CIMA P1 2020 Notes

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CIMA 2020 Exams Watch free CIMA P1 lectures 1
CIMA P1
Management Accounting
1. Accounting for Management 3
2. Cost Classification and Behaviour 7
3. Traditional Costing Methods 11
4. Activity Based Costing 15
5. Limiting Factor Analysis and throughput accounting 19
6. Joint Product Costing 23
7. Other Costing Issues 27
8. Linear Programming 31
9. Standard Costing and Basic Variance Analysis 33
10. Advanced Variances 39
11. Budgeting 43
12. Forecasting Techniques 51
13. Risk and Uncertainty 59
14. Relevant Costing 65
15. Cost Volume Profit Analysis 71
Answers to Examples 77
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Chapter 1
ACCOUNTING FOR MANAGEMENT
1. Introduction
The purpose of management accounting is to assist management in running the business in ways
that will improve the performance of the business.
2. The definition of management accounting

CIMA defines management accounting as “the application of the principles of accounting and
financial management to create, protect, preserve and increase value for the stakeholders of for-
profit and not-for-profit enterprises in the public and private sectors”.
3. Data and information

One way of assisting management is to provide them with good information to help them with
their decisions.
The information can be provided to them in different ways, but is usually in the form of reports. For
example, a report analysing costs of producing each of several products may assist management in
deciding which products to produce.
It is the management accountant who will be expected to provide the information, and in order to
do so he/she needs to collect data.
Data consists of the facts that are gathered and stored. Data has no clear meaning until it is
processed – analysed and sorted – into information.
4. What makes good information?

Good quality information should:
๏ be Accurate
๏ be Complete (but not excessive)
๏ be Cost effective (should cost less than the savings to be made)
๏ be Understandable (to whoever is using it)
๏ be Relevant (to the decision being made)
๏ be Authoritative (be able to be trusted by the users)
๏ be Timely
๏ be Easy to use
5. The main managerial processes

The main areas of management accounting are:
๏ Costing
Cost accounting is identifying the cost of producing an item (or providing a service) in order
to, for example, assist in deciding on a selling price.
๏ Planning
e.g. plan how many staff will be required in the factory next year
๏ Decision making
e.g. decide on what selling price to charge for a new product
๏ Control
e.g. check month-by-month whether the company is over or under spending on wages
๏ Performance evaluation
Comparing the performance of mangers or departments against budgets or targets
6. The different levels of planning

๏ strategic planning
long-term plans (e.g. 5 to 10 years) for the business
e.g. what new offices to open? / what new products to launch?
๏ tactical planning
medium-term, more detailed, plans – usually involving producing budgets for the next year
e.g. how many staff to employ next year?
๏ operational planning
short-term planning and decisions
e.g. which supplier to choose for a purchase next week
7. Comparison of Management Accounting with Financial

Accounting
Financial accounting Management accounting
Prepare reports, generally based on past Collate information such as revenue, cashflow and
performance; in line with reporting outstanding debts to produce timely trend reports
requirements and statistics to inform important, day-to-day
management and business decisions
Produce the required financial information Combine financial information with non financial
for use by other functions within the information data to paint a complete picture of the
business, for example department business. They use this to drive business success.
managers.
Chapter 2
COST CLASSIFICATION AND
BEHAVIOUR
1. Cost classification
Cost classification is the arrangement of cost items into logical groups. For example: by their nature
(materials, wages etc.); or function (administration, production etc.).
The eventual aim of costing is to determine the cost of producing a product/service; for profitability
analysis, selling price determination and stock valuation purposes.
Cost unit
A cost unit is a unit of product or service in relation to which costs may be ascertained.
The cost unit should be appropriate to the type of business, for example:
Example 1
Suggest appropriate cost units for the following businesses
Solution
Business Appropriate cost unit
Car manufacturer
Cigarette manufacturer
Builder
Audit company
Types of expenses
$
Production/manufacturing costs X
Administration costs X
Selling and distribution costs X
TOTAL EXPENSES X
Only the production costs will be relevant in costing.
Direct costs
Direct costs are those costs which can be identified with and allocated to a particular cost unit.
TOTAL DIRECT COSTS = PRIME COST
Example 2
Direct costs
Indirect production costs (overheads)
Indirect production costs (known as production overheads) are those costs which are incurred in
the course of making a product/service but which cannot be identified with a particular cost unit.
Example 3
Indirect production costs
TOTAL PRODUCTION COST = PRIME COST + PRODUCTION OVERHEADS
Non-production costs
Other costs required to run the business.
Example 4
Non-manufacturing/production costs
TOTAL COSTS = PRODUCTION COSTS + NON-PRODUCTION COSTS
2. Cost behaviour
It is expected that costs will increase as production increases (i.e. as output increases) but the exact
way in which costs behave with output may differ.
Example 5
Types of behaviour
Variable cost
Fixed cost
Stepped fixed cost
Semi variable/fixed cost
Linear assumption
For this examination we will assume that total variable costs vary linearly with the level of
production (or that the variable cost per unit remains constant). In practice this may not be the
case, but we will not consider the effect of this until later examinations.
Behaviour of manufacturing costs
With the linear assumption all costs can be categorised as either fixed or variable. This fits together
with previous definitions:
Direct costs
By their nature direct costs will be variable costs.
Indirect costs/overheads
Overheads can be fixed or variable
Fixed Variable
Direct costs X √
Production overheads √ √
Non-manufacturing costs √ √
Semi-variable costs
It is necessary to determine the fixed and variable elements of semi-variable costs. A method
known as ‘High-Low’ can be used to establish the fixed and variable elements. This technique is
best illustrated by the use of an example.
Example 6
The total costs of a business for differing levels of output are as follows:
Output Total Costs
(units) ($’000)
200 30
1,000 110
(a) What are the fixed and variable elements of the total cost using the High-Low method?
(b) Describe the relationship between the output and costs in the form of a linear equation.
A better approximation of the fixed and variable elements can be obtained using Regression
Analysis. This will be considered in the next chapter of these notes.
Typical cost card for a cost unit
$/unit
Direct costs:
- Direct materials (2kg @ $1.50/kg) 3.00
- Direct labour (3 hrs @ $4/hr) 12.00
Prime cost 15.00
Indirect costs
- Variable overheads 2.00
- Fixed overheads 3.00
Full product cost 20.00
Chapter 3
TRADITIONAL COSTING METHODS
1. Introduction
The collective term traditional costing methods refers to:
๏ Absorption Costing
๏ Marginal costing
These costing methods will be familiar to you from previous studies.
You will need to understand traditional costing methods in order to compare and contrast their
differences. From here you will be able to consider their strengths or weaknesses against
modern alternatives such as ABC costing.
Important to this section is the concept of marginal costing contribution which links to many
other parts of CIMA P1 syllabus for example, limited factor analysis, variance reconciliations and
cost volume profit (CVP) techniques. (see later chapters)
2. The purpose of calculating a cost per unit.
Example 1
Why do we need to obtain a cost per unit?
3. Features of Absorption costing

Includes a share of production overheads in the product cost.
Acceptable method of inventory valuation as per IAS 2.
Results in a FULL product cost per unit.
Overheads are allocated apportioned then absorbed across all units using a single cost driver
(usually machine or labour hours).
Suitable costing system for mass produced, homogeneous products - where overheads are largely
volume driven.
4. Strengths and weaknesses of Absorption Costing
5. Features of Marginal Costing

Useful for internal, short term decision making.
Only variable costs are included in product cost.
Overheads are classed as period costs.
Focus is on CONTRIBUTION earned (which is not distorted by overhead costs) and can be used to
evaluate decisions relating to incremental units.
Contribution = Selling Price less Variable cost.
6. Strengths and weaknesses of Marginal costing
7. Reconciliation of profits, Absorption Vs Marginal Costing

Absorption and Marginal costing result in different reported profits in the short term. This is
because inventory includes or does not include a charge for fixed overheads.
When production in the period is not equal to sales (inventory decreases or increases) there will be
a different profit figure reported under each costing system.
The reconciliation required is below:

๏ ABSORPTION PROFIT $X
Change in inventory levels in period x OAR (X / (X))
๏ Marginal Costing Profit $X
To determine the direction of the adjustment - a useful mnemonic is SIAM

When Stocks Increase Absorption (profit) is More
Example 2
Sales in period 12000 units.
Production volume 13500 units
Selling price $150
Variable costs $65 per unit
Fixed production costs per unit $30
The company above uses a marginal costing system.
Calculate the difference in reported profit under absorption costing?
Chapter 4
ACTIVITY BASED COSTING
1. Introduction
Traditional absorption costing systems share overheads across all products based on a single cost
driver (usually machine or labour hours).
It is argued that a modern manufacturing environment requires a more sophisticated and

intelligent costing system.
Under ABC costing, overhead costs are given greater attention and visibility because they are
assigned to different products based on the extent to which each product ‘drives’ or causes that
cost.
This costing system can be relatively time-consuming and costly to implement but can be useful, if
manufacturing overhead expenditure is significant and a diverse product range exists. ABC can also
be applied to costing within service industries.
2. The steps to be followed are as follows:

๏ Identify the major ‘activities’ that give rise to overheads (e.g. quality testing, ordering costs
etc)
๏ Determine what causes the cost of each activity – the cost driver (e.g. number of inspections,
number of orders)
๏ Calculate the total costs for each activity – the cost pools.
๏ Calculate a cost per cost driver.
๏ Allocate the overhead costs to products based on their usage of cost driving activities.
๏ Calculate the overhead cost per unit for each item of output.
NOTE on CIMA new objective test exams.

It is unlikely that objective tests questions will require you to complete all steps from
beginning to end. However, it is important to be familiar with the entire process before you
can answer questions on isolated areas of the sequence.
Example 1
Una manufactures three products: A, B, and C.
Data for the period just ended is as follows:
A B C
Production (units) 20,000 25,000 2,000
Sales price ( per unit) $20 $20 $20
Material cost (per unit) $5 $10 $10
Labour hours (per unit) 2 hours 1 hour 1 hour
(Labour is paid at the rate of $5 per hour)
Overheads for the period were as follows:
Set-up costs 90,000
Receiving 30,000
Despatch 15,000
Machining 55,000
$190,000
Cost driver data:
A B C
Machine hours per unit 2 2 2
Number of set-ups 10 13 2
Number of deliveries received 10 10 2
Number of orders despatched 20 20 20
(a) Calculate the cost (and hence profit) per unit, absorbing all the overheads on the basis
of labour hours.
(b) Calculate the cost (and hence profit) per unit absorbing the overheads using an Activity
Based Costing approach.
3. ABC Cost Hierarchy

ABC costing classifies costs into the following categories.
๏ Unit level cost – are incurred with each unit of output -e.g. power is used by factory
machines each time a unit is produced.
๏ Batch level costs –increase with each ‘batch’ of output -e.g. equipment set-up costs are
incurred each time a new batch is processed.
๏ Product Sustaining costs – this type of cost does not increase in relation to batches or units
produced but are necessary costs to support particular product types – e.g. design costs.
๏ Facility level costs – General manufacturing overheads these can not easily be traced to
production activity e.g. admin staff salaries.
4. Strengths / Weaknesses of ABC Costing
Example 2
Explain the benefits, which can be gained from changing to a more effective costing system?
Chapter 5
LIMITING FACTOR ANALYSIS AND
THROUGHPUT ACCOUNTING
1. Introduction
Limited Factor analysis can be used to determine optimum production levels when faced with
scarcity of a single resource (a limiting factor).
The limiting factors, in exam questions will often take the form of a shortage of a particular raw
material or an insufficient number of labour hours being available.
Management are faced with a decision of what quantities and mix of products to manufacture in
order to maximise profits given this constraint.
In a marginal costing environment, the concept of contribution can be used to plan production
in a manner which will maximise profits.
Following this, we find solutions to limiting factor scenarios in a throughput costing environment.
2. Traditional Limiting Factor Analysis

When faced with a shortage in production resources, management can use a contribution-focussed
approach to help them identify an optimum production plan.
The marginal costing model provides information on the contribution level of all products. In the
short term, fixed costs do not change – so profits can be maximised through following a
production plan that maximises contribution.
In a situation where there is a scarcity of a particular resource, the products competing for use of
that resource can be ranked in terms of their contribution earned per unit of limited resource.
For example, a shortage of labour hours will require products to be prioritised based on those
which earn the most contribution per each scarce labour hour used.
Example 1
Pi plc manufactures 2 products, A and B.
The cost cards are as follows:
A B
Selling price 25 28
Materials 8 20
Labour 5 2
Other variable costs 7 2
Fixed costs 3 2
23 26
Profit $2 $2
Machine hours p.u. 2 hrs 1 hr
Maximum demand 20,000 units 10,000 units
The total hours available are 48,000.
Calculate the optimum production plan and the maximum profit using conventional limiting
factor analysis.
3. Theory of Constraints and Throughput

