RFT, an engineering company, has been asked to provide a quotation for a contract to build a new engine.
The potential customer is not a current customer of RFT, but the directors of RFT are keen to try and win the contract as they believe that this may lead to more contracts in the future. As a result, they intend pricing the contract using relevant costs. The following information has been obtained from a two-hour meeting that the Production Director of RFT had with the potential customer. The Production Director is paid an annual salary equivalent to $1,200 per 8-hour day. 110 square meters of material A will be required. This is a material that is regularly used by RFT and there are 200 square meters currently in inventory. These were bought at a cost of
$12 per square meter. They have a resale value of $10.50 per square meter and their current replacement cost is $12.50 per square meter. 30 liters of material B will be required. This material will have to be purchased for the contract because it is not otherwise used by RFT. The minimum order quantity from the supplier is 40 liters at a cost of $9 per liter. RFT does not expect to have any use for any of this material that remains after this contract is completed. 60 components will be required. These will be purchased from HY. The purchase price is $50 per component. A total of 235 direct labour hours will be required. The current wage rate for the appropriate grade of direct labour is $11 per hour. Currently RFT has 75 direct labour hours of spare capacity at this grade that is being paid under a guaranteed wage agreement. The additional hours would need to be obtained by either (i) overtime at a total cost of $14 per hour; or (ii) recruiting temporary staff at a cost of $12 per hour. However, if temporary staff are used they will not be as experienced as RFT's existing workers and will require 10 hours supervision by an existing supervisor who would be paid overtime at a cost of $18 per hour for this work. 25 machine hours will be required. The machine to be used is already leased for a weekly leasing cost of $600. It has a capacity of 40 hours per week. The machine has sufficient available capacity for the contract to be completed. The variable running cost of the machine is $7 per hour. The company absorbs its fixed overhead costs using an absorption rate of $20 per direct labour hour.
Select ALL the true statements.

• A. The machine is currently being leased and it has spare capacity so it will either stand idle or be used on this work. The lease cost will be a relevant cost or $10 per hour.
• B. The relevant cost is $7080
• C. The relevant cost is $7100
• D. The company absorbs its fixed overhead costs using an absorption rate of $20 per direct labour hour. This is a relevant cost.
• E. The cost for the production director meeting was a relevant cost.
• F. Material B was a relevant cost.
• G. Material A was a relevant cost.
• H. The relevant cost is $7010
• I. The components are to be purchased from HY at a cost of $50 each. This is a relevant cost because it is future expenditure that will be incurred as a result of the work being undertaken.

A major company sells a range of electrical, clothing and homeware products through a chain of department stores. The main administration functions are provided from the company's head office. Each department store has its own warehouse which receives goods that are delivered from a central distribution center.
The company currently measures profitability by product group for each store using an absorption costing system. All overhead costs are charged to product groups based on sales revenue. Overhead costs account for approximately one-third of total costs and the directors are concerned about the arbitrary nature of the current method used to charge these costs to product groups.
A consultant has been appointed to analyses the activities that are undertaken in the department stores and to establish an activity based costing system.
The consultant has identified the following data for the latest period for each of the product groups for the X Town store:

Calculate the total profit for each of the product groups:
.... using the current absorption costing system;

• A. The profit or loss in $ was.... Clothing (175); Electrical 86; Homeware 22
• B. The profit or loss in $ was.... Clothing 122; Electrical 56; Homeware (178)
• C. The profit or loss in $ was.... Clothing 85; Electrical 36; Homeware (28)
• D. The profit or loss in $ was.... Clothing 192; Electrical (56); Homeware 148

PL currently earns an annual contribution of $2,880,000 from the sale of 90,000 units of product B. Fixed costs are $800,000 per annum.
The management of PL is considering reducing the selling price per unit to $48. The estimated levels of demand at the revised selling price and the probabilities of them occurring are as follows:

Calculate the probability that the profit will increase from its current level if the selling price is reduced to $48.

• A. The probability therefore that the contribution will exceed $2,880,000 is 40%.
• B. The probability therefore that the contribution will exceed $2,880,000 is 70%.
• C. The probability therefore that the contribution will exceed $2,880,000 is 50%.
• D. The probability therefore that the contribution will exceed $2,880,000 is 90%.

A medium-sized manufacturing company, which operates in the electronics industry, has employed a firm of consultants to carry out a review of the company's planning and control systems. The company presently uses a traditional incremental budgeting system and the inventory management system is based on economic order quantities (EOQ) and reorder levels. The company's normal production patterns have changed significantly over the previous few years as a result of increasing demand for customized products. This has resulted in shorter production runs and difficulties with production and resource planning.
The consultants have recommended the implementation of activity based budgeting and a manufacturing resource planning system to improve planning and resource management.
Select ALL the benefits for the company that could occur following the introduction of an activity based budgeting system.

• A. Activity based techniques including activity based budgeting focus on the outputs of a process rather than the input to the process. This approach provides a clear framework for understanding the link between costs and the level of activity. It allows the ranking of activities and the determination of how limited resources should be allocated across competing activities.
• B. ABB systems present costs under functional headings i.e. the emphasis is on the nature of the cost. The weakness of this approach is that it gives little indication of the link between the level of activity and the cost incurred.
• C. Activity based budgeting allows the identification of value added and non-value added activities and ensures that cuts are made to non-value added activities. ABB is also useful for review of capacity utilization.
• D. The approach under an activity based system is to make arbitrary cuts in order to meet overall financial targets.
• E. Under an activity based budgeting system the focus is on existing resources and operations. Adjustments are then made for changes in activity and price which results in past inefficiencies being perpetuated.
  Under a traditional budgeting system, only resources that are needed to perform activities required to meet the budgeted production and sales volumes are included.
• F. Under an activity based budgeting system, resource allocation is linked to the strategic plan is prepared after considering alternative strategies. This approach ensures that new activities that are required to meet the company's strategic objectives are included in the budget.