MANAGEMENT ACCOUNTING

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1 MANAGEMENT ACCOUNTING 2 nd Year Examination August 2014 Exam Paper, Solutions & Examiner s Comments 1

2 NOTES TO USERS ABOUT THESE SOLUTIONS The solutions in this document are published by Accounting Technicians Ireland. They are intended to provide guidance to students and their teachers regarding possible answers to questions in our examinations. Although they are published by us, we do not necessarily endorse these solutions or agree with the views expressed by their authors. There are often many possible approaches to the solution of questions in professional examinations. It should not be assumed that the approach adopted in these solutions is the ideal or the one preferred by us. Alternative answers will be marked on their own merits. This publication is intended to serve as an educational aid. For this reason, the published solutions will often be significantly longer than would be expected of a candidate in an examination. This will be particularly the case where discursive answers are involved. This publication is copyright 2014 and may not be reproduced without permission of Accounting Technicians Ireland. Accounting Technicians Ireland,

3 Accounting Technicians Ireland 2 nd Year Examination: Autumn 2014 Paper: MANAGEMENT ACCOUNTING Monday 18 th August p.m. to 5.30 p.m. INSTRUCTIONS TO CANDIDATES PLEASE READ CAREFULLY In this examination paper the / symbol may be understood and used by candidates in Northern Ireland to indicate the UK pound sterling and the / symbol may be understood by candidates in the Republic of Ireland to indicate the Euro. Answer ANY FIVE of the six questions. If more than the required number of questions is answered, then only the requisite number, in the order filed, will be corrected. Candidates should allocate their time carefully. All figures should be labelled, as appropriate, e.g. / s, units etc. Answers should be illustrated with examples, where appropriate. Question 1 begins on Page 2 overleaf. Note: Examinees are permitted to use terminology of either International Accounting Standards (I.A.S s) or Financial Reporting Standards (F.R.S s) where appropriate (e.g. Receivables/Debtors) when preparing management accounting statements. 3

4 SECTION A ANSWER ALL THREE QUESTIONS QUESTION 1 (Compulsory) Stars Ltd. is concerned that two of its products, Mercury and Jupiter may not be appropriately costed and priced. This is as a result of declining sales volumes. You have therefore been asked to make relevant calculations, using both traditional and modern overhead costing methods, to assist with pricing decisions. The company calculates its selling prices based on cost plus a mark-up. The company uses a pre-determined overhead absorption rate based on the predominant factor, machine hours. The overhead absorption rate is calculated at the start of each year based on budgeted information as follows: Production overhead / 2,400,000 Direct labour hours 100,000 Machine hours 200,000 Set-up hours 8,000 Unit costs Mercury Jupiter Direct materials cost / 350 / 480 Direct labour hours Direct labour cost per hour / 20 / 20 Machine hours Set-up hours 2 3 Mark-up 60% 50% The production overheads can be divided into the following cost pools; Cost pools / Set up 600,000 Maintenance 400,000 Cutting 800,000 Assembly 600,000 Total overhead 2,400,000 Question 1 is continued overleaf 4

5 QUESTION 1 (Cont d) Required: (a) (b) Using machine hours as the basis, calculate the pre-determined overhead absorption rate. Calculate the standard cost and the standard selling price of both Mercury and Jupiter, using the pre-determined overhead absorption rate that you have calculated in part (a). 2 Marks 6 Marks (c) (d) (e) In relation to the information given in this question identify suitable cost pools and cost drivers if Stars Ltd were to use activity based costing. 2 Marks Calculate suitable activity-based overhead rates for each of the cost pools you have identified in part (c). 4 Marks Calculate the standard cost and the standard selling price of both Mercury and Jupiter, using the activity-based overhead rates that you have calculated in part (d). 6 Marks Total: 20 Marks 5

6 QUESTION 2 (Compulsory) Planet plc. uses a standard costing system. The following information relates to the company s product Earth, for the month of August: Standard data Actual data Sales Sales Volume units 20,000 18,500 Selling Price per unit ( / ) Production Materials used per unit (kg) Materials price per kg ( / ) Labour hours per unit Labour rate per hour ( / ) Required: (a) Prepare a statement showing the budgeted profit and the actual profit for August. (b) Calculate the following variances: i. Sales Price ii. Sales Volume iii. Materials Price iv. Material Usage v. Labour rate vi. Labour efficiency Note: each section carries equal marks. 4 Marks 12 Marks (c) Outline the key factors that should be considered before deciding whether or not a variance should be investigated. 4 Marks Total: 20 Marks 6

