MANAGEMENT ACCOUNTING
Module Guide
Copyright© 2019
MANAGEMENT COLLEGE OF SOUTHERN AFRICA
All rights reserved, no part of this book may be reproduced in any form or by any means, including photocopying
machines, without the written permission of the publisher. Please report all errors and omissions to the following
email address: modulefeedback@mancosa.co.za
This Module Guide,
Management Accounting (NQF level 6),
will be used across the following programmes:
•
Bachelor of Business Administration
•
Bachelor of Commerce in Information and Technology Management
•
Bachelor of Commerce in Supply Chain Management
•
Bachelor of Commerce in Marketing Management
•
Bachelor of Commerce in Retail Management
•
Bachelor of Commerce in Entrepreneurship
•
Bachelor Commerce Project Management
Management Accounting
MANAGEMENT ACCOUNTING
Preface........................................................................................................................................................... 1
Unit 1: Management Accounting – An Introduction ..................................................................................... 6
Unit 2: Classification of Costs ..................................................................................................................... 12
Unit 3: Materials .......................................................................................................................................... 21
Unit 4: Labour .............................................................................................................................................. 35
Unit 5: Absorption Costing and Marginal Costing ..................................................................................... 55
Unit 6: Cost-Volume-Profit Analysis ........................................................................................................... 69
Unit 7: Budgets and Budgetary Control...................................................................................................... 99
Unit 8: Standard Costing........................................................................................................................... 123
Unit 9: Capital Investment Appraisal ........................................................................................................ 144
Bibliography ............................................................................................................................................... 173
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Management Accounting
Preface
A.
Welcome
Dear Student
It is a great pleasure to welcome you to Management Accounting (MA6). To make sure that you share
our passion about this area of study, we encourage you to read this overview thoroughly. Refer to it as
often as you need to since it will certainly be making studying this module a lot easier. The intention of
this module is to develop both your confidence and proficiency in this module.
The field of Accounting is extremely dynamic and challenging. The learning content, activities and selfstudy questions contained in this guide will therefore provide you with opportunities to explore the latest
developments in this field and help you to discover the field of Accounting as it is practiced today.
This is a distance-learning module. Since you do not have a tutor standing next to you while you study,
you need to apply self-discipline. You will have the opportunity to collaborate with each other via social
media tools. Your study skills will include self-direction and responsibility. However, you will gain a lot
from the experience! These study skills will contribute to your life skills, which will help you to succeed in
all areas of life.
The module is a 15 credit module at NQF level 6
We hope you enjoy the module.
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Management Accounting
B.
Learning Outcomes and Associated Assessment Criteria of this Module
Module Outcomes
At the end of this module,
students will be able to:
•
Explain the need for pre-determined costs and management
accounting systems;
•
Distinguish between direct and indirect costs and fixed and
variable costs;
•
Calculate the value of stock using different valuation methods;
•
Explain Absorption Costing;
•
Explain Marginal Costing and Breakeven Analysis;
•
Determine the optimal costing methods (Absorption Costing
Vs Marginal Costing);
Associated Assessment
Criteria
•
Explain the principles of effective budgeting;
•
Apply Cost control using Standard Costing methods;
•
Apply techniques of Investment Appraisal.
•
Complete the relevant module activities, and self-reflection
questions and think points
Complete and pass the formative and summative
assessments
•
The student needs to:
C.
How to Use this Module
This Module Guide was compiled to help you work through your units and textbook for this module, by
breaking your studies into manageable parts. The Module Guide gives you extra theory and explanations
where necessary, and so enables you to get the most from your module.
The purpose of the Module Guide is to allow you the opportunity to integrate the theoretical concepts
from the prescribed textbook and recommended readings. We suggest that you briefly skim read through
the entire guide to get an overview of its contents.
At the beginning of each Unit, you will find a list of Learning Outcomes and Assessment Standards. This
outlines the main points that you should understand when you have completed the Unit/s. Do not attempt
to read and study everything at once. Each study session should be 90 minutes without a break
This module should be studied using the recommended textbook/s and the relevant sections of this
Module Guide. You must read about the topic that you intend to study in the appropriate section before
you start reading the textbook in detail. Ensure that you make your own notes as you work through both
the textbook and this module. In the event that you do not have the prescribed textbook, you must make
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Management Accounting
use of any other source that deals with the sections in this module. If you want to do further reading, and
want to obtain publications that were used as source documents when we wrote this guide, you should
look at the reference list and the bibliography at the end of the Module Guide. In addition, at the end of
each Unit there is a link to the PowerPoint presentation and other useful reading.
D.
Study Material
The study material for this module includes tutorial letters, programme handbook, this Module Guide,
prescribed textbook which is supplemented by recommended readings. The Module Guide is written
based on a prescribed textbook which is supplemented by recommended readings.
E.
Prescribed Textbook
The textbook presents a tremendous amount of material in a simple, easy-to-learn format. You should
read ahead during your course. Make a point of it to re-read the learning content in your module textbook.
This will increase your retention of important concepts and skills. You may wish to read more widely than
just the Module Guide and the prescribed textbook, the Bibliography and Reference list provides you with
additional reading.
There is no prescribed book for this module. This study guide will serve as your prescribed reading.
F.
Recommended Readings
In addition to the prescribed textbook, the following should be considered for recommended
books/readings:
•
Fundamentals of Cost and Management Accounting Sixth edition, 2012. Els. G, Meyer, L., van
der Walt. R, de Wet. S.R
•
3
The Essence of Management Accounting First edition, 2003. Chadwick, L
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Management Accounting
G.
Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to
help you study. It is imperative that you work through them as they also provide guidelines for examination
purposes.
Prescribed Textbook
Title, author, publisher and edition details of the prescribed textbook/s
must be written here.
Think Point
A think point asks you to stop and think about an issue. Sometimes you
are asked to apply a concept to your own experience or to think of an
example.
Activity
You may come across activities that ask you to carry out specific tasks.
In most cases, there are no right or wrong answers to these activities.
The aim of the activities is to give you an opportunity to apply what you
have learned.
Readings
At this point, you should read the reference supplied. If you are unable to
acquire the suggested readings, then you are welcome to consult any
current source that deals with the subject. This constitutes research.
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Management Accounting
Practical Application or Examples
Real business examples or cases will be discussed to enhance
understanding of business ethics.
Self-Test Questions
Real business examples or cases will be discussed to enhance
understanding of business ethics.
Revision Questions
You may come across self-assessment questions that test your
understanding of what you have learned so far. These may be attempted
with the aid of your textbooks, journal articles and Module Guide.
Case Study
It is advisable to include Case Studies after Sections of the guide. This
activity must give students an opportunity to apply theory to practice.
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Management Accounting
Unit
1:
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Management Accounting–
An Introduction
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Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF THIS
On successful completion of this Unit, the student UNIT:
will be able to:
The student needs to:
Complete the relevant activities and think
•
Define Management accounting and the •
points to be able to define management
purpose thereof.
accounting.
•
Explain the nature of management
•
Complete the relevant activities and think
accounting and be able to distinguish it
points to be able to distinguish between
from financial accounting.
management and financial accounting.
•
Explain the functions of management
•
Complete the relevant activities and think
accounting.
points to be able to discuss the functions of
•
State the reasons and requirements for
management accounting.
effective management accounting.
•
To demonstrate an understanding of the
requirements for effective management
•
Identify the limitations and drawbacks of
accounting
management accounting.
•
To demonstrate an understanding of the
limitations management accounting
Key Concepts
1.1 What is management?
1.2 Differences between management accounting and financial accounting
1.3 Management accounting serving the needs of managers
1.4 Requirements for effective management accounting
1.5 Limitations of management accounting
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
7
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Management Accounting
1.1 What Is Management Accounting?
Management accounting may be defined as the identification, analysis, interpretation and communication
of financial information that enables management to do planning and controlling within the business as
well as to make a number of management decisions. Management accounting is thus concerned with
providing information within the business that will assist in making informed decisions in
1.2 Differences Between Management Accounting and Financial Accounting
Management accounting involves the use of financial information to meet the needs of managers or
internal users. Financial accounting provides financial information about the business to external users
i.e. those who not involved in the day-to-day running of the enterprise. The major differences between
the two may be tabulated as follows: order to improve the efficiency and profitability of the business.
User groups
Management accounting
Financial accounting
Internal users: Managers
External: Owner(s); Lenders,
Creditors; Investors
Nature of
Reports tend to be specific usually with
Reports tend to be general-purpose
reports
some decision in mind.
useful to a wide range of users.
Legal
Management accounting reports are not
Financial reports are required by law
requirements
required by law since they are for internal
and are also regulated in terms of
use only.
content and format.
Management accounting reports are not
Financial reports must conform to
subject to the practices and principles of
the practices and principles set by
GAAP (Generally Accepted Accounting
GAAP.
GAAP
Practice).
Time focus
The emphasis is on the future but also
It reflects on the financial result and
provides information on past
financial position for the past period.
performance.
Nature of
Information used may be less objective
Objective and verifiable information
information
and verifiable.
is needed to prepare reports.
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Management Accounting
Frequency of
Reports are produced as often as
Reports are produced annually
reporting
required by managers even on a weekly
although some businesses prepare
basis.
half-yearly or even quarterly reports.
Focuses on parts of the business e.g. a
Focuses on the performance of the
Focus on the
whole or parts of certain department as well as the
the business
business as a whole.
business as a whole.
1.3 Management Accounting Serving the Needs of Managers
Management accounting serves the following functions:
It provides information for managers that enable them to make better and informed decisions.
Management requires a steady flow of information to respond to possible problems that may be starting
to develop or to be proactive in ensuring that certain problems do not occur. This information could be in
the form of reports, spreadsheets, graphs etc.It advises management about the likely results of its
intended decisions.
Management accounting information is concerned with planning and control decisions that managers
are required to make regularly. Planning decisions relate to the setting of goals or objectives and the
formulation of policy. Control involves the comparison of actual results with standards set e.g. actual
expenditure compared to budgeted expenditure. Deviations from the standard are analysed with a view
to implementing remedial measures.
1.4 Requirements for Effective Management Accounting
Information intended for managers must be effectively and timeously communicated. The information
must also be user-friendly and understandable.
The environment in which the enterprise operates is never static and management accounting must
therefore be flexible so that it can respond to changes. The environment must be monitored closely so
that information can be updated or amended.
There must be good co-operation between the management accounting section and the other business
functions. For example, the preparation of budgets requires the co-operation of all departments in the
enterprise.
The management accounting department must ensure that the managers who use the information it
provides are well trained in the techniques and the processes that go into making the information usable.
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Management Accounting
1.5 Limitations of Management Accounting
•
Management accounting is not an exact science. A lot of information is based on assumptions and
making judgements which are subjective.
•
It cannot solve all financial problems or help in providing the best alternatives. It is merely one tool
amongst others that are available to help managers to make appropriate or informed decisions.
Self-Test Questions
For each of the following, state whether it is concerned mainly with financial
accounting or management accounting. Place a tick in the appropriate column.
No. Statement
1.
Prepares financial statements.
2.
Emphasis is on the past rather than
Financial
Management
Accounting
Accounting
the future.
3.
Focuses on parts as well as the entire
enterprise.
4.
It is subject to the principles of GAAP.
5.
It provides information for internal
users.
6.
Information is used for planning and
control.
7.
Provides information that is precise
and objective.
8.
Specific purpose reports are
prepared.
6.2 Tabulate 5 differences between financial accounting and management
accounting.
6.3 Management accounting is not required in non-profit organisations such as
welfare bodies and state clinics. Do you agree with this statement? Give reasons
for your answer.
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Management Accounting
SOLUTIONS
6.1
No. Statement
Financial
Management
Accounting
Accounting
1.
Prepares financial statements.
P
2.
Emphasis is on the past rather than the future.
P
3.
Focuses on parts as well as the entire enterprise.
4.
It is subject to the principles of GAAP.
5.
It provides information for internal users.
P
6.
Information is used for planning and control.
P
7.
Provides information that is precise and objective.
8.
Specific-purpose reports are prepared.
P
P
P
P
6.2 Refer to paragraph 2.
6.3 disagree with the statement for the following reasons:
Management accounting provides information that is useful in planning, controlling and making
decisions. The elements of planning, organising and decision-making are characteristic of both profitmaking and non-profit organisations.
Non-profit organisations are also concerned with the control of income and expenditure and therefore
rely on management accounting information.
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Management Accounting
Unit
2:
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Classification of Costs
12
Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
On successful completion of this Unit, the
student will be able to:
•
Define costs
•
•
•
•
•
to be able to define costs.
•
Complete the relevant activities and think points
Define direct costs and provide an
to be able to differentiate and distinguish
example
between direct and indirect costs.
Define indirect costs and provide an
•
Complete the relevant activities and think points
example
to be able to discuss the meaning and
Distinguish between Fixed and
understanding of the concept-Direct Costs
Variable costs.
•
The student needs to:
• Complete the relevant activities and think points
Distinguish between Direct and Indirect
Costs
•
ASSOCIATED ASSESSMENT CRITERIA OF THIS
UNIT:
•
Complete the relevant activities and think points
What are fixed costs and explain by an
to be able to discuss the meaning and
example
understanding of the concept-Indirect Costs
What are variable costs and explain by
•
Complete the relevant activities and think points
an example
to be able to discuss how to improve an
Explain the elements of product
organisation’s ethical climate
manufacturing costs
•
To understand the concept of fixed costs and
how to apply it to the business context
•
To understand the concept of variable costs and
how to apply it to the business context
•
Complete the relevant activities and think points
to be able to discuss the definition of all the
manufacturing costs and the relevant sub-costs
relating to them.
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Management Accounting
Key Concepts
2.1 What are costs?
2.2 Direct and indirect costs
2.3 Fixed and variable costs
2.4 Manufacturing costs and non-manufacturing costs
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
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Management Accounting
2.1 What Are Costs?
Costs may be defined as the value of economic resources used for the production of a product or service.
Costs may be viewed as a necessity in producing a product or service. Costs may be classified according
to type e.g. direct and indirect costs as well as by behaviour e.g. fixed and variable costs.
2.2 Direct and Indirect Costs
All costs may be categorised as direct or indirect costs. Costs are considered to be direct or indirect to
the extent to which they can be accurately traced to a cost centre. A cost centre may be defined as any
part of a business to which costs are charged e.g. a particular product or job or department.
2.2.1
Direct costs
Direct costs are costs that can be accurately identified as forming part of a cost centre. Examples of such
costs would include the materials used to make the product (direct materials) and the wages of the
employees who work with these materials (direct labour).
2.2.2
Indirect costs
Indirect costs are costs that cannot be easily traced to a particular cost centre. They may be said to
include all costs with the exception of direct costs. For example, indirect product costs include all
manufacturing costs excluding direct materials and direct labour. Costs that are shared between different
departments or products are also considered to be indirect costs e.g. common advertising on national
television that benefits two products of the same manufacturer.
2.3 Fixed and Variable Costs
Costs behave differently relative to the output. They may remain constant or they may vary. There are
no set rules to determine whether a cost is fixed or variable. It depends on the circumstances of each
case.
Fixed costs
Fixed costs are those costs that remain the same irrespective of the level of output or activity. Examples
include rent and insurance. However, it must be remembered that fixed costs remain fixed over a certain
range. For example, if a factory is producing goods at full capacity and if more units have to be produced
then additional premises would be needed resulting in additional rent expense being incurred.
2.3.1 Variable costs
Variable costs are those costs that change in proportion to the changes in the level of output or activity.
Examples include direct materials, direct labour and certain variable overheads e.g. packing materials.
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Management Accounting
The classification of costs into fixed and variable costs are important in many facets of management
accounting e.g. break-even analysis. It must be remembered, though, that some costs e.g. water contain
a fixed component (a fixed monthly charge) plus a variable component (additional charged based on
usage). These costs may be termed semi-variable.
2.4 Manufacturing Costs and Non-Manufacturing Costs
Manufacturing costs consists of three elements viz. direct material, direct labour and manufacturing
overheads. Included in manufacturing overheads are indirect materials and indirect labour. Nonmanufacturing costs include marketing costs and administrative costs. All these concepts are explained
below.
Material
Material consists of direct material and indirect material. Direct material can be regarded as the primary
material used to manufacture a product. It forms a part of the final product and its usage depends on the
volume of production. Direct material forms one part of the primary (direct) cost of a product.
Indirect material does not form part of the final product e.g. cleaning materials, maintenance materials.
The quantity used is not linked to the volume of production. Indirect materials form part of manufacturing
overheads.
2.4.1 Labour
Labour can also be divided into two components viz. direct labour and indirect labour. Direct labour refers
to labour that is physically applied to the manufacturing of a product and can also be easily traced to the
manufactured product. Direct labour forms part of the primary (direct) cost of a product.
Indirect labour refers to labour costs that cannot be directly linked to a particular product. For example,
the wages of the employees who maintain and service the machines used during manufacturing are
classified as indirect labour. Indirect labour forms part of manufacturing overheads.
2.4.2 Manufacturing overheads
Manufacturing overheads include indirect materials, indirect labour and all other costs incurred during the
manufacturing process that cannot be directly traced to the product. In other words, in includes all costs
excluding direct material and direct labour that are incurred during the production process. Apart from
indirect materials and indirect labour, manufacturing overheads include rent (of the factory floor space),
insurance (of the factory stock and buildings), depreciation of production machinery etc.
2.4.3 Marketing costs
Marketing costs are costs incurred to market the product and are largely expenses incurred in promoting
sales, obtaining orders and delivery of products. Examples include advertising and commission on sales.
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Management Accounting
2.4.4 Administrative costs
These are costs incurred during the performance of administrative duties. They include costs that arise
from departments such as finance, administration, human resources and management. Examples
include salaries of executives, legal costs, clerical costs etc.
Self-Test Questions
1.1
Classify the following costs as direct or indirect. Place a tick in the appropriate
column.
No. Cost
1.
Fabric used in the manufacture of shirts
2.
Grease for the factory machines
3.
Depreciation of factory machinery
4.
Cleaning materials
5.
Salary of the supervisor
6.
Wood used in making tables
7.
Wages of the person who operates the machine
Direct
Indirect
cost
cost
that makes the shoes
8.
Rent of the factory
1.2
Classify the following costs as fixed or variable in terms of the level of output.
Place a tick in the appropriate column.
Cost
Fixed cost Variable
No.
cost
1.
Rent expense
2.
Direct materials
3.
Property rates and taxes
4.
Commission of salesperson
5.
Depreciation
using
straight-line
method
17
6.
Direct labour
7.
Insurance
8.
Salary of factory manager
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Management Accounting
5.3 Classify the following costs as manufacturing, marketing or administrative costs.
Place a tick in the appropriate column.
No. Cost
Manufacturing
1.
Advertising
2.
Salary of the typist
3.
Repairs to the factory
Marketing
Administrative
machine
4.
Depreciation on office
furniture
5.
Bad debts
6.
Audit fees
7.
Carriage
costs
on
materials purchased
8.
Rent
of
the
office
building
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Management Accounting
2.6 Answers to Revision Questions and Activities
SOLUTIONS
5.1
No. Cost
Direct cost
Indirect
cost
P
1.
Fabric used in the manufacture of shirts
2.
Grease for the factory machines
P
3.
Depreciation of factory machinery
P
4.
Cleaning materials
P
5.
Salary of the supervisor
P
6.
Wood used in making tables
P
7.
Wages of the person who operates the machine that makes the
P
shoes
8.
P
Rent of the factory
5.2
No.
Cost
Fixed cost
Variable
cost
P
1.
Rent expense
2.
Direct materials
3.
Property rates and taxes
4.
Commission of salesperson
5.
Depreciation using straight-line method
6.
Direct labour
7.
Insurance
P
8.
Salary of factory manager
P
19
P
P
P
P
P
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Management Accounting
5.3
No.
Cost
1.
Advertising
2.
Salary of the typist
3.
Repairs to the factory machine
4.
Depreciation on office furniture
5.
Bad debts
6.
Audit fees
7.
Carriage costs on materials purchased
8.
Rent of the office building
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Manufacturing
Marketing
Administrative
P
P
P
P
P
P
P
P
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Management Accounting
Unit
3:
21
Materials
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Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
On successful completion of this Unit, the
student will be able to:
• Be familiar with the various activities
ASSOCIATED ASSESSMENT CRITERIA OF
THIS UNIT:
The student needs to:
• Complete the relevant activities and think
associated with materials.
points to be able to define the terminology and
•
Explain the term primary material
terms associated with materials.
•
Explain the term secondary material
•
Explain the term work-in-progress
points to be able to calculate the economic
•
Explain the term finished goods
order quantity
•
Explain the term Inventory
•
Calculate the economic order quantity
points to be able to understand the inventory
•
Valuate materials according to the FIFO
valuation methods and tabulate the
and AVCO methods.
movements in stock. Finally grasping that the
Explain the FIFO method and understand
units will remain the same for all methods ,
how to tabulate the movements in stock
accept that the value of the units changes
across this method.
amongst the methods.
•
•
Explain the FIFO method and understand
•
•
•
Complete the relevant activities and think
Complete the relevant activities and think
Complete the relevant activities and think
how to tabulate the movements in stock
points to be able to demonstrate the
across this method.
understanding and calculation of valuing stock
•
What is the market price method?
using the FIFO method of inventory valuation.
•
State the advantages and shortcomings of
•
the just in time(JIT) inventory policy.
Complete the relevant activities and think
points to be able to demonstrate the
understanding and calculation of valuing stock
using the AVCO method of inventory
valuation.
•
Explain what is the market price method and
what it is used for.
•
Complete the relevant activities and think
points to be able to understand the concepts
and contrast the inventory piling versus the
just in time inventory policy
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Key Concepts
3.1 Introduction
3.2 Terminology associated with materials
3.3 Economic order quantity
3.4 Methods of valuation of materials
3.5 Inventory piling versus Just in time (JIT) inventory policy
3.6 Self-Assessment Activities
3.7 Answers to revision questions and activities
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
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Management Accounting
3.1 Introduction
We have learnt from the previous topic that material is an important component of the cost of
manufacturing a product. We have also learnt that material cost may be divided into direct materials and
indirect materials. There are a few other terms that we need to be familiar with:
3.2 Terminology Associated with Materials
3.2.1 Primary material
This is another term for direct material i.e. raw materials that are used in the manufacturing process.
3.2.2 Secondary material
This is another term for indirect material i.e. material that usually does not form part of the finished
product.
3.2.3 Work-in-progress
This refers to raw materials that have been put into the production process but are not yet complete.
They are part of unfinished products to which a certain amount of labour and overheads have also been
applied.
3.2.4 Finished goods
These are goods that have been completed from the raw materials that have been put into production.
These goods are now ready for sale.
3.2.5 Inventory
This refers to the stock of material (direct and indirect), work-in-progress and finished goods at any given
time.
3.3 Economic Order Quantity
With regard to the control of materials, one of the problems that managers face is what quantity of any
item should be ordered each time. One must bear in mind that if too little is purchased, the enterprise
may run out of stock. If too much is purchased, a lot of working capital is tied up unproductively in
inventory and the cost of holding the stock is high. Therefore, managers have to find a balance between
purchasing too little and purchasing too much.
