CHAPTER 7: COST DETERMINATION

SUGGESTED SOLUTIONS
SOLUTION TO MULTIPLE CHOICE QUESTIONS
7.1 (d) 7.6 (d) 7.11 (c)
7.2 (c) 7.7 (c) 7.12 (b)
7.3 (b) 7.8 (b) 7.13 (c)
7.4 (d) 7.9 (d) 7.14 (a)
7.5 (d) 7.10 (d) 7.15 (d)

END OF CHAPTER QUESTIONS

7.1
Financial accounting is designed to provide information to a range of potential users, most
specifically the investors (owners), potential investors, and creditors. The information is used
mainly to make decisions relating to the expected returns and risks of investing in the
company or of extending loans. Other users are also privy to the information in the case of
listed companies.
Management information, while drawing on a similar data base of past transactions, is aimed
specifically at those who manage the company, at various levels. It is used for the purpose of
planning, co-ordinating and controlling the activities of the business.

7.2
Planning: Every business needs a plan, starting at a broad strategic plan, which identifies the
mission, objectives and goals of the company. As these are defined, the plan cascades down
to budgets for all areas and departments of the business, which serve as a type of map of
where the business is planning to operate and offers a focus on the resources which it plans
to invest in achieving its goals.
Organising: This is a management function, requiring actions, which lead to achieving the
objectives and goals. Top management will allocate responsibilities to individuals at all levels
of the business, designed to ensure that there is an orderly progression of achievement.
Control: Management accounting information enables managers who are responsible for
achieving goals, to monitor the effectiveness of the plans, which were made. If offers feedback
as to the success and achievement. This is done timeously in the form of feedback and
reports. Management are then expected to act, in order to correct deviations from the plan.

7.3
Fixed costs do not change with the production output, within a defined range. So for example
a factory which manufacture sprinklers or valves used in irrigation, may be able to
manufacture a maximum of 100 000 units. The fixed costs will then be constant regardless of
the output up to 100 000 units (the relevant range). Should they plan to manufacture 200 000
units, then clearly a larger factory, with more machinery will be required, which will increase
the fixed costs, such as rent, depreciation on machinery and factory managers salaries.
Variable costs are those that only change with the number of units of output. Continuing with
the example of sprinklers or valves, all of which have component parts, it is evident that the
more units manufactured, the greater will be the cost as more component parts will be
required.
Of particular significance is the fact that the unit cost of production will be increase, as the
number of units decreases and vice-versa, because fixed costs are divided between the
number of units manufactured.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 1

7.4
Inventory of Raw Materials: All production requires raw materials, which are kept on hand,
awaiting the materials requisition from the factory.
Inventory of Work in Progress: Once raw materials have moved onto the factory floor,
the manufacturing process begins. Value is added to the raw materials through labour and the
application of other factory overheads as it moves toward becoming a finished product. While
on the factory floor, the partially competed units constitute work in progress.
Inventory of Consumables: materials such as oils, cleaning materials, stationery, and other
tangible items necessary for the smooth running of the factory support most production
processes. These materials often referred to generically as "consumables" are drawn from
inventory from time to time, as they are needed. In order to ensure that stoppage time is not
required, they are maintained as an inventory, available on request.
Inventory of Finished Goods: Once the production process is completed, units move from
being work in progress, to the retail floor, or to store rooms awaiting sale. Finished items, not
yet sold constitute the inventory of finished goods.

