Video Assignment 03 Relevant Costing Video

Florenz Sabalburo

25 Sept 202408:58

Summary

TLDRThe lesson covers relevant costing, a key concept in decision-making that compares future costs between different activities. It explains differential costs, incremental and avoidable costs, and other concepts like traceable, replacement, opportunity, and sunk costs. The lesson uses simple examples, such as receiving special orders and choosing between college or work, to explain these cost types. The process for analyzing problems is outlined, focusing on evaluating alternatives both quantitatively and qualitatively. The instructor encourages students to prepare for upcoming problem-solving sessions using these concepts.

Takeaways

📚 Relevant costs, also called differential costs, represent the expected changes in future costs due to changes in activity levels.
⚖️ Differential costs are the difference between the total costs of two alternative actions in decision-making.
⬆️ Incremental costs occur when there is an increase in activity or volume, while avoidable costs arise when there is a decrease in activity.
🍪 Traceable costs are directly identifiable with a specific product, department, or division, such as the cost of chocolate chips in baking cookies.
🔄 Replacement costs are incurred when replacing old systems or assets with new ones.
🎓 Opportunity costs represent the benefits forgone by choosing one course of action over another, such as going to college versus working.
⛔ Sunk costs are past expenditures that cannot be recovered and are irrelevant to future decision-making.
💸 Out-of-pocket costs refer to unbudgeted or unexpected personal expenses.
📊 Relevant costing is used in evaluating alternatives for decision-making, such as make-or-buy decisions and evaluating supply, demand, or price analysis.
📝 The process of relevant costing involves defining the problem, identifying alternatives, weighing quantitative and qualitative consequences, and making a decision.

Q & A

What is the definition of relevant costs, also known as differential costs?
-Relevant costs, or differential costs, are the expected changes in future costs when shifting from one level of activity to another. They represent the difference in total costs between two alternative courses of action and are used in decision-making.
How are incremental costs and avoidable costs related to changes in activity or volume?
-Incremental costs occur when there is an increase in activity or volume, representing the additional costs incurred. Avoidable costs occur when there is a decrease in activity or volume, and they represent the costs that can be avoided when no longer operating at a higher level.
What is a traceable cost, and can you provide an example?
-A traceable cost is directly attributable to a specific product, job, department, or operating division. For example, the cost of chocolate chips in a cookie business is a traceable cost, as it can be directly identified with the production of cookies.
What are replacement costs, and when are they incurred?
-Replacement costs are incurred when something in the old system is replaced with a new one. These costs are associated with upgrading or substituting outdated resources or equipment with more current alternatives.
What is an opportunity cost, and how does it impact decision-making?
-Opportunity cost represents the measurable benefit forgone by choosing one alternative over another. For example, if you choose to attend college rather than getting a job, the opportunity cost is the salary you could have earned if you had taken the job.
What is a sunk cost, and why is it considered irrelevant for future decisions?
-A sunk cost is an unrecoverable cost that has already been incurred and cannot be changed. These costs are considered irrelevant in future decision-making because they do not affect future actions or outcomes. For example, the original cost of a machine bought for 800,000 pesos after two years is a sunk cost.
What are out-of-pocket costs, and how do they differ from other costs?
-Out-of-pocket costs refer to unbudgeted expenses or cash disbursements, often personal in nature. They differ from other costs because they are typically unexpected or not part of planned expenditures, such as emergency personal expenses.
What are some examples of problems that involve evaluating only costs in relevant costing?
-Examples include method change problems (evaluating alternative processes), make-or-buy decisions (comparing costs of raw materials or inputs), and order quantity problems (analyzing profits at different levels of quantity or volume).
What types of problems in relevant costing require evaluating both costs and revenues?
-Problems requiring evaluation of both costs and revenues include supply and demand analysis (break-even points), contribution pricing (analyzing contribution margins and variable costs), and decisions related to discontinuing a product or adding services.
What are the general steps in analyzing problems in relevant costing?
-The steps include: 1) Defining the problem and its impact on the business, 2) Identifying alternative solutions, 3) Weighing the quantitative consequences of each alternative, 4) Evaluating qualitative effects, and 5) Reaching a decision based on the analysis.

Outlines

00:00

📊 Introduction to Relevant Costing

This section introduces relevant costing, building on previous lessons in cost accounting and cost-volume-profit relationships. Relevant costs, also known as differential costs, refer to expected changes in future costs when comparing different levels of activity. These costs are crucial for decision-making, involving incremental costs (when activity increases) and avoidable costs (when activity decreases). The lesson emphasizes the importance of comparing current costs to future costs to determine the most beneficial course of action.

05:02

🍪 Practical Examples of Cost Concepts

Using the example of a homemade products business, this section explains how differential costs are calculated by comparing current costs to future costs when order volumes change. It also introduces various cost concepts such as traceable costs, replacement costs, opportunity costs, and sunk costs. Traceable costs are directly identifiable with a specific product or division, while replacement costs are incurred when replacing an old system. Opportunity costs represent the benefits of a forgone alternative, and sunk costs are past expenses that no longer affect future decisions.

