MANAGEMENT

ACCOUNTING (FMA)

COURSE NOTE

1
 Relevance
Completeness
MANAGEMENT ACCOUNTING
Accuracy
Clarity
Confidence
Volume
MANAGEMENT
Timing
Cost MANAGER
INFORMATION

COST ACCOUNTING

COSTS PLANNING CONTROLLING

DECISION
MAKING

COSTS
CLASSIFICATION BUDGETING VARIANCE
ANALYSIS

MATERIAL LABOUR FIXED OVERHEAD COST

ACCOUNTING
TECHINIQUES
ABC ABSORPTION MARGINAL
PERFORMANCE
COSTING COSTING
MEASUREMENT

TARGET LIFE CYCLE PROCESS COSTING SERVICE COSTING BATCH JOB

COSTING COSTING COSTING COSTING
2
 3 FMA LECTURER NOTE

PRACTISE QUESTION:
1. Reginald is the manager of production department M in factory which has ten other production
departments.
He receives monthly information that compares planned and actual expenditure for department M.
After department M, all production goes into other factory departments to be completed prior to
being dispatched to customers. Decisions involving capital expenditure in department M are not
taken by Reginald.

Which of the following describes Reginald’s role in department M?

A. A cost centre manager

B. An investment centre manager
C. A revenue centre manager

2. The following statements relate to financial accounting or to cost and management accounting:
(i) The main users of financial accounting information are external to an organization.
(ii) Cost accounting is part of financial accounting and establishes costs incurred by an
organization.
(iii) Management accounting is used to aid planning, control and decision making.
Which of the statements are correct?

A. (i) and (ii) only

B. (i) and (iii) only
C. (ii) and (iii) only
D. (i), (ii) and (iii)
(2 marks)

3. Which of the following is correct?

A. Qualitative data is generally non-numerical information.
B. Information can only be extracted from external sources.
C. Operational information gives details of long-term plans only.
(1 mark)

4. The manager of a profit centre is responsible for which of the following?

(i) Revenues of the centre
(ii) Costs of the centre
(iii) Assets employed in the centre
A. (i) only
B. (ii) only
C. (i) and (ii) only
D. (i), (ii) and (iii)

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

 4 FMA LECTURER NOTE

5. Which of the following would be best described as a short-term tactical plan?

A. Reviewing cost variances and investigate as appropriate
B. Comparing actual market share to budget
C. Lowering the selling price by 15%
D. Monitoring actual sales to budget
(2 marks)

6. The following statements refer to strategic planning:

(i) It is concerned with quantifiable and qualitative matters.
(ii) It is mainly undertaken by middle management in an organization.
(iii) It is concerned predominantly(uu the, vuottroi) with the long term.
Which of the statements are correct?

A. (i) and (ii) only

B. (i) and (iii) only
C. (ii) and (iii) only
D. (i), (ii) and (iii)
(2 marks)

7. The following statements refer to qualities of good information:

(i) It should be communicated to the right person.
(ii) It should always be completely accurate before it is used.
(iii) It should be understandable by the recipient.
Which of the above statements are correct?

A. (i) and (ii) only

B. (i) and (iii) only
C. (ii) and (iii) only
D. (i), (ii) and (iii)
(2 marks)

8. Which one of the following may be included in the cost accounts but excluded from the
financialaccounts?
A. Depreciation of equipment
B. Distribution expenses
C. Factory manager’s salary
D. Notional rent
(2 marks)

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

 5 FMA LECTURER NOTE

9. Consider the following incomplete statements relating to management information:

(i) Clear to the user

(ii) Detailed and completely accurate

(iii) Provided whatever the cost

(iv) Relevant for purpose

Which of the above are necessary features of useful management information?

A. (i) and (ii)

B. (i) and (iv)
C. (ii) and (iv)
D. (i), (ii) and (iii)
(2 marks)

10. What is the purpose of management information?

A. Planning only
B. Planning and control only
C. Planning, control and decision-making only
D. Planning, control, decision-making and research and development
(2 marks)

11. The management accountant of X Ltd has written a report assessing the cost savings that could be
made if thecompany was to invest in new technology.
In which area will the report primarily aid the management of X Ltd?

A. Budgeting
B. Control
C. Decision-making
D. Monitoring
(2 marks)

12. Which of the following only contains essential features of useful management information?
A. Accurate, clear, presented in report forma
B. Timely, reliable, supported by calculations
C. Regular, complete, communicated in writing
D. Clear, accurate, relevant for its purpose
(2 marks)

13. Which of the following describes the control process?

A. The action of monitoring something to keep it on course
B. The choice between alternatives

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

 6 FMA LECTURER NOTE

C. The development of strategies to achieve objectives

D. The establishment of a plan for a future period
14. Consider the following statements in relation to management information:
(i) It should always be provided regardless of its cost

(ii) It is data that has been processed in such a way as to be meaningful to the person who receives
it

(iii) It should not be provided until it is as detailed and accurate as possible

Which of the above statements is/are true of good management information?

A. (i) only
B. (ii) only
C. (i) and (iii)
D. (ii) and (iii)
(2 marks)

15. Which of the following are characteristics of management accounting information?

(i) Non-financial as well as financial

(ii) Used by all stakeholders

(iii) Concerned with cost control only

(iv) Not legally required

A. (i) and (iv)

B. (ii) and (iii)
C. (i), (ii) and (iii)
D. (ii), (iii) and (iv)
(2 marks)

16. Sources of useful data may be:

(i) External

(ii) Internal

(iii) Financial

(iv) Non-financial
Which of the above sources may be used by an accounting technician?

A. 1, 2 and 3 only
B. 2, 3 and 4 only
C. 2 and 3 only
D. all four sources

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

 7 FMA LECTURER NOTE

(2 marks)

17. Which of the following statements about cost and management accounting are true?
(i) Cost accounting cannot be used to provide inventory valuations for external financial reporting

(ii) There is a legal requirement to prepare management accounts

(iii) The format of management accounts may vary from one business to another

(iv) Management accounting provides information to help management make business decisions

A. 1 and 2
B. 1 and 4
C. 2 and 3
D. 3 and 4
(2 marks)

18. Which of the following are characteristics of management accounting information?

(i) Forward looking

(ii) Legally required

(iii) Concerned with cost control

(iv) Follows clearly defined standards

A. 1 and 3 only
B. 2 and 4
C. 1, 3 and 4
D. 1, 2 and 3
(2 marks)

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

 8 FMA LECTURER NOTE
COST CLASSIFICATION AND COST BEHAVIOUR

NATURE BEHAVIOUR DIRECT/INDIRECT FUNCTION OTHERS

How total cost change Whether or not can Whether or not
when we change trace fully to cost unit related in production
output
MATERIAL LABOUR EXPENSE

FIXED VARIABLE DIRECT INDIRECT/ PRODUCTION COST CONTROLLABLE/

OVERHEAD Cost in making product UNCONTROLLABLE
COST BEHAVIOUR Cost arise when
TOTAL certain activity happen
FIXED COST VARIABLE NON-PRODUCTION
COST PRIME COST/ PERIOD COST AVIODABLE/
COST UNAVIOADABLE
Selling cost Can control
HIGH- MIXED COST
How to
LOW
separate Distribution cost DISCREATION
METHOD
? Arise due to decision
STEP COST Administration cost making
Finance cost
NON-LINEAR OR OPPORTUNITY
CURVILINEAR R&D cost COST
VARIABLECOST

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

EXAMPLE QUESTION

PART 1: DIRECT AND INDIRECT COST

Example

Eldorado Ltd manufactures a product which requires 3kg of material A costing £6.20 per kg and 4 kg
of material B costing £5.60 per kg. The product requires 2 hours of labour at a cost of £7.40 per hour.
The product is sold in packs of 10 and the packaging for 10 units costs £22. Fixed production costs are
£60,000 per annum and selling, distribution and administration costs are £24,000 per annum. The
company makes 15,000 units of the product each year.

Question 1

What is the prime cost of the product?

A £55.80 B £58.00 C £62.00 D £63.60

Question 2

What is the production cost of the product?

A £55.80 B £58.00
Question 3

What is the total cost of the product?

A £55.80 B £58.00 C £62.00 D £63.60

10 FMA LECTURER NOTE

PART 2 FIXED AND VARIABLE COST

Example 1:

Output (Units) Total Cost ($)

200 7,000
300 8,000
400 9,000
Required:Find the variable cost/unit and total fixed cost

Example 2: High low method with stepped fixed cost

Activity level (Units) Cost ($)

4,000 40,800

6,000 50,000

7,500 54,800

Variable cost per unit is constant within this activity range and there is a step up cost of 10% in the
total fixed costs when the activity level exceeds 5,500 units

Required: what is the total cost at the activity level of 5,000 units

Example 3: High low method with changes in variable cost

Activity level (Units) Cost ($)

200 7,000

300 8,000

400 8,600

For output volume of above 350 units, the variable cost per units falls by 10%. (Note that this fall
applies to all units, not just the excess).

Required: what is the total cost at the activity level of 450 units.

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

11 FMA LECTURER NOTE

PRACTISE QUESTION
PART 1: TYPES OF COST

Match the cost classification to the definition by putting a definition letter next to each cleassification.

Classification Definition

1. Uncontrollable (a) written off (deducted) as expense-not included in stock value

2. Fixed (b) full cost cannot be related to product/service/department

3. Direct (c) can be influenced by management

4. Unavoidable (d) changes in line with the level of activity

5. Discretionary (e) the total of direct materials, labour and expenses

6. Indirect (f) full cost can be related to product/service/department

7. Prime cost (g) cannot be influenced by management

8. Controllable (h) stop the activity and the cost continues

9. Variable (k) stop the activity and the cost stops

10. Avoidable (j) these costs are decided by management

11. Period (i) do not change with the level of activity

Ngo Nhu Vinh PhD, FCCA, CPA, SIRM

PART 2

1. The following data relate to the overhead expenditure of a contract cleaners at two activity
levels
Square metres cleaned 12,750 15,100

Overhead 73,950 83,585

What is the estimate of the overheads if 16,200 square metres are to be cleaned?

A. 66,420
B. 88,095
C. 89,674
D. 93,960
2. A production worker is paid a salary of $650 per month, plus an extra 5 pence for each unit
produced during the month. This labour cost is best described as:
A. A variable cost
B. A fixed cost
C. A step cost
D. A semi-variable cost
3. B limited has recorded the following data in the two most recent periods
Total cost of production Volume of production

$ Unit

13,500 700

18,300 1,100

What is the best estimate of the company’s fixed costs per period?

A. 13,500
B. 13,200
C. 5,100
D. 4,800
4. What type of cost is supervisor salary cost, where one supervisor is needed for every ten
employees added to the staff?
A. A variable cost
B. A fixed cost
C. A mixed cost
D. A step cost
5. Which of the following describes a cost unit?
A. cost per unit of output
B. direct costs

12
C. unit of product
D. production department
6. What is prime cost?
A. total direct costs only
B. total indirect costs only
C. total non-production costs
D. total production costs
7. The following items are some of the costs incurred by a company:
(i) training of direct operatives

(ii) wages of distribution staff

(iii) normal idle time in the factory

(iv) productive time of direct operatives

(v) sales personnel salaries

Which of the above items will usually be treated as production overhead costs?

A. (i) and (ii) only

B. (i) and (iii) only
C. (i), (iii) and (iv) only
D. (ii), (iv) and (v) only
8. A particular cost is fixed in total for a period.
What is the effect on the cost per unit of a reduction in activity of 50%?

A. Cost per unit increases by 50%

B. Cost per unit reduces by 50%
C. Cost per unit increases by 100%
D. Cost per unit is unchanged.
9. The table shows the total of Cost Y at different production levels of Product X:
Units of Product X Total Cost Y (£000)

50 60

100 60

150 60

200 90

250 90

What could have been the cause of the increase in cost?

A. Increased fuel and maintenance costs for delivery vehicles

13
B. Increased storage requirements
C. Loss of discounts on raw materials
D. Pay increase for direct labour.
10. The following classifications may be applied to costs:
(i) Direct

(ii) Fixed

(iii) Period

(iv) Production

Which of the above classifications could be applied to the cost of raw materials used by a
company in the manufacture of its range of products?

A. (i) only
B. (i) and (iv) only
C. (ii) and (iii) only
D. (ii), (iii) and (iv) only

11. Total production costs and output over three periods have been:
Period Production costs Output

1 £230,485 12,610 units

2 £254,554 14,870 units

3 £248,755 14,350 units

What are the estimated variable production costs per unit if the high–low method is applied?

A. 10·50
B. £10·65
C. £11·15
D. £15·50
12. The following summary data is provided for two periods:
Production costs Output

Period 1 £48,981 29,720 units

Period 2 £55,893 35,480 units

Using the high-low method, what are the estimated fixed costs per period?

A. £6,912
B. £13,317
C. £24,214
D. £26,326

14
13. A particular cost is classified as being ‘semi-variable’.
If activity increases by 10% what will happen to the cost per unit?

A. Increase
B. Reduce but not in proportion to the change in activity
C. Reduce in proportion to the change in activity
D. Remain constant
14. The following data is available relating to costs and activity:
Total cost Activity

£28,420 11,600 units

£29,294 12,440 units

£29,764 12,880 units

Using the high-low method, what is the variable cost per unit (to the nearest penny)?

A. £0·95
B. £1·04
C. £1·05
D. £1·07
15. A firm’s cost function may be expressed as:
y = a + bx

Where:

y is the total cost

a is the total fixed cost

b is the variable cost per unit

x is the number of units of output

The total cost for output of 8,400 units in a period is £106,250 and the total period fixed cost is
£41,990.

