Overhead allocation rate = R / = R10,80 per machine hour

Transcription

1 COSTING DAY 1 LECTURE EXAMPLE SUGGESTED SOLUTIONS COST ASSIGNMENT LE1: Allocation rate based on units Overhead allocation rate = R / = R8,00 per unit Total amount absorbed in WIP = R8,00 x = R Expenditure variance = R R = R (Favourable) Volume variance = R R = R (Unfavourable) LE2: Allocation based on hours Overhead allocation rate = R / = R10,80 per machine hour Machine hours per unit = / = 0,75 Total number of machine hours expected to be utilised = 0,75 x = Total amount absorbed in WIP = R10,80 x = R Expenditure variance = R R = R (Favourable) Volume variance = R R = R (Unfavourable) LE3: Determining product costs Part (a) Gross profit per unit Non-electric Electric Direct materials Direct labour cost 198, Overhead costs (6,5 x 80; 15 x 80) Total manufacturing costs 1 218, Selling price Gross profit per unit 781, C1: Direct labour costs Total budgeted cost Total actual labour hours ( ) Direct labour per hour ( / ) 62,00 Non-electric toys ( x 62) Labour cost per unit ( / ) 198,40 Non-electric toys ( x 62) Labour cost per unit ( / ) 527 Accelerated Revision Course

2 Alternative Non-electric toys Actual labour hours per unit ( / ) 3,20 Labour cost per unit (62 x 3,20) 198,4 Electric toys Actual labour hours per unit ( / ) 8,50 Labour cost per unit (62 x 8,50) 527 C2: Allocated overheads C2.1: Overhead allocation rate per machine Depreciation of manufacturing plant Rental of factory building Salary of factory manager Other fixed manufacturing costs Total budgeted manufacturing fixed costs Total budgeted machine hours ( ) Overhead allocation rate ( / ) 80,00 C2.2: Machine hours per unit Non-electric toy ( / ) 6,50 Electric toy ( / ) 15,00 Part (b) Contribution per unit Non-electric Electric Direct materials Direct labour cost 198, Variable selling costs (10% x 2 000; 10% x 4 000) Total manufacturing costs 898, Selling price Contribution per unit 1 101, Alternative Gross profit per unit 781, Add back overhead costs per unit Variable selling costs (10% x 2 000; 10% x 5 250) (200) (400) Contribution per unit 1 101, Accelerated Revision Course

3 Part (c) Expenditure and volume variances Expenditure variance Applicable for both manufacturing and non-manufacturing costs Actual fixed costs Budgeted fixed costs Expenditure variance This would be treated as an expense because the actual expenditure is higher than the budgeted expenditure Volume variance Budgeted fixed costs Allocated fixed costs ( x x 1 200) or [( x 6, x 15) x 80] Volume variance This would be treated as an expense because the budgeted fixed costs have been under-recovered Accelerated Revision Course

4 COST-VOLUME-PROFIT ANALYSIS LE1A: Hi-low / Relevant range The electricity cost is a mixed cost, therefore hi-low method might be useful in splitting the costs between fixed and variable cost Changes in cost ( ) Changes in activity ( ) Variable cost per unit ( / ) 1,35 Fixed cost ( ,35 x ) (candidates may use any point within the relevant range to derive this figure) Therefore, total budgeted costs for kwh would be Variable costs ( x 1,35) Fixed costs ( x 1,10) Total electricity costs LE1B: Hi-low / Relevant range The electricity cost is a mixed cost, therefore hi-low method might be useful in splitting the costs between fixed and variable cost However, there are two different relevant range due to the price increase in FY2015. Hi-low can only applied to costs within a relevant range Changes in cost ( ) Changes in activity ( ) Variable cost per unit in FY2014 1,50 Variable cost per unit in FY2015 (1,50 x 1,20) 1,80 Fixed cost ( ,50 x ) (candidates may use any point within the relevant range to derive this figure) Or Fixed cost ( ,80 x ) Therefore, total budgeted costs for kwh would be Variable costs ( x 1,80) Fixed costs ( x 1,10) Total electricity costs Accelerated Revision Course

5 LE2: Single product break-even (a) Break-even determination Step 1: Determine the contribution per unit Selling price Raw material - steel (2 500 x 75) ( ) Raw material - other (45 000) Selling commission (2,5% x ) (7 500) Contribution per unit Step 2: Total fixed costs Direct labour salaries (250 x ) Total number of hours required in FY2016 (150 x = ) Total number of employees required ( / = 250) Salaries payable to commission staff ( x 2 000) Other fixed manufacturing costs Fixed non-manufacturing costs Total fixed costs Break-even sales volume ( / ) Break-even sales revenue (1 820 x ) (b) Margin of safety determination Margin of safety - sales volume ( ) 180 Margin of safety - sales revenue (180 x ) Margin of safety - percentage (180 / 2 000) 9,00% (c) Target profit sales volume determination Alternative 1 Break-even sales volume Additional sales volume to reach target profit ( / ) 40 Total sales volume to reach the target profit Alternative 2 Total fixed costs + target profit ( ) Contribution per unit Total sales volume to reach the target profit ( / ) Accelerated Revision Course

