NATIONAL QUALIFICATIONS CURRICULUM SUPPORT
Accounting
Managerial Accounting
[ADVANCED HIGHER]
Lindsay Mitchell
The Scottish Qualifications Authority regularly reviews
the arrangements for National Qualifications. Users of
all NQ support materials, whether published by LT
Scotland or others, are reminded that it is their
responsibility to check that the support materials
correspond to the requirements of the current
arrangements.
Acknowledgement
Learning and Teaching Scotland gratefully acknowledge this contribution to the National
Qualifications support programme for Accounting.
First published 2005
© Learning and Teaching Scotland 2005
This resource may be reproduced in whole or in part for educational purposes by educational
establishments in Scotland provided that no profit accrues at any stage.
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
Contents
Introduction
4
Section 1:
Activity-Based Costing (ABC)
5
Section 2:
Multi-Product Break-Even Analysis
30
Section 3:
Contract Costing Statements
46
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INTRODUCTION
Introduction
This pack contains notes and exercises for three topics – activity-based
costing, multi-product break-even analysis and contract costing.
Activity-based costing and multi-product break-even analysis are both new
topics for Advanced Higher and it is intended that the enclosed material will
provide guidance to tutors as to what students are expected to know when
covering the topics.
Contract costing appeared in the old Higher Accounting and Finance
arrangements but is now included in the Advanced Higher content. As no
previous material on this topic has been produced it is hoped that this
package will fill the gap.
Each topic contains notes, exercises and full solutions.
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MANAGERIAL ACCOUNTING (AH)
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ACTIVITY-BASED COSTING (ABC)
Section 1
Activity-Based Costing (ABC)
In your studies in Higher Accounting one of the major topics in the
Cost/Management Accounting part of the syllabus was the treatment of
overhead costs within a business.
This involved the allocation and apportionment of overheads among cost
centres and the subsequent absorption of these cost-centre overheads into the
cost units produced in the cost centres.
The whole process described above can best be illustrated by the following
diagram.
Overhead Costs
Allocation
Apportionment using
selected basis
Single Cost Centre
Multiple Cost Centres
Production Cost Centres
Service Cost Centres
Re-apportionment
using selected basis
Cost Units using
appropriate absorption rate
The above approach is sometimes referred to as the ‘trad itional’ approach to
overhead absorption. Activity-based costing has been developed within the
last 20–30 years in an effort to avoid defects in the traditional system.
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ACTIVITY-BASED COSTING (ABC)
The main characteristics of the traditional system are as follows:
• it was developed in manufacturing industry
• there were typically a narrow range of products
• production processes were much simpler than now
• direct material and labour costs were the main production costs
• overhead costs were relatively small
• inaccuracies due to arbitrary nature of process were therefore relatively
unimportant.
Activity-Based Costing (ABC) has therefore emerged due to the following:
• product ranges have increased
• overhead costs have become more significant
• manufacturing concerns no longer dominate
• service organisations account for a much larger share of economic activity
• production is more complex and capital intensive.
The main ideas behind ABC are:
• costs are caused by activities – for example ordering, material handling,
scheduling, machining, assembling, etc.
• production of products or supply of services creates the demand for these
activities
• costs are therefore assigned to products or services on the basis of
consumption of these activities.
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ACTIVITY-BASED COSTING (ABC)
Therefore ABC involves a number of stages.
1.
Identify the major activities of the organisation.
2.
Identify the factors which affect the cost of an activity. These factors
are known as COST DRIVERS e.g. the number of purchase orders
might be considered as the cost driver for the costs of a purchasing
department.
3.
Collect the associated costs of each activity. This is known as the
COST POOL.
4.
Allocate costs to products/services based on the demand created for the
cost drivers.
As with the traditional approach, ABC can be illustrated by a diagram:
Identify major activities
Create cost pool for each activity
Identify cost driver for each activity
Produce absorption rate for each pool based on cost driver
Overhead cost per unit
Let us now look at an example which will show both the traditional approach
to the treatment of overheads and then how ABC would treat the same
situation.
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ACTIVITY-BASED COSTING (ABC)
Example
Deeside plc manufactures three products, A, B and C in their factory and uses
a factory-wide absorption rate for absorbing overheads based on direct labour
hours. The following information relates to Period 5 of Year 3.
Product
Production (units)
Direct Material Cost p.u.
Direct Labour Hours p.u.
A
12,000
£40
4
B
8,000
£30
6
C
4,000
£20
2
Direct labour is paid at £8 per hour.
The overhead costs for Period 5 are as follows:
Machining
Set-up
Assembling
Goods Receiving
Dispatch
£
312,000
56,000
80,000
128,000
100,000
676,000
(a)
Calculate the factory-wide absorption rate for Period 5.
(b)
Calculate the cost p.u. of each product under the traditional approach to
treatment of overheads.
The company is considering using ABC as a method of arriving at the cost
per unit of their products and the following information is available for this
purpose:
The overheads have been investigated and while machining costs will be
absorbed on the basis of machine hours, cost drivers have been identified for
the other overheads.
Overhead
Set-up
Assembling
Goods Receiving
Dispatch
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Cost Driver
No. of production runs
No. of production orders
No. of receipts
No. of production orders
ACTIVITY-BASED COSTING (ABC)
The following additional information is also available:
Product
Machine hours per unit
No. of Production runs
No. of Material receipts
No. of Production orders
A
2
1
3
3
B
3
2
5
2
C
1
5
24
5
(c)
Calculate a cost driver absorption rate for each of the above overheads.
(d)
Calculate the cost per unit for each product under the ABC system.
This question contains a lot of information and lots of figures and therefore it
is important to read it carefully with a view to deciding which information
relates to each part of the question.
The purpose of this question is to show how the traditional method of
overhead absorption works and then to demonstrate the Activity -Based
Costing approach.
At the end of the question we will compare the two methods and see if we can
explain the differing results they produce.
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ACTIVITY-BASED COSTING (ABC)
Solution
(a)
This opening part of the question asks us to calculate a factory -wide
overhead absorption rate (sometimes called a ‘blanket rate’), b ased on
labour hours.
You should recall that the calculation of an overhead absorption rate divides
the relevant overhead (which may be for a cost centre or, as in this case, for
the whole factory) by the relevant units of the base selected. (There were
actually six possibilities, i.e. per unit, % on material, % on wages, % on
prime cost, per labour hour or per machine hour).
In this question we are using labour hours and therefore the calculation is as
follows:
Overhead Absorption Rate =
Factory Overheads
Labour Hours
Although we know the total factory overheads we need to calculate the total
labour hours, i.e.