Goldratt’s Theory of Constraints is an important management methodology which can be applied
to systems that are unable to meet their goals (usually maximising profit) due to a constraint.
Management should ensure that efforts are focussed on making the best possible use of this
limitation. Ideally the constraint will need to be eliminated in the longer term, meanwhile Goldratt
recommended reorganising all other system activities around the constraint to ensure its use is
optimised. The constraint in manufacturing is referred to as a bottleneck.
Goldratt refers to Throughput as a key performance measure. The main concepts of throughput
accounting are given below.
๏ Throughput is the rate at which the system generates money. It is measured in monetary
terms and links directly to profitability therefore the objective is to maximise throughput
values or throughput flow.
Throughput ($) = Sales Revenue less Direct Material Costs
๏ In the short run, ALL costs (except direct materials) are viewed as being fixed. This
includes LABOUR as Fixed cost. The sum of all these production costs including labour is
called TOTAL FACTORY COSTS.
๏ The constraint on production is referred to a Bottleneck.
๏ Throughput accounting can be used in a Just-in-time environment.
4. Key formulae:
Throughput ($) = Sales revenue – Direct Material costs
Total factory costs = ALL production costs (except materials)
Throughput per Unit $

1 Return per factory hour =
Time per unit in bottleneck resource (hrs)
Total factory cost (inc labour +overheads)

2 Cost per factory hour =
Total time available in Bottleneck (ALL hrs)
Return per factory hour (1)

3 Throughput accounting ratio (TPAR)=
Cost per factory hour (2)
4.1. Interpretation of TPAR ratios:
The TPAR ratio should be greater than 1 for the product to be classed as financially viable.
Priority should be given to the products which generate the highest TA ratios.
Products with a TPAR ratio less than one should be discontinued.
Example 2
Pi plc manufactures 2 products, A and B.
The cost cards are as follows:
A B
Selling price 25 28
Materials 8 20
Labour 5 2
Other variable costs 7 2
Fixed costs 3 2
23 26
Profit $2 $2
Machine hours p.u. 2 hrs 1 hr
Maximum demand 20,000 units 10,000 units
The total hours available are 48,000.
(a) Calculate the optimum production plan and the maximum profit, on the assumption
that in the short-term only material costs are variable i.e. using a throughput
accounting approach
(b) Calculate and Interpret the Throughput Accounting ratios (TPAR ratios)
(c) Suggest some business strategic reasons why management might decide NOT to
withdraw an unprofitable product from sale.
Chapter 6
JOINT PRODUCT COSTING
1. Introduction
Sometimes, one process may produce several products. In this case we need to decide on a cost
per unit for each of the products. These products, produced in the same process, are known as
joint products.
Joint products refer to our main products with full sales value. However, there may be an additional
product (or products) which is produced incidentally and has a relatively low sales value (effectively
a waste product). This is known as a by-product.
2. Accounting treatment
๏ Any sale proceeds of a by-product are subtracted from the joint costs of the process.
๏ The net total cost of the process is then split between the joint products.
๏ For the examination, there are two ways of splitting the joint costs:
‣ The physical units basis
‣ The market value at the point of separation basis.
3. Physical units basis

Under this method, the same cost per unit is applied to all the joint products
Example 1
During August, the following costs were incurred in a process:
Materials (3,500 kg) $5,000

Labour and overheads $2,300
The production from the process was as follows:
kg
Product A 1,000 selling price $5 per kg
Product B 2,000 selling price $2 per kg
by-product X 500 scrap value $0.20 per kg
Calculate a cost per kg and profit per kg for A and B using the physical units basis.
4. Market value basis

Under this method the costs per unit are calculated so as to be in the same proportions as the
market values of each product
Example 2
During August, the following costs were incurred in a process:
kg
Product A 1,000 selling price $5 per kg
Product B 2,000 selling price $2 per kg
Sales during the period were 800 kg of A and 1,500 kg of B.
Calculate a cost per kg and profit per kg for A and B using the market value basis
5. Net-realisable value approach

The market value approach is not always possible. This is because the products will often require
further work (and therefore costs) after leaving the process. We have to use the net realisable value
at a point of separation as an approximation to the market value.
The net realisable value is the final market value less costs incurred after leaving the joint process.
Example 3
During September the following costs were incurred in a process:

kg
Product A 1,000 selling price $8.40 per kg
Product B 2,000 selling price $4.50 per kg
All the output of A and B incurred further processing at a cost of $4.80 per kg for A and $2.20 per kg
for B.
Calculate a cost per kg for A and B using the net realisable value approach.
Chapter 7
OTHER COSTING ISSUES
1. Introduction
In this chapter we will look at three separate issues: the costing of digital products, the CGMA Cost
Transformation Model, and digital costing systems.
2. Digital products
Examples include:
๏ Online courses
๏ Apps
๏ eBooks
๏ Software
๏ Graphics
๏ Downloadable music
3. Costing of digital products

Standard costing for digital products is often inappropriate because:
๏ Marginal costs such as materials are likely to be zero for digital products
๏ Lifespan of products can be uncertain – sometime as short as one day – sometimes much
longer due to the updates and changes which can be added
๏ Overheads and their drivers are difficult to identify
๏ Rapid changes in technology can affect costs and selling prices with little warning
๏ Digital products can evolve over different accounting periods. There are likely to have large
upfront design costs and incur later costs for royalties, testing and marketing
Example 1
Suggest some costs which might be involved in creating a digital audio book – can you
suggest any costs which might be saved in comparison to manufacture of physical books?
4. CGMA’s Cost Transformation Model
Managing the
Engendering a
risks inherent in
cost-conscious
driving cost-
culture
competitiveness
Understanding
cost drivers: Cost Connecting
accounting Products with
systems and Profitability
processes
Generating
Incorporating
maximum value
sustainability to
through new
optimise profits
products
The CGMA cost transformation model suggests six changes which are designed to to help
businesses achieve and retain cost competitiveness.
๏ Creating a cost conscious culture

‣ Organisations need to strive for cost-leadership (costs should be lower competitors –
benchmarks should be used here)
‣ Commitment to cost reduction needs to be throughout the organisation -all levels- all
employees
‣ Ability to use technology to control costs
๏ Understanding cost drivers

‣ Investigation of cause of costs & impact of different variables on these costs.
‣ Plans should look to reduce the drivers of costs AND costs themselves.
‣ ABC costing is a tool to use here.
๏ Managing the risks that come from a cost conscious culture

‣ Risks that impact quality & customer satisfaction
‣ Risk management process needs to identify these risks and mitigate
๏ Connecting products with profitability

‣ Ensuring products and services are profitable & make positive contribution
‣ Allocation of shared costs and accurate individual product costs are important here
๏ Maximising value from new products

‣ Profitability of new products must be assessed before production begins.
‣ New products / services should aim to be adaptable/ flexible so can be changed to
satisfy as many customer segments as possible
๏ Incorporate Sustainability : Consider the environmental impact of products

‣ Negative impacts (such as creating unnecessary waste) can add costs as well as
damaging reputation and sales.
5. Digital Costing Systems

As products have become more complex, costing systems have evolved alongside.
Many products have hundreds of components and specifications can change for different
customers.
For example – consider the number of different parts which are involved in producing a car or an
aeroplane.
The number of components/ multiple suppliers/ cost prices arriving in different currencies etc here
would be very difficult to keep track of without digital costing systems.
๏ Digital Costing Systems
These are intelligent costing systems able to collect and input hundreds of real time price
changes/ supplier lead times and can even forecast the businesses upcoming resource needs.
They work in real time situations to calculate current product costs of complex production
scenarios – but also these systems have the ability to use the data collected over time to
analyse differences in costs/ supplier flexibility and flag any changes to the nature of costs.
More advanced systems can advise on buying behaviour, recommend changes to product
design and work to help improve efficiency of business operations
Digital costing systems are expensive to implement but once established bring immense
cost-savings
They are designed to be easy to use – the complex system provides an understandable
interface that can be used by management for decision making providing detailed reports on
costs, break downs overheads, cost drivers and cost behaviour.
๏ Target Costing
Some digital costing systems are programmed to operate a ‘Target costing’ approach. This
involves determining the most appropriate selling price in a competitive market, then
working backwards to ensure that the products cost and any required profit will be covered
by the selling price.
You will learn more about Target Costing further on in your CIMA studies.
Chapter 8
LINEAR PROGRAMMING
1. Introduction
Previously we dealt with scenarios, which had ONE scarce resource –we approached these using
either limiting factor analysis or throughput accounting.
Linear programming is the method for use when there are TWO or more limiting factors.
2. Linear Programming
2.1. The steps are as follows:
(1) Define the variables
(2) Formulate an equation for the objective function
(3) Formulate equations for the constraints
(4) Graph the constraints, shade the feasible region and label its vertices
(5) Plot the iso contribution line and use it to find the optimum solution.
(6) Confirm solution with simultaneous equations.
CIMA – EXAM FOCUS

It is unlikely that you will be required to follow the whole process in an objective test
question.
However, any part of the process could be examined and this method is best understood in
its entirety before you can attempt questions based on isolated parts.
Example 1
Peter makes two types of chair – the ‘Executive’ and the ‘Standard’.
The data relating to each as follows:
Standard Executive
Materials 2 kg 4 kg
Labour 5 hours 6 hours
Contribution $6 $9
There is a maximum of 80 kg of material available each week and 180 labour hours per week.
Demand for ‘Standard’ chairs is unlimited, but maximum weekly demand for ‘Executive’ chairs is 10.
Find the optimal production plan, which will maximise contribution and state the
contribution value that will be generated.
3. Spare capacity: Slack

Linear programming scenarios are likely to involve various resource shortages.
Despite this, you may find that the optimum solution does not fully utilise all of the resources
available.
If the optimum solution results in using less than the maximum available of a particular resource,
then we have spare capacity of that resource known as slack.
Example 2
Using the information from example 1, calculate the slack for each of the constraints i.e. for
materials, for labour, and for demand for ‘Executive’ chairs.
4. Shadow prices
In business, resource shortages can often be overcome through paying a premium to obtain
additional units of scarce resource.
For example – a shortage of labour hours can usually be resolved if overtime payments are offered.
The shadow price (also known as the dual price) of a limited resource is the additional that we
would be prepared to pay, over-and-above the current resource price per unit.
This value is equal to the extra profit that would result if one extra unit of the limited resource was
available.
NB) If there is slack in the resource, then shadow price is Nil – we would not pay any additional
amount for an extra unit – because we have spare capacity already.
Example 3
Using the information from example 1, calculate the shadow price of each of the constraints
i.e. for materials, for labour, and for demand for ‘Executive’ chairs.
Chapter 9
STANDARD COSTING AND BASIC
VARIANCE ANALYSIS
1. Introduction
In an earlier chapter we identified that budgeting as a means of controlling the organisation.
Through comparison of budgeted figures and actuals areas can be identified that may need
corrective action. Problems can be addressed in an attempt to control future outcomes.
In this chapter we will look at the setting of standard costs, which form the basis of budget figures.
This section also requires basic variance calculations and interpretations.
Please Note:
All basic variances (calculations and interpretations) are examinable under CIMA P1
syllabus. The formulae relating to these are not included in this chapter but you should be
familiar with these from previous studies.
Advanced variances are an extension of this topic and are dealt with in the next chapter.
2. Standard costs
A Standard cost is an estimated unit cost.
The standard cost for a product (or service) is determined in advance based on expected resource
usage using expected resource prices.
Standard costing systems use these predetermined values to estimate income and expenditure
under standard conditions.
It was developed primarily for manufacturing (but can be applied to services), and was designed for
environments where there is mass production of homogenous products
The standard costs form the basis of budget totals, which can then be compared to actuals as part
of the performance management process.
The standard cost card below shows the standard costs/ prices and usage / efficiency rates that
are expected to produce one unit of product X. Any deviations from these expected rates will result
in variances (adverse or favourable)
Illustration 1
Standard cost card for Product X
$ per unit
Sales price 100
Materials (2 kg @ $20/kg ) 40
Labour (1.5 hrs @ $2/hr ) 3
Variable o/h (1.5 hrs @ $6/hr) 9
Fixed o/h (1.5 hrs @ $10/hr) 15
Standard cost of production 67
Standard profit per unit 33
2.1. Uses of standard costing

๏ Inventory valuation (for internal and/or external use)
๏ As a basis for pricing decisions
๏ For budget preparation
๏ For budgetary control
๏ For performance measurement
๏ For motivating staff using standards as targets
2.2. Limitations of standard costing

๏ Obtaining appropriate standards can be difficult
๏ Standards may be different depending on their purpose (see next section)
๏ Less useful when environment does not involve mass production of homogenous items.
๏ Standard costing can lead to an over-emphasis on quantitative measures of performance at
the expense of qualitative measures (e.g. customer satisfaction; quality and employee morale)
๏ Traditional standards are based on company’s own costs – a more modern approach is
benchmarking, which considers best practice of other organisations.
๏ Please also see chapter on Modern manufacturing environment with regard to the
relevance of standard costing
2.3. McDonaldisation
McDonaldisation is a term to describe the increasing level of standardisation in society. It is

based on the fast food giant’s approach to mass delivery of standardised products.
Through use of predetermined products and methods on a global scale - the restaurant chain is
described as achieving efficiency, calculability, predictability and control.
However, critics argue this occurs at the expense of individuality and that cost reduction takes
priority over other important factors such as employee motivation and consumer choice
2.4. Types of standards

