- 15 Marks
MA – L2 – Q35 – Relevant cost and revenue
Question
Apex Manufacturing Limited (AML) is engaged in the manufacture of specialised motors. The company has been asked to provide a quotation for building a motor for a large textile industrial unit in Kumasi. Following information has been obtained by AML’s technical manager in a one-hour meeting with the potential customer. The manager is paid an annual salary equivalent to GH¢2,500 per eight-hour day.
(i) The motor would require 120 ft. of Wire-C which is regularly used by AML in production. AML has 300 ft. of Wire-C in inventory at the cost of GH¢65 per ft. The resale value of Wire-C is GH¢63 and its current replacement cost is GH¢68 per ft.
(ii) 50 kg of another material viz. Wire-D and 30 other small components would also be required by AML for the motor. Wire-D would be purchased from a supplier at GH¢10 per kg. The supplier sells a minimum quantity of 60 kg per order. However, the remaining quantity of Wire-D will be of no use to AML after the completion of the contract. The other small components will be purchased from the market at GH¢80 per component.
(iii) The manufacturing process would require 250 hours of skilled labour and 30 machine hours.
The skilled workers are paid a guaranteed wage of GH¢20 per hour and the current spare capacity available with AML for such class of workers is 100 direct labour hours. However, additional labour hours may be obtained by either:
- Paying overtime at GH¢23 per hour; or
- Hiring temporary workers at GH¢21 per hour. These workers would require 5 hours of supervision by AML’s existing supervisor who would be paid overtime of GH¢20 per hour.
The machine on which the motor would be manufactured was leased by AML last year at a monthly rent of GH¢5,000 and it has a spare capacity of 110 hours per month. The variable running cost of the machine is GH¢15 per hour.
(iv) Fixed overheads are absorbed at the rate of GH¢25 per direct labour hour.
Required:
Compute the relevant cost of producing the textile motor. Give brief reasons for the inclusion or exclusion of any cost from your computation.
Answer
Apex Manufacturing Limited (AML)
| Item | Note | GH¢ |
|---|---|---|
| Technical manager – meeting | 1 | NIL |
| Wire – C | 2 | 8,160 |
| Wire – D | 3 | 600 |
| Components | 4 | 2,400 |
| Direct labour | 5 | 3,250 |
| Machine running cost | 6 | 450 |
| Fixed overhead | 7 | NIL |
| Total relevant cost | 14,860 |
Notes:
- In case of the technical manager’s meeting with the potential client, the relevant cost is NIL because it is not only a past cost but also the manager is paid an annual salary and therefore AML has incurred no incremental cost on it.
- Since Wire-C is regularly used by AML, its relevant value is its replacement cost. The historical cost is not relevant because it is a past cost and the resale value is not relevant since AML is not going to sell it.
- Calculation: 120 ft. × GH¢68/ft. = GH¢8,160
- Since Wire-D is to be purchased for the contract, therefore its purchase cost is relevant. AML only requires 50 kg of Wire-D but due to the requirement of a minimum order quantity, AML will be purchasing 60 kg of the material and since AML has no other use for this material, the full cost of purchasing the 60 kg is the relevant cost.
- Calculation: 60 kg × GH¢10/kg = GH¢600
- Since the components are to be purchased from the market at a cost of GH¢80 each, the entire purchase price is a relevant cost.
- Calculation: 30 components × GH¢80 = GH¢2,400
- The 100 hours of direct labour are presently idle and hence have no relevant cost. The remaining 150 hours are relevant. AML has two choices: either use its existing employees and pay them overtime at GH¢23 per hour which is a total cost of GH¢3,450; or engage temporary workers which would cost AML GH¢3,250 including supervision cost of GH¢100. The relevant cost is the cheaper of the two alternatives, i.e., GH¢3,250.
- Calculation: (150 hours × GH¢21) + (5 hours × GH¢20) = GH¢3,150 + GH¢100 = GH¢3,250
- The lease cost of the machine will be incurred regardless of whether it is used for the manufacture of motors or remains idle. Hence, only the incremental running cost of GH¢15 per hour is relevant.
- Calculation: 30 hours × GH¢15/hour = GH¢450
- Fixed overhead costs are incurred whether the work goes ahead or not, so they are not a relevant cost.
- Uploader: Salamat Hamid