Question

Question – 4                                                                                                         20 Marks

A Hardware company is considering a new project to improve its manufacturing capacity. A new project requires the use of an existing machine that would otherwise be sold.

The managing Director (MD) of the Company is aware about the concept of relevant costing but he is not clear about the application of it in a particular situation.

The following information is available about the machine

Original purchase price = OMR 40,000

Net Book Value of Machine = OMR 10,000

Current sales value (estimated) = OMR 9,000

Required:

1. If company is using the above machine, what is the relevant cost and what is irrelevant cost of the information available about the machine. Explain all the costs clearly.    

                                                                                                                                         10 Marks                                                                                                                                         

2. What do you understand by relevant cost? Explain the different Elements of Relevant Costing.                                                                                                                             10 Marks                                                                                   

Answer 1

Answer: Relevant costs’ can be defined as any cost relevant to a decision. A matter is relevant if there is a change in cash flow that is caused by the decision.the relevant cost is that cost which affects the decision of the decision-maker

An irrelevant cost is a cost that will not change as the result of a management decision. However, the same cost may be relevant to a different management decision. Consequently, it is important to formally define and document those costs that should be excluded from consideration when reaching a decision

applying the above definition-

Machine if not used for this job, will be sold, that sale value becomes Relevant cost. It is not used for this project then it could generate the cash flow, but it is now used for this so that the selling price of OMR 9000 will be relevant cost. The other two are irrelevant as the other two do not impact the result. Book value has nothing to do with the decision.

Answer a) Relevant costing attempts to determine the objective cost of a business decision. An objective measure of the cost of a business decision is the extent of cash outflows that shall result from its implementation. Relevant costing focuses on just that and ignores other costs that do not affect the future cash flows.

Relevant costing is just a refined application of such basic principles to business decisions. The key to relevant costing is the ability to filter what is and isn't relevant to a business decision. There are the following type of relevant cost-

• Future Cost - Incurred in the future based on the potential decision made. This should vary from decision option to decision option. If this does not change based on the decision, then it is an irrelevant cost (see below).
• Opportunity Cost - The cost in lost opportunity depending on the decision made.