Required:

Using the above information and formula, calculate:

(i) The variable cost per unit; (2 marks)

(ii) The total cost for output of 8,660 units in a period; (2 marks)

(iii) The cost per unit for output of 8,500 units in a period. (2 marks)

16. Total costs incurred by a business may be expressed as:

y = a + bx

When: y represents the total costs

15
 a represents the total fixed costs

b represents the variable costs per unit

x represents the number of units of output

A company has variable costs of £12·20 per unit and total costs, for output of 7,400 units in a period,
of £156,980.

Using the above formula and information, what are the total fixed costs in the period?

A. £42,540
B. £66,700
C. £90,280
D. £247,260
17. A company currently produces 6,000 units of its single product each period, incurring total
variable costs of £60,000and fixed costs of £42,000. Production will increase to 8,000 units per
period if the company expands capacityresulting in changes both to the variable costs per unit
and to the total fixed costs. For production of 8,000 units perperiod total variable costs would be
£76,000 and fixed costs £50,000.
What is the reduction in total cost per unit comparing the costs for 8,000 units per period with the
unit costs currently being incurred?

A. £0·50
B. £0·75
C. £1·25
D. 2·08
18. Production units and total costs relating to the last three periods have been:
Period 1 Period 2 Period 3

Production (units) 129,440 117,620 126,310

Total costs (£) 198,968 187,739 195,376

Using the high-low method, what is the estimated variable cost per unit of production?

A. £0·87
B. £0·95
C. £1·05
D. £1

16
PART 3: PAST YEAR QUESTIONS
QUESTION 1

QUESTION 2

QUESTION 3

17
QUESTION 4

QUESTION 5

QUESTION 6

QUESTION 7

18
QUESTION 8

QUESTION 9

QUESTION 10

QUESTION 11

19
QUESTION 12

QUESTION 13

QUESTION 14

20
QUESTION 15

QUESTION 16

QUESTION 17

21
QUESTION 18

QUESTION 19

QUESTION 20

22
QUESTION 21

QUESTION 22

23
QUESTION 23

24
 MATERIALS
HOW TO RECORD How PERIODIC OR
VALUATION METHOD CONTROL COUNT/
to CONTINUOUS
WHY ? kno STOCKTAKE
Purchase Good received w PERPETUAL
FIFO LIF WEIGHTED
requisition note (GRN)
O AVERAGE MINIMIZE level
PRICING INVENTORY COSTS
In In
Purchase
first, first
order CUMULATIVE PEORIDIC
out out OBSOLETE
Holding

PROBLEMS
Ordering Purchasing Stock out (out of date)
first last costs
Whenever a At the costs costs cost
Delivery
note new end of
Delivery SLOW-MOVING
delivery is given
goods (Buffer D/Q x C Bulk discount
Invoice received period
inventory + or trade
DETERIORATION
Q/2) x h discount

Record E.G
E.G interest, E.G
insurance, transport, contribution
risk of admin loss
obsoletence
MATERIAL CONTROL ACCOUNT
REORDER LEVEL SYSTEM LEVEL OTHER INDICATES

PAYABLE COTROL A/C PAYABLE CONTROL A/C

(Purchase from supplier) (return to supplier)

Reorder Minimum Maximum Reorder quantity Free inventory Average stock

WORK IN PROGRESS WORK IN PROGRESS level inventory level (EOQ)
EOQ
inventory level
(unused material) (direct material)
Maximum Reorder level – Reorder level +
√ √ Unit in inventory Safety stock
FACTORY OVERHEAD usage x (average usage x reorder quantity – + unit on order (buffer inventory)
(indirect material) maximum average lead time) (minimum usage x – unit order but + reorder
lead time minimum lead time) d the demand not issued quantity/2
d the demand
c cost of one order
c cost of one order
h holding cost pu
h holding cost pu
Q reorder quantity
Q reorder quantity

25
EXAMPLE QUESTIONS

VALUATION METHOD

Example 1

A firm has the following transactions with its product R.

Year 1
Opening inventory: nil
Buys 10 units at $300 per unit
Buys 12 units at $250 per unit
Issue 8 units at for production product A
Buys 6 units at $200 per unit
Issue 12 units at for production of product A and B
Buys 10 units at $200 per unit
Issue 5 units at for production of product A
Buys 12 units at $150 per unit
Required: determine value of inventory issued by using
- FIFO
- LIFO
- WEIGHTED AVERAGE COST

26
Example 1:

A company uses components at the rate of 6,000 units per year which are bought in at a cost of
$1.2/unit. The company orders 1,000 units each time it places and order and the average inventory
held is 500 units. It cost $20 each time to place an order regardless of order quantity. Assume that
the components are used evenly during the year.

The total holding cost per annum is 20% of the purchase prices.

Required: Calculate the annual holding cost and annual ordering cost

Example 2

You are given the following information for a component

Weekly Usage Lead Time

(Units) (Weeks)

Average 800 3

Maximum 1,500 5

Minimum 500 2

Required:Calculate the reoder quantity, the maximum and minimum inventory levels and the
average inventory level

27
EOQ

Example 1

Janish has demand for 40,000 desks p.a the purchase price of desk is $25. There are ordering cost of
$20 for each oder placed. Stockholding cost amount to 10% p.a of stock value

Required:

Calculate the stock cost p.a for the following order quantities.

a. 500 units
b. 750 units
c. 1000 units
d. 1250 units
Example 2:

Annual Demand is 25,000 units. Raw materials are $16/unit. Holding Cost is $6.4/ unit. Cost of
placing order is $31/order.

Requirement: Determine EOQ

Example 3

A company uses components at the rate of 500 units per month which are bought in at a cost of
$1.2/unit. It cost $20 to place an order, regardless of the quantity ordered. The total holding cost is
20% of purchased price.

Required: calculate the EOQ

EOQ WITH DISCOUNT

Example 4

A company uses components at the rate of 500 units per month which are bought in at a cost of
$1.2/unit. It cost $20 to place an order, regardless of the quantity ordered. The total holding cost is
20% of purchased price.

The supplier offers a 5% discount on the purchase price for order quantities of 2,000 items or more.

Question: should the discount be accepted?

Example 5

AB Ltd makes a component for one of the engines that it builds. It uses on average, 2,000 of these
components, steadily throughout the year. The components costs $16 per unit to make and it costs
an additional $320 to set up the production process each time a batch of component is made. The
holding cost per unit is 10% of the unit production cost.

The Company makes these components at a rate of 200 per week and the factory is open for 50
weeks per annum.

Required: Calculate EBQ

28
 PRACTISE QUESTION:

1. The following are statements relating to raw material pricing in a situation where raw material prices
are risingconsistently.
(i) Production costs will be lower using weighted average pricing rather than LIFO.
(ii) Profit will be higher using LIFO pricing rather than FIFO.
(iii) Stock values will be lower using FIFO pricing rather than weighted average.
Are the statements true or false?

A. Statement 1 is true but Statements 2 and 3 are false

B. Statements 1 and 2 are true but Statement 3 is false
C. Statements 1 and 3 are true but Statement 2 is false
D. Statements 2 and 3 are true but Statement 1 is false.
Day Transaction Units Unit Price (£) Value (£)

1 Balance b/f 100 5·00 500

3 Issue 40

4 Receipt 50 5·50 275

6 Receipt 50 6·00 300

7 Issue 70

2. If the first-in, first-out method of pricing is used what is the value of the issue on Day 7?
A. £350
B. £355
C. £395
D. £420.
3. If the last-in, first-out method is used what is the value of the issue on Day 7?
A. £350
B. £395
C. £410
D. £420.
4. 340 litres of Chemical X were produced in a period. There is a normal loss of 10% of the material
inputinto the [Link] was an abnormal loss in the period of 5% of the material input.
How many litres of material were input into the process during the period?

A. 357 litres
B. 374 litres
C. 391 litres

29
 D. 400 litres.
5. A company orders a particular raw material in order quantities of 250 units. No safety stock is held,
the stockholdingcost is £3 per unit per annum and the annual demand is 2,500 units.
What is the total annual stockholding cost of the material?

A. £375
B. £750
C. £3,750
D. £7,500.
6. Which of the following is NOT relevant to the calculation of the economic order quantity of a raw
material?
A. Ordering cost
B. Purchase price
C. Stockholding cost
D. Usage.
7. The order quantity of a raw material is 2,000 kg. Safety stock of 1,200 kg is held. The stockholding
cost of the rawmaterial is £1·20 per kg per annum.
What is the total annual stockholding cost of the raw material?

A. £1,200
B. £1,920
C. £2,640
D. £3,840
8. 6,500 kg of a product were manufactured in a period. There is a normal loss of 20% of the weight of
material [Link] abnormal gain of 4% of the material input occurred in the period.
How many kg of material (to the nearest kg) were input to production in the period?

A. 5,460
B. 7,738
C. 8,125
D. 8,553
9. The following transactions relate to a raw material for a period:
Day Transaction Units Total value (£)

1 Balance b/f 100 500

3 Issue 40

4 Receipt 50 275

6 Receipt 50 300

7 Issue 70

30
 The periodic weighted average method is used to price material issues.

What is the value of the issue on Day 7?

A. £376·25
B. £382·81
C. £402·50
D. £410·00
10. The following statements relate to raw material pricing:
1. Profit will be lower using FIFO rather than LIFO.
2. Production costs will be higher using weighted average pricing rather than FIFO.
Are the above statements true or false in a situation where raw material prices are rising
consistently over time?

Statement 1 Statement 2

A False False

B False True

C True False

D True True

The following information applies to Question 12 and 11

The re-order level of Material M is 1,600 kg and the order quantity is 1,400 kg. Lead times and usage
are as follows:

Lead time: minimum 1 week

average 11/2 weeks

maximum 2 weeks

Usage: minimum 600 kg per week

average 700 kg per week

maximum 800 kg per week

11. What is the maximum stock control level of Material M?

A. 1,400 kg
B. 1,950 kg
C. 2,400 kg
D. 3,000 kg
12. What is the minimum stock control level of Material M?

31
 A. Nil
B. 350 kg
C. 550 kg
D. 1,000 kg
13. The following relate to the management of raw materials:
(i) holding costs per unit of stock would increase;
(ii) the economic order quantity would decrease;
(iii) average stock levels would increase;
(iv) total ordering costs would decrease.
Which of the above would result from the introduction of buffer (safety) stocks?

A. (iii) only
B. (ii) and (iii) only
C. (ii), (iii) and (iv) only
D. (i), (ii), (iii) and (iv)
14. The following documents are used within a cost accounting system:
(i) invoice from supplier
(ii) purchase order
(iii) purchase requisition
(iv) stores requisition
Which TWO of the documents are matched with the goods received note in the buying process?

A. (i) and (ii)

B. (i) and (iv)
C. (ii) and (iii)
D. (iii) and (iv)
15. Many manufacturing organisations hold raw material stocks.
Required:

(a) List three examples of holding costs. (3 marks)

(b) List two examples of stockout costs. (2 marks)
16. The following statements describe the effect of raw material pricing policy in a situation where
prices are rising consistently:
(i) Stock values will be higher using last-in first-out (LIFO) rather than weighted average.
(ii) Profit will be lower using weighted average rather than first-in first-out (FIFO).
Are the statements TRUE or FALSE?

Statement 1 Statement 2

A True True

32
 B False False

C True False

D False True

17. What is the purpose of calculating an economic order quantity (EOQ) for a raw material?
A. To minimise the stockholding quantity of the material
B. To minimise the stockholding costs of the material
C. To minimise the total cost of purchasing and storing the material
D. To enable the reorder level of the material to be established
18. The following documents are used in accounting for raw materials:
(i) Goods received note
(ii) Materials returned note
(iii) Materials requisition note
(iv) Delivery note
Which of the documents may be used to record raw materials sent back to stores from
production?

A. (i) and (ii)

B. (i) and (iv)
C. (ii) only
D. (ii) and (iii)
19. Material M is used by a manufacturer. Stock of Material M at 1 May was valued at a cost of £3,302
(260 kg at £12·70 per kg). 500 kg were purchased on 7 May for £6,500. 410 kg of Material M were
used in production during the month. The LIFO method is applied at the end of each month.
What is the cost accounting entry for the issues of Material M during the month?

Debit Credit

A. Material stock £5,252 Work-in-progress £5,252

B. Work-in-progress £5,252 Material stock £5,252

C. Material stock £5,330 Work-in-progress £5,330

D. Work-in-progress £5,330 Material stock £5,330

20. How is the re-order level calculated ?

A. Maximum usage × Maximum lead time
B. Maximum usage × Minimum lead time
C. Minimum usage × Maximum lead time
D. Minimum usage × Minimum lead time
21. The following information relates to a raw material stock item:

33
 Economic order quantity 800 units (established using the formula )

Demand 12,000units per annum

Cost of holding stock £1·50 per unit per annum

What is the cost of placing an order?

A. £27
B. £40
C. £71
D. £80

22. What is the first-in first-out (FIFO) method used for?

A. Calculating normal/abnormal losses
B. Estimating equivalent units
C. Valuing raw material issues from stock
D. Valuing raw material receipts into stock
23. Wastage of a raw material during a manufacturing process is 20% of input quantity.
What input quantity of raw material is required per kg of output?

A. 0·8 kg
B. 1·2 kg
C. 1·25 kg
D. 1·33 kg
24. In the context of stock control what is the maximum stock control level?
A. The level below which stock should not fall if usage is at the maximum expected
B. The level below which stock should not fall if average usage occurs
C. The level that stock should not exceed if usage is at the minimum expected
D. The level that stock should not exceed if average usage occurs
25. The raw materials issued to a job were overestimated and the excess is being sent back to the
materials store.
What document is required?

