Relevant Costing

Explanation of Spreadsheet:

Primarily this question is one that resolves around incremental revenues
and costs. According to my textbook, relevant information involves
“costs or benefits that are different for each course of action”.
Horngren in another textbook on management accounting highlights that an
“incremental cost is the additional cost incurred for an activity”
(i.e, telemetry units). Incremental revenue is defined in an analogous
manner – the additional revenue form an activity.

In this analysis, I have decided to leave out the standard room rate of
$120 per day when calculating the revenue from the addition of the
telemetry units. By only including the $80 or $120 incremental revenue
from the telemetry units, I believe (but want your advice) that the
revenue will be better matched to the costs as outlined in the question.
As we can see in the question, the costs that are stipulated are only
related to the telemetry units (incremental costs of this activity), not
the actual standard room revenue.

I believe therefore that we will have a more accurate differential
margin to base our Return On Equipment calculation (as seen in the
attached solution) as the income figure I have derived (made up of only
incremental revenues and incremental costs) is directly related to the
initial investment amount ($44,570).

I was a little concerned about the effect on the ‘bad debts and
insurance estimate’ of 10%. But in reality if we think back to the
basics, we are only interested in the effect of the 10% on the
differential revenue, not the entire room rate…

The Return On Capital percentages are much more realistic as well,
ranging between 16.95% to over 252.81%.

The second part of the question to this problem asks us to “advice
management as to the alternative to choose explaining why you think this
is the right choice”.

This is where the opportunity cost comes into play: Basing our answer
only on the return on capital, we could deduce that charging $120 per
day at a 60% usage rate is the best alternative (alternative D – the
obvious choice) as it has the highest return on capital. But by
including the opportunity cost, the whole story changes!

Because of the inherent opportunity costs of committing to this project
(Forgone revenue from the cardiac rooms), we find that option C is
actually the best alternative. In my answer of course, I would have to
reveal that there are numerous qualitative issues to consider as well.

So what is your interpretation of this? Do you think I’m right here?

I know that in the end it makes no difference to the final alternative
chosen but nevertheless the lecturer stipulated that if asked this sort
of question in the exam to only include relevant information to the
question at hand because in generating information in the workplace is a
costly process, requiring time and effort and it is a requirement of the
management accountant to simplify and shorten the data-gathering process
so as to enhance decision-making within an organisation.