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Notes On End of Chapter Questions
Notes On End of Chapter Questions
Note: the below are not sample answers to the questions, and do not always
give guidance or comments on every part of each question. These are notes for
your information only.
They are designed to help you to check that you have understood the
concepts being examined and what is required by the questions.
You should always formulate your own full and clear answers to examination
questions, paying attention to what the question asks you to do and using your
own examples.
Chapter 1
1. My Drugs plc and Their Drugs plc
A good way to address this question is to apply the value chain framework
and indicate what costs and performance variables are relevant to each
part of the value chain in each firm. A diagrammatic answer is suggested.
An example of such an answer is below.
This table indicates the main management accounting variables that should
be measured in the two firms, according to the value chain framework. This
framework refers to management accounting; those variables that are not
management accounting are highlighted in italics.
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Chapter 2
1. Using traditional methods of cost allocation
a. In situations where indirect costs account for a small proportion of all costs,
the arbitrary allocation of costs caused by the traditional methods is less
significant, hence they can be more safely used.
When the aim of the cost analysis is to compare the overall efficiency of
different organisations, the traditional methods can provide meaningful
results.
Some companies have routine processes and a small number of different
products (but high volume) and are mostly priced competitively using market
price. These companies are likely to use a contribution approach and make
decisions based on changes in contribution. They allocate fixed costs which
relate to a specific product line to that line, but not to individual products. This
provides better information for decision making, planning and control.
b. The production of white paper lends itself to the use of process costing, so that
the cost of materials, labour and overheads are allocated through the process
rather than on a product-by-product basis.
The production of ordinary posters lends itself to the use of batch costing,
whereby all costs that refer to each batch are clustered together and allocated
to the products of that batch.
The production of very large posters lends itself to the use of job costing,
because it is possible to identify the materials and labour that have been
employed for a specific poster.
2. Consulting Ltd
a. One-stage traditional method
i. The only direct costs are production team salaries, because there is no
indication as to how to trace the other costs to each production. The
average cost of direct labour in production per hour is: $1,200,000 /
3,780 hours in the year = $317.46
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3. Mr Wilcox
a.
Last year’s consumables × 100
Standard charge for consumables = = £3,000 × 100 = 12.5%
Last year’s paper £24,000
b.
Income statement £ £
Sales as above 229,185
Less: Expenses (actual costs)
Paper 22,000
Consumables 2,250
Wages 120,000
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Chapter 3
1. Smooth Running Ltd
Parts (a)–(c) are answered in the tables below.
Costs £ £
Opening WIP 68,160 51,600
Cost for period 1,433,500 1,050,180
Total 1,501,660 1,101,780
Cost per equivalent unit
Weighted average 1,501,660 / 13,975 1,101,780 / 13,255
£190.575 =£107.453 =£83.122
FIFO
Completion of opening stock 0 360
Started and completed in month (11575 – 600) 10,975 10,975
Closing WIP 2,400 1,680
Total 13,375 13,015
Cost per equivalent unit 1,433,500 / 13,375 1,050,180 / 13,015
FIFO £187.867 = £107.177 = £80.690
Job costing Arises where there is a customised, one-off commission (for example,
in industries such as printing, shipping, construction, film, hospitals,
accountancy). Requires tracing specific resources required for the product;
may involve research, negotiation and estimation of costs to be included.
Total cost of complete job calculated, usually including allocations for fixed
costs and usually a profit mark-up.
Batch costing Used for batches of products which are standardised within the batch,
such as clothing, motor cars and components. The products are designed
by the company and may be made for stock or customer order. May use
variable or full absorption methods of tracing costs to products. Unit cost
is calculated by dividing total cost by number produced in batch.
Process Suitable for continuous flow production (e.g. oil, paper, sugar, plastic)
costing where there is a standardised product which may go through a series of
processes. Usually absorption costing is used, i.e. a fair share of overhead
is included in the cost. Unit costs are calculated as in parts (a) and (b) of
this question.
Chapter 4
1. Alpha plc
a. Traditional approach
The overhead could be recovered based on consulting hours for
web- and telephone-based advice, as follows:
Overhead recovery rate £300,000 / (800 × 1 hour) + (1590 × 2 hours)
= £75.38
Client profitability
b. ABC approach
Cost driver for processing orders: £150,000 / (300 x 0.5) + (60 x 1) = £714
per hour of order
Cost driver for marketing: £90,000 / 3 = £30,000 per client
Cost driver for invoicing: £60,000 / 300 + 60 = £167 per invoice
Client profitability
Chapter 5
1. HumanityHelp
a.
i. Direct costs
• Volunteer insurances
• Travel costs to and from missions
ii. Overhead costs that can be allocated using ABC
• Responding to enquiries and arranging interviews
• Carrying out interviews
• Post-mission support
• Rescue operations (but this could be considered a direct
cost, too)
iii. Overhead costs that cannot be allocated for lack of information
• Maintenance of the webpage
• Conferences and events
• Flyers
b. and c. Cost drivers to be used and calculation of cost driver rate:
• Responding to enquiries: allocation based on number of
enquiries multiplied by average time of each enquiry.