7 QUESTION 3 (Compulsory) Moone Ltd. has produced the following budgeted figures for a new product that it hopes to launch. Direct Material Direct Labour Variable Production Overhead Fixed Production Overhead Budgeted Output Selling Price / 15 per unit / 8 per unit / 6 per unit / 30,000 per month 10,000 units per month / 40 per unit The following levels of activity took place over the first two months of the products life: Month 1 Month 2 Production units 10,000 12,000 Sales units 8,800 10,500 Note: Actual prices and costs were the same as budgeted for the first two months. Required: (a) Calculate the standard cost per unit and standard profit per unit under Absorption costing principles. 4 Marks (b) Prepare a profit statement for each month (separately) on each of the following basis: i. Absorption Costing ii. Marginal Costing 12 Marks (c) Prepare a reconciliation of the difference in profit reported in the profit statements prepared in part (b) above. 2 Marks (d) Clearly explain the reason for the difference in reported profit under the two methods. 2 Marks Total: 20 Marks 7

8 SECTION B ANSWER TWO OUT OF THE FOLLOWING THREE QUESTIONS QUESTION 4 The budgeting process is an important feature of effective management performance. Required: (a) Outline and briefly explain five benefits of budgeting. (b) Provide a brief overview of the budgeting process. (c) Explain each of the following approaches to budgeting; i. Activity based budgeting; ii. Zero based budgeting; iii. Rolling budgets. 5 Marks 6 Marks 9 Marks Total 20 Marks 8

9 QUESTION 5 Pluto Ltd. manufactures plastic storage boxes. The following is a budgeted Income Statement for the business for September 2013: / Sales Revenue 35,000 Direct Material 5,600 Direct Labour 2,500 Production Overhead 3,800 Selling Overhead ,874 Profit 22,126 The following information is also supplied: 1. The monthly budgeted production and sales is 7,000 units. 2. The following breakdown between fixed and variable costs applies: Variable Fixed Direct Materials 100% n/a Labour / 1,400 / 1,100 Production Overhead / 2,100 / 1,700 Selling Overhead n/a 100% Required: (a) Calculate the following: i. Contribution for the year; ii. Contribution per unit; iii. Contribution / sales ratio; iv. Breakeven sales volume; v. Margin of safety %; vi. Sales volume required to achieve a profit of / 1, Note: Each section carries equal marks. 12 Marks (b) Prepare a clearly labelled breakeven chart, showing the breakeven point, margin of safety and expected profit. 6 Marks (c) In deciding whether to make or buy the labels that are glued to the storage boxes, list any two qualitative factors that would need to be considered in making this decision. 2 Marks Total: 20 Marks 9

10 QUESTION 6 A business manufactures high quality bags. The following information relates to the business four different products. Deluxe Grande Lite Midi / / / / Sales Price Direct labour cost Direct materials cost Labour hours required per unit Materials required per unit 18kg 45kg 30kg 36kg Maximum sales demand 15,000 15,000 15,000 15,000 Due to the specialist nature of the work, only 150,000 skilled labour hours are available in the next quarter. Required: (a) Explain, using two examples what is meant by a limiting factor. (b) How may a company overcome a limiting factor(s)? 3 Marks 5 Marks (c) Advise the business on the mix of products that it should produce during the quarter in order to maximise profit if labour hours are limited to 150,000 hours. Total 20 Marks 12 Marks END OF PAPER 10

11 2 nd Year Examination: August 2014 Management Accounting Suggested Solutions and Examiner s Comments Students please note: These are suggested solutions only; alternative answers may also be deemed to be correct and will be marked on their own merits. General Comments: Statistical Analysis - Overall Pass Rate 76% Average Mark 61% Range of Marks Nos. of Students and over 57 Total No. Sitting Exam 158 Total Absent 54 Total Approved Absent 10 Total No. Applied for Exam 222 The majority of the scripts were very well presented scripts but there is still scope for improvement in some cases. i. The handwriting in some cases was very poor. ii. The questions were not labelled. iii. There was no logical sequence to some answers. iv. In some cases there was no evidence of workings. Candidates presented a final figure rather than showing the workings that lead to this figure. If this final figure is not correct then valuable marks are lost for workings. Overall the level of knowledge and the standard of answers have improved. However it is still very obvious that candidates are experiencing difficulty with standard costing and variance analysis. 11

