QUESTION TWO $[20]$

EC$,$ an engineering company, produces tools and components to customers' specific requirements. EC uses absorption costing to absorb overheads into the cost of each customer order. Selling prices are usually determined by adding a $30\%$ mark up to the costs incurred in completing the order.

EC has recently been asked to provide a quotation for a new customer. The details of the work have been discussed at a meeting with the customer and the following resource requirements have been determined. The cost of these resources has been calculated using the company$$s routine costing system.

Note

R

Direct material A

$1$

$5$ square metres @ R$20$

$100$

Direct material B

$2$

$10$ square metres @ R$15$

$150$

Skilled labour

$3$

$100$ hours @ R$8$

$800$

Unskilled labour

$4$

$60$ hours @ R$6$

$360$

Supervision labour

$5$

$20$ hours @ R$20$

$400$

Machine overhead

$6$

$20$ hours @ R$12$

$240$

Other overhead

$7$

$160$ labour hours @ R$4$

$640$

Total cost

$2,690$

Notes:

$1.$ Direct material A is currently held in inventory and is in regular use. The latest price paid for material A was R$22$ per square metre, but the replacement cost would be R$23$ per square metre.

$2.$ Direct material B is currently not used by EC and would have to be bought if the work is undertaken. The minimum order from the supplier of material B is for $25$ square metres. EC does not expect to be able to use this material on any other work, though it would be able to sell it as scrap for R$2$ per square metre.

$3.$ The skilled labour that would be required is available within EC$,$ but only if those employees are transferred from other work that they are currently doing. This other work could be done by sub$-$contractors who could be hired on an hourly basis at a cost of R$7$ per hour. Alternatively sub$-$contractors could be hired to work on this new customer$$s order at a cost of R$9$ per hour. EC$$s current skilled labour is paid R$8$ per hour.

$4.$ The unskilled labour is paid an hourly rate of R$6$ but only for hours that they are actively working. There are only $40$ hours of additional unskilled labour available within normal working hours. In order to complete the customer order on time they would have to work $20$ hours of overtime. EC pays an overtime premium of $50\%.$

$5.$ The work would be supervised by the existing supervisor as part of his normal activity. The supervisor is paid an annual salary which is equivalent to R$20$ per hour for a $40$ hour working week.

$6.$ The machines that would need to be used have a running cost of R$12$ per hour. Two different machines would be required: machine W for $12$ hours and machine Z for $8$ hours. Both machines are regularly used by EC$.$ Machine W is very specialised and is used for only some of EC$$s work. There is sufficient spare capacity on this machine. Machine Z is in constant use by EC and, if it is required for this customer order, EC would need to hire an additional machine at a hire cost of R$5$ per hour $($excluding running costs$)$ to fulfill its normal work.

$7.$ EC$$s non$-$machine related fixed overhead costs are absorbed into product costs using an absorption rate per labour hour.

If this customer order is accepted it must be completed during the next $30$ days.

EC would like to win this order as it believes that it will probably win repeat orders from the customer. The directors have therefore decided to price this work on the basis of its relevant cost plus $10\%$

REQUIRED:

$2\mathrm{.}1$ Prepare a schedule that shows the relevant cost of the new customer's order. $(13)$

$2\mathrm{.}2$ Explain, for each of the resource items numbered $1$ to $7,$ the reason for each of the values you have included in your answer to $2\mathrm{.}1$ above. $(7)$