Management Accounting: Exam Pack (Updated)
Management Accounting: Exam Pack (Updated)
Management Accounting
EXAM PACK
(UPDATED)
WITH NOTES!
UNIVERSITY EXAMINATIONS
October/November 2022
MAC3761
Management Accounting III
100 Marks
Duration: 3 Hours
30 minutes for uploading to myExams (submission cut-off time)
EXAMINATION PANEL AS APPOINTED BY THE DEPARTMENT
Use of a non-programable pocket calculator is permissible
Close book examination
The examination question paper remains the property of the University of South Africa and may not be
distributed beyond its intended use for this examination
Converting your answers to a PDF file and successfully uploading your one PDF file.
You must successfully upload your PDF file on myExams before 19:15 South African
30
time, 2 November 2022. The submission platform will automatically close at 19:15
(2 November 2022, South African time) and no submission can be made henceforth.
100 210
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Oct/Nov 2022
• Ensure you are connected to the internet in order to log into the Invigilator App and scan this
QR code.
• If you encounter difficulty in scanning the QR code, you can alternatively enter the Exam
Access Code below the QR code to start the invigilation.
• Unless otherwise specified by your institution, note that you can only scan this QR code once.
If your assessment has multiple online sections, tests or attempts, you should NOT finish the
invigilation until your entire assessment has been completed.
• Only scan the QR code when the assessment formally commences.
• The QR code is only scannable for a limited time and it should therefore be scanned as
soon as possible to start the invigilation.
• Once the QR code is scanned, ensure your media volume is turned up and place your
smartphone next to you. The Invigilator App will notify you with a notification beep when you
are required to action a request, which you should then perform.
• We recommend that you keep your smartphone on charge for the duration of the assessment.
• If you only have one device, you may access your assessment in the application by pressing
the ‘Access Exam’ button in the top right corner of your app.
• Keep the Invigilator App open on your cell phone for the full duration of the assessment.
You are not allowed to minimise or leave the app.
• Ensure you are connected to the internet in order to commence the invigilation as well as at
the end of the assessment. No internet connection is required during the assessment.
• You have to adhere to the assessment time limit communicated to you by your institution
as the time displayed in the Invigilator App could differ from the time allocated to complete your
assessment.
• You can click the "Finish Assessment" button in the app if you finish your assessment early.
• If you are performing a written or Scan-and-Upload assessment:
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• The Invigilator App will request you to take a picture of every page of your answer sheet at the
end of the assessment ie at 18:45, you have 10 MINUTES to take pictures of every page
of your answer sheet. Unless otherwise specified by your institution, this does NOT
replace the normal upload of your script to your institution’s online portal and you still
need to upload on myExams by 19:15.
• After completing invigilation and following all app instructions, you must upload your Invigilation
App data. If however there is a delay in the upload of the app data at the end of the assessment,
you should prioritise the upload of your script to your university portal and you can temporarily
minimise the app to do so. Uploading of app data is not time sensitive and you can come back
and do it after you have successfully uploaded your script to the exam portal.
• Students are allowed 48 hours to upload all the data collected during invigilation to the
App database. This data will include everything, selfies and script photos as well. It’s just
important to understand that once the invigilation ends at the end of the assessment ie
at 18:45, you have only 10 minutes to take a photo of each page of your answer sheets.
Once the photos have been taken, you then have 48 hours to upload everything onto the
App database.
• Should you encounter any technical difficulty,
please WhatsApp The Invigilator Helpdesk on 073 505 8273.
Access the myExams portal and navigate to the module site and take-home assessment:
1. Go to the College of Accounting Sciences’ myExams portal
https://cas.myexams.unisa.ac.za/my/
2. Type in your myUnisa username and password and click on the Login button.
3. Click on the myExams button in the header and select the module, MAC3761-22-EX10, for
which you need to complete the exam.
4. On the module’s exam page select the Take-Home assessment
MAC3761-Exam Oct/Nov 2022.
5. You can now review the assessment information and start.
Follow the steps below to complete and submit a Take-Home exam assessment:
1. Open the Take-Home assessment MAC3761-Exam Oct/Nov 2022.
2. Download the question paper and note any additional information provided, such as the
proctoring tool to be used.
Please take note that the use of The Invigilator App is compulsory for this exam. Failure to
use the application will result in your exam mark being retained.
3. Complete the Take-Home assessment in MS Word or on paper.
Note: MS Word documents need to be saved as PDF documents, and paper-based answers
must be scanned into a combined PDF document.
Note: Students must upload their answer scripts in a single PDF file.
4. When ready to submit, open the Take-Home assessment again and click on the Add
Submission button.
Note: You only get 10 minutes after the due time (ie. after 18:45) to take pictures of
your script for the Invigilator App BUT 30 minutes to upload your answer sheet on the
myExams portal. DO NOT MISS THE SYSTEM CUT-OFF TIME OF 19:15 ON MYEXAMS!
5. Note the file requirements such as:
a. File size limit.
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b. Number of files that can be submitted.
c. File formats allowed.
6. Check the acknowledgement checkbox and upload your answers document and then click
on the Save changes button.
Remember that you are required to check/accept the submission statement.
The submission statement is the declaration of honesty, where you acknowledge that the
submission is your own work.
7. Review your submission information regarding the status and click on your submission file
link to check if it's correct.
8. If you need to resubmit a file, you can click on the Edit Submission button. Note: You will
need to delete any existing files.
NOTE: You must successfully submit your single PDF file before the submission cut-off time.
Please do not wait until the last minute to submit, instead, submit your file as soon as the three (3)
hours duration of the examination has passed. If you do not successfully submit before the cut-off
time you will be marked as absent from the examination. The system will close for submission
at 19:15 sharp.
October/November 2022 online examination rules
Students are expected to familiarise themselves with online examination rules before their
examination sittings.
Examination sessions commence at the time indicated on the final examination timetable. You are
required to adhere strictly to the specified times.
For file upload/take-home examinations:
1. Students must upload their answer scripts in a single PDF file on the official myExams platform
(answer scripts must not be password protected or uploaded as “read-only” files).
2. NO e-mailed scripts will be accepted.
3. Students are advised to preview submissions (answer scripts) to ensure legibility and that the
correct answer script file has been uploaded.
4. Students are permitted to resubmit their answer scripts should their initial submission be
unsatisfactory.
5. Incorrect file format and uncollated answer scripts will not be considered.
6. Incorrect answer scripts and/or submissions made on unofficial examination platforms
(including the invigilator cellphone application) will not be marked and no opportunity will be
granted for resubmission.
7. A mark awarded for an incomplete submission will be the student’s final mark. No opportunity
for resubmission will be granted.
8. A mark awarded for illegible scanned submission will be the student’s final mark. No
opportunity for resubmission will be granted.
9. Only the last file uploaded and submitted will be marked.
10. Submissions will only be accepted from registered student accounts.
11. Students who have not utilised invigilation or proctoring tools will be deemed to have
transgressed Unisa’s examination rules and will have their marks withheld.
12. Students have 48 hours from the day of their examination to upload their invigilator results
from the Invigilator App. Failure to do so will result in students deemed not to have utilised
invigilation or proctoring tools.
13. Students must complete the online declaration of their work when submitting. Students
suspected of dishonest conduct during the examinations will be subjected to disciplinary
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processes. Students may not communicate with other students or request assistance from
other students during examinations. Plagiarism is a violation of academic integrity, and
students who do plagiarise or copy verbatim from published work will be in violation of the
Policy on Academic Integrity and the Student Disciplinary Code and may be referred to a
disciplinary hearing. Unisa has zero tolerance for plagiarism and/or any other forms of
academic dishonesty.
14. Students are provided 30 minutes to submit their answer scripts after the official examination
time. This means that you should start uploading at 18:45 and the system closes at 19:15
sharp. Students who experience technical challenges should report to the SCSC on 080 000
1870 or their College exam support centres (refer to the Get help during the examinations by
contacting the Student Communication Service Centre (unisa.ac.za)) within the 30 minutes
upload time. Queries received more than 30 minutes after the official examination
duration time (i.e. queries received after 19:15) will not be responded to. Submissions
made after the official cut-off time (i.e. after 19:15) will be rejected by the examination
regulations and will not be marked.
15. Non-adherence to the processes for uploading examination responses will not qualify the
student for any special concessions or future assessments.
16. Queries that are beyond Unisa’s control include the following:
a. Personal network or service provider issues
b. Load shedding/limited space on personal computer
c. Crashed computer
d. Using work computers that block access to myExams site (work firewall challenges)
e. Unlicensed software (eg license expires during exams)
Postgraduate students experiencing the above challenges are advised to apply for an aegrotat
and submit supporting evidence within ten days of the examination session. Students will not
be able to apply for an aegrotat for a third examination opportunity.
Postgraduate/Undergraduate students experiencing the above challenges in their second
examination opportunity will have to reregister for the affected module.
Students experiencing technical challenges should contact the SCSC on 080 000 1870 or via e-
mail at [email protected] or refer to the Get help during the examinations by
contacting the Student Communication Service Centre (unisa.ac.za) for the list of additional
contact numbers. Communication received from your myLife account will be considered.
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QUESTION 1 (50 Marks; 90 Marks)
Stellenbroach Family (“SF”) owns a 25-hectare piece of prime land that is considered suitable for both
agricultural and residential purposes. Currently, only two of these 25 hectares are in use, and primarily
for residential dwelling. SF has now decided to make productive use of the land and will soon establish
a wine and juice making group comprising of two major operating companies. SF has also consulted
with McKingsley Business Consultants (“MBC”), a leading business consulting firm to assist with its
business case. Companies within the SF group will adopt the absorption costing method and the first-
in-first-out (FIFO) inventory valuation method.
Only Grade A grapes will be fermented to produce the semi-sweet white wine. During the fermentation
process, a small quantity of Grade A grapes will result in waste. This waste has no sales value and will
be discarded at a cost of R0,15 per kilogram. Thereafter, wine will be stored in barrels to mature and
will only be bottled just before sale. The expected selling price to wine retailers is R65 per bottle of semi-
sweet white wine. Grade B grapes will be processed further to make grape juice, and cellulose and other
organic compounds are added to the grape juice to give it a rich and natural taste (grape juice will be
sold to local retailers at R30 per litre). The annual production is expected to match the annual demand
at 304 000 litres of semi-sweet white wine and 152 000 litres of white grape juice. Grade C will be sold
to pig farmers at R4,50 per kilogram.
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QUESTION 1 (continued)
2.2. BOREHOLE SUPPLIED WATER
2.2.1. If the borehole supplied water option is considered, SF will use one of the boreholes currently
used for its residential needs. This borehole was drilled four years ago at a cost of R38 000. With
this option, this borehole will be used to supply 40% of the irrigation water requirements for the
grapes at pumping costs of R2,60 per kilolitre.
2.2.2. SF-Winery will be required to drill a second borehole from which the other 60% of the irrigation
water requirements for the grapes will be pumped. The current drilling costs for a similar borehole
is R45 000, however, as a repeat client, SF is entitled to a 5% drilling costs discount. This borehole
will be used exclusively by SF-Winery. New advanced drilling and pumping technology will make
it possible to reduce the pumping costs for this borehole only, to R1,80 per kilolitre.
2.2.3. SF-Winery will depreciate the boreholes at 5% per annum on a straight-line basis.
2.2.4. The expected annual service costs will be R5 000 for the existing borehole, 70% resulting from
domestic usage and 30% from business usage). For the new borehole, the service costs will be
R3 000. The service costs are mainly driven by the level of usage of boreholes.
2.3. To set up the irrigation system to cover the entire farm, the associated costs are expected to be
R87 000, once-off payable upfront regardless of the option chosen.
3. SF-BOTTLING
3.1. One of the other companies that will be set up is SF-Bottling. The company will manufacture and
sell empty wine bottles (bottles) to both SF-Winery and external customers. SF-Bottling will have
maximum capacity to manufacture 960 000 bottles annually. The bottles come in a standard 750
millilitre size. Although the expected annual demand for the bottles is 410 000 and 640 000 for
SF-Winery and external customers respectively, SF-Bottling will be required to prioritise the supply
of the bottles to SF-Winery. The grape juice is packed in recyclable 1 litre, 2 litre and 5 litre
containers which are sourced externally and not from SF-Bottling.
3.2. The manufacturing costs based on maximum manufacturing capacity are estimated as follows:
Details Amount
Raw material costs per bottle (for glass) R5,50
Direct labour costs per bottle @ R45 per hour R4,50
Total annual manufacturing overheads R2 448 000
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QUESTION 1 (continued)
4. MANAGEMENT OF THE WOODEN CRATES INVENTORY
Upon presenting to MBC the group’s business case, MBC recommended that instead of the proposed
just-in-time (JIT) inventory management technique, SF-Bottling should rather consider using the
economic order quantity (EOQ) technique. In this regard, the crates’ purchase price will remain the
same; the expected ordering costs are determined at R120 per order; while annual storage and
insurance costs are expected to be R0,75 and R1,50 per crate, respectively.
Furthermore, a safety inventory of 10 crates should be maintained while the applicable cost of capital is
11% per annum. The recommendation by MBC is based on a quantitative analysis. In this regard,
instead of an expected annual holding and ordering costs of R6 000 based on the JIT technique, MBC
is of the view that the implementation of the EOQ technique will only cost R4 500 per annum for holding
and ordering costs.
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REQUIRED
For each question below, clearly show all your calculations; where necessary also indicate
irrelevant amounts with R0; and ignore time value of money and all tax implications.
(a) With reference to the information under “Extract from the business case for SF-Winery”
(section 1) above, draft a memorandum to the management of SF wherein you
recommend and motivate for the most appropriate costing system that SF-Winery
should use for the allocation of production costs of SWW and GJ. Calculations are not
required and other costing systems that are not considered appropriate, should not be
addressed. Your motivation (using information provided) must incorporate:
A discussion of points from the information that support your
recommendation;
An outline of the cost accounting treatment of the different products outlined
in the “Extract from the business case for SF-Winery”;
Identification of possible methods for allocating costs to SWW and GJ; and
Reference to supporting figures from the information where necessary.
Motivation 10 marks; Recommendation 1 mark and Layout 2 marks. (13)
(b) With regard to “Irrigation cost estimation for SF-Winery”:
(i) Determine the expected annual irrigation costs for each of the two given options
and recommend the most financially viable option of the two for SF-Winery’s water
supply requirements. [Your analysis should be based on the first year of operation
only]. (13)
(ii) Assume that SF-Winery chooses the municipality supplied water option. Discuss
four factors that could affect the accuracy at which SF-Winery can estimate the
expected irrigation costs. (4)
(c) After an assessment of SF-Bottling’s business case, MBC made the following
recommendation: “To encourage goal congruency, minimum transfer price principles
should be utilised to determine a unit transfer price regarding the transfer of all the
bottles required by SF-Winery from SF-Bottling.”
From SF-Bottling’s perspective, critically evaluate and subsequently conclude whether
the recommendation by MBC to adopt the minimum transfer price principles as opposed
to the currently proposed transfer price represents a sound financial recommendation.
Support your evaluation and conclusion with relevant and necessary
calculations.
Supporting calculations 7 marks; Evaluation and conclusion 3 marks. (10)
(d) For question 1 (d)(i) only, assume that instead of 960 000 bottles, SF-Bottling’s
maximum annual manufacturing capacity is 1 200 000 bottles and that the
R6 000 expected annual cost for the JIT technique is correct.
(i) From a quantitative perspective only, advise SF-Bottling whether the proposed
recommendation and view by MBC regarding changes to the inventory (wooden
crates) management technique is appropriate from a financial perspective. (8)
Calculations 7 marks; Advice 1 mark.
(ii) Without reference to quantitative aspects, identify and explain two features from
the scenario to motivate for JIT as the most appropriate inventory management
technique for the wooden crates. (2)
Total question 1 [50]
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QUESTION 2 (50 Marks; 90 Marks)
Pepper Clothing (“Pepper”) is a clothing retailer in South Africa with its head office located in Cape
Town. It sells low-cost clothes to mass lower- to middle-income end customers. Pepper now owns over
1 500 stores or franchised stores and employs more than 14 000 employees. The company has stores
across South Africa, with strong presence in Gauteng, the Western Cape and Limpopo. Pepper is the
largest single-brand retailer of low-cost clothing in South Africa and its board believes that there are
opportunities to take advantage of the rapid economic growth in some African countries. The latest
market research indicates that “discount clothing stores” offer the greatest opportunity for future growth
in Southern Africa, and as a result, the Finance Director has identified two investment opportunities.
Both these investments can be undertaken, but the board has put some financial restrictions on how
much can be expended on capital investments over the next few years. Details about the two
investments are as follows:
Investment 1 – Build a new “discount clothing store” in the Western Cape (South Africa)
The Western Cape offers the smallest number of “discount clothing stores” as a percentage of the Gross
Domestic Product of any province in South Africa. Pepper has already opened discussions with a seller
of suitable land as well as the local authority. If this acquisition is approved there will be some financial
assistance available to a purchaser such as Pepper. However, a decision is not expected from the local
authority for at least one month. Pepper has paid a non-refundable holding deposit of R50 000 on the
freehold land pending the outcome of its investment appraisal. The seller requires a decision within a
month. This investment appraisal will have to be done over an indefinite period, where a terminal value
must be established.
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Other information
• Under Investment 1, income and expenses are expected to increase by 6% per annum from Year 4
onwards. This is approximately the expected rate of inflation in South Africa.
• Current spot rates are: USD 1,00 = ZAR 14,80. Assume that risk-free interest rates are currently 8%
in South Africa and 5% in the US. These rates are likely to be maintained until the end of Year 3.
• The Finance Director has concluded that the forecast for interest rates and future inflation in
Zimbabwe is unreliable. The directors of Pepper therefore assume, for convenience, that in
Investment 2 the income receivable in year 3 in South Africa Rand (R) terms will remain constant,
in nominal terms, until Year 15.
• Operating costs are assumed to be 60% of gross profit received each year in both investments.
• For the purpose of this evaluation, depreciation or capital allowances on land and buildings (including
use of land) must be ignored.
• Both operations will be located in “Industrial Development Zones”. This provides for accelerated
wear and tear allowances and equipment can be written off over two years for tax purposes.
• Refurbishment of buildings and replacement of equipment will be needed within the life of both
investments, but these costs have not as yet been identified and have been excluded from the
evaluation.
• If Investment 1 is chosen, in addition to other operating costs, storage costs will amount to 1% of the
store’s gross profit each year.
• If Investment 2 is chosen it will result in a decline in profits generated by the South African operations.
This R5 million annual loss is expected to remain fixed.
• If Investment 2 is selected, all profits from Zimbabwe will be repatriated to South Africa at the end of
each year. The taxable income will be taxed at a rate of 28% in South Africa due to the tax treaty
that exists between the two countries. Tax is paid in the same year as the cash flows (including wear
and tear deductions) that give rise to the tax liability.
• Assume all capital costs are incurred in Year 0 and all operating cash flows are received or incurred
at the end of each year.
• 12% is considered an appropriate discount rate for Investment 1. A premium on this South Africa
rate of 400 basis points is considered appropriate for the investment in Zimbabwe (Investment 2).
Method of funding
The directors of Pepper plan to utilise accumulated cash reserves of R20 million towards the funding
any of the projects. This is not expected to influence the stable dividend policy currently employed. The
remaining capital investment will be funded by long-term borrowings aligned with the Finance Director’s
suggestions that debt should be used with the relatively low current interest rates.
If Investment 1 is chosen, the balance of the capital investment will be funded by a 20-year commercial
mortgage secured on the land and buildings. Interest will be fixed at 9% per annum, payable annually.
If Investment 2 is chosen, the balance of the capital investment will be funded by one of the following
methods:
i. A 15-year commercial loan taken out in South African Rand (R) at 9,5% interest per annum
payable annually in arrears, with the capital being repayable at the end of the term;
ii. 15-year non-cumulative preference shares issued in USD at an annual dividend rate of 10% on
the capital;
iii. A USD-denominated loan from a bank based in the United States. Borrowing rates in this market
appear very favourable at the present time. The interest rate will depend on the bank’s perceived
risk of the investment.
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REQUIRED
For each question below, remember to:
• Clearly show all your calculations in detail;
• Where necessary, indicate irrelevant amounts/adjustments with a R0 (nil-value);
(a) Explain the types of the capital investment projects Pepper Clothing is planning to
embark on and advise on how best these can be evaluated using capital budgeting
techniques. (4)
(b) Calculate the net present value (NPV) in South African Rand for each of the two capital
investments, applying the information provided in the scenario. (17)
(c) As the Senior Finance Manager of Pepper Clothing, you are required to prepare a
report to the Chief Executive evaluating the investment decision and its funding. Your
report should include the following sections:
(i) An evaluation of the two investments, including a discussion of the key risk factors (10)
Pepper Clothing should consider.
(ii) A discussion of how the abandonment, timing and strategic features of each
(4)
investment option may impact the investment decision.
(iii) A discussion of the advantages and disadvantages of the three methods of funding
outlined in the scenario for Investment 2. Use appropriate calculations, where (12)
possible, to support your arguments.
(iv) Recommendations about the choice of investment and, if relevant, the method of (3)
funding.
Total question 2 [50]
TOTAL (questions 1 and 2) 100
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CONFIDENTIAL
UNIVERSITY EXAMINATIONS
June 2021
MAC3761
100 Marks
Duration 3 Hours
Instructions:
1. This assessment consists of two independent questions.
2. All questions must be answered, and all calculations must be shown.
3. For hand-written answer files, you must not write with a pencil or a red pen. Only use a
black pen.
4. You can only upload a PDF document on myUnisa as your answer file.
5. It is your responsibility that once uploaded, you must view your answer file and ensure that
it is correct, complete (no missing pages), legible, it can open, not of poor image quality, not
password protected, and not corrupted.
6. Your attention is brought to the announcement posted on MAC3761 myUnisa site titled
“Cheating in MAC3761 assessments”, as well as the plagiarism declaration in the TL101.
100 240
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MAC3761
June 2021
1. The company’s factory overheads have not been allocated. They are allocated to the five
divisions as per below activities:
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MAC3761
June 2021
QUESTION 1 (continued)
(i) The divisions recorded a total of 7 890 000 machine hours of which 2 827 000 relate
to the Masks Division.
(ii) The Masks Division occupies and utilises 2 022m2 of the company’s total factory floor
space.
(iii) Safety and wellness costs relate to health and safety activities. For the period ending
31 December 2020, the company clocked a total of 1 247 hours on health and safety
activities. The Masks Division logged 30,72 property maintenance days for the 2020
financial year. Each daily shift consists of 12 hours.
(iv) 23 cents of each rand incurred in ordering and handling materials is attributed to the
Masks Division.
(v) The Masks Division had 214 staff throughout the 2020 financial year. The company’s
total staff complement of the 2020 financial year is expected to increase by 17% to 702
for the 2021 financial year.
2. The above factory overheads do not include the divisions’ specific fixed overheads and
the Head Office’s allocated fixed overheads. These are always reflected separately in the
divisions’ respective management accounts.
Baba Ndou, the business manager of the Masks Division, has presented the actual
management accounts below as recorded and reported in his division to the executive
management of PPE. He is confident that his division will meet the new target of R18 million
in operating profit set for the full 2021 financial year, leading to his division qualifying for
bonuses. The extract from the Masks Division’s actual management accounts and its notes
and additional information for the 9 months ended 31 December 2020 are presented below in
Schedules C and D:
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MAC3761
June 2021
QUESTION 1 (continued)
D. NOTES AND ADDITIONAL INFORMATION
1. For the 9-month period ending 31 December 2020, the Masks Division produced and sold
a total of ninety million masks. The unit selling price is expected to increase by 12% for
the 2021 financial year as the company expects increase in global demand of masks.
3. This material relates to straps bought from the Safety Shoes Division (which already
manufactures straps and laces for the shoes manufactured by the division). These straps
are then used as ear loops for the masks. There were no straps on hand at the end of the
2020 financial year.
4. For the 2020 period, the Masks Division labourers were remunerated at an hourly rate of
R18, just slightly below the national minimum wage gazetted of R20,76 due to the fact that
the company is fairly new and had to invest heavily in the plant at the beginning of the
year. For 2021, PPE plans to increase this to R25 per labourer, per hour.
5. Indirect labour costs relate to fixed salaries of supervisors and foreman who are working
on the factory floor to make sure that production processes run accordingly.
6. These costs are determined by the Head Office and although they are correctly allocated
to the divisions of PPE, they bear no direct relationship with the underlying products’
volume.
7. Lowest number of masks sold was recorded in April due to poor advertising campaign, but
the month of September saw the highest number of units sold (probably as the government
relaxed the lockdown restrictions). There were 4,5 million masks sold in April and 10,5
million masks sold in September. Total administration and selling costs were R150 025
and R296 455 for April and September, respectively. Both the unit variable costs and total
fixed costs for the 2021 financial year will remain as that of the 2020 financial year.
8. There are no expected changes in material costs and overheads for the 2021 financial
year, except for any changes evident above.
9. Unless indicated otherwise, assume all income and expenses are incurred evenly
throughout the reporting period.
PPE has started exploring ways of diversifying its business for the purpose of long-term
viability, especially in the post-Covid19 era. PPE has embarked on discussions with Aloetiser
(Pty) Ltd (“Aloetiser”) for a possible acquisition of Aloetiser’s operations. The owners of
Aloetiser are emigrating to Canada soon and are desperately in need of a buyer to take over
their entire Gqeberha-based operations in the Eastern Cape. For the year ended 31 March
2021, the owners of Aloetiser claimed to have made an actual net profit of R22m. The
projections are that this reported net profit will likely increase by 20% for the 2022 financial
year. Aloetiser uses a direct costing system and accounts for inventory using the weighted
average method. As part of PPE’s investment strategy, PPE will consider buying Aloetiser’s
operations if Aloetiser has for the recent financial period, reported a contribution margin ratio
of 0,4 for each product.
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MAC3761
June 2021
QUESTION 1 (continued)
Aloetiser uses aloe vera leaves bought from local farmers and then put these through the
production process, where a gel is squeezed from the leaves to generate aloe vera gel. This
aloe vera gel is then further processed to make hand sanitisers after alcohol and other
ingredients have been added. The squeezed aloe vera leaves are boiled and sifted through
during the process to produce aloe vera liquid. This aloe vera liquid, after adding some
chemicals, is then sold to cosmetics manufacturers which use it to make facial and other skin
products. The residual aloe vera leaves left after these processes are then scrapped and sold
to Left Aloe Limited, the only pharmaceutical company which uses it in the manufacturing of a
special medicine. The following has been extracted from the production cost schedule of
Aloetiser (Pty) Ltd for the year ended 31 March 2021:
2.2. These manufacturing costs relate to the joint manufacturing process of extracting the
aloe vera gel and of boiling the aloe vera leaves. These costs are allocated to hand
sanitisers and aloe vera liquid based on the net realisable values of the products. There
were 2,2 million litres of aloe vera gel (for making hand sanitisers – further refer to 2.4
below) and 3,04 million litres of aloe vera liquid produced during the 2021 financial year.
2.3. These overheads are not incurred within the joint manufacturing process and are also
not allocated to products.
2.4. For each litre of aloe vera gel, 250 millilitres of alcohol and other ingredients are added
to make the complete hand sanitiser. There are no volume losses in the process.
2.5. Chemicals added in processing the aloe vera liquid do not materially increase the
quantity and there are no known volume losses in the process.
CONFIDENTIAL
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MAC3761
June 2021
QUESTION 1 (continued)
2.6. The sales for the 2021 financial year were made as follows:
a. 2,1 million litres of hand sanitisers were sold at R3,46 per litre and it cost Aloetiser
R545 364 to market and sell these hand sanitisers to different retail stores. This
amount, as per the contract, has been fixed for the past three years.
b. 2,97 million litres of aloe vera liquid was sold to cosmetics manufacturers at R6,50
per litre. The company makes use of agencies who are paid a commission
equivalent to R0,50 per each litre sold.
c. Residual aloe vera leaves were sold to Left Aloe Limited for R875 000.
2.7. There were no raw materials, alcohol and other ingredients, chemicals, and work in
progress on hand both at the beginning and at the end of the financial year.
CONFIDENTIAL
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MAC3761
June 2021
QUESTION 1 (continued)
REQUIRED
For each question below, remember to:
CONFIDENTIAL
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Page 8 of 12
MAC3761
June 2021
A. The financial statements, together with other key information relating to Brat Lows
Furniture Group, are first presented below:
CONFIDENTIAL
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MAC3761
June 2021
QUESTION 2 (continued)
2. STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 2020
Current assets
Inventory and financial assets 1 097 1 042
Trade and other receivables 2 956 3 326
Cash-on-hand and deposits 1 970 1 193
Total current assets 6 023 5 561
TOTAL ASSETS 8 173 7 390
2020 2019
Target capital structure – Debt: Equity (market values) 40:60 40:60
Prime lending rate (closing %) 7,0 10,0
ZAR: 1 US dollar (average) 17,84 14,45
ZAR: 1 US dollar (closing) 14,93 14,40
CONFIDENTIAL
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MAC3761
June 2021
QUESTION 2 (continued)
4. NOTES AND ADDITIONAL INFORMATION
4.1. This relates to sale of furniture and electrical appliances both to cash customers and credit
customers. The value of cash sales is approximately 25% of the value of credit sales. The
Group’s purchases from the manufacturers are mainly on credit, and the Group continues
to maintain good relations with its suppliers.
4.2. The Group also provides credit life insurance cover to credit customers. Interest income
is derived from instalment sales and overdue accounts.
4.3. Operating costs include debtor costs of R2,257 billion for the current year (2019: R1,255
billion). The debtor costs are made up of trade bad debts written off, debt management
costs and debt impairments.
4.4. Finance costs relate mainly to the following long-term interest-bearing liabilities:
i. A 10-year loan facility received from Da Bank on 5 January 2017. This loan of R1,24 billion
currently incurs an interest rate of prime less 125 basis points per annum. Interest is
payable annually in arrears. Similar facilities bear an annual interest at prime less 100
basis points.
ii. Medium-term loan of R400m from Cressida Finance which is repayable fully on 20
December 2023. Fixed interest of R26 million is payable annually in arrears. BLF had
applied to Cressida Finance’s COVID relief fund to postpone its 20 December 2020
interest payment. However, the approval only came after the payment was made.
Cressida Finance has now agreed to postpone the 20 December 2021 interest amount to
20 December 2022. All other future payments are scheduled to be repaid as initially
planned. There is no additional interest on postponed payments. Market related interest
rate on similar term loans is 6,85% per annum.
iii. Fifteen million preference shares were issued two years ago at R70 per share. Preference
share dividends are payable annually in arrears at 80% of prime rate. Currently for the
same value of preference shares in the market, BLF would be expected to pay R62,4
million as an annual dividend.
iv. Twelve million debentures were issued at R45 each and are redeemable in four years’
time. However, there is a once-off premium of R0,75 per debenture payable one year
after redemption. Annual interest on these debentures is R36 million and is payable
annually in arrears. Similar debentures are trading at 6,25% per annum.
v. Other non-current liabilities (non-interest bearing) were recorded at R268 million for the
year ended 31 December 2020 (2019: R283 million).
vi. The market value of long-term interest-bearing facilities on 31 December 2019 was
R3,972 billion. The market value of equity on 31 December 2019 was R4,466 billion.
vii. The balance of finance costs relates to short-term borrowing costs.
CONFIDENTIAL
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MAC3761
June 2021
QUESTION 2 (continued)
4.5. BLF issued additional shares to its existing shareholders during the 2020 financial
year in an effort to strengthen its balance sheet and decrease its gearing levels. These
shares were issued at a discounted price of R20 per share, bringing the total number
of ordinary shares issued to 224,9 million. This was the only movement in ordinary
share capital during the 2020 financial year. The market price subsequently
plummeted to R18,25 per share by the end of the 2020 financial year.
4.6. There were 366 days in 2020 (2019: 365) and the South African corporate tax rate
has remained unchanged at 28%.
CONFIDENTIAL
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MAC3761
June 2021
QUESTION 2
REQUIRED
For each question below, remember to:
©
UNISA 2021
All rights reserved. No part of this document may be reproduced or transmitted in any form or
by any means without prior written permission of Unisa.
CONFIDENTIAL
[TURN OVER]
Blue ticks
SUGGESTED SOLUTION (✓) are
alternative
QUESTION 1
(a) Calculate the total overheads attributed to the Masks Division for the 9-
[8]
month period ending 31 December 2020.
Overheads R Marks
Depreciation & machine service costs 12 943 826 ✓ r/w
[36 125 500 ÷ 7 890 000 x 2 827 000]
Rent, rates, water and electricity 5 547 622 ✓ r/w
[18 766 438 ÷ 6 840 m2 x 2 022 m2]
Safety and security costs 1 489 176 ✓✓
[(5 037 442 x 30,72 x 12)✓ ÷ 1 247✓]
OR: [(5 037 442 ÷ 1 247 ÷ 12)✓ x 30,72✓]
Ordering and material handling costs 284 866 ✓ r/w
[1 238 546 x 0,23]
Cafeteria, development and teambuilding costs 299 868 ✓✓
[(840 750 ÷ (702 ÷ 1,17)✓ x 214✓]
Head Office’s allocated overheads 2 128 423
Division’s specific costs (indirect labour costs) 9 470 000 ✓ r/w
Total overheads 32 163 781
Given
(b) Determine whether Baba Ndou and his Masks Division are entitled to
bonuses (and how much, if any) for the period ended 31 December 2020. [8]
Show all workings.
Details R Marks
Sales 83 252 205 ✓ r/w
Variable manufacturing costs (39 487 668) ✓ r/w
Factory overheads [part a] (32 163 781) ✓ ©
Gross profit 11 600 356
Administration and selling costs (1 886 600) ✓ r/w
Net profit before tax 9 713 756
Gross profit margin 13,93% ✓ ©
Conclusion:
The Masks Division’s gross profit margin of 13,93% is more than the 12,75% target while
the actual net profit before tax of R9,713m is also more than the R8,5m target. As such,
both Baba Ndou and his division are entitled to a total of R2 166 504✓✓ in bonuses for
the 9-month period ending 31 December 2020 (R166 504 of this goes to Baba Ndou).✓©
1 mark for conclusion
Given 2 marks for calculation
20 875 828 + 4 611 840 + 14 000 400 = 39 487 668
11 600 356 ÷ 83 252 205 = 13,93%
Baba Ndou’s bonuses: R83 252 205 x 0,2% = R166 504 ✓rw
Division’s bonuses: R2 000 000 ✓rw
Total bonuses payable to Masks Division: R2 166 504 (R166 504 + R2 000 000)
(c) Critically evaluate the overall remuneration scheme of Phalaborwa
[5]
Pharmaceutics Enterprise.
On determining bonuses
• The company seems to be instilling commitment to the success of the organisation
by giving the divisions incentives over and above the normal wages and salaries.
This is likely to increase productivity by the divisions.
• Some manufacturing overheads may not be within the control✓ of the divisions or
methods to allocate these may not be favourable to other divisions.
• The bonus payable is not proportionated to the operating profit✓ – e.g. it does not
matter by how much the targeted operating profit is exceeded, this does not
influence how much is paid out as a bonus. There will be no bonuses payable if the
operating profit is slightly below the set target.
• The manager may be tempted to increase sales at any cost (overstatement or
incorrect classification) as their bonus is based on the sales generated✓. The
manager also gets paid significantly higher in bonuses than the entire division (and
he might still benefit from the divisional pool of bonuses). This may lead to
demotivated and unhappy workforce.
• The fixed bonus pool does not take into account the number of employees (currently
the Masks Division accounts for 35% of the entire factory labour force, and yet the
bonus pool of R2m is the same across the factory)✓.
• The bonus structure only takes into account financial factors – non-financial factors
should also be considered in rewarding the staff.
MAX: 5 marks
(d) Determine the number of masks that the Masks division needs to produce
[10]
in order to meets its operating profit target for the 2021 financial year.
Total fixed costs + target profit (43 367 471✓✓✓ + 18 000 000✓)
✓𝐟
Contribution per unit 0,513✓✓✓✓✓✓
MAX: 10 marks
(e) Discuss business ethical issues that may be of concern to Phalaborwa
[5]
Pharmaceutics Enterprise and its operations.
• The company might be engaging in illegal work with the government entities. The
company cannot be paying the entities✓ (and/or their employees) in order to sell
goods to these entities. This should be investigated to ensure that it is not a bribe of
any sort✓.
• PPE should ensure that the orders in the pipeline are valid and that the necessary
government procurement processes were followed✓.
• The company should have reported the electrical fault immediately✓ (supply of
electricity was considered essential services). Only ESKOM personnel or ESKOM
approved service provider should (re)/connect electricity and it is illegal for anyone
else to make these connections✓. PPE should report the matter and ESKOM must
make appropriate assessment of what might be owed. Electricity costs resulting from 1 mark for
this must be considered and accounted for appropriately for the following years✓. ethical concern
• The company seems to be in contravention of the Basic Conditions of Employment 1 mark for
Act, as it currently pays its labourers R18 per hour, while the minimum wage is consequences
R20.76✓. This may lead to fines and penalties imposed by the Government, and 1 mark for
possible labour unrest and strikes✓. PPE should consider adjusting and backdating appropriate
action
the wages or restructure the benefit package to consolidate all the benefits (e.g.
bonus portions and cafeteria benefits)✓.
• PPE seems to have continued its operations even during the hard lockdown (level
5)✓ and this might have been against the law at that time while exposing its
workforce to COVID-19 (unless considered essential services)✓.
MAX: 5 marks
(f) Prepare a segmented income statement (by product) of Aloetiser
(Pty) Ltd, showing the profit for the year ended 31 March 2021 for [12]
each product, as well as the total for the company.
Given
13 682 817 – 875 000 + 76 543 = 12 884 360✓r/w:
Sanitiser: 12 884 360 x 35,54%✓ = R4 579 102;
Liquid: 12 884 360 x 64,46% = R8 305 258
R1,20 x 3,04m = R3 648 000
Net realisable value
NET REALISABLE VALUE
Details – Rands Sanitiser Liquid Total
Sales (2,75m x R3,46); (3,04m x R6,50) 9 515 000 19 760 000 29 275 000
Less: further processing costs ©✓ (923 187) (3 648 000) (4 571 187)
Less: Selling costs ✓ rw (545 364) (1 520 000) (2 065 364)
Net realisable value 8 046 449 14 592 000 ✓ 22 638 449
Allocation 35,54% 64,46% 100%
R0,50 x 3,04m = R1 520 000✓
Sanitiser: (1 494 491 + 4 579 102 + 923 187) ÷ (500K + 2 750K) x 1 150K
R2 475 783
Liquid: (1 873 109 + 8 305 258 + 3 648 000) ÷ (820K + 3 040K) x 890K
R3 187 945
CLOSING FINISHED GOODS INVENTORY
Details – quantity in litres Sanitiser Liquid Total
Units at the beginning of the year 500 000 820 000 1 320 000
Units produced during the year 2 750 000 3 040 000✓ 5 790 000
Less: Sold units (2 100 000) (2 970 000) (5 070 000)
Units remaining at end of the year 1 150 000 890 000✓© 2 040 000
Sanitiser: 2 200 000 x 1,25l = 2 750 000✓
MAX: 12 marks
(g) Based on the investment criteria and other factors Phalaborwa
Pharmaceutics Enterprise needs to take into consideration, advise if the [7]
Phalaborwa Pharmaceutics Enterprise should buy Aloetiser (Pty) Ltd.
The contribution margin ratio for aloe vera liquid is 0,45 slightly above the required 0,40 as
the investment criterion and the contribution margin ratio for hand sanitiser is 0,38 (not
meeting the required criterion). Based on these two ratios only, PPE should consider not
buying Aloetiser (Pty) Ltd✓©. These below additional factors may also be considered before
reaching the decision:
• Possible synergistic benefits✓, considering that both companies are in the business
of manufacturing safety and health products currently in high demand due to COVID-
19.
• PPE uses the absorption costing method✓, and the importance of using the
contribution margin ratio as means of evaluating an investment should be carefully
evaluated.
• Alignment and running of operations especially between different provinces✓ (i.e.
Limpopo and Eastern Cape) should be considered carefully, including different
accounting and reporting systems used and PPE’s time in the market.
• The claims made by the owners that the business generated R22m net profit✓ in
the recent financial year raise concerns about the accuracy of the accounting
information provided, as well as the integrity of the owners (sales were only R26m
before taking into account obvious operating costs).
• Claims that the business will grow by 20% in 2022 should be verified✓, especially
by reviewing the performance of the first quarter of 2022.
• Increased global use of hygiene and healthy products may lead to profit growth for
the company✓.
• Owners might be desperate to sell✓, and this can present an opportunity for PPE to
offer a lower purchase price. At the same, this can be a concern if PPE may need
proper handover and post-acquisition support from the owners of Aloetiser.
• It may be difficult to predict how well Aloetiser will do post COVID-19✓ or once the
vaccine has been rolled out successfully. Considerations must also be made
regarding new companies entering this low-barriers-to-entry market.
• There seems to be a small market to sell the by-product✓ (residual aloe vera
leaves), considering that currently there is only one buyer.
• Hand sanitisers at hand cost about R2,99 (R1 494 491 ÷ 500 000) and this might
point to possibly decreasing selling price due to increased supply of these goods✓
in the market.
• Details assessments must be conducted to determine the profitability of further
processing the products✓ instead of selling them off before incurring additional
processing costs.
• Inventory levels seem to be increasing✓, pointing to possible difficulties in moving
the stock.
• Inclination of inventory valuation errors due to multiple valuation methods and
different costing systems✓.
• Consideration of future enforceability of existing contracts✓. For example, the
marketing and selling contract of hand sanitisers is currently negotiated at fixed cost
of R545 364.
MAX: 7 marks
QUESTION 2
Interest-bearing debt
2020: R1 240m [Da Bank loan] + R400m [Cressida loan] + (R70 x 15m) [pref. shares] +
(R45 x 12m) [debentures] = R3 230m.
2019: R4 105m – R283m = R3 822m.
MARKET VALUES:
INSTRUMENT MARKET VALUE (FINANCIAL CALC.) COST OF LOAN
PV of interest + capital
FV - 1 240 million
PMT - 51,336 million (1 240 million x 7%-1,25%)x0,72 ✓ 𝐾𝑑1 = 4,32%
N 6 (10 years – 4 years: Dec 2020- Jan 2017) ✓
I 4,32% (7%-1% x 0,72)
Da Bank Comp PV 1 228 million (OR 1 228 420 464)
INSTRUMENT MARKET VALUE (FINANCIAL CALC.) COST OF LOAN
CF0 0
CF1 – 2021 0✓
CF2 – 2022 - 37,44 million (26 million x 0,72 x 2 years)✓ 𝐾𝑑2 = 4,932%
CF3 – 2023 - 418,72 million (400m + 18,72m✓)
I/Y 4,932% (6,85% x 0,72)
Cressida Finance Comp NPV 396 million (OR 396 412 945)
𝐾𝑑3 = 4,50%
CF0 0
CF1 - 25,92 million (36 million x 0,72) ✓
Debentures CF2 - 25,92 million
CF3 - 25,92 million Mark for
CF4 - 565,92 million ([12 mil x R45]✓+ 25,92m) R540m
CF5✓ - 6,48 million (12 mil x R0,75 x 0,72)
I/Y 4,50 (6,25% x 0,72)
Comp NPV 551 million (551 011 674)
MAX: 5 marks
(c) Discuss factors you would have considered before taking part in the
Group’s issue of additional ordinary shares during the year, if you were one [8]
of the Group’s shareholders.
▪ How does this proposed issue affect my percentage holding in Brat Lows Furniture
Group? Am I likely to lose control or significant influence✓ if I do not exercise the
option to buy more shares?
▪ Do I have the required funds (availability) ✓ to further invest in the business, and
how will this additional investment affect the diversification of my investment
portfolio?
▪ Do I have the appetite for additional risk in the equity market? ✓ What are my other
investment alternatives and how much return do they offer? How have the other
comparable companies in this sector fared?
▪ What are the prospects of the entire industry and is it the industry one would like to
invest in?
▪ The shares have been discounted to R20 – how has the share performed✓ in the
past and am I likely to make substantial profit at the additional purchase of the
shares?
▪ How confident am I in the business and the managers that they will be able to turn
the business around? ✓ Am I likely to see an increase in the value of the shares?
▪ The Group has recently suspended its dividend – is this likely to continue?✓ How
has the Group enforced its dividend policy in the past?
▪ What has been my historical return✓ on this share (based on the dividend yield as
well as the share price growth)? Have I also lost patience and confidence that things
will get better?
▪ How has the business been impacted by COVID-19✓ and is it likely to survive in the
post-COVID era? Are there any new markets the business can go into?
▪ Is the business likely to continue as a going concern? What are the company’s future
growth prospects?
▪ Is this the best time to buy the share✓ – probably at lowest levels?
▪ Have I considered the tax effect✓ of buying at R20, and tax on dividends to be
declared in the future? Am I a speculative investor or a long-term investor, and what
is the tax implication on each of the options?
▪ Are there any measures I can put in place to limit or mitigate✓ against the risk
associated with this investment (e.g. use of derivatives)?
MAX: 8 marks
(d) Calculate the cash conversion cycle of Brat Lows Furniture Group at 31
December 2020 and based on the information and nature of industry, [9]
advise on some practical ways to improve the cash conversion cycle.
CASH CONVERSION CYCLE:
2020
Trade receivable days: DAYS
2 956
𝑇𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
x 366
(2 882✓©+2 068✓)
x 366
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
218
2 956
x 366
4 950
2020
Trade payable days: DAYS
874
𝑇𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
x 366
1 401
x 366
𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
228✓r/w
2020
Inventory days: DAYS
844
x 366
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 1 666
x 366
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
185✓r/w
DAYS
CASH CONVERSION CYCLE
(218+185-228) ✓© 175
ADVICE: MAX: 3 marks (one mark per each class of working capital)
When improving the cash conversion cycle, a company attempts to collect from its debtors
sooner; convert its inventory sooner; and delay payment to its creditors. By so doing a
company reduces the number of business days (operating or cash conversion cycle).
Inventory days: ✓
The furniture and electric appliances remain on the floor for about six months. The Group
runs the risk of stock being “outdated”, especially electric appliances. The entry of small
boutiques with more trendy furniture will also lead to difficulties in selling the furniture. The
Group should consider reducing the amount of stock that is kept on hand (this will also lead
to decrease in holding costs). The Group could also take orders from customers before the
goods are sourced from suppliers, which based on good relations they maintain, are likely
to deliver within reasonable timeframe.
MAX: 9 marks
(e) Advise the management of Brat Lows Furniture Group on how to effectively
[5]
structure the business to return to profitability.
The Group can consider the following strategies: MAX: 5 marks
o Establish an online sales platform✓ to reach a broader market (locally and
internationally), especially during the lockdown.
o Develop and execute social media marketing campaigns✓ and advertise via social
media “influencers”.
o Shut down unprofitable stores✓ and sell assets from these operations or move to
profitable stores.
o Reduce the percentage of credit sales✓ as a percentage of total sales and put
stringent controls in place to ensure creditworthiness of the potential customers.
o Add free after-sales services✓ (free delivery, assembly or minor items).
o Buy struggling and desperate furniture retailers and/small boutiques✓ which are
likely to bring more synergies to the business. Explore other markets to expand to.
o Renegotiate✓ prices with suppliers (consider free delivery) and lower interest rates
with long-term capital providers.
o Review product profitability✓ and adjust to ensure focus is on more profitable
products. Electrical appliances are likely to be sourced outside the country – and the
weakening rand may lead to lower profit margins or less sales.
o Keep inventory levels✓ low and buy items after they have been ordered by the
customers. Consider effective leadership to be put in place.
o Partner with property development companies✓ to build and sell fully furnished
properties.
o Consider supplying school furniture✓ via engagement with the Department of
Education.
lOMoARcPSD|8336999
1
lOMoARcPSD|8336999
Ratio Analysis
Liquidity Ratios
Current Ratio = (Current Assets/Current Liabilities)
Quick Ratio (Acid Test) = (Current Assets - Inventory)/Current Liabilities
Profitability Ratios
Gross Profit Margin = (Sales – Cost of Goods Sold)/Sales
Operating Profit Margin = (Operating Income/Sales)
Net Profit Margin = (Net Income/Sales)
Return on Assets = (Net Income/Assets)
Return on Equity = (Net Income/Common Equity****)
Market Values
Price/Earnings Ratio = (Market Price/Earnings Per Share)
Market/Book Ratio = (Market Price/Book Value)
Dividend Yield = (Dividends per Share/Market Price)
---------------------------------------------------------------------------------------
*Some analysts calculate the Inventory Turnover Ratio as Sales//Inventory
**Net Fixed Assets typically refers to Net Property, Plant and Equipment. If Property,
Plant and Equipment is not specifically identified on the balance sheet, just use
long-term assets.
***EBIT stands for Earnings Before Interest and Taxes (sometimes referred to as
operating income).
Ratio Summary
Liquidity Ratios
Working Capital Current Assets 3 Current Liabilities Amount of current assets left
over after paying liabilities
Acid-test (quick) Ratio Quick Assets (Cash + Marketable Test of immediate debt-
Securities + net receivables) paying ability 3 how much
Current Liabilities cash do we have available
immediately to pay debt
Cash flow liquidity ratio (Cash + Marketable securities + Test of short-term, debt
Cash flow from operating activities) paying ability
Current Liabilities
Accounts Receivable Net credit sales (or net sales) Test of quality of accounts
Turnover Average Accounts Receivable receivable 3 how many times
have we collected avg accts
**Avg Accounts Receivable is calculated as receivable
(beg. or last year9s accounts receivable +
current year end Accounts receivable) / 2
Days Sales Uncollected Accts Receivable, Net x 365 days How many days it takes to
Net Sales collect on accounts receivable
Adapted from <Accounting Principles: A Business Perspective, Financial Accounting (Chapters 9 3 18)= A Textbook Equity Open
College Textbook originally by Hermanson, Edwards, and Maher
lOMoARcPSD|8336999
Equity (or Stockholder9s Total Equity How much equity we have for
Equity) Ratio Total Assets every $1 in assets.
Profitability Ratios
Profit Margin Ratio Net Income How much NET income we
Net Sales generate from every dollar of
sales.
Gross Margin Ratio Net sales 3 Cost of goods sold How much gross profit is
Net Sales earned on every dollar of
sales (also known as markup)
Return on common Net Income 3 Preferred dividends How much net income was
stockholder9s equity Average common stockholder9s generated from every dollar of
equity common stock invested.
Basic Earnings per Share Net Income 3 Preferred Dividends How much net income
(EPS) Weighted Avg common shares generate on every share of
outstanding common stock
Market Prospects
Price-earnings ratio Market price per common share How much the market price is
Earnings per share for every dollar of earnings
per share
Dividend yield Annual cash dividends per share How much dividends you
Market price per share receive based on every dollar
of market price per share.
Adapted from <Accounting Principles: A Business Perspective, Financial Accounting (Chapters 9 3 18)= A Textbook Equity Open
College Textbook originally by Hermanson, Edwards, and Maher
lOMoARcPSD|8336999
HMS 1
FORMULA SHEET – MAC2602
QUESTION 1 - TIME VALUE OF MONEY (TVM)
1. SIMPLE INTERST: I=PxRxT ³ I = simple interest, P = principal, R = interest rate and T = time
3. FUTURE VALUE (SINGLE PAYMENT – 1 PERIOD): FV = PV(1 + i) ³ FV = future value, PV = present value, i = interest rate
n
4. FUTURE VALUE (SINGLE PAYMENT – MULTIPLE PERIODS): FV = PV(1 + i) ³ FV = future value, PV = present
value, i = interest rate and n = Number of years/periods
14. INTERPOLATION
HMS 2
2. DIVIDEND GROWTH MODEL (To determine the market value of the share)
where P0 = current market price of the share (current value of the share) at point 0 in time
D0 = current dividend (or earnings per share x payout ratio)
D1 = D0 x (1 + g) = the expected dividend per share for year 1 (after growth)
ke = the required rate of return (market discount rate or cost of ordinary equity/shares)
g = expected CONSTANT growth rate in earnings (and assuming a constant payout ratio,
therefore in dividends as well)
a. Formula
ke = equity-holders’ current required rate of return (cost of equity)
kd = debt-holders’ current required rate of return (cost of debt after tax)
ve = market value of equity (weighting for ke )
vd = market value of debt (weighting for kd )
b. Table format
lOMoARcPSD|8336999
HMS 3
QUESTION 3 – ANALYSIS IF FINANCIAL INFORMATION AND WORKING CAPITAL MANAGEMENT
GROWTH RATE
Operating
x Net profit x Net profit x EBIT Revenue
Gross profit x profit x 100 x 100
100 Revenue 100 Equity 100 Total assets Total assets
Revenue 100 Revenue
2. Liquidity
Current ratio Current assets:Current liabilities
Current assets less inventory:Current liabilities
Liquid asset ratio (or acid test or quick ratio)
Inventory days
Cash ratio
Debt to equity ratio Long-term interest bearing debt (including its current portion):Equity
Debt ratio (or gearing)
4. Financial market
Earnings per share
Earnings yield
Dividend yield
lOMoARcPSD|8336999
HMS 4
1. PAYBACK PERIOD
Years before break-even year = number of years that the cumulative cash outlay is still negative
Remaining cost to cover = capital outlay (investment) less cash recovered in years before the break-even year or cumulative negative cash outlay at
the start of the breakeven year
Cash flow during the break-even year = cash flow during the year in which break-even takes place
Cash flows = operational cash flows AFTER tax
Average net profit after taxation = the average annual profit after taxation for the whole period (life of the project/asset)
Average investment = the average of the original investment cost (outlay) and any residual value at the end of its useful life (usually Rnil). (This is
equal to the cost of the investment ÷ 2 if depreciation is levied on the straight-line basis!)
5. PROFITABILITY INDEX
UNIVERSITY EXAMINATIONS
June 2021
MAC3761
100 Marks
Duration 3 Hours
Instructions:
1. This assessment consists of two independent questions.
2. All questions must be answered, and all calculations must be shown.
3. For hand-written answer files, you must not write with a pencil or a red pen. Only use a
black pen.
4. You can only upload a PDF document on myUnisa as your answer file.
5. It is your responsibility that once uploaded, you must view your answer file and ensure that
it is correct, complete (no missing pages), legible, it can open, not of poor image quality, not
password protected, and not corrupted.
6. Your attention is brought to the announcement posted on MAC3761 myUnisa site titled
“Cheating in MAC3761 assessments”, as well as the plagiarism declaration in the TL101.
100 240
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1. The company’s factory overheads have not been allocated. They are allocated to the five
divisions as per below activities:
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QUESTION 1 (continued)
(i) The divisions recorded a total of 7 890 000 machine hours of which 2 827 000 relate
to the Masks Division.
(ii) The Masks Division occupies and utilises 2 022m2 of the company’s total factory floor
space.
(iii) Safety and wellness costs relate to health and safety activities. For the period ending
31 December 2020, the company clocked a total of 1 247 hours on health and safety
activities. The Masks Division logged 30,72 property maintenance days for the 2020
financial year. Each daily shift consists of 12 hours.
(iv) 23 cents of each rand incurred in ordering and handling materials is attributed to the
Masks Division.
(v) The Masks Division had 214 staff throughout the 2020 financial year. The company’s
total staff complement of the 2020 financial year is expected to increase by 17% to 702
for the 2021 financial year.
2. The above factory overheads do not include the divisions’ specific fixed overheads and
the Head Office’s allocated fixed overheads. These are always reflected separately in the
divisions’ respective management accounts.
Baba Ndou, the business manager of the Masks Division, has presented the actual
management accounts below as recorded and reported in his division to the executive
management of PPE. He is confident that his division will meet the new target of R18 million
in operating profit set for the full 2021 financial year, leading to his division qualifying for
bonuses. The extract from the Masks Division’s actual management accounts and its notes
and additional information for the 9 months ended 31 December 2020 are presented below in
Schedules C and D:
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QUESTION 1 (continued)
D. NOTES AND ADDITIONAL INFORMATION
1. For the 9-month period ending 31 December 2020, the Masks Division produced and sold
a total of ninety million masks. The unit selling price is expected to increase by 12% for
the 2021 financial year as the company expects increase in global demand of masks.
3. This material relates to straps bought from the Safety Shoes Division (which already
manufactures straps and laces for the shoes manufactured by the division). These straps
are then used as ear loops for the masks. There were no straps on hand at the end of the
2020 financial year.
4. For the 2020 period, the Masks Division labourers were remunerated at an hourly rate of
R18, just slightly below the national minimum wage gazetted of R20,76 due to the fact that
the company is fairly new and had to invest heavily in the plant at the beginning of the
year. For 2021, PPE plans to increase this to R25 per labourer, per hour.
5. Indirect labour costs relate to fixed salaries of supervisors and foreman who are working
on the factory floor to make sure that production processes run accordingly.
6. These costs are determined by the Head Office and although they are correctly allocated
to the divisions of PPE, they bear no direct relationship with the underlying products’
volume.
7. Lowest number of masks sold was recorded in April due to poor advertising campaign, but
the month of September saw the highest number of units sold (probably as the government
relaxed the lockdown restrictions). There were 4,5 million masks sold in April and 10,5
million masks sold in September. Total administration and selling costs were R150 025
and R296 455 for April and September, respectively. Both the unit variable costs and total
fixed costs for the 2021 financial year will remain as that of the 2020 financial year.
8. There are no expected changes in material costs and overheads for the 2021 financial
year, except for any changes evident above.
9. Unless indicated otherwise, assume all income and expenses are incurred evenly
throughout the reporting period.
