Managerial Accounting –Decision Making: Relevant Costs & Benefits

When you have a choice between two or more alternatives and you have to select one, you are making a decision. If there is no choice, you will have to simply follow or obey. So a decision implies a selection, a choice, a verdict or a nod.

In everyday life, decisions are made. A personal decision affects an individual but organizational decisions cause a change, good or bad, to a lot many people known as stakeholders. So decision making in an organization must be systematic and not off the cuff. A good executive must be good at decision making.


A formal definition of decision making by is given below:

Decision making can be regarded as an outcome of mental processes leading to the selection of a course of action among several alternatives. Every decision making process produces a final choice. The output can be an action or an opinion of choice.

It may be noted that every decision involves a certain degree of risk. Very few decisions are made with absolute certainty. So a good decision would be to choose a solution with the highest probability of success and in accordance with the goals, desires, lifestyle and values etc.


Relevant means linked or concerned. If an event has nothing to do with a situation, it is not relevant. Marble processing units at Karachi may suffer because of unrest in a far-off area like Swat. It would be relevant as Swat supplies marble rocks. But turmoil in Hyderabad, a town much near to Karachi than Swat, would be irrelevant for the marble units.

Any decision must be evaluated under cost-benefit criteria. The benefits must be more than the cost except in social projects where benefits may be equal to cost. Benefits can be in the form of cash return, perks, advantages, customer’s satisfaction or reputation of a company. While cost means value, worth or sacrifice made.

Only relevant cost should be considered. CIMA defines relevant costs as: ‘the costs appropriate to a specific management decision’ A study of relevant costs and benefits helps make better decision?

Six steps in decision making process and MA role

  1. Clarify the decision problem. One must be clear about the problem. One must look for the root cause or hidden problem rather than the apparent problem. Some skill is required to define a problem in such terms that can be addressed effectively.
  2. Specify the criteria. After clarifying a problem, criteria must be specified for decision-making. What is the objective: maximize profit, increase market share or social service.
  3. Identify alternatives. Explore all alternatives, their pros and cons. This is a critical step in the decision making process.
  4. Develop a decision model. This is a simplified version of the problem. No irrelevant information, only factors relevant to the problem are highlighted. It brings together all elements of a problem like the criteria, the constraints, and the alternative.
  5. Collect the data. Relevant data must be collected to incorporate objectivity in the process. It may be primary data or secondary data. But it must be up-to-date, timely and accurate.
  6. Select an alternative. One all formalities are completed, requisite information obtained and processed, a most suitable or appropriate choice should be selected.

Qualitative and Quantitative Analysis

Management Accountant mostly deal with financial data. But they also maintain records of physical units produced and quantities of raw material consumed, labor hours used. In addition, they asses qualitative factors such as employee morale, customers satisfaction, image of the company in the eyes of the public.

Role of Management Accountant

A management accountant is a member of cross functional team and, having unrestricted access to MIS, makes a contribution by providing facts and figure which bring objectivity to the report.

Besides, a management accountant would ensure that the information must be relevant (pertinent to the decision problem); accurate (precise); and timely (arrive in time for the decision to be made). Companies will occasionally trade-off accuracy for timeliness.

Relevant Costs

In order to qualify for relevancy, a cost must meet two criteria: (i) They affect the future and (ii) they differ among alternatives.

Normally, the following are relevant Costs:


  • A differential cost is the difference in cost items under two or more decision alternatives specifically two different projects or situations. Where same item with the same amount appears in all alternatives, it is irrelevant. For example, a plot of land can be used for a shopping mall or entertainment park. The plot is irrelevant since it would be used in both the cases. Similarly, future costs and benefits that are identical across all decision alternatives are not relevant.
  • An example of differential cost would be of a company which is selling its products through distributors. It is paying them a commission of Rs.16 million. Any alternate which costs lesser would be considered. Let us suppose that the company is planning to appoint salespersons to sell its products and cancels the contracts with distributors. In this case, the selling expense is expected to be to Rs.12 million. There is cost differential Rs.4 million (Rs.16 m - 12m). This a good sign but the risk would have to considered for changing the channel of distribution. If there is low risk, it would be prudent to go for own arrangements for sales.
  • Differential costs must be compared to differential revenues. In case, switching over to direct sales bring additional revenues of Rs.2 million, it would increase the net benefit to Rs.6 million. This would provide more comfort to the decision maker while considering a change in the distribution channel.


