DEPARTMENT OF ACCOUNTANCY

POST GRADUATE DIPLOMA IN ACCOUNTING

SCIENCES - 2024
(PGDAS)*
(POST GRADUATE DIPLOMA IN ACCOUNTING SCIENCE – 2024)

FINANCIAL MANAGEMENT

MODULE A

INTRODUCTION TO COSTING AND

DIRECT AND ABSORPTION COSTING
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1. Learning Objectives

Learning Objectives will be dealt with in the slides

2. General background into the topic

▪ Understand the decision-making process

Why?
A lot of the topics covered this year deal with a certain aspect of the decision-making process. If
you want to improve your overall understanding of a topic, after you have studied it, take a few
minutes to think where it fits in the decision-making process.

Cost Classification

▪ Know the classifications of costs for stock valuation purposes

▪ Period vs Product costs
▪ Elements of Manufacturing costs:
Direct material
Plus: Direct labour
Plus: Other direct costs
= Prime cost
Plus: Manufacturing overheads
= Product cost (Total manufacturing costs)
▪ Job Costing vs Process Costing

▪ Know the classification of costs for decision-making purposes

▪ Cost Behaviour
▪ Fixed
▪ Variable
▪ Stepped
▪ Mixed (semi-variable)
▪ Relevant vs irrelevant costs
▪ Sunk costs
▪ Opportunity costs
▪ Avoidable vs unavoidable costs
▪ Incremental vs marginal costs and revenues

▪ Know the classification of costs for control purposes

▪ Controllable vs Uncontrollable costs and revenues

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Material

▪ Understand the methods of pricing materials for:

▪ Internal reporting
▪ External reporting
▪ Know the treatment of the following:
▪ Stock losses
▪ Transport costs
▪ Material handling costs
▪ Understand JIT production and JIT purchasing and the accounting entries

Labour

▪ Distinguish between labour cost accounting and payroll accounting

▪ Know the treatment of:
▪ Overtime premiums
▪ Bonuses
▪ Employer contributions
▪ Idle time
▪ Understand the application of incentive schemes

Overheads - remember: Allocated = Absorbed = recovered

▪ Understand why it is necessary to allocate fixed overheads

▪ Be able to calculate an overhead recovery rate, and know which basis to use (cause and effect
vs arbitrary)
▪ Treatment of unallocated overheads - understand why they arise
▪ Understand why it is necessary to allocate service departmental overheads to product
departments
▪ Be able to define Normal Capacity
▪ Understand the relevance of fixed overheads for decision-making
▪ Understand why blanket overheads are not a suitable method for allocating overheads
▪ Understand why it is necessary to use a budgeted overhead rate

Accounting entries

▪ Understand the flow of costs through the accounting system

Recording of costs → WIP → Finished Goods → Cost of Sales

Leave construction contracts!

▪ Know the following basic rules:

▪ All product costs taken to WIP:
▪ Direct Material: Directly
▪ Direct Labour: Directly
▪ Overheads: By Allocation
▪ NB: Abnormal costs are treated as period costs  NEVER included in the cost of
the product

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Cost Volume Profit

▪ Be able to calculate and interpret the following:

▪ Break-even point

𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕𝒔 𝑭𝑪
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏/𝒖𝒏𝒊𝒕
= 𝑼𝒏𝒊𝒕 𝑽𝒂𝒍𝒖𝒆 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝒎 𝒂𝒓𝒈 𝒊𝒏
= 𝑹𝒂𝒏𝒅 𝑽𝒂𝒍𝒖𝒆

▪ Margin of safety

Units = Current sales level – break even sales level

Rands = Current Sales (R) – break even sales value

▪ Contribution

= Selling Price – all (man/non-man) variable costs

▪ Contribution Margin

𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏
× 𝟏𝟎𝟎
𝑺𝒂𝒍𝒆𝒔

▪ Break-even point of more than 1 product

Use the sales mix (Example, sell 2 Product A for every product B, sales mix 2:1) to
calculate a weighted contribution

High Low Method

▪ Know how to split a semi-variable cost using the high low method

NB: High low can only be used within the relevant range- where the fixed cost (and variable
cost per unit) remains constant.
Also look out for the effect of inflation where relevant in a question!

BASIC GUIDELINES FOR REPORT WRITING

(Important – you’ll get marks to write your question in a report format, so don’t forget it!)

a) Headings. A report should have headings stating:

(i) who it is to;

who it is from;
date of report;
title.

⚫ For example:

To : Board of Directors
From : Management Accountant Date: 1 January 2024

Title: Investigation into recent adverse labour efficiency variances

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b) Introduction or terms of reference.

Start by stating briefly why the report has been written.

c) Main body of report and appendices.

Write the main body of the report as clearly as you can, in a logical order. Don’t ramble on
and on. It might help to make one point in each short paragraph, and number your paragraphs.
Divide the text into sections, each with its own sub-headings.

Detailed calculations should not be included in the main body of the report. You should refer
where necessary to calculations in an appendix to the report. In an examination, you will need
to do the calculations first, before you start to write your report, and you should state in your
solution that your workings would be incorporated into an appendix to the report. Your report
can then refer to the appendix, and the marker will know what you mean.

d) Recommendation.
The report should end with a recommendation or conclusion. Alternatively, a recommendation
might be put at the beginning of a report, just after the terms of reference.
(You’ll get marks for a conclusion, so always write one)

Management accountants are information providers by profession, and they ought to be

concerned with the ability of all the reports they produce, both routine and ad hoc, to make an
impact on the people to whom they are sent.

Reports need two things to make people notice them and use them:

(a) format for maximum impact;

(b) content that motivates the recipient into action.

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Direct and absorption Costing

Differences summarized
Direct Absorption
Used for internal reporting/ decision Used for external reporting as it
making complies with IAS 2
Considers all variable manufacturing Considers fixed and variable costs
costs in cost of inventory
Not a good tool for stock valuation A good stock valuation tool
No under /over allocations Will be under/over allocations
Superior for decision making Superior for inventory valuation

There will be differences in the two methods in the following instances.

Please note: In the direct method no fixed manufacturing overhead costs are included as
part of stock. Only variable costs.

Profit will be the same under both methods where Production = Sales (i.e., no opening or
closing stock)

The only way it will differ is if the absorption rate for fixed costs differs from last year to this
year, and we carry stock in the absorption method. Because then even though we may
have the same no. of units opening and closing stock, they won’t have the same amount of
fixed manufacturing overheads allocated to them, because of the difference in methods from
last year, to this year.

Absorption profit > Direct profit, when Production > Sales (i.e., there is closing stock)

The reason is because fixed manufacturing overheads are included in Cost of Stock in
Absorption method. If we produce more than we sell, we will have closing stock, which we
deduct to calculate Cost of Sales. (In the formula: Opening stock + Purchases – closing
stock). This makes our Cost of Sales smaller (because we deducted the closing stock, and
the fixed manufacturing overheads are included in closing stock) which in turn creates a
bigger absorption profit.

Direct profit > Absorption profit, when Sales > Production (i.e., there would have been
opening stock)

The same as above. Except that we now have to add opening stock (remember the fixed
manufacturing cost are included in opening stock). Therefore, the Cost of Sales are now
higher, and the effect is that the absorption profit is smaller than the Direct profit.

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Differences between Income Statements prepared under both methods:

Direct/Variable Absorption

Sales Sales
Less Cost of Sales Less Cost of sales
O/S (variable Man costs incl) O/S (Fixed & variable man)
Cost of production (var Man) production (fixed & var)
Closing stock (Variable costs) C/S (fixed & variable)

Less other variable non man costs Less all non-man costs
= contribution (fixed and variable)
Less fixed costs (man and non-man) (less)/add (under)/over
= Net Profit allocation*
= Net Profit

* The under/over recovery should be considered in the production cost line as this affects
the production cost and thus gross profit. In this example it is below the gross profit line only
for explanation purposes.

Explanation of the under/ over recovery:

This will only ever occur in an absorption-costing environment.
Under this type of costing method, the fixed manufacturing costs are included as part of the
cost of inventory (cost of sales). When determining the amount of fixed costs that should be
included in the cost of inventory an allocation rate is used which often leads to the cost that
is allocated to the COS being different from the actual amount of fixed overheads that were
incurred. This leads to an over or under allocation/recovery. So, if based on the allocation
of fixed overheads R200 is allocated to the cost of sales and at the end of the month it is
determined that actual fixed overheads are R 300, to little was allocated to COS and there
is thus an under allocation/recovery. The effect thereof is that COS was initially too low
resulting in a higher profit. To reverse this effect the under recovery of R 100 must be
deducted to get a lower profit and vice versa for the over recovery.

When doing a question, always think: “what am I busy with?” Stock valuation/decision
making.

Stock valuation Decision making

Only consider manufacturing and non- Consider manufacturing and non-
manufacturing costs (direct=variable / manufacturing costs when making
absorption= variable + fixed) decisions as well as both fixed and
variable costs
Remember fixed manufacturing overheads
is the difference between direct and
absorption costing

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3. REFERENCES

Drury, 11th Edition, Chapters 1-4, 7-8, 24

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TOOLBOX
(Use this page make notes of key information and core principles)

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QUESTIONS
Question Marks Timeline Done
✓
1 – TTT Bpk (CE 2013) 30 March
2 – Bulk 10 March
3 - FitLeist 30 March
4 – Zee trading 15 March
5 – TomTom 25 April
6 – Mr Butler (CE 2012) 30 April
7 – Boogy 40 June
8 – Bolton 40 June
9 – Slam 50 September
10 – Execuchair 40 September

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QUESTION 1 (30 MARKS)

Tip Top Transport Ltd (‘TTT’) is a logistics group listed on the Johannesburg Securities Exchange.
TTT has the following operating divisions:

Division Focus area

Commercial Goods This division services the retail industry and is
responsible for the transport of fast-moving
consumable goods.
Fuel Logistics This division transports petrol and diesel from
refineries and oil depots to forecourts of fuel retailers.
Agricultural Logistics This division services the agricultural industry by
transporting wheat, maize, rice, sunflower seeds,
sugar, and flour.
FastLiner This division operates a fleet of luxury buses which
transports paying customers between major cities in
South Africa.
Servicing and Maintenance This division is responsible for all servicing and
maintenance of TTT’s trucks and buses.

Return on investment (ROI) is one of the group’s key performance measures and divisional
management is incentivised on the basis of divisional ROI. TTT’s overall ROI has declined in recent
years mainly as a result of the challenging economic conditions and operating cost increases. The
operating divisions have been asked to propose initiatives to improve ROI as part of the group’s
efforts to enhance shareholder value and returns. The financial director of TTT is particularly
concerned about the historic and forecast performance of the Commercial Goods Division (‘CGD’).
The financial manager of CGD informed you of his concern regarding CGD’s key strategic objective
of attaining a safety margin of 30%.

Commercial Goods Division (‘CGD’)

CGD is planning to replace its entire fleet of 70 trucks in the financial year commencing on 1 January
2014. The fleet is standardised, and each new truck is forecast to cost R900 000. CGD has
purchased all its trucks from the VIS Transport Group (‘VIS’) in the past and has been negotiating
with VIS about the replacement of the fleet in 2014. VIS has agreed to sell the trucks to CGD and
arrange financing for CGD. As part of the financing arrangement, VIS had agreed to purchase the
trucks from CGD for their estimated residual value of R225 000 each on 31 December 2018.

