TrinJam (TJ) is a company building eco-friendly houses using energy saving techn
ID: 2568025 • Letter: T
Question
TrinJam (TJ) is a company building eco-friendly houses using energy saving technology. TJ has been asked to provide a quotation to build a pilot house in a housing development. Management of TJ believes that securing the contract will help to launch their houses and have agreed to quote a price for the house that will exactly cover its relevant cost
The following information has been obtained in relation to the contract:
1. The Chief Executive recently met with the potential client to discuss the house. The meeting was held at a restaurant and TJ provided food and drinks at a cost of $375.
2. 1,200 kg of Material Z will be required for the house. TJ currently has 550 kg of Material Z in its inventory purchased at a price of $58 per kg. Material Z is regularly used by TJ in its houses and has a current replacement cost of $65 per kg. The resale value of the Material Z in inventory is $35 per kg.
3. 400 hours of construction worker time are required to build the house. TJ’s construction workers are paid an hourly rate of $22 under a guaranteed wage agreement and currently have spare capacity to build the house.
4. The house will require 90 hours of engineer time. TJ engineers are paid a monthly salary of $4,750 each and do not have any spare capacity. In order to meet the engineering requirement for the house, TJ can choose one of two options:
(i) Pay the engineers an overtime rate of $52 per hour to perform the additional work.
(ii) Reduce the number of engineers’ hours available for their existing job, the building of Product Y. This would result in lost sales of Product Y.
Summary details of the existing job the engineers are working on:
Information for one unit of Product Y
Sales revenue $4,860
Variable costs $3,365
It takes 30 Hrs to produce a unit of product Y
5. A specialist machine would be required for 7 weeks for the house build. TJ has 4 weeks remaining on the 15 week specialist machine rental contract that cost $15,000. The machine is currently not in use. The machine can be rented for an additional 15 weeks at a cost of $15,250. The specialist machine can only be rented in blocks of 15 weeks.
Alternatively, a machine can be purchased for $160,000 and sold after the work on the house has been completed for $140,000.
6. The windows required for the house have recently been developed by TJ and use the latest eco friendly insulating material. TJ produced the windows at a cost of $34,950 and they are currently the only ones of their type. TJ were planning to exhibit the windows at a house building conference. The windows would only be used for display purposes at the conference and would not be for sale to prospective clients.
TJ has had assurances from three separate clients that they would place an order for 25 windows each if they saw the technology demonstrated at the conference. The contribution from each window is $10,450. If the windows are used for the contract, TJ would not be able to attend the conference. The conference organisers will charge a penalty fee of $1,500 for non-attendance by TJ. The CEO of TJ can meet the clients directly and still secure the orders for the windows. The meetings would require two days of the CEO’s time. The CEO is paid an annual salary of $414,000 and contracted to work 260 days per year.
7. The house build requires 400kg of other materials. TJ currently has none of these materials in its inventory. The total current purchase price for these other materials is $6,000.
8. TJ’s fixed overhead absorption rate is $37 per construction worker hour.
9. TJ’s normal policy is to add a 12% mark-up to the cost of each house.
Required:
(a) Produce a schedule that shows the minimum price that could be quoted for the contract to build the house. Your schedule should show the relevant cost of each of the nine items identified above. You should also explain each relevant cost value you have included in your schedule and why any values you have excluded are not relevant. (16 marks)
(b) Explain TWO reasons why relevant costing may not be a suitable approach to pricing houses in the longer term for TJ. (2 marks)
(c) Recommend, with justifications, a pricing strategy for TJ to use to price the innovative, eco-friendly houses when they are launched. (2 marks)
Explanation / Answer
POINT NO
DESCRIPTION
RELEVANT COST
REASON
1
MEETING WITH POTENTIAL CLIENT
NIL
AS THE MEETING IS ALREADY HELD, AND THE COST IS INCURRED IT IS SUNK COST. AND SUNK COSTS ARE NOT RELEVANT COSTS.
2
MATERIALS COST
1200KG * $65 = $78000
AS MATERIAL Z IS REGULARLY USED BY COMPANY, THE COMPANY WILL HAVE TO BUY NEW MATERIAL IF IT USES THE CURRENT STOCK. HENCE THE RELEVANT COST WOULD BE THE REPLACEMENT COST, i.e. $65
3
LABOUR COST
NIL
AS THE COMPANY HAS SPARE CAPACITY, COMPANY WILL HAVE TO INCUR NO EXTRA COST FOR THE SAME.
