ALL FOUR questions are compulsory and MUST be attempted

1 Edward Co assembles and sells many types of radio. It is considering extending its product range to include
digital radios. These radios produce a better sound quality than traditional radios and have a large number of
potential additional features not possible with the previous technologies (station scanning, more choice, one
touch tuning, station identification text and song identification text etc).
A radio is produced by assembly workers assembling a variety of components. Production overheads are
currently absorbed into product costs on an assembly labour hour basis.
Edward Co is considering a target costing approach for its new digital radio product.

Required:
(a) Briefly describe the target costing process that Edward Co should undertake. (3 marks)

(b) Explain the benefits to Edward Co of adopting a target costing approach at such an early stage in the product
development process. (4
marks)

(c) Assuming a cost gap was identified in the process, outline possible steps Edward Co could take to reduce
this gap. (5
marks)

A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable
features to Edward Co’s intended product. The board have agreed that the acceptable margin (after allowing
for all production costs) should be 20%.
Cost information for the new radio is as follows:
Component 1 (Circuit board) – these are bought in and cost $4·10 each. They are bought in batches of 4,000
and additional delivery costs are $2,400 per batch.
Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed radio. However,
there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in
the assembly process. Edward Co estimates that 2% of the purchased wire is lost in the assembly process.
Wire costs $0·50 per metre to buy.
Other material – other materials cost $8·10 per radio.
Assembly labour – these are skilled people who are difficult to recruit and retain. Edward Co has more staff of
this type than needed but is prepared to carry this extra cost in return for the security it gives the business. It
takes 30 minutes to assemble a radio and the assembly workers are paid $12·60 per hour. It is estimated that
10% of hours paid to the assembly workers is for idle time.
Production Overheads – recent historic cost analysis has revealed the following production overhead data:
Total production overhead Total assembly labour hours
$
Month 1 620,000 19,000
Month 2 700,000 23,000
Fixed production overheads are absorbed on an assembly hour basis based on normal annual activity levels.
In a typical year 240,000 assembly hours will be worked by Edward Co.

Required:
(d) Calculate the expected cost per unit for the radio and identify any cost gap that might exist. (13 marks)

(25 marks)
3 [P.T.O.
2 Big Cheese Chairs (BCC) manufactures and sells executive leather chairs. They are considering a new design of
massaging chair to launch into the competitive market in which they operate.
They have carried out an investigation in the market and using a target costing system have targeted a competitive
selling price of $120 for the chair. BCC wants a margin on selling price of 20% (ignoring any overheads).
The frame and massage mechanism will be bought in for $51 per chair and BCC will upholster it in leather and
assemble it ready for despatch.
Leather costs $10 per metre and two metres are needed for a complete chair although 20% of all leather is wasted
in the upholstery process.
The upholstery and assembly process will be subject to a learning effect as the workers get used to the new design.
BCC estimates that the first chair will take two hours to prepare but this will be subject to a learning rate (LR) of 95%.
The learning improvement will stop once 128 chairs have been made and the time for the 128th chair will be the
time for all subsequent chairs. The cost of labour is $15 per hour.
The learning formula is shown on the formula sheet and at the 95% learning rate the value of b is –0·074000581.

Required:
(a) Calculate the average cost for the first 128 chairs made and identify any cost gap that may be present at
that stage. (8 marks)

(b) Assuming that a cost gap for the chair exists suggest four ways in which it could be closed. (6 marks)

The production manager denies any claims that a cost gap exists and has stated that the cost of the 128th chair will
be low enough to yield the required margin.

(c) Calculate the cost of the 128th chair made and state whether the target cost is being achieved on the 128th
chair. (6 marks)

(20 marks)

3 [P.T.O.
2 The Universal Health System (UHS) provides the entire healthcare service to residents in Illopia. The UHS is funded
centrally through revenues from taxpayers. However, the government is not involved in the day-to-day running of the
UHS, which is largely managed regionally by a number of self-governing trusts, such as the Sickham UHS Trust.
The Sickham UHS Trust runs one hospital in Sickham and, like other trusts in Illopia, receives 70% of its income
largely from the UHS’ ‘payments by results’ scheme, which was established two years ago. Under this scheme, the
trust receives a pre-set tariff (fee income) for each service it provides. If the Trust manages to provide any of its services
at a lower cost than the pre-set tariff, it is allowed to use the surplus as it wishes. Similarly, it has to bear the cost of
any deficits itself. Currently, the Trust knows that a number of its services simply cannot be provided at the tariff paid
and accepts that these always lead to a deficit. Similarly, other services always seem to create a surplus. This is partly
because different trusts define their services and account for overheads differently. Also, it is partly due to regional
differences in costs, which are not taken into account by the scheme, which operates on the basis that ‘one tariff fits
all’.
The remaining 30% of the Trust’s income comes from transplant and heart operations. Since these are not covered
by the scheme, the payment the Trust receives is based on the actual costs it incurs in providing the operations.
However, the Trust is not allowed to exceed the total budget provided for these operations in any one year.
Over recent years, the Trust’s board of directors has become increasingly dissatisfied with the financial performance
of the Trust and has blamed it on poor costing systems, leading to an inability to control costs. As a result, the finance
director and his second in command – the financial controller – have now been replaced. The board of directors has
taken this decision after complaining that ‘the Trust simply cannot sustain the big deficit between income and
spending’. The new financial controller comes from a manufacturing background and is a great advocate of target
costing, believing that the introduction of a target costing system at the Sickham UHS Trust is the answer to all of its
problems. The new financial director is unconvinced, believing target costing to be only really suitable in
manufacturing companies.

Required:
(a) Explain the main steps involved in developing a target price and target cost for a product in a typical
manufacturing company. (6 marks)

(b) Explain four key characteristics that distinguish services from manufacturing. (4 marks)

(c) Describe how the Sickham UHS Trust is likely, in the current circumstances, to try to derive:
(i) a target cost for the services that it provides under the ‘payment by results’ scheme; and (2 marks)
(ii) a target cost for transplants and heart operations. (2 marks)

(d) Discuss THREE of the particular difficulties that the Sickham UHS Trust may find in using target costing in
its service provision. (6 marks)

(20 marks)

3 [P.T.O.
Section B – ALL FIVE questions are compulsory and MUST be attempted

Please write your answers to all parts of these questions on the lined pages within the Candidate Answer Booklet.

1 The Chemical Free Clean Co (C Co) provides a range of environmentally-friendly cleaning services to business
customers, often providing a specific service to meet a client’s needs. Its customers range from large offices and
factories to specialist care wards at hospitals, where specialist cleaning equipment must be used and regulations
adhered to. C Co offers both regular cleaning contracts and contracts for one-off jobs. For example, its latest client
was a chain of restaurants which employed them to provide an extensive clean of all their business premises after an
outbreak of food poisoning.
The cleaning market is very competitive, although there are only a small number of companies providing a chemical
free service. C Co has always used cost-plus pricing to determine the prices which it charges to its customers but
recently, the cost of the cleaning products C Co uses has increased. This has meant that C Co has had to increase its
prices, resulting in the loss of several regular customers to competing service providers.
The finance director at C Co has heard about target costing and is considering whether it could be useful at C Co.

Required:
(a) Briefly describe the main steps involved in deriving a target cost. (3 marks)

(b) Explain any difficulties which may be encountered and any benefits which may arise when implementing
target costing at C Co. (7 marks)

(10 marks)