Topic A09: Cost Accounting for Decision-making Topic Overview P.1
Learning Objective:
To apply costing concepts and techniques for decision-making under business environment.
Overview of Contents:
Lesson 1 Prepare Marginal Costing Statements to Make Drop Out Decisions of a Product
Lesson 2 Distinguish Sunk Costs from Future Costs for Decision Making in Selling an Additional Product Line
Lesson 3 Apply the Concept of Opportunity Costs for a Selling Decision
Resources:
Topic Overview, Teaching Plan and Answers to Student Worksheet
PowerPoint Presentation
Student Worksheet
Suggested Activities:
Group Discussion
Matching
Case Study
Topic Overview
Topic BAFS Elective Part – Accounting Module – Cost Accounting
A09: Cost Accounting for Decision Making –Application of Costing Concepts and Techniques in Decision Making
Level S5 / S6
Duration 3 lessons (40 minutes per lesson)
Topic A09: Cost Accounting for Decision-making Topic Overview P.2
Lesson 1
Theme Prepare Marginal Costing Statement to Make Drop Out Decision of a Product
Duration 40 minutes
Expected Learning Outcomes:
Upon completion of this lesson, students will be able to:
1. Define and classify expenses into variable cost, specific fixed cost and general fixed cost;
2. Identify variable and specific fixed costs, which are relevant for a product drop out decision and general fixed costs, which are irrelevant for such decisions; and 3. Prepare marginal costing statement to determine if a particular product should be
eliminated by the business.
Teaching Sequence and Time Allocation:
Activities Reference Time
Allocation Part I: Introduction
Teacher starts the lesson by asking and recalling students’ understanding on marginal costing and types of cost of a manufacturing business under marginal costing system.
Under marginal costing, the calculation of net profit of a business is gone through.
Teacher shows students that for manufacturing businesses, costs can be classified into variable costs and fixed costs under marginal costing.
PPT #1-3 5 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.3
Part II: Content
Teacher explains the meaning of variable costs, specific fixed costs and general fixed costs.
Case Study – The Lunar New Year Stall
The class plans to sell three products (Models A, B and C) in the Lunar New Year Fair. However, the Draft Income Statement shows that Model B produces a net loss of $6,600. The theme of this case study is to see whether the class can earn more profit (original $4,200) if it does not sell Model B.
This product drop out decision can be made if the income statement is prepared by using marginal costing concepts. In order to alert and guide students to prepare a revised income statement, brain-storming discussions are designed in Activities 1 and 2 while preparation of the said statement in Activity 3.
PPT#4-5
PPT#6
Student Worksheet
pp.1-2
8 minutes
Activity 1 - Discussion
Students are asked to think whether each cost item of Model B can be eliminated if this model is dropped.
Aim of this activity is to alert students that some costs can change when the number of units change while some costs cannot be reduced even when the number of units reduces to zero.
PPT#7-8
Student Worksheet
p.3
6 minutes
Activity 2 - Discussion
Teacher reminds students about the calculation of net profit under marginal costing.
Two formats of income statements under marginal costing are provided and students are required to identify the correct one to facilitate the drop out decision of Model B.
PPT #9-11
Student Worksheet
pp.4-5
6 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.4
Activity 3 - Preparation of Income Statement to facilitate Drop Out Decision of Model B of the Lunar New Year Stall Case
Students are required to classify all costs inside the Draft Income Statement into variable cost, specific fixed cost and general fixed cost in Task 1 and then prepare a revised income statement with recommendation in Task 2.
PPT #12-15
Student Worksheet
pp.6-7
13 minutes
Part III: Conclusion
Teacher concludes the lesson by explaining:
Variable and specific fixed costs are relevant for the drop out decision because they will change as a result of the decision.
General fixed costs are irrelevant for the drop out decision because they remain unchanged by the decision.
PPT#16 2 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.5
Lesson 2
Theme Distinguish Sunk Costs from Future Costs in Decision Making in Selling an Additional Product
Duration 40 minutes
Expected Learning Outcomes:
Upon completion of this lesson, students will be able to:
1. Classify costs into future costs, incremental costs and sunk costs; and
2. Apply future costs and incremental costs in decision making when selling an additional product.
Teaching Sequence and Time Allocation:
Activities Reference Time
Allocation Part I: Introduction
Teacher starts the lesson by asking students to offer some examples of variable costs, specific fixed costs and general fixed costs learnt from last lesson.
PPT #17-19 5 minutes
Part II: Content
Teacher explains the meaning of future costs and sunk costs. Teacher tells students that only future costs are relevant to decision making.
Case Study
Students are divided into groups of four or five.
They read a case of an additional product, Model D, to be sold in a Lunar New Year Stall. The case study theme to determine whether or not sales of Model D will earn a profit. It is important that only costs which are relevant to this decision are taken into account.
