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

Mehta Auto Ltd. is deciding whether to continue making a part in-house or buy it from outside. Last year's depreciation on the existing machine, already purchased for Rs 6,00,000, is Rs 60,000 per year. Which statement about this depreciation is correct for the decision?

The depreciation is a sunk cost and is irrelevant to the make-or-buy decision. The machine has already been bought, so the expenditure cannot be avoided or changed by the choice. Depreciation is also only an allocation, not a future cash outflow.

  1. AIt is a relevant cost because it is a future cash outflow
  2. BIt is a relevant cost because it varies with the decision
  3. CIt is a sunk cost and irrelevant because the machine has already been purchasedCorrect
  4. DIt is an opportunity cost and must be included

Explanation

The machine's purchase cost has already been incurred and cannot be changed by the decision, so the related depreciation is a sunk cost. Sunk costs are irrelevant for decision making. Depreciation is a non-cash allocation and does not represent a future cash outflow, which is why the first option is wrong.

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