You are on page 1of 40

For latest course notes, free audio & video lectures, support and forums please visit

PAPER F5 REVISION NOTES


TRADITIONAL ABSORPTION V ACTIVITY BASED COSTING
A company manufactures two products: X and Y.
Information is available as follows:
(a) Product Total production Labour time per unit
X 1,000 0.5 hours
Y 100 1.0 hour
Total overhead: $16,500
Calculate the overhead content of each product using traditional absorption methods.
(b) The total overhead has now been broken down into:
Materials handling 4,800
Production scheduling 6,500
Machine-related 5,200
Product X Product Y
Number of purchase orders received (total) 8 4
Number of production runs (total) 3 2
Number of machine operations (per unit) 2 6
Recalculate the overhead content of each product using an activity-based costing approach.
Answer
(a) Absorption ratio
Total overheads $16,500
Total labour hours
X: 1,000 x 0.5 500
Y: 100 x 1.0 100
600 hours
Absorption rate = 16,500 / 600 = $27.50 per labour hour
Overhead content in products
X: 0.5 hours x 27.50 = $13.75 per unit
Y: 1 hour x 27.50 = $27.50 per unit
(b)
Cost driver Total X Y
Materials handling Purchase orders 4,800 3,200 1,600
Production scheduling Production runs 6,500 3,900 2,600
Machine operations Number of operation 5,200 4,000 1,200
16,500 11,100 5,400
Number of units 1,000 100
Overhead cost per unit $11.10 $54
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
ACTIVITY BASED COSTING
* Gives fairer valuation of cost per unit
Identifes cost driver for each overhead rather than absorb all at one arbitrary rate
* Focuses attention on cost drivers
Leads to better control of overheads
BUT:
* time - consuming to identify cost drivers
* not always possible to identify a cost driver
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
THROUGHPUT ACCOUNTING
A company produces 3 products, details of which are given below:
A B C
Selling price 50 60 40
Materials 10 15 8
Labour 10 5 6
Variable overheads 18 20 4
Fixed overheads 5 8 10
43 48 28
Proft p.u. 7 12 12
Machine hours p.u. 1 hr 2 hrs 2 hrs
Maximum demand 500u 500u 500u
The machine time is limited to 1,800 hours.
Determine the optimum production plan and calculate the maximum proft
(a) using key factor analysis
(b) using throughput accounting
Main assumptions of throughput accounting:
* in the short term, all costs except materials are fxed
* inventory levels are kept to a minimum, ideally zero.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
THROUGHPUT ACCOUNTING (ANSWER)
(a)
A B C
Contribution per unit $12 $20 $22
Hour per unit 1 2 2
Contribution per hour $12 $10 $11
(1) (3) (2)
Production plan:
A 500 units x 1 500
C 500 units x 2 1,000
B 150 units x 2 300 (balance)
1,800
Maximum proft
A 500 units x $12 6,000
B 150 units x $20 3,000
C 500 units x $22 11,000
Maximum contribution 20,000
Less: Fixed overheads
A 500 units x $5 2,500
B 500 units x $8 4,000
C 500 units x $10 5,000
11,500
Maximum proft $8,500
(Note: In the absence of a fgure being given for fxed overheads, it is assumed that they were absorbed into product costs before
knowledge of the limited time available)
(b)
A B C
Throughput per unit $40 $45 $32
Hour per unit 1 2 2
Return per hour $40 $22.50 $16
(1) (2) (3)
Production plan:
A 500 units x 1 500
B 500 units x 2 1,000
C 150 units x 2 300 (balance)
1,800
Maximum proft
A 500 units x 40 20,000
B 500 units x 45 22,500
C 150 units x 32 4,800
47,300
Less: Fixed costs
A 500 units x 33 16,500
B 500 units x 33 16,500
C 500 units x 20 10,000
43,000
Maximum proft $4,300
(Note: In the absence of a fgure being given for fxed overheads, it is assumed that they were absorbed into product costs before
knowledge of the limited time available)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
LIFE CYCLE COSTING
Consider costs and revenues over the estimated entire life of a product.
Phases of life cycle:
* Development
* Introduction
* Growth
* Maturity
* Decline
For example, might plan to have high selling price initially (high development/introduction costs, low competition), and then to have
lower prices during the maturity phase (higher volume of sales, lower costs, more competition) and plan for eventual withdrawal of
product (and replacement with new product) towards end of life cycle.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
TARGET COSTING
1. Determine a realistic / competitive selling price.
2. Determine the proft required (e.g. required proft margin)
3. Calculate the maximum cost p.u. in order to achieve the required proft.
4. This is the target cost
5. Compare the estimated actual cost with the target cost. If higher, look for ways of achieving the target cost.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
PRICING
Full cost plus:
Take full cost (i.e. including fxed overheads) and add on a percentage
Example
variable cost of production $5 p.u.
budgeted fxed costs $60,000 p.a.
budgeted production 20,000 units p.a.
mark-up of 30%
Answer
fxed costs p.u. = 60,000/20,000 = $3
full cost = 5 + 3 = $8 p.u.
selling price = $8 + 30% x $8 = $10.40 p.u.