You have compiled, through your discussions with the financial manager of CGD, the following
information about forecast revenues and costs for the 2014 financial year.

Revenue

1. Each truck travels an average of 108 000 km per annum transporting customer goods. An
average trip comprises a total distance of 600km. It is budgeted that customers will pay a
fixed fee of R12 per km, excluding fuel costs, to CGD in the 2014 financial year for the
transportation of their goods.

2. Fuel costs are billed separately to customers. All routes have been mapped and standard
distances agreed with customers. The average fuel consumed per km travelled by trucks on
each route is also agreed with customers. CGD invoices customers the prevailing fuel cost
per litre, multiplied by the pre-agreed number of litres consumed per km on routes. CGD does

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not mark - up fuel costs when invoicing customers. Fuel recovery charges are estimated at
an average of R324 000 per truck for the 2014 financial year.

Operating costs

3. For a variety of reasons, fuel costs are forecast to be higher than that invoiced to customers.
The most common reason is that drivers deviate from pre-agreed routes or take detours. In
addition, trucks have to travel from CGD depots to the TTT Servicing and Maintenance
Division’s workshops on a regular basis for servicing, repairs, and maintenance.

The portion of the fuel cost related to route deviations and travelling for services is R40 000
per year in total for all trucks and is treated by management as a fixed cost. Additional
variable fuel costs for all 70 trucks are R22 680 000.

4. CGD insures trucks against theft and accident damage which is budgeted to cost R45 000
per truck in the 2014 financial year. In line with customer requirements, CGD also insures
itself against potential liability in the event of environmental damage as well as third party
claims for injury and consequential losses suffered as a result of negligence of truck drivers,
mechanical breakdown, or truck malfunction. This type of insurance is estimated to amount
to R65 000 per truck in the 2014 financial year.

5. Drivers are budgeted to be paid a base fee per annum on a cost to company basis in the
2014 financial year as well as a fixed fee per trip. Estimated costs according to the number
of trips undertaken are as follows:

Trips per truck Driver Costs per truck per annum

R
40 120 000
80 228 000
120 336 000
200 555 000

As negotiated with the drivers’ union, if drivers undertake 200 or more trips in a given year,
they will receive an additional R3 000 as part of their base fee.

There is also a pool of back-up drivers on standby, in the event that any of the primary drivers
become ill or to accompany drivers on long-distance trips. Back-up drivers are paid an annual
retainer fee of R20 000 per driver to remain on standby. CGD budgets on having one back-
up driver per truck for the 2014 financial year.

6. Trucks are serviced under a fixed contract for R 180 000 per year for 2014. Commented [A1]: Variable Cost not Fixed
Commented [A2R1]: Changed scenario to make it fixed
7. CGD allocates overheads based on the number of trips undertaken at an allocation rate of
R400 per trip. The allocated costs represent divisional expenses incurred in dealing with
customers (e.g., scheduling deliveries, customer service, complaints, and queries), invoicing
and collecting amounts from customers, human resource management, and general
management and control of operations.

8. Other operating costs relating to the operation of trucks vary directly in proportion with the
number of trips undertaken and are expected to be R156 000 per truck for the 2014 financial
year.

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9. The acquisition cost of the trucks less estimated residual values will be depreciated evenly
over five years. Total depreciation for the division is expected to amount to R9.45m per
annum.

CGD: Owner driver proposal

The CGD management is considering whether an ‘owner driver’ scheme should be

implemented instead of acquiring the 70 new trucks in 2014. The key rationale for the
scheme is to empower drivers to become entrepreneurs and generate wealth.
CGD’s management has researched the owner driver scheme implications and has made the
following proposals:

(a) Drivers would acquire the new trucks directly from VIS on 1 January 2014 on the same terms
and conditions negotiated between CGD and VIS. In addition, the Azania Development Bank
has agreed to guarantee the obligations of each driver to VIS and will stand surety in favour
of VIS if drivers default on obligations to VIS.

(b) Drivers will cease to be employees of TTT on 31 December 2013 and instead enter into a
contractual relationship with CGD to perform transport services on behalf of CGD.

(c) Drivers will be paid a fixed fee (excluding fuel costs) per km travelled as per agreed transport
routes and distances. Fuel costs will be recovered and invoiced separately by drivers to CGD
on the same basis as agreed between CGD and its customers.

(d) Drivers will contractually agree to have their trucks serviced and maintained by the
Servicing and Maintenance Division of TTT on the same basis as previously
undertaken by CGD.
(e) Drivers will take full responsibility for all operating costs of trucks except for other
insurance costs and allocated overheads set out in the notes on CGD’s revenue and
costs
(f) Drivers will need the services of accountants on an outsourced basis to handle the
invoicing and administration of their businesses.
(g) CGD estimates that its allocated overheads will drop by 80% following the
introduction of the owner driver scheme.
Additional Information:

• All amounts exclude VAT.

(Source: SAICA Adapted)

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Required

(a) Calculate the number of average trips that the CGD Division needs to
undertake to break even in the 2014 financial year; also, briefly comment
on your answer in light of the concerns of the financial manager of CGD
(assuming the owner driver scheme is not implemented). 14
(Round to 2 decimal places)

(b) Discuss the strategic considerations and other factors that TTT should
consider in evaluating whether to implement the owner driver scheme in 14
CGD.

Communication skills – logical argument; clarity of expression 2

Total Marks 30

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SUGGESTED SOLUTION
Part (a) Commented [A3]: Service Costs are not Fixed, When sales are 0
trucks will not need to be serviced and Service costs will be 0.
Marks
Number of Trucks 70
Total Km per Truck 108000
Average Km per trip 600
Thus Average Number of trips 180 1

Revenue per trip R

Revenue 600km*R12 7200 1/2
Fuel Recovery 324000/108000 *600 1800 1/2
Total Revenue 9000

Variable Costs per trip

Fuel 22 680 000/(180*70) 1800 1
Drivers C1 2700 1P
Other operating costs 156000/180 866.67 1/2
Total Variable Costs 5366.67

Fixed Costs
Fuel 40000 1/2
Insurance (45000+65000)*70 7700000 1
Drivers C1 840000 1P
Backup Drivers 20000*70 1400000 1
Service Costs 180000*70 12600000 1
Allocated Overheads (1P) 400*180(1/2)*70(1/2) 5040000 1 + 1/2
Depreciation 9450000 1/2
Total Fixed Costs 37070000

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Breakeven Point
Fixed Costs 37070000 1P
Contribution per trip 9000-5366.67 3633.33
Breakeven Point 10202.762
Therefore the breakeven point is 10203 TRIPS

Margin of Safety
Available Capacity:
70*180 12600 1
Breakeven Point 10203 1P
Margin of Safety (12600-10203)/12600 23.50%
19% 1P
The margin of safety is 23.5%,
19% which is below the 30% desired by the 1P
financial manager of CGD. They will thus not be meeting their key
strategic objective based on the forecast revenues and costs of
replacing the truck fleet.
Calculations
C1) Hi- Low Calc for driver costs
336000-120000 216000 1/2
120-40 80 1/2
Cost per trip 2700 Given above
Fixed Portion 336000-(2700*120) 12000 Per Driver
Total Fixed 12000*70 840000 Given above
Minus -1 if used 200 trips: outside relevant range. -1

Total 17
Max 14

(b) Discuss the strategic considerations and other factors that TTT should
consider in evaluating whether to implement the owner-driver scheme in
CGD:
What are competitors doing? Is TTT following a trend in the industry or are they (1)
trying something new which could result in a sustainable competitive (1)
advantage?
Does this divisional scheme fit in with the overall strategy of TTT or is it in conflict
therewith? (1)
Do relevant management members buy into this scheme or will there be
resistance from various levels of management? (1)
The owner-driver scheme gives the ex-employees more bargaining power –
before they were employees of the company and could strike; now they are free
agents and suppliers to the company. Although they are under contract, they (1)
are empowered to not renew their contracts at the end of the relevant term and
offer their services elsewhere should the rate offered by TTT not be high enough (1)
Is the contractual relationship with CGD exclusive? If not, what is stopping the (1)
drivers from offering their services to TTT’s competitors at the expense of TTT
(i.e., TTT sets them up, trains them etc.)? This could also lead to a deterioration (1)
of TTT’s competitive advantage

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Given the nature of the business, the transportation / drivers are a key success
factor and a very crucial part of the business, particularly for the CGD division
as fast-moving consumable goods are often perishable necessitating on-time (1)
delivery – is management comfortable “outsourcing” this and giving up an
element of control over such a critical resource? One such instance of this (1)
having a negative impact on TTT’s business would be if owner-drivers decide
they don’t want to employ back-up drivers given the relatively high cost – this
could make the drivers less reliable than currently where the CGD division (1)
ensures that there are always back-up drivers
The reputational risk to TTT must be considered – aside from the fact that they (1)
are giving up an element of control over such a crucial part of their business, it
is unrealistic to assume that there will be a 100% smooth transition and (1)
therefore arrangements will need to be made to manage the transition so that
customers do not experience a deterioration in service levels which could impact
on repeat business and cause customers to go to competitors
With the trucks being owned by TTT, they could be branded with the company’s
name, logo, website etc. – this is a very valuable and visible source of
advertising which would be lost if the trucks are owned by the drivers (assuming
this is not covered in the contract with CGD, or the services offered to CGD are (2)
not exclusive)
Does TTT have the necessary internal systems and IT infrastructure to
successfully manage this arrangement and ensure no damage to their (1)
reputation?
Are there any legal implications of implementing the new scheme? For (1)
instance, what happens if not all drivers opt for the scheme – would it be
possible for TTT to terminate their employment contracts if they wanted to, or
would they carry on employing these drivers and operate a “mix” of both (1)
options?
Empowering workers is positive; however, this scheme will require more than
just making drivers business owners – TTT would have a responsibility to
educate the drivers to ensure they understand the implications of running their
own business, owning an asset, having a liability, contracting the services of (1)
accountants etc. This involvement would be positive from the perspective of
community upliftment and TTT being a responsible corporate citizen, however
management should consider the cost, resource, and other implications (2)
What impact will this have on staff morale of the other divisions – would they
not also want to become empowered and be business owners? (1)
What impact will this have on the corporate culture of the organization – will it
be positive or negative? (1)
What impact will this scheme have on the other stakeholders (aside from the
drivers) of TTT – will it be positive or negative? (1)
Rewards and incentives, both monetary and non-monetary should be aligned
with the strategy of the company i.e., a company should reward the behaviour
it wants to see. With the drivers no longer being employees, TTT loses some
control over them and will have less influence over their behaviour in terms of
not being able to incentivise them with “softer” non-financial measures (2)
CGD must consider the impact the owner driver scheme will have on operating
profits, IRR and NPV (1)

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Scheduling deliveries with customers may become more difficult as CGD will
need to confirm timing with drivers. This adds an additional step to the business (1)
process
ROI should increase as an investment in assets (i.e., the trucks) will no longer
be required (1)
As drivers will be working for themselves, they may become more efficient and
service levels could improve (1)
CGD will convert fixed costs into a variable expense, so that it only pays drivers
if they deliver or work. This should decrease operating leverage and thus reduce (0.5)
the risk of CGD. CGD must also consider the effect on break even and the 30% (0.5)
safety margin required (0.5)
There is a risk that drivers could collaborate and attempt to service CGD
customers directly (1)
Owner driver scheme will empower drivers to become entrepreneurs and
generate wealth (1)
CGD should consider whether there is a minimum business for drivers – if not,
the drivers may be worse off during times where business is slow (1)
CGD will not be required to make a deposit or finance the trucks – this positively
affects CGD’s cash flow position and could reduce gearing, allowing CGD to (1)
pursue other growth opportunities (1)
Any other valid point

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QUESTION 2 (10 MARKS)

Bulk Limited and Groei Beperk are two companies producing nitrogenous fertilisers for the South
African market. As a result of drought conditions, both companies are currently operating well below
full capacity. It is anticipated that the selling price of the fertiliser will be constant at R40 per ton for
at least the next two years.

