Tutorial Answers D4

Section A: Evaluate the following statements and state TRUE or FALSE. Discuss the
validity of your answers.

1. Cost accounting is a branch of management accounting.

2. In finance, marginal cost is the change in total cost that arises when the quantity
produced changes by one unit.

3. Marginal costing method is also referred to as full costing method.

(Marginal costing method is also referred to as direct costing method)
(The Absorption Costing method is also referred to as full costing method)

4. Plans for the short-term budget contain much more detailed and prescriptive
information than long-term or intermediate plans.

5. In budgeting, negotiation for staffing and advertisement falls under the planning
stage.
(Negotiation for staffing and advertisement falls under the co-ordination stage)

6. The zero-base budgeting is indifferent to whether the total budget is increasing or

decreasing and is a time-consuming process that takes much longer than
traditional, cost-based budgeting.

7. Business that are highly capitalised through investment in labour-saving assets (i.e.
automation) will have greater levels of fixed costs (depreciation of plants)
and lower contribution margins through variable-cost savings in direct labour.
(higher contribution margins through variable-cost savings in direct labour.)

8. The higher the fixed cost, the higher would be the breakeven point.

9. If beginning and ending inventory levels are equal;

Absorption costing profit = Marginal costing profit.

10. Marginal costing method is less cumbersome than absorption method and gives
better approach to pricing as breakeven point can be calculated
Section B

1. Reference to the operational and selling expenses incurred by a business; state

your understanding of the following.

1.1 Direct costs

1.2 Overheads

1.1 If an expense can be attributed to a specific job (e.g. if you were a shipbuilder you
would have to buy steel if you got the job to build ships) then the expense is known
as Direct Cost (or Cost of Sale)

1.2 It is not possible to lay down rules on what are and are not overheads for every type
of business, however a quick rule of thumb is that overheads (or Indirect, or Fixed
Cost) are those costs which are incurred in the running of the business and which
are not directly associated with a specific job. For instance you will pay for a
telephone and advertising whether you get any business or not - therefore that is an
overhead. Overheads or indirect costs include taxes, administration, personnel and
security costs.

2. State the methods of treatment of fixed production overheads and differentiate

between them?

2. The two method of treating the fixed production overheads are marginal costing and
absorption costing.

Marginal costing
In marginal costing or the variable costing method, manufacturing costs includes :
- direct materials (those materials that become an integral part of a finished
product and can be conveniently traced into it)
- direct labour (those factory labour costs that can be easily traced to
individual units of product. Also called touch labour)
- only variable manufacturing overhead in the cost of a unit of product. The
entire amount of fixed costs are expenses in the year incurred.

Absorption costing
In absorption costing or the full costing method, manufacturing costs includes:
- direct materials (those materials that become an integral part of a finished
product and can be conveniently traced into it)
- direct labour (those factory labour costs that can be easily traced to
individual units of product. Also called touch labour)
- both variable and fixed manufacturing overhead in the cost of a unit of
product.
Q3. Jules & Julian Enterprise (JJE) is considering renting a machine for $1650. JJE
estimated that the variable cost per unit production is $0.45.
3.1 If JJE sells each unit at $1.00, calculate the number of units that it has to sell
to “break-even”.
3.2 If JJE intends to make $550 per month, what should be its sales target?

3.1 Break-even point (units) = Fixed cost / Unit contribution

= 1650 / 0.55
= 3000 units

3.2 Sales target (units) = (Fixed cost + Target surplus)

Unit contribution
= 1650 + 550
0.55
= 4000 units

4. Premium Storage Pte Ltd (PSPL) owns a 10 000 sq. ft. warehouse which can be
rent out for $7 000 per month. There was a proposal that PSPL provides two
forklifts and a potential tenant will be willing to pay $1.50 per sq.ft. per month
minimum usage of 7 000 sq.ft. The market hire of a forklift is $2 500 per month.
Evaluate and provide advice to PSPL.

4. PSPL has the option to rent with or without forklifts.

1st option: Rental is $7 000 for whole warehouse without forklifts

Income = $7 000

2nd option: Rent at $1.50 per sq.ft. with forklifts.

Minimum revenue 7 000 x $1.50 = $10 500
Maximum revenue 10 000 x $1.50 = $15 000
Hire expenses of two forklifts = 2 x $2 500 = $5 000
Minimum income = $10 500 - $5 000 = $ 5 500
Maximum income = $15 000 - $5 000 = $10 000

Suggestion: For the 2nd option, if the minimum floor usage can be set at 8000 sq.ft.
then the minimum income would be:
($12 000 - $5 000) = $7 000
In this case PSPL is better with the 2nd option because of the potential
higher income.

Alternatively, reduce the floor usage and sublet out a smaller lot (or
left for own use)

The above is based on no other expense related to the forklifts.

5. Star Marine Engineering (SME) manufactures generator spare parts and at present
has an output of 20 000 units. The following data relates to 2007.

$
Selling price 50
Variable production cost 30
Variable selling cost 5

Fixed production costs 100 000

Fixed selling costs 20 000

5.1 Calculate the level of production needed for SME to break-even.

5.2 SME is considering of doubling its production. To do so, it needs to occupy
additional premises at a cost of $210 000. What will be the break-even point?
5.3 Comment of SME’s new position in comparison to his original position.