๏ Ideal standard
100% efficient 100% of the time.
Calculated assuming perfect operating conditions.
Could form the basis for long-term aims, but not useful for variance analysis or budgeting
because unrealistic.
๏ Basic standard
This is a long-term standards which remain unchanged over many years. Often they are
determined at the inception of a product.
It is only really of use to show trends or improvements over time.
They are not useful measures of current performance.
๏ Expected / Attainable standard
This is a standard expected to apply to a specific budget period and is based on normal
efficient operating conditions. It can incorporate allowance for wastage and idle time.
This is usually the basis for variance analysis. However, standards may be too ‘easy’ to be
used as targets.
๏ Current standard
This is the current attainable standard which reflects conditions actually applying in the
period under review.
They are useful when operating under abnormal conditions – eg a period of hyper inflation.
They may reduce the drive for improvement because the standards reflect up-to-date cost
environment.
3. Variance analysis
In the chapter on budgeting, we looked at the comparison between the actual results for a
period and the flexed budget. The differences between the two are referred to as variances.
* Basic variance formulae should be knowledge brought forward from previous studies.
In this section we will repeat the exercise, and then analyse them into their different components. If
we are to investigate variances properly and use them for control, then it is important that we are
able to consider the reasons for their occurrence.
3.1. Total variances
Example 1
A company has prepared the following standard cost card:
$ per unit
Materials (4 kg at $4.50 per kg) 18
Labour (5 hrs at $5 per hr) 25
Variable overheads (5 hrs at $2 per hr) 10
$53
Budgeted selling price $75 per unit, and the budgeted fixed overheads are $130,500
Budgeted production 8,700 units

Budgeted sales 8,000 units
There is no opening inventory
The actual results are as follows:
Sales: 8,400 units for $613,200
Production: 8,900 units with the following costs:
Materials (35,464 kg) 163,455

Labour (45,400 hrs paid, 44,100 hrs worked) 224,515
Variable overheads 87,348
Fixed overheads 134,074
Prepare a flexed budget and calculate the total variances
Note: the company currently uses marginal costing
3.2. Analysis of variances
The total variance that we have calculated for materials indicates that the actual expenditure on
materials was not $18 per unit. However, this could be either because we used the wrong amount
of materials (which should have been 4 kg per unit) or that we paid the wrong price (which should
have been $4.50 per kg). More likely of course, it would be a combination of the two.
We will therefore analyse this and the other variances in as much detail as possible.
Example 2
Using the data from example 1, analyse the variances and use them to produce on Operating
Statement reconciling the budgeted profit with the actual profit.
3.3. Absorption costing

In the previous example, the company had been using absorption costing. They could alternatively
have used marginal costing. The variances will be calculated in very much the same way, but when
using marginal costing the focus is on contribution (rather than profit) and the fact that we will not
be absorbing fixed overheads means that any fixed overhead volume variance is not relevant.
Example 3
Using data from example 1
(a) prepare the original fixed budgets using absorption costing
(b) prepare an Operating Statement using a absorption costing approach
3.4. Interpretation of variances
Example 4
In the previous example there was a materials price variance.
Suggest possible reasons for its occurrence.
Chapter 10
ADVANCED VARIANCES
1. Introduction
In this chapter we will look at variances in further detail. This builds on the techniques and
principles of basic variances (previous chapter).
Planning and Operational variances allow management to concentrate on controllable issues

only by removing the effect of an incorrect or outdated standard, which is beyond the entity’s
control.
Sales Mix variances look at the effect of altering proportions of a standard mix of sales.
We will also look at ABC variances.
2. Planning and Operational variances

Variance analysis assists management in exercising control by identifying areas where there may
be operational problems.
Amongst the possible reasons for a variance – it may be that the factor driving it is uncontrollable
and/or external to the organisation.
For example, adverse material price variances would usually be seen as the responsibility of the
procurement department.
However, imagine that the increase in material costs, in this case, had been caused by a global price
rise due to scarcity. This factor is not in the control of the procurement manager.
With hindsight the original budget should’ve allowed for a higher material cost. As it stands, the
original budget is based on an incorrect/ outdated material standard cost.
By calculating planning variances, we are able to remove the effect of this incorrect standard so
we can focus on operational performance only.
It makes more sense to compare actual results with a revised budget, when the original budget
value is not valid.
The first step in these situations is to create a revised budget (sometimes called Ex post) which
will be based on the ‘revised or updated’ prices or efficiency rates.
2.1. Planning variance
Calculated by comparing the:
Original budget (or ex ante)
to
Revised budget – (ex post)
2.2. Operational variance
Calculated by comparing the:
Revised budget – (ex post)
To
Actual results.
Operational variances are of interest to management because they represent performance of the
business and factors influencing them should be controllable.
Example 1
Original budget:
Standard labour cost per unit of product is $7.
Each unit takes 0.5hours to produce at a labour rate of $14 per hour.
Budgeted production for January was 20,000 units
Actual results:
Production: 22,000 units
Actual labour worked were 11,400 hours at $15.50 per hour.
Since preparation of the budget the prevailing external labour rate has increased to $17.50
Calculate the labour rate planning variance and the labour rate operational variance.
Example 2
Original budget:
Budget production: 21,000 units
Standard Material cost per unit 3kg @$4 per kg
Actual results:
Production: 10,000 units
Materials: 33,000 kg for $4.20
A global shortage meant that the external price for this material was higher than budgeted and
should have been $5.20
Calculate the planning and operational material price variances.
e yield variance.
3. Sales mix variances

Suppose a company sold two types of desk which although similar had different profit margins.
Clearly the company would hope for higher sales, but they would also be interested in the mix of
sales – it would be better if customers bought more of the desks giving higher profit per unit even
if it were to mean selling fewer of the desks that gave lower profit per unit..
Example 3
Olga plc sells three products – A, B and C.
The following table shows the budget and actual results for these products:
A B C
Budget:
Sales (units) 200 100 100
Price (p.u.) $20 $25 $30
Cost (p.u.) $17 $21 $24
Actual:
Sales (units) 180 150 170
Price (p.u.) $22 $22 $26
Cost (p.u.) $16 $18 $25
Calculate the total sales margin variance, and analyse into the sales price variance; the sales
mix variance; and the sales quantity variance.
4. Activity Based Costing Variances

You will remember from an earlier chapter that ABC is a way of allocating overheads to products
using cost drivers.
The main reason for doing this was not just to encourage cutting the total cost of the overhead, but
also to encourage more efficient use of the overhead.
For example, we may have had an overhead cost for despatch of $100,000 and a total of 5,000
despatches. This would mean that it was costing $20 per despatch. We could reduce the cost per
despatch by either cutting the total cost (an expenditure variance) or by increasing the number of
despatches (an efficiency variance).
Example 4
The following information is available for a period:
Budget Actual
Production 48,000 units 50,400 units
Activity level 2,000 dispatches 2,200 dispatches
Total overhead cost of dispatching $120,000 $126,720
Calculate the total overhead variance for despatching, and analyse into the expenditure and
efficiency variances.
Chapter 11
BUDGETING
1. Introduction
Budgeting is core to management accountancy and represents a method with which to plan,
control and evaluate performance of an organisation. This syllabus area links to standard costing,
variance analysis and forecasting.
Students need to be able to explain the purposes of budgeting and discuss the different budgeting
methods and their suitability to a particular scenario. Calculations of key budget figures are
expected- as is knowledge of the usefulness of budgets as a control mechanism.
2. Budgeting Objectives
๏ Planning
๏ Communication
๏ Coordination
๏ Motivation
๏ Authorisation / Delegation
๏ Control
๏ Evaluation of performance
Example 1
Consider budgets you may have experienced in your workplace or elsewhere. How successful were
they at fulfilling the objectives above?
(a) Suggest how a budget might be used as a motivational tool.
(b) To what extend does a budget enable the communication of business objectives and
future plans to others in the company?
3. Principal budget factor

The principal budget factor is the factor that limits the activity for the budget period. Normally this
is the level of sales demand and therefore the sales budget is usually the first budget to be
prepared and this leads to the others.
However, it could be (for example) a limit on the availability of raw materials that limits activity. In
this case Raw Materials would be the principal budget factor, and this would the first budget to be
prepared.
4. The preparation of budgets
Sales Budget
Production Budget
Raw materials Labour Factory overheads
Cost of goods sold

budget
Selling and General and

distribution expenses administrative expenses
Budgeted Income
Statement
Capital expenditure
Cash Budget
budget
Budgeted Statement
of Financial Position
Example 2
The XYZ company produces three products, X, Y, and Z. For the coming accounting period budgets
are to be prepared using the following information:
Budgeted sales
Product X 2000 units at $100 each
Product Y 4000 units at $130 each
Product Z 3000 units at $150 each
Standard usage of raw material

Wood Varnish
(kg per unit) (litres per unit)
Product X 5 2
Product Y 3 2
Product Z 2 1
Standard cost of raw material $8 $4
Inventories of finished goods

X Y Z
Opening 500u 800u 700u
Closing 600u 1000u 800u
Inventories of raw materials

Wood Varnish
Opening 21,000 10,000
Closing 18,000 9,000
Labour
X Y Z
Standard hours per unit 4 6 8
Labour is paid at the rate of $3 per hour
Using the information provided above-

Prepare the following budgets:
(a) Sales budget (quantity and value)
(b) Production budget (units)
(c) Material usage budget (quantities)
(d) Material purchases budget (quantities and value)
(e) Labour budget (hours and value)
5. Key Terms (Revision)

The terms below should be familiar to you from earlier studies.
๏ Fixed Budget
๏ Flexed Budget
๏ Rolling Budget
๏ Feed forward Control
๏ Feedback Control
Explain how the above could be used in the planning, control and performance evaluation of an
organisation?
Example 3
A company has prepared the following fixed budget for the coming year.
Sales 10,000 units
Production 10,000 units
$
Direct materials 50,000
Direct labour 25,000
$97,500
Budgeted selling price $10 per unit.

At the end of the year, the following costs had been incurred for the actual production of 12,000
units.
$
Direct materials 60,000
Direct labour 28,500
$114,500
The actual sales were 12,000 units for $122,000

(a) Prepare a flexed budget for the actual activity for the year
(b) Calculate the variances between actual and flexed budget, and summarise in a form
suitable for management. (Use a marginal costing approach)
6. Behavioural aspects
6.1. Participation
If the budget process is not handled properly, it can easily cause dysfunctional activity. It is
therefore necessary to give thought to the behavioural aspects.
๏ Top-down budgeting
This is where budgets are imposed by top management without the participation of the
people who will actually be involved for implementing it.
๏ Bottom-up budgeting
Here the budget-holders do participate in the setting of their own budgets.
๏ Advantages and disadvantages
6.2. Target setting and motivation

Targets can assist motivation and appraisal if they are set at the right level.
๏ if they are too difficult then they will demotivate
๏ if they are too easy then managers are less likely to strive for optimal performance
๏ ideally they should be slightly above the anticipated performance level
Good targets should be:

๏ agreed in advance
๏ dependant on factors controllable by the individual
๏ measurable
๏ linked to appropriate rewards and penalties
๏ chosen carefully to ensure goal congruence
6.3. Responsibility accounting

A system of accounting that separates revenues and costs into areas of separate responsibility,
which can then be assigned to specific managers
6.4. Management by objectives

A system of management incorporating clearly established objectives at every level of the
organisation.
Here there is less emphasis on monetary budgets and more emphasis on taking action which helps
the business to achieve its objectives.
7. Methods of budgeting
7.1. Incremental budgeting
This approach uses prior period figures and adjusts them by an amount to cover inflation and any
other known changes.
It is the most common approach, it is reasonably quick and for stable companies it tends to be fairly
accurate.
However, one potential problem is that it can encourage errors and past inefficiencies to be carried
forward.
Incremental planning does not encourage the company to consider new ways of operating the
business. Wasteful expenditure is not questioned each year because the budgeting process
incorporates and carries this forward to next period.
For example, if we require a wages budget, we will probably ask the wages department to produce
it and they (using an incremental approach) will assume that our workers will continue to operate
as before. They will therefore simply adjust by any expected wage increases.
As a result, the ‘plan’ for our workers stays the same as before. Nobody has been encouraged to
consider different ways of operating that may be more efficient.
7.2. Zero-based budgeting (ZBB)

With zero-based budgeting we do not build upon the prior period values. Instead, we consider
each activity on its own merits and draw up the costs and benefits of the different methods of
achieving it (and indeed whether or not the activity should continue). The management then
decide on the most effective way of performing each activity.
ZBB is bottom up by nature and aims to cut wasteful expenditure.
Although this approach is in principle a much better approach to budgeting, it is time-consuming

and also requires high level of management expertise. For this reason, it is sometimes restricted to
just to a few activities each year in order that training and help may be given to the people
involved. The remaining activities may then be budgeted using the incremental approach.
7.3. Activity Based Budgeting (ABB)

