Triumph Dynamic Professionals Limited
Relevant cost of non-current assets
The relevant costs associated with non-current assets, such as plant and machinery, are
determined in a similar way to the relevant costs of materials.
•
•
If plant and machinery is to be replaced at the end of its useful life, then the relevant
cost is the current replacement cost.
If plant and machinery is not to be replaced, then the relevant cost is the higher of the
sale proceeds (if sold) and the net cash inflows arising from the use of the asset (if not
sold).
Relevant Costs for Materials
No
Issue
Action
Relevant Cost
1
Materials are needed for the one-off To buy them and Current Purchase Price
contract or job but they are not in use
for
the
store
contract, job or
proposal
2
Materials are needed for the one-off To buy them and Current Purchase Price
contract or job and they are in store use
for
the
but they are regularly in use by the contract, job or
company
proposal
3
Materials are needed for the one-off To be used in the Nil
contract or job and they are in store contract, job or
proposal
but;
i.
ii.
4
Materials are needed for the one-off To be used in the Resale value, Scrap
contract or job and they are in store contract, job or value, realisable value
but;
proposal
i.
ii.
iii.
5
they are not regularly in use
by the company
they have no resale value
they are not regularly in use
by the company
they have resale value
they have no alternative
use
Materials are needed for the one-off To be used in the The higher of;
contract or job and they are in store contract, job or
i.
Resale value
but;
proposal
ii.
Value of the
i.
they are not regularly in use
alternative
by the company
use
ii.
they have resale value
iii.
they have alternative use
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Triumph Dynamic Professionals Limited
6
Materials are in short supply and the
only way a proposal can be
undertaken would be by denying
another part of the organisation that
resource.
Deny other part Normal materials cost +
of
the lost contribution in the
organisation and other department.
use the materials
for the job
Relevant cost and Toxic
If a chemical that could be disposed of at a cost is needed for the new contract under
consideration, the disposal cost of the toxic or chemical will be a saving if as a result of the
new contract the decision is made not to discard it. This saving will reduce the amount to be
incurred on the new contract because disposal cost could have been incurred if the new order
is not made.
Lecture Example 1
A company has received a special order for which it is considering the use of material B which
it has held in its inventory for some time. This inventory of 945 kg was bought at N4·50 per
kg. The special order requires 1,500 kg of material B. If the inventory is not used for this order,
it would be sold for N2·75 per kg. The current price of material B is N4·25 per kg.
What is the total relevant cost of material B for the special order?
Lecture Example 2
A company is considering publishing a limited-edition book bound in a special leather. It has
in stock the leather bought some years ago for N1,000. To buy an equivalent quantity now
would cost N2,000. The company has no plans to use the leather for other purposes, although
it has considered the possibilities:
a) of using it to cover desk furnishings, in replacement for other material which could cost
N900
b) of selling it if a buyer could be found (the proceeds are unlikely to exceed N800).
Lecture Example 4
Material Qty Needed Qty in Store Original Cost Current Price Current Resale Value
A
400 kg
200 kg
N10/kg
N15/kg
N12/kg
B
200 kg
100 kg
N20/kg
N22/kg
N15/kg
Relevant costs refer to costs which are directly incurred (or saved) by the decision being
made.
o Material A is used regularly in the business.
o Material B is no longer used and has no alternative use in the business.
Identify the relevant cost of materials “A” and “B”.
Lecture Example 4
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Triumph Dynamic Professionals Limited
Zimglass Industries Ltd. has been approached by a customer who would like a special job to be
done for him, and is willing to pay N60,000 for it. The job would require the following
materials.
Material Total units Units already Book value of Realisable
Replacement cost
required
in stock
units in stock value N/unit
N/unit
N/unit
A
1000
0
16.00
B
1000
600
12.00
12.50
15.00
C
1000
700
13.00
12.50
14.00
D
200
200
14.00
16.00
19.00
a) Material B is used regularly by Zimglass Industries Ltd, and if units of B are required for this
job, they would need to be replaced to meet other production demands.
b) Materials C and D are in stock due to previous over-buying, and they have restricted use.
No other use could be found for material C, but the units of material D could be used in
another job as a substitute for 300 units of material E, which currently costs N15 per unit (of
which the company has no units in stock at the moment).
Calculate the relevant costs of material for deciding whether or not to accept the contract.
You must carefully and clearly explain the reasons for your treatment of each material.
