Management Accounting and Finance II

ACCN 2006 & 2011

SCHOOL OF ACCOUNTANCY
COMMERCE, LAW AND MANAGEMENT FACULTY
Management Accounting and Finance II
ACCN 2006/2011

Relevant costing lecture material

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LEARNING OUTCOMES
Learning objectives

• Define and explain the concept of relevant and irrelevant costs and
revenues for decision making.

• Identify avoidable, unavoidable, sunk, opportunity costs, incremental a

marginal costs.

• Explain why in the short term some costs and revenues are not releva
decision making.

Measuring relevant costs and

revenues for decision-making
Chapter 11
Pages 284-305
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LEARNING OUTCOMES
• Define and explain the concept of relevant and irrelevant costs and
revenues for decision making.

• Discuss and evaluate qualitative considerations in decision making.

• Use the relevant-costing decision model as a tool in choosing amongst

alternatives.
• Apply relevant costing to special pricing decisions, make-or-buy-
decisions, starting a new department or closing down an existing
department and to sell-or-process-further, outsourcing decisions etc.

• Distinguish between short term and long-term decision making.

• Explain, calculate and apply the opportunity cost concept.

• Explain why the book value of equipment is irrelevant in equipment

replacement decisions.
Relevant costing • Understand and apply the general approach to making decisions where
there is uncertainty, including the use of probabilities and expected
Chapter 2 values.

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RELEVANT COSTING
 Relevant costing is a method that is used for long term and short-term decisions.

 Short-term decisions concern how to make the best use of resources in the short term- they are operational or

tactical in nature.
 Short-term decisions usually concern with relatively low values, are likely to be repeatable/ reversible and individually are
not expected to have much impact on the business long term.
 Relevant costs and revenues are those costs and revenues that change as a direct result of a decision taken.

 They have the following characteristics:

FUTURE INCREMENTAL CASHFLOWS

EXAMPLES OF NON RELEVANT COSTS

Sunk costs Irrelevant as it has already been incurred – we cannot change the past
1 Example: expenditure already incurred in developing a new product cannot
be recovered even if a decision to abandon is taken

Committed costs Expenditure that will be incurred in the future, but as a result of
2 decisions taken in the past.
In other words, a commitment has already been made through past
decisions
Fixed costs Fixed costs incurred regardless of whichever decision is made are
3 irrelevant

Depreciation Remember one of the characteristics of relevant cost is cash flow

Depreciation is an accounting adjustment but does not result in any cash
4 flows, therefore should never be included as a relevant cost for decision
making

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OPPORTUNITY COST

Opportunity cost The value of the benefit sacrificed when one course of action is
chosen, in preference to an alternative. The opportunity cost is
represented by the forgone potential benefit from the best
rejected course of action.

OPPORTUNITY COST
SCENARIO RELEVANT COST

Amanda is deciding whether or not to take a skiing holiday

this year. The travel agent is quoting an all inclusive holiday
cost of R6 750 for a week. Amanda will lose the chance to
earn R2 000 for a part-time job during the week that the Opportunity cost ‐ R2 000 per week
holiday would be taken Out of pocket cost ‐ R6 750 per week
Total relevant cost ‐ R8 750

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HOW DO YOU DECIDE BETWEEN TWO CHOICES?

Always discuss quantitative and qualitative factors and conclude.

Quantitative analysis
 Identify the objective of the decision maker
 Identify the set of alternative actions under consideration
 Identify the set of relevant events that can occur
 Assign the set of probabilities for the events that can occur (%)
 Identify the possible outcomes

Always consider the definition! The relevant financial inputs for decision‐making are
FUTURE CASH FLOWS that will DIFFER between the various alternatives being considered.