🔍 Evaluating Alternatives in Relevant Costing

This section delves into the practical application of relevant costing in decision-making, covering several types of problems. These include method change problems, operations planning problems, make or buy decisions, and order quantity problems. Each scenario involves evaluating costs and sometimes revenues to determine the best course of action. The general steps in problem analysis are outlined: defining the problem, selecting alternative solutions, weighing quantitative and qualitative consequences, and making a final decision. The session concludes with a call to prepare for sample problems in the next class.

Mindmap

Keywords

💡Relevant Costs

Relevant costs, also known as differential costs, are future costs that change as a result of a decision. In the video, these costs are discussed as the primary focus of decision-making, where businesses compare the future costs of two alternatives. For example, the instructor explains how relevant costs would be the difference between current costs at a regular volume of orders and the future costs after accepting a special order.

💡Incremental Costs

Incremental costs refer to the additional costs that a company incurs if it increases its level of activity. These costs are relevant in decision-making when determining whether to take on extra production or sales. In the example of increasing homemade product orders from 30 to 100, the incremental cost is the added cost due to producing the extra 70 units.

💡Avoidable Costs

Avoidable costs are costs that a company can eliminate if it reduces its level of activity. In the video, avoidable costs are discussed in relation to a business that no longer serves special orders; the costs associated with those orders can be avoided, making them relevant to decision-making.

💡Traceable Costs

Traceable costs are expenses that can be directly linked to a specific product, job, or department. The video uses the example of chocolate chips in cookie production to illustrate traceable costs, which directly impact decision-making as these costs are easy to identify and allocate to a specific activity or product line.

💡Replacement Costs

Replacement costs refer to the costs of replacing an old asset or system with a new one. In the context of relevant costing, replacement costs are important because they affect decisions about whether to continue using old equipment or invest in new assets. The video introduces this concept when discussing cost analysis for future decisions.

💡Opportunity Costs

Opportunity costs are the benefits forgone when choosing one alternative over another. The video uses the example of deciding between going to college and getting a job. If you choose to go to college, your opportunity cost is the money you could have earned by working instead. Opportunity costs are crucial in relevant costing because they represent potential gains lost due to the chosen course of action.

💡Sunk Costs

Sunk costs are costs that have already been incurred and cannot be recovered. They are considered irrelevant to future decision-making. For example, the video explains that if a machine was purchased for 800,000 pesos two years ago, its cost is now considered a sunk cost and does not affect future decisions about replacing or upgrading equipment.

💡Out-of-Pocket Costs

Out-of-pocket costs are cash expenses that are not part of a company's budget, often personal or unforeseen expenses. In relevant costing, these costs are analyzed as they can directly affect short-term decision-making and cash flow. The video mentions that these costs must be carefully considered in alternative evaluation.

💡Make-or-Buy Decisions

Make-or-buy decisions involve choosing between manufacturing a product internally or purchasing it from an external supplier. The video highlights this as a common problem in relevant costing, where businesses must compare the costs of raw materials and production against the price of purchasing the finished goods.

💡Contribution Margin

The contribution margin is the difference between sales revenue and variable costs. This margin is important in relevant costing for determining how much a product contributes to covering fixed costs and generating profit. The video refers to contribution pricing problems, where businesses need to evaluate contribution margins and variable costs to make informed pricing decisions.

Highlights

Introduction to relevant costing, also known as differential costs, which are changes in future costs from one level of activity to another.

Relevant costs are used in decision making to compare current costs with future costs resulting from different courses of action.

Incremental costs occur when there is an increase in activity, while avoidable costs occur when there is a decrease in activity.

Application of previous lessons, such as cost-volume-profit analysis, to understand the impact of relevant costing.

Example: Comparing current costs of 30 pieces with the future costs of 100 pieces due to a special order. The difference is classified as an incremental cost.

Avoidable costs are explained when the special customer stops ordering, and the additional costs associated with higher volume are eliminated.

Introduction to traceable costs, which can be directly linked to a product, job, or division within a company.

Example of traceable costs: The cost of chocolate chips in a cookie business, where the cost is directly linked to the product.

Explanation of replacement costs, which occur when replacing something in the old system with something new.

Introduction to opportunity costs: the measurable benefits lost by choosing one alternative over another.

Example of opportunity costs: Deciding between going to college or getting a job, and the financial benefits lost in each scenario.

Sunk costs: Costs that have already been incurred and are irrelevant to future decisions. Example: A machine purchased for 800,000 pesos after two years is a sunk cost.

Out-of-pocket costs: Cash disbursements that are not part of the budget, such as personal expenses.

General steps for analyzing relevant costing problems: Define the problem, identify alternative solutions, weigh quantitative and qualitative consequences, and reach a decision.

The lecture concludes by preparing students to solve sample problems related to relevant costing in the next session.