MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - APRIL 2011
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 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 2011
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.
Montrose Ltd manufactures plastic containers for the pharmaceutical industry. The factory, in which the company
undertakes all of its production, has two production departments – ‘Cutting’ and ‘Shaping’, and two service
departments –‘Stores’ and ‘Maintenance’.
The information provided below has been extracted from the company’s budget for the next financial year which
ends on 31 March 2012:
Allocated Overhead Costs
Cutting Department
Shaping Department
Stores Department
Maintenance Department
€
14,000
16,000
3,500
2,800
Other Production Overheads
Factory rent
Factory building insurance
Plant & machinery insurance
Plant & machinery depreciation
Canteen subsidy
€
525,000
70,000
39,000
58,500
150,000
Direct Costs
Cutting Department
Shaping Department
€
144,000
210,000
The following additional information is also provided:
Cutting Dept.
Shaping Dept.
Floor area (square metres)
18,000
12,000
Value of Plant & Machinery (€)
300,000
50,000
Number of stores requisitions
1,000
500
Maintenance hours required
2,700
2,000
Number of employees
34
60
Machine hours
12,000
2,200
Labour hours
9,000
15,000
Stores Dept.
3,000
25,000
Maintenance Dept.
2,000
15,000
300
4
2
REQUIRED:
(a)
Prepare an overhead analysis sheet based on the above information.You must clearly state the basis used for any
apportionments.
(8 marks)
(b)
Re-apportion the service department costs and calculate the most appropriate overhead rate for each department.
(Rate should be calculated to two decimal places).
(4 marks)
Page 1
(c)
Using the rates calculated in part (b) calculate the full production costs of the following job and the selling price if
the company requires a margin of 20%:
JOB NUMBER A1234
Direct Materials
Direct Labour
Cutting Department
Shaping Department
Machine hours required
Cutting Department
Shaping Department
(d)
€100
10 hours at €16 per hour
15 hours at €14 per hour
20 hours
12 hours
(4 marks)
During the year ended 31 March 2012, the following hours were actually worked and the following actual costs
actually incurred:
Department
Cutting
Shaping
Labour Hours
8,000
16,000
Machine Hours
14,000
3,000
Overhead costs incurred
€531,500
€405,500
Calculate the over/under absorbed overhead for each of the two departments for the year ended 31 March 2012.
(Your answer must clearly indicate whether the company has over/under absorbed in each instance).
(3 marks)
(e)
Explain what is meant by the term “blanket overhead rate”.
(3 marks)
(f)
State three reasons why companies calculate pre-determined overhead absorption rates.
(3 marks)
[Total: 25 marks]
Page 2
ANSWER PART (A) OR PART (B)
2.
(a)
You are the Trainee Management Accountant with Nevada Ltd, a company involved in the production of a large
number of products for the sport and leisure industry in Ireland.
The Managing Director of Nevada Ltd, Mrs Rosaleen Kelly, has just returned from a conference in London where
the theme of the conference was “Activity Based Costing (ABC) in the modern environment”. Mrs Kelly would like
to develop a better understanding of ABC before deciding on whether or not to implement it into Nevada Ltd.
REQUIRED:
Prepare a memorandum for Mrs Kelly explaining the following factors:
(i)
The factors that led to the emergence of ABC.
(4 marks)
(ii)
The advantages and disadvantages of adopting ABC in Nevada Ltd.
(8 marks)
(iii)
How ABC can be used to eliminate non-value added costs in Nevada Ltd.
(3 marks)
[Total: 15 Marks]
OR
(b)
Mr. Mark Crehan, a Certified Public Accountant, is in the process of preparing the budget for Chicago Ltd for the
forthcoming financial period. The company currently uses an incremental approach to budgeting but in the current
economic environment Mr. Crehan would like to investigate other budgeting systems, which may improve both the
planning and control processes within the organisation. One of Chicago Ltd’s main competitors, Alaska Ltd, has
recently introduced Zero Based Budgeting (ZBB) to their organisation. Mr Crehan would like to develop a better
understanding of Zero Based Budgeting before deciding on whether to recommend to the Board of Directors the
adoption of this budgeting technique.
