I have a question regarding the relevant cost of materials . As mentioned in the question “the materials have just been purchased” . This in a way gives us a hint that the materials are actually purchased for the project . However we are not considering their cost as relevant when they are in fact purchased solely for the project . Guide please ?
The fact that they have just been purchased does not mean they were purchased for the project – it has not yet been decided whether or not to do the project 馃檪
firstly thanks for the wonderful lectures. I would to know if I am right on my understanding of the reason why we should not include the sunk cost in our calculation to make a decision. how I understand is we would like to know whether if we carry on the project from this position we are now would result positive/negative outcome. so we would say in the case of positive outcome it would reduce the impact of any sunk cost whereas if it is negative it would increase the cost further and we reject the project. am I right there? thank you.
While deciding whether to accept or decline the project, we’re just considering the additional relevant cost. Shouldn’t the already incured costs of 拢150,000 also be considered while determining if the project is profitable or not?
Thank you for the lecture. Will there be a difference in decision making if the amount saved on disposal ($5000) is added to cash inflow instead of subtracting it from outflows. What other effect will this have on our calculation. Thank you.
Hi sir great lecture. However, Why do we subtract 5000 and add all the other items in the list of cash outflows. Wont all of it be summed to get the difference?
I assume that you mean the cost of disposing of the materials if they are not used in the project?
They are subtracted from the other costs in order to get the net cost, because if we do the project we will save 5,000 (we will not have to spend the money to dispose of the materials).
Wonderful lecture as always. Just a small question Sir. I know when dealing with Statement of Cash flows, the treatment of disposal gains or losses uses the same logic as depreciation. Would it be far fetched to think the same should be extended to determining if said expected gains or losses are relevant? specifically, shouldn’t the 2000 disposal value lost be irrelevant?
I have a problem as In cash outflow coloumn you marked saved in disposal and saved in material in negative and lost in rent and lost in sales 150,000 as positive as what I understand is I not doing the project materials can be disposed off for 5000 so Could you explain me why you are not considering material as opportunity cost .
We are listing the total cost. So, for example, the extra wages needed are a cost and so are shown as positive in the list.
There is a saving on materials (because if we use them in the contract we will not have to pay for their disposal, so we will save 5,000). Because it is a saving, it is shown as a negative cost – it reduces the total cost.
Lost rent (for example) is a cost and therefore it is an extra cost and therefore included in the total of costs.
There are no materials of $40,000 in the prime cost (and they are not the same materials!).
You did not say which materials you were asking about – the only materials needed for the contract are those under the heading ‘materials’ and they are what my answer here was referring to.
It seems you are actually asking about the relevant cost of the labour used. Because they are being moved from other work there is the opportunity cost of $90,000 of moving them. You can get the same answer two ways – whichever is more obvious to you – either it is the cost of labour (40,000) plus the lost contribution (150,000 – 100,000 = 50000). Alternatively, if you find it more obvious, if we stop the other production then we lose the sales (150,000). However if we are not producing the other product we do not need to spend the money on the materials for the other product (60,000 (100,000 – 40000)). So the net cost is 150,000 – 60,000 = 90,000.
Hi John. Shouldn’t we discount the redundancy cost that will be incurred in a years time rather than subtract it from the redundancy cost if we were to discontinue the project?
That would be fine, except that this example specifically says (the last line) to ignore the time value of money (which means to not discount). This first example is just a check on relevant costs.
Thank You! A great lecture! 馃檪 But I have 2 questions. 1. If we have to rent the premises specifically for this project, then do we consider it as a relevant cost? 2. Why don’t we consider $ 40,000 Labour cost as a relevant cost. I get the point why we don’t consider it when we calculate Loss from the other products. But why don’t we take it to account for this project seperately?
If we did rent premises specifically, then we would include them (but we don’t in this question).
With regard to the labour, we will be paying them whether we move them to this project or whether they stay where they are – there is no extra cost involved.
usama93 says
I have a question regarding the relevant cost of materials . As mentioned in the question “the materials have just been purchased” . This in a way gives us a hint that the materials are actually purchased for the project . However we are not considering their cost as relevant when they are in fact purchased solely for the project . Guide please ?
John Moffat says
The fact that they have just been purchased does not mean they were purchased for the project – it has not yet been decided whether or not to do the project 馃檪
usama93 says
Alright Thank you 馃檪
John Moffat says
You are welcome 馃檪
yugunman says
firstly thanks for the wonderful lectures. I would to know if I am right on my understanding of the reason why we should not include the sunk cost in our calculation to make a decision. how I understand is we would like to know whether if we carry on the project from this position we are now would result positive/negative outcome. so we would say in the case of positive outcome it would reduce the impact of any sunk cost whereas if it is negative it would increase the cost further and we reject the project. am I right there?
thank you.
John Moffat says
Yes – you are correct 馃檪
Rizwan says
While deciding whether to accept or decline the project, we’re just considering the additional relevant cost. Shouldn’t the already incured costs of 拢150,000 also be considered while determining if the project is profitable or not?
magdeline says
Thanks very much,well explain and I will apply the same logic when retaking F5
Once again thanxxx.
John Moffat says
You are welcome 馃檪
4tcube says
Thank you for the lecture. Will there be a difference in decision making if the amount saved on disposal ($5000) is added to cash inflow instead of subtracting it from outflows. What other effect will this have on our calculation. Thank you.
