Relevant Costs and Benefits

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From the course by University of Virginia

Managerial Accounting Fundamentals

40 ratings

University of Virginia

Managerial Accounting Fundamentals

40 ratings

This course will teach you the fundamentals of managerial accounting including how to navigate the financial and related information managers need to help them make decisions. You'll learn about cost behavior and cost allocation systems, how to conduct cost-volume-profit analysis, and how to determine if costs and benefits are relevant to your decisions. By the end of this course, you will be able to: - Describe different types of costs and how they are represented graphically; - Conduct cost-volume-profit analyses to answer questions around breaking even and generating profit; - Calculate and allocate overhead rates within both traditional and activity-based cost allocation systems; - Distinguish costs and benefits that are relevant from those that are irrelevant for a given management decision; - Determine a reasonable course of action, given the financial impact, for a given management decision.

From the lesson

RELEVANT COSTS AND BENEFITS

In our final week, we'll discuss costs and benefits, and gain an understanding of those that are relevant for a given decision. We'll evaluate the financial impact of a given decision, then determine a reasonable course of action.

Week 4 Overview1:13

Relevant Costs and Benefits3:07

Important Terms2:50

Relevant Costs in an Example4:16

Your Turn: Relevant Costs and Benefits4:04

Special Order Decision7:12

Your Turn: Special Order Decision3:45

Make or Buy Decision5:43

Your Turn: Make or Buy Decision4:49

Keep or Drop a Product Line Decision5:23

Your Turn: Keep or Drop a Product Line Decision4:22

Product Mix Decisions10:53

Your Turn: Product Mix Decisions4:22

Meet the Instructors

Luann J. Lynch
Almand R. Coleman Professor of Business Administration
Darden School of Business

Let's start by talking about costs and

benefits that are relevant to consider when making a decision.

Relevant costs and benefits are incremental costs and benefits that

an organization will incur or generate by selecting a particular course of action.

When comparing two alternative courses of action, relevant costs and

benefits are those costs and benefits that differ between the two alternatives.

Think about it this way.

If you are considering two alternatives, and

those alternatives cost you a different amount of money,

that difference is relevant to the decision you're making.

But if those alternatives cost you exactly the same amount of money, but

give you different benefits,

you will make your decision based on the difference in benefits.

The costs, because they're the same under each alternative,

will not affect your decision, so they are not relevant to the decision.

Relevant costs are sometimes called incremental or differential costs.

They might be called incremental because a decision might yield additional,

or incremental, costs or additional, or

incremental, revenues when compared to an alternative.

And they might be called differential because cost or

benefits might differ between alternatives.

Here's a quick example.

Suppose you need to buy some orange juice and there are two supermarkets

from which you can purchase the juice and each supermarket is equally accessible.

At one supermarket a gallon of orange juice costs $2.00, and

at the second supermarket that same brand cost $2.25.

Because the cost of the orange juice differs between these two alternatives,

it is relevant to your decision about where to go to purchase, and

you will choose the supermarket that charges $2.00.

Now suppose you go to that supermarket to purchase the orange juice and you discover

that you could purchase the gallon of orange juice for $2 or alternatively,

you can purchase the same brand of orange juice but in a larger size for

exactly the same price, $2.00, because of a promotion the store is running.

The cost of the orange juice is not relevant to your decision about which of

these two juices you buy,

because the cost is exactly the same between the two alternatives, $2.00.

However, the benefits differ between these two alternatives.

The larger size offers a greater benefit, so

the benefits become relevant to this purchase decision.

But, your decision will be unaffected by the cost

because the cost is the same between the alternatives.

Well, this is what we mean by relevance of cost and

benefits, those that differ between two alternatives.

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