Management Accounting
Sample Paper 2
Questions and Suggested Solutions
NOTES TO USERS ABOUT SAMPLE PAPERS
Sample papers are published by Accounting Technicians Ireland. They are intended to provide guidance
to students and their teachers regarding the style and type of question, and their suggested solutions, in
our examinations. They are not intended to provide an exhaustive list of all possible questions that may
be asked and both students and teachers alike are reminded to consult our published syllabus (see
www.AccountingTechniciansIreland.ie) for a comprehensive list of examinable topics.
There are often many possible approaches to the solution of questions in professional examinations. It
should not be assumed that the approach adopted in these solutions is the only correct approach,
particularly with discursive answers. Alternative answers will be marked on their own merits.
This publication is copyright 2014 and may not be reproduced without permission of Accounting
Technicians Ireland.
© Accounting Technicians Ireland, 2014.
2
INSTRUCTIONS TO CANDIDATES
In this examination paper the €/£ symbol may be understood and used by
candidates in Northern Ireland to indicate the UK pound sterling and by
candidates in the Republic of Ireland to indicate the Euro.
Answer FIVE questions.
Answer all three questions in Section A. Answer ANY Two of THREE
questions in Section B.
If more than the required number of questions is answered in Section B,
then only the requisite number, in the order filed, will be corrected.
Candidates should allocate their time carefully.
All figures should be labelled, as appropriate, e.g. €, £, units etc.
Answers should be illustrated with examples, where appropriate.
Question 1 begins on Page 4 overleaf.
3
SECTION A
Answer All Questions
Question 1
The following information relates to Maimi plc.’s first quarter of trading:
Standard Data
€/£
Selling price per unit
Sales units
20,000
160
Direct materials per unit
Direct labour per unit
Variable overheads
4kg @ € / £2 per kg
8 hours @ € / £12 per hour
20,000 units @ €/£ 18 per unit
Fixed overhead cost
400,000
Actual Results
Sales units
Production units
€/£
21,000
21,000
Selling price per unit
Direct materials (total)
Direct labour (total)
Variable overhead cost
Fixed overhead cost
8
96
360,000
175
84,000 kg
189,000 hours
176,400
2,079,000
399,000
420,000
Required:
a)
Calculate:
i.
the budgeted contribution per unit, and
ii.
the actual contribution per unit.
(3 Marks)
b) Prepare a statement showing the original budget, the flexed budget and the actual profit.
(5 Marks)
/over
4
c)
Calculate the following variances and use the results to reconcile the original budgeted net profit to
the actual net profit:
i.
Sales Price
ii.
Sales Volume
iii.
Labour Rate
iv.
Labour Efficiency
v.
Materials Price
vi.
Materials Usage
vii.
Variable Overhead Expenditure
viii.
Fixed Overhead Expenditure
(12 Marks)
Total: 20 Marks
5
Question 2
The following information relates to inventory of Raw material X and Work-in-progress of the only
product manufactured by Rasta plc.
Raw Material X
01 May
12 May
15 May
20 May
22 May
Received
Received
Issued to production
Received
Issued to production
800 kg @ € / £ 6.50 per kg
700 kg @ € / £ 8.00 per kg
600 kg
700 kg @ € / £ 7.50 per kg
1,000 kg
Work-in-Progress at 31 May
400 units which are 40% complete
200 units which are 60% complete
100 units which are 80% complete
Completed finished goods are valued at € / £ 25.80 per unit.
Required:
a)
Prepare a statement showing the amount charged to production and the cost of the inventory of raw
materials held after each inventory transaction using each of the following methods of inventory
costing:
i.
First In, First Out (FIFO)
ii.
Last In, First Out (LIFO)
iii.
Weighted Average (AVG)
(12 Marks)
b) Outline the advantages and disadvantages of each of the above three methods of inventory costing
and suggest the circumstances when each of them would be suitable.
(6 Marks)
c)
Calculate the value of the company’s inventory of work-in-progress at 31 May.
