Question

1. Explain whether past costs play any role in relevant costing decisions.
2. Discuss whether depreciation on an existing asset is always relevant or irrelevant in decision making.
3. Explain whether the salary of the supervisor of an assembly line with excess capacity is an example of relevant or irrelevant future cost for an accept-or-reject decision.
4. Can direct materials ever be irrelevant in a ‘make’ or ‘buy’ decision? Explain.
5. Specific Water Company produces water bottles. It has been asked by a large retail shop to supply water bottles which would be libelled in the name of the retail shop. The retail shop would pay Specific Water Company a price of $25 per bottle. However, its regular price is $26. If Specific Water Company agrees to sell water bottles to the retail shop at a price of $25, what type of relevant costing decision would you call this? Is it possible to make net benefit (earnings) by selling at a price lower than the regular price? What other reasons might motivate to sell at a price below regular price?

Answer 1

A) Historical costs are sunk costs. They play no role in decision making in the current period. Sunk Cost do not affect future costs and cannot be changed by any current or future action, hence these costs are irrelevant in decision making

B) Depreciation represents an allocation of a cost already incurred. It is a sunk cost, because no future decision can alter the original cost of the machinery; the original cost is the same for both alternatives

C) Irrelevant costs are those that will not change in the future when you make one decision versus another. Examples of irrelevant costs are sunk costs, committed costs, or overheads as these cannot be avoided. As there is already an excess capacity of production any decision of accept or reject will not include this supervisor salary which is actually a fixed in nature(Assuming he is a skilled)

D) Direct materials can be irrelevant in a make-or-buy decision if they do not change. In case of material which is actually have no selling situation outside and its been long time in our warehouse where it cannot be used in any production process but on the times where it can be used further for one specific project then that cost of raw materials will not be considered in decision making.

E) The cost that Specific Water Company should consider is only that cost that are variable in nature to that specific project. Any expenses in the nature of fixed irrespective of this project accepted or rejected will not be considered for decision making.

At times we will gain by selling at lower price also as this will be possible when we already have some excess production capacity so that no cost which are fixed in nature shall not change for time being.

As we are using unused capacity of production then we will arrive at economies of scale and experience curve which acts agents of cost reduction in our project.

So it's not always that we incur loss if we sell at prices which are lower than regular price.

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