Relevant costing for materials

This topic has 3 replies, 2 voices, and was last updated 7 months ago by John Moffat.

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November 8, 2021 at 10:38 am #640218
fizaali
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1) Material exists but regularly used:
If materials already exist in inventory & regularly used then we need to purchase new material for the contract.

Relevant cost = material units x current purchase cost

2) Material exists but not regularly used:
If materials already exist in inventory & no other use of them except for utilizing them for the contract. Then the relevant cost would be opportunity cost which is higher of scrap value and Alternative use foregone

Relevant cost = Opportunity cost
Higher of: (1) Scrap value (2) Alternative use foregone

Could you please tell me how to calculate alternative use foregone when we modify existing material in order to use them for alternative material?
November 8, 2021 at 3:40 pm #640230
John Moffat
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It is the net incremental cash flows that would occur if they did the alternative.
November 8, 2021 at 5:32 pm #640237
fizaali
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Thanks for that but please first tell me what I said in my previous query was correct about scenarios of relevant cost when material is regularly used and when it is not regularly used?

For example:
If a contract requires 100 kgs of material X which is not regularly used but it can be modified at a cost of $12 per kg so it could be used as substitute for material Y which is in regular use and currently cost $20 per kg.

[doubt 1]
We have a choice either to buy the material Y at $20 or we could modify material X at $12 which obviously we prefer to modify and use it due to lower cost.

Since we are considering the option to modify and losing the opportunity of purchasing material Y at a cost of $20 so the opportunity cost is the net incremental cost of $8.

[doubt 2]
But I don’t understand that how it could be incremental cash flow because we are modifying because of lower cost so we actually don’t have any incremental cost rather we have a saving of $8.

Please help me here with these two doubts which one is correct?
November 9, 2021 at 3:04 pm #640284
John Moffat
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If we did not use it in the new contract then we would modify it, use it instead of material Y and therefore save $8.

If we use it in the new contract then we do not make that saving and there is therefore an opportunity cost of the lost saving of $8.
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