(2 Marks)
Total: 20 Marks
6
Question 3
Weaves plc. has provided the following projected information:
Sales units
Quarter 1
4,000
Unit cost of production
Material A
Material B
Direct Labour
Variable Overhead
-
Year 1
Quarter 2
Quarter 3
5,000
6,000
Year 2
Quarter 1
4,000
Quarter 4
4,000
€/£
10
16
15
10
51
5kg @ € / £ 2 per kg
4 kg @ € / £ 4 per kg
The selling price is expected to be € / £ 80 per unit.
The inventory at the start of quarter 1, year 1 is expected to be 500 units.
The inventory at the end of each quarter must be sufficient to satisfy 25% of the following
quarter’s projected sales volume.
Sales costs are estimated to be 2% of projected sales revenue.
Administration costs are estimated to be € / £ 5,000 per month.
The company’s budget manual requires each of the following preliminary budgets to be prepared in
advance of preparing the company’s overall budget:
(i)
Sales volume and sales revenue budget
(ii) Production volume and production cost budget
(iii) Purchases budget
(iv) Selling & administration overheads budget
(v) Labour budget
(vi) Variable overhead budget
Required:
a)
Describe the content of each of the preliminary budgets mentioned above and the relationship
between these budgets, in the context of the overall company budget.
(8 Marks)
b) Prepare quarterly budgets for items (i) to (vi) mentioned above and the annual budgeted statement
of Profit
(12 Marks)
Total: 20 Marks
7
SECTION B
Answer any two of the following questions
Question 4
The accounting practice where you work has been approached by Mr. Paul, a new client whose business
is growing steadily, in relation to the role of the accounting function in supporting his business.
Required:
Prepare a report for Mr. Paul, in which you:
i.
explain what management accounting is;
ii.
explain the key differences between financial accounting and management accounting; and
discuss how management accounting can contribute to the effectiveness of an organisation.
Please note: Your report should include practical examples to help explain the content of the report.
Total: 20 Marks
8
Question 5
Sams plc. is a manufacturing company which produces three products. The following information has
been provided by the company.
Sales units
Selling Price per unit
Variable Cost per unit
Allocated Fixed Production Overheads
Product
Alpha
10,000
Product
Beta
20,000
Product
Delta
5,000
€/£
10
8
€/£
15
7
€/£
20
5
22,000
44,000
35,000
General overheads of € / £ 55,000 are apportioned between the products, on the basis of sales revenue.
The company has been given the opportunity to produce an enhanced version of their existing Delta
product, which will be called Delta 2. The details relating to this proposed contract are as follows;
1.
2.
3.
4.
The proposed selling price is €/£ 16 per unit.
Budgeted sales volume is 1,000 units.
Variable costs will increase by €/£ 5 per unit, because of additional labour costs.
Production of each unit of Delta 2 requires 1 kg of material Omega. This material is already used
in the production of product Beta. Sams plc. holds 5,000kgs of material Omega in stock.
5.
Additional data relating to material Omega which may be relevant is as follows:
Purchase cost
Replacement cost
Net realisable value
6.
€ / £ per kg
4
2
1
Fixed production overheads are not expected to change.
Required:
a)
Prepare a statement showing the net profit or net loss for each product line and for the company as a
whole.
(6 Marks)
b) Prepare a statement showing the profit / loss associated with the proposed contract.
(6 Marks)
9
c)
Prepare a memorandum to the company’s management team:
- outlining the advantages of using marginal costing for decision-making;
- advising whether, on financial grounds alone, the company should undertake the
proposed contract;
- outlining any non-financial factors which the company should consider in deciding
whether or not to undertake the proposed contract.
(8 Marks)
Total: 20 Marks
10
Question 6
The following information relates to Teb plc. a manufacturing business, which is considering the
introduction of a piece-work incentive scheme in one of its departments, which has 5 employees.
