Question
Mr. Lee has been asked to review a research contract, which to date has cost the company $200,000. If the contract proceeds, it will be
Mr. Lee has been asked to review a research contract, which to date has cost the company $200,000. If the contract proceeds, it will be completed in approximately three months. The research findings would then be sold to a government agency for $400,000. The additional expenses which will be necessary to complete the work are listed below:
1. Materials required for completing the contract has just been purchased at a cost of $50,000. It can be used only for this contract and it is toxic. If it is not used, it must be disposed of at a cost of $6,000.
2. The contract would require 300 hours of skilled labor that is hard to recruit. The skilled labor will be transferred to the contract from a production department. The hourly rate is $80 per hour. At a recent meeting, the production department manager claimed that if the men were returned to him they could generates sales of $100,000. The material costs for the sales will be $30,000.
3. The contract would require 800 hours of unskilled labor. These are fully employed by the company on jobs where they produce a contribution of $2 per unskilled labor hour. The rate for the employed unskilled labor is $31 per hour, although extra could be hired at $34 if necessary.
4. The contract utilizes a special microscope which was purchased a year ago at a cost of $18,000. The microscope has no other use and if it is not used for the contract, it has a current disposal value of $10,000. If used in the contract, it is estimated that the disposal value will be $7,000.
5. The contract is charged with $3,000 per month to cover the general building expenses. Immediately after the contract is discontinued, the space occupied could be sub-let for a monthly rental of $4,000.
Required:
a. Advise Mr. Lee as to whether the contract should be allowed to proceed, explaining the reasons for the treatment of each item. (24 marks)
b. From a decision-making point of view, should joint costs be allocated among joint products?
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