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CA Intermediate · Cost and Management Accounting · Introduction to Cost and Management Accounting

Kaveri Engineering Ltd. uses a machine whose original cost was Rs 9,00,000, with a written-down book value of Rs 4,00,000 and a current resale value of Rs 2,50,000. A new order needs this machine for a year, during which it will lose Rs 50,000 of resale value. The alternative is to rent it out for Rs 1,10,000 for the same year, which is forgone if the order is accepted. Depreciation as per books is Rs 80,000 for the year. For the decision whether to accept the order, what cost relating to the machine is relevant?

The relevant machine cost is Rs 1,60,000, being the Rs 50,000 fall in resale value plus Rs 1,10,000 rent forgone as opportunity cost. Original cost, book value and book depreciation are sunk or allocated amounts and are ignored in the decision.

  1. ARs 1,60,000Correct
  2. BRs 80,000
  3. CRs 1,30,000
  4. DRs 2,40,000

Explanation

Relevant costs are future, incremental ones: the fall in resale value Rs 50,000 plus the opportunity cost of rent forgone Rs 1,10,000 = Rs 1,60,000. Book depreciation Rs 80,000 and original or book value are sunk or non-cash allocations. Rs 1,30,000 would add depreciation to rent wrongly omitting resale loss... (80,000+50,000), and Rs 2,40,000 adds depreciation to the correct figure.

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