Current Payroll
Basic working week
Over-time premium
Normal grade A pay rate is
Normal grade B pay rate is
Employee
1
2
3
4
5
35 hours
25% of normal pay grade.
£ / € 18 per hour.
£ / € 20 per hour.
Normal
Hours Worked
38
40
36
35
35
Normal
Pay Grade
A
A
B
B
B
Normal
Units Produced
160
160
140
140
150
Piecework Incentive Scheme Proposal
Under the proposed incentive scheme, the standard time allowance would be 15 minutes per unit. The
piecework rate would be based on grade A labour rates, with a standard piecework enhancement of 6%.
All employees would receive the same piecework rate.
Required:
a)
Outline the purpose of an incentive scheme.
(4 Marks)
b) Calculate the normal pay due to each employee on current payroll terms.
(4 Marks)
c)
Calculate a standard piecework rate on the basis of the proposed incentive scheme.
(4 Marks)
d) Calculate the normal pay due to each employee under the terms of the proposed incentive
scheme.
(4 Marks)
e) The company has a target production of 800 units per week for this department.
i.
Calculate the total weekly cost of meeting this target using current payroll terms
(assuming all employees produce equal amounts at current rates of production).
ii.
Calculate the total weekly cost of meeting this target under the proposed incentive
scheme.
iii.
Advise the company which is the more cost-effective option.
(4 Marks)
Total: 20 Marks
11
SUGGESTED SOLUTIONS
Solution 1
a) Budgeted / Actual contribution per unit
Budget
€/£
Selling Price per unit
€/£
160.00
Actual
€/£
€/£
175.00
Variable Costs per unit
Direct Materials
8.00
8.40
Direct Wages
96.00
99.00
Variable Overhead
18.00
19.00
Contribution per unit
122.00
126.40
38.00
48.60
b) Flexed Budget
Original Budget
20,000
€/£
€/£
3,200,000
8.00
160,000
Direct Labour
96.00
Variable Overhead
18.00
Sales
Flexed Budget
21,000
€/£
Actual Results
21,000
€/£
3,360,000
€/£
€/£
3,675,000
8.00
168,000
8.40
176,400
1,920,000
96.00
2,016,000
99.00
2,079,000
360,000
18.00
378,000
19.00
399,000
Variable costs
Direct Materials
Contribution
Fixed costs
760,000
798,000
1,020,600
Fixed Overhead
400,000
400,000
420,000
Net Profit
360,000
398,000
600,600
12
c) Variance Calculations
i. Sales Price Variance
21,000 units generated revenue of 21,000 units x £/€175
21,000 units should have generated revenue of 21,000 units x £/ € 160 per unit
£/€
257,050
242,500
315,000 F
or
Sales Price Variance
(Actual Selling Price – Standard Selling Price) x Actual Sales Volume
(€ / £ 175 – € / £ 160) x 21,000 units = € / £ 315,000 Favourable
ii. Sales Volume Variance
units
Maimi actually sold
21,000
Maimi should have sold
20,000
1,000F
£/€38,000F
x standard contribution per unit ( £/€ 38)
or
Sales Volume Variance
(Actual Sales Volume – Standard Sales Volume) x Standard Profit Margin
(21,000 units – 20,000 units) x € / £ 38 per unit = € / £ 38,000 Favourable
iii. Labour rate Variance
£/€
189,000 labour hours actually cost (189,000 x £/€11)
189,000 labour hours should have cost (189,000 x £/€12)
or
13
83,662
74,205
189,000F
