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ACCA F5 Workbook Activity Based Costing
ACCA F5 Workbook Activity Based Costing
ACCA F5 Workbook Activity Based Costing
com
ACCA F5 Workbook
Lecture 1
Activity Based
Costing
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Illustration 1
%
Costs relating to set-ups 35
Costs relating to materials handling 15
Costs relating to inspection 50
Total production overhead 100
The following total activity volumes are associated with each product line for the period as
a whole:
Product D 1 75 1 12 1 150
Product C 115 1 21 1 ,180
Product P 480 87 , 670
670 120 1,000
Required:
Identify the cost drivers for each of the cost categories above.
Solution
Category Driver
Illustration 2
Required
Solution
Illustration 3
Using the cost per driver in the previous example, what are the total overheads applicable
to product A?
Solution
Illustration 4
Company A has the following information applicable to its products:
Product A B
Units of Production 2,500 5,000
% Overheads
Set up Costs 35
Inspections 45
Materials Handling 20
A B Total
Set ups 300 50 350
Inspections 500 250 750
Goods Movements 300 700 1000
Solution
100,000 50,000 2
Item Working A B
76.4 72.8
Comparison
Pilot Paper Q1
June 2008 Q4
June 2010 Q1
December 2010 Q4
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Modern production techniques are such that many complex products with different
specifications, designs etc.will come off the same production line.
Aside from costs associated with simple absorption drivers such as labour hours
there will be many more costs associated with modern production lines such as set-
up costs, inspection costs and materials handling costs.
Just OVERHEADS!
Absorption costing can lead to overproduction because the more units you produce,
the lower the cost per unit as you absorb the same amount of labour hours or
machine hours over a larger number of units.
The price may change because the cost may change. If the company uses cost plus
pricing then they will change the price they charge as the cost per unit has
changed.
Pilot Paper Q1
June 2008 Q4
June 2010 Q1
December 2010 Q4
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Lecture 2
Life Cycle Costing
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Illustration 1
A product has a four year life-cycle.
The costs in each year are shown below. Calculate the total life-cycle cost and categorise
them into each type of cost.
Year 1 2 3 4
R&D 300
Design 200
Product Costs 75 90 90
Marketing 70 50 30
Costs
Distribution 20 27 24
Costs
Customer 15 23 30
Service Costs
Solution
Total
Distribution Costs 20 27 24 71
Illustration 2
R&D 200
Marketing Costs 50 40 20 4
($ million)
Production 2m 5m 10m 4m
Volume
The CEO says that a price of $54 should be charged to cover costs and has produced the
following schedule to support it:
$m
Marketing Costs 50
Production Costs 2m x 4 8
Total Production 2m
Calculate the Life-Cycle cost of the product and suggest an alternative price.
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Solution
R&D 200
Marketing Costs 50 40 20 4
($ million)
The costs in each year are shown below. Calculate the total life-cycle cost and categorise
them into each type of cost.
Year 1 2 3 4
R&D 200
Design 100
Product Costs 60 50 40
Marketing 40 30 10
Costs
Distribution 10 12 8
Costs
Customer 8 12 9
Service Costs
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R&D 300
Marketing Costs 70 40 30 8
($ million)
Production 4m 8m 11m 3m
Volume
The CEO says that a price of $40.25 should be charged to cover costs and has produced
the following schedule to support it:
$m
Marketing Costs 70
Production Costs 4m x 4 16
Total Production 4m
Calculate the Life-Cycle cost of the product and suggest an alternative price.
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Development.
The costs in each year are shown below. Calculate the total life-cycle cost and
categorise them into each type of cost.
Year 1 2 3 4
R&D 200
Design 100
Product Costs 60 50 40
Marketing 40 30 10
Costs
Distribution 10 12 8
Costs
Customer 8 12 9
Service Costs
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Answer
Period 1 2 3 4 Total
Marketing Costs 40 30 10 80
Distribution Costs 10 12 8 30
R&D 300
Marketing Costs 70 40 30 8
($ million)
Production 4m 8m 11m 3m
Volume
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The CEO says that a price of $40.25 should be charged to cover costs and has
produced the following schedule to support it:
$m
Marketing Costs 70
Production Costs 4m x 4 16
Total Production 4m
Calculate the Life-Cycle cost of the product and suggest an alternative price.
Answer:
R&D 300
Marketing Costs 70 40 30 8
($ million)
300 86 68 63 17.6
Total Production (4 + 8 + 11 + 3) 26
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Lecture 3
Target Costing
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Edward Co assembles and sells many types of radio. It is considering extending its
product range to include digital radios. These radios produce a better sound quality than
traditional radios and have a large number of potential additional features not possible with
the previous technologies (station scanning, more choice, one touch tuning, station
identification text and song identification text etc).
Required:
(a) Briefly describe the target costing process that Edward Co should undertake.!
! ! ! ! ! ! ! ! ! ! ! ! (3 marks)
(b) Explain the benefits to Edward Co of adopting a target costing approach at such
an early stage in the product development process.
! ! ! ! ! ! ! ! ! ! ! ! (4 marks)
(c) Assuming a cost gap was identified in the process, outline possible steps
Edward Co could take to reduce this gap.!
! ! ! ! ! ! ! ! ! ! ! ! (5 marks)
A selling price of $44 has been set in order to compete with a similar radio on the market
that has comparable features to Edward Co’s intended product. The board have agreed
that the acceptable margin (after allowing for all production costs) should be 20%.
Component 1 (Circuit board) – these are bought in and cost $4·10 each. They are bought
in batches of 4,000 and additional delivery costs are $2,400 per batch.
Assembly labour – these are skilled people who are difficult to recruit and retain. Edward
Co has more staff of this type than needed but is prepared to carry this extra cost in return
for the security it gives the business. It takes 30 minutes to assemble a radio and the
assembly workers are paid $12·60 per hour. It is estimated that 10% of hours paid to the
assembly workers is for idle time.
Production Overheads – recent historic cost analysis has revealed the following production
overhead data:
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Fixed production overheads are absorbed on an assembly hour basis based on normal
annual activity levels. In a typical year 240,000 assembly hours will be worked by Edward
Co.
