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Class Notes
December 2014
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Contents
PAGE
CHAPTER 3: PRICING 63
CHAPTER 5: BUDGETING 85
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Introduction to the
paper
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INTRO DU C TIO N TO THE P AP E R
FAQS
What are the skills that a student must bring to the paper?
As a student approaching this paper the basic requirement is an ability to
understand and compute the differing techniques and methods in the syllabus. In
addition there is a need to understand the scenario and critically be able to write in
relation to the scenario and whatever the numbers you have already calculated.
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Formulae provided in
the examination paper
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FO RMU L AE & TABL E S P RO VIDE D IN THE E XAMIN ATIO N P AP E R
FORMULAE SHEET
Learning curve
Y axb
Demand curve
P a bQ
changein price
b
changein quantity
a price when Q 0
MR = a – 2bQ
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Chapter 1
2. Target costing
a) Derive a target cost in manufacturing and service industries.
b) Explain the difficulties of using target costing in service industries.
3. Life-cycle costing
a) Identify the costs involved at different stages of the life-cycle.
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4. Throughput accounting
a) Discuss and apply the theory of constraints.
b) Calculate and interpret a throughput accounting ratio (TPAR).
c) Suggest how a TPAR could be improved.
5. Environmental accounting
a) Discuss the issues business face in the management of environmental costs.
b) Describe the different methods a business may use to account for its
environmental costs.
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CHAPTER CONTENTS
TARGET COSTING---------------------------------------------------------24
T RADITIONAL COSTING SYSTEMS 24
T ARGET COSTING STEPS 24
CLOSING A TARGET COST GAP 24
ADVANTAGES AND DISADVANTAGES OF TARGET COSTING 26
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COST CLASSIFICATION
Before the different costing methods can be considered, it is important to
understand clearly the nature of the costs which are incurred by companies.
Depending on the costing system applied, these cost types may be dealt with in
different ways.
Cost behaviour
Cost behaviour looks at whether or not a cost changes when level of activity
changes, where level of activity is the units of output.
Variable costs
Variable costs increase or decrease in proportion to the level of activity. If the
variable cost/unit is $10, then every time an additional unit is produced the
company will incur an additional cost of $10.
While total variable cost s will change in proportion to level of activity, it is expected
that variable cost/unit will be constant at least in the short term.
Fixed costs
Fixed costs are costs which remain constant in total terms when level of activity
changes. Rent or insurance paid in relation to the factory would be examples of
fixed costs. Regardless of the number of units produced, we would expect that the
rent cost will not change.
While total fixed cost is constant, the fixed cost per unit will decrease as level of
activity increases. This is because the total fixed cost is spread across a greater
number of units as level of activity goes up.
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MARGINAL COSTING
Marginal costing is a costing system which focuses on cost behaviour. When
calculating profits in a marginal costing system, the following approach is applied.
Sales - total variable costs = contribution
Contribution - fixed costs = profit
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ABSORPTION COSTING
Identifying the direct costs per unit should be straightforward. However, as the
indirect costs cannot be easily linked to the production of one unit, it is more
difficult to estimate the overhead cost/unit.
Activity levels generally used by examiners are number of units, labour hours ,
or machine hours, which means overheads are charged to units on these
bases.
i. Number of Units: Single product environment
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Production complexity
A wide variety of production processes have become more complex in recent years
in a number of ways:
1. Flexible manufacturing systems allow for a number of differing products to
be produced on the same machinery. Absorbing overheads on a simple
volume basis is unlikely to reflect the differing overhead costs incurred by
each product.
2. Fast product development may mean that a number of differing iterations
of the same product may be produced in quick order.
Costs are also incurred in selling and distributing a product. The c osts associated
with servicing customers are often more important than production costs and
therefore it is important for management to understand what drives these costs
and how they can be controlled.
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ABC analysis
Activity based costing provides a more accurate estimate of the overhead cost/unit
which takes into account the issues highlighted above.
3. Work out the cost incurred each time the activity occurs.
4. For each cost pool, calculate the cost/unit of each product type.
Cost drivers
Remember the cost driver is the activity which causes the cost pool to increase.
Typical examples of cost pools and cost drivers are:
Cost pool Possible Cost Drivers
Material ordering number of orders
Material handling quantity of material
Production scheduling number of production run
Despatching number of deliveries
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(3) Information.
Advantages
1. Leads to a better understanding of the cost/unit of each product, and
therefore product profitability.
Disadvantages
1. Cost v benefit.
2. ABC information is historic .
3. Difficult to apply in practice.
4. Focuses on the allocation of cost rather than minimizing the cost incurred.
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THROUGHPUT ACCOUNTING
Throughput is the rate at which the system generates money through sales. In a
throughput accounting environment, the focus is on putting units through the entire
production process in the minimum possible time to avoid any build-up of inventory
holdings.
In throughput, it is assumed that the only real variable costs, at least in the short
term, are the direct material costs. All labour and overhead costs are assumed to
be fixed. These are usually referred to as ‘other factory costs’.
Calculating throughput
There are a number of key formulae you need to remember f or the exam:
Throughput/unit = Selling price – direct material cost/unit
For each product, we would expect TPAR to be greater than 1. This means that the
rate at which the organisation is generating cash from sales of this product is
greater than the rate at which it is incurring costs. It follows on, then, that if the
ratio is less than 1, this is not the case, and changes need to be made quickly.
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Required:
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Advantages
● Efforts are focused on the products which make the most money .
● Costs such as inventory holding costs are reduced.
Disadvantages
● Selling price could be uncompetitive.
● Material suppliers may not be reliable.
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TARGET COSTING
3. Calculate the target cost – ie the cost that the company must produc e at in
order to be able to achieve the required profit level (Selling price – profit
margin).
4. Calculate and close the cost gap. The cost gap is the current actual cost/unit –
target cost/unit. If the actual cost is higher than the target, the company must
look for ways to reduce costs.
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Required:
(a) Calculate target cost.
(b) Calculate the cost gap.
(c) Explain how the cost gap for product H could be reduced.
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Advantages
● Cost reduction and control
Possible elimination of non-value added elements and activities in production
process.
● Market based costing
Selling price considers what customer might want to pay for the product.
● Customers
Customer requirements for quality, cost, and time are incorporated into
product and process decisions. The value of product features to the
customers must be greater than the cost of providing them.
● Design
Cost control is emphasised at the design stage so any engineering changes
must happen before production starts.
Disadvantages
● Excessive focus on cost reduction may compromise the quality of the product .
● Detailed cost data must be available in order to analyse and reduce the actual
cost/unit.
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Advantages
● Lifecycle costing ensures that the revenues earned from the product will be
greater than the sum all the costs incurred due to that product.
Disadvantages
● It may be difficult to accurately estimate what future costs and volumes will
be over the life of the product.
● Using lifecycle costing will result in a higher selling price. This must be
carefully considered in relation to the price which customers are prepared to
pay.
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Approach 1
Development costs = $1,250,000
Variable manufacturing cost per unit = $25
Selling price per unit = $50
Repairs and warranty costs = $50/unit needing repairs, and 1% of sales will incur
these costs
Clean-up and machinery dismantling costs at end of production $50,000
Approach 2
Development costs = $2,350,000
Variable manufacturing cost per unit = $20
Selling price per unit = $50
Repairs and warranty costs = $30/unit needing repairs, and 0.5% of sales will incur
these costs
Additional fixed cost per year to run new manufacturing machinery = $20,000
Clean-up and machinery dismantling costs at end of production = $30,000
The life of Product 801 if developed and manufactured using Approach 1 should be
5 years and 50,000 units per year should be sold. Because of the higher level of
research used in Approach 2, the product’s life will be increased to 6 years.
Required:
(a) Using a life-cycle costing approach, calculate the profits under
Approach 1 and Approach 2. (8 marks)
(b) If the target gross profit for any product sold by the company is 40%,
what is the target cost of Product 801 and calculate whether the life -
time costs per unit of Approach 1 and Approach 2 would give costs
less than the target cost. Explain, using calculations where possible,
how any cost gaps could be c losed in this case. (7 marks)
(c) Explain why life-cycle costing is particularly important in high-
technology mass production industries. (5 marks)
(20 marks)
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Once the costs have been defined and identified, steps need to be put in plac e
to control the costs.
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● Conventional costs
Raw materials, energy consumption.
● Potentially hidden costs
These are environmental costs which may be incurred at a future date, for
example clean-up costs, future compliance costs.
● Image and relationship costs
Input/outflow analysis
This method looks to balance material inputs with material outputs. For example, if
50 units of material have been input to the process, then 50 units of material
should also be output from the process. If the output is less than 50 units, then
the material wastage in the production process needs to be investigated and
reduced. This will be beneficial to both the environment and the company (as it will
reduce costs).
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Packaging
Raw material Finished
Customers
Production
storage goods storage
Suppliers
Disposal
system
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Chapter 2
B Decision-making techniques
b) Identify and calculate relevant costs for specific decision situations from given
data.
c) Explain and apply the concept of opportunity costs.
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3. Limiting factors
a) Identify limiting factors in a scarce resource situation and select an
appropriate technique.
b) Determine the optimal production plan where an organisation is restricted by
a single limiting factor, including within the context of ‘make’ or ‘buy’
decisions.
c) Formulate and solve multiple scarce resource problem both graphically and
using simultaneous equations as appropriate.
d) Explain and calculate shadow prices (dual prices) and discuss their
implications on decision-making and performance management.
e) Calculate slack and explain the implications of the existence of slack for
decision-making and performance management. (Excluding simplex and
sensitivity to changes in objective functions.)
c) Compare in-house costs and outsource costs of completing tasks and consider
other issues surrounding this decision.
d) Apply relevant costing principles in situations involving shut down, one-off
contracts and the further processing of joint products.
