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Sir, Could you please answer my two problems. I would be thankful 🙂
1) Is it true that Opportunity Costs can be either Net Benefit from Alternative Use OR Lost Contribution? And Opportunity cost is only relevant when material in stock is not in regular use?
2) Is that also true that both Net Benefit from Alternative Use and Lost Contribution is the relevant cost of alternative material which is not currently being used in a new contract rather the alternative material is used in another project somewhere else in the business BUT undertaking a new contract makes us lose those alternate projects that is why they are taken into account as relevant cost? Is that correct?
1. An opportunity cost is any lost income as a result of taking the inventory, which might be lost sale proceeds or lost contribution because of alternative use. It is only relevant if the inventory is not in regular use.
2. Yes, that is correct.
Have you watched my free lectures on relevant costing?
Yes, I have watched it 🙂 BUT sir you never used any diagram for relevant cost for material in different situations!?
Could you also please tell me if I have correctly got the relevant cost for material in situations like below?
1) If material is not in stock:
RC = Purchase cost2) if material is in stock but it has no regular use:
RC = Opportunity costwhere opportunity cost is higher of:
i) Scrap value
ii) Alternative UsePlease first correct me if I had correctly mentioned everything or not. Secondly, please do share how do we calculate the Net Benefit from Alternative Use? Does Alternative Use include modification cost?
No, I deliberately do not draw a diagram because learning a diagram does not help with exam questions. The examiner deliberately designs question that check your understanding rather than that you have learned a diagram or set of rules.
1 and 2 are correct. You have not included the situation where the material is in regular use, in which case the relevant cost is the current purchase cost.
The net benefit from any alternative use the is the saving to be made less the costs of modification .
[Question]
A company is calculating the relevant cost of the material to be used on a particular contract. The contract requires 4200 kgs of material H and this can be bought for $6.30 per kg. The company bought 10,000 kgs of material H some time ago when it paid $4.50 per kg. Currently 3700 kgs of the remains in inventory. The inventory of material H could be sold for $3.20 per kg.The company has no other use for material H other than on this contract, but this could be modified it at a cost of $3.70 per kg and use it as a substitute for material J. Material J is regularly used by the company and can be bought for $7.50 per kg.
[My questions]
Is it true that we are considering whether the 3700 kgs held in inventory which has no other use besides this new contract; so we have two choices here such as:either:
1) we can sell the 3700 kgs in scrap at a cost of $3.20 or
2) we can use 3700 kgs of material H in new contract rather than on another project as a substitute for material J; so in this case, we do save $3.80 (7.50 – 3.70) because we are modifying the material H at a cost of $3.70 to use it on another project for the material J but we are also saving the cost $7.50 of buying the material J. So, the Net Benefit from alternative use is $3.80.Please correct me if I am wrong somewhere. Thanks for your last reply 🙂
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