Required:
(d) Calculate the expected cost per unit for the radio and identify any cost gap that
might exist.!
! ! ! ! ! ! ! ! ! ! ! (13 marks)
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Solution
(a)! Target costing process
Target costing begins by specifying a product an organisation wishes to sell. This will
involve extensive customer analysis, considering which features customers value and which
they do not. Ideally only those features valued by customers will be included in the product
design.
The price at which the product can be sold at is then considered. This will take in to account
the competitor products and the market conditions expected at the time that the product will
be launched. Hence a heavy emphasis is placed on external analysis before any
consideration is made of the internal cost of the product.
From the above price a desired margin is deducted. This can be a gross or a net margin. This
leaves the cost target. An organisation will need to meet this target if their desired margin
is to be met.
Costs for the product are then calculated and compared to the cost target mentioned above. If
it appears that this cost cannot be achieved then the difference (shortfall) is called a cost gap.
This gap would have to be closed, by some form of cost reduction, if the desired margin is to
be achieved.
–! The organisation will have an early external focus to its product development.
Businesses have to compete with others (competitors) and an early consideration of this will
tend to make them more successful. Traditional approaches (by calculating the cost and
then adding a margin to get a selling price) are often far too internally driven.
–! Only those features that are of value to customers will be included in the product
design. Target costing at an early stage considers carefully the product that is intended.
Features that are unlikely to be valued by the customer will be excluded. This is often
insufficiently considered in cost plus methodologies.
–! Cost control will begin much earlier in the process. If it is clear at the design stage
that a cost gap exists then more can be done to close it by the design team. Traditionally,
cost control takes place at the ‘cost incurring’ stage, which is often far too late to make a
significant impact on a product that is too expensive to make.
–! Costs per unit are often lower under a target costing environment. This enhances
profitability. Target costing has been shown to reduce product cost by between 20% and 40%
depending on product and market conditions. In traditional cost plus systems an
organisation may not be fully aware of the constraints in the external environment until
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after the production has started. Cost reduction at this point is much more difficult as
many of the costs are ‘designed in’ to the product.
–! It is often argued that target costing reduces the time taken to get a product to
market. Under traditional methodologies there are often lengthy delays whilst a team goes
‘back to the drawing board’. Target costing, because it has an early external focus, tends to
help get things right first time and this reduces the time to market.
Team approach
Cost reduction works best when a team approach is adopted. Edward Limited should bring
together members of the marketing, design, assembly and distribution teams to allow
discussion of methods to reduce costs. Open discussion and brainstorming are useful
approaches here.
Components
Edward Limited should look at the significant costs involved in components. New suppliers
could be sought or different materials could be used. Care would be needed not to damage the
perceived value of the product. Efficiency improvements should also be possible by reducing
waste or idle time that might exist. Avoid, where possible, non-standard parts in the design.
Assembly workers
Productivity gains may be possible by changing working practices or by de-skilling the
process. Automation is increasingly common in assembly and manufacturing and
Edward Limited should investigate what is possible here to reduce the costs. The learning
curve may ultimately help to close the cost gap by reducing labour costs per unit.
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(d)
Workings
Difference 80,000
Difference 4,000
Workings
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Cost Gap.
Manufacturing.
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Lecture 4
Throughput
Accounting
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Illustration 1
Required
Solution
(i)
Working $
7,500
(ii)
Working $
(iii)
10. State 3 other factors should be considered before ceasing production based on the
THAR.
June 2009 Q1
June 2011 Q5
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Just In Time
It ties up cash.
It increases costs eg. storage, insurance, etc.
It increases the risk of obsolescence.
It is an inefficient use of resources.
There are constraints within production processes called ‘bottlenecks’ that will
limit the amount that a factory can produce in a certain time period.
Return Per Factory Hour / Other Factory Costs Per Factory Hour
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10. State 3 other factors should be considered before ceasing production based on
the THAR.
Customer Perception.
Long term impact on the business.
Lost related sales.
Excess capacity.
June 2009 Q1
June 2011 Q5
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Lecture 5
Environmental
Accounting
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Internal
External
Carbon emissions
Use of energy and water.
De-forestation.
Health care costs.
Social costs.
Society as a whole.
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Lecture 6
Linear
Programming I
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Illustration 1
The number of machine hours available for production in the month is restricted to 500.
Sneakers 2
Maximum demand in the month is 150 units made up of any mix of designer shoes and
trainers.
What is the optimum level of production and the profit made at that level?
Solution
Machine Hours
X (Designer Shoes) 5
Y (Sneakers) 2
Any combination of X and Y must take less than 500 hrs to produce
So we can say:
(5hrs x No. Designer Shoes) + (2hrs x No. Sneakers) must be less
than 500 hrs
Demand
So we can say:
No. Designer Shoes + No. Sneakers must be less than or equal to 150 units
Non-Negativity
So we can say:
X can’t be less than 0
Y can’t be less than 0
Product Profit
Designer Shoes 50
Sneakers 30
If X = 0 then Y = 150
If Y = 0 then X = 150
Choose a profit level of say $2,000 and use the objective function to get 50X + 30Y =
2,000
We need to plot this on the graph so set X then Y to zero to get the points
Plot these on a graph and move the Iso-Profit line outwards in parallel from the origin to
find the outermost intersection and thus the optimal solution.
Optimum level
We can read from the graph at point B to find the production levels of 83 sneakers and
67 designer shoes.
We can also use simultaneous equations to solve the two constraints that intersect.
1) 5X + 2Y = 500
2) X + Y = 150
If we then multiply equation 2) by 2 we will be able to cancel out the Y portion of the
two equations:
That gives:
1) 5X + 2Y = 500
2) 2X + 2Y = 300
Optimum level
3. A business has only 300 labour hours available and 400 machine hours . They
produces 2 products - Digestives and Jammy Dodgers. Digestives take 3 labour hours
to produce and 5 machine hours. Jammy Dodgers take 4 labour hours and 3 machine
hours. Define the variables and establish the constraints.
4. If Digestives make contribution of $25 and Jammy Dodgers $37 establish the objective
function.
