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Sir could u pls explain the answer to this question: Event hough i have understood the concept of relevant costing
H has inventory 15,000 kg of M, a raw material which it bought for 3/kg five yrs ago, for a product line which was discontinued four yrs ago. M has no use in its existing state but could be sold as scrap for 1 per kg. One the company’s current products (HN) requires 4 kg of a raw material, available for 5 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?
The original cost of M is not relevant, because it is a sunk cost.
The lost scrap value of $1 is not relevant because they will lose the $1 whether they modify and use it in HN or whether they use it for the new product.However if they use if for the new product, they will have to buy raw material specially for HN at a cost of $5 per kg, but they will save $0.75 a kg because they will not need to spend money modifying M.
So the relevant cost is 5 – 0.75 = $4.25 per kg.
Ooops – I have realised my mistake 🙂
I will start again!!
Currently, for every unit of HN they are using 5kg of M and are therefore paying 5 x 0.75 = 3.75 to modify it.
If they use M for the new product, then will not be paying 3.75 for every unit of HN but will instead have to pay for 4kg of raw material at $5, so a cost of $20 per unit.
Therefore every 5 kg of M that they use for the new product will cost them an extra 20 – 3.75 = $16.25. That means the cost per kg for taking M is 16.25 / 5 = $3.25
(I think you will find that the Kaplan Kit does show $3.25 as the correct answer (not $3.35))
Sorry about that 🙁
Sir last question, when the question states “in its present state” it means that material M should use the same amount of kg in the new product as it is used in product HN?
I subtracted 3.75 because although they will have to pay for the other material, they will save from not having to modify material M.
No – present state simply means it will not need modifying.
Because (as I wrote before) for every 5kg that they use it will cost them an extra 16.25.
The question asks for the cost per kg and so if 5 kg is 16.25, then one kg is 16.25 / 5
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