Cost Accounting for decision HKDSE (2016, 7) (Limited Company) Anson Company started to manufacture a toy plane, Hippo, as its only product line in 2015. It uses the absorption costing system. The cost information for Hippo is given below: $/unit Direct materials 18 Direct labour 12 Total manufacturing overheads 6 (i) The total manufacturing overheads include both variable and fixed manufacturing overheads, based on the production of 10,000 units of Hippo each year. (ii) Fixed manufacturing overheads for 2015 were estimated to be $40,000, which was the same as the actual amount. (iii) The company hired two salesmen for a total annual salary of $128,000 to sell Hippo. On top of the salary, there was an incentive payment to the salesmen of 5% of sales (iv) Hippo was sold at a selling price of $60 per unit. (v) The actual production and sales of Hippo for 2015 were 10,000 units and 9,000 units respectively. The company is considering using the marginal costing system. (a) Prepare for Anson Company the income statement for the year ended 31 December 2015 using the marginal costing system. Show separately the contribution and the net profit. (b) (i) Calculate the amounts of inventory as at 31 December 2015 under the marginal and absorption costing systems respectively. (ii) Explain the reason for the difference in the amounts of inventory in (b)(i) above. (c) Compare the net profits of 2015 under the marginal and absorption costing systems. Anson Company receives an offer from a local supplier to supply a component for Hippo at a price of $5.7 per unit. The company estimates that if the supplier s offer is accepted, variable manufacturing overheads will be reduced by $0.2 per unit direct labour cost will be reduced by 10% and direct materials cost will be reduced by $4.5 per unit. (d) Explain, with supporting calculations, whether Anson Company should continue to manufacture the component or purchase it from the local supplier. 145
(a) Anson Company Income Statement for the year ended 31 December 2015 using marginal costing $ $ Sales (9,000 $60) 540,000 Less: Variable cost of goods sold: Direct materials (10,000 $18) 180,000 Direct labour (10,000 $12) 120,000 Variable manufacturing overheads (10,000 $2) (W1) 20,000 320,000 Less Closing inventory [1,000 x (320,000 10,000)] (32,000) 288,000 Product contribution margin 252,000 Less Variable non-manufacturing overheads ($540,000 x 5%) 27,000 Total contribution margin 225,000 Less: Fixed manufacturing overheads 40,000 Fixed non-manufacturing overheads 128,000 168,000 Net profit 57,000 Variable production overheads per unit = (10,000 x 6 40,000)/10,000 = $2 (b) (i) Under the marginal costing system, The amounts of inventory as at 31 December 2015 = $32,000 Under the absorption costing system, The amounts of inventory as at 31 December 2015 = $32,000 + $40,000/10,000 = $36,000 (ii) Under marginal costing, only variable costs are included in the cost of production and the fixed manufacturing overheads are written off as period costs. However, under absorption costing, fixed and variable manufacturing overheads are both recognized as the cost of production, thus the fixed manufacturing overheads will be absorbed by the closing inventory. (c) The difference in closing inventory under the marginal and absorption costing = $36,000 $32,000 = $4,000 The net profit of 2015 under absorption costing is higher than that under marginal costing by $4,000. (d) Comparison between the relevant costs of making the component itself and buying from outside: Make $/unit Buy $/unit Direct materials 18 13.5 Direct labour 12 10.8 Variable manufacturing overheads 2 1.8 Purchase costs 5.7 Total relevant cost per unit 32 31.8 Anson Company should purchase it from the local supplier because this can reduce the relevant cost of production by $0.2 per unit. 146
