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I have a problem understanding the relevant cost of material. Kaplan textbook has given a diagram fot that but I have still few doubts that I have understood them perfectly. Please correct me if I am wrong anywhere!
1) If we have material in stock which is also in regular use [which means that we need to buy new material to employ in the contract?] true?
Then RC would be current purchase price
BUT
2) If the material is not in regular use [which I suppose mean that we have spare material which is not used anywhere in the company so we can use them in the contract]
Here we have two choices either we can sold off spare material as scrap or we can use it in our current project.
Then RC would be scrap value or lost contributionBut the diagram says to see whether there is any alternative use for the spare material which give us two choices such as:
No, there is no alternative
Then RC would be = scrap valueYes, there is an alternative
Then RC would be (higher of) = scrap value or alternative useCould you please explain my doubt (2) that whether it is true that scrap value of material is also called opportunity cost which is acutally a lost contribution in a sense that we lose an opportunity of selling the material as scrap but rather used it in our current relevant project?
Secondly, as the diagram says that look for whether the spare material has any alternate use & if yes then we have to take higher value of either scrap value or alternative use. Could you please explain whether alternative use is also opportunity cost?
1 is correct.
For 2, if there is no alternative use then the relevant cost is the lost scrap proceeds.
That is an opportunity cost but nothing to do with lost contribution – an opportunity cost. simply refers to lost income.If there is an alternative use then the relevant cost would be the higher of the scrap value or the alternative use. Again both would be an opportunity cost because they both would represent lost income.
Be careful of trying to learn relevant costing by learning diagrams. The examiner is very clever in designing questions which test your understanding as opposed to how well you have learned a diagram.
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.
I’ve watched your lecture completely!
From your second line, I guess that you’re trying to say that there is a difference between opportunity cost & lost contribution (I thought they were both the same thing!)
If it is true then I understood opportunity cost as you stated that it is a lost income but what is a lost contribution then! and how would I identify it in the exam question?
Could you please also state an example where the relevant cost is higher of either scrap value & alternative use? I don’t understand the alternative use part and how would we be able to identify it?
Thanks in advance 🙂
Sorry I see now that my second line reads a bit confusing. What I was trying to explain was that an opportunity cost is lost income. In your statement 2 the lost income is the sale proceeds and so this is an opportunity cost (lost contribution is also an opportunity cost, but there is no lost contribution is this case).
As far as examples are concerned, alternative use is not common in the exam and how you would identify it depends on the wording of the question. Do not simply learn rules (even though I know study texts tend to have a complicated chart!) – the examiner deliberately sets questions checking that you understand the particular situation and have not simply learned rules.
You will have plenty of questions on this in your Revision Kit. If you come to one where you do not understand the answer then ask in this forum and I will explain.
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