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The contract from aircraft carrier, Moll plc should not be accepted as there is no profit arising out
of the contract. The total material cost in manufacturing 400 components is £38,320. The labour
cost involved is £40,800 (£19,200 + £21,600). The overhead cost involved is £40,200. Thus, the
total cost comes to £119,320. The total sales revenue is £90,000. Thus, this leads to a net loss
of £29,320 and thus the project should not be accepted.
The workings for the project are given below:
Cost statement for the order of aircraft
Particulars Amount
Number of components requested £ 400
Selling price per unit £ 225
Total sales for the order [A] £ 90,000
Costs:
Material cost (Note-1) £ 38,320
Labor cost:
Skilled labor (4 hours x 400 units x 12) £ 19,200
Semi-skilled labor (6 hours x 400 units x 9) £ 21,600
Overhead cost:
Variable overhead (10 hours x 400 units x 9) £ 36,000
Fixed overhead £ 4,200
Total cost [B] £ 119,320
Net loss on order [A-B] –£ 29,320
Note-1 : Calculation of material cost
Particulars Per unit (A) Cost per unit (B) Amount (AxB)
Material K1 4kg £ 5.80 £ 23.20
Material Q2 3kg £ 4.20 £ 12.60
1 Part No. 2095 1 Part £ 60.00 £ 60.00
Total material cost for one component £ 95.80
Total number of components requested 400
Total material cost for the components £ 38,320
Answer (b):
Three factors which management should consider which can influence their decision are:
a) Renegotiate the selling price from £225 to a price greater than £298.3 per unit (£119,320
cost /400 units). This is the break-even point can price above this will lead to acceptance
of project.
of the contract. The total material cost in manufacturing 400 components is £38,320. The labour
cost involved is £40,800 (£19,200 + £21,600). The overhead cost involved is £40,200. Thus, the
total cost comes to £119,320. The total sales revenue is £90,000. Thus, this leads to a net loss
of £29,320 and thus the project should not be accepted.
The workings for the project are given below:
Cost statement for the order of aircraft
Particulars Amount
Number of components requested £ 400
Selling price per unit £ 225
Total sales for the order [A] £ 90,000
Costs:
Material cost (Note-1) £ 38,320
Labor cost:
Skilled labor (4 hours x 400 units x 12) £ 19,200
Semi-skilled labor (6 hours x 400 units x 9) £ 21,600
Overhead cost:
Variable overhead (10 hours x 400 units x 9) £ 36,000
Fixed overhead £ 4,200
Total cost [B] £ 119,320
Net loss on order [A-B] –£ 29,320
Note-1 : Calculation of material cost
Particulars Per unit (A) Cost per unit (B) Amount (AxB)
Material K1 4kg £ 5.80 £ 23.20
Material Q2 3kg £ 4.20 £ 12.60
1 Part No. 2095 1 Part £ 60.00 £ 60.00
Total material cost for one component £ 95.80
Total number of components requested 400
Total material cost for the components £ 38,320
Answer (b):
Three factors which management should consider which can influence their decision are:
a) Renegotiate the selling price from £225 to a price greater than £298.3 per unit (£119,320
cost /400 units). This is the break-even point can price above this will lead to acceptance
of project.
b) Outsourcing the manufacturing or assembling function to a third party vendor at a lower
cost so that the overall cost reduces
c) Redetermining the variable overhead cost per hour as in relation to other costs, the rate
of £9 per labor hour is very high.
Scenario 2
The following are the risk the company’s proposed capital investment projects are likely going
face in the coming years –
(i) Operational Risk – This type of risk is due to the mismanagement or technical failures
because of which the project has been at hault. This can lead to affect the cash flows of the
project and in turn will lead to negative results. For e.g.- in our case the company has been
pre-booked with an order over the twelve months however it may so happen that there
might be failure in operations and the project may not be feasible for the company. (CFI,
2020)
(ii) Inflation risk – This is the most influential risk while analysing a project because it is the
risk which reduces the purchasing power of the money in the future. This will in turn affect
the cost of capital of the project and will lead to lower value of cash flows at present. For e.g.
