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ACCA

F5 – Performance Management
June 2009
Exercise Pack

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Contents Question Answer
Exercise 1 5 36
Exercise 2 6 37
Exercise 3 7 39
Exercise 4 8 42
Exercise 5 9 43
Exercise 6 10 45
Exercise 7 11 46
Exercise 8 12 48
Exercise 9 13 50
Exercise 10 14 51
Exercise 11 15 52
Exercise 12 16 53
Exercise 13 17 55
Exercise 14 18 56
Exercise 15 19 58
Exercise 16 20 60
Exercise 17 22 62
Exercise 18 23 65
Exercise 19 24 68
Exercise 20 25 70
Exercise 21 26 72
Exercise 22 27 79
Exercise 23 28 81
Exercise 24 29 82
Exercise 25 31 86
Exercise 26 32 87
Exercise 27 33 89

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4 © 7city Learning
Exercise 1

Budgeted overheads are $200,000 per month, and direct labour hours for each month
have been estimated at 50,000 hours. Overheads are absorbed on the basis of
direct labour hours.

Required:

Calculate the over- or under-absorption of overheads for the first three months of
the year:

i) January
Actual overheads were $190,000. 50,000 hours were worked.

ii) February
Actual overheads were $200,000. 48,000 hours were worked.

iii) March
Actual overheads were $190,000. 48,000 hours were worked.

5 © 7city Learning
Exercise 2

A Company manufactures a single product. The budgeted cost


for the product is as follows:

Selling price per unit $260


Variable production cost per unit $135
Fixed production cost per unit $40

Variable selling and distribution cost $300,000


Fixed selling and distribution cost $180,000
Budgeted sales volume 16,000 units
Budgeted production volume 17,500 units
Opening inventory of finished goods 750 units

Required:

What is the budgeted profit


under:

i) marginal costing?
ii) absorption costing?
Reconcile the two profit figures you have calculated

6 © 7city Learning
Exercise 3

Anichebe Co makes three products, X, Y and Z. Currently overheads are absorbed on the
basis of direct labour hours, though Anichebe is considering implementing an ABC system
for the year. Anichebe uses a cost-plus pricing system for its products.

Budgeted total overhead costs for the year are:


$
Material receipt 47240
Power 23600
Material handling 25280
Supervision 11880
108000

The following data has been budgeted for the year:

X Y Z
Production quantity (units) 2800 2000 400
Batches of material 14 10 16

Per unit:
Direct material (kg) 5 8 4
Direct material ($) 5 4 8
Direct labour (hrs) 3 1 1
Direct labour ($) 27 9 9
Power drill operations 6 3 2

Anichebe has carried out an ABC investigation into its production process,
and this has revealed the following cost drivers:

Material receipt: number of batches of material


Power: number of power drill operations
Material handling: kg of material handled
Supervision: direct labour hours
Required:

a) Produce a summary showing the budgeted cost per unit for each of products X, Y and Z,
i) using the existing method for the absorption of product
costs (4 marks)
ii) using an ABC method. (10 marks)
b) Compare the figures you have calculated, and comment on their implications.
(6 marks)

7 © 7city Learning
Exercise 4

Castillo makes air conditioning units in three consecutive processes, process X,


process Y and process Z.
Market demand for air conditioning units is 20 units per day. Current daily capacities
for X, Y and Z are as follows:

Process X Y Z
Capacity per day 22 16 10

The long-run benefit to Castillo for each extra air conditioning unit sold would be $10,000.

Castillo's production manager has been investigating ways to elevate the capacity of
each of X, Y and Z.
Various projects have been identified:

i) The staff on production process Y could take an intensive training course. This will cost
$20,000 but will increase capacity of process Y to 21 units per day.

ii) An additional machine could be purchased for production process Z. This would cost
$32,000 but will increase capacity of process Z to 23 units per day.

Required:

Identify which, if any, of the projects should be carried out, and evaluate the increase in
relevant benefit that would result.

8 © 7city Learning
Exercise 5

The following budgeted data relates to three products made by Cahill Ltd:

Per unit of product


P Q R

Selling price $16 $22 $17

Direct material cost $4 $13 $9

Maximum demand (units) 12,000 35,000 16,000

Hours required on the bottleneck machine 5 3 10

Total factory costs have been budgeted at $240,000 for the period, and Cahill Ltd
has 160,000 budgeted hours available on the bottleneck machine.

Required

i) Calculate the TA ratio for each product


ii) Determine the optimum product mix and resulting profit for the period

9 © 7city Learning
Exercise 6

Kissock manufactures small items of bathroom furniture. All three products


made by Kissock use the same grade of labour and of direct materials.
Kissock has absorbed fixed costs on the basis of maximum demand.

The following details relate to Kissock:


Product
J K L
$ per $ per $ per
unit unit unit
Selling price 60 85 100

Direct materials ($5 per kg) 15 20 30


Direct labour ($10 per hr) 10 15 12
Variable overhead 5 8 10
Fixed overhead 10 16 20
Total cost 40 59 72
Profit per unit 20 26 28

Maximum demand in August 500 1500 300

Calculate the profit made by Kissock for the month of August,


assuming that only 2000 hours of labour can be worked.

10 © 7city Learning
Exercise 7

Harvey produces a single product, the standard cost card of one unit of one unit
of which is given below:

$ per $ per
unit unit

Direct material 18
Direct labour 22
Production overheads:
variable 12
fixed 10
22
Total production cost 62

Non-production overheads:
variable 4
fixed 2
6
68

Calculate (to the nearest whole cent) the selling price under
each of the following sets of circumstances:

i) using a 30% mark-up on production cost


ii) using a 30% margin on production cost
iii) using a 30% mark-up on total cost
iv) using a 30% margin on total cost
v) using a 30% mark-up on marginal cost
vi) using a 30% margin on marginal cost

11 © 7city Learning
Exercise 8

Parkinson manufactures a single product, the Joe. Budgeted production of Joe is


45000 units for the year. The variable cost of a Joe is $7 per unit, and annual fixed
costs are budgeted at $135000.

The owner of Parkinson, an economist by trade, has suggested that a profit margin
of 20% on full cost should be set for each Joe sold.
There is no opening inventory. The marketing director of Parkinson has challenged this
Suggestion and has estimated the following levels of sales demand for the Joe:

Price per Joe ($) Units demanded


11 40000
12 38000
13 35000
14 31000
Required 15 25000

Assuming the budgeted number of Joes are produced, regardless of sales volume:
i) Calculate, and comment upon, the profit for the year if a full-cost price is
charged,
using both absorption and marginal costing principles.
ii) Calculate the long-run profit-maximising price.

12 © 7city Learning
Exercise 9

Baines plc is considering a special contract. The contract requires 300kg


of material X, 700kg of which is currently in stock.
The price paid for X when it was purchased last month was $5 per kg,
but the current purchase price has rocketed to $8 per kg due to market
shortages caused by recent flooding.
Baines could resell material X for $3 per kg.

There is no other use for material X except as a 1 for 1 substitute for


material H, which is in constant use by Baines. The existing inventory of
H was originally purchased by Baines for $2 per kg, and can be resold
by Baines for $1.50 per kg. The current replacement cost of H is $4 per kg.

What is the relevant cost of material for the special contract?

13 © 7city Learning
Exercise 10

Baines's skilled workers are currently working their full contracted hours, and
a dispute between Baines and the trade union has resulted in an overtime ban
being enforced around the factory.

During this industrial unrest, the production manager of Baines will not consider hiring
more skilled workers under any circumstances.

If the contract is accepted, skilled workers will need to be transferred from Baines's
existing production of their other product, the Q. No such problems exist for
Baines's non-unionised unskilled workers - enough idle time exists to allow them
to carry out the contract within their contracted hours. 50 hours of each grade of
labour would be required by the contract.

The standard cost card of product Q is as follows:


$ per
unit
Selling price 150
Direct
materials 20
Direct labour
Skilled workers 2 hours x $12 per hour 24
Unskilled workers 2 hours x $7 per hour 14
Variable indirect cost 12
Fixed indirect cost 20
Standard profit 60

What is the relevant labour cost for the contract?

14 © 7city Learning
Exercise 11

Cahill Group manufactures cuddly toys for children, namely Roos, Galahs and
Dingos, all in the same factory. The managing director of Cahill might delist
the Dingos product line due to non-profitability. Here is the budget for
the forthcoming year:

Roos Galahs Dingos Total


$000 $000 $000 $000
Sales revenue 430 480 310 1220
Manufacturing costs:
Materials 80 128 70 278
Labour 92 120 110 322
Variable production overhead 55 70 50 175
Fixed production overhead 30 30 30 90
Non-manufacturing costs:
Marketing 48 22 15 85
Selling and distribution 32 15 10 57
Head office recharge 55 65 30 150
Profit 38 30 -5 63

Further information:
i) Material costs and variable production overhead costs are wholly variable.
ii) 5% of labour cost represents the fixed cost of the factory supervisors and line
leaders.
iii) Only two-thirds of the fixed production overhead is directly attributable to individual
products; the remainder is an allocation of general fixed production overheads.
iv) Marketing costs include $4,000 per product used for general advertising, and $6,000
used for specific product advertising. The remainder is marketing staff costs.
v) Selling and distribution costs include a 1% commission on sales revenue for sales staff.
The remainder is for Cahill's lorry used to distribute all three products to customers.

