Practices
Question 9.1 Determine relevant costs
For a job, following information is available regarding Labour cost.
Skilled labour is currently paid at £25 per hour. To complete the job they will require 260
skilled hours. Skilled labour is in short supply and only 200 hours are available. The
other 60 hours will be released from not undertaking some repair work that would have
generated £5,000 contribution.
80 hours of semi-skilled labour is required and they are currently paid £20 per hour.
They are currently under-employed and if not engaged on this task they would be
temporarily laid off and paid 60% of their normal wage rate.
What is the total relevant cost of Labour?
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A job requires following estimates for labour costs.
Labour costs:
Skilled 1000 hours x £25 £25,000
Construction 5,000 hours x £20 £100,000
Supervision 600 hours x £30 £18,000
Skilled workers are currently in short supply. If this contract is undertaken some of this
current work would have to be cancelled, and they estimate that this would result in a lost
contribution of £20,000.
Construction hours: It is estimated that 50% of the construction hours (2500 hours) can
be provided internally but the remaining 50% of the construction hours would need to be
outsourced from an employment agency. The cost of outsourcing is £30 per hour.
Supervision hours: Supervision staff are currently underutilized and if not employed on
this contract they would be laid off and paid 60% of their normal £30 per hour rate.
Calculate the total relevant cost for Labour.
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Question 9.2 make or buy decision
Han Products manufactures 30,000 units of part S-6 each year for use on its production
line. At this level of activity, the cost per unit for part S-6 is as follows:
Direct materials $3.60
Direct labor $10.00
Variable manufacturing overhead $2.40
Fixed manufacturing overhead $9.00
Total cost per part $25.00
An outside supplier has offered to sell 30,000 units of part S-6 each year to Han Products
for $21 per part. If Han Products accepts this offer, the facilities now being used to
manufacture part S-6 could be rented to another company at an annual rental of $80,000.
However, Han Products has determined that two-thirds of the fixed manufacturing
overhead being applied to part S-6 would continue even if part S-6 were purchased from
the outside supplier.
Required:
Should the company buy part S-6 from outside supplier or continue to make inside? How
much profits will increase or decrease if the outside supplier’s offer is accepted
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Question 9.3 accept or reject a special order
Delta Company produces a single product. The cost of producing and selling a single unit
of this product at the company’s normal activity level of 60,000 units per year is:
Direct materials $5.10
Direct labor $3.80
Variable manufacturing overhead $1.00
Fixed manufacturing overhead $4.20
Variable selling and administrative expense $1.50
Fixed selling and administrative expense $2.40
The normal selling price is $21 per unit. The company’s capacity is 75,000 units per year.
An order has been received from a mail-order house for 15,000 units at a special price of
$14.00 per unit. This order would not affect regular sales.
Required:
1. Can the company accept this order? If the order is accepted, by how much will annual
profits be increased or decreased? (The order will not change the company’s total fixed
costs.)
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2. Assume the company has 1,000 units of this product left over from last year that are
inferior to the current model. The units must be sold through regular channels at reduced
prices. What unit cost is relevant for establishing a minimum selling price for these units?
Explain.
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Question 9.4 Prepare profit report using relevant information
Hutton Plc is considering whether to accept the offer of a contract to undertake some
reconstruction work at a price of £73,000. The work would begin almost immediately and
will take about a year to complete. The company’s accountant has submitted the
following statement.
£ £
Contract price 73,000
Less costs
Pre-production survey, contract assessment 4,700
Materials
A 7,000
B 8,000 15,000
Labour
Direct 21,000
Indirect 12,000 33,000
Machinery
Depreciation on machines owned 4,000
Hire of special equipment 5,000 9,000
General overheads 10,500
Total cost 72,200
Expected profit 800
The management of the company is rather apprehensive as to whether it is advisable to
incur the inevitable risks involved for such a small profit margin. On making further
enquiries the following information becomes available.
1. £4,700 was the cost of field investigation and costs of activities related to the
preparation of the contract that had already been paid.
2. Material A was bought two years ago for £7,000. It would cost £8,000 at today’s
prices. If not used on this contract, it could be sold for £6500. There is no
alternative use for this material.
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3. Material B was ordered for another job but will be used on this job if the contract
is accepted. The replacement for the other job will cost £9,000.
4. The trade union has negotiated a minimum wage agreement, as a result of which
direct wages of £21,000 will be incurred whether the contract is undertaken or not.
If not employed on this contract, it is thought that these employees could be used
to do much needed maintenance work, which would otherwise be done by an
outside contractor at an estimated cost of £18,500.
5. The indirect labour is the wage of a foreman who will have to be taken on to
supervise the contract. A suitable person is ready to take up the appointment at
once.
6. The machine which is already owned is six years old. £4,000 is the final
instalment of depreciation required to write off the balance on the asset account.
There is no alternative use for the machine, and its scrap value is negligible,
because of the high cost of dismantling and removal.
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7. The general overhead absorption rate is 50% of direct labour. Overheads are
expected to rise by £4,000 if the contract is accepted.
The CEO after looking at this additional information requires you as his assistant, draw
up an amended report of costs and projected profit for this contract. Explain your
workings.
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