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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.