STRICTLY CONFIDENTIAL

THE INSTITUTE OF CHARTERED ACCOUNTANTS

IN MALAWI

2017 EXAMINATIONS

ACCOUNTING TECHNICIAN PROGRAMME

PAPER TC9: COSTING AND BUDGETARY CONTROL

(DECEMBER 2017)

TIME ALLOWED : 3 HOURS

SUGGESTED SOLUTIONS
1. (a) Advantages of marginal costing as a decision making tool are:

(i) Marginal costing is simple to understand. As such, decisions made based

on marginal costing can be easily explained to and understood by
everybody.

(ii) By not charging fixed overhead to cost of production, the effect of varying
charges per unit is avoided.

(iii) It prevents the illogical carry forward in inventory valuation of some

proportion of current year’s fixed overhead.

(iv) The effects of alternative sales or production policies can be more readily
available and assessed, and decisions taken would yield the maximum
return to business.

(v) It eliminates large balances left in overhead control accounts which

indicate the difficulty of ascertaining an accurate overhead recovery rate.

(vi) Practical cost control is greatly facilitated. By avoiding arbitrary

allocation of fixed overhead, efforts can be concentrated on maintaining a
uniform and consistent marginal cost. It is useful at various levels of
management.

(vii) It helps in short-term profit planning by breakeven and profitability

analysis, both in terms of quantity and graphs. Comparative profitability
and performance between two or more products and divisions can easily
be assessed and brought to the notice of management for decision making.

(b) (i) The limiting factor is Process B labour as it is in short supply.

(ii) Direct labour hours per unit per product

Product X Product Y Product Z
Hours Hours Hours
Process A (K90/hr) 4 3.33 5
Process B (K100/hr) 1.5 1.8 3
Process C (K90/hr) 2 1 4

Total process B hours = (100,000 x 1.5) + (50,000 x 1.8) + (60,000 x 3)

= 150,000 + 90,000 + 180,000
= 420,000 hours

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 Contribution per unit:
Product X Product Y Product Z
Production (units) 100,000 50,000 60,000
K’000 K’000 K’000
Sales 150,000 95,000 156,000
Less variable costs:
Direct materials 15,000 22,500 18,000
Direct labour – process A 36,000 15,000 27,000
Direct labour – process B 15,000 9,000 18,000
Direct labour – process C 18,000 4,500 21,600
Variable overheads 30,000 10,000 30,000
Total variable costs 114,000 61,000 114,600
Contribution 36,000 36,000 41,400

Contribution per hour for Process B labour (limiting factor)

= K36,000,000 K34,000,000 K41,400,000

150,000 hrs 90,000 hrs 180,000 hrs

= K240 K377.78 K230

Ranking 2 1 3

Production mix:

Product Units Hours

Y 70,000 126,000
X 120,000 180,000
Z 38,000 114,000
420,000

(b) (i) Whether the new production quantities will be sold (availability of the
market).

(ii) Whether the shortfall in production of Z (60,000 – 38,000 = 22,000) will

not cause problems with under-utilization of labour and machines
previously used in making product Z.

(iii) If customers buy combinations of the products, will the reduction in the
availability of Product Z cause reductions in the sales of X and Y?

(iv) Whether the shortfall in production of Z will not lead to redundancies of

labour, hence additional costs.

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2. (a)(i) (1) Reorder level is the quantity of stock at which an order will be placed for
additional supplies of stocks material so that delivery will be made before
the business runs out of stock.

(2) Reorder quantity is the optimum quantity that should be ordered each time
an order is being placed.

(3) Minimum level is the level of inventory below which inventory should not
be allowed to fall. In case of any item falling below this level, there is
danger of disrupting production.

(4) Maximum level is the quantity of material above which the inventory of
any item should not normally be allowed to go.

(ii) Problems associated with stock outs include the following:

(1) Lost contribution due to lost sales arising from stock out.
(2) Loss of future sales because customers will go elsewhere.
(3) Loss of customer goodwill
(4) Cost of production stoppages e.g. idle time pay, not using plant optimally.

