Traffick PLC has been forced to close for two weeks because of supply problems.

During that time the company produced no count meters. The company issued a press statement that the supply failure had cost the company £1 million. This figure was based on the loss of turnover over the two-week period.

The company’s financial accountant has subsequently made a more detailed assessment of the cost, as follows:

The following information is available:
(i) The direct labour was paid 75% of the normal wage during the two-week period, and this amounted to £75,000.
(ii) Depreciation is based on the straight-line method. However, there is a variable component of depreciation amounting to 50 pence per unit produced.
(iii) Fixed overhead is absorbed at the rate of 200% on direct wages.
(iv) The maintenance team was able to carry out a major overhaul of one of the machines during the period of closure. They had to purchase materials costing £5000, but a contractor would normally have performed the overhaul at a cost of £25,000 (including materials). The cost of the maintenance team is included within fixed overheads. The cost of the materials has not yet been recorded.
(v) The sales manager has estimated that because of the closure, there will be unsatisfied demand amounting to half the production lost. This can be made up by the production workforce working overtime during the next month. Overtime is paid at an enhanced rate of 50% above the normal hourly rate.

(a) Examine points (i)–(v) and discuss the relevance of each of these costs to the identification of the cost of closure.

(b) Produce a statement indicating the net cost of the closure. You will need to explain the inclusion (or exclusion) of any items that you have not discussed in part

(a) of the question.

(c) Outline two potential problems with the use of relevant costing in decision making.

Transcribed Image Text:

Lost revenue (40,000 units @25 each) Standard cost 000 000 1000 Costs saved per unit () Materials 1.0 40 Direct labour 2.5 100 Depreciation 4.0 160 Variable overhead 3.0 120 Sub-contracting work 1.0 40 Fixed overhead 5.0 200 660 Cost of the supply failure 340