A–
B–
C–
= 48,000
= 48,000
= 8,000
104,000
We can now calculate the factory-wide rate
=
£676,000
104,000
= £6.50 per labour hour
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© Learning and Teaching Scotland 2005
ACTIVITY-BASED COSTING (ABC)
(b)
In this next part we are asked to calculate the total cost per unit for each
product using the traditional approach.
This total cost will be the sum of the two direct costs – material and labour,
plus overheads.
The question gives us the material cost p.u. for each product, but we will
have to calculate the figures for labour and overheads. For labour this will be
the number of labour hours per unit multiplied by the labour rate per hour.
For overheads it will be the number of labour hours per unit multiplied by the
overhead absorption rate calculated in part (a), i.e.
Cost per unit
Material
Labour
Overheads
A
£40
£32 (4
£26

B
£30
£48
£39
C
£20
£16
£13
£117
£49


£98
The remaining parts of the question now introduce the Activity -Based
Costing technique.
(c)
This part asks us to calculate cost driver absorption rates for the
separate overheads.
The total overhead of the factory has been broken down into five activities.
For the first of these, machining, a traditional -style absorption rate is to be
used, i.e. machine hour rate.
Machine Hour Rate =
Machine Overhead
Machine Hours
Once again we know the overhead but need to calculate the machine hours,
i.e.
A – 12,000 
B–

C–

= 24,000
= 24,000
= 4,000
52,000
Therefore the calculation is
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ACTIVITY-BASED COSTING (ABC)
£312,000
52,000
= £6 per m/c hour
Machine Hour Rate =
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ACTIVITY-BASED COSTING (ABC)
For the other activities, which comprise the factory overheads, appropriate
cost drivers have been identified and we can use these to calculate the
relevant absorption rate.
The cost drivers identified are the number of production runs, the number of
production orders and the number of receipts. Therefore before we go any
further we must calculate the relevant figure for each driver.
Production Runs –
A
B
C
1
2
5
8
Production Orders –
A
B
C
3
2
5
10
Receipts –
A
B
C
3
5
24
32
Now we can calculate the absorption rate for each activity, based on the
relevant cost driver.
Set-up
=
£56,000
8
= £7,000 per run
Assembling
=
£80,000
10
= £8,000 per order
Goods Receiving
=
£128,000
32
= £4,000 per receipt
Dispatch
=
£100,000
10
= £10,000 per order
MANAGERIAL ACCOUNTING (AH)
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ACTIVITY-BASED COSTING (ABC)
(d)
The final part requires us to use these figures to produce a cost per unit
for each product. Therefore we need to calculate the overhead cost per
unit to add to the material and labour costs which we calculated in part
(b).
Machinery overhead is the simplest, i.e. machine hours per unit multiplied by
machine hour rate.

£6 = £18

A–
B–
C–
For the other overhead activities we need to relate the cost driver absorption
rate to the units produced.
Set-up
A
£7,000

12,000
= £0.58
B
£14,000 (7,000
C
£35,000
8,000
= £1.75
4,000
= £8.75
Assembling £24,000
(8,000
12,000
=£2

Goods
£12,000

12,000
=£1

£30,000

12,000
= £2.50
 3)£20,000
Receiving
Dispatch
£16,000

£40,000
8,000
= £2
£20,000
4,000
=£10

£96,000
8,000
= £2.50
8,000
= £2.50
4,000
= £24

£50,000
4,000
= £12.50
Therefore using ABC total cost per unit for the products would be as follows:
Direct Materials
Direct Labour
Machinery
Set-up
Assembling
14
A
£40
£32
£12
£0.58
£2
MANAGERIAL ACCOUNTING (AH)
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B
£30
£48
£18
£1.75
£2
C
£20
£16
£6
£8.75
£10
ACTIVITY-BASED COSTING (ABC)
Goods Receiving
Dispatch
£1
£2.50
£24
£2.50
£2.50
£12.50
£90.08
£104.75
£97.25
Contrast these figures with the ones produced in the ans wer to part (b) of the
question. The most striking change is in the increase in the cost per unit of
Product C, although there is also a less substantial decrease in the cost per
unit of the other two products. The increase in the cost of C has arisen
because most of the charges relating to C were not identified under the
traditional absorption system. The cost drivers identified in the ABC system
are responsible for generating these charges and thus we can suggest that the
ABC system produces a more accurate cost for each product.
The following examples will provide practice in applying the ABC system.
Solutions are provided at the end of this section.
MANAGERIAL ACCOUNTING (AH)
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15
ACTIVITY-BASED COSTING (ABC)
Question 1
Your company currently produces and sells 4 products, Alpha, Beta, Gamma
and Delta. The following information relates to Period 3.
Production (units)
Costs per unit:
Direct material
Direct labour
Machine hours per unit
Number of production runs
Number of requisitions raised
Number of orders completed
Alpha
180
Beta
150
Gamma
120
Delta
180
£46
£21
4
6
30
18
£58
£14
3
5
30
15
£35
£7
2
4
30
12
£70
£14
3
6
30
18
Currently the production overhead is absorbed by the machine -hour rate
method and the following are the total production overhead costs for Period
3.
£
24,540
6,300
7,200
3,150
7,560
48,750
Machine Department
Set-up costs
Receiving costs
Inspection costs
Despatch costs
Cost drivers have been identified as follows:
Set-up costs
Stores receiving
Inspection
Despatch
Number
Number
Number
Number
of
of
of
of
production runs
requisitions raised
production runs
orders completed
You are required to calculate:
(a)
(i)
The machine-hour rate currently used to absorb the production
overhead.
(ii)
The total cost per unit for each product if overheads are absorbed
by the method in (a)(i).
(b)
The cost per unit for each product using an ABC approach.
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MANAGERIAL ACCOUNTING (AH)
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ACTIVITY-BASED COSTING (ABC)
Question 2
Jomit plc has budgeted for the following overhead costs for Period 6.
Material receipt costs
Power costs
Material handling costs
£
31,200
39,000
27,300
The company produces 3 products, P, Q and R for which the following
budgeted information is available for Period 6.
Product
Output (units)
Material batches
P
4,000
20
Q
3,000
10
R
1,600
32
Per Unit
Direct material (kg)
Direct material (£)
Direct labour (hours)
Number of power operations
Direct labour rate per hour
4
6
0.2
6
£8
6
5
0.5
3
£8
3
9
1.0
2
£8
Currently the overhead costs are each absorbed using a rate per direct labour
hour.
However, the company is considering applying overheads using an ABC
approach and has identified drivers for the activities as follows:
Material receipt costs
Power costs
Material handling costs
number of batches of material
number of power operations
kg of material handled
You are required to calculate:
(a)
The total cost per unit for each product using the current overhead
absorption method.
(b)
The total cost per unit for each product using the ABC method.
MANAGERIAL ACCOUNTING (AH)
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17
ACTIVITY-BASED COSTING (ABC)
Question 3
Your company currently produces a range of three products, D, E and F to
which the following details relate for Period 2.
D
1,500
£18
1
3
Production (units)
Material cost per unit
Labour hours per unit
Machine hours per unit
E
2,500
£10
3
2
F
14,000
£20
2
6
Labour costs are £8 per hour and production overheads are currently absorbed
in the conventional system by reference to machine hours. Total production
overheads for Period 2 have been analysed as follows:
Set-up costs
Handling costs
Machining costs
Inspection costs
(a)
£
327,250
187,000
140,250
280,500
935,000
Calculate the cost per unit for each product usi ng conventional
methods.
The introduction of an ABC is being considered and to that end the following
volume of activities have been identified with the current output levels.
Number of set-ups
Number of material issues
Number of inspections
D
90
16
180
E
138
28
216
F
576
116
804
(b)
Calculate the cost per unit for each product using the ABC approach.
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
ACTIVITY-BASED COSTING (ABC)
Question 4
The following table summarises the details of the production levels, costs and
cost drivers for Abtronics Ltd who have traditionally absorbe d overheads into
production on the basis of a labour hour absorption rate. They wish to move
to an ABC system.
Product
Material cost per unit
Labour hours per unit
Machine hours per unit
Number of production runs
Number of production orders
Number of orders delivered
Number of receipts
Production (units)
P
£20
4
4
6
45
30
12
15,000
Q
£15
6
3
14
30
20
28
10,000
R
£10
3
6
40
75
50
80
4,000
Labour hours are paid for at £10 per hour.
Overheads
Machining
Set-up costs
Receiving costs
Packing costs
Engineering costs
£
684,000
60,000
240,000
300,000
450,000
1,834,000
Cost Driver
machine hours
production runs
number of receipts
number of orders delivered
number of production orders
(a)
Calculate the cost per unit for each product using the traditional
overhead absorption approach.
(b)
Calculate the cost per unit using the ABC approach.
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ACTIVITY-BASED COSTING (ABC)
Question 5
Param plc has incurred the following overheads in its factory during Period 6.
Quality control
Process set-ups
Purchasing
Order processing
Occupancy costs
£
90,000
135,000
105,000
120,000
150,000
Param plc produces a range of products, two of which are Product X and
Product Y. The following information relate to these two products.
Material costs per unit
Labour cost per unit
Number of process set-ups
Number of purchase orders issued
Number of customer orders
Machine hours per unit
Production (units)
X
£5
£8
150
500
1,000
3
10,000
Y
£8
£12
210
300
800
2
6,000
Inspection takes place after each process set -up.
The cost drivers which have been identified for the factory are:
Quality control
Process set-ups
Purchasing
Order processing
Occupancy costs
450 inspections
450 set-ups
1,000 purchase orders
2,000 customer orders
75,000 machine hours
Calculate the cost per unit for Products X and Y using:
(i)
existing overhead absorption rate per machine hour
(ii)
an activity-based costing approach.
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ACTIVITY-BASED COSTING (ABC)
Solutions
Question 1
(a)
(i)
Total machine hours:




