MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - AUGUST 2014
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. Please read each Question carefully.
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 to pay particular attention to your communication skills and care must be taken
regarding the format and literacy of your solutions. The marking system will take into account the content
of your 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
attempted.
NB:
PLEASE ENSURE TO ENCLOSE YOUR ANSWER SHEET TO QUESTION 3 IN THE ENVELOPE
PROVIDED.
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 - AUGUST 2014
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.
Ludo Limited manufactures a specialised storage accessory for automobiles called ‘the Storax’, which is a type of
pocket which can be easily fixed in the boot of any vehicle. The company has been in operation for two years and,
now that the production process has been established and refined, the directors have decided to focus on the
income and costs arising from activities. The managing director has recently read an article about product costing
and, in particular, absorption and variable costing and is keen to understand how this would affect company profits.
The following information is available for the months of July and August:
July
13,000
12,000
€29,250
€19,500
€7,800
€45,200
Production (units)
Sales (units)
Direct materials
Direct labour
Variable production overheads
Total selling and administrative expenses
August
15,000
16,000
€33,750
€22,500
€9,000
€57,600
Additional information:
1.
For Ludo Limited normal production capacity is 15,000 units per month.
2.
Fixed production overheads are €29,400 per month.
3.
The company sells ‘the Storax’ for €20 each.
4.
Total selling and administrative expenses includes a fixed and variable element. The variable portion is
incurred based on units sold.
5.
At 30 June the company had no ‘Storax’ accessories in its warehouse.
REQUIREMENT:
(a)
Prepare profit statements for Ludo Limited for the months of July and August using:
(i)
(ii)
Absorption costing
Variable costing
(20 marks)
(b)
Reconcile the profit calculated using Absorption costing to that calculated using Variable costing.
(3 marks)
(c)
Provide a brief explanation of the effect on profit of using each of the methods at (a) above.
(2 marks)
[Total: 25 Marks]
Page 1
ANSWER PART (A) OR PART (B)
2.
(A)
Last year, James Moody established a gourmet food business and to date has achieved good sales and a small
profit. While attending a recent business networking event, James was advised to consider employing a
management accountant to enhance and improve his business. James has asked you for advice. He would like to
understand why management accounting has become so important to achieving business success and how it
differs from financial accounting. James is also keen to know how employing a management accountant could
improve his business.
REQUIREMENT:
Prepare a briefing note for James Moody which:
(i)
Outlines the changes in the business enviroment that have contributed to the growth and importance of
management accounting.
(4 marks)
(ii)
Differentiates between financial accounting and management accounting.
(iii)
Describes how the employment of a management accountant could enhance and improve a business. (7 marks)
(4 marks)
[Total: 15 Marks]
OR
(B)
The managing director of Brandon Limited has asked you to prepare a report suitable for senior management, to
assist in its understanding of management accounting. He has suggested that senior management need clarification
on the topic of cost terms and their importance and application in management accounting.
REQUIREMENT:
Draft a report for the managing director which:
(i)
Explains the following commonly used cost terms in management accounting:
●
●
●
●
cost object
direct and indirect costs
variable and fixed costs
product and period costs.
Illustrate your answer with examples.
(ii)
(10 marks)
Briefly outline areas (tools/techniques) in management accounting where these cost terms are used.
(4 marks)
Format and Presentation (1 mark)
[Total: 15 Marks]
Page 2
SECTION B - ANSWER ANY THREE QUESTIONS.
3.
Attempt each of these multiple-choice questions. Only one of the offered solutions is correct. Each question
carries equal marks. Record your answers to each section on the answer sheet provided.
(i)
Prime Cost is calculated as:
(a)
(b)
(c)
(d)
(ii)
Direct materials plus direct labour.
Direct materials plus direct labour plus direct expenses.
Direct labour plus direct expenses.
Direct materials plus direct labour plus factory overheads.
Stripe Limited uses a traditional absorption costing system to allocate production overheads to products. The
following information was used to record production in the month of August:
Machining department
€
238,700
23,870
31,000
Total budgeted factory overheads
Total labour hours
Total machine hours
The management accountant has stated that for the machining department the actual factory overhead cost for
August totalled €255,400 and that actual labour hours worked were 24,000 and actual machine hours were 29,000.
For this department in the month of August factory overhead was:
(a)
(b)
(c)
(d)
(iii)
Under absorbed by €32,100.
Over absorbed by €32,100.
Under absorbed by €16,700.
Over absorbed by €15,400.
ABC Limited manufactures one product which requires 2 kgs of material for each unit produced. The following
details relating to variance calculations for the month of June were also available:
€
1,136
1,180
132,912
Materials price variance (Favourable)
Materials usage variance (Adverse)
Materials purchased and used (56,800 kgs)
The number of units produced during the month of June was:
(a)
(b)
(c)
(d)
(iv)
56,300
28,150
132,868
57,308
Which of the following is NOT an advantage of a Just in Time (JIT) inventory management system:
(a)
(b)
(c)
(d)
With JIT waste is eliminated at all stages of the manufacturing process.