Ensures that company covers fxed costs, BUT how to budget the level of production?
Takes no account of the efect of the selling price on demand.
Marginal cost plus:
Take marginal (variable cost) and add on a percentage
Example
Variable cost of production $5 p.u.
budgeted fxed costs $60,000 p.a.
budgeted production 20,000 units p.a.
mark-up of 50%
Answer
marginal cost = $5 p.u.
selling price = $5 + 50% x $5 = $7.50 p.u.
Avoids the problems of absorbing fxed overheads, BUT what percentage to add in order to ensure that fxed overheads are covered?
Takes no account of the efect of the selling price on demand.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
THEORETICAL PRICING
1. At a selling price of $80 p.u., the demand will be 50,000 units p.a..
For every $5 change in the selling price, the demand will change by 2,000 units.
Derive the price/demand equation.
Answer
b = 52,000 = 0.0025
a = 80 + (0.0025 x 50,000) = 205
P = 205 0.0025Q
2. At a selling price of $100 p.u., the demand will be 80,000 units p.a..
For every $10 change in the selling price, the demand will change by 5,000 units.
Derive the price/demand equation.
Answer
b = 105,000 = 0.002
a = 100 + (0.002 x 80,000) = 260
P = 260 0.002Q
3. At a selling price of $200, the demand will be 100,000 units p.a..
The demand will change by 10,000 units for every $30 change in the selling price.
The total costs will be 60,000 + 8Q
What should be the selling price p.u. to achieve maximum proft p.a.?
Answer
b = 3010,000 = 0.003
a = 200 + (0.003 x 100,000) = 500
P = 500 0.003Q
MR = 500 0.006Q
MC = 8
For maximum proft MR = MC
500 0.006Q = 8
Q = 82,000
When Q = 82,000, P = 500 (0.003 x 82,000)
= $254 per unit
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
RELEVANT COSTING
* Suitable for one-of contracts.
* Calculate the future, incremental (i.e. extra), cash fows which will result from doing the contract.
Sunk costs: costs already incurred - not relevant
Opportunity costs: lost income as a result of doing the contract - are relevant
Fixed costs: only relevant if the total changes as a result of doing the contract
Examples:
1. Contract requires 200 kg of material X.
Company has 500 kg in stock, which originally cost $6 per kg..
Material X has no other use, and if not used in the contract will be scrapped for $2 per kg..
2. Contract requires 300 kg of material Y.
Company has 600 kg in stock, which originally cost $10 per kg..
Material Y is in regular use by the company has the current purchase price is $12 per kg..
3. Contract requires 50 hours of skilled labour.
The company pays skilled labour $5 per hour, and there is currently plenty of idle time.
4. Contract requires 80 hours of skilled labour.
Labour is paid $5 per hour.
There is no spare time, and the contract would have to be done in overtime.
Overtime is paid at normal rate plus 50%.
5. Contract requires 100 hours of skilled labour.
Labour is paid $5 per hour.
Labour is currently fully occupied making another product which is generating a contribution of $8 p.u.
Each unit of the other product requires 2 hours of skilled labour.
Answers
1) No other use, so scrap proceeds: 200 x $2 = $400
2) In regular use, so current purchase price: 300 x $12 = $3,600
3) Plenty of idle time, so no extra cost: $NIL
4) No spare time, so extra cost: 80 x ($5 + 50%) = $600
5) Taken from other product, so rate per hour + lost contribution per hour: 100 x (5 + 82) = $900
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
UNCERTAINTY
Sales per week
Sales (units) Probability
10 0.3
20 0.5
30 0.2
Selling price: $20 p.u.
Cost: $10 p.u.
Any unsold units must be sold as scrap for $1 p.u.
The company can contract to purchase 10, 20 or 30 units each week.
How many units should they contract for?
Answer
Proft table
(a) Demand
Contract size
10 20 30
10 100 100 100
20 10 200 200
30 (80) 110 300
(a) Expected Values
Contract size Expected value
10: 100
20: (0.3 x 10) + (0.7 x 200) 143
30: (0.3 x (80)) + (0.5 x 110) + (0.2 x 300) 91
Contract to buy 20 units per week
(b) Maximax
Contract size Maximum
10: 100
20: 200
30: 300 Maximum
Contract to buy 30 units per week
(c) Maximin
Contract size Maximum
10: 100 Maximum
20: 10
30: (80)
Contract to buy 10 units per week
(d) Minimax Regret
Regret table
Demand
Contract size
10 20 30
10 0 100 200
20 90 0 100
30 180 90 0
Contract size Maximum regret
10 200
20 100 Minimum
30 180
Contract to buy 20 units per week
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
BUDGETING (1)
Incremental budgeting
Take last years fgures and adjust for growth and infation.
