MANAGEMENT ACCOUNTING

FORMATION 2 EXAMINATION - AUGUST 2014

NOTES:
Section A - Questions 1 and 2 are compulsory. You have to answer Part A or Part B only of Question 2. (If you
provide answers to both Part(s) A and B of Question 2, you must draw a clearly distinguishable line through the
answer not to be marked. Otherwise, only the first answer to hand for this question will be marked).
Section B - You are required to answer any three out of Questions 3 to 6. (If you provide answers to all of
Questions 3 to 6, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise,
only the first three answers to hand for these four questions will be marked).

TIME ALLOWED:
3 hours, plus 10 minutes to read the paper.

INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence
writing in your answer book. Please read each Question carefully.

Marks for each question are shown. The pass mark required is 50% in total over the whole paper.

Start your answer to each question on a new page.

You are reminded to pay particular attention to your communication skills and care must be taken
regarding the format and literacy of your solutions. The marking system will take into account the content
of your answers and the extent to which answers are supported with relevant legislation, case law or
examples where appropriate.

List on the cover of each answer booklet, in the space provided, the number of each question
attempted.

NB: PLEASE ENSURE TO ENCLOSE YOUR ANSWER SHEET TO QUESTION 3 IN THE ENVELOPE
PROVIDED.

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - AUGUST 2014

Time allowed: 3 hours, plus 10 minutes to read the paper.

Section A: Answer Question 1 and either Part A or Part B of Question 2.
Section B: You are required to answer any three out of Questions 3 to 6.

SECTION A - QUESTIONS 1 AND 2 ARE COMPULSORY

1. Ludo Limited manufactures a specialised storage accessory for automobiles called ‘the Storax’, which is a type of
pocket which can be easily fixed in the boot of any vehicle. The company has been in operation for two years and,
now that the production process has been established and refined, the directors have decided to focus on the
income and costs arising from activities. The managing director has recently read an article about product costing
and, in particular, absorption and variable costing and is keen to understand how this would affect company profits.
The following information is available for the months of July and August:

July August
Production (units) 13,000 15,000
Sales (units) 12,000 16,000
Direct materials €29,250 €33,750
Direct labour €19,500 €22,500
Variable production overheads €7,800 €9,000
Total selling and administrative expenses €45,200 €57,600

Additional information:
1. For Ludo Limited normal production capacity is 15,000 units per month.
2. Fixed production overheads are €29,400 per month.
3. The company sells ‘the Storax’ for €20 each.
4. Total selling and administrative expenses includes a fixed and variable element. The variable portion is
incurred based on units sold.
5. At 30 June the company had no ‘Storax’ accessories in its warehouse.

REQUIREMENT:
(a) Prepare profit statements for Ludo Limited for the months of July and August using:

(i) Absorption costing

(ii) Variable costing (20 marks)

(b) Reconcile the profit calculated using Absorption costing to that calculated using Variable costing. (3 marks)

(c) Provide a brief explanation of the effect on profit of using each of the methods at (a) above. (2 marks)

[Total: 25 Marks]

Page 1
 ANSWER PART (A) OR PART (B)
2.
(A) Last year, James Moody established a gourmet food business and to date has achieved good sales and a small
profit. While attending a recent business networking event, James was advised to consider employing a
management accountant to enhance and improve his business. James has asked you for advice. He would like to
understand why management accounting has become so important to achieving business success and how it
differs from financial accounting. James is also keen to know how employing a management accountant could
improve his business.

REQUIREMENT:
Prepare a briefing note for James Moody which:

(i) Outlines the changes in the business enviroment that have contributed to the growth and importance of
management accounting. (4 marks)

(ii) Differentiates between financial accounting and management accounting. (4 marks)

(iii) Describes how the employment of a management accountant could enhance and improve a business. (7 marks)

[Total: 15 Marks]

OR
(B) The managing director of Brandon Limited has asked you to prepare a report suitable for senior management, to
assist in its understanding of management accounting. He has suggested that senior management need clarification
on the topic of cost terms and their importance and application in management accounting.

REQUIREMENT:
Draft a report for the managing director which:

(i) Explains the following commonly used cost terms in management accounting:

● cost object
● direct and indirect costs
● variable and fixed costs
● product and period costs.

Illustrate your answer with examples. (10 marks)

(ii) Briefly outline areas (tools/techniques) in management accounting where these cost terms are used. (4 marks)

Format and Presentation (1 mark)

[Total: 15 Marks]

Page 2
 SECTION B - ANSWER ANY THREE QUESTIONS.
3. Attempt each of these multiple-choice questions. Only one of the offered solutions is correct. Each question
carries equal marks. Record your answers to each section on the answer sheet provided.

(i) Prime Cost is calculated as:

(a) Direct materials plus direct labour.

