Management Accounting Pilot Paper 3 Questions and Suggested Solutions
NOTES TO USERS ABOUT PILOT PAPERS Pilot papers are published by Accounting Technicians Ireland. They are intended to provide guidance to students and their teachers regarding the style and type of question, and their suggested solutions, in our examinations. They are not intended to provide an exhaustive list of all possible questions that may be asked and both students and teachers alike are reminded to consult our published syllabus (see www.accountingtechniciansireland.ie) for a comprehensive list of examinable topics. There are often many possible approaches to the solution of questions in professional examinations. It should not be assumed that the approach adopted in these solutions is the only correct approach, particularly with discursive answers. Alternative answers will be marked on their own merits. This publication is copyright 2010 and may not be reproduced without permission of Accounting Technicians Ireland. Accounting Technicians Ireland, 2010. 2
INSTRUCTIONS TO CANDIDATES In this examination paper the symbol may be understood and used by candidates in Northern Ireland to indicate the UK pound sterling and the symbol may be understood by candidates in the Republic of Ireland to indicate the Euro. Answer FIVE questions. Answer all three questions in Section A. Answer ANY Two of THREE questions in Section B. If more than the required number of questions is answered in Section B, then only the requisite number, in the order filed, will be corrected. Candidates should allocate their time carefully. All figures should be labelled, as appropriate, e.g.,, units etc. Answers should be illustrated with examples, where appropriate. Question 1 begins on Page 2 overleaf. 3
SECTION A Answer All Questions QUESTION 1 Gamble Ltd has noted a number of market fluctuations in relation to sales of two specific products Amber and Venus. They are concerned that their products are appropriately costed and priced. The company uses a cost mark up pricing policy and uses a pre-determined overhead absorption rate based on direct labour hours. The rate is calculated at the start of the year based on the following information:- Production overhead 1,200,000 Direct labour hours 50,000 Machine hours 100,000 Set up hours 1,000 You have carried out preliminary investigations and have identified the following additional product information :- Amber Venus Direct materials 250 350 Direct labour hours 10 20 Machine hours 80 25 Set up hours 1 2 Mark up 50% 40% Direct labour rate 15 15 Further analysis of production overheads and supporting information reveals the following:- Set up Maintenance Cutting Assembly TOTAL Indirect 50,000 50,000 100,000 100,000 300,000 Materials Supervision - - 160,000 180,000 340,000 Support Costs 50,000 50,000 120,000 120,000 340,000 Depreciation - 25,000 145,000 50,000 220,000 1,200,000 You have been asked to analyse the information and make relevant calculations using traditional and modern costing methods, to inform decisions on pricing. 4
QUESTION 1 (Cont d) Requirement (a) Calculate the predetermined overhead absorption rate used by Gamble Ltd at the start of the year. 2 marks (b) Calculate the standard cost and the sales price of Amber and Venus, using the predetermined overhead absorption rate. 6 marks (c) Identify suitable alternate cost pools and cost drivers for Gamble Ltd. 2 marks (d) Calculate an activity based overhead absorption rate. 4 marks (e) Calculate the cost and the sales price of Amber and Venus using the activity based overhead absorption rate. 6 marks Total: 20 marks QUESTION 2 ROBENS Ltd manufactures and sells an electrical component. The company have had a good first year s trading although they have struggled to manage cash flows because of initial set up costs incurred. The bank balance at the start of Year 2 is projected to be an overdraft of 85,000 and in preparation for a meeting with the account manager you have gathered the following budgetary information:- The current sales price is currently / 5.50 per unit and this is expected to increase to /6.00 per unit at the start of Quarter 2. Sales are projected for each quarter as follows:- Year 1 Quarter 4 Year 2 Quarter 1 Quarter 2 Quarter 3 Quarter 4 50,000 units 50,000 units 40,000 units 30,000 units 70,000 units All sales are on credit and debts are settled in the quarter following sale. Bad debts of 5% of total sales are anticipated. The company normally holds a closing stock of 20,000 units at the end of each quarter The electrical components are produced in batches of 2,000. Each batch requires 200 direct labour hours and 800 kg of raw materials. 5
