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It is company’s policy to charge all contracts with notional interest at 8% on estimated working capital involved in contracts. (interest charge for contract A is 5120 and contract B is 6400).
headquaters costs alllocated at rate of 5% on total contract costs on contract A is 12,676 and on contract B is 3240.
both these costs are not taken as relevant costs.
reason they gave is
it is assumed that the notional interest has no cash flow implications.it is assumed that the HQ costs are not specific to particular contracts.
I dont understand their reasons. thanks for your helping hand.
For relevant costing we are only interested in any extra costs that will be incurred by the company.
Notional interest means ‘pretend’ interest. It means that we are not actually having to pay any extra interest – it is just charged for profit purposes. If we are not actually paying any extra interest then it is not relevant.
With regard to the headquarters costs, the word ‘allocated’ simply means that we are charging part of the cost against the profit for the contract. We can do this for calculated profits in a profit statement, but it does not mean that we are actually paying any more in total. If the company is not paying out any more in total then it is not relevant.
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