Managers need to also consider the two main costs in any purchasing order viz. the cost of purchasing
and the cost of holding the inventory. The cost of purchasing inventory includes the costs involved in
negotiations, cost of telephone and faxes, stationery, internet usage and receiving the goods. The cost
of holding inventory include the cost of storage, loss of interest on capital tied up in inventory, personnel
costs, insurance, goods going out of fashion or becoming obsolete.
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Management Accounting
Thus one finds that if small quantities are purchased each time, the cost of purchasing will be high as
many orders need to be placed. On the other hand if larger quantities are purchased, the cost of holding
inventory becomes high. Somewhere between these two extremes is a point where the total cost of
purchasing and holding the inventory is at a minimum. The quantity ordered at this point is the economic
order quantity (EOQ).
The economic order quantity can be calculated using the following formula:
2CU
H
EOQ =
Where:
C = cost of placing an order
U = annual usage
H = inventory (stock) holding cost per unit
Example 1
Arlen Limited purchases 800 school bags at R60 each per annum. The bags are sold at R80 each at a
steady rate during the year. The cost of placing a single order amounts to R20,25. Inventory holding cost
amounts to R4 per unit. Calculate the:
1.1 economic order quantity
1.2 the number of orders that should be placed each year
1.1
Solution
EOQ =
=
2CU
H
2 X 20,25 X 800
4
8 100
=
=
25
90 units
MANCOSA
Management Accounting
1.2
The number of orders that should be placed per year is calculated as follows:
Total annual demand__
Economic order quantity
= 800
90
= 8,89 or 9 orders (rounded off)
Managers need to be aware that there are some limitations to the use of the basic EOQ model. These
limitations relate to its assumptions. It assumes that annual demand can be predicted accurately. It also
assumes that inventory can be purchased in single units e.g 73 but goods are often packaged in multiples
of 20 or 50 units etc. Finally, it also assumes that quantity or bulk discounts are not available. Despite
these limitations the EOQ model is still a useful tool in managing inventory.
3.4
Methods of Valuation of Materials
The purchase price of materials is often subject to constant change. These changes could be through
the effects of inflation, shortages in supply, unstable markets etc. Materials need to be valued for two
purposes viz.
•
to determine the value of materials issued to production (affects cost of production)
•
.to determine the value of the materials on hand (inventory valuation).
Various methods are used to value inventory. These include the first-in-first-out method (FIFO), last-infirst-out method (LIFO), the weighted average cost method (AVCO) and the market price method. The
LIFO method is usually not allowed when calculating profit for tax purposes and will therefore not be
discussed.
3.4.1
First-in-first-out method (FIFO)
This method values material issued to production in the order in which it was received. It is based on the
premise that material that is received first is issued first (to avoid losses due to deterioration or
obsolescence). The following example explains the application of the FIFO method:
MANCOSA
26
Management Accounting
Example 2
The following transactions of BNM Ltd took place during April 20.6 in respect of a component
used in production:
April
01
Opening inventory
90 units at R10 per unit
07
Issued to production
50 units
10
Purchased from supplier
160 units at R11 per unit
17
Issued to production
30 units
20
Purchased from supplier
60 units at R12 per unit
24
Issued to production
60 units
30
Returned to supplier (bought on 10 April)
20 units
Required
Using the FIFO method, calculate the issue price to production and the value of closing
inventory.
Purchases
Date Quantity
Price
Issues and returns
Amount
Quantity
Price
Balance
Amount
Quantity
Price
Amo
unt
01
07
10
50
160
11
24
30
27
30
60
12
500
1 760
17
20
10
10
300
720
90
10
900
40
10
400
40
10
400
160
11 1 760
10
10
100
160
11
1760
10
10
100
160
11 1 760
60
12
720
10
10
100
110
11 1 210
50
11
550
60
12
720
20
11
220
90
11
990
60
12
720
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Management Accounting
3.4.2
Weighted average cost method (AVCO)
When using the AVCO method, all issues of material and inventory of material are valued at the average
price. This average price is re-calculated each time materials are purchased from suppliers. When
materials are purchased the quantity and monetary value is added to the previous stock balance and a
new average unit price is available for additional issues of materials. If prices fluctuate greatly, AVCO
method provides a good option for dealing with this. For a time all products will be charged at a uniform
rate for the same material. However, the disadvantage of this method is that the average price may be
fictitious and not be related to the market price.
The following example explains the application of the AVCO method:
Example 3
Required
Refer to the information used in example 2. Using the AVCO method, calculate the issue price to
production and the value of closing inventory.
Purchases
Date Quantity
Price
Issues and returns
Amount
Quantity
Price
Balance
Amount
01
07
50
10
160
11
30
60
500
1 760
17
20
10
12
10,80
324
720
Quantity
Price
Amount
90
10
900
40
10
400
200
10,80
2 160
170
10,80
1 836
230
11,11
2 556
24
60
11,11
667
170
11,11
1 889
30
20
11
220
150
11,13
1 669
REMARKS
n
The weighted average per unit for the 10th is calculated as follows:
(400 + 1 760) ÷ (40 + 160)
2 160 ÷ 200
R10,80
n
The stock issued on the 7th, 17th and 24th are issued at the latest weighted average per unit.
n
The weighted average per unit for the 20th is calculated as follows:
(1 836 + 720) ÷ (170 + 60)
2 556 ÷ 230
MANCOSA
28
Management Accounting
11,113043 or R11,11
n
The weighted average per unit for the 30th is calculated as follows:
(1 889 - 220) ÷ (170 - 20)
1 669 ÷ 150
11,126666 or R11,13
3.4.3
Market price method
This method uses the current market price to determine the price at which materials are issued for
production.
3.5
Inventory Piling Versus Just In Time (JIT) Inventory Policy
A business may hold stock (inventory piling or stockpiling) for various reasons. It may want to ensure that
production is uninterrupted. It is possible that future supplies may become scarce. It may be that the
prices of the materials are expected to rise shortly. However, there are many costs that need to be borne
in inventory piling. These include storage and handling costs, financing costs, theft and obsolescence.
Moreover, large amounts of working capital may be tied up in inventory.
A modern trend among many businesses is to eliminate the need to hold inventory by applying the just
in time (JIT) inventory policy. Toyota (Pty) Ltd situated south of Durban (South Africa) uses the JIT stock
management system. The advantages to the business are that:
inventory is kept to a minimum (thus minimising costs associated with handling, theft, insurance and
obsolescence).
•
the investment in inventory is kept to a minimum.
•
less storage facilities are required (inventory holding costs rest with the suppliers).
The success of the JIT inventory policy depends a lot on maintaining an excellent relationship with
suppliers. Suppliers must be informed of orders in advance and suppliers must deliver at the appropriate
times. The downside of JIT inventory management is that if suppliers don’t deliver on time, production
may be halted and the supply of products to customers could be interrupted. Furthermore, since suppliers
are required to hold the inventory, they may compensate for this through increased prices.
29
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Management Accounting
3.6 Self-Assessment Activities
Self-Test Questions
3.6.1
What are the consequences to a business of holding a very low a level of inventory?
3.6.2
DNA Ltd sells 4 000 drums of grease each year. The inventory holding cost of one drum of
grease is R8. The cost of placing an order for stock is estimated at R250.
3.6.3
Calculate the EOQ for drums of grease.
Calculate the number of orders that should be placed per annum.
(Round off calculations to the nearest whole number.)
3.6.4
You are the newly appointed management accountant at Kelso Industries. The company
uses the EOQ model to determine the quantity of raw material Z54 to order from REM Ltd.
The following details regarding raw material Z54 are brought to your attention: Kelso
Industries consumes 2 400 units of material Z54 each working day.
•
It is estimated that there are 250 working days in the 20.7 financial year.
•
The cost of placing an order amounts to R120.
•
The cost of holding inventory per unit is estimated at R3,90 plus 11% of the invoice price
per unit.
•
The invoice price per unit is R10.
REQUIRED
3.6.5
Calculate the EOQ for raw material Z54 for the 20.7 financial year.
3.6.6
Calculate the number of orders that should be placed during 20.7. (Round off calculations
to the nearest whole number.)
3.6.7
The following transactions of CAN Manufacturers took place during June 20.6 in respect of
a raw material M321 used in production:
June
MANCOSA
01
Opening inventory
2 000 units at R30 per unit
08
Issued to production
1 600 units
11
Purchased from supplier
1 800 units at R31 per unit
18
Issued to production
1 900 units
21
Purchased from supplier
2 000 units at R32 per unit
30
Management Accounting
25
Issued to production
1 400 units
30
Returned to supplier (bought on 21 June)
100 units
Required
Use the FIFO method and weighted average cost methods to complete the tables below
that include the issue price to production and the value of closing inventory.
FIFO
Purchases
Date
Quantity
Price
Issues and returns
Amount
Quantity
Price
Balance
Amount
Quantity
Price
Amount
WEIGHTED AVERAGE COST METHOD
Purchases
Date
31
Quantity
Price
Issues and returns
Amount
Quantity
Price
Amount
Balance
Qty
Price
Amount
MANCOSA
Management Accounting
3.7 Answers to Revision Questions and Activities
Solutions
3.6.1
•
Production may be interrupted due to shortage of raw materials.
•
Loss of sales may result as goods cannot be provided immediately.
•
There may be a loss of goodwill from customers due to finished stock shortages.
•
Higher purchasing price may have to be paid in order to replenish inventory quickly.
•
High transport costs may be incurred to replenish inventory quickly.
3.6.2
EOQ =
=
2CU
H
2 X 250 X 4000
8
250 000
=
=
500 units
3.6.3 The number of orders that should be placed per annum is calculated as follows
Total annual demand
Economic order quantity
= 4 000
500
= 8 orders
6.3.1
EOQ =
MANCOSA
2CU
H
32
Management Accounting
2 X 120 X 600 000
5
=
28 800 000
=
=
5 367 units (rounded off)
3.6.4
The number of orders that should be placed per annum is calculated as follows:
Total annual demand
Economic order quantity
= 600 000
5 367
= 112 orders (rounded off)
3.6.5
FIFO
Purchases
Date Quantity
Price
Issues and returns
Amount Quantity
Price
Amount Quantity
Price
Amount
2 000
30
60 000
400
30
12 000
400
30
12000
1 800
31
55 800
300
31
9 300
300
31
9 300
2 000
32
64 000
01
08
11
1 600
1 800
31
25
30
33
2 000
32
48 000
55 800
18
21
30
Balance
400
30
12 000
1500
31
46 500
64 000
300
31
9 300
1 100
32
35 200
900
32
28 800
100
32
3 200
800
32
25 600
MANCOSA
Management Accounting
3.6.7
WEIGHTED AVERAGE COST METHOD
Purchases
Date Quantity
Price
Issues and returns
Amount Quantity
Price
Amount Quantity
Price
Amount
2 000
30
60 000
400
30
12 000
2 200
30,82
67 800
300
30,82
9 245
2 300
31,85
73 245
01
08
1 600
11
1 800
31
1 900
2 000
32
48 000
55 800
18
21
30
Balance
30,82
64 000
25
1 400
31,85
44 584
900
31,85
28 661
30
100
32
3 200
800
31,83
25 461
n
REMARKS
The weighted average per unit for the 11th is calculated as follows:
(12 000 + 55 800) ÷ (400 + 1 800)
67 800 ÷ 2 200
30,818181 or R31,82
n
The stock issued on the 8th, 18th and 25th are issued at the latest weighted average per unit.
n
The weighted average per unit for the 21st is calculated as follows:
(9 245 + 64 000) ÷ (300 + 2 000)
73 245 ÷ 2 300
31,845652 or R31,85
n
The weighted average per unit for the 30th is calculated as follows:
(28 661 – 3 200) ÷ (900 - 100)
25 461 ÷ 800
31,82625 or R31,83
MANCOSA
34
Management Accounting
Unit
4:
35
Labour
MANCOSA
Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS
UNIT:
On successful completion of this Unit,
the student will be able to:
• Familiar with the administrative
ASSOCIATED ASSESSMENT CRITERIA OF THIS UNIT:
The student needs to:
•
Complete the relevant activities and think points to be able to
issues and various calculations
demonstrate an understanding of administrative issues and
related to labour.
perform the necessary calculations accordingly.
• Be familiar with the employee
•
Complete the relevant activities and think points to be able to.
records maintained for labour
•
Complete the relevant activities and think points to be able to
recognise the different remuneration methods. Additionally, be
remuneration.
able to calculate the net wage or net salary.
• Calculate the net wage or net
salary of an employee.
•
define wage incentive schemes and explain the different
• Be familiar with the various wage
aspects of the wage incentive schemes. As well as being able
incentive schemes.
to calculate wages according to the different wage incentive
• State the principles of the wage
schemes.
incentive schemes
• Calculate the hourly rate for
•
•
Complete the relevant activities and think points to be able to
calculate the hourly rates allocated to the various cost centres.
centres.
• Explain the essence of Taylor’s
Complete the relevant activities and think points to be able to
discuss the key principles of wage incentive schemes.
employees that would be
allocated to the various cost
Complete the relevant activities and think points to be able to
•
Complete the relevant activities and think points to be able to
differential piecework system and
demonstrate an understanding and calculate the standard rate
the calculation thereof.
per unit of Taylor’s differential piecework system.
• Explain the essence of the Halsey
•
demonstrate an understanding and calculate the time saved
Bonus system and the calculation
when manufacturing a product using the Halsey Bonus
thereof.
• To allocate the direct labour costs
and calculate the hourly recovery
tariff of an employee
Complete the relevant activities and think points to be able to
system.
•
Complete the relevant activities and think points to be able to
demonstrate an understanding of the allocation of the direct
labour costs and calculate the hourly recovery tariff of an
employee.
MANCOSA
36
Management Accounting
Key Concepts
4.1 Introduction
4.2 Labour administration
4.3 Employee records
4.4 Calculation of net wage or net salary
4.5 Wage incentive schemes
4.6 Allocation of direct labor costs
4.7 Self-assessment activities
4.8 Answers to revision questions and activities
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
37
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Management Accounting
4.1 Introduction
Labour may be described as the physical and mental effort of employees in the manufacturing process.
Labour costs, as we already know, can be divided into direct labour (work that is directly related to the
production of goods) and indirect labour (work that is not directly related to the production of goods).
Direct labour costs form part of the primary (direct) cost of production while indirect labour forms part of
the overhead costs. Labour costs can be substantial and it is therefore important for management to
exercise effective control over matters relating to employees. If management can create an environment
conducive to job satisfaction, then this should result in high levels of labour productivity. Productivity
levels need to be monitored on an on-going basis.
4.2 Labour Administration
Labour administration allows management to set standards for the manufacturing process and to
measure and compare the actual results obtained. Management can determine whether labour is
effectively employed or not. If necessary, remedial measures need to be taken.
The following matters linked to personnel administration have a bearing on labour costs:
determining the number of employees required to complete all the production tasks
•
recruitment and selection process
•
job analysis including job description and job specification
•
work study including method study and work measurement
•
training of employees including induction and in-service training
•
maintaining employee records.
•
resignations and dismissal of employees
the number of resignations is high, this is an indication that all is not well.
Labour turnover can be calculated by using the following formula:
Number of employees who left X 100
Total number of employees
Example 1
If the number of persons who left during 20.6 was 16 out of a total staff of 80 employees, then the labour
turnover will be 20%, calculated as follows:
16 X 10
If
80
= 20%
MANCOSA
38
Management Accounting
The rate of labour turnover may also be calculated per department, per gender group, per age group etc.
Managers need to establish why employees are leaving and analyse whether the reasons are controllable
or not. Employees may resign for many reasons including remuneration, working conditions, relationship
with manager, health reasons, promotion, working hours, transport problems etc.
The cost of labour turnover includes all those costs mentioned above relating to recruitment, selection,
training etc.
4.3 Employee Records
It is important that proper records are kept relating to each employee. The human resources (personnel)
department will keep records relating to the employee’s date of appointment, salary scale, leave,
deductions, promotions etc. As far as labour costing is concerned, the following records are important:
•
clock cards
•
job cards
4.3.1 Clock cards
A clock card machine is a device used to determine the exact time an employee works each day. Each
employee is given a clock card. When the employee reports for duty, he/she inserts the card into the
device that records the time on it. When the employee goes off duty, he/she clocks out and the time is
once again printed. Using the clock card, the exact number of hours worked as normal time and overtime
can be calculated. In this way, the gross wage of each employee is calculated. Computerised clocks
are used nowadays that are designed to make it difficult for employees to dishonestly clock in for another
employee.
4.3.2 Job cards
Job cards are used to indicate the time an employee starts a job and the time when the job is completed.
When an employee commences a new job, a new card is used. The supervisor fills in the start time and
finishing time on the job card. The job card also indicates to the employee what job needs to be done. If
the job is halted for some reason e.g. electricity failure, an idle time card is filled.
It is important to reconcile the times reflected on the clock cards with the job cards. The times recorded
form the basis for the allocation of labour costs to the various cost centres.
39
MANCOSA
Management Accounting
4.4 Calculation of Net Wage or Net Salary
Before we go on to the calculation of net wage or net salary, let us examine some of the methods of
remunerating employees and the terminology used in labour costing.
Employees may be remunerated by using any of the following methods:
•
Employees may be paid a fixed salary irrespective of the number of hours worked or the quantity
of work done.
•
Employees may be paid an hourly rate. The amount an employee earns depends on the number
of hours worked.
•
Employees may be paid for the work that he/she has performed (piecework) and not according
to the time taken to do the work. The employer thus pays only for work that has been done.
•
The following terms are used in connection with labour costs: Normal time refers to remuneration
employees receive for working during normal working hours (e.g. 45 hours per week).
•
Overtime is the remuneration employees receive for work done beyond normal working hours.
•
Idle time refers to time that is lost because of machine breakdown, power cuts, materials not
available etc. Idle time is usually not regarded as an overhead.
•
Gross wage is the total remuneration (normal time, overtime, bonus etc) before any deductions
are made.
•
Net wage is the gross wage less deductions (e.g. pension, medical aid, income tax etc).
•
Pension fund is a fund that employees contribute to in order to receive remuneration (pension)
when they retire. The employer may also contribute to the fund on behalf of the employees.
•
Income tax is a compulsory deduction payable to the state. The employer deducts the money
according to the “Pay As You Earn” (PAYE) system.
•
Unemployment insurance fund is a fund that employees contribute to in order to receive
remuneration when they become unemployed. The employer also contributes to the fund on
behalf of the employees.
•
Medical aid fund is a fund employees contribute to in exchange for having their medical
expenses (up to certain limits) paid from the fund. The employer may also contribute to the fund
on behalf of the employees.
MANCOSA
40
Management Accounting
The following example will be used show how net wage is calculated.
Example 2
The following information applies to Mrs J. Tladi, an employee of Dermat Ltd, who is paid
weekly. Calculate Mrs. J. Tladi’s net wage for the week. Also indicate the double entries to be
made in the books of Dermat Ltd.
Normal working hours (6 days)
45 hours
Number of hours worked
51 hours
Monday
8 hours
Tuesday
8 hours
Wednesday
9 hours
Thursday
9 hours
Friday
8 hours
Saturday
5 hours
Sunday
4 hours
Normal hourly rate
R20
Overtime: Normal working week
1½ times normal rate
Sundays
double normal rate
Pension fund (calculated on normal pay):
Employee’s deduction
7,5%
Employer’s contribution
6%
Unemployment insurance fund (UIF):
Employee’s deduction
1% of normal pay
Employer’s contribution
1% of normal pay
Income tax (PAYE)
41
15% of taxable income
MANCOSA
Management Accounting
Solution
R
Normal pay (45 hours X R20)
900,00
Overtime:
2 hours X R20 X 1,5
60,00
4 hours X R20 X 2
160,00
Gross wage
1 120,00
Pension deduction (R900 X 7,5%)
(67,50)
Taxable income
1 052,50
Other deductions
(166,88)
PAYE (R1 052,50 X 15%)
UIF (R900 X 1%)
Net wage
157,88
9,00
885,62
REMARKS
•
Gross wage = Normal wage + Overtime
•
Pension is calculated on normal pay (basic wage) and not on the gross wage i.e. no pension is
deducted from overtime pay.
•
Taxable income = Gross wage – Pension deduction
•
Income tax (PAYE) is calculated on the taxable income and not on the gross wage.
•
UIF is calculated on the normal pay.
•
Net wage = Taxable income – Other deductions
Double entries in the books of Dermat Ltd:
The double entry relating to the calculation of the employee’s wage is:
MANCOSA
42
Management Accounting
Debit (R)
Wages
Credit (R)
1 120,00
Creditors for wages
885,62
Pension fund
67,50
South African Revenue Services - PAYE
157,88
Unemployment insurance fund
9,00
The double entry to record the employer’s contribution to the various funds is:
Wages (or Contribution accounts)
63,00
Pension fund
54,00
Unemployment insurance fund
9,00
The double entry to pay off the liabilities created above is:
Creditors for wages
885,62
Pension fund (R67,50 + R54)
121,50
South African Revenue Services - PAYE
157,88
Unemployment insurance fund (R9 + R9)
18,00
Bank
1 183,00
Remarks
The double entry to pay off the liabilities is not done weekly (as shown above). Only the net wage is
paid weekly. The rest of the liabilities are settled at the end of the month. Of course the amounts in
respect of all employees are taken.
•
The employer’s contribution to the pension fund is calculated as follows:
R900 X 6% = R54
4.5 Wage Incentive Schemes
Wage incentive schemes are aimed at increasing the productivity of employees and to actually reduce
total production costs. Employees are granted additional or increased remuneration if their performance
is excellent and high productivity is maintained
43
MANCOSA
Management Accounting
4.5.1 Principles of wage incentive schemes
For wage incentive schemes to be successful they should adhere to certain principles. Some of these
principles include:
•
The system must be fair towards the employees.
•
Employees must be paid their bonuses as soon as possible.
•
The system must be understandable to employees.
•
The standards set to qualify for the bonus must be realistic.
•
Control measures must be put in place to ensure efficiency.
4.5.2 Examples of wage incentive schemes
Straight piecework
Piecework remuneration involves paying an employee as follows:
Units produced X rate per hour
If an employee produces more than the target set, the rate per hour may be increased for the additional
units produced.
Example 3
John is employed by a building contractor to tile floors and walls. The standard time to tile 4 m2 is 20
minutes. He is paid R120 per hour and the normal working time is 9 hours per day. If he tiles more
than his quota, he receives 1,5 times his hourly rate on the additional output. He tiled 124 m2 for the
day. Calculate his earnings for the day.
Solution
Standard output:
4 m2 X 3 (20 minutes X 3 = 1 hour) X 9 hours = 108 m2
Additional output:
(124 m2 – 108 m2)
Standard wage:
R1 080 (9 hours X R120)
Bonus
R240 (1,33 hours [16÷12] X R120 X 1,5)
Earnings for the day
R1 320
MANCOSA
= 16 m2
44
Management Accounting
Taylor’s differential piecework system
Using this system an employee is paid according to extent he/she meets the predetermined
standards set. If an employee performs below standard, he/she receives lower remuneration
*
than an employee whose performance is standard. Employees whose output is above
standard are compensated at a higher rate per unit.
The system works as follows:
The standard rate per unit produced is first calculated.
