Revision Questions

10
Question 1
1.1 Which feature distinguishes backflush accounting from other systems?
(A) Labour costs are not charged to the units produced.
(B) Costs are attached when output is completed or sold.
(C) Cost records reflect the flow of work through the production process.
(D) Entries are not made until the customer pays for goods purchased.
(E) Material entries are made when the material is received and moved.
1.2 Company X produces a single product with the following standard cost per unit:
Material cost £10
Conversion cost £12
Total cost £22

The company operates a backflush costing system with a raw material inventory
control account. Details for the current month are:
Raw material inventory control account opening balance £500
Raw materials purchased £4,600
Conversion costs incurred £5,200
Cost of goods sold at standard cost £8,998
The closing balance on the raw material inventory control account is:
(A) £290
(B) £502
(C) £790
(D) £800
(E) £1,010.

1.3 A company operates a throughput accounting system. The details of product A per
unit are:
Selling price £24.99
Material cost £8.87
Conversion costs £12.27
Time on bottleneck resource 6.5 minutes

The return per hour for product A is:

(A) £81.88
(B) £113.26

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282 REVISION QUESTIONS P2

COSTING SYSTEMS (C) £117.42

(D) £123.80
(E) £148.80.
1.4 A company produces two products, A and B, which pass through two production
processes, J and K. The time taken to make each product in each process is:
Product A Product B
Process J 6.5 minutes 9 minutes
Process K 22 minutes 15 minutes

The company operates a 16-hour day and the processes have an average downtime
each day of:
Process J 2.5 hours
Process K 2 hours.

The costs and revenue for each unit of each product are:
Product A Product B
£ £
Direct materials 15.00 15.0
Direct labour 17.00 12.00
Variable overhead 8.00 6.00
Fixed costs 8.00 6.00
Total cost 48.00 39.00
Selling price 87.50 72.50
Sales demand restricts the output of A and B to 40 and 60 units a day, respectively.
The daily production plan that would maximise the throughput contribution is
(A) 40 units of A.
(B) 38 units of A.
(C) 36 units of A and 4 units of B.
(D) 34 units of A and 5 units of B.
(E) 56 units of B.
1.5 The selling price of product Z is set at £250 for each unit and sales for the coming
year are expected to be 500 units.
If the company requires a return of 15% in the coming year on its investment of
£250,000 in product Z, the target cost for each unit for the coming year is
(A) £145
(B) £155
(C) £165
(D) £175
(E) £185.

Question 2
‘Many of the topics that come under the heading of modern management philosophies
and which appear in CIMA examination syllabuses, once the veneer is removed there
is either nothing underneath or else one finds an old friend with a new name. One can
become sceptical of all new ideas since some add little to the fount of management account-
ing knowledge.’
(Extract from a journal article on ‘modern’ management accounting technique.)
 PERFORMANCE MANAGEMENT 283

(a) EC Flow Ltd manufactures a product which requires to pass through the cutting

COSTING SYSTEMS
department. Owing to lack of cutting machines this is seen as the bottleneck resource.
Each unit of the product requires 0.75 cutting machine hours and 200 of these hours
are available each week.
Other data relating to the product are:
£
Selling price per unit 6.00
Direct material cost per unit 3.00
Other factory costs per week 500
Calculate the product’s return per factory hour and the throughput accounting ratio.
(b) Explain the term ‘throughput accounting’; compare and contrast throughput account-
ing with ‘limiting factor analysis’; explain the circumstances (if any) in which through-
put accounting is an effective management accounting technique.
(c) Explain the term ‘life cycle costing’; explain the changes in the business environment
during the last 10 years that have prompted the development of life cycle costing.

Requirements
(a) Prepare summary journal entries for the last period.
(b) Under an ideal just-in-time system state how your journal entries in (a) above will
change.
(c) Explain what backflush costing is and the circumstances (if any) in which the use of
backflush costing is appropriate.

Question 3
Disc Sounds Ltd specialises in the manufacture of CD players. It is planning to introduce a
new CD player specially designed for young children. Development of the new CD player is
to begin shortly, and Disc Sounds Ltd is in the process of preparing a product life cycle budget.
It expects the new product to have a life cycle of 3 years and estimates the following costs:
Year 1 Year 2 Year 3
Units manufactured and sold 50,000 200,000 150,000
CD players per batch 400 500 500
Price per CD player £45 £40 £35
R&D and design costs £900,000 £100,000 –
Production costs
Variable cost per CD player £16 £15 £15
Variable cost per batch £700 £600 £600
Fixed costs £600,000 £600,000 £600,000
Marketing costs
Variable cost per CD player £3.60 £3.20 £2.80
Fixed costs £400,000 £300,000 £300,000
Distribution costs
CD players per batch 200 160 120
Variable cost per CD player £1 £1 £1
Variable cost per batch £120 £120 £100
Fixed costs £240,000 £240,000 £240,000
Customer service costs
per CD player £2 £1.50 £1.50

Ignore the time value of money in your answers.

