BSR Long Question Summary
LA 5: Cost Behaviour
1. High – Low Method
 Find the lowest and highest levels of ACTIVITY and their associated costs. Do
not use highest and lowest costs.
 To get the variable cost per unit of activity, divide the difference between the
highest and lowest cost by the difference in the activity levels.
 We can now determine the fixed cost. We take either the high value and
associated cost or the low value and associated cost.
Fixed Cost = Total Cost – (Variable cost per unit of activity x
Amount of activity)
 Using the formula y = a + bx
a = total fixed cost
b = variable cost per unit of activity
2. Scatter graph method
 Plot all points. Activity on the x axis, cost on the y axis
 Draw a regression line so that there is approximately the same number of points
on either side of the line. It is easier if your line bisects one of these points.
 Slope of line represents average variable cost per unit of activity.
 The fixed cost is represented by where the regression line intersects the cost/y
axis.
 Variable cost = Total cost – fixed cost
 Major setbacks are that no one will ever draw the same line. The estimate of the
fixed cost is not as precise as other methods.
3. Least squares regression method
 More objective and precise.
 Uses mathematical formulas to fit the regression line.
 Computes the regression line that minimises the sum of these squared errors.
𝑅2
 Additional information provided by this method.
 Measure’s goodness of fit of regression line to data points.
 Tells us what percentage of variation in cost (dependant variable) that is explained by
variation in the independent variable (activity).
4. Contribution Approach (costs organized by behaviour)
Separates costs into fixed and variable, first deducting variable expenses from revenue to
obtain contribution margin (amount of remaining from sales revenue after variable
expenses have been deducted).
Revenue
Less variable Expenses:
Cost of goods sold
Variable selling
Variable admin
12000
UNITS X VC/unit
(2000)
(600)
(400)
Contribution Margin:
Less fixed Expenses:
Fixed manufacturing
Fixed selling
Fixed admin
Net profit:
= 9000
(4000)
(2500)
(1500)
= 1000
5. Fixed and Variable costs
Important to remember:
Summary of Variable and fixed cost behaviour
Cost
In total
Per unit
Total variable
Variable cost per
Variable
cost changes
unit remains the
when activity
same
level changes
Fixed
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Total fixed cost
remains the same
even when
activity levels
change.
Fixed cost per
unit goes down as
activity levels go
up
Sales
commission,
shipping, DM,
DL, VMOH,
COGS
Taxes, insurance,
salaries,
depreciation,
advertising
In identifying if a cost is mixed, fixed or variable use the rules above.
Step 1; Identify fixed costs FIRST, they are the easiest. Fixed cost remains
the same in total even if activity changes.
Step 2: Identify mixed and variable costs. If we calculate a cost per unit at
various levels, & we get the same answer, that is a VC.
If we calculate a cost per unit at vario us levels & we DO NOT get the
same answer, that must be a MC.
LA 6: Variable and Absorption costing
Product Costs
Period Costs
Absorption Costing
Direct Materials
Direct Labour
Variable Manufacturing Overhead
Fixed Manufacturing Overhead (divide by prod units)
Selling and administrative expenses
Product Costs
Variable Costing DO FIRST
Direct Materials
Direct Labour
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Selling and administrative expenses
Period Costs
Calculating Unit Product Costs
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Use the rules above to determine which costs are used in each method.
Always calculate beginning inventory of the month they ask for.
Take revenue of previous month divided by the cost per unit. This gives the number
of products sold. If they produced 40000 and you find only 35000 sold then the next
months BI is 5000.
Beginning Inventory
+ Units Produced
= Total Units Available
 Units sold
Closing Inventory
Jan
0
40000
40000
35000
5000
Feb
5000
50000
55000
40000
15000
E.g. Variable Costing Profit and loss Statement
Sales = 40 000 x R30 per unit = R1 200 000
1. Variable COGS:
Opening Balance 5000 x (R5 cost to produce unit in jan, variable costing)
COGM
50 000 x R5.5
Less Closing Balance (15 000 x R5.5)
2. Variable admin and selling expenses 40 000 x R2 (R2 times by units SOLD)
3. Total Variable costs = 1 + 2 = 297500
4. Contribution Margin = revenue – total variable costs = 902500
5. Fixed Expenses:
Fixed manufacturing overhead 600 000
Fixed selling and admin expense 300 000 – 80 000(40 000x2)
Net Income = 82500
Reconcile (Compare Absorp and CM Profit and Loss totals) :