6 (d) Revised break-even sales volume determination Alternative 1 Break-even sales volume Additional sales volume to cover additional fixed costs ( / ) 15 Total sales volume to cover additional fixed costs Alternative 2 Total fixed costs + additional fixed costs ( ) Contribution per unit Total sales volume to cover additional fixed costs ( / ) (e) Impact of increase in sales commission An increase in the sales commission rate will result in an increase in the variable costs Assuming all other variable costs and the selling price remain constant, an increase in variable costs will result in a decrease in contribution per unit Assuming all other fixed costs remain constant, a decrease in contribution will result in an increase in break-even sales volume LE3: Single product break-even Option 1: Variable grant Contribution per unit Grant rebate (6% x ) Revised contribution per unit Total fixed costs Break-even sales volume ( / ) Option 2: Fixed grant Contribution per unit Total fixed costs Fixed grant ( ) Revised fixed costs Break-even sales revenue ( / ) Given that the primary objective of Tesla is to reduce the break-even sales volume, Tesla should elect the rebate as it would result in lower break-even sales volume. Accelerated Revision Course

7 LE4: Multi-product break even Step 1: Determine sales mix Light meal Main meal Total budgeted sales Sales mix ( / ; / ) 65,2% 34,8% Step 2: Determine contribution per unit Light meal Main meal R R Food revenue 45,00 120,00 Beverage revenue 20,00 50,00 Total revenue 65,00 170,00 Variable costs Cost of food (R45 x 45%; R120 x 45%) (Note 1) (20,25) (54,00) Cost of beverages (R20 x 50%; R50 x 50%) (Note 2) (10,00) (25,00) Commission (R20 x 2%; R50 x 2%) (0,40) (1,00) Cleaning and utility costs (1,80) (2,40) Contribution per unit 32,55 87,60 Step 3: Determine weighted average contribution Light meal Main meal Sales mix 65,2% 34,8% Contribution per unit R32,55 R87,60 Weighted contribution (65,2% x 32,55; 34,8% x 87,60) R21,22 R30,48 Weighted average contribution per meal (R21,22 + R30,48) R51,71 Step 4: Determine total fixed costs R Staff costs Depreciation Other fixed costs Total fixed costs Step 5: Determine break even sales batches Break even sales ( / 51,71) Step 6: Determine break even sales volumes Light meal Main meal Sales mix 65,2% 34,8% Break even sales batches Notes Note 1: A profit margin of 55% on the food implies that the cost is 45% (i.e. 100% - 55%) of the revenue per meal. Note 2: Convert mark-up to margin: 100 / ( ) = 50% Accelerated Revision Course

8 LE5: Operating leverage Evaluate the financial information and advise, with supporting calculations, the management of Tesla on whether or not they should proceed w ith the upgrade Currently the net income from both options is the same at R and the company is therefore indifferent as to which manufacturing method to use. However, management forecasts indicate that in future the profitability of the company might be materially different to the net income generated in the current year. The degree of operating leverage will play a critical role in deciding whether to invest in the new machinery or not. Degree of operating leverage refers to the sensitivity of profit as a result of changes in sales. The labour intensive operations have a lower degree of operating leverage of 2x ( / ) relative to the capital intensive operations which have a higher operating leverage of 8x ( / ). If revenue increase by 20%, then it might be beneficial for the company to automate because it has a higher contribution and its profits will therefore increase faster. Alternatively: If revenue increases by 20%, then it might be beneficial for the company to automate because the profitability of the company will increase by 160% due to the higher degree of operating leverage relative to an increase of only 40% for labour intensive operations. However, if revenue decrease by 10%, then it might be beneficial for the company to keep operations labour intensive because it has a lower fixed costs and therefore a lower sales value would be required to break even. Alternatively: However, if revenue decreases by 10%, then it might be beneficial for the company to keep operations labour intensive because the profitability of the company will drop by only 20% due to the lower degree of operating leverage versus a drop of 80% with the automated operations. Although the labour intensive operations provide a greater stability in net income, management need to take into consideration that there is less stability in the operations because of the increased labour unrest. The ultimate decision of which manufacturing operations to select would therefore be based on the risk appetite of management. Consequential mark would be awarded for providing advice to management on whichever method to use. Accelerated Revision Course

9 INCOME EFFECT OF ALTERNATIVE ACCUMULATION SYSTEMS (a) Absorption costing Sales (325 x ) Cost of sales ( ) - Opening balance (165 x 1,000) Production costs [( ) x ] Closing balance (182 x 3 400) ( ) Under absorption of overheads (5 200) - Expenditure variance ( ) (70 000) - Volume variance [ ( x 27)] Gross profit Period costs ( ) - Non-manufacturing costs (54 x 30,000) ( ) - Fixed non-manufacturing costs ( ) Absorption costing profit Overhead allocation rate = R / = R27 per unit (b) Reconciliation of profit Absorption costing profit Opening balance ( ) Closing balance ( ) (91 800) Variable costing profit (c) Break even sales Contribution per unit ( ) 125 Total fixed costs ( ) Break even units ( / 125) Accelerated Revision Course

