Question

Intercontinental Chemical Company, located in Buenos Aires, Argentina, recently received an order for a product it does not normally produce. Since the company has excess production capacity, management is considering accepting the order. In analyzing the decision, the assistant controller is compiling the relevant costs of producing the order. Production of the special order would require 8,900 kilograms of theolite. Intercontinental does not use theolite for its regular product, but the firm has 8,900 kilograms of the chemical on hand from the days when it used theolite regularly. The theolite could be sold to a chemical wholesaler for 14,500 p. The book value of the theolite is 2.90 p per kilogram. Intercontinental could buy theolite for 3.30 p per kilogram. (p denotes the peso, Argentina’s national monetary unit. Many countries use the peso as their unit of currency. On the day this exercise was written, Argentina’s peso was worth 0.104 U.S. dollar.)

2. Identify the relevance of each of the numbers given in the exercise in making the decision.

Sales Revenue:

Book Value:

Current Purchase Cost:

Answer 1

The new order will require 8900 kilograms of theolite.

The company does not use the theolite for its regular product. But it still have the require stock from the days when it used theloite regularly.

So if the company does not use this theolite for its regular product , it can sell the theolite to wholesaler at 14500 p.

Therefore the relevant cost is 14500 p. for the order.

Relevant cost in dollar = 14500 p *$0.104 =$1508.

2)Book value of theolite is 2.90 p per kilogram which is historical cost and hence sunk cost.So it will be irrelevant for decision making.

Sales value to wholesaler is a relevant cost as company can sell the theolite to wholesaler at 14500 p.

Current purchase cost is irrelevant here as the company have the required stock for the order and there is no need to buy theolie from outside.