5.1 Fixed costs = Fixed production costs + Fixed selling costs

= $100 000 + $20 000
= $120 000

Unit contribution = Unit selling price – Unit variable costs

= $50 – ($30 + $5)
= $15

Break-even point (units) = Fixed costs / Unit contribution

= 120 000/15
= 8 000 units

5.2 New fixed costs = $120 000 + $210 000

= $330 000

Break-even point (units) = 330 000/15

= 22 000 units

5.3 There is a substantial increase in break-even point. The unit contribution may be
reduced as more volume is pushed into the market place because there may be a
high chance that selling price may have to be reduced (price elasticity and
demand).
6. The following draft budgeted P&L has been made by Seagull Marine Supplier
for the year 2008.

$ (‘000) $ (‘000)
Sales 4 000
Direct sales costs 1 080
Direct labour costs 1 000
Variable overhead 400
Fixed overhead 1 000 3 480
Profit 520

6.1 Redraft the budget for 20% increase in sales.

6.2 Redraft the budget to take into account a 5% additional labour cost due to
restoration of CPF contribution and 20% increase in sales.
6.3 Complying in ENV new requirements will incur an additional $100000 for
safety equipment. Redraft the budget taking into account the 5% CPF
restoration and the 20% increase in sales.
6.4 Comment of the redrafted budget.

6.1
$ (‘000) $ (‘000)
Sales 4 800
Direct sales costs 1 296
Direct labour costs 1 200
Variable overhead 480
Fixed overhead 1 000 3 976
Profit 824

6.2
$ (‘000) $ (‘000)
Sales 4 800
Direct sales costs 1 296
Direct labour costs 1 260
Variable overhead 480
Fixed overhead 1 000 4036
Profit 764

6.3
$ (‘000) $ (‘000)
Sales 4 800
Direct sales costs 1 296
Direct labour costs 1 260
Variable overhead 480
Fixed overhead 1 100 4136
Profit 664

6.4 There are no limited resources. Is 20% increase in sales realistic? Will there be
more changes to the CPF or ENV requirements.
7. Prepare a pro forma analysis for Smith Blocks & Purchases, a small, start-up
manufacturing company, taking into consideration three alternative sales levels.
The company has no variable marketing costs.

Smith Blocks & Purchases

Pro forma analysis
For the upcoming month
Income Budgeted Pro Forma Analysis for
Statement amount Alternative Output Levels
line-item per unit
($) 10000 20000 30000
units units units
Revenue 40

Variable costs:
Materials 15
Labour 10
Overhead 5
Total

Contribution margin

Fixed costs:
Manufacturing 100000
overhead 50000
Marketing costs
Total fixed costs

Operating income
7.
Smith Blocks & Purchases
Pro Forma Analysis
For the upcoming month
Income Budgeted Pro Forma Analysis for
Statement amount Alternative Output Levels
line-item per unit
10,000 units 20,000 units 30,000 units
Revenue $40 $400,000 $800,000 $1,200,000

Variable costs:
Materials 15 150,000 300,000 450,000
Labor 10 100,000 200,000 300,000
Overhead 5 50,000 100,000 150,000
Total 30 300,000 600,000 900,000

Contribution $10 100,000 200,000 300,000

margin

Fixed costs:
Manufacturing
Overhead 100,000 100,000 100,000
Marketing costs 50,000 50,000 50,000
Total fixed costs 150,000 150,000 150,000

Operating income ($50,000) $50,000 $150,000

Since by definition, fixed costs are not expected to change as volume of output changes
within the relevant range, fixed costs remain the same at all three projected levels of
output. Revenue and variable costs vary with output in a linear fashion. Hence, when
output increases 100% from 10,000 units to 20,000 units, revenue, each line-item for
variable costs, and contribution margin all increase 100%.
8. The following information was obtained from Pan-Ocean Marine Consultancy and
Training Services.

Sales (sessions) for the month of October, 2008 = 24

Selling price per session $12,000
Material cost per session $ 600
Labour cost per session $ 4,000
Variable overhead per session $ 1,500 (based on 30 sessions per month)
Fixed overheads cost $80,000 per month

Prepare profit and loss statements for the months ended October 2008 on the basis
of the following.

8.1 Absorption costing

8.2 Marginal costing
8.3 The company is negotiating with a shipping consortium to conduct 20 training
sessions in the month of November, 2008. The outcome and its confirmation
will primarily depend on the selling price per session. Calculate the minimum
selling price that Pan-Ocean Marine may accept to breakeven (assuming no
other clients in November, 2008).