7.5
The concept that both LIFO and FIFO are "notional" is fundamental to understanding how they
are applied. Notional means that the actual physical item does not have its cost price attached
to it in any way. It is just an item, and it is "imagined" that the cost attached to it is used in a
specific order. LIFO means that the last item in (at whatever it cost) is the first item out. The
cost assigned to that sale will therefore be the cost of the last item purchased. FIFO means
that the first (or earliest item at its cost) is the first item to be sold. The cost assigned to that
sale is therefore the cost of the earliest item of stock, which was still on hand at the time of
sale.
LIFO can be imagined as a bin where items are loaded and the bin gets more and more full.
When an item is sold, the one at the top of the bin is being sold (ie the last one purchased), at
its cost. FIFO can be imagined as a shelf, where the packer packs from behind. The first item
purchased therefore moves to the front of the shelf and is sold first, at its cost.
If the cost of items purchased never changed, there would be no difference between the cost
of sales under LIFO or FIFO. However, under inflationary conditions, for example, the cost of
items is gradually increasing. Using LIFO, the latest price will always be the cost of the sale (a
higher price), making the profit seem smaller when reported. Compare this with FIFO, where
the earlier (lower) price is considered to be the cost of the sale, this reporting a higher profit on
the sale of that item.

7.6
Variable costing treats only the variable costs as cost assigned to the product. Fixed costs are
treated as a cost for the period, and are written off in full as expenses for the period. Full
costing develops a notional absorption basis and assigns fixed costs to the product on that
basis. This enables all products (and therefore job lots, contracts etc) to be fully priced. There
is no difference between the two methods if only a single product is being manufactured and
there is never any inventory on hand at the end of the period. However, this is seldom the
case in practice.
Assume a factory produces 100 items (no opening inventory). Fixed costs are R100 and
variable costs are R5 per item. Items are sold at R9 per unit and 80 units are sold.
The figures which follow demonstrate how fixed costs are treated as a period cost in the case
of variable costing, but are assigned to each unit in the case of full costing. This affects the
reported net income, in the income statement and the reported cost assigned to closing
inventory in the balance sheet. The balance sheet number is carried forward to the following
period as the cost assigned to opening inventory.
It is worth noting that these are representations of reality (the "art" aspect of accounting), in
that both methods are reflecting identical events and present conditions. Stated differently, the
reported numbers attempt to reflect the same reality, yet lead to different figures for exactly the

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 2

 same phenomena. Both situations have sold 80 items and have 20 on hand. It is also worth
noting, that in any given period, the cost of production (purchases) plus the cost assigned to
inventory on hand will always be identical, regardless of the costing method used.

PRODUCTION COST STATEMENT

Variable
Full Costing
Costing
Units 100 100
Variable Costs [100 units] 500 500
Fixed Costs 100 100
Total Manufacturing Cost 600 600
Factory cost per unit R 5.00 R 6.00
INCOME STATEMENT
Units 80 80
Sales [80 units @ R9] R 720.00 R 720.00
Less Total Costs R 500.00 R 480.00
Variable R 400.00 R 480.00
Fixed R 100.00
Net Profit R 220.00 R 240.00
BALANCE SHEET
Units 20 20
"Value" of Inventory on hand [20] R 100.00 R 120.00

Total Costs PLUS Inventory R 600.00 R 600.00

7.7
Three typical fixed overhead costs are:
 Rent of factory
 Depreciation of Machinery
 Salary of permanent staff
Possible methods of fixed cost allocation (all with shortcomings) are:
 Material used based on price or volume
 Direct labour hours
 Floor space
 Machine hours
 Any other measurable base, which has some connection with resources used
7.8
 Material requisitions form: Defines the raw materials to be issued by the inventory
clerk and serves as a record of the movement of materials

 Labour job card: Records the time spent on specified job to enable direct labour costs
to be allocated

 Job Order Cost Sheet: Offers a summary of all costs incurred in completion of the job
and serves as a control record as well as, in certain instances, information on which to
base the selling price.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 3

7.9 BRUER SHOWER DOOR (PTY) LTD

BRUER SHOWER DOORS (PTY) LTD

QUANTITY MANUFACTURED
COSTS TYPE 300 500 700 1,000
Cost of material R 27.00 V 8,100 13,500 18,900 27,000
Depreciation R 4,900.00 F 4,900 4,900 4,900 4,900
Fixed operating expenses R 2,350.00 F 2,350 2,350 2,350 2,350
Variable operating expenses R 18.00 V 5,400 9,000 12,600 18,000
Selling commission R 20.00 V 6,000 10,000 14,000 20,000
Total cost 27,050 40,250 53,450 73,250
Cost per unit produced R 90.17 R 80.50 R 76.36 R 73.25

