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

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  2. 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鈥檛 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!

    • 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.

  3. Hy Sir,
    Could you please explain me materials (note 6) the wording of amounting to 10,000 that is given in the bracket. What does that mean?

    Also when I checked to the answers at the end of notes it is given historic cost of 34000 (for note 6) what is this amount referred to?

    • 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?

  4. 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!

    • 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).

  5. 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?

  9. 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 4000×3 + 2000×2 = 16000 or 6000×3 + 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.

    • 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 馃檪

  10. 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?

    • 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)

  11. 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

    • 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

  12. 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!

  13. 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.

    • 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).

      • 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?

      • 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??

  14. 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).

  15. 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.

    • 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.

  16. 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.

      • 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.

      • 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.

  17. 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

  18. 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

  20. 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.

    • 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.

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