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CHAPTER CONTENTS
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1. Future
2. Cash flow
Opportunity costs
The benefit foregone by choosing one alternative in preference to the next best
alternative.
Avoidable costs
Costs attached to a part or segment of a business which could be avoided if that
part or segment ceased to exist. Variable costs are normally considered avoidable,
fixed costs normally not. Fixed costs may be considered avoidable if arise within
the single part or segment of the business that is relevant. They are particularly
applicable in shutdown decisions.
Incremental costs
Those additional costs (or revenues) which arise as a result of the decision. This
classification is particularly useful for further processing decisions, but may be used
as a basis for tackling any relevant cost analysis.
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Sunk costs
Sunk costs are costs which have been incurred in the past. These will never be
relevant as they are past cash flows (as oppose to future). For example, suppose
we purchased material costing $50,000 3 years ago. We are now considering the
relevant cost of using this material for a particular customer order. The $50,000 is
not relevant as regardless of any decision we make now, this cash flow will not
change.
Committed costs
Committed costs are costs which the company has an obligation to pay regardless
of any decision which management make today. Committed costs would include
fixed salaries which must be paid to employees.
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Is the material
in stock?
YES NO
Purchase price is
Next question
relevant
Is the material in
constant use?
YES NO
Replacement cost is
Next question
relevant
Is there a scrap
value?
YES NO
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Note that the original cost of materials is never relevant as this is a sunk cost.
Is the labour in
permanent
YES employment? NO
Hourly rate is
Next question
relevant
Overtime possible?
YES NO
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Example 1 Tricks
You are the management accountant of Tricks, an organisation which has been
asked to quote for the production of a pamphlet for an event . The work could be
carried out in addition to the normal work of the company. Due to existing
commitments, some overtime working would be required to complete the printing
of the pamphlet. A trainee has produced the following cost estimate based upon
the resources required as specified by the operations manager:
$
Direct materials:
- paper (book value) 4,000
- inks (purchase price 2,400
(2) The inks required are presently not held in stock. They would have to be
purchased in bulk at a cost of $3,000. 80% of the ink purchased would be
used in producing the pamphlet. There is no foreseeable alternative use for
the remaining unused ink.
(3) Highly skilled direct labour is in short supply, and the factory labour is already
being utilised at full capacity, therefore, to accommodate the production of
the pamphlet, 50% of the time required would be worked at weekends for
which a premium of 25% above the normal hourly rat e is paid. The normal
hourly rate is $4.00 per hour.
(4) Semi-skilled labour is presently under-utilised, and 200 hours per week are
currently recorded as idle time. If the printing work is carried out, 25
unskilled hours would have to occur during the weekend, but the employees
concerned would be given two hours time off during the week in lieu of each
hour worked at the weekend.
(5) Variable overhead represents the cost of operating the printing press and
binding machines.
(6) When not being used by the company, the printing press is hired to outside
companies for $6.00 per hour. This earns a contribution of $3.00 per hour.
There is unlimited demand for this facility.
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(7) Fixed production costs are those incurred by and absorbed into production,
using an hourly rate based on budgeted activity.
(8) The cost of the estimating department represents time spent in discussions
with the organisation concerning the printing of its pamphlet .
Required:
Prepare a revised cost estimate using the opportunity cost approach,
showing clearly the minimum price that the company should accept for the
order. Give reasons for each resource valuation in your cost estimate.
(20 marks)
The avoidable costs include variable costs and specific fixed costs. Specific fixed
costs are those costs specific to the part or segment of the business to be
shutdown, for example machinery used only in that part of the business . General
fixed costs will not be relevant.
To make a shutdown decision, the revenue forgone must be compared to the
variable costs + specific fixed costs for that part of the business. If the revenue
forgone is greater than the avoidable costs, then management should not shutdown
that part of the business as it would reduce profits overall.
Division A B C
($000s) ($000s) ($000s)
Sales 100 80 40
Variable costs 60 50 30
Fixed costs 20 20 20
Profit/(loss) 20 10 (10)
You are also informed that 40% of the fixed cost is division specific, the remainder
being allocated arbitrarily to the divisions from head office.
Required:
Using relevant cost analysis, advise the CEO on whether or not Division C
should be shut down.
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Note: Any common/joint processing costs should be ignored as these do not have
any impact on the decision made.
Example 3 CF Ltd
CF Ltd manufactures two cleaning fluids, X and Y. The two fluids are manufactured
in a joint process. Every 8,000 litres of materials input to the joint process
produces 4,000 litre of X and 3,200 of Y. The costs of processing are as follows:
$
Direct material 1,600
Direct labour 200
Variable production overheads 300
Fixed production overheads 2,000
Product X sells for $1.10 per litre and product Y for $0.75 per litre.
CF Ltd could put product X through another production process, where there is
spare production capacity. The further processing would produce another cleaning
product, Zplus. Every one litre of input to the further process will produce 0.90
litres of Zplus.
Required:
Using financial reasons only to justify the decision, state whether the
company should sell product X or should further process the product to
make Zplus.
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● Specific fixed costs. There may be particular fixed costs which would no
longer be incurred if the company buys in the components. For example,
specialist machinery only used to produce that component. These costs will
also be saved if the company buys in the component.
A sub-contractor has offered to supply units of W, X, Y and Z for $12, $21, $10,
and $14 respectively.
Required:
Advise whether the company should make or buy each component.
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● The estimates of sales demand for each product are known with certainty .
Step 1
Calculate the contribution per unit for each product. Contribution/unit = Selling
price – Variable cost/unit
Step 2
Calculate the c ontribution per unit of limiting factor =
Step 3
Use the calculations in step 2 to rank each product (highest first).
Step 4
Calculate the optimal production schedule. Produce as many units as possible of
the highest ranking product, up to the maximum demand for that product. If there
is scarce resource left over after this, then move on to the second ra nking product,
third ranking product etc.
Step 5
Calculate the maximum profit earned (if required). Remember that fixed costs will
not change when level of activity changes.
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Step 1
Calculate the savings made by producing the units internally =
Cost of buying - cost/unit to make.
Step 2
Calculate the savings made per unit of limiting factor =
Savings per unit / limiting factor usage per unit .
Step 3
Use the calculations in step 2 to rank each product (highest first).
Step 4
Step 5
Any units which cannot be made internally should be purchased externally.
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Required:
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Steps
3. Subject to – constraints
Labour 3L + 4M 15000
Materials 3L + 6M 18000
(non-negativity) L, M ≥0
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4000
3500
3000
2500
Units of M 2000
1500
1000
500
0
0 1000 2000 3000 4000 5000 6000 7000
Units of L
To draw this line in the exam, a figure for Z (total contribution) must be assumed.
Any number can be selected but you must ensure that the number you chose will
enable you to easily draw the ISO contribution line on your graph.
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If L = 0, then M = 1,000
If M = 0, then L = 1,500
Now this line can be shown on the graph.
Regardless of the value selected for Z, the slope of the ISO contribution line will
always remain the same (as the contribution/unit of e ach product does not
change). Selecting a higher value for Z will result in the ISO contribution line being
pushed upwards on the graph.
Corner 1
The point where the material constraint line meets the y axis
At this point:
L = 0, M = 3000
Contribution = 40(0) + 60(3000) = $180,000
Corner 2
The point where the material constraint line meets the labour constraint line .
Simultaneous equation technique can be used to find the point of intersection
of these 2 lines:
Labour: 3L + 4M = 15,000
Materials: 3L + 6M = 18,000
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Corner 3
The point where the labour constraint line meets the x axis.
At this point:
L = 5,000, M = 0
Contribution = 40(5,000) + 60(0) = $200,000
Suppose that in addition to the above information, we discovered that the company
cannot produce more than 20,000 units of L due to machine hours availability.
Then the additional constraint would be:
L ≤20,000
As the company is only current ly producing 3,000 units of L (per the optimal
production plan), this is a slack constraint. There are still machine hours
available to produce further unit s of L.
Shadow prices
A shadow price is the additional contribution which would be earned if one more
unit of limiting factor became available.
Shadow prices can only be calculated for the binding constraints, as additional
availability of slack constraints could not be utilised.
Shadow prices could therefore be calculated for labour hours and materials in the
above exercise.
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Step 1
Add one additional unit to the constraint.
This means the availability of labour hours would increase by 1 and the new labour
constraint would be:
3L + 4M ≤ 15,001
Step 2
Calculate the new optimal production schedule.
This will be the point where the new labour constraint line meets the material
constraint line:
Labour: 3L + 4M ≤ 15,001
Materials: 3L + 6M ≤ 18,000
Step 3
Step 4
Calculate the shadow price = New max contribution – Original max contribution
The shadow price for labour hours = $210,010 - $210,000 = $10
This means that each additional labour hour added will increase contribution by $10
● Assumes contribution per unit for each product is constant irrespective of the
total quantities produced and sold.
● Assumes utilisation of resource per unit for each product is constant
irrespective of the total quantities produced and sold.
● Assumes that units produced and resources allocated are infinitely divisible.
● When there are a number of variables, it becomes too complex to solve
manually and a computer is required.
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Example 7
A company makes two products (X and Y), within three departments (A, B and
C). Production times per unit, contribution per unit and the hours available in
each department are shown below:
Product X Product Y Capacity (hours)
Contribution/unit $4 $8
Hours/unit Hours/unit
Department A 8 10 11,000
Department B 4 10 9,000
Department C 12 6 12,000
Required:
(a) Calculate the optimum production plan, assuming the company
objective is to maximise contribution.