The activity-based approach uses the principles and costing information obtained by an ABC
costing system.
ABB budgets will use a number of different cost drivers e.g. number of orders , number of machine-
set-ups, number of inspections etc – to calculate the budgeted overhead figures.
Activity Based measures recognise that certain costs are are a result of a demand for activities
rather than output driven (which is the assumption in our traditional budgeting model).
The process will begin with the key budget factor (usually sales) in order to first determine the
volume driven costs and revenues – from here the various other overhead costs will be calculated
according to the expected level of support activities, which drive them.
7.4. Suitability
Based on your assessment of budget methods above, be able to comment on their suitability for
different scenarios.
Factors you might consider – Size of business, management expertise, culture, skills and attitudes,
time available, business objectives, economic climate, the type of business (manufacturing, service
industry, not for profit) etc.
8. Budgeting in a digital age

8.1. Big Data
Big data are extremely large collections of data that may be analysed to reveal patterns and trends,
especially relating to human behaviour.
For example, Amazon - one of the world’s leading e-retailers - collects an enormous amount of
information about each customer. Not only, obviously, what a customer has bought, but what
other products they may have looked at on the website but not bought, how they made payment
for purchases, where they live, what items they may have returned, what products they have
ordered more than once, what ratings and/or comments that customers may have posted about
specific products. All of this enables them to make recommendations to customers of other items
that might appeal to them.
Big Data has the following characteristics:

๏ Volume - The amount of data being stored by the likes of Amazon is enormous - many times
the amount of data that can be stored on a normal PC.
๏ Velocity – For the data to be useful, the data needs to be analysed and information provided
quickly enough. In the case of Amazon, suggestions need to be presented to customers
immediately they access the website.
๏ Variety - The data being stored will come from a large variety of sources - again, Amazon
collects information about past purchases, which other products the customer has looked at
on their website, etc. etc.. All of this information needs special software and algorithms that
collates the different data into useful information.
Later a 4th V was added:
๏ Veracity – users must consider data integrity to decide whether it is representative &
authentic and can be trusted.
8.2. Big data analytics
Big data can be collected ( sometimes purchased or obtained via company data collection process)
then analysed and used to provide insights that lead to better decisions based on more informed
knowledge
Using Big Data for Budgets & Forecasts
We have seen that sale forecasts are often the principle budget factor in many businesses.
Big data can be used to predict buyer behaviour, product popularity and used to estimate likely
sales demand in the form of detailed forecasts.
The data may be misleading and can be misinterpreted - it can also be overwhelming in some cases
but if used correctly can lead to competitive advantage and intelligent insight into customer
preferences.
It may enable businesses to determine why customers are selecting a rival’s product or the reasons
behind other subtle behaviour shifts.
Big Data – Stress Testing
Stress testing is a form of analysis that can determine which factors are important in a budget’s
success and how they could change and impact the final outcomes.
Big data analytics can play a key role in stress testing. It can help in the following ways:
๏ Identify stress events
๏ Help quantify the effects of stress events
๏ Help test the validity of assumptions in measures to deal with stress
๏ Identify correlations for stress events
๏ ︎Create and identify warning signs / triggers for stress events
For example, financial institutions regularly use big data analytics to manage and ensure the
adequacy of assets used for retirement investments and insurance funds. Through data modelling
and simulation they can determine their ability to withstand economic shocks and ensure decisions
are resilient enough to withstand changes in the economy. Big data can be used to inform these
models indicating employment shifts/ credit changes/ recession factors and other behaviours
which can lead to better decisions.
Chapter 12
FORECASTING TECHNIQUES
1. Introduction
This chapter demonstrates some of the key mathematical techniques, which can be used to
prepare financial forecasts.
These are:
๏ High low method

๏ Regression Analysis
๏ Time Series.
You are expected to be able to calculate and interpret results for all methods.
2. Semi Variable costs

From your previous studies, you will be aware of different types of cost and the typical cost
behaviour of variable and fixed costs.
Many costs are ‘semi-variable’ and have a fixed AND a variable element.
A typical example of a semi variable cost would be a telephone bill where the customer’s total bill
comprises of a fixed monthly line rental and the cost of telephone calls on top.
The line rental is fixed and does not change throughout the period. It is known in advance and
does not change regardless of how many telephone calls are made.
The cost relating to telephone calls is classed as variable because it is determined by the usage in
the period. (i.e. it is volume driven and increases in a linear fashion)
2.1. Importance of accurate costing information
As a management accountant, you will need to obtain accurate cost information to provide a
reliable basis for budgets and forecasts.
In addition to statutory and reporting requirements- better costing information supports better
planning as well as better decision making in areas such as product pricing.
2.2. Historic Data.
Historic cost data can be obtained from system records.
A graph of total costs, in relation to output could look something like this:
Individually, the costs are unlikely to be useful in determining which element is fixed and which
variable.
However, our techniques of High-low and Regression analysis enable us to use this data as a basis
for estimating costs and identifying their variable and fixed elements.
3. High-low method
The high-low method is a very quick and simple approach to identifying the variable and fixed
elements of semi variable cost.
This approach assumes a linear relationship and uses the highest and lowest data points taken
from a normal range of business activity.
Once identified – the highest and lowest activity levels and the associated total cost for each, can
be input into the following formula to obtain variable cost per unit.
Total Cost at highest activity – Total Cost at lowest activity

VC = Total Units at high activity level – Total units at low activity
level
Substituting total variable cost back into the total cost figures can then identify the fixed cost
element.
Total Cost = Fixed Cost + Total Variable Cost
NB) Total Variable Cost = Variable cost per unit x Number of Units
Example 1
The following table shows the total costs recorded at different activity levels during the year
Output Total Cost
(units) ($)
100 40,000
400 65,000
200 45,000
700 85,000
600 70,000
500 70,000
300 50,000
Use the High-low technique to estimate variable cost per unit and fixed cost per month.
NB) It is important that data selected is representative of normal business activity. Any anomalies or
one-off occurrences that could distort the results should be removed.
4. Regression Analysis
Also known as ‘least squares’ method, this technique is also appropriate for use when costs are
believed to follow a linear relationship.
Similar to High-low method, regression analysis can be used to separate semi-variable costs into
their fixed and variable elements.
However, instead of using just two extreme points, highest and lowest, as our method previously,
this superior technique allows you to incorporate all of the data sets into your computation and
thus provides an estimate of variable and fixed costs that is based on a greater amount of historic
information.
Effectively, this recreates a line of best fit through the scattered data points.
The equation of a line and the formula needed to find ‘a’ and ‘b’ are given below:
y = a + bx
n∑ xy − ∑ x ∑ y
∑ y − b∑ x
n∑ x 2 − (∑ x )
2
n n
Applied to our costing scenarios,
a will be the fixed cost (y intercept)
b will be the variable cost per unit (the gradient)
y will be total cost (independent variable)
x will be the activity level ( dependent variable)
n is the number of data sets
The method is far simpler than the formula appears and involves a logical process (see lecture).
* CIMA have confirmed that this formulae is examinable and will not be provided in the
objective test examinations.
Example 2
The following table shows the number of units produced each month and the total cost incurred:
Output Total Cost

(units) ($)
100 40,000
400 65,000
200 45,000
700 85,000
600 70,000
500 70,000
300 50,000
Calculate the regression line, y = a + bx
Note – this will give you a slightly different answer to the high-low technique. This is because both
provide approximations only.
4.1. Using the equation as a forecasting tool
Once a linear expression for the data has been obtained – we are able to use this to estimate or
predict total costs ‘y’ for any given activity level x.
However, forecasting beyond the data range or applying to scenarios, which are based on different
circumstances, should be avoided.
Example 3
Calculate the estimated total cost for the above scenario if the forecast output level is
expected to be 650 units.
4.2. Correlation Coefficient
You are NOT required calculate or remember the formula for Pearson’s correlation coefficient for
CIMA P1 however you must be able to show an understanding of the results.
For information only
n∑ xy − ∑ x ∑ y
Correlation Coefficient r =
( n∑ x 2 − ( ∑ x ) )( n ∑ y − ( ∑ y ) )
2
2
2
The formula is applied to the historic data as before and can be used to determine how linear the
relationship between variables is.
The result should fall within the range of -1 to + 1 and can be interpreted as follows:
r=1 the data variables X and Y display a perfect positive linear correlation (ie costs Y
are increasing directly with output X.)
r = -1 the variables display a perfect negative linear correlation (in this case Y will
decrease for each increase in X)
r=0 The variables do not appear to exhibit linear correlation.
Eg. If correlation coefficient r = 0.91 (close to +1) then this tells us that the two variables ( for
example, cost and output, appear to have a very strong positive linear correlation – based on the
data observations selected.
Example 4
Our techniques can be applied to scenarios outside management accounting.
State what type of correlation you would expect to find in examples below: i.e. positive,
negative or no correlation.
(a) Number of hours spent studying and likely exam score.
(b) Number of pages printed and ink levels in a printer.
(c) Shoe size and level of disposable income .
4.3. Problems with regression analysis?
5. Time series analysis

Management accountants can use historic data to identify trends and patterns, which can be used
to better inform their forecasts.
As before – these patterns may not be exhibited by each individual value within the data but
instead become apparent when looking a general movements across a period of time.
5.1. Key Definitions

Time series: A data set of observations recorded in equal intervals over a period of time –
e.g. monthly.
Histogram is a graph of time series data. Where X axis displays time period –e.g. years,
quarters, months.
5.2. Time series components

๏ Trend within data is the ‘underlying’ general movement over time.
๏ Seasonal fluctuations in data, -this is a regular variation within the data that is calendar or
seasonally related. Any predictable change or pattern that recurs or repeats within one year
can be described as seasonal.
๏ Cyclical variations repeat in cycles over period that is more than one year, eg often these are
fluctuations relating to economic cycles of boom and bust.
๏ Random (residual) fluctuations are unpredictable and irregular and are not therefore useful
for forecasting.
You will not be required to calculate the cyclical or random components in CIMA P1
exam questions
๏ Additive model - assumes that all components are independent of each other.
TS = T + SV + C + R
๏ Multiplicative model is better for use when components are moving in line with trend (eg
seasonal variations appear to be increasing as level of trend rises).
TS = T x SV x C x R
Regression analysis can be used to estimate a trend line for a time series. The X variables in the
regression formulae will be represented by time – with period one being the first data observed.
This line can then be used as a forecasting tool.
5.3. Obtaining the Trend - Moving averages
In order to distinguish the trend from the seasonal variations, we use the method of moving
averages. This is a smoothing technique intended to reveal underlying data trends and cancel the
effect of random fluctuations.
Example 5
Set out below are the sales per quarter (in 000’s of units) of a company over the last 3 years.
Quarter
1 2 3 4
2000 80 87 82 90
2001 90 95 93 102
2002 105 112 103 116
Identify the trend and calculate the average seasonal variation.
5.4. The multiplicative model
In the previous example we calculated the seasonal variations using the additive model.
However, if the trend is increasing it would perhaps be more sensible to accept an increasing
seasonal variation.
The multiplicative model deals with this by measuring the seasonal variation as actual as a
percentage of trend.
Example 6
Using the data from example 5 together with the trend already calculated, calculate the
average seasonal variation using the multiplicative model.
6. Forecasting Considerations
Example 7
Discuss below the limitations of using past data as a prediction of future results.
Chapter 13
RISK AND UNCERTAINTY
This topic represents 15% of the 2015 CIMA P1 syllabus.
It lends itself well to objective type questions and will provide the basis for further techniques
introduced in CIMA P2 and P3.
1. Introduction
Business decision-making often requires choices to be made now about future outcomes, which
are unlikely to be known with certainty.
Key decisions such as new product launches, capital investments and other opportunities are
usually made without guarantee of future results.
Risk exists where the actual outcomes of a decision may not be in line with the forecasted or
expected outcomes. This will mean that results will be different than planned or hoped for.
2. Risk vs Uncertainty
The terms risk and uncertainty are often used interchangeably but there is a technical difference:
Risk differs from uncertainty in that risk can be quantified. For example – we do not know what the
result will be from a roll of a dice – but we do know it can only be one of six possible outcomes.
Uncertainty exists when there are no such ‘well defined’ possible outcomes. The outcomes are not
known or quantifiable in the same way as risk. This means probabilities cannot be used as a basis
for predictions.
3. Risk profiles
The approach taken to decision- making may be influenced by the decision-makers attitude to risk.
A risk seeker will be interested in the best possible outcome, no matter how small the chance that
they may occur. This is described as an optimistic attitude, which may be considered reckless if
likelihood of outcomes are ignored.
Someone who is risk neutral will be concerned with the most likely or ‘average’ outcome.
A risk averse decision maker is pessimistic and selects options on the basis of the worst outcomes
occurring.
4. Decision Making Techniques (Risk and Uncertainty)