Required:
Assess the managing director's suggestion from a financial point of view.

15 © 7city Learning
Exercise 12

MoyesCorp are a multinational company operating in northern Europe.


Given below are details referring to four joint products of a chemical process:

Product
H J K L
per litre per litre per litre per litre
Selling price ($) 7.40 13.10 10.20 12.00

Output 5,000 7,500 15,000 14,000

MoyesCorp budgets waste of all processing within the group at 5% of input.


Each product can be modified by further processing after the split-off point,
to produce products H-star, J-star, K-star and L-star, respectively, at a cost
of $3 per hour of machine time. Machine processing time and selling price
per litre are expected to be:
Product
H-star J-star K-star Lstar
per litre per litre per litre per litre
Selling price ($) 16.20 17.00 19.40 17.10
Machine processing time (hrs) 0.75 1.0 2.5 1.5

Required:
Show which, if any, of MoyesCorp's joint chemical products should
undergo further processing.

16 © 7city Learning
Exercise 13

Ferguson Inc launches the theme park stall and begins selling its snacks at a price
of $3.50 per unit. The finance director asks you to prepare a report analysing the
results of the stall over the 100-day long 2008 summer season.

It is now October 2008. You are carrying out the analysis of the actual snack
sales for the summer. Actual sales volumes (to the nearest 50 snacks) were:

Number of
Daily demand days
(snacks sold per day)
50 14
100 35
150 38
200 11
250 2
Assumptions for 2009:
i) Variable and total fixed costs will remain constant at $1.50 per unit and
$15,000
ii) An inflationary increase of price to $3.70 per unit will not alter the expected
number of units sold for next summer.
iii) Profit will be earned at an even rate throughout the summer.

Required

Calculate the following for your report:


i) a probability distribution, and the expected volume of snack sales
ii) the expected profit for next summer
iii) on how many days next summer, the stall will break even
iv) on how many days the profit earned by the stall will be at least $240 that day

17 © 7city Learning
Exercise 14

Rodwell PLC is replacing a factory machine. It has the choice of two machines.

For the purpose of this exercise, there are two possible demand levels, low and high.
The estimated annual profit for each demand level is as follows:

Demand level
Low High
Machine $ $

X 120,000 150,000

Y 20,000 200,000

Using each of the following decision-making criteria, which machine should Rodwell
choose to purchase?

i) Maximin
ii) Maximax
iii) Minimax regret

18 © 7city Learning
Exercise 15

Continuing with Rodwell…

The probability of demand being high has now been estimated as 0.7, and
that of demand being low as 0.3.

Using the information from the previous example, which machine would be
purchased by Rodwell, assuming the decision-maker is

i) risk seeking
ii) risk averse
iii) risk neutral?

19 © 7city Learning
Exercise 16
Alex Young Salads is a producer of own-brand bagged salads and coleslaw
products for several large UK supermarkets. They buy in salad goods from
farmers and convert these into products sold by supermarkets to consumers,
often for barbecues.
The management of Alex Young has asked you, the management accountant
at Alex Young, for help in analysing the relationship between the
average weekly midday temperature and the sales of salad products
to supermarket chains.

You have been provided with the following data from weeks 26 to 31 last year:

Average Weekly Weekly Sales


Temp (°C) Revenue ($000)
18 250
24 308
26 334
21 292
16 228
20 267

In addition, the meterological office has just issued a long-range forecast of


19°C for next week (week 31), and 21°C for the following week (week 32).

Required:

a) Using the high-low method, predict sales for:


i) week 31
ii) week 32

Continuing with the figures from the Alex Young Salads example…

b) Using regression analysis, establish the formula of the line representing the relationship
between average temperature and weekly sales revenue. Explain what the line is telling
the management of Alex Young Salads.

c) Using the formula derived in part b), predict sales for:


i) week 31
ii) week 32

20 © 7city Learning
d) Explain the uses the information you have derived in parts a) to c) might be put to by
the management of Alex Young Salads.

e) Explain any issues you would bring to the attention of the management of Alex Young
Salads

21 © 7city Learning
Exercise 17

Temple is creating its monthly sales budgets for next year for two products, the Tem
and the Pul.

Deseasonalised sales in units (y) of each product have been found to be reliably estimated
using the following equations:

Tem y = 10x + 420 Q1 20X5, x = 1


Q2 20X5, x = 2
Pul y = 8x +350 Q1 20X6, x = 5
etc.
where x represents the quarter number in question.

Quarterly seasonal variations for the two products are as follows:

Quarter Q1 Q2 Q3 Q4

Tem 10% 25% -20% -15%


Pul -30 25 55 -50

Required

Prepare forecast sales units estimates for both products for 20X7.

22 © 7city Learning
Exercise 18

Vaughanee Ltd has commissioned some production efficiency research into three
proposed new products, the Cookee, the Kaypee, and the Montee.
The results of this research will be used to calculate standard labour costs per unit.

The first unit of the Cookee is expected to take 100 hours to produce.
A 70% learning curve is expected to apply to the Cookee.

40 units of the Kaypee have been produced, at an average time of 5 hours


per unit. An 80% learning curve applies to this product.

The first unit of the Montee was found to take 200 hours to produce.
The average time per unit for the first 80 Montees was 32 hours.

Required

a) For the Cookee,

i) calculate the average time per unit for the first 16 units
ii) calculate the average time per unit for the first 17 units
iii) calculate the time taken to make the 17th unit

b) For the Kaypee,

i) find the average time per unit if 200 units are produced
ii) find the average time per unit for the next 50 units

c) For the Montee, calculate the learning curve rate.

23 © 7city Learning
Exercise 19

Cunningham manufactures items of prefabricated steel and concrete to order for customers
engaged in the construction and steel erecting industry.
There are a number of different departments within Cunningham, and budgeted and actual
information for the steel girder fabrication department is given below:

Budget Actual Variance

Machine hours 17,000 20,340 3,340 A


Number of girders produced 10,000 12,500
$ $ $

Rivets 1,700 2,065 365 A

Steel 76,500 89,850 13,350 A

Other direct materials 850 1,150 300 A

Direct labour 47,000 54,450 7,450 A

Production overheads 33,950 44,000 10,050 A

Total 160,000 191,515 31,515 A

The variable element of all steel girder fabrication costs vary proportionally with
machine hours.
All costs are variable except direct labour, which includes $8750 fixed supervisor salaries,
and also production overheads, fixed up to 18,000 hours, but then have a stepped
fixed element of $8000.

The manager of the steel girder fabrication department has received a rather terse
email from the factory manager of Cunningham plc, requiring her to explain the
'serious overspending' of $31515 within her department.
She has asked you to help with preparing her response.

Required
Prepare a revised budgetary control statement. Advise the manager of the steel
girder fabrication department of possible points she might like to make in response
to the factory manager.

24 © 7city Learning
Exercise 20

Chedgzoy Ltd makes a single product, the standard cost details of which
are given below:
$
Direct materials 5 kg @ $4 /kg 20
Direct labour 4 hours @ $6 /hour 24

Actual results are that 1000 units were produced and sold. The actual hours paid for during
The period were 4100, and the hours worked were 3900. Actual labour costs came to $27060.

Material purchased during the month was 5200kg at a cost of $21320. However, only 4900kg
of this material was used.
Chedgzoy calculates material price variances at the time of purchase.

i) Calculate appropriate variances for materials and for labour.

The product manufactured by Chedgzoy has recently been updated. The production manager
has recently been to a CPD seminar at which the 'learning curve effect' was discussed.
She is concerned as to whether this might be relevant to Chedgzoy's product and labour
variances.

ii) Explain what is meant by the 'learning curve effect'. Explain the effect this might have on
Chedgzoy's labour variances.

25 © 7city Learning
Exercise 21

Harvey Ltd manufactures a variety of products, including Product Colin. Harvey uses an
absorption costing system.
The standard cost card for a Colin (set during the previous year) is given below:
$ $
Selling price 130
Direct material X 6 kg x $4.50 per kg 27
Direct material Y 2 kg x $5.50 per kg 11
Assembly labour 6 hrs x $7.50 per hour 45
Variable overheads 6 hrs x $2.50 per hour 15
Fixed overheads 6 hrs x $0.50 per hour 3
101
Profit per unit 29
Additional information:

Purchases during November were 18700kg of material X at $4.30 per kg, and 6350kg of
material Y at $5.30 per kg.
3100 Colins were sold during November, at an average selling price of $127 per unit.
There was no change in inventory of either raw material, or of finished goods,
during the month. It is not possible to substitute any of material X with any of material Y.

