cost logics

8/12/2019 Cost Logics

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Basic concepts of relevant costing and related

issues.Relevant cost Sunk cost

Cost to be incurred for A1 10000 sunk cost must be ignored for every selection

Cost to be incurred for A2 20000 means out here Rs.100000 downpayment.

Note:

a. Irrelevant cost is to be ignored for the purpose of selection kyunki unse koi fark toh padtahai hi nahi.

b. Yeh dekhe ki kaunsa kaam kare toh bekar hai lekin yeh dekhe ki kaam kiya jaye ya na kiya jaye toh yeh usefull hai.

c. We have two types of descionkaunse kaunse descion hai sunk relevant irrlevant

Desion of selection ignore consider consider either to do or not to do the act

relevant cost woh hoti hai jo har alternative par alag hai aur kisi kaam na kare toh nahi lagegi.

Q1) what do u mean by opportunity cost?1. Ek alternative chodh kar jo benefit loose karte ho dusre ke liye, woh opp cost kehlata hai.2. Dhyaan rahe jab aap ek loss karke dusre ko karte ho tab aati hai opp. Cost ki baat nahi toh

agar mera kisi chiz mein koi loss hi nahi ho raha hai toh woh opp. Cost kaise hoga.3. Cost sirf woh hi nahi hota jo jaa raha hai, woh bhi toh hota hai jo nahi aa raha hai.4. Opp. Cost ki baat tab aata hai jab mutually exclusive chizo ki baat hai, means ek ko karne ke

liye aapko baaki sab ko chodhna padega.Eg.Mere paas capital hai 10 lac kiToh mere paas do option hai pehla ki main usko bank mein laga dun @10000 pm

Dusra mutual fund mein laga dunga @140000 paCost of capita mere paas ho gayi 140000

Product X Y Z

Sp 10 12 12Vc 6 9 7
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Demand 3000 2000 1000Capacity 2000 3000 900Fc 30000 30000 30000

What is the opportunity cost.

Solution: opportunity cost for each productParticulars X Y ZCont. Pu 4 3 5Total contri =2000*4=8000 2000*3=6000 5*900=4500Opp cost 6000 8000 8000

Note: The concept of opp. Cost should be applied only when we have mutually exclusiveevents

Concepts of relevant cost Relevant cost of material:

A company has a material M1 purchased 4 yrs ago @ Rs.100 for an offerNow the material is in godown from last 4 years hence the nature of material is to bedeclared as a obsolete (taking logics from AS-2 which says that stock of the year shallbe valued). Then company decides to remove the material from the stocks, it has noscrap value, before removing the material, the company receives an offer which willutilize such material (requirement = availability)Current purchase price of material M1 is Rs. 120, what should be the relevant costfor material M1 in respect of new offer.

Sol: Statement of relevant costCost to be incurred due to acceptance of offer: nillBenefit to be lost due to acceptance of offer : nill

Minimum price : nill

1.

Original cost of Rs.100 to be known as sunk cost due to past cost. 2. Current purchase price of Rs.120 has no relevance on the decision becausethere is no question to purchase the material which we have already lying inour godown

Case 2: When scrap value of the material is givenSuppose in above case, the scrap value of M1 material is Rs.20 and other factremain same then what should be the RELEVANT COST of M1 in respect ofnew offer.

Sol.: Statement of relevant cost


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Cost to be incurred due to acceptance of offer: nillBenefit to be lost due to acceptance of offer : 20

Minimum cost :20Case 3: Where the scrap value is given by different people and and different

parts are sold differently.scooter x takes the scooter

purchase price:40000 at as it is @ 4000/-less: depriciat -40000

y takes the stock after y says that kirepair cost for Rs.6000 stapney

nahi lungaand stapney value400

what will be the relevant cost of scoterStatement of relevant cost

Cost to be incurred due to acceptance of offer: 6000Benefit to be lost due to acceptance of offer : 4000Benefit to be achieved due to acceptance of offer : (400)

Minimum cost :9600

Case 4: The company has one material purchased for Rs.100, 4 years ago for an offer. The

nature of material is toxic and is obsolete as well. Current purchase price of M1 is 150. Thecompany decides to remove such material by incurring extra cost of Rs.60. before removingthe material the company receives an offer which will require such material , what shouldbe the relevant cost of material M1 for the utilization of such material in respect of offer?

