Managerial Accounting - Assignment Example

Managerial Accounting Assignment 2007 (a) Explanation for Regulation IAS 2 Inventories: International Accounting Standards 2 inventories, formerly known as SSAP 9 Stock and Long-Term contracts and the Companies Act 1985 regulates the definition, valuation methods and categorization of stock for disclosure in the financial statements. The IAS 2 "provides guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value." (IASC Foundation) The regulation also provides guidance on the cost formulas that are used to assign cost to inventories. Definition of Cost in Relation to Stock: According to the regulation, the definition of cost includes all costs of purchase, costs of conversion and all other costs incurred by any firm in bringing the inventories to their personal location and condition. Inventories shall be measured at the lower of cost and net realizable value. Inventories include assets representing fixed assets held for sale in the ordinary course of business, assets in the production process for sale in the ordinary course of business representing the work in process and materials and supplies that are consumed in production which covers the raw materials. Stock Valuation Methods: In the valuation of stock, the standard cost and retail methods can be adopted. The only condition prescribed under the regulation is that the method of measuring the cost should result in approximate actual cost of the inventory measured. Under regulation IAS 2.23 the firm should adopt specific costs for the specific individual items of inventory where it the inventory items represent those that cannot be interchanged. For items that are interchangeable the regulations allows the First in First out (FIFO) method or Weighted Average Cost methods. However the regulation discontinued the measurement of inventory under Last in First out (LIFO) method. Categorisation of Stock for Disclosure Requirements: IAS 2.36 classifies the cost of inventory for disclosure in the financial statements. According to the regulation: Carrying Amounts - including merchandise, supplies, materials, work-in-progress and finished goods. This classification depends on the requirement of the enterprise concerned. Carrying Amount of any inventories carried at fair value less costs to sell Amount of any write-down value of inventories that can be recognized as expense for the period A further disclosure of the reversal or write down made to Net Realizable Value. The firm should also disclose the circumstance that led to such reversal Carrying Amount of inventories pledged as security for liabilities Cost of inventories recognized as expenses: This includes operating costs recognized by the nature of cost like raw materials and consumables, labour costs and other operating costs. These operating costs are classified on the basis of nature of the costs and the amount of net change in inventories for the period. (b) Sylvester Sales Limited: Gross Profit under Marginal Costing: Details Year 1 Year 2 Year 3 Production Units 240,000 300,000 180,000 Sales Units 200,000 200,000 200,000 Price per Unit 26 26 26 Sales Value 5,200,000 5,200,000 5,200,000 Variable Costs: Direct Material and Labour costs 1,200,000 1,200,000 1,200,000 Variable Overheads 800,000 800,000 800,000 Total Variable Costs 2,000,000 2,000,000 2,000,000 Contribution 3,200,000 3,200,000 3,200,000 Fixed Manufacturing Costs 800,000 800,000 800,000 Gross Profit 2,400,000 2,400,000 2,400,000 Gross Profit under Absorption Costing: Details Year 1 Year 2 Year 3 Production Units 240,000 300,000 180,000 Sales Units 200,000 200,000 200,000 Price per Unit 26 26 26 Sales Value 5,200,000 5,200,000 5,200,000 Direct Material and Labr Costs 1,440,000 1,800,000 1,080,000 Indirect Costs: Variable Costs 960,000 1,200,000 720,000 Fixed Costs 800,000 800,000 800,000 Total Costs 3,200,000 3,800,000 2,600,000 Gross Profit 2,000,000 1,400,000 2,600,000 (c ) Choice of Costing System: The year-wise gross profit figures as indicated in the marginal costing system shows identical profits irrespective of the different production levels. The marginal cost changes with volume and so at each level of production and sales the marginal cost is the cost of the next unit of the goods produced or sold. Here in the case of the example of Sylvester Sales Limited, though the number of units manufactured differs from year to year the gross profit