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Cost Accounting and Decision Making Workshop Case Study (ACC2CAD) Workshop 3 - Gateway Construction Company Gateway Construction Company, directed by Jack Gateway, employs 25 to 30 people as subcontractors for laying gas, water and sewerage pipelines. Most of Gateway Construction business comes from contacts with water and gas supply companies, state governments and municipal councils. All of the company's business is located in the state of Victoria. The company's sales revenue averages around $3 million, and profits vary between 0 and 10 per cent of sales. Sales and profits have been somewhat below average for the past three years due to a recession and intense competition. Because of this competition, Jack Gateway is constantly reviewing the prices that other companies tender for jobs; when a tender is lost, he makes every attempt to analyse the reasons for the differences between his tender and that of his competitors. He uses this information to increase the competitiveness of future tenders Gateway Construction Company's income statement for the previous financial year is detailed below: Gateway Construction Company Income Statement For the year ended June 30, 2018 Sales revenue (18,200 equipment hours at $165) Less Expenses Utilities (administrative building Equipment operators (casual employees) Rent (office building) CPA fees Other direct labour Administrative salaries Supervisor salaries Pipe Tyres and fuel Depreciation, pipe laying equipment Salaries of mechanics Advertising Total expenses Net income $3,003,000 $24,000 218,000 24,000 20,000 265,700 114,000 70,000 1,401,340 418,600 198,000 50,000 15,000 $2,818,640 $184.360 Jack has become convinced that Gateway Construction Company's current accounting system is deficient. Currently, all expenses are simply deducted from revenues to arrive at net income. No effort is made to distinguish between the costs of laying pipe, obtaining contracts and administering the company. Yet, all the tenders are based on the costs of laying pipe. With these thoughts in mind, Jack began a careful review of the income statement (detailed above). First, he noted that jobs were priced on the basis of equipment-hours, with an average price of S165 per equipment-hour. However, when it comes to classifying and assigning costs he needed some help. One thing that really puzzled him was how to classify his own salary of S114,000. About half of his other half was spent in general administrative matters. time was spent in preparing tenders and securing contracts and the Jack also knows that the knowledge of cost behaviour is important. He is certain that the company could offer more competitive bids if he knew which costs are variable and which are fixed. For example, Gateway often has idle pipe laying equipment (the company needs more equipment than is often necessary so that it can bid on larger projects). If Gateway could bid enough to cover its variable costs and use the idle equipment, the casual equipment operators could be more productively utilised and would have better job stability. In fact, if the bid covered more than variable costs, profits would increase as well, since the fixed costs remain unchanged for increased activity Previously you recommended that functional income statements and a total cost function separating the costs into their fixed and variable components would provide Jack with more useful information for tendering for contracts/jobs. Required: Assume that the only significant cost driver is equipment-hours. Also assume that the costs are either strictly fixed or strictly variable. 1. Classify the costs as fixed or variable, providing brief justifications why you have 2. Build a cost formula that describes Gateway Construction Company's cost structure 3. Suggest to Jack Gateway the minimum price per equipment-hour would he need to bid 4. Jack Gateway predicts that next financial year's production will amount to 19,000 5. Describe how the knowledge of the cost behaviour can assist Jack in managing his included each cost in the cost category base on your last week's work in the tender for the prospective job, if Jack has idle equipment (excess capacity) and he wants to prepare a tender for a prospective job. equipment hours. Advise him of the production cost next year business