Statement of relevant costCost to be incurred due to acceptance of offer: nillBenefit to be lost due to acceptance of offer : nillBenefit to be achieved due to acceptance of offer : (60)

Minimum cost : (60)

Case 5: the company has a material M1 purchased some years ago at a cost of Rs.100 for REGULARactivities but such material is lying in godown as it is since the date when it was purchase hence isobsolete now and of no use , it has 2 alternativesIst : It can be sold as srap @ Rs.90 OR IInd : It can be utilized in the place of M2 for an offer (to make a table) which has been acceptedCurrent purchase price of material M1 is Rs.200 and material M2 is Rs.120 and now the companyreceives another offer for the manufacture of chair which would require M1 materialWhat should be the relevant cost of M1 material for the offer.


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If we had not accepted the offer then benefits would have been in the following manner from M1a. Sale it @ Rs,.90 ORb. Substitute use in table of Rs.120(this the cost of amount saved from buying the material

M2) Thus the Maximum benefit would have been 120 from M1

But due to acceptance of offer , such benefit would have to be lost and henceforth the samemust be charged from the offer.

Statement of Relevant CostCost to be incurred nillAdd :Benefit to be lost 120 (this is the cost saved by not buying M2)Minimum price to be charged 120

Case6 : Suppose in above case M1 can be utilized in place of M2 after incurring some extracost of Rs.10 (expenses of painting and others) and other facts remaining the same

Solution: In this case the net benefit of cost saving in substitute ways would be 120-10=110which is the maximum benefit and hence the relevant cost of M1 would be Rs.110/-.

If say in above the current purchase price of M1 is 70 then its better to purchase M1 fromthe market instead of utilizing existing material and the relevant cost would be Rs.70

Case6: Regular Use If a company has 600 cement bags in godown which are of regular nature and purchased atthe rate of Rs.400. now the company receives an offer which will require 600 bags ,currentpurchase price of material would be Rs.420/-. What should be the relevant cost of suchmaterial for the offer?

In order to complete the offer , it is not possible to utilize the existing material which are ofregular nature and hence we should purchase from the market for the offerAnd the relevant cost will be the COST TO BE INCURRED i.e. 600 bags* Rs.420= Rs.252000/-.

Now say that the supplier only supplies the cements ate fixed lot of 800 bags pertransaction Then you will have to buy the whole lot of 800*420 i.e. Rs.336000 and then transfer the restof 200 bags to the regular stock and the remaining would be the relevant cost of thematerial used for offer.

RELEVANT COST OF LABOUR Casual labours : These labours can be appointed and retrenched as when required and payment is

made as per their work. Permanent labours: These labours cant be terminated / retrenched due to an agreement with

the management. Payment will be made irrespective of working. Short Supply: When its not possible to appoint extra labour from the market for next period . Busy: They are not idle and are engaged in regular activity and providing some contribution to

the company.

Case1:Casual and not busy (not in short supply)


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M/s XYZ and co, is a sanitary store has a casual worker X with Rs.500 for the each day he works,the company anticipates that due to some reason he has no work to do for the next 4 days. Nowthe company receives an offer which will require such labour for next 4 days.Statement of relevant costCost to be incurred due to acceptance of offer (500*4) : Rs.2000/-

Case2: Permanent and not busy (not in short supply)Suppose in above case the nature of labour is permanent and not busy and salary amount will be15000 p.m. other facts remaining same, compute the relevant cost of the labour.

Statement of relevant costCost to be incurred due to acceptance of offer : nil

Logic: The relevant cost of the labour is nil because the existing labour cost would continue tooccur with the same amount irrespective of acceptance of offer.

