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A machine owned by a company has been idle for some months but could now be used on a one year contract which is under consideration. The net book value of the machine is $1,000. If not used on this contract, the machine could be sold now for a net amount of $1,200. After use on the contract, the machine would have no saleable value and the cost of disposing of it in one year’s time would be $800. What is the total relevant cost of the machine to the contract? $
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The correct answer is: $2,000 Opportunity cost (net realisable value) Cost of disposal in one year’s time Total relevant cost of machine $ 1,200+ 800= 2,000.
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2.A Co has three options for machine B. One of these options involves modifying the machine now at a cost of $7,200, which will mean that the company does not have to hire an alternative machine at a cost of $19,800. This modification would mean that machine B would have to be disposed of in one year’s time at a cost of $4,000. Ignoring the time value of money, calculate the relevant cost of this option.
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The correct answer is: saving of $8,600 Modification = $7,200, hire costs avoided = $(19,800) and disposal costs = $4,000 and so the relevant cost is a saving of $8,600.
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HELLO SIR
I don’t understand in the both questions relevant cost is asked in question 2 why are we subtracting the two options isn’t the answer for 2 question 7200+8600=15800 since 7200 and 8600 are related to modification.- Topics: 65
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So for ans 2 modification is costing 15800 and hire costs 19800 so the economical option among both would be 15800
Q2 is a silly question because it says that there are three options but only gives two of them (hiring a machine or modifying the machine). Also, if they hired a machine then the existing machine would presumably be disposed of now, but the question does not give the cost of disposing now (which would be relevant to the decision).
Certainly of the two choices and on the information given, the best option would be to modify the machine and the relevant cost would be 15,800. Only if it had to be one of the two choices would modifying the machine give a saving of $8,600 as against not modifying the machine.
Whatever, the best option would be to modify (and the only purpose of relevant costing is to decide on the best option).
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Thank u so much sir
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