– in our case the products to be offered over twelve months this may be largely impacted by
the inflation since the prices may be rising like the material K1 price rise from 4.8 per kg to
5.8 per kg. (Sraders, 2019)
(iii) Liquidity Risk – Liquidity risk is the risk associated with scarcity of funds in short terms for
the company i.e. the company is not able to settle its short term obligations. For e.g. – the
company may also face risk to manage its working capital which in turn shall lead to
liquidity risk for the company.
(iv) Market Risk – This type of risk is associated with various factors like competition among
the peers which may also affect the projects future cash flows.
(v) Credit Risk – It is the risk associated with failing of the counterparties to fulfill their
obligation i.e. one party fails to pay its due to the other. For e.g. – in our case it may happen
that Moll Plc may default in its payment for the future months due to uncertainties which
cost so that the overall cost reduces
c) Redetermining the variable overhead cost per hour as in relation to other costs, the rate
of £9 per labor hour is very high.
Scenario 2
The following are the risk the company’s proposed capital investment projects are likely going
face in the coming years –
(i) Operational Risk – This type of risk is due to the mismanagement or technical failures
because of which the project has been at hault. This can lead to affect the cash flows of the
project and in turn will lead to negative results. For e.g.- in our case the company has been
pre-booked with an order over the twelve months however it may so happen that there
might be failure in operations and the project may not be feasible for the company. (CFI,
2020)
(ii) Inflation risk – This is the most influential risk while analysing a project because it is the
risk which reduces the purchasing power of the money in the future. This will in turn affect
the cost of capital of the project and will lead to lower value of cash flows at present. For e.g.
– in our case the products to be offered over twelve months this may be largely impacted by
the inflation since the prices may be rising like the material K1 price rise from 4.8 per kg to
5.8 per kg. (Sraders, 2019)
(iii) Liquidity Risk – Liquidity risk is the risk associated with scarcity of funds in short terms for
the company i.e. the company is not able to settle its short term obligations. For e.g. – the
company may also face risk to manage its working capital which in turn shall lead to
liquidity risk for the company.
(iv) Market Risk – This type of risk is associated with various factors like competition among
the peers which may also affect the projects future cash flows.
(v) Credit Risk – It is the risk associated with failing of the counterparties to fulfill their
obligation i.e. one party fails to pay its due to the other. For e.g. – in our case it may happen
that Moll Plc may default in its payment for the future months due to uncertainties which
shall impact the projected cash flows of the project and which in turn shall lead negative
results for the project. (Verma, 2021)
Scenario 3
Answer 1
Sales price variance = (Actual selling price – Standard selling price) x Actual number of
units sold
= (£3.70 – £4.00) x 18,000
= £5,400 (Adverse)
Sales volume variance = (Actual units sold – Budgeted units to be sold) x Budgeted price
per unit
= (18,000 – 20,000) x £4.00
= £8,000 (Adverse)
Operating cost variance = Budgeted operating cost – Actual operating cost
= £24,000 – £20,000
= £4,000 (Favorable)
Answer 2
Reconciliation of budgeted to actual profit
Particulars Type of variance Amount
[A] Budgeted contribution to corporate costs and profits £ 16,000
Adjustments to reconcile budgeted to actual :
[B] Sales price variance (as per part a) Adverse £ 5,400
[C] Sales volume variance (as per part a) Adverse £ 8,000
[D] Material cost variance (£40,000-£36,000) Favourable £ 4,000
[E] Operating cost variance (as per part a) Favourable £ 4,000
[F] Actual contribution to corporate costs and profits
[A-B-C+D+E]
£ 10,600
Answer 3
The shareholders’ value maximization is the ultimate goal of each and every company. The
company has been very smooth in running its operations and efficiently managing its cost which
in turn has led to favourable variances for costs. This has the positive impact on the overall
contribution of the company. However, the company has default in managing its sales price and
quantity which has led to adverse variances for the company and led to negative impact on the
