Management Accounting

Transcription

1 Management Accounting Suggested Solutions to Practice Questions Professional, Practical, Proven

2 Table of Contents Part 1:... 2 Part 2:... 8 Part 3: Part 4: Part 5: Part 6: Part 7: Part 8: Part 9: Part 10:... 84

3 Part Solution Users of accounting information fall into two broad categories: (i) (ii) Users external to the organisation (external users); Users within the organisation (internal users). Within each of these two categories, there are several user groups. Examples of these user groups, and their respective information needs, are as follows: Internal users Managers Employees External users Equity investors Analysts and advisors Lenders and suppliers Governments and regulators Special interest groups such as: Environmental groups Lobby groups Community groups Information needs Decision-making Planning Control Require information about an organisation s ability to meet wage demands and provide secure employment Information needs Investment values Potential return to be earned from investment Require information about how the business is doing now and its future prospects Require information about the organisation s ability to meet current and future financial obligations Assessment of tax liabilities Economic projections Enforcement of legislation Information relating to their specific interests Page 2 of 91

4 1463 Solution (i) A buyer in a retail clothing business; Financial information Non-financial information Product costs Delivery lead times Supplier credit terms Product quality information Foreign exchange information Will same products will be supplied to competitors? Expected gross profit margin Potential market size for new clothing lines Selling price required to breakeven Past sales trends for existing clothing lines (ii) A production manager in a toy factory; Financial information Non-financial information Product profitability by product line Safety standards for production Cost information for raw materials, labour and Quality assurance data overheads Employee training data Availability of materials (iii) The managing director of a private hospital; Financial information Non-financial information Breakdown of staff salaries Patient satisfaction surveys Projected capital expenditure Medical accreditation information Occupancy rates Waiting times Rates approved by health insurers Trolley count Staff training and development (iv) Project managers in an overseas charity aid organisation. Financial information Non-financial information Cost information for development projects Details of potential supporters Budgeted donations Evaluation of effectiveness Staff pay and non-pay costs of projects from a community perspective Risk assessment Page 3 of 91

5 1465 Solution One of the primary duties of management is to ensure that organisations are run in a manner that will achieve shareholders objectives. (i) (ii) (iii) (iv) (v) (i) (ii) (iii) (iv) (v) Planning and control are key features of effective management. Without planning and control, it would not be possible to run an organisation effectively. It is also important that planning and control are not seen as one-off exercises planning and control is a fluid process that changes and updates in accordance with changes to (or in) the business environment. The planning and control cycle (and its link with decision-making processes) is as follows: Decide on plan; Devise an operational course of action to implement the plan; Compare actual results achieved to results expected under the plan; Evaluate managerial and operational performance; As a result of evaluation, revise the plan or make changes to the operational course of action. Planning can be defined as: The establishment of objectives, the formulation, evaluation and selection of policies, strategies, tactics and action required to achieve these objectives. Planning comprises long-term strategic planning and short-term operational planning. Planning is a key function of management which precedes control and feedback to assist in the effective running of an organisation. Levels of planning There are a number of different types of planning: Long-term, strategic planning normally covers a period of three, five or ten years and is an involved process including assessment of internal and external environments, opportunities and expectations. Once objectives are established, options are evaluated and appraised to formulate the long-term corporate plan. Tactical planning is the process of developing specific strategies or tactics relevant to the prevailing circumstances (e.g. a new marketing strategy) in the context of the long-term strategic plan. Short-term planning usually involves the deployment of resources to effectively achieve specific objectives and normally covers a period up to one year. Organisational control processes Organisational control is concerned with the efficient use of resources to achieve a plan. Control involves the measurement of activity, comparison with plans and identification of performance issues. Control will provide information on corrective action required to alter performance so as to conform with plan or to modify original plans. The key elements of control include: a specification; measurement of actual performance; comparison between specification and actual performance; feedback on performance; action to control performance; Page 4 of 91

6 (vi) on-going feedback. Control actions must be appropriately timed - otherwise the action may have a detrimental effect. Control is exercised in organisational systems by feedback loops which gather information on performance from the output of the system. Page 5 of 91

7 1467 Solution Performance management is a term used to describe activities carried out to ensure that an organisation s goals and objectives are being met in an effective and efficient manner. (i) (ii) (iii) It is described by Armstrong and Baron as a strategic and integrated approach to increasing the effectiveness of organisations, by improving the performance of the people who work in them and developing the capabilities of teams and individual contributors. Performance management normally operates at a number of levels: for the organisation as a whole; within departments or sections; in teams or for individuals. Performance management is used both in businesses and, increasingly, in not-for profit organisations (such as public service departments). Performance management can involve a range of qualitative and quantitative activities, but a main aim is to create goal congruence within an organisation. Goal congruence entails everyone acting in the common interest of achieving the most-important objectives of the organisation these can be expressed as Key Performance Indicators (KPIs). From a financial perspective, performance management targets are likely to include market share, manufacturing efficiencies, profit earned. From a service perspective, performance management is likely to focus on customer satisfaction measures, service output measures, repeat business, innovative developments or improvements. The benefits of good control and performance management can be direct financial gains, improved motivation and employee satisfaction and improved efficiency in systems and processes. Page 6 of 91

