STRICTLY CONFIDENTIAL THE PUBLIC ACCOUNTANTS EXAMINATION COUNCIL OF MALAWI 2008 EXAMINATIONS ACCOUNTING TECHNICIAN PROGRAMME PAPER TC9:

COSTING AND BUDGETARY CONTROL

DECEMBER 2008 TIME ALLOWED :3 HOURS

SUGGESTED SOLUTIONS

2 1. (a) Date Sept 1 Sept 2 Sept 4 Sept 9 Sept 11 Sept 16 400 Sept 18 Sept 23 600 Sept 25 Sept 30 300 21.00 6,300 22.00 13,200 60 0 22.0 0 13,20 0 20.00 8,000 50 0 20.1 5 10,07 5 300 21.00 6,300 30 0 20.7 5 6,22 5 (i) Qty Stores ledger card Receipts Price Value K 500 K Issues Qt Price y K Value K Balance Qt Price Value y K K Nil Nil Nil 50 20.0 10,000 0 0 10 20.0 2,000 0 0 40 20.7 8,300 0 5 10 20.7 2,075 0 5 50 20.1 10,075 0 5 Nil Nil Nil 60 0 Nil 30 0 22.0 0 Nil 21.0 0 13,200 Nil 6,300

20.00 10,000 40 0 20.0 0 8,00 0

(ii)

XYZ Limited Income Statement for September 2008 K 224,867

K Sales 15,500 units Less cost of sales: Opening stock 200 units 1,950 Plus production 16,000 units (W1) 126,291 Minus closing stock 700 units x K7.89 (W2) 5,523 Gross profit Administration overheads Net profit W1 Production cost Direct materials K(8,000 + 6,225 + 10,075 + 13,200 + 43,250) Direct wages Production overheads K(9,000 + 20,541)

122,718 102,149 5,059 97,090

K 80,750 16,000 29,541

3 126,291 W2 Production cost per unit = K126,291/16,000 units = K7.89 per unit (b) (i) XYZ Limited does not have a stock purchasing policy for steel sheets as during September they ran out of stock twice which could have resulted in costly production delays. To avoid stock-outs, XYZ Limited should set stock control levels like the minimum level of stock, the maximum level, reorder level and reorder quantity. These stock control levels will be set after considering the anticipated demand for the stock item. XYZ Limited adopts the conventional absorption costing system in which fixed costs incurred during a period are charged against items produced in that period in accordance with the matching concept. Closing stocks therefore include a proportion of fixed overheads. However, most organisations recover overheads using predetermined overhead absorption rates based on budgeted expenditure and estimated activity levels as using actual rates causes delays in the calculation of overheads. Alternatively XYZ Limited can use marginal costing in which fixed costs are charged against the period in which they are incurred. (i) A B C D Canteen Stores K K K K K K 200,000 500,000 300,000 400,000 50,000 100,000 5,000 205,000 21,000 226,000 2,100 228,100 420 228,520 42 228,562 12 228,574 15,000 515,000 10,500 525,500 6,300 531,800 210 532,010 126 532,136 5 532,141 10,000 310,000 31,500 341,500 4,200 345,700 630 346,330 84 346,414 13 346,427 15,000 415,000 21,000 436,000 6,300 442,300 420 442,720 126 442,846 12 442,858 (50,000) 5,000 105,000 21,000 (105,000) 21,000 (21,000) 2,100 2,100 420 (2,100) 420 (420) 42 42 (42) -

(ii)

2.

