MANAGEMENT ACCOUNTING

MANAGEMENT ACCOUNTING FORMATION 2 EXAMINATION - APRIL 2009 NOTES: Section A - Questions 1 and 2 are compulsory. You have to answer Part A or Part B only of Question 2. (If you provide answers to both Part(s) A and B of Question 2, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for this question will be marked). Section B - You are required to answer any three out of Questions 3 to 6. (If you provide answers to all of Questions 3 to 6, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first three answers to hand for these four questions will be marked). TIME ALLOWED: 3 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND MANAGEMENT ACCOUNTING FORMATION 2 EXAMINATION - APRIL 2009 Time allowed: 3 hours, plus 10 minutes to read the paper. Section A: Answer Question 1 and either Part A or Part B of Question 2. Section B: You are required to answer any three out of Questions 3 to 6. Section A - Questions 1 and 2 are COMPULSORY 1. Impy Ltd. produce three different products using two production departments. The company currently uses absorption costing to establish product costs and profitability. The Directors have recently attended a conference on Activity Based Costing (ABC) and are examining whether ABC might provide a better system for Impy Ltd. The following budgeted information for period ended 31st December 2008 has been collated for each of the three products: Taya Maya Paya Production and Sales 8,750 units 4,000 units 6,000 units Unit sales price 56 106 84 Direct materials 1.5 kg 6 kg 7 kg Direct labour - Machine Dept 1 hour 8 hours 6 hours - Assembly Dept 4 hours 3 hours 1 hour Direct expenses 2 6 3 Machine Dept (machine hours per unit) 2 hours 5 hours 4 hours Raw material costs 4 per kilo and the hourly rate for all labour is 5. The direct expenses relate entirely to specialised packaging which is uniquely designed for each of the products and is therefore directly attributable to that product alone. The current costing system absorbs overheads to the Machine and Assembly Departments on the basis of a recovery rate of 3.50 per machine hour and 1 per labour hour respectively. The following is an analysis of the overheads by department: Department Overheads Purchasing Department 22,400 Production Set-up & Design Department 34,500 Customer Service Department 32,600 Machine Department 123,000 Assembly Department 26,500 The Departmental Managers have provided the following additional information about operations in their departments: Taya Maya Paya Total Number of set-ups 10 10 30 50 Number of customer orders 80 86 160 326 Number of purchase orders 30 32 50 112 The Machine Dept is capital intensive and the Assembly Dept is labour intensive. REQUIRED: (a) Calculate the prime cost of each product. (3 marks) (b) Calculate the profit per unit for each product if overheads are absorbed on the current costing basis. (6 marks) Page 1

(c) (d) Calculate the profit per unit for each product if overheads are absorbed using an activity-based costing approach. Clearly identify any cost drivers you assign. (13 marks) Comment on why there is a difference between the profit/loss shown on an absorption costing basis and that shown using activity-based costing. (3 marks) [Total: 25 marks] Question 2 - Answer either Part A or Part B 2. (A) You have just been hired as the Management Accountant in Enforcer Ltd., a medium sized manufacturing company producing technical equipment for use in laboratories. Your first task is to produce the budget for the forthcoming financial period. The Managing Director is a lapsed accountant having qualified many years ago and then moved away from the accounting function into general management. Having finished the initial planning meeting you realise that the Managing Director considers budgets as being a purely technical exercise which should be performed by the accountant alone, with no need for involvement or input from other staff members in the organisation. It also becomes clear that he sees the whole process as little more than guess work and the resulting budget to be something of no real benefit to anyone within Enforcer Ltd. You have a different view and understand how important it is in the context of preparing budgets that the behavioural and subjective aspects are not neglected. REQUIRED: (i) (ii) Prepare a Memorandum for the Managing Director in which you discuss the importance of behavioural and subjective aspects of budgeting including the defining of goals, ensuring goal congruence, promoting participation and any other behavioural or subjective benefit of your choice. (9 marks) Your memorandum should conclude with an outline of the benefits a company can obtain from an effective budgeting process. (5 marks) (1 mark for presentation) OR [Total : 15 marks] (B) Understanding cost behaviour is a critical aspect of the role of the Management Accountant. One of the most important aspects of cost behaviour is the differentiation between fixed and variable costs. Techniques such as the high / low method; scattergraphs and regression analysis may be used to analyse total cost into its fixed and variable components. Your Managing Director has just presented you with this quotation taken from a popular business journal. However, he does not understand what this means for his manufacturing business. He has asked your advice as a Management Accounting Consultant. REQUIRED: Prepare a Report to the Managing Director in which you discuss the importance of cost behaviour analysis in a manufacturing business. Your report should specifically address the following issues: Page 2

