Red Sea limited

Red Sea is a medium sized engineering company specialized in forming; a mechanical process used in manufacturing industries wherein materials, (mostly metals) undergo plastic deformation and acquire required shapes and sizes by application of suitable stresses such as compression, shear and tension. The company was established in 2003 in the city of Yanbu mainly serving customers in the industrial sector in the city and around. The business was going well for the family owning Red Sea until March of 2020 when the company was confronted with a peculiar situation involving a fire accident at the factory which destroyed a large part of its storage facilities. A legal team was quickly assembled to pursue the insurance compensation for losses both of materials and equipment. As the company was under pressure from its customers, the management team met to review the proposed operations for the next quarter following the fire at the factory. The fire had destroyed all the finished goods stock, some of the raw materials and about half of the machines in the forming shop.

At the meeting of the management team the following additional information was provided:

1. Only 27,000 machine hours of forming capacity will be available in the forthcoming quarter. Although previously it was thought that sales demand would be the only binding limitation on production it has now become apparent that for the forthcoming quarter the forming capacity would be a limiting factor
2. It will take about three months to re-instate the forming shop to its previous operational capacity. Hence the restriction on forming capacity is for the next quarter only.
3. Some details of the product range manufactured by Rossi are provided in the following table:

Per unit details of Red Sea's product range

	Product
	A	B	C	D	E
Sales price	50	60	40	50	80
Units of special material Required for production:
W or X	2	2	2	1	3
Y	-	-	-	-	6
Z	1	2	1	1	-
Other direct material costs	6	12	6	5	13
Other variable production costs	8	4	8	4	4
Fixed production costs (based on standard costs)	6	3	6	3	3
Forming hours required	5	6	2	10	6

4. The forecasts of demand, in units, for the forthcoming quarter are:

Product	A	B	C	D	E
Units demanded	2,000	2,000	4,000	3,000	4,000

It was originally intended that the number of units produced would equal the units demanded for each product.

5. Due to a purchasing error there is an excess for material W in stock. This has a book value of 6 per unit which is also its current replacement cost. This could be sold to realize 4 per unit after sales and transport costs. Material X could be used instead of material W; material X is not in stock and has a current replacement cost of 5 per unit.
6. Material Y was in stock at a book value of 2 per unit, which is its normal cost if ordered 3 months in advance, but the stocks of this material were entirely destroyed by the fire. In order to obtain the material quickly a price of 3 per unit will have to be paid for the first 3,000 units obtained in the quarter and any additional units required will cost 6 per unit. These special prices will apply only to this quarter's purchases.
7. Some of the stock of material Z was destroyed by the fire. The remaining stocks of 2,000 units have a book value of 7 per unit. The replacement price for Z is currently 8 per unit.
8. As a result of the fire it is estimated that the fixed production costs will be 42,000 for the next quarter and the administration and office overheads will amount to 11,500.
9. The demand figures shown in note (iv) include a regular order from a single customer for 3,000 units of C, and

3,000 units of E.

This order is usually placed quarterly and the customer always specifies that the order be fulfilled in total or not at all.

Instructions:

(a) Ignoring the information contained in note (ix) for this section of the question, determine the optimum production plan for the forthcoming quarter and prepare a statement which indicates to the management of Red Sea the estimated financial results of their planned production, in terms of total contribution, net current operating profit and financial accounting profit.

(b) Prepare a statement which clearly shows the management of Red Sea Limited the financial consequence of both the acceptance and the rejection of the order mentioned in note

(ix). Advise Red Sea on the desirability of acceptance of the order in total. Indicate what further information would be useful in arriving at a decision whether to accept or reject the order.