Question: 1

BB Company has received an enquiry from a customer for the supply of 500 units
of a new product, product B22. Negotiations on the final price to charge the
customer are in progress and the sales manager has asked you to supply relevant
cost information. The following information is available:
1. Each unit of product B22 requires the following raw materials:
Raw material type
X 4 kg
Y 6 kg
2. The company has 5,000 kg of material X currently in stock. This was
purchased last year at a cost of Rs.7 per kg. If not used to make product B22,
this stock of X could either be sold for Rs.7.50 per kg or converted at a cost
of Rs.1.50 per kg, so that it could be used as a substitute for another raw
material, material Z, which the company requires for other production. The
current purchase price per kilogram for materials is Rs.9.50 for material Z
and Rs.8.25 per kg for material X.
3. There are 10,000 kilograms of raw material Y in inventory, valued on a
FIFO basis at a total cost of Rs.142,750. Of this current inventory, 3,000
kilograms were purchased six months ago at a cost of Rs.13.75 per kg. The
rest of the inventory was purchased last month. Material Y is used regularly
in normal production work. Since the last purchase of material Y a month
ago, the company has been advised by the supplier that the price per
kilogram has been increased by 4%.
4. Each unit of product B22 requires the following number of labour hours in
its manufacture:
Type of labour:
Skilled: 5 hours
Unskilled: 3 hours
Skilled labour is paid Rs.8 per hour and unskilled labour Rs.6 per hour.
5. There is a shortage of skilled labour, so that if production of B22 goes ahead
it will be necessary to transfer skilled workers from other work to undertake
it. The other work on which skilled workers are engaged at present is the
 manufacture of product B16. The selling price and variable cost information
for B16 are as follows:
Rs./unit Rs./unit
Selling Price 100
Less: Variable costs of production
Skilled labour (3 Hour) 24
Other Variable costs 31
55
45

6. The company has a surplus of unskilled workers who are paid a fixed wage
for a 37-hour week. It is estimated that there are 900 hours of unused
unskilled labour time available during the period of the contract. The
balance of the unskilled labour requirements could be met by working
overtime, which is paid at time and a half.
7. The company absorbs production overheads by a machine hour rate. This
absorption rate is Rs.22.50 per hour, of which Rs.8.75 is for variable
overheads and the balance is for fixed overheads. If production of product
B22 is undertaken, it is estimated that an extra Rs.4, 000 will be spent on
fixed costs. Spare machining capacity is available and each unit of B22 will
require two hours of machining time in its manufacture using the existing
equipment. In addition, special finishing machines will be required for two
weeks to complete the B22. These machines will be hired at a cost of Rs.2,
650 per week, and there will be no overhead costs associated with their use.
8. Cash spending of Rs.3, 250 has been incurred already on development work
for the production of B22. It is estimated that before production of the B22
begins, another Rs.1, 750 will have to be spent on development, making a
total development cost of Rs.5, 000.
Required:
Calculate the minimum price that the company should be prepared to accept for
the 500 units of product B22
Answer: 1
Working for relevant costing
Material X
The company has enough kilograms of material X in inventory for the contract.
When it is used, the inventory of material X will not be replaced. The relevant
cost of the material is therefore its opportunity cost, not its replacement cost.
The opportunity cost is the higher of its current sale value (Rs.7.50 per kg) or
the net saving obtained if it is used as a substitute for material Z (Rs.9.50 –
Rs.1.50 = Rs.8 per kg). The relevant cost of material X is therefore Rs.8 per kg.
Material Y
Material Y is in regular use, so its relevant cost is its current replacement cost.
Kg. Rs.
Total inventory 10,000 142,750
Purchased six months ago 3,000 (x Rs. 13.75) 41,250
Purchased last month 7,000 101,500

Purchase price last month = Rs.101,500/7,000 kg = Rs.14.50 per kg. Current

purchase price = 4% higher = Rs.14.50 × 1.04 = Rs.15.08.
Skilled labour
Skilled labour is in short supply. If it is used to make product B22, workers will
have to be taken off other work. The relevant cost of skilled labour is the wages
for the skilled workers for the time spent on B22, plus the lost contribution (net
of skilled labour cost) from not being able to make units of product B16.
Opportunity cost of skilled labour
Skilled labour cost per unit of Product B16 = Rs.24
Number of hours per unit = 3 hours
Contribution per unit of B16 = Rs.45
Contribution per skilled labour hour from B16 = Rs.15
Opportunity cost of skilled labour if it is used to make B22 = (500 × 5) × Rs.15
= Rs.37,500
Unskilled labour
900 unskilled labour will be available at no incremental cost to the company (as
it is already being paid and is not fully employed). There is no relevant cost for
these hours. The additional 600 hours required will involve extra wage
payments, including overtime payments. The relevant cost of these 600 hours is
Rs.6 per hour × 150% = Rs.9 per hour, including the overtime premium.
Overheads
Variable overheads are included as relevant costs because they will be
additional costs if the units of B22 are made. The only incremental fixed costs,
however, are the extra cash costs of Rs.4,000. The fixed overhead absorption
rate is ignored. The additional costs of hiring special finishing machinery are
also included as a relevant cost.
Development costs
Those costs already incurred are past costs (sunk costs) and are not relevant.
The future development costs involve additional expenditure and are included
as relevant costs.
Minimum price for making 500 units of B22

Material Rs.
X (500 units  4kg)  Rs.8 16,000
Y 500 units  6kg)  Rs.15.08 45,240

Labour Rs.
Skilled Labour 500 units  5 hours)  Rs.8 20,000
Oppurtunity costs 500 units  5 hours)  Rs.15 37,500
Unskilled (500  3) – 900] x 6  1.5 5,400

Overheads Rs.
Variable 500 units  2 hours)  Rs.8.75 8,750
Fixed incremental spending 4,000
Machine hire 2 weeks  Rs.2,650) 5,300
Development costs 1,750
Minimum price 143,940