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Short-term Decision making – Relevant Costing – ACCA Performance Management (PM)

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  2. thank you for this lecture ,
    i am confuse about one thing though, the electricity since it is only 4000 hours available isn’t that mean we will have to pay extra for only this 4000 h , as the 2000 rest already incurred whether we make the order or not , but the lost will be the contribution ?
    that mean ?
    4000 * 3 = 12000
    2000 * 2 = 4000

  4. Hello John, assuming a company prepared a quote for which will require 200kg of material A. The current purchase price of material A is $6/kg. the company has 50kg of material A in inventory for which is paid $250. The material is no longer used by the company and could be sold for $3 per kg… calculate the relevant cost of material A to be included on the cost for the job?

    • In future ask this kind of question in the Ask the Tutor Forum and not as a comment on a lecture.

      The relevant cost of the 50kg is 50 x $3 = $150. The relevant cost of the other 150kg is 150 x $6 = $900. So a total of $1,050.

  6. Dear John,

    I have following confusions, please help me sort out:

    Point 6) Replacement cost of material is given $33,375 (probably for 10,000 KG). Per KG of it becomes out $ 3.34. However, in other part of this point 6, it is also mentioned that if we sale the material, we will get $4.20 per kg (means we can recover our sunk cost). The thing confusing me is… how the replacement cost is lower then the recoverable amount through sale. And even if somehow it is justifiable, then the question would be, should we not consider the difference of these two (recoverable amount -minus- replacement cost) of 7,500 KG in driving the relevant cost.

    • The question says that the $33,375 is the replacement cost of the material used, and the material used is 7,500 kg..
      So the replacement cost is 33,375/7,500 = $4.45 per kg.. (I appreciate that the wording might be a little confusing, but the whole question is an old real exam question.)

      The sale proceeds of the inventory could never be more than the replacement cost – nobody would pay us more for it if they could buy it themselves cheaper šŸ™‚

  7. Hi Sir,

    For point number 6, Assuming that the proceeds from the sales of material would be more than the replacement cost, say we get a sales proceed of $35,000, would Paser ltd sell the inventory and replace it? And if so, would the relevant cost be the replacement cost of $ 33,375.

    Thank you.

  8. Hello John
    I copied this adjustment from a question on relevant costing.
    What do they mean by post Nakusanga revenue…
    Are we going to calculate the 1% savings based on the following year revenue or we calculate the savings based on current year revenue?

    Here is the adjustment:

    Despite increased revenues, Nakusanga will still make overall savings in terms of vehicle running costs. These cost savings are estimated at 1% of the post Nakusanga revenues each year (i.e. the K11 million revenue, rising by 5% thereafter, as referred to in note (iv)). John
    I copied this adjustment from a question on relevant costing.
    What do they mean by post Nakusanga revenue…
    Are we going to calculate the 1% savings based on the following year revenue or we calculate the savings based on current year revenue?

    Here is the adjustment:

    Despite increased revenues, Nakusanga will still make overall savings in terms of vehicle running costs. These cost savings are estimated at 1% of the post Nakusanga revenues each year (i.e. the K11 million revenue, rising by 5% thereafter, as referred to in note (iv)).

  9. Hello John
    I copied this adjustment from a question on relevant costing.
    What do they mean by post Nakusanga revenue…
    Are we going to calculate the 1% savings based on the following year revenue or we calculate the savings based on current year revenue?

    Here is the adjustment:

    Despite increased revenues, Nakusanga will still make overall savings in terms of vehicle running costs. These cost savings are estimated at 1% of the post Nakusanga revenues each year (i.e. the K11 million revenue, rising by 5% thereafter, as referred to in note (iv)).

    • I can only assume that it is a typing mistake in the question and that it should read ‘past’ and not ‘post’. Otherwise it makes no sense. I do not know where you found the question, but presumably there is an answer in the same book which would then make sense of it. (Although you should be using a Revision Kit from one of the ACCA Approved Publishers.)

  10. If there was lost contribution due to using existing labour hours, why do we have to include the variable cost of labour as relevant if it was already included in formulating the contribution?

    • To illustrate, suppose the existing job has a selling price of $10 per hour, a materials cost of $5 per hour, and overheads of $3 per hour. So the contribution is $2 per hour.
      If hours are taken away from the existing job, the overheads will still be paid. So they will lose revenue of $10 and will save materials of $5. The net cost of taking one hour is 10 ā€“ 5 = $5. This is equal to (and will always be equal to) the lost contribution of $2 plus the overheads of $3.