A. Stores credit note

B. Stores debit note
C. Materials returned note
D. Materials transfer note
26. Material X is used by a company in the manufacture of one of its products, Product Z. Demand for
Product Z forthe next year is forecast to be 26,000 units.

34
 Each finished unit of Product Z contains 0·72 kilograms of Material X. There is a preparation loss of
10% ofmaterial used. It is not planned to change the stock-holding of Product Z in the year ahead but
a reduction of1,000 kilograms in the stock of Material X is planned.

a)Required:Calculate the quantity of Material X that needs to be purchased in the year ahead.

(4 marks)

27. Material Y is also used in the manufacture of Product Z and in several other products. The total
annualrequirement for Material Y is 120,000 litres, used evenly over each year.
The costs of ordering stock and holding stock are as follows:

Ordering £45 per order

Holding £0·30 per litre per annum

A safety stock of 2,500 litres of Material Y is held and the average lead time (the interval between
placing anorder for materials and having them delivered) is 1·5 weeks.

Required:Calculate for Material Y the:

(i)Economic order quantity, using the formula √*(2CoD) ÷ Ch+; (4 marks)

(ii) Reorder level (assume 1 year = 50 weeks); (4 marks)

(iii) Total annual cost of ordering stock; (3 marks)

(v) Total annual cost of holding stock. (3 marks)

28. The inventory record of a raw material has the following details for a week:
Day Cost ($ per unit) Receipts (units) Issues (units)

2 260 18

3 270 12

4 10

6 14

The first-in first-out (FIFO) method is used for pricing issues. There was no raw material at the start
of Day 1.

Which was the value of the inventory on Day 5?

A. $5,200
B. $5,220
C. $5,320
D. $5,400
29. Average usage of a raw material is 200 kg per day, the average ordering lead time is five days, the
reorder level is1,600 kg and the reorder quantity is 2,800 kg.

35
What is the average raw material inventory?

A. 800 kg
B. 1,400 kg
C. 1,700 kg
D. 2,000 kg

36
 SESSION 4: LABOUR
HOW TO RECORD
CONTROL

ATTENDANCE JOB TIME ADVISE PAY

TIME REMUNERATION
MEASURE
METHOD

Time sheets Job cards Operation IDLE-TIME LABOUR PRODUCTION AND PRODUCTIVITY
TIME WORK
card TURNOVER

Total idle time EFFICIENCY OR

PIECEWORK PRODUCTIVITY CAPACITY RATIO
total hour RATIO

Replacement (new recuirment in period)

Average number of employees in period
BONUS/ INCENTIVE Expected hour to
make output Actual hour taken
SCHEMES
(standard hour x
WAGE CONTROL ACCOUNT actual output) Hour budgeted
INDIVIDUAL
Actual hour taken
BANK A/C FACTORY OVERHEAD GROUP
(pay wage) (indirect labor cost)
PRODUCTION VOLUME RATIO

DEDUCTION CONTROL A/C PROFIT SHARING

WORK IN PROGRESS
(health insurance …) (direct labor cost)
Expected hour to make output
SHARE OPTION (standard hour x actual output)
(option to buy share)
Budgeted hour
ADDED VALUE
(sales – costs of
bought in material
and service)

37
EXAMPLE QUESTIONS
EXAMPLE 1

Budgeted output for a month is 2000 units. Budgeted time for the production is 200 hours. The
actual output in March is 2300 units and actual time work by labour force is 180 hours.

Required: Calculate production volume ratio, capacity ratio and efficiency ratio.

EXAMPLE 2

Rush and Fluster Co budgets to make 25,000 standard units of output (in four hours each) during a
budget period of 100,000 hours. Actual output during the period was 27,000 units which took
120,000 hours to make.

Required: Calculate the efficiency, capacity and production volume ratios.

38
 PRACTISE QUESTION:
1. Employee A works a normal working week of 36 hours at a basic rate of £3·60 per hour. A premium
of 50% of the basichourly rate is paid for all hours worked in excess of 36 hours per week. Employee
A worked for a total of 42 hours lastweek. The reasons for the overtime were:
 machine breakdown 4 hours
 completion of a special job at the request of a customer 2 hours
How much of Employee A’s earnings for the last week should be treated as direct wages?

A. £129·60
B. £140·40
C. £151·20
D. £162·00.
2. The following items are some of the costs incurred by a company:
(i) training of direct operatives
(ii) wages of distribution staff
(iii) normal idle time in the factory
(iv) productive time of direct operatives
(v) sales personnel salaries
Which of the above items will usually be treated as production overhead costs?

A. (i) and (ii) only

B. (i) and (iii) only
C. (i), (iii) and (iv) only
D. (ii), (iv) and (v) only
3. A company manufactures a single product at the rate of 25 units per direct labour hour. 660 direct
labour hourswere budgeted to be worked in a period during which 640 hours were actually worked
and 16,390 units weremanufactured.
Required:Calculate the following ratios for the period:

(i) Efficiency;

(ii) Capacity;

(iii) Production volume. (10 marks)

4. A differential piecework scheme has a basic rate of £0·50 per unit. Output in addition to 500 units is
paid at higherrates. The premiums over and above the basic rate, which apply only to additional
units over the previous threshold,are:
Output (units) Premium (per unit)

501–600 £0·05

Above 600 £0·10

39
 What is the total amount paid if output is 620 units?

A. £317
B. £318
C. £322
D. £372
5. Labour costs may include:
(i) Overtime hours of direct operatives at basic rate

(ii) Overtime premiums of factory employees

(iii) Productive time of direct operatives

(iv) Training of direct operatives

Which of the above items will usually be treated as a direct cost?

A. (i) and (ii)

B. (i) and (iii)
C. (ii) and (iv)
D. (i), (iii) and (iv)
6. How is the activity (production volume) ratio calculated?
A. Actual hours ÷ budgeted hours
B. Budgeted hours ÷ actual hours
C. Standard hours for actual output ÷ actual hours
D. Standard hours for actual output ÷ budgeted hours
7. Production labour costs may include:
(i) cost centre supervisors, wages

(ii) overtime hours of direct operatives at basic rate

(iii) overtime costs of indirect operatives

(iv) piecework payments to direct operatives

Which items will usually be included in production overheads?

A. (i) and (iii) only

B. (i) and (iv) only
C. (i), (ii) and (iii) only
D. (ii), (iii) and (iv) only
8. A company manufactures a single product. Currently, the company employs a team of six direct
operatives whoproduce a total of 2,500 units of the product in a 40-hour week. The hourly rate of
pay for all operatives is £8·00.

40
 In an effort to improve productivity, and thus to increase output in the normal 40-hour week, an
incentive schemehas been suggested. The scheme, which the six operatives have agreed to trial over
a 4-week period, provides fordifferential piecework payments in addition to a reduced basic rate per
hour. Details of the scheme are:

Basic hourly rate £4·00 per hour

Differential piecework rates:

First 2,500 units of output in a week £0·375 per unit

Output 2,501 to 3,000 units in a week £0·45 per unit on additional units over
2,500

Output over 3,000 units in a week £0·60 per unit on additional units over
3,000

In the first week of the trial, total output was 3,080 units in the 40 hours worked.

Required:

(a) For the existing time rate payment system, calculate:

(i) the labour cost per unit, based on the current weekly output of 2,500 units; (2 marks)

(ii) the % change in the labour cost per unit if weekly output in the 40 hours worked could be
increased to 2,750 units. (2 marks)

(b) For the incentive scheme, calculate:

(i) the labour cost per unit, based on the results of the first week of the trial; (6
marks)

(ii) the level of output in a 40 hour week at which total labour cost would be the same as under
the existing time rate payment system. (5 marks)

9. Which of the following are aspects of payroll systems?

(i) Attendance records

(ii) Calculation of bonuses

(iii) Employee tax codes

(iv) Apportionment of wages to cost centres

A. (i), (ii) and (iii) only

B. (ii), (iii) and (iv) only
C. (i), (ii) and (iv) only
D. All four items
10. The direct labour capacity ratio for a period was 104%.
What could have caused this?

41
 A. Actual hours worked being greater than budgeted hours
B. Actual hours worked being less than budgeted hours
C. Standard time for actual output being greater than budgeted hours
D. Standard time for actual output being less than budgeted hours
11. A job cost estimate includes 630 productive labour hours. In addition, it is anticipated that idle time
will be 10% ofthe total hours paid for the job. The wage rate is £12 per hour.
What is the total estimated labour cost for the job?

A. £6,804
B. £7,560
C. £8,316
D. £8,400
12. Analysis of the gross wages in a factory reveals the following:
Direct operatives ($) Indirect operatives ($)

Normal hours worked at basic rate 36,260 14,320

Overtime hours at basic rate 4,112 1,760

Overtime premium 1,028 440

Overtime working is a usual aspect of running the business.

What amount would be recorded as a direct cost?

A. $36,260
B. $40,372
C. $41,400
D. $41,840

42
 SESSION 5: ABSORPTION COSTING
OVERHEAD PRODUCTION COST
STEP 1 ALLOCATION &
APPOINTMENT

ALLOCATION Charge overhead directly to specific department

PRODUCTION SERVICE APPORTMENT Charge overhead related to more than a specific

PRODUCTION SERVICE
DEPARTMENT DEPARTMENT department to specific departments
DEPARTMENT DEPARTMENT
A B 1 2
REAPPOINTMENT

REAPPOINTMENT Reappointment of overhead of services

departments to production departments
STEP 2

PRODUCTION PRODUCTION
DEPARTMENT A DEPARTMENT B
Machine-hour % of direct
wage
Budget overhead WHAT ?
Labor-hour
ABSORPTION

Budget activities level

OVERHEAD

% of prime cost Units

STEP 3

OAR (department A,B) Actual OH >< Overhead absorbed

How to
Problems of determine
under/over under over
absorption
OAR X actual activity level
OVERHEAD TO
STEP 3 ASSIGN
COST CENTRE

PRODUCTS

PRODUCTION COST PER UNIT (PRODUCT

X,Y)

43
EXAMPLE QUESTION

EXAMPLE 1

ABC limited company is preparing its departmental budgets and production cost estimates for the
year ended 31 Dec 2013. The company has three manufacturing department – machine shop A,
machine shop B and three service department Assembly, Canteen and Maintenance. The following
costs and related data has been estimated for the year end to 31 Dec 2013.

(a) Determine total overhead of department A and B

(b) Determine appropriate OAR of department A and B

(c) Determine the under- or over-absorption of overheads.

(d) Determine cost per unit of product MZ2
To prepare a cost estimate, based o the following data for a product (product MZ2) which is to be
manufactured in 2013

Machine shop A Machine shop B

Direct material ($) 2,500 400

Direct labor hours 800 350

Machine hours 1,400 100

44
 PRACTISE QUESTIONS
1. P + J Limited absorb overheads on the basis of direct labour hours. You have obtained the following
details from their account:
Overheads – budgeted £350,000; actual £400,000. Output is 10,000 units less than the expected
70,000 units, for 30,000 labour hours (35,000 were budgeted for). Which statement is correct?
A. Overheads were £50,000 under-absorbed
B. Overheads were correct
C. Overheads were £100,000 under-absorbed
D. Overheads were £150,000 over-absorbed

2. XX Ltd absorbs overheads based on units produced. In one period, 23,000 units were produced,
actual overheads were £276,000 and there was £46,000 under-absorption
The budgeted overhead absorption rate per unit was
A. £10
B. £12
C. £13
D. £14

The following information relates to questions 3 and 4

Budgeted information relating to two departments in JP Ltd for the next period is as follows.
Department Production Direct Direct labour Direct labour Machine
overhead material cost cost hours hours
£ £ £
1 27,000 67,500 13,500 2,700 45,000
2 18,000 36,000 100,000 25,000 300

Individual direct labour employees within each department earn differing rates of pay, according to
their skills, grade and experience.
3. What is the most appropriate production overhead absorption rate for department 1?
A. 40% of direct material cost
B. 200% of direct labour cost
C. £10 per direct labour hour
D. £0.60 per machine hour
4. What is the most appropriate production overhead absorption rate for department 2?
E. 50% of direct material cost
F. 18% of direct labour cost
G. £0.72 per direct labour hour

45
 H. £60 per machine hour
5. Which of the following statements about predetermined overhead absorption rates are true?
(i) Using a predetermined absorption rate avoids fluctuations in units costs caused by abnormally
high or low overhead expenditure or activity levels
(ii) Using a predetermined absorption rate offers the administrative convenience of being able to
record full production costs sooner
(iii) Using a predetermined absorption rates avoids problems of under/over absorption of overheads
because a constant overhead rate is available
I. (i) and (ii) only
J. (i) and (iii) only
K. (ii) and (iii) only
L. All of them
6. Factory overheads can be absorbed by which of the following methods?
(i) Direct labour hours
(ii) Machine hours
(iii) As a percentage of prime cost
(iv) £x per unit
A. (i), (ii), (iii) and (iv)
B. (i) and (ii) only
C. (i), (ii) and (iii) only
D. (ii), (iii) and (iv) only
7. The production overhead control account for R Limited at the end of the period looks like this.
Production overhead control account
£ £
Stores control 22,800 Work in progress 404,800
Wages control 180,400 Profit and loss 8,400
Expense creditors 210,000
413,200 413,200
Which of the following statements are correct?
(i) Indirect material issued from stock was £22,800
(ii) Overhead absorbed during the period was £210,000
(iii) Overhead for the period was over absorbed by £8,400
(iv) Indirect wages costs incurred were £180,400

46
 A. (i), (ii) and (iii)
B. (i), (iii) and (iv)
C. (i) and (iv)
D. all of them
8. A company had the following budgeted and actual production overhead costs in its two production
cost centres,
Machining and Assembly:
Budget Actual
Machining £210,000 £212,000
Assembly £136,000 £134,000
Which statement is true?
A. From the data available it is not possible to determine overhead over/under absorption

B. Machining overheads were over-absorbed: Assembly overheads were under-absorbed

C. Machining overheads were over-absorbed: Assembly overheads were over-absorbed
D. Machining overheads were under-absorbed: Assembly overheads were over-absorbed.