PPE has started exploring ways of diversifying its business for the purpose of long-term
viability, especially in the post-Covid19 era. PPE has embarked on discussions with Aloetiser
(Pty) Ltd (“Aloetiser”) for a possible acquisition of Aloetiser’s operations. The owners of
Aloetiser are emigrating to Canada soon and are desperately in need of a buyer to take over
their entire Gqeberha-based operations in the Eastern Cape. For the year ended 31 March
2021, the owners of Aloetiser claimed to have made an actual net profit of R22m. The
projections are that this reported net profit will likely increase by 20% for the 2022 financial
year. Aloetiser uses a direct costing system and accounts for inventory using the weighted
average method. As part of PPE’s investment strategy, PPE will consider buying Aloetiser’s
operations if Aloetiser has for the recent financial period, reported a contribution margin ratio
of 0,4 for each product.
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QUESTION 1 (continued)
Aloetiser uses aloe vera leaves bought from local farmers and then put these through the
production process, where a gel is squeezed from the leaves to generate aloe vera gel. This
aloe vera gel is then further processed to make hand sanitisers after alcohol and other
ingredients have been added. The squeezed aloe vera leaves are boiled and sifted through
during the process to produce aloe vera liquid. This aloe vera liquid, after adding some
chemicals, is then sold to cosmetics manufacturers which use it to make facial and other skin
products. The residual aloe vera leaves left after these processes are then scrapped and sold
to Left Aloe Limited, the only pharmaceutical company which uses it in the manufacturing of a
special medicine. The following has been extracted from the production cost schedule of
Aloetiser (Pty) Ltd for the year ended 31 March 2021:
2.2. These manufacturing costs relate to the joint manufacturing process of extracting the
aloe vera gel and of boiling the aloe vera leaves. These costs are allocated to hand
sanitisers and aloe vera liquid based on the net realisable values of the products. There
were 2,2 million litres of aloe vera gel (for making hand sanitisers – further refer to 2.4
below) and 3,04 million litres of aloe vera liquid produced during the 2021 financial year.
2.3. These overheads are not incurred within the joint manufacturing process and are also
not allocated to products.
2.4. For each litre of aloe vera gel, 250 millilitres of alcohol and other ingredients are added
to make the complete hand sanitiser. There are no volume losses in the process.
2.5. Chemicals added in processing the aloe vera liquid do not materially increase the
quantity and there are no known volume losses in the process.
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June 2021
QUESTION 1 (continued)
2.6. The sales for the 2021 financial year were made as follows:
a. 2,1 million litres of hand sanitisers were sold at R3,46 per litre and it cost Aloetiser
R545 364 to market and sell these hand sanitisers to different retail stores. This
amount, as per the contract, has been fixed for the past three years.
b. 2,97 million litres of aloe vera liquid was sold to cosmetics manufacturers at R6,50
per litre. The company makes use of agencies who are paid a commission
equivalent to R0,50 per each litre sold.
c. Residual aloe vera leaves were sold to Left Aloe Limited for R875 000.
2.7. There were no raw materials, alcohol and other ingredients, chemicals, and work in
progress on hand both at the beginning and at the end of the financial year.
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June 2021
QUESTION 1 (continued)
REQUIRED
For each question below, remember to:
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June 2021
A. The financial statements, together with other key information relating to Brat Lows
Furniture Group, are first presented below:
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June 2021
QUESTION 2 (continued)
2. STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 2020
Current assets
Inventory and financial assets 1 097 1 042
Trade and other receivables 2 956 3 326
Cash-on-hand and deposits 1 970 1 193
Total current assets 6 023 5 561
TOTAL ASSETS 8 173 7 390
2020 2019
Target capital structure – Debt: Equity (market values) 40:60 40:60
Prime lending rate (closing %) 7,0 10,0
ZAR: 1 US dollar (average) 17,84 14,45
ZAR: 1 US dollar (closing) 14,93 14,40
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MAC3761
June 2021
QUESTION 2 (continued)
4. NOTES AND ADDITIONAL INFORMATION
4.1. This relates to sale of furniture and electrical appliances both to cash customers and credit
customers. The value of cash sales is approximately 25% of the value of credit sales. The
Group’s purchases from the manufacturers are mainly on credit, and the Group continues
to maintain good relations with its suppliers.
4.2. The Group also provides credit life insurance cover to credit customers. Interest income
is derived from instalment sales and overdue accounts.
4.3. Operating costs include debtor costs of R2,257 billion for the current year (2019: R1,255
billion). The debtor costs are made up of trade bad debts written off, debt management
costs and debt impairments.
4.4. Finance costs relate mainly to the following long-term interest-bearing liabilities:
i. A 10-year loan facility received from Da Bank on 5 January 2017. This loan of R1,24 billion
currently incurs an interest rate of prime less 125 basis points per annum. Interest is
payable annually in arrears. Similar facilities bear an annual interest at prime less 100
basis points.
ii. Medium-term loan of R400m from Cressida Finance which is repayable fully on 20
December 2023. Fixed interest of R26 million is payable annually in arrears. BLF had
applied to Cressida Finance’s COVID relief fund to postpone its 20 December 2020
interest payment. However, the approval only came after the payment was made.
Cressida Finance has now agreed to postpone the 20 December 2021 interest amount to
20 December 2022. All other future payments are scheduled to be repaid as initially
planned. There is no additional interest on postponed payments. Market related interest
rate on similar term loans is 6,85% per annum.
iii. Fifteen million preference shares were issued two years ago at R70 per share. Preference
share dividends are payable annually in arrears at 80% of prime rate. Currently for the
same value of preference shares in the market, BLF would be expected to pay R62,4
million as an annual dividend.
iv. Twelve million debentures were issued at R45 each and are redeemable in four years’
time. However, there is a once-off premium of R0,75 per debenture payable one year
after redemption. Annual interest on these debentures is R36 million and is payable
annually in arrears. Similar debentures are trading at 6,25% per annum.
v. Other non-current liabilities (non-interest bearing) were recorded at R268 million for the
year ended 31 December 2020 (2019: R283 million).
vi. The market value of long-term interest-bearing facilities on 31 December 2019 was
R3,972 billion. The market value of equity on 31 December 2019 was R4,466 billion.
vii. The balance of finance costs relates to short-term borrowing costs.
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QUESTION 2 (continued)
4.5. BLF issued additional shares to its existing shareholders during the 2020 financial
year in an effort to strengthen its balance sheet and decrease its gearing levels. These
shares were issued at a discounted price of R20 per share, bringing the total number
of ordinary shares issued to 224,9 million. This was the only movement in ordinary
share capital during the 2020 financial year. The market price subsequently
plummeted to R18,25 per share by the end of the 2020 financial year.
4.6. There were 366 days in 2020 (2019: 365) and the South African corporate tax rate
has remained unchanged at 28%.
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June 2021
QUESTION 2
REQUIRED
For each question below, remember to:
©
UNISA 2021
All rights reserved. No part of this document may be reproduced or transmitted in any form or
by any means without prior written permission of Unisa.
CONFIDENTIAL
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Blue ticks
SUGGESTED SOLUTION (✓) are
alternative
QUESTION 1
(a) Calculate the total overheads attributed to the Masks Division for the 9-
[8]
month period ending 31 December 2020.
Overheads R Marks
Depreciation & machine service costs 12 943 826 ✓ r/w
[36 125 500 ÷ 7 890 000 x 2 827 000]
Rent, rates, water and electricity 5 547 622 ✓ r/w
[18 766 438 ÷ 6 840 m2 x 2 022 m2]
Safety and security costs 1 489 176 ✓✓
[(5 037 442 x 30,72 x 12)✓ ÷ 1 247✓]
OR: [(5 037 442 ÷ 1 247 ÷ 12)✓ x 30,72✓]
Ordering and material handling costs 284 866 ✓ r/w
[1 238 546 x 0,23]
Cafeteria, development and teambuilding costs 299 868 ✓✓
[(840 750 ÷ (702 ÷ 1,17)✓ x 214✓]
Head Office’s allocated overheads 2 128 423
Division’s specific costs (indirect labour costs) 9 470 000 ✓ r/w
Total overheads 32 163 781
Given
(b) Determine whether Baba Ndou and his Masks Division are entitled to
bonuses (and how much, if any) for the period ended 31 December 2020. [8]
Show all workings.
Details R Marks
Sales 83 252 205 ✓ r/w
Variable manufacturing costs (39 487 668) ✓ r/w
Factory overheads [part a] (32 163 781) ✓ ©
Gross profit 11 600 356
Administration and selling costs (1 886 600) ✓ r/w
Net profit before tax 9 713 756
Gross profit margin 13,93% ✓ ©
Conclusion:
The Masks Division’s gross profit margin of 13,93% is more than the 12,75% target while
the actual net profit before tax of R9,713m is also more than the R8,5m target. As such,
both Baba Ndou and his division are entitled to a total of R2 166 504✓✓ in bonuses for
the 9-month period ending 31 December 2020 (R166 504 of this goes to Baba Ndou).✓©
1 mark for conclusion
Given 2 marks for calculation
20 875 828 + 4 611 840 + 14 000 400 = 39 487 668
11 600 356 ÷ 83 252 205 = 13,93%
Baba Ndou’s bonuses: R83 252 205 x 0,2% = R166 504 ✓rw
Division’s bonuses: R2 000 000 ✓rw
Total bonuses payable to Masks Division: R2 166 504 (R166 504 + R2 000 000)
(c) Critically evaluate the overall remuneration scheme of Phalaborwa
[5]
Pharmaceutics Enterprise.
On determining bonuses
• The company seems to be instilling commitment to the success of the organisation
by giving the divisions incentives over and above the normal wages and salaries.
This is likely to increase productivity by the divisions.
• Some manufacturing overheads may not be within the control✓ of the divisions or
methods to allocate these may not be favourable to other divisions.
• The bonus payable is not proportionated to the operating profit✓ – e.g. it does not
matter by how much the targeted operating profit is exceeded, this does not
influence how much is paid out as a bonus. There will be no bonuses payable if the
operating profit is slightly below the set target.
• The manager may be tempted to increase sales at any cost (overstatement or
incorrect classification) as their bonus is based on the sales generated✓. The
manager also gets paid significantly higher in bonuses than the entire division (and
he might still benefit from the divisional pool of bonuses). This may lead to
demotivated and unhappy workforce.
• The fixed bonus pool does not take into account the number of employees (currently
the Masks Division accounts for 35% of the entire factory labour force, and yet the
bonus pool of R2m is the same across the factory)✓.
• The bonus structure only takes into account financial factors – non-financial factors
should also be considered in rewarding the staff.
MAX: 5 marks
(d) Determine the number of masks that the Masks division needs to produce
[10]
in order to meets its operating profit target for the 2021 financial year.
Total fixed costs + target profit (43 367 471✓✓✓ + 18 000 000✓)
✓𝐟
Contribution per unit 0,513✓✓✓✓✓✓
MAX: 10 marks
(e) Discuss business ethical issues that may be of concern to Phalaborwa
[5]
Pharmaceutics Enterprise and its operations.
• The company might be engaging in illegal work with the government entities. The
company cannot be paying the entities✓ (and/or their employees) in order to sell
goods to these entities. This should be investigated to ensure that it is not a bribe of
any sort✓.
• PPE should ensure that the orders in the pipeline are valid and that the necessary
government procurement processes were followed✓.
• The company should have reported the electrical fault immediately✓ (supply of
electricity was considered essential services). Only ESKOM personnel or ESKOM
approved service provider should (re)/connect electricity and it is illegal for anyone
else to make these connections✓. PPE should report the matter and ESKOM must
make appropriate assessment of what might be owed. Electricity costs resulting from 1 mark for
this must be considered and accounted for appropriately for the following years✓. ethical concern
• The company seems to be in contravention of the Basic Conditions of Employment 1 mark for
Act, as it currently pays its labourers R18 per hour, while the minimum wage is consequences
R20.76✓. This may lead to fines and penalties imposed by the Government, and 1 mark for
possible labour unrest and strikes✓. PPE should consider adjusting and backdating appropriate
action
the wages or restructure the benefit package to consolidate all the benefits (e.g.
bonus portions and cafeteria benefits)✓.
• PPE seems to have continued its operations even during the hard lockdown (level
5)✓ and this might have been against the law at that time while exposing its
workforce to COVID-19 (unless considered essential services)✓.
MAX: 5 marks
(f) Prepare a segmented income statement (by product) of Aloetiser
(Pty) Ltd, showing the profit for the year ended 31 March 2021 for [12]
each product, as well as the total for the company.
Given
13 682 817 – 875 000 + 76 543 = 12 884 360✓r/w:
Sanitiser: 12 884 360 x 35,54%✓ = R4 579 102;
Liquid: 12 884 360 x 64,46% = R8 305 258
R1,20 x 3,04m = R3 648 000
Net realisable value
NET REALISABLE VALUE
Details – Rands Sanitiser Liquid Total
Sales (2,75m x R3,46); (3,04m x R6,50) 9 515 000 19 760 000 29 275 000
Less: further processing costs ©✓ (923 187) (3 648 000) (4 571 187)
Less: Selling costs ✓ rw (545 364) (1 520 000) (2 065 364)
Net realisable value 8 046 449 14 592 000 ✓ 22 638 449
Allocation 35,54% 64,46% 100%
R0,50 x 3,04m = R1 520 000✓
Sanitiser: (1 494 491 + 4 579 102 + 923 187) ÷ (500K + 2 750K) x 1 150K
R2 475 783
Liquid: (1 873 109 + 8 305 258 + 3 648 000) ÷ (820K + 3 040K) x 890K
R3 187 945
CLOSING FINISHED GOODS INVENTORY
Details – quantity in litres Sanitiser Liquid Total
Units at the beginning of the year 500 000 820 000 1 320 000
Units produced during the year 2 750 000 3 040 000✓ 5 790 000
Less: Sold units (2 100 000) (2 970 000) (5 070 000)
Units remaining at end of the year 1 150 000 890 000✓© 2 040 000
Sanitiser: 2 200 000 x 1,25l = 2 750 000✓
MAX: 12 marks
(g) Based on the investment criteria and other factors Phalaborwa
Pharmaceutics Enterprise needs to take into consideration, advise if the [7]
Phalaborwa Pharmaceutics Enterprise should buy Aloetiser (Pty) Ltd.
The contribution margin ratio for aloe vera liquid is 0,45 slightly above the required 0,40 as
the investment criterion and the contribution margin ratio for hand sanitiser is 0,38 (not
meeting the required criterion). Based on these two ratios only, PPE should consider not
buying Aloetiser (Pty) Ltd✓©. These below additional factors may also be considered before
reaching the decision:
• Possible synergistic benefits✓, considering that both companies are in the business
of manufacturing safety and health products currently in high demand due to COVID-
19.
• PPE uses the absorption costing method✓, and the importance of using the
contribution margin ratio as means of evaluating an investment should be carefully
evaluated.
• Alignment and running of operations especially between different provinces✓ (i.e.
Limpopo and Eastern Cape) should be considered carefully, including different
accounting and reporting systems used and PPE’s time in the market.
• The claims made by the owners that the business generated R22m net profit✓ in
the recent financial year raise concerns about the accuracy of the accounting
information provided, as well as the integrity of the owners (sales were only R26m
before taking into account obvious operating costs).
• Claims that the business will grow by 20% in 2022 should be verified✓, especially
by reviewing the performance of the first quarter of 2022.
• Increased global use of hygiene and healthy products may lead to profit growth for
the company✓.
• Owners might be desperate to sell✓, and this can present an opportunity for PPE to
offer a lower purchase price. At the same, this can be a concern if PPE may need
proper handover and post-acquisition support from the owners of Aloetiser.
• It may be difficult to predict how well Aloetiser will do post COVID-19✓ or once the
vaccine has been rolled out successfully. Considerations must also be made
regarding new companies entering this low-barriers-to-entry market.
• There seems to be a small market to sell the by-product✓ (residual aloe vera
leaves), considering that currently there is only one buyer.
• Hand sanitisers at hand cost about R2,99 (R1 494 491 ÷ 500 000) and this might
point to possibly decreasing selling price due to increased supply of these goods✓
in the market.
• Details assessments must be conducted to determine the profitability of further
processing the products✓ instead of selling them off before incurring additional
processing costs.
• Inventory levels seem to be increasing✓, pointing to possible difficulties in moving
the stock.
• Inclination of inventory valuation errors due to multiple valuation methods and
different costing systems✓.
• Consideration of future enforceability of existing contracts✓. For example, the
marketing and selling contract of hand sanitisers is currently negotiated at fixed cost
of R545 364.
MAX: 7 marks
QUESTION 2
Interest-bearing debt
2020: R1 240m [Da Bank loan] + R400m [Cressida loan] + (R70 x 15m) [pref. shares] +
(R45 x 12m) [debentures] = R3 230m.
2019: R4 105m – R283m = R3 822m.
MARKET VALUES:
INSTRUMENT MARKET VALUE (FINANCIAL CALC.) COST OF LOAN
PV of interest + capital
FV - 1 240 million
PMT - 51,336 million (1 240 million x 7%-1,25%)x0,72 ✓ 𝐾𝑑1 = 4,32%
N 6 (10 years – 4 years: Dec 2020- Jan 2017) ✓
I 4,32% (7%-1% x 0,72)
Da Bank Comp PV 1 228 million (OR 1 228 420 464)
INSTRUMENT MARKET VALUE (FINANCIAL CALC.) COST OF LOAN
CF0 0
CF1 – 2021 0✓
CF2 – 2022 - 37,44 million (26 million x 0,72 x 2 years)✓ 𝐾𝑑2 = 4,932%
CF3 – 2023 - 418,72 million (400m + 18,72m✓)
I/Y 4,932% (6,85% x 0,72)
Cressida Finance Comp NPV 396 million (OR 396 412 945)
𝐾𝑑3 = 4,50%
CF0 0
CF1 - 25,92 million (36 million x 0,72) ✓
Debentures CF2 - 25,92 million
CF3 - 25,92 million Mark for
CF4 - 565,92 million ([12 mil x R45]✓+ 25,92m) R540m
CF5✓ - 6,48 million (12 mil x R0,75 x 0,72)
I/Y 4,50 (6,25% x 0,72)
Comp NPV 551 million (551 011 674)
MAX: 5 marks
(c) Discuss factors you would have considered before taking part in the
Group’s issue of additional ordinary shares during the year, if you were one [8]
of the Group’s shareholders.
▪ How does this proposed issue affect my percentage holding in Brat Lows Furniture
Group? Am I likely to lose control or significant influence✓ if I do not exercise the
option to buy more shares?
▪ Do I have the required funds (availability) ✓ to further invest in the business, and
how will this additional investment affect the diversification of my investment
portfolio?
▪ Do I have the appetite for additional risk in the equity market? ✓ What are my other
investment alternatives and how much return do they offer? How have the other
comparable companies in this sector fared?
▪ What are the prospects of the entire industry and is it the industry one would like to
invest in?
▪ The shares have been discounted to R20 – how has the share performed✓ in the
past and am I likely to make substantial profit at the additional purchase of the
shares?
▪ How confident am I in the business and the managers that they will be able to turn
the business around? ✓ Am I likely to see an increase in the value of the shares?
▪ The Group has recently suspended its dividend – is this likely to continue?✓ How
has the Group enforced its dividend policy in the past?
▪ What has been my historical return✓ on this share (based on the dividend yield as
well as the share price growth)? Have I also lost patience and confidence that things
will get better?
▪ How has the business been impacted by COVID-19✓ and is it likely to survive in the
post-COVID era? Are there any new markets the business can go into?
▪ Is the business likely to continue as a going concern? What are the company’s future
growth prospects?
▪ Is this the best time to buy the share✓ – probably at lowest levels?
▪ Have I considered the tax effect✓ of buying at R20, and tax on dividends to be
declared in the future? Am I a speculative investor or a long-term investor, and what
is the tax implication on each of the options?
▪ Are there any measures I can put in place to limit or mitigate✓ against the risk
associated with this investment (e.g. use of derivatives)?
MAX: 8 marks
(d) Calculate the cash conversion cycle of Brat Lows Furniture Group at 31
December 2020 and based on the information and nature of industry, [9]
advise on some practical ways to improve the cash conversion cycle.
CASH CONVERSION CYCLE:
2020
Trade receivable days: DAYS
2 956
𝑇𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
x 366
(2 882✓©+2 068✓)
x 366
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
218
2 956
x 366
4 950
2020
Trade payable days: DAYS
874
𝑇𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
x 366
1 401
x 366
𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
228✓r/w
2020
Inventory days: DAYS
844
x 366
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 1 666
x 366
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
185✓r/w
DAYS
CASH CONVERSION CYCLE
(218+185-228) ✓© 175
ADVICE: MAX: 3 marks (one mark per each class of working capital)
When improving the cash conversion cycle, a company attempts to collect from its debtors
sooner; convert its inventory sooner; and delay payment to its creditors. By so doing a
company reduces the number of business days (operating or cash conversion cycle).
Inventory days: ✓
The furniture and electric appliances remain on the floor for about six months. The Group
runs the risk of stock being “outdated”, especially electric appliances. The entry of small
boutiques with more trendy furniture will also lead to difficulties in selling the furniture. The
Group should consider reducing the amount of stock that is kept on hand (this will also lead
to decrease in holding costs). The Group could also take orders from customers before the
goods are sourced from suppliers, which based on good relations they maintain, are likely
to deliver within reasonable timeframe.
MAX: 9 marks
(e) Advise the management of Brat Lows Furniture Group on how to effectively
[5]
structure the business to return to profitability.
The Group can consider the following strategies: MAX: 5 marks
o Establish an online sales platform✓ to reach a broader market (locally and
internationally), especially during the lockdown.
o Develop and execute social media marketing campaigns✓ and advertise via social
media “influencers”.
o Shut down unprofitable stores✓ and sell assets from these operations or move to
profitable stores.
o Reduce the percentage of credit sales✓ as a percentage of total sales and put
stringent controls in place to ensure creditworthiness of the potential customers.
o Add free after-sales services✓ (free delivery, assembly or minor items).
o Buy struggling and desperate furniture retailers and/small boutiques✓ which are
likely to bring more synergies to the business. Explore other markets to expand to.
o Renegotiate✓ prices with suppliers (consider free delivery) and lower interest rates
with long-term capital providers.
o Review product profitability✓ and adjust to ensure focus is on more profitable
products. Electrical appliances are likely to be sourced outside the country – and the
weakening rand may lead to lower profit margins or less sales.
o Keep inventory levels✓ low and buy items after they have been ordered by the
customers. Consider effective leadership to be put in place.
o Partner with property development companies✓ to build and sell fully furnished
properties.
o Consider supplying school furniture✓ via engagement with the Department of
Education.
MAC3702
MAY/JUNE 2020
UNIVERSITY EXAMINATIONS
May/June 2020
MAC3702
100 marks
3 hours
30 minutes additional time for uploading
INSTRUCTIONS:
PLEASE NOTE:
Page 1 of 8 CONFIDENTIAL
[TURN OVER]
Open Rubric
MAC3702
MAY/JUNE 2020
Eddy Fashion Holdings (“EFH”) is South Africa’s oldest and biggest retailer by assets and is
listed on the Johannesburg Stock Exchange. In the recent years the company has struggled
to deliver impressive results as it faces serious competition from both local and international
retailers. The company’s share price was trading at 4 598 cents on 01 October 2018, at the
start of the financial year, but had lost about 52% of its value by the end of September 2019
as it recorded a net loss of R109 million. With no dividend declared at the end of the year, this
loss brought the company’s net asset value down to R1 269 billion. EFH’s significant
shareholders include the Public Investment Corporation (22%), Rembrandt Group (19%) and
African Rainbow Capital (15%). Only 50% of the company’s authorised shares remains
unissued.
The company has approached the Industrial Development Company (IDC) for a possible
capital injection into the business of up to R8 850 million in order to pay off its interest-bearing
debt, increase working capital levels, and embark on a new expansion programme. EFH
requires R600 million for its ARISE & DREAM project (see Part A below); R8 billion to repay
its long-term debts (see Part B); and R250 million (see Part C) to manage liquidity for the next
few months. IDC has proposed that EFH issues new EFH ordinary shares in return for the
capital injection into EFH business.
EFH will be embarking on a new comprehensive business model that is aimed not only at
revenue generation, but also at the empowerment of upcoming and aspiring young designers.
The EFH procurement team has already identified four of South Africa’s top young designers
to be part of the new clothing range called “ARISE & DREAM”. The designers will
conceptualise and design the clothes which will then be sent to EFH’s trusted local
manufacturers to manufacture the required quantities for all its 350 participating stores. Once
major alterations and renovations have been completed at these stores, ARISE & DREAM
clothing range will be sold for a period of five years (ending December 2025) before the range
becomes out of fashion. It is estimated that afterwards the company will be able to find
substitute products to sell utilising space previously occupied by ARISE & DREAM clothing
range. Each store is expected to generate an average trading profit of R65 000 per annum on
the extra space going forward (after taking into account future wear and tear allowances). This
trading profit will increase at 4,80% per annum.
The final four top young designers, with their designs showcased below, are: Nkhensani Nkosi,
Amanda Laird, Mzukisi Mbane and Jacques van der Watt.
Page 2 of 8 CONFIDENTIAL
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MAC3702
MAY/JUNE 2020
Imprint, by Mzukisi Mbane Lace and frills, by Jacques van der Watt
1. Capital expenditure
The first two years (2020 & 2021) will be for the construction phase, however, ARISE &
DREAM sections at all participating stores will be operational at the end of the first year.
Full capacity will only be reached at the end of 2023. At the start of the project EFH will
spend R245 million on alterations and renovations and another R245 million will only be
spent a year later (these qualify for 5% wear and tear allowance). The balance of the
project amount will be spent between store fittings and working capital (see note 3 below).
Working capital will be equivalent to 50% of the store fittings costs. Store fittings will also
be purchased at the beginning of the project and are subject to a capital allowance of 20%.
Wear and tear as well as capital allowance are only deductible once the stores are opened
and operational (pro rata applies).
2. Working capital
The working capital will only be required once the ARISE & DREAM sections at all
participating stores are operational. 60% of the total working capital requirement will be
provided for in the first year of opening the stores, with the balance being provided in the
following year. Only 90 cents in a Rand of the invested working capital will be recovered
at the end of the project.
Page 3 of 8 CONFIDENTIAL
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MAC3702
MAY/JUNE 2020
3. Sales
The young designers have signed a five-year agreement to design the clothing range to
be sold at the 350 participating stores. The range entails men’s, women’s, kids’, footwear
and accessories for every occasion. The expected number of units to be sold by each
designer per annum are given below, with the starting average price per item. The ARISE
& DREAM clothing line is priced at a mark-up of 50% on cost (manufacturing).
Manufacturing costs include designers’ fees paid to the four young designers.
1
This is at full capacity per store per year. There is a demand, spread evenly throughout the year for all the
products manufactured each year. All four clothing labels will be available at all participating stores.
2
This average price per unit is the price at the start of the construction phase. The selling price will increase
by 6% per annum.
4. Operating/trading costs
Expected operating costs will amount to a total of R30 million per annum for all the
participating stores (excluding marketing costs). These operating costs will be incurred at
the same time the revenue is realised. The company will also be embarking on a 3D
marketing campaign for its new clothing range. The 3D marketing will display the new
clothing range using a 3D clothing visualisation technology at various shopping centres
where the participating stores are located. Payment for related marketing costs, made in
advance, will be R2 million in the first year of launching the clothing range but will reduce
by 20% (based on the initial marketing cost) in each following year. Excluded from the
amounts above is an annual depreciation charge of 10% on buildings and 25% on
equipment and fittings. Depreciation is only accounted for once the asset has been brought
into use.
5. Salaries
The company will have to contract a digital marketing manager and Sethu Ndamase with
eight years’ experience in the advertising industry has already been identified. Sethu
Ndamase will likely start at the beginning of 2020 in order to familiarise herself with the
business. The job requires her to manage, develop and expand the marketing department
with current marketing technology models and tools. She will be responsible for:
Page 4 of 8 CONFIDENTIAL
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MAC3702
MAY/JUNE 2020
No interview has been conducted with her yet but her expected salary package for the
2020 financial year will be R982 377 with an expected increase of 8% per annum and
included in this amount are the following:
Sethu Ndamase was referred to EFH by one of the reputable recruitment agencies, and
the agency will be paid R120 000 for their work in identifying the suitable candidates for
this job. This payment will be effected at the beginning of 2020.
EFH has the following interest- and dividend-bearing facilities at 30 September 2019:
Preference share capital: The three million preference shares were issued three years ago
at a nominal cost of R605 per share, which bear a fixed dividend yield of prime+20bps. Similar
shares are estimated to be trading at R581 each. The redemption date of all these shares is
29 September 2025.
Debentures: 10-year term debentures for R3 144 million were also issued around the same
time as the preference shares above. The finance costs (net of tax) on these debentures
amount to R249 million per annum. The premium and the annual administration costs are
waived, but there is a once-off administration fee of R15 million payable on 30 September
2025. Debentures structured in this manner incur interest at prime lending rate.
Long-term loan: A loan of R871,5 million was obtained on 2 October 2018 and its capital is
repaid in three equal annual instalments. The fixed 11% interest is also paid on the last day
of each financial year. Similar loans bear an interest rate of about 9,75%.
Subordinated debt: EFH also obtained an unsecured subordinated debt from African
Rainbow Capital for R2 010 million on 10 October 2015 at an equivalent interest rate of
prime+2. Similar subordinated debt facilities are estimated to yield an interest at prime lending
rate.
Short-term loan: The loan for R450 million was obtained from CreditSis Bank at prime lending
rate and is repayable on 28 February 2020. The loan was taken out to settle unexpected legal
costs after the company was embroiled in a price-fixing scandal. The company was forced to
take out this loan due to low cash reserves at the time. The cash position of the company has
since improved as EFH closed the year with more than R300 million of cash and cash
equivalents and a zero balance on its bank overdraft facility.
The interest expense on this loan for the year ending 30 September 2019 was R26 million.
Similar loans and overdraft facilities are generally priced around prime+1.
Page 5 of 8 CONFIDENTIAL
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MAC3702
MAY/JUNE 2020
EFH’s debt levels have been on the rise in recent years due to a number of internal and
external factors which have unfolded over the years. One of the major internal factors cited is
poor liquidity management processes. The company has often flout the budgeting/forecasting
processes and as a result finds itself having to use expensive debt to fund any deficits in its
working capital. However, since the IDC bailout application the management team has
implemented more stringent controls around the working capital of the company.
The statement of financial position on 30 September 2019 had net current assets of
approximately R2 billion and is made up of the following:
Cash sales average 25% of total sales and each month’s credit sales are invoiced on the last
day of the month. Credit sales are also collected as follows:
o 60% within 7 days after the invoice date;
o 28% by the end of the month after sales.
o 9% by the end of the second month after sales; and
o 3% is uncollectible.
Half of the monthly purchases the company makes, is paid for in the month of purchase and
the remainder in the following month. The number of items of clothing (units) in each month’s
closing inventory equals 120% of the next month’s units of sales. EFH maintains an average
product mark-up of 33% on selling price. The company also expects in the foreseeable future
to maintain the existing average cost price per unit (as indicated in net current assets above).
Month Units
September 2019 (Actual) 5 253 000
* October 2019 (Actual) 5 110 000
November 2019 (Budgeted) 5 876 500
December 2019 (Budgeted) 6 054 000
January 2020 (Budgeted) 5 270 000
February 2020 (Budgeted) 5 538 600
* Actual units purchased during October 2019 totalled 6 029 800.
Page 6 of 8 CONFIDENTIAL
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MAC3702
MAY/JUNE 2020
EFH undertakes projects that have an internal rate of return of at least 20%.
As at 30 September 2019, EFH had 840 million authorised ordinary shares.
The South African corporate income tax is rate 28%.
Prime lending rate is 10,25% and the cost of equity is 15,2%.
Page 7 of 8 CONFIDENTIAL
[TURN OVER]
MAC3702
MAY/JUNE 2020
REQUIRED
a) By calculating the internal rate of return, determine whether EFH should undertake the
ARISE & DREAM project. [You can scale your workings down by Rm]
(27)
b) Using market values at 30 September 2019, calculate the weighted average cost of
capital (WACC).
(18)
c) Draw up a purchases (production) budget in units for EFH for the months of November,
December 2019 and January 2020.
(10)
d) Calculate budgeted cash receipts and payments for the months of November, December
2019 and January 2020.
[Focus only on the sales and costs associated with the purchase of inventory]
(15)
e) Calculate the following ratios for EFH for the year ended 30 September 2019; and provide
practical ways the ratios can be improved (use market values where possible):
Interest-bearing debt equity ratio (net)
Current ratio
Return on equity
Price/book ratio
Cash interest cover
(Calculations – 5 marks; comments – 12 marks)
(17)
g) Discuss the factors that should have been considered before deciding on obtaining the
funds from the Industrial Development Company. No calculations are required.
(5)
UNISA 2020
Page 8 of 8 CONFIDENTIAL
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MAC3702 May /June 2020
Sales 231 000 400 680 471 912 500 266.7 530 240.3
Cost of sales (154 000) (267 120) (314 608) (333 484.4) (353 493.5)
Operating Costs (30 000) (30 000) (30 000) (30 000) (30 000)
Marketing costs (2 000) (1 600) (1 280) (1 024) (819.2) 0
Recruitment agency (120)
fees
Marketing manager (982.48) (911.9) (984.8) (1 063.6) (1 148.8) (1 240.7)
Wear and Tear (24 500) (24 500) (24 500) (24 500) (24 500)
Wear and Tear - Fittings (14 667) (14 667) (14 667) (14 667) (14 667)
Taxable cash (3102.48) 5321.1 62128.2 85049.4 95647.7 106339.1
Tax at 28% 868.70 (1489.91) (17395.9) (23813.8) (26781.35) (29774.95)
Net cashflows (320566.8) (224 002) 76 566.3 100 402.2 108 033.5 148 731.2
EFH should not undertake the project because the IRR is 6.5% and is below the 20% which is below the
recommended percentage.
Calculations
• Working capital recovered at the end of the project = R36 666 667 X 0.90
= R33 000 000
2. Sales
2021 2022 2023 2024 2025
660 000 X 350 1 144 800 X350 1 348 320 X 350
231 000 000 400 680 000 471 912 000 500 226.7 530 240.3
3. Cost of sales
(b)
Calculations
1. Ordinary shares
Market value of the shares = (840 000 000 x 50%) x (4598 x 0.48)
= R 926 856 800 000
Ke = 15.2%
2. Preference shares
Market value = 3 000 000 x 581
= 1 743 000 000
3. Debentures
Cost of debentures = 10.25(1 - 0.28)
= 7.38%
Market value
FV = 3 144
I = 7.38
PMT = 249
N=7
PV = ?
PV = 3234.27
Admin fees.
N =6
FV = 15 000 000
I = 7.38
PV = ?
Present value = R9 784 775.40
Therefore, the present value of the debenture = (9 784 775.4 + 3 234 270 000)
Cash payments:
Cost of sales (1) 552302631 568984962 520545113
(2) 517857143 552302631 568984962
Bed debts 29548125 287437750 33055313
(e). Ratios
• Issuing of high dividends. This will send the message that the company is optimistic of
the future profits generations.
Shares will be issue at 10% premium thus the price will be 2207.04 + 10% =2427.744
MAC3702
FASSET MOCK EXAMINATION
PLEASE NOTE:
PROPOSED TIMETABLE
100 180
QUESTION 1 (50 marks; 90 minutes)
Tiles & Styles of Africa (“Tiles & Styles”) is South Africa’s leading retailer of tiles, bathroom fixtures and
related products. The company provides superior ceramic tile flooring and walling at competitive prices to
a growing market. Listed on the JSE three years ago, today Tiles & Styles has a network of 162 retail
stores in the African continent.
As the company continues to enjoy strong brand affinity based on its reputation for a high quality year-
round value offering, the market capitalisation of Tiles & Styles at the end of its 2017 financial year was
R9,45 billion (market value of equity). This was despite constrained discretionary disposable income of its
customers and the Rand plunging to its lowest levels in more than 15 years against major currencies.
The Competition Tribunal has just approved the company’s offer to acquire 51% of Tile Ses’la (Pty) Ltd
(“Tile Ses’la”), one of its suppliers in an effort to ensure that the company continues to attain its growth
targets. Tiles & Styles has offered R5 billion in cash to the existing shareholders of Tile Ses’la. This
strategic acquisition has been well received by the market, as it will likely lead to cost reduction and other
synergistic benefits. Tiles & Styles also continues to invest substantially in information technology and e-
commerce to keep abreast of opportunities in the rapidly changing environment.
The statement of financial position of Tiles & Styles, salient information and notes are provided on the next
page, followed by the financial information relating to Tile Ses’la.
Statement of financial position of Tiles & Styles of Africa
For the year ended 31 December 2017
2017 2016
Notes Rm Rm
ASSETS
Property, plant and equipment 3 788 3 659
Goodwill 681 590
Intangible assets 334 151
Deferred tax 61 58
Other non-current assets 102 68
Total non-currents assets 4 966 4 526
LIABILITIES
Medium and long-term borrowings 1 1 912 2 077
Net retirement benefits liability 240 212
Provisions 44 40
Total non-current liabilities 2 196 2 329
1. Tiles & Styles has a target capital structure of 30: 70 (Debt: Equity), and aims to maintain a ratio of
3:1:1 (debentures: bank loans: preference shares) on its debt composition. The ordinary dividend
(2017: R280 million) is expected to continue growing at 9% per annum in the foreseeable future.
The medium and long-term borrowings at 31 December 2017 were made up of only the following:
R1 billion debentures were issued three years ago and are redeemable at a premium of
0,5% and the maturity date is 31 December 2021. The premium is payable on 31 December
2022; and although the premium is tax deductible there is no interest charged for the late
settlement of the premium. The debentures were issued at a fixed interest rate of 6,8%
(similar debentures are currently trading at a post-tax rate of 5,2%).
A bank loan of R612 million was obtained on 28 December 2015 and the interest paid yearly
is fixed at R55,08 million. The going rate in the market for similar loans is 8,5% per annum.
2. Interest expense on short-term borrowings is negligible. Interest rates given are before tax unless
stated otherwise.
The information below relates to Tile Ses’la (Pty) Ltd:
Inventories 550
Trade and other receivables 327
Cash and cash equivalents 511
Total current assets 1 388
TOTAL ASSETS 4 163
LIABILITIES
Subordinated loan 74
Provisions 12
Total non-current liabilities 86
Short-term borrowings 26
Trade and other payables 278
Total current liabilities 304
TOTAL EQUITY AND LIABILITIES 4 163
Valuation information
1. The following items should be considered in establishing the sustainable earnings of Tile Ses’la:
Gross profit in 2015 was down by R83 million because of protests that led to Tile Ses’la being
outlets closed for three weeks. There was no material change in other operating expenses
during that year.
On 22 June 2017 Tile Ses’la received an out-of-court settlement of R20 million after one of its
competitors infringed the company’s trademark.
Other operating expenses in 2016 include a R40 million insurance pay-out which was received
by Tile Ses’la in September 2016 for loss of a key member of staff.
(The above amounts are net of tax and therefore tax implication on the above transactions can
be ignored).
2. In the event that the board of directors of Tile Ses’la decides to wind up the company through
disposing of its assets, the following financial information has been established:
The company’s land and buildings (recorded at a carrying value of R400 million) is currently
worth R4,24 billion. This is before taking into account selling and other legal expenses of 0,3%.
The company will be able to sell some of its trademarks with a carrying value of R30 million for
R380 million.
40% of the company’s inventory will be sold at cost, while the balance will be sold at a gross
profit margin of 20% on cost.
The subordinated loan was obtained at the inception of the company from its shareholders at
a 0% interest rate. The agreement requires the company to pay a fee equal to 0,43% of the
current net asset value whenever it settles the loan in the event of liquidation or sale of its
assets.
The company will settle all its other liabilities at carrying value.
3. To determine annual free cash flows yearly, the company uses the following formula below:
Free cash flows (FCF) =
Previous two years’ average net profit for the year
Add: Non-cash expenses for the previous year (if any)
Less: Non-cash income for the previous year (if any)
Additional information
The future growth in profits in the near future for Tile Ses’la will average 4% per annum. Similar companies
listed on the JSE trade at an average P/E multiple of 13,29. Analysts estimate that unlisted companies in
the same sector should allow for a risk factor of 1,5 in establishing the business value. The required rate
of return to be used in the valuation of Tile Ses’la is 14%.
REQUIRED
a) Calculate the weighted average cost of capital of Tiles & Styles at 31 December 2017.
(6)
b) Advise how the acquisition of Tile Ses’la (Pty) Limited should be financed, assuming that Tiles &
Styles is working towards the target capital structure.
(Show all calculations)
(14)
c) Advise the board of directors and shareholders of Tile Ses’la whether they should accept the offer
made by Tiles & Styles, using both the price-earnings multiple and the discounted cash flow
methods.
(Price-earnings multiple method 11 marks, free cash flow method 5 marks)
(16)
d) Use the net asset value method to check the reasonableness of the calculations performed in part
(c) above.
(7)
e) Describe different types of acquisitions, and provide an example for each. Explain the type of
acquisition of Tile Ses’la by Tiles & Styles.
(7)
[50]
Question 2 (20 marks; 36 minutes)
Mbombela Concession Company (MCC) is a railway company running the state-of-the-art rapid rail
network in Gauteng. Its flagship initiative in South Africa is the Gautrain, a world class rail connection
comprising of two links, namely a link between Tshwane and Johannesburg and a link between OR Tambo
International Airport and Sandton. The Gautrain is responsible for carrying more than 80 000 passengers
per week between 10 major stations. The service is quite popular amongst Gauteng’s workforce due to
the fast speed the trains travel at, saving commuters invaluable time while providing comfort and safety on
board. The Gautrain also provides bus services for commuters who do not work or live close to the Gautrain
stations. Commuters who choose to drive their cars to the Gautrain station can also park their cars at
Gautrain parking buildings at a reasonable fee. Non-Gautrain users are charged more than Gautrain users
for utilising either the bus services or parking facilities.
Following the success of this 80 kilometre rail network launch and its increasing demand, MCC has
embarked on a feasibility study to introduce a new rail corridor linking Roodepoort and Sandton (known as
“Jozi Connect project”). New stations will be built in Roodepoort, Fairland, Cresta and Randburg, while
minor alterations will be effected at the Sandton station. Three major components (phases) of this project
have been identified, mainly:
The construction and setting up all these phases is expected to be finalised at the end of 2018.
a) Advise the management of Mbombela Concession Company whether to undertake the construction
of the parking buildings, and provide motivation for the advice given.
(Calculation 17 marks; comment 3 marks)
(20)
Question 3 (30 marks; 54 minutes)
The Fire and Brimstone Limited is a company that trades in the tyre industry. The following information is
available on 28 February 2018:
2018 2017
Rand Rand
Note
Turnover 1 8 500 000 7 850 000
Cost of sales 3 850 000 3 600 000
Opening inventory 850 000 1 200 000
Purchases 2 4 200 000 3 250 000
Closing inventory (1 200 000) (850 000)
Attributable to
Preference shareholders 300 500 600 000
Ordinary shareholders 1 038 540 1 239 840
1 339 040 1 839 840
Statement of financial position on 28 February 2018
1. Credit sales increased from 55% of turnover in 2017 to 65% of turnover in 2018. Credit terms
for the debtors of the company are 60 days from invoice date and for the standard industry
terms are between 45 and 60 days.
2. In 2018, 40% of the company’s purchases were made on credit in comparison to 50% in
2017. The company’s payment terms to creditors are between 45 and 60 days from invoice
date, and discount of 10% is received if payment is made before 45 days. Standard payment
terms for the industry are 60 days from invoice date.
3. The average stock turnover period for the industry is 90 days and the average business
cycle for the industry is 100 days. All raw materials are purchased on the just-in-time (JIT)
basis. The inventory in the statement of financial position consists of finished goods only.
Additional information
Inventory
A new industrial engineer was appointed in order to reassess the company’s stock turnover
period. He established the reason for the time lag as being new, inexperienced staff
members recently employed in the manufacturing division.
Transport companies are experiencing backlogs due to recent floods, making some areas
inaccessible. This leads to a longer turnaround time for collection of finished goods at the
company’s warehouse and distribution thereof to sales outlets.
The manufacturing plant still uses old technology that does not enable sufficient workflow
due to long setups and throughput times.
Finished goods are transported from the plant to the warehouse, from where it is then
distributed to various outlets.
14
The Fire and Brimstone Limited stores its inventory at a third party’s warehouse. The
warehouse is situated in an industrial area known for its high crime statistics. There have
been incidents in the past of burglaries at the warehouse. The warehouse is located
approximately 100 kilometres away from the company’s major outlets. A monthly storage
fee is charged based on floor space used to store the inventory. The larger the stock
holding, the bigger the floor space needed and the higher the storage fee will be.
REQUIRED
a) Calculate the business cycle of The Fire and Brimstone Limited for year 2018 in days
and comment on the performance of each component in line with the notes provided.
There are 365 days in a year and the company adjusts for VAT at 14%, where necessary.
Round off your answers to two decimal places.
(15)
b) Discuss the impact of the additional information provided on the company’s business
cycle by explaining how the additional information will affect the business cycle.
(15)
[30]
©
UNISA 2018
Notes for marking:
1. Symbols/signs used:
r/w Right or wrong – the answer must be exact
CA Calculation must be completed and correctly expressed
C Carry-through mark (use marks from previous calculation)
±/y Year and signage must be correct
2. Note that extra marks may be awarded for presentation and logical layout.
Open Rubric
Question 1 (a)
CALCULATION OF WACC – based on target capital structure (see workings below)
Max: 8 marks
Question 1 (b)
FINANCING DECISION – R5bn acquisition of Tile Ses’la (see workings below)
Max: 12 marks
WORKINGS
1(b) workings 1(a) workings
INSTRUMENT MARKET VALUE COST OF EQUITY
𝑲𝒆 = 12,2%
CF0 0
CF1 - 48,96m (1bn x 6,8% x 0,72)
Debentures CF2 - 48,96m 𝐾𝑑1 = 5,2% (given)
CF3 - 48,96m
CF4 - 1 048,96m (1bn)+48,96m
CF5 - 3,6m (1bn x 0,005 x 0,72)
I 5,2
NPV 992 064 186
PV of premium
FV - 3,6m (R1bn x 0,005 x 0,72)
N 5
I 5,2
Comp PV 2,794m (c3)
Max: 11 marks
ii). Valuation using the free cash flow method
941
=
(14%−4%)
Conclusion: The board of directors, together with the shareholders, of Tile Ses’la (Pty) Ltd should
accept the Tiles & Styles of Africa offer of R5 billion as the valuations performed above show that
the company is worth R4,8 billion. CA (mark whether under P/E multiple or DCF method workings)
Max: 5 marks
Question 1 (d)
i). Valuation using the net asset value method
Rm
ASSETS
PPE (1 989 – 400 + 4 240) – (4 240 x 0,003) 5 816 r/w
Investments 732 r/w
Intangible assets (54 – 30 + 380) 404 r/w
Inventory (550 * 40%) + (550 * 60%) + (550 * 60% * 20%) 616 r/w
Trade and other receivables 327 r/w
Cash and cash equivalents (can be netted off against price) 511
Less: LIABILITIES & OTHER COSTS
Non-current liabilities (86) r/w
Settlement of the subordinated loan (3 773 * 0,0043) (16) r/w
Current liabilities (304)
Conclusion: According to net asset value method, the stake to be sold is worth R4,1 billion (R700 million
below the other two valuation methods, and R900 million below the offer made by Tiles & Styles of Africa).
The net asset value method will not consider the true value attached to the brand of Tile Ses’la (including
human capital, customer loyalty, brand, value of exclusive rights, etc.). The board of directors and
shareholders of Tile Ses’la should accept the offer as it is better than all three methods used. CA
Max: 7 marks
Question 1 (e)
a) Types of acquisitions (general)
The type of
1. Horizontal acquisition: Two companies that are in direct competition and share the same product line
acquisition and markets. Example – a beer manufacturing company buying another beer manufacturing company
must be
defined (AB InBev buying SABMiller).
2. Vertical acquisition: Two companies both on a given chain of supply (customer and a supplier).
Example – ESKOM buying a coal mine like Anglo Coal.
3. Conglomerate acquisition: Two companies that trade in unrelated markets. Example – Woolworths
buying Kulula.com
b) Types of acquisition of Tile Ses’la – VERTICAL ACQUSITION (Tile retailer buying a tile
manufacturer) r/w
Max: 7 marks
Question 2
R’000
Rev: Gautrain users R200 x 52 x 10 000&12000 104 000 110 240 140 225 148 639 157 557
Rev: Non-Gautrain users R467 x 52 x 5 000 & 3 000 121 354 128 635 81 812 86 720 91 924
Max: 17 marks
The taxation calculation table needed not
be shown separately, especially where
there is no sale of an asset OR wear & tear.
Net cash-flows (65 000) (1 000 000) 142 769 151 335 136 726 144 929 1 621 551
Rev: Non-Gautrain use 1,000 0,870 0,756 0,658 0,572 0,497 0,432
Discounted cash flows (65 000) (869 565) 107 954 99 505 78 173 72 055 701 041
I/Y = 15%
Net Present Value 124 163
Conclusion
The aggregate NPV for this project is R127 480 000 - positive (R3,445m + R124,163m c – R0,128m) and
therefore the project must be accepted.
The project is indivisible and the company cannot choose to implement one phase of the project and reject
others, e.g. MCC cannot accept the parking service and bus shuttle service phase and reject the station,
rail works & trains.
These phases are also dependent in the sense that rejecting one of the phases will have an impact on
projected cash flows from the other phases, e.g. without the stations, trains and rail infrastructure, there is
no need for the parking and bus shuttle services.
In making the decision, the company should also consider the performance of the existing Gautrain
operations and to help it better forecast.
The implementation of Jozi Connect project will also boast the economy with possible direct and indirect
job opportunities to be created and efficiencies in the economic activities of the province.
Max: 3 marks
For any valid discussion point, a mark is
given as the question requires any
comment based on notes 1 to 3.
Question 3 (a)
i). Calculate and comment on debtor’s collection period Bonus mark if consistent rounding to 2 decimal places
Accounts receivable
x 365
Credit sales
1 048 000ᵅ
114 x 365
65% x (8 500 000) x
100
1 048 000
x 365
6 298 500
= 60,73 days
Customers adhere to credit policy as an average debtor settles their account (60,73) in line with the normal credit
terms 60 days).
There is a low risk of bad debts as customer generally settle in line with credit terms.
The company is more lenient to its customers as the industry collects as early as in 45 days. The competitors might
be having better credit controls and incentives than the company.
980 000
Debtors are settling their accounts quicker than last year 2017: 72,67 days) [ 114 x 365]
55% x 7 850 000 x
100
Improved communication with customers, reminders of outstanding debt and selling more to existing credit
customers led to the decrease in debtors’ days.
Note: where VAT has not been taken into account in the calculation, the debtors’ collection period is 69,23 days
2017: 82,85 days) – valid comment: Debtors not adhering to credit terms and take longer to settle than industry
average although the ratio is improving or bad debt risk increases).
ii). Calculate and comment on the stock turnover period
Inventory
Cost of sales
1 200 000ᵅ
x 365
3 850 000
= 113,77 days
It takes the company almost 4 months to convert its stock into sales (24 days later than industry) – this indicates
poor stock management processes. This is evidenced by the issues already pointed out by the industrial engineer.
Note: where average has been used, the stock turnover period is only 7,18 days longer than the industry norm –
students must comment in line.
iii). Calculate and comment on creditors’ payment period
Trade payables
x 365
Credit purchases
350 000ᵅ
114 x 365
40% x (4 200 000) x
100
350 000
x 365
1 915 200
= 66,70 days
Note: where VAT has not been taken into account in the calculation, the creditors’ collection period is 76,04 days
2017: 95,46 days) – Comments above are still valid. Denominator, if without VAT, is 1 680 000
iv). Calculate and comment on business cycle of The Fire and Brimstone Limited
Days
Debtors’ collection period 60, 73
Plus: Stock turnover period 113,77 c
Less: creditors’ payment period (66,70) c
Max: 15 marks
1 mark for presentation (each component presented with a heading
Question 3 (b) 1 mark for understanding how the business cycle is affected
Debtors’ collection period Business cycle not affected For new cash paying
customers (10%
OR discount), there will be no
change in business cycle
No change in business days
cycle days (no impact on trade
receivables & credit
sales)
Debtors’ collection period Business cycle not affected Impact of sales to the
major car manufacturer
OR has already been effected
(last year)
No change in business (no additional impact on
cycle days trade receivables & credit
sales)
Debtors’ collection period Business cycle not affected Sales to cash paying
insurance companies will
OR not change the business
cycle days
No change in business (no impact on trade
cycle days receivables & credit
sales)
Purchases and Accounts payable
Inventory
Business cycle component Increase/decrease of the Reason for increase/decrease
business cycle days
Stock turnover period Business cycle negatively The time lag means
affected inventory takes longer to
leave the factory
OR (increase in inventory &
stock turnover period)
Increase of business cycle New and inexperienced
days staff in the manufacturing
division will inevitably
lead to an increased
manufacturing turn-
around time which will
increase the business
cycle.
Max: 15 marks
1
MAC 3702
SUGGESTED SOLUTION
OCTOBER 2018 EXAM
a) When funding new projects, it is essential to consider the target debt equity ratio as this will
determine the capacity of the company to raise a particular form of funding without drastically
altering its capital structure and weighted average cost of capital.
Also note that when a company issues non-redeemable preference shares it can serve as equity
when analysing the capital structure.
Note that SA Clinic is a private company and does not have a tradeable market price.
PROPOSAL 1
Current
capital Target capital
structure structure Capacity
Book value
Equity 14 240 000 (1) 25 410 000 (3) 11 170 000
Debentures 3 560 000 (2) 10 890 000 (4) 7 330 000
17 800 000 36 300 000 18 500 000
New R12 500 000 x
project 18 500 000 1.48
36 300 000
No of ordinary
shares to be issues
Total value 11 170 000
Net price ÷ R3,86 (R4.05 – 4.78%)
2 893 782
Shares
No of debentures
Total value 7 330 000
Nominal value R70,00
104 714
Debentures
2
PROPOSAL
No of Preference
shares to issued
Total value 11 170 000
Nominal value ÷ R100,00
111 700
preference
shares
No of debentures
Total value 7 330 000
Nominal value R70,00
104 714
Debentures
Cost of equity: In order to calculate the cost of equity we need the current market price. Since the
company is not listed, this information is unavailable. The R4,05 given in the question is not an
indication of fair value as this is a private company and the issue price could have been agreed upon
by the shareholders to raise the funds.
I have therefore used the current issue price of R3,25 as per the statement of financial position
Growth: The question states that growth will double going forward, therefore 3.5% x 2 = 7%.
𝐷1
𝐾𝑒 = +𝑔
𝑃0
0.15 𝑥 1.07
𝐾𝑒 = + 0.07
𝑅3.25
𝐾𝑒 = 11.94%
3
1 2 3 4
2019 2020 2021 2022
Capital repayment (3 560 000)
Premium (1) (11 392)
Interest paid (300 000) (300 000) (300 000) (300 000)
Tax benefit on interest (2) 84 000 84 000 84 000 84 000
Tax benefit on premium (3) 3 190
(216 000) (216 000) (224 202) (3 776 000)
𝑃𝑉 @ 8.64%: − 216000𝑐𝑓, −216000𝑐𝑓, −224202𝑐𝑓, −3776000𝑐𝑓, 8.64𝑖 𝐶𝑜𝑚𝑝 𝑁𝑃𝑉
𝑵𝑷𝑽 = 𝑹𝟑 𝟐𝟔𝟕 𝟑𝟑𝟎
𝑲𝒅 = 𝟏𝟐% 𝒙 𝟎. 𝟕𝟐 = 𝟖. 𝟔𝟒%
e) Ratio analysis
470
− 1 = −11.32%
530
No available information with respect this line item. Management needs to identify reasons for
the decrease. Given that this is a clinic, it may relate to sales of over-the-counter medication and
supplies.
EBITDA margin
𝑬𝑩𝑰𝑻𝑫𝑨
=
𝑹𝒆𝒗𝒆𝒏𝒖𝒆
2018 2017
1640 + 560(𝑑𝑒𝑝) 1380 + 420(𝑑𝑒𝑝)
= =
6600 5500
= 33.33% = 32.73%
2018 2017
334 307
= =
1260 1060
= 26.51% = 28.96%
𝑬𝑩𝑰𝑻
=
𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒑𝒂𝒊𝒅
NB: Interest received generally not a sustainable income item. Sometimes solutions net-off
the interest. This ratio is about financial risk and the ability to meet interest payments. I
therefore recommend not to net-off the interest received against the interest paid
2018 2017
1640 1380
= =
420 340
= 3.9 𝑡𝑖𝑚𝑒𝑠 = 4.06 𝑡𝑖𝑚𝑒𝑠
• Interest costs have increased for no logical reason as the non-current debt is the same as
2017 and the short-term borrowings have decreased.
• Notwithstanding this, EBIT has increased by R260 000 while the interest only by R40 000
which gives rise to the slight drop in the interest cover.