12 Examiner s Comments on Question One This question was compulsory and tested the candidate s knowledge of the traditional method of costing and activity based costing. Whilst the question was generally well answered it was evident that candidates had a better understanding of activity based costing compared to their understanding of traditional costing. Suggested Solution 1 (a) Pre-determined Overhead Absorption Rate Production Overhead / 2,400,000 Machine hours 200,000 = / 12 per machine hour Marks 2 (b) Standard Cost & Standard Selling Price using Pre-determined Overhead Absorption Rate Marks / / Mercury Jupiter Direct Materials cost (given) Direct Labour cost (labour hours x pay rate) Production Overhead (Machine hours x OAR) 1, Standard Cost 1, , Mark Up (60%) 1, (50%) Standard Selling Price 2, , (c) Activity-based Cost pools and cost drivers Marks Cost Pools Cost Drivers Set-Up Costs Set-Up Hours 0.5 Maintenance Machine Hours 0.5 Cutting Machine Hours 0.5 Assembly Direct Labour Hours

13 (d) Activity-based Overhead Rate Set-Up / Maintenance / Cutting / Assembly / Production O/heads 600, , , ,000 Cost driver 8,000 SUH 200,000 MH 200,000 MH 100,000 DLH Activity-based O/head Rate / 75 per SUH / 2 per MH / 4 per MH / 6 per DLH Marks Available (e) Standard Cost & Standard Selling Price using an activity-based overhead rate / / Marks Mercury Jupiter Direct Materials cost (given) Direct Labour cost (labour hours x pay rate) Production Overheads Set-Up Cost (2/3 x / 75 per Set-up Hour) Maintenance costs (90/30 x / 2 per machine hour) Cutting Costs (90/30 x / 4 per machine hour) Assembly Costs (DL x / 6 per direct labour hour) Standard cost 1, , Mark Up (60%) (50%) Standard Selling Price 2, ,302.5 Examiner s Comments on Question Two As evidenced from previous sittings the area of standard costing and variance analysis is an area that candidates seem to be struggling with. Most candidates only got half of the variance calculation correct thereby losing valuable marks. 13

14 Suggested Solution 2 (a) Budgeted Profit / / Marks Sales Revenue (20,000 x / 24) 480, Cost of Sales Materials Cost (20,000 x 1.75 kg x / 8.50) 297, Labour Cost (20,000 x 0.65 x / 10.80) 140, ,900 Budgeted Profit ( / per unit) 42, Actual Profit / / Marks Sales Revenue (18,500 x / 28.50) 527, Cost of Sales Materials Cost (18,500 x 2 kg x / 9) 333, Labour Cost (18,500 x 0.85 x / 10.50) 165, ,112 Actual Profit 29, (b) Variances i. Sales Price Variance / Marks 18,500 units generated revenue of 18,500 units x / , ,500 units should have generated revenue of 18,500 units x / ,000 1 per unit 83,250 F or (Actual Sales Volume x Actual Selling Price) (Actual Sales Volume x Standard Selling Price) (18,500 units x / per unit) - (18,500 units x / per unit) / 527,250 - / 444,000 = / 83,250 favourable 14

15 ii. Sales Volume Variance units Marks Planet plc. actually sold 18,500 1 Planet plc. Should have sold 20, ,500 A x standard contribution per unit ( / 2.105) / 3,157.5 A (Working) Standard Contribution per Unit Selling Price / Less Variable Costs: Materials (1.75 kg x 8.50 / kg) / Labour (0.65 hrs x 10.80/hr) / Contribution / or Budgeted Sales Volume Actual Sales Volume = / = / 3,157.5 adverse iii. Material price Variance / Marks 37,000 kg of materials actually cost (37,000 x / 9) 333, ,000 kg of materials should have cost (37,000 x / 8.50) 314, ,500 A or (Actual Quantity of Inputs x Actual Price) (Actual Quantity of Inputs x Standard Price) (37,000 kg x / 9 per kg) - (37,000 kg x / 8.50 per kg) / 333,000 - / 314,500= / 18,500 adverse iv. Materials Usage Variance kg Marks Planet plc. actually used (18,500 x 2 kg) 37,000 1 Planet plc. Should have used (18,500 x 1.75 kg) 32, ,625A x standard cost per kg ( / 8.50) / 39,312.5 A 15