8 1468 Solution (i) A cost accounting system could identify vehicles which are more-expensive to run than the average in the fleet. (ii) (iii) Once identified, these vehicles could be replaced, thereby reducing the overall costs of the business. A cost accounting system could identify the best ranking of vehicles for use on jobs. Not all vehicles in the fleet will cost exactly the same to run. Those that can be run more-cheaply than others should be the first ones booked out on jobs. A cost accounting system could assist in deciding which jobs to take on for given prices - by ensuring that jobs are only accepted if they are cost-effective. Page 7 of 91

9 Part Solution Typical issues that should be considered when trying to predict future costs include: (i) (ii) (iii) Cost classification - regular review of actual cost behaviour is important for classification of costs as either fixed costs or variable costs. For example, labour costs, which are normally considered to be a variable cost, may comprise a fixed cost element. Use of historical data - relevant current and future conditions should be considered in cost prediction, rather than over-relying on historical data. Costs and cost behaviour may be over-simplified. Linear assumptions, statistical data and overhead cost drivers should be analysed and carefully projected in cost prediction. Page 8 of 91

10 1469 Solution (i) Cost object A cost object is any thing or activity for which an individual measurement of costs is required. (ii) (iii) (iv) (v) (vi) (vii) If you want to know the cost of a holiday, the holiday is the cost object. If you want to know the cost of manufacturing a chair, the chair is the cost object Relevant range The range of activity within which the assumptions made about cost behaviour patterns are valid. Example: from 0 units to 20,000 units. Product costs Product costs are costs that are associated with manufacturing a product. An example would be materials costs. Period costs Period costs are costs that are associated with a reporting period rather than related to the manufacturing process. All non-manufacturing costs are treated as period costs. Examples include advertising costs, administration costs, legal costs, audit fees. Direct costs Direct costs are costs that can be directly attributed (or traced) to a particular product, activity or department Examples include materials exclusively related to the cost object, labour costs incurred exclusively in relation to the cost object or overheads incurred exclusively in relation to the cost object Indirect costs Indirect costs are costs that cannot be directly attributed (or traced) to a particular product, activity or department. In essence, indirect costs are similar to shared costs more than one cost object will be attributed with a share of the indirect costs. Examples include rent of production facility, production supervisors salaries, repairs to production equipment. Cost behaviour Costs can also be analysed into fixed costs (those that remain the same regardless of activity level - within the relevant range) and variable costs (those which vary directly in relation to activity levels). Cost behaviour is influenced by a number of factors but most significant is often the level or volume of activity. Activity levels in a manufacturing environment can change and these changes impact on cost behaviour, which forms the basis of many practical decisions. For example, if production volume is increased by 20% what are the increased costs? Page 9 of 91

11 1470 Solution (a) Fixed costs Fixed costs are costs that remain unchanged in total, within the relevant range as activity levels fluctuate. Typical fixed costs include rent and depreciation. (b) (i) Whilst the total amount of fixed cost is unchanged, the amount of fixed cost allocated to a unit will decrease as unit output increases, and will increase as unit output decreases. Variable costs Variable costs are costs that do change in total, within the relevant range, as activity levels fluctuate. Typical variable costs include direct materials costs and direct labour costs. Total variable cost can be represented by an equation in the form: Total variable cost = b(x) where b is the variable cost per unit, and X is the level of output. Whilst the amount of variable cost per unit is unchanged, the total amount of variable cost will increase as unit output increases, and will decrease as unit output decreases. Example A business manufactures Product X. Product X requires 5 kg of Material Beta, which costs 1 per kg. The rent expense for the factory is 8,000. The business anticipates production volumes to be: 1,000 units of Product X; or (ii) 1,500 units of Product X. Material Beta is a variable cost of production, in this case 5 per unit of Product X manufactured. The more units produced, the higher the total materials cost. Rent is a fixed cost. Regardless of the level of production, the rent will still cost 8,000. (i) If the business produces 1,000 units of product X: Variable costs Materials cost per unit of Product X for Material Beta is 5 (5 1 per kg). Total materials cost for 1,000 units of Product X is 5,000 ( 5 per unit x 1,000 units). Fixed costs Total rent is 8,000. Rent per unit of Product X produced is 8 ( 8,000 / 1,000 units). (ii) If the business produces 1,500 units of product X: Variable costs Materials cost per unit of Product X for Material Beta is 5 (5 1 per kg) Total materials cost for 1,500 units of Product X is 7,500 ( 5 per unit x 1,500 units) Fixed costs Total rent is 8,000. Rent per unit of Product X produced is 5.33 ( 8,000 / 1,500 units). Page 10 of 91

12 1471 Solution Cost classifications Costs can be classified in many different ways (for example, by activity, by department, by job or by product) depending upon the nature of the business and its use of cost information. Cost classification is an important element of management accounting as it is required for: (a) allocating costs within the accounting system to cost of goods sold and inventory to calculate gross profit / net profit or loss and enable the production of internal and external reports; (b) (c) (i) (ii) providing relevant information to assist managers in making better decisions; providing information for planning, control and performance measurement. Typical cost behaviours patterns include: Fixed costs and variable costs Fixed costs Fixed costs remain unchanged regardless of the activity level over a specified period of time. Examples of fixed costs include depreciation, rental costs or maintenance costs. Although the fixed costs of a business are static, the amount of fixed cost allocated to a unit will decrease with increased production and increase if unit output is reduced. Variable costs Variable costs normally vary with different levels of production. Examples of variable costs in most businesses include direct materials costs or direct labour costs - which increase or decrease according to levels of production. Some costs behave in a semi-variable manner that is they contain a variable cost element and a fixed cost element. An example of this could be certain sales-related costs, such as sales staff commission, which have an initial fixed cost and a cost per unit. Certain other costs can be described as stepped where they are fixed up to a certain level of activity and then increase to a higher fixed amount above a certain activity level. Direct Costs and Indirect Costs Direct costs Direct costs can be exclusively attributed to a particular product, activity, job, service or department. Examples of direct costs would include: Direct materials cost raw materials used in production; Direct labour cost - wages paid for work directly related to production; Direct expenses - other costs which are related exclusively to a job or production unit; The total of direct costs is known as the Prime Cost. Indirect costs Indirect costs, such as supervisory costs or inspection costs, cannot be directly traced to a particular product, activity or department but are still very relevant to decision-making or costing exercises. Sometimes, direct costs, such as screws or nails used in production, will be treated as indirect costs because the amount of the cost is not significant and the direct tracing to the cost object may not be cost-effective. Page 11 of 91