(b) Calculate the shadow prices for the binding constraints.
(c) Calculate the slack for Department C.
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CVP analysis is a technique which uses cost behaviour to identify the level of
activity at which we have no profit or loss (break-even point).
It can also be used to predict the profits or losses to be earned at varying activity
levels (using the assumed linearity of costs and revenues).
CVP analysis assumes that selling prices and variable costs are constant per unit
regardless of the level of activity and that fixed costs are just that – fixed.
Margin of safety
The margin of safety indicates by how much sales can decrease before a loss
occurs.
Target volumes
If the company wishes to earn a profit of a certain amount, CVP can be used to
determine how many units must be produced and sold in order to achieve the
target.
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Required:
(a) Calculate the following:
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Break-even chart
Total costs
Profit
Fixed costs
Margin of safety
Sales activity
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Profit/volume chart
A break-even chart shows the costs and revenues at a number of activity levels. It
does not however, show the amount of profit or loss at these levels. This is shown
on the profit/volume chart.
Sales activity
Break-even point
Loss
Fixed costs (total loss)
From this chart we can read off the amount of profit or loss for any level of activity.
1. The x axis represents sales (units or revenue).
2. The y axis shows profits above the x axis and losses below.
3. When sales = zero, the net loss is equal to the fixed costs.
4. If contribution per unit and total fixed costs are constant throughout the
relevant range, the profit/volume chart is shown as a straight line.
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= 400,000/0.54 = $746,667
3. B/E mixes = Fixed costs/contribution per mix
In multi-product CVP, it is assumed that products will be sold in a constant
mix. In the above budget, the following applies:
Product A Product B
Budgeted sales 16,000 8,000
So, for each 2 units of Product A sold, 1 unit of Product B will be sold.
The contribution per mix is then:
$20 x 2 + $35 x 1 = $75
B/E mixes = $400,000 / $75 = 5,333. The break even units of each product
can now be calculated:
Product A Product B
Units/mix 2 1
B/E units 10,666 5,333
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Following are the extracts from last year’s budgeted results relating t o three
products.
PINS NUMBS NEEDLES
$ $ $
Required:
(a) Calculate the budgeted profit. (2 marks)
(b) Determine the break even revenue and margin of safety if the
company sells all the products as pe r their origina l sa les plans. (6 marks)
(c) Advise the company of an alternative plan if the management wishes
to produce and se ll products in prefe rence to each other. (4 marks)
(d) Using the same graph:
(i) Plot a P/V chart when all the products are produced and sold
together in their original ratio.
(ii) Plot a P/V chart when products are made and sold using an
alternative plan dete rmined in part (c) above. (8 marks)
(20 marks)
NOTE: YOUR GRAPH SHOULD BE CLEARLY DRAWN WITH ALL POINTS
SHOWN AND LABELLED.
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Chapter 3
Pricing
B Decision-making techniques
4. Pricing decisions
a) Explain the factors that influence the pricing of a product or service.
d) Calculate the optimum selling price and quantity for an organisation, equating
marginal cost and marginal revenue.
e) Evaluate a decision to increase production and sales levels, considering
incremental costs, incremental revenues and other factors.
f) Determine prices and output levels for profit maximisation using the demand
based approach to pricing (both tabular and algebraic methods).
iii) Penetration
iv) Complementary product
v) Product-line
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INTRODUCTION TO PRICING
The pricing of products or services is one of the more difficult and more import ant
decisions for the organisation. The prices adopted by a company will have an
immediate effect on the profitability of an organisation and longer term implications
on the marketing of the product.
1. Organizational goals
3. Competitors
4. Cost
5. Product mix
6. Quality
7. Inflation
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COST-PLUS PRICING
The simplest form of pricing, it is still widely used particularly in the retail industry
and in specific /job order situations. The price is based on the cost plus a margin.
Cost-plus pricing may be based on:
1. full cost (calculated using absorption costing or ABC), or
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Advantages
● Can price below total cost when demand is low if there is spare capacity.
● Efficient and most economic use of scarce resources.
Disadvantages
● Ignores fixed overheads. The price may not be high enough to ensure that a
profit is made after fixed overheads are covered.
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Market skimming
The price is set at a high level to generate maximum return per unit in the early
units. The aim is to sell to only that small part of the market which is not price
sensitive. For market skimming to be effective the company must have a barrier to
entry in the form of a patent , brand, technological innovation or other.
Features
1 Low volume, high price.
2 Low initial investment in production capacity.
Features
1 Low price, mass market.
● The product is suitable for a mass market and there is sufficient demand.
● The product will face competition soon after introduction.
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Volume discounting
A volume discount is a reduction in price given for purchases of large volume. The
objective is to increase sales from large customers. The discount differentiates
between wholesale and retail customers. The reduced cost of a large order will
compensate for the loss of revenues from offering the discount.
Price discrimination
This is the practice of selling the same product at different prices to different
customers. Examples: off peak travel bargains; theatre tickets sold at different
prices based on location so that customers pay different prices for the sa me
performance.
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This technique considers the demand for a product at a given price by developing a
demand curve. Demand based pricing assumes that as the price of the product
increases, the quantity demanded will decrease.
P = Price
Q = Quantity Demanded
changein price
b
changein quantity
a price when Q 0
Example 1 Biscan
A product sells 500 units at a price of $25 and 700 units at a price of $20.
Required:
Establish the equation of the demand curve.
Example 2 Mellor
A company presently sells 20,000 units at $12.50 each. The managing director
believes that they will be more profitable if they sell 20% more unit at a price of
$11 each.
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Required:
(a) Derive the demand curve.
(b) Calculate the total revenue in each circumstance.
(c) Discuss the belief of the managing director that selling more units at a
lower price will increase profits.
Example 3 Spearing
The price of a good is $1.20 per unit and the annual demand is 800,000 units.
Market research indicates that an increase in pric e of 10cents per unit will result in
a fall in annual demand of 75,000 units.
Required:
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Marginal revenue is the additional revenue earned from selling one more unit.
Using a demand based approach, we assume that for one extra unit to be sold, the
selling price would have to drop by a certain amount. Therefore, as quantity sold
increases, the marginal revenue will decrease.
Marginal cost is the additional cost incurred from producing one more unit. We
can assume that this is equal to the variable cost per unit.
Cost/revenue $
Marginal Revenue
Marginal Cost
Quantity demanded
Example 4 Kozma
A company sells 1,000 units at $10 per unit and 1,500 units $8 per unit. Variable
costs are $5 per unit.
Required:
(a) Derive the demand function for this company, and explain its
usefulness.
(b) Equate Marginal Revenue and Marginal Cost to determine the optimal
quantity and optimal price.
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Chapter 4
B Decision-making techniques
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SIMULATION --------------------------------------------------------------83
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Uncertainty
Uncertainty simply reflects that there is more than one possible outcome for a
given event, but there is little previous statistical evidence to enable the possible
outcomes to be predicted.
Risk
Risk is where that uncertainty can be quantified in some way.
Risk attitudes
Risk preference describes the attitude of a decision-maker toward risk – as there is
a relationship between risk and reward.
● Risk averse – a risk averse decision-maker considers risk in making a
decision, and will not select a course of action that is more risky unless the
expected return is higher and so justifies the extra risk.
● Risk seeker – a risk seeker decision-maker also considers risk in making a
decision.
A risk seeker, unlike a risk averse decision-maker, will take extra risks in the
hope of earning a higher return.
● Risk neutral – a risk neutral decision-maker ignores risk in making a
decision.
A risk neutral decision-maker will select the course of action with the highest
expected return, regardless of risk
Pay-off tables
The choice between two or more alternative courses of action might be based on
the worst, most likely or best expected outcomes from each course of action.
This choice will show the full range of possible outcomes from a decision, and might
help managers to reject certain alternatives because the worst possible outcome
might involve an unacceptable amount of loss.
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DECISION CRITERIA
Once the pay-off table has been prepared, a decision has to be made between the
different courses of action.
The choice may be based on a maximax, maximin, minimax regret decision rule ,
and expected value.
Maximax
The decision maker will select the course of action with the highest possible payoff
(the best of the best).
The maximax decision rule is the decision rule for the risk seeker.
Maximin
The decision maker will select the course of action with the highest expected return
under the worst possible conditions. This decision rule might be associated with a
risk averse decision maker.
Minimax regret
The decision maker selects the course of action with the lowest possible regret. It
aims at minimising the regret from making the wrong decision.
Regret is the opportunity cost of having made the wrong decision, giv en the actual
conditions that apply in the future.
Expected values
Expected value is a weighted average value of all the possible outcomes. It does
not reflect the degree of risk, but simply what the average outcome would be if the
event were repeated a number of times.
A decision rule is to select the course of action with the highest expected value of
profit or the lowest expected value of cost.
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Required:
Calculate the expected value of sales.
Example 2 Mr Sartre
Mr Sartre runs a market stall selling vegetables and fruit. He buys a product for
$20 per case. He can sell the product for $40 per case on his stall. The product is
perishable and it is not possible to store it, instead any cases unsold at the end of
the day can be sold off as scrap for $2 per case.
Purchase orders must be made before the number of sales is known. He has kept
records of demand over the last 150 days.
Demand / day Number of days
10 45
20 75
30 30
Required:
(a) Prepare a summary of possible net daily margins using a payoff table.
(b) Advise Mr Sartre:
(i) How many cases to purchase if he uses expected values.
