Hello sir,
Point 5. Given that the machine has 4000hrs available capacity, why are we recognising the whole 6000hrs*3=$18 000 has the relevant cost. And not 2000hrs*3=$6000 cost and lost contribution of 2000*2=$4000?
J
John MoffatTutor·
Because we will have to pay for the hours that they work. Spare capacity means that they can work more hours if we want them to buy we will still only pay them for the hours that they do work.
L
Laszlo·
Dear John,
brilliant lecture as always. I would like to rephrase EllaZ's question above.
If we recognise 6,000 hours of electricity cost for the extra job, why don't we recognise 2,000 hours saved from the normal job since it was not used? That would reduce our costs by 6,000.
Thanks!
T
THIAN·
Hi sir, may I ask a simple question? If the question stated that:
Material A (9,000 kg RM26 per kilo) at RM 234,000
The note for this cost is the Material is in continual use and there are 3,000 kg of material in stock, which was purchased at RM26.00 per kg. The current cost of the material is RM32 per kg.
How should I recognise the relevant cost? Is it 6000kg x RM32 per kg?
T
THIAN·
Because it says in continual use, I'm not sure shall I recognise the relevant cost as 9000kg x RM32 or just 6000kg x RM32 because there are 3000kg of material in stock.
J
John MoffatTutor·
Because it is in regular use the items used from inventory will need replacing, so the relevant cost is all 9000kg at RM32.
T
THIAN·
Thank you, Sir, for your response.
What about this one :
Unskilled labour (8,000 hours RM7 per hour) at RM 56,000
The note for this cost is Unskilled labour is only employed when such workers are required.
J
John MoffatTutor·
If they are only employed as required then the relevant cost is the cost of paying them.
T
THIAN·
Alright, Sir. I got the idea already. Thank you so much.
J
John MoffatTutor·
You are welcome :-)
J
John MoffatTutor·
You are welcome :-)
R
rim·
thank you so much for this explanation sir, this was really helpful
J
John MoffatTutor·
If they did not do the project then they would sell all of the material.
By using 7,500 kg in the project they would be losing the revenue that they would otherwise have got from selling the material. (The other 2,500 kg would be sold anyway whether or not they do the project).
S
samah·
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
D
Darin·
if we take on the special order, 6000 hrs will be required regardless of its availability or not. so, 6000*$3= 18000
but since we only have 4000 limited hrs available, 2000 hrs will be used for the special order instead of normal work with $2 cont. $2*2000 = $4000 is lost income/opportunity cost
I
IBRAHIM·
sir, what if a course of action was not taken, can the incremental cost still be relevant?
J
John MoffatTutor·
Yes. The relevant cost is whatever is lost by not being able to take the other course of action.
G
Geno·
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?
J
John MoffatTutor·
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.
V
Vicky·
Just wanted to say,
Thank you so much for this lecture!!!
J
John MoffatTutor·
Thank you for your comment :-)
K
Kamran·
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.
J
John MoffatTutor·
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 :-)
B
Biseko·
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.
J
John MoffatTutor·
How could they sell the material for more than the replacement cost? Nobody would buy it if they could buy it themselves at the replacement cost!
B
Biseko·
Thank you Sir, I was just being hypothetical.
M
Moses·
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)).
M
Moses·
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)).
J
John MoffatTutor·
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.)
J
JojoBeat·
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?
J
John MoffatTutor·
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.
S
Sulayman·
You are a magician, I thought I will never understand the logic of relevant costs but you just literally simplify it for me.
A big thank to you Sir ?
J
John MoffatTutor·
You are welcome :-)
D
Daniel·
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
J
John MoffatTutor·
It will need 6,000 hours of electricity and it will need paying for.
T
THARIQ·
sir, can you explain me note 5?
machine hours is available whether we use it or not.right?
so why do we need to take into account?
J
John MoffatTutor·
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.
T
Terramce·
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?
J
John MoffatTutor·
Because it will need 6,000 hours of electricity which will need paying for.
