Essential Beauty Group was established in 1985. The company manufactures and sells electronic personal grooming and beauty products

Essential Beauty Group was established in 1985. The company manufactures and sells electronic personal grooming and beauty products. The group has two Divisions: Division 1 and Division 2. Division 1 manufacturers luxury products that cater to niche customers who prefer specialised personal grooming and beauty care. Division 2 caters to regular daily beauty and grooming requirements that has a wide reach within the market. Factories of both divisions are located in India. The products are sold to wholesalers, who supply these products to the retail market. Essential beauty group purchases its raw material requirements from both domestic and overseas markets. Additionally, certain products manufactured by Division 1 can be enhanced based on the products manufactured by division two. Therefore, as per production requirements, Division 1 sources some product components from division 2. Essential beauty group has a centralised decision-making set-up. Basic policy decisions for functions such as production planning, sales and client relationship, finance and human resources are handled at the corporate head office. Divisions 1 and 2 concentrate on the manufacturing alone.

You are an assistant manager in Accounting and Finance department of Essential Beauty Group. You report to Laura, the manager of Accounting and Finance department. Sometimes you are also asked to assist Fiona (the director of Accounting and Finance department) in analysing financial and non-financial information, drafting reports for board meetings, preparation of presentation and staff trainings.

Yesterday, 5:15 PM

You got an email from Fiona with Cc to Laura. Fiona asked you to prepare a cost statement containing information which is relevant for making a quotation to a new customer. She has also informed you that the customer can also maintain a long-term business relation with the company. You have been requested to gather information related to the specification from Sales Manager.

Yesterday, 5:25 PM

You were called for a meeting by Laura where she provided the product specification received from Sales Manager for which you’ve been asked to create a cost statement. Laura has also requested you to gather relevant information to prepare the cost statement due to the expected long term business relationship that Division 1 wants to have with the customer, the sales manager wants to quote the lowest possible price. Division 1 currently has some spare capacity that can be utilised to cater to this entire order. After meeting with your reporting manager, you mailed to various departments to seek further data.

Today, 10:05 AM

You got an email from production manager informing that 40 kilos of material DX would be required for this contract. This material is in regular use by Division 1 and has a current purchase price of ₹1 3,800 per kilo. Currently, there are five kilos in inventory which costs ₹3,500 per kilo. The resale value of the material in inventory is ₹2,400 per kilo. Further, with regards to components, it has been informed that 4,000 components would be required. These could be bought externally for ₹150 each or alternatively they could be supplied by Division 2. The variable cost of the component if it were manufactured by division two would be ₹80 per unit. Division 2 has sufficient capacity to produce 2,500 components without affecting its ability to satisfy its own external customers. However, in order to make the extra 1,500 components required by Division 1, Division 2 would have to forego other external sales of ₹500,000 which would have a contribution to sales ratio of 40%. To have uniformity in the quality of the components, it is assumed that Division 1 would procure its entire requirement of 4,000 components either externally or from Division 2. You were also informed that 2,000 hours of highly skilled labour time would be required for this contract.

Today, 10:45 AM

You got an email from HR manager informing that space the grade of labour required is currently paid at ₹500 per hour. Highly skilled labour is in short supply and cannot be increased significantly in the short term. This labour is presently engaged in meeting the demand for product G which requires 4 hours of highly skilled labour per unit. The contribution from sale of each unit of product G is ₹2,400. It has also been informed that the contract for the new customer would require a special machine. The machine could be hired at ₹150,000 or it could be bought for ₹500,000. If the machine was bought, it could be sold at the end of the contract for ₹300,000. Alternatively, it could be modified at the cost of ₹50,000 and then used on other contracts instead of buying another essential machine (for those other contracts) that would cost ₹450,000. The operating cost of the machine are payable by division 1 irrespective whether it hires or buys the machine. These costs would total ₹120,000 in respect of the new contract.

Supervisor

The contract would be supervised by an existing manager who is paid an annual salary of ₹500,000 and has sufficient capacity to carry out the supervision. The manager would receive a bonus of ₹50,000 for this additional work.

Development time

15 hours of development time at a cost of ₹30,000 have already been worked in determining the resource requirements of the contract. Fixed overhead absorption rate Division 1 uses an absorption rate of ₹20 per direct labour hours to recover its general fixed overhead costs. This includes ₹5 per hour for depreciation.

Required

(1) Analyse the case facts to determine the relevant cost of the contract to Essential Beauty Group. You must present your answer in a schedule that clearly shows the relevant cost value for each of the items identified. Clearly explain how you determined each relevant cost value you have included in your schedule. List any items that you have not considered to be relevant for this analysis and explain your rationale for considering them to be irrelevant.

(2) Discuss TWO key problems that may arise for Essential Beauty Group as a result of setting prices using relevant costing