Lecture Example 5
A 1-year contract has been offered which will utilize an existing machine that is only suitable
for such contact work. The machine cost N25,000 five years ago and has been depreciated
N4,000 per year on a straight-line basis and thus has a book value of N5,000. The machine
could be sold now for N8,000 or in 1 years’ time for N1,000. Four types of material would be
needed for the contract as follows:
Price per Unit
Material
Unit in Stock
Unit
Purchase
Current
Current
Required for
Price of
Buying-in
Resale Price
the Contract
Stock
Price
N
N
N
W
1,200
300
1.80
1.50
1.20
X
200
1,100
0.75
2.80
2.10
Y
3,000
600
0.50
0.80
0.60
Z
1,800
1,200
1.80
2.00
1.90
W and Z are in regular use within the firm. X could be sold if not used for the contract and
there are no other uses for Y, which has been deemed to be obsolete.
What are the relevant costs in connection with the contract (ignoring the time value of
money)?
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Triumph Dynamic Professionals Limited
Relevant Cost of Labour
No
Issue
1
Labour is needed for the
job but labour is not
available.
Note: Labour can be
skilled, semi-skilled and
unskilled
2
Labour is needed for the
job and labour is available
but they are currently idle
(spare capacity)
3
Labour is needed for the
job and labour is available
but they are currently fully
engaged in the normal
operation of the business
Action
Labour will be hired.
Relevant Cost
Hiring and Training cost
Engage the labour to Nil
carry out the job
There 3 options from The lower of:
which one will be chosen:
i.
Overtime
pay
i.
Compel labour
(hourly rate plus
to
Work
overtime
overtime
premium)
ii.
Hire
new
ii.
Hiring cost
labour
iii.
Divert
from
iii.
Hourly pay plus
another job
contribution lost
Another method for the third option is: - calculate the lost contribution (selling price less all
variable costs) plus the wages paid to the workers working on the new product/work.
Lecture Example 1
A contract requires 500 hours of labour. There are 400 hours of spare labour capacity. The
remaining hours can be worked as overtime at time and a half. Labour rate is N12/hr.
Lecture Example 2
To make a special order, labour will have to be transferred from the production of Product X,
which earns a contribution of N24 per unit made.
Each unit of Product X requires 0.5 hours of labour, which is paid at N24 per hour. The special
order will require 100 hours of labour and 500 hours of machine time.
The variable cost of running the machine is N30 per hour.
What are the total relevant costs for labour and machine time that should be included in the
cost of the special order?
Lecture Example 3
B Co. operates a production process which generates a contribution of N4 per hour. Wages
are paid at N7 per hour and labour is fully utilised. During busy periods workers are offered
the chance to work overtime, which is paid at N10 per hour. However, workers are currently
refusing to work overtime because of an industrial dispute.
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Triumph Dynamic Professionals Limited
B Co has just received an additional order which must be fulfilled immediately which will
require 10 hours of labour to fulfill.
What is the total relevant cost of labour for the additional order?
Lecture Example 4
A company is thinking about accepting a contract. If the contract is accepted, the company
will have the following cost:
Hours needed
Current Labour Cost
External Hiring cost
Skilled
100
N4
N5
Semi-Skilled
20
N3
N4
Unskilled
20
N10
N10
The skilled labour will be hired are required. Semi-skilled will be diverted from another project
called project A resulting in a loss of sales. Otherwise, the semi-skilled labour can be paid a
N0.50 overtime premium to perform this contract after normal working hours. Product A
generates a contribution of N3 per unit. 3 labour hours are required to produce a unit of
product A. Management salaries are regarded as fixed.
What is the relevant labour cost?
Exam Type Question 1
Pantum Ltd is considering whether or not to undertake an order from a customer. It is trying
to establish the relevant costs of the order. The order would require 3,000 kilos of material
W. There are over 3,000 kilos already held in inventory. Material W is no longer in regular use
by the company and could be sold for scrap at N1.5 per kilo. It could also be used as a
substitute for material Z, which is in regular use for making another product. Material Z can
be purchased for N4 per kilo. To use material W, as a substitute for material Z, conversion
costs of N1.6 per kilo would have to be spent on the material W. One kilo of material W, after
conversion, would be a substitute for one kilo of material Z
Skilled labour needed to fulfill the order would be specifically recruited for N50,000.
Unskilled labour needed to fulfill the order would be transferred from another department.
The cost of the labour time (3000 hours) would be N30,000 in wages. However, 1,500 of these
hours would be idle time if the order is not undertaken. The other 1,500 would be spent on
work that would provide a contribution of N5,000.
Required:
Identify the relevant costs of material and labour for this customer order.
Exam Type Question 2
Ennerdale Co 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 requires 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 that had been
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Triumph Dynamic Professionals Limited
purchased last month for a total cost of N19,600. 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 N3,125. If not
used on this contract, the stock of material L would be sold for N11 per kg.