F
Furqan·
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.
F
Furqan·
I am sorry I get it now. I assumed we were adjusting the schedule but in fact we are preparing a new correct one.
J
John MoffatTutor·
I am glad you are now sorted out :-)
M
muralikrishna1001·
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 ....
J
John MoffatTutor·
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.
J
Jatin·
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!
J
John MoffatTutor·
That is not an extra cost because they are still able to sell the remaining 2,500 kg..
T
Tim·
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
J
John MoffatTutor·
In that case $20,000 would be the relevant cost because it would be cheaper to buy new (and we would still be able to scrap the existing and so have no opportunity cost).
T
Tim·
Well noted. Thank you!
J
John MoffatTutor·
You are welcome :-)
H
Huyen·
Hello Matt
I’m a bit confused at the note 5.
The machine has 4,000h capacity only and this special order will have to steal 2,000 h from an existing job. So I think this 2,000h would have happened anyway no matter we decide to take this special order. So the material o/h cost would be 4,000x3=12,000$
Opportunity cost is 2,000x2= 4,000$
Total= 16,000$
J
John MoffatTutor·
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.
J
John MoffatTutor·
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 :-)
E
Ermal·
Hello John, isnt the Nr. 2 - salary and bonus of the supervisor - a case of labour ?
J
John MoffatTutor·
It is labour, but the normal salary of the supervisor is a fixed cost and so the normal salary is not relevant.
P
Pratyush·
thank you professor you are a real master.
i enjoy your enthusiasm and conceptual understanding for mathematical problems.
J
John MoffatTutor·
Thank you for your comment :-)
S
shakir7385·
Dear John,
In Example 2, while calculating the relevant cost of point 4 (i.e. Machine maintenance cost). What if due to inclusion of new work, the company change its depreciation policy and say if it was to be depreciated previously over a period of 40 years, after inclusion of new product line company start to depreciate its relevant class of asset over a period of 30 years which results in more depreciation charge on monthly basis. Would that additional charge on monthly basis be treated as the additional cost due to addition of new product line, and the same shall be considered as additional cost?
In Example 5, as you mentioned that losing contribution of $2 due to inclusion of new production will only be considered if the new production gives at-least $2 or more contribution. Since we do not have details available about the contribution of new production so why we considered the taking off existing job of 2000 units?
In Example 6, why we are treating purchase cost of 7,500 kg material as a sunk cost despite that we have option available to recover this amount at $4.20 per kg.? Shouldn’t the difference of purchase price of that material (which is although not given in question) and the recoverable amount is treated as sunk cost?
Thanks in advance for your precious time!
J
John MoffatTutor·
The machine will be depreciated whether or not we do the on-off contract. There is no extra cost involved if we do the contract.
If we do the contract then 2,000 hours will be taken away from the existing job. Therefore we will lose the contribution that could be earned and this is therefore effectively a cost of doing the new contract. It is irrelevant what contribution we earn from the new contract. We are calculated the total cost to the company of doing the new contract. It is only when we know what it will cost us to do that we can decide how much we need to charge to do it.
The materials have already been bought and the money has been spent whether or not we do the new contract. The original cost is therefore irrelevant. All that is relevant is that if we do the new contract we will then not be able to sell the inventory and so doing the contract will lose us the $4.20 that we would otherwise receive.
J
John MoffatTutor·
The question says that there are 10,000kg in inventory. The special order needs 7,500 kg of materials and so these will come from the inventory (since they are not wanted for anything else). The question also says that the $34,000 appearing in the original schedule was the cost when the kgs were first purchased.
Have you watched the lecture working through this example?
E
evisevi·
Dear John,
I am not very clear on committed cost and why do we not include it in relevant costing. Can you please give me an example of committed cost?
For example, is a solicitor's cost committed cost? It is usually paid wether or not the deal goes through. As it is relevant to the project itself, I would think of it as a relevant cost.
Many thanks!