Alpha
Beta
Gamma
Delta
720
450
240
540
= 1950
Total overheads = £48,750
£48,750
1,950
= £25
Machine hour absorption rate =
(ii)
Cost per unit
Direct material
Direct labour
Production overhead
(b)
Cost
Machine Dept
Set-up
Receiving
Inspection
Despatch
£
24,540
6,300
7,200
3,150
7,560
Alpha
£
46
21
100
167
Beta
£
58
14
75
147
Driver
m/c hours
Runs
Requisitions
Runs
Orders
Gamma
£
35
7
50
92
Driver
transactions
1950
21
120
21
63
Delta
£
70
14
75
159
Cost per
driver
£12.58
£300
£60
£150
£120
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ACTIVITY-BASED COSTING (ABC)
Overheads cost per unit
Alpha
Beta
Gamma
Delta
Set-up
£1800
= £10
180
£1500
= £10
150
£1200
= £10
120
£1800
= £10
180
Receiving
£1800
= £10
180
£1800
= £12
150
£1800
= £15
120
£1800
= £10
180
Inspection
£900
= £5
180
£750
= £5
150
£600
= £5
120
£900
= £5
180
Despatch
£2160
= £12
180
£1800
= £12
150
£1440
= £12
120
£2160
= £12
180
Machine
Dept

= £50.32

= £37.74

= £25.16

= £37.74
Total cost per unit
Materials
Labour
Set-up
Receiving
Inspection
Despatch
Machine Dept
22
Alpha
£
46.00
21.00
10.00
10.00
5.00
12.00
50.32
154.32
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Beta
£
58.00
14.00
10.00
12.00
5.00
12.00
37.74
148.74
Gamma
£
35.00
7.00
10.00
15.00
5.00
12.00
25.16
109.16
Delta
£
70.00
14.00
10.00
10.00
5.00
12.00
37.74
158.74
ACTIVITY-BASED COSTING (ABC)
Question 2
(a)
Direct labour hours:


R 1,600 
=
=
=
3,900
800
1,500
1,600
Overhead absorption rates:
Material receipt
£31,200
= £8 per labour hour
3,900
Power
£39,000
= £10 per labour hour
3,900
Material handling
£27,300
= £7 per labour hour
3,900
Overhead cost per unit
Material receipt
P
£ 
= £1.60
Q
 0.5
= £4

R

= £8

= £2
= £5
£10
= £10
Material handling
£ 
= £1.40

= £3.50

= £7
Total cost per unit
P
£
6.00
1.60
1.60
2.00
1.40
12.60
Power
Direct material
Direct labour
Material receipt costs
Power costs
Material handling
Q
£
5.00
4.00
4.00
5.00
3.50
21.50
R
£
9.00
8.00
8.00
10.00
7.00
42.00
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© Learning and Teaching Scotland 2005
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ACTIVITY-BASED COSTING (ABC)
(b)
ABC absorption rates
Material receipt
£31,200
= £503.23 per batch
62
Power
£39,000
= £1.08 per operation
36,200 (W1)
Material handling
£27,300
= £0.70 per kg
38,800 (W2)


Overhead costs
per unit


P
Q
R
£503.23  20
4,000
£503.23  10
3,000
£503.23  10
1,600
= £2.52
= £1.68
= £10.06
Power

= £6.48
£1.08
= £3.24
£1.08
= £2.16
Material handling

= £2.80

= £4.20

= £2.10
Material receipts
Total cost per unit
Direct material
Direct labour
Material receipt costs
Power costs
Material handling costs
24


MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
P
£
6.00
1.60
2.52
6.48
2.80
19.40
Q
£
5.00
4.00
1.68
3.24
4.20
18.12
R
£
9.00
8.00
10.06
2.16
2.10
31.32
ACTIVITY-BASED COSTING (ABC)
Question 3
(a)
Number of machine hours
= D
= E
= F
Overhead absorption rate
=