(b) Direct materials plus direct labour plus direct expenses.
(c) Direct labour plus direct expenses.
(d) Direct materials plus direct labour plus factory overheads.

(ii) Stripe Limited uses a traditional absorption costing system to allocate production overheads to products. The
following information was used to record production in the month of August:

Machining department
€
Total budgeted factory overheads 238,700
Total labour hours 23,870
Total machine hours 31,000

The management accountant has stated that for the machining department the actual factory overhead cost for
August totalled €255,400 and that actual labour hours worked were 24,000 and actual machine hours were 29,000.
For this department in the month of August factory overhead was:

(a) Under absorbed by €32,100.

(b) Over absorbed by €32,100.
(c) Under absorbed by €16,700.
(d) Over absorbed by €15,400.

(iii) ABC Limited manufactures one product which requires 2 kgs of material for each unit produced. The following
details relating to variance calculations for the month of June were also available:

€
Materials price variance (Favourable) 1,136
Materials usage variance (Adverse) 1,180
Materials purchased and used (56,800 kgs) 132,912

The number of units produced during the month of June was:

(a) 56,300
(b) 28,150
(c) 132,868
(d) 57,308

(iv) Which of the following is NOT an advantage of a Just in Time (JIT) inventory management system:

(a) With JIT waste is eliminated at all stages of the manufacturing process.
(b) JIT builds a strong relationship between buyer and supplier.
(c) A JIT inventory management system guarantees that no inventory is held.
(d) JIT ensures a smooth flow of material and work through the production system.

Page 3
(v) When using the Last In First Out (LIFO) method to value inventory which of the following statements is TRUE?

(a) During inflationary periods, cost of sales calculated using LIFO is lower than FIFO or Average (Weighted
Average) cost methods.
(b) LIFO reflects the physical flow of materials through an organisation.
(c) LIFO is accepted by accounting standards as suitable for valuing inventory.
(d) During inflationary periods closing inventory calculated using LIFO is valued at the lowest prices.

(vi) Fixit Limited had the following information in its accounts for the year:

March September December

Production volume in units 5,000 15,000 12,000
Maintenance expenses €39,000 €91,500 €75,750

The fixed portion of the monthly maintenance expense is:

(a) €36,750
(b) €52,500
(c) €15,750
(d) €12,750

The following information is relevant to parts (vii) and (viii):

Brady Limited currently has spare production capacity and is considering a short term contract which requires the following
materials:

Material Quantity in inventory Original cost Current purchase Scrap value

price
Alpha 1,000 kgs €12.50 per kg €16.00 per kg €2.00 per kg
Beta 500 kgs €8.00 per kg €9.25 per kg Nil

Material Alpha is in constant use by the company to manufacture its existing products. Material Beta is obsolete and if not
used on the contract it will be scrapped.

(vii) The contract requires using 800 kgs of material Alpha. The total relevant cost of this material is:

(a) €10,000
(b) €1,600
(c) €12,800
(d) None of the above.

(viii) The contract also requires 1,000 kgs of material Beta. The total relevant cost of this material is:

(a) €9,250
(b) €4,000
(c) €4,625
(d) €8,625
[Total: 20 Marks]

Page 4
4. Spritz Limited produces a range of spring water based fruit drinks for the health food market. The company is
currently preparing its budget for the next three months, January to March, based on a number of assumptions and
using a range of information.

(i) Lemon Spring is manufactured in a simple production process from a blend of spring water and lemon
concentrate and sold in 500ml bottles. Projected sales for the four months are shown below.

January February March April

Sales units (500ml bottles) 42,000 44,000 47,500 48,000
Sales value (@ €1.40 per bottle) €58,800 €61,600 €66,500 €67,200

(ii) Assume that at 1 January the company will not have any bottles of Lemon Spring in inventory. However, the
sales manager requires that at the end of each of the next six months there will be 5,000 bottles in the
warehouse to satisfy any unexpected demand.

(iii) The company uses variable costing to value producton and the costs incurred to produce one 500ml bottle
of Lemon Spring are as follows:
€
Materials:
- Spring water (450ml @ €0.20 per litre) 0.09
- Lemon concentrate (50ml @ €0.80 per litre) 0.04
- 500ml plastic bottle 0.06
Labour (0.05hr @ €8 per hour) 0.40
Variable production overhead 0.11
0.70

(iv) Assume that at 1 January the company will have 2,000 litres of spring water, 500 litres of lemon concentrate
and 5,000 plastic bottles in inventory. To reduce the risk of disruption to manufacturing, Spritz Limited has a
policy of maintaining the same opening and closing monthly inventory of product materials and plastic bottles.

(v) The recommended selling price for a 500ml bottle of Lemon Spring is €1.40.

(vi) The cost of material purchases has not changed in the past two years and is not expected to change for the
next year.

