MANAGEMENT ACCOUNTING

FORMATION 2 EXAMINATION - AUGUST 2019

NOTES:
Section A - Questions 1 and 2 are compulsory. You have to answer Part A or Part B only of Question 2. Should
you provide answers to both Part(s) A and B of Question 2, you must draw a clearly distinguishable line through
the answer not to be marked. Otherwise, only the first answer to hand for this question will be marked.
Section B - You are required to answer any three out of Questions 3 to 6. Should you provide answers to all of
Questions 3 to 6, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise,
only the first three answers to hand for these four questions will be marked.

TIME ALLOWED:
3 hours, plus 10 minutes to read the paper.

INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence
writing in your answer book. Please read each Question carefully.

Marks for each question are shown. The pass mark required is 50% in total over the whole paper.

Start your answer to each question on a new page.

You are reminded to pay particular attention to your communication skills and care must be taken
regarding the format and literacy of your solutions. The marking system will take into account the content
of your answers and the extent to which answers are supported with relevant legislation, case law or
examples where appropriate.

List on the cover of each answer booklet, in the space provided, the number of each question
attempted.

NB: PLEASE ENSURE TO ENCLOSE YOUR ANSWER SHEET TO QUESTION 3 IN THE ENVELOPE
PROVIDED.

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - AUGUST 2019
Time allowed: 3 hours, plus 10 minutes to read the paper.
Section A: Answer Question 1 and either Part A or Part B of Question 2.
Section B: You are required to answer any three out of Questions 3 to 6.

SECTION A
1. Outdoorz DAC (Outdoorz) is based in Cork and manufactures a range of garden furniture for the Irish market. The
company commenced trading five years ago and its sales have increased substantially since then. The garden
furniture is made from wood that has been treated to withstand Irish weather conditions. There are two production
departments: Cutting and Assembly, and two support departments: Stores and Machine Maintenance.

Direct materials and direct labour costs have already been identified and Outdoorz uses a traditional absorption
costing system to allocate production overheads to products.

The following budgeted cost information is available for the month:

Total Cutting Assembly Stores Machine

Maintenance
€ € € € €
Direct wages 371,480 83,880 201,600 39,000 47,000
Indirect wages 69,000 21,000 15,000 15,000 18,000
Power 28,360
Factory security 10,500
Factory rent and rates 36,200
Machine depreciation 6,600
Light and heat 6,240
Factory insurance 12,400
Supervisors’ salaries 16,480

The company has also supplied details of its budgeted activity for the month:

Total Cutting Assembly Stores Machine

Maintenance
Machine hours 38,600 30,880 7,720
Direct labour hours 24,000 7,200 16,800
Value of stores issues (€) 186,400 139,800 46,600
Kilowatt hours (% usage) 100 60 25 5 10
Number of employees 32 8 18 3 3
Value of machinery (€) 400,000 240,000 100,000 40,000 20,000
Floor area (square metres) 1,000 300 400 200 100

REQUIREMENT:

(a) On the basis of the information provided, prepare a schedule of the total budgeted overheads for each of the four
departments, clearly showing the basis of apportionment.
(9 marks)

(b) Calculate the total budgeted overheads for each of the production departments after the service departments have
been re-apportioned.
(3 marks)

(c) Compute the budgeted overhead absorption rates for each of the production departments. (4 marks)

Page 1
(d) At the end of the period the actual production overhead cost incurred by the Cutting department was €117,240.
Actual labour hours worked in that department were 7,050 and actual machine hours recorded were 31,500.
Calculate the under or over absorbed production overhead for the Cutting department.
(2 marks)

(e) One of the company’s most popular products is a garden bench and cost information relating to this product is
shown below.

Direct materials €15.25

Direct labour hours:

Cutting 0.25 hour
Assembly 0.75 hour

Machine hours
Cutting 0.25 hour
Assembly 0.25 hour

Calculate the total product cost per garden bench. (7 marks)

[Total: 25 Marks]

Page 2
ANSWER PART (A) OR PART (B)
2.
(A) David Cullen commenced his manufacturing business earlier this year and has been preparing management
accounts using variable (marginal) costing. He has approached you as a Certified Public Accountant, to prepare
financial statements for his company for the first year of trading. As part of your discussions with him, you mentioned
that you will use absorption costing to prepare the financial statements. David said that he was unfamiliar with this
method of costing and has asked you for more information about it.

REQUIREMENT:

Draft a memorandum for David Cullen that:

(a) Briefly describes the basis of variable (marginal) and absorption costing systems. (4 marks)

(b) Explains the effect on profit of using variable (marginal) and absorption costing. (5 marks)

(c) Outlines TWO advantages and TWO disadvantages of both variable (marginal) AND absorption costing systems.