(b)(i) (1) Variable costs = Sales x (100 – 35%)

= K900,000 x 65%
= K585,000
(2) Contribution = Sales x contribution/sales ratio
= K900,000 x 35%
= K315,000
(3) Break-even point (in sales revenue) = Sales – margin of safety
= K900,000 – 525,000
= K375,000
(4) Fixed costs = Breakeven x contribution/sales ratio
= K375,000 x 35%
= K131,250
(5) Profit = Contribution – Fixed costs
= K315,000 – K131,250
= K183,750

(ii) (1) Margin of safety (in sales revenue) = Profit/contribution ratio

= K360,000/50%
= K720,000

(2) Sales = margin of safety + breakeven

= 720,000 + K480,000
= K1,200,000

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 (3) Variable costs = Sales x (100 – 50%)
= K1,200,000 x 50%
= K600,000

(4) Contribution = Sales x contributions/sales ratio

= K1,200,000 x 50%
= K600,000

(5) Fixed costs = Contribution – profit

= K600,000 – K360,000
= K240,000

3. (a) (i) The separation of costs into fixed and variable is difficult and sometimes
gives misleading results.

(ii) Normal costing systems also apply overhead under normal operating
volume and this shows that no advantage is gained by marginal costing.

(iii) Under marginal costing, inventory and work in progress are understated.
The exclusion of fixed costs from inventories affect profit and true and
fair view of financial affairs or an organization may not be clearly shown.

(iv) Volume variance in standard costing also discloses the effect of

fluctuating output on fixed overhead. Marginal cost data becomes
unrealistic in case of highly fluctuating levels of production, e.g. in case of
seasonal factories.

(v) Application of fixed overhead depends on estimates and not on the actuals
and as such there may be under or over absorption of the same.

(vi) In practice, sales price, fixed cost and variable cost per unit may vary.
Thus, the assumptions underlying the theory of marginal costing
sometimes becomes unrealistic.

(b) (i) Normal loss is the loss of input whose occurrence is inevitable and occurs
on account of normal reasons. It is expected in the course of production.

(ii) Abnormal loss is the loss in excess of the normal loss.

(iii) Abnormal gain is the difference between actual loss and normal loss, i.e.
when the normal loss is higher than the actual loss.

(iv) Equivalent units refers to notional units representing completed units

based on a conversion of part-completed units into an equivalent number
of wholly-completed units.

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 (c) The value of abnormal gain represents a cost saving which has an effect of
improving the profit. Abnormal gain is therefore valued at the normal cost of
expected output. Abnormal gain is debited to the process account and credited
into a separate abnormal gain account.

(d)(i) Statement of equivalent units

% % Conversion
Kgs Completion Material Completion Cost
Completed units 14,400 100% 14,400 100% 14,400
Normal loss 1,440 100% 1,440 100% 1,440
Abnormal loss 1,160 100% 1,160 100% 1,160
Closing WIP 3,000 100% 3,000 66.67% 2,000
20,000 20,000 19,000

(ii) Equivalent cost per unit

Costs:
Opening 30,000 29,200
Cost in process 120,000 160,800
150,000 160,800
Equivalent units 20,000 19,000
Cost per unit 7.50 10.00
Total cost per unit = K7.5 + K10 = K17.5

(iii) Process A Account

Kgs K Kgs K
Opening WIP 4,000 59,200 ½ Transfer to process B 14,400 277,200
Material 16,000 120,000 ½ Abnormal loss 1,160 20,300
Conversion cost - 160,800 ½ Normal loss 1,440 -
___ ______ WIP 3,000 42,500
20,000 340,000 20,000 340,000

Workings

WIP: Material = 3,000 x K7.50 = K22,500

Conversion cost = 2,000 x K10 = K20,000
K42,500

Abnormal loss = 1,160 x K17.5 = K20,300

Transfer to process B = balancing figure = K340,000 – K20,300 – K42,500

= K277,200

4. (a) (i) Variances should be investigated so as to know and understand the causes
and take corrective action.

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 (ii) Factors to consider include the following:

 The materiality/significance of the variance. Only variances

considered material and therefore significant enough should be
investigated.

 Variances that have a known history of frequent recurrence may not be

investigated but those that are unusual should be investigated.

 The cost benefit implications of investigation of the variances should

be considered.

(b) (i) Advantages of individual incentive scheme

 Individual employees are motivated to be more efficient and

productive since

 It may generate competitive spirit among employees which may be

good for the organization.

 Employee morale is raised since individual effort is rewarded.

(ii) Disadvantages of individual incentive scheme

 Employees may compromise on quality in an effort to increase their

bonus earnings.

 Excessive competition can bring about unhealthy rivalry which may

bring about conflicts between and among employees.

 The determination of standard performance levels for the purpose of

determining efficiency levels can conflict in the organization or may
be difficult to set.

 It is relatively more difficult and expensive to operate an individual

incentive scheme compared to a group incentive scheme.

