- This topic has 5 replies, 2 voices, and was last updated 4 years ago by
.
- Posts
Good Day
I am struggling with relevant costing, particularly figuring out what information is useful and what is not.
I can usually do the arithmetic but I find myself doing the correct arithmetic for the wrong options.
Here is a question in particular that I struggled with but there were some others also.H has in inventory 15,000 kg of M, a raw material which it bought for $3/kg five years ago,
for a product line which was discontinued four years ago. M has no use in its existing state
but could be sold as scrap for $1.00 per kg. One of the company’s current products (HN)
requires 4 kg of a raw material, available for $5.00 per kg. M can be modified at a cost of
$0.75 per kg so that it may be used as a substitute for this material. However, after
modification, 5 kg of M is required for every unit of HN to be produced.
H has now received an invitation to tender for a product which could use M in its present
state.
What is the relevant cost per kg of M to be included in the cost estimate for the tender?
A $0.75
B $1.00
C $3.00
D $3.25I have revisited the lectures and notes but I am still struggling the exam questions
You must have an answer in the same book in which you found the question, so please in future ask about whatever it is in the answer that you are not clear about 🙂
If they do not use M for the tender then they would have the choice of either selling the inventory of M or using it as a substitute for the other material.
Selling it would earn them $1 per kg.
Using it as a substitute would mean using 5 kg of M to save them buying 4 kg of the other material at $5 per kg. So they would save $20 for every 5 kg of M, which is a saving of 20/5 = $4 per kg. However they would have to pay $0.75 per kg, giving a net saving of $3.25 per kg.
As a result, if it wasn’t being used in the tender, they would choose to use it as a substitute for the other material and would be saving $3.25 per kg.
Using it the tender would mean that they would not make that saving and therefore the relevant cost is the opportunity cost of $3.25 per kg.
Ok thank you sir.
This was the answer:Replacement material cost saved (4 kg @ $5.00) $20.00
Less further processing cost ($0.75 × 5 kg) $3.75
–––––
Value of M in current use, for each unit made $16.25
–––––
Therefore opportunity cost of using M on the job being tendered for is $16.25/5 kg =
$3.25 per kg.I understand the calculation of the replacement cost but I don’t understand why we didn’t use the scrap option of $1 per kg as a relevant cost since it is also another option if they don’t use the tender?
The answer you have typed is exactly the same as the answer that I typed !!!
They will not be scrapping the material whatever happens.
You always have to decide what they will do if the material is not used in the tender. In this case, then as I wrote before they would use it as a substitute for the other material. Therefore they would save $3.25 per kg. So using it in the tender simply loses them the $3.25.
Had the scrap value of the material been (say) $5, then if they didn’t use it in the tender they would choose to sell as scrap rather than use it as a substitute (because $5 is greater then $3.25). So in that case, using it in the tender would lose them $5 and this would have been the relevant cost.
- The topic ‘I am struggling with Relevant Costing’ is closed to new replies.