HKDSE (2015, 7) (Decision-making) Susan Café operates its own bakery and produces cookies and cupcakes. Information on the two products is as follows: Cookies Cupcakes Selling price per box $290 $390 Direct material cost per box $20 $120 Direct labour hour per box 1 hour 1 hour 3 2 Labour wage rate per hour $90 $90 Variable production overheads per box $15 $15 The bakery produces and sells 2400 boxes of cookies and 1800 boxes of cupcake per year. Production overhead are allocated on the basis of direct labour hours. Details of annual fixed production overheads for the bakery are as follows: $ Supervisor s salary $286 000 Depreciation on equipment $80 000 Rent $144 000 (a) Calculate the following for the bakery: (i) the predetermined fixed production overhead absorption rate (ii) the total production cost per box of cupcakes A local supplier offered to supply Susan Café with all the cookies and cupcakes it needed. The prices were $170 per box for cookies and $270 per box for cupcakes. The offer was conditional that Susan Café must buy both products. In other words, the supplier would not supply just one type of product for the price indicated. If the offer was accepted, all the equipment would be scrapped and the bakery would be closed. (b) Explain, with supporting calculations, whether Susan Café should continue to produce its own cookies and cupcakes, or purchase them from the local supplier. Finally, Susan Café decided to produce its own products, for better quality control. The bakery is operating at only 85% of its full capacity of 2000 direct labour hours per year. It is therefore decided that one more product, shortbread, will be produced to fully utilize the capacity of the bakery. The estimated annual demand for shortbread is 3900 boxes and the selling price is $370 per box. Additional information on the production of shortbread is provided below: Direct material cost per box $180 Direct labour hour per box 1 hour 6 Labour wage rate per hour $90 Variable production overheads per box $15 (c) (i) Calculate the contribution per direct labour hour for each of the three products. (ii) To maximize the total contribution of the bakery at its full capacity, calculate the annual production quantity for each of the three products. 147
(a) (i) The predetermined fixed production overhead absorption rate = $286 000 + $80 000 + $144 000 / (1/3 x 2400 + 1/2 x 1800) = $510 000 / 1 700 = $300 per labour hour (ii) Total production cost per box of cupcakes = $120 + 1/2 x $90 + $15 + 1/2 x $300 = $330 (b) Purchasing Cookies Cupcakes Purchases price per box $170 $270 Total purchasing cost = $170 x 2 400 + $270 x 1 800 = $894,000 Producing Producing Purchasing Direct material ($20 x 2400 + $120 x 1800) 264,000 Direct labour ($90 x 1/3 x 2400 + $90 x 1/2 x 1800) 153,000 Variable production overheads ($15 x 2400 + $15 x 1800) 63,000 Fixed production overheads (exclude depreciation) 430,000 Purchasing cost 894,000 Total producing cost 910,000 894,000 Depreciation on equipment is irrelevant because it is a sunk cost. Net savings by purchasing : $16,000 Susan Café should buy cookies and cupcakes from the local supplier. (c) (i) Cookies Cupcakes Shortbread Selling price per box $290 $390 $370 Less: Direct material cost per box $20 $120 $180 Direct labour cost per box $30 $45 $15 Variable production overheads per box $15 $15 $15 Contribution per box $225 $210 $160 Direct labour hour per box 1/3 hr 1/2 hr 1/6 hr Contribution per direct labour hour $675 $420 $960 Production Priority 2 nd 3 rd 1 st (ii) According to the contribution per direct labour hour for each of the three products, the priority of the production should be shortbread, cookies and cupcakes. The direct labour hours required for making 3900 boxes of shortbread = 1/6 X 3900 = 650 hours The direct labour hours required for making 2400 boxes of cookies = 1/3 x 2400 = 800 hours The direct labour hour left for producing cupcakes = 2,000 650 800 = 550 hours The number of boxes of cupcakes produced = 550 x 2 = 1100 boxes The annual production quantity for cookies, cupcakes and shortbread are 2400 boxes, 1100 boxes and 3900 boxes respectively. 148
