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An org is considering the cost to be incurred in respect of a special order opportunity. The order would require 1250kg of material D, that is readily available and regularly used by the org on its normal products. There are 265 kgs of Material D in inventory which costs 795 last week. The current market price is 3.24 per kg. Material D is normally used to make product X. Each unit of X requires 3kg of material D, and if material D costed at 3 per kg, each unit of X yields a contribution of 15. What is relevant cost with respect to material D?
Why do we consider 1250kg and not the balance amount which is required ie (1250-265)?
The material is in regular use and so even if there is material in inventory it will need replacing (at the current price) if is taken for a special order.
I do explain this in my free lectures on relevant costing.
Hi John,
I found this question and I am having trouble getting the answer right.
A company has been asked to quote for a special contract. The following information about the contract has been given.
Material X: Book value $5.00/kg, Scrap value $0.50/kg, Replacement cost $5.50/kgThe contract requires 10kg of Material X. There are 250kg of this material in inventory which was purchased in error over two years ago. If Material X is modified, at a cost of $2/kg, it could be used as a substitute for material Y which is in regular use and currently costs $6/kg.
What is the relevant cost of the materials for the special contract?If they did not use the material in the contract they would have the choice of selling it and getting $0.50 per kg, or using it as a substitute for material Y which would save them 6 – 2 = $4 per kg.
They would choose to use it as a substitute because the saving is greater than the scrap value.
(The book value is irrelevant as always, and the replacement cost is irrelevant because they will not want to replace it.)Therefore using it in the contract would lose them the $4 they would otherwise have saved, and this is therefore the relevant cost per kg.
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