7.10 NATURAL STONE WAREHOUSE LTD

(a)

NATURAL STONE WAREHOUSE LTD

QUANTITY MANUFACTURED
COSTS TYPE 1,000 1,500 2,000 3,000
Cost of material R 7.35 V 7,350 11,025 14,700 22,050
Depreciation R 8,800.00 F 8,800 8,800 8,800 8,800
Fixed operating expenses R 95,000.00 F 95,000 95,000 95,000 95,000
Variable operating expenses R 1.80 V 1,800 2,700 3,600 5,400
Selling commission R 15.00 V 15,000 22,500 30,000 45,000
Total cost 127,950 140,025 152,100 176,250

Cost per unit produced R 127.95 R 93.35 R 76.05 R 58.75

(b) The unit cost falls as the quantity manufactured increases, because the fixed costs do not vary
with production and are thus spread over a larger number of units making the cost per unit fall.
For example (see the table which follows), when 1 000 units are manufactured, the fixed cost
per unit is R103.80, but when 3 000 units are produced, the fixed cost per unit falls to R34.60.
This is a very significant principle in cost and management accounting.

Compilation of total cost per unit QUANTITY MANUFACTURED

1,000 1,500 2,000 3,000
Total fixed costs 103,800 103,800 103,800 103,800
Total variable cost 24,150 36,225 48,300 72,450
Total cost 127,950 140,025 152,100 176,250
Fixed cost per unit [Note this line] 103.80 69.20 51.90 34.60
Variable cost per unit 24.15 24.15 24.15 24.15
Total cost per unit R 127.95 R 93.35 R 76.05 R 58.75

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 4

7.11 PERSPEX PRODUCTS LTD
(a) Cost of goods transferred to the factory and inventory "value" at month end

Opening Material Material to Ending COST OF

LIFO Inventory Purchased Factory Inventory
COST TO
ENDING TOTAL
FACTORY
INVENTORY
Units Price Units Price Units Price Units Price
JANUARY 500 10 1,800 13 1,800 13 500 10
800 12 100 12 700 12

1,300 1,800 1,900 1,200 24,600 13,400 38,000

FEBRUARY 500 10 2,000 14 2,000 14 500 10

700 12 100 12 600 12
1,200 2,000 2,100 1,100 29,200 12,200 41,400

MARCH 500 10 2,400 15 2,000 15 500 10

600 12 600 12
400 15 30,000 18,200 48,200
1,100 2,400 2,000 1,500

Opening Material Material to Ending COST OF

FIFO Inventory Purchased Factory Inventory
COST TO
ENDING TOTAL
FACTORY
INVENTORY
Units Price Units Price Units Price Units Price
JANUARY 500 10 1,800 13 500 10 1,200 13
800 12 800 12
600 13
1,300 1,800 1,900 22,400 15,600 38,000

FEBRUARY 1,200 13 2,000 14 1,200 13 1,100 14

900 14
2,100 28,200 15,400 43,600

MARCH 1,100 14 2,400 15 1,100 14 1,500 15

900 15
2,000 28,900 22,500 51,400
(b)
Under LIFO, when there are inflationary conditions, (which is most normal), the recorded cost to the
production process is higher than under FIFO, while the reported Rand figure for the asset of Inventory
on hand is always lower. This means that the cost to production (reflected in the Production Cost
Statement) is generally accepted to be more accurate (in that it is closer to the cost of replacing the
inventory used), while the asset Inventory on hand (reported in the Balance sheet), is generally under
valued, as it is reflected at a cost price in the past. The opposite tends to be true if FIFO is used.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 5

7.12 JICTAR ELECTRONICS (PTY) LTD
(a) Using Perpetual Inventory Principles

PERPETUAL INVENTORY [PER PURCHASE OR SALE]