(a)

Initial cost Reapportion: Canteen 10:30:20:30:10 Stores 20:10:30:20:20 Canteen Stores Canteen Stores

(ii)

Let x = total canteen overheads

4 Let y = total stores overheads x = 50,000 + 0.2 y .(1) y = 100,000 + 0.1 x ..(2) Substitute y = 100,000 + 0.1 x in x = 50,000 + 0.2 (100,000 + 0.1 x) x = 50,000 + 20,000 + 0.02 x x = 70,000 + 0.02 x x 0.02 x = 70,000 0.98 x = 70,000 x = 70,000/0.98 x = 71,429 Substitute x = 71,429 in (2) y = 100,000 + 0.1 x y = 100,000 + 0.1 x 71,429 y = 100,000 + 7,143 y = 107,143 A B C D K K K K Initial cost 200,000 500,000 300,000 400,000 Apportion Canteen (x) 10:30:20:30 7,143 21,429 14,286 21,429 Apportion Stores (y) 20:10:30:20 21,429 10,714 32,143 21,429 228,572 532,143 346,429 442,858 (b) Overhead costs for service departments are reapportioned with the aim of calculating total product costs required for product pricing and measuring product profitability as in the long term it is necessary for any organization to recover all costs. However, the reapportionment of these overheads to production cost centres to assist in control and decision making is not worthwhile as the reapportionment is highly subjective and the costs are largely fixed making them uncontrollable in the short-term. An alternative treatment would be to charge the fixed component of such costs as a period cost and the variable component would be charged as a production cost on the basis of an appropriate measure of output. (a) (i) Normal loss is the expected loss, allowed for in the budget, and normally calculated as a percentage of the input into a process during a period of time. (ii) Joint products are two or more products produced from the same process and separated in processing with each having a sufficiently high saleable value to merit recognition as a main product. (1)

3.

5 (iii) (b) (i) A by-product is the output of some value produced incidentally in manufacturing the main product. As normal loss is expected, it is not given a cost except where the normal loss has a scrap value which is usually deducted from the cost of materials. As the by-product has a commercial value, the income earned from the sale of the by product may be recognized in different ways: it may be added to the sales from the main product, treated as a separate incidental source of income, deducted from the production cost of sales of the main product or deducting the net realizable value of the by-product from the production cost of the main product.

(ii)

(c)

As a product separates into different states, the sales value at split-off point will be used as the basis of apportioning joint process costs. Sales value Product P 6,000 litres x K10 per litre Product Q 10,000 litres x K4 per litre Product R 20,000 kg x K10 per kg Apportionment of joint costs Product P /K300,000 x K60,000 Product Q K200,000/K300,000 x K40,000 Product R K200,000/K300,000 x K200,000 Total
K200,000

K 60,000 40,000 200,000 300,000 K 40,000 26,667 133,333 200,000

(d)

(i)

The initial process is viable as shown below: Sales revenue 6,000 x K10 + 10,000 x K6 + 20,000 x K10 Joint process costs Gross profit K 300,000 200,000 100,000

(ii)

Incremental revenue K Product P K(20 10) 10 Product Q K(8 4) 4 Product R K(16 10) 6

Incremental Excess of revenue cost over cost K K 14 -4 2 2 6 0

6 Enhanced product Q should be produced as the incremental revenue exceeds the incremental costs. 4. (a) A fixed budget is a budget prepared on the basis of estimated production and sales volumes but does not anticipate that actual volumes may differ from the budgeted volumes. A flexible budget is a budget which is designed to change with changes in the volume of activities. A fixed budget is primarily used for planning purposes and it is used to define an organisations objectives whereas a flexible budget is used both as a contingent plan as well as a control technique. (b) 12,000 units require (x 0.4 kg per unit) = 4,800 kg at a cost of K17,760 Cost per kg = K17,760/4,800 kg = K3.70 per kg 15,000 units require (x 0.4 kg per unit) = 6,000 kg at a cost of K22,200 Cost per kg = K22,200/6,000 kg = K3.70 per kg The cost per kg for purchases on the excess of 6,000 kg will be 90% x K3.70 = K3.33 (c) For the production of 17,000 units Flexible budget Allowance Actual cost K K Direct materials: Material A (W1) Material B (W2) Labour (W3) Overhead (W4) 5,100 24,864 33,400 13,700 5,025 25,118 32,889 13,315 Variance K 75 F 254 A 511 F 385 F

W1 Material A 12,000 units cost K3,600 Cost per unit = K3,600/12,000 units = K0.30 15,000 units cost K4,500 Cost per unit = K4,500/15,000 units = K0.30