Activity 4 – Costs of Materials of Model D Students are requested to distinguish between future costs from sunk costs of materials to be used for making Model D. Teacher reminds students that only
PPT#20-21
PPT#22
PPT#23
Student Worksheet
5 minutes
8 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.6
future costs are relevant to the sales decision of the product.
Teacher checks the results with students
pp.8-9
PPT #24-25
Teacher explains the meaning of incremental costs and explains that they are relevant to decision making.
Activity 5 - Additional charges of general fixed costs arising from the sales of Model D
Students are asked to identify incremental costs of two general fixed expenses because they are relevant to the decision making of selling Model D.
Teacher checks the results with students
PPT #26-27
PPT #28
Student Worksheet
pp.10-11
PPT#29
3 minutes
8 minutes
Activity 6 - Selling of Model D in Lunar New Year Fair
Students are asked to advise whether Model D should be sold in Lunar New Year Fair by
preparing an income statement. They are reminded that only costs that are relevant to the sales
decision are included in the statement.
Teacher checks the results with students
PPT#30
Student Worksheet
pp.12
PPT #31
8 minutes
Part III: Conclusion
Teacher concludes the lesson that future costs and incremental costs are relevant to decision making whereas sunk costs are irrelevant to decision making.
PPT #32 3 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.7
Lesson 3
Theme Apply the Concept of Opportunity Costs for a Selling Decision Duration 40 minutes
Expected Learning Outcomes:
Upon completion of this lesson, students will be able to:
1. Identify opportunity costs; and
2. Apply the concept of opportunity cost in a selling decision.
Teaching Sequence and Time Allocation:
Activities Reference Time
Allocation Part I: Introduction
Teacher starts the lesson by revisiting the concept that incremental costs are relevant to decision making.
PPT #33-35 5 minutes
Part II: Content
Teacher explains the meaning of opportunity costs and tells students that they are relevant to decision making.
Activity 7 – Identify the Opportunity Costs
Students are divided into groups of four or five.
They are required to read a case of a summer sales to be organised by Student Union. They are
requested to identify opportunity costs of two sales items, namely folders and pencil cases, in order to fix their selling price.
Teacher checks the results with students.
PPT #36
PPT #37
Student Worksheet
pp.13-14
PPT #38
5 minutes
8 minutes
Activity 8 - Soft toys to be sold in Summer Clearance Sales?
Students are asked to identify the opportunity costs for another sales decision. In this case, Student Union has to determine whether or not to sell soft toys at summer sales.
Teacher checks the results with students
PPT #39
Student Worksheet
pp.15
PPT #40-41
8 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.8
Teacher tells students that opportunity costs and incremental costs are relevant to decision making.
Activity 9 - Discussion
Students are requested to prepare an income statement to see whether any loss will arise from paying salaries to Student Union members in summer sales. Students are reminded that both opportunity costs and incremental costs that are relevant to the decision should be included in the statement.
Teacher checks the results with students
PPT #42
PPT #43
Student Worksheet
p.16
PPT #44
3 minutes
8 minutes
Part III: Conclusion
Teacher concludes the lesson that as incremental costs and opportunity costs are changed by a decision, they are relevant to decision making.
PPT #45-46 3 minutes
Topic A09: Cost Accounting for Decision-making Topic Overview P.9
Answer to Student Worksheet
Activity 3: Preparation of Marginal Costing Statement to facilitate Drop Out Decision of Model B of the Lunar New Year Fair Case
Revise Income Statement
Model A
(2,000 units)
Model B (1,000
units)
Model C (700 units)
Total
$ $ $ $
Sales 40,000 30,000 35,000
Less: Variable Cost
Purchase cost 17,000 -- --
Materials -- 26,000 18,200
Royalty charge 5,000 -- --
Contribution 18,000 4,000 16,800
Less: Specific Fixed Cost
One set of special tools -- 1,000 --
Hire charge of a special equipment -- -- 4,800
Contribution after Specific Fixed Cost 18,000 3,000 12,000 33,000
Less: General Fixed Costs
Materials for fixing and decorating the stall 3,000
Transportation expense 4,800
Rental of the stall 21,000
Net Profit / (Loss) 4,200
Topic A09: Cost Accounting for Decision-making Topic Overview P.10
Answer to Student Worksheet
Activity 6
Model D
$ Sales 22,500
Less: costs
-Material X 0
-Material Y 23,000
-Incremental costs on decoration
materials 1,000 -Incremental costs on
transportation expenses 0 24,000
Net Loss 1,500
Topic A09: Cost Accounting for Decision-making Topic Overview P.11
Answer to Student Worksheet
Activity 9
Relevant costs 1. Opportunity costs
$
- Folders 2,000
- Pencil cases 3,500
- Soft toys 8,000
2. Incremental costs of salaries to be paid to
the five members 1,500
Relevant costs 15,000
Less: Sales revenue 16,000
Profit 1,000
1
BAFS Elective Part Accounting Module –
Cost Accounting
Topic A09:
Cost Accounting for Decision Making – Application of Costing Concepts and Techniques in Decision Making
Technology Education Section Curriculum Development Institute
Education Bureau, HKSARG April 2009
Introduction
This session will apply cost concepts and techniques for decision-making.
