Relevant Costs and Opportunity Cost Quiz

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Questions and Answers

What distinguishes relevant costs from irrelevant costs in decision-making?

Relevant costs include costs that have already been incurred.

Relevant costs can be non-cash expenses.

Relevant costs are always fixed costs.

Relevant costs are future incremental cash flows that will change based on a decision. (correct)

Which of the following statements about sunk costs is accurate?

Sunk costs are future costs that are expected to occur.

Sunk costs are incurred in the past and cannot be changed by current decisions. (correct)

Sunk costs are relevant costs that can change with new decisions.

Sunk costs should always be included in decision-making.

What type of expenses are considered irrelevant to the decision-making process?

Future costs that will be incurred as a direct result of a decision.

Costs that will not change regardless of the decision taken. (correct)

Incremental cash flows that directly affect future revenues.

Additional cash flows that arise from a new project.

Which costs can be considered relevant costs in certain decision-making situations?

Fixed costs that will alter due to a decision made. Signup and view all the answers

Which of the following is NOT a characteristic of relevant costs?

They are incurred in the past. Signup and view all the answers

How are non-cash expenses, like depreciation, classified in decision making?

They are non-relevant costs. Signup and view all the answers

When evaluating whether to proceed with a project, which type of cash flow is most significant?

Future incremental cash flows arising from the decision. Signup and view all the answers

In decision making, which costs are automatically considered non-relevant?

Costs that have been fully incurred and cannot be recovered. Signup and view all the answers

What is the impact on contribution margin if the product is sold for P100 per unit with a variable cost of P80?

P80,000 increase Signup and view all the answers

Which costs are considered relevant to a make-or-buy decision?

Variable costs and avoidable fixed costs Signup and view all the answers

In the context of decision-making, how should unavoidable costs be treated?

They are irrelevant to the decision. Signup and view all the answers

What does opportunity cost represent in decision-making?

The benefit lost from not choosing the next best alternative Signup and view all the answers

Which method of cost analysis focuses only on the costs that differ between alternatives?

Differential analysis Signup and view all the answers

When considering whether to continue or drop a product line, which of the following factors should be considered?

Contribution margin loss from closure Signup and view all the answers

In a make-or-buy decision, which type of cost is specifically categorized as avoidable?

Direct materials costs for production Signup and view all the answers

What is the main characteristic of fixed costs within the decision-making framework?

They remain constant unless there is a change in the level of activity. Signup and view all the answers

For a temporary shutdown decision, what equates the loss from continuing operations?

Contribution Margin - Fixed Costs Signup and view all the answers

Which of the following would NOT affect a make-or-buy decision?

Historical costs of production Signup and view all the answers

What defines cash flow costs in the context of decision-making?

Costs that arise in cash terms as a consequence of a decision Signup and view all the answers

Which cost is typically not relevant in a decision-making scenario?

Depreciation on machinery already purchased Signup and view all the answers

What is the difference in focus between total analysis and differential analysis?

Total analysis considers all costs, while differential focuses only on varying costs. Signup and view all the answers

What should be considered alongside financial factors when deciding whether to continue or discontinue a product line?

Impact on other business units Signup and view all the answers

What defines the split-off point in joint product manufacturing?

The moment of product identification Signup and view all the answers

When should a company decide to process a joint product further instead of selling it at the split-off point?

If incremental revenue exceeds incremental costs Signup and view all the answers

In resource allocation, what should be prioritized when managing a scarce resource?

Producing the product with the highest contribution margin per unit Signup and view all the answers

Which pricing strategy tends to ignore customer interest and competitor positioning?

Cost-plus pricing Signup and view all the answers

What should be calculated to decide whether to accept a special order?

Cost of fulfilling the contract compared to normal production costs Signup and view all the answers

What is the relationship between avoided fixed costs and lost contribution margin in making continuity decisions?

If lost CM is less than avoidable FC, continue the line Signup and view all the answers

When utilizing sales mix decisions, what factor does NOT typically affect the appropriate sales mix?

Customer demographics Signup and view all the answers

What economic principle explains why joint costs should not be considered in selling decisions after the split-off point?

They are irrelevant to decision-making Signup and view all the answers

In competition-based pricing, what aspect does it primarily consider?

