ACC10007 Lecture Notes - Lecture 11: Sunk Costs, Opportunity Cost
Week 11
Tactical Decision Making
Relevant costing for decision making
Tactical Decision Making or Relevant costing
•We use our knowledge of cost behaviour to help us in a wide range of tactical or short
term decision making.
•Long term strategic decisions are not considered and therefore capital investment is
not an available option.
•When measuring costs for decision-making purposes, it is useful to identify relevant
costs, and exclude those costs that are not relevant to the decision
Relevant Information
•Relevant costs and benefits are future costs / benefits that differ across alternative
courses of action.
• Should be consistent with business objectives
• May require a balance between timeliness & accuracy
• Can be quantitative or qualitative
When choosing amongst alternative courses of action relevant information can include:
•Incremental Revenue
•Incremental Costs
•Opportunity costs
•Avoidable versus unavoidable costs
•Qualitative factors
Relevant costs
Opportunity costs - the benefit given up or sacrificed when one alternative is chosen
over another
For example: The opportunity cost of studying full time is the full time salary you are
giving up, or, the difference between a full time salary and your part time salary
The focus of relevant information includes an understanding and knowledge of avoidable
and unavoidable costs
•Avoidable costs – costs that will not be incurred in the future if a particular
decision is made
•Unavoidable costs – costs that will continue to be incurred no matter which
alternative is chosen. Unavoidable costs are irrelevant to the decision.
Irrelevant Information
•Unavoidable costs
•Sunk costs are past costs that have already been incurred and cannot be affected by
any future action
•Future costs or revenues that are the same for all courses of action being considered
•Costs or benefits not related to the alternatives being considered
Relevant costing and decision making
In decisions involving limited periods of time, or small variations from usual practice, fixed
costs may not be so easily changed. Fixed costs that stay the same regardless of the
course of action are irrelevant.
Areas of decision making can include:
•whether to continue to make or buy a product or component
•whether to accept or reject special orders/contracts
•making the most efficient use of scarce resources
•adding or dropping a product line
•closing or continuing a department
Lecture Illustration 1: Make or Buy
Swintech currently makes 10,000 units of a component for one of its products. It can be
made by an outside supplier for $20per unit. Swintech estimates the cost to make the
component is $23 per unit:
Direct materials $8
Direct labour 7
Variable overhead 3
Fixed overhead * 5
Unit Cost $23
*Fixed Overhead is an allocated cost for rent & supervisory salaries that would be
incurred regardless of make or buy decision
Question:
Should Swintech continue to make the component or should it buy it from the
supplier?
What type of decision is this?
Which costs are relevant to this decision?
Make or Buy Decision
Direct materials $8
Direct labour 7 $18 Variable Cost to make is relevant
Variable overhead 3
Fixed overhead * 5 Irrelevant to this decision
Unit Cost $23
* Fixed Overhead is an allocated cost for rent & supervisory salaries that would be
incurred regardless of make or buy decision
Should Swintech continue to make the component or should it buy it from the supplier?
Qualitative factors
Include:
• Will the outsourced component be at least the same quality as Swintech’s? If not,
what are the implications?
• Will the outside supplier be able to deliver on time as required? If not, what are the
implications?
• How reliable is the supplier’s quote? What are the implications if the price increases?
• If jobs are lost, are there any redundancy costs?
• What is the impact on employee morale if outsource?
• Could the decision be easily reversed if required?
• If outsource, could the spare capacity be put to use?
Need to consider qualitative as well as quantitative factors
In a make or buy decision - the choice is whether to produce a product or purchase it
from an external supplier
• Consider avoidable versus unavoidable costs
Document Summary
We use our knowledge of cost behaviour to help us in a wide range of tactical or short term decision making. Long term strategic decisions are not considered and therefore capital investment is not an available option. When measuring costs for decision-making purposes, it is useful to identify relevant costs, and exclude those costs that are not relevant to the decision. Relevant costs and benefits are future costs / benefits that differ across alternative courses of action. May require a balance between timeliness & accuracy. When choosing amongst alternative courses of action relevant information can include: Opportunity costs - the benefit given up or sacrificed when one alternative is chosen over another. For example: the opportunity cost of studying full time is the full time salary you are giving up, or, the difference between a full time salary and your part time salary. The focus of relevant information includes an understanding and knowledge of avoidable and unavoidable costs.