13 Indirect costs are often apportioned to products, activities, jobs or departments which involves estimating the cost of resources used. (iii) Using direct and indirect cost classifications ensures accurate costing for product costing and pricing decisions. Product Costs and Period Costs Product costs Product costs are costs related to a manufacturing process and will normally include: Direct materials cost Direct labour cost Direct manufacturing expenses Prime cost Indirect materials cost Indirect labour cost Indirect manufacturing overhead cost Product cost Period costs Period Costs are costs which are associated with running a business within a reporting period rather than directly related to manufacturing or production. Examples of period costs include general administration costs or professional fees. This distinction between product costs and period costs is an important difference between internal management accounting and external financial accounting in that inventory valuations for external accounting should be based on product costs only, with period costs being directly expensed when incurred. x x x x x x x x Page 12 of 91

14 1473 Solution (a) Cost Cost type Reason for cost type Scientists' salaries Fixed Cost Cost is the same at both activity levels Technicians' salaries Fixed Cost Cost is the same at both activity levels Chemistry costs Clinical assessment costs Mixed Cost Mixed Cost Cost increased, but not by the same percentage as the activity level increased Cost increased, but not by the same percentage as the activity level increased Laboratory lease cost Fixed Cost Cost is the same at both activity levels Cost of chemical compound F1 Va r i a b l e Cost Cost increased by the same percentage as the activity level (16%) Administration costs Fixed Cost Cost is the same at both activity levels (b) Activity (tests) Chemistry costs Clinical assessment High activity level 1,276 31,460 23,617 Low activity level 1,100 30,250 20,900 Difference 176 1,210 2,717 Variable cost per test ( ) Chemistry costs Total costs (high) 31,460 Variable costs (1,276 x 6.88 per unit) 8,779 Fixed costs 22,681 Clinical assessment costs Total costs (high) 23,617 Variable costs (1,276 x per unit) 19,701 Fixed costs 3,916 Page 13 of 91

15 Part Solution (i) Examples of direct labour costs: Basic hourly rate of staff working on cost object; Holiday pay of staff working on cost object; Overtime expressly linked to an urgent production order. Reason: Can be traced directly to a cost object. (ii) Examples of indirect labour costs: Overtime premium on general overtime; Supervisors salaries; Labour costs of staff not specifically working on cost object. Reason: Cannot be traced directly to a cost object. Page 14 of 91

16 1477 Solution Incentive schemes are a means of remuneration which relate payment to output. The aims of such schemes are to benefit the employee, by providing an opportunity to increase earnings while encouraging performance and providing for increased productivity, which may reduce overhead cost per unit. Incentive schemes can be based upon individual performance or aimed at incentivising groups of employees. Incentive schemes should be based on efficient working methods following comprehensive work studies and may be financial or non-financial in nature. Page 15 of 91

17 Part Solution The following steps will be evident in an effective materials recording system in a small manufacturing business: (i) (ii) (iii) (iv) (v) (vi) (vii) Production department issues a materials requisition to the warehouse; Warehouse will (a) issue the materials to production and update warehouse records, and (b) order/re-order materials as required; For materials orders a purchase requisition will be completed and issued to the purchasing department; Purchasing department will select the appropriate supplier and complete a purchase order which will be sent to (a) supplier, (b) goods receiving area and (c) accounts department; Goods receiving area compares materials received to the purchase order (to ensure that the materials received were actually ordered) and completes a Goods Received Note detailing materials actually received; Goods Received Note is entered in the software system to complete the purchase order and to update inventory records; When the accounts department staff receive the supplier invoice, they will check to ensure that what has been invoiced is the same as has been ordered and received. Page 16 of 91

18 1479 Solution Factors other than EOQ that may Influence order quantity: (i) (ii) (iii) (iv) (v) (vi) Security of supply scarcity in the market, threat of industrial action or transportation difficulties may lead to an increased order quantity; Possibility of obsolesce may lead to smaller, more-regular, orders; Uncertainty around holding arrangements or related opportunity costs (it is a fundamental assumption of EOQ that holding costs remain constant); Negotiation of bulk discount arrangements or forward-buying arrangements; Inflationary or deflationary environments can generally influence buying policies; Cash flow. Page 17 of 91

