QUESTION 2 [30]

DLW is a company that builds innovative, environmentally friendly housing. DLW's houses use high quality materials and the unique patented energy saving technology used in the houses has been the result of the company's own extensive research in the area.

DLW is planning to expand into another country and has been asked by a prominent person in that country for a price quotation to build them a house. The Board of Directors believes that securing the contract will help to launch their houses in the country and have agreed to quote a price for the house that will exactly cover its relevant cost. The following information has been obtained in relation to the contract:

1. The Chief Executive and Marketing Director recently met with the potential client to discuss the house. The meeting was held at a restaurant and DLW provided food and drinks at a cost of R375.

2. 1,200 kg of Material Z will be required for the house. DLW currently has 550 kg of Material Z in its inventory purchased at a price of R58 per kg. Material Z is regularly used by DLW in its houses and has a current replacement cost of R65 per kg. The resale value of the Material Z in inventory is R35 per kg.

3. 400 hours of construction worker time are required to build the house. DLW's construction workers are paid an hourly rate of R22 under a guaranteed wage agreement and currently have spare capacity to build the house.

4. The house will require 90 hours of engineer time. DLW engineers are paid a monthly salary of R4,750 each and do not have any spare capacity. In order to meet the engineering requirement for the house, DLW can choose one of two options:

(i) Pay the engineers an overtime rate of R52 per hour to perform the additional work.

(ii) Reduce the number of engineers' hours available for their existing job, the building of Product Y. This would result in lost sales of Product Y.

Summary details of the existing job the engineers are working on:

Information for one unit of Product Y

Sales revenue R4,860

Variable costs R3,365

Engineers' time required per unit 30 hours

5. A specialist machine would be required for 7 weeks for the house build. DLW have 4 weeks remaining on the 15 week specialist machine rental contract that cost $15,000. The machine is currently not in use. The machine can be rented for an additional 15 weeks at a cost of $15,250. The specialist machine can only be rented in blocks of 15 weeks. Alternatively, a machine can be purchased for $160,000 and sold after the work on the house has been completed for $140,000.

6. The windows required for the house have recently been developed by DLW and use the latest environmentally friendly insulating material. DLW produced the windows at a cost of $34,950 and they are currently the only ones of their type. DLW were planning to exhibit the windows at a house building conference. The windows would only be used for display purposes at the conference and would not be for sale to prospective clients.

DLW has had assurances from three separate clients that they would place an order for 25 windows each if they saw the technology demonstrated at the conference. The contribution from each window is $10,450. If the windows are used for the contract, DLW would not be able to attend the conference. The conference organisers will charge a penalty fee of $1,500 for non-attendance by DLW. The Chief Executive of DLW can meet the clients directly and still secure the orders for the windows. The meetings would require two days of the Chief Executive's time. The Chief Executive is paid an annual salary of $414,000 and contracted to work 260 days per year.

7. The house build requires 400kg of other materials. DLW currently has none of these materials in its inventory. The total current purchase price for these other materials is $6,000.

8. DLW's fixed overhead absorption rate is $37 per construction worker hour.

9. DLW's normal policy is to add a 12% mark-up to the cost of each house.

Required:

2.1 Calculate the relevant cost of building the house. You should present your answer in a schedule that clearly shows the relevant cost value for each of the items identified above. (10)

2.2 Explain each relevant cost value you have included in your schedule and why the values you have excluded are not relevant. (15)

2.3 Explain reasons why relevant costing may not be a suitable approach to pricing houses in the longer term for DLW.