Relevant Costs in Short-Term Decision Making Your friend is also in this same cl
ID: 2530510 • Letter: R
Question
Relevant Costs in Short-Term Decision Making
Your friend is also in this same class. He says, “The topic on relevant costs is easy……..all you have to know is that variable costs are always relevant, and fixed costs are always irrelevant.”
REQUIRED:
Is his statement about variable costs correct? (Answer Yes or No)
Is his statement about fixed costs correct? (Answer Yes or No)
Provide one example to support your answer concerning variable costs in #1
Provide one example to support your answer concerning fixed costs in #2.
Explanation / Answer
Answer 1 : Yes. All variable costs are relevant.
Variable costs are those costs which vary with the level of production and occurs if the production/ such other activity happens. So if the activity is done, cost will get incurred. If activity is not done, cost will not get incurred.
Hence, such costs are relevant.
Answer 2 : No. All Fixed costs are not irrelevant.
Fixed costs are those costs which do not depend on production activities instead relate to costs incurred for creating infrastructure and other facilities which will aid production. Whether or not production activity is carried out, these expenses will get incurred. However, in some cases, these expenses can be done away with if the production activity is planned to be discontinued. In that case, these fixed costs become relevant.
Answer 3: Direct Material Cost
Direct material will be purchased and cost will be incurred only if production is done. If there is no production requirement, such purchases will not be made.
Answer 4 : Rent of factory building
Rent of factory building where production is done is a fixed cost. Whether actual output is produced or not, rent is required to be paid. However, in case the company plant to discontinue the production and instead plan to buy it from outside supplier, in that case this rent can be avoided and hence becomes relevant.