QUESTION ONE [30] 1.1. The managing director of Parser Ltd, a small business, is considering undertaking a once-off contract and has asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can price at a profit. The following schedule has been prepared: Costs for special order Notes R 1 2 3 Direct wages Supervisor costs General overheads Machine depreciation Machine overheads Materials 4 28 500 11 500 4 000 2 300 18 000 34 000 98 300 5 6 Notes 1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job, who could be transferred from another department to undertake work on the special order. They are fully occupied in their usual department and sub-contracting staff would have to be brought in to undertake the work left behind. Subcontracting costs would be R32 000 for the period of the work. Different subcontractors who are skilled in the special order techniques are available to work on the special order and their costs would amount to R31 300. 2. A supervisor would have to work on the special order. The cost of R11 500 is comprised of R8 000 normal payments plus R3 500 additional bonus for working on the special order. Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his normal work to R2 500. It is not anticipated that any replacement costs relating to the supervisor's work on other jobs would arise. 3. General overheads comprise an apportionment of R3 000 plus an estimate of R1 000 incremental overheads. 4. Machine depreciation represents the normal period cost based on the duration of the contract. It is anticipated that R500 will be incurred in additional machine maintenance costs. 5. Machine overheads (for running costs such as electricity) are charged at R3 per hour. It is estimated that 6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost contribution of R2 per hour. 6. Materials represent the purchase costs of 7 5000 kg bought some time ago. The materials are no longer used and are unlikely to be wanted in the future except on the special order. The complete stock of materials (amounting to 10 000 kg), or part thereof, could be sold for R4.20 per kg. The replacement cost material used would be R33 375. 7. Costs will be incurred evenly over the project duration of three months. The prospective client is willing to make an upfront payment of R40 000. The outstanding balance will be paid one month after completion. Because the business does not have adequate funds to finance the special order, a bank overdraft shortfall will be required. The overdraft will be repaid on the settlement of the outstanding debt. The company uses a cost of capital of 15% to appraise projects. The bank's overdraft rate is 12% for Parser Ltd. The managing director has heard that, for special orders such as this, relevant costing should be used that also incorporates opportunity costs. She has approached you to create a revised costing schedule based on relevant costing principles. Determine the minimum price to be quoted by Parser on the once-off contract. Explain why you included or excluded amounts from your calculation. (20) 1.2. Hawthorne Car Hire is a vehicle hiring company in KwaZulu-Natal. The previous CEO was over optimistic in his expectations for the company and had purchased too many vehicles. They are considering selling five of the vehicles but have been approached by a direct marketing company that require vehicles for a special contract. The company had purchased Ford Figo's at R140 000 each. Their current book value is R120 000 and could be sold for R105 000. The marketing company requires the five vehicles for 180 days at an all inclusive rental of R100 per day. Hawthorne would be responsible for all the running costs including fuel for the rental period. They have estimated that the fuel cost will be R5 000 per vehicle, The insurance R3 000 and the repairs and maintenance R2 500 per vehicle for the rental period. Additionally the rental agent's salary of R5 000 per month would be allocated to the project and a 5% commission is payable on the rental value. The rental agent would however remain with the company if the special contract was not accepted. Additional administrative costs of R10 000 would be incurred for the contract. It is believed that the vehicles resale value would be R95 000 at the end of the 180 days. The vehicles are being depreciated over 5 years. Determine whether the marketing company's contract should be accepted or if the vehicles should be sold. You may ignore the time value of money. (10) QUESTION TWO [40] Zek Ltd assembles heavy industrial switchboxes. Hitherto, Zek Ltd has assembled only one type, but recently a decision was made to expand the product range into two types. The following data pertains to each switchbox: Existing product Z686 (R) New product 2797 (R) Selling price per unit 8 000 6 800 Variable costs per unit: Direct materials 6 000 5 600 Direct labour 500 400 500 200 Manufacturing overhead Specific fixed costs per day 10 000 5 000 Zek Ltd's total general fixed costs per day amount to R27 000. The organisation operates its factory 24 hours per day and this equates to one operating cycle. Each switchbox goes through two processes, namely assembly and testing. The number of units which can be assembled or tested in one operating cycle is as follows: Assemble Test 2686 2 6 2797 6 Zek Ltd is limited to 600 assembly hours and 400 testing hours in one operating cycle. Management is anxious to ascertain the following, but are unsure as to how to determine these factors: 1. The most profitable daily (that is, in one operating cycle) production combination. 