J
John MoffatTutor·
A committed cost is a cost that will have to paid whether or not the new contract is accepted. We are not doing financial accounts, to make the decision we simply need to know whether or not accepting a new contract means paying extra costs or not. In your example of a solicitor, you would only pay the costs if you decided to go ahead with using a solicitor (whether or not the deal goes through is irrelevant, so it is not a committed cost).
E
evisevi·
Many thanks!
A
Angelica Amposta·
Hello sir!
In the bank overdraft of $20 000, you had a reply wherein you said that it would be paid back in the future. Therefore, is it safe to say that it is a committed cost since we will pay it back whether or not we take the special order?
J
John MoffatTutor·
Effectively yes (although what we call it doesn't actually matter) :-)
S
salminawaris·
You are a an amazing teacher.Bless you Sir!
J
John MoffatTutor·
Thank you for your comment :-)
I
Ibrahim·
Dear John, thank you so much for your appreciated time.
U
Umar·
Thank you!
J
John MoffatTutor·
You are welcome :-)
R
rosicm·
Hi John,
i saw someone asked this already, but still not sure why you calculate it that way then. So if I use machine 4000hrs extra and add lost contribution, I calculate it as 4000x3 + 2000x2 = 16000 or 6000x3 + 2000*(2-3), where 2-3 represents lost contr. minus saved machine OH, in both cases you get 16k relevant costs. What am I forgetting here so I would get to 22k like you did?
Thanks for assistance in advance, much appreciated.
J
John MoffatTutor·
For the 2,000 hours being used on an existing job, the $2 contribution is after charging variable costs and so is after charging the running costs of $3. They will still be paying the running costs for those 2,000 hours, so what they will actually be losing is $5 per hour (the revenue less other variable costs).
So in total they are losing 2,000 x $5 = $10,000. In addition they are paying for another 4,000 hours at $3 per hour, which is $12,000. So a total of $22,000 :-)
R
rosicm·
Perfect, thanks a lot for clarifying this issue.
Best, Miha
J
John MoffatTutor·
You are welcome :-)
L
lambujon99·
Hi sir, I'd like to clarify:
"Because the business does not have adequate funds to finance the special order, a bank overdraft amounting to $20,000 would be required for the project duration of three months." Does this not mean that they spent specifically 20,000 more to finance the special order, therefore, is considered an opportunity cost?
J
John MoffatTutor·
No. There is no mention of them having to spend the $20,000 on anything specific. So presumably they will pay back the $20,000 later and the only relevant cost is the interest.
(This is in fact a very old exam question)
Y
yulia150391·
Hi,
Thank you very much John. I am so sorry but I did not understand in the example 2, in the note 3, why do we ignore general overheads of $3,000. Could you please explain one more time here.
Many thanks in advance
A
Azeez·
As explained, the overhead apportionment of $3000 would be incurred whether or not the special order is made. However, the incremental cost of $1000 is an extra cost resulting directly as a result of the engagement of the new special order which is a relevant cost. I hope this helps
N
Nodirjon·
Good day sir,
I think, I misunderstood #2 of example 2: In the notes it says "In addition, the supervisor would lose incentive payments in his normal work amounting to $2,500." From that sentence, doesn't it mean that the supervisor would lose incentive during normal work and that is why in the special order work he/she is gets the incentive?
Thank you in advance for your clarification!
J
John MoffatTutor·
The company will not pay him the normal bonus (of $2,500) and so the company will save $2,500), but instead they will pay him $3,500 and so the net cost to the company will be an extra $1,000.
L
Levan·
Good day,
#5 of example 2. If you have available capacity of 4000 hrs and the special order needs 6000 hr. shouldn't the cost be 2000hr @$3 per hr (needed to make up that 6000 hr) plus the opportunity cost of taking that 2000hr off their normal job? Because there is no extra cost involved for that 4000 hrs if the machine has the capacity.
J
John MoffatTutor·
Although the machine is capable of running for an extra 4,000 hours, it is not currently doing so (which is why there is available capacity). If it does run for the extra 4,000 hours then there will be extra running costs (such as more electricity used).