2018 2017
3560 3560
= =
3560 + 14240 3560 + 13830
= 20% = 20.47%
• This ratio has improved slightly but as a result of decreased debt but rather an increase in
retained profits
7
2018 2017
0.15 0.1449
= =
0.2692 0.2189
= 55.72% = 66.2%
2018 2017
𝑅926 000 𝑅753 000
𝑒𝑝𝑠 = 𝑒𝑝𝑠 =
3 440 000 3 440 000
= 0.2692 = 0.2189
Dividend 2017: Dividend growth is 3.5% therefore Div2018 is 3.5% bigger than Div2017
∴ R0.15 ÷ (1+3.5%) = R0.1449
𝑁𝑜 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 𝑅11 180 000 ÷ 𝑅3.25 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 3 440 000 𝑠ℎ𝑎𝑟𝑒𝑠
Return on equity
𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙
=
𝑬𝒒𝒖𝒊𝒕𝒚
2018 2017
𝑅926 000 𝑅753 000
= =
𝑅14 240 000 𝑅13 830 000
= 6.5% = 5.45%
• Equity remained fairly stable while earnings per share grew by 23%
• More of revenue was converted into profits.
• As mentioned earlier revenues increased at a better rate than costs.
8
1. Interest received is assumed to be earned from cash and cash equivalents. It has been left out of
the free cash flow as the actual cash balances will be added to the value.
2.
Taxation R
Taxation per SOCI 334 000
Add: Tax on interest paid 84 000
Less : tax on interest received (11 200)
406 800
3.
Capital expenditure R
Opening carry value 9 500 000
Depreciation (560 000)
Closing carry value (9 975 000)
(1 035 000)
9
Value of operations
𝐹𝐶𝐹1
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 =
𝑊𝑎𝑐𝑐 − 𝑔
Valuation
The NAV is being compared to the FCF value before owner level adjustments.
The Difference in value is due the fact that NAV is based on historical results which excludes
potential growth, while the FCF method has been based on future sustainable cash flows with
growth built into the valuation
10
Calculations
1. R4 500 000 x 20%
2. 2 single payments then 3 double payments: 𝑥 + 𝑥 + 3(2𝑥) = 𝑅3 240 000𝑥 3𝑢𝑛𝑖𝑡𝑠
∴ 𝑥 = 𝑅1 215 000 𝑎𝑛𝑑 2𝑥 = 𝑅2 430 000
3. R25 000 x 4 quarters = R100 000, increase by 6% thereafter
4. R120 000 per nurse x 3 = R360 000, increase by 6% thereafter
5. R4 500 x 12 months x 3 units = R162 000, increase by 6% thereafter
h) The NPV is negative, therefore from a quantitative perspective the project should be rejected.
From a qualitative perspective
• To try and procure additional funding as this is a PBO
• The service is for the community and maybe to negotiate better prices on the mobile units
• Try to get some private funding as well
1
In recent years, however, there has been a dramatic fall in the costs of processing
information. And, with the advent of advanced manufacturing technology (AMT),
overheads are likely to be far more important and in fact direct labour may
account for as little as 5% of a product’s cost. It therefore now appears difficult to
justify the use of direct labour or direct material as the basis for absorbing overheads
or to believe that errors made in attributing overheads will not be significant.
Many resources are used in non-volume related support activities, (which have
increased due to AMT) such as setting-up, production scheduling, inspection and
data processing. These support activities assist the efficient manufacture of a wide
range of products and are not, in general, affected by changes in production
volume. They tend to vary in the long term according to the range and complexity
of the products manufactured rather than the volume of output.
The wider the rand and the more complex the products, the more support service
will be required. Consider, for example, factory X which produces 10,000 units of
one product, the Alpha, and factory Y which produces 1,000 units each of ten
slightly different versions of the Alpha. Support activity costs in the factory Y are
likely to be a lot higher than in factory X but the factories product an identical
number of units. For example, factory X will only need to set-up once whereas
factory Y will have to set-up the production run at least ten times for the ten
different products. Factory Y will therefore incur more set-up costs for the same
volume of production.
Traditional costing systems, which assume that all products consume all resources in
proportion to their production volumes, tend to all allocate too great a proportion of
overheads to high volume products (which cause relatively little diversity and hence
use fewer support services) and too small a proportion of overheads to low volume
products (which cause greater diversity and therefore use more support services).
Activity based costing (ABC) attempts to overcome this problem.
2
Definition of ABC
KEY TERM
Step 2. Identify the factors which determine the size of the costs of an
activity/cause the costs of an activity. These are known as cost drivers.
KEY TERM
Step 3. Collect the costs associated with each cost driver into what are known
as cost pools.
Step 4. Charge costs to products on the basis of their usage of the activity. A
product’s usage of an activity is measured by the number of the
activity’s cost driver is generates.
ILLUSTRATION
Which of the following definitions best describes a cost driver?
Answer
The correct answer is D.
Cost drivers
For those costs that vary with production levels in the short term, ABC uses volume-
related cost drivers such as labour or machine hours. The cost of oil used as a
lubricant on the machines would therefore be added to products on the basis of
the number of machine hours, since oil would have to be used for each hour the
machine ran.
Kaplan and Cooper argue that long-term variable overhead costs are related to
the transactions undertaken by the support departments where the costs are
incurred.
(a) Logistical transactions are those activities concerned with organising the flow
of resources throughout the manufacturing process.
4
(b) Balancing transactions are those activities which ensure that demand for and
supply of resources are matched.
(c) Quality transactions are those activities which relate to ensuring the
production is at the required level of quality.
(d) Change transactions are those activities associated with ensuring that
customers’ requirements (delivery date, changed design etc) are met.
These transactions in the support departments are the appropriate cost drivers to
use.
The following example illustrates the point that traditional cost accounting
techniques result in a misleading and inequitable division of costs between low-
volume and high-volume products, and that ABC can provide a more meaningful
allocation of costs.
Suppose that Cooplan Ltd manufactures four products, W, X, Y and Z. Output and
cost data for the period just ended are as follows :
Number of
Direct
production Machine
Material labour
runs in the hours per
Output cost per hours per
period unit
units unit unit
R
W 10 2 20 1 1
X 10 2 80 3 3
Y 100 5 20 1 1
Z 100 5 80 3 3
14
5
Required
Prepare unit costs for each product using conventional costing and ABC.
SOLUTION
W X Y Z Total
R R R R
Direct material R
200 800 2,000 8,000
Direct labour 50 150 500 1,500
Overheads * 700 2,100 7,000 21,000
950 3,050 9,500 30,500 44,000
Units produced 10 10 100 100
Cost per unit R95 R305 R95 R305
Using activity based costing and assuming that the number of production runs is the
cost driver for set-up costs, expediting and scheduling costs and materials handling
costs and that machine hours are the cost driver for short-run variable costs, unit
costs would be as follows :
W X Y Z Total
R R R R
Direct material R
200 800 2,000 8,000
Direct labour 50 150 500 1,500
Short-run variable overheads 70 210 700 2,100
(WI) costs (W2)
Set-up 1,560 1,560 3,900 3,900
Expediting scheduling costs 1,300 1,300 3,250 3,250
(W3)
Materials handling costs (W4) 1,100 1,100 2,750 2,750
4,280 5,120 13,100 21,500 44,000
Units produced 10 10 100 100
Cost per unit R428 R512 R131 R215
Workings
Summary
Convention
al costing ABC unit Difference Difference in
unit costs cost per unit total
Product
R R R R
W 95 428 + 333 + 3,330
X 305 512 + 207 + 2,070
Y 95 131 + 36 + 3,600
Z 305 215 - 90 - 9,000
7
The figures suggest that the traditional volume-based absorption costing system is
flawed.
Both traditional absorption costing and ABC systems adopt the two stage allocation
process.
Allocation of overheads
ABC establishes separate cost pools for support activities such as despatching. As
the costs of these activities are assigned directly to products through cost driver
rates, reapportionment of service department costs is avoided.
Absorption of overheads
The principal difference between the two systems is the way in which overheads are
absorbed into products.
(a) Absorption costing most commonly uses two absorption bases (labour hours
and/or machine hours) to charge overheads to products.
(b) ABC uses many cost drivers as absorption bases (number of orders, number of
despatches and so on).
Absorption rates under ABC should therefore be more closely linked to the causes
of overhead costs.
8
Cost drivers
The principal idea of ABC is to focus attention on what causes costs to increase, ie
the cost drivers.
(a) Those costs that do vary with production volume, such as power costs, should
be traced to products using production volume-related cost drivers as
appropriate, such as direct labour hours or direct machine hours.
Overheads which do not vary with output but with some other activity should
be traced to products using transaction-based cost drivers, such as number
of production runs and number of orders received.
ILLUSTRATION
A company manufactures two products, L and M, using the same equipment and
similar processes. An extract of the production data for these products in one
period is shown below::
L M
Quantity produced (units) 5,000 7,000
Direct labour hours per unit 1 2
Machine hours per unit 3 1
Set-ups in the period 10 40
Orders handled in the period 15 60
Overhead costs R
Relating to machine activity 220,000
Relating to production run set-ups 20,000
Relating to handling of orders 45,000
285,000
Required
Calculate the production overheads to be absorbed by one unit of each of the
products using the following costing methods.
(a) A traditional costing approach using a direct labour hour rate to absorb
overheads.
(b) An activity based costing approach, using suitable cost drivers to trace
overheads to products
Answer
Using ABC the overhead costs are absorbed according to the cost drivers.
Machine-hour driver costs 220,000 ÷ 22,000 m/c hours = R10 per m/c hour
Set-up driven costs 20,000 ÷ 50 set-ups = R400 per set-up
Order driven costs 45,000 ÷ 75 orders = R600 per order
Product L Product M
R R
Machine-driven costs (15,000 hrs x R10) 150,000 (7,000 hours x 70,000
R10)
Set-up costs (10 x R400) 4,000 (40 x R400) 16,000
Order handling costs (15 x R600) 9,000 (60 x R600) 36,000
163,000 122,000
Units produced 5,000 7,000
Overhead cost per unit R32,60 R17,43
As you will have discovered when you attempted the question above, there is
nothing difficult about ABC. Once the necessary information has been obtained it is
similar to traditional absorption costing. This simplicity is part of its appeal. Further
merits of ABC are as follows :
(a) The complexity of manufacturing has increased, with wider product ranges,
shorter product life cycles and more complex production processes. ABC
recognises this complexity with its multiple cost drivers.
Criticisms of ABC
It has been suggested by critics that activity based costing has some series flaws :
(a) Some measure of (arbitrary) cost apportionment may still be required at the
cost pooling stage for items like rent, rates and building depreciation.
(b) Can a single cost driver explain the cost behaviour of all items in its associated
pool?
(c) Unless costs are caused by an activity that is measurable in quantitative terms
and which can be related to production output, cost drivers will not be
usable. What drives the cost of the annual external audit, for example?
(e) The cost of implementing and maintaining ABC system can exceed the
benefits of improved accuracy.
12
(i) The incorrect belief that ABC can solve all an organisation’s problems.
(ii) Lack of the correct type of data.
(iii) Difficulty in determining appropriate cost drivers.
‘World wide adoption rates for ABC have peaked at 20 percent and a
declining number of firms are giving it further consideration’. (Tom Kennedy,
Financial Management, May 2000). Recent SA studies have found ABC
usage rates of about 25%, with larger organisation and service sector
companies being most likely to use it.
Planning
The information database produced from such an exercise can then be used as a
basis for forward planning and budgeting. For example, once an organisation has
set its budgeted production level, the database can be used to determine the
number of times that activities will need to be carried out, thereby establishing
necessary departmental staffing and machine levels. Financial budgets can then
be drawn up by multiplying the budgeted activity levels by cost per activity.
The activity-based approach may not produce the final budget figures but it can
provide the basis for different possible planning scenarios.
13
Control
The information database also provides an insight into the way in which costs are
structured and incurred in service and support departments. Traditionally it has
been difficult to control the costs of such departments because of the lack of
relationship between departmental output levels and departmental costs. With
ABC, however, it is possible to control or manage the costs by managing the
activities which underlie them by monitoring a number of key performance
measures.
Decision making
Many of ABC’s supporters claim that it can assist with decision making is a number
of ways :
Pricing
Promoting or discontinuing products or parts of the business
Redesigning products and developing new products or new ways to do business
Note, however, that an ABC cost is not a true cost, it is simply an average cost
because some costs such as depreciation are still arbitrarily allocated to products.
An ABC cost is therefore not a relevant cost for all decisions.
The traditional cost behaviour patterns of fixed cost and variable cost are felt by
advocates of ABC to be unsuitable for longer-term decisions, when resources are
not fixed and changes in the volume or mix of business can be expected to have
an impact on the cost of all resources used, not just short-term variable costs. A five-
level hierarchy has therefore been suggested to facilitate the analysis of costs.
As Innes and Mitchell (Activity Based Costing : A Review with Case Studies, CIMA
1990) say::
‘This analysis of cost highlights the decision level at which each element of cost can
be influenced. For example, the reduction of production cost levels will not imply
depend on a general reduction in output volumes, but also on reorganising
production to perhaps increase batch size and reduce batch volume, on
eliminating or modifying a process, on cutting out or merging product lines or on
altering or removing facility capacity’.
‘Traditionally, accounting has assumed that if costs did not vary until changes in
production at the unit level, those costs were fixed rather than variable. Such an
assumption is not true. Batch level, product level, and organisational level costs are
all variable, but these types of costs vary for reasons other than changes in
production volume. For this reason, to determine an accurate estimate of product
or service cost, costs should be accumulated at each successively higher level of
costs. Because unit, batch and product level costs are all related to units of
products (merely at different levels), these costs can be gathered together at the
product level to match with the revenues generated by product sales.
Organisational level costs, however, are not product related and, thus, should only
be subtracted in total from net product revenues.’
Conclusion
‘It can offer considerable benefits to some companies but a decision to adopt ABC
should not be taken lightly. The staff time involved in developing and getting the
system into operation is conservatively estimated at tow person years, costs are at
least R100,000 though it depends on the system being implemented and the size of
the company.
Its implementation is not easy but is made easier by the availability of IT support
within the organisation. Existing IT facilities can make it possible, at little extra cost to
obtain useful cost driver data. There is now a range of PC based packages on
which to develop stand alone ABC systems, or they can be integrated with existing
system, though the former seem advisable at the prototype stage.
There are cases of companies claiming significant benefit from adopting ABC
(changing the way they do business) but also examples of companies trying but
rejecting the activity-based approach.
A product’s life cycle costs are incurred from its design stage through development
to market launch, production and sales, and finally to its eventual withdrawal from
the market. The component elements of a product’s cost over its life cycle could
therefore include the following::
Life cycle costs can apply to services, customers and projects as well as to physical
products.
Traditional cost accumulation systems are based on the financial accounting year
and tend to dissect a products life cycle into a series of 12-month periods. This
means that traditional management accounting systems do not accumulate costs
over a product’s entire life cycle and do not therefore assess a product’s profitability
over its entire life. Instead they do it on a periodic basis.
Life cycle costing, on the other hand, tracks and accumulates actual costs and
revenues attributable to each product over the entire product life cycle. Hence the
total profitability of any given product can be determined.
KEY TERM
Life cycle costing is the accumulation of costs over a product’s entire life.
17
Growth. The product gains a bigger market as demand builds up. Sales revenues
increase and the product begins to make a profit.
Maturity. Eventually, the growth in demand for the product will slow down and it will
enter a period of relative maturity. It will continue to be profitable. The product
may be modified or improved, as a means of sustaining its demand.
Decline. At some stage, the market will have bought enough of the product and it
will therefore reach ‘saturation point’. Demand will start to fall. Eventually it will
become a loss-maker and this is the time when the organisation should decide to
stop selling the product or service.
The level of sales and profits earned over a life cycle can be illustrated
diagrammatically as follows :
Sales
profits
Sale
+
Time
Introduction Growth Maturity Declin
Profit
18
The horizontal axis measures the duration of the life cycle, which can last from, say
18 months to several hundred years. Children’s crazes or fad products have very
short lives while some products, such as binoculars (invented in the eighteenth
century) can last a very long time.
Traditional cost accumulation systems usually total all non-production costs and
record them as a period expense.
With life cycle costing, non-production costs are traced to individual products over
complete life cycles.
(a) The total of these costs for each individual product can therefore be reported
and compared with revenues generated in the future.
(c) Individual product profitability can be more fully understood by attributing all
costs to products.
TARGET COSTING
Here are some examples of decisions made at the design stage which directly
impact on the cost of a product.
KEY TERMS
Target costing has its greatest impact at the design stage because a large
percentage of a product’s life cycle costs are determined by decisions made early
in its life cycle.
20
Case example
Any requirements to take back products will affect post-production costs and
ultimately overall projected life cycle costs. To cut these costs, the design could, for
example, make the product easy to dismantle and its raw materials easy to recycle.
Or it may be possible to design a product for use over several life cycles rather than
just one. (Xerox has been doing this for several years.)
The technique requires managers to change the way they think about the
relationship between cost, price and profit.
(b) The target costing approach is to develop a product, determine the market
selling price and desired profit margin, with a resulting cost which must be
achieved.
Step 2. Set a selling price at which the organisation will be able to achieve a
desired market share.
Step 4. Calculate the target cost = target selling price – target profit.
21
Step 5. Compile an estimated cost for the product based on the anticipated
design specification and current cost levels.
Step 7. Make efforts to close the gap. This is more likely to be successful if
efforts are made to ‘design out’ costs prior to production, rather than to
control out costs during the production phase. (See Paragraph below.)
Step 8. Negotiate with the customer before making the decision about
whether to go ahead with the project.
When a product is first manufactured, its target cost may well be much lower than
its currently-attainable cost, which is determined by current technology and
processes. Management can then set benchmarks for improvement towards the
target costs, by improving technologies and processes. Various techniques can be
employed.
Even if the product can be produced within the target cost the story does not end
there. Target costing can be applied throughout the entire life cycle. Once the
product goes into production target costs will therefore gradually be reduced.
These reductions will be incorporated into the budgeting process. This means that
cost savings must be actively sought and made continuously over the life of the
product.
1
Almost every company carries stocks of some sort, even if they are only stocks of
consumables such as stationery. For a manufacturing business, stocks (sometimes
called inventories), in the form of raw materials, work in progress and finished goods,
may amount to a substantial proportion of the total assets of the business.
- The economic order quantity (EOQ) model can be used to decide the
optimum order size for stocks which will minimise the cost of ordering
stocks plus stockholding costs.
- Uncertainty in the demand for stocks and/or the supply lead time may
lea a company to decide to hold buffer stocks (thereby increasing its
investment in working capital) in order to reduce or eliminate the risk of
‘stock-outs’ (running out of stock).
Stock costs
- Holding costs comprise the cost of capital tied up, warehousing and
handling costs, deterioration, obsolescence, insurance and pilferage.
- Procuring costs depend on how the stock is obtained but will consist of
ordering costs for goods purchased externally, such as clerical cost,
telephone charges and delivery costs.
2
the loss of a sale and the contribution which could have been earned
from the sale;
the cost of lost production and sales, where the stock-out brings an entire
process to a halt.
- The cost of the stock itself, the supplier’s price or the direct cost per unit of
production, will also need to be considered when the supplier offers a
discount on orders for purchases in bulk.
Stock models
There are several different types of stock model, and these can be classified under
the following headings:
A deterministic model is one in which all the ‘parameters’ are known with
certainty. In particular, the rate of demand and the supply lead time are
known.
A stochastic model is one in which the supply lead time or the rate of
demand for an item is not known with certainty. However, the demand or
the lead time follows a known probability distribution (probably constructed
from a historical analysis of demand or lead time in the past).
In a deterministic system, since the demand and the lead time are known with
certainty, there is no need for a safety stock. However, in a stochastic model, it
may be necessary to have a buffer stock to limit the number of stock-outs or to
avoid stock-outs completely.
3
The economic order quantity (EOQ) is the optimal ordering quantity for an item of
stock which will minimise costs.
Assume that:
- demand is constant;
- the lead time is constant or zero;
- purchase costs per unit are constant (i.e. no bulk discounts).
QCh + CoD
2 Q
3.7 The order quantity, Q, which will minimise these total costs is:
CoD
Q Ch
=
4
The demand for a commodity is 40 000 units a year, at a steady rate. It costs R20 to
place an order, and 40c to hold a unit for a year. Find the order size to minimise
stock costs, the number of orders placed each year, and the length of the stock
cycle.
Solution
2Co 2 x 20 x 40
Q D = 000
= Ch 0,4
= 2 000 units
40 000 = 20 orders placed each year, so that stock cycle is once every 52
20 = 2,6
2 000
weeks.
When the volume of demand is uncertain, or the supply lead time is variable,
there are problems in deciding what the re-order level should be. By holding a
‘safety stock’ a company can reduce the likelihood that stocks run out during
the re-order period (due to high demand or a long lead time before the new
supply is delivered). The average annual cost of such a safety stock would be:
Stock
level
x x x x
x x
Safety
stock
0
Time
Figure 1
Points marked ‘x’ show the re-order level at which a new order is placed. The
number of units ordered each time is the EOQ. Actual stock levels sometimes fall
below the safety stock level, and sometimes the re-supply arrives before stocks
have fallen to the safety level, but on average, extra stock holding amounts to
the volume of safety stock.
The size of the safety stock will depend on whether stock-outs (running out of
stock) are allowed.
Reduced stock levels mean that a lower level of investment in working capital will
be required.
JIT will not be appropriate in some cases. For example, a restaurant might find it
preferable to use the traditional economic order quantity approach for staple non-
perishable food stocks but adopt JIT for perishable and ‘exotic’ items. In a hospital,
a stock-out could quite literally be fatal and JIT would be quite unsuitable.
The basic principle of TQM is that the cost of preventing mistakes is less than the cost
of correcting them once they occur plus the cost of lost potential for future sales.
The aim should, therefore, be to get things right first time consistently.
(a) Approach 1: minimise total quality costs by budgeting for a level of quality
which minimises prevention costs plus inspection costs on the one hand and
internal and external failure costs on the other.
7
(b) Approach 2: aim for zero rejects and 100% quality. The desired standard of
production is contained within the product specification and every unit
produced ought to achieve this standard; in other words, there ought to be
no defects. Zero-defect targets are one aspect of Japanese management
philosophy. However, the actual level of defects must be recorded and
reported, even if the quality costs are not measured.
Computex (Pty) Ltd is a supplier of computer equipment. Its premises are situated
nearby the local university. One of its products, a laptop computer selling at R4 900,
is very popular among the B Com students.
The company sells on average approximately 20 laptop computers per week. Sales
take place evenly throughout the year which consists of 50 weeks.
The company purchases the laptop computers at a cost of R3 430 each. The cost to
place an order amounts to R300 and orders are executed within 5 weeks.
Direct stockholding costs are R35,00 per unit and insurance on the laptop
computers amount to 10% of the unit cost per year.
The supplier has offered a quantity discount of 5% per laptop computer on orders of
150 units. The company implemented the economic order quantity model to
manage its inventory.
The current after tax cost of capital is 11% per annum, the current rate of inflation is
7% per annum and the current rate of taxation is 29%.
REQUIRED:
(a) Advise the management of the company whether they should accept the
special offer from the supplier. (20)
(b) Determine the re-order point for the laptop computers. (2)
[25]
9
Purchase price
1 000 x 3 430 3 430 000
1 000 x (3 258.50) 3 258 500
Order cost
29① x 300 8 700
7③ x 300 2 100
Therefore Computex should accept the new special offer which results in lower
costs.
10
Workings:
① Number of orders = annual demand
EOQ②
= 1 000
35
= 29 orders
= 2 x 1 000 x 300
3 430 x [11 – 7] + [35 + (10% x 3 430)].
100
= 600 000
515.20
= 34.13 = 35 units
= 1 000
150
= 7 orders
= unit price x [interest on capital – inflation rate] + stockholding costs p.u. p.a.
100
(c)
- Higher carrying costs
- Lower acquisition costs
- Lower ordering costs
12
Comfyflex Ltd manufactures ladies sandals. The soles used to manufacture these
sandals are imported from a supplier based in Italy and local craftsman are
employed to hand stitch leather straps to these soles. Thirty thousand (30 000) soles
are required annually. The financial year consists of 260 working days.
In addition to the required rate of return, direct stockholding costs amount to R5 per
sole.
Comfyflex uses the economic order quantity model to manage inventory. The
Italian suppliers have offered Comfyflex a discount of 5% should they agree to place
20 orders per year.
Due to the fact that the Comfyflex premises is very small, in order to make use of the
discount offered by the Italian supplier, additional storage space would have to be
rented for R250 per month.
Required:
b) Determine whether Comfyflex Ltd should accept the special offer. (20)
c) List three (3) assumptions underlying the economic order quantity model. ( 2)
[25]
13
a) Re-order point = (Demand per lead time x lead time) + safety stock
= 2 423 + 150
= 2 573 units
b)
EOQ Special Offer
EOQ =
2 x Annual demand x ordering cost per order
(Unit price x (interest on capital – inflation) + stockholding costs per unit per annum
100
14
=
2 x 30 000 x 300
(75 x (10 – 0) ) + 5
100
=
18 000 000
12.5
= 1 200 units
= 30 000
1 200
= 25 orders
= 12.125
b)
Demand is known and continuous.
Load time is known and does not vary in length.
Delivery of ordered stock takes place in one batch, etc.
15
Sparkle Limited is a manufacturer of pool cleaners and operates for 250 days per
annum.
The company currently purchases one of the components for the pool cleaner at a
cost of R35 per unit from Splash CC. Orders are executed within 15 days. The
demand for the component is 12 000 units per annum. There is no seasonal
fluctuation in the demand for the component. The company makes use of the
economic order quantity method to determine the number of units to be ordered.
Sparkle Limited requires safety stock of 70 units.
The cost to place an order amounts to R100 and delivery costs amount to R120 per
order. The company requires a 20% return on capital before taxation. In addition to
the required rate of return, direct stockholding costs, excluding annual insurance at
5% of the unit cost, amount to R5,50 per unit.
The company has been approached by Splash CC, offering a discounted price of
R25 per unit, provided that orders are placed in batches of at least 800 units each
and a delivery charge of R200 per order will be charged. The lead time for delivery
would remain 15 days. The ordering cost per order will remain the same, but
additional storage space of R50 000 per annum will be needed.
Required:
Question 3:
= 5 280 000
11.8
= 669 units
(b) Re-order point = (demand per time unit x lead time) + safety stock
= (12 000 / 250 x 15) + 70
= 790 units
Saving if special offer is accepted: R428 733 - R359 200 = R69 533
LEARNING OBJECTIVES:
People, when asked to repeat a task, often take less time to repeat the same
task when asked to do it again. This is the premise of learning curve theory.
The theory assumes that each time production quantity doubles, the
cumulative average time per unit will be a fixed percentage of the previous
cumulative average time per unit.
Illustration
If a first unit took 100 hours to complete, how long will it take to complete the
second unit if an 80% learning curve is applicable.
Illustration
Same as previous illustration but how long does it take to produce the third
and fourth unit.
1 100 100
2 80(100 X 80%) 160
4 64(80 X 80%) 256
8 51 (64 X 80%) 408
16 41(51 X 80%) 656
32 33(41 X 80%) 1056
Thus if a question using a learning curve requires the amount of time for
producing the 24 units from unit 9 to 32, the number of hours can be easily
calculated by doing this table and subtracting 408 hours from 1056 hours.
It is very important to look out for these relationships when doing questions
concerning learning curves.
However a question may require the difference in time between units 13 and
29. As these units are not found on the table, the learning curve has to be
calculated algebraically.
where:
y= cumulative average time per unit
b= log l
log 2
Illustration
Using the above formula, if 32 units have been produced, use the formula to
determine the number of hours.
b = log 0.8
log 2
= 0.3219
y = axb
= 100 X 32-0.3219
Total hours = ax
Illustration
To determine the total hours it would take for 32 units in the above example,
the calculations would be as follows:
= 100 X 32
= 1049
If the first unit takes 40 hours and a 80% learning curve exists, calculate the
average time, total time and marginal time to produce the first 10 units.
To determine the learning curve tempo, if two figures on the curve are
known.
5
If there is one gap between items such as between 33 and 41, the learning
tempo is calculated as follows:
LT = 33
41
= 0.8 i.e. 80 % learning curve
If there are two gaps between items such as between 33 and 51, a square
root is needed. The learning tempo is calculated as follows:
LT = 33 / 51
= 0.6471
EXAMINATION CONSIDERATIONS
ANSWER TO EXAMPLE 1
Cumulative
Production production Average time Total time Marginal
time
1 1 40 40 40
1 2 32 64 24
1 3 28.1 84.3 20.3
1 4 25.6 102.4 18.1
1 5 23.86 119.3 16.9
1 6 22.46 134.8 15.5
1 7 21.4 149.7 14.9
1 8 20.48 163.8 14.1
1 9 19.71 177.4 13.6
1 10 19.06 190.6 13.2
REQUIRED
REQUIRED
REQUIRED
REQUIRED
Assume that the variable cost, subject to the learning curve, consists of
direct labour and associated overheads of R150 per hour.
REQUIRED
REQUIRED
= (20 + 16)/(20 x 2)
= 36/40
d)
* (300/10) = 30
10
e)
CUMULATIVE PRODUCTION CUMULATIVE AVERAGE COST CUMULA- ADDITIONAL
PER UNIT TIVE COST CUMULATIVE
COST
Number Number of units
of lots (lot size = 10)
R
Direct labour (61,47 hours at R5 per hour) 307,35
Raw material cost 56,00
Overheads 226,00
588,35
=====
Overheads
An order of 200 units was received after a display at the Rand Easter show.
The four units already being manufactured will be held for viewing purposes.
The management’s objective is to recover all direct cost plus a profit of 25%
on the selling price.
12
REQUIRED
(UNISA - adapted)
Hint
Log y = log a + b x
= 31,36/32
= 0,98
Test
= 0,98
= 1,13682
Hours
= 23 756/200
= R118,78
15
Material 26 193,80
Labour (474,9 hour @ R23/hour) 10 922,70
Overheads (474,0 hour @ R15/hour) 7 123,50
REQUIRED
Calculate the selling price for the 10 additional machines if a profit of 20% on
selling price is required.
(UNISA)
16
ALPHA LIMITED
33,5 + 25,8
33,5 x LF = 2
LF = 0,88507
y = axb
474.9 log LF
log 25 = log 33,5 + log2 x log 25
log LF
1,27868 = 1,52504 + 0,30103 x 1,39794
1, 27868 - 1,52504
logLF = 1,39794 x 0,30103
logLF = 0,05305
antilog = T,94695
LF = 0,088501
= 0,885
= 88,5%
17
y = axb
log 0,885
log y = log 33,5 + log 2 x log 35
-1 + 0,94694
= 1,52504 + 0,30103 x 1,54407
= 1,52504 - 0,27216
= 1,25288
y = 17,901
= 626,54
R26193,80 R
Raw material 25 x 10 10 478
IPM (Pty) Limited manufactures luxury sports cars. The company recently
started manufacturing a new model of which, to date, two units have been
completed and sold. The manufacturing costs for these two units were as
follows:
R
Material 200 000
Direct labour 80 000
Overhead 120 000
The direct labour hours taken for the manufacturing of the first two sports cars
were as follows:
An order for another six of these sports cars has been received. The price of
material and labour increased by the following percentages since the
manufacturing of the first two sports cars:
Material : 10%
Direct labour : 15%
REQUIRED:
Determine the price at which each of the six sports cars should sell at if the
company wants to recovery only directly related manufacturing costs
and earn a total profit of R500 000. (15)
R
Material ( R200 000 x 6 x 1,1) 660 000
2
Selling price per sports car (R1 711 015) 285 169
6
( 9)
Calculations:
1 Learning curve
= 95% ( 2)
20
Hours
Total time for 8 sports cars (137,18 x 8) 1 097,44
Less: Time for first two sports cars (160 + 144) 304
Time for next six sports cars 793,44
1. The direct labour costs, at R6 per hour, to manufacture the first two dresses
is as follows:
R
First dress 150
Second dress 120
270
2. The designer earns R5 760 per month, and designs approximately 18 new
creations during the course of a month.
3. Each dress will require 4,5 metres of material, at a factory cost of R17 per
metre.
4. It was estimated that sundry items, like decorative trimmings, buttons and
cotton, will amount to R7 per dress.
8. Stylish Modes (Pty) Limited intends selling the dresses to the chain of
boutiques at R420 each.
22
REQUIRED:
Calculate the total net income expected to be earned from the order.
R
Sales (R420 x 16) 6 720
Less: Cost of sales 3 840
Direct material (4,5 x R17 x 16) 1 224
Direct labour [(R270 + (217,4411 x R6 x 1,1)] 1 705
Design cost (R5 760) 320
18
Sundry items (R7 x 16) 112
Machine costs allocated
general sewing machines (262,442 x R0,50) 131
overlocking machines (262,442 x R0,75) 197
[ (R150 + R120) 2 ]
[( 6 6 ) ]
= __________________ x 100
R150 1
6
= 90%
24
OR
Hours
Total hours for 16 dresses 4th doubling
3. 90% x 25 = 22,5
4. 90% x 22,5 = 20,25
5. 90% x 20,25 = 18,225
6. 90% x 18,225 = 16,4025
7. 22,5 x 2 = 45
8. 20,25 x 4 = 81
9. 18,225 x 8 = 145,8
10. 16,4025 x 16 = 262,44
Hours
First unit 60
Second unit 48
R
Per unit
Material 620
Labour 440
Variable overheads 324
1 384
3. Since the first two units were manufactured, material costs have increased
by 10% and labour costs by 5%.
5. Fixed costs incurred solely for the manufacture of FXAN units: R9 254.
REQUIRED:
(b) Calculate the minimum selling price per unit that the enterprise can quote
on a contract for 30 units in order only to recover direct costs, and earn a
profit of 25% on the selling price. Ignore all costs relating to the
manufacture of the first 2 units. (11)
Round final hours to the nearest hour and rands to the nearest rand.
27
= 0.90 ( 2)
R
Direct costs for 30 units:
Note: Fixed costs apportioned do not form part of direct costs and are,
therefore, not taken into account.
28
Calculation:
1
The variable manufacturing costs for the first four water-skis were as follows :
R
Direct labour at R55 per labour hour 16 896
Direct material costs 92 840
Overheads (variable at 40% direct labour hours, and 60% 68 200
raw material costs)
Additional information:
The total direct labour hours to manufacture the first unit were 120 hours,
and the total direct labour hours to manufacture the first two units were
192 hours.
Raw material costs have increased by 10% since the first four units were
produced.
REQUIRED :
(b) Calculate the minimum selling price per unit that the company can
quote for the 12 water-skis in order to recover the relevant costs and
earn a profit of 35% based on the cost price. (17)
30
(c) State the limits between which a learning curve may vary and briefly
explain the significance of each limit. (2)
VANEGILL:
= (192 ÷ 2) x 100
120
= 80%
(b)
Cumulative average time per unit for the first 16 units
= (0.8)4 x 120 = 49.152 hours
OR
Total time for the first 16 units = cumulative av. time per unit for
first 16 units x 16 units
= 49.152 x 16
= 786.43 hours
≈ 786 hours
Hours
Total time for the first 16 units 786
Less: total time for the first 4 units (307)
Total time for 12 units in order 479
We only want to recover relevant costs. The apportioned overheads are not
relevant but the fixed portion of overheads incurred solely for the
manufacture of the water-skis are relevant. The direct labour, direct materials
and variable overheads are all relevant.
Want to earn a profit of 35% based on cost. Therefore profit ÷ costs = 35%.
Sales 135%
Less: Costs 100%
Profit 35%
(c) The learning curve may vary from 50% which is the maximum learning
effect and 100% where no learning takes place.
1
Learning Objectives:
INTRODUCTION
COST
e1 e2 e4
e3
Volume
In the case of the least squares method the straight line is fitted in such
a way as to minimise the sum of the squares of the distance between
the various points on the line.
Y = a = bx
3
Hence, from the general equation the summation of the above would
be:
y = an + bx
The above equations are solved simultaneously to find the values for a
and b.
n x y x2 xy
1 7 247 49 1729
2 10 270 100 2700
3 11 278 121 3058
4 10 271 100 2710
5 8 257 64 2056
6 6 235 36 1410
7 11 280 121 3080
8 12 287 144 3444
9 11 277 121 3047
10 9 265 81 2385
Hence, substitute the values from the above table in the equations:
y = an + bx
b = 8,19
When the independent variable (x) and the dependent variable (y)
have been identified, they can be plotted on a graph by the
independent variable being represented on the x-axis and the
dependent variable represented on the y-axis.
The data you have been supplied with to apply correlation and
regression analysis to, however, differs from this in that not all points lie
on the straight line.
This obviously calls for a more sophisticated technique than the high-
low method to determine the best objective fit of the straight line
between all the given points. Regression analysis can be used for this
purpose.
In the case of the least-squares method, the straight line is fitted in such
a way as to minimise the sum of the squares of the distances between
the various points and the straight line
(i.e. e12 + e22 + … + en2)
In our attempt to fit a straight line to a set of given points we, however,
have to remember that the equation of a straight line contains an
independent variable (x), and a dependent variable (y). As the
wording indicates, we can only fit a straight line to a given set of data,
if a relationship exists between these two variables. The existence of, or
lack of existence of this relationship, is determined by means of
correlation analysis.
From the above, it is, therefore, clear that regression analysis cannot be
applied unless the existence of an acceptable relationship between
the independent variable (x) and the dependent.
Correlation
Formula
The only formula used in this course for the calculation of the
coefficient of correlation is as follows:
n ∑x y - ∑x ∑ y
r =
n ∑x - (∑x ) n ∑y - (∑y )
2 2 2 2
= 0,9938
6
Note
0,75 or –0,75 is accepted as being a general guideline as to the lowest
possible limit the coefficient of correlation can be, to justify the
application of regression analysis
RELIABILITY OF ESTIMATES
DEGREES OF FREEDOM
∑y - a ∑ y - b ∑x y
2
Se =
√ n-2
The standard error can be used to determine the confidence limits for
the estimate of y, and these limits are shown by ŷ ± tSe, where t is the
factor for a t distribution with (n-2) degrees of freedom based on a
confidence level of (100 – α)%
8
Confidence = ŷ ± tSe
limits
= ŷ ± (2,306)(1,37)
= ŷ ± 3,16
We can now use the above information to forecast and analyse the
results.
Ŷ = a + bx ± tSe
= 188,9 + 8,19(13) ± (2,306)(1,37)
= 295,37 ± 3,16
It can thus be stated with 95% certainty that the actual cost of
producing 13 units will vary between R292,21 and R 298,53.
9
4. The first item in the x2-column will be the first item in the x-column,
squared. The same applies to the y2-column.
5. The first item in the xy-column will be the first item in the x-column,
multiplied by the first item in the y-column.
6. Complete all these columns and add them up, which will give you
x, y, x2, y2, xy (sum of x, etc).
7. Substitute these values into the formula for correlation and solve for
r. Calculate r2.
In all cases you should be led by the “required” section of the question.
Method
1-8. Unless already done for correlation analysis, follow steps 1 to above.
a) y = na + bx
b) xy = ax + bx2
Limitations (Read)
2. Adaptability
QUESTION 1
You departmental head, being in a rush, supplied you with only the
following information:
x = 1 980
y = 1 324
x2 = 563 400
y2 = 251 676
xy = 376 510
r = 0,9816
Relevant formulae:
y = a + bx
x = na + bx
xy = ax + bx2
a) 1m6046
b) 19,2857
c) 2
d) 19 (3)
a) 169,39
b) 151,70
c) 152,10
d) 170,00 (3)
13
1 324 = 7a 1 980b
1 324 = 7a + 1 980 (0,6004)
1 324 = 7a + 1 189
7a = 1 324 – 1 189
7a = 135
a = 19,2857
QUESTION 2
Normal profits were maintained until the end of December 2013. It has
been decided to analyse the actual production cost for the period
October 2013 to December 2014 in order to determine normal
production cost. The extent of the malpractice during the period
January 2014 to March 2014 is to be determined by using this normal
cost as basis.
You realise that a three month period is normally too short to apply
correlation and regression analysis, but these particular spares and
components have only been purchased from 1 October 2013, due to a
change in the manufacturing process.
Units Production
produced cost
R
October 2013
November 2013 16 8 380
December 2012 15 7 800
19 9 450
January 2014 18 10 740
February 2014 14 8 800
March 2014 20 11 800
16
Required:
Relevant formulae:
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
y = a + bx
y = an + bx
a) Coefficient of correlation
Month x y x2 y2 xy
October 2013 16 8 380 256 70 224 400 134 080
November 2013 15 7 800 225 60 840 000 117 000
December 2013 19 9 450 361 89 302 500 179 550
50 25 630 842 220 366 900 430 630
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 10 390
10 455
= 0,9938
Significance of r
Y = an + bx …. (a)
XY = ax + bx2 …. (b)
Substitute into (a) : 25 630 = 3a + 50b …. (1)
Substitute into (b) : 430 630 = 50a + 842b …. (2)
(1) x 50 : 1 281 500 = 150a + 2 500b …. (3)
(2) x 3 : 1 291 890 = 150a + 2 526b …. (4)
(4) – (3) : 10 390 = 26b
b = 399,62
Substitute b = 399,62 in (1):
25 630 = 3a + 50 (399,62)
a = 1 883
18
Fixed = R1 883
Variable = R400/unit
(5)
Calculations:
QUESTION 3
Semi-variable
Month Production manufacturing costs
(Units) R
1 1 500 800
2 2 000 1 000
3 3 000 1 350
4 2 500 1 250
5 3 000 1 300
6 2 500 1 200
7 3 500 1 400
8 3 000 1 250
9 2 500 1 150
10 1 500 800
Other costs:
REQUIRED:
c) Calculate the cash requirements for month 11, from the available
particulars. (4)
20
a) Coefficient of correlation
Month x y xy x2 y2
1 1 500 800 1 200 000 2 250 000 640 000
2 2 000 1 000 2 000 000 4 000 000 1 000 000
3 3 000 1 350 4 050 000 9 000 000 1 822 500
4 2 500 1 250 3 125 000 6 250 000 1 562 500
5 3 000 1 300 3 900 000 9 000 000 1 690 000
6 2 500 1 200 3 000 000 6 250 000 1 440 000
7 3 500 1 400 4 900 000 12 250 000 1 960 000
8 3 000 1 250 3 750 000 9 000 000 1 562 500
9 2 500 1 150 2 875 000 6 250 000 1 322 500
10 1 500 800 1 200 000 2 250 000 640 000
25 000 11 500 30 000 000 66 500 000 13 640 000
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 12 500 000 .
__________ _________
40 000 000 4 150 000
= 12 500 000 .
6 324,56 x 2 037,15
= 12 500 000
12 884 077
= 0,97 (5)
21
QUESTION 3 – Continued
Y = an + bx …. (a)
b = 1 250 000
4 000 000
b = 0,3125
10a = 3 587,5
10
a = 368,75
a =
QUESTION 4
You are the cost accountant of Yours Truly (Pty) Limited, a company
that specialises in the manufacturing of small quality articles sold to gift
and departmental stores.
A statement has been made that this department does not earn the
required rate of return of 25% on sales that has been set for this
department, and that the latter should be closed down as a
rationalisation measure.
You do not agree with this statement and have decided to prove it to
be false. You have extracted the following details from the
production records of this department for the first nine months it has
been in operation:
1 120 10 200
2 135 10 440
3 162 10 560
4 180 10 740
5 180 10 830
6 150 10 530
7 198 10 950
8 240 11 310
9 210 10 980
1 575 96 540
23
You realise that a nine month period is normally too short to apply
correlation and regression analysis, but due to a lack of other
information, have no choice but to use this limited information.
Additional information:
1. Of the fixed cost included in the total manufacturing cost, 90% is not
directly related to this department, but represents general company
overheads that have been apportioned to this department.
REQUIRED:
y = na + bx
xy = ax + bx2
xy = 16 994 520
24
Y = an + bx …. a
b = 100 020
11 448
b = 8,736897
Substitute b = 8,736897 in 1:
9a = 96 540 – 13 761
9a = 82 779
a = 9 197,66
Calculation:
Notes to solution:
1 x as given.
2 Fixed and variable elements as calculated in a) above.
26
QUESTION 5
The accountant informed the financial director that he has based the
above information on the result of a sample in which he has compared
the number of late cancellations in relation to the number of
passengers booked. The above extract is, consequently,
representative of the statistics for the past year. He has also confirmed
that the trend of late cancellations is similar for all flights on a particular
day.
27
REQUIRED:
y = na + bx
y = na + bx
xy = ax + bx2
r = nxy - xy .
__________ ___________
nx – (x) ny - (y)
2 2 2 2
28
x y xy x2 y2
520 25 13 000 270 400 625
480 23 11 040 230 400 529
510 25 12 750 260 100 625
490 24 11 760 240 100 576
530 27 14 310 280 900 729
550 27 14 850 302 500 729
540 26 14 040 291 600 676
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 1 510 .
______ __
27 600 94
= 1 510 .
(166,1325) (9,6954)
= 1 510 .
1 610,7210
= 0,9375
y = An + bx …. a
b = 0,0547
Substitute b = 0,0547 in 1:
7a = 177 – 198,014
a = -21,014
7
a = 3,002
QUESTION 6
The following are the production figures, for the first eight months of
production:
Output Cost of
production
Units R
(‘000) (‘000)
5 11,8
7 14,7
9 18,5
11 24,0
13 26,2
15 30,1
17 33,6
14 28,0
y = a + bx
Where y = na + bx
xy = ax + bx2 and
r = nxy - xy .
__________ ___________
nx – (x) ny2 - (y)2
2 2
31
REQUIRED:
Steely Limited
a) Correlation
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 18 781,6 - 17 007,90 .
___________ __________________
9 240 – 8 281 38 231,92 – 34 931,61
= 1 773,7 .
30,97 x 57,45
= 1 773,7 .
1 779,23
= 0,9969
n X y Xy x2 y2
(‘000) (‘000) (‘000 000) (‘000 000) (‘000 000)
5 11,8 25 139,24 59,0
7 14,7 49 216,09 102,9
9 18,5 81 342,25 165,5
11 24,0 121 576,00 264,0
13 26,2 169 686,44 340,6
15 30,1 225 906,01 451,5
17 33,6 289 1 128,96 571,2
14 28,0 196 784,00 392,0
1
91 186,9 1 155 4 778,99 2 347,7
y = An + bx …. a
b = 0,0547
Substitute b = 0,0547 in 1:
7a = 177 – 198,014
a = -21,014
7
a = 3,002
2
PROCESS COSTING
Learning objectives:
INTRODUCTION
Oil refining
Paper
Food and drinks
Chemicals
The output of one process become the inputs of the next process
until the goods are complete in the final process.
Due to the nature of the production process, there is often work in
progress that needs to be valued. Because of mass production it is
difficult to maintain stock records per unit.
There is often a loss in the process due to spoilage, evaporation and
wastage.
Material for 10 000 units are placed into production at a total material
cost of R100 000 and conversion costs for process 1 amounts to R56 400
and for process 2 R30 400.
4
Further assume that at the end of the month, process 1 completes and
transfers 8 000 units to process 2 and process 2 in turn completes and
transfers 7 000 units to finished goods.
Remember this is still accounting and it’s about debits and credits. Let’s
examine the WIP accounts for the 2 processes.
In process 1 there are 2 000 units which are incomplete. Assume that
they are 70% complete. (Obviously they are 100% complete for
materials as all materials were added at the beginning of the process).
How will the costs of production be allocated to the different
products?
Similarly in process 2, 7 000 units are complete and 1 000 units are in
progress. Assume that these units are 70 % complete. Costs must be
allocated to all units, finished or unfinished.
Opening stock
10 000 Current production
Note:
Input must equal output.
All 8 000 units are completed for material and conversion. In other
words units started and completed in the same period.
There are 2 000 unfinished units, but remember material has already
been added .Which means I have incurred all my material costs.
As far as conversion costs are concerned only 70% are complete. In
other word 1 400 units
The total costs incurred in process 1 is R156 400 and this must be
allocated to the complete and incomplete units. We do this in the
allocation statement.
Allocation statement
156 400
PRODUCTION STATEMENT
INPUT DETAILS OUTPUT PROCESS 1 MATERIAL CONVERSION
- Opening stock
8 000 Received from process 1
Completed and
transferred 7 000 7 000 7 000 7 000
Closing WIP 1 000 1 000 1 000 600
8 000 8 000 8 000 8 000 7 600
Note:
Input must equal output.
All 7 000 units are completed for material and conversion. In other
words units started and completed in the same period.
There are 1 000 unfinished units, but remember material has already
been added .Which means I have incurred all my material costs.
As far as conversion costs are concerned only 60% are complete. In
other word 600 units
A process 1 column is included as the costs of process 1 are brought
forward.
COST STATEMENT
The total costs incurred in process 2 is R158 400 and this must be
allocated to the complete and incomplete units. We do this in the
allocation statement.
8
Allocation statement
158 400
As we have seen from the previous example, that 8 000 units were
complete and 2 000 units were incomplete. What if some of these units
were spoilt and lost?
We have to account for two types of spoilage, viz normal spoilage and
abnormal spoilage.
NORMAL SPOILAGE
The problem with normal losses is that it does not share in the costs. This
simply means that the cost of normal spoilage must be carried by the
good output.
Assume that the above 10 units were inputted at a total cost of R100.
10% of the units are spoilt but the cost still remains R100. This simply
means that the cost of output is not R10,00 per unit (R100÷10), but
R11,11 (R100÷9). Good output is 9 units
9
ABNORMAL LOSSES
Abnormal losses are additional losses which occur during a process. This
loss is unplanned for and therefore carries a cost.
Assume the cost of input of 500 units is R7 500. Assume that the normal
losses are 10% of input. Out put at the end of the process is 410 units. At
the outset the cost per unit seems to be R7 500÷500 = R15 per unit.
Remember we have normal spoilage so the cost per unit increases.
Units Cost
Total input 500 7 500
Normal spoilage (50) -
450 7 500
What this means is that the cost of normal spoilage is carried by the
good output and the abnormal spoilage.
ILLUSTRATION 1
Units R
Opening WIP - -
Units introduced 10 000
10
80%(closing WIP)
100%(end of process)
- Opening stock
10 000 Current production
Note:
Input must equal output.
7 000 units are completed for material and conversion. In other words
units started and completed in the same period.
There are 1 500 unfinished units, but remember we need to account
for 10 000 units, this means that 1 500 have been spoilt.
Spoilage must be split between normal and abnormal.
In this case spoilage takes place at the beginning of the process, viz at
the 0% point.
All 10 000 units are placed at the 0% point in this period, which means
at that all units pass the spoilage point.
Normal spoilage is 10 000 x 5% = 500 units.
Abnormal spoilage is the balancing figure.
What happened to the material from the spoilt units? They have been
wasted, but I still incurred the cost.
Enter 500 units in the material column for normal spoilage(100%)
At the 0% point how much work have I done on the spoilt units? None,
therefore nothing is entered in the conversion column.
Abnormal spoilage is allocated in the same way as normal spoilage.
ALLOCATION STATEMENT
157 400
* Normal spoilage
ILLUSTRATION 2
0%(start of process )
80%(closing WIP)
100%(end of process)
point of spoilage
NOW IT’S TIME TO VISUALISE.I KNOW IT’S HARD FOR YOU. JUST TRY.
PLEASE!!
We introduce 10 000 units at 0% point. Now close your eyes, yes close your
eyes and imagine those units moving down your time line. At the 80%
point 1 500 units get left behind. Which means that 8 500 units reach the
100% point, which is also the point of spoilage.
At this point we lose 5% of the units that reach this point of spoilage. 8 500
x 5% = 425. This is now normal spoilage. Closing WIP has not passed
through this point so spoilage cannot be allocated to closing WIP
14
- Opening stock
10 000 Current production
Note:
Input must equal output.
7 000 units are completed for material and conversion. In other words
units started and completed in the same period.
There are 1 500 unfinished units, but remember we need to account
for 10 000 units, this means that 1 500 have been spoilt.
Spoilage must be split between normal and abnormal.
In this case spoilage takes place at the end of the process, viz at the
100% point.
Normal spoilage is 8 500 x 5% = 425 units.
Abnormal spoilage is the balancing figure.
What happened to the material from the spoilt units? They have been
wasted, but I still incurred the cost.
Enter 425 units in the material column for normal spoilage(100%)
At the 100% point how much work have I done on the spoilt units? All,
therefore all work is lost and 100% is entered in the conversion column.
Abnormal spoilage is allocated in the same way as normal spoilage.
COST STATEMENT
Total Material Conversion
Opening stock - - -
Current production 157 400 100 000 57 400
157 400 100 000 57 400
÷ ÷
Equivalent production 10 000 9 700
Material Conversion
Units completed
- Material (7000/8075) x 425 368
- Conversion (7000/8075) x 425 368
Abnormal spoilage
- Material (1075/8075) x 425 57
- Conversion (1075/8075) x 425 57
____ ____
425 425
ALLOCATION STATEMENT
Rounding (24)
157 400
* Normal spoilage ; Note:(spoilage is not allocated to closing WIP)
What we have dealt with so far is what we call the long method. The
long method can be used at all times. The short method (see below)
can only be used if closing WIP has already passed through the point of
spoilage.
16
Refer to illustration 1
- Opening stock
10 000 Current production
Note that with the short method, no normal spoilage is allocated to the
material and conversion columns. Please compare this to illustration 1
and understand where the differences are.
COST STATEMENT
Total Material Conversio
n
Opening stock - - -
Current production 157 400 100 000 57 400
157 400 100 000 57 400
÷ ÷
Equivalent production 9 500 8 200
In illustration 1 The material cost per unit is R10 and in this case it is
R10,526. The additional R0,526 is the cost of normal spoilage.
With the long method the normal spoilage is part of the units and in the
short method it is part of the cost per unit.
17
ALLOCATION STATEMENT
Rounding 3
157 400
The weighted average method works on the premise that all available
stock, in other words, opening stock and current production are costed
at an average rate per unit.
We have a total of 5 000 units in stock at a total cost of R16 700. The
average cost per unit is therefore:
16 700 = R3,34
5 000
18
If we used FIFO the basic premise is that what ever was there first will
leave first. Hence in the above example what will closing stock be?
ILLUSTRATION 4
Units R
Opening WIP 4 000
- Material 43 000
- Conversion – 60% complete 12 120
Units introduced 10 000
- Material cost 100 000
- Conversion cost 57 400
Units completed and transferred 9 000
Closing WIP – 70% complete 2 600
60%(opening WIP)
70%(closing WIP)
100%(end of process)
Time to visualise:
I start the new month with opening units of 4 000, which is 60% complete. This
means that 4 000 has already passed the point of spoilage in the previous
month. It can’t be spoilt again.
The current units start at 0% point. 10 000 units are introduced and worked on.
At the 50% point 10% is lost. This means that 9 000 (10 000 x 90%) units are left
to work on. When we get to the 70% point 2 600 units remain at this point as
unfinished stock. The remainder go through to output.
Since closing WIP has passed spoilage I can use the short method.
COST STATEMENT
Total Material Conversion
Opening stock 55 120 43 000 12 120
Current production 157 000 100 000 57 000
212 120 143 000 69 120
÷ ÷
Equivalent production 10 000 11 520
ALLOCATION STATEMENT
Rounding
212 120
21
ILLUSTRATION 5
Completed and
transferred 4 000 - 1 600
- Opening stock 5 000 5 000 5 000
- Current production
1 000 - -
Normal spoilage 1 400 1 400 700
Abnormal spoilage 2 600 2 600 1 820
Closing WIP
14 000 14 000 9 000 9 120
Note
COST STATEMENT
Total Material Conversion
Opening stock 55 120 - -
Current production 157 000 100 000 57 000
212 120 100 000 57 000
÷ ÷
Equivalent production 9 000 9 120
ALLOCATION STATEMENT
Rounding 10
212 120
23
QUESTION 1
During the period 20 000 units were started and the following costs
were incurred:
The completed production for the month was 15 000 units and the
closing work in progress consisted of 4 000 units which were 50%
complete. Because of an error an unexpected loss occurred and all
the opening work in progress was spoilt. This loss was discovered when
the opening work in progress was 40% complete. Normal loss is as
expected and this is detected at the 90% stage.
Produce the process account for the period and show your
calculations of the cost per unit, closing work in progress and cost of
completed production. Use the weighted average method.
(Drury adapted)
24
Units
Input
Opening WIP 3 000
Introduced during period 20 000
23 000
Output
Completed production 15 000
Closing WIP 4 000
Abnormal loss (opening WIP) 3 000 22 000
Difference = normal loss _1 000
23 000
Total cost
Opening WIP 17 880 12 600 2 400 - 2 880
Current cost 208 000 84 000 16 000 19 200 88 800
Work in progress
R
Cost element A 16 800
Cost element B 3 200
Cost element C -
Conversion cost _9 600
29 600
25
Notes
a) All of the material will have been added at the 90% stage.
Therefore materials are 100% complete as regards normal loss.
Value of stock
R
Closing WIP 29 600
Completed production 15 000 x 11,00 = 165 000
Normal loss 1 000 x 4,20 = 4 200
1 000 x 0,80 = 800
1 000 x 1,20 = 1 200
900 x 4,80 = 4 320 175 520
Abnormal loss
A 3 000 x 4,20 = 12 600
B 3 000 x 0,80 = 2 400
Conversion cost 1 200 x 4,80 = 5 760 20 760
225 880
Process account
R R
Opening WIP 17 880 Completed production 175 520
A 84 000 Abnormal loss 20 760
B 16 000 Closing WIP 29 600
C 19 200
Conversion cost 88 800 ______
225 880 225 880
26
QUESTION 2
Quantity R Quantity R
Balance: beginning of December 62 000 62 000 265 000 18 550
Purchase 12 December 39 500 49 375
20 December 28 500 34 200
Issues 83 200 50 000
i) Quantity schedule
Opening WIP 3 000
Placed in process 25 000
28 000
v) Summary of costs R
Completed and transferred to 400 122 (W3)
finishing
Closing WIP 96 000 (W4)
496 122
29
Workings:
The cost for Bypro will be the same for FIFO and WA as no purchases
were made.
