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Leinster Limited has the opportunity of quoting for a 'one off' contract. The junior accountant has prepared the following cost estimate. Management are worried that the price looks too high to win the contract.
Material: AX (500kg at €10 per kg) 5,000
YB (1,000 litres at €8 per litre) 8,000
ZC (500 kg at €3 per kg) 1,500
Labour: Department 1 (1200 hours at €10 per hour) 12,000
Department 2 (2000 hours at €15 per hour) 30,000
Overheads: Absorbed on a budgeted labour basis 9,600
(3200 hours at €3 per hour)
Department Time and travelling expenses already incurred 4,000
Total Costs 70,100
The following is also relevant:
Material AX The cost of €10 is the original purchase cost incurred some years ago. The material is no longer used by Leinster Limited. It could be sold for scrap at €6 per kg.
Material YB This is in continuous use by the business. The historic cost was €8 per litre but can now be purchased for €6 per litre.
Material ZC Leinster Limited has 350kg of this material in stock. New supplies would cost €4 per kg. Material ZC can also be substituted for material W in another process. W costs €7 per kg. It requires 2 kg of material ZC for every kg of W.
Department 1: There is spare capacity in this department sufficient to complete the contract, and the workers would be paid in any event.
Department 2: This department is at full capacity at the moment. The workers would be available to work overtime but they would be paid 50% per hour more than normal hours or they could divert hours from another job where the contribution is €4 per labour hour.
Overheads: These are arbitrarily absorbed on a predetermined basis. They are all regarded as fixed costs.
Calculate the minimum contract price that Leinster Limited could quote for the contract to break even using relevant costing techniques. [You must explain your choices by way of note briefly for each item.]
What concerns would you highlight to management in using relevant costing techniques?
Explain the concept of 'opportunity cost' to a business colleague who is unfamiliar with the term. Use some examples to make what you mean clear.
Total (25 marks)
(a) Biarritz plc
Biarritz plc is reviewing investment proposals that have been submitted from a number of divisional managers for consideration. You have determined that the investment funds available are limited to €800,000. Details of the three projects are given below. None of the projects can be delayed.
This will require an investment of €300,000 in automating an element of back office functions. The savings that would be achieved would be in labour costs by increasing efficiency and so reducing expected staff hiring later on. The savings have been reviewed and the savings in money terms are expected to be as follows:
Year 1 2 3 4 5
Cash flow (€000) 90 90 85 95 110
An investment of €450,000 by creating an intranet Human Resources System making it self-service for staff is expected to reduce administration costs by €142,000 in money terms in each of the next five years.
An investment of €400,000 in scanning technology will deliver additional income of €120,000 in money terms in year 1 and is expected to increase by 5% per annum for each of the following four years.
Biarritz plc has a money cost of capital of 12%. Ignore taxation consequences.
Present Value Factors - extract.
Years 12% Cumulative
Determine the best way for Biarritz plc to invest the available funds using Net Present Value with the assumption that none of the projects is divisible.
Explain to a colleague in clear terms what 'net present value' is, why it is preferred to any other method of investment evaluation and what are the important assumptions that underlie it.
(b) Globalisation is shaping the way business is being conducted today and is affecting services type businesses when these were once thought to be protected.
The following is a list of some strategic cost management ideas.
Life cycle costing;
Value chain analysis;
Business Process Reengineering;
Activity Based Management;
Total Quality Management.
Select any two, and for your choices, write a concise note on each, for your Management colleagues who understand that you are familiar with the concepts, with a specific emphasis on business improvement in the services sector.
Total (25 marks)
You have been asked to help Oasis Limited which is a start up company. It makes a particular brand of electronic device for the retail trade. The company needs forecast cash flow analysis for the six months from January 2009 to June 2009. It expects to commence trading on January 1 2009. The company, with your help, has drawn up the following estimates for the first six months.
Production is relatively straightforward and they will hire labour on the basis of what they need.
You have the following information:
(1) The company has acquired premises and it will occupy them from January 1 2009, rent being paid quarterly in advance and on the first day of the quarter. The rent is €35,000 per quarter.
(2) Production equipment will cost €400,000 and will be payable two months after delivery. Delivery is the first week in January.
(3) Estimates of sales and stock levels are as follows:
Stock at Sales
month end of units
January 2,000 NIL
February 6,000 NIL
March 10,000 6,400
April 6,000 9,000
May 4,000 6,800
June 3,000 3,000
(4) Raw material costs are €130 per unit. No stock of raw material will be held. Purchases are paid the month following delivery.
(5) All workers will be paid €44 per item produced and wages are paid in the month of production.
(6) Cash expenses are expected to be €16,000 per month payable during the month.
(7) Selling price is expected to be €250 per unit. All sales are on credit, and should be paid two months after delivery.
(8) The company expects to receive a government grant of €250,000 in January. Additionally a number of investors will contribute a total of €400,000. They expect 50% of this €400,000 in February and the balance in June.
(9) Depreciation is 20% on an annual basis straight line.
(10) Ignore interest costs if the company has a cash surplus or has borrowings.
Prepare the following budgets for the six months to 30th June 2009:
A production budget for each of the six months;
A labour cost budget for each of the six months;
A cash flow forecast for each of the six months;
Comment on the liquidity position of the company and make suggestions as to how to deal with any issues identified.