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Chapter 6
1. Direct labour
Unless direct labour employees are paid by the hour or for piece work (in
other words, paid for a certain amount of work done) their cost to the firm
cannot change in proportion to the volume of production, so this cost
would appear to be fixed.
However, under the condition of full capacity of direct labour, if the firm
chooses to increase the volume of production of one product, the volume
of production of another product must be curbed. To this extent, the cost
of direct labour allocated to a department can be considered proportional
to the department’s volume of production.
For example, a company has two departments: A and B. The direct labour
employees are interchangeable (i.e. they can work in both departments
according to where they are needed). If the volume of production in
department A decreases by 10 per cent, the direct labour consumption will
also decrease by 10 per cent. The full capacity assumption implies that
employees will use their freed up time to work for department B. From the
departments’ point of view the cost increases in proportion to the volume of
production (i.e. it is a variable cost).
Indirect costs measure the use of resources that enable the production of
goods or services. These resources may be required in quantities that are
proportional to the volume of production, such as the electricity that powers
a machine that produces goods in fixed quantities per unit of time. In this
case the electricity used and the number of goods produced are constantly in
proportion. However, the electricity that powers a machine that can produce
one or more goods at the same time will be considered a fixed cost, because
its consumption is not proportional to the volume of production. There may
also be variable costs which are treated as indirect because they are too
insignificant to be traced to products, like glue and small nails. They will be
variable but the costs will be captured under indirect costs.
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AC2097 Management accounting: Notes on the end-of-chapter questions
Note: These sorts of costs are a reason why, in order to plan and make
decisions, the elements of mixed costs must be determined using statistical
methods, which we covered in Chapter 6 of the subject guide.
Chapter 7
1. Freddy and Flora
a. Based on the information given, the most appropriate unit would be
packages consisting of: initial contact plus two hours of consulting
and a set of illustrative material.
b. Given the suggestion above,
€
Freddy and Flora’s salaries 150,000
Full-time employee salary 90,000
Annual costs 24,000
Total 264,000
Selling price of one package = €900
Variable cost of one package:
Tax consultant 2 hours €130 × 2 = 260
Illustrative material 50
Total 310
Contribution margin per package = € 590
Break-even point = 264,000/310 = 448 packages.
Both employees’ salaries are a fixed cost because their capacity would
not be used completely, given that the practice’s maximum number of
packages is 400 per year, whereas they could in theory work on 450
packages per year.
c. In the new situation the fixed costs would increase by €90,000 to
€354,000.
Selling price of one package = €900
Variable cost of one package = €50
Contribution margin per package = €850
Break-even point = €354,000 / 850 = 417 packages.
d. In both cases Freddy and Flora cannot break even. However,
appointing a new full-time employee lowers the loss and shows a
lower break-even point. You are faced with the challenge of the
dissonance between increasing fixed costs but at the same time
lowering the risk. A good answer would address this dilemma. You
should also bear in mind that Freddy’s and Flora’s salaries are not the
result of a negotiation, but simply of their own allocation, so there is
still the option to revise that allocation in light of the alternative
opportunities that are available to them. Alternatively they could
increase their capacity to work by working harder to obtain clients or
by taking on some of the consultancy themselves and reducing the
variable costs.
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Chapter 8
1. Lost opportunities and make-or-buy
a. The effect of a missed opportunity on profit is equivalent to an
additional cost. For example, a company misses the opportunity to
produce and sell a service that would increase its profit by $100. This
has the same effect on profit as an inefficiency which results in
increased costs of $100.
b.
• Depreciation is irrelevant in this case, because the decision to
produce in-house or to buy the product from a supplier will not
affect the effect of the depreciation of that machine. If, as in the
example, the machine becomes unusable, its remaining
depreciation is accounted for all in one go upon scrapping it.
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AC2097 Management accounting: Notes on the end-of-chapter questions
2. Raleigh Ltd
a. Total future cost for three years
*Written-down value
Cost 4,000,000
Less two years’ depn –1,600,000
Written down value 2,400,000
Less disposal value after 2 years –800,000
Loss on sale 1,600,000
This shows that despite the long-term savings available from replacing
the machine, in the short-term the net income of that option is reduced
by the loss on sale, so if the manager is focusing on the short-term
results, the upgrade will be implemented.