REQUIREMENT:

(a) For the first three months of next year you are asked to:

(i) Prepare a production budget in units. (3 marks)

(ii) Prepare a materials purchase budget (in units and €) for each material. (7 marks)

(iii) Prepare a labour cost budget (in hours and €). (2 marks)

(iv) Prepare a variable production overhead cost budget. (2 marks)

(b) Prepare a budgeted income statement based on the results you have obtained in (i) to (iv) above. (4 marks)

(c) Explain the term ‘flexible budget’. (2 marks)

[Total: 20 Marks]

Page 5
5. Preston Limited manufactures liquid plant food and uses a process costing system based on the weighted average
method to value production and inventory. There are two main processes used in the production of the plant food.
Firstly, mixing, where various compounds are combined, and then blending where the mixed materials are heated
and blended. All raw materials are introduced at the start of the mixing process and the completed output is
transferred to the blending department. No additional materials are input during the blending process. Labour and
production overheads, also called conversion costs, are incurred evenly throughout both mixing and blending
processes. Information relating to the most recent financial period is shown below:

Mixing Blending
Opening WIP Nil 20,000 litres
Inputs in period 150,000 litres
Completed and transferred 103,000 litres 106,700 litres
Closing WIP 44,000 litres 15,000 litres

Other information:

1. The company expects a normal loss of 2% of materials input to the mixing process. No loss is expected to
occur in the blending process. Any losses arising can be sold for a scrap value of €0.10 per litre.

2. Costs relating to the process are as follows:

Mixing Blending
€ €
Opening WIP
- Prior process costs (from mixing process) 12,476
- Conversion costs Nil 1,920
Input to process
- Materials 34,845 Nil
- Conversion costs 40,761 40,815

3. Opening work in progress in the blending department was fully complete in terms of prior process costs and
40% complete in terms of conversion costs.

4. Closing work in progress in the mixing department was fully complete in terms of materials and 60% complete
in terms of conversion costs. Closing work in progress in the blending department was fully complete in
terms of prior process costs and 50% complete in terms of conversion costs.

REQUIREMENT:
(a) Prepare the following completed accounts for the most recent financial period. You must show all workings clearly.

(i) Mixing process account

(ii) Blending process account
(iii) Normal loss account
(iv) Abnormal loss/Abnormal gain account (18 marks)

(b) Explain the difference between a normal loss and an abnormal loss. (2 marks)

[Total: 20 Marks]

Page 6
6. Expert Solutions provides a range of project management services to clients, ranging from one-off design of
buildings to overall development, and ongoing supervision in completion of structures. As it is a service company
it incurs only labour and overhead costs. Expert Solutions have two categories of labour cost, technical and
secretarial support. To allocate labour costs to jobs, separate technical labour and secretarial support labour rates
are calculated and applied to jobs based on hours worked. Currently the company uses traditional overhead
absorption, allocating overheads to jobs based on total labour hours worked (both technical and secretarial support).

In an attempt to improve accuracy in tendering for new jobs and to better assess profitability of existing contracts,
Expert Solutions is considering adopting an activity based costing (ABC) approach to overhead allocation. Last year,
to facilitate the adoption of ABC, the firm employed accountants to research and compile the detailed information
required. Four main cost types or pools were identified: design costs, planning costs, supervision costs and sundry
completion costs. The following budgeted information is available for the year ahead:

Cost pool Cost driver €

Design costs Number of drafts of project 18,333
Planning costs Number of planning meetings 32,170
Supervision costs Number of site visits 42,084
Sundry completion costs Secretarial support labour hours 25,202

Technical labour cost €245,000

Secretarial support labour cost €162,015
Technical labour hours 1,960
Secretarial support labour hours 9,258
Number of drafts of projects 378
Total site visits 560
Number of planning meetings 250

Details relating to two jobs undertaken by Expert Solutions are as follows:

Kildare Meath
Contract price agreed €10,000 €10,000
Technical labour hours 50 45
Secretarial support labour hours 67 49
Number of drafts of project 5 7
Site visits 15 30
Planning meetings 6 10

REQUIREMENT:
(a) Calculate the total cost of each of the two jobs noted above using:

(i) The costing approach currently used by Expert Solutions. (6 marks)

(ii) Activity based costing. (11 marks)

(b) Compare and comment on your answers in (a)(i) and (ii) above. (3 marks)

[Total: 20 Marks]

END OF PAPER

Page 7
 SUGGESTED SOLUTIONS
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - AUGUST 2014

SOLUTION 1

WORKINGS

W1 Calculation of product cost

Under Absorption costing
€
Direct materials 2.25
Direct labour 1.50
Variable production overhead 0.60
Fixed production overhead ** 1.96
Total product cost per unit 6.31