REQUIRED:
You are required to prepare a memorandum for Mr. Crehan outlining the following issues:
(i)
The stages involved in Zero Based Budgeting (ZBB).
(4 marks)
(ii)
The advantages and disadvantages of adopting a system of Zero Based Budgeting (ZBB).
(8 marks)
(iii)
The problems that Mr. Crehan may face, from current employees, from changing the budgeting system to one
based on Zero Based Budgeting principles.
(3 marks)
[Total: 15 marks]
Page 3
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. Give your answers to each section on the answer sheet provided.
1.
Alpha Ltd is currently preparing the budget for the next financial period. Due to the current economic conditions the
company is unsure what activity level to expect in the forthcoming period and has therefore decided to prepare three
different budgets based on different activity levels. The following is a summary of the activity levels with their related
total costs:
Activity level
50,000 units
65,000 units
72,000 units
Total costs
€320,000
€395,000
€430,000
What is the budgeted value of fixed costs for the forthcoming period?
(a)
€50,000
(b)
€60,000
(c)
€70,000
(d)
€80,000.
2.
Donegal Ltd has just completed its budget for 2012. An extract from the budget is as follows:
Sales revenue
Variable costs
Fixed production overheads
Fixed selling overhead
€1,000,000
€450,000
€275,000
€55,000
What is the break-even revenue value?
(a)
€600,000
(b)
€550,000
(c)
€700,000
(d)
Not enough information provided to calculate.
3.
Which of the following statements is true?
(a)
Overtime premium for direct workers is always classified as a direct cost.
(b)
Overtime premium for direct workers is only classified as a direct cost if the overtime is worked as a specific
request by a customer to finish a job.
(c)
Overtime premium for direct workers is always classified as a production overhead.
(d)
Overtime premium for direct workers is never classified as a direct cost.
4.
Dingle Ltd uses an integrated accounting system. The following information is provided in relation to the financial
period just ended:
Overheads are absorbed using a plant wide rate of €10 per labour hour.
Actual overheads incurred were €500,000.
Actual labour hours worked were 45,000.
Which of the following double entry transactions is correct?
(a)
(b)
(c)
(d)
Debit
Production overhead a/c €450,000
Work-In-Progress a/c €500,000
Production overheads a/c €500,000
Work-In-Progress a/c €450,000
Credit
Work-In-Progress a/c €450,000
Production overhead a/c €500,000
Work-In-Progress a/c €500,000
Production overhead a/c €450,000
Page 4
5.
Ballagh Ltd use marginal costing principles for the purpose of preparing management accounts. For the period
just ended the company recorded a profit of €75,000. Opening inventory was 200 units and closing inventory was
700 units. If absorption costing principles were used, the fixed production overhead absorption rate would equal €8
per unit.
What profit would Ballagh Ltd have recorded using absorption costing principles?
(a)
€79,000
(b)
€71,000
(c)
€76,600
(d)
€69,400
6
In a limiting factor situation which of the following statements is true?
(a)
A company should produce the product that uses the largest amount of the scarce resource first in order to
maximise its profits.
(b)
A company should produce the product with the highest profit first in order to maximise its profits.
(c)
A company should produce the product with the highest contribution per scarce resource first in order to
maximise its profits.
(d)
A company will maximise its profits regardless of the product mix chosen.
7
Kilcarr Ltd is preparing its variance analysis for March 2011, during which it produced 5,000 units and sold 4,500
units. The following information relates to materials for the month of March 2011:
Standard material for one unit
4.5 kgs at €20 per kg
Actual results
Materials purchased
20,000 kg’s at €25 per kg
There was no opening inventory at the start of March and all materials purchased were used in production.
