ACCA F5 Make Or Buy And Other Short-term Decisions Flashcards

2 Relevant costs and revenues Relevant costs are future cash flows arising as a direct consequence of the decision under consideration

2 Relevant costs and revenues 1) Cash flows. Actual cash flows should be considered. Noncash items such as depreciation and interdivisional charges should be ignored. 2) Future costs and revenues. Past costs and revenues are only useful as a guide to the future. Costs already spent - sunk costs- are irrelevant for decision making. 3) Differential costs and revenues. Only the costs and revenues that alter as a result of a decision are relevant. Factors common to all alternatives being considered can be ignored; only the differences are relevant.

2 Relevant costs and revenues 1) In many shortrun situations fixed costs remain constant for each alternatives being considered therefore marginal costing showing sales, marginal cost and contribution is particularly appropriate 2) Fixed costs do change and the differential costs must include any changes in the amount of fixed costs.

- Value of the best alternative that is foregone when a particular course of action is undertaken. - by choosing one plan there may well be sacrifices elsewhere in the business.

4 The relevant cost of materials

4 The relevant cost of materials - always a sunk cost and never relevant unless it happens to be the same as the current purchase price.

5 The relevant cost of labour

6 Make versus buy - if relevant cost of making the product in-house is less than the cost of buying the product externally.

6 Make versus buy relevant cost = variable cost of internal manufacture + fixed costs directly related to that product

6 Make versus buy relevant cost = variable cost of internal manufacture + fixed costs directly related to that product + opportunity cost of internal manufacture (e.g. lost contribution from another product).

Reliability of external supplier- quantity required- quality required- delivering on time- price stability Specialist skills: the external supplier may possess some specialist skills that are not available in-house Alternative use of resource: outsourcing will free up resources which may be used in another part of the business. Social: will outsourcing result in a reduction of the workforce? Redundancy costs should be considered. Legal: will outsourcing affect contractual obligations with suppliers or employees? Confidentiality: is there a risk of loss of confidentiality, especially if the external supplier performs similar work for rival companies Customer reaction: Do customers attach importance to the products being made in-house?

7 Shut-down decisions - the lost contribution from the area that is being closed (= relevant cost of closure) - savings in specific fixed costs from closure (=relevant benefit of closure) - known penalties and other costs resulting from the closure, e.g. redundancy, compensation to customers (=relevant cost of closure) - any known reorganisation costs (= relevant cost of closure) - any known additional contribution from the alternative use for resources released (= relevant benefit of closure)

7 Shut-down decisions - penalties and other costs resulting from the closure (e.g. redundancy, compensation to customers) may not be known with certainty. - reorganisation costs may not be known with certainty - additional contribution from the alternative use for resources released may not be known with certainty - Knock-on impact of the shut-down decision. For example, supermarkets often stock some goods which they sell at a loss. This is to get customers through the door, who they then hope will purchase other products which have higher profit margins for them. If the decision is taken to stop selling these products then the customers may no longer come to the store

8 One-off contracts The minimum contract price = the total of the relevant cash flows associated with the contract. If the contract price does not cover these cash flows then it should be rejected

9 Further processing decisions - Any difference in revenue and any extra costs - Joint costs are sunk at this stage and thus not relevant to the decision