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The managing director of Parser Ltd, a small business, is considering undertaking a once-off contract and 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: Costs for special order Direct wages Supervisor costs General overheads Machine depreciation Machine overheads Materials Notes 12345 6 R 28 500 11 500 4 000 2 300 18 000 34 000 98 300 Notes 1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job, who could be transferred from another department to undertake 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. Subcontracting costs would be R32 000 for the period of the work. Different subcontractors who are skilled in the special order techniques are available to work on the special order and their costs would amount to R31 300. 2. A supervisor would have to work on the special order. The cost of R11 500 is comprised of R8 000 normal payments plus R3 500 additional bonus for working on the special order. Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his normal work to R2 500. It is not anticipated that any replacement costs relating to the supervisor's work on other jobs would arise. 3. General overheads comprise an apportionment of R3 000 plus an estimate of R1 000 incremental overheads. 4. Machine depreciation represents the normal period cost based on the duration of the contract. It is anticipated that R500 will be incurred in additional machine maintenance costs. 5. Machine overheads (for running costs such as electricity) are charged at R3 per hour. It is estimated that 6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost contribution of R2 per hour. 6. Materials represent the purchase costs of 7 5000 kg bought some time ago. The materials are no longer used and are unlikely to be wanted in the future except on the special order. The complete stock of materials (amounting to 10 000 kg), or part thereof, could be sold for R4.20 per kg. The replacement cost material used would be R33 375. 7. Costs will be incurred evenly over the project duration of three months. The prospective client is willing to make an upfront payment of R40 000. The outstanding balance will be paid one month after completion. Because the business does not have adequate funds to finance the special order, a bank overdraft shortfall will be required. The overdraft will be repaid on the settlement of the outstanding debt. The company uses a cost of capital of 15% to appraise projects. The bank's overdraft rate is 12% for Parser Ltd. The managing director has heard that, for special orders such as this, relevant costing should be used that also incorporates opportunity costs. She has approached you to create a revised costing schedule based on relevant costing principles. Required: 1.1 1.2 Briefly explain what is meant by opportunity cost. (3) Determine the minimum price to be quoted by Parser on the once-off contract. Explain why you included or excluded amounts from your calculation. (22) The managing director of Parser Ltd, a small business, is considering undertaking a once-off contract and 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: Costs for special order Direct wages Supervisor costs General overheads Machine depreciation Machine overheads Materials Notes 12345 6 R 28 500 11 500 4 000 2 300 18 000 34 000 98 300 Notes 1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job, who could be transferred from another department to undertake 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. Subcontracting costs would be R32 000 for the period of the work. Different subcontractors who are skilled in the special order techniques are available to work on the special order and their costs would amount to R31 300. 2. A supervisor would have to work on the special order. The cost of R11 500 is comprised of R8 000 normal payments plus R3 500 additional bonus for working on the special order. Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his normal work to R2 500. It is not anticipated that any replacement costs relating to the supervisor's work on other jobs would arise. 3. General overheads comprise an apportionment of R3 000 plus an estimate of R1 000 incremental overheads. 4. Machine depreciation represents the normal period cost based on the duration of the contract. It is anticipated that R500 will be incurred in additional machine maintenance costs. 5. Machine overheads (for running costs such as electricity) are charged at R3 per hour. It is estimated that 6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost contribution of R2 per hour. 6. Materials represent the purchase costs of 7 5000 kg bought some time ago. The materials are no longer used and are unlikely to be wanted in the future except on the special order. The complete stock of materials (amounting to 10 000 kg), or part thereof, could be sold for R4.20 per kg. The replacement cost material used would be R33 375. 7. Costs will be incurred evenly over the project duration of three months. The prospective client is willing to make an upfront payment of R40 000. The outstanding balance will be paid one month after completion. Because the business does not have adequate funds to finance the special order, a bank overdraft shortfall will be required. The overdraft will be repaid on the settlement of the outstanding debt. The company uses a cost of capital of 15% to appraise projects. The bank's overdraft rate is 12% for Parser Ltd. The managing director has heard that, for special orders such as this, relevant costing should be used that also incorporates opportunity costs. She has approached you to create a revised costing schedule based on relevant costing principles. Required: 1.1 1.2 Briefly explain what is meant by opportunity cost. (3) Determine the minimum price to be quoted by Parser on the once-off contract. Explain why you included or excluded amounts from your calculation. (22)

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11 Opportunity Cost is the value of an alternative not opted over a chosen alternative In this case ... View the full answer