12500 assembly hours were worked and paid at a rate of $7.75 per hour, and 6000 hours
were worked at $8 per hour.
However, 6200 hours were paid at $8 per hour due to a last-minute packaging
change.

Harvey budgets to produce 2800 units every month. To build up stocks of Colin for
Christmas, this is 250 units higher than budgeted sales.
Budgeted fixed overheads for the month were $8400.
Actual variable and fixed overheads were $43000 and $10500 respectively.

Required

Calculate appropriate Product Colin variances for November and present an operating
statement reconciling budgeted with actual profit.

26 © 7city Learning
Exercise 22

Bullens plc makes a single product, of which the standard


material input for 1 unit is:
$
Material A 6 kg at $18 per kg 108
Material B 4 kg at $14 per kg 56
10 kg 164
During period 4:

100 units were produced


530 kg of material A were used
530 kg of material B were used

Required

Calculate the material mix and yield variance for Bullens plc

27 © 7city Learning
Exercise 23

Gladwys plc makes a single product, of which the standard material input
for 2500 units is:

$
kg at
Material P 1600 $ 3.20 per kg 5120
kg at
Material Q 600 $ 0.50 per kg 300
kg at
Material R 800 $ 3.60 per kg 2880
3000 kg 8300

During period 7:

21000 units were produced


16000 kg of material P were used
5500 kg of material Q were used
5500 kg of material R were used

Required

Calculate the material mix and yield variance for Gladwys plc

28 © 7city Learning
Exercise 24

The summarised income statements and balance sheets for the past two years for
Carsley plc are as follows:
20X8 20X7
Summarised income statements: $000 $000 $000 $000
Turnover:
Cash sales 135 131
Credit sales 3776 3684
3911 3815
Cost of sales:
Opening inventory 407 331
Cash purchases 439 298
Credit purchases 2207 2029
Closing inventory 562 457
2491 2201
Gross profit 1420 1614
Expenses 777 856
Profit before interest and tax 643 758
Interest 164 132
Profit before
tax 479 626
Tax 134 175
Profit after tax 345 451

29 © 7city Learning
Summarised balance sheets: 20X8 20X7
$000 $000 $000 $000 $000 $000
Non-current assets (NBV) 3106 2664
Current assets:
Inventories 562 457
Receivables Trade receivables 479 366
Other 207 306
686 672
Cash 202 195
1450 1324
Total assets 4556 3988

Equity:
Share capital 1578 1578
Retained
profits 777 767
2355 2345
Payables: amounts falling due after more than 1 yr
Long-term loans 1338 842

Payables: amounts falling due within 1 yr


Loans, overdrafts, tax and dividend 603 618
Payables: Trade payables 256 158
Other 4 25
260 183
Current liabilities 863 801
Total equity and liabilities 4556 3988

Required
Calculate the following ratios for both years:

i) ROCE
ii) Gross profit margin
iii) Net profit margin (based on PBIT)
iv) Asset turnover
v) Financial gearing
vi) Current ratio
vii) Quick ratio (acid test)
viii) Accounts receivable days
ix) Accounts payable days
x) Inventory days

30 © 7city Learning
Exercise 25

McFadden Group is made up of two divisions, X and Y. Currently divisional


performance has been appraised using ROI.

Details of the two divisions are as follows:


Division Division
X Y
Profit $120,000 $16,000
Capital employed $375,000 $145,000

The two divisions are considering whether to invest in two different projects.
Division X can invest in project X1. This will cost $125,000, and yield a profit
of $21,000.
Division Y can invest in project Y1. This will also cost $125,000, but yield a profit
of only $14,500.
McFadden has a cost of capital of 12%.

31 © 7city Learning
Exercise 26

Stubbs Group has two divisions, Division Cue and Division Tee. The divisional managers of
Stubbs have their performance appraised based on the internal profit each division makes.
Annual performance related bonuses are sufficiently high to motivate divisional managers.

Cue manufactures two products, Pee and Gee. Pee is sold on the open market for $80 per
unit.
No external market exists for Gee. Each unit of Pee and Gee uses the same production
resources as each other.

Tee supplies an external market and can obtain its components (product Gee) from
either Cue, or from an external supplier, that supplies Gee to Tee for $43 per unit.

Production costs for products Pee and Gee are as follows:


Pee Gee
$ $

Variable cost per unit 64 33


Fixed overhead per
unit 6 6
Total unit
costs 70 39

Required

a) State the minimum and maximum possible transfer


prices
for product Gee that would enable an internal transfer to take place.

b) Give advice as to a suitable transfer price for Gee:


i) when Cue has spare capacity and limited demand for Pee
ii) when Cue has no spare capacity and unlimited demand for Pee

32 © 7city Learning
Exercise 27

Trebilcock company makes and sells a single product, the standard cost card is as follows:
$
Direct materials 1.5kg x $3 / kg 4.50
Direct labour 0.5hrs x $7.50 / hour 3.75
Standard prime cost per unit 8.25
Other costs 4.75
Standard cost per unit 13.00
Selling price 25.00
Standard profit per unit 12.00
Budgeted sales for November 20X8 were 7500 units, and budgeted production was 7250
units.

Actual performance details for November 20X8 are as follows:

i) Trebilcock sold 7300 units. This was a particularly impressive performance, given that a
recession
had caused the entire market to shrink by 5%. This was done by setting an average selling
price of $24.00 per unit. The open market selling price for Trebilcock's product was
$23.50 per unit.
ii) Production for the month was 7000 units. Total usage of materials came to 11000kg, and
total labour hours worked amounted to 3700 hours.

iii) The open market price of direct material during the month was $3.50, and total material
cost came to $36000.
A total quality management programme at Trebilcock's major material supplier has
dramatically improved the quality of raw material entering Trebilcock's production process.

As a result, the standard raw material usage per unit should reduce to 1.4kg per unit.
iv) The total labour cost for the month came to $29000, which was not
surprising given that the actual labour rate per hour for November X8 was $7.75 per hour.

The budget was set using standards devised during May 20X8. You
are concerned at the effect that the changes highlighted above might have
on the evaluation of the performance of Trebilcock's managers, and so have
decided to calculate planning and operational variances as a result.

33 © 7city Learning
Required

Calculate:
i) traditional material price and usage variances
ii) material planning price and material planning usage variances, and
material operational price and operational usage variances
iii) traditional labour rate and efficiency variances
iv) labour planning cost variance, and labour operational rate and operational
efficiency variances
v) traditional sales price and volume variances
vi) sales planning price and sales planning volume variance,
and sales operational price and sales operational volume variances

34 © 7city Learning
Answers

35 © 7city Learning
Exercise 1

Budgeted overhead
Overhead absorption rate = Budgeted activity level

$200,000
= 50,000 hours

=$ 4 per hour.

i) January

To calculate under- or over-absorption:


$
Overhead absorbed 50000 x 4 200,000
Overhead incurred 190,000
Over-absorption 10,000

ii) February

To calculate under- or over-absorption:


$
Overhead absorbed 48000 x 4 192,000
Overhead incurred 200,000
Under-absorption -8,000

iii) March

To calculate under- or over-absorption:


$
Overhead absorbed 48000 x 4 192,000
Overhead incurred 190,000
Over-absorption 2,000

36 © 7city Learning
Exercise 2

i) Marginal costing
$ $

Sales $260 x 16,000 4,160,000


Variable cost of sales:

Op inventory $135 x 750 101,250

Variable prod'n cost $135 x 17,500 2,362,500

Closing inventory (W1) $135 x 2,250 303,750


2,160,000
2,000,000
Variable selling and distribution cost 300,000
Contribution 1,700,000
Fixed costs:

Production cost $40 x 17,500 700,000

Non-production cost 180,000


880,000
Marginal costing profit 820,000

W1 - Closing inventory
calculation
units

Opening inventory 750

Units produced 17,500

less units sold 16,000

Closing inventory 2,250

37 © 7city Learning
ii) Absorption costing
$ $

Sales $260 x 16,000 4,160,000


Full cost of sales:

Op inventory $175 x 750 131,250

Full prod'n cost $175 x 17,500 3,062,500

Closing inventory (W1) $175 x 2,250 393,750


2,800,000
Gross profit 1,360,000
Non-production cost:

Variable selling and distribution cost 300,000


Fixed selling and distribution
cost 180,000
480,000
Absorption costing profit 880,000