For the examination you are expected to be aware of, and to apply, several different approaches
when dealing with risk and uncertainty within the decision making process.
๏ Expected values
๏ Decision Rules (Maximax, maximin, minimax regret)
๏ Decision Trees
๏ Sensitivity Analysis
๏ Standard deviation
5. Expected Values
Expected Values can be obtained when in situations which have various possible outcomes for
which the probabilities of each are known.
The expected value represents a long run average result that the decision maker could expect if the
event were repeated numerous times.
EV = Σpx
Example 1
The outcome of a new venture has been forecast below.
Probability of $50,000 profit = 0.3
Probability of ($20,000) loss = 0.7
What is the expected value of this project?
Should the decision maker go ahead with the venture?
5.1. Limitations of Expected Value Method.
Expected value method is often the approach of a risk neutral decision maker. However there are
some serious limitations of this method.
6. Decision Rules
Given a range of possible outcomes (usually profits or payoffs) examination questions may ask you
to identify the decision that would be chosen by the decision making criterion below.
๏ Maximax – represents the choice of an optimist who will prefer the option that results in
the best possible returns regardless of likelihood.
๏ Maximin – this pessimistic decision maker considers the worst result of all available
options and seeks to minimise this. Therefore maximin option will choose the option that
gives the best of the worst outcomes.
๏ Minimax Regret– this represents the choice of a ‘sore loser’. They seek to minimise the
maximum possible ‘regret’ from all the options available.
Example 2
John has a factory capacity of 1,200 units per month.
Units cost him $6 each to make and his normal selling price is $11 each. However, the demand per
month is uncertain and is as follows:
Demand Probability
400 0.2
500 0.3
700 0.4
900 0.1
He has been approached by a customer who is prepared to contract to a fixed quantity per month
at a price of $9 per unit. The customer is prepared to sign a contract to purchase 300, 500, 700 or
800 units per month.
The company can vary production levels during the month up to the maximum capacity, but
cannot carry forward any unsold units in inventory.
(a) Calculate all possible profits that could result from the various demand levels.
(b) Determine for what quantity John should sign the contract, under each of the following
criteria:
i) expected value
ii) maximin
iii) maximax
iv) minimax regret
(c) What is the most that John would be prepared to pay in order to obtain perfect
knowledge as to the level of demand?
7. Decision Trees
A decision tree is a diagrammatical representation of the various alternatives and outcomes. It is
relevant when using an expected value approach and where there are several decisions to be made
– it makes the options more understandable.
Example 3
Combi plc are having problems with one of their offices and have decided that there are three
courses of action available to them:
(a) shut down the office, raising proceeds of $5 million
(b) have an expensive refurbishment of the office costing $4,000,000
(c) have a cheaper refurbishment of the office at a cost of $2,000,000
If they do the expensive refurbishment, then a good result will yield a return of $13,500,000
whereas a poor result will yield a return of only $6,500,000.
If they alternatively decide to do the cheaper refurbishment, then a good result will yield a return of
$8,500,000 whereas a poor result will yield $4,000,000.
In either case, the probability of the refurbishment achieving a good result has been estimated to
be 2/3.
An independent company has offered to undertake market research for them in order to identify in
advance whether the result of refurbishment is likely to be good or poor. The research will cost
$200,000 and there is a 68% probability that it will indicate a good result.
Unfortunately, the research cannot be guaranteed to be accurate. However, if the research
indicates a good result, then the probability of the actual result being good is 91%.
If the survey indicates a poor result, then the probability of the actual result being good is 13%.
Combi have already decided that if they do have market research, and if the research indicates a
poor result, then they will only be prepared to consider the cheaper refurbishment.
Use a decision tree to recommend what actions should be taken.
Note: In this example, the market research is not guaranteed to be accurate. This is likely to be the
case in real life and is an example of imperfect knowledge
8. Sensitivity Analysis
Sensitivity analysis can be useful to appraise a decision, where the outcome is dependent on a
number of uncertain input variables.
For example, a decision to launch a new product is likely to be based on estimated demand levels,
estimated selling price, estimated variable costs etc.
Sensitivity analyses the effect of changes made to each variable, in order to determine their effect
on the decision.
By considering the sensitivity of each input variable we can ascertain which variables are the most
critical and therefore perhaps need more work confirming our estimates.
Example 4
Harry is about to considering a new business opportunity.
Based on his current estimations – the opportunity looks profitable.
His forecasted sales revenue is $30,000 per year – based on 1000 units sold.
His accountant has helped him to estimate fixed costs of 15,000 p.a.
The variable costs per unit are likely to be $10 per unit.
(a) Confirm, on the basis of the above figures, that the new opportunity is worthwhile
(b) Calculate the sensitivity to change of:
i. Sales Revenue (selling price)
ii. Sales volume
iii. Total variable costs
iv. Fixed costs
(c) Comment on the results
9. Standard Deviation.
When dealing with average outcomes – such as expected values – it can be useful to have an
indication of ‘dispersion’. That being the difference between individual values within a sample
from their ‘mean’ average.
The higher the standard deviation – the more spread out the individual values will be from their
mean. High standard deviation therefore represents high risk.
For example – project A and project B both have an expected value of $40,000.
Project A has a standard deviation of $2000
Project B has a standard deviation of $6500
This means that project A’s profits are within ±$2000 of $40,000. Whereas Project B profits have a
difference of ±$6500 from $40,000.
The formula for standard deviation is below:
∑(X–X) p
2
SD=
Note: you will not be asked to calculate the standard deviation in the exam, but you are expected
to understand what it is.
Example 5
The following are likely returns from project Z.
Return Probability
10% 0.2
15% 0.5
20% 0.3
Calculate the expected value and the standard deviation for project Z.
What is the co-efficient of variation in this case?
Chapter 14
RELEVANT COSTING
1. Introduction
A key part of business is decision making. This involves selecting a course of action NOW that will
affect the future.
Relevant costing is a method that is used for long term and short term decisions.
Short-term decisions concern how to make the best use of resources in the short term- they are
operational or tactical in nature. Short-term decisions are usually concern relatively low values, are
likely to be repeatable/ reversible and individually are not expected to have much impact on the
business long term.
For short term decisions we can ignore the time value of money.
Typical examples involve make-or-buy, contract pricing, acceptance of one-off orders and shut
down decisions.
2. Relevant Costing
Relevant costs refer to costs which are directly incurred (or saved) by the decision being made.
As a rule they should be Future, Incremental and cash based.
An exception to this is Opportunity costs which is the value of the next best alternative, that must
be sacrificed in order to pursue the current course of action.
Opportunity costs can only apply to limited or finite resources- otherwise no sacrifice results from
using them.
Example:
The cost of contribution lost from transferring key workers to focus on a new project would be a
relevant cost for the new project.
3. Non –relevant costs

Non-relevant costs are those that will not change as a result of the decision.
Always read the particulars of the question – but in general the following costs are not relevant for
decision making.
Sunk costs – These are costs, which have already been paid. Therefore they will not change as a
result of a decision and therefore are not relevant when evaluating the costs of a decision. An
example may be costs of research relating to a new product – these should not be allowed to
influence the decision to go ahead with the product because those costs have been already paid
and not change
Committed Costs – these type of costs must be paid regardless of the decision. They are usually
ongoing commitments – possibly lease or rental agreements that must be honoured by the
business in the short term.
Book Values or historic costs these costs are usually irrelevant to a decision because they are out
of date and are not a consequence of a decision being taken now.
Non- monetary costs – these are accounting valuations and estimates such as depreciation and
amortisation – these are not cash flows, so are seen as irrelevant for decision making.
Example 1
Identify the relevant costs from scenarios below:
Your research team have spent $50,000 researching project Q during 2X14? ( Relevant / Non-
relevant)
The production manager currently earns a salary of $20,000p.a. Your new project will incur
approximately $5000 p.a of overtime from him which means his salary is expected to be $25,000 for
the duration of the project. (Which is relevant cost for project here? $20,000 or $5000 or $25,000)
A decision to manufacture a new product is expected to increase fixed costs by $3000 per month.
( Relevant / Non-relevant)
4. Relevant costing – further practice

This sort of question is really testing that you can determine what information in the question is
relevant to the decision, and what information (for example, sunk costs) is irrelevant.
This is not a topic for which you can really learn rules. The main thing is to understand the thought
process involved and then to read questions very carefully and to state the assumptions you have
made where relevant.
Example 2
The managing director of Parser Ltd, a small business, is considering undertaking a one-off contract
and has asked her inexperienced accountant to advise on what costs are likely to be incurred so
that she can price at a profit. The following schedule has been prepared:
Costs for special order:
Notes $
Direct wages 1 28,500
Supervisor costs 2 11,500
General overheads 3 4,000
Machine depreciation 4 2,300
Machine overheads 5 18,000
Materials 6 34,000
98,300
Notes:
Direct wages comprise the wages of two employees, particularly skilled in the labour process for
this job, who could be transferred from another department to undertake work on the special
order. They are fully occupied in their usual department and sub-contracting staff would have to be
bought-in to undertake the work left behind. Subcontracting costs would be $32,000 for the period
of the work. Different subcontractors who are skilled in the special order techniques are available to
work on the special order and their costs would amount to $31,300.
A supervisor would have to work on the special order. The cost of $11,500 is comprised of $8,000
normal payments plus $3,500 additional bonus for working on the special order. Normal payments
refer to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments
in his normal work amounting to $2,500. It is not anticipated that any replacement costs relating to
the supervisor’s work on other jobs would arise.
General overheads comprise an apportionment of $3,000 plus an estimate of $1,000 incremental
overheads.
Machine depreciation represents the normal period cost based on the duration of the contract. It is
anticipated that $500 will be incurred in additional machine maintenance costs.
Machine overheads (for running costs such as electricity) are charged at $3 per hour. It is estimated
that 6000 hours will be needed for the special order. The machine has 4000 hours available
capacity. The further 2000 hours required will mean an existing job is taken off the machine
resulting in a lost contribution of $2 per hour.
Materials represent the purchase costs of 7,500 kg bought some time ago. The materials are no
longer used and are unlikely to be wanted in the future except on the special order. The complete
inventory of materials (amounting to 10,000 kg), or part thereof, could be sold for $4.20 per kg. The
replacement cost of material used would be $33,375.
Because the business does not have adequate funds to finance the special order, a bank overdraft
amounting to $20,000 would be required for the project duration of three months. The overdraft
would be repaid at the end of the period. The bank’s overdraft rate is 18%.
The managing director has heard that, for special orders such as this, relevant costing should be
used that also incorporates opportunity costs. She has approached you to create a revised costing
schedule based on relevant costing principles.
Adjust the schedule prepared by the accountant to a relevant cost basis, incorporating
appropriate opportunity costs.
5. Shutdown problems
This sort of question is asking for a decision as to whether or not to close part of the business.
Example 3
(a) A company manufactures three products, Pawns, Rooks and Bishops. The present net annual
income from these is as follows:
Pawns Rooks Bishops Total

$ $ $ $
Sales 50,000 40,000 60,000 150,000
Less variable costs 30,000 25,000 35,000 90,000
Contribution 20,000 15,000 25,000 60,000
Less fixed costs 17,000 18,000 20,000 55,000
Profit/loss 3,000 (3,000) 5,000 5,000
The company is considering whether or not to cease selling Rooks. It is felt that selling prices
cannot be raised or lowered without adversely affecting net income. $5,000 of the fixed costs of
Rooks are direct fixed costs which would be saved if production ceased. All other fixed costs would
remain the same.
(b) Suppose, however, that it were possible to use the resources released by stopping production
of Rooks to produce a new item, Crowners, which would sell for $50,000 and incur variable costs of
$30,000 and extra direct fixed costs of $6,000.
Consider whether the company should cease production and sale of Rooks under each of the
scenarios in (a) and (b) above.
6. Make or Buy decisions

In order to overcome problems of limited resources, a firm may buy in a product instead of making
it itself.
Where incremental costs of manufacture are less than those of buying in, the firm should make –
assuming that there are not limited resources.
Where resources are limited, the firm should concentrate on making those products which give the
greatest saving (over buying in) per unit of the scarce resource.
To decide which products should be made and which should be bought, we calculate the saving
per unit of scarce resource from making the product rather than buying it in.
Example 4
The availability of Material B is limited to 8,000 kg
Product X Y Z
Demand (units) 2,000 2,500 4,000
Variable cost to make ($ per unit) 10 12 14
Buy-in price ($ per unit) 13 17 16
Kg of B required per unit 3 2 1
(included in variable cost)
Which products should the company make and which should it buy?
Chapter 15
COST VOLUME PROFIT ANALYSIS
1. Introduction
You are likely to be familiar with elements of CVP analysis from your previous studies. CIMA P1
syllabus advances this knowledge by requiring application of breakeven techniques to more
complex decision making scenarios. You will need to become familiar with Profit Volume (P/V)
analysis – and the calculation of breakeven point in a multi-product environment.
Cost-volume-profit analysis considers the relationship between costs (fixed and variable), sales
volume and levels of profit.
The techniques of CVP analysis are used in breakeven calculations, contribution/ sales ratio
analysis and can be applied to indicate the level of sales necessary to make a desired profit (target
profit) or the amount by which sales can fall before the product is loss making (margin of safety).
2. Breakeven
Breakeven point represents the minimum level of sales (revenue or volume) needed to cover total
costs (fixed and variable). At breakeven point, profit is equal to zero because our total sales income
is equal to total expenditure.
The formula is for breakeven volume is below:
Total Fixed Costs

Breakeven point (in UNITS) =
Contribution per unit
3. Contribution to sales ratio (C/S Ratio)

The contribution sales ratio is an important concept – it indicates the level of contribution that is
included in sales revenue or selling price.