Fixed production overheads per year (€29,400 x 12) €352,800

Normal production capacity per year (15,000 units x12) 180,000
Fixed production overhead absorption rate per unit **(FOAR) €1.96

Under Variable costing

€
Direct materials 2.25
Direct labour 1.50
Variable production overhead 0.60
Total product cost per unit 4.35

July August
W2 Calculation of changes in inventory units units
Opening inventory 0 1,000
Production 13,000 15,000
Total inventory available 13,000 16,000
Sales 12,000 16,000
Closing inventory 1,000 0

W3 Calculation of Under/Over absorbed overheads July August

€ €
Actual fixed production overhead 29,400 29,400
Absorbed fixed production overhead (Units produced x FOAR) 25,480 29,400
Under/(over) absorbed overhead 3,920 0

Page 8
W4 Separation of fixed and variable selling and administrative expenses

July August Change in Change in Variable cost Fixed cost

€ sales units per unit
Sales volume 12,000 16,000 4,000
€ € € € €
Total selling and
administrative
expenses 45,200 57,600 12,400 3.10 8,000

Total variable
selling and
admin expense 37,200 49,600
Total fixed selling
and admin
expenses 8,000 8,000
Total Selling and
admin expenses 45,200 57,600
(7.5 marks)

(a) Profit statements for Ludo Limited for the months of July and August

Using Absorption costing (Product cost = €6.31 see W1)

July August
€ €
Sales 240,000 320,000
Cost of Sales:
Opening stock 0 6,310
+ Production 82,030 94,650
- Closing stock (see W2) 6,310 0
75,720 100,960

Under/(over) absorbed overhead (see W3) 3,920 0

Gross profit 160,360 219,040
Total selling and administrative expenses 45,200 57,600
Profit 115,160 161,440

Using Variable costing (Product cost = €4.35 see W1)

July August
€ €
Sales 240,000 320,000
Cost of Sales:
Opening stock 0 4,350
+ Production 56,550 65,250
- Closing stock (see W2) 4,350 0
Production cost of sales 52,200 69,600

Variable selling and administrative expenses (see W4) 37,200 49,600

Contribution 150,600 200,800
Fixed costs
Production overhead costs 29,400 29,400
Selling and administrative expenses (see W4) 8,000 37,400 8,000 37,400

Profit 113,200 163,400

(12.5 marks)

Page 9
(b) Reconcilation of Absortion and Variable costing profit figures

July Aug
€ €
Profit per absorption costing 115,160 161,440

Adjustment for fixed production overhead in inventory

(0 - 1,000)*€1.96 -1,960
(1,000 - 0) * €1.96 1,960
Profit per variable costing 113,200 163,400

(3 marks)

(c) Explain the effect on profit of using Absorption or Variable costing

In relation to the effect of absorption costing and variable costing on profit, the details are as follows:

- If sales are greater than production then the use of absorption costing will show lower profit than if
variable costing is used because product cost includes fixed production overhead and so more fixed
production overhead is included in the income statement thus reducing profit.

- Similarly, if production is greater than sales then the use of absorption costing will show higher profit
than if variable costing is used because less fixed production overhead will be included in the income
statement so that profit will be greater.

- If sales volume equals production volume then profits calculated using absorption costing will be the
same as profits calculated using variable costing.
(2 marks)

[Total: 25 Marks]

Page 10
SOLUTION 2
(A)

(i) Factors that have contributed to the growth and importance of management accounting

Management accounting has grown and become more important as a result of the following factors:
- Changing cost structures – in the past materials and labour comprised the highest product costs but
this has changed, in many cases overheads are now more significant and need to be carefully
monitored. Management accounting facilitates the monitoring and control of costs.
- Increased competition – it is now more important than ever to have accurate cost information as
companies are competing not just in terms of product price but also other factors such as product quality
and customer service. Access to accurate produce cost information allows companies to focus attention
away from pricing to other significant factors.
- Global market – with improvements in transportation and communication the market for customers has
expanded and so too have company operations. Management accounting enables cost information to
be provided and analysed across divisions, segments and countries to support overall activities of the
company.
- Internet opportunities – the arrival of the internet has brought more opportunity to buy and sell products
and services more easily, and to monitor competitors and consumer trends. Management accounting
may be applied to gather cost information from all sources easily.
- Changing customer needs – customers have become more discerning and it is now more important to
have pertinent information relating to customers and their profitability to a business. Management
accounting allows companies to use cost information and techniques to obtain data on the cost of
providing services to customers.
- Changing product lifecycles – due to intense competition and changing customer needs product
lifecycles are becoming shorter. Companies need to be ready and able to introduce new products quickly
and management accounting can facilitate this process by providing essential information for costing
and decision making.
- Any other relevant point (4 marks)