Chapter 9
1. Interior design business
a. Demand and use of Lillian’s and Johanna’s days is shown in this table:
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Lillian’s time is constrained but Johanna has exactly the right amount of
work to fill her time. So, in order to find the most profitable portfolio the
types that provide the most contribution per hour of Lillian’s time will be
prioritised.
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d. Firstly, the accounting firm would have to be decide how this new tier
of management would work. Would the account managers be drawn
from the pool of existing audit and consulting managers or would they
be new appointments? Whichever method is adopted it would cause
initial jealousies from those who previously worked with clients and
there may be resistance from clients to liaising with different personnel.
Chapter 10
1. Consultants Ltd
a. The 5,200 consulting hours worked last year were made up of eight
consultants working 500 hours = 4,000 hours, and 1,200 hours of
external consultants. The expected demand for year 1 is 5,100 hours.
Consultants Ltd has enough expected demand in year 1 to justify the
appointment of two new full-time consultants.
b. The current gross margin is 32.8 per cent. As the cost of the software
is specifically related to the new project, it is reasonable to assume
that Consultants Ltd consider this direct cost as part of the calculation
to reach its margin.
Calculation of price of new project:
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Chapter 11
1. Net present value
Project B will have a higher NPV than project A as long as the discount rate
(whatever it may be) is the same for both projects. This is because
discounting affects the cash flows that are further in the future more than the
cash flows that are nearer in the future. Projects A and B have the same total
cash flows but the cash flows of A are more skewed towards the future than
those of project B.
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AC2097 Management accounting: Notes on the end-of-chapter questions
The production cost per unit went down between the two years for IM
and DL indicating learning curve effects/economies of scale. QM’s
production cost is planned to increase per unit. It is £375 per unit in
year 1, £400 per unit in year 2 and £467 in year 3. This should be
investigated. Overall QM, though generating good sales, has poor net
income due to very high customer call out and support.
Since this product is not due to be launched until 2019 there is time
to spend more on design to make a more robust product.
The impact of the new packages on the company’s income for years
2017–21 is helpful for planning purposes. It shows the importance
of having three new products each year. This means that a new (or
revised) product must be launched every year.
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Chapter 12
1. The logic of the budgeting process
In order that the budget of sales can be drawn, conclusive decisions must
have been taken on the quality of the products or services that the firm is
planning to sell, the segments it will target and the time of delivery. This
information is necessary for planning the usage of materials, direct labour,
machines and all other resources in terms of their quality, quantity and
timing.
The ultimate manifestation of a firm’s strategy is in its output of products
or services, their quality, quantity, time and place of delivery. Hence, the
fact that the budget reflects the firm’s strategy supports the logic of starting
from the sales budget. Managers must strike
a balance between what is ideal and what is possible; starting the
budgeting process from any other budget than sales would indicate that
the firms’s priority is on what it can do as opposed to what it is
appropriate to do in order to succeed in the market.
2. Greaves Ltd
a. i)
Workings
Sales – using probabilities
Probability Sales January February March
£ £ £ £
20% 140,000 28,000
70% 180,000 126,000
10% 200,000 20,000
20 174,000 191,400 200,970
AC2097 Management accounting: Notes on the end-of-chapter questions
b. The budget is a planning document. The above figures show that the
budgeted net income is positive, although March’s net income is
impacted by lower growth and high advertising costs. The figures could
suggest that using higher advertising during January or February might
help March’s sales to improve.
The cash budget shows a large overdraft. This can be seen to be largely
due to the purchase of capital expenditure. Since the company is still at
the planning stage it can consider how to fund this cash deficit.
Overdraft interest is usually one of the most expensive forms of
borrowing and can be withdrawn at any time by the bank, so is not
usually considered appropriate for financing long-term assets.
Long-term funding could be raised by loans or share capital to finance
the capital expenditure. Alternatively it may be possible to defer some
expenses to later months. If adjustments cannot be made an overdraft
facility must be negotiated with the bank.