(i) (ii) An explanation of the terms total, fixed and variable costs stating why it is necessary to analyse total cost into its fixed and variable components in a manufacturing business. Provide a practical example and a graphical illustration for each cost type indicating likely behaviour patterns. (7 marks) For each of the three analysis techniques listed in the quotation, briefly explain the operation of the technique and give one advantage and one disadvantage in each case. (Numerical examples are not required.) (6 marks) (iii) Indicate which technique you consider to be the best, clearly stating a reason for your choice. (1 mark) (1 mark for presentation) [Total: 15 marks] Section B - Answer any 3 out of 4 questions. 3. The following multiple choice question contains 8 sections, each of which is followed by a choice of answers. Only one of the offered solutions is correct. Each question carries 2.5 marks. Give your answer to each section on the answer sheet provided. 1. Fixer Ltd. has budgeted fixed overheads for the period of 150,000 to be absorbed at a predetermined rate per production unit. Actual production for the period was 92,000 units incurring an actual fixed overhead of 145,000. Normal budgeted production is for 100,000 units. The variances calculated by Fixer Ltd. for fixed overheads are: (a) Expenditure 5,000; Volume 12,000. (b) Expenditure 5,000 (Fav); Volume 12,000 (Adv). (c) Expenditure 5,000 (Fav); Volume 8,000 (Adv). (d) Nil in all cases as fixed overheads are deemed to be fixed within the given parameters and hence, by definition, do not vary. 2. Ethan is a manual worker in Manufac Ltd., which has a standard working week of 35 hours and a number of different pay schemes in operation. In week 15, Ethan worked 43 hours and produced 120 units of product which exceeds standard production rates by 20%. Assume 50 operational weeks per standard year. Which of the following schemes will result in the highest take home wages for Ethan for week 15? (a) Basic pay of 8 per hour with an overtime premium of 50%. (b) Piece rate of 3 per unit with no basic pay. (c) Basic pay of 300 per week with a piece rate of 4 per unit produced in excess of standard production. (d) Fixed wage of 372 per standard operational week. 3. Which of the following statements are not true in relation to service costing systems: (i) Service costing applies where there is no tangible output produced. (ii) It is sometimes difficult to establish a suitable cost unit in service costing due to the absence of a physical product. (iii) Service costing often involves a large proportion of overheads with relatively low direct costs. (a) (b) (c) (d) Statements (i) and (ii). Statements (i), (ii) and (iii). Statement (iii) only. None of the above. Page 3

4. Stepper Ltd. recorded the following total operating costs for a two month period just ended. The Management Accountant has been advised that fixed costs increase by 20,000 for monthly volumes in excess of 120,000 units due to the hire of extra storage space. Period Production (units) Cost ( ) Month 1 90,000 395,000 Month 2 150,000 625,000 The estimated total costs for Month 3 when a production volume of 130,000 units is expected are: (a) 555,000. (b) 548,400. (c) 548,200. (d) 597,900. 5. Which of the following statements are true in relation to the role of the Management Accountant in the modern business environment? (i) (ii) (iii) (a) (b) (c) (d) The management accountant has a responsibility to act ethically in providing information to stakeholders. The management accountant is always responsible for preparing the annual statutory accounts for presentation to shareholders. The management accountant is responsible for providing information to assist in planning, control and decision making internally. Statement (i) only. Statement (iii) only. Statement (i) and (ii). Statement (i) and (iii). 6. Caprice Ltd. have just received an order requiring the use of 100 kg of Material X which is in regular use in the factory and 100 kg of Material Y which is no longer manufactured by their suppliers. The company currently has stocks of 80 kg of X purchased at 2 each and 80 kg of Y purchased at 3 each five years ago. If not used on this new order Material Y will be obsolete to Caprice Ltd. The current cost of X is 2.50 per kg. Another company Clipper Ltd. has offered to purchase the remaining Material Y from Caprice Ltd. for 1 per kg or to sell their own remaining stock of 20 kg to Caprice Ltd. for 1.50 per kg. The relevant cost of all raw material for the new order is: (a) 360. (b) 500. (c) 80. (d) 160. The following information is to be used for question 7 and 8. Stockings Ltd. had the following stores record for the month of July 2008. July 1 Stock on hand 100 litres, valuation 100 July 2 Issue 60 litres July 3 Receipt 40 litres, cost 1.20 per litre July 10 Issue 30 litres July 13 Receipt 20 litres, cost 1.30 per litre July 24 Receipt 20 litres, cost 1.50 per litre July 29 Issue 60 litres Page 4

