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ACCA F5 Relevant Costing

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  1. Sir …
    A firm has some material which originally cost $45000. Its has a scrap value of $12500 but if reworked at a cost of $7500 it could be sold for $17500 .
    What would be the incremental effect of reworking and selling the material?
    How to solve it?

    • Please ask this sort of question in the Ask the Tutor Forum and not as a comment on a lecture.

      The incremental effect of reworking it would be that they would receive 17,500, would have a cost of 7,500, but would lose scrap proceeds of 12,500. So a net cost of $2,500.

  3. Dear sir, if the replacement value of the inventories was lower than the scrap value ($4.2 x 7500 kgs) $31500 then what would be the relevant cost be? Will it still be the $31500 or its replacement value say, $30200??

  5. Sir,

    at 12:03 you worked out that supervisors will only be paid the bonus . If because of the supervisors leaving, production would stop at their current position, would the cost of their normal labour pay be included, even though they are not replaced?

  6. Sir, could you please help me understand question 40, Stay Clean part 4.

    Also, I tried posting it in the ask the tutor forum but the page was inaccessible.
    Please do help because I simply cannot understand it from the text book.

    Thank you

  10. Great videos!

    Example 2, note 3. Let’s assume that there is no incremental fixed overhead of $1,000 in this example. If the deal to produce the special order actually goes through then, won’t it be strange to create a cost card for a product with no fixed cost attached to it…

  11. Dear Sir,

    For Example: ABC Ltd is a plastic manufacturer who produce plastic cups and plastic jugs, since the market price of a row material (called resin) was lower therefore the finance director decided to buy resin in large volume (3 months material stock) in cash.

    ABC Ltd just suddenly receive a new special order for Plastic Glass.

    1) My question here is, does the cost of resin is relevant ?
    2) will we really just ignore the material cost, just because it is already being paid ?

  12. I have a reservation with note 5.

    Since the special order requires 6,000hrs, and our machine currently has 4,000hrs available capacity, shouldn’t then the relevant costs be the extra 2,000hrs x $3 = $6,000?

    And of course the lost contribution of $4,000 as well.

  13. Since we are doing the contract the forgone alternative which the income we are going to earn when we sell the material is the opportunity cost for doing the contract. If we are not doing the contract the imcone we earn when sell the material is the 7500kg * $4.2 = 31500.

  14. Hi John,

    Regarding the Bank OD, yes it is not incurred upfront (no outflow of cash) as you explained in this lecture. But, it is still however repaid at the end of the project duration of 3 months.
    So, why is this not an extra cost apart from the OD interest.
    Wouldn’t the company not opt for the OD of 20,000 if not for this project. So no 20,000 is borrowed and repaid.

    However, whether the project is taken up or not, as the money is borrowed and repaid, it would cancel out to zero and it’s only the OD interest that is extra cost incurred which is considered in the revised cost schedule.

    Please confirm if my understanding is correct.

  15. Thank you sir for the lecture.

    I have two things I’m not clear of.

    1) in note 6 about the materials, if the material replacement cost was lower than what the company could have earned by selling them, what would be the relevant cost here?

    2) at the end of the lecture you have mentioned committed cost. Can the bank overdraft be considered as one of them? If not, could you please give me another example of such a cost.

    • 1. If the replacement cost were lower, then this would be the relevant cost. (The existing inventory would not be used, but would be sold).

      2. A committed cost it one that you are going to have to pay whether or not you do the new project. For example, you might have had market research done but have not yet paid the bill. You are going to have to pay the bill whether you go ahead or not and it is therefore irrelevant for the decision (like a sunk cost).

  16. Hi,

    Can I ask with regards to example 2, point 6. When I looked at the question initially my approach would have been to sell all 10,000KG of material (held in stock) for 拢42,000. Then brought replacement material for 拢33,375, resulting in no cost but a reduction of overall cost.

    I fully understand where your figures have come from, I’m just curious to know had I taken my approach would it have been completely wrong? Or would it have been considered an acceptable answer?

    Thank you in advance, and thank you for these lectures. I am finding them a massive help in understanding how to approach the questions.

    Gemma

    • Hi

      I had the same issue. But I think there is no need to repurchase those 10 000 KG since its clearly stated that this 10 000 Kg would not be used in the future. Therefor I think we should only consider the revenue lost (opportunity cost) due to using 7500 Kg, which amounts to $31 500. Hope this helped.

      • Hi,

        Same thought as Gemma. If we sold all inventory (10,000 kg) at $4.2 and repurchase 7,500 kg for the contract at $3.3375, we have saved of $16,969. Therefore, we only need an overdraft of $3,031 instead of $20,000 and relevant cost is $25,031 (7,500kg * $3,3375/kg) without losing income from selling inventory.

