1.Costing is a very important part of accounting. It involves the basic financial data which will help in price fixing as well as in profit marking. There are many aspects to costing and each one is relevant depending on the product or service provided by the owner. Relevant costing is an important aspect in costing and accounting decisions. A relevant cost is the cost which is specific to a management decision. This generates only the information which is necessary for decision making and removes the unnecessary extraneous information. Relevant cost is only specific and limited to a particular decision that the management is required to make.
When the management makes a decision about the costing or pricing of a product, not all information is necessary. Hence, relevant costing enables to avoid unnecessary information and use only the information that is relevant for decision making. Relevant costing, as the name suggests, is a method of costing where the relevant costs in reference to the particular decision are considered. If the cost is not connected to the decision to be taken, then it is not relevant for the management.
Relevant costing aims to determine the outflow of cash with a particular business decision. The outflow of cash will be relevant for the business and hence it is necessary to be considered as well as compared. Relevant costing does not consider the future cash outflow or the costs incurred in the past, it only considers the current outflow of cash which will take place when a decision is taken. When the decision is taken, the cash outflows that may incur in the future regarding this decision will be relevant. Thus, in cash of a particular decision, the current and future outflow of cash is relevant along with the other expenses that may occur. Avoidable costs are also relevant to a decision because they can be avoided by not taking the decision. The cost of all avoidable expenses is to be considered and is relevant to the decision. The avoidable expenses will save on the outflow of cash and hence is relevant.
The incremental costs are also termed as relevant costs because incremental cost is the difference between two alternatives when one is to be chosen. When a decision is to be made between two alternatives, the difference between the costs is the incremental cost and hence extremely relevant for decision making. Opportunity cost also forms part of relevant costing because it is the opportunity foregone when this decision is made. These are the four main elements of relevant costing. Each aspect is to be considered when a decision is to be taken.
Costs already incurred are sunk costs and hence not relevant for decision making. Only opportunity costs, incremental costs, avoidable costs and future cash flow is to be considered. The costs already incurred have no relevance for decision making. Relevant costing is applicable for pricing decisions, operate or shut down decisions, make or buy decisions and further processing decisions. They enable to ensure that the cost is considered and only then a decision is made.
Relevant costing is best suited for short term decisions and helps to decide within a range of products. It will also help make a decision about a new project and whether it should be accepted or not. The relevant costs can be used to calculate the total cost of a product and a profit margin can be added to it to generate appropriate price of the product or service. When a product is to be processed further, its additional costs are considered relevant for decision making.
2.In relation to the given scenario about the farmer, the farmer has two alternatives to choose from. Hence, relevant costing comes in place. Out of the four available options for the farmer, the relevant costs are those which will enable him to maximize the revenue and minimize the costs.
The sales value of harvested potatoes is relevant to the farmer because it will be the revenue for the farmer and will show the cash inflow. Hence, the sales value of the potatoes will be relevant and is of importance to the farmer.
The cost per kg of growing potatoes will not be relevant for the farmer because that will be the cost already incurred for harvesting. In the current case, the decision lies about the packaging and the cost per kg of growing potatoes is a sunk cost and already incurred hence not relevant in the given case. The farmer is going to grow potatoes even if he sells them in sacks or packs them in cartons, thus this cost is historical and irrelevant. There is not going to be any new outflow of money. Whatever the cost be it is already incurred and this decision will not be affected by the cost of growing potatoes.
The cost of washing and packaging the potatoes is the cost which will have to incur if the decision is taken. Since the farmer wants to wash and pack the potatoes, the cost of the same is relevant and will be an additional outflow of cash. The incremental cost of washing and packing will need more time and labor, and there will be an outflow of cash for the same. Thus, this is an important and relevant cost to the farmer which he should consider when taking a decision.
The sales value of 2 kg cartons is also relevant cost to the farmer. Now the farmer has to decide between two alternatives, which are to sell the potatoes in sacks or to wash and pack them in 2 kg cartons. Here, the cost of the cartons will be an incremental cost and relevant to the farmer. The sales value of 2 kg cartons will be determined after the cost of washing and packing is made so as to fix a price. Since the cost of washing and packing is an incremental expense, the sales value of the cartons is also relevant cost for the same.
Thus, relevant costing is about making the best choice out of the alternatives available. And this can ideally be done through the information that is available at the point of decision making. The major elements of relevant costing will enable the farmer to decide the best alternative which will maximize revenue and generate profits and well as increase the sale of potatoes. The relevant costs need to be estimated and compared before choosing an alternative from the two. Incremental cost and the outflow of cash are the main elements to be estimated for this given case.
References
Chapter 5 - Information for decision making. (n.d.).[online] Available at http://www.fao.org/docrep/w4343e/w4343e06.htm [Accessed 13 April 2016]
Hafeezrm. (2012, Feb 12). Managerial Accounting –Decision Making: Relevant Costs & Benefits. [online] Available at http://hubpages.com/education/Managerial-Accounting-Decision-Making-Relevant-Costs-Benefits [Accessed 13 April 2016]
Jan, O. (n.d.). Relevant vs Irrelevant Costs. [online] Available at http://accountingexplained.com/managerial/costs/relevant-irrelevant-costs [Accessed 13 April 2016]
Relevant Cost and Decision Making. (n.d.). [online] Available at http://accounting-simplified.com/management/relevant-costing/ [Accessed 13 April 2016]
Relevant Costing and short-term decisions. (n.d.).[online] Available at http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Relevant%20Costing%20and%20short-term%20decisions.aspx [Accessed 13 April 2016]