Easiest and most common approach, but assumes that we continue to do things the same way. (For example, if we make our products by
hand, we will budget to continue to make them by hand and ignore the fact that maybe there are now machines capable of producing
them.)
Zero based budgeting
Ignore what currently happens.
Instead, identify diferent solutions available, cost them out, and budget on adopting the best solution.
For example, if our product can be made by hand or made by machine, then cost out both approaches, see which is the cheaper, and
budget on that basis.
Although zero based is in principle a much better approach, it is time-consuming and requires expertise.
A realistic way of using a zero based approach is to apply it to one area of the business each year, and budget the other areas using an
incremental approach.
Activity based budgeting
Use an activity based costing approach. Budget the costs for each activity and how each activity is being used, in an attempt to ensure
that each activity is being used efciently.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
BUDGETING (2)
Top-down budgeting
Budget is prepared centrally and then imposed on the managers of each department
Bottom-up budgeting
Each manager produces his/her budget. It is the job of central management to make sure the budgets are challenged and that diferent
departments budgets coordinate with each other.
Bottom-up budgeting is regarded as being more motivational for managers. However the budgets do need to be challenged well
otherwise there is the danger of managers introducing slack into their budgets.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
BUDGETING (3)
Fixed budget The original budget based on the originally estimated levels of sales and production.
The original budget proft remains the overall target of the company.
Flexed budget The budget is adjusted (or fexed) for the actual levels of sales and production. This is usually done
monthly and is used for the purpose of control (compare the actual results with the fexed budget. i.e.
variance analysis)
Rolling budget
(continuous budgeting)
Update the budget each month and always have a budget for the next 12 months
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
FORECASTING
HIGH LOW METHOD
Month Sales
(units)
1 23100
2 24000
3 24100
4 24800
5 25000
6 26030
7 26000
8 27100
9 27200
10 27800
11 27800
12 27500
Month Units
High 12 27500
Low 1 23100
Diference 11 4400
Change per month: 4400 / 11 = 400
Forecast for next month: 27500 + 400 = 27900 units
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
LEARNING CURVES
As cumulative output doubles, the cumulative average time (labour cost) per unit falls to a fxed percentage of the previous average time
(labour cost)
Example 1
First batch takes 100 hours to produce. There is a 75% learning efect.
How long will it take to produce another 7 batches.
Answer 1
Average time
per batch
Total time
1 100
2 75
4 56.25
8 x 42.1875 = 337.5hours
Time for another 7 = 337.5 100 = 237.5 hours
Example 2
First batch takes 60 hours to produce. There is an 80% learning efect.
How long will it take to produce the 7
th
batch?
Answer 2
= = b
log0.8
log2
0.3219
Average time per batch if 7 produced: 60 x 7
-0.3219
= 32.07 hours
Average time per batch if 6 produced: 60 x 6
-0.3219
= 33.70 hours
Total time for 7 batches 7 x 32.07 = 224.49
Total time for 6 batches 6 x 33.70 = (202.20)
Time for 7
th
22.29 hours
Learning curve formula: y = ax
b
y = average time per batch
a = time for initial batch
x = number of batches
b = learning factor
b =
log r
log 2
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
OPERATING STATEMENT (ABSORPTION COSTING)
Original Budget Proft
Sales Volume Variance
units
Actual sales
Budgeted sales
units Standard proft p.u.
Sales Price Variance
Actual sales at actual S.P.
Actual sales at standard S.P
Materials Expenditure Variance
Actual purchases at actual cost
Actual purchases at standard cost
Materials Usage Variance
kg
Actual usage
Standard usage for actual production
kg Standard cost
Labour Rate of Pay Variance
Actual hours paid at actual cost
Actual hours paid at standard cost
Labour Idle Time Variance
hours
Actual hours paid
Actual hours worked
Standard cost
Labour Efciency Variance
hours
Actual hours worked
Standard hours for actual production
Standard cost
Variable Expenditure Variance
Actual hours worked at actual cost
Actual hours worked at standard cost
Variable Efciency Variance
hours
Actual hours worked
Standard hours for actual production
Standard cost
Fixed Overhead Expenditure Variance
Actual total
Budget Total
Fixed Overhead Volume Variance
units
Actual production
Budget production
Standard cost per unit
Actual Proft
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
OPERATING STATEMENT (MARGINAL COSTING)
Original Budget Proft
Sales Volume Variance
units
Actual sales
Budget sales
units Standard contribution p.u.
Sales Price Variance
Actual sales at actual S.P.