Suggested activities include group discussion, matching and case study.
Duration
Three 40-minute lessons
Contents
Lesson 1 – Prepare Marginal Cost Statement to Make Drop Out Products Decisions
Lesson 2 – Distinguish Sunk Costs from Future Costs in Decision Making for Selling Additional Products
Lesson 3 – Apply the Concept of Opportunity Costs for Selling Decisions
2 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Lesson 1
Prepare marginal costing statement to make drop out decision of a product
Lesson 1
A product drop out decision can be made by using marginal costing concepts and techniques. Upon completion of this lesson, students are capable of preparing such marginal costing statements and making appropriate decisions.
3 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Recall your memory …
z
What is marginal costing?
z
How can costs of a manufacturing business be classified under marginal costing?
Recall the students’ learning concerning marginal costing and types of costs for a manufacturing business.
Under marginal costing, net profit of a business is calculated as follows:
Net profit = Sales – Variable costs – Fixed costs
whereas, (Sales – Variable costs) is known as Contribution in other words, Net profit = Contribution – Fixed costs
For a manufacturing business, costs can be classified under marginal costing as follows:
• Variable costs include direct materials, direct labour, direct expenses and variable overheads such as electricity charges and water charges.
• Fixed costs such as rent and rates, insurance, salaries.
Definition of variable and fixed cost:
• Variable cost – A cost which tends to vary with the level of activity.
(CIMA Official Terminology)
• Fixed cost – A cost which is incurred for a period, and which, within certain output and turnover limits, tends to be unaffected by fluctuations in the level of activity. (CIMA Official Terminology)
4 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Classification of costs under marginal costing
z
Two categories of costs:
z
z
Variable costs Variable costs – costs that vary in direct proportion to units manufactured.
z
z
Fixed costs Fixed costs – costs that are fixed in short term no matter the number of units
manufactured.
Introduce the cost categories under marginal costing. It serves as a response to the last PPT and cost classification is also an important concept to be applied in the case study.
Variable cost increases (decreases) proportionally when units increase (decrease). For example, the material cost for a product (say a T-shirt) is
$50, this material cost will change as follows:
Number of units Material cost
0 0 ($50 x 0)
100 5,000 ($50 x 100)
300 15,000 ($50 x 300)
800 40,000 ($50 x 800)
Material costs, which is a variable cost, will reduce to zero if no T-shirt is produced.
Fixed costs will not change when the number of units increases or decreases. For example, the factory monthly rent is $20,000, this rental expense will not change if the business manufactures zero or 100 units of product.
5 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Further Classification of Fixed Costs Further Classification of Fixed Costs
General Fixed Costs
General fixed costs are those fixed costs general to the operation of the whole business rather than the operation of a particular product, department or segment.
Examples:
•Salary of the production director
•Insurance of the factory building
Specific Fixed Costs
Specific fixed costs are those fixed costs existing for a particular product, department or segment of the business.
Examples:
•Salary of production supervisor of a particular product line
•Insurance in relation to machines of producing a particular product
Some businesses produce more than one type of product, or they have more than one department, or they sell goods in several market segments.
For these businesses, fixed costs can be further analysed into specific and generalised fixed costs. This breakdown of fixed costs is important for decision making.
Application of specific fixed costs for decision making:
A company sells goods in Hong Kong, Malaysia and Thailand via three local offices and pays a monthly rental of $10,000, $5,000 and $6,000 respectively for the three locations. Rental expense (say $6,000) is a fixed cost because it remains unchanged no matter the number of goods sold in Thailand. However, it is related specifically to Thailand operations only. In other words, this specific fixed cost (rental expense of $6,000) can be saved if the company closes down its Thailand operations. This information is relevant for the management to decide whether to close down the Thailand operation.
Application of general fixed costs for decision making:
In the above example, the company’s head office is located in Hong Kong.
The Sales Director is responsible for overseeing the company’s total sales operations and his month salary is $40,000. This fixed cost cannot be reduced even the company closes down its operation in Thailand. This information is NOT relevant for the management to decide whether to close down the operation in Thailand.
6 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Case Study – The Lunar New Year Stall
z
Refer Student Worksheet P.1 and 2
z
Your class rented a stall during the Lunar New Year Fair
z
Draft income statement shows total net profit of $4,200 with two models earning a profit and one model making a loss
Teacher introduces the case study to students.