HKDSE (2013, 8) (Decision-making) Helen Ltd sells sunglasses in three shops (A, B and C) in Hong Kong. Its budgeted income statement for the year ended 31 December 2014 is given below: Helen Ltd Budgeted income statement for the year ended 31 December 2014 $ $ Sales 6,000,000 Cost of goods sold (3,300,000) Gross profit 2,700,000 Selling expenses fixed rental expenses (270,000) sales commission (630,000) (900,000) Administrative expenses salaries (560,000) office expenses (350,000) (910,000) Net profit 890,000 Additional budgeted information: (i) Sales of shop C accounted for 20% of the total company s sales. (ii) (iii) (iv) Gross profit ratio of shop C for 2014 is half of that for the company as a whole. One-third of the fixed rental expenses are from shop C. Sales commission is calculated on the basis of sales dollars. Administrative expenses are to be allocated to shop A, B and C in a ratio of 2:2:3 respectively. (a) Prepare a budgeted income statement for the year ended 31 December 2014 for shop C only. Losses were incurred in shop C over the past two years. The management of Helen Ltd is considering closing the shop on 1 January 2014. Relevant information is as follows: (v) Some customers of shop C will purchases sunglasses from shop A and shop B instead. It is estimated that sales of the two shops will be increased by 10%. (vi) The gross profit ratio of Helen Ltd will change to 48%. (vii) Landlord of shop C allows Helen Ltd to terminate the lease contract but rental deposit of $15,000 paid will be forfeited. (viii) An employee currently earning $10,000 per month in shop C will have to be made redundant and receive $20,000 as compensation. Other employees in the shop will be transferred to the remaining shops. (ix) Four-fifth of the office expense originally allocated to shop C will still have to be paid. (b) Assume that shop C is closed, prepare an overall budgeted income statement for Helen Ltd for the year ended 31 December 2014. (c) Based on your answer in (b), briefly explain whether Helen Ltd should close shop C. (d) State two non-financial factors that may influence Helen Ltd s decision in (c). 149
HKDSE (2013, 8) (Decision-making) (a) Shop C Budgeted income statement for the year ended 31 December 2014 $ $ (b) Sales ($6,000,000 x 20%) 1,200,000 Cost of goods sold (1,200,000 x 77.5%) (930,000) Gross profit (1,200,000 x 22.5%) 270,000 Selling expenses fixed rental expenses (270,000 x 1/3) (90,000) sales commission (1,200,000 x 10.5%) (126,000) (216,000) Administrative expenses salaries (560,000 x 3/7) (240,000) Net Loss office expenses (350,000 x 3/7) (150,000) (390,000) Helen Ltd Budgeted income statement for the year ended 31 December 2014 (336,000) $ $ Sales ($6,000,000 x 80% x 110%) 5,280,000 Cost of goods sold (5,280,000 x 52%) (2,745,600) Gross profit (5,280,000 x 48%) 2,534,400 Selling expenses fixed rental expenses ($270,000 x 2/3 + $15,000) (195,000) sales commission ($5,280,000 x 10.5%) (554,400) (749,400) Administrative expenses salaries ($560,000 $10,000 x 12 + $20,000) (460,000) office expenses (350,000 x 4/7 + 150,000 x 4/5) (320,000) (780,000) Net profit 1,005,000 (c) As net profit will be increased by $115,000 ($1,005,000 - $890,000), Helen Ltd should close Shop C. (d) Non-financial factors: The need to focus on a longer-term time horizon: A decision based on two years is too short The impact on the morale of staff working in other shop: potential threat of redundancies lead to lower morale and productivity Negative image of the company as a whole from the closure 150
HKDSE (sample, 7) (Job costing) Top Four Co Ltd is a manufacturing firm specializing in producing tailor-made souvenirs. The sales manager has received an urgent order of 1,000 metal photo frames at the price of $15 each to be supplied in one week s time. The following information relates to the order: (i) Materials: (1) Metal bar is the materials for the frame and hard plastic board for the backing. A batch of 20 photo frames requires 8 metres of metal bar and 4 pieces of standard plastic board. (2) The metal bars are in constant use and there is sufficient stock in hand for the order. The cost information is as follows: $ per metre Historical cost 5 Current buying-in cost 7 Scrap value 2 (3) The cost of the plastic board currently in stock is $50 per piece. It is made of a traditional material which has been banned in some western countries. The replacement price of the plastic board is currently $70 per piece while the scrap value of that in stock is $5 per piece. The production manager does not foresee any alternative use for the plastic board if it is not used for the order. (ii) Direct labour (1) Labour hours are required at 15 minutes per photo frame. (2) The hourly rate is $20. (3) Being the low