Question 1 - December 2011

Question 2 UU Co has been asked to quote for a special contract. The following information about the material needed has been given, Material X – book value - $5/kg, scrap value - $0.50/kg, Replacement cost - $5.5/kg. The contract requires 10kg of material X. there are 250kg of this material in inventory which was purchased in error over 2 years ago. If material X is modified, at a cost of $2/kg, it could then be used as a substitute for material Y which is in regular use and currently costs $6/kg. Required- what is the relevant cost of the materials for the special contract? Soln The relevant cost is the higher of 1. Disposal value = $1/kg * 4kg = $4 OR 2. Alternative use $5/kg * 4kg = $20 Modification cost 5kg * 40.75 = ($3.75) Relevant cost = $16.25 - $16.25/5 kg = $3.25 I don’t understand why my working to question 1(above) is wrong, given that I used the same “rules” to arrive at the correct answer for question 2. Is it because in question 1, swipe 1 is not primarily required in this particular project i.e. it’s an alternative (can only be used if modified) where as in question 2, material X is required and not a substitute for the particular project. (I hope this makes sense) Please shed some light.

Q1. If they buy Swipe 2 then they will pay $10,800 and will sell the existing Swipe 1 for $3,000. This costs them a net $7,800. Alternatively they can use the existing Swipe 1 in which case they will pay $4,600 to modify it and lose the $3,000 they could have received from selling it. A total cost of $7,600. Using Swipe 1 is the cheaper option at $7,600.

Q2 I don't know where you are getting your figures from in either of the two solutions you have typed out. The book value of the inventory ($5) is of no relevance, and they need 10kg so I do not know where you are getting 4kg from. The disposal value is $0.50 per kg and not $1. If it is a past exam question or a question in the current edition of the BPP Revision Kit, then please tell me which question :-)

Sorry, I keyed the incorrect solution (for question 2). This question is in Kaplan exam kit question 72. As for question 2, the relevant cost will be the higher of 1. The disposal value = 10kg * $0.5 = $5 OR 2. Its alternative use = 10 kg * $6/kg = $60 Modification cost = 10kg * $2/kg = ($20) Relevant cost = $40 Therefore, the relevant cost is $40. (correct answer as per the Kaplan exam kit) As for question 1, the answer is $7600 (as you explained) My question – as what I have understood so far in relevant costing is that, if an alternative use is available then, the relevant cost is the higher of 1) The disposal value of the material 2) The alternative use (this is exactly what I did for the above solution where I got the relevant cost of $40) But, I ended up with the wrong answer if I use the same “rules” (as above). Will I be correct to say the differences between the 2 questions are, 1. in question 1, the Co has an option to buy the swipe 2 or modify the swipe 1. Obviously then the Co will choose the cheaper option (that is to modify swipe 1, as you explained) 2. the difference comes in question 2, where the Co does NOT have an option to choose between materials ie it must use material X (unlike question 1), so the relevant cost will be the higher of disposal value or its alternative use. 3. My workings for question 1 would have been correct if the question is slightly changed, for example, swipe 1 is required for the current project (cannot be replaced), but could be used as an alternative (after modifying it) to swipe 2 in other project. The rest of details are the same. I would have been right with $6200 relevant cost (the workings in the very top of this page) Sorry for such long queries. Please confirm

You cannot learn relevant costing as a set of 'rules'. It all depends on the information in the question and every question is deliberately worded differently because the examiner wants to test that you understand the idea and not that you have simply learned 'rules'. You cannot compare these two examples. Have you watched my free lectures on relevant costing? The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.