Question

Understand the concept of relevant revenues and costs. What makes a revenue or cost relevant?

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Know and understand the following terms:

Avoidable costs _______________________________________________________________

Opportunity costs _____________________________________________________________

Relevant Costs ________________________________________________________________

Differential Costs ______________________________________________________________

Sunk Costs ___________________________________________________________________

Differential Revenues ___________________________________________________________

Understand the concept of Cost Hierarchy and Cost Avoidance. What are the different cost hierarchies and when are they eliminated?

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Review examples of costs in the above 4 categories that we covered in class or in problems.

Understand the difference between Qualitative and Quantitative information – both are relevant to decision making.

Special Order Decisions

What is a Special Order Decision? ____________________________________________

Review how to determine relevant (differential) revenues and relevant (differential) costs to make the decision whether or not to take a Special Order.

Outsourcing Decisions

What is an Outsourcing Decision? ____________________________________________

What level costs generally are relevant to a decision to outsource?

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What is vertical integration?

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How does outsourcing impact vertical integration? ____________________________________

Asset Replacement Decisions

What do Asset Replacement Decisions involve? ______________________________________________________________________________

What are the relevant cost levels involved in an asset replacement decision?

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Answer 1

1. An Avoidable cost is a cost which can be avoided by not producing a particular good. One example is If you are building cars, an avoidable cost can be the raw material production and you can avoid the production by outsourcing.

2. Opportunity Cost is the value of the best alternative to a decision which can be constraints of time, resources, rules, etc. It also the practice of calculating what you can't do as a result of possible decision.

3. Relevant Costs are expenditures that are costs because of our particular decision or strategy of doing business example- taxes.

4. Differential Costs is the change in the costs due to change in other factors, example - change in sales volume, change in production mix, etc. These changes would result in the change in labour cost, material costs, etc.

5. Sunk Cost are the cost which is already occurred and cannot be recovered such as the gas filled in the car cannot be returned or the rent paid or the payroll for the lat month paid.

Cost Hierarchy is the cost commonly used in the Activity based costing wherein we can easily determine the cost incurred in various levels of production

6. Differential revenue is the difference between two or more alternative routes of investment when taken into account would give us the increase or decrease in the revenues and cost avoidance is the method used by companies to avoid the cost by various means such as reduction in expenses and cost savings. With the help of the cost Hierarchy we would be able to easily identify the cost intensive areas of production for example - electricity, labor, etc and take appropriate measures in controlling the same.