season, there is a total idle time of 100 hours for direct labour. However, if the job is accepted, overtime work will be required and a bonus of 50% on the normal rate has to be paid. (iii) Overheads (1) The overhead costs for the year ended 31 December 20X7 are budgeted as follows: $ 000 Depreciation (factory building) 1,000 Supervision 900 Depreciation (machinery) 450 Insurance (machinery) 150 Heating and lighting 200 (2) Overheads are allocated to the three departments on the following basis: Metal work Assembly Store Floor area (square metres) 2,000 1,200 800 Number of employees 47 24 4 Book value of machinery 13,000 2,000 Number of material requisitions 3,500 500 Total direct labour hours 200,000 90,000 (3) If the order is accepted, no additional overheads will be incurred. (iii) Pricing The business normally adds a 10% profit on job cost to arrive at its invoice price. (a) (b) (c) (d) Prepare an overheads distribution statement and determine the overheads absorption rate both for the metal work and assembly departments. (Correct all amounts to the nearest dollar.) Based on the absorption costing method and the company s pricing policy, calculate the selling price that should be charged for the above order. Should the order be accepted if the relevant cost approach is used? Support your suggestion with appropriate figures to convince the management. Suggest two other factors that the management should consider before making the decision. 151
HKDSE (sample, 7) (Job costing and Decision-making) (a) Overhead distribution statement Cost Items Bases Total Cost Centres Metal work Assembly Store $ 000 $ 000 $ 000 $ 000 Depreciation (factory building) Floor area 1,000 500 300 200 Supervision No of employees 900 564 288 48 Depreciation (equipment) Book value 450 390 60 Insurance (equipment) Book value 150 130 20 Heating and lighting Floor area 200 100 60 40 2,700 1,684 728 288 Secondary apportionment 3500 : 500 252 36 (288) 2,700 1,936 764 Absorption rate per labour hour 10 8 (b) Absorption costing approach Materials $ Metal bar (1,000/20 x 8 x $5) 2,000 Plastic board (1,000/20 x 4 x $50) 10,000 Direct labour Basic pay (1,000 x 15/60 x $20) 5,000 Overtime bonus [(1,000 x 15/60 100) x $20 x 50%] 1,500 Overheads Metal work (1,000 x 15/60 x $10) 2,500 Assembly (1,000 x 15/60 x $8) 2,000 Total cost 23,000 Profit loading (10%) 2,300 Invoice price 25,300 (c) Relevance costing approach Materials $ Metal bar (1,000/20 x 8 x $7) 2,800 Plastic board (1,000/20 x 4 x $5) 1,000 Direct labour Basic pay [(1,000 x 15/60 100) x $20) 3,000 Overtime bonus [(1,000 x 15/60 100) x $20 x 50%] 1,500 Total cost 8,300 The normal selling price is built on historical cost concept and has little relevant in making decision. The relevant costing approach looks to the future such that the offer of $15 per frame should be accepted as it is higher than the cost of $8.3, at which the firm will make neither a loss nor a gain. (d) Other customers may request the lower price charged and the current buyers may ask for the same special offer in future. The firm should be sure they can meet the rush order with premium quality, or the reputation of the firm will be impaired. The competitive state of the market should be considered. The firm may not be able to afford to lose potential customers. There may be limiting factors which will affect the completion of the order. Legal/social implications in relation to the banned materials should be considered. 152
HKDSE (sample, 9) (Cost Accounting) Mary is a fresh university graduate who has majored in marketing. She is enthusiastic about conducting a business of her own alongside her full-time employment. She borrowed a sum of $90,000 from a bank at an interest rate of 5% per annum on 1 January 20X7 to run a shop which sells free-sized T-shirts of her own design. Information relating to the shop is as follows: (i) The shop s rental is $5,000 per month. The annual rates and insurance expenses are $3,600 and $4,500 respectively. (ii) A shop attendant is hired at a basic salary of $7,000 per month plus a commission of 5% of the sales value. (iii) All T-shirts are imported from factories based on the Mainland and are sold at 100% mark-up on cost. (iv) The budgeted sales volume is 500 