10 ACTIVITY BASED COSTING Part (i) Traditional costing ADT Chubb Direct materials 160,00 190,00 Direct labour (200 x 1,20; 200 x 2,00) 240,00 400,00 Total variable costs 400,00 590,00 Overhead cost per unit (268,70 x 0,40; 268,70 x 0,80) 107,48 214,96 Total cost per unit 507,48 804,96 C1: Overhead allocation rate Total overheads Total machine hours (0,40 x ,80 x ) Overhead allocation rate 268,70 Part (ii) Activity based costing ADT Chubb Direct materials 160,00 190,00 Direct labour (200 x 1,20; 200 x 2,00) 240,00 400,00 Total variable costs 400,00 590,00 Overhead cost per unit 222,00 136,40 Total cost per unit 622,00 726,40 C1: Activities Total costs Total activities Cost per cost driver Machine maintenance Machine set-ups Inspections / quality control C2: Total activities Machine maintenance Machine hours - ADT (0,40 x ) Chubb (0,80 x ) Machine set-ups Machine set-ups - ADT (625 x 4) Chubb (160 x 5) 800 Quality control Inspection - ADT (625 x 2) Chubb (160 x 4) 640 Total activities Number of batches - ADT ( / 80) Chubb ( / 500) 160 Accelerated Revision Course

11 C3: Allocated costs ADT Chubb Machine maintenance Machine set-ups Inspections / quality control Total overhead costs to be allocated Number of units Overhead cost per unit ( / ; / ) 222,00 136,40 Part (b) Traditional costing versus activity based costing ADT Chubb Difference Traditional costing 107,48 214,96 107,48 Activity based costing 222,00 136,40 85,60 Difference 114,52 78,56 Commentary Traditional costing system Traditional method uses machine hours to allocate overheads to the alarm systems. A Chubb unit requires twice the number of machine hours (0,80 hours) compared to an ADT unit (0,40 hours). As a result, the traditional costing method allocates R107,48 additional overhead costs per unit to Chubb than to ADT. Activity based costing Activity based costing, on the other hand, uses more than a single cost driver to allocate the overhead costs. Utilising more than a single cost driver results in ADT being allocated more of the overhead costs per unit than for the Chubb unit (R85,60). This is as a result of product diversity (differing batch sizes) because the batch size of ADT (80 units) are much smaller compared to the batch sizes of Chubb (500 units). Traditional costing system versus activity based costing In conclusion, activity based costing results in more overhead costs per unit being attributed to ADT (R114,52) while lower overhead costs per unit are allocated to Chubb (R78,56). This is likely to reflect the reality as the use of more than a single rate is likely to reflect the actual consumption of the resources of the company. Accelerated Revision Course

12 JOINT AND BY-PRODUCTS Production schedule GT CP KZ Kg Kg Kg Opening inventory Production (2 000 x 6; x 5; x 2) (1½) R/W Less: Closing inventory (3 200) (2 200) (100) Sales (1½) R/W Cost of by-product KZ Sales value (R): (4 100 x 50) (½) R/W Cost of sales Profit (s/b nil) - (½) R/W Then cost of sales Less: Opening inventory (FIFO) (12 500) (½) R/W Production cost Production September Cost per unit 48,125 (½) R/W Closing inventory (x 100) 4 812,5 Joint costs ( ,5) ,5 (1) C Relative sales value GT CP R 000 R 000 Sales value of production (R 000) (1) R/W (half each) Further processing cost Variable (1 296) (1 450) (1) R/W (half each) Fixed (324) (810) (1) R/W (half each) Relative sales value \ Ratio 50% 50% (1) R/W (half each) Alternative: Per 10kg packaging GT CP R R Sales value of production (1) R/W (half each) Further processing cost Variable (1 080) (1 450) (1) R/W (half each) Fixed (270) (810) (1) R/W (half each) Relative sales value Joint cost allocation Total joint cost (2 000 x 1 400) (½) Allocated to by-product KZ ( ,5) (½) c Accelerated Revision Course

13 ,5 Split: GT ,75 (½) c CP ,75 (½) c Income statement September Sales (R4300 x (11800 / 10); R5800 x / 10) GT R CP (1)R/W Less: Cost of sales Opening inventory - given (1)R/W Variable cost (12000 x R108; x R145) Joint cost Fixed cost - given Closing inventory note 2 ( ) ( ) R Profit for the month (1)C Profit % 44,0% 39,8% (1)C Note 2: Total production cost (½) + (½) C \ Inventory ( x 3 200) (½) C ( x 2 200) (½) C Max 15 Accelerated Revision Course

14 PROCESS COSTING Part (a) FIFO Cost element Current period costs Completed units WIP equivalent Total equivalents (Completed+WIP) Cost per unit Materials ,62 Labour ,20 Overheads ,02 427,84 Amount (R) Total cost ( x 427,84) Cost of opening WIP ( ) Total costs Workings C1: (1 800 x 100%) = C2: (60% x 8 000) = C3: x 100% = C4: x 90% = C5: x 40% = Part (b) WAC Cost element Current period costs Completed units WIP equivalent Total equivalents (Completed+WIP) Cost per unit Materials ,31 Labour ,00 Overheads ,00 403,31 Amount (R) Total costs ( x 403,31) Workings C1: (1 800 x 100%) = C2: = C3: = C4: = C5: x 100% = C6: x 90% = C7: x 40% = Accelerated Revision Course

