Problem

• John Robertson, a self employed builder, has

been asked to provide a fixed price quotation
for some building work required by a
customer. Robertson’s accountant has
compiled the following figures, together with
some notes as a basis for a quotation.

1
 Problem
Direct materials: Rs.
Bricks 200,000 @ Rs. 100 per thousand 20,000 note 1
200,000 @ Rs. 120 per thousand 24000

Other materials 5000 note 2

Direct labor:
Skilled 3200 hours @ Rs. 12 per hour 38400 note 3
Unskilled 2000 hours @ Rs. 6 per hour 12000 note 4

Other costs:
Scaffolding hire 3500 note 5
Depreciation of general purpose machinery 2000 note 6
General overheads 5,200 hours @ Re. 1 per hour 5200 note 7
plans 2000 note 8

Total Cost 112,100 note 9

Profit 22,420
Suggested price 134,520
2
 Problem
Notes
1. The contract requires 400,000 bricks, 200,000 are already in stock and
200,000 will have to be bought in. This is a standard type of brick
regularly used by Robertson. The 200,000 in stock were purchased earlier
in the year at £100 per 1,000. The current replacement cost of this type
of brick is £120 per 1,000. If the bricks in stock are not used on this job
John is confident that he will be able to use them later in the year.
2. Other materials will be bought in as required; this figure represents the
purchase price.
3. Robertson will need to be on site whilst the building work is performed.
He therefore intends to do 800 hours of the skilled work himself. The
remainder will be hired on an hourly basis. The current cost of skilled
workers is £12 per hour. If John Robertson does not undertake the
building work for this customer he can either work as a skilled worker for
other builders at a rate of £12 per hour or spend the 800 hours
completing urgently needed repairs to his own house. He has recently
had a quotation of £12,000 for labor to repair his home.

3
 Problem
4. John employs four unskilled workers on contracts guaranteeing them a
40 hour week at £6 per hour. These unskilled laborers are currently idle
and would have sufficient spare time to complete the proposal under
consideration.
5. This is the estimated cost of hiring scaffolding.
6. John estimates that the project will take 20 weeks to complete. This
represents 20 weeks’ straight line depreciation on equipment used. If
the equipment is not used on this job it will stand idle for the 20 week
period.
In either case its value at the end of the 20 week period will be identical.
7. This represents the rental cost of John’s storage yard. If he does not
undertake the above job he can rent his yard out to a competitor who
will pay him rent of £500 per week for the 20 week period.
8. This is the cost of the plans that John has already had drawn for the
project.
9. John attempts to earn a mark up of 20% on cost on all work undertaken.
John is surprised at the suggested price and considers it rather high. He
knows that there will be a lot of competition for the work.

4
 Problem

Required:
• Using relevant costing principles, calculate the
lowest price that John could quote for the
customer’s building work. Explain your
treatment of each item in the accountant’s
estimate.

5
6
 Problem
• Krol plc uses a standard costing system to control its costs. In the
most recent month its cost accountant has reported a large adverse
direct material usage variance. An initial investigation has shown
that the variance is caused by a faulty machine.

• The production manager is trying to decide whether to close down

the production line for one day to allow engineers to perform
emergency maintenance work that could rectify the problem. Past
experience of investigating raw material usage variances suggests
that there is a 70% chance of correcting the fault.
• If the emergency maintenance work is not carried out now it is
estimated that extra material costs of £60,000 per month for the
next six months will be incurred. After this time the problem will
definitely be corrected by scheduled maintenance work during the
company’s annual shut down.

7
 Problem
• Two maintenance engineers would be required to carry out the
emergency maintenance work. Maintenance engineers are paid £25,000
per annum and each engineer works for 250 days each year.
• There is currently surplus capacity in the maintenance department. The
emergency maintenance would use parts costing £10,000. These parts
would have to be replaced again during the scheduled annual
maintenance.
• Emergency maintenance would involve stopping production for a day
resulting in lost production with an estimated sales value of £160,000,
direct material cost of £45,000 and direct labor cost of £90,000.
• Direct labor would continue to be paid during the one-day stoppage. In
this time the otherwise idle labor would be used to repaint the factory,
saving £7,000 in outside painting contractor costs.
• Krol carries no finished goods stocks and is currently unable to satisfy
demand for its product.

8
 Problem
1. Using relevant cost principles, calculate
whether the emergency maintenance should
be performed.
2. Suggest three potential causes of direct
material usage variances.

9
10
 Problem
• Karachi Electrics (K.E) Ltd., a local company
produces electrical household equipment
including 50,000 electric irons per annum. For
each iron, they use a specialized component
which they import at a cost of Rs.115.