doesn't change due to the fact that there is no variation in the number of units sold over the three years. Since the fixed manufacturing costs remain the same during all the three years the gross profits also remain the same. But under the absorption costing method there is a difference in the gross profit figures indicating that the total cost of manufacture is absorbed over the number of units sold and hence the gross profits as per absorption costing differ from the gross profit figures under marginal costing. However under absorption costing system normal product costs are considered product costs and included in the inventory. "As sales occur, the cost of inventory is transferred to cost of goods sold; meaning that the gross profit is reduced by all costs of manufacturing, whether those costs relate to direct materials, direct labor, variable manufacturing overhead, or fixed manufacturing overhead." (Principles of Accounting.com) Any management decision thus based on absorption or 'full costing' will lead to wrong decisions and lost opportunities which otherwise would have been available to the firm had the marginal costing method been followed. This phenomenon of the absorption costing system makes the gross profits over the years different from the gross profits as per marginal costing in spite of the sales and production being identical. As regards the choice of the costing system, since the marginal costing system makes a sharp distinction between variable costs and fixed costs and it is the variable costs on the basis of which the production and sales policies are designed by a firm the marginal costing system offers a meaningful analysis of the profit figures over the complete life of the business the incremental profit the company is making with every additional unit of product manufactured and sold. Whereas the absorption costing the inefficiencies of the production processes will directly reflect on the profitability of the units sold. (d) Berkley and Barkers Plc: Working of Break Even Units under Different Options: (i) Changes in packaging and color: Details Quarter IV Units produced and sold in Quarter I 9000 Changed Demand due to change in Packaging and color 20% more 10,800 Sales Price per unit 14.00 Sales Value 151,200 Variable Costs: Material Cost at 3.65 + 0.30 = 3.95 42,660 Labour Cost at 2.10 22,680 Variable Factory Overhead Costs at 1.40 15,120 Variable Selling Costs at 0.85 9,180 Total Variable Costs 89,640 Contribution 73872 61,560 Contribution per Unit 5.70 Fixed Costs: Factory Overheads 21,375 Selling and Admn Overheads 16,125 Total Fixed Costs 37,500 Break Even Volume = Total Fixed Cost/Contribution per Unit 6,578.9 or 6,579 (ii) Change in the Guarantee/Increase in Selling Price: Details Quarter IV Units produced and sold in Quarter I 9,000 Changed Demand due to change guarantee period: 7% more 9,630 Sales Price per unit 14.50 Sales Value 139,635 Variable Costs: Material Cost at 3.65 + 0.15 = 3.80 36,594 Labour Cost at 2.10 20,223 Variable Factory Overhead Costs at 1.40 13,482 Variable Selling Costs at 0.85 8185.5 Total Variable Costs 78,484.5 Contribution 61,150.50 Contribution per Unit 6.35 Fixed Costs: Factory Overheads 21,375 Selling and Admn Overheads 16,125 Total Fixed Costs 37,500 Break Even Volume = Total Fixed Cost/Contribution per Unit 5,905.5 or 5,906 (iii) Reduction in Selling Price by 10%: Details Quarter IV Units produced and sold in Quarter I 9000 Changed Demand due to change in Selling price 20% more 10,800 Sales Price per unit 12.60 Sales Value 136,080 Variable Costs: Material Cost at 3.65 39,420 Labour Cost at 2.10 22,680 Variable Factory Overhead Costs at 1.40 15,120 Variable Selling Costs at 0.85 9,180 Total Variable Costs 86,400 Contribution 49,680 Contribution per Unit 4,60 Fixed Costs: Factory Overheads 21,375 Selling and Admn Overheads 16,125 Total Fixed Costs 37,500 Break Even Volume = Total Fixed Cost/Contribution per Unit 8,152.17 or 8,153 (iv) Payment of commission to Sales Staff instead of Fixed Salary: Details Quarter IV Units produced and sold in Quarter I 9000 Sales Price per unit 14.00 Sales Value 126,000 Variable Costs: Material Cost at 3.65 32,850 Labour Cost at 2.10 18,900 Variable Factory Overhead Costs at 1.40 12,600 Variable Selling Costs at 0.85 7,650 Total Variable Costs 72,000 Contribution 54,000 Contribution per Unit 6.00 Fixed Costs: Factory Overheads 21,375 Selling and Admn Overheads 