MAKERERE                 UNIVERSITY

COLLEGE OF BUSINESS AND MANAGEMENT SCIENCE
SCHOOL OF BUSINESS
MASTER OF BUSINESS ADMINISTRATION (MBAM)
COURSE UNIT: COST AND MANAGEMENT ACCOUNTING
COURSE CODE: MBS 8101
YEAR: TWO

FACILITATOR: DR. FESTO NYENDE TUSUBIRA

GROUP 1

STUDENTS NAME REG NO

SSEBATTA PASCAL 2021/HD06/20575U
MUNEZERO MUGISHA HENRY 2021/HD06/20487U
NAKIMULI CATHERINE 2021/HD06/20510U
IVAN AKAMPA 2021/HD06/20386U
ABEL KWIKIRIZA 2020/HD06/20435U
KHAINZA CATHERINE CLARE 2021/HD06/20450U
MUHUMUZA GERALD 2021/HD06/20482U
NANTONGO JOSEPHINE 2021/HD06/20530U
KIVIRI DERICK 2021/HD06/20458U
 

TOPIC; MEASUREMENT OF RELEVANT COSTS AND IRRELEVANT

COSTS FOR DECISION MAKING.

DECEMBER 2022

Decision Making

Classified as Internal use only

 Decision making is one of the management functions and this can be facilitated by use of
relevant information. According to (Drury, 2021), decision making involves selecting the best
alternative from a pool of choices.
Decision Making Scenarios
1. Product mix decisions when capacity constraints exist;
2. Discontinuation decisions.
3. Special selling price decisions/ Special Offers
4. Outsourcing (make or buy) decisions

The above scenarios can be easily understanding after a clear understanding of the concept of
relevant cost and revenue.

IDENTIFYING RELEVANT COSTS AND REVENUES

Relevant costs and revenues are those costs and revenues that change as a direct result of a
decision taken. I.e., those that will be affected by the decision. Costs and revenue are relevant
information in decision making. Costs and revenues that are independent of a decision are not
relevant and need not be considered when making that decision (Drury, 2012). Not all costs are
relevant for specific decisions. When making decisions management should consider only future
costs and revenues and should be concerned only with those thigs it can affect. Relevant costs
are future costs that will defer depending on the actions of the management therefore
management should decide which costs are relevant i.e., a cost may be relevant in one case and
the same cost may not be relevant in another case (Arora, 2021) .

Relevant costs and revenues have the following features:

1. They are future costs and revenues – as it is not possible to change what has happened in
the past, and then relevant costs and revenues must be future costs and revenues. Relevant
costs and revenue are futuristic and differ between alternatives;

2. They are incremental – relevant costs are incremental costs and it is the increase in costs and
revenues that occurs as a direct result of a decision taken that is relevant. Common costs can
be ignored for the purposes of decision making. Incremental Cost means increase in the cost
of production as a result of an increase in action/activity. For example, the cost of production
increased from Shs 10,000 to Shs 12,000. The increase resulted in the increase of numbers of
hours needed to complete the project. The incremental cost for the increase in the number of
hours is Shs 2, 000.

3. Differential Cost,
On the other hand, is the difference of cost to be incurred when there is more than one
alternative. For example, Option 1 will incur a total of Shs15,000 to meet the production
requirement. Option 2 needs a total of Shs14,000 to complete the same. There is a Differential
Cost of Shs 1,000 and Option 2 is favorable.

4. Opportunity costs
Opportunity cost is an important concept in decision making. It represents the best alternative
that is foregone in taking the decision. The opportunity cost emphasizes that decision making is

Classified as Internal use only

 concerned with alternatives and that a cost of taking one decision is the profit or contribution
forgone by not taking the next best alternative.
If resources to be used on projects are scarce (e.g., labour, materials, machines), then
consideration must be given to profits or contribution which could have been earned from
alternative uses of the resources.
For example, the skilled labour which may be needed on a new project might have to be
withdrawn from normal production. This withdrawal would cause a loss in contribution which is
obviously relevant to the project appraisal.
The cash flows of a single department or division cannot be looked at in isolation. It is always
the effects on cash flows of the whole organisation which must be considered.

