Accounting for Managers: Interpreting accounting information for decision-making

420 ACCOUNTING FOR MANAGERS

10.3
Direct materials and variable costs are relevant costs as they are only incurred if
manufacture takes place. Direct labour is avoidable, i.e. it will only be incurred if Car-
dinal makes the part. As 60% of the fixed costswill continue regardless of the decision,
only 40% of the fixed cost is relevant for thedecision. Therefore, relevant costs of in-house
manufacture:

Direct material £4

Direct labour 16

Variable costs 8

Fixed costs (40% of £10) 4

Total 32 × 20 ,000 units=£640, 000

Relevant costs of outsourcing to Oriole are:

Purchase cost 36 × 20 ,000 units=£720, 000

Consequently, based on relevant costs, it is cheaper to manufacture the part in-house.
Note: the fixed manufacturing overhead of £10 per unit is an arithmetic calculation of
total fixed costs divided by the number of units produced. This doesnotmean that the cost
is a variable cost, just because it isexpressed as a cost per unit.

10.4
The manufactured cost is £235 (120+ 60 + 30 +25). The relevant costs are direct mate-
rials £120 and variable overhead £30, a total of £150. Direct labour and fixed costs
are not relevant. Direct labour cannot be avoided as the business has spare capacity
and wishes to retain its skilled employees. As the cost of purchasing the compo-
nent is £140, on a relevant cost basis Cirrus should buy the component rather than
make it.
10.5

Partners’ cost £200, 000

Total hours 800= £250 per hour

Juniors’ cost £450, 000

Total hours 5, 000 =£90 per hour

See Table A2.9.
Audit services cost £314,500.

Table A2.9

Accounting Audit Tax Total

Partner hours 150 250 400 800

@ £250 37,500 62,500 100,000 200,000

Junior hours 1200 2800 1000 5,000

@ £90 108,000 252,000 90,000 450,000

Total 145,500 314,500 190,000 650,000