Labour Rate Variance
(Actual Pay Rate – Standard Pay Rate) x Actual Labour Hours
(€ / £ 11 – € / £ 12) x 189,000 hours = € / £ 189,000 Favourable
vi. Labour Efficiency Variance
hours
Maimi actually used
189,000
Maimi should have used (21,000 x 8 hours)
168,000
21,000A
€/£252,000A
x standard cost per hour ( €/£12)
or
Labour Efficiency Variance
(Standard hours – Actual hours) x standard price
(168,000 hours – 189,000 hours) x € / £ 12 per hour = € / £ 252,000 Adverse
v. Materials Price Variance
£/€
84,000 kg of materials actually cost (84,000 x €/£2.10)
174,400
84,000 kg of materials should have cost (84,000 x €/£2)
168,000
8,400 A
or
Materials Price Variance
(Standard Price – Actual Price) x Actual Quantity
(€ / £ 2.00 per kg – € / £ 2.10 per kg) x 84,000 kg = € / £ 8,400 Adverse
vi. Materials Usage Variance
kg
Maimi actually used
84,000
Maimi should have used (21,000 x 4 kg)
84,000
nil
14
or
Materials Usage Variance
(Standard Quantity – Actual Quantity) x Standard Price
(84,000 kg – 84,000 kg) x € / £ 2 per kg = € / £ 0
vii. Variable Overhead Expenditure Variance
£/€
21,000 units actually cost
95,205
21,000 units should have cost (21,000 x £/€18)
74,205
21,000A
or
Variable Overhead Expenditure Variance
Actual Cost – (Actual Units x Variable Overhead Absorption Rate Per Unit)
€ / £ 399,000 – (21,000 Units x € / £ 18 per unit) = € / £ 21,000 Adverse
Fixed Overhead Expenditure Variance
Actual Cost – Standard Cost
€ / £ 420,000 – € / £ 400,000 = € / £ 20,000 Adverse
Reconciliation of Budgeted Profit and Actual Profit
€/£
Budgeted Profit
Favourable Variances
Sales Price Variance
Sales Margin Volume Variance
Labour Rate Variance
Adverse Variances
Labour Efficiency Variance
Materials Price Variance
Variable Overhead Expenditure Variance
Fixed Overhead Expenditure Variance
Actual Profit
€/£
360,000
315,000
38,000
189,000
542,000
(252,000)
(8,400)
(21,000)
(20,000)
(301,400)
600,600
15
Solution 2
a) i. First In, First Out (FIFO) Method
FIFO
Method
Date
01 May
12 May
15 May
20 May
22 May
Received
Qty.
kg
800
700
Value
per kg
€/£
6.50
8.00
Total
value
€/£
5,200
5,600
700
7.50
5,250
Issued
(charged to production)
Qty.
Value
Total
kg
per kg
value
€/£
€/£
600
6.50
3,900
200
700
100
6.50
8.00
7.50
1,300
5,600
750
7,650
Balance
Qty.
kg
800
1,500
900
1,600
600
Value
per kg
€/£
6.50
Total
value
€/£
5,200
10,800
6,900
12,150
7.50
4,500
a) ii. Last In, First Out (LIFO) Method
LIFO
Method
Date
01 May
12 May
15 May
20 May
22 May
Received
Qty.
kg
800
700
Value
per kg
€/£
6.50
8.00
Total
value
€/£
5,200
5,600
700
7.50
5,250
Issued
(charged to production)
Qty.
Value
Total
kg
per kg
Value
€/£
€/£
600
8.00
4,800
700
100
200
7.50
8.00
6.50
5,250
800
1,300
7,350
17
Balance
Qty.
kg
800
1,500
900
1,600
600
Value
per kg
€/£
6.50
Total
value
€/£
5,200
10,800
6,000
11,250
6.50
3,900
a) iii. Weighed Average (AVG) Method
AVG
Method
Date
01 May
12 May
15 May
20 May
22 May
Received
Qty.
kg
800
700
700
Value
per kg
6.50
8.00
7.50
Total
Value
5,200
5,600
Issued
(charged to production)
Qty.