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The price that one would be willing to pay in order to gain access to perfect
information of an uncertain outcome in decision making is known as Value of
Perfect Information.
Mathematically, VPI is the difference between the payoff under certainty and the
payoff under risk.
VPI = Expected value with perfect information - highest possible expected value
without perfect information
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Decision tree analysis is designed to illustrate the full range of alternatives that can
occur, under all possible given conditions.
On the decision tree:
1. Constructing the decision tree (which is done from left to right on the page).
2. Evaluating the decision tree (which is done from right to left on the tree). An
expected value must be calculated at each outcome point. Decisions will be
made based on selecting the option with the highest expected value.
Required:
Draw a decision tree to illustrate the above problem, and recommend to
management the best course of action.
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SENSITIVITY ANALYSIS
Introduction
Sensitivity analysis is a method of risk or uncertainty analysis in which the effect on
the expected outcome of the change in values of key variables or key factors is
tested. For example, in budget planning, the effect on budgeted profit might be
tested for changes in the budgeted sales volume, or the budgeted sale price,
material and labour costs, and so on.
Required:
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SIMULATION
Simulation is a quantitative technique that uses IT based computerised packages
with built in mathematical models for decision making under conditions of
uncertainty. It evaluates various courses of action based upon facts and
assumptions.
● Medical diagnosis
● Gambling
● Air force training
● Traffic scheduling.
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MARKET RESEARCH
Market research is a process of systematically and objectively gathering, recording
and analysing information. This can be used to reduce uncertainty.
This information may relate to:
● customers;
● economic trends;
● technological advancements; and
● any other factors that constitute the business environment.
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Chapter 5
Budgeting
1. Budgetary systems
a) Explain how budgetary systems fit within the performance hierarchy.
c) Describe the information used in budget systems and the sources of the
information needed.
d) Explain the difficulties of changing a budgetary system.
e) Explain how budget systems can deal with uncertainty in the environment.
2. Types of budget
a) Prepare rolling budgets and activity based budgets.
b) Indicate the usefulness and problems with different budget types (including
fixed, flexible, zero-based, activity-based, incremental, rolling, top-down,
bottom up, master, functional).
c) Explain the difficulties of changing the type of budget used.
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WHAT IS A BUDGET?
A quantitative plan prepared for specific time period. It is normally expressed in
financial terms and prepared for one year.
1. Planning
2. Control
3. Communication
4. Co-ordination
5. Evaluation
6. Motivation
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BUDGET PREPARATION
It is important that suitable administration procedures are introduced to ensure that
the budget process works efficiently.
● coordinate budgets
● suggest amendments to budgets, example, because they are not adequate
● approve budgets after amendments, as necessary
Steps in budgeting
1. Budget aims
Strategic aims.
Key assumptions.
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2. Promotes ownership.
5. Negotiation
Meeting between junior management and senior managers to ensure that the
budget is a realistic target. In particular the aim is to eliminate budgetary slack.
6. Review
Bring all individual functional budgets together to form a master budget, an overall
budget for the whole organisation.
Budget assessed for:
1. Feasibility
2. Acceptability
Once completed budgeted financial statements and cash flow statements can be
prepared.
7. Acceptance
Acceptance means that the budget becomes a formal authorisation for all levels of
management to take action for and on behalf of the company.
Budgetary control
Budgetary control involves:
Feedback control
Feedback control is defined as the measurement of differences between planned
outputs and actual outputs achieved, and the modification of subsequent action
and/or plans to achieve future required results.
Control through feedback is where actual result (output) are compared with those
which were planned for the budget period. Likewise, the input (cost) are compared
with the budget, taking account of the actual level of outputs. This comparison of
actual with plan takes place after the event. The intention is to learn for the future
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so that future deviations of actuals and plans are avoided or minimised. Feedback
is a reactive process.
Feed-forward control
Feed-forward control is an alternative approach to control using feedback.
Feed-forward control is defined as the forecasting of differences between the actual
and planned outcomes and the implementation of actions before the event, to
prevent such differences.
Control through feed-forward is where prediction is made of what output and inputs
are expected for some budget period. If these predictions are different from what
was planned, then control actions are taken which attempts to minimise the
differences. The aim is for control to occur before the deviation is reported hence
feed-forward control is more proactive. Budget generation is a form of fe ed-
forward in that various outcomes are considered before one is selected.
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TYPES OF BUDGET
There are a number of different ways in which a budgetary system can be
approached.
The budget types required for the F5 syllabus are:
1. Participatory/Non participatory
2. Incremental
3. Rolling budgets
4. Zero based budgeting
The quality of departmental budgets will vary based on the skill of individual
managers.
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Incremental budgeting
This is the traditional approach to budgeting. This approach bases the budget on
current results and adjusts for known changes, eg estimated changes in sales,
inflation.
Incremental budgeting is appropriate in environments where activities do not
change significantly each year.
Advantages
1. This is usually the quickest and easiest type of budgeting.
2. Management have more time available to focus on other areas (rather than
budget preparation).
Disadvantages
1. Inefficiencies from the current year will be included in the budget for next
year.
Rolling budgets
In a periodic budgeting system the budget is normally prepared for one year, a
totally separate budget will then be prepared for the following year. In continuous
budgeting the budget from one period is ‘rolled on’ from one period to the next.
Typically the budget is prepared for one year, only the first quarter in detail, the
remainder in outline. After the first quarter is revised for the following three
quarters based on the actual results and a further quarter is budgeted for.
This means that the budget will again be prepared for 12 months in advance. This
process is repeated each quarter (or month or half year).
Disadvantages
1. More costly and time consuming.
2. An increase in budgeting work may lead to less control of the actual results.
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2. Rank
Rank the decision packages in order of importance, starting with the mandatory
requirements of a department. This forces the management to consider carefully
what their aims are for the coming year.
3. Funding
Identify the level of funding that is available for the organisation.
4. Utilise
Use up the funds in order of the ranking until exhausted.
Advantages
1. Emphasis on future need not past actions.
2. Eliminates past errors that may be perpetuated in an incremental analysis.
Disadvantages
1. Can be costly and time consuming.
2. May lead to increased stress for management.
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Advantages
1. Better understanding of overhead costs.
Disadvantages
1. Identifying appropriate cost drivers may be subjective and therefore accuracy
depends on the judgement of management .
2. The implementation and maintenance of an ABB system will be expensive and
time consuming.
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FIXED BUDGETS
A budget prepared at a single (budgeted) level of activity.
Advantage:
A fixed budget is likely to be useful in circ umstances where the organisational
environment is relatively stable and can be predicted with a reasonable degree of
certainty.
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FLEXIBLE BUDGETS
A budget prepared with the costs classified as either fixed or variable. The budget
may be prepared at any activity level and can be ‘flexed’ or changed to the actual
level of activity for budgetary control purposes.
Flexible budget recognises the difference in behaviour between fixed and variable
cost in relation to fluctuations in output, turnover or other variable factors and is
designed to change appropriately with such fluctuations.
2. This is then flexed to correspond with actual level of activity . Variable costs
and sales revenue are adjusted to reflect the actual level of activity.
3. The result is compared with actual cost and differences (variances) are
reported to the managers responsible.
Step 1
Variable cost/unit =
Total cost at the high level of act ivity – total cost at the low level of activity
Volume at the high level of activity – volume at the low level of activity
Step 2
Fixed costs =
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Required:
(a) Using a flexible budgeting approach, redraft the operating statement
so as to provide a more realistic indication of the variances, and
comment briefly on the possible reasons (other than inflation) why
they have occ urred. (10 marks)
(b) Explain why the original operating statement was of little use to
management. (2 marks)
(c) (i) Discuss the problems associated with the forecasting of figures
which a re to be used in flexible budgeting. (4 marks)
(ii) Further analysis has indicated that the 'variable' overheads for
cost of sales are, in fact, only semi-variable. Whilst the
budgeted overheads for 640,000 units is indicated to be
$32,000, it is felt that the budget for 760,000 units would be
$37,000. Included in this later cost is $1,000 incurred when the
activity reached 750,000 units due to extra hiring capacity.
Produce a revised flexed budget for the overheads contained in
cost of sales for an activity level of 720,000 units. (4 marks)
(20 marks)
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LEARNING CURVE
Learning curve is used to estimate more accurate labour and labour related costs,
where these may change due to employees becoming more skilled.
It can be used as part of the budgeting process, but is also useful in other areas
such as target costing, life-cycle costing and decision making.
The learning curve is a statistical relationship which establishes the fact that labour
time per unit falls as a complex task is repeated. As workers become more familiar
with the production of a new product or task, average time (and average cost) will
decline at a known rate.
“As cumulative production doubles from the first unit, the cumulative
average time per unit falls by a constant percentage”
Mathematical illustration
Incremental
Average Cum
Cumulative Incremental Incremental Average
time per total
units units total time time per
unit time
unit
1 unit
2 units
4 units
8 units
As cumulative output doubles, the cumulative average time per unit falls to a fixed
percentage of the previous average time.
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x = cumulative output
Required:
Using the above example calculate the incremental time taken by the 2nd, 3rd and
4th units.
Example 4 BG
BG has recently developed a new product. The nature of their work is repetitive,
and it is usual for there to be 80% learning curve effect when a new product is
developed. The time taken for the first unit was 22 minutes. Assuming that an
80% learning effect applies:
Required:
What is the time to be taken for the fourth unit?
Required:
Calculate the average cost for each unit for this order.