5. Establish the points to plot the graph of the constraints established in Q3.
June 2008 Q2
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3. A business has only 300 labour hours available and 400 machine hours . They
produces 2 products - Digestives and Jammy Dodgers. Digestives take 3 labour hours
to produce and 5 machine hours. Jammy Dodgers take 4 labour hours and 3 machine
hours. Define the variables and establish the constraints.
X (Digestives) 3 5
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Y (Jammy Dodgers) 4 3
Any combination of X and Y must take less than 300 hrs to produce
So we can say:
(3hrs x No. Digestives) + (4hrs x No. Jammy Dodgers) must be less than 300 hrs
Any combination of X and Y must take less than 400 hrs to produce
So we can say:
(5hrs x No. Digestives) + (2hrs x No. Jammy Dodgers) must be less than 400 hrs
So we can say:
X can’t be less than 0
Y can’t be less than 0
4. If Digestives make contribution of $25 and Jammy Dodgers $37 establish the objective
function.
Product Profit
Digestives 25
Jammy Dodgers 37
5. Establish the points to plot the graph of the constraints established in Q3.
Choose a profit level of say $2,000 and use the objective function to get 25X + 37Y =
2,000
We need to plot this on the graph so set X then Y to zero to get the points
Plot these on a graph and move the Iso-Profit line outwards in parallel from the origin to
find the outermost intersection and thus the optimal solution.
On our graph this is at point A where 3X + 4Y < 400 crosses the Y axis.
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Profit
We can read from the graph at point A to find the production levels of 75 Jammy
Dodgers and 0 Digestives.
June 2008 Q2
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Lecture 7
Linear
Programming II
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Illustration 1
The company producing sneakers and designer shoes in the previous illustration has
calculated that a marketing campaign will increase the demand for shoes by 1 unit to 150.
It is estimated that the campaign will increase overall costs by $7 per unit on average.
Solution
Shadow Price
We can also use simultaneous equations to solve the two constraints again with the
new constraint.
1) 5X + 2Y = 500
2) X + Y = 151
If we then multiply equation 2) by 2 we will be able to cancel out the Y portion of the
two equations:
That gives:
1) 5X + 2Y = 500
2) 2X + 2Y = 302
New Profit level at point B = (66 x 50) + (85 x 30) = £5,850 Profit
Shadow Price is the difference between the old and new levels of profit.
June 08 Q2
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Shadow Price
The company should not take up the offer as the labour hour added $9.25 in profit but
cost $20 to pay the labour.
June 08 Q2
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Lecture 8
Demand & Costs
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Illustration 1
A firm produces widgets and has found that for an increase in price from 35c per unit to
45c per unit demand will fall from 750,000 units to 500,000 units.
Calculate the price elasticity of demand and state whether it is elastic or inelastic.
Solution
Illustration 2
ABC Ltd sells a product at $12 per unit and has demand of 16,000 units at that price.
If the selling price were to be increased by $1 per unit, demand would fall by 2500 units.
On the assumption that the price/demand function is linear, derive the equation relating the
selling price to demand.
Solution
P (Price) 12
Illustration 3
A firm can choose to set the following prices which will lead to the following levels of
demand:
Price Demand
$20 50,000
$30 40,000
$40 20,000
Fixed Costs are $300,000 and variable costs are $15 per unit. What price should the firm
charge?
Solution
Illustration 4
A company is able to sell 2000 units per month at a price of $100. An increase in the
selling price to $110 will lead to a fall in demand to 1600 units. The variable cost per unit
is $40 and the fixed costs per month are $50,000.
Solution
(2 x 0.025Q) = 110
0.05Q = 110
Q= 2200
Profit 71,000
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5. A firm can choose to set the following prices which will lead to the following levels of
demand:
Price Demand
$25 60,000
$35 50,000
$45 35,000
Fixed Costs are $400,000 and variable costs are $17 per unit. What price should the firm
charge?
6. A company is able to sell 2500 units per month at a price of $120. An increase in the
selling price to $130 will lead to a fall in demand to 1800 units. The variable cost per
unit is $43 and the fixed costs per month are $60,000.
Now do it!
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P = a - bc
5. A firm can choose to set the following prices which will lead to the following levels of
demand:
Price Demand
$25 60,000
$35 50,000
$45 35,000
Fixed Costs are $400,000 and variable costs are $17 per unit. What price should the firm
charge?
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6. A company is able to sell 2500 units per month at a price of $120. An increase in the
selling price to $130 will lead to a fall in demand to 1800 units. The variable cost per
unit is $43 and the fixed costs per month are $60,000.
(2 x 0.014Q) = 112
0.028Q = 112
Q= 4,000
Profit 164,000
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Lecture 9
Pricing Strategy
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It ignores demand in the market which may well set the price.
An absorption rate is needed to absorb fixed costs.
Products which are bought and used together i.e. the sale of one depends on the
sale of another.
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Lecture 10
Cost/Volume/Profit
Analysis
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Illustration 1
Mage Co. produces a product with the following information for next month:
Variable Cost 40
Solution
(i)
Working $
Variable Cost 40
(ii)
Contribution $17,000
Sales 0
Variable Cost 0
Contribution 0
If Marge do not take the offer they make losses of $20,000 compared to losses of
$3,000 if they take the offer.
This highlights the importance of management understanding contribution (to fixed costs
and profit).
Neither option is sustainable in the long term but as trading is expected to improve then
accepting the smaller loss if $3,000 may mean the business can trade into the future
until conditions improve.
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Illustration 2
Sales Price 50
Variable Cost 30
Required:
(i) Calculate the following using ratios rather than the chart:
• Contribution to sales ratio.
• Break even point in units.
• Break even point in revenue.
• How many units need to be sold to achieve a profit of $50,000
• How much revenue is required to achieve a profit of $50,000.
• The margin of safety.
(ii) Draw a Break-even chart for the product based on the above information and determine
where the break even point is using the chart.
Solution
(i)
Illustration 3
Sales Price 50
Variable Cost 30
Required:
(i) Draw a Break-even chart for the product based on the above information and determine
where the break even point is using the chart.
