Question 1

(a) Explain why it is important to classify cost in terms of behaviors, and how cost can be classified by
different behaviors.
ANSWER:
It is important to know and analyze the costs of a product or service , because it provides the necessary
information for institutional planning, the study of alternatives, decision-making or measures that avoid the
negative performance of the factors that generate deviations between the actual and planned costs and the
exercise of management control and evolution functions. From a managerial point of view, the knowledge and
analysis of costs, provides the return information (feedback), it is possible to measure the behavior on the
efficiency and effectiveness of the institution and its dependencies, allowing administrative decisions.

(b) Calculate the break-even point and margin of safety if Patel Ltd prices their office set at f36 per unit.
Draw the break-even chart that shows break-even point and margin of safety.
ANSWER:
Fixed costs = 360,000
Sales price per unit = 36
Variable costs per unit = 13 + 9 + 5 + 3 = 30
Break-Even point (units) = Fixed Costs / (Sales price per unit – Variable costs per unit)
= 360,000 / (36 – 30) = 360,000 / 6 = 60,000 units
Contribution Margin = (Sale price per unit – Variable costs per unit) / Sale price per unit
= (36 – 30) / 36 = 6 / 36 = 1/6

Break-Even point (prices) = Fixed Costs / Contribution Margin

= 360,000 / (1/6) = 2,160,000
Current output = 75,000 units
Break-Even point (units) = 60,000 units
Safety Margin = Current output - Break-Even point (units) = 75,000 – 60,000 = 15,000 units
(c) Calculate the anticipated profit for the order of 75,000 chairs by using marginal costing. (Note that a
full statement of profit or loss is not required)

ANSWER:

Anticipated profit using marginal cost

Sold Cost/
Particulars Total
units Price
2,700,00
Total Revenue 75,000 36
0
Less: Variable costs
Direct material 75,000 13 975,000
Direct labour 75,000 9 675,000
Variable selling & distribution 75,000 5 375,000
Other variable production
75,000 3 225,000
overhead
2,250,00
Variable costs
0
Gross profit 450,000
Fixed costs 360,000
Anticipated profit 90,000

Formulas:
(d) Briefly describe all the steps required to calculate a full cost using absorption costing.

ANSWER:

Step
Calculation a full cost using absorption costing
s
1 Revenue
Sold units x Sales pricing = Total revenue
2 Cost of goods sold
Sold units x Direct material = Direct material Cost
Sold units x Direct labour = Direct labour Cost
Sold units x Variable selling & distribution = Variable selling & distribution Cost
Sold units x Other variable production overhead = Other variable production overhead Cost
Fixed costs Total fixed costs
Total production
3 SUM(Costs)
costs
Unit cost = Total production costs ÷ Actual produced units
Ending inventory = (Actual produced units - Sold units) x Unit cost
Cost of goods sold = Total production costs - Ending inventory
3 Profit (loss) = Total revenue - Cost of goods sold

(e) Prepare a statement of profit or loss for Patel Ltd for the year ended 30 June 2019 using absorption
costing, assuming budgeted fixed overheads are equal to the actual fixed overhead. Explain how
net profit figures are different under marginal and absorption costing. All workings must be clearly
shown.
ANSWER:
 Absorption costing
Given data:
90,00
Budgeted produced units
0
91,00
Actual produced units
0
Direct material 13
Direct labour 9
Variable selling & distribution 5
Other variable production overhead 3
75,00
Sold units
0
Selling price unit 36
16,00
Ending inventory
0

Statement of profit (loss):

Revenue:
Sales 2,700,000
Cost of goods sold:
Direct material 1,183,000
Direct labour 819,000
Variable selling & distribution 455,000
Other variable production overhead 273,000
Total variable costs 2,730,000
Fixed costs 360,000
Total production costs 3,090,000
Unit cost 33.956
Less: Ending inventory 543,297
Cost of goods sold 2,546,703
Profit (loss) before taxes 153,297