Batches Hours
15 79.51
30 71.56
45 67.28
60 64.40
75 62.25
90 60.55
105 59.15
120 57.96
Labour hours worked and paid for will be adjusted to eliminate spare capacity
during each quarter. All time will be paid for at $5 per hour.
(c) Variable overhead is estimated at 150% of direct labour cost during 2013.
(d) All units produced will be sold in the quarter of production at $1,200 per
batch.
Required:
(a) Calculate the labour hours requirement for the second batch and the
sum of the labour hours for the third and fourth batches produced in
quarte r 4, 2012. (3 marks)
(b) Prepare a budget for each of quarters 1 and 2, 2013 showing the
contribution earne d from the product. Show all relevant workings.
(12 marks)
4. Standard costing
a) Explain the use of standard costs.
b) Outline the methods used to derive standard costs and discuss the different
types of cost possible.
c) Explain and illustrate the importance of flexing budgets in performance
management.
d) Explain and apply the principle of controllability in the performance
management system.
CHAPTER CONTENTS
STANDARD COSTING
● A standard is ‘a benchmark measurement of resource usage, set in defined
conditions’.
● Standard costing is a system of accounting based on pre-determined costs
and revenue per unit, which are used as a benchmark to compare actual
performance, and therefore provide useful feedback information to
management.
● Variance analysis is performed by comparing the actual c ost and the standard
cost to ascertain the difference.
● Standard costs can be prepared using either absorption costing or marginal
costing.
Types of standards
Ideal standard
● A standard that assumes perfect working conditions and does not make
allowance for any losses, waste and machine breakdown.
● It can be used as a long-term organisational goal and is particularly applicable
in total quality management environments.
● The variances can only be adverse and it may have an adverse motivational
impact.
Attainable standard
● It is based upon efficient (but not perfect) levels of operation but will include
allowances for normal material losses, realistic allowances for fatigue ,
machine breakdowns, etc.
● Attainable standards must be based on a tough but realistic performance level
so that its achievement is possible, but has to be worked for.
Basic standard
● These are long-term standards which remain unchanged over a period of
years. Their sole use is to show trends over time for such items as material
prices, labour rates and efficiency and the effect of changing methods.
● They cannot be used to highlight current efficiency because they are out -of-
date.
Material
Build the variable costs up to
Usage x Price
the unit cost
Labour
Hours x Rate
Var. O/H
Hours x rate
Standard cost
per unit
Fixed O/H
Budgeted fixed
cost
Break the total fixed costs down using ÷
the budgeted level of activity Budgeted number
of units
VARIANCE ANALYSIS
The main application of standard costing is for budgetary control purposes. The
standard is compared to the actual result the difference being the variance. The
analysis provides the following information:
1. Cost control.
The budgeted output and sales was 1,000 units. Actual production and sales for
the period were 1,300 units
Actual cost and revenue were as follows:
$
Direct Material 5,000 kg, costing 22,700
Direct Labour 2,850 hours, costing 21,500
Variable Overhead 7,800
Fixed Overhead 14,600
Sales Revenue 1,300 units at $68 per unit 88,400
Required:
Material variances
Standard Cost
Direct Material 4 kg at $5 per kg
Actual Results
Actual output 1,300 units
Materials Purchased and used 5,000 Kg, costing $22,700
SQSP
Usage
AQSP
Price
AQAP
Labour variances
Standard Cost
Direct Labour 2 hours at $8 per hour
Actual Results
Actual output 1,300 units
Hours paid and worked 2,850
Labour Cost $21,500
SHSR
Efficiency
AHSR
Rate
AHAR
Standard Cost
Variable overhead 2 hours at $3.5 per hour
Actual Results
Actual output 1,300 units
Hours worked (from above) 2,850
Variable overhead Cost $7,800
SHSR
Efficiency
AHSR
Expenditure
AHAR
Question extract
Standard and Budgeted Cost
The fixed cost is($7/hour for 2 hours) $14per unit
The budgeted number of units is 1,000
Budgeted fixed overheads is therefore $14,000
Actual Results
Actual output 1,300 units
Hours worked (from above) 2,850
Fixed overhead Cost $14,600
SHSR
(Std fixed OH cost of actual output)
Volume variance
BHSR
(Budgeted fixed OH cost)
Expenditure variance
AHAR
(Actual fixed OH cost)
SHSR
Efficiency
AHSR
Capacity
BHSR
Expenditure
AHAR
SALES VARIANCES
Standards and
budget
Actual Results
Sales (units) 1,300
Selling Price £68
Key formulae
Price variance
(AP - SP) x AS
REPORTING ON VARIANCES
Once the variances have been calculated, an operat ing statement can be prepared
which reconciles budgeted contribution to actual contribution using the variances.
Materials Usage
Labour Rate
Labour Efficiency
Sub-total
Variance Manager
Material price Purchasing manager
Material usage Production manager
Advanced variance
analysis
b) Explain the wider issues involved in changing material mix eg cost, quality
and performance measurement issues.
c) Identify and explain the relationship of the material usage variance with the
material mix and yield variances.
d) Suggest and justify alternative methods of controlling production processes.
b) Identify and explain those fac tors that could and could not be allowed to
revise an original budget.
c) Calculate, identify the cause of and explain planning and operational variances
for:
CHAPTER CONTENTS
INTRODUCTION--------------------------------------------------------- 118
INTRODUCTION
Variance analysis is used to separate costs and revenues into controllable elements
(eg material, labour etc) in order that we can compare expected (standard)
performance with actual results. Advanced areas simply increase the degree to
which the variances may be sub-analysed into:
Normal
analysis
Planning Operational
variance variance
Uncontrollable
Usage
Price
Advantages
● Variances are more relevant, especially in an unpredictable environment.
● The operational variances give fair reflection of the actual results achieved in
the actual conditions that existed.
Disadvantages
● The establishment of the revised standard is very difficult.
● There is a considerable amount of administrative work.
● It may become too easy to justify all variances as being due to bad planning,
so no adverse operational variances will be highlighted.
Example 1 Performance
Standards
3kg/unit for $5/kg
Actual
Output 12,500 units
Usage 38,000 kg
Cost $195,500
Required:
Prepare the variances using basic variance analysis and assess whether
the purchasing manager and production manager individually have done a
good or bad job.
Example 1 (cont)
After further consideration the standards have been revised to reflect changes that
have occurred over time. The standard usage is now expected to be 3.1kg due to a
poor harvest leading poorer quality material inputs. In addition due to adverse
movements in the exchange rate the material costs have changed. It is now
expected that each kg will cost $5.15.
Required:
Prepare an analysis of variances into both planning and operational
elements and assess the performance of the purchasing manager and the
production manager individually.
An adverse yield variance occurs if more inputs have been used to produce output
when compared with the standard inputs.
SQ(SM)SP
Yield
AQ(SM)SP
Mix
AQ(AM)SP
Price
AQ(AM)AP
Example 2 Dalglish
Dalglish manufactures a fertiliser by mixing three chemicals, A, B and C, and the
following standards apply:
Standard proportions Standard cost per tonne
% $
A 70 20
B 20 30
C 10 50
During the process of mixing, a process loss of 10% is regarded as the standard.
In a week, 855 tonnes of the fertiliser were produced and inputs were as follows:
Actual inputs Actual prices Actual cost
tonnes $ per tonne $
A 660 21 13,860
B 210 32 6,720
C 130 47 6,110
_____ ______
1,000 26,690
_____ ______
Required:
Required:
Calculate sales mix and quantity variances.
The market size variance is calculated by comparing the budgeted sales with the
revised budgeted sales:
(Revised budgeted sales - original budgeted sales) x Standard contribution/unit
Required:
Calculate the following variances:
1. Sales price and sales volume.
Performance
evaluation
c) Identify and discuss the direct data capture and process costs of management
accounting information.
d) Identify and discuss the indirect costs of producing information.
3. Management reports
a) Discuss the principal controls required in generating and distributing internal
information.
b) Discuss the procedures that may be necessary to ensure security of highly
confidential information that is not for external consumption.
d) Explain the causes and problems created by short -termism and financial
manipulation of results and suggest methods to encourage a long term view.
e) Explain and interpret the Balanced Scorecard, and the Building Block model
proposed by Fitzgerald and Moon.
f) Discuss the difficulties of target setting in qualitative areas.
CHAPTER CONTENTS
Profitability ratios
net profit
Return on Capital Employed =
capitalem ployed
net profit
Net Profit margin * =
sales
sales
Asset Turnover =
capitalem ployed
*alternatively you can use gross profit to calc ulate gross profit margin
Liquidity ratios
current assets
Current ratio =
current liabilities
current assets inventory
Quick (acid test) ratio =
current liabilities
Gearing ratio
debt
Gearing =
debt equity
The business’s trading results for the first two quarters of trade are shown below.
Quarter 1 Quarter 2
$ $ $ $
Required:
Assess the financial performance of the business during its first two
quarte rs using the data given above. (12 marks)
Non financial performance indicators tell us HOW the company has achieved current
performance and WHY the company has been successful. By analysing company
performance in this way (in addition to financial performance), it gives us a fuller
understanding of the company’s prospects for the future.
Furthermore, by focusing only on financial performance, management may take a
very short term view of company success. For example, cost reduction measures
may be taken in order to improve measures of profitability in the current year.
However, these cost reduction measures may affect product quality and damage
company performance in the longer time. By including non financial performance
measures such as customer satisfaction in our analysis, management should be
more likely to focus on longer term success.
● changes in the business and market environment do not show in the financial
results of a company until much later. Factors other than financial
performance must therefore be targeted.