Reconciliation:
$
Marginal costing profit 820,000
Change in inventory x fixed OAR per
unit 1,500 x $40 60,000
Absorption costing profit 880,000

38 © 7city Learning
Exercise 3

Using existing absorption costing method:

1. Calculate OAR:

OAR = 108000 108000


(3 x 2800) + (1 x 2000) + (1 x
400) = 10800

= $10 per direct labour hour

2. Calculate budgeted cost per unit:

Budgeted Unit Cost: X Y Z


$ $ $
Direct Material 5.00 4.00 8.00
Direct Labour 27.00 9.00 9.00
Production Overheads 30.00 10.00 10.00
Total 62.00 23.00 27.00

Using ABC:

1. Calculate cost driver rates:

Material receipt: 47240


(14 + 10 + 16)

= $1181 per batch

Power: 23600
(6 x 2800) + (3 x 2000) + (2 x
400)

= $1 per power drill operation

Material handling: 25280


(5 x 2800) + (8 x 2000) + (4 x
400)

39 © 7city Learning
$0.8 per kg of material handled

Supervision: 11880
(3 x 2800) + (1 x 2000) + (1 x
400)

$1.1 per direct labour hour

2. Calculate overhead cost per unit based on activity:

Rate X Y Z
$ act's $ act's $ act's $
Material receipt (W1): 1181.00 0.005 5.905 0.005 5.905 0.04 47.24
Power: 1.00 6 6 3 3 2 2
Material handling: 0.80 5 4 8 6.4 4 3.2
Supervision: 1.10 3 3.3 1 1.1 1 1.1
19.205 16.405 53.54

W1: Material receipt batches

X: 14 batches to create 2800 units is 0.005 batches per unit


Y: 10 batches to create 2000 units is 0.005 batches per unit
Z: 16 batches to create 400 units is 0.04 batches per unit

3. Calculate budgeted cost per unit:

Budgeted Unit Cost: X Y Z


$ $ $
Direct Material 5.00 4.00 8.00
Direct Labour 27.00 9.00 9.00
Production Overheads 19.21 16.41 53.54
Total 51.21 29.41 70.54

40 © 7city Learning
Comparison of cost per unit figures:

Budgeted Unit Cost: X Y Z


$ $ $
Under absorption costing 62.00 23.00 27.00
Under ABC 51.21 29.41 70.54
Difference 10.80 -6.41 -43.54

Comment:

Using traditional overhead absorption assumes all overheads vary with labour hours.
This has resulted in an inaccurate allocation of overheads, since only 11% of
total overheads truly vary in this way.

Using ABC has allocated overheads on the basis of the activity that has caused those
overheads. This has resulted in a far more accurate allocation of overheads to the
three products.

It can now be seen that product X has been allocated too much cost in the past, and
has been subsidising product Z and (to a lesser extent) product Y.

This will have resulted in:

- an overvaluation of inventory of product X, and


an
undervaluation of inventory of Y and Z

- an overpricing of product X, possibly reducing market demand


for this product

-an underpricing of products Y and Z, meaning that the margin


Enjoyed for these products is too low.
The selling prices for these products might not be covering their
production costs at present.

From a performance measurement point of view, there is a real risk that product Z might
be unfairly perceived as being much more profitable to produce and to sell than is
actually the case.

41 © 7city Learning
Exercise 4

Process capacity per


= bottleneck day
X Y

Current 22 16

Invest in ii) 22 16

Invest in i) + ii) 22 21

Financial implications of the proposed projects:

Invest in ii)

Additional sales = 6 units per day


$
Relevant benefit 6 units x $10,000 60,000
Relevant cost 32,000
Net benefit 28,000

Invest in i) + ii)

Additional sales = 10 units per day


$
Relevant benefit 10 units x $10,000 100,000
Relevant cost $20,000 + $32,000 52,000
Net benefit 48,000

Castillo will benefit by a total of $48,000 by investing in both projects.

42 © 7city Learning
Exercise 5

Begin by ranking the products:

$240,000
Cost per factory hour 160,000
= = hours = $1.50 per hour

Per unit of product


P Q R

Selling price $16 $22 $17

Direct material cost $4 $13 $9

Throughput contribution $12 $9 $8

Hours required on the 5 3 10


bottleneck machine

Return per factory hour $2.40 $3.00 $0.80

TA ratio 1.60 2.00 0.53

RANKING 2nd 1st 3rd

43 © 7city Learning
Now calculate the optimal production plan:

Product Units Hours Hours Return Throughput


per
unit per hour contribution

160,000

Q 35,000 3 105,000 $3.00 $315,000


55,000

P 11,000 5 55,000 $2.40 $132,000


- $447,000

Less total factory


costs $240,000

PROFIT $207,000

Cahill should manufacture 11,000 units of P, and 35,000 units of Q. This will yield
a profit of $207,000 for the period. No other production mix will produce a higher
profit than this.

44 © 7city Learning
Exercise 6
Product
J K L
$ per unit $ per unit $ per unit
Selling price 60 85 100
Marginal cost per unit 30 43 52
Contribution per unit 30 42 48
Labour hours per unit 1 1.5 1.2
Contribution per labour hour 30 28 40
Ranking 2 3 1

Hours Contribution
Product Units taken Balance ($)
2000
L 300 360 360 @ $40 /hr 14400
1640
J 500 500 500 @ $30 /hr 15000
1140
K 760 1140 1140 @ $28 /hr 31920
0
Total contribution 61320
Total budgeted fixed costs (W1) 35000
Total profit 26320

W1 - Fixed Costs
Budgeted units Fixed OAR / unit $

J 500 x 10 = 5000
K 1500 x 16 = 24000
L 300 x 20 = 6000
35000

45 © 7city Learning
Exercise 7

i) Using a 30% mark-up on production cost:


$
Production cost 62.00
30% mark-up 62 x 30% 18.60
Selling price 80.60

ii) Using a 30% margin on production cost:


$
Production cost 62.00
30% margin 26.57
Selling price 62 / (100%-30%) 88.57

iii) Using a 30% mark-up on total cost:


$
Total cost 68.00
30% mark-up 68 x 30% 20.40
Selling price 88.40

iv) Using a 30% margin on total cost:


$
Total cost 68.00
30% margin 29.14
Selling price 68 / (100%-30%) 97.14

v) Using a 30% mark-up on marginal cost:


$
Marginal cost 56.00
30% mark-up 56 x 30% 16.80
Selling price 72.80

46 © 7city Learning
vi) Using a 30% margin on marginal cost:
$
Production cost 56.00
30% margin 24.00
Selling price 56 / (100%-30%) 80.00

47 © 7city Learning
Exercise 8

Full cost per Joe: $ per unit

Variable cost 7.00


Fixed cost ($135000 / 45000 units) 3.00
10.00

Selling price per Joe: $10.00 per unit x 120% 12.00 $ per unit
Therefore demand would be 38000 units at this selling price.

Using absorption costing:


Profit: $ $
Sales $12 per unit x 38000 units 456000
Cost of sales:
Cost of producing 45000 units:
Variable 315000
Fixed 135000
450000
Less inventory increase:
(45000 - 38000) x 10.00 per unit 70000
380000
Profit 76000

Using marginal costing:


Profit: $
Contribution ($12.00 - $7.00) x 38000 units 190000
Fixed cost 135000
Profit 55000

Producing more units than sales is likely to be unsustainable in the long run.
Therefore, marginal costing is likely to better indicate the long-term profitability
of Joes.

ii) Profit-maximising price

This is the price that will give the greatest contribution:

48 © 7city Learning
Price Unit contribution Demand Total contribution
$ $ (units) $
11.00 4.00 40000 160000
12.00 5.00 38000 190000
13.00 6.00 35000 210000
14.00 7.00 31000 217000
15.00 8.00 25000 200000

The profit maximising price is $14.00 per unit.

49 © 7city Learning
Exercise 9

The model instructs us to use the higher of scrap value, or the opportunity cost
of the next best alternative use foregone.

Scrap value: 300kg x $3 per kg = $900

Opportunity cost: The alternative use for X is as a substitute for H. The relevant
cost of H is the current replacement cost of H, so by accepting the contract, this
involves sacrificing the opportunity to use 300kg of X as a substitute for 300kg of
H.

Opportunity cost: 300kg x $4 per kg = $1200

The higher of these two values is $1200, so this is the relevant material cost for
the special contract.

50 © 7city Learning
Exercise 10

To attempt this question, treat the two grades of labourer separately in the decision
model. The model tells
us:

$ per hour
Relevant cost of skilled labour:
Opportunity cost of contribution foregone from Q (W1) 40
Existing hourly rate for skilled workers 12
52
Relevant cost of unskilled labour 0
52

Total relevant labour cost is $52 per hour x 50 hours = $2,600

W1 - Opportunity cost of contribution foregone from Q

Product Q contribution per unit is $60 profit + $20 fixed indirect cost = $80 per unit

Skilled labour time required per unit of Q is 2 hours

Therefore, the contribution foregone from Q = $80 per unit = $40 per hour
2 hours per
unit

In other words, each hour diverted from making product Q means that $40
contribution is lost by Baines - this has to be built into the labour rate used to
assess the special contract.