19 1480 Solution (a) Maximum usage rate (units per day) 890 Maximum lead time (days) 8 Inventory re-order level (units) (890 units x 8 days) 7,120 (b) Inventory re-order level (units) 7,120 Average usage rate (units per day) 570 Average lead time (days) 6 (3,420) Minimum inventory level 3,700 (c) Annual projected demand (36,000 units x 4) 144,000 Order cost per order 11 Holding cost per unit ( 48 x 7%) 3.36 EOQ = Square root of ((2 x 11 x 144,000 units)/ 3.36) 972 (d) Re-order level 7,120 EOQ 972 8,092 Minimum usage rate (units per day) 140 Minimum lead time (days) 4 (560) Maximum inventory level 7,532 Page 18 of 91

20 1481 Solution FIFO Received Cost Issued Cost Production Inventory Value Date kg kg kg 1 August ,720 2 August ,869 5 August ,540 (600) (3,540) 8 August , August ,180 (200) (1,180) 12 August ,869 (730) (3,869) 12 August (60) (402) 990 Charged to production 8,991 Closing inventories 700 4,690 LIFO Received Cost Issued Cost Production Inventory Value Date kg kg kg 1 August ,720 2 August ,869 5 August ,180 (600) (3,180) 8 August , August ,092 (760) (5,092) 12 August (130) (689) 12 August (100) (590) 990 Charged to production 9,551 Closing inventories 700 4,130 AVCO In/out Cost Value Production Date kg 1 August ,720 2 August ,869 1, ,589 5 August (600) 5.61 (3,366) 3, ,223 8 August ,092 1, , August (990) 6.10 (6,039) 6,039 Closing inventories 700 4,276 Charged to production 9,405 Page 19 of 91

21 2423 Solution (a) (i) FIFO Received Cost Issued Cost Production Inventory Value Date kg kg kg 01 April 1, ,000 7, April , April ,006 (770) (6,006) 20 April , April ,794 (230) (1,794) 26 April ,972 (830) (6,972) 26 April ,088 (240) (2,088) 1,300 Charged to production 16,860 Closing inventories (ii) LIFO Received Cost Issued Cost Production Inventory Value Date kg kg kg 01 April 1, ,000 7, April , April ,468 (770) (6,468) 20 April , April ,784 (320) (2,784) 26 April (60) (504) 26 April ,176 (920) (7,176) 1,300 Charged to production 16,932 Closing inventories (iii) AVCO In/out Cost Value Production Date kg 01 April 1, , April ,972 1, , April (770) 8.07 (6,214) 6, April ,784 1, , April (1,300) 8.22 (10,686) 10,686 Closing inventories Charged to production 16,900 (b) FIFO Page 20 of 91

22 Acceptable for financial accounting Accepted by tax authorities for taxation purposes. Advantages: Actual costs system unrealised profit/loss eliminated Encourages good store-keeping practices (issuing oldest inventory first) Inventory valuation comprises of the most recent valuation Disadvantages: Not suitable in times of inflation product costs understated and profits overstated Can be administratively clumsy Cost comparison of batches difficult Limited decision-making uses LIFO Used in management accounting/cost accounting, particularly in an inflationary environment Advantages: Actual cost system Up-to-date relevant market costs charged to production Realistic costing approach useful in some decision-making scenarios Disadvantages: Inventory is valued at oldest prices may distort profits Not acceptable to tax authorities Can be administratively clumsy as purchase batches only partially charged to production Weighted average Acceptable under financial accounting regulations and to tax authorities Most suitable in a fluctuating price environment Advantages: Relatively straight-forward administratively Moderates effects of price changes on inventory valuation and production charges Useful for cost-comparison exercises Disadvantages: Although realistic, not based on actual costs (d) Equivalent units: Value Total 660 units at 30% units at 60% 396 Units 740 units at 50% ,136 Page 21 of 91

23 Part Solution (a) Overhead Basis of apportionment Joinery Assembly Admin Total Indirect labour: Number of employees 42,200 x 47/130 15,257 42,200 x 51/130 16,555 42,200 x 32/130 10,388 Heat, light, power: Electricity usage 50,900 x 7,200/18,000 20,360 50,900 x 6,900/18,000 19,512 50,900 x 3,900/18,000 11,028 Rent and rates: Floor space 57,500 x 19,200/48,000 23,000 57,500 x 21,600/48,000 25,875 57,500 x 7,200/48,000 8,625 Materials handling: Materials requisitions 55,100 x 106/220 26,548 55,100 x 114/220 28,552 Depreciation: Book value of equipment 55,800 x 185,400/452,000 22,888 55,800 x 171,800/452,000 21,209 55,800 x 94,800/452,000 11, , ,703 41, ,500 (b) Joinery Assembly Admin Total Apportionment ( ) 108, ,703 41, ,500 Re-apportionment of administration: 41,744 x 47/98 20,020 (20,020) 41,744 x 51/98 21,724 (21,724) 128, , ,500 Tutorial note: Basis of re-apportionment is number of employees (excluding admin employees) Number of employees (c) Joinery Assembly Overheads allocated, apportioned and re-apportioned ( ) 128, ,427 Direct labour hours 103,000 63,000 Overhead absorption rate ( per direct labour hour) Page 22 of 91