Case3: Casual and busy (in short supply)

Suppose M/s XYZ co. A sanitary store has a worker X with the wages of Rs.500 per day at presentmanagement can estimate the benefit would be derived from the utilization of such labour fornext 4 days in the following manner .Revenue 10000Less : Mat cost (1500)Less: labour cost (2000)Contribution 6500The company receives an offer for next 4 days which will require such labour .What should be the relevant cost of labour for the offer?

Statement of relevant cost

Cost to be incurred due to acceptance of offer (500*4) 2000/-Add: benefit to be lost due to acceptance of offer 6500/-Price 8500/-

Case4: Permanent and busy (in short supply)

M/s XYZ co. has a labour Mr. X with the salary of 15000p.m.Management predicts that the profits would be 55000 for the next month from regular activitieswith the utilization of such labour i.e.Revenue 100000Less : Mat cost (30000)

Less: labour cost (15000)Contribution 55000

The company receives a offer which would require such labour for the next moth then whatshould be the relevant cost of labour for the offer.

Statement of relevant costThe labour cost of Rs.15000 is knwn as sunk costand henceforth it must be ignored and than thebenefit to be lost ignoring the benefit should bethe amount which should be charged from theoffer.If we had not accepted the offer then sunk cost would have been recovered i.e. Rs.15000 alongwith the profit of Rs.55000/- and both will have to be sacrificed due to acceptance of offer and itshould be charged from the offer i.e. non recovery of sunk cost and loss of profit.


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Amount to be charged from the offer 70000/-

Price 70000/-

Sales **Less: variable cost **Contribution $$Less: avoidable fixed cost **Benefits $$Less: unavoidable fixed cost **Profits $$

RELEVANT COST OF LABOUR

Types Not busy/no shotsupply

Busy & shortsupply

Casual Labour cost Labour cost **+contri **

Permanent Nil Benefit to be lostignoring thelabour cost.

RELEVANT COST OF OVERHEAD

Overhead are of two type1. Variable overhead: variable overhead is always called relevant cost because variableoverhead is always to be incurred during productive hours.

2. Fixed overhead: Avoidable FO: this means the overhead which continue to occur only when offer is to

be accepted i.e. always relevant like extra supervisors salary or extra rent ofmachinery.

Unavoidable FO: They would continue to occur in totality irrespective of acceptanceof offer hence called sunk cost like factory rent, electricity and depreciation of

existing machine. These expenses may be called general overheads.

Change in apportionment doesnt change the outflow and are always referred to as sunkcost.

Case1Suppose a company has a machine and the nature of machine is obsolete means such machinescannot be utilized in regular production and hence management decides to resale such machinefor Rs.10000, just before selling the machine as scrap, the company receives an offer for next 6months which would require such machines, the resale value at the end of 6 months would beRs.8000, what should be the relevant cost of the machine for the offer.


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Relevant costBenefit to be lost due to acceptance of offer :10000Less: Benefit to be achieved due to acceptance of offer :(8000)Difference of re sale value Relevant cost 2000

Case2suppose a construction company has a machine or machines for regular activities .thecompany receives an offer for the construction of guest house which will require themachine for next 6 months. Current purchase price of the machine is 100000 and themarket price hence 6 months would be 80000, then what should be the relevant cost of themachine.

In order to complete the order we must purchase a machine from the market rather thanutilising the machine from the regular use and regular work be stopped for the same

purpose. But after completing the offer the released machine should be transferred toregular stock instead of selling them as scrap in the scrap price.

Statement of relevant costCost to be incurred due to acceptance of offer :100000Benefit to be achieved due to acceptance of offer :(80000)Relevant cost of the machine 20000

In the absence of any instruction we should follow the following presumptionsResources PresumptionsMaterial ObsoleteMachine ObsoleteFixed overhead Unavoidable fixed costLabour Casual

In the following cases we should considerthe nature of labour to be permanentCase1: Such labour cannot be retrenched or

retrenched.Case2: They are employees.Case3: They get idle wages (they areunderutilised).