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 (c) (i) Employee X Employee Y

Time allowed = 20 x 189 15 x 204

60 60

= 63 hours 51 hours
Time taken 45 hours 39 hours
Time saved 18 hours 12 hours
Bonus (½ x time saved x day rate) ½ x 18 x 200 ½ x 12 x 200
= K1,800 K1,200

(ii) Basic wages 42 hours x K200 8,400 8,400

Overtime (3 hours x 1.5 x 200) 900
Bonus 1,800 1,200
11,100 9,600

(iii) Gross wage 11,100 9,600

Less non-productive pay -__ 3 x 200 (600)
11,100 9,000

Good units made (189-6) 183 (204-4) 200

Wages cost per good unit 11,100 9,000

183 200
K60.66 K48

5. (a) (i) Characteristics of information for decision-making:

 Relevance – appropriate to the manager’s sphere of activity and to the

decision in hand.

 Timeliness – produced and available to the manager in time for him/her

to use.

 Accuracy – free from error for it to be relied upon by the manager

making decision.

 Understandable – in a form readily usable by the manager. The avoidance

of unexplained technical terms, the use of summaries, the use of graphical
and other display methods assist in making the information understandable.

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 (ii) Advantages of absorption costing as a decision-making aid

 Fixed costs are a substantial and increasing proportion of costs in modern

industry.
Production cannot be achieved without incurring fixed costs which thus
form an inescapable part of the cost of production. As such, they should
be included in stock valuations.

 Where production is constant but sales fluctuate, net profit fluctuations

are less with absorption costing than with marginal costing.

 Where stock building is a necessary part of operations, the inclusion of

fixed costs in stock valuation is necessary and desirable; otherwise a
series of fictitious losses will be shown in earlier periods to be offset
eventually by excessive profits when the goods are sold.

 The inclusion of fixed costs in production costs enables proper and correct
pricing decisions to be made – price which recovers all costs.

 Accounting standard on stock valuation recommends the use of absorption

costing for financial accounts because costs and revenues must be matched
in the period when the revenue arises not when the costs are incurred. It
also recommends that stock valuations must include production overhead
incurred in the normal course of business even if such overheads are fixed.

(b) Criticisms of budgeting include the following:

(i) It encourages rigid planning and incremental thinking.
(ii) It is time consuming.
(iii) Produces inadequate variance reports leaving the ‘how’ and ‘why’ questions
unanswered.
(iv) Ignores the key drivers of shareholder value by focusing too much attention
on short term financial numbers.
(v) Ties the company to a 12 month commitment, which is risky since it is based
on uncertain forecasts.
(vi) Meeting only the lowest targets and not attempting to beat them.
(vii) Spending what is in the budget, even if this is not necessary, in order to guard
against next year’s budget being reduced.
(viii) Achieving the budgets even if this results in undesirable actions.

(c) (i) Types of standards

 Basic standards – These are long term standards remaining unchanged

over several years. They are standards established for use over a long
period from which a current standard can be developed.

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  Ideal standards – These are standards which can only be attained under
the most favourable working conditions. Ideal standards are based on
optimal operating conditions such as: no break downs of machinery,
no wastage of materials, no stoppages, no idle time, no spoilage, no
shrinkage of materials etc.

 Attainable standards – these are standards which can be attained if a

standard unit of work is carried out efficiently, a machine properly
operated or material properly used. Allowances are made for normal
losses and machine breakdowns. It represents future performance and
objectives which are reasonably attainable.

 Current standards – These are standards set for use over a short period
to reflect current changed conditions. Where conditions are stable
then current standards will be the same as attainable standards. But
where a temporary problem exist then a current standard could be set
to deal with the problem.

(ii) Limitations of standard costing

 Standard costing can only exist realistically within the framework of a

budgetary system.
 Variance analysis merely directs attention to the cause of off-standard
performances. It does not solve the problem nor does it establish the
reasons behind the variance.
 Solutions to the identified problems are management tasks.
 All standards involve forecasting which is subjective with the inherent
possibility of error.
 The process is a bit complex and difficult and is not understood by
most line managers.
 Variance analysis are post mortems on past events and does not correct
that post error or wrong.
 It may be expensive and time consuming to install.
 In volatile conditions with rapidly changing methods, rates and prices,
standards quickly becomes out of date losing their control and
motivational effects.

(iii) The favourable material price variance may be caused by purchase of low
quality materials at an equally low price. The low quality materials may be
difficult to work with leading to a lot of wastages thereby using more
materials than planned – hence adverse material usage variance.

END
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