(ii) The difference between financial accounting and management accounting

There are a number of areas where financial accounting differs from management accounting:
• Financial accounting has an external focus. It is designed to provide information to users who are
external to an organisation, whereas management accounting has an internal focus. It is designed to
assist company managers in planning, controlling and decision-making activities.
• There is a legal requirement for companies to prepare financial statements while there is no legal
requirement to prepare management accounts.
• Financial accounting focuses on the organisation as a whole while management accounting information
may focus on many areas as required by the company.
• Financial accounting information is presented in a format prescribed by law and by accounting
standards, whereas the layout and substance of management accounting information is decided by
company management.
• Usually most financial accounting information is expressed in monetary terms however management
accounting information may include both monetary and non-monetary information.
• Financial accounting information provides information on what has happened in the past, while
management accounting may be used for planning purposes and also for presenting information on past
activities.
(4 marks)

(iii) The role of the management accountant in enhancing and improving a business
As part of his/her role the management accountant provides information to facilitate a range of activities
including:

Allocation of costs between cost of goods sold and inventories

It is important to allocate costs to products as accurately as possible in order to establish the profitability of
the business. The management accountant ensures that cost information is collected and correctly allocated
to cost of sales or inventories as appropriate. The management accountant may use techniques such as
activity based costing to allocate overheads to products or the first in first out (FIFO) method to value inventory.

Page 11
 Planning and controlling
To carry out their roles effectively the various managers in a business require information to assist them in
planning and controlling the operations of the organisation. Planning involves translating goals and objectives
into the specific activities and resources that are required to achieve the goals and objectives. The
management accountant is involved in the preparation of both long term and short term plans. Budgets are
short-term plans that are prepared in more detail than longer term plans. Control involves the process of
ensuring that actual outcomes conform to planned or expected outcomes. Budgets may be used to support
the controlling of activities by providing a measure against which actual performance may be compared.

Performance measurement
The management accountant generates periodic reports, which compare actual performance to plan, and
provides these to managers enabling them to determine if operations are proceeding as expected and to
identify where corrective action may be required. These periodic reports also allow managerial performance
to be evaluated and provide incentives for managers to try to achieve favourable results.

Decision making
Managers also require information to assist them with routine and non-routine decision making. Routine
decisions relate to issues such as assessing the profitability of different segments of an organisation such as
products, services and customers. Non-routine decisions are made infrequently and may relate to strategic
issues such as the introduction of new products or services. The information provided by the management
accountant to support these decisions may be financial or non-financial in nature, depending on what best
meets the needs of management. In many instances cost information accumulated by the management
accountant is relied upon to inform decisions, and therefore it is critical that such information be of a high
quality.
(7 marks)
[Total: 15 Marks]

(B) Report

TO: Managing Director, Brandon Limited

FROM: A Management Accountant
RE: Cost terms and their importance in Management Accounting
Date: August 2014

This report has been prepared in response to your request for information regarding cost terms and their importance
and application in management accounting. The report consists of two sections, the first section defines commonly
used management accounting cost terms, providing examples to more clearly explain their meaning. The second
section outlines why it is important to understand these cost terms, indicates why they are important and how they
are used in management accounting.

(i) Definitions of commonly used cost terms in management accounting

Cost object – this is any activity for which a measurement of cost is required. For example, the cost of a tin
of paint, the cost of maintaining a bank account, the cost of operating a particular department, etc.

Direct costs – these are costs that can be specifically and exclusively identified with a particular cost object.
For example, if it takes 1kg of material to make each unit of product then the material cost is called a direct
cost as there is a specific, identifiable relationship between the material and the manufacture of the product.

Indirect costs – contrary to direct costs, these are costs that cannot be specifically and exclusively identified
with a cost object. For example, if a company employs casual workers in the factory to keep it clean and tidy
the cost of this staff is considered to be an indirect labour cost as no specific identifiable relationship can be
established between the manufacture of a product and these labour costs.

Variable costs – costs are classified as variable when they vary in direct proportion to the volume of activity.
For example, staff paid on a piecework basis so that the more they produce the higher the labour cost.

Fixed costs – are costs that remain constant over a wide range of activity for a specific time period. For
example, factory rent or factory insurance may remain constant for a particular capacity or volume or time
period.
Page 12
 Product costs – are those costs associated with goods purchased or manufactured for resale. In a
manufacturing organisation all manufacturing costs are considered to be product costs. In a non-manufacturing
organisation the cost of goods purchased is considered to be a product cost and all other costs are not. For
example, the cost of the wood used in in producing a table is a product cost.

Period costs – these are costs that are not associated with the manufacture of a product; they are incurred
by a company to operate its business and usually occur from year to year. For example, administration costs
such as auditors’ fees are period costs as they do not relate to the product and usually are incurred every year.