JIT builds a strong relationship between buyer and supplier.
A JIT inventory management system guarantees that no inventory is held.
JIT ensures a smooth flow of material and work through the production system.
Page 3
(v)
When using the Last In First Out (LIFO) method to value inventory which of the following statements is TRUE?
(a)
(b)
(c)
(d)
(vi)
During inflationary periods, cost of sales calculated using LIFO is lower than FIFO or Average (Weighted
Average) cost methods.
LIFO reflects the physical flow of materials through an organisation.
LIFO is accepted by accounting standards as suitable for valuing inventory.
During inflationary periods closing inventory calculated using LIFO is valued at the lowest prices.
Fixit Limited had the following information in its accounts for the year:
March
5,000
€39,000
Production volume in units
Maintenance expenses
September
15,000
€91,500
December
12,000
€75,750
The fixed portion of the monthly maintenance expense is:
(a)
(b)
(c)
(d)
€36,750
€52,500
€15,750
€12,750
The following information is relevant to parts (vii) and (viii):
Brady Limited currently has spare production capacity and is considering a short term contract which requires the following
materials:
Material
Alpha
Beta
Quantity in inventory
Original cost
1,000 kgs
500 kgs
€12.50 per kg
€8.00 per kg
Current purchase
price
€16.00 per kg
€9.25 per kg
Scrap value
€2.00 per kg
Nil
Material Alpha is in constant use by the company to manufacture its existing products. Material Beta is obsolete and if not
used on the contract it will be scrapped.
(vii)
The contract requires using 800 kgs of material Alpha. The total relevant cost of this material is:
(a)
(b)
(c)
(d)
€10,000
€1,600
€12,800
None of the above.
(viii) The contract also requires 1,000 kgs of material Beta. The total relevant cost of this material is:
(a)
(b)
(c)
(d)
€9,250
€4,000
€4,625
€8,625
[Total: 20 Marks]
Page 4
4.
Spritz Limited produces a range of spring water based fruit drinks for the health food market. The company is
currently preparing its budget for the next three months, January to March, based on a number of assumptions and
using a range of information.
(i)
Lemon Spring is manufactured in a simple production process from a blend of spring water and lemon
concentrate and sold in 500ml bottles. Projected sales for the four months are shown below.
January
42,000
€58,800
Sales units (500ml bottles)
Sales value (@ €1.40 per bottle)
February
44,000
€61,600
March
47,500
€66,500
April
48,000
€67,200
(ii)
Assume that at 1 January the company will not have any bottles of Lemon Spring in inventory. However, the
sales manager requires that at the end of each of the next six months there will be 5,000 bottles in the
warehouse to satisfy any unexpected demand.
(iii)
The company uses variable costing to value producton and the costs incurred to produce one 500ml bottle
of Lemon Spring are as follows:
€
Materials:
- Spring water (450ml @ €0.20 per litre)
0.09
- Lemon concentrate (50ml @ €0.80 per litre)
0.04
- 500ml plastic bottle
0.06
Labour (0.05hr @ €8 per hour)
0.40
Variable production overhead
0.11
0.70
(iv)
Assume that at 1 January the company will have 2,000 litres of spring water, 500 litres of lemon concentrate
and 5,000 plastic bottles in inventory. To reduce the risk of disruption to manufacturing, Spritz Limited has a
policy of maintaining the same opening and closing monthly inventory of product materials and plastic bottles.
(v)
The recommended selling price for a 500ml bottle of Lemon Spring is €1.40.
(vi)
The cost of material purchases has not changed in the past two years and is not expected to change for the
next year.
REQUIREMENT:
(a)
For the first three months of next year you are asked to:
(i)
Prepare a production budget in units.
(3 marks)
(ii)
Prepare a materials purchase budget (in units and €) for each material.
(7 marks)
(iii)
Prepare a labour cost budget (in hours and €).
(2 marks)
(iv)
Prepare a variable production overhead cost budget.
(2 marks)
(b)
Prepare a budgeted income statement based on the results you have obtained in (i) to (iv) above.
(4 marks)
(c)
Explain the term ‘flexible budget’.
(2 marks)
[Total: 20 Marks]
Page 5
5.
Preston Limited manufactures liquid plant food and uses a process costing system based on the weighted average
method to value production and inventory. There are two main processes used in the production of the plant food.