The case study is about sales planning of three products (Models A, B and C) during the Lunar New Year Fair. However, the draft income statement shows that Model B produces a net loss of $6,600. In this case, students must consider whether the class can earn more profit (original $4,200) if it does not sell Model B.
This product drop out decision can be made if the income statement is prepared by using marginal costing concepts. In order to alert and guide students to prepare a revised income statement, brain-storming
discussions are designed in Activities 1 and 2 while preparation of the statement is in Activity 3.
7 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 1: Discussion
z
Refer Student Worksheet P.3
z
Can any cost item of Model B be
eliminated if it is dropped in the Lunar New Year Fair?
Teachers ask students to form groups of four or five to discuss the case study and write down their opinions on the student worksheet.
To drop Model B means the number of units becomes zero. Ask students to think if the class still needs to pay for each cost item concerned.
8 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 1: Answer
Teachers can refer to the explanation column above for details.
9 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Calculation of Net Profit under Marginal Costing
Sales at $100 per unit (100 units) $10,000 Less: Variable cost at $80 per unit 8,000
Contribution 2,000
Less: Fixed cost 5,000
Net Profit / (Loss) (3,000)
Under marginal costing, all costs are classified into variable and fixed costs, and net profit is calculated as follows:
Net profit = Sales – Variable costs – Fixed costs
whereas, (Sales – Variable costs) is known as Contribution in other words, Net profit = Contribution – Fixed costs
In the above slide, the company makes a net loss of $3,000 when it sells 100 units. Someone may suggest to not sell the goods to avoid a loss. It is incorrect. The company needs to pay the fixed costs no matter the number of units sold. Without selling the 100 units, the company’s net loss will increase to $5,000. The only way to reduce net loss or even turn it into net profit is to earn more contribution, greater the amount of contribution means greater net profit. Management should refer contribution rather than net profit for decision-making.
10 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 2: Discussion
z
Refer Student
Worksheet P.4 and 5
z
Which one of the two income statements can facilitate the drop out decision of Model B?
The previous slide shows the basic format of the income statement under marginal costing. It is suitable for a single product situation. In our case, there are three product models, we need more specific information on individual models for the drop out decision.
In activity 2, students are required to choose a suitable income statement to facilitate their decision-making. Students are also required to provide comments / reasons for their choice.
11 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 2: Answer
z
Format 2 should be chosen.
z
It shows
contribution and specific fixed cost for each model.
Format 1 is suitable for a multi-products situation and contribution on each model is shown. However, there are specific fixed costs in our case and these costs affect a particular model only. Format 1 does not show their effects and does not support the drop out decision.
Format 2 is the best one for multi-products with a specific fixed cost situation. It shows individual contribution as well as the specific fixed costs on each model. This format can facilitate the drop out decision of Model B.
Both variable and specific fixed costs of Model B can be eliminated if this model is dropped. Sale of Model B will provide a net contribution (i.e.
contribution after specific fixed costs) for the deduction of general fixed costs. More total net contribution means more total net profit. Therefore, when Model B provides a positive contribution after specific fixed cost, Model B should be retained. On the other hand, if Model B results in a negative contribution after specific fixed costs, then Model B should be dropped.
12 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 3: Preparation of income statement to recommend on the drop out decision of Model B
Task 1 Task 1
z
z
Refer Student Worksheet P.6 Refer Student Worksheet P.6
z
Classify costs into variable cost, specific fixed cost and general fixed cost
Task 1 of activity 3 will facilitate students’ preparation of the revised income statement in Task 2. Students are required to classify the cost items into variable costs, specific fixed costs and general fixed costs.
Revision
Variable costs – A variable cost increase (decrease) proportionally when the number of units increase (decrease).
Specific fixed costs – A specific fixed cost relates to a particular product, department or segment of a business.
General fixed costs – A general fixed cost is generally related to the overall business operational costs rather than operational cost of a particular product line, department or segment.
13 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Task 1: Answer
Teacher checks the answer with students.
Purchase costs of Model A, material costs of Models B and C as well as a royalty charge of Model A are variable costs because they vary in direct proportion to the number of units.
Special tools for Model B and hire charges for special equipment of Model C are specific fixed costs because they are incurred specifically for the models concerned and the amounts are fixed sums unrelated to the number of units.
Material costs for fixing and decorating the stall, transportation expense as well as rental of the stall are general fixed costs because these expenses are required no matter the stall sells two or three models of products.
14 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 3: Preparation of income statement to recommend on the drop out decision of Model B
Task 2 Task 2
zz
Refer Student Worksheet P.7 Refer Student Worksheet P.7
z
Prepare a revised income statement
z
Give your recommendation
With reference to the answer of Activity 1 and 2 and Task 1 of Activity 3, students are required to prepare an income statement. Recommendation can be made by reference to the figure “Contribution after specific fixed cost” of Model B.
