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- June 5, 2020 at 1:35 pm
“If a material is in short supply, then the only way a proposal can be undertaken would be by denying another part of the organisation that resource.
In this case the relevant cost = normal materials cost + lost contribution in the other department.”
Sir why will the ‘normal materials cost’ be counted as relevant cost? material cost would be incurred whether we make products using that material in one department or other, its a cost that will be incurred regardless. So how is it relevant?June 5, 2020 at 4:43 pm
I do explain this in my free lectures, but I will explain again here with a simple example.
Suppose the materials are currently being used in another product which has a selling price of 100 per unit, a materials cost of 20 per unit, and other variable costs of 10 per unit (such as. labour). So a contribution of 70 per units.
If the material is taken to use for a new contract then for every 20 of material taken they will lose the revenue from the current product of 100. They will also save the other variable costs of 10 that are not being spent on the current product. (They will still be spending 20 on materials, so no saving there.)
So the net amount lost (and therefore the relevant cost) is 100 – 10 = 90.
This is the same as (and will always be the same as) the lost contribution of 70 plus the cost of the materials of 20.
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