Firstly, mixing, where various compounds are combined, and then blending where the mixed materials are heated
and blended. All raw materials are introduced at the start of the mixing process and the completed output is
transferred to the blending department. No additional materials are input during the blending process. Labour and
production overheads, also called conversion costs, are incurred evenly throughout both mixing and blending
processes. Information relating to the most recent financial period is shown below:
Mixing
Nil
150,000 litres
103,000 litres
44,000 litres
Opening WIP
Inputs in period
Completed and transferred
Closing WIP
Blending
20,000 litres
106,700 litres
15,000 litres
Other information:
1.
The company expects a normal loss of 2% of materials input to the mixing process. No loss is expected to
occur in the blending process. Any losses arising can be sold for a scrap value of €0.10 per litre.
2.
Costs relating to the process are as follows:
Opening WIP
Prior process costs (from mixing process)
Conversion costs
Input to process
Materials
Conversion costs
Mixing
€
Blending
€
Nil
12,476
1,920
34,845
40,761
Nil
40,815
3.
Opening work in progress in the blending department was fully complete in terms of prior process costs and
40% complete in terms of conversion costs.
4.
Closing work in progress in the mixing department was fully complete in terms of materials and 60% complete
in terms of conversion costs. Closing work in progress in the blending department was fully complete in
terms of prior process costs and 50% complete in terms of conversion costs.
REQUIREMENT:
(a)
Prepare the following completed accounts for the most recent financial period. You must show all workings clearly.
(i)
(ii)
(iii)
(iv)
(b)
Mixing process account
Blending process account
Normal loss account
Abnormal loss/Abnormal gain account
(18 marks)
Explain the difference between a normal loss and an abnormal loss.
(2 marks)
[Total: 20 Marks]
Page 6
6.
Expert Solutions provides a range of project management services to clients, ranging from one-off design of
buildings to overall development, and ongoing supervision in completion of structures. As it is a service company
it incurs only labour and overhead costs. Expert Solutions have two categories of labour cost, technical and
secretarial support. To allocate labour costs to jobs, separate technical labour and secretarial support labour rates
are calculated and applied to jobs based on hours worked. Currently the company uses traditional overhead
absorption, allocating overheads to jobs based on total labour hours worked (both technical and secretarial support).
In an attempt to improve accuracy in tendering for new jobs and to better assess profitability of existing contracts,
Expert Solutions is considering adopting an activity based costing (ABC) approach to overhead allocation. Last year,
to facilitate the adoption of ABC, the firm employed accountants to research and compile the detailed information
required. Four main cost types or pools were identified: design costs, planning costs, supervision costs and sundry
completion costs. The following budgeted information is available for the year ahead:
Cost pool
Design costs
Planning costs
Supervision costs
Sundry completion costs
Cost driver
Number of drafts of project
Number of planning meetings
Number of site visits
Secretarial support labour hours
€
18,333
32,170
42,084
25,202
Technical labour cost
Secretarial support labour cost
Technical labour hours
Secretarial support labour hours
Number of drafts of projects
Total site visits
Number of planning meetings
€245,000
€162,015
1,960
9,258
378
560
250
Details relating to two jobs undertaken by Expert Solutions are as follows:
Kildare
€10,000
50
67
5
15
6
Contract price agreed
Technical labour hours
Secretarial support labour hours
Number of drafts of project
Site visits
Planning meetings
Meath
€10,000
45
49
7
30
10
REQUIREMENT:
(a)
Calculate the total cost of each of the two jobs noted above using:
(b)
(i)
The costing approach currently used by Expert Solutions.
(ii)
Activity based costing.
(6 marks)
(11 marks)
Compare and comment on your answers in (a)(i) and (ii) above.