284 REVISION QUESTIONS P2

COSTING SYSTEMS Requirements

(a) Calculate the budgeted life cycle operating profit for the new CD player.
(b) Market research has indicated that reducing the selling price by £3 each year would
result in increased sales volume of 10 per cent each year. If sales increase by 10 per
cent, Disc Sounds Ltd plans to increase its production and distribution batch sizes
by 10 per cent as well. Assuming all other costs remain the same should the price be
reduced by £3?
(c) Explain how an organisation would benefit from a product life cycle costing exercise.

Question 4
You are the Assistant Management Accountant of QXY plc, a food manufacturer. The
Board of Directors is concerned that its operational managers may not be fully aware of
the importance of understanding the costs incurred by the business and the effect that this
has on their operational decision making. In addition, the operational managers need to be
aware of the implications of their pricing policy when trying to increase the volume of sales.
You are scheduled to make a presentation to the operational managers tomorrow to
explain to them the different costs that are incurred by the business, the results of some
research that has been conducted into the implications for pricing and the importance of
understanding these issues for their decision making. The diagram on the opposite page
has already been prepared for the presentation.

Requirement
You are required to interpret the diagram and explain how it illustrates issues that the
operational managers should consider when making decisions. (Note: your answer must
include explanations of the Sales Revenue, Total Cost and Fixed Cost lines, and the signifi-
cance of each of the activity levels labelled A, B, C, D). (10 marks)
 PERFORMANCE MANAGEMENT 285

COSTING SYSTEMS
Diagram for Question Four - Costs and Revenues over a range of activity levels
$
Sales Revenue

Total Cost

Fixed Cost

A B C D Activity
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Solutions to
Revision Questions 10
Solution 1
1.1 Answer: (B)
Backflush accounting is a method of costing associated with JIT. It delays the record-
ing of costs until after the events have taken place. The recording of costs may be
triggered when goods are transferred to finished goods inventory or, in a true JIT
system, when goods are sold.
1.2 Answer: (E)
Material cost of goods sold  £8,998  £10/£22  £4,090
Raw materials inventory control account
£ £
Opening balance 500 Standard cost of goods sold 4,090
Materials purchased 4,600 Closing balance 1,010
5,100 5,100

1.3 Answer: (E)

Product A Product B
60 60
Throughput of J per day 13.5 hours   124.62 13.5 hours   90
6.5 9

60 60
Throughput of K per day 14 hours   38.18 14 hours   56
22 15

So process K is the bottleneck for both products

Contribution per hour of product A  £87.50  15.00  £72.50  60  22  £197.73
Contribution per hour of product B  £72.50  15.00  £57.50  60  15  £230.00
Processing product B will give the larger contribution per day  56 units

1.4 Answer: (D)

£
Sales revenue 500 units @ £250 125,000
Return on investment required 15%  £250,000 37,500
Total cost allowed 87,500
Target cost per unit £175

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288 SOLUTIONS TO REVISION QUESTIONS P2

COSTING SYSTEMS
Solution 2
Tip
● Part (a) of the question is a simple example to test your knowledge of the various
throughput ratios.
(a)
Sales  Direct material costs
Return per factory hour 
Usage o f bottleneck resource
£6.00  £3.00

0.75
 £4.00 per hour.
Total factory costs
Cost per factory hour 
Bottleneck resource h ours available
£500

200
 £2.50 per hour
Return per factory hour
Throughput accountin g ratio 
Cost per factory hour
£4.000

£2.50
 1.6:1

(b) Throughput accounting is an approach that concentrates attention on time spent in

production or service facilities. For example, costs (other than direct materials) may
be charged to products in proportion to the time that those products spend in a
‘bottle-neck’ facility. The performance of products can be ranked according to the sales
revenue less direct material costs that they generate per hour in the bottleneck facility.
Throughput accounting and limiting factor analysis are variations on a theme. The
former is an approach to management reporting and the latter is a financial analysis
tool – the two are not the same.
(c) Conspicuous developments in the business environment have been the increase in
product diversity and the shortening of product life cycles. Associated with this has
been the replacement of ‘mass production’ by ‘flexible manufacturing’. It has been
claimed that the costs of a product are now likely to be largely determined at the out-
set of its life cycle. Consequently, reporting on costs in any one given period may not
be very meaningful. The life cycle approach to costing is to report on costs incurred on
each product over the whole course of its life.