RELEVANT COSTS • With questions involving labour costs, the key question is
whether spare capacity exists? You may be faced with one
OF LABOUR of the following scenarios:

Relevant cost
Spare capacity Existing workforce are idle and Nil
being paid regardless
No spare capacity Only option is to hire in additional Cost to hire in workers
workers
Only option is to transfer existing Opportunity cost
workers from alternative projects

Choice of hiring in or transferring Lowest cost

labour

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RELEVANT COSTS OF LABOUR

The following flow chart might help to determine the relevant cost of labour

Start here

YES
Is there spare labour Relevant cost =NIL
capacity

NO

Transfer labour from

Hire additional labour
another project

Relevant cost
Relevant cost =Cost to hire
Choose the lower =contribution foregone
labour
PLUS direct labour cost 9

RELEVANT COSTS OF MATERIAL

Start here

Are the materials already NO Relevant cost =Cost of

in inventory? purchase

YES

YES Relevant cost=

Will they be replaced?
Replacement cost

NO
YES Relevant cost =
Will it be used for other Opportunity cost of
purposes? alternative use
NO

Relevant cost =Net

realisable value
10
The flow chart above might help to determine the relevant cost of material

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QUALITATIVE ANALYSIS
Decisions should not be based only on items that can be expressed in quantitative terms; qualitative factors must also be considered.
Use the scenario to generate qualitative factors.
Here are some examples:

• Does the decision align with the strategic goals and objectives of the firm?

• Are the estimates included in the calculation accurate?

• Customer satisfaction considerations – current and new customers

• Internal efficiencies and operational factors – e.g. quality, efficiency, etc.

• Future opportunities – e.g. repeat orders

Do not discuss the calculations that you have already included in the quantitative analysis (e.g. If the company decides to outsource
they would gain from a significant cash inflow from reducing their production capacity).

Conclude
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a) Special selling price decisions

Special pricing decisions are typically one-time only orders and/or
orders below the prevailing market price when there is idle capacity.
In the short term, capacity cannot be changed but could be used for
the order. It would make sense to accept if the price exceeds the
incremental costs of the order.

b) Make-or-buy (outsourcing) decisions

Relevant Costing Should you obtain goods/services from outside suppliers instead of
from within the organisation?
Scenarios
c) Decisions on replacement of equipment

Should you continue using an old piece of equipment or to replace it

with new equipment? The original purchase cost of the old machine,
its written down value and depreciation are irrelevant for decision-
making. Expected cash flows are relevant: disposal value for old
machine, cost of new machine, different operating costs etc.

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d) Discontinuation decisions

This entails deciding whether we should continue or discontinue a

segment or department that appears to be unprofitable. Routine
periodic profitability analysis by cost objects provides attention-
directing information that highlights those potential unprofitable
activities. Which costs are avoidable when closing a branch/
division? Only if the cost differs between options (to keep or let go)
will it be relevant.

Relevant Costing e) Sell now or process further

Scenarios Refer to joint and by-product costing.

f) Product-mix decisions when capacity constraints exist

Deciding on the optimal product mix (how much of which product we

should produce) when constraints exist. Constraints are limiting or
scarce factors that restrict output (e.g. machine hours.)

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DECISION MAKING
BASED ON RELEVANT
COSTING PRINCIPLES

DECISION DESCRIPTION
Special order pricing Should be calculated based on relevant
costing principles
Accept/reject Should compare relevant revenue against
decisions relevant costs.
Further processing If the incremental revenue generated through
further processing is greater than the
incremental cost of further processing, then
. the products should be further processed.

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DECISION MAKING
BASED ON RELEVANT
COSTING PRINCIPLES

DECISION DESCRIPTION
Shutdown if the product/department is generating a positive
contribution and the fixed costs are unavoidable,
then it should not be shut down.

Limiting factor products should be produced in order of contribution

per scarce resource.
Make or buy/ if the variable cost of producing the product internally
outsourcing is less than the cost of purchasing the product from
the external market and the fixed costs are
. unavoidable, then the company should produce
internally.