Customer perspective
● How do customers perceive the firm?
o New markets.
o Customer retention.
o Customer satisfaction.
● Quality.
● Motivated workforce.
● Amount of training.
● Number of employee suggestions.
● Extent of employee empowerment.
Financial perspective
● This is concerned with the shareholders’ view of performance.
o Profit ratio.
o Return on investment.
o Economic value added.
3. Dimensions.
Dimensions
● Financial
performance
● Competitiveness
● Quality
● Flexibility
● Resource utilisation
● Innovation
Standards Rewards
● Ownership ● Clarity
● Achievability ● Motivation
● Equity ● Controllability
●
1. Standards
This refers to the targets that are set within the organisation. These should be :
● High enough to motivate.
● Be owned by the employees (through participation in target -setting).
● Be seen to be equitable.
2. Rewards
This refers to what the organisation (and the employee) is trying to achieve.
3. Dimensions
This refers to how performance will be measured. The areas are :
● Financial
● Competitive performance
● Quality of service
● Flexibility
● Resource Utilisation
● Innovation.
1. Input measurement
In the absence of easily measured output then more consideration can be put
into the costs and resourcing of an organisation.
3. External comparison
2. Efficiency
3. Economy
Operational 0 Transaction
processing system
● manufacturing
o planning for production
o planned purchasing of materials
o budgeting
o standard costing
● human resources
o training
o recruitment
o employee development.
Divisional performance
and transfer pricing
CHAPTER CONTENTS
DIVISIONALISATION
Decentralisation refers to delegating responsibilities to divisional managers or unit
heads.
Advantages
● It increases motivation of the divisional managers as they feel involved in the
decision making of the organisation.
● It is a form of training for the divisional managers and it easy for them to rise
through the ranks to strategic positions.
● It should promote goal congruence (see later), as all decisions been taken are
all geared towards achieving the objectives of the whole organisation.
Disadvantages
● Divisional managers may make dysfunctional decisions (decisions that are not
in the best interests of the organisation).
● There is a need for a performance appraisal system to assess the performance
of individual managers.
In practice the obvious uncontrollable cost for a division would be apportioned head
office costs on the basis that the incurrence of cost is controllable by head office
and is charged in an arbitrary manner to the division.
When looking at an investment centre the manager is able to control the amount of
investment in the division. It is normal to assess the performance of profit in
relation to investment made by head office in the division using either return on
investment (ROI) or residual income (RI)
Return on investment
profit beforeinterestand tax
ROI = 100
capitalem ployed
If return on investment is greater than the cost of capital (or target return where
given), then divisional performance has been good (based on ROI).
Advantages of ROI
1. It is easy to understand and easy to calculate.
2. ROI is still the commonest way in which business unit performance is
measured and evaluated, and is certainly the most visible to shareholders.
Disadvantages of ROI
1. It fails to take account of the project life or the timing of cash flows and time
value of money within that life.
2. When assets are valued at net book value, reported performance improves
with time as the assets get old. In this case there is a disincentive to invest
in new assets.
If residual income is positive, then divisional performance has been good (based on
RI).
Example 1 Tata
Tata is a division of Tatan group. Its manager has the authority to invest in new
capital expenditure, within limit set by head office. The senior management team
of the division is considering an investment of $4.2 million. This would have a
residual value of zero after four years. Net cash flows from the investment would
be $1.4 million for each of the next four years.
The cost of capital for the Tata division is 10%. It is the group’s policy to use
straight-line depreciation when measuring divisional profit.
For measuring purpose and reporting purposes, capital is defined as the opening
net book value at the start of each year.
Required:
(a) Calculate residual income each year.
(b) Calculate the return on investment each year.
Behaviour issues
In decision making, managers should not use measures like ROI and RI. However,
generally the aforementioned measures are used in performance measurement;
therefore managers tend to include these in their assessments of new projects.
Assessing divisional performance using ROI or RI may lead to the following
behavioural issues:
● Short termism.
● Management fraud.
Management fraud
Having a single profit measure or relatively few related measures of performance
appraisal allows managers to manipulate the figures underpinning these measures.
In simple terms the manager only needs to overstate profits in a period or
understate the investment.
Division X y
Investment ($m) 10 30
Controllable Profit ($m) 2 3
Required:
Calculate the performance of each division based using:
(a) ROI
(b) RI
Which division has superior performance?
Example 2 contd
Continuing from the previous example each division has the opportunity to invest in
a new project.
Division X y
Investment ($000s) 500 1,000
Controllable Profit ($000) 80 120
Required rate of return is 15% (set by the head office).
Required:
Using the measures of performance above assess the decisions that would
be made by:
(a) the divisional managers;
(b) head office;
TRANSFER PRICING
Transfer pricing is used when divisions of an organization need to charge other
divisions of the same organization for goods or services they provide to them.
Buying
Supplying Division
Division
The supplying division provides some product or service to the buying division.
The supplying division may also sell this product to external customers.
The buying division pays the supplying the division for the product which has
been provided. The price the buying division pays is called the transfer price.
Note that transfer pricing is an internal activity which does not affect the company’s
overall financial performance. However, the transfer price will affect division
performance as the transfer price is revenue for the supplying division and a cost to
the buying division.
Transfer prices
There are a number of different transfer prices which could be used:
● External market price.
● Marginal cost of production.
It may be difficult to select the ‘fairest’ transfer price between the two extremes.
Generally, a fair transfer price will be:
1. The market price if an external market for the product exists (less any savings
made from selling internally)
2. If there is no external market price, then a fair transfer price would be the
opportunity cost to the supplying division of producing the units.
Division R Division S
$000’s $000’s
Internal@$900/unit 1,800 -
Division R variable selling costs are only incurred where sales are made to external
customers.
Required:
(a) Calculate ROI for each division and comment briefly on the
performa nce of eac h. (3 marks)
(b) The transfer price was established a number of years ago. Head office will
only allow Division S to purchase the frames from Division R, although the
manager of Division S believes the frame could be purchased externally for
$825.
CHAPTER 1
(a) (ii)
Cost Drivers Calculation:
Number of batches
X 10
Y 5
Z 16
Total 31
Number of drill operations:
X 2,000 x 6 = 12,000
Y 1,500 x 3 = 4,500
Z 800 x 2 = 1,600
Total 18,100
Quantity of materials:
X 2,000 x 4 = 8,000
Y 1,500 x 6 = 9,000
Z 800 x 3 = 2,400
Total 19,400
OR
Drivers
Drivers X Y Z TOTAL
Batches of material 10 5 16 31
(b)
Relevance of cost drivers in ABC environment:
The basic principle in developing an ABC model is to establish a relationship
between the manufacturing activities and the cost generat ion. This is best
described as “cause and effect” relationship. It is only possible and fruitful exercise
if the production process is divided into clear sub activities, where the cost effect
can be fairly linked. Linking the right activity with the true cost driver makes the
cost allocation fairer, and hence, better product costing and pricing.
Overhead costs are so complex in reality that finding a true relationship between
every single overhead cost to the relevant activity may be difficult enough, and
therefore, for many general overhead costs, we still apply absorption costing
principles adopting labour or machine hours to charge overheads to the products.
(a)
Machine 2 is the bottleneck. This is because all products take the longest amount
of time in Machine 2. Production will be limited to the quantity of units which can
be produced in Machine 2.
Machine 2 represents the bottleneck activity because it has the highest machine
utilization.
(b)
X Y Z
Return per factory hour 1.33 3.33 4.00
Cost per factory hour 1.75 1.75 1.75
Throughput accounting ratio 0.76 1.90 2.29
Ranking 3 2 1
(c)
The allocation of the 1,600 hours of the bottleneck activity is:
Production Machine hours balance of hours available
200 units of Z 300 1,300
200 units of Y 600 700
77 units of X 700 -
The maximum profits to be generated from the above production plan would be as
follows:
Throughput Return: $
200 units of Z x $6 1,200
200 units of Y x $10 2,000
77 units of Xx $12 924
(b)
Expected current cost per unit: $
Direct materials 20
ABC conversion cost
Assembly 20
Finishing 12
Head office fixed cost 18.33
Total expected current cost per unit 70.33
(c)
The company is falling considerably short of its 12% net profit margin target. If
sales quantities and prices are to remain unchanged, costs must be reduced if the
required return is to be reached.
Cost reduction methods exercise must be concentrated particularly on this product
if its production is to continue to be seen to be worthwhile.
The designed specification for each product and the production methods should be
examined for potential areas of cost reduction that will not compromise the quality
of the products. For example:
● Can any materials be eliminated, eg cut down on packing materials?
● Can a cheaper material be substituted without affecting quality?
Example 4 Aeonplc
(a)
Approach 1
Life-time costs are:
Approach 1 $
Development costs 1,250,000
Clean-up costs 50,000
Variable manufacturing c osts 6,250,000
5 x 25 x 50,000
Repairs and warranty costs 125,000
5 x 50,000 x 1% x 50
Total costs 7,675,000
Approach 2 $
Development costs 2,350,000
Clean-up costs 30,000
Variable manufacturing costs 6,000,000
6 x 20 x 50,000
Repairs and warranty costs 45,000
6 x 50,000 x 0.5% x 30
Additional fixed costs 120,000
20,000 x 6
Total costs 8,545,000
Approach 1
Total revenue = 5 x 50,000 x $50 = 12,500,000
Total costs = 7,675,000
Total profit = 4,825,000
Approach 2
Total revenue = 6 x 50,000 x $50 = 15,000,000
Total costs = 8,545,000
Total profit = 6,455,000
Therefore, Approach 2 is preferable as it yields the higher total profits.
