Micro Limited has some spare capacity. It is now considering whether it should accept a special contract to use some of the spare capacity. However, this contract will use some specialist direct labour that is in short supply. The following details relate to the proposed contract:

Question

	£000
Contract price	50
Variable costs:
Direct materials	10
Direct labour	30

In order to complete the contract, 4000 direct labour hours would be required. The company’s budget for the year during which the contract would be undertaken is as follows:

	£000
Sales	750
Variable costs	(500)
Contribution	250
Fixed costs	(230)
Profit	20

There would be 50,000 direct labour hours available during the year.

Required:
Determine whether the special contract should be accepted.

Accepted Answer

A special contract for Micro Limited:

Budgeted contribution per unit of limiting factor for the year:

[latex]\frac{£250000}{50000} = £5 per direct labour hour[/latex]

Contribution per unit of limiting factor for the special contract:

	£	£
Contract price		50000
Less: Variable costs:	10000
Direct materials
Direct labour	30000	40000
Contribution		10000

Therefore contribution per unit of limiting factor:

[latex]\frac{£10000}{4000 DLH } =£2.50 per direct labour hour[/latex]

Conclusion:
The special contract earns less contribution per unit of limiting factor than does the average of ordinary budgeted work. It may be profitable to accept the contract if either it displaces less profitable work or surplus direct labour hours are available. A careful assessment should be undertaken to ascertain whether much more profitable work would be found than is the case with the contract if it will displace other more profitable contracts that could arise in the near future.

Question 18.TQ.4 : Micro Limited has some spare capacity. It is now considering...

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