What were the material price and material usage variances for March 2011?
(a)
(b)
(c)
(d)
8.
Material price variance
€100,000 Adverse
€125,000 Favourable
€100,000 Favourable
€100,000 Adverse
Material usage variance
€62,500 Adverse
€50,000 Favourable
€50,000 Favourable
€50,000 Favourable
Which of the following statements best describes the term “principal budget factor?”
(a)
It is the factor that restricts the activities of an organisation and must be identified at the start of the budgeting
process.
(b)
It is the factor which restricts the amount of cash a company can borrow.
(c)
It is the factor that gives the company a competitive advantage in the market in which it operates.
(d)
It is the factor that allows a company to meet any increase in demand from customers.
[Total: 20 marks]
Page 5
4.
Cong Ltd is involved in the production and sale of “Quickdry”, a product used in the building industry. The company
operates a standard marginal costing system. Details of the budgeted results and actual results for Cong Ltd for
the month of March 2011 are as follows:
Budget
6,000
€600,000
24,000 kgs
€240,000
18,000 hours
€216,000
€100,000
Sales/production in units
Total sales revenue
Total materials (kgs)
Material cost
Total labour hours
Total labour cost
Fixed production overheads
Actual
5,500
€660,000
24,750 kgs
€222,750
15,125 hours
€211,750
€110,000
REQUIRED:
(a)
Prepare the standard cost card for one unit of “Quickdry”.
(b)
(c)
(d)
(2 marks)
Prepare an operating statement reconciling the budget contribution to the actual profit for the month of March 2011.
(11 marks)
Cong Ltd currently uses attainable standards but is investigating using ideal standards.
Explain each of the terms in bold above.
(4 marks)
State three advantages of operating a system of standard costing.
(3 marks)
[Total: 20 marks]
5.
Clontarf Ltd commenced business on 1st January 2011 making one product only, which sells for €160 per item.
The production and sales data for each of the first three months of 2011 was as follows:
Sales in units
Production in units
January
2,400
2,700
February
2,500
2,400
March
3,800
4,000
Actual/budget information for each month was as follows:
Direct materials
Direct labour
Variable production overheads
Sales commission
Fixed production overheads
Fixed selling overheads
3 kilograms at €5 per kilogram
4 hours at €10 per hour
150% of direct labour
10% of sales value
€10,000
€35,000
There was no opening inventory at the start of January. Fixed production overheads are budgeted at €120,000 per
annum and are absorbed into products based on a budgeted normal output of 30,000 units per annum.
REQUIRED:
(a)
Prepare a profit statement for each of the three months using absorption costing principles.
(6 marks)
(b)
Prepare a profit statement for each of the three months using marginal costing principles.
(8 marks)
(c)
Present a reconciliation of the profit or loss figures given in your answer to (a) and (b) together with an explanation
of the reason for the difference.
(3 marks)
(d)
The Managing Director of Clontarf Ltd stated at a recent board meeting that “the company should consider using
marginal costing principles for the preparation of financial statements as this would provide better information for
shareholders”.
Discuss the above statement.
(3 marks)
[Total: 20 marks]
Page 6
6.
Roscommon Plc is involved in the design and manufacture of custom built factory equipment. The company has
just received an enquiry about the supply of 10 machines from one of their regular clients, Boyle Ltd. Boyle Ltd has
informed the company that the maximum price they are willing to pay for each machine is €7,000.
The following details relates to the production of the machines:
1.
Each machine would require 10 units of Material A, which is used regularly by the company. The company
has 120 units of Material A in stock, which originally cost €150 per unit. The replacement cost of Material A
is €170 per unit.
2.
Each machine would also require 5 units of Material B. The company has 50 units of Material B in stock, as
it was purchased a few years ago for use in the production of other equipment which the company no longer
produces. The original purchase price for the units of Material B, in stock, was €200 per unit. The replacement
cost of Material B is €160 per unit. The net realisable value for the units of Material B in stock is €140.
