5 the equipment to be used on the contract cost 80000

5. The equipment to be used on the contract cost £ 80,000 five years ago. It was
planned to keep it for ten years after which its scrap value was expected to be
£ 10,000. The depreciation charge in the cost estimate is based on this data. At
present, the equipment is worth £ 30,000. If used on the contract, its realisable
value is likely to decline to about £ 28,000. The company has no further use for
the equipment and, if the contract is not accepted, they would sell it now.
6. The new contract is so specialised that it has now been realised that one of the
supervisors will have to be recruited from a competitor. She will be expected to
be paid a premium salary of £ 2,000 per month. The second supervisor, who is
currently paid £ 1,000 per month, can be transferred from another department.
However, he will only transfer to the project if he is offered a one-off bonus
payment of £ 500. His role will be replaced by a temporary upgrading of an
existing worker which is estimated to cost an additional £ 200 per month.
7. The management accountant has allowed fixed overheads for the contract using
the company’s pre-determined policy of 40% of direct labour. The general fixed
overhead recovery rate consists of allocated rent, rates, general expenses and
similar fixed costs. However, it is anticipated that this additional contract
would make general expenses increase by £ 500 per month for the duration of
the contract.
Required:
(a) Define opportunity cost.
(2 marks)
(b) Prepare a revised cost estimate for the contract in the light of the above
information. Clearly explain for each item why your calculations differ from the
original estimate submitted by the management accountant.
(19 marks)
(c) Identify two other considerations which should be taken into account in
deciding whether to tender for the contract.
(4 marks)
Reading for this question
Subject guide, Chapter 10.
Perks, R. and D. Leiwy (2013), Chapter 17.
23

AC1025 Principles of accounting
Approaching the question
Relevant and opportunity cost recognition are key techniques in short-term decision-making. This
question tested candidates’ ability to apply these techniques. It is important when answering
such questions that candidates keep in mind the basic contribution approach to the analysis, and
clearly distinguish between those costs and revenues that are relevant to the decision and those
that are not. Good answers would set out the computations in a clear, logical and coherent way.
Candidates should note that the question required a full explanation of the figures used in the
analysis and marks were awarded as appropriate.
(a) This question was a straightforward textbook explanation of terms.
Opportunity cost – ‘maximum contribution foregone by using scarce resources for an
alternative purpose’.
(b)
Curan plc £
Revised cost estimate
Direct materials – A 4,800
– B 6,400
– C 2,000
Direct labour 14,000
Variable overhead – Incremental 3,000
Depreciation 2,000
Supervisors 7,100
General overhead 1,500
Revised cost 40,800
Explanations
Material A – Past cost is irrelevant. Alternative use saves £ 4,800, which is higher than sale
value of £ 4,000.