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

Meera Textiles has a machine bought for Rs 5,00,000 five years ago, with a book value of Rs 1,00,000 now. A new machine would save Rs 70,000 per year in running costs. The old machine can be sold now for Rs 1,20,000 or used for 3 more years with no resale value. Management is deciding whether to replace it. Which statement about the cost data is correct?

The Rs 1,20,000 sale value is the opportunity cost of keeping the old machine, because it is the benefit forgone by not selling. Original cost and book value are sunk historical costs and irrelevant, while the Rs 70,000 saving is a relevant future differential benefit.

  1. AThe Rs 5,00,000 original cost is a relevant cost
  2. BThe Rs 1,00,000 book value is a relevant cost because it is a future write-off
  3. CThe Rs 1,20,000 sale value is an opportunity cost of keeping the old machineCorrect
  4. DThe Rs 70,000 savings is a sunk cost

Explanation

Keeping the old machine means giving up the Rs 1,20,000 sale proceeds, which is an opportunity cost and is relevant. The original cost and book value are historical, sunk costs and irrelevant. The Rs 70,000 saving is a future differential benefit, not a sunk cost.

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