3.
Each machine would require 8 units of Material C, a material that the company has never used. The purchase
cost per unit of Material C is €250.
4
10 skilled hours, per machine, would be required. Skilled workers are paid €20 per hour and are part of the
permanent work-force. At present there are 100 paid surplus skilled hours per month.
5.
20 unskilled hours, per machine, would be required. Unskilled workers are paid €12 per hour and are
employed on a casual basis.
6.
A supervisor, with the necessary experience in the production of similar machines, who is currently paid
€40,000 per annum, would be transferred to the job. This would necessitate the hiring of a replacement
supervisor for the duration of the contract at a cost of €7,000.
7.
Each machine would require 15 hours processing time on the factory equipment. If the order is not accepted
then Roscommon Plc would sub-contract the factory equipment to Castlerea Ltd at a rate of €100 per hour.
The company estimates that the depreciation charge for using the factory equipment to produce the 10
machines would be €4,000.
8.
Variable overheads are absorbed at a rate of €50 per skilled labour hour.
9.
Fixed production overheads are absorbed at a rate of €30 per skilled labour hour.
10.
It is company policy to add 20% on to the production cost as an allowance against administration costs
associated with the jobs accepted.
11.
The planning department of Roscommon Plc estimates that they have incurred costs to date of €600.
REQUIRED:
(a)
The Production Manager of Roscommon Plc stated that “it is essential that in the short-run, only projects that are
generating a profit should be undertaken.”
Discuss the above statement.
(4 marks)
(b)
Determine using relevant costing principles whether or not Roscommon Plc should undertake the contract. Your
answer must include an explanation for the inclusion or exclusion of each of the above points.
(12 marks)
(c)
Discuss the importance of qualitative factors in short-term decision making.
(4 marks)
[Total: 20 marks]
END OF PAPER
Page 7
SUGGESTED SOLUTIONS
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - APRIL 2011
SOLUTION1
(a)
Nature of cost
€
36,300
Cutting
Dept
€
14,000
Shaping
Dept
€
16,000
Stores
Dept
€
3,500
270,000
70,000
39,000
58,500
150,000
878,800
180,000
36,000
30,000
45,000
51,000
446,000
45,000
24,000
5,000
7,500
90,000
322,500
30,000
6,000
2,500
3,750
6,000
66,750
4,000
1,500
2,250
3,000
43,550
Using Step-down method (all other applicable methods are also allowed)
878,000
446,000
322,500
Maint Dept
Maint hours
23,517
17,420
Stores Dept
Stores Req’s
46,242
23,121
515,759
363,041
66,750
2,613
(69,363)
0
43,550
(43,550)
0
0
Allocated
Apportioned
Rent Floor area
Building ins
P&M ins
P&M Dep
Canteen subsidy
Basis
of apportionment
€
N/A
525,000
Floor area
Value of P&M
Value of P&M
No. of employees
Total
Maint
Dept
2,800
(b)
Cutting Department
Shaping Dept
€ 515,759/12,000 M/H
€ 363,041/15,000 L/H
= € 42.98 per M/H
= € 24.20 per L/H
(c)
Direct materials
Direct labour
Cutting Dept
Shaping Dept
Prime cost
Production overheads
Cutting Dept
Shaping Dept
Full Production cost
Profit
Selling price
(d)
Cutting Department
Actual overhead cost
Overheads absorbed
Over absorbed
Shaping Department
Actual overhead cost
Overheads absorbed
Under absorbed
€
100.00
[10 L/H x € 16]
[15 L/H x € 14]
160.00
210.00
470.00
[20 M/H x € 42.98]
[15 L/H x € 24.20]
859.60
363.00
1,692.60
423.15
2,115.75
[14,000 M/H x € 42.98]
[16,000 L/H x € 24.20]
Page 9
€
531,500
601,720
70,220
€
405,500
387,200
18,300
(e)
Blanket overhead rates are where a company calculates one overhead rate for the company as a whole. Example;
A company budgets that its production overheads will be € 200,000 in the forthcoming year and total budgeted
machine hours are 50,000 and total budgeted labour hours are 25,000. The company’s pre-determined overhead
rate will equal [€ 200,000/ 50,000 M/H] € 4 per machine hour. This method is not as accurate as using individual
departmental overhead rates.
