Relevant Costing

Hey, I’m trying to learn relevant costs for a January exam. I’m getting my head around the concepts, but still struggling with some aspects when answering questions. I will post a question and then detail areas of that question wherein I am having difficulties.

Below is a question:

Lecture Question Reliance Ltd

Reliance Ltd has recently set up in business manufacturing motorised scooter boards. Reliance’s only customer is a large high street retailer, Skate plc. Reliance has just developed a motorised skateboard, the Scoot, and has been approached by Board plc, a competitor of Skate plc for an initial supply of the Scoot. Reliance bases selling prices on a 10% profit margin and Board plc have indicated they will pay no more than £17,000 for the initial supply of the Scoot. You have been provided with the following information regarding costs:

• Reliance estimates that it will take eight weeks to manufacture and supply all of the Scoot and currently has spare capacity to manufacture.
• New equipment costing £20,000 would have to be required, this could be sold after the initial supply of the Scoot for £18,000. Alternatively, the equipment could be rented at a cost of £2,100.
• Type A material is currently in stock and cost £2,360, if used for the Scoot it would have to be replaced at a cost of £3,000,
• Type B material would have to be purchased at a cost of £1,440.
• Type C material is required and would cost £5,000 to purchase. Type D is currently in stock and cost £3,000, it is no longer used and has a scrap value is £500. Type D material could be reworked at a cost of £1,000, once reworked it could be used as a replacement for material C or sold for £3,000.
• Reliance has agreed with suppliers that due to the increase in volumes a discount of £1,000 will be received on existing purchases.
• Staff used to manufacture the Scoot are paid a flat rate of £10 per hour, for a 40 hour week, plus overtime at a rate of £13 per hour. Manufacturing the initial supply of Scoot will require three members of staff working a total of 450 labour hours each over the 8 week period.
• Fixed costs of £10,000 that includes £5,000 relating to depreciation, £3,000 relating to the temporary hire of a warehouse required to store the Scoot and £2,000 allocation of fixed administration overheads.
• Reliance Ltd has spare capacity and the business will allow provide staff development on the new product.

REQUIRED:

a) Evaluate ALL of the costs and prepare a statement that identifies for ALL of the costs and savings:

i. The type of cost and/or saving and
ii. For each of the costs and/or savings state whether they are relevant or irrelevant to the pricing decision.

b) Advise Reliance on whether to accept the tender price of £17,000.

c) Compare the nature of costs used for conventional accounting purposes to relevant costs used for short term decision making.

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Below are the particular areas I’m struggling with in some detail:

• New equipment costing £20,000 would have to be required, this could be sold after the initial supply of the Scoot for £18,000. Alternatively, the equipment could be rented at a cost of £2,100.

Despite initially thinking the new equipment and resale of thereof were relevant costs, I’m thinking after seeing the answers that it would not be feasible to buy and sell new equipment after the initial sale of the Scoot, so that the rental option is instead taken?
Also, what does the cost type ‘Non Cashflow’ mean? I would imagine it means that means a non cashflow like depreciation, but I see it used a few times in contexts which confuses me.

• Regarding “Type C material is required and would cost £5,000 to purchase. Type D is currently in stock and cost £3,000, it is no longer used and has a scrap value is £500. Type D material could be reworked at a cost of £1,000, once reworked it could be used as a replacement for material C or sold for £3,000.”

I’ve spent a lot of time trying to figure this out but I just can’t seem to get my head around it?!

• Reliance has agreed with suppliers that due to the increase in volumes a discount of £1,000 will be received on existing purchases.

This is because in relevant costs a decrease in revenues is seen as a cost?

• Staff used to manufacture the Scoot are paid a flat rate of £10 per hour, for a 40 hour week, plus overtime at a rate of £13 per hour. Manufacturing the initial supply of Scoot will require three members of staff working a total of 450 labour hours each over the 8 week period.

I struggled with this at first, but am getting there. I was hoping you could explain the theory and thinking of this segment as it might help me to better understand similar questions.

• Fixed costs of £10,000 that includes £5,000 relating to depreciation, £3,000 relating to the temporary hire of a warehouse required to store the Scoot and £2,000 allocation of fixed administration overheads.

Fixed costs are (I think) committed so that they are not relevant, but this was not included in the answers? I get that the £5,000 relating to depreciation is not a cashflow, so is recorded as such, irrelevant. I get that the warehouse is relevant because it is dependent on the initial manufacture and supply of Scoot. And I’m assuming that the fixed administrative overhead is committed, although it says non-cash in the answers, which throws me a bit?

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I would be enormously grateful if somebody could please illuminate the areas where my understanding is having difficulty.

James