51 © 7city Learning
Exercise 11

Show the relevant costs and revenues for the Dingos toy, and use this to
establish the net relevant benefit of selling the toy: Dingos
$000

Relevant revenue 310.0

Relevant cost:
Materials (i) Wholly incremental 70.0
Labour (ii) Remove 5% 104.5
Variable production overhead (i) Wholly incremental 50.0
Fixed production overhead (iii) 2/3 avoidable 20.0
Marketing (iv) Specific advertising 6.0
Selling and distribution (v) 1% avoidable 3.1
Head office recharge Not relevant 0.0

Net relevant benefit from Dingos 56.4

Therefore, new profit for Cahill Group:

$63,000 - $56,400 = $6,600

Cahill Group's profit will fall to $6600 if they discontinue the Dingo.
N.B. This can be proven as follows:
If we discontinue the Dingos toy, the following costs will need to be borne by
the other toys in Cahill's range:
$000

Factory supervisors and line leaders (ii) 5% x 110 5.5


General fixed production overheads (iii) 1/3 x 30 10.0
General advertising (iv) 4.0
Marketing staff cost (iv) 15 - 6 - 4 5.0
Selling and distribution cost (v) 10 - 3.1 6.9
Head office recharge 30.0

Unavoidable costs 61.4

Net relevant benefit from Dingo (above) 56.4


Less unavoidable costs 61.4
Current loss attributed to Dingo -5.0

52 © 7city Learning
Exercise 12
Product
H J K L

Litres to sell of current product 5,000 7,500 15,000 14,000


Litres to sell of processed
product 4,750 7,125 14,250 13,300

Extra revenue from processing:

Current revenue ($) 37,000 98,250 153,000 168,000

Processed revenue ($) 76,950 121,125 276,450 227,430

39,950 22,875 123,450 59,430


Extra relevant cost from processing:

H 0.75 x $3 x 5000 11,250

J 1 x $3 x 7500 22,500

K 2.5 x $3 x 15000 112,500

L 1.5 x $3 x 14000 63,000


-
Net benefit of further processing: 28,700 375 10,950 3,570

Is further processing worthwhile? Yes Yes Yes No

53 © 7city Learning
Exercise 13

i) Probability distribution for Ferguson

Daily demand Probability


(x) Days (p) px

50 14 0.14 7
100 35 0.35 35
150 38 0.38 57
200 11 0.11 22
250 2 0.02 5

100 1 126
E(x) = Σpx

Σpx = 126 units, from the probability distribution above.

This means that the expected number of snack sales per day is 126 units.

ii) There are two possible ways of approaching this task:

Either: Contribution per unit = $3.70 - $1.50 = $2.20

Total daily contribution earned = $2.20 x 126 = $277.20

Expected contribution for next summer = $277.20 x 100 = $27,720

Expected profit for next summer = $27,720 - $15,000 = $12,720

Or: Selling price per unit next year $3.70 per unit.

Expected daily revenue = 126 x $3.70 = $466.20

($3.70 -
C/S ratio of dessert = $1.50) = 59%
$3.70

Expected daily contribution = $466.20 x 59% = $277.20

54 © 7city Learning
Expected contribution for next summer = $277.20 x 100 = $27,720

Expected profit for next summer = $27,720 - $15,000 = $12,720

iii) Breakeven units = (daily fixed cost) = $150 = 68 units


cont'n per unit $2.20

Probability of selling at least 68 units = 1 - 0.14 = 0.86

Therefore, we expect to break even on 86 days next summer

($150
(daily fixed cost + +
iii) Required units = required profit) = $240) = 177 units
cont'n per unit ($3.70
-
$1.50)

Probability of selling at least 177 units = 0.11 + 0.02


= 0.13

Therefore, we expect to make at least $240 profit on 13 days next summer

55 © 7city Learning
Exercise 14

i) Maximin

Maximin criterion assumes that the worst possible outcome will always occur. The
decision-maker should therefore choose the highest payoff given this scenario.

The worst possible outcome is that demand might be low. Given low demand:

Machine Profit ($)

X 120,000

Y 20,000

If demand is low, X yields a higher profit and should therefore be chosen.

ii) Maximax

Maximax criterion assumes that the best possible outcome will always occur. The
decision-maker should therefore choose the highest payoff given this scenario.

The best possible outcome is that demand might be high. Given high demand:

Machine Profit ($)

X 150,000

Y 200,000

If demand is high, Y yields a higher profit and should therefore be chosen.

iii) Minimax regret

This criterion is based on the fact that if a decision-maker chooses an option


that turns out not to be the best, the decision-maker will regret not having chosen
a better option when the opportunity arose.

For instance, if machine Y is purchased on the assumption that demand will be


high, and demand turns out to be high, no regret will occur. However, if demand
turns out to be low, the decision-maker will regret not taking the opportunity to select
machine X. The value of regret is the difference in payoffs for the two choices.

56 © 7city Learning
Regret = Profit from optimal decision possible - profit from actual decision made

In this example, given low demand, X is the optimal decision possible

Regret from Y = $120,000 - $20,000 = $100,000

A regret matrix can be used to summarise the situation:

Low High
Machine $ $

X - 50,000

Y 100,000 -

The aim of this criterion is to minimise the maximum possible regret. The maximum
regret for machine X is $50,000, whilst that of machine Y is $100,000. Therefore
machine X should be chosen.

57 © 7city Learning
Exercise 15

i) risk seeking
This person is an optimist - apply the maximax decision-making criterion

Assuming high demand,


Profit
Machine ($)

X 150,000

Y 200,000

Y yields a higher profit and should therefore be chosen.

ii) risk averse


This person is a pessimist - apply the maximin decision-making criterion

Assuming low demand,


Profit
Machine ($)

X 120,000

Y 20,000

X yields a higher profit and should therefore be chosen.

iii) risk neutral?


This person considers all possible outcomes of a decision, and chooses
the option that maximises the expected value of benefit.

58 © 7city Learning
Expected value of x, EV(x) = Σpx

Expected value
Machine ($)

X $120,000 x 0.3 = 36000


$150,000 x 0.7 = 105000
141000

Y $20,000 x 0.3 = 6000


$200,000 x 0.7 = 140000
146000

Machine Y has the higher expected value, and should therefore be chosen.

59 © 7city Learning
Exercise 16

a) Using the high-low method:

1. Select the data points with the highest and lowest activity levels. If relevant,
inflate the figures given to current prices.

In the Alex Young Salads example, we will treat average weekly temperature
as the activity (x) level.
The highest temperature given is 26°C, and the lowest is 16°C.
High 26 °C sales $334,000
Low 16 °C sales $228,000

2. Calculate the variable cost per unit

Cost high - cost low


VC = Units high - units low

$334 - $228
= 26 - 16

= $10,600 sales increase for each rise of 1°C

In other words, a $10600 sales increase occurs for each rise of 1°C

3. Calculate fixed costs

Using the high value (it doesn't matter which),


FC = TC - (VC x units)
- (10600 x 26
= $334,000 °C)
= $58,400

In other words, the model is predicting that even if the weekly temperature
was 0°C, there would still be sales of $58400 for Alex Young Salads

60 © 7city Learning
4. Use the figures you have calculated to predict the total cost at the activity
level you have been given.

ai) For 19 °C, (week 31)


Total cost = Fixed cost + variable cost
= $58,400 + (10600 x 19)
= $259,800 predicted sales

aii)
For 21 °C, (week 32)
Total cost = Fixed cost + variable cost
= $58,400 + (10600 x 21)
= $281,000 predicted sales

b) To use regression analysis, set up the following table:

Sales
Temp (°C) ($000)
(x) (y) xy x2 y2

18 250 4500 324 62500


24 308 7392 576 94864
26 334 8684 676 111556
21 292 6132 441 85264
16 228 3648 256 51984
20 267 5340 400 71289
125 1679 35696 2673 477457

Σx Σy Σxy Σx2 Σy2

61 © 7city Learning
Then apply the formulae:

If y = a +
bx,

nΣxy - ΣxΣy
b = nΣx2 - (Σx)2

(6 x 35696) - (125 x 1679)


= (6 x 2673) - (125 x 125)

214176 - 209875
= 16038 - 15625

= 10.414

Σy bΣx
a = n - n

1679 10.414 x 125


= 6 - 6

= 279.83 - 216.96

= 62.874

The linear regression line is y = 62.874 + 10.414 x


In other words, the line says that even at 0°C, Alex Young Salads would enjoy sales
of $62874 and sales will increase by $10414 for each rise of 1°C above this.

c) Using the regression line, sales predictions are:


i) week 31

y = 62.874 + 10.414 x
= 62.874 + (10.414 x 19 )
= $260,741 predicted sales

ii) week 32

y = 62.874 + 10.414 x
= 62.874 + (10.414 x 21 )
= $281,569 predicted sales

62 © 7city Learning
d) Explain the uses the information you have derived in parts a) to c) might be put to by
the management of Alex Young Salads.

