Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Strategic Cost & Performance Management

Decision Making and Relevant Costing for CA Final

Updated 5 October 2026 · Fact-checked

Relevant costing means using only future cash flows that differ between alternatives. Ignore sunk and unavoidable costs, include opportunity costs, and compare incremental revenue with incremental cost. For make-or-buy, shutdown and limiting factor questions, work on contribution, then check fixed costs that can really be avoided.

Understand Decision Making and Relevant Costing

Every short-term decision asks one question: what changes if I choose this option over the other? Only the things that change matter. These are the relevant costs and revenues.

A cost is relevant if it is a future cost, it is incremental (it differs between alternatives), and it is a cost you can still avoid or control. Past costs are sunk costs and are never relevant. Costs that stay the same whatever you choose, such as allocated common overheads, are also not relevant.

Opportunity cost is the benefit you give up by using a resource in one way instead of its next best use. It is relevant. If a material in stock has no other use, its relevant cost is the higher of its resale or scrap value and its value in the job (the opportunity cost), not its purchase price. If it is regularly used and would be replaced, the relevant cost is its replacement cost. If it has an alternative use and will not be replaced, the relevant cost is the contribution lost from that alternative use.

Most decisions use contribution (selling price less variable cost), because fixed costs usually do not change in the short run. Make-or-buy compares the avoidable cost of making with the buying price. A shutdown decision compares the contribution lost with the fixed costs saved. When one resource is scarce, rank products by contribution per unit of the limiting factor, not by contribution per unit of product.

In the Paper 6 case studies, these decisions are hidden inside a business story. Pick out the facts that change, ignore the rest, and also mention non-financial points such as quality, supplier reliability, labour relations and capacity use.

Key rules to remember

Contribution: Contribution = Sales − Variable cost; Use this as the base for most short-term decisions. Fixed costs come in only if they change.
Relevant cost of material: Material to be bought: current purchase price. Held and regularly used (will be replaced): replacement cost. Held with an alternative use and not replaced: contribution from the alternative use. Held with no other use: higher of resale/scrap value and value in the job; Historic cost is never relevant. For material with no other use, the relevant cost is the opportunity cost: the higher of its resale or scrap value and its value in the job.
Relevant cost of labour: Spare capacity: nil extra cost (if paid anyway). Fully used: wage paid + contribution lost per hour; Idle time paid in any case is not a relevant cost.
Make-or-buy rule: Make if avoidable cost of making < purchase price. Buy if purchase price < avoidable cost of making; Avoidable cost = variable cost + fixed costs that would be saved. Add any benefit from using freed capacity.
Shutdown rule (short run): Continue if Contribution > Avoidable fixed costs. Shut if Contribution < Avoidable fixed costs; Allocated fixed costs that continue after closure are ignored.
Limiting factor ranking: Contribution per unit of limiting factor = Contribution per unit ÷ Units of scarce resource per unit; Rank products by this figure and allocate the scarce resource in that order, up to the demand limit.
Special order rule: Accept if Incremental revenue > Incremental cost; Include extra fixed costs and lost sales from existing customers if any.

How to solve Decision Making and Relevant Costing questions

Use this method for any relevant costing or short-term decision question.

1Define the decision and the alternatives clearly, including the option of doing nothing.
2List every cost and revenue given, and mark each as future or past. Cross out sunk costs.
3Mark each remaining item as incremental or not. Cross out costs that are the same under all alternatives, such as unavoidable fixed costs and apportioned overheads.
4Adjust for opportunity costs: scarce materials, labour fully used, capacity that could earn elsewhere.
5Check for a limiting factor. If one resource is scarce, rank on contribution per unit of that resource. If there are several, think of linear programming.
6Compute the incremental profit or cost of each alternative and compare in a clear table.
7State the decision, then add qualitative factors such as quality, supply risk, customer goodwill and long-term strategy.
8Show working notes for each relevant figure so that partial marks are safe.

Quickest way: Contribution and avoidable-cost check

When to use it: Use it in MCQs and in the first pass of a case study when time is short.

Ask only: what cash changes if I choose this option?
Take selling price less variable cost, and add or subtract only avoidable fixed costs.
For scarce resources, divide contribution by scarce units and rank.
Compare the two totals and pick the higher benefit or lower cost.
Add one line on non-financial factors before moving on.