        Summary, relevant cost is $25,031. That’s it.

      • But selling all the inventory has nothing to do with it.

        Whether or not they do the contract, the extra 2,500 kg can still be sold – so that is irrelevant to the decision. All the is relevant is the opportunity cost of the 7,500 needed for the contract.

        The solution in the lecture is completely correct (and is the same as the original examiners solution – this was an actual exam question!).

  17. Thanks for your lecture. As I know that financial cost such as interest and dividend is irrelevant cost, but in this lecture you consider the interest to be relevant cost. Please but could you explain it?

    • I do not know why you say that interest is an irrelevant cost!!

      We are wanting all extra costs of doing the work, and if they have to borrow money to do the work and therefore pay interest, then the interest is an extra cost.

      (I think you may be confusing this with investment appraisal, which is something completely different and is not examinable in Paper F5.)

  18. Hello Sir, I’m revisiting this chapter one more time as I’m really struggling with relevant costing.

    In Note 5, 2,000 hours of 6,000 hours has to be taken off the machine. Does it not make it committed cost; already committed to another job? If so, the relevant costs will be:

    – variable cost: 4,000 hours x $3 = $12,000 (instead of $18,000)
    – opp. cost: 2,000 hours x $2 = $ 4,000
    – Total: $16,000 (instead of $22,000)

    Would you please kindly explain why this is not committed cost?

    • Have you watched the lecture (because I do explain in the lecture, and there is obviously no point at all in using the lecture notes if you are not watching the lectures 馃檪 )

      The lost contribution of $2 per hour is after charging all variable costs including the machine overheads of $3 per hour.

      Since the $2 per hour will be payable anyway, the lost amount is $5 per hour. So for the extra 2,000 hours needed the opportunity cost is 2 x $5 = $10,000.
      (The other 4,000 hours available capacity will cost $3 per hour, so a total of $12,000)/

      Do the overall total is 10,000 + 12,000 = $22,000

      (This was in fact an old exam question 馃檪 )

      • Thank you so much for your quick response.
        I’ve watched the lecture twice and was watching it again when you replied. It will be unwise not to watch your wonderful lectures.

        However, I had to chew on your reply quite a few times but I finally got it. Eureka!
        So, my calculation, in effect, would have deducted the $3 variable cost twice resulting in not charging the electricity cost at all.
        Therefore, you have to calculate it in the way described either in the lecture or alternatively in your reply above.
        With hindsight it’s always very obvious. 馃檪 Makes you wonder why I didn’t get it in the first place.

        Thank you again for your help Sir. You are a star!

  20. For Note 6, where it says we can sell either the complete inventory of 10,000 kg OR part thereof, why have we decided to include ONLY the 7500kg X $4.20 worth of opportunity cost instead of 10,000kg X $4.20? (Considering there’s no mention in the question that the new contract only requires 7500kg and therefore the remaining 2500kg can/will be sold anyway?)

    Thankyou.

    • That is not the opportunity cost
      Since the statement only tells us that the inventory held “in stock” i.e. 10,000 kg has a scrap value (aka. NRV) of $4.20/ kg. (Whenever we use the items that are available in stock we take the Higher of the alternative use and the NRV. Here the statement tells us there is no alternative use).
      Thus the relevant cost for Parser ltd would be ($4.20 x 7500 Kg= $31,500/-) as the number of kg’s required is only 7500 kg and not more.
      The Opportunity Cost principle does not apply here.

      • Opportunity cost is that cost we choose to incurred as part of the relevant costs when undertaking a new project as far as that costs will be covered and still yield profit. Simply put, opportunity cost is the forgone alternative cost.I hope this help. John is indeed, a perfect tuitor for us all here.

    • Tan:

      The question does say that the contract requires 2,500 kg, because that was what was on the original schedule (even though the inexperienced accountant had costed it incorrectly).

      Syed Danish:

      The opportunity cost principle certainly does apply!!!!!
      The lost scrap value of the 7,500 kg is a perfect example of an opportunity cost. The definition of an opportunity cost is that it is lost income!!!

      • Hi sir,
        If we sold all inventory (10,000 kg) at $4.2 and repurchase 7,500 kg for the contract at $3.3375, we have saved of $16,969. Therefore, we only need an overdraft of $3,031 instead of $20,000 and relevant cost is $25,031 (7,500kg * $3,3375/kg) without losing income from selling inventory (we still earns profit hence it’s not opportunity cost).

        Finally, relevant cost would be $25,031. That鈥檚 it.

        Thanks

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