contribution of the company. Eventually, these adverse impacts have nullified the positive
results for the project. (Verma, 2021)
Scenario 3
Answer 1
Sales price variance = (Actual selling price – Standard selling price) x Actual number of
units sold
= (£3.70 – £4.00) x 18,000
= £5,400 (Adverse)
Sales volume variance = (Actual units sold – Budgeted units to be sold) x Budgeted price
per unit
= (18,000 – 20,000) x £4.00
= £8,000 (Adverse)
Operating cost variance = Budgeted operating cost – Actual operating cost
= £24,000 – £20,000
= £4,000 (Favorable)
Answer 2
Reconciliation of budgeted to actual profit
Particulars Type of variance Amount
[A] Budgeted contribution to corporate costs and profits £ 16,000
Adjustments to reconcile budgeted to actual :
[B] Sales price variance (as per part a) Adverse £ 5,400
[C] Sales volume variance (as per part a) Adverse £ 8,000
[D] Material cost variance (£40,000-£36,000) Favourable £ 4,000
[E] Operating cost variance (as per part a) Favourable £ 4,000
[F] Actual contribution to corporate costs and profits
[A-B-C+D+E]
£ 10,600
Answer 3
The shareholders’ value maximization is the ultimate goal of each and every company. The
company has been very smooth in running its operations and efficiently managing its cost which
in turn has led to favourable variances for costs. This has the positive impact on the overall
contribution of the company. However, the company has default in managing its sales price and
quantity which has led to adverse variances for the company and led to negative impact on the
contribution of the company. Eventually, these adverse impacts have nullified the positive
impact of the cost variances and has led to reduction in the actual contribution of the company.
This reduction has reduced the overall value of the shareholders which will have a negative
impact on the company.
Scenario 4
1. Relevant costing deals with those situations where the decisions are required to be taken in
the short term based on the relevant cost involved in taking the decision. Here, a situation
may arise where the firm may be required to evaluate the cost of decisions in the most
restrictive sense so that optimal use of the resources can be made.
For instance, a firm may be required to provide a quote of minimum price for a special one-
time order under some special circumstances. This is very common in recessionary
scenarios imposed by Covid-19 pandemic. In this case, for determining the minimum price to
be offered, the firm needs to take into account all the relevant cost of supplying the special
order. In this case, the relevant cost would include all the additional variable cost that would
be incurred for the order plus any additional opportunity cost if he firm will be losing on some
sales. The portion of fixed cost will not be included as they are already committed costs and
has no bearing with the level of output. Similarly, the calculation of minimum price would not
involve the quantum of profit. Thus, if the additional material cost of producing the product is
$ 10 and the additional labour cost is $20, the minimum price that should be quoted would be
$ 30, provided there are no specific additional variable cost that may be involved.
2. Limitations of relevant cost principle are:
The computation of relevant cost involves some estimates about the additional variable
cost that may be incurred for executing a decision. Thus, the aspect of estimates may lead
to some errors in the future about the accuracy of cost records.
Although, the relevant cost principle advocates that all the relevant cost should be taken
into account for evaluating a proposal. However, sometimes, it may not be possible to
account for all the kinds of cost that may impact a decision in advance. This is especially
true in scenarios of fluctuating levels of cost and inflationary conditions. For instance, a
firm may not be able to estimate the requirement of any additional capital expenditure for
a product especially when the entity is operating with spare capacity of production.
This reduction has reduced the overall value of the shareholders which will have a negative
impact on the company.
Scenario 4
1. Relevant costing deals with those situations where the decisions are required to be taken in
the short term based on the relevant cost involved in taking the decision. Here, a situation
may arise where the firm may be required to evaluate the cost of decisions in the most
restrictive sense so that optimal use of the resources can be made.
