Main Examination and solution

Question 1

a. describe to management what standard costing is? (5 marks)

b. Aktar, a manufacturing firm, operates a standard marginal costing system. It makes a

single product, Husain, using a single raw material, LET.

Standard costs relating to Husain have been calculated as follows:

Standard cost schedule – Husain per unit

Direct material, LET, 100 kg at £5 per kg 500

Direct labour, 10 hours at £8 per hour 80

Variable production overhead, 10 hours at £2 per hour 20

600

The standard selling price of a Husain is £900 and Aktar Co produce 1020 units a month.

During December 2013, 1,000 units of Husain were produced.

Related details of this production are as follows:

Direct material LET

90,000 kgs costing £720,000 were bought and used.

Direct labour

8,200 hours were worked during the month and total wages were £63,000.

Variable production overhead

The actual cost for the month was £25,000.

Inventories of the direct material LET are valued at the standard price of £5 per kg.

Each Husain was sold for £975.

Required:

Calculate the following for the month of December 2013.

 (a) Variable production cost variance (3 marks)
(b) Material price variance (2.5 marks)
(c) Material usage variance (2.5 marks)
(d) Labour rate variance (2.5 marks)
(e) Labour efficiency variance (2.5 marks)
(f) Variable production overhead expenditure variance (3 marks)
(g) Variable overhead efficiency variance (3 marks)
(h) Selling price variance (3 marks)
(i) Sales volume contribution variance (3 marks)

[Total 30 marks]

Question 2

(a) A company manufactures and sells a single product which has the following cost and
selling price structure:

£/unit £/unit

Selling price 120

Direct Material 22

Direct labour 36

Variable overhead 14

Fixed overhead 12

84

Profit per unit 36

The fixed overhead absorption rate is based on the normal capacity of 2000 units per month.
Assume that the same amount is spent each month on fixed overheads.

Budgeted sales for next month are 2200 units.

You are required to calculate:

(i) the breakeven point, in sales units per month;

(ii) the margin of safety for next month;

(iii) the budgeted profit for next month;

(iv) the sales require to achieve a profit of £96,000 in a month

(20 Marks)

(b) Explain five main assumptions of breakeven point.

(5 Marks)

(c) Discuss five short run decisions for which the breakeven point can be used.

(5 Marks)

(Total 30 Marks)

Question 3

ABC ltd is wondering whether or not to invest in one of three possible projects. The initial
investment will be £10,000, and the cost of capital is 10 per cent. There is no scrap value for
fixed assets used.

Details of the net cash inflows are as follows:

Project M N P

£ £ £

Year 1 3,000 5,000 4,000

Year 2 6,000 5,000 5,000

Year 3 4,000 2,000 3,000

Year 4 - 1,600 1,000

Year 5 - - 1,400

Required:

Using each method on its own, without reference to the other methods, which project should
ABC invest in using the following methods:

(a) Accounting rate of return, using average investment (6 marks)

(b) Pay back (6 marks)
(c) Net present value (8 marks)
 (d) Internal rate of return (IRR) (10 marks)

[Total marks 30]

The discount factors for 10 per cent for six years are as follows:

Year 1 0.909

Year 2 0.826

Year 3 0.751

Year 4 0.683

Year 5 0.621

Year 6 0.564

Question 4

The following table shows the number of units of a good produced and the total costs
incurred.

Units produced Total costs (£)

100 40,000

200 45,000

300 50,000

400 65,000

500 70,000

600 70,000

700 80,000

Required:

(a) Calculate the regression line for y on x (10 marks)

(b) Estimate the total cost for 200 units of production (5 marks)
(c) Calculate the coefficient of correlation (10 marks)
(d) Interpret your result in (c) above (5 marks)

(Total 30 marks)

Question 5
Elizabeth and Company produces a single product with the following budget:

Selling price £10

Direct materials £3 per unit

Direct wages £2 per unit

Variable overhead £1 per unit

Fixed overhead £10,000 per month.

The fixed overhead absorption rate is based on a volume of 5,000 units per month.

Production was 4,800 units and sales were 4,500 units.

Required:

Show the operating statement for the month under:

(a) Absorption costing (10 marks)

(b) Marginal costing (10 marks)

(c) Reconcile the difference in reported profit (10 marks)

[Total marks 30]

End of paper

2014 BUS022 Main Examination - Suggested Solutions

Solution 1

(a) This is simply a ‘total’ variance.