(10 marks)

(ii) Importance of cost terms and how they are used

The cost terms described in the previous section are key building blocks in management accounting. A clear
understanding of the cost terms allows their use in many management accounting applications such as:

• Product costing – this is where direct and indirect costs are accumulated for each product so that a
company may establish the price and profitability of the product.

• Cost-volume-profit (CVP) analysis – by separating fixed and variable costs CVP analysis allows a
company to produce information relating to its sales volumes such as the number of units that must be
sold to cover all of its costs; the number of units that must be sold to generate a particular profit; and it
also allows a company to calculate by how much sales volumes may fall before the company starts to
make a loss.

• Decision making – the classification of its costs into fixed and variable costs provides a company with
information that may be used for a variety of decisions including whether to make a product internally
or outsource; how much to price a special order; whether to discontinue a particular business segment
or division; whether to replace non-current assets; and how best to use scarce resources.

• Budgeting and variance analysis – using product and period costs a company may prepare a budget
for a particular period. This budget provides a plan for the period under review and by comparison with
actual costs incurred facilitates the company in controlling its costs.

I hope this report clearly explains the commonly used cost terms in management accounting, why they are important
and how they are used. If you have any further queries related to anything mentioned in this report, please do not
hesitate to contact me.

Yours sincerely,
A Management Accountant

Mark awarded for use of report format and presentation (1 mark)

(4 marks)

[Total: 15 Marks]

Page 13
QUESTION 3
(i) Answer (b)
Prime cost = direct materials plus direct labour plus direct expenses.

(ii) Answer (a)

Overhead absorption rate = €238,700/31,000 machine hours = €7.70 per machine hour

Actual overhead for August €255,400

Absorbed overhead for August = 29,000 machine hours x €7.70 = €223,300
Under absorbed overhead € 32,100

(iii) Answer (b)

Materials price variance = (SP – AP) x AQ

(SP – (€132,912/56,800)) x 56,800 = 1,136
56,800 SP = 132,912 + 1,136
SP = 2.36

Materials usage variance = (SQ – AQ) x SP

(SQ -56,800) x 2.36 = -1,180
2.36 SQ = 134,048-1180
SQ = 56,300
SQ = 2kg for each unit => 56,300/2 = 28,150 units

(iv) Answer (c)

A JIT system aims to reduce inventory to a minimum but does not guarantee that no inventory is held by a
company.

(v) Answer (d)

During inflationary periods closing inventory calculated using LIFO is valued at the lowest prices.

(vi) Answer (d)

Volume Maintenance
Expenses
Highest month of activity September 15,000 units €91,500
Lowest month of activity March 5,000 units €39,000
Difference 10,000 units €52,500

Variable overhead = €52,500/10,000 = €5.25 per unit

Fixed overhead = €91,500 – (15,000 x €5.25) = €12,750

(vii) Answer (c)

The original cost of material Alpha is a sunk cost. As material Alpha is being used regularly to make existing
products, the company will have to purchase more at the current purchase price if it uses any of the existing
inventory. Hence the cost of using material Alpha for the contract is:
800 kg x €16 = €12,800

(viii) Answer (c)

The original cost of material Beta is a sunk cost. Material Beta is considered by the company to be obsolete
and has no scrap value so if the company were to use all 500 kg in inventory for the contract there would be
a zero cost. However, the contract requires 1,000 kg of material Beta so it must purchase an additional 500
kg at the current purchase price of €9.25 per kg. Hence the cost of using material Beta for the contract is: 500
kg x 0 + 500 kg x €9.25 = €4,625.
[Total: 20 Marks]

Page 14
SOLUTION 4

(a)
(i) Production Budget in units (500ml bottles)
January February March April
Sales 42,000 44,000 47,500 48,000
Closing Inventory 5,000 5,000 5,000 5,000
47,000 49,000 52,500 53,000
Less opening Inventory 0 5,000 5,000 5,000
Production required in 500ml bottles 47,000 44,000 47,500 48,000

Production required in litres 23,500 22,000 23,750 24,000

(ii) Materials Purchase Budget

Each 500ml bottle contains 450ml or 90% spring water and 50ml or 10% lemon concentrate

Spring water January February March

Production in litres 23,500 22,000 23,750
Spring water required per
500ml bottle i.e 90% 21,150 19,800 21,375
Closing Inventory 2,000 2,000 2,000
23,150 21,800 23,375
Less opening Inventory 2,000 2,000 2,000
Purchases required 21,150 19,800 21,375
Cost @ €0.20 per litre € 0.20 € 0.20 € 0.20
Total Cost € 4,230 € 3,960 € 4,275

Total spring water purchases € 12,465

Lemon concentrate January February March

Production in litres 23,500 22,000 23,750
Lemon concentrate per
500ml bottle i.e 10% 2,350 2,200 2,375
Closing Inventory 500 500 500
2,850 2,700 2,875
Less opening Inventory 500 500 500
Purchases required 2,350 2,200 2,375
Cost @ €0.80 per litre € 0.80 € 0.80 € 0.80
Total Cost € 1,880 € 1,760 € 1,900