2,500

=
=
=
=
4,500
5,000
84,000
93,500
£935,000
93,500
= £10 per machine hour
Cost per unit
Material
Labour
Overhead
(b)
D
£18
£8
£30
£56
Total number of set-ups
Absorption rate per set-up
Total number of issues
Absorption rate per issue
E
£10
£24
£20
£54
F
£20
£16
£60
£96
= 90 + 138 + 576
= 804
£327,250
804
= £407.03 per set-up
=
= 16 + 28 + 116
= 160
£187,000
160
= £1,168.75
=
£140,250
93,500
= £1.50
=
Absorption rate per machine hour
Total number of inspections
Absorption rate per inspection
= 180 + 216 + 804
= 1,200
£280,500
1,200
= £233.75
=
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
25
ACTIVITY-BASED COSTING (ABC)
Overheads per unit
Set-up
Issue
Machining
Inspection
D
90  £407.03
1,500
= £24.42
 £1.50
= £4.50

= £3

= £9
180  £233.75
1,500
= £28.05
216  £233.75
2,500
= £20.20
804  £233.75
1,400
= £13.42
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
F
576  £407.03
14,000
= £16.75
16  £1,168.75 28  £1,168.75 116  £1,168.75
1,500
2,500
14,000
= £12.47
= £13.09
= £9.68
Total cost per unit
Material
Labour
Set-up costs
Handling costs
Machine costs
Inspection costs
26
E
138  £407.03
2,500
= £22.47
D
£18.00
£8.00
£24.42
£12.47
£4.50
£28.05
£95.44
E
£10.00
£24.00
£22.47
£13.09
£3.00
£20.20
£92.76
F
£20.00
£16.00
£16.75
£9.68
£9.00
£13.42
£84.85
ACTIVITY-BASED COSTING (ABC)
Question 4
(a)
Total labour hours =



P
Q
R
= 60,000
= 60,000
= 12,000
132,000
Total overheads = £1,834,000
£1,834,000
132,000
= £13.89
Total absorption rate
Cost per unit
Direct material
Direct labour
Production overheads
(b)
P
£20.00
£40.00
£55.56
£115.56
Q
£15.00
£60.00
£83.34
£158.34
R
£10.00
£30.00
£41.67
£81.67
Cost driver absorption rates
Machining
Set-up costs
£684,000
114,000
= £6.00 per machine hour
£60,000
(6 + 14 + 40)
= £1,000 per production run
Receiving costs
£240,000
(12 + 28 + 80)
= £2,000 per receipt
Packing costs
£300,000
(30 + 20 + 50)
= £3,000 per order delivered
Engineering costs
£450,000
(45 + 30 + 75)
= £3,000 per production order
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
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ACTIVITY-BASED COSTING (ABC)
Overhead cost per unit
Machining
Set-up costs
Receiving costs
Packing costs
Engineering costs
Total cost per unit
Direct material
Direct labour
Machining
Set-up
Receiving
Packing
Engineering
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
P
Q
R
£6.00 
= £24.00