15 COSTING DAY 2 LECTURE EXAMPLE SUGGESTED SOLUTIONS STANDARD COSTING LE1: Sales variances Sales price variance Alpha [(17,50-20,00) x ] ( ) Omega [(35,00-30,00) x ] ( ) Sales volume variance Alpha [( ) x (20,00-12,00)] Omega [( ) x (30,00-20,00)] (37 500) Analysis of the sales volume variance Actual quantity at actual mix Actual quantity at standard mix Budgeted quantity at standard mix Alpha (1) Omega (2) ) x / = ) x / = Sales mix variance Alpha [( ) x 8] Omega [( ) x 10] (50 000) (10 000) Sales margin quantity variance Alpha [( ) x 8] Omega [( ) x 10] Analysis of sales margin quantity variance (CTA Level 2 only) Weighted average contribution [80% x 8, % x 10,00] 8,40 Market size variance [( ) x 23,4375% x 8,40] - Actual market size ( / 31.25%) = Budgeted market share ( / ) = 23,4375% ( ) Market share variance [(31,25% - 23,4375%) x x 8,40] Accelerated Revision Course

16 LE2: Material variances (a) Material variances Material price variance Beta [(28,00-30,00) x ] - Actual cost per kg ( / ) = 28, Vega [(55,00-50,00) x ] - Actual cost per kg ( / ) = 55,00 ( ) (15 000) Material quantity variance Budgeted number of Beta kgs per unit ( / ) 0,8 Budgeted number of Vega kgs per unit ( / ) 0,4 Standard Beta kgs to be utilised ( x 0,80) Standard Vega kgs to be utilised ( x 0,40) Beta [( ) x 30,00] ( ) Vega [( ) x 50,00] Analysis of the material quantity variance Actual quantity at actual mix Actual quantity at standard mix Standard quantities (Flexed budgeted) Beta (1) Vega (2) ) x / ( ) = ) x / ( ) = Material mix variance Beta [( ) x 30,00] (90 000) Vega [( ) x 50,00] Material yield variance Beta [( ) x 30,00] (16 800) Vega [( ) x 50,00] (14 000) (30 800) Accelerated Revision Course

17 (b) Accounting journal entries Debit Credit Raw materials: Beta ( x 30) Raw materials: Vega ( x 55) Material price variance: Vega Material price variance: Beta Bank ( ) Acquisition of raw materials Work in progress ( x x 50) Material quantity variance: Beta Material quantity variance: Vega Raw materials: Beta ( x 30) Raw materials: Vega ( x 50) Issue of raw materials to production LE3: Labour variances Labour wage rate variance [(79,20-77,60) x ] Labour idle time variance - Idle time as a percentage of clock hours (1 860 / ) 3,00% - Expected idle hours ( x 3,00%) Actual idle hours ( ) Work time as a percentage of clock hours (100,00% - 3,00%) 97,00% - Work rate (77,60 / 97,00%) Labour idle time variance [( ) x 80] Labour efficiency variance - Number of work hours per unit [( ) / ] 4,00 - Expected work hours ( x 4,00) Labour efficiency variance [( ) x 80] ( ) Accelerated Revision Course

18 LE4: Fixed overhead variances Expenditure variance ( ) (50 000) Volume variance - Budgeted overhead allocation rate ( / ) 40,00 - Number of machine hours per unit ( / ) 2,50 - Expected number of machine hours ( x 2,50) Volume variance [( ) x 40] Analysis of the volume variance - Capacity variance [( ) x 40] Efficiency variance [( ) x 40] ( ) LE5: Ex-post variance analysis Material price variance [( ) x 300] ( ) Analysis of the material price variance - Planning variance [( ) x 300] ( ) - Operational variance [( ) x 300] LE6: Standard costing and ABC Cost per driver (based on practical capacity) ( / ) 15,00 Salary charged to products ( x 15,00) Unused capacity variance [( ) x 15,00] Capacity utilisation variance [( ) x 15,00] Budgeted annual salary Expenditure variance ( ) Actual annual salary Accelerated Revision Course

19 LE6: Ex-post variance analysis If attempted, award a bonus mark The average time per batch required for 6 batches assuming a 90% learning curve is: Y = ax b A = labour hours / 6 batches A = 400 average hours per batch (1) Bonus (1) R/W Y = 400 x = hours (1) R/W Revised standard hours for 6 batches = x 6 = 1, hours (note may be rounded) (1) R/W Standard labour rate = R / labour hours = R40/hour (1) R/W Revised standard = 1, hours x R40 = R (note may be rounded) (1) R/W Planning variance caused by learning effect = (Original budgeted labour hours versus revised labour hours) x labour rate = R R [Alt: ( ,82) x R40] = R Favourable (1) R/W Operational efficiency variance = (Revised labour hours versus actual hours) x labour rate = R R [Alt: (1 827, **) x R40] = R Adverse ** [(R R16 000) / R40 = 2 800] (1) R/W Accelerated Revision Course