The following formula may be used:
Standard rate per unit =
*
Hours worked X Rate per hour________
Standard units expected to be produced
A premium expressed as a percentage is determined for two categories of employees viz.
those that produce less than the standard units expected and those that produce the standard
units expected or more than the standard. For example the premium for the first category may
*
be 85% and the premium for the second category may be 115%.
The remuneration is then determined for each employee as follows:
Number of units produced X Standard rate per unit X Premium
While this system is meant to discourage employees from not maintaining the standard, it may
be unfair on new employees.
Example 4
Calculate the remuneration for each employee per day using Taylor’s differential piecework
system from the information given.
Information
Standard time allowed : 150 units per hour
Standard work day
: 8 hours
Normal wage rate
: R24 per hour
Premium
: 85% of piecework rate if below standard
115% of piecework rate if standard or above standard
Production of employees per day:
45
Mary
1 200
Harry
1 150
Gumede
1 250
MANCOSA
Management Accounting
Solution
Standard rate per unit = hours worked X rate per hour
standard units
= 8 X R24
8 X 150
= R0,16
Remuneration for each employee
(Standard units per day = 150 X 8 = 1 200)
Mary:
(1 200 units X R0,16) X 115%
=
R220,80
Harry:
(1 150 units X R0,16) X 85%
=
R156,40
Gumede:
(1 250 units X R0,16) X 115%
=
R230,00
REMARKS
Harry is the only employee whose output (1 150 units) was below standard (1 200 units). That is why
85% is used in calculating his remuneration.
4.5.3 Halsey bonus system
Using this system, the employee is rewarded for the time he/she saves. Suppose an employee
manufactures 40 units in an eight-hour day for which the standard has been set at 32 units.
The employee has saved 2 hours for the day (8 units X 15 minutes’ production time per unit = 120
minutes). (The production time per unit is 8 hours [or 480 minutes] ÷ 32 = 15 minutes). The employee
will be compensated for his/her normal pay (8 hours per day) plus the additional 2 hours.
Example 5
For example, Jacob’s normal wage is R32 per hour and his normal working day is 8 hours. Management
has set a standard of 300 units per hour. On a given day, Jacob produced 3 000 units within his 8-hour
shift. A bonus of 50% of the time saved is given to employees. Calculate the number of hours saved by
Jacob and his remuneration for the day.
Solution
Time allocated
10 hours (3 000 units ÷ 300)
Time worked
8 hours
Time saved
2 hours
MANCOSA
46
Management Accounting
Normal pay:
R256 (R32 X 8 hours)
Bonus/Premuim
R32 (50% X 2 hours X R32 per hour)
Pay for the day
R288
4.6 Allocation of Direct Labour Costs
Direct labour costs are first calculated on an hourly basis and then allocated to the various cost centres
(e.g. products) in proportion to the number of hours worked. Accurate calculations are essential to
prevent under recovery or over recovery. Provision must also be made for holiday leave and idle time.
The gross salaries and wages, bonuses and the employer’s portion of fringe benefits (e.g. pension,
medical aid) must be allocated to the various cost centres.
Example 6
The following information relates to an employee at MGM Ltd for the year 20.6.
Calculate the hourly recovery tariff of the employee.
Information
Holiday leave
3 weeks
Normal working hours
5 working days, 9 hours per day
Public holidays
12 (all falling on work days)
Idle time
10%
Gross annual salary including leave
R48 000
Holiday bonus
R4 000
Employer’s contributions to fringe benefits
R5 000
Solution
Number of weeks in a year
52
Holiday leave
(3)
Weeks available
49
Normal working hours
X
45
Available working hours
2 205
Public holidays (12 days X 9 hours)
(108)
2 097
47
Idle time
(209,7)
Expected productive hours
1 887,3
MANCOSA
Management Accounting
Gross salary including leave
R48 000
Holiday bonus
R4 000
Employer’s contributions to fringe benefits
R5 000
R57 000
Hourly recovery tariff
=
R57 000
1 887,3 Hours
= R30,20 per hour
=
Self-Assessment Activities
4.7
Dube is employed by Restonic Manufacturers.
The following details relate to him for the third week of June 20.6.
Hours
worked
Monday
10
Tuesday
8
Wednesday
8
Thursday
8
Friday
8
Saturday
5
Sunday
3
Additional information
1.
The income tax (PAYE) deduction is 18% of the taxable income.
2.
The unemployment insurance fund deduction is 0,9% of the normal wages. The employer
contributes the same amount as the employee to the fund.
3.
The employee’s deduction for medical aid amounted to R150 for the week. The employer
contributes 1,5 times the amount the employees pay to the fund.
MANCOSA
48
Management Accounting
4.
Employees are remunerated at R24 per hour during normal working hours.
5.
Contributions to the pension fund is calculated on the normal time and is made up as follows:
Employee’s deduction
7,5%
Employer’s contribution 11,25%
The normal working week is from Monday to Friday for 8 hours per day. Any time worked in
6.
addition to this on weekdays and Saturdays is overtime calculated at 1½ times normal rate.
Overtime on Sundays is remunerated at double the normal rate.
7.
Required
7.1.1
Calculate the net wage due to D. Dube for the third week of June 20.6.
7.1.2
Calculate the contributions made by Restonic Manufacturers for pension, medical aid and
unemployment insurance in respect of D. Dube for the week.
7.2
Compu Manufacturers produces a single product called Diskette A. The basic hourly rate is
R20 for all four production workers. The following is an extract from the manufacturing records
for the week ended 22 August 20.6:
Employee
Hours worked
Number produced
K. Naidoo
40
820
H. Grant
46
874
M. Mbeki
40
760
J. Lewis
45
945
Additional information
n
The normal working hours per week is 40.
n
Overtime is paid at 1,5 times the normal rate.
n
Standard production for all employees is 20 diskettes per hour.
Required
Calculate the gross wage of all the employees for the week ending 22 August 20.6 using the
straight piecework scheme (bonus is 1½ times the hourly rate on the additional output).
49
MANCOSA
Management Accounting
7.3
Calculate the remuneration for each employee using Taylor’s differential piecework system
from the information given.
Information
Standard time allowed
:
150 units per hour
Standard work day
:
9 hours
Normal wage rate
:
R30 per hour
Premium
:
80% of piecework rate if below standard
120% of piecework rate if standard or above standard
Production of employees per day:
7.4
Tom:
1 250
Dick:
1 350
Harry:
1 500
Jim’s normal wage is R36 per hour and his normal working day is 9 hours. Management has
set a standard of 250 units per hour. On a given day, Jim produced 2 500 units within his 9hour shift. A bonus of 50% of the time saved is given to employees (Halsey bonus system).
Calculate the number of hours saved by Jim and his remuneration for the day.
7.5
Manco Ltd has three employees whose basic monthly salary is as follows:
V. Zuma
R10 400
R. Singh
R9 600
B. Botha
R12 800
Each employee is entitled to 30 days’ pay vacation leave. Each employee receives an annual
bonus of 90% of the basic monthly salary payable in the last month of the year. The employer
contributes twice the amount that the employees contribute to the pension fund. The
employee’s pension deduction is 8% of the basic salary and income tax is 18% on taxable
income. The employees work for 8 hours per day, five days per week. There are 12 public
holidays, of which 8 fall on weekdays.
Required
7.5.1
Calculate the net salary of each employee for the second month of the year.
7.5.2
Calculate the hourly recovery tariff for each employee.
MANCOSA
50
Management Accounting
4.7 Answers to revision questions and activities
SOLUTIONS
7.1.1
R
Normal pay (40 hours X R24)
960
Overtime:
7 hours X R24 X 1,5
252
3 hours X R24 X 2
144
Gross wage
1 356
Pension deduction (R960 X 7,5%)
(72)
Taxable income
1 284
Other deductions
(389,76)
PAYE (R1 284 X 18%)
231,12
UIF (R960 X 0,9%)
8,64
Medical aid
150
Net wage
7.1.2
7.2
894,24
Pension contributions:
R108 (R960 X 11,25%)
Medical aid contributions:
R225 (R150 X 1,5)
Unemployment insurance:
R8,64 (R960 X 0,9%)
K. Naidoo
Expected output:
20 diskettes per hour X 40 hours
=
800 diskettes
Additional output:
820 – 800
=
20 diskettes
Normal wage:
R800 (40 hours X R20)
=
920 diskettes
Overtime
0
Bonus
R30 (1 hour [20÷20] X R20 X 1,5)
Gross wage
R830
H. Grant
Expected output:
20 diskettes per hour X 46 hours
Additional output:
874 – 920 (below expected output) =
Normal wage:
R800 (40 hours X R20)
Overtime
R180 (6 hours X R20 X 1,5)
Bonus
Gross wage
51
0
0
R980
MANCOSA
Management Accounting
M. Mbeki
Expected output:
20 diskettes per hour X 40 hours
Additional output:
760 – 800 (below expected output) =
Normal wage:
R800 (40 hours X R20)
Overtime
0
Bonus
0
Gross wage
=
800 diskettes
0
R800
J. Lewis
7.3
Expected output:
20 diskettes per hour X 45 hours
=
900 diskettes
Additional output:
945 – 900
=
45 diskettes
Normal wage:
R800,00 (40 hours X R20)
Overtime
R150,00 (5 hours X R20 X 1,5)
Bonus
R67,50 (2,25 hours [45÷20] X R20 X 1,5)
Gross wage
R1 017,50
Standard rate per unit
=
hours worked X rate per hour
standard units
=
9 X R30
9 X 150
=
R0,20
Remuneration for each employee
(Standard units per day = 150 X 9 = 1 350)
Tom:
(1 250 units X R0,20) X 80%
=
R200,00
Dick:
(1 350 units X R0,20) X 120% =
R324,00
Harry
(1 500 units X R0,20) X 120% =
R360,00
MANCOSA
52
Management Accounting
7.4
Time allocated
10 hours (2 500 units ÷ 250)
Time worked
9 hours
Time saved
1 hour
Normal pay:
R324 (R36 X 9 hours)
Bonus/Premuim
R18 (50% X 1 hour X R36 per hour)
Pay for the day
R342
7.5.1
V. Zuma
R. Singh
B. Botha
R
R
R
10 400
9 600
12 800
0
0
0
Gross salary
10 400
9 600
12 800
Pension deduction (basic salary X 8%)
(832)
(768)
(1 024)
Taxable income
9 568
8 832
11 776
Other deductions
(1 722,24)
(1 589,76)
(2 119,68)
1 722,24
1 589,76
2 119,68
7 845,76
7 242,24
9 656,32
Basic salary
Bonus
PAYE (taxable income X 18%)
Net salary
7.5.2 Number of days in the year
Vacation leave
365
(30)
335
Public holidays
(8)
327
53
Saturdays and Sundays
(96) (52 X 2 – 8 from leave)
Work days
231
Hours per day
X 8
Expected productive hours
1 848
MANCOSA
Management Accounting
V. Zuma
R. Singh
B. Botha
R
R
R
124 800
115 200
153 600
9 360
8 640
11 520
134 160
123 840
165 120
Employer’s contributions to pension
19 968
18 432
24 576
Total salary bill
154 128
142 272
189 696
R154 128
R142 272
R189 696
1 848 hrs
1 848 hrs
1 848 hrs
R83,40
R76,99
R102,65
Basic annual salary (per month X 12)
Annual bonus
Hourly recovery tariff
=
=
REMARKS
n
Annual bonus = 90% of the monthly salary.
n
Employer’s contribution to pension fund = 16% of the basic annual salary.
MANCOSA
54
Management Accounting
Unit
5:
55
Absorption Costing and
Marginal Costing
MANCOSA
Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF
On successful completion of this Unit, the THIS UNIT:
student will be able to:
The student needs to:
•
Distinguish between absorption costing • Complete the relevant activities and think
and marginal costing.
•
Prepare
the
points to be able to identify and contrast the
income
statements
differences between the two concepts;
according to both the absorption and
marginal costing methods.
•
•
namely Marginal and Absorption costing.
•
Complete the relevant activities and think
Calculate the net profit using absorption
points to be able to populate the income
costing and marginal costing methods
statements in the legislated framework and
and be able to reconcile the difference in
structure for both formats including the
the profits calculated.
absorption and marginal costing methods.
Reconcile the difference in net profit •
Complete the relevant activities and think
between the two costing methods
points to be able to demonstrate the
articulation and calculation of reconciling the
profit between these two stipulated costing
methods.
Key Concepts
5.1 Introduction
5.2 Difference between absorption costing and marginal costing
5.3 Preparing income statements according to both the absorption and marginal costing methods
5.4 Reconciliation of profit calculated according to absorption costing with profit calculated according to
marginal costing
5.5 Answers to Self-Test questions and activities
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
MANCOSA
56
Management Accounting
5.1 Introduction
An important aspect of product costing is to calculate the manufacturing cost per unit. This is done by
dividing the total manufacturing cost for a particular period by the number of units produced during this
period. For example, if the total manufacturing costs for 30 000 units is R90 000, then the cost per unit is
R3. The availability of a unit manufacturing cost makes it easy to determine the manufacturing costs of
units sold and units on hand. This information has an impact on the calculation of the net profit.
There are different opinions as to what should be included in the unit cost of manufacturing. Some people
favour absorption costing. Others favour marginal costing.
In absorption costing both the fixed cost and variable cost are included in the total manufacturing cost of
a product. In marginal costing only the variable cost is included in the manufacturing cost of a product.
5.2 Difference Between Marginal Costing and Absorption Costing
In marginal costing (also called direct costing or variable costing), the manufacturing cost takes only the
variable manufacturing cost into account viz. direct material, direct labour and variable manufacturing
overheads. When marginal income is calculated all variable costs (including selling and administrative
costs) are taken into account. Fixed manufacturing overheads are considered to be a period cost and are
written off in the period in which they were incurred.
In absorption costing (also called total costing or full cost method) the manufacturing cost takes both the
variable and fixed manufacturing costs into account. Fixed manufacturing overheads are classified as a
product cost and not as a period cost (as is the case with marginal costing).
The following is a summary of product costs and period costs using both methods of costing:
PRODUCT COSTS
MARGINAL COSTING
ABSORPTION COSTING
Direct materials
Direct materials
Direct labour
Direct labour
Variable overhead
Variable overhead
Fixed overhead
PERIOD COSTS
MARGINAL COSTING
ABSORPTION COSTING
Fixed overhead
Selling expenses
Selling expenses
Administrative expenses
Administrative expenses
57
MANCOSA
Management Accounting
5.3
Preparing Income Statements According to Both the Marginal and Absorption Costing
Methods
The treatment of the period costs and product costs outlined above in the income statements of both
costing methods may be illustrated as follows:
MARGINAL COSTING METHOD
ABSORPTION COSTING METHOD
Sales
Sales
Less: Variable cost
Less: Manufacturing cost
Direct material
Direct material
Direct labour
Direct labour
Variable manufacturing overheads
Variable manufacturing overheads
Other variable costs:
Fixed manufacturing overheads
Administrative expenses
Selling expenses
= Marginal income
= Gross profit
Less: Fixed cost
Less: Other costs
Manufacturing cost
Selling cost
Selling cost (fixed & variable)
Administrative cost
Administrative cost (fixed & variable)
= Net profit
MANCOSA
= Net profit
58
Management Accounting
The income statements can also be represented as follows:
MARGINAL COSTING METHOD
ABSORPTION COSTING METHOD
Sales
Sales
Less: Variable cost
Less: Manufacturing cost of sales
Opening inventory (finished goods)
Opening inventory (finished goods)
Add: Variable manufacturing costs
Add: Variable manufacturing costs
Add: Fixed manufacturing costs
= Goods available for sale
= Goods available for sale
Less: Closing inventory (finished goods)
Less: Closing inventory (finished goods)
= Variable cost of goods sold
+ Variable selling expenses
+ Variable administrative expenses
= Marginal income
= Gross profit
Less: Fixed cost
Less: Other costs
Manufacturing cost
Selling cost
Selling cost (fixed & variable)
Administrative cost
Administrative cost (fixed & variable)
= Net profit
= Net profit
Income statements completed according to both costing methods will show the same net profit
provided that the number of units produced and the number of units sold are the same and that there
is no inventory on hand. If there is inventory on hand, the net profit computed for each costing
method will be different. The difference will be due to the fact that in absorption costing fixed
overheads are included in inventory valuation while in marginal costing they are treated as period
costs.
59
MANCOSA
Management Accounting
Example 1
Valdo Ltd manufactures only one product. The following information pertains to June 20.6:
Number of units manufactured
30 000
Number of units sold
24 000
Selling price per unit
R100
Variable manufacturing cost
R750 000
Fixed manufacturing cost
R300 000
Selling and administrative cost:
Variable
Fixed
R10 per unit sold
R100 000
Required:
Draft the income statement for June 20.6 using:
(a)
the marginal costing method
(b)
the absorption costing method
Solution
(a)
MARGINAL COSTING METHOD
INCOME STATEMENT FOR JUNE 20.6
R
Sales
2 400 000
Less: Variable cost
(840 000)
Opening inventory
0
Variable manufacturing costs
750 000
Goods available for sale
750 000
Closing inventory (6 000 X R25)*
(150 000)
Variable cost of goods sold
600 000
Variable selling and administrative expenses (24 000 X R10)
240 000
Marginal income
1 560 000
Less: Fixed cost
(400 000)
Manufacturing cost
300 000
Selling and administrative cost
100 000
Net profit
1 160 000
MANCOSA
60
Management Accounting
*
REMARKS
Closing inventory = 30 000 (manufactured) – 24 000 (sold) = 6 000 units
Closing inventory is valued at R25 per unit calculated as follows:
Variable manufacturing cost__
Number of units manufactured
= R750 000
30 000
= R25 (variable manufacturing cost per unit)
(b)
ABSORPTION COSTING METHOD
INCOME STATEMENT FOR JUNE 20.6
R
Sales
2 400 000
Manufacturing cost of sales
(840 000)
Opening inventory
0
Fixed manufacturing cost
300 000
Variable manufacturing cost
750 000
Goods available for sale
1 050 000
Less: Closing inventory (6 000 X R35)*
(210 000)
Gross profit
1 560 000
Other costs
(340 000)
Fixed selling and administrative cost
100 000
Variable selling and administrative cost (24 000 X R10)
240 000
Net profit
1 220 000
61
MANCOSA
Management Accounting
n
REMARKS
*Closing inventory = 30 000 (manufactured) – 24 000 (sold) = 6 000 units
*Closing inventory is valued at R35 per unit calculated as follows:
Total manufacturing cost____
Number of units manufactured
= R1 050 000
30 000
= R35 (manufacturing cost per unit)
n
There is a difference in the net profit calculated according to each costing method. This was
due to the fact that there was closing inventory on hand. Using the absorption costing method
the value of closing inventory includes both the variable and fixed manufacturing costs while
with the marginal costing method the value of closing inventory includes only the variable
manufacturing cost.
n
One could therefore say that the COST PRICE OF INVENTORY ON HAND is calculated
according to each of the two costing methods using the following costs:
MARGINAL COSTING METHOD
ABSORPTION COSTING METHOD
Direct material
Direct material
Direct labour
Direct labour
Variable manufacturing overheads
Variable manufacturing overheads
Fixed manufacturing overheads
MANCOSA
62
Management Accounting
5.4 Reconciliation of Profit Calculated According to Marginal Costing with Profit
Calculated According to Absorption Costing
In example 1 above, the difference in the net profit between the absorption costing method
(R1 220 000) and the marginal costing method (R1 160 000) is R60 000. As mentioned earlier,
the difference is due to the fact that fixed manufacturing costs are included in calculating the
closing inventory using the absorption costing method. The difference in profit may be
explained as follows:
Closing inventory according to absorption costing method
R210 000
Closing inventory according to marginal costing method
(R150 000)
Difference
R60 000
Another way of explaining the difference in the profits is as follows:
Calculate the fixed manufacturing cost per unit:
Fixed manufacturing cost
Number of units produced
= R300 000
30 000
= R10 per unit
This R10 per unit is included in the value of closing inventory using the absorption costing
method. Thus:
6 000 units (closing inventory) X R10 (fixed manufacturing cost per unit) = R60 000
5.5 Self-Assessment Activities and Solutions
5.1 The following information relates to the only product made by Bellini CC during May 20.6:
Opening inventory
0
63
Number of units manufactured
9 000
Number of units sold (at R540 per unit)
7 200
Direct materials cost per unit
R90
Direct labour cost per unit
R180
Variable manufacturing overheads per unit
R90
Variable selling cost per unit
R20
Fixed manufacturing overhead cost
R450 000
Fixed selling and administrative cost
R180 000
MANCOSA
Management Accounting
Required:
5.1
Draft the income statement for May 20.6 using:
5.1.1
the marginal costing method
5.1.2
the absorption costing method
5.1.3
Reconcile the profit calculated according to absorption costing (in 5.1.2) with the profit
calculated according to marginal costing (in 5.1.1).
5.2
Draft the income statements for May 20.6 using the marginal costing method and the
absorption costing method but assume that all the goods manufactured (9 000 units) have
been sold and that there is thus no closing inventory. Prove that the net profit calculated using
both costing methods will be the same.
5.1.1
SOLUTION
MARGINAL COSTING METHOD
INCOME STATEMENT FOR MAY 20.6
R
Sales (7 200 X R540)
3 888 000
Less: Variable cost
(2 736 000)
Opening inventory
0
Variable manufacturing costs ([R90 + R180 + R90 = 360] X 9 000)*
3 240 000
Goods available for sale
3 240 000
Closing inventory (1 800 X R360)**
(648 000)
Variable cost of goods sold
2 592 000
Variable selling expenses (7 200 X R20)
144 000
Marginal income
1 152 000
Less: Fixed cost
(630 000)
Manufacturing cost
450 000
Selling and administrative cost
180 000
Net profit
522 000
MANCOSA
64
Management Accounting
REMARKS
*
Variable manufacturing costs = [Direct materials cost (R90 per unit) + Direct labour cost (R180
per unit) + Variable manufacturing overheads per unit (R90 per unit)] X number of units
manufactured (9 000)
**
Closing inventory = 9 000 (manufactured) – 7 200 (sold) = 1 800 units
Closing inventory is valued at R360 per unit which is the variable manufacturing cost per unit
as indicated above viz. R90 + R180 + R90 = R360 per unit
5.1.2
ABSORPTION COSTING METHOD
INCOME STATEMENT FOR MAY 20.6
R
Sales (7 200 X R540)
3 888 000
Manufacturing cost of sales
(2 952 000)
Opening inventory
0
Fixed manufacturing cost*
450 000
Variable manufacturing cost* ([R90 + R180 + R90 = 360] X 9 000)
3 240 000
Goods available for sale
3 690 000
Less: Closing inventory (1 800 X R410)**
(738 000)
Gross profit
936 000
Other costs
(324 000)
Fixed selling and administrative cost
180 000
Variable selling cost (7 200 X R20)
144 000
Net profit
65
612 000
MANCOSA
Management Accounting
REMARKS
n
* Instead of showing fixed manufacturing costs and variable manufacturing costs as two
items, one item viz. the cost of goods manufactured could have been shown as follows:
Cost of goods manufactured (9 000 X R410)
n
3 690 000
Note:
Fixed manufacturing cost per unit = R450 000= R50 per unit
9 000
Thus cost of goods manufactured per unit = R90 + R180 + R90 + R50 = R410
** Closing inventory = 30 000 (manufactured) – 24 000 (sold) = 6 000 units
Closing inventory is valued at R410 per unit calculated as above.
n
The effect of the two costing methods on net profit is that:
-
When production is greater than sales, a larger net profit will be reported using absorption
costing.