QUESTION 2 (Cont d) Direct labour is projected at a rate of /16.00 per hour for Quarter 1 and at / 16.50 thereafter. Raw materials cost /5 per kg and are expected to increase by 5% with effect from Quarter 3. The company has agreed an average of 90 days credit with its main suppliers. General overheads are projected to be /25,000 per month. Requirement (a) Prepare a cash budget for ROBENS Ltd for Year 2, providing quarterly balances. 14 marks (b) Prepare a report setting out: - the benefits of good budgetary control; - typical problems encountered in exercising budgetary control. 6 marks Total: 20 marks QUESTION 3 The following information has been provided by OLYMICE Ltd in relation to a particular product line for the month of December: Materials Price Variance Materials Usage Variance Labour Rate Variance Labour Efficiency Variance 19,000Adv 5,450 Fav 12,480Fav 18,720 Adv Production output Materials Labour 12,000 units 517,750 for 95,000 Kg 486,720 for 62,400 hours Requirement (a) Using the information provided prepare a standard cost sheet for this product. 14 marks (b) Provide a possible explanation for the material and labour variances reported. 6 marks Total: 20 Marks 6
SECTION B Answer any two of the following questions QUESTION 4 Rich Fashions Ltd has carried out market research which indicates that the next year will see a recession in sales demand. Projected sales for the months of January, February and March are 20,000 per month representing 50% of production capacity rising to 40,000 in April, May and June (75% of production capacity). The following information has been ascertained Normal operational costs per annum are estimated as follows: Capacity Level 50% 75% 100% Direct Labour 100,000 150,000 200,000 Direct Material 75,000 112,500 150,000 Premises Overheads 51,000 62,500 65,000 Administration Costs 40,000 45,000 50,000 Miscellaneous Expenses 10,000 15,000 15,000 Normal sales turnover would be 65,000 per month if the company is trading at full capacity. Upon closing down, exceptional costs of 15,000 are anticipated. Restart costs are estimated at 10,000, annual cost of maintaining buildings is 5,000 and the retention of key personnel would cost 2,000 per month. The company premises, which have freehold ownership, are valued at 600,000, but in the current climate, it could take up to a year to sell at this price. Requirement: Prepare a report to the Directors of Rich Fashions Ltd advising them on whether they should cease business for any period within the next six months and to advise them of other factors that need to be taken into consideration. QUESTION 5 20 marks You have been asked by you manager to assist with the induction of a new member of the finance team. After a number of days, they approach you with a number of queries about terms which have been used which they are not familiar with. These include:- Integrated cost accounting system Limiting factors Flexible budgets Cost codes 7
QUESTION 5 (Cont d) Sensitivity analysis Sunk costs Conscious of the importance placed upon clear guidance by your manager, and in order to provide material for future reference, you decide that the best approach is for you to provide your prodigy with a written paper. Requirement Prepare a briefing paper setting out an explanation and outlining the practical context of each of the above terms. 20 marks QUESTION 6 INVAR Ltd is reviewing is portfolio of products and has provided you with the following flexible budget information in relation to budgeted sales for the product VART 1 Flexed Budget 1 Flexed Budget 2 Sales (units) 40,000 50,000 Sales income 480,000 600,000 Net Profit / (Loss) (15,000) 15,000 In order to assist the sales manager with further analysis you are asked to repare a number of calculations relative to this product line. Requirement (a) Calculate the fixed costs attributable to VART 1 4 marks (b) Calculate the Contribution/Sales ratio (%) for VART 1 4 marks (c) Explain the term breakeven and calculate the breakeven point, expressed in both units and sales turnover 6 marks (d) Provide an example of a breakeven chart 2 marks (e) The company is considering a policy of requiring a target profit of 10% of turnover. Calculate the activity required to generate this target profit. 4 marks Total: 20 marks 8