Actual sales at standard S.P
Materials Expenditure Variance
Actual purchases at actual cost
Actual purchases at standard cost
Materials Usage Variance
kg
Actual usage
Standard usage for actual production
kg Standard cost
Labour Rate of Pay Variance
Actual hours paid at actual cost
Actual hours paid at standard cost
Labour Idle Time Variance
hours
Actual hours paid
Actual hours worked
Standard cost
Labour Efciency Variance
hours
Actual hours worked
Standard hours for actual production
Standard cost
Variable Expenditure Variance
Actual hours worked at actual cost
Actual hours worked at standard cost
Variable Efciency Variance
hours
Actual hours worked
Standard hours for actual production
Standard cost
Fixed Overhead Expenditure Variance
Actual total
Budget Total
Actual Proft
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
VARIANCE ANALYSIS
Budget sales and production of Product X are 600,000 units p.a. at a standard selling price of $100 p.u.
The original standard costs of production were:
Materials: 2 kg @ $20 per kg
Labour: 1.5 hrs @ $2 per hr
Variable overheads: 1.5 hrs @ $6 per hr
Fixed overheads were budgeted at $10.8M for the year.
Actual results for January were as follows:
Sales: 53,000 units @ $95 p.u.
Production costs for 55,000 units produced:
Materials (110,000 kg) $2,300,000
Labour (85,000 hrs) $180,000
Variable Overheads $502,000
Fixed Overheads $935,000
(a) Prepare an operating statement, reconciling actual proft with budget proft.
(Note: the companys policy is to use marginal costing)
Since preparation of the budget, the suppliers of the materials had announced a permanent price increase of 10%. As a result the
manufacturing process was examined and ways were found of reducing material usage by 5% without afecting the quality of fnished
goods.
(b) Using the additional information, analyse the total materials variance into Planning and Operational Variances.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
VARIANCE ANALYSIS (ANSWER A)
a) Note: Budget sales are 600,000 pa, and so budget sales for January are 600,000/12 = 50,000 units
Cost card
Materials (2 kg x $20) 40
Labour (1.5 hours x $2) 3
Variable o/h (1.5 hours x $6) 9
Marginal cost $52
Standard contribution = 100 52 = $48 per unit
Budgeted proft:
50,000 units x $48 2,400,000
Less: fxed overheads (900,000)
$1,500,000
Operating statement
Budgeted proft 1,500,000
Sales volume variance (3,000 units x $48) 144,000 (F)
Sales price variance (53,000 x $5) 265,000 (A)
1,379,000
Materials Expenditure Variance
Actual cost 2,300,000
Actual purchases at standard cost (11,000 kg x $20) 2,200,000
100,000 (A)
Materials Usage Variance kg
Actual usage 110,000
Standard usage for actual production (55,000 x 2kg) 110,000 NIL
Labour rate of pay variance
Actual cost 180,000
Standard hours for actual production (85,000 hrs x 2) 170,000
10,000 (A)
Labour efciency variance
Actual hours 85,000
Standard hours for actual production (55,000 hrs x 1.5) 82,500
2,500 hours x $2 5,000 (A)
Variable overheads expenditure variance
Actual cost 502,000
Actual hours at standard cost (85,500 hrs x $6) 510,000 8,000 (F)
Variable overheads efciency variance
Actual hours 85,000
Standard hours for actual production (55,000 hrs x 1.5) 82,500
2,500 hours x $6 15,000 (A)
Fixed overheads expenditure variance
(935,000 900,000) 35,000 (A)
$1,222,000
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
VARIANCE ANALYSIS (ANSWER B)
(b) Total materials variance
Actual total cost 2,300,000
Standard cost for actual production (55,000 x $40) 2,200,000
Sales price variance 100,000 (A)
Revised cost card for materials
Materials (1.9 kg x $22) $41.80 pu
Planning variances
Expenditure
Revised std purchases at revised std cost 55,000 u x 1.9 kg = 104,500 kg x $22 2,299,000
Revised std purchases at original std cost 104,500 kg x $20 2,090,000
$209,000 (A)
Usage
Revised std usage at actual production (55,000 units x $1.9kg) 104,500
Original std usage for actual production (55,000 x 2kg) 110,000
5,500 x$20 = $110,000 (F)
Operational variances
Expenditure
Actual purchases at actual cost 2,300,000
Actual purchases at revised std cost 110,000 kg x $22 2,420,000
$120,000 (F)
Usage kg
Actual usage 110,000
Revised std usage for actual production (55,000 x 1.9kg) 104,500
5,500 x$22 = $121,000 (A)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
VARIANCES
1. Always marginal costing in exam unless told otherwise, but check carefully.
2. Always show standard cost per unit (cost card) unless given in question. (Make sure you still get the marks even if you have misread
something).
3. Examiner sometimes uses the word cost variance to mean total variance. (e.g. calculate for materials the cost, expenditure, and
usage variances. Means expenditure and usage as normal + total variance. Do not calculate total separately, it is simply the total of
expenditure + usage).