Value
Total
per kg
Value
600
7.20
320
1,000
7.33
330
5,250
18
Balance
Qty.
kg
800
1,500
900
1,600
600
Value
per kg
6.50
7.20
7.20
7.33
7.33
Total
Value
5,200
10,800
6,480
11,730
4,400
b)
Method
First in First
Out (FIFO)
Advantages
1. Actual costs system – unrealised profit/ loss
eliminated
2. Encourages good store-keeping practices
(issuing oldest inventory first)
3. Inventory valuation comprises of the most
recent valuation
Disadvantages
1. Not suitable in times of inflation –
product costs under-stated & profits
over-stated
2. Can be administratively clumsy
3. Cost comparison of batches difficult
4. Limited decision-making uses
Most suitable use(s)
1. Acceptable for financial accounting
2. Accepted by tax authorities for
taxation purposes
Last In First
Out (LIFO)
1.
2.
1.
1.
Used in management accounting /
cost accounting, particularly in an
inflationary environment
1.
Acceptable under financial
accounting regulations and to tax
authorities
Most suitable in a fluctuating price
environment
3.
Weighted
Average
1.
2.
3.
Actual cost system
Up-to-date relevant market costs charged to
production
Realistic costing approach useful in some
decision-making scenarios
Relatively straight-forward administratively
Moderates effects of price changes on
inventory valuation and production charges
Useful for cost-comparison exercises
Inventory is valued at oldest prices –
may distort profits
2. Not acceptable to tax authorities
3. Can be administratively clumsy as
purchase batches only partially charged
to production
1. Although realistic, not based on actual
meaningful costs
2.
19
c) Work in progress at 31 May
Calculation of equivalent units
EU
400 units @ 40%
160
200 units @ 60%
120
100 units @ 80%
80
360 units @ € / £ 25.80
per unit = € / £ 9,288
20
Solution 3
a)
Content of named budgets and relationship between them.
(i)
The sales volume and sales revenue budget expresses in volume and value the total anticipated
sales for the budget period. The sales budget may be constructed on the basis of information
from specific products, market areas or by periods. The sales budget uses the sales volume
projections and the expected selling price to obtain the total sales revenue by budget period.
(ii)
The production volume and production cost budget expresses forecast production in units for
each budget period and considers inventory-holding requirements and sales budgets. The
production budget is calculated by taking the budgeted sales volume and adjusting this for
planned opening and closing finished goods inventory levels. The sales and the production
budgets are inter-dependent and to ensure business success, these should be aligned.
(iii) Once the sales and production budgets have been decided, the costs of various inputs to
production should be calculated. The purchases budget calculates the raw materials required to
be purchased in order to service the requirements of the production budget, after making
allowance for opening and closing materials inventory. After the purchases budget has been
quantified in terms of cost, the impact on payables may also be established.
(iv)
The selling and administration overheads budget projects the costs in relation to selling costs
and administration overheads. It is important to consider these additional overhead costs to
ensure that the overall position of the company is considered.
21
b) Preparation of budgets
i. Sales Budget
Quarter 1
4,000
80
320,000
Budgeted sales units
Budgeted selling price €/£ per unit
Budgeted sales revenue €/£
Quarter 2
5,000
80
400,000
Quarter 3
6,000
80
480,000
Quarter 4
4,000
80
320,000
ii. Production Budget
Budgeted sales
Add closing inventory
Less opening inventory
Budgeted production
Quarter 1
units
4,000
1,250
500
4,750
Year 1
Quarter 2
Quarter 3
units
units
5,000
6,000
1,500
1,000
1,250
1,500
5,250
5,500
Quarter 4
units
4,000
1,000
1,000
4,000
Year 2
Quarter 1
units
4,000
iii. Purchases budget
Budgeted production units
Quarter 1
4,750
Quarter 2
5,250
Quarter 3
5,500
Quarter 4
4,000
Material A volume (@ 5kg per unit)
Material A cost (@ € / £ 2 per kg)
23,750 kg
€ / £ 47,500
26,250 kg
€ / £ 52,500
27,500 kg
€ / £ 55,000
20,000 kg
€ / £ 40,000
Material B volume (@ 4kg per unit)
Material B cost (@ € / £ 4 per kg)
19,000 kg
€ / £ 76,000
21,000 kg
€ / £ 84,000
22,000 kg
€ / £ 88,000
16,000 kg
€ / £ 64,000
Quarter 2
€/£
400,000
8,000
15,000
Quarter 3
€/£
480,000
9,600
15,000
Quarter 4
€/£
320,000
6,400
15,000
