Cost Accounting (14th Edition)

THE CONCEPT OF RELEVANCE 393
Relevant Costs and Relevant Revenues
Relevant costs are expected future costs, and relevant revenues are expected future
revenues that differ among the alternative courses of action being considered.
Revenues and costs that are not relevant are said to be irrelevant. It is important to
recognize that to be relevant costs and relevant revenues they must:
Occur in the future—every decision deals with selecting a course of action based on
its expected future results.
Differ among the alternative courses of action—costs and revenues that do not differ
will not matter and, hence, will have no bearing on the decision being made.
The question is always, “What difference will an action make?”
Exhibit 11-2 presents the financial data underlying the choice between the do-notreorganize
and reorganize alternatives for Precision Sporting Goods. There are two ways
to analyze the data. The first considers “All revenues and costs,” while the second considers
only “Relevant revenues and costs.”
The first two columns describe the first way and present all data. The last two
columns describe the second way and present only relevant costs—the $640,000 and
$480,000 expected future manufacturing labor costs and the $90,000 expected future
reorganization costs that differ between the two alternatives. The revenues, direct materials,
manufacturing overhead, and marketing items can be ignored because they will
remain the same whether or not Precision Sporting Goods reorganizes. They do not differ
between the alternatives and, therefore, are irrelevant.
Note, the past (historical) manufacturing hourly wage rate of $14 and total past (historical)
manufacturing labor costs of $560,000 (20 workers * 2,000 hours per worker
per year * $14 per hour) do not appear in Exhibit 11-2. Although they may be a useful
basis for making informed predictions of the expected future manufacturing labor costs of
$640,000 and $480,000, historical costs themselves are past costs that, therefore, are
irrelevant to decision making. Past costs are also called sunk costs because they are
unavoidable and cannot be changed no matter what action is taken.
The analysis in Exhibit 11-2 indicates that reorganizing the manufacturing operations
will increase predicted operating income by $70,000 each year. Note that the managers at
Precision Sporting Goods reach the same conclusion whether they use all data or include only
relevant data in the analysis. By confining the analysis to only the relevant data, managers
Learning
Objective 2
Distinguish relevant
from irrelevant
information in decision
situations
. . . only costs and
revenues that are
expected to occur in the
future and differ among
alternative courses of
action are relevant
Exhibit 11-2
Determining Relevant Revenues and Relevant Costs for Precision
Sporting Goods
All Revenues and Costs
Relevant Revenues and Costs
Alternative 1: Alternative 2: Alternative 1: Alternative 2:
Do Not Reorganize Reorganize Do Not Reorganize Reorganize
Revenues a $6,250,000 $6,250,000 — —
Costs:
Direct materials b 1,250,000 1,250,000 — —
Manufacturing labor 640,000 c 480,000 d $ 640,000 c $ 480,000 d
Manufacturing overhead 750,000 750,000 — —
Marketing 2,000,000 2,000,000 — —
Reorganization costs — 90,000 — 90,000
Total costs 4,640,000 4,570,000 640,000 570,000
Operating income $1,610,000 $1,680,000 $(640,000) $(570,000)
$70,000 Difference $70,000 Difference
a 25,000 units $250 per unit = $6,250,000 c 20 workers 2,000 hours per worker $16 per hour = $640,000
b 25,000 units $50 per unit = $1,250,000 d 15 workers 2,000 hours per worker $16 per hour = $480,000