Acceptance of a contract JB Limited is a small specialist manufacturer of electronic components and much of its output is used by the makers of aircraft for both civil and military purposes. One of the few aircraft manufacturers has offered a contract to JB Limited for the supply, over the next twelve months, of 400 identical components.

The data relating to the production of each component is as follows:

(i) Material requirements:

3 kg material M1 — see note | below 2 kg material P2 — see note 2 below 1 Part No. 678 — see note 3 below Note 1. Material M1 is in continuous use by the company. 1000 kg are currently held in stock at a book value of £4.70 per kg but it is known that future purchases will cost £5.50 per kg.

Note 2. 1200 kg of material P2 are held in stock. The original cost of this material was

£4.30 per kg but as the material has not been required for the last two years it has been written down to £1.50 per kg scrap value. The only foreseeable alternative use is as a substitute for material P4 (in current use) but this would involve further processing costs of

£1.60 per kg. The current cost of material P4 is £3.60 per kg.

Note 3. It is estimated that the Part No. 678 could be bought for £50 each. (ii) Labour requirements: Each component would require five hours of skilled labour and five hours of semi-skilled. An employee possessing the necessary skills is available and is currently paid £5 per hour. A replacement would, however, have to be obtained at a rate of £4 per hour for the work which would otherwise be done by the skilled employee.

The current rate for semi-skilled work is £3 per hour and an additional employee could be appointed for this work.

(iii) Overhead: JB Limited absorbs overhead by a machine hour rate, currently £20 per hour of which £7 is for variable overhead and £13 for fixed overhead. If this contract is undertaken it is estimated that fixed costs will increase for the duration of the contract by £3200. Spare machine capacity is available and each component would require four machine hours.

A price of £145 per component has been suggested by the large company which makes aircraft.

You are required to:

(a) State whether or not the contract should be accepted and support your conclusion with appropriate figures for presentation to management; (16 marks)

(b) comment briefly on three factors which management ought to consider and which may influence their decision. (9 marks)

CIMA Cost Accounting Stage 2