MALec Batch 2

University Of London
Management Accounting
Lecture Notes
Lecture 6 & 7
Topics Covered
Cost behaviour analysis and cost volume profit analysis
Readings: Horngren, Chapters 8,9.

Lecture 6 & 7
This lecture begins with a review of cost behavior and deals with
the issues of cost behavior and cost functions at an advanced level.
This part can be tested in Section B of the exam.
The parts on cost volume profit analysis very popular in Section A

of the exam, especially multi-product break-even analysis.
Finally, the computations associated with learning curves can be

tested in Section A of the exam. This part can also make a good
multiple part question for 5 marks in section B of the exam.
101
Cost Classification by behaviour
Cost can be classified by behavior as follows:
1) Variable Cost
2) Fixed Cost
3) Semi Variable Cost
1. Linear Variable Cost Example Direct materials
• Variable cost is a cost that vary directly with the level of output within the
relevant range.
• This means that the higher the output, the higher the level of total variable
cost.
• Unit variable cost per unit is a constant within the relevant range.
• The relevant range is the range of activity over which the cost behaviour is
assumed to be constant.
• If the activity level goes outside the relevant range, then the expected
behaviour of costs changes, for example fixed costs can no longer be
assumed to be fixed.
102
Example of Variable Cost Behavior
Assume output of clay-pot:

Direct Material used: KG of clay
1 unit of clay-pot requires 1 kg of clay
1 kg of Clay = $10
Total Variable
Units of output Cost of clay Cost per unit
0 $0 NA
1 $10 $10
2 $20 $10
3 $30 $10
Cost $
Total Variable Cost
Variable Cost per unit

Relevant Range
Activity
2. Fixed Cost – Cost that does not vary with the level of output within the
relevant range.
Example – Rent
Cost $
Total Fixed Cost
Relevant Range
Fixed Cost per unit
Activity
103
3. Stepped(non-linier) fixed cost
Stepped fixed costs are those which do not vary with volume of activity between
two levels of activity but which, at the higher level, will require an extra resource.
Example rental of a factory which has a maximum capacity after which a new
factory will have to be rented.
Cost
Step Fixed cost
Output
Graph of step cost
3.Semi Variable Cost - Cost that contains both fixed and variable elements.
Cost $
Semi Variable Cost
Gradient(slope)
= Variable cost per
unit
Activity
104
Linear Cost Function
A cost function is a mathematical function describing cost behavior patterns.
The cost driver is the activity that causes the incurrence of the cost.(x function)
If we can assume that there is a linear relationship between two variables X & Y
and that this relationship can be shown on an equation of a straight line
(Y = a + bx), we can use the equation to forecast values of Y (total Cost) for
given values of x(Cost Driver).
Y=a+bx
Where Y = forecast variable of interest
a= Y intercept. The point at which the straight line cuts the Y axis.
b = the slope or the gradient of the straight line.
Therefore if Y = Total Cost
a = Total Fixed Cost
b = Variable cost per unit
Lecture Illustration – Dealing with Cost
Analysis of the maintenance department shows a fixed cost of $50,000 per

month and a variable element related to machine hours amounting to $3 per
machine hour. This information was determined over a range of between 1,000
machine hours to 2,000 machine hours.
What is the expected cost for the month when the planned activity level is:
1) 1500 machine hours
2) 1800 machine hours
105
Linear Cost Function
y = Total Maintenance Department cost per month
x = Machine Hours per month - cost driver
a = Total Fixed Cost per month
= $_____________
50,000 per month
b = Variable Cost per machine hour
= _______
$3 per machine hour
Cost function: (forecasting)
y = $ 50,000 + $ 3
Valid only for 1,000 to 2,000 machine hours

(Relevant Range)
Forecast:
Within Relevant Range
1) y = $50,000 + $3 X 1,500 machine hours
= $54,500
2) y = $50,000 + $3 X 1,800 machine hours
= $55,400
106
Factors to note regarding cost functions
1) Choice of the cost object and related cost driver
Must specify the cost object and the related cost driver clearly as a cost object
may be variable with respect to one cost driver and fixed with respect to
another cost driver
Example
A company incurs van registration cost of $1,000 per van. Is this a variable or
fixed cost?
Cost Object Cost Driver Behaviour

Van Registration cost per van Km driven per van Fixed cost
$1,000
Cost Object Cost Driver Behaviour

Van Registration cost per van Numbeer of vans VC
$1,000 registered
2) Time Span
Whether a cost is variable or fixed with respect to a particular cost driver

depends on the time span considered in the decision situation. The longer
the time span, other things being equal, the more likely the cost will be
variable.
Hence, in the long run, all cost is variable (subject to change).
107
3) Relevant Range
The linear cost function can only be assumed within the relevant range.
A relevant range is the range of the cost driver where the relationship
between the total cost and the cost driver is valid.
Outside the relevant range, the cost function may be non-linear and hence
the cost equation loses its predictive power. The more extreme the output
levels beyond the observed range, the less will be our confidence in the
prediction of future cost.
Hence, outside this range costs may behave in unknown and

unobservable ways.
108
4) The cause and effect criteria in choosing the cost driver
The cause and effect relationship between the cost driver and the
resultant cost might arise in several ways:
A) May be due to a physical relationship between the cost and the

cost driver. For example, when units of production is used as a cost
driver of material costs.
B) May arise out of a contractual arrangement. For example, when the

number of phone minutes used as a cost driver of telephone line
cost.
C) May be implicitly established by logic and knowledge of operations.

For example, where the number of components parts used is the
cost driver of design cost.
The cause and effect relationship is the most important issue in estimating
a cost function. Only a cause and effect relationship, not merely
correlation, establishes an economic plausible relationship between the
cost and the cost driver.
Example of cost and effect and correlation
Assume the following information:

Number of rainy days in Month Monthly Overhead cost($)
2 80,000
3 100,000
5 120,000
Hence, there seem to be a correlation between the number of
rainy days and overhead cost, but certainly no cause and effect
relationship as its not plausible to imply that rainy days effect
overhead cost.
109
Cost Estimation Approaches
There are 4 methods of cost estimation and in practice, all four methods could
be used together depending on requirements.
1. Industrial Engineering Method – Consult the Engineers (External)
• Estimates the cost functions by analysing the relationship between input and
output in physical terms. A physical relationship between the input and output
must exist to apply this method.
• Also termed the work measurement approach, as time and motion or work
studies are carried out by engineers.
• Use of time and motion studies to measure the relationship between inputs
and output in physical terms.
• Useful for direct cost category items such as direct materials and direct labour
cost.
• Example a study to analyse the time and materials required to perform the
various operations to produce one carpet.
• Very time consuming and expensive as need to employ engineers or

consultants to carry out study.
• As it is based on actual data, the results achieved will be relatively objective.
2. Conference Method- Consult the Experts (Internal)
• Cost estimates developed by personnel familiar with the factors influencing

the cost to be estimated.
• Accuracy depends on the care taken by the personnel providing the input.
• Consultative Method. Get inputs from personnel involved(experts) in

production, marketing or distribution.
• Benefits from the expert knowledge and hence must ensure personnel
providing the information have the necessary experience.
110
3. Account Analysis method
• This method involves using the prior year’s financial statements(accounts)

and using your judgement to distinguish between variable and fixed cost.
• Managers use qualitative rather than quantitative analysis when making these
cost classification decisions, hence the results could be subjective.
• Account analysis method is widely used because it is easy to use, cost

effective and reasonably accurate.
• To ensure reliable estimates of cost using the account analysis method, only
individuals with a good knowledge about the operations should make cost
classification decisions.
• Supplementing the account analysis method with the conference method

improves its credibility.
Lecture Illustration
Car Wash Specials is a car wash outlet in a petrol kiosk. Last year, the following
cost were reported.
Account Description Cost $

Car wash labour FC 40,000
Soap, cloth, and supplies- car wash VC 42,000
Water for car wash VC 38,000
Electric power to move conveyor belt VC 72,000
Depreciation on car wash equipment FC 64,000
Salaries of car wash Supervisor FC 46,000
Salaries of petrol pump attendant 30,000 not relevant
Depreciation is computed on a straight line basis. Last year, 500,000 litres of

petrol was sold and 80,000 cars were washed.
A call to the car wash manager (conference method) confirms that the car wash
labour cost above relates to the monthly salary of two car wash attendants
employed by the company. FC
Required:
1) Using the account analysis method, classify each account as variable or

fixed with respect to the number of cars washed.
2) State the cost function assume that the cost object is the total cost of cars
washed per year.
111
3) The company now forecast that it will serviced 100,000 cars this year. Use
the cost function above to estimate the company’s total cost for cars wash
this year and comment on the result.
4) If a sales promotion we to be conducted, what is the minimum price that

could be charged for a car washed.
2)
y = Total cost of cars washed per year (Cost Object)
x = Number of cars washed per year (Cost Driver)
a = Total Fixed Cost
= 40k + 64k +46k
= $150,000
b = Variable Cost per unit
= (42k x 38k x 72k) / 80,000 car washed

152k / 80k
= $1.90 per car
Cost function:
y = $150,000 + $1.90x
3) Predicted cost :
y = $150,000 + $1.90 X 100,000 cars
= $ 340,000
Comment
The volume of 100,000 may be outside the relevant range and hence the
predicted cost may not be accurate.
4) Minimum Price = Total variable cost
112
4. Quantitative Analysis method- For semi variable cost
• Involves comparison of past cost to estimate cost function. For example
using a monthly observation of manufacturing overheads cost and
machine hours to estimate cost function.
• This method is used to split semi variable cost into its fixed and variable
element.
Estimating the Cost function using the quantitative analysis method
There are 2 methods to achieve this:
1) High-Low Method
2) Least square Method
This method important for exam

High-Low Method
This is a simple technique as it uses only two observation points, the highest
and the lowest activity and simply ignores the rest of the observation points.
This method is used to split semi variable cost into its fixed and variable
element
Use only the highest and lowest values in a set of data.
The difference between the values at the highest and the lowest activity level
determines the rate of cost change and hence the variable cost.
The advantage of the high low method is its simplicity. It gives a quick, initial
insight into the relationship between the cost driver and the cost object.
The disadvantage is that it ignores all other observation points and hence less
accurate compared to least square method.
113
Exam Tip- This method important for
Steps in performing the High Low method exam
Step 1 – Identify the highest activity and the corresponding cost amount & the
lowest activity and the corresponding cost amount. Activity means the output in
units or the amount of direct labour hours or machine hours.
Step 2 – Find the difference from the point above.
Example:
Description Activity Total Cost

Highest 10,000 Units $1 million $10M
Lowest 4,000 Units $6 million

Difference 6,000 unit** $4 million*
Step 3 – Compute the variable cost per unit.
Variable cost per unit = Difference in total cost*

----------------------------------
Difference in total activity**
Variable cost per unit = ______________________

$4M/ 6k units = $666.67 per unit
Step 4 – Compute the total fixed cost
Total fixed cost = Total cost Less Total variable cost
At Highest
$10m - ($666.67 x 10k units) = $3,333,333
Total fixed cost = ______________________________________
At Lowest
Total fixed cost = ______________________________________
$6mil - ($666.67 x 4k units) = $3,333,320
Note that the total fixed cost computed at both the highest and the lowest point
should be constant.
Exam Tip- Exam, don’t compute
twice as answer will be the same
at highest or lowest activity
114
ABC company overheads are absorbed on a labour hour basis. The company
has collected overhead information for the last four months and this is shown
below:
Hours worked Overhead cost $

