Imagine you are the Senior Management Accountant for Vitago Plc$.$ Vitago are a pharmaceutical Company in the UK$.$

The board considered the proposal to bid for a contract to produce own$-$label vitamins, minerals and supplements for MegaMart, the largest supermarket chain in South East Asia. Vitago does not currently supply MegaMart with Vitago branded products, so this would present an opportunity to build a relationship with MegaMart. The board was informed that a number of competitors have also been invited to bid for the contract.

The contract will be for the supply of capsules and tablets only. The capsules and tablets will be manufactured using Vitago$$s formulation but will utilise different packaging and labelling. The contract will be for an initial period of one year and will then be re$-$negotiated.

The board requested Melanie Tan, the Sales and Marketing Director, to present further details, including estimated prices and costs, at the next board meeting.

You have just had a meeting with Melanie Tan, Sales and Marketing Director. Melanie is keen to win this contract as she believes it will result in future orders from MegaMart and help to build our reputation. She was also telling you that the product development team has spent a lot of time and effort on the bottle and packaging for the new product range. The initial feedback on these from MegaMart has been extremely positive. She has prepared some figures on the costs of the contract and has asked for your help with the pricing decision.

Vitago normally uses a full cost$-$plus pricing approach where we calculate the full cost of the contract and add a profit mark$-$up$.$ However, Vitago pharmaceutical would like you to consider the relevant costs associated with this contract.

Costs Schedule for the MegaMart contract for the first year:

Product development cost: This represents the cost of developing the prototype bottle and packaging. The cost already incurred is $20,000$ but it is estimated that a further $40,000$ will be incurred if the contract goes ahead. $-60,000$

Raw materials: the raw materials to be used for the contract are in regularly use for Vitago$$s branded products. The current inventory valuation of these materials is $800,000$ and the replacement cost is $850,000.$ The remaining raw materials requirement of $600,000$ will be bought$-$in specifically for the contract $-1,400,000$

Packaging: the packaging will be bought$-$in specifically for this contract. $-112,000$

A further packaging machine will need to be purchased at a cost of $50,000.$ This machine could also be used for other contracts. If the new machine is purchased an existing machine which currently has a net book value of $10,000$ could be sold for $20,000.-50,000$

Direct labour: this represents the cost of direct labour at the normal hourly rate of $10$ per hour. Labour is in short supply and to accommodate this contract it would require delaying another contract. There will be a penalty payable for this delay of $20,000.-500,000$

Technical specialist: it is estimated that a technical specialist would be required to work a total of $100$ hours on the contract. The technical specialist is currently working at full capacity so would need to be paid overtime to do this. He is paid an hourly rate of $20$ and is paid for all overtime at a premium of $50\%$ above his normal hourly rate. $-3,000$

Fixed manufacturing overhead cost: this represents fixed production overheads at our normal absorption rate. $-400,000$

Total costs $-2,525,000$

Required:

Prepare a report to explain the following:

A$)$ The definition of relevant cost and what underlying principles should be followed in determining relevant costs to be used in decision making? B$)$ Explain, giving clear justification, which of the costs in the schedule below would be relevant and which would be irrelevant. In light of your understanding of the MegaMart contract deal, discuss whether a relevant cost approach would be appropriate in this situation or not. In your answer, please consider factors other than cost that would have an impact on the pricing of this contract.