Take calculated operating profit from profit and loss statement for each year/month.
Add : Fixed manufacturing overhead cost deferred in stock under absorption costing
(this is the closing balance of stock x the difference in unit cost between variable and
absorption costing)

Deduct FMOH cost released from stock under absorption costing (this is the opening
balance stock x the difference in unit cost between variable costing and absorption
costing.)
When asked about why, under absorption costing, the operating profit for year 2 is higher
than year 1 although the same amount of products have been sold:


The increase in production in year 2 led to a build-up of stock and a deferral of a
portion of the fixed manufacturing overheads to the next year.
By increasing production, and thereby building up stock the company was able to
increase profits without increasing sales. Major criticism.
Difference if JIT had been used:

Two differences, production would have been geared to sales. The unit production
cost for year 2 would be the same as year 1 as the same number of products would be
produced.
** Absorption costing is not in line with breakeven analysis
LA 7: Cost – Volume – Profit relationships
Contribution margin = Revenue – variable expenses
Contribution margin ratio = (contribution margin)/(revenue)
CMpu = SPpu – Vcpu
Variable expense ratio = 100% - CM ratio
Using CM ratio to calculate breakeven point:


Break even point in units sold = (fixed expenses)/(CMpu)
Break even point in total revenue = (fixed expenses)/(CM ratio)
TARGET PROFIT: How many units much be sold to earn a profit of x? -> BE = (fixed exp +
x)/(CM per unit)
High breakeven point = BAD
Low net income = BAD
MoS = Actual Sales – Breakeven Sales (higher the better)
Can also be expressed as % of sales = MoS/Sales
Application of CVP:
Change in sales volume and fixed cost:

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First add extra sales to original sales. Divide by the selling price per unit to see the
number of sales.
From this you can multiply the number of products by the variable cost per unit to get
variable expense cost
Add any fixed cost they mention.
Change in selling price, increase in fixed costs. “Would increase the sales by 1/3”:

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We test the saying “would increase sales by.”
First calculate proposed sales by adding 1/3 to original sales (units sold).
Add the value to fixed expense. Calculate normally and compare the profits of each.
Degree of operating leverage (DoL):


CM / net profit
You can use the degree of operating leverage to calculate increase in net
income/profit. For example, 20% increase in sales. 0.2 x 4(degree of operating
leverage) 80% increase in net income. 60 x 180% = 108000 -> new net income
amount
When asked “if they sell 12000 pairs (UNITS) what will the profit be”:


Take the break even amount minus the stated amount sold, multiply the remainder by
the CM per unit.
Or take the selling price per unit, multiply by the number of units stated. Subtract the
variable costs and fixed costs.
If they ask what the profit will be and they give you increased sales value you times this by
CM RATIO.
Incremental contribution margin (SALES INCREASE):


Take the sales increase and multiply by the CM ratio for sales.
Subtract any added fixed cost.
LA 8: Segment Reporting
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If sales are increased and nothing else changes and they ask for the profit increase,
multiply the CM with the given increase in sales. (REMEMBER RATIOS REMIAN
UNCHANGED)
Net operating profit = net operating income
Return on investment = (net operating profit)/(Average operating assets)
ROI = margin x turnover
Margin = net operating profit/revenue
Turnover = revenue/average operating assets
Residual income = net operating profit – (average operating assets x minimum
required rate of return)
If they give a rate of return and ask to compare to the original, check if the original
ROI and RI is higher or lower than that stated.
OPERATING INCOME IS BEFORE INTEREST AND TAXES
Sales increase = Net income increase, ROI increase
Expenses decrease = Net income increase, ROI increase
Assets decrease = Net income increase, ROI increase

If machinery is purchase, add to assets.


