CIPMAWB15 Solutions 2

MANAGEMENT ACCOUNTING
COST BEHAVIOUR AND COST

ACCOUNTING TECHNIQUES
SOLUTIONS 2
Updated January 2018
Valid for exams in 2018
1
Management Accounting
First published 2016
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2
2: Cost behaviour and cost accounting techniques
Table of contents
Exercise Solution 2.1 ................................................................. 4
Exercise Solution 2.4 ............................................................... 10
Exercise Solution 2.10 ............................................................. 20
3
Exercise Solution 2.1

(a) FIFO method
 Record each purchase as a new column

 Record issue as a new row working left to right
Purchases
5th June 9th June 21st June
@ £5 @ £5.50 @ £6
Issues
100 50 50
14th June (40 units) -40@£5
60
18th June (70 units) -60@£5 -10@£5.50
0 40
25th June (70 units) -40@£5.50 -30@£6
0 20
Value of closing inventory = (20 × £6) = £120
Issues to production = (100 × £5) + (50 × £5.5) + (30 × £6) =
£955
(b) LIFO method

 Record issue as a new row working right to left
Purchases
5th June 9th June 21st June
@ £5 @ £5.50 @ £6
Issues
100 50 50
14th June (40 units) -40@£5.50
10
18th June (70 units) -60@£5 -10@£5.50
40 0
25th June (70 units) -20@£5 -50@£6
20 0 0
Value of closing inventory = (20 × £5) = £100
4
Issues to production = (80 × £5) + (50 × £5.5) + (50 × £6) =

£975
(c) Weighted average method
 Record each movement in and out of inventory as a new

row
 After each purchase recalculate the total value of inventory

and the weighted average cost per unit
Wtd av
cost per
Units £ unit £
5th June Purchase 100 units @ £5 100 500 5
9th June Purchase 50 units @ £5.50 50 275
150 775 5.17
14th June Issue 40 units -40 -207
21st June Purchase 50 units @ £6 50 300
90 506 5.62
20 113
Value of closing inventory = £113
Issues to production = £(207 + 362 + 393) = £962
5

(a) Cost of labour for worker G
Shift 1 – Units made 118
£
100 units @ £1.25 125.00
15 units @ £1.30 19.50
3 units @ £1.35 4.05
Total pay 148.55
Shift 2 – Units made 70, piecework rate = 70 x £1.25 = £87.50.
This is less than the guaranteed minimum and so she is paid the
guaranteed rate of £90.
Total cost of labour = £148.55 + £90.00 = £238.55
(b) Cost of labour for Worker H
£
Product LL (8 × 0.6) × £6 28.80
Product MM (7 × 1.05) × £6 44.10
Product NN (5 × 0.79) × £6 23.70
Total piecework pay 96.60
Pay subject to a guaranteed minimum of £100, therefore cost of
labour = £100.
(c) Cost of labour for Worker J
£
Standard pay - 38 hours @ £12 456.00
Bonus pay - 6 hours/2 @ £12 × 60% 21.60
Total pay 477.60
6

Method
 Calculate the normal loss

 Calculate the abnormal gain or loss
 Calculate the cost per unit
 Draw up the process and loss accounts
(a) 3 500 units
Normal loss = 0.151 × 4 000 = 604 units
Abnormal loss / gain is calculated as
Units
Input 4 000
Less normal loss -604
Expected output 3 396
Less actual output 3 500
Abnormal gain -104
Total cost – Expected scrap value of normal loss
Cost per unit =
Expected good production
Total cost =
£
Input from previous process
4 000 @ £3 each 12 000
Materials 35 350
Labour and overhead 10 006
Total cost 57 356
Expected scrap value of normal loss = 604 units × £5 = £3 020
57 356 – 3 020
Cost per unit =
3 396
= £16
7
Process Account
Units £ Units £
Costs Output
incurred
Input from 4 000 12 000 Actual output 3 500 56 000
previous (@ £16 p/u)
process
Materials added 35 350 Normal loss 604 3 020
(@ £5 p/u)
Labour & 10 006
Overhead
Abnormal gain 104 1 664
(@ £16 p/u)
4 104 59 020 4 104 59 020
Loss account
Units £ Units £
Normal loss 604 3 020 Scrap 500 2 500

(@ £5 p/u) proceeds
received for
actual loss
(604 – 104)
@ £5
Gain written Bal 1 144 Abnormal gain 104 1 664
to income fig @ £16 p/u)
statement
604 4 164 604 4 164
(b) 3 300 units

Normal loss = 604 units as before
Units
Input 4 000
Less normal loss -604
Less actual output -3 300
Abnormal loss 96
Note that the cost per unit will be the same as in a) as it is
based on the expected figures which are unchanged – it is the
actual figures that are different.
8
Process Account
Units £ Units £
Costs Output
incurred
Input from 4 000 12 000 Actual output 3 300 52 800
previous (@ £16 p/u)
process
Materials 35 350 Normal loss 604 3 020
added (@ £5 p/u)
Labour & 10 006 Abnormal 96 1 536
Overhead loss
(@ £16 p/u)
4 000 57 356 4 000 57 356
Loss account
Units £ Units £
Normal loss 604 3 020 Scrap 700 3 500

(@ £5 p/u) proceeds
received for
actual loss
(@ £5 p/u)
Abnormal loss 96 1 536 Loss written Bal 1 056
(@ £16 p/u) to income fig
statement
700 4 556 700 4 556
9

Method:
 Calculate the actual units of WIP
 Calculate the EUs for each type of input
 Calculate the Cost per EU for each type of cost
 Value completed units and closing WIP and draw up process

account
Actual units of WIP = Input less finished production
8 200 – 7 750 = 450
EUs
Material – 80% complete = 450 × 0.8 = 360 EU
Labour and overhead – 60% complete = 450 × 0.6 = 270 EU
Cost per EU calculation:
Actual Labour and

Units Material cost overhead
Completed 7 750 7 750 EU 7 750 EU

Closing WIP 450 360 EU 270 EU
Total EUs 8 110 8 020
Amount spent £13 787 £3 208
Cost per EU 1.7 0.4
Process Account
Units £ Units £
Costs Output
incurred
Materials 8 200 13 787 Finished goods 7 750 16 275
(7 750 × 1.7) +
(7 750 × 0.4)
Labour & 3 208 Closing WIP 450 720
Overhead (360 × 1.7)+
(270 × 0.4)
8 200 16 995 8 200 16 995
10

Method:
 Find the final sales value of each product

 Establish the ratio needed for each method
 Draw up the profit statements
Final sales value
Product X Product Y Product Z Total

19200 × £5 9600 × £7.50 7200 × £12 £254 400
=£96 000 =£72000 =£86400
Ratios
Product X Product Y Product Z

Weight 19200 9600 7200
Sales value at 19200 × £0.6 9600 × £1.86 7200 × £0.72
SOP = £11520 = £17856 = £5184
NRV £96 000 – £72000 – £86400 –
£10 200 = £4800 = £9000 =
£85800 £67200 £77400
Profit statements
(a)
PRODUCT X PRODUCT Y PRODUCT TOTAL

£ £ Z £
£
Sales revenue 96 000 72000 86400 254 400
Less joint costs -61440 -30720 -23040 -115 200
split by weight
Less separate -10 200 -4 800 -9 000 -24 000
costs
Profit/Loss 24 360 36 480 54 360 115 200
(b)
Sales revenue 96 000 72 000 86 400 254 400

Less joint costs -38400 -59520 -17280 -115200
split by sales
value at SOP
Less separate -10 200 -4 800 -9 000 -24 000
costs
Profit/Loss 47 400 7 680 60 120 115 200
11
(c)
Sales revenue 96 000 72000 86400 254 400

Less joint costs -42900 -33600 -38700 -115200
split by NRV
Less separate -10 200 -4 800 -9 000 -24 000
costs
Profit/Loss 42 900 33 600 38 700 115 200
Inventory values
Product X Product Y Product Z

£ £ £
Inventory as a 2400/19200 960/9600 900/7200
proportion of
output
(a)
Total costs 71 640 35 520 32 040

Value of inventory 8 955 3 552 4 005
(b)
Total costs 48 600 64 320 26 280

Value of inventory 6 075 6 432 3 285
(c)
Total costs 53 100 38 400 47 700

Value of inventory 6 637.5 3 840 5 962.5
12

Bloggs
Part (a):
i. Calculating overheads using specified order of closure
Note: the service that will apportion the greatest cost to the
other service should be closed first:
Maintenance will apportion £180 000 × 100/1 000 = £18 000 to
finance.
Finance will apportion £67 500 × 150/1 500 = £6 750 to
maintenance
Therefore close maintenance first.
FINANCE MAINTENANCE PROCESSING ASSEMBLY

£ £ £ £
Costs to 67 500 180 000
apportion
Maintenance 18 000 (180 000) 99 000 63 000
(100:550:350)
Subtotal 85 500 99 000 63 000
Finance (85 500) 47 500 38 000
(750:600)
Total 0 0 146 500 101 000
ii. Calculating overhead apportionment using repeated
distribution/ continuous allotment method

