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Hi my Dear Tutor, I have a question.The question has been taken from the Bpp’s study text because there is a case which drew my attention to that point.
O’Reilly Co has been approached bu a customer who would like a special job to be done for them, and who is willing to pay $22000 for it.The job would require the following materials.
RC-replacement cost
———————————————units
Material—total units required—–already in stock—book value of units in stock-NRV–RCA——————1000———————–0————————-nil————————–nil—–6$
B——————1000———————–600———————–2$————————2.5$—-5$
C——————1000———————–700———————–3$————————2.5$—-4$
D——————-200————————-200———————–4$————————6$—-9$Notes)
A) Materials B is used regularly by the company and if units of B are required for this job they would need to be replaced to meet other production demand
B) Materials C and D are in inventory as the result of prior overbuying and they have a restricted use.No other use could be found for Material C but the units of materials D could be used in another job as substitute for 300$ units of material E which currently costs $5 per unit(of which the company has no units in inventory at the moment)
Solution
Material A) 1000*6$=6000-it has not been purchased that is why its current price will be based on RC-understood
Material B)there is 600 units in inventory which is regularly used and its current price will be RC and the rest 400 has not been purchased yet which its RC will be 6$
600*6=3600
400*6=2400
equal—5000Material C) it is not used and restricted so its 700 units will be based on NRV 700*2.5=1750 and the rest 300 units have not been bought and will be based on RC 300*4=1200+1750=2950
Material D) its 200 units can substitute 300 units of Material E costing 5$ so its opportunity cost will be 300*5=1500 .
If I calculate it by 200*6$(NRV)=1200
1500-1200=300-what will be the difference between 1500 and 1200 if 1500 is opportunity cost?is it called incremantal opportunity cost?
I just need explanation on this part.
There is no such thing as incremental opportunity cost, and it is irrelevant anyway.
If they use material D as a substitute, then they will lose the income they could have made which is 200 x $6 = $1,200.
If instead they buy material E, then will will not lose the income from D but instead will have to pay out 300 x $5 = $1,500.
They will choose whichever is the cheapest option, which is to use material D. Therefore the relevant cost is $1,200 (the opportunity cost).
Have you watched my free lectures on relevant costing? The lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.
I took it from Bpp study text and it says,Material D:these are already in inventory and will not be replaced.There is an opportunity cost of using D in the contract because there are alternative opportunites either to sell the existing inventory for $6 per unit (1200″ in total) or avoid other purchases of Material E, which cost 300*5$=1500.Since the substitution for E is more beneficial , 1500 is the opportunity cost.
I do not think 1200 will be opportunity cost because if i have 200 units in stock which can be used for MATERIAL E production costing 1500 my opportunity cost will be 1500 not 1200.In fact imagime if i did not have 200 units in stock i would pay and buy materials costing 1500 so from this inference my opportunity cost is 1500$ not 1200$
I must apologise – I had read the original question too quickly 🙁
I was thinking that they needed material E for the new contract, which of course they do not – they need material D.
If they did not do the contract then they would use Material D to make E (because it would be cheaper to lose 1,200 that they could have sold it for rather than spend 1,500).
However, because they do need D for the contract, they will either have to not use it for E (and therefore spend 1,500 on E) or use it for E in which case buy new D which would cost them 1,800. They will choose the cheaper of the two and therefore use D on the contract and then spend 1,500 on buying E.
So the relevant cost of using D in the contract is 1,500.
Sorry about that, but I hope it is now clear 🙂
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