  • Whereas differential cost is a difference between the cost of two independent alternatives, incremental or marginal cost is a cost associated with producing an additional unit. In case of a university, it could be cost of admitting another student. Even operating a second shift is an example of incremental cost. It would be noted that the two decisions are not independent as second shift depends upon first shift.
  • Increamental cost must be compared with incremental revenues to arrive at a decision.


  • It is cost of opportunity foregone. Mr. Ahmed Shah left a bank job which was paying him Rs.15,000 per month and got admission in a University. Monthly fee-charge in the university is Rs.10,000 per month. For Ahmed Shah, this would be Rs.25,000 per month (Rs.10,000 + Rs,15,000).
  • Farhana is a fresh graduate from a business university. She got two offers, one of Rs.25,000 from an investment bank and another of Rs.15,000 for a teaching-assistant in a university. Another of her class-fellow, Shabana got the same offer from the same university. While Shabana would be happy to join the university, Faraha would not be as she would lose an opportunity to serve at the bank for Rs.25,000.
  • Whenever an organization is deciding to go for a particular project, it should not ignore opportunities for other projects. It should consider (i) what alternative opportunities are there? (2) Which is the best of these alternative opportunities?


Sunk costs are past costs. These cannot be changed with any future decision. Suppose, a piece of land has already been purchased by a company for a sum of Rs.30 million. Also suppose, the company is consider covering it with a wall which would cost Rupees two million. While the sum of Rs.30 million is a sunk cost, the other of Rs.2 million is a future cost or out of pocket expenses. It is relevant to decision: whether to erect a wall now or postpone it for the next month, whether it should be two-meter or three-meter high. Whether a wall is erected or not and, if erected, whether it is 2 or 3 meter, the sum of Rs.30 million for land would remain the same. It is a sunk cost and therefore irrelevant to the decision.

Similarly, a cost which is identical in all decisions is irrelevant.

Special Decisions

There are special decisions where relevant costs and benefits are to identified before proceeding further. Such decisions are:

  • Accept or reject an order when there is excess capacity
  • Accepting or reject an other when there is no excess capacity
  • Outsource a product or service
  • Add, drop a product, service or department
  • Sell or process further
  • Optimization of limited resources or working under constraint.


Management Accounting picks up data from cost database and prepare reports for the management to facilitate decision making. Both financial and non-financial data are used in the reports. In the non-financial data, both numerical and non-numerical information are used.

While numerical information consist of operational statistics such as units produced, raw materials considered and labor hours used, the non-numerical or qualitative information pertain to customers satisfaction, employees moral, access to markets and image of an organization.

For a particular decision, different types of cost and benefits are considered. Called relevant costs, these have a bearing on the future and differ under various decision alternatives. If any of these qualification is absent, it would be an irrelevant cost.

Since most decision are under uncertainty, some other techniques are used to given an insight in the problem such as best- worst case scenario, sensitivity analysis and simulation.

Though technology has made a lot of advancement in manufacture, concepts like cost : benefit analysis are still valid and useful. They have been made more strong and convincing with the introduction of ABC, ABM and EVA.

More by this Author

Comments 109 comments

Rufi Shahzada profile image

Rufi Shahzada 7 years ago from Karachi

Dear Sir,

Decision making is explained so well, SIX STEPS in DM are very much clarified to me. The examples you used in IRRELEVANT COSTS, OPPORTUNITY COST and DIFFERENTIAL COST were awesome, you have made it so simple.

Thanks a Million!

Rufi Shahzada

hafeezrm profile image

hafeezrm 7 years ago from Pakistan Author

Thanks Rufi Shahzada for your comments.

Sana Rao 7 years ago


Thank you Sir,v are still getting knowldge from ur hub page,it is best oppurtunity for us.The article is informative.Take care

hafeezrm profile image

hafeezrm 7 years ago from Pakistan Author

Thanks Sana Rao.


TEERATHMAHESHWARI 7 years ago from karachi

thankyou sir

your above article about different type cost clear my concept and hope help me to clear my test of MTO in National Bank Of Pakistan , in ehich mostly question was relating to managerial costing , target costing and types of costing.

hafeezrm profile image

hafeezrm 7 years ago from Pakistan Author


mercon profile image

mercon 7 years ago

hhmm... i like your article sir.. :)

tarek 7 years ago

thank you very much sir

mkunda 7 years ago

The article helps me a lot big up

Accounting firm 7 years ago

More good informations thanks for helping me out. Always a pleasure to see information that is useful, thanks again

varman 6 years ago

10Q 4 information.....

Emmanuel Eze 6 years ago

A great treatise that has helped me in my accounting(elect)course indeed.Keep up the good work.Thanks Sana!!!

Marion Masango 6 years ago

Great work thanks for the information!

