Question

"The following data relates to 20 tonnes of chemical X105 that is currently held by the business and can be used to fulfill a contract.

Purchase cost: ​2,800
Replacement cost: ​3,200
Net realisable value: ​3,000

The material is no longer used for production and​ so, unless it is used in this​ contract, it will be converted into 15 tonnes of chemical X106 at a cost of £400. This chemical is widely used in the production process and such a quantity has a cost of £​3,500.
What is the relevant cost of chemical X105 when considering the viability of the​ contract?

A. £​3,000
B. £​2,800
C.£​3,200
D. £​3,100"

Answer 1

The relevant cost of chemical X105 for the contract is the net benefit foregone if not used for the contract, which is £3,100, calculated as the replacement cost of chemical X106 (£3,500) minus conversion costs (£400).

Step-by-step explanation:

When considering the viability of a contract, the relevant cost of chemical X105 is the cost of the next best alternative use of the resource, net of any additional costs that would be incurred. If the chemical is not used for the contract, it would be converted into chemical X106 at a cost of £400, which could then replace £3,500 worth of chemical X106 used in production. Therefore, the relevant cost of using chemical X105 for the contract is the net benefit foregone, which is £3,500 minus the £400 conversion cost, amounting to £3,100.