Common mistakes in Decision Making and Relevant Costing

Including apportioned fixed overheads in a make-or-buy or shutdown comparison.
Full cost sheets show total cost per unit and students use it as given.
Fix: Split fixed costs into avoidable and unavoidable. Include only the avoidable ones.
Using the historic purchase cost of material already in stock.
It looks like the cost of the job, so it feels natural to include it.
Fix: Use replacement cost, resale value or the contribution lost from the next best use, whichever the facts support.
Ranking products by contribution per unit when a resource is scarce.
Students rank on the product with the highest contribution without checking the constraint.
Fix: Divide contribution by units of the limiting factor, rank, and allocate in order, respecting demand limits.
Ignoring the opportunity cost of freed capacity in make-or-buy.
Focus stays on the buying price versus the cost of making.
Fix: If the freed capacity can earn contribution elsewhere, deduct that benefit from the cost of buying, or add it to the cost of making.
Closing a loss-making segment without checking its contribution.
The segment shows a net loss after allocated costs, so it looks bad.
Fix: If its contribution exceeds the fixed costs saved, keep it. Fixed costs that continue will otherwise fall on other segments.
Giving only numbers and no recommendation.
Time pressure leads to stopping once the calculation is done.
Fix: Always end with a clear decision and one or two qualitative points.

Worked examples

Example 1

Case: Kaveri Components Ltd makes 10,000 units of part K a year. Cost per unit: direct material ₹120, direct labour ₹80, variable overhead ₹40, fixed overhead apportioned ₹60. A supplier offers to sell part K at ₹250 per unit. If the part is bought, ₹2,00,000 of the fixed overhead would be saved, and the freed capacity could be used to earn a contribution of ₹1,00,000. Should the company make or buy?

Show the solution

Variable cost of making per unit = 120 + 80 + 40 = ₹240.
Variable cost for 10,000 units = ₹24,00,000.
Add avoidable fixed overhead = ₹2,00,000. Avoidable cost of making = ₹26,00,000.
Cost of buying = 10,000 × ₹250 = ₹25,00,000.
Buying frees capacity that earns a contribution of ₹1,00,000. Deduct this benefit from the cost of buying: net cost of buying = ₹25,00,000 − ₹1,00,000 = ₹24,00,000.
Compare: making costs ₹26,00,000 against a net cost of ₹24,00,000 for buying. Buying is better by ₹2,00,000. Apply the freed-capacity benefit only once. The same ₹2,00,000 can also be read as a ₹1,00,000 direct saving (₹26,00,000 − ₹25,00,000) plus the ₹1,00,000 contribution. These are two ways of showing one result, not two separate adjustments.
Non-financial: check quality, delivery reliability and dependence on a single supplier.

Answer: Buy the part. After allowing for the ₹1,00,000 contribution from freed capacity, buying has a net cost of ₹24,00,000 against ₹26,00,000 for making, an advantage of ₹2,00,000, subject to quality and supply checks.

Example 2

Case: Meridian Foods Ltd makes products P and Q. Per unit: P sells at ₹100 with variable cost ₹60 and uses 2 machine hours; Q sells at ₹150 with variable cost ₹90 and uses 4 machine hours. Available machine hours are 4,000. Maximum demand is 1,500 units of P and 800 units of Q. Find the best product mix and the total contribution.

Show the solution

Contribution per unit: P = 100 − 60 = ₹40; Q = 150 − 90 = ₹60.
Contribution per machine hour: P = 40 ÷ 2 = ₹20; Q = 60 ÷ 4 = ₹15.
Rank: P first, then Q.
Hours needed to meet P demand = 1,500 × 2 = 3,000 hours. Hours left = 4,000 − 3,000 = 1,000.
Units of Q possible = 1,000 ÷ 4 = 250 units, which is below the demand of 800.
Contribution from P = 1,500 × 40 = ₹60,000. From Q = 250 × 60 = ₹15,000.
Total contribution = ₹75,000.

Answer: Make 1,500 units of P and 250 units of Q, for a total contribution of ₹75,000, because P earns more contribution per machine hour.

Exam tips

In case studies, underline every number and tag it as relevant or not. Examiners plant sunk costs and apportioned overheads on purpose.
Show working notes for each relevant cost. Marks are given for the treatment of each item, even if the final figure is wrong.
Always add a short qualitative paragraph after the numbers. Written answers in Paper 6 carry marks for judgement.
For MCQs, check for a limiting factor before doing anything else. A hidden scarce resource changes the answer.
Read the exact wording on fixed costs: words like avoidable, specific, or saved on closure signal that they are relevant.

Practice questions from Strategic Cost & Performance Management

Decision Making and Relevant Costing in other exams

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

Decision Making and Relevant Costing: frequently asked questions

What is the difference between relevant cost and sunk cost?

A relevant cost is a future cost that differs between alternatives. A sunk cost has already been incurred and cannot be changed by the decision, so it is ignored.

When should a loss-making division be shut down?

In the short run, shut it when its contribution is less than the fixed costs that would actually be saved on closure. Also consider effects on other divisions, customer goodwill and restart costs.

How do I handle more than one limiting factor?

Set up the objective function of contribution and the constraint inequalities, then solve using the linear programming method, graphically or by corner points. With a single limiting factor, simply rank on contribution per unit of the scarce resource.

Is full cost ever used in decision making?

Full cost is mainly used for long-run pricing and cost recovery. For short-term decisions, relevant costs and contribution are the right basis.