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Hi Sir
Here is the question, ‘The company is preparing a quotation for a one-off job that would require 1200 kg. There are 900 kg of material B in inventory that were bought at a cost of $3 per kg. The company does not foresee any other use for the material The material held in inventory could be sold for $3.50 kg. The current purchase for material B is $4.50 per kg.
The relevant cost for material B to be included in the cost estimate is?
Could you please help me how to answer this type of question? I tried reading your notes but it doesn’t help me answer this question. All I know that relevant costs are; differential, not sunk cost, incremental and not fix cost. Could you please explain the rules in tackling relevant cost questions.
Thank you in advance.
You cannot really learn rules for relevant costing.
You have to ask yourself what will be the effect on the company of doing the work compared with not doing the work.Since they need 1200 kg, they will take 900 kg from inventory and need to buy the other 300 kg.
For the 300 kg they have to buy, there is no problem – it will mean paying 300 x $4.50 (the current purchase price).For the 900 kg in inventory, since there is no other use for it, if they were not to do the contract then they would sell it for $3.50 per kg. Using it in the contract means that they will not be able to sell it and will therefore lose 900 x $3.50 that they would otherwise have received – an opportunity cost.
Therefore the total relevant cost is (300 x $4.50) + (900 x $3.50)
(Dealing with inventory as in this question is very standard – you can find lectures on relevant costing in the revision section of the F5 page)
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