  12. Regarding note 5. So I would have to assume that Parser ltd have paid the full cost of the electricity without the knowledge of there real potential consumption (4000 hrs). But on what basis. Second thing I believed that electricity isnt a fixed cost but a consumption based cost, so when we consume 4,000 hrs hence that what we should be paying for. So what I dont understand is why do we account for the assumed cost of electricity, when we know our machine cant handle it?

  13. sir, I don’t quite understand note 5 since we need 6000hrs
    4000 are available
    2000 can acquired from existing job. I found $10,000 as the relevant cost
    4000hrs @ $0/hr. (spare capacity)
    2000hrs @ ($3/hr. + $2/hr.) full capacity(labor cost + opportunity cost)
    = $10,000

    • To illustrate, suppose the existing job has a selling price of $10 per hour, a materials cost of $5 per hour, and overheads of $3 per hour. So the contribution is $2 per hour.
      If hours are taken away from the existing job, the overheads will still be paid. So they will lose revenue of $10 and will save materials of $5. The net cost of taking one hour is 10 ā€“ 5 = $5. This is equal to (and will always be equal to) the lost contribution of $2 plus the overheads of $3.

  15. Hello sir could you help me with note 5… The relevant costs for machine overheads, looking at the fact that we had the 4000hrs available capacity, why can’t the relevant cost(extra cost) be of the 2000hrs instead of the whole 6000hrs?

  16. Hi there! I am very grateful for your lectures. But I have one problem in note 5. In note 5 it says Machine OH charged at 3 per hour hasn’t this amount already been charged to the schedule prepared by the inexperience accountant I don’t quite understand why we need to make an adjustment for that.

  17. Hi Sir,

    Confused with Note No 6 dealing with Materials.. Actual cost of the materials usage was 34,000 , but why we see only the opportunity cost 31,500 ,which is less than the cost , in this context how do we practically apply to make a decision , what is the interpretation, how this technique of relevant cost being used practically ?

    Thanks ….

    • It is very practical indeed. Suppose you needed 7,500 kg for some new work. You have two choices – either buy material for $33,375 (and sell the material in inventory for $31,500 because there is nothing else you can do with it), or use the material in inventory and not get the $31,500 you could have received. Obviously it would make more sense to use the material in inventory. That would effectively be costing you $31,500 that you could otherwise have received. As a result you would need to get paid at least 31,500 to make it worthwhile doing the work.

      The fact that you originally paid $34,000 for the material is irrelevant. That money has been paid whatever you decide to do and you cannot get it back.

      I do suggest that you watch the lecture again because I do explain all of this.

      • Good evening Sir!

        I wanted to ask that, why haven’t we considered the extra amount of inventory of 2,500kg(10,000-7,500) for the opportunity cost, as we can sell it as well for $4.2/kg? Can you please explain this part?

        Thank you!

  18. Hello John,

    Regarding the cost of Materials in the example, I understand that we would have an opportunity cost of $31,500 as we could have sold the 7,500 kg of existing (and paid for) inventory for $4.2 per kg. But what if the replacement cost was say, $20,000 for 7,500 kg? Could we not then account for no opportunity cost for this Special Order (as we can continue to sell the existing inventory for $4.2 per kg at any time regardless), and account for Relevant or Incremental Cost of $20,000 as a result of our decision to purchase the replacement instead?

    Thanks in advance!

    Regards,
    Tim

  19. Hello Matt
    Iā€™m a bit confused at the note 5.
    The machine has 4,000h capacity only and this special order will have to steal 2,000 h from an existing job. So I think this 2,000h would have happened anyway no matter we decide to take this special order. So the material o/h cost would be 4,000×3=12,000$
    Opportunity cost is 2,000×2= 4,000$
    Total= 16,000$

    • No. To illustrate, suppose the existing job has a selling price of $10 per hour, a materials cost of $5 per hour, and overheads of $3 per hour. So the contribution is $2 per hour.
      If hours are taken away from the existing job, the overheads will still be paid. So they will lose revenue of $10 and will save materials of $5. The net cost of taking one hour is 10 – 5 = $5. This is equal to (and will always be equal to) the lost contribution of $2 plus the overheads of $3.

    • It is the same logic as for all relevant costs. I am guessing you are looking at a specific question where the relevant cost of the labour is the labour cost plus the lost contribution. If so, then it is the same logic as with the materials in my example, but if you are not clear ask in the Ask the Tutor Forum and I will explain it šŸ™‚

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