Relevant costing is not a list of costs to memorise. It is a way of thinking about a decision: what future cash flows will change if this option is chosen?
That question sounds simple, but ACCA Performance Management (PM) scenarios deliberately mix useful information with sunk costs, accounting allocations, book values and other figures that do not change. Strong answers identify the relevant amount and explain why every material item is included or excluded.
Current PM scope: the September 2026 to June 2027 syllabus requires the concept and calculation of relevant costs, opportunity costs, make-or-buy and outsourcing decisions, shutdown decisions, one-off contracts, further processing of joint products and single limiting-factor decisions in a make-or-buy context.
1. The three tests of a relevant cost
A cost is relevant only when it passes all three tests:
Future: it has not already been incurred or irrevocably committed.
Cash: it represents a cash flow, not an accounting entry such as depreciation.
Different: the cash flow changes between the alternatives because of the decision.
Opportunity costs are included even though they may not appear in the accounting records. Choosing one option can sacrifice a contribution, sale proceeds or another benefit; that lost benefit is part of the economic cost of the chosen option.
2. Common items and their normal treatment
Item | Normal relevant-cost treatment | Reason |
|---|---|---|
Sunk cost | Exclude | It has already been incurred and cannot be changed by the decision. |
Committed cost | Exclude if unavoidable | Although it may be paid in the future, an existing commitment means the decision cannot avoid it. |
Depreciation or book value | Exclude | These are accounting measures, not future cash flows. Disposal proceeds or tax effects may be relevant if supplied. |
Allocated general overhead | Exclude if unchanged | Re-apportioning an existing total does not change cash. |
Incremental fixed cost | Include | It is caused by the decision—for example, rent of extra premises or a project-specific salary. |
Avoidable fixed cost | Include as a saving when avoided | The decision changes the organisation’s total cash outflow. |
Opportunity cost | Include | It is the benefit from the best alternative use that will be sacrificed. |
Working capital or financing cost | Include only when the scenario makes it incremental | A decision-specific cash requirement may change financing cash flows; a general allocation does not. |
These are starting points, not automatic rules. “Fixed” does not mean irrelevant, and “variable” does not guarantee relevance. Ask whether the total cash flow changes.
3. Relevant cost of materials
Materials questions become much easier if you identify what would happen to the material if the project were rejected.
Situation | Relevant amount |
|---|---|
No inventory: material must be purchased | Current purchase price, including any incremental delivery or discount effect |
Inventory is regularly used | Current replacement cost, because using it accelerates replacement |
Inventory is not used but can be sold | Net disposal proceeds forgone |
Inventory has no use and no disposal value | Zero; the historical purchase cost is sunk |
Inventory could be adapted for another purpose | The greater relevant benefit sacrificed, including conversion effects where appropriate |
Example: a contract needs 1,000 kg. Six hundred kilograms are in inventory, have no other operational use and could be sold for $4 per kg. The remaining 400 kg must be bought for $7 per kg.
Relevant material cost = (600 × $4) + (400 × $7) = $5,200.
The old inventory purchase price is irrelevant. The first 600 kg cost $2,400 because that is the cash inflow sacrificed; the balance costs its current purchase price.
4. Relevant cost of labour
Labour situation | Relevant amount |
|---|---|
New employees or paid overtime are required | Incremental wage and related cash costs |
Existing employees are paid anyway and have genuine idle time | Usually zero for the idle hours |
Employees are diverted and the displaced work is subcontracted | Incremental subcontract cost |
Employees are diverted from another product | Cash labour cost that continues plus contribution forgone where the labour cost was included in that contribution |
Double-counting trap: establish exactly how “contribution” was calculated. If the displaced product’s contribution already deducts labour but the labour cash cost will still be paid after redeployment, the continuing labour cost must also be recognised. Follow the cash flows rather than applying a memorised phrase.
5. Worked special-order decision
A one-off order uses the material facts above. It also needs 600 labour hours. Two hundred paid idle hours are available; the remaining 400 hours require overtime at $18 per hour. The following other information applies:
a supervisor’s $4,000 salary will be paid anyway, but a $1,500 project bonus will be paid;
$2,000 of general overhead is an unchanged allocation and $900 is incremental power;
$1,200 depreciation is charged to the order and $600 extra maintenance will be paid; and
using the machine sacrifices $1,200 contribution from another order.
Item | Relevant cost ($) | Reason |
|---|---|---|
Materials | 5,200 | Disposal proceeds forgone plus current purchase cost |
Labour | 7,200 | 200 idle hours cost zero; 400 overtime hours × $18 |
Supervisor salary | – | Unchanged and already payable |
Supervisor bonus | 1,500 | Incremental cash payment |
General overhead allocation | – | No change to total cash overhead |
Incremental power | 900 | Caused by the order |
Depreciation | – | Not a cash flow |
Extra maintenance | 600 | Incremental cash payment |
Contribution forgone | 1,200 | Opportunity cost |
Minimum relevant-cost price | 16,600 | Before strategic, risk and capacity considerations |
Accepting a price above $16,600 increases short-term profit on these facts. That does not automatically make it a good commercial price: management should also consider capacity, customer expectations, quality, risk, precedent and whether a low one-off price could damage the normal market.
