ACCA SBL Syllabus G. Finance In Planning And Decision-Making - Accept or Decline contracts - Notes ^{10 / 11}

A business should identify the incremental cash flows associated with a new one-off contract/project.

Illustration

The managing director of Q Limited is considering undertaking a one-off contract. 

She has asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can price at a profit. The following schedule has been prepared:

Notes

Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job. 

They could be transferred from another department to undertake the work on the special order. 

They are fully occupied in their usual department and sub-contracting staff would have to be brought in to undertake the work left behind. 


Sub-contracting costs would be $32,000 for the period of the work. 

Other sub-contractors who are skilled in the special order techniques are also available to work on the special order. 

The costs associated with this would amount to $31,300.

General overheads comprise an apportionment of $3,000 plus an estimate of $1,000 incremental overheads.

Machine depreciation represents the normal period cost, based on the duration of the contract. It is anticipated that $500 will be incurred in additional machine maintenance costs.

Materials represent the purchase costs of 7,500kg bought some time ago. 

The materials are no longer used and are unlikely to be wanted in the future except for the special order. 

The complete stock of materials (amounting to 10,000kg), or part thereof, could be sold for $4.20 per kg. 

The replacement cost of material used would be $33,375.

Required: 
Produce a revised costing schedule for the special project based on relevant costing principles. Fully explain and justify each of the costs included in the costing schedule.

• Direct Wages

  1. Option 1:

     Take the workers from their usual departments at a cost of $32,000 to replace them there

  2. Option 2:

      Hire sub-contractors at a cost of $31,300

     Therefore choose sub contractors

• General Overheads

  General fixed overheads will have to paid anyway

  We are only interested in 'extra' fixed costs which here are $1,000

• Machine Depreciation

  We are only interested in the relevant cashflows - depreciation is not a cashflow

  There are extra maintenance costs though with the new contract of $500

• Materials

  The amount already in stock is a past sunk cost. 

  We are only interested in future incremental costs

  The replacement cost is not a future cost either (as we have the stock already and is not to be used elsewhere)

  The only relevant future cost is the fact we cannot sell it in the future (as we would as we are not using it) 

  This cost is 7,500 x $4.20 = $31,500

• Overdraft Interest

  This is a future incremental cost if the contract is taken
  $20,000 x 3/12 x 18% = $900

• Item	Cost
  Direct wages	31,300
  Overheads	1,000
  Maintenance	500
  Materials	31,500
  Interest	900