12,025 Total Fixed Costs 33,400 Break Even Volume = Total Fixed Cost/Contribution per Unit 5,566.66 or 5,567 (v) Subcontracting one component: Details Quarter IV Units produced and sold in Quarter I 9000 Sales Price per unit 14.00 Sales Value 126,000 Variable Costs: Material Cost at 3.65 - 0.55 (saving) + 0.60 (subcontracting) 3.70 33,300 Labour Cost at 2.10 18,900 Variable Factory Overhead Costs at 1.40 + 0.30 redundancy cost = 1.70 15,300 Variable Selling Costs at 0.85 7,650 Total Variable Costs 75,150 Contribution 50,850 Contribution per Unit 5.65 Fixed Costs: Factory Overheads 21,375 Selling and Admn Overheads 16,125 Total Fixed Costs 37,500 Break Even Volume = Total Fixed Cost/Contribution per Unit 6,637.17 or 6,638 Note: (i) The Break even Volume is worked out by taking I quarter units of production and sales and the changes in volume and other criteria for various options have been applied to I quarter units. (ii) The Redundancy cost of 12,000 applied over the total production of 40,000 units in the quarter resulting in 0.30 per unit is added to Variable Factory Overheads. If the total cost of 12,000 is added to Fixed Factory overheads would vitiate the calculation of break even volume. Hence it is considered appropriate to include this item in the Variable Factory Overheads and absorbed over the number of units produced/sold. (e) Limitations of Breakeven Analysis and the Assumptions Associated with CVP Analysis: Though there is lot of advantages result from the breakeven analysis, the concept also has some shortcoming which needs to be understood carefully before employing the model to take managerial decisions: Breakeven analysis will work best in a situation where there is only one product need to analysed at a point of time. Considering breakeven points of multiple products will pose practical problems in calculation and making decisions thereon. Secondly, it is not possible at all times to classify the costs into fixed and variable costs. There are bound to be overlaps that will make the classification of the cost difficult for the purpose of calculating the breakeven point. Thirdly it will be a tendency to use the breakeven point volumes for serious managerial decisions despite the fact that there have been material changes in the cost and income functions. This is a serious shortcoming from the managerial decision making point of view as changed circumstances in respect of cots and revenues would definitely affect the volume to be produced and sold. The assumptions underlying the using of the cost-volume-profit (CVP) relationship also pose some limitations which restrict the use of this tool for key management decisions. The CVP relationship also assumes that all costs can be analysed into their fixed and variable elements. "Assessing the fixed and variable cost split can be fraught with difficulties and can be time consuming." (Duncan Williamson)The CVP assumes that the fixed costs remain fixed over a wide range of activity which in reality doesn't hold ground. There is always a tendency for the fixed costs to behave in a step wise fashion and to understand the behavior a detailed cost analysis will be required. Another assumption of CVP is that Variable costs always vary directly with activity. This assumption cannot also held to be true in large volume of activities. Such a situation of variable costs behaving abnormally will arise in situations when diseconomies of scale arise or increasing import tariffs are being imposed. The assumption of CVP that the selling prices are constant per unit is also not correct, as there is always quantity and price discounts are being offered depending upon the volume of purchases. It is also not correct to assume that only levels of activity affects costs and revenues as there are various other external factors that contribute to the variations in the cost and revenues like government policies or other regulations. References: 1. Duncan Williamson Cost Volume Profit Analysis: Its Assumptions and Their Pitfalls http://business.fortunecity.com/discount/29/cvpassweb.html 2. IASC Foundation Technical summary: IAS 2 Inventories http://www.iasb.org/NR/rdonlyres/6E4D4F43-CDBE-4CBC-AB94-BAF785E7ABB3/0/IAS2.pdf 3. Principles of Accounting.com Chapter 23: Reporting Techniques in Support of Managerial Decision Making http://www.principlesofaccounting.com/chapter%2023.htm#VARIABLE%20VERSUS%20ABSORPTION%20COSTING Read More