QUESTION ONE [25] K is the holding company of a number of companies within the engineering sector. One of these subsidiaries is POR which specialises in building machines for manufacturing companies. POR uses absorption costing as the basis of its routine accounting system for profit reporting. POR is currently operating 90% of its available capacity and has been invited by external manufacturing company to tender for the manufacture of machine B. If PORs tender is accepted by the manufacturing company, then it is likely that another company within the K group will be able to obtain work in the future servicing of the machine. As a result, the Board of Directors of K are keen to win the tender for the machine and are prepared to accept a price from the manufacturing company that is based on the relevant costs of building the machine. An engineer from POR has already met with the manufacturing company to determine the specification of machine B and he has worked with a non-qualified accountant from POR to determine the following cost estimates for machine B.

Item Note Cost Engineer specification

1 R1 500 Direct material A

2 R61 000 Direct material B

3 R2 500 Components

4 R6 000 Direct labour

5 R12 500 Supervision

6 R350 Machine hire

7 R2 500 Overheads cost

8 R5 500 Total R91 850

Notes:

1. The engineer that would oversee the project to build the machine has already met with the manufacturing company, and subsequently prepared specifications for the machine. This has taken 3 days of his time and his salary related cost is R500 per day. The meeting with the manufacturing company only took place because of this potential work; no other matters were discussed at the meeting. 2. The machine would require 10 000 square meters of Material A. This material is regularly used by POR. There is currently 15000 square meters in inventory, 10 000 square meters Page 3 of 8 were bought for R6 per square meter and the remainder were bought for R6,30 per square meter. POR uses the weighted average basis to value its inventory. The current market price of material A is R7 per square meter, and the inventory could be sold for R6,50 per square meter. 3. The machine could also require 250 meters length of material B. This is not a material that is regularly used by POR, and it would have to be purchased specifically for this work. The current market price is R10 per meter length, but the sole supplier of this material has a minimum order size of 300 meters lengths. POR does not foresee any future use of any unused lengths of material B and expects that the net revenue from any sale material B remaining material would be negligible. 4. The machine B would require 500 components. The components could be produced by HK, another company within the K group. The direct cost of HK for producing each component is R8, and normal transfer pricing policy within K group is to add a 50% mark-up to the direct cost to determine the transfer price. HK has unused capacity which would allow them to produce 350 components, but thereafter any more components could be produced by reducing other components which are sold to the external market. These other components, although different, require the same machine time per unit as those required by POR, have a direct cost of R6 per component and currently are sold for R9 each. Alternatively, POR can buy the components from the external market for R14 each. 5. The manufacturing of machine B will require 1000 hours of skilled labour. The current market rate within the appropriate skills is R15 per hour. POR currently employs engineers that have the necessary skills at a cost of R12,50 per hour, but they do not they do not have any capacity. They could be transferred from their existing duties if temporary replacements were to be engaged at a cost of R14 per hour. 6. The project would be supervised by a senior engineer who currently works 150 hours per month is paid an annual salary of R42 000. The project is expected to take a total of one month to complete, and if it goes ahead is likely to take up to 10% of supervisors time during that month. If necessary, the supervisor will work overtime which is unpaid. 7. It will be necessary to hire a specialist machine for part of the project. In total the project will require the machine for 5 days, but it is difficult to determine which days the machine would be required within the overall project time of one month. One option is to hire the machine for the entire month at accost of R5000 and then sub-hire the machine for R150 per day when it Page 4 of 8 is not required by POR. POR expects that it would be able to sub-hire the machine for 20 days. Alternatively, POR could hire the machine on the days it requires, and its availability would be guaranteed at a cost of R500 per day. 8. PORs fixed production overhead cost budget for the year totals to R200 000 and is absorbed into its project using a skilled direct labour hour absorption rate, based on normal operating capacity of 80 per cent. PORs capacity budget for the year is total of 50 000 skilled direct labour hours. PORs latest annual forecast is for the overhead costs to total R220 000, and the capacity to be as originally budgeted.

Required:

1.1. You are employed as the Assistant Management Accountant for K group. For each of the resource items identified you are to: a) Discuss the basis for the evaluation provided for each item. b) Discuss whether you agree with the valuation provided in the context of the proposed tender. c) Prepare a revised schedule of the relevant costs for the tender document on behalf of K group. (15)

1.2. Assume that POR successfully wins the bid to build the machine for a selling price of R100 000 and that the cost incurred are expected. Discuss the conflict that will arise between the profit expected from the project by the Board of K group on a relevant cost basis and the project profit that will be reported to them by POR using a routine accounting practise. Use at least two specific examples from the bid to explain the conflict that you discuss. (5)

1.3. Discuss two non-financial matters that you consider relevant to this decision. (5)