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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 Notes R Direct wages 1 28 500 Supervisor costs 2 11 500 General overheads 3 4 000 Machine depreciation 2 300 Machine overheads 18 000 34 000 98 300 Materials 6 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. 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 Briefly explain what is meant by opportunity cost. (3) 1.2 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)

Expert Answer

1.1 Opportunity Cost is the value of an alternative not opted over a chosen alternative. In this case, we can say that the Opportunity Cost is the val…View the full answer

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