standard usage of materials for actual production standard labour time for actual production ( ) x 27,500 = 5,500 (A)

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1 Contributing to the Management of Costs and Enhancement of Value (MCV) (1998 standards) / Management of Performance and Enhancement of Value (PEV) (2003 standards) Suggested Answers SECTION 1 Task 1.1 (a) (i) actual price of materials per kg 143,000 = ,500 (ii) standard usage of materials for actual production 900 x 30 = 27,000 kgs (iii) actual labour rate per hour 26,040 = ,200 (iv) standard labour time for actual production 900 x 5 = 4,500 hours (v) budgeted production overheads (b) (i) (ii) (iii) 1,000 x 20 = 20,000 the material price variance ( ) x 27,500 = 5,500 (A) the material usage variance (27,500 kgs - 27,000 kgs) x 5 = 2,500 (A) the labour rate variance ( ) x 4,200 = 840 (A)

2 (iv) the labour efficiency variance (4,500-4,200) x 6 = 1,800 (F) (v) the fixed overhead expenditure variance 23,000-20,000 = 3,000 (A) (vi) the fixed overhead volume variance (5,000-4,500) x 4 = 2,000 (A) (vii) the fixed overhead capacity variance (5,000-4,200) x 4 = 3,200 (A) (viii) the fixed overhead efficiency variance (4,500-4,200) x 4 = 1,200 (F) (c) Standard absorption cost of actual production 180,000 Favourable Adverse Material price variance 5,500 Material usage variance 2,500 Labour rate variance 840 Labour efficiency variance 1,800 Fixed overhead expenditure variance 3,000 Fixed overhead capacity variance 3,200 Fixed overhead efficiency variance 1,200 3,000 15,040 12,040 Actual absorption cost of actual production 192,040

3 (d) To: Sam Thomas Subject: Operating statement The operating statement set out above provides management with an explanation of why actual costs differ from standard costs. It is important that this report is used to ascertain the reasons for each of the variances so that action may be taken to eliminate future inefficiencies or for altering future plans to reflect changing circumstances. The operating statement will have a greater value if it is supplemented with explanations of the causes for each significant variance. In addition, some variances may be beyond the control of management. It would be helpful to distinguish between controllable and noncontrollable variances with explanations of any remedial action that can be taken to eliminate any controllable variances. Task 1.2 (a) Average prices in the period January to March were: = = Average prices in the period February to April were: = = Average prices in the period March to May were: = =

4 (b) To: Sam Thomas Subject: Material prices Trend in material prices The moving average series demonstrates there is an upward trend in material prices. This is more noticeable from the moving average series than from the original series of actual monthly prices. For example, the actual monthly data showed a price reduction in February. Standard for material prices The upward trend can be used to forecast a trend line. This trend line can be used to forecast future prices. This process is known as extrapolation. Other information Two further sources of information are as follows. 1. Customer demand for desks Once the demand for desks has been established, it will be possible to estimate the demand for materials. The greater the demand, the greater will be the need for materials since they are a variable input. Increased material purchases may enable the company to take advantage of quantity discounts which would have the result of reducing standard costs. 2. Product specification The standard cost for direct materials is computed from two elements - the price of materials and the quantity to be used. If would be significant, therefore, to ensure that the bill of materials for the executive desk is to remain unchanged, otherwise there are likely to be cost consequences in setting the standard material cost.

5 SECTION 2 Task 2.1 (a) Actual Budget Gross profit margin 16.7% 20.0% Operating profit margin 4.2% 8.0% Return on capital employed 10.7% 20.0% Stock turnover (in months) Labour capacity ratio 97.0% 100.0% Labour efficiency ratio 96.2% 100.0% (b) To: Sam Thomas Subject: Performance indicators (i) Gross profit margin An increase in the selling price of a desk will result in an increase in the gross margin. At present, however, the company is achieving the budgeted price of 250 per desk and it may not be possible to increase the price. If this is the case, efforts should be made to reduce the cost of production of a desk. (ii) Net operating margin The net operating margin will increase if the company is able to reduce its distribution and administration costs. It would appear from the actual results that a reduction has already taken place since distribution and administration costs are 15,000 below budget. (iii) Return on capital employed The return on capital employed will improve if operating profits improve with no increase in capital employed. The measures detailed above will, therefore, have the effect of improving the return. An alternative, however, would be to examine whether all the assets employed are required for use in the business. If not, an asset disposal programme could be implemented and the proceeds distributed to shareholders. This would have the effect of reducing capital employed and improving the return on capital employed. (iv) Average age of stock The current stock of desks represents 1.2 months production. An increase in sales volumes may lead to a reduction in the number of desks held in stock and will consequently improve this indicator.

6 (v) Labour capacity ratio The labour capacity ratio is below budget and probably results from a lower than anticipated demand for desks. Increased sales will again improve this ratio. (vi) Labour efficiency ratio The efficiency ratio is below budget and indicates inefficiencies within the direct labour workforce. Workplace training and increased supervision are likely to lead to improvements in this indicator. Task 2.2 To: Sam Thomas Subject: Value Engineering Production cost of an executive desk The cost of producing an executive desk may be examined using the technique of value engineering. It is clear from the actual results for November that, although the budgeted sales price has been achieved, the gross margin has not. Value engineering may be employed to examine ways in which production costs may be reduced. Value engineering is the process of driving down costs by examining: the product design ways of eliminating unnecessary functions which increase the product cost. Value engineering requires the use of functional analysis which involves the identification of the attributes of the executive desk. Once these are established, a price can be determined for each attribute. Functional analysis may lead to a change in design and a reduction in the materials required for production. Also, if the product design is simplified, assembly time may be reduced and this will lead to lower labour costs. Production overheads may also be reduced if a simplified design leads to lower rework costs.