R
Direct labour 154 000
Departmental overheads 132 000
Allocated overheads (see below) 66 000
352 000
i) Quantity schedule
Opening WIP 3 000
Placed in process 25 000
28 000
v) Summary of costs R
Completed and transferred to 399 570 (W5)
finishing
Closing WIP 101 220 (W6)
500 790
Workings:
LEARNING OBJECTIVES
INTRODUCTION
Carcass
Ox Slaughtering
process
Hide
JOINT COSTS
It frequently happens that joint products are not sold directly after the
split-off point. They first have to undergo further processing, separately.
These additional processing costs can be allocated directly to the
respective products by means of a job or process costing system.
The problem that arises is: How are the joint costs of the joint
manufacturing process divided between the joint products and by-
products? Normally no joint cases are allocated to the by-products.
Joint costs are therefore allocated only to the joint products (principal
products). Allocation may be based on one of the following:
relative market value of the final product method (the market value
of the final product is used and all additional processing costs after
the split-off point and selling and distribution costs are deducted
there from. In other words, the estimated market value at the split-
off point is calculated in this way).
Opening stock, finished goods, 200 units XX, 250 units XY and 300 of XZ
with a cost price of R1,50, R2,50 and R4,00 respectively.
One unit X cost R10 and produces 2 units of XX, 3 units of XY and 4 units
of XZ.
Separate cost of processing the units further amount to R0,50c for XX,
R0,75 for XY and R1 for XZ.
XX XY XZ
Units produced:
XX 1 000 x 2 = 2 000
XY 1 000 x 3 = 3 000
XZ 1 000 x 4 = 4 000
9 000
Details as in Illustration 1.
Joint costs will be allocated on the basis of relative sales value in the
following way:
Relative sales value is defined as the selling price of the end product less
any costs necessary to process after split off – point, sell it and distribute it.
Please note that we referring to the sales value of production.
XX XY XZ
Allocation
Details as in illustration 1.
Details as in illustration 1.
Joint costs will be allocated on the basis of relative sales value at split off
point in the following way:
% Allocation
You will know by now that joint costs are allocated to joint products.
The question which arises now is how the proceeds obtained from the
sale of by-products should be dealt with.
The basic principle is that for decision making purposes, there is never a
profit or loss on a by-product. The proceeds of the by-products are
used to reduce the joint cost where after it is allocated to joint
products.
- Director's valuation
- Separate cost only.
Details as in illustration 1.
SUGGESTED ANSWER
Total XX XY XZ
Sales of the main product amounted to 90% of output during the period,
and 10% of production was held as closing stock at 30 November.
Sales revenue from the main product during November was R150 000.
REQUIRED:
Calculate the profits for November using the four different methods of
accounting for by-products.
SUGGESTED SOLUTION
R R
Sales of main product (R150 000 + R700) 150 700
Opening stock -
Cost of production 120 000
120 000
Less: Closing stock 12 000
Cost of sales 108 000
Profit – main product 42 700
R R
Sales of main product 150 000
Opening stock -
Cost of production (R120 000 – R700) 119 300
119 300
Less: Closing stock (10%) 11 930
Cost of sales 107 370
Profit – main product 42 630
R R
Sales of main product 150 000
Opening stock -
Cost of production (R120 000 – R1000) 119 000
119 000
Less: Closing stock 11 900
Cost of sales 107 100
Profit – main product 42 900
QUESTION 1
ABC Ltd manufactures three joint products using the same production
process. All three products can be sold either at the split-off point or
after further processing. The following information was obtained from
the budget for the three months ending 31 October 2014:
Sales value
Product Units At split-off After further Additional
point processing processing costs
R R R
Beba 1 000 40 000 50 000 10 000
Casa 2 500 80 000 115 000 25 000
Delta 1 500 50 000 60 000 15 000
The joint processing costs at the split-off point amount to R100 000.
REQUIRED:
b. Calculate the budgeted total profit for the three months ending 31
October 2014, taking your findings in (a) into account.
QUESTION 1 – SUGGESTED SOLUTION
Recommendations:
Further processing and sale after the split-off point are only justified in
the case of product Casa.
R
Sales 205 000
The following abridged income statement shows the profit per product
for the first financial year of the business. In this statement the joint cost
is allocated based on the volume produced.
Product A B C Total
R R R R
R
Product A 55 000
Product B 28 000
Product C 5 000
YOU ARE REQUIRED TO
U/93/81/7
LETTER HEAD
Dear Sirs
The savings for the short-term is small and the effects of qualitative
factors must also be taken into account.
Yours faithfully
(40)
QUESTION 2 - SUGGESTED SOLUTION
Product A B C Total
R R R R
b) Further processing A B C
R R R
2. Rossi and Bianco can be sold at the split-off at R3,50 per unit each,
whilst Sec has no sales value if not processed further.
Research department
- 10% to the maintenance department
- 60% to production department 1
- 30% to production department 2
Maintenance department
- 20% to the research department
- 60% to production department 1
- 20% to production department 2
a) calculate the total profit for each product for the period.
(30)
,98 I = 34 300
I = 35 000 (2)
N = 50 000 + ,2 (35 000)
= 57 000 (1)
Sales value of production R80 000 R150 000 R30 000 (2)
Less: Separate costs R20 000 R 50 000 (2)
Allocation 6 10 (1)
- Joint costs 33 638 (1) 56 062 (1) 15 500 (1) 105 200
- costs of further processing 20 000 50 000 15 000 85 000
Med
47 100
Less: Closing stock 7 820 (1)
39 280
Gross profit 44 720
On long-term and short-term Rossi sells at split-off point and Bianco, Sec
and Med sells after further processing.
NB: Here joint costs are irrelevant. Relevant costs are cost incurred
for further processing after a split-off point. (a)
Additional income process only if the relevant income exceeds
the costs.
1
LEARNING OBJECTIVES:
Explain how budgeting fits into the overall framework of decision making,
planning and control
To help you understand the budgeting process we shall begin by looking at how it
fits into an overall framework of planning, decision-making and control.
STAGE 1 :
ESTABLISHING OBJECTIVES
Unit objectives relate to the specific objectives of individual units with the
organisation, such as a division or one company within a holding company.
Corporate objectives are normally set for the organisation as a whole and are then
translated into unit objectives, which become the targets for the individual units.
You should note that the expression aims is sometimes used as an alternative to
mission and the term goals is synonymous with objectives.
The next stage is to identify a range of possible courses of action (or strategies) that
might enable the company's objectives to be achieved. The corporate strategy
literature advocates that, prior to developing strategies, it is necessary to
undertake a strategic analysis to become better informed about the organisation's
present strategic situation. This involves understanding the company's present
position, its strengths and weaknesses and its opportunities and risks.
An organisation should determine the basis on which it will compete and/or sustain
a superior level of performance. The purpose is to ensure that deliberate choices
are made regarding the type of competitive advantage it wishes to attain.
Porter (1985) has identified three generic strategies that an organisation can follow:
1. cost leadership, whereby the organisation aims to be the lowest cost producer
within the industry;
3. focus, whereby the organisation determines the way in which the strategy is
focused at particular parts of the market. For example, a product or service
may be aimed at a particular buyer group, segment of the product line or small
geographical area. An organisation that adopts a focused strategy aimed at
3
1. doing nothing;
2. withdrawing from some markets;
3. selling existing products more effectively in existing markets (market
penetration);
4. selling existing products in new markets (market development);
5. developing new products for sale in existing markets (product development);
6. developing new products for sale in new markets (diversification).
1. suitability, which seeks to ascertain the extent to which the proposed strategies
fit the situation identified in the strategic analysis.
When management has selected those strategic options that have the greatest
potential for achieving the company's objectives, long-term plans should be
created to implement the strategies. A long term plan is a statement of the
preliminary targets and activities required by an organisation to achieve its
strategic plans together with a broad estimate for each year of the resources
required.
Budgeting is concerned with the implementation of the long-term plan for the year
ahead. Because of the shorter planning horizon budgets are more precise and
details. Budgets are a clear indication of what is expected to be achieved during
the budget period whereas long-term plans represent the broad directions that top
management intend to follow.
The budget is not something that originates "from nothing" each year - it is
developed within the context of ongoing business and is ruled by previous
decisions that have been taken within the long-term planning process. When the
activities are initially approved for inclusion in the long-term plan, they are based
on uncertain estimates that are projected for several years.
The final stages in the decision-making, planning and control process are to
compare the actual and the planned outcomes, and to respond to any
divergencies from the plan. These stages represent the control process of
budgeting.
5
PLANNING
The major planning decisions will already have been made as part of the long-term
planning process. However, the annual budgeting process leads to the refinement
of those plans, since managers must produce detailed plans for the
implementation of the long-range plan. Without the annual budgeting process,
the pressure of day-to-day operating problems may tempt managers not to plan
for future operations.
COORDINATION
The budget serves as a vehicle through which the actions of the different parts of
the organisation can be brought together and reconciled into a common plan.
Without any guidance, managers may each make their own decisions, believing
that they are working in the best interests of the organisation.
COMMUNICATION
MOTIVATION
The budget can be a useful device for influencing managerial behaviour and
motivating manages to perform in line with the organisational objectives. A
budget provides a standard that under certain circumstances, a manager may be
motivated to strive to achieve. However, budgets can also encourage inefficiency
and conflict between managers.
CONTROL
A budget assists managers in managing and controlling the activities for which
they are responsible. By comparing the actual results with the budgeted amounts
for different categories of expenses, managers can ascertain which costs do not
conform to the original plan and thus require their attention. This process enables
management to operate a system of management by exception, which means
that a manager's attention and effort can be concentrated on significant
deviations from the expected results.
PERFORMANCE EVALUATION
Because a single budget system is normally used to serve several purposes there is
a danger that they may conflict with each other. For instance the planning and
motivation roles may be in conflict with each other. Demanding budgets that may
not be achieved may be appropriate to motivate maximum performance, but
they are unsuitable for planning purposes. For these a budget should be set based
on easier targets that are expected to be met.
7
The conventional approach is that once per year the manager of each budget
centre prepares a detailed budget for one year. The budget is divided into either
twelve monthly or thirteen four-weekly periods for control purposes.
The budget committee should consist of high-level executives who represent the
major segments of the business. Its major task is to ensure that budgets are
realistically established and that they are coordinated satisfactorily. The normal
procedure is for the functional heads to present their budget to the committee for
approval. If the budget does not reflect a reasonable level of performance, it will
not be approved and the functional head will be required to adjust the budget
and re-submit it for approval. It is important that the person whose performance is
being measured should agree that the revised budget can be achieved otherwise,
if it is considered to be impossible to achieve, it will not act as a motivational
device. If budget revisions are made, the budgetees should at lease feel that they
were given a fair hearing by the committee.
ACCOUNTING STAFF
The accounting staff will normally assist managers in the preparation of their
budgets; they will, for example, circulate and advise on the instructions about
budget preparation, provide past information that may be useful for preparing the
present budget, and ensure that managers submit their budgets on time.
8
The accounting staff do not determine the content of the various budgets, but
they do provide a valuable advisory and clerical service for the line managers.
BUDGET MANUAL
Cash budgets
The objective of the cash budget is to ensure that sufficient cash is available at all
times to meet the level of operations that are outlined in the various budgets.
Because cash budgeting is subject to uncertainty, it is necessary to provide for
more than the minimum required, to allow for some margin of error in planning.
Cash budgets can help a firm to avoid cash balances that are surplus to its
requirements by enabling management to take steps in advance to invest the
surplus cash in short-term investments. Alternatively, cash deficiencies can be
identified in advance, and steps can be taken to ensure that bank loans will be
available to meet any temporary cash deficiencies.
Final review
The budgeted profit and loss account, the Statement of Financial Position and the
cash budget will be submitted by the accountant to the budget committee,
together with a number of budgeted financial ratios such as the return on capital
employed, working capital, liquidity and gearing ratios. If these ratios prove to be
acceptable, the budgets will be approved.
COMPUTERISED BUDGETING
ACTIVITY-BASED BUDGETING
The conventional approach to budgeting works fine for unit level activity costs
where the consumption of resources varies proportionately with the volume of the
final output of products or services. However, for those indirect costs and support
activities where there are no clearly defined input-output relationships, and the
consumption of resources does not vary with the final output of products or
services, conventional budgets merely serve as authorisation levels for certain levels
of spending for each budgeted item of expense.
With conventional budgeting indirect costs and support activities are prepared on
an incremental basis. This means that existing operations and the current
budgeted allowance for existing activities are taken as the starting point for
preparing the next annual budget. The base is then adjusted for changes (such as
changes in product mix, volumes and prices) which are expected to occur during
the new budget period. This approach is called incremental budgeting, since the
budget process is concerned mainly with the increment in operations or
expenditure that will occur during the forthcoming budget period. For example,
the allowance for budgeted expenses may be based on the previous budgeted
allowance plus an increase to cover higher prices caused by inflation. The major
disadvantage of the incremental approach is that the majority of expenditure,
which is associated with the "base level" of activity, remains unchanged. Thus, the
cost of non-unit level activities become fixed and past inefficiencies and waste
inherent in the current way of doing things is perpetuated.
ZERO-BASED BUDGETING
ZBB works from the premise that projected expenditure for existing programmes
should start from base zero, with each year's budgets being compiled as if the
programmes were being launched for the first time. The budgetees should present
their requirements for appropriations in such a fashion that all funds can be
allocated on the basis of cost-benefit or some similar kind of evaluative analysis.
The cost-benefit approach is an attempt to ensure "value for money"; it questions
long-standing assumptions and serves as a tool for systematically examining and
perhaps abandoning any unproductive projects.
QUESTION 1 20 marks
At the end of 2012/2013 there were 75 Down beds and 64 Dreamcast beds were
still in inventory. It is company policy to maintain enough inventory of beds at the
end of each month to meet demand for 55% of the next month’s forecast sales.
The sales and production of both products tend to be evenly distributed
throughout the year.
Both beds are made from the same raw materials. These are wood, plastic and
treated nylon. These are required in the following quantities per bed in terms of
output (finished product):
Some wastage occurs during the manufacturing process. This is 1,5% of wood
and plastic and 3% of nylon. This material wastage has no further use.
14
At the end of 2012/2013 most of the remaining raw material inventory was sold to
another company because the warehouse was undergoing essential
maintenance. The budget should allow for inventory levels to be built up to
normal levels of 25% of the next month’s usage. The raw materials that remained
at the end of 2012/2013 were:
Wood 196kg
Plastic 72kg
Treated nylon 62 square metres
R
Wood 4,60 per kg
Plastic 5,50 per kg
Treated nylon 21,00 per square metre
Skilled labour costs R14,00 per hour and unskilled labour costs R6,50 per hour
REQUIRED
(a) In your role as accountant produce the following budgets for the
year 2013/2014:
(i) Sales budget in units and in rand value. (2)
(ii) Production budget in units. (3)
(iii) Materials usage budget in units. (3)
(iv) Materials purchases budget in units and in value. (Only show
total requirement for period June – July and August – May. Do not (4)
show individual monthly requirements)
(v) Labour budget in hours and in value. (4)
(b) Describe how the approach used to construct these budgets differs
from the methods used in the public service. (4)
(a) In your role as accountant produce the following budgets for the year
2013/2014:
(1 056/12 = 88 x 55%)*
(1 176/12 = 98 x 55%)**
Skilled Semi-skilled
Down bed Dreamcast Down bed Dreamcast
Production units 1 030 1 166 1 030 1 166
Time per unit 5hrs 6hrs 4hrs 4,5hrs [1]
Total hours 5 150 6 996 4 120 5 247 [1]
Rate per hour R14 R14 R6,50 R6,50 [1]
Labour cost 72 100 97 944 26 780 34 106 [1]
Total direct labour cost R230 930
(b) Describe how the approach used to construct these budgets differs from the [4]
methods used in the public service
In the public service incremental budgets are based on the previous budget. This
is then adjusted for expected changes in the next budget period. In (a) above
the whole budget is driven by the limiting factor, which in this case is the sales [2]
volume
In the public service rolling budgets are continuously being updated in relation to
new information. The above budget will not be adjusted according to
circumstances but monitored using variance analysis. [2]
18
REQUIRED:
(a) Calculate the variable production costs per unit, and the fixed production [4]
costs per month, over the three month period.
Month 1 Month 2 Month 3
Production 12 000 10 500 10 000
Unit Cost 23,75 25,00 25,50
Total Cost R285 000 R262 500 R255 000
LOW HIGH DIFFERENCE
Volume 10 000 12 000 2 000 [1]
Total Cost R255 000 R285 000 R30 000 [1]
Unit Variable cost R30 000/2000 R15 [1]
Total Variable costs (Based on low 10000 x R15 = R150 000
volume)
Total Fixed costs (Based on low R255 000 - R150 000 = R105 000 [1]
volume)
(b) Estimate the total cost that would be incurred in Month 4 if 12 500 units are [2]
manufactured.
Month 4
Production (Units) 12 500
Variable Cost (R15 X 12500) R187 500 [0.5]
Fixed Cost R105 000 [0.5]
Selling + Admin R87 000 [0.5]
Total Cost R379 500 [0.5]
(c) Prepare a profit statement for Month 2 using the absorption costing method. [7]
Assume that the fixed production overhead absorption rate is based upon
normal production of 12 000 units per month.
UNITS R
Production 12 000
Fixed overhead 105 000
Recovery rate 105 000/12 000 R8,75 per unit [1]
Under absorbed production overhead: (1 500 units at R8,75 per (13,125) [1]
unit)
Gross profit (after adjustment) 89,375 [1]
Selling and administration overheads (87) [1]
Net profit 2,375 [1]
(d) Prepare a profit statement for Month 3 using the marginal costing method. [5]
(e) Explain, with supporting figures, the profit difference in Month 2 if the [2]
marginal costing method had been used instead of absorption costing.
QUESTION 2
You are the accountant of the Mountain Creek Estate (Pty) Limited, an upmarket
mountain resort.
A project to upgrade the resort has commenced this year, the funding of which is
placing a great deal of pressure on the available funds. An overdraft facility of R60
000 has been arranged, but you are unsure if this will be sufficient. If this facility is
insufficient, a long-term loan will have to be raised.
You have extracted the following information, relating to the 2010 financial year
from the records:
1. Actual Budget
March 2010 April 2010 May 2010 June 2010
R R R R
Kitchen supplies
- Kitchen supplies used 39 600 42 800 56 800 48 500
- Opening stock 4 000 4 400 5 600 4 800
Sales
- Accommodation 130 000 150 000 180 000 120 000
- Bar 17 500 22 500 27 000 19 500
9. The company has been assessed for company taxation for the
financial year which ended on 29 February 2009. The amount due
is R40 800 and it is payable on 31 May 2010.
10. The following is an extract from the capital budget for the year:
10,2 Cost of refurbishing 10 guest suites will amount to R25 000 per
suite, and will be payable upon completion of a suite. Two
suites were completed in April; one is expected to be
completed in May and two in June 2010. The cost of
refurbishing the suites will be capitalised as improvements to
the land and building.
11. The existing courtesy bus will be sold on 31 May 2010 at a loss of R1
500. On 1 March 2010, the book value of this bus was R20 000.
REQUIRED:
Calculations
1. Accommodation
Purchases
March April
R R
Expected usage 39 600 42 800
Add: Closing stock 4 400 5 600
44 000 48 400
Less: Opening stock 4 000 4 400
5. General Expenses
May June
R R
Monthly payments 68 000 68 000
Add: In arrears 01.05.10 3 000 -___
71 000 68 000
6. Interest paid
R
Loan 280 000
Interest (17% x R280 000 x 6/12) 23 800
May June
Number of suites completed 1 2
R R
Cost per suite 25 000 25 000
Total payment due 25 000 50 000
Payable as follows:
April 2010 (10/100 x R36 000) 3 600
May 2010 (80/100 x R36 000) 28 800
June 2010 (10/100) x R36 000) 3 600
36 000
26
Kengary Supplies (Pty) Limited has recently incorporated. The issued share capital
of the company amounts to R75 000, consisting of 75 000 ordinary shares of R1
each. The shares have been issued for cash.
The company has managed to obtain a R50 000 loan from a banking institution.
Plant and machinery, costing R60 000, has been given as security for the loan. The
loan is repayable, annually in arrear, in five equal instalments of R16 000. The
effective rate of interest applicable to the loan amounts to 18% per annum.
The company has also managed to obtain an overdraft facility of R50 000 on its
current account.
Operations are intended to commence on 1 June 2010. The production target for
the first year has been set at 140 000 units.
The selling price has been fixed at R20 per unit. The budgeted ratios of costs in
relation to the selling price are as follows:
1. Due to problems with the availability of raw material, stock should be sufficient
to make provision for the production requirement of the following three months.
3. From the beginning of the year, finished goods stock should be sufficient to
make provision for the budgeted sales of the following two months.
27
According to expectations, sales will take place evenly throughout the year.
The company is allowed 45 days for its raw material supplies. All other expenses
have to be paid for in cash.
All sales will be on credit. Debtors are granted a period of 30 days after delivery of
the goods to pay their accounts. Five percent of all debtors should be provided for
as being irrecoverable.
REQUIRED:
a) Prepare a cash budget for the company for the first year of business. (10)
a) Cash budget
Production budget
(Representing the budgeted sales for 14 months)
Given as 140 000 units
Consisting of:
- units required for sales (12 months) 120 000 1
- units required for closing stock 20 000 2
(2 months’ budgeted sales) _______
140 000
Calculations
1 140 000 x 12
14 = 120 000
2 140 000 x 2
14 = 20 000
Required for
R
- closing stock (140 000 / 12 x 3 x R20 x 35%) 245 000
- production (140 000 x R20 x 35%) 980 000
- purchases 1 225 000
580 740
(9)
Calculations
Long term
Portion = R43 000 – short term portion
= R[(43 000 – 16 000) + (18% x 43 000)]
= R34 740
R
2 Plant and machinery 54 000
- At cost 60 000
- Less: Accumulated depreciation (10% x R60 000) 6 000
5 Creditors
Creditors = Total raw material purchase – cash payments
= R1 225 000 – R1 071 875 (per cash budget)
= R153 125
6 Loan
Short term portion = R43 000 – R34 740
= R 8 260
Projected statement of comprehensive income for the year ended 31 May 2010
R
Sales: (120 000 x R20) 2 400 000
Less: Cost of sales 1 680 000
Production cost 1 1 960 000
Less: Closing stock finished goods
[20 000 x (35 + 25 + 10)% x R20] 280 000
Calculation:
R
1 Production cost
Raw material 980 000
Purchases 1 225 000
Less: Closing stock (per raw material purchases budget) 245 000
Labour (25% x 140 000 x R20) 700 000
Overhead (10% x 140 000 x R20) 280 000
Production cost 1 960 000
(8)
31
African Mining Supplies (Pty) Ltd is a supplier of mining equipment to various mines
in the North-West Province.
The following information has been obtained for purposes of compiling the cash
budget for November 2010 :
R
Bank (positive) 50 000
Savings account 355 000
Instalment sale creditor – Delivery-van 124 962
Prepaid fixed selling and administrative 27 000
expenses
2. Sales
R
October 2010 1 500 000
November 2010 2 000 000
2.2 Eighty percent (80%) of sales are on credit. Debtors tend to settle their
accounts as follows:
2.3 Debtors settling their accounts within the month of sale receive a 2,5%
discount.
32
3. Purchases
R
October 2010 950 000
November 2010 800 000
3.2 Purchases are paid for in the month following the month of purchase.
4. Stock
7. Fixed assets
7.1 During August 2010, a delivery-van with a cost price of R60 000 and a
book value of R50 000 was hijacked. Confirmation has been received
from the insurers that the insurance claim amounting to R45 000 will be
paid out on the 20 November 2010 by means of a direct transfer into
the company’s current account.
7.2 A new delivery-van has been purchased for R90 000 at the beginning
of October 2010. The purchase was financed by means of a
instalment sale agreement. At an effective interest rate of 14,5% per
annum, the amount is repayable in 60 equal payments of R2 118,
payable monthly in arrear, commencing on 31 October 2010.
8. Dividends
REQUIRED:
[20]
34
a) Amount to be transferred
R
Projected cash inflows 1 705 000
Calculations:
(2) R
Oct: 1 500 000 x 79% x 80% 948 000
Nov: 2 000 000 x 80% x 20% x 97,5% 312 000
1 260 000
(3)
Prepaid fixed selling and administrative expenses
2010 R 2010 R
01 Nov Balance 27 000 30 Nov Expenses 19 000
30 Nov Bank 24 000 30 Nov Balance 32 000
51 000 51 000
01 Dec Balance 32 000
(17)
35
b) Advantages of budgets
- Guides personnel to knowing what is expected of them and how their efforts will
be evaluated.
- Isolates problem areas and enables corrective action to be taken before they
occur.
The Betabuild housing company has two types of housing estates in the Blackberry
Area. (Type A and Type B). The following information is available:
1. The company has its own team of painters who carry out the painting and
decorating work on the housing estates. The estimated cost for each house
in which the work will be done in 2010 is as follows:
2. The total number of houses of each type and the percentage requiring
painting and decorating each year is as follows:
Type
A B
Total number of houses 500 600
Percentage of houses requiring
maintenance each year 30% 20%
37
3. Adjustments in wage rates and increases in prices will result in the following
annual fixed percentage increases in the painting and decorating costs from
the beginning of 2011:
%
Direct materials 5
Direct labour 7
Total overheads 6
R
Creditors for materials 2 100
Materials on hand Nil
Labour cost accrued 2 800
Creditors – variable overheads 600
- The credit purchases outstanding at a year end are estimated at 10% of the
annual materials purchased on credit.
- Variable overheads are paid for as follows: 60% during the month of accrual
and 40% in the following month.
- Fixed overheads are paid in twelve equal amounts during the year on a
regular monthly basis.
38
REQUIRED:
Compile a cash budget for the existing painting and decorating function for
both the financial years 2010 and 2011. (Exclude fixed overhead for 2011.)
(Work to the nearest Rand.) (27)
(Oct 2006 Exam)
39
QUESTION 5 - SOLUTION
BETABUILD
(a) Costs incurred for painting and decorating:
2010 2011
54 000 56 700
Direct material
72 900 78 003
Direct labour
Variable overheads③ 27 540 29 192
Fixed overheads:
Avoidable 16 848
Depreciation 11 232
Head office – administrative costs 28 080
Direct material:
Number of houses each = (500 x 30%) + (600 x 20%)
year: = 270 houses
Direct material for 270 houses = R200 x 270 for 2010 = R54 000
for 2011 = R54 000 x 105%
= R56 700
Direct labour:
For 2010: = R270 x 270 houses = R72 900
For 2011: = R72 900 x 107% = R78 003
③ Variable overheads:
Total overheads per house = Material related + Labour related
= (R200 x 20%) + (R270 x 100%)
= R40 + R270
= R310
Of which (30% x R40) + (⅓ x 270) = variable
= R12 + R90
= R102 variable overhead per house
Fixed overheads:
Total overheads per house – variable overheads per house = fixed overheads
R310 - R102 = R208 per house
Therefore:
Total for 2010 = R208 x 270 = R56 160
40
2010 2011
R R
Direct materials payments to creditors:
Previous year creditors (2009:given) 2 100
(2010:90% x R54 000 x 10%)
43 740 4 860
Current year [90% x (90% x R54 000)(a)]
[90% x (90% x R56 700)(a)] 5 400 45 927
Cash purchases (2010:10% x R54 000(a))
5 670
(2011:10% x R56 700(a))
Variable overhead:
Previous year (2009: given) 600
(2010: 40% x R27 540/12)
918
Current year 2010: 26 622(i)
2011:
28 223(i)
Fixed overhead:
Avoidable
Head office – administration costs 16 848
(No depreciation – not cash flow) 28 080 Excluded
- Excluded
-
196 174 163 397
(i) Variable overhead cash (13)
expense
Clusters Limited has finalised its statements for the financial year that ended on 31
December 2009. A reasonable growth in volumes has not dispelled concerns over the
immediate sales and production outlook and this has resulted in the following
assumptions as regards its trading activities and budgets for the financial year which will
end on 31 December 2010.
Sales
There will be no cash sales and it is estimated that the current turnover of the
completed goods stock, which is six times per annum, based on the average
stockholding for the year, will be maintained.
Completed goods
The closing stock at the end of the financial year will show a 50% increase over the
opening stock and will be valued by using the absorption cost basis.
R
Materials 8,00
Labour – direct 6,00
Total production overheads 6,00
20,00
The total production overheads allocated and paid for completed goods is based on
the estimated normal production volume for 2010. An amount of R200 000 for the
annual depreciation of machinery and fixed assets is included in this payment. The
machinery and fixed assets which were installed on 1 January 2009 at cost, have an
expected useful life of five years and depreciation is written off at 20% per annum on
cost based on the straight line method.
Materials
The stock of materials is expected to remain at this level throughout the financial year.
43
Debtors
The sales are expected to occur on an even daily basis throughout the financial year
which normally consists of 360 days per annum. The normal debtors collection period is
30 days after the date of sale.
Creditors
The creditors are expected to remain at this level throughout the financial year.
Additional information :
- On 1/1/2010, the bank balance reflected an overdraft of R180 000, whilst the
projected favourable balance on 31/12/2010 is R710 000.
REQUIRED :
(a) Set out a concise production budget in units for 2010. (5)
(b) Draft a budgeted statement of comprehensive income for the year ending
31 December 2010. (11)
Stock t/o = 6
Stock t/o = COS ÷ Average stock
Average stock = (Closing stock + opening stock) ÷ 2
R
Closing stock of FG = 30,000 units x R20 x 1.5 = 900,000 told that CS will be 50% ↑ than OS
R
Opening stock of FG = 30,000 units x R20 = 600,000
Average stock = (900,000 + 600,000) ÷ 2 =
bear in mind the following relation: O/S + Purchases (or production) - C/S = COS
Statement of financial
position as at 31/12/10
Calcs R R
ASSETS
Non-current
Assets
-
Machinery 1 600,000
600,000
Current
Assets
- Inventory 2 1,050,000
- Debtors 3 562,500
- Bank 710,000
2,322,500
TOTAL ASSETS 2,922,500
Calculations:
1 machinery has expected useful life of 5 years, depreciation p.a. is R200,000, therefore cost
of machinery =R1,000,000. 2 years have passed, therefore 3 years are left, so current value
of machinery = R200,000 x 3 = R600,000
2 Closing stock of FG = R900,000 and closing stock of materials = R150,000; therefore total
closing stock is = R900,000 + R150,000 = R1,050,000.
3 Debtors collection period is 30 days (1 month) after sale - there is thus one month's sales in
debtors at any point in time; = R6,750,000 ÷ 12 = R562,500.
4 Opening balance equity (01/01/10) = A-L
Fixed asset = 800,000
stock FG = 600,000
stock Materials = 150,000
Debtors = 450,000
Creditors = -160,000
Bank = -180,000
1,660,000
Add current net profit = R 1,102,500
Total Equity = R 2,762,500
46
The University of Africa requires all second year engineering students to have their own
laptop computers in order to do practical work and tasks. During the last quarter of
2009, a close corporation, Laptops for Students CC was established to supply laptops
according to the specifications set by the university, at affordable prices. At that time,
a loan of R800 000 was granted to the close corporation and the funds were deposited
into the bank account.
1. According to estimates, 200 of the 400 second year engineering students will buy
their laptops from Laptops for Students CC. There are two types of laptops which
will be supplied, namely Exceptional at a selling price of
R10 000 and Superior at a selling price of R8 000. Since the Exceptional laptop
has a more powerful hard drive, it is expected that 60% of the 200 students will
prefer to buy this laptop and the other 40% the Superior.
2. The following quarterly sales forecast for 2010 has been made :
Quarter % of the 200 students who will buy their laptops in the
1 quarter
65%
2 20%
3 15%
4 -
It is expected that the sales for 2011 will follow the same pattern as that of 2010.
3. All sales will be on credit with a 45 day average debtors collection period from
the invoice date. Sales will take place evenly throughout each quarter. Assume
a month has 30 days.
4. During any quarter, purchases from suppliers are equal to 80% of the next
quarter’s estimated sale value. Suppliers are paid within 90 days after the end of
the quarter of purchase.
5. At the beginning of the first quarter, a delivery vehicle was bought on credit. The
instalment is R11 000 per quarter. Depreciation on the delivery vehicle amounts
to R8 000 per quarter.
6. Commission of 5% of the sales per quarter will be paid out in the relevant quarter.
47
7. Interest on the R800 000 loan, which was granted in 2009, amounts to 16% per
annum and is payable in equal amounts every quarter.
8. In November 2010, new posters and price lists for 2011 will be ordered from K-
Printers. A deposit of R5 000 will be paid, while the balance of R6 000 will be paid
on delivery in the first quarter of 2011.
REQUIRED :
(a) Compile the sales budget for Laptops for Students CC for each of the four
quarters of 2010. (6)
(b) Compile the cash budget for Laptops for Students CC for each of the four
quarters of 2010. (19)
(c) State whether the close corporation will be in a position to repay the R800 000
loan at the end of the fourth quarter of 2010 without their bank account going
into overdraft and motivate your answer. (1)
R
Sales- Quarter 1 (units) 65% x 120 ① = 78 65% x 80 ① = 52
Selling price per unit R10 000 R8 000
Sales value R780 000 R416 000 1 196 000
1 840 000
(6)
OR
R R R
Exceptional (65% x 120 ① x R10 000) 780 000 - -
Superior (65% x 80 ① x R8 000) 416 000 - -
Exceptional (20% x 120 ① x R10 000) - 240 000 -
Superior (20% x 80 ① x R8 000) - 128 000 -
Exceptional (15% x 120 ① x R10 000) - - 180 000
Superior (15% x 80 ① x R8 000) - - 96 000
Calculations:
Less: Budgeted payments 1 059 600 355 800 277 600 48 000
Payments to creditors ③ 956 800 294 400 220 800 -
Instalment on delivery vehicle 11 000 11 000 11 000 11 000
Commission ④ 59 800 18 400 13 800 -
Interest on loan (16% x 800 000 ÷ 4) 32 000 32 000 32 000 32 000
K-Printers deposit - - - 5 000
Bank balance - closing 338 400 764 600 809 000 899 000
(19)
(c) Yes, since there will still be a favourable bank balance of R99 000 after the capital of
R800 000 has been repaid. (1)
Calculations:
OR
R R R R
1 (50% x R1 196 000) 598 000 598 000 - -
2 (50% x R368 000) - 184 000 184 000 -
3 (50% x R276 000) - - 138 000 138 000
Last quarter 2010: 80% x R1 196 000 = R956 800 to be paid in quarter 1
Quarter 1: 80% x R368 000 = R294 400 to be paid in quarter 2
Quarter 2: 80% x R276 000 = R220 800 to be paid in quarter 3
Quarter 3: R0
Quarter 4: 80% x R1 196 000 = R956 800 to be paid in quarter 1 of 2011.
OR
R R R R R
1 (80% x R1 196 000) 956 800 - - - -
2 (80% x R368 000) - 294 400 - - -
3 (80% x R276 000) - - 220 800 - -
4 (80% x R1 196 000) - - - - 956 800
Total purchases per quarter 956 800 294 400 220 800 - 956 800
Payments to creditors - 956 800 294 400 220 800 -
④ Commission
You are the chairperson of the finance committee of Hillside College, a private
school which was founded two years ago. Numerous fundraising projects are
continually being organised in order to complete the school buildings and
establish the required sporting facilities.
An amount of R100 000 is required to complete the athletic track and rugby fields.
A suggestion has been made to have a beer festival during the second weekend
in September 2010.
The parents association and finance committee members have provided you with
the following information regarding the proposed beer festival :
1. Entrance tickets
Entrance tickets can be sold at R50 each, which includes a light meal and a
500ml beer mug. It is expected that 1 800 tickets will be sold, 1 080 of which
are expected to be sold to males and 720 to females. A special price of R1
000 has been negotiated for the printing of 2 000 tickets which will have to
be printed and paid for in August 2010. Any unsold tickets will be disposed
of.
2. Food
The expected cost of the food other than that which has been donated will
be R190000, R12 000 of which will have to be paid for in August 2010 and the
balance in September 2010.
3. Beer
A major brewery has agreed to supply draught beer for the festival on a
C.O.D. (cash on delivery) basis. The draught beer is supplied in 50 litre
reusable vats, the content costing R250 per vat. A refundable deposit of R50
is payable on each vat supplied at the time of delivery. The beer will be
delivered to the school premises in a refrigerated trailer. The hiring of the
trailer will amount to R500 for the weekend and will be payable on
collection of the trailer.
As the brewery is prepared to refund the full purchase price of unused vats
returned, it has been decided to purchase 10 extra vats to provide for the
possibility of more beer being consumed or more tickets being sold.
The beer will only be sold in 500ml quantities at R8 each. Each guest wishing
to drink beer uses his/her own 500ml beer mug. On average, males are
expected to consume 5 mugs of draught beer each and females, 1,5 mugs
each.
52
4. Beer mugs
The beer mugs will be purchased and paid for in August 2010 and are
expected to cost R8 500.
5. Cold drinks
It is expected that 70 dozen cans of cold drinks could be sold at R5 per can.
The cold drinks cost R20 per dozen. A quote of R400 has been obtained for
the rental of the sink baths and the supply of dried ice to keep the cold
drinks cold.
One of the parents owns a catering business and is prepared to let out his
marquee to the school as a special favour, at a drastically reduced price.
The rental he will charge the school is equal to one monthly instalment he
pays in terms of a suspensive sale agreement. The amount that is being
financed for the marquee is R103 232 and it is repayable in equal monthly
instalments of 2½ years at a nominal interest rate of 12% per annum,
payable monthly.
7. Band
8. Sponsorships
Advertisers have been found for 20 sponsorship boards that will be placed in
prominent places during the beer festival. The school is charging R1 000 per
board, 50% payable by June 2010 and the balance in September 2010.
REQUIRED :
(a) Prepare a beer sales budget for the proposed beer festival in September
2010. (3)
(b) Determine the projected amount payable to the brewery on delivery of the
beer. (4)
③ Cold drinks :
= R4 000
④ Purchases
b)
(2,5ℓ x 1 080) + (0,75ℓ x 720) = 3 240ℓ
50ℓ
= 64,8 vats
= 65 vats
+ Extra 10
75 vats
x 250
18 750
102 490
As from May 2010, you have been appointed a the new financial manager of Exo
(Pty) Limited, a company selling a wide range of plastic products directly to the
public.
At the end of May, the general manager requested you to prepare a revised
statement of comprehensive income for the remainder of the financial year, a
period of nine months ending 28 February 2011. The following decisions which
were taken at a management meeting and will take effect as from 1 June 2010,
should be incorporated in the revised budgeted statement of comprehensive
income:
- the selling prices of all the products in the existing product range are to be
increased by 8%
- a new product will be added to the existing product range
- an advertising campaign, costing R30 000 will be launched on 1 June 2010
which is expected to have the effect of a ten percent (10%) increase in the
original budgeted sales volume for the remainder of the 2010-2011 financial
year. It is not anticipated that the advertising campaign will have an effect
on sales subsequent to February 2011.
You have analysed the actual results for the past three months ended 31 May 2010
and have also obtained the following information:
1. Sales
After having taken the effect of the advertising campaign into account, it is
estimated that sales of the new product will amount to R160 000.
60% of all sales are on credit. Debtors tend to settle their accounts as
follows:
2. Stock
Fixed : R9 000
Variable : 8% of turnover
4. Director’s Loan
A loan from D Exo, a director of the company, amounts to R60 000 at 1 June
2010. There is no fixed date for the repayment of the capital. Interest for the
nine months ending 28 February 2011 must be capitalized against the loan
account at a nominal rate of 14% per annum.
5. Fixed Assets
On 1 June 2009, a pick-up vehicle was acquired for R100 000. The
transaction was financed by means of a suspensive sale agreement at a
guaranteed effective interest rate of 18%. No deposit was paid. The full
amount in terms of the suspensive sale agreement is repayable in four equal
annual instalments, payable annually in arrear.
57
The delivery van which was acquired approximately three years ago, will be
sold on 1 December 2010 for R47 500. The cost price of the van amounted
to R70 000 and the book value at March 2010 was R28 000.
Depreciation on fixed assets for the nine months ending 28 February 2011,
excluding depreciation on the delivery van in 5.2 above, amounts to R30
200. Motor vehicles are depreciated according to the straight line method
at a rate of 20% per annum.
6. Dividends
REQUIRED:
Cost of sales [(1 000 000 x 1.1) + 160 000] ÷ 1.25 (1,008,000)
Gross Profit 340,000
Other income
- investment income (1000 x 0.5) 500
- profit on sale of van1 30,000
370,500
Expenditure 293,793
Advertising 30,000
Bad debts (1 348 000 x 60% x 2%) 16,176
Selling and Admin expenses - fixed (9 000 x 9) 81,000
- variable (1 348 000 x 8%) 107,840
Municipal costs (6 000 x 9/12 x 0.97) 4,365
Interest on Director's loan (60 000 x 9/12 x 14%) 6,300
Finance costs2 (interest on suspensive sale) (14 549 x 9/12) 10,912
Depreciation - sold asset (14 000 x 6/12) 7,000
- other assets 30,200
Note 1
Book value @ 01/03/10 28,000
Less: depn. for 9 months 1 Mar - 1 Dec (14 000 x 9/12) 10,500
(annual depn. = 70 000 x 20% = 14 000 p.a.)
Book value @ 01/12/10 (date of sale) 17,500
Proceeds received @ 01/12/10 47,500
Profit on sale 30,000
59
capital
year OB instalment CB interest portion
In March of this year, 440 kilograms of ANALG were produced, using the
following chemicals at the prices indicated:
(NATAL - adapted)
2
Therefore the total material cost variance = price + usage = 28 (u) + 2 (u) = R30 (u)
Usage R2 (u)
3
The following budgeted information for the year that ended on 30 June
2014 was obtained:
Units
Production capacity – standard ……………………….. 60 000
Product – “Selene”
Production and sales …………………………………… 60 000
R
Selling price – per unit …………………………………. 224,00
During the financial year, a client was given a special discount of R16,00
per unit on an order for 5 000 units. The remaining units were sold at the
budgeted selling price.
REQUIRED:
(a) Compile an income statement for the year that ended on 30 June
2014, which reflects the actual figures. ( 5)
(b) Reconcile the difference between the budgeted and the actual net
profit, before normal taxation, for 2014, by calculating as many
variances as possible. (22)
5
SIDECUT LIMITED
R
Sales 13 360 000
(b) Reconciliation of the difference between the budgeted and the actual
net profit for the year ended 30 June 2014
Calcu- R
lation
Budgeted net profit
1 440 000
Less: Unfavourable variances from standard cost
1 167 800
Sales
- Selling price 7 80 000
272 200
Calculations
Material
Zilon Brilon
R R
Opening stock – 1/7/2013 -- --
Plus : purchases @ actual
- 250 000 x R12,40 3 100 000
- 187 000 x R7,80 1 458 600
3 100 000 1 458 600
Variances
Zilon R(250 000 x 12,40) = 3 100 000 R(250 000 x 12,00) = 3 000 000
Brilon R(187 000 x 7,80) = 1 458 600 R(187 000 x 8,00) = 1 496 000
4 558 600 4 496 000
Purchase price
R62 600 (u)
( 2)
Actual input @ std cost Mixture Actual input in std ratio @ std cost
Zilon: R(247 500 x 12,00) = 2 970 000 4 286(u) 432 500 x 4/7 x 12,00 = 2 965 714
Brilon: R(185 000 x 8,00) = 1 480 000 2 857(f) 432 500 x 3/7 x 8,00 = 1 482 857
4 450 000 1 429(u) 4 448 571
8
Actual input in std ratio @ std cost Yield Actual output @ std cost
Labour
Actual cost Actual input @ std cost Actual output @ std cost
Rate Efficiency
R97 600(u) R48 000(u)
( 3)
9
Actual Budget Actual input @ std cost Actual output @ std cost
R2 465 600 R(60 000 x 48 x 75%) R(244 000 x 12 x 75%) R(60 000 x 48 x 75%)
6. Expenditure
= R2 640 000
Expenditure
R408 000(u)
( 2)
7. Sales
Price
R80 000(u)
( 2)
10
Budget Actual
R R
Sales 252 000 270 750
Less: Cost of sales 203 670 229 079
Raw materials
- Bird seed 157 500 179 215
- Vitamin extract 33 750 36 900
Wages 4 140 4 464
Variable overheads 4 500 4 600
Fixed overheads 3 780 3 900
Additional information:
REQUIRED:
(a) Calculate all possible variances for July 2014 (for sales reconciliation
purposes). (26)
(b) State one potential cause for the material mixture variance. ( 1)
12
(a) Variances
Material
Actual input @ std cost Mixture Actual input in std ratio @ std cost
Variance
R R
Seed 128 000 x 1,25 = 160 000 4 500 (f) 126 000 x 188 000 x 1,25 = 164 500
180 000
Extract 60 000 x 0,625 = 37 500 2 250(u) 54 000 x 188 000 x 0,625 = 35 250
_______ ______ ______ 180 000 ______
188 000 197 500 2 250 (f) 199 750
( 3)
Seed 164 500 1 750(f) 126 000 x 1 900 x 1,25 = 166 250
1 800
Labour
Actual cost Actual input @ std cost Actual output @ std cost
Variable overhead
Actual cost Actual input @ std cost Actual output @ std cost
Fixed overhead
Actual cost Budgeted Actual input @ std cost Actual output @ std cost
July
Volume R210(f)
( 5)
14
Sales
- an incorrect standard
- inferior or superior material used
- poor inspection
- incorrect mixture
- more of the cheaper material was used ( 1)
15
The standard product and cost specifications for 2 000 kg finished product
are as follows:
1. Raw material
2. Labour
3. Production overhead
An extract of the cost and production records for March 2014 indicates
the following:
1. Raw material
2. Labour
The actual wages for 4 000 hours during March 2014 amounted to
R23 104.
3. Production overhead
4. Production
REQUIRED:
(a) Calculate the budgeted labour hours for a normal month. (2)
(b) Calculate the budgeted production in kilograms for March 2014. (2)
(c) Determine the value of raw material usage during March 2014. (6)
17
(d) Calculate all possible standard cost variances for March 2014 in
respect of the following:
BRANDON LIMITED
= 4 00 000 kg
X Y
Kg Kg
Opening stock 20 000 24 000
Purchases 324 000 60 000
344 000 84 000
Closing stock (30 000) (8 000)
Usage 314 000 76 000
Chemical powder X
Kg R
Opening stock 20 000 11 000
Purchases 324 000 155 520
344 000 166 520
Chemical powder Y
Kg R
Opening stock 24 000 18 240
Purchases 60 000 50 400
84 000 68 640
d) Variances
i) Raw material
Actual input Mixture Actual input in std mixture @ std cost Actual output @
@ std cost std cost
R R R
X: 157 000 10 750 (u) 390 000 x 1 500 x R0,50 = 146 250 380 000 x R1 100
2 000 2 000
Actual cost Actual input @ std cost Actual output @ std cost
Actual cost Actual input @ std cost Actual output @ std cost
Budgeted – March Actual input @ std cost Actual output @ std cost
*60% x R10 = R6
(4)
21
1. Material
Material X 33⅓%
Material Y 66⅔%
2. Labour
Variable R 36 000
Fixed R120 000
1. Material
2. Labour
3. Overheads incurred
Variable R3 175
Fixed R9 750
Additional information:
REQUIRED:
Material - price
- mixture
- yield
- usage (9)
Labour - rate
- efficiency (3)
PRECISION ENGINEERING
a) Material
Actual Mixture Actual input in std mixture Yield Actual output @ std cost
input @ @ std cost
std cost
R R R R R
X 10 260 1 710 (u) 8 550 x 33½% x R3,00 = 8 550 550 (u) 8 000 x ⅓ x R3,00 = 8 000
Y 24 624 2 736 (f) 8 550 x 66⅔% x R4,80 = 27 360 1 760 (u) 8 000 x ⅔ x R4,80 = 25 600
34 884 1 026 (f) 35 910 2 310 (u) 33,600
b) Labour
Actual cost Actual input @ std cost actual output @ std cost
2 500 x R5,00 2 500 x R4,80 8 000 x ⅓ x R4,80
= R12 500 = R12 000 = R12 800
Rate R500 (u) Efficiency R800 (f)
(3)
c) Variable overhead
Actual cost Actual input @ std cost actual output @ std cost
2 500 x R36 000_ 8 000 x R36 000
90 000 x ⅓ 90 000
R3 175 = R3 000 = R3 200
Rate R175 (u) Efficiency R200 (f)
(3)
24
d) Fixed overhead
Actual Budget normal Budget – actual input @ std cost actual output @
cost month March std cost
R120 000 R10 000 x 108% 2 500 x R120 000 8 000 x R120 000
12 90 000 x ⅓ 90 000
The budget for the abovementioned division for the year ended 28
February 2014, at a capacity utilisation of 30 000 labour hours, indicates
the following:
Budgeted production
Cost per unit
R
Material – 10 kg @ R3 per kilogram 30
Labour – 3 hours @ R8 per hour 24
Variable overhead – 3 hours @ R2 per hour 6
Fixed overhead – 3hours @ R5 per hour 15
75
Additional information:
2. The actual wage rate deviated from the budgeted wage rate only
with regard to a 25% increase granted to all labourers with effect 1
March 2013.
REQUIRED:
a) Determine the total variable costs budgeted for the 2014 financial
year. (3)
i. material (2)
ii. labour (2)
iii. variable overhead (2)
iv. fixed overhead (3)
b) Variances
(i) Material
Actual cost Actual input @ std cost Actual output @ std cost
R(520 000 ÷ 4) x R3 12 500 x R30
R520 000 = R390 000 = R375 000
Price R130 000 (u) Usage R15 000 (u) (2)
(ii) Labour
Actual cost Actual input @ std cost Actual output @ std cost
40 000 1 x R8 12 500 x R24
R400 000 = R320 000 = R300 000
Rate R80 000 (u) Efficiency R20 000 (u) (2)
Actual cost Actual input @ std cost Actual output @ std cost
40 000 1 x R2 12 500 x R6
R72 000 = 80 000 = R75 000
Rate R8 000 (f) Efficiency R5 000 (u) (2)
1 actual input (labour hours) = actual cost = 400 000 = 40 000 hours
actual rate 10
28
R
Budgeted variable costs per (a) above 600 000
Add: Unfavourable total variable costs volume variance 150 000 2
Material
- price 130 000
- usage 15 000
Labour
- rate 80 000
- efficiency 20 000
Variable overhead efficiency 5 000
Actual variable costs [R(520 000 + 400 000 + 72 000)] 992 000
(4)
2 variable costs volume variance = (actual output – budgeted output) x VC p.u.
= (12 500 – 10 000) x 60
= R150 000
(This is unfavourable because your actual output cost R150 000 more than what
you budgeted it to cost.)
29
Crusty Limited manufactures a single product whilst utilizing a standard costing system. Any
stock of materials is valued at standard cost whilst completed goods are valued at standard
absorption cost.
The following sales and costs at standard was budgeted for the month that ended on 30
September 2014:
Units
Sales – Finished products 10 000
R
Prime cost per unit 250,00
- Materials 175,00
- Siv - 10kg @ R 5,00 per kg 50,00
- Lon - 5kg @ R25,00 per kg 125,00
- Labour - 5 hours @ R15,00 per hour 75,00
Variable overheads are allocated to production based on labour hours at a predetermined rate of
R24,00 per hour. The selling price of the single product as budgeted realizes a gross profit of
20% on the selling price and during the budgeted month the actual selling price per unit was 10%
higher than the original budgeted selling price.
The costs incurred and the relevant information for the month that ended on 30 September 2014
was as follows:
Units
Production and sales 9 500
Siv Lon
Kg R Kg R
- Opening stock - 1/9/2014 4 000 20 000 2 000 50 000
- Closing stock - 30/9/2014 3 000 - 1 500 -
- Purchased - 570 000 - 1 140 000
- Used in production – September 2014 96 000 - 48 000 -
There was no opening or closing stock of finished products at the beginning or end of the month.
The following variances as part of the system’s variances for the month were calculated at the
end of September 2014:
R
Materials purchase price 47 500 unfavourable
Materials mix Nil
Labour rate 46 000 unfavourable
Labour efficiency 22 500 favourable
Variable overhead efficiency 36 000 favourable
30
Required:
a) Compile a budgeted income statement for the month that ended on 30 September 2014.
( 7)
Materials yield ( 4)
Production overhead rate ( 2)
Sales price ( 3)
Sales volume (for profit reconciliation purposes). ( 4)
c) Determine the actual gross profit by reconciling the budgeted and actual gross profit for
September 2014. ( 8)
QUESTION 7
(a)
Material 175
Labour 75
Overhead (5 hours x R24 per hour) 120
370
Budgeted selling price p.u. = cost p.u. = 370 = R462.50 per unit
0.8 0.8
R
Budgeted Sales (10 000 x 462.50) 4 625 000
Less: Budgeted Cost of Sales 3 700 000
Material (10 000 x 175) 1 750 000
Labour (10 000 x 75) 750 000
Overhead (10 000 x 120) 1 200 000
(b)
MATERIALS YIELD VARIANCE
If the materials mix variance is nil, then the materials yield variance = materials usage
variance
Lon: 48 000 x 25 = R1 200 000 R12 500 (u) 9 500 x 125 = R1 187 500
R1 680 000 R17 500 (u) R1 662 500
32
(c)
R
Budgeted Profit 925 000
Less: Sales Volume Variance (u) 46 250
Standard Profit 878 750
Plus: Favourable other variances 497 875
Labour efficiency 22 500
Production overhead 36 000
efficiency
Sales price 439 375
Less: Unfavourable other variances 157 000
Materials purchase price 47 500
Materials usage 17 500
Labour rate 46 000
Production overhead rate 46 000
The budget for the two models for the year ending on 31 December 2014
is as follows:
Model
“Rustenburg” “Plettenburg”
R R
Production 50 units - 30 units -
Materials
Raw granite
Black 50 000 kg 500 000 - -
Green - - 30 000 kg 330 000
Saw blades 500 units 15 000 300 units 9 000
Labour 2 500 37 500 1 500 22 500
hours hours
Overhead:
Variable - 65 000 - 39 000
Fixed - 30 000 - 18 000
Saw blades are used to cut the raw granite. The standard consumption is
one saw blade per 100 kilograms of raw granite processed.
The finished goods, materials and other stock records reflected the
following for April 2014:
Quantity
01/04/2014 31/04/2014
Finished goods:
“Rustenburg” 4 units 3 units
“Plettenburg” 3 units 2 units
Raw granite:
Black 2 000 kg 3 000kg
Green 1 000 kg 1 500 kg
Saw blades 27 units 20 units
Work-in-progress Nil Nil
35
Model Total
“Rustenburg” “Plettenburg” R
Sales 6 units 4 units - -
Purchases
Black granite 6 100 kg - - 65 000
Green granite - 3 300 kg - 36 000
Saw blades - - 73 units 2 100
Labour hours worked 257 148 405 6 165
Overhead incurred:
Variable 9 000
Fixed 4 200
65% of the saw blades issued to production were used for the production
of “Rustenburg”, and the remaining 35% for Pletttenburg.
REQUIRED:
Granite:
Saw Blades:
Granite:
Saw Blades:
Black Granite
kg
Opening Stock 2 000
Add: Purchases 6 100
Less: Closing Stock (3 000)
Usage (actual input) 5 100
Rustenburg
units
Opening Stock 4
Add: Production (actual output) *5
Less: Closing Stock (3)
Sales 6
* Balancing figure
38
Green Granite
kg
Opening stock 1 000
Add purchases 3 300
Less: Closing Stock (1 500)
Usage (actual input) 2 800
Plettenburg
(units)
Opening stock 3
Add: Production (actual output) *3
Less: Closing Stock (2)
Sales 4
* Balancing figure
Saw Blades
(units)
Opening stock 27
Add: Purchases 73
Less: Closing Stock (20)
Usage (actual input) 80
P: 148 x 4 200 = 1 534,81 18 000 = 1 500 148 x 18 000 = 1 776 3 x 18 000 = 1 800
405 12 1 500 30
4 200,00 4 000 4 860 4 800
During a normal month, 400 computers are assembled. The standard ratio
of Educational to Gaming computers sold is 70% to 30% respectively.
REQUIRED :
(a)
SALES
(i)
(ii)
Actual sales @ std SP Mix Actual sales in units in std Quantity Budgeted Sales
Variance mix @ std SP Variance
R R R R R
Edu: 230 x 3500 = 805,000 371,000 (u) 0.7 x 480 x 3500 = 1,176,000 196,000 (f) 280 x 3500 = 980,000
Game: 250 x 5000 = 1,250,000 530,000 (f) 0.3 x 480 x 5000 = 720,000 120,000 (f) 120 x 5000 = 600,000
Total: 2,055,000 159,000 (f) 1,896,000 316,000 (f) 1,580,000
OR
Volume variance = mix variance + quantity variance = 159,000 (f) + 316,000 (f) = R475,000 (f)
43
(b)
R
Budgeted Sales 1,580,000
Add: Favourable sales volume variance 475,000
Less: Unfavourable selling price variance (125,000)
Actual sales 1,930,000
(c)
Actual cost Price Actual input @ std cost
Variance
R R R
Edu: 231 x 1250 = 288,750 11,550 (u) 231 x 1200 = 277,200
Game: 252 x 2100 = 529,200 25,200 (f) 252 x 2200 = 554,400
Total: 817,950 13,650 (f) 831,600
Actual input @ std cost Mix Variance Actual input in std ratio @ Yield Actual output @ std
std cost Variance cost
R R R R R
Edu: 231 x 1200 = 277,200 128,520 (f) 0.7 x 483 x 1200 = 405,720 129,720 (u) 230 x 1200 = 276,000
Game: 252 x 2200 = 554,400 235,620 (u) 0.3 x 483 x 2200 = 318,780 231,220 (f) 250 x 2200 = 550,000
Total: 831,600 107,100 (u) 724,500 101,500 (f) 826,000
OR
Usage variance = mix variance + yield variance = 107,100 (u) + 101,500 (f) = R5,600 (u)
44
(d)
Fixed overheads:
Budgeted cost Actual input @ std cost Actual output @ std cost
R R R
Edu: (280 x 960) = 268,800 4238 x 120 = 508,560 (230 x 960) = 220,800
Game: (120 x 1200) = 144,000 (250 x1200) = 300,000
Total: 412,800 520,800
RELEVANT COSTING
KEY TERM
A relevant cost is a future cash flow arising as a direct consequence of a decision.
a) A decision is about the future; it cannot alter what has been done already. A cost that has been
incurred in the past is totally irrelevant to any decision that is being made ‘now’.
b) Costs that have been incurred include not only costs that have already been paid, but also costs
that are the subject of legally binding contracts, even if payments due under the contract have
not yet been made. (These are known as committed costs.)