-
When sales are greater than production, a larger net profit will be reported using marginal
costing.
-
When sales and production are equal, the net profit will be the same under both methods.
5.1.3
Reconciliation of profit calculated according to marginal costing with profit calculated
according to absorption costing
The difference in the net profit between the absorption costing method (R612 000) and the
marginal costing method (R522 000) is R90 000. The difference, as we already know, is due
to the fact that fixed manufacturing costs are included in calculating the closing inventory
using the absorption costing method.
The difference in profit may be explained as follows:
Closing inventory according to absorption costing method
R738 000
Closing inventory according to marginal costing method
(R648 000)
Difference
MANCOSA
R90 000
66
Management Accounting
Another way of explaining the difference in the profits is as follows:
Calculate the fixed manufacturing cost per unit:
Fixed manufacturing cost
Number of units produced
= R450 000
9 000
= R50 per unit
This R50 per unit is included in the value of closing inventory using the absorption costing
method.
Thus: 1 800 units (closing inventory) X R50 (fixed manufacturing cost per unit) = R90 000
5.2
MARGINAL COSTING METHOD
INCOME STATEMENT FOR MAY 20.6
R
Sales (9 000 X R540)
4 860 000
Less: Variable cost
(3 420 000)
Opening inventory
0
Variable manufacturing costs ([R90 + R180 + R90 = 360] X 9 000)
3 240 000
Goods available for sale
3 240 000
Closing inventory
0
Variable cost of goods sold
3 240 000
Variable selling expenses (9 000 X R20)
180 000
Marginal income
1 440 000
Less: Fixed cost
(630 000)
Manufacturing cost
450 000
Selling and administrative cost
180 000
Net profit
67
810 000
MANCOSA
Management Accounting
ABSORPTION COSTING METHOD
INCOME STATEMENT FOR MAY 20.6
R
Sales (9 000 X R540)
4 860 000
Manufacturing cost of sales
(3 690 000)
Opening inventory
0
Fixed manufacturing cost
450 000
Variable manufacturing cost ([R90 + R180 + R90 = 360] X 9 000)
3 240 000
Goods available for sale
3 690 000
Less: Closing inventory
0
Gross profit
1 170 000
Other costs
(360 000)
Fixed selling and administrative cost
180 000
Variable selling cost (9 000 X R20)
180 000
Net profit
810 0
MANCOSA
68
Management Accounting
Unit
6:
Cost-Volume-Profit Analysis
69
MANCOSA
Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS
UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF THIS
UNIT:
On successful completion of this Unit,
the student will be able to:
• Appreciate the importance of cost-
The student needs to:
•
Complete the relevant activities and think points to
volume-profit analysis as a
be able to identify the differences between the
management accounting tool and
traditional and the marginal income statements and
be able to perform the relevant
the calculations thereof
calculations between the two
•
•
•
Complete the relevant activities and think points to
costing methods.
be able to populate the income statements in the
Understand what is meant by cost-
legislated framework and structure for both formats
volume-profit analysis.
including the absorption and marginal costing
Understand the concept of
methods.
marginal income and an example
•
thereof.
Complete the relevant activities and think points to
be able to understand and explain marginal income.
•
Calculate the break-even point.
•
Calculate the break- even value
be able to demonstrate the understanding and the
using the marginal income ratio
calculation of the break-even analysis.
method.
•
•
•
Complete the relevant activities and think points to
Complete the relevant activities and think points to
Prepare a marginal income
be able to demonstrate the understanding and the
statement that will provide the
calculation of the break-even analysis using the
necessary information required for
marginal income ratio method.
cost-volume-profit analysis.
•
Complete the relevant activities and think points to
Calculate the sales required to
be able to demonstrate the application of the CVP
attain a targeted net profit
analysis whilst preparing the marginal income
•
Calculate the margin of safety
statement.
•
Apply the cost-volume-profit-
•
•
Complete the relevant activities and think points to
analysis when there are changes in
be able to calculate the necessary sales required to
selling price, variable costs, fixed
attain a goal targeted net profit.
costs and number of products
marketed.
•
Complete the relevant activities and think points to
be able to calculate and demonstrate an
understanding the concept of margin of safety.
MANCOSA
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Management Accounting
•
•
•
The calculation and understanding
be able to calculate the changes in different
the results thereof.
aspects (selling price, variable
Calculate the effects of changes in
•
•
costs, fixed costs and number of products
variable costs
marketed, whilst applying the CVP analysis to
Calculate the effects of changes in
obtain a relevant answer.
•
Complete the relevant activities and think points to
Calculate the effects of the
be able to calculate the changes in selling price and
changes in the number of products
demonstrate an understanding thereof
marketed
•
Complete the relevant activities and think points to
of the changes in selling price and
fixed costs
•
•
•
Complete the relevant activities and think points to
List the limiting assumptions
be able to calculate the changes in variable costs
between the Break-even and cost-
and demonstrate an understanding thereof.
volume- profit analysis
Complete the relevant activities and think points to be
Understand the ratios
able to calculate the changes in variable costs and
demonstrate an understanding thereof.
•
Complete the relevant activities and think points to
be able to calculate the changes in with regards to
the changes in the number of products marketed
and demonstrate an understanding thereof.
•
Complete the relevant activities and think points to
be able to understand the differences between the
break even and CVP analysis in regards to the
limiting assumptions thereof.
•
Complete the relevant activities and think points to
be able to understand the relevance of the ratios
and know how to use and calculate them, in making
effective, succinct business decisions for the
organisation.
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Key Concepts
6.1 Introduction
6.2 Marginal income statement
6.3 Cost-volume-profit analysis using the marginal income approach
6.4 Applying the cost-volume-profit analysis
6.5 Applying the cost-volume-profit analysis with changes in selling price, variable costs, fixed costs and
number of products marketed.
6.6 Limiting assumptions of break-even and cost-volume-profit analysis
6.7 Summary of the ratios
6.8 Self-assessment activities and solutions
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
•
MANCOSA
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
The Essence of Management Accounting First edition, 2003.
Chadwick, L
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Management Accounting
6.1 Introduction
Cost-volume-profit (CVP) analysis is used to explain how profits and costs change with a change in
volume. In particular, it examines the effect on profits when there are changes in factors such as selling
price, variable costs, fixed costs, volume and the number of products marketed. CVP analysis puts
management in a better position to cope with various short-term planning decisions.
Using CVP analysis, managers would be able to get information relating to the following:
§
How profits are affected by a change in costs.
§
What effect a change in sales volume will have on profit.
§
The profit that is expected from a certain sales volume.
§
How many units need to be sold to achieve a targeted profit.
§
At what output of production will the income and costs be the same.
6.2 Marginal Income Statement
The traditional income statement that we learnt in financial accounting does not distinguish between fixed
costs and variable costs. Consequently, its use is limited as far as management accounting is concerned.
Cost information needs to be in a format that makes the task of management easier when doing planning,
control and decision-making. The marginal approach to drawing up an income statement where fixed and
variable costs are available is more suitable. Using this approach all expenses are classified as fixed or
variable.
EXAMPLE 1
The following is an example of a traditional income statement and a marginal income statement:
Traditional income statement
R
Sales
90 000
Cost of sales
(45 000)
Gross profit
45 000
Operating expenses:
(37 500)
Marketing costs
23 250
Administration costs
14 250
Net profit
73
7 500
MANCOSA
Management Accounting
Marginal income statement
R
Sales
90 000
Variable costs:
(22 500)
Production
15 000
Marketing
4 500
Administration
3 000
Marginal income
67 500
Fixed expenses:
(60 000)
Production
30 000
Marketing
18 750
Administration
11 250
Net profit
7 500
6.3 Cost-Volume-Profit Analysis Using the Marginal Income Approach
CVP analysis is based on the marginal income approach. The marginal income statement is useful when
determining the effects of changes in selling price, cost or volume on profit. A proper understanding of
fixed and variable costs is needed for CPV analysis.
The following example will be used to illustrate the CVP analysis:
Example 2
The following is a budgeted marginal income statement of Mobeen Ltd, a manufacturer of a
single product called component X.
Marginal income statement for July 20.6
R
Sales (40 000 units X R40 per unit)
1 600 000
Variable cost (40 000 units X R30 per unit)
(1 200 000)
Marginal income (R10 per unit)
400 000
Fixed costs
(200 000)
Net profit
200 000
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Management Accounting
6.3.1
Marginal income
Marginal income is the excess of sales over the variable costs. It refers to the amounts of
money available to cover firstly the fixed costs and then to generate profits. If the fixed costs
are greater than marginal income, then a loss will result.
Example 3
If Mobeen Ltd sells only one item of component X, the income statement will appear as
follows:
Marginal income statement for July 20.6
R
Sales (1 unit X R40)
40
Variable cost (1 unit X R30)
(30)
Marginal income
10
Fixed costs
(200 000)
Net loss
(199 990)
For each additional unit of component X that Mobeen Ltd sells, an additional R10 marginal
income becomes available to cover the fixed costs.
The increase in the total costs as a result of an additional unit being manufactured is called
marginal costs. Marginal costs may therefore be seen as the total variable costs incurred to
manufacture or market a product.
6.3.2
Calculation of break-even point (using the marginal income method)
The volume of sales at which marginal income is equal to fixed costs is called the break-even
point. The break-even point can also be called the point of no profit and no loss. The breakeven quantity is the minimum quantity that must be sold to ensure that fixed cost are covered.
Break-even quantity can be calculated using the marginal income method as follows:
Break even quantity
=
Total fixed cost
Marginal income per unit
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Example 4
Using the figures from example 2, break-even quantity may be calculated as follows:
Break-even quantity
Total fixed cost
=
Marginal income per unit
= R200 000
R10
= 20 000 units
The break-even value (i.e. break even point in rands) is calculated as follows:
Break-even value
= Break-even quantity X Selling price per unit
Example 5
Using the figures from example 2, break-even value may be calculated as follows:
Break even value
=
Break-even quantity X Selling price per unit
=
20 000 X R40
=
R800 000
To reach break-even point during July 20.6 Mobeen Ltd needs to sell 20 000 units.
This can be proven as follows:
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Management Accounting
Marginal income statement for July 20.6
R
Sales (20 000 units X R40 per unit)
800 000
Variable cost (20 000 units X R30 per unit)
(600 000)
Marginal income (R10 per unit)
200 000
Fixed costs
(200 000)
Net profit/loss
6.3.3
0
Calculating break-even value using the marginal income ratio method
Variable costs and marginal income may be expressed as a percentage of sales. Using the
figures from example 2 (Mobeen Ltd), this can be illustrated as follows:
Total (R)
Per unit (R)
Percentage (%)
Sales (40 000 units)
1 600 000
40
100
Variable cost
(1 200 000)
30
75
Marginal income
400 000
10
25
Marginal income ratio (also called profit volume ratio) is the percentage of marginal income
to sales.
Marginal income ratio may be expressed as follows:
Marginal income ratio
=
Marginal income
X
Sales
100
1
Example 6
The marginal income ratio for Mobeen Ltd is:
Marginal income ratio
=
Marginal income
X
Sales
= R10
100
1
X 100
R40
1
= 25%
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The break-even value may be calculated as follows:
Break even value
=
Total fixed cost
Marginal income ratio
Example 7
The break-even value for Mobeen Ltd is calculated as follows:
Break even value
Total fixed cost
=
Marginal income
ratio
=
R200 000
25%
=
R200 000
0,25
=
R800 000
6.4 Applying The Cost-Volume-Profit Analysis
The information contained in example 2 (Mobeen Ltd) will be used to illustrate the application of CVP
analysis. This information is reproduced below:
6.4.1
Total (R)
Per unit (R)
Percentage (%)
Sales (40 000 units)
1 600 000
40
100
Variable cost
(1 200 000)
30
75
Marginal income
400 000
10
25
Fixed costs
(200 000)
Net profit
200 000
Calculation of sales required to attain a targeted net profit
Cost-profit-volume analysis may be used to determine the sales required to attain a targeted
net profit. This can be done in one of two ways. The first is as follows:
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Management Accounting
Target sales volume
=
Fixed cost + Target profit
Marginal income per unit
Target sales value
=
Target sales volume X Selling price per unit
Example 8
If Mobeen Ltd targets a net profit of R40 000 from the sale of component X, the sales required
will be as follows:
Target sales volume
=
Fixed cost + Target profit
Marginal income per unit
= R200 000 + R40 000
R10
= 24 000 units
Targets sales value
Target sales volume X Selling price per unit
=
24 000 units X R40
=
R960 000
=
The second way of calculating the required sales for a targeted net profit is as follows:
Target sales value
=
Fixed cost + Target profit
Marginal income ratio
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Management Accounting
Example 9
The sales required by Mobeen Ltd to realise a profit of R40 000 is:
Target sales value
= Fixed cost + Target profit
Marginal income ratio
= R200 000 + R40 000
25%
= R200 000 + R40 000
0,25
= R960 000
6.4.2
Margin of safety
The margin of safety is the amount by which the actual level of sales exceeds the break-even
point. It is the amount by which the sales volume may drop before losses are incurred. The
margin of safety may be expressed in value or in units:
Margin of safety (in terms of value)
=
Margin of safety (in terms of units)
= Budgeted sales units – Break-even sales units
MANCOSA
Budgeted sales – Break-even sales
80
Management Accounting
Example 10
The margin of safety for Mobeen Ltd is:
Margin of safety (in terms of value)
Budgeted sales – Break-even sales
=
R1 600 000 – R800 000
= R800 000
=
Budgeted sales units – Break-even sales units
40 000 – 20 000
Margin of safety (in terms of units)
20 000 units
=
=
=
6.5
Applying the Cost-Volume-Profit Analysis with Changes in Selling Price, Variable Costs,
Fixed Costs and Number of Products Marketed
Thus far it has been assumed that factors such as prices, costs and volumes remained the same. We
are now going to examine the application of the cost-volume-profit analysis with changes in selling
price, variable costs, fixed costs and number of products marketed.
To illustrate this the following information from example 2 (Mobeen Ltd) will be utilized.
Selling price per unit
R40
Variable cost per unit
R30
Marginal income per unit
R10
Total fixed costs for July 20.6
6.5.1
R200 000
Change in selling price
Whenever enterprises increase the selling prices of their products, the result is usually a drop
in sales volume. The decrease in sales is the result of consumer reaction to the price
increase. The cost-volume-profit (CVP) analysis can be used by management to determine
the level to which sales volume can decline before this impacts negatively on its targeted
profit.
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Example 11
Mobeen Ltd plans to increase the selling price of component X by 10% and targets a profit of
R40 000. Using the information from example 2 (reproduced above), calculate the quantity of
component X that must be sold (rounded off to nearest whole number) to:
11.1
break even
11.2
achieve the targeted profit
Solution
11.1
11.2
Present situation
After increase in price
Selling price per unit
R40
R44
Variable cost per unit
R30
R30
Marginal income per unit
R10
R14
Fixed costs
= R200 000
= R200 000
Marginal income per unit
R10
R14
= 20 000 units
= 14 286 units
Fixed cost + Target profit
= R200 000 + R40 000
= R200 000 + R40 000
Marginal income per unit
R10
R14
= 24 000 units
= 17 143 units
Break even quantity =
Sales volume required
to attain target profit of
R40 000
6.5.2
Change in variable cost
If management can succeed in reducing variable costs, then the number of units needed to
achieve a targeted profit will fall. This is illustrated as follows:
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Management Accounting
Example 12
Using the information from example 2, suppose Mobeen Ltd succeeds in reducing variable
costs by 10% (with the selling price remaining at R40). The targeted profit is R40 000.
Required
Calculate the quantity of component X that must be sold (rounded off to nearest whole
number) to:
12.1
12.2
break even
achieve the targeted profit
Solution
12.1
12.2
Present situation
After a 10% decrease in variable cost
Selling price per unit
R40
R40
Variable cost per unit
R30
R27
Marginal income per unit
R10
R13
Fixed costs
= R200 000
= R200 000
Marginal income per unit
R10
R13
= 20 000 units
= 15 385 units
Fixed cost + Target profit
= R200 000 + R40 000
= R200 000 + R40 000
Marginal income per unit
R10
R13
= 24 000 units
= 18 462 units
Break even quantity =
Sales volume required
to attain target profit of
R40 000
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5.3
Change in fixed costs
If fixed costs (e.g. rent) increase, then the number of units needed to achieve a targeted profit
will increase. This is illustrated as follows:
Example 13
Using the information from example 2, suppose the fixed costs increase by R20 000 (with
no change to the selling price or variable cost). The targeted profit is still R40 000.
Required
Calculate the quantity of component X that must be sold (rounded off to nearest whole
number) to:
12.1
break even
12.2
achieve the targeted profit
Solution
Present situation
After increase in fixed cost
Selling price per unit
R40
R40
Variable cost per unit
R30
R30
Marginal income per unit
R10
R10
R200 000
R220 000
Fixed costs
= R200 000
= R220 000
Marginal income per unit
R10
R10
= 20 000 units
= 22 000 units
Fixed cost + Target profit
= R200 000 + R40 000
= R220 000 + R40 000
Marginal income per unit
R10
R10
= 24 000 units
= 26 000 units
Fixed costs
12.1
12.2
Break even quantity =
Sales volume required
to attain target profit of
R40 000
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Management Accounting
6.5.4
Change in number of products marketed
Break-even calculation becomes complicated when more than one product is marketed. As
each product has its own marginal income ratio, a sales mix is determined so that a marginal
income ratio based on the weighted average is calculated in order to determine break-even
quantity and value. This is illustrated as follows:
Example 14
XYZ Enterprises manufactures and sells 3 different products viz. product X, product Y and
product Z. The following details apply:
Product X
Product Y
Product Z
Selling price per unit
R12
R15
R18
Variable cost per unit
R8
R11
R13
Sales mix
3
:
2
:
5
Fixed costs total R72 000
Required
Calculate the break-even quantity and break-even value for each product.
Solution
Product X
Product Y
Product Z
Selling price per unit
R12
R15
R18
Variable cost per
R8
R11
R13
unit
R4
R4
R5
Marginal Income
Sales mix
Total
Product X
R4
3
R12
Product Y
R4
2
R8
Product Z
R5
5
R25
10
R45
Marginal income
Average marginal income per unit = R45 ÷ 10 = R4,50
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Management Accounting
Break-even quantity
Fixed costs
=
(Total)
Average marginal income per unit
=
R72 000
R4,50
=
16 000 units
Product X
Product Y
Product Z
Break-even quantity for
3 X 16 000
2 X 16 000
5 X 16 000
each product
10
10
10
= 4 800 units
= 3 200 units
= 8 000 units
4 800 X R12
3 200 X R15
8 000 X R18
= R57 600
= R48 000
= R144 000
Break-even value for
each product
Total break-even value
6.6
= R57 600 + R48 000 + R144 000 = R249 600
Limiting Assumptions of Break-Even and Cost-Volume-Profit Analysis
The Break-Even and Cost-Volume-Profit Models Discussed Above Are Based On Some Limiting
Assumptions:
§
All costs are classified as either fixed or variable.
§
Variable costs are affected only by volume.
§
The behaviour of both sales income and expenses is linear.
§
There is only one product.
§
Inventories do not change a great deal from one period to the next.
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Management Accounting
6.7 Summary of The Ratios
7.1
Break even quantity
=
Total fixed cost
Marginal income per unit
7.2
Break even value
7.3
Marginal income ratio
= Break-even quantity X Selling price per unit
=
Marginal income
X
100
Sales
7.4
Break even value
=
(using marginal income ratio)
7.5
Target sales volume
1
Total fixed cost
Marginal income ratio
= Fixed cost + Target profit
Marginal income per unit
7.6
Target sales value
=
7.7
Target sales value
=
Target sales volume X Selling price per unit
Fixed cost + Target
profit
(using marginal income ratio)
7.8
Marginal income ratio
Margin of safety (in terms of value)
Budgeted sales – Break-even sales
=
Budgeted sales units – Break-even sales units
Margin of safety (in terms of units)
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6.8
SELF-ASSESSMENT ACTIVITIES AND SOLUTIONS
8.1
Complete the following sentences with the most appropriate answers.
8.1.1
The difference between sales and variable expenses is called ____________.
8.1.2
Break-even point is reached when ____________ is equal to ____________.
8.1.3
The _________is the amount by which the actual level of sales exceeds the break-even point.
The break-even point will ____________ if there is an increase in fixed costs.
8.1.4
One of the key assumptions underlying break-even analysis is that costs are classified as
8.1.5
either ____________ or ____________.
8.2
Bysan Ltd plans to manufacture a new product and the following information is applicable:
Estimated sales for the year 20.6
7 000 units at R40 each
Estimated costs for the year 20.6
Direct material
R12 per unit
Direct labour
R2 per unit
Factory overheads (all fixed)
R24 000 per annum
Selling expenses
30% of sales
Administrative expenses (all fixed)
R32 000 per annum
Required
8.2.1
Calculate the break-even quantity.
8.2.2
Calculate the break-even value.
8.2.3
Calculate the break-even value using the marginal income ratio.
8.2.4
Calculate the selling price per unit if the profit per unit is R2.
8.3
AIM Ltd supplies component J to furniture manufacturers. The marketing manager is of the
opinion that if the selling price of component J is reduced, sales could increase by 25%.
The following information is available:
Present
Proposed
R6
R5
Sales volume
100 000 units
25% more
Variable costs
R400 000
Same unit variable cost
Fixed costs
R140 000
R140 000
Net profit
R60 000
?
Selling price per unit
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Management Accounting
Required
8.3.1
Calculate the expected profit or loss on the marketing manager’s proposal.
8.3.2
Calculate the number of sales units required under the proposed price to make a profit of
R60 000.
8.3.2
Calculate the sales value required under the proposed price to make a profit of R60 000.
8.4
Yashik CC manufactures one product. The following details relating to the product applies:
Direct material cost per unit
R20
Direct labour cost per unit
R30
Variable overheads per unit
R22
Total fixed cost
R36 000
Selling price per unit
R82
Number of units sold
6 000
Required
8.4.1
Calculate the marginal income ratio.
8.4.2
Calculate the break-even quantity and break-even value.
8.4.3
Calculate the margin of safety in terms of units and value.
8.5
Kivi (Pty) Ltd manufactures and sells only one product. The budgeted details for 20.7 are as
follows:
Sales
150 000 per month
Selling price per unit
R3
Variable cost per unit
R1,40
Total fixed cost
R1 350 000
Required
8.5.1
Calculate the budgeted profit for 20.7.
8.5.2
Calculate the break-even quantity and value.
8.5.3
Suppose Kivi (Pty) Ltd wants to make provision for a 10% increase in fixed costs and an
increase in variable costs by R0,20 per unit.