4. If more than one material, do NOT calculate mix & yield variances unless asked for. (or unless he says the materials are substitutable
but he is unlikely to use these words).
5. Remember: for cost variances we are always comparing actual costs with standard cost for actual level of production. It is worth
writing down the actual level of production if you have misread, it is then obvious what you were trying to do.
6. Planning and Operational Variances
(a) Planning (or Revision) Variances
This variance cannot be corrected (or controlled) but when it is identifed that it is going to occur company may
decide to change plans for the future ie. feed-forward control.
(b) Operational Variances
Normally calculated monthly. It is too late to do anything about the period under review, but can use information to
attempt to correct (or control) any problems for the future. ie. feedback control.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
MIX & YIELD VARIANCES
Standard cost for every 8 kg of output:
A 6 kg @ $8 48
B 3 kg @ $4 12
60
Actual results:
Materials input A 99,000 kg at a total cost of $800,000
B 36,000 kg at a total cost of $140,000
Actual production: 130,000 kg
Answer
Expenditure Variance
Actual purchases Actual cost Actual purchases Standard cost
kg $ kg $
A 99,000 800,000 99,000 x $8 792,000
B 36,000 140,000 36,000 x $4 144,000
$940,000 $936,000
Expenditure Variance = $4,000 (A)
Mix variance
Actual total Actual mix standard cost Actual total Actual mix standard cost
kg $ kg $
A 99,000 x $8 792,000 (69) 90,000 x $8 720,000
B 36,000 x $4 144,000 (39) 45,000 x $4 180,000
135,000 $936,000 135,000 $900,000
Mix Variance = $36,000 (A)
Yield variance
Actual total Standard mix standard cost Standard total standard mix standard cost
kg $ kg $
A 90,000 x $8 720,000 97,500 x $8 780,000
B 45,000 x $4 180,000 48,750 x $4 195,000
135,000 $900,000 (130,000 x 98) 146,250 $975,000
Yield Variance = $75,000 (F)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
COST-VOLUME-PROFIT ANALYSIS MULTIPLE PRODUCTS
A company produces and sells three products: A, Band C.
The budget information for the coming year is as follows:
A B C
Sales (units) 5,000 6,000 8,000
Selling price (p.u.) $10 $12 $15
Variable cost (p.u.) $5 $8 $6
Contribution (p.u.) $5 $4 $9
The total budgeted fxed overheads for the year are $50,000
(a) Calculate the CS ratio for each product individually
(b) Calculate the average CS ratio (assuming that the budget mix of production remains unchanged)
(c) Calculate the breakeven revenue (assuming that the budget mix of production remains unchanged)
(d) Construct a PV chart (assuming that the budget mix of production remains unchanged)
Assuming that the products are produced in order of their CS ratios, contruct a table showing the cumulative revenue and cumulative
profts
(e) Calculate the breakeven sales revenue on this basis
(f) Add the information to the P/V chart already produced
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
ENVIRONMENTAL MANAGEMENT ACCOUNTING
Note: there can be no calculations on this in the exam, and there will be a maximum of 8 marks for it as one part of a question.
Environmental costs comprise such things as electricity, water, and the disposal of waste. In addition there is the efect on the image of the
company of not being environmentally friendly, although this is much harder to quantify.
For the exam you should be able to write briefy about four techniques that may be useful:
Infow / Outfow analysis
This approach balances the quantity of resources input with the quantity that is output (either as production or as waste).
Resources include not just raw materials, but also ones such as electricity.
Measuring these in physical quantities and in monetary terms forces the business to focus on environmental costs.
Flow cost accounting
This is really infow / outfow analysis, but concentrates on material fows in each of three categories:
Material: the resources used in storing raw materials and in production
System: the resources used in storing fnished goods and in quality control
Delivery & disposal: the resources used in delivering to the customer and in disposing of any waste.
Life-cycle costing
Ensuring that environmental costs such as the disposal of waste are included in the life-cycle costs. It may be possible to design-out these
costs before the product is launched.
Environmental Activity Based Costing
Environmental costs should be allocated to their own cost centres rather than simply being included in general overheads.
As with ABC in general, this focuses more attention on these costs and potentially leads to greater efciency and cost reduction.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
LIFE-CYCLE COSTING / TARGET COSTING
William plc is planning to commence production of a new product the Kate.
It is expected that demand for Kates will last for 6 years and that they will sell 1,000 units in the frst year; 3,000 units in the second year;
and 6,000 units per year thereafter.
The selling price will be $15 per unit, and the company wishes to achieve a mark-up of 50% on cost.