16 or (Actual Quantity of Inputs x Standard Price) (Flexed Quantity of Inputs x Standard Price) (37,000 kg x / 8.50 per kg) - ((18,500 units x 1.75 kg per unit) x / 8.50 per kg) / 314,500 - / 275,187.5 = / 39,312.5 adverse v. Labour Rate Variance or / Marks 15,725 labour hours actually cost (15,725 x / 10.50) 165, ,725 labour hours should have cost (15,725 x / 10.80) 169, ,717.50F (Actual Labour Hours x Actual Pay Rate) (Actual Labour Hours x Standard Pay Rate) (15,725 hours x / per hour) - (15,725 hours x / per hour) / 165, / 169,830.00= / 4, Favourable vi. Labour Efficiency Variance hours Marks Planet plc. actually used (18,500 x 0.85 hours) 15,725 1 Planet plc. should have used (18,500 x 0.65 hours) 12, ,700A x standard cost per hour ( / 10.80) / 39,960A or (Actual Labour Hours x Standard Rate) (Flexed Labour Hours x Standard Rate) (15,725 hours x / per hour) - ((18,500 units x 0.65 hours per unit) x / per hour) / 169,830 - / 129,870 = / 39,960 adverse c) Factors to be considered before deciding whether or not to investigate a variance i. The size of the variance and whether the impact on profitability is positive or negative. ii. The likelihood of the variance being controllable / uncontrollable. iii. Investigation costs. iv. Benefits to be gained from the investigation v. The likelihood of the variance re-occurring. Marks Available: 4 marks (1 mark per point) 16

17 Examiner s Comments on Question Three There was a clear improvement in the calculation and use of the fixed overhead absorption rate as required in part (a) of the paper since the May 2014 paper. As evidenced in previous sittings, candidates are still failing to identify opening and closing inventories and the under/over absorption of fixed production overhead as required in part (b). Parts (c) and (d) were generally well answered, with most candidates able to reconcile and explain the reason for any difference in reported profit as a result of using the two different bases of costing. Suggested Solution 3 (a) / / Marks Selling Price 40 Direct Material 15 Direct Labour 8 Variable Production Overheads 6 Fixed Production Overheads(W1) 3 Production cost 32 3 Profit per unit 8 1 (b) (i) Absorption Costing Month 1 Month 2 Marks / / Revenue 352, ,000 1 Opening Inventory 0 38,400 1 Cost of Production 320, ,000 1 Closing Inventory (38,400) (86,400) 1 Cost of Sales 281, ,000 Profit 70,400 84,000 1 Over Absorption Nil 6,000 1 Adjusted Profit 70,400 90,000 Working: Production overhead cost per unit (W1) / 30,000 10,000 = / 3 17

18 (ii) Marginal Costing Month 1 Month 2 Marks / / Revenue 352, ,000 1 Opening Inventory 0 34,800 1 Cost of Production 290, ,000 1 Closing Inventory (34,800) (78,300) 1 Variable Cost of Sales 255, ,500 Contribution 96, ,500 1 Fixed Cost 30,000 30,000 1 Profit 66,800 85,500 (c) Reconciliation of Profit Month 1 Month 2 Marks / / Absorption Costing 70,400 90,000 Marginal Costing 66,800 85,500 Difference 3,600 4,500 Being: Opening / 3 / unit 0 3,600 Closing / 3 / unit 3,600 8,100 3,600 4,500 Marks Available 1 1 (d) The reason for the difference in profit is due to the difference in the valuation of inventory. For example in month 1 the difference is 3,600. This is due to the fact that in absorption 3,600 worth of the fixed overhead is not written off but instead is carried forward to Month 2. This does not happen in marginal costing as fixed overheads are not included in inventory valuation. Marks : 2 18

19 Examiner s Comments on Question Four This question was exceptionally well answered, with candidates demonstrating a very strong knowledge of the budgetary process. Suggested Solution 4 (a) There are many advantages to using budgets. The use of budgets: provide a method of allocating and using resources within the organisation help to monitor and control operations promote forward thinking show employees an overall picture of the direction of the organisation which can motivate staff help to co-ordinate different departments and align them towards shared objectives provide a framework for delegation. (Note: Other reasonable suggestions are acceptable) Marks : 5 (b) The budgeting process normally follows a set structure as follows; Form a budget committee Establish a budget administration system Set the budget period Set budget guidelines Prepare initial budgets Negotiate, review and approve Budget revision (each needs to be briefly explained to get marks) Marks : 6 (c) Activity Based Budgeting is a method of budgeting in which the activities that incur costs in every functional area of an organisation are recorded and their relationships are defined and analyzed. Activity based budgeting stands in contrast to traditional, cost-based budgeting practices in which a prior period's budget is simply adjusted to account for inflation or revenue growth. As such, ABB provides opportunities to align activities with objectives, streamline costs and improve business practices. A rolling budget is one that is revised at regular intervals by adding a new budget period to the full budget as each budget period expires. A budget for one year, for example, could have a new quarter added to it as each quarter expires. In this way, the budget will continue to look one year forward. Cash budgets are often prepared on a continuous basis. 19