(b)
Target cost = 60% x $50 = $30
Approach 1 cost per unit = 7,675,000/(5 x 50,000) = $30.70
Approach 2 cost per unit = 8,545,000/(6 x 50,000) = $28.48
Approach 2 produces product below the target cost, but with Approach 1 there is a
cost gap of $0.70/unit.
This cost gaps could potentially be closed by:
● Reducing the clean up costs – though completely eliminating those would save
only $50,000/(5 x 50,000) = $0.20 per unit.
● Increasing the production run length. The variable costs relate to variable
manufacturing and warranty costs, and these amount to 6,375,000 over
250,000 units = $25.50 per unit. This leaves a maximum cost of $4.50 per
unit for the development costs and clean-up costs. Therefore, the required
production would be: 1,300,000/4.50 = 288,889 units.
If production stayed at 50,000 per year, then a production run of 5.78 years
would achieve the required target cost.
● Reducing the variable production costs per unit by $0.70. For example, by
negotiating a better deal with suppliers or attempting to use less labour on
each item.
(c)
Life-cycle costing is particularly important in high-technology mass production
industries because:
● Development costs are likely to be substantial – new products are complex.
Therefore, these must not be ignored.
Complex production technology can often produce toxic by -products and the
disposal of these must be taken into account.
CHAPTER 2
Example 1 Tricks
Revised estimate: $
Direct materials- paper (opportunity cost) 2,500
Inks(full purchase value) 3,000
NOTES
As there is no spare capacity, t he variable cost of the full 250 hours is relevant at
$4/hour. In addition, the overtime is an incremental cost of accepting the order.
Variable o/h
This varies proportionately with activity so is relevant.
Printing press
The relevant cost of the printing press is the contribution lost (opportunity cost).
These costs will be incurred regardless of this order so are not relevant.
Estimating costs
These are sunk costs so are not relevant.
Example 3 CF Ltd
The joint processing costs are irrelevant to the decision. They will be incurred
whether product X is sold for $1.10 per litre or is processed further to make Zplus.
The analysis of relevant cash flow is as follows:
Every 4,000 litres of product X can be further processed to make 3,600 litres of
Zplus.
$ $
Revenue from sale of 3,600 litres of Zplus @ $1.4 5,040
Revenue from sale of 4,000 litres of X @ $1.1 4,400
Incremental revenue from further processing 640
The relevant costs are the differential costs between making and buying, and they
consist of differences in unit variable costs plus the differences in directly
attributable fixed costs.
W X Y Z
$ $ $ $
Unit variable cost of making 14 17 7 12
Marginal cost of buying $12 $21 $10 $14
Decision Buy Make Make Buy
Buy
W (balance) 750 9 6,750
Z 1,000 9 17,500
Total
73,250
contribution
Objective function
Z = 4x + 8y
Where Z = total contribution
Constraints
(Dept A hrs) 8x + 10y 11000
(Dept B hrs) 4x + 10y 9000
Graph
If we know the constraints we are able to plot the limitations on a graph identifying
feasible and non-feasible regions. The linearity of the problem means that we need
only identify two points on each constraint boundary or line. The easiest to identify
will be the intersections with the x and y-axes.
For example:
Dept A hrs – equating the formula 8x + 10y = 11,000
4x + 8y = 3,000.
If x = 0, then y = 375
If y = 0, then x = 750
2500
U
n
2000
i
t
1500
s
1000
o
f
500
Y
0
0 500 1000 1500 2000 2500
Units of X
The ISO-contribution (IC line) line is plotted identifying points of equal c ontribution.
The linear nature of the problem means that this line will be a straight line
identifying an inverse relationship between the two products.
The optimal solution can now be found by interrogating the point at which the IC
line leaves the feasible region to identify the co-ordinates and hence the product
mix and maximum contribution.
b 4x + 10y = 9,000
(a – b) 4x = 2,000
x = 500
y = 700
Therefore the optimal product mix is to make and sell 500 units of X and 700 units
of Y. The maximum contribution is (500 x 4 + 700 x 8) = $7,600.
Shadow prices
Department A:
If one more hour was available (ie 11,001 hours), the constraint of department A
will relax outward slightly which should improve the overall optimum solution.
Solve the new constraint equations:
Dept A 8x + 10y = 11,001
Dept B 4x + 10y = 9,000
Solving these equations:
Department B:
If one more hour was available (ie 9,001 hours), the constraint of department B will
relax outward slightly which should improve the overall optimum solution.
Department C Slack
This can be checked by seeing how much of the constraints are used up, based on
the existing optimum production schedule:
Dept hours used hours available
Margin of safety =
(15,000 – 10,000)/15,000 x 100% = 33%
CS Ratio = 20/50 = 0.4
(a)
Budgeted profit:
$
Pins 3,000 units x $6/unit = 18,000
Numbs 2,000 units x $3/unit = 6,000
Needles 1,000 units x $1/unit = 1,000
25,000
(b)
Totalfixedcosts
Breakeven revenue =
Weightedaveragec/s ratio
Total fixed costs = ($2 x 3,000) + ($3 x 2,000) + ($6 x 1,000) = $18,000
$8 3,000 $6 2,000 $7 1,000
Weighted average c/s ratio =
$12 3,000 $14 2,000 $9 1,000
= $43,000 / $73,000 = 0.589 or 58.9%
Break even revenue = $18,000 / 58.9%
= $30,560 (rounded)
(c)
(d)
Workings:
Therefore total contribution required to break even using above plan will be
calculated as follows:
Revenue from Needles = $9,000
Revenue required from Pins = $11,000/$8 x $12 $16,500
$25,500
Graph:
Profit
($)
25,000
13,000 x
(ii)
BEP
(25,500)
x x x x x
9,000 B BEP 45,000 73,000 Sales Revenue ($)
(30,560)
(i)
Loss x
A
($)
18,000 Fixed Cost
A – Needles
B - Pins
C - Numbs
CHAPTER 3
Example 1 Biscan
25 = a – (b x 500)
b = 5/200 = 0.025
25 = a – (0.025 x 500)
A = 37.50
So:
P = 37.50 – 025Q
Example 2 Mellor
(a)
12.50 = a – (b x 20,000)
b = 1.50/(20,000 x 20%) = 0.000375
12.50 = a – (0.000375 x 20000)
a = 20
So:
P = 20 – 0.000375Q
(b)
PxQ =
If price = $12.50
(c)
The MD is correct in that revenue will increase if more units are sold at a lower
price. However, this does not necessary mean that profits will increase. More
information would be needed on the costs incurred. If there is a step up in fixed
costs when activity exceeds a certain level, then profits may not increase due to the
higher volumes.
Example 3 Spearing
% changeQ
% changeP
Annual demand at $1.20 = 800,000 units
Annual demand at $1.30=725,000 units
75,000
100
Elasticity of demand 800,000 = -1.125
0.10
100
1.20
Ignoring the negative sign, the elasticity of demand is 1.125.
The demand will therefore be elastic, because the price elasticity of demand is
greater than 1.
Example 4 Kozma
(a) Demand Curve (function)
CHAPTER 4
35,000 .2 7,000
∑26,500
EV of sales is £26,500.
Example 2 Mr Sartre
45 45/150 = 0.3
75 75/150 = 0.5
30 30/150 = 0.2
Total 150
TABLE IN $ DECIDE 10 20 30
To Buy
Add probability:
TABLE IN $ DECIDE 10 20 30
To Buy
(b) (i)
∑200
0.3 X 20 6
0.2 X 200 80
∑286
∑182
(b) (ii)
Maximin buy 10, Maximax buy 30
TABLE IN $ DECIDE 10 20 30
To Buy
PROBABLE
OUTCOME
Demand
10 0 180 360
20 200 0 180
30 400 200 0
With perfect information gained from the research associate, following decisions will
be made:
To buy 10 and sell 10, expected value = $200 x 0.3 = 60
Step 1: Draw the tree from left to right showing appropriate decisions and
events/outcomes.
Symbols to use:
3 (0.4) $540,000
2 (0.75) B 4 (0.3)
$100,000
A
1 5 (0.3) $(400,000)
6 (0.25) $(180,000)
7
$0
1. Develop product
2. Development succeeds
3. Very successful
4. Moderately successful
5. Failure
6. Development fails
7. Do not develop the product
To do this, you must move from right to left, calculating the expected value at each
outcome point.
OUTCOME POINT B
OUTCOME POINT A
Thus, based on expected values developed from the decision tree, the company
should develop the product as the expected value is positive and greater than the
expected value of not developing.
Direct labour 70
Variable overhead 90 (760)
Incremental profit from further processing $190
Sensitivity:
Selling price $190 x 100 unviable if price goes down by 6.13%
$3100
Added materials
$190 x 100 unviable if material price goes up by 31.67%
$600
Direct labour $190 x 100 unviable if labour cost goes up by 271%
$3100
Variable overhead
$190 x 100 unviable if variable overhead goes up by 211%
$3100
CHAPTER 5
Example 1 Strauss
(a)
Fixed costs:
Labour 100 94 6F
Selling & Distribution 72 83 11 A
Administration 184 176 8F
(b)
The original operating statement was prepared on the basis of fixed budgeting
basis, and is of little use to management due to following reasons:
1. Out of date budgeted figures were compared with actual results – which were
a year later.
2. Market fluctuations were not considered and updated into the original budget
in order to give better ideas to management , thus providing less meaningful
variance analysis.
3. The original budgeted statement was produced on the basis of original
budgeted output, whereas actual results were drafted on actual output
achieved – which was significantly different from the budget.