C/S ratio = x 100
Selling price
It can be used in the calculation of Breakeven point ($s)
Total Fixed Costs

Breakeven point (in REVENUE) =
C/S ratio
Example 1
Product X has variable costs of $2 per unit, and selling price of $6 per unit.
The fixed costs are $1,000 per year
(a) Use the above information to calculate budgeted sales revenue and budgeted costs
when planned production is 300 units per year. What is budgeted profit (or loss) at this
level?
(b) What is the breakeven point (in units)?
(c) What is C/S ratio of this product – explain the meaning?
(d) What is the breakeven revenue ($) ?
4. Margin of safety
The Margin of Safety measures the difference between budgeted sales and breakeven sales.
It can be expressed as percentage and shows the fall in budgeted sales that can be tolerated before
breakeven point is reached. This is a key measure of risk because management know that any fall
beyond breakeven point means the product will become loss making.
Margin of Safety ($) = Budgeted Sales less Breakeven sales
Budgeted Sales less Breakeven sales

Margin of Safety as % = x 100
Budgeted Sales
Example 2
Calculate the margin of safety % for example 1
5. Target Profit
Breakeven calculations will often ask for level of sales that is necessary to earn a target profit figure.
Fixed Costs + Target Profit

Target Profit (Sales units) =
Fixed Costs + Target Profit

Target Profit (Sales revenue) =
C/S Ratio
Example 3
Using example 1, calculate the sales revenue needed to generate a target profit of $320?
6. Breakeven chart
Breakeven point can be displayed and solved graphically.
Example 4
Draw a breakeven chart for example 1
Cost and
revenue
($)
Output (units)
7. Profit-volume chart
The profit volume chart shows the profit or loss at any level of activity. Intuitively, the greatest loss
will occur when no sales are made (sales = zero). This loss will be equal to the fixed costs. The point
will be the vertical intercept and is the starting point when creating this graph.
Example 5
Draw a profit-volume chart for example 1
Profit ($)
Sales units)
Loss ($)
8. Multi-product CVP analysis

Breakeven analysis so far has assumed that just one product is being sold –in reality a company is
likely to make several products, a range - each with a different CS ratio.
Management are still likely to be interested in the break-even sales revenue (in order to cover the
fixed overheads), but the existence of several products makes it less certain and this is approach
through an assumption that products will be sold in a predetermined ‘budgeted’ sales mix.
The mix may be obtained from scenario’s forecast sales volumes or from indicated ratios or
percentages.
A weighted average c/s ratio is the quickest way to find the breakeven sales values for a
multiproduct scenario.
Total Contribution (standard proportions)

Weighted Average C/S Ratio =
Total Sales Revenue (standard proportions)
Fixed Costs
Breakeven Sales Revenue =
Weighted average C/S ratio
Example 6
A company produces and sells three products: C, V and P.
The budget information for the coming year is as follows:
C V P
Sales (units) 4,800 4,800 12,000
Selling price (p.u.) $5 $6 $7
Variable cost (p.u.) $3.75 $5.25 $4.35
Contribution (p.u.) $1.25 $0.75 $2.65
The total budgeted fixed overheads for the year are $8,000
(a) Calculate the CS ratio for each product individually
(b) Calculate the weighted average CS ratio (assuming that the budgeted product mix
remains unchanged)
(c) Calculate the breakeven revenue (assuming that the budgeted product mix remains
unchanged)
(d) Construct a PV chart (assuming that the budgeted product mix remains unchanged)
(e) Assume that the products are sold in order of their CS ratios, construct a table showing
the cumulative revenue and cumulative profits associated with this selling order.
(f) Add the information to the P/V chart already produced for Exercise 6 and calculate the
breakeven sales revenue on this basis
9. Limitations of CVP analysis

CVP analysis is sometimes described as a crude, oversimplified model of cost, behaviour. The
following assumptions are its weaknesses.
๏ The selling price per unit is assumed to remain constant at all levels of activity
๏ The variable cost per unit is assumed to remain constant at all levels of activity.
๏ It is assumed that the total fixed costs do not change across all levels of production.
๏ It is assumed that the production volume is equal to sales volume in the period (i.e. there are
no changes in the levels of inventory)
๏ It requires the budgeted product mix proportions to be known in advance and remain
unchanged.
ANSWERS TO EXAMPLES
Chapter 1
No examples
Chapter 2
Answer to Example 6
units cost
High 1,000 110,000
Low 200 30,000
Difference 800 80,000
80,000
Therefore, variable cost = = $100 per unit
800
Using in ‘high’, total cost = $110,000

variable cost
(1,000 × $100) $100,000
Therefore, fixed cost = $10,000
Therefore, y = 100x +10,000
Chapter 3
Answer to Example 1
Reasons why a cost per unit is required:
๏ To value inventory (SFP)
๏ To calculate cost of sales for income statement.
๏ To determine a selling price.
๏ To plan and make decisions (budgeting, forecasting)
๏ To determine the impact of management decisions on costs i.e. evaluation of a cost savings
or change in cost due to a new supplier etc.
๏ To measure performance- eg using key ratios and variance analysis.
Answer to Example 2
Production units > Sales units (inventory has increased).
SIAM helps us to remember when stocks increase absorption costing profit will be higher.
The adjustment required is:
Change in units x OAR
(13500-12000) x $30 = $45,000
Absorption costing profit will be $45,000 higher than the marginal costing profit reported for that
period.
NB) The inclusion of selling price, variable cost etc are distracters and not needed to solve this
problem.
Fixed production cost per unit is another name for Overhead Absorption Rate (OAR).
Chapter 4
Answer to Example 1
(a) Total overheads $190,000

Total labour hours
A 20,000 × 2 = 40,000
B 25,000 × 1 = 25,000
C 2,000 × 1 = 2,000
67,000hours
190,000
O.A.R. = = $2.836 per hour
67,000
Cost cards:
A B C
Materials 5 10 10
Labour 10 5 5
Overheads (at $2.84 per hr) 5.68 2.84 2.84
20.68 17.84 17.84
Selling price 20 20 20
Profit / Loss $(0.68) $2.16 $2.16
(b) Total A B C
Set-up costs
(Cost per set up = ) 90,000 36,000 46,800 7,200
Receiving
(Cost per delivery = ) 30,000 13,636 13,636 2,728
Despatch
(Cost per order = ) 15,000 5,000 5,000 5.000
Machining
(Cost per machine hour: ) 55,000 23,404 29,256 2,340
190,00
0 78,040 94,692 17,268
Number of units 20,000 25,000 2,000
Overheads p.u. $3.90 $3.79 $8.63
Costings:
A B C
Materials 5 10 10
Labour 10 5 5
Overheads 3.90 3.79 8.63
18.90 18.79 23.63
Selling price 20 20 20
Profit / Loss $1.10 $1.21 $(3.63)
Answer to Example 2
Better costing information can be used to reduce and control costs more effectively.
Better pricing decisions
More accurate basis for forecasting and budgeting
Supports other areas of decision-making – such as identification and discontinuation of

unprofitable product lines.
Chapter 5
Answer to Example 1
A B
Selling price 25 28
Materials 8 20
Other variable 12 4
20 24
Contribution p.u. 5 4
Machine hrs p.u. 2 1
Contribution per hour $2.50 $4
Production
units hours
B: 10,000 × 1 hr = 10,000
A: 19,000 × 2hrs = 38,000
48,000hours
Profit
$
A: 19,000 × $5 95,000
B: 10,000 × $4 40,000
135,000
less Fixed costs:
[A: 20,000 × $3
B: 10,000 × $2] 80,000
Profit $55,000
Answer to Example 2
(a) A B
Selling price 25 28
Materials 8 20
Throughput p.u. $17 $8
Machine hrs p.u. 2 1
Contribution per hour $8.50 $8

(2) (1)
Production Plan
units hours
A: 20,000 × 2hrs = 40,000
B: 8,000 × 1hr = 8,000
48,000 hours
Profit
$
A: 20,000 × $17 340,000
B: 8,000 × $8 64,000
404,000
less “fixed” costs:
[A: 20,000 × $15
B: 10,000 × $6] 360,000
Profit $44,000
360,000
Cost per factory hour = = $7.50
$48,000
(b) Throughput accounting ratios:
8.50
A: = 1.13
7.50
8
B: = 1.07
7.50
Interpretation: Both products have a TPAR greater than 1 which means they are both
financially viable products (they return more per hour than the factory cost per hour)
However, Product A is more profitable than product B – which is why the production plan we
created prioritised resources to producing all of product A first.
(c) Management should always consider other business strategic factors before withdrawing a
product from sale. For example, product may be a vital part of the range that customers value.
Alternatively, sale price may be deliberately low due to pricing strategies such as introductory
pricing, loss leadership or a price penetration policy.
Chapter 6
Answer to Example 1
Total joint costs: $

Materials 5,000
Labour & o/h 2,300
7,300
Less: proceeds of by-product
(500 kg × $0.20) (100)
Started & finished (25,000 u) $7,200
Production of joint products: kg

A 1,000
B 2,000
3,000 kg
7,200
Cost per kg = $2.40
3,000
(for A and B)
Answer to Example 2

Materials 5,000
Labour o/h 2,300
7,300
Less: Proceeds of by-product
(500 kg × $0.20) (100)
$7,200
Sales value of production of joint products:
$
A (1,000kg × $5) 5,000
B (2,000kg × $2) 4,000
$9,000
Allocation of joint costs to production:
$
5,000
A ⎛⎜ ⎞
× 7,200⎟ 4,000 for 1,000 kg
⎝ 9,000 ⎠
4,000
B ⎛⎜ ⎞
× 7,200⎟ 3,200 for 2,000 kg
⎝ 9,000 ⎠
Cost per kg:
⎛ 4,000 ⎞
A ⎜ = $4.00 per kg
⎝ 1,000 ⎟⎠
⎛ 3,200 ⎞ = $1.60 per kg

B ⎜
⎝ 2,000 ⎟⎠
Answer to Example 3

Materials 5,000
Labour o/h 2,300
7,300
Less: Proceeds of by-product
(500 kg × $0.20) (100)
$7,200
Net realisable value of production
$
A 1,000 kg × ($8.40 – $4.80) = 3,600
B 2,000 kg × ($4.50 – $2.20) = 4,600

$8,200
Allocation of joint costs to production:
$
3,600
A ⎛⎜ ⎞
× 7,200⎟ 3,161
⎝ 8,200 ⎠
4,600
B ⎛⎜ ⎞
× 7,200⎟ 4,039
⎝ 8,200 ⎠
$7,200
Cost per kg:
⎛ 3,161⎞
A ⎜ = $3.16 per kg
⎝ 1,000 ⎟⎠
⎛ 4,039 ⎞ = $2.02 per kg

B ⎜
⎝ 2,000 ⎟⎠
Chapter 7
Answer to Example 1
Types of costs – e-books
๏ Software expertise
๏ Royalties for author
๏ Design costs for cover image
๏ Marketing costs
๏ IT support ongoing for updates etc
๏ Licence/ commission paid to advertise on audio book site.
Note – many of these are fixed and paid up front.
Once the product is created, the cost of selling it again and again has virtually no extra cost.
Costs saved
Compared to physical manufacturing of books -there are no inventory storage or holding costs or
any transportation costs.
Chapter 8
Answer to Example 1
Let S = number of standard chairs produced per week
E = number of executive chairs produced per week

Constraints:
Materials: 2S + 4E ≤ 80
Labour: 5S + 6E ≤ 180
Demand: E ≤ 10
Non-negativity: S ≥ 0; E ≥ 0
Objective:
Maximise C = 6S + 9E
40
Feasible area:
A, B, C, D, 0
A
30
B
20 C
10
D
0 10 20 30 40 E
Maximum contribution occurs at point B (using the objective function).

