Page 157 - Microsoft Word - 00 Prelims.docx

Relevant costing

One off contracts

When a business is presented with a one-off contract, it should apply
relevant costing principles to establish the cash flows associated with
the project in order to help set a price.

Minimum contract price = total net relevant cash flow associated
with the contract.

11.1 Comments on the method used

 The minimum price is effectively a break-even price, so will give the firm no
gain or loss.

 If the contract price does not cover these cash flows then it should be
rejected as the company will have less cash if it accepts the contract.

 Any price higher than the minimum will mean that the company is better-off
accepting the contract than rejecting it.

11.2 Further considerations

 The price may be acceptable for a one-off contract but not for pricing all
contracts and products – for example, when viewing a one-off contract fixed
costs will probably be ignored as unavoidable. However, if every manager
ignores fixed costs, then the company will end up making a loss.

 The minimum price obtained using relevant costing may be much lower than
typical market prices. A firm may thus be reluctant to accept this price if it
might affect the prices of other contracts in the future – for example, other
customers may hear about the low prices offered and demand similar lower
prices on their contracts.

 On the other hand a company may be willing to accept a loss on this contract
if it increases the chances of winning subsequent contracts (albeit at what
price?).

151