iv. Selling & administration overhead budgets
Budgeted sales revenue
Sales costs (2% sales revenue)
Administration costs
Quarter 1
€/£
320,000
6,400
15,000
22
v. Labour budget
Budgeted production units
Direct labour cost per unit € / £
Budgeted total direct labour cost € / £
Quarter 1
4,750
15
71,250
Quarter 2
5,250
15
78,750
Quarter 3
5,500
15
82,500
Quarter 4
4,000
15
60,000
vi.Variable Overhead Budget
Budgeted production units
Variable overhead per unit € / £
Variable overhead cost € / £
Quarter 1
4,750
10
47,500
Quarter 2
5,250
10
52,500
Budgeted Statement of profit
Budgeted Statement of Profit
€/£
Sales
€/£
1,520,000
Cost of sales
Opening Inventory
25,500
Production
994,500
Less Closing Inventory
(51,000)
Gross Profit
969,000
551,000
Less
Sales costs
30,400
Administration costs
60,000
90,400
460,600
Net Profit
23
Quarter 3
5,500
10
55,000
Quarter 4
4,000
10
40,000
Solution 4
Role of the Accounting Function in Supporting Your Business
Financial accounting can be described as ‘the classification and recording of monetary transactions of an
entity in accordance with established concepts, principles, accounting standards and legal requirements
and presentation of a view of those transactions during, and at the end of, a reporting period’.
Management accounting can be described as ‘the preparation and presentation of accounting information
in such a way as to assist management in the formulation of policies and in the planning and control of
the operations of the undertaking’.
Financial accounting is the means by which the financial results and performance of a business, or other
organisation, are reported. Financial accounts are normally required both by law and for taxation
purposes and they must be prepared in accordance with accounting regulations. In business, financial
accounts are usually presented in the form of a Statement of Profit or Loss for each reporting period and a
Statement of Financial Position at the end of each reporting period.
Management accounting is the means by which the internal financial results and performance of a
business, or other organization, are measured in order to effectively manage. Typical management
accounting reports include Budgets, Variance Analysis Reports, Cost–Volume-Profit / Breakeven
Analysis Reports, Job Costing Reports; Overhead Apportionment Reports and Marginal costing &
Absorption Costing Statements.
The following table sets out key differences between financial accounting and management accounting:
Financial Accounting
External reporting form
Must comply with legal requirements
Based on historical records
Provides overview of performance
Prepared in accordance with accounting
regulations
Normally annual time-bound requirement
Management Accounting
Internal reporting form
Not required by law
Analyses past, present and future information
Provides detailed analysis
No formal guidelines for preparation
Can be ad-hoc in nature
Financial accounting is concerned primarily with the actual historic performance and is reported in
monetary terms to present an accurate, true and fair view of an organisation’s financial performance for a
reporting period.
Management accounting involves the use of internal management information systems to analyse past,
present and future information to inform management in decision-making and to assist with planning,
control and decision-making. Management accounting information can be used to contribute to the
effectiveness of an organisation in a number of ways, including:
Planning
In the planning process, management accounting helps to formulate future plans by providing information
which can be used to formulate medium-term and long-term strategic plans. That information can include
24
data on past performance, which can be useful as a guide for future performance. By establishing overall
organisational budget procedures and timetables, management accounting will ensure co-ordination of
various plans into one overall plan for the organisation as a whole.
Control
Management accounting aids the control process by producing performance reports which internally
compare actual outcomes with planned outcomes. This highlights specific activities or aspects of
organisational activities which do not conform to plan, prompting action. Management accounting can
facilitate a management-by-exception approach, which frees managers from unnecessary concern with
activities or aspects of operations which are adhering to plans.