T
Tugcem Kocadal·
Hi John
Thanks for the lecture again.
Relating this question, if it wasn't the machine and it was labour that has spare capacity, do we still pay extra? We already pay them anyways yes?
J
John MoffatTutor·
It depends on the wording. If labour is paid a fixed salary then there is no extra cost. If labour is paid by the hour then there will be extra cost.
V
Vidhi·
Hello Mr John,
I have question for point 5
4000hrs is available capacity which means machine is anyways idle for 4000hrs and hence idle capacity hours relevant cost is 0.
For 2000 hrs *5 = 10000 shall be relevant cost??
A
alie2018·
Thanks John. Excellent presentation. Only future incremental cash flows should be considered as relevant in undertaking the special order. It is economical to hire cheaper subcontractors for the special order than higher cost might suggest. Fixed cost is not relevant unless there is an incremental fixed cost or a directly attributable fixed cost (product specific fixed cost). Apportioned costs are not relevant. Opportunity cost is always relevant (value of the best alternative foregone for the special order).
Depreciation is not a cash flow so not relevant. Sunk (dead) cost in respect of materials is never relevant (we can't change the past).
H
hitsui·
Hello,
could you please explain why we are not using the replacement cost instead of the disposal cost of ($4.20)?
Because material is no longer used, but it is used for the special contract.
So i thought that we would use the materials at cost $33.375 and the remaining materials will be sold off.
Im just confused and can't understand unless this isnt cleared, please.
J
John MoffatTutor·
They could do what you suggest, but they would then be paying out 33,375 to buy new materials and would only be receiving 31,500 by selling the existing materials.
It would therefore be cheaper to not buy new materials and simply use the existing materials.
S
saiteja·
Hi John ,
In the bank overdraft part of the question , I have considered a different scenario where the company has adequate funds yet decides to take a loan amounting to $20,000 specifically dedicated for the one-off job and would be repaid after the same 3 month duration and for example this was done to allocate the existing companies funds to expenses without going negative in the bank balance. Will the $20,000 loan for the specific job be considered as extra costs relevant to the one-off job in this scenario ?
Thank you very much for the lectures Sir.
J
John MoffatTutor·
No - the situation would be exactly the same. Just as with the overdraft, the money is repaid (and so not actually spend on the project) and therefore the only cost is the interest.
A
aayushi·
Sir I am still very confused.
20,000 is more like a replacement cost, because your going to have to take the bank overdraft because youve used up 20,000 from the amount set aside for the normal course of actions.
J
John MoffatTutor·
The question lists where money is spent and presumably that is the reason they went overdrawn, but there is no mention of specifically spending thee 20,000 on anything. If you borrow 20,000 from me, you will have to repay me and the cost involved of borrowing is just the interest you would have to pay me.
A
Avery·
Sir, regarding the final point on the overdraft issue, isn't the bank overdrafting $20,000 because of the special project? Does it not mean that if the special project wasn't accepted then an overdraft of $20,000 wouldn't occur? So, Shouldn't we add $20,000 in addition to the interest payments?
I'm hoping you can clarify
Thank you so much
J
John MoffatTutor·
It is true that the overdraft would not occur (and therefore they would not be paying interest).
However it does not say that they spent the 20,000. It simply means that their balance balance goes negative for three months (and then presumably it stops being negative at the end of three months).
A
Avery·
thank you sir
J
John MoffatTutor·
You are welcome :-)
J
Jassim·
Hi
why we do not charge the whole 18% interest but only for 3 month , as understood the the OD is taken because of this special order so the whole interest should relevant not only 3 month duration of the job. please clarify my doubt
thanks
J
John MoffatTutor·
Interest is always given as a yearly rate (unless told differently). Therefore the interest has only been calculated for 3 months.
F
Faridzi·
Sir,
Can you explain for the materials part as I don't really quite understand. I will appreciate your help.