(3 marks)
[Total: 20 Marks]
END OF PAPER
Page 7
SUGGESTED SOLUTIONS
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - AUGUST 2014
SOLUTION 1
WORKINGS
W1 Calculation of product cost
Under Absorption costing
€
2.25
1.50
0.60
1.96
6.31
Direct materials
Direct labour
Variable production overhead
Fixed production overhead **
Total product cost per unit
Fixed production overheads per year (€29,400 x 12)
Normal production capacity per year (15,000 units x12)
Fixed production overhead absorption rate per unit **(FOAR)
€352,800
180,000
€1.96
Under Variable costing
€
2.25
1.50
0.60
4.35
Direct materials
Direct labour
Variable production overhead
Total product cost per unit
W2 Calculation of changes in inventory
Opening inventory
Production
Total inventory available
Sales
Closing inventory
W3 Calculation of Under/Over absorbed overheads
Actual fixed production overhead
Absorbed fixed production overhead (Units produced x FOAR)
Under/(over) absorbed overhead
Page 8
July
units
0
13,000
13,000
12,000
1,000
August
units
1,000
15,000
16,000
16,000
0
July
€
29,400
25,480
3,920
August
€
29,400
29,400
0
W4 Separation of fixed and variable selling and administrative expenses
Sales volume
Total selling and
administrative
expenses
Total variable
selling and
admin expense
Total fixed selling
and admin
expenses
Total Selling and
admin expenses
July
August
12,000
€
16,000
€
45,200
57,600
37,200
49,600
8,000
8,000
45,200
57,600
Change in
€
Change in
sales units
4,000
Variable cost
per unit
Fixed cost
€
€
€
12,400
3.10
8,000
(7.5 marks)
(a)
Profit statements for Ludo Limited for the months of July and August
Using Absorption costing (Product cost = €6.31 see W1)
Sales
Cost of Sales:
Opening stock
+ Production
- Closing stock (see W2)
July
€
240,000
0
82,030
6,310
Under/(over) absorbed overhead (see W3)
Gross profit
Total selling and administrative expenses
Profit
August
€
320,000
6,310
94,650
0
75,720
100,960
3,920
160,360
45,200
115,160
0
219,040
57,600
161,440
July
€
240,000
August
€
320,000
Using Variable costing (Product cost = €4.35 see W1)
Sales
Cost of Sales:
Opening stock
+ Production
- Closing stock (see W2)
Production cost of sales
0
56,550
4,350
4,350
65,250
0
52,200
69,600
Variable selling and administrative expenses (see W4)
Contribution
Fixed costs
Production overhead costs
29,400
Selling and administrative expenses (see W4)
8,000
37,200
150,600
49,600
200,800
Profit
113,200
37,400
29,400
8,000
37,400
163,400
(12.5 marks)
Page 9
(b)
Reconcilation of Absortion and Variable costing profit figures
July
€
115,160
Profit per absorption costing
Aug
€
161,440
Adjustment for fixed production overhead in inventory
(0 - 1,000)*€1.96
(1,000 - 0) * €1.96
Profit per variable costing
-1,960
113,200
1,960
163,400
(3 marks)
(c)
Explain the effect on profit of using Absorption or Variable costing
In relation to the effect of absorption costing and variable costing on profit, the details are as follows:
-
If sales are greater than production then the use of absorption costing will show lower profit than if
variable costing is used because product cost includes fixed production overhead and so more fixed
production overhead is included in the income statement thus reducing profit.
-
Similarly, if production is greater than sales then the use of absorption costing will show higher profit
than if variable costing is used because less fixed production overhead will be included in the income
statement so that profit will be greater.
-
If sales volume equals production volume then profits calculated using absorption costing will be the
same as profits calculated using variable costing.
(2 marks)
[Total: 25 Marks]
Page 10
SOLUTION 2
(A)
(i)
Factors that have contributed to the growth and importance of management accounting
Management accounting has grown and become more important as a result of the following factors:
Changing cost structures – in the past materials and labour comprised the highest product costs but
this has changed, in many cases overheads are now more significant and need to be carefully
monitored. Management accounting facilitates the monitoring and control of costs.
Increased competition – it is now more important than ever to have accurate cost information as
companies are competing not just in terms of product price but also other factors such as product quality
and customer service. Access to accurate produce cost information allows companies to focus attention
away from pricing to other significant factors.
Global market – with improvements in transportation and communication the market for customers has
expanded and so too have company operations. Management accounting enables cost information to
be provided and analysed across divisions, segments and countries to support overall activities of the
company.
Internet opportunities – the arrival of the internet has brought more opportunity to buy and sell products
and services more easily, and to monitor competitors and consumer trends. Management accounting
may be applied to gather cost information from all sources easily.
Changing customer needs – customers have become more discerning and it is now more important to
have pertinent information relating to customers and their profitability to a business. Management
accounting allows companies to use cost information and techniques to obtain data on the cost of
providing services to customers.
Changing product lifecycles – due to intense competition and changing customer needs product
lifecycles are becoming shorter. Companies need to be ready and able to introduce new products quickly
and management accounting can facilitate this process by providing essential information for costing
and decision making.
Any other relevant point
(4 marks)
(ii)
The difference between financial accounting and management accounting
There are a number of areas where financial accounting differs from management accounting:
•
Financial accounting has an external focus. It is designed to provide information to users who are
external to an organisation, whereas management accounting has an internal focus. It is designed to
assist company managers in planning, controlling and decision-making activities.
•
There is a legal requirement for companies to prepare financial statements while there is no legal
requirement to prepare management accounts.
•
Financial accounting focuses on the organisation as a whole while management accounting information
may focus on many areas as required by the company.
•
Financial accounting information is presented in a format prescribed by law and by accounting
standards, whereas the layout and substance of management accounting information is decided by
company management.
•
Usually most financial accounting information is expressed in monetary terms however management
accounting information may include both monetary and non-monetary information.