A8.1 Absorption costing

Pan-Ocean Marine Consultancy and Training Services

Profit & Loss Statement for the month ending 31st October, 2008
$ $
Sales 288,000
Material 14,400
Labour 96,000
Variable overheads 36,000
Work costs of sales 146,400
Gross Profit 141,600
Fixed overheads 80,000
Net profit 61,600

A8.2 Marginal

Pan-Ocean Marine Consultancy and Training Services

Profit & Loss Statement for the month ending 31st October, 2008
$ $
Sales 288,000
Material 14,400
Labour 96,000
Total marginal costs 110,400
Total contribution 177,600
Total fixed costs 125,000
Net profit 52,600
A8.3 Total material cost = $ 12,000
Total labour cost = $ 80,000
Total variable cost = $ 92,000
Total fixed cost = $ 125,000
Total cost = $ 217,000

To break even, total sales must equal total cost

 Total sales = $217,000

Minimum price per session = $ 217,000 ÷ 20

= $ 10,850
9. Rates charged by PacMar Shipping Services Pte Ltd
Sources of Income/Revenue
Container management fee per TEU $30
Freight commission 4½% of gross freight
Cargo commission per vessel/call $1,500
Husbandry fee per vessel/call $2,000

Base on 400 TEU’s per vessel/call, prepare a pro forma analysis for PacMar Shipping
Services Pte Ltd (PSSPL), a shipping agency company, taking into consideration three
alternative activity levels of two-ship, four-ship, and six-ship calls.
Based on past record and activities, the following assumptions are made in preparing
the analysis.
a) The average gross freight on 400 TEUs is $800,000
b) No significant change in variable costs with change in the numbers of
TEUs managed.

9.1 What is the minimum number of ship calls required so that PSSPL will not incur
any losses?
9.2 Based on your answer obtained in 91, what is the minimum number of TEUs
that PSSPL must manage on the latest ship call in order to break-even?
(Assuming freight = $2,000/TEU)
9.3 If PSSPL enterprise wants to break-even at two ship calls, calculate the
minimum number of TEUs it must manage at each call?

PacMar Shipping Services Pte Ltd

Pro-forma Analysis
For the upcoming month
Income Budgeted Pro Forma Analysis for
Statement amount Different Levels of Activities
line-item per ship 2 ship 4 ship 6 ship
call ($) calls calls calls
Revenue

Variable costs:
Materials 600
Labour 4,000
Tpt/Com/Crew/Surcharge 8,500
Total variable costs 13,100

Contribution margin

Fixed overhead 110,000

Operating income (loss)

A9.1 Container management fee per vessel/call ($30 x 400)=$ 12,000
Container freight commission per vessel/call
(4½% x $ 800,000) = $ 36,000
Cargo commission per vessel/call = $ 1,500
Husbandry fee per vessel/call = $ 2,000
Total revenue per vessel/call = $ 51,500

PacMar Shipping Services Pte Ltd

Pro forma analysis
For the upcoming month
Income Budgeted Pro Forma Analysis for
Statement amount Alternative Sales Levels
line-item per ship 2 ship 4 ship 6ship
call ($) calls Calls calls
Revenue 51,500 103,000 206,000 309,000

Variable costs:
Materials 600 1,200 2,400 3,600
Labour 4,000 8,000 16,000 24,000

Transport/Communication/
Crew / Surcharge 8,500 17,000 34,000 51,000
Total 13,100 26,200 52,400 78,600

Contribution margin 76,800 153,600 230,400

Fixed overhead 110,000 110,000 110,000 110,000
Operating income (loss) (33,200) 43,600 120,400

PacMar Shipping Services Pte Ltd

Pro forma analysis
For the upcoming month
Income Budgeted Pro Forma Analysis for
Statement amount Alternative Sales Levels
line-item per ship 2 ship 3 ship 4 ship
call ($) calls calls calls
Revenue 51,500 103,000 154,500 206,000

Variable costs:
Materials 600 1,200 1,800 2,400
Labour 4,000 8,000 12,000 16,000
Overhead 8,500 17,000 25,500 34,000
Total 13,100 26,200 39,300 52,400

Contribution margin 76,800 115,200 153,600

Fixed overhead 110,000 110,000 110,000 110,000

Operating income/loss (33,200) 5,200 43,600

A9.2

To break-even on the 3rd ship’s call, revenue earned = $ 51,500 - $ 5,200

= $ 46,300

Break-even revenue = $ 46,300 (3rd ship’s call)

Fixed revenue = $ 3,500 (cargo commission & husbandry)
Variable revenue = $ 42,800

Let the number of TEU be “x”

Container management fee per vessel/call ($30 x “x”) = 30x
Container freight commission per vessel/call (4½% x $2,000 x “x”) = 90x

90x + 30x = 42,800

120x = 42,800
x = 356.7

Minimum number of TEUs is 357 units.

Alternative method:
90x + 30x = $5,200
x = 43.3
 Minimum number of TEUs is 400 – 43 = 357 units

A9.3

To break-even at two ship calls,

Total contribution = $110,000
Unit contribution = $ 55,000
Unit variable cost = $ 13,100
Break-even revenue = $ 68,100
Fixed revenue = $ 3,500
Variable revenue = $ 64600

Let the number of TEU be “x”

Container management fee per vessel/call ($30 x “x”) = 30x
Container freight commission per vessel/call (4½% x $2,000 x “x”) = 90x

90x + 30x = 64,600

120x = 64,600
x = 538.3 units

Minimum number of TEUs is 539 units.