9. What is the correct entry in the cost ledger to record the over-absorption of production overhead?
Debit Credit
A. Over-absorbed production overhead a/c Production overhead a/c
B. Over-absorbed production overhead a/c Work-in-progress a/c
C. Production overhead a/c Over-absorbed production overhead a/c
D. Work-in-progress a/c Over-absorbed production overhead a/c

[Link] following production overhead costs relate to a production cost centre:

Budget £124,000
Actual £126,740
Absorbed £125,200
Which of the following statements is true?
A. overheads were over-absorbed by £1,200

B. overheads were over-absorbed by £1,540

C. overheads were under-absorbed by £1,200
D. overheads were under-absorbed by £1,540

[Link] a cost bookkeeping system what would be the entry for the absorption of production overhead?
Debit Credit
E. Cost Ledger Control Account Production Overhead Account

47
 F. Production Overhead Account Work-in-Progress Account
G. Work-in-Progress Account Cost Ledger Control Account
H. Work-in-Progress Account Production Overhead Account
[Link] overheads allocated and apportioned to cost centres in a factory for a period, along with
additional data, are:
Production Cost Centre Service Cost Centre
A B C X Y
Allocated overheads £17,628 £38,490 £14,671 £3,795 £6,130
Apportioned overheads £29,938 £45,841 £28,360 £4,640 £5,750
Additional data:
Number of employees 14 21 14 7 8
Direct labour hours 5,200 7,460 4,780 – –
Overheads allocated and apportioned to Service Cost Centre X are re-apportioned on the
followingbasis: ProductionCost Centre A 20%, Production Cost Centre B 45%, Production Cost Centre
C 35%.
Overheads allocated and apportioned to Service Cost Centre Y are re-apportioned on the basis of the
number ofemployees in the other cost centres.
Production overheads are absorbed on the basis of direct labour hours.
Required:
(a) Re-apportion the service cost centre overheads. (7 marks)
(b) Calculate an overhead absorption rate for each production cost centre. (3 marks)
[Link] are two production cost centres and two service cost centres in a factory. Production
overheads have been allocated and apportioned to cost centres and now require re-apportionment
from service cost centres to production cost centres. Relevant details are:
Service Cost Service Cost
Centre A Centre B
Total overhead £42,000 £57,600
% to Production Cost Centre X 40 55
% to Production Cost Centre Y 60 45
What is the total re-apportionment to Production Cost Centre Y?
A. £42,720

B. £48,480
C. £51,120
D. £56,880

48
[Link] are absorbed at a pre-determined rate based on direct labour hours. The following
additional information is available for a period:
Budget £164,000 overhead expenditure 10,000 direct labour hours
Actual £158,000 overhead expenditure 9,800 direct labour hours
What was the overhead over/under-absorption in the period?
A. £2,720 over-absorbed

B. £3,224 over-absorbed
C. £3,280 under-absorbed
D. £6,000 under-absorbed

15.A company uses absorption costing. In a period, 34,000 units of the company’s single product were
manufactured and 33,000 units were sold.
Consider the following two statements:
(i) Fixed production overheads would be over-absorbed.

(ii) Profit would be higher than in the previous period.

Are the statements true in relation to the situation described or is it not possible to determine
whether or not theyare true?
Statement 1 Statement 2
A. Cannot determine Cannot determine
B. Cannot determine True
C. True Cannot determine
D. True True
[Link] of the following would be the most appropriate basis for reapportioning the cost of personnel
services in a factory?
A. Floor space occupied

B. Hours worked by direct operatives

C. Number of direct operatives
D. Number of employees

[Link] overhead absorption rate of £12·00 per direct labour hour was established based on a budget of
2,100 hours. Actual direct labour hours worked were 2,180 and actual overhead expenditure was
£25,470.
What was the over/under absorption of overhead?
A. £270 under absorbed

B. £690 over absorbed

C. £960 over absorbed

49
 D. £960 under absorbed

[Link] hours are used to absorb overheads in a production cost centre. Overheads allocated and
apportioned to the cost centre are:
£
Allocated 13,122
Apportioned 7,920
Reapportioned from service cost centres 2,988
216,000 units of product are manufactured at a rate of 120 units per machine hour.
What is the overhead absorption rate per machine hour?
A. £7·29

B. £11·13
C. £11·69
D. £13·35

[Link] in a production cost centre for a period are:

Budget £74,600
Absorbed £71,890
Actual £73,220
What is the overhead over/under absorption?
A. £1,330 over absorbed
B. £1,330 under absorbed
C. £2,710 over absorbed
D. £2,710 under absorbed
[Link] an appropriate basis of apportionment for each of the following production overhead costs:
(a) Factory rent;(2 marks)
(b) Staff canteen. (2 marks)
Bases of overhead apportionment:
(i) Factory rent – floor space occupied
(ii) Staff canteen – number of staff
[Link] allocated, apportioned and re-apportioned to the two production cost centres in a
factory for a period were:
Production Cost Centre
X Y
Budget £161,820 £97,110
Actual £163,190 £96,330

50
 Overheads are absorbed using predetermined rates. A machine hour rate is used in Production Cost
Centre X anda direct labour hour rate in Production Cost Centre Y. Machine and direct labour activity
in each production cost centre is:
Production Cost Centre
X Y
Machine hours:
Budget 8,700 1,760
Actual 8,960 1,725
Direct labour hours:
Budget 6,220 8,300
Actual 6,276 7,870
Required:Calculate for each production cost centre for the period
(a) the predetermined production overhead absorption rate; (3 marks)
(b) the production overheads absorbed; (3 marks)
(c) the over/under absorption of production overhead.
(4 marks)
[Link] in a factory are apportioned to four production cost centres (A, B, C and D). Direct labour
hours are used to absorb overheads in A and B and machine hours are used in C and D. The following
information is available:

Production cost centre

A B C D
Overhead expenditure (£) 18,757 29,025 46,340 42,293
Direct labour hours 3,080 6,750 3,760 2,420
Machine hours 580 1,310 3,380 2,640
Which cost centre has the highest hourly overhead absorption rate?
A. Production Cost Centre A
B. Production Cost Centre B
C. Production Cost Centre C
D. Production Cost Centre D
23.A company sold 56,000 units of its single product in a period for a total revenue of £700,000.
Finished stock increased by 4,000 units in the period. Costs in the period were:
Variable production £3·60 per unit

51
 Fixed production £258,000 (absorbed on the actual number of units produced)
Fixed non-production £144,000
Using absorption costing, what was the profit for the period?
A. £82,000
B. £96,400
C. £113,600
D. £123,200
[Link] are two production cost centres (P1 and P2) and two service cost centres (Materials Store and
Employee Facilities) in a factory. Estimated overhead costs for the factory for a period, requiring
apportionment to cost centres, are:
£
Buildings depreciation and insurance 42,000
Management salaries 27,000
Power to operate machinery 12,600
Other utilities 9,400
In addition, the following overheads have been allocated to cost centres:
Cost Centre
P1 P2 Materials Employee
Store Facilities
£107,000 £89,000 £68,000 £84,000
Further information:
Cost Centre Total
P1 P2 Materials Employee
Store Facilities
Floor area (m2) 4,560 5,640 720 1,080 12,000
Number of employees 18 24 6 6 54
Share of other utilities overhead 35% 45% 10% 10% 100%
Machine hours 6,200 5,800 12,000
Share of Materials Store overheads 40% 60% 100%
Required:
(a) Prepare a schedule showing the allocated and apportioned factory overhead costs for each cost
centre; (7 marks)
(b) Re-apportion the service cost centre overheads. (4 marks)

52
[Link] overheads of two service departments (SCC1 and SCC2) in a factory require re-apportionment to
the two production departments (PCC1 and PCC2):
Total overhead % to PCC1 % to PCC2
SCC1 £32,170 35 65
SCC2 £24,850 65 35
What is the total re-apportionment to production department PCC2?
A. £19,957
B. £27,412
C. £29,608
D. £37,063
26.A company has three production departments (X, Y and Z) in its factory. After completion of all
overhead allocation and apportionment, the production department budgets for Year 6 included the
following:
Department
X Y Z
Overhead costs £51,240 £87,120 £66,816
Direct labour hours – – 11,520
Machine hours 4,200 5,280 –
A predetermined overhead absorption rate is established for each production department each
year.
Actual data for Month 1 of Year 6 included:
Department
X Y Z
Overhead costs £4,410 £7,190 £5,610
Direct labour hours – – 985
Machine hours 340 426 –
Required:
(a) Calculate, from the data provided, an appropriate predetermined overhead absorption rate for
eachproduction department for Year 6.
(4 marks)
(b) Calculate the amount of the over/under absorption of overhead in Month 1 in each production
departmentand in total for the factory. (9 marks)
(c) Suggest two general causes of overhead under absorption (3 marks)

53
27.A company has three production cost centres (P1, P2 and P3) and two service cost centres (S1 and
S2) in its factory. The actual production overhead costs for a period, totalling £487,430, have been
allocated and apportioned to cost centres as follows:
Production cost centre Service cost centre
P1 P2 P3 S1 S2
£176,860 £96,250 £134,770 £42,150 £37,400
The overheads of service cost centre S1 are reapportioned on the basis of the number of materials
requisition notes (MRN) raised in the period. The overheads of service cost centre S2 are
reapportioned on the basis of the number of employees in the other cost centres. The following
additional actual information is available for the period:
Cost centre Number of employees Number of MRNs
P1 20 4,970
P2 25 3,550
P3 50 5,680
S1 8
S2 5
Required:
(a) Reapportion the service cost centre overheads. (7 marks)
(b) The predetermined production overhead rates for the period, used to absorb overheads, are:
P1 £24·60 per machine hour
P2 £13·40 per direct labour hour
P3 £10·80 per direct labour hour
Machine hours and direct labour hours in each production cost centre are:
Cost centre Machine hours Direct labour hours
Budget Actual Budget Actual
P1 8,100 8,250 3,650 3,680
P2 1,960 1,880 8,650 8,440
P3 3,610 3,720 15,600 15,990
Required:Calculate for the period for each production cost centre
(i) The amount of overheads absorbed; (3 marks)
(ii) The amount of any over or under absorption of overheads. (6 marks)
[Link] the following statements, regarding the reapportionment of service cost centre overheads
to production cost centres, where reciprocal services exist:
1. The direct method results in costs being reapportioned between service cost centres

54
 2. If the direct method is used, the order in which the service cost centre overheads are
reapportioned is irrelevant
3. The step down method results in costs being reapportioned between service cost centres
4. If the step down method is used, the order in which the service cost centre overheads are
reapportioned isirrelevant
Which statement(s) is/are correct?
A. 1, 2 and 4
B. 1, 3 and 4
C. 2 only
D. 2 and 3
[Link] following information is available for two production cost centres in a factory for a period:
Cost centre X Cost centre Y
Budgeted costs $28,556 $54,264
Budgeted hours 1,210 machine hours 6,460 labour hours
Predetermined absorption rate $23·60 per machine hour $8·40 per labour hour
Actual costs $29,609 $52,567
Actual hours 1,235 machine hours 6,395 labour hours
Required:
(a) Calculate the over or under absorption of overhead for the period in each cost centre. (6 marks)
30.A cost centre is charged with the following actual overhead costs for a period:
Allocated costs $28,720
Apportioned costs $10,260
Overheads were absorbed in the cost centre over the period on 1,760 actual labour hours at a
predeterminedabsorption rate of $21·50 per hour. Actual labour hours worked in the period were 90
hours above budget.
What was the overhead over/under absorption in the cost centre?
A. $1,140
B. $1,935
C. $3,055
D. 9,120
[Link] of the cost items that are included in the production overhead budget for a factory for a
period are:
Machine maintenance labour $33,600
Power $26,000
Rent and rates $39,800

55
Production overheads are currently absorbed using a single factory-wide rate.
It has been suggested that a separate overhead absorption rate should be calculated for each of the
three groups ofmachines in the factory. The following additional budgeted data has been collected
for the period:
Machine Group Total
MG1 MG2 MG3
Floor area (m2) 1,600 1,400 1,000 4,000
Machine values ($’000) 320 250 230 800
Kilowatt hours (’000) 220 110 110 440
Machine maintenance (labour hours) 600 400 600 1,600
Number of indirect workers 4 4 2 10
Machine hours 8,200 5,600 4,900 18,700
Required:
(a) Briefly explain one reason why a separate overhead absorption rate for each machine group
would bepreferable to a single factory-wide rate.
(2 marks)
(b) Apportion each of the three items of budgeted overhead cost (machine maintenance labour,
power and rentand rates) to the three machine groups.
(7 marks)
The totals of ALL budgeted production overhead cost items, allocated and apportioned to the three
machine groups,are as follows:
MG1 $129,560
MG2 $107,520
MG3 $119,070
Required:
(c) Calculate an appropriate absorption rate for each machine group.
(3 marks)
(d) Calculate the production overhead that would be charged to Job J21 which requires five hours
on MG1machines, two hours on MG2 machines and three hours on MG3 machines.
(3 marks)

56
 SESSION 6: ABSORPTION COSTING & MARGINAL COSTING

COST

Manufacturing or production cost Non-manufacturing or

non-production cost

DIRECT COSTS INDIRECT COSTS/

OVERHEAD

VARIABLE FIXED
MATERIAL LABOUR EXPENSE
OVERHEA OVERHEAD
D

PRIME COST
ABSORPTION MARGINAL
COSTING COSTING
MARGINAL PRODUCTION COST

PRODUCTION COST

FINISHED GOOD PROFIT AND

LOSS

ABSORPTION MARGINAL
COSTING COSTING

MORE Increa CHANG Decre MORE

PROFIT se E IN ase PROFIT
Full cost INVENT Marginal cost
ORY

ABSORPTI
ON 57
OVERHEA
D (OAR)
EXAMPLE QUESTION

EXAMPLE 1:

To make a product A :

Direct Material 10

Direct Labor 5

Variable production overhead 4

Variable non-production cost 3

Selling price 35

Require : Calculate

(a)Marginal production cost.