Teacher can refer to Topic Overview p.9 for suggested answer.
15 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Task 2: Answer
z
Model B should NOT NOT be dropped.
The purpose of this activity is to determine whether dropping Model B can increase the total net profit of $4,200. As explained in slide #11 if Model B can provide a positive contribution after specific fixed costs, Model B should be retained. On the other hand, if Model B results are a negative contribution after specific fixed costs, then Model B should be dropped.
Referring to the income statement above, Model B should not be dropped in the Lunar New Year Fair because by dropping it the total net profit will reduce from $4,200 to $1,200 (by cutting $3,000 contribution after specific fixed cost from Model B).
16 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Conclusion
zz
Variable and specific fixed costs Variable and specific fixed costs are are
z
relevant to drop out decisions because they change due to the decision.
zz
General fixed costs are General fixed costs are
z
irrelevant to drop out decisions because they remain unchanged by the decision.
Classification of costs are important for management decisions.
Without such a classification, the draft income statement fails to reflect the true trading results of the three models. With the classification of cost into variable costs, specific fixed costs and general fixed costs, the revised income statement shows the figure “contribution after specific fixed cost”
for the drop out decision.
End of Lesson 1
17 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Lesson 2
Distinguish sunk costs from future costs for decisions involving the production and selling of additional products
Lesson 2
In this lesson, students are required to identify and apply future costs in decision making.
Only future costs, not sunk costs, are relevant for decision making.
The case study discussion is about deciding whether to sell an additional product during the Lunar New Year Fair. It is profitable if its sales revenue exceeds future costs.
Some costs will be affected by the decision whether to sell an additional product. These costs are called future costs. They are relevant for decision making. On the other hand, costs already incurred will be unaffected by the decision of whether to sell the additional product. These costs are called
‘sunk costs’ which is irrelevant for decision making.
Future costs and sunk costs will be discussed in-depth in the lesson.
18 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Recall your memory …
z
What are variable costs? Any examples?
z
What are general fixed costs and specific fixed costs? Any examples?
Definition of variable cost – A cost which tends to vary with the level of activity.
(CIMA Official Terminology)
Examples of variable costs – Direct materials, direct labour, direct expenses
• Referring to the case study in Lesson 1, the materials for making the models in Lunar New Year Fair
Definition of fixed costs – A cost which is incurred for a period, and which, within certain output and turnover limits, tends to be unaffected by fluctuations in the level of activity. (CIMA Official Terminology).
Fixed costs can be divided into general and specific
1. General business fixed costswill not be changed when a particular product, department or segment is added or cancelled.
Examples:
• Salary of the production manager
• Insurance of the factory building
• Referring to the case study, rental of the stall in Lunar New Year Fair 2. Specific fixed costsare those fixed costs exiting for a particular product, department or segment.
Examples:
• Salary of production supervisor of a particular product line
• Insurance in relation to machines of a particular product
• Referring to the case study, special tools for Model B in Lunar New Year sales
19 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Recall your memory …
z
Variable costs and specific fixed costs are relevant to drop out decisions and the production of new products
z
General fixed costs are not relevant for drop out decisions for producing new products
Referring to the case study in Lesson 1, variable costs and specific fixed costs of Model B are used to calculate the contribution. As the contribution after specific fixed costs is positive, the product should not be dropped.
Thus, variable costs and specific fixed costs are relevant for the product drop out decision.
On the other hand, general fixed costs, e.g. rental of the stall, remain unchanged no matter whether Model B will be dropped. These costs are irrelevant to the product drop out decision.
20 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Are all variable costs relevant for decision making?
z
‘Variable costs’ are relevant for decision making if they are ‘future costs’.
z
Future costs are costs that will be changed by a decision .
z
Examples: Materials to be purchased for a product, workers to be hired for manufacturing a product
Teacher further elaborates how variable costs are relevant for decision making.
Referring to the case study in Lesson 1, material costs of Model B are relevant to the product drop out decision. Why? Because if the model is dropped the material costs will be eliminated. The future materials cost is zero.
21 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
z
Variable costs will be irrelevant for decision making if they are sunk costs.
z
Sunk costs are those costs that will not be changed by a decision.
z
Examples: Materials already purchased to be used for manufacturing a product, workers already hired to be transferred to manufacture a product
Teacher tells students what sunk costs are and its relevancy to decision- making.
The materials in stock were purchased at $700. These materials are transferred out of stock and used for manufacturing Product X.
The material costs for Product X will be zero, but not $700 because the materials were previously purchased. Material costs of $700 remain no matter whether Product X is manufactured or not. Thus, the $700 is a sunk cost. This cost is irrelevant for the production decision making under cost accounting.
22 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Case Study
Further discussion about The Lunar New Year Sales – the selling of additional product, Model D
Students can refer to Student Worksheet p.8 for the case study.