Costs or charges which do not reflect additional cash spending should be ignored for the purpose of decision
making. These include the following:
c) All overheads absorbed. Fixed overhead absorption is always irrelevant since it is overheads to
be incurred with affect decisions.
A relevant cost is one which arises as a direct consequence of a decision. Thus, only costs which will differ
under some or all of the available opportunities should be considered; relevant costs are therefore sometimes
referred to as incremental costs.
2
KEY TERM
Avoidable costs are costs which would not be incurred if the activity to which they relate did not exist.
One of the situations in which it is necessary to identify the avoidable costs is in deciding whether or not to
discontinue a product. The only costs which would be saved are the avoidable costs, which are usually the
variable costs and sometimes some specific fixed costs. Costs which would be incurred whether or not the
product is discontinued are known as unavoidable costs.
KEY TERM
Opportunity cost is the benefit which could have been earned, but which has been given up, by choosing one
option instead of another.
Suppose for example that there are three mutually exclusive options, A, B and C. The net profit from each
would be R80, R100 and R70 respectively. Since only one option can be selected option B would be chosen
because it offers the biggest benefit.
R
Profit from option B 100
Less opportunity cost (i.e. the benefit from the most profitable alternative, A) 80
Differential benefit of option B 20
The decision to choose option B would not be taken simply because it offers a profit of R100, but because it
offers a differential profit of R20 in excess of the next best alternative.
Non-relevant costs
A number of terms are used to describe costs that are irrelevant for decision making because they are either
not future cash flows or they are costs which will be incurred anyway, regardless of the decision that is taken.
KEY TERM
A sunk cost is a cost which has already been incurred and hence should not be taken account of in decision
making.
An example of this type of cost is depreciation. If the fixed asset has been purchased, depreciation may be
charged for several years but the cost is a sunk cost, about which nothing can now be done.
KEY TERM
A committed cost is a future cash outflow that will be incurred anyway, whatever decision is taken now about
alternative opportunities.
Committed costs may exist because of contracts already entered into by the organisation, which it cannot get
out of.
KEY TERM
A notional cost or imputed cost is a hypothetical accounting cost to reflect the use of a benefit for which no
actual cash expense is incurred.
3
Example as in cost accounting systems include notional rent (such as that charged to a subsidiary of an
organisation for the use of accommodation which the organisation owns) or notional interest charges on
capital employed (sometimes made against a profit centre or cost centre).
Although historical costs are irrelevant for decision making, historical cost data will often provide the best
available basis for predicting future costs.
Unless you are given an indication to the contrary, you should assume the following:
This need not be the case, however, and you would analyse variable and fixed cost data carefully. Do not
forget that ‘fixed’ costs may only be fixed in the short term.
There might, however, be occasions when a variable cost is in fact a sunk cost. For example, suppose that a
company has some units of raw material in stock. They have been paid for already, and originally cost R2,000.
they are now obsolete and are no longer used in a special job which the company is trying to decide whether to
undertake. The special job is a ‘one-off’ customer order, and would use up all these materials in stock.
In deciding whether the job should be undertaken, the relevant cost of the materials to the special job is nil.
Their original cost of R2,000 is a sunk cost, and should be ignored in the decision.
However, if the materials did have a scrap value of, say, R300, then their relevant cost to the job would be the
opportunity cost of being unable to sell them for scrap, i.e. R300.
a) Directly attributable fixed costs are those costs which, although fixed within a relevant range of
activity level, or regarded as fixed because management has set a budgeted expenditure level (for
example advertising costs are often treated as fixed), would, in fact, do one of two things.
b) General fixed overheads are those fixed overheads which will be unaffected by decisions to
increase or decrease the scale of operations. An apportioned share of head office charges is
an example.
You should appreciate that whereas directly attributable fixed costs will be relevant to a decision I hand,
general fixed overheads will not be.
A company has been making a machine to order for a customer, but the customer has since gone into
liquidation, and there is no prospect that any money will be obtained from the winding up of the company.
Costs incurred to date in manufacturing the machine are R50 000 and progress payments of R15 000 had been
received from the customer prior to the liquidation. The sales department has found another company willing to
buy the machine for R34 000 once it has been completed. To complete the work, the following costs would be
incurred.
4
a) Materials: these have been bought at a cast of R6 000. They have no other use, and if the machine is
not finished, they would be sold for scrap for R2 000.
b) Further labour costs would be R8 000. Labour is in short supply, and if the machine is not finished, the
work force would be switched to another job, which would earn R30 000 in revenue, and incur direct
costs of R12 000 and absorbed (fixed) overhead of R8 000.
c) Consultancy fees R4 000. If the work is not completed, the consultant’s contract would be cancelled at
a cost of R1 500.
d) General overheads of R8 000 would be added to the cost of the additional work.
REQUIRED:
SOLUTION
a) Costs incurred in the past, or revenue received in the past are not relevant because they
cannot affect a decision about what is best for the future. Costs incurred to date of R50 000 and
revenue received of R15 000 should therefore be ignored.
b) Similarly, the price paid in the past for the materials is irrelevant. The only relevant cost of
materials affecting the decision is the opportunity cost of the revenue from scrap which would be
forgone – R2 000.
c)
R
Labour costs required to complete work 8 000
Opportunity costs: contribution forgone by losing other work
R(30 000 – 12 000) 18 000
Relevant cost of labour 26 000
d) The incremental cost of consultancy from completing the work is the difference between the cost
of completing the work and the cost of canceling the contract (R(4 000 – 1 500) = R2 500).
e) Absorbed overhead is a notional accounting cost and should be ignored. Actual overhead
incurred is the only overhead cost to consider. General overhead costs (and the absorbed
overhead of the alternative work for the labour force) should be ignored.
5
Identifying relevant costs
The relevant cost of raw materials is generally their current replacement cost unless the materials have
already purchased but will not be replaced. The relevant cost of using them will then be the higher of the
following:
If the materials have no resale value and no other possible use, then the relevant cost of using them for the
opportunity under consideration would be nil.
The flowchart below shows how the relevant costs of materials can be identified, provided that the materials
are not in short supply and so have no internal opportunity cost.
Yes No
Yes No
You should test your knowledge of the relevant cost of materials by attempting the following question.
6
QUESTION 1
Darwin Ltd has been approached by a customer who would like a special job to be done for him, and who is
willing to pay R22 000 for it. The job would require the following materials:
Material B is used regularly by Darwin Ltd, and if units of B are required for this job, they would need to be
replaced to meet other production demand.
Materials C and D are in stock as the result of previous over buying, and they have a restricted use. No other
use could be found for material C, but the units of material D could be used in another job as substitute for 300
units of material E, which currently costs R5 per unit (and of which the company has no units in stock at the
moment).
REQUIRED:
Calculate the relevant costs of material for deciding whether or not to accept the contract.
ANSWER
a) Material A is not yet owned. It would have to be bought in full at the replacement cost of R6 per unit.
b) Material B is used regularly by the company. There are existing stocks (600 units) but if these are
used on the contract under review a further 600 units would be bought to replace them. Relevant costs
are therefore 1 000 units at the replacement cost of R5 per unit.
c) 1 000 units of material C are needed and 700 are already in stock. If used for the contract, a further
300 units must be bought at R4 each. The existing stocks of 700 will not be replaced. If they are used
for the contract, they could not be sold at R2,50 each. The realisable value of these 700 units is an
opportunity cost of sales revenue forgone.
d) The required units of material D are already in stock and will not be replaced. There is an opportunity
cost of using D in the contract because there are alternative opportunities either to sell the existing
stocks for R6 per unit (R1 200 in total) or avoid other purchases (of material E), which would cost 300 x
R5 = R1 500. Since substitution for E is more beneficial, R1 500 is the opportunity cost.
7
The relevant cost of using machines
Once a machine has been bought its cost is a sunk cost. Depreciation is not a relevant cost, because it is not
a cash flow. However, using machinery may involve some incremental costs. These costs might be referred
to as user costs and they include hire charges and any fall in resale value of owned assets, through use.
Sydney Ltd is considering whether to undertake some contract work for a customer. The machinery required
for the contract would be as follows:
a) A special cutting machine will have to be hired for three months for the work (the length of the
contract). Hire charges for this machine are R75 per month, with a minimum hire charge of R300.
b) All other machinery required in the production for the contract has already been purchased by the
organisation on hire purchase terms. The monthly hire purchase payments for this machinery are
R500. This consists of R450 for capital repayment and R50 as an interest charge. The last hire
purchase payment is to be made in two months’ time. The cash price of this machinery was R9
000 two years ago. It is being depreciated on a straight line basis at the rate of R200 per month.
However, it still has a useful life which will enable it to be operated for another 36 months.
The machinery is highly specialized and is unlikely to be required for other, more profitable jobs
over the period during which the contract work would be carried out. Although there is no
immediate market for selling this machine, it is expected that a customer might be found in the
future. It is further estimated that the machine would lose R200 in its eventual sale value if it is
used for the contract work.
REQUIRED:
SOLUTION
a) The cutting machine will incur an incremental cost of R300, the minimum hire charge.
b) The historical cost of the other machinery is irrelevant as a past cost; depreciation is irrelevant as a
non-cash cost; and future hire purchase repayments are irrelevant because they are committed
costs. The only relevant cost is the loss of resale value of the machinery, estimated at R200
through use. This user cost will not arise until the machinery is eventually resold and the R200
should be discounted to allow for the time value of money. However, discounting is ignored here.
8
QUESTION 2
A machine which originally cost R12 000 has an estimated life of ten years and is depreciated at the rate of R1
200 a year. It has been unused for some time, however, as expected production orders did not materialize.
A special order has now been received which would require the use of the machine for two months.
The current net realisable value of the machine is R8 000. If it is used for the job, its value is expected to fall to
R7 500. The net book value of the machine is R8 400.
Routine maintenance of the machine currently costs R40 a month. With use, the cost of maintenance and
repairs would increase to R60 a month.
REQUIRED:
Calculate the relevant cost of using the machine for the order.
SOLUTION
R
Loss in net realisable value of the machine
through using it on the order R(8 000 – 7 500) 500
Costs in excess of existing routine maintenance costs R(120 – 80) 40
Total marginal user cost 540
Often the labour force will be paid irrespective of the decision made and the costs are therefore not
incremental. Take care, however, if the labour force could be put to an alternative use, in which case the
relevant costs are the variable costs of the labour and associated variable overheads plus the contribution
forgone from not being able to put it to its alternative use.
Some of the assumptions that are typically made in relevant costing are as follows:
a) Cost behaviour patterns are known; if a department closes down, for example the attributable
fixed cost savings would be known.
b) The amount of fixed costs, unit variable costs, sales price and sales demand are known with
certainty.
9
c) The objective of decision making in the short run is to maximize ‘satisfaction’, which is often
regarded as ‘short-term profit’.
KEY TERM
A key factor or limiting factor is a scarce resource which limits the activity of an organisation.
There might be just one limiting factor (other than maximum sales demand) but there might also be several
scarce resources, with two or more of them putting an effective limit on the level of activity that can be
achieved. We shall concentrate on single limiting factor problems and a technique for resolving these.
A limiting factor could be sales if there is a limit to sales demand but any one of the organisation’s resources
(labour, materials, manufacturing capacity, financial resources and so on) may be insufficient to meet the level
of production demanded.
a) If sales demand is the factor which restricts greater production output, profit will be maximized by
making exactly the amount required for sales (and no more) provided that each product sold
earns a positive contribution.
b) If labour supply, materials availability, machine capacity or cash availability limits production to
less than the volume which could be sold, management is faced with the problem of deciding what to
produce and what should not be produced because there are insufficient resources to make
everything.
It is assumed in limiting factor accounting that management wishes to maximize profit and that profit
will be maximized when contribution is maximized (given no change in fixed cost expenditure incurred). In
other words, marginal costing ideas are applied.
Contribution will be maximizes by earning the biggest possible contribution per unit of limiting factor.
Thus if grade A labour is the limiting factor, contribution will be maximized by earning the biggest contribution
per hour of grade A labour worked.
The limiting factor decision therefore involves the determination of the contribution earned by each
different product per unit of limiting factor. In limiting factor decisions, we generally assume that fixed
costs are the same whatever production mix is selected, so that the only relevant costs are variable
costs.
10
EXAMPLE 3 : LIMITING FACTOR
D Ltd makes two products, the B and the S. Unit variable costs are as follows:
B S
R R
Direct materials 1 3
Direct labour (R3 per hour) 6 3
Variable overhead 1 1
8 7
The sales price per unit is R14 per B and R11 per S. During July the available direct labour is limited to 8 000
hours. Sales demand in July is expected to be 3 000 units for B and 5 000 units for S.
REQUIRED:
Determine the profit-maximising production levels, assuming that monthly fixed costs are
R20 000 and that opening stocks of finished goods and work in progress are nil.
SOLUTION
Step 1. Confirm the limiting factor is something other than sales demand.
B S Total
Labour hours per unit 2 hrs 1 hr
Sales demand 3 000 units 5 000 units
Labour hours needed 6 000 hrs 5 000 hrs 11 000 hrs
Labour hours available 8 000 hrs
Shortfall 3 000 hrs
Step 2. Identify the contribution earned by each product per unit of scarce resource, that is per labour
hour worked.
B S
R’s R’s
Sales price 14 11
Variable cost 8 7
Unit contribution 6 4
Labour hours per unit 2 hrs 1 hrs
Contribution per labour hour (= unit of limiting factor) R3 R4
Although Bs have a higher unit contribution than Ss, two Ss can be made in the time it takes to make one B.
Because labour is in short supply it is more profitable to make Ss than Bs.
Step 3. Work out the budgeted production and sales. Sufficient Ss will be made to meet the full sales
demand, and the remaining labour hours available will then be used to make Bs.
a)
Product Demand Hours Hours Priority of
Required available manufacture
S 5 000 5 000 5 000 1st
B 3 000 6 000 3 000 (bal) 2nd
11 000 8 000
11
b)
Product Units Hours Contribution Total
Needed per unit R
R
S 5 000 5 000 4 20 000
B 1 500 3 000 6 9 000
8 000 29 000
20 000
9 000
Note that it is not more profitable to begin by making as many units as possible of the product with the bigger
unit contribution. We could make 3 000 units of B in 6 000 hours and 2 000 units of S in the remaining 2 000
hours but profit would be only R6 000. Unit contribution is not the correct way to decide priorities, because it
takes two hours to earn R6 from a B and one hour to earn R4 from a S. Ss make more profitable use of the
scarce resource, labour hours.
QUESTION 3
Twickers Ltd makes two products, widgets and splodgets, for which there is unlimited demand at the budgeted
selling prices. A widget takes three hours to make, and has a variable cost of R18 and a selling price of R30.
A splodget takes two hours to make, and has a variable cost of R10 and a selling price of R20. Both products
use the same type of labour, which is in short supply.
REQUIRED:
Determine the product which should be made to maximize profits, and describe the other considerations which
might alter your decision.
SOLUTION
We must rank the products in order of contribution earning capability per labour hour.
Although widgets have the higher unit contribution, splodgets are more profitable because they make a greater
contribution per labour hour. Three splodgets (worth 3 x R10 = R30) can be made in the same time as two
widgets (worth only 2 x R12 = R24).
12
A profit-maximising decision would, therefore, be to produce splodgets only, given the assumptions made. It is
important to remember, however, that other considerations, so far excluded from the problem might alter the
decision.
a) Can the selling price of either product be raised, thereby increasing unit contribution, and the
contribution per labour hour, and also reducing demand? Since demand is apparently unlimited, it
would be reasonable to suspect that both products are underpriced.
b) Would a decision to make and sell only splodgets have a harmful effect on customer loyalty and
demand? To what extent are sales of each product interdependent? For example, a manufacturer of
knives and forks could not expect to cease production of knives without affecting demand for forks.
c) Would a decision to cease production of widgets have no effect on fixed costs? The assumption that
fixed costs are unaffected by limiting factor decisions is not always valid, and closure of either the
widgets or the splodgets production line might result in fixed cost savings. These savings would need
to be considered when making the product mix decision.
d) Will the decision affect the long-term plans of the company as well as the short term? If widgets are not
produced, it is likely that competitors will take over the markets vacated by Twickers Ltd. Labour skilled
in the manufacture of widgets will be lost, and a decision at a later date to re-open manufacture of
widgets might not be possible.
In certain circumstances an organization faced with a limiting factor on production and sales might not be able
to produce the profit-maximising product mix because the mix and/or volume of products that can be
produced and sold is also restricted by a factor other than a scarce resource.
a) The organization might have contracted to supply a certain number of products to a customer.
b) The organization might have to produce and sell a minimum quantity of one or more of its products to
provide a complete product range and/or to maintain customer goodwill.
c) The organization might need to maintain a certain market share of one or more of its products.
In each of these cases, the organization might have to produce more of a particular product or products
than the level established by ranking according to contribution per unit of li8miting factor.
The basic approach to dealing with such situations is to rank the products in the normal way but the
optimum production plan must take into account the minimum production requirements. The
remaining resource must then be allocated according to the ranking.
Work carefully through the following example which illustrates this approach.
13
EXAMPLE 4 : RESTRICTED FREEDOM OF ACTION
Harvey Ltd is currently preparing its budget for the year ending 30 September 20X2. The company
manufactures and sells three products, Beta, Delta and Gamma.
The unit selling price and cost structure of each product is budgeted as follows:
Variable costs:
Labour 24 48 6
Materials 26 7 8
Overhead 10 5 6
60 60 20
Direct labour rate is budgeted at R6 per hour, and fixed costs at R1 300 000 per annum. The company has a
maximum production capacity of 228 000 direct labour hours.
A meeting of the board of directors has been convened to discuss the budget and to resolve the problem as to
the quantity of each product which should be made and sold. The sales director presented the results of a
recent market survey which reveals that market demand for the company’s products will be as follows:
Product Units
Beta 24 000
Delta 12 000
Gamma 60 000
The production director proposes that since Gamma only contributes R12 per unit, the product should no longer
be produced, and the surplus capacity transferred to produce additional quantities of Beta and Delta. The sales
director does not agree with the proposal. Gamma is considered necessary to complement the product range
and to maintain customer goodwill. If Gamma is not offered, the sales director believes that sales of Beta and
Delta will be seriously affected. After further discussion the board decided that a minimum of 10 000 units of
each product should be produced. The remaining production capacity would then be allocated so as to achieve
the maximum profit possible.
REQUIRED
Prepare a budget statement which clearly shows the maximum profit which could be achieved in the year
ending 30 September 20X2.
14
SOLUTION
Since only 228 000 hours are available we need to establish which product earns the greatest contribution per
labour hour.
The optimum production plan must take into account the requirement that 10 000 units of each product are
produced, and then allocate the remaining hours according to the above ranking.
Hours
Beta 10 000 units x 4 hours 40 000
Delta 10 000 units x 8 hours 80 000
Gamma 10 000 units x 1 hour 10 000
130 000
Gamma 50 000 units x 1 hour (full demand) 50 000
Beta 12 000 units x 4 hours (balance) 48 000
228 000
15
Step 4. Draw up a budget.
BUDGET STATEMENT
R
Contribution
Beta (22 000 units x R40) 880 000
Delta (10 000 units x R64) 640 000
Gamma (60 000 units x R12) 720 000
2 240 000
Fixed costs 1 300 000
Profit 940 000
16
QUESTION 4
Jam Ltd makes two products, the K and the L. The K sells for R50 per unit, the L for R70 per unit. The variable
cost per unit of the K is R35 that of the L R40. Each unit of K uses 2 kgs of raw material. Each unit of L uses 3
kgs of material.
In the forthcoming period the availability of raw material is limited to 2 000 kgs. Jam Ltd is contracted to supply
500 units of K. Maximum demand for the L is 250 units. Demand for the K is unlimited.
SOLUTION
K L
Contribution p0er unit R15 R30
Contribution per unit of limiting factor R15/2 = R7,50 R30/3 = R10
Ranking 2 1
Whenever there are limiting factors, there will be opportunity costs. For example, suppose that a company
manufactures two items X and Y, which earn a contribution of R24 and R18 per unit respectively. Product X
requires 4 machine hours per unit, and product Y 2 hours. Only 5 000 machine hours are available, and
potential sales demand is for 1 000 units each of X and Y.
Machine hours would be a limiting factor, and with X earning R6 per hour and Y earning R9 per hour, the profit-
maximising decision would be as follows:
Priority is given to Y because the opportunity cost of making Y instead of more units of X is R6 per hour (X’s
contribution per machine hour), and since Y earns R9 per hour, the incremental benefit of making Y instead of
X would be R3 per hour.
17
If extra machine hours could be made available, more units of X (up to 1 000) would be made, and an extra
contribution of R6 per hour could be earned. Similarly, if fewer machine hours were available, the decision
would be to make fewer units of X and to keep production of Y at 1 000 units, and so the loss of machine hours
would cost the company R6 per hour in lost contribution. This R6 per hour, the marginal contribution-earning
potential of the limiting factor at the profit-maximising output level, is referred to as the shadow price (or
dual price) of the limting factor.
KEY TERM
A shadow price is the increase in value obtainable from having available one additional unit of a limiting
resource at the original cost.
Note that the shadow price only applies while the extra unit of resource can be obtained at its normal variable
cost. The shadow price also indicates the amount by which contribution could fall if an organization is deprived
of one unit of the resource.
The shadow price of a resource is its internal opportunity cost. This is the marginal contribution towards
fixed costs and profit that can be earned for each unit of the limiing factor that is available. A knowledge of the
shadow price of a resource will help managers to decide how much it is worth paying to acquire another unit of
the resource.
Limiting factor analysis provides us with a profit-maximising product mix, within the assumptions made. It is
important to remember, however, that other considerations might entirely alter the decision reached.
Qualitative factors
Factor Examples
Demand Will the decision reached (perhaps to make and sell just one product rather than
two) have a harmful effect on customer loyalty and sales demand? For example,
a manufacturer of knives and forks could not expect to cease production of knives
without affecting sales demand for the forks.
Long-term Is the decision going to affect the long-term as well as the short-term plans of the
effects organization? If a particular product is not produced, or produced at a level below
sales demand, is it likely that competitors will take over vacated markets? Labour
skilled in the manufacture of the product may be lost and a decision to reopen or
expand production of the product in the future may not be possible.
Labour If labour is a limting factor, is it because the skills required are difficult to obtain,
perhaps because the organization is using very old-fashioned production
methods, or is the organization a high-tech newcomer in a low-tech area? Or
perhaps the conditions of work are so unappealing the people simply do not want
to work for the organization.
Other The same sort of questions should be asked whatever the limiting factor. If
limiting machine hours are in short supply is this because more machines are needed, or
factors newer, more reliable and efficient machines? If materials are in short supply,
what are competitors doing? Have they found an equivalent or better substitute?
Is it time to redesign the product?
18
Assumptions in limiting factor analysis
In the examples we have been looking at, certain assumptions have been made. If any of the assumptions are
not valid, then the profit-maximising decision might be different. These assumptions are as follows:
a) Fixed costs will be the same regardless of the decision that is taken, and so the profit-maximising and
contribution-maximising output level will be the same.
This will not necessarily be true, since some fixed costs might be directly attributable to a product or
service. A decision to reduce or cease altogether activity on a product or service might therefore result
in some fixed cost savings, which would have to be taken into account.
b) The unit variable cost is constant, regardless of the output quantity of a product or service. This
implies the following:
i) The price of resources will be unchanged regardless of quantity; for example, there will be no
bulk purchase discount of raw materials.
ii) Efficiency and productivity levels will be unchanged; regardless of output quantity the direct
labour productivity, the machine time per unit, and the materials consumption per unit will
remain the same.
c) The estimates of sales demand for each product, and the resources required to make each product,
are known with certainty.
In Example 3 – page 10, there were estimates of the maximum sales demand for the two products, and
these estimates were used to establish the profit-maximisng product mix. Suppose the estimates were
wrong? The product mix finally chosen would then either mean that some sales demand of the most
profitable item would be unsatisfied, or that production would exceed sales demand, leaving some
stock unsold. Clearly, once a profit-maximising output decision is reached, management will have to
keep their decision under continual review, and adjust their decision as appropriate in the light of actual
results.
d) Units of output are divisable, and a profit-maximising solution might include fractions of units as the
optimum output level.
Where fractional answers are not realistic, some rounding of the figures will be necessary.
The ‘make’ option should give management more direct control over the work, but the ‘buy’ option often
has the benefit that the external organization has a specialist skill and expertise in the work. Make or buy
decisions should certainly not be based exclusively on cost considerations.
If an organization has the freedom of choice about whether to make internally or buy externally and has no
scarce resources that put a restriction on what it can do itself, the relevant costs for the decision will be the
differential costs between the two options.
19
EXAMPLE 5 : MAKE OR BUY
Shellfish Ltd makes four components, W, X, Y and Z, for which costs in the forthcoming year are expected to be
as follows:
W X Y Z
Production (units) 1 000 2 000 4 000 3 000
Unit marginal costs R R R R
Direct materials 4 5 2 4
Direct labour 8 9 4 6
Variable production overheads 2 3 1 2
14 17 7 12
Directly attributable fixed costs per annum and committed fixed costs are as follows:
R
Incurred as a direct consequence of making W 1 000
Incurred as a direct consequence of making X 5 000
Incurred as a direct consequence of making Y 6 000
Incurred as a direct consequence of making Z 8 000
Other fixed costs (committed) 30 000
50 000
A subcontractor can supply units of W, X, Y and Z for R12, R21, R10 and R14 respectively.
REQUIRED:
The relevant costs are the differential costs between making and buying, and they consist of differences
in unit variable costs plus differences in directly attributable fixed costs. Subcontracting will result in
some fixed cost savings.
W X Y Z
R’s R’s R’s R’s
Unit variable cost of making 14 17 7 12
Unit variable cost of buying 12 21 10 14
R(2) R4 R3 R2
Extra variable cost of buying (per annum) (2 000) 8 000 12 000 6 000
Fixed costs saved by buying 1 000 5 000 6 000 8 000
Extra total cost of buying (3 000) 3 000 6 000 (2 000)
The company would save R3 000 pa by subcontracting component W (where the purchase cost would be less
than the marginal cost per unit to make internally) and would save R2 000 pa by subcontracting component Z
(because of the saving in fixed costs of R8 000).
20
Important further considerations would be as follows:
a) If components W and Z are subcontracted, the company will have spare capacity. How should that
spare capacity be profitably used? Are there hidden benefits to be obtained from subcontracting?
Would the company’s workforce resent the loss of work to an outside subcontractor, and might such a
decision cause an industrial dispute?
b) Would the subcontractor be reliable and delivery times, and would he supply components of the
same quality as those manufactured internally?
c) Does the company wish to be flexible and maintain better control over operations by making
everything itself?
d) Are the estimates of fixed cost saving reliable? In the case of Product W, buying is clearly cheaper
than making in-house. In the case of production Z, the decision to buy rather than make would only be
financially beneficial if the fixed cost savings of R8 000 could really be ‘delivered’ by management.
A company might want to do more things than it has the resources for, and so its alternatives would be as
follows:
a) Make the best use of the available resources and ignore the opportunities to by help from outside.
b) Combine internal resources with buying externally so as to do more and increase profitability.
Buying help from outside is justifiable if it adds to profits. A further decision is then required on how to split the
work between internal and external effort. What parts of the work should be given to suppliers or sub-
contractors so as to maximize profitability?
In a situation where a company must sub-contact work to make up a shortfall in its own in-house
capabilities, its total costs will be minimized if those units bought have the lowest extra variable cost of
buying per unit of scarce resource saved.
Seaman Ltd manufactures three components, S, A and T using the same machines for each. The budget for
the next year calls for the production and assembly of 4 000 of each component. The variable production cost
per unit of the final product is as follows:
Machine Variable
hours cost
R
1 unit of S 3 20
1 unit of A 2 36
1 unit of T 4 24
Assembly 20
100
Only 24 000 hours of machine time will be available during the year, and a sub-contractor has quoted the
following unit prices for supplying components: S R29; A R40; T R34.
21
REQUIRED:
SOLUTION
The company’s budget calls for 36 000 hours of machine time, if all the components are to be produced in-
house. Only 24 000 hours are available, and so there is a shortfall of 12 000 hours of machine time, which is
therefore a limiting factor. The shortage can be overcome by subcontracting the equivalent of 12 000 machine
hours’ output to the subcontractor.
The assembly costs are not relevant costs because they are unaffected by the decision.
The decision rule is to minimize the extra variable costs of sub-contracting per unit of scarce resource
saved (that is, per machine hour saved).
S A T
R R R
Variable cost of making 20 36 24
Variable cost of buying 29 40 34
Extra variable cost of buying 9 4 10
Machine hours saved by buying 3 hrs 2 hrs 4 hrs
Extra variable cost of buying per hour saved R3 R23 R2.50
This analysis shows that it is cheaper to buy A than to buy T and it is most expensive to buy S. The
priority for making the components in-house will be in the reverse order; S, then T, then A. There are
enough machine hours to make all 4 000 units of S (12 000 hours) and to produce 3 000 units of T (another 12
000 hours). 12 000 hours’ production of T and A must be sub-contracted.
22
QUESTION 5
TW Ltd manufactures two products, the D and the E, using the same material for each. Annual demand for the
D is 9 000 units, while for the E is 12 000 units.
The variable production cost per unit of the D is R10, that of the E R15. The D requires 3.5 kgs of raw material
per unit, the E requires 8 kgs of raw material per unit.
Supply of raw material will be limited to 87 500 kgs during the year.
A sub contractor has quoted prices of R17 per unit for the D and R25 per unit for the E to supply the product.
How many of each product should TW Ltd manufacture in order to maximize profits?
SOLUTION
D E
R per unit R per unit
Variable cost of making 10 15
Variable cost of buying 17 25
Extra variable cost of buying 7 10
Raw material saved by buying 3.5 kgs 8 kgs
Extra variable cost of buying per kg saved R2 R1.25
Priority for internal manufacture 1 2
SHUTDOWN PROBLEMS
Shutdown problems involve the following type of decisions:
a) Whether or not to close down a factory, department, product line or other activity, either because it is
making losses or because it is too expensive to run.
b) If the decision is to shut down, whether the closure should be permanent or temporary.
Although in practice shutdown decisions will involve longer-term considerations (such as savings in annual
operating costs for a number of years), and capital expenditures and revenues (sales of fixed assets and
redundancy payments), it is possible for shutdown problems to be simplified into short-run decisions, by
assuming that either fixed asset sales and redundancy costs would be negligible or that income from fixed
asset sales would match redundancy costs and so these capital items would be self-cancelling. In such
circumstances the financial aspect of shutdown decisions would be based on short-run relevant costs.
23
EXAMPLE 7 : ADDING OR DELETING PRODUCTS
A company manufactures three products, Pawns, Rooks and Bishops. The present net annual income from
these is as follows:
The company is concerned about its poor profit performance, and is considering whether or not to cease selling
Rooks. It is felt that selling prices cannot be raised or lowered without adversely affecting net income. R5 000
of the fixed costs of Rooks are direct fixed costs which would be saved if production ceased. All other fixed
costs, it is considered, would remain the same.
By stopping production of Rooks, the consequences would be a R10 000 fall in profits.
R
Loss of contribution (15 000)
Savings in fixed costs 5 000
Incremental loss (10 000)
Suppose, however, it were possible to use the resources realized by stopping production of Rooks and switch
to producing a new item, Crowners, which would sell for R50 000 and incur variable costs of R30 000 and
extra direct fixed costs of R6 000. A new decision is now required.
Rooks Crowners
R R
Sales 40 000 50 000
Less variable costs 25 000 30 000
15 000 20 000
Less direct fixed costs 5 000 6 000
Contribution to shared fixed costs and profit 10 000 14 000
It would be more profitable to shut down production of Rooks and switch resources to making Crowners, in
order to boost profits by R4 000 to R9 000.
Relative profitability
The relative profitability of products can be judged by calculation of their contribution to sales (C/S) ratios.
Suppose an organization produces three products A, B and C, and that production capacity is limited. If
product A has a C/S ratio of 22%, production B a C/S ratio of 27% and product C a C/S ratio of 25%, given
unlimited demand for the three products the organization should concentrate on producing product B.
Temporary closure
The decision whether to shut down temporarily should take into account the following factors:
The impact on the organisation’s other products and the product in question
Problems of recruitment of skilled labour when production begins again
Possibility of plant obsolescence
Problems of closing down and restarting production in some industries
Expenditure on disconnection of services, start up costs and so on
24
If contribution is only just covering fixed costs but improved trading conditions in the future seem likely it
may be worth continuing the business.
a) A product may be retained if it is providing a contribution, albeit a small one. Retaining a wide range of
low volume/low contribution products would add to the complexity and hence costs of
manufacture, however, but very little to overall profit. Low volume/low contribution products should
therefore be examined on a regular basis.
b) The effect on demand for other products if a particular product is no longer produced should be
taken into account.
c) The extent to which demand for other products (existing or new) can expand to use the capacity
vacated by the product being deleted is an issue.
d) Pricing policy. Is the product a loss leader? Is the product in the introductory stage of its life cycle
and consequently priced low to help it to become accepted and hence maximize its long-term market
share (penetration pricing).
If an organization does decide to shut down a factory, department, product line or other activity, it may well
be faced with a decision about what to do with the resulting idle production capacity.
b) Idle plant and machinery could be moved to another department or factory, thereby reducing
expenditure on new plant and machinery and/or interest charges.
c) Special orders could be accepted, providing that the contribution generated is either greater than any
reduction in fixed overheads which would occur if the idle capacity was not used or greater than any
increase in fixed overheads if the idle capacity were to be used.
a) Would the work force be willing to work the shift hours, and if so, what overtime or shift work
premium over their basic pay might they expect to receive?
b) Do extra hours have to be worked just to remain competitive? Banks might decide to open on
Saturdays just to match what competitors are doing and so keep customers.
25
c) Would extra hours result in more sales revenue, or would there merely be a change in the demand
pattern. For example, if a shop were trying to decide whether to open on Sundays, one consideration
would be whether the customers it would get on Sunday would simply be customers who would
otherwise have done their shopping on another day of the week instead, or whether they would be
additional customers.
When a business expands, the management is often faced with the problems of whether to acquire larger
premises and more plant and machinery and whether to persuade existing personnel to work longer hours
(on an overtime basis) or to engage extra staff who would use the existing equipment but a different time
(on a shift basis).
If the management decide to incur additional expenditure on premises and plant, that expenditure is a
fixed cost. It will therefore be necessary to determine how much additional contribution will be required
from the anticipated increased production to cover the extra fixed cost.
If it is decided to use the existing fixed assets, but for a longer period each day, the choice of shift working
or overtime will also involve a marginal costing consideration.
a) If overtime is selected, the direct wages cost per unit produced will be increased because the
wages paid to workers on overtime are a basic rate plus an overtime bonus.
b) If the management opt for shift working the shift premium may not be as expensive as the overtime
premium so the direct wages cost may be relatively lower. On the other hand, there may be an
increase in fixed (or semi-fixed) costs such as lighting, heating and canteen facilities.
If an organization has spare capacity (which means that it would not have to turn away existing business), a
‘special’ (one-off) order (which is normally (in the exam) at a price below the normal price of the product),
should be accepted if the price offered makes some contribution to fixed costs and profit. In other words,
the variable cost of the order needs to be less than the price offered. Fixed costs are irrelevant to such a
decision since they will be incurred regardless of whether or not the order is accepted. Additional fixed costs
incurred as a result of accepting the order must be taken into account, however.
If an organization does not have sufficient spare capacity, existing business should only be turned away
if the contribution from the order is greater than the contribution from the business which must be
sacrificed.
26
EXAMPLE 8 : ACCEPTING OR REJECTING ORDERS
Holdup Ltd makes a single product which sells for R20, and for which there is great demand. It has variable
cost of R12, made up as follows:
R
Direct material 4
Direct labour (2 hrs) 5
Variable overhead 2
12
The labour force is currently working at full capacity producing a product that earns a contribution of R4 per
labour hour. A customer has approached the company with a request for the manufacture of a special order for
which he is willing to pay R5 500. The costs of the order would be R2 000 for direct materials, and 500 labour
hours will be required.
REQUIRED:
SOLUTION
a) Labour is a limiting factor. By accepting the order, work would have to be diverted away from the
standard product, and contribution will be lost, that is, there is an opportunity cost of accepting the new
order, which is the contribution forgone by being unable to make the standard product.
b) Direct labour pay costs R3 per hour, but it is also usually assumed that variable production overhead
varies with hours worked, and must therefore be spent in addition to the wages cost of the 500 hours.
c)
R R
Value of order 5 500
Cost of order
Direct materials 2 000
Direct labour (500 hrs x R3) 1 500
Variable overhead (500 hrs x R1) 500
Opportunity cost (500 hrs x R4) (Contribution forgone) 2 000
Relevant cost of the order 6 000
Loss incurred by accepting the order (500)
Although accepting the order would earn a contribution of R1 500 (R5 500 – R4 000), the lost production of the
standard product would reduce contribution earned elsewhere by R2 000 and so the order should not be
accepted.
a) Will relationships with existing customers, or prices that can be commanded in the market, be
affected if the order is accepted?
c) Should existing business be turned away in order to fulfil a one-off enquiry or could a long-term
contract be established?
27
QUALITATIVE FACTORS IN DECISION MAKING
Qualitative factors in decision making are factors which might influence the eventual decisions but which have
not been quantified in terms of relevant income or costs. They may stem from non-financial objectives and
from factors which might be quantifiable in money terms, but which have not been quantified, perhaps because
there is insufficient information to make reliable estimates.
Qualitative factors in decision making will vary with the circumstances and nature of the opportunity being
considered. Here are some examples:
Qualitative factor Detail
Availability of There must be sufficient cash to finance any purchases of equipment and build-up of
cash working capital. If cash is not available, new sources of funds (for example an
overdraft or loan) must be sought.
Inflation If the income from an opportunity is fixed by contract, but the costs might increase with
inflation, the contract’s profitability would be over-stated unless inflation is taken into
account.
Employees Any decision involving the shutdown of a plant or changes in work procedures or
location will require acceptance by employees, and ought to have regard to employee
welfare.
Customers Decisions about new products, the quality of output or after-sales service will inevitably
affect customer loyalty and customer demand. Remember that a decision involving
one product may have repercussions on customer attitudes towards a range of
products.
Competitors In a competitive market, some decisions may stimulate a response from rival
companies. The decision to reduce selling prices to raise demand may fail if all
competitors take similar action.
Timing factors There might be a choice in deciding when to take up an opportunity. There might also
be choice about whether a shutdown should be permanent or temporary. Temporary
closure may be a viable proposition during a period of slack demand. And if a decision
is taken to sell goods at a low price where the contribution earned will be relatively
small, it is important to consider the duration of the low price promotion. If it is a long-
term feature of selling, and if demand for the product increases, the company’s total
contribution may sink to a level where it fails even to cover fixed costs.
Suppliers Long-term goodwill may be damaged by a decision to close a product line temporarily.
Decisions to change the specifications for purchased components, or change
stockholding policies so as to create patchy, uneven demand might also put a strain on
suppliers.
Feasibility A proposal may look feasible, but technical experts or managers may have
reservations about their ability to carry it out.
Flexibility & Decisions to subcontract work, or to enter into a long-term contract, have the
internal control disadvantages of inflexibility and lack of controllability.
Unquantified Even where no opportunity costs are specified, it is probable that other opportunities
opportunity costs would be available for using the resources to earn profit.
Political Some large companies may suffer political pressures applied by the government to
pressures influence their investment or disinvestments decisions.
Legal constraints A decision might occasionally be rejected because of questions about the legality of
the proposed action.
28
QUESTION 6 (30 marks)
The managing director of Parser Ltd, a small business, is considering undertaking a once-off contract and has
asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can price at a
profit. The following schedule has been prepared:
Notes R
Notes
1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job,
who could be transferred from another department to undertake work on the special order. They are fully
occupied in their usual department and sub-contracting staff would have to be bought-in to undertake the
work left behind. Subcontracting costs would be R32 000 for the period of the work. Different
subcontractors who are skilled in the special order techniques are available to work on the special order
and their costs would amount to R31 300.
2. A supervisor would have to work on the special order. The cost of R11 500 is comprised of R8 000
normal payments plus R3 500 additional bonus for working on the special order. Normal payments refer
to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his
normal work amounting to R2 500. It is not anticipated that any replacement costs relating to the
supervisor’s work on other jobs would arise.
4. Machine depreciation represents the normal period cost based on the duration of the contract. It is
anticipated that R500 will be incurred in additional machine maintenance costs.
5. Machine overheads (for running costs such as electricity) are charged at R3 per hour. It is estimated that
6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The
further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost
contribution of R2 per hour.
6. Materials represent the purchase costs of 7 500 kg bought some time ago. The materials are no longer
used and are unlikely to be wanted in the future except on the special order. The complete stock of
materials (amounting to 10 000 kg), or part thereof, could be sold for R4,20 per kg. The replacement cost
of material used would be R33 375.
7. Costs will be incurred evenly over the project duration of three months.
The prospective client is willing to make an upfront payment of R40 000. The outstanding balance
will be paid one month after completion. Because the business does not have adequate funds to finance the
special order, a bank overdraft shortfall will be required. The overdraft will be repaid on settlement of the
outstanding debt. The company uses a cost of capital of 15% to appraise projects. The bank’s overdraft rate is
12% for Parser Ltd.
29
The managing director has heard that, for special orders such as this, relevant costing should be used that also
incorporates opportunity costs. She has approached you to create a revised costing schedule based on
relevant costing principles.
REQUIRED
(b) Determine the minimum price to be quoted by Parser Ltd on the once-off contract; an NPV approach is
not required. (16)
(c) Explain why very Small to Medium-size Enterprises (SMEs), such as Parser Ltd, might face problems in
obtaining appropriate sources of finance. In your answer pay particular attention to problems and issues
associated with:
(ACCA – adapted)
30
QUESTION 6 : SOLUTION
(a) Opportunity costs represent the value of the loss or sacrifice when choosing between scarce alternatives.
(2)
Note R
Notes:
1. The choice lies between the two subcontractor costs that have to be incurred because of the
shortage of existing labour. The minimum cost is to have subcontractors employed who are skilled
in the special process.
2. Only the difference between the bonus and the incentive payment represents an additional cost
that arises due to the special order. Fixed salary costs do not change.
4. Depreciation is a period cost and is not related to the special order. Additional
maintenance costs are relevant.
5. The relevant costs are the variable overheads (R3 x 6 000 hours) that will be incurred, plus the
displacement costs of R2 x 2 000 hours making a total of R22 000.
6. Since the materials are no longer used the replacement cost is irrelevant. The historic cost of
R34 000 is a sunk cost. The relevant cost is the lost sale value of the stock used in the special
order which is: 7 500 kg x R4,20 per kg = R31 500.
7. Full opportunity costing will also allow for imputed interest costs on the incremental loan. The
correct interest rate is the overdraft rate since this represents the incremental cost the company will
pay. (1)
31
Incremental cash outflows (87 300 – 31 500) 55 800 (1)
18 600 (1)
The managing director should decide whether a profit margin should be added to take cognisance of the
required 15% cost of capital. (1)
• Banks consider a range of issues when screening loan applications, one of which is collateral or
security.
• Personal security from owner may not be possible – put his assets/finance in business.
Sources of finance
32
QUESTION 7 (30 MARKS)
Pringle trades as a vat maker for the wine industry. His profit in this business during the year to
30 June was R20 000. Pringle also undertakes occasional contracts to build hand-crafted
cabinets, and is considering the price at which to bid for the contract to build five for an
exclusive furniture supplier, delivery to be in one year’s time. He has no other contract in
hand, or under consideration, for at least the next few months. If he accepts the contract it
will take up all his cabinet-making capacity for the next twelve months.
Pringle expects that if he undertakes the contract he would devote one-quarter of his time
to it. To facilitate this he would employ Smith, an unqualified accountant, to undertake his
book-keeping and other paperwork, at a cost of R12 000 per annum.
He would also have to employ on the contract one supervisor at a total cost of R22 000 and
two craftsmen at a total cost of R8 800 each. These costs include Pringle’s normal
apportionment of the fixed overheads of his business at the rate of 10% of labour cost.
Part of the finishing processes of the cabinets, involves applying a special varnish and
leaving the wood to absorb this. During this maturation time, one of the craftsmen could be
employed for the equivalent of up to three months full-time in maintenance and painting
work in the vat maker’s business. He would use additional materials not carried in inventory
costing R1 000. Pringle already has two inclusive quotations from jobbing repairmen for this
maintenance and painting work, one for R2 500 and the other for R3 500, the work to start
immediately.
The equipment which would be used on the cabinet contract was bought nine years ago
for R32 000. Depreciation has been written off on a straight-line basis, assuming a ten-year
life and a scrap value of R2 000. The current replacement cost of similar new equipment is
R70 000, and is expected to be R75 000 in one year’s time. Pringle has recently been offered
R5 000 for the equipment, and considers that in a year’s time he would have little difficulty in
still obtaining R3 000 for it. The plant is useful to Pringle only for contract work.
In order to build the cabinets Pringle will need six types of material, as follows:
C 200 6.00
Materials B and E are used regularly in the vat maker’s business. Material A could be sold
to a local sculptor if not used for the contract. Materials A and E can be used for other
purposes, such as property maintenance. Pringle has no other use for materials D and F,
the stocks of which are obsolete.
The cabinets would be crafted in a factory held on a lease with three years remaining at a
fixed annual rental of R7 000. It would occupy half of this factory, which is useful to Pringle
only for contract work.
Pringle anticipates that the direct expenses of the contract, other than those noted above,
would be R8 600.
Pringle has recently been offered a one-year appointment at a fee of R40 000 per annum
to manage a furniture manufacturing firm. If he accepted the offer, he would be unable
to take on the contract to build the five cabinets, or any other contract. He would have to
employ a manager to run the vat maker’s business at an annual cost (including fidelity
insurance) of R12 000, and would incur additional personal living costs of R3 000.
REQUIRED:
· Calculate the minimum price at which Pringle should be willing to take on the
contract in order to break even, based exclusively on the information given above.
(20)
· Set out any further considerations which you think that Pringle should take into
account in setting the price at which he would tender for the contract.
(10)
Notes R R
Material costs: d
94,600
(20)
- 36 -
a The costs given in the question include apportioned fixed overheads which are
not a relevant cost. Therefore R2 000 has been deducted from the total
supervision cost (1/11 x R22 000) and R800 from each of the craftsmen’s total
costs.
c The historical cost of the equipment is a sunk cost. It is assumed that the existing
equipment would have been sold if the contract was not accepted. Therefore
the relevant cost of using the equipment is the reduction in the scrap value over
the duration of the contract.
d Material A: It is assumed that the 100 units in stock will be used on property
maintenance first. This is more profitable than the alternative of selling the
materials for R2 and replacing them at a later date at R3. The quantities
needed for the contract will be replaced at the current purchase price.
Material B: It is assumed that the 1 000 units issued from stock for the contract will
be replaced at R0.90 per unit. This material is used regularly in the business.
Materials D and F: The stocks of these materials have no alternative use within
the business and will be sold if not used on the contract. Hence the sale price
represents the opportunity cost of using these materials. The remainder of the
materials will be purchased at current prices.
Material E: It is assumed that the material taken from stock for this contract will
be replaced at the current purchase price. This material is used regularly in the
business.
e The lease of the factory would have to be paid even of the contact were not
accepted.
f It is assumed that the alternative is for Pringle to pay out R15 000 to maintain the
existing business while he earns R40 000 on the one year appointment. If the
contract is undertaken then Pringle will lose R25 000.
2
Disney Limited manufactures Mickey Mouse and Donald Duck Murals for children’s bedrooms.
The following projected information for the 2014 financial year is supplied at a capacity utilisation of 100%:
Mickey Donald
Mouse Duck
R R
2. It is anticipated that fixed overheads will amount to R144 000 per annum and will, at full capacity utilisation, be
applied at a rate of R2,40 per machine hour.
3. Market research has shown that 27 000 Mickey Mouse murals and 18 000 Donald Duck murals could be sold.
4. A shortage of skilled labour is being experienced. As a result, only 80 000 labour hours will be available.
REQUIRED:
(a) Determine the product mixture which will maximise the net income of Disney Limited for 2014. (19)
(b) Calculate the total marginal income that will be earned from Mickey Mouse murals if the selling price increases
by 10%, resulting in a decrease of 5% in the sales volume. Use the full market potential as a basis. Assume
that no limiting factors exist. ( 4)
(c) Calculate what the selling price per unit of the Donald Duck murals should be in order to earn a profit of
R126 000. Assume that the full market potential will be sold and that no limiting factors exist. Fixed overheads
must be applied at the same rate as in (a) above. ( 3)
3
Super Sport Products Ltd is a manufacturer of sport equipment. In order to compile the budget of the section
manufacturing cricket bats for children for the next financial year, a decision must be taken regarding the optimal
product mix.
The standards per unit for each of the models are as follows:
Additional information:
1. Both bats are made from the same material, of which only 35 500 kilograms, at a total cost of R248 500, will be
available during the next financial year.
3. It is estimated that 11 000 Hansie bats and 14 500 Johnty bats could be sold annually.
4. Selling and administration expenses are fixed and amount to R15 000 per annum.
REQUIRED:
Determine the product mix which will maximise the net profit of the section for the next financial year.
(14)
4
Pecdu Limited manufactures two different electronic products, namely electronic igniters and vacuum
sensors.
Electronic Vacuum
igniters sensors
R R
Selling price 90,00 120,00
Additional information:
1. Components are acquired on a monthly basis. The supply is limited to a maximum of R53 500 per month.
2. The company employs 12 workers on the production line. Each employee has to work 170 hours per
month. Direct labour cost amounts to R40 per hour.
3. Fixed cost amounts to R235 200 per annum and is allocated to production at the rate of 15% of prime
cost (i.e. 15% of components and direct labour cost).
The company has been requested to give a quotation for an order of 5 000 electronic igniters. The order,
if accepted, must be delivered in full during the course of 2007.
If the order is accepted, it will not affect the normal annual demand for electronic igniters, as indicated in the
budget in point 2 above.
REQUIRED
(a) Determine the optimal product mixture in respect of the normal annual demand, assuming
that the order for 5 000 units is accepted. (25)
(b) Determine the number of units in respect of the normal annual demand which cannot be
manufactured due to the production of the 5 000 units for the order. (4)
(c) Calculate the marginal income relating to the units calculated in (b) above. (1)
[30]
Hussle (Pty) Limited manufactures electrical kitchen equipment. One of its product lines is toasters. They currently
manufacture two types namely the two slice toaster and the four slice toaster.
Mr Robbs, the production manager, has extracted the following information regarding the manufacturing of toasters
for the month ended 28 February 2014 :
Material
An analysis of the material requisitions shows the following apportionment of materials costs :
Labour
Hours Hours
Skilled labour (@ R20 per hour) 0,5 0,9
Unskilled labour (@ R7 per hour) 1 1,5
The skilled labour cost is 40% fixed. The unskilled labour cost is 100% variable. There are 2 200 skilled
labour hours available per month.
Overheads
Overheads are charged to production at a rate of 150% of the skilled labour cost per hour. The budgeted fixed
manufacturing overheads for the month amount to R20 640.
Production
Sales commission
Future demand
According to estimate the demand for the next month will be 20% above the production of the month ended 28
February 2014. The current selling prices, which will remain unchanged, are as follows :
REQUIRED :
Determine the optimal product mixture which will maximise the income of Hussle (Pty) Limited for the month
ending 31 March 2014.
[31]
OPTIMISATION
INTRODUCTION
FACTORS OF PRODUCTION
UNERLYING ASSUMPTIONS
The assumptions are similar to those of Cost Volume Profit analysis, the most
important of which are:
ILLUSTRATION 1
Assume a company manufactures 2 products, viz Elsi and Mate. Both
products require the same raw material which is called Sharp.
ELSI MATE
The question that needs to be asked is whether you have any limiting factors.
The possible limiting factors are raw material and labour. We have been told
that there are unlimited quantities available which means no limiting factors.
Let’s calculate our total contribution should we produce all of Elsi and all of
Mate.
R
Elsi 300 x 3 900
Mate 200 x 6 1 200
Total contribution 2 100
Now, what if we faced with shortage of raw materials? Let’s say we only had
600 kg of sharp available.
So if we produce all of Mate how much of Elsi can we make? Let’s check.
Kg
To produce 200 Mate 200 x 1kg 200
Available 600
Available to produce 400
Elsi
Once Mate has been produced only 400 kg are available to produce Elsi,
which means we can produce (400 ÷ 1,5) = 266 units of Elsi.
Assume now that Elsi needs 1,2 hours to manufacture and Mate 1,5 hours. Also
assume for now that we only have 610 hours available.
hours
Elsi 1,2 hrs x 300 360
Mate 1,5 hrs x 200 300
Required 660
Available 610
Shortage 50
Labour is a limiting factor. We are now faced with two limiting factors. What
do we produce?
With one limiting factor all we needed to look at was the total contribution.
With 2 limiting factors we need to look further. We will now compare the
contribution per limiting factor (also referred to as marginal income per
limiting factor).
Material
ELSI MATE
Contribution per unit A R3,00 R6,00
Raw material required per unit (limiting factor) B 1,5kg 1kg
Contribution per unit of raw material required A÷B R2/kg R6/kg
Ranking 2 1
What this means is that for every kg of raw material used for Elsi I can earn R2
and for every kg of raw material used for Mate I can earn R6. Hence, this
limiting factor favours the production of Mate and is therefore ranked 1.
ELSI MATE
Contribution per unit A R3,00 R6,00
Labour hours required per unit (limiting factor) B 1,2hrs 1,5hrs
Contribution per labour hour required A÷B R2,5/hr R4/hr
Ranking 2 1
Again I can earn more by employing more hours on mate. Labour also
favours the production of Mate.
5
Hours
To produce 200 Mate 200 x 1,5 hrs 300
Available 610
Available to produce 310
Elsi
Once Mate has been produced only 310 hours are available to produce Elsi,
which means we can produce (310 ÷ 1,2) = 258 units of Elsi.
Labour constraints dictate that we produce 258 units of Elsi while raw material
tells us 266. What do we make? What this means is that we have sufficient raw
material to make 266 units but we don’t have sufficient time to make 266
units. This means, we will have to settle for 200 of Mate and 258 of Elsi.
The above technique is called marginal costing and is used when the ranking
of limiting factors favours the same product.
Let us take the above scenario and change the given information so that the
ranking favours both products for the different limiting factors. Assume that
the amount of labour hours required to manufacture one unit of Mate is 2,5
hours. Let’s see what happens to the ranking:
Labour
ELSI MATE
Contribution per unit A R3,00 R6,00
Labour hours required per unit (limiting factor) B 1,2hrs 2,5hrs
Contribution per labour hour required A÷B R2,5/hr R2,4/hr
Ranking 1 2
Labour favours the manufacture of Elsi while Raw materials favour the
manufacture of Mate. We call this conflicting ranking. In such a case we
have to resort to linear programming.
The above problem can be solved algebraically by solving simultaneous
equations.
6
Parameters: 0 ≤ e ≤ 300
0 ≤ m ≤ 200
2.55e ≤ 890
Substitute in equation 2: e ≤ 349
1,2e + 2,5m ≤ 610 Limited to 300
1,2e + 2,5(600 – ≤ 610
1,5e)
1,2e + 1 500 – 3,75e ≤ 610
890 ≤ 2,55e
E ≤ 349
Note your parameters. The demand for Elsi is limited to 300 units which means
that we will produce 300 units of Elsi.
Remember - NB!!!
Limiting factor is just another word for a constraint! (Denoted below as
“LF” in order to save space)
Marginal income and contribution mean the same thing! (Denoted
below as “MI” in order to save space)
Please write the terms out in full in the exam – do not use “LF” or “MI”.
(we can usually only do the above after we have worked out marginal
income per unit in step 2 so leave a space for this at the beginning of your
question – a few lines needed)
EG:
4. If there is only one limiting factor use MI/ contribution per unit and
produce all of the product with the highest MI/contribution per unit.
(There will be no step 5 and 6).
If there is more than one limiting factor calculate the marginal income
(contribution) per limiting factor relating to each actual limiting factor
for each product.
= Marginal income (MI) per unit of product ÷ limiting factor (LF) per
unit of product
= MI per LF
NB! IT IS AT THIS POINT THAT YOU NEED TO DECIDE WHICH TECHNIQUE YOU
ARE USING (based primarily on your rankings): you can either use
marginal costing (if rankings favour the same product) or linear
programming (if rankings favour different products). Note that steps 1-5
are identical for both techniques.