Non-relevant costs
Costs which are not relevant to a decision are known as non-relevant costs and include:

1. Sunk costs: These have already been incurred and cannot be avoided (unavoidable), These are
costs that have been created by a decision made in the past and that cannot be changed by any
decision that will be made in the future. Sunk costs are irrelevant for decision-making, but not all
irrelevant costs are sunk costs. For example, two alternative production methods may involve
identical direct material expenditure. The direct material cost is irrelevant because it will remain
the same whichever alternative is chosen, but the material cost is not a sunk cost since it will be
incurred in the future.

2. Allocated common fixed costs are also irrelevant for decision-making, regardless of the
alternatives being considered. Facility sustaining costs, such as general administrative and
property costs, are examples of common costs. They are incurred to support the organization as a
whole and generally will not change whichever alternative is chosen. They will only change if
there is a dramatic change in organizational activity resulting in an expansion or contraction in
the business facilities. Common fixed costs may be allocated (i.e., apportioned) to cost objects
but they should be disregarded for decision-making. This is because decisions merely lead to a
redistribution of the same sunk cost between cost objects – they do not affect the level of cost to
the company as a whole.

3. Non cash flow costs are costs which do not involve the flow of cash, for example, depreciation
and notional costs. A notional cost is a cost that will not result in an outflow of cash either now
or in the future, for example sometimes the head office of an organisation may charge a
‘notional’ rent to its branches. This cost will only appear in the accounts of the organisation but
will not result in ‘real’ cash expenditure.

4. General fixed overheads are usually not relevant to a decision. However, some fixed overheads
may be relevant to a decision,for example stepped fixed costs may be relevant if fixed costs
increase as a direct result of a decision being taken.

5. Net book values are not relevant costs because like depreciation, they are determined by
accounting conventions rather than by future cash flows.

Classified as Internal use only

 DETERMINING THE RELEVANT COSTS OF DIRECT MATERIALS, DIRECT
LABOUR.

Direct Materials
If the materials are to be replaced then the decision to use them on an activity will result in
additional acquisition costs compared with the situation if the materials were not used on that
particular activity and the future replacement cost represents the relevant cost of the materials.
However, where materials are taken from existing inventories, the original purchase price
represents a past or sunk cost and is therefore irrelevant for decision-making
Consider, a situation where the materials have no further use apart from being used on a
particular activity, If the materials have some realizable value, the use of the materials will result
in lost sales revenues, and this lost sales revenue will represent an opportunity cost that must be
assigned to the activity and if the materials have no realizable value the relevant cost of the
materials will be zero.

Direct Labour

When Determining if the direct labour costs are relevant to short-term decisions depends on the
following circumstances.
 Labour cost will be a relevant cost for decision-making purposes in a situation where
casual labour is used and where workers can be hired on a daily basis, a company may
then adjust the employment of labour to exactly the amount required to meet production
requirements and therefore the labour cost will increase if the company accepts additional
work, and will decrease if production is reduced. However, where a company has
temporary spare capacity and the labour force is to be maintained in the short term, the
direct labour cost incurred will remain the same for all alternative decisions and the direct
labour cost will be irrelevant for short-term decision-making purposes.

 In a situation where full capacity exists and additional labour supplies are unavailable in
the short term, and where no further overtime working is possible, the only way that
labour resources could then be obtained for a specific order would be to reduce existing
production. This would release labour for the order, but the reduced production would
result in a lost contribution, and this lost contribution must be taken into account when
ascertaining the relevant cost for the specific order. The relevant labour cost per hour
where full capacity exists is therefore the hourly labour rate plus an opportunity cost
consisting of the contribution per hour that is lost by accepting the order.

RELEVANT COSTS FOR MATERIALS

Classified as Internal use only

 THE RELEVANT COST OF LABOUR

Illustration
Zadi Cakes Ltd is considering taking up a special contract of making a cake while still running
its daily production to meet its current market. The following information has been gathered
concerning the contract. The contract will require 200 kg of baking flour and 300 trays of eggs.
The contract will use 50 hours of skilled labour of department A and 80 hours of skilled labour
of department B. In addition to the above, the contract will need 100 hours of administration
employee skills for its pricing and contract management. The company has 500 kg of baking
flour in stock at a cost Shs 6,000 per kg. Baking flour has no other use and can currently be
resold at Shs 3,000per kg. There are 600 trays of eggs which were purchased at Shs 8,000 per
tray and are regularly used in the daily production runs at market value of Shs 10,000 per tray.
The company pays labour in department A at Shs 5,000 per hour. There is plenty of idle time in
this department currently. Department B labour is paid Shs 5,000 per hour and there is no spare
capacity in this department. Administration labour force does not work over time and to work on
the contract, they need to leave the current production which is earning the company a
contribution of Shs 3,800 per hour so that all their time is directed to the contract. These are paid