Solution
Illustration 4
Product X Product Y
Sales Price 50 60
Variable Cost 30 45
Required:
(i) Calculate the break even point in sales revenue for company B
(ii)Calculate the sales revenue required to make a profit of $300,000.
550,000 1,600,000
Illustration 5
ABC produces 3 products A,B & C with the following data available:
A B C
Selling Price 30 50 75
Variable Cost 20 35 60
% of Total Sales 20 50 30
Required
(iii)Draw a Profit-Volume chart using the data in the question assuming the company
decides to sell the most profitable product first.
Solution
A 20 10 200 30 600
B 50 15 750 50 2500
C 30 15 450 75 2250
1400 5350
(iii)
We need to rank the products as we will show the effect if the company decides to sell the
most profitable product first:
A 10/30 = 0.33 1
B 15/50 = 0.3 2
C 15/75 = 0.2 3
We then need a table to set out the figures for our graph:
Graphing this showing one bow shaped line assuming that we sell all of the most
profitable product first and a second straight line assuming a constant product mix.
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Sales Price 75
Variable Cost 40
Required:
Product X Product Y
Sales Price 40 75
Variable Cost 20 52
Required:
(i) Calculate the break even point in sales revenue for company B
(ii)Calculate the sales revenue required to make a profit of $250,000.
5. ABC produces 3 products A,B & C with the following data available:
A B C
Selling Price 40 45 90
Variable Cost 35 37 75
% of Total Sales 30 50 20
Required
(iii)Show the points to plot on a Profit-Volume chart using the data in the question
assuming the company decides to sell the most profitable product first.
Sales Price 75
Variable Cost 40
Required:
Solution
Product X Product Y
Sales Price 40 75
Variable Cost 20 52
Required:
(i) Calculate the break even point in sales revenue for company B
(ii)Calculate the sales revenue required to make a profit of $250,000.
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Solution
3,760,000 11,000,000
5. ABC produces 3 products A,B & C with the following data available:
A B C
Selling Price 40 45 90
Variable Cost 35 37 75
% of Total Sales 30 50 20
Required
(iii)Show the points to plot on a Profit-Volume chart using the data in the question
assuming the company decides to sell the most profitable product first.
Solution
A 3 5 15 40 120
B 5 8 40 45 225
C 2 15 30 90 180
85 525
(iii)
We need to rank the products as we will show the effect if the company decides to sell the
most profitable product first:
A 5/40 = 0.125 3
B 8/45 = 0.178 1
C 15/90 = 0.167 2
We then need a table to set out the figures for our graph:
Lecture 11
Relevant Costing
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Illustration 1
ABC Co. is considering a project to produce a one-off run of products for a customer. They
can employ non-skilled staff at short notice who are paid $8 per hour and are not currently
needed elsewhere in the business. The production run will also use skilled labour who are
currently employed on another project which creates contribution of $35 per hour for the
business. The skilled labour are paid $20 per hour.
(i) What is the relevant cost of labour for inclusion in the evaluation of the project by ABC?
(ii) If the unskilled labour was employed by ABC on contract guaranteeing them work for
the 500 hours in any area of the factory then what would the labour cost be?
Solution
(i)
Working $
Working $
Illustration 2
Laddy Co. is considering undertaking a one-off building project.
The project will use 2 different types of window, standard and decorative.
Standard windows currently cost $40 each and the project will require 20,000 of these.
Decorative brick currently costs $120 each and the project will require 2,000 of these.
Laddy has 7,000 standard windows in stock which cost $30 when they were purchased 3
months ago. These are used in all projects undertaken by Laddy and there are 3 other
projects in progress at the moment.
Laddy has 300 decorative windows in stock which cost $150 when they were purchased.
They do not expect to use the decorative type on future projects and could sell any that
they have for their current cost price less 10% as some are damaged.
What is the total relevant cost of the windows for consideration of the project?
Solution
Working $
Illustration 3
A builder has been asked to quote for a job and has the following information available
about the costs:
Item Detail $
Direct Materials
Direct Labour
Other Costs
Notes:
1. The contract requires 400,000 bricks of this standard type. The builder has 200,000
already in stock and will need to buy 200,000. The 200,000 at $100 per 1,000 in the
quote above were bought at that price earlier in the year. The current replacement cost
for this type of brick is $120 per 1,000. If the bricks are not used on this project the
builder is confident that he will be able to use them later on in the year.
2. This is the purchase price of other materials that will be bought in as required.
3. The builder intends to work 800 hours of the skilled work himself and hire the rest in on
an hourly basis at $12 per hour. If the builder does not take on this job he can either
work for other builders at $12 per hour or complete urgently required work to his own
house for which he has been quoted $12,000 by another builder.
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6. The job will take 20 weeks and the machine will not be used on any other job if this job
is not taken on.
7. This represents the cost of the storage yard used by the builder. If this is not used it can
be rented out to a competitor for the 20 week period at a rent of $500 per week.
8. This is the cost of drawing up the plans for the project. These were drawn up several
weeks ago.
Required:
20 Marks
Solution
(i)
Note Treatment
1 The bricks are used regularly and replaced so the relevant cost is the
replacement cost of $120 per 1,000.
3 The builder’s personal labour will be charged at the next best use of his time
which would be the $12,000 to repair his own house. The rest of the labour
will be charged at $12.
4 The unskilled labour must be paid in any case and is therefore not relevant.
6 Depreciation is not a cash flow and the machinery has been purchased
already and it’s value is unaffected by the contract so this is not included.
7 The cost will be the next best use of the yard i.e. renting it out.
(ii)
Item Detail $
Direct Materials
Direct Labour
Other Costs
Profit 0
Illustration 4
Archie Co. produces 2 products, A and B with the following information available:
A B
Another supplier has offered to supply A at a price of $12 and B for $21.
Solution
A B
Illustration 5
Alder Co. produces 3 components with the following information available:
A B C
Required:
Solution
(i)
A B C
(ii)
A B C
(iii)
Buying in Product A
Saving/(Cost) $0.05
(iv)
How any spare capacity created by outsourcing the component production would be
used.
How the current workforce will react to the outsourcing - could it create ill will from the
employees?
