A special cutting machine will have to be hired for three months for the work based on contract. Hire charges for this machine are $75 per month, with a minimum hire charge of $300. Why here $75 is not relevant cost?
because 300 is minimum hire charge..
$75 is hire charge as well, three months payment only $225.
The relevant cost would be $300 as it’s the minimum hire charge. It means nothing less than $300 would be acceptable.
75$ per month is understandable but how 300 $ is accounted for , if it is minimun that on what basis weather it is for 3 months also or for a year.
The question says, the ”minimum” hire charge is $300, this means anything less than $300 is NOT acceptable be it, 75*3=225. Since we’re talking about ‘relevant’ cost here, $300 would be relevant if the project has to be undertaken.
Sid is absolutely correct.
let me explain the basic principle to determine weather a cost is relevant or irrelevant.
***1) Avoidable/Relevant:- The cost which is directly related to the decision. if you take the decision cost will be incurred, if you don’t take the decision you wont be incurred the cost.
***2) Cash flow:- To recognise the relevant cost it should have to be cash flow, any cost which wont make cash flow are not relevant e.g Depreciation.
you question meet this all criteria……..
now your question is the amount. how much you should recognise as a relevant cost………???
it’s the minimum (amount) of cost you have pay for anything if you take the decision.
like in your example
If you hire the machine for 3 months you cost will be 75 X 3 = 225
but in your question there is a condition that you have to pay a minimum charge of 300. this means it doesn’t mater how many weeks you use the machine even if you use this machine for only 1 week you still have to pay a minimum charge of 300.
so if you take the decision and hire the machine for less then 4 weeks your relevant cost is 300, because you can’t pay less then this amount.
but (suppose) if you use the machine for 6 weeks
your rental charge will be 75 X 6 = 450
it exceed the minimum charge of 300, so your relevant cost is 450. because you can not pay less then 450.
does it make sense??? if still unclear reply the point which is not understandable.
Mahfuz, you’ve explained it brilliantly! (Y)
thank you sids
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