9
6. Work out the optimal product mix (i.e. how much of each product you
will produce) using the ranking as determined above.
Keep in mind that you cannot produce more of a product than the amount
that is demanded of that product. Also remember that production will stop as
soon as one of the actual constraints has been exhausted despite a surplus of
the other constraints/LFs.
If you were required to calculate net profit from making the optimal product
mix, then you would simply subtract fixed costs from the total marginal
income (total contribution) earned. In this case the total marginal income
would be the marginal income per unit multiplied by the number of units in
the optimal product mix for each product.
OR
Keep in mind that you cannot produce more of a product than the amount
that is demanded of that product. Also remember that production will stop as
soon as one of the actual constraints has been exhausted despite a surplus of
the other constraints.
If you were required to calculate net profit from making the optimal product
mix, then you would simply subtract fixed costs from the total marginal
income (total contribution) earned. In this case the total marginal income
would be the marginal income per unit multiplied by the number of units in
the optimal product mix for each product.
1
In recent years, however, there has been a dramatic fall in the costs of processing
information. And, with the advent of advanced manufacturing technology (AMT),
overheads are likely to be far more important and in fact direct labour may
account for as little as 5% of a product’s cost. It therefore now appears difficult to
justify the use of direct labour or direct material as the basis for absorbing overheads
or to believe that errors made in attributing overheads will not be significant.
Many resources are used in non-volume related support activities, (which have
increased due to AMT) such as setting-up, production scheduling, inspection and
data processing. These support activities assist the efficient manufacture of a wide
range of products and are not, in general, affected by changes in production
volume. They tend to vary in the long term according to the range and complexity
of the products manufactured rather than the volume of output.
The wider the rand and the more complex the products, the more support service
will be required. Consider, for example, factory X which produces 10,000 units of
one product, the Alpha, and factory Y which produces 1,000 units each of ten
slightly different versions of the Alpha. Support activity costs in the factory Y are
likely to be a lot higher than in factory X but the factories product an identical
number of units. For example, factory X will only need to set-up once whereas
factory Y will have to set-up the production run at least ten times for the ten
different products. Factory Y will therefore incur more set-up costs for the same
volume of production.
Traditional costing systems, which assume that all products consume all resources in
proportion to their production volumes, tend to all allocate too great a proportion of
overheads to high volume products (which cause relatively little diversity and hence
use fewer support services) and too small a proportion of overheads to low volume
products (which cause greater diversity and therefore use more support services).
Activity based costing (ABC) attempts to overcome this problem.
11
Definition of ABC
KEY TERM
Step 2. Identify the factors which determine the size of the costs of an
activity/cause the costs of an activity. These are known as cost drivers.
KEY TERM
Step 3. Collect the costs associated with each cost driver into what are known
as cost pools.
Step 4. Charge costs to products on the basis of their usage of the activity. A
product’s usage of an activity is measured by the number of the
activity’s cost driver is generates.
ILLUSTRATION
Which of the following definitions best describes a cost driver?
Answer
The correct answer is D.
Cost drivers
For those costs that vary with production levels in the short term, ABC uses volume-
related cost drivers such as labour or machine hours. The cost of oil used as a
lubricant on the machines would therefore be added to products on the basis of
the number of machine hours, since oil would have to be used for each hour the
machine ran.
Kaplan and Cooper argue that long-term variable overhead costs are related to
the transactions undertaken by the support departments where the costs are
incurred.
(a) Logistical transactions are those activities concerned with organising the flow
of resources throughout the manufacturing process.
4
(b) Balancing transactions are those activities which ensure that demand for and
supply of resources are matched.
(c) Quality transactions are those activities which relate to ensuring the
production is at the required level of quality.
(d) Change transactions are those activities associated with ensuring that
customers’ requirements (delivery date, changed design etc) are met.
These transactions in the support departments are the appropriate cost drivers to
use.
The following example illustrates the point that traditional cost accounting
techniques result in a misleading and inequitable division of costs between low-
volume and high-volume products, and that ABC can provide a more meaningful
allocation of costs.
Suppose that Cooplan Ltd manufactures four products, W, X, Y and Z. Output and
cost data for the period just ended are as follows :
Number of
Direct
production Machine
Material labour
runs in the hours per
Output cost per hours per
period unit
units unit unit
R
W 10 2 20 1 1
X 10 2 80 3 3
Y 100 5 20 1 1
Z 100 5 80 3 3
14
5
Required
Prepare unit costs for each product using conventional costing and ABC.
SOLUTION
W X Y Z Total
R R R R
Direct material R
200 800 2,000 8,000
Direct labour 50 150 500 1,500
Overheads * 700 2,100 7,000 21,000
950 3,050 9,500 30,500 44,000
Units produced 10 10 100 100
Cost per unit R95 R305 R95 R305
Using activity based costing and assuming that the number of production runs is the
cost driver for set-up costs, expediting and scheduling costs and materials handling
costs and that machine hours are the cost driver for short-run variable costs, unit
costs would be as follows :
W X Y Z Total
R R R R
Direct material R
200 800 2,000 8,000
Direct labour 50 150 500 1,500
Short-run variable overheads 70 210 700 2,100
(WI) costs (W2)
Set-up 1,560 1,560 3,900 3,900
Expediting scheduling costs 1,300 1,300 3,250 3,250
(W3)
Materials handling costs (W4) 1,100 1,100 2,750 2,750
4,280 5,120 13,100 21,500 44,000
Units produced 10 10 100 100
Cost per unit R428 R512 R131 R215
Workings
Summary
Convention
al costing ABC unit Difference Difference in
unit costs cost per unit total
Product
R R R R
W 95 428 + 333 + 3,330
X 305 512 + 207 + 2,070
Y 95 131 + 36 + 3,600
Z 305 215 - 90 - 9,000
7
The figures suggest that the traditional volume-based absorption costing system is
flawed.
Both traditional absorption costing and ABC systems adopt the two stage allocation
process.
Allocation of overheads
ABC establishes separate cost pools for support activities such as despatching. As
the costs of these activities are assigned directly to products through cost driver
rates, reapportionment of service department costs is avoided.
Absorption of overheads
The principal difference between the two systems is the way in which overheads are
absorbed into products.
(a) Absorption costing most commonly uses two absorption bases (labour hours
and/or machine hours) to charge overheads to products.
(b) ABC uses many cost drivers as absorption bases (number of orders, number of
despatches and so on).
Absorption rates under ABC should therefore be more closely linked to the causes
of overhead costs.
8
Cost drivers
The principal idea of ABC is to focus attention on what causes costs to increase, ie
the cost drivers.
(a) Those costs that do vary with production volume, such as power costs, should
be traced to products using production volume-related cost drivers as
appropriate, such as direct labour hours or direct machine hours.
Overheads which do not vary with output but with some other activity should
be traced to products using transaction-based cost drivers, such as number
of production runs and number of orders received.
ILLUSTRATION
A company manufactures two products, L and M, using the same equipment and
similar processes. An extract of the production data for these products in one
period is shown below::
L M
Quantity produced (units) 5,000 7,000
Direct labour hours per unit 1 2
Machine hours per unit 3 1
Set-ups in the period 10 40
Orders handled in the period 15 60
Overhead costs R
Relating to machine activity 220,000
Relating to production run set-ups 20,000
Relating to handling of orders 45,000
285,000
Required
Calculate the production overheads to be absorbed by one unit of each of the
products using the following costing methods.
(a) A traditional costing approach using a direct labour hour rate to absorb
overheads.
(b) An activity based costing approach, using suitable cost drivers to trace
overheads to products
Answer
Using ABC the overhead costs are absorbed according to the cost drivers.
Machine-hour driver costs 220,000 ÷ 22,000 m/c hours = R10 per m/c hour
Set-up driven costs 20,000 ÷ 50 set-ups = R400 per set-up
Order driven costs 45,000 ÷ 75 orders = R600 per order
Product L Product M
R R
Machine-driven costs (15,000 hrs x R10) 150,000 (7,000 hours x 70,000
R10)
Set-up costs (10 x R400) 4,000 (40 x R400) 16,000
Order handling costs (15 x R600) 9,000 (60 x R600) 36,000
163,000 122,000
Units produced 5,000 7,000
Overhead cost per unit R32,60 R17,43
As you will have discovered when you attempted the question above, there is
nothing difficult about ABC. Once the necessary information has been obtained it is
similar to traditional absorption costing. This simplicity is part of its appeal. Further
merits of ABC are as follows :
(a) The complexity of manufacturing has increased, with wider product ranges,
shorter product life cycles and more complex production processes. ABC
recognises this complexity with its multiple cost drivers.
Criticisms of ABC
It has been suggested by critics that activity based costing has some series flaws :
(a) Some measure of (arbitrary) cost apportionment may still be required at the
cost pooling stage for items like rent, rates and building depreciation.
(b) Can a single cost driver explain the cost behaviour of all items in its associated
pool?
(c) Unless costs are caused by an activity that is measurable in quantitative terms
and which can be related to production output, cost drivers will not be
usable. What drives the cost of the annual external audit, for example?
(e) The cost of implementing and maintaining ABC system can exceed the
benefits of improved accuracy.
12
(i) The incorrect belief that ABC can solve all an organisation’s problems.
(ii) Lack of the correct type of data.
(iii) Difficulty in determining appropriate cost drivers.
‘World wide adoption rates for ABC have peaked at 20 percent and a
declining number of firms are giving it further consideration’. (Tom Kennedy,
Financial Management, May 2000). Recent SA studies have found ABC
usage rates of about 25%, with larger organisation and service sector
companies being most likely to use it.
Planning
The information database produced from such an exercise can then be used as a
basis for forward planning and budgeting. For example, once an organisation has
set its budgeted production level, the database can be used to determine the
number of times that activities will need to be carried out, thereby establishing
necessary departmental staffing and machine levels. Financial budgets can then
be drawn up by multiplying the budgeted activity levels by cost per activity.
The activity-based approach may not produce the final budget figures but it can
provide the basis for different possible planning scenarios.
13
Control
The information database also provides an insight into the way in which costs are
structured and incurred in service and support departments. Traditionally it has
been difficult to control the costs of such departments because of the lack of
relationship between departmental output levels and departmental costs. With
ABC, however, it is possible to control or manage the costs by managing the
activities which underlie them by monitoring a number of key performance
measures.
Decision making
Many of ABC’s supporters claim that it can assist with decision making is a number
of ways :
Pricing
Promoting or discontinuing products or parts of the business
Redesigning products and developing new products or new ways to do business
Note, however, that an ABC cost is not a true cost, it is simply an average cost
because some costs such as depreciation are still arbitrarily allocated to products.
An ABC cost is therefore not a relevant cost for all decisions.
The traditional cost behaviour patterns of fixed cost and variable cost are felt by
advocates of ABC to be unsuitable for longer-term decisions, when resources are
not fixed and changes in the volume or mix of business can be expected to have
an impact on the cost of all resources used, not just short-term variable costs. A five-
level hierarchy has therefore been suggested to facilitate the analysis of costs.
As Innes and Mitchell (Activity Based Costing : A Review with Case Studies, CIMA
1990) say::
‘This analysis of cost highlights the decision level at which each element of cost can
be influenced. For example, the reduction of production cost levels will not imply
depend on a general reduction in output volumes, but also on reorganising
production to perhaps increase batch size and reduce batch volume, on
eliminating or modifying a process, on cutting out or merging product lines or on
altering or removing facility capacity’.
‘Traditionally, accounting has assumed that if costs did not vary until changes in
production at the unit level, those costs were fixed rather than variable. Such an
assumption is not true. Batch level, product level, and organisational level costs are
all variable, but these types of costs vary for reasons other than changes in
production volume. For this reason, to determine an accurate estimate of product
or service cost, costs should be accumulated at each successively higher level of
costs. Because unit, batch and product level costs are all related to units of
products (merely at different levels), these costs can be gathered together at the
product level to match with the revenues generated by product sales.
Organisational level costs, however, are not product related and, thus, should only
be subtracted in total from net product revenues.’
Conclusion
‘It can offer considerable benefits to some companies but a decision to adopt ABC
should not be taken lightly. The staff time involved in developing and getting the
system into operation is conservatively estimated at tow person years, costs are at
least R100,000 though it depends on the system being implemented and the size of
the company.
Its implementation is not easy but is made easier by the availability of IT support
within the organisation. Existing IT facilities can make it possible, at little extra cost to
obtain useful cost driver data. There is now a range of PC based packages on
which to develop stand alone ABC systems, or they can be integrated with existing
system, though the former seem advisable at the prototype stage.
There are cases of companies claiming significant benefit from adopting ABC
(changing the way they do business) but also examples of companies trying but
rejecting the activity-based approach.
A product’s life cycle costs are incurred from its design stage through development
to market launch, production and sales, and finally to its eventual withdrawal from
the market. The component elements of a product’s cost over its life cycle could
therefore include the following::
Life cycle costs can apply to services, customers and projects as well as to physical
products.
Traditional cost accumulation systems are based on the financial accounting year
and tend to dissect a products life cycle into a series of 12-month periods. This
means that traditional management accounting systems do not accumulate costs
over a product’s entire life cycle and do not therefore assess a product’s profitability
over its entire life. Instead they do it on a periodic basis.
Life cycle costing, on the other hand, tracks and accumulates actual costs and
revenues attributable to each product over the entire product life cycle. Hence the
total profitability of any given product can be determined.
KEY TERM
Life cycle costing is the accumulation of costs over a product’s entire life.
17
Growth. The product gains a bigger market as demand builds up. Sales revenues
increase and the product begins to make a profit.
Maturity. Eventually, the growth in demand for the product will slow down and it will
enter a period of relative maturity. It will continue to be profitable. The product
may be modified or improved, as a means of sustaining its demand.
Decline. At some stage, the market will have bought enough of the product and it
will therefore reach ‘saturation point’. Demand will start to fall. Eventually it will
become a loss-maker and this is the time when the organisation should decide to
stop selling the product or service.
The level of sales and profits earned over a life cycle can be illustrated
diagrammatically as follows :
Sales
profits
Sale
+
Time
Introduction Growth Maturity Declin
Profit
18
The horizontal axis measures the duration of the life cycle, which can last from, say
18 months to several hundred years. Children’s crazes or fad products have very
short lives while some products, such as binoculars (invented in the eighteenth
century) can last a very long time.
Traditional cost accumulation systems usually total all non-production costs and
record them as a period expense.
With life cycle costing, non-production costs are traced to individual products over
complete life cycles.
(a) The total of these costs for each individual product can therefore be reported
and compared with revenues generated in the future.
(c) Individual product profitability can be more fully understood by attributing all
costs to products.
TARGET COSTING
Here are some examples of decisions made at the design stage which directly
impact on the cost of a product.
KEY TERMS
Target costing has its greatest impact at the design stage because a large
percentage of a product’s life cycle costs are determined by decisions made early
in its life cycle.
20
Case example
Any requirements to take back products will affect post-production costs and
ultimately overall projected life cycle costs. To cut these costs, the design could, for
example, make the product easy to dismantle and its raw materials easy to recycle.
Or it may be possible to design a product for use over several life cycles rather than
just one. (Xerox has been doing this for several years.)
The technique requires managers to change the way they think about the
relationship between cost, price and profit.
(b) The target costing approach is to develop a product, determine the market
selling price and desired profit margin, with a resulting cost which must be
achieved.
Step 2. Set a selling price at which the organisation will be able to achieve a
desired market share.
Step 4. Calculate the target cost = target selling price – target profit.
21
Step 5. Compile an estimated cost for the product based on the anticipated
design specification and current cost levels.
Step 7. Make efforts to close the gap. This is more likely to be successful if
efforts are made to ‘design out’ costs prior to production, rather than to
control out costs during the production phase. (See Paragraph below.)
Step 8. Negotiate with the customer before making the decision about
whether to go ahead with the project.
When a product is first manufactured, its target cost may well be much lower than
its currently-attainable cost, which is determined by current technology and
processes. Management can then set benchmarks for improvement towards the
target costs, by improving technologies and processes. Various techniques can be
employed.
Even if the product can be produced within the target cost the story does not end
there. Target costing can be applied throughout the entire life cycle. Once the
product goes into production target costs will therefore gradually be reduced.
These reductions will be incorporated into the budgeting process. This means that
cost savings must be actively sought and made continuously over the life of the
product.
1
Almost every company carries stocks of some sort, even if they are only stocks of
consumables such as stationery. For a manufacturing business, stocks (sometimes
called inventories), in the form of raw materials, work in progress and finished goods,
may amount to a substantial proportion of the total assets of the business.
- The economic order quantity (EOQ) model can be used to decide the
optimum order size for stocks which will minimise the cost of ordering
stocks plus stockholding costs.
- Uncertainty in the demand for stocks and/or the supply lead time may
lea a company to decide to hold buffer stocks (thereby increasing its
investment in working capital) in order to reduce or eliminate the risk of
‘stock-outs’ (running out of stock).
Stock costs
- Holding costs comprise the cost of capital tied up, warehousing and
handling costs, deterioration, obsolescence, insurance and pilferage.
- Procuring costs depend on how the stock is obtained but will consist of
ordering costs for goods purchased externally, such as clerical cost,
telephone charges and delivery costs.
2
the loss of a sale and the contribution which could have been earned
from the sale;
the cost of lost production and sales, where the stock-out brings an entire
process to a halt.
- The cost of the stock itself, the supplier’s price or the direct cost per unit of
production, will also need to be considered when the supplier offers a
discount on orders for purchases in bulk.
Stock models
There are several different types of stock model, and these can be classified under
the following headings:
A deterministic model is one in which all the ‘parameters’ are known with
certainty. In particular, the rate of demand and the supply lead time are
known.
A stochastic model is one in which the supply lead time or the rate of
demand for an item is not known with certainty. However, the demand or
the lead time follows a known probability distribution (probably constructed
from a historical analysis of demand or lead time in the past).
In a deterministic system, since the demand and the lead time are known with
certainty, there is no need for a safety stock. However, in a stochastic model, it
may be necessary to have a buffer stock to limit the number of stock-outs or to
avoid stock-outs completely.
3
The economic order quantity (EOQ) is the optimal ordering quantity for an item of
stock which will minimise costs.
Assume that:
- demand is constant;
- the lead time is constant or zero;
- purchase costs per unit are constant (i.e. no bulk discounts).
QCh + CoD
2 Q
3.7 The order quantity, Q, which will minimise these total costs is:
CoD
Q Ch
=
4
The demand for a commodity is 40 000 units a year, at a steady rate. It costs R20 to
place an order, and 40c to hold a unit for a year. Find the order size to minimise
stock costs, the number of orders placed each year, and the length of the stock
cycle.
Solution
2Co 2 x 20 x 40
Q D = 000
= Ch 0,4
= 2 000 units
40 000 = 20 orders placed each year, so that stock cycle is once every 52
20 = 2,6
2 000
weeks.
When the volume of demand is uncertain, or the supply lead time is variable,
there are problems in deciding what the re-order level should be. By holding a
‘safety stock’ a company can reduce the likelihood that stocks run out during
the re-order period (due to high demand or a long lead time before the new
supply is delivered). The average annual cost of such a safety stock would be:
Stock
level
x x x x
x x
Safety
stock
0
Time
Figure 1
Points marked ‘x’ show the re-order level at which a new order is placed. The
number of units ordered each time is the EOQ. Actual stock levels sometimes fall
below the safety stock level, and sometimes the re-supply arrives before stocks
have fallen to the safety level, but on average, extra stock holding amounts to
the volume of safety stock.
The size of the safety stock will depend on whether stock-outs (running out of
stock) are allowed.
Reduced stock levels mean that a lower level of investment in working capital will
be required.
JIT will not be appropriate in some cases. For example, a restaurant might find it
preferable to use the traditional economic order quantity approach for staple non-
perishable food stocks but adopt JIT for perishable and ‘exotic’ items. In a hospital,
a stock-out could quite literally be fatal and JIT would be quite unsuitable.
The basic principle of TQM is that the cost of preventing mistakes is less than the cost
of correcting them once they occur plus the cost of lost potential for future sales.
The aim should, therefore, be to get things right first time consistently.
(a) Approach 1: minimise total quality costs by budgeting for a level of quality
which minimises prevention costs plus inspection costs on the one hand and
internal and external failure costs on the other.
7
(b) Approach 2: aim for zero rejects and 100% quality. The desired standard of
production is contained within the product specification and every unit
produced ought to achieve this standard; in other words, there ought to be
no defects. Zero-defect targets are one aspect of Japanese management
philosophy. However, the actual level of defects must be recorded and
reported, even if the quality costs are not measured.
Computex (Pty) Ltd is a supplier of computer equipment. Its premises are situated
nearby the local university. One of its products, a laptop computer selling at R4 900,
is very popular among the B Com students.
The company sells on average approximately 20 laptop computers per week. Sales
take place evenly throughout the year which consists of 50 weeks.
The company purchases the laptop computers at a cost of R3 430 each. The cost to
place an order amounts to R300 and orders are executed within 5 weeks.
Direct stockholding costs are R35,00 per unit and insurance on the laptop
computers amount to 10% of the unit cost per year.
The supplier has offered a quantity discount of 5% per laptop computer on orders of
150 units. The company implemented the economic order quantity model to
manage its inventory.
The current after tax cost of capital is 11% per annum, the current rate of inflation is
7% per annum and the current rate of taxation is 29%.
REQUIRED:
(a) Advise the management of the company whether they should accept the
special offer from the supplier. (20)
(b) Determine the re-order point for the laptop computers. (2)
[25]
9
Purchase price
1 000 x 3 430 3 430 000
1 000 x (3 258.50) 3 258 500
Order cost
29① x 300 8 700
7③ x 300 2 100
Therefore Computex should accept the new special offer which results in lower
costs.
10
Workings:
① Number of orders = annual demand
EOQ②
= 1 000
35
= 29 orders
= 2 x 1 000 x 300
3 430 x [11 – 7] + [35 + (10% x 3 430)].
100
= 600 000
515.20
= 34.13 = 35 units
= 1 000
150
= 7 orders
= unit price x [interest on capital – inflation rate] + stockholding costs p.u. p.a.
100
(c)
- Higher carrying costs
- Lower acquisition costs
- Lower ordering costs
12
Comfyflex Ltd manufactures ladies sandals. The soles used to manufacture these
sandals are imported from a supplier based in Italy and local craftsman are
employed to hand stitch leather straps to these soles. Thirty thousand (30 000) soles
are required annually. The financial year consists of 260 working days.
In addition to the required rate of return, direct stockholding costs amount to R5 per
sole.
Comfyflex uses the economic order quantity model to manage inventory. The
Italian suppliers have offered Comfyflex a discount of 5% should they agree to place
20 orders per year.
Due to the fact that the Comfyflex premises is very small, in order to make use of the
discount offered by the Italian supplier, additional storage space would have to be
rented for R250 per month.
Required:
b) Determine whether Comfyflex Ltd should accept the special offer. (20)
c) List three (3) assumptions underlying the economic order quantity model. ( 2)
[25]
13
a) Re-order point = (Demand per lead time x lead time) + safety stock
= 2 423 + 150
= 2 573 units
b)
EOQ Special Offer
EOQ =
2 x Annual demand x ordering cost per order
(Unit price x (interest on capital – inflation) + stockholding costs per unit per annum
100
14
=
2 x 30 000 x 300
(75 x (10 – 0) ) + 5
100
=
18 000 000
12.5
= 1 200 units
= 30 000
1 200
= 25 orders
= 12.125
b)
Demand is known and continuous.
Load time is known and does not vary in length.
Delivery of ordered stock takes place in one batch, etc.
15
Sparkle Limited is a manufacturer of pool cleaners and operates for 250 days per
annum.
The company currently purchases one of the components for the pool cleaner at a
cost of R35 per unit from Splash CC. Orders are executed within 15 days. The
demand for the component is 12 000 units per annum. There is no seasonal
fluctuation in the demand for the component. The company makes use of the
economic order quantity method to determine the number of units to be ordered.
Sparkle Limited requires safety stock of 70 units.
The cost to place an order amounts to R100 and delivery costs amount to R120 per
order. The company requires a 20% return on capital before taxation. In addition to
the required rate of return, direct stockholding costs, excluding annual insurance at
5% of the unit cost, amount to R5,50 per unit.
The company has been approached by Splash CC, offering a discounted price of
R25 per unit, provided that orders are placed in batches of at least 800 units each
and a delivery charge of R200 per order will be charged. The lead time for delivery
would remain 15 days. The ordering cost per order will remain the same, but
additional storage space of R50 000 per annum will be needed.
Required:
Question 3:
= 5 280 000
11.8
= 669 units
(b) Re-order point = (demand per time unit x lead time) + safety stock
= (12 000 / 250 x 15) + 70
= 790 units
Saving if special offer is accepted: R428 733 - R359 200 = R69 533
LEARNING OBJECTIVES:
People, when asked to repeat a task, often take less time to repeat the same
task when asked to do it again. This is the premise of learning curve theory.
The theory assumes that each time production quantity doubles, the
cumulative average time per unit will be a fixed percentage of the previous
cumulative average time per unit.
Illustration
If a first unit took 100 hours to complete, how long will it take to complete the
second unit if an 80% learning curve is applicable.
Illustration
Same as previous illustration but how long does it take to produce the third
and fourth unit.
1 100 100
2 80(100 X 80%) 160
4 64(80 X 80%) 256
8 51 (64 X 80%) 408
16 41(51 X 80%) 656
32 33(41 X 80%) 1056
Thus if a question using a learning curve requires the amount of time for
producing the 24 units from unit 9 to 32, the number of hours can be easily
calculated by doing this table and subtracting 408 hours from 1056 hours.
It is very important to look out for these relationships when doing questions
concerning learning curves.
However a question may require the difference in time between units 13 and
29. As these units are not found on the table, the learning curve has to be
calculated algebraically.
where:
y= cumulative average time per unit
b= log l
log 2
Illustration
Using the above formula, if 32 units have been produced, use the formula to
determine the number of hours.
b = log 0.8
log 2
= 0.3219
y = axb
= 100 X 32-0.3219
Total hours = ax
Illustration
To determine the total hours it would take for 32 units in the above example,
the calculations would be as follows:
= 100 X 32
= 1049
If the first unit takes 40 hours and a 80% learning curve exists, calculate the
average time, total time and marginal time to produce the first 10 units.
To determine the learning curve tempo, if two figures on the curve are
known.
5
If there is one gap between items such as between 33 and 41, the learning
tempo is calculated as follows:
LT = 33
41
= 0.8 i.e. 80 % learning curve
If there are two gaps between items such as between 33 and 51, a square
root is needed. The learning tempo is calculated as follows:
LT = 33 / 51
= 0.6471
EXAMINATION CONSIDERATIONS
ANSWER TO EXAMPLE 1
Cumulative
Production production Average time Total time Marginal
time
1 1 40 40 40
1 2 32 64 24
1 3 28.1 84.3 20.3
1 4 25.6 102.4 18.1
1 5 23.86 119.3 16.9
1 6 22.46 134.8 15.5
1 7 21.4 149.7 14.9
1 8 20.48 163.8 14.1
1 9 19.71 177.4 13.6
1 10 19.06 190.6 13.2
REQUIRED
REQUIRED
REQUIRED
REQUIRED
Assume that the variable cost, subject to the learning curve, consists of
direct labour and associated overheads of R150 per hour.
REQUIRED
REQUIRED
= (20 + 16)/(20 x 2)
= 36/40
d)
* (300/10) = 30
10
e)
CUMULATIVE PRODUCTION CUMULATIVE AVERAGE COST CUMULA- ADDITIONAL
PER UNIT TIVE COST CUMULATIVE
COST
Number Number of units
of lots (lot size = 10)
R
Direct labour (61,47 hours at R5 per hour) 307,35
Raw material cost 56,00
Overheads 226,00
588,35
=====
Overheads
An order of 200 units was received after a display at the Rand Easter show.
The four units already being manufactured will be held for viewing purposes.
The management’s objective is to recover all direct cost plus a profit of 25%
on the selling price.
12
REQUIRED
(UNISA - adapted)
Hint
Log y = log a + b x
= 31,36/32
= 0,98
Test
= 0,98
= 1,13682
Hours
= 23 756/200
= R118,78
15
Material 26 193,80
Labour (474,9 hour @ R23/hour) 10 922,70
Overheads (474,0 hour @ R15/hour) 7 123,50
REQUIRED
Calculate the selling price for the 10 additional machines if a profit of 20% on
selling price is required.
(UNISA)
16
ALPHA LIMITED
33,5 + 25,8
33,5 x LF = 2
LF = 0,88507
y = axb
474.9 log LF
log 25 = log 33,5 + log2 x log 25
log LF
1,27868 = 1,52504 + 0,30103 x 1,39794
1, 27868 - 1,52504
logLF = 1,39794 x 0,30103
logLF = 0,05305
antilog = T,94695
LF = 0,088501
= 0,885
= 88,5%
17
y = axb
log 0,885
log y = log 33,5 + log 2 x log 35
-1 + 0,94694
= 1,52504 + 0,30103 x 1,54407
= 1,52504 - 0,27216
= 1,25288
y = 17,901
= 626,54
R26193,80 R
Raw material 25 x 10 10 478
IPM (Pty) Limited manufactures luxury sports cars. The company recently
started manufacturing a new model of which, to date, two units have been
completed and sold. The manufacturing costs for these two units were as
follows:
R
Material 200 000
Direct labour 80 000
Overhead 120 000
The direct labour hours taken for the manufacturing of the first two sports cars
were as follows:
An order for another six of these sports cars has been received. The price of
material and labour increased by the following percentages since the
manufacturing of the first two sports cars:
Material : 10%
Direct labour : 15%
REQUIRED:
Determine the price at which each of the six sports cars should sell at if the
company wants to recovery only directly related manufacturing costs
and earn a total profit of R500 000. (15)
R
Material ( R200 000 x 6 x 1,1) 660 000
2
Selling price per sports car (R1 711 015) 285 169
6
( 9)
Calculations:
1 Learning curve
= 95% ( 2)
20
Hours
Total time for 8 sports cars (137,18 x 8) 1 097,44
Less: Time for first two sports cars (160 + 144) 304
Time for next six sports cars 793,44
1. The direct labour costs, at R6 per hour, to manufacture the first two dresses
is as follows:
R
First dress 150
Second dress 120
270
2. The designer earns R5 760 per month, and designs approximately 18 new
creations during the course of a month.
3. Each dress will require 4,5 metres of material, at a factory cost of R17 per
metre.
4. It was estimated that sundry items, like decorative trimmings, buttons and
cotton, will amount to R7 per dress.
8. Stylish Modes (Pty) Limited intends selling the dresses to the chain of
boutiques at R420 each.
22
REQUIRED:
Calculate the total net income expected to be earned from the order.
R
Sales (R420 x 16) 6 720
Less: Cost of sales 3 840
Direct material (4,5 x R17 x 16) 1 224
Direct labour [(R270 + (217,4411 x R6 x 1,1)] 1 705
Design cost (R5 760) 320
18
Sundry items (R7 x 16) 112
Machine costs allocated
general sewing machines (262,442 x R0,50) 131
overlocking machines (262,442 x R0,75) 197
[ (R150 + R120) 2 ]
[( 6 6 ) ]
= __________________ x 100
R150 1
6
= 90%
24
OR
Hours
Total hours for 16 dresses 4th doubling
3. 90% x 25 = 22,5
4. 90% x 22,5 = 20,25
5. 90% x 20,25 = 18,225
6. 90% x 18,225 = 16,4025
7. 22,5 x 2 = 45
8. 20,25 x 4 = 81
9. 18,225 x 8 = 145,8
10. 16,4025 x 16 = 262,44
Hours
First unit 60
Second unit 48
R
Per unit
Material 620
Labour 440
Variable overheads 324
1 384
3. Since the first two units were manufactured, material costs have increased
by 10% and labour costs by 5%.
5. Fixed costs incurred solely for the manufacture of FXAN units: R9 254.
REQUIRED:
(b) Calculate the minimum selling price per unit that the enterprise can quote
on a contract for 30 units in order only to recover direct costs, and earn a
profit of 25% on the selling price. Ignore all costs relating to the
manufacture of the first 2 units. (11)
Round final hours to the nearest hour and rands to the nearest rand.
27
= 0.90 ( 2)
R
Direct costs for 30 units:
Note: Fixed costs apportioned do not form part of direct costs and are,
therefore, not taken into account.
28
Calculation:
1
The variable manufacturing costs for the first four water-skis were as follows :
R
Direct labour at R55 per labour hour 16 896
Direct material costs 92 840
Overheads (variable at 40% direct labour hours, and 60% 68 200
raw material costs)
Additional information:
The total direct labour hours to manufacture the first unit were 120 hours,
and the total direct labour hours to manufacture the first two units were
192 hours.
Raw material costs have increased by 10% since the first four units were
produced.
REQUIRED :
(b) Calculate the minimum selling price per unit that the company can
quote for the 12 water-skis in order to recover the relevant costs and
earn a profit of 35% based on the cost price. (17)
30
(c) State the limits between which a learning curve may vary and briefly
explain the significance of each limit. (2)
VANEGILL:
= (192 ÷ 2) x 100
120
= 80%
(b)
Cumulative average time per unit for the first 16 units
= (0.8)4 x 120 = 49.152 hours
OR
Total time for the first 16 units = cumulative av. time per unit for
first 16 units x 16 units
= 49.152 x 16
= 786.43 hours
≈ 786 hours
Hours
Total time for the first 16 units 786
Less: total time for the first 4 units (307)
Total time for 12 units in order 479
We only want to recover relevant costs. The apportioned overheads are not
relevant but the fixed portion of overheads incurred solely for the
manufacture of the water-skis are relevant. The direct labour, direct materials
and variable overheads are all relevant.
Want to earn a profit of 35% based on cost. Therefore profit ÷ costs = 35%.
Sales 135%
Less: Costs 100%
Profit 35%
(c) The learning curve may vary from 50% which is the maximum learning
effect and 100% where no learning takes place.
1
Learning Objectives:
INTRODUCTION
COST
e1 e2 e4
e3
Volume
In the case of the least squares method the straight line is fitted in such
a way as to minimise the sum of the squares of the distance between
the various points on the line.
Y = a = bx
3
Hence, from the general equation the summation of the above would
be:
y = an + bx
The above equations are solved simultaneously to find the values for a
and b.
n x y x2 xy
1 7 247 49 1729
2 10 270 100 2700
3 11 278 121 3058
4 10 271 100 2710
5 8 257 64 2056
6 6 235 36 1410
7 11 280 121 3080
8 12 287 144 3444
9 11 277 121 3047
10 9 265 81 2385
Hence, substitute the values from the above table in the equations:
y = an + bx
b = 8,19
When the independent variable (x) and the dependent variable (y)
have been identified, they can be plotted on a graph by the
independent variable being represented on the x-axis and the
dependent variable represented on the y-axis.
The data you have been supplied with to apply correlation and
regression analysis to, however, differs from this in that not all points lie
on the straight line.
This obviously calls for a more sophisticated technique than the high-
low method to determine the best objective fit of the straight line
between all the given points. Regression analysis can be used for this
purpose.
In the case of the least-squares method, the straight line is fitted in such
a way as to minimise the sum of the squares of the distances between
the various points and the straight line
(i.e. e12 + e22 + … + en2)
In our attempt to fit a straight line to a set of given points we, however,
have to remember that the equation of a straight line contains an
independent variable (x), and a dependent variable (y). As the
wording indicates, we can only fit a straight line to a given set of data,
if a relationship exists between these two variables. The existence of, or
lack of existence of this relationship, is determined by means of
correlation analysis.
From the above, it is, therefore, clear that regression analysis cannot be
applied unless the existence of an acceptable relationship between
the independent variable (x) and the dependent.
Correlation
Formula
The only formula used in this course for the calculation of the
coefficient of correlation is as follows:
n ∑x y - ∑x ∑ y
r =
n ∑x - (∑x ) n ∑y - (∑y )
2 2 2 2
= 0,9938
6
Note
0,75 or –0,75 is accepted as being a general guideline as to the lowest
possible limit the coefficient of correlation can be, to justify the
application of regression analysis
RELIABILITY OF ESTIMATES
DEGREES OF FREEDOM
∑y - a ∑ y - b ∑x y
2
Se =
√ n-2
The standard error can be used to determine the confidence limits for
the estimate of y, and these limits are shown by ŷ ± tSe, where t is the
factor for a t distribution with (n-2) degrees of freedom based on a
confidence level of (100 – α)%
8
Confidence = ŷ ± tSe
limits
= ŷ ± (2,306)(1,37)
= ŷ ± 3,16
We can now use the above information to forecast and analyse the
results.
Ŷ = a + bx ± tSe
= 188,9 + 8,19(13) ± (2,306)(1,37)
= 295,37 ± 3,16
It can thus be stated with 95% certainty that the actual cost of
producing 13 units will vary between R292,21 and R 298,53.
9
4. The first item in the x2-column will be the first item in the x-column,
squared. The same applies to the y2-column.
5. The first item in the xy-column will be the first item in the x-column,
multiplied by the first item in the y-column.
6. Complete all these columns and add them up, which will give you
x, y, x2, y2, xy (sum of x, etc).
7. Substitute these values into the formula for correlation and solve for
r. Calculate r2.
In all cases you should be led by the “required” section of the question.
Method
1-8. Unless already done for correlation analysis, follow steps 1 to above.
a) y = na + bx
b) xy = ax + bx2
Limitations (Read)
2. Adaptability
QUESTION 1
You departmental head, being in a rush, supplied you with only the
following information:
x = 1 980
y = 1 324
x2 = 563 400
y2 = 251 676
xy = 376 510
r = 0,9816
Relevant formulae:
y = a + bx
x = na + bx
xy = ax + bx2
a) 1m6046
b) 19,2857
c) 2
d) 19 (3)
a) 169,39
b) 151,70
c) 152,10
d) 170,00 (3)
13
1 324 = 7a 1 980b
1 324 = 7a + 1 980 (0,6004)
1 324 = 7a + 1 189
7a = 1 324 – 1 189
7a = 135
a = 19,2857
QUESTION 2
Normal profits were maintained until the end of December 2013. It has
been decided to analyse the actual production cost for the period
October 2013 to December 2014 in order to determine normal
production cost. The extent of the malpractice during the period
January 2014 to March 2014 is to be determined by using this normal
cost as basis.
You realise that a three month period is normally too short to apply
correlation and regression analysis, but these particular spares and
components have only been purchased from 1 October 2013, due to a
change in the manufacturing process.
Units Production
produced cost
R
October 2013
November 2013 16 8 380
December 2012 15 7 800
19 9 450
January 2014 18 10 740
February 2014 14 8 800
March 2014 20 11 800
16
Required:
Relevant formulae:
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
y = a + bx
y = an + bx
a) Coefficient of correlation
Month x y x2 y2 xy
October 2013 16 8 380 256 70 224 400 134 080
November 2013 15 7 800 225 60 840 000 117 000
December 2013 19 9 450 361 89 302 500 179 550
50 25 630 842 220 366 900 430 630
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 10 390
10 455
= 0,9938
Significance of r
Y = an + bx …. (a)
XY = ax + bx2 …. (b)
Substitute into (a) : 25 630 = 3a + 50b …. (1)
Substitute into (b) : 430 630 = 50a + 842b …. (2)
(1) x 50 : 1 281 500 = 150a + 2 500b …. (3)
(2) x 3 : 1 291 890 = 150a + 2 526b …. (4)
(4) – (3) : 10 390 = 26b
b = 399,62
Substitute b = 399,62 in (1):
25 630 = 3a + 50 (399,62)
a = 1 883
18
Fixed = R1 883
Variable = R400/unit
(5)
Calculations:
QUESTION 3
Semi-variable
Month Production manufacturing costs
(Units) R
1 1 500 800
2 2 000 1 000
3 3 000 1 350
4 2 500 1 250
5 3 000 1 300
6 2 500 1 200
7 3 500 1 400
8 3 000 1 250
9 2 500 1 150
10 1 500 800
Other costs:
REQUIRED:
c) Calculate the cash requirements for month 11, from the available
particulars. (4)
20
a) Coefficient of correlation
Month x y xy x2 y2
1 1 500 800 1 200 000 2 250 000 640 000
2 2 000 1 000 2 000 000 4 000 000 1 000 000
3 3 000 1 350 4 050 000 9 000 000 1 822 500
4 2 500 1 250 3 125 000 6 250 000 1 562 500
5 3 000 1 300 3 900 000 9 000 000 1 690 000
6 2 500 1 200 3 000 000 6 250 000 1 440 000
7 3 500 1 400 4 900 000 12 250 000 1 960 000
8 3 000 1 250 3 750 000 9 000 000 1 562 500
9 2 500 1 150 2 875 000 6 250 000 1 322 500
10 1 500 800 1 200 000 2 250 000 640 000
25 000 11 500 30 000 000 66 500 000 13 640 000
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 12 500 000 .
__________ _________
40 000 000 4 150 000
= 12 500 000 .
6 324,56 x 2 037,15
= 12 500 000
12 884 077
= 0,97 (5)
21
QUESTION 3 – Continued
Y = an + bx …. (a)
b = 1 250 000
4 000 000
b = 0,3125
10a = 3 587,5
10
a = 368,75
a =
QUESTION 4
You are the cost accountant of Yours Truly (Pty) Limited, a company
that specialises in the manufacturing of small quality articles sold to gift
and departmental stores.
A statement has been made that this department does not earn the
required rate of return of 25% on sales that has been set for this
department, and that the latter should be closed down as a
rationalisation measure.
You do not agree with this statement and have decided to prove it to
be false. You have extracted the following details from the
production records of this department for the first nine months it has
been in operation:
1 120 10 200
2 135 10 440
3 162 10 560
4 180 10 740
5 180 10 830
6 150 10 530
7 198 10 950
8 240 11 310
9 210 10 980
1 575 96 540
23
You realise that a nine month period is normally too short to apply
correlation and regression analysis, but due to a lack of other
information, have no choice but to use this limited information.
Additional information:
1. Of the fixed cost included in the total manufacturing cost, 90% is not
directly related to this department, but represents general company
overheads that have been apportioned to this department.
REQUIRED:
y = na + bx
xy = ax + bx2
xy = 16 994 520
24
Y = an + bx …. a
b = 100 020
11 448
b = 8,736897
Substitute b = 8,736897 in 1:
9a = 96 540 – 13 761
9a = 82 779
a = 9 197,66
Calculation:
Notes to solution:
1 x as given.
2 Fixed and variable elements as calculated in a) above.
26
QUESTION 5
The accountant informed the financial director that he has based the
above information on the result of a sample in which he has compared
the number of late cancellations in relation to the number of
passengers booked. The above extract is, consequently,
representative of the statistics for the past year. He has also confirmed
that the trend of late cancellations is similar for all flights on a particular
day.
27
REQUIRED:
y = na + bx
y = na + bx
xy = ax + bx2
r = nxy - xy .
__________ ___________
nx – (x) ny - (y)
2 2 2 2
28
x y xy x2 y2
520 25 13 000 270 400 625
480 23 11 040 230 400 529
510 25 12 750 260 100 625
490 24 11 760 240 100 576
530 27 14 310 280 900 729
550 27 14 850 302 500 729
540 26 14 040 291 600 676
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 1 510 .
______ __
27 600 94
= 1 510 .
(166,1325) (9,6954)
= 1 510 .
1 610,7210
= 0,9375
y = An + bx …. a
b = 0,0547
Substitute b = 0,0547 in 1:
7a = 177 – 198,014
a = -21,014
7
a = 3,002
QUESTION 6
The following are the production figures, for the first eight months of
production:
Output Cost of
production
Units R
(‘000) (‘000)
5 11,8
7 14,7
9 18,5
11 24,0
13 26,2
15 30,1
17 33,6
14 28,0
y = a + bx
Where y = na + bx
xy = ax + bx2 and
r = nxy - xy .
__________ ___________
nx – (x) ny2 - (y)2
2 2
31
REQUIRED:
Steely Limited
a) Correlation
r = nxy - xy .
___________ _____________
nx2 – (x) 2 ny2 – (y)2
= 18 781,6 - 17 007,90 .
___________ __________________
9 240 – 8 281 38 231,92 – 34 931,61
= 1 773,7 .
30,97 x 57,45
= 1 773,7 .
1 779,23
= 0,9969
n X y Xy x2 y2
(‘000) (‘000) (‘000 000) (‘000 000) (‘000 000)
5 11,8 25 139,24 59,0
7 14,7 49 216,09 102,9
9 18,5 81 342,25 165,5
11 24,0 121 576,00 264,0
13 26,2 169 686,44 340,6
15 30,1 225 906,01 451,5
17 33,6 289 1 128,96 571,2
14 28,0 196 784,00 392,0
1
91 186,9 1 155 4 778,99 2 347,7
y = An + bx …. a
b = 0,0547
Substitute b = 0,0547 in 1:
7a = 177 – 198,014
a = -21,014
7
a = 3,002
2
PROCESS COSTING
Learning objectives:
INTRODUCTION
Oil refining
Paper
Food and drinks
Chemicals
The output of one process become the inputs of the next process
until the goods are complete in the final process.
Due to the nature of the production process, there is often work in
progress that needs to be valued. Because of mass production it is
difficult to maintain stock records per unit.
There is often a loss in the process due to spoilage, evaporation and
wastage.
Material for 10 000 units are placed into production at a total material
cost of R100 000 and conversion costs for process 1 amounts to R56 400
and for process 2 R30 400.
4
Further assume that at the end of the month, process 1 completes and
transfers 8 000 units to process 2 and process 2 in turn completes and
transfers 7 000 units to finished goods.
Remember this is still accounting and it’s about debits and credits. Let’s
examine the WIP accounts for the 2 processes.
In process 1 there are 2 000 units which are incomplete. Assume that
they are 70% complete. (Obviously they are 100% complete for
materials as all materials were added at the beginning of the process).
How will the costs of production be allocated to the different
products?
Similarly in process 2, 7 000 units are complete and 1 000 units are in
progress. Assume that these units are 70 % complete. Costs must be
allocated to all units, finished or unfinished.
Opening stock
10 000 Current production
Note:
Input must equal output.
All 8 000 units are completed for material and conversion. In other
words units started and completed in the same period.
There are 2 000 unfinished units, but remember material has already
been added .Which means I have incurred all my material costs.
As far as conversion costs are concerned only 70% are complete. In
other word 1 400 units
The total costs incurred in process 1 is R156 400 and this must be
allocated to the complete and incomplete units. We do this in the
allocation statement.
Allocation statement
156 400
PRODUCTION STATEMENT
INPUT DETAILS OUTPUT PROCESS 1 MATERIAL CONVERSION
- Opening stock
8 000 Received from process 1
Completed and
transferred 7 000 7 000 7 000 7 000
Closing WIP 1 000 1 000 1 000 600
8 000 8 000 8 000 8 000 7 600
Note:
Input must equal output.
All 7 000 units are completed for material and conversion. In other
words units started and completed in the same period.
There are 1 000 unfinished units, but remember material has already
been added .Which means I have incurred all my material costs.
As far as conversion costs are concerned only 60% are complete. In
other word 600 units
A process 1 column is included as the costs of process 1 are brought
forward.
COST STATEMENT
The total costs incurred in process 2 is R158 400 and this must be
allocated to the complete and incomplete units. We do this in the
allocation statement.
8
Allocation statement
158 400
As we have seen from the previous example, that 8 000 units were
complete and 2 000 units were incomplete. What if some of these units
were spoilt and lost?
We have to account for two types of spoilage, viz normal spoilage and
abnormal spoilage.
NORMAL SPOILAGE
The problem with normal losses is that it does not share in the costs. This
simply means that the cost of normal spoilage must be carried by the
good output.
Assume that the above 10 units were inputted at a total cost of R100.
10% of the units are spoilt but the cost still remains R100. This simply
means that the cost of output is not R10,00 per unit (R100÷10), but
R11,11 (R100÷9). Good output is 9 units
9
ABNORMAL LOSSES
Abnormal losses are additional losses which occur during a process. This
loss is unplanned for and therefore carries a cost.
Assume the cost of input of 500 units is R7 500. Assume that the normal
losses are 10% of input. Out put at the end of the process is 410 units. At
the outset the cost per unit seems to be R7 500÷500 = R15 per unit.
Remember we have normal spoilage so the cost per unit increases.
Units Cost
Total input 500 7 500
Normal spoilage (50) -
450 7 500
What this means is that the cost of normal spoilage is carried by the
good output and the abnormal spoilage.
ILLUSTRATION 1
Units R
Opening WIP - -
Units introduced 10 000
10
80%(closing WIP)
100%(end of process)
- Opening stock
10 000 Current production
Note:
Input must equal output.
7 000 units are completed for material and conversion. In other words
units started and completed in the same period.
There are 1 500 unfinished units, but remember we need to account
for 10 000 units, this means that 1 500 have been spoilt.
Spoilage must be split between normal and abnormal.
In this case spoilage takes place at the beginning of the process, viz at
the 0% point.
All 10 000 units are placed at the 0% point in this period, which means
at that all units pass the spoilage point.
Normal spoilage is 10 000 x 5% = 500 units.
Abnormal spoilage is the balancing figure.
What happened to the material from the spoilt units? They have been
wasted, but I still incurred the cost.
Enter 500 units in the material column for normal spoilage(100%)
At the 0% point how much work have I done on the spoilt units? None,
therefore nothing is entered in the conversion column.
Abnormal spoilage is allocated in the same way as normal spoilage.
ALLOCATION STATEMENT
157 400
* Normal spoilage
ILLUSTRATION 2
0%(start of process )
80%(closing WIP)
100%(end of process)
point of spoilage
NOW IT’S TIME TO VISUALISE.I KNOW IT’S HARD FOR YOU. JUST TRY.
PLEASE!!
We introduce 10 000 units at 0% point. Now close your eyes, yes close your
eyes and imagine those units moving down your time line. At the 80%
point 1 500 units get left behind. Which means that 8 500 units reach the
100% point, which is also the point of spoilage.
At this point we lose 5% of the units that reach this point of spoilage. 8 500
x 5% = 425. This is now normal spoilage. Closing WIP has not passed
through this point so spoilage cannot be allocated to closing WIP
14
- Opening stock
10 000 Current production
Note:
Input must equal output.
7 000 units are completed for material and conversion. In other words
units started and completed in the same period.
There are 1 500 unfinished units, but remember we need to account
for 10 000 units, this means that 1 500 have been spoilt.
Spoilage must be split between normal and abnormal.
In this case spoilage takes place at the end of the process, viz at the
100% point.
Normal spoilage is 8 500 x 5% = 425 units.
Abnormal spoilage is the balancing figure.
What happened to the material from the spoilt units? They have been
wasted, but I still incurred the cost.
Enter 425 units in the material column for normal spoilage(100%)
At the 100% point how much work have I done on the spoilt units? All,
therefore all work is lost and 100% is entered in the conversion column.
Abnormal spoilage is allocated in the same way as normal spoilage.
COST STATEMENT
Total Material Conversion
Opening stock - - -
Current production 157 400 100 000 57 400
157 400 100 000 57 400
÷ ÷
Equivalent production 10 000 9 700
Material Conversion
Units completed
- Material (7000/8075) x 425 368
- Conversion (7000/8075) x 425 368
Abnormal spoilage
- Material (1075/8075) x 425 57
- Conversion (1075/8075) x 425 57
____ ____
425 425
ALLOCATION STATEMENT
Rounding (24)
157 400
* Normal spoilage ; Note:(spoilage is not allocated to closing WIP)
What we have dealt with so far is what we call the long method. The
long method can be used at all times. The short method (see below)
can only be used if closing WIP has already passed through the point of
spoilage.
16
Refer to illustration 1
- Opening stock
10 000 Current production
Note that with the short method, no normal spoilage is allocated to the
material and conversion columns. Please compare this to illustration 1
and understand where the differences are.
COST STATEMENT
Total Material Conversio
n
Opening stock - - -
Current production 157 400 100 000 57 400
157 400 100 000 57 400
÷ ÷
Equivalent production 9 500 8 200
In illustration 1 The material cost per unit is R10 and in this case it is
R10,526. The additional R0,526 is the cost of normal spoilage.
With the long method the normal spoilage is part of the units and in the
short method it is part of the cost per unit.
17
ALLOCATION STATEMENT
Rounding 3
157 400
The weighted average method works on the premise that all available
stock, in other words, opening stock and current production are costed
at an average rate per unit.
We have a total of 5 000 units in stock at a total cost of R16 700. The
average cost per unit is therefore:
16 700 = R3,34
5 000
18
If we used FIFO the basic premise is that what ever was there first will
leave first. Hence in the above example what will closing stock be?
ILLUSTRATION 4
Units R
Opening WIP 4 000
- Material 43 000
- Conversion – 60% complete 12 120
Units introduced 10 000
- Material cost 100 000
- Conversion cost 57 400
Units completed and transferred 9 000
Closing WIP – 70% complete 2 600
60%(opening WIP)
70%(closing WIP)
100%(end of process)
Time to visualise:
I start the new month with opening units of 4 000, which is 60% complete. This
means that 4 000 has already passed the point of spoilage in the previous
month. It can’t be spoilt again.
The current units start at 0% point. 10 000 units are introduced and worked on.
At the 50% point 10% is lost. This means that 9 000 (10 000 x 90%) units are left
to work on. When we get to the 70% point 2 600 units remain at this point as
unfinished stock. The remainder go through to output.
Since closing WIP has passed spoilage I can use the short method.
COST STATEMENT
Total Material Conversion
Opening stock 55 120 43 000 12 120
Current production 157 000 100 000 57 000
212 120 143 000 69 120
÷ ÷
Equivalent production 10 000 11 520
ALLOCATION STATEMENT
Rounding
212 120
21
ILLUSTRATION 5
Completed and
transferred 4 000 - 1 600
- Opening stock 5 000 5 000 5 000
- Current production
1 000 - -
Normal spoilage 1 400 1 400 700
Abnormal spoilage 2 600 2 600 1 820
Closing WIP
14 000 14 000 9 000 9 120
Note
COST STATEMENT
Total Material Conversion
Opening stock 55 120 - -
Current production 157 000 100 000 57 000
212 120 100 000 57 000
÷ ÷
Equivalent production 9 000 9 120
ALLOCATION STATEMENT
Rounding 10
212 120
23
QUESTION 1
During the period 20 000 units were started and the following costs
were incurred:
The completed production for the month was 15 000 units and the
closing work in progress consisted of 4 000 units which were 50%
complete. Because of an error an unexpected loss occurred and all
the opening work in progress was spoilt. This loss was discovered when
the opening work in progress was 40% complete. Normal loss is as
expected and this is detected at the 90% stage.
Produce the process account for the period and show your
calculations of the cost per unit, closing work in progress and cost of
completed production. Use the weighted average method.
(Drury adapted)
24
Units
Input
Opening WIP 3 000
Introduced during period 20 000
23 000
Output
Completed production 15 000
Closing WIP 4 000
Abnormal loss (opening WIP) 3 000 22 000
Difference = normal loss _1 000
23 000
Total cost
Opening WIP 17 880 12 600 2 400 - 2 880
Current cost 208 000 84 000 16 000 19 200 88 800
Work in progress
R
Cost element A 16 800
Cost element B 3 200
Cost element C -
Conversion cost _9 600
29 600
25
Notes
a) All of the material will have been added at the 90% stage.
Therefore materials are 100% complete as regards normal loss.
Value of stock
R
Closing WIP 29 600
Completed production 15 000 x 11,00 = 165 000
Normal loss 1 000 x 4,20 = 4 200
1 000 x 0,80 = 800
1 000 x 1,20 = 1 200
900 x 4,80 = 4 320 175 520
Abnormal loss
A 3 000 x 4,20 = 12 600
B 3 000 x 0,80 = 2 400
Conversion cost 1 200 x 4,80 = 5 760 20 760
225 880
Process account
R R
Opening WIP 17 880 Completed production 175 520
A 84 000 Abnormal loss 20 760
B 16 000 Closing WIP 29 600
C 19 200
Conversion cost 88 800 ______
225 880 225 880
26
QUESTION 2
Quantity R Quantity R
Balance: beginning of December 62 000 62 000 265 000 18 550
Purchase 12 December 39 500 49 375
20 December 28 500 34 200
Issues 83 200 50 000
i) Quantity schedule
Opening WIP 3 000
Placed in process 25 000
28 000
v) Summary of costs R
Completed and transferred to 400 122 (W3)
finishing
Closing WIP 96 000 (W4)
496 122
29
Workings:
The cost for Bypro will be the same for FIFO and WA as no purchases
were made.
R
Direct labour 154 000
Departmental overheads 132 000
Allocated overheads (see below) 66 000
352 000
i) Quantity schedule
Opening WIP 3 000
Placed in process 25 000
28 000
v) Summary of costs R
Completed and transferred to 399 570 (W5)
finishing
Closing WIP 101 220 (W6)
500 790
Workings:
LEARNING OBJECTIVES
INTRODUCTION
Carcass
Ox Slaughtering
process
Hide
JOINT COSTS
It frequently happens that joint products are not sold directly after the
split-off point. They first have to undergo further processing, separately.
These additional processing costs can be allocated directly to the
respective products by means of a job or process costing system.
The problem that arises is: How are the joint costs of the joint
manufacturing process divided between the joint products and by-
products? Normally no joint cases are allocated to the by-products.
Joint costs are therefore allocated only to the joint products (principal
products). Allocation may be based on one of the following:
relative market value of the final product method (the market value
of the final product is used and all additional processing costs after
the split-off point and selling and distribution costs are deducted
there from. In other words, the estimated market value at the split-
off point is calculated in this way).