•
Financial accounting information provides information on what has happened in the past, while
management accounting may be used for planning purposes and also for presenting information on past
activities.
(4 marks)
(iii)
The role of the management accountant in enhancing and improving a business
As part of his/her role the management accountant provides information to facilitate a range of activities
including:
Allocation of costs between cost of goods sold and inventories
It is important to allocate costs to products as accurately as possible in order to establish the profitability of
the business. The management accountant ensures that cost information is collected and correctly allocated
to cost of sales or inventories as appropriate. The management accountant may use techniques such as
activity based costing to allocate overheads to products or the first in first out (FIFO) method to value inventory.
Page 11
Planning and controlling
To carry out their roles effectively the various managers in a business require information to assist them in
planning and controlling the operations of the organisation. Planning involves translating goals and objectives
into the specific activities and resources that are required to achieve the goals and objectives. The
management accountant is involved in the preparation of both long term and short term plans. Budgets are
short-term plans that are prepared in more detail than longer term plans. Control involves the process of
ensuring that actual outcomes conform to planned or expected outcomes. Budgets may be used to support
the controlling of activities by providing a measure against which actual performance may be compared.
Performance measurement
The management accountant generates periodic reports, which compare actual performance to plan, and
provides these to managers enabling them to determine if operations are proceeding as expected and to
identify where corrective action may be required. These periodic reports also allow managerial performance
to be evaluated and provide incentives for managers to try to achieve favourable results.
Decision making
Managers also require information to assist them with routine and non-routine decision making. Routine
decisions relate to issues such as assessing the profitability of different segments of an organisation such as
products, services and customers. Non-routine decisions are made infrequently and may relate to strategic
issues such as the introduction of new products or services. The information provided by the management
accountant to support these decisions may be financial or non-financial in nature, depending on what best
meets the needs of management. In many instances cost information accumulated by the management
accountant is relied upon to inform decisions, and therefore it is critical that such information be of a high
quality.
(7 marks)
[Total: 15 Marks]
(B)
Report
TO: Managing Director, Brandon Limited
FROM: A Management Accountant
RE: Cost terms and their importance in Management Accounting
Date: August 2014
This report has been prepared in response to your request for information regarding cost terms and their importance
and application in management accounting. The report consists of two sections, the first section defines commonly
used management accounting cost terms, providing examples to more clearly explain their meaning. The second
section outlines why it is important to understand these cost terms, indicates why they are important and how they
are used in management accounting.
(i)
Definitions of commonly used cost terms in management accounting
Cost object – this is any activity for which a measurement of cost is required. For example, the cost of a tin
of paint, the cost of maintaining a bank account, the cost of operating a particular department, etc.
Direct costs – these are costs that can be specifically and exclusively identified with a particular cost object.
For example, if it takes 1kg of material to make each unit of product then the material cost is called a direct
cost as there is a specific, identifiable relationship between the material and the manufacture of the product.
Indirect costs – contrary to direct costs, these are costs that cannot be specifically and exclusively identified
with a cost object. For example, if a company employs casual workers in the factory to keep it clean and tidy
the cost of this staff is considered to be an indirect labour cost as no specific identifiable relationship can be
established
between
the
manufacture
of
a
product
and
these
labour
costs.
Variable costs – costs are classified as variable when they vary in direct proportion to the volume of activity.
For example, staff paid on a piecework basis so that the more they produce the higher the labour cost.
Fixed costs – are costs that remain constant over a wide range of activity for a specific time period. For
example, factory rent or factory insurance may remain constant for a particular capacity or volume or time
period.
Page 12
Product costs – are those costs associated with goods purchased or manufactured for resale. In a
manufacturing organisation all manufacturing costs are considered to be product costs. In a non-manufacturing
organisation the cost of goods purchased is considered to be a product cost and all other costs are not. For
example, the cost of the wood used in in producing a table is a product cost.
Period costs – these are costs that are not associated with the manufacture of a product; they are incurred
by a company to operate its business and usually occur from year to year. For example, administration costs
such as auditors’ fees are period costs as they do not relate to the product and usually are incurred every year.
(10 marks)
(ii)
Importance of cost terms and how they are used
The cost terms described in the previous section are key building blocks in management accounting. A clear
understanding of the cost terms allows their use in many management accounting applications such as:
•
Product costing – this is where direct and indirect costs are accumulated for each product so that a
company may establish the price and profitability of the product.
•
Cost-volume-profit (CVP) analysis – by separating fixed and variable costs CVP analysis allows a
company to produce information relating to its sales volumes such as the number of units that must be
sold to cover all of its costs; the number of units that must be sold to generate a particular profit; and it
also allows a company to calculate by how much sales volumes may fall before the company starts to
make a loss.