Classified as Internal use only

 Shs 10,000 per hour. Generally over time is paid 50% more than the normal rate for each
respective department.

Required:
(i) Prepare Zadi Cakes Ltd’s statement of relevant and irrelevant costs clearly explaining
why the cost is relevant or considered irrelevant.
Zadi Cakes Ltd
Statement of relevant and irrelevant costs
Relevant costs Reason
It’s an opportunity cost for the
Shs 3,000 per kg for the scrap vale of baking flour special contract
Trays of eggs under regular use and
Shs 10,000 per tray of eggs will be replaced (Future cost)
Shs 5,000 per hour in Dept. B Full capacity
Contribution Shs 3,800 per hour Lost contribution (Opportunity cost)
Shs 10,000 per hour for administration Extra labour cost
Irrelevant costs Reason
Shs 6,000 per kg of baking flour It is a sunk cost (past)
Shs 8,000 per tray of egg it is a sunk cost (in stock)
Shs 5,000 per hour in Dept. A There is spare capacity (Idle time)

(ii) If Zadi Cakes Ltd wishes to make a 50% mark-up on the total contract costs, calculate the
special contract price.
Part (ii) Shs

Material
Baking flour (W1) 600,000
Eggs (W2) 3,000,000
Labour
Dept. B (W3) 400,000
Admin (W4) 1,380,000
Total cost 5,380,000
Profit (50% markup) 2,690,000
Price 8,070,000
Workings
(W1) Baking flour
200 kg X Shs 3,000
Shs 600,000

Classified as Internal use only

 W2 Eggs
300 X Shs 10,000
Shs 3,000,000

W3 Dept. B
80 hrs X Shs 5,000
Shs 400,000

W4 Admin
100 hrs X Shs (3,800 + 10,000)
100 X 13,800
Shs 1,380,000

SPECIAL PRICING DECISIONS

Special pricing decisions relate to pricing decisions outside the main market. They involve
onetime only orders or orders at a price below the prevailing market price.

Illustration
Zambaali Textiles Ltd (ZTL) deals in the production and sale of textile products in Iganga
district. ZTL is the leading producer and supplier of school uniforms in the area. A set of
uniform for a primary school pupil is sold at Shs 100, 000. The average cost for production of a
full set has been provided as
Shs
Direct material 30,000
Direct labour 20,000
Direct expenses 15,000
Production overheads 20,000
Total 85,000
20% of the total production overheads are variable. ZTL has received an order from rise and
shine primary school for 450 sets at Shs 85,000 per set. Costs in relation to the order:
Shs
Labeling (per set) 4,500
General administration 1,000,000
Designing school badge 1,200,000
ZTL has got spare capacity to meet the order needs and no other costs will be affected by the
decision taken.
Required:
Determine whether ZTL should accept or reject the special offer?
Solution
ZTL

Classified as Internal use only

 Shs
'000'
Revenue (w1) 38,250
Variable costs
Direct material (W2) (13,500)
Direct labour (W3) (9,000)
Direct expense (W4) (6,750)
Variable production overheads (W5) (1,800)
Labelling (W6) (2,025)
Fixed costs
General admin (1,000)
Designing (1,200)
Net profit 2,975

Therefore, ZTL should accept the special offer

since it’s profitable with amounting to UGX
2,975,000
Workings
W1) Revenue
revenue = units sold X selling price per unit
450 sets X Shs 85,000
Shs 38,250,000

W2) Direct material

Shs 30,000 X 450 sets
Shs 13,500,000

W3) Direct labour

Shs 20,000 X 450 sets
Shs 9,000,000
W4) Direct expense
Shs 15,000 X 450 sets
Shs 6,750,000