20 RELEVANT COSTING LE1SS: Profit maximisation Step 1: Determine the limiting factor Powder Chemical Labour Dura Powder: 160 / 0,8 x / Chemical: 250 / 0,5 x / Labour: 300 / 200 x Cell Powder: 240 / 0,8 x / Chemical: 450 / 0,5 x / Labour: 400 / 200 x Ready Powder: 280 / 0,8 x / Chemical: 700 / 0,5 x / Labour: 500 / 200 x Total budgeted requirements Total available capacity (Shortfall) / Surplus (1 800) Limiting factor? Yes No No Step 2: Calculate the contribution per unit Dura Cell Ready Gross profit per unit Fixed overheads per unit Contribution per unit Step 3: Calculate contribution per limiting factor Dura Cell Ready Contribution per unit (a) Requirements of limiting factor per unit (b) Dura: (160 / 0,8) / Power: (240 / 0,8) / Ready: (280 / 0,8) / ,20 0,30 0,35 Contribution per kg of Powder ((a) / (b)) 6 700, , ,26 Ranking (highest to lowest) Step 4: Limiting factor requirements from contracts Dura Cell Ready Contracted units (a) Number of Powder kgs required per unit (b) 0,20 0,30 0,35 Total Powder requirements ((a) x (b)) Accelerated Revision Course

21 Step 5: Determine Powder available for production Total Powder available in upcoming period Total Powder requirements for existing contracts (11 600) Total Powder available for the remaining production Produce the highest ranking production up to its demand - Dura ** Desired production (3 400 / 0,2) ** Maximum production as a result of limitation of demand ( ) ,20 (1 000) - Power ** Maximum production as a result of remaining Powder kgs (3 400 / 0,3) ,30 (2 400) Remaining Powder kgs - Step 6: Determine the optimal production mix Dura Cell Ready Contract requirements General sales Total production and sales Gross profit per unit Total profit Total company net profit Accelerated Revision Course

22 LE2: Advise management on whether Product A should be discontinued? Impact on Product B existing sales (5% x ) ( ) Impact on volume rebate Total material purchases Total units acquired Direct materials per unit, after rebate 10,80 Direct materials per unit, before rebate (10,80 / 0,90) 12,00 Volume rebate per unit (12,00-10,80) 1,20 Lost rebate ( x 1,20) (Purchases < units) ( ) Savings on materials for Product A ( x 12) Alternative approach Existing direct raw materials Future purchases of Product B materials ( x 12) Total material cost savings Lost sales of Product A ( ) Attributable fixed costs to be saved - Depreciation (non-cash flow) - - Proceeds from the sale of machine ( ) Direct labour costs ** Supervisor's salary Total labour costs Labour costs attributable to unskilled labour (5 700 x 8 x 12) ( ) Supervisor's salary Supervisor's salary to be saved Retrenchment package for supervisor ( ) ** Unskilled labour force Retrenchment costs for 6 unskilled workers ( ) Salary savings for 6 unskilled workers (5 700 x 6 x 12) Relocated labour force - Total common fixed costs (15% x ) Net benefit / (cost) of discontinuing Product A (40 160) Therefore, do not discontinue Product A as it will result in a negative contribution to common fixed costs Accelerated Revision Course

23 LE3: Should Component Z continue to be acquired externally or should it be manufactured internally? Cost of producing Component Z internally Depreciation of machine (non-cash flow) - Direct materials Direct labour costs Total labour hours required for Component Z (0,5 x ) Note: The rational assumption is that CA Ltd will desire to produce enough Component Z in order to meet the demand requirements of Product X. Therefore, 12,000 units would be produced instead of 10,000 units. Total labour hours available - at standard rate (1 000) Total labour hours shortfall Total labour hours available - at overtime rate (1 200) Total labour hours to be sourced from reducing production Contribution per labour from the existing product (30 / 2) 15,00 Alternative 1 Therefore, cost of labour Labour hours at standard rate (20 x 1 000) Labour hours at overtime rate (20 x 1.5 x 1 200) Labour hours sourced from existing production (3 800 x 20) Lost contribution on the product whose production is reduced (3 800 x 15) Alternative 2 Number of units to be reduced to obtained hours required (3 800 / 2) Contribution per unit lost 30 Total contribution lost Labour hours at standard rate (20 x 1 000) Labour hours at overtime rate (20 x 1.5 x 1 200) Labour hours sourced from existing production is reduced (3 800 x 20) Lost contribution on the product whose production is reduced (1 900 x 30) Alternative 3 Contribution per unit lost 30 Labour cost to incurred whether production is cut or not - irrelevant, therefore add back (2 x 20) 40 Contribution per unit lost 70 Labour hours at standard rate (20*1,000) Accelerated Revision Course

24 Labour hours at overtime rate (20 x 1.5 x 1 200) Labour hours sourced from existing production (1 900 x 70) Alternative 4 Contribution per unit lost 30 Labour cost to incurred whether production is cut or not - irrelevant, therefore add back (2 x 20) 40 Contribution per unit lost 70 Number of hours required 2 Contribution per labour hour lost 35 Labour hours at standard rate (20 x 1 000) Labour hours at overtime rate (20 x 1.5 x 1 200) Labour hours sourced from existing production (3800 x 35) Additional contribution to be generated from production enough Component Z to be meet external demand Total available Component Z Existing supply of Component Z (10 000) Total additional Component Z available Number of Component Z required per Product Y ( / 5 000) 2 Additional Product Y to be produced from the additional 2,000 Component Z Contribution per Product Y 20 Add back cost of purchase of Component Z ((15+1) x 2) 32 Total contribution per Product Y before Component Z 52 Therefore, additional contribution to be generated (1 000 x 52) (52 000) Total cost of manufacturing Component Z internally Number of Component Z to be produced Cost per Component Z 17,92 Cost of purchasing Component Z externally (including delivery costs) 16,00 Therefore, it is cheaper to continue to purchase Component Z externally Accelerated Revision Course