(5 marks)

Format and Presentation (1 mark)

[Total: 15 Marks]

OR
(B) You are a Certified Public Accountant in the firm of Henry & French. The firm has a number of small business
clients who often require advice and information regarding monthly management accounting matters. Recently, one
client asked about the purposes of, and procedures involved in, the annual budgeting process. To address this
request, one of the partners in the firm has asked you to prepare a briefing note to outline the main features of
budgeting.

REQUIREMENT:

Prepare a briefing note that:

(a) Describes the SIX main purposes of budgeting. (6 marks)

(b) Explains the difference between fixed and flexible budgets. (2 marks)

(c) Briefly outlines the functional budgets that may be prepared as part of the budgeting process. (4 marks)

(d) Describes TWO behavioural issues that may arise from the budgeting process. (2 marks)

Format and Presentation (1 mark)

[Total: 15 Marks]

Page 3
SECTION B - ANSWER ANY THREE QUESTIONS.
3. The following multiple-choice question contains eight sections, each of which is followed by a choice of
answers. Only one answer is correct in each case. Each question carries equal marks. On the answer sheet
provided, indicate for each question, which of the options you think is the correct answer. Marks will not
be awarded where you select more than one answer for any question.

1. Which of the following costs is a DIRECT cost:

(a) Factory maintenance.

(b) Wood for a furniture maker.
(c) Brushes and materials used by factory cleaners.
(d) Oil for factory machinery.

2. The following information relates to the output level in units and corresponding production overhead costs for Grey
Ltd for the past 3 months:

Output (Units) Production overhead costs

January 80,000 €278,000
February 55,000 €208,000
March 120,000 €390,000

Production overheads include both a fixed and variable element. Total fixed production overhead costs are
estimated to be:

(a) €70,000
(b) €54,000
(c) €112,000
(d) €154,000.

3. When using the First in First Out (FIFO) method to value inventory which of the following statements is FALSE?

(a) When prices are increasing, the cost of issues to production calculated using FIFO is higher than if using Last In
First Out (LIFO) or Average Cost methods.
(b) FIFO makes the same assumptions as the physical flow of materials through an organisation.
(c) FIFO is accepted by IFRS as suitable for valuing inventory.
(d) When prices are increasing, closing inventory calculated using FIFO is valued at the highest prices.

4. XY Ltd. had the following stores records for the month of July:

July 1 Receipt 100 units, cost €1.00 per unit

July 2 Issue 60 units
July 3 Receipt 40 units, cost €1.20 per unit
July 10 Issue 60 units
July 13 Receipt 20 units, cost €1.30 per unit
July 24 Receipt 20 units, cost €1.50 per unit
July 29 Issue 60 units

Assuming that XY Ltd. uses a FIFO costing approach, the value of the issue to production on July 10 is:

(a) €60
(b) €64
(c) €72
(d) €75.

Page 4
5. Zed Ltd. operates an incentive scheme to pay its staff. Workers are paid based either a piecework rate (number
of units produced) or 80% of pay based on the hourly rate, whichever is higher. The company produces one product,
X5, and the standard time to make this product is 7 minutes. For the purposes of piecework calculations each
minute is valued at €0.12. The following information for a week in December relates to one worker:

Hours worked 37
Rate of pay per hour €12.20
Units of X5 produced 505

The amount of pay that the worker will receive is:

(a) €451.40
(b) €361.12
(c) €424.20
(d) €339.36.

6. DS Ltd. uses the Economic Order Quantity (EOQ) to calculate the amount of inventory that it should order. The
following details have been extracted from the company’s accounting system:

Monthly demand 490 units

Purchase price per unit €10
Cost of placing an order €15
Costs of holding one unit of inventory for one year 1% of purchase price

The amount of inventory (in units) that the company should order (rounded to nearest whole number) is:

(a) 1,212
(b) 1,328
(c) 383
(d) 4,200.

The following information relates to Question 7 and Question 8.

Red DAC is considering using Material C and Material D to produce a new product. Material C is no longer used
by the company in its production activities, while Material D is in regular use. The following details are available
for Materials C and D:

Material Quantity available Original Cost per kg Current cost per kg Scrap value per kg
C 4,200 kg €3.50 €3.25 €0.90
D 3,000 kg €2.10 €2.40 €0.50

Production of the new product requires 6,000 kg of Material C and 2,000 kg of material D.

7. The relevant cost of Material C to be included in the new product cost is:

(a) €20,550
(b) €9,630
(c) €10,080
(d) €19,500.