Opening Items COST OF
LIFO Items Sold Ending Inventory
Inventory Purchased PURCHASES

Units Price Units Price Units Price Units Price

20 2 40 20 20 @ 2 R 40
1 60 3 180 80 20 @ 2 60 @ 3 R 220
2 35 4 140 115 20 @ 2 60 @ 3 35 @ 4 R 360
3 30 85 20 @ 2 60 @ 3 5 @ 4 R 240
4 40 5 200 125 20 @ 2 60 @ 3 5 @ 4 40 @ 5 R 440
5 50 75 20 @ 2 55 @ 3 0 @ 4 0 @ 5 R 205
6 100 4 400 175 20 @ 2 55 @ 3 100 @ 4 0 @ 5 R 605
7 60 115 20 @ 2 55 @ 3 40 @ 4 0 @ 5 R 365
COST OF ALL PURCHASES R 960
COST OF SALES R 595
COST OF CLOSING INVENTORY R 365

Opening Items
FIFO Items Sold Ending Inventory
Inventory Purchased
Units Price Units Price Units Price Units Price
20 2 40 20 20 @ 2 R 40
1 60 3 180 80 20 @ 2 60 @ 3 R 220
2 35 4 140 115 20 @ 2 60 @ 3 35 @ 4 R 360
3 30 85 0 @ 2 50 @ 3 35 @ 4 R 290
4 40 5 200 125 0 @ 2 50 @ 3 35 @ 4 40 @ 5 R 490
5 50 75 0 @ 2 0 @ 3 35 @ 4 40 @ 5 R 340
6 100 4 400 175 0 @ 2 0 @ 3 135 @ 4 40 @ 5 R 740
7 60 115 0 @ 2 0 @ 3 100 @ 4 15 @ 5 R 475
COST OF ALL PURCHASES R 960
COST OF SALES R 485
COST OF CLOSING INVENTORY R 475

(b) Using Periodic Inventory Principles

PERIODIC INVENTORY [PER PURCHASE OR SALE]

Opening Items COST OF
LIFO Items Sold Ending Inventory
Inventory Purchased PURCHASES

Units Price Units Price Units Price Units Price

20 2 40 20 20 @ 2 R 40
1 60 3 180 80
2 35 4 140 115
No continuous records are kept. The earliest
3 30 85
records or purchase form the basis for
4 40 5 200 125
assigning costs.
5 50 75
6 100 4 400 175
7 60 115 20 @ 2 60 @ 3 35 @ 4 0@ 5 R 360
COST OF ALL PURCHASES R 960
COST OF SALES R 600
COST OF CLOSING INVENTORY R 360

Opening Items
FIFO Items Sold Ending Inventory
Inventory Purchased
Units Price Units Price Units Price Units Price
20 2 40 20 20 @ 2
1 60 3 180 80
2 35 4 140 115
No continuous records are kept. The latest
3 30 85
records or purchase form the basis for
4 40 5 200 125
assigning costs.
5 50 75
6 100 4 400 175
7 60 115 0@ 2 0@ 3 100 @ 4 15 @ 5 R 475
COST OF ALL PURCHASES R 960
COST OF SALES R 485
COST OF CLOSING INVENTORY R 475
(c) The implications of selecting between periodic inventory and perpetual inventory method.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 6

 The report based on the experiment with the one line item ALECAB 245should make the
following points:

 Clearly perpetual inventory method requires considerably more record keeping. This is not
a problem with modern technology

 There must be certainty that the technology can be applied without problems in this
situation

 The two methods produce different numbers if LIFO is the selected policy, but identical
numbers if FIFO is selected.
(d) The implications of selecting between LIFO and FIFO policies for assigning costs to Inventory
The report should make the following points:

 The different policies are all attempting to assign costs to goods sold. They are therefore
not "valuation" methods, and no subjective judgement is required in any of the policies.

