David Collison & Massimo Contrafatto
DEFINITIONS Relevant costs and revenues are those future costs and Relevant costs and revenues revenues that will be changed by a decision, whereas irrelevant costs and revenues are those that will not be affected by the decision (Drury, p.37) For decision-making, only those costs and revenues that will be affected by the decision must be taken into account; i.e. relevant costs and revenues
THE CASE STUDY Data: Data: A) Company: J B Development and Construction Ltd; A) Company: B) Sector: Construction (Building private houses) B) Sector: C) Decision between two projects : Northfield (N) and Southfield (S); C) Decision between two projects D) Acquisition : - N was bought in 1987 for £220,000 (CV: £150,000) D) Acquisition - S was bought in 1991 for £160,000 (CV: £170,000); E)Landscaping improvements : S would require £40,000 E)Landscaping improvements F) Financial information available: see table below F) Financial information available: Now one project must Which costs and be cancelled? revenues are relevant? Which one?
BUDGETED FINANCIAL INFORMATION NORTHFIELD SOUTHFIELD SALES REVENUES 1050 1200 LAND 120 160 MATERIALS 250 325 - 50 bought (40 re-usable) - 100 (20 re-usable) - 10 saleable (5) - 80 saleable (20) LABOUR 100 100 MACHINE PROCESS 25 40 - 25 (500 hr*50) - 40 (800 hr*50)
FINANCIAL INFORMATION AVAILABLE NORTHFIELD SOUTHFIELD CONSULTANCY FEE 70 100 - 10 £ - 70 £ - 5 cancellation fee - 10 cancellation fee PLANT HIRE 40 65 CENTRAL FIXED 50 60 OVERHEAD APPORT.
IRRELEVANT INFORMATION The irrelevant information (excluded from decision- - The irrelevant information (excluded from decision making): making): A) Cost of acquisition land ; A) Cost of acquisition land B) Materials: those which cannot use elsewhere and not re-saleable; B) Materials: C) Machine processing: allocated costs; C) Machine processing: D) Consultancy : money already spent on consultancy which has been D) Consultancy provided. All this information is irrelevant and thus will be excluded from m All this information is irrelevant and thus will be excluded fro decision- -making process. making process. decision
RELEVANT INFORMATION (INFLOWS) NORTHFIELD SOUTHFIELD HOUSES SALES 1050 1200 SALE OF UNUSED 170 150 LAND SALE OF STOCK 20 5 SAVINGS FROM USE 20 40 OF STOCK TOTALE (A) =1260 = 1395 =1260 = 1395
RELEVANT INFORMATION (OUTFLOWS) NORTHFIELD SOUTHFIELD LANDSCAPING 40 CONSULTANCY 60 30 CANCELLATION FEE 10 5 MATERIAL 200 225 LABOUR 100 100
RELEVANT INFORMATION (OUTFLOWS) NORTHFIELD SOUTHFIELD PROCESSING 400*80 + 100*100 400*80+400*100 HOURS =42 = 72 PLANT HIRE 40 65 Total (B) 452 537 A- B 808 858 1260-452= 808 1395-537= 858 Southfield better by £ £50,000 50,000 Southfield better by
DECISION ON OPPORTNITY COST An opportunity cost is a cost that measures the opportunity An opportunity cost that is lost or sacrificed when the choice of one course of action requires that an alternative course of action is given up (Drury, p.39) NORTHFIELD SOUTHFIELD HOUSES SALES (A) 1050 1200 OUTFLOWS 452 537 OPP.COST LAND 150 170 OPP. COST OF MAT’L 45 40 TOTAL OUTFLOWS (B) 452+195= 647 537+210= 747 A - A - B B 1050-647= 403 1200- 747= 453
RELEVANT INFORMATION: QUESTION B NORTH SOUTH NEITHER HOUSES 1050 1200 - SALES SALE OF 170 150 320 UNUSED LAND SALE OF 20 5 25 STOCK SAVINGS 20 40 6 FROM USE OF STOCK TOTALE =1260 = 1395 = 405 =1260 = 1395 = 405 (A)
RELEVANT INFORMATION: QUESTION B NORTH SOUTH NEITHER OUTFLOWS 452 537 - CANCELLATION 15 FEES FOR BOTH TOTAL (B) 452 537 15 452 537 15 A- B 808 858 390 808 858 390 S leaves the firm 858- S leaves the firm 858 - 390= 468 better off than it would 390= 468 better off than it would have been if neither contract had been allowed. have been if neither contract had been allowed.
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