The following information relates to the two companies:

Bulk Ltd Groei Beperk

Annual fixed costs R20 000 000
Variable costs A R5 per ton up to a production
level of 500 000 tons p.a.; R3
per ton if production exceeds
500 000 tons p.a
Variable costs B R10 per ton
Plant capacity 1 000 000 tons per year
Current sales volume 800 000 tons per year
R10 000 000
R15 per ton up to a
production level of 800 000
tons p.a, R5 per ton if
production exceeds 800 000
tons p.a.
R15 per ton
1 200 000 tons per year
900 000 tons per year

REQUIRED:

1. Calculate the break-even sales volume for Bulk Ltd, using the fixed selling price of R40 per ton.

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QUESTION 2 (SUGGESTED SOLUTION)

Cost per ton - BULK LTD

Variable Semi-variable
Expenses expenses Total Contribution
per ton per ton per ton per ton

R R R R

0 - 500 000 tons 10 5 15 25

500 001 and over 10 3 13 27

1. (a) Contribution at 500 000 tons = 500 000 x R25 = R12,5 million
Unrecovered overhead = R20,0 million - R12,5 million = R7,5 million

Break-even sales volume = R7,5 million + 500 000

R27

= 777 778 tons

Explanatory Note:

Break-even point determines the extent to which fixed costs are covered by contribution, so
that we can break even. You have total fixed costs of R20 000 000, which must be covered
by contribution. As your contribution differs at different production levels, you have to
calculate different break-even points.

At 500 000 your total contribution is 500 000 X 25 = 12,5 mil. This means that R12,5 mil of
your fixed costs will be covered by the 500 000 units contribution. (Break-even point is -
12,5mil/25 = 500 000 units).

You still have 20-12,5 = 7,5mil of fixed costs to cover. You now have a contribution of R27
per unit (that's the contribution with which you are going to cover these fixed costs). How
much units will you now have to sell to cover those costs? 7 500 000/27 = 277 778 units.
(Break-even point).

Thus, for the total fixed costs, we add the 2 break-even points together. (500 000 +
277 778 units), as it is going to cover the total fixed costs of 12,5mil + 7,5 mil

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QUESTION 3 (30 marks)

You have recently been appointed as a management accountant at Fitleist (Pty) Ltd
(“Fitleist”). Fitleist is a newly incorporated golf ball manufacturing company situated in
Nasrec, Johannesburg.

Background

Fitleist was incorporated by Rodge Nadal (“Rodge”) in 2017 after his conclusion of a
strategic group mapping exercise through which he identified a “white space” for a locally
based brand in an industry dominated by large foreign based competitors situated mainly in
China. Rodge’s analysis revealed that his main competitors pride themselves on being
globally recognisable brands across golf equipment and golf wear production and
distribution. His vision for Fitleist is for it to become a locally based global brand, producing
quality golf balls whilst uplifting the community and creating sustainable jobs.

To be successful in the golf industry, endorsements by professional golfers (Pro’s) are of

upmost importance. Larger manufacturers sponsor world renowned Pros who in turn,
appear in several of their advertisements and wear their branded clothing for promotional
purposes. Amateur golfers (a grouping of fringe, recreational and avid golfers) are influenced
by the pyramid of influence principle, which is ingrained in most golfers, more especially avid
golfers. This principle holds that given that the game of golf is learned by observation and
imitation, golfers improve their own performance by attempting to emulate highly skilled
golfers (pro’s). Golfers are therefore influenced not only by how pro golfers swing but also
by what they swing with and what they swing at.

Market research has been done to gain a deeper insight into the amateur golfer grouping. A
summary of the research has been included below:
• Fringe golfer – these golfers play 1-2 rounds a year, normally as part of golf days or
special events.
• Recreational golfer – these golfers play 6-12 rounds a year as a social activity.
• Avid golfer – these are dedicated golfers who play once a week.

The sport of golf gives rise to a global commercial opportunity of more than US$85 billion
annually, which captures all spending related to golf. There are over 50 million golfers
worldwide playing over 800 million rounds annually on over 32,000 golf courses.
After careful consideration of forces driving change in the golfing sector, management
identified the following factors as the most influential:
• golfer demographics,
• avid golfers,
• weather conditions and
• economic factors.

Fitleist’s initial value proposition analysis steered its business model to focus its product
offering towards the sale of golf balls to retailers, who in return would sell to amateur golfers.
Following a year of dismal financial performance, management of Fitleist needs to re-
evaluate its initial proposition to its intended market, in particular around the factors driving
change in the sector, by having to ask some probing questions.
21
Module A – 2024

You obtained the following information from your junior in order to understand the current
performance of Fitleist better. Your junior correctly prepared the partially completed budget
presented below for the month of February 2024.

Budgeted Income Statement for the month of February 2024

Notes Rand
Sales 1 7 200 000

Cost of Sales
Opening Inventory 2 0
Direct Material 3 1 275 000
Direct Labour 3 825 000
Manufacturing Overheads 3,4 ?
Closing Inventory 2,5 0

Contribution ?

Manufacturing overheads ?
Non-manufacturing overheads 6 125 000

Net Profit ?

Notes
1. Golf balls are sold by the dozen (12 Golf balls per dozen). Each ball was budgeted to be
sold at R40. Actual selling prices were 10% below expected prices.

Actual sales amounted to R 4 881 600.

2. It was budgeted that all units produced in the current and previous month would have
been sold.

3. Budgeted variable production costs were equal to actual costs incurred on a per unit
basis.

4. Manufacturing overheads are mixed in nature.

Units produced Cost (Rand)

15 000 1 432 500
14 000 1 417 000
13 000 1 401 500
12 000 1 186 000
11 000 1 170 500

Actual manufacturing overheads costs were equal to budgeted costs, except for repairs
and maintenance. Repairs and maintenance represent a step fixed cost.

22
Module A – 2024

5. Actual closing stock per the absorption basis amounted to R117 750.

6. Actual non-manufacturing costs amounted to R130 000.

Additional information
• Ignore taxation

Total
REQUIRED

(a) Analyse the performance of Fitleist for the month of February 2024 by:

(i) Preparing the actual absorption income statement for the

14
month of February 2024;
(ii) Calculating the actual direct profit for the month of February
2
2024;
(iii) Briefly interpreting the performance of Fitleist for the month of 3
February 2024.

.
(b) Given the forces driving change identified, formulate the questions
management is required to answer to assist Fitleist to clarify its value 11
proposition.
Total 30

23
Module A – 2024

Suggested Solution Marks

Part a
(i) Preparing the actual absorption income statement
for the month of February 2024;

Calculate actual units produced

Opening stock 0
Production 11800 1P
Closing stock (Calc 1) 500
Sales (Calc 2) 11300

Calc 1
Actual closing stock total value 117750

Budgeted units sold 7200000/(40*12) 0.5

15000 0.5

Variable cost per unit using

budgeted units
Material 1275000/15000 85 0.5P
Labour 825000/15000 55 0.5P
Variable o/h (from calc below) 15.5 0.5P
Fixed allocation rate (from calc
below) 80 0.5P

Total cost p/unit 85+55+15.5+80

235.5

Therefore, closing units

117750/235.5 500 1P

Calc 2
Actual selling price 40*12*0.9 1
432
Actual sales/SP 4881600/432 1P
Actual units sold 11300

24
Module A – 2024

Calculate budgeted fixed

overheads using high low

Units Cost
15000 1432500
14000 1417000
13000 1401500
12000 1186000
11000 1170500
To calc "Step" - High-low at
every level
The calculations below are for
explanatory purposes only.
Mark awarded for identifying
where the step was, even if
didn’t show each calc

(1432500-1417000)/(15000-
14000) 15.5 1
(1417000-1401500)/(14000-
13000) 15.5
(1401500-1186000)/(13000-
12000) 215.5
(1186000-1170500)/(12000-
11000) 15.5

OR OR

(1432500-1417000) 15500 1
(1417000-1401500) 15500
(141500-1186000) 215500
(1186000-1170500) 15500

Thus, at Production level below 13000 there is a "step" (and

vice versa)
This is because all variable manufacturing costs remained
unchanged on a per unit basis

y=mx+c

If production is 15000 units 1432500=15.5*15000+FC

Thus FC = 1200000 1

If production is 12000 units 1186000=12000*15.5+FC

25
Module A – 2024

Thus FC 1000000 1

Thus, step in FC = 1200000-1000000

200000 1P

The below is included for explanatory purposes, marks

awarded for: one calc with
units above 13000; one calc with units below 13000;
identifying the step in fixed cost

If production is 14000 units 1417000=15.5*14000+FC

thus FC= 1200000

If production is 13000 units 1401500=13000*15.5+FC

Thus FC 1200000

If production is 12000 units 1170500=11000*15.5+FC

Thus FC 1000000

Calculate over/under absorption

Budgeted o/h (given) 1200000

Budgeted units 15000

Allocation rate bud overhead/ bud units

1200000/15000
80 1

Allocated 80*11800
944000 1

Actual 1000000

Under absorption 1000000-944000

56000 1P

26
Module A – 2024

Actual absorption costing

statement

Sales (given) 4881600

Cost of Sales
Opening inventory 0
Direct Material (calc 3) -1003000
Direct Labour (calc 4) -649000
if actual
overheads
Manufacturing Overheads (calc 5) -1126900 are used
award 3
marks
Closing Inventory (given) 117750

Over/Under -56000

Non-manufacturing overheads -130000 0.5

Profit 2034450

Calc 3
1275000/15000
85
11800*85 1
mark
awarded for
Calc 4 using actual
825000/15000 production
55
11800*55

Calc 5
Variable
15.5*11800
182900

Fixed
Allocation rate*actual
80*11800

27
Module A – 2024

944000
Total
182900+944000
1126900

Available 15.5
Max 14

Part a
(ii) Calculating the actual direct profit for the month of February
2024; Marks

Reconciliation

Actual absorption profit (part a) 2211950 0.5P

o+ opening stock fixed costs 0
0- closing stock fixed costs
(calc a) -40000
Actual direct profit 2171950 0.5P

Calc a

Closing stock units 500

Fixed cost allocation rate 80
Therefore 500*80 40000 1P

Note to markers: if under/over absorption considered in recon, marks limited

to one.
Max 2

(iii) Briefly interpreting the performance of Fitleist for the month of February 2024;

Actual performance under the absorption statement appeared better than actual
performance 1
under direct profit.
This is because production was higher than sales, thus resulting in a larger
closing stock figure 1
under the absorption costing statement. This resulted in a smaller CoS and thus
a greater profit.
However, the direct statement still resulted in a profit therefore it is
clear that sales were above breakeven. 1
Max 3
28
Module A – 2024