20 Advantages of rolling budgets: The budgeting process should be more accurate Much better information upon which to appraise the performance of management The budget will be much more relevant by the end of the traditional budgeting period Disadvantages of rolling budgets: More costly and time consuming An increase in budgeting work may lead to less control of the actual results Zero based budgeting is an alternative approach that is sometimes used particularly in government and not for profit sectors of the economy. Under zero based budgeting managers are required to justify all budgeted expenditures, not just changes in the budget from the previous year. The base line is zero rather than last year's budget. Zero based budgeting approach requires considerable documentation. In addition to all of the schedules in the usual master budget, the manager must prepare a series of decision packages in which all of the activities of the department are ranked according to their relative importance and the cost of each activity is identified. Higher level managers can then review the decision packages and cut back in those areas that appear to be less critical or whose costs do not appear to be justified. Marks : 3 x 3 Examiner s Comments on Question Five Although part (a) was generally well answered question very few candidates attempted part (b) of the question which required the construction of a breakeven chart. Those that did attempt it were unable to construct a graph and fill in the elements required. This difficulty with the construction of a breakeven chart has been evidenced in previous papers. 20

21 Solution 5 (a) (i) / / Marks Sales Revenue 35,000 Variable Cost Direct materials 5,600 Direct labour 1,400 Production overhead 2,100 9,100 Contribution 25,900 2 (ii) / Marks Total contribution 25,900 Total units 7,000 CPU or / Marks Sales price per unit 5.00 Variable cost per unit 1.30 CPU (iii) Contribution to sales ratio Marks C.P.U. / SP x / 5 x 100 = 74% 2 or Contribution / Sales revenue / 25,900 / / 35,000 = 74% (iv) Breakeven sales volume Marks Fixed Cost 3,774 CPU 3.70 = 1,020units 2 (v) Margin of safety % Units Expected sales 7,000 Breakeven sales 1,020 Margin of safety 5,980 Marks Margin of Safety % 85.4% 2 (vi) Sales volume required to achieve a profit of 1,

22 Fixed Costs + Target Profit Marks C.P.U. ( 3, ,387.50) = 1,395 units (c) Factors that would need to be considered before deciding to make or buy the Packaging for the toys: 1) The reliability of the supplier in terms of delivery time. 2) Quality issues relating to the quality of the suppliers product. 3) The price quoted by the supplier and the risk of the supplier increasing the price of its product. 4) The benefit that the use of a supplier for packaging might bring in terms of being able to concentrate on core competencies. (other relevant factors would be acceptable) Marks : 6 Examiner s Comments on Question Six Parts (a) and (b) of the question was exceptionally well answered with candidates demonstrating a clear understanding of what is meant by and how to overcome a limiting factor. Part (c) required the calculation of the maximum contribution achievable when labour hours were limiting. Whilst the standard of answers had improved from previous sittings many candidates were unable to rank the products according to the highest contribution per limiting factor. Many ranked them according to the highest contribution per unit. 22

23 Solution 6 (a) A limiting factor is a resource that is in short supply. An example is materials or labour. Marks : 3 (b) 1. Some of the work that cannot be carried out in-house due to the constraint could be subcontracted out. 2. Some lower level workers could be re trained and they could then work on these products. 3. A recruitment campaign could be launched and new workers could be sourced. 4. Productivity and efficiency could be improved to reduce the time required per unit. Marks : 5 (c) STEP 1 Deluxe Grande Lite Midi Marks Contribution per unit / / / / Sales price Direct labour Direct material Contribution per unit STEP 2 Contribution per unit of limiting factor Deluxe Grande Lite Midi CPU ( ) Lab hours per unit Contribution per Labour Hour ( ) STEP 3 Rank the products Rank Marks 3 3 STEP 4 Prepare the optimal production plan 23

24 Production Hours Contribution Marks / Grande 15,000 units 15,000 x 6 hrs per unit 90,000 2,535,000 Midi 15,000 units 4,000 x 15 hrs per unit 60, , ,000 3,071,

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