Performance Management · Make-or-buy and other short-term decisions

Relevant Costing Principles for ACCA Performance Management

Updated 11 October 2026 · Fact-checked

Relevant costing means using only the cash flows that change because of a decision. Include future, incremental cash flows and opportunity costs. Exclude sunk costs, committed costs, non-cash items such as depreciation, and general absorbed overheads. Compare the cash position with and without the decision.

Understand Relevant Costing Principles

Every decision compares two futures: one if you act, one if you do not. A cost is relevant only if it differs between those two futures. If it is the same either way, it cannot help you choose.

Three tests decide relevance. The cash flow must be future, so money already spent is out. It must be incremental, so it only arises or changes because of the decision. It must be a cash flow, so accounting entries with no cash effect are out.

A sunk cost is already incurred, for example market research done last month. A committed cost will be paid whatever you decide, for example a contract you cannot cancel. Depreciation is a non-cash allocation. Absorbed fixed overheads are only relevant if total overhead spending actually changes. None of these affect the decision.

An opportunity cost is the benefit you give up by using a resource in one way rather than its best alternative. It is relevant even though no new payment is made. For example, if staff time could earn contribution elsewhere, that lost contribution is a cost of using it here.

The PM exam applies this mainly to materials, labour and overheads, and to make-or-buy, special orders and shut-down decisions. The principle is always the same: ask what cash changes.

Key rules to remember

Relevant cost test: Relevant cost = future + incremental + cash flow (including opportunity costs); If a cost fails any one of these tests, leave it out.
Opportunity cost: Opportunity cost = benefit lost from the best alternative use of the resource; Use the higher of the alternatives that actually apply, such as resale value or the cost of replacement.
Material already in stock, regularly used: Relevant cost = current replacement cost; Using it means it must be replaced.
Material in stock, not needed again: Relevant cost = higher of resale value and cost of using it in another job (net of any disposal cost); If it would otherwise be disposed of at a cost, avoiding that cost is a benefit.
Labour: spare capacity: Relevant cost = extra payment only (often nil for fixed-wage staff); Paying idle workers anyway means no incremental cost.
Labour: no spare capacity: Relevant cost = wages + lost contribution after labour cost (which equals the lost contribution before labour cost on its own); Add the wage to the contribution measured after labour cost. If the contribution is measured before labour cost, it already includes the wage, so use it on its own and do not add the wage again.
Overheads: Relevant cost = extra overhead spending only; Absorbed overhead rates are not relevant unless spending changes.

How to solve Relevant Costing Principles questions

Use this checklist on any relevant costing question, however it is worded.

1Define the decision and the alternatives, including doing nothing.
2List every cost and revenue mentioned in the question.
3Cross out sunk and committed costs and anything already paid or contractually unavoidable.
4Cross out non-cash items such as depreciation and apportioned overheads, unless spending changes.
5For each resource, ask: is it already owned, and does it have another use? Apply the material, labour or overhead rule to find the opportunity cost or replacement cost.
6Add any extra incremental costs and benefits, such as a disposal cost avoided or a redundancy cost saved.
7Total the relevant costs and compare with relevant revenue, then state a clear recommendation.
8Add brief non-financial points if the question asks, such as customer reaction or reliability.

Quickest way: The Three-Question Filter

When to use it: Use in Section A and OT case questions where you need one figure fast.

Ask: is it future? If not, ignore it.
Ask: does it change with this decision? If not, ignore it.
Ask: is it cash, or a lost cash benefit? If not, ignore it.
For owned resources, take the higher of replacement cost, resale value and benefit from alternative use, as the facts fit.
Sum what is left and check you have not included depreciation or absorbed overheads.