(b) Marginal cost of sales.

(c) Contribution.

58
EXAMPLE 2:

 Variable cost per unit: $6/ unit

 Sales price: $10/unit
 Opening inventory: Nil
 Production during the month: 20,000 units
 Fixed cost (production, administration, sales and distribution): $45,000.
Requirement:

Calculate the total net profit, total contribution, contribution per unit and net profit per unit sold
using marginal costing: if sales were as follows:

 10,000 units
 15,000 units
 20,000 units
MARGINAL COSTING
PROFIT STATEMENT
10,000 15,000 20,000
£ £ £ £ £ £
Sales
Opening inventory
Variable production cost
Less
Value of closing stock
(Marginal cost)
Variable cost of sales
Other variable cost
Contribution
Less Fixed costs
Profit/(Loss)
Profit/(Loss) per unit
Contribution per unit

59
EXAMPLE 3
A company commenced business on 1 Mar making one product only, the cost card of product is as
follows:

Direct Labour 5

Direcr Material 8

Variable production Overhead 2

Fixed production Overhead 5

Standard production cost 20

Fixed production Overhead figure has been calculated on the basis of a budget nomal output of
36,000 units per annum. The fixed production overhead incurred in Mar was $15,000n each month.

Selling, distribution and administration expenses are:

Fixed $10,000 per month

Variable 15% of the sales value

The selling price per unit is $35 and the number of units produced and sold was

March (units)

Production 2,000

Sales 1,500

Required:

1. Prepare the adsorption costing profit statement for Mar

2. Prepare the marginal costing profit statement for Mar
3. Comparison of the profits
4. Reconcile the profits/loss between 2 methods

60
ANSWER
ABSORPTION COSTING
MAR
£ £
Sales (1500 units)
COS
Opening
Production
Closing
COS
Gross profit
Admin, selling - Fixed
Admin, selling - Variable
Over/under Fixed OH
Profit/loss

MARGINAL COSTING
MAR
£ £
SALES
COS
Opening
Production
Closing
VarCoS
VarAdm, selling cost
Contribution
Fixed admin, selling
Fixed OH
Profit/loss

RECONCILIATION OF PROFIT MAR

£ £

Absorption costing profit

(Increase)/Decrease in closing stock

Marginal costing profit

61
 PRACTISE QUESTION

1. Carrel produces two types of jacket, Blouson and Bomber, in its factory that is divided into two
departments, cutting and stitching. The firm wishes to calculate a fixed overhead cost per unit figure
from the following budgeted data.

Cutting dept Stitching dept

Direct and allocated fixed overheads £120,000 £72,000

Labour hours per unit

Blouson 0.05 hours 0.20 hours

Bomber 0.10 hours 0.25 hours

Budgeted production

Blouson 6,000 units 6,000 units

Bomber 6,000 units 6,000 units

If fixed overheads are absorbed by reference to labour hours, the fixed overhead cost of a Bomber
would be:
A. £5.33
B. £6.67
C. £12.00
D. £20.00
2. A company budgeted to produce 3,000 units of a single product in a period at a budgeted cost per
unit, build up as follows:

£/unit

Direct costs 12

Variable overhead 5

Fixed overhead 9

£26

In the period covered by the budget:

a) Actual sales were 3,500 units and finished stocks decreased by 300 units
b) Actual fixed overhead expenditure was 5% above that budgeted – all other costs were as
budgeted
Determine which of the following statements is correct

A. Overheads in the period were £450 over-absorbed

B. Overheads in the period were £450 under-absorbed
C. Overheads in the period were £1,450 over-absorbed
D. Overheads in the period were £1,450 under-absorbed
3. A management consultancy recovers overheads on chargeable consulting hours. Budgeted
overheads were £615,000 and actual consulting hours were 32,150. Overheads were under-
recovered by £35,000
If actual overheads were £694,075 what was the overhead absorption rate per hour?
A. £19.13

62
 B. £20.50
C. £21.59
D. £22.68
4. The management accountant of Gympie Limited has already allocated and apportioned the fixed
overheads for the period although she has yet to reapportion the service centre costs. Information for
the period is as follows:

Production departments Service department Total

1 2 Stores Maintenance

Allocated and apportioned £17,500 £32,750 £6,300 £8,450 £65,000

Work done by:

Stores 60% 30% - 10%

Maintenance 75% 20% 5% -

What are the total overheads including in production department 1 if the reciprocal method is
used to reapportion service centre costs?
A. £27,618
B. £28,171
C. £28,398
D. £28,453
The following information relates to question 5 & 6
Hayward’s Limited reported an annual profit of £47,500 for the year ended 31 March 20X4. The
company uses absorption costing. One product is manufactured, the Health, which has the following
standard cost per unit:

Direct material (2kg at £5/kg) 10

Direct labour (4 hours at £6.50/hour) 26

Variable overheads (4 hours at £1/hour) 4

Fixed overheads (4 hours at £3/hour) 12

52

The normal level of activity is 10,000 units although actual production was 11,500 units. Fixed costs
were as budgeted.
Stock levels at 1 April 20X3 were 400 units and at the end of the year were 600 units
5. What would be the profit under marginal costing?
A. £44,300
B. £45,100
C. £49,900
D. £50,700
6. What were the budgeted fixed overheads for the year ended 31 March 2000 and the actual
under – or over – absorption?
Budgeted overheads Under-/over-absorbed
A. £120,000 £18,000 over-absorbed

63
 B. £120,000 £18,000 under-absorbed
C. £138,000 £18,000 over-absorbed
D. £138,000 £18,000 under-absorbed
The following data are for question 7 & 8

Dundee makes cakes, for which the standard cost card is as follows:

Materials 2

Labour 3

Variable production overhead 3

Fixed production overhead 4

Variable selling cost 1

Fixed selling overhead 2

Profit 5

Sales price 20

Both types of fixed overheads were based on a budget of 10,000 cakes a year
In the first year of production, the only difference from the budget was that Dundee produced 11,000
cakes and sold 9,000
7. What was the profit made under an absorption costing system?
A. £39,000
B. £43,000
C. £47,000
D. £51,000
8. What would the profit have been using a marginal costing system?
A. £35,000
B. £39,000
C. £42,000
D. £47,000
9. The following data is available for period 9.
Opening stock 10,000 units
Closing stock 8,000 units
Absorption costing profit £280,000
The profit for period 9 using marginal costing would be:
A. £278,000
B. £280,000
C. £282,000
D. impossible to calculate without more information

64
10. In a period where opening stocks were 15,000 units and closing stocks were 20,000 units, a firm had
a profit of £130,000 using absorption costing. If the fixed overhead absorption rate were £8 per unit,
the profit using marginal costing would be:
A. £90,000
B. £130,000
C. £170,000
D. impossible to calculate without more information
The following information relates to questions 11 and 12

Cost and selling price details for product Z are as follows.

£ per unit

Direct materials 6.00

Direct labour 7.50

Variable overhead 2.50

Fixed overhead absorption rate 5.00

21.00

Profit 9.00

selling price 30.00

Budget production for the month was 5,000 units although the company managed to produce 5,800
units, selling 5,200 of them and incurring fixed overhead costs of £27,400.

11. The marginal costing profit for the month is:

A. £45,400
B. £46,800
C. £53,800
D. £72,800
12. The absorption costing profit for the month is:
A. £45,200
B. £45,400
C. £46,800
D. £48,400
13. A company sold 82,000 units of its single product in a period in which 84,000 units were
[Link] the following statements:
1. Stock value at the end of the period would be higher than at the beginning of the period.
2. Stock values both at the beginning and at the end of the period would be higher using
absorption rather thanmarginal costing.
Are the statements true or false in relation to the situation described?

Statement 1 Statement 2

65
 A. False False

B. False True

C. True False

D. True True

14. A company has the following costs for its single product, based on planned production and sales of
46,000 litres ina period:
£ per litre

Prime costs 5·20

Production overhead – all fixed 2·80

Non-production overhead

– variable 0·65

– fixed 1·70

–––––––

£10·35

–––––––

Actual production and sales in the period were:

Production 46,000 litres

Sales 45,600 litres (at £12·00 per litre)

There was no finished stock at the beginning of the period. Variable costs per litre and total fixed
costs in the periodwere as planned. Variable non-production overheads vary in total with the
number of litres sold.

Required:

a) Prepare a profit statement for the period using absorption costing.

(8 marks)

b) Explain fully why, and calculate by how much, the profits for the period would be different if
marginal costingwas used instead.
(6 marks)

15. What distinguishes absorption costing from marginal costing?

A. Product costs include both prime cost and production overhead

B. Product costs include both production and non-production costs

C. Stock valuation includes a share of all production costs

66
 D. Stock valuation includes a share of all costs

16. A company uses a marginal costing system. 10,000 units of its single product were manufactured in a
period duringwhich 9,760 units were sold.
If absorption costing is applied instead what would be the effect on profit?

A. Higher by (240 units x fixed production overhead cost per unit)

B. Lower by (240 units x fixed production overhead cost per unit)
C. Higher by [240 units x (fixed production overhead cost per unit + fixed non-production overhead
cost per unit)]
D. Lower by [240 units x (fixed production overhead cost per unit + fixed non-production overhead
cost per unit)
17. A company with a single product sells more units than it manufactures in a period.
Which of the following correctly describes the use of marginal costing in comparison with
absorption costing inthe above situation?

[Link] profit and stock values will be higher

[Link] profit and stock values will be lower

[Link] will be higher; stock values will be lower

[Link] will be lower; stock values will be higher

18. A company with a single product manufactured 10,200 units in a period in which 10,300 units were
sold. Considerthe following statements:
(i) The profit for the period would be higher using absorption costing (compared with marginal
costing)

(ii) Stock values would be higher using absorption costing (compared with marginal costing)

Are the statements true or false in relation to the situation described?

Statement (i) Statement (ii)

A. False False

B. False True

C. True False

D. True True

19. The following is a list of unit costs for a single product, incurred in a period, using either marginal
costing or absorptioncosting:
Marginal costing Absorption costing

$ $

Production costs:

67
 Prime cost 4·20 4·20

Variable overhead 0·60 0·60

Fixed overhead – 3·80

––––– –––––

4·80 8·60

Selling & administration costs:

Variable overhead 1·00 1·00

Fixed overhead – 2·90

––––– –––––

1·00 3·90

––––– ––––––

Total 5·80 12·50

––––– ––––––

The selling price of the product, throughout the period, was $14·50 per unit. 11,400 units of the
product weremanufactured in the period during which 11,200 units were sold. There were no
finished goods at the beginning ofthe period. The fixed production overhead costs per unit listed
above are based on the production units for the periodand the fixed selling and administration
overhead costs per unit are based on the sales units.

Required:

a) Prepare an absorption costing profit statement for the period. The statement should include the
total cost ofproduction, closing inventory value, total gross profit and total net profit.
b) Using marginal costing, calculate for the period:
(i) total contribution; (3 marks)

(ii) total net profit (3 marks

(iii) break-even sales revenue. (3 marks)

c) Explain why the net profit using absorption costing differs from that using marginal costing.
20. A company sells more than it manufactures in a period.
Which of the following explains the difference in profit between absorption and marginal costing
in the above situation?

A. Absorption costing profit is higher because of the difference in inventory levels

[Link] costing profit is lower because of the difference in inventory levels

68
[Link] costing profit is higher because of overhead over-absorption

[Link] costing profit is lower because of overhead under-absorption

69
For customers’ special
requirements and
each order is of
comparatively short JOB, BATCH AND SERVICE COSTING
duration Cost for service
provided

JOB COSTING BATCH COSTING SERVICE COSTING

Direct material X Job costing with a

Direct labour X group of units
Direct expense X Cost Total cost of the period
per =
Prime cost
unit Number of service units in
Production overhead X Cost Total batch cost
per the period
Production cost =
Non - production cost unit Number of units
Administration overhead X
Selling & distribution overhead X
Total cost Intangible
% mark up/margin X
Selling price
Simultaneous

CHARACTERISTICS
(cannot be inspected
for quality before use,
cannot be returned)

Perishable
cannot be stored

Heterogeneous
70 exact services can be
vary
EXAMPLE

EXAMPLE 1: JOB COSTING

Example 1:

A jobbing enterprise calculates the prices of its jobs by adding overheads to the prime cost and
adding 30% to total costs as a profit margin. Job number 265 was sold for £1,690 and incurred
overheads of £694. What was the prime cost of the job?
A. £489
B. £507
C. 606
D. 996
Example 2 :
PA Ltd operates a job costing system. The company’s standard net profit margin is 20 per cent
of sales.
The estimated costs for job 173 are as follows.

