WEEK 2 ACCY312

7.3 Distinguish between value-added and non-value-added costs. Support your answer by
giving two examples of a value-added cost and two examples of a non-value-added cost.

Solution:
A value-added cost is a cost that customers perceive as adding value, or utility, to a product or
service. Examples are costs of materials, direct labour, tools and machinery. A non-value-added
cost is a cost that customers do not perceive as adding value, or utility, to a product or service.
Examples of non-value-added costs are costs of rework, scrap, expediting and breakdown
maintenance.

7.6 Explain the benefits and costs of using a product life-cycle reporting format.

Solution:
Three benefits of using a product life-cycle reporting format are:
1. The full set of revenues and costs associated with each product becomes more visible.
2. Differences among products in the percentage of total costs committed at early stages in
the life cycle are highlighted.
3. Interrelationships among business function cost categories are highlighted.

7.16 Target costing, analyse activities

Adonis Pty Ltd is a small distributor of marble tiles. Adonis identifies its three major activities and
cost pools as ordering, receiving and storage, and shipping, and it reports the following details
for 2018:
Quantity of Cost per unit of

Activity Cost driver cost driver cost driver

1. Placing and paying for orders of Number of orders 500 $50 per order

marble tiles
2. Receiving and storage Number of loads moved 4000 $30 per load
3. Shipping of marble tiles to Number of shipments 1500 $40 per shipment

retailers

For 2018, Adonis buys 250 000 marble tiles at an average cost of $3 per tile and sells them to
retailers at an average price of $4 per tile. Assume that Adonis has no fixed costs and no
inventories.

Required
1. Calculate Adonis’s operating profit for 2018.
2. For 2019, retailers are demanding a 5% discount off the 2018 price. Adonis’ suppliers are
only willing to give a 4% discount. Adonis expects to sell the same quantity of marble tiles
in 2019 as in 2018. If all other costs and cost-driver information remain the same,
calculate Adonis’s operating profit for 2019.
3. Suppose further that Adonis decides to make changes in its ordering and receiving and
storing practices. By placing long-run orders with its key suppliers, Adonis expects to
reduce the number of orders to 200 and the cost per order to $25 per order. By

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 redesigning the layout of the warehouse and reconfiguring the crates in which the
marble tiles are moved, Adonis expects to reduce the number of loads moved to 3125
and the cost per load moved to $28. Advise the management of Adonis on whether it will
achieve its target operating profit of $0.30 per tile in 2019. Show your calculations.

Solution: (25-30 min.)

Target costing, analyse activities
1. Adonis’s operating profit in 2018 is as follows:

Total for
250 000 Tiles Per Unit
(1) (2) = (1) ÷ 250 000
Revenues ($4  250 000) $1 000 000 $4.00
Purchase cost of tiles ($3  250 000) 750 000 3.00
Ordering costs ($50  500) 25 000 0.10
Receiving and storage ($30  4 000) 120 000 0.48
Shipping ($40  1 500) 60 000 0.24
Total costs 955 000 3.82
Operating profit $ 45 000 $0.18

2. Price to retailers in 2019 is 95% of 2018 price = 0.95  $4 = $3.80; cost per tile in 2019 is
96% of 2018 cost = 0.96  $3 = $2.88.

Adonis’s operating profit in 2019 is as follows:

Total for
250 000 Tiles Per Unit
(1) (2) = (1) ÷ 250 000
Revenues ($3.80  250 000) $ 950 000 $3.80
Purchase cost of tiles ($2.88  250 000) 720 000 2.88
Ordering costs ($50  500) 25 000 0.10
Receiving and storage ($30  4 000) 120 000 0.48
Shipping ($40  1 500) 60 000 0.24
Total costs 925 000 3.70
Operating profit $ 25 000 $0.10

3. Adonis’s operating profit in 2019, if it makes changes in ordering and material handling,
will be as follows:
Total for
250 000 Tiles Per Unit
(1) (2) = (1) ÷ 250 000
Revenues ($3.80  250 000) $950 000 $3.80
Purchase cost of tiles ($2.88  250 000) 720 000 2.88
Ordering costs ($25  200) 5 000 0.02
Receiving and storage ($28  3 125) 87 500 0.35
Shipping ($40  1 500) 60 000 0.24
Total costs 872 500 3.49
Operating profit $ 77 500 $0.31

Through better cost management, Adonis will be able to achieve its target operating
profit of $0.30 per tile despite the fact that its revenue per tile has decreased by $0.20

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 ($4.00 – $3.80), while its purchase cost per tile has decreased by only $0.12 ($3.00 –
$2.88).