• Recently the management of K. E Ltd., instructed

their Chief Accountant to advise on the costs
involved, if the company were to manufacture
the components instead of importing them since
the company has the necessary technological
know-how.

11
 Problem
The Chief Accountant after consulting various departmental managers made
calculation based on the following information:
– Direct materials to produce 50,000 components would cost Rs.3,000,000
– Direct labor at the standard hourly rate of Rs.50 would cost Rs.2,000,000
– The company’s overheads excluding depreciation and supervision costs
would increase from Rs.2,100,000 to Rs.2,400,000.
– With the level of overheads Rs.2,400,000 the overhead recovery rate
would be Rs.6 per direct labor hour.
– For the components to be produced locally, the K. E Ltd., would have to
buy a new machine worth Rs.1,000,000. The expected useful life of this
machine is 5 years.
– Production of these components would also utilize 10% capacity of an
existing machine which was bought in the previous year at a cost of
Rs.40,000,000. The expected useful life of this machine is 8 years.
Currently, only 70% of the machine.s capacity is being utilized.
– The supervision of production will fall on Mr. Ubaydullah who earns a
salary of Rs.500,000 per annum. Management thinks that Mr. Ubaydullah
is only half utilized.
– The company uses straight line method of depreciation, which reduces
salvage value of the machines to zero.

12
 Problem
• After making all the calculations be deemed
necessary, the Chief Accountant concluded
that the standard cost of manufacturing the
components was Rs.125 per unit.
• On the basis of this information the
management decided to continue importing
the components as this would save the
company Rs.500,000 per annum.

13
 Problem

Required:
• Prepare a comprehensive statement, showing how the
Chief Accountant worked out the standard cost of
Rs.125 per component.
• State whether the management made use of relevant
costs in arriving at their decision. If you think that
management did not use relevant costs, then prepare a
statement and apply the criteria of relevant costs.
• Assuming that the costs of producing or importing the
components were equal, give six major advantages of
manufacturing the components.

14
 Solution
(a). The standard cost of manufacturing 50,000 components:

Total Per unit

Rs.
Material 3,000,000 60
Direct labor 2,000,000 40
Variable overhead 300,000 6
(2,400,000 - 2,100,000)
Depreciation of new machine 200,000 4
(1,000,000/ 5)
Depreciation of existing machine 500,000 10
(40,000,000/ 8)*10%
Supervision 250,000 5
(500,000/ 2)
Total 6,250,000 125
15
 Solution
(b). The chief accountant does not use the relevant cost. By using relevant
cost, the per unit cost of manufacturing will be:

Per unit
Rs.
Material 60
Direct labor 40
Variable overhead 6
Depreciation of new machine 4
Depreciation of existing machine -
Supervision -
Total 110

Depreciation of existing machine and supervisory cost is not relevant.

16
 Solution
(c). Advantages of manufacturing the components:

(i). Better utilization of available resources.

(ii). Cost per unit reduces, due fixed cost remaining the same.

(iii). Increasing demand will be met quickly, just by working overtime.

(iv). Saving in foreign exchange.

(v). Saving time and trouble of arranging import license.

(vi). Expansion improve the job opportunity.

(vii). Quality of components can be assured.

17
 Problem
The Businet newspaper group is to commence
publication of a weekly supplement called
Bizcom. They have estimated that printing
cost will be as follows:
No. of 5,000 6,000 7,000 8,000 9,000
copies
Cost (Rs.) 6,250 7,200 8,310 9,200 9,500

18
 Problem
Additional cost will be Re. 0.50 as delivery cost for each copy
ordered and a 15% commission payable on each copy sold. Any
unsold copies are considered worthless.
The management has as yet not decided on a selling price for the
supplement and has evaluated that the demand will be as follows
at the following prices:
Prices Demand
(Rs.) (copies)
2.75 9,000
3.00 8,000
3.25 7,000
3.50 6,000
3.75 5,000

19
 Problem

Required:
1. Calculate the number of copies that the
management should order and the selling price
that it should set.
2. Assuming that 9,000 copies had been ordered
and the selling price set at Rs. 3.25, advise the
management whether to accept an upcountry
order at Rs. 1.25 a copy for 2,000 copies
(demand is expected to fall by 10% as a result of
accepting the offer). Show your working notes.
20
 Solution
(a)- col.1 col.2 col.3 col.4 col.5 col.6 col.3 -
(col.1*co (15%*col.3) (0.50*col.2) sum(col.4,5,6)
l.2)

Selling Demand Revenue Printing Commission Delivery Profit

price costs (15%) costs (Re.
0.50)