Samandari 6 years ago

Clear explanations with comprehensible examples. Less Jargon. Good approach

Sarah 6 years ago

This really cleared up some questions I was having and helped me a great deal. Thanks!

ann 6 years ago

I truly love this page it gives very important information and answers to question please keep up the good work

Amin Shaikh 6 years ago

Assalam Allaikoom,

I am preparing project for my college and its really helped us thanks for your support.

osama kettaneh 5 years ago

hi for all

i wanna to add something,the base in decision making is(CM&NOI)



thanks for all


Good and simplified

Que 5 years ago

Sir , could help me please , what is example of relevant cost actually ?

lynpearlph 5 years ago

It's a very nice article on my review in CPA board exam. it help me a lot in understanding relevant costs. thanx a lot. More power!!!

shashike 5 years ago

Dear sir

can you tall me is management Accountant and General manager both are same

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

As the title imply, one is dealing with financial

accounting while the other with cost accounting. So these two are different positions. But there is no hard & fast rule, titles may differ for the same position.

Nardose 5 years ago

I am pleasant for your writing

sindhu 5 years ago

dear sir

can u tell me production cost and irs method

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thanks @Nordose for your comments.

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Production costs are computed using a number of techniques such as traditional costing, ABC and ABC-EVA.

share market tips 5 years ago

I absolutely adore reading your blog posts, the variety of writing is smashing.

This blog as usual was educational, I have had to bookmark your site and subscribe to your feed in i feed.

Your theme looks lovely.Thanks for sharing.

Share Market Tips

tania 5 years ago

your article is so much knowledgeable. So thank u so much sir

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thanks share market tips for your comments.

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thanks Tania for your comments.

Marie Andrée 5 years ago

Thank you sir for your articles! but I want to know what is meant by the terms relevant and irrelevant costs in decision-making?

2. Can you identify relevant costs for decision-making and their characteristics

3. Help me to identify and to explain short-run decisions. Thank so much

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thanks Marie Andree for your comments.

Relevant means 'appropriate' or 'suitable' to a particular decision. Suppose you have a piece of land. You are now thinking whether to make a hospital or a university. The cost of land is irrelevant to this decision. Whether you make a hospital or university, the same land will be used in both the cases. But if you are thinking of swapping this land with some other piece of land, the cost of land would be relevant.

Short term decisions are small and routine decisions or administrative decisions or operational decisions. As against this, there are long term decisions or strategic decision. Both have different time horizons.

chandru 5 years ago

thank you sir for the inormation and also i want the difference b/w Relevent cost and Differential cost..

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Relevant cost has been explained above.

Differential cost is the differece between costs of two alternate opportunities. Suppose, you have a plot of land and are now considering whether to put up a textile unit or an edible unit. The cost of land is irrelevant to this decision, it is the differential cost that matter. Suppose the textile unit takes up Rs.500 million whereas the edible oil can be setup with 150 million. The differential cost would be 500 - 150 = 350. It would be relevant cost for this decision.

xuanniecxian 5 years ago to answer "explain the main priciples used to differentiate between relevant and irrelevant costs for investment appraisal".thank you.

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thank you @xuanniecxian for going through my article.

As explained, relevant and irrelevant costs depend on the situation. If it is a simple investment, cost of funds or opportunity cost would be relevant. If any charges are to be paid after buying the investment, these charges would be relevant. Irrelevant would be prepaid insurance or other costs which have already been incurred to bring the investment for sale such as improvement ( in case of house, it could be painting, floor cleaning, replacement of broken items.)

Macmorrison 5 years ago

It came at the appropriate time for it. The topic was well researched and the criterias were of clarity and simplified. Thank u Sir. But, could u please Sir, assist me on a problem in marketing field?

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thanks @Macmorrison for your comments. I have written some articles on Methods of Business Research which includes Market Research. You may start with

naima 5 years ago

thans a lot

hafeezrm profile image

hafeezrm 5 years ago from Pakistan Author

Thanks Naima for reading my article.

manish 4 years ago

well thank you very much sir for this concept as it helped me for my exam to understand easily all the concepts,thank you

Manoj Kumar Srivastav 4 years ago

Thank A lot for your paper DM 6 points. I impress very much i am a chartered account located in Nepal.

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Manoj Kumar Srivastav for your comments. Your country is beautiful. I have been there enjoying places like Kathmandu, fish-tail mountain, Chitwan Park and many other places.

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Manish for your comments.