Taking these increases into account, calculate the following:
8.5.3.1 New break-even quantity and value
8.5.3.2 Safety margin (in terms of value)
8.5.3.3 The number of units that need to be sold to earn a net profit of R400 000
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8.6
Multi Vit Ltd has the following sales mix (fixed costs amount to R300 000):
Product
Sales
Variable cost
Proportion
Vit A
R600 000
R300 000
50%
Vit B
R300 000
R150 000
30%
Vit C
R100 000
R150 000
20%
R1 000 000
R600 000
100%
Required
8.6.1
Calculate the total break-even value.
8.6.2
Calculate the break-even value for each product.
(Assume that the selling price per unit of each product is the same.)
SOLUTIONS
8.1
8.1.1
marginal income
8.1.2
marginal income; fixed costs
8.1.3
margin of safety
8.1.4
increase
8.1.5
variable; fixed
8.2
Total (R)
Per unit (R)
Percentage (%)
Sales (7 000 units)
280 000
R40
100
Variable cost (R84 000 + R14 000 + R84
182 000
R26
65
98 000
R14
35
000)
Marginal income
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Break even quantity
=
Total fixed cost
8.2.1
Marginal income per unit
= R56 000
R14
= 4 000 units
8.2.2
Break even value
= Break-even quantity X Selling price per unit
= 4 000 X R40
= R160 000
8.2.3
Break even value
=
Total fixed cost
Marginal income ratio
= R56 000
35%
= R56 000
0,35
= R160 000
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8.2.4
Let the selling price per unit be represented by P.
Sales = Variable costs + Fixed costs + Net profit
7 000P = R14(7 000) + 0,3P(7 000) + R56 000 + R2(7 000)
7 000P = R98 000 + 2 100P + R56 000 + R14 000
7 000P – 2 100P = R168 000
4 900P = R168 000
P = R168 000
4 900
P = R34,29 (rounded off)
8.3.1
8.3.2
Expected profit or loss
Total (R)
Sales (125 000 X R5)
625 000
Variable cost (125 000 X R4)
(500 000)
Marginal income (125 000 X R1)
125 000
Fixed costs
(140 000)
Net loss
(15 000)
Sales volume required to attain
target profit of R60 000
Fixed cost + Target profit
= R140 000 + R60 000
Marginal income per unit
R1
R1
= 200 000 units
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Management Accounting
8.3.3
Sales value
= 200 000 units X R5
= R1 000 000
8.4
8.4.1
Total (R)
Per unit (R)
Sales (6 000 units)
492 000
82
Variable cost (R20 + R30 + R22) X 6 000
(432 000)
72
Marginal income
60 000
10
Fixed costs
(36 000)
Net profit
24 000
Marginal income ratio =
Marginal income
X
100
Sales
1
= R10 X 100
R82
1
12,20%
=
8.4.2
Break even quantity
=
Total fixed cost
Marginal income per unit
R36 000
=
R10
= 3 600 units
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8.4.2
8.4.3
Break even value
=
Break-even quantity X Selling price per unit
=
3 600 X R82
=
R295 200
Margin of safety (in terms of value)
Budgeted sales – Break-even sales
=
R492 000 – R295 200
=
R196 800
=
Budgeted sales units – Break-even sales units
Margin of safety (in terms of units)
=
6 000 – 3 600
= 2 400 units
=
8.5.1
Calculation of budgeted profit
Total (R)
Per unit (R)
Sales (150 000 units X 12 months= 1 800 000 units)
5 400 000
R3
Variable cost
(2 520 000)
R1,40
Marginal income
2 880 000
R1,60
Fixed costs
(1 350 000)
Net profit
1 530 000
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Management Accounting
8.5.2
Break even quantity
=
Total fixed cost
Marginal income per unit
= R1 350 000
R1,60
= 843 750 units
8.5.2
Break even value
= Break-even quantity X Selling price per unit
= 843 750 X R3
= R2 531 250
8.5.3
95
Total (R)
Per unit (R)
Sales (150 000 units X 12 months= 1 800 000 units)
5 400 000
R3
Variable cost
(2 880 000)
R1,60
Marginal income
2 520 000
R1,40
Fixed costs (R1 350 000 + R135 000)
(1 485 000)
Net profit
1 035 000
MANCOSA
Management Accounting
8.5.3.1
Break even quantity
Total fixed cost
=
Marginal income per
unit
=
R1 485 000
R1,40
=
1 060 714 units
Break even value
= Break-even quantity X Selling price per unit
= 1 060 714 X R3
= R3 182 142
8.5.3.2 Margin of safety (in terms of value)
Budgeted sales – Break-even sales
=
R5 400 000 – R3 182 142
=
R2 217 858
=
MANCOSA
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Management Accounting
8.5.3.3 Sales volume required to attain target
profit of R400 000
Fixed cost + Target profit
= R1 485 000 + R400 000
Marginal income per unit
R1,40
= 1 346 429 units
8.6
Total sales
R1 000 000
Total variable costs
R600 000
Total marginal income
R400 000
Marginal income ratio
Marginal income
X 100
=
Sales
1
= R400 000__ X 100
R1 000 000
1
= 40%
97
MANCOSA
Management Accounting
8.6.1
Break even value (total)
Total fixed cost
=
Marginal income ratio
= R300 000
40%
= R300 000
0,40
= R750 000
8.6.2
Break-even value for each product
MANCOSA
Vit A
Vit B
Vit C
R750 000 X 50%
R750 000 X 30%
R750 000 X 20%
= R375 000
= R225 000
= R150 000
98
Management Accounting
Unit
7:
Budgets and Budgetary Control
99
MANCOSA
Management Accounting
UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
On successful completion of this Unit, the
student will be able to:
•
Define budgets and budgetary control
•
•
•
•
•
•
The student needs to:
• Complete the relevant activities and think
Apply the principles of effective
points to be able to define budgets and the
budgeting
importance of budgetary control.
Explain the advantages of budgets and
•
Complete the relevant activities and think
budgetary control.
points to be able to demonstrate an
Explain the advantages of budgets and
understanding of the principles relating to
budgetary control.
effective budgeting.
Appreciate the importance of budgets
•
Complete the relevant activities and think
and budgetary control and be able to
points to be able to populate and illustrate
prepare the various types of budgets.
the pros / advantages relating to budgets
Prepare a sales budget, cash budget, a
and budgetary control.
budgeted income statement and a
•
ASSOCIATED ASSESSMENT CRITERIA OF
THIS UNIT:
•
Complete the relevant activities and think
budgeted balance sheet.
points to be able to populate and illustrate
Explain how zero-based budgeting
the cons/ disadvantages relating to budgets
balance sheet
and budgetary control.
works
•
Complete the relevant activities and think
points to be able to populate, demonstrate
and illustrate in a structured format the
necessary budgets such as Sales budget,
Cash budget and a budgeted income
statement and balance sheet.
•
Understand the fundamental principles of
preparation of budgets and relevant support
working schedules.
•
Complete the relevant activities and think
points to be able to define and explain the
concept zero-based budgeting and
articulate the steps to follow in zero-based
budgeting.
MANCOSA
100
Management Accounting
Key Concepts
7.1 Introduction
7.2 Concepts of budgets and budgetary control
7.3 Principles of effective budgeting
7.4 Advantages of budgets and budgetary control
7.5 Disadvantages of budgets
7.6 Preparation of budgets
7.7 Zero-based budgeting
7.8 Self-assessment activities and solutions
7.9 Answers to revision questions and activities
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
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Management Accounting
7.1 Introduction
Proper planning and effective control of costs are important if an enterprise wishes to maximize profit.
Budgets and budgetary control are important management tools that assist management in planning and
cost control.
7.2 Concepts of Budgets and Budgetary Control
It is important to distinguish between these two terms as they are not the same.
7.2 1 Budgets
A budget may be described as a plan expressed in financial terms. It is the path that must be followed
from the present time to the future. A budget must reveal the plans to achieve the objective of the
enterprise for a given period.
7.2.2 Budgetary control
As indicated above a budget is the path that an enterprise must follow to achieve its objective. Budgetary
control, on the other hand, includes measures put into place to monitor any deviations from the path and
to ensure that the objective is realised within the budgeted period. This can be achieved by regularly
comparing actual results with the budgeted targets. Budgetary control must ensure that deviations from
the plan are analysed and if necessary remedial measures are put in place to remedy or prevent problems
that may occur.
7.3 Principles of Effective Budgeting
The following principles are useful for those responsible for the budgeting process:
The objective(s) that need to be achieved must be discussed.
Those involved in the budgeting process must work in harmony and apply common sense during the
process.
•
They must realise that there is an inter-relationship of the various budgets.
•
All workers, supervisors and managers whose inputs are required to draw up budgets should be
given an opportunity to participate in the budgeting process.
•
It must be decided how to share scarce resources.
•
A timetable should be prepared for the preparation of budgets so that they are completed well in
advance of the budgeted period.
§
Budgets must be flexible to allow for changes that may become necessary once they have been
implemented.
§
The actual results and budgeted figures need to be monitored regularly to detect any deviations.
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Management Accounting
7.4 Advantages of Budgets and Budgetary Control
They act as a mean to achieving the objectives of the enterprise.
§
Manufacturing costs can be carefully planned and controlled.
§
Budgetary control facilitates the delegation of authority.
§
Budgets can motivate managers and employees to better performance.
§
Budgets can provide a basis for a system of control of employees.
§
Budgets promote forward thinking and the identification of possible problems.
7.5 Disadvantages of Budgets
Predictions cannot be totally accurate as the information used to prepare budgets is obtained from
estimates.
§
If targets are badly set, they may stifle the enthusiasm and flair of managers and employees.
§
Managers may spend to the limit of their budgets, although this may be wasteful.
§
If budget targets are set at a more difficult level than can be achieved, comparing actual results
with the budget becomes less meaningful.
§
Budgets cannot be perfect since they have to adapt to changing circumstances.
7.6 Preparation of Budgets
The main budget called the master budget is developed from the operating budget and the financial
budget. The operating budget consists of the sales budget, production budget, direct labour budget,
factory overhead budget, inventory budget, selling and administrative budget and budgeted income
statement. The financial budget consists of the cash budget and budgeted balance sheet.
For the purposes of this module, the preparation of the sales budget, cash budget, budgeted income
statement and budgeted balance sheet will be discussed.
7.6.1 Sales budget
The reliability of the sales budget is important as all other budgets are based on it. After the number of
units that may be sold is estimated, the number of units that can be produced may be determined. Whilst
the sales budget depends a lot on previous sales figures, consideration is also given to sales trends,
future predictions and competitors. A sales budget may be described as a forecast of the number of units
the enterprise expects to sell for a predetermined period.
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Management Accounting
Example 1
§
The following is the sales forecast (in units) of Manco Ltd that manufactures two products viz.
product X and product Y:
November 20.6
December 20.6
January 20.7
Product X
3 000
4 500
4 000
Product Y
4 000
6 000
5 000
n
The selling price per unit of product X is R20 and the selling price of product Y is R30.
n
All sales are on credit.
Collections from debtors are as follows:
*50% is collected during the month of sale.
*30% is collected in the following month.
*15% is collected in the second month after the sale.
The balance is written off as bad debts at the end of the second month after the sale.
Required
n
Prepare a sales budget for the period 1 December 20.6 to 31 January 20.7.
n
Prepare a schedule of collections from debtors for the period 1 December 20.6 to
31 January 20.7.
Solution
Sales budget
Product
November
December
January
Units
R
Units
R
Units
R
Product X
3 000
60 000
4 500
90 000
4 000
80 000
Product Y
4 000
120 000
6 000
180 000
5 000
150 000
180 000
MANCOSA
270 000
230 000
104
Management Accounting
Debtors collection schedule
Credit
Month
Balance
sales November
R
R
December
January
Bad
on 31 Jan
R
R
debts
R
R
November
180 000
90 000
54 000
27 000
9 000
-
December
270 000
-
135 000
81 000
-
54 000
January
230 000
-
-
115 000
-
115 000
680 000
90 000
189 000
223 000
9 000
169 000
REMARKS
Collections of credit sales and bad debts for each month are calculated as follows:
Credit sales for November
Collection for November:
R180 000 X 50% = R90 000
Collection for December:
R180 000 X 30% = R54 000
Collection for January:
R180 000 X 15% = R27 000
Bad debts:
R180 000 X 5% = R9 000
Credit sales for December
Collection for December:
R270 000 X 50% = R135 000
Collection for January:
R270 000 X 30% = R81 000
Balance on 31 January:
R270 000 X 20% = R54 000
Credit sales for January
Collection for January:
R230 000 X 50% = R115 000
Balance on 31 January:
R230 000 X 50% = R115 000
.
7.6.2 Cash budget
Once all the other budgets including the sales budget are prepared, the cash budget can be drawn up.
The cash budget shows the expected receipts and expected payments for a certain period of time. It
usually depicts the monthly cash position of the enterprise. The cash budget is prepared for the purpose
of cash planning and control. It helps in avoiding to keep cash lying idle for long periods and identifying
possible cash shortages.
105
MANCOSA
Management Accounting
Note that a cash budget only involves amounts that affect the cash balance of the enterprise. Therefore,
non-cash items such as depreciation, bad debts, discount allowed and discount received are not included.
Since budgets are used internally by an enterprise, the style may vary from business to business.
However, most cash budgets have the following features:
•
The budget period is broken down into sub-periods usually months.
•
Receipts of cash are identified and totalled.
•
Payments of cash are identified and totalled.
•
The surplus (or shortfall) in cash for each month is calculated (receipts minus payments).
•
The closing cash balance is calculated by taking into account the cash surplus (or
shortfall) and the opening cash balance.
The following example illustrates how a cash budget is prepared.
Example 2
The following information is available for Timbuk Enterprises:
1.
On 31 March 20.6 the bank account in the general ledger reflected a debit balance of
R20 000.
2.
3.
Sales figures before taking any discounts in respect of cash or credit sales are:
March
April
May
June
R
R
R
R
Cash sales
30 000
34 000
32 000
35 000
Credit sales
21 000
18 000
16 000
20 000
The following discounts are given as incentives to customers:
12% on cash sales
5% on credit sales if accounts are settled after 30 days
4.
Collections from debtors are expected to be as follows:
50% 30 days after the sale
30% 60 days after the sale
18% 90 days after the sale
2% written off after 90 days
5.
50% of the material purchased is bought on credit.
Creditors are usually paid as follows:
70% within the same month of the purchase
30% 30 days after the purchase.
MANCOSA
106
Management Accounting
6.
Payment of overhead costs and selling and administrative costs are delayed by one month.
Selling and administrative costs are as follows:
March (actual) R6 500
April (expected) R7 000
May (expected) R7 200
June (expected) R8 000
7.
Employees involved in the production of finished goods are paid wages. Since wages are paid
on specific days, only 75% of a month’s budgeted wages are paid in that month. The rest are
paid in the following month.
8.
The proprietor is expected to increase her capital contribution by R50 000 in June 20.6.
9.
The production records for finished goods reveal the following:
Actual
Budgeted
March
April
May
June
R
R
R
R
14 000
20 000
18 000
16 000
Direct material
20 000
16 000
14 000
15 000
Direct labour
16 000
12 000
10 000
8 000
Overheads
8 000
6 000
5 000
4 000
58 000
54 000
47 000
43 000
Closing inventory
(20 000)
(18 000)
(16 000)
(14 000)
Cost of sales
38 000
36 000
31 000
29 000
Opening inventory
Production costs:
Required
n
Prepare the debtors collection schedule for the period 01 April to 30 June 20.6.
n
Prepare a creditors payment schedule for the period 01 April to 30 June 20.6.
n
Prepare the cash budget for the period 01 April to 30 June 20.6.
107
MANCOSA
Management Accounting
Solution
Debtors collection schedule
Credit
Month
sales
April
May
June
R
R
R
R
March
21 000
9 975
6 300
3 780
April
18 000
-
8 550
5 400
May
16 000
-
-
7 600
June
20 000
-
-
-
9 975
14 850
16 780
REMARKS
Collections of credit sales for each month are calculated as follows:
Credit sales for March
Collection for April:
(R21 000 X 50%) – 5% = R9 975
Collection for May:
R21 000 X 30% = R6 300
Collection for June:
R21 000 X 18% = R3 780
Credit sales for April
Collection for May:
(R18 000 X 50%) – 5% = R8 550
Collection for June:
R18 000 X 30% = R5 400
Credit sales for May
Collection for June:
(R16 000 X 50%) – 5% = R7 600
Creditors payment schedule
Month
Credit purchases
April
May
June
R
R
R
R
March
10 000
3 000
-
-
April
8 000
5 600
2 400
-
May
7 000
-
4 900
2 100
June
7 500
-
-
5 250
8 600
7 300
7 350
MANCOSA
108
Management Accounting
REMARKS
50% of the purchase of materials is on credit. Payments to creditors each month are calculated
as follows:
Credit purchases for March
Payment for April:
R10 000 X 30% = R3 000
Credit purchases for April
Payment for April
R8 000 X 70% = R5 600
Payment for May:
R8 000 X 30% = R2 400
Credit purchases for May
Payment for May:
R7 000 X 70% = R4 900
Payment for June
R7 000 X 30% = R2 100
Credit purchases for June
Payment for June:
R7 500 X 70% = R5 250
Cash budget for the period 01 April to 30 June 20.6
April
May
June
Cash receipts
39 895
43 010
97 580
Cash sales (after discount)
29 920
28 160
30 800
Receipts from debtors
9 975
14 850
16 780
-
-
50 000
(44 100)
(37 800)
(35 550)
Cash purchases of materials
8 000
7 000
7 500
Payments to creditors
8 600
7 300
7 350
Wages
13 000
10 500
8 500
Overheads
8 000
6 000
5 000
Selling and administrative costs
6 500
7 000
7 200
Cash surplus (shortfall)
(4 205)
5 210
62 030
Opening cash balance
20 000
15 795
21 005
Closing cash balance
15 795
21 005
83 035
Capital
Cash payments
109
MANCOSA
Management Accounting
REMARKS
n
Cash sales: 12% cash discount has been deducted from the figures provided.
n
Receipts from debtors: are obtained from the debtors collection schedule.
n
Capital: is expected to be received only in June.
n
Cash purchases of materials: is 50% of the total purchases.
n
Payments to creditors: are obtained from the creditors payment schedule.
n
Wages: are calculated as follows:
April:(March R16 000 X 25%)
= R4 000
(April R12 000 X 75%)
= R9 000
May: (April R12 000 X 25%)
= R3 000
(May R10 000 X 75%)
= R7 500
June: (May R10 000 X 25%)
= R2 500
(June R8 000 X 75%)
= R6 000
R13 000
R10 500
R8 500
n
Overheads: are paid in the month following the month in which they were incurred.
n
Selling and administrative expenses: are paid in the month following the month in which
they were incurred.
n
Cash surplus: is expected for all May and June only as expected receipts exceed expected
payments, whereas in April, payments exceed receipts (resulting in an expected cash
shortfall).
n
Opening cash balance: for April is the closing cash balance for March, the opening cash
balance for May is the closing cash balance for April and the opening cash balance for June
is the closing cash balance for May.
n
Closing cash balance: is calculated using the cash surplus (shortfall) and the opening cash
balance.
6.6.3
Budgeted income statement and budgeted balance sheet
Once the sales budget, purchases budget, production budget and expenses budget have
been prepared, the budgeted income statement can be prepared. The budgeted income
statement is a summary of the various component projections of income and expenses for
the budget period.
MANCOSA
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Management Accounting
A budgeted balance sheet is prepared by starting with the balance sheet for the period just
ended and adjusting it using all the activities which are expected to take place during the
budgeted period. A budgeted balance sheet can help management to calculate a variety of
ratios. It also highlights future resources, obligations and possible unfavourable conditions.
The following example illustrates how a budgeted (projected) income statement and balance
sheet is drawn up.
Example 3
The following is an abridged balance sheet of KMS Manufacturers on 31 December 20.6.
KMS Manufacturers
Balance Sheet as at 31 December 20.6
R
ASSETS
Non-current assets
650 000
Land and buildings
500 000
Machinery
150 000
Current assets
300 000
Inventories
200 000
Debtors
90 000
Bank
10 000
Total assets
950 000
EQUITY AND LIABILITIES
Equity
Capital
900 000
Current liabilities
50 000
Creditors
50 000
Total equity and liabilities
950 000
111
MANCOSA
Management Accounting
Additional information
1.
Costs for the year ended 31 December 20.6 are as follows:
R
Direct material
384 000
Direct labour
192 000
Variable overheads
96 000
Fixed overheads
208 000
2.
The gross profit for the year ended 31 December 20.6 amounted to R80 000.
3.
Budgeted sales for 20.7 are as follows:
R
First quarter
200 000
Second quarter
220 000
Third quarter
240 000
Fourth quarter
250 000
4.
Fixed costs for 20.7 will be the same as for 20.6.
5.
Variable costs will vary in the same ratio to sales as for 20.6.
6.
Fixed costs include depreciation on the machinery. Depreciation is 10% p.a. on cost. The
cost price of the machinery is R200 000.
7.
KMS Manufacturers plan to extend the factory during January 20.7. The cost of the extension
is expected to be R200 000 and ten monthly instalments of R20 000 will commence on 01
February 20.7.
8.
Inventory and debtors are expected to be equal to two (latest) months’ sales.
9.
The amount owing to creditors is expected to equal two (latest) months’ purchases of direct
materials.
10.
Selling and administrative expenses are estimated to be 7% of the sales for each quarter.
Required
n
The budgeted income statement for each quarter of 20.7.
n
The budgeted balance sheet on 31 December 20.7.
MANCOSA
112
Management Accounting
Solution
Budgeted income statement
1st Quarter
2nd quarter
3rd quarter
4th quarter
Total
R
R
R
R
R
Sales
200 000
220 000
240 000
250 000
910 000
Cost of sales
(192 000)
(206 000)
(220 000)
(227 000)
(845 000)
Direct material
80 000
88 000
96 000
100 000
364 000
Direct labour
40 000
44 000
48 000
50 000
182 000
Variable
20 000
22 000
24 000
25 000
91 000
overheads
52 000
52 000
52 000
52 000
208 000
8 000
14 000
20 000
23 000
65 000
Other expenses
(14 000)
(15 400)
(16 800)
(17 500)
(63 700)
Selling & admin
14 000
15 400
16 800
17 500
63 700
Net profit (loss)
(6 000)
(1 400)
3 200
5 500
1 300
Fixed overheads
Gross profit
REMARKS
n
Since variable costs vary in the same ratio to sales as for 20.6, the sales figure for 20.6 and
the percentage of direct materials, direct labour and variable overheads to sales are
calculated:
R
% of sales
Direct material
384 000
40
Direct labour
192 000
20
Variable overheads
96 000
10
Fixed overheads
208 000
Cost of sales
880 000
Gross profit
80 000
Sales
960 000
100
n
Sales forecast for each quarter is provided in the information.
n
Cost of sales is the manufacturing cost of sales.
Cost of sales = Direct material + Direct labour + Variable overheads + Fixed overheads
113
MANCOSA
Management Accounting
n
Direct material = 40% of sales
n
Direct labour = 20% of sales
n
Variable overheads = 10% of sales
n
Fixed overheads are the same as 20.6.
n
Gross profit = Sales – Cost of sales
n
Selling and administration costs = 7% of sales.
n
Net profit (loss) = Gross profit – Other expenses
A net loss is expected for the first two quarters while for the last two quarters a profit is
predicted culminating in a net profit for the year of R1 300.
