Chapter 9: Decision Making with Relevant Costs and a Strategic Emphasis

Summary

Relevant cost analysis uses future costs that differ for the decision maker's options. The principle of relevant cost analysis can be applied in a number of specific decisions involving manufacturing, service, and not-for-profit organizations. The decisions considered in the chapter include

• The special order decision for which the relevant costs are the direct manufacturing costs and any incremental fixed costs.
• The make, lease, or buy decision for which the relevant costs are the direct manufacturing costs and any avoidable fixed costs.
• The decision to sell a product before or after additional processing for which the relevant costs are the additional processing costs.
• The decision to keep or drop a product line or service for which the relevant costs are the direct costs and any fixed costs that change if the product or service is dropped.
• The evaluation of programs and projects.
• The decision of a not-for-profit organization to offer a service.

Strategic cost analysis complements relevant cost analysis by having the decision maker consider the strategic issues involved in the situation.

When two or more products or services are involved, another type of decision must be made: to determine the correct product mix. The solution depends on the number of production activities that are at full capacity. With one production constraint, the answer is to produce and sell as much as possible of the product that has the highest contribution margin per unit of time on the constrained activity. With two or more constrained activities, the analysis uses graphical and quantitative methods to determine the correct product mix.

A number of key behavioral, implementation, and legal issues must be considered in using relevant cost analysis. Many who use the approach fail to give sufficient attention to the firm's long-term, strategic objectives. Too strong a focus on relevant costs can cause the manager to overlook important opportunity costs and strategic considerations. Other issues include the tendency to replace variable costs with fixed costs when relevant cost analysis is used in performance evaluation, the pervasive tendency of people not to correctly view fixed costs as sunk but to view them as somehow controllable and relevant.