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					                             Relevant Cost for Material

Case-1   Opportunity Cost of Material already purchased and               Nil
         having no other use in current production process
         and having No Realisable Value.
Case-2   Opportunity Cost of Material already purchased and       Opportunity Cost of
         having no other use in current production process       the Material i.e., Best
         but having Realisable Value.                               Alternative Use
Case-3   Opportunity Cost of Material required under               Realisable Value
         proposed production. Only some portion thereof is
         held in stock out of purchase and having no other
         use in current production process but having
         Realisable Value.
Case-4   Opportunity Cost of Material already Purchased and       Replacement Cost
         held in Godown and having Regular Use in current            i.e., Current
         production process.                                       Purchase Price
Case-5   Opportunity Cost of Material already Purchased and       Replacement Cost
         held in Godown and having Regular Use in current            i.e., Current
         production process as a substitute Material.              Purchase Price
Case-6   Opportunity Cost of Material already purchased and      Saving in Additional
         having no other use in current production process        Disposal Cost i.e.,
         and having No Realisable Value but can be                Benefit or (-) Cost.
         disposed by incurring some additional cost.
Case-7   Opportunity Cost of Material (Say A) already           (a) Resale Value of
         purchased that can be used after suitable alteration   Material A
         in place of other material (Say B) or can be                      or
         disposed off.                                          (b) Current Purchase
                                                                Price of Material B –
                                                                Alteration cost of
                                                                Material A.

                                                                w.e. is higher



Instead of all the above 7 cases remember simple Funda: -

Already purchased Material not used in     The maximum Benefit you can drive from
Regular Production Process                  the Material is the Opportunity Cost. (for
                                            other than using in an offer)
                                          If used in Offer the Old Purchase Price.
Material used in Regular Production      Current Purchase Price
Process or Material required to be
purchased for the offer.



                                             1
Q.1.
Material P, used till last year, now not used, have no market
Already Purchased                               5,000 units @ Rs.2
Management decided to either give this material to someone for Free or through it away
without incurring Further Cost. By chance the concern receives an offer which will
require exactly 5,000 units of this Material P.
What will be the Opportunity Cost of the Material P?

Sol.) The Opportunity Cost of this Material P will be Nil, which is measured from the
Best Alternative Use of the available market i.e., either to give this material to someone
for free of cost or through it away without incurring further cost.

Q.2. What if in the above example Material P can be sold in the Market @ Rs.1?
Sol.) Then the Opportunity Cost will be Rs.5,000 (Best Alternative Use)

Q.3. Material P,
Already Purchased                              5,000 units @ Rs.2
used till last year, now not used, but having Realisable Value of Rs.1
There is an offer to produce a particular product which will require 12,000 KG of
Material P. Material P is currently available in the Market @ Rs.3. What will be the
Opportunity Cost of the Material required to be used for proposal under consideration?
Sol.)
Opportunity Cost of Material P: -
Already Purchased (5,000 units)                  Rs.5,000 (Best Alternative Use)
7,000 units to be purchased                      Rs.21,000 (i.e., Current Purchase Price)


Q.4. Suppose a concern uses Material X in its “Routine Production Process”
Already Purchased (Last year Purchased in Bulk)                @ Rs.7 per kg
40,000 Kg. still in Godown, The same Material is now available @ Rs.9
Now, 8,000 KG of the aforesaid material X is required for an Offer. Determine
Opportunity Cost.
Sol.)
     The Opportunity Cost of 8,000 units will be its Replacement Cost i.e., Rs.72,000
       (8,000 × 9)
     If we use the 8,000 Kg. of Material X for the Offer then we will have to purchase
       the same material from the market to meet the requirement under the regular
       production process and it will then cost us Rs.72,000 (8,000 × 9)

Q.5.
Material A Already Purchased (Last year Purchased in             @ Rs.7 per kg
Bulk)
Material A 11,000 Kg. still in Godown
If this material is not used for the proposal under consideration it can be used in place of
5000 KG of a substitute material Z which is in regular use.
The Current Replacement cost of Material Z is Rs.8 per KG. Find Opportunity Cost.


                                              2
Sol.) Rs.40000 (5000 × Rs.8)

Q.6.
Already Purchased Material P                     5,000 units @ Rs.2
used till last year, now not used, It can be disposed off by incurring an additional cost of
Rs.500
An offer received which will consume 5000 units of Material P. Find Opportunity Cost.

Sol.) (-) Rs.500

Q.7.
    Offer Requires 5000 KG of Material A
    Last year material A purchased in bulk @ Rs.10 per kg – 5000 KG still in
     godown.
    If Materail A is not used for the offer then it can be used after suitable alteration
     in place of Material B, which is in regular use.
    The current replacement cost of Material B is Rs.8 per KG
    The alteration cost of material A to be used in place of Material B is Rs.2 per Kg
    The current Resale Value of Material A Rs.4 per KG
    What will be the Opportunity Cost of Material A required to be used for the offer?

Sol.) Rs.30,000


                                          Labour
Labour is of two types: -

   (1) Casual Labour
           It means Temporary Labour.
           Payment according to work only.
           It may be Idle or Busy (if Busy it means Short Supply)

   (2) Permanent Labour
           Those Labour to whom the management could not reduce, retrench,
          terminate, due to an agreement with labour.
           Agreed Labour payment irrespective of work.
           It may be Idle or Busy.

