected changes in future costs among alternative courses of action

Incremental cost Future

Current Cost / Cost /
costs?usual
in selling
costs? Vol / Vol /
orders plus
in selling usual Profit Profit special orders
orders at 30
at
pcs
100 pcs

Current
costs? Cost / Avoidable cost Future
Cost / Vol
in selling usual Vol / costs?
/ Profit
orders and Profit with avoided costs
special orders once special orders
are dropped
 Traceable Costs

• Costs wherein its source is identifiable

COST

Product A
 Traceable Costs

• Costs wherein its source is identifiable

Cost of Chocolate
COST Chips

Chocolate
Product
Chip A
Cookies
 Replacement Costs

• Costs to be incurred in a market transaction to replace

something in the old system with a new one
 Opportunity Costs

• The potential benefits that were given up because of

choosing another alternative action

Decision: Go to college Get a job

 Earn a degree to get a  Earn money right away

higher starting salary in with a rank and file
Benefits: the future position
 Sunk Costs

• Irrecoverable costs that are irrelevant because they

have already been incurred in the past
 Depreciated
 Expired
Purchase cost of
 Used the machine
= Php 800,000

After 2 years of usage

Php 800,000 is not

anymore relevant.
 Out-of-Pocket Costs

• Unexpected cash disbursements

 Not part of the budget
 Personal expenses
 Cost Problems

• Method Change  methods/processes

• Operations Planning  schedules

• Make or Buy Decisions  raw materials

• Order Quantity  profit from order

 Cost & Revenue Problems

• Supply/Demand/Price Analysis  BEP, etc.

• Contribution Pricing  CM, VC, etc.

• Discontinuing a Product  low revenue

• Adding Services  expansion (opportunity in sales)

• Sell or Process Further  by-products

• Other Marketing Tactics  price

 General Steps
(Problem Analysis)
1. Define the problem.
 Determine impact on the business (functions, time,
relationships, costs, etc.)

2. Select the possible alternative solutions.

3. Weigh the quantitative consequences of each alternative.

 Identify all possible/traceable costs

4. Identify qualitative effects/consequences.

5. Reach a decision.
Sample Problem:

Acceptance of Additional Orders

 Unit Selling Price

 Quantity/Volume Sold

 Variable & Fixed

Costs
 Sample Problem:
Acceptance of Additional Orders
a. Should the management accept the offer?
 Unit Selling Price Do NOT Accept
 Quantity/Volume Sold Add’l Orders Accept Add’l Orders
Revenue & Costs:
 Variable & Fixed
(80% capacity) (100% capacity)
Costs
240,000 units * P5.25/unit (240,000 units * P5.25/unit)
+ (60,000 units * P4.30/unit)
P1.26M + P258,000
Revenue (Sales) = P 1.26 M = P 1,518,000
P180,000 + 82,000 P180,000 + 82,000
less: Fixed costs = P262,000 = P262,000
240,000 units * P4.00/unit (240,000+60,000 units) *
P4.00/unit
Variable costs = P 960,000 = P 1,200,000

Profit P 38,000 < P 56,000

∴ Accept add’l orders!

 Sample Problem:
Acceptance of Additional Orders
b. If all prices have to be reduced to P4.30/unit, what action should you recommend?

Do NOT Accept
Add’l Orders Accept Add’l Orders
Revenue & Costs: (80% capacity) (100% capacity)
Revenue (Sales) 240,000 units * P5.25/unit (300,000 units * P4.30/unit)
= P 1.26 M = P 1.29 M
less: Fixed costs
P262,000 P262,000
Variable costs
240,000 units * P4.00/unit 300,000 units * P4.00/unit
Profit = P 960,000 = P 1.2 M
P 38,000 - P 172,000
With this new computation, should the add’l orders still be accepted?
 Sample Problem:

Acceptance of Additional Orders

c. What minimum price would be acceptable to obtain the
increased volume if all prices were to be reduced?

x = minimum price
Profit = 300,000 units * (x) – 300,000 units * (P4.00/unit) – P 262,000

Profit = ?  Current Profit

x=?
Sample Problem:

Operational vs. Plant Shutdown

 Sample Problem:

Operational vs. Plant Shutdown

Operational Shutdown
Revenue (Sales) 10,000 machines * 46/machine
= P 460,000 0
less: Fixed costs
P150,000 P100,000
Variable costs
10,000 machines * P40/machine
Profit = P 400,000 0

- P 90,000 - P 100,000
Should the plant continue operating or shutdown?
 Sample Problem:

Keep or Replace an Old Equipment

Assume that there is a machine, with a cost of P120,000, 2/3 depreciated on a
straight-line basis, with a book value of P40,000 and with a remaining useful life of 4
years. The old machine has a P4,000 disposal value now; in 4 years its disposal value
will be zero. A new machine is available that will dramatically reduce operating costs.
Annual revenue of P100,000 will not change regardless of the decision. The new
machine will cost P60,000 have zero disposal value at the end of its 4-year life. The new
machine promises to slash variable operating costs from P80,000 per year to P56,000
per year. What should you recommend?

Notes:
1. Book value of old equipment. Irrelevant, because it is in the past (historical cost).
2. Disposal value of old equipment. Relevant, because it is an expected future inflow which
usually differs between alternatives.
3. Gain or loss on disposal. Algebraic difference between (1) & (2). Combination of irrelevant
book value and relevant disposal value. Best to think of each separately.
4. Cost of new equipment. Relevant, because it is an expected future outflow that will differ
between alternatives.
 Sample Problem:

Keep or Replace an Old Equipment

COSTS: (for the next 4 Keep Eqpt. Replace Eqpt.

years) P 80,000/year * 4 years P 56,000/year * 4 years
= P 320,000 = P 224,000
Variable operating costs 0 P60,000 (no disposal value)
Cost of new machine
- P 4,000
0 Gain: negative cost
Disposal value of
old machine P 320,000 P 280,000
Total Cost:
Should the old equipment be kept or replaced?
Sample Problem:

Pricing Products For Sale

Sample Problem:

Pricing Products For Sale

Goal: maintain profit = P20,000

Problem: USP = x = ?

Solution:

P20,000 = 40,000 units * (x) – 40,000 * (P7.70) CGS = P308,000

Profit Sales
Variable selling &
– 40,000 * (P1.00) administrative
expenses = P40,000
Fixed selling &
– P60,000 administrative
expenses

x=?
Sample Problem:
Contribution Per Unit of Constraining Factor

*Constraining factor: machines can produce 1 product at a

time
Product A Product B
Output/hour 3 units/hour 1 unit/hour

Output given the 1000hours * 3units/hour 1000hours * 1 unit/hour

available capacity = 3000 units = 1000 units

Contribution P3 * 3000 units P6 * 1000 units

Margin = P 9,000 = P 6,000

Which product should be chosen?

Sample Problem:

Dropping a Product Line

Keep Product C Drop Product C

Sales P100 0
VC 75 ?
CM 25 ?
FC 45* ?
Should Product C
NI (20) ?
be kept or
dropped?
Sample Problem:

Sell or Process Further

 Selling Price
 Quantity/Volume Sold

 Cost

Difference between 2 alternatives

Sunk Cost

Sell Process Further

Sales 20,000gal * P0.40/gal Gas: 0.75 * 20,000gal * P0.56/gal = P 8,400
= P 8,000 + Fuel: 0.15 * 20,000gal * P0.40/gal = P 1,200
Cost 0 - Differential cost: P0.10/gal * 20,000gal = P 2,000
Profit P 8,000 P 7,600
Should the fuel oil be sold as is or processed further?