7. Assuming that Stockings Ltd. uses a LIFO stock pricing system, the value of the issue on July 29th is: (a) 80. (b) 78. (c) 72. (d) 60. 8. Assuming that Stockings Ltd. uses a FIFO stock pricing system, the value of closing stock on 31st July is:. (a) 30. (b) 43. (c) 45. (d) 72. [Total : 20 marks] 4. Sheridan Ltd. manufactures chemical solutions for the automotive industry. The manufacturing takes place in a number of processes involving dangerous chemical reactions and the company uses a FIFO process costing system to value work-in-process and finished goods. At the end of the last month, one of the chemical reactions became unstable and resulted in a fire in the factory. As well as damaging the premises, the fire also destroyed some of the paper files containing records of the process operations for the month. You are the Management Accountant in Sheridan Ltd. and you now have to attempt to prepare the process accounts for the month during which the fire occurred. You have been able to gather some information about the month s operating activities but some of the information could not be retrieved due to the damage. The following information was salvaged: Opening work-in-process at the beginning of the month was 500 litres, 80% complete for labour and 60% complete for overheads. Opening work-in-process was valued at 13,900. Closing work-in-process at the end of the month was 100 litres, 20% complete for labour and 10% complete for overheads. Normal loss is 10% of input and total losses during the month were 2,000 litres partly due to the fire damage. Output sent to finished goods warehouse was 3,400 litres. Losses have a scrap value of 2 per litre. All raw materials are added at the commencement of the process. The cost per equivalent unit is 33 for the month made up as follows: REQUIRED: Raw Material 15 Labour 10 Overheads 8 33 (a) Calculate the quantity (in litres) of raw material inputs during the month. (3 marks) (b) (c) Calculate the quantity (in litres) of normal loss expected from the process and the quantity (in litres) of abnormal loss / gain experienced in the month. (2 marks) Calculate the values of raw material, labour and overheads added to the process during the month. (10 marks) (d) Prepare the process account for the month. (2 marks) (e) Explain why Sheridan Ltd. uses process costing as opposed to job costing in the calculation of their unit costs for the period. (3 marks) [Total : 20 marks] Page 5

5. Colclough Ltd. has just introduced a new standard marginal costing system to assist in the planning and control of the production activities for the single product which the company manufactures The Stand. The system became operational on 1st March 2009. The Management Accountant has consulted with the Senior Engineer and they have agreed the following standard specifications to manufacture one unit of the product known as The Stand. Direct materials Direct labour Variable overhead 4kg @ 1.75 per kg 2 hours @ 10 per hour 2 hours @ 8.25 per hour The Marketing Director has advised that in Colclough Ltd s industry, the budgeted selling price is normally calculated to achieve a mark up of 30% on cost. The budgeted level of production and sales activity has been agreed with both production managers and sales staff at 24,000 units per month. The actual results for the month of March 2009 are as follows: Sales - 22,000 units yielding a total revenue of 1,276,000. Production - 23,000 units. Direct Materials - 90,000 kgs at a cost of 162,000. Direct labour - 48,000 hours at a cost of 576,000 Variable overhead - 350,000 REQUIRED: (a) (b) (c) (d) Identify and briefly explain three types of standard that a Management Accountant may consider when introducing a Standard Costing system. (4 marks) Calculate the standard selling price of one unit of The Stand and prepare a summary budgeted profit statement for Colclough Ltd. for the month of March 2009. (2 marks) Calculate the relevant variances for March 2009 under the headings of sales, materials, labour and overheads. (10 marks) Colclough Ltd. uses a standard marginal costing system and therefore fixed costs have been ignored in the calculations shown above. Assuming that the fixed costs for the company are estimated to be 1,879,200 per annum, calculate the monthly sales in both units and value which will be required to break-even and estimate the margin of safety, based on the current budget levels. (4 marks) [Total : 20 Marks] Page 6