 The figure used for Cost of Sales obviously has an impact on reported net profit.
 The cost of Opening Inventory plus Cost of Purchases will always be the same under all
policies

 The different figures obtained through applying the selected policy will thus have a
resultant impact on the figure reported as Inventory on hand at the end of the period.
(Because Cost of Sales plus Inventory on hand always equal Cost of Opening Inventory
plus Cost of Purchases)

 FIFO is the more generally accepted policy for financial reporting, and the is generally the
only policy acceptable to SARS, so it is the most likely policy to be selected.

 FIFO does tend to understate costs of sales, in inflationary times and therefore can give a
somewhat inflated profit figure. It does however offer a fairly accurate reflection of the
replacement cost of inventory as reported in the Balance Sheet.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 7

7.13 DEEJAY (PTY) LTD

PRODUCTION COST STATEMENT OF DEEJAY

(PTY) LTD FOR JUNE 19.7

Direct materials 63,800

Opening inventory 8,600
Add: Inventory purchased 62,000
Material available 70,600
Less: Closing inventory 6,800
Direct labour 135,000
Prime cost 198,800
Fixed overheads 75,000
Cost of production for the month 273,800
Add: Opening work in progress 12,000
Total production cost 285,800
Less: Closing work in progress 14,000
Cost of finished goods for the year 271,800

Number of finished units 450

Unit cost of finished goods R 604.00

7.14 RAVAGIO (PTY) LTD

PRODUCTION COST STATEMENT OF

RAVAGIO (PTY) LTD FOR JUNE 19.7

Direct materials 355,700

Opening inventory 22,560
Add: Inventory purchased 367,900
Material available 390,460
Less: Closing inventory 34,760
Direct labour 847,500
Prime cost 1,203,200
Fixed overheads 711,400
Cost of production for the month 1,914,600
Add: Opening work in progress 123,700
Total production cost 2,038,300
Less: Closing work in progress 34,500
Cost of finished goods for the year 2,003,800

Number of finished units 2700

Unit cost of finished goods R 742.15

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 8

7.15 AQUAMARINE FLOW LTD
(a) Calculation of variable cost per unit

Total units 1,800 [600+1200]

Total labour hours 6,000 [(600X4)+(1200X3)]
Total machine hours 7,200 [(600X2)+(1200X5)]
Total labour cost 90,000 [(600X30)+(1200X60)]

VARIABLE COST Taps Mixers

Direct material per unit R 50.00 R 90.00
Direct labour per unit R 30.00 R 60.00
Variable cost per unit R 80.00 R 150.00

(b) Allocation to products based on different allocation bases

UNITS LABOUR MACHINE LABOUR

PRODUCED HOURS HOURS COST
Indirect Overheads R 180,000 R 180,000 R 180,000 R 180,000
Base selected 1,800 6,000 7,200 90,000
Allocation per base R 100.00 R 30.00 R 25.00 R 2.00
Allocation per unit
Taps R 100.00 R 120.00 R 50.00 R 60.00
Mixers R 100.00 R 90.00 R 125.00 R 120.00
Overheads allocated to
Taps R 60,000 R 72,000 R 30,000 R 36,000
Mixers R 120,000 R 108,000 R 150,000 R 144,000
check R 180,000 R 180,000 R 180,000 R 180,000

(c) Reported cost per unit based on different allocation bases

Reported cost per unit

Taps R 180.00 R 200.00 R 130.00 R 140.00
Mixers R 250.00 R 240.00 R 275.00 R 270.00

Difference -R 70.00 -R 40.00 -R 145.00 -R 130.00

(d) The allocation base selected is done so as a matter of convenience. Its real objective
is to try to reflect the actual costs which are incurred from the production of the item.
Because this is not uncomplicated, practitioners have settled for some arbitrary base,
considered to at least in some approximate sense, reflect the actual usage of
overhead resources. In many cases this fails, as is evident from the wide
discrepancies which emerge between different bases. The primary consideration
should therefore be how closely the base selected approximates the actual use of
resources. If this cannot be achieved, then a different approach, such as that of
Activity Based Costing should be considered.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 9

