Klein Ltd produces specialist parts for motor vehicles and has a number of contracts to supply a variety of different parts to automotive manufacturers throughout Europe.

Klein produces the T65, an automotive part which is coming to the end of its product life cycle and will only be used by car manufacturers for one more year. Klein has contracts with various car manufacturers which require the production of a total of 120,000 T65's over the next 12 months. After this time, Klein Ltd will discontinue production of the T65 as it will no longer be required by car manufacturers.

Klein Ltd is keen to focus its resources on the development and production of new and profitable products. The company is therefore currently investigating the option of outsourcing the production of T65 over the next 12 months in order that it can focus on other projects. Klein Ltd has received an offer from an outsource supplier who will provide the required 120,000 units of T65 at a cost of 66 per unit.

In order to assist with the decision-making, the manager of the department which produces the T65, Chris, has provided the following cost information:

Cost data per unit of T65
Material A	0.5KG @ 10 per KG	5.00
Material B	1 KG @ 4 per KG	4.00
Labour - skilled	1 HR @ 16 per HR	16.00
Labour - unskilled	4 HRS @ 8 per HR	32.00
Variable overhead	5 HRs @ 2 per HR	10.00
Factory rent	120,000 per annum	1.00
Factory supervisor salaries	2 @ 30,000 per annum	0.50
Head Office admin charge		2.00
Total cost per unit		70.50

Chris has recommended that the company should go ahead with the outsourcing contract for T65, as it will be cheaper than the company's current cost of production.

However, the management accountant, Kate, has suggested that the following information should be taken into account before any decision is made.

1. Klein Ltd currently has 20,000KG of material A in stock. The company has no use for material A other than for the production of T65. If not used for the production of T65, the remaining stocks of material A will be scrapped (at no cost to the company).
2. Klein Ltd currently has 80,000KG of material B in stock. If not used for the production of T65, material B can be sold for 2 per KG. Alternatively, material B can be converted to another material, material C, used regularly in the production of other automotive parts. The conversion would cost 0.20 per KG and the current cost of material C is 3 per KG.
3. The company would have no further use for the Skilled Labour if not used in the production of T65. There are 60 skilled labourers, who would each be offered a redundancy payment of 5,120.
4. There are currently 2,000 hours of idle time per month in respect of the unskilled labour. If not used on the production of T65, the unskilled labourers could be transferred to a different production line, but this would incur a training cost of 50,000.
5. The variable overhead is based on direct labour hours and is only incurred for the production of T65.
6. If Klein Ltd discontinues production of the T65, the factory can be used as warehouse storage space. This means that the company would no longer need to rent a storage warehouse, the current cost of which is 70,000 per annum.
7. Of the two factory supervisors, one supervisor could be transferred to another factory for no cost. The other supervisor would be made redundant and would be offered a redundancy payment equivalent to 80% of his annual salary.
8. The Head Office admin expense is a charge made to all production lines and represents a proportion of the annual Head Office costs.

Requirement:

Prepare a report for the managers of Klein Ltd to help them to decide whether or not they should proceed with the outsourcing of T65. Your report should include the following:

1. A description of relevant costing principles and an explanation of why relevant costing is useful for this outsourcing decision;

(7 marks)

1. Calculations using relevant costing principles;

(15 marks)

1. An explanation of the treatment of each of the items (1) to (8) in your calculations;

(15 marks)

1. An evaluation of the usefulness of the calculations, including an explanation of any other factors which the company should consider before making a decision.

(13 marks)

(Total 50 marks)