Making a Decision: The Irrelevant Costs in Production

What are the irrelevant costs in the decision?

Select one:

$100,000

$50,000

$70,000

$80,000

Answer:

The irrelevant costs in the decision of making or buying the component are the costs that will remain the same regardless of the decision made. In this case, the fixed manufacturing costs that would be reduced by 80% if production is discontinued are irrelevant to the decision. Therefore, the irrelevant costs in this decision are $80,000.

When a company like Sanders Pty Ltd is faced with the decision of whether to make or buy a component used in production, it is crucial to distinguish between relevant and irrelevant costs. In this scenario, the irrelevant costs refer to those costs that do not change based on the decision made.

The reduction in fixed manufacturing costs by 80% if the production is discontinued is not directly related to the choice between making or buying the component. These costs remain unchanged regardless of the decision and hence are considered irrelevant in the decision-making process.

On the other hand, relevant costs include the expenses associated with producing the components internally such as direct labor, direct materials, and variable manufacturing overhead. By comparing these relevant costs with the costs of purchasing the components externally, Sanders Pty Ltd can determine the most cost-effective option.

By focusing on the relevant costs and disregarding the irrelevant fixed manufacturing costs, the company can make an informed decision that maximizes efficiency and profitability. Understanding the distinction between relevant and irrelevant costs is essential for effective financial planning and decision-making in business.