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Task 2 (1200 words equivalent) Turki Construction Ltd considers tendering a contract which would take three months to complete. It is felt that tenders over OMR 80,000 are extremely unlikely to be successful. The company is in a specialised, highly competitive market and new contracts are difficult to win and keep. If the contract is taken, Turki Construction Ltd still expects to complete its other current contracts. The management accountant submitted the cost estimates below: OMR 8,000 6,000 5,000 30,000 Direct materials Type A (already in stock) Type B (firm order placed) Type C (not yet ordered, shown at current purchase price) Direct labour Other costs: Variable overheads Depreciation of equipment (straight-line basis) Supervisors' salaries (Two supervisors @ OMR 4,000 each per month) (Two supervisors @ OMR 4,000 each per month) General fixed overheads TOTAL COSTS 3,000 3,750 24,000 12,000 91,750 Additional information with respect to the above cost is given below: 1. Type A material, originally cost OMR 8,000, is already in stock. The material is not in common use and would realise about OMR 6,000 if sold. If Material A is not used in this contract, all materials could be used later in the year as substitute to a material that currently costs 30% less than A's original price. 2. Type B material is in regular use by the company. The order for Type B material was placed twelve days ago and cannot be cancelled anymore. Due to a world-wide shortage which is expected to continue for the foreseeable future, Material B's price has increased by 50% since the order was placed. Material could be sold at this new higher price (after deducting 15% selling costs) to a competitor who urgently needs this material. Alternatively, it can be used on other contracts later in the year, 3. A team of semi-skilled staff would be recruited locally specifically for the duration of this contract. The wages of these semi-skilled staff will amount to a total of OMR 17,000. Skilled staff would also need to be reallocated to this contract from within the company. They have already worked for the company and are currently being paid although there is very little work for them to do. The estimated wages for these workers for the period of the contract are OMR 10,000. On top of this re-allocation of skilled staff, it is estimated that a further OMR 3,000 of overtime will also need to be incurred by specialist employees who are currently fully employed on other jobs within the company. 4. The management accountant has calculated variable overheads for the contract using the company's standard policy of 10% of direct labour cost. However, the project manager has estimated that, due to the unique nature of this work, the actual variable overhead arising as a result of the contract is likely to be about OMR 4,750. 5. The equipment to be used on the contract cost OMR 180,000 when it was purchased in May 2011. It was planned to keep it for ten years after which its scrap value was expected to be OMR 30,000. The depreciation charge in the cost estimate is based on this data. At present, the equipment is worth OMR 45,000. If used on the contract its current value is likely to decline to approximately OMR 40,000. Turki Construction Ltd has no further use for the equipment and if the contract is not accepted they would sell it now. 6. The new contract is so specialised that one of the two supervisors need to be recruited from a competitor. She is expected to be paid a premium salary of OMR 5,000 per month. The second supervisor, who is currently paid OMR 4,000 per month, can be temporarily transferred from another department. However, he will only transfer to the project if he is incentivised through a one-off bonus payment of OMR 800. His current role will be filled by a temporary upgrading of an existing worker with an estimated additional cost of OMR 400 per month. 7. The management accountant allowed fixed overheads for the contract using the company's pre-determined policy of 40% of direct labour cost. The general fixed overhead absorption rate is calculated based on budgeted rent, rates, Insurance, general expenses and similar fixed costs. However, it is anticipated that this additional contract would cause general expenses to increase by OMR 750 per month for the duration of the contract. Pg.8 Version 1 Required: a) Using a relevant/opportunity cost approach, prepare a revised cost estimate for the contract in the light of the above information b) For each item of cost referred to in the question, clearly explain your reasoning behind its inclusion in (or omission from) your estimate in a) above. c) On the basis of your estimate in (a) above, state whether the company should tender this contract. d) What is transfer pricing and what is the risk and benefits of transfer pricing for enterprises