                                 Relevant Cost of Labour

                                           Idle                            Busy
Casual                              Cost to be incurred            Cost to be incurred +
                                                                    Contribution Lost
Permanent                                    Nil                Benefit Lost (ignoring Sunk
                                                                           Cost)



                                              3
                               Relevant Cost of Machines

                Machine                                     Relevant Cost
                 Useless                              Difference of Resale Value
               Regular Use                          Difference of Replacement Cost

Example-1

Machine (Original Cost)                         Rs.100000
Life of Machine                                 5 Years
WDV                                             Nil
Resale Value                                    Rs.10000
No other use of the machine.

Offer: To use the machine for construction of a Guest House for 1 year.
       Resale Value after 1 year is Rs.1000
Find out the Opportunity Cost of Machine.

Sol.)
     Relevant Cost of utilising machine in order to complete the offer is Rs.9000
      (10000 – 1000), that is benefit lost due to acceptance of offer.
     If the machine has no other use then Relevant Cost is difference of Resale Value.

Example-2 – (Relevant cost of machines which are in Regular Use)

The Company has M1 type of Machines which are of regular use. The company receives
an offer for construction of guest house. The Company requires M1 type of machine.
    - Current Purchase Price of Machine at beginning of the Year Rs.100000.
    - Such machine shall be transferred to regular work at Rs.90000 at the end of work
        of offer.
Sol.)
Cost to be incurred                                                            100000
(-) Transferred Cost                                                            90000
                       Difference of Replacement Cost                           10000




                                            4
                            Relevant Cost for Fixed Assets

                                      Overheads




                         Fixed                         Variable




      Avoidable                      Unavoidable


Fixed Overheads

(1) Avoidable Fixed Costs are always relevant for the decision (cost to be incurred) like
extra machine rent, extra supervisor salary.

(2) Unavoidable Fixed Costs: Always to be ignored due to Sunk Cost (future obligation
already decided).

    Change in apportionment does not change in cash outflow.
    For Decision Making Fixed Costs are always to be expressed in totality instead
     of unit wise.

Variable Overheads

    Variable Overheads to be incurred due to acceptance of offer, hence relevant for
     decision making.
    If Variable Overheads include Indirect Material, Indirect Labour then such
     Variable Overheads to be linked with Production.
    If Variable Overheads include Indirect Expenses (Power, Electricity, Energy)
     then Variable Overheads always linked with Working Hours.
    If the break-up of Variable Overheads are not given in question then always
     presume Variable Overheads include Indirect Expenses like power, electricity,
     based on hours.

If the Question is silent about nature of Resources: -
(i) Material                Slow Moving
(ii) Labour                 Casual
(iii) Casual + Busy         Short Supply
(iv) Overheads              Fixed – Unavoidable (allocated, absorbed, recovered,
                            apportioned, added to products, General Overheads)




                                           5
Drawings and Design
    If the drawings and design relates to the machine then such drawings and design
      to be termed as marketable.
    If the drawing and design relates to the infrastructure then such drawings and
      deign can not be termed as marketable.

Depreciation
    If offer consumes a substantial part of machine then existing machine not to be
      utilised for completion of offer. Hence we can say that in order to complete the
      order, fresh new machine to be purchased from market.
    And after completing the offer such new machine either to be sold or transferred
      to regular stock.
    If offer does not consume substantial part of the machine then no part of
      depreciation to be charged from offer.

Profit Centre
    Profit Centre means a unit of organisation in which profit earned on “regular
       basis”.
    In other words we can say profit earned only when actual output is more than
       Break-Even Level of output.
    Simply we presume Actual Output always = 100% capacity which means if any
       Department of Company to be a Profit Centre then say they are utilising 100%
       resources at Regular Basis. (No spare Capacity).
Example-1                                    Example-2
                Company                                   Company

A.O. > BEP (A.O. = 100% Capacity                             Profit Centre

                 Profit Centre                   A.O. > BEP (A.O. < 100%, say 80%)

                    Offer                            Offer for less than 20% units
Charge: -                                     Charge: -
Variable Cost                    XXX          Variable Cost                 XXX
(+) Cont. Lost                   XXX                                        XXX
                                 XXX

    Relevant Cost in case of Profit Centre comes to Variable Cost + Contribution Lost
    Contribution lost means Selling Price – Variable Cost and Contribution Lost
     does not mean Transfer Price – Variable Cost. Because Transfer Price to be
     termed as Notional Price.




                                          6
Cost Centre
                                      Cost Centre

                               Profit: Irregular Basis

                                        Costs



                       Variable                       Fixed
                    (Relevant Cost)                 (Unavoidable)

   Cost Centre means: -
       Unit of organisation in which the occurrence of profit are not consistence.
       Hence due to acceptance of offer, No Benefit Lost should be considered.
       Only the Cost which we are going to incurr (Variable Cost) should be charged
         from offer.

       If the nature of a Department is silent then always presume such Department
        to be a Cost Centre.
       All the activities of Research and Development Department, Planning,
        Designing, Engineering to be termed as preceding activity for Costing
        Division. Hence Cost incurred in these Departments to be termed as Sunk
        Cost in context of Decision Making.




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