25 LE4: Special order Material A (100 x 2 x 165) (33 000) 1 All units need to be purchased externally and therefore the replacement price is applicable Marks Material B Items which no alternative use [( ) x 30] Disposal costs that would have been incurred would be saved and therefore this would represent a relevant benefit to the project Additional units to be obtained either through cutting production from special order or import Special order contribution ( / 3) China import (11 / 0,0625) It is cheaper to import than to reduce the production of special order Cost of additional Material B required [( ) x 176] (26 400) 1 Material C Options available to JML before special order - Proceeds from returning to a supplier Modification ** Modification costs (80 x 15) (1 200) ** Cost of Material A to be saved (165 x 415] Therefore, JML would have modified Material C 1 Options available to JML after special order - Net benefit from modification Purchase of Material C externally (805 x 80) Therefore, JML should continue with the modification 1 Cost of Material C (805 x 100) (80 500) 1 Labour hours Total labour hour requirements 800 Available labour hours (500) Labour hour shortfall to be sourced from reducing production 300 Kettles Toasters Contribution per unit Number of labour hours per unit 1,2 1,8 Contribution per labour hour Rank, in terms of highest contributor per labour hour 2 1 Accelerated Revision Course

26 Therefore, JML should source the additional hours from cutting production of Kettles 1 Total cost of labour - Normal time, no cost attached to spare capacity - 1C - Overtime (300 x 1,5 x 90) (40 500) 1C - Kettles labour hours (300 x 120) (36 000) 1C Total cost of special order ( ) Total consideration Contribution from the special order C Conclusion / Recommendation: Accept special order as it generates a positive contribution 1C Available marks 25 Maximum marks 25 Accelerated Revision Course

27 PRINCIPLES BASED LECRURE EXAMPLES LE4.1 LE4.2 LE4.3 RC is Rnil (because the entity does not need to sacrifice any benefit nor does it save any costs by using the materials) RC = +R250 (R2,50/m x 100) (This is actually a relevant benefit because the entity saves on scrapping cost by accepting the special order) RC = R1 050 (R10,50 x 100) (This is an opportunity cost, as defined, because, in accepting the order, the entity has to forgo a benefit that would otherwise have been generated had the order did not exist) LE4.4 RC = R1 200 (R12 x 100m) (The entity is dealing with an irrational buyer who is willing to buy Material C from CA Ltd at a price that is above the current market price of R12/m. CA Ltd would therefore need not forgo any sale as it can afford to sell at R15/m to the buyer and go replace for the special order at R12/m. Therefore, by accepting the order it generates a benefit of R3/m but had it rejected the order it would have generated R15/m. Therefore, the only benefit forgone is R15/m R3/m = R12/m. Another way of looking at it, is to acknowledge that by accepting the order, the entity is obliged to replace Material C following the sale something which it does not have to do should it reject the order. This is because the material is not required for future use as it is from a discontinued product.) LE4.5 RC = R1 200 (R12/m x 100) As rational beings, management would want to obtain Material C as the least possible cost for the order. In this case management is faced with two decisions: should it buy from the supplier or sacrifice the product to be manufactured. In most cases, if not all, it is likely that buying is cheaper than sacrificing the products. Pause and think about it. Why would an entity get into manufacturing if it could simply acquire goods and on sell them to other parties for cheaper? (Now that will not be a rational manager). With that in mind, management has a choice of purchasing Material C off the shelf at R12/m or cut production. With respect to cutting production, the simplest way to deal with this is to assume a selling price of R100/m. This would imply that the contribution has been calculated as follows: SP Material C Other variable costs = R8/m, then R100 (assumed) (1 x R10) R82 (balancing figure) = R8/m. However, given that Material C is already on hand, the entity does not need to go to the market to buy Material C and therefore no incremental cash flows relating to this input. As a result, the real cash contribution to be considered is the selling price lost if the order is accepted less other variable costs to be saved as the product will not be manufactured if the product is not going to be sold. The cash contribution would be R100 R82 = R18/m. Alternatively, the most recommended manner of dealing with this is to add back the cost of Material C because it is not an incremental cash flow to be considered, therefore R10 + R8 = R18/m. This makes cutting production more expensive compared to buying the item off the shelf at R12/m. The rational manager would elect to purchase Material C off the shelf. Accelerated Revision Course

