Strategic Cost Management · Relevant Cost Analysis

Relevant Costing of Material, Labour and Replacement Decisions

Updated 11 October 2026 · Fact-checked

Relevant costing counts only future cash flows that change because of the decision. For material, use replacement cost if you will buy more, or the better of resale value and alternative use if it is in stock. For labour, use extra pay plus lost contribution when labour is scarce. Ignore sunk costs.

Understand Replacement, Material and Labour Relevant Costing

A relevant cost is a future cost or revenue that differs between the alternatives. If a figure stays the same whichever option you pick, or has already been spent, it does not belong in your working.

For material, ask one question: what does the firm give up or pay because of this job? If the material must be bought, the relevant cost is the purchase price you will pay now. If it is already in stock and regularly used, using it means buying a replacement later, so the relevant cost is the replacement cost. If it is in stock and will never be used again, the relevant cost is the higher of its resale value and the value from another use, less any disposal cost saved. If it has no other use and no resale value, the relevant cost is nil. The original purchase price is a sunk cost and is never relevant.

For labour, the answer depends on capacity. With spare capacity (idle time that is paid anyway), the relevant cost is nil, because wages do not change. With full capacity, workers must be moved from other work. The relevant cost is the wages paid plus the contribution lost on that other work, measured after deducting the labour wages. This is the opportunity cost. It equals the contribution lost before labour cost, so do not add wages to a contribution that is calculated before labour. If extra workers are hired or overtime is paid, the relevant cost is the extra amount actually paid, including any premium.

For equipment replacement, compare keeping the old machine with buying the new one. The old machine's book value is sunk. What matters is its current resale value, future operating costs, the new machine's cost, and its future resale value. Depreciation is a non-cash allocation, so leave it out of cash comparisons. Where the timing differs, discount the cash flows.

The same idea covers other resource-usage decisions. Use of a machine you already own, or of space that could be let out, is costed at what you give up, not at its book cost.

Key rules to remember

Relevant cost of material to be bought: Current purchase (replacement) price × quantity needed; Include carriage inward if it changes with the decision.
Relevant cost of stock material in regular use: Replacement cost × quantity used; Using it forces a future purchase.
Relevant cost of stock material not needed again: Higher of (resale value − selling cost) and (value in alternative use); If neither exists, the cost is nil. Original cost is ignored.
Relevant cost of labour at full capacity: Wages paid for the job + contribution lost after deducting the labour wages; This equals the contribution lost before labour cost. Use one version only: if you add wages separately, the lost contribution must be after labour wages, otherwise the wages are counted twice.
Relevant cost of labour with spare capacity: Nil (if wages are fixed and idle time is paid anyway); Add any extra cost such as overtime premium or hiring.
Replacement decision (incremental cash): Relevant cost of keeping = future cash costs − resale value at the end; of replacing = new cost + future cash costs − resale value at the end − old machine sale value now; Book value and depreciation are excluded. Discount if the timings differ.

How to solve Replacement, Material and Labour Relevant Costing questions

Use this method for any material, labour or replacement question. Work in the sequence below and write a reason for each item.

1List every cost and revenue given in the question, and tag each as future or past.
2Remove sunk costs, such as historic purchase price, book value and depreciation. Remove committed costs and allocated fixed overheads that do not change.
3For each material, decide: will it be bought, is it in regular use, or is it surplus stock? Apply the matching rule.
4For each labour item, check capacity. Spare capacity gives nil, and full capacity gives wages plus lost contribution. Add any overtime premium.
5For equipment, list cash flows of each option, including the sale value of the old machine and the end-of-life value. Discount only if the question gives a rate.
6Total the relevant costs, compare them with the relevant revenue or with the other option, and give a clear recommendation.
7Add non-financial points briefly, such as quality, supplier reliability or customer goodwill.

Quickest way: Three-question screen

When to use it: Use it when time is short and the problem lists many cost items with data that tempt you to include everything.

For each item ask: is it a future cash flow that changes with the decision? If no, strike it out.
Material: bought, regularly used or surplus. Write replacement cost, replacement cost or resale/alternative use.
Labour: spare or full capacity. Write nil or wages plus contribution lost.
Add up only what remains and compare with the revenue or the alternative.