Decision-Making
Management accounting information has a specific role to provide information for short-term and longterm decision-making purposes. For example, the decision to invest in non-current assets may be
influenced by returns of a product line and efficiencies or inefficiencies in the operation of that line.
Organising
Management accounting, through establishing internal areas of responsibility in cost and / or revenue
terms, can assist with effective performance of an organisation by identifying and developing the mostappropriate structure.
Communication
Management accounting aids communication by developing and maintaining an effective communication
and reporting system in an organisation. For example, the establishment of a budget communicates
organisational plans to managers and employees of an organisation and can ensure co-ordination between
different areas as it defines what is required. Budget performance reports subsequently communicate
important information on how activities are being managed against that plan.
Motivation
Management accounting information can have an important influence on employee motivation in an
organisation. For example, standard costs can represent targets, which particular sections of the
organization can be motivated to achieve, or surpass. Regular performance information can be used for
motivation purposes, and can highlight areas for improvement.
In large organisations the financial accounting and management accounting functions are entirely
separate – however in small organisations these functions may be combined.
While there are numerous differences between financial accounting and management accounting, both
form integral parts of the financial information systems of an organisation.
I hope that the above adequately addresses your queries and I will be happy to provide further
information if required.
25
Solution 5
Workings
Working 1:
Apportionment of general overheads
Sales Revenue
Apportioned
general overheads
Alpha
€/£
100,000
55 / 500 x 100
=11,000
Beta
€/£
300,000
55 / 500 x 300
=33,000
Delta
€/£
100,000
55 / 500 x 100
=11,000
Total
€/£
500,000
a) Profit / Loss Statement
Sales revenue
Variable cost
Contribution
Fixed Costs
Allocated fixed production overheads
Apportioned General Overheads
Net Profit / (Loss)
Product
Alpha
€/£
100,000
80,000
20,000
Product
Beta
€/£
300,000
140,000
160,000
Product
Delta
€/£
100,000
25,000
75,000
Company
Total
€/£
500,000
245,000
255,000
22,000
11,000
(13,000)
44,000
33,000
83,000
35,000
11,000
29,000
101,000
55,000
99,000
b) Delta 2 Proposed Contract
€/£
Incremental revenue
Sales revenue
Incremental Costs
Variable cost
Additional materials cost
Fixed overheads
Total
Net profit
1,000 units x € / £ 16 per unit
€ / £ 5 per unit original variable cost
+ € / £ 5 per unit additional labour cost x 1,000
units
1,000 @ € / £ 2 replacement cost
Not expected to change
€/£
16,000
10,000
2,000
0
(12,000)
4,000
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c)
To:
MEMORANDUM
Management Team
From: Student
Date: x/ x/ xx
Re: (i) Marginal costing for decision making
(ii) Proposed Contract – financial decision & non-financial factors
Marginal costing for decision making
Marginal costing focuses on separating variable costs and fixed costs and assists in focusing on relevant
costs to provide more relevant information. Marginal costing recognises that, as fixed costs are
committed and cannot be avoided, they are largely irrelevant to many decision-making situations.
Marginal costing avoids arbitrary allocations, apportionments and the use of pre-determined overhead
absorption rates, which can be misleading in decision-making scenarios.
Profit calculations are not dependent upon changes in inventory levels. Holding inventory is normal in
most businesses (other than service businesses), where production is at a different rate to sales. Differing
costing approaches will result in different inventory valuations. This can result in differing profit figures
when the inventory level changes during a reporting period. Marginal costing charges fixed costs to the
period in which they are incurred and does not incorporate fixed costs in inventory costs, which results in
profits reported relative to sales.
A marginal cost represents the most relevant cost for short-term tactical decisions, such as pricing. In a
scenario where a manager is seeking to make the best use of resources, as fixed costs are treated as
committed and unchanging, so the marginal cost, sales revenue and contribution are the key issues. In
these circumstances, the selection of the alternative which maximises contribution is the correct decision
rule. Where sales volumes are declining but production volume is sustained, marginal costing provides an
early profit warning, as opposed to other methods such as absorption costing.
