Cost Accounting Decision Making Lecture-43 Main Ahmad Farhan

Relevant Cost of Material The relevant cost of raw materials is generally their current replacement cost, unless the material have already been purchased and would not be replaced once used. In this case recoverable amount will be its relevant cost.

Recoverable Amount Recoverable amount is the higher of realizable value or the value it will be used as an alternative decision.

Book value of units in stock Question ABC company performs a job for a manufacturing of an office tables and has been received a special job by a customer who is willing to pay Rs. 82,000. The job will require the following materials: Material Total units required Units already in stock Book value of units in stock Realizable value Wood 4,000 Sq ft ---- --- Glue 1,000 Lbs 600 2 2.5 Bolts 1,000 Pcs 700 3 Polish 200 Lbs 200 4 6.00 Replacement cost 200 5 4 9 First Wood , second glue than bolts than polish will appear Than 4000, 1000, 1000, 200 ,0 600,700, 200, ---,2,3 and so on

Question Glue is used regularly and if glue is required for this job it would need to replace d to meet other production demand. Bolts and polish are in stock as the result of previous over buying and they have a restricted use. No other use could be found for Bolts, but the Polish could be used in another job as substitute for 300 lbs of paint, which currently cost Rs. 5 per unit (of which the company has no units in stock at the moment) Required: Calculate the relevant costs of material for deciding whether or not to accept the job.

a). Wood has been purchased in full at the replacement cost of Rs a). Wood has been purchased in full at the replacement cost of Rs. 200 unit. = 4,000 x 200 = 8,00,000 b). Glue is used regularly by the company. There are existing stock 600 units if these are used on the contract under review a further 600 units would be bought to replace them. Relevant cost are therefore 1,000 units at the replacement cost of 5 per unit. c). 1,000 units of Bolts are needed and 700 are already in stock. If used for the contract, a further 300 units must be bought at Rs. 4 each. The existing stocks of 700 will not be replaced. If they are used for the contract, they could not be sold at Rs. 2.50 each. The realizable value of these 700 units is an opportunity cost of sales revenue for gone. Realizable value = 700 x 2.5 = 1,750 Replacement cost = 300 x 4 = 1,200 2,950

d). The required units o polish are already in stock and will not be replaced Realizable value Polish = 200 x 6 = 1,200 Value use in paint = 300 x = 1,500 Higher recoverable amount 1,500

e) Summary of relevant cost: Wood 8,00,000 Glue 5,000 Bolts 2,950 Polish 1,500 8,09,450 The price of project is Rs. 8,20,000. so accept the project.

Question ABC company is currently deciding whether to undertake a new contract of 20 hours of labor will be required for the contract. The company currently producing product S the standard cost details of which are given below: Standard Cost Card Product S Rs/unit Direct Material 200 Direct Labor 300 500 Selling Price 700 Contribution margin 200

Question Requirement: a) What is the relevant cost of labor if the labor must be hired from outside the organization. b) What is the relevant cost of labor if the company expect to have 5 hours spare capacity. C) What is the relevant cost of labor if the labor is in a short supply.

Solution a) Where labor must be hired from outside the organization, the relevant cost of labor will be the variable cost incurred. 20 hours x 25 per hour = 500 It is assumed that the 5 hours spear capacity will be b) Relevant cost of labor on new contract Direct labor (15 hrs x 25) 375 Spare capacity (5 hrs x 0) 0 Relevant cost 375

Solution c). Contribution margin earned per unit of product S produced = Rs 200 Rs 200 / 12 hrs = 16.67 Relevant cost of labor on new contract: Direct labor (20 hrs x Rs 25) 500 Contribution margin lost by not making product (20 hrs x Rs 16.67) 333.33 833.33