6. Lakeside Ltd. is a small manufacturing company producing two high quality products called Orta and Como. Both products use a raw material Zee (costing 30 per kg) in their manufacture. The Directors are reviewing the company s stock management policies for the forthcoming year as part of the annual budget preparation cycle. Due to the product specification, quality is an important factor and a quality control inspection takes place immediately after the production cycle has ended. At this point, any inferior products are rejected and only good production becomes available for sale. In addition to these losses, a certain quantity of waste is unavoidable from material Zee due to the cutting process for both products. The following forecast information has been extracted from departmental estimates for the year ended 31st December 2009 (the budget period): Product Orta Product Como Sales (quality approved units) 23,000 10,000 Finished goods stock increase by year-end 275 185 Post-production rejection rate (%) 2 3 Material Zee usage (per completed unit, net of wastage) 2 kg 3 kg Material Zee wastage (%) 5 10 Additional information: Usage of raw material Zee is expected to be at a constant rate over the period. Annual cost of holding one unit of raw material in stock is 17% of the material cost. The cost of placing orders is 30 per order. Lakeside Ltd. maintain a constant 1,000 kg of safety / buffer stock of material Zee regardless of the quantity ordered each time. REQUIRED: (a) Prepare operational budgets for the year ended 31st December 2009 under the following headings: (Show your workings clearly) (i) Production budget for Products Orta and Como (in units). (3 marks) (ii) Purchases budget for Material Zee (in kgs and value). (4 marks) (b) Calculate the Economic Order Quantity for Material Zee (in kgs). (5 marks) (c) The supplier of material Zee has offered a bulk discount of 1% to Lakeside Ltd. if they purchase material in batches of 5,000 kgs per order. Based on the financial information provided, advise the Directors whether they should accept the suppliers offer or remain ordering at the EOQ level. (8 marks) [Total: 20 marks] END OF PAPER Page 7

SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND MANAGEMENT ACCOUNTING Section A: This question is COMPULSORY Solution 1 FORMATION 2 EXAMINATION - APRIL 2009 Part (a) Taya Maya Paya Direct materials @ 4 per kg 6 24 28 Direct labour @ 5 per hour - Machine Dept 5 40 30 - Assembly Dept 20 15 5 Direct expenses 2 6 3 Prime Cost 33 85 66 (3 marks) Part (b) Per unit profit calculation using current absorption basis: Taya Maya Paya Prime Cost 33.00 85.00 66.00 Overhead absorption: - Machine Department @ 3.50 per machine hour 7.00 17.50 14.00 - Assembly Department @ 1.00 per labour hour 4.00 3.00 1.00 Total Product Cost 44.00 105.50 81.00 Selling Price 56.00 106.00 84.00 Profit per Unit 12.00 0.50 3.00 (6 marks) Part (c) Per unit profit calculation using activity based costing basis: Taya Maya Paya Overhead Allocation: - Purchasing Department (W1) 6,000 6,400 10,000 - Production Set-up & Design Department (W2) 6,900 6,900 20,700 - Customer Service Department (W3) 8,000 8,600 16,000 - Machine Department (W4) 35,000 40,000 48,000 - Assembly Department (W5) 17,500 6,000 3,000 Total Product Overheads 73,400 67,900 97,700 Units Produced 8,750 4,000 6,000 Overhead per Unit 8.39 16.98 16.28 Page 9

Taya Maya Paya Prime Cost 33.00 85.00 66.00 Overhead allocation: 8.39 16.98 16.28 Total Product Cost 41.39 101.98 82.28 Selling Price 56.00 106.00 84.00 Profit per Unit 14.61 4.02 1.72 Workings Cost Drivers and Rates per unit of Cost Driver W1 ABC cost per unit of driver for purchasing department 22,400/112 = 200 per purchase order W2 W3 W4 W5 ABC cost per unit of driver for set up & design department 34,500/50 = 690 per set up ABC cost per unit of driver for customer service department 32,600/326 = 100 per customer order ABC cost per unit of driver for machine department 123,000/61,500 = 2 per machine hour (See W6) ABC cost per unit of driver for Assembly Department 26,500/53,000 = 0.50 per assembly labour hour (See W6) W6 Machine Hours (Machine Dept) Taya (8750 x 2 hrs) 17,500 Maya (4000 x 5 hrs) 20,000 Paya (6000 x 4 hrs) 24,000 61,500 hours Labour Hours (Assembly Dept) Taya (8750 x 4 hrs) 35,000 Maya (4000 x 3 hrs) 12,000 Paya (6000 x 1 hrs) 6,000 53,000 hours (13 marks) Part (d) Taya Maya Paya Absorption System - Profit per Unit 12.00 0.50 3.00 ABC System - Profit per Unit 14.61 4.02 1.72 The difference in unit profit/loss between the two costing approaches is due to the different approaches in applying overhead. Under the traditional absorption based approach the overhead is absorbed using only volume based cost drivers (machine hours and assembly hours). Using ABC three of the cost pools have cost drivers driven by the number of transactions. Product Maya is the lowest volume product but it makes relatively low demands on set up costs, customer service and purchasing compared to the other two products hence under ABC it shows a higher profit. Product Paya has the highest ABC usage of activities compared to the other products. Under traditional costing Paya will get an understated amount of these costs but under ABC it gets a deservedly higher allocation hence returning a lower profit per unit. (3 marks) [Total: 25 marks] Page 10

