Costs in Decision Making

Shahid Musthafa
Mind Map by Shahid Musthafa, updated more than 1 year ago
Shahid Musthafa
Created by Shahid Musthafa over 6 years ago


Master ACCA F5: Performance Management (B1: Relevant Cost Analysis) Mind Map on Costs in Decision Making, created by Shahid Musthafa on 07/28/2013.

Resource summary

Costs in Decision Making
1 Relevant costs
1.1 Differential cost
1.1.1 Differential cost is the difference between the cost of two alternative decisions, or of a change in output levels.
1.2 Opportunity Cost
1.2.1 Opportunity cost is an important concept in decision making. It represents the best alternative that is foregone in taking the decision. The opportunity cost emphasises that decision making is concerned with alternatives and that the cost of taking one decision is the profit or contribution foregone by not taking the next best alternative.
1.3 Avoidable costs
1.3.1 Avoidable costs are the specific costs associated with an activity that would be avoided if that activity did not exist.
2 Non - Relevant costs
2.1 Costs which are not relevant to a decision are known as non relevant costs and include: sunk costs; committed costs; non cash flow costs; general fixed overheads; and net book values.
2.2 Sunk costs
2.2.1 A cost that has already been incurred and thus cannot be recovered. A sunk cost differs from other, future costs that a business may face, such as inventory costs or R&D expenses, because it has already happened. Sunk costs are independent of any event that may occur in the future. When making business or investment decisions, individuals and organizations typically look at the future costs that they may incur, by following a certain strategy. A company that has spent $5 million building a factory that is not yet complete, has to consider the $5 million sunk, since it cannot get the money back. It must decide whether continuing construction to complete the project will help the company regain the sunk cost, or whether it should walk away from the incomplete project.
2.3 Committed cost
2.3.1 A committed cost is an investment that a business entity has already made and cannot recover by any means, as well as obligations already made that the business cannot get out of. You should be aware of which costs are committed costs when you are reviewing company expenditures for possible cutbacks or asset sales. if a company buys a machine for $40,000 and also issues a purchase order to pay for a maintenance contract for $2,000 in each of the next three years, all $46,000 is a committed cost, because the company has already bought the machine, and has a legal obligation to pay for the maintenance. A multi-year property lease agreement is also a committed cost for the full term of the lease, since it is extremely difficult to terminate a lease agreement.
2.4 Fixed costs
2.4.1 A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses that have to be paid by a company, independent of any business activity. It is one of the two components of the total cost of a good or service, along with variable cost. An example of a fixed cost would be a company's lease on a building. If a company has to pay $10,000 each month to cover the cost of the lease but does not manufacture anything during the month, the lease payment is still due in full. In economics, a business can achieve economies of scale when it produces enough goods to spread fixed costs. For example, the $100,000 lease spread out over 100,000 widgets means that each widget carries with it $1 in fixed costs. If the company produces 200,000 widgets, the fixed cost per unit drops to 50 cents.
2.5 Net Book Values
2.5.1 Net book values are not relevant costs because like depreciation, they are determined by accounting conventions rather than by future cash flows.
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