•
Decision making – the classification of its costs into fixed and variable costs provides a company with
information that may be used for a variety of decisions including whether to make a product internally
or outsource; how much to price a special order; whether to discontinue a particular business segment
or division; whether to replace non-current assets; and how best to use scarce resources.
•
Budgeting and variance analysis – using product and period costs a company may prepare a budget
for a particular period. This budget provides a plan for the period under review and by comparison with
actual costs incurred facilitates the company in controlling its costs.
I hope this report clearly explains the commonly used cost terms in management accounting, why they are important
and how they are used. If you have any further queries related to anything mentioned in this report, please do not
hesitate to contact me.
Yours sincerely,
A Management Accountant
Mark awarded for use of report format and presentation
(1 mark)
(4 marks)
[Total: 15 Marks]
Page 13
QUESTION 3
(i)
Answer (b)
Prime cost = direct materials plus direct labour plus direct expenses.
(ii)
Answer (a)
Overhead absorption rate = €238,700/31,000 machine hours = €7.70 per machine hour
Actual overhead for August
Absorbed overhead for August = 29,000 machine hours x €7.70 =
Under absorbed overhead
(iii)
€255,400
€223,300
€ 32,100
Answer (b)
Materials price variance = (SP – AP) x AQ
(SP – (€132,912/56,800)) x 56,800 = 1,136
56,800 SP = 132,912 + 1,136
SP = 2.36
Materials usage variance = (SQ – AQ) x SP
(SQ -56,800) x 2.36 = -1,180
2.36 SQ = 134,048-1180
SQ = 56,300
SQ = 2kg for each unit => 56,300/2 = 28,150 units
(iv)
Answer (c)
A JIT system aims to reduce inventory to a minimum but does not guarantee that no inventory is held by a
company.
(v)
Answer (d)
During inflationary periods closing inventory calculated using LIFO is valued at the lowest prices.
(vi)
Answer (d)
Volume
Highest month of activity
Lowest month of activity
Difference
September
March
15,000 units
5,000 units
10,000 units
Maintenance
Expenses
€91,500
€39,000
€52,500
Variable overhead = €52,500/10,000 = €5.25 per unit
Fixed overhead = €91,500 – (15,000 x €5.25) = €12,750
(vii)
Answer (c)
The original cost of material Alpha is a sunk cost. As material Alpha is being used regularly to make existing
products, the company will have to purchase more at the current purchase price if it uses any of the existing
inventory. Hence the cost of using material Alpha for the contract is:
800 kg x €16 = €12,800
(viii) Answer (c)
The original cost of material Beta is a sunk cost. Material Beta is considered by the company to be obsolete
and has no scrap value so if the company were to use all 500 kg in inventory for the contract there would be
a zero cost. However, the contract requires 1,000 kg of material Beta so it must purchase an additional 500
kg at the current purchase price of €9.25 per kg. Hence the cost of using material Beta for the contract is: 500
kg x 0 + 500 kg x €9.25 = €4,625.
[Total: 20 Marks]
Page 14
SOLUTION 4
(a)
(i)
Production Budget in units (500ml bottles)
January
42,000
Sales
Closing Inventory
5,000
47,000
Less opening Inventory
0
Production required in 500ml bottles
47,000
Production required in litres
(ii)
23,500
February
44,000
5,000
49,000
5,000
44,000
March
47,500
5,000
52,500
5,000
47,500
April
48,000
5,000
53,000
5,000
48,000
22,000
23,750
24,000
Materials Purchase Budget
Each 500ml bottle contains 450ml or 90% spring water and 50ml or 10% lemon concentrate
Spring water
Production in litres
Spring water required per
500ml bottle i.e 90%
Closing Inventory
Less opening Inventory
Purchases required
Cost @ €0.20 per litre
Total Cost
January
23,500
February
22,000
March
23,750
21,150
2,000
23,150
2,000
21,150
€ 0.20
€ 4,230
19,800
2,000
21,800
2,000
19,800
€ 0.20
€ 3,960
21,375
2,000
23,375
2,000
21,375
€ 0.20
€ 4,275
Total spring water purchases
€ 12,465
Lemon concentrate
Production in litres
Lemon concentrate per
500ml bottle i.e 10%
Closing Inventory
January
23,500
February
22,000
March
23,750
Less opening Inventory
Purchases required
Cost @ €0.80 per litre
Total Cost
2,350
500
2,850
500
2,350
€ 0.80
€ 1,880
2,200
500
2,700
500
2,200
€ 0.80
€ 1,760
2,375
500
2,875
500
2,375
€ 0.80
€ 1,900
Total lemon concentrate purchases
€ 5,540
February
44,000
5,000
49,000
5,000
44,000
€ 0.06
€ 2,640
March
47,500
5,000
52,500
5,000
47,500
€ 0.06
€ 2,850
Plastic bottles
Production in 500ml bottles
Closing Inventory
Less opening Inventory
Purchases required
Cost @ €0.06 per bottle
Total Cost
Total plastic bottle purchases
January
47,000
5,000
52,000
5,000
47,000
€ 0.06
€ 2,820
€ 8,310
Tutorial Note: For each of the ingredients the opening inventories and closing inventories are the same, hence,
the above calculations may be computed by excluding these and just using production quantities.