W5) Variable production overheads

Shs 20,000 X 0.2 X 450 sets
Shs 1,800,000

W6) Labelling
Shs 4,500 X 450 sets
Shs 2,025,000

Classified as Internal use only

 PRODUCT MIX DECISIONS WHEN CAPACITY CONSTRAINTS EXIST

When sales demand is in excess of a company’s productive capacity, the resources responsible
for limiting the output should be identified. For example, output maybe restricted by a shortage
of skilled labour, materials, equipment or space. When sales demand is in excess of a company’s
productive capacity, the resources responsible for limiting the output should be identified.
(Drury, 2012) .
These scarce resources are known as limiting factors.
We apply the contribution per unit per limiting factor criteria.

Steps
1. Confirm that the decision maker has a single limiting factor by comparing the required resources
and available resources.
2. Determine the contribution per unit of the decision variables.
3. Determine the resource requirement of the limiting factor by each decision variable
4. Compute for the contribution per unit per limiting factor.
5. Rank the decision variables
6. Allocate the scarce resources basing on the ranks.

Illustration
Kasu Ltd deals in the production of Parrot books (R), Kasuku reams (K) and Geometry sets (S)
using three different machines known as the Gladiator (G), the Operator (T) and the Producer
(P). The management accountant has provided the following information regarding the firm’s
performance on a per unit basis to the general manager of Kasu Ltd:
Products R K S
Shs Shs Shs
Selling price 18,000 16,000 12,000
Direct costs
Direct labour 2,000 3,000 4,000
Direct materials 4,000 3,000 2,000

Due to the nature of the season, the estimated sales demand is 200 units for each of the three
products.
The management accountant has also provided the following information on the machine
requirements (hours per unit) for each of the products:
Machine Product
R K S
G 6 1 1
T 9 3 1.5
P 3 1 0.5

The management accountant has further informed you that the machine capacity is limited to
1,600 hours for each machine.

Classified as Internal use only

 Required:
Determine the optimal plan that should be adopted by Kasu Ltd in order to maximize profits.

Solution

Step 1: Confirm the limiting factor (by comparing the available resources and the required
resources)

Machine Type G
Available = 1,600 hrs.
Required

Product R K S Grand Total

Units 200 200 200
Machine hrs. per unit
(hrs.) 6 1 1

Total (hrs.) 1,200 200 200 1,600

Machine Type G is not a limiting factor because the required resources (1,600) are available (1,600)

Machine Type T
Available = 1,600 hrs.

Required
Product R K S Grand Total
Units 200 200 200
Machine hrs. per unit
(hrs.) 9 3 1.5

Total (hrs.) 1,800 600 300 2,700

Machine Type T is a limiting factor because the required hrs. (2,700) are more than the available hrs.
(1,600)

Machine Type P
Available = 1,600 hrs.

Required

10

Classified as Internal use only

 Product R K S Grand Total
Units 200 200 200
Machine hrs. per unit
(hrs.) 3 1 0.5

Total (hrs.) 600 200 100 900

Machine type P is not a limiting factor because the required resources (900) are available (1,600)

Step 2: Determine the contribution per decision variable (contribution per unit)
Contribution per unit = selling price per unit - variable costs per unit.

Product R K S
Shs Shs Shs
Selling price 18,000 16,000 12,000
Variable costs
Direct material (2,000) (3,000) (4,000)
Direct labour (4,000) (3,000) (2,000)
Contribution per unit 12,000 10,000 6,000

Step 3: Determine the machine hrs. required for each product

Machine Type T

Product R K S

Machine hrs. 9 3 1.5

Step 4: Determine the contribution per unit per Machine hr.

Product R K S
Contribution per unit
(Shs) 12,000 10,000 6,000

Machine hours per unit

(hrs.) 9 3 1.5

Contribution per unit

per 1,333.3 3,333.3 4,000
machine hour (Shs per
hr.)
11

Classified as Internal use only

 Step 5: Rank 3rd 2nd 1st

Step 6: Apportion the limited resource (Machine type T)

Product S
1 unit = 1.5hrs
200 units = (200 X 1.5)
1

300 hrs.

Balance = 1,600 - 300

1,300 hrs.

Product K

1 unit = 3 hrs.
200 units = (200 X 3)
1

600 hrs.