= £18.00

= £36.00
6  £1,000
15,000
= £0.40
14  £1,000
10,000
= £1.40
40  £1,000
4,000
= £10
12  £2,000
15,000
= £1.60
28  £2,000
10,000
= £5.60
80  £2,000
4,000
= £40
30  £3,000
15,000
= £6
20  £3,000
10,000
= £6
50  £3,000
4,000
= £37.50
45  £3,000
15,000
= £9
30  £3,000
10,000
= £9
75  £3,000
4,000
= £56.25
P
£
20.00
40.00
24.00
0.40
1.60
6.00
9.00
101.00
Q
£
15.00
60.00
18.00
1.40
5.60
6.00
9.00
115.00
R
£
10.00
30.00
36.00
10.00
40.00
37.50
56.25
219.75
ACTIVITY-BASED COSTING (ABC)
Question 5
(i)
Total Factory Overheads =
Total machine hours
Absorption rate
Cost per unit
Material
Labour
Overheads
(ii)
£90,000
£135,000
£105,000
£120,000
£150,000
£600,000
= 75,000
£600,000
75,000
= £8 per machine hour
X
£
5.00
8.00
24.00
37.00
Y
£
8.00
12.00
16.00
36.00
Cost Driver Absorption Rates
Quality control
£90,000
450
= £200 per inspection
Process set-up
£135,000
450
= £300 per set-up
Purchasing
£105,000
1,000
= £105 per order
Order processing
£120,000
2,000
= £60 per order
Occupancy costs
£150,000
75,000
= £2 per machine hour
MANAGERIAL ACCOUNTING (AH)
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ACTIVITY-BASED COSTING (ABC)
Overhead cost per unit
Quality control
Process set-up
Purchasing
Order processing
Occupancy
Cost per unit
Material
Labour
Quality control
Set-up
Purchasing
Order processing
Occupancy
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
X
Y
150  £200
10,000
= £3
210  £200
6,000
=£7
150  £300
10,000
= £4.50
210  £300
6,000
= £10.50
500  £105
10,000
= £5.25
300  £105
6,000
= £5.25
1,000  £60
10,000
= £6
800  £60
6,000
= £8
£6
£4
X
£
5.00
8.00
3.00
4.50
5.25
6.00
6.00
37.75
Y
£
8.00
12.00
7.00
10.50
5.25
8.00
4.00
54.75
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Section 2
Multi-Product Break-Even Analysis
You will recall from your studies of Break-Even Analysis in Higher
Accounting that the basis of this technique was the ability to classify all costs
in an enterprise as either fixed or variable.
That is not to say that all costs are either totally fixed or totally variable.
Indeed there will be very few costs in the long run which could be said to fall
into either of these categories. However, the assumpt ion that is made is that
all costs will be made up of a variable component and a fixed component, and
that these can be separated. Thus we could add all the variable components
together to arrive at a total variable cost per unit, and all the fixed
components to arrive at total fixed costs, e.g. if we consider a cost like
machine maintenance it can be argued that there would be a minimum amount
of maintenance required even if production was zero. That then would
constitute the fixed component of machine maintenance. Then, of course, as
output builds up the machines will be subject to more wear and tear and
breakdowns, and thus require more and more maintenance. This would
constitute the variable component of machine maintenance.
However, in your past studies the behaviour of costs (i.e. how costs change as
output changes) was kept relatively simple (e.g. direct costs like material and
wages were often assumed to be perfectly variable and costs like rent
assumed to be perfectly fixed).
In fact there were a number of assumptions made in break-even analysis
which had the effect of keeping things relatively simple e.g. the relationship
between sales revenue and volume was based on the assumption that the
selling price was constant at all levels of output and variable costs per unit
were also assumed to stay constant.
As far as this section of notes is concerned there was one further assumption
which simplified matters and which we are now going to relax, i.e. we
assumed that we were dealing with a single pro duct model or perhaps, if there
were more than one product, we assumed a constant sales mix.
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
Therefore what we are now going to consider is the effect of several products
on the calculations of break-even and profit and loss and the effect of changes
in product or sales mix.
Basic Concepts of Break-Even Analysis
It is perhaps worth revising the basic relationships which Break -Even
Analysis depends on.
As already stated the starting point is
Total Costs = Fixed Costs + Variable Costs
Since, by definition, fixed costs have no relationship with output/sales no
attempt is made to arrive at a total cost per unit.
The next step is to find what is left over out of sales revenue once the
variable costs have been met. This is called the contribution.
Contribution = Sales – Variable Costs
It is so called because it is the contribution towards paying the fixed costs. If
there is sufficient contribution to pay the fixed costs and have something left
over then that will be profit (since all costs have now be en met). If there is
insufficient contribution to cover the fixed costs then a loss will be made
(since the total costs have exceeded sales revenue).
In between these two situations there must be a point where there is just
sufficient contribution to pay the fixed costs and thus neither a profit nor a
loss is made.
This is known as Break-Even Point and is where
Contribution = Fixed Costs
Remember as we said above
Contribution – Fixed Costs
= Profit (if positive)
= Loss (if negative)
The key to calculating the profit or loss in any situation is therefore
contribution, and profit/loss can only be found by two steps, i.e.
• find contribution by comparing sales and variable costs
• deduct fixed costs from contribution to determine profit or loss.
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
Break-Even Point is important, because it marks the output level where a
business moves from loss into profit; therefore there is an important formula
which allows us to calculate it, i.e.
Break-Even Point (units) =
Fixed Costs
Contribution per unit
To convert this into Break-Even Sales we only need to multiply the break even units by the selling price per unit.
Break-Even Point (£) = B/E unitsSelling Price per unit
There is one other relationship which is important in break -even analysis and
that is the relationship between contribution and sales value. This is
calculated as contribution/sales and is sometimes referred to as the
Profit/Volume Ratio, although it can be referred to simply as the
contribution/sales ratio.
The important thing about this ratio is that it will remain constant at all levels
of output. This is because all the constituent parts of the ratio are by
definition variable, i.e. sales, variable costs and consequently contribution. It
must be remembered, however, that this ratio will only remain constant as
long as the basic assumptions mentioned earlier hold true, i.e. a constant
selling price per unit and a constant variable cost per unit.
The advantage of this ratio is that once calculated you can apply it at any
level of output and thus determine the contribution earned from a particular
level of sales or the sales necessary for a particular level of contribution and
hence profit.
MANAGERIAL ACCOUNTING (AH)
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
Multi-Product Break-Even
The problem with calculating the break-even point for a business with more
than one product is that another variable has been added, i.e. the product mix.
Product mix means the relative percentage or share of tot al sales which each
product represents.
If each product earns a different contribution per unit then any change in the
relative volume of sales of each product will cause difficulties.
The way round this is to calculate a weighted average contribution pe r unit to
apply when calculating the break-even point.
Example
CMA plc produce a range of three products to which the following details
relate:
Product
Selling Price p.u.
Variable Costs p.u.
Basic
£205
£130
Special
£250
£145
Deluxe
£350
£200
Fixed costs for CMA plc total £600,000
Let us take each product in turn and calculate what the break -even point
would be if only that product were produced and sold.
Basic
Contribution per unit
= £205 – £130
= £75
Break-Even Point (units)
=
34
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
£600,000
£75
= 8,000
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Special
Contribution per unit
= £250 – £145
= £105
Break-Even Point (units)
=
£600,000
£105
= 5,715 (approx.)