Month 1 9,300 115,000
Month 2 9,200 113,600 lowest
Month 3 9,400 116,000
Month 4 9,600 116,800 highest
The company normally works around 120,000 labour hours in a year.
The company uses the high low method to analyse overheads.
Required: Compute the overhead absorption rate per hour using the high-low
method and the monthly cost function.
Step 1 & 2
Hours Worked Total Overhead Cost
$
Highest 9,600 116,800
Lowest 9,200 113,600
Difference 400 3,200
Step 3
Variable Cost per unit(b) = $3,200/ 400 units = $8 per hour
115
Step 4 Total Fixed Cost
At Highest
TOH - VC
9,600 hours = $116,800 - ($8 x 9,600hrs)
TFC = $40,000 per month
At Lowest
9,200 hours = $113,600 - ($8 X 9,200)
= $40,000 per moth
Monthly Cost Function
y = Total Overhead Cost per month (Cost Object)
x = Labour Hours Worked per month (Cost Driver)
a = $40,000 Total Fixed Cost per month
b = $8 Variable Cost per hour
Fixed Cost (monthly cost function)
y = $40,000 + $8x
Fixed Cost per hour = $40,000 x 12 months /120,000 LH
= $4 per hour
Overhead Absorption rate per hour = $8 + $ 4
= $12 per hour
116
Least Square Method
This method involves the use of statistical formula for estimate the cost function.
It is more accurate than the high-low method, but also more time consuming to
derive.
General difficulties with all 4 methods
1) There may be no past reliable data for statistical purposes for example when
new technology is introduced or where data is missing or inaccurate.
2) Extreme values of observations which are isolated in nature and not expected
to recur should be ignored.
3) Inflation rates and their impact on future cost needs to be estimated and it may
be difficult to forecast of inflation rates.
4) The cause and effect relationship may not exist between the activity and the
cost.
5) The cost versus benefit criteria should always be applied. Hence, must always
determine if the additional cost of research justify the benefits to be received.
6) Compromise may be needed if data cannot be split accurately. This usually

involves treating variable costs as fixed and this will impact the reliability of
forecasts, for example electricity used is a semi variable cost, but its time
consuming to breakdown into variable and fixed cost. Hence in the real world we
may just assume it is a fixed cost.
The most difficult task is cost estimation is collecting high quality reliable
measured data on the cost and the cost driver.
117
Steps in estimating a cost function
Estimating a cost function using quantitative analysis involves a six-step
procedure:
Step 1:
Choose the dependent variable (cost being estimated or predicted). The
dependent variable is the cost being estimated(cost object) (y in the equation)
and depends on the cost function being estimated.
For example, the dependent variable is production overhead cost.
Step 2:
Identify the independent variable, or cost driver. The independent variable is
the factor used to predict the cost function. This is the cost driver, otherwise
referred to as X in the equation, or the slope. The cost driver should be
measurable and have an economically plausible relationship to the dependent
variable.
For example, the independent variable is machine hours.
Step 3:
Collect data on the dependent variable and the cost driver. This is usually
the most difficult step, as the data comes from a number of sources, and
managers need to be concerned about the validity of the data.
For example the data collected is as such:
Cost Driver Production
Week Machine Hours Overheads ($)
1 68 1190
2 88 1211
3 62 1004
4 72 917
5 49 1860
6 96 1456
7 78 1180
8 46 710
9 82 1316
10 94 1032
11 68 752
12 48 963
118
Step 4:
Plot the data. By plotting the data on a scattergraph it can be determined if a linear
relationship exists. Also, this alerts the manager to any extreme observations.
Step 5:
Estimate the cost function. As mentioned, there are two primary methods of
estimating a cost function—the high-low method and regression analysis.
Step 6:
Evaluate the cost driver of the estimated cost function.
119
Evaluating and choosing a cost driver
The choice of a cost driver for predicting the cost object should be based on the
following criteria:
CRITERIA WHAT DOES IT CRITERIA FOR

MEASURE EVALUATION
1) Economic This measures the A qualitative analysis
Plausibility relationship between the of the relationship
independent variable (x) between x and y.
& the dependent
variable (y). Is it logical
to say that an increase
in the independent
variable will cause an
increase in the
dependent variable
1) Goodness of Fit How close are the actual Review the Scatter
Coefficient of observations(Y) to the graph
Determination values predicted by the To determine the
cost function(y). How difference between the
well does the cost actual cost and the
function fit the observed predicted cost.
points. Goodness of fit
has meaning only if the
relationship between the
cost and the cost driver
is economically
plausible.
3) slope of regression If the regression line (or Review the Scatter
line total cost line) has a graph
steep slope, this To determine the
indicates a strong steepness of the slope
relationship between the
cost driver and the costs
incurred.
120
Example, assume the following lines
Required:
Identify the appropriate cost driver? Justify your answer.
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
121
Scatter graph and the Line of best Fit
Scatter graph indicating correlation
122
Economic Plausibility: Examples
123
Exam Tip:
Break Even Analysis You need to memorise all this formulas for
quick recall in the exam
Break - Even Point
This refers to the number of units to be sold whereby total sales equals to total
cost and hence profit or loss is zero.
This is also the point at which the contribution margin provided by the units sold
is equal to the fixed cost for the period.
Recall: Total contribution = Profit +Total fixed cost

At BE, profit(loss) equal $0, hence Total contribution = Total fixed cost
The break-even point is a measure of the business risk of the business, the
higher the break-even point, the higher the business risk.
Formula for Break – Even (B/E) point:
1) B/E Point in units = Total Fixed Cost________

Contribution per unit
Contribution per unit = Selling Price minus Variable cost per unit
2) B/E Revenue $ = B/E Units X Selling price per unit
OR
Total Fixed Cost_______

Contribution Margin Ratio
!"#$%&'($&"# *+% (#&$ 1"$2- /"#$%&'($&"#

Contribution Margin Ratio = ,+--&#. *%&/+ *+% (#&$0 OR 1"$2- 02-+0
3) Level of Sales to Achieve Target Profit = Fixed Cost + Target Profit

Contribution per unit
Note for Cost volume profit analysis or break-even analysis, we

are analysing the impact of sales volume on profit, not cash flow.
So, the fixed cost must include the annual depreciation expense.
124
Margin of Safety
Is the difference between the actual (or budgeted) sales level and the break –
even sales level.
The margin of safety can be expressed in sales units or sales dollar value.
The margin of safety gives an indication of the level of risk involved that is how
much sales can the business lose before it starts to make losses.
The larger the margin of safety the lower the business risk.
Margin of Safety (in Units) = Present Output Less Breakeven Point output
Margin of Safety %
= Present (Budgeted) Output Less Breakeven Output X 100%

Present (Budgeted) Output
Remember, profit is computed in the Income
Many ways to compute profit
Statement and hence accrual, not cash based. Must
include (non-cash) depreciation expense as a fixed
Profit = Total Sales Less Total Cost
cost
Profit = Total Contribution less Total Fixed cost
Profit = Margin of safety X Contribution per unit
Assume a contribution per unit of $10 per unit and break-even point of 200 units.
Compute the profit or loss if
1) 320 units sold. ______________________________________________.

(320 - 200 units) x $10 = $1,200
2) 150 units sold._______________________________________________.
125
Big Ltd makes and sells a single product using plant with a maximum capacity of
60,000 units per annum. The results for the six months ended 31st December
20X6 were as follows:
£’000 £’000
Sales (20,000 units) 6,000
Direct materials 2,200
Direct labour 640
Production overhead 1,600
Selling and administration overheads (all fixed) 1,960 6,400
Loss for the period (400)
Production overheads incurred was £1,560,000 in the first six months of 20X6
when the output was 15,000.
The management of Big Ltd are planning a reduction of selling price by £20 per
unit for the six months to 30th June 20X7.
Required:
(a) Calculate the break-even point in units for the six months to 31st December
20X6 and the margin of safety. VC per unit = 1,560/15 = $104, cost per unit is not constant
, semi variable, more produced lower cost per unit
(b) Calculate the break-even point in units for the six months to 30th June 20X7.
(c) Calculate the profit for the six months to 30th June 20X7 assuming that the
plant works at full capacity and can sell all it produces at the lower price.
(d) Calculate the profit and break-even point for the next financial year if market
conditions do not allow the selling price to be increased from the new level
proposed by management, but fixed costs increase by 10% in total and variable
costs by 4% per unit, assuming that the plant works at full capacity.
Use High/Low Method - Split Production Overhead
(a) Variable Cost per unit = . 1.6 £. - £ 1.56mil.

20,000 Units - 15,000 Units
= £8 per unit
Total Fixed Cost
(At Highest)
= £1.6mil - (£8 X 20,000 Units)
= £1,440,000
126
Total Fixed Cost = £1,440,000 + £1,960000
= £3.4 mil per 6 months
B/E Unit = £3.4 mil Exam tip:

£ 150 Find the fastest way to derive
(profit/loss + TFC)/20000 = cost/u =150 the contribution per unit
= 22,666.67 Units
Margin of Safety = 20k units Units - 22,666.67 Units
= (2,266.67)
Exam Tip: Use the contribution
(b) B/E for 30/6/X7 per unit from part a to derive it
for part b. Don’t round off the BE
B/E Unit = £3.4 mil . point. Similarly, use b. to derive
£150 - £20 c.
= 26,153.85 Units
full capacity for 6mth: 60k/2 = 30k units
(c ) Profit = ( 30k Units - 26,153.85 Units) X £130 (150k-20)
= £500,000
(d) Total Fixed Cost per year = £3.4 mil X 2 X 1.1

(3.4m is for 6mth)
= £7.48 mil
B/E per year = £7.48 mil

*£ 124
= 60,322.58 Units
(d) Loss = ( 60,000 Units - 60,322.58 Units) x £124
= (£40,000)
Working: Revised Variable cost per unit (c)*

Price £280 (£300 - £20) (600/2 - 20)
Variable Cost (£150)
Contribution £130 @part C
Revised Variable Cost
£150 X £1.04 = £156
Revised Contribution Margin
£280 - £156 = £124
127
Exam Tip- You are constantly required to apply
MA techniques to different situations.
Here you computing the BE for cruise ships.
Seven Seas Ltd is a cruise ship company, offering luxury passenger cruises
around the Indian Ocean. One of its old ships, The Mauritius, was built 20 years
ago, and is fully depreciated. It is now being refitted for less demanding cruises in
the Mediterranean operating from Monaco.
You are appointed to manage the Mauritius operation in the Mediterranean and
are expected to earn an income of at least 10% on capital employed at the Distinguish
beginning of the year. The capital employed will be: the refit of the Mauritius between IS
costing £8 million, to be depreciated straight line at 20% per year: investment in and
dock facilities in Monaco £3 million also to be depreciated straight line at 20% per Balance
year: and working capital of £1 million. sheet
numbers.
Each cruise will be a six-day tour. The Mauritius can carry up to 800 passengers Refit and
and plans to operate 50 cruises per year. The annual fixed costs of the operation dock
(excluding depreciation) are estimated to be: Staff and accommodation £1.5 facilities of
million, Marketing £2.5 million and allocated corporate costs £2 million. £11 million
is a capital
The avoidable operating costs for each 6-day cruise will be: expenditure
Variable cost per Fixed cost per cruise , a balance
passenger sheet
£ £ number.
Labour 30 40,000
Food 50 5,000
Fuel cost 120,000
Supplies 14 20,000
Market research suggests that for the first year of operations the cruise can be
priced at an average of £750 per passenger. Each passenger is also expected to
spend £200 on drinks and entertainment aboard the ship. The contribution
margin on these is 50%.
Note: £ %
Revenue from food 200 100
Less: Cost of food(VC) ( )
Contribution ___ 50
128
Note the difference between i) and ii)
Required: i) To compute the BE for 1 cruise, so
With regard to the first year only: must cover the fixed cost of 1 cruise
Provide supporting calculations to determine: only
i)the number of passengers you would need for a cruise to break even. (3 marks)
ii)the number of passengers required per cruise and in total for the year to break
even. (4 marks)
Total fixed cost for the year must include depreciation
iii)the profit or loss expected per year if each cruise operates at 70% of the
capacity. (2 marks)
Exam Tip: For Part iii) and iv), use
iv)the maximum profit possible for the year. (1mark) the computation from i) and ii) to
derive answers as very few marks
UOL adapted here
(i) Total Fixed Cost per cruise
= 40k +5k + 120k + 20k
= £185,000
Contribution per passenger

£
Selling Price 750
Less: Variable Cost ( ) (94)
Contribution 656
Add: Contribution from Food Sales 100
Sales( 50% X £200)
Add; contribution from Food sales 756
B/E per cruise = £ 185,000