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(A) SHORT TERM ORDER

EXAMPLE 1:
Relevant Without Total with order (2) Difference due to order (3)
(1)
Sales R1 400 000 R1 460 000 (R20*3000 units) = R60 000 Two approaches to presenting relevant costs:

Without order (column 1) compared to Total with order (column 2) OR Only

Direct Labour R420 000 R420 000 incremental (column 3)

Since relevant revenues exceed relevant costs the order is acceptable, but
NB> subject to the following qualitative considerations:
Variable Costs R350 000 R380 000 ( R10*3000 units)= (R30 000)
1. Will the normal selling price of R40 be affected?

Manufacturing R280 000 R280 000 2. Are there no better opportunities available during the period?

non‐variable 3. Are there no alternative uses for the resources?

overheads
4. Are the fixed costs unavoidable for the period under consideration ?
Fixed marketing R105 000 R105 000
and distribution 5. Is there sufficient capacity to complete the special order without affecting
our existing customers?
costs

Extra selling costs R3 000 ( R1*3000 units) = (R3 000)

Profit R245 000 R272 000 R 27 000 incremental

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(A) LONGER-TERM ORDER

EXAMPLE 2:(Approach 1) Accept/Do not accept

Do not accept Accept the order Difference if you do accept

Units sold 35 000 50 000 15 000

Sales 1 400 000 1 775 000 375 000
Revenues‐ 25 000 (25 000)
facilities
Direct labour 294 000 420 000 (126 000)
Variable costs 350 000 500 000 (150 000)
Manufacturing 210 000 280 000 (70 000)
non‐variable
overheads
Extra selling costs 15 000 (15 000)

Marketing/dist 85 000 105 000 (20 000)

cost
Profit 486 000 455 000 (31 000)

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EXAMPLE 2: LONGER TERM ORDER

EXAMPLE 2:(Approach 2) Incremental

DOWNSCALE CONTRACTUAL ORDER DIFFERENCE

Reduction in: Additional sales

Labour 126 000 (15000*R25) 375 000

costs
70 000 Additional VC
Manufactur
20 000 (15000*(R10+R1)) 165 000
ing

Marketing
Rental revenue 25 000
Total increase in 241 000 Additional 210 000 31 000
profits contribution

Company will be better off by R31 000 per month if it reduces capacity (assuming there are no qualitative factors).
NB. Remember your qualitative factors.
• In the longer‐term all of the above costs and revenues are relevant.

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(B) MAKE OR BUY (OUTSOURCING

DECISIONS)
Assuming there is no alternative use for the released
internal capacity

Make Buy (Outsource) Difference if you outsource

Direct materials 120 000 120 000

Direct labour 100 000 100 000

Variable man. O/H 10 000 10 000

Fixed man. O/H 80 000 70 000 10 000

Non‐manufacturing 50 000 50 000 ‐

costs

Outsourcing cost 300 000 (300 000)

Total cost 360 000 420 000 (60 000)

incurred/(saved)

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EXAMPLE 2: LONGER TERM ORDER

Assuming there is an alternative use for the released internal capacity

Make Buy (Outsource) Difference

Total cost (above) 360 000 420 000 (60 000)

Rental on released (90 000) 90 000

capacity

Total Costs 360 000 330 000 30 000

Outsourcing is now the cheaper alternative.

NB. Remember your qualitative factors.
• Quality, reliability, subsequent price increases, long term contract?

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(C) DECISION ON REPLACEMENT OF

EQUIPMENT
Retain Replace Difference if you
replace
Variable costs (*3
years)
(180 000) (120 000) 60 000
20 000*R3; 20
000*R2
Old machine 40 000 40 000
disposal value
Initial purchase price (70 000) (70 000)

Total cost (180 000) (150 000) 30 000

Cheaper to buy the new machine (replace).

NB. Remember your qualitative factors.

• Quality, training of staff, maintenance available for new machine?