Suggested solution – Part B

Given the forces driving change identified, formulate the questions management is
required to answer to assist Fitleist to clarify its value proposition.
GOLFER DEMOGRAPHICS
Which ethnic groups are represented within the amateur golfer population? 1
What is the socioeconomic representation of the amateur golfer population? (Also, 1
Economic Factors)
What percentage of the golfer demographic is male versus that which is female? 1
Which age cohort drives the golf market? 1
What percentage of the total golfers’ market does the identified age cohort 1
represent?
What is the generational breakdown (gen x, gen z, baby boomers, etc) 1
represented by the amateur golfer demographic?
On average, what is the total number rounds of golf played by the amateur golfer 1
demographic?
What is the total number of rounds of golf played by the amateur market and what 2
is the average spent on golf equipment per category of amateur golfer?
What percentage of total income earned per household is represented by each 1
category of amateur golfer?
AVID GOLFERS
What percentage of the amateur golfer market is representative of the avid golfer 1
category?
Which percentage of pro’s currently make use of Fitleist golf balls? 1
Which percentage of total income generated in the golf industry is attributable to 1
avid golfer spent?
Of the total avid golfer spent identified, what percentage can be attributed to golf 1
ball purchases?
What other golfing equipment (other than golf balls) do the avid golfers spend on 1
in search of emulating pros? (Pyramid of influence principle)
Which pros are of South African decent versus that from foreign decent? (Local 1
success inspires participation)
WEATHER CONDITIONS
What is the average number of playable days of golf in the local market 1
compared to that of foreign-based competitors?
What is the impact of climate change on local weather patterns? 1
ECONOMIC CONDITIONS
What is the current economic climate (general business conditions, interest rates, 1
the availability of consumer credit, taxes, and consumer confidence in future
economic conditions) experienced locally compared to that of foreign based
competitors?
(Golf is a discretionary spent sport. Economic conditions have a direct impact on
the amount spent on golfing equipment)
Any other valid marks 2
Available 21
Maximum 11

29
Module A – 2024

QUESTION 4 (15 MARKS)

(a) You are given the following information in connection with the Zee Trading Company Limited
for the year ended 30 June 2025:

Net profit R40 000

Break-even sales R200 000
Total sales R300 000

From the beginning of July 2024 the fixed costs increased by R9 500 per annum while the ratio of
variable costs to sales increased by 5%.

REQUIRED:

(a) Calculate the fixed costs for the year ended 30 June 2025.

(b) Calculate the variable costs for the year ended 30 June 2025.

(c) Calculate the new annual value of sales required to maintain the net profit of R40 000 per
annum; and

(d) Calculate the new break-even turnover.

(FQE)

30
Module A – 2024

QUESTION 4 (SUGGESTED SOLUTION)

(a) R100 000 sales in excess of break-even produced R40 000 profit.
The contribution margin is therefore 40 000 ÷ 100 000 x 100 = 40%
Fixed costs are 40% of break-even sales = R80 000

(b) Variable costs can be derived in two ways:

Sales for the period less profit less fixed costs =

R300 000 - 40 000 - 80 000 = R180 000
or
Sales for the period x 60% = R180 000

(c) New fixed costs = 80 000 + 9 500 = R89 500

New contribution margin = 100% - (60 x 1,05) = 37%

New annual value of sales to maintain net profit at R40 000:

89 500 + 40 000
0,37 = R350 000

(d) The new break-even turnover:

89 500
0,37 = R241 891,89

31
Module A – 2024

QUESTION 5 (25 MARKS)

Tom Tom (Pty) Ltd (hereafter TT) was started by Tommy Martin in 1985, out of his garage at his
home in Springs, Gauteng. Tommy is quite an interesting individual which could never find
sunglasses that suited his style perfectly. As a result, he saw an opportunity in the market for a
specific type of sunglasses made for people with square shaped heads. He began by manufacturing
sunglasses for himself and his friends which rapidly grew into the business as it stands today. TT is
a well-known brand in South Africa as well as neighbouring countries. Since establishment Tommy
has been the financial and operations manager.

TT’s objective is to produce a product of high quality that is unique yet affordable. TT strive to
continue being a market leader in the production and distribution of unique, affordable, and quality
sunglasses. TT’s sunglasses get sold with a one year warranty as they believe in the quality of their
product. TT currently produce and sell sunglasses to both local as well as international stores.

Tommy had a pricing dispute with Eye-Wear Optometrists (Pty) Ltd, in early 2000. Eye-Wear is one
of South Africa’s largest optometry firms. Eye-Wear stopped carrying TT’s products in their stores
and as a result TT’s sales declined with 33%.

TT then signed a five-year agreement (in 2001) to manufacture eyewear designed by Glass-Savers
(Pty) Ltd. Glass-Savers sold this eyewear in their respective clinics for the period of agreement. The
contract wasn’t renewed.

One of TT’s biggest competitors in neighbouring countries, Vogue, recently expanded their business
to South Africa by building a brand new factory near Plettenberg Bay in the Western Cape. Rogue
exports most of these products manufactured but also actively market their products in South Africa.

TT imports its materials from Yesh Ltd in China. Yesh Ltd has been TT’s supplier since 1995 and TT
intend to keep sourcing materials from them in the foreseeable future. Tommy Martin supplied you
with the following information to assist him in understanding TT’s performance for the 2025 financial
year, which just ended.

Actual Income statement for the year ended 31 January 2025

Sales 1 500 000

Cost of sales (976 000)

Raw material 412 500

Direct labour 357 500
Production overheads 614 000
Closing stock (408 000)

Gross profit 524 000

Patent cost (60 000)
Other non-manufacturing costs (275 000)
EBIT 189 000
Finance costs (30 000)
Profit 159 000

32
Module A – 2024

You determined the following when you met with Tommy Martin a week ago:

• Production overheads consists of both fixed and variable costs.

• The over recovery in 2025 was R 112 000.
• The actual selling price in 2025 of R75 was equal to the budgeted selling price.
• Production and sales were budgeted at 22 500 units.
• The budgeted overheads were equal to the actual overheads incurred.
• Besides having closing stock of finished goods, closing stock in terms of material amounts to
R 50 000.
• Patent costs consist of both a minimum annual contractual fee payable as well as a specified
fee charged per unit sold. The total budgeted patent fee cost amounted to R2.80 per
budgeted units sold. The minimum contractual fee increases with R500 for every full 1 000
units of activity.
• Normal capacity = Budgeted production.
• Budgeted variable costs for TT was R28 per unit (Manufacturing and non-manufacturing).

Additional information:

• Ignore taxation
• Round all calculation to two decimals.
• If not otherwise stated, assume actual expenses equal budgeted expenses

(a) Calculate and critically discuss the actual break-even of TT in terms of the
2025 financial year ended 31 January 2025. (14)

(b)Calculate and critically evaluate the business risk that TT is exposed to.
You should refer to both the budgeted as well as actual results for the (9)
2025 financial year.
Communication skills – presentation; logical argument; clarity of expression. (2)

33
Module A – 2024

(SUGGESTED SOLUTION)

BREAKEVEN
965000.00/42.2 22 867 Units

•
• TomTom did not break-even in the 2025 year, yet they still managed to show a net profit on
their income statement

34
Module A – 2024

• The reason for the 2025 income statement showing a net profit despite not breaking even is
that management has manipulated the profits shown on the income statement using the
absorption method. Management included fixed manufacturing overheads in closing stock
of R168000, which in effect decreased the cost of sales figure. As Cost of sales was
reduced, the net profit increased for the year.
• The net profit as per the direct method better reflects the fact that TomTom is not breaking
even in 2025, as a Net Loss in shown for the year (Calculated Above)

Calculations
1) Over- recovery 112000
Difference between actual units and normal capacity 5000
27500 - 22500
Budgeted Overhead Rate 22.4 /Unit

Fixed Costs = 22.4 * 27500 (Actual = Budgeted) 616000

Actual Production Overheads 614000

Add: Over Absorption 112000
Less: Fixed Costs -616000
Variable Costs in total 110000
Number of units 27500
Variable Cost per Unit 4.00

Patent Costs Units Costs

High 22500 63000
Low 20000 60000
2500 3000
-1000
2500 2000

2000/2500
Variable Cost per Unit 2500/2000 0.8
Fixed Costs @ 20000 units 44000

35
Module A – 2024

Part B - Business Risk

Calculation of Degree of Operating Leverage
Actual
Total Contribution 844 000.00
(42.2 * 20 000)
(44.2*20000)
EBIT -Given 189000
DOL = (887600/189000) 4.47

Budgeted
Sales (22500 * 75) 1687500
Less: Variable Costs: (22500*28) -630000
Total Contribution 1057500

Total Contribution 1057500

Less: Fixed Overheads (22500*22.4) -504000
Less:Fixed Patent Cost (44000 + (500*2)) -45000
Less: Other Manufacturing Costs -275000
Earnings Before Interest and Tax 233500

DOL =(1057500/349500) 4.53

• The Actual DOL is higher than the Budgeted Degree of Operating leverage. The
reason for this, is that TT actually sold less than expected, and therefore did not
cover fixed costs as comfortably as expected. Fixed Costs were also more than
budgeted which led to a higher degree of operating leverage
• Variability of Sales - We actually sold 20 000 units, yet we expected to sell 22500
units, therefore we sold 88,89% of budgeted.
• Risk of the Rand strengthening against the foreign currencies, as we export our
products internationally.
• Risk of further contracts being lost with major clientele leading to a decrease in
sales will have a negative impact on profit
• Risk of materials being of a low quality due to it being imported from China - this
is not in line with our business objective
• Risk that the Rand will weaken against the Yen, therefore increasing costs of
materials.
• Risk of Competitors increasing their market share, decreasing TT’s market share
in South Africa
• Risk of business continuity as Tommy is the operational and financial manager
since establishment

36
Module A – 2024

QUESTION 6 (30 MARKS)

Sabi (Pty) Ltd is a company that was founded and incorporated by Mr. Butner approximately
5 years ago. Mr. Butner studied ecology and environmentalism at the University of Pretoria
and did both his masters and his doctorate degree in this study field. Mr. Butner specialised
in wild animals and realised that vaccinating wild animals by using vaccination medicine is
both expensive and time consuming. Most wild animals in game reserves need to be
injected with both a vaccination medicine as well as a multi-vitamin at least once a year.
Due to it being very expensive to catch wild animals and then inject them, Mr. Butner decided
to formulate vaccination medicine which includes a multi-vitamin, this vaccination is cheaper
and only needs to be given once every two years.

In his yearlong research Mr. Butner found that contrary to the perception in the market, you
cannot use the same amount of vaccination for smaller animals (such as springbuck) and
for larger animals (elephants). Sabi (Pty) Ltd therefore manufactures 3 vaccination
medicines namely:

• ISMV 80: Animals under 80 kg

• ISMV 180: Animals between 81 and 130 kg
• ISMV Plus: Animals over 130 kg

The reason why the product can be priced so much cheaper than that of competitors in the
market is because Mr. Butner uses technologically advanced machinery imported from
France in the manufacturing of the products.

Mr. Butner, although brilliant in his study area, is not very experienced in financial
management and has therefore asked you to assist him in various matters.

Income Statement for the year ended 31 December 2011:

ISMV 80 ISMV 180 ISMV PLUS

R R R
Sales 2 400 000 2 440 000 4 950 000
Cost of Sales 894 120 915 000 2 145 000
Opening stock 106 620 75 000 130 000
Material 375 000 720 000 1 440 000
Labour 562 500 180 000 900 000
Closing stock 150 000 60 000 325 000
Difference 1 505 880 1 525 000 2 805 000

Units Sold 24 000 12 200 33 000

The material cost of ISMV 80 has increased by 15% in 2011 and is expected to increase
with 10% in 2012.