Suggested Solutions QUESTION 1 a) GAMBLE Ltd Pre-determined Overhead Absorption Rate Production Overhead 1,200,000.00 Direct Labour Hours 50.000 Hrs Total Overhead per Cost Centre - 1,200,000.00 Total no of units of Absorption base 50,000 = 24.00 per direct labour hour. b) Standard Cost & Selling Price Amber Venus Direct Materials 250.00 350.00 Direct Labour 150.00 300.00 Production Overhead 240.00 480.00 Standard Price 640.00 1130.00 Mark Up (50%) 320.00 (40%) 452.00 Selling Price 960.00 1582.00 c) Cost Pools Set Up Costs Maintenance Cutting Assembly Cost Drivers Set Up Hours Machine Hours Machine Hours Direct Labour Hours 9
d) Set Up Maintenance Cutting Assembly 50,000 50,000 100,000 100,000 Indirect Materials Supervision - - 160,000 180,000 Support Costs 50,000 50,000 120,000 120,000 Depreciation - 25,000 145,000 50,000 100,000 125,000 525,000 450,000 Absorption Overhead Rate 100.00 per Set up Hr e) Gamble Ltd 1.25 per Machine Hr 5.25 per Machine Hr 9.00 per Direct Labour Hr Amber Venus Direct Materials 250.00 350.00 Direct Labour 150.00 300.00 Set Up Cost 100.00 200.00 Maintenance costs 100.00 31.25 Cutting Costs 420.00 131.25 Assembly Costs 90.00 180.00 Standard cost 1110.00 1192.50 Mark Up (50%) 555.00 (40%) 477.00 Selling Price 1665.00 1669.50 QUESTION 2 (a) ROBENS LTD CASH BUDGET YEAR 2 Quarter 1 Quarter 2 Quarter 3 Quarter 4 TOTAL Cash Inflows Debtor income 261,250 261,250 228,000 171,000 921,500 Cash Outflows Direct labour cost 80,000 64,000 49,500 115,500 309,000 Supplier payments 100,000 100,000 80,000 63,000 343,000 10
Overheads 75,000 75,000 75,000 75,000 300,000 255,000 239,000 204,500 253,500 952,000 Net Inflows/Outflows 6,250 22,250 23,500 (82,500) (30,500) Opening Balance (85,000) (78,750) (56,500) (33,000) (85,000) Closing Balance (78,750) (56,500) (33,000) (115,500) (115,500) Sales Workings Quarter 4 Quarter 1 Quarter 2 Quarter 3 Quarter 4 (Yr1) Sales 50,000 50,000 40,000 30,000 70,000 Volume Sales Price 5.50 5.50 6.00 6.00 6.00 Sales 275,000 275,000 240,000 180,000 420,000 Income Bad debt (13,750) (13,750) (12,000) (9,000) (21,000) 261,250 261,250 228,000 171,000 399,000 Debtor income 261,250 261,250 228,000 171,000 Production Calculations Quarter 4 Quarter 1 Quarter 2 Quarter 3 Quarter 4 (Yr1) Sales Volume 50,000 40,000 30,000 70,000 Closing stock 20,000 20,000 20,000 20,000 20,000 Opening Stock (20,000) (20,000) (20,000) (20,000) Production 50,000 50,000 40,000 30,000 70,000 No of batches 25 25 20 15 35 Direct labour 5,000 4,000 3,000 7,000 hrs Direct labour 80,000 64,000 49,500 115,500 cost Raw 20,000 20,000 16,000 12,000 28,000 materials(kg) Raw mats cost 100,000 100,000 80,000 63,000 147,000 Supplier payment 100,000 100,000 80,000 63,000 11
(b) REPORT ON BUDGETARY CONTROL & TYPICAL PROBLEMS The benefits of budgetary control include: Improved planning and co-ordination The preparation of formal budget plans requires detailed planning, which in turn requires the co-ordination of activities within a section or department or on an organization-wide basis. Clarification of authority and responsibility Budget preparation requires clarification of manager responsibilities. A budget can provide clear guidelines for managers and translate organizational objectives into specific tasks related to individual managers. Communication As the budgetary process will involve all levels of management, it provides a vehicle for communication and ultimately should be communicated to all staff Motivation The process of setting targets and comparing actual results with budget can be a motivating factor for staff, if correctly handled by management. This may include participation to achieve goal congruence. Control Similarly, variance reporting on deviations and from budget systematic monitoring can assist with control in an organization and allow corrective action to be taken. Efficiency Management by exception techniques facilitated by budgeting can result in more efficient use of manager time. Integration The integration of budgets can assist with cashflow and working capital management Typical problems which can arise in exercising budgetary control include: Measuring change Variance information may arise because of various changing circumstances and/or poor forecasting Market conditions Budgets are often developed internally and may not respond to changing external market circumstances In-flexibility Well documented plans can be a contributory factor to inertia and a lack of flexibility with an organization Human aspects Budgetary systems which are not well communicated can cause employee relations difficulties and impact on the morale of the organization 12