T
tabusheev·
When you account for machine overheads, why you multiply $3 electricity for 6000 hours, when there are 4000 hours available capacity? If you take 2000 hours of capacity from another process, so you will not spend extra electricity for it.
J
John MoffatTutor·
Correct - we will be paying the electricity anyway. However we will be losing the revenue from the other job and saving all the other variable costs (except for electricity).
The net loss (revenue less other variable costs) is always the same as the contribution plus the electricity.
Point 5. Given that the machine has 4000hrs available capacity, why are we recognising the whole 6000hrs*3=$18 000 has the relevant cost. And not 2000hrs*3=$6000 cost and lost contribution of 2000*2=$4000?
brilliant lecture as always. I would like to rephrase EllaZ's question above.
If we recognise 6,000 hours of electricity cost for the extra job, why don't we recognise 2,000 hours saved from the normal job since it was not used? That would reduce our costs by 6,000.
Thanks!
Material A (9,000 kg RM26 per kilo) at RM 234,000
The note for this cost is the Material is in continual use and there are 3,000 kg of material in stock, which was purchased at RM26.00 per kg. The current cost of the material is RM32 per kg.
How should I recognise the relevant cost? Is it 6000kg x RM32 per kg?
What about this one :
Unskilled labour (8,000 hours RM7 per hour) at RM 56,000
The note for this cost is Unskilled labour is only employed when such workers are required.
By using 7,500 kg in the project they would be losing the revenue that they would otherwise have got from selling the material. (The other 2,500 kg would be sold anyway whether or not they do the project).
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
but since we only have 4000 limited hrs available, 2000 hrs will be used for the special order instead of normal work with $2 cont. $2*2000 = $4000 is lost income/opportunity cost
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.
Thank you so much for this lecture!!!
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.
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 :-)
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.
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)).
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)).
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.
A big thank to you Sir ?
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
machine hours is available whether we use it or not.right?
so why do we need to take into account?
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.
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 ....
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.
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!
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 $20,000 as a result of our decision to purchase the replacement instead?
Thanks in advance!
Regards,
Tim
I’m a bit confused at the note 5.
The machine has 4,000h capacity only and this special order will have to steal 2,000 h from an existing job. So I think this 2,000h would have happened anyway no matter we decide to take this special order. So the material o/h cost would be 4,000x3=12,000$
Opportunity cost is 2,000x2= 4,000$
Total= 16,000$
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.
i enjoy your enthusiasm and conceptual understanding for mathematical problems.
In Example 2, while calculating the relevant cost of point 4 (i.e. Machine maintenance cost). What if due to inclusion of new work, the company change its depreciation policy and say if it was to be depreciated previously over a period of 40 years, after inclusion of new product line company start to depreciate its relevant class of asset over a period of 30 years which results in more depreciation charge on monthly basis. Would that additional charge on monthly basis be treated as the additional cost due to addition of new product line, and the same shall be considered as additional cost?
In Example 5, as you mentioned that losing contribution of $2 due to inclusion of new production will only be considered if the new production gives at-least $2 or more contribution. Since we do not have details available about the contribution of new production so why we considered the taking off existing job of 2000 units?
In Example 6, why we are treating purchase cost of 7,500 kg material as a sunk cost despite that we have option available to recover this amount at $4.20 per kg.? Shouldn’t the difference of purchase price of that material (which is although not given in question) and the recoverable amount is treated as sunk cost?
Thanks in advance for your precious time!
If we do the contract then 2,000 hours will be taken away from the existing job. Therefore we will lose the contribution that could be earned and this is therefore effectively a cost of doing the new contract. It is irrelevant what contribution we earn from the new contract. We are calculated the total cost to the company of doing the new contract. It is only when we know what it will cost us to do that we can decide how much we need to charge to do it.
The materials have already been bought and the money has been spent whether or not we do the new contract. The original cost is therefore irrelevant. All that is relevant is that if we do the new contract we will then not be able to sell the inventory and so doing the contract will lose us the $4.20 that we would otherwise receive.
Have you watched the lecture working through this example?