Solution 3
Tips
● A long question with a lot of information regarding the new CD player. Candidates
should not be put off by the length of the question or the amount of information.
● Part (a) of the question requires you to calculate the life cycle profit – the sum of the
three years’ data given.
 PERFORMANCE MANAGEMENT 289

Part (b) tests your knowledge of sensitivity analysis – a drop in selling price increases

COSTING SYSTEMS
●

demand. What effect would this have on profit given the increased batch sizes?
(a) Life cycle operating profit for the new disc player:
Year 1 Year 2 Year 3 Life cycle
£000 £000 £000 £000
Sales 2,250 8,000 5,250 15,500
R&D and design (900) (100) (1,000)
Production costs
Variable cost/CD (800) (3,000) (2,250) (6,050)
Variable cost/batch (87.5) (240) (180) (507.5)
Fixed costs (600) (600) (600) (1,800)
Marketing costs
Variable cost/CD (180) (640) (420) (1,240)
Fixed costs (400) (300) (300) (1,000)
Distribution costs
Variable cost/CD (50) (200) (150) (400)
Variable cost/batch (30) (150) (125) (305)
Fixed costs (240) (240) (240) (720)
Customer service
Costs/CD (100) (300) (225) (625)
Operating profit (1,137.5) 2,230 760 1,852.5

(b) Effect on operating profit when S.P reduced by £3 and volume increased by 10 per cent:
Year 1 Year 2 Year 3
New selling price £42 £37 £32
Sales volume 55,000 220,000 165,000
Production batch size 440 550 550
Distribution batch size 220 176 132
Operating statement
Year 1 Year 2 Year 3 Life cycle
£000 £000 £000 £000
Sales 2,310 8,140 5,280 15,730
R&D and design (900) (100) (1,000)
Production costs
Variable cost/CD (880) (3,300) (2,475) (6,655)
Variable cost/batch (87.5) (240) (180) (507.5)
Fixed costs (600) (600) (600) (1,800)
Marketing costs
Variable cost/CD (198) (704) (462) (1,364)
Fixed costs (400) (300) (300) (1,000)
Distribution costs
Variable cost/CD (55) (220) (165) (440)
Variable cost/batch (30) (150) (125) (305)
Fixed costs (240) (240) (240) (720)
Customer service
Cost/CD (110) (330) (247.5) (687.5)
Operating profit (1190.5) 1956 (485.5) 1,251

Overall life cycle profit decreased by £600,000. Price should not be reduced unless there
is a reduction in costs through economies of scale due to the 10 per cent increase in volume.
(c) A life cycle costing exercise enables an organisation to appraise the profitability over the
whole life of the product rather than a period at a time. Thus, products that are loss
making initially but profitable in the longer term will be accepted. A large proportion
of the costs are locked in at the design stage – a life cycle costing exercise will enable
290 SOLUTIONS TO REVISION QUESTIONS P2

COSTING SYSTEMS organisations to reconsider some of these costs at the R&D stage. It also enables
management to focus marketing and promotion when required – at certain critical
points of the life cycle.

Solution 4
Notes for meeting with Operational Managers: The implications of understanding costs and
revenues for decision making
The diagram shows the monetary values of costs and revenues over a range of activity
levels.
Fixed costs are costs which are not expected to change in total when there is a change
in activity level within the relevant range. The diagram shows that these costs are incurred
when there is a zero level of activity. This is usually as a result of making a decision to
commence activity and incurring costs such as rent and rates on a business premises. In
this case it can be seen that the level of fixed costs changes at certain levels of activity
which have been identified as points B and D. This is an example of a stepped fixed cost.
Clearly there is a significant increase in the level of costs as soon as these activity levels
are reached. This means that for decision making a manager must be aware of these key
activity points because otherwise they might accept an order which causes a significant
increase in cost for a small amount of additional revenue.
Total costs are the sum of the fixed costs referred to above and the variable costs. Variable
costs are incurred in proportion to the level of activity and are most likely to be the ingre-
dients and packing materials used in the food manufacturing process. The diagram shows
that the variable costs are constant per unit of activity up to activity level B as the gradient
of the line is constant throughout this activity range. Between activity levels B and D the
variable costs are constant per unit, but the unit cost is lower than that up to point B possi-
bly due to economies of scale and learning effects. However, above activity level D it can be
seen that the gradient of the line increases. This represents a higher unit cost for these units.
Sales revenue increases as the level of activity increases and the rate of increase is constant
from the activity level of zero up to activity point C. This implies that the selling price per
unit is constant up to this point. However, above point C while the total sales revenue con-
tinues to increase, it does so at a decreasing rate. This shows that the market research indicates
that in order to sell a volume higher than activity level C the price per unit must be reduced.
The diagram can also be used to identify the level of activity at which profits are max-
imised. This lies at the activity level where the vertical distance between the sales revenue
and total cost lines is greatest.
Activity level A represents the level of activity at which the total revenue and total costs
are equal and thus there is neither a profit nor a loss. This is commonly referred to as the
breakeven point. This means that at activity levels lower than point A the company makes
a loss, but that beyond activity point A profits start to be earned.
Activity level B has already been explained as the point at which the fixed costs and total
costs increase due to the step effect. It can be seen that this has a significant effect on the
profit being earned.
Activity level C shows the point at which reductions in selling price are required in
order to increase the volume of sales being achieved. Beyond this point the slopes of the
total cost and sales revenue lines show that total costs are rising faster than total revenues
and thus profits are falling.
Activity level D shows the impact of the next step in the fixed costs which has a similar
effect on profit as that indicated in relation to activity point B above.