Page 3 - CIMA MCS Workbook May 2019 - Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

Date: Today

Subject: Relevant costing and capacity

Relevant costing

Relevant costing looks at future, incremental cash flows and opportunity cash flows to determine
whether taking a different course of action would be beneficial in terms of the overall cash
position.

The principle is that if the switch would lead to a better cash position, then the switch should be
made.

In order to determine whether the switch from five houses to one hotel would be beneficial, the
differences between the two choices need to be evaluated.

Revenues

For instance, if the switch is made, five sets of house revenues will no longer be received, but one
larger revenue sum will be received instead relating to the hotel. Therefore, the house revenues
would be lost cash inflows (a cost of making the switch) and the hotel revenue would be an
incremental cash inflow (a benefit of making the switch).

Materials cash flows

It is always important to determine the incremental cash flows from the switch. If there are no
incremental cash flows then the relevant cost is zero.

For instance, if the timber that would have been sourced for the five houses can be repurposed to
use in the hotel, then there is no incremental cost of sourcing that material and its relevant cost is
zero. If the hotel needs to use more timber than would be used for the houses, then the cost of
the extra timber is incremental and should be included.

We do not have stocks of timber stored in the factory because of our just in time system, so there
would be no opportunity to make use of timber that would have otherwise have gone to waste,
which would essentially be free for relevant costing purposes.

A similar approach would be adopted for all required materials.

If there were any materials that had already been ordered for the house production that would
no longer be used, we’d have to consider them. If we could cancel the order without charge then
the cost no longer spent would represent a saved cash flow and should be included. If there was a
charge for cancelling the order then that would be an extra cost to be included in the evaluation.
If the order couldn’t be cancelled but the timber could be used elsewhere then there would be no
relevant cost for the switch to hotel production. If it could be disposed of by being sold elsewhere
then there would be a relevant cash inflow.

Labour cash flows

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