£ £ £ £
Costs to 67 500 180 000
apportion
Finance (67 500) 6 750 33 750 27 000
(150:750:600)
Subtotal 0 186 750 33 750 27 000
Maintenance 18 675 (186 750) 102 712 65 363
(100:550:350)
Subtotal 18 675 0 136 462 92 363
Finance (18 675) 1 868 9 338 7 469
Subtotal 0 1 868 145 800 99 832
13

£ £ £ £
Maintenance 187 (1 868) 1 027 654
Subtotal 187 0 146 827 100 486
Finance (187) 19 93 75
Subtotal 0 19 146 920 100 561
Maintenance 2 (19) 10 7
Subtotal 2 0 146 930 100 568
Finance (2) 0 1 1
(750:600)
Total 0 0 146 931 100 569
iii. Calculating overheads using simultaneous equations
Let: f = finance and m = maintenance
f = £67 500 + 0.1m and m = £180 000 + 0.1f
Substituting m into f, gives an equation of:

f = £67 500 +0.1 × (£180 000 + 0.1f)
Expanding the equation gives:

f = £67 500 + £18 000 + 0.01f
Rearranging this gives: 0.99f = £85 500

Therefore, f = £86 363.636
Substituting this value of f into m, gives an equation of:

m = £180 000 + (0.1 × £86 363.636)
Therefore, m = £188 636.36
So, apportioning finance and maintenance to the production
departments according to the basis of allocation specified:
PROCESSING ASSEMBLY
£ £
Finance 43 181.82 34 545.45
(£86 363.636) (750/1 500) (600/1 500)
Maintenance 103 750.00 66 022.73
(£188 636.36) (550/1 000) (350/1 000)
Total 146 931.82 100 568.18
14
Part (b)
Overall results
 All three methods apportion 100% of the overheads to the two

production departments.
 The three methods produced two different suggestions for

distributing the overheads to production departments (repeated
distribution/ continuous allotment and simultaneous equations
produced essentially the same allocation).
 The result obtained using specified order of closure differed by

less than 1% from the other methods. It has to be decided
whether a more complex but more accurate method is cost-
beneficial.
Specified order of closure
 Easy to use as return charges are not made.
 Acknowledges partial inter-service department apportionments

but may result in slightly inaccurate calculations.
Reciprocal
 Takes full account of inter-servicing departments.
 More complex to use, especially as an organisation is likely to

have many service departments.
Comments relevant to all techniques
 The costs are apportioned to service departments on the basis

of arbitrary apportionment bases. The costs are then
reapportioned to production departments using further arbitrary
bases. Hence the overheads attached to products will be
arbitrary and largely dependent upon the selected bases.
 The method does not acknowledge the existence of fixed and

variable overheads.
 Overheads are apportioned to production departments but the

production departments do not have control over the costs, for
example, service department inefficiencies will be passed on to
production departments.
15

Crowchester Hospital
Determination of cost pool
PROCESSING AND QUALITY PACKAGING

COMPOUNDING CONTROL AND SALES
£ £ £
Staffing costs 138 900 79 670 55 900
Manager costs 11 200 11 200 9 600
General overheads 42 000 42 000 36 000
Other overheads 70 000 70 000 35 000
Total 262 100 202 870 136 500
Processing and compounding £262 100
Apportioned over 6 000 hours = £43.68 per hour
Quality control £202 870
Apportioned over 10 000 tests = £20.29 per test
Packaging and sales £136 500
Apportioned over 7 000 orders = £19.50 per order

Cost per cost driver
A B C D
£ £ £ £
Processing and 873.60 655.20 174.72 349.44

compounding
(£43.68 × 20) (£43.68 × 15) (£43.68 × 4) (£43.68 × 8)
Quality control 405.80 507.25 243.48 730.44
(£20.29 × 20) (£20.29 × 25) (£20.29 × 12) (£20.29 × 36)
Packaging and 292.50 234.00 585.00 331.50
sales
(£19.50 × 15) (£19.50 × 12) (19.50 × 30) (£19.50 × 17)
Direct materials 240.00 720.00 810.00 620.00
Total cost 1 811.90 2 116.45 1 813.20 2 031.38
16

(a) (i) Each of the three departments is a cost pool. In activity
based costing it is necessary for an organisation to define
cost pools. These are similar to cost centres and are used
as collecting points for costs. Each cost is then allocated or
apportioned in an appropriate way to the relevant cost
pool, prior to the calculation of absorption rates based on
cost drivers.
(ii) A cost driver is an activity that causes a cost in a particular
cost pool. In the above example the number of tests,
number of hours and number of orders are all cost drivers.
The absorption rates are calculated using these cost drivers
to establish a cost per cost driver. The rates are then
applied to the item being costed according to its
use/consumption of the cost driver.
(b) The key reasons why an organisation may consider ABC as
opposed to using traditional methods are as follows:
Traditional systems can report distorted costs where
organisations cost a range of low-volume and high-volume
products. This may lead to the under costing of low volume
products and the over costing of high volume products.
ABC recognises that overheads are driven by different activities
and costs incurred may be unrelated to volume. Products are
costed according to their consumption of these activities. This
will, therefore, result in a more accurate assignment of cost.
17

(a) Identify the major activities that take place in an organisation.
This should cover the following:
 Activities are composed of units of work tasks.
 Activities are identified by carrying out an activity analysis.
 Activities chosen should be at a reasonable level of

aggregation based on costs versus benefits criteria.
 The final choice of activities must be a matter of

judgement. However, it can be influenced by the total cost
of the activity centre and the ability of a single driver to
provide a satisfactory determinant of the cost of the
activity.
Assigning costs to cost pools/activity centres for each activity:
 This process happens after the activities have been

identified.
 Many of the resources can be directly attributed to cost

pools; others will be shared and will have to be apportioned
on a suitable basis.
 The greater the amount of costs traced to activity centres

by cost apportionments, the more arbitrary and less
reliable the product/service cost information will be.
Determine the cost driver for each major activity:
 A cost driver must be selected for each activity centre/cost

pool.
 It should provide a good explanation of costs in each

activity centre/cost pool.
 The cost driver should be easily measurable and the data

easy to obtain and to identify with products/services.
 The cost of measurement should be taken into account.
 Cost drivers should represent a reasonably homogenous

measure of output for each activity.
 The final choice of the cost driver is likely to be based on

managerial judgement.
18
Assigning the cost of the activities to products according to the

product’s demand for the cost driver:
 The final stage involves applying cost driver rates to

products.
 Therefore the cost driver must be measurable in a way that

enables it to be identified with individual products.
(b) Advantages of activity based costing:
 It allows for resource allocation at different activity levels;

this information can be used for planning and estimating
future expenditure.
 It establishes a link between decision-making and cost

behaviour.
 It encourages a critical review of processes related to

activities by exposing true cost, and facilitates cost cutting.
 It is likely to give a more accurate estimate of product

costs especially in multi-product, diverse organisations.
Disadvantages of activity based costing:
 There may be problems in defining activities and cost

drivers.
 It is not always possible to monitor on a frequent basis in

the short term.
 It requires a total review of the organisation’s accounting

and possibly managerial system.
 It is likely to be costlier to implement and maintain than

traditional absorption costing.
 It may lead to behaviour changes that are sub-optimal

from an organisational perspective.
19

There is no right answer to this question. The cost drivers chosen by
management should be those that best reflect the factors that cause
the overall overhead cost to increase. You may have made different
suggestions from those made below.
Refuse collection Number of bins emptied
Number of houses from which collections made
Number of miles driven
Number of collection runs carried out per
month
Recycling Weight of recycling collected
Proportion of recycling requiring additional
sorting
Customer support Number of calls dealt with
Number of cases dealt with
Number of customer visits made
Disposal Number of journeys to disposal site
Weight of waste disposed of
20