1,000 units should have cost (× $600) 600,000

but did cost (see working) 808,000

Variable production cost variance 208,000 (A)

(b) Direct labour cost variances

8,200 hours should cost (× $8) 65,600

but did cost 63,000

Direct labour rate variance 2,600 (F)

1,000 units should take (× 10 hours) 10,000 hrs

but did take 8,200 hrs

Direct labour efficiency variance in hrs 1,800 hrs (F)

× standard rate per hour × $8

Direct labour efficiency variance in $ $14,400 (F)

Summary

Rate 2,600 (F)

Efficiency 14,400 (F)

Total 17,000 (F)

(c) Direct material cost variances

 $

90,000 kg should cost (× $5) 450,000

but did cost 720,000

Direct material price variance 270,000 (A)

1,000 units should use (× 100 kg) 100,000 kg

but did use 90,000 kg

Direct material usage variance in kgs 10,000 kg

× Standard cost per kg × $5

Direct material usage variance in $ $50,000 (F)

Summary

Price 270,000 (A)

Usage 50,000 (F)

Total 220,000 (A)

(d) Variable production overhead variances

8,200 hours incurring overheads should cost (× $2) 16,400

but did cost 25,000

Variable production overhead expenditure variance 8,600 (A)

Efficiency variance in hrs (from (b) 1,800 hrs (F)

× standard rate per hour × $2

Variable production overhead efficiency variance $3,600 (F)

Summary

Expenditure 8,600 (A)

Efficiency 3,600 (F)

Total 5,000 (A)

(e) Selling price variance

Revenue from 1,000 units should have been (× $900) 900,000

but was (× $975) 975,000

Selling price variance 75,000 (F)

(f) Sales volume contribution variance

Budgeted sales 1,020 units

Actual sales 1,000 units

Sales volume variance in units 20 units (A)

× Standard contribution margin ($(900-600)) × $300

Sales volume contribution variance in $ $6,000 (A)

Workings

Direct material 720,000

Total wages 63,000

Variable production overhead 25,000

808,000

Solution 2
(i) Breakeven point = Fixed cost

Contribution per unit

= £12 x 2,000 = £48 = 500 units

(ii) Margin of safety = budgeted sales – breakeven sales

= 2200 – 500

= 1,700 units

(iii) Budgeted profits = 1,700 units margin of safety x £48 contribution per unit

=£81,600

Fixed overhead + desired profit

Contribution per unit

= (£12 x 2000) + £96,000 = 2500 units

£48

(b) Assumptions of BEP

• All costs can be resolved into fixed and variable elements.

• Fixed costs will remain constant and variable costs vary proportionately with activity.

• Over the activity range being considered costs and revenues behave in a linear
fashion.

• That the only factor affecting costs and revenues are volume.

• That technology, production methods and efficiency remain unchanged.

• Particularly for graphical methods, that the analysis relate to one product only.

• There are no stock level changes or that stocks are valued at marginal cost only.

• There is assumed to be no uncertainty.

(c) Short run Decisions

• Acceptance of a special order

• Dropping a product

• Choice of product where a limiting factor exists

• Make or buy decisions

• Purchase new equipment;

• Replace existing equipment;

• Introducing new products.

• Product-pricing decisions

Solution 3

Accounting rate of return method:

Average yearly profit × 100 1,000 = 20% 900 = 18% 880 = 17.6%

Average investment 1 5,000 5,000 5,000

Payback method:

M N P

2.25 years 2 years 2 years

Net present value method (cost of capital 10%)

Discount Present values (£)

factors per
tables
M N P

1,000 × (10,000) = × (10,000) = × (10,000) =

(10,000) (10,000) (10,000)

0.909 × 3,000 = × 5,000 = × 4,000 =

2,727 4,545 3,636

0.826 × 6,000 = × 5,000 = × 5,000 =

4,956 4,130 4,130
 0.751 × 4,000 = × 2,000 = × 3,000 =
3,004 1,502 2,253

0.683 × 1,600 = × 1,000 =

1,092 683

0.621 × 1,400 =
869

Net present
values 687 1,269 1,571

Internal rate of return:

Stage 1: Use a rate of return which will give negative net present values. In this instance it
is taken to be 18%.

