ABMC3084 Information for control and decision making

Tutorial 4: Short Term Decision Making

Question 1: (Make or buy decision with Limiting Factor)

Merryl Ltd manufactures four components (E, F, G and H) which are
incorporated into different products made by the company. All the
components are manufactured using the same general purpose machinery.

The following production cost and machine hour data are available:
E F G H
Variable production cost (RM per unit) 32 27 34 35
Fixed production cost (RM per unit) 6 14 8 16
General purpose machine hours per unit 5 6 7 8

The fixed production costs represent a share of factory-wide costs that have
been related to the individual components by using a direct labour hour rate.
There are no fixed costs which can be specifically related to individual
components.
From next month the company’s monthly manufacturing requirements are
for 2,000 units of each component. The maximum number of machine hours
available for component manufacture is 35,000 per month.

The company can purchase any quantity of each component from Sergeant
Ltd at the following unit prices next month:
E F G H
RM48 RM51 RM55 RM63
Merryl Ltd aims to minimise its monthly costs.

Required:
a) Calculate the shortfall in general purpose machine hours next month.
(Answer: 1,700 hrs)
b) Determine how many units of which components should be purchased
from Sergeant Ltd next month.

ANSWER: E F G H

Ranking (Buy) 2ND 4th 1st 3rd

Optimal buy-Units 600 - 2,000 -

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c) Briefly explain THREE other factors that the management of Merryl Ltd
should consider before making a final decision to buy in components
from Sergeant Ltd for next month.

Question 2: Relevant Costing

JB Limited is a small specialist manufacturer of electronic components and
much of its output is used by the makers of aircraft for both civil and
military purposes. One of the few aircraft manufacturers has offered a
contract to JB limited for the supply, over the next twelve months, of 400
identical components.

The data relating to the production of each component is as follows:

i) Material requirements:
3 kg material M1 – see note 1 below
2kg material P2 – see note 2 below
1 Part No.678 – see note 3 below

Note 1:
Material M1 is in continuous use by the company. 1,000 kg are
currently held in stock at a book value of RM4.70 per kg but it is
known that future purchases will cost RM5.50 per kg.

Note 2:
1,200 kg of material P2 are held in stock. The original cost of this
material was RM4.30 per kg but as the material has not been required
for the last two years it has been written down to RM1.50 per kg scrap
value. The only foreseeable alternative use is as a substitute for
material P4 (in current use) but this would involve further processing
costs of RM1.60 per kg. The current cost of material P4 is RM 3.60
per kg.

Note 3:
It is estimated that Part No. 678 could be bought for RM 50 each.

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ii) Labour requirements:

Each component would require five hours of skilled labour and five
hours of semi-skilled. An employee possessing the necessary skills is
available and is currently paid RM5 per hour.
A replacement would, however, have to be obtained at a rate of RM4
per hour for the work which would otherwise be done by the skilled
employee. The current rate for semi-skilled work is RM3 per hour and
an additional employee could be appointed for this work.

iii) Overhead:
JB limited absorbs overhead by a machine hour rate, currently RM20
per hour of which RM7 is for variable overhead and RM13 for fixed
overhead. If this contract is undertaken it is estimated that fixed costs
will increase for the duration of the contract by RM 3,200.
Spare machine capacity is available and each component would
require four machine hours.

A price of RM145 per component has been suggested by the large

company which makes aircraft.

Required:
a) State whether or not the contract should be accepted and support your
conclusion with appropriate figures for presentation to management.
(Answer: Accept the contract= RM 1,400 contribution)

b) Comment briefly on three factors which management ought to consider

and which may influence their decision.

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Question 3: Relevant Costing

The production manager of your organisation has approached you for some
costing advice on project X, one-off order from overseas that he intends to
tender for.

The costs associated with the project are as follow:

RM
Material A 4,000
Material B 8,000
Direct labour 6,000
Supervision 2,000
Overheads 12,000
32,000

You have ascertained the following:

1. Material A is in stock and above was the cost. There is now no other use
for material A, other than the above project, within the factory and it
would cost RM1,750 to dispose of. Material B would have to be ordered
at the cost shown above.

2. Direct labour costs of RM6,000 relate to workers that will be transferred

to this project from another project. Extra labour will need to be recruited
to the other project at a cost of RM7,000.

3. Supervision costs have been charged to the project on the basis of 33 1/3 %
of labour costs and will be carried out by existing staff within their
normal duties.

4. The company is currently operating at the rate of 200% on direct labour.

5. The company is currently operating at a point above break-even.

6. The project will need the utilisation of machinery that will have no other
use to the company after the project has finished. The machinery will
have to be purchased at a cost of RM10,000 and then disposed of for
RM5,250 at the end of the project.

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The production manager tells you that the overseas customer is prepared to
pay up to a maximum of RM30,000 for the project and a competitor is
prepared to accept the order at that price.
He also informs you the minimum that he can charge is RM40,000 as the
above costs show RM32,000 and this does not take into consideration the
cost of machine and profit to be taken on the project.

Required:
a) Cost the project for the production manager, clearly stating how you have
arrived at your figures and give reasons for the exclusion of other figures.
(Answer: Relevant cost= RM18,000, contribution =RM12,000,
OK to accept at RM30k contract)

b) Write a report to the production manager stating whether the organisation

should go ahead with the tender for the project, the reasons why and the
price, bearing in mind that the competitor is prepared to undertake the
project for RM30,000.
Note: the project should only be undertaken if it shows a profit.

c) State FOUR non-monetary factors that should be taken into account

before tendering for this project.

d) What would be your advice if you were told that the organisation was
operating below breakeven point ?
Give reasons for your advice.

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Question 4:
A factory manager is preparing the production plan for the next quarter
ending 31 March 2013. One of the major components manufactured in this
factory is component C121. The following relates to the budgeted cost of
manufacturing 1,200 units of component C121:

RM per unit
Direct material 28
Direct labour - skilled 24
- unskilled 15
Variable overheads 10
Fixed overheads 20

The factory manager has received an offer from a supplier that can supply
1,200 units of this component at a price of RM78 per unit.

The management accountant has informed the factory manager that 60% of
the fixed overheads of component C121 represents absorbed fixed cost. The
remainder 40% of the fixed overheads is avoidable if component C121 is not
manufactured.

Required:

Advise the factory manager whether or not to purchase component C121

from the supplier. Show relevant workings to support your answer.

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Question 4:
Component C121: RM RM

Relevant cost of buying[1,200 x RM78] 93,600

Less: Relevant cost of making

Direct material [1,200 x RM28] 33,600
Direct labour
- Skilled [1,200 x RM24] 28,800
- Unskilled [1,200 x RM15] 18,000
Variable overhead[1,200 x RM10] 12,000
Avoidable fixed cost[1,200 x RM20 x 40%] 9,600
102,000
Total cost savings if bought 8,400

The factory manager is advised to buy 1,200 units of component C121 from the supplier
as this would result in cost savings of RM8,400.