Chapter 13
1. Westward Ltd
a. Standard cost budget and actual performance
Favourable Unfavourable
£ £
Sales volume variance 25.80 x 600 15,480
Sales price 1,376,000 – 1,401,800 25,800
Material 007 price (50,960 x 12.25) – 634,452 10,192
XL 90 price (25,600 x 3.20) – 81,664 256
Material 007 quantity (51,600 – 50,960) x 12.25 7,840
XL 90 quantity (25,800 – 25,600) x 3.20 640
Labour rate 35,690 x (8.4 – 8.6) 7,138
Labour efficiency (34,400 – 35,690) x 8.4 10,836
Variable overhead labour spending (35,690 x 1 ) – 38,425 2,735
Variable overhead labour efficiency (34,400 – 35,690) x 1 1,290
Variable o/head machine spending (25,740 x £2) – 51,080 400
Variable o/head machine efficiency (25,800 – 25,740) x 2 120
Set up cost spending* (500 x 7) – 3,860 360
Set up cost efficiency* 4,300 – (500 x 7) 800
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AC2097 Management accounting: Notes on the end-of-chapter questions
Chapter 14
1. Purpose and information provided by variances
a. Material mix and yield variances
Some processes require the input of various different material resources,
the proportions of which can be adjusted but still produce the correct
final product. Changes in the mix can lead to cheaper production
overall. Changes will often be made if input prices have altered.
However, the change in the mix can result in greater or lesser amounts
of the final product being produced. This is the yield variance. The mix
and yield variances added together will agree with the material usage
variance.
The information provided enables decision makers to understand the
impact of changes in inputs on both the amount of the yield and
whether or not there are financial savings. Since the variances are
calculated based on standard material prices, it is also important to
calculate the material price variances as this is an important part of
making the decision to change the mix.
b. Sales mix and quantity variances
When budgeting for sales in companies with several products, it is
usual to detail the expected sales quantity of each product. This is both
to help the planning process and to determine budgeted net income, as
products will have different contribution margins.
In any one month the actual quantity of each product sold is likely to be
different from the budgeted quantity. The total quantity may also be
more or less than budgeted.
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Since the proportions of each type of product relative to the total sales
are likely to have changed, the impact of the changed mix must be
measured. The sales mix contribution variance plus the sales quantity
contribution variance will give the total for the sales volume variance.
c) Evaluation of responsibilities
• Chantal is responsible for hiring, dismissing and paying all full-time
members of all teams.
This seems unfair because full-time employees may be entitled to
overtime as and when Steffan and Mariel decide, so why should
Chantal be responsible for these costs?
• Mariel is responsible for overhead administrative activities.
This seems acceptable as long as the administrative activities do not
depend on the team directors’ decisions. However, if the directors
can influence the administrative costs it is difficult to justify this
allocation of responsibility.
• Steffan is responsible for finding clients and negotiating selling
prices.
This seems acceptable, as long as Steffan is actually the only
person determining who the clients will be. It is, however, likely
that the clients depend on the product, hence the other directors
should be jointly responsible for their share.
• Each team director is responsible for hiring freelance
consultants.
This seems fair because the freelance consultants are a variable cost
that is determined by the directors.
• Each team head is also responsible for all other costs incurred by
his or her respective team. For a similar reason to hiring freelance
consultants, this allocation seems reasonable.
It would be advisable for Alfa plc to review the allocation of the
cost of administration (and possibly the costs of finding clients and
negotiating selling prices) with the intention of charging each
director for the costs their activities give rise to.
Note: If your answer is merely descriptive, perhaps just repeating
the information provided in the scenario, then you should think of
improving it with critical evaluation (in other words, give
comments and criticise).
d)
Planning
Operational
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This shows that €9,075 was explained by the market rise in pay.
If we regard the operational variances as the measure of each
manager’s responsibility:
Chantal is now responsible for –€2,050
Steffan has managed to keep costs down by +€15,300
Mariel is now responsible for –€3,375.
Chapter 15
1. Net income and EVA
EVA measures the excess profit that a firm or part of a firm makes after
having covered all its costs, including the cost of risk borne by the
investment. In other words, the two concepts of a firm’s profit and its EVA
are similar in that they both measure the added value of a firm’s operations.
However, profit only refers to the costs that are recognised in the profit and
loss. EVA, instead, considers further costs: the implicit or ‘economic’ cost of
taking the risk.
2. Snackandgo
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AC2097 Management accounting: Notes on the end-of-chapter questions
As the above calculations show, the residual income approach would rectify
this, as the project would improve the residual income of each store.
Residual income has the limitation of not providing a percentage figure,
which some managers prefer. Both measures suffer from the problems of
asset values and provide a single measure related to complex activities.
d.