Budgeted balance sheet as at 31 December 20.7
R
ASSETS
Non-current assets
830 000
Land and buildings (500 000 + 200 000)
700 000
Machinery ([150 000] – [200 000 X 10%])
130 000
Current assets
333 334
Inventories (250 000 X 2 ÷ 3)
166 667
Debtors (250 000 X 2 ÷ 3)
166 667
Bank
0
Total assets
1 163 334
EQUITY AND LIABILITIES
Equity
Capital (900 000 + 1 300)
901 300
Current liabilities
262 034
Creditors (100 000 X 2 ÷ 3)
66 667
Bank overdraft (balancing figure i.e. Total assets – Capital – Creditors)
195 367
Total equity and liabilities
1 163 334
MANCOSA
114
Management Accounting
7.7 Zero-Based Budgeting
Traditional budgeting tends to concentrate on the incremental change from the previous year. The focus
is on examining what happened last year with some adjustments for any changes in factors (like inflation)
that may affect the budgeted period.
With zero-based budgeting cost estimates are built up from zero level and it rests on the philosophy that
all spending must be justified. It is not automatically accepted that if some activity was financed this year
it will be financed again in the future. A good case must be made for the allocation of scarce resources
for that activity.
The basic steps in zero-based budgeting are:
- Describe each activity in the organisation in a “decision” package.
- Analyse, evaluate and rank the packages in order of priority on the basis of the costbenefit analysis.
- Resources are allocated accordingly.
Zero-based budgeting forces managers to think carefully about certain activities and the way they are
undertaken. This approach should result in more effective use of resources. However, zero-based
budgeting is time-consuming and expensive to undertake. It appears to be more suited to enterprises
that do not have a profit motive.
7.8
Self-Assessment Activities And Solutions
7.8.1
The following information is available for Thandi Enterprises for 20.6.
1.
Actual
Budgeted
January
February
March
April
May
R
R
R
R
R
Cash sales
308 000
242 000
264 000
275 000
291 500
Credit sales
320 000
260 000
270 000
275 000
280 000
Purchases
400 000
320 000
340 000
350 000
360 000
Salaries and
72 000
72 000
79 200
79 200
79 200
wages
32 000
27 000
28 500
29 000
30 000
Sundry expenses
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MANCOSA
Management Accounting
2.
Credit sales is expected to be collected as follows:
60% after 30 days (A discount of 5% is allowed to debtors who pay after 30 days.)
25% after 60 days
10% after 90 days
5% is written off as bad debts.
3.
Customers who buy for cash receive a 10% discount. (The sales figures provided are before
any discount.)
4.
Salaries, wages and sundry expenses are settled in cash.
5.
Seventy percent of all purchases are on credit and are paid one month after the purchases.
6.
Sundry expenses include depreciation of R4 000 per month.
7.
The cash in the bank on 31 March was R25 200.
Required
Prepare a debtors collection schedule for the period 01 April to 31 May 20.6
Prepare a cash budget for the period 01 April to 31 May 20.6
The following information has been obtained from Aliwal Ltd:
7.8.1.2 Total sales figures (actual and budgeted) are:
Actual
Total sales
Budgeted
January
February
March
April
May
June
R
R
R
R
R
R
320 000
260 000
400 000
420 000
380 000
360 000
7.8.1.3 The abridged balance sheet on 31 March 20.6 is as follows:
Balance Sheet as at 31 March 20.6
ASSETS
Non-current assets
200 000
Property, plant and equipment
200 000
Current assets
605 600
Inventories
240 000
Debtors
361 600
Bank
4 000
Total assets
MANCOSA
805 600
116
Management Accounting
EQUITY AND LIABILITIES
Equity
Capital
693 600
Current liabilities
112 000
Creditors
112 000
Total equity and liabilities
805 600
3.
Rent amounts to R240 000 per annum and is payable monthly.
4.
Selling and administration expenses are estimated to be 25% of sales and are
payable in the same month as the sale.
5.
The gross profit percentage on sales is 60%.
6.
Depreciation on fixed assets for the year amount to R28 000.
7.
Cash sales account for 20% of total sales. Credit sales (80%) are usually collected
as follows:
80% 1 month after the sale
20% 2 months after the sale.
8.
Thirty percent (30%) of all purchases are for cash. The total purchases are as follows:
March
April
May
June
R160 000
R168 000
R152 000
R144 000
9.
Creditors are paid in full in the month after the purchase.
10.
All other expenses are paid monthly and are expected to amount to R22 000 per
month.
Required
7.8.3.1 Prepare a monthly cash budget for April, May and June 20.6.
7.8.3.2 Prepare a budgeted income statement for the 3 months ended 30 June 20.6.
7.8.3.3 Prepare a budgeted balance sheet on 30 June 20.6.
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7.9 Answers to Revision Questions and Activities
SOLUTIONS
7.9.1
Debtors collection schedule
Credit sales
April
May
R
R
R
January (April R320 000 X 10%)
320 000
32 000
-
February (April R260 000 X 25%)
260 000
65 000
26 000
270 000
153 900
67 500
April (May R275 000 X 60%) – 5%
275 000
-
156 750
May
280 000
-
-
250 900
250 250
April
May
Cash receipts
498 400
512 600
Cash sales (after discount)
247 500
262 350
Receipts from debtors
250 900
250 250
Cash payments
(447 200)
(458 200)
Cash purchases
105 000
108 000
Payments to creditors
238 000
245 000
Salaries and wages
79 200
79 200
Sundry expenses
25 000
26 000
Cash surplus (shortfall)
51 200
54 400
Opening cash balance
25 200
76 400
Closing cash balance
76 400
130 800
(May R260 000 X 10%)
March (April R270 000 X 60%) – 5%
(May R270 000 X 25%)
7.9.2
Cash budget for April and May 20.6
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REMARKS
n
Cash sales: 10% cash discount has been deducted from the figures provided.
n
Receipts from debtors: are obtained from the debtors collection schedule.
n
Cash purchases: is 30% of total purchases.
n
Payments to creditors: 70% of the total purchases for March is paid in April and 70% of the
total purchases for April is paid in May.
n
Salaries and wages: are the same amounts provided in the information.
n
Sundry expenses: Since depreciation is a non-cash item, R4 000 per month is deducted from
sundry expenses.
n
Cash surplus: is expected for both months as expected receipts exceed expected payments.
n
Opening cash balance: for April is the closing cash balance for March and the opening cash
balance for May is the closing cash balance for April.
n
Closing cash balance: is calculated using the cash surplus (shortfall) and the opening cash
balance.
7.9.3
Cash budget for the period 01 April to 30 June 20.6
119
April
May
June
Cash receipts
381 600
408 800
382 400
Cash sales
84 000
76 000
72 000
Receipts from debtors
297 600
332 800
310 400
Cash payments
(309 400)
(300 200)
(281 600)
Cash purchases
50 400
45 600
43 200
Payments to creditors
112 000
117 600
106 400
Rent
20 000
20 000
20 000
Selling and administrative costs
105 000
95 000
90 000
Other expenses
22 000
22 000
22 000
Cash surplus (shortfall)
72 200
108 600
100 800
Opening cash balance
4 000
76 200
184 800
Closing cash balance
76 200
184 800
285 600
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REMARKS
n
Cash sales: are 20% of total sales.
n
Receipts from debtors: are calculated as follows:
Credit
Month
sales
April
May
June
R
R
R
R
February (April R208 000 X 20%)
208 000
41 600
-
-
March (April R320 000 X 80%)
320 000
256 000
64 000
336 000
-
268 800
67 200
304 000
-
-
243 200
297 600
332 800
310 400
(May R320 000 X 20%)
April
(May R336 000 X 80%)
(June R336 000 X 20%)
May
n
(June R304 000 X 80%)
Cash purchases and payments to creditors: The following calculations reflect the cash
purchases and payments to creditors:
March
April
May
June
R
R
R
R
Total purchases
160 000
168 000
152 000
144 000
Cash purchases (30% of purchases)
48 000
50 400
45 600
43 200
Credit purchases (70% of purchases)
112 000
117 600
106 400
100 800
112 000
117 600
106 400
Payments to creditors (1 month
after)
n
Rent: is paid monthly (R240 000 ÷12 = R20 000)
n
Selling and administrative expenses: are 25% of sales.
n
Other expenses: are paid monthly.
n
Opening cash balance: for April is obtained from the Balance sheet as at 31 March 20.6.
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7.9.4
Budgeted income statement for the 3 months ended 30 June 20.6
R
Sales (R420 000 + R380 000 + R360 000)
1 160 000
Cost of sales (40% of sales)
(464 000)
Gross profit (60% of sales)
696 000
Expenses
(423 000)
Rent expense (R20 000 X 3)
60 000
Selling and distribution (R1 160 000 X 25%)
290 000
Depreciation (R28 000 ÷4)
7 000
Other expenses (R22 000 X 3)
66 000
Net profit
273 000
REMARKS
n
Sales: reflects the total sales for April, May and June.
n
Cost of sales: is 40% of sales since the gross profit percentage on sales is 60%.
n
Rent expense: is R2 000 per month and includes rent for April, May and June.
n
Selling and distribution: is 25% of the total sales (R1 160 000).
n
Depreciation: is R28 000 per annum and this translates to R7 000 every 3 months.
n
Other expenses: are R22 000 per month for 3 months.
Budgeted Balance Sheet as at 30 June 20.6
R
ASSETS
Fixed assets
193 000
Property, plant and equipment (200 000 – 7 000)
193 000
Current assets
874 400
Inventories
240 000
Debtors (60 800 + 288 000)
348 800
Bank
285 600
Total assets
1 067 400
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EQUITY AND LIABILITIES
Equity
Capital (693 600 + 273 000)
966 600
Current liabilities
100 800
Creditors
100 800
Total equity and liabilities
1 067 400
REMARKS
n
Plant, property and equipment: was subject to an annual depreciation of R28 000. For 3
months it would amount to R7 000 and this is the amount by which property, plant and
equipment decreases.
n
Inventories will remain the same as the previous month balance as all inventory sold is
replaced during the month of sale.
n
Debtors: The amount owing by debtors includes 20% of the credit sales for May (R60 800)
and the entire credit sales for June (R288 000).
n
Bank: The expected bank balance at the end of June is obtained from the cash budget.
n
Capital: increases by the expected profit as calculated in the income statement.
n
Creditors: The amount owing to creditors will be the credit purchases for June (R100 800).
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Unit
8:
123
Standard Costing
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UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
On successful completion of this Unit, the
student will be able to:
• Understand the concept of standard
ASSOCIATED ASSESSMENT CRITERIA OF THIS
UNIT:
The student needs to:
• Complete the relevant activities and think points
costing.
to be able to identify and define standard
•
Explain the advantages of standard costing
costing.
•
Compute material variances.
•
Calculate labour variances.
to be able to list and understand the
•
Calculate the manufacturing overheads
advantages of standard costing.
standards and variances
•
•
Complete the relevant activities and think points
Complete the relevant activities and think points
•
Calculate the sales variances
to be able to demonstrate the articulation and
•
Understand and know the summary of
calculation of material price and quantity
formulae
variances.
•
Complete the relevant activities and think points
to be able to demonstrate the articulation and
calculation of labour rate and labour efficiency
variances.
•
Complete the relevant activities and think points
to be able to demonstrate the articulation and
calculation of manufacturing overhead standards
and variances as well as Variable and Fixed
manufacturing overhead variances.
•
Complete the relevant activities and think points
to be able to demonstrate the articulation and
calculation of sales price variances.
•
Complete the relevant activities and think points
to be able to demonstrate an understanding and
calculation of the variance formulae.
•
MANCOSA
Learn and know all the formuale
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Key Concepts
8.1 Introduction
8.2 Advantages of standard costing
8.3 Material standards and variances
8.4 Labour standards and variances
8.5 Manufacturing overheads standards and variances
8.6 Sales variances
8.7 Summary of formulas
8.8 Self-assessment activities and solutions
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
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8.1 Introduction
What Are Standard Costs?
A standard cost is a predetermined target cost that aims to provide a benchmark against which to
measure actual performance. Factors such as quantities, prices, rates of pay and quality are considered
in the setting of a standard. Standards may be set for materials, labour, manufacturing overheads and
selling prices. The standard cost is determined by multiplying the standard quantity of an input by its
standard price.
One of the important tasks of management is to evaluate performance by comparing actual costs with
standard costs. The difference between actual costs and standard costs is called the variance. All
variances are the result of two factors viz. price and quantity. The variance could be either favourable or
unfavourable to the enterprise.
8.2 Advantages of Standard Costing
§
Standard cost serve as a benchmark against which actual costs can be measured.
§
Control is exercise over the production process through the calculation and analysis of variances.
§
Greater control is exercised over the various costs.
§
The analysis of cost reports by management is facilitated.
§
Standard costs make it easier to value inventories.
§
The introduction of standards usually leads to greater efficiency.
8.3 Material Standards and Variances
When material standards are set consideration is given to prices, quantity, quality, grades, wastages etc.
A price and a quantity standard are set for material. The standard material price is usually based on past,
present and expected future prices and also gives consideration to economic order quantities, suppliers’
quotations and market factors. The standard material quantity specifies the quantity required to
manufacture one unit of a completed product.
Two main variances can occur with respect to material viz. a price variance and a quantity variance.
3.1 Material price variance
Two methods may be used to calculate material price variance viz. the purchase price variance and the
issue price variance.
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3.1.1 Purchase price variance
The purchase price variance is calculated when the material is received and occurs when the actual
price is not the same as the standard price. The purchasing department is responsible for any material
price variance that may arise e.g. incorrect calculation of discounts and delivery costs. However,
material price variances may be the result of mistakes made when the standard price was set and
unexpected price changes.
The variance is calculated by subtracting the actual cost of the quantity purchased with the standard
cost for the same quantity.
The following formula may be used to calculate purchase price variance.
(Actual price – Standard price) X Actual quantity purchased
or
(AP – SP) AQ
3.1.2
Issue price variance
Issue price variance is calculated when raw materials are issued to production. It is based
on the number of units issued and used. It is the difference between the actual quantity issued
at actual cost and the actual quantity issued at standard price.
The formula to calculate issue price variance is similar to purchase price variance except that
the actual quantity (AQ) now refers to actual quantity issued instead of actual quantity
purchased.
The formula for issue price variance is:
(Actual price – Standard price) X Actual quantity issued
or
(AP – SP) AQ
3.2
Material quantity variance
This variance is the difference between the actual quantity of material used (at the standard
price) and the standard quantity of material allowed (at standard price). Assume that 2 kg of
raw material is used to manufacture one unit of a finished product. If 200 units are
manufactured, then the standard material quantity allowed is 400 kg (200 X 2 kg). The
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production department is responsible for any material quantity variances that might occur e.g.
poor control over materials. However, variances may be due to faulty standards and changes
in the quality of the material supplied.
The formula to calculate the material quantity variance is:
(Actual quantity – Standard quantity) X Standard price
or
(AQ – SQ) SP
The total material variance i.e. the total of the material price and quantity variances may be
calculated as follows:
(Actual quantity X Actual price) – (Standard quantity X Standard price)
or
(AQ X AP) – (SQ X SP)
Example 1
The standard cost of material of product C for the third quarter of 20.6 was:
4 kg per unit at R3 per kg
45 000 kg of material was purchased at R2,80 for the third quarter.
The actual production of product C for the third quarter of 20.6 was:
9 000 units which took 37 000 kg of material
Required
In respect of material, calculate the following variances:
n
Purchase price variance
n
Issue price variance
n
Quantity variance
n
Total material variance for the 37 000 kg of material issued.
Solution
Material purchase price variance
= (Actual price – Standard price) X Actual quantity purchased
= (R2,80 – R3,00) X 45 000
= R9 000 (favourable)
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Material issue price variance
= (Actual price – Standard price) X Actual quantity issued
= (R2,80 – R3,00) X 37 000
= R7 400 (favourable)
Material quantity variance
= (Actual quantity – Standard quantity) X Standard price
= (37 000 – 36 000) X R3
= R3 000 (unfavourable)
Note: Standard quantity = 9 000 X 4 kg = 36 000 kg
Total Material variance
= (Actual quantity X Actual price) – (Standard quantity X Standard price)
= (37 000 X R2,80) – (36 000 X R3)
= R103 600 – R108 000
= R4 400 (favourable)
or
Material issue price variance
R7 400 (favourable)
Material quantity variance
R3 000 (unfavourable)
Total material variance
R4 400 (favourable)
8.4 Labour Standards and Variances
Labour standards are set in terms of rate (tariff) and efficiency (time). With respect to rate, wages scales
that have been devised for various types of labour usually form the basis of the rate standards. Efficiency
relates to how long it should take to complete a task. Efficiency standards are set with the help of work
study and in particular work measurement.
Let us examine the two variances concerning labour viz. labour rate variance and labour efficiency
variance.
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8.4.1 Labour rate variance
The labour rate variance is calculated by multiplying the difference between the standard rate and the
actual rate to the number of hours worked. Labour rate variance formula is:
(Actual rate – Standard rate) X Actual hours worked
or
(AR – SR) AH
The personnel manager will usually be responsible for this variance. However the variance
could be ascribed to change to wage rates, unscheduled overtime, use of lower skilled workers
with lower pay etc.
8.4.2
Labour efficiency variance
This variance is related to the time it takes to manufacture a single product. It is calculated by
finding the difference between the actual hours worked (at standard rate) and the standard
time (hours) allowed for the actual production (at standard rate).
The formula is:
(Actual time worked – Standard time allowed) X Standard rate
(AT – ST) SR
The manager responsible for the supervision of labour is usually responsible for this variance.
However this variance may be due to the quality of supervision, skill of employees,
interruptions in production etc
.
Example 2
Details relating to labour in the production department of AMI Ltd are as follows:
Standard labour cost
1,25 hours per unit at R5,50 per hour
Actual hours worked and rate
600 hours @ R5,25 per hour
Number of units manufactured
450
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Required
Calculate the following:
n
Labour rate variance
n
Labour efficiency variance
n
Total labour variance
Solution
Labour rate variance
= (Actual rate – Standard rate) X Actual hours worked
= (R5,25 – R5,50) X 600
= R150 (favourable)
Labour efficiency variance
= (Actual time worked – Standard time allowed) X Standard rate
= (600 – 562,5) X R5,50
= R206,25 (unfavourable)
Note:
Standard time allowed = 450 units X 1,25 hours per unit
= 562,5 hours
Total Labour variance
= (Actual time worked X Actual rate) – (Standard time allowed X Standard rate)
= (600 X R5,25) – (562,5 X R5,50)
= R3 150 – R3 093,75
= R56,25 (unfavourable)
or
131
Labour rate variance
R206,25 (unfavourable)
Labour efficiency variance
R150,00 (favourable)
Total labour variance
R56,25 (unfavourable)
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Management Accounting
8.5 Manufacturing Overheads Standards and Variances
Manufacturing overheads may be classified as fixed or variable and standards are set separately.
Variable costs (the same for each product) change in direct proportion to level of business activity. The
fixed overhead rate is calculated according to a predetermined level of business activity.
Manufacturing overhead variances may be due to equipment lying idle, absenteeism, changes in
demand, efficiency of employees, working conditions etc.
Separate variances in respect of fixed and variable manufacturing may be calculated as follows:
5.1 Variable manufacturing overheads variance
Overhead rates are often based on direct labour hours (used in this module) or machine hours.
The efficiency variance is calculated as follows:
(Actual hours – Standard hours allowed) X Standard rate
or
(AH – SH) SR
Note:
Standard hours allowed = Number of units produced X standard time to make one product
Standard rate = Standard variable overheads ÷ standard number of labour hours
The expenditure variance is calculated as follows:
(Actual rate – Standard rate) X Actual hours
or
(AR – SR) AH
Note:
Actual rate = Actual variable overheads ÷ actual number of labour hours
Standard rate = Standard variable overheads ÷ standard number of labour hours
Example 3
The budgeted figures of GHI Manufacturers for August 20.6 are as follows:
Variable overheads
R49 000
Fixed overheads
R60 025
Number of labour hours
24 500
Standard time to manufacture one product
12 hours
The actual results are as follows:
Variable overheads
R50 652
Fixed overheads
R60 300
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Number of labour hours worked
24 120
Units manufactured
2 000
Required
Calculate the following variable manufacturing overheads variances:
n
Efficiency variance
n
Expenditure variance
n
Total variable overheads variance
Solution
Efficiency variance
= (Actual hours – Standard hours allowed) X Standard rate
= (24 120 – [2 000 X 12]) X (49 000 ÷ 24 500)
= (24 120 – 24 000) X R2,00
= 120 X R2,00
= R240 (unfavourable)
Expenditure variance
= (Actual rate – Standard rate) X Actual hours
= ([50 652 ÷ 24 120] – R2,00) X 24 120
= (R2,10 – R2,00) X 24 120
= R2 412 (unfavourable)
Total variance
= Actual amount – Standard amount
= R50 652 – (24 000 X R2)
= R50 652 – R48 000
= R2 652 (unfavourable)
or
R240 unfavourable (efficiency variance)
R2 412 unfavourable (expenditure variance)
R2 652 unfavourable (total variance)
Note:
Actual amount = Actual variable overheads
Standard amount = Standard hours allowed X Standard rate per hour
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8.5.1
Fixed manufacturing overheads variance
The total fixed overheads variance is the difference between the actual fixed overheads and
the standard fixed overheads allowed. The expenditure variance and the volume variance are
the main fixed manufacturing overheads variances.
The expenditure variance is calculated as follows:
Actual fixed overheads – Budgeted fixed overheads
The volume variance is calculated as follows:
Budgeted fixed overheads – Standard fixed overheads
Note:
Standard fixed overheads = Number of units produced X Standard time to make 1 product
X Standard rate per hour
Standard rate per hour = Standard fixed overheads ÷ standard number of labour hours
Example 4
Refer to the information provided in example 3 and calculate the following fixed overhead
variances:
n
Expenditure variance
n
Volume variance
n
Total fixed overheads variance
Expenditure variance
= Actual fixed overheads – Budgeted fixed overheads
= R60 300 – R60 025
= R275 (unfavourable)
Volume variance
= Budgeted fixed overheads – Standard fixed overheads
= R60 025 – (2 000 X 12 X R2,45)
= R60 025 – R58 800
= R1 225 (unfavourable)
Note:
Standard fixed overheads = Number of units produced X Standard time to make 1 product
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X Standard rate per hour
Standard rate per hour = Standard fixed overheads ÷ standard number of labour hours
= R60 025 ÷ 24 500
= R2,45
Total fixed overhead variance
= Actual fixed overheads – Standard fixed overheads
= R60 300 – (2 000 X 12 X R2,45)
= R60 300 – R58 800
= R1 500 (unfavourable)
or
R275 unfavourable (expenditure variance)
R1 225 unfavourable (volume variance)
R1 500 unfavourable (total variance)
8.6.
Sales Variances
When one kind of product is manufactured, the sales variances will be related to the price and
quantity.