(f)
Three reasons why companies calculate pre-determined overhead rates:
(i)
(ii)
(iii)
In order to establish selling prices
For inventory valuation purposes
Facilitates the control process within an organisation
Page 10
SOLUTION 2
(a)
Memorandum
To: Mrs Rosaleen Kelly
From:Trainee Accountant
Re: ABC
(i)
Factors that led to the emergence of ABC
Activity Based Costing (ABC) was developed by Professors Cooper and Kaplan during the 1980 to address the
associated problems with the traditional system. The main factors that led to the emergence of ABC were:
The traditional system was developed at a time when direct costs were the dominant costs and overheads
•
were insignificant in the overall cost of a product. This situation had now reversed.
•
Companies were now producing a wide range of products and ABC facilitated the true cost/profitability of
products been established.
•
Companies were now competing on a global market, with cost considerations been very important.
•
Product had a short life cycle and therefore it was important to validate if products could recover costs
incurred.
(ii)
Advantages of adopting ABC
•
As Nevada Ltd produces a wide range of products the profitability/viability of each product can be established
more accurately than by using the traditional system.
•
Company will determine the most appropriate selling prices
•
ABC recognises the complexity of the modern manufacturing environment by identifying multiple cost drivers.
•
ABC will focus on the real drivers of cost and aim to eliminate/reduce them
Disadvantages of adopting ABC
•
Nevada Ltd may have problems in identifying the appropriate cost pools/drivers.
•
ABC is more complex and expensive than the traditional system.
•
ABC does not have one method for dealing with common costs such as factory rent
•
The implementation of ABC may be met with resistance from existing employees who view it purely as a cost
reduction method and may fear for their jobs
(iii)
Eliminate non-value added costs
The implementation of ABC would require Nevade Ltd to establish multiple cost pools and assign the relevant costs
to each of these pools. Nevade Ltd could examine each cost pool and try and reduce/eliminate costs which do not
add value to the products, e.g. moving costs, storage costs.
(b)
Memorandum
To: Mr Mark Crehan
From:Trainee Accountant
Re: ZBB
(i)
Stages involved in ZBB
There are four distinct stages involved in ZBB
•
Managers should identify the activities that can be individually evaluated within their responsibility centres.
•
Each individual activity identified is called a decision package. Each decision package should be evaluated
in terms of resources required, costs involved and revenues expected.
•
Management will then evaluate each decision package using cost/benefit analysis.
•
The packages selected are then allocated the required resources.
(ii)
Advantages of adopting ZBB
•
ZBB requires a questioning attitude to all areas of a company and this can lead to cost savings or elimination
of inefficient and obsolete activities.
•
Motivational levels by staff can increase as ZBB requires significant staff involvement.
•
It ensures that resources are only allocated to decision packages that are efficient/economically viable.
•
It reduces the risk of budgetary slack and can eliminate wasteful expenditure.
Page 11
Disadvantages of ZBB
•
It may be difficult to identify, evaluate and rank decision packages. It is a subjective exercise.
•
ZBB may encourage companies taking a short term view to the determent of their long term plans. Some
decision packages may not rank high in the short term but are essential to the growth strategy of an
organisation.
ZBB requires skills that may not exist within current management and staff in the organisation.
•
•
ZBB is often seen a rigid form of budgeting that makes it difficult for organisations to react to unforeseen
events.
(iii)
Problems from existing staff.