£
= 244.71 passengers
(ii) Total Fixed Cost per year
Cost per cruise

£
£185,000 (i) X cruises per year 9.25 mil
Annual Depreciation
Other Fixed Cost

(1.5 + 2.5 + 2) . 6.0 mil .
Total fixed cost for the year 17.45 mil
129
B/E for the Year = £17.45 mil
756 (i)
= 23,082.01 passengers
Per Cruise = 23,082.01 passengers

cruises
= 461 passengers
(iii) 70% Capacity per year =
= 28,000 passengers
Profit = (28,000 - 23,082.01 passengers) X £756
= £3,718,000
(iv) Maximum Capacity = 800 passengers X 50 cruises
= 40,000 passengers
100/70 X 28,000
Profit = (40,000 - 23,082.01 passengers) X £756
= £12,790,000
130
Multi product BE is very popular for Section A
in the exam. Just learn to adapt the original BE
formula for the multiple product BE formulae
Multiple Product Break-even Analysis as stated below
When dealing with multiple products, the break-even analysis is carried out
assuming that the sales mix is constant.
The sales mix is the proportionate units of each products sold.
Multiple products BE formula
1) B/E Point in units = Total Fixed Cost________

Weighted Average Contribution per unit
2) B/E Revenue $ = Total Fixed Cost_________________

Weighted Average Contribution Ratio
Weighted Average Contribution per unit equals:
Σ = (sales mix % X contribution margin per unit) for all products

Weighted Average Contribution Ratio equals:
Weighted average contribution per unit

________________________________
Weighted average selling price per unit
Weighted Average selling price per unit equals:
Σ = (sales mix % X selling price per unit) for all products
131
Lecture Illustration Dealing with Multi Products
The ABC Co. has three lines of belts, A, B, C. The president of the company
foresees sales of 200,000 units in the forthcoming year, consisting of 20,000 A,
100,000 B &80,000 C. Fixed cost for the period are $255,000.
The following information is available:
Products A B C
$ $ $
Selling Price 10 8 4.50
Variable cost (7) (6) (3.50)
Contribution 3 2 1.00
Required:
1. What is the company breakeven point in units, assuming the given sales
mix is maintained.
2. Compute the contribution margin ratio, assuming the sales mix

maintained.
3. Compute the breakeven revenue, assuming the sales mix maintained.
4. If the sales mix is maintained, what is the total operating profit when
200,000 units are sold.
5. What would operating profit become if 60,000 units of A,80,000 units of B

& 60,000 units of C were sold. What is the new break-even point in units if
these relationships persists in the next period.
Sales Mix %
Product
A B C Total
Units ‘000 20 100 80 200
% 10% 50% 40% 100%

= (0.1 x $3) + (0.5 x $2) + (0.4 x $ 1)
= $1.70
BE unit = fix cost/ contribution per unit
132
1) B/E Units = $ 255k
$ 1.7
= 150,000 Units
Assuming Sales Mix Constant

Mix Unit Contribution Total Contribution
For A 10% 15,000 X $3 = $45,000
Info B 50% 75,000 X $2 = $150,000
Only C 40% 60,000 X $1 = $60,000
255,000
Fixed Cost (255,000)
Profit/(Loss) . 0 .
2) Weighted Average Selling Price
= (0.1 x $10) + (0.5 x $8) + (0.4 x $4.5)
= $1 + $4 + $1.80
= $6.80
Weighted Average Contribution Ratio (Margin)
= $ 1.7 = 25% (0.25)

$ 6.8
3) B/E Revenue = $255,000 = $1,020,000

25%
or BE revenue = 150k units x $6.8 = $1,020k
4) Profit = (200,000 - 150,000 Units)) X $1.70
= $85,000
133
5) Sales Mix %
%
A 60,000 30
B 80,000 40
C 60,000 30
200,000
= (0.3 x $3) + (0.4 x $2) + (0.3 x $1)
= $0.90 + $0.80 + $0.30
= $2.00
Revised B/E = $255,000

$ 2
= 127,500 Units
Profit = ( 200k unit - 127,500 units ) X $2.00
= $145,000
134
Limitations (Assumptions) Of Cost Volume (CVP) or Break – Even Analysis
1) Assumes that all cost can be classified as either variable or fixed.
In practice this may not be easy because some cost are semi variable, having both
fixed and variable element, e.g. electricity cost which has a fixed charge plus a
variable cost based on usage.
It may be difficult and impractical to separate semi variable cost into fixed and
variable elements, so compromise required, for example assume that electricity is
a fixed cost.
2) Total Fixed cost remains constant & variable cost per unit remain constant.
In practice, fixed cost may increase once relevant range exceeded.
Variable cost per unit may also decrease as bulk discounts given for higher
purchase unit.
3) The selling price is constant.
In practice the selling price may have to be lowered to increase sales volume.
4) Analysis applied only to the relevant range.
CVP analysis is only appropriate when applied within the relevant production
range.
The relevant range is the range of output which the company is expecting to
operate within the short-term planning horizon
The linear cost function can only be assumed within the relevant range.
Outside the relevant range, the cost function may be non linear and hence the
cost equation loses its predictive power. The more extreme the output levels
beyond the observed range, the less will be our confidence in the prediction of
future cost.
5) The concept of Break-even is only consistent with the marginal costing

approach. When absorption costing approach is used, the break-even point is only
valid if production units equals sales units.
135
What can managers do with the uncertainty or changes in the underlying
assumptions
Managers can apply sensitivity analysis, a “what if” technique, which examines
how an outcome will change if the original predicted data are not achieved or the
underlying assumptions change.
When making decisions, managers use CVP analysis to compare contribution

margin, margin of safety and fixed cost under different assumptions.
Conclusion: To be realistic a range of BE should be used instead of a single

estimated BE. For example, the BE can be forecast in the range of 20,000 to
25,000 units.
136
Note: Learning curves only applies to labour cost
Learning Curves and NEVER to materials cost.
Learning curve theory may be useful for forecasting production labour costs.
Learning curve theory is used to describe the situation where the worker is able to
carry out the job faster as he gains more experience.
The learning curve effects are more likely in the following situations:
• The production is repetitive
• The procedure is labour intensive
• The procedure or the product is new
• The procedure is complex.
The Learning Rate: Cumulative Average Time Model
In learning theory, the cumulative average time per unit produced is assumed to
decrease by a constant percentage every time total output of the product doubles.
For example, if there is an 80% learning curve, the cumulative average time
required per unit of output is reduced to 80% of the previous cumulative average
time when output is doubled. This information was most likely
generated using the Industrial
Example: Learning Curve using the tabular approach Engineering Method, consult the
engineers.
The first unit of output of a new product requires 100 hours. An 80% learning curve
applies. The production times would be as follows:
(x) ( y)
Number of units Cumulative avg time Total time Incremental time
Produced required per unit required for additional units
1 100.0 (x1) 100.0

2* (80%) 80.0 (x2) 160.0 60.0 (for 1 extra unit)
4* (80%) 64.0 (x4) 256.0 96.0 (for 2 extra unit)
8* (80%) 51.2 (x8) 409.6 153.6(for 4 extra unit)
137
Method 2 – Mathematical approach
This involves using a formula for the learning curve
The formula for the learning curve is y=axb
Where y is the cumulative average cost per unit

x is the (cumulative) total number of units produced
a is the cost or hours of the first unit
b is learning factor (logLR/log2)
LR is the learning rate as a decimal
Logarithms and the value of b
When y=axb in learning curve theory, the value of b = log of the learning rate/log
of 2. The learning rate is expressed as a proportion, so that for an 80% learning
curve, the learning rate is 0.8 and for a 90% learning curve it is 0.9 and so on.
For an 80% learning curve, b = log0.8/log2
b = - 0.0969 = - 0.322
0.3010
Use the following table to determine the incremental cost:
Example
Cumulative Average cost Exam Tip:
Month Units (x) per unit(y) Total Cost Memorise the
$ $ structure of the table.
1 230 21 4,830 4 columns
2 280 19 5,320
Increase 50 Units 490
A 90% learning curve will apply to the production of a new product.
The first item will cost $2,000 in materials, and will take 500 labour hours. The cost
per hour for labour and variable overhead is $5.
138
Calculate the cost for the first unit and for the first 8 units.
b = log 0.9 = -0.152 (given)

Log 2
1st Unit
Material 2,000
Conversion Cost ($5 X 500 hours) 2,500
Total cost 4,500
1st 8 Units 8 Units
Material ($2,000 X 8 units) 16,000
Labour ( 2,916 hours X $5) 14,580
30,580
y = axb
Per unit
-0.152
y = 500 hours X 8 units
= 364.5 hours per unit
Total hours = 364.5 hours X 8 units
= 2,916 hours
An 80% learning curve applies to production of a certain item. To date (the end of
June) 230 units of ABC have been produced. Budgeted production for July is 55
units.
The labour cost of the very first unit ABC, in January, was $120.
Required
Calculate the budgeted total labour cost for July.
b = -0.322
139
Cumulative Average cost per unit(y)
Month Units (x) Total Cost
$
June 230 Y=
=
July 285 Y=
=
Increase 55 Units Total cost for 55 units $750
Average labour cost per unit in July = $750

-----------
55 units
= $13.64 per unit
140
Lecture 6 & 7 – Homework Questions
Short answer questions
Q1
Given the following figure, what is the margin of safety, express as a percentage
of budgeted monthly sales (Round up to 1 decimal place)?
Selling price per unit £10
Variable cost per unit £6
Fixed cost per month £4,000
Budgeted sales 1,200 units
Q2
The C/S ratio of product A is 20%. The company’s total fixed cost is £90,000. How
many units of product A must be sold in order to get breakeven if the selling price
is £20 per unit?
Q3
A product has the following costs:
Direct materials £ 12
Direct labour £ 10
Variable overheads £ 2
Fixed overheads are £20,000 per month.
Budgeted sales for the months are 5,000 units.
The profit margin is 10% added on the production costs.
Required
a) Calculate the price set using full cost plus pricing
b) Calculate the price set using marginal cost plus pricing?
c) Calculate is the margin of safety in units under full cost plus pricing?
Q4
Tindall Ltd sells a single product for $40 per unit. Fixed costs are $48,000 and
variable costs 80% of revenue. If fixed costs increase by $8,000 the break-
even number of units will increase by:
Q5
HH manufactures and sells two products, J and K. Annual sales are expected to
be in the ratio of J:1 K:3. Total annual sales are planned to be $420,000. Product
J has a contribution to sales ratio of 40% whereas that of product k is 50%. Annual
fixed costs are estimated to be $120,000.
Required:
Calculate the budgeted break-even sales value (to the nearest $1,0000).
141
Q6
A company has the following budgeted information for the coming month:
Budgeted sales revenue £500,000

Budgeted contribution £200,000
Budgeted profit £ 50,000
What is the budgeted break-even sales revenue?
Q7
A company manufactures one product which it sells for £40 per unit. The product
has a contribution to sales ratio of 40%. Monthly total fixed costs are £60,000. At
the planned level of activity for next month, the company has a margin of safety
of £64,000 expressed in terms of sales value.
What is the planned activity level (in units) for next month?
Q8
A company sells a single product which has a contribution of £27 per unit and a
contribution to sales ratio of 45%. This period it is forecast to sell 1,000 units
giving it a margin of safety of £13,500 in sales revenue terms.
Calculate the company’s total fixed costs per period?
142
QUESTION 1
Echo manufactures various product. It is currently reviewing the profitability
of one of its product lines.
Echo’s total costs of £50,000 have been allocated to this specific product but
are expected to step up to £100,000 once production exceeds 30,000 units.
This is because a new factory will need to be rented in order to produce the
extra units.
Variable costs per unit are stable at £5 per unit over all levels of activity.
Selling price from this product will be £7.50 per unit.
Required:
(a) Formulate the total cost functions at:

(i)less than or equal to 30,000 units;
(ii) more than 30,000 units.
(b) Compute the 2 break-even points.
(c) Discuss the implications of the results from (b) with

regard to Echo’s production plans.
143
University of London
Lecture Notes
Lecture 8 & 9
Topics Covered
Relevant Costing & Decision Making
Readings: Horngren Chapter 10

Lecture 8 & 9
Lecture 8 deals with decision making involving one-off contracts and

the concepts of relevant costing is important for Section A of the exam,
so understand them well.
Lecture 9 involves short-run decision making, also important for Section

A of the exam.
145
Cost Object: Determining the relevant cost for decision making
Decision making involves a choice between alternative for example a decision

could involve accepting or rejecting a potential contract.
When making decision, the relevant revenue(contract price)(benefit) and the

relevant cost needs to be identified.
Relevant costing involves incremental cash flows and
RELEVANT COST not profit, so different from BE analysis as done in
lecture 7.
Relevant cost involves future cash flows (not profit) that differ between the two
alternative of accept or reject. A relevant cost is also an avoidable cost.
Example: Assume a company is considering undertaking a contract which requires

$1,000 of material A which the company has to buy for the contract.
The cost of material A is a relevant cost as it differs between the mutually exclusive
alternative.
Decision alternative
Accept Reject Difference
Material A to buy ($1,000) 0 (1,000)
Opportunity cost – Important
Opportunity cost is also a relevant cost. The opportunity cost of a decision is the
benefit foregone from the next best alternative use of the resources as a result of
using the resources in the current facility.
146
Irrelevant cost
The following cost are considered irrelevant for decision making:

1) Sunk Cost
These are cost that already been incurred and cannot be changed by any
current or future action. Examples of sunk cost are book values of assets,
or any cost already incurred.
Hint: All past tense = sunk cost
Example: Assume a company is considering undertaking a contract which requires
$2,000 of material B which was bought last year.
The cost of material B is an irrelevant cost as it does not differ between the mutually
exclusive alternative. Sunk cost is akin to
Decision alternative the phase “don’t cry
Accept Reject Difference over spilled milk”,
meaning you can’t
Material B already bought ($2,000) ($2,000) $0 change the past.
Only got to learn to

milk the cow better!
2) Fixed (non-incremental) or committed Cost HA HA!!!!!!
A fixed or committed cost is an unavoidable cash cost that will be incurred

whichever decision is taken.
3) Depreciation expense as it is a non-cash expense or because it arises from a

sunk cost.
Why is depreciation considered an irrelevant cost?
Depreciation is the portion of the cost of the non-current asset that was
used to generate revenue that is expensed in the Income Statement in
order to properly match the cost of the asset consumed to the revenue
generated. This is a financial accounting concept.
Assume that a machine was bought for $1million specifically for a

contract. It has a useful life of 10 years and no residual value. The
straight-line method of depreciation is used.
Hence, annual depreciation is $100,000. Identify the relevant cash flows.

