Relevant Costing
Introduction: -
A management decision involves predictions of costs & revenues. Only the costs and revenues that will differ among alternative actions are relevant to the decision. The role of historical data is to aid the prediction of future data. But historical data may not be relevant to the management decision itself. Qualitative factors may be decisive in many cases, but to reduce the number of such factors to be judged, accountants usually try to express many decision factors as possible in quantitative terms.
Meaning of Relevant Costs: -
Relevant costs represent those future costs that will be changed by a particular decision. While irrelevant costs are those costs that will not be affected by a decision. In the short run, if the relevant revenues exceed the relevant costs then it will be worthwhile accepting the decision. Therefore relevant costs playa major role in the decision-making process of an organization. A particular cost can be relevant in one situation but irrelevant in another, the important point to note is that relevant costs represent those future costs that will be changed by a particular decision, while irrelevant costs are those costs that will not be affected by that decision. We shall now see what are relevant costs and revenues for decision-making process. In summary relevant information concerns:
Other Important Terminologies : -
Relevant costs are costs appropriate to aiding the making of specific management decisions. Actually, to affect a decision a cost must be:
Future: Past costs are irrelevant as they are not affected them by future decisions & decisions should be made as to what is best now.
Incremental: This refers to additional revenue or expenditure, which may appear as a result of our decision-making.
(A cash flow - Such charges as depreciation may be future but do not represent cash flows and, as such, are not relevant.)
Sunk costs: Past costs, not relevant for decision making
Committed costs: This is future in nature but which arise from past decisions, perhaps as the result of a contract.
Relevant Costs: Problem areas:
1 Problems in determining the relevant costs of materials:
When considering various decisions, if the any materials required is not taken from existing stocks but would be purchased on a later date, then the estimated purchase price would be the relevant material cost. A more difficult problem arises when materials are taken from existing stock. In this situation the relevant cost of materials for a particular job (say job X) depends on
Material is in regular use of the company
Material is not in regular use of the company
Material is in short supply.
If the material is in regular use of the company then the material taken from existing stock requires replacement for the purpose of regular use therefore the relevant cost of material will be the Replacement cost.
If the material is not in regular use of the company the relevant cost of the materials depends on their alternative use. The alternative use of the materials will be either to sell them or to use them on other jobs. Hence the cost of using the materials results in an opportunity cost consisting of either
The net sales revenue if the materials were sold (or) The expense that would be avoided if the materials were used on some other job Whichever is greater.
If the material is in short supply the only way material for the job under consideration can be obtained is by reducing production of some other product / job. This would release material for the order. but the reduced production will result in loss of contribution which should be taken in to account when ascertaining the relevant costs for the specific order. Therefore the relevant cost will be Contribution lost (before the material cost since the material cost will be incurred in any case) will be the relevant cost.
labour:
2 Determining the direct labour that are relevant to short - term decision depends on the circumstances.
Where a company has temporary sparse capacity and the labour force is to be maintained in the short - term, the direct labour cost incurred will remain same for all alternative decisions. The direct labour cost will therefore be irrelevant for short - term decision - making purposes.
However where casual labour is used and where workers can be hired on a daily basis; a company may then adjust the employment of labour to exactly the amount required to meet the production requirements. The labour cost will increase if the company accepts additional work, and will decrease if production is reduced. In this situation the labour cost be a relevant cost for decision - making purposes.
In a situation where full capacity exists and additional labour supplies are unavailable in the short - term, and where no further overtime working is possible, the only way that labour resources could then be obtained for a specific order would be to reduce existing production. This would release labour for the order. but the reduced production will result in loss of contribution, which should be taken in to account when ascertaining the relevant costs for the specific' order. Therefore the relevant cost will be Contribution lost (before the labour cost) will be the relevant cost.
PROBLEMS
1. In a firm, material A has no alternative uses and 200 units of which lie in stock. The information below has been collected. You are required to find the relevant price of 120 units and 250 units respectively.
Book value
Current price
Sale price obtainable
Rs.2 per kg Rs.3 per kg Rs.2.80 per kg
2. Assume in the above problem the material is in regular use of the company
3. Assume in the above problem the material is in short ‘supply and it is not possible to obtain the stock of material for some more time. At present the material is used in another product on which a contribution at the rate of Rs.1 O/unit is earned (after meeting the material cost). Each unit of the product requires 1 KG of Raw material A.
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