For instance, a firm may be required to provide a quote of minimum price for a special one-
time order under some special circumstances. This is very common in recessionary
scenarios imposed by Covid-19 pandemic. In this case, for determining the minimum price to
be offered, the firm needs to take into account all the relevant cost of supplying the special
order. In this case, the relevant cost would include all the additional variable cost that would
be incurred for the order plus any additional opportunity cost if he firm will be losing on some
sales. The portion of fixed cost will not be included as they are already committed costs and
has no bearing with the level of output. Similarly, the calculation of minimum price would not
involve the quantum of profit. Thus, if the additional material cost of producing the product is
$ 10 and the additional labour cost is $20, the minimum price that should be quoted would be
$ 30, provided there are no specific additional variable cost that may be involved.
2. Limitations of relevant cost principle are:
The computation of relevant cost involves some estimates about the additional variable
cost that may be incurred for executing a decision. Thus, the aspect of estimates may lead
to some errors in the future about the accuracy of cost records.
Although, the relevant cost principle advocates that all the relevant cost should be taken
into account for evaluating a proposal. However, sometimes, it may not be possible to
account for all the kinds of cost that may impact a decision in advance. This is especially
true in scenarios of fluctuating levels of cost and inflationary conditions. For instance, a
firm may not be able to estimate the requirement of any additional capital expenditure for
a product especially when the entity is operating with spare capacity of production.
The calculation of relevant cost for a product or decision does not take into account the
non-financial factors that may arise or may be involved in executing the decision. For
instance, the level of employee dissatisfaction that may be triggered due to an additional
work hours for a special order is not taken into account for computation of relevant cost.
Similarly, accepting a special order on the basis of relevant cost may lead to
dissatisfaction among the old customers and the firm may lose a significant part of its
traditional market share. (nd, 2020)
non-financial factors that may arise or may be involved in executing the decision. For
instance, the level of employee dissatisfaction that may be triggered due to an additional
work hours for a special order is not taken into account for computation of relevant cost.
Similarly, accepting a special order on the basis of relevant cost may lead to
dissatisfaction among the old customers and the firm may lose a significant part of its
traditional market share. (nd, 2020)
References
CFI, 2020. Risk. [Online]
Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/risk/
[Accessed 21 May 2021].
nd, 2020. Relevant Costing. [Online]
Available at: https://theintactone.com/2019/06/08/ma-u4-topic-9-concept-of-relevant-costs-
steps-in-decision-
making/#:~:text=Limitation%20of%20relevant%20costing%3A&text=Each%20cost%20item%20
apparent%20or,a%20given%20level%20of%20activity.
[Accessed 21 May 2021].
Sraders, A., 2019. What Is Risk? Definition, Types and Examples. [Online]
Available at: https://www.thestreet.com/markets/what-is-risk-14909043
[Accessed 21 May 2021].
Verma, E., 2021. Financial Risk and its types. [Online]
Available at: https://www.simplilearn.com/financial-risk-and-types-rar131-article
[Accessed 21 May 2021]
CFI, 2020. Risk. [Online]
Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/risk/
[Accessed 21 May 2021].
nd, 2020. Relevant Costing. [Online]
Available at: https://theintactone.com/2019/06/08/ma-u4-topic-9-concept-of-relevant-costs-
steps-in-decision-
making/#:~:text=Limitation%20of%20relevant%20costing%3A&text=Each%20cost%20item%20
apparent%20or,a%20given%20level%20of%20activity.
[Accessed 21 May 2021].
Sraders, A., 2019. What Is Risk? Definition, Types and Examples. [Online]
Available at: https://www.thestreet.com/markets/what-is-risk-14909043
[Accessed 21 May 2021].
Verma, E., 2021. Financial Risk and its types. [Online]
Available at: https://www.simplilearn.com/financial-risk-and-types-rar131-article
[Accessed 21 May 2021]
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