The following costs have been estimated:
Design and development: $40,000
Variable production costs: $7 per unit
Additional fxed production costs: $4,000 per year
End of life costs: $10,000
You are required to:
(a) calculate the target cost per unit for production of Kates
(b) calculate the actual full production cost per unit for the frst year and comment as to whether or not there is a cost
gap
(c) calculate the lifecycle cost per unit and comment as to whether or not there is a cost gap
Answer
(a) target cost = 15/1.50 = $10 per unit
(b) First year production cost:
Variable cost 7.00
Fixed costs $4,000/1,000 4.00
$11
Cost gap = 11 10 = $1 per unit
(c) Life cycle cost:
Total costs:
4,000 + (28,000 x 7) + (6 x 4,000) + 10,000 = $270,000

Total production
1,000 + 3,000 + (4 x 6,000) = 28,000
Life cycle cost per unit = 270,000 / 28,000 = $9.64
No cost gap
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
DECISION TREES
Charming plc have to make a decision as to which, if either, of two machines to buy machine A or machine B.
Machine A will cost $10,000 and will last for 10 years, generating $2,000 a year if demand for the product is high, but only $1,000 a year
if demand is low. If demand is low, they will be able after 5 years to scrap the machine for $1,000 or, alternatively, to invest an additional
$5,000 in which case it will generate $1,500 a year for the remaining 5 years.
Machine B will cost $15,000 and will also last for 10 years, generating $4,000 a year if demand is high, or $1,000 a year if demand is low.
Neither machine has any scrap value at the end of 10 years.
For both machines, the probability of demand being high is 0.6.
Charming intend to make the decision using expected values, based on the expected net cash receipts over the life of the machines.
Which (if either) of the two machines should they buy?
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
PERFORMANCE INDICATORS
RETURN ON CAPITAL
Proft before interest & tax
100%
Long term capital
(ie Equity + Long Term debt)
OPERATING PROFIT MARGIN
Operating Proft
100%
Sales
CURRENT RATIO
Current Assets
Current liabilities
QUICK RATIO
Current Assets Inventory
Current liabilities
EARNINGS PER SHARE (E.P.S.)
Proft after interest & tax
Number of shares
P / E ratio
Market value per share
Earnings per share
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
RETURN ON INVESTMENT V RESIDUAL INCOME
Division X of Y plc is currently reporting profts of $100,000 p.a. on capital employed of $800,000
A new project is being considered which will cost $100,000 and is expected to generate profts of $15,000 p.a.
The target return of Y plc is 16%
(a) Should Y plc accept or reject the project?
(b) Will the manager of Division X be motivated to accept the project if his performance is measured
(i) on Return on Investment?
(ii) on Residual Income?
Answer
(a) Return from project = 15,000/100,000 x 100% = 15%
< target return of 16%, so reject
(b) Divisional manager
(i) ROI
Current ROI 100,000/800,000 x 100% = 12.5%
ROI with project: 115,000/900,000 x 100% = 12.8%
Manager motivated to accept
(ii) Current RI:
Proft 100,000
Less: notional interest 16% x 800,000 (128,000)
(28,000)
RI with project
Proft 115,000
Less: notional interest 16% x 900,000 (144,000)
16% x 80,000 (29,000)
Manager motivated to reject
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
DIVISIONAL PERFORMANCE MEASUREMENT
Type of responsibility centre:
Cost centre:
Manager has authority for decisions over costs (but not revenue)
Revenue centre:
Manager has authority for decisions over revenue (but not costs)
Proft centre:
Manager has authority for decisions over costs and revenues (but not capital investment decisions)
Investment centre:
Manager has authority for decisions over costs, revenues, and new capital investment.
Controllable factors:
The manager should only be assessed over those items over which he has control.
For example, if a manager is given authority to make decisions over everything except salary increases which are dictated by central
management, then it would be unfair to include salaries in his performance measurement.
If (for example) it is a proft centre, then for the purposes of measuring his performance the proft of the division should be calculated
ignoring salaries.
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
TRANSFER PRICING
OBJECTIVES:
* Goal congruence
* Performance appraisal
* Divisional autonomy
OVERALL:
* Must maximise group proft
PRACTICAL:
* T.P. often fxed by Head Ofce
* Problem loss of autonomy
possibility of dysfunctional decisions
APPROACH:
Allow individual managers to negotiate the transfer price
Selling division:
Minimum T.P. = Marginal cost + opportunity cost
Receiving division:
Maximum T.P. is lower of
(a) external purchase price (on intermediate market)
and
(b) net marginal revenue (selling price less costs of receiving division)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
TRANSFER PRICING
[S = selling division; R= receiving division]
S R
1. Variable production cost 15 8
Final selling price $30
2. As (1), but intermediate market exists.
S can sell intermediate market at $18; R can buy on intermediate market at $20
(a) S has unlimited production capacity and there is limited demand on the intermediate market
(b) S has limited production capacity and there is unlimited demand on the intermediate market
3. S has restricted capacity to make A and B
R wants product A.
