Dempster Limited purchased a delivery truck three years ago for $17,000 and has

Question

Dempster Limited purchased a delivery truck three years ago for $17,000 and has been using it in the business since then. The truck is being depreciated for accounting purposes on a straight-line basis and the amount of depreciation claimed has been $3,000 per year. Annual operating/maintenance costs for the truck have averaged $7,500 per year. The company is considering the purchase of a new truck. The list price of the new truck is $23,500 and the truck dealer has agreed to accept the old truck as a trade-in at a value of $5,000: Therefore the net cost of the new truck will be $18,500. Operating/maintenance costs for the new truck are estimated at 6,200 per year. 23560 ne

Explanation / Answer

Fixed Cost is the amount incurred irrespective of the output produced.

Fixed Cost : Purchasing price of the truck

$17000

Sunk cost is the cost which has already been incurred and cannot be recovered.

Sunk Cost : Operating /Maintenance Cost of the truck which cannot be recovered

$7500 per year or $22500 for three years

Irrelevant Cost is the cost which will not change as a result of management decision. Depreciation cost comes under Irrelevant cost.

Irrelevant Cost : Depreciation Cost

$3000 per year

Differential cost is the difference between two possible options

Differential Cost :Difference in the price of old and new truck.

23500 - $5000 = $18500

Avoidable Cost is the cost which can be avoided as the project takes another direction.

Avoidable Cost : As the firm has decided to sell the old truck, they could have avoided the last year's maintenance cost.

$7500

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