Question

Ennerdale Ltd has been asked to quote a price for a one-off contract. The company’s management accountant has asked for your advice on the relevant costs for the contract. The following information is available.

Materials

The contract requites 3, 000 kg of material K, which is a material used regularly by the company in other production. The company has 2, 000 kg of material K currently in stock which had been purchased last month for a total cost of $ 19, 600. Since then the price per kilogram for material K has increased by 5%

The contract also requires 200 kg of material L. There are 250 kg of material L in stock which are not required for normal production. This material originally cost a total of $3, 125. If not used on this contract, the stock of material L would be sold for $11 per kg.

Labour

The contract requires 800 hours of skilled labour. Skilled labour is paid $9.50 per hour. There is a shortage of skilled labour and all the available skilled labour is fully employed in the company in the manufacture of product P. The following information relates to product P:

                                                                                                                                                $ per Unit                                $ per Unit

Selling price                                                                                                                                                                                  100

Less

                  Skilled Labour                                                                                                     38

                  Other Variable Cost 22

                                                                                                                                                                                                            (60)

                                                                                                                                                                                                             40

Required:

Prepare calculation showing the total relevant costs for making a decision about the contract in respect of the following cost elements:

Material K and L; and Skilled Labour

Explain how you would decide which overhead costs would be relevant in the financial appraisal of the contract.

Answer 1

Part-a

Statement Showing Calculation of total relevant Cost
Relevant cost of Material K will be ( $19600/2000 Kg)*105% (Material K is regularly used for production and it's required to purchased it from market at higher price by 5%)	$10.29/Kg	3000 Kg	$30,870.00
Relevnat cost will be resale Value of Material L (Material L is laying in Surplus and not require for any further use)	$11/Kg	200 Kg	$2,200.00
Relevant Cost for Skilled Labour will be Labour cost and Margin/Hour lost on Product P : ( $9.50+$10) ( Refer W/Note-1 (Skilled Labour is in shortage and deploy them in such one off- contract required , margin per Hour lost on Product P)	$19.5/Hour	800 Hour	$15,600.00
Total Relevant Cost			$48,670.00
Working Note :1 Computation of Margin lost/Hour Detail $/Unit Selling Price $100.00 Skilled Labour -$38.00 Variable Cost -$22.00 Margin $40.00 Labour Hours require ($38/$9.50 per Hour) 4 Hour Margin /Labour Hour $10.00 Part-b The Overhead which directly incurred for manufacturing the product and avoidable in nature will be treated as relevant for evaluation of the contract.