Section B Answer EITHER part (a) OR part (b) SOLUTION 2 Part (a) To: From: Subject: Memorandum Managing Director, Enforcer Ltd Management Accountant Benefits and Behavioural Aspects of Budgeting Date: xxth August 2008 Further to our recent meeting to discuss the budget process for the forthcoming financial period. Accountants may sometimes consider budgets as being a purely technical process and, as a result, the subjective aspects of budgeting can be neglected. Such subjective aspects include the defining of goals, ensuring goal congruence, promoting participation and creating motivation. It is commonly accepted that people work more efficiently when they have clearly defined targets and objectives. In an ideal world, personal goals would coincide with organisational goals so that individual motivation would coincide with the motivation of the organisation. However, we do not operate in an ideal world and it is thus important that goal definition is considered an important part of budget preparation. Clearly defined goals which are agreed by all of the parties to a budget will encourage goal congruence and give rise to increased motivation. Goal congruence simply means that the goals of individuals and groups should coincide with the goals and objectives of the entity as a whole. Those responsible for the formulation of budgets must recognise that organisational objectives cannot be imposed through the budgeting system without consideration of the influences of individuals and individual groups and departments within the enterprise. Team management (i.e. participative management) is much more likely to be successful in the context of budgeting than the traditional style of management with its emphasis on authority and hierarchy. Participation promotes common understanding regarding the objectives and makes the acceptance of the goals of the organisation by the individual much more likely. The entire control process in any organisation is also assisted by participation of individuals in the resolution of problems which arise as a result of variances from the budgeted figures. It is now widely accepted that if people are genuinely involved they will feel part of a team and are hence more likely to be more highly motivated to achieve the desired outcomes. The entire process involved in the preparation of budgets must be designed so as to motivate managers rather than create resentment and adverse reactions. If the budget is seen to be a pressure device it will discourage initiative and responsibility. If the budget is structured in such a way that unachievable targets are set, it will create demotivation, which is undesirable. If the budgetary system (like any control system) is not accepted by the people who have to operate it, they will make every effort to hamper and obstruct its purpose. Frequent and up-to-date feedback of information to participants regarding their performance will have a positive motivating effect. Conversely, inaccurate data, reports containing details of items over which the individual has no control and undue delay, all reduce motivation and severely restrict the usefulness of the information. (9 marks available) Page 11

The advantages which result from the use of a system of budgetary control depend to a large extent upon the preparation and groundwork carried out before a system is introduced. Unless there is confidence in budgetary control, participation and agreement from those involved and backing from senior management, then it is unlikely that the system will be successful. The possible benefits obtainable for Enforcer Ltd are: (a) (b) (c) (d) (e) The organisation of the business should be more clearly defined, and with it the responsibilities of individual managers. Managers are given greater awareness of the business objectives and become more closely involved with the need for profit achievement and cost control whilst at the same time being properly motivated to ensure quality and customer satisfaction with our products. There is better co-ordination of the various functions of the business. Management skills are progressively improved. Budgetary control should lead to a better understanding of company activities, the accounting system and the responsibilities of each manager. When managers are involved in preparation of budgets, there should be a ready acceptance of the budgeted figures which should lead to better control. At the same time, the budgetary control system acts as a kind of monitor so that all managers are accountable for their particular areas, and this should stimulate greater effort. Variance analysis can promote and facilitate control as it helps identify areas of weakness in the business operations. (5 marks available) I trust the above outlines the importance of behavioural aspects of budgeting and the potential benefits form an effective system however, if you have any further queries in this regard, please do not hesitate to contact me. Yours sincerely, M. Accountant (1 mark for presentation) [Total: 15 marks] Page 12

Part (b) To: From: Subject: REPORT Managing Director, Manufacturing Company Ltd. Management Accounting Consultant Cost Behaviour Patterns and Analysis Date: xxth August 2008 Further to your request for information on cost behaviour patterns and analysis, I have outlined below the key areas that you wanted clarification on. Part (i) and (ii) Cost behaviour is normally classified according to how each cost behaves over different activity levels. Some costs vary directly in relation to changes in the volume of output while others remain more or less fixed in amount in a period as they are incurred based on time rather than volume. Fixed costs are those that remain constant within a relevant output range. As they do not vary, there will be a decrease of fixed costs per unit with increased output. They have to be absorbed into product cost as overheads often by arbitrary managerial decisions or cost allocation methods. Example The rent of a factory is 10,000 per month. If production is zero units in the month then rent is 10,000. If production is 8,000 units in the month the rent is still 10,000. This can be represented in a graph as follows: COST 10,000 2,000 4,000 6,000 8,000 ACTIVITY (UNITS) Variable costs are those that do not remain constant in the period but vary upwards or downwards direct proportion to volume or output. They result in a constant cost per unit in the face of changing volume and are easy to charge to operating departments as for the most part they are direct costs. Example An example of a variable cost is raw material. As output in units rises or falls then total variable cost rises and falls proportionately. Page 13