If money is used to repurchase inventory, subtract from assets.
If revenue increases, adjust variable costs as well.
Remember ROI is based on average operating assets computed from the beginning of year
and end of year balances. / 2
Written off inventory as a loss: Expenses will increase (they are not available for sale)
LA 9: Activity based costing
Get TOTALS first.
Activity rate = (total cost) / (total activity measure)

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When asked to calculate total cost. Multiply the activity rate by the number of current
activities in that poo. E.g. activity rate for ticket bookings is R20, 40 people buy
tickets, therefore, R800.
Absorption rate is also activity rate.
Plantwide Overhead Rate = POHR using direct labour hours or machine hours.
Plantwide Overhead rate = (total manufacturing overhead) / (total direct labour hours)
Traditional Overhead

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To work out direct labour hours. Take the cost for labour divided by the rate per hour,
this gives you the labour hours per product. Multiply this by sales demand to get
direct labour hours in total.
Multiply the cost per direct labour hour by the total number of direct labour hours to
get the manufacturing overhead.
Multiply material cost per kilo by the sales demand to get direct material cost.
Multiply the labour cost by the sales demand to get the direct labour cost.
Unit product cost – direct materials + direct labour + manufacturing overhead POHR x
direct labour hours per unit)
ABC Overhead
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Work on a previous percentage.
They will ask for 1st stage allocation of costs to the activity cost pools, multiply the %
given by the total for that cost pool.
Normally place the Cost pools on the top and the activities on the left-hand side
vertically.
Once you have worked out the total cost for each cost pool they might ask to calculate
the total cost for a specific customer. Here use the costs of the cost pools and multiply
by the required units in the given customer requirements.
LA 10: Relevant costs
Constrained Resources:

Usually given some kind of constraint such as a time constraint. For example,
Product X
2000 units x 1 min
2000 min

Product Y
2200 units x 0.5 min 1100 min
Total
3100 min
Total available
2400 min (given)
Shortage
700 min
To see which option is better, work out the CM per unit of the constrained resource.
CM per unit (a)
X
R24
1 min
Constrained
resource required to
produce one unit
CM per unit of the
R24/1 min
constrained resource
Y
R15
0.5 min
R30/min
Therefore, Y is better as it has a better CM per constrained resource.

If asked to calculate max profits, take the better option (Y). Take planned unit sales
and multiply by the time required to produce one unit, the rest of the time is for X.
Multiply these times by the CM per unit.
Adding and dropping segments:
Prepare the analysis asked, usually an analysis to show if the segment is dropped. Start
with lost CM as this is lost if the segment is dropped.
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Here we look for avoidable costs, these are costs that are saved if the segment is
dropped, we add this to the lost CM.
Avoidable costs are mainly variable costs but beware of allocated fixed costs.
Depreciation is a sunk cost.
This will give the net increase/decrease in profits if the segment is dropped.
Make or buy decision:
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Compare the make to the buy.
Eliminate costs that are not avoidable. (sunk costs and future costs that have no
effect).
Compare the total variable costs to make and buy, be careful about a joint product,
split it up.
If the avoidable costs are less than the outside purchase price, then the company
should continue to make its own.
For make, calculate the total variable make cost and calculate the cost of each product
used in the making, use percentages given.
For buy, calculate all the variable costs, and add the cost to buy the product.
Compare
Special Orders:
Joint production costs:
Keep or replace old equipment:
Usually asked to prepare a profit summary for each:
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Calculate revenue for both the old machine and new machine.
Deduct the variable expenses.
Calculate the depreciation of each.
Given the remaining book value and the disposal value, you can calculate the loss
if disposed now for the old machine. This is reported as loss from disposal under
the proposed new machine.
If asked to determine the desirability, use all the relevant costs. To get relevant
costs, eliminate the sunk costs and the future costs that do not differ between the
alternatives.
To make this easier, calculate the difference in cost between the alternatives. And
don’t forget the cost of the new machine/alternative.