Relevant costing is a key part of the PM syllabus. It is a topic that students tend to struggle with initially, Jo Tuffill is here to help you avoid that fate.
Last year was the year I celebrated a major milestone birthday, and I had booked a trip of a lifetime to an amazing country. It was supposed to be my ‘passage to India’! Sadly, cancelled events and trips were a common feature of 2020. So being a true management accounting geek I decided to concentrate on the financial positives instead.
In ‘relevant costing terms’ you only focus on what is Future, Incremental and Cash (FIC). So the cancelled trip to India is a great example to demonstrate this concept. All flights, hotel deposits and agents’ commission are past and sunk, and therefore not relevant. So what is relevant are the avoidable costs from not going, such as the incremental cost of restaurant meals, trips and accommodation, plus of course the opportunity benefits of my extra hours working instead. The numbers don’t lie. Just a small point though – it wasn’t my decision!
Now you have the concept, let’s turn to how it is examined in the ACCA Performance Management exam. Exam questions tend to focus on whether to go ahead with manufacturing a new product or providing a new service or setting a minimum price for a special contract. Let’s look at a special contract question.
Spice up your life
Spice Tours, a travel company that specialises in group trips to India, has been asked by a corporate client to price up a special contract.
The contract is to organise a ‘Passage to India’ for the winners of the employees of the year award. The highlight will be a sunrise visit to the
Taj Mahal. Spice Tours regularly runs trips to different regions of India, but mainly operates trips to the Rajasthan region out of an office in New Delhi. In the table I have listed the potential costs and how they should be considered in pricing up the group trip to come up with a minimum contract price.
Remember – the key is to cost up what is Future, Incremental and Cash (FIC).
In summary, the principle is that a cost will be relevant if there is a change in cash flow that is caused by the decision. Here we have found a minimum contract price. Now Spice Tours will add a profit mark-up to the price and submit the quote to the corporate client.
Note that exam questions will require you to state all assumptions and reasons in justifying the relevant cost and will also ask about nonfinancial factors which are difficult to quantify.
For instance Spice Tours might be willing to offer this at a minimum price to get the ‘free promotional value’ of running a trip for prize winners who will inevitably publish their adventures on social media.
Above all, it is very important to relate answers to the scenario in the question as marks are awarded for application and implication.
Congratulations, you are now ready to pass that ‘relevant costing’ question!
• Jo Tuffill is the ACCA PM Tutor with FME Learn Online