MBA/MSc 22 Illustration on the application of relevant costing principles Question One TECH PLC produces custom-built sensors. Each sensors has a standard circuit board (SCB) in it. The current average selling price from a sensor is $400. TECH PLCs business is steadily expanding and in the year ending 2021, the company will have produced 55000 sensors. The demand for TECH PLCs sensors is predicted to grow over the next three years. Year Units 2022 58000 2023 62000 2024 65000 The production of sensors is limited by the number of SCBs the company can produce. The present production level of 55000 SCBs is the maximum that can be produced without overtime working. Overtime could increase annual output to 60500, allowing production of sensors to increase to 60500. However, the variable costs of SCBs produced in overtime would increase by $75 per unit. Because of the pressure on capacity, the company is considering having SCBs manufactured by another entity, UCC PLC. This company is very reliable and produces products of good quality. UCC PLC has quoted a price of $116 per SCB, for orders greater than 50000 units a year. TECH PLCs own costs data are predicted to be as follows: $ Direct material 28 Direct labour 40 Variable overhead 20 (Based on labour cost) Fixed overhead 24 (Based on labour cost and output of 55000 units) Total cost 112

The fixed overheads directly attributable to SCBs are $250,000 a year; these costs will be avoided if SCBs are not produced. If more than 59000 units are produced, SCBs fixed overheads will increase by $130,000. In addition to the above overheads, TECH PLCs fixed overheads are predicted to be as follows: Sensor Production, Units 54001 to 59000 59001 to 64000 64001 to 70000 Fixed overhead $2600,000 $2900,000 $3100,000 TECH PLC currently holds a stock of 3500 SCBs but the production manager feels that a stock of 8000 SCBs should be held if they were bought in; this would increase stock holding costs by $10,000 Page 1 of 2 MBA/MSc 22 Illustration on the application of relevant costing principles a year. A purchasing officer, who is paid $20,000 a year, spends 50% of her time on SCB duties. If SCBs were bought in, a laision officer will have to be employed at a salary of $30,000 in order to liaise with UCC PLC and will have to monitor the quality and supply of SCBs. At present, 88 staff were involved in the production of SCBs at an average salary of $25,000 a year: if the SCBs were purchased, 72 of these staffs would be made redundant at an average cost of $4000 per employee. The SCB department, which occupies an area of 240 by 120 square meters at the far end of the factory, could be rented out, at a rent of $45 per square meter a year. However, if the SCBs were to be bought in, for the first year only, TECH PLC would need the space to store the increased stock cause by the outsourcing, until the main stockroom has been reorganized and refurbished. From 2023, the space could be rented out; this would limit the annual production of sensors to 60500 units. Alternatively, the space could be used for the production of sensors, allowing annual output to increase to 70000 units if required. Required: a) Critically discuss the validity of the following statement. It was produced by Harriet, the company accountant, to show the gain for the 2022 financial year if the SCBs were bought in. Savings In $ Manufacturing staff salaries saved: 72 staff * $25000 1800,000 Purchasing officer time saved 10,000 Placing orders for SCB materials: 1000 orders * $20 per order 20,000 Transport costs for raw materials for SCB 45,000 Cost Saved 1,875,000 Additional costs per SCB: ($116-$112) * 58000 units (232000) Net gain if SCBs purchased 1643000 b) Produce detailed calculations that show which course of action is the best financial option for the three year under consideration (Ignore the time value of money) c) Advise the company of the long-term advantages and disadvantages of buying in SCBs