John Moffat says
No – it makes no difference.
4tcube says
Thank you
John Moffat says
You are welcome 馃檪
Sandy says
Wonderful!
I just passed 2 more exams of acca and all the credit goes to you Mike. These lectures are just so awsome.
Sandy says
John*
John Moffat says
Thank you, and congratulations 馃檪
sruthinflippy says
Hi sir great lecture. However,
Why do we subtract 5000 and add all the other items in the list of cash outflows. Wont all of it be summed to get the difference?
John Moffat says
I assume that you mean the cost of disposing of the materials if they are not used in the project?
They are subtracted from the other costs in order to get the net cost, because if we do the project we will save 5,000 (we will not have to spend the money to dispose of the materials).
sruthinflippy says
Oohhh thank you john .. 馃檪
John Moffat says
You are welcome 馃檪
Kelly says
Wonderful lecture as always. Just a small question Sir. I know when dealing with Statement of Cash flows, the treatment of disposal gains or losses uses the same logic as depreciation. Would it be far fetched to think the same should be extended to determining if said expected gains or losses are relevant? specifically, shouldn’t the 2000 disposal value lost be irrelevant?
Many thanks
John Moffat says
The disposal value itself is a cash flow.
The gain or loss on disposal (the difference between the disposal proceeds and the net book value) is not relevant.
Kelly says
Ah yes! thank you Sir
John Moffat says
You are welcome 馃檪
gonko says
Excellent lecture as always. Thank you very much, John. I am forever grateful.
John Moffat says
Thank you, and you are welcome 馃檪
Mohammed says
Explain wonderful , Thanks Sir.
paharn says
Hello John,
I have a problem as In cash outflow coloumn you marked saved in disposal and saved in material in negative and lost in rent and lost in sales 150,000 as positive as what I understand is I not doing the project materials can be disposed off for 5000 so Could you explain me why you are not considering material as opportunity cost .
John Moffat says
We are listing the total cost. So, for example, the extra wages needed are a cost and so are shown as positive in the list.
There is a saving on materials (because if we use them in the contract we will not have to pay for their disposal, so we will save 5,000). Because it is a saving, it is shown as a negative cost – it reduces the total cost.
Lost rent (for example) is a cost and therefore it is an extra cost and therefore included in the total of costs.
Shawon says
Sir Moffat,
The wrong lecture of inflation(example 1) starts here instead of Relevant Cash Flows for DCF Inflation (example 4).
Could it be sorted ASAP please?
Love all your lectures
Thanks 馃檪
opentuition_team says
reload the page
it should be OK now 馃槈
beatrice says
sir
can you please explain how we are saving on materials? i did not understand the logic
John Moffat says
The materials are toxic and if we do not use them in the contract we will have to pay to dispose of them.
If we use them on the contract then we will not dispose of them and therefore will save the cost of disposing of them.
beatrice says
the materials of 40000 included in the prime cost is the same as the toxic materials of 40000?
John Moffat says
There are no materials of $40,000 in the prime cost (and they are not the same materials!).
You did not say which materials you were asking about – the only materials needed for the contract are those under the heading ‘materials’ and they are what my answer here was referring to.
It seems you are actually asking about the relevant cost of the labour used. Because they are being moved from other work there is the opportunity cost of $90,000 of moving them. You can get the same answer two ways – whichever is more obvious to you – either it is the cost of labour (40,000) plus the lost contribution (150,000 – 100,000 = 50000).
Alternatively, if you find it more obvious, if we stop the other production then we lose the sales (150,000). However if we are not producing the other product we do not need to spend the money on the materials for the other product (60,000 (100,000 – 40000)). So the net cost is 150,000 – 60,000 = 90,000.
beatrice says
thank you sir for clearing my doubt ????
Nelson says
Well done, thank you.
John Moffat says
And thank you for the comment 馃檪
Ahmed says
Hi John. Shouldn’t we discount the redundancy cost that will be incurred in a years time rather than subtract it from the redundancy cost if we were to discontinue the project?
John Moffat says
That would be fine, except that this example specifically says (the last line) to ignore the time value of money (which means to not discount).
This first example is just a check on relevant costs.
hamzaharoon says
Excellent Lecture, You are Indeed Legend Sir Moffaat 馃檪
Ken says
it was brilliant lecture. well done and thank you.
iluvgorgeous says
Sir, you managed to bring a smile on my face even with exam pressures just around the corner. thank you
sdmaalex says
Thank You! A great lecture! 馃檪
But I have 2 questions.
1. If we have to rent the premises specifically for this project, then do we consider it as a relevant cost?
2. Why don’t we consider $ 40,000 Labour cost as a relevant cost. I get the point why we don’t consider it when we calculate Loss from the other products. But why don’t we take it to account for this project seperately?
John Moffat says
If we did rent premises specifically, then we would include them (but we don’t in this question).
With regard to the labour, we will be paying them whether we move them to this project or whether they stay where they are – there is no extra cost involved.
sdmaalex says
Thanks alot! 馃檪
I asked about the question regarding premises in case we don’t come across a question with that point in the examples.
Mahoysam says
Wow! I just realised that I still remember and understand F5 very well! That’s a surprise! lol!
Thank you Mr John, good stuff.