Opening stock, finished goods, 200 units XX, 250 units XY and 300 of XZ
with a cost price of R1,50, R2,50 and R4,00 respectively.
One unit X cost R10 and produces 2 units of XX, 3 units of XY and 4 units
of XZ.
Separate cost of processing the units further amount to R0,50c for XX,
R0,75 for XY and R1 for XZ.
XX XY XZ
Units produced:
XX 1 000 x 2 = 2 000
XY 1 000 x 3 = 3 000
XZ 1 000 x 4 = 4 000
9 000
Details as in Illustration 1.
Joint costs will be allocated on the basis of relative sales value in the
following way:
Relative sales value is defined as the selling price of the end product less
any costs necessary to process after split off – point, sell it and distribute it.
Please note that we referring to the sales value of production.
XX XY XZ
Allocation
Details as in illustration 1.
Details as in illustration 1.
Joint costs will be allocated on the basis of relative sales value at split off
point in the following way:
% Allocation
You will know by now that joint costs are allocated to joint products.
The question which arises now is how the proceeds obtained from the
sale of by-products should be dealt with.
The basic principle is that for decision making purposes, there is never a
profit or loss on a by-product. The proceeds of the by-products are
used to reduce the joint cost where after it is allocated to joint
products.
- Director's valuation
- Separate cost only.
Details as in illustration 1.
SUGGESTED ANSWER
Total XX XY XZ
Sales of the main product amounted to 90% of output during the period,
and 10% of production was held as closing stock at 30 November.
Sales revenue from the main product during November was R150 000.
REQUIRED:
Calculate the profits for November using the four different methods of
accounting for by-products.
SUGGESTED SOLUTION
R R
Sales of main product (R150 000 + R700) 150 700
Opening stock -
Cost of production 120 000
120 000
Less: Closing stock 12 000
Cost of sales 108 000
Profit – main product 42 700
R R
Sales of main product 150 000
Opening stock -
Cost of production (R120 000 – R700) 119 300
119 300
Less: Closing stock (10%) 11 930
Cost of sales 107 370
Profit – main product 42 630
R R
Sales of main product 150 000
Opening stock -
Cost of production (R120 000 – R1000) 119 000
119 000
Less: Closing stock 11 900
Cost of sales 107 100
Profit – main product 42 900
QUESTION 1
ABC Ltd manufactures three joint products using the same production
process. All three products can be sold either at the split-off point or
after further processing. The following information was obtained from
the budget for the three months ending 31 October 2014:
Sales value
Product Units At split-off After further Additional
point processing processing costs
R R R
Beba 1 000 40 000 50 000 10 000
Casa 2 500 80 000 115 000 25 000
Delta 1 500 50 000 60 000 15 000
The joint processing costs at the split-off point amount to R100 000.
REQUIRED:
b. Calculate the budgeted total profit for the three months ending 31
October 2014, taking your findings in (a) into account.
QUESTION 1 – SUGGESTED SOLUTION
Recommendations:
Further processing and sale after the split-off point are only justified in
the case of product Casa.
R
Sales 205 000
The following abridged income statement shows the profit per product
for the first financial year of the business. In this statement the joint cost
is allocated based on the volume produced.
Product A B C Total
R R R R
R
Product A 55 000
Product B 28 000
Product C 5 000
YOU ARE REQUIRED TO
U/93/81/7
LETTER HEAD
Dear Sirs
The savings for the short-term is small and the effects of qualitative
factors must also be taken into account.
Yours faithfully
(40)
QUESTION 2 - SUGGESTED SOLUTION
Product A B C Total
R R R R
b) Further processing A B C
R R R
2. Rossi and Bianco can be sold at the split-off at R3,50 per unit each,
whilst Sec has no sales value if not processed further.
Research department
- 10% to the maintenance department
- 60% to production department 1
- 30% to production department 2
Maintenance department
- 20% to the research department
- 60% to production department 1
- 20% to production department 2
a) calculate the total profit for each product for the period.
(30)
,98 I = 34 300
I = 35 000 (2)
N = 50 000 + ,2 (35 000)
= 57 000 (1)
Sales value of production R80 000 R150 000 R30 000 (2)
Less: Separate costs R20 000 R 50 000 (2)
Allocation 6 10 (1)
- Joint costs 33 638 (1) 56 062 (1) 15 500 (1) 105 200
- costs of further processing 20 000 50 000 15 000 85 000
Med
47 100
Less: Closing stock 7 820 (1)
39 280
Gross profit 44 720
On long-term and short-term Rossi sells at split-off point and Bianco, Sec
and Med sells after further processing.
NB: Here joint costs are irrelevant. Relevant costs are cost incurred
for further processing after a split-off point. (a)
Additional income process only if the relevant income exceeds
the costs.
1
LEARNING OBJECTIVES:
Explain how budgeting fits into the overall framework of decision making,
planning and control
To help you understand the budgeting process we shall begin by looking at how it
fits into an overall framework of planning, decision-making and control.
STAGE 1 :
ESTABLISHING OBJECTIVES
Unit objectives relate to the specific objectives of individual units with the
organisation, such as a division or one company within a holding company.
Corporate objectives are normally set for the organisation as a whole and are then
translated into unit objectives, which become the targets for the individual units.
You should note that the expression aims is sometimes used as an alternative to
mission and the term goals is synonymous with objectives.
The next stage is to identify a range of possible courses of action (or strategies) that
might enable the company's objectives to be achieved. The corporate strategy
literature advocates that, prior to developing strategies, it is necessary to
undertake a strategic analysis to become better informed about the organisation's
present strategic situation. This involves understanding the company's present
position, its strengths and weaknesses and its opportunities and risks.
An organisation should determine the basis on which it will compete and/or sustain
a superior level of performance. The purpose is to ensure that deliberate choices
are made regarding the type of competitive advantage it wishes to attain.
Porter (1985) has identified three generic strategies that an organisation can follow:
1. cost leadership, whereby the organisation aims to be the lowest cost producer
within the industry;
3. focus, whereby the organisation determines the way in which the strategy is
focused at particular parts of the market. For example, a product or service
may be aimed at a particular buyer group, segment of the product line or small
geographical area. An organisation that adopts a focused strategy aimed at
3
1. doing nothing;
2. withdrawing from some markets;
3. selling existing products more effectively in existing markets (market
penetration);
4. selling existing products in new markets (market development);
5. developing new products for sale in existing markets (product development);
6. developing new products for sale in new markets (diversification).
1. suitability, which seeks to ascertain the extent to which the proposed strategies
fit the situation identified in the strategic analysis.
When management has selected those strategic options that have the greatest
potential for achieving the company's objectives, long-term plans should be
created to implement the strategies. A long term plan is a statement of the
preliminary targets and activities required by an organisation to achieve its
strategic plans together with a broad estimate for each year of the resources
required.
Budgeting is concerned with the implementation of the long-term plan for the year
ahead. Because of the shorter planning horizon budgets are more precise and
details. Budgets are a clear indication of what is expected to be achieved during
the budget period whereas long-term plans represent the broad directions that top
management intend to follow.
The budget is not something that originates "from nothing" each year - it is
developed within the context of ongoing business and is ruled by previous
decisions that have been taken within the long-term planning process. When the
activities are initially approved for inclusion in the long-term plan, they are based
on uncertain estimates that are projected for several years.
The final stages in the decision-making, planning and control process are to
compare the actual and the planned outcomes, and to respond to any
divergencies from the plan. These stages represent the control process of
budgeting.
5
PLANNING
The major planning decisions will already have been made as part of the long-term
planning process. However, the annual budgeting process leads to the refinement
of those plans, since managers must produce detailed plans for the
implementation of the long-range plan. Without the annual budgeting process,
the pressure of day-to-day operating problems may tempt managers not to plan
for future operations.
COORDINATION
The budget serves as a vehicle through which the actions of the different parts of
the organisation can be brought together and reconciled into a common plan.
Without any guidance, managers may each make their own decisions, believing
that they are working in the best interests of the organisation.
COMMUNICATION
MOTIVATION
The budget can be a useful device for influencing managerial behaviour and
motivating manages to perform in line with the organisational objectives. A
budget provides a standard that under certain circumstances, a manager may be
motivated to strive to achieve. However, budgets can also encourage inefficiency
and conflict between managers.
CONTROL
A budget assists managers in managing and controlling the activities for which
they are responsible. By comparing the actual results with the budgeted amounts
for different categories of expenses, managers can ascertain which costs do not
conform to the original plan and thus require their attention. This process enables
management to operate a system of management by exception, which means
that a manager's attention and effort can be concentrated on significant
deviations from the expected results.
PERFORMANCE EVALUATION
Because a single budget system is normally used to serve several purposes there is
a danger that they may conflict with each other. For instance the planning and
motivation roles may be in conflict with each other. Demanding budgets that may
not be achieved may be appropriate to motivate maximum performance, but
they are unsuitable for planning purposes. For these a budget should be set based
on easier targets that are expected to be met.
7
The conventional approach is that once per year the manager of each budget
centre prepares a detailed budget for one year. The budget is divided into either
twelve monthly or thirteen four-weekly periods for control purposes.
The budget committee should consist of high-level executives who represent the
major segments of the business. Its major task is to ensure that budgets are
realistically established and that they are coordinated satisfactorily. The normal
procedure is for the functional heads to present their budget to the committee for
approval. If the budget does not reflect a reasonable level of performance, it will
not be approved and the functional head will be required to adjust the budget
and re-submit it for approval. It is important that the person whose performance is
being measured should agree that the revised budget can be achieved otherwise,
if it is considered to be impossible to achieve, it will not act as a motivational
device. If budget revisions are made, the budgetees should at lease feel that they
were given a fair hearing by the committee.
ACCOUNTING STAFF
The accounting staff will normally assist managers in the preparation of their
budgets; they will, for example, circulate and advise on the instructions about
budget preparation, provide past information that may be useful for preparing the
present budget, and ensure that managers submit their budgets on time.
8
The accounting staff do not determine the content of the various budgets, but
they do provide a valuable advisory and clerical service for the line managers.
BUDGET MANUAL
Cash budgets
The objective of the cash budget is to ensure that sufficient cash is available at all
times to meet the level of operations that are outlined in the various budgets.
Because cash budgeting is subject to uncertainty, it is necessary to provide for
more than the minimum required, to allow for some margin of error in planning.
Cash budgets can help a firm to avoid cash balances that are surplus to its
requirements by enabling management to take steps in advance to invest the
surplus cash in short-term investments. Alternatively, cash deficiencies can be
identified in advance, and steps can be taken to ensure that bank loans will be
available to meet any temporary cash deficiencies.
Final review
The budgeted profit and loss account, the Statement of Financial Position and the
cash budget will be submitted by the accountant to the budget committee,
together with a number of budgeted financial ratios such as the return on capital
employed, working capital, liquidity and gearing ratios. If these ratios prove to be
acceptable, the budgets will be approved.
COMPUTERISED BUDGETING
ACTIVITY-BASED BUDGETING
The conventional approach to budgeting works fine for unit level activity costs
where the consumption of resources varies proportionately with the volume of the
final output of products or services. However, for those indirect costs and support
activities where there are no clearly defined input-output relationships, and the
consumption of resources does not vary with the final output of products or
services, conventional budgets merely serve as authorisation levels for certain levels
of spending for each budgeted item of expense.
With conventional budgeting indirect costs and support activities are prepared on
an incremental basis. This means that existing operations and the current
budgeted allowance for existing activities are taken as the starting point for
preparing the next annual budget. The base is then adjusted for changes (such as
changes in product mix, volumes and prices) which are expected to occur during
the new budget period. This approach is called incremental budgeting, since the
budget process is concerned mainly with the increment in operations or
expenditure that will occur during the forthcoming budget period. For example,
the allowance for budgeted expenses may be based on the previous budgeted
allowance plus an increase to cover higher prices caused by inflation. The major
disadvantage of the incremental approach is that the majority of expenditure,
which is associated with the "base level" of activity, remains unchanged. Thus, the
cost of non-unit level activities become fixed and past inefficiencies and waste
inherent in the current way of doing things is perpetuated.
ZERO-BASED BUDGETING
ZBB works from the premise that projected expenditure for existing programmes
should start from base zero, with each year's budgets being compiled as if the
programmes were being launched for the first time. The budgetees should present
their requirements for appropriations in such a fashion that all funds can be
allocated on the basis of cost-benefit or some similar kind of evaluative analysis.
The cost-benefit approach is an attempt to ensure "value for money"; it questions
long-standing assumptions and serves as a tool for systematically examining and
perhaps abandoning any unproductive projects.
QUESTION 1 20 marks
At the end of 2012/2013 there were 75 Down beds and 64 Dreamcast beds were
still in inventory. It is company policy to maintain enough inventory of beds at the
end of each month to meet demand for 55% of the next month’s forecast sales.
The sales and production of both products tend to be evenly distributed
throughout the year.
Both beds are made from the same raw materials. These are wood, plastic and
treated nylon. These are required in the following quantities per bed in terms of
output (finished product):
Some wastage occurs during the manufacturing process. This is 1,5% of wood
and plastic and 3% of nylon. This material wastage has no further use.
14
At the end of 2012/2013 most of the remaining raw material inventory was sold to
another company because the warehouse was undergoing essential
maintenance. The budget should allow for inventory levels to be built up to
normal levels of 25% of the next month’s usage. The raw materials that remained
at the end of 2012/2013 were:
Wood 196kg
Plastic 72kg
Treated nylon 62 square metres
R
Wood 4,60 per kg
Plastic 5,50 per kg
Treated nylon 21,00 per square metre
Skilled labour costs R14,00 per hour and unskilled labour costs R6,50 per hour
REQUIRED
(a) In your role as accountant produce the following budgets for the
year 2013/2014:
(i) Sales budget in units and in rand value. (2)
(ii) Production budget in units. (3)
(iii) Materials usage budget in units. (3)
(iv) Materials purchases budget in units and in value. (Only show
total requirement for period June – July and August – May. Do not (4)
show individual monthly requirements)
(v) Labour budget in hours and in value. (4)
(b) Describe how the approach used to construct these budgets differs
from the methods used in the public service. (4)
(a) In your role as accountant produce the following budgets for the year
2013/2014:
(1 056/12 = 88 x 55%)*
(1 176/12 = 98 x 55%)**
Skilled Semi-skilled
Down bed Dreamcast Down bed Dreamcast
Production units 1 030 1 166 1 030 1 166
Time per unit 5hrs 6hrs 4hrs 4,5hrs [1]
Total hours 5 150 6 996 4 120 5 247 [1]
Rate per hour R14 R14 R6,50 R6,50 [1]
Labour cost 72 100 97 944 26 780 34 106 [1]
Total direct labour cost R230 930
(b) Describe how the approach used to construct these budgets differs from the [4]
methods used in the public service
In the public service incremental budgets are based on the previous budget. This
is then adjusted for expected changes in the next budget period. In (a) above
the whole budget is driven by the limiting factor, which in this case is the sales [2]
volume
In the public service rolling budgets are continuously being updated in relation to
new information. The above budget will not be adjusted according to
circumstances but monitored using variance analysis. [2]
18
REQUIRED:
(a) Calculate the variable production costs per unit, and the fixed production [4]
costs per month, over the three month period.
Month 1 Month 2 Month 3
Production 12 000 10 500 10 000
Unit Cost 23,75 25,00 25,50
Total Cost R285 000 R262 500 R255 000
LOW HIGH DIFFERENCE
Volume 10 000 12 000 2 000 [1]
Total Cost R255 000 R285 000 R30 000 [1]
Unit Variable cost R30 000/2000 R15 [1]
Total Variable costs (Based on low 10000 x R15 = R150 000
volume)
Total Fixed costs (Based on low R255 000 - R150 000 = R105 000 [1]
volume)
(b) Estimate the total cost that would be incurred in Month 4 if 12 500 units are [2]
manufactured.
Month 4
Production (Units) 12 500
Variable Cost (R15 X 12500) R187 500 [0.5]
Fixed Cost R105 000 [0.5]
Selling + Admin R87 000 [0.5]
Total Cost R379 500 [0.5]
(c) Prepare a profit statement for Month 2 using the absorption costing method. [7]
Assume that the fixed production overhead absorption rate is based upon
normal production of 12 000 units per month.
UNITS R
Production 12 000
Fixed overhead 105 000
Recovery rate 105 000/12 000 R8,75 per unit [1]
Under absorbed production overhead: (1 500 units at R8,75 per (13,125) [1]
unit)
Gross profit (after adjustment) 89,375 [1]
Selling and administration overheads (87) [1]
Net profit 2,375 [1]
(d) Prepare a profit statement for Month 3 using the marginal costing method. [5]
(e) Explain, with supporting figures, the profit difference in Month 2 if the [2]
marginal costing method had been used instead of absorption costing.
QUESTION 2
You are the accountant of the Mountain Creek Estate (Pty) Limited, an upmarket
mountain resort.
A project to upgrade the resort has commenced this year, the funding of which is
placing a great deal of pressure on the available funds. An overdraft facility of R60
000 has been arranged, but you are unsure if this will be sufficient. If this facility is
insufficient, a long-term loan will have to be raised.
You have extracted the following information, relating to the 2010 financial year
from the records:
1. Actual Budget
March 2010 April 2010 May 2010 June 2010
R R R R
Kitchen supplies
- Kitchen supplies used 39 600 42 800 56 800 48 500
- Opening stock 4 000 4 400 5 600 4 800
Sales
- Accommodation 130 000 150 000 180 000 120 000
- Bar 17 500 22 500 27 000 19 500
9. The company has been assessed for company taxation for the
financial year which ended on 29 February 2009. The amount due
is R40 800 and it is payable on 31 May 2010.
10. The following is an extract from the capital budget for the year:
10,2 Cost of refurbishing 10 guest suites will amount to R25 000 per
suite, and will be payable upon completion of a suite. Two
suites were completed in April; one is expected to be
completed in May and two in June 2010. The cost of
refurbishing the suites will be capitalised as improvements to
the land and building.
11. The existing courtesy bus will be sold on 31 May 2010 at a loss of R1
500. On 1 March 2010, the book value of this bus was R20 000.
REQUIRED:
Calculations
1. Accommodation
Purchases
March April
R R
Expected usage 39 600 42 800
Add: Closing stock 4 400 5 600
44 000 48 400
Less: Opening stock 4 000 4 400
5. General Expenses
May June
R R
Monthly payments 68 000 68 000
Add: In arrears 01.05.10 3 000 -___
71 000 68 000
6. Interest paid
R
Loan 280 000
Interest (17% x R280 000 x 6/12) 23 800
May June
Number of suites completed 1 2
R R
Cost per suite 25 000 25 000
Total payment due 25 000 50 000
Payable as follows:
April 2010 (10/100 x R36 000) 3 600
May 2010 (80/100 x R36 000) 28 800
June 2010 (10/100) x R36 000) 3 600
36 000
26
Kengary Supplies (Pty) Limited has recently incorporated. The issued share capital
of the company amounts to R75 000, consisting of 75 000 ordinary shares of R1
each. The shares have been issued for cash.
The company has managed to obtain a R50 000 loan from a banking institution.
Plant and machinery, costing R60 000, has been given as security for the loan. The
loan is repayable, annually in arrear, in five equal instalments of R16 000. The
effective rate of interest applicable to the loan amounts to 18% per annum.
The company has also managed to obtain an overdraft facility of R50 000 on its
current account.
Operations are intended to commence on 1 June 2010. The production target for
the first year has been set at 140 000 units.
The selling price has been fixed at R20 per unit. The budgeted ratios of costs in
relation to the selling price are as follows:
1. Due to problems with the availability of raw material, stock should be sufficient
to make provision for the production requirement of the following three months.
3. From the beginning of the year, finished goods stock should be sufficient to
make provision for the budgeted sales of the following two months.
27
According to expectations, sales will take place evenly throughout the year.
The company is allowed 45 days for its raw material supplies. All other expenses
have to be paid for in cash.
All sales will be on credit. Debtors are granted a period of 30 days after delivery of
the goods to pay their accounts. Five percent of all debtors should be provided for
as being irrecoverable.
REQUIRED:
a) Prepare a cash budget for the company for the first year of business. (10)
a) Cash budget
Production budget
(Representing the budgeted sales for 14 months)
Given as 140 000 units
Consisting of:
- units required for sales (12 months) 120 000 1
- units required for closing stock 20 000 2
(2 months’ budgeted sales) _______
140 000
Calculations
1 140 000 x 12
14 = 120 000
2 140 000 x 2
14 = 20 000
Required for
R
- closing stock (140 000 / 12 x 3 x R20 x 35%) 245 000
- production (140 000 x R20 x 35%) 980 000
- purchases 1 225 000
580 740
(9)
Calculations
Long term
Portion = R43 000 – short term portion
= R[(43 000 – 16 000) + (18% x 43 000)]
= R34 740
R
2 Plant and machinery 54 000
- At cost 60 000
- Less: Accumulated depreciation (10% x R60 000) 6 000
5 Creditors
Creditors = Total raw material purchase – cash payments
= R1 225 000 – R1 071 875 (per cash budget)
= R153 125
6 Loan
Short term portion = R43 000 – R34 740
= R 8 260
Projected statement of comprehensive income for the year ended 31 May 2010
R
Sales: (120 000 x R20) 2 400 000
Less: Cost of sales 1 680 000
Production cost 1 1 960 000
Less: Closing stock finished goods
[20 000 x (35 + 25 + 10)% x R20] 280 000
Calculation:
R
1 Production cost
Raw material 980 000
Purchases 1 225 000
Less: Closing stock (per raw material purchases budget) 245 000
Labour (25% x 140 000 x R20) 700 000
Overhead (10% x 140 000 x R20) 280 000
Production cost 1 960 000
(8)
31
African Mining Supplies (Pty) Ltd is a supplier of mining equipment to various mines
in the North-West Province.
The following information has been obtained for purposes of compiling the cash
budget for November 2010 :
R
Bank (positive) 50 000
Savings account 355 000
Instalment sale creditor – Delivery-van 124 962
Prepaid fixed selling and administrative 27 000
expenses
2. Sales
R
October 2010 1 500 000
November 2010 2 000 000
2.2 Eighty percent (80%) of sales are on credit. Debtors tend to settle their
accounts as follows:
2.3 Debtors settling their accounts within the month of sale receive a 2,5%
discount.
32
3. Purchases
R
October 2010 950 000
November 2010 800 000
3.2 Purchases are paid for in the month following the month of purchase.
4. Stock
7. Fixed assets
7.1 During August 2010, a delivery-van with a cost price of R60 000 and a
book value of R50 000 was hijacked. Confirmation has been received
from the insurers that the insurance claim amounting to R45 000 will be
paid out on the 20 November 2010 by means of a direct transfer into
the company’s current account.
7.2 A new delivery-van has been purchased for R90 000 at the beginning
of October 2010. The purchase was financed by means of a
instalment sale agreement. At an effective interest rate of 14,5% per
annum, the amount is repayable in 60 equal payments of R2 118,
payable monthly in arrear, commencing on 31 October 2010.
8. Dividends
REQUIRED:
[20]
34
a) Amount to be transferred
R
Projected cash inflows 1 705 000
Calculations:
(2) R
Oct: 1 500 000 x 79% x 80% 948 000
Nov: 2 000 000 x 80% x 20% x 97,5% 312 000
1 260 000
(3)
Prepaid fixed selling and administrative expenses
2010 R 2010 R
01 Nov Balance 27 000 30 Nov Expenses 19 000
30 Nov Bank 24 000 30 Nov Balance 32 000
51 000 51 000
01 Dec Balance 32 000
(17)
35
b) Advantages of budgets
- Guides personnel to knowing what is expected of them and how their efforts will
be evaluated.
- Isolates problem areas and enables corrective action to be taken before they
occur.
The Betabuild housing company has two types of housing estates in the Blackberry
Area. (Type A and Type B). The following information is available:
1. The company has its own team of painters who carry out the painting and
decorating work on the housing estates. The estimated cost for each house
in which the work will be done in 2010 is as follows:
2. The total number of houses of each type and the percentage requiring
painting and decorating each year is as follows:
Type
A B
Total number of houses 500 600
Percentage of houses requiring
maintenance each year 30% 20%
37
3. Adjustments in wage rates and increases in prices will result in the following
annual fixed percentage increases in the painting and decorating costs from
the beginning of 2011:
%
Direct materials 5
Direct labour 7
Total overheads 6
R
Creditors for materials 2 100
Materials on hand Nil
Labour cost accrued 2 800
Creditors – variable overheads 600
- The credit purchases outstanding at a year end are estimated at 10% of the
annual materials purchased on credit.
- Variable overheads are paid for as follows: 60% during the month of accrual
and 40% in the following month.
- Fixed overheads are paid in twelve equal amounts during the year on a
regular monthly basis.
38
REQUIRED:
Compile a cash budget for the existing painting and decorating function for
both the financial years 2010 and 2011. (Exclude fixed overhead for 2011.)
(Work to the nearest Rand.) (27)
(Oct 2006 Exam)
39
QUESTION 5 - SOLUTION
BETABUILD
(a) Costs incurred for painting and decorating:
2010 2011
54 000 56 700
Direct material
72 900 78 003
Direct labour
Variable overheads③ 27 540 29 192
Fixed overheads:
Avoidable 16 848
Depreciation 11 232
Head office – administrative costs 28 080
Direct material:
Number of houses each = (500 x 30%) + (600 x 20%)
year: = 270 houses
Direct material for 270 houses = R200 x 270 for 2010 = R54 000
for 2011 = R54 000 x 105%
= R56 700
Direct labour:
For 2010: = R270 x 270 houses = R72 900
For 2011: = R72 900 x 107% = R78 003
③ Variable overheads:
Total overheads per house = Material related + Labour related
= (R200 x 20%) + (R270 x 100%)
= R40 + R270
= R310
Of which (30% x R40) + (⅓ x 270) = variable
= R12 + R90
= R102 variable overhead per house
Fixed overheads:
Total overheads per house – variable overheads per house = fixed overheads
R310 - R102 = R208 per house
Therefore:
Total for 2010 = R208 x 270 = R56 160
40
2010 2011
R R
Direct materials payments to creditors:
Previous year creditors (2009:given) 2 100
(2010:90% x R54 000 x 10%)
43 740 4 860
Current year [90% x (90% x R54 000)(a)]
[90% x (90% x R56 700)(a)] 5 400 45 927
Cash purchases (2010:10% x R54 000(a))
5 670
(2011:10% x R56 700(a))
Variable overhead:
Previous year (2009: given) 600
(2010: 40% x R27 540/12)
918
Current year 2010: 26 622(i)
2011:
28 223(i)
Fixed overhead:
Avoidable
Head office – administration costs 16 848
(No depreciation – not cash flow) 28 080 Excluded
- Excluded
-
196 174 163 397
(i) Variable overhead cash (13)
expense
Clusters Limited has finalised its statements for the financial year that ended on 31
December 2009. A reasonable growth in volumes has not dispelled concerns over the
immediate sales and production outlook and this has resulted in the following
assumptions as regards its trading activities and budgets for the financial year which will
end on 31 December 2010.
Sales
There will be no cash sales and it is estimated that the current turnover of the
completed goods stock, which is six times per annum, based on the average
stockholding for the year, will be maintained.
Completed goods
The closing stock at the end of the financial year will show a 50% increase over the
opening stock and will be valued by using the absorption cost basis.
R
Materials 8,00
Labour – direct 6,00
Total production overheads 6,00
20,00
The total production overheads allocated and paid for completed goods is based on
the estimated normal production volume for 2010. An amount of R200 000 for the
annual depreciation of machinery and fixed assets is included in this payment. The
machinery and fixed assets which were installed on 1 January 2009 at cost, have an
expected useful life of five years and depreciation is written off at 20% per annum on
cost based on the straight line method.
Materials
The stock of materials is expected to remain at this level throughout the financial year.
43
Debtors
The sales are expected to occur on an even daily basis throughout the financial year
which normally consists of 360 days per annum. The normal debtors collection period is
30 days after the date of sale.
Creditors
The creditors are expected to remain at this level throughout the financial year.
Additional information :
- On 1/1/2010, the bank balance reflected an overdraft of R180 000, whilst the
projected favourable balance on 31/12/2010 is R710 000.
REQUIRED :
(a) Set out a concise production budget in units for 2010. (5)
(b) Draft a budgeted statement of comprehensive income for the year ending
31 December 2010. (11)
Stock t/o = 6
Stock t/o = COS ÷ Average stock
Average stock = (Closing stock + opening stock) ÷ 2
R
Closing stock of FG = 30,000 units x R20 x 1.5 = 900,000 told that CS will be 50% ↑ than OS
R
Opening stock of FG = 30,000 units x R20 = 600,000
Average stock = (900,000 + 600,000) ÷ 2 =
bear in mind the following relation: O/S + Purchases (or production) - C/S = COS
Statement of financial
position as at 31/12/10
Calcs R R
ASSETS
Non-current
Assets
-
Machinery 1 600,000
600,000
Current
Assets
- Inventory 2 1,050,000
- Debtors 3 562,500
- Bank 710,000
2,322,500
TOTAL ASSETS 2,922,500
Calculations:
1 machinery has expected useful life of 5 years, depreciation p.a. is R200,000, therefore cost
of machinery =R1,000,000. 2 years have passed, therefore 3 years are left, so current value
of machinery = R200,000 x 3 = R600,000
2 Closing stock of FG = R900,000 and closing stock of materials = R150,000; therefore total
closing stock is = R900,000 + R150,000 = R1,050,000.
3 Debtors collection period is 30 days (1 month) after sale - there is thus one month's sales in
debtors at any point in time; = R6,750,000 ÷ 12 = R562,500.
4 Opening balance equity (01/01/10) = A-L
Fixed asset = 800,000
stock FG = 600,000
stock Materials = 150,000
Debtors = 450,000
Creditors = -160,000
Bank = -180,000
1,660,000
Add current net profit = R 1,102,500
Total Equity = R 2,762,500
46
The University of Africa requires all second year engineering students to have their own
laptop computers in order to do practical work and tasks. During the last quarter of
2009, a close corporation, Laptops for Students CC was established to supply laptops
according to the specifications set by the university, at affordable prices. At that time,
a loan of R800 000 was granted to the close corporation and the funds were deposited
into the bank account.
1. According to estimates, 200 of the 400 second year engineering students will buy
their laptops from Laptops for Students CC. There are two types of laptops which
will be supplied, namely Exceptional at a selling price of
R10 000 and Superior at a selling price of R8 000. Since the Exceptional laptop
has a more powerful hard drive, it is expected that 60% of the 200 students will
prefer to buy this laptop and the other 40% the Superior.
2. The following quarterly sales forecast for 2010 has been made :
Quarter % of the 200 students who will buy their laptops in the
1 quarter
65%
2 20%
3 15%
4 -
It is expected that the sales for 2011 will follow the same pattern as that of 2010.
3. All sales will be on credit with a 45 day average debtors collection period from
the invoice date. Sales will take place evenly throughout each quarter. Assume
a month has 30 days.
4. During any quarter, purchases from suppliers are equal to 80% of the next
quarter’s estimated sale value. Suppliers are paid within 90 days after the end of
the quarter of purchase.
5. At the beginning of the first quarter, a delivery vehicle was bought on credit. The
instalment is R11 000 per quarter. Depreciation on the delivery vehicle amounts
to R8 000 per quarter.
6. Commission of 5% of the sales per quarter will be paid out in the relevant quarter.
47
7. Interest on the R800 000 loan, which was granted in 2009, amounts to 16% per
annum and is payable in equal amounts every quarter.
8. In November 2010, new posters and price lists for 2011 will be ordered from K-
Printers. A deposit of R5 000 will be paid, while the balance of R6 000 will be paid
on delivery in the first quarter of 2011.
REQUIRED :
(a) Compile the sales budget for Laptops for Students CC for each of the four
quarters of 2010. (6)
(b) Compile the cash budget for Laptops for Students CC for each of the four
quarters of 2010. (19)
(c) State whether the close corporation will be in a position to repay the R800 000
loan at the end of the fourth quarter of 2010 without their bank account going
into overdraft and motivate your answer. (1)
R
Sales- Quarter 1 (units) 65% x 120 ① = 78 65% x 80 ① = 52
Selling price per unit R10 000 R8 000
Sales value R780 000 R416 000 1 196 000
1 840 000
(6)
OR
R R R
Exceptional (65% x 120 ① x R10 000) 780 000 - -
Superior (65% x 80 ① x R8 000) 416 000 - -
Exceptional (20% x 120 ① x R10 000) - 240 000 -
Superior (20% x 80 ① x R8 000) - 128 000 -
Exceptional (15% x 120 ① x R10 000) - - 180 000
Superior (15% x 80 ① x R8 000) - - 96 000
Calculations:
Less: Budgeted payments 1 059 600 355 800 277 600 48 000
Payments to creditors ③ 956 800 294 400 220 800 -
Instalment on delivery vehicle 11 000 11 000 11 000 11 000
Commission ④ 59 800 18 400 13 800 -
Interest on loan (16% x 800 000 ÷ 4) 32 000 32 000 32 000 32 000
K-Printers deposit - - - 5 000
Bank balance - closing 338 400 764 600 809 000 899 000
(19)
(c) Yes, since there will still be a favourable bank balance of R99 000 after the capital of
R800 000 has been repaid. (1)
Calculations:
OR
R R R R
1 (50% x R1 196 000) 598 000 598 000 - -
2 (50% x R368 000) - 184 000 184 000 -
3 (50% x R276 000) - - 138 000 138 000
Last quarter 2010: 80% x R1 196 000 = R956 800 to be paid in quarter 1
Quarter 1: 80% x R368 000 = R294 400 to be paid in quarter 2
Quarter 2: 80% x R276 000 = R220 800 to be paid in quarter 3
Quarter 3: R0
Quarter 4: 80% x R1 196 000 = R956 800 to be paid in quarter 1 of 2011.
OR
R R R R R
1 (80% x R1 196 000) 956 800 - - - -
2 (80% x R368 000) - 294 400 - - -
3 (80% x R276 000) - - 220 800 - -
4 (80% x R1 196 000) - - - - 956 800
Total purchases per quarter 956 800 294 400 220 800 - 956 800
Payments to creditors - 956 800 294 400 220 800 -
④ Commission
You are the chairperson of the finance committee of Hillside College, a private
school which was founded two years ago. Numerous fundraising projects are
continually being organised in order to complete the school buildings and
establish the required sporting facilities.
An amount of R100 000 is required to complete the athletic track and rugby fields.
A suggestion has been made to have a beer festival during the second weekend
in September 2010.
The parents association and finance committee members have provided you with
the following information regarding the proposed beer festival :
1. Entrance tickets
Entrance tickets can be sold at R50 each, which includes a light meal and a
500ml beer mug. It is expected that 1 800 tickets will be sold, 1 080 of which
are expected to be sold to males and 720 to females. A special price of R1
000 has been negotiated for the printing of 2 000 tickets which will have to
be printed and paid for in August 2010. Any unsold tickets will be disposed
of.
2. Food
The expected cost of the food other than that which has been donated will
be R190000, R12 000 of which will have to be paid for in August 2010 and the
balance in September 2010.
3. Beer
A major brewery has agreed to supply draught beer for the festival on a
C.O.D. (cash on delivery) basis. The draught beer is supplied in 50 litre
reusable vats, the content costing R250 per vat. A refundable deposit of R50
is payable on each vat supplied at the time of delivery. The beer will be
delivered to the school premises in a refrigerated trailer. The hiring of the
trailer will amount to R500 for the weekend and will be payable on
collection of the trailer.
As the brewery is prepared to refund the full purchase price of unused vats
returned, it has been decided to purchase 10 extra vats to provide for the
possibility of more beer being consumed or more tickets being sold.
The beer will only be sold in 500ml quantities at R8 each. Each guest wishing
to drink beer uses his/her own 500ml beer mug. On average, males are
expected to consume 5 mugs of draught beer each and females, 1,5 mugs
each.
52
4. Beer mugs
The beer mugs will be purchased and paid for in August 2010 and are
expected to cost R8 500.
5. Cold drinks
It is expected that 70 dozen cans of cold drinks could be sold at R5 per can.
The cold drinks cost R20 per dozen. A quote of R400 has been obtained for
the rental of the sink baths and the supply of dried ice to keep the cold
drinks cold.
One of the parents owns a catering business and is prepared to let out his
marquee to the school as a special favour, at a drastically reduced price.
The rental he will charge the school is equal to one monthly instalment he
pays in terms of a suspensive sale agreement. The amount that is being
financed for the marquee is R103 232 and it is repayable in equal monthly
instalments of 2½ years at a nominal interest rate of 12% per annum,
payable monthly.
7. Band
8. Sponsorships
Advertisers have been found for 20 sponsorship boards that will be placed in
prominent places during the beer festival. The school is charging R1 000 per
board, 50% payable by June 2010 and the balance in September 2010.
REQUIRED :
(a) Prepare a beer sales budget for the proposed beer festival in September
2010. (3)
(b) Determine the projected amount payable to the brewery on delivery of the
beer. (4)
③ Cold drinks :
= R4 000
④ Purchases
b)
(2,5ℓ x 1 080) + (0,75ℓ x 720) = 3 240ℓ
50ℓ
= 64,8 vats
= 65 vats
+ Extra 10
75 vats
x 250
18 750
102 490
As from May 2010, you have been appointed a the new financial manager of Exo
(Pty) Limited, a company selling a wide range of plastic products directly to the
public.
At the end of May, the general manager requested you to prepare a revised
statement of comprehensive income for the remainder of the financial year, a
period of nine months ending 28 February 2011. The following decisions which
were taken at a management meeting and will take effect as from 1 June 2010,
should be incorporated in the revised budgeted statement of comprehensive
income:
- the selling prices of all the products in the existing product range are to be
increased by 8%
- a new product will be added to the existing product range
- an advertising campaign, costing R30 000 will be launched on 1 June 2010
which is expected to have the effect of a ten percent (10%) increase in the
original budgeted sales volume for the remainder of the 2010-2011 financial
year. It is not anticipated that the advertising campaign will have an effect
on sales subsequent to February 2011.
You have analysed the actual results for the past three months ended 31 May 2010
and have also obtained the following information:
1. Sales
After having taken the effect of the advertising campaign into account, it is
estimated that sales of the new product will amount to R160 000.
60% of all sales are on credit. Debtors tend to settle their accounts as
follows:
2. Stock
Fixed : R9 000
Variable : 8% of turnover
4. Director’s Loan
A loan from D Exo, a director of the company, amounts to R60 000 at 1 June
2010. There is no fixed date for the repayment of the capital. Interest for the
nine months ending 28 February 2011 must be capitalized against the loan
account at a nominal rate of 14% per annum.
5. Fixed Assets
On 1 June 2009, a pick-up vehicle was acquired for R100 000. The
transaction was financed by means of a suspensive sale agreement at a
guaranteed effective interest rate of 18%. No deposit was paid. The full
amount in terms of the suspensive sale agreement is repayable in four equal
annual instalments, payable annually in arrear.
57
The delivery van which was acquired approximately three years ago, will be
sold on 1 December 2010 for R47 500. The cost price of the van amounted
to R70 000 and the book value at March 2010 was R28 000.
Depreciation on fixed assets for the nine months ending 28 February 2011,
excluding depreciation on the delivery van in 5.2 above, amounts to R30
200. Motor vehicles are depreciated according to the straight line method
at a rate of 20% per annum.
6. Dividends
REQUIRED:
Cost of sales [(1 000 000 x 1.1) + 160 000] ÷ 1.25 (1,008,000)
Gross Profit 340,000
Other income
- investment income (1000 x 0.5) 500
- profit on sale of van1 30,000
370,500
Expenditure 293,793
Advertising 30,000
Bad debts (1 348 000 x 60% x 2%) 16,176
Selling and Admin expenses - fixed (9 000 x 9) 81,000
- variable (1 348 000 x 8%) 107,840
Municipal costs (6 000 x 9/12 x 0.97) 4,365
Interest on Director's loan (60 000 x 9/12 x 14%) 6,300
Finance costs2 (interest on suspensive sale) (14 549 x 9/12) 10,912
Depreciation - sold asset (14 000 x 6/12) 7,000
- other assets 30,200
Note 1
Book value @ 01/03/10 28,000
Less: depn. for 9 months 1 Mar - 1 Dec (14 000 x 9/12) 10,500
(annual depn. = 70 000 x 20% = 14 000 p.a.)
Book value @ 01/12/10 (date of sale) 17,500
Proceeds received @ 01/12/10 47,500
Profit on sale 30,000
59
capital
year OB instalment CB interest portion
In March of this year, 440 kilograms of ANALG were produced, using the
following chemicals at the prices indicated:
(NATAL - adapted)
2
Therefore the total material cost variance = price + usage = 28 (u) + 2 (u) = R30 (u)
Usage R2 (u)
3
The following budgeted information for the year that ended on 30 June
2014 was obtained:
Units
Production capacity – standard ……………………….. 60 000
Product – “Selene”
Production and sales …………………………………… 60 000
R
Selling price – per unit …………………………………. 224,00
During the financial year, a client was given a special discount of R16,00
per unit on an order for 5 000 units. The remaining units were sold at the
budgeted selling price.
REQUIRED:
(a) Compile an income statement for the year that ended on 30 June
2014, which reflects the actual figures. ( 5)
(b) Reconcile the difference between the budgeted and the actual net
profit, before normal taxation, for 2014, by calculating as many
variances as possible. (22)
5
SIDECUT LIMITED
R
Sales 13 360 000
(b) Reconciliation of the difference between the budgeted and the actual
net profit for the year ended 30 June 2014
Calcu- R
lation
Budgeted net profit
1 440 000
Less: Unfavourable variances from standard cost
1 167 800
Sales
- Selling price 7 80 000
272 200
Calculations
Material
Zilon Brilon
R R
Opening stock – 1/7/2013 -- --
Plus : purchases @ actual
- 250 000 x R12,40 3 100 000
- 187 000 x R7,80 1 458 600
3 100 000 1 458 600
Variances
Zilon R(250 000 x 12,40) = 3 100 000 R(250 000 x 12,00) = 3 000 000
Brilon R(187 000 x 7,80) = 1 458 600 R(187 000 x 8,00) = 1 496 000
4 558 600 4 496 000
Purchase price
R62 600 (u)
( 2)
Actual input @ std cost Mixture Actual input in std ratio @ std cost
Zilon: R(247 500 x 12,00) = 2 970 000 4 286(u) 432 500 x 4/7 x 12,00 = 2 965 714
Brilon: R(185 000 x 8,00) = 1 480 000 2 857(f) 432 500 x 3/7 x 8,00 = 1 482 857
4 450 000 1 429(u) 4 448 571
8
Actual input in std ratio @ std cost Yield Actual output @ std cost
Labour
Actual cost Actual input @ std cost Actual output @ std cost
Rate Efficiency
R97 600(u) R48 000(u)
( 3)
9
Actual Budget Actual input @ std cost Actual output @ std cost
R2 465 600 R(60 000 x 48 x 75%) R(244 000 x 12 x 75%) R(60 000 x 48 x 75%)
6. Expenditure
= R2 640 000
Expenditure
R408 000(u)
( 2)
7. Sales
Price
R80 000(u)
( 2)
10
Budget Actual
R R
Sales 252 000 270 750
Less: Cost of sales 203 670 229 079
Raw materials
- Bird seed 157 500 179 215
- Vitamin extract 33 750 36 900
Wages 4 140 4 464
Variable overheads 4 500 4 600
Fixed overheads 3 780 3 900
Additional information:
REQUIRED:
(a) Calculate all possible variances for July 2014 (for sales reconciliation
purposes). (26)
(b) State one potential cause for the material mixture variance. ( 1)
12
(a) Variances
Material
Actual input @ std cost Mixture Actual input in std ratio @ std cost
Variance
R R
Seed 128 000 x 1,25 = 160 000 4 500 (f) 126 000 x 188 000 x 1,25 = 164 500
180 000
Extract 60 000 x 0,625 = 37 500 2 250(u) 54 000 x 188 000 x 0,625 = 35 250
_______ ______ ______ 180 000 ______
188 000 197 500 2 250 (f) 199 750
( 3)
Seed 164 500 1 750(f) 126 000 x 1 900 x 1,25 = 166 250
1 800
Labour
Actual cost Actual input @ std cost Actual output @ std cost
Variable overhead
Actual cost Actual input @ std cost Actual output @ std cost
Fixed overhead
Actual cost Budgeted Actual input @ std cost Actual output @ std cost
July
Volume R210(f)
( 5)
14
Sales
- an incorrect standard
- inferior or superior material used
- poor inspection
- incorrect mixture
- more of the cheaper material was used ( 1)
15
The standard product and cost specifications for 2 000 kg finished product
are as follows:
1. Raw material
2. Labour
3. Production overhead
An extract of the cost and production records for March 2014 indicates
the following:
1. Raw material
2. Labour
The actual wages for 4 000 hours during March 2014 amounted to
R23 104.
3. Production overhead
4. Production
REQUIRED:
(a) Calculate the budgeted labour hours for a normal month. (2)
(b) Calculate the budgeted production in kilograms for March 2014. (2)
(c) Determine the value of raw material usage during March 2014. (6)
17
(d) Calculate all possible standard cost variances for March 2014 in
respect of the following:
BRANDON LIMITED
= 4 00 000 kg
X Y
Kg Kg
Opening stock 20 000 24 000
Purchases 324 000 60 000
344 000 84 000
Closing stock (30 000) (8 000)
Usage 314 000 76 000
Chemical powder X
Kg R
Opening stock 20 000 11 000
Purchases 324 000 155 520
344 000 166 520
Chemical powder Y
Kg R
Opening stock 24 000 18 240
Purchases 60 000 50 400
84 000 68 640
d) Variances
i) Raw material
Actual input Mixture Actual input in std mixture @ std cost Actual output @
@ std cost std cost
R R R
X: 157 000 10 750 (u) 390 000 x 1 500 x R0,50 = 146 250 380 000 x R1 100
2 000 2 000
Actual cost Actual input @ std cost Actual output @ std cost
Actual cost Actual input @ std cost Actual output @ std cost
Budgeted – March Actual input @ std cost Actual output @ std cost
*60% x R10 = R6
(4)
21
1. Material
Material X 33⅓%
Material Y 66⅔%
2. Labour
Variable R 36 000
Fixed R120 000
1. Material
2. Labour
3. Overheads incurred
Variable R3 175
Fixed R9 750
Additional information:
REQUIRED:
Material - price
- mixture
- yield
- usage (9)
Labour - rate
- efficiency (3)
PRECISION ENGINEERING
a) Material
Actual Mixture Actual input in std mixture Yield Actual output @ std cost
input @ @ std cost
std cost
R R R R R
X 10 260 1 710 (u) 8 550 x 33½% x R3,00 = 8 550 550 (u) 8 000 x ⅓ x R3,00 = 8 000
Y 24 624 2 736 (f) 8 550 x 66⅔% x R4,80 = 27 360 1 760 (u) 8 000 x ⅔ x R4,80 = 25 600
34 884 1 026 (f) 35 910 2 310 (u) 33,600
b) Labour
Actual cost Actual input @ std cost actual output @ std cost
2 500 x R5,00 2 500 x R4,80 8 000 x ⅓ x R4,80
= R12 500 = R12 000 = R12 800
Rate R500 (u) Efficiency R800 (f)
(3)
c) Variable overhead
Actual cost Actual input @ std cost actual output @ std cost
2 500 x R36 000_ 8 000 x R36 000
90 000 x ⅓ 90 000
R3 175 = R3 000 = R3 200
Rate R175 (u) Efficiency R200 (f)
(3)
24
d) Fixed overhead
Actual Budget normal Budget – actual input @ std cost actual output @
cost month March std cost
R120 000 R10 000 x 108% 2 500 x R120 000 8 000 x R120 000
12 90 000 x ⅓ 90 000
The budget for the abovementioned division for the year ended 28
February 2014, at a capacity utilisation of 30 000 labour hours, indicates
the following:
Budgeted production
Cost per unit
R
Material – 10 kg @ R3 per kilogram 30
Labour – 3 hours @ R8 per hour 24
Variable overhead – 3 hours @ R2 per hour 6
Fixed overhead – 3hours @ R5 per hour 15
75
Additional information:
2. The actual wage rate deviated from the budgeted wage rate only
with regard to a 25% increase granted to all labourers with effect 1
March 2013.
REQUIRED:
a) Determine the total variable costs budgeted for the 2014 financial
year. (3)
i. material (2)
ii. labour (2)
iii. variable overhead (2)
iv. fixed overhead (3)
b) Variances
(i) Material
Actual cost Actual input @ std cost Actual output @ std cost
R(520 000 ÷ 4) x R3 12 500 x R30
R520 000 = R390 000 = R375 000
Price R130 000 (u) Usage R15 000 (u) (2)
(ii) Labour
Actual cost Actual input @ std cost Actual output @ std cost
40 000 1 x R8 12 500 x R24
R400 000 = R320 000 = R300 000
Rate R80 000 (u) Efficiency R20 000 (u) (2)
Actual cost Actual input @ std cost Actual output @ std cost
40 000 1 x R2 12 500 x R6
R72 000 = 80 000 = R75 000
Rate R8 000 (f) Efficiency R5 000 (u) (2)
1 actual input (labour hours) = actual cost = 400 000 = 40 000 hours
actual rate 10
28
R
Budgeted variable costs per (a) above 600 000
Add: Unfavourable total variable costs volume variance 150 000 2
Material
- price 130 000
- usage 15 000
Labour
- rate 80 000
- efficiency 20 000
Variable overhead efficiency 5 000
Actual variable costs [R(520 000 + 400 000 + 72 000)] 992 000
(4)
2 variable costs volume variance = (actual output – budgeted output) x VC p.u.
= (12 500 – 10 000) x 60
= R150 000
(This is unfavourable because your actual output cost R150 000 more than what
you budgeted it to cost.)
29
Crusty Limited manufactures a single product whilst utilizing a standard costing system. Any
stock of materials is valued at standard cost whilst completed goods are valued at standard
absorption cost.
The following sales and costs at standard was budgeted for the month that ended on 30
September 2014:
Units
Sales – Finished products 10 000
R
Prime cost per unit 250,00
- Materials 175,00
- Siv - 10kg @ R 5,00 per kg 50,00
- Lon - 5kg @ R25,00 per kg 125,00
- Labour - 5 hours @ R15,00 per hour 75,00
Variable overheads are allocated to production based on labour hours at a predetermined rate of
R24,00 per hour. The selling price of the single product as budgeted realizes a gross profit of
20% on the selling price and during the budgeted month the actual selling price per unit was 10%
higher than the original budgeted selling price.
The costs incurred and the relevant information for the month that ended on 30 September 2014
was as follows:
Units
Production and sales 9 500
Siv Lon
Kg R Kg R
- Opening stock - 1/9/2014 4 000 20 000 2 000 50 000
- Closing stock - 30/9/2014 3 000 - 1 500 -
- Purchased - 570 000 - 1 140 000
- Used in production – September 2014 96 000 - 48 000 -
There was no opening or closing stock of finished products at the beginning or end of the month.
The following variances as part of the system’s variances for the month were calculated at the
end of September 2014:
R
Materials purchase price 47 500 unfavourable
Materials mix Nil
Labour rate 46 000 unfavourable
Labour efficiency 22 500 favourable
Variable overhead efficiency 36 000 favourable
30
Required:
a) Compile a budgeted income statement for the month that ended on 30 September 2014.
( 7)
Materials yield ( 4)
Production overhead rate ( 2)
Sales price ( 3)
Sales volume (for profit reconciliation purposes). ( 4)
c) Determine the actual gross profit by reconciling the budgeted and actual gross profit for
September 2014. ( 8)
QUESTION 7
(a)
Material 175
Labour 75
Overhead (5 hours x R24 per hour) 120
370
Budgeted selling price p.u. = cost p.u. = 370 = R462.50 per unit
0.8 0.8
R
Budgeted Sales (10 000 x 462.50) 4 625 000
Less: Budgeted Cost of Sales 3 700 000
Material (10 000 x 175) 1 750 000
Labour (10 000 x 75) 750 000
Overhead (10 000 x 120) 1 200 000
(b)
MATERIALS YIELD VARIANCE
If the materials mix variance is nil, then the materials yield variance = materials usage
variance
Lon: 48 000 x 25 = R1 200 000 R12 500 (u) 9 500 x 125 = R1 187 500
R1 680 000 R17 500 (u) R1 662 500
32
(c)
R
Budgeted Profit 925 000
Less: Sales Volume Variance (u) 46 250
Standard Profit 878 750
Plus: Favourable other variances 497 875
Labour efficiency 22 500
Production overhead 36 000
efficiency
Sales price 439 375
Less: Unfavourable other variances 157 000
Materials purchase price 47 500
Materials usage 17 500
Labour rate 46 000
Production overhead rate 46 000
The budget for the two models for the year ending on 31 December 2014
is as follows:
Model
“Rustenburg” “Plettenburg”
R R
Production 50 units - 30 units -
Materials
Raw granite
Black 50 000 kg 500 000 - -
Green - - 30 000 kg 330 000
Saw blades 500 units 15 000 300 units 9 000
Labour 2 500 37 500 1 500 22 500
hours hours
Overhead:
Variable - 65 000 - 39 000
Fixed - 30 000 - 18 000
Saw blades are used to cut the raw granite. The standard consumption is
one saw blade per 100 kilograms of raw granite processed.
The finished goods, materials and other stock records reflected the
following for April 2014:
Quantity
01/04/2014 31/04/2014
Finished goods:
“Rustenburg” 4 units 3 units
“Plettenburg” 3 units 2 units
Raw granite:
Black 2 000 kg 3 000kg
Green 1 000 kg 1 500 kg
Saw blades 27 units 20 units
Work-in-progress Nil Nil
35
Model Total
“Rustenburg” “Plettenburg” R
Sales 6 units 4 units - -
Purchases
Black granite 6 100 kg - - 65 000
Green granite - 3 300 kg - 36 000
Saw blades - - 73 units 2 100
Labour hours worked 257 148 405 6 165
Overhead incurred:
Variable 9 000
Fixed 4 200
65% of the saw blades issued to production were used for the production
of “Rustenburg”, and the remaining 35% for Pletttenburg.
REQUIRED:
Granite:
Saw Blades:
Granite:
Saw Blades:
Black Granite
kg
Opening Stock 2 000
Add: Purchases 6 100
Less: Closing Stock (3 000)
Usage (actual input) 5 100
Rustenburg
units
Opening Stock 4
Add: Production (actual output) *5
Less: Closing Stock (3)
Sales 6
* Balancing figure
38
Green Granite
kg
Opening stock 1 000
Add purchases 3 300
Less: Closing Stock (1 500)
Usage (actual input) 2 800
Plettenburg
(units)
Opening stock 3
Add: Production (actual output) *3
Less: Closing Stock (2)
Sales 4
* Balancing figure
Saw Blades
(units)
Opening stock 27
Add: Purchases 73
Less: Closing Stock (20)
Usage (actual input) 80
P: 148 x 4 200 = 1 534,81 18 000 = 1 500 148 x 18 000 = 1 776 3 x 18 000 = 1 800
405 12 1 500 30
4 200,00 4 000 4 860 4 800
During a normal month, 400 computers are assembled. The standard ratio
of Educational to Gaming computers sold is 70% to 30% respectively.
REQUIRED :
(a)
SALES
(i)
(ii)
Actual sales @ std SP Mix Actual sales in units in std Quantity Budgeted Sales
Variance mix @ std SP Variance
R R R R R
Edu: 230 x 3500 = 805,000 371,000 (u) 0.7 x 480 x 3500 = 1,176,000 196,000 (f) 280 x 3500 = 980,000
Game: 250 x 5000 = 1,250,000 530,000 (f) 0.3 x 480 x 5000 = 720,000 120,000 (f) 120 x 5000 = 600,000
Total: 2,055,000 159,000 (f) 1,896,000 316,000 (f) 1,580,000
OR
Volume variance = mix variance + quantity variance = 159,000 (f) + 316,000 (f) = R475,000 (f)
43
(b)
R
Budgeted Sales 1,580,000
Add: Favourable sales volume variance 475,000
Less: Unfavourable selling price variance (125,000)
Actual sales 1,930,000
(c)
Actual cost Price Actual input @ std cost
Variance
R R R
Edu: 231 x 1250 = 288,750 11,550 (u) 231 x 1200 = 277,200
Game: 252 x 2100 = 529,200 25,200 (f) 252 x 2200 = 554,400
Total: 817,950 13,650 (f) 831,600
Actual input @ std cost Mix Variance Actual input in std ratio @ Yield Actual output @ std
std cost Variance cost
R R R R R
Edu: 231 x 1200 = 277,200 128,520 (f) 0.7 x 483 x 1200 = 405,720 129,720 (u) 230 x 1200 = 276,000
Game: 252 x 2200 = 554,400 235,620 (u) 0.3 x 483 x 2200 = 318,780 231,220 (f) 250 x 2200 = 550,000
Total: 831,600 107,100 (u) 724,500 101,500 (f) 826,000
OR
Usage variance = mix variance + yield variance = 107,100 (u) + 101,500 (f) = R5,600 (u)
44
(d)
Fixed overheads:
Budgeted cost Actual input @ std cost Actual output @ std cost
R R R
Edu: (280 x 960) = 268,800 4238 x 120 = 508,560 (230 x 960) = 220,800
Game: (120 x 1200) = 144,000 (250 x1200) = 300,000
Total: 412,800 520,800
RELEVANT COSTING
KEY TERM
A relevant cost is a future cash flow arising as a direct consequence of a decision.
a) A decision is about the future; it cannot alter what has been done already. A cost that has been
incurred in the past is totally irrelevant to any decision that is being made ‘now’.
b) Costs that have been incurred include not only costs that have already been paid, but also costs
that are the subject of legally binding contracts, even if payments due under the contract have
not yet been made. (These are known as committed costs.)