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(D) DISCONTINUATION DECISIONS

Keep Central Discontinue Difference

Sales 2 800 1 900 900

Variable costs (1 592) (994) (598)
Fixed costs (942) (692) (250)

Reported profit 266 214 52

Therefore Central provides a contribution of R52 000 towards fixed costs and profits.

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 Management Accounting and Finance II

RELEVANT COSTING EXAMPLES

A. One‐time special orders (selling price decisions)

Example 1: A SHORT‐TERM ORDER

Monthly capacity for a department within a company =50 000 units

Expected monthly production and sales for next quarter =35 000 units (at a normal selling price of R40)

Estimated costs and revenues (for 35 000 units):

TOTAL UNIT

Sales R1 400 000 R40

Direct Labour R420 000 R12

Variable Costs R350 000 R10

Manufacturing non‐variable overheads R280 000 R8

Fixed marketing and distribution costs R105 000 R3

Profit R245 000 R7

The excess capacity is temporary* and a company has offered to buy 3 000 units each month for the
next three months at a price of R20 per unit. Extra selling costs for the order would be R1 per unit. All
staff are permanent salaried employees.

Page 1 of 8
What costs are relevant? = What costs differ between the two alternatives?

Relevant Without (1) Total with order (2) Difference due to order (3)

Sales R1 400 000 R1 460 000 (R20*3000 units) = R60 000

Direct Labour R420 000 R420 000

Variable Costs R350 000 R380 000 ( R10*3000 units)= (R30 000)

Manufacturing non‐ R280 000 R280 000

variable overheads

Fixed marketing and R105 000 R105 000

distribution costs

Extra selling costs R3 000 ( R1*3000 units) = (R3 000)

Profit R245 000 R272 000 R 27 000 incremental

Two approaches to presenting relevant costs:

Without order (column 1) compared to Total with order (column 2) OR Only incremental (column 3)

Since relevant revenues exceed relevant costs the order is acceptable, but NB> subject to the following
qualitative considerations:

1. Will the normal selling price of R40 be affected?

2. Are there no better opportunities available during the period?

3. Are there no alternative uses for the resources?

4. Are the fixed costs unavoidable for the period under consideration?

5. Is there sufficient capacity to complete the special order without affecting our existing customers?

Page 2 of 8
Example 2: A LONGER‐TERM ORDER

• Assume now spare capacity in the foreseeable future*

An opportunity for a contract of 15 000 units per month at R25 SP emerges involving R1 per unit special
selling costs. No other opportunities exist so if the contract is not accepted direct labour will be reduced
by 30%, manufacturing non‐variable costs by R70 000 per month and marketing by R20 000. Unutilised
facilities can be rented out at R25 000 per month.

Do not accept Accept the order Difference if you do accept

Units sold 35 000 50 000 15 000

Sales 1 400 000 1 775 000 375 000

Revenues‐facilities 25 000 (25 000)

Direct labour 294 000 420 000 (126 000)

Variable costs 350 000 500 000 (150 000)

Manufacturing non‐ 210 000 280 000 (70 000)

variable overheads

Extra selling costs 15 000 (15 000)

Marketing/dist cost 85 000 105 000 (20 000)

Profit 486 000 455 000 (31 000)

Page 3 of 8
Incremental Approach:

DOWNSCALE CONTRACTUAL ORDER DIFFERENCE

Reduction in: Additional sales

Labour costs 126 000 (15000*R25) 375 000

Manufacturing 70 000 Additional VC

Marketing 20 000 (15000*(R10+R1)) 165 000

Rental revenue 25 000

Total increase in 241 000 Additional 210 000 31 000

profits contribution

Company will be better off by R31 000 per month if it reduces capacity (assuming there are no
qualitative factors).

NB. Remember your qualitative factors.

• In the longer‐term all of the above costs and revenues are relevant.

Page 4 of 8
 B. Make‐or‐buy (outsourcing) decisions

Example 1:

A division currently manufactures 10 000 components per annum.

