132 ACCOUNTING FOR MANAGERS
replacement price of the materials. Therefore it is irrelevant whether or not those
materials are held in inventory, unless such materials have only scrap value or
an alternative use, in which case the relevant cost is the opportunity cost of the
forgone alternative. The cost of using materials can be summarized as follows:
žIf the material is purchased specifically the relevant cost is the purchase price.
žIf the material is already in stock and is used regularly, the relevant cost is the
purchase price (i.e. the replacement price).
žIf the material is already in stock but is surplus as a result of previous
overbuying, the relevant cost is the opportunity cost, which may be its scrap
value or its value in any alternative use.
Stanford Potteries Ltd has been approached by a customer who wants to place a
special order and is willing to pay £16,000. The order requires the materials shown
in Table 9.7.
Material A would have to be purchased specifically for this order. Material B is
used regularly and any inventory used for this order would have to be replaced.
Material C is surplus to requirements and has no alternative use. Material D
is also surplus to requirements but can be used as a substitute for material E.
Material E, although not required for this order, is in regular use and currently
costs £8.00 per kg, but is not in stock. The relevant material costs are shown in
Table 9.8.
As a result of the above, Stanford Potteries would accept the special order
because the additional income exceeds the relevant cost of materials. In the case
of A, the material is purchased at the current purchase price. For B, even though
some inventory is held at a lower cost price, it is used regularly and has to be
replaced at the current purchase price. For C, the 400 kg in inventory have no
other value than scrap, which is the opportunity cost of using it in this order. The
100 kg of C not in inventory have to be purchased at the current replacement price.
For D, the opportunity cost is either the scrap value or the saving made by using
material D as a substitute for material E. As the substitution value is higher, this
is what Stanford would do in the absence of this particular order. Therefore, the
opportunity cost of D is the loss of the ability to substitute for material E.
Relevant costs are a useful tool in helping to make operational decisions.
However, there are other approaches to costing that are also valuable.
Table 9.7 Material requirements
Material Total kg
required
Kg in stock Original
purchase price
per kgScrap value
per kgCurrent
purchase
price per kg
A 750 0 – – 6.00
B 1,000 600 3.50 2.50 5.00
C 500 400 3.00 2.50 4.00
D 300 500 4.00 6.00 9.00