This information could be used for many planning purposes:

- arranging supply contracts with local farmers


- logistical planning, for example warehousing and vehicles
- workforce planning, for example temporary staff numbers
- cash management, for example cashflow forecasting
- planning of routine factory machine maintenance
- other purchasing requirements, for example packaging and labels

e) Explain any issues you would bring to the attention of the management of Alex Young
Salads

1. The forecasts that have been raised depend on the accuracy of the weather forecast from
the Met Office. It is notoriously difficult to predict the weather for a period as long as a week.
This problem will be even more relevant in week 32 (which is two weeks away).

2. The forecasts raised assume that the relationship between salad sales and temperature is
linear. This is not necessarily the case.

3. The sample of values from which the forecasts have been drawn is too small to be
statistically significant, in that it only covers a six-week period of a single year.

4. Both forecasting methods assume that the only factor influencing salad sales is the
weather. Other things can affect sales of particular food-stuffs, for instance

- consumer taste
- celebrity chef endorsements
- unusual one-off events, such as sporting events (e.g. sales of convenience food
usually increase dramatically during the World Cup football tournament and
Olympic Games, etc.)

5. Forecasting in this way assumes that the past is a reliable indicator to future events.
There is no necessary causal link between the future and the past.

63 © 7city Learning
Exercise 17

Tem Q1 Q2 Q3 Q4

Quarter number 9 10 11 12
Trend 510 520 530 540
Seasonal variation (%) 10% 25% -20% -15%
Seasonal variation (units) 51 130 -106 -81
Forecast sales 561 650 424 459

Pul Q1 Q2 Q3 Q4

Quarter number 9 10 11 12
Trend 422 430 438 446
Seasonal variation (units) -30 25 55 -50
Forecast sales 392 455 493 396

64 © 7city Learning
Exercise 18

a) i) Average time for the first 16 Cookees:

y= axb
a= 100
log rate log 0.7
b= log 2 = log 2

-
-0.154902 0.51457
= 0.30103 =
x= 16
-0.51457
y= 100 x 16
y= 24.01 hours per Cookee

(N.B. To make the 16 Cookees, this would take

24.01 x 16 = 384.16 hours)

a) ii) Average time per unit for the first 17 Cookees

y= axb
a= 100
b= -0.5145732
x= 17
y= axb
-0.51457
y= 100 x 17
y= 23.27 hours per Cookee

(N.B. To make the 17 Cookees, this would take


23.27 x 17 = 395.63 hours)

a) iii) Time taken to make the 17th Cookee

The time taken to make the 17th Cookee is the difference between the total
time for 17 Cookees and the total time for 16 Cookees.

Total time for 17 Cookees 395.63 hours


Total time for 16 Cookees 384.16 hours
th
Time for 17 Cookee 11.47 hours

65 © 7city Learning
b) i) average time per unit if 200 Kaypees are produced

We are given the values of y, x and learning rate. We must calculate a.

y= axb
log rate log 0.8
b= log 2 = log 2

-0.09691 -
= 0.30103 = 0.32193

x= 40
y= 5
y= axb
y 5
b -0.3219
a= x = 40

5
= 0.30497 = 16.395 hours

If x = 200 units,
-0.32193
y= 16.395 x 200
y= 2.98 hours per unit

b) ii) average time per unit for the next 50 Kaypees

If x = 250 units,
-0.32193
y= 16.395 x 250
y= 2.77 hours per unit
hours
Total for 250 units = 2.77 x 250 = 692.94
Total for 200 units = 2.98 x 200 = 595.64
st th
Total time for the 201 to the 250 unit = 97.30

Average time for those 50 units = 97.30


50 = 1.95 hours per unit
c) The Montee learning curve rate

y= axb
y= 32
a= 200

66 © 7city Learning
x= 80
b
32 = 200 x 80
b
0.16 = 80
b
log 0.16 = log 80
log 0.16 = b log 80

log 0.16
log 80 = b

-0.79588
1.90308999 = b

b = -0.4182

log rate
log 2 = -0.4182

log rate = -0.4182 x log 2


log rate = -0.4182 x 0.30103
-
log rate = 0.12589
-0.12589
rate = 10
rate = 0.7484 i.e. 75%

67 © 7city Learning
Exercise 19

Start by establishing the cost behaviour of each cost:

Rivets:
Variable cost 1700
of rivets / hr = 17000 = $0.10

Steel:
Variable cost 76500
of steel / hr = 17000 = $4.50

Other direct materials:


Variable cost of 850
other materials / hr = 17000 = $0.05

Direct labour: $

17000 hours budgeted cost 47,000


Less fixed element of budgeted -
cost 8,750

Variable cost of 17000 hours 38,250

Variable cost 38,250


of direct labour /
hr = 17000 = $2.25

Production overheads
By working 20340 hours, the step has been crossed, and so a further $8000 must be added
to find the flexed budget allowance.

Flexed budget: 33950 + 8000 = 41950

Then prepare a flexed budget and compare this to actual costs:

% of flexed
Original Flexed Total budget variance
Budget Budget Actual Variance

Machine hours 17,000 20,340 20,340 -


$ $ $ $

68 © 7city Learning
Rivets 1,700 2,034 2,065 31 A 1.52% A

Steel 76,500 91,530 89,850 1,680 F 1.84% F

Other direct materials 850 1,017 1,150 133 A 13.08% A

Direct labour 47,000 54,515 54,450 65 F 0.12% F

Production overheads 33,950 41,950 44,000 2,050 A 4.89% A

Total 160,000 191,046 191,515 469 A 0.25% A

Points to make to the factory manager:

Production volumes were higher than originally budgeted, meaning that the original
budget cannot fairly be compared to actual cost.
The budget must first be flexed. One cannot sensibly compare the budgeted
cost of producing 10000 girders with the actual cost of producing 12500 girders.

Overall the total variance was very small indeed - only $469A, which is 0.25% of total
flexed budget cost for the period.
The variances for the two biggest areas of expenditure, steel and direct labour,
are both favourable, and less than 2% of flexed budget cost.

Other direct material cost had an actual value over 13% higher than flexed budget.
However, given that the absolute value of the variance was merely $133A,
it is debatable as to how much time and effort should be spent in trying to understand
this particular overspend.

The most worrying variance in this particular cost centre is that of production overheads,
which were $2050 overspent (nearly 5% of flexed budget),
after allowing for the step. Getting to grips with this is probably where the majority
of investigation time and effort should be spent.

69 © 7city Learning
Exercise 20

i) Labour variances

Labour efficiency variance = (Std hours for actual production - actual hours worked) x std
rate per hour
Labour rate variance = (Std cost of hours paid - Actual cost of hours paid)

Efficiency: hrs Rate: $


units should hours
1000 take 4100 should cost
( 1000 x 4 hrs/unit) 4000 ( 4100 x 6 $/hr) 24600
But did take 3900 But did cost 27060
100 F 2460A
x 6 / hr = $ 600 F

Idle time variance = (Actual hours paid - actual hours worked) x std rate per
hour

Idle time variance: hrs

Hours
paid 4100
Hours worked 3900
Idle
hours 200
x 6 / hr = $ 1200 A

Material variances

Material usage = (Std material for actual production - actual material used) x std cost per kg
Material price = (Std cost of material purchased - Actual cost of material purchased)

Usage: kg Price: $
1000 units should use 5200 kg should cost
( 1000 x 5 kg/unit) 5000 ( 5200 x 4 $/kg) 20800
But did
use 4900 But did cost 21320
100 F 520 A
x 4 / kg = $ 400 F

(N.B. If the company in the question values material price variance at the time of usage,
use the amount of material actually used to calculate the price variance)

70 © 7city Learning
ii) The learning curve effect

The learning curve effect describes the 'speeding up' effect experienced by staff as
they perform a repetitive activity many times. Since Chedgzoy's product has recently
been updated, this might well have resulted in a new production procedure being designed
for the product, and it is therefore possible that a new learning effect might be present.

If such an effect is present, this will result in Chedgzoy being unable to


reliably
apply a standard production time per unit to the product. The time taken per unit would
be expected to fall at a predictable rate until the learning curve has worn off.