Sabi (Pty) Ltd has not taken any overhead costs into account in compiling the above income
statement since they are not sure how to allocate overhead costs.
37
Module A – 2024

You have assisted him in allocating overhead costs and have started allocating the
overheads as shown below.

The following information relates to the allocation of overhead costs for 2011:

ISMV 80 ISMV 180 ISMV PLUS TOTAL

R R R R
Manufacturing 438 025 105 075 589 400 1 132 500
fixed overheads,
excluding rent
Rent Note 1 ??? ??? ??? 161 000
Non- 20 098 21 221 28 681 70 000
manufacturing
fixed overheads,
excluding patent
cost
Patent cost Note 2 88 000 64 400 106 000 258 400

Note 1:

Sabi (Pty) Ltd paid R161 000 during 2011 for the rental of a manufacturing building with an
area of 4100m2. Sabi Ltd uses the manufacturing building as follows:

ISMV 80 ISMV 180 ISMV PLUS

Rental space in m2 1 000 900 2 000
(2010 and 2011)

Note 2:

Sabi (Pty) Ltd pays Mr. Butner a fixed amount annually for the use of his vaccination formula
as well as a fixed fee per unit of vaccination sold. The fixed annual amount is allocated
evenly to the three products.

Future demand concern

Mr. Butner is concerned about the future demand of Sabi vaccinations as a well-known
pharmaceutical company will commence importing similar products during 2012. He is in
doubt regarding what the actual effect of this will be on their current demand levels. He told
you that he will be working on other possible products to offset the possible market share
loss. He estimates that he will incur costs of R2 000 000 in 2012 with no corresponding
income to develop new possible products. He is concerned that Sabi’s sales would drop
below break-even in 2012. He requested that you calculate and comment on how much his
demand per product can drop before he will make a loss in the 2012 financial year.

Additional information:

• The current sales figure represents market demand.

• Opening stock and closing stock includes only material and labour.
• Assume that all items remained constant from 2010 to 2011 and will remain constant
in 2012, unless indicated otherwise.
• Inventory is carried on a FIFO basis.
• Assume that overhead allocations performed above are correct.
38
Module A – 2024

• There were 3 000 units of ISMV 80 on hand on 31 December 2010.

• Assume that actual production is equal to normal capacity.
• Ignore taxation
• Round all amounts to the nearest rand.

REQUIRED:

(a) Prepare a detailed income statement for each individual

product for the year ending 31 December 2011, which may
assist management in the decision-making process. (8)

(b) Calculate the absorption profit for 2011 for Sabi (Pty) Ltd
without drawing up an income statement. (8)

(c) Advise Mr. Butner regarding his concern relating to future

demand levels. (14)

39
Module A – 2024

QUESTION 6 (SUGGESTED SOLUTION)

(a) ISMV 80 ISMV 180 ISMV Plus

Sales R 2 400 000.00 R 2 440 000.00 R 4 905 000.00
Cost of Sales R 894 120.00 R 915 000.00 R 2 145 000.00
O/S R 106 620.00 R 75 000.00 R 130 000.00
Material R 375 000.00 R 720 000.00 R 1 440 000.00
Labour R 562 500.00 R 180 000.00 R 900 000.00
C/S R 150 000.00 R 60 000.00 R 325 000.00

Difference R 1 505 880.00 R 1 525 000.00 R 2 805 000.00

Variable Non-Manufacturing
(2 x 24000/12200/33000) -R 48 000.00 -R 24 400.00 -R 66 000.00

Contribution R 1 457 880.00 R 1 500 600.00 R 2 739 000.00

Fixed Manufacturing cost -R 479 307.00 -R 142 229.00 -R 671 964.00

R 438 025.00 R105 075.00 R589 400.00
R 41 282.00 R 37 154.00 R 82 564.00
Fixed Non-Manufacturing cost -R 60 098.00 -R 61 221.00 -R 68 681.00
R 20 098.00 R 21 221.00 R 28 681.00
R 40 000.00 R 40 000.00 R40 000.00

Profit R 918 475.00 R 1 297 150.00 R 1 998 355.00

Calculations:
ISMV 80 ISMV 180 ISMV Plus
Note 1
R 161 000 allocated on basis of 3900m-
normal capacity R 41 282.00 R 37 154.00 R 82 654.00
OR on basis of 4100m R 39 268.00 R 35 341.00 R 78 536.00
Manufacturing R 7 854.00
now allocate manufacturing
based on 3900m R 7 854.00 R 2 014.00 R 1 812.00 R 4 028.00
Note 2
High-low
total patent cost R 64 400.00 R 106 000.00
Units 12 200 33 000

Variable cost p.u. 2

Fixed component 40 000
Total fixed component 120 000
(3 x R 40 000)
Avail (10)
Max (8)

40
Module A – 2024

(b)
ISMV 80 ISMV 180 ISMV Plus
Total Manufacturing Fixed
cost R 479 307.00 R 142 229.00 R 691 964.00

Units produced = Normal Capacity 25000 12000 36000

Allocation rate R 19.00 R 12.00 R 19.00

- Opening stock -3000 -1000 -2000
+ Closing stock 4000 800 5000

Direct Profit R 918 475.00 R 1 297 150.00 R 1 998 355.00

O/S -R 57 000.00 -R 12 000.00 -R 38 000.00
C/S R 76 000.00 R 9 600.00 R 95 000.00

Absorption Profit R 937 475.00 R 1 294 750.00 R 2 055 355.00

Units produced
calculation:
Cost of Sales R 894 120.00 915000/12200 = 75 2145000/33000 = 65
2010 O/S realised as sales -R 106 620.00 60000/75= 800 325000/65=5000
R 787 500.00
Units produced in 2011 and sold in 2011 21000
Thus 2011 variable cost per unit R 37.50
Closing stock units 4000 800 5000
Units produced 25000 12000 36000
Avail (11)
Max (8)

(c) ISMV 80 ISMV 180 ISMV Plus

Selling Price R 100.00 R 200.00 R 150.00
Variable cost -R 41.00 -R 77.00 -R 67.00
[22.5 (1) + 2 (1) +((375 (75 (0.5) + 2 (65 (0.5) + 2
000/25000)(0.5) X 1.1 (0.5) )] (0.5)) (0.5))
Contribution per unit R 59.00 R 123.00 R 83.00

Demand 69 200 24 000 12 200 33 000

Weighted 81.72 20.4624 21.68 39.5809

Breakeven:
Total Fixed overheads 3 483 00.00
(1 132 500 (0.5) +161 000 (0.5)+70 000 (0.5) +(40000x3) (0.5)+2 000 000 (1) )
OR PER PRODUCT
( ( 438 025 +105 075 + 589 400) (0.5) + (20 098 + 21 221 + 28 681)(0.5) + (41 282 + 37 154 + 82
654) + (40 000 x 3) )
Weighted Contribution R 81.72
Breakeven units 42 625
Demand/Expected sales 69 200
Margin of Safety 26 575

41
Module A – 2024

Conclusion:
Thus, will breakeven and more, relatively high safety margin, risk of making a loss is
low.
Demand per product can drop with the following units:

ISMV 80* 9 216

ISMV 180** 4 685
ISMV PLUS*** 12 673

*24/69.2 x 26 575
**12.2/69.2 x 26 575
***33/69.2 x 26 575

Additional factors:
- Increases in the material or labour cost will lead to a higher breakeven point, developmental
expenditure of R2 000 000 will lead to a loss.
- Are there any hidden or additional cost before new products are ready to generate income?
- How long will development of "new" products take/how long before income will be generated.
- Possibility of lowering selling prices of current three products (especially ISMV 80 and PLUS)
to retain market share and stimulate sales
- Chances of pharmaceutical companies also selling similar products to "new" products shortly
after Sabi introduced them
- Due to the uncertainty in demand, it would be best not to incur further fixed cost; consider renting
machinery, vehicles other ways of converting fixed costs to variable costs
- Can Sabi act as an agent for the competitor?
- What effect will the Rand's strength have on the competitor as they are doing imports?
Now the Rand is strong –to the advantage of competitor.
- Is there a risk for Sabi as their products are patented? The competitor will not be able to sell a
- product that is the same as Sabi's.
- What is the mix between the products? Is it constant? What will happen if the mix changes?
- Sabi is currently only selling vaccinations for wild animals. Is it possible for them to diversify into
other markets?
- Sabi can consider a different pricing strategy or to differentiate the product to improve sales

Avail (18)
Max (14)

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Module A – 2024

QUESTION 7 (40 MARKS)

Boogy Limited is a company which manufactures fashion clothes for sale to retail chains and whose
objective is to maximize shareholders’ wealth. It operates in a competitive market, and it may
therefore be assumed that it has no control over selling prices and quantities demanded.

At the beginning of 2024 Boogy Limited acquired a factory making leather jackets, together with its
stock of finished goods. At the end of the first year of operation under new management, the
company’s accountant drew up the Income Statement for the twelve months to 31 December 2024
as follows:

Year end 2024

No of jackets R’000 R’000

Sales 50 000 5 000

Less: Opening stock of finished goods 5 000 350

Cost of manufacture 50 000
Variable costs 1 250
Fixed costs _______ 2 250 3 500

55 000 3 850
Closing stock of finished goods (5 000) (350)

Cost of goods sold 50 000 3 500

Gross profit 1 500

Less:
Fixed administrative expenses 1 250
Variable selling costs 500 1 750

Net loss (R250)

You are given the following additional information:

1. Stocks of finished goods are stated at fully absorbed factory cost, with actual fixed
manufacturing overhead being allocated based on units produced.

Stocks are identified on a first-in-first-out (FIFO) basis.

There were no stocks of raw materials or work in progress at the beginning or end of the
year.

2. Selling costs represent distribution expenses which were 10% of the sales value of goods
sold.

3. It is not possible in the foreseeable future for the factory manager to change variable costs
per unit, fixed costs per annum, selling price per unit, selling costs per unit of the number
or jackets sold each year.

You are also informed that the directors of Boogy Limited were unhappy with the performance of the
factory in 2024 and consequently appointed a new factory manager on a short-term contract for two
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years commencing on 1 January 2025. Under its terms he was to have complete control over the
scheduling of production, and to provide an incentive it was agreed his remuneration should be 10%
of net profit before deducting such a charge. It was further agreed that for this purpose, profit should
be calculated applying the accounting policies adopted in preparing the 2024 Income Statement
shown above.

In 2025 the factory produced 75 000 jackets, the limit of its output capacity, and 50 000 jackets were
sold.

In 2026 the factory again produced 75 000 jackets, and sales were once more 50 000.

As anticipated at the end of 2024, variable costs per unit, fixed costs per annum selling price per unit
and selling costs per unit all remained at their previous levels in 2025 and 2026.

It is not possible to subcontract production.