shirts per month. Mary has made arrangements with the Mainland suppliers for the supply of 500 shirts each month. Then a logo sticker will be fixed on each shirt by a sewing service provider nearby at the cost of $2 each. The purchase costs for the first quarter of 20X7 are as follows: $ January 20X7 22,500 February 20X7 24,000 March 20X7 25,000 (v) In order to publicise her new brand, Mary will print some promotional leaflets to be distributed once a week in the neighborhood. The printing cost of the leaflets amounts to $500 per month and a part-time worker is hired at $1,000 per month for the distribution work. (vi) A point-of-sale system costing $30,000 was purchased to help keep inventory record and cash transactions. In addition, Mary furnished the shop with necessary furniture and fixtures by spending a further $60,000. Depreciation is to be calculated at 12% per annum on a reducing balance basis for the point-of-sale system and 10% on cost for the furniture and fixtures. (vii) The actual sales figures for the first quarter ended 31 March 20X7 are as follows: (a) Number of shirts January 20X7 350 February 20X7 420 March 20X7 400 Define direct costs and indirect costs and identify one example for each from the case above. (b) (c) (d) Compare marginal costing with absorption costing with respect to inventory valuation and income determination. Prepare an income statement for the first quarter ended 31 March 20X7 using the marginal costing method, assuming the FIFO method is adopted in the valuation of unsold goods. With the figures you have compiled in (c) above, calculate the breakeven point (in sales dollars) of the first quarter ended 31 March 20X7. Noting that there are several giant enterprises in the low-margin garment market, Mary s father has always persuaded Mary to discontinue her small business which is unlikely to be competitive enough to survive. (e) Discuss two possible reasons why Mary is still enthusiastic about running a business of her own. 153
HKDSE (sample, 9) (Cost Accounting) (a) Direct costs costs that would be economical to trace their cost object e.g. purchase cost, cost of stickers, sales commission Indirect costs costs that would not be economical to trace their cost object e.g. printing cost, salaries, rent and rates, insurance, depreciation (b) Inventory valuation Income determination Marginal costing Absorption costing Only variable costs are charged to units. Fixed costs are treated as product costs and can be carried forward to the next period in the value of each unit. Fixed costs incurred will not be carried A proportion of the fixed costs of the forward and the profit of the current current period will be carried forward to accounting period will be lower. the next accounting period and therefore the profit of the current accounting period will be higher. (c) Income statement for the first quarter ended 31 March 20X6 $ $ Sales [($22,500 + $24,000 + 170 x $50) x 200%] 110,000 Opening inventories Purchases ($22,500 + $24,000 + $25,000) 71,500 Logo stickers (1,500 x $2) 3,000 Less Closing inventories [(500 170) x ($50 + $2)] (17,160) 57,340 Product contribution margin 52,660 Less Variable costs: Commission ($110,000 x 5%) 5,500 Contribution 47,160 Less: Fixed costs Rent and rates ($5,000 x 3 + $3,600 x 3/12) 15,900 Insurance ($4,500 x 3/12) 1,125 Salaries ($7,000 x 3 + $1,000 x 3) 24,000 Printing costs ($500 x 3) 1,500 Depreciation [$30,000 x 12% x 3/12 + $60,000 x 10% x 3/12] 2,400 44,925 Net profit 2,235 (d) Total fixed costs = $44,925 Contribution margin ratio = $47,160 $110,000 Breakeven sales dollars = Fixed cost Contribution margin ratio = $44,925 / ($47,160 $110,000) = $104,787 (e) a platform for self-actualization: the business provides an outlet for Mary to introduce products of her own design a form of investment: the rate of return on her business has reached 8%, which is higher than the market interest rate an opportunity for self-development: Mary will acquire management skills by developing her business strategies and job design in real situations a way to serve the public: Mary may target the needs or interests of minority groups that may well not be served by giant enterprises. 154
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