Total lemon concentrate purchases € 5,540

Plastic bottles January February March

Production in 500ml bottles 47,000 44,000 47,500
Closing Inventory 5,000 5,000 5,000
52,000 49,000 52,500
Less opening Inventory 5,000 5,000 5,000
Purchases required 47,000 44,000 47,500
Cost @ €0.06 per bottle € 0.06 € 0.06 € 0.06
Total Cost € 2,820 € 2,640 € 2,850

Total plastic bottle purchases € 8,310

Tutorial Note: For each of the ingredients the opening inventories and closing inventories are the same, hence,
the above calculations may be computed by excluding these and just using production quantities.

(7 marks)

Page 15
(iii) Labour cost budget
January February March
Production in 500ml bottles 47,000 44,000 47,500
Cost to produce each bottle € 0.40 € 0.40 € 0.40
Production labour cost € 18,800 € 17,600 € 19,000
Total production labour cost € 55,400
(2 marks)

(iv) Variable overhead budget

January February March
Production in 500ml bottles 47,000 44,000 47,500
Cost to produce each bottle € 0.11 € 0.11 € 0.11
(from Question)
Variable overhead cost € 5,170 € 4,840 € 5,225
Total variable overhead cost € 15,235
(2 marks)

(b) Budgeted Income statement

Sales € 186,900
Cost of Sales
Opening Inventory Note 1 € 1,100
+Production Cost Note 2 € 96,950
€ 98,050
-Closing Inventory Note 3 € 4,600
Cost of sales € 93,450
Gross Profit € 93,450

Note 1

Opening Inventory Quantity Cost Value

Spring water 2,000 € 0.20 € 400
Lemon concentrate 500 € 0.80 € 400
Plastic bottles 5,000 € 0.06 € 300
€ 1,100
Note 2
Production Cost (from (a) (i) to (iv))
Spring water € 12,465
Lemon concentrate € 5,540
Plastic bottles € 8,310
Labour € 55,400
Variable overheads € 15,235
€ 96,950

Note 3
Closing Inventory Quantity Cost Value
Lemon Spring 5,000 € 0.70 € 3,500
Spring water 2,000 € 0.20 € 400
Lemon concentrate 500 € 0.80 € 400
Plastic bottles 5,000 € 0.06 € 300
€ 4,600
(4 marks)

(c) Explain the term 'flexible budget'

A flexible budget is a budget which, by recognising the difference in behaviour between variable and fixed
overheads in relation to changes in volume, turnover or other variable factors, is designed to change in
accordance with such fluctuations.
(2 marks)
[Total: 20 Marks]
Page 16
SOLUTION 5

Workings
Mixing process Equivalent units
Inputs Total
Physical Materials Labour &
Units Overheads
Litres Litres Litres
Opening WIP 0
Materials input 150,000
150,000
Outputs
Closing WIP (100% / 60% complete) 44,000 44,000 26,400
Normal loss (2% x materials input) 3,000 0 0
Transferred to blending process 103,000 103,000 103,000
150,000 147,000 129,400

Costs
Total costs incurred (given in question) €34,845 €40,761
Less scrap value of normal loss (3,000 x €0.10) -€300
Total costs to be allocated €75,306 €34,545 €40,761

Cost per equivalent unit €0.235 €0.315 €0.550

Allocation of costs
Valuation of output transferred to blending process = 103,000 litres x €0.55 per litre = €56,650
Valuation of closing WIP (44,000 litres)
Materials: 44,000 litres x €0.235 = €10,340
Conversion costs: 26,400 litres x €0.315 = €8,316
€18,656

Total Costs €75,306

Blending process Equivalent units

Inputs Total Mixing

Physical process Labour &
Units costs overheads
Litres Litres Litres
Opening WIP 20,000
Materials transferred from mixing 103,000
123,000
Outputs
Completed and transferred 106,700 106,700 106,700
Closing WIP 15,000 15,000 7,500
Abnormal loss 1,300 1,300 1,300
123,000 123,000 115,500

Opening WIP (given in question) €12,476 €1,920

Prior process costs transferred in €56,650
Costs incurred (given in question) €40,815
Total costs to be allocated €111,861 €69,126 €42,735

Cost per equivalent unit €0.562 €0.370 €0.932

Page 17
Allocation of Costs
Valuation of finished output transferred: 106,700 litres @ €0.932 per litre = €99,444.40
Valuation of abnormal loss : 1,300 litres x €0.932 per litre = €1,211.60

Valuation of closing WIP (15,000 litres 50% complete in terms of conversion costs)
Prior process costs: 15,000 litres x €0.562 = €8,430
Conversion costs: 7,500 litres x €0.370 = €2,775
€11,205