2. The minimum number of units which should be produced in one operating cycle if Zek Ltd wishes to achieve a total daily profit of R10 000. Required 2.1 Explain why linear programming is appropriate in determining the optimal production solution for Zek Ltd. (3) 2.2 Outline the steps to be undertaken when using the graphic linear programming method. (5) 2.3 Determine, using graphic linear programming, the production combination for Zek Ltd which maximises daily profit. (Draw the graph in your answer book. Ensure that you label the graph comprehensively and clearly.) (17) 2.4 Solving algebraically, verify your answer in 1.3. (2) 2.5 Calculate the production mix which will achieve the desired daily profit of R10 000. (8) 2.6 Outline some key assumptions and limitations pertaining to linear programming. (5) QUESTION ONE [30] 1.1. The managing director of Parser Ltd, a small business, is considering undertaking a once-off contract and has asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can price at a profit. The following schedule has been prepared: Costs for special order Notes R 1 2 3 Direct wages Supervisor costs General overheads Machine depreciation Machine overheads Materials 4 28 500 11 500 4 000 2 300 18 000 34 000 98 300 5 6 Notes 1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job, who could be transferred from another department to undertake work on the special order. They are fully occupied in their usual department and sub-contracting staff would have to be brought in to undertake the work left behind. Subcontracting costs would be R32 000 for the period of the work. Different subcontractors who are skilled in the special order techniques are available to work on the special order and their costs would amount to R31 300. 2. A supervisor would have to work on the special order. The cost of R11 500 is comprised of R8 000 normal payments plus R3 500 additional bonus for working on the special order. Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his normal work to R2 500. It is not anticipated that any replacement costs relating to the supervisor's work on other jobs would arise. 3. General overheads comprise an apportionment of R3 000 plus an estimate of R1 000 incremental overheads. 4. Machine depreciation represents the normal period cost based on the duration of the contract. It is anticipated that R500 will be incurred in additional machine maintenance costs. 5. Machine overheads (for running costs such as electricity) are charged at R3 per hour. It is estimated that 6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost contribution of R2 per hour. 6. Materials represent the purchase costs of 7 5000 kg bought some time ago. The materials are no longer used and are unlikely to be wanted in the future except on the special order. The complete stock of materials (amounting to 10 000 kg), or part thereof, could be sold for R4.20 per kg. The replacement cost material used would be R33 375. 7. Costs will be incurred evenly over the project duration of three months. The prospective client is willing to make an upfront payment of R40 000. The outstanding balance will be paid one month after completion. Because the business does not have adequate funds to finance the special order, a bank overdraft shortfall will be required. The overdraft will be repaid on the settlement of the outstanding debt. The company uses a cost of capital of 15% to appraise projects. The bank's overdraft rate is 12% for Parser Ltd. The managing director has heard that, for special orders such as this, relevant costing should be used that also incorporates opportunity costs. She has approached you to create a revised costing schedule based on relevant costing principles. Determine the minimum price to be quoted by Parser on the once-off contract. Explain why you included or excluded amounts from your calculation. (20) 1.2. Hawthorne Car Hire is a vehicle hiring company in KwaZulu-Natal. The previous CEO was over optimistic in his expectations for the company and had purchased too many vehicles. They are considering selling five of the vehicles but have been approached by a direct marketing company that require vehicles for a special contract. The company had purchased Ford Figo's at R140 000 each. Their current book value is R120 000 and could be sold for R105 000. The marketing company requires the five vehicles for 180 days at an all inclusive rental of R100 per day. Hawthorne would be responsible for all the running costs including fuel for the rental period. They have estimated that the fuel cost will be R5 000 per vehicle, The insurance R3 000 and the repairs and maintenance R2 500 per vehicle for the rental period. Additionally the rental agent's salary of R5 000 per month would be allocated to the project and a 5% commission is payable on the rental value. The rental agent would however remain with the company if the special contract was not accepted. Additional administrative costs of R10 000 would be incurred for the contract. It is believed that the vehicles resale value would be R95 000 at the end of the 180 days. The vehicles are being depreciated over 5 years. Determine whether the marketing company's contract should be accepted or if the vehicles should be sold. You may ignore the time value of money. (10) QUESTION TWO [40] Zek Ltd assembles heavy industrial switchboxes. Hitherto, Zek Ltd has assembled only one type, but recently a decision was made to expand the product range into two types. The following data pertains to each switchbox: Existing product Z686 (R) New product 2797 (R) Selling price per unit 8 000 6 800 Variable costs per unit: Direct materials 6 000 5 600 Direct labour 500 400 500 200 Manufacturing overhead Specific fixed costs per day 10 000 5 000 Zek Ltd's total general fixed costs per day amount to R27 000. The organisation operates its factory 24 hours per day and this equates to one operating cycle. Each switchbox goes through two processes, namely assembly and testing. The number of units which can be assembled or tested in one operating cycle is as follows: Assemble Test 2686 2 6 2797 6 Zek Ltd is limited to 600 assembly hours and 400 testing hours in one operating cycle. Management is anxious to ascertain the following, but are unsure as to how to determine these factors: 1. The most profitable daily (that is, in one operating cycle) production combination. 2. The minimum number of units which should be produced in one operating cycle if Zek Ltd wishes to achieve a total daily profit of R10 000. Required 2.1 Explain why linear programming is appropriate in determining the optimal production solution for Zek Ltd. (3) 2.2 Outline the steps to be undertaken when using the graphic linear programming method. (5) 2.3 Determine, using graphic linear programming, the production combination for Zek Ltd which maximises daily profit. (Draw the graph in your answer book. Ensure that you label the graph comprehensively and clearly.) (17) 2.4 Solving algebraically, verify your answer in 1.3. (2) 2.5 Calculate the production mix which will achieve the desired daily profit of R10 000. (8) 2.6 Outline some key assumptions and limitations pertaining to linear programming