Labour
The contract requires 800 hours of skilled labour. Skilled labour is paid N9·50 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:
N per unit
N per unit
Selling price
100
Less
Skilled labour
38
Other variable costs
22
(60)
40
Required:
(a) Prepare calculations showing the total relevant costs for making a decision about the
contract in respect of the following cost elements:
(i) Materials K and L; and
(ii) Skilled labour.
(7 marks)
(b) Explain how you would decide which overhead costs would be relevant in the financial
appraisal of the contract.
(3 marks)
Exam Type Question 3
You are the management accountant of Tricks, an organisation which has been asked to
quote for the production of a pamphlet for an event. The work could be carried out in addition
to the normal work of the company. Due to existing commitments, some overtime working
would be required to complete the printing of the pamphlet. A trainee has produced the
following cost estimate based upon the resources required as specified by the operations
manager:
N
Direct materials:
- paper (book value)
4,000
- inks (purchase price)
2,400
Direct labour: - highly skilled 250 hours @ N4.00
1,000
- semi-skilled 100 hours @ N3.50
350
Variable overhead 350 hours @ N4.00
1,400
Printing press depreciation 200 hours @ N2.50
500
Fixed production costs 350 hours @ N6.00
2,100
Estimating department costs
400
12,150
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Triumph Dynamic Professionals Limited
You are aware that considerable publicity could be obtained for the company if you are able
to win this order and the price quoted must be very competitive.
The following notes are relevant to the cost estimate above:
(1) The paper to be used is currently in stock at a value of N5,000. It is of an unusual
specification (texture and weight) and has not been used for some time. The replacement
price of the paper is N9,000, whilst the scrap value of that in stock is N2,500. The store’s
manager does not foresee any alternative use for the paper if it is not used on the pamphlet.
(2) The inks required are presently not held in stock. They would have to be purchased in bulk
at a cost of N3,000. 80% of the ink purchased would be used in producing the pamphlet. There
is no foreseeable alternative use for the remaining unused ink.
(3) Highly skilled direct labour is in short supply, and the factory labour is already being utilised
at full capacity, therefore, to accommodate the production of the pamphlet, 50% of the time
required would be worked at weekends for which a premium of 25% above the normal hourly
rate is paid. The normal hourly rate is N4.00 per hour.
(4) Semi-skilled labour is presently under-utilised, and 200 hours per week are currently
recorded as idle time. If the printing work is carried out, 25 unskilled hours would have to
occur during the weekend, but the employees concerned would be given two hours’ time off
during the week in lieu of each hour worked at the weekend.
(5) Variable overhead represents the cost of operating the printing press and binding
machines.
(6) When not being used by the company, the printing press is hired to outside companies for
N6.00 per hour. This earns a contribution of N3.00 per hour.
There is unlimited demand for this facility.
(7) Fixed production costs are those incurred by and absorbed into production, using an
hourly rate based on budgeted activity.
(8) The cost of the estimating department represents time spent in discussions with the
organisation concerning the printing of its pamphlet.
Required:
Prepare a revised cost estimate using the opportunity cost approach, showing clearly the
minimum price that the company should accept for the order. Give reasons for each resource
valuation in your cost estimate.
(20 marks)
Exam Type Question 4
A decision has to be taken by firm whether or not to initiate manufacture of a new product
called Wizzo. The following data have been established.
i.
ii.
A market research study carried out three months ago into the sales potential of Wizzo
cost N250,000.
A new machine would require to be purchased at a cost of N1,000,000 solely to make
Wizzo. A nil scrap value is anticipated and it is the firm’s policy to write off depreciation
on a straight-line basis over five years.
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Triumph Dynamic Professionals Limited
iii.
iv.
v.
vi.
vii.
Wizzo would be manufactured in a factory owned by the firm, the annual depreciation
charge of which is N80,000. At present the factory is sub-let at N175,000.
The labour requirements for Wizzo are
Normal Wage Rates/Hour
Hours /unit of
First Year
Subsequent Years
Wizzo
N
N
Skilled
4
30
35
Semi-skilled
3
22
26
Unskilled
2
18
18.5
It is expected that there will be shortage of skilled labour in the first year only so the
manufacture of Wizzo will make it necessary for the skilled labour to be diverted from
other work on which a contribution of N45 per hour is earned, net of wage costs. The
firm currently has a surplus of semi-skilled labour paid at full rate but doing unskilled
work. The labour concerned could be transferred to provide sufficient labour for the
manufacture of Wizzo and would be replaced by unskilled labour.