REQUIRED:

(a) Calculate the net profits earned by the factory in 2025 and 2026 and the factory manager’s
remuneration for those years. (12)

(b) Compare the stock values and post remuneration profit figures calculated on a direct costing
basis with those on a variable costing basis. (8)

(c) Asses the performance of the factory manager 2025 and 2026 and discuss the implications
of applying fully absorbed factory cost rather than variable cost stock valuation in the
circumstances described. (12)

(d) Indicate how your assessment of the factory manager’s performance in 2025 and 2026
would differ from your answer in (c) if he forecast on his appointment that demand in 2027
would be for 125 000 jackets and this subsequently proved to be correct. In so doing,
suggest an appropriate method for valuing stock which would produce profit figures to
support your assessment, and which would reward the factory manager accordingly.
(8)

(NATAL)

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QUESTION 7 (SUGGESTED SOLUTION)

(a) Profits for 2025 and 2026

2025 2026
R’000 R’000 R’000 R’000
Sales (50 000) 5 000 5 000
Less: Opening stock 350 (given) 1 650
Variable production costs 1 875 1 875
Fixed production costs 2 250 2 250
4 475 5 775
Plus: Closing stock (@R55/unit) 1 650 3 025
Cost of sales (2 825) (2 750)
Gross profit 2 175 2 250
Less: Fixed admin costs 1250 1250
Variable selling costs 500 500
(1 750) (1 750)
Profit before remuneration 425 500
Factory manager’s remuneration (42,5) (50)
Net profit R382,5 R450

Calculations:

Blanket overhead rate = fixed overheads/normal capacity

= 2 250 000/75 000
= 30 per unit

Variable cost per unit = 1 250 000/50 000 (vc per unit stays the same-based on info given)
= 25 per unit

Hence unit cost for stock valuation = R55 per unit

(b) Stock and profits using variable costing

Assuming that opening stock would also be revalued, figures for the three years would have been:

Sales (50 000) 5 000 000

Variable selling costs (500 000)
Variable production costs (1 250 000)
3 250 000
Fixed admin costs (1 250 000)
Fixed production costs (2 250 000)
(250 000)
This is because profit under a variable costing system is a function of sales only. Therefore, the profit
will be unchanged for all 3 years. Only the stock values will change. Stock will be valued at the
variable manufacturing cost per unit.

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2024 2025 2026

R’000 R’000 R’000
(i) Variable costing
Closing stock 125 750 1 375
Profit before remuneration (250) (250) (250)
Remuneration - - -
Net profit / (loss) (250) (250) (250)

(ii) Absorption costing

Closing stock 350 1 650 3 025
Profit before remuneration (250) 425 500
Remuneration - (42,5) (50)
Net profit / (loss) (250) 382,5 450

(c) Performance Assessment; Implications of Using Absorption Costing

(i) At first sight, the new factory manager has produced a remarkable turnaround in the
fortunes of Boogy Ltd. He has turned a R250 000 loss into a R382 500 then R450 000
profit even after taking a sizable remuneration.

In fact, the figures are deceptive. Costs in 2025 and 2026 have run at the same level as
2024, sales and revenue are identical. The apparent improvement comes from the policy
of “stocking up” over the two years. Since production far exceeded sales, a sizable
proportion of the fixed costs that Boogy incurred was not written against profit but rather
carried forward in stocks.

If there is no likelihood of this excess production being sold such a move could be regarded
as “window dressing”, manipulating profits. This effect of manipulating profit by stocking up
at year ends will not be seen if a variable (marginal) costing system is adopted. In (b), since
sales in all three years are the same, the reported loss is the same.

(ii) Those additional implications not dealt with in (I) can be discussed under various headings:

Effect on stock valuation – If absorption costing is used, a stock valuation is produced which
is appropriate for published accounts. If marginal costing is used, stock would need to be
revalued for external reporting purposes.

Effect on profit – Using absorption costing, as here, profit depends on not just the level of
sales but also on the level of production. This problem does not occur if marginal costing
is used.

Costing techniques – The use of absorption costing requires that a fixed overhead cost per
unit needs to be calculated for stock valuation and other purposes. This may require
relatively complex calculation in multi-product, multi-centre firms with reciprocal service
arrangements, such calculations are unnecessary if marginal costing is used, although in
such circumstances the split of semi-variable costs into their fixed and variable elements is
critical.

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(d) Revised Assessment in View of Increased Sales

In (c) it was suggested that the new factory manager might have been trying to manipulate
profits by producing surplus stocks and therefore capitalising fixed production costs.
Considering the increased sales in 2027 (and the firm’s limited production capacity) it
becomes apparent that this represents shrewd planning for which he should be
congratulated.

Assuming production in 2027 was also 75 000 jackets (and not 70 000) leaving Boogy with
closing stock of 5 000 units, there are various possible stock valuations.

The first method would be that which was used in previous years. This would produce a
profit for 2027 of:

Sales revenue (125 x 100) 12 500

Less: Opening stock 3 025
Production costs 4 125
7 150
Closing stock (275)
Cost of sales (6 875)
Gross profit 5 625
Less: Fixed administration costs 1 250
Variable selling costs 1 250
2 500
Profit before remuneration 3 125
Factory manager’s remuneration (312,5)
Net profit R2 812,5

Alternative methods would include valuing stock throughout the period at the same unit
cost as in 2024 or perhaps revaluing 2025’s opening stock to put it on the same basis as
that used for 2025 and the two subsequent year’s closing stock.

Since, over his three-year tenure, the factory manager maintained a level of production of
75 000 units this should be regarded as the “normal level of activity” for absorbing fixed
overheads. Thought could be given to revaluing the 2025 opening stock to R275 000 to
produce equal profits in the comparable years 2025 and 2026 and providing an
appropriate comparison between these two years and 2027 where sales levels would be
2,5 times the earlier years.

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QUESTION 8 (40 MARKS)

Bolton Ltd manufactures two products and uses a standard absorption costing system for recording
purposes.

The two products are known as Pentel and Zen and have the following unit cost structure.

Pentel Zen

R R
Direct material 4 6
Direct labour 2 4
Variable overhead 2 4
Fixed overhead 12 8
R20 R22

Average monthly production 8 000 units 15 000 units

The fixed overhead is absorbed into production using the average monthly production as the
allocation basis and any volume variance is written off to the income and expenditure account in the
month in which it occurs.

At the half yearly board meeting the draft income and expenditure statement for the period ending
31 December 2024 was presented for consideration. The statement showed a budgeted profit of
R304 000 for Pentel and R410 000 for Zen.

The statement shown below in detail was received with much amazement, as it seemed to show that
Zen contributes more profit than Pentel. The board had always believed Pentel was the more
profitable product and could not believe the change in fortunes over the
6 months.

The sales director points out that the proposed sales plan for the second half of the year is
identical to that of the first half which showed a budgeted profit of R400 000 for Pentel and R314
000 for Zen. Actual results for the first half of the year to date are also in line with the accepted
budget for the period ending 30 June 2024.

The production director emphasizes that identical assumption as to unit variable costs selling prices
and manufacturing efficiency underlie both budgets but there has been a change in the budgeted
production pattern.

Budgeted production Pentel Zen

1st half year to 30/6/2024 48 000 units 78 000 units

2nd half year to 31/12/2024 40 000 units 90 000 units

The production director urges that the company’s budgeting procedures be overhauled as he can
see no reason why the net profit for Pentel should fall from R8,33 to R6,33 per unit sold, whereas
for Zen it should rise from R3,69 to R4,82 per unit.

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Module A – 2024

Budgeted Income Statement for half year ending 31 December 2024

Pentel Zen

Budgeted sales quantity (units) 48 000 85 000

Budgeted production quantity (units) 40 000 90 000

R R

Budgeted sales revenue 1 440 000 2 380 000

Budgeted production costs:
Direct material 160 000 540 000
Direct labour 80 000 360 000
Variable overhead 80 000 360 000
Fixed overhead 576 000 720 000
896 000 1 980 000
Add:
Budgeted finished goods stock
1 July 2024 (12 000 units) 240 000 (5 000 units) 110 000
1 136 000 2 090 000
Less:
Budgeted finished goods stock
31 December 2024 (4 000 units) 80 000 (10 000 units) 220 000
Budgeted manufacturing cost
of budgeted sales (1 056 000) (1 870 000)

Budgeted manufacturing profit 384 000 510 000

Administration costs (fixed) (80 000) (100 000)
Budgeted profit R304 000 R410 000

REQUIRED:

(a) Reconstruct the company’s budget for the half year ending 30 June 2024 in a manner that
is consistent with the half year budget ending 31/12/2024 as shown above. (15)

(b) Restate the budgets (for both half years) in a manner that will show the company
performance more accurately. (15)

(c) Comment on the queries raised by the sales director and the production director and on the
varying profit figures disclosed by the alternative budgets. (10)

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QUESTION 8 (SUGGESTED SOLUTION)

The under/over recovery of fixed overheads is not shown separately in the profit statement in the
question but is included within the total overhead charge. To be consistent this approach is adopted
in the answer to part (a).

To construct the income statement for the half year commencing January it is necessary to determine
the budgeted opening stocks. The calculation is as follows:

Pentel Zen

Budgeted opening stock ? ?

Budgeted production 48 000 78 000
Budgeted closing stock (12 000) (5 000)

Budgeted units available for sale 48 000 85 000

Opening stock (difference) 12 000 12 000

Budgeted Income Statement for half year ending 30 June 2024

Pentel Zen

Budgeted sales quantity 48 000 units 85 000 units

Budgeted production quantity 48 000 units 78 000 units

Budgeted sales revenue R1 440 000 R2 380 000

R R

Budgeted production costs

Direct material 192 000 468 000
Direct labour 96 000 312 000
Variable overhead 96 000 312 000
Fixed overhead 576 000 720 000
960 000 1 812 000
Add:
Budgeted finished goods
Stock on 1 January 2024 (12 000 units) 240 000 (12 000 units) 264 000
1 200 000 2 076 000
Less:
Budgeted finished goods
Stock on 30 June 2024 (12 000 units) (240 000) (5 000 units) (110 000)
Budgeted manufacturing cost of budgeted sales 960 000 1 966 000
Budgeted manufacturing profit 480 000 414 000
Budgeted administrative
and selling costs (fixed) 80 000 100 000
Budgeted profit 400 000 314 000

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Module A – 2024

(b) Budgeted Income Statements for the two half years under a variable costing basis
1st Half 2nd Half
Pentel Zen Pentel Zen
Budgeted sales quantity 48 000 85 000 48 000 85 000
Units
Budgeted production 48 000 78 000 40 000 90 000
quantity Units
Budgeted sales revenue R1 440 000 R2 380 000 R1 440 000 R2 380 000

Budgeted production R R R R
costs
Direct material 192 000 468 000 160 000 540 000
Direct labour 96 000 312 000 80 000 360 000
Variable overhead 96 000 312 000 80 000 360 000
384 000 1 092 000 320 000 1 260 000
Add:
Budgeted opening 96 000 168 000 96 000 70 000
finished goods stock
480 000 1 260 000 416 000 1 330 000
Less: Budgeted closing (96 000) (70 000) (32 000) (140 000)
finished goods stock
Budgeted manuf cost of 384 000 1 190 000 384 000 1 190 000
budgeted sales (variable)

Budgeted manufacturing 1 056 000 1 190 000 1 056 000 1 190 000
Contribution
Budgeted fixed (576 000) (720 000) (576 000) (720 000)
manufacturing overheads
Selling costs (fixed) (80 000) (100 000) (80 000) (100 000)
Budgeted profit 400 000 370 000 400 000 370 000

(c) The profits in the budgeted income statements have been calculated based on absorption costing.
With a system of absorption costing fixed manufacturing overheads are included in the stock
valuations. The effect of this is that the fixed overheads charged against profits for a period might
not be the same as the fixed overheads incurred during a period. When stock is decreasing, then
fixed overheads charged will be greater than the fixed overheads incurred. This occurs in the second
half for product Zen

With an absorption costing system, profits are a function of sales and production. This can result
in a distortion in the profits calculated thus causing the situation that has occurred in the question.
This situation can be avoided by adopting a variable costing system. From the answer to part (b) we
can see that profits are identical for both periods when a marginal costing system is adopted.