TOTAL UNIT

Direct materials R120 000 R12

Direct labour R100 000 R10

Variable manufacturing overhead costs R10 000 R1

Fixed manufacturing costs R80 000 R8

Share of non‐manufacturing overheads R50 000 R5

A supplier has offered to supply 10 000 components per annum at a price of R30 per unit for a minimum
of three years.

If the components are outsourced the direct labour will be made redundant. Direct materials and
variable overheads are avoidable and fixed manufacturing overhead would be reduced by R10 000 per
annum but non‐manufacturing costs would remain unchanged. The capacity has no alternative uses.

Assuming there is no alternative use for the released internal capacity arising from outsourcing, annual
costs will be as follows:

Make Buy (Outsource) Difference if you outsource

Direct materials 120 000 120 000

Direct labour 100 000 100 000

Variable man. O/H 10 000 10 000

Fixed man. O/H 80 000 70 000 10 000

Page 5 of 8
 Non‐manufacturing 50 000 50 000 ‐
costs

Outsourcing cost 300 000 (300 000)

Total cost 360 000 420 000 (60 000)

incurred/(saved)

Where the released internal capacity arising from the outsourcing can be used to generate rental
income, this needs to be taken into consideration.

Assume that the released capacity from outsourcing enables a rental contribution of R90 000 to be
generated. The relevant costs/revenues will now be:

Make Buy (Outsource) Difference

Total cost (above) 360 000 420 000 (60 000)

Rental on released (90 000) 90 000

capacity

Total Costs 360 000 330 000 30 000

Outsourcing is now the cheaper alternative.

NB. Remember your qualitative factors.

• Quality, reliability, subsequent price increases, long term contract?

Page 6 of 8
 C. Decisions on replacement of equipment

Example 1:

Book value of existing machine (remaining life of 3 years) R90 000

Cost of new machine (expected life of 3 years and zero scrap value) R70 000

Operating costs: R3 per unit old machine; R2 per unit new machine

Output of both machines is 20 000 units per annum.

Disposal value of old machine now R40 000

Disposal value of new and old machines in 3 years time Zero

Total costs over a 3 year period are as follows:

Retain Replace Difference if you replace

Variable costs (*3 years)

20 000*R3; 20 000*R2 (180 000) (120 000) 60 000

Old machine disposal value 40 000 40 000

Initial purchase price (70 000) (70 000)

Total cost (180 000) (150 000) 30 000

Cheaper to buy the new machine (replace).

NB. Remember your qualitative factors.

• Quality, training of staff, maintenance available for new machine?

Page 7 of 8
 D. Discontinuation decisions

Example 1:

Assume the periodic profitability analysis of sales territories reports the following:

Southern Northern Central Total

R000 R000 R000 R000

Sales 900 1 000 900 2 800

Variable costs (466) (528) (598) (1 592)

Fixed costs (266) (318) (358) (942)

Profit/(Loss) 168 154 (56) 266

Assume that a special study indicates that R250 000 of CENTRAL fixed costs and all variable
costs are avoidable and R108 000 fixed costs are unavoidable if the territory is
discontinued.

The relevant financial information is as follows:

Keep Central Discontinue Difference

Sales 2 800 1 900 900

Variable costs (1 592) (994) (598)

Fixed costs (942) (692) (250)

Reported profit 266 214 52

Therefore Central provides a contribution of R52 000 towards fixed costs and profits.

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©School of Accountancy,University of the Witwatersrand
 E. COMPREHENSIVE CLASS EXAMPLE: MANFIN 11 SEPTEMBER TEST 2023

Adscape

Advertising agencies are companies that create advertisements or host promotional events for other
businesses. The advertisements that they create can appear on billboards, in printed newspapers,
electronic news sites, on Google or Facebook. Adscape Ltd (‘Adscape’) is an advertising agency with a head
office in Johannesburg and offices in Cape Town and Durban. The company listed on the Johannesburg
stock exchange in 2019 and attracted shareholders due to its regular dividend payouts. It was established
in 1998 and has built good relationships with customers over the years. The company has a good reputation
for delivering high‐quality work to a wide range of clients. Adscape offers a full range of advertising services,
including strategy and content generation as well as purchasing of advertising space on behalf of clients.
The company has won numerous local and international awards for their ‘out‐of‐the‐box’ marketing
strategies. At the same time the company boasts a highly experienced team of creative directors and
strategists who have years of industry experience between them. However, the company has lagged behind
its competitors in recent times due to its lack of effective digital strategies.

