ABSTRACT
When analyzing the manufacturing and/or selling functions of your department, you are faced with the problem of choosing between alternative courses of action. What should you produce? How should you manufacture it? Where should you sell the product? What price should you charge? In the short run, you may be confronted with the following nonroutine, nonrecurring situations:
• Whether to accept or reject a special order • How to price standard products • Whether to sell or process further • Whether to make or buy • Whether to add or drop a certain product line • How to utilize scarce resources
In each of these situations, the ultimate management decision rests on cost data analysis. Cost data, which are classified by function, behavior patterns, and other criteria, are the basis for profit calculations. However, not all costs are of equal importance in decision making, and you must identify the costs that are relevant to a decision. The
relevant costs
are the future costs that differ between the decision alternatives. Therefore, the
sunk costs
are not relevant to these decisions because they are past costs. The
incremental or differential costs
are relevant because they are the ones that differ between the alternatives. For example, in a decision on whether to sell an existing business for a new one, the cost to be paid for the new business is relevant. However, the initial cost of the old business is not relevant because it is a sunk cost.
