Question Tag: Differential Cost

Semenhyia Ltd is involved in the design and manufacture of custom-built factory equipment. The company has just received an enquiry about the supply of 10 machines from one of their regular clients, Kukua Ltd.

Kukua Ltd has informed the company that the maximum price they are willing to pay is GH¢5,200 per machine. The order would need to be completed within two weeks.

The following details relate to the production of the machines:

i) Materials per machine:

• 10 units of Material A, which is used regularly by the company. The company has 120 units of Material A in stock, which originally cost GH¢120 per unit. The replacement cost of Material A is 20% higher than the original price.
• 5 units of Material B. The company has 40 units of Material B in stock, as it was purchased a few years ago for use in the production of other equipment, which the company no longer produces. If this material is not used in the production of this order, it would never be used again. The original purchase price for Material B was GH¢190 per unit. The replacement cost is GH¢150 per unit, and the net realizable value is GH¢130 per unit.
• 3 units of Material C. This material is used regularly and usually costs GH¢85 per unit. However, the earliest delivery time for new stock from the regular supplier is three weeks. An alternative supplier could deliver immediately but would charge GH¢90 per unit. Semenhyia Ltd has 600 units in stock, but 580 units are required to complete other orders over the next two weeks.

ii) Labour hours per machine:

• 12 skilled labour hours, paid GH¢20 per hour. Skilled workers are part of the permanent workforce, with 125 surplus skilled hours available per month. Skilled workers are paid time and a half for overtime.
• 22 unskilled labour hours, paid GH¢15 per hour, employed on a casual basis.

iii) Supervision: A supervisor currently paid GH¢56,500 per annum will oversee the project, but a replacement will be hired for the duration of the contract at a cost of GH¢8,500.

iv) Machine hours: Each machine requires 18 hours of processing time on factory equipment. If the order is not accepted, the equipment would be subcontracted to Fimi Ltd for a contribution of GH¢70 per hour.

v) Depreciation: The depreciation charge for using the equipment for this order would be GH¢4,000.

vi) Overheads: Overheads are absorbed at a rate of GH¢35 per skilled labour hour.

vii) Estimate costs: The planning department has incurred costs to date of GH¢600.

Required:

a) Explain relevant cost and state TWO (2) examples of relevant cost in short-term decision-making. (3 marks)

b) Determine, using relevant costing principles, whether or not Semenhyia Ltd should undertake the contract. Your answer must include an explanation for the inclusion or exclusion of each of the above points. (13 marks)

c) Distinguish between “marginal cost” and “differential cost”. (4 marks)