Relevant Costs

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BA 215Agenda for Lecture 4

• Relevant Costs
• Variable and Fixed Costs
• Break
• In-class Exercise

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The microeconomic foundations of management
accounting
Sunk Costs Costs that have already been
incurred. Sunk costs are irrelevant for all
decisions, because they cannot be changed.
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The microeconomic foundations of management
accounting
Opportunity Costs The profit foregone by
selecting one alternative instead of another the
net return that could be realized if a resource
were put to its best alternative use.
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The microeconomic foundations of management
accounting
Relevant Costs Also sometimes called
Differential Costs or Incremental Costs A
differential cost for a particular decision is
one that changes if an alternative decision is
chosen.
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When are Costs and Revenues Relevant?
Answer The relevant costs and revenues are those
which, as between the alternatives being
considered, are expected to be different in the
future.
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BA 215Agenda for Lecture 4

• Relevant Costs
• Variable and Fixed Costs
• Break
• In-class Exercise

7
Classification of Costs
All Costs of doing business
thread
television commercials
Warranty expense
Legal dept
Sewing operator wages
fabric
Costs to ship product from factory to warehouse
Sales commissions
Design dept.
factory electricity
factory managers salary
depreciation on factory building
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Three ways to classify costs

• Direct and Indirect Costs
• Fixed and Variable Costs
• The Value Chain

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Classification of Costs
Total Costs
Direct costs
Indirect costs (a.k.a. overhead)
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Direct versus Indirect Costs

• Defined in terms of a particular activity, such
  as a product, product line, or factory.
• Direct costs can be traced to the activity in an
  economically feasible way.
• Indirect costs cannot be traced to the cost
  object.
• Indirect costs are sometimes allocated to the
  cost object.

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Direct versus Indirect Costs
EXAMPLE LEVI STRAUSS FACTORY
Are the following costs direct or indirect?
Fabric Plant Managers Salary Thread Sewing
Operators Labor Plant Utilities
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Classification of Costs
Total Costs
Direct costs
Fabric sewing operator wages
Indirect costs (a.k.a. overhead)
Plant utilities, thread, Plant managers salary
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Three ways to classify costs

• Direct and Indirect Costs
• Fixed and Variable Costs
• The Value Chain

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Fixed Costs vs. Variable Costs

• Variable costs change in direct proportion to
  changes in volume of activity (e.g., production).
  
• Fixed costs remain the same in total, as volume
  changes.

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Fixed Costs vs. Variable Costs

• Linear relationship is assumed.
• Relevant range and time-span must be identified.
• Many costs are semi-variable or mixed.

0
units

units
0
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Fixed Costs vs. Variable Costs
EXAMPLE LEVI STRAUSS FACTORY
Are the following costs fixed or variable?
- Fabric - Assistant Managers Salary -
Electricity - Sewing Operator Labor - Repairs
Maintenance - Rent on building
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Classification of Costs
Total Costs
Direct costs
fixed
variable
Indirect costs (a.k.a. overhead)
fixed
variable
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Combinations of Variable Fixed,Direct
Indirect
Fixed Variable
Yes
Direct Indirect
Not very often
Yes
Yes
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Classification of Costs
Total Costs
Direct costs
fixed
variable
Fabric, Sewing Wages
Indirect costs (a.k.a. overhead)
fixed
variable
Electricity, Repairs
Rent, Salaries
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Three ways to classify costs

• Direct and Indirect Costs
• Fixed and Variable Costs
• The Value Chain

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Costs by Business Functiona.k.a. the value chain

• R D
• Manufacturing
• Marketing
• Distribution
• Sales

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BA 215Agenda for Lecture 4

• Relevant Costs
• Break
• Variable and Fixed Costs
• Break
• In-class Exercise

23
BA 215Agenda for Lecture 4

• Relevant Costs
• Break
• Variable and Fixed Costs
• Break
• In-class Exercise