(a) Advantages and disadvantages of simple absorption costing.
 The aim of the clinic’s costing system is to find the full cost
of treating a patient. A decision has been made to base this
on a cost per chiropodist hour.
 The direct cost of a chiropodist hour can be derived based

on information about their salary, other costs and
contracted hours of work. If a number of chiropodists work
at the clinic, at different rates, an average direct cost per
hour could be calculated.
 To arrive at the full cost of treatment it would then be

necessary to absorb all other costs to arrive at a full cost
per hour. The simplest way to do this would be to divide all
the remaining costs by the number of chiropodist hours to
arrive at an overhead recovery rate per hour. This could be
added to the direct cost per hour to arrive at a full cost per
hour.
 One complication is that chiropodists would not spend all

their contracted hours treating patients. Some hours would
be spent on non-productive tasks such as administration
and training. The cost of these hours should be treated as
part of overheads.
 The main advantage of a costing system of this kind is that

it is simple and easy to understand.
 The main disadvantage is that it fails to reflect the way in

which many overhead costs behave.
To illustrate this, consider a situation in which the clinic
needs to reduce costs. Suppose that the full cost per
productive hour has been found to be £42 of which £24 is
absorbed overheads. A particular treatment takes one
hour and is therefore seen as costing £42. A proposal has
been made to cut the time taken for this treatment to 30
minutes by changing the method used.
On the face of it this should halve the cost of this
treatment. It will certainly halve the direct cost, thus
allowing the chiropodists to do twice as many treatments in
the time available. However, it will not necessarily halve
the overhead costs: for example administration costs per
21
patient may stay the same. If the number of treatments

doubled, the total cost of patient administration may also
double.
(b) ABC identifies the activities that drive costs. In our example,
under ABC both the length of appointment and the number of
appointments would be identified as cost drivers. Changes in on
or more cost drivers are able to be reflected in revised cost
apportionment.
The disadvantage of ABC is that it is more complex to
implement. It therefore takes more time and hence is more
costly.
(c) Applying ABC to the clinic
The first step is to identify the cost object; that is the thing
which we need to cost. At present the clinic costs an hour of
productive chiropodist time. An alternative could be to cost
specific types of treatment. Let’s assume that the clinic decides
to find the cost of each separate type of treatment.
The next step is to identify the various activities in the clinic.
These activities can then be treated as cost pools and all
overhead costs can be allocated to the appropriate pool.
The next step is to identify the cost driver for each pool. Here
are some examples of the type of cost pools which might be
identified and their drivers:
Cost pool Cost driver

Chiropodist time time taken per treatment
Patient administration number of consultations needed
Sterilisation number of instruments used
Dressings and drugs direct cost of items used
Cleaning fixed cost so driven by time taken per
treatment
Once all the costs have been allocated to appropriate cost pools
the cost of a treatment can be calculated. For example, the
patient administration costs can be divided by the total number
of consultations to find a cost per consultation. The
administration cost for each treatment can then be found by
multiplying this cost by the number of consultations the
treatment involves.
22
An analysis of cost in this way makes it easier to find effective

ways of reducing costs. For example, it may be possible to
reduce admin costs by persuading chiropodists to complete a
treatment in one visit rather than asking the patient to come
back.
23

Under and over absorption
(a) Under/over absorption is the consequence of using
predetermined overhead rates as the forecasts of both
overheads to be incurred and actual units of the absorption
base are likely to be inaccurate. It means that the amount of
overhead charged or absorbed is different from the actual cost
incurred. If the amount absorbed is less than the actual cost
then overheads are under-absorbed. If the amount absorbed is
more than the actual cost then overheads are over-absorbed.
(b) Under/over absorption will occur if:
 actual overheads differ from budgeted overheads

and/or
 differences occur between actual and budgeted activity

level of the absorption base. (e.g. labour hours in cost
centre different from that budgeted).
24

(a)
Marginal Period 1 Period 2

Costing £ £
Sales (8 000 x £8) 64 000 (12 000 x £8) 96 000
Variable cost
of sales:
Opening - (2 000 x £4) (8 000)
inventory
Production (10 000 x £4) (40 000) (10 000 x £4) (40 000)
Closing (2 000 x £4) 8 000 -
inventory
Total variable (32 000) (48 000)
cost of sales
Contribution 32 000 48 000
Fixed costs* (20 000) (20 000)
Profit/(loss) 12 000 28 000
The OAR is £2/unit. Budgeted production is 10 000 units. The
budgeted fixed overhead must therefore have been £20 000.
Absorption Period 1 Period 2

costing £ £
Sales (8 000 × £8) 64 000 (12 000 × £8) 96 000
Cost of sales:
Opening – (2 000 × £6) (12 000)
inventory
Production (10 000 × £6) (60 000) (10 000 × £6) (60 000)
Closing (2 000 × £6) 12 000 –
inventory
Total cost of (48 000) (72 000)
sales
Profit / (loss) 16 000 24 000
(b) (i) Under marginal costing, only variable costs are charged to
cost units. Fixed costs are written off against sales of the
period in which they occur and, consequently, they are not
included in the closing inventory.
25
In absorption costing, fixed and variable costs are absorbed

at the point of manufacture, and a proportion of all costs,
including fixed, will be included in the valuation of closing
inventory.
(ii) The value of closing inventory is deducted from cost of
sales and therefore increases the level of profit.
The use of marginal costing will give lower profits in an
operating statement in those periods when production
exceeds sales, i.e. when the value of closing inventory
exceeds the value of opening inventory. However, when
the sales during a costing period exceed production, as in
period 2, marginal costing will show a higher profit.
The difference between the two profit figures can be
reconciled as:
Period I Periods II
Marginal costing profit (£) 12 000 28 000
Opening inventory (units) 0 2 000
Closing inventory (units) 2 000 0
Inventory movement 2 000 (2 000)
Inventory movement x OAR (£) 4 000 (4 000)
Absorption costing profit (£) 16 000 24 000
26

(a)
Marginal March April

costing £ £
Sales (10 000 × £50) 500 000 (12 000 × £50) 600 000
Variable cost
of sales
Opening – (2 000 × £25) (50 000)
inventory
Production (12 000 × £25) (300 000) (10 000 × £25) (250 000)
Closing (2 000 × £25) 50 000 –
inventory
Total variable 250 000 300 000
cost of sales
Variable (50 000) (60 000)
selling cost
10% × sales
Fixed costs
Production (99 000) (99 000)
Sales (14 000) (14 000)
Administration (26 000) (26 000)
Profit/(loss) 61 000 101 000
27
Absorption March April

costing £ £
Sales (10 000 × £50) 500 000 (12 000 × £50) 600 000
Cost of Sales
Opening – (2 000 × £34) (68 000)
inventory
Production (12 000 × £34) (408 000) (10 000 × £34) (340 000)
Closing (2 000 × £34) 68 000 –
inventory
Total cost of (340 000) (408 000)
sales
(under)/over (12 000 × £9*) 9 000 (10 000 × £9*) (9 000)
absorption of – £99 000 – £99 000
overhead
Gross Profit 169 000 183 000
Non–
production
costs
Variable (50 000) (60 000)
selling
Fixed selling (14 000) (14 000)
Fixed admin (26 000) (26 000)
Net Profit 79 000 83 000
*Overhead absorption rate £99 000/11 000 units = £9
(b) The difference between the two profit figures can be reconciled
as:
March April
Marginal costing profit (£) 61 000 101 000
Opening inventory (units) – 2 000
Closing inventory (units) 2 000 –
Inventory movement 2 000 (2 000)
Inventory movement x OAR (£) 18 000 (18 000)
Absorption costing profit (£) 79 000 83 000
28

(a) Valuations
(i) FIFO method

 Record issue as a new row working left to right
Purchases
4th May 8th May 23rd May
@ £6.40 @ £6.00 @ £6.20
Issues
80 30 40
15th May (50 units) –50
30
19th May (40 units) –30 –10
0 20
23rd May (30 units) –20 –10
0 30
Value of closing inventory = (30 × £6.20) = £186
Issues to production = (80 × £6.4) + (30 × £6) +
(10 × £6.20) = £754
(ii) LIFO method

 Record issue as a new row working right to left
Purchases
4th May 8th May 23rd May
@ £6.40 @ £6.00 @ £6.20
Issues
80 30 40
15th May (50 units) –20 –30
60 0
19th May (40 units) –40
20
23rd May (30 units) –30
0 10
29
Value of closing inventory = (10 × £6.2) + (20 × £6.4)

= £190
Issues to production = (60 × £6.4) + (30 × £6) +
(30 × £6.2) = £750
(iii) Weighted average method
 Record each movement in and out of inventory as a

new row
 After each purchase recalculate the total value of

inventory and the weighted average cost per unit
Wtd av
cost per
Units £ unit £
4th May Purchase 80 units @ £6.4 80 512 6.40
8th May Purchase 30 units @ £6.0 30 180
110 692 6.29
15th May Issue 50 units –50 –315
23rd May
Purchase 40 units @ £6.20 40 248
60 373 6.22
30 186
Value of closing inventory = £186
Issues to production = £(315 + 252 + 187) = £754
(b) Recommendation
Since the chemical XG3 is stored in a single tank, new deliveries
will mingle with quantities already held. It would therefore be
logical to use the weighted average cost to value the chemical.
30

Cost of labour for Worker A
£
Product Alpha (12 x 0.75) x £9 81.00
Product Beta (6 x 1.25) x £9 67.50
Product Gamma (4 x 1.01) x £9 36.36
Total piecework pay 184.86
Pay subject to a guaranteed minimum of £150
Earnings exceed the minimum therefore cost of labour = £184.86.
Cost of labour for Worker B
£
Standard pay - 20 hours @ £10 200.00
Bonus pay - 5 @ £10 x 45% 22.50
Total pay 222.50
Cost of labour for worker C
Units made 160, piecework rate = 160 × £1.11 = £177.60. This is
less than the guaranteed minimum and so he is paid the guaranteed
rate of £180.
Total cost of labour for the contract =
£184.86 + £222.50 + £180 = £587.36
31