8. The relevant cost of Material D to be included in the new product cost is:

(a) €2,900
(b) €6,300
(c) €4,800
(d) €4,200.
[Total: 20 Marks]

Page 5
4. Beachy DAC has developed a new range of high quality affordable sandals for beachwear. The sandals are based
on an innovative design that protects feet from the effects of sun, salt and sand. The company has already received
some sales orders for the sandals and production is due to commence next month. The management accountant
has prepared the following projections for the trading year ahead:

(Production and sales of 100,000 pairs of sandals) € €

Sales 2,750,000
Cost of sales
Direct materials 619,000
Direct labour (Note 1) 411,000
Production overhead (Note 2) 236,000 1,266,000
Gross profit 1,484,000
Administration expenses (Note 2) 336,500
Selling and distribution expenses (Note 2) 145,000 481,500
Profit 1,002,500

Notes:
1. It is assumed that the company will pay workers based on a fixed time basis i.e. hours worked regardless
of output achieved.

2. The production, administration, and selling and distribution costs have been analysed and the cost behaviour
is shown below:

Fixed element Variable element

Production overhead 25% 75%
Administration expenses 100% n/a
Selling and distribution expenses 80% 20%

REQUIREMENT:

(a) Calculate the break-even point in units (pairs of sandals) and revenue. (5 marks)

(b) Calculate the margin of safety in units (pairs of sandals) and revenue. (3 marks)

(c) How many pairs of sandals must Beachy DAC sell to make a profit of €1,500,000? (3 marks)

(d) Beachy DAC is considering changing the basis of paying staff from a fixed time basis to a piece rate system. Under
the new system employees will be paid €4.25 per pair of sandals produced. If the company introduces this new
system it will have to employ an extra production supervisor who will be paid a salary of €60,000 per year.

Assuming that the company implements the new pay system:

(i) What is the new break-even point in units (pairs of sandals)? (4 marks)

(ii) How many pairs of sandals must be sold to achieve the current level of profit (i.e. €1,002,500)? (2 marks)

(iii) Which of the pay systems (fixed time or piece rate) would you recommend for the company? Give reasons
for your answer.
(3 marks)

[Total: 20 Marks]

Page 6
5. Tabletopz DAC (Tabletopz) manufactures high quality wooden table mats using beech sourced from sustainable
forests. The company began trading two years ago having identified a niche market for the product, both in Ireland
and Europe. During the year, Tabletopz was forced to purchase wood from a different company as the usual supplier
did not have sufficient stock available.

The company operates a standard variable (marginal) costing system and details relating to the most recent
financial period are shown below.

Actual information:
Production in units 135,000
Direct materials: 10,800 square metres beech wood €300,240
Direct labour hours: 27,000 hours €486,000
Variable production overhead €194,400
Fixed production overhead €30,150

Budgeted information:
Production in units 134,400
Direct materials: 10,080 square metres beech wood €282,240
Direct labour: 33,600 hours €483,840
Variable production overhead (based on direct labour hours) €225,792
Fixed production overhead €29,200

REQUIREMENT:

(a) Prepare a standard cost card for one table mat. (4 marks)

(b) Calculate relevant variances in as much detail as the information above permits. (10 marks)

(c) For each of the materials variances calculated, suggest TWO reasons that may explain why the variance has
occurred.
(4 marks)

(d) Briefly explain the following terms:

• Ideal standard.
• Attainable standard. (2 marks)

[Total: 20 Marks]

Page 7
6. Sweet Treatz DAC is based in Tipperary and makes a range of tasty confectionery, including toffee squares.
Manufacturing toffee involves two production processes: mixing and cooking. All of the ingredients are added in
the mixing process and combined thoroughly. Next, the toffee mix is cooked to the correct temperature and then
poured into large trays. When the toffee is cool it is cut into squares and packaged. The company has adopted
process costing based on the weighted average approach to value the toffee. Cost and other information relating
to both processes for the month of March are provided below.

Mixing Process Cooking Process

Opening work in progress at 1 March 10,000 kg 16,000 kg
- Material €24,200 €43,130
- Labour and production overhead €6,924 €35,790
Costs incurred during the month
- Materials input 40,000 kg €108,800 Nil
- Direct labour cost €84,600 €45,150
- Production overhead €31,020 €14,820
Transferred from mixing to cooking process 41,000 kg n/a
Transferred from cooking process to packaging n/a 56,000 kg
Normal loss expected (% material input in the month) 5% Nil
Scrap value €0.50 per kg Nil
Closing work in progress at 31 March 6,000 kg Nil

Note 1: All materials are added immediately in the mixing process. The opening work in progress in the mixing
process at 1 March was 60% complete in relation to labour and overheads. At at 31 March it was 40% complete
in relation to labour and overheads.

