Chapter 9: Short-term decision making

The managing director of Parser Ltd, a small business, is considering undertaking a one-off contract and has asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can price at a profit. The following schedule has been prepared:

1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job, who could be transferred from another department to undertake work on the special order. They are fully occupied in their usual department and sub-contracting staff would have to be bought in to undertake the work left behind. Subcontracting costs would be $32,000 for the period of the work. Different subcontractors who are skilled in the special order techniques are available to work on the special order and their costs would amount to $31,300.

2. A supervisor would have to work on the special order. The cost of $11,500 is comprised of $8,000 normal payments plus $3,500 additional bonus for working on the special order. Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his normal work amounting to $2,500. It is not anticipated that any replacement costs relating to the supervisor's work on other jobs would arise.

3. General overheads comprise an apportionment of $3,000 plus an estimate of $1,000 incremental overheads.

4. Machine depreciation represents the normal period cost based on the duration of the contract. It is anticipated that $500 will be incurred in additional machine maintenance costs.

5. Machine overheads (for running costs such as electricity) are charged at $3 per hour. It is estimated that 6,000 hours will be needed for the special order. The machine has 4,000 hours available capacity. The further 2,000 hours required will mean an existing job is taken off the machine, resulting in a lost contribution of $2 per hour.

6. Materials represent the purchase costs of 7,500 kg bought some time ago. The materials are no longer used and are unlikely to be wanted in the future except on the special order. The complete inventory of materials (amounting to 10,000 kg), or part thereof, could be sold for $4.20 per kg. The replacement cost of material used would be $33,375.

Because the business does not have adequate funds to finance the special order, a bank overdraft amounting to $20,000 would be required for the project duration of three months. The overdraft would be repaid at the end of the period. The bank's overdraft rate is 18%.

Adjust the schedule prepared by the accountant to a relevant cost basis, incorporating appropriate opportunity costs.