Direct materials 5 metres @ £20 per metre

Direct labour 14 hours @ £8 per hour

Variable production overheads are recovered at the rate of £3 per direct labour hour.

Fixed production overheads for the year are budgeted to be £200,000 and are to be recovered on
the basis of the total of 40,000 direct labour hours for the year. Other overheads, in relation to
selling, distribution and administration, are recovered at the rate of £80 per job.

The price to be quoted for job 173 is, to the nearest £

A. £404
B. £424
C. £485
D. £505

71
Example 3

Example 4 :

Annie is to set up a small hairdressing business at home. She anticipates working a 35 hour week
and taking four weeks’ holiday per year. Her expenses for materials and overheads are expected to
be £3,000 per year, and she has set herself a target profit of £18,000 for the first year.
Assuming that only 90% of her working time will be chargeable to clients, what price should she
charge for a ‘colour and cut’ which would take 3 hours?

A. £13.89

B. £35.71

C. £37.50

D. £41.67

Example 5

72
73
 PRACTISE QUESTION:

1. The following items may be used in costing jobs

(i) Actual material cost
(ii) Actual manufacturing overheads
(iii) Absorbed manufacturing overheads
(iv) Actual labour cost
Which of the above are contained in a typical job cost?
A. (i), (ii) and (iv) only
B. (i) and (iv) only
C. (i), (iii) and (iv)
D. All four of them
The following data are to be used for questions 2 & 3
A firm uses job costing and recovers overheads on a direct labour cost basis
Three jobs were worked on during a period, the details of which were:

Job 1 Job 2 Job 3

£ £ £

Opening work-in-progress 8,500 0 46,000

Material in period 17,150 29,025 0

Labour for period 12,500 23,000 4,500

The overheads for the period were exactly as budgeted £140,000

2. Jobs 1 and 2 were the only incomplete jobs at the end of the period
What was the value of closing work-in-progress?
A. £81,900
B. £90,175
C. £140,675
D. £214,425
3. Job 3 was completed during the period and consisted of 2,400 identical circuit boards. The firm adds
50% to total production costs to arrive at a selling price
What is the selling price of a circuit board?
A. It cannot be calculated without more information
B. £31.56
C. £41.41
D. £58.33
The following data are to be used for questions 4 to 6
A firm makes special assemblies to customers’ orders and uses job costing. The data for a period
are:

Job numberAA10 Job numberBB15 Job numberCC20

£ £ £

74
 Opening WIP 26,800 42,790 0

Material added in period 17,275 0 18,500

Labour for period 14,500 3,500 24,600

The budgeted overheads for the period were £126,000. Overheads are absorbed on the basis of
labour costs
4. What overhead should be added to job number CC20 for the period?
A. £24,600
B. £65,157
C. £72,761
D. £126,000
5. Job number BB15 was completed and delivered during the period and the firm wishes to earn 33.33%
profit on sales
What is the selling price of job number BB15?
A. £69,435
B. £70,804
C. £75,521
D. £84,963
6. What was the approximate value of closing WIP at the end of the period?
A. £58,575
B. £101,675
C. £147,965
D. £217,323
7. Which of the following is NOT likely to be used in the non-profit organisation?
(i) cost per patient
(ii) cost per bed-day
(iii) bed throughput
(iv) profit per patient
8. For operational purposes, for a company operation a fleet of delivery vehicles, which of the
following cost units would be most useful?
(i) Cost per mile run
(ii) Cost per drive hour
(iii) Cost per tone mile
(iv) Cost per kilogram carried
9. Which of the following would be appropriate cost units for a passenger coach company?
Vehicle cost per passenger – kilometre

Fuel cost for each vehicle per kilometre

Fixed cost per kilometre

(i) only

75
 (i) and (ii) only

(i) and (iii) only

All of them

10. The following information is available for the Whitely Hotel for the latest thirty day period.
Number of rooms available per night 40

Percentage occupancy achieved 65%

Room servicing cost incurred £3,900

The room servicing cost per occupied room-night last period, to the nearest penny, was:

£3.25

£5.00

£97.50

£150.00

76
 PROCESS COSTING
MATERIALS PROCESS 1
PROCESS 2

CLOSING OPENING
WIP 1 WIP 2
SCRAP VALUE DISPOSAL COST

LOSSES IN THE PROCESS EQUIVALENT HOW TO VALUE?

NORMAL NORMAL UNITS OF
LOSS LOSS PRODUCTION
NORMAL ABNORMAL ABNORMAL
LOSS GAIN LOSS
COST OF ABNORMAL COST OF ABNORMAL
PROCESS GAIN OR LOSS PROCESS GAIN OR LOSS MATERIAL LABOUR OVERHEAD FIFO WEIGHTED
LOSS EXPECTED Extra loss when Gain when ACCOUNT ACCOUNT %complete %complete %complete AVERAGE COST
normal>actual normal<actual

+ - COST PER COST

COST INCURRED FOR EACH COMPONENTS
UNIT PER = TOTAL EQUIVALENT
(MATERIAL, LABOUR, OVERHEAD)
0 INCOME STATEMENT
UNIT UNIT
Work in progress All units are
will completed completed at
EXPECTED first after that same time
OUTPUT units put in the
process will
complete after
COST
COST PER INCURRED
UNIT = EXPECTED TOTAL COST IN PROCESS 2 TOTAL COST IN PROCESS 2 + COST OF OPENING WIP
1 COST PER
OUTPUT COST PER
UNIT UNIT

EQUIVALENT UNIT START AND EQUIVALENT EQUIVALENT UNIT START AND EQUIVALENT
UNIT NEED TO COMPLETE IN OF CLOSING UNIT COMPLETED COMPLETE IN OF CLOSING
COMPLETED THE PROCESS WIP IN PROCESS 1 THE PROCESS WIP

No of opening No of unit put No of closing No of opening No of unit put No of closing

WIP x 77 –
in the process WIP x WIP x 100% in the process – WIP x
% need to Closing WIP % complete Closing WIP % complete
complete
Example 1 :Normal loss

Example - Normal loss has no scrap value

Input to a process consisted of:

1,000 units of material $4,300

Direct labor cost $500

Absorbed production overheads $1,500

Normal loss is 10% of input. Loss has no scrap value

Output from the process is 900 units.

Calculate cost per unit?

Example 2 :Normal loss with scrap value

Input to a process consisted of:

1,000 units of material $4,300

Direct labor cost $500

Absorbed production overheads $1,500

Normal loss is 10% of input. Loss has no scrap value

Output from the process is 900 units.

Normal loss has scrap value of $0.9 per unit.

Calculate cost per unit?

Example 3 : Abnormal loss

Input to a process was 2,000 units. Normal loss is 5% of input. Costs of production were:

Direct materials $3,700

Direct labor $1,300

Production overhead $2,600

Actual output during the period was 1,780 units.

Calculate cost per unit of output?

Example 4:

Input to a process was 1,000 units. Normal loss is 3% of input. Costs of production were:

78
Direct materials $3,705

Direct labor $600

Production overhead $3,000

Actual output during the period was 950 units. Items lost in process have a scrap value of $1 per unit

Calculate cost per unit of output?

Example 5: Abnormal gain

Input to a process was 5,000 units at $12 per unit. Normal loss is 4% of input. Costs of production
were:

Direct materials $60,000

Direct labor $710

Production overhead $2,130

Actual output during the period was 4,820 units. Waste units have a scrap value of $1 per unit

Calculate cost per unit of output?

Example 6- Closing WIP

Input: 4,000 litres of material.

Output: 3,800 litres, 200 litres were still in progress

No loss in progress

Cost:

Direct materials $16,000

Direct Labor $7,920

Absorbed production overhead $11,880

An estimate has been made of the degree of completion of closing inventory

Material 100% complete

Labor 80% complete

Overhead 80% complete

Calculate cost per equivalent unit using FIFO method?

Example 7

79
Example 8

80
 PRACTISE QUESTION:

The following information relates to questions 1 to 3

A chemical compound is made by raw material being processed through two processes. The output of
Process A is passed to Process B where further material is added to the mix. The details of the
process costs for the financial period number 10 were as shown below:
Process A
Direct material 2,000 kilograms at £5 per kg
Direct labour £7,200
Process plant time 140 hours at £60 per hour
Process B
Direct material 1,400 kilograms at £12 per kg
Direct labour £4,200
Process plant time 80 hours at £72.50 per hour
The departmental overhead for Period 10 was £6,840 and is absorbed into the costs of each process
on direct labour cost

Process A Process B

Expect output was 80% of input 90% of input

Actual output was 1,400 kgs 2,620 kgs

Assume no finished stock at the beginning of the period and no work-in-progress at either the
beginning or the end of the period.
Normal loss is contaminated material which is sold as scrap for £0.50 per kg from Process A and
£1.825 per kg from Process B, for both of which immediate payment is received
1. For process A what is the scrap value of the normal loss?
A. £200
B. £2,000
C. £1,000
D. £0
2. What is the abnormal loss for process A in units?
A. 100
B. 200
C. 300
D. 400
3. What is the cost per kg for process A?
A. £18.575
B. £13.454
C. £14.575
D. £16.575
4. Burgess operates a continuous process into which 3,000 units of material costing £9,000 was input in
a period.

81
 Conversion costs for this period were £11,970 and losses, which have a scrap value of £1.50, are
expected at a rate of 10% of input. There were no opening or closing stocks and output for the period
was 2,900 units.
What was the output valuation?
A. £20,271
B. £20,520
C. £20,970
D. £22,040
5. A factory manufactures mode cars. During October, work commenced on 110,000 new cars. This was
in addition to 20,000, which were 50% complete at the start of the month. At the end of October there
were 40,000 cars which were 50% complete
Costs of October were:

£000

Brought forward 11,000

Incurred this period 121,000

£132,000

If this factory chooses the weighted average method of spreading costs, what is the cost per
car for October production?
A. £1,100
B. £1,200
C. £1,210
D. £1,320
6. An error was made in a firm’s computation of the percentage of completion of closing WIP. The error
resulted in assigning a lower percentage of completion than actually was the case.
What was the effect of this error upon the cost per unit and the cost of goods completed for
the period?

Cost per unit Cost of goods completed

A. Understated Understated

B. Understated Overstated

C. Overstated Understated

D. Overstated Overstated

The following information relates to questions 7 and 8

A company manufactures Chemical X, in a single process. At the start of the month, there was no
work-in-progress. During the month, 300 litres of raw material were input to the process at a total cost
of £6,000. Conversion costs during the month amounted to £4,500. At the end of the month, 250 litres
of Chemical X were transferred to finished goods stock. The remaining work-in-progress was 100%
complete with respect to materials and 50% complete with respect to conversion costs. There were no
losses in the process.
7. The equivalent units for closing work-in-progress at the end of the month would have been:

Material Conversion costs

A. 25 litres 25 litres

82
 B. 25 litres 50 litres

C. 50 litres 25 litres

D. 50 litres 50 litres

8. If there had been a normal process loss of 10% on input during the month the value of this loss
would have been:

A. Nil

B. £450

C. £600

D. £1,050

9. In a process account, abnormal losses are valued:

A. At their scrap value
B. The same as good production
C. At the cost of raw materials
D. At good production cost less scrap value
10. A company needs to produce 340 litres of Chemical X. This is a normal loss of 10% of the material
input into the process. During a given month the company did produce 340 litres of Good production,
although there was an abnormal loss of 5% of the material input into the process
How many litres of material were input into the process during the month?
A. 357 litres
B. 374 litres
C. 391 litres
D. 400 litres
The following information related to questions 11 and 12
Patacake Ltd produces a certain food item in a manufacturing process. On 1 November, there was no
opening stock of work in process. During November 500, units of material were input to the process,
with a cost of £9,000. Direct labour costs in November were £3,840. Production overhead is absorbed
at the rate of 200% of direct labour costs. Closing stock on 30 November consisted od 100 units
which were 100% complete as to materials and 80% complete as to labour and overhead. There was
no loss in process.
11. The full production cost of completed units during November was
A. £10,400
B. £16,416
C. £16,800
D. £20,520
12. The value of the closing work in progress on 30 November is
A. £2,440
B. £3,720
C. £4,104
D. £20,520

83
 PROCESS COSTING
Split-off
point 1
JOINT PRODUCT A
MATERIALS
significant value JOINT PRODUCT A
PROCESS 2
PROCESS 1
JOINT PRODUCT B JOINT PRODUCT B

BY-PRODUCT X

Insignificant value BY-PRODUCT X

TOTAL PROCESS COST

= Cost per unit x
actual output – net Deduct from
sale of by- product process cost

How to apportion ?

Based on
PHYSICAL MEASUREMENT output
METHODS

SALE VALUE Based on sale

value of
84 production unit
Example 1:

During August, the follwing cost were incurred in a process:

Materials (3,500 kg) $5,000

Labourand overheads $2,600

The production from the process was follows:

kg

Product A 1,000 selling price $ 5 per kg

Product B 2,000 selling price $ 2 per kg

by – product X 500 scrap value $0.20 per kg

Calculate a cost per kg and profit per kg for A and B using the physical units basis;

Example 2 :

During August, the follwing cost were incurred in a process:

Materials (3,500 kg) $5,000

Labourand overheads $2,600

The production from the process was follows:

kg

Product A 1,000 selling price $ 5 per kg

Product B 2,000 selling price $ 2 per kg

by – product X 500 scrap value $0.20 per kg

Sales during the period were 800 kg of A and 1,500kg of B.

