- This topic has 3 replies, 3 voices, and was last updated 1 year ago by
.
- Posts
Ace limited is considering a new project that will require the use of a currently idle machine. The machine has a current book value of $12000 and a potential disposal value of $10500 (before $200 disposal costs) and hence has been under depreciated by $1500 over its life to date. If the machine is to be fit for purpose on the new project it will have to be relocated at a cost of $500 and refitted at a further cost of $800.
What is the relevant cost of using the machine on the new project?
The answer is 10300+1300 =11600
I didn’t understand how 1300 is calculated and why it is included as a relevant cost. ? Depreciation is not a cash flow right so why is it considered here ?The relevant cash flow is:
Lost disposal proceeds (net) $10,300
Additional costs of set up $1,300
Total $11,600
By using the machine we lose the scrap proceeds that we could have received if we did not use the machine but sold it instead (an opportunity cost). In addition we have the extra costs of relocating and refitting. (500+800)
Have you watched the free lectures on relevant costing?
Good day Sir,
Can you confirm for me please: Opportunity cost= actual cost (labour or material) + Loss of Contribution per labour hour or machine hour.
Thank you in advance.
No
An opportunity cost is income lost as a result of doing something.
A cost of taking one decision is the profit or contribution forgone by not taking the next best alternative.
If resources to be used on projects are scarce this could be labour, materials, machines ….then consideration must be given to profits or contribution which could have been earned from alternative uses of the resources.
Watch our video on relevant costing ?
- You must be logged in to reply to this topic.