The objective of the directors of Bolton Ltd is to maximise the net cash inflow to the company. The company expects to have spare capacity during the coming year and its directors are considering whether to undertake a contract for a fixed price of 60,000. Work would have to start almost immediately and it would take exactly one year to complete.

A management accountant has submitted the following statement and advises rejection of the contract:

Materials:

A (100 tonnes at 140 per tonne) 14,000

B (130 tonnes at 50 per tonne) 6,500

C (80 tonnes at 45 per tonne) 3,600

24,100

Labour:

Direct labour (4 men at 100 each per week) 20,800

Foreman (7,000 plus overtime at 500) 7,500

28,300

Overheads:

(20% of total labour cost) 5,660

Total cost 58,060

Add: Profit mark up

(10% of total cost) 5,806

63,866

Contract Price 60,000

Deficit 3,866

On enquiry, you ascertain the following information:

(1) 40 tonnes of material A are already in stock at an original cost of 100 per tonne. The current replacement cost of material A is 140 per tonne and existing stocks would realise 110 per tonne net of selling costs. There is no alternative use for material A within the company in the foreseeable future.

(2) Bolton has no stocks of material B, nor is it committed to buying any. The current purchase price of material B is 50 per tonne. Material B is used regularly by the company.

(3) The required quantity of material C was purchased last year at 45 per tonne. In its present form, it has no alternative use in the company. If the contract was not undertaken, material C could be sold at a price of 30 per tonne. However, Bolton would have to pay transportation costs of 10 per tonne. Alternatively, material C could be used as a substitute for material D which is in regular use in the company. Material D currently costs 35 per tonne. In order to use material C as a substitute for material D, Bolton would have to pay conversion costs of 5 per tonne.

(4) Four skilled workers would be needed for the contract at a weekly wage of 100 each. Three could be transferred from other departments. However, this would require hiring three less-skilled workers at a wage a 90 per week to fill the gaps created. The fourth would have to be specially recruited for the contract and would require one week of initial training before the job commenced. Bolton operates a 50 week working year with two weeks paid holiday.

(5) The foreman is a member of the permanent staff and, if the contract were accepted, he would be required to work overtime costing 500.

(6) Overhead costs are currently allocated to contracts on the basis of 20% of total labour cost. If this contract is undertaken, it is envisaged that overhead costs will increase by 2,000 in the coming year.

(7) The machine needed for the contract is seldom used and it has a book value of 5,000. It was previously decided to scrap it next year and the costs of dismantling it at any time are expected to absorb its sale proceeds. The works manager has pointed out that, over the coming year, the company could use the machine for sub-contract work yielding net cash inflow of 4,000.

(8) It is company policy to apply a profit margin of 10% to all contracts.

REQUIREMENTS:

(a) Advise the directors of Bolton Ltd whether or not they should accept the contract. Show all calculations and comment briefly on your treatment of each item. State all assumptions made.

(b) Set out any further considerations that you think the directors of Bolton Ltd should take into account in deciding whether or not to accept the contract.

	Relevant/Not Relevant + Explanation
(1) Material A
Original cost 100 per tonne
Replacement cost 140 per tonne
Resale income 110 per tonne
(2) Material B
Current purchase price 50 per tonne
(3) Material C
Original purchase price 45 per tonne
Resale (income) .............. per tonne
Conversion (cost saving) ............ per tonne
N.B. When faced with an alternative, the lowest cost/highest income option should be selected.
(4) Skilled labour
Weekly wage 100 per week
Weekly wage 90 per week
(5) Foreman
Overtime 500
Current salary
(6) Overhead costs
Current overhead cost (20% of total labour cost)
Additional overhead cost 2,000
(7) Machine
Book value 5,000
Sub-contract work 4,000 (income)
(8) Profit margin
10% profit margin