QUESTION 3 (a) Standard Cost Sheet Olymice Ltd Materials Unit Total 8kg @ 5.25/kg 42.00 504,000 Labour 5 hours @ 8/hr 40.00 480,000 82.00 984,000 Workings: DATA 95,000 Kg @ 5.45 = 517,750 62,400 hrs @ 7.80 = 486,720 Methodology Apply data to variance formulae to calculate inputs Materials Price Variance (AP SP) x AQ (5.45 x ) = 0.20 x 95,000= 19,000 Adv x = 5.25 per kg Materials Usage (AQ SQ) x AP (x 95,000) x 5.45 = 5,450 Fav x = 96,000 96,000/12,000 = 8 kg per unit Labour Rate (AR SR) x AH (7.80 x) = 0.2 x 62,400 = 12,480 Fav x = 8 per hour Labour Efficiency Variance (AH SH) x SB (62,400 x) x 7.80 = 18,720 Adv x = 60,000 60,000/12,000 = 5 hours per unit (b) Material Variances Olymice Ltd may have sourced more expensive, better quality materials for production. Accordingly these cost more, resulting in the significant adverse price variance of 19,000. However there has been less usage (perhaps less wastage or less faults) with a favourable usage variance of 5450. 13
Labour Variances Olymice Ltd s adverse labour efficiency variance of 18,720 could be attributable to less skilled or experienced staff that have proved to be cheaper to employ, hence the favourable labour rate variance, but have taken longer to do the job. Section B Question 4 Rich Fashions Ltd 1. Position if Production continues for 3 months Sales 60,000 Cost of Sales & Operations 69,000 Net Loss 9,000 2. Position if Production is continued for the next 6 months Sales 180,000 Cost of Sales & Operations 165,000 Net profit 15,000 3. Position if production is ceased for three months then restarted in April Sales 120,000 Cost of Sales & Operations 96,000 Exceptional costs 15,000 Restart Costs 10,000 Maintenance Costs (3 months) 1,250 Retention of key personnel (3 months) 6,000 Net Loss 8,250 14
4. Position if Production ceases immediately Exceptional costs 15,000 Maintenance Costs 5,000 Loss of six months profits 15,000 Loss 35,000 Company premises could be sold realising value 600,000 Opportunity cost on going loss of potential profits per annum 300,000 Rich Fashions Ltd From the calculations above you can clearly see the position of Rich Fashions Ltd after considering the four main options available to them in the short term. If production is continued the company will make a loss of 9,000 over the next three months of trading, but will return a modest profit of 15000 if sales recover to the projected position after three months. If the company closes down for three loss making months and then restarts the company s loss would increase to 8,250 over the six month period due to the exceptional and restart costs. Another more radical option is for the company to cease production immediately and permanently. This incurs an immediate loss of 23,000 but would allow the company the opportunity to realise the value of their buildings estimated to be 600,000. The opportunity cost of this is the potential profits of up to 300,000 per annum if the company is operating at full capacity. Therefore I would advise Rich Fashions to continue trading for six months (as this provides the only positive financial result) and review the position at that stage in light of market conditions. Rich Fashions should also take the following factors into consideration; Loss of customers to competitors during any period of closure short term or long term. These customers might be reluctant to return to the company when they reopened. If they lay off their existing experienced staff they will very hard to replace and any new staff will need to be trained. Rich Fashions will not be ready to take full advantage of the anticipated production capacity increase demand as the factory has to be restarted and the new staff will not have the same skills as the old staff. Staff morale will be lowered due to recent events and this will in turn affect customer confidence Other market conditions including property values Scope for developing new markets or new products to address under capacity issues Reliability of market information and projections 15
Workings Sales Calculations Jan, Feb Mar 20,000 x 3 60,000 Apr, May, June 40,000 x 3 120,000 180,000 Cost of Sales Calculation Capacity Level 50% 75% 100% Direct Labour 100,000 150,000 200,000 Direct Material 75,000 112,500 150,000 Premises Overheads 51,000 62,500 65,000 Administration Costs 40,000 45,000 50,000 Miscellaneous Expenses 10,000 15,000 15,000 Per Annum 276,000 384,000 480,000 Per month 23,000 32,000 40,000 Jan, Feb Mar 23,000 x 3 69,000 Apr, May, June 32,000 x 3 96,000 165,000 Normal Profits if trading at 100% capacity Sales 65,000 Costs 40,000 Profit per month 25,000 Profits per annum 300,000 16