24 1491 Solution (a) Overhead allocation and apportionment Production 1 Production 2 Service A Service B Total Allocation 136, , ,600 71,200 Apportionment: Basis Indirect labour Indirect labour hours 41,440 x 16,400/21,500 31,610 41,440 x 5,100/21,500 9,830 Heat and light Floor area 30,660 x 1,210/4,820 7,697 30,660 x 2,370/4,820 15,076 30,660 x 580/4,820 3,689 30,660 x 660/4,820 4,198 Repairs/maintenance Floor area 46,010 x 1,210/4,820 11,550 46,010 x 2,370/4,820 22,623 46,010 x 580/4,820 5,536 46,010 x 660/4,820 6,301 Canteen subsidy Number of staff 7,670 x 31/40 5,944 7,670 x 9/40 1,726 Machine depreciation Machine value 42,470 x 33,100/202,200 6,952 42,470 x 149,700/202,200 31,443 42,470 x 19,400/202,200 4,075 Machine insurance Machine value 7,530 x 33,100/202,200 1,233 7,530 x 149,700/202,200 5,575 7,530 x 19,400/202, , , ,622 81, ,280 (b) Overhead re-apportionment Production 1 Production 2 Service A Service B Total Apportionment 201, , ,622 81, ,280 Re-apportionment of service A: 158,622 x 30% 47,587 (47,587) 158,622 x 70% 111,035 (111,035) Re-apportionment of service B: 81,699 x 45% 36,765 (36,765) 81,699 x 55% 44,934 (44,934) 286, , ,280 (c) Production 1 Production 2 Overheads allocated, apportioned and re-apportioned ( ) 286, ,042 Machine- or labour-intensive Labour Machine Labour hours 22,460 Machine hours 21,180 Overhead absorption rate ( per direct labour hour) Page 23 of 91

25 Overhead absorption rate ( per machine hour) Page 24 of 91

26 1493 Solution (a) A B C Budgeted production overhead cost ( ) 90, , ,700 Budgeted production hours 7,000 7,600 6,500 Pre-determined overhead absorption rate ( per hour) (b) A B C Actual production hours 7,700 8,000 6,000 Overhead absorption rate ( per hour) Overhead absorbed (hours x per hour) 99, , ,800 Actual production overhead cost ( ) 104, , ,000 Under-absorbed overhead ( ) 4,970 14,200 Over-absorbed overhead ( ) 13,830 (c) (i) (ii) (iii) Possible causes of under-/over-absorbed overhead: Labour efficiencies or inefficiencies; Incorrect estimates for production hours; A significant percentage of the production overhead may be fixed in nature. Page 25 of 91

27 1495 Solution Businesses use pre-determined overhead absorption rates rather than actual overhead absorption rates for the following reasons: (i) (ii) Facilitates price quotations for jobs; Enables preparation of regular financial reports as actual overheads will not be available until after the end of the reporting period. Page 26 of 91

28 1496 Solution Activity-based costing (ABC) is an approach to overhead costs based on overheads being caused by activities, such as ordering inventory, setting-up machines, etc, rather than being driven by measures of output such as the number of machine hours or the number of direct labour hours. (i) (ii) (iii) (iv) (i) (ii) The activities that drive overhead costs are known as cost drivers. ABC attributes overheads to products, based on the cost drivers. ABC is appropriate where overheads represent a significant amount of costs and are driven by a variety of factors, which are not necessarily volume-related factors. The primary objective of ABC is to provide accurate costing of products and services in order to assist better decision-making. Overheads are accumulated and grouped together in overhead cost pools and then attributed to products using the appropriate cost driver. Hence, a product which uses more of a cost driver bears a greater proportion of the relevant overhead. Examples of overhead cost pools and cost drivers: Overhead cost pools Set-up costs Inspection costs Warehouse costs Setting up an ABC system There are four steps involved in setting up an ABC system. Identify major activities; Identify overhead cost drivers for each activity; Accumulate costs of activities into overhead cost pools; Cost drivers Number of set-ups Number of inspections Number of inventory issues Calculate overhead cost driver rates to assign overhead costs to products. Benefits of using an ABC system ABC improves the accuracy of product costs. Specific overhead cost is matched to the activity that gave rise to it and, from there, to the product. Assigning overheads to products using overhead cost driver rates is based more on a cause-and-effect relationship than an arbitrary volume-based approach that simply considers volume of output. ABC reinforces the concept that activities cause costs. This highlighting of activities and overhead cost pools focuses management attention on how costs arise and the type and value of these costs. It is especially helpful for businesses that produce products that differ substantially, both in volume and the activities they require and in situations where overheads are high and increasing without apparent reason. The improved accuracy of costs can lead to improved efficiency and decision- making. (i) Limitations of an ABC system ABC systems are expensive to develop and maintain. Page 27 of 91

29 Setting up an ABC system requires significant time and effort, often necessitating collecting data that there has been no previous need to collect. (ii) (iii) Identifying activities, overhead cost pools and overhead cost drivers, is a subjective exercise. How many activities should be identified? Can some activities be consolidated? At what point is the level of detail sufficient? There is no theoretical model to answer these questions. The focus on activities and costs may have behavioural implications. There may be some resistance to the new product information. Example of ABC calculations The following information relates to a business which produces two products: Product A Product B Total Production volume/sales volume (units) 5,000 50,000 55,000 Machine hours per unit (hours) 8 3 Total machine hours 40, , ,000 Direct labour hours per unit Total direct labour hours 5,000 75,000 80,000 Number of set-ups Number of sales orders The business fixed production overhead costs are as follows: Activity Cost ( ) Set-up costs 15,000 Machine overheads 62,000 Packaging costs 18,000 Total 95,000 The business has identified the following cost drivers for each of the above activities: Overhead cost Overhead cost driven by: Set-up costs Number of set-ups Machine overheads Number of machine hours Packaging costs Number of sales orders The overhead cost associated with each product using ABC is calculated as follows: Cost per set-up ( 15,000 overhead/26 set-ups) Cost per machine hour ( 62,000 overheads/190,000 machine hours) 0.33 Cost per sales order ( 18,000 overheads/35 sales orders) Product A Product A Product B Product B Cost per setup ( ) Number of set-ups ,538 3,462 Cost per machine hour ( ) Number of machine hours 40, ,000 13,200 49,500 Cost per sales order ( ) Number of sales orders ,857 5,143 Total overhead cost 37,595 58,105 Page 28 of 91