Balance = 1,300 - 600

700 hrs.

Product R

1 unit = 9 hrs.
? = 700 hrs.

(1 X 700)
9

77.78 units

Approximate = 77 units not 78 units because we don't have the machine hrs. to produce the last unit.

Kasuku Ltd Should produce 77 unit of Product R, 200 units of product K and 200 units of product S
In order to maximize contribution and in the end profits.

12

Classified as Internal use only

 OUTSOURCING AND MAKE OR BUY DECISIONS

Outsourcing is the process of obtaining goods or services from outside suppliers instead of
producing the same goods or providing the same services within the organization.
Outsourcing is also known as ‘make or buy’ decisions and therefore Decisions on whether to
produce components or provide services within the organization or to acquire them from outside
suppliers (Drury, 2012).

Illustration
PSUL has a policy of providing meals to all staff members at the staff canteen. The standard
cost of a plate of food for each staff comprises of the following costs:
Shs
Inputs (material) 4,000
Labour cost 80% of input cost
Overheads 10% of labour cost
Heaven Foods Limited (HFL) has offered to supply meals to PSUL at a cost of Shs 7,500 per
plate of food.

Required:
Advise PSUL whether it is viable to outsource staff meals

Solution
Decision alternative Make Buy (outsource)
Shs Shs
Inputs (material) 4,000 -
Labour cost (80% x 4,000) 3,200 -
Overheads 10% x 3,200 320 -
Purchases cost - 7,500
Total 7,520 7500

PSUL should outsource staff meals from HFL as it will be able to save Shs 20 per plate of food.

DISCONTINUATION DECISIONS

The decision whether to discontinue operating a department or territory can also be applied to
discontinuing products, services or customers using the same principles.
Organizations occasionally analyze profits by one or more cost objects, such as products or
services, customers and locations (Drury, 2012). Periodic profitability analysis can highlight
unprofitable activities that require a more detailed appraisal to ascertain whether or not they
should be discontinued.

Illustration

13

Classified as Internal use only

 Superior Industries Limited (SIL) is the leading manufacturer of poultry feed concentrates in
Uganda. SIL produces high quality feed concentrates for kroilers, which are packaged in 50 kg
bags. 
SIL’s management is considering shutting down the production line of feed concentrate for
kroilers due to its poor performance. 
Below is the information relating to production and sale of the three products for the year ending
31 December 2019: 
 
Particulars  Kroilers  
Bags 
Output sold (‘000)  1,050 
Unit sales and costs  Shs 
Selling price  185,000 
Direct materials  100,000 
Direct labour  50,000 
Fixed production costs  24,000 
Selling and distribution costs  7,000 
Administrative  5,000 
 
Management accountant further advised that shutting down the production line of feed
concentrate for Kroilers will save 20% of the total annual fixed costs. 
Required: 
Advise SIL’s management, on whether the production line of feed concentrate for Kroilers
should be shutdown.  

Super Industries Ltd

Do not
Shutdown Shutdown
Shs '000' Shs '000'
Revenue (W1) - 194,250,000
variable costs
(105,000,000
Direct material (W2) - )
Direct labour (3) - (52,500,000)

Fixed costs (W4) (28,800,000) (36,000,000)

Net profit / (loss) (28,800,000) 750,000

Workings
W1) Revenue

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Classified as Internal use only

 Revenue = selling price per bag X
No. of bags
1,050,000 bags X
185,000
Shs
194,250,000,000

w2) Direct materials

1,050,000 bags X Shs 100,000

Shs 105,000,000,000

w3) Direct labour

1,050,000 bags X Shs 50,000

= 52,500,000,000

W4) Fixed costs

Fixed production 24,000,000,000
Selling and distribution 7,000,000,000
Administration 5,000,000,000
Total 36,000,000,000

Shutdown = 0.8 X 36,000,000

Shs 28,800,000,000

References

15

Classified as Internal use only

 Arora, M., 2021. Cost Accounting: Principles and practices. 13th Edition ed. India:
Vikas Publishing House Private Limited.
Drury, C., 2012. Management and Cost Accounting. 8 ed. Hampshire: Cengage
Learning.
Drury, C., 2021. Management and Cost Accounting. 11 ed. Hampshire: Cengage
Learning.

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