The ability to produce the components will likely be lost if they are bought in. This looses
the company control of that production process.
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2. If a business is to use machinery currently owned on a new project is the cost of the
machinery relevant?
3. If labour can be used elsewhere in the organisation what are the 3 elements to
calculating the relevant cost of that labour?
4. If materials are in stock and are used and replaced regularly then what is their relevant
cost?
5. If materials are in stock but aren’t used and replaced regularly how is their relevant cost
determined?
6. What other considerations other than financial need to be considered when deciding
whether to make or buy in components?
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The cost must be a cash-flow, a future cost and caused by the project i.e.
incremental or additional.
2. If a business is to use machinery currently owned on a new project is the cost of the
machinery relevant?
3. If labour can be used elsewhere in the organisation what are the 3 elements to
calculating the relevant cost of that labour?
4. If materials are in stock and are used and replaced regularly then what is their relevant
cost?
5. If materials are in stock but aren’t used and replaced regularly how is their relevant cost
determined?
6. What other considerations other than financial need to be considered when deciding
whether to make or buy in components?
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Lecture 12
Decision Making
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Illustration 1
ABC Ltd manufactures two components A & B. There are to be 5000 of each component
manufactured next year. The following information is available for each unit of A & B.
A sub-contractor is willing supply ABC with units of A & B for $27 and $38 respectively.
Advise ABC.
Solution
Considerations
B (5,000 x 6) 30,000
50,000
The one with the LOWEST EXTRA VARIABLE COST TO BUY PER MACHINE HOUR.
A B
Extra variable cost of buying P/hr saved (2/4) = $0.50 (4/6) = $0.66
The company should make all of product B and as much as possible of product A before
buying in the rest of A.
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Illustration 2
ABC Ltd manufactures two components A & B. There are to be 3,000 of unit A and 4,000
of unit B manufactured next year. The following information is available for each unit of A
& B.
A sub-contractor is willing supply ABC with units of A & B for $25 and $40 respectively.
Advise ABC on which components should be made and calculate how many units of the
other should be bought in.
Solution
Considerations
B (4,000 x 5) 20,000
29,000
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A B
The company should make all of product A and as much as possible of product B before
buying in the rest.
Illustration 3
ABC Ltd produces two products out of a joint process - products A & B.
At this point A can be sold for $1.25 and B can be sold for $2.00.
ABC can further process product A to produce A+ but it will incur further set up costs of
$20,000 and variable costs of $0.30 per unit introduced into the further process to do so.
Solution
A A+
Illustration 4
Elco Co. has decided to close department 3 in it’s operations.
You have been asked to review the decision based on the following information:
1 2 3 Total
Cost of Sales
Notes
1. The production overheads of $15,000 have been allocated to the 3 departments on the
basis of sales revenue. On further investigation you realise that only 50% of these can
be traced directly to these departments and can be allocated on the basis 2:2:1.
2. Expenses are head office expenses of which 60% can be traced to the departments and
can be allocated on the basis 3:3:2.
3. 80% of the labour is a fixed cost and the remaining amounts would be better allocated
on the basis of sales volume.
Solution
1 2 3 Total
Cost of Sales
2. ABC Ltd manufactures two components A & B. There are to be 300 of each component
manufactured next year. The following information is available for each unit of A & B.
A sub-contractor is willing supply ABC with units of A & B for $21 and $25 respectively.
Advise ABC.
5. ABC Ltd produces two products out of a joint process - products A & B.
At this point A can be sold for $3 and B can be sold for $2.00.
ABC can further process product A to produce A+ but it will incur further set up costs of
$8,000 and variable costs of $1.30 per unit produced at the end of further processing to do
so.
6. Why might a company choose not to shut down a division which is making a loss?
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The company will buy in the element with the lowest EXTRA variable cost PER UNIT
OF SCARCE RESOURCE.
2. ABC Ltd manufactures two components A & B. There are to be 300 of each component
manufactured next year. The following information is available for each unit of A & B.
A sub-contractor is willing supply ABC with units of A & B for $21 and $25 respectively.
Advise ABC.
Solution
Considerations
B (300 x 4) 1,200
2,700
The one with the LOWEST EXTRA VARIABLE COST TO BUY PER MACHINE HOUR.
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A B
The company should make all of product B and as much as possible of product A before
buying in the rest of A as A has the LOWEST EXTRA VARIABLE COST TO BUY PER
MACHINE HOUR i.e. it is cheaper to buy in product A per machine hour used.
5. ABC Ltd produces two products out of a joint process - products A & B.
At this point A can be sold for $3 and B can be sold for $2.00.
ABC can further process product A to produce A+ but it will incur further set up costs of
$8,000 and variable costs of $1.30 per unit produced at the end of further processing to do
so.
Solution
A A+
6. Why might a company choose not to shut down a division which is making a loss?
December 2007 Q4
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Lecture 13
Risk & Uncertainty
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Illustration 1
ABC Ltd produces widgets and has the following expected sales volumes and costs
Price $5 $6
Expected Sales:
Variable costs are $3 per unit and fixed costs are $20,000
Solution
The price chosen will depend on the attitude to risk of the manager making the decision.
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Illustration 2
Ed Co. are considering 2 options for investing their money in a new project. The expected
probability of various profit levels are shown below.
Option 1 Option 2
Probability Profit Probability Profit
£ £
70% 5000 20% (1000)
30% 7000 20% 4000
40% 7000
20% 10000
Calculate an expected value for each option and advise Ed Co. on which option should be
chosen.
Solution
Option 1 Option 2
Illustration 3
A company is considering a project which is expected to generate a return of $40,000. The
investment required in the project is $100,000 and the sales generated are expected to be
$250,000.
Solution
Sensitivity Analysis
The initial investment would have to go up by 40% to cancel out the return generated.
Sales would need to fall by 18% to cancel out the return generated.
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Illustration 4
Jim Co. sell smoothies to coffee shops and bars. A smoothie costs $3 to make and sells
for $5 to the coffee shop or bar. The contribution per smoothie is therefore $2.
Jim Co. supplies smoothies on 350 days per year and based on previous experience the
demand will be as follows:
Days Demand
70 300 smoothies
60 400 smoothies
Each production run of smoothies is in batches of 100 so Jim Co. must decide how many
smoothies to supply per day this year.
