Question

For a cost to be relevant, it must meet which of the following criteria? (Please Choose One)

A) It must differ between the decision alternatives and it must be incurred in the future rather than in the past.

B) It must not differ between the decision alternatives and it must be incurred in the future rather than in the past.

C) It must differ between the decision alternatives and it must have occurred in the past rather than in the future.

D) It must not differ between the decision alternatives and it must have occurred in the past rather than in the future.

Answer 1

The costs which should be used for decision making are often referred to as "relevant costs".

For Decision Making see the following points

a) Future: Past costs are irrelevant, as we cannot affect them by current decisions and they are common to all alternatives that we may choose.

b) Incremental: ' Meaning, expenditure which will be incurred or avoided as a result of making a decision. Any costs which would be incurred whether or not the decision is made are not said to be incremental to the decision.

c) Cash flow: Expenses such as depreciation are not cash flows and are therefore not relevant. Similarly, the book value of existing equipment is irrelevant, but the disposal value is relevant.

d) Common costs: Costs which will be identical for all alternatives are irrelevant, e.g. rent or rates on a factory would be incurred whatever products are produced.

e) Sunk costs: Another name for past costs, which are always irrelevant, e.g. dedicated fixed assets, development costs already incurred.

f) Committed costs: A future cash outflow that will be incurred anyway, whatever decision is taken now, e.g. contracts already entered into which cannot be altered.

basis for the above definition the sunk cost i.e cost incurred in the past is always irrelevant for decision making.

Therefore there must be must differ between the decision alternatives and it must be incurred in the future rather than in the past.