Strategic Cost Management and Decision Making
Paper 20A tests whether you can convert cost data into a defensible decision rather than a product cost. Expect relevant-costing, limiting-factor, pricing and performance-measurement scenarios.
Decision rules
- Relevant costs are future, incremental and avoidable. Sunk costs and apportioned fixed overhead are excluded.
- Include opportunity cost when a scarce resource is diverted from an alternative use.
- For a single limiting factor, rank products by contribution per unit of the limiting factor, not contribution per unit.
- Make-or-buy compares avoidable in-house cost with the purchase price plus any contribution lost.
- Target cost = competitive selling price − required profit; close the gap through design, value engineering and process improvement.
- Throughput accounting ranks by throughput per bottleneck minute; inventory is not value-added.
Worked example
A machine has 10,000 hours. Product X: contribution ₹60, 2 hours. Product Y: contribution ₹50, 1 hour. Maximum demand: X 3,000 units, Y 6,000 units. Contribution per hour: X ₹30, Y ₹50. Allocate to Y first: 6,000 hours, contribution ₹3,00,000. Remaining 4,000 hours make 2,000 X, contribution ₹1,20,000. Total ₹4,20,000. If X were made first, 6,000 hours would give ₹1,80,000 plus 4,000 Y (₹2,00,000) = ₹3,80,000, so the ranking is worth ₹40,000.
Traps
- Unitising fixed costs and treating the result as avoidable.
- Ignoring the contribution lost when a scarce resource is redeployed.
- Using absorption cost for a special-price decision; the floor is incremental cost plus opportunity cost.
- Treating depreciation as a relevant cash cost unless it creates a tax shield.