Decision alternative
machine for contract $1m 0 1m
dep 0 100k
Hence, to deduct the cost of machine and the depreciation expense
results in double counting the cost. Hence, either deduct the cost of the
machine or the depreciation and never both.
Deduct
Computing cash flow ______________________________
cost of machine $1m
Computing Profit ______________________________
dpe expense $100k
147
The relevant costing approach should be used for questions involving decision-
making for one-off contracts.
A one-off contract is a contract which is done only once and not expected to be
repeated or undertaken regularly in the future.
Decision-making questions for one-off contracts are generally of two types:
1) Make accept/ reject decision where the fixed contract price

is given in the question.
Decision criteria:
Where the relevant revenue > relevant cost: Decision Accept Hence, it is always
comparison of
Where the relevant revenue < relevant cost: Decision Reject benefit to cost for
decision making
2) Computing the minimum or break-even contract price.
The minimum (break-even) price = Total relevant cost.
Why would a company do a contract for

no profit?
The minimum of break-even price is normally used in a

competitive tender situation whereby the company’s
objective is to outbid the other competitors so as to win the
tender contract.
Think of this as a strategy to “get your foot in the door”.

The company sacrifices the profit on the contract to get “its
foot into the door” as this will enable it to build a
relationship with the customer to secure future contracts at
a profit.
148
Relevant Cost for materials
The relevant cost of material used depends on whether the material is obsolete or
not obsolete.
The material is considered not obsolete when it is to be purchased for the job or if
in inventory, it is required for further use (or used regularly).
The material is considered obsolete (excess inventory) if it is already in inventory

and has no further use in making the company’s products. (take, no need to
replace)
Rules: Relevant Cost for Materials
Not Obsolete (NO) = Current Replacement (Purchase) Cost
Obsolete(excess)(O) Materials Relevant Cost = Opportunity Cost of the material
Remember: Opportunity cost represents benefit foregone from the next best
alternative use.
Remember, not obsolete inventory means inventory required for
other contracts that the company is doing.
So, if the inventory is in store and if you use it for your contract,
the company will have to replace it by buying it at the current
purchase price.
Hence,
NO inventory, take must replace.
O inventory, take, no need to replace.
Rule: Relevant cost

1) NO = Replacement cost
2) O = Opportunity cost
149
Lecture Illustration - Determining the relevant cost of materials
A company wants to bid for a competitive contract at the minimum or break-even

price.
The contract requires following materials only:
Material A: 2,000 units is to be purchased at $6 per unit.
Material B: 1,000 units are required for the contract. There is however, 400 units
in store purchased last month at $4 per unit. These materials was bought for
another contract to be undertaken next month. The current purchase cost of the
materials is $5 per unit.
Material C: 1,000 units required. There are 800 units in store as result over
previous over buying. This 800 units, if not used will be scrapped for $2.50 per unit.
The current purchase cost of this material is $4.00.
Material D: 100 units required. There is also 100 units in store which is no longer
required by the company and has no scrap value. If not used, the 100 units would
have to be disposed at a cost of $500.
opportunity saving = $500, if 100 units used for this job, company avoided payig $500 of
dipossal cost
Required:
Compute the minimum or break-even price of the contract.
Relevant cost $
Material A to Buy 2k units x $6 12,000
Material B to Buy 1k units x $5 5,000
Material C
Opportunity cost
Lost scrap value 800 units x $2.5 2,000
to buy 200 units x $4 800
Material D
Opportunity Savings (500)
Total relevant cost 19,300

Minimum or Break-even price = 19,300
150
Exam Tip
This absolute cash flow analysis will make it easier to identify the relevant
cash flows. You can do as working when it is difficult to identify the
relevant cash flow. But no need to do for every item.
Working: Absolute cash flow analysis
$ $ $
Material C 800 units use can scrap
earn scrap 800 x $2.5 0 +2k (2,000) O
no disposal dispose
Material D 0 (500) 500 O
Note: If you were the project manager, what would be your options for
material B?
Option 1 Cost incurred($)

Buy 1,000 units X $5 5,000
Option 2
Use the 400 units in store, hence
Buy 600 Units X$5 3,000
But storeman needs to replace
400 units for the other contract
400 units X $5 2,000
Total 5,000
Hence, relevant cost = 1,000 X $5, as the material in store is not
obsolete(NO), take must replace.
The answer is no, because after this contact is

done, there will be no excess materials C or D in
store and hence the relevant cost of these
materials will change. That’s why the minimum
price can only be applied to a 1 time only or
one-off contract.
151
Exam Tip:
For relevant costing question, use the combing technique, where you test each amount as either
relevant or irrelevant. Take about 2 minutes to decide, if not sure, then just guess intelligently. No
need to get the question done perfectly. Partial credit will awarded for each correct answer.
Lecture Illustration Making - Accept/ Reject Decisions
A research project undertaken on behalf of a client has already incurred costs of

$200,000.
It is estimated that a further $440,000 would be charged to the project before its
completion in one year’s time.
The further cost can be calculated as follows:
Materials purchased $100,000

Staff cost 60,000 =25k x 2 + 10k
Skilled labour 160,000
Overheads allocated 120,000
You have been asked to review the project because the project’s total estimated
costs of $640,000 exceed the contracted value of $500,000 for the completed
research.
If the project is abandoned the client will receive $150,000 in compensation. You
obtain the following information about the estimated cost to completion of the
project.
The material mentioned above is of no further use to the company and would have
to be disposed of at a cost of $15,000.
Staffing: two highly skilled researchers each receive a salary of $25,000 per
annum. The other $10,000 is an allocation of part of the salary of a supervisor who
is overall in charge of several projects.
If the project is abandoned, the research workers would be declared redundant,

each receiving $10,000 in compensation.
The project calls for the further use of 10,000 hours of skilled labour, the rate of
which is $16 per hour. Currently, there is a severe shortage of this quality of skilled
labour.
A shortage of skilled labour means that the relevant staff would have to be moved
from other work on the super production line.
If continue, stop Super production for 1yUnits if super units lost = 10k hr / 2hrs =5,000 unitsOpportunity
cost;
152
The Super product makes a profit of $8 per unit calculated as follows:
Selling Price $102
Material Y- 3 KG 30
Skilled labour 32
Fixed Overheads 32
Unit profit 8
Required:
1) Give your recommendation on financial grounds as to whether the project
should continued or abandoned.
2) Show how the contract, if completed, will be reported in the summary job
cost sheet used by the company.
153
Exam Tip- This is the way to
structure actual answer
Benefit of Continuation & Complete Project
Cash Inflow/
(Cash Outflow)
$
Contract Price 500k
Abandonment Penalty Savings (150k)
Disposal Cost Saving
Research Salary
Opportunity Cost
Lost contribution from 5,000 units of Super
Net Benefit of Continuing 275,000
Decision: Continue and complete Project as net benefit of completing is

$275,000 as compared to abandonment.
List of Irrelevant Cost

Reason
1) Cost Incurred $200,000 sunk cost
2) Material Purchased $100,000 sunk cot
3) Supervisor Salary $10,000 (Unavoidable) fixed cost
Exam Tip
Useful to list the irrelevant cost that you have ignored in the main answer
even if the question did not require you to do so. By listing the irrelevant
cost and the reason, you have displayed understanding of the concepts
clearly.
Hence, it will be clear why you ignored the irrelevant cost. Otherwise, it
may be perceived that you were simply guessing!
154
In Job costing, the job cost sheet reports the total revenue and total cost
of the job so that the total profit can be reported.
Job Cost Sheet

$
Contract Price 500,000
Total Contract Cost (640k)

(200k + 440k)
loss (140k)
Working
Absolute cash flow analysis
Continue Abandon Difference
$ $ $
Price 500k 0 500k
no penalty pay penalty
Penalty 0 (150k) 150k
use-nondisposal dispose
Disposal Cost 0 (15k) 15k
work for this project work for other
Supervisor Salary (10k) (10k) 0
employ pay entrench pay
Research [25kx2] (50k) [10kx2] (20k) (30k)
work for this work on "Super"
Skilled Labour (160k) (160k) 0
no super production super production
Price 0 102 (102)
skilled labour (32) (32) 0
Material 0 (30) 30
FOH (32) (32) 0
Why would you complete a job knowing that the job would be showing a
loss of $140,000?
That’s because when you were making a decision, the job was already
started and some cost were already sunk ($200,000 already incurred)
and hence irrelevant.
Hence, if you knew the total cost of the job would be $660,000 when
you bid for the contract at a price of $500,000 before the start of the
contract, you would have rejected it.
But remember, you can’t go back in time to change things in the past.
Opportunity cost per unit: -102 + 30 = $72 per unit

155
Lecture Illustration - Determining the minimum price of a contract
Hardy Builders is a small company based in Manchester. It has recently been
asked whether it wishes to bid for a particular contract to carry out some
reconstruction work. The contract would begin almost immediately and would
take about a year to complete. The company accountant has submitted an
estimate of contract cost, as shown below:
$ $
Cost of work already incurred in drawing
up detailed costing 4,000
Materials:
A 30,000
B 7,000
37,000
Labour:
Direct 40,000
Indirect 12,000
52,000
Machinery:
Depreciation 4,000
Hire of special equipment 5,000
9,000
General Overheads 20,000
Total Costs 122,000
On making further investigations, the following information becomes available:
1. Material A was ordered for another job but will be used on this job if the
contract is accepted. The replacement material for the other job will cost
$40,000. NO=RC
2. Material B was bought two years ago for $7,000. The material is highly
specialized and if not already in stock would have to specially ordered for
$8,000. If not used on this contract, it would be sold for $1,000. There is
no other use for the material.
O=OC
156
3. Hardy Builders has recently signed a 1 year contract with its workforce
which will guarantee their pay whether or not they work. There are several
workers currently not assigned to jobs who would be available for the
proposed contract. If the contract is not accepted, these workers could be
employed on refurbishing Hardy depot, which would otherwise have to be
done by an outside firm at a cost of $36,000.
4. The indirect labour cost relate to a part-time supervisor who would be

employed only is the contract is accepted. A suitable person to take on
this position is available.
5. The machine which is already owned is 10 years old and the depreciation
will write the book value of the machine down to zero. There is no
alternative use of the machine, and its scrap value is negligible.
6. Hardy currently pays a total of $35,000 per year to hire machinery, all from
the same company. The company offers its customers a discount of 5 %
on all hire charges if these amount to $40,000 or more in any one year.
7. General overheads are normally assigned to contracts by Hardy Builders

at a rate of 50% of direct labour cost. However, if the contract is accepted,
the only additional overheads will be the government building license
costing $4,000.
Required:
Determine the minimum contract price at which Builders should accept the
proposed contract.
(UOL Adapted)
Irrelevant Cost
Reason
Detailed Costing $4,000 sunk cost
Material A, B $37,000 sunk cost

