Question

In this week’s readings, you learned about other types of cost classifications, such as differential costs, sunk costs, and opportunity costs. Discuss how these concepts are used in managerial decision making? Include an example in your response. Please be sure to validate your opinions and ideas with citations and references in APA format.

Answer 1

Answer:

Differential costs- It is the difference between the cost of two alternatives. This cost is analyzed when there are multiple alternatives available and best has be chosen. This is only used for management decision making, no accounting standard mandates how the cost is calculated so it can be variable or fixed.

Example- If you have two choice, one is to make 100000 widgets per year at the cost of $1000000 through automation, other is to make the same units at the coat of $1200000 manually through direct labor so differential cost is $200000.

This will enable the management to take decision which choice is more feasible and profitable for the company. Management can do cost and benefit analysis on the basis of differential cost.

Sunk costs- It is the cost that has been incurred and cannot be recovered. This cost is not considered because it cannot be recovered that is why only relevant cost is considered in accounting purpose. This cost does not help in managerial decisions.

Example: Research and development cost or marketing survey cost, this cost is not considered but written off in several years because it has huge amount.

This is not considered in management decision because it is irrelevant cost and does not have any impact on the project.

Opportunity costs- This cost is the loss of other alternatives when one alternative is chosen. It includes the benefits that forgo because some other alternative had been chosen. This is very important concept in managerial decision making but two or more alternatives only can be compared when they have same qualitative and quantitative features, two different alternatives cannot be compared. This cost is not recorded anywhere.

Example: You chose an investment alternative that gives 5% return if you would have chosen some other alternative that would have given you 8% then your opportunity cost is 3%.