7 Material A cost is variable at K0.30 per unit The cost of 17,000 units = K0.30 per unit x 17,000 units = K5,100 W2 Material B 17,000 units require (x 0.4 kg per unit) = 6,800 kg 6,800 kg cost = 6,000 kg x K3.70 + 800 kg x K3.33 = K24,864 W3 Labour 12,000 units require (x 0.2 hours) at a cost of K25,700 2,400 hours cost K25,700 15,000 require (x 0.2 hours) at a cost of K29,900 3,000 hours cost K29,900 Output Hours High 3,000 Low 2,400 600 Cost K 29,900 25,700 4,200

Cost per hour = K4,200/600 hours = K7 per hour Total cost for 3,000 hours Variable cost K7 per hour x 3,000 hours Fixed cost K 29,900 21,000 8,900

17,000 units will require (x 0.2 hours per unit) = 3,400 hours 3,400 hours will cost = 3,000 hours x K7 per hour + 400 hours x K7 per hour x 125% + K8,900 = K33,400 W4 Overhead Output Units High 18,000 Low 12,000 6,000 Cost K 13,960 12,400 1,560

Variable cost per unit = K1,560/6,000 units = K0.26 per unit K Total cost for 18,000 units 13,960 Variable cost 18,000 units x K0.26 per unit 4,680

8 Fixed cost 9,280

17,000 units will cost = 17,000 units x K0.26 + K9,280 = K13,700

(d)

Budgeted price per kg of Material A 12,000 units require (0.2 kg per unit) 2,400 kg at a cost of K3,600 The budgeted cost per kg = K3,600/2,400 kg = K1.50 17,000 units should have used (x 0.2 kg per unit) 3,400 kg But did use K5,025/K1.50 per kg 3,350 kg Variance 50 kg F x Standard price per kg K1.50 75 F

5.

(a)

(i)

If the concert does go ahead then all costs given will be incurred. These total K455,000 so: At a price of K400: Breakeven sales level = K455,000/K400 = 1,137.5 tickets = 1,138 tickets At a price of K500: Breakeven sales level = K455,000/K500 = 910 tickets

(ii)

If the artist agrees a fee equal to 25% of gross proceeds, then at a sales price of K400, he/she will receive K100 and, at a sales price of K500, he/she will receive K125 per ticket. However the fixed costs will fall to K355,000 so the new breakeven level at each price is: At a price of K400: breakeven sales level = K355,000/K400 K100 = 1,183 tickets At a price of K500: breakeven sales level = K355,000/K500 K125 = 947 tickets

(iii)

Indifference level between alternatives

9 Let T be the number of tickets sold Profits/losses are identical under each scheme when: K400 per ticket (T) K455,000 = K300 per ticket (T) K355,000 400T 455,000 = 300T 355,000 400T 300T = 455,000 355,000 100T = 100,000 T = 100,000/100 T = 1,000 tickets Or 500T 455,000 = 375T 355,000 500T 375T = 455,000 355,000 125T = 100,000 T = 100,000/125 T = 800 tickets (iv) From the calculations presented in parts (i) to (iii), it is evident that the option of paying the artist a fixed fee has a lower breakeven point at each sales price. In addition, for each sales level above the point of indifference of 1,000 tickets at a price of K400 and 800 tickets at a price of K500, Galant Promotions Limited will make a higher profit from the fixed fee deal. However, for sales levels below the calculated indifference point, the percentage fee alternative is more attractive. However, at the indifference levels and all points below it the company will incur losses. Thus, if ticket sales are low i.e. below the indifference level, the company will minimize losses by opting for the percentage fee alternative. At sales levels above the indifference level the company will do better with the fixed fee alternative. Thus A major factor in the decision will be the companys attitude with regard to the expected level of sales, and in particular, the probability that sales will exceed the relevant indifference levels. Obviously, the final decision will depend on the attitude to risk of the companys management. (b) Cost-volume-profit or breakeven analysis is especially useful for: (i) (ii) (iii) Providing an easily interpreted summary of the relationship between the various variables. Presenting the relevant information in a cost effective and timely manner. Emphasizing the relative profitability of the various products offered by the organisation. This type of information is particularly relevant

10 for decision making in relation to marketing, pricing and product deletion/retention issues. Analyzing the relationship between the risk/return elements of a particular course of action in a useful (albeit incomplete) fashion.