Note 2: The opening work in progress in the cooking process at 1 March was 50% complete.

REQUIREMENT:

Prepare the following accounts, where applicable, for the month of March. You should ensure that all workings are shown
clearly:

(a) Mixing process account.

(b) Cooking process account.

(c) Normal loss account.

(d) Abnormal loss/abnormal gain account. [Total: 20 Marks]

END OF PAPER

Page 8
SUGGESTED SOLUTIONS
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

MANAGEMENT ACCOUNTING
FORMATION 2 EXAMINATION - AUGUST 2019

SOLUTION 1

(a) Schedule of budgeted overheads Machine

Overhead expense Basis Total Cutting Assembly Stores maintenance

Exclude direct wages Not a production overhead

Indirect labour Given 69,000 21,000 15,000 15,000 18,000

Power Kilowatt hours 28,360 17,016 7,090 1,418 2,836
Factory security Floor area 10,500 3,150 4,200 2,100 1,050
Factory rent and rates Floor area 36,200 10,860 14,480 7,240 3,620
Machine depreciation Value of machinery 6,600 3,960 1,650 660 330
Light and heat Floor area 6,240 1,872 2,496 1,248 624
Factory insurance Floor area** 12,400 3,720 4,960 2,480 1,240
Supervisors' salaries Number of employees 16480 4120 9270 1545 1545
185,780 65,698 59,146 31,691 29,245
9
(b) Reapportionment of service departments
- Stores Value of stores issues 23,768 7,923 -31,691
89,466 67,069 0 29,245
- Machine Maintenance Machine hours 23,396 5,849 -29,245
112,862 72,918 0 0
3
(c) Calculation of budgeted overhead rates

Machine hours 30,880

Labour hours 16,800

Overhead absorption rate 3.65 4.34 4

Per machine Per direct
hour labour hour

(d) Under/over absorption of production overhead

Cutting dept

Actual production overhead cost 117,240
Absorbed production overhead cost
31,500 x 3.65 114,975
Under absorbed production overhead 2,265 2

(e ) Total Product Cost for garden bench

Direct materials 15.25
Direct labour (see Note 1 below)
- Cutting department: 0.25 hr x 11.65 2.91
- Assembly department: 0.75 hr x 12.00 9.00
Production overhead 7
- Cutting department: 0.25 machine hrs x 3.65 0.91
- Assembly department: 0.75 labour hours x 4.34 3.26
Total product cost per garden bench 31.33

Note 1
Direct labour rate per hour = Direct wages/direct labour hours

Cutting department = 83,880/7,200 = 11.65 per hour

Assembly department = 201,600/16,800 = 12.00 per hour

Total 25

**Note: Kilowatt hours may also be used as the basis of apportionment of light and heat.

Page 9
SOLUTION 2

(A)
MEMORANDUM
To: Mr David Cullen
From: A Certified Public Accountant
Subject: Absorption and variable (marginal) costing systems
Date: August 2019

Further to your request, some information regarding absorption and variable (marginal) costing systems is presented
below. First, the basis of variable (marginal) and absorption costing systems is explained. Next, the effect on profit of using
variable (marginal) and absorption costing systems is described. Finally, some advantages and disadvantages of both
costing systems are outlined.

(a) Description of basis of variable (marginal) costing and absorption costing systems

Variable (marginal) costing

Variable costing (also called marginal costing) refers to a system in which only variable production costs are
assigned to products. Product costs comprise direct materials, direct labour, direct expenses and variable
production overheads.

Absorption costing
Absorption costing refers to a system in which fixed production overheads are allocated to products. Product costs
then comprise, direct materials, direct labour, direct expenses, variable production overhead and an allocation of
fixed production overheads.
(4 marks)

(b) Effect on profit of using variable (marginal) costing and absorption costing
Profit is affected by three situations that may arise, production levels are greater than sales levels, sales levels are
greater than production levels, and sales levels equal production levels. The effect of each of these situations is
described below.

Where the production level exceeds the sales level

In this case the profit in an absorption costing system will be higher than in a variable (marginal) costing system.
This is because absorption costing only includes that portion of the fixed manufacturing overheads allocated to the
units sold and the remaining fixed manufacturing costs are included in the closing inventory valuation and carried
forward to the next accounting period. Variable (marginal) costing on the other hand includes ALL fixed
manufacturing costs relating to this particular accounting period.

Where the sales level exceeds the production level

In this case the profit in an absorption costing system will be lower than in a variable (marginal) costing system.
This arises due to the fact that more fixed manufacturing overheads are being charged against profit than were
actually incurred during the period. These fixed manufacturing costs are included in the product cost and if sales
exceed production, inventories decline and less fixed costs are thus deferred.

