Question

Explain the principles of relevant cost analysis?

and an explanation of future incremental cash flow?

Answer 1

As per the basic principles of costing, a relevant cost is a cost that is basic to decision making. Such cost has the ability to change the course of decision making and select an alternative best suited to the budget. In other words, it is a future cash flow that arises as a direct consequence of decision making. The main intent of relevant costing is to determine the objective cost of decision making. The varied principles are :

• Future Costs : Relevant costs are future costs that would happen in the future due to execution of the decision made. Since these cost are future based the costs already incurred are known as the sunk cost. Such sunk costs are irrelevant to decision making.
• Cash Flows : The relevant costs are future costs that result in probable outflow of cash. This means that the costs that do not result in outflow of cash are to be ignored such as depreciation and notional costs.
• Incremental In nature : Relevant costs are incremental costs in nature. For eg. An employee is paid $ 200 for a work week irrespective of the work he does. If he does nothing he will be paid $ 200 and if the manager decides to give him a task that earns the company $ 60 then the net gain here is $ 60. The employee would be paid $ 200 in either case whether he is free or working on the task. So $ 200 here is sunk cost and $ 60 is relevant.

If you the above answer carefully, you figure out that relevant cost is nothing but "Future incremental cash flow".