Quiz 4: Fundamentals of Cost Analysis for Decision Making

Business

Fixed Costs: Fixed costs remain constant in total amount over a specific range of activity, these do not increase or decrease when the volume of manufacture changes. Fixed cost per unit is inversely proportional to the level of activity. These fixed costs are deducted from the contribution margin to calculate the net operating income. Short run period is the period of 12 months or less. Fixed costs are mostly fixed in the short run. It does not imply that the fixed costs are fixed only in the short run period. These costs can be fixed in the long run period also. Depreciation expense is a fixed cost which is fixed for a short run period as well as long run. Hence, not all the fixed costs are fixed in the short term. There are fixed costs which are fixed over the long run period also.

Sunk costs: A cost that had already been incurred by the organization and irrecoverable in future is called a sunk cost. Sunk cost is different from the future cost that may be incurred by the business, for example decision related to the price of product or purchase of inventory. Differential costs: The differential cost is calculated as the difference between two different decisions and of different level of outputs. The concept is used when there are several possible options to follow and only one option could be selected and others are dropped. Difference between sunk cost and differential cost: Sunk cost is the cost incurred in past and which cannot be changed now. On the other hand, a differential cost is the cost which can be changed according to the decision making. Sunk costs are not considered at the time of business decisions related to future because the sunk cost will be same and will not affect the decision. The differential cost is calculated as the difference between two different decisions and of different level of outputs.

Sunk costs: A cost that had already been incurred by the organization and irrecoverable in future is called a sunk cost. Sunk cost is different from the future cost that may be incurred by the business, for example decision related to the price of product or purchase of inventory. Differential costs: The differential cost is calculated as the difference between two different decisions and of different level of outputs. The concept is used when there are several possible options to follow and only one option could be selected and others are dropped. From the conceptual understanding of differences between sunk cost and differential costs, it can be said that the sunk costs and differential costs will never be same. However, certain amount of differential costs can be determined using the sunk costs. Most of the contracts depend on sunk costs. The decision making will have contractual implications due to the plan changes.