A variable cost can be represented in a graph as follows: 600 500 400 COST 300 200 100 0 20 40 60 80 100 120 OUTPUT (UNITS) Total Cost is the amalgamation of all fixed and variable costs and is sometimes described as semi-variable containing both fixed and variable elements. Example Total Cost for your manufacturing company will behave in this fashion having a fixed (rent) element and a variable (raw material) element based on the number of units produced. This can be represented in a graph as follows: VARIABLE COSTS COSTS FIXED COSTS OUTPUT (UNITS) It is important to remember that in the long run all costs could be termed as variable. Our analysis is only interested in how these costs behave in the short run. It is important to differentiate between fixed and variable aspects so that costs can be monitored and controlled effectively and also to ensure reliable data is available for the computation of standard costs and budget preparation. (7 marks altogether) Page 14

Part (iii) High / Low Method: This method compares the cost at the highest and at the lowest level of activity. The differential in cost is directly related to the differential in activity and hence is deemed to be entirely variable given that fixed costs remain unchanged. By dividing the cost differential by the units differential, the variable cost per unit can be found. This can then be used to find the fixed cost by substitution. Advantage: The method is simple and quick to use. Disadvantage: The method only takes account of two (extreme) pairs of data which may not be representative of normal operating levels. Scattergraph: This method plots all available pairs of data on a graph and then seeks to draw a line of best fit which approximates closest to the line of total cost in the graph shown above. By extrapolating this line to the Y-axis this will give us the fixed cost because at this point activity, and hence variable cost, is zero. Again, by substitution, the variable cost can then be found. Advantage: The method takes account of all available sets of data. Disadvantage: The choice of line of best fit is highly subjective. Regression Analysis: This is a mathematical method based largely on the principles underlying the other two described above. By using a formula (or spreadsheet program) all available sets of data are considered in arriving at an estimated variable and fixed cost but without the subjectivity introduced in the scattergraph by the necessity of a human choice for line of best fit. Advantage: The method takes account of all available sets of data but in an impartial way which provides more dependable accuracy. Disadvantage: The use of mathematical formulae introduces a level of complexity which makes this method harder to understand for non-accountants. (6 marks) Part (iv) Regression analysis is considered the best of the three methods as it by-passes the disadvantages of the other two methods and provides a more reliable estimate of variable cost per unit and fixed cost for the period. (1 mark) If you have any further queries in this regard, please do not hesitate to contact me. Yours sincerely, M. Accountant. (1 mark for presentation) [Total: 15 marks] Page 15

Solution 3 Multiple Choice Section 1 Answer (b ) Section C - Answer any 3 out of 4 questions Fixed overhead expenditure variance Actual Expenditure 145,000 Budgeted Expenditure 150,000 = 5,000 Fav Fixed overhead volume variance Budgeted Expenditure 150,000 Overhead Absorbed (92,000 x 1.50) 138,000 = 12,000 Adv 2 Answer (c). Note: Option (c) and (d) both give equal pay amounts of 380 per week however, option (d) is not a real option as manual workers are paid a wage not a salary. 3 Answer (d). All statements are in fact true. 4 Answer (a). At 150,000 units, cost is 625,000. At 90,000 units, cost is 395,000 Difference is 230,000 for 60,000 extra units. But the stepped fixed cost of 20,000 must be eliminated giving an increase of 210,000 for 60,000 units which is entirely variable. Hence variable cost per unit is 210,000 = 3.50 per unit 60,000 At 150,000 units Total Cost is 625,000 Variable Cost is (150,000 x 3.50) 525,000 Hence Fixed Cost is 100,000 (including step) Add new Variable Cost (130,000 x 3.50) 455,000 New Total Cost 555,000 5 Answer (d). 6 Answer (a). Material X : 100 kg @ 2.50 = 250 (replacement cost as the material is in regular use hence will have to be replaced) Material Y: 80 kg @ 1 (Opportunity Cost) = 80 Additional supplies from Clipper Ltd 20 kg @ 1.50 = 30 110 Total Relevant Cost of Raw Materials for new order 360 7 Answer (b). 8 Answer (b). (8 x 2.5 marks = 20 marks) Page 16