MUH 4 years ago

Hello My name is Mohammed and I am promising research on the role of the accountant in administrative costs in order to rationalize the decision-makincosts in order to rationalize the decision-making in industrial companies and suffer from the problem of the lack of references and research related p

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks MUH for your message.

Chukwuemeka Victor 4 years ago

Sir, tank u so much 4 dis wonderful article, u ar simply Great. All grease 2 ur elbow. Sir am a marketin student in fidei poly, i need ur counselin and professional advices concernin my course of study.

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Chukwuemeka Victor for your comments.

Obinna Christian 4 years ago

Am an Accounting student, please, what are the objectives and importants of cost Accounting to managerial decision?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

@Obinna Christian,

Consider cost accounting as database or MIS. It helps generate data for business decisions such as which product to promote, which one to drop. Besides information provided is used in managerial evaluation by comparing projected performance with actual ones ultimately leading to promotions and demotions.

Please ask any specific question.

Richie ehimare .o. 4 years ago

Tank u very mush sir it gud 2 av people like u. I wish 2 b like u. Sire wat are the derivation of cost accounting and the code of cost accounting?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

@Richie Ehimare .o.

I am not aware of the derivation of cost accounting. However, my comments on code of cost accounting are as follows.

In cost accounting, one has to deal with Direct Costs (Direct Material and Direct Labor) and Manufacturing Overhead. The latter is called a common cost and has to be shared by various products or process. It poses a problem of allocation or assignment. With the help of cost code for each expense, using alphabetic or numerical method, this allocation is facilitated.

jyoti narvekar 4 years ago

U have written a great article

Could you just help me out in answering how does process costing helps management in decision making?

could u just answer me in detail sir.

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Process costing is suitable for industries engaged in mass production of near identical products.

Please go to the given and find answer to your question:

linda 4 years ago

thank u sir, your article helps me a lot.

Ukoh Blessing 4 years ago

Thank u sir, your article was a great insight. Please sir can you discuss something on:

cost accounting as a guide to futuristic decision

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Cost Accounting in fact is a data base. This is used to compute reports based on actual cost of product or a process or a department. Side by side, standard cost for each product or process or department is computed. This is compared with actual to find out variances which may be due to internal or external factors.

This being the background, it would help the business in its future decisions: what products to promote, what to delete, which manager to reward, which to penalize, which branch to close, which to upgrade.

There are endless decisions based on (i) cost accounting, (ii) company's conditions, (iii) industrial environments and (iv) vision.

Shannon 4 years ago

Thank you for your help!

John Ouko Otok 4 years ago

The information provided in this section concerning about Relevant cost revenue and decision making is quite informative and relevant to the data being provided in most Universities. The only issue at hand is that there is no information concerning the major methods used when an individual(s) wants to carry out an effective decision regarding the best alternative that might eventually assist in the attainment of the major objectives of an Organization. I loved the article though. Cheers

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Shannon and John Ouko Otok for your comments.

muddasir Aliyu 4 years ago

thank so much sir may continue help you

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Muddasir Aliya for your comments.

miss yuka 4 years ago


may i know the ways in which a management accountant might contribute to a formal decision making process?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Briefly speaking, management accountant is a part of management which is involved in decision-making. As a management accountant has access to all accounting and cost information, both financial and non-financial (Quantitative production & sales), he or she can provide background information necessary for decision-making.

Blessing 4 years ago

Pls i want 2 be part of u

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

@Blessing, thanks for your comments. God bless you.

imran 4 years ago

salam... sir ap bohat mushkil topic ko bhi asan words mai bata daty hain thanks... ap ki waja sy bohat help milti hai q k mai self study kar raha hon.... once again thanks a lot. plz aisay he apny students ko guide karty rahye ga. allah pak apko is ka ajar day ameen. imran

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Imran.

Renaissance 4 years ago

That was wow! now as i sit for ma exams nothing to fail

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Renaissance for your comments.

vera 4 years ago

may i ask, how to know whether a product need to continue or discontinued to produce based on standard costing and relevant costing? Is that we need to compare the actual and forecast result?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author


Cost accounting tries to find out true cost of a product. If a product is loss-making, it evident from product-wise profit and loss account. If there is no hope of improvement, it should be discontinued. Of course sometimes, a project appears loss-making due to wrong costing. ABC and EVA are refined methods to arrive at true cost of a product.

