Intermediate: Acceptance of a contract

(a) A small contractor has been asked to quote for a contract which is larger than he would normally consider. The contractor would like to obtain the job as he does have surplus capacity.

The estimating and design department has spent 200 hours in preparing drawings and the following cost estimate

The following notes may be relevant:
(1) A sufficient stock of raw material X is held in the stores. It is the residue of a quantity bought some 1 0 years ago. If this stock is not used on the prospective contract it is unlikely that it will be used in the foreseeable future. The net resale value is thought to be £20000.
(2) Material Y is regularly used by the contractor on a variety of jobs. The current replacement cost of the material is £130 per unit.
(3) This is the estimated cost of the required material.
(4) Staff are paid on a time basis for a 40 hour week. The labour hour rate includes a charge of 100% of the wage rate to cover labour related overhead costs. It is estimated that, at the current level of operations, 80%
of the overheads are variable. It is considered that one extra worker will be required temporarily for 3 months if the contract is obtained. His salary of £100 per week (and the associated amount of labour related overhead expense) is included in the estimate of £13600.
(5) No additional trainees would be taken on. The trainees' wage rate is £1 per hour but their time is charged out at £2 to allow for labour related overhead on the same basis as in note 4 above.
(6) The curing press is normally fully occupied. If it is not being used by the contractor's own workforce it is being hired out at £500 per week.
(7) This is the estimated cost for the work.
(8) It is not considered that it would be necessary to employ any additional supervisory staff. The estimated cost of £6150 includes an allowance of £1000 for overtime which it may be necessary to pay to the supervisors.
(9) The expense of this department is predominantly fixed but the overtime payments were specifically incurred to get the drawings and plans out in time.
(10) The administrative expense is a fixed cost. This is the established method of allocating the cost to specific contracts.
It is considered that any quotation higher than £100000 will be unsuccessful. You are required to prepare a revised cost estimate using an opportunity cost approach. State whether you consider that the revised calculations can provide support for a quotation below £100000. (15 marks)

(b) Comment on the use of opportunity cost:
(i) for decision-making and (ii) for cost control purposes.

Transcribed Image Text:

Direct materials: 3000 units of X at 10 (original cost) 100 units of Y (charged out using FIFO) () see note 1 30 000 see note 2 50 units at 100 5000 50 units at 125 6250 11250 Direct material to be bought in: see note 3 12000 Direct labour: Skilled staff (2720 hours at 5 per hour) see note 4 13 600 Trainees (1250 hours at 2 per hour) see note 5 2500 Depreciation on curing press: see note 6 Annual depreciation (straight line) 12000 One month's depreciation 1000 Subcontract work see note 7 20000 Supervisory staff see note 8 6150 Estimating and design department: see note 9 200 hours at 10 per hour 2000 Overtime premium for 50 hours 500 2500 99 000 Administration overhead at 5% of above see note 10 4950 costs 103 950