Sales price variance is calculated as follows:
(Actual selling price – Standard selling price) X Actual quantity sold
or
(AP – SP) AQ
Sales quantity variance is calculated as follows:
(Actual quantity sold – Standard/Budgeted sales) X Standard selling price
or
(AQ – SQ) SP
Example 5
135
Budgeted sales
2 000 units
Standard cost per unit
R12
Standard selling price per unit
R15,50
Actual sales
1 900 units at R16 per unit
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Management Accounting
Required
Calculate the:
n
Sales price variance
n
Sales quantity variance
Sales price variance
= (Actual selling price – Standard selling price) X Actual quantity sold
= (R16 – R15,50) X 1 900
= R950 (favourable)
Sales quantity variance
= (Actual quantity sold – Standard/Budgeted sales) X Standard selling price
= (1 900 – 2 000) X R15,50
= R1 550 (unfavourable)
8.7
Summary of Formulas
8.7.1
Material Variances
7.8.7.1.1
Material purchase price variance
= (Actual price – Standard price) X Actual quantity purchased
8.7.1.2
Material issue price variance
= (Actual price – Standard price) X Actual quantity issued
8.7.1.3
Material quantity variance
= (Actual quantity – Standard quantity) X Standard price
8.7.1.4
Total Material variance
= (Actual quantity X Actual price) – (Standard quantity X Standard price)
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8.7.2
LABOUR VARIANCES
8.7.2.1
Labour rate variance
= (Actual rate – Standard rate) X Actual hours worked
8.7.2.2
Labour efficiency variance
= (Actual time worked – Standard time allowed) X Standard rate
8.7.2.3
Total Labour variance
= (Actual time worked X Actual rate) – (Standard time allowed X Standard rate)
8.7.3
8.7.3.1
Variable Manufacturing Overheads Variance
Efficiency variance
= (Actual hours – Standard hours allowed) X Standard rate
8.7.3.2
Expenditure variance
= (Actual rate – Standard rate) X Actual hours
8.7.3.3
Total variable overheads variance
= Actual amount – Standard amount
8.7.4
Fixed Manufacturing Overheads Variance
8.7.4.1 Expenditure variance
= Actual fixed overheads – Budgeted fixed overheads
8.7.4.2 Volume variance
= Budgeted fixed overheads – Standard fixed overheads
8.7.4.3 Total fixed overheads variance
= Actual fixed overheads – Standard fixed overheads
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8.7.5
Sales Variances
Sales price variance
= (Actual selling price – Standard selling price) X Actual quantity sold
Sales quantity variance
= (Actual quantity sold – Standard/Budgeted sales) X Standard selling price
8.8
8.1
Self-Assessment Activities And Solutions
A standard quantity of 2 kilograms of material Z at a standard price of R4 per kilogram is
allowed for the production of one unit of product Zeplin.
The cost figures for the first quarter of 20.6 showed that 4 400 kg of material Z was purchased
at R4,20 per kg. 2 000 units of product Zeplin were produced using 4 200 kg of material Z.
Required
In respect of material, calculate the following variances:
8.1.1
Purchase price variance
8.1.2
Issue price variance
8.1.3
Quantity variance
8.1.4
Total material variance for the 4 200 kg of material issued.
8.2
To produce one unit of product Zeplin a standard quantity of 4 direct labour hours at a
standard rate of R6 per hour is allowed.
The wage records show that it took 2 100 hours at R5,90 per hour to produce 500 units of
product Zeplin.
Required
Calculate the following labour variances:
8.2.1
Labour rate variance
8.2.2
Labour efficiency variance
8.2.3
Total labour variance
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8.3
A manufacturer that manufactures product J provides the following information for May 20.6:
Budgeted figures:
Variable manufacturing overheads
R20 000
Fixed manufacturing overheads
R48 000
Labour hours
4 000
Expected production
1 000 units
Actual results:
Variable manufacturing overheads
R19 135
Fixed manufacturing overheads
R49 880
Labour hours worked
4 300
Actual production
1 050 units
Required
8.3.1
Calculate the following variable manufacturing overheads variances:
8.3.1.1
Efficiency variance
8.3.1.2
Expenditure variance
8.3.1.3
Total variable overheads variance
8.3.2
Calculate the following fixed manufacturing overheads variances:
8.3.2.1 Expenditure variance
8.3.2.2 Volume variance
8.3.2.3 Total fixed overheads variance
8.4
The following information was provided by GHI Manufacturers for April 20.6:
Budgeted sales
5 000 units
Standard selling price per unit
R36
Actual sales
5 200 units for R189 800
Required
Calculate the:
n
Sales price variance
n
Sales quantity variance
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SOLUTIONS
8.1
Material variances
8.1.1
Material purchase price variance
= (Actual price – Standard price) X Actual quantity purchased
= (R4,20 – R4,00) X 4 400
= R880 (unfavourable)
8.1.2
Material issue price variance
= (Actual price – Standard price) X Actual quantity issued
= (R4,20 – R4,00) X 4 200
= R840 (unfavourable)
8.1.3
Material quantity variance
= (Actual quantity – Standard quantity) X Standard price
= (4 200 – [2 000 X 2]) X R4,00
= (4 200 – 4 000) X R4,00
= R800 (unfavourable)
8.1.4
Total Material variance
= (Actual quantity X Actual price) – (Standard quantity X Standard price)
= (4 200 X R4,20) – (4 000 X R4,00)
= R17 640 – R16 000
= R1 640 (unfavourable)
or
Material issue price variance
R840 (unfavourable)
Material quantity variance
R800 (unfavourable)
Total material variance
R1 640 (unfavourable)
8.2
Labour variances
8.2.1
Labour rate variance
= (Actual rate – Standard rate) X Actual hours worked
= (R5,90 – R6,00) X 2 100
= R210 (favourable)
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8.2.2
Labour efficiency variance
= (Actual time worked – Standard time allowed) X Standard rate
= (2 100 – [500 X 4]) X R6,00
= (2 100 – 2 000) X R6,00
= R600 (unfavourable)
Total Labour variance
= (Actual time worked X Actual rate) – (Standard time allowed X Standard rate)
= (2 100 X R5,90) – (2 000 X R6,00)
= R12 390 – R12 000
= R390 (unfavourable)
or
8.3.1
Labour rate variance
R210,00 (favourable)
Labour efficiency variance
R600,00 (unfavourable)
Total labour variance
R390,00 (unfavourable)
Variable manufacturing overheads variances
8.3.1.1 Efficiency variance
= (Actual hours – Standard hours allowed) X Standard rate
= (4 300 – [1 050 X 4*]) X (R20 000 ÷ 4 000)
= (4 300 – 4 200) X R5,00
= R500 (unfavourable)
Note: * Standard time to make 1 product is 4 hours (4 000 labour hours ÷ 1 000 units)
8.3.1.2 Expenditure variance
= (Actual rate – Standard rate) X Actual hours
= ([R19 135 ÷ 4 300] – [R20 000 ÷ 4 000]) X 4 300
= (R4,45 – R5,00) X 4 300
= R2 365 (favourable)
8.3.1.3
Total variable overheads variance
= Actual amount – Standard amount
= R19 135 – ([1 050 X 4]) X R5)
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= R19 135 – (4 200 X R5)
= R19 135 – R21 000
= R1 865 (favourable)
or
R500 unfavourable (efficiency variance)
R2 365 favourable (expenditure variance)
R1 865 favourable (total variance)
8.3.2
Fixed manufacturing overheads variances
8.3.2.1 Expenditure variance
= Actual fixed overheads – Budgeted fixed overheads
= R49 880 – R48 000
= R1 880 (unfavourable)
8.3.2.2 Volume variance
= Budgeted fixed overheads – Standard fixed overheads
= R48 000 – (1 050 X 4 X R12)
= R48 000 – R50 400
=R2 400 (favourable)
Note:
Standard fixed overheads = Number of units produced X Standard time to make 1 product
X Standard rate per hour
Standard rate per hour = Standard fixed overheads ÷ standard number of labour hours
= R48 000 ÷ 4 000
= R12
8.3.2.3
Total fixed overheads variance
= Actual fixed overheads – Standard fixed overheads
= R49 880 – (1 050 X 4 X R12)
= R49 880 – R50 400
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= R520 (favourable)
or
R1 880 unfavourable (expenditure variance)
R2 400 favourable (volume variance)
R520
favourable (total variance)
8.4
Sales Variances
8.4.1
Sales price variance
= (Actual selling price – Standard selling price) X Actual quantity sold
= ([R189 800 ÷ 5 200] – R36] X 5 200
= (R36,50 – R36) X 5 200
= R2 600
8.4.2
Sales quantity variance
= (Actual quantity sold – Standard/Budgeted sales) X Standard selling price
= (5 200 – 5 000) X R36
= R7 200
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Unit
9:
MANCOSA
Capital Investment Appraisal
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UNIT LEARNING OUTCOMES AND ASSOCIATED ASSESSMENT CRITERIA
LEARNING OUTCOMES OF THIS UNIT:
ASSOCIATED ASSESSMENT CRITERIA OF THIS
UNIT:
On successful completion of this Unit, the
student will be able to:
The student needs to:
• Understand the concept of present value of • Complete the relevant activities and think points
•
money
to be able to identify, understand and define the
Apply techniques to evaluate capital
concept of present value of money.
investment projects
•
•
•
•
•
Complete the relevant activities and think points
Apply the payback and accounting rate of
to be able to apply the techniques of capital
return methods to capital investment
investment projects. The candidate should be
appraisal.
able to demonstrate and calculate the payback
Apply techniques to evaluate capital
and accounting rate of return to assess the
investment projects.
relevant projects to discern their feasibility.
Apply discounted cash flow methods to •
Complete the relevant activities and think points
capital investment appraisal.
to be able to apply the discounted cash flow
Demonstrate the effects of income tax,
methods to capital investment projects. The
depreciation and scrap value on capital
candidate should be able to demonstrate and
investment decisions.
calculate the NPV and IRR methods to assess
the relevant projects to discern their feasibility.
•
Complete the relevant activities and think points
to be able to apply the techniques of capital
investment projects. The candidate should be
able to demonstrate the effects of income tax,
depreciation and scrap value on capital
investment decisions and the impact thereof.
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Key Concepts
9.1 Introduction
9.2 Present value of money
9.3 Capital investment appraisal using techniques that ignore the time value of money
9.4 Capital investment appraisal using discounted cash flow methods
9.5 Influence of income tax, depreciation and scrap value
9.6 Self-assessment activities and solutions
Recommended Readings
Below is the prescribed reading for specific to this unit;
•
Fundamentals of Cost and Management Accounting Sixth
edition, 2012. Els. G, Meyer, L., van der Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003.
Chadwick, L
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9.1 Introduction
Capital investment appraisal is also known as capital budgeting. A capital budget is a financial plan for
the replacement of fixed assets. Capital investments involve large sums of money and are usually
financed from retained earnings, issue of shares or long-term borrowing. Management must be convinced
of the profitability of these capital investments before a final decision is taken because:
§
Large amounts of resources are usually involved.
§
It is difficult and/or expensive to cancel an investment once it has been made.
9.2 Present Value of Money
A sum of money today has a greater value than the same amount at any time in the future. This may be
due to the effects of inflation, risk and loss of interest. The present value of money is very important in
capital investment appraisal. A simple illustration of this is as follows:
Example 1
Suppose Jack decides to sell his second-hand computer to Jill. Jill makes two proposals to Jack
regarding the payment:
- The first proposal is to pay R 980 immediately
- The second proposal is to pay R1 100 in one year’s time.
Required
Determine which proposal Jack must accept if the current rate for investments is 10% p.a.
Solution
The two amounts cannot be compared as the amounts apply to different times (viz. present day and one
year later). Both values must therefore be converted to a common base (common date). One way of
doing this is to calculate the (future) value of R980 (first proposal) in one year’s time. This future value
can then be compared to the R1 100 (second proposal).
The second method is to use the present time as a common base. This means that the present value of
R1 100 must be calculated and this value is then compared to R980. This can be done as follows:
Future value = Present value + Interest rate
= 100% + 10%
= 110%
We can thus state
R1 100 = 110%
To calculate the present value, we multiply 110 by 100/110 (to get 100%) and do the same
for R1 100 (i.e. multiply it by 100/110).
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Therefore
R1 100 X 100 = 110 X 100
110
110
R1 000 = 100%
The present value of the R1 100 is therefore R1 000.
Jack should therefore accept the second proposal (present value R1 000) since it is more
profitable than the first proposal (present value R980).
Present value tables
In order to eliminate the number of steps to calculate the present value of any amount, present
value tables are available. The present value of R1 can be read from the tables. Two tables
(Table 1 and Table 2) are available and appear at the end of this chapter. Table 1 shows the
present value of R1 at various interest rates receivable after n years (n can represent any
number). Table 2 reflects the present value of R1 at various interest rates receivable annually
for n years.
Example 2
Use the present value tables at the end of this chapter to calculate the present values for the
following amounts at an interest rate of 12% p.a.:
End of year
Amount
1
R2 000
2
R3 500
3
R4 200
Solution
End of year
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Calculation
Present value
1
R2 000 X 0,8929
R1 786
2
R3 500 X 0,7972
R2 790
3
R4 200 X 0,7118
R2 990
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Example 3
Use the present value tables at the end of this chapter to calculate the present values for the
following amounts at an interest rate of 12% p.a.:
End of year
Amount
1
R2 000
2
R2 000
3
R2 000
4
R2 000
Solution
Instead of calculating the present value for each year, table 2 can be used since we are
working with a constant amount of R2 000 per year. Table 2 provides a quicker means of
getting the answer:
R2 000 X 3,0373 = R6 075
9.3 Capital Investment Appraisal Using Techniques That Ignore the Time Value Of Money
When appraising investment decisions, net cash flows need to be calculated. Net cash flow
is the difference between the cash inflow arising from an investment and the cash outflow that
it requires. However, the minimum rate of return of an investment should be greater than the
interest rate on borrowed funds or rate of return of the enterprise (depending on the source of
financing – borrowed or own).
Also note that cash flows = profit/(loss) + depreciation
The following techniques that ignore the time value of money may be used to evaluate capital
investment projects:
n
Payback period
n
Accounting rate of return
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9.3.1
Payback period
Payback period measures the amount of time required to recover the initial cost of the
investment from the net cash inflows from the project. The general decision rule to follow is to
choose the project with a shorter payback period. The reason for this is that the shorter the
payback period, the less risky the project and the greater the liquidity. Whilst the payback
method is simple and easy to use, it does not recognise the time value of money. It also
ignores the influence of cash inflows on profitability after the payback period.
Payback period is calculated as follows if the net cash inflow is the same each year:
Cost of project
Net cash inflow (p.a.)
Example 4
FDG Ltd obtained information in respect of two machines, one of which it intends purchasing.
The following details are available:
Machine X
Machine Y
Purchase price
R60 000
R60 000
Economic lifetime
6 years
4 years
Average annual net cash inflow over economic lifetime
R20 000
R28 000
Depreciation (straight-line method)
R10 000
R15 000
Average annual profits
R10 000
R13 000
Required
Calculate the payback period of each machine and recommend the machine that should be
chosen based on the payback period.
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Solution
Payback period:
Machine X
Machine Y
Cost of machine
= R60 000
R60 000
Net cash inflow
R20 000
R28 000
3 years
2,14 years
=
According to the calculation above FDG Ltd should choose machine Y since it recovers the
purchase price in a shorter time (2,14 years) than Machine X (3 years). However, the
management of FDG Ltd must also consider that machine X will be able to generate an income
of R60 000 (R20 000 X 3) for 3 years after the payback period whereas machine Y will only be
able to generate an income of R28 000 (for only 1 more year) after the payback period.
When the cash inflows are not even, the payback period is determined as follows:
Example 5
Consider two projects whose cash inflows are not even. Assume that the project costs R2 000.
The net cash inflows for each year is as follows:
Year
Project X
Project Y
1
R200
R1 000
2
R400
R800
3
R600
R600
4
R800
R200
5
R1 000
-
6
R1 200
-
Required
Calculate the payback period of each machine and recommend the project that should be
selected based on the payback period.
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Solution
Investment
Year 1 Cash flow
Year 2 Cash flow
Year 3 Cash flow
Project X
Project Y
(2 000)
(2 000)
200
1 000
(1 800)
(1 000)
400
800
(1 400)
(200)
600
600
(800)
Year 4 Cash flow
800
0
Payback period is
4 years
2 years 4 months
Note:
200 X 12 mths
600
= 4 months
Project Y should be chosen since the payback period (2 years and 4 months) is less than
that of project X (4 years).
9.3.2
Accounting rate of return (ARR)
The accounting rate of return (ARR) measures profitability by relating the average investment
to the future annual net profit. In other words, ARR uses the average profit an investment will
generate and expresses it as a percentage of the average investment over the life of the
project.
The accounting rate of return of an investment is calculated as follows:
ARR =
Average annual profit
X 100
Average investment
1
The average investment in respect of a machine is calculated as follows:
Average investment =
Cost of machine + Disposal value or scrap value or residual value
2
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Using the ARR method, the project that is expected to realise a higher rate of return is chosen.
Example 6
Use the figures from example 4 to calculate the accounting rate of return.
Solution
Accounting rate of return:
Average annual profit X 100 =
Average investment
Machine X
Machine Y
R10 000 X 100
R13 000 X 100
1 R30 000
1 R30 000
= 33%
= 43%
1
Note: Since there is no disposal value, the average investment is R60 000 ÷ 2.
Using ARR, machine Y gives a higher rate of return and appears to be a better investment.
The advantage of the ARR method is that it is easy to calculate and it recognises profitability.
However, it does not take into account the time value of money. Also it uses accounting data
instead of cash flow data.
9.4 Capital Investment Appraisal Using Discounted Cash Flow Methods
Since the two methods described above do not take into account the time value of money, the following
methods are widely used to evaluate investment opportunities:
§
Net present value (NPV)
§
Internal rate of return (IRR)
9.4.1 Net present value (NPV)
The NPV method takes into account all the costs and benefits of each investment opportunity and also
makes provision for the timing of the costs and benefits. By applying the present value method (discussed
earlier), the present values of future cash flows are calculated using the enterprise’s minimum rate of
return. The net present value is the difference between the present value of the projected cash inflows
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and the present value of the cash outflows. If the NPV is positive, then the project is considered for
acceptance. If the NPV is negative, the project is rejected since it would not be profitable.
Example 7
Excel Ltd has a choice of purchasing one of two machines. The following details relate to
these machines:
Machine A
Machine B
Purchase price
R75 000
R80 000
Expected economic lifetime
6 years
6 years
12%
12%
1st year
R20 000
R22 000
2nd year
R22 000
R22 000
3rd year
R24 000
R22 000
4th year
R26 000
R22 000
5th year
R23 000
R22 000
6th year
R21 000
R22 000
Minimum required rate of return
Net annual cash inflows
Required
Use the net present value method to determine which machine Excel Ltd should purchase.
Solution
Machine A
Year
Cash inflow
Discount
Present
Factor
value
(see Table 1)
1
R20 000
0,8929
R17 858
2
R22 000
0.7972
R17 538
3
R24 000
0,7118
R17 083
4
R26 000
0,6355
R16 523
5
R23 000
0.5674
R13 050
6
R21 000
0,5066
R10 639
Total PV
R92 691
Investment
(R75 000)
NPV (positive)
R17 691
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Machine B
Net inflow
R22 000
Discount factor (see Table 2)
X 4,1114
Total Present value
R90 451
Investment
(R80 000)
NPV (positive)
R10 451
Decision: Machine A should be purchased since it has a higher net present value.
9.4.2
Internal rate of return (IRR)
This is the discount rate that will discount the cash flows to a net present value of zero. In
other words, the present value of cash flows minus the initial investment equals a zero NPV.
The IRR therefore indicates what a particular project is expected to earn. A project must only
be considered if the IRR exceeds the cost of capital. The advantage of the IRR method is that
it considers the time value of money and is therefore more realistic than the accounting rate
of return (ARR). However, the calculation can be difficult especially when the cash flows are
not even.
When the cash flows are not even, the trial-and-error method for calculating IRR may be
summarised as follows:
n
Calculate the NPV at the cost of capital rate (r1)
n
Check if the NPV is positive or negative.
n
If the NPV is positive, then pick another rate (r2) higher than the cost of capital rate. (If the
NPV is negative, pick a smaller rate.) The correct IRR at which NPV = 0 lies somewhere
between these two rates, with one rate indicating a positive NPV and the other rate indicating
a negative NPV.
n
Calculate the NPV using r2.
n
Use interpolation to calculate the exact rate.
Example 8
Use the information in example 7 and determine which machine should be purchased using the
internal rate of return.
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Solution
Machine A
Step 1
We notice that the NPV is positive, and is far away from zero.
Step 2
We now pick a higher rate e.g. 18%. (Trial-and-error is used to obtain the higher rate.)
Machine A
Year
Cash
Discount
Discount
Discount
Present
Present
Present
inflow
factor
factor
factor
value
value
value
18%
19%
20%
18%
19%
20%
1
R20 000
0,8475
0,8403
0,8333
16 950
16 806
R16 666
2
R22 000
0,7182
0,7062
0,6944
15 800
15 536
R15 277
3
R24 000
0,6086
0,5934
0,5787
14 606
14 242
R13 889
4
R26 000
0,5158
0,4987
0,4823
13 411
12 966
R12 540
5
R23 000
0,4371
0,4190
0,4019
10 053
9 637
R9 244
6
R21 000
0,3704
0,3521
0,3349
7 778
7 394
R7 033
Total PV
78 598
76 581
74 649
Investment
(75 000)
(75 000)
(75 000)
NPV
R3 598
R1 581
(R351)
Step 3
Interpolation:
The IRR is between 19% and 20%.
IRR
= 19 +
1581
1581 + 351
= 19 + 1 581
1 932
= 19,82%
Machine B
Step 1
We notice that the NPV is positive, and also far from zero.
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Step 2
We now pick a higher rate e.g. 16%. (Trial-and-error is used to obtain the higher rate.)
Machine B
Year
Cash
Discount
Discount
Present
Present
inflow
Factor
Factor
value
value
p.a.
16%
17%
16%
17%
R22 000
3,6847
3,5892
81 063
78 962
Investment
(80 000)
(80 000)
NPV
R1 063
(R1 038)
1-6
Step 3
Interpolation:
The IRR is between 16% and 17%.
IRR
= 16 +
1 063
1 063 + 1 038
= 16 + 1 063
2 101
= 16,51%
Decision: Machine A should be chosen since the IRR is greater.
9.5 Influence of Income Tax, Depreciation and Scrap Value
Income tax has an influence on capital investment decisions. A project that may be approved on a pretaxation basis may be rejected on an after-tax basis. Although depreciation is not a cash outflow, it is
deducted when calculating taxable income. Scrap value has an influence on the calculation of
depreciation.
The following example illustrates the effects of income tax, depreciation and scrap value on capital
investment decisions:
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Example 9
Milton Ltd is considering buying a machine and has presented the following information:
Machine A
Purchase price
R13 000
Expected economic lifetime
10 years
Minimum required rate of return
12%
Net annual cash inflows
R2 500
Rate of taxation
30%
Depreciation is calculated using the straight-line method
Required
Calculate the:
n Net present value (NPV)
n Internal rate of return (IRR)
n Net present value if the machine has a scrap value of R1 500 at the end of 10 years.