The advertising industry has been rapidly changing with the decline in traditional media as more people
make use of digital sources of information. Newspapers and magazines are nowadays often read online
and subscriptions for print media have dropped sharply. Google, Facebook and Instagram are also able to
gather large amounts of data on clients and direct adverts to targeted audiences, which make them more
desirable advertising targets. Many marketing companies are creating strategic partnerships with digital
platforms or tech companies to compete against these large tech companies. The competition in the
industry is very high as many companies are trying to capture the attention of potential clients and at the
same time there is limited costs for clients to move from one advertising agency to another making it harder
for companies to retain loyal clients. In general, a larger slice of advertising budgets is accordingly being
allocated to digital strategies and some advertising agencies have begun to specialise in digital offerings.

Financial information of Adscape

The operating profit growth of Adscape has been suppressed in recent years. Many clients want to
extract greater value from their advertising budgets and are negotiating harder for bigger discounts and
for services to be provided on credit. This resulted in Adscape allowing for 40 % of their services to be
provided on credit. Increasing electricity costs, load shedding and higher than inflation salary increases
have all contributed towards corporates allocating less funds to advetising budgets.

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©School of Accountancy,University of the Witwatersrand
Given the existing operational and economic challenges faced by Adscape, Mr. Farouk Mohideen the
current CFO, has significant concerns regarding the company's operational trajectory. He has tasked the
financial manager to provide him with Adscape's financial data as well as relevant market insights
pertaining to the industry in which the company operates.

The following information has been extracted from the annual financial statements of Adscape for the
financial year ended 31 December 2022, together with some explanatory notes:

Statement of comprehensive income for the year ended 31 December 2022

R’000 Notes 2022 2021
Revenue 152 178 145 845
Ongoing operations 131 395 131 260
New Acquisition 1 20 783 14 585

Segmental Revenue 152 178 145 845

Johannesburg 90 213 85 740
Cape Town 43 379 43 378
Durban 18 586 16 727

Cost of services provided 2 (90 252) (85 678)

Gross profit 61 926 60 167
Operating expenses (41 435) (40 914)

Operating profit 20 491 19 253

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 Statement of Financial position as at 31 December 2022
R’000 Notes 2022 2021
Non Current assets 109 947 104 464
Property, plant and equipment 92 310 89 160
Intangible assets 9 380 7 930
Other investments 8 257 7 374

Current assets 97 380 116 523

Accounts receivable 65 247 66 326
Taxation receivable 22 755 22 910
Cash and cash equivalents 3 9 378 27 287
Total Assets 207 327 220 987

Equity and Liabilities

Capital and reserves 50 802 50 479
Share capital (R2 per share) 40 000 40 000
Retained income 10 802 10 479

Non current liabilities 85 914 77 731

Deferred tax liability 10 914 10 746
Long term loan 75 000 66 985

Current Liabilities 70 611 92 777

Trade and other payables 20 758 19 636
Bank overdraft 30 782 54 781
Short – Term borrowing 19 071 18 360

Total equity and liabilities 207 327 220 987

Notes:

1. Adscape acquired a small media agency company in the past 2 years in order to expand its
current product offerings to include social media advertising.
2. Cost of services provided consist of employee salaries amongst other non‐material service
related expenses.
3. The largest contributor to the movement in cash and cash equivalents is due to the dividend
payout and overdraft repayment that took place in December 2022.