4. Variable costs should have been flexed on the basis of actual output to
provide reasonable comparison. For example, the material costs original
budget was produced on the basis of 640,000 units whereas 720,000 units
were actually produced: therefore the flexed costs for materials should have
been calculated to compare with act ual material costs – thus providing more
meaningful variance.
(c) (i)
The following are the main problems associated with forecasting of figures used in
flexible budgeting:
1. Accurate identification of different cost behaviours, in their variable and fixed
components, may be complicated in complex manufacturing environments.
4. Use of different forecasting models may produce different results which may
create a misleading effect.
5. Cost bases used in original budgets may be different as to the flexible budgets
due to change in cost behaviours and market patterns. Furthermore, they
may be significantly different from actual spending patterns.
6. Currency fluctuations and inflation adjustment can be complicated to be
incorporated on exact and accurate basis.
(c) (ii)
Using High Low method
Variable cost per unit $4,000 / 120,000 units = $0.0333 per unit
Fixed cost will be = $10,667
Flexed budget for 720,000 units (720,000 x $.0333) + $10,667 = $34,667
Example 2
Average Cum
Cumulative Incremental Incremental
time per total
units units total time
unit time
Example 3
2nd = 60 hours
3rd and 4th – can’t do using this as you can get time of next 2 so 2 take 96 hours
but not actual time of 3rd and 4th
Example 4 BG
b = log 0.8/log 2 = -0.3219
Total time of 4
(a) Time for second batch, sum of third and fourth together
Average Cum
Cumulative Incremental Incremental
time per total
units units total time
unit time
(b)
Quarter 1 Quarter2
$ $
Variable costs:
Material
(c)
Cumulative total to end Q3 = 132 batches
132 batches – first 120 batches in Q4, Q1and Q2
For 132 in total (y = axb ) x 132 = (120 (132 - 0 .152)) x 132 = 57.13x 132 =
7,541hours
For 120 in total = (120 (120 - 0 .152)) x 120 = 57.96 x 120 = 6,955.2hours
(note 57.96 hours was given too)
7,541.16 hours
(6,955.2hours)
585.96 hours @$5 = $2,929.80 are the labour costs
And variable overhead would be = $4,394.70
CHAPTER 6
Direct Materials:
Total Variance = Standard material cost for actual output – actual material cost
Total Variance = Standard labour cost for actual output - actual labour
cost
($16 x 1300) - $21,500 = $700 A
Sales variances:
Price variance = (SP – AP) x actual units sold
Sub-total 32,500
CHAPTER 7
Example 1
SQSP
12,500 x 3kg x $5 = $187,500
Based on the above, the purchasing manager has not done a good job. The actual
price paid for material per kg was higher than expected. Actual price =
195,500/38,000 = $5.14/kg
The production manager has also done a poor job as material usage was higher
than expected which has also increased costs. Actual usage per unit was
38,000/12,500 = 3.04kg.
Example 1 (contd)
PLANNING VARIANCES
SQSP
12,500 x 3kg x $5 = $187,500
Planning usage variance = -$6,250 adverse
RSQSP
12,500 x 3.1kg x $5 =$193,750
Planning price variance = -$5,812.5 adverse
RSQRSP
12,500 x 3.1kg x $5.15 = $199,562.5
OPERATIONAL VARIANCES
RSQRSP
12,500 x 3.1kg x $5.15 = $199,562.5
Operational usage variance = $3,862.5 favourable
AQRSP
38,000 x $5.15 =$195,700
Operational variance = $200 favourable
AQAP
= $195,500
The planning variances calculated above reflect the variances which have been
caused by factors outside of management control. Therefore, these would not be
used to assess the performance of the purchasing or production managers.
Only the operational variances should be considered as they are the variances
which have arisen due to individual manager actions.
Based on this, the production manager has performed well as the operational usage
variance is favourable. Actual usage of material was 3.04kg per unit which, given
the poor harvest, was actually quite good. The production manager may have
provided training to staff to reduce material wastage.
The purchasing manager has also had a reasonable performance as the price
variance is also favourable. This means that they have negotiated effectively with
suppliers and therefore slightly reduced the impact of adverse exchange rates on
material costs.
Care must be taken when planning and operational variances are calculated
separately. Senior management must ensure that the revised standards are
reasonable. It may be tempting for individual managers to ‘blame’ adverse
variances on poor planning rather than operational issues.
Example 2 Dalglish
Material A B C Total/Variance
A:660 x $20
B:210 x $30
C:130 x $50
Price variances 630 Adv 420 Adv 390 Fav 690 Adv
SQ(SM)SP
The 950 is the total quantity of inputs which should have been used to produce 855
tonnes of output. A loss of 10% of material input is expected. Therefore to output
855 units, we should have input 855/0.9 = 950 units in total.
This is then divided out into the standard mix (valued at the standard price).
AQ(SM)SP
This is the total actual quantity of material used, divided out into the standard mix.
If 1,000 units were input in total, then 70% of this should have been material A,
20% should have been material B and 10% should have been material C.
Budgeted sales 10,000 units, so the standard mix of these budgeted sales will be:
A 10,000 x 2/5 = 4,000 units
B 10,000 x 3/5 = 6,000 units.
Actual sales 13,000 units, the actual sales at budgeted mix will be:
A 13,000 x 2/5 = 5,200 units
B 13,000 x 3/5 = 7,800 units.
CHAPTER 8
Sales
680,000/420,000 x 100% = 162%
Ties only have done very well in Q1 with first quarter sales of $480,000 which is
excellent for a new business. In addition, sales have increased by 62% in quarter 2
which also reflects a strong initial performance.
Website development
90/120 x 100% = 75%
Website development costs have decreased 25%. This c ost should continue to
decrease as website development is completed. This should lead to further
improvements to net profits in the future.
Administration costs
150,640/100,500 x 100% = 160%
Administration costs have increased by 60% versus an increase in sales of 62%.
This is good, as larger volumes have been processed in Q2 which suggests good
cost control or use of resource.
Distribution costs
Launch marketing
40,800/60,000 x 100% = 68%
This has decreased by 32% which is good. On-going marketing costs will still be
incurred, but these should be lower than the initial high cost of launch marketing.
CHAPTER 9
Example 1 Tata
(a)
YEAR 1 2 3 4
Cost-
accumulated
depreciation
(b)
YEAR 1 2 3 4
(1.4-1.05)
Example 2 Tonic
(a)
ROI
X = $2 m / $10 m = 20%
Y = $3m / $30m = 10%
(b)
RI = NOPAT – internal cost of capital
X $2m - $1.5m = $0.5m
Y $3m - $4.5m = -$1.5m
Example 2 contd
X ROI = $80,000/$500,000 = 16%
RI = $80,000 - $75,000 = $5,000
Y ROI = $120,000/$1,000,000 = 12%
RI = $120,000 - $150,000 = -$30,000
(a) ROI: Using ROI, division X would reject the project as it would reduce the
average ROI for the division. Division Y would accept their project as it would
increase the average ROI for the division.
RI: Using RI, division X would accept the project as having a positive RI and
would therefore increase the RI for the division. Division Y would reject their
project due to the negative RI.
(b) Head office would accept project X and reject project Y as they would only
accept projects where ROI is greater than the cost of capital (or have a
positive RI). Note that using ROI leads to divisional management making a
different decision to Head Office. However, using RI leads to the same
decision being made by both parties.
Based on the above results, Division R has performed very well with an ROI
comfortably above the required rate of return of 15%. Division S however is
slightly below, so has not performed well.
Division R Division S
$000’s $000’s
Part (c)
Transfer pricing and divisional decisions:
Under the current transfer pricing policy, Division S is incurring a cost of $900/unit
purchased. By buying the frames externally for $825, division profits increase to
$1,210,000. This results in an improved ROI for the division of $1,120/$7,800 x
100% = 15.5% which is above the required rate of return. The Division S manager
would therefore be keen to take advantage of the cheaper external purchase price.
Purchasing the frames from the external supplier, however, results in company
profits of $1,910. Purchasing the frames internally results in company profits of
$2,960. This is because the contribution lost in Division R is greater than the
savings made in Division S from purchasing externally. It is therefore not in the
Changing the transfer price would not impact company profits as the reduction in
revenue in Division R would be equal to the reduction in costs of Division S.
To quote ACCA:
Below I have set out ACCA’s Study Guide in detail for you. To help you even more,
I have also cross-referenced the individual items to the relevant chapters in your
Notes.
B Decision-making techniques
c) Formulate and solve multiple scarce resource problem both graphically and
using simultaneous equations as appropriate.
d) Explain and calculate shadow prices (dual prices) and discuss their
implications on decision-making and performance management.
e) Calculate slack and explain the implications of the existence of slack for
decision-making and performance management. (Excluding simplex and
sensitivity to changes in objective functions.)
ii) Skimming
iii) Penetration
iv) Complementary product
v) Product-line
vi) Volume discounting
vii) Discrimination
b) Outline the methods used to derive standard costs and discuss the different
types of cost possible.
c) Explain the importance of flexing budgets in performance management.
c) Identify and explain the relationship of the material usage variance with the
material mix and yield variances.
e) Discuss the effect that variances have on staff motivation and action.
f) Explain the benefits and difficulties of the participation of employees in the
negotiation of targets.
d) Explain the causes and problems created by short -termism and financial
manipulation of results and suggest methods to encourage a long term view.
e) Explain and interpret the Balanced Scorecard, and the Building Block model
proposed by Fitzgerald and Moon.
f) Discuss the difficulties of target setting in qualitative areas.