The class committee executive team hopes to raise profits during Lunar New Year sales by selling an additional product of Model D. This proposal will be acceptable if this product brings in a profit.
In order to determine whether the sales of Model D will earn a profit, it is important that students can distinguish between future and sunk costs.
Otherwise, profits will be calculated incorrectly and lead to incorrect decisions.
23 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 4 – Costs of Material X and Material Y for Model D
1. Material X left from last year’s Lunar New Year Fair was purchased at $20,000. It has no other use.
2. Material Y left from last year’s Lunar New Year Fair was purchased at $22,000. It is a popular material. If used up, it has to be replaced at
$23,000.
z Required: Identify the material costs which are relevant for the decision of selling Model D.
This activity requires students to distinguish between future and sunk costs for Material X and Material Y. Ask students to read the case carefully.
Remind them that only future costs are relevant to selling Model D as sunk costs are irrelevant to the decision.
24 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 4 – For Material X Material X was purchased at
$20,000 in last year.
Purchasing cost of $20,000 remains unchanged no matter whether Model D will be made for Lunar New Year sales.
It is a sunk cost which is irrelevant sunk cost for the decision to sell Model D.
Teacher invites students to offer their answers and concludes that the purchasing cost of $20,000 is a sunk cost and irrelevant to the selling Model D decision. The cost of Material X for Model D is zero.
25 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 4 – For Material Y Material Y was purchased at
$22,000 in last year. This cost is a
‘ ‘sunk cost sunk cost’ which is irrelevant irrelevant for sales decision making for Model D.
The replenishment cost of Material Y, $23,000 is a ‘ ‘future cost future cost’ ’. . This cost is relevant relevant for decision of selling Model D.
Teacher continues to tell students that the cost of replacing Material Y is
$23,000 which is a future cost.
The replenishment cost of $23,000 is a future cost and incurred if Model D is sold during the Lunar New Year Fair.
26 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Are all general fixed costs irrelevant for decision making?
z
If general fixed costs remain unchanged by making a choice over alternatives, they will be irrelevant for decision making.
z
Examples: Rent of a factory, Insurance of a factory
Teacher reminds students that general fixed costs which remain unchanged are irrelevant to decision making.
Referring to the case study in Lesson 1, rental of the stall in Lunar New Year Fair remains unchanged no matter whether Model B is dropped or not.
27 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
z
If general fixed costs are changed by making a choice over
alternatives, these costs will be relevant for decision making.
z
If general fixed costs increase as a result of a decision, this increase represents an incremental cost.
z
Example: extra rent for a bigger factory to producing an additional product
However, teacher should show to students that if general fixed costs are changed by making a choice over alternatives, it will be relevant for decision making. Teacher further elaborates this idea and introduces what incremental cost is.
The rent of a factory to manufacture existing products amounts $100,000.
Following the production of an additional product, a bigger factory has to be leased. The rent of the new factory will be $150,000. The additional rent of
$50,000 represents an increase in fixed cost. This increase is an
incremental cost which is relevant for the decision making of producing an additional product.
28 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 5 – Additional charges of general fixed costs arising from the sales of Model D
1.1.Material costs for decorating the stall, $3,000Material costs
-Following the sales of Model D, the costs of new decoration materials will be $4,000.
2. Transportation expense, $4,800 2. Transportation expense, $4,800
-The other class offers to transport free of charge Model D from school to the stall. The hiring fee of a van to be paid by the other class amounts $7,000.
Required: Identify the incremental costs of decoration materials and transportation expenses.
In this activity, remind students to consider the incremental fixed cost arising only from the sales of Model D.
29 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 5 – answer
1. 1. Incremental costs of decoration materials is Incremental costs of decoration materials is
$1,000
$1,000
Due to the sales of Model D, special decoration materials will be purchased. Additional costs of
$1,000 ($4,000 - $3,000) will then be incurred
.
2. 2. Incremental costs of transportation: Zero Incremental costs of transportation: Zero
The hiring charge of the transportation van remains unchanged.
Teacher invites students to answer the question. Here is further elaboration for point 2: The hiring fee of a van which is used by the other class to transport Model D is irrelevant for the sales decision making of the product. It is because the class’s own transportation expense is unaffected by such decision.
30 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 6 – Selling of Model D in Lunar New Year Fair?
Hints for discussion:
- Model D will be sold if a profit is made.
- Sales revenue of Model D is estimated to be
$22,500.
- Refer to the cost estimations in Activity 4 and Activity 5
In Activity 6, students are required to decide whether Model D should be sold during the Lunar New Year Fair. Students should note that only future variable costs and incremental fixed costs are relevant to the decision of selling Model D.