Chapter 16
1. Transfer pricing and tax avoidance
An opportunistic choice of transfer prices may result in allocation of profits
among subsidiaries of the same multinational group in a way that ‘transfers’
taxable income from subsidiaries registered in high-tax regions to
subsidiaries registered in low-tax regions. For example, a subsidiary in a
low-tax region may invoice its fellow subsidiaries for services such as
consultancy, use of licences, etc. In so doing, the fellow those will produce
lower taxable income, which is beneficial to the group as a whole. This
inappropriate (and often illegal) policy can be detected by observing that the
price level for these services cannot be explained by any of the methods
accepted in management and cost accounting or OECD regulations.
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2. Microelectronics
a.
Circuit Board Mobile Phones
Division Assembly
Division
$000 $000
Contribution of two divisions without super phone
Outside sales (70,000 units) 1,400 1,200
Transfer sales (30,000 units) 600
Total sales 2,000 1,200
Variable costs 1,300 450
Transfer price 600
Total variable costs 1,300 1,050
Contribution 700 150
Contribution of super phone
Transfer sales 800
Outside sales 1,920
Variable costs 520 1,200
Transfer price 800
Contribution 280 –80
b. The new phone project makes an overall profit of $200,000 but the high
transfer price means that the Mobile Phones Assembly Division makes a
loss of $80,000 and the Circuit Board Division makes a profit of $280,000.
It appears that there is no alternative market for the 30,000 original circuit
boards transferred or the 40,000 extra circuit boards. The original transfer
price was market price. Since the Mobile Phones Assembly Division will
not continue with the super phone at this market price. Theoretically, the
correct price for the transfer is outlay cost plus opportunity cost, which in
this case is $13. However, in order for the Circuit Board Division to be
motivated to produce the additional boards, the managers need to negotiate
a price above $13, the variable cost. Whether this will apply to all circuit
boards will have to be discussed. It is also worth considering whether the
price of the super phone is too low.
Chapter 17
1. Gregory Ltd
a.
Cost of quality – existing motors 2016 2017 2018
£ £ £
Lost contribution due to insufficient machine time
2,160,000
used for rejected units 60,000 x (120–84) = £36
Lost contribution due to use of machine for
1,440,000
reworking 20,000 x 2 x £36
Rework direct material and labour 60,000 x £8 480,000
Cost of modification per year 2,100,000 1,800,000
Saving in inspection cost (60,000) (60,000)
Staff retraining 2017 80,000 0
Total cost of quality 4,080,000 2,120,000 1,740,000
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AC2097 Management accounting: Notes on the end-of-chapter questions
The table above shows that in 2017 there would be a saving in quality
costs of $1,960,000 and that from 2018 onwards it is well worth
implementing the new design with savings of $2,540,000.
b. The most important qualitative aspects are the improvement in
customer confidence and staff morale. There could be staff
redundancies due to reduction in the inspection costs. It may be
possible to deploy these workers in the work required due to the
modification.
c. At present the machine hours are just sufficient to meet the demand
of 700,000 motors if 100 per cent good units are produced. To
produce anything else would require some of these motors to be
discontinued.
The demand from Williams of 20,000 units at a rate of 1.6 per hour
would use 20,000 / 1.6 = 12,500 hours and contribute 20,000 × £40
= £800,000.
The lost contribution would be 12,500 × 2 =25,000 motors x £36
contribution = £900,000.
This is not profitable financially. The contribution would need be
negotiated to more than (40 × 9 / 8) = £45 per unit to make it
worthwhile.
Also, if this were done Gregory Ltd would lose goodwill from
existing customers.
Since Gregory Ltd is operating at full capacity to meet demand it
might be worth exploring its customers’ plans for expansion and
possibly considering expansion of its production capacity.
Chapter 18
1. Globe Oil plc
a. Globe Oil has met its main target. It has exceeded its profit target from
price recovery by £10M and increased profit from growth. This
indicates that there has been a move to increased sales to high-income
customers.
b. Since Globe Oil’s main strategy is focused on good customer service
at the service stations, employee satisfaction is important. The focus
of the other perspectives on quality, reliability, availability and
implementation of more advanced controls all require skilled,
motivated employees. This means that employee satisfaction and
training are very important throughout the organisation.
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Chapter 19
1. Management accounting and control versus strategic management
accounting and control
Strategic management takes a wide approach to monitoring and
controlling activities and opportunities for change by ensuring that they
focus on the strategic goals identified by the company.
Strategic management control ensures not only that the accounting
measures are meeting the strategic goals but that the lead measures
(learning and growth, internal business process efficiency and
customer retention and growth activities) are also monitored to ensure
that they are in line with future strategy.
Strategic management accounting for decision making will give senior
managers an overview of the far-reaching effects of their decisions,
whereas non-strategic management accounting supports the decision
makers by providing very specific and financially-orientated measures.
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