Where the sales level equals the production level

In this case profit as calculated under both costing systems will be the same. In an absorption costing system, the
only fixed manufacturing overhead that will be included in cost of sales will be the amount of fixed manufacturing
overhead that is incurred for the period.
(5 marks)

(c) Some advantages and disadvantages of variable (marginal) costing and absorption costing
(Any TWO advantages and disadvantages)

Variable (Marginal) Costing

Advantages
It provides more useful information for decision making as it requires separation of variable and fixed costs. This
separation of costs allows greater understanding of cost behaviour, facilitating projection of future costs and
revenues for different activity levels and the use of relevant cost decision making techniques.

It removes the effect of inventory changes on profit giving a more logical, constant picture of operations.

Page 10
It avoids fixed manufacturing overheads being included in unsaleable inventories as products are not charged with
any share of such overheads.

Under or over absorption of fixed manufacturing overheads does not arise with variable (marginal) costing and so
a false impression of profit is not be created which could then be totally altered by an adjustment for under/over
absorbed overheads.

Any other relevant point.

Disadvantages
It is not an acceptable basis for valuation of inventory for financial reporting purposes as it is contrary to financial
reporting standards.

It may cause a business to accept work or price contracts such that fixed costs will not be covered and losses may
be incurred. Over time this may affect the survival of the business.

It may cause difficulties in pricing products. Pricing policies are often based on calculation of product cost and
adding on an appropriate mark up. If variable (marginal) costing is used this mark up must be sufficient to cover
fixed costs and desired profit, which makes the selling price very difficult to calculate.

Any other relevant point.

Absorption Costing
Advantages
It does not understate the importance of fixed costs. The allocation of fixed manufacturing costs to products
recognises that sufficient revenue must be generated to cover fixed costs in the long run.

It causes fewer profit fluctuations than variable (marginal) costing when inventory is being increased to match
sales demand.

It is based on the revenue production concept, which assumes that any cost essential in making a product that may
reasonably be expected to be sold represents a cost of obtaining sales revenue. Hence these costs should be
deferred and included in inventory valuation so that they may be matched with revenue in calculating profit for the
period of sale. Absorption costing is thus acceptable under financial reporting standards which require that the
cost of inventory includes all costs incurred in bringing the inventory to its present condition.

It is theoretically superior to variable costing. Theory suggests that fixed manufacturing costs are just as much
expended in the production of goods as variable manufacturing costs and consequently all costs expended in the
manufacture of a product should be charged to the goods produced.

Any other relevant point.

Disadvantages
It does not require separation of variable and fixed costs and consequently is not as useful as variable (marginal)
costing in decision making situations where relevant costs must be highlighted.

If inventory levels fluctuate significantly, profit may be distorted as changes in inventory will affect the amount of
fixed manufacturing overheads allocated to an accounting period.

If absorption costing is used, any unsold inventory will include a share of fixed manufacturing overheads. This
defers fixed manufacturing overheads from one accounting period to subsequent periods. If inventory cannot be
sold without a significant decrease in the selling price then inventory will be over-valued requiring a write down.

Any other relevant point. (5 marks)

If you have any questions relating to information contained in this memorandum I will be pleased to provide further
clarification.

Yours sincerely,
A Certified Public Accountant
Format and Presentation (1 mark)
[Total: 15 marks]

Page 11
(B) BRIEFING NOTE

(a) The SIX purposes of budgeting

There are many reasons for preparing budgets, the SIX main purposes may be summarised as follows:

Planning: budgeting facilitates planning for future operations as managers become aware of the long range
objectives of the company. It also encourages managers to anticipate potential problems that may occur and plan
their resolution.

Co-ordination: there is better co-ordination of the various functions of the business as managers examine the
operations of their departments relative to other departments.

Communication: the budgeting process requires that all levels of the organisation are informed of long range plans,
providing and receiving feedback throughout the budgeting process.

Motivation: a budget, if it is realistic and prepared with the participation of managers, provides a standard of
performance that managers will strive to achieve. However, if a budget is set by higher level managers and imposed
on lower level managers it may be resisted and cause dissatisfaction and demotivation.

Control: a budget assists managers in controlling the activities for which they are responsible by allowing them to
compare actual performance with expected or budgeted performance. Any significant differences may then be
investigated and inefficiencies highlighted for remedial action.