Method
 Calculate the normal loss

 Calculate the abnormal gain or loss
 Calculate the cost per unit
 Draw up the process and loss accounts
(a) 5 740 units
Normal loss = 0.04 × 6 000 = 240 units
Units
Input 6 000
Less normal loss –240
Less actual output –5 740
Abnormal loss 20
Cost per unit =–
Total cost – Expected scrap value of normal loss
Expected good production
Total cost =
£
Input from previous process 6 000 @ £5 each 30 000
Materials 42 750
Labour and overhead 43 050
Total cost 115 800
Expected scrap value of normal loss = 240 units × £2.50 =
£600
115 800 – 600
Cost per unit = = £20
5 760
32
Process Account
Units £ Units £
Costs Output
incurred
Input from 6 000 30 000 Actual 5 740 114 800
previous output
process (@ £20 p/u)
Materials 42 750 Normal loss 240 600
added (@ £2.5 p/u)
Labour & 43 050 Abnormal 20 400
Overhead loss
(@ £20 p/u)
6 000 115 800 6 000 115 800
Loss account
Units £ Units £
Normal loss 240 600 Scrap 260 650
(@ £2.5 p/u) proceeds
received for
actual loss
(@ £2.5 p/u)
Abnormal Loss Bal
loss written to fig
(@ £20 p/u) 20 400 income 350
statement
260 1 000 260 1 000
(b) 5 780 units

Normal loss = 240 units as before
Units
Input 6 000
Less normal loss –240
Less actual output –5 780
Abnormal gain –20
Note that the cost per unit will be the same as in a) as it is
based on the expected figures which are unchanged – it is the
actual figures that are different.
33
Process Account
Units £ Units £
Costs Output
incurred
Input from 6 000 30 000 Actual 5 780 115 600
previous output
process (@ £20 p/u)
Materials 42 750 Normal loss 240 600
added (@ £2.5 p/u)
Labour & 43 050
Overhead
Abnormal gain 20 400
(@ £20 p/u)
6 020 116 200 6 020 116 200
Loss account
Units £ Units £
Normal loss 240 600 Scrap proceeds 220 550
(@ £2.5 p/u) received for
actual loss
(240 – 20) @
£2.5
Gainwritten Bal 350 Abnormal gain 20 400
to income fig @ £20 p/u)
statement
240 950 240 950
34

Method:
 Calculate the actual units of WIP
 Calculate the EUs for each type of input
 Calculate the Cost per EU for each type of cost
 Value completed units and closing WIP and draw up process

account
Actual units of WIP = Input less finished production
14 600 – 13 800 = 800
EUs of WIP
Material – 80% complete = 800 × 80% = 640 EU
Labour and overhead – 65% complete = 800 × 65% = 520 EU
Cost per EU
Actual Labour and
Units Material cost overhead
Completed 13 800 13 800 EU 13 800 EU

Closing WIP 800 640 EU 520 EU
Total EUs 14 440 14 320
Amount spent £59 204 £21 480
Cost per EU 4.1 1.5
Process Account
Units £ Units £
Costs Output
incurred
Materials 14 600 59 204 Finished 13 800 77 280
goods
(13 800 ×
4.1) +
(13 800 ×
1.5)
Labour & 21 480 Closing WIP 800 3 404
Overhead (640 × 4.1)
+
(520 × 1.5)
14 600 80 684 14 600 80 684
35

Method:
 First allocate the joint costs between the joint products – Note
that the by-product will not be allocated any of the joint costs.
− Find the final sales value of each product
− Establish the ratio needed for each method
− Draw up the profit statements
− Value inventory
 Value the by-product

Final sales value
Product J Product K Product L Total

15 000 x £8 18000 × £12 7 000 × £9 £399 000
=£120 000 =£216 000 =£63 000
Ratios
Product J Product K Product L

Volume 15 000 18 000 7 000
Sales value at 15 000 × £2 = 18000 × £3 = 7 000× £0.75
SOP £30 000 £54 000 = £5 250
NRV £120 000 – £216 000 – £63 000–
£26 000 = £52 000 = £5 000 =
£94 000 £164 000 £58 000
Profit statements
PRODUCT J PRODUCT K PRODUCT L TOTAL

£ £ £ £
(a) Sales revenue 120 000 216 000 63 000 399 000
Less joint costs (39 375) (47 250) (18 375) (105 000)
split by volume
(15:18:7)
Less separate (26 000) (52 000) (5 000) (83 000)
costs
Profit/Loss 54 625 116 750 39 625 211 000
36
PRODUCT J PRODUCT K PRODUCT L TOTAL

£ £ £ £
(b) Sales revenue 120 000 216 000 63 000 399 000
Less joint costs (35 294) (63 529) (6 177) (105 000)
split by sales
value at SOP
(30:54:5.25)
Less separate (26 000) (52 000) (5 000) (83 000)
costs
Profit/Loss 58 706 100 471 51 823 211 000
(c) Sales revenue 120 000 216 000 63 000 399 000
Less joint costs

split by NRV (31 234) (54 494) (19 272) (105 000)
(94:164:58)
Less separate
(26 000) (52 000) (5 000) (83 000)
costs
Profit/Loss 62 766 109 506 38 728 211 000
Inventory values
Product J Product K Product L
£ £ £
Inventory as a
proportion of 2 000/15 000 1 500/18 000 750/7 000
output
(a) Total costs 65 375 99 250 23 375
Value of
8 717 8 271 2 504
inventory
(b) Total costs 61 294 115 529 11 177
Value of 8 173 9 627 1 198
inventory
(c) Total costs 57 234 106 494 24 272
Value of 7 631 8 875 2 601
inventory
Value of the by-product
1 000 litres of by-product can either be sold for £400 (1 000 @
£0.40) or further processed at a cost of £900 and sold for £1 500 (1
000 @ £1.50). Since the net realisable value of £600 (£1 500 -
37
£900) is greater than the current sales value of £400, it should be

further processed.
By-products are valued at the higher of their current selling price or
their net realisable value. In this case that is the NRV of £600.
No inventory of the by-product remains.
38

The IRIS engineering company
(a) Firstly, it is necessary to apportion the costs of general factory
overhead to all the cost centres on the basis of their floor area.
Secondly, the resulting total costs within the two service cost
centres need charging to the production cost centres, but as per
the question this exercise should avoid cross-charging between
the service cost centres. Instead, the whole of these costs
should be charged directly to the two production cost centres.
So, for example, the apportionment of the full costs of service
cost centre 1 should be in the ratio 63:9 to production cost
centres 1 and 2 respectively.
General
Factory
Overhea SCC1 SCC2 PCCA PCCB
d £ £ £ £
£
Original costs 210 000 93 800 38 600 182 800 124 800
Primary (210 000) 10 500 21 000 31 500 147 000
apportionment
Sub-total 104 300 59 600 214 300 271 800
Apportion (104 300) - 91 262 13 038
SCC1 (63/72) (9/72)
Apportion - (59 600) 8 221 51 379
SSC2 (4/29) (25/29)
Total cost - - 313 783 336 217
Budgeted DLH 120 000 20 000
DLH rate £2.61 £16.81
This year Next year

£ £
Cost Centre A DLHR 3.10 2.61
Cost Centre B DLHR 11.00 16.81
In Cost Centre A, the lower absorption rate budgeted is due to
higher budgeted activity next year, thus a lower absorption
rate, other things being equal. The reverse applies to cost
centre B, hence the increase in the absorption rate there.
The difference is also partly due to the projected overhead
expenditure used to determine the absorption rate between the
39
two years. Next year total overheads are £650 000 yet current
year’s overheads must only be £640 000 (from (£3.10 ×
100 000) + (£11 × 30 000)).
(b) To fully recognise the existence of reciprocal service charges
must adopt either the repeated distribution or simultaneous
equation method:
Let
X = Total cost of service cost centre 1
Y = Total cost of service cost centre 2
X = 104 300 +1/30Y
Y = 59 600 + 18/
90 X
The above fractions make allowance for the work that service
cost centre 1 does for itself, as reflected by the fact that 10% of
personnel (the apportionment basis) are within service cost
centre 1. Consequently, to ensure that the full cost of this
service cost centre is charged to other cost centres the relevant
fraction is 90ths. Solving the equations:
X = 104 300 + 1986.67 + 1/150 X
149/ X = 106286.67
150
X = 106 286.67 x 150/149

X = 107 000
Substituting X = £107 000 into either original equation gives
Y = £81 000.
SCC1 SCC2 PCCA PCCB

Initial 104 300 59 600 214 300 271 800
Allocations
Allocate (107 000) 21 400 74 900 10 700
SCC1(£) (18/90) (63/90) (9/90)
Allocate SCC2 2 700 (81 000) 10 800 67 500
(£) (1/30) (4/30) (25/30)
Total cost 300 000 350 000
Budgeted direct 120 000 20 000
labour hours
Direct labour £2.50 £17.50
hour rates
40
Or using the repeated distribution method:
SCC1 SCC2 PCCA PCCB

