Question

Please explained the difference for the following: Target costing, Differential cost, Relevant cost, Sunk cost and what is the important qualitative factor to consider regarding a special order? I get confused differentiating each of these. Please explain thoroughly. Thanks

Answer 1

Target costing will start with the selling price of a particular product and work back to the cost by removing the profit element instead of starting with the cost and working to the selling price by adding on the expected margin. This means that the company has to find ways of not exceeding that cost.

Differential cost is a cost that differs from alternatives. The cost may exist in only one of the alternatives or the total amount of the cost may differ between the alternatives. Differential costs and opportunity costs should be the main focus of decision making.

Relevant costs are those future costs and revenues to the decision being made. It includes only those cash flows which will be affected by the decision and therefore ignore sunk costs, unavoidable costs and apportioned costs.

Sunk costs are those which have already been incurred before the decision is made. This is an irrelevant cost. Instead, the current replacement value or the scrap value would be considered the relevant cost to the decision.

Regarding a Special Order, only the Relevant and Marginal costs should be considered.