Performance evaluation: a manager’s performance may be evaluated by reference to how well budgeted results
are achieved. Budgets thus allow managers to gauge how well they are meeting targets that they have been
involved in setting.
(6 marks)

(b) Difference between fixed and flexible budgets

A fixed budget, once developed and agreed, is not changed or altered if actual activity differs from budgeted activity.
A flexible budget is prepared based on actual activity and shows what the budgeted costs and revenues would have
been if the budget had been based on actual activity achieved. A flexible budget thus allows comparison of actual
and budgeted costs and revenues based on the same activity level. It is much more useful than a fixed budget as
it allows more meaningful variances to be calculated.
(2 marks)

(c) Functional budgets that may be prepared

Sales budget: this is the first budget to be prepared and forms the basis for other budgets. It shows sales in units
and monetary value.

Production budget: this includes information from the sales budget and opening and closing inventories to establish
production for the period. It shows only units to be produced.

Direct materials usage budget: having obtained production in units this budget is prepared for each material required
and shows how many units of each material is required. It shows only units (kg, litres, etc.) required for production.

Direct materials purchases budget: this budget is produced for each material. It includes the materials that are
required for production and the opening and closing inventories allowing calculation of those materials that must
be purchased for the period. It is prepared in units and monetary value.

Direct labour budget: based on the production budget, this budget shows the labour hours required and the cost
of those labour hours to achieve the necessary production.

Production overhead budget: this budget compiles indirect production expenses so that departmental absorption
rates may be calculated using suitable bases such as labour hours or machine hours. It is prepared in monetary
value terms.

Selling and administration expenses budget: this budget uses information from the sales budget and other operating
information to establish the selling and administration expenses for the period in monetary value.

Master budget: compiling information from the other subsidiary budgets, a budgeted profit and loss account and
balance sheet is prepared.
(4 marks)

Page 12
(d) Behavioural issues that may arise from the budgeting process

(Any TWO of the following)

Budgets facilitate comparison of planned outcomes with actual results allowing the organisation to improve sales
performance, monitor capital expenditure projects, forecast cash flows and control expenditure levels. Failure to
fully understand the budgeting process may result in inefficiencies being carried forward from one year to the next.

If the manager has limited or no control over budgeted outcomes he/she may consider any evaluation based on
these outcomes as unfair and become less motivated to improve performance.

If managers are not involved in developing the overall budget for the organisation they will be less committed and
motivated to achieve the desired results. They may attempt to secure easier, less challenging targets. Managers
may include some ‘budgetary slack’, which means that budgeted costs may be overstated and budgeted revenues
may be understated.

Any other relevant point. (2 marks)

Format and Presentation (1 mark)

[Total: 15 marks]

Page 13
SOLUTION 3: Multiple choice questions – solutions

1. Answer (b) Wood for a furniture maker.

2. Answer (b) €54,000.

x y y-x
February March Change
Production overhead €208,000 €390,000 €182,000
Output in units 55,000 120,000 65,000
Variable production overhead per unit
= €182,000/65,000 €2.80

Fixed overhead = €208,000 – (55,000 x €2.80) = €54,000.

3. Answer (a) When prices are increasing, the cost of issues to production calculated using FIFO is higher than if using
LIFO or Average cost methods.

4. Answer (b) €64.

Date Receipt Issue € Inventory

July 1 100 units x €1 = €100 100 units €100
July 2 60 units x €1 = €60 40 units € 40
July 3 40 units x €1.20 = €48 80 units € 88
July 10 40 units x €1 = €40
20 units x €1.20 = €24
€64

5. Answer (c) €424.20.

Pay based on piece rate = 505 units x 7 mins x €0.12 = €424.20
80% pay based on hourly rate = 80% x 37 hours x €12.20 = €361.12

6. Answer (b) 1,328.

Square Root [(2 x D x O) / H] D = annual demand = 490 units x 12 = 5,880 units

O = €15
H = Cost of holding stock in inventory for 1 year = 1% x €10 = €0.10

Square Root [(2 x 5, 880 x 15) / 0.10] = 1,328

7. Answer (b) 9,630.

The original cost of material C is a sunk cost. Material C is no longer used in production by the company but it does
have a scrap value of €0.90 per kg. If the company were to use all 4,200 kg in inventory for the new product it would
lose out on earning income from selling the material for scrap of €3,780 (4,200 kg x €0.90 per kg). However, the
contract requires 6,000 kg of material C so it must purchase an additional 1,800 kg at the current purchase price
of €3.25 per kg. Hence the relevant cost of using material C for the contract is: €3,780 + (1,800 kg x €3.25) =
€9,630.

8. Answer (c) €4,800.

The original cost of material D is a sunk cost. Material D is in regular use by the company in its production activities.
If 2,000 kg are taken to produce a new product then more supplies of this material must be purchased at the current
cost price. Hence the relevant cost of using material D for the contract is: 2,000 kg x €2.40 = €4,800.

