Trinco Ltd (Trinidad & Tobago-T&T) has been negotiating a contract with the potential customer in the Jamaica. Before negotiations started the Jamaican company accepted to pay $10,000 in advance to cover the expenditures of Trinco. These expenditures were to cover the costs of sending out technical staff to the Jamaica. This is the first export order the company has obtained since 1988. Regrettably, the previous export orders weren’t profitable and managers decided the best policy was to concentrate on business in T&T.
The sales department has made a statement presentation that the contract will make a profit. It is normal for the sales department to prepare cost estimates as they have a lot of knowledge of this type of work.
Occasionally the management accountant will also be asked to comment on estimates made by the sales department. As this order is different and might lead to a lot more business in the prospect the senior managers asked the management accountant to comment on the statement, shown below.
Statement prepared by sales department
Sales - including deposit of $20,000 (see note 1) 250,000
Labour (see note 2) 85,000
Supervisor (see note 3) 15,000
Design overheads (see note 4) 2,000
Administrative charge (see note 5) 25,000
Materials (see note 6) 110,000
Depreciation on machinery (see note 7) 5,000
After her exploration the management accountant made a concise report. The main points are summarised below.
Comments from management accountant
Note1. The deposit will not have to be refunded.
Note2. The labour costs comprise $15,000 of costs for work that has already been acquired. This is the cost of sending engineers to Jamaica to assist with the negotiations.
Note3. This is 50% of the cost of a supervisor. It is estimated that the supervisor will pay out about half his time on contract. This cost doesn’t include a $2,000 bonus for the supervisor if the contract is completed on time.
Note4. These costs have already been acquired.
Note5. This charge is equivalent to 10% of sales. This is levied on all contracts to cover general administrative costs.
40,000kg of material X at $1.5 per kg = $60,000
20,000kg of material Y at $2.50 per kg = $50,000
Material X is used regularly by company. There is 20,000kg in stock excluding the market price has just raised to $2 per kg.
Material Y is never employed by the company. There is 30,000kg in stock that cost $2.50 per kg. To buy it today would cost $4 per kg. An alternative choice for the company is to sell it for scrap at $2.10 per kg.
Note7. Depreciation has been computed at $5,000. However the management accountant discovers that this charge is for a machine that is currently not employed. The management accountant has received an offer of $100,000 for the machine now but if the project goes ahead it will only be sold for $50,000 at the end of the project.
The statement above doesn’t include the cost of additional training if the contract goes ahead. The cost of the training has been estimated at $10,000.
Advise managers whether or not this contract is profitable. All assumptions should be clearly stated.
Identify and find out any additional information that managers require to consider before accepting or rejecting this contract