28 LE4.6 RC = R1 800 (R18/m x 100m) (Cost of cutting production = R18/m (see previous example) versus cost of buying off shelf is R25/m. The rational manager would again elect the cheapest option) LE4.7 RC = R1 800 (R18/m x 100) (See below for analysis) Solution to LE4.7 Comment Selling price (assumed) R100 Any starting figure is appropriate Material C (4m * 10) (R40) This will not result in additional cash flows as it is already on hand Other variable costs (R28) This is always the balancing figure Contribution Contribution Add back Material C Cash contribution per unit Number of Material C Contribution per m (72/4) R32 R32 R40 R72 4m R18 The contribution is per unit and is not comparable with the replacement cost In order to determine the cost per m, we require the number of units of m required to generate the contribution per unit Now this is the appropriate cost to compare with the replacement cost LE4.8 LE4.9 LE5.1 LE5.2 LE5.3 LE5.4 The current replacement cost is R25/m. The rational manager would once again elect to sacrifice production in order to obtain the required amount of Material C required for the special order RC = R2 500 (R25/m x 100) (Material C would need to be replaced irrespective because it is required for the production of the main product of the company. Therefore, no sale would be lost as additional Material C would be acquired again before the lost sale). RC = R312,50 (R12,50 x 100m / 4) (Should the entity accept the project, it would be unable to use Material C as a replacement for Material A and therefore additional Material A would need to acquired. Thus the replacement cost would be cheaper). RC = R2 500 (Obviously!) RC = R (17 batches x R600/batch) Existing production: / 6 = 166,7 167 batches Existing production and special order: / 6 = 183, batches Therefore, additional 17 batches ( ) are required because of special order Do not do this RC = 110 / 6 = 17 batches x R600 if input is in regular use RC = R (17 batches x R600 / batch) (110/6 = batches) For exam purposes, a mark may be available for indicating that additional units of m have a cost of Rnil Therefore = 102 (17 x 6) 100 (required) = 2m, RC = Rnil RC = R (17 batches x R600/batch) RC unused capacity = R1/m x 2 = R2 (in an exam, this could have a significant impact) Total RC = R (R R2) Accelerated Revision Course

29 LE6.1 Spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (45) Total budgeted labour hours available 115 Total Product N requirements (100) Surplus labour hours 15 Cost of 100 labour hours, no incremental costs - LE6.2 No spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (120) Total budgeted labour hours available 40 Total Product N requirements (100) Shortfall in labour hours (60) Cost of 40 labour hours, no incremental costs - Cost of 60 labour hours (60 x / 160 x 1,5) LE6.3 No spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (160) Total budgeted labour hours available - Total Product N requirements (100) Shortfall in labour hours (100) Cost of reduced production (120 / 1,5) 80 Cost of overtime labour hours ( / 160 x 1,5) 113 Cost of 100 labour hours (80 x 100), cheaper to reduce production LE6.4 No spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (160) Total budgeted labour hours available - Total Product N requirements (100) Shortfall in labour hours (100) Cost of additional employee Accelerated Revision Course

30 LE6.5 No spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (160) Total budgeted labour hours available - Total Product N requirements (100) Shortfall in labour hours (100) Cost of additional employee No overtime will be required after appointing an additional employee LE7.1 Spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (50) Total budgeted labour hours available 110 Total Product N requirements (100) Surplus labour hours 10 Cost of 100 labour hours, at variable costs (80*100) 8 x 000 LE7.2 No spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (120) Total budgeted labour hours available 40 Total Product N requirements (100) Surplus labour hours (60) Cost of 40 labour hours, at standard variable costs (40 x 80) Cost of 60 labour hours, at overtime variable costs (60 x 80 x 1,5) LE7.3 No spare capacity exists Total labour hours available (40 x 4) 160 Total budgeted requirements (120) Total budgeted labour hours available 40 Total Product N requirements (100) Surplus labour hours (60) Cost of normal labour hours 80 Cost of overtime labour hours (80 x 1,5) 120 Cost of reduced production [( ,5 x 80) / 1,5] 160 Cost of 40 labour hours, at standard variable costs (40 x 80) Cost of 60 labour hours, at overtime variable costs (60 x 80 x 1,5) Accelerated Revision Course

31 LINEAR PROGRAMMING Refer to Drury study example Accelerated Revision Course

32 DECISION UNDER UNCERTAINTY Product M Possible profit (Ax) Probability (Pr) Expected value Boom % Recession % Expected profit (A) Ax A A - Ax (A - Ax) 2 Pr (A - Ax) 2 x Pr Boom (12 000) % Recession % Standard deviation 9 797,96 Expected profit (Y) Coefficient of variation (9 797,96 / ) 8,75% Product S Possible profit (Ax) Probability (Pr) Expected value Boom % Recession % Expected profit (A) Ax A A - Ax (A - Ax) Pr (A - Ax) x Pr Boom (33 000) % Recession % Standard deviation ,33 Expected profit (Y) Coefficient of variation (50 408,33 / ) 40,98% Product S has a greater risk (as measured by the coefficient of variation) relative to Product M, a risk averse manager would select Product M because of the lower risk and the contrary will be true for a risk taking manager. The manager who is risk -neutral would elect the product with the higher expected profit, therefore Product M Accelerated Revision Course