Costs or charges which do not reflect additional cash spending should be ignored for the purpose of decision
making. These include the following:
c) All overheads absorbed. Fixed overhead absorption is always irrelevant since it is overheads to
be incurred with affect decisions.
A relevant cost is one which arises as a direct consequence of a decision. Thus, only costs which will differ
under some or all of the available opportunities should be considered; relevant costs are therefore sometimes
referred to as incremental costs.
2
KEY TERM
Avoidable costs are costs which would not be incurred if the activity to which they relate did not exist.
One of the situations in which it is necessary to identify the avoidable costs is in deciding whether or not to
discontinue a product. The only costs which would be saved are the avoidable costs, which are usually the
variable costs and sometimes some specific fixed costs. Costs which would be incurred whether or not the
product is discontinued are known as unavoidable costs.
KEY TERM
Opportunity cost is the benefit which could have been earned, but which has been given up, by choosing one
option instead of another.
Suppose for example that there are three mutually exclusive options, A, B and C. The net profit from each
would be R80, R100 and R70 respectively. Since only one option can be selected option B would be chosen
because it offers the biggest benefit.
R
Profit from option B 100
Less opportunity cost (i.e. the benefit from the most profitable alternative, A) 80
Differential benefit of option B 20
The decision to choose option B would not be taken simply because it offers a profit of R100, but because it
offers a differential profit of R20 in excess of the next best alternative.
Non-relevant costs
A number of terms are used to describe costs that are irrelevant for decision making because they are either
not future cash flows or they are costs which will be incurred anyway, regardless of the decision that is taken.
KEY TERM
A sunk cost is a cost which has already been incurred and hence should not be taken account of in decision
making.
An example of this type of cost is depreciation. If the fixed asset has been purchased, depreciation may be
charged for several years but the cost is a sunk cost, about which nothing can now be done.
KEY TERM
A committed cost is a future cash outflow that will be incurred anyway, whatever decision is taken now about
alternative opportunities.
Committed costs may exist because of contracts already entered into by the organisation, which it cannot get
out of.
KEY TERM
A notional cost or imputed cost is a hypothetical accounting cost to reflect the use of a benefit for which no
actual cash expense is incurred.
3
Example as in cost accounting systems include notional rent (such as that charged to a subsidiary of an
organisation for the use of accommodation which the organisation owns) or notional interest charges on
capital employed (sometimes made against a profit centre or cost centre).
Although historical costs are irrelevant for decision making, historical cost data will often provide the best
available basis for predicting future costs.
Unless you are given an indication to the contrary, you should assume the following:
This need not be the case, however, and you would analyse variable and fixed cost data carefully. Do not
forget that ‘fixed’ costs may only be fixed in the short term.
There might, however, be occasions when a variable cost is in fact a sunk cost. For example, suppose that a
company has some units of raw material in stock. They have been paid for already, and originally cost R2,000.
they are now obsolete and are no longer used in a special job which the company is trying to decide whether to
undertake. The special job is a ‘one-off’ customer order, and would use up all these materials in stock.
In deciding whether the job should be undertaken, the relevant cost of the materials to the special job is nil.
Their original cost of R2,000 is a sunk cost, and should be ignored in the decision.
However, if the materials did have a scrap value of, say, R300, then their relevant cost to the job would be the
opportunity cost of being unable to sell them for scrap, i.e. R300.
a) Directly attributable fixed costs are those costs which, although fixed within a relevant range of
activity level, or regarded as fixed because management has set a budgeted expenditure level (for
example advertising costs are often treated as fixed), would, in fact, do one of two things.
b) General fixed overheads are those fixed overheads which will be unaffected by decisions to
increase or decrease the scale of operations. An apportioned share of head office charges is
an example.
You should appreciate that whereas directly attributable fixed costs will be relevant to a decision I hand,
general fixed overheads will not be.
A company has been making a machine to order for a customer, but the customer has since gone into
liquidation, and there is no prospect that any money will be obtained from the winding up of the company.
Costs incurred to date in manufacturing the machine are R50 000 and progress payments of R15 000 had been
received from the customer prior to the liquidation. The sales department has found another company willing to
buy the machine for R34 000 once it has been completed. To complete the work, the following costs would be
incurred.
4
a) Materials: these have been bought at a cast of R6 000. They have no other use, and if the machine is
not finished, they would be sold for scrap for R2 000.
b) Further labour costs would be R8 000. Labour is in short supply, and if the machine is not finished, the
work force would be switched to another job, which would earn R30 000 in revenue, and incur direct
costs of R12 000 and absorbed (fixed) overhead of R8 000.
c) Consultancy fees R4 000. If the work is not completed, the consultant’s contract would be cancelled at
a cost of R1 500.
d) General overheads of R8 000 would be added to the cost of the additional work.
REQUIRED:
SOLUTION
a) Costs incurred in the past, or revenue received in the past are not relevant because they
cannot affect a decision about what is best for the future. Costs incurred to date of R50 000 and
revenue received of R15 000 should therefore be ignored.
b) Similarly, the price paid in the past for the materials is irrelevant. The only relevant cost of
materials affecting the decision is the opportunity cost of the revenue from scrap which would be
forgone – R2 000.
c)
R
Labour costs required to complete work 8 000
Opportunity costs: contribution forgone by losing other work
R(30 000 – 12 000) 18 000
Relevant cost of labour 26 000
d) The incremental cost of consultancy from completing the work is the difference between the cost
of completing the work and the cost of canceling the contract (R(4 000 – 1 500) = R2 500).
e) Absorbed overhead is a notional accounting cost and should be ignored. Actual overhead
incurred is the only overhead cost to consider. General overhead costs (and the absorbed
overhead of the alternative work for the labour force) should be ignored.
5
Identifying relevant costs
The relevant cost of raw materials is generally their current replacement cost unless the materials have
already purchased but will not be replaced. The relevant cost of using them will then be the higher of the
following:
If the materials have no resale value and no other possible use, then the relevant cost of using them for the
opportunity under consideration would be nil.
The flowchart below shows how the relevant costs of materials can be identified, provided that the materials
are not in short supply and so have no internal opportunity cost.
Yes No
Yes No
You should test your knowledge of the relevant cost of materials by attempting the following question.
6
QUESTION 1
Darwin Ltd has been approached by a customer who would like a special job to be done for him, and who is
willing to pay R22 000 for it. The job would require the following materials:
Material B is used regularly by Darwin Ltd, and if units of B are required for this job, they would need to be
replaced to meet other production demand.
Materials C and D are in stock as the result of previous over buying, and they have a restricted use. No other
use could be found for material C, but the units of material D could be used in another job as substitute for 300
units of material E, which currently costs R5 per unit (and of which the company has no units in stock at the
moment).
REQUIRED:
Calculate the relevant costs of material for deciding whether or not to accept the contract.
ANSWER
a) Material A is not yet owned. It would have to be bought in full at the replacement cost of R6 per unit.
b) Material B is used regularly by the company. There are existing stocks (600 units) but if these are
used on the contract under review a further 600 units would be bought to replace them. Relevant costs
are therefore 1 000 units at the replacement cost of R5 per unit.
c) 1 000 units of material C are needed and 700 are already in stock. If used for the contract, a further
300 units must be bought at R4 each. The existing stocks of 700 will not be replaced. If they are used
for the contract, they could not be sold at R2,50 each. The realisable value of these 700 units is an
opportunity cost of sales revenue forgone.
d) The required units of material D are already in stock and will not be replaced. There is an opportunity
cost of using D in the contract because there are alternative opportunities either to sell the existing
stocks for R6 per unit (R1 200 in total) or avoid other purchases (of material E), which would cost 300 x
R5 = R1 500. Since substitution for E is more beneficial, R1 500 is the opportunity cost.
7
The relevant cost of using machines
Once a machine has been bought its cost is a sunk cost. Depreciation is not a relevant cost, because it is not
a cash flow. However, using machinery may involve some incremental costs. These costs might be referred
to as user costs and they include hire charges and any fall in resale value of owned assets, through use.
Sydney Ltd is considering whether to undertake some contract work for a customer. The machinery required
for the contract would be as follows:
a) A special cutting machine will have to be hired for three months for the work (the length of the
contract). Hire charges for this machine are R75 per month, with a minimum hire charge of R300.
b) All other machinery required in the production for the contract has already been purchased by the
organisation on hire purchase terms. The monthly hire purchase payments for this machinery are
R500. This consists of R450 for capital repayment and R50 as an interest charge. The last hire
purchase payment is to be made in two months’ time. The cash price of this machinery was R9
000 two years ago. It is being depreciated on a straight line basis at the rate of R200 per month.
However, it still has a useful life which will enable it to be operated for another 36 months.
The machinery is highly specialized and is unlikely to be required for other, more profitable jobs
over the period during which the contract work would be carried out. Although there is no
immediate market for selling this machine, it is expected that a customer might be found in the
future. It is further estimated that the machine would lose R200 in its eventual sale value if it is
used for the contract work.
REQUIRED:
SOLUTION
a) The cutting machine will incur an incremental cost of R300, the minimum hire charge.
b) The historical cost of the other machinery is irrelevant as a past cost; depreciation is irrelevant as a
non-cash cost; and future hire purchase repayments are irrelevant because they are committed
costs. The only relevant cost is the loss of resale value of the machinery, estimated at R200
through use. This user cost will not arise until the machinery is eventually resold and the R200
should be discounted to allow for the time value of money. However, discounting is ignored here.
8
QUESTION 2
A machine which originally cost R12 000 has an estimated life of ten years and is depreciated at the rate of R1
200 a year. It has been unused for some time, however, as expected production orders did not materialize.
A special order has now been received which would require the use of the machine for two months.
The current net realisable value of the machine is R8 000. If it is used for the job, its value is expected to fall to
R7 500. The net book value of the machine is R8 400.
Routine maintenance of the machine currently costs R40 a month. With use, the cost of maintenance and
repairs would increase to R60 a month.
REQUIRED:
Calculate the relevant cost of using the machine for the order.
SOLUTION
R
Loss in net realisable value of the machine
through using it on the order R(8 000 – 7 500) 500
Costs in excess of existing routine maintenance costs R(120 – 80) 40
Total marginal user cost 540
Often the labour force will be paid irrespective of the decision made and the costs are therefore not
incremental. Take care, however, if the labour force could be put to an alternative use, in which case the
relevant costs are the variable costs of the labour and associated variable overheads plus the contribution
forgone from not being able to put it to its alternative use.
Some of the assumptions that are typically made in relevant costing are as follows:
a) Cost behaviour patterns are known; if a department closes down, for example the attributable
fixed cost savings would be known.
b) The amount of fixed costs, unit variable costs, sales price and sales demand are known with
certainty.
9
c) The objective of decision making in the short run is to maximize ‘satisfaction’, which is often
regarded as ‘short-term profit’.
KEY TERM
A key factor or limiting factor is a scarce resource which limits the activity of an organisation.
There might be just one limiting factor (other than maximum sales demand) but there might also be several
scarce resources, with two or more of them putting an effective limit on the level of activity that can be
achieved. We shall concentrate on single limiting factor problems and a technique for resolving these.
A limiting factor could be sales if there is a limit to sales demand but any one of the organisation’s resources
(labour, materials, manufacturing capacity, financial resources and so on) may be insufficient to meet the level
of production demanded.
a) If sales demand is the factor which restricts greater production output, profit will be maximized by
making exactly the amount required for sales (and no more) provided that each product sold
earns a positive contribution.
b) If labour supply, materials availability, machine capacity or cash availability limits production to
less than the volume which could be sold, management is faced with the problem of deciding what to
produce and what should not be produced because there are insufficient resources to make
everything.
It is assumed in limiting factor accounting that management wishes to maximize profit and that profit
will be maximized when contribution is maximized (given no change in fixed cost expenditure incurred). In
other words, marginal costing ideas are applied.
Contribution will be maximizes by earning the biggest possible contribution per unit of limiting factor.
Thus if grade A labour is the limiting factor, contribution will be maximized by earning the biggest contribution
per hour of grade A labour worked.
The limiting factor decision therefore involves the determination of the contribution earned by each
different product per unit of limiting factor. In limiting factor decisions, we generally assume that fixed
costs are the same whatever production mix is selected, so that the only relevant costs are variable
costs.
10
EXAMPLE 3 : LIMITING FACTOR
D Ltd makes two products, the B and the S. Unit variable costs are as follows:
B S
R R
Direct materials 1 3
Direct labour (R3 per hour) 6 3
Variable overhead 1 1
8 7
The sales price per unit is R14 per B and R11 per S. During July the available direct labour is limited to 8 000
hours. Sales demand in July is expected to be 3 000 units for B and 5 000 units for S.
REQUIRED:
Determine the profit-maximising production levels, assuming that monthly fixed costs are
R20 000 and that opening stocks of finished goods and work in progress are nil.
SOLUTION
Step 1. Confirm the limiting factor is something other than sales demand.
B S Total
Labour hours per unit 2 hrs 1 hr
Sales demand 3 000 units 5 000 units
Labour hours needed 6 000 hrs 5 000 hrs 11 000 hrs
Labour hours available 8 000 hrs
Shortfall 3 000 hrs
Step 2. Identify the contribution earned by each product per unit of scarce resource, that is per labour
hour worked.
B S
R’s R’s
Sales price 14 11
Variable cost 8 7
Unit contribution 6 4
Labour hours per unit 2 hrs 1 hrs
Contribution per labour hour (= unit of limiting factor) R3 R4
Although Bs have a higher unit contribution than Ss, two Ss can be made in the time it takes to make one B.
Because labour is in short supply it is more profitable to make Ss than Bs.
Step 3. Work out the budgeted production and sales. Sufficient Ss will be made to meet the full sales
demand, and the remaining labour hours available will then be used to make Bs.
a)
Product Demand Hours Hours Priority of
Required available manufacture
S 5 000 5 000 5 000 1st
B 3 000 6 000 3 000 (bal) 2nd
11 000 8 000
11
b)
Product Units Hours Contribution Total
Needed per unit R
R
S 5 000 5 000 4 20 000
B 1 500 3 000 6 9 000
8 000 29 000
20 000
9 000
Note that it is not more profitable to begin by making as many units as possible of the product with the bigger
unit contribution. We could make 3 000 units of B in 6 000 hours and 2 000 units of S in the remaining 2 000
hours but profit would be only R6 000. Unit contribution is not the correct way to decide priorities, because it
takes two hours to earn R6 from a B and one hour to earn R4 from a S. Ss make more profitable use of the
scarce resource, labour hours.
QUESTION 3
Twickers Ltd makes two products, widgets and splodgets, for which there is unlimited demand at the budgeted
selling prices. A widget takes three hours to make, and has a variable cost of R18 and a selling price of R30.
A splodget takes two hours to make, and has a variable cost of R10 and a selling price of R20. Both products
use the same type of labour, which is in short supply.
REQUIRED:
Determine the product which should be made to maximize profits, and describe the other considerations which
might alter your decision.
SOLUTION
We must rank the products in order of contribution earning capability per labour hour.
Although widgets have the higher unit contribution, splodgets are more profitable because they make a greater
contribution per labour hour. Three splodgets (worth 3 x R10 = R30) can be made in the same time as two
widgets (worth only 2 x R12 = R24).
12
A profit-maximising decision would, therefore, be to produce splodgets only, given the assumptions made. It is
important to remember, however, that other considerations, so far excluded from the problem might alter the
decision.
a) Can the selling price of either product be raised, thereby increasing unit contribution, and the
contribution per labour hour, and also reducing demand? Since demand is apparently unlimited, it
would be reasonable to suspect that both products are underpriced.
b) Would a decision to make and sell only splodgets have a harmful effect on customer loyalty and
demand? To what extent are sales of each product interdependent? For example, a manufacturer of
knives and forks could not expect to cease production of knives without affecting demand for forks.
c) Would a decision to cease production of widgets have no effect on fixed costs? The assumption that
fixed costs are unaffected by limiting factor decisions is not always valid, and closure of either the
widgets or the splodgets production line might result in fixed cost savings. These savings would need
to be considered when making the product mix decision.
d) Will the decision affect the long-term plans of the company as well as the short term? If widgets are not
produced, it is likely that competitors will take over the markets vacated by Twickers Ltd. Labour skilled
in the manufacture of widgets will be lost, and a decision at a later date to re-open manufacture of
widgets might not be possible.
In certain circumstances an organization faced with a limiting factor on production and sales might not be able
to produce the profit-maximising product mix because the mix and/or volume of products that can be
produced and sold is also restricted by a factor other than a scarce resource.
a) The organization might have contracted to supply a certain number of products to a customer.
b) The organization might have to produce and sell a minimum quantity of one or more of its products to
provide a complete product range and/or to maintain customer goodwill.
c) The organization might need to maintain a certain market share of one or more of its products.
In each of these cases, the organization might have to produce more of a particular product or products
than the level established by ranking according to contribution per unit of li8miting factor.
The basic approach to dealing with such situations is to rank the products in the normal way but the
optimum production plan must take into account the minimum production requirements. The
remaining resource must then be allocated according to the ranking.
Work carefully through the following example which illustrates this approach.
13
EXAMPLE 4 : RESTRICTED FREEDOM OF ACTION
Harvey Ltd is currently preparing its budget for the year ending 30 September 20X2. The company
manufactures and sells three products, Beta, Delta and Gamma.
The unit selling price and cost structure of each product is budgeted as follows:
Variable costs:
Labour 24 48 6
Materials 26 7 8
Overhead 10 5 6
60 60 20
Direct labour rate is budgeted at R6 per hour, and fixed costs at R1 300 000 per annum. The company has a
maximum production capacity of 228 000 direct labour hours.
A meeting of the board of directors has been convened to discuss the budget and to resolve the problem as to
the quantity of each product which should be made and sold. The sales director presented the results of a
recent market survey which reveals that market demand for the company’s products will be as follows:
Product Units
Beta 24 000
Delta 12 000
Gamma 60 000
The production director proposes that since Gamma only contributes R12 per unit, the product should no longer
be produced, and the surplus capacity transferred to produce additional quantities of Beta and Delta. The sales
director does not agree with the proposal. Gamma is considered necessary to complement the product range
and to maintain customer goodwill. If Gamma is not offered, the sales director believes that sales of Beta and
Delta will be seriously affected. After further discussion the board decided that a minimum of 10 000 units of
each product should be produced. The remaining production capacity would then be allocated so as to achieve
the maximum profit possible.
REQUIRED
Prepare a budget statement which clearly shows the maximum profit which could be achieved in the year
ending 30 September 20X2.
14
SOLUTION
Since only 228 000 hours are available we need to establish which product earns the greatest contribution per
labour hour.
The optimum production plan must take into account the requirement that 10 000 units of each product are
produced, and then allocate the remaining hours according to the above ranking.
Hours
Beta 10 000 units x 4 hours 40 000
Delta 10 000 units x 8 hours 80 000
Gamma 10 000 units x 1 hour 10 000
130 000
Gamma 50 000 units x 1 hour (full demand) 50 000
Beta 12 000 units x 4 hours (balance) 48 000
228 000
15
Step 4. Draw up a budget.
BUDGET STATEMENT
R
Contribution
Beta (22 000 units x R40) 880 000
Delta (10 000 units x R64) 640 000
Gamma (60 000 units x R12) 720 000
2 240 000
Fixed costs 1 300 000
Profit 940 000
16
QUESTION 4
Jam Ltd makes two products, the K and the L. The K sells for R50 per unit, the L for R70 per unit. The variable
cost per unit of the K is R35 that of the L R40. Each unit of K uses 2 kgs of raw material. Each unit of L uses 3
kgs of material.
In the forthcoming period the availability of raw material is limited to 2 000 kgs. Jam Ltd is contracted to supply
500 units of K. Maximum demand for the L is 250 units. Demand for the K is unlimited.
SOLUTION
K L
Contribution p0er unit R15 R30
Contribution per unit of limiting factor R15/2 = R7,50 R30/3 = R10
Ranking 2 1
Whenever there are limiting factors, there will be opportunity costs. For example, suppose that a company
manufactures two items X and Y, which earn a contribution of R24 and R18 per unit respectively. Product X
requires 4 machine hours per unit, and product Y 2 hours. Only 5 000 machine hours are available, and
potential sales demand is for 1 000 units each of X and Y.
Machine hours would be a limiting factor, and with X earning R6 per hour and Y earning R9 per hour, the profit-
maximising decision would be as follows:
Priority is given to Y because the opportunity cost of making Y instead of more units of X is R6 per hour (X’s
contribution per machine hour), and since Y earns R9 per hour, the incremental benefit of making Y instead of
X would be R3 per hour.
17
If extra machine hours could be made available, more units of X (up to 1 000) would be made, and an extra
contribution of R6 per hour could be earned. Similarly, if fewer machine hours were available, the decision
would be to make fewer units of X and to keep production of Y at 1 000 units, and so the loss of machine hours
would cost the company R6 per hour in lost contribution. This R6 per hour, the marginal contribution-earning
potential of the limiting factor at the profit-maximising output level, is referred to as the shadow price (or
dual price) of the limting factor.
KEY TERM
A shadow price is the increase in value obtainable from having available one additional unit of a limiting
resource at the original cost.
Note that the shadow price only applies while the extra unit of resource can be obtained at its normal variable
cost. The shadow price also indicates the amount by which contribution could fall if an organization is deprived
of one unit of the resource.
The shadow price of a resource is its internal opportunity cost. This is the marginal contribution towards
fixed costs and profit that can be earned for each unit of the limiing factor that is available. A knowledge of the
shadow price of a resource will help managers to decide how much it is worth paying to acquire another unit of
the resource.
Limiting factor analysis provides us with a profit-maximising product mix, within the assumptions made. It is
important to remember, however, that other considerations might entirely alter the decision reached.
Qualitative factors
Factor Examples
Demand Will the decision reached (perhaps to make and sell just one product rather than
two) have a harmful effect on customer loyalty and sales demand? For example,
a manufacturer of knives and forks could not expect to cease production of knives
without affecting sales demand for the forks.
Long-term Is the decision going to affect the long-term as well as the short-term plans of the
effects organization? If a particular product is not produced, or produced at a level below
sales demand, is it likely that competitors will take over vacated markets? Labour
skilled in the manufacture of the product may be lost and a decision to reopen or
expand production of the product in the future may not be possible.
Labour If labour is a limting factor, is it because the skills required are difficult to obtain,
perhaps because the organization is using very old-fashioned production
methods, or is the organization a high-tech newcomer in a low-tech area? Or
perhaps the conditions of work are so unappealing the people simply do not want
to work for the organization.
Other The same sort of questions should be asked whatever the limiting factor. If
limiting machine hours are in short supply is this because more machines are needed, or
factors newer, more reliable and efficient machines? If materials are in short supply,
what are competitors doing? Have they found an equivalent or better substitute?
Is it time to redesign the product?
18
Assumptions in limiting factor analysis
In the examples we have been looking at, certain assumptions have been made. If any of the assumptions are
not valid, then the profit-maximising decision might be different. These assumptions are as follows:
a) Fixed costs will be the same regardless of the decision that is taken, and so the profit-maximising and
contribution-maximising output level will be the same.
This will not necessarily be true, since some fixed costs might be directly attributable to a product or
service. A decision to reduce or cease altogether activity on a product or service might therefore result
in some fixed cost savings, which would have to be taken into account.
b) The unit variable cost is constant, regardless of the output quantity of a product or service. This
implies the following:
i) The price of resources will be unchanged regardless of quantity; for example, there will be no
bulk purchase discount of raw materials.
ii) Efficiency and productivity levels will be unchanged; regardless of output quantity the direct
labour productivity, the machine time per unit, and the materials consumption per unit will
remain the same.
c) The estimates of sales demand for each product, and the resources required to make each product,
are known with certainty.
In Example 3 – page 10, there were estimates of the maximum sales demand for the two products, and
these estimates were used to establish the profit-maximisng product mix. Suppose the estimates were
wrong? The product mix finally chosen would then either mean that some sales demand of the most
profitable item would be unsatisfied, or that production would exceed sales demand, leaving some
stock unsold. Clearly, once a profit-maximising output decision is reached, management will have to
keep their decision under continual review, and adjust their decision as appropriate in the light of actual
results.
d) Units of output are divisable, and a profit-maximising solution might include fractions of units as the
optimum output level.
Where fractional answers are not realistic, some rounding of the figures will be necessary.
The ‘make’ option should give management more direct control over the work, but the ‘buy’ option often
has the benefit that the external organization has a specialist skill and expertise in the work. Make or buy
decisions should certainly not be based exclusively on cost considerations.
If an organization has the freedom of choice about whether to make internally or buy externally and has no
scarce resources that put a restriction on what it can do itself, the relevant costs for the decision will be the
differential costs between the two options.
19
EXAMPLE 5 : MAKE OR BUY
Shellfish Ltd makes four components, W, X, Y and Z, for which costs in the forthcoming year are expected to be
as follows:
W X Y Z
Production (units) 1 000 2 000 4 000 3 000
Unit marginal costs R R R R
Direct materials 4 5 2 4
Direct labour 8 9 4 6
Variable production overheads 2 3 1 2
14 17 7 12
Directly attributable fixed costs per annum and committed fixed costs are as follows:
R
Incurred as a direct consequence of making W 1 000
Incurred as a direct consequence of making X 5 000
Incurred as a direct consequence of making Y 6 000
Incurred as a direct consequence of making Z 8 000
Other fixed costs (committed) 30 000
50 000
A subcontractor can supply units of W, X, Y and Z for R12, R21, R10 and R14 respectively.
REQUIRED:
The relevant costs are the differential costs between making and buying, and they consist of differences
in unit variable costs plus differences in directly attributable fixed costs. Subcontracting will result in
some fixed cost savings.
W X Y Z
R’s R’s R’s R’s
Unit variable cost of making 14 17 7 12
Unit variable cost of buying 12 21 10 14
R(2) R4 R3 R2
Extra variable cost of buying (per annum) (2 000) 8 000 12 000 6 000
Fixed costs saved by buying 1 000 5 000 6 000 8 000
Extra total cost of buying (3 000) 3 000 6 000 (2 000)
The company would save R3 000 pa by subcontracting component W (where the purchase cost would be less
than the marginal cost per unit to make internally) and would save R2 000 pa by subcontracting component Z
(because of the saving in fixed costs of R8 000).
20
Important further considerations would be as follows:
a) If components W and Z are subcontracted, the company will have spare capacity. How should that
spare capacity be profitably used? Are there hidden benefits to be obtained from subcontracting?
Would the company’s workforce resent the loss of work to an outside subcontractor, and might such a
decision cause an industrial dispute?
b) Would the subcontractor be reliable and delivery times, and would he supply components of the
same quality as those manufactured internally?
c) Does the company wish to be flexible and maintain better control over operations by making
everything itself?
d) Are the estimates of fixed cost saving reliable? In the case of Product W, buying is clearly cheaper
than making in-house. In the case of production Z, the decision to buy rather than make would only be
financially beneficial if the fixed cost savings of R8 000 could really be ‘delivered’ by management.
A company might want to do more things than it has the resources for, and so its alternatives would be as
follows:
a) Make the best use of the available resources and ignore the opportunities to by help from outside.
b) Combine internal resources with buying externally so as to do more and increase profitability.
Buying help from outside is justifiable if it adds to profits. A further decision is then required on how to split the
work between internal and external effort. What parts of the work should be given to suppliers or sub-
contractors so as to maximize profitability?
In a situation where a company must sub-contact work to make up a shortfall in its own in-house
capabilities, its total costs will be minimized if those units bought have the lowest extra variable cost of
buying per unit of scarce resource saved.
Seaman Ltd manufactures three components, S, A and T using the same machines for each. The budget for
the next year calls for the production and assembly of 4 000 of each component. The variable production cost
per unit of the final product is as follows:
Machine Variable
hours cost
R
1 unit of S 3 20
1 unit of A 2 36
1 unit of T 4 24
Assembly 20
100
Only 24 000 hours of machine time will be available during the year, and a sub-contractor has quoted the
following unit prices for supplying components: S R29; A R40; T R34.
21
REQUIRED:
SOLUTION
The company’s budget calls for 36 000 hours of machine time, if all the components are to be produced in-
house. Only 24 000 hours are available, and so there is a shortfall of 12 000 hours of machine time, which is
therefore a limiting factor. The shortage can be overcome by subcontracting the equivalent of 12 000 machine
hours’ output to the subcontractor.
The assembly costs are not relevant costs because they are unaffected by the decision.
The decision rule is to minimize the extra variable costs of sub-contracting per unit of scarce resource
saved (that is, per machine hour saved).
S A T
R R R
Variable cost of making 20 36 24
Variable cost of buying 29 40 34
Extra variable cost of buying 9 4 10
Machine hours saved by buying 3 hrs 2 hrs 4 hrs
Extra variable cost of buying per hour saved R3 R23 R2.50
This analysis shows that it is cheaper to buy A than to buy T and it is most expensive to buy S. The
priority for making the components in-house will be in the reverse order; S, then T, then A. There are
enough machine hours to make all 4 000 units of S (12 000 hours) and to produce 3 000 units of T (another 12
000 hours). 12 000 hours’ production of T and A must be sub-contracted.
22
QUESTION 5
TW Ltd manufactures two products, the D and the E, using the same material for each. Annual demand for the
D is 9 000 units, while for the E is 12 000 units.
The variable production cost per unit of the D is R10, that of the E R15. The D requires 3.5 kgs of raw material
per unit, the E requires 8 kgs of raw material per unit.
Supply of raw material will be limited to 87 500 kgs during the year.
A sub contractor has quoted prices of R17 per unit for the D and R25 per unit for the E to supply the product.
How many of each product should TW Ltd manufacture in order to maximize profits?
SOLUTION
D E
R per unit R per unit
Variable cost of making 10 15
Variable cost of buying 17 25
Extra variable cost of buying 7 10
Raw material saved by buying 3.5 kgs 8 kgs
Extra variable cost of buying per kg saved R2 R1.25
Priority for internal manufacture 1 2
SHUTDOWN PROBLEMS
Shutdown problems involve the following type of decisions:
a) Whether or not to close down a factory, department, product line or other activity, either because it is
making losses or because it is too expensive to run.
b) If the decision is to shut down, whether the closure should be permanent or temporary.
Although in practice shutdown decisions will involve longer-term considerations (such as savings in annual
operating costs for a number of years), and capital expenditures and revenues (sales of fixed assets and
redundancy payments), it is possible for shutdown problems to be simplified into short-run decisions, by
assuming that either fixed asset sales and redundancy costs would be negligible or that income from fixed
asset sales would match redundancy costs and so these capital items would be self-cancelling. In such
circumstances the financial aspect of shutdown decisions would be based on short-run relevant costs.
23
EXAMPLE 7 : ADDING OR DELETING PRODUCTS
A company manufactures three products, Pawns, Rooks and Bishops. The present net annual income from
these is as follows:
The company is concerned about its poor profit performance, and is considering whether or not to cease selling
Rooks. It is felt that selling prices cannot be raised or lowered without adversely affecting net income. R5 000
of the fixed costs of Rooks are direct fixed costs which would be saved if production ceased. All other fixed
costs, it is considered, would remain the same.
By stopping production of Rooks, the consequences would be a R10 000 fall in profits.
R
Loss of contribution (15 000)
Savings in fixed costs 5 000
Incremental loss (10 000)
Suppose, however, it were possible to use the resources realized by stopping production of Rooks and switch
to producing a new item, Crowners, which would sell for R50 000 and incur variable costs of R30 000 and
extra direct fixed costs of R6 000. A new decision is now required.
Rooks Crowners
R R
Sales 40 000 50 000
Less variable costs 25 000 30 000
15 000 20 000
Less direct fixed costs 5 000 6 000
Contribution to shared fixed costs and profit 10 000 14 000
It would be more profitable to shut down production of Rooks and switch resources to making Crowners, in
order to boost profits by R4 000 to R9 000.
Relative profitability
The relative profitability of products can be judged by calculation of their contribution to sales (C/S) ratios.
Suppose an organization produces three products A, B and C, and that production capacity is limited. If
product A has a C/S ratio of 22%, production B a C/S ratio of 27% and product C a C/S ratio of 25%, given
unlimited demand for the three products the organization should concentrate on producing product B.
Temporary closure
The decision whether to shut down temporarily should take into account the following factors:
The impact on the organisation’s other products and the product in question
Problems of recruitment of skilled labour when production begins again
Possibility of plant obsolescence
Problems of closing down and restarting production in some industries
Expenditure on disconnection of services, start up costs and so on
24
If contribution is only just covering fixed costs but improved trading conditions in the future seem likely it
may be worth continuing the business.
a) A product may be retained if it is providing a contribution, albeit a small one. Retaining a wide range of
low volume/low contribution products would add to the complexity and hence costs of
manufacture, however, but very little to overall profit. Low volume/low contribution products should
therefore be examined on a regular basis.
b) The effect on demand for other products if a particular product is no longer produced should be
taken into account.
c) The extent to which demand for other products (existing or new) can expand to use the capacity
vacated by the product being deleted is an issue.
d) Pricing policy. Is the product a loss leader? Is the product in the introductory stage of its life cycle
and consequently priced low to help it to become accepted and hence maximize its long-term market
share (penetration pricing).
If an organization does decide to shut down a factory, department, product line or other activity, it may well
be faced with a decision about what to do with the resulting idle production capacity.
b) Idle plant and machinery could be moved to another department or factory, thereby reducing
expenditure on new plant and machinery and/or interest charges.
c) Special orders could be accepted, providing that the contribution generated is either greater than any
reduction in fixed overheads which would occur if the idle capacity was not used or greater than any
increase in fixed overheads if the idle capacity were to be used.
a) Would the work force be willing to work the shift hours, and if so, what overtime or shift work
premium over their basic pay might they expect to receive?
b) Do extra hours have to be worked just to remain competitive? Banks might decide to open on
Saturdays just to match what competitors are doing and so keep customers.
25
c) Would extra hours result in more sales revenue, or would there merely be a change in the demand
pattern. For example, if a shop were trying to decide whether to open on Sundays, one consideration
would be whether the customers it would get on Sunday would simply be customers who would
otherwise have done their shopping on another day of the week instead, or whether they would be
additional customers.
When a business expands, the management is often faced with the problems of whether to acquire larger
premises and more plant and machinery and whether to persuade existing personnel to work longer hours
(on an overtime basis) or to engage extra staff who would use the existing equipment but a different time
(on a shift basis).
If the management decide to incur additional expenditure on premises and plant, that expenditure is a
fixed cost. It will therefore be necessary to determine how much additional contribution will be required
from the anticipated increased production to cover the extra fixed cost.
If it is decided to use the existing fixed assets, but for a longer period each day, the choice of shift working
or overtime will also involve a marginal costing consideration.
a) If overtime is selected, the direct wages cost per unit produced will be increased because the
wages paid to workers on overtime are a basic rate plus an overtime bonus.
b) If the management opt for shift working the shift premium may not be as expensive as the overtime
premium so the direct wages cost may be relatively lower. On the other hand, there may be an
increase in fixed (or semi-fixed) costs such as lighting, heating and canteen facilities.
If an organization has spare capacity (which means that it would not have to turn away existing business), a
‘special’ (one-off) order (which is normally (in the exam) at a price below the normal price of the product),
should be accepted if the price offered makes some contribution to fixed costs and profit. In other words,
the variable cost of the order needs to be less than the price offered. Fixed costs are irrelevant to such a
decision since they will be incurred regardless of whether or not the order is accepted. Additional fixed costs
incurred as a result of accepting the order must be taken into account, however.
If an organization does not have sufficient spare capacity, existing business should only be turned away
if the contribution from the order is greater than the contribution from the business which must be
sacrificed.
26
EXAMPLE 8 : ACCEPTING OR REJECTING ORDERS
Holdup Ltd makes a single product which sells for R20, and for which there is great demand. It has variable
cost of R12, made up as follows:
R
Direct material 4
Direct labour (2 hrs) 5
Variable overhead 2
12
The labour force is currently working at full capacity producing a product that earns a contribution of R4 per
labour hour. A customer has approached the company with a request for the manufacture of a special order for
which he is willing to pay R5 500. The costs of the order would be R2 000 for direct materials, and 500 labour
hours will be required.
REQUIRED:
SOLUTION
a) Labour is a limiting factor. By accepting the order, work would have to be diverted away from the
standard product, and contribution will be lost, that is, there is an opportunity cost of accepting the new
order, which is the contribution forgone by being unable to make the standard product.
b) Direct labour pay costs R3 per hour, but it is also usually assumed that variable production overhead
varies with hours worked, and must therefore be spent in addition to the wages cost of the 500 hours.
c)
R R
Value of order 5 500
Cost of order
Direct materials 2 000
Direct labour (500 hrs x R3) 1 500
Variable overhead (500 hrs x R1) 500
Opportunity cost (500 hrs x R4) (Contribution forgone) 2 000
Relevant cost of the order 6 000
Loss incurred by accepting the order (500)
Although accepting the order would earn a contribution of R1 500 (R5 500 – R4 000), the lost production of the
standard product would reduce contribution earned elsewhere by R2 000 and so the order should not be
accepted.
a) Will relationships with existing customers, or prices that can be commanded in the market, be
affected if the order is accepted?
c) Should existing business be turned away in order to fulfil a one-off enquiry or could a long-term
contract be established?
27
QUALITATIVE FACTORS IN DECISION MAKING
Qualitative factors in decision making are factors which might influence the eventual decisions but which have
not been quantified in terms of relevant income or costs. They may stem from non-financial objectives and
from factors which might be quantifiable in money terms, but which have not been quantified, perhaps because
there is insufficient information to make reliable estimates.
Qualitative factors in decision making will vary with the circumstances and nature of the opportunity being
considered. Here are some examples:
Qualitative factor Detail
Availability of There must be sufficient cash to finance any purchases of equipment and build-up of
cash working capital. If cash is not available, new sources of funds (for example an
overdraft or loan) must be sought.
Inflation If the income from an opportunity is fixed by contract, but the costs might increase with
inflation, the contract’s profitability would be over-stated unless inflation is taken into
account.
Employees Any decision involving the shutdown of a plant or changes in work procedures or
location will require acceptance by employees, and ought to have regard to employee
welfare.
Customers Decisions about new products, the quality of output or after-sales service will inevitably
affect customer loyalty and customer demand. Remember that a decision involving
one product may have repercussions on customer attitudes towards a range of
products.
Competitors In a competitive market, some decisions may stimulate a response from rival
companies. The decision to reduce selling prices to raise demand may fail if all
competitors take similar action.
Timing factors There might be a choice in deciding when to take up an opportunity. There might also
be choice about whether a shutdown should be permanent or temporary. Temporary
closure may be a viable proposition during a period of slack demand. And if a decision
is taken to sell goods at a low price where the contribution earned will be relatively
small, it is important to consider the duration of the low price promotion. If it is a long-
term feature of selling, and if demand for the product increases, the company’s total
contribution may sink to a level where it fails even to cover fixed costs.
Suppliers Long-term goodwill may be damaged by a decision to close a product line temporarily.
Decisions to change the specifications for purchased components, or change
stockholding policies so as to create patchy, uneven demand might also put a strain on
suppliers.
Feasibility A proposal may look feasible, but technical experts or managers may have
reservations about their ability to carry it out.
Flexibility & Decisions to subcontract work, or to enter into a long-term contract, have the
internal control disadvantages of inflexibility and lack of controllability.
Unquantified Even where no opportunity costs are specified, it is probable that other opportunities
opportunity costs would be available for using the resources to earn profit.
Political Some large companies may suffer political pressures applied by the government to
pressures influence their investment or disinvestments decisions.
Legal constraints A decision might occasionally be rejected because of questions about the legality of
the proposed action.
28
QUESTION 6 (30 marks)
The managing director of Parser Ltd, a small business, is considering undertaking a once-off contract and has
asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can price at a
profit. The following schedule has been prepared:
Notes R
Notes
1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for this job,
who could be transferred from another department to undertake work on the special order. They are fully
occupied in their usual department and sub-contracting staff would have to be bought-in to undertake the
work left behind. Subcontracting costs would be R32 000 for the period of the work. Different
subcontractors who are skilled in the special order techniques are available to work on the special order
and their costs would amount to R31 300.
2. A supervisor would have to work on the special order. The cost of R11 500 is comprised of R8 000
normal payments plus R3 500 additional bonus for working on the special order. Normal payments refer
to the fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his
normal work amounting to R2 500. It is not anticipated that any replacement costs relating to the
supervisor’s work on other jobs would arise.
4. Machine depreciation represents the normal period cost based on the duration of the contract. It is
anticipated that R500 will be incurred in additional machine maintenance costs.
5. Machine overheads (for running costs such as electricity) are charged at R3 per hour. It is estimated that
6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The
further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost
contribution of R2 per hour.
6. Materials represent the purchase costs of 7 500 kg bought some time ago. The materials are no longer
used and are unlikely to be wanted in the future except on the special order. The complete stock of
materials (amounting to 10 000 kg), or part thereof, could be sold for R4,20 per kg. The replacement cost
of material used would be R33 375.
7. Costs will be incurred evenly over the project duration of three months.
The prospective client is willing to make an upfront payment of R40 000. The outstanding balance
will be paid one month after completion. Because the business does not have adequate funds to finance the
special order, a bank overdraft shortfall will be required. The overdraft will be repaid on settlement of the
outstanding debt. The company uses a cost of capital of 15% to appraise projects. The bank’s overdraft rate is
12% for Parser Ltd.
29
The managing director has heard that, for special orders such as this, relevant costing should be used that also
incorporates opportunity costs. She has approached you to create a revised costing schedule based on
relevant costing principles.
REQUIRED
(b) Determine the minimum price to be quoted by Parser Ltd on the once-off contract; an NPV approach is
not required. (16)
(c) Explain why very Small to Medium-size Enterprises (SMEs), such as Parser Ltd, might face problems in
obtaining appropriate sources of finance. In your answer pay particular attention to problems and issues
associated with:
(ACCA – adapted)
30
QUESTION 6 : SOLUTION
(a) Opportunity costs represent the value of the loss or sacrifice when choosing between scarce alternatives.
(2)
Note R
Notes:
1. The choice lies between the two subcontractor costs that have to be incurred because of the
shortage of existing labour. The minimum cost is to have subcontractors employed who are skilled
in the special process.
2. Only the difference between the bonus and the incentive payment represents an additional cost
that arises due to the special order. Fixed salary costs do not change.
4. Depreciation is a period cost and is not related to the special order. Additional
maintenance costs are relevant.
5. The relevant costs are the variable overheads (R3 x 6 000 hours) that will be incurred, plus the
displacement costs of R2 x 2 000 hours making a total of R22 000.
6. Since the materials are no longer used the replacement cost is irrelevant. The historic cost of
R34 000 is a sunk cost. The relevant cost is the lost sale value of the stock used in the special
order which is: 7 500 kg x R4,20 per kg = R31 500.
7. Full opportunity costing will also allow for imputed interest costs on the incremental loan. The
correct interest rate is the overdraft rate since this represents the incremental cost the company will
pay. (1)
31
Incremental cash outflows (87 300 – 31 500) 55 800 (1)
18 600 (1)
The managing director should decide whether a profit margin should be added to take cognisance of the
required 15% cost of capital. (1)
• Banks consider a range of issues when screening loan applications, one of which is collateral or
security.
• Personal security from owner may not be possible – put his assets/finance in business.
Sources of finance
32
QUESTION 7 (30 MARKS)
Pringle trades as a vat maker for the wine industry. His profit in this business during the year to
30 June was R20 000. Pringle also undertakes occasional contracts to build hand-crafted
cabinets, and is considering the price at which to bid for the contract to build five for an
exclusive furniture supplier, delivery to be in one year’s time. He has no other contract in
hand, or under consideration, for at least the next few months. If he accepts the contract it
will take up all his cabinet-making capacity for the next twelve months.
Pringle expects that if he undertakes the contract he would devote one-quarter of his time
to it. To facilitate this he would employ Smith, an unqualified accountant, to undertake his
book-keeping and other paperwork, at a cost of R12 000 per annum.
He would also have to employ on the contract one supervisor at a total cost of R22 000 and
two craftsmen at a total cost of R8 800 each. These costs include Pringle’s normal
apportionment of the fixed overheads of his business at the rate of 10% of labour cost.
Part of the finishing processes of the cabinets, involves applying a special varnish and
leaving the wood to absorb this. During this maturation time, one of the craftsmen could be
employed for the equivalent of up to three months full-time in maintenance and painting
work in the vat maker’s business. He would use additional materials not carried in inventory
costing R1 000. Pringle already has two inclusive quotations from jobbing repairmen for this
maintenance and painting work, one for R2 500 and the other for R3 500, the work to start
immediately.
The equipment which would be used on the cabinet contract was bought nine years ago
for R32 000. Depreciation has been written off on a straight-line basis, assuming a ten-year
life and a scrap value of R2 000. The current replacement cost of similar new equipment is
R70 000, and is expected to be R75 000 in one year’s time. Pringle has recently been offered
R5 000 for the equipment, and considers that in a year’s time he would have little difficulty in
still obtaining R3 000 for it. The plant is useful to Pringle only for contract work.
In order to build the cabinets Pringle will need six types of material, as follows:
C 200 6.00
Materials B and E are used regularly in the vat maker’s business. Material A could be sold
to a local sculptor if not used for the contract. Materials A and E can be used for other
purposes, such as property maintenance. Pringle has no other use for materials D and F,
the stocks of which are obsolete.
The cabinets would be crafted in a factory held on a lease with three years remaining at a
fixed annual rental of R7 000. It would occupy half of this factory, which is useful to Pringle
only for contract work.
Pringle anticipates that the direct expenses of the contract, other than those noted above,
would be R8 600.
Pringle has recently been offered a one-year appointment at a fee of R40 000 per annum
to manage a furniture manufacturing firm. If he accepted the offer, he would be unable
to take on the contract to build the five cabinets, or any other contract. He would have to
employ a manager to run the vat maker’s business at an annual cost (including fidelity
insurance) of R12 000, and would incur additional personal living costs of R3 000.
REQUIRED:
· Calculate the minimum price at which Pringle should be willing to take on the
contract in order to break even, based exclusively on the information given above.
(20)
· Set out any further considerations which you think that Pringle should take into
account in setting the price at which he would tender for the contract.
(10)
Notes R R
Material costs: d
94,600
(20)
- 36 -
a The costs given in the question include apportioned fixed overheads which are
not a relevant cost. Therefore R2 000 has been deducted from the total
supervision cost (1/11 x R22 000) and R800 from each of the craftsmen’s total
costs.
c The historical cost of the equipment is a sunk cost. It is assumed that the existing
equipment would have been sold if the contract was not accepted. Therefore
the relevant cost of using the equipment is the reduction in the scrap value over
the duration of the contract.
d Material A: It is assumed that the 100 units in stock will be used on property
maintenance first. This is more profitable than the alternative of selling the
materials for R2 and replacing them at a later date at R3. The quantities
needed for the contract will be replaced at the current purchase price.
Material B: It is assumed that the 1 000 units issued from stock for the contract will
be replaced at R0.90 per unit. This material is used regularly in the business.
Materials D and F: The stocks of these materials have no alternative use within
the business and will be sold if not used on the contract. Hence the sale price
represents the opportunity cost of using these materials. The remainder of the
materials will be purchased at current prices.
Material E: It is assumed that the material taken from stock for this contract will
be replaced at the current purchase price. This material is used regularly in the
business.
e The lease of the factory would have to be paid even of the contact were not
accepted.
f It is assumed that the alternative is for Pringle to pay out R15 000 to maintain the
existing business while he earns R40 000 on the one year appointment. If the
contract is undertaken then Pringle will lose R25 000.
2
Disney Limited manufactures Mickey Mouse and Donald Duck Murals for children’s bedrooms.
The following projected information for the 2014 financial year is supplied at a capacity utilisation of 100%:
Mickey Donald
Mouse Duck
R R
2. It is anticipated that fixed overheads will amount to R144 000 per annum and will, at full capacity utilisation, be
applied at a rate of R2,40 per machine hour.
3. Market research has shown that 27 000 Mickey Mouse murals and 18 000 Donald Duck murals could be sold.
4. A shortage of skilled labour is being experienced. As a result, only 80 000 labour hours will be available.
REQUIRED:
(a) Determine the product mixture which will maximise the net income of Disney Limited for 2014. (19)
(b) Calculate the total marginal income that will be earned from Mickey Mouse murals if the selling price increases
by 10%, resulting in a decrease of 5% in the sales volume. Use the full market potential as a basis. Assume
that no limiting factors exist. ( 4)
(c) Calculate what the selling price per unit of the Donald Duck murals should be in order to earn a profit of
R126 000. Assume that the full market potential will be sold and that no limiting factors exist. Fixed overheads
must be applied at the same rate as in (a) above. ( 3)
3
Super Sport Products Ltd is a manufacturer of sport equipment. In order to compile the budget of the section
manufacturing cricket bats for children for the next financial year, a decision must be taken regarding the optimal
product mix.
The standards per unit for each of the models are as follows:
Additional information:
1. Both bats are made from the same material, of which only 35 500 kilograms, at a total cost of R248 500, will be
available during the next financial year.
3. It is estimated that 11 000 Hansie bats and 14 500 Johnty bats could be sold annually.
4. Selling and administration expenses are fixed and amount to R15 000 per annum.
REQUIRED:
Determine the product mix which will maximise the net profit of the section for the next financial year.
(14)
4
Pecdu Limited manufactures two different electronic products, namely electronic igniters and vacuum
sensors.
Electronic Vacuum
igniters sensors
R R
Selling price 90,00 120,00
Additional information:
1. Components are acquired on a monthly basis. The supply is limited to a maximum of R53 500 per month.
2. The company employs 12 workers on the production line. Each employee has to work 170 hours per
month. Direct labour cost amounts to R40 per hour.
3. Fixed cost amounts to R235 200 per annum and is allocated to production at the rate of 15% of prime
cost (i.e. 15% of components and direct labour cost).
The company has been requested to give a quotation for an order of 5 000 electronic igniters. The order,
if accepted, must be delivered in full during the course of 2007.
If the order is accepted, it will not affect the normal annual demand for electronic igniters, as indicated in the
budget in point 2 above.
REQUIRED
(a) Determine the optimal product mixture in respect of the normal annual demand, assuming
that the order for 5 000 units is accepted. (25)
(b) Determine the number of units in respect of the normal annual demand which cannot be
manufactured due to the production of the 5 000 units for the order. (4)
(c) Calculate the marginal income relating to the units calculated in (b) above. (1)
[30]
Hussle (Pty) Limited manufactures electrical kitchen equipment. One of its product lines is toasters. They currently
manufacture two types namely the two slice toaster and the four slice toaster.
Mr Robbs, the production manager, has extracted the following information regarding the manufacturing of toasters
for the month ended 28 February 2014 :
Material
An analysis of the material requisitions shows the following apportionment of materials costs :
Labour
Hours Hours
Skilled labour (@ R20 per hour) 0,5 0,9
Unskilled labour (@ R7 per hour) 1 1,5
The skilled labour cost is 40% fixed. The unskilled labour cost is 100% variable. There are 2 200 skilled
labour hours available per month.
Overheads
Overheads are charged to production at a rate of 150% of the skilled labour cost per hour. The budgeted fixed
manufacturing overheads for the month amount to R20 640.
Production
Sales commission
Future demand
According to estimate the demand for the next month will be 20% above the production of the month ended 28
February 2014. The current selling prices, which will remain unchanged, are as follows :
REQUIRED :
Determine the optimal product mixture which will maximise the income of Hussle (Pty) Limited for the month
ending 31 March 2014.
[31]
OPTIMISATION
INTRODUCTION
FACTORS OF PRODUCTION
UNERLYING ASSUMPTIONS
The assumptions are similar to those of Cost Volume Profit analysis, the most
important of which are:
ILLUSTRATION 1
Assume a company manufactures 2 products, viz Elsi and Mate. Both
products require the same raw material which is called Sharp.
ELSI MATE
The question that needs to be asked is whether you have any limiting factors.
The possible limiting factors are raw material and labour. We have been told
that there are unlimited quantities available which means no limiting factors.
Let’s calculate our total contribution should we produce all of Elsi and all of
Mate.
R
Elsi 300 x 3 900
Mate 200 x 6 1 200
Total contribution 2 100
Now, what if we faced with shortage of raw materials? Let’s say we only had
600 kg of sharp available.
So if we produce all of Mate how much of Elsi can we make? Let’s check.
Kg
To produce 200 Mate 200 x 1kg 200
Available 600
Available to produce 400
Elsi
Once Mate has been produced only 400 kg are available to produce Elsi,
which means we can produce (400 ÷ 1,5) = 266 units of Elsi.
Assume now that Elsi needs 1,2 hours to manufacture and Mate 1,5 hours. Also
assume for now that we only have 610 hours available.
hours
Elsi 1,2 hrs x 300 360
Mate 1,5 hrs x 200 300
Required 660
Available 610
Shortage 50
Labour is a limiting factor. We are now faced with two limiting factors. What
do we produce?
With one limiting factor all we needed to look at was the total contribution.
With 2 limiting factors we need to look further. We will now compare the
contribution per limiting factor (also referred to as marginal income per
limiting factor).
Material
ELSI MATE
Contribution per unit A R3,00 R6,00
Raw material required per unit (limiting factor) B 1,5kg 1kg
Contribution per unit of raw material required A÷B R2/kg R6/kg
Ranking 2 1
What this means is that for every kg of raw material used for Elsi I can earn R2
and for every kg of raw material used for Mate I can earn R6. Hence, this
limiting factor favours the production of Mate and is therefore ranked 1.
ELSI MATE
Contribution per unit A R3,00 R6,00
Labour hours required per unit (limiting factor) B 1,2hrs 1,5hrs
Contribution per labour hour required A÷B R2,5/hr R4/hr
Ranking 2 1
Again I can earn more by employing more hours on mate. Labour also
favours the production of Mate.
5
Hours
To produce 200 Mate 200 x 1,5 hrs 300
Available 610
Available to produce 310
Elsi
Once Mate has been produced only 310 hours are available to produce Elsi,
which means we can produce (310 ÷ 1,2) = 258 units of Elsi.
Labour constraints dictate that we produce 258 units of Elsi while raw material
tells us 266. What do we make? What this means is that we have sufficient raw
material to make 266 units but we don’t have sufficient time to make 266
units. This means, we will have to settle for 200 of Mate and 258 of Elsi.
The above technique is called marginal costing and is used when the ranking
of limiting factors favours the same product.
Let us take the above scenario and change the given information so that the
ranking favours both products for the different limiting factors. Assume that
the amount of labour hours required to manufacture one unit of Mate is 2,5
hours. Let’s see what happens to the ranking:
Labour
ELSI MATE
Contribution per unit A R3,00 R6,00
Labour hours required per unit (limiting factor) B 1,2hrs 2,5hrs
Contribution per labour hour required A÷B R2,5/hr R2,4/hr
Ranking 1 2
Labour favours the manufacture of Elsi while Raw materials favour the
manufacture of Mate. We call this conflicting ranking. In such a case we
have to resort to linear programming.
The above problem can be solved algebraically by solving simultaneous
equations.
6
Parameters: 0 ≤ e ≤ 300
0 ≤ m ≤ 200
2.55e ≤ 890
Substitute in equation 2: e ≤ 349
1,2e + 2,5m ≤ 610 Limited to 300
1,2e + 2,5(600 – ≤ 610
1,5e)
1,2e + 1 500 – 3,75e ≤ 610
890 ≤ 2,55e
E ≤ 349
Note your parameters. The demand for Elsi is limited to 300 units which means
that we will produce 300 units of Elsi.
Remember - NB!!!
Limiting factor is just another word for a constraint! (Denoted below as
“LF” in order to save space)
Marginal income and contribution mean the same thing! (Denoted
below as “MI” in order to save space)
Please write the terms out in full in the exam – do not use “LF” or “MI”.
(we can usually only do the above after we have worked out marginal
income per unit in step 2 so leave a space for this at the beginning of your
question – a few lines needed)
EG:
4. If there is only one limiting factor use MI/ contribution per unit and
produce all of the product with the highest MI/contribution per unit.
(There will be no step 5 and 6).
If there is more than one limiting factor calculate the marginal income
(contribution) per limiting factor relating to each actual limiting factor
for each product.
= Marginal income (MI) per unit of product ÷ limiting factor (LF) per
unit of product
= MI per LF
NB! IT IS AT THIS POINT THAT YOU NEED TO DECIDE WHICH TECHNIQUE YOU
ARE USING (based primarily on your rankings): you can either use
marginal costing (if rankings favour the same product) or linear
programming (if rankings favour different products). Note that steps 1-5
are identical for both techniques.
9
6. Work out the optimal product mix (i.e. how much of each product you
will produce) using the ranking as determined above.
Keep in mind that you cannot produce more of a product than the amount
that is demanded of that product. Also remember that production will stop as
soon as one of the actual constraints has been exhausted despite a surplus of
the other constraints/LFs.
If you were required to calculate net profit from making the optimal product
mix, then you would simply subtract fixed costs from the total marginal
income (total contribution) earned. In this case the total marginal income
would be the marginal income per unit multiplied by the number of units in
the optimal product mix for each product.
OR
Keep in mind that you cannot produce more of a product than the amount
that is demanded of that product. Also remember that production will stop as
soon as one of the actual constraints has been exhausted despite a surplus of
the other constraints.
If you were required to calculate net profit from making the optimal product
mix, then you would simply subtract fixed costs from the total marginal
income (total contribution) earned. In this case the total marginal income
would be the marginal income per unit multiplied by the number of units in
the optimal product mix for each product.
11