Initial allocation 104 300 59 600 214 300 271 800
Apportion SCC1 (104 300) 20 860 73 010 10 430
(£) (18/90) (63/90) (9/90)
Apportion SCC2 2 682 (80 460) 10 728 67 050
(£) (1/30) (4/30) (25/30)
Apportion SCC1 (2 682) 537 1 877 268
(£) (18/90) (63/90) (9/90)
Apportion SCC2 18 (537) 72 447
(£) (1/30) (4/30) (25/30)
Apportion SCC1 (18) 4 12 2
(£)
Apportion SCC2 – (4) 1 3
(£)
Total costs – – 300 000 350 000
Overhead £2.50 £17.50
apportion rates
(c) The following comments are relevant (although other points
could attract credit):
 Overhead absorption rate calculations need to distinguish

between the fixed and variable elements of overheads to
assist in short term decision making so that relevant
incremental costs can be identified.
 SCC1 is primarily variable in nature. The present basis of

apportionment (personnel) therefore seems inappropriate.
More appropriate would be an activity measure which
exerts most influence on these variable costs and apportion
the costs accordingly (e.g. output, labour hours).
41
 SCC2 is primarily fixed in behaviour, indicating a high

degree of planned preventative maintenance. This should
be allocated according to planned hours per department.
For the variable cost element, machine hours would be a
sound base as the costs are likely to vary with this activity
base (not clear from question whether it is machine hours
that have been used).
 Production cost centre B is highly mechanised suggesting

the need for a machine hour absorption rate rather than
the direct labour hour rate. The latter is, though,
appropriate for cost centre A given its labour intensity.
42

Care homes
(a) Overhead apportionment
HOME 1 HOME 2 FINANCE ADMIN TOTAL

£ £ £ £ £
Indirect 100 000 100 000 45 000 9 000 254 000
materials
Indirect 100 000 98 500 92 500 46 000 337 000
wages
Managers’ 30 000 30 000 10 000 10 000 80 000
salaries
(employees)
Depreciation 120 000 30 000 – – 150 000
of machines
(value)
Heating and 10 000 15 000 15 000 10 000 50 000
lighting
(area)
Building 5 000 7 500 7 500 5 000 25 000
insurance
(area)
Insurance of 12 000 3 000 – – 15 000
machines
(value)
Rent (area) 20 000 30 000 30 000 20 000 100 000
Total 397 000 314 000 200 000 100 000 1 011 000
allocations
43
(b) Reapportion stores and maintenance department.

Note: Could use repeated distribution or algebraic method
(simultaneous equations)
Repeated distribution
Home 1 Home 2 Finance Administration

Finance 50% 25% 25%
(invoices received)
Administration 40% 40% 20%
(administration
hours)
(i.e. reciprocal service costs)
HOME 1 HOME 2 FINANCE ADMINISTRATION

Total allocations 397 000 314 000 200 000 100 000
Apportion finance 100 000 50 000 (200 000) 50 000
Apportion 60 000 60 000 30 000 (150 000)
administration
Apportion finance 15 000 7 500 (30 000) 7 500
Apportion 3 000 3 000 1 500 (7 500)
administration
Apportion finance 750 375 (1 500) 375
Apportion 150 150 75 (375)
administration
Apportion finance 38 19 (75) 18
Apportion 7 7 4 (18)
administration
Apportion finance 2 2 (4) –
Total cost 575 947 435 053 – –
Algebraic method
F = £200 000 + 0.2A
A = £100 000 + 0.25F
Therefore:
A = £100 000 + 0.25 × (£200 000 + 0.2A)
A – 0.05A = £150 000
A = £150 000/0.95
A = £157 895
44
Therefore:
F = £200 000 + (0.2 × £157 895)
F = £231 579
HOME 1 HOME 2 FINANCE ADMINISTRATI

ON
Total allocations 397 000 314 000 200 000 100 000
Apportion 115 790 57 895 (231 579) 57 895
finance
Apportion 63 158 63 158 31 579 (157 895)
administration
Total cost 575 948 435 053 – –
Both methods should end with overhead absorption rates as follows:
Home 1 £575 948/50 000 care hours = £11.52 per care

hour
Home 2 £435 053/75 000 care hours = £5.80 per care hour
(c) Reasons to use budgeted figures:
 Need to charge overheads to residents throughout costing

period
 Not practical to wait till end of costing period
 Helps smooth out seasonal fluctuations
 Allows price setting to take place before the period is

underway
Main problem:
 Can cause problem of under/over absorption
45

Tradeline
(a)
BASIS MACHINE FINISHING STORES MAINT
SHOP SHOP £ £
£ £
Allocated - 136 500 41 750 52 350 119 420

overheads
Supervision Employees 170 445 57 778 17 333 33 222
Rent m2 20 815 2 184 4 536 966
Cleaning m2 99 917 10 482 21 771 4 636
Heating and m2 35 684 3 744 7 775 1 656
lighting
Sub-total 463 361 115 938 103 765 159 900
Stores % usage 75 177 18 000 (103 765) 10 588
Sub-total 538 538 133 938 – 170 488
Maintenance WDV 125 666 44 822 – (170 488)
Total 664 204 178 760 – –
Absorption 152 280 75 840
base machine labour
hours hours
Overhead 4.36 2.36
absorption
rate per
hour
(b)
UNIT COSTS P1 P2 P3 MARKS
£ £ £
Machine shop 35.53 44.94 124.75
materials
Finishing shop 7.45 12.00 14.55
materials
Machine shop labour1 26.46 31.50 38.22
Finishing shop labour1 4.85 16.49 15.04
Machine shop 15.91 21.36 34.44
overhead2
Finishing shop 2.36 8.02 7.32
overhead3
92.56 134.31 234.32
46
1. Unit costs calculated by multiplying labour hours per unit

by labour’s hourly cost:
e.g. for P1 in the machine shop: 6.30 hours × £4.20 per
hour;
for P1 in the finishing shop: 1 hour × £4.85 per hour
2. Unit costs derived by multiplying overhead absorption rate
(£4.36 per machine hour) by the number of machine hours
consumed by a product per unit
e.g. for P1 3.65 machine hours ×£4.36 per machine hour
3. Derived from finishing shop’s labour hour overhead
absorption rate multiplied by product’s use of labour hours
per unit
e.g. for P1 1 labour hour × £2.36 per labour hours
(c)
REPEATED MACHINE FINISHING

DISTRIBUTION SHOP SHOP STORES MAINTENANCE
£ £ £ £
Initial 463 361 115 938 103 765 159 900
allocation
Apportion 75 177 18 000 (103 765) 10 588

Stores
Apportion 116 154 41 430 12 904 (170 488)

Maintenance
Apportion 9 349 2 238 (12 904) 1 317

Stores
Apportion 897 320 100 (1 317)

Maintenance
Apportion 73 17 (100) 10
Stores
Apportion 7 3 – (10)
Maintenance
665 018 177 946 – –
47
Algebraic method
S = £103 765 + 0.075688M

M = £159 900 + 0.1020408S
S = £103 765 + 0.075688 (£159 900 + 0.1020408S)
S = £115 868 + 0.0077232S
0.9922768S = £115 868
S = £116 770
By substitution
M = £171 815
MACHINE FINISHING STORES MAINTENANCE

SHOP SHOP £ £
£ £
Brought 463 361 115 938 103 765 159 900
forward
Apportion 84 599 20 256 (116 770) 11 915
Stores1
Apportion 117 058 41 752 13 004 (171 815)
Maintenance
Total cost 665 018 177 946 – –
1. When apportioning stores, the ratios are 71/98 (Machine shop),
17/98 (Finishing shop) and 10/98 (Maintenance).
Machine shop overhead absorption rate = £4.37 per machine
hour
Finishing shop overhead absorption rate = £2.35 per labour
hour
Very marginal change in total overhead allocated to the two
departments, with around £800 distributed to finishing shop
rather than to the machine shop. Resultant effect on absorption
rate would be consequently immaterial. This lack of impact is
very much due to the fact that the support services, stores and
maintenance, carry out work in similar proportions to each
other for the production departments
48

Paloma
(a) Calculating full cost
Allocate
Directly Allocate:
Human
Bookkeeping Accountancy Resources Payroll Cleaning
£ £ £ £ £
24 000 30 000 10 000 7 000 3 000
Apportion
Apportion:
General Apportioned Book- Human

