1. Can a particular cost be relevant for one purpose, but not for other purposes? Give three examples in which this would be the case.
Yes, a particular cost can be relevant for one purpose but not for other purposes. Here are three examples:
a) Opportunity cost: Opportunity cost refers to the value of the next best alternative foregone when making a decision. It is relevant for decision-making purposes as it helps in assessing the trade-offs involved. However, it may not be relevant for financial reporting purposes, as financial reports focus on actual costs incurred rather than potential costs.
b) Sunk costs: Sunk costs are costs that have already been incurred and cannot be recovered. While sunk costs are irrelevant for decision-making purposes, as they cannot be changed or recovered, they may be relevant for financial reporting purposes to show the historical costs incurred.
c) Incremental costs: Incremental costs are the additional costs incurred as a result of a particular decision or action. These costs are relevant for decision-making purposes as they help in assessing the impact of the decision on overall costs. However, they may not be relevant for financial reporting purposes if they are not material or do not meet the recognition criteria.
2. Are sunk costs ever relevant in decision making? If so, give one or more examples.
Sunk costs are generally not relevant in decision making because they are costs that have already been incurred and cannot be recovered. However, there are certain situations where sunk costs may still be considered:
Example: A company has invested a significant amount of money in a research and development project. Despite the project not meeting the expected outcomes, the company may decide to continue investing in it due to the potential long-term benefits or strategic reasons. In this case, the sunk costs are relevant as they influence the decision to continue investing, even though they cannot be recovered.
3. Helen Y, owner of Helen Restaurant, is trying to decide whether to make Enjera or buy them from a supplier. Helen has come to you for advice. What factors would you tell her to consider in making her choice?
When advising Helen on whether to make Enjera or buy them from a supplier, the following factors should be considered:
a) Cost analysis: Helen should compare the costs of making Enjera in-house, including the cost of ingredients, labor, equipment, and overhead, with the cost of buying them from a supplier. This analysis will help determine which option is more cost-effective.
b) Quality control: Helen should assess the quality of Enjera made in-house compared to the supplier's product. If the in-house Enjera meets the desired quality standards, it may be preferable to make them internally to maintain control over the product.
c) Capacity and demand: Helen should evaluate the restaurant's capacity to produce Enjera in-house and the demand for it. If the restaurant has excess capacity and there is sufficient demand, making Enjera in-house may be a viable option.
d) Supplier reliability: Helen should consider the reliability and consistency of the supplier in terms of timely delivery and quality. If the supplier consistently meets the restaurant's requirements, it may be more convenient to buy from them.
e) Strategic considerations: Helen should also consider the strategic implications of the decision. Making Enjera in-house may provide a unique selling point or align with the restaurant's brand image, while buying from a supplier may offer cost savings and operational efficiency.
4. What is a special order decision? What typical circumstances lead to the need to make this type of decision?
A special order decision refers to a one-time order or request for a product or service that is not part of the company's regular operations. It involves evaluating whether to accept or reject the special order based on its impact on profitability.
Typical circumstances that lead to the need for a special order decision include:
a) Excess capacity: When a company has idle production capacity or underutilized resources, it may consider accepting special orders to generate additional revenue and cover fixed costs.
b) Price discount: If a customer requests a large order or offers to purchase at a discounted price, the company needs to assess whether accepting the special order will still result in a profit after considering the lower selling price.
c) Seasonal demand: During off-peak seasons or holidays, companies may receive special orders for customized products or services. Evaluating the profitability of these orders is crucial to optimize revenue during slow periods.
d) Strategic considerations: Special orders may also be accepted for strategic reasons, such as entering a new market, building relationships with potential long-term customers, or gaining a competitive advantage.
5. What are the differences among avoidable fixed costs, unavoidable direct fixed costs, and common fixed costs? Which are relevant and which are irrelevant for decision making?
a) Avoidable fixed costs: These costs can be eliminated or avoided if a particular decision is made. They are directly attributable to a specific activity or decision and would cease to exist if that activity or decision is eliminated. Avoidable fixed costs are relevant for decision making as they can be controlled and should be considered