Question

QUESTION THREE [25]
EC, an engineering company, produces tools and components to customers' specific
requirements. EC uses absorption costing to absorb overheads into the cost of each customer
order. Selling prices are usually determined by adding a 30% mark up to the costs incurred in
completing the order.
EC has recently been asked to provide a quotation for a new customer. The details of the work
have been discussed at a meeting with the customer and the following resource requirements
have been determined. The cost of these resources has been calculated using the company‟s
routine costing system.

	Note		R
Direct Material A	1	5 square metres @R20	100
Direct Material B	2	10 square metres @ R15	150
Skilled Labour	3	100 hours @ R8	800
Unskilled labour	4	60 hours @ R6	360
Supervision labour	5	20 hours @ R20	400
Machine overhead	6	20 hours @ R12	240
Other overhead	7	160 labour hours @ R4	640
Total Cost			2690

Notes:
1. Direct material A is currently held in inventory and is in regular use. The latest price
paid for material A was R22 per square metre, but the replacement cost would be
R23 per square metre.
2. Direct material B is currently not used by EC and would have to be bought if the work is
undertaken. The minimum order from the supplier of material B is for 25 square metres.
EC does not expect to be able to use this material on any other work, though it would
be able to sell it as scrap for R2 per square metre.

3. The skilled labour that would be required is available within EC, but only if those
employees are transferred from other work that they are currently doing. This other
work could be done by sub-contractors who could be hired on an hourly basis at a
cost of R7 per hour. Alternatively sub-contractors could be hired to work on this new
customer‟s order at a cost of R9 per hour. EC‟s current skilled labour is paid R8 per hour.
4. The unskilled labour is paid an hourly rate of R6 but only for hours that they are actively
working. There are only 40 hours of additional unskilled labour available within normal
working hours. In order to complete the customer order on time they would have to work
20 hours of overtime. EC pays an overtime premium of 50%.
5. The work would be supervised by the existing supervisor as part of his normal activity.
The supervisor is paid an annual salary which is equivalent to R20 per hour for a 40
hour working week.
6. The machines that would need to be used have a running cost of R12 per hour. Two
different machines would be required: machine W for 12 hours and machine Z for 8
hours. Both machines are regularly used by EC. Machine W is very specialised and is
used for only some of EC‟s work. There is sufficient spare capacity on this machine.
Machine Z is in constant use by EC and, if it is required for this customer order, EC would
need to hire an additional machine at a hire cost of R5 per hour (excluding running costs)
to fulfill its normal work.
7. EC‟s non-machine related fixed overhead costs are absorbed into product costs using
an absorption rate per labour hour.
If this customer order is accepted it must be completed during the next 30 days.
EC would like to win this order as it believes that it will probably win repeat orders from
the customer. The directors have therefore decided to price this work on the basis of its
relevant cost plus 10%.

Required:
3.1 Prepare a schedule that shows the relevant cost of the new customer's order. (16)
3.2 Explain, for each of the resource items numbered 1 to 7, the reason for each of the
values you have included in your answer to 1.1 above. (9)

Answer 1

		RELEVANT COSTS:
			R
		Direct Material A	115
		Direct Material B	345
		Skilled Labour	900
		Unskilled labour	420
		Supervision labour	400
		Machine overhead	280
		Other overhead	640
		Total Cost	3100
	Note		R
	1	Material A to be purhased for this job will cost R23 per square meter	115	(Relevant cost for this order=5*23
	2	Cost of material B for this order=(25*15) Salvage value of (25-10)*2 tobe deducted	345	(25*15)-(25-10)*2
	3	The company does not have capacity . The cost of subcontracting is the relevant cost	900	(100*9)
	4	Relevant cost should be amount tobe paid for this order(40*6)+(20*6*1.5)	420
	5	Since it will be within normalworking hour, the relevant cost should be 20*R20	400
	6	Relevant cost should be 20*12 plus Additional highering cost for this order =5*8	280	(20*12+5*8)
	7	Relevant cost =160*4	640