Material B $8,000 no need to order
Direct Labour $$40,000 FC
Depreciation $4,000
General Overhead Allocated
157
Minimum Contract Price = Total relevant cost $
Material A – Replacement cost 40k
Material B
Opportunity Cost 1k
Lost Scrap Value 12k
Supervisor Salary
Hire of Equipment
Replacement Labour
Additional Overhead to pay for license
Minimum Contract Price-Total relevant cost
Working- Absolute cash flows

$ $ $
Direct Labour (40k) (40k) 0
Supervisor Salary
Replace Labour
158
Custom Boats Ltd works on contracts to customers’ specification for pleasure
boats. The company has been approached by Harbour Tours Ltd to accept a
contract to build a boat for a fixed price of £3,000,000.
The resources needed would be as follows:

Labour
Grade 1 30,000 hours
Grade 2 60,000 hours
Materials
Wood 10,000 square metres
Glass 100 square metres
Personalised Fitments £200,000
Grade 1 labour is highly skilled and although it is currently under-utilised in the

company it is Custom Boats Ltd’s policy to continue to pay Grade 1 labour in full.
Acceptance of the contract would reduce the idle time of Grade 1 labour. Idle
time payments are treated as production overheads. Grade 2 is unskilled labour
with a high turnover and is considered a variable cost.
The costs to Custom Boats Ltd of each type of labour are:

Grade 1 £16 per hour
The wood and glass required to fulfil the contract would be drawn from materials
already in inventory. The wood is widely used within the company and amounts
used for this contract will need to be replaced. The glass was purchased to fulfil
an expected order which did not proceed; if the glass is not used for this contract
it will be sold. For accounting purposes FIFO is used. The various values and
costs for wood and glass are:
Wood - Per Glass - per

square metre square metre
£ £
Book value 40 130
Replacement cost 48 136
Net realisable value 36 110
The personalised fitments will only be purchased if the contract goes ahead.
159
Variable production overheads are £12 per productive labour hour using both
skilled and unskilled labour. A single recovery rate for fixed factory overheads is
used throughout the company. The overhead is recovered per productive labour
hour (skilled and unskilled). Estimates of the year’s activity show budgeted
annual fixed production overheads of £3,600,000 and budgeted productive
labour hours of 450,000.
A special machine is required for this contract. The fixed costs of running and
depreciating the machine are included in production overhead. Accepting the
contract would not cause these costs to change but using the machine time
would mean that Custom Boats Ltd would not be able to make 100 basic rowing
boats, which are in regular demand, thus decreasing the total expected sales.
Details of revenues and cost for the rowing boats’ are as shown below.
Per boat
Sales price £4,800
Labour – grade 2 50 hours
Materials – relevant variable costs £280
Custom Boats Ltd uses full absorption job costing to derive a profit figure for
each contract, so the contract with Harbour Tours Ltd will be treated as a
separate job for routine costing purposes.
Required:
(a) Advise Custom Boats Ltd on whether to accept the contract on financial
grounds. Support your advice with calculations. (8 marks)
(b) Show how the contract, if accepted, will be reported in the routine job
costing system used by Custom Boats Ltd. (5 marks)
(c) Explain how each of the two methods (a) and (b) above are used by
businesses. (4 marks)
UOL adapted Zone A 2010 Question 2
Exam Tip:
This is a typical UOL MA question in Section A, multiple

parts and lots of information provided.
160
(a) List of Irrelevant Cost
Reason
Book Value of
Glass, Wood sunk cost
Fixed Overheads and grade lv1 FC
a) Benefit of Accepting Contract

Cash Inflow/
(Cash Outflow)
£000
Contract Price 3k
Grade 2 Labour 60k x $8 (4800
Wood
Replacement Cost
Glass
Opportunity Cost
Lost Scrap Value
Personalised Fitments
Variable Production Overhead

$12 x 90k hrs (1,080)
Opportunity Cost
Lost Contribution form Rowing Boats
100 boats x 50hrs x $3,520 (352)
Net Benefit +397
Decision:
Accept contract as net benefit of £397,000 compared to rejecting it.
Exam Tip:
Don’t forget to make a decision as 1 mark awarded for the
right decision, irrespective of the actual answer.
161
Working - Opportunity Cost
Per Boat
Sales Price 4,800
Less: Relevant Variable Cost
Labour Grade 2
Material
Variable overheads
Contribution Per Boat
162
(b) Job Cost Sheet
£‘000
Price
Less: Full (Actual) Cost
Material:
Glass
Personalised Fitments
Labour:
Grade 1:
Grade 2:
Overheads
Net Loss (373)
Working Absolute cash flow analysis

£’000 £’000 £’000
163
Exam Tip:
Write in accordance to marks, 4 marks write about 4
Part c points
1)Method in (a) is based on relevant costing and is only useful for decisions
involving one-off contracts.
2)It ensures no recovery of fixed cost, hence should only be used when fixed
cost is not relevant.
3)Method in (b) is based on full(absorption) costing and is to be used to establish

the normal price to charge to regular customers.
4)Hence, the normal price for the custom boat should be at least £3.373 million
(£3 mil + £373,000) plus profit.
164
Advantages of Using relevant (opportunity costing)
Main advantage of using relevant costing is that management is more aware of
how well they are using resources, or whether resources could be better used in
other ways.
Disadvantages of relevant (opportunity costing)

It is not always easy to recognise alternative uses of certain resources or to put
accurate value on opportunity costing.
Why relevant costs are rarely captured by a company’s accounting

information system.
1) Relevant cost often does not involve a transaction so cannot be picked up as

part of the data processing mechanism. Historical record keeping is limited
transaction involving alternative that were actually selected, rather that
alternatives that were rejected. Rejected alternatives do not produce
transactions, and hence they are not recorded.
2) relevant cost changes depending on other factors for example depending on

alternative use of resource. Opportunity cost varies from 0 to lost contribution of
highest competing alternative.
3) May be difficult to measure financially.
Issues to be considered in decision making using data from the routine

accounting system
In making ad hoc decisions, information from the routine accounting systems

may need to be modified and additional information sought.
Hence, in identifying the relevant cost, the following are some issues to be
considered:
1) In many companies full product costs and full departmental costs are routinely
reported as these make decision makers aware of total cost. Usually opportunity
costs are not routinely reported.
2) Thus for many ad hoc decisions the costs need to be revised to ensure correct
decisions are made, for example identifying future cash flows for each option,
identifying opportunity costs, and/or sunk costs.
3) Difficulties in identifying what relevant costs are particularly problematic with

an absorption cost routine management accounting system is used.
4) Research may be needed to gather more information not available from the
routine accounting system to incorporate into the new analysis.
165
Short Run Decision Making
Choice of Product with resources are limited
This situation arises if there is not enough of a resource (for e.g. direct materials)
to produce sufficient output to meet all potential sales demand. A decision
therefore has to be made about using available resources as efficiently as
possible.
Note that this model deals with only one resource restriction. Where two or more
restriction exist, for example both material and labour is in short supply, the
model used here to derive a solution cannot be used. Instead, Linear
programming (Lecture 13) will be used.
Decision Criteria : Follow the following steps in deciding which of the products
to produce once you have determined that there is a limited resource.
Step 1 - Determine the Contribution Margin per unit for each product.
Step 2 - Determine the limiting factor per unit for each product.
Step 3 - Compute the contribution per unit of the limiting factor for each
product.
Step 4 - Rank the products in accordance to the highest contribution per unit of
the limited resource.
Step 5 – Prepare the optimal production or sales schedule.
166
You have been engaged as a consultant to A Co. to provide advise on the most
profitable production plan for the company.
The company makes three products X, Y, Z and the appropriate

data is as follows:
Product X Product Y Product Z

Cost Per Unit:
Direct material 15 45 30
Direct labour
Process A 36 30 45
Process B 15 18 30
Process C 18 9 36
Variable Overheads 30 20 50
Fixed costs 20 20 20
Total Cost 134 142 211
Selling Price 150 190 260
The rates of pay for the direct labour for process A are $3 per
hour, $6 per hour for process B and $3 per hour for process
C. You are advised that the type of labour used in process B is in
short supply and cannot be increased.
Fixed cost are recovered on a unit basis and the current

production and forecast for the three products are shown below:
Product X Product Y Product Z

Current production 10,000 5,000 6,000
Forecast of maximum sales possible 12,000 7,000 9,000
Required:
Advise the company on the most profitable mix of production showing what
improvements in profitability there is over current levels.
167
Working
A B C
Process B hours per unit $15/$6 $45/6 $30/6
= 2.5 hrs 3 hrs 5 hrs
X Current Production Units 10,000 15,000 30,000
Total hours 25,000 15,000 30,000
Total hours Available = 70,000 hours
Hours to satisfy maximum demand

A B C
Process B hours per unit 2.5 3 5
X Maximum Demand 12k units 7k 9k
Total hours 30k hours 21k 35k
Total hours = 96k hours
Shortage of hours to satisfy maximum demand = 96k - 70k = 26k hrs
X Y Z
FC per unit 20 20 20
Contribution per unit $16+20 48+20 $49+20
(selling - TC +FC) =36 =$68 =$69
Process B
Labour hour per unit 2.5 hrs 3 hrs 5 hrs
Contribution per hour $36/2.5hr 68/3 69/5
$14.40 p.h $22.67 p.h $13.80 p.h
Ranking 2 1 3
Why do we use contribution per hour to rank products to produce?

!"#$%&'($&"# *+% (#&$ Want to maximise
Contribution per hour = ,"(%- *+% (#&$
Want to minimise as this

hours are constrained, hence
Want to maximise prefer products that consume
least amount of hours
168
Optimal Production / Sales Plan
Process B Demand
Product hrs per unit Unit Total Hours
Y 3 7k 21k
X 2.5 12k 30k
Z 5 3.8k 19k
Total Hours 70,000

19k/5 = 3,800 units
Improvement in Profit
X = (12k - 10k) x $36 = $72
Y = (7k - 5k unit) x $68 = $136k
Z = (3,800 - 6k units) x $69 = ($151,800)
Improved Profit $56,200

TC is constant and hence not relevant
Other non-financial factors to consider in make or buy decisions:
a) The quality of the products bought in may be compromised.
b) Need to ensure that the supplier is reliable
c) Ensure that the supplier is committed to supplying the product at the given
price. That is, we may have to sign an agreement with the supplier that
they will continue to supply at a given price.
169
Make or Buy (Sourcing) Decisions:
This involves a situation whereby the company has to decide if it is cheaper to

make the product itself or buy the product from a supplier.
Decision criteria
1) Compute the relevant cost to make
2) Compare the relevant cost to buy in.
3) Select the lower 1) or 2) above.
A component has the following cost to manufacture:

$ per unit
Variable cost 8
Fixed cost 4
Total cost 12
The component can also be bought in for $10.00 per unit. If the component is
bought in, fixed cost will be reduced to $3 per unit.
Determine of the product should be manufactured or bought in?