Deluxe
Contribution per unit
= £350 – £200
= £150
Break-Even Point (units)
=
£600,000
£150
= 4,000
The two extreme outcomes for break-even are 8,000 units if all sales were the
basic model and 4,000 units if all sales were deluxe.
Therefore any sales mix will be bound to produce a break -even point which
lies somewhere between these two levels.
Given a sales mix the break-even point can be found using the familiar
formula but using a weighted average contribution per unit.
Using the figures from the above example let us calculate the break -even
point if sales were split evenly between the thr ee products.
Weighted Average Contribution per unit
= (1/3£75) + (1/3£105)
+ (1/3£150)
= £25 + £35 + £50
= £110
Break-Even Point (units)
=
£600,000
£110
= 5454.5
= 5455
MANAGERIAL ACCOUNTING (AH)
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
We can prove that this is correct by working out the r elevant figures.
Basic
1,818
Special
1,818
Deluxe
1,818
Sales (£)
Variable Costs
372,690
236,340
454,500
263,610
636,300
363,600
Contribution
136,350
190,890
272,700
Sales (units)
Total Contribution
Fixed Costs
£599,940
£600,000
–60 (caused by rounding units)
Now let us see what happens when the sales mix changes.
Suppose the product mix is 3:2:1 for Basic/Special/Deluxe.
Total sales are then represented by
Basic 3/6 = 1/2
Special 2/6 = 1/3
Deluxe 1/6
Weighted Average Contribution per unit =
(1/2£75) + (1/3£105) + (1/6£150)
= £37.50 + £35 + £25
= £97.50
Break-Even Point (units)
£600,000
£97.50
= 6154 (nearest unit)
=
The answer is greater than the previous answer and that makes sense because
we have moved to a situation where we are selling most of the product which
has the lowest contribution per unit and we are selling fewest of the one with
the highest contribution per unit.
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
Once again we can prove that this is the correct answer by multiplying out the
figures.
Total Units = 6,154
Split as follows:
Sales (£)
Variable Costs
Basic
Special
Deluxe
Basic
630,785
400,010
Contribution
230,775
Total Contribution
Fixed Costs
3077
(1/2)
2051
(1/3)
1026
(1/6)
Special
Deluxe
512,750
359,100
297,395
205,200
215,355
153,900
£600,030
£600,000
30 (due to rounding)
This approach can then be used to answer the typical range of questions
which you associate with basic break-even problems, i.e. calculating the level
of sales required to earn a specified profit.
For example, using the sales mix of 3:2:1 above calculate the sales in units of
each product which would produce a profit of £100,000.
Remember in marginal or break-even problems there is no direct connection
between units and profit, and therefore we must convert profit into
contribution.
Contribution
= Fixed Costs + Profit
= £600,000 + £100,000
= £700,000
Total No. of Units Required
=
Units of Basic
= 1/2  7,180
= 3,590
Units of Special
= 1/3  7,180
= 2,393
Units of Deluxe
= 1/6  7,180
= 1,197
£700,000
£97.50
= 7,180 (approx)
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
Let us just prove that this is the correct solution.
Sales (£)
Variable Costs
Basic
735,950
466,700
Special
598,250
346,985
Deluxe
418,950
239,400
Contribution
269,250
251,265
179,550
Total Contribution
Less: Fixed Costs
Profit
£700,065
£600,000
100,065 (due to rounding)
If we now consider the opposite type of problem:
How much profit will be made from sales of 9,000 units, also assuming a
ratio of 3:2:1 between sales of the three pro ducts?
Once again we must convert the units into contribution before we can
calculate profit.
Contribution from 9,000 units
Less: Fixed Costs
Profit
= 9,000  £97.50
= £877,500
£600,000
£277,500
Once again we can prove the result:
Sales Mix Basic – 1/2  9,000 = 4,500
Special – 1/3  9,000 = 3,000
Deluxe – 1/6  9,000 = 1,500
Sales (£)
Variable Costs
Basic
922,500
585,000
Special
750,000
435,000
Deluxe
525,000
300,000
Contribution
337,500
315,000
225,000
Total Contribution
Fixed Costs
£877,500
£600,000
£277,500
Here are some questions to try.
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© Learning and Teaching Scotland 2005
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Question 1
Clear Picture Ltd produce two models of television sets, Brilliant and Super
Bright to which the following details relate for the current year.
Selling price per set
Variable cost per set
Current sales (units)
Brilliant
£250
£125
5,000
Fixed costs
£600,000
Super Bright
£350
£190
2,500
(a)
Calculate the profit which Clear Picture would earn from the above
situation.
(b)
Calculate the total number of sets which require to be sold to break
even if the above sales mix applies.
(c)
Prepare a detailed Profit Statement to show the full figures for each
product at break-even point.
(d)
What would the break-even point be if the sales mix changed to three
Brilliant sets for every Super Bright set?
(e)
Explain why the increase/decrease in break-even point was predictable.
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
39
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Question 2
MPV plc manufactures and sells three products with the following selling
prices and variable costs:
Unit selling price
Unit variable cost
Current sales (units)
Basic
£3.00
£2.10
500,000
Superior
£3.75
£1.50
230,000
Supreme
£5.00
£3.25
190,000
Existing fixed costs amount to £1,000,000.
(a)
Calculate the total number of units MPV plc will require to sell in order
to break even if the current sales mix persists.
(b)
Prepare a Profit Statement showing the relevant figures for the three
products to prove your answer to (a).
40
MANAGERIAL ACCOUNTING (AH)
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
Question 3
Easylearn Ltd provide expert tutoring on a range of subjects. Next year’s
budget shows the following expected figures:
Accounting
2,500
£40
£10
Expected hours of work
Charge per hour
Variable cost per hour
Maths
3,000
£50
£15
English
3,500
£45
£9
French
1,000
£35
£10
Fixed costs for the year are expected to be £198,600.
(a)
Calculate the total number of hours Easylearn Ltd will have to work to
break even, assuming the above mix of tutoring hours.
(b)
Calculate the contribution from each subject and in total at break-even
point.
(c)
Using the same mix as above prepare a Profit Statement for Easylearn
plc to earn a profit of £100,000.
(d)
The actual hours provided during the year turned out to be:
Accounting
Maths
English
French
1,500
1,000
4,500
3,000
Calculate the break-even number of hours.
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
41
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Solutions
Question 1
(a)
Contribution p.u.
Total Contribution
Brilliant
£125
5,000  £125
= £625,000
Total Contribution for company
less: Fixed Costs
Profit
(b)
Sales (units)
– Brilliant
– Super Bright
Super Bright
£160
2,500  £160
= £400,000
£1,025,000
600,000
425,000
5,000
2,500
7,500
67%
33%
100%
Weighted Average Contribution p.u.= (£125 67%)+(£16033%)
= £83.75 + £52.80
= £136.55
B/E Point (units)
=
£600,000
£136.55
= 4,394 (nearest unit)
(c)
Sales (units)
Profit Statement for Year
Sales 736,000
Variable Costs
Contribution
Total Contribution
less: Fixed Costs
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
Brilliant
4394  67%
2944
Super Bright
4394 33%
1450
Brilliant
£
507,500
368,000
368,000
Super Bright
£
£600,000
£600,000
275,500
232,000
MULTI-PRODUCT BREAK-EVEN ANALYSIS
(d)
Weighted Average Contribution p.u. = (£125 75%)+(£160 25%)
= £93.75 + £40
= £133.75
B/E point (units)
=
£600,000
£133.75
= 4,486
(e)
Since they were selling more of the product with the lower contribution
per unit, it was inevitable that the break-even point would increase.
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
43
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Question 2
(a)
Sales (units)
Basic
Superior
Supreme
Contribution per unit
500,000
230,000
190,000
920,000
– Basic
– Superior
– Supreme
0.5435
0.25
0.2065
1.0
or
or
or
54.35%
25%
20.65%
100%
= £0.90
= £2.25
= £1.75
Weighted Average Contribution p.u.
= (£0.90x0.5435)+(£2.25 x
0.25) + (£1.75  0.2065)
= 48.915p + 56.25p + 36.138p
= 141.303p
B/E point (units)
=
£1,000,000
£1.413
= 707,714
(b)
Total Sales (units) = 707,714
Basic
Superior
Supreme
= 707,714  0.5435
= 707,714  0.25
= 707,714  0.2065
= 384,643
= 176,928
= 146,143
MPV – Profit Statement