The following differences between absorption and marginal costing statements can arise:

(i) Production = Sales: Absorption and variable costing profit calculations will be identical.
This situation occurs with product Pentel in the first half of the year.

(ii) Production > Sales (second half of year for product Zen). Then profits will be greater with
an absorption costing system.

(iii) Production < Sales:

Then profits will be lower with an absorption costing system. This situation occurs with
product Pentel in the second half of the year.

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Module A – 2024

Question 9 – Slam (50 MARKS)

You have recently joined Slam (Pty) Ltd, a company that manufactures and distributes brake
pads to the automotive industry, as a financial accountant. The managing director and
majority shareholder has asked you to assist him in interpreting the draft financial results for
the year ended 28 February 2003 and to review the budget for the new financial year.

As part of his preparations for the budget for the financial year ended 28 February 2003, the
previous accountant completed a breakeven analysis and concluded that the breakeven
production and sales volumes amounted to 20 500 units. The fact that the company only
sold
20 000 units but is reporting a preliminary profit of R130 000 for the year ended 28 February
2003, has raised a concern about the integrity of the information generated by your
department.

You have been able to establish the following:

1 The draft income statement for the year ended 28 February 2003 is as follows:

R
Sales 2 000 000
Cost of sales 1 700 000
Production costs
Inventory at beginning of year –
Raw materials 500 000
Direct labour costs 600 000
Production overheads 1 025 000
Inventory at end of year: Finished products (425 000)

Gross profit 300 000

Production overheads – over/under-recovery 90 000
Administration costs (80 000)
Selling costs (180 000)
Net income before tax 130 000

2 Sales and production had been budgeted for the 2003 year at 22 000 units. The
budgeted selling price for the 2003 financial year was R100 per unit.

3 There was no opening raw material inventory. At the end of 2003, the company had 3
000 units of raw material on hand.

4 Actual production volumes exceed actual sales.

5 The actual unit costs and selling prices as well as fixed costs were all equal to budgeted
amounts.

6 Production overheads and selling costs comprise both fixed and variable costs. The
budget reflected selling costs of R190 000.

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Module A – 2024

7 Administration costs are fixed.

8 Production overheads are absorbed based on units sold and produced.

Budget for 2004

As a result of the unexpected profit, a review of the 2004 budget was deemed necessary.
Based on a discussion with the managing director and the sales and production managers,
the following key assumptions were agreed upon:

1 Unit sales prices are expected to increase by 8%.

2 Sales volumes are expected to be 22 000 units.

3 Raw materials costs are expected to increase by 20%. All other unit variable costs are
expected to increase by 10%.

4 A key objective in the forthcoming financial year is to achieve a net income before tax of
5% of turnover.

5 All fixed costs are expected to increase by 5%.

6 Production volumes of 21 000 units are forecast.

Special order

As a result of the supply disruptions caused by the recent liquidation of one of its
competitors, Slam (Pty) Ltd has been invited to quote for a special order of 4 000 units,
which is to be supplied during the 2004 financial year. Product specifications vary from the
existing brake pads that are produced and will accordingly require different machine
settings. Therefore, labour and variable production overhead costs are expected to be 50%
higher for the first batch of 1 000 units than for the existing product. Thereafter an 80%
learning curve is expected to reduce unit costs. Material costs are not expected to differ
from the existing product. No variable selling costs will be incurred.

This special order was not considered in the 2004 budget.

Because of current industry conditions, bidding for this order is likely to be highly aggressive.
Slam (Pty) Ltd regards this order as an opportunity to gain a foothold in that market, which
offers great expansion opportunities. As a consequence, the managing director wants to
quote the minimum price that can be charged while still producing profits that conform to the
overall financial objectives of the company.

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Module A – 2024

REQUIRED:

Note: Ignore the special order in answering questions (a) to (d)

(a) Re-perform the calculation of the breakeven sales volume based on the
2003 budget assumptions. (11)

(b) Discuss the apparent contradiction between the budgeted breakeven

sales and production volumes and the preliminary profit achieved in the
2003 financial year. (8)

(c) Calculate the budgeted profit before tax for the 2004 financial year using
the costing basis preferred for management accounting. (8)

(d) Advise the managing director on possible steps that could be taken to
enable the company to achieve its targeted profit before tax of 5% of
turnover. Support your advice with calculations on how the target profit
could be achieved. (10)

(e) Calculate the labour costs relevant for the special order (3)

(f) Discuss the treatment of abnormal gains in a process costing system

and substantiate your answer with reference to relevant accounting (10)
standards.

(QE 2003 – adapted)

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Module A – 2024

WORKING EXAMPLE (SUGGESTED SOLLUTION)

Part (a)
Actual units of production:
Closing stock
425 000/1 700 000 x 20 000 = 5 000 Closing stock
Sales
2 000 000/100 = 20 000
Production
20 000 + 5 000 = 25 000

Calculation of Fixed and Variable costs:

Variable costs Fixed costs
Raw materials
R 500 000/25 000 = R 20/unit 20 (2)
Direct Labour
R 600 000/25 000 = R 24/unit 24 (1)
Production overheads
Over-recovery = R 90 000
Difference between actual units and normal capacity
25 000 – 22 000 = 3 000
Therefore, allocation rate = R 30 per unit (3)
(R 90 000/3 000)
Absorbed overheads
R 30 x 25 000 = R 750 000
R 1 025 000 – R 750 000 = R 275 000 Total variable costs
R 275 000/25 000 = R 11 per unit 11 (2)
Fixed costs
= R 30 x 22 000 = R 660 000 660 000
Administrative costs 80 000
Selling costs
“Use high-low”
Units Total costs
20 000 180 000
22 000 190 000 5 80 000 (2)
______________________
TOTAL COSTS 60 820 000

Break-even sales level based on 2003 budget

Contribution (100-60) 40
Fixed costs 820 000
Break-even volume (820 000/ 40) 20 500 (1P)
Total 11

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Module A – 2024

Part (b)

1. CVP analysis assumes a variable costing system. (2)

2. The income statement showing a profit of R130 000 is drawn up on the
absorption costing basis. (1)
3. Under absorption costing, profit is a function of sales and production
volumes, while under variable costing, profit is a function of sales (1)
volume only.
4. Under the absorption costing system, fixed overheads amounting to (2)
R150 000 were capitalised as part of closing stocks. This led to an
increase in net profit of R150 000. (2)
5. Break-even is the relationship between fixed costs and contribution, and
not fixed costs verses gross profit.

(8)

Part (c) BUDGET 2004

Volume Unit price Rand
Sales 22 000 108,00 2 376 000 (1)
Cost of sales
Opening inventory 5 000 55,00 (275 000) (2P)
Raw materials – opening units 3 000 20,00 (60 000) (P)
Raw materials – new units 18 000 24,00 (432 000) (P)
Direct labour costs 21 000 26,40 (554 400) (P)
Variable production overheads 21 000 12,10 (254 100)
Closing inventory 4 000 62,50 250 000
Variable Selling costs 22 000 5,50 (121 000) (1)
Contribution 929 500
Administration costs (84 000) (1)
Fixed production overhead (693 000)
Fixed selling costs (84 000)
Net income before tax 68 500

FIFO method of accounting for inventory is assumed.

Total (8)

Part (d)

2004 budget profit/turnover 2,88% (1)

Target ratio 5,0%

Or expressed in rand terms R118 (1)
800
Profit shortfall 50 300

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Module A – 2024

1 Selling prices increased with 8% while variable costs also increased. Try
to pass cost increases to clients. (1)
• Fixed overheads will increase with 5%
• Variable costs are the problem, increase from R60 per unit to R68 per
unit (1)
• To make up for the loss selling prices should increase with an
additional R2,29 per unit (50 300 ÷ 22000)
• The price elasticity and market conditions relevant to the product
should be considered.
2 Focus on cost management
• Variable overheads need to be considered. Negotiate with material
suppliers? 20% increase is too much. (1)
• Variable production costs should decrease with R2,29 per unit to (1)
R65,71.
• Consider decreasing admin costs (e.g., outsourcing of less important
services)
3 Try to increase sales volume
• Sell 1258 more units. (1)
• Higher volumes may result in additional marketing costs. (1)
4. Market share (1)
• Competitor left the market; this may create an opportunity to increase
the market share permanently.
• Aggressive marketing may fill the gap.
• The costs that are incurred may decrease profits over the short term
but may hold long term advantages.
5. Industry consolidation (1)
• Industry is very competitive, may be too many players
• Can possibly lead the industry in the consolidation process by buying
out an inefficient competitor.
• Mergers synergy etc. can lead to higher profits over long term.
• Success depends on the availability of resources.

Total (10)

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Module A – 2024

Part (e)

Labour cost

Learning curve

Batch Cum cost /unit

1000 39,63✓
2000 31,68
4000 25,34

 TOTAL COST = 25,34 x 4000✓

= 101 376✓ (3)

Part (f)

Abnormal gains should be recognized as income. (Drury) (1)

The corresponding debit should be applied against stock to increase the value of stock, as
a result of an additional number of units with selling potential. (1)

The increase in stock is justified as it meets the definition of an asset. There are an additional
number of units of stock (that were not expected) that can be sold, resulting in future
economic benefits flowing to the enterprise. (2)

The credit in the journal entry should not reduce the value of stock, as stock would then be
undervalued. Stock should be carried at the lower of cost or NRV (1)

The credit can either be a credit to income or a credit to liability. (1)

There is clearly no liability involved- No present obligation. (1). However, prudence may
require that the income be deferred (provision) to the period in which the items are actually
sold. (1) This will, though, give rise to a double-effect to income in that year- and it is
questionable whether that is really prudent after all. (1) The benefit of this, however, is that
stock will be carried at manufactured cost, rather than at cost + fair value adjustment for
gain. (1)

The credit to income can be justified in that the efficiency arose in the current operating
period, and not in future, and hence the income should be taken upfront. (1)(Max 10)

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Module A – 2024

QUESTION 10 (40 MARKS)

Execuchair (Pty) Ltd manufactures three types of dining room chairs, namely Admirals, Fiddle-backs,
and Feather-backs, for the South African market. Sales have declined during the past 18 months
and management has reduced production levels accordingly. In terms of a management decision
taken 12 months previously, current production levels will be maintained for the foreseeable future,
as they are expected to satisfy forecast demand.

The company's annual financial statements for the year ended 31 December 2023 are being
finalised.

You were appointed as accountant to the company at the end of February 2024. In response to a
query from the financial director you reviewed the following inventory valuation workings prepared
by the previous accountant who had left at the end of January 2024.

Inventory and product statistic for the year (units):

___________________________________________________________________________________
Admirals Fiddle-backs Feather-backs
Material (rand per chair) 100 100 105
Direct labour hours, per chair 2 2,5 2
Packaging (rand per chair) 2 3 1,5
Fixed manufacturing overheads 96 120 96
(Rand per chair)
Sales price (rand per chair) 436 516 445

Fixed manufacturing overheads are allocated on the basis of direct labour hours. Normal capacity
is set at 360 000 direct labour hours per annum.