Cost to Buy Cost to make
$ $
Buy in price 10 0
Variable cost to make 0 8
Fixed cost 3 4
Total cost 13 12
Decision: Continue to make the component as saving is $1 per unit to make

compared to buy in. since cost buy $13 > make $12
170
Note: The key pad is a component
part in the in the final product, which
Lecture Illustration is the burglar alarm.
Robber Co manufactures control panels for burglar alarms. It currently produces

and sells 80,000 units per annum. Each control panel includes one keypad.
At present, Robber Co manufactures the keypad in-house. However, the

company is currently considering outsourcing the production of keypads.
A newly established company based in Burgistan is keen to secure a place in the

market, and has offered to supply the keypads for the equivalent of $4·10 per unit.
The current total annual costs of producing the keypads is as follows:
Keypads
Production 80,000
$’000
Direct materials 160
Direct labour 40
Heat and power costs 64
Machine costs 26
Depreciation and insurance costs 84
Total annual production costs 374
Notes:
1. Materials costs for keypads are expected to increase by 5% in six months’
time.
2. Direct labour costs are purely variable and not expected to change over the
next year.
3. Heat and power costs include an apportionment of the general factory

overhead for heat and power as well as the costs of heat and power directly
used for the production of keypads. The general apportionment included is
calculated using 50% of the direct labour cost for each component and
would be incurred irrespective of whether the components are
manufactured in-house or not.
4. Machine costs are semi-variable; the variable element relates to set up

costs, which are based upon the number of batches made. The keypads’
machine has fixed costs of $4,000 per annum. Whilst the key pads are
currently made in batches of 500, this would need to change, with
immediate effect to batches of 400.
5. 60% of depreciation and insurance costs relate to an apportionment of the

general factory depreciation and insurance costs; the remaining 40% is
specific to the manufacture of keypads and display screens.
171
Required:
Advise Robber Co whether it should continue to manufacture the keypads in-
house or whether it should outsource their manufacture to the supplier in
Burgistan, assuming manufacture and sales of 80,000 control panels in the
coming year.
Exam Tip
Do some planning before you start to derive answer.
For example, will it be better to compute the cost to make or buy for
total 80,000 units, or better to compute the cost to make or buy on a per
unit basis.
Since the costing data is provided for 80,000 total units, better to
compute the total cost to make/buy for 80,000 units.
If you choose to work on a per unit basis, then you will have to devide
each of the 5 cost above individually by 80,000 units, which will be
more time consuming.
172
Cost to Make Cost to Buy-in
80,000 units 80,000 units
$ $
Material 164k 0
Labour 40k 0
Heat & Power 64k

Fixed unavoidable 0.5 x $40k 20k
Machine Fixed Cost 4k
FC avoidable 0
Machine Variable Cost 27,500 0
Depreciation & insurance 84k

60% x 84k unavoidable 50,400
Buy In Price
Total cost 383,500 398,400

Decision: Continue to make as the savings is $14,900,
($398,400 Less $383,500)
173
Workings
Variable Machine Cost

$26,000 - $4,000 = $22,000
No of Batches at Present = 80,000 = 160 Batches

500
Revised Batches = 80,000 = 200 Batches

400
Revised Variable Cost

200 x 22,000 = $27,500
160
OR
500 x 22,000 = $27,500
400
Inflation Rate
Material cost = $160,000 $168,000
Inflation Rate Inflation Rate

1/1/19 0% 30/6/19 5% 31/12/19
.%01%
Average Inflation Rate= 2
= 2.5%
Average material cost for the year = $160,000 X1.025 = $164,000

OR
Average material cost = $160,000 + $168,000/2 = $164,000 per year
Note that inflation is a process that takes place throughout the year.
The material cost will be $160,000 from 1/1/19 to 30/6/19, as

question state that material cost only increase in 6 months time.
Hence, the material cost will increase to $168,000 on the 1/7/19 and
stay at $168,000 from the 1/7/19 to 31/12/19.
174
Lecture 8 & 9 – Homework questions
Short answer questions

Q1
B Ltd establishes a new product line which is specialized in producing product C.
The contribution margin for product C is 40% when the selling price is £240. The
capacity of the product line is 50,000 units per month. If B Ltd has to expand the
existing capacity, the incremental fixed cost will be £500 for additional 20,000 units.
D Ltd approaches B Ltd to manufacture 20,000 units of product C.
What is the minimum price for product C quoted to D Ltd if B Ltd is currently
producing 30,000 units per month?
Q2
E Ltd produces one item only. The standard cost information is as follow:
Direct labour 2 hours @ £40 £80
Direct materials 2 kg @ £10 £20
Fixed overhead (@$10/direct labour hour) £20
Selling price £150
There will be no opening and closing inventories.
What is the limiting factor if the demand for next month is 10,000 units but
there are only 18,000 labour hours and 22,000 kg of materials available?
Q3
A company existing production plan is as follows:
Product Product
A B
Units 1,000 750
$ $
Unit selling price 13.00 21.00
Unit variable costs
Direct material 1.00 1.00
Direct Labour at $2 per hour 5.00 12.00
Overhead 0.50 1.20
6.50 6.80
This represents the maximum demand for each product. The company is
limited to 7,000 labour hours availability. A contract to produce 200 units of
product C is under review. A customer who will provide his own materials
requires these. Net proceeds from the contract after deducting labour and
overhead costs amount to $3,000 and will utilize 1,500 labour hours.
Required:
175
Assuming that the company wishes to maximize profit, which is the optimum
production plan?
Q4
A firm has some material, which originally cost $45,000. It has a scrap value
of $12,500 but if reworked at a cost of $7,500, it could be sold for $17,500.
What would be the incremental effect of reworking and selling the material?
Q5
A company has just secured a new contract which requires 500 hours of labour.
There are 400 hours of spare labour capacity. The remaining hours could be
worked as overtime at time and a half or labour could be diverted from the
production of product X. Product X currently earns a contribution of £4 in two
labour hours and direct labour is currently paid at a rate of £12 per normal hour.
Calculate the relevant cost of labour for the contract?
Q6
A company manufactures and sells two products (X and Y) both of which utilize
the same skilled labour.
For the coming period, the supply of skilled labour is limited to 2,000 hours.
Data relating to each productare as follows:
Product X Y
Selling price per unit £20 £40
Variable cost per unit £12 £30
Skilled labour hours per unit 2 4
Maximum demand (units) per period 800 400
Required:
In order to maximise profit in the coming period, how many units of each
product should the company manufacture and sell?
Q7
An organisation manufactures a single product. The total cost of making 4,000
units is £20,000 and the total cost of making 20,000 units is £40,000. Within this
range of activity the total fixed costs remain unchanged.
What is the variable cost per unit of the product?
Q8
A company manufactures and sells a single product. The variable cost of the
product is £2·50 per unit and all production each month is sold at a price of £3·70
176
per unit. A potential new customer has offered to buy 6,000 units per month at a
price of £2·95 per unit. The company has sufficient spare capacity to produce
this quantity. If the new business is accepted, sales to existing customers are
expected to fall by two units for every 15 units sold to the new customer.
Required:
Calculate the overall increase in monthly profit which would result from
accepting the new business?
Q9
A machine owned by a company has been idle for some months but could now
be used on a one year contract which is under consideration. The net book
value of the machine is £1,000. If not used on this contract, the machine could
be sold now for a net amount of £1,200. After use on the contract, the machine
would have no saleable value and the cost of disposing of it in one year’s time
would be £800.
Required:
What is the total relevant cost of the machine to the contract?
177
Question 1
A new business is considering undertaking a one-off contract and has asked the
recently appointed 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:
1. 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.
2. 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 work on other jobs would arise.
3. General overheads comprise an apportionment of £3,000 plus an estimate of

£1,000 incremental overheads.
4. 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.
5. 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.
6. 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 stock of materials (amounting to 10,000 kg), or
178
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
company uses a cost of capital of 20% to appraise projects. The bank 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.
Required:
(a) Briefly explain what is meant by opportunity cost.
(b) Adjust the schedule prepared by the accountant to a relevant cost basis,
incorporating appropriate opportunity costs.
179
Question 2
A company has just completed an order for a customer, who has gone into liquidation before
taking delivery. The sales department has finally found a potential customer
who will buy the product if certain conversion work is undertaken.
The company has already spent $20,000 on manufacturing the product and the following
information relating to the proposed conversion work is collected.
Materials required at cost $ 2,000

Direct wages: four workers 2,000
Variable overheads 400
Depreciation 1,000
Foreman 150
Fixed production overhead cost 800
6,350
It is company policy to price its products at 25% mark up on cost, and accordingly a price of
$32,937.50 ($20,000 + 6,350 + 6,587.30) would be quoted.
Notes:
(a) The materials which are to be used on the conversion are in stock.
The material could be used in the production of another good in place of material that the
company would otherwise have to buy at a cost of $4,000.
(b) Four workers would be required to complete the conversion. They would be from a
department which is currently working well below full capacity.
(c)The conversion work will require the use of machinery which cost $120,000 eight
years ago. It has an estimated life of ten years. Depreciation is charged on a straight line basis.
(d) The conversion work will be supervised by a foreman who is currently employed by the
company. The foreman receives a salary which is equivalent to $1,500 per month.
It is estimated that the conversion will occupy 10% of the foreman's time.
(e) The conversion will take one month.
(f) The original customer had paid a non-returnable deposit of $3,000.
(g) It is the company policy to charge production with a proportion of general fixed
overheads at an absorption rate of 40% of material costs.
(h) In its existing condition the product could be sold for scrap, earning a revenue of $ 1,000.
Required:
Prepare calculation to show to the minimum price which you recommend the company
to quote to the new customer. Assume that no other customer will be found.
180
Give reasons for the inclusion or exclusion of items in your computation
Question 3
C Ltd is considering whether to accept a one-year contract from a customer. The

customer offers £25,000 for this contract.
To complete the work, the following costs will be incurred:
a. The company needs to use a machine which cost £50,000 when it was
bought last year. The machinery is outdated and it will be sold for scrap at
£2,000 this year. If this contract is accepted, the machinery will be used for
production and it could only be sold for scrap at £500 after the production.
b. 500 kg of material A is needed for this contract. 200 kg of material A was
bought at £5 per kg last year and now they are at stock. They have no use
but can be sold at £0.5 per kg as scrap value. The current purchase price for
material A was £5.5 per kg.
c. 300 kg of material B is needed for this contract.100 kg of material B was
bought at £3 per kg last year and all of them were currently in use for another
project, called X. The current purchase price for materials B is £3.5 per kg.
For project X, 100 kg of material B can be substituted by 150 kg of material Z,
which currently costs £1 per unit (and of which the company has no material
Z in stock at the moment).
d. Five skilled employees will be recruited for this contract at a cost of £4,000
per employee. Alternatively, the company can ask the existing staff to work
overtime and the cost for each existing staff will be £3,000 per head for this
contract.
e. The employees would be supervised by and existing manager who £6,000
per year. It is expected that 20% of his time will be used but no overtime work
is necessary.
f. The company has already appointed a technician to help doing this contract.
Technical consultancy fee £5,000, including £1,000 which has been promised
to pay no matter that the contract is performed or not.
g. General overheads of £8,000 would be allocated to the cost of the additional
work.
Required
Assess whether the new customer’s offer should be accepted.
181
Question 4
Define the term “Opportunity Cost” and explain why opportunity costs are rarely
captured by a company’s accounting information system. (8 marks)
(UOL adapted 2010 Zone A Question 8c)
Question 5
Crabtree Ltd makes a range of its own products and works on contracts to
customer’s specification.
Crabtree Ltd has been approached to accept a contract for the production of
20,000 Kg of product X at a price of £400 per Kg.
The resources used in the production of 1 Kg of X are:
Resources per Kg of X
Labour – Grade 1 2 hours
Grade 2 6 hours
Material – A 2 units
B 1 litre
Grade 1 labour is highly skilled and although it is currently under-utilised in the

firm it is Crabtree’s policy to continue to pay Grade 1 labour in full. Acceptance of
the contract would reduce the idle time of Grade 1 labour. Idle time payments are
treated as production overheads.
Grade 2 is unskilled labour with a high turnover and is considered a variable cost.
The costs to Crabtree Co Ltd of each type of labour are:

Grade 2 £7.50 per hour
The materials required to fulfil the contract would be drawn from materials
already in inventory.
Material A is widely used within the firm and the amounts used by this contract
will need to be replaced. Material B was purchased to fulfil an expected order
which was not completed; if material B is not used for this contract it will be sold.
For accounting purposes FIFO is used. The various values and costs for A and B
are:
A B
per unit per litre
£ £
Book value 32 120
Replacement cost 40 128
Net realisable value 36 100
182
Variable production overheads are £12 per productive labour hour using both
skilled and unskilled labour. A single recovery rate for fixed factory overheads is
used throughout the firm. The overhead is recovered per productive labour hour
(skilled and unskilled). Estimates of the year’s activity show budgeted annual
fixed production overheads of £2,400,000 and budgeted productive labour hours
of 400,000.
A special machine is required for this contract. The fixed costs of running and
depreciating the machine are included in production overhead. Accepting the
contract would not cause these costs to change but using the machine time
would mean that Crabtree Co Ltd would not be able to make 5,000 units of
product Y, a product in regular demand, thus decreasing the total expected
sales.
Details of Product Y’s revenues and costs are as shown below.

