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ACCA Strategic Professional · Strategic Business Leader · Cost and management accounting

Harbour Components plc is deciding whether to continue making a part in-house. The finance director lists the annual rent of the factory, which will be payable whether or not the part is made, as part of the cost of the part. Which cost classification best describes the rent for this decision, and what does it imply?

The rent is a fixed cost that will be incurred whatever the decision, so it is not incremental and is irrelevant. It should be excluded when comparing making with buying in, because only costs that differ between the alternatives affect the decision.

  1. AIt is an irrelevant (non-incremental) fixed cost for this decision, so it should be excluded from the comparison with buying inCorrect
  2. BIt is a relevant variable cost, so it should be included in full in the comparison with buying in
  3. CIt is an opportunity cost, so it should be added to the purchase price of the bought-in part
  4. DIt is a sunk cost only if the lease was signed in a previous year, so it must always be included

Explanation

Rent payable regardless of the decision does not change with the choice, so it is not an incremental cash flow and is irrelevant. Including it (option B) would overstate the benefit of buying in. Rent is not an opportunity cost unless the space has an alternative use.

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