I am not very clear on committed cost and why do we not include it in relevant costing. Can you please give me an example of committed cost?
For example, is a solicitor's cost committed cost? It is usually paid wether or not the deal goes through. As it is relevant to the project itself, I would think of it as a relevant cost.
Many thanks!
In the bank overdraft of $20 000, you had a reply wherein you said that it would be paid back in the future. Therefore, is it safe to say that it is a committed cost since we will pay it back whether or not we take the special order?
i saw someone asked this already, but still not sure why you calculate it that way then. So if I use machine 4000hrs extra and add lost contribution, I calculate it as 4000x3 + 2000x2 = 16000 or 6000x3 + 2000*(2-3), where 2-3 represents lost contr. minus saved machine OH, in both cases you get 16k relevant costs. What am I forgetting here so I would get to 22k like you did?
Thanks for assistance in advance, much appreciated.
So in total they are losing 2,000 x $5 = $10,000. In addition they are paying for another 4,000 hours at $3 per hour, which is $12,000. So a total of $22,000 :-)
Best, Miha
"Because the business does not have adequate funds to finance the special order, a bank overdraft amounting to $20,000 would be required for the project duration of three months." Does this not mean that they spent specifically 20,000 more to finance the special order, therefore, is considered an opportunity cost?
(This is in fact a very old exam question)
Thank you very much John. I am so sorry but I did not understand in the example 2, in the note 3, why do we ignore general overheads of $3,000. Could you please explain one more time here.
Many thanks in advance
I think, I misunderstood #2 of example 2: In the notes it says "In addition, the supervisor would lose incentive payments in his normal work amounting to $2,500." From that sentence, doesn't it mean that the supervisor would lose incentive during normal work and that is why in the special order work he/she is gets the incentive?
Thank you in advance for your clarification!
#5 of example 2. If you have available capacity of 4000 hrs and the special order needs 6000 hr. shouldn't the cost be 2000hr @$3 per hr (needed to make up that 6000 hr) plus the opportunity cost of taking that 2000hr off their normal job? Because there is no extra cost involved for that 4000 hrs if the machine has the capacity.
Thanks for the lecture again.
Relating this question, if it wasn't the machine and it was labour that has spare capacity, do we still pay extra? We already pay them anyways yes?
I have question for point 5
4000hrs is available capacity which means machine is anyways idle for 4000hrs and hence idle capacity hours relevant cost is 0.
For 2000 hrs *5 = 10000 shall be relevant cost??
Depreciation is not a cash flow so not relevant. Sunk (dead) cost in respect of materials is never relevant (we can't change the past).
could you please explain why we are not using the replacement cost instead of the disposal cost of ($4.20)?
Because material is no longer used, but it is used for the special contract.
So i thought that we would use the materials at cost $33.375 and the remaining materials will be sold off.
Im just confused and can't understand unless this isnt cleared, please.
It would therefore be cheaper to not buy new materials and simply use the existing materials.
In the bank overdraft part of the question , I have considered a different scenario where the company has adequate funds yet decides to take a loan amounting to $20,000 specifically dedicated for the one-off job and would be repaid after the same 3 month duration and for example this was done to allocate the existing companies funds to expenses without going negative in the bank balance. Will the $20,000 loan for the specific job be considered as extra costs relevant to the one-off job in this scenario ?
Thank you very much for the lectures Sir.
20,000 is more like a replacement cost, because your going to have to take the bank overdraft because youve used up 20,000 from the amount set aside for the normal course of actions.
I'm hoping you can clarify
Thank you so much
However it does not say that they spent the 20,000. It simply means that their balance balance goes negative for three months (and then presumably it stops being negative at the end of three months).
why we do not charge the whole 18% interest but only for 3 month , as understood the the OD is taken because of this special order so the whole interest should relevant not only 3 month duration of the job. please clarify my doubt
thanks
Can you explain for the materials part as I don't really quite understand. I will appreciate your help.
The net loss (revenue less other variable costs) is always the same as the contribution plus the electricity.