Overheads on basis of keeping Accountancy Resources Payroll Cleaning
£ £ £ £ £
IT IT Value 4 344 8 687 1 042 927 0
Maintenance
Insurances Floor Area 2 042 2 553 766 511 128
Heating/ Floor Area 4 085 5 106 1 532 1 021 256
Lighting
Telephones/ Number of 2 234 3 276 894 596 0
Broadband Employees
Total 36 705 49 622 14 234 10 055 3 384

including
allocated
costs
Reciprocal Services Test for Order of Closure:
Human Order
£ Resources Payroll Cleaning Total £ of
Closure
Human 14 234 0 2 135 712 2 847 2
Resources
Payroll 10 055 3 519 0 503 4 022 1
Cleaning 3 384 169 169 0 338 3
49
Reciprocal Services Specified Order of Closure:
Book- Human
keeping Accountancy Resources Payroll Cleaning
£ £ £ £ £
Total 36 705 49 622 14 234 10 055 3 384
Close 2 514 3 519 3 519 (10 055) 503
Payroll
Total 39 219 53 141 17 753 CLOSED 3 887
Close 7 310 9 399 (17 753) CLOSED 1 044
Human
Resources
(35:45:5)
Total 46 529 62 540 CLOSED CLOSED 4 931
Close 1 644 3 287 CLOSED CLOSED (4 931)
Cleaning
(30:60)
Total 48 173 65 827 CLOSED CLOSED CLOSED
Absorb
Calculation of Overhead Absorption Rates:
On basis of delivered hours
Bookkeeping = 48 173/2 000 = £24.09 per hour
Accountancy = 65 827/1 800 = £36.57 per hour
Absorption into services to create full cost:
Bookkeeping = £24.09 + £10.00 = £34.09 per hour
Accountancy = £36.57 + £18.00 = £54.57 per hour
(b) Comment on prices:
Paloma currently have a policy of charging full cost plus 15%.
Using the above absorption full costs this should equate to
prices of £39.20 for Bookkeeping and £62.76 for Accountancy
services per hour.
However, Paloma are currently charging £40 for bookkeeping
services (£0.80 more per hour) and only £60 for Accountancy
services (£2.76 less per hour).
Based on the services provided in the period just ended, this
had an overall impact of a loss of £3 368 ((2 000 × 0.8)–(1 800
× 2.76)). Paloma’s total costs for the period were £166 400
(£114 000 overheads and (2 000 × 10) + (1 800 × 18) staff
50
costs). Its total income was £188 000 ((2 000 × 40) + (1 800 ×
60)). This means that despite the overall loss of £3 368 costs
have still been fully covered.
Therefore Paloma will have to consider whether it is worthwhile
altering their current prices. It is clearly a competitive market
so it is unlikely that a substantial price increase would be
appropriate. If current demand levels are to remain and be
unaffected by any price changes, it would be possible for
Paloma to maintain its bookkeeping price and slightly increase
its accountancy prices from £60 to £62 to increase profits
(£3 368/1 800=£1.87 rounded to nearest £).
51

Dodo
(a) i. Under absorption costing
OAR = £190 000/67 000 = £2.836 per hour
A B C
£ per unit £ per unit £ per unit
Direct cost 15.00 15.00 15.00
Overheads 5.67 2.84 2.84
Total cost 20.67 17.84 17.84
Price 20.00 20.00 20.00
Profit (0.67) 2.16 2.16
ii.
Machine costs = £55 000/(40 000+50 000+4 000)
= £0.5851 per machine hour
Production planning = £40 000/(10 + 13 + 2)
= £1 600 per production run
Quality control = £25 000/(10 + 13 + 2)
Set-up costs = £25 000/(10 + 13 + 2)
Receiving = £30 000/(10 + 10 + 2)
= £1 363.64 per component receipt
Packing = £15 000/(20 + 20 + 20)
= £250 per customer order
Note: Other cost drivers, especially for quality control,
seem possible, and, if justified, would gain equal credit.
52
A B C Total
£ £ £ £
Machine costs 23 404 29 255 2 341 55 000
Production 16 000 20 800 3 200 40 000
planning1
Quality control 10 000 13 000 2 000 25 000
Set-up costs 10 000 13 000 2 000 25 000
Receiving 13 636 13 636 2 728 30 000
Packing 5 000 5 000 5 000 15 000
Total overhead 78 040 94 691 17 269 190 000
costs
Units produced 20 000 25 000 2 000
Overhead £3.90 £3.79 £8.63
cost/unit
1. Example of calculation for A:
Cost driver rate
= (£1 600 per production run) × No of production runs
(10)
= £16 000
A B C
£ £ £
Direct materials 5.00 10.00 10.00
cost per unit
Direct labour cost 10.00 5.00 5.00
per unit
Production 3.90 3.79 8.63
overhead cost per
unit
Total cost per unit 18.90 18.79 23.63
Sales price 20.00 20.00 20.00
Profit per unit 1.10 1.21 (3.63)
(b) Implications for management
Indicates that, at current prices, C is not profitable, whilst A and
B are. Contrast this to the traditionally derived cost data which
suggested A was a loss-maker, with B and C profitable. This is
due to the disproportionate (relative to its volume) consumption
of cost drivers by C, compared to B and especially A.
53
Indicates a possible need for a changed pricing structure if Dodo

wish to maintain the product range and product costs cannot be
altered. If C’s price cannot be raised by near to £4 (a 20% rise)
they will require product cost reductions for it to show a profit;
or Dodo could accept a loss by, for example, cross-subsidising it
with profits on other products, especially if prices are essentially
‘market driven’.
Even though C does make a loss, management would need to
carefully assess the savings in costs that could actually be
realised if C were discontinued, remembering that ABC is a
resource consumption rather than an expenditure model and
hence the full costs of C may not be saved if C were not
manufactured.
Identifies the means by which cost can be managed by having
specified their causes, i.e. the cost drivers (e.g. number of
orders, production runs, etc.). Can use cost driver rates as
performance indicators and judge the efficiency of processes
like quality control. Gives vital information both for current
processes, customers served and products manufactured, but
also for the design of new products, or product variations, by
giving clearer picture of the full cost implications of such
developments.
Whether it is worth developing an ABC system depends greatly
on the need for more accurate product cost information for both
measurement and management purposes. This depends mainly
on the type, and level, of competitive pressures faced by Dodo
for products A, B and C. If competition is quite intense and/or
unpredictable, it is probably important for Dodo to develop the
ABC approach and to use the information to support pricing and
future product development and mix decisions. The level of
competition is the key factor for Dodo as it determines whether
inaccurate cost information per se matters greatly. The diversity
of the products indicates that product costs under ABC would be
substantially different, although there are only 3 products,
which may be reason enough to move to ABC, but the need for
change depends on their competitive environment.
54
Abracadabra
(a) Total direct material cost =
(30 000 × £25) + (20 000 × £20) + (8 000 × £11) =
£1 238 000
Materials handling OAR = £435 000/£1 238 000 = 35.14%
Total machine hours =
(30 000 × 11/3) + (20 000 × 1) + (8 000 × 2) = 76 000
Other overheads = £1 848 000 – £435 000 = £1 413 000
Machine hour rate = £1 413 000/76 000 = £18.59 per machine
hour
Product costs are therefore:
X (£) Y (£) Z (£)

Labour 8.00 12.00 6.00
Materials 25.00 20.00 11.00
Overhead1 8.78 7.03 3.87 (Materials handling)
2 24.79 18.59 37.18 (Machine hours)
Total 66.57 57.62 58.05
1. 35.14% × product's direct material cost.
2. Machine hour rate ×number of machine hours.
(b)
Activity Cost per driver

Set-up costs £30 000/30 £1 000 per production run
Machine hours £760 000/76 000 £10 per machine hour
Receiving £435 000/270 £1 611 per receipt
costs
Packing £250 000/32 £7 812 per customer
delivery
Engineering £373 000/50 £7 460 per production order
Note: Other cost drivers may be reasonable.
The share of a support department's cost is traced to each unit
of output for each product as follows:-
Number of transaction per product
Cost per transaction ×
No of units produced
55
The unit costs are therefore:
X (£) Y (£) Z (£)

Direct labour 8 12 6
Direct materials 25 20 11
Machines 13.33 10 20
Set-up1 0.10 0.35 2.50
Receiving2 0.81 2.82 44.30
Packing3 2.34 1.17 19.53
Engineering4 3.73 3.73 23.31
Total 53.31 50.07 126.64
Price 80 70 72
1. X = £1 000 × 3/30 000 etc.
2. X = £1 611 × 15/30 000 etc.
3. X = £7 812 × 9/30 000 etc.
4. X = £7 460 × 15/30 000 etc.
(c) Traditional product costing systems assume products consume
resources in relation to volume measures such as direct labour
or machine hours. The ABC system recognises that some
overheads are unrelated to production volume, and thereby
uses cost drivers that are independent of production volume.
For instance: under ABC, the low-volume product Z receives the
following percentage of costs:
Set-up related costs: 66.67% (20/30)
Delivery related costs: 62.5% (20/32)
Receiving costs: 81.5% (220/270)
Engineering related costs: 50% (25/50)
In contrast, the current system assigns the cost of the above

activities according to production volume (machine hours), of
which product Z has only 21% of volume (16 000 of 76 000
machine hours). Hence the traditional system, undercosts the
low volume product Z, and the high volume product X is
overcosted; for instance, 53% of these costs (40 000 of 76 000
machine hours) are traced to X with the current system,
whereas ABC assigns a much lower proportion of non-
volumerelated costs to this product. This explains the currently
low reported profit margins.
56
The main issues for the company to consider are:
 Can Z sustain a large price rise in excess of 70% to make it

profitable?
 Should instead Z be scrapped (but what costs are really

saveable?) or only offered in even more limited quantities
to those customers prepared to pay a price around or
above £130 a unit?
 Should price cuts be considered for X and Y?
 Is there scope for rationalisation of activities, change in

operations to reduce support costs, e.g. need for so many
component receipts?
An overarching issue is the nature/extent of the competition for
each of the products which will strongly affect scope for price
changes mentioned above and the need for more accurate costs
as an input to pricing decisions.
57