Do question no.6We have three type of decisions in hand they are-:

Situation 1If we have only one offer or revenue ka amount and cost amount are

given.Then in that case we should prepare statement of cost benefit.


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Statement of cost benefitRevenue **Cost

MaterialLabourOverheads

**Benefits **

Situation 2If we have only one offer and only cost amounts are given.Then in that case we should prepare statement of cost benefit.Statement of cost benefit

Material **Labour **Overheads **

**Minimum price **

Situation 2

If we have more than one offer and revenue amount and cost amountsare given respectively.Then in that case we should prepare statement of COMPARATIVE costbenefit.Statement of COMPARATIVE cost benefit

REVENUEPARTICULARS A1 A2 A3

REVENUE ** ** ** Total (a) ** ** ** COST ** ** ** Material ** ** ** Labour ** ** ** Overhead ** ** ** Total (b) ** ** ** Benefit (a-b) ** ** **


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COSTMaterial **Labour **Overheads **

**Minimum price **

If we have more than one alternatives with different amount of benefits , then in that case weshould not consider the benefit of one alternative as an opportunity cost for the otheralternatives in the descion of comparisonHowever in the decision of quotation of minimum price for the selected alternative, we shouldconsider the higher benefit to be lost in favour of selected alternative as an opportunity cost.

Profit centrethe unit company of the group which always makes profit . they are always a profit centre of thecompany.We are not the one to decide that which unit is profit making and cost making.

Profit centre means profit making unit or department , in other words we can say any departmentor company is to be considered profit centre when profit occurs in that division on regular basis withsubstantial amounts.Normally we can say profit would occur when actual output would be higher than breakeven levelbut substantial profit on regular basis would be achieved only when actual output becomes closer to

the capacityIn the abscense of instruction , always we should presume actual output would be equall to thecapacity, which means 100% capacity utilization exist in the factory .

Cost centreThe original name was loss making unit and is shortly called is cost centre

In other words we can say loss exist when actual output becomes closer to the breakevenpoint , which indicate spare capacity always existHence we can say that minimum price will be variable cost for the acceptance of any offer

In the absence of any information of nature of any centre or department, it shall beassumed that the particular department is a cost centre

Summary for relevant cost

material

MAKE OR BUY


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Make or buy decision relates with component of a product. Component here means a part of theproduct but not an integral part.E.g. Empty bottle is a component in Soft Drink Company. And bicycle chain in the bicycle.

If the decision relates with product for purchase or manufacture then that is to be known as SUBCONTRACTING OR OUTSOURCINGWhat is the non costing factor to be considered in make or buy factor.

1. The quality if the component must be standard and sub standard component must not bepurchased.

2. The delivery of the component should be on scheduled time.3. The delivery of the component should be on regular basis with constant price.

What is the costing factor to be considered in make or buy factor.1. Purchase cost of the component should be compared with cost to be incurred due to

MANUFACTURING THE COMPONENT. 2. Cost to be incurred includes

a. Variable cost and avoidable fixed cost

3. Unavoidable fixed cost(general overhead) should not be considered in the decision of makeor buy due to sunk cost.(change in apportionment does not amount to change in cash flow).

4. The above decision can be analysed by preparing statement of comparative cost

Statement of comparative costManufacture Purchase

Cost to incurredMaterialLabourVariable o/h

Purchase cost

Avoidable f/oTotal Total

AND SELECT THE OPTION WHICH HAS THE LEAST COST.

THE above decision can be analysed by preparing two statements or one statement in thefollowing manner.

First :Statement of comparative cost

Manufacture PurchaseCost to incurred 130MaterialLabourVariable o/h

Purchase cost 180

Avoidable f/o 20Total 150 Total 180

Statement of cost benefitLoss on purchase 30000


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Benefits from released capacity 50000Total benefit 20000

Second :Statement of comparative cost (on the basis of relevant cost)

Cost to be incurred 130+20=150Add: benefit to be lost due to rental income 50

Total relevant cost 200

Purchase cost (if purchased) 180

Total benefit to be lost if manufactured is Rs.20Thus buying the component is beneficial

cost logics

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