At B, 2S + 4E = 80 (1)
5S + 6E = 180 (2)
(1) × 2.5: 5S + 10E = 200 (3)
(3) – (2): 4E = 20
E=5
In (1): 2S + 20 = 80
2S = 60
S = 30
C = 6S + 9E
= 180 + 45
= $225
Produce 5 Executive chairs and 30 standard chairs per week.
Maximum contribution is $225 per week.
Answer to Example 2
There is no spare material or labour
The spare demand for executive chairs is 5 chairs (10 – 5)
Answer to Example 3
(a) If there was 1 more kg of material available, then the material constraint becomes:
2S + 4E ≤ 81
Point B will still be the optimum solution, and therefore this will be when:
2S + 4E = 81 (1)
5S + 6E = 180 (2)
(1) × 2.5 5S + 10E = 202.5 (3)
(3) – (2) 4E = 22.5
E = 5.625
in (1) 2S + 22.5 = 81
2S = 58.5
C = 6S +9E
= 175.5 + 50.625
= 226.125
Shadow price of material = extra contribution
= 226.125 – 225
= $1.125 per kg
(b) If there was 1 more hour of labour available, then the labour constraint becomes: 5S + 6E ≤
181
Point B will still be the optimum solution, and therefore this will be when:
2S + 4E = 80 (1)
5S + 6E = 181(2)
(1) × 2.5 5S + 10E = 200(3)
(3) – (2) 4E = 19
E = 4.75
in (1) 2S + 19 = 80
2S = 61
S = 30.5
C = 6S +9E
= 183 + 42.75
= 225.75
Shadow price of labour = 225.75 – 225
= $0.75 per hour
The shadow price of demand for executive chairs is $0, because there is already spare
demand.
Chapter 9
Answer to Example 1
Original Flexed Variances

Actual
Fixed Budget Budget
Sales (units) 8,000 8,400 8,400
$ $ $
Sales 600,000 630,000 613,200 16,800 (A)
Materials 156,600 160,200 163,455 3,255 (A)
Labour 217,500 222,500 224,515 2,015 (A)
Variable o/h 87,000 89,000 87,348 1,652 (F)
461,100 471700 475318
Less: Inventory (37,100) (26,500) (26,500)
424,000 445,200 448,818
Contribution 176,000 184,800 (164,382)
Less: Fixed o/h (130,500) (130,500) (134,074) 3,574 (A)
Profit $45,500 $54,300 $30,308 23,992 (A)
Answer to Example 2
Materials
Expense variance
Actual purchases at actual cost 163,455
35,464kg
at standard cost
($4.50) 159,588
$3,867 (A)
Usage variance
kg
Actual usage 35,464
Standard usage for actual production
(8,900 u × 4kg) 35,600
136 kg
at a standard cost ($4.50) = $612 (F)
Labour
Rate of Pay variance
Actual hours paid at actual cost 224,515

45,400 hours at standard cost ($5) 227,000
$2,485 (F)
Idle Time Variance
Actual hours paid 45,400
Actual hours worked 44,100
1,300 hrs
at a standard cost ($5) = $6,500 (A)
Efficiency variance
Standard hours for actual production
(8,900 u × 5hrs) 44,500
400 hrs
at a standard cost ($5) = $2,000 (F)
Variable overheads
Expenditure variance
Actual hours worked at actual cost 87,348
44,100 at standard cost 88,200
$852 (F)
Efficiency variance
(8,900u × 5hrs) 44,500
400 hrs
at a standard cost ($2) = $800 (F)
Fixed overheads
Actual total 134,074

Original budget total 130,500
$3,574 (A)
Operating Statement
$
Original budget profit 45,500
Sales – volume variance 8,800 (F)
54,300
Sales – price variance (16,800) (A)
Materials – expense variance (3,867) (A)
– usage variance 612 (F)
Labour – rate of pay variance 2,485 (F)
– idle time variance (6,500) (A)
– efficiency variance 2,000 (F)
Variable o/hs – expense variance 852 (F)
– efficiency variance 800 (F)
Fixed o/hs – expense variance (3,574) (A)
Actual profit $30,308
Answer to Example 3
Original Flexed
Actual Variances
Fixed Budget Budget
Sales (units) 8,000 8,400 8,400
$ $ $
Sales 600,000 630,000 613,200 16,800 (A)
Materials 156,600 160,200 163,455 3,255 (A)
Labour 217,500 222,500 224,515 2,015 (A)
Variable o/h 87,000 89,000 87,348 1,652 (F)
Fixed o/h 130,500 133,500 134,074 574 (A)
591,600 605,200 609,392
Closing inventory (47,600) (34,000) (34,000)
544,000 571,200 575,392
Profit $56,000 $58,800 $37,808 20,992 (A)
Fixed overheads
Actual total 134,074

Original budget total 130,500
$3,574 (A)
Capacity variance
Budget hours (8,700u × 5hrs) 43,500
600 hrs
Efficiency variance
(8,900u × 5hrs) 44,500
400 hrs
Operating Statement
$
Original budget profit 56,000
Sales – volume variance 2,800 (F)
58,800
Sales – price variance (16,800) (A)
Materials – expense variance (3,867) (A)
– usage variance 612 (F)
Labour – rate of pay variance 2,485 (F)
– idle time variance (6,500) (A)
Variable o/hs – expense variance 852 (F)
– efficiency variance 800 (F)
Fixed o/hs – expense variance (3,574) (A)
– capacity variance 1,800 (F)
Answer to Example 4
No Answer
Chapter 10
There are different ways to calculate planning variances – however, this method is CIMA’s
preferred method – as per examiner’s article
Answer to Example 1
Labour rate planning variance
Actual output x revised std hours x original labour rate
22000 x 0.5 x $14 = 154000
= $38,500 ADV
Actual output x revised std hours x revised labour rate
22000 x 0.5 x $17.50 = 192500
Labour rate Operational variance
Actual output x actual std hours x revised labour rate
22000 x 0.518* x 17.50 = 199500
=22800 Fav
Actual output x actual hours x actual labour rate
22000 x 0.518* x 15.50 = 176700
*11,400/22,000 =0.511h per unit
Answer to Example 2
Planning material price variance
Actual output x revised std kg x original cost per kg
10,000 x 3kg x $4 = 120,000
= 36000 ADVERSE
Actual output x revised std kg x revised cost per kg
10,000 x 3kg x $5.20 = 156,000
Operational material price variance
Actual output x actual kg x revised cost per kg
10,000 x 3.3kg x 5.20 =171600
=33,000 FAV
Actual output x actual kg x actual cost per kg
10,000 x 3.3kg x 4.20 =138600
Answer to Example 3
Note: throughout this answer we use standard costs because cost variances are calculated
separately in the usual way
Total sales margin variance
Budget profit:
A 200u × (20 – 17) 600
B 100u × (25 – 21) = 400
C 100u × (30 – 24) = 600
1,600
Actual profit (using standard costs):
A 180u × (22 – 17) 900

B 150u × (22 – 21) = 150
C 107u × (26 – 24) = 340
1,390
Total variance = 1,390 – 1,600 = $210 (A)
Sales price variance

Actual selling Standard
Actual sales Actual sales
price selling price
units $ units $
A 180 × 22 = 3,960 180 × 20 = 3,600
B 150 × 22 = 3,300 150 × 25 = 3,750
C 170 × 26 = 4,420 170 × 30 = 5,100
$11,680 $12,450
Sales price variance = 11,680 – 12,450 = $770 (A)
Sales mix variance
Actual total Actual selling Actual total Standard
sales price sales profit p.u.
units $ units $
A 180 × $3 = 540 (2/4) 250 × $3 = 750
B 150 × $4 = 600 (1/4) 125 × $4 = 500
C 170 × $6 = 1,020 (1/4) 125 × $6 = 750
500 $2,160 500 $2,000
Mix variance = 2,160 – 2,000 = $160 (F)
Sales quantity variance

Actual total
Standard Standard
sales standard Budget sales
Profit profit
mix
units $ units $
A 250 × $3 = 750 200 × $3 = 600
B 125 × $4 = 500 100 × $4 = 400
C 125 × $6 = 750 100 × $6 = 600
500 $2,000 400 $1,600
Quantity variance = 20,000 – 1,600 = $400 (F)
Answer to Example 4
Total variance:
$
Actual total expenditure 126,720
Standard cost for actual production 126,000
(50,400 × 120,000/48,000)
720 (A)
Expenditure variance:
$
Actual total expenditure 126,720
Standard cost for actual despatches 132,000
(2,200 × 120,000/2,000)
5,280 (F)
Efficiency variance:
Despatches
Actual number of despatches 2,200
Standard number of despatches for actual production 2,100
(50,400 × 2,000/48,000)
100
Variance = 100 despatches × standard cost per despatch
= 100 × 120,000/2,000 = $6,000 (A)
Chapter 11
Answer to Example 1
Budget Objectives Discussion
Depending on your own experiences, you may find the budgets that you have dealt with so far
were or were not effective in their purpose of planning, coordination, communication and other
goals.
If you found the budgets you have experienced were particularly poor in any of the aspects –
consider why this was the case. How might the results or the reaction of those involved be
different, if the budget process had been approached a different way?
A budget is a key internal document and underpins the foundations of the next period’s activities.
Therefore, as a management accountant the choice of budget and how successful it is
implemented will depend on your ability to consider different methods and the suitability of each,
for the organisation where you work.
(a) Budgets can be motivating if targets are challenging but achievable. Motivation can be
enhanced further by involving staff in their own target setting. Rewards such as salary
bonuses can also be linked to achievement of budgeted figures. However, when dealing
with individuals and incentivising courses of action, care must be taken to ensure that the
results are goal congruent with the aims of the company.
(b) Budgets can be used to communicate strategic aims of the owners and senior managers to
all levels of the company. The budget executes these plans by translating them into smaller
objectives. Messages on strategic direction of the company, will be transferred across the
organisation. For example, a drive for growth, quality or cost-cutting should be apparent in
the targets set. This communication should be consistent with other messages that are
conveyed across the company and elsewhere.
Answer to Example 2
(a) Sales budget
$
X 2,000u × $100 = 200,000
Y 4,000u × $130 = 520,000
Z 3,000u × $150 = 450,000
$1,170,000
(b) Production budget
X Y Z
Sales 2,000 4,000 3,000
Opening inventory (500) (800) (700)
Closing inventory 600 1,000 800
Production 2,100 u 4,200u 3,100u
(c) Material usage budget

Wood Varnish
X 2,100u ×5= 10,500 ×2 4,200
Y 4,200u ×3= 12,600 ×2 8,400
Z 3,100u ×2= 6,200 ×1 3,100
29,300 kg 15,700 litres
(d) Materials purchases budget
Wood Varnish
Usage 29,300 15,700
Opening inventory (21,000) (10,000)
Closing inventory 18,000 9,000
26,300 kg 14,700 litres
× $8 × $4
$210,400 $58,800
(e) Labour budget
hours
X 2,100u × 4 = 8,400
Y 4,200u × 6 = 25,200
Z 3,100u × 8 = 24,800
58,400 hours
×$3
$175,200
Answer to Example 3
Flexed Actual Variances
Sales 12,000u 12,000 u
Production 12,000u 12,000 u
Sales 120,000 122,000 2,000 (F)

Materials 60,000 60,000 –
Labour 30,000 28,500 1,500 (F)
Variable o/h 15,000 15,000 –
105,000 103,500
Contribution 15,000 18,500
Fixed o/h 10,000 11,000 1,000 (A)
Profit $5,000 $7,500 $2,500 (F)
Statement
$
Original budget contribution (10,000u × $1.25) 12,500
Sales volume variance (2,000 × $1.25) 2,500 (F)
15,000
Sales price variance 2,000 (F)
Labour variance 1,500 (F)
Actual contribution 18,500
Fixed overheads
Budget 10,000
Variance 1,000 (A) 11,000
Chapter 12
Answer to Example 1
u $
High 700 85,000
Low 100 40,000
600u $45,000
45,000
Variable cost = = $75
600
For high:
Total cost = 85,000

Variable cost (700u @ $75) 52,500
Fixed cost $32,500
Answer to Example 2
x y xy x2 y2
1 40 40 1 1,600
4 65 260 16 4,225
2 45 90 4 2,025
7 85 595 49 7,225
6 70 420 36 4,900
5 70 350 25 4,900
3 50 150 9 2,500
28 425 1,905 140 27,375
Σx Σy Σxy Σx2 Σy2
n∑ xy−∑ x ∑ y
b= 2
n∑ x 2 −(∑ x )
7×1,905−28×425
=
7×140−282
1, 435
= = 7.321
196
a=
∑ y − b∑ x
n n
425 7.321×28
= − = 31.430
7 7
y = 31.430 + 73.21x
Answer to Example 3
y =31,430 + 73.21(650)
y = $79,016
Answer to Example 4
Number of hours spent studying and Exam results [positive correlation expected]
Number of pages printed and ink levels in a printer. [Negatively correlated]
Shoe size and level of disposable income [No correlation]
Answer to Example 5
Moving Trend Seasonal % variation
Average Variation
2000 1 80
2 87 84.75
3 82 87.25 86 -4 95.3
4 90 89.25 88.25 + 1.75 102.0
2001 1 90 92 90.62 - 0.62 99.3
2 95 95 93.5 +1.5 101.6
3 93 98.75 96.87 - 3.87 96.0
4 102 103 100.87 +1.13 101.1
2002 1 105 105.5 104.25 +0.75 100.7
2 112 109 107.25 +4.75 104.4
3 103
4 116
1 2 3 4
2000 - - -4 + 1.75
2001 - 0.62 + 1.5 - 3.87 + 1.13
2002 + 0.95 + 4.75 - -
Total + 0.13 + 6.25 - 7.87 + 2.88
Averages + 0.06 + 3.12 - 3.93 + 1.44
Answer to Example 6
1 2 3 4
2000 - - 95.3 102.0
2001 99.3 101.6 96.0 101.1
2002 100.7 104.4 - -
Total 200 206 191.3 203.1
Averages 100% 103% 95.6% 101.5%
Answer to Example 7
Discussion could include:
Correlation does not necessarily imply causation.
Too few data observations reduces the reliability of using data as a forecast.
The past is not necessarily an indication to the future.
Take care when predicting outside the range of normal activity.
Take care when predicting too far in the future.
Consider other factors that may influence future results (PEST factors).
Conclusion
As a management accountant techniques, which can analyse past data and use them to forecast
future results, can be very useful.
However, these methods should always be applied carefully – considering the points discussed
above – in addition to application of good judgment and management expertise.
Chapter 13
Answer to Example 1
(a) The expected value will be ( 0.3*50,000) + (0.7 * -20,000) = $1000.
In the long run they should end up with an average profit of $1000.
(b) On the basis of EV alone - the decision maker can accept the project.
However, the actual result of the venture may be loss making. The principle of expected values is
designed for experiments that are due to be repeated multiple times – therefore using this
technique to appraise a one-off venture may not be appropriate.
Answer to Example 2
Demand
(a) Contract size 400u 500u 700u 900u
300u 2,900 3,400 4,400 5,400
500u 3,500 4,000 5,000 5,000
700u 4,100 4,600 4,600 4,600
800u 4,400 4,400 4,400 4,400
(b) (i) Expected value if contract size =