Devo
(a) Overhead absorption
MACHINERY FITTING
(£000) (£000)
Direct cost 2 500 2 000
Apportioned overheads 6 500 4 000
Total cost 9 000 6 000
Total direct labour hours 1 100 000 350 000
Overhead absorption rate £8.182 per £17.143 per
direct direct
labour labour hour
hour
PRODUCT A PRODUCT B
£ £
Machinery department: 4 091 000
500 000 x 8.182
Machinery department: 4 909 200
600 000 x 8.812
Finishing department: 2 571 450
150 000 x 17.143
Finishing department: 3 428 600
200 000 x 17.143
Total costs 6 662 450 8 337 800
Volume 300 000 300 000
Unit cost (overhead) £22.21 £27.79
58
Activity based costing
Cost Cost driver Cost driver rate

(£000) volume
Material 1 500 2 540 material £590.55 per
handling movements material
movement
Material 2 000 6 500 orders £307.69 per
procurement order
Set up 1 500 624 set-ups £2 403.85 per
set-up
Maintenance 2 500 30 000 maintenance £83.33 per
hours maintenance hour
Quality control 3 000 4 120 inspections £728.16 per
inspection
Machinery 2 500 1 100 000 direct £2.27 per direct
labour hours labour hour
Fitting 2 000 350 000 direct £5.71 per direct
labour hours labour hour
Part 1 and 2 (Product A)
Cost
(£000)
Materials handling 340 × £590.55 = 200 787
Material procurement 500 × £307.69 = 153 845
Set up 24 × £2 403.85 = 57 693
Maintenance 12 000 × £83.33 = 999 960
Quality control 720 × £728.16 = 524 275
Machinery 500 000 × £2.27 = 1 135 000
Fitting 150 000 × £5.71 = 856 500
Total cost 3 928 060
Production volume (units) 300 000
Unit overhead cost £13.09
59
Part 3 and 4 (Product B)
Cost
(£000)
Materials handling 2 200 × £590.55 = 1 299 210
Material procurement 6 000 × £307.69 = 1 846 140
Set up 600 × £2 403.85 = 1 442 310
Maintenance 18 000 × £83.33 = 1 499 940
Quality control 3 400 × £728.16 = 2 475 744
Machinery 600 000 × £2.27 = 1 362 000
Fitting 200 000 × £5.71 = 1 142 000
Total Cost 11 067 344
Production volume for 300 000
(units)
Unit overhead cost £36.89
(b) From the cost driver analysis it can be seen that B consumes
much more of the five overhead activities than A. This could be
reflected if Activity Based Costing were used. Instead, with
overhead absorption, the cost of the overhead activities is
shared according to the direct labour time of each product; B
would still have a higher amount of overhead attributed to it,
but a much lower share than with Activity Based Costing.
Product B, with its customised production, complexity, and
shorter, more numerous production runs, causes much more of
the overhead, and only with the use of Activity Based Costing
will this be reflected in the final unit costs. The use of direct
labour hours in the conventional system causes an inaccuracy in
product costings of about £9 a unit:
Unit
Costs
A B
£ £
Absorption Costing 22.21 27.79
Activity Based Costing 13.09 36.89
Activity Based Costing would be very useful for Devo, leading to
better awareness of costs incurred in production and potentially
better decision-making, for example, concerning pricing and
product mix. If, for Devo, the indirect costs are a significantly
high proportion of overall costs, the benefits are clear. There
60
are practical problems likely to be encountered. In selecting

cost pools, costing systems must be capable of generating costs
for each pool, and then volumes of chosen cost drivers must be
measurable and systematically generated. A problem here is
that it is often impractical to choose enough cost pools to
ensure that they are sufficiently homogeneous for one cost
driver to be applied to the cost pool. The extent to which a
single cost driver does reflect the cost behaviour of a pool needs
continual monitoring.
The measurability of cost drivers is crucial, and likely to be
difficult for many more corporate, top level managerial
activities. Finally, it is doubtful whether Activity Based Costing
can totally overcome the problem of cost commonality when
applying cost driver rates to product costs, as cost drivers will
tend to relate to several products. For instance, a purchase
order is often likely to contain items used on many different
product lines. The cost of that order is then not specific to one
product, but will have to be spread over all relevant products in
some way.
61

Quaffers
(a) (i) Option 1:
Recharge per staff nos. = £2 500 000/1 000 = £2 500 per
person
Recharge to divisions:
Wine shops Wine importing Courses
£2 000 000 £250 000 £250 000
(ii) Option 2:
Firstly determine total costs of each activity by allocating
and apportioning the cost items to the activities defined in
the question:
Activity Apportioned
Staff Direct office
cost1 costs2 supplies3 Total
(£) (£) (£) (£)
Recruitment 450 000 300 000 62 500 812 500

Disciplinary hearings 216 000 50 000 30 000 296 000
Staff grievances 108 000 15 000 123 000
Staff leavers 90 000 12 500 102 500
Appraisals 90 000 12 500 102 500
Internal courses 306 000 50 000 42 500 398 500
Personnel 360 000 50 000 50 000 460 000
administration
Queries 180 000 25 000 205 000
1 800 000 450 000 250 000 2 500 000
1. Apportioned according to productive time estimates

given in question
2. Cost items that are directly identifiable with, and so
have been allocated directly to, the relevant activities.
3. Apportioned on staff cost data as office supplies likely
to be used by staff, but other appropriate bases would
be acceptable.
Secondly, re-apportion costs of personnel administration,
to other activities and determine the cost drivers:
62
Cost Personnel
carried administration
forward apportioned1 Total Cost Cost driver
£ £ £ driver2 rate
Recruitment 812 500 183 211 995 711 Recruits £995 711/450
Disciplinary, 521 500 117 593 639 093 Staff £639 093/
Grievances numbers 1 000
and
Appraisals
Leavers 102 500 23 113 125 613 Leavers £125 613/550
Courses 398 500 89 858 488 358 Training £488 358/
days 3 500
Queries 205 000 46 225 251 225 Time £251 225/
spent 100%
2 040 000 460 000 2 500 000
1. Personnel administration apportioned pro-rata to cost

of activities. Other methods could be suitable e.g.
proportional to staff costs.
2. It is unlikely that other cost drivers could be
adequately justified other than those listed.
Thirdly, resulting apportionments to each business division:
WS (£) WI (£) WTC (£)

Per recruit (£2 212.69) 929 330 11 064 55 317
Per staff member (£639.09) 511 275 63 909 63 909
Per leaver (£228.39) 114 193 5 710 5 710
Per training day (£139.53) 418 592 30 697 39 069
% (70/20/10) 175 858 50 245 25 122
Total 2 149 248 161 625 189 127
(b) Possible developments might include:
 use of service level agreement
 breaking activities into greater detail (example needed)

− e.g. different types of recruitment
− training activities
− disciplinaries
63
 Identifying better cost drivers (example needed)

− e.g. disciplinary hearings need to relate to the activity
rather than being spread across all staff. Other similar
areas such as grievances, payroll, etc.
 Considering whether reciprocal services should be

accounted for by briefly outlining repeated
distribution/specified order of closure methods and their
costs/benefits.
64

Alpha
(a) i.
Absorption costing Period 1 Period 2
Sales (6 000 × £120) 720 000 (9 000 × £120) 1 080 000

Cost of Sales
Opening inventory (2 000 × £72) (144 000) (8 000 × £72) (576 000)
production (12 000 × £72) (864 000) (3 000 × £72) (216 000)
closing inventory (8 000 × £72) 576 000 (2 000 × £72) 144 000
Cost of sales (432 000) (648 000)
(under)/over 0 × £12 0 9 000 × £12 (108 000)
absorption of overhead
(432 000) (756 000)
Gross Profit 288 000 324 000
Non-manufacturing (60 000) (60 000)
costs
Net Profit 228 000 264 000
(a) ii.
Marginal costing Period 1 Period 2
Sales (6 000 × £120) 720 000 (9 000 × £120) 1 080 000

Variable cost of
sales
Opening inventory (2 000 × £60) (120 000) (8 000 × 60) (480 000)
production (12 000 × £60) (720 000) (3 000 × £60) (180 000)
closing inventory (8 000 × 60) 480 000 (2 000 × £60) 120 000
Variable cost of sales (360 000) (540 000)
Fixed costs
Production (144 000) (144 000)
Selling, distribution (60 000) (60 000)
and admin costs
Profit / (loss) 156 000 336 000
(b) The difference in profit is due to the valuation in inventory. The

marginal costing approach values inventory at £60 per unit.
Whereas the absorption approach values inventory at £72 per
unit.
65
For January the difference is profit is (£228 000 – £156 000) =