Labour rate and idle time variances should not be affected by the learning curve effect.
It is still possible for labour efficiency variances to be calculated; however, a large caveat
should be placed upon any interpretation carried out on these variances
until the
steady state has been reached and a standard time per unit can be reliably calculated.

71 © 7city Learning
Exercise 21

To answer this question, first set out the proforma, then calculate as many variances as
you can from the information given.
Work your way down the standard cost card, calculating variances from the costs given
as you go.

Note that there is no change in any inventory during the month. Therefore actual production
of Colins must equal actual sales of Colins, and also actual usage of both materials
X and Y must equal actual purchases.

Material variances

Material usage = (Std material for actual production - actual material used) x std rate
per hour
Material price = (Std cost of material purchased - Actual cost of material purchased)

Material X

Usage: kg Price: $

3,100 units should use 18,700 kg should cost

( 3,100 x 6 kg/unit) 18,600 ( 18,700 x 4.50 $/kg) 84,150

But did use 18,700 But did cost 80,410

100 A 3,740 F

x$ 4.50 / kg = $ 450 A

Material Y

Usage: kg Price: $

3,100 units should use 6,350 kg should cost

( 3,100 x 2 kg/unit) 6,200 ( 6,350 x 5.50 $/kg) 34925

But did use 6,350 But did cost 33655

150 A 1,270 F

x$ 5.50 / kg = $ 825 A

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Labour variances

Labour efficiency variance = (Std hours for actual production - actual hours worked) x std
rate per hour
Labour rate variance = (Std cost of hours paid - Actual cost of hours paid)

Assembly labour

Efficiency: hrs Rate: $

3,100 units should take 18,500 hours should cost

( 3,100 x 6 hrs/unit) 18,600 (18,500 x 7.50 $/hr) 138,750

But did take 18,500 But did cost 144,875

100 F 6,125 A

x$ 7.50 / hr = $ 750 F

Idle time variance = (Actual hours paid - actual hours worked) x std rate per hour

Idle time variance: hrs

Hours paid 6,200


Hours worked 6,000
Idle hours 200
x$ 8.00 / hr = $ 1,600 A

Variable overhead variances

V. ohd efficiency variance = (Std hours for actual production - actual hours worked)
x std VO rate per hour
V. ohd expenditure variance = (Std cost of var ohds - Actual cost of var ohds)

Efficiency: hrs

3,100 units should take


( 3,100 x 6 hrs/unit) 18,600
But did take 18,500
100 F
x$ 2.50 / kg = $ 250 F

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Expenditure: $

18,500 hours should cost

( 18,500 x 2.50 $/hr) 46,250

But did cost 43,000

3,250 F
Fixed overhead variances

F. ohd expenditure variance = (Budgeted cost of F. ohd - Actual cost of F. ohd)


F. ohd volume variance = (Budgeted hours worked - Standard time for actual production)
x Std F. ohd per hour

F. ohd expenditure variance: $


16,800 budgeted hours should cost

( 16,800 x 0.50 $/hr) 8,400

But did cost 10,500

2,100 A

F. ohd efficiency variance = (Standard hours for actual production - actual hours) x Std
F.ohd per hour
F. ohd capacity variance = (Budgeted hours - actual hours) x Std F.ohd per hour

F. ohd efficiency variance:


3,100 actual units should take
( 3,100 x 6 hrs/unit)
3,100 actual units did take

x$ 0.50 / hr = $

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F. ohd capacity variance: hrs
actual units did
3,100 take 18,500
2,800 budgeted units should take

( 2800 x 6 hrs/unit) 16,800

1,700 F

x$ 0.50 / hr = $ 850 F

Note: Although this is not required by the question, notice how the fixed overhead efficiency
and capacity
variances add to give the fixed overhead volume variance:

F. ohd volume variance: hrs


3,100 actual units should take
( 3,100 x 6 hrs/unit) 18,600
2,800 budgeted units should take
( 2,800 x 6 hrs/unit) 16,800
1,800 F
x$ 0.50 / hr = $ 900 F

Sales variances

Sales volume profit variance = (Actual units sold - budgeted units sold) x std profit per
unit
Sales price variance = (Actual selling price per unit - Std selling price per unit) x Actual
units sold

Sales volume profit variance: units

Actual units sold 3,100

Budgeted units sold 2,550

550 F

x 29.00 $ / unit 15,950 F

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Sales price variance: $
Act SP per unit 127
Std SP per unit 130
3 A
x 3100 units 9300 A

Once you have completed all of the variances, plug the numbers you have calculated into
the operating statement proforma.

Harvey Ltd Product Colin Operating statement for November


$

Budgeted gross profit 2550 budgeted units x $29 budgeted profit per unit 73,950

Sales volume profit variance 15,950 F

Standard profit on actual sales 89,900

Sales price variance 9,300 A

80,600
Cost variances $F $A

Material X:

usage 450

price 3,740
Material Y:

usage 825

price 1,270
Assembly labour:

efficiency 750

rate 6,125

idle time 1,600


Variable overhead:
efficiency

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250

expenditure 3,250
Fixed overhead:

expenditure 2,100

efficiency 50

capacity 850

10,160 11,100 940 A

Actual profit 79,660

Author's Note 1

Although this is not required by the question asked, it is possible to calculate actual
profit directly for this question in the following way:

$ $
units x per
Sales 3,100 $ 127.00 unit 393,700

Material X 18,700 kg x $ 4.30 per kg 80,410

Material Y 6,350 kg x $ 5.30 per kg 33,655

Assembly labour: 12,500 hrs x $ 7.75 per hour 96,875

6,200 hrs x $ 8.00 per hour 49,600


Variable overhead 43,000
Fixed overhead 10,500
314,040
Actual profit 79,660

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Author's Note 2

Again, not required by the question, but notice how the fixed overhead cost variance is
caused by underabsorbing fixed overheads:

$
Fixed overhead absorbed:

6 hrs x $0.50 per hour x 3100 units produced 9,300


Actual fixed
overhead 10,500

Underabsorption 1,200

Fixed overhead variances: $

Expenditure 2,100 A

Efficiency 50 F

Capacity 850 F

1,200 A

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Exercise 22

Material mix variance:


Material Material
A B Total
kg kg kg
Actual input in actual mix 530 530 1060
Actual input in standard mix 636 424 1060
Quantity mix variance 106 F 106 A 0
Std price per kg 18 14
$ mix variance 1908 F 1484 A

Total material mix variance = 424 F

Material yield variance


units
Standard yield for actual input (W1) 106
Actual yield for actual input 100
Quantity yield variance 6 A
Std cost per unit of output 164
$ yield
variance 984 A

W1 - Standard yield for actual input

Actual input 1060 kg


To make 1 unit requires 10 kg of material input
So, standard yield for actual input is 106 units

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Author's Note

It is possible to prove these figures by calculating the usage variances for Bullens:

Mix variance + yield variance = usage variance

424 F + 984 A = 560 A

Usage for A: kg

100 units should use

( 100 x 6 kg/unit) 600

But did use 530

70 F

x$ 18.00 / kg = $ 1,260 F

Usage for B: kg

100 units should use

( 100 x 4 kg/unit) 400

But did use 530

130 A

x$ 14.00 / kg = $ 1,820 A

Total usage variance = 1,260 F

+ 1,820 A
560 A

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Exercise 23

Material mix variance:


Material Material Material
P Q R Total
kg kg kg kg
Actual input in actual mix 16,000 5,500 5,500 27,000
Actual input in standard mix 14,400 5,400 7,200 27,000
Quantity mix variance 1,600 A 100 A 1,700 F 0
Std price per kg 3.20 0.50 3.60
$ mix variance 5,120 A 50 A 6,120 F

Total material mix variance = 950 F

Material yield variance


units

Standard yield for actual input (W1) 22,500

Actual yield for actual input 21,000

Quantity yield variance 1,500 A


Std cost per unit of output (W2) $3.32

$ yield variance 4,980 A

W1 - Standard yield for actual input

Actual input 27,000 kg

To make 2,500 units requires 3,000 kg of material input

So, standard yield for actual input is 22,500 units

W2 - Std cost per unit of output

$8,300
2,500 = $3.32 per unit of output

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Exercise 24

i) ROCE

PBIT PBIT
Capital
ROCE = employed = (Equity + long term liabilities)

643 = 17.4%
20X8 = 2355 + 1338

758
20X7 = 2345 + 842 = 23.8%

ii) Gross profit margin

Gross profit
Profit margin = Sales turnover

1420
20X8 = 3911 = 36.3%

1614
20X7 = 3815 = 42.3%

iii) Net profit margin (based on PBIT)

Profit before interest and


tax
Profit margin = Sales turnover

643
20X8 = 3911 = 16.4%

758
20X7 = 3815 = 19.9%

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iv) Asset turnover

Sales turnover Sales turnover


Asset turnover = Capital employed = (Equity + long term liabilities)

3911 = 1.06 times


20X8 = 2355 + 1338

3815
20X7 = 2345 + 842 = 1.20 times

v) Financial gearing

For the purposes of F5, 'debt' means any


Debt Loans that pay interest and are secured.
Do not include any overdrafts in a gearing
Financial gearing = Debt + Equity ratio.

