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CMA Foundation · Fundamentals of Financial and Cost Accounting · Meaning and Significance of Cost Accounting and its Relationship with Financial Accounting

Gupta Foods Ltd is deciding whether to continue using a machine bought two years ago for ₹6,00,000 (book value now ₹4,50,000, resale value ₹1,00,000). Replacing it with a new machine saves ₹70,000 per year in running costs. Which statement correctly identifies the cost treatment in this decision?

The ₹1,00,000 resale value is the relevant opportunity cost of keeping the old machine, while the ₹4,50,000 book value and ₹6,00,000 original cost are sunk costs already incurred and irrelevant. The ₹70,000 annual saving is a future differential benefit, so it is relevant.

  1. AThe ₹4,50,000 book value is a relevant cost since it will be written off
  2. BThe ₹6,00,000 original cost is an opportunity cost of keeping the machine
  3. CThe ₹1,00,000 resale value is the relevant opportunity cost of keeping the old machine; the ₹4,50,000 book value is a sunk costCorrect
  4. DThe ₹70,000 saving is a sunk cost because it arises in the future

Explanation

Book value and original cost are past, unavoidable costs and are sunk, so they are irrelevant. The resale value of ₹1,00,000 is what is given up by keeping the machine, so it is the opportunity cost. The ₹70,000 saving is a future differential benefit, relevant rather than sunk. Hence only the third statement is correct.

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