£72 000. This can be reconciled back as:
6 000 units of inventory movement x £12 per unit overhead
rate = £72 000.
(c) i. For absorption costing:
 Does not understate the importance of fixed costs

 Avoids fictitious losses being reported (seasonal sales)
 Technically superior (matches costs to sales)
ii. For marginal costing
 Useful for decision making
 Removes effect for inventory changes from profit
 Avoids fixed costs being capitalised in un-saleable

inventory
66

Adams
(a)
VARIABLE COST PER UNIT: £

Direct Labour 7
Direct Materials 9
Production overheads 2
Total 18
Quarterly fixed production overhead
= (200 000/4 x £8 x 75%) = £300 000
Q1 Q2 Q3 Q4
Opening 0 10 000 25 000 25 000
inventory
Production 50 000 60 000 50 000 40 000
Sales (40 000) (45 000) (50 000) (65 000)
Closing 10 000 25 000 25 000 0
inventory
Marginal costing statement
Q1 Q2 Q3 Q4
£ £ £ £
Sales 1 400 000 1 575 000 1 750 000 2 275 000
Cost of sales:
Opening inventory 0 (180 000) (450 000) (450 000)
Production (900 000) (1 080 000) (900 000) (720 000)
(£18/unit)
Closing inventory 180 000 450 000 450 000 0
Total cost of sales (720 000) (810 000) (900 000) (1 170 000)
Contribution 680 000 765 000 850 000 1 105 000
Fixed production (300 000) (300 000) (300 000) (300 000)
Selling and (400 000) (400 000) (400 000) (400 000)
distribution
Profit / (loss) (20 000) 65 000 150 000 405 000
67
Absorption costing statement
Q1 Q2 Q3 Q4
£ £ £ £
Sales 1 400 000 1 575 000 1 750 000 2 275 000

Cost of sales
Opening 0 (240 000) (600 000) (600 000)
inventory
Production (1 200 000) (1 440 000) (1 200 000) (960 000)
(£24/unit)
Closing inventory 240 000 600 000 600 000 0
Total Cost of (960 000) (1 080 000) (1 200 000) (1 560 000)
sales
Over / (under) 0 60 000 0 (60 000)
absorption
Gross profit 440 000 555 000 550 000 655 000
Selling and (400 000) (400 000) (400 000) (400 000)
distribution
Profit / (loss) 40 000 155 000 150 000 255 000
(b)
Q1 Q2 Q3 Q4
Fixed cost/unit (£) 6 6 6 6
Movement in inventory 10 000 15 000 0 (25 000)
(units)
Marginal profit (£) (20 000) 65 000 150 000 405 000
Change in fixed 60 000 90 000 0 (150 000)
overhead inventory
valuation (£)
Absorption profit (£) 40 000 155 000 150 000 255 000
68

XYZ
(a)
£
Variable production cost per unit 98.00
Non production variable cost 42.00
(15% of sales price)
Production absorption cost per Ratchet 138.00
Fixed costs for the period (£40 × 32 000) (or 1 280 000
£640 000 per 6 month period)
i. Profit statements using absorption costing
Period to Period to Period to

30/6/13 1/12/13 1/12/13
£000 workings £000
Sales revenue 3 920 (16 000 × £280) 4 480
(14 000 × £280)
Cost of sales:
Opening inventory - (3 000 × £138) (414)
Production cost (2 346) (14 000 × £138) (1 932)
(17 000 × £138)
Closing inventory 414 (1 000 × £138) 138
(3 000 × £138)
Total cost of sales (1 932) (2 208)
(Under)/over recovery of 40 (2 000 × £40) (80)
fixed overheads
(£40 × 1 000)
Gross Profit 2 028 2 192
Variable non-production (588) (£42 × 16 000) (672)
costs (£42 × 14 000)
Fixed non-production costs (180) (180)
Profit 1 260 1 340
69
ii. Profit statements using marginal costing
Period to Period to Period to

30/6/13 1/12/13 1/12/13
£000 workings £000
Sales revenue 3 920 4 480
Cost of sales:
Opening inventory - (3 000 × £98) (294)
Production cost
(17 000 × £98) (1 666) (14 000 × £98) (1 372)
Closing inventory 294 (1 000 × £98) 98
(3 000 × £98)
Total cost of sales (1 372) (1 568)
Variable non-production (588) (£42 × 16 000) (672)
costs (£42 × 14 000)
Fixed costs (820) (820)
(£180 + £640)
Profit 1 140 1 420
(b) Statement to reconcile the profits using alternative costing

methods
Period to Period to
30/6/13 1/12/13
£000 £000
Marginal costing profit 1 140 1 420
Fixed production overhead 120 (£40 × 2 000) (80)
absorbed in changes in
inventory (£40 × 3 000)
Absorption costing 1 260 1 340
profit
(c)
 Absorption costing must be used for inventory valuation in

published accounts, under IAS 2.
 Marginal costing distinguishes between fixed and variable

costs and therefore for decision making purposes, allows
managers to focus on those costs that will change as a
result of a decision. Many fixed costs will not change and as
such should not influence the decision making process.
70
 If absorption costing were to be used in order to make

decisions there is a danger that the incorrect decision may
result because fixed overhead absorption rates treat fixed
costs as if they were variable by calculation of unit costs.
 Marginal costing relies on being able to separate fixed and

variable costs. This may not be possible for all
organisations.
 Marginal costing may have little relevance in industries

where the majority of the total cost is fixed, such as, for
example advanced manufacturing technologies.
 An element of subjectivity exists when apportioning fixed

costs and deciding on an appropriate basis to calculate an
overhead absorption rate.
 Marginal costing can be useful in flexible budgeting, where

separation of fixed and variable cost elements allows more
effective budget control comparisons.
 As there is an element of fixed overhead that is carried

forward to the next period in closing inventory values, the
analysis and understanding of absorption costing profit
statements may cause confusion in periods where
inventory levels are changing. In marginal costing the
variability in profit levels results directly from changes in
the level of sales revenue and cost levels.
 When pricing decisions are made, marginal costing takes a

short term view. In the longer term all costs have to be
covered and as such absorption costing may be more
suitable.
71
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London E1 8AN
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Website: www.cipfa.org.uk
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MANAGEMENT ACCOUNTING

COST BEHAVIOUR AND COST

Updated January 2018

Valid for exams in 2018

First published 2016

Copyright © 2016 Chartered Institute of Public Finance and Accountancy

All rights reserved. No part of this publication may be reproduced, stored in

Exercise Solution 2.1

 Record each purchase as a new column

 Record each purchase as a new column

Value of closing inventory = (20 × £5) = £100

Issues to production = (80 × £5) + (50 × £5.5) + (50 × £6) =

 Record each movement in and out of inventory as a new

 After each purchase recalculate the total value of inventory

Exercise Solution 2.2

Exercise Solution 2.3

 Calculate the normal loss

4 104 59 020 4 104 59 020

Normal loss 604 3 020 Scrap 500 2 500

604 4 164 604 4 164

(b) 3 300 units

4 000 57 356 4 000 57 356

Normal loss 604 3 020 Scrap 700 3 500

700 4 556 700 4 556

Exercise Solution 2.4

 Calculate the actual units of WIP

 Calculate the EUs for each type of input

 Calculate the Cost per EU for each type of cost

 Value completed units and closing WIP and draw up process

Actual Labour and

Completed 7 750 7 750 EU 7 750 EU

8 200 16 995 8 200 16 995

Exercise Solution 2.5

 Find the final sales value of each product

Product X Product Y Product Z Total

Product X Product Y Product Z

PRODUCT X PRODUCT Y PRODUCT TOTAL

Sales revenue 96 000 72 000 86 400 254 400

Sales revenue 96 000 72000 86400 254 400

Product X Product Y Product Z

Total costs 71 640 35 520 32 040

Total costs 48 600 64 320 26 280

Total costs 53 100 38 400 47 700

Exercise Solution 2.6

FINANCE MAINTENANCE PROCESSING ASSEMBLY

FINANCE MAINTENANCE PROCESSING ASSEMBLY

FINANCE MAINTENANCE PROCESSING ASSEMBLY

Substituting m into f, gives an equation of:

Expanding the equation gives:

Rearranging this gives: 0.99f = £85 500

Substituting this value of f into m, gives an equation of:

 All three methods apportion 100% of the overheads to the two

 The three methods produced two different suggestions for

 The result obtained using specified order of closure differed by

 Easy to use as return charges are not made.

 Acknowledges partial inter-service department apportionments

 Takes full account of inter-servicing departments.

 More complex to use, especially as an organisation is likely to

 The costs are apportioned to service departments on the basis

 The method does not acknowledge the existence of fixed and

 Overheads are apportioned to production departments but the

Exercise Solution 2.7

PROCESSING AND QUALITY PACKAGING

Apportioned over 6 000 hours = £43.68 per hour