(iv)

The limitations of CVP analysis are attributable to the simplifying assumptions which underlie this type of analysis, such as: (i) (ii) (iii) (iv) (v) (vi) (vii) Volume is the only factor affecting costs. All costs can be divided into fixed and variable elements. Costs and revenues behave in a linear fashion. Only one product is involved, or it is assumed that a given sales mix will be maintained as volume changes. The analysis only applies within a predetermined relevant range of activity. As outlined earlier, while the model provides some insight into the relationships between the risks/returns of various alternatives, it does not consider this issue in a more formal manner. The model fails to consider the realities of business such as changing prices of production inputs, efficiency, mix and productivity changes. However, when combined with other techniques such as simulation models, linear programming and sensitivity analysis, such deficiencies can be overcome.

6.

(a)

Option 1 Cancel the job Cost of cancelling the job Option 2 Subcontract K Fee 550,000 Lost revenue from senior consultants (80 hours x K1,200) 96,000 646,000 Option 3 Temporary staff Temporary staff pay (K150 x 2,000) Recruitment costs (K7,500 x 4) Computers, lower of: Purchase cost = (4 x K(200,000 150,000)) = K200,000 Lease cost = 4 x K75,000 = K300,000 K 300,000 30,000 200,000 K 680,000

11 Office space (and heat and light), lower of:

Transfer to CD ROM = (K (130,000 (20 x K2,500) + (40 x K500))) = K60,000 Spare office = K150,000 + (K500 x 50) = K175,000

60,000 590,000

Option 3 is the most cost effective. (b) Non-financial factors relevant when considering the three options are as follows: (i) Cancelling the job may have commercial implications which could affect the long term profitability of the organization. Potential customers may be reluctant to deal with Web Ltd, fearing that other jobs may be cancelled. Alternatively, customers might demand that high cancellation penalty clauses be inserted into future contracts. The reliability of any firm subcontracted to do the work should be checked. Web Ltd will, of course, lose a certain degree of control over the work should it be subcontracted. Web Ltd would need to ensure that the temporary staff have the necessary skills and expertise to perform the development work. The effect on the organisations software development staff of the option chosen should be considered. 7. (a) (i) A cost centre is a production or service location, function, activity or item of equipment for which costs are accumulated. A cost unit is a unit of product or service in relation to which costs are ascertained. The common feature between the definitions is that costs are accumulated and ascertained to provide management with information for control. (ii) Suitable cost units for: (1) (2) (b) a hospital - patient/day or bed/day or the number of patients treated. a public transport company - passenger/kilometre.

(ii) (iii) (iv)

A sales forecast is a prediction of sales based on a given set of assumptions. A sales budget is a predetermined plan to allow the achievement of an agreed sales target. The difference between a sales forecast and a sales budget is that the sales budget is a plan of action to achieve a given target whereas a sales forecast is an attempt to quantify likely future sales under certain circumstances.

12 (c) A budgeted cost is the estimated cost of a product which is incorporated in an organisations plans for a period of time i.e. a budget. A standard cost is a product cost developed through a systematic analysis of the inputs required to achieve the desired quality of output under defined circumstances. The difference between a budgeted cost and standard cost is that the budgeted cost is derived from previous levels of budgeted costs or actual costs whereas a standard cost is developed from a detailed analysis of the inputs required to make a particular product. Budgets are quantifications of expectations of aggregate future costs and revenues; they are aspects of future performance and are used as comparators against which current performance is measured as well as authorisation of allowed expenditure. Standards on the other hand measure performance at unit level. Standard costing and budgetary control should be used simultaneously as in combination the two techniques embrace the organisation completely than either technique would achieve in isolation.

(d)

END