Per unit
Sales price £280
Labour – grade 2 4 hours
Materials – relevant variable costs £48
Crabtree Co Ltd uses full absorption job costing in order to derive a profit figure
for each contract.
If the contract for X is accepted, it will be treated as a separate job for routine
costing purposes.
Required:
(a) Based on financial grounds, advise Crabtree Ltd whether or not to accept the
contract. Support your advice with calculations. (8 marks)
(b) Show how the contract, if accepted, will be reported in the routine job costing
system used by Crabtree Ltd (5 marks)
(c) Explain how each of the two methods (a) and (b) above are used by
businesses. (4 marks)
(d) i. Calculate the difference in profit revealed in your answers to (a) and (b)
above. (1 mark)
ii. Since Crabtree Ltd uses a routine job costing system, accepting the
contract would mean that the difference in profit would have impacts on costs
and revenues elsewhere in the system.
183
Draw up a schedule to explain which costs and revenues would be affected by
accepting the contract. (The total of your schedule should be the difference in
profits which you have already calculated). (7 marks)
(UOL adapted 2010 Zone B Question 2, 25 Marks)
Question 6
In respect of ad-hoc decision making, identify four situations where information
from the routine accounting systems may need to be modified and/or additional
information may be sought. In each case explain the issues that arise in
identifying which are relevant costs.
(UOL adapted 2009 Zone A Question 6, 25 Marks)
The end –Lecture 8 & 9
184
University Of London
Lecture Notes
Lecture 10 & 11
Topics Covered
Decision Making 2- Pricing Decisions, Target costing
Readings : Horngren Chapter 12

Lecture 10 and 11
This lectures deals with how companies price their products, the
computation of the normal price.
Do not confuse the normal price with the break-even price that was
dealt with in lectures 8 and 9. The break-even price is only used for
one-off contract and not normally used.
The discursive elements in this lectures make is frequently tested in

section B of the exam. Pricing decision also popular for Section B of
the exam.
185
Computing the Normal Price
The major Influences on the normal pricing decision are commonly termed the 3
Cs of pricing.
The 3 Cs are customers, competitors and cost.
Alternative long run pricing approach consists of the following:
1. Cost- based pricing – Starts by asking about the company’s own cost of
manufacturing the product and then adds a reasonable mark –up to these
cost to compute the selling price
The method is useful in less competitive markets and where the

company’s products can be differentiated (customize) from the
competitors.
The prices can then modified according to customer’s reaction to initial

prices. Therefore, the market forces will eventually dictate the eventual
mark-up and thus the final price.
2. Market Based pricing – Starts by asking about what customers want and
how will competitors react. This method is useful in a very competitive
market and where companies sell similar (non-differentiated) products.
Question:
Which pricing method would be more appropriate for
Methods Pricing Why?

Method
Job Costing
Process Costing
186
Customer - Price elasticity of Demand
Measures the extent of a change in demand as result of a change in price

The higher the price, the lower the quantity demanded.
Normal Demand
The normal demand curve is downward sloping and shows that demand will
increase as price decrease.
The lower the price, the higher the quantity demanded. The higher the price, the
lower the quantity demanded.
Price Note that the actual demand function is a

downward sloping line, implying diminishing
returns when the price is lowered significantly.
Quantity Demanded
Price Elasticity of Demand:
The demand for the product is elastic if the quantity demanded increases or
decreases by a larger percentage that the Percentage change in price.
For example, if a 10 % reduction in price leads to a 25 % increase in the quantity

demanded, the demand is elastic.
The demand for the product is inelastic if the quantity demanded increases or
decreases by a smaller percentage that the Percentage change in price.
For example, if a 10 % reduction in price leads to a 5 % increase in the quantity

demanded, the demand is inelastic.
187
Elasticity & the pricing decision
Where demand is inelastic, an increase in price will bring about a less than
proportionate decrease in quantity demanded and therefore will bring about an
increase in revenues.
Where demand is elastic, an increase in price will bring about a more than
proportionate decrease in quantity demanded and therefore bring about a
reduction in revenues.
When demand for the product is inelastic, prices should be increased. This is done to
maximise total
When demand for the product is elastic, prices should be decreased. revenue
The Product Life Cycle
We need to recognise that the profitability and sales of a product can be

expected to change over time.
Sales/ Profit
Intro Growth Maturity Decline
As can be seen from the above diagram, there are four main stages:
• Introduction:
• Growth
• Maturity
• Decline
188
The price of the product will differ according to the stage of the life cycle the
product is at.
At the Introduction and growth stage, high prices are charged as competition is
low. At the maturity and decline stage, lower prices are charged as competition is
high.
Strategy and pricing
The pricing decision should also be consistent with the company’s overall
strategy.
Examples of such strategies are:
Cost leadership – being the lowest cost producer, hence charging a low price.
Differentiation strategy – providing unique or superior products, hence charging a

high price.
Different Pricing methods Exam Tip

This is a popular section B
Full cost-plus pricing question in the exam
This involves calculating the full cost of the product & add percentage mark- up
for the product.
Advantages of full –cost pricing
1. Simple to use and easily delegated to junior managers.

2. Ensure full recovery of all cost including fixed and variable cost.
Disadvantages of full –cost pricing
1. Tends to ignore the demand and the competitor’s reactions as focus on

cost recovery.
2. Need to determine the budgeted output volume in order to absorb the
fixed overheads and this can be subjective and difficult.
Marginal cost-plus pricing (Contribution margin pricing)
Calculate the marginal (variable cost) of the product & add percentage mark- up
for the product’s variable cost.
This does not necessarily lead to fixed costs not being covered as businesses
who use this method adopt a higher mark-up than they would use for full
absorption costing mark up.
189
This method is mainly used by retailers whose variable cost is the purchase cost
of the product and hence the variable cost can be easily identifiable.
Advantages of marginal cost-plus pricing
1. Simple and easy to use

2. Useful for the retail industry where there is a readily identifiable variable
cost which is the purchase price of the product
Disadvantages of marginal cost-plus pricing
1. Ignores fixed cost, so sales price must be sufficiently high to ensure a

profit is made after covering fixed cost.
2. Tends to ignore the demand and the competitor’s reactions as focus on
cost recovery.
Return on Investment Pricing Method
Using this method, the desired profit is computed on a target return on

investment.
Return on investment = Operating profit divide by invested capital.
Invested capital can be defined in many ways, for example invested capital could
be total assets.
Assume the following for a retailer.
The purchase cost of a product is $4 per unit.
Fixed cost are $20,000 and 20,000 units are budgeted to be sold. Total invested
capital was $200,000.
Required
a) Compute the price assuming that the company wishes to make a profit of 20
% on full product cost.
b) Compute the mark-up using contribution margin pricing method to achieve the
same selling price as in 1) above.
c) The company wishes to make a profit of 40% of invested capital. (Return on

investment pricing).
190
Budgeted Fixed Overhead Rate Per Unit
= $20,000 = $1.00 per unit

20,000 per unit
(a)
Per Unit $
Variable purchase Cost
Fixed Production Cost
Total Cost
Add: Profit @ 20%
Price
(b) Marginal Cost-plus pricing
Per Unit
The mark up % is higher
Variable purchase Cost here compared to part a,
50% as compared to
Mark Up @ 20%.
Net profit = $1 per unit
Selling Price 6.00 $2 - $1(fixed cost)
(c) ROI = Total Profit

Capital
Total Profit =
Profit per unit = =

20,000 unit
Price = Full Cost + Desired Profit
191
Lecture Illustration - Pricing a new product Pricing decision involving new
products often difficult as the
A company is considering the launch of a new product, demand and customer’s
and have provided you with the following information. reaction is uncertain, so
companies tend to conduct
Budgeted cost market research to access the
per unit customer’s reaction and to
Variable cost 6.20 determine the optimal price.
Fixed cost 1.60
7.80 The fixed cost per unit is not constant,
hence profit per unit will not be
Market research conducted revealed the following: constant at the different sales volume
Selling price ($) 13 12 11 10 9

Demand (units) 5,000 6,000 7,200 11,200 13,400
Required:
Compute the profit maximising price.
Note:
High price, gives high profit margin but low sales volume
Low price, gives high sales volume but low profit margin.
Hence, what is the profit maximising price?

It’s the price with the highest total contribution as this considers both price
and sales volume. The total fixed cost remains the same irrespective of the
sales volume. So, as long as total contribution is the highest, total profit will
be the highest.
Contribution Total
Volume Price per unit Contribution
Unit $ $ $
5,000 13 13-6.2=6.8 34k
6,000 12 5.8 34.8k
7,200 11 4.8 34.560
11,200 10 4.8 42.560 maximise
13,400 9 2.8 37.520
Profit Maximising price =$ 10 per unit

Total Contribution is highest with this price
192
Innovate plc produces motor cars. Four years ago it moved into the electric car
market producing a basic electric city car, the Minile, which is sold through a
network of dealers as an economical, eco-friendly car appealing to city
commuters and shoppers. It sells at a retail price of £6,000.
In 2011, Innovate plc became aware of the market potential for a more up-
market, larger electric car and has designed the EcoDrive to be launched in
2012. The marketing aim is to exploit the potential cult status of such vehicles,
which are seen as futuristic, stylish and fun.
The EcoDrive will be produced using production facilities made available from the
phasing out of one of Innovate plc petrol cars. The fixed(non-current) assets
included in the production facilities to be used are valued at £40 million at the
beginning of 2012.
The following information has been collected:
Innovate plc require a return-on-fixed assets of 10%. ROI
At current levels of productivity, Innovate plc has enough manufacturing capacity

to produce to 5,000 units per year of the EcoDrive. Exceeding this by more than
20% would require investment in new plant capacity. The Production Director Note the difference
favours a production volume of 5,000 units in 2012. between fixed
assets £40 million
The total specific fixed costs of producing and marketing the EcoDrive are and fixed cost £10
million.
estimated at £10 million:
Which number is
used for BE units?
The total variable costs are estimated at £5,000 per unit. Answer:________.
$10M
Market information
The leading competitor in the market provides an electric car of similar size to the
EcoDrive, designed in 2007, retailing in 2011 at £8,000. This competitor charges
its dealers £6,400 per vehicle and forecasts to sell about 7,000 vehicles in 2011
representing 60% of 2011 demand for this size of electric car. The competitor’s
net profit margin is about £450 per vehicle, a return on assets of 5%. Market
analysts consider that the total market will grow by about 40% per year for the
next three years.
Market research at Motor Shows has indicated very favourable reviews for the
EcoDrive which is perceived as much better designed and fitted than competing
models. The buy-response technique was used with a sample of non-users of
electric cars.
193
Note that the demand
function here is not a
Selling Price % of Respondents willing to buy downward sloping
£ 8,000 70 straight line but a
£ 9,000 66 downward sloping curve
£ 10,000 62 as there diminishing
return on the price
£ 11,000 40
increased to £ 11,000.
Required:
(a)Provide calculations and comments based on a cost-based approach to
pricing, which considers:
i. what should be the per unit price to the dealer?
ii. what will be the retail selling price at different dealer margins?
iii.what is Eco Drive break-even point? (9 marks)
(b)
i. Compute and comment on main competitor market share in 2012;
ii. Calculate the main competitor capital employed. (6 marks)
(c) Provide calculations and comment on the market research conducted at

Motor Shows. (2 marks)
(d) Compare the various prices provided by your analyses in (a), (b), and (c)
above and recommend, with reasons, the price you consider appropriate,
taking into account any information you consider necessary. (3 marks)
UOL Adapted 2011 Zone B question 3
Note:
1)This an actual section A past exam question.
2)Note that section A questions are based on practical real world setting.
The challenge is to able to read the question quickly and understand the
situation quickly.
3)For example, in the this question the examiner expects you, being a
young adult to know that cars are sold not by the manufacturer directly but
through a network of dealers. That’s why theres a price to the dealer and
the retail selling price in part a) (2 prices).
Innovate
Manufacturer Dealer Consumer
4) You also are expected to use your initiative to use the information
provided about the leading competitor to assist you in the necessary
computations because Innovate has no experience in the electric car
market. Hence, use all information provided in the question intelligently.
194
What’s the difference between the market size and the market share?
The market size represents the total number of units sold in the
industry by all the companies in the industry.(size of the pie)
The market share in the number of units sold by 1 company in the

industry. (slice of the pie)
A company should always strive to position themselves in industries

that are growing (bigger size of the pie) and get a bigger market share
(slice of the pie)
Market Size – Size of the pie
Market share- slice of the

pie
195
(ai)
Per Unit Price to Dealer
Target Total Profit = 10% x $40M = $4M
ROI = Target profit