1338
20X8 = 1338 + 2355 = 36.2%

842
20X7 = 842 + 2345 = 26.4%

vi) Current ratio

Current assets
Current ratio = Current liabilities

1450
20X8 = 863 = 1.68 times

1324
20X7 = 801 = 1.65 times

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vii) Quick ratio (acid test)

Current assets less


inventory
Quick ratio (acid test) = Current liabilities

1450 - 562
20X8 = 863 = 1.03 times

1324 - 457
20X7 = 801 = 1.08 times

viii) Accounts receivable days

Trade
Accounts receivable receivables
days = Credit sales x 365

479
20X8 = 3776 x 365 = 46.3 days

366
20X7 = 3684 x 365 = 36.3 days

ix) Accounts payable days

Trade payables
Accounts payable Credit
days = purchases x 365

256
20X8 = 2207 x 365 = 42.3 days

158
20X7 = 2029 x 365 = 28.4 days

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x) Inventory days

Inventory
Inventory days = Cost of sales x 365

562 = 82.3 days


20X8 = 2491 x 365

457
20X7 = 2201 x 365 = 75.8 days

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Exercise 25

i) Using ROI
Division Division
X Y
Exising ROI:
Profit 120000 16000
Capital 375000 145000
32.0% 11.0%
New ROI if project accepted:
New profit 141000 30500
New capital 500000 270000
28.2% 11.3%
Accept? No Yes

However, this is not in the interest of McFadden as a whole:


Project Project
X1 Y1
Project ROI:
Profit 21000 14500
Capital 125000 125000
16.8% 11.6%
Cost of capital 12.0% 12.0%
Worthwhile? Yes No

ii) Using RI instead.


Division Division
X Y
Exising RI:
Profit 120000 16000
Interest charge 45000 17400
75000 -1400
New RI if project accepted:
New profit 141000 30500
New interest charge 60000 32400
81000 -1900
Accept? Yes No

Now the decisions taken are in the interest both of the divisions,
and of McFadden as a whole.

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Exercise 26

a) Minimum possible transfer price is $33/unit, since a transfer price below


this would give Cue a negative contribution per unit of Gee transferred.

Maximum possible transfer price is $43/unit, since a transfer price above


this value would cause division Tee to buy Gees from the external supplier.

b) i) when Cue has spare capacity and limited demand for Pee

In this circumstance, the minimum transfer price for Gee is $33, since this is
the incremental cost to Stubbs Group of producing Gee. However, this
would provide no incentive to Cue to supply Tee, since no contribution is
made.

The maximum transfer price would be $43, since anything above


this price would cause Tee to choose the external supplier over
Cue.
This would not be good for the group, since Cue is losing the chance to use
up spare capacity (and hence absorb some fixed overhead cost).

The transfer price set therefore needs to be in the range of $33 to $43.
Each extra dollar above $33 is an extra dollar profit for division Cue at the
expense of a dollar of Tee's profit from each Gee transferred - therefore
there will be a negotiation whereby Cue's manager will try to set the transfer
price as close to $43 as possible, and Tee's manager will try to set the
transfer price as close to $33 as possible. It is in the interest of Stubbs
group
to enable this negotiation to take place for motivational reasons - both
managers participate in the negotiation, and (assuming the negotiation
is fair) both will see the transfer price set as fair.

b) ii) when Cue has no spare capacity and unlimited demand for
Pee

If Division Cue is to supply division Tee, this means that some capacity for
producing product Pee has to be sacrificed. Therefore, producing Gee
has an opportunity cost - this is the lost contribution from selling Pee
externally. For each Gee produced, one less Pee is produced and sold.

For every unit of Gee supplied internally, Cue loses $16 contribution from
Pee. The relevant cost from supplying product Gee internally is therefore

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$49 (that is, $16 + $33). It is in the interest of Stubbs Group for Tee to buy
in Gee from the external supplier at the cheaper relevant cost of
$43.

If a transfer price of $49 is set, and the buy-in price rises above $49, then it becomes
right for the group for the internal transfer to take place since the total relevant cost
to Stubbs of producing and selling Tee's products (i.e. $49 per unit) would be lower
than the market price per Gee.

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Exercise 27

Material cost variances:

Traditional
price: $

11,000 kg should cost

( 11,000 x 3.00 $/kg) 33,000


But did
cost 36,000

3,000 A

Traditional usage: kg

7,000 units should use

( 7,000 x 1.5 kg/unit) 10,500

But did use 11,000

500 A

x$ 3.00 / kg = $ 1,500 A

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i) Traditional material price variance = $ 3,000 A

Traditional material usage variance = $ 1,500 A

Operational material price: $


kg should cost at revised std.
11,000 cost

( 11,000 x 3.50 $/kg) 38,500

But did cost 36,000

2,500 F

Operational material usage: kg

7,000 units should use (rev. std usage)

( 7,000 x 1.4 kg/unit) 9,800

But did use 11,000

Value at revised std. cost per kg 1,200 A

x$ 3.50 / kg = $ 4,200 A

Planning material price: $


kg should cost at original std.
10,500 cost

( 10,500 x 3.00 $/kg) 31,500


kg should cost at revised std.
10,500 cost

( 10,500 x 3.50 $/kg) 36,750

5,250 A

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Planning material usage: kg
7,000 units should use (orig. std usage)

( 7,000 x 1.5 kg/unit) 10,500


7000 units should use (rev. std usage)

( 7000 x 1.4 kg/unit) 9,800

Value at revised std. cost per kg 700 F


x
$ 3.50 / kg = $ 2,450 F

ii) Planning material price variance = $ 5,250 A

Planning material usage variance = $ 2,450 F

Operational material price variance = $ 2,500 F

Operational material usage variance = $ 4,200 A

Labour cost variances:

Traditional labour rate: $


3,700 hours should cost

( 3,700 x 7.50 $/hr) 27,750

But did cost 29,000

1,250 A

Traditional labour efficiency: hrs


7,000 units should take

( 7,000 x 0.5 hrs/unit) 3,500

But did take 3,700

200 A
x
$ 7.50 / hr = $ 1,500 A

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iii) Traditional labour rate variance = $ 1,250 A

Traditional labour efficiency variance = $ 1,500 A

Operational labour rate: $


3,700 hours should cost

( 3,700 x 7.75 $/hr) 28,675

But did cost 29,000

325 A

Operational labour efficiency: hrs

7,000 units should take

( 7,000 x 0.5 hrs/unit) 3,500

But did take 3,700

200 A

x$ 7.75 / hr = $ 1,550 A

Planning labour rate: $


hrs should cost at original std.
3,500 cost

( 3,500 x 7.50 $/hr) 26,250


hrs should cost at revised std.
3,500 cost

( 3,500 x 7.75 $/hr) 27,125

875 A

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N.B. There is no planning labour efficiency variance, since the standard labour time
per unit has not been amended.

iv) Planning labour rate variance = $ 875 A


Planning labour efficiency variance = $ -

Operational labour rate variance = $ 325 A

Operational labour efficiency variance = $ 1,550 A

Sales revenue variances:

Traditional sales price $


Act SP per unit 24.00
Std SP per unit 25.00
for actual units sold 1.00 A

x 7,300 units 7,300 A

v) Traditional sales price variance = $ 7,300 A

Traditional sales volume profit variance = $ 2,400 A

Traditional sales volume profit units

Actual units sold 7,300

Budgeted units sold 7,500

200 A
$/
x 12.00 unit 2,400 A

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v) Traditional sales price variance = $ 7,300 A

Traditional sales volume profit variance = $ 2,400 A


Planning sales price $
Original std SP per unit 25.00
Revised std SP per unit 23.50
for budgeted units sold 1.50 A

x 7,500 units 11,250 A


Planning sales volume profit units

Original budgeted units sold 7,500

Revised budgeted units sold 7,125

at revised standard profit per unit 375 A


$/
x 10.50 unit 3,938 A
Operational sales price $
Act SP per unit 24.00
Rev. std SP per unit 23.50
for actual units sold 0.50 F

x 7,300 units 3,650 F

Operational sales volume profit units

Actual units sold 7,300

Revised budgeted units sold 7,125

at revised standard profit per unit 175 F


$/
x 10.50 unit 1,838 F

vi) Planning sales price variance = $ 11,250 A

Planning sales volume profit variance = $ 3,938 A

Operational sales price variance = $ 3,650 F

Operational sales volume profit variance = $ 1,838 F

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