Common mistakes in Relevant Costing Principles

Including the historical cost of materials already in stock.
The question gives the original purchase price, and it looks like the obvious cost.
Fix: Ask what using the material actually costs now: replacement cost if it will be replaced, otherwise the higher of resale value and alternative use.
Treating all labour as relevant at the full wage rate.
Students assume labour is always a cost of the job.
Fix: Check for spare capacity. If staff are paid anyway, the incremental cost is nil. If not, add the lost contribution from diverted work.
Including absorbed fixed overheads or depreciation.
They appear in the standard cost card, so they feel like part of the cost.
Fix: Include overheads only if total spending changes. Always exclude depreciation as non-cash.
Ignoring opportunity costs because no money is paid.
Students think of cost only as cash leaving the bank.
Fix: Count benefits given up, such as contribution lost or resale proceeds forgone.
Including committed costs because the item is being used in the project.
A contract exists for the material, so it seems connected to the decision.
Fix: If the cost must be paid whatever you decide, it is irrelevant. Only the cost of any extra or cancellable amount counts.
Double counting labour and lost contribution.
Lost contribution is sometimes calculated after deducting wages.
Fix: Include the wage once, plus the contribution lost after labour cost, or use the contribution before labour cost on its own.

Worked examples

Example 1

A firm is pricing a one-off job. It needs 500 kg of Material X. The firm holds 300 kg, bought at $6 per kg. Material X is used regularly and now costs $8 per kg to buy. Its resale value is $5 per kg. Calculate the relevant cost of Material X for the job.

Show the solution

Material X is regularly used, so any stock used must be replaced.
The relevant cost per kg is therefore the replacement cost of $8 for all 500 kg.
The historical cost of $6 is sunk and the resale value of $5 is not the best alternative.
Relevant cost = 500 × $8 = $4,000.

Answer: $4,000

Example 2

A job needs 200 hours of skilled labour paid at $15 per hour. Only 120 hours are spare, as the staff are on a fixed weekly wage. The other 80 hours must be taken from product Z, which earns a contribution of $10 per hour of labour after labour has been paid at $15 per hour. Calculate the relevant cost of labour.

Show the solution

The 120 spare hours are paid anyway, so their incremental cost is nil.
The 80 hours diverted from Z must be paid the wage of $15 per hour: 80 × $15 = $1,200.
Z earns $10 per hour after labour is paid, so diverting 80 hours loses contribution after labour of 80 × $10 = $800.
Relevant cost of the 80 hours = wage $1,200 + contribution lost after labour $800 = $2,000.
Check: contribution before labour is $10 + $15 = $25 per hour, and 80 × $25 = $2,000. This is the same calculation, because the $25 already includes the wage. Do not add the wage a second time to the $25 figure.
Total relevant cost of labour = $0 + $2,000 = $2,000.

Answer: $2,000

Exam tips

Write a short line beside each item saying relevant or not, and why. Markers reward the reasoning in Section C.
Look for hidden words such as already purchased, committed, apportioned and depreciation. They usually signal irrelevant items.
Read the stock wording carefully: regularly used, no other use, or could be sold. Each gives a different rule.
OT questions are marked all or nothing, with no partial credit, so check you have excluded sunk and non-cash items before you answer.
State your recommendation and mention one or two qualitative factors when the question asks for advice.

Practice questions from Make-or-buy and other short-term decisions

Relevant Costing Principles in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Relevant Costing Principles: frequently asked questions

What is the difference between a sunk cost and an opportunity cost?

A sunk cost has already been incurred and cannot be changed, so it is irrelevant. An opportunity cost is the benefit lost by choosing one use of a resource over the next best use. It is relevant because it changes with the decision.

Is depreciation ever a relevant cost?

No. Depreciation is a non-cash allocation of past expenditure. The cash spent on an asset in the future could be relevant, but the depreciation charge itself never is.

Are fixed overheads relevant in ACCA PM?

Only if the decision causes total fixed overhead spending to change. Absorbed or apportioned overheads are not relevant. An extra cash cost caused by the decision, such as additional supervision, is relevant.

How do I treat labour that is already employed?

Check whether the staff would otherwise be idle. If they are paid regardless and have spare time, the cost is nil. If their time must be diverted from other work, include their wages plus the contribution lost.