10% £ 40M You need to
estimate the
production volume
to absorb the fixed
cost of £10 million
Estimated Production volume = 5k units to the cars
produced.
Reason:
1) Production Manager responsible for production favour a volume of 5,000
units.
2) Above 5,000 units, facilities required and would will be expensive.
Per Unit
£
Variable Cost 5k
Fixed Cost = $10M 2k

5k units
Total Cost 7k
Add: ROI Profit = $4M / 5k units 800
Price to Dealer 7,800
(aii)
Based on competitor’s experience
Dealer Profit = $8k - $6,400 = $1,600

Mark Up % = $1.6k/ $6.4k = 25%
Retail Selling Price = 7,800 x 1.25 = $9,750
196
(aiii)
Eco Drive B/E Unit $40/ 7,800 - 5000 = 3,571 units
Comments:
B/E point is fairly low than the expected sales of 5,000 units,
giving rise to a positive margin of safety of (5,000 unit - 3,571 unit)
= 1,429 units, leading to profitable project and hence can be undertaken
(bi)
Competitor’s Market Share 2012

Market Share = 60% in 2011 f0r 7,000 units
2011 Market Size (100%)
2012 Market size =
Less: Competitor Market Share @ 60% =
Potential Market Available =
Comment:
Potential Market to sell 5,000 units exist in 2012.
(bii)
Total Profit =
ROI = £3.15mil
0.05 Capital
Capital Employed =
197
Exam Tip
This part popular for Section B of exam
Other Pricing Methods
1) Peak load pricing Examples of

Peak-load pricing is the practice of charging a higher price for the same product peak load
or service when the demand approaches physical capacity to produce the pricing in
product or service. Singapore is
Peak load pricing is a deliberate mechanism to try to encourage users to use off our
peak when the capacity is otherwise underused. It is therefore not a problem if Electronic
people change from using on peak to off peak. road pricing
(ERP)
2) The Contribution margin pricing method
The Contribution margin pricing method is needed if there is not already a price
which can be taken from the market, so contribution is not, in this case sales
price – variable cost. It is a mark-up on variable cost.
This does not necessarily lead to fixed costs not being covered as businesses
who use this method adopt a higher mark-up than they would use for full
absorption costing mark up.
3) Return on Investment pricing

The target rate of return is computed is computed by taking the target annual
profit divided by invested capital. Once calculated, is to be applied to each
product in order to set prices which will ensure that the profit target is met.
4) Cost-plus pricing where there is a learning curve effect.

The effect of the learning curve is that labour costs will fall. However the
company can decide the extent to which it passes these benefits on in lower
prices, depending on the market for their new product.
5) Market Penetration Pricing
This is a policy of charging low prices when the product is first launched in order
to obtain sufficient penetration into the market.
Useful in the following circumstances:

1. If the company wishes to discourage new entrants into the market or when
the market is easy to enter
2. High volume of output is produced
3. Where demand for the product is elastic or close substitute available
198
6)Market Skimming Prices
This is a policy of charging high prices when the product is first launched and
spending heavily on advertising and sales promotion to obtain sales.
The objective of this is to gain high unit profit early in the product life cycle.
Useful in the following circumstances:
a) When the product is new and different.

b) Where the strength of demand and sensitivity of demand to prices is
unknown. Therefore it will be better to charge higher prices first and
then reduce them if demand is weak.
c) Where the product has a short life cycle and the company needs to
recover the development cost and makes profit relatively quickly.
7) Price Discrimination
This is the practice of charging different prices to different customers for the
same product or service. Price discrimination must only be practiced where the
market for the product can be segmented, for example offer a standard price to
all customers in Singapore and offer the discounted price only to overseas
customers.
Examples of price discrimination method include peak load pricing, special

orders pricing.
Why does an airline offer a discounted fare on the “2 to go” offer.
This is because they are practicing price discrimination and want

to offer the lower fare to the holiday passenger and not to the
passenger travelling for business purposes.
The holiday passenger demand is elastic whereas the business

passenger demand is inelastic, hence price should only be
lowered when demand is elastic.
The “2 to go” requirement is used to segment (split)the market

into holiday travelers and business travelers.
199
Traditional product pricing
Traditional product pricing Cost + Profit = Selling Price
Traditional product pricing starts with the cost of the product and adds a mark-up
profit % to the cost to determine selling price.
The approach is cost driven and can lead to overpricing if the company’s cost is
too high due to non-value added cost.
Target Costing (market based pricing)
Target cost is the estimated product cost which is determined by subtracting a

desired profit margin from a competitive market price.
Target cost is the estimated long –run cost of a product that, when sold, will
enable a company to achieve the target profit per unit. All cost, both fixed and
variable should be included in the target cost.
Target costing is market driven and assumes that costs can be reduced by
paying careful attention to the quality of the product.
200
Exam Tip
Memorise steps 1 to 6 below
for section B questions in
Steps required to develop target costs and prices
exam
Step 1 – Determine the relative importance to customer of different product
features by market research.
Step 2 – Choose competitive market price reflecting product features and

competition.
Step 3 – Derive target cost by subtracting the desired profit from the selling price.
Step 4 – Design product in discussion all managers involved. This activity may
require analysis of competitor’s products.
Step 5 – If product cost is higher than target cost (cost gap exist), perform value
engineering across the value chain to eliminate non-value added costs.
Step 6 – Perform additional market research to ensure that product still meets
customer needs and price perception.
Target cost Gap = estimated cost less target cost
Target costing - Example

Per unit $
Step 2 - Market Price = 10
- Desired Profit = (3)

Step 4 - Target cost 7
Actual cost 8
Step 5 Cost Gap 1
Cost reduction necessary to reduce cost by $1 per unit.
201
Value engineering- Closing the Target gap
Is a systematic evaluation of all aspects of the value chain with the objective of
reducing cost while satisfying customer needs.
Value engineering via improvement in product and process designs is a principal

technique that companies use to achieve target cost per unit.
Managers often make a distinction between value added & non-value added
activities
A value-added activity is an activity is a cost that the customer perceives as

adding value.
Value engineering seeks to reduce non-value added activities such as

unnecessary waiting time, spoilage or rework cost.
Deriving a Target Cost
Market-based price Less Desired profit margin
A company wants to calculate a target cost for a new product, the market price of
which is $21,000. The company requires a 8% profit margin.
Assume that the actual cost of the product is $20,520
Required: Calculate the target cost.
Market Price = $21,000
Less: Desired Profit
Target Cost
Example: Actual Cost
Cost Gap
202
Implication of using target costing
Target costing requires managers to change the way they think about the
relationship between cost, price, and profit.
With target costing, there is focus on strategic issues such as the competition
and the need to satisfy customers requirements for quality, cost and timeliness.
The value of the product to the customer must be greater than the cost of
providing them.
Remember, customer are willing to pay for value and not for waste.
Closing a target cost gap
The following may be some the techniques to be employed to close the gap:
• Reduce the number of components or features that don’t add value
• Using standardised parts wherever possible
• Training staff in more efficient techniques to improve productivity
• Using new, more efficient technology
• Cutting out non value added activities, example unnecessary waiting time
203
Homework Questions – Lecture 10 &11
Short answer Questions

Q1
The following information relates to a management consultancy organisation:
Salary cost per hour for senior consultants £40

Salary cost per hour for junior consultants £25
Overhead absorption rate per hour applied to all hours £20
The organisation adds 40% to total cost to arrive at the final fee to be
charged to a client.
Assignment number 789 took 54 hours of a senior consultant’s time and
110 hours of junior consultants’ time.
What is the final fee to be charged for Assignment 789?

Q2
Describe the downward demand (death) spiral and its implication for pricing
decisions.
Question 1
A small company is engaged in the production of plastic tools for the garden.
Sub-totals on the spread-sheet of budgeted overheads for a year reveal:
Moulding Finishing General Factory

Department Department Overhead
Variable overhead 1,600 500 1,050
£000
Fixed overhead 2,500 850 1,750
£000
Budgeted activity
Machine hours 800 600
(000)
Practical capacity
Machine hours 1,200 800
(000)
For the purposes of reallocation of general factory overhead it is agreed that the
variable overheads accrue in line with the machine hours worked in each
department. General factory fixed overhead is to be reallocated on the basis of the
practical machine hour capacity of the two departments.
It has been a long-standing company practice to establish selling prices by

applying a mark-up on full manufacturing cost of between 25% and 35%
204
A possible price is sought for one new product which is in the final development
stage. The total market for this product is estimated at 200,000 units per annum.
Market research indicates that the company could expect to obtain and hold about
10% of the market. It is hoped the product will offer some improvement over
competitors products, which are currently marketed at between £90 and £100
each.
The product development department have determined that the direct material
content is £9 per unit. Each unit of the product will task two labour hours (four
machine hours) in the moulding department and three labour hours (three machine
hours) in finishing. Hourly labour rates are £5.00 and £5.50 respectively.
Management estimate that the annual fixed costs which would be specifically
incurred in relation to the product are: supervision £20,000, depreciation of a
recently acquired machine £120,000 and advertising £27,000. It can be assumed
that these costs are included in the budget given above. Given the state of
development of this new product, management do not consider it necessary to
make revisions, to the budgeted activity levels given above for any possible extra
machine hours involved in its manufacture.
Required:
(a) Prepare full cost and marginal cost information which may help with the pricing
decision.
(b) Comment on the cost information and suggest a price range which should be
considered.
205
Question 2
Explain and critically evaluate the following pricing methods and give one
example of a type of business or situation where each method would be used.
i. Economist’s optimum price.
ii. Full cost plus pricing.
iii. Marginal cost pricing.
iv. Return on investment pricing.
v. Conversion cost plus pricing. (25 marks)
(UOL adapted 2008 Zone B Question 8)
THE End- Lecture 10 & 11
206

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University Of London

Cost behaviour analysis and cost volume profit analysis

Readings: Horngren, Chapters 8,9.

The parts on cost volume profit analysis very popular in Section A

Finally, the computations associated with learning curves can be

Cost can be classified by behavior as follows:

3) Semi Variable Cost

1. Linear Variable Cost Example Direct materials

Assume output of clay-pot:

Total Variable Cost

Variable Cost per unit

Total Fixed Cost

Fixed Cost per unit

Step Fixed cost

Semi Variable Cost

A cost function is a mathematical function describing cost behavior patterns.

Where Y = forecast variable of interest

b = the slope or the gradient of the straight line.

Therefore if Y = Total Cost

a = Total Fixed Cost

b = Variable cost per unit

Lecture Illustration – Dealing with Cost

Analysis of the maintenance department shows a fixed cost of $50,000 per

1) 1500 machine hours

2) 1800 machine hours

y = Total Maintenance Department cost per month

x = Machine Hours per month - cost driver

a = Total Fixed Cost per month

b = Variable Cost per machine hour

Cost function: (forecasting)

Valid only for 1,000 to 2,000 machine hours

1) y = $50,000 + $3 X 1,500 machine hours

2) y = $50,000 + $3 X 1,800 machine hours

1) Choice of the cost object and related cost driver

Cost Object Cost Driver Behaviour

Cost Object Cost Driver Behaviour

Whether a cost is variable or fixed with respect to a particular cost driver

Hence, in the long run, all cost is variable (subject to change).

Hence, outside this range costs may behave in unknown and

A) May be due to a physical relationship between the cost and the

B) May arise out of a contractual arrangement. For example, when the

C) May be implicitly established by logic and knowledge of operations.

Example of cost and effect and correlation

Assume the following information:

1. Industrial Engineering Method – Consult the Engineers (External)

• Very time consuming and expensive as need to employ engineers or

• As it is based on actual data, the results achieved will be relatively objective.

2. Conference Method- Consult the Experts (Internal)

• Cost estimates developed by personnel familiar with the factors influencing

• Consultative Method. Get inputs from personnel involved(experts) in

• This method involves using the prior year’s financial statements(accounts)

• Account analysis method is widely used because it is easy to use, cost

• Supplementing the account analysis method with the conference method

Account Description Cost $

Depreciation is computed on a straight line basis. Last year, 500,000 litres of

1) Using the account analysis method, classify each account as variable or

4) If a sales promotion we to be conducted, what is the minimum price that

x = Number of cars washed per year (Cost Driver)

a = Total Fixed Cost

= 40k + 64k +46k

b = Variable Cost per unit

= (42k x 38k x 72k) / 80,000 car washed

y = $150,000 + $1.90 X 100,000 cars