7.16 THREE WAY TEXTILES
(a)

THREE WAY TEXTILES

MATERIALS REQUISITION FORM
Date requested: 29 September 20.4 Date issued: 30 September 20.4
Department requesting: Production approved by: XXX
Requisition No: XG347 Issued to:YYY
J ob Quantity Description Per unit Total
ref
296 200 rolls Yarn A567 R100 20,000
Indirect Materials R460 460
20,460

THREE WAY TEXTILES

CLOCK CARD WEEK: XX
NAME: Webster Shaniz STAFF NO: 1234
Mon Tue Wed Thur Fri Sat Sun
08h02 08h05 08h00 08h10 08h01
12h02 12h04 12h00 12h00 12h01
13h00 13h01 12h58 12h50 13h00
17h00 17h02 16h59 17h00 17h00
8 8 8 8 8
Regular hours: 40 Overtime hours: 0

THREE WAY TEXTILES

JOB ORDER COST SHEET

Customer:A Large Retailer Job No: 296
Product: Sheeting units Date ordered: 28 September 20.4
Quantity: 300 Date started: 3 October 20.4
Specifications Per Doc: 8765 Delivery date: 15 October 20.4
Set size: Standard Date completed: 12 October 20.4

Direct materials Direct Labour Factory overhead Applied

Date Requisition Amount Date Amount Date Amount
2 October YB3347 R 20,000.00 4 October R 1,500.00 12 October R 4,500.00
5 October R 1,500.00
6 October R 1,500.00
7 October R 3,000.00
8 October R 1,500.00
Total R5 000 R 9,000.00 R 4,500.00

Selling price (say) R 20,000.00

Factory costs: R 13,500.00
Direct materials R5 000
Direct labour R 9,000.00
Factory overhead R 4,500.00
Gross profit R 6,500.00

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 10

 THREE WAY TEXTILES

LABOUR JOB CARD

Job No: 296 Department: Production

Date: 5 Octob er Employee: Webster Shaniz
Start: 1.00 pm Rate: 32,00
Stop: 5.00 pm
Total: 4 hours Total: R128.00

(b)

20.4 GENERAL JOURNAL OF THREE WAY TEXTILES

Sept 29 Direct Materials 36,000
Creditor 36,000
300 Rolls of Yarn A567 and
400 Rolls of Yarn Z198 received
29 Work in Progress [Job 296] 20,000
Direct Materials 20,000
200 Rolls of Yarn A567 as per
Materials Requisition XXX
29 Factory Overhead Control 460
Indirect Materials 460
Indirect Materials issued
Materials Requisition XXX
Oct 15 Work in Progress [Job 296] 9,000
Factory Overhead Control 5,000
Bank [Payroll] 14,000
Labour costs paid
15 Work in Progress [Job 296] 4,500
Factory Overhead Control 4,500
Transfer of overheads allocated
on completion of job 296
at 50% of direct labour
15 Finished Goods Inventory 13,500
Work in Progress [Job 296] 13,500
Transfer of finished goods on
completion at factory cost
15 Cost of Sales 13,500
Finished Goods Inventory 13,500
Cost of Sales on delivery of
300 sheeting units to ALR
15 ALR [A large Retailer] 20 000
Sales 20,000
Delivery and Invoice of completed
job 296 as per order

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 11

7.17 HYBRID (PTY) LTD
(a)
NOTE: The Question incorrectly stated "third quarter, July to September" and should read
"second quarter, April to June". The error is regretted, but hopefully it is realised that this must
be what is required, from the information provided.
Income Statement using variable costing with workings.