2.75 9,000 24,750 9,500 3712.5 4,500 7,038

3 8,000 24,000 9,200 3600 4,000 7,200

3.25 7,000 22,750 8,310 3412.5 3,500 7,528

3.5 6,000 21,000 7,200 3150 3,000 7,650

3.75 5,000 18,750 6,250 2812.5 2,500 7,188

Decision: The management should order 6,000 copies at a selling price of 3.50 Rs.
per copy, in order to maximize the profit

21
 Solution
(b) The relevant costs and revenues to be considered for this analysis are those
- that may be affected, if the company accepts the upcoming offer. The
additional revenue and the costs in case of acceptance have been worked out
as below:
Additional 2,500
revenue
(2,000*1.25)
Loss of revenue 1,934
- (net of
commission)
(10%*22750*0.
85)
Gain 566

The offer should be accepted, because out of 9,000 copies, 7,000 copies will
be sold at Rs. 3.25, and the additional revenue of 2,000 copies will be Rs.
2,500 (at Rs. 1.25 each), which is more than the revenue loss (1,934) that will
be incurred by the company by accepting the offer.
22
 Problem
• Allied PLC wishes to decide whether or not to
supply a contract to a large retail store for a
one year contract period. The management
accountant prepares an initial summary as
follows:

23
 Problem
Material Rs.
X: in stock at original cost 8,000
Y: on order (contract price) 2,000
Labor
Skilled men 25,000

Foreman 9,000
Overhead
Production 40,000

Administration 6,000
Distribution 2,000
Total Cost 92,000

Contract Price from retail store 70,000

Net loss from contract 22,000

24
 Problem

• The General Manager assumes that the

contract should be rejected since a loss of Rs.
22,000 would arise.
• The management accountant now details a
number of additional facts which he has
obtained relating to the above information
and suggests that he applies the incremental
cost approach to the problem.

25
 Problem
The additional information is as follows:

1. Material X is an obsolete material which could only be sold as

scrap for Rs. 400, if not used on the contract. It could,
however, be used as a substitute on another job for material
K, which would cost Rs. 5,000. Before being used in this, was
material X would have to be adapted at a cost of Rs. 1,000.
2. Material Y has been contracted for on a long term basis, but
the contract could be avoided for the coming year if a
penalty payment of 20% of the contract price of Rs. 2,000 is
made. Alternatively, it could be taken and resold for Rs. 1,800
after incurring resale cost of Rs. 500. It is perishable and
could not be retained for use in future years.

26
 Problem
3. If the skilled men are not used on the contract, they will
be made redundant at a cost of Rs. 3,000 in one
year’s time, so that redundancy pay would then be Rs.
1,600
4. The foreman will be retained at his present salary of Rs.
9,000 whether or not the contract is accepted. If not
required for the contract, however, he will be used to fill a
clerical post for which a salary of Rs. 5,000 is payable.
5. Production Overhead includes depreciation of machinery
of Rs. 10,000. This machinery is old and will be sold for Rs.
5,000 if not used on the contract. If it is used on the
contract, it is estimated that it will be sold in one year’s
time for Rs. 3,000. All other production overheads is fixed
and will remain unchanged by the contract.
27
 Problem
6. Administrative overhead includes Rs. 2,000 appointment
of company rates for an office to be used to coordinate
work on the contract. If not used for the contract this
office space will be sub-let for the year for Rs. 4,000. All
other administrative overhead is fixed and will remain
unchanged by the contract.
7. Distribution overhead represents the amount which will
be paid to an outside haulage firm should the contract be
accepted.

Required:
• Advise Management of Allied PLC regarding acceptance of
contract.

28
 Solution
ALLIED PLC
ACCEPTANCE OF THE CONTRACT
Rs.
Benefits:
Contract price 70,000
Reduction in redundancy pay 1,600
Total benefits 71,600
Costs:
Loss in sale value of machinery (5,000-3,000) 2,000
Sublet income forgone 4,000
Material X (5,000-1,000) 4,000
Material Y (2,000-400) 1,600
Skilled men's wages 25,000
Clerical salary 5,000
Distribution expense 2,000
Total cost 43,600
Net benefits 28,000
29
 Solution
Using Cash Flow Approach:
Accept contract Reject contract

Rs.
Cash inflows:
of machinery 3,000 5,000
Sublet income - 4,000
Contract price 70,000 -
Total cash inflows 73,000 9,000
Cash outflows:
Material X (purchase of K) 5,000 -
Material X (adoption) - 1,000
Material Y 2,000 -
Material Y (penalty) - 400
Skilled men's wages 25,000 -
Skilled men's redundancy pay 1,400 3,000
Foreman (clerical vacancy) 5,000 -
Distribution costs 2,000 -
Total cash outflows 40,400 4,400
Net cash flow 32,600 4,600

Increase in cash flow by accepting the contract is:

Rs. (32,600 - 4,600) = Rs. 28,000
Therefore, the contract should be accepted 30