A B
Ss Variable production cost per unit 80 120
Ss Intermediate market price per unit 100 150
Answer
1) Transfer price: $15 $22
2) i) Transfer price: $15 $20
ii) Transfer price $18 $20
3) Contributions from A B
A $20 p.u.
B $30 p.u.
Would prefer to sell B on intermediate market
Minimum Transfer price for A =
Marginal cost + Lost contribution from B
80 + 30 = $110 per unit
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
NON-FINANCIAL PERFORMANCE MEASURES
Quality
Flexibility
Efciency (Resource utilisation)
Innovation
Competitiveness
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
VARIANCES - DIFFERENCES BETWEEN MARGINAL AND ABSORPTION COSTING
All the variances are the same in both cases, except:
Sales Volume Variance:
Take diference in units between budget and actual sales, and cost out at:
Marginal costing: Standard contribution per unit
Absorption costing: Standard proft per unit
Fixed Overheads Variances
Marginal costing: Only expenditure variance
Absorption costing: Expenditure variance and volume variance (Volume
Variance can be analysed into capacity and efciency -
see separate sheet)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
ORIGINAL BUDGET
Standard cost of materials:
8kg at $4 per kg = $32 per unit
Budget production: 20,000 units
Actual results:
Production 24,000 units
Materials: 190,000kg for $769,500
Since preparation of the budget, the price per kg had increased to $4.10 and the usage had been revised to 7.5 kg per unit.
Calculate the planning and operational variances, and analyse each into expenditure and usage variances
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
ORIGINAL BUDGET (ANSWER)
Flexed original budget (for 24,000 units produced):
24,000 units x $32 = $768,000
Revised budget (for 24,000 units produced):
24,000 units x $30.75 = $738,000
Actual results (for 24,000 units produced):
$769,500
Planning
$30,000 (F)
Operational
$31,500 (A)
Analysis
Planning variances
Expenditure
24,000u x 7.5 kg = 180,000 kg x $4.10 = 738,000
180,000 kg x $4 = 720,000
$18,000 (A)
Usage:
kg
Revised 180,000
Flexed budget (24,000u x 8 kg 192,000
12,000 x $4 = $48,000 (F)
Operational variances
Expenditure
Actual 190,000 kg 769,500
Revised 190,000 kg x $4.10 = 779,000
$9,500 (F)
Usage:
kg
Actual 190,000
Revised (24,000 x 7.5 kg) 180,000
10,000 x $4.10 = $41,000 (A)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
USAGE VARIANCES
Original budget:
Standard cost of materials: 10 kg at 5 per kg = $50 per unit
Budget production: 10,000 units
Actual results:
Production 11,000 units
Materials 108,900kg at $4.75 per kg
Since preparation of the budget the price per kg has changed to $4.85 and the usage to 9.5kg per unit
Calculate the planning and operational variances, and analyse each into expenditure and usage variances
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
USAGE VARIANCES (ANSWER)
Flexed original budget (for 11,000 units produced):
11,000 units x $50 = $550,000
Revised budget (for 11,000 units produced):
11,000 units x $46.075 = $506,825
Actual results (for 11,000 units produced):
108,900 kg x $4.75 = $517,275
Planning
$43,175 (F)
Operational
$10,450 (A)
Analysis
Planning variances
Expenditure
11,000u x 9.5 kg = 104,500 kg x $4.85 = 506,825
104,500 kg x $5 = 522,500
$15,675 (F)
Usage:
kg
Revised 104,500
Flexed budget (11,000 x 10kg) 110,000
5,500 kg x $5 = $27,500 (F)
Operational variances
Expenditure
Actual 108,900 kg x $4.75 = 517,275
Revised 108,900 kg x $4.85 = 528,165
$10,890 (F)
Usage:
kg
Actual 108,900
Revised (11,000 x 9.5 kg) 104,500
4,400 kg x $4.85 = $21,340 (A)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
BUSINESS SOLUTIONS
Business Solutions is a frm of management consultants which experienced considerable business growth during the last decade. By 2000
the frms senior managers were beginning to experience difculties in managing the business.
During 2001 the frm was reorganised and a regional divisional structure was introduced with individual proft targets being set for each
of the semi-autonomous proft centres. Although North division has its own customer base that is distinct from that of its sister division
South, it does occasionally call upon the services of a South consultant to assist with its projects. North has to pay a cross charge to South
per consulting day. The amount of the charge is determined by HQ. North is free to choose whether it employs a South consultant or
subcontracts the project to an external consultant. The manager of North division believes that the quality of the external consultant and
the one from South division are identical and on this basis will always employ the one who is prepared to work for the lower fee.