6. Try the special order in the spreadsheet
The accounting schedule is locked. Enter the relevant amounts in the yellow cells, then calculate the total minimum price. Select Show answer to compare your treatment and use the notes column to explain each inclusion or exclusion.
| Special-order item | Accountant schedule | Relevant amount | Decision note |
| Enter only the cash flow changed by accepting the order | |||
| Materials | 5,400 | Inventory sale proceeds forgone + new purchases | |
| Labour | 9,000 | Idle hours are already paid; overtime is incremental | |
| Supervisor salary | 4,000 | Paid whether or not the order is accepted | |
| Supervisor bonus | 1,500 | Paid only if the order is accepted | |
| General overhead allocation | 2,000 | Existing total is unchanged | |
| Incremental power | 900 | Caused by the order | |
| Machine depreciation | 1,200 | Accounting entry, not a cash flow | |
| Extra maintenance | 600 | Caused by the order | |
| Contribution forgone | 0 | Best alternative use of machine time | |
| Total relevant cost | Sum the changed cash flows and opportunity cost | ||
| Minimum relevant-cost price | Before strategic and risk considerations |
7. Make or buy
With spare capacity, compare the supplier’s price with the avoidable cost of making internally. Unavoidable fixed costs remain whichever option is chosen and should be excluded.
Relevant cost to make = incremental production costs + opportunity cost + avoidable fixed costs caused by making
Relevant cost to buy = purchase price + incremental buying/inspection/logistics costs − cash savings from buying
Suppose making a component costs $18 per unit plus $24,000 of avoidable fixed cost, while an external supplier charges $24 per unit:
$24,000 + $18Q = $24Q, so the crossover volume is 4,000 units. Below 4,000, buying is cheaper; above 4,000, making is cheaper—assuming capacity has no better use.
The graph shows both relevant-cost lines, their crossover and the cheaper region on either side. Use the required-volume input to test the recommendation at a specific demand level.
Interactive make-or-buy lab
Change the avoidable fixed cost, two unit costs and required volume. The crossover point and the lower-cost regions recalculate immediately.
Three quick experiments: remove the avoidable fixed cost, reduce the supplier price, then increase demand beyond the crossover. Explain the recommendation before looking at the shaded region.
Cost is only part of the recommendation. Discuss supplier reliability, quality, confidentiality, ethical sourcing, staff effects, contract flexibility, loss of internal capability and dependency risk.
8. Make or buy when a resource is scarce
If demand must be met but internal capacity cannot make everything, calculate the saving from making rather than buying for each product:
Saving per unit = buy-in price − relevant variable cost to make
Saving per unit of scarce resource = saving per unit ÷ scarce resource used per unit
Prioritise internal production by the greatest saving per scarce-resource unit. Use the available resource in that order, then buy the balance. This is the make-or-buy version of a single limiting-factor decision.
9. Shutdown decisions
A loss-making product or branch should not automatically close. The accounting loss may contain unavoidable fixed costs that will remain after closure.
Financial effect of shutdown = contribution lost − avoidable fixed costs saved − other benefits from released resources
If a division earns contribution of $15,000 and only $5,000 of its fixed costs can be avoided, closing it reduces profit by $10,000. If the released resources can earn $14,000 contribution elsewhere, replacement improves profit by $4,000 after allowing for the lost $15,000 and saved $5,000.
Also consider closure penalties, redundancy, customer relationships, strategic products, future recovery and whether temporary closure changes maintenance or restart costs.
10. Further processing of joint products
Joint costs incurred before the split-off point are sunk for the decision whether to sell now or process further. Compare only the extra revenue with the extra processing and selling costs:
Process further when incremental revenue > incremental processing cost
Do not allocate joint cost to the product and use that allocation in the decision. It was incurred to reach the split-off point whichever post-split option is chosen.
11. A reliable PM exam method
State the decision: identify the alternatives and the time horizon.
Use the future-cash-flow test: for every item, ask what changes.
Find the alternative use: identify sale proceeds, replacement, subcontracting or contribution forgone.
Build an incremental table: show relevant amounts only, with clear labels and signs.
Explain exclusions as well as inclusions: “fixed” or “sunk” alone is rarely enough; connect the fact to the cash flow.
Calculate the net benefit: compare alternatives consistently.
Discuss non-financial factors: apply them to the scenario rather than producing a generic list.
Recommend: state which option is preferred and the conditions that could change that conclusion.
Examiner-report lesson: students often identify the right numbers but lose explanation marks. Explain why both included and excluded items are treated as they are; do not use financial-accounting inventory values, include general overhead allocations, or assume spare labour has a cash cost merely because a wage rate appears in the scenario.
12. Continue studying PM
In a nutshell: ignore the label on the cost and follow the decision’s cash flows. Include what changes, add the best benefit sacrificed, explain your reasoning and then apply commercial judgement.