Overhead costs are allocated to manufacture at the rate of N180 per skilled labour hour
as follows:
N
Fixed overheads
130
Variable overheads 50
180
The manufacture and sale of Wizzo is expected to cause sales of an existing product,
Bango, to fall by 3,000 units per annum. The contribution on Bango is N90 pr unit.
The manufacture of Wizzo would require the services of an existing manager who
would be paid N120,000 per annum. If not required for Wizzo the manager would be
made redundant and would receive N30,000 per annum under a service agreement.
What are the relevant costs from the above data in deciding whether or not to manufacture
Wizzo. (Ignore time value of money)?
Exam Type Question 5
A research project, which to date has cost the company N150,000, is under review. It is
anticipated that, should the project be allowed to proceed, it will be completed in
approximately one year when the results would be sold to a government agency for
N300,000.
Shown below are the additional expenses which the Managing Director estimates will be
necessary to complete the work.
Materials - N60,000
This material, which has just been received, is extremely toxic and if not used on the project
would have to be disposed of by special means, at a cost of N5,000
Labour - N40,000
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Triumph Dynamic Professionals Limited
The men are highly skilled and very difficult to recruit. They were transferred to the project
from a production department and, at a recent board meeting, the works Director claimed
that if the men were returned to him, he could earn the company each year N150,000 extra
sales. The accountant calculated that the prime cost of those sales would be N100,000 and
the overhead absorbed (all fixed) would amount to N20,000
Research Staff - N60,000
A decision has already been taken that this will be the last major piece of research undertaken,
and consequently when work on the project ceases the staff involved will be made redundant.
Redundancy and severance pay have been estimated at N25,000
Share of General Building Services - N35,000
The Managing Director is not sure what is included in this expense. He knows however that
the accounts staff charges similar amounts every year to each department.
Required:
Assuming the estimates are accurate, advice the Managing Director whether the project
should be allowed to proceed. You must carefully and clearly explain the reasons for your
treatment of each expense item.
Exam Type Question 6
The Asterix Company has received an order for a product it does not usually produce. It has
available the machines and operators needed to fill incremental costs. The available
information is summarized below:
Exium: The order required 1,000 units of this material. While Asterix never uses this material
in its regular operations, records indicate the cost records show 4,000 units being carried at
N4 per unit. According to the purchasing department it would cost N8 per unit to replace it.
However, the best offer they had when they tried to sell it earlier was N3.50 per unit.
Whyite: 2,000 units are required. This material is used regularly, and Asterix has a large
inventory of it. The average cost per unit of the current inventory is N2.50. the market price is
now N3. Purchasing estimates that if it uses the Whyite in this order, it will reorder one month
sooner than usual. At that time, the seasonal decline will have dropped the price of whyite to
N2.75. This is above the expected seasonal low of N2.20
Zeebium: Only 500 units are needed. This material is carried in large quantities in Asterix’s
inventory. The average cost is 10kobo per unit. Because of the heavy usage and poor storage
characteristics, it must be purchased weekly. The current price is 12kobo per unit.
Scrapite: About 1,000 units are needed. This is an unstable by-product of one of Asterix’s other
processes. It is sometimes saleable at prices of up to 10kobo per unit. However, usually it must
be disclosed of by the local authority at a cost of N1 per case. Each case contains 25 units.
Labour: All of Asterix’s employees are guaranteed pay for a 40-hour work-week even when
work is unavailable. At present, the hours actually worked average about 35. The production
manager indicates that the order will require 10 hours of his time at N10 per hour and about
70 hours of worker time at N4 per hour plus 10 hours at time-and-a-half in order to meet the
deadline
You are required to calculate the relevant cost for decision making purposes of each of the
raw materials and the labour cost. Explain your calculations.
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Triumph Dynamic Professionals Limited
Home Study Question 1
The managing director of Parser Ltd, a small business, is considering undertaking a one-off
contract and has asked her inexperienced accountant to advise on what costs are likely to be
incurred so that she can price at a profit. The following schedule has been prepared:
Costs for special order:
Notes
N
Direct wages
1
28,500
Supervisor costs
2
11,500
General overheads
3
4,000
Machine depreciation
4
2,300
Machine overheads
5
18,000
Materials
6
34,000
98,300
Notes:
(1) Direct wages comprise the wages of two employees, particularly skilled in the labour
process for this job, who could be transferred from another department to undertake work
on the special order. They are fully occupied in their usual department and sub-contracting
staff would have to be bought-in to undertake the work left behind. Subcontracting costs
would be N32,000 for the period of the work. Different subcontractors who are skilled in the
special-order techniques are available to work on the special order and their costs would
amount to N31,300.
