ACCA Applied Skills · Performance Management
Relevant Cost Analysis for ACCA Performance Management
Relevant cost analysis means including only future, incremental cash flows that change because of a decision. You ignore sunk costs, committed costs, non-cash items and general overheads that do not change. Then you compare the options on that basis and choose the one with the best incremental benefit.
What this chapter covers
This chapter teaches you how to pick the right numbers for a decision. A relevant cost is a future, incremental cash flow that differs between the options. Everything else is noise. You learn to spot sunk costs, committed costs, depreciation, apportioned overheads and other items that look important but change nothing.
You then apply the rule to specific inputs: materials, labour and overheads. Each has its own test. For materials, you ask whether the stock is already owned, whether it will be replaced, and whether it has another use. For labour, you ask whether staff are spare, or whether work must be given up to do the job. After that you apply the rule to bigger choices: make or buy, outsourcing, shutting down a segment, and processing a product further.
The chapter connects to much of the rest of PM. Limiting factor analysis, pricing, budgeting and variances all use the same idea of contribution and incremental thinking. It also links to the Section C style of question, where you set out a decision with clear workings and a short recommendation. Non-financial factors usually matter too, so you need to be ready to comment on them.
Relevant costing can be examined in any section: Section A objective questions, Section B OT cases and Section C constructed response questions. Coverage is not guaranteed, but it tests judgement as well as arithmetic. The calculations are usually short, so you can pick up marks quickly once the rules are secure. Objective questions are marked all or nothing, so one wrong treatment, such as including a sunk cost, loses the whole question. The same thinking also supports limiting factor, pricing and performance questions elsewhere in the paper, so the effort pays back across the syllabus.
Relevant cost analysis: topics in the order to study them
- 1Relevant Costs and RevenuesIt sets the core rule and the terms (sunk, committed, opportunity, incremental) that every later topic depends on.
- 2Relevant Cost of Materials, Labour and OverheadsIt applies the core rule to the three most tested inputs, so you learn the specific tests before whole decisions.
- 3Make-or-Buy and Outsourcing DecisionsIt uses relevant costs to compare two options, and adds limiting factors and non-financial points.
- 4Shut-Down and Further Processing DecisionsIt comes last because it combines avoidable costs, lost contribution and incremental revenue in one decision.
How to prepare Relevant cost analysis
Aim to learn the rules first, then drill them on short questions, then practise full written answers.
- Learn the definitions of relevant, sunk, committed, opportunity and avoidable costs, and write one example of each in your own words.
- For every cost in a question, ask: is it future, is it cash, and does it differ between the options? Cross out anything that fails.
- Memorise the tests for materials (owned or not, replaced or not, other use), labour (spare capacity or not) and overheads (only extra spend counts).
- Practise make-or-buy by comparing relevant cost per unit to the buy-in price, and check for a limiting factor before you decide.
- For shut-down and further processing, work from contribution and avoidable fixed costs, and compare incremental revenue with incremental cost.
- Do timed objective questions, then at least two written questions, ending each answer with a recommendation and two or three non-financial factors.
- Keep an error log of every wrong treatment and review it before your exam.
Common mistakes in Relevant cost analysis
Including sunk or committed costs in the answer.
Fix: Test each figure: is it a future cash flow that changes with the decision? If not, leave it out.
Using the original purchase price of materials already in stock.
Fix: Use replacement cost if the material will be replaced, or the higher of resale and alternative use value if it will not.
Charging spare labour at the full wage rate.
Fix: If workers are already paid and idle, the relevant cost is zero. Add opportunity cost only when the hours come from other work.
Including apportioned fixed overheads in make-or-buy or shut-down decisions.
Fix: Include only fixed costs that would be saved or incurred because of the decision.
Choosing the cheaper option without checking for a limiting factor.
Fix: If a resource is scarce, rank by saving or contribution per unit of that resource.
Giving a number but no recommendation or qualitative points in a written question.
Fix: Finish with a clear decision and a few non-financial factors such as quality, reliability, supplier dependence and staff morale.
Last-day revision: Relevant cost analysis
- Relevant costs are future, incremental cash flows.
- Sunk costs are never relevant, whatever they cost originally.
- Committed costs are not relevant because they happen either way.
- Depreciation and apportioned fixed overheads are usually not relevant.
- Opportunity cost is the benefit lost by choosing one option over another, and it is relevant.
- Materials already owned and not replaced: relevant cost is the higher of net resale value and the value in the best alternative use; zero if it has neither.
- Materials that must be replaced: use the current replacement cost.
- Spare labour has no relevant cost; labour that must be moved costs wage plus lost contribution.
- Only extra overhead spend caused by the decision is relevant.
- Make or buy: compare avoidable cost of making with the buy-in price, and use contribution per limiting factor unit if resources are scarce.
- Shut down if the avoidable costs saved (variable plus avoidable fixed) exceed the revenue lost, that is, if the segment's contribution is less than its avoidable fixed costs; also consider knock-on effects on other segments.
- Process further if incremental revenue exceeds incremental cost; joint costs are irrelevant.
Relevant cost analysis practice questions
- Ridge Co makes component Z internally at a variable cost of $14 per unit and allocates fixed overheads of $6 per unit, of which only 40% wou…
- Cobalt Co is considering stopping Product P, which has sales of $90,000, variable costs of $60,000, directly attributable avoidable fixed co…
- Zeta Co is considering a special order that needs 400 kg of Material X. Zeta holds 500 kg of X in inventory, bought for $6 per kg. X is regu…
- Which of the following is a relevant cost for a decision on whether to accept a special order?
- Dalton Co is pricing a one-off contract. Which of the following overhead items is relevant to the decision?
- Which of the following is a qualitative factor that favours outsourcing a service rather than providing it in-house?
- Orla Co makes 5,000 units of a component at a variable cost of $12 each. Machine capacity used for the component could instead be used to ma…
- Brook Co is deciding whether to accept a one-off order requiring 1,000 labour hours. Workers are paid $12 per hour and are currently idle fo…
Relevant cost analysis in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Relevant cost analysis: frequently asked questions
What is a relevant cost in ACCA PM?
A relevant cost is a future cash flow that changes because of a decision. It must be incremental and avoidable. Sunk costs, committed costs and non-cash items are not relevant.
How do I treat opportunity cost?
Include it as a relevant cost. It is the benefit you give up by using a resource on one option instead of its next best use, such as contribution lost when labour is moved from other work.
Is depreciation ever relevant?
No. Depreciation is a non-cash accounting charge, so it is not a relevant cash flow. The cash spent to buy the asset may be relevant if it is a future purchase caused by the decision.
How is relevant costing tested in the exam?
It can be examined in any section: Section A objective questions, Section B OT cases or Section C constructed response questions. Coverage is not guaranteed, so prepare for all formats. Objective questions are all or nothing, so you need accurate treatment of each item. Written questions also expect a recommendation and non-financial comments.