4
ENGINEER’S COST
$4485
REFER WORKING NOTE 1
5
SPECIALIST MACHINE
$15250
REFER WORKING NOTE 2
6
WINDOW SALE
$ 1500
REFER WORKING NOTE 3
7
PURCHASE OF OTHER MATERIALS
$6000
AS THE COMPANY HAS NO STOCK OF THESE MATERIALS, IT WILL BE A RELEVANT COST
8
OVERHEAD COSTS
NIL
AS THE OVERHEAD COSTS ARE FIXED COSTS AND ARE NOT INFLUENCED BY EXECUTION OR NON- EXECUTION OF PROJECT, THEY ARE NOT RELEVANT COSTS
9
MARKUP
NIL
AS TJ HAS AGREED TO QUOTE A PRICE THAT WILL EXACTLY COVER ITS RELEVANT COST, IT WILL NOT BE RELEVANT COST. (HOWEVER DIFFERENCE OF OPINION MAY EXIST.)
TOTAL
105235
WORKING NOTES:
(1)
(i) IF THE COMPANY CHOOSES TO PAY AT OVERTIME RATE TO ENGINEERS
TOTAL COST = $52 * 90 HOURS = $4680
(ii) IF THE COMPANY CHOOSES TO REDUCE THE NUMBER OF HOURS AVAILABLE FOR PRODUCT Y
NUMBER OF UNITS OF PRODUCT Y SALES FORGONE = 90 HOURS / 30 HOURS = 3 UNITS
i.e. HOURS REQUIRED BY CURRENT PROJECT / HOURS REQUIRED PER UNIT BY PRODUCT Y
TOTAL COST = CONTRIBUTION FORGONE = 3 UNITS * ($4860 SALES PRICE - $3365 VARIABLE COST)
= $4485
HENCE THE LOWER OF THE TWO OPTIONS IS $4485
(2)
GIVEN THE SITUATION THE COMPANY REQUIRES SPECIALIST MACHINE FOR 3 WEEKS IN ADDITION TO SPARE CAPACITY OF 4 WEEKS.
IF RENTING OPTION IS USED, THE COST WOULD BE $ 15250
AND IF PURCHASE OPTION IS USED, THE COST WOULD BE ($160000 - $140000) =$20000
HENCE, THE LOWER OF THE TWO, RENTING OPTION WOULD BE CHOSEN AND $ 15250 WILL BE THE RELEVANT COST
(3)
IN ORDER TO USE WINDOWS FOR THE PROJECT THE COMPANY HAS TO LET THE CONFERENCE BE UNATTENDED.
NOW FURTHER THE COMPANY HAS TWO OPTIONS, i.e. TO LET GO THE CONTRACT OR TO SECURE ORDERS THROUGH CEO.
AS THE CEO IS PAID ANNUALLY, THERE WILL BE NO INCREMENTAL COSTS TO THE COMPANY IF CEO MEETS THE CLIENT TO SECURE ORDERS.
HENCE THE COMPANY WILL CHOSE TO SECURE ORDERS THROUGH CEO AND THE ONLY COST THAT IT WILL HAVE TO INCURR IS NOW OF THE PENALTY COST FOR NON-ATTENDANCE OF MEEETING. i.e. $1500
2. THE RELEVANT COSTING MAY NOT BE SUITABLE FOR LONG TERM, BECAUSE
- IN LONG TERM THE COMPANY HAS TO COVER ITS OVERHEAD AND OTHER FIXED COSTS FROM THE PROJECT, AND IN THAT CASE THE RELEVANT COSTING MAY NOT BE USEFUL.
POINT NO
DESCRIPTION
RELEVANT COST
REASON
1
MEETING WITH POTENTIAL CLIENT
NIL
AS THE MEETING IS ALREADY HELD, AND THE COST IS INCURRED IT IS SUNK COST. AND SUNK COSTS ARE NOT RELEVANT COSTS.
2
MATERIALS COST
1200KG * $65 = $78000
AS MATERIAL Z IS REGULARLY USED BY COMPANY, THE COMPANY WILL HAVE TO BUY NEW MATERIAL IF IT USES THE CURRENT STOCK. HENCE THE RELEVANT COST WOULD BE THE REPLACEMENT COST, i.e. $65
3
LABOUR COST
NIL
AS THE COMPANY HAS SPARE CAPACITY, COMPANY WILL HAVE TO INCUR NO EXTRA COST FOR THE SAME.
4
ENGINEER’S COST
$4485
REFER WORKING NOTE 1
5
SPECIALIST MACHINE
$15250
REFER WORKING NOTE 2
6
WINDOW SALE
$ 1500
REFER WORKING NOTE 3
7
PURCHASE OF OTHER MATERIALS
$6000
AS THE COMPANY HAS NO STOCK OF THESE MATERIALS, IT WILL BE A RELEVANT COST
8
OVERHEAD COSTS
NIL
AS THE OVERHEAD COSTS ARE FIXED COSTS AND ARE NOT INFLUENCED BY EXECUTION OR NON- EXECUTION OF PROJECT, THEY ARE NOT RELEVANT COSTS
9
MARKUP
NIL
AS TJ HAS AGREED TO QUOTE A PRICE THAT WILL EXACTLY COVER ITS RELEVANT COST, IT WILL NOT BE RELEVANT COST. (HOWEVER DIFFERENCE OF OPINION MAY EXIST.)
TOTAL
105235
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