(7 marks)
Page 15
(iii)
Labour cost budget
Production in 500ml bottles
Cost to produce each bottle
Production labour cost
Total production labour cost
January
47,000
€ 0.40
€ 18,800
€ 55,400
February
44,000
€ 0.40
€ 17,600
March
47,500
€ 0.40
€ 19,000
(2 marks)
(iv)
Variable overhead budget
Production in 500ml bottles
Cost to produce each bottle
(from Question)
Variable overhead cost
Total variable overhead cost
January
47,000
€ 0.11
February
44,000
€ 0.11
March
47,500
€ 0.11
€ 5,170
€ 15,235
€ 4,840
€ 5,225
(2 marks)
(b)
Budgeted Income statement
Sales
Cost of Sales
Opening Inventory
+Production Cost
-Closing Inventory
Cost of sales
Gross Profit
€ 186,900
Note 1
Note 2
Note 3
€ 1,100
€ 96,950
€ 98,050
€ 4,600
€ 93,450
€ 93,450
Note 1
Opening Inventory
Spring water
Lemon concentrate
Plastic bottles
Quantity
2,000
500
5,000
Cost
€ 0.20
€ 0.80
€ 0.06
Note 2
Production Cost (from (a) (i) to (iv))
Spring water
Lemon concentrate
Plastic bottles
Labour
Variable overheads
Note 3
Closing Inventory
Lemon Spring
Spring water
Lemon concentrate
Plastic bottles
Value
€ 400
€ 400
€ 300
€ 1,100
€ 12,465
€ 5,540
€ 8,310
€ 55,400
€ 15,235
€ 96,950
Quantity
5,000
2,000
500
5,000
Cost
€ 0.70
€ 0.20
€ 0.80
€ 0.06
Value
€ 3,500
€ 400
€ 400
€ 300
€ 4,600
(4 marks)
(c)
Explain the term 'flexible budget'
A flexible budget is a budget which, by recognising the difference in behaviour between variable and fixed
overheads in relation to changes in volume, turnover or other variable factors, is designed to change in
accordance with such fluctuations.
(2 marks)
[Total: 20 Marks]
Page 16
SOLUTION 5
Workings
Mixing process
Inputs
Equivalent units
Total
Physical
Units
Litres
0
150,000
150,000
Litres
Labour &
Overheads
Litres
44,000
3,000
103,000
150,000
44,000
0
103,000
147,000
26,400
0
103,000
129,400
Costs
Total costs incurred (given in question)
Less scrap value of normal loss (3,000 x €0.10)
Total costs to be allocated
€75,306
€34,845
-€300
€34,545
€40,761
€0.235
€0.315
Opening WIP
Materials input
Outputs
Closing WIP (100% / 60% complete)
Normal loss (2% x materials input)
Transferred to blending process
Cost per equivalent unit
Materials
€40,761
Allocation of costs
Valuation of output transferred to blending process = 103,000 litres x €0.55 per litre =
Valuation of closing WIP (44,000 litres)
Materials: 44,000 litres x €0.235 =
Conversion costs: 26,400 litres x €0.315 =
Total Costs
Opening WIP
Materials transferred from mixing
Outputs
Completed and transferred
Closing WIP
Abnormal loss
Opening WIP (given in question)
Prior process costs transferred in
Costs incurred (given in question)
Total costs to be allocated
€56,650
€10,340
€8,316
€18,656
€75,306
Blending process
Inputs
€0.550
Equivalent units
Total
Physical
Units
Litres
20,000
103,000
123,000
Mixing
process
costs
Litres
Labour &
overheads
Litres
106,700
15,000
1,300
123,000
106,700
15,000
1,300
123,000
106,700
7,500
1,300
115,500
€12,476
€56,650
€1,920
€111,861
Cost per equivalent unit
Page 17
€69,126
€40,815
€42,735
€0.562
€0.370
€0.932
Allocation of Costs
Valuation of finished output transferred: 106,700 litres @ €0.932 per litre
Valuation of abnormal loss : 1,300 litres x €0.932 per litre
=
=
Valuation of closing WIP (15,000 litres 50% complete in terms of conversion costs)
Prior process costs: 15,000 litres x €0.562 =
Conversion costs: 7,500 litres x €0.370 =
Total cost
€99,444.40
€1,211.60
€8,430
€2,775
€11,205
€111,861
(12 marks)
(a) (i)
Inputs
Materials
Labour & overhead
Litres
150,000
Mixing process account
€
Normal loss
34,845
Transferred to blending
40,761
Process
Closing WIP
150,000
75,606
Litres
3,000
€
300
103,000
56,650
44,000
150,000
18,656
75,606
Litres
106,700
1,300
15,000
€
99,444
1,212
11,205
123,000
111,861
Litres
3,000
€
300
3,000
300
Litres
1,300
€
130
1,082
1,212
(a) (ii)
Opening WIP
- Prior process costs
- Conversion costs
Transferred in from mixing
Conversion costs
Litres
20,000
103,000
123,000
Blending process account
€
Completed & transferred
12,476
Abnormal loss
1,920
Closing WIP
56,650
40,815
111,861
(a) )iii)
Mixing process account
Litres
3,000
3,000
Normal loss account
€
300
Cash for units scrapped
300
(a) (iv)
Mixing process account
Litres
1,300
1,300
Abnormal loss account
€
1,212
Cash for units scrapped
Income statement
1,212
1,300
(6 marks)
(b)
Difference between a normal loss and an abnormal loss
A normal loss arises under efficient operating conditions. It is expected and is unavoidable or uncontrollable.
