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There is a relevant cost question that I’m confused with…
[Question]
Units needed for a contract is 200kg while quantity currently in inventory is 100kg with the current resale value is $15/kg & current purchase price is $22/kgMaterial A is no longer used and has no alternative use in the business
[Answer]
Material B – 100 kgs in stock could be sold if not used in the contract
Sold = 100 kg x $15 = $1500The other 100kg needs to be purchased at $22
100 kg x $22 = $2200Total relevant cost will be 1500 + 2200 = $3700
My question is that the question states that the contract needs 200kg while 100kg is in the inventory. So, we will sell the 100kg on resale value as they are scrap. But then we will need 200kg which is the requirement of the contract but in the answer, it states that only 100kg will be bought. BUT WHY?
I didn’t see the exact question by to my understanding the relevant cost for contract is the amount required to purchase new stock that is still missing so in this question (100 is already in inventory and) 100 kg needs purchasing at current price plus any contribution foregone which is 100 × 15 which is what we would get otherwise if sold instead of used in contract.
We won’t be selling the goods already in inventory hence we only requiring 100 kg, however we need to price it for contract and we need to account for the fact that 100 kg used from inventory could otherwise be sold so we have lost the contribution of 1500 hence this also need to be charged on contract.namah1: Please do not answer questions in this forum because it is the Ask the Tutor Forum. However please do help people in the other PM forum.
john1998m: The question does not say they will sell the 100kg in inventory, It says that they will sell them if they do not do the contract. Therefore if they do the contract they will use the 100kg in inventory and there is then an opportunity cost of the lost sale proceeds of $15 per kg.
This (and variations of it) is a very common question in the exam because it is such an important concept.
I do suggest that you watch 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.
Sir John, you missed the line in question stating ‘Material A is no longer used and has no alternative use in the business’.
If the material is no longer used in the business then it would have probably been sold as scrap by the company rather than being used in the contract.
So, if we have sold the 100kg in the scrap, then we still need to buy 200kg for the contract not 100kg as mention in the answer. That is what confuses me!!!
Sir John Moffat, you missed the line in question stating ‘Material A is no longer used and has no alternative use in the business’.
Sorry, there is a typo made in the Answer, it is Material A, not B.
If the material is no longer used in the business then it would have probably been sold as scrap by the company rather than being used in the contract.
So, if we have sold the 100kg in the scrap, then we still need to buy 200kg for the contract not 100kg as mention in the answer. That is what confuses me!!!
I certainly did not miss the line!!!
The 100 kg material has obviously not yet been sold because the question says that it is still in inventory.
They can either sell it and receive $15 per kg, or they can use it in the contract and not need to spend $22 per kg.
They will obviously be better to use it in the contract and lose the $15 that they could otherwise have received rathe then spend $22 buying more.
Questions like this are always asked in the exam and I suggest again that you watch my free lectures on Relevant Costing.
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