ACCT 2107 · Decision-Relevant Costs: What Counts and What Doesn't

Led by Margaret Vance-Foster Simulacrum

1. Module 7 ○ Open

   Decision-Relevant Costs: What Counts and What Doesn't

   Led by Margaret Vance-Foster Simulacrum

   The question

   Relevant-cost analysis — the discipline of identifying which costs and revenues actually change with a specific decision, and which (sunk, allocated, committed) do not. The module covers the relevance criterion, the sunk-cost fallacy, allocated vs avoidable overhead, opportunity costs, differential analysis, the typical decision types (make-or-buy, keep-or-drop product lines, accept-or-reject special orders, sell-or-process-further), and the difference between accounting numbers (financial-statement view) and decision numbers (relevant-cost view). The closing scenario decides whether to drop a product line.

   Outcome

   The student can identify which costs and revenues are relevant for a specific decision, separate sunk costs from going-forward costs, recognise allocated vs avoidable overheads, identify opportunity costs, and produce a decision-relevant analysis for make-or-buy, keep-or-drop, and similar choices. (Decision-relevant costs)

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   Practice scenarios

   Drop the Product Line?

   Your company has four product lines. The accounts show Product C as a £180,000 annual loss: revenue £600,000, variable cost £450,000, allocated central overhead £200,000, contribution to direct fixed costs £130,000, line-specific direct fixed cost £60,000, allocated head-office costs £200,000 — apparent loss £130k contribution minus £60k direct minus £200k allocation = −£130k. (Numbers are illustrative; the apparent loss arises mainly from the central allocation.) The CFO wants to drop Product C. The CEO is uncertain. Foster Simulacrum wants you to do the decision-relevant analysis.

   Your goals

   • Strip out the irrelevant: the £200k allocated central overhead will *not* disappear if Product C is dropped — it will be reallocated to the surviving products. It is irrelevant to the drop decision.
   • Strip out the sunk: any past investment in Product C cannot be recovered and is not part of the decision.
   • Identify the relevant: the £150k contribution (revenue minus variable cost) and the £60k direct fixed cost specific to Product C. If C is dropped, the company saves £60k and loses £150k of contribution. Net effect: profit *falls* by £90k if C is dropped.
   • Identify the opportunity cost: if the resources freed by dropping C could be redeployed to a higher-contribution use, that's relevant. If they cannot (capacity is otherwise idle), the £90k loss is the right number.
   • Recommend keeping Product C unless a clearly higher-value use of its resources can be identified. Make the broader point: the absorption-cost P&L showed a loss; the relevant-cost analysis shows positive contribution. The two numbers serve different purposes.

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