Discount Present values (£)

factors
per tables
at 18% M N P

1,000 × (10,000) = (10,000) × (10,000) = (10,000) × (10,000) = (10,000)

0.847 × 3,000 = 2,541 × 5,000 = 4,235 × 4,000 = 3,388

0.718 × 6,000 = 4,308 × 5,000 = 3,590 × 5,000 = 3,590

0.609 × 4,000 = 2,436 × 2,000 = 1,218 × 3,000 = 1,827

0.516 × 1,600 = 826 × 1,000 = 516

0.437 × 1,400 = 611

Net (715) (131) ( 68)

present
values
 Stage 2: Calculate the internal rate of return (IRR), using figures for positive present
values already calculated in 3 above.

M 10% + 8% × 687 = 13.92%

687 + 715

N 10% + 8% × 1,269 = 17.25%

1,269 + 131

P 10% + 8% × 1,571 = 17.67%

1,571 + 68

If used on its own, without reference to the other methods:

1 Accounting rate of return would choose project M, as it gives the highest rate of 20 per
cent.

2 Payback would choose project N, as it pays back in the shortest time of two years.

3 Net present value would choose project P as it gives the highest net present value of
£1,571.

4 Internal rate of return would choose project P, as it shows highest return of 17.67 per
cent, which is itself higher than the cost of capital.

Solution 4

The calculation is set out as follows, where x is the activity level in units of hundreds and
y is the cost in units of £1,000.
X y xy x2

1 40 40 1

2 45 90 4

3 50 150 9

4 65 260 16

5 70 350 25

6 70 420 36

7 80 560 49

28 420 1870 140

n=7

b = n ∑ xy -∑ x ∑ y

n ∑ x2 – (∑ x)2

(Try to avoid rounding at this stage since, although n ∑ xy and ∑ x ∑ y are large, their
difference is much smaller.)

= (7 × 1,870) – (28 × 420)

(7 × 140) – ( 28 × 28)

= 13,090 – 11,760

980 – 784

= 1,330

196

= 6.79

a = ∑y–b∑x

n n

420 – (6.79 × 28)

7 7

= 60 – 27.16
 = 32.84

Therefore the regression line for y on x is:

y = 32.84 + 6.79x (x in hundreds of units produced, y in £1,000s).

(Always specify what x and y are very carefully.)

This line would be used to estimate the total costs for a given level output.
If,

say, 200 units were made we can predict the expected yield by using the

regression line where x = 2.0.

y = 32.84 + 6.79 × 2.0

= 32.84 + 13.58

= 46.42

i.e. we predict total costs of £46,42 for production of 200 units.

∑x = 28, ∑y = 420, ∑xy = 1,870, ∑x2 = 140, ∑y2 = 26,550, n=7

(7×1,870)-(28×420)

Thus r = √((7 ×140)-(28 ×28) )((7×25,550)-(420 ×420))

= 13,090-11,760

√(980-784) (185,850-176,400)

= = 0.977

r2 = 0.955

Interpretation of result

As 0.977 is very close to 1, this suggests that there is positive correlation between the
units and total cost. This can be interpreted that 95.5% of the variation in costs may be
predicted by changes in the output level. Alternatively, factors other than output changes
influence costs to the extent of (100-98), i.e. 4.5%.

Solution 5

(a) Absorption costing

 £ £

Sales (4500x £10) 45,000

Cost of sales:

Opening stock -

Production cost (4,800x£8) 38,400

Closing stock (300x£8) 2,400

(36,000)

Operating margin 9,000

Under-absorbed overhead (400)

Operating profit 8,600

(b) Marginal costing

Sales (4,500x£10) 45,000

Cost of sales:

Opening stock (4,800x£6) 28,800

Production (300x£6) (1,800)

(27,000)

Contribution 18,000

Fixed costs 10,000

Operating profit 8,000

(c) Reconciliation of profit figures

Profit under marginal costing 8,000

Closing stock valuation under

absorption costing (300x£8) 2,400

Closing stock valuation under

marginal costing (300x£6) 1,800

Fixed cost absorbed into closing stock

In absorption costing 600

Profit under absorption costing 8,600