Free Accounting Dissertations - Even If We Assume That Turc Has Already Hired The Labour And Has No
Even if we assume that Turc has already hired the labour and has no alternative use of it for the time being, the cost of material itself is more than the sales.
Turc may use the order to develop expertise in special manufacturing. So it might accept the order for strategic reasons. Successful completion of this order might lead to subsequent placement of large order by the same customer. Increased economies of scale at higher orders will probably lead to lower direct material and labour costs. Also if it has no other alternative use of labour in the time being, removal of labour costs from the contribution makes the negative contribution quite less.
Turc should also compare the contribution from this order against any other alternative order.
Table 6 shows the contribution of the current facility of 100,000 units
Table 6
In $
Sales
15,000,000
Variable costs
Material
-1,600,000
Labour
-2,400,000
Indirect costs
-1,500,000
-5,500,000
Contribution
9,500,000
Since the existing facility of 100,000 units has a positive contribution, Turc should not accept the new order against the existing facility.
3.
Annexure I shows the NPV calculations for proposals S,A and M. Both proposals S and A have negative NPV of -$23,193 and -$21,386 respectively. Only proposal M has a positive NPV of $210,843. So Hovana should select proposal M.
4.
The management should evaluate whether it can successfully pass on the increased costs to the buyers or not. This will depend on a large number of factors including the capacity of the industry, average financial gearing, and availability of substitutes. Customers don’t like to see increased prices. The management should undertake a detailed study of each cost component of the product.
Management should use contribution approach to highlight the impact of each cost element. Contribution approach is a method of internal reporting that emphasizes the distinction between variable and fixed costs. By segregating variable costs, management can see whether the product still makes positive contribution in face of higher variable costs or not. If the product doesn’t make positive contribution, then the firm should stop making products or else look at each component of cost for reduction.
Activity based costing assigns the costs of activities to the products and services that caused the activity ((Horngren, Sundem & Stratton, 1999). Managers should identify significant overhead activities and then the costs of overhead resources used to perform these activities are traced to the activities using the most appropriate cost drivers.
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