Decisions and relevant information
Decisions affect future, and involve future
consequences
Every decision involves choosing from among
at least two alternatives. In making a decision,
the costs and benefits of one alternative must
be compared to the costs and benefits of other
alternatives.
When considering various decisions, managers
often focus on relevant information (to the
decision) and ignore irrelevant ones
Relevance defining
Some information varies among various
options while other information does not
change. Relevant information is the one that
differs among different alternatives
Relevant cost illustration
Relevant cost illustration
Relevant information
Management accounting has the role to
provide relevant information to managers who
make the decisions
Relevant information
differs among alternatives
is future-oriented
Consists of information about revenues and costs
Relevant costs
Cost already incurred (sunk cost)
Cannot change, does not differ
Is not relevant (to the decision making)
Opportunity cost
Is not recognized in financial accounting, but has
effect on economic decisions
Is relevant (to the decision making)
Cost that will incur in the future
Relevant if it differs among alternatives
Irrelevant if it does not differ among alternatives
Practice
Question 9.1
Implications of relevant costing
The relevant information (revenues and costs)
can be used in performing incremental
analysis – a tool for decision making – that is
based on the comparison between incremental
revenues and incremental costs
Incremental revenue
the additional revenue that will be gained as a
result of choosing one alternative over another
Incremental costs
the additional costs that arise from choosing an
alternative
Types of incremental analysis
Make or buy components or finished products
Accept an order at a special price
Eliminate an unprofitable business segment
Sell products or process further
Retain or replace equipment
Allocate limited resources
Make or buy decision
Whether to produce particular goods or
services, or purchase them from an external
supplier
Considerations
avoidable costs vs. unavoidable costs
incremental costs and opportunity costs
Practice
Question 9.2
Make or buy decision
Qualitative issues
quality of the product
delivery responsiveness of supplier
technical capabilities of the supplier
labour relations at the supplier
financial stability of the supplier
ability of the supplier to respect confidential
information to produce particular goods or
services, or purchase them from an external
supplier
Accept or reject a special order
Whether or not to supply a customer with a
single, one-off order for goods or services, at a
special price
Excess capacity
if incremental revenues > incremental costs,
acceptable on financial grounds
allocated fixed costs should not be included
no alternative uses for resources needed to fill the
order
Accept or reject a special order
No excess capacity
include opportunity costs
Other factors
qualitative factors
any adverse effects on regular business
consider the significance of a one-off decision
Practice
Question 9.4