Formulas:
Comparison:
Marginal Absorption
Particulars
Cost Costing
Produced units 91,000 91,000
Sold Units 75,000 75,000
Revenue 2,700,000 2,700,000
Variable costs 2,250,000 2,730,000
Fixed costs 360,000 360,000
Total production costs 2,250,000 3,090,000
Unit cost 30 33.956
Less: Ending inventory 543,297
Cost of goods sold 2,546,703
Net Profit (loss) 90,000 153,297
Difference 63,297

Formulas:
The difference between the two methods is that the absorption cost method considers all costs, both variable
and fixed, as means to produce inventories. The profit will be higher in the direct costing system if the sales
volume is greater than the production volume. Using absorbing costing, the profit will be higher if the sales
volume is less than the production volume.
So, we find a difference in net profit because the units produced (91,000 units) is greater than the units sold
(75,000 units), which makes a difference of 16,000 units. The difference in the unit cost is £3.956 (£33.956 -
£30), which when multiplied by 16,000 is £63,297 (£3.956 x 16,000 units, rounding).

(f)Explain the difference between mark-up and margin in cost-plus pricing.

ANSWER:

The mark-up is the net sales income of a company minus its cost. Gross margin represents the amount of sales
revenue that the business retains after incurring direct costs associated with producing the goods and services
that you sell. The in-cost-plus pricing margin refers to the difference between the selling price of a good or
service and its cost. It is expressed as a percentage of the cost. In other words, it is the aggregate price over the
total cost of the good or service that provides the seller with a profit. The difference between margin and markup
is that margin is sales minus the cost of goods sold, while markup is the amount by which the cost of a product is
increased to derive the selling price.

(g) Calculate the price based on full-cost plus and marginal-cost plus, provided that budgeted sales and
production units, costs and expenditures remain constant.
ANSWER:
 Price based on marginal cost
Price based on full cost plus
plus
Cost-plus pricing = Break-even pricing x Mark- Increase
Actual
up value Particulars 30%
Break-even pricing 2,160,000 Direct material 13 16.9
Mark-up value 30% Direct labour 9 11.7
Cost-plus pricing 2,808,000 Variable selling & distribution 5 6.5
Other variable production
Sold units 75,000 3 3.9
overhead
Price per unit (30% mark-up) 37.44 Total costs increased 39
Actual price per unit 36 Price per unit 36 46.8
Profit per unit 1.44 Profit per unit increased 7.8
Sold units 75,000 Sold units 75,000
Increase on Profit 108,000 Increase on Profit 585,000
2,700,00
Revenue 2,808,000 Revenue 3,285,000
0

Formulas:

(h) State THREE advantages and THREE disadvantages of the company's intended pricing approach.
ANSWER:
Advantages
1) This type of pricing approach is easy to calculate. For each product, the price is established by simply
multiplying the cost by (1 + M). For example, a retail company with a large number of products could choose all
of its prices simply by adding the desired markup to the purchase price. In the case of discounts, the retailer must
consider the purchase price that they are likely to pay.
2) With this method, profits are guaranteed by the current contract and there is less risk of losses: this method of
pricing is one of the least prone to risk. Each unit sold increases margins, because costs are amortized and the
margin on sale becomes margin.
3) This type of pricing is relatively transparent to customers, as it makes it easier for companies to explain how
they set their prices. For example, a company may explain that since its costs are C and its margin on sale is set
at M, the established price is fully justified. The transparency of the pricing method allows all customers to
understand it.
Disadvantages
1) There is usually little pressure to control costs, since the higher the cost, the higher the price. This sometimes
leads designers and engineers to create products with expensive features that the customer is not willing to pay
for.
2) If costs are the main factor in pricing, then the price should fluctuate from month to month. Raw materials and
sales commissions are variable costs or costs that change from period to period. Consumers may be skeptical of
price fluctuations and their trust in the brand may be eroded.
3) If production costs decrease, cost plus price margin suggests that prices should decrease. Then they lose out
on the benefits. It works the opposite if production costs increase. Cost plus margin pricing does not inspire
efficiency. While customers are paying production costs there is no incentive to cut costs or find the fastest,
cheapest, and most efficient way to produce the products. In this case it is easy for a company to be complacent.
Meanwhile, competitors are taking steps to produce a better product faster, allowing them to steal a slice of the
market.