7.19 Life-cycle budgeting and costing

Doyle Ltd plans to develop a new industrial-powered vacuum cleaner for household use that
runs exclusively on rechargeable batteries. The product will take 6 months to design and test.
The company expects to sell 12 000 units of vacuum cleaners during the first 6 months of sales;
24 000 units per year over the following 2 years; and 10 000 units over the final 6 months of the
product’s life-cycle. Management expects the following costs:
Period Cost Total fixed cost for the period Variable cost per unit
Months 0–6 Design costs $600 000
Months 7–12 Production $1 600 000 $100 per unit

Marketing $1 200 000

Distribution $250 000 $12 per unit

Months 13–36 Production $6 000 000 $80 per unit

Marketing $2 800 000

Distribution $800 000 $10 per unit

Months 37–42 Production $1 000 000 $75 per unit

Marketing $550 000

Distribution $150 000 $9 per unit

Required
Ignore the time value of money.
1. If managers price the cleaners at $400 each, calculate the total per-unit operating profit
over the product’s life-cycle.
2. Excluding the initial product design costs, calculate the operating profit in each of the
three sales phases of the product’s life-cycle, assuming that the price stays at $400. For
these sales phases, also ignore production and distribution fixed costs.
3. Explain the change in budgeted operating profit over the product’s life-cycle. Identify
other factors that managers need to consider before developing the new vacuum
cleaner.
4. Management is concerned about the operating profit it will report in the first sales
phase. It is considering pricing the vacuum cleaner at $450 for the first six months and
decreasing the price to $400 thereafter. With this pricing strategy, Doyle Ltd expects to
sell 10 000 units instead of 12 000 units in the first six months, and the same number of

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 units for the remaining life-cycle. Assuming the same cost structure given in the problem,
which pricing strategy would you recommend? Explain.

Solution: (20 min.)

Life-cycle budgeting and costing
1.
Revenues ([$400 x (12 000 + (24 000 x 2)+ 10 000)] $28 000 000
Variable costs:
Months 7 – 12
Production ($100 x 12 000) $1 200 000
Distribution ($12 x 12 000) $144 000
Months 13 – 36
Production ($80 x 24 000 x 2) $3 840 000
Distribution ($10 x 24 000 x 2) $480 000
Months 37 – 42
Production ($75 x 10 000) $750 000
Distribution ($9 x 10 000) $90 000
Total variable costs $6 504 000
Fixed Costs:
Design $600 000
$4 550
Marketing ($1 200 000 + 2 800 000 + 550 000) 000

Production (1 600 000+ 6 000 000+ 1 000 000) $8,600,000

Distribution (250,000+ 800,000+ 150,000) $1,200,000

Total fixed costs $14,950,000

Life-cycle operating profit $6,546,000
Life-cycle operating profit per unit ($6,546,000/70 000) $93.51

2.
Months 7 -12
Revenues ($400 x 12 000) $4 800 000
Variable costs ($1 200 000 + 144 000) $1 344 000
Fixed costs $1 200 000
Operating profit $2 256 000

Months 13 – 36
Revenues ($400 x 24 000 x 2) $19 200 000
Variable costs (3 840 000 + 480 000) $4 320 000
Fixed costs $2 800 000
Operating profit $12 080 000

Months 37 – 42

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 Revenues ($400 x 10 000) $4 000 000
Variable costs (750 000 + 90 000) $840 000
Fixed costs $550 000
Operating profit $2 610 000

3. Months 13 – 36 has the highest operating profit because it is a 2 year period, much
longer than the other two sections, thus having higher revenues. Months 37 – 42
have the lowest revenue, because, at this stage of the product life-cycle, sales are
lower (and this stage covers only a six month period).