31 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 6 – Answer
Model D
$ Sales
Sales 22,500
Less: Costs Less: Costs
-Material X -Material Y -Incremental costs on decoration materials -Incremental costs on transportation expense
0 23,000 1,000
0
24,000 Net loss
Net loss 1,500
Teacher can invite students to demonstrate the calculation with explanation.
Remarks:
• Model D should not be sold because a loss of $1,500 will be suffered.
• Cost of Material X is zero because it is a sunk cost.
• Cost of Material Y is a future cost. It amounts $23,000.
• Only the additional costs of decoration materials, $1,000 represents the incremental fixed costs. No incremental cost is incurred on the transportation fee.
32 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Conclusion
z
‘Variable costs Variable costs’ ’ which are future costs are relevant relevant for decision making.
z
z
‘Variable ‘ Variable costs costs’ ’ which are sunk costs are irrelevant irrelevant for decision making.
z
‘Incremental fixed costs Incremental fixed costs’ ’ are relevant
relevant for decision making.
Teacher concludes the lesson by highlighting the following:
• Future costs and incremental costs are costs that are affected by a choice of alternatives. Thus, they are relevant for decision making.
• Sunk costs are the costs that will be not be affected by a choice of alternatives. Thus, they are irrelevant for decision making.
• In the case study, the future and incremental costs are the Material Y cost and cost of decoration materials respectively. On the other hand, the sunk cost is the cost of Material X.
• In order to determine whether to sell Model D in Lunar New Year Fair, an income statement must be prepared to show the trading result. It is important that only the future costs and incremental costs, but not the sunk costs, are taken into account. As a result, a $1,500 loss will be suffered by selling the product. It is not advisable to sell Model D.
End of Lesson 2
33 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Lesson 3
Apply the concept opportunity costs for sales decisions
Lesson 3
In this lesson, students will identify and apply opportunity costs to a sales decision.
Following decisions will be discussed in this lesson:
i) setting price of products; and
ii) products to be sold in the summer or at Christmas.
34 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Recall your memory …
z
What are incremental costs?
z
Why do we need to consider when using incremental costs for decision making?
Teacher reviews the definition of incremental costs which are incurred additional costs.
Example of incremental costs: The labour costs of $500,000 to
manufacture existing products and requires additional workers. Wages will increase to $650,000 or by an additional $150,000. This increase is an incremental cost which is relevant to the decision of whether to produce and sell an additional product.
35 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Recall your memory …
z
Incremental costs are relevant for decision making .
Referring to the case study in Lesson 2, the extra $1000 cost of decoration materials is incurred if an additional product is sold. Teacher reminds students that this extra cost or incremental cost is relevant to the decision to sell an additional product.
36 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Opportunity costs
z
Opportunity costs is the value of best alternative foregone.
z
Examples of opportunity costs: the profit foregone on producing an alternative product
z
Opportunity costs should be considered for decision making e.g. use material A to make Product X or Product Y.
In addition to incremental costs, opportunity costs should be considered in the decision.
Further elaboration of opportunity costs:
Material A of $8,000 will be purchased for manufacturing Product X with a selling price of $8,500. Alternatively, the materials could be used to manufacture Product Y which will earn a profit of $1,000. If the company manufactures Product X, it will sacrifice a profit of $1,000 from the lost output of Product Y. This represents an opportunity cost of $1,000.
If material A is used for manufacturing Product X, its opportunity cost is
$1,000. This cost is important for making decisions to use material A to manufacture Product X because its selling price of $8,500 is less than its total relevant cost of $9,000 i.e.$8,000 (incremental costs) + $1,000 (opportunity cost).
37 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Case study – Summer Clearance Sales
Activity 7: Set the prices of folders and pencil cases in summer sales
Sales Items which are kept in stock:
Sales Items which are kept in stock:
1. Batches of folders with SU logo are to sold at the coming Easter Carnival. The sales revenue would be
$2,000.
2. Batches of pencil cases are to be sold at the coming Christmas Fun Fair or Easter Carnival. Their sales revenue would be $3,000 or $3,500 respectively.
Required:
Identify the opportunity costs of the folders and the pencil cases to be sold in the summer sales as to fix the selling price at a mark-up.
Teacher introduces the case study to students. They are required to identify the opportunity costs of folders and the pencil cases to be sold in the summer sales in Activity 7.
Opportunity costs of the summer clearance sale must be identified to help establish a selling price because the costs will have been understated and a loss may then be suffered.
38 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 7 - answer
$ Explanation
Folders 2,000 the revenue to be earned in an alternative function i.e. Easter Carnival is foregone. The value of an alternative foregone is an opportunity cost.
Pencil cases
3,500 the greater revenue to be earned in Easter Carnival is foregone. The value for the best alternative foregone is an opportunity costs.
Teacher invites students to answer the question.
In conclusion, students must set the folders total selling price and pencil cases above $2,000 and 3,500 respectively in order to earn a mark-up during the summer sale.
