Page 39 - BA2 Integrated Workbook STUDENT 2018
P. 39
Cost identification and classification
Relevant cost
Organisations face many decisions, and they often must choose between two or
more alternatives. Decisions will generally be based on taking the decision that
maximises shareholder value. In all decision making, only relevant costs and
revenues should be used.
Relevant costs and revenues are those costs and revenues that change as a
direct result of a decision taken.
4.1 Relevant costs
They are future costs and revenues. Past costs are not relevant as we
cannot affect them by current decisions and they are common to all
alternatives that we may choose.
They are incremental. Relevant costs are incremental costs and it is the
increase or decrease in costs and revenues that occurs as a direct result of a
decision taken that is relevant.
They are cash flows. Relevant costs do not include items which do not involve
cash flows (depreciation for example).
4.2 Opportunity costs
The CIMA terminology defines opportunity cost as ‘the value of the
benefit sacrificed when one course of action is chosen in preference
to an alternative. The opportunity cost is represented by the forgone
potential benefit from the best rejected course of action’.
The opportunity cost emphasises that decision making is concerned with alternatives
and that the cost of taking one decision is the profit or contribution forgone by not
taking the next best alternative.
Opportunity cost is always relevant in decision making.
33
