Exercises 9.1.

Relevant cost of labour

Company A is costing a one off project for a client that will require 50 hours of labour. Employees are
paid £10 per hour. There is sufficient idle capacity among the workforce for 40 hours of the work. The
extra 10 hours would be worked as overtime at a rate of £12.50 per hour.

Calculate the relevant cost of this project.

Exercise 9.2. Relevant cost of materials

Company B has been approached by a customer who would like a job to be done. The customer is
willing to pay £22,000. The job would require the following materials:

Material Total units UnitsBook value Realisable Replacement

required already in
of units in value per cost per unit
inventoryinventory unit
£ £ £
A 1,000 0 0 0 10
B 1,000 600 2 2.50 5
C 1,000 700 3 2.50 4
D 200 200 4 6 9
Material B is used regularly by the company and if units of B are required for this job they will need to
be replaced.

Materials C and D are in inventory as a result of previous overbuying and have limited use. No other use
is known for C but D could be used as a substitute for 300 units of E which currently costs £5 per unit
and is not held in inventory.

Calculate the relevant costs of materials.

Exercise 9.3a. Opportunity costs

An information technology consultancy has been asked to do an urgent job by a client for a price of
£2,500. The job would require the following:

30 hours of work from one member of staff, who is paid on an hourly basis at a rate of £20 per hour but
who would normally be employed on work for clients where the charge out rate is £45 per hour. No
other member of staff is able to do this work.

The use of 5 hours of mainframe computer time which the firm normally charges out to external users at
a rate of £50 per hour. Mainframe computer time is currently used 24 hours a day, seven days a week.

Supplies and incidental expenses of £200.

Calculate the relevant cost of this project and the potential contribution.

Exercise 9.3b. Opportunity cost

Esme has been asked to quote a price for a one-off contract. The following information is available; The
contract requires 3,000 kg of material K, which is a materials used regularly by the company in other
production. The company has 2,000 kg of material K currently in stock which had been purchased last
month for a total cost of £19,600. Since then the price per kg for material K has increased by 5%.

The contract also requires 200kg of material L. There are 250kg in stock which are not required for
normal production. The material orginally cost a total of £3,125. If not used on this contract, this
material woud be sold for £11 per kg.

The contract requires 800 hours of skilled labour. Skilled labour is paid at £9.50 per hour. There is a and
all the company's skilled labour is currently employed on manufacture of product P, details of which are
shown below:

£ per unit
selling price 100
skilled labour 38
other variable costs 22
Prepare on a relevant cost basis the lowest cost estimate that could be used as the basis for a quote.
Exercise 9.4.

The production manager of your organisation has approached you for some costing advice on project X,
a one-off order from overseas that he intends to tender for. The costs associated with the project are as
follows:

£
Material A 4,000
Material B 8,000
Direct labour 6,000
Supervision 2,000
Overheads 12,000
32,000
You ascertain the following:

(i) Material A is in stock and the above was the cost. There is now no other use for material A,
other than the above project, within the factory and it would cost £1,750 to dispose of.
Material B would have to be ordered at the cost shown above.
(ii) Direct labour costs of £6,000 relate to workers that will be transferred to this project from
another project. Extra labour will need to be recruited to the other project at a cost of
£7,000.
(iii) Supervision costs have been charged to the project on the basis of 1/3 of labour costs and
will be carried out by existing staff within their normal duties.
(iv) Overheads have been charged to the project at the rate of 200% on direct labour. The
company is currently operating at a point above break-even. The project will need the
utilisation of machinery that will have no other use to the company after the project has
finished. The machinery will have to be purchased at a cost of £10,000 and then disposed of
for £5,250 at the end of the project.

The production manager tells you that the overseas customer is prepared to pay up to a maximum of
£30,000 for the project and a competitor is prepared to accept the order at that price. He also informs
you the minimum that he can charge is £40,000 as the above costs show £32,000, and this does not take
into consideration the cost of the machine and profit to be taken on the project.

Required:

Cost the project for the production manager, clearly stating how you have arrived at your figures and
giving reasons for the exclusion of other figures.
Exercise 9.5.

A company in the civil engineering industry with headquarters located 22 miles from London undertakes
contracts anywhere in the United Kingdom.

The company has had its tender for a job in north-east England accepted at £288,000 and work is due to
begin in March. However, the company has also been asked to undertake a contract on the south coast
of England. The price offered for this contract is £352,000. Both of the contracts cannot be taken
simultaneously because of constraints on staff site management personnel and on plant available. An
escape clause enables the company to withdraw from the contract in the north-east, provided notice is
given before the end of November and an agreed penalty of £28,000 is paid.