Solution
Probabilities Calculation
Pay-off Table
Daily Supply
Illustration 5
Using each of the Maximax, Maximin and Minimax regret rules which option will Jim Co.
choose when deciding on how many smoothies to supply each day?
Solution
Maximin Rule
The best minimum profit that is available is gained supplying 100 smoothies for a
minimum profit of $200.
Pay-off Table
Daily Supply
Maximax Rule
The maximum achievable profit is gained by supplying 400 smoothies a day to achieve
$800.
Pay-off Table
Daily Supply
Minimax Regret rule seeks to minimise the opportunity cost of making the wrong
decision.
Take the pay-off at each level of supply and establish the difference between the biggest
pay-off available and the pay-off at the rest of the levels of supply.
Daily Supply
Pay-off Table
3. If there is a 35% chance that a project will make $10,000 and a 65% chance that it will
make $25,000 what is the expected value?
6. If a project has an expected return of $400,000 and an initial investment of $1m what is
the sensitivity margin of the project to the initial investment?
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3. If there is a 35% chance that a project will make $10,000 and a 65% chance that it will
make $25,000 what is the expected value?
Probability Profit
It tells us what we would expect the result to be on average over time with
repetition.
Sensitivity Analysis.
6. If a project has an expected return of $400,000 and an initial investment of $1m what is
the sensitivity margin of the project to the initial investment?
A pay-off table sets out the profit or loss from various choices of supply depending
on what demand is.
The maximin decision rule states that decisions will be based on maximising the
minimum achievable profit. It is a risk averse decision making technique.
The maximax decision rule states that decisions will be based on maximising the
maximum achievable profit. It is based on an optimistic view of what can be
achieved, but can be argued to be too optimistic.
The minimax regret decision rule states that decisions will be based on minimising
the opportunity cost of making the wrong decision. The opportunity cost is set out
for each level and the level with the lowest opportunity cost is chosen.
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Lecture 14
Decision Trees
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Illustration 1
A student is deciding how to get to class and has 2 choices:
There is a 25% chance that it will rain and if it does the student will have to pay $10 to get
their clothes dry cleaned.
Draw a decision tree to assess whether the student should walk or take the bus.
Solution
W1 - Expected Value of Public Transport
Rain 0.25 0 0
No Rain 0.75 0 0
Total EV 0
No Rain 0.75 0 0
Total EV -2.5
Public Transport 5 0 5
Illustration 2
Say that the student in the above illustration could take an umbrella to avoid getting wet
when walking but there is a 10% chance that the student will lose the umbrella costing $20
at college.
Solution
No Rain 0.75 0 0
Total EV -2.5
Total EV -2
Public 5 0 0 5
Transport
Walking - With 0 0 2 2
umbrella
Walking with the umbrella has the lowest total cost so is the best option
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Illustration 3
We have 3 choices, we can invest in stocks, bonds or put the money on deposit. The
returns of each are sumarised below:
Up
$1,500 $900 $500
(50% chance)
Even
$300 $600 $500
(30% chance)
Down
-$800 $200 $500
(20% chance)
(i) Calculate the expected value for investing in each of stocks, bonds and deposit.
(ii)Select the best investment for each of the 3 possibilities i.e that the market goes up,
goes down and is even and calculate the expected value of these ‘best’ choices.
(iii)Based on the above answers, what is the price of perfect information in this instance?
Solution
(i)
Up
$1,500 x
(50% 750 $900 x 0.5 450 $500 x 0.5 250
0.5
chance)
Even
(30% $300 x 0.3 90 $600 x 0.3 180 $500 x 0.3 150
chance)
Down
-$800 x
(20% -160 $200 x 0.2 40 $500 x 0.2 100
0.2
chance)
(ii)
(iii)
4. How is each of the items outlined in Q2 & Q3 represented on the decision tree?
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A choice that the manager must make that is therefore controlled by the manager.
The event is what will occur - it can’t be controlled but the probability of it
happening can be calculated and used to make the decision.
4. How is each of the items outlined in Q2 & Q3 represented on the decision tree?
By comparing the expected value of the outcome with the expected value if you
knew what was going to happen.
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Lecture 15
Budgeting
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Any 3 of:
The budget may lack detail and thus create conflict between managers.
Managers may build slack into the budget.
The budget may be sat in a way that is too inflexible.
The budget may be un-coordinated between divisions or departments.
Employees may focus on the minimum level expected to be achieved rather than
aiming higher.
The budget may encourage short term-ism.
The budget may not be communicated throughout the organisation.
The budget may be set at too high a level for the employees to meet the targets.
This may well be demotivating to the employees as they feel that they are being set
impossible levels to try to achieve.
The staff setting the budget will know the department well.
The setting of the budget by employees may well result in higher motivation among
those employees.
The setting of the budget by employees may well result in more commitment by
those employees.
The budget set by employees may be more realistic.
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Lecture 16
Budgetary Systems
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It would be kept as a broad planning tool in order to evaluate how far the business
had come from the point at which it was fixed.
Define the decision packages based on the cost and the benefits provided by that
area of the business.
Evaluate and rank the areas of the business based on step 1.
Allocate resources based on the ranking in step 2.
ABB uses the data created through Activity Based Costing to create the budget.
A rolling budget is continually updated monthly with a budget always available for
the next period, for example 6 months. As each month passes an extra month added
to the end.
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Lecture 17
Learning Curve
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Illustration 1
ABC plans to produce a new type of product.
The first unit will take 300 hours to produce and 80% learning curve will apply.
What will be the cumulative average time taken per unit and the total time taken for the
first unit and the eighth unit?
Solution
1 300 300
Illustration 2
Calculate the learning factor for an 80% learning rate.
Solution
Working Value
Illustration 3
ABC plans to produce a new type of product.
The first unit will take 300 hours to produce and 80% learning curve will apply.
What will be the cumulative average time taken per unit and the total time taken for the
eighth unit?
Solution
1 300 300
Illustration 4
An 80% learning curve applies to production of Widgets.
