Costs

Costs

1. Relevant Cost

   • Future Cost
     • b. Avoidable
     • a. Differ between alternatives
     • = not yet incurred
   • Involves Opportunity Cost
     • OC = Orignial unit CM X No. of units to give up
   • if Fixed Cost
     • b. Avoidable
     • a. Differ between alternatives
     • Eg. Salary of supervisor if company decides to close production line and supervisor is laid off
   • if variable cost
     • when future cost
     • a. Differs between alternatives
   • (i) Make or buy analysis
     • Relevant Cost less purchasing cost
       • Conclusion: NOI will increase/decrease
     • If can rent out factory
       • Incremental Cost + O.C. VS Purchase Cost
         • Or Incremental costs VS purchase cost less rental income
         • Conclusion: Buy externally because cheaper
           • or make internally because cheaper
   • (ii) Special Order
     • How to compute O.C.
       • Maximum production capacity   Less: Current production  ---------------------------------------------------------  = Excess capacity Less: Special order   ---------------------------------------------------------- = Excess/(Shortfall)                                  \\ Unit Opportunity cost (in dollars) = 
   • (iii) Product line drop or retain
     • Example: Loss of Contribution Margin (Sales - VC) ($845,000– $390,000– $65,000)       =      ($390,000) Add: Avoidable Costs Fixed advertising expense                   =         275,000 Salary of product line manager           =            25,000                                                               ------------------------           Net disadvantage                                           ($90,000) Conclusion: If Tam product line is dropped, the company’s profits will decrease further by $90,000.
   • (iv) Sell or process further
     • As long as incremental revenue > incremental cost after split-off point, more profitable to process further :) Else, sell at split-off point
     • Calculations
       • Final Sales value after further processing Less: Sales value at split-off point Incremental Revenue  Less: Further processing costs Net advantage or (disadvantage)  Conclusion:
   • (v) Utilisation of constrained resource
     • In a company: 1. Constraints = when a limited resource restricts a company's ability to satisfy demand. 2. Bottleneck = when machine or process is limiting overall output
     • Constraints
       • Examples: 1. Labour crunch 2. Shortage of raw materials 3. Floor space 4. Machinery 5. Time
       • Steps for constrained resources: 1. Identify constrained or limited resource. 2. Calculate contribution margin per unit of limited resource. (eg. CM per DLH) 3. Rank the products. 4. Allocate constrained resource in order of ranking. 5. Compute optimal combination of different products that will maximise profit.

2. Irrelevant Cost

   • 1. Already Incurred
   • 2. Do not differ between alternatives
   • 3. Unavoidable
   • Sunk Cost
     • 1. Already Incurred
     • 3. Unavoidable
   • Future Cost
     • 2. Do not differ between alternatives
     • does not involve opportunity cost
   • If variable cost
     • 1. Already Incurred
     • Eg. Products manufactured but not yet sold
   • Joint Cost
     • During decision making :) This is because it is a sunk cost. It will not affect the decision to sell or further process.