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Importance of the Relevant Costs Concept Within Management Accounting Studies

Essay by   •  April 25, 2018  •  Essay  •  1,399 Words (6 Pages)  •  351 Views

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  • Introduction

This essay is about the importance of the relevant costs concept within management accounting studies. Relevant information is very important for decision-making and it is the most important functions of management accounting. There are 2 more parts in this essay, question a and b. In question a, it will discuss what is meant by the relevant cost concept and describe the main principles of relevant cost. About question b, it will discuss how the relevant cost concept helps in the management decision making process. It will analyze how management choose base on three alternative resources. About relevant costs’ definition, Relevant costs are those future costs that will be changed by a decision. (Colin, D 2009) This essay concludes with the gained understanding of the importance of the relevant cost concept as relevant information of future costs.

  • Key finding

Q(a)

 Relevant cost is important and effective for decision making. It is the relevant information of future cost. Relevant costing portions future costs and revenues to the decision being made. It includes only those cash flows which will be affected by the decision. (ACCA, 2018) For every company, managers have to make decisions about accounting. Making profit is every company’s aim. When mangers make decision, they have to compare different accounting solutions or plans. Because the money is budget, it is future costs and revenues, it represents by future cash flow. These are relevant information, which include different alternative solutions for decision-making.

An example of relevant cost is Apple. Apple has bought material “display panel A” to use for the produce of iphone 8. Theses material cost are unavoidable and irrelevant. However, due to the good responds on its iphone X and the market is currently shortage on iphone X “display panel B”. management has not made the decision yet. The conversion cost are avoidable and the decision rules is that additional profits from alternative must be in excess of the avoidable cost (conversion costs) for management to accept the decision.

About the importance of the relevant cost concept to business, there are some examples. For instance, there is a growing demand for events and a great amount of entertainment for residents in Shanghai. (Mättö & Sippola, 2016) There are art event, car show event and music event. Why it is important? As the demand for events increase, the market become more competitive. Therefore, business need to understand how much their relevant costs, revenues and profits when they make decisions to accept a contract within the for a specific event or business.

There are some principles linked to the relevant cost concept. The concept of opportunity cost is one of these linked principles. Opportunity cost is defined as,” an opportunity cost is a cost that measures that opportunity that is lost or sacrificed when the choice of one course of action requires that an alternative course of action is given up.” (Colin, D 2009) And it is also linked to relevant cost concept.

  Relevant costs are future costs that differ between alternatives. Past costs or sunk costs irrelevant costs. About sunk costs, they are costs that have been created by a decision made in the past and cannot be changed by any decision that will be made in future. (Colin, D 2009) For example, the expenditure of $100 on materials that no longer required, referred to in the preceding section, is an example of a sunk costs.

  Relevant costs are cash flows. They are cash flows-only flow informational required, cash to spend or cash to earn. About cash flow, it will include cash inflows and outflows, the inflows may be represented by saving in cash outflows. For instance, a decision to purchase new machinery may generate cash saving in the form of reduced out-of-pocket operating costs. (Colin, D 2009) Relevant cost are incremental or marginal costs and revenues. About incremental costs and revenues are difference between cost and revenues for the corresponding items under each alternative being considered. (Colin, D 2009) there is an example, a company has an opportunity to obtain a contract for the production of a special component. This component will require 100 hours of processing on machine X. Machine X is working at full capacity on the production of product A, and the only way in which the contract can be fulfilled is by reducing the output of product A. this will result in a lost profit contribution of $200. The contract will also result in additional variable costs of $1000. If the company takes on the contract, it will sacrifice a profit contribution of $200 from the lost output of product A. this represents an opportunity cost, and should be included as part of the cost when negotiating for the contract. The contract price should at least cover the additional costs of $1000 plus the $200 opportunity cost to ensure that the company will be better off in the short term by accepting the contract.

Q(b)

To answer Question b (i) raw material, discuss relevant costs in terms of the decisions related to a business’s resource allocation on its raw materials. When a business has a full inventory of raw material, business could use regularly or not use. If they use material regularly, they will buy on current purchase price. If business don’t use the stock, they will lose scrap or saved disposal costs. And if businesses don’t stock, they will also buy on current purchase price. This can be present form the following tables.

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