The costs involved in the production of the 1st unit are as follows:
Cost $
Materials 100
148
Solution
Total Cost of 50 units
Working Value
Illustration 5
A 90% learning curve applies to production of Widgets.
Solution
December Costs
Working Value
January Costs
Working Value
5. How can I remember the learning curve formula and what each bit of it means for the
exam?
6. What will b be in the learning curve formula for a 90% learning rate?
December 2009 Q2
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The learning curve refers to the fact that over time a process will become more
efficient as employees learn to do it more efficiently. This will lead to less time being
taken to complete the task and therefore less cost.
The learning rate states that the cumulative average time taken to produce one unit
decreases by a constant percentage each time output doubles and tells us what that
percentage is.
5. How can I remember the learning curve formula and what each bit of it means for the
exam?
You are given the formula and told what each bit is on your exam paper.
6. What will b be in the learning curve formula for a 90% learning rate?
Working Value
To predict the time and cost of labour in the future on a process or one-off job.
To create realistic budgets.
To create an accurate standard cost of production.
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Lecture 18
Standard Costing
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2. If we compare our standard cost with the actual cost, what is the difference called?
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2. If we compare our standard cost with the actual cost, what is the difference called?
A variance.
An ‘Ideal’ standard cost is an aspirational standard set at the highest possible level
and is usually unattainable but serves as something to strive for.
Idle time is time where production has stopped creating a gap in production. It may
be due to break-down in machinery or perhaps a lack of orders for the factory to
produce.
The manager who controls the cost should be responsible for it.
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Lecture 19
Simple Variances
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Illustration 1
Sticky Wickets manufactures Cricket Bats. In May 2010 the budgeted sales and production
were 19,000 bats and the standard cost card is as follows:
Marginal Cost 49
Selling Price 68
Contribution 19
Total fixed costs in the period were budgeted at $100,000 and were absorbed on the
basis of labour hours worked.
40,000kg of wood were bought at a cost of $196,000, this produced 19,200 cricket bats.
No inventory of raw materials is held. The labour was paid for 62,000 hours and the total
cost was $694,000. Labour worked for 61,500 hours.
The sales price was reduced to protect the sales levels. However, only 18,000 cricket bats
were sold at an average price of $65.
Calculate the sales, materials, labour, variable overheads, fixed overheads variances and
any other appropriate variances in as much detail as possible.
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Solution
Idle Time
Absorption Rate
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Whether each unit sold for more or less than the budgeted selling price.
Whether more or less than the budgeted amount of units were sold.
Whether the actual production used more or less units of materials than budgeted.
Whether the labour cost more or less per hour than budgeted for.
The difference between expected Idle time and actual idle time.
Whether the variable overhead cost more or less per hour than expected.
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Lecture 20
More Variances
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Illustration 1
A soup manufacturing company makes soup using two raw materials, leeks and potatoes.
The standard materials usage and cost of one litre of soup is:
$
Leeks 4 @ $0.25 per Leek 1
1.60
In December 3,000 litres of soup were made using 8,000 leeks and 28,000 potatoes.
Solution
Inputs Amounts
Leeks 8,000
Potatoes 28,000
Leeks 4 4/10
Potatoes 6 6/10
Total 10
Illustration 2
A soup manufacturing company makes soup using two raw materials, leeks and potatoes.
The standard materials usage and cost of one litre of soup is:
$
Leeks 4 @ $0.25 per Leek 1
1.60
In December 3,000 litres of soup were made using 8,000 leeks and 28,000 potatoes.
Solution
Leeks 4 0.25 1
Working $
Illustration 3
A company produces 3 products with the following budgeted information available:
A B C
A B C
Calculate:
Solution
Total 488,500
Total 508,500
A B C
Product Amounts
A 9,500
B 13,500
C 8,500
A 10,000 10/32
B 13,000 13/32
C 9,000 9/32
Total 32,000
A 344 $4 $1,376 A
B 703 $5 $3,515 F
C 359 $5 $1,795 A
A B C
Illustration 4
ABC produces a product with a budgeted standard materials cost of $30. The price of
materials rose during the period due to a world shortage to $40.
Calculate the Materials Price Variance and the Materials Price Planning Variance.
Solution
Working $
Working $
Illustration 5
ABC produces a product with a budgeted standard materials cost of $30. The price of
materials rose during the period due to a world shortage to $40.
Calculate the Materials Price Variance and the Materials Price Operational Variance.
Solution
Working $
Working $
Working $
Illustration 6
ABC produces a product with a budgeted standard materials cost of $45. The price of
materials rose during the period due to a world shortage to $55.
Calculate the Materials Price Variance and the Materials Price Planning and Operational
Variance.
Solution
Working $
Working $
Working $
Working $
Illustration 7
A new product requires 4 hours of labour at a standard rate of $7 per hour.
Actual results:
Management realised during the first day of the job that the job was more specialised than
anticipated and that labour would have to be paid at $8 per hour but that the standard time
should have been 3 hours per unit.
Calculate the labour rate variance, the labour efficiency variance and the planning and
operational rate and efficiency variances.
Solution
Total Labour Variance
Working $
Working $
Working $
Working $
Working $
Variance Adverse 80
Working
Standard Cost $7
Working $
Standard Cost $7
Working $
Illustration 8
The budgeted sales volume for January is 100 units, with a selling price of $21 per unit
and marginal cost of $11.
Solution
Pilot Paper Q2
June 2011 Q3 (b)
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The difference between the standard mix of materials expected to be used and the
actual mix of materials used.
The difference between what would be expected to be produced given the inputs
into the system and what was actually produced.
The difference between the profit generated from the standard sales mix and the
actual sales mix (measured at the standard profit).
The difference between the actual sales in the standard mix and the budgeted sales
(measured at the standard profit).
Managers should only be responsible for variances that they can control.