33 DIVISIONAL PERFORMANCE MEASUREMENT (a) Divisional return on investment SA Ltd Africa Ltd Marks Profit before tax Other income, arises from non-controllable assets (1) (8 500) (16 800) 2 Controllable profit before tax Divisional assets Cash balances, not within the control of divisional managers (1) ( ) ( ) 2 Controllable divisional assets Return on investment 15,00% 20,00% 1 (b) Evaluation of the proposed investment SA Ltd Africa Ltd Marks (i) Division profit Additional annual contribution Decision Marks SA Ltd would accept the proposed investment as the proposed project increases the divisional annual contribution. 1 Africa Ltd would accept the proposed investment as the proposed project increases the divisional annual contribution. 1 (ii) Return on investment SA Ltd Africa Ltd Marks Additional annual contribution Capital investment required Return on investment ( / ; / ) 16,00% 19,00% 1 Existing return on investment 15,00% 20,00% 1 Decision Marks SA Ltd would accept the proposed investment as the return on the proposed investment is higher than its existing return on investment. 1 Africa Ltd would reject the proposed investment as the return on the proposed investment is lower than its existing return on investment. 1 (c) Assessment of goal congruency Marks The weighted average cost of CA Ltd is 18% and this will be the minimum hurdle rate for evaluation of projects. 1 Therefore, the decision to accept all projects that exceed the 18% hurdle rate would be promote goal congruency. 1 For goal congruency to be achieved, SA Ltd's proposed investment should be rejected and Africa Ltd's proposed project should be accepted. 1 Accelerated Revision Course

34 However, based on ROI, SA Ltd would accept the proposed investment and this will not promote goal congruency because the ROI of 16% is below the hurdle rate of 18%. 1 In addition, based on the ROI, Africa Ltd would reject the proposed investment and this will not promote goal congruency because the ROI of 19% is above the hurdle rate of 18%. 1 LE2: Residual income Marks Additional divisional contribution Capital charge ( x 18%; x 18%) ( ) ( ) 1 Residual income ( ) Decision Marks SA Ltd would reject the proposed investment because the residual income of the proposed investment is higher than its existing return on investment. 1 Africa Ltd would accept the proposed investment because the residual income on the proposed investment is lower than its existing return on investment. 1 Accelerated Revision Course

35 LE3: EVA Marks Net operating profit after tax (NOPAT) Net income for the year Adjustment in respect of: - Add back finance related costs, interest ( x 72%) Add back non-cash items, bad debts Add back non-cash items, depreciation Deduct economic depreciation ( ) 1 - Add back discretionary item, research and development Amortise discretionary item, research and development ( / 4) ( ) 1 NOPAT Controllable investment Controllable investment (given) Carrying amount of non-current assets ( ) ½ Market value of non-current assets ½ Capitalised research and development ( ) Capitalised non-cash expenditure Adjusted controllable investment Capital charge ( x 15%) C EVA ( ) C Accelerated Revision Course

36 LE4: Practical application Shortcomings of the current incentive scheme It is solely based on revenue - no regard is made to the cost of production. 1 The profitability of each product is ignored - this could result in sales representatives directing their efforts to a less profitable product. 1 Profitability of product based on gross profit margin: Product Z (100 / 1 000) = 10%; Product Y (50 / 200) = 25%. 2 Although the selling price of Product Z is 5 times greater than the selling price of Product Y, the profitability (as measured by the gross profit margin) of Product Z is much higher. 1 Based on the above it, it is likely that the sales representatives will aggressively pursue Product Z, despite it being the less profitable one for the company. 1 Furthermore, the costs of generating a sale are not taken into consideration. 1 The sales representatives could carelessly incur significant costs to generate a sale (e.g. client visits, dinners, transport calls, etc.). 1 The sales representatives could sell products to customers who are not creditworthy in attempt to increase sales. 1 This could result in significant bad debts to the company which might cause liquidity problems for the company. 1 The commission is paid a week after the end of the quarter. 1 If a significant amount of the sales is locked in receivables, this could result in cash flows problems for the company. 1 Furthermore, this could be worsened if the sales representatives have sold a significant amount to uncreditworthy customers as their cash would not be receivable. 1 The commission appears to be based on gross revenue. 1 No attempt appears to be made to set a revenue target or threshold on which the commission would be payable. 1 The sales representatives might be complacent and take no initiative to grow the revenues and/or market share of the company. 1 The incentive scheme seems to suffer from being a short term measure. 1 The sales representative could sell to customers would are not entirely certain of the goods and who would later return them in the next quarter - no indication of whether goods returned will result in reduction in commission paid. 1 Although extreme, sales representatives could engage in fraudulent activities and generate invoices in order to obtain commission for fictitious sales. 1 The sales commission is between a range of 2% - 5%. 1 No indication of how the final percentage level is determined, therefore it might lack transparency or objectivity. 1 Remedies / Improvements Incremental costs should be taken into account, i.e. production costs and costs of generating a sale direct or all costs? 1 These costs could be based on predetermined rates, i.e. standard costs rather than actual costs. 1 Non-financial measures need to be considered as these might be important for the long term sustainability of the company, e.g. market share, customer satisfaction, etc. 1 The period of assessment could be lengthened, e.g. six-monthly basis or annual basis. 1 Marks Accelerated Revision Course

37 The use of bonus bank whereby a bonus is banked every, say, six months and the bonus amount only payable after six months could be considered in order to avoid fraud, unethical behaviour of selling to customers that are not creditworthy. 1 The bonus would be reduced during the period before payment date for returns and/or bad debts written off. 1 A credit policy should be in place - all deviations would need to be approved by a senior official or customers need to be vetted before credit transaction concluded 1 Sales targets, based on prevailing market conditions, should be set on a quarterly or six monthly basis. 1 These targets should be fair and be aligned with the company's overall objectives. 1 The commission rate should be based on the sales targets - thus making it transparent and motivating. 1 Any other valid, well-reasoned points would earn full credit Accelerated Revision Course