Direct labour costs amount to R10 per hour.

Fixed administration overheads amount to R2 million per annum.

Inventory and production statistics for the year (units):

Admirals Fiddle-backs Feather-backs

Opening inventory 15 500 21 000 18 500

Production 29 500 59 000 29 500
Closing inventory 9 000 16 000 12 000

Sales were evenly spread throughout the year and inventory is valued using the FIFO method. Sales
prices are based on a set mark-up on total production costs.

The fixed manufacturing overhead allocation basis used in the above working paper is consistent
with that used for the inventory valuation for the 2022 financial year.

The following additional information, which was not considered in the valuation of inventory, may be
relevant:

1. The company replaced the existing production machine at the beginning of October
2023. The new production machine reduced total labour time by approximately 30%
Management had noticed the resulting increase in idle time, but it was assumed that
it was due to reduced production levels.

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Module A – 2024

2. Direct labour hours per chair using the new machine were as follows:
Admirals Fiddle-backs Feather-backs
1 1,5 2

3. More than 80% of fixed manufacturing overheads are machine related. Machine
hours per chair using the new machine were as follows:
Admirals Fiddle-backs Feather-backs
1,5 2 2

4. The new machine gave rise to a 20% increase in fixed manufacturing overheads per
annum.

5. Actual production volumes per month on the new machine were 35% higher than on
the old machine.

The financial director has asked you to prepare relevant information in order to discuss the valuation
of inventory at a meeting with the auditors.

REQUIRED:

(a) prepare a memorandum for the meeting, addressing the following issues:

(i) The factors to be considered when determining an appropriate rate

at which overheads should be absorbed; 5

(ii) The appropriate allocation basis and rate of fixed manufacturing over-
heads absorption for Execuchair (Pty) Ltd: 10

(ii) The correct value at which closing stock should be carried in the yearly
Financial statements of December 2023. 10

(iv) The appropriate accounting treatment for any over- or under-absorbed

overheads; 5

10
(b) Discuss how profitability can be maintained following the acquisition of the new
machine.

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QUESTION 10 (SUGGESTED SOLUTION)

EXECUCHAIR (PTY)LTD
MEMORANDUM

To: Sir Financial Director

From: Your Humble Accountant (1P)

Part A

Valuation of inventory. – Year ended December 2023

(i) Factors to be considered when determining an appropriate rate at

which overheads should be absorbed.

Budgeted overhead is simply the organisation’s best estimate of the amount of overhead to be
incurred in the coming year. The second input requires that the value for the activity level be
specified. This second input has two steps: first identify a measure of production activity; second,
predict the level of this
activity. (2)

Production activity can be measured in many different ways. In assigning overhead costs, it is
Important to select an activity base that is correlated with overhead consumption. This will assure
that individual products receive an accurate allocation of overhead costs. While there are many
choices available, five common measures are: (1)

1. Units produced
2. Direct labour hours
3. Direct labour rands
4. Machine hours
5. Direct materials (1)

The most obvious measure of production activity is output. If there is only one product, overhead
costs are clearly incurred to produce that product. In a single product setting, the overhead costs of
the period are traceable directly to the period’s output. Although any reasonable level of activity
could be chosen, the two leading candidates are expected actual activity and normal activity.
Expected activity level is the production level the company expects to attain for the coming year.
Norm activity level is the average activity that a company experiences in the long term (normal
volume is computed over more than one year). Of the two choices, normal activity has the advantage
of using the same activity level year after year. As a result, it produces less fluctuation from year to
year in the assignment of per-unit overhead cost.
(2)

Other activity levels used for computing predetermined overhead rates are those corresponding to
the theoretical and practical levels. Theoretical activity level is the absolute maximum production
activity of a manufacturing firm. It is output than can be realized if everything operates perfectly.
Practical activity level is the maximum output that can be realized if everything operates efficiently.
Efficient operation allows for some imperfections, such as normal breakdowns, some shortages,
workers operating at less than peak capability, and so on. Normal and expected actual activities
tend to reflect consumer demand while theoretical and practical activities reflect a firm’s production
capabilities. (2)
ii) Appropriate allocation basis and rate for fixed manufacturing over- heads

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For the old machine labour hours have been an appropriate allocation basis that has been
consistently applied. (1)

Given changes in planned production volumes that are applicable for the foreseeable future, the
normal capacity used in the allocation of overheads and the valuation of inventory needs to be
reduced to recognize the reduction in capacity. (1)

The appropriate capacity for inventory produced by the old machine is therefore 265 500 hours
compared to 360 000 hours currently used; given rise to an allocation rate of R65 per direct labour
hour compared to the current R48. For the new machine the appropriate allocation basis is machine
hours given:
- that direct labour component has reduced relative to the old machine.
- 80% of overheads are machine related.
- it is assumed that allocating the remaining 20% of overheads, based on machine hours, will
not give
- rise to materially incorrect valuations.
Based on the planned production volume the machine hour capacity amounts to 221 250 hours
giving rise to an allocation rate per machine hour of R93,7.

Workings:
Old Machine:

Labour hours were used as allocation basis the previous year and it is therefore assumed that this
basis was accepted by the auditors as reasonable. In terms of IAS 2 “normal capacity” should be set
at average actual production volumes over a number of periods. Given the decision to maintain
current production levels for the foreseeable future. It is assumed that current production levels
represent
“Normal capacity”. (1)

Admiral Fiddle Feather Total

Units produced 29 500 59 000 29 500

Labour hours per
unit 2 2,5 2
Allocation basis
(capacity) 59 000 147 500 59 000 265 500 (2)

Current allocation rate R48 per hour (96/2) (1)

Total costs R17 280 000 (48 x 360 000 hours) (1)
Revised allocation rate (R17 280 000/265500) R65.08 (1P)

New Machine:

Given the reduced labour hours required to produce the chairs with the new machine and the direct
relationship between fixed manufacturing overheads and machine hours (80% of overheads are
machine related) the appropriate allocation basis should be machine hours. The question is silent
on the remaining 20% of the costs and it is therefore assumed that these costs are also allocated
based on machine hours. (2)

Admiral Fiddle Feather Total

Production volume
(output) (pa) 29 500 59 000 29 500
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Machine Hours 1,50 2 2

Allocation basis 44 250 118 000 59 000 221 250 (2)

Total Overheads 17 280 000

-per above 3 456 000 (1P)
-20% increase 20 736 000

Allocation rate (R20 736 000/221 250 hours) 93,7 (1P)

Inventory valuation

(iii) Calculation of amount of inventory produced by the two machines (Inventory is valued on FIFO
basis).

Admiral Fiddle Feather Total

Monthly production
vol.: old machine x (9mths)
Monthly production
vol.: new machine 1.35x (3mths)
(1)

Total vol. (9x+3*1,35x

= 13,05) 29 500 59 000 29 500 (1)
Total new machine
production [(29 500/
13,05) x4,05] 9 155 18 310 9 155 (2)
Closing inventory 9 000 16 000 12 000

Old Machine 0 0 2 845

New Machine 9 000 16 000 9 155 (2P)

Old machine (unit costs)

Material 105.0 (1)
Labour 20.0 (1)
Packaging 1.5 (1)
Fixed overheads (2xR65) 130.0 (1P)
256.5
Inventory val. (2 845 units@ R256,50) 729 743 (1P)

New machine (unit costs)

Material 100.0 100.0 105.0 (1)
Labour 10.0 15.0 20.0 (1)
Packaging 2.0 3.0 1.5 (1)
Fixed overheads
(Machine hours @ 2XR93.7) 141.0 187.0 187.4 (1P)
253.0 305.0 313.9
Inventory value 2 277 000 4 880 000 2 873 754.5 10 030 754.5 (1P)
10 760 497.5
Valuation of closing inventory

Closing inventory has been revalued using the revised allocation basis and rates set out below:

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Current value Revised value Difference

Inventory produced by old

machine
- Feather-back 633 013 729 743 96 730

Inventory produced by new

machine
-Admiral 1 962 000 2 277 000 315 000
-Fiddle-back 4 128 000 4 880 000 752 000
-Feather-back 2 036 988 2 873 754.5 (836 766.5)
8 760 001 10 030 754.5 230 233.5

Current value before

adjustments

Material 100.0 110.0 105.0

Labour 20.0 25.0 20.0
Packaging 2.0 3.0 1.5
Fixed overheads 96.0 120 96.0
Inventory value 1 962 000 4 128 000 2 670 000 8 760 000 (2)
2 086 591

(iv) Under/over-absorbed overheads

Admiral Fiddle Feather Total

Overheads absorbed currently 2 832 000 7 080 000 2 832 000 12 744 000 (1)

Costs incurred R
-old machine (above) 17 280 000 (1)
-20% increase (3 months) for new machine 864 000 (2)
18 144 000
Under-absorbed
(R18 144 000 – R12 744 000) 5 400 000 (1P)
Absorption of manufacturing overheads

Total manufacturing overheads Incurred for the year amount to 18 144 000
Total manufacturing overheads absorbed using current allocation method (12 744 000)
Overheads not absorbed 5 400 000
In terms of IAS 2, manufacturing overheads not absorbed must be written off against income
provided that the allocation basis used is appropriate and that the allocation rate has been
determined using normal capacity. (1)

As set out above, inventory has been undervalued given that the allocation basis as well as the
capacity used in the valuation of closing inventory is inappropriate. (1)

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Accounting treatment recommended:

Increase closing inventory 230 233.5

Total under-absorbed overheads 5 400 000

Additional overheads absorbed in closing inventory, (230 233.5)
Income statement write off 5 169 766.5 (1)

In the above adjustments it is assumed that there is no work-in-progress.

Part B

Fixed overheads have increased with the acquisition of the new machine. Variable costs have
decreased leading to an increased contribution. However, the increase in contribution was less than
the increase in fixed overheads.

Admiral Fiddle Feather Total

Sales Price 436 516 445
Total variable costs
(New machine) 112 (1) 118 (1) 127 (1)
Contribution 324 398 318
(New machine)
Sales (units) 36 000 64 000 36 000

Total Contribution
(Old machine) 11 304 000 (1)24 832 000 (1)11 448 000 (1)47 584 000
Total contribution
(New machine) 11 664 000 25 472 000 11 448 000 48 584 000
Increased contribution 1 000 000

New Machine Old Machine

Contribution 48 584 000 47 584 000

Overheads 20 736 000 17 280 000
Net costs before admin. Costs 27 848 000 (1P) 30 304 000 (1P)
Break-even point and hence operating leverage and risk has increased.
(1)

The following options are available:

• Increase selling price to increase contribution: however, the market in depressed having
given rise to a curtailment of capacity
(1)
• Increased prices are thus likely to give rise to even lower demand. (1)

The Admiral and Fiddle-back chairs have increased contributions relative to the old machine.
Consideration should be given to changing the sales mix to push those chairs with a higher
contribution.(1)

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The issues to be considered are:

Selective price increases on individual types of chairs may be possible depending on market
situations. The company only produces for the local market. Exports may be able to enhance
profitability given that the contribution on additional export sales does not give rise to additional
overheads provided the relevant range for the fixed costs does not change. (2)

The new machine has resulted in additional capacity. Any additional contribution earned ads to the
bottom line. (1)

66