SOLUTION 4 Part (a) Quantities Entering Process Litres Quantities Leaving Process Litres Opening WIP 500 Transfer to Finished Goods 3,400 Raw material input 5,000 Process Losses 2,000 (balancing figure) Closing WIP 100 5,500 5,500 Part (b) Litres Total process losses for month 2,000 (3 marks) Normal Loss (10% input) 500 Abnormal Loss (balancing figure) 1,500 (2 marks) Part (c) Statement of Equivalent Units: Physical Heading Materials Labour Overheads 500 Opening WIP completed - 100 200 2,900 Units Started & Completed 2,900 2,900 2,900 3,400 Finished Goods 500 Normal Loss - - - 1,500 Abnormal Loss 1,500 1,500 1,500 100 Closing WIP 100 20 10 Quantity of Equivalent Units 4,500 4,520 4,610 Cost per Equivalent Unit 15 10 8 67,500 45,200 36,880 Scrap Value of Normal Loss (500 litres @ 2) 1,000 Total Value Added 68,500 45,200 36,880 (10 marks) Part (d) Sheridan Ltd. Process Account for Month Litres Value Litres Value Opening WIP 500 13,900 Transfer to warehouse 3,400 112,200 Raw materials 5,000 68,500 Normal Loss 500 1,000 Labour 45,200 Abnormal Loss 1,500 49,500 Overheads 36,880 Closing WIP 100 1,780 5,500 164,480 5,500 164,480 Page 17 (2 marks)

Part (e) Process costing is suitable in industries where there is a continuous flow of production which cannot be halted to facilitate stock taking. The chemical reactions taking place in Sheridan Ltd cannot be paused at the end of each month to allow for valuations. When inputs (and costs) are added to a process it is very difficult to establish the cost of good output as there may be a certain amount of loss which is inevitable and unavoidable (normal losses). Hence process losses must be divided into normal and abnormal. The cost of normal loss (less its scrap value) must then be borne by the good production. Job costing would not be suitable for Sheridan Ltd as individual cost units cannot be identified for the purpose of cost allocation until the end of the chemical reactions (i.e. the process). (3 marks) [Total: 20 marks] SOLUTION 5 Part (a) When choosing a standard, the enterprise is faced with the choice of which performance level to select. There are three main bases (or types) described below: 1. Ideal standards These standards are based on perfect operating conditions. If such standards were to apply there would not be any inefficiencies, wastage etc. As employees would rarely achieve such a standard the performance variances would continuously be adverse. Such a situation would have an unfavourable impact on employees motivation. Employees would not view the standards as legitimate and would cease attempting to attain the standard required. 2. Current standards These standards are based on current operating conditions, and may be used over a short period of time. Management, however, would hope to improve efficiency levels on current operating conditions. 3. Attainable standards These standards are based on normal operating conditions. Allowance is made for normal wastage and inefficiencies. Standards set on this basis should provide encouragement to employees to improve on existing efficiency. The standard must be realistic and attainable; otherwise it will have the same pitfalls as ideal standards. Standards are normally reviewed annually to see if any changes are required, e.g. prices, inflation, efficiency. (1 mark for identifying and 1 mark each for explanations = 4 marks) Part (b) The standard selling price of one unit of The Stand is as follows: Direct materials (4kg @ 1.75/kg) 7.00 Direct labour (2 hrs @ 10/hr) 20.00 Variable overhead (2 hrs @ 8.25/hr) 16.50 Standard marginal cost 43.50 Standard Contribution (Mark-up on cost 30% x 43.50) 13.05 Standard selling price 56.55 (1 mark) Page 18

Colclough Ltd Budgeted Profit Statement for month ended 31st July 2008 Sales (24,000 units @ 56.55) 1,357,200 Direct materials (24,000 units @ 7) 168,000 Direct labour (24,000 units @ 20) 480,000 Variable overhead (24,000 units @ 16.50) 396,000 1,044,000 Budgeted profit 313,200 (1 mark) Part (c) Sales Price Variance Did sell (22,000 units for) 1,276,000 Expected to sell (22,000 x 56.55) 1,244,100 31,900 (Fav) Sales Volume Variance (based on lost contribution) Did sell 22,000 units Expected to sell 24,000 units 2,000 units @ 13.05 = 26,100 (Adv) Materials Price Variance Did pay 162,000 Expected to pay (90,000 x 1.75) 157,500 4,500 (Adv) Materials Usage Variance Did use Expected to use (23,000 x 4) 90,000 kgs 92,000 kgs 2,000 kgs @ 1.75 = 3,500 (Fav) Labour Rate Variance Did pay 576,000 Expected to pay (48,000 x 10) 480,000 96,000 (Adv) Labour Efficiency Variance Did take Expected to take 48,000 hours (23,000 x 2) 46,000 hours 2,000 hours @ 10 20,000 (Adv) Overhead Expenditure Variance Did cost 350,000 Expected to cost (48,000 x 8.25) 396,000 46,000 (Fav) Overhead Efficiency Variance Did base on Expected to base on (23,000 x 2) 48,000 hours 46,000 hours 2,000 hours @ 8.25 16,500 (Adv) (10 marks) Page 19

