The management of Springs pk is considering next year's pro­ duction and purchase budgets. One of the components produced by the company, which is incorporated into another product before being sold, has a budgeted manufacturing cost as follows:

Direct materials

Direct labour (4 hours at £6 per hour) Variable overhead (4 hours at £4 per hour) Fixed overhead (4 hours at £5 per hour)

£
20
24
16
20
80 per unit

Trigger pk has offered to supply the above component at a guaranteed price of £70.

You are required to:

(a) Considering cost criteria only, advise management whether the above component should be purchased from Trigger pie. Any calculations should be shown and assumptions made, or aspects which may require further investigation, should be clearly stated.

(b) Explain how your above advice would be affected by each of the two separate situations shown below:

(i) As a result of recent government legislation, if Springs pie continues to manufacture this component the company will incur additional inspection and testing expenses of £60,000 per annum. These additional expenses are not included in the above budgeted manu­facturing costs.

(ii) Additional labour cannot be recruited and if the above component is not manufactured by Springs pie, the direct labour released will be employed in increasing the pro­ duction of an existing product which is sold for £140 and which has budgeted manufacturing cost as follows:

£
Direct material 20
Direct labour (8 hours at £6 per hour) 48
Variable overhead (8 hours at £4 per hour) 32
Fixed overhead (8 hours at £5 per hour) 40
140 per unit

(c) The Production Director of Springs pie recently said: 'We must continue to manufacture the component as only one year ago we purchased some special grinding equipment to be used exclusively by this component. The equipment cost £100,000, it cannot be resold or used elsewhere and if we cease production of this component we will have to write off the written down book value which is £80,000.'

Draft a brief reply to the Production Director commenting on his statement.

(This is a modified ACCA question.)