Sales
Variable Costs
Contribution
Fixed Costs
44
Basic
£
1,153,929
807,750
346,179
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
Superior
£
663,480
265,392
398,088
Supreme
£
730,715
474,965
255,750
Total
£
2,548,124
1,548,107
1,000,017
1,000,000
17
MULTI-PRODUCT BREAK-EVEN ANALYSIS
Question 3
(a)
Tutoring hours:
Accounting
Maths
English
French
Contribution per hour
–
–
–
–
2,500
3,000
3,500
1,000
10,000
Accounting
Maths
English
French
25%
30%
35%
10%
100%
£30
£35
£36
£25
Weighted Average Contribution per hour
= (£3025%) + (£3530%) + (£3635%) + (£2510%)
= £7.50 + £10.50 + £12.60 + £2.50
= £33.10
B/E Point (hours)
=
£198,600
£33.10
= 6,000
(b)
Hours of
Tutoring
Contribution
Accounting
1,500
Maths
1,800
English
2,100
French
600
1,500
£30
1,800
£35
2,100
£36
600
£25
£45,000
£63,000
£75,600
£15,000
Total
6,000
198,600
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MULTI-PRODUCT BREAK-EVEN ANALYSIS
(c)
Contribution required
= £198,600 + £100,000
= £298,600
Number of hours required
=
£298,600
£33.10
= 9,021 (nearest hour)
Hours per subject:
Accounting
Maths
English
French
25%
30%
35%
10%
– 2,255
– 2,706
– 3,158
– 902
Profit Statement for Easylearn Ltd
Sales
Variable Costs
Contribution
less: Fixed Costs
Profit
(d)
Accounting
Maths
English
French
Accounting
£
90,200
22,550
67,650
1,500
1,000
4,500
3,000
10,000
Maths
£
135,300
40,590
94,710
English
£
142,110
28,422
113,688
French
£
31,570
9,020
22,550
15%
10%
45%
30%
100%
Weighted Average Contribution per unit
= (15%£30) + (10%£35) + (45%£36) + (30%£25)
= £4.50 + £3.50 + £16.20 + £7.50
= £31.70
B/E Point (hours)
=
£198,600
£31.70
= 6,265
46
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
Total
£
399,180
100,582
298,598
198,600
99,998
CONTRACT COSTING STATEMENTS
Section 3
Contract Costing Statements
A long-term contract is defined as:
‘A contract entered into for the design, manufacture or construction of a single
substantial asset or the provision of a service where the time taken to complete the
contract is such that the contract activity falls into different ac counting periods.’
So a contract is really an example of job costing with the following important
features:
• it usually takes a long time to complete
• it is usually completed at a particular site which is not the contractor’s
workplace.
Therefore contracts are common in most types of building and construction work,
civil engineering, shipbuilding, etc.
These contracts pose a particular problem for the accountant, i.e. when should any
profit on the contract be recognised in the accounts?
The problem arises because there is a conflict between two fundamental
accounting concepts or principles, i.e. matching and prudence.
The matching or accruals concept states that income and expenditure should be
matched against one another and placed in the accounting period to which they
relate.
Clearly in the case of long-term contracts the costs and indeed the revenues will
overlap more than one accounting period. Because a contractor cannot wait until
the end of a contract before he receives any income from it, t he work is valued at
regular intervals by architects who certify the value of the work at selling price.
When this is compared with the costs incurred to date it may well indicate a profit
on the contract.
MANAGERIAL ACCOUNTING (AH)
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CONTRACT COSTING STATEMENTS
However, the prudence concept states that profi ts should not be anticipated and
therefore recording profit on an incomplete contract could be construed as
breaching that concept.
As with many problems where basic principles conflict, the resolution of the
problem is something of a compromise. It woul d clearly be unacceptable only to
recognise contract profit at the end of the contract. This would mean that in any
accounting period the profits would simply relate to those contracts which had
finished during the period, irrespective of the length of pe riod of the contracts.
It seems that recognition of profit on a contract would be acceptable as long as the
concept of prudence is not ignored.
Statement of Standard Accounting Practice Number 9 (SSAP 9) gives guidance on
this matter.
It states that profits should only be recognised on a contract when its outcome can
be assessed with reasonable certainty. The profit to be included should be
calculated prudently and should reflect the amount of work completed at the
accounting date. On the other hand if losses are anticipated they must be
recognised in full.
The standard does not give unequivocal guidance on a formula to be applied in
recognising profit on a contract, and several methods have been developed which
meet the underlying principles outlined above.
One approach is to determine the expected profit at the conclusion of the contract
and recognise a proportion of this figure based on the percentage completion of
the contract at the appropriate date.
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CONTRACT COSTING STATEMENTS
Consider the following example:
At 31 December Year 4 the figures relating to an incomplete contract are as
follows:
Costs to date
Estimated costs to complete
Value of certified work
Contract price
£
3m
1m
4m
5m
We can calculate the expected outcome of the contract as follows:
Cost of work completed
Add: estimated costs to complete
estimated total costs
contract price
estimated profit
Profit Recognised =
=
£3m
£1m
£4m
£5m
£1m
Estimated Profit Value of Certified Wor
k
Contract Price
£1m  4m
5m
= £800,000
However, if a contract is not close to compl etion the forecast of expected profits
may be deemed to be too unreliable to adopt as a basis for profit recognition.
In these circumstances the fraction may be based on the notional profit at that
point in the life of the contract rather than on the esti mated profit at the end of the
contract, i.e.
Profit recognised =
Work Certified
 Notional Profit
Contract Price
What is important is that whichever formula is used takes into account the degree
of completion of the contract, which both of the formulae above do.
MANAGERIAL ACCOUNTING (AH)
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CONTRACT COSTING STATEMENTS
Preparing Contract Accounts
Example
A builder is currently working on two major contracts, both of which are
incomplete at the end of his financial year on 31st March Year 7.
The details of the contracts are as follows:
Contract A
£000s
Contract B
£000s
–
–
–
–
1,620
80
300
20
Costs Incurred During Year to 31st March Year 7
Materials Delivered to Site
Wages Paid
Salaries
Value of Plant Delivered
Head Office/Establishment Charges Apportioned
340
180
60
800
40
880
400
160
140
80
Closing Balances at 31st March Year 7
Materials on Site
Value of Plant on Site
Wages Accrued
80
600
20
–
80
40
800
1,200
3,200
5,800
Opening Balances at 1st April Year 6
Completed Work
Materials on Site
Plant & Machinery (written down value)
Wages Accrued
Other Details
Value of Work Certified at year end
Contract Price
Profit is recognised using the following formula:
Work Certified
 Notional Profit
Contract Price
Prepare accounts for each of the contracts showing clearly the calculations of any
profit to be taken for the period.
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
CONTRACT COSTING STATEMENTS
Solution
Contract A a/c
340
Materials
Wages Paid
add: accrued
Salaries
Plant & Machinery
Head Office costs
180
20
Cost of Contract
Profit & Loss a/c (Profit Taken)
Profit not Taken
Balances b/d: material
plant
200
60
800
38
1,438
Balances c/d
material
plant
Cost of contract to date
80
600
758
1,438
758
28
12
800
Work Certified
80
600
Balances b/d wages
800
800
20
Working
Notional Profit
= Value of Work Certified less cost of contract to date
= 800 – 758
= 42
Profit Recognised
=
800  42
1,200
= 28
The first step is to charge or debit the Contract a/c with all the costs incurred
during the year to date, including any accruals, e.g. in this case wages accrued.
However, not all of these costs have been used up in the course of the year so any
remaining unused, i.e. material and plant and machinery are carried down as
balances to start the next period.
This allows the cost of the contract to date to be calculated as the sum of the debit
entries less the credit balances being carried forward.
