6 QUESTION 3 50 marks Aqua-systems Ltd has two divisions.

6QUESTION 3 50 marksAqua-systems Ltd has two divisions. The Pumpworks division manufactures standardised electric waterpumps for industrial use and the Agri-water division manufactures irrigation systems for agriculturalpurposes.The normal production capacity of Pumpworks is 1 000 units per month, while an average of 970 unitsare sold. Pricing is based on a set mark-up as prescribed by Aqua-systems Ltd.During a recent management meeting, the management of Aqua-systems Ltd reviewed the budgetedincome statement of Pumpworks for April 2005. The manager of the Pumpworks division explained thatthe division is slowly but surely turning the corner. The division had improved its performance over thepast three months and profitability should improve soon. In fact, the manager of Pumpworks indicatedthat the loss of the division has decreased and that it should reach a break-even position in five months’time.However, the management of Aqua-systems Ltd is not convinced of this and they approached you, themanagement accountant of the company, to advise them on the likelihood that the Pumpworks divisionwill return to profitability soon.PUMPWORKS DIVISIONBUDGETED INCOME STATEMENT FOR THE MONTH ENDING 30 APRIL 2005Notes RSales (970 units)Less: Cost of sales1 703 3201 578 260Opening stock (24 casings @ R205 each)Production cost (1 000 finished units)Closing stock (30 finished units)4 9201 622 000(48 660)Gross profitInsurance claimSales and administration costHead Office allocation123125 06054 300(148 400)(173 580)Loss for the month (142 620)Notes1 During June 2004 the Pumpworks production facilities were damaged in a fire caused by anelectrical fault. After initial problems with the insurance company, Aqua-systems Ltd received aletter from it shortly before the completion of the April budget to the effect that the amount ofR54 300 was awarded to the company for the damage.2 25% of sales and administration costs are variable.3 Head Office overheads include a fee of R14 per water pump sold. The fee relates to a patent usedon one of the components of the water pump.Pumpworks has received two offers for contracts1 The SA Mining Ltd offerPumpworks has been approached by SA Mining Ltd to supply 200 pumps for a project in the LimpopoProvince in April 2005. They need a scaled down version of the water pumps that will be brought into useby the end of April 2005. 200 units will be required for the project, at R1 600 per unit. SA Mining Ltd hasindicated that they will approach a competitor of Pumpworks if the latter were not interested in the order.7The following information relates to the normal production costs of Pumpworks and the order from SAMining Ltd:The cost of the water pump components and related labour costs are set out below:(a) Pipe connectorsThese units are bought from an external supplier. One connector is used per pump system.Pumpworks recently bought 250 pipe connectors at R20 each for use on the standard system.Unfortunately the units were the wrong size and Pumpworks planned to return them to the supplier.However, the supplier offered Pumpworks a 50% discount on the unit price for keeping the units. Inanticipation of the possible contract to supply smaller water pumps to SA Mining Ltd, Pumpworkshas now decided to accept the supplier’s offer.(b) CasingsCurrent casings could be modified to fit the specifications of the order. The modification will costR54 and entail 30 labour minutes per casing. Information on the 24 standard casings that are instock are as follows:CostReplacement costNet replacement valueR205 each230 each225 each(c) ImpellersOne set of impellers is used per pump. Pumpworks is able to manufacture 1 150 sets of impellersper month, at a total variable cost of R250 per set. It can sell any spare sets of impellers at R370per set. No impellers are currently in stock. The total fixed cost for the production of impellersamounts to R132 000 per month, and represents depreciation on recently acquired machinery.(d) ShaftsShafts are cut from standard steel bars. Each bar is cut into one shaft. According to the stocksheets, the total cost (excluding labour) amounts to R175 per shaft. Pumpworks has the capacityto cut 1 100 standard shafts per month. Depreciation and other fixed costs (excluding labour)related to this activity amount to R160 000 per month.(e) Electric motorsElectric motors are bought at R450 per unit. One motor is used per pump system.(f) Labour• Shaft cutting: Shaft cutting labourers are highly skilled. They are paid R60 per hour and work160 hours per month. Because of the high cost of training, all five the shaft cutting labourersare full-time employees of the company.• Casings: A total of 13 labourers are employed in this section. Each labourer receives a salaryof R5 000 per month and works 160 hours per month. Each standard casing takes two hoursto manufacture. New casing casters can be trained at a cost of R5 000 per employee. Theminimum employment period for these workers is three months.• Impellers: Labour consists of full-time machine operators. Existing operators will be able tohandle any expansion.8• Assembly: Labourers are paid R50 per hour to do the assembly. One pump system takestwo hours to assemble. Assembly hours are not limited and can be adjusted as necessary.2 The Agri-water offerAs an alternative to the SA Mining Ltd order, Agri-water has offered to buy the 200 smaller pumps fromPumpworks at a price of R1 400 per unit. The 200 pumps will be used for an irrigation project in theMakatini area in northern KwaZulu-Natal. Agri-water was approached by the government when theprevious contractor became unable to complete the contract. The project is an initiative of the KwaZulu-Natal government and the contract price for the 200 irrigation systems on the Makatini project is R500000. Agri-water has however been unable to source the correct water pumps for the project from anyother supplier. Though the water pumps manufactured by Pumpworks are normally for industrial use andas such very powerful and generally too expensive for agricultural purposes, they could be used for theMakatini project. Agri-water has sufficient capacity to complete the contract.The cost for one irrigation system is as follows:Notes RMaterial (excluding piping) 1 1 800Labour 342Piping 2 174Manufacturing fixed cost 210Total cost 2 526Notes1 Material cost includes the cost of R1 400 per unit that will have to be paid to Pumpworks.2 Piping costs consist of both the piping used per unit and the maintenance of equipment. Previousrecords show that the cost per unit changes with changes in output. At an output of 1 000 units thecost per unit is R185 while the cost per unit at an output of 710 units is R197,68. Further, for every100 unit increase (or part thereof) in output, maintenance costs increase by R10 000.REQUIREDMarks(a) Analyse and discuss the budgeted income statement for April 2005 and the detailed costsof Pumpworks, and(i) specifically comment on the statement by the manager of Pumpworks that the divisionis capable of returning to profitability within the next five months, and(ii) suggest possible actions that could lead to profitability for the division.25(b) Calculate the contribution per unit that Pumpworks would make if it accepted the orderfrom SA Mining Ltd.10(c) Advise the management of Aqua-systems Ltd on whether Pumpworks should supply Agriwaterwith 200 pumps as opposed to accepting the SA Mining Ltd order. Show all yourworkings and provide detailed reasons to support your answer.10(d) Comment on the pricing strategy used by Aqua-systems Ltd. 5

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