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Question from study text BPP Pg 158.
Emerdale has been asked to quote a price for a one-off contract. The following info is available.
Materials:
The contract requires 3000kg of material K, which is used regularly by the company in other production. The company has 2000 kg 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 of material L in stock which are not required for normal production. This material originally cost a total of $3125. If not used on this contract, the stock of material L would be sold for $11 per kg.
Labour:
The contract requires 800 hours of skilled labour. Skilled labour is paid $9.50 per hour. There is a shortage of skilled labour and all the available skilled labour is fully employed in the company in the manufaccture of product P. The following information relates to product P.
Selling price per unit $100
Less skilled labour $38
Other variable costs $22Required: Prepare on a relevant cost basis, the lowest cost estimate that could be used as the basis for a quotation.
Answer:
I calculated the cost of Material K as follows:
cost for the month $19600/3000kg = $9.80 x 1.05 = $10.29 per kg
cost of material = 3000 kg x 10.2 = $30870For Material L, I did:
200kg x cost of 1 kg (3125/250) = $2500
less income from sale of surplus material: 50 kg x $11 = $550
Therefore cost of material L = $1950
This is where I have the query, as the answer in the book takes the 200 kg and multiplies at net realisable value of $11/kg = $2200. Why is this?I understood how to work the cost of labour, so got this part of the question right.
Can you please explain the reasoning behind the working of the cost of material L?
Thanks
The original cost of the material is a sunk cost and is therefore irrelevant.
All that is relevant is the opportunity cost. If the material is not used in the contract then it will be sold for $11 per kg. Therefore the relevant cost is simply the 200 kg needed at $11 per kg.
I do suggest that you watch my free lectures on relevant costing where I explain how to deal with inventory in various situations.
(Our lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.)Hi Sir,
In the above example I calculated material correctly but labor. It seems that the word short on supply is key but I do not get it. Since we take the employees from product P it means that we keep paying same amount of 9.5 per hr. So this is not an extra cost no? No matter we accept the contract, we keep paying them the same. So we just need to calculate the lost contribution of P as an opportunity cost.
I know you will ask me if I have watched your lessons… Just to let you know that I did 🙂
Well I do explain in the lectures 🙂
Let me explain with a tiny example. Suppose the other product has a selling price of $20, labour of $5, and other variable costs (materials etc) of $6. The contribution is 20 – 5 – 6 = $9.
Suppose the labour is taken to do the new contact. We still pay the $5, but we lose the revenue of $20 and save the other variable costs of $6. So the net amount lost from the other product is 20 – 6 = 14 (which is always equal to the contribution plus labour: 9 + 5 = $14).
Ask me a new question please!
Make it clear which question you are referring toEmerdale has been asked to quote a price for a one-off contract. The following info is available.
Materials:
The contract requires 3000kg of material K, which is used regularly by the company in other production. The company has 2000 kg 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 of material L in stock which are not required for normal production. This material originally cost a total of $3125. If not used on this contract, the stock of material L would be sold for $11 per kg.
Labour:
The contract requires 800 hours of skilled labour. Skilled labour is paid $9.50 per hour. There is a shortage of skilled labour and all the available skilled labour is fully employed in the company in the manufaccture of product P. The following information relates to product P.
Selling price per unit $100
Less skilled labour $38
Other variable costs $22Required: Prepare on a relevant cost basis, the lowest cost estimate that could be used as the basis for a quotation.
Contribution per unit of product P: $100 – $38 – $22 = $40 pu
38.50/9.50 = 4 hours
$40\4 = $10
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