The introduction of ZBB may be met with resistance from existing staff as they may feel that their jobs are under
threat. At present the company uses incremental budgeting which does not require staff to have a detailed
knowledge of the company’s activities. Existing staff may feel that they do not possess the necessary skills to adopt
to a ZBB system.
Page 12
SOLUTION 3
1
Answer C
Tutorial note:
High
Low
Units
72,000
50,000
22,000
Total cost
430,000
320,000
110,000
Variable cost p/u € 110,000/22,000 units = € 5
Fixed costs will be same at all levels.
At 72,000 units fixed costs = 430,000 – (72,000*€ 5) = € 70,000
2.
Answer A
Tutorial note:
Contribution = [€ 1,000,000 - € 450,000] € 550,000
C/S ratio = [€ 550,000/€ 1,000,000 x 100] 55%
Break-even in revenue = [(€ 275,000 + € 55,000)/55%] € 600,000
3.
Answer B
4.
Answer D
Tutorial note:
Overheads are absorbed by the following transaction:
Dr:
WIP a/c
[45,000 hours *€ 10] € 450,000
Cr
Production o/h a/c
[45,000 hours *€ 10] € 450,000
5.
Answer A
Tutorial note:
If absorption costing was used opening inventory would be [200 units x € 8] € 1,600 higher and closing inventory
would be [700 units x € 8] € 5,600 higher. Therefore with absorption profits would be € 4,000 higher.
6.
Answer C
7.
Answer D
Tutorial note:
Material price variance
Actual
[20,000 kg’s x € 25]
Standard
[20,000 kg’s x € 20]
Material Usage Variance
Actual
[5,000 units]
Standard
[5,000 units x 4.5 kg’s]
8.
€ 500,000
€ 400,000
€ 100,000 (Adv)
20,000 kgs
22,500 kgs
2,500 kgs
x € 20
€ 50,000 (Fav)
Answer A
Page 13
SOULTION 4
(a)
Materials
Labour
4 kgs x € 10 per kg
3 hours x € 12 per hr
€ 40
€ 36
€ 76
(b)
Sale price variance
Actual
Standard
[5,500 units]
[5,500 units x € 100]
660,000
550,000
€ 110,000 (Fav)
Sales volume (margin) variance
Actual
Budget
5,500 units
6,000 units
500 units
x € 24
€ 12,000 (Adv)
X (std contribution p/u) [€ 100 -€ 76]
Material Price variance
Actual
[24,750 kgs]
Standard
[24,750 kgs x € 10]
222,750
247,500
€ 24,750 (Fav)
Material usage variance
Actual
[5,500 units]
Standard
[5,500 units x 4 kgs]
Labour rate variance
Actual
Standard
24,750 kgs
22,000 kgs
2,750 kgs
x € 10
€ 27,500 (Adv)
[15,125 hours]
[15,125 hours x € 12]
211,750
181,500
€ 30,250 (Adv)
Labour efficiency variance
Actual
[5,500 units]
Standard
[5,500 units x 3 hours]
Fixed overhead expenditure variance
Actual
Budget
Operating Statement
Budget contribution [6,000 x € 24]
Sales volume (margin) variance
Flexed contribution
Sale price variance
Material price variance
Material usage variance
Labour rate variance
Labour efficiency variance
Actual contribution
Budget fixed overheads
Fixed overhead expenditure variance
Actual profit
15,125 hours
16,500 hours
1,375 hours
x € 12
€ 16,500 (Fav)
110,000
100,000
10,000 (Adv)
€
144,000
2,000
132,000
110,000
24,750
27,500
30,250
16,500
225,500
100,000
10,000
115,500
Page 14
(Adv)
(Fav)
(Fav)
(Adv)
(Adv)
(Fav)
(Adv)
(c)
Attainable standards
These are challenging but achievable targets if employees operate efficiently. They make some allowances for
factors such as machine down time, sub-standard material or staff training. These are usually preferred in practice
and can have a positive motivational level on employees.