300 units = (0.2 ×2,900) + (0.3 × 3,400) + (0.4 × 4,400) + (0.1 × 5,400) = $3,900
500 units = (0.2 × 3,500) + (0.3 × 4,000) + (0.5 × 5,000) = $4,400
700 units = (0.2 × 4,100) + (0.8 × 4,600) = $4,500
900 units = $4,400
Sign contract for 700 units

(ii) maximin
Worst outcome from:
300 units = $2,900
500 units = $3,500
700 units = $4,100
800 units = $4,400
(iii) Best outcome from
300 units = $5,400
500 units = $5,000
700 units = $4,600
800 units = $4,400
(iv) Regret table:
Demand 400u 500u 700u 900u

Contract size
300u 1,500 1,200 600 0
500u 900 600 0 400
700u 300 0 400 800
800u 0 200 600 1,000
Worst regret for
300 units = $1,500
500 units = $900
700 units = $800
800 units = $1,000

(c) With perfect knowledge of the level of demand, the payoffs would be as follows:
Payoff
Result of perf. know. Decision Contract
$
400 800u 4,400
500 700u 4,600
700 500u 5,000
900 300u 5,400
The expected return with perfect knowledge =
(0.2 × 4,400) + (0.3 × 4,600) + (0.4 × 5,000) + (0.1 × 5,400) = $4,800
The expected return without perfect knowledge (from (b)(i) is $4,500
So the most to pay for perfect knowledge
= 4,800 – 4,500
= $300
Answer to Example 3
13.5M
5M
2/3
od
Go
A
)
(4M
t
shu
ive
ens
exp Bad
⅓ 6.5M
1
(2M 8.5M
)
che
ap 2/3 13.5M
d
Goo .91
0
B od
Go
C
Bad
Market ⅓ 4M
)
research e (4M Bad
(0.2M) e nsiv 0.0
exp 9
6.5M
Good result
2
F 0.68 (2M 8.5M
che
)
d 0.91
Ba ap Goo
0.3 d re D
shut
2 sul
t
Bad
0.0
9
3 5M 4M
ch
eap
(2M
) .13 8.5M
o od0
shu
G
E
t
5M Ba
d0
.87
4M
Expected values:
at A (2/3 × 13.5M) + (1/3 ×6.5M) = 11.17M

B (2/3 ×8.5M) + (1/3 × 4M) = 7M
C (0.91 × 13.5M) + (0.09 × 6.5M) = 12.87M
D (0.91 × 8.5M) + (0.09 × 4M) = 8.095M
E (0.13 × 8.5M) + (0.87 × 4M) = 4.585M
Decisions
at 2: choose expensive, 8.87M (12.87 – 4)
at 3: choose shut, 5M
Expected value at F, (0.68 × 8.87M) + (0.32 × 5M) = 7.63M
Decision at 1: choose market research, 7.43M (7.63 – 0.2)
Answer to Example 4
Sensitivity Analysis
Current Assumptions – based on 1000 units sold:

$
Sales Revenue 30,000
Variable costs (10,000)
Contribution 20,000
Fixed Costs (15000)
Profit 5,000 <Based on these estimates – this project will be profitable
Sensitivity Analysis
Sales revenue
5000
x 16.6%
30,000
Sales Volume ( this is like sensitivity of contribution)
5,000
x 100 = 25%
20,000
Total Variable costs
5,000
x 100 = 50%
10,000
Fixed costs
5,000
x 100 = 33.3%
15,000
Interpretation.
Each element can be interpreted in similar way as below:

If total sales revenue was to fall by more than 16.6% (of its current estimated value) then the project
will be loss making.
If the total variable costs were to rise by more than 50% of the current estimated figure then the
project will become loss making.
Critical variable: Sales Revenue

In sensitivity analysis – the smallest % of the results identifies the most critical variable.
In this case - sales revenue (based on the estimated selling price) is the lowest percentage of the
project. This means management should recognise that this variable needs to be carefully
estimated and based on thorough market research. The analysis tells them that a drop in selling
price of more than 16.6% will make the project non-viable.
All sensitivity calculations assume the other variables of the project are held constant.
Answer to Example 5
Standard Deviation with Expected Value
x p px x–x p (x – x)2
10 0.2 2 – 5.5% 6.05
15 0.5 7.5 – 0.5% 0.125
20 0.3 6 + 4.5% 6.075
15.5% 12.25
x
Standard deviation = 12.25 = 3.5%
The expected value of return = 15.5%
The standard deviation is 3.5% (expressed in same units as the data given).
The coefficient of variation is 3.5/15.5 = 0.2258 which is 22.6% ( This % gives an indication of
relative magnitude of variation in the data).
Chapter 14
Answer to Example 1
(1) Your research team have spent $50,000 researching project Q during 2X14? (Non-relevant)
(2) The production manager currently earns a salary of $20,000p.a. Your new project will incur
approximately $5000 p.a of overtime from him which means his salary is expected to be
$25,000 for the duration of the project. (Which is relevant cost for project here? $5000 )
(3) A decision to manufacture a new product is expected to increase fixed costs by $3000 per
month. ( Relevant )
Answer to Example 2
Revised costs for special order:
Notes $
Subcontractor costs 1 31,300
Supervisor costs 2 1,000
General overheads 3 1,000
Machine maintenance 4 500
Machine overheads 5 22,000
Materials 6 31,500
Interest costs 7 900
88,200
Notes:
1. The choice lies between the two subcontractor costs that have to be employed because of
the shortage of existing labour. The minimum cost is to have subcontractors employed who
are skilled in the special process.
2. Only the difference between the bonus and the incentive payment represents an additional
cost that arises due to the special order. Fixed salary costs do not change.
3. Only incremental costs are relevant.
4. Depreciation is a period cost and is not related to the special order. Additional maintenance
costs are relevant.
5. The relevant costs are the variable overheads ($3 × 6000 hours) that will be incurred, plus the
displacement costs of $2 × 2000 hours making a total of $22,000.
6. Since the materials are no longer used the replacement cost is irrelevant. The historic cost of
$34,000 is a sunk cost. The relevant cost is the lost sale value of the inventory used in the
special order which is: 7,500 kg × $4.20 per kg = $31,500.
7. Full opportunity costing will also allow for imputed interest costs on the incremental loan.
The correct interest rate is the overdraft rate since this represents the incremental cost the
company will pay. Simple interest charges for three months are therefore: (3/12) × $20,000 ×
18% = $900.
Answer to Example 3
(a) Lost contribution from Rooks (15,000)

Save fixed overheads 5,000
Net loss from ceasing Rooks 10,000
Therefore, should continue production of Rooks.
(b) Lost contribution from Rooks (15,000)

Save fixed overheads 5,000
Extra contribution from Crowners 20,000
Extra fixed costs of Crowthers (6,000)
Net gain from ceasing Rooks 4,000
Therefore, should cease production of Rooks and produce Crowners instead.
Answer to Example 3
X Y Z
Buy-in price 13 17 16
Cost to make 10 12 14
Saving (p.u.) $3 $5 $2
Kg of B 3 2 1
Saving per kg $1 $2.50 $2

RANKING 3 1 2
Material B
Units
(kg)
Y MAKE 2,500 5,000
Z MAKE 3,000 3,000
8,000 kg
Z BUY 1,000
X BUY 2,000
Chapter 15
Answer to Example 1
$
Selling price 6
Variable costs 2
Contribution 4
(a) $
Total contribution (300u × $4) 1,200
Fixed costs (1,000)
Profit $200
Fixed costs 1,000

(b) Breakeven = = = 250 units
Contribution p.u 4
(c) C/S Ratio is 4/6 = 0.66 (This tells us that 66% of selling price is contribution)
(d) Breakeven revenue = 250 u × $6p.u. = $1,500
1,000
If used formula with C/ S ratio – result is approx the same as above = 1,515
0.66
Approx $1500
Answer to Example 2
Margin of safety
Budgeted sales = 300 units

Breakeven = 250 units
300 – 250
Margin of safety = × 100 = 16.67%
300
Answer to Example 3
Contribution 4
C/S ratio = = = 0.67
Sales 6
$
Target profit 320
Target contribution $1,320
Sales revenue required = Target contribution ÷ C/S ratio = 1320 ÷ 4/6 = $1,980
Answer to Example 4
Cost & revenue
($)
3,000 Total
revenue
}
2,000 Total cost
variable
cost
}
1,000
fixed cost
0 250 500 output

(units)
breakeven
Answer to Example 5
Profit
($)
1,000
0 500 Sales (units)
breakeven
(250 units)
1,000
Answer to Example 6
(a) CS ratios:
C = 1.25 / 5.00 = 0.25 (or 25%)
V = 0.75 / 6.00 = 0.125 (or 12.5%)
P = 2.65 / 6.00 = 0.379 (or 37.9%)
(b) Average CS ratio:
Based on budget sales,
Total revenue = (4800 x 5) + (4800 x 6) + (12000 x 7)
= $136,800
Total contribution = (4800 x 1.25) + (4800 x 0.75) + (12000 x 2.65)
= $41,400
Average CS ratio = 41400/136800 = 0.303 (or 30.3%)
(Alternatively, the average CS ratio may be calculated by taking the weighted average of the
individual CS ratios, weighting by the budgeted sales revenues.)
(c) Breakeven sales revenue = fixed overheads / CS ratio
= 8000/0.303
= $26,400
(d) See graph below
Profit ($)
+ 40,000
+ 30,000
+ 20,000
+ 10,000 P
0 50,000 100,000 150,000 Sales ($)
– 10,000
(e) P has the highest CS ratio, followed by C, followed by V.
Cumulative Cumulative
Sales Profit
P (12,000 × 7 =) 84,000 ((12,000 × 2.65) – 8000) 23,800
C (4,800 × 5 = 24,000) 108,000 (4,800 × 1.25 = 6000) 29,800
V (4,800 × 6 = 28,800) 136,800 (4,800 × 0.75 = 3600) 33,400
(f) If selling products in the order of highest contribution (P then C then V) Product P’s sales
alone will achieve breakeven. This means breakeven point from this selling strategy will be =
8000/0.379 = $21,108 of product P.
See dotted lines on P/V chart above

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IMPORTANT!!! PLEASE READ CAREFULLY

In addition question practice is vital!!

2. The definition of management accounting

3. Data and information

4. What makes good information?

5. The main managerial processes

Comparing the performance of mangers or departments against budgets or targets

6. The different levels of planning

7. Comparison of Management Accounting with Financial

Business Appropriate cost unit

Only the production costs will be relevant in costing.

TOTAL DIRECT COSTS = PRIME COST

Indirect production costs (overheads)

TOTAL PRODUCTION COST = PRIME COST + PRODUCTION OVERHEADS

Other costs required to run the business.

TOTAL COSTS = PRODUCTION COSTS + NON-PRODUCTION COSTS

Stepped fixed cost

Semi variable/fixed cost

Behaviour of manufacturing costs

By their nature direct costs will be variable costs.

Overheads can be fixed or variable

Typical cost card for a cost unit

These costing methods will be familiar to you from previous studies.

2. The purpose of calculating a cost per unit.

3. Features of Absorption costing

Acceptable method of inventory valuation as per IAS 2.

Results in a FULL product cost per unit.

4. Strengths and weaknesses of Absorption Costing

5. Features of Marginal Costing

Only variable costs are included in product cost.

Overheads are classed as period costs.

Contribution = Selling Price less Variable cost.

6. Strengths and weaknesses of Marginal costing

7. Reconciliation of profits, Absorption Vs Marginal Costing

The reconciliation required is below:

Change in inventory levels in period x OAR (X / (X))

๏ Marginal Costing Profit $X

To determine the direction of the adjustment - a useful mnemonic is SIAM

It is argued that a modern manufacturing environment requires a more sophisticated and

2. The steps to be followed are as follows:

NOTE on CIMA new objective test exams.

3. ABC Cost Hierarchy

4. Strengths / Weaknesses of ABC Costing

2. Traditional Limiting Factor Analysis

3. Theory of Constraints and Throughput

Throughput ($) = Sales Revenue less Direct Material Costs

Total factory costs = ALL production costs (except materials)

Throughput per Unit $

Total factory cost (inc labour +overheads)

Return per factory hour (1)

4.1. Interpretation of TPAR ratios:

Products with a TPAR ratio less than one should be discontinued.

3. Physical units basis

Materials (3,500 kg) $5,000

4. Market value basis

5. Net-realisable value approach

Materials (3,500 kg) $5,000

3. Costing of digital products

4. CGMA’s Cost Transformation Model

๏ Creating a cost conscious culture