(2) A supervisor would have to work on the special order. The cost of N11,500 is comprised of
N8,000 normal payments plus N3,500 additional bonus for working on the special order.
Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would
lose incentive payments in his normal work amounting to N2,500. It is not anticipated that any
replacement costs relating to the supervisor’s work on other jobs would arise.
(3) General overheads comprise an apportionment of N3,000 plus an estimate of N1,000
incremental overheads.
(4) Machine depreciation represents the normal period cost based on the duration of the
contract. It is anticipated that N500 will be incurred in additional machine maintenance costs.
(5) Machine overheads (for running costs such as electricity) are charged at N3 per hour. It is
estimated that 6000 hours will be needed for the special order. The machine has 4000 hours
available capacity. The further 2000 hours required will mean an existing job is taken off the
machine resulting in a lost contribution of N2 per hour.
(6) Materials represent the purchase costs of 7,500 kg bought some time ago. The materials
are no longer used and are unlikely to be wanted in the future except on the special order.
The complete inventory of materials (amounting to 10,000 kg), or part thereof, could be sold
for N4.20 per kg. The replacement cost of material used would be N33,375.
Because the business does not have adequate funds to finance the special order, a bank
overdraft amounting to N20,000 would be required for the project duration of three months.
The overdraft would be repaid at the end of the period. The bank’s overdraft rate is 18%.
The managing director has heard that, for special orders such as this, relevant costing should
be used that also incorporates opportunity costs. She has approached you to create a revised
costing schedule based on relevant costing principles.
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Triumph Dynamic Professionals Limited
Adjust the schedule prepared by the accountant to a relevant cost basis, incorporating
appropriate opportunity costs.
Home Study Question 2
John Robertson, a self-employed builder, has been asked to provide a fixed price quotation
for some building work required by a customer. Robertson's accountant has compiled the
following figures, together with some notes as a basis for a quotation.
N
Direct materials
Bricks 200,000 at N100 per thousand
20,000
note 1
200,000 at N120 per thousand
24,000
Other materials
5,000
note 2
Skilled 3,200 hours at N12 per hour
38,400
note 3
Unskilled 2,000 hours at N6 per hour
12,000
note 4
Other costs
Scaffolding hire
3,500
note 5
Depreciation of general-purpose machinery
2,000
note 6
General overheads 5,200 hours at N1 per hour
5,200
note 7
Plans
2,000
note 8
Total cost
112,100
Profit
22,420
note 9
Suggested price
134,520
Notes:
i.
The contract requires 400,000 bricks, 200,000 are already in inventory and 200,000
will have to be bought in. This is a standard type of brick regularly used by Robertson.
The 200,000 in inventory were purchased earlier in the year at N100 per 1,000. The
current replacement cost of this type of brick is N120 per 1,000. If the bricks in
inventory are not used on this job John is confident that he will be able to use them
later in the year.
ii.
Other materials will be bought in as required; this figure represents the purchase price.
iii.
Robertson will need to be on site whilst the building work is performed. He therefore
intends to do 800 hours of the skilled work himself. The remainder will be hired on an
hourly basis. The current cost of skilled workers is N12 per hour. If John Robertson does
not undertake the building work for this customer, he can either work as a skilled
worker for other builders at a rate of N12 per hour or spend the 800 hours completing
urgently needed repairs to his own house. He has recently had a quotation of N12,000
for labour to repair his home.
iv.
John employs four unskilled workers on contract guaranteeing them a 40 hours week
at N6 per hour. These unskilled labourers are currently idle and would have sufficient
spare time to complete the proposal under consideration.
v.
This is the estimated cost of hiring scaffolding.
vi.
John estimates that the project will take 20 weeks to complete. This represents 20
weeks' straight-line depreciation on the equipment used. If the equipment is not used
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Triumph Dynamic Professionals Limited
on this job, it will stand idle for the 20-week period. In either case its value at the end
of the 20-week period will be identical.
vii.
This represents the rental cost of John's storage yard. If he does not undertake the
above job, he can rent his yard out to a competitor who will pay him rent of N500 per
week for the 20-week period.
viii.
This is the cost of the plans that John has already had drawn for the project.
ix.
John attempts to earn a mark-up of 20% on cost on all work undertaken.
John is surprised at the suggested price and considers it rather high. He knows that there will
be a lot of competition for the work.
Required
(a) Explain how each item in the accountant's estimate should be treated
(6 marks)
(b) Using relevant costing principles, calculate the lowest price that John could quote for the
customer's building work. Explain why in practice the minimum price is never actually used.
(10 marks)
(c) Discuss the advantages and disadvantages of full cost-plus pricing.
(4 marks)
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