Total (25 marks)
As part of the management team of Munster Partners, you are helping to review the operations of one area of the company with a view to making operational decisions for the next month. Details of three of the products that you are involved with are given below:
Product AB1 CD2 EF3
Selling price (€/unit) 42.00 57.00 54.60
Material R2 (kg/unit) 2.0 3.0 3.0
Material R3 (kg/unit) 2.0 2.2 1.6
Direct labour (hours /unit) 0.6 1.2 1.5
Variable production overheads (€/unit) 2.20 2.60 2.20
Fixed production overheads (€/unit) 3.00 3.20 3.40
Expected demand for next month (units) 1,900 2,000 1,800
Products AB1, CD2 and EF3 are all sold to customers of Munster Partners.
Material R2, which is not used in any of Munster Partners other products, is expected to be in short supply due to a strike at a major producer of the material. Munster Partners has just received a delivery of 11,000 kg and this is expected to be available for next month's production. The company does not expect to be able to obtain further supplies unless it pays a premium price. The normal market price is €5.00 per kg.
Material R3 is available at a price of €4.00 per kg and plentiful supplies are available. Direct labour is paid €8.00 per hour.
Determine the optimum production schedule for Products AB1, CD2 and EF3 for the next month on the assumption that additional supplies of R2 are not purchased.
If Munster Partners decides to buy more supplies of Material R2, suggest what the maximum price per kg that the company could pay.
Discuss the use of marginal costing (variable costing) as a basis for short term decision making.
Total (25 marks)
Independent plc operates an activity-based costing system and has forecast the following information for next year.
Cost Pool Cost Cost Driver Number
Production set-ups €105,000 Set-ups 300
Product testing €300,000 Tests 1,500
Component supply and storage €25,000 Component orders 500
Customer orders and delivery €112,500 Customer orders 1,000
General fixed overheads such as lighting and heating, which cannot be linked to any specific activity, are expected to be €900,000 and these overheads are absorbed on a direct labour hour basis.
Total direct labour hours for next year are expected to be 300,000 hours.
Independent plc expects orders for Product ZT3 next year to be 100 orders of 60 units per order and 60 orders of 50 units per order. The company holds no stocks of Product ZT3 and will need to produce the order requirement in production runs of 900 units. One order for components is placed prior to each production run. Four tests are made during each production run to ensure that quality standards are maintained.
The following additional cost and profit information relates to product ZT3:
Component cost: €1·00 per unit
Direct labour: 10 minutes per unit at €7·80 per hour
Profit mark-up: 40% of total unit cost.
Calculate the activity-based recovery rates for each cost pool.
Calculate the total unit cost and selling price of Product ZT3.
Discuss the reasons why activity-based costing may be preferred to traditional absorption costing in the modern manufacturing environment.
Total (25 marks)
Mary Murphy has just returned from a fact finding mission to an overseas health spa. She is currently considering the possibility of setting up her own health spa in Wexford.
She has some idea of the costs involved, but needs to put together a business plan to present to her bank manager so she can secure the bank's backing.
Your company has asked you to help her. Mary has given you the following estimates of costs and revenues for the year ahead.
• Mary has found a suitable property that is currently being used for a similar purpose on the market for rent. The rent will be €220,000 per annum.
• The spa will be managed by a full time manager who will be paid €30,000 per annum. In addition to this, there will be one assistant manager who will cost €18,000 per annum and 6 full-time health professionals trained in various disciplines, costing €13,500 each per annum.
• The maintenance costs for the spa are estimated at €28,000 per annum.
• The utilities such as gas, electricity and telephone are expected to cost €29,000 per annum.
• Advertising will cost €6,500 per annum.
• The cost of breakfast is expected to be €3.30 per guest per day, lunch €4.75 per guest per day and evening meal €6.30 per guest per day.
• Mary will employ local people to work as domestic staff. They will be paid €7.50 per hour. It is expected that they will be able to clean 3 rooms per hour and each room will only be cleaned after a guest has occupied it. The main spa areas will be cleaned by a part-time member of staff, costing €7,500 per annum.
• Towels and robes will be supplied to each resident. These will be provided clean every day. The cost of this is expected to be €3.45 per day per guest.
• Each treatment involves some consumables and these are estimated to cost €10.60 per treatment. Each guest would have two treatments per day.
• It is proposed that the price charged will be €110 per night, although Mary feels that the market could take a higher price. This price would be for use of the fitness facilities, all meals (breakfast, lunch and dinner), and clean laundry. Any treatments would be charged in addition to this.
• Treatments offered will be charged at €20 each. It is expected that guests on average will choose to have 2 treatments per day of their visit.
• The spa will be able to accommodate 20 guests per night. It is expected that the spa will operate 365 days per year and on average will achieve 65% occupancy.
(a) List the costs that you think are 'fixed' for Mary's Health Spa for the year ahead;
(b) Determine what you think are the variable costs per guest night;
(c) Determine what you think the revenue per guest night would be;
(d) Draft a statement that clearly shows the level of profit that can be expected from the health spa assuming levels of occupancy at 60%, 65% and 70% .
(e) Outline some assumptions that you have made in your analysis.