QUESTION TWO PART A

[50]

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 companys routine costing system.

Direct material A Direct material B Skilled labour Unskilled labour Supervision labour Machine overhead Other overhead

Total cost

Notes:

Note R

1 5 square metres @ R20 100 2 10 square metres @ R15 150 3 100 hours @ R8 800 4 60 hours @ R6 360 5 20 hours @ R20 400 6 20 hours @ R12 240 7 160 labour hours @ R4 640

2,690

1. Direct material A is currently held in inventory and is in regular use. The latest price paid for material A was R22 per square metre, but the replacement cost would be R23 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 R2 per square metre.

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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 R7 per hour. Alternatively sub-contractors could be hired to work on this new customers order at a cost of R9 per hour. ECs current skilled labour is paid R8 per hour.

4. The unskilled labour is paid an hourly rate of R6 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 R20 per hour for a 40 hour working week.

6. The machines that would need to be used have a running cost of R12 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 quite specialised and is used for only some of ECs 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 R5 per hour (excluding running costs) to fulfil its normal work.

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

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

9. 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:

2.1

2.2

Prepare a schedule that shows the minimum price the directors should quote to win this order. (15)

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 2.1 above.

(10)

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PART B

J Plumber (Pty) Ltd

J Plumber (Pty) Ltd has purchased 50 000 pumps annually from Koop Ltd. The price has increased each year and reached R70.00 per unit last year. Because the purchase price has increased significantly, J Plumber (Pty) Ltd management has asked that an estimate be made of the cost to manufacture the pump in J Plumber (Pty) Ltd facilities. J Plumber (Pty) Ltd products consist of stamping and castings. The company has little experience with products requiring assembly.

The engineering, manufacturing and accounting departments have prepared a report for management, which included the estimate shown below for an assembly run of

5 000 pumps.

Additional production employees would be hired to manufacture the subassembly.

No additional equipment, space, supervision or administrative staff would be needed.

The report states that total costs for 5 000 units are estimates at R560 000 or R112 a unit. The current purchase price is R75.00 a unit, so the report recommends a continued purchase of the product.

Components (outside purchases) Assembly labour*

Factory overhead**

General and administrative overhead*** Total Costs

R120 000 R150 000 R225 000

R65 000 R560 000

*Assembly labour consists of hourly production workers.

**Manufacturing overhead is applied to products on a direct labour basis. Variable overhead costs vary closely with direct labour cost.

Fixed Overhead

Variable Overhead Manufacturing overhead rate

50% of direct labour cost 100% of direct labour cost

150% of direct labour cost

***General and administrative overhead is applied at 13.13% of the total cost of material (or components), assembly labour and manufacturing overhead.

Required:

1. Was the analysis prepared by J Plumber (Pty) Ltd and their departments, and their recommendation to continue purchasing the pumps correct?

Explain your answer and include any supporting calculations you consider necessary. (15)

2.

Discuss three qualitative factors related to this make or buy decision.

END OF MANAGEMENT ACCOUNTING AND FINANCE 3: ASSIGNMENT

(10)