Prices of competing products Signup and view all the answers

What does incremental revenue represent in the context of processing joint products?

Final sales price minus sales value at split-off point Signup and view all the answers

What should management recognize before accepting additional orders?

Impact on existing contract fulfillments Signup and view all the answers

How does the contribution margin relate to the decision to continue or drop a product line?

It helps assess the profitability against avoidable fixed costs Signup and view all the answers

What is the primary goal when deciding on the allocation of scarce resources?

Maximize company profits Signup and view all the answers

Study Notes

Relevant Costs

Relevant costs are future incremental cash flows directly related to a decision.
Relevant costs are future, incremental, and cash flows.
Sunk costs are irrelevant to decision making as they have already been incurred.
Avoidable costs are relevant as they can be prevented by a decision.
Unavoidable costs are irrelevant as they will be incurred regardless of the decision.
Cash flow costs are relevant and include future costs arising from a decision.
Depreciation, notional interest charges, and absorbed fixed overheads are not cash flow items and are not relevant to decision making.
Variable costs are often relevant as they change with activity levels.
Fixed costs are usually irrelevant except when they are step costs that change with a decision.

Opportunity Cost

Opportunity cost represents the potential benefit lost from choosing one option instead of the best alternative.
Opportunity costs arise when limited resources force a choice between multiple beneficial options.

Analyzing Alternatives

Total analysis considers all costs associated with each alternative, including fixed and variable costs.
Differential analysis focuses only on the costs that differ between alternatives, including variable costs and incremental costs.
Differential analysis is typically preferred for non-routine decisions due to its focus on relevant costs.

Types of Decisions

Make or Buy Decisions

Make or buy decisions involve choosing between manufacturing a product internally or purchasing it externally.
Relevant costs in make-or-buy decisions include those associated with manufacturing internally and the purchase price from an external supplier.
Opportunity costs of using production facilities for alternative purposes should be considered.
Other factors, such as supply chain reliability, control over production, and social/legal implications, also impact make-or-buy decisions.

Continue or Drop/Shutdown a Product Line/Segment

Continue or drop/shutdown decisions involve evaluating the profitability of a product line, department, or channel.
Relevant costs include lost contribution margin, savings in specific fixed costs, penalties, and alternative use of resources.
Temporary shutdown decisions involve comparing the losses associated with continuing operations and shutting down temporarily.
The shutdown point is where the loss from continuing operations equals the loss from discontinuing.
Continue or drop decisions compare lost contribution margin with avoidable fixed costs.

Sell or Process Further

Joint products are produced simultaneously and have a common split-off point.
Joint costs incurred before the split-off point are sunk and irrelevant in decisions regarding further processing.
Relevant costs in sell-or-process-further decisions include incremental processing costs and additional revenue from further processing.

Best Product Combination

Scarce resources are limited resources essential to production or service delivery, such as machine hours or skilled labor.
Scarce resource decisions involve maximizing profit by allocating the scarce resource to the product with the highest contribution margin per unit of the scarce resource.
Sales mix decisions involve determining the optimal proportions of products in total sales.

Pricing Decisions

Cost-Plus Pricing

Cost-plus pricing is a pricing method that adds a markup to the cost per unit.
Markup is a percentage of cost, while margin is a percentage of sales price.

Customer-Based Pricing

Customer-based pricing considers customers' perceptions of value and benefits, pricing the product accordingly.

Competition-Based Pricing

Competition-based pricing involves setting prices based on competitors' prices.
Product type and substitutes are key factors in competition-based pricing.

Special Contract Pricing

Special contract pricing involves determining a profitable price for additional orders.
Limiting factors should be considered when determining the price, ensuring the existing rate of contribution per unit of the limiting factor is maintained.

Accept or Reject Special Order

Special order decisions involve pricing and accepting production or services outside the normal scope of operations.
Minimum sales price should cover variable, incremental fixed costs, and generate a profit.
Opportunity costs are included in incremental costs if there is no idle capacity.

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Description

Test your understanding of relevant costs and opportunity costs with this quiz. Explore concepts like sunk costs, avoidable costs, and the impact of decision-making on future cash flows. Ideal for students studying financial decision-making.