QUESTION 5 Integrated cost accounting system An integrated accost accounting system is one where the cost and financial accounts are kept in the same set of books. This system avoids the need for separate set of books for financial and costing purposes but is able to provide or meet the information requirement for costing plus financial accounts. There are a number of requirements for the successful operation of an Integrated Cost Accounting System. These include:- Top management decision on the extent of integration of the two set of books re: to integrate until the stage of primary cost or factory cost or full integration. A suitable coding system must be developed to serve the purposes of both financial and cost accounting An agreed routine, with regard to the treatment of provision for accruals, prepaid expenses, other adjustments necessary for the preparation of interim accounts Proper coordination should exist between the staff responsible for the financial and cost aspect of the accounts Basically, in an integrated cost accounting system, the financial and cost transactions are recorded in an integrated ledger which is self balancing. The advantages are as follows: Savings in clerical work because one set of accounts is kept thereby reducing clerical costs; No need to reconcile financial and cost profits; No confusion arises from different stock valuations, method of depreciation and profits The probability of error is less because recording takes place in one set of accounts and Information produced on an integrated system is quicker, thus helping management in decision making Limiting factors A limiting factor prevents a company from expanding to infinity. Limiting factors affect budgeting and they must be considered to ensure that the budgets can be attained. Examples are: raw material shortage, labour shortage, insufficient production capacity, low demand for products, lack of capital, etc The principal budget factor is the factor that limits the activities of an organization because such a limit/constraint will have a pervasive effect on all plans and budgets. The limiting factor must be identified during the budget preparation process Examples of principal budget factors are:- Shortage of labour material Shortage of production capacity. Shortage of finance or working capital 17
Shortage of demand for goods or services. Flexible budgets A flexible budget is a budget which is designed to change in accordance with the level of activity attained. It is also known as Variable budget as the budget recognises the difference in cost behaviour namely fixed and variable costs in relations to fluctuations in output or turnover. The budget is designed to change appropriately with such fluctuation. For a fixed budget, the budget remains unchanged irrespective of the level of activity actually attained. The fixed budget is prepared based only on one level of output. Therefore, if the level of output actually achieved differs considerably from that budgeted, large variances will arise. 18
The difference between Fixed and Flexible Budget are: For a fixed budget, the figures are for a SINGLE level of activity while a flexible budget is prepared for DIFFERENT levels of activity; Under fixed budgets, managers are held responsible for variances not under his control ( both fixed and variable cost); The fixed budget is never able to assess properly the efficiency and actual performance of the manager. For example, a fixed budget is set with a planned 8,000 hours but an actual 10,000 hours are recorded, from both the motivational or control point, it is difficult to gauge the efficiency of the managers who are involved in the manufacture of the output at that actual level; The flexible budget allows more meaningful comparison as it flex s to the actual volume. It computes what costs should have been for the actual level of activity and The flexible budget has the advantage of assisting the managers deal with uncertainty by allowing them to see the expected outcomes for a range of activity; Cost codes Job Cost Management modules enable you to effectively manage jobs from revenue and cost perspective. To do this effectively, we allow for a work breakdown, which we refer to as a cost code. User defined cost codes can be established by type of job. Cost Analysis by cost-code links each class of expense with budget. These reports may be selected by job range, open or complete jobs, department, or division. Features: Cost codes are