Cost classification for an export bid at Konark Furniture Works
Konark Furniture Works, a partnership in Bhubaneswar, makes 400 wooden chairs a month and is bidding for a 100-chair export order that would use existing idle capacity. The current domestic selling price is Rs 2,500 per chair. The owner supplies the following monthly cost data: teak wood Rs 1,200 per chair; glue, nails and polish Rs 25 per chair; carpenters' wages Rs 350 per chair; supervisor's salary Rs 40,000; factory rent Rs 25,000; depreciation on an old lathe Rs 8,000 (book value Rs 60,000, no resale value); electricity Rs 18,000, of which 80% is machine-related; sales commission 5% of selling price; packing for the export order Rs 60 per chair; idle-time wages Rs 4,500 caused by a power cut. The export customer will collect the chairs, so no domestic selling commission applies. The owner asks whether the old lathe depreciation and supervisor salary should enter the export quotation and how the costs should be classified.
1. Classify the costs in the setup by traceability (direct/indirect) and by behaviour (fixed/variable/semi-variable). State any item whose classification depends on accounting policy.
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| Cost | Traceability | Behaviour | Reason |
|---|---|---|---|
| Teak wood | Direct | Variable | Traceable to each chair and varies with output |
| Glue, nails, polish | Direct if traceable; often indirect | Variable | Small value, but can be measured per chair |
| Carpenters' wages | Direct | Variable | Paid for chair production |
| Supervisor's salary | Indirect | Fixed | Common factory cost, unchanged in the short run |
| Factory rent | Indirect | Fixed | Capacity cost |
| Depreciation on old lathe | Indirect | Fixed | Allocation of historical cost; sunk |
| Electricity | Indirect unless sub-metered | Semi-variable | 80% machine-related, 20% standing charge |
| Sales commission | Indirect selling | Variable | 5% of domestic selling price |
| Export packing | Direct for the order | Variable | Caused specifically by the export order |
| Idle-time wages | Indirect | Fixed/abnormal | Not caused by good output; due to power cut |
The key judgement is glue and nails: they are traceable but often treated as indirect because the effort of measurement exceeds the benefit. The export packing is direct because it is incurred only for that order.
2. Identify the sunk cost and the opportunity cost in the export decision, and explain how each should be treated in the quotation.
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The sunk cost is the book value of the old lathe, Rs 60,000, and the related depreciation of Rs 8,000 a month. The money has already been spent and cannot be recovered; resale value is nil. Historical-cost depreciation should therefore not be included as a future incremental cost of the export order. However, if the Rs 8,000 represents a genuine future replacement provision needed because the lathe will wear out faster, that future outlay is relevant.
The opportunity cost is the contribution forgone from the best alternative use of the capacity. The setup says there is idle capacity, so the opportunity cost is normally zero. If the 100 chairs would displace domestic sales, the opportunity cost would be the domestic contribution per chair, roughly selling price Rs 2,500 less relevant variable cost. The owner should include that forgone contribution in the quotation only if domestic sales would actually be lost.
3. The owner wants to quote full cost plus 10%. Explain the danger and compute a relevant-cost floor per chair, stating assumptions.
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Full cost plus 10% is dangerous here because the allocated fixed costs, rent, supervisor salary and historical depreciation are already recovered from domestic sales. Adding them to the export bid can make the price uncompetitive and lose a profitable contribution. The export order should be judged on incremental cost and contribution, subject to any long-term price effect.
A reasonable relevant-cost floor is:
| Item | Rs per chair |
|---|---|
| Teak wood | 1,200 |
| Glue, nails and polish | 25 |
| Carpenters' wages | 350 |
| Export packing | 60 |
| Variable electricity (80% of Rs 18,000 ÷ 400 chairs) | 36 |
| Relevant cost floor | 1,671 |
Assumptions: glue and nails are treated as direct; electricity is genuinely variable with machine use; no domestic sales are displaced; domestic commission is not incurred. Any price above Rs 1,671 contributes towards fixed costs and profit. The owner should still check that the export price does not undermine the domestic price of Rs 2,500.