Q. 1 The Aylett Company Ltd has offered a contract that, if accepted, would significantly increase next year's activity levels. The contract requires the production of 20,000 kg of product Sigma and specifies a contract price of Rs. 100 per kg. The resources used in the production of each kg of sigma include the following: Resources per kg of Sigma Labor: Grade - 1 2 Hours Grade - 2 6 Hours Material A 2 Units B 1 Liter Grade - 1 labor is highly skilled and although it is currently under-utilized in the firm, it is Aylett's policy to continue to pay grade - 1 labor in full. Acceptance of the contract would reduce the idle time of grade - 1 labor. Idle time payments are treated as non - production overheads. Grade - 2 is unskilled labor with a high turnover, and may be considered a variable cost. 

The cost to Aylett of each type of labor are: Grade - 1 Rs. 4 per hour Grade - 2 Rs. 2 per hour The materials required to fulfill the contract would be drawn from those materials already in stock. Material - A is widely used within the firm, and any usage for this contract will necessitate replacement. Material - B was purchased to fulfill an expected order that was not received, if material B is not used for the contract, it will be sold. For accounting purposes FIFO is used. The various values and cost of A & B are: A B Rs. Per unit Rs. Per unit P a g e | 2 Book Value 8 30 Replacement cost 10 32 Net realizable value 9 25 A single recovery rate for fixed factory overheads is used throughout the firm, even though some fixed production overheads could be attributed to single products or departments.

 The overhead is recovered per productive labor hour, and initial estimates of next year's activity, which excludes the current contract, show fixed production overheads of Rs.600,000 and productive labor hours of 300,000. Acceptance of the contract would increase fixed production overheads by Rs.228,000. Variable production overheads are accurately estimated at Rs. 3 per productive labor hour. Acceptance of the contract would be expected to encroach on the sales and production of another product - Y, which is also made by Aylett Ltd. It is estimated that the sales of Y would then decrease by 5000 units in the next year only. However, this forecast reduction in sales of Y would enable attributable fixed factory overheads of Rs. 58,000 to be avoided. Information on Y is as follows: Per unit Sales price Rs. 70 Labour grade - 2 4 hours Materials: relevant variable cost Rs.12 All activity undertaken by Aylett is job costed using absorption costing in order to derive a profit figure for each contract - if the contract for Sigma is accepted, it will be treated as a separate job for routine costing purpose. The decision to accept or reject the contract will be taken in sufficient time to enable its estimated effects to be incorporated in the next year's budgets and also in the calculations carried out to derive the overhead recovery rate to be used in the forthcoming year. 

Required: 

(a) Advise Aylett on the desirability of the contract. (12) 

(b) Show how the contract, if accepted, will be reported on the routine job costing system used by Aylett. (8

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a Advise Aylett on the desirability of the contract To determine the desirability of the contract we need to consider the financial impact and other relevant factors 1 Sales Revenue The contract requi... View the full answer