Joy lucky 4 years ago

Thanks Sir.u hv really helped me.pls sir,can u tell me in details The threats to the relevant management accounting and how they can be integrated.thanks

roxy 4 years ago

article helped a lot. thanks XD

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thaks Joy Lucky and Roxy for your comments.

roxy 4 years ago

sir, do you have any detailed article on the special decisions part?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Thanks Roxy for reading my article. You may go through this link for further knowledge:

Aliyu 4 years ago

Kindly provide me materials that concern solving questions under certainty,uncertainty,risk,relevant cost ,etc

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

I am on my annual safari. Please consult a book on managerial accounting.

dharmmelorlah 4 years ago

I will say a one thousand and one thank to this site for solving my question for me, is it for my assignment in class, question from lecturers and frd and most especially on my project.


lizore 4 years ago

nice article! clear & well understandable

shwetha 4 years ago

Dear sir

thank you very much add some more information in this regard.

Habib 4 years ago

Sir Pls anser the Q

A company has revalued its non-current assets during the most recent accounting period. How will this affect the calculation of return on Capital Employed (ROCE) ?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

ROCE will down. But some other related ratios would improve giving a good impression on the company;s image. Such ratios are: fixed assets cover, fixed assets to total assets and solvency)

Suhel 4 years ago

Dear Sir,

Could you please help me to get the answer of below question.

"Define the importance of accounting as a tool of managerial decision-making. How is management accounting different from financial accounting?

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Definition is given in the hub. Financial accounting is in aggregates say sales during 2011. A decision to drop a product for poor sales or to encourage a product for showing good result cannot be made unless one knows contribution of each product in total sales for the past 2 or 3 years. This contribution is given Cost Accounting and a decision is taken by Management Accounting.

Suhel 4 years ago

Dear Sir,

Thanks a lot.


jasnta 4 years ago

Could you please help me to get the answer of below question

'' does qualitative analysis matter in managerial decision?''

hafeezrm profile image

hafeezrm 4 years ago from Pakistan Author

Of course, it matters. Many aspects are difficult to quantify and hence qualitative terms are used like reputation, goodwill, quality of employees, customers dedication, suitability of location and thousand others.

vipul 3 years ago


what is the meaning and difference between insource and outsourcing decision in Management Accountancy Decision making

hafeezrm profile image

hafeezrm 3 years ago from Pakistan Author

In-source and out-source are two opposite terms. In-source mean using own facilities for some out-side jobs. For example, a bank has a large IT Division and feels the IT equipment and staff is not being fully utilized. There are many options such as (i) staff reduction or (ii) in-sourcing which means getting outside jobs to do in house. When there is an idle capacity, in-sourcing is recommended.

Silas 3 years ago


I want you to throw more light on liner programming & decision tree in management accounting.

Krystian 3 years ago

Could You recommend me simply but reliable literature about relevant cost? I write in Poland thesis about relevant cost in decison-making. Thanks for your help.

hafeezrm profile image

hafeezrm 3 years ago from Pakistan Author

Please surf the Internet. There are lot many information.

Mr MW Mapaya 3 years ago

I respect your Capacity in Cost and Management respective, i can proudly declare that am future accountant, it’s in deed fair for cost manager to focus on qualitative and quantitative characteristics, which will boost the company's sustainability in long run. Keep up with good work of boosting organization to succeed

imty from int islamic university 3 years ago


can i have exercise solution"s web site id..


aaa 3 years ago

This is full of water when anyone start to drink shows how depth it has

thanks for this effort to us

summan azam 3 years ago

give some references of articles that are related to relevant costing application in manufacturing conerns.impacts of relevant costing principles

@NanaBoatengSkab 2 years ago

sir, what are the various costs used in decision making and their characteristics?

Ahadi 2 years ago

I appreciate your thought in this article keep coming up.

Elvis keya 2 years ago

the article has opened my mind congratulations

frank itambiko 2 years ago

thank you very much sir you open my mind well.

zeni 2 years ago

Thank you

Hafeez Sahib 2 years ago

I was searching you . How are you sir.

Tariq Baig

hafeezrm profile image

hafeezrm 2 years ago from Pakistan Author

Thanks Tariq Baig. I am in Bahria University, Karachi as a visiting faculty.

sheik mahaboob basha 2 years ago

thanku very much sir

sammy o howbay 20 months ago

Good morning Sir,

I'm Sam from Nigeria and I'm involving in accounting Higher National Diploma programme. I have a paper which I'm to present on the Relevance of ICT to decision making processes: the accounting perspectives. Could you help me out how I'll go about it 10 months ago

thank u so much sir,

sir r puting ur great effort just for our future......i am really thankful to u sir

    Sign in or sign up and post using a HubPages Network account.

    0 of 8192 characters used
    Post Comment

    No HTML is allowed in comments, but URLs will be hyperlinked. Comments are not for promoting your articles or other sites.

    Click to Rate This Article