39 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 8
The selling of soft toys in Summer Clearance Sales?
Soft toys
Soft toys which are kept in stock: which are kept in stock:
z If the soft toys are sold at Christmas Fun Fair, a revenue of $20,000 will be earned.
z The rent of storing the soft toys during the summer vacation will be $12,000.
z If the soft toys are sold in the summer sales, a revenue of $10,000 will be earned.
Required:
Shall we support that the soft toys would not be sold at the Summer Clearance Sales?
In this activity students are required to show their support for not selling the soft toys during the summer clearance sale.
If a loss will be suffered from selling the soft toys during the Summer Clearance Sale, then this item should not be sold. It will happen when the opportunity costs of the soft toys are greater than their revenue to be earned.
40 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 8
Activity 8 - answer
$ Explanation 1. Revenue of soft toys to
be earned at Summer Clearance Sales
10,000
2. Opportunity costs i.e.
net revenue of soft toys to be earned at
Christmas Fun Fair sales
8,000 Net revenue to be earned at
Christmas Fun Fair of soft toys is the deduction of …
Teacher invites students to provide answers.
41 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 8 - answer
$ Explanation
the incremental costs
$12,000 from its revenue.
This net amount is the value of Christmas sales foregone. It is an
opportunity cost of
summer sales of soft toys.
Net profit (1-2) 2,000
Teacher concludes that the soft toys should be sold at summer clearance sale as it will generate a $2000 profit meaning that the SU will be better off selling soft toys during the summer clearance sale rather than the Christmas Fun Fair.
42 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Costs relevant for decision making
z
Incremental costs as well as opportunity costs are relevant for decision making.
Examples of incremental costs and opportunity costs5 relevant for decision making:
The existing stock of materials could be utilised for a special order at a conversion cost of $2,000. Alternatively, this old stock could be sold at a scrap value of $500.
The incremental cost of the special order is $2,000 and the opportunity cost is $500. Thus, the relevant costs total $2,500.
Application of relevant costs (incremental costs plus opportunity costs) for decision making:
• The special order will be accepted if its selling price is higher than $2,500.
Remind students that opportunity costs can be easily overlooked as compared to incremental costs, Incremental costs involve expected future payments while opportunity costs may be implicit to decisions. Whenever relevant costs are calculated, opportunity costs should not be ignored.
43 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 9
Will the SU members be paid for their extra work in Summer Clearance Sales?
zA salary of $300 will be paid to each SU members for their extra work in summer sales.
zThe sales revenue in Summer Clearance is estimated to be $16,000.
zThe Secretary argues that a loss will be suffered following the additional costs on salaries paid to the committee members. Thus, the proposal of salaries payment should be rejected.
Required:
Is the Secretary’s argument acceptable?
In this activity students will determine whether paying for extra work by SU members will result in a profit loss. Students are required to refer to Student Worksheet p.16 to answer the question.
• If the relevant costs of summer sales (after the payment of salaries) are greater than the sales revenue of $16,000, the Secretary’s argument will be accepted.
• The relevant costs include the followings:
i) opportunity costs of folders, pencil cases and soft toys identified in Activity 7 and Activity 8.
ii) incremental salary costs of the five committee members for extra work.
44 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Activity 9 - answer
Relevant costs Relevant costs
1. Opportunity costs
- Folders
- Pencil cases
- Soft toys
$
2,000 3,500 8,000 2. Incremental costs
2. Incremental costs
- Salaries to SU members for their extra work 1,500 15,000
Less:
Less: Sales revenue Profit
16,000 1,000
Teacher invites students to demonstrate their answers.
The relevant summer sales costs include opportunity costs of $13,500 and incremental costs of $1,500 = $15,000.
The relevant summer sales costs are less than the sales revenues of
$16,000. Thus, no loss will be suffered.
The Secretary’s argument to avoid paying the five committee members salaries should not be accepted.
45 BAFS Elective Part Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
Conclusion
z
Opportunity costs and
incremental costs are relevant for decision making .
Teacher concludes the lesson by highlighting the following:
• Opportunity costs and incremental costs are relevant to decision making.
• In the case study, the opportunity costs are the folders, pencil cases and soft toys revenues that were foregone during the Christmas or Easter sales period, following the sales decision in the summer.
• Incremental costs mean additional costs incurred as a result of decisions made. In the case study, the incremental costs are salaries to paid to 5 SU committee members for extra work.
• Both the opportunity and incremental costs are relevant to the decision making process. In the case study, The decision making scenarios include the following:
i) price setting of folders and pencil cases;
ii) soft toys to be sold in Summer Sales or Christmas Sales; and iii) salaries to paid to SU committee members for their extra work in Summer Sales or not.
46 BAFS Elective Part
Learning and Teaching Example Topic A09
Cost Accounting for Decision-making
The End
End of Lesson 3.
