146 ACCOUNTING FOR MANAGERS
Table 10.3 Make versus buy – relevant costs
Relevant cost to make Relevant cost to buy
Stationery 10,000 @ £0.50 5,000
Outsourcing cost 20,000Total relevant cost £5,000 £20,000In the above example, it was implicit that TUPE required the cost of labour to be
transferred to the external company, as labour ceased to be a relevant cost under
the outsourcing option. However, if the labour were not transferred to the external
company but retained in the organization, it could become a relevant cost and the
financial calculation of the outsourcing decision may be different, depending on
the alternative use of the labour.
The relevant costs for each alternative would then be those shown in Table 10.3.
Note in the example in Table 10.3 that labour is no longer a relevant cost, as it
is incurred irrespective of the decision to outsource. In this case it would be more
costly to outsource the service unless the underutilized labour could be directed
at tasks that generated a contribution of at least £15,000. This example shows how
it is important in any calculation of relevant costs to be sure about which costs are
avoidable and which costs are unavoidable.
Unfortunately, one of the first business responses to a downturn in profits is
to make staff redundant. Although the redundancy payments will be recognized
as a cost, there is a substantial social cost, not reflected in the financial reports
of a business. The social effects will be borne by the redundant employee, while
the financial burden of unemployment benefits may be borne by the taxpayer
(see Chapter 5 for a discussion). This short-term concern with reducing labour
cost often ignores the potential for cost improvement that can arise from a better
understanding of business processes.
Business processes and activity-based costs
Activity-based costing (or ABC) was introduced in Chapter 9 in relation to the cost
of unused capacity. ABC developed from the work of Cooper and Kaplan (Cooper
and Kaplan, 1988; Cooper, 1990; and Cooper and Kaplan, 1992), who argued
that many resource demands are not proportional to volume but arise from the
diversity and complexity of the product and customer mix. ABC systems estimate
the costs of resources used to perform activities for various outputs and directly
link the cost of performing activities to the products/services and customers for
which those activities are performed.
ABC achieves this through the concept of thecost driver,whichisthemost
significant determinant of the cost of an activity. The cost driver seeks to determine
cause-and-effect relationships for costs, and measures the demand for activities by
each product or service. ABC is described more fully in Kaplan and Cooper (1998)
and is covered in more detail in Chapter 11.