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©School of Accountancy,University of the Witwatersrand
Industry and other ratios

Current ratio 1.5

Dividend yield 10%
Accounts receivable collection period 45
Total Debt ratio 0.4
Inflation 4.5%

*The share price of Adscape as at 31December 2022 was R20 and the dividend payout ratio was 0.3:1

Pricing decision for special order

Adscape was recently approached by HotEventz (HE), an events management company, regarding some
printwork for an upcoming event. HE has decided to host a spring celebration party for college students.
The management of HE is sure that the Spring party will be greatly welcomed by many students who have
been kept indoors by this year’s long and cold winter. They reckon that students will be eager to experience
the sunny outdoors once again, increasing the party’s odds of success.

HE has begun inhouse marketing of this event through different social media platforms. However, they are
also eager to conduct some of their marketing via traditional print media. They would like to print the event
programme details for distribution across various university campuses in Gauteng. The printed programme
would include details such as the list of artists and disc jockeys (DJ’s) expected to perform on the day,
together with the times that they would be expected to perform. HE has therefore invited six companies,
including Adscape, to bid for the printing work project.

The management of Adscape is very keen to bid for this printing project and have decided to submit a
quotation to HE.

Due to existing commitments at Adscape, the printing work would have to be carried out in addition to the
normal work of the company. The production manager has indicated that some weekend work would be
required to complete the printing of the programme. HE is a renowned brand in the events management
space. Considerable publicity could be obtained for AdSpace if they are able to win this order. The price
quoted must therefore be very competitive.

A junior finance officer has produced the following cost estimate based upon the resources that would be
required as specified by the print production manager:

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©School of Accountancy,University of the Witwatersrand
 Rands
Direct materials Paper (carrying value) 500 000
Inks (purchase price) 240 000
Direct labour Skilled 250 hours @R400 100 000
Unskilled 100 hours @R350 35 000
Variable overhead 350 hours @R400 140 000
Specialised laser printer 200 hours @R250 50 000
depreciation
Fixed Production Costs 350 hours@R600 210 000
Estimating Department 40 000
Costs
1 315 000

The following notes are relevant to the cost estimate above:

1. The paper to be used is currently in inventory at a carrying value of R500 000. It is of an unusual color which has
not been used for many years. The replacement price of the paper is R800 000, while the scrap value of that
inventory is R250 000. There is no alternative use for the paper if it is not used for the proposed printing work.
2. The inks required are not held in inventory. They would have to be purchased in a single bulk container at a cost
of R300 000. Eighty per cent of the ink purchased would be used in printing the programmes. No other use is
foreseen for the remainder.
3. Skilled direct labour is in short supply, and to accommodate the printing of the programmes, 50 per cent of the
time required would be worked at weekends for which an additional charge of 25 per cent above the normal
hourly rate is paid. The normal hourly rate is R400 per hour.
4. Unskilled labour is presently under‐utilised, and at present 200 hours per week are recorded as idle time. If the
printing work is carried out at a weekend, 25 unskilled hours would have to occur at this time, but the employees
concerned would be given two hours’ time off as payment for each weekend hour worked.
5. Variable overhead represents the cost of operating the specialised laser printer.
6. When not being used by the company, the specialised printer is hired to outside companies for R600 per hour.
This earns a contribution of R300 per hour. There is unlimited demand for this facility.

7. Fixed production costs are those incurred by and absorbed into production, using an hourly rate based on
budgeted activity.
8. The cost of the estimating department represents the time that was spent in discussions with HE management
concerning the requirements of the printing work.
Required part b
b) As the financial manager at Adscape you have reviewed the cost estimate prepared by the junior finance officer. You
have noticed that relevant costing principles were not largely considered in the preparation of the cost estimate. Prepare
a revised cost estimate clearly showing the minimum price that Adscape should charge for the order. Underneath the
revised cost estimate, provide detailed reasons for each inclusion/exclusion in your cost estimate.