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Dear John,
I hope you are doing well,
The question is as follow,
A research contract, which to date has cost the company $150,000 , is under review
if the contract is allowed to proceed
*It will e competed in approximately one year
*the results would then be sold to a government agency for $300,000
Shown below are the additional expenses which the managing director estimates will be necessary to complete the work
=Share of general building services.
*the contract is charged with $35,000 pa to cover general building expenses.
*Immediately after the contract is discontinued, the space occupied could be sub-let for an annual rental of $7000.
=Answer as per Kaplan Text book,
General building services.
Apportioned Costs-Irrelevant
Opportunity costs of rental foregone 7,000 which should be considered in the decision making.
**Actually sir I have some confusion about this point I mean why the amount of $35,000 is considered irrelevant to the decision whilst it is mentioned in the head of the question that the following are additional expenses will be incurred to the contract.
If we apply the relevant cash flow cost principle according to my understanding will get the following answer.
1- Cash position if we accept the proposal-as the cost of general services for the current year of the contract $35,000
2- Cash position if we reject the proposal-as the opportunity costs of rental foregone ($7,000)
= So, the relevant cash flow should be considered in the contract costing is the difference (1-2)=$28000.Could you help me out to understand why am I wrong,please?
Thank you in advance.
The $35,000 is irrelevant because it is a share (apportionment) of existing general expenses. Whatever the total general expenses are, they will remain the same in total whether or not the contract proceeds. I do make this point in my lectures on relevant costing.
A research contract, which to date has cost the company $150,000 is under review. If the contract is allowed to proceed: it will be completed in approximately one year. The results would then be sold a government agency for $300,000.
Shown below are the additional expenses which the managing director estimates will be necessary to complete the work.
Materials
• This material for contract has just been purchased at a cost of $ 60,000.
• It is toxic, if not used in this contract it disposed of at a cost of $ 5,000.Labor
– Skilled labor is hard to recruit.
– The workers concerned were transferred to the contract from a production department, and at a recent meeting, the production manager claimed that if the men were returned to him they could generate sales of 150,000 in next year.
• The prime cost of these sales would be 100,000 including $ 40,000 for the labor cost itself.
• The overhead absorbed into this production would amount to $ 20,000
Research staff
– It has been decided that when work on this contract ceases, the research department will be closed,
– Research wages for the year are $ 60,000 and redundancy and severance pay has been estimated at 15,000 now. Or $ 35,000 in one year’s time.
Equipment
– The contract utilizes a special microscope which cost $ 18,000 three year ago.
– It has a residual value of $ 3,000 in another two years. And a current disposal value of 8000.
– If used on the contract it is estimated that the disposal value in a year’s time will be $ 6,000.
share of general building services
– The contract is charged with $ 35,000 pa to cover general building expenses.
– Immediately after the contract of discontinued, the space occupied.
Required:
Advise the managing director as to whether the contract should be allowed to proceed, explaining the reasons for the treatment of each item.
(note: ignore the time value of money)Please do not simply type out a full question and expect to be provided with a full answer.
Unless you have been given this as an assignment (in which case you are surely not expecting us to do your homework for you), you must have an answer in the same book in which you found the question.
So whatever it is in the answer that you are not clear about, then you can let me know what it is and then I will explain.You can find everything needed to be able to answer this question in our free lectures. The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
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