30 Cost per unit ( 37,595/5,000 units) 7.52 Cost per unit ( 58,105/50,000 units) 1.16 (i) (ii) Product A places more demand on the (indirect) support services. ABC recognises this, and the associated overhead applied to each unit of Product A is significantly higher than that attributed to each unit of Product B. Using the traditional approach to overheads: If overheads were absorbed based on machine hours, each unit of Product A would still absorb more overheads than each unit of Product B, as the number of machine hours required to produce Product A is much greater. However, if overheads were absorbed based on direct labour hours, each unit of Product B would absorb more overheads than each unit of Product A, as the number of direct labour hours required to produce each unit of Product A is greater. Therefore, if selling prices are based on costs (which they always are, to some extent at least), the choice of overhead costing method has implications for pricing, and therefore profit. Page 29 of 91

31 1498 Solution Absorption costing can provide more accurate product cost information by recognising that the costs of overheads constitute an input into the production process. Where the overhead relates to service costs, it is important that the total cost is considered for accounting and decision-making purposes. This will assist in improving decisions about resource utilisation and encourage the optimal use of services. However, traditional absorption costing methods are usually calculated on a single volume-based calculation, related to the most appropriate base (e.g., machine hours or direct labour hours) and this can lead to cost distortion as it can overlook the real underlying driver of cost. If there is a significant amount of service related overhead costs, it may be more-appropriate to look at activity-based costing. Page 30 of 91

32 1500 Solution Activity Cost Driver Driver rate Parts No. of parts 13,233/670 parts 19.75per part Maintenance No. of hours 9,604/560 hours 17.15per hour Stores No. of requisitions 11,310/30 reqs per requisition Administration No. of employees 1,880/51 employees 36.87per employee Overhead recovered by each unit of product Y Parts (148 parts x per part) 2, Maintenance hours (168 hours x per hour) 2, Materials requisitions (7 requisitions x per requisition) 2, Employees (12 employees x per employee) , Overhead recovered per unit ( 8,885.64/610 units) Page 31 of 91

33 1501 Solution (a) Activity Cost Driver Driver rate Set-up Production runs 17,360/40 production runs per run Operating Machine hours 74,000/20,000 machine hours 3.70per hour Inspection Production volume 106,190/25,900 units 4.10per unit Distribution Sales orders 132,300/2,100 sales orders 63.00per order (b) Black White Total Set-up 22 production runs x per run 9, production runs x per run 7,812 Operating 10,000 machine hours x 3.70 per machine hour 37,000 10,000 machine hours x 3.70 per machine hour 37,000 Inspection 13,000 units x 4.10 per unit 53,300 12,900 units x 4.10 per unit 52,890 Distribution 1,300 sales orders x per order 81, sales orders x per order 50, , , ,850 (c) Overhead cost per unit ( 181,748/13,000 units) Overhead cost per unit ( 148,102/12,900 units) Page 32 of 91

34 1504 Solution (a) Product B Product C Product E Total Production volume (units) 2,840 1, Labour hours per unit Total labour hours 7,100 2,415 1,750 11,265 Total production overhead ( ) 412,020 Pre-determined overhead absorption rate ( 412,020/11,265 labour hours) Product B Product C Product E Direct materials 2,840 units x 31 per unit 88,040 1,610 units x 32 per unit 51, units x 37 per unit 25,900 Direct labour 2,840 units x 2.5 hour per unit x 25 per hour 177,500 1,610 units x 1.5 hour per unit x 25 per hour 60, units x 2.5 hour per unit x 25 per hour 43,750 Production overhead 2,840 units x 2.5 hour per unit x per hour OAR 259,684 1,610 units x 1.5 hour per unit x per hour OAR 88, units x 2.5 hour per unit x per hour OAR 64,007 Total production cost 525, , ,657 Cost per unit (b) Product B Product C Product E Total Production volume (units) 2,840 1, Machine hours per unit Total machine hours 2,840 3,220 1,400 7,460 Activity Driver Driver rates Rate ( ) Production set up Production runs 84,840/120 runs 707 Ordering materials Materials orders 111,250/250 orders 445 Handling materials Materials reqs 21,970/130 requisitions 169 Utility costs Machine hours 193,960/7,460 hours 26 Product B Product C Product E Direct materials 88,040 51,520 25,900 Direct labour 177,500 60,375 43,750 Production overhead: Production set-up 56 production runs x 707 per production run 39, production runs x 707 per production run 31, production runs x 707 per production run 14,140 Ordering materials 83 orders x 445 per order 36, orders x 445 per order 36, orders x 445 per order 38,270 Handling materials 41 requisitions x 169 per requisition 6,929 Page 33 of 91