The following information is also available:
North division is very busy and it charges its clients $1,200 per consulting day
North division pays its external consultant $500 per consulting day
The variable cost per internal consulting day is $100
Required:
(a) Determine a possible optimal daily cross charge that should be paid by North for the services of a consultant from
South in the scenarios outlined below. The charges that you select must induce both divisional managers to arrive at
the same decision independently. Explain how you have determined your cross charges and state any assumptions that
you think necessary.
Scenario (i)
South division has spare consulting capacity.
Scenario (ii)
South division is fully occupied earning fees of $400 per consulting day.
Scenario (iii)
South division is fully occupied earning fees of $700 per consulting day. (10 marks)
(b) Identify the possible factors that may have prompted the senior management to introduce a divisional structure in
2001 and suggest some potential problems that may arise. (10 marks)
(20 marks)
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
BUSINESS SOLUTIONS (ANSWER)
(a) Scenario (i)
If North uses the external consultant, the daily contribution to the company is $1,200 $500 = $700. If North uses a consultant from
South the daily contribution to the company is $1,200 $100 = $1,100. Therefore the cross charge rate should be set on a level
where both North and South will perceive that they will beneft above $100 and below $500 say $300.
Scenario (ii)
If North uses the external consultant, the total contribution for one days consultancy in both North and South divisions would be:
Income VC
North 1,200 500
South 400 100
1,600 600= $1,000
If the South consultant goes to North, then the total contribution would be:
$1200 $100 = $1,100
Therefore it is best if North employs the South consultant by setting the cross charge above $400 and below $500, say $450, both
parties will beneft and agree to the transaction.
Scenario (iii)
If the North uses the South Consultant, the total contribution will be:
$1200 $100 = $1,100
If North employs the external consultant, the total contribution will be:
Income VC
North 1,200 500
South 700 100
1,900 600= $1,300
The lost contribution of the work in South ($600) exceeds the incremental cost ($400) of the external consultant undertaking the
work.
The company therefore needs to set a cross charge that discourages a consultant going North i.e. above $500 but below $700
Assumptions:
the objective of the company is to maximise contribution in the short run (not long run considerations)
the long term business consequences of rejecting work in the South (Scenario ii) can be ignored
the divisional managers behaviour and responses determined only by short term sectional (divisional) fnancial performance
measurement.
access to all the decision making data that the separate divisions use.
(b) Reasons for re-organisation
the need to have local knowledge applied specifcally to local decisions
a divisional company ofers the opportunity to make decentralised speedy decisions especially with a rapidly changing
environment
it permits senior managers to concentrate on global strategic issues detailed operational activities are dealt with separately
by those most suitable
it permits junior managers to experience broader decision making and can be used as part of their development programme
local semi-autonomous decision making is likely to be a motivating factor for managers (less central control)
a divisional structure may reduce the complexity and cost of the communication systems within an unitary hierarchical
structure
Suggested problems
the senior management may have difculty in letting go permitting decision to be made locally
senior management may become involved in resolving disputes between the divisions
the divisions might eventually compete against each other to the detriment of the entire company
some divisional decisions may not be in the best interests of the entire company (problems of local optimality v global
optimality) ensuring goal congruence
the potential waste from the duplication of functions
For latest course notes, free audio & video lectures, support and forums please visit
PAPER F5 REVISION NOTES
HOW TO PASS ACCA EXAMS !!!!
1 Attempt every question
2 Attempt every part of every question
(attempt does not mean fnish even just copying a relevant formula from the formula sheet will get a mark and could make
the diference between 49 and 50)
3 Help the marker start each new question on a new sheet of paper
4 Start each part of a question on a new sheet of paper. If you can only write one line for part (a) of a question, leave the rest of
the page blank you might think of something else later to add.
5 Help the marker be neat! You will get marks for the correct approach even if your calculations are wrong provided the
marker can see what you have done.
6 Always write something for a written part never write nothing! Anything sensible will almost certainly get you 1 mark, which
could be the diference between passing and failing. There is no negative marking, and so even if you are wrong you will not
lose marks.
7 Allocate your time between questions and parts of questions. Spending an hour on one part of one question will certainly
mean you will fail because you will not have enough time for other questions.
8 In a calculation question, no one fgure can be worth more than 3 or 4 marks (if it is it will be a separate part of the question). If
you fnd yourself spending too long on one fgure then leave it there will be plenty more marks available in the same time.
9 Help the marker in essay parts of questions put each separate point on a new line. If you string points one after the other,
there is the danger of the marker missing some of them. Do make each point into a sentence never write one-word answers.
10 Read the requirements frst do not start worrying about the fgures in the body of the question until you know what it is you
are trying to do!
11 Remember the pass mark is 50%. Aim to get 50% on every part of every question as fast as you can by going for the easy bits
frst. Once you feel you have got half the marks then you can spend more time on the harder bits.
12 Allocate your time and attempt every part of every question.
13 Allocate your time and attempt every part of every question.

You might also like