[20 marks]

Page 14
SOLUTION 4

(a) Break even point in sales units (pairs of sandals) and revenue
Workings
Sales in units (pairs of sandals) 100,000
Per unit Total

Sales 27.50 2,750,000

Variable costs
Direct materials 6.19 619,000
Variable production overhead (75% of total) 1.77 177,000
Variable selling and distribution expenses (20% of total) 0.29 29,000
Total variable costs 8.25 825,000

Contribution 19.25 1,925,000

Fixed costs
Direct labour 411,000
Fixed production overhead (25% of total) 59,000
Administration expenses 336,500
Fixed selling and distribution expenses (80% of total) 116,000
Total fixed costs 922,500

Profit 1,002,500

Break even point in units

Formula = Total fixed costs/contribution per unit
= 922,500/19.25 = 47,922 units

Break even point in sales revenue 5

Formula = Total fixed costs/contribution to sales ratio

OR Break even point in units x selling price per unit

Contribution to sales ratio = 19.25/27.50 = 0.70

Break even point in sales revenue = 922,500/0.70 = 1,317,857

or 47,922 units x 27.50 = 1,317,855

(b) Margin of safety in units (pairs of sandals) and revenue

Assuming actual sales = expected sales

Margin of Safety = Expected sales - Break Even sales

Margin of safety in units = 100,000 units - 47,922 units = 52,078 units

3
Margin of safety in sales revenue = 2,750,000 - 1,317,857 = 1,432,143

Page 15
(c) How many pairs of sandals (units) must be sold to make a profit of 1,500,000?

Target profit in units = Total fixed costs + Target profit

Contribution per unit

= 922,500 + 1,500,000 = 125,844

19.25 pairs of sandals 3

PROOF: Not required by question

Total sales revenue: 125,844 x 27.50 per pair 3,460,710.00
Less: total variable costs 125,844 x 8.25 per pair 1,038,213.00
Total contribution 2,422,497.00
Less: total fixed costs 922,500.00
Profit (approximately 1,500,000) 1,499,997.00

(d) Change in basis of paying staff

Workings Per unit

Selling price per pair of sandals 27.50
Revised variable costs
Direct materials 6.19
Direct labour 4.25
Variable production overhead (75% of total) 1.77
Variable selling and distribution expenses (20% of total) 0.29
Total variable costs 12.50

Revised Contribution 15.00

Total
Revised fixed costs
Fixed production overhead (25% of total) 59,000
Salary of extra supervisor 60,000
Administration expenses 336,500
Fixed selling and distribution expenses (80% of total) 116,000
Total fixed costs 571,500
4
i) New break even point in units
Formula = Total fixed costs/contribution per unit
= 571,500/15 = 38,100 pairs of sandals

ii) How many pairs must be sold to achieve current/expected profit level?
Target profit = expected profit of 1,002,500

Target profit in units = Total fixed costs + Target profit

Contribution per unit

= 571,500 + 1,002,500 = 104,933

15.00 pairs of sandals
2
iii) Which of the pay systems (fixed time or piece rate) would you recommend for the company? Give
reasons for your answer
Recommendation and any TWO reasons:
The company may prefer the piece rate pay system as:
- Fixed costs are lower, which puts less pressure on the company to make profits
- The break-even point in units is lower - the company needs to sell a lower quantity to cover its costs
- Staff may be motivated to produce more units so as to increase their pay
- Any other relevant point

The company may prefer the fixed time system as: 3

- The company needs to sell a lower quantity to achieve its current profit level (100,000 pairs compared to 104,933 pairs)
- Staff may feel more secure and motivated to work as they have a fixed amount of pay
- Product quality may be better so the quality control costs/inspection costs should be cheaper
- Any other relevant point

Total 20
Page 16
SOLUTION 5

(a) Standard cost card for one table mat

Per unit

Direct materials (10,080 sq mtrs/134,400 units) = 0.075 x (282,240/10,080 sq mtrs) = 28/sq mt 2.10
Direct labour (33,600 hrs/134,400 units) = 0.25hr x (483,840/33,600 hrs) = 14.40/hr 3.60
Variable production overhead 0.25hr x (225,792/33,600 hrs) = 6.72/hr 1.68
Total product cost 7.38 4

(b) Variances
Direct material price variance
(SP - AP) x AQ
= (28 - (300,240/10,800)) x 10,800 = 2,160 F