35 (c) 45 requisitions x 169 per requisition 7, requisitions x 169 per requisition 7,436 Utility costs 2,840 machine hours x 26 per hour 73,840 3,220 machine hours x 26 per hour 83,720 1,400 machine hours x 26 per hour 36,400 Total production cost 422, , ,896 Cost per unit In general The traditional approach to overhead costing sees overheads absorbed on the basis of direct labour hours and the volume of production. This is not particularly accurate as it uses a single cost driver (direct labour hours), while there is information to suggest that overhead costs are related to a number of activities. However, the traditional approach to overhead costing does recognise the importance of production overheads and is simple to use. Activity-based costing is more-accurate as it identifies multiple cost drivers and recovers overheads on the basis of the relative proportion of each activity consumed by each product. This provides more accurate information for decision making - such as pricing. While it is more complex to establish and maintain, using activity-based costing can lead to a better understanding of overheads and can support benchmarking and performance management. Page 34 of 91

36 Part Solution The correct answer is option (c). Direct materials cost 15,700 Direct labour cost: A: (43 labour hours x 34 per hour) 1,462 B: (44 labour hours x 27 per hour) 1,188 Overhead cost: A: (700 machine hours x 21 OAR) 14,700 B: (548 machine hours x 15 OAR) 8,220 Total cost 41,270 Page 35 of 91

37 1507 Solution The correct answer is option (a). Direct materials cost Direct labour costs Production 1: 27 hours x 23 per hour Production 2: 9 hours x 9 per hour Overheads Production 1: 27 labour hours x 2.07 per labour hour OAR Production 2: 13 machine hours x 4.07 per machine hour OAR Total cost 1, Page 36 of 91

38 1508 Solution (a) Dept. 1 Dept. 2 Dept. 3 Budgeted production overhead for the year ( ) 126, , ,125 Labour or machine intensive? labour labour machine Budgeted labour hours for the year 34,700 31,000 Budgeted machine hours for the year 12,800 Pre-determined overhead absorption rate: per direct labour hour per machine hour 9.23 (b) Dept. 1 Dept. 2 Dept. 3 Total Direct materials costs 1, ,238 Direct labour costs: 840 hours x 5.41 per hour 4,544 4, hours x 6.55 per hour 5,699 5, hours x 6.15 per hour 1,476 1,476 Production overheads absorbed: 840 hours x 3.64 per direct labour hour OAR 3,058 3, hours x 5.53 per direct labour hour OAR 4,811 4, machine hours x 9.23 per machine hour OAR 8,307 8,307 Total production costs 30,133 (c) Total production costs 30,133 Mark-up (100%) 30,133 Selling price 60,266 Page 37 of 91

39 1509 Solution Journals dr cr 1 Accounts receivable 583,000 Profit or loss (sales revenue) 583,000 Being sales revenue 2 Work in progress - direct labour grade 1 179,300 Wages due 179,300 Work in progress - direct labour grade 2 185,100 Wages due 185,100 Being direct labour costs Page 38 of 91

40 1511 Solution The correct answer is option (b). Direct materials Assembly department labour Finishing department labour Overhead Page 39 of 91

41 1512 Solution The correct answer is option (c). Direct materials Direct labour: Machine: 6 hours x 15 per hour Finish: 12 hours x 21 per hour Overheads: Machine: 32 machine hours x per mach. hour Finish: 12 labour hours x 5.45 per lab. hour Total cost per batch of 110 units 1, Cost per unit 9.18 Page 40 of 91

42 1513 Solution A B C Total Sales revenue 386, , ,620 1,421,560 Direct materials: Material X 2,640 units x 1.00 kg per unit x 3.00 per kg 7,920 3,960 units x 2.50 kg per unit x 3.00 per kg 29,700 3,820 units x 2.50 kg per unit x 3.00 per kg 28,650 Material Y 2,640 units x 2.50 kg per unit x 4.00 per kg 26,400 3,960 units x 2.50 kg per unit x 4.00 per kg 39,600 3,820 units x 1.50 kg per unit x 4.00 per kg 22,920 Material Z 3,960 units x 1.00 kg per unit x 6.00 per kg 23,760 3,820 units x 1.50 kg per unit x 6.00 per kg 34,380 Direct labour: Grade 1 3,820 units x 0.50 hours per unit x per hour 24,830 Grade 2 2,640 units x 0.50 hours per unit x per hour 23,760 3,960 units x 1.00 hours per unit x per hour 71,280 3,820 units x 1.00 hours per unit x per hour 68,760 Variable overheads: Direct labour cost x 30% 7,128 21,384 28,077 Total variable costs 65, , , ,549 Contribution 321, , , ,011 Fixed overheads: 321,000 x ( 386,210/ 1,421,560) 87, ,000 x ( 506,730/ 1,421,560) 114, ,000 x ( 528,620/ 1,421,560) 119,367 Total fixed overheads 87, , , ,000 Profit 233, , , ,011 Page 41 of 91

43 1515 Solution (a) Activity Driver Driver rates Rate ( ) Handling materials Materials volume 3,552/6,020 kgs 0.59 Setting up machines Batches produced 21,829/190 batches Machine processing Machine hours 41,643/1,360 machine hours Quality assurance Quality checks 21,998/251 quality checks (b) Product 1 Product 2 Product 3 Total Handling materials 2,168 kgs x 0.59 per kg 1,279 1,734 kgs x 0.59 per kg 1,023 2,118 kgs x 0.59 per kg 1,250 Setting up machines 75 batches x per batch 8, batches x per batch 5, batches x per batch 7,238 Machine processing 762 machine hours x per hour 23, machine hours x per hour 6, machine hours x per hour 12,065 Quality assurance 108 quality checks x per check 9, quality checks x per check 7, quality checks x per check 5,259 Total overhead costs 42,693 20,517 25,812 89,022 (c) Product 1 Product 2 Product 3 Overhead costs ( ) 42,693 20,517 25,812 Production volume (units) 5,250 2,600 7,560 Overhead cost per unit ( ) (d) Product 1 Product 2 Product 3 Overhead cost Direct materials cost Direct labour cost Page 42 of 91

