Chapter 5: Short Term Decision Making
Make or Buy? Shut down or Continue? It all depends on Relevant Costs.
About this Lecture
When managers make decisions, not all costs matter. In this chapter, we master the concept of Relevant Costing. You will learn to identify which costs to include (Future, Incremental, Cash flow) and which to ignore (Sunk costs, Depreciation). We apply this to scenarios like Make vs Buy, special orders, and whether to discontinue a business segment.
Study Guide Highlights
1. The "FIC" Test for Relevant Costs
For a cost to be relevant to a decision, it must meet ALL three criteria:
- F - Future: It hasn't happened yet (Sunk costs are irrelevant).
- I - Incremental: It will change because of this specific decision.
- C - Cash Flow: It involves real money (Depreciation is irrelevant).
2. Key Decision Scenarios
- Make or Buy: Compare the variable/incremental cost of making vs the quote from the supplier. Ignore general fixed overheads.
- Discontinuation: Only close a department if the saved costs exceed the lost contribution.
- Further Processing: Compare incremental revenue vs incremental costs. Joint costs incurred up to the split-off point are sunk!
3. Exam Tips
Depreciation is an accounting adjustment, not a cash flow. NEVER include it in relevant cost calculations.
Numbers aren't everything. Always mention non-financial factors like quality, supplier reliability, staff morale, or customer reaction.
Chapter Resources
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