Common mistakes in Replacement, Material and Labour Relevant Costing

Using the original purchase price of stock material.
The stores ledger shows the historic cost, so it looks like the natural figure.
Fix: Use replacement cost if the material is in regular use, or resale or alternative use value if it is surplus.
Charging normal wages for labour that is idle.
Students treat labour as always variable.
Fix: Check capacity first. If idle time is paid anyway, the relevant cost is nil.
Forgetting lost contribution when labour is at full capacity.
Only the wage rate is read from the question.
Fix: Add the contribution of the displaced work, computed after deducting the labour wages, to the wages paid. If you use contribution before labour cost, do not add wages again.
Including book value or depreciation in a replacement decision.
Accounting profit habits carry into decision work.
Fix: Treat book value as sunk. Use the old machine's sale value now and future cash flows only.
Including allocated fixed overheads as a relevant cost.
Costs are given as a total absorbed rate per hour.
Fix: Include overhead only if it actually increases because of the decision.
Deducting the old machine's sale value from the wrong option.
The sale is a benefit of replacing, and students lose track of sign.
Fix: Show the sale value as an inflow under the replace option only.

Worked examples

Example 1

Ganga Fabrics has a special order needing 500 kg of Material X. It holds 300 kg bought at ₹120 per kg; Material X is regularly used and its current replacement price is ₹150 per kg. The remaining 200 kg must be bought at the current price of ₹150 per kg. Another 100 kg of Material Y, no longer used, is also in stock at a cost of ₹80 per kg. It can be sold for ₹50 per kg, or used instead of a material costing ₹65 per kg that the order would otherwise need. The order needs 100 kg of that substitute. Find the relevant cost of materials for the order.

Show the solution

Material X in stock, 300 kg: regularly used, so the relevant cost is replacement cost. 300 × ₹150 = ₹45,000. The ₹120 cost is sunk.
Material X to be bought, 200 kg: 200 × ₹150 = ₹30,000.
Material Y, 100 kg: the alternatives are selling at ₹50 or using it to save buying 100 kg at ₹65. The higher is ₹65, so 100 × ₹65 = ₹6,500. The ₹80 cost is ignored.
Total = ₹45,000 + ₹30,000 + ₹6,500 = ₹81,500.

Answer: The relevant cost of material for the order is ₹81,500.

Example 2

Himalaya Engineering is considering a job that needs 200 hours of skilled labour at a wage of ₹250 per hour. Skilled labour is fully employed on Product P, which earns a selling price of ₹900 per unit with material of ₹300 and labour of ₹250 per unit (one hour per unit), and no other variable cost. Find the relevant cost of the labour for the job. Also state the cost if the workers were idle and paid anyway.

Show the solution

Labour is fully employed, so the workers must be taken off Product P.
Contribution of P after deducting labour = ₹900 − ₹300 − ₹250 = ₹350 per hour of labour.
Contribution lost for 200 hours = 200 × ₹350 = ₹70,000.
Wages paid for the job = 200 × ₹250 = ₹50,000.
Relevant cost of labour = wages ₹50,000 + contribution lost ₹70,000 = ₹1,20,000.
Check: contribution of P before labour is ₹900 − ₹300 = ₹600 per hour, and 200 × ₹600 = ₹1,20,000. The figures agree.
If workers were idle and paid anyway, the relevant cost is nil.

Answer: At full capacity the relevant cost of labour is ₹1,20,000 (₹50,000 wages + ₹70,000 contribution lost after wages). With idle paid time it is nil.

Exam tips

Read the capacity statement in the question first. It decides whether labour cost is nil, wages, or wages plus lost contribution.
Write one line of reason beside each figure, such as 'sunk, ignored' or 'replacement cost'. Marks are given for the reasoning.
In replacement problems, show the old machine's sale value as a separate line and state that book value is ignored.
Finish with a clear recommendation and one or two non-financial points, since case-based answers are marked on application.

Practice questions from Relevant Cost Analysis

Replacement, Material and Labour Relevant Costing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Replacement, Material and Labour Relevant Costing: frequently asked questions

What is the relevant cost of material already in stock?

It depends on use. If the material is regularly used, it is the replacement cost. If it will not be used again, it is the higher of resale value and the value from another use. If it has neither, it is nil.

What is the relevant cost of labour with spare capacity versus full capacity?

With spare capacity and fixed paid wages, the relevant cost is nil. At full capacity it is the wages paid plus the contribution lost from the work given up.

Is the book value of the old machine relevant in a replacement decision?

No. Book value is a past cost and cannot change. Only the old machine's current sale value and future cash flows matter.

Is depreciation relevant in relevant costing?

No. Depreciation is an allocation of past cost and not a future cash flow. Use the actual cash outflows and inflows, including resale value at the end.