Ideal standards
These are based on perfect working conditions. They make no allowances for factors such as machine down time
or sub-standard materials. They are rarely achieved and can de-motivate employees (depending on the country and
culture where they are used)
(d)
Advantages of standard costing
(i)
Process of setting standards, revising standards and monitoring production techniques can lead to cost
reductions
(ii)
Facilitates management by exception
(iii)
Standards represents what a product should cost, they are not averages
(iv) If based on employee participation it can increase motivation
(v)
Allowable method of stock valuation (IAS 2)
Page 15
SOLUTION 5
(a)
Working 1: calculate full production cost
Direct materials
[3 kg x € 5]
Direct labour
[4 hours x € 10]
[€ 40 x 150%]
Variable production o/h’s
Fixed production o/h’s
[€ 120,000/30,000 units]
Full production cost
€
15.00
40.00
60.00
4.00
119.00
Working 2: calculate value of inventory and production (These must be valued at € 119 per unit]
Production
[2,700 units x € 119]= € 321,300
[2,400 units x € 119] = € 285,600
[4,000 units x € 119] = € 476,000
Closing inventory
[300 units x € 119] = € 35,700
[200 units x € 119] = € 23,800
[400 units x € 119] = € 47,600
Working 3: Under/over absorbed fixed production overhead
January
February
Actual fixed prod o/h
€ 10,000
€ 10,000
Fixed o/h absorbed
[2,700*€ 4] € 10,800
[2,400 units *€ 4] € 9,600
€ 800 (over absorbed)
€ 400 (under absorbed)
March
€ 10,000
[4,000 units * € 4] € 16,000
€ 6,000 (over absorbed)
January
February
March
Opening inventory
0
[300 units x € 119] = € 35,700
[200 units x € 119] = € 23,800
Absorption costing profit statement
Working
€
Sales
Less cost of sales
Opening inventory
Production
Closing inventory
2
2
Under/(over) absorbed Fixed prod o/h
Gross profit
Less expenses
Variable sales comm
Fixed selling
Net profit
3
January
€
384,000
February
€
400,000
March
608,000
0
321,300
(35,700)
35,700
285,600
(23,800)
23,800
476,000
(47,600)
(800)
99,200
400
102,100
(6,000)
161,800
(38,400)
(35,000)
25,800
(40,000)
(35,000)
27,100
(60,800)
(35,000)
66,000
(b)
Working 1: Calculate variable production cost
Direct materials
Direct labour
Variable production o/h’s
Full production cost
€
15.00
40.00
60.00
115.00
[3 kg x € 5]
[4 hours x € 10]
[€ 40 x 150%]
Working 2: calculate value of inventory and production (These must be valued at € 115 p/u]
January
February
March
Opening inventory
0
[300 units x € 115] = € 34,500
[200 units x € 115] = € 23,000
Production
[2,700 units x € 115]= € 310,500
[2,400 units x € 115] = € 276,000
[4,000 units x € 115] = € 460,000
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Closing inventory
[300 units x € 115] = € 34,500
[200 units x € 115] = € 23,000
[400 units x € 115] = € 46,000
Marginal costing profit statement
Sales
Less variable costs
Opening inventory
Production
Closing inventory
Working
January
€
384,000
February
€
400,000
March
€
608,000
2
0
310,500
(34,500)
34,500
276,000
(23,000)
23,000
460,000
(46,000)
(38,400)
69,600
(40,000)
72,500
(60,800)
110,200
(10,000)
(35,000)
24,600
(10,000)
(35,000)
27,500
(10,000)
(35,000)
65,200
2
Variable sales comm
Contribution
Less fixed costs
Fixed production
Fixed selling
Net profit
c)
The difference between the profit figures calculated under absorption and marginal costing principles is caused by
the treatment of fixed production overheads. In marginal costing the full amount of fixed production overheads is
written off in the period that it occurs. In absorption part of the fixed production overheads is carried between
accounting periods as part of inventory valuations.
