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I hope you are doing well,
The question is as follow,
A research contract, which to date has cost the company $150,000 , is under review
if the contract is allowed to proceed
*It will e competed in approximately one year
*the results would then be sold to a government agency for $300,000
Shown below are the additional expenses which the managing director estimates will be necessary to complete the work
=Share of general building services.
*the contract is charged with $35,000 pa to cover general building expenses.
*Immediately after the contract is discontinued, the space occupied could be sub-let for an annual rental of $7000.
=Answer as per Kaplan Text book,
General building services.
Opportunity costs of rental foregone 7,000 which should be considered in the decision making.
**Actually sir I have some confusion about this point I mean why the amount of $35,000 is considered irrelevant to the decision whilst it is mentioned in the head of the question that the following are additional expenses will be incurred to the contract.
If we apply the relevant cash flow cost principle according to my understanding will get the following answer.
1- Cash position if we accept the proposal-as the cost of general services for the current year of the contract $35,000
2- Cash position if we reject the proposal-as the opportunity costs of rental foregone ($7,000)
= So, the relevant cash flow should be considered in the contract costing is the difference (1-2)=$28000.
Could you help me out to understand why am I wrong,please?
Thank you in advance.
The $35,000 is irrelevant because it is a share (apportionment) of existing general expenses. Whatever the total general expenses are, they will remain the same in total whether or not the contract proceeds. I do make this point in my lectures on relevant costing.