The following estimates have been submitted by the company’s quantity surveyor:

Cost estimates North-east South coast

£ £
Materials:
In stock at original cost,
Material X 21,600
In stock at original cost,
Material Y 24,800
Firm orders placed at original cost,
Material X 30,400
Not yet ordered – current cost,
Material X 60,000
Not yet ordered – current cost,
Material Z 71,200
Labour hired locally 86,000 110,000
Site management 34,000 34,000
Staff accommodation and travel for
site management 6,800 5,600
Plant on site – depreciation 9,600 12,800
Interest on capital, 8% 5,120 6,400
Total local contract costs 253,520 264,800
Headquarters costs
allocated at rate of 5%
on total contract costs 12,676 13,240
266,196 278,040
Contract price 288,000 352,000
Estimated profit 21,804 73,960
Notes:
1 X, Y and Z are three building materials. Material X is not in common use and would not realise
much money if re-sold; however, it could be used on other contracts but only as a substitute for
another material currently quoted at 10% less than the original cost of X. The price of Y, a
material in common use, has doubled since it was purchased; its net realisable value if re-sold
would be its new price less 15% to cover disposal costs. Alternatively it could be kept for use on
other contracts in the following financial year.

2 With the construction industry not yet recovered from the recent recession, the company is
confident that manual labour, both skilled and unskilled, could be hired locally on a subcontracting
basis to meet the needs of each of the contracts.

3 The plant which would be needed for the south coast contract has been owned for some years
and £12,800 is the year’s depreciation on a straight-line basis. It the north-east contract is
undertaken, less plant will be required but the surplus plant will be hired out for the period of the
contract at a rental of £6,000.

4 It is the company’s policy to charge all contract with notional interest at 8% on estimated working
capital involved in contracts. Progress payments would be receivable from the contractee.

5 Salaries and general costs of operating the small headquarters amount to about £108,000 each
year. There are usually ten contracts being supervised at the same time.

6 Each of the two contracts is expected to last from March to February which, coincidentally, is the
company’s financial year.

7 Site management is treated as fixed cost.

You are required, as the management accountant to the company.

a. to present comparative statements to show the net benefit to the company of under-taking
the more advantageous of the two contracts;

b. to explain the reasoning behind the inclusion in (or omission from) your comparative
financial statements, of each item given in the cost estimates and the notes relating there
to.
Exercises 9.6. Relevant costing – machine user costs

Bronty Co is considering whether to undertake a project for a customer. The project will take two
months to complete and production would begin in three weeks’ time. The machinery required for the
contract would be as follows:

A. A special cutting machine will have to be hired for three months. Hire charges are £75 per
month with a minimum charge of £300.
B. All other machinery required for the project has already been purchased by Bronty on hire
purchase terms. The monthly hire purchase payments are £500. This consists of £450 capital and
£50 interest. The final hire purchase charge will be made in two months’ time. The cash price of
the machinery was £9,000 two years ago. It is being depreciated on a straight line basis at a rate
of £200 per month. It has a useful life which will enable it to be operated for another 6 months.
The machinery is highly specialised and is unlikely to be used for anything other than this project
over the next few months. It is thought that a customer could be found to purchase the machine
in the future and using it on this project would devalue it by £200.

Required:

1. Calculate the relevant cost of the machinery for the purposes of costing this project.
2. Explain how you have arrived at this cost.
Exercises 9.7.
Barnaby Ltd is preparing a tender for a project it wants to undertake. The costs associated with
the project are as follows:
(i) Material A is in stock and cost £3,000 when it was purchased several months ago.
There is no use in Barnaby Ltd for material A, other than on the project in question,
and it would cost £500 to dispose of it.
(ii) Material B would have to be ordered at a cost of £6,000.
(iii) Direct labour costs of £8,000 relate to workers that will be transferred to this project
from another project. Extra labour will need to be recruited to the other project at a
cost of £6,500.
(iv) Supervision costs of £1,200 have been charged to the project and will be carried out
by existing staff within their normal duties.
(v) Overheads amounting to £5,400 have been charged to the project at the rate of
100% on direct labour.
(vi) The project will need machinery that will have no other use to the company after
the project has finished. The machinery will have to be purchased at a cost of
£4,500 and then sold for £500 at the end of the project.
(vii) £800 has already been spent preparing for and attending meetings with the
potential customer to discuss the project.
The customer is prepared to pay up to a maximum of £18,000 for the project.
Required:
(a) Calculate the expected profit from this project.
(b) Write a report to the production manager stating whether the organisation should go
ahead with the tender for the project, stating the reasons why, and explaining how you
have arrived at your decision.