4. This plan actually lowers operating profit in the first sales phase (from $2 256 000 to
$2 180 000 so should not be undertaken.

7.28 Capacity concepts

Lucky Lager has just purchased Austin Brewery. The brewery is two years old and uses
absorption costing. It will ‘sell’ its product to Lucky Lager at $45 per barrel. Paul Brandon, Lucky
Lager’s management accountant, obtains the following information about Austin Brewery’s
capacity and budgeted fixed production costs for 2019:

Required
1. Calculate the budgeted fixed production overhead rate per barrel for each of the
denominator-level capacity concepts. Explain why they are different.
2. In 2019, Austin Brewery reported these production results:

There are no variable cost variances. Fixed production overhead cost variances are
written off to cost of goods sold in the period in which they occur. Calculate Austin
Brewery’s operating profit when the denominator-level capacity is: (a) theoretical
capacity, (b) practical capacity and (c) normal capacity utilisation.

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Solution: (25-30 min.)
Capacity concepts
1.
Budgeted Fixed Days of Hours of
Manuf. Overhead Production Production
Capacity Concept per Period per Period per Day
(1) (2) (3)
Theoretical capacity $28 000 000 360 24
Practical capacity 28 000 000 350 20
Normal capacity utilisation 28 000 000 350 20
Master-budget utilisation
(a) January-June 2019 14 000 000 175 20
(b) July-December 2019 14 000 000 175 20

Budgeted Fixed
Barrels Budgeted Production
per Denominator Overhead Rate
Capacity Concept Hour Level (Barrels) per Barrel
(4) (5) = (2) × (3) × (4) (6) = (1) ÷ (5)
Theoretical capacity 540 4 665 600 $ 6.00
Practical capacity 500 3 500 000 8.00
Normal capacity utilisation 400 2 800 000 10.00
Master-budget utilisation
(a) January-June 2019 320 1 120 000 12.50
(b) July-December 2019 480 1 680 000 8.33

The differences arise for several reasons:

a. The theoretical and practical capacity concepts emphasise supply factors, while
normal capacity utilisation and master-budget utilisation emphasise demand factors.
b. The two separate six-month rates for the master-budget utilisation concept differ
because of seasonal differences in budgeted production.

2. Using column (6) from above,

Per Barrel Budgeted Budgeted Budgeted
Fixed Production Variable Total
Overhead Production Production
Rate per Barrel Cost Rate Cost Rate
Capacity Concept (6) (7) (8) = (6) + (7)
Theoretical capacity $6.00 $30.20a $36.20
Practical capacity 8.00 30.20 38.20
Normal capacity utilisation 10.00 30.20 40.20

Fixed Production
Overhead Fixed Production
Costs Allocated Overhead Variance
Capacity Concept (9) = 2 600 000 × (6) (10) = $27 088 000 – (9)
Theoretical capacity $15 600 000 $11 488 000 U
Practical capacity 20 800 000 6 288 000 U
Normal capacity 26 000 000 1 088 000 U

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utilisation

a
$78 520 000 ÷ 2 600 000 barrel

Absorption-Costing Income Statement

Theoretical Practical Normal Capacity
Capacity (a) Capacity (b) Utilisation (c)
Revenues
(2 400 000 barrel × $45 per barrel) $108 000 000 $108 000 000 $108 000 000
Cost of goods sold
Beginning inventory 0 0 0
Variable production costs 78 520 000 78 520 000 78 520 000
Fixed production overhead costs
allocated
(2 600 000 units × $6.00; $8.00;
$10.00 per unit) 15 600 000 20 800 000 26 000 000
Cost of goods available for sale 94 120 000 99 320 000 104 520 000
Deduct ending inventory
(200 000 units × $36.20; $38.20;
$40.20 per unit) 7 240 000 7 640 000 8 040 000
Add: Adjustment for variances
(all unfavourable) 11 488 000 U 6 288 000 U 1 088 000 U
Cost of goods sold 98 368 000 97 968 000 97 568 000
Gross margin 9 632 000 10 032 000 10 432 000
Other costs 0 0 0
Operating profit $9 632 000 $10 032 000 $10 432 000