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 9,900 kilograms of theolite. Intercontinental does not use theolite for its regular product, but the firm has 9,900 kilograms of the chemical on hand from the days when it used theolite regularly. The theolite could be sold to a chemical wholesaler for 14,800 p. The book value of the theolite is 3.70 p per kilogram. Intercontinental could buy theolite for 4.10 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 .104 U.S. dollar.)

Required:

1. 1-a. What is the relevant cost of theolite for the purpose of analyzing the special-order decision?
2. 1-b. The relevant cost of theolite for the purpose of analyzing the special-order decision is an example of:

Answer 1

1- a. The relevant cost of theolite for the pupose of analyzing the special order is the value at which the company will sell it to the chemical wholesaler which is the current market value that could be realized on selling the existing stock. The current buying price and book value is irrelevant since the product is not in regular use.

Therefore the relevant cost = 14,800p

1-b. This case is an example of opportunity cost. Opportunity costs are benefits foregone in lieu of current proposal assuming current is more beneficial in general case.