44 1516 Solution (a) Abnormal losses Abnormal loss is a term normally used in process costing that is costing of products which result from a series of processes. (b) During such production processes, certain losses can be inherent and cannot be eliminated. For example, a percentage of liquids may evaporate during certain production processes or part of the cloth cut to make a suit may be lost due to the style/cut of the suit. Losses which occur under efficient operating conditions, are described as normal losses. However, in addition to losses which cannot be avoided, there are some losses which are not expected to occur under efficient operating conditions (for example through improper mixing of ingredients or the incorrect cutting of cloth). These losses are not an inherent part of the production process and are referred to as abnormal losses. Abnormal losses are not included in the process cost they are written off as a period cost to the income statement. Equivalent units This is a term used in process costing which can be relevant to the valuation of manufactured inventory. At the end of any given reporting period, there are likely to be partly-completed units in-process. Clearly, some of the costs, including direct materials cost, direct labour cost and overhead cost which have been incurred during the reporting period are attributable to these units as well as those units which are fully-complete. In order to spread cost equitably, the number of equivalent units is calculated on a mathematical basis - this is the equivalent number of complete units which the partly-complete units represent. The formula for equivalent units is: Number of equivalent units = number of partially-completed units x percentage of completion Example: Production of fully complete units during the reporting period = 2,000 units Work-in-progress = 500 units 50% complete Total equivalent production = 2,000 units + (500 units x 50%) = 2,250 units The costs incurred during the period would be spread over the total equivalent production of 2,250 units Page 43 of 91

45 Part Solution The correct answer is option (b). Tutorial note: Budgets are prepared starting with last year s budget (or actual results) and adding or subtracting according to expectations. Page 44 of 91

46 1090 Solution Units Opening inventories (800) Projected sales 24,700 Closing inventories (800 units x (1 + 30%)) 1,040 24,940 Page 45 of 91

47 1521 Solution The key elements of a standard cost include: Direct materials cost - detail to include specific type, quantity and unit cost; Direct labour cost detail to include grade, number of hours and rate of pay applicable; Variable overhead cost total variable overhead (analysed) and relevant absorption method and rate; Fixed overhead cost total fixed overhead (analysed) and relevant absorption method and rate. Page 46 of 91

48 1522 Solution Numerical example of the build-up of a standard cost Standard Cost for product X Variable Costs Details Quantity Input unit cost Cost per unit of output Direct materials cost Material 1 5 kg 2 per kg Material 2 2 kg 4 per kg 8.00 Direct labour cost Grade 5 10 hours 8 per hr Variable overhead cost Direct labour hours OAR 10 hours 2 per hr Fixed costs Fixed overhead cost Direct labour hours OAR 10 hours 4 per hr Total standard cost per unit Standard selling price per unit Standard profit per unit Page 47 of 91

49 1523 Solution An ideal standard is a target standard cost which can only be attained under the most favourable operating conditions with no allowance for normal losses, waste, machine breakdown etc. Because, in reality, this is an unlikely situation, ideal standards are normally unattainable in practice, and therefore are rarely used except for development or research purposes. The ideal standard can be used to inform the normal, attainable standard, which should be based upon technical, engineering and work studies. Example: A product, produced in perfect working conditions has the following costs (an ideal standard cost): Direct materials cost 2 5 per kg Direct Labour Cost 4 10 per hour Production overhead Cost 4 labour 4 per hour OAR Due to normal losses and expected downtime, the standard cost, per unit of the product is (an attainable standard cost): Direct materials cost per kg Direct Labour Cost 5 10 per hour Production overhead Cost 5 labour 4 per hour OAR Page 48 of 91

50 1524 Solution Advantage of using standard costing to estimate cost of inventories (i) Creates a constant benchmark, against which actual cost can be compared. Disadvantages of using standard costing to estimate cost of inventories (i) Can be complex, requiring detailed projections and forecasting; (ii) Only useful if standard cost is kept up-to-date. Page 49 of 91

51 1526 Solution (a) Sales budget Feb Mar Apr May Sales volume (units) 10,000 10,600 9,200 9,000 Sales price ( net of discount) Sales revenue ( ) 320, , , ,000 (b) Production budget (units) Feb Mar Apr May Jun Sales volume 10,000 10,600 9,200 9,000 9,500 Closing inventories 6,360 5,520 5,400 5,700 16,360 16,120 14,600 14,700 Opening inventories (6,000) (6,360) (5,520) (5,400) Production volume 10,360 9,760 9,080 9,300 Tutorial notes: Closing inventories are calculated as 60% of the following month's budgeted sales volume. Closing inventories for one month are the opening inventories for the following month. (c) Direct materials cost budget Feb Mar Apr May Production volume (units) 10,360 9,760 9,080 9,300 Direct materials cost per unit ( ) Direct materials cost ( ) 113, ,360 99, ,300 (d) Direct labour cost budget Feb Mar Apr May Production volume (units) 10,360 9,760 9,080 9,300 Direct labour cost per hour ( ) Direct labour cost ( ) 93,240 87,840 81,720 83,700 Page 50 of 91