Total cost €111,861 (12 marks)

(a) (i)
Mixing process account
Litres € Litres €
Inputs 150,000 Normal loss 3,000 300
Materials 34,845 Transferred to blending
Labour & overhead 40,761 Process 103,000 56,650

Closing WIP 44,000 18,656

150,000 75,606 150,000 75,606

(a) (ii)
Blending process account
Litres € Litres €
Opening WIP 20,000 Completed & transferred 106,700 99,444
- Prior process costs 12,476 Abnormal loss 1,300 1,212
- Conversion costs 1,920 Closing WIP 15,000 11,205
Transferred in from mixing 103,000 56,650
Conversion costs 40,815
123,000 111,861 123,000 111,861

(a) )iii)
Normal loss account
Litres € Litres €
Mixing process account 3,000 300 Cash for units scrapped 3,000 300

3,000 300 3,000 300

(a) (iv)
Abnormal loss account
Litres € Litres €
Mixing process account 1,300 1,212 Cash for units scrapped 1,300 130
Income statement 1,082
1,300 1,212 1,300 1,212

(6 marks)

(b) Difference between a normal loss and an abnormal loss

A normal loss arises under efficient operating conditions. It is expected and is unavoidable or uncontrollable.
For example, evaporation of liquids or offcuts of wood. A normal loss must be carefully monitored
to ensure that it can be fully explained.

An abnormal loss is not an inherent part of the production process. It arises from inefficiencies and is
avoidable or controllable. This loss should be fully investigated and corrective action should be taken to
ensure that it does not re-occur.
(2 marks)
[Total: 20 Marks]
Page 18
SOLUTION 6

(a)
(i) Total job cost using traditional overhead costing approach

Workings
W1 Labour rates per hour
Technical labour Secretarial Total
Support
Total labour cost €245,000 €162,015 €407,015
Total labour hours 1,960 9,258 11,218

Labour rate per hour €125.00 €17.50

W2 Overhead rate per hour

€
Design costs 18,333
Planning costs 32,170
Supervison costs 42,084
Sundry completion costs 25,202
Total overhead cost 117,789

Total labour hours (technical & support) 11,218

Overhead rate per labour hour €10.50

Cost of Jobs using traditional overhead absorption costing

Kildare Meath
€ €
Technical labour cost (@ €125 per hr) (W1) 6,250.00 5,625.00
Secretarial support labour (@ €17.50 per hr) (W1) 1,172.50 857.50
Overheads(@ €10.50 per hr) (W2) 1,228.50 987.00
Total job cost 8,651.00 7,469.50
(6 marks)

(ii) Total job cost using activity based costing approach

W3 Calculation of cost per driver

Activity Cost driver Cost Total of drivers Cost per driver

(x) (y) (x/y)
€ €
Design costs No of project drafts 18,333 378 48.50
Planning costs No of planning meetings 32,170 250 128.68
Supervison costs No of site visits 42,084 560 75.15
Sundry completion costs Secretarial support hours 25,202 9,258 2.72
117,789

W4 Calculation of total overhead cost for each job

Kildare Meath
€ €
Design costs (No. of drafts @€48.50 per draft) (W3) 242.50 339.50
Planning costs (No. of planning meetings @€128.68 per meeting) (W3) 772.08 1,286.80
Supervison costs (No. of site visits @€75.15 per visit) (W3) 1,127.25 2,254.50
Sundry completion costs (No. of secretarial hours@€2.72 per hr)(W3) 182.24 133.28
Total overhead cost 2,324.07 4,014.08

Page 19
 Calculation of total job cost
Kildare Meath
€ €
Technical labour cost (as for (a) (i)) 6,250.00 5,625.00
Secretarial support labour cost (as for (a)(i)) 1,172.50 857.50
Overheads (W4) 2,324.07 4,014.08
Total job cost 9,746.57 10,496.58

(11 marks)

(b) Comparison of costs

Traditional/ ABC approach Difference
Existing approach
€ € €
Kildare 8,651.00 9,746.57 -1,095.57
Meath 7,469.50 10,496.58 -3,027.08

Comments

ABC is a more accurate method of absorbing overheads into the cost of products and services.
In relation to the 2 jobs undertaken by Expert solutions:
In (a) (i) the traditional absorption costing approach suggests that the Kildare job has a higher cost than the Meath
job.
However, when ABC is applied as in (a) (ii) the Meath job is shown to be much more costly.
The company is making a very small profit on the Kildare job (€10,000 - €9,746.57 = €253.43) and is making a loss
on the Meath job (€10,000 - €10,496.58 = €-496.58. This suggests that the company needs to use ABC so as to
more accurately cost its job contracts and earn a higher profit.
(3 marks)

[Total: 20 Marks]

Page 20