Calculate a cost per kg and profit per kg for A and B using the market units basis;

Example 3: Using Net real value approach.

During September , the follwing cost were incurred in a process:

Materials (3,500 kg) $5,000

Labour and overheads $2,600

the production from the process was follows:

85
 kg

Product A 1,000 selling price $ 8.40per kg

Product B 2,000 selling price $ 4.50 per kg

By – product X 500 scrap value $0.20 per kg

All the output of A and B incurred furtherprocessing at a cost of $4.80 per kg for A and $2.20 per
kg for B

Calculate a cost per kg for A and B using the net real value approach.

Example 4:

During November 2003, Splatter recorded the following information:

Opening stock of Main product of X: Nil

Opening stock of by product of Y: Nil

Cost of production: $120,000

Sales of the main product amounted to 90% of output during the period and 10% of production was
held as closing stock at 30 November.

Sales revenue from the main product was $150,000

A by product Y was produced and output had a net sales value of $1,000. Of this output, $700 was
sold during the month and $300 was in the stock at the month end.

Requirement: calculate the profit for November 2003 using the four methods:

86
 PRACTISE QUESTION:
MCQs
The following data relates to questions 1 and 2
PR Ltd manufactures two joint products, P and R, in a common process. Data for June are as follows.
£
Opening stock 1,000
Direct materials added 10,000
Conversation costs 12,000
Closing stock 3,000

Production Sales Sales price

Units Units £ per unit
P 4,000 5,000 5
R 6,000 5,000 10

1 If cost are apportioned between joint products on a sales value basis, what was the cost per
unit of product R in June?
A. £1.25
B. £2.22
C. £2.50
D. £2.75
2 If cost is apportioned between joint products on a physical unit basis, what was the total cost
of product P production in June?
A. £8,000
B. £8,800
C. £10,000
D. £12,000
3 Which of the following statements in/are correct?
(i) A by- product is a product produced at the same time as other products which has a relatively low
volume compared with the other products.
(ii) Since a by-product is a saleable item it should be separately costed in the process account, and
should absorb some of the process costs
(iii) Costs incurred prior to the point of separation are known as common or joint costs.
A. (i) and (ii)
B. (ii) and (iii)
C. (i) and (iii)
D. only
4 EQ Ltd manufactures two joint products and one by-product in a single process. Data for
November are as follows.
£
Raw material input 216,000

87
 Conversation costs 72,000
There were no stocks at the beginning or end of the period.
Output Sales price
Units £ per unit
Joint product E 21,000 15
Joint product Q 18,000 10
By-product X 2,000 2
By –product sales revenue is credited to the process account. Joint costs are apportioned on a sales
value basis. What were the full production costs of product Q in November (to the nearest £)?
A. £102,445
B. £103,273
C. £104,727
D. £180,727
5 JW Ltd manufactures three joint products and one by-product from a single process.
Data for May are as follow.
Opening and closing stocks Nil
Raw materials input £180,000
Conversation costs £50,000
Output
Output Sales price
Units £ per unit
Joint product L 3,000 32
M 2,000 42
N 4,000 38
By-product R 1,000 2
By-product sales revenue is credited to the sales account. Joint costs are apportioned on a sales
value basis.
What were the full production costs of product M in May (to the nearest £)?
A. £57,687
B. £57,844
C. £58,193
D. £66,506
6. What is a by product?

A. A product produced at the same time as other products which has no value
B. A product produced at the same time as other products which requires further processing to put
it in a saleable state
C. A product produced at the same time as other products which has a relatively low volume
compared with the other products
D. A product produced at the same time as other products which has a relatively low value
compared with the other products

88
89
 ALTERNATIVE COSTING PRINCIPLES

ACTIVITY BASED LIFE CYCLE TARGET COSTING

COSTING COSTING
$
Set selling price
Overhead costs are assigned to activity cost pools associated with significant activities

Estimate required profit

Setup Purchasing Material Quality
handling assurance Growth Maturity
Target cost = selling price –
Decline target profit
Overhead costs are allocated from each activity cost pool to each product in proportion to its
consumption of the activity. Each activities has its own cost driver

Estimate cost for the product

Flow of production products consume production-related activities
Time Cost gap = estimate cost –
Introduction
target cost

Effort to close the gap

Cheap staff & mate

Efficient technolog
Standard compont
Cut non value add

No of component

Training staff
Negotiate with customer
90
EXAMPLE 1: ACTIVITY BASED COSTING

Brick by Brick (BBB) is a building business that provides a range of building services to the
public. Recently they have been asked to quote for garage conversions (GC) and extensions
to properties (EX) and have found that they are winning fewer GC contracts than expected.

BBB has a policy to price all jobs at budgeted total cost plus 50%. Overheads are currently
absorbed on a labour hour basis. BBB thinks that a switch to activity based costing (ABC) to
absorb overheads would reduce the cost associated to GC and hence make them more
competitive.

You are provided with the following data:

Overhead Annual overheads Activity driver Total number of

category activities per year
Supervisors 90,000 Site visits 500
Planners 70,000 Planning 250
documents
Property related 240,000 Labour hours 40,000
Total 400,000
A typical GC costs $3,500 in materials and takes 300 labour hours to complete. A GC
requires only one site visit by a supervisor and needs only one planning document to be
raised. The typical EX costs $8,000 in materials and takes 500 hours to complete. An EX
requires six site visits and five planning documents. In all cases labour is paid $15 per hour.

Required:

(a) Calculate the cost and quoted price of a GC and of an EX using labour hours to absorb
the overheads. (5 marks)

(b) Calculate the cost and the quoted price of a GC and of an EX using ABC to absorb the
overheads. (5 marks)

91
EXAMPLE 2: TARGET COSTING
A company want to product a new type of radio.
The company set selling price a radio to compete on the market is $44.
The board have agreed that the acceptable margin should be 20%
Cost information of the radio
Component 1 bought in at cost $4.7 per radio
Component 2 bought in at $0.5 per metre. A radio need 25 cm of component 2.
Other material – cost $8.1 per radio
Labour – a radio need 0.5 labour hour at cost $12.6 per hour.
Production overhead – recent historic cost analysis has revealed following production overhead data

Total production overhead Total assembly labour hour

Month 1 620,000 19,000

Month 2 700,000 23,000

Fixed production overhead are absorbed on an assembly hour basis based on normal annual activity
levels. In a typical year 240,000 assembly hours will be worked.
Requirement
Determine cost gap

92
EXAMPLE 2: LIFE CYCLE COSTING

Fit Co specialises in the manufacture of a small range of hi-tech products for the fitness
market. They are currently considering the development of a new type of fitness monitor,
which would be the first of its kind in the market. It would take one year to develop, with
sales then commencing at the beginning of the second year. The product is expected to
have a life cycle of two years, before it is replaced with a technologically superior product.
The following cost estimates have been made.

Year 1 Year 2 Year 3

Units manufactured and sold 100,000 200,000
Research and development costs $160,000
Product design costs $800,000
Marketing costs $1,200,000 $1,000,000 $1,750,000
Manufacturing costs
Variable cost per unit $40 $42
Fixed production costs $650,000 $1,290,000
Distribution costs:
Variable cost per unit $4 $4·50
Fixed distribution costs $120,000 $120,000
Selling costs:
Variable cost per unit $3 $3·20
Fixed selling costs $180,000 $180,000
Administration costs $200,000 $900,000 $1,500,000

Note: You should ignore the time value of money.

Required: Calculate the life cycle cost per unit. (6 marks)

93
PRACTISE QUESTION

QUESTION 2

94
QUESTION 3

95
PART 2: TARGET COSTING

QUESTION 4

96
 FORECASTING
INDEX
LINEAR TIME SERIES ANALYSIS HIGH-LOW NUMBER
REGRESSION METHOD
ANALYSIS
TREND SEASONAL VARIANCES CYCLICAL RESIDUAL
Long-term general Regular variance around the trend VARIANCES VARIANCES
LINE OF BEST FIT movement of data Economic Irregular, PRICE INDEX QUALITY INDEX
cycle of random Change in monetary Change in non-monetary
Y=a+bX
booms and fluctuations value of group item value of group items
MOVING ADDITIVE PROPORTIONAL slumps
CORRELATION
AVERAGE MODEL MODEL
COEFFICIENT
WEIGHTED AVERAGE INDICES
R Actual Actual (forecast) ∑WVn
(forecast) = = ∑WV0
COEFFICIENT OF Based Trend + Trend x Seasonal Trend =
DETERMINATION number Seasonal variance actual/variance
R
2 variance LASPEYRE PASSCHE
of point FISHER INDEX
PRICE INDEX INDEX
price price
∑PnQ0 √
∑PnQn
Total seasonal Total seasonal ∑P0Q0
∑P0Qn
variance for 4 variance for 4 quantity
quantity
∑P0Qn
quarters equal 0 quarters equal 4 ∑PnQn
∑P0Q0
∑PnQ0

Based 0 Based 1

97
EXAMPLE: LINER REGRESSION ANALYSIS

98
EXAMPLE OF TIME SERIES ANALYSIS

99
FINDING THE SEASONAL VARIATIONS

Additive model

100
SEASONAL VARIATIONS USING THE MULTIPLICATIVE MODEL

101
EXAMPLE QUESTIONS

EXAMPLE QUESTION 1: MOVING AVERAGE MODEL

Requirement: Take a moving average of the annual sales over a period of three years?

EXAMPLE QUESTION 2

Requirement: Determine line of best fit.

EXAMPLE QUESTION 3

102
LASPEYRE AND PAASCHE PRICE INDICES

103
PRACTISE QUESTION

104
105
106
 BUDGETING
PLANNING AND CONTROLLING CYCLE

BUDGET PERIOD

IDENTIFY OBJECTIVES administration BUDGET MANUAL Collection of Instruction

OBJECTIVES
BUDGET COMMITTE Coordinate and admin
PLANNING
Sale
IDENTIFY COURSES OF BUDGET Communicate details of budget demand
CONTROL
ACTION WHICH MIGHT PROCESS policy and budget guidelines
CONTRIBUTE TOWARDS Machine
COMMUNICATION capacity
ACHIEVING THE
OBJECTIVES COORDINATION PRINCIPLE BUDGET FACTORS Key raw
material
Factor limits the activities of
organization
RESPONSIBLE Cash
EVALUATE ACCOUNTING PROBLEMS OF
STRATEGIES BUDGETING
SALES BUDGET

HOW TO
CHOOSE COURSE CONTROLABLE FORECAST IN PREPARATION OF
OF ACTION BUDGETING BUDGETS PRODUCTION
BUDGET

TYPES OF BUDGETING
RESPONSIBILITY MATERIAL
CENTRE BUDGET
IMPLEMENT THE FUNCTIONAL
LONG TERM PLAN BUDGET
IN THE FORM OF BUDGETING LABOUR
ANNUAL BUDGET BUDGET FINAL
OTHER ACCEPTANCE OF
FUNCTIONAL THE BUDGET
FAVOURABLE
FLEXIBLE BUDGET BUDGET
MEASURE ACTUAL VARIANCE
RESULTS AND ADVERSE
CASH BUDGET CO-ORDINATION
COMPARE WITH
THE PLAN AND OF BUDGET
CORRECTIVE MASTER BUDGET BUDGET INCOME
ACTIONS STATEMENT AND
SOFP

107 NEGOTIATE BUDGET WITH SUPERVISORS

 BUDGETING

TYPES OF BUGET BUDGET ADMINISTATION BUGET PROCESS

OBJECTIVES
Sale
demand
TOP DOWN BUDEGT PLANNING
BUDGET PERIOD PRINCIPLE BUDGET FACTORS
Machine
CONTROL Factor limits the activities of capacity
BOTTOM UP BUDGET
BUDGET MANUAL organization
Key raw
COMMUNICATION material
FLEXIBLE BUDGET
Collection of
COORDINATION SALES BUDGET
Instruction Cash

RESPONSIBLE
BUDGET COMMITTE PREPARATION OF
ACCOUNTING PRODUCTION
BUDGETS
Coordinate and admin
BUDGET

MATERIAL
FUNCTIONAL BUDGET
BUDGET
LABOUR
BUDGET

OTHER
FUNCTIONAL
BUDGET

CASH BUDGET

MASTER BUDGET BUDGET INCOME

STATEMENT AND
SOFP

108
109 FMA LECTURER NOTE

EXAMPLE 1: SALE BUDGET

A company makes two products- A and B. The products are sold in the ratio: 1:1. Planned selling
prices are $100 and $200 per unit respectively. The company needs to earn $900,000 revenue in the
coming year.
Required: Prepare the sales budget for the coming year.
EXAMPLE 2: PRODUCTION BUDGET
Newton Ltd manufactures three products. The expected sales for each product are: A: 3,000 units; B:
4,500 units, C: 3,000 units. Opening inventory is expected to be: A: 500 units, B: 700 units; C: 500
units.
Management have stated their desire to reduce inventory levels and closing inventory is budgeted
as: A: 200 units, B: 300 units; C: 300 units.
Required: Calculate the number of A, B, C to be produced.

