CIMA P2 Syllabus B. Capital Investment Decision Making - Relevant Costs - Notes ^{6 / 6}

Decision making costs are often referred to as "Relevant Costs"

(ie They're relevant to this decision)

Future
Past costs are irrelevant, decisions are about now and the future
Incremental
Only include extra costs incurred or avoided as a result of making the decision.
Cash Flow
Depreciation isn't a cash flows and therefore not relevant.

Common Costs
Costs which will be identical for all alternatives are irrelevant
e.g. rent or rates on a factory would be incurred whatever decision is made
Sunk Costs
Another name for past costs, which are always irrelevant
e.g. dedicated fixed assets, development costs already incurred.
Committed Costs
A future cash outflow that will be incurred anyway (and so isn't relevant), whatever decision is taken now
E.g. contracts already entered into which cannot be altered.

Relevant costs may also be expressed as Opportunity costs.

An opportunity cost is the benefit foregone by choosing one opportunity instead of the next best alternative.

Example
A company is considering a project with a 9% return - to make it though, they can't do another project which would have made a 6% return
The Opportunity cost of doing the 9% project is the 6% that the alternative project forgone would have brought in

Avoidable Outlay costs
i.e. those costs which will be incurred only if the project is approved, and will be avoided if it is not
Opportunity costs
This total is a true representation of 'economic cost'.

Cost behaviour patterns are known, e.g. if a department closes down, the attributable fixed cost savings would be known.
The amount of fixed costs, unit variable costs, sales price and sales demand are known with certainty.
The objective of decision making in the short run is to maximise 'short-term profit'.
The information on which a decision is based is complete and reliable.