Solution
Calculation of net present value: Machine A
Calculation of tax
Cash inflow
Net annual cash inflow
R2 500
R2 500
Depreciation (R13 000 ÷ 10)
(R1 300)
Taxable income
R1 200
Income tax (30% of R1 200)
(R360)
(R360)
Income after tax
R840
______
Net annual cash inflow after tax
R2 140
The present value factor for 10 years at 12% p.a. is 5,6502
Present value of future cash flows after tax (R2 140 X 5,6502)
R12 091
Present value of investment
(R13 000)
Net present value (negative)
(R909)
Internal rate of return
The NPV is negative. We pick a lower rate e.g. 11%. (trial and error)
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We now calculate the NPV at 10%.
Machine A
Year
Cash
Discount
Discount
Present
Present
inflow
Factor
Factor
value
value
p.a.
11%
10%
11%
10%
R2 140
5,8892
6,1446
R12 603
R13 149
Investment
(13 000)
(13 000)
NPV
(R397)
R149
1-10
Interpolation: The IRR is between 10% and 11%.
IRR
= 10% +
149
149 + 397
= 10% + 149
546
= 10,27%
Net present value if the machine has a scrap value of R1 500 at the end of 10 years.
Calculation of tax
Cash inflow
Net annual cash inflow
R2 500
R2 500
Depreciation [(13 000 – R1 500) ÷ 10]
(R1 150)
Taxable income
R1 350
Income tax (30% of R1 350)
(R405)
(R405)
Income after tax
R945
______
Net annual cash inflow after tax
R2 095
The present value factor for 10 years at 12% p.a. is 5,6502.
Present value of future cash flows after tax (R2 095 X 5,6502)
Scrap value (R1 500 X 0,3220)
R11 837
R483
R12 320
159
Present value of investment
(13 000)
Net present value (negative)
(R680)
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9.6 Self-Assessment Activities and Solutions
An investment has the following cash flows:
Year
Cash flow
0
(R60 000)
1
R10 000
2
R12 000
3
R28 000
4
R20 000
5
R30 000
Required:
6.1.1
Calculate the following:
6.1.1.1 Payback period
6.1.1.2 Net present value (NPV) at 12% cost of capital
6.1.1.3 Accounting rate of return (ARR) (Assume that there is no depreciation)
6.1.2
Must the investment be considered positively or negatively? Give reasons for your answer.
6.2
The financial manager at Rico Ltd had to choose between these two projects, Alpha and Beta,
which have the following after-tax cash inflows:
Year
Alpha
Beta
1
0
R36 000
2
R18 500
R36 000
3
R36 200
R36 000
4
R123 000
R36 000
Both projects require an initial investment of R117 700.
Required:
Calculate the payback period for each project. Which project would you choose? Why?
6.2.1
Calculate the net present value (NPV) for each project, using a discount rate of 12%. Which
6.2.2
project would you choose? Why?
Calculate the Internal Rate of Return (IRR) for both projects. Which project should be chosen?
Why?
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6.3
Mica Ltd is considering buying a machine and has presented the following information:
Machine Y
Purchase price
R100 000
Expected economic lifetime
4 years
Minimum required rate of return
14%
Net annual cash inflows
R35 000
Rate of taxation
30%
Depreciation is calculated using the straight-line method
Required
Calculate the:
6.3.1
Net present value (NPV)
6.3.2
Internal rate of return (IRR)
6.3.3
Net present value if the machine has a scrap value of R10 000 at the end of 4 years.
Solutions
6.1.1.1 Investment
(R60 000)
Year 1 Cash flow
R10 000
(R50 000)
Year 2 Cash flow
R12 000
(R38 000)
Year 3 Cash flow
R28 000
(R10 000)
Year 4 Cash flow
Payback period is
R20 000
3 years 6 months
Note:
R10 000 X 12 mths
R20 000
= 6 months
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6.1.1.2
Year
Cash inflow
Discount
Present
Factor
value
(see Table 1)
1
R10 000
0,8929
R8 929
2
R12 000
0.7972
R9 566
3
R28 000
0,7118
R19 930
4
R20 000
0,6355
R12 710
5
R30 000
0.5674
R17 022
Total PV
R68 157
Investment
(R60 000)
NPV (positive)
R8 157
6.1.1.3 Accounting rate of return:
Machine X
Average annual profit X 100 =
Average investment
R20 000 X 100
1 R30 000
1
= 66,67%
Note:
Average annual profit =
R10 000 + R12 000 + R28 000 + R20 000 + R30 000
5 years
= R20 000 p.a.
Average investment R60 000 + 0
2
= R30 000
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6.1.2
The investment should be considered positively because:
-
The payback period is only 2 ½ years.
-
The net present value (R8 157) is positive.
-
The accounting rate of return (66,67%) is higher than the cost of capital (12%).
6.2.1
Investment
(R117 700
Year 1 Cash flow
0
(R117 700)
Year 2 Cash flow
R18 500
(R99 200)
Year 3 Cash flow
R36 200
(R63 000)
Year 4 Cash flow
R123 000
Payback period is 3 years 6 months 4 days
Note:
R63 000 X 12 mths
R123 000
= 6,146 months
0,146 X 30 days
= 4,38 days
Project Beta
Cost of project
Net cash inflow
=
R117 700
R36 000
3,27 years
=
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Note:
0,27 X 12 = 3,24 months
0,24 X 30 = 7,2 days
The payback period is 3 years 3 months 7-8 days
Project Beta should be chosen since the payback period (3 years 3 months 7-8 days) is less
than that of Project Alpha (3 years 6 months 4 days)
6.2.2
Project Alpha
Year
Cash inflow
Discount
Present
Factor
value
(see Table 1)
1
0
0,8929
0
2
R18 500
0.7972
R14 748
3
R36 200
0,7118
R25 767
4
R123 000
0,6355
R78 167
Total PV
R118 682
Investment
(R117 700)
NPV (positive)
R982
Project Beta
Net inflow
R36 000
Discount factor (see Table 2)
X 3,0373
Total Present value
R109 343
Investment
(R117 700)
NPV (negative)
(R8 357)
Project Alpha should be chosen since the NPV is positive.
The NPV for project Beta is negative and is therefore rejected.
MANCOSA
164
Management Accounting
6.2.3
Project Alpha
Step 1
We notice that the NPV is positive, and above zero, but not by a large margin.
Step 2
We now pick a higher rate e.g. 13%. (Trial-and-error is used to obtain the higher rate.)
Project Alpha
Year
Cash
Discount
Discount
Present
Present
inflow
Factor
Factor
value
value
12%
13%
12%
13%
1
0
0,8929
0,8850
0
0
2
R18 500
0.7972
0,7831
R14 748
R14 487
3
R36 200
0,7118
0,6931
R25 767
R25 090
4
R123 000
0,6355
0,6133
R78 167
R75 436
Total PV
R118 682
R115 013
Investment
(R117 700)
(R117 700)
R982
(R2 687)
NPV
Step 3
Interpolation:
The IRR is between 12% and 13%.
IRR
= 12 +
982
982 + 2 687
= 12 + 982
3 669
= 12,27%
165
MANCOSA
Management Accounting
Project Beta
Step 1
We notice that the NPV is negative.
Step 2
We now pick a lower rate e.g. 10%. (Trial-and-error is used to obtain the higher rate.)
Project Beta
Year
Cash
Discount
Discount
Discount
Present
Present
Present
inflow
Factor
Factor
Factor
value
value
value
p.a.
10%
9%
8%
10%
9%
8%
1-4
R36
3,1699
3,2397
3,3121
114 116
116 629
119 236
Investment
000
117 700
117 700
117 700
(R3 584)
(R1 071)
R1 536
NPV
Step 3
Interpolation:
The IRR is between 8% and 9%.
IRR
=8+
1 536
1 536 + 1 071
= 8 + 1 536
2 607
= 8,59%
Decision: Project Alpha should be chosen as the IRR is greater.
6.3.1
Calculation of net present value
Calculation of tax
Cash inflow
Net annual cash inflow
R35 000
R35 000
Depreciation (R100 000 ÷ 4)
(R25 000)
Taxable income
R10 000
Income tax (30% of R10 000)
(R3 000)
(R3 000)
Income after tax
R7 000
_______
Net annual cash inflow after tax
MANCOSA
R32 000
166
Management Accounting
The present value factor for 4 years at 14% p.a. is 2,9137.
Present value of future cash flows after tax (R32 000 X 2,9137)
6.3.2
R93 238
Present value of investment
(R100 000)
Net present value (negative)
(R6 762)
Internal rate of return
The NPV is negative and far from zero. We pick a lower rate e.g. 12%. (trial and error)
Machine B
Year
Cash Discount
Discount
Discount
Present
Present
Present
inflow
Factor
Factor
Factor
value
value
value
p.a.
12%
11%
10%
12%
11%
10%
1-4
R32
3,0373
3,1024
3,1699
97 194
99 277
101 437
Investment
000
100 000
100 000
100 000
(R2 806)
(R723)
R1 437
NPV
IRR
= 10 +
1 437
1 437 + 723
= 10 + 1 437
2 160
= 10,67%
6.3.3
Net present value if the machine has a scrap value of R10 000 at the end of 4 years.
Calculation of tax
Cash inflow
Net annual cash inflow
R35 000
R35 000
Depreciation [(100 000 – R10 000) ÷ 4]
(R22 500)
Taxable income
R12 500
Income tax (30% of R12 500)
(R3 750)
(R3 750)
Income after tax
R8 750
_______
Net annual cash inflow after tax
R31 250
The present value factor for 4 years at 14% p.a. is 2,9137.
167
MANCOSA
Management Accounting
Present value of future cash flows after tax (R31 250 X 2,9137)
R91 053
Scrap value (R10 000 X 0,5921)
R5 921
R96 974
Present value of investment
(R100 000)
Net present value (negative)
(R3 026)
MANCOSA
168
Management Accounting
Table 1: Present value interest factor of R1 per period at i% for n periods, PVIFA(i,n).
Number
of
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
25%
1
0.9901
0.9804
0.9709
0.9615
0.9524
0.9434
0.9346
0.9259
0.9174
0.9091
0.9009
0.8929
0.8850
0.8772
0.8696
0.8621
0.8547
0.8475
0.8403
0.8333
0.8000
2
0.9803
0.9612
0.9426
0.9246
0.9070
0.8900
0.8734
0.8573
0.8417
0.8264
0.8116
0.7972
0.7831
0.7695
0.7561
0.7432
0.7305
0.7182
0.7062
0.6944
0.6400
3
0.9706
0.9423
0.9151
0.8890
0.8638
0.8396
0.8163
0.7938
0.7722
0.7513
0.7312
0.7118
0.6931
0.6750
0.6575
0.6407
0.6244
0.6086
0.5934
0.5787
0.5120
4
0.9610
0.9238
0.8885
0.8548
0.8227
0.7921
0.7629
0.7350
0.7084
0.6830
0.6587
0.6355
0.6133
0.5921
0.5718
0.5523
0.5337
0.5158
0.4987
0.4823
0.4096
5
0.9515
0.9057
0.8626
0.8219
0.7835
0.7473
0.7130
0.6806
0.6499
0.6209
0.5935
0.5674
0.5428
0.5194
0.4972
0.4761
0.4561
0.4371
0.4190
0.4019
0.3277
6
0.9420
0.8880
0.8375
0.7903
0.7462
0.7050
0.6663
0.6302
0.5963
0.5645
0.5346
0.5066
0.4803
0.4556
0.4323
0.4104
0.3898
0.3704
0.3521
0.3349
0.2621
7
0.9327
0.8706
0.8131
0.7599
0.7107
0.6651
0.6227
0.5835
0.5470
0.5132
0.4817
0.4523
0.4251
0.3996
0.3759
0.3538
0.3332
0.3139
0.2959
0.2791
0.2097
8
0.9235
0.8535
0.7894
0.7307
0.6768
0.6274
0.5820
0.5403
0.5019
0.4665
0.4339
0.4039
0.3762
0.3506
0.3269
0.3050
0.2848
0.2660
0.2487
0.2326
0.1678
9
0.9143
0.8368
0.7664
0.7026
0.6446
0.5919
0.5439
0.5002
0.4604
0.4241
0.3909
0.3606
0.3329
0.3075
0.2843
0.2630
0.2434
0.2255
0.2090
0.1938
0.1342
10
0.9053
0.8203
0.7441
0.6756
0.6139
0.5584
0.5083
0.4632
0.4224
0.3855
0.3522
0.3220
0.2946
0.2697
0.2472
0.2267
0.2080
0.1911
0.1756
0.1615
0.1074
11
0.8963
0.8043
0.7224
0.6496
0.5847
0.5268
0.4751
0.4289
0.3875
0.3505
0.3173
0.2875
0.2607
0.2366
0.2149
0.1954
0.1778
0.1619
0.1476
0.1346
0.0859
12
0.8874
0.7885
0.7014
0.6246
0.5568
0.4970
0.4440
0.3971
0.3555
0.3186
0.2858
0.2567
0.2307
0.2076
0.1869
0.1685
0.1520
0.1372
0.1240
0.1122
0.0687
13
0.8787
0.7730
0.6810
0.6006
0.5303
0.4688
0.4150
0.3677
0.3262
0.2897
0.2575
0.2292
0.2042
0.1821
0.1625
0.1452
0.1299
0.1163
0.1042
0.0935
0.0550
14
0.8700
0.7579
0.6611
0.5775
0.5051
0.4423
0.3878
0.3405
0.2992
0.2633
0.2320
0.2046
0.1807
0.1597
0.1413
0.1252
0.1110
0.0985
0.0876
0.0779
0.0440
15
0.8613
0.7430
0.6419
0.5553
0.4810
0.4173
0.3624
0.3152
0.2745
0.2394
0.2090
0.1827
0.1599
0.1401
0.1229
0.1079
0.0949
0.0835
0.0736
0.0649
0.0352
16
0.8528
0.7284
0.6232
0.5339
0.4581
0.3936
0.3387
0.2919
0.2519
0.2176
0.1883
0.1631
0.1415
0.1229
0.1069
0.0930
0.0811
0.0708
0.0618
0.0541
0.0281
17
0.8444
0.7142
0.6050
0.5134
0.4363
0.3714
0.3166
0.2703
0.2311
0.1978
0.1696
0.1456
0.1252
0.1078
0.0929
0.0802
0.0693
0.0600
0.0520
0.0451
0.0225
Periods
MANCOSA
169
Management Accounting
18
0.8360
0.7002
0.5874
0.4936
0.4155
0.3503
0.2959
0.2502
0.2120
0.1799
0.1528
0.1300
0.1108
0.0946
0.0808
0.0691
0.0592
0.0508
0.0437
0.0376
0.0180
19
0.8277
0.6864
0.5703
0.4746
0.3957
0.3305
0.2765
0.2317
0.1945
0.1635
0.1377
0.1161
0.0981
0.0829
0.0703
0.0596
0.0506
0.0431
0.0367
0.0313
0.0144
20
0.8195
0.6730
0.5537
0.4564
0.3769
0.3118
0.2584
0.2145
0.1784
0.1486
0.1240
0.1037
0.0868
0.0728
0.0611
0.0514
0.0433
0.0365
0.0308
0.0261
0.0115
25
0.7798
0.6095
0.4776
0.3751
0.2953
0.2330
0.1842
0.1460
0.1160
0.0923
0.0736
0.0588
0.0471
0.0378
0.0304
0.0245
0.0197
0.0160
0.0129
0.0105
0.0038
30
0.7419
0.5521
0.4120
0.3083
0.2314
0.1741
0.1314
0.0994
0.0754
0.0573
0.0437
0.0334
0.0256
0.0196
0.0151
0.0116
0.0090
0.0070
0.0054
0.0042
0.0012
40
0.6717
0.4529
0.3066
0.2083
0.1420
0.0972
0.0668
0.0460
0.0318
0.0221
0.0154
0.0107
0.0075
0.0053
0.0037
0.0026
0.0019
0.0013
0.0010
0.0007
0.0001
50
0.6080
0.3715
0.2281
0.1407
0.0872
0.0543
0.0339
0.0213
0.0134
0.0085
0.0054
0.0035
0.0022
0.0014
0.0009
0.0006
0.0004
0.0003
0.0002
0.0001
*
60
0.5504
0.3048
0.1697
0.0951
0.0535
0.0303
0.0173
0.0099
0.0057
0.0033
0.0019
0.0011
0.0007
0.0004
0.0002
0.0001
0.0001
*
*
*
*
•
The factor is zero to four decimal places
MANCOSA
170
Management Accounting
Table 2: Present value interest factor of an (ordinary) annuity of R1 per period at i% for n periods, PVIFA(i,n).
Number
of
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
1
0.9901
0.9804
0.9709
0.9615
0.9524
0.9434
0.9346
0.9259
0.9174
0.9091
0.9009
0.8929
0.8850
0.8772
0.8696
0.8621
0.8547
0.8475
0.8403
0.8333
2
1.9704
1.9416
1.9135
1.8861
1.8594
1.8334
1.8080
1.7833
1.7591
1.7355
1.7125
1.6901
1.6681
1.6467
1.6257
1.6052
1.5852
1.5656
1.5465
1.5278
3
2.9410
2.8839
2.8286
2.7751
2.7232
2.6730
2.6243
2.5771
2.5313
2.4869
2.4437
2.4018
2.3612
2.3216
2.2832
2.2459
2.2096
2.1743
2.1399
2.1065
4
3.9020
3.8077
3.7171
3.6299
3.5460
3.4651
3.3872
3.3121
3.2397
3.1699
3.1024
3.0373
2.9745
2.9137
2.8550
2.7982
2.7432
2.6901
2.6386
2.5887
5
4.8534
4.7135
4.5797
4.4518
4.3295
4.2124
4.1002
3.9927
3.8897
3.7908
3.6959
3.6048
3.5172
3.4331
3.3522
3.2743
3.1993
3.1272
3.0576
2.9906
6
5.7955
5.6014
5.4172
5.2421
5.0757
4.9173
4.7665
4.6229
4.4859
4.3553
4.2305
4.1114
3.9975
3.8887
3.7845
3.6847
3.5892
3.4976
3.4098
3.3255
7
6.7282
6.4720
6.2303
6.0021
5.7864
5.5824
5.3893
5.2064
5.0330
4.8684
4.7122
4.5638
4.4226
4.2883
4.1604
4.0386
3.9224
3.8115
3.7057
3.6046
8
7.6517
7.3255
7.0197
6.7327
6.4632
6.2098
5.9713
5.7466
5.5348
5.3349
5.1461
4.9676
4.7988
4.6389
4.4873
4.3436
4.2072
4.0776
3.9544
3.8372
9
8.5660
8.1622
7.7861
7.4353
7.1078
6.8017
6.5152
6.2469
5.9952
5.7590
5.5370
5.3282
5.1317
4.9464
4.7716
4.6065
4.4506
4.3038
4.1633
4.0310
10
9.4713
8.9826
8.5302
8.1109
7.7217
7.3601
7.0236
6.7101
6.4177
6.1446
5.8892
5.6502
5.4262
5.2161
5.0188
4.8332
4.6586
4.4941
4.3389
4.1925
11
10.3676
9.7868
9.2526
8.7605
8.3064
7.8869
7.4987
7.1390
6.8052
6.4951
6.2065
5.9377
5.6869
5.4527
5.2337
5.0286
4.8364
4.6560
4.4865
4.3271
12
11.2551
10.5753
9.9540
9.3851
8.8633
8.3838
7.9427
7.5361
7.1607
6.8137
6.4924
6.1944
5.9176
5.6603
5.4206
5.1971
4.9884
4.7932
4.6105
4.4392
13
12.1337
11.3484
10.6350
9.9856
9.3936
8.8527
8.3577
7.9038
7.4869
7.1034
6.7499
6.4235
6.1218
5.8424
5.5831
5.3423
5.1183
4.9095
4.7147
4.5327
14
13.0037
12.1062
11.2961
10.5631
9.8986
9.2950
8.7455
8.2442
7.7862
7.3667
6.9819
6.6282
6.3025
6.0021
5.7245
5.4675
5.2293
5.0081
4.8023
4.6106
15
13.8651
12.8493
11.9379
11.1184
10.3797
9.7122
9.1079
8.5595
8.0607
7.6061
7.1909
6.8109
6.4624
6.1422
5.8474
5.5755
5.3242
5.0916
4.8759
4.6755
16
14.7179
13.5777
12.5611
11.6523
10.8378
10.1059
9.4466
8.8514
8.3126
7.8237
7.3792
6.9740
6.6039
6.2651
5.9542
5.6685
5.4053
5.1624
4.9377
4.7296
17
15.5623
14.2919
13.1661
12.1657
11.2741
10.4773
9.7632
9.1216
8.5436
8.0216
7.5488
7.1196
6.7291
6.3729
6.0472
5.7487
5.4746
5.2223
4.9897
4.7746
Periods
MANCOSA
171
Management Accounting
18
16.3983
14.9920
13.7535
12.6593
11.6896
10.8276
10.0591
9.3719
8.7556
8.2014
7.7016
7.2497
6.8399
6.4674
6.1280
5.8178
5.5339
5.2732
5.0333
4.8122
19
17.2260
15.6785
14.3238
13.1339
12.0853
11.1581
10.3356
9.6036
8.9501
8.3649
7.8393
7.3658
6.9380
6.5504
6.1982
5.8775
5.5845
5.3162
5.0700
4.8435
20
18.0456
16.3514
14.8775
13.5903
12.4622
11.4699
10.5940
9.8181
9.1285
8.5136
7.9633
7.4694
7.0248
6.6231
6.2593
5.9288
5.6278
5.3527
5.1009
4.8696
25
22.0232
19.5235
17.4131
15.6221
14.0939
12.7834
11.6536
10.6748
9.8226
9.0770
8.4217
7.8431
7.3300
6.8729
6.4641
6.0971
5.7662
5.4669
5.1951
4.9476
30
25.8077
22.3965
19.6004
17.2920
15.3725
13.7648
12.4090
11.2578
10.2737
9.4269
8.6938
8.0552
7.4957
7.0027
6.5660
6.1772
5.8294
5.5168
5.2347
4.9789
40
32.8347
27.3555
23.1148
19.7928
17.1591
15.0463
13.3317
11.9246
10.7574
9.7791
8.9511
8.2438
7.6344
7.1050
6.6418
6.2335
5.8713
5.5482
5.2582
4.9966
50
39.1961
31.4236
25.7298
21.4822
18.2559
15.7619
13.8007
12.2335
10.9617
9.9148
9.0417
8.3045
7.6752
7.1327
6.6605
6.2463
5.8801
5.5541
5.2623
4.9995
60
44.9550
34.7609
27.6756
22.6235
18.9293
16.1614
14.0392
12.3766
11.0480
9.9672
9.0736
8.3240
7.6873
7.1401
6.6651
6.2402
5.8819
5.5553
5.2630
4.9999
MANCOSA
172
Management Accounting
Bibliography
•
Fundamentals of Cost and Management Accounting Sixth edition, 2012. Els. G, Meyer, L., van der
Walt. R, de Wet. S.R
•
The Essence of Management Accounting First edition, 2003. Chadwick, L
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