109
110 FMA LECTURER NOTE

EXAMPLE 3: MATERIAL BUDGET

Newton Ltd manufactures three products. The expected production levels for each product are: A:
2,700 units; B: 4,100 units, C: 2,800 units. Three types of material are used in varying amounts in the
manufacture of the three products. Material requirements (for one unit) are shown as below:

A B C

Material M1 2kg 3kg 4kg

Material M2 3kg 3kg 4kg

Material M3 6kg 2kg 4kg

The opening inventory of material is expected to be: M1: 4,300 kg; M2: 3,700kg; M3: 4,400kg.
Management are keen to reduce inventory levels for materials, and closing inventory levels are to be
much lower. Expected levels are shown: M1: 2,200kg; M2: 1,300kg; M3: 2,000 kg.
Materials prices are expected to be 10% higher than this year and the current prices are: M1:
$1.1/kg; M2: $3.00/kg; M3: $2.5/kg.
Required: Calculate the quantity of material M1, M2, M3 to be used; quantity and value of M1, M2,
M3 to be purchased

EXAMPLE 4: OVERHEAD BUDGET

Newton Ltd manufactures three products. The expected production levels for each product are
shown as follows: A: 2,700 units; B: 4,100 units, C: 2,800 units.
Two types of labour are used in producing the three products. Standard times per unit and expected
wages rates for the forthcoming year are as follows:
A B C
Hours per unit
Skilled labor 3 1 3
Semi-skilled labor 4 4 2
Production overheads per labor hours (for both skilled and semi-skilled labour) are as follows:
Variable: $3.5 per labor hour
Fixed: $5.5 per labor hour.
Required: Calculate the overhead budget

110
111 FMA LECTURER NOTE

PRACTISE QUESTIONS

QUESTION 1

QUESTION 2

QUESTION 3

QUESTION 4

QUESTION 5

QUESTION 6

111
112 FMA LECTURER NOTE

QUESTION 7

QUESTION 8

QUESTION 9

QUESTION 10

QUESTION 11

112
113 FMA LECTURER NOTE

QUESTION 12

QUESTION 13

QUESTION 14

QUESTION 15

113
114 FMA LECTURER NOTE

QUESTION 16

114
115 FMA LECTURER NOTE
VARIANCE ANALYSIS
Budgeted activity level
Actual activity level Actual activity level
FIXED BUDGETING ACTUAL RESULTS
FLEXIBLE BUDGETING

ADVERSE FAVOURABLE
VARIANCES

SALES DIRECT MATERIAL DIRECT LABOUR VARIABLE OVERHEAD FIXED OVERHEAD

PRICE VOLUME PRICE USAGE RATE EXPENDITURE EFFICIENCY EXPENDITUR VOLUME

EFFICIENCY

IDLE TIME
E
(AP – SP) X (SP – AP) X (SR – AR) X (SR – AR) X AHW BC - AC
AQSOLD AQBOUGHT AHPAID

Absorption (AQ – BQ) X (SQ – AQUSED) X (SH–AHWORKED) Actual idle (SH–AHW)X CAPACITY EFFICIENCY
costing Std PROFIT PU SP X SP time X SP SR
(AH-BH)X (SH-AH)X
OAR OAR
Marginal (AQ – BQ) X
costing Std CPU
Work more Work more
hour than efficiency or
budget or not than budget
or not

Only in absorption costing

INVESTIGATION

CORRECTIVE ACTIONS
115
EXAMPLE QUESTIONS
EXAMPLE 1: SALE VARIANCES
Wolf budgeted sales of 6,500 units but actually sold 6,000 units. Its standard cost card is as follows:
$
Direct material 25
Direct Wages 8
Variable overhead 4
Fixed overhead 18
Total standard cost 55
Standard gross profit 5
Standard selling price 60
The actual selling price 61
Requirement: Calculate the sales price and sales volume variances for the period (using absorption
costing). Suggest two possible causes for variances.
EXAMPLE 2: MATERIAL VARIANCES
James makes a single product with the following budgeted material cost per unit:
2Kg of material at $10/kg
Actual details:
Output 1,000 units
Material purchased and used 2,200 kg
Material cost $20,900
Requirement: Calculate the total material variance, price and usage variances and suggest two
possible caused for each variances
EXAMPLE 3: LABOR VARIANCES
Rosemary Ltd makes a single and has the following budgeted information:
Budgeted production 1,000 units
Budgeted labor hours 3,000 hours
Budgeted labor costs $15,000
Actual results:
Output 1,100 units
Hours paid for 3,400 hours
Labor cost $17,680
Requirement: Determine labor total, price and efficiency variances

116
EXAMPLE 4: VARIABLE OVERHEAD VARIANCE
Suppose that the variable production overhead cost of product X is as follows:
2 hours at $1.5 = $ 3 per unit
During period 6, 400 units of product X were made. The labor force worked 820 hrs of which 60 hrs
was recorded as idle time. The variable overhead was $ 1,230
Requirement: Calculate the following variances
a. The variable OH total variance
b. The variable OH expenditure variance
c. The variable OH efficiency variance
Notes: this example relates to variable production costs, the total variance is based on actual units of
production, it the OH had been a variable selling cost, the variance would be based on sales volumes
EXAMPLE 5: FIXED OVERHEAD VARIANCE
The following information is available for a company for period 4
Budget
Fixed production overheads $22,960
Unit 6,560
Standard time is 2hrs labor/unit
Actual
Fixed production overheads $24,200
Labor hours 12,600
Units 6,460
Requirement: Fixed overhead expenditure variance, Fixed overhead volume variance, Fixed
overhead efficiency variance, Fixed Overhead capacity variance

117
EXAMPLE 6: VARIANCES AND OPERATING STATEMENT
Sydney Ltd manufactures one product, and the entire product is sold as soon as it is produced. There
is no opening or closing stocks and work in progress is negligible. The company operates a standard
costing system and analysis of variances is made every month. The standard cost card for the
product, a boomerang, is as follows.
Standard cost card-boomerang

Direct materials 0.5 kilos at £4 per kilo 2.00

Direct wages 2 hours at £2.00 per hour 4.00

Variable overheads 2 hours at £0.30 per hour 0.60

Fixed overhead 2 hours at £3.70 per hour 7.40

Standard cost 14.00

Standard profit 6.00

Standing selling price 20.00

Selling and administration expenses are not included in the standard cost, and are deducted from
profit as a period charge.
Budgeted output for the month of June year 7 was 5,100 units. Actual result for June year 7 was as
follows.
Production of 4,850 units was sold for £95,600.
Materials consumed in production amounted to 2,300 kgs at a total cost of £9,800.
Labour hours paid for amounted to 8,500 hours at a cost of £16,800.
Actual operating hours amounted to 8,000 hours.
Variable overheads amounted to £2,600.
Fixed overheads amounted to £42,300.
Selling and administration expenses amounted to £18,000.
Required: Calculate all variances for the month ended 30 June year 7

118
PRACTISE QUESTIONS

PART 1: SALE VARIANCE

QUESTION 1

QUESTION 2

QUESTION 3

119
QUESTION 4

120
PART 2: MATERIAL VARIANCE

QUESTION 5

FOLLOWING QUESTION RELATED TO QUESTION 6 AND 7

QUESTION 6

QUESTION 7

121
PART 3: LABOR VARIANCE

FOLLOWING QUESTIONS RELATED TO QUESTION 8 AND 9

QUESTION 8

QUESTION 9

QUESTION 10

QUESTION 11

QUESTION 12

122
FOLLOWING QUESTIONS RELATED TO QUESTION 13 AND 14

QUESTION 13

QUESTION 14

QUESTION 15

123
PART 4: VARIABLE PRODUCTION OVERHEAD

QUESTION 16

124
PART 5 FIXED OVERHEAD PRODUCTION

QUESTION 18

QUESTION 19

QUESTION 20

125
QUESTION 21

126
PART 6: OTHER EXERCIES OF VARIANCES

FOLLOWING QUESTIONS RELATED TO QUESTION 22 AND 25

QUESTION 22

QUESTION 23

QUESTION 24

QUESTION 25

127
QUESTION 26

QUESTION 27

FOLLOWING QUESTION RELATED TO QUESTION 28 AND 29

QUESTION 28

QUESTION 29

128
QUESTION 30

QUESTION 31

QUESTION 32

129
 CAPTIAL INVESTMENT APPRAISAL

INTEREST CAPTIAL INVESTMENT METHODS

SIMPLE NORMINAL PRESENT

ANNUITY PAYBACK DISCOUNT NET PRESENT INTERNAL RATE
INTEREST INTEREST VALUE
METHOD PAYBACK VALUE OF RETURN
(IRR)
COMPOUND EFFECTIVE 1/(1+i%) + Discount
INTEREST INTEREST 1/(1+i%)2 future value
Time for cash Take account Discount cash IRR =
+…. + to present
(1+r)(1+i)=(1 inflow equal time value of flow to present a% +
1/(1+i%)N value
+R) cash outflow money in value A/(A-B)x(b%-a%)
r is the real A/(1+i)n determine
interest rate, PERPETURY
cash inflow
i is the
inflation rate, 1/(1+i%) +
and 1/(1+i%)2
R is the +…. ….. RELEVANT CASH FLOW
nominal = 1/i%
interest rate FUTURE CASH FLOW INCREMENTAL OPPORTUNITY
COST COST COST

Sunk cost Non-cash Change as Benefit forgone

cost direct as result as
consequence choosing
of the course of
decision action

130
 CAPTIAL INVESTMENT APPRASIAL
EXAMPLE QUESTION
Question 1
A company is considering an investment in new equipment. The company has a cost of capital of
12% per annum.
Of the investment project, using the following information as appropriate:

Required:
Calculate:
(i) The net present value (NPV);
(ii) The internal rate of return (IRR);
(iii) The discounted payback period,

131
Question 2
A company is considering investment in several projects. The following information relates to three
of the projects:
Project 1: Investment of £119,000 at the start of the project.
Net cash inflow of £13,500 per annum in perpetuity.
NPV = -119,000 + 13,500/14% = (22,571)
Project 2: Investment of £241,000 at the start of the project.
Net cash inflows of:
1st year £60,000
2nd year £65,000
3rd year £70,000
4th year £100,000
5th year £85,000
NPV = 12,249
Project 3: Investment of £186,000 at the start of the project.
Constant annual net cash inflows for five years.
Internal rate of return (IRR) of 14%.
NPV 14% = A * 3.433 – 186,000 = 0
A = 54,180
Assume that net cash inflows occur at the end of each year.
Discount factors at 10% per annum (the company’s cost of capital) and at 14% per annum are:

Required:
(a) Calculate the net present value (NPV) of Project 1 at the company’s cost of capital.
(b) Calculate the estimated internal rate of return (IRR) of Project 2.
(c) Calculate the annual net cash inflow of Project 3.
(d) If the cost of capital increased to 15%, state, with reasons, whether investment in Projects 2
and 3 would be justified.

132
Question 3
A company is considering whether to add a new product to its range. Machinery costing $280,000
would have to be bought at the start of the project (Year 0). The project life would be five years with
no disposal value at the end of the project.
Sales of the new product are forecast at 12,000 units in each of Years 1 and 2, rising to 15,000 units
in each of Years 3, 4 and 5. The selling price per unit will be $15 in Year 1 and $16 thereafter.
Variable costs are estimated at $9 per unit.
Straight-line depreciation of the machine would be $56,000 in each year. No other future
incremental fixed costs would be incurred. However, the company has already incurred expenditure
of $6,000 for a market research survey and has decided to write this off against profits made in the
first year if the investment takes place.
Assume that all cash flows, apart from the investment in machinery, occur at the end of each year.
The cost of capital is 14% per annum. Discount factors at 14% are:

Required:
(a) Calculate the net cash flows for each year of the project (Year 0 to 5).
(b) Calculate the net present value of the project (working in $000).
(c) State whether the internal rate of return is above or below 14% and justify your conclusion.

133
PRACTISE QUESTIONS
QUESTION 1

QUESTION 2

QUESTION 3

QUESTION 4

QUESTION 5

134
QUESTION 6

QUESTION 8

QUESTION 9

QUESTION 10

135
QUESTION 11

QUESTION 12

QUESTION 13

136
QUESTION 14 D

QUESTION 15

QUESTION 16

QUESTION 17

QUESTION 18

137
QUESTION 19

QUESTION 20

QUESTION 21

QUESTION 22

QUESTION 23

138
QUESTION 24

QUESTION 25

QUESTION 26

QUESTION 27

QUESTION 28

139
QUESTION 29

QUESTION 30 C

QUESTION 32

140
 Purpose
Strategy
Strategic scope ECONOMY
Policies and standards Operating at mini
of behavior cost (input)
Value and culture Specific measurable

EFFICIENCY
MISSION STRATEGIC CRITICAL KEY Desired result at

STATEMENT OBJECTIVES SUCCESS PERFORMANCE PERFORMANCE MEASUREMENT mini cost (input and
output)
FACTORS INDICATORS
EFFECTIVENESS
Achieve objectives
(output)

FINANCIAL NON-FINANCIAL

BALANCE SCORECARD
EFFICIENCY LIQUIDITY PROFITABILITY

EFFICIENCY OR CAPACITY RATIO CURRENT RATIO = RETURN ON CUSTOMER PROCESS EFFICIENCY GROWTH
PRODUCTIVITY CA/CL INVESTMENT (ROI) = SATISFACTION What processes must we excel Can we continue to
RATIO profit/capital employed What do customers improve and create
at to achieve our financial and
Expected hour to Actual hour taken QUICK RATIO/ ACID value from us ? customer objectives? future value?
make output TEST RATIO = CA-
Hour budgeted INVENTORY/CL ASSET TURNOVER =
Actual hour taken turnover/capital
employed Great service Timely food delivery Trained staff
Efficiency staff GOALS
PRODUCTION VOLUME RATIO
Innovative food Low food wastage New menu choices
RESIDUAL INCOME =
controllable profit –
Expected hour to make output
imputed interest
Budgeted hour charged on controllable Excellent results on Time from order to Employees with
customer survey delivery relevant training KPIs
investment
New menu on regular Time of processing of qualifications
basic food order Number of new dishes
introduced

141
142