Profit under absorption
Difference in units of inventory
* fixed production overhead p/u
Profit under marginal costing
(d)
January
€ 25,800
February
27,100
March
66,000
[300 units * € 4] (€ 1,200)
[100 units * € 4] € 400
[200 units * € 4] (€ 800)
€ 24,600
27,500
65,200
Financial statements must be prepared under absorption principles to comply with IAS2 Inventory. IAS 2 requires
inventory to be valued at the cost of producing them and this includes fixed production overheads. Therefore Clontarf
Ltd cannot use marginal costing principles in the preparation of their financial statements. However for internal
decision purposes marginal costing principles would be used. This would hopefully allow the company to make
better decisions which would ultimately lead to a gain for the shareholders.
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SOLUTION 6
(a)
Short –run decision making should be based on the principles of relevant costs and not on the profitability of a
project. A relevant cost is a future, incremental cash-flow. Profitability would include a number of non-cash items
such as depreciation and provisions that are not relevant costs. However in the long term it is important that all costs
that exist within the business, such as existing fixed costs, are covered.
(b)
Material A
Material B
Material C
Skilled labour
Unskilled labour
Supervisor
Machine depreciation
Machine opportunity cost
Variable overheads
Fixed production overheads
Administration costs
Estimate
Revenue
Net relevant loss
Note
1
2
3
4
5
6
7
8
9
10
11
12
€
17,000
7,000
20,000
0
2,400
7,000
0
15,000
5,000
0
0
0
73,400
70,000
(3,400)
13
Roscommon Plc should not undertake the contract as they would achieve a net relevant loss of € 3,400.
Notes:
1.
Material a is used regularly and if used on this project it will be replaced. Therefore it is valued at its
replacement cost. [10 machines x 10 units x € 170 = € 17,000]
2.
As Material B is not used regularly within the company it should be valued at its net realisable value, i.e. the
value they would loose by using it on this project. [10machines x 5 units x € 140 = € 7,000]
3.
Material C will have to be purchased specifically for this project. [10machines x 8 units x € 250 = € 20,000]
4.
The relevant cost of the skilled labour is 0. At present the company has enough paid idle time to cover the
job. Therefore the company would incur no additional skilled labour costs.
Extra skilled labour would be employed at a cost of € 2,400 [10 machines x 20 hours x € 12].
5.
6.
The company would only incur an additional supervising charge of € 7,000. The relevant cost of the existing
supervisor is € 0 as he/she will not receive any additional payments over what they currently receive.
7.
Depreciation is not a cash-flow and therefore not a relevant cost.
8.
By undertaking the contract Roscommon Plc will have to forego [15 hours x € 100x 10 machines] € 15,000
from Castlerea Ltd (opportunity cost).
9.
Variable overheads are relevant costs as they will only be incurred if the job is undertaken. [ 10 machines x
10 hours x € 50 = € 5,000]
10.
No additional fixed overheads will be incurred
11.
No additional administration costs will be incurred, only the apportionment/allocation of existing costs.
12.
The time spent on the estimate is a sunk cost.
13.
By undertaking the contract the company would receive [10 machines x € 7,000] € 70,000.
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(c)
While most decisions are made based on financial projections it is essential that companies do not ignore nonfinancial factors such as quality, customer relations, local community, employee morale ect. An example of the
impact of ignoring qualitative factors would be the following; on financial grounds a company decided to discontinue
one of their product lines and close one of their factories. This could affect morale of the remaining workforce and
lead to a reduction in efficiency. Also people from the local community may boycott their products in retaliation for
their treatment of their employees and existing customers who previously bought the products that are now
discontinued as well as other products from the product range way transfer all of their business to other companies.
The financial gain achieved by their decision may be now be out weighed by the qualitative factors that followed.
END OF PAPER
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