The working for the notional profit and the part of it which is going to be
recognised can now be done, using whichever formula the question suggests.
The profit taken is then debited to the account as it will go to the credit of the
Profit & Loss a/c.
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CONTRACT COSTING STATEMENTS
Contract B a/c
Balances b/d
Completed Work
Material
Plant & Machinery
Materials Delivered
Wages Paid
add accrued
Salaries
Plant & Machinery
Head Office Costs
1,620
80
300
880
400
40
Cost of Contract
440
160
140
80
3,700
3,600
Balance b/d: Wages
Balances c/d: Plant
Cost of Contract to date
Work Certified
Profit & Loss
(Loss written off)
3,600
Balances b/d: plant
80
Balances b/d wages
20
80
3,600
3,700
3,200
400
3,600
40
There are a number of differences to be accounted for with Contract B.
Firstly, this is a contract which was already under way at the start of the year and
therefore has opening balances which must be entered in the account to start with.
Thereafter the procedure is the same, but when we attempt to calculate the
notional profit we discover that in fact the contract is showing a loss at this point
in time. When that happens we have to write off the whole of the loss (there is no
division into part recognised and part not recognised) to comply with the prudence
concept.
The above question illustrated a number of basic principles of accounting for longterm contracts:
•
•
•
•
how
how
how
how
to
to
to
to
deal with opening balances
calculate notional profit
apply formulae for recognising profit
treat anticipated losses.
The following questions give you the opportunity to test your understanding of
these principles. Some of the questions are based on previous Higher Accounting
or Higher Accounting and Finance paper questions.
52
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© Learning and Teaching Scotland 2005
CONTRACT COSTING STATEMENTS
Question 1
(based on Higher Paper II 1997 Q7)
JBC plc, a construction company, undertook a 2 -year contract with Factory Outlets
Ltd for a fixed price of £1m.
Work began in September of Year 5 and on 1 January Year 6 the following
information was available.
Direct materials on site
Plant at cost on site
£10,000
£90,000
At 31 December Year 6 the following information was available.
Direct materials sent to site
Materials requisitioned from stores
Materials returned to stores
Direct wages paid
Direct expenses
Sub-contracting costs
£
350,000
5,000
2,000
337,000
20,000
28,000
Architect’s fees
Insurance
Hire of special equipment
Plant maintenance
Value of plant on site at 31 Dec Year 6
Value of work certified by architect
Cost of work not yet certified at 31 Dec Year 6
Direct wages due at 31 Dec Year 6
Direct materials on site at 31 Dec Year 6
2,000
1,000
6,000
2,000
78,000
850,000
15,000
3,000
3,000
Overheads are charged at 10% of Direct Wages cost.
JBC plc recognises profit using the formula
Notional Profit 
Work Certified
Contract Price
Prepare the Contract Account at 31 December Year 6 showing clearly the profit
recognised.
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
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CONTRACT COSTING STATEMENTS
Question 2
(based on Higher 1993 Paper II Q2)
Appin Builders plc started work on a 3 -year contract on 1 April Year 2 at a
contract price of £5m. On 31 March Year 3 the following information was
available.
Plant sent to site
Materials sent to site
Materials delivered from store
Sub-contracting costs
Direct wages
Direct expenses
Hire of scaffolding
Work certified by architect
Cost of work not yet certified
Value of plant at 31 March Year 3
Material unused on site at 31 March Year 3
Accrued wages
£000s
75
375
50
48
250
85
20
1,000
150
50
23
10
Overheads are recognised at 10% of Direct Material costs (including sub -contract
costs).
Appin Builders plc recognise profit using the formula
Notional Profit 
Work Certified
Contract Price
Prepare the Contract Account for year ended 31 Ma rch Year 3.
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MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
CONTRACT COSTING STATEMENTS
Question 3
(based on Higher 1992 Paper II Q4(a))
Contract Builders plc undertook a 3-year contract in January Year 4 for a fixed
price of £4,800,000.
On 31 December Year 4 the following information was available relating to the
first year of the contract.
Materials sent to site
Direct wages paid
Direct expenses
Overhead charged
Plant hire
£000s
535
380
180
200
110
At 31 Dec Year 4
Material on site
Wages accrued
Value of work certified
Cost of work completed but not certified
10
20
1,000
165
Prepare the Contract Account for the year ended 31 December Year 4.
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
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CONTRACT COSTING STATEMENTS
Question 4
The following information relates to Contract 654 of Builders plc at 31 December
Year 5.
Materials sent to site
Materials delivered from store
Materials transferred to other contracts
Direct wages
Plant purchased
Plant transferred from other contracts
Sub-contract costs
Site expenses
£
108,400
1,320
3,100
84,310
25,500
10,000
40,137
10,172
At 31 December Year 5
Materials on site
Value of plant on site
Accrued wages
Site expenses prepaid
Value of work certified
Contract price
36,680
29,500
1,840
1,014
420,000
560,000
Overheads are charged at 10% of wages cost.
Profits are recognised using the formula
Notional Profit 
Work Certified
Contract Price
Prepare the Contract 654 Account for year ended 31 December Year 5.
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CONTRACT COSTING STATEMENTS
Solutions
Question 1
£
10,000
Material b/f
Plant b/f
Material sent to site
Materials taken from stores
Direct wages paid
add: accrued
Direct expenses
Sub-contract costs
Architect’s fees
Insurance
Hire of equipment
Plant maintenance
Overheads
90,000
350,000
5,000
337,000
3,000
20,000
28,000
2,000
1,000
6,000
2,000
34,000
888,000
Cost of contract
Profit taken
805,000
51,000
Profit not taken
9,000
865,000
3,000
78,000
805,000
……….
888,000
Value of work certified
Cost of work not
certified
850,000
15,000
……….
865,000
£850,000 – (£805,000 – £15,000)
£850,000 – £790,000
£60,000
Notional profit
=
=
=
Profit taken
= £60,000 
=
Material returned to
stores
Material c/d
Plant c/d
Cost of contract
£
2,000
850,000
1,000,000
£51,000
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
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CONTRACT COSTING STATEMENTS
Question 2
Material sent to site
Material from store
Sub-contract costs
Plant sent to site
Direct wages
Add: accrued
Direct expenses
Hire of scaffolding
Overheads (10%  450)
Contract a/c
£000s
375
50
48
75
250
10
260
85
20
45
958
Cost of contract
Profit taken
Profit not taken
885 Value of work certified
53 Cost of work not certified
212
£1,150
Notional Profit
= 1,000 – (885 – 150)
= 1,000 – 735
= 265
Profit Taken
=
1,000
 265
5,000
= 53
58
Material c/d
Plant c/d
Cost of contract
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
£000s
23
50
885
…
958
1,000
150
……
£1,150
CONTRACT COSTING STATEMENTS
Question 3
Contract a/c
£000s
535
380
20
400
180
110
200
1,425
Material
Wages
add: accrued
Direct expenses
Plant hire
Overheads
Cost of contract
1,415
……
1,415
Profit/loss on contract
Loss
Material c/d
Cost of contract
£000s
10
1,415
……
1,425
Value of work certified
1,000
Value of work not certified
165
Loss on contract
250
1,415
= 1,000 – (1,415 – 165)
= 1,000 – 1,250
= 250
MANAGERIAL ACCOUNTING (AH)
© Learning and Teaching Scotland 2005
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CONTRACT COSTING STATEMENTS
Question 4
Contract 654 a/c
Material sent to site
Material from store
Direct wages
add: accrued
Plant purchased
Plant transferred
Sub-contract costs
Site expenses
less: prepaid
Overheads
£
108,400
1,320
84,310
1,840
10,172
1,014
Cost of contract
Profit taken
Profit not taken
86,150
25,500
10,000
40,137
9,158
8,615
289,280
220,000
150,000
50,000
420,000
Notional profit
= £420,000 – £220,000
= £200,000
Profit taken
= £200,000 
= £150,000
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© Learning and Teaching Scotland 2005
Material transferred
Material c/d
Plant c/d
Cost of contract
420,000
560,000
£
3,100
36,680
29,500
220,000
……
289,280
Work certified
420,000
……
420,000