Proposed Contract – financial decision
On financial grounds alone, it makes sense to proceed with the proposed contract, as the calculations
show that doing so contributes to profit.
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Proposed Contract – non-financial factors
Other considerations which the company should consider before accepting this contract include:
• Impact on other existing Delta sales and customers;
• Impact on other product revenues and costs;
• Consideration of overhead cost drivers to identify cost allocations, particularly general
overheads;
• Consideration of variable and fixed costs split;
• Other uses and returns for product omega;
• Future potential contracts from the same source.
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Solution 6
a)
Incentive schemes are a means of remuneration which relate payment to output. The aims of
such schemes are to benefit employees by providing an opportunity to increase earnings, while
encouraging performance and providing for increased productivity, which may result in
reduced cost per unit. Incentive Schemes can be based upon individual performance or aimed
at incentivising groups of employees. Incentive schemes should be based on efficient working
methods following comprehensive work studies and may be financial or non-financial in
nature.
b)
c)
Normal pay on current payroll terms
Employee
Employee 1
Calculation
35 hours @ € / £ 18
3 hours @ (€ / £ 18+25%)
€/£
630.00
67.50
697.50
Employee 2
35 hours @ € / £ 18
5 hours @ (€ / £ 18+25%)
630.00
112.50
742.50
Employee 3
35 hours @ € / £ 20
1 hour @ (€ / £ 20+25%)
700.00
25.00
725.00
Employee 4
35 hours @ € / £ 20
700.00
Employee 5
35 hours @ € / £ 20
700.00
Standard piecework rate
Standard Weekly Pay (Grade A)
Standard Weekly Production
35 hours = 2,100 minutes / 15
Basic Piecework Rate
630.00
Incentive Element 6%
Standard Incentive Piecework Rate
29
140 units
€ / £ 4.50 per
unit
0.27
€ / £ 4.77
d)
Normal pay under the proposed incentive scheme
Employee
Employee 1
Calculation
160 units x € / £ 4.77
Result
€/£
763.20
Employee 2
160 units x € / £ 4.77
763.20
Employee 3
140 units x € / £ 4.77
667.80
Employee 4
140 units x € / £ 4.77
667.80
Employee 5
150 units x € / £ 4.77
715.50
e)
i. Cost of producing 800 units under current payroll terms
Result
€/£
630.00
67.50
697.50
Employee
Employee 1
Calculation
35 hours @ € / £ 18
3 hours @ (€ / £ 18+25%)
Employee 2
35 hours @ € / £ 18
5 hours @ (€ / £ 18+25%)
630.00
112.50
742.50
Employee 3
35 hours @ € / £ 20
6.13 hours @ (€ / £ 20+25%)
700.00
153.25
853.25
Employee 4
35 hours @ € / £ 20
5 hours @ (€ / £ 20+25%)
700.00
125.00
825.00
Employee 5
35 hours @ € / £ 20
2.29 hours @ (€ / £ 20+25%)
700.00
57.25
757.25
Total Weekly Cost
ii.
Cost of producing 800 units under Incentive Scheme proposal
800 pieces @ € / £ 4.77 = € / £ 3,816.00
iii.
Incentive Scheme = more cost-effective option
30
3,875.50
Workings
Target average production
800 units / 5 employees
= 160 units / week
Current Average Production Rate
Employee 1
160 units / 38 hours = 4.21 units per hour
Time required for target
38 hours
Employee 2
160 units / 40 hours = 4.00 units per hour
40 hours
Employee 3
140 units / 36 hours = 3.89 units per hour
41.13 hours
Employee 4
140 units / 35 hours = 4.00 units per hour
40 hours
Employee 5
150 units / 35 hours = 4.29 units per hour
37.29 hours
END OF SOLUTIONS
31