Well, as promised, below are the answers for relevant and irrelevant cost…
Solution – Relevant and irrelevant costs
We have two alternatives: (a) dental care division is sold off and (b) dental care division continues to operate. Identifying relevant costs and irrelevant costs is easy when we see if a cost changes between two alternatives or not. If it changes it is relevant, if it doesn’t it is irrelevant.
- CEO’s salary is irrelevant because it shall remain the same whether the dental care division exists or it is disposed off.
- Salaries of employees who can be laid off is relevant because the cost shall continue to be incurred if the division exists but it shall be reduced to zero if the division is disposed off.
- Salaries of employees who can’t be laid-off is irrelevant because it shall continue to be incurred regardless of whether the division is disposed off or not.
- One-time retirement benefits cost is relevant because it shall be incurred only if the division is disposed off. If the division continues to operate, the cost shall continue to be incurred.
- Cost of raw materials is relevant cost because it shall be zero if the division no longer operates because then there will be no production.
- Annual directors fee is irrelevant cost because it shall stay the same even if dental care is disposed off.
- Interest paid on dental care division loans is relevant because if the division is sold off the loan could be paid off which shall cease the interest cost.
- Salary of the dental care chief operating officer is relevant because he will most likely lose his job. If he is accommodated in another division, this cost shall be irrelevant.
- Company-wide quality certification fee is irrelevant because it shall continue to be incurred even if dental care division is no longer there.
- License fee paid for manufacturing dental care products is a relevant cost because it shall cease with disposal of the division.
- Head office rent is irrelevant because it shall remain the same regardless of the number of divisions. If a division is sold-off, head-office will still exist and the office rent shall be incurred.
- Audit fee is irrelevant if it does not depend on the number of divisions. Audit shall be conducted even if there is one division less.
Solution – Controllable and Uncontrollable Costs
The controllable costs are: direct materials, direct labor, indirect materials, and indirect labor (supervision). Depreciation, insurance, allocated repairs and maintenance, and allocated rent and utilities expense are not under the influence of the production manager. Under responsibility accounting, managers are evaluated based on costs that they can control. Hence, uncontrollable costs are ignored in evaluating managers.