Hybrid (Pty) Ltd Income Statement for the quarter 1 April to 30 June

units Rands
Sales (@ R1000) 1,600 1,600,000
Variable factory cost of goods sold: 1,600 800,000
Beginning inventory (@ R50) 50 25,000
Plus variable manufacturing costs (@R500) 1,650 825,000
Goods available for sale 1,700 850,000
Less ending inventory (@R 500) 100 50,000
Factory contribution margin 800,000
Less Variable operating overheads (R38750/1550x1600) 40,000
Contribution margin 760,000
Less fixed expenses 571,250
Fixed manufacturing overhead [Actual] 410,000
Fixed selling and admin expenses [Actual] 161,250

Net Income (using Variable Costing) 188,750

Variable cost of inventory

Jan-Mar Apr-Jun
Opening inventory of finished goods 0 50
Units of production 1600 1650
Sales units 1550 1600 Per unit
Direct material costs [R320'x165/160] R 320,000 R 330,000 R 200
Direct labour costs [R400'x165/160] R 400,000 R 412,500 R 250
Variable factory overheads [R80'x165/160] R 80,000 R 82,500 R 50
Total variable manufacturing costs (R200+R250+R50) R 500
Variable operating overheads [R338750x160/155] R 38,750 R 40,000 R 25

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 12

(b) Income Statement (with workings) using Full absorption costing

Hybrid (Pty) Ltd Income Statement for the quarter 1 April to 30 June

units Rands
Sales ( 1600 x R 1000) 1,600 R 1,600,000.00
Less cost of goods sold [unadjusted]: 1,600 R 1,210,186.47
Beginning inventory (50 x [R500 + 256.25]) 50 R 37,812.50
Plus cost of goods manufactured
(1650 x [ R 500 + R 256,37]) 1,650 R 1,248,011.00
Goods available for sale 1,700 R 1,285,823.50
Less ending inventory 100
(100 x [ R 500 + R 256.37]) R 75,637.03
Unadjusted gross margin R 389,813.53
Add over-applied manufacturing overheads
(R 423 011 – R 410 000) R 13,011.00
Gross Margin R 402,824.53
Less operating expenses R 201,250.00
Fixed R 161,250.00
Variable ( 1600 x R 25) R 40,000.00

Net Income (using Full Costing) R 201,574.53

Fixed
Direct labour
Unit cost [the same per unit for both quarters] manufacturing per unit
hours
overheads

Construction 32,000 680,000 R 21.25

Painting 28,000 520,800 R 18.60
Finishing 20,000 439,200 R 21.96

Direct labour hours absorbed Jan-Mar Apr-Jun

Construction @ R21.25 per unit 8,000 8,168 R 170,000.00 R 173,570.00

Painting @ R18.60 per unit 7,000 7,177 R 130,200.00 R 133,492.20
Finishing @ R21.96 per unit 5,000 5,280 R 109,800.00 R 115,948.80
R 410,000.00 R 423,011.00

Overheads applied per unit Jan to Mar [R410'/1600], Apr to Jun

R 256.25 R 256.37
[R4230011/1650]
Total variable manufacturing costs (R200+R250+R50) R 500.00 R 500.00
R 756.25 R 756.37

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 13

(c)

Reconciliation of Variable Costing and Full Costing Net

Income

Net income per FULL costing R 201,574

Plus Fixed manufacturing overheads in
R 12,813
opening inventory (50 units x R256.25)
R 214,387
Less Fixed manufacturing overheads in closing
R 25,637
inventory (100 units x R256.37)
Net income per VARIABLE costing R 188,750

The difference between full (absorption) costing and variable costing is that variable costing
treats overheads a cost for the period (in this case each quarter), whereas full costing assigns
all costs, including overheads to the product. This has implications when prices change and
when levels of inventory differ over periods.
Variable costing is clearly simpler to deal with in practice as it avoids having to deal with
allocation bases for fixed overheads. The outcome however, may be that products are
incorrectly priced for the purpose of tendering for contracts or for establishing appropriate
selling prices.
The difference between reported incomes for each period is solely a function of the inventory
levels at the end of each period, and the rate at which the overheads are applied. In this case,
the opening inventory of 50 units at a rate of R256.25, is set off against the closing inventory
of 100 units at a rate of R256.37, to fully explain the difference between reported income
under Full costing and reported income under Variable costing for the quarter April to June.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 14