Management Accounting Quiz for Decision-Making Skills

Relevant costs are those that directly influence future decisions. They differ among alternatives and include costs that can be avoided or incurred depending on the chosen course of action. Past or sunk costs are excluded since they cannot be changed. Recognizing relevant costs ensures optimal financial decision-making based on future impact rather than historical data.

The three elements of relevant costs are cash flows, future costs, and differential costs. Cash flows represent real money movement, future costs relate to upcoming decisions, and differential costs show variations between alternatives. This triad ensures decisions reflect financial consequences accurately and exclude irrelevant data.

In the short run, fixed costs often remain constant and are thus irrelevant for decision-making, while variable and differential costs are emphasized. In the long run, however, some fixed costs may change and need inclusion. Understanding these time-based differences allows managers to plan resource allocation efficiently.

Opportunity cost measures what a business sacrifices by choosing one option over another. It represents the potential benefit lost from the next best alternative. Recognizing opportunity cost ensures that businesses consider all implicit trade-offs and make economically sound decisions that maximize profitability.

Historic material costs are sunk and irrelevant since they have already been incurred. Only the current purchase price or replacement cost matters in decision-making. This ensures managers assess future expenses realistically instead of basing decisions on outdated figures.

The relevant cost of labor includes variable costs tied directly to a specific project. It considers only the incremental labor expenses necessary to complete the task. Fixed salaries or past payments are excluded because they remain unchanged regardless of the decision made.

A company should produce in-house when the relevant cost of internal manufacturing is lower than the cost of external purchase. This ensures cost efficiency and better control over production quality, provided the firm has the required capacity and resources.

When spare capacity exists, the relevant cost of making in-house equals the variable manufacturing cost plus any fixed costs directly associated with that product. It reflects the actual incremental cost of production without considering opportunity costs since no alternative use of resources is sacrificed.

When no spare capacity exists, relevant cost includes variable cost, related fixed cost, and opportunity cost (e.g., lost contribution from another product). This holistic approach ensures all financial implications of production decisions are considered.

Beyond cost, factors like supplier reliability, product quality, delivery timelines, legal risks, and customer perception influence make-or-buy decisions. Outsourcing may save money but could risk confidentiality or brand reputation. Thus, non-financial aspects are crucial to strategic decision-making.

Closure decisions require analyzing lost contribution, fixed cost savings, penalties, reorganization costs, and additional income from alternative resource use. These relevant cash flows determine whether closing an operation is financially viable. Excluding non-cash or historical data ensures accurate outcomes.

Non-quantifiable costs include uncertain penalties, reorganization expenses, and indirect effects like reduced customer traffic. These are difficult to measure but can significantly impact future profits. For instance, closing a product line might reduce customer loyalty or store visits.

A one-off contract should be priced to cover all relevant cash flows — direct materials, labor, and other incremental costs. If the price fails to cover these, the contract should be rejected. This method ensures financial sustainability and avoids short-term decisions that erode profitability.

Further processing decisions depend on comparing additional revenue with extra costs incurred beyond the split-off point. Joint costs are sunk and therefore irrelevant. By focusing on incremental costs and revenues, firms ensure that additional processing only occurs when it increases profit.