Part (d) Break Even Point (BEP) If annual fixed costs are 1,879,200 then the monthly level of fixed costs will be 156,600. Standard contribution per unit is 13.05 (from part (b) above). Based on standard contribution the BEP will be 156,600 = 12,000 units 13.05 In terms of revenue values (12,000 units @ 56.55 each) = 678,600. Alternative method: Contribution to Sales Ratio is 13.05/56.55 = 23.077% F.C. = 156,600 = 678,598 (approx 678,600) C/S Ratio 0.23077 Margin of Safety Sales required to break even Budgeted level of sales = 12,000 units = 24,000 units Margin of Safety 2,000 = 50% 24,000 This means sales can drop by 50% before there is any risk of losses occurring. (BEP 3 marks, MOS 1 mark = 4 marks) [Total: 20 marks] Page 20

SOLUTION 6 Part (a) (i) Lakeside Ltd - Production Budget for Year End 31st December 2009 Product Orta Product Como Units to satisfy sales targets 23,000 10,000 Units to cover stock increases 275 185 Units required from good production (net of loss) 23,275 10,185 Losses due to quality control check 2% 3% Losses in units 475 315 Units to be produced to cover sales, stock increases and quality control rejections 23,750 10,500 (3 marks) (ii) Lakeside Ltd Purchasing Budget for Year End 31st December 2009 Part (b) Product Orta Product Como Units to be produced (from (i) above) 23,750 10,500 Usage of raw material Zee 2 kg 3 kg Material Zee needed for production budget 47,500 31,500 Wastage due to cutting process 5% 10% Wastage in kgs 500 3,500 Material Zee purchasing requirements 50,000 35,000 (3 marks) Total raw material to be purchased is 85,000 kgs of material Zee at a cost per kg of 30 gives a total purchasing budget of 2,550,000 for the period. (1 marks) (sub total 4 marks) Economic Order Quantity (EOQ) EOQ = 2 d c h d = annual demand in units c = cost of making one order h = Cost of holding one unit for one year Applying the formula to the Lakeside Ltd case: Page 21

EOQ Material Zee = 2 x 85,000 x 30 (30 x 17%) = 5,100,000 = 1,000 kgs 5.1 (5 marks) Part (c) To assess the financial viability of the supplier s offer, Lakeside Ltd must assess the relevant costs of the current order size compared to the new order size. The offer will only be accepted if the new size puts Lakeside Ltd in a better position overall. Annual demand for material Zee remains at 85,000 units There are two relevant costs associated with this material: Ordering cost: Holding cost: (Number of orders placed annually x cost of one order) (Average stock on hand x cost of holding) There will also be an associated saving with the new order size due to the discount saved on the purchase price of the material Zee itself. It is important to remember that the safety / buffer stock will be maintained in both scenarios regardless of the size of each order (the 1,000 units will be present in both cases regardless of the decision). Hence they are not relevant to the current decision and can be ignored for the question. Option 1 Order size 1,000 units (EOQ) Ordering cost: (85 orders @ 30) = 2,550 Holding cost: (500 units @ ( 30 x 17%)) = 2,550 Costs associated with Option 1 5,100 Option 2 Order size 5,000 units (to avail of bulk discount) Ordering cost: (17 orders @ 30) = 510 Holding cost: (2,500 units @ ( 29.70 x 17%)) (2,500 units @ 5.05) = 12,625 Costs associated with Option 1 13,135 Saving on actual purchase price of units due to bulk discount 1% (85,000 units x 30cent discount) ( 25,500) Net costs associated with Option 2 (actually a saving) ( 12,365) Advice: The directors should accept the suppliers offer as it not only reduces the cost of stock management it actually produces a net saving overall as a result of the high level of demand and the discount on the purchase price of each unit. (8 marks) [Total: 20 marks] Page 22