Direct material usage variance

(SQ - AQ) x SP
= ((0.075sq mtrs x 135,000) - 10,800) x 28 = -18,900 A

Direct labour rate variance

(SR - AR) x AH
= (14.40 - (486,000/27,000)) x 27,000 = -97,200 A

Direct labour efficiency variance

(SH - AH) x SR
= ((0.25 hr x 135,000) - 27,000) x 14.40 = 97,200 F

Variable overhead expenditure variance

(SR - AR) x AH
= (6.72 - (194,400/27,000)) x 27,000 = -12,960 A

Variable overhead efficiency variance

(SH - AH) x SR
= ((0.25 hr x 135,000) - 27,000) x 6.72 = 45,360 F

Fixed production overhead expenditure variance

(BFO - AFO)
= (29,200 - 30,150) = -950 A
10

(c) For each of the materials variances, suggest TWO reasons that may explain why the variance
occurred
Materials price variance
Any TWO of the following:
- The company had to purchase from a different supplier and so obtained a lower price than expected.
- There may have been a change in market conditions that resulted in a decrease in the price of wood.
- The company may have purchased lower quality beech wood at cheaper prices.
4
Materials usage variance
Any TWO of the following:
- The materials purchased from the different supplier were of a poorer quality than the regular supplier
and caused more wastage.
- The staff may have been careless in handling the wood resulting in more wastage than expected.
- The company may have introduced changes in quality control procedures or in the production process
during the year that caused more rejection/wastage of materials.

(d) Briefly explain the following terms

Ideal standard - this is a standard based on ideal operating conditions i.e. 100% efficiency is
expected from staff, machinery and management. This standard is unlikely to be used in practice as
it may adversely affect staff motivation. 2

Attainable standard - this is a standard based on efficient operating conditions. It allows

for normal wastage, machine breakdown and lost time. This standard is difficult but not impossible
for staff to achieve.

Total 20
Page 17
SOLUTION 6
Workings
Mixing process
Inputs Total Equivalent units
Physical
Units Materials Conversion costs
kg kg kg
Opening WIP 10,000
Materials input 40,000
50,000
Outputs
Closing WIP 6,000 6,000 2,400
Normal loss (5% x materials input) 2,000 0 0
Abnormal loss 1,000 1,000 1,000
Transferred to Cooking process 41,000 41,000 41,000
50,000 48,000 44,400

Costs
Opening inventory 24,200 6,924
Total costs incurred 108,800 115,620
Less scrap value (2,000 kgs @ 0.50 per kg) -1,000
Total costs to be allocated 254,544 132,000 122,544

Cost per equivalent unit 2.75 2.76 5.51

Allocation of costs
Valuation of output transferred to cooking process = 41,000 kg x 0.51
5 per kg = 225,910
Valuation of abnormal loss = 1,000 kg x 5.51 per kg 5,510
Valuation of closing WIP (6,000 kg)
Materials: 6,000 kg x 2.75 = 16,500
Conversion costs: 6,000kg x 40% x 2.76 = 6,624
23,124

254,544
Cooking process
Inputs Total Equivalent units
Physical Mixing process Labour &
Units costs overheads
kg kg kg
Opening WIP 16,000
Materials transferred from mixing 41,000
57,000
Outputs
Completed and transferred 56,000 56,000 56,000
Closing WIP 0 0 0
Abnormal loss 1,000 1,000 1,000
57,000 57,000 57,000

Opening WIP 43,130 35,790

Prior process costs transferred in 225,910
Costs incurred 59,970
Total costs to be allocated 364,800 269,040 95,760

Cost per equivalent unit 4.72 1.68 6.40

Valuation of finished output transferred: 56,000 kg @ 6.40 per kg = 358,400

Valuation of abnormal loss : 1,000 kg x 6.40 per kg = 6,400
Total cost 364,800

14

Page 18
a) Mixing process account
kg kg

Opening inventory 10,000 31,124

Normal loss 2,000 1,000
Inputs 40,000 Transferred to Cooking
Materials 108,800 Process 41,000 225,910
Labour & overhead 115,620 Abnormal loss 1,000 5,510
Closing WIP 6,000 23,124
50,000 255,544 50,000 255,544

b) Cooking process account

kg kg
Opening WIP 16,000 Completed & transferred 56,000 358,400
- Prior process costs 43,130 Abnormal loss 1,000 6,400
- Conversion costs 35,790 Closing WIP 0 0
Transferred in from mixing 41,000 225,910
Conversion costs 59,970
57,000 364,800 57,000 364,800

c) Normal loss account

kg kg
Mixing process account 2,000 1,000 Cash for units scrapped 2,000 1,000

2,000 1,000 2,000 1,000

d) Abnormal loss account

kg kg
Mixing process account 1,000 5,510 Cash for Units Scrapped * 1,000
2,000 500
Cooking process account 1,000 6,400 Income statement 11,410
2,000 11,910 11,910

6
Total 20

*Note: Cash is only received for 1,000 units scrapped from the Cooking process but all
units scrapped are included here to balance the account.

Page 19