user defined. They may be customized to your needs and preferences. You may set up a different code structure for each job. Balancing your jobs to general ledger is easy because nothing hits job cost with out hitting general ledger. Reporting of labour burden cost allows you to have a more accurate job cost by allowing you to see not only what you pay an employee, but also what he/she is costing you in invisible cost. Sensitivity analysis Sensitivity analysis is implemented to analyze the various risks to the project by looking at all aspects of the project and their potential impact on the overall goal. Knowing the level of impact various elements have on a project can assist management with setting priorities to more quickly achieve the end result. Sensitivity analysis facilitates comparisons between the various elements to quickly discern which risks are worth taking. Project management can use sensitivity analysis to create priorities in dealing with elemental risks to the project. By knowing which affects the objective the most, more efforts can be concentrated to lessen that risk. Lowering risk potential allows for projects to flow in a smoother fashion with fewer unexpected delays. 19
Sunk Costs: Sunk cost is a past cost not directly relevant in decision making. If we refer to relevant costs, the main feature is that we are referring to future costs. As Sunk costs are cost which have already been incurred therefore it should be ignored when making any decisions. Sunk costs are irrelevant costs which are simply costs that will not affect the decision. By analysing these types of sunk costs, management will be wasting their time and efforts as these costs do not affect the decision they are going to make. In short term decision making, fixed costs are generally regarded as sunk costs. Say Company A has a factory which produced product A. Earlier last year it has extended and renovated the factory at an additional cost of 200,000 to produce product B. Now management is thinking of whether to let outsiders produce product B or not. Should this 200,000 be considered? 200,000 is sunk costs which existed as a result of previous decision. Sunk costs are costs which cannot be recovered once they have been incurred. Sunk costs are sometimes contrasted with variable costs, which are the costs that will change due to the proposed course of action, and prospective costs which are costs that will be incurred if an action is taken. Only variable costs are relevant to a decision. 20
QUESTION 6 (a) Fixed Costs Working Flexed Budget 1 Flexed Budget 2 Per unit Sales income 480,000 600,000 12 Variable Cost 360,000 450,000 9 Contribution 120,000 150,000 3 Fixed Costs 135,000 135,000 Net Profit / (Loss) (15,000) 15,000 The increase in sales from Flexed Budget 1 to Flexed Budget 2 is 10,000 units. This results in increased sales revenue of 120,000 hence the sales price per unit can be calculated at 12. The increase in profits from Flexed Budget 1 to Flexed budget to is 30,000. As only variable costs increase these can be calculated at 90,000 (120,000-30,000) which is 9 per unit. The increase in profit of 30,000 represents the additional contribution of 10,000 units of additional sales hence the contribution per unit is 3. Fixed costs can be calculated as the balancing figure in either Budget as follows: Contribution Net Profit = Fixed Costs Fixed Costs = 135,000 (b) Contribution/Sales ratio Contribution per unit x 100 = 3 x 100 = 25% Sales price per unit 12 (c ) Breakeven Point Breakeven Point is the term used in cost volume profit analysis for the point at which neither profit nor loss occurs. At breakeven, contribution exactly covers the fixed costs of an organisation or unit. The breakeven point can be expressed in the number of sales units or in sales revenue. To find the number of units required to breakeven, the fixed cost is divided by the contribution per unit. In a multi product situation the break even revenue is calculated by dividing fixed cost by the contribution sales value Fixed Costs = 135,000 = 45,000 units Contribution per unit 3 21
d) Breakeven Chart Please refer to page 203 2010/2010 Management Accounting Manual. (e) The level of activity which will yield a profit of 10% of turnover Calculation of Revised Contribution/Sales Ratio Original C/S ratio 25% Profit requirement 10% Revised C/S Ratio 15% (for calculation of target profit) Revised breakeven calculation to achieve target profit calculation Fixed Costs = 135,000 = 900,000 = 75,000 units Revised C/S ratio 15% sales 22