Pilot Paper Q2
June 2011 Q3 (b)
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Lecture 21
Performance
Measurement
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Illustration 1
X1 X2 X3
$‘000 $‘000 $‘000
Tax 120 90 50
Using the information on the previous page calculate and comment on the following Ratios
for each year:
Solution
Return on Capital Employed (ROCE)
X1 X2 X3
Non Current Assets + Net Current Non Current Assets 500 700 1000
Assets
Net Current Assets (Current (150 - 100) = (200 - 120) = (300 - 270) =
Assets - Current Liabilities) 50 80 30
Return on Capital Employed PBIT / Capital Employed (500 / 550) = (500 / 780) = (300 / 1030)
90.91% 64.10% = 29.13%
X1 X2 X3
In the first year the ROCE was 90.91%. At first glance this would appear to be a good return, however
without industry averages or prior period information we are unable to tell if this is the case.
In year X2 the ROCE is 64.10%. This is a fall of 29.5% from the previous year indicating that the business
in not able to make the same return on it’s assets that it has previously been able to do.
In the year X3 the ROCE is 29.13%. This is a fall of 54.55% indicating that there may be some serious
underlying problems which are affecting the ability of the business to generate the return on capital
previously generated.
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Margin Analysis
X1 X2 X3
Gross Margin (Gross Profit / Revenue) (1000 / 3000) = (1100 / 3500) = (1000 / 4200) =
33.33% 31.42% 23.89%
Net Margin (PAT / Revenue) (280 / 3000) = 9.3% (260 / 3500) = 7.4% (30 / 4200) = 0.7%
Operating Margin (PBIT / Revenue) (500 / 3000) = (500 / 3500) = (300 / 4200) = 7.1%
16.66% 14.28%
Margin Analysis
The Gross Margin is 33.33% in X1 and holds reasonably steady in X2 at 31.42%. However in X3 the Gross Margin
falls to 23.89% indicating that the business has either had to cut prices to sell the greater volume it has, or the cost of
it’s purchases have gone up.
The Net Margin is 9.3% in X1 but begins to fall in X2 with 7.4% achieved, before falling dramatically to 0.7% in X3.
The main reason for this is the fall in Gross Profit as other costs have risen in line with expectations given the
increase in sales. However another point to note is that interest costs have risen with the increase in long term loans.
The extra interest costs have put pressure on the business.
The Operating Margin dropped slightly in X2 to 14.28% from 16.66% the previous year - a fall of almost 15%. In X3
the Operating Margin fell away to 7.1%, a decrease of over 50%. This is due to the decreasing Gross Margin
achieved as well as rises in the other expenses.
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X1 X2 X3
EPS (280 / 300) = 93c (260 / 300) = 86c (30 / 300) = 10c
The EPS in year X1 is 93c. We don not have industry comparatives or prior year information with which to
compare this.
In year X2 the EPS decreases to 86c. This indicates that the business earnings are dropping as the
number of shares has remained constant.
In year X3 the EPS has decreased dramatically to 10. This is a problem and indicates a severe problem in
the earning capacity of the business. EPS has now decreased by 90% in 2 years.
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Illustration 2
$‘000
ASSETS
Inventory 300
Receivables 200
Cash 300
1800
LIABILITIES
Reserves 200
Payables 100
Overdraft -
1800
Income Statement
$‘000
Revenue 1000
COS 800
Other Information:
Required:
Solution
Less:
164
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Illustration 3
$‘000
ASSETS
Inventory 300
Receivables 200
Cash 300
1800
LIABILITIES
Reserves 200
Payables 100
Overdraft -
1800
Required:
Calculate the Current ratio and Quick ratio for Inter Ltd.
Solution
Illustration 4
X1 X2 X3
$‘000 $‘000 $‘000
Using the information on the previous page calculate and comment on the following Ratios
for each year:
Solution
Item X1 X2 X£
Financial Gearing
Item X1 X2 X3
Operational Gearing
Item X1 X2 X3
Interest Cover
2. What are the 3 ways to calculate capital employed in the ROCE calculation?
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2. What are the 3 ways to calculate capital employed in the ROCE calculation?
The period of time a business takes between paying money out on inventory an
getting it back via customers paying for sales.
Contribution / PBIT
PBIT / Interest
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Lecture 22
More Performance
Measurement
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Illustration 1
Firm A produces a component used by another division in the group (Firm B).
Transferring the unit to B means that A cannot sell the unit on the open market which
would have gained them contribution of $20.
Calculate the:
Solution
Illustration 2
A business has two divisions with the following result applicable:
Division A Division B
$‘000 $‘000
The non current assets are depreciated on 20% straight line depreciation.
The company assesses the performance of it’s divisions on the basis of the Return on
Investment.
Calculate the ROI for each division for this year and the next if the profit before
depreciation and net current assets are the same for each period.
Solution
Illustration 3
A business has two divisions with the following result applicable:
Division A Division B
$‘000 $‘000
The non current assets are depreciated on 20% straight line depreciation.
The company assesses the performance of it’s divisions on the basis of the Residual
Income and has a cost of capital of 8%
Calculate the RI for each division for this year and the next if the profit before depreciation
and net current assets are the same for each period.
ACCA F5 - Performance Measurement www.mapitaccountancy.com
Solution
Period 1 Division A Division B
2,100 3,150
Cost of Capital 8% 8%
1,700 2,550
Cost of Capital 8% 8%
6. What are the advantages of setting the market price as the transfer price?
8. What are the downsides of using ROI to measure performance between divisions?
10.What are the 4 aspects to the Balanced Scorecard method of performance evaluation?
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Divisions self interest means they will not necessarily agree with the price set.
The transfer price set will affect the performance of the division and the
organisation.
The price set may cause disputes between managers.
The transfer price may not enable the organisation best achieve it’s goals.
6. What are the advantages of setting the market price as the transfer price?
It gives the division autonomy to make profit if the market price enables them to do
so.
It should maximise company profits.
Less arguments will be created as the market price cannot be disputed.
ACCA F5 - Performance Measurement www.mapitaccountancy.com
8. What are the downsides of using ROI to measure performance between divisions?
The ROI will change with accounting policies e.g. Depreciation rates.
If the NBV of assets decreases the ROI increases.
It is a dis-incentive to investment.
No focus on shareholder wealth maximisation.
Ignores intangible assets.
Financial Perspective
Internal Processes Perspective
Learning and Growth Perspective
Customer perspective
Pilot Paper Q4
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