For example, evaporation of liquids or offcuts of wood. A normal loss must be carefully monitored
to ensure that it can be fully explained.
An abnormal loss is not an inherent part of the production process. It arises from inefficiencies and is
avoidable or controllable. This loss should be fully investigated and corrective action should be taken to
ensure that it does not re-occur.
(2 marks)
[Total: 20 Marks]
Page 18
SOLUTION 6
(a)
(i)
Total job cost using traditional overhead costing approach
Workings
W1 Labour rates per hour
Technical labour
Total labour cost
Total labour hours
€245,000
1,960
Secretarial
Support
€162,015
9,258
€125.00
€17.50
Labour rate per hour
Total
€407,015
11,218
W2 Overhead rate per hour
€
18,333
32,170
42,084
25,202
117,789
Design costs
Planning costs
Supervison costs
Sundry completion costs
Total overhead cost
Total labour hours (technical & support)
11,218
Overhead rate per labour hour
€10.50
Cost of Jobs using traditional overhead absorption costing
Technical labour cost (@ €125 per hr) (W1)
Secretarial support labour (@ €17.50 per hr) (W1)
Overheads(@ €10.50 per hr) (W2)
Total job cost
Kildare
€
6,250.00
1,172.50
1,228.50
8,651.00
Meath
€
5,625.00
857.50
987.00
7,469.50
(6 marks)
(ii)
Total job cost using activity based costing approach
W3 Calculation of cost per driver
Activity
Design costs
Planning costs
Supervison costs
Sundry completion costs
Cost driver
No of project drafts
No of planning meetings
No of site visits
Secretarial support hours
Cost
(x)
€
18,333
32,170
42,084
25,202
117,789
Total of drivers Cost per driver
(y)
(x/y)
€
378
48.50
250
128.68
560
75.15
9,258
2.72
W4 Calculation of total overhead cost for each job
Design costs (No. of drafts @€48.50 per draft) (W3)
Planning costs (No. of planning meetings @€128.68 per meeting) (W3)
Supervison costs (No. of site visits @€75.15 per visit) (W3)
Sundry completion costs (No. of secretarial hours@€2.72 per hr)(W3)
Total overhead cost
Page 19
Kildare
€
242.50
772.08
1,127.25
182.24
2,324.07
Meath
€
339.50
1,286.80
2,254.50
133.28
4,014.08
Calculation of total job cost
Kildare
€
6,250.00
1,172.50
2,324.07
9,746.57
Technical labour cost (as for (a) (i))
Secretarial support labour cost (as for (a)(i))
Overheads (W4)
Total job cost
Meath
€
5,625.00
857.50
4,014.08
10,496.58
(11 marks)
(b)
Comparison of costs
Kildare
Meath
Traditional/
Existing approach
€
8,651.00
7,469.50
ABC approach
Difference
€
9,746.57
10,496.58
€
-1,095.57
-3,027.08
Comments
ABC is a more accurate method of absorbing overheads into the cost of products and services.
In relation to the 2 jobs undertaken by Expert solutions:
In (a) (i) the traditional absorption costing approach suggests that the Kildare job has a higher cost than the Meath
job.
However, when ABC is applied as in (a) (ii) the Meath job is shown to be much more costly.
The company is making a very small profit on the Kildare job (€10,000 - €9,746.57 = €253.43) and is making a loss
on the Meath job (€10,000 - €10,496.58 = €-496.58. This suggests that the company needs to use ABC so as to
more accurately cost its job contracts and earn a higher profit.
(3 marks)
[Total: 20 Marks]
Page 20