Management Accounting: Costing and Budgeting - Essay Example

1. Many of MPL’s raw materials are expected to rapidly increase in cost next year. (a) Identify which method of stock valuation would give the lowest reported profit next year in these circumstances, and explain why. Ans. LIFO method of stock valuation will give the lowest reported profit next year in case of increasing costs. The high costs stock items will be received last and issued first. This will reduce the cost of closing stock. Consequently, the cost of issue will be increased and the profit will be decreased. (b) What effect would the method in (a) have on the reported profits of MPL if it were used over the lifetime of the business? Ans: If LIFO method is used over the lifetime of the business where the costs of raw materials are expected to rapidly increase, it will have minimal effect on the reported profits of the business. In the first year of operations, there will be a differ rence in the cost of opening stock and closing stock. However, in future reporting periods, the cost of receipts and issues will be the same or close to each other as the stock received first will be issued first. Thus, there will be no big difference exist between opening and closing stock. Consequently, there will be no difference that will be caused by opening or closing stock. Thus, the LIFO method in the long-term will not effect the reported profits much. (c) One possible stock valuation method is FIFO. Explain the potential problems with using FIFO when raw materials are rapidly increasing in cost. Ans: FIFO (First In First Out) is a method of valuation of stock in which the item are issued in the same manner in which they are received. In the period of rapidly increasing raw materials cost, the use of FIFO method may cause some potential problems in stock valuation. In case of rising prices, this method may give an inadequate picture of the company’s profits. Where the real profits of the company are low, the use of FIFO method may report higher profits. This is due to the reason that the cost of opening stock is lesser than the cost of closing stock and consequently the cost of issues is reported at lower price which generate higher profits. Thus, the company’s profits are not reported adequately. The material issued for the production of a specific product bears a purchase price. Where the cost of material rises, the costs that are charged to the same job or product will vary from one period to another. The cost of product or job will not reflect the cost prevailing in the market during the reporting period. This is due to the reason that the costs of material charged to the production of a product or completion of job will be those at which these materials are receive din some prior periods.2. (a) Identify the method being used to value issues in the stock record card below. It is a weighted average method. (b) Complete the stock record card below for raw material 5164 for November. Round all costs per litre to 3 decimal places. Receipts Issues Balance Date Quantity litres Cost per litre (p) Total cost (£) Quantity litres Cost per litre (p) Total cost (£) Quantity litres Total cost (£) Balance as at 1 November 44,000 17,168 8 November 60,000 40.200 24,120 104,000 41,288 10 November 70,000 39.700 27,790 34000 13,498 21 November 40,000 40.300 16,120 74,000 29,618 30 November 50,000 40.024 20,012 24,000 9,606 (c) Explain the terms ‘direct cost’ and ‘indirect cost’ and give ONE example of each cost for MPL. Ans: DIRECT COST: - The costs which are directly attributable to a cost object are called a direct cost. Cost object is a project, a department or a product to which costs are allocated. The direct costs when attributed to such cost object, they become part of its cost. In case of Malpas Products Limited (MPL), the material used for the production of pharmaceutical products is a direct material cost which may be attributed to the product being manufactured. Similarly, the labour applied for the manufacture of the product is also a direct manufacturing cost and its cost may also be attributed to the manufactured on the basis of time sheets available. INDIRECT COST: - The costs that are not directly attributable to a specific cost object are called indirect costs. These costs do not form part of a product or project, rather they are attributed to the company as a whole. As such, these costs do form part of company’s expenses but are not included when calculating the production cost of a product or project. In case of MPL, the cost associated with warehouse and stores such as warehouses’ rents and utilities costs are indirect costs. The costs attributed to the Quality Assurance department are also indirect costs. The wages and salaries of support staff such as cleaners, shop clerks and general helpers who are not directly including in the production of medicines are also known as indirect costs. Data MPL is considering what the effect would be of costing its products under marginal costing (MC) principles, instead of under full absorption costing (FAC) principles that it currently follows. The following information relates to one of the company’s products: Selling price per unit £12 Prime cost per unit £4 Variable production cost per unit £3 Budgeted fixed production overhead £30,000 per month Budgeted production 15,000 units per month Budgeted sales 12,000 units per month Opening stock 2,000 units 3. (a) Calculate the contribution per unit (on a MC basis): (b) Calculate the profit per unit (on a FAC basis): (a) CONTRIBUTION MARGIN PER UNIT (on MC basis): - Description £ £ Selling price per unit 12 Less: Variable cost per unit: Prime cost per unit 4 Variable production cost per unit 3 (7) Contribution Margin per Unit 5 (a) PROFIT PER UNIT (on FAC basis): - Description £ £ Selling price per unit 12 Less: Cost of Sale: Prime cost per unit 4 Variable production cost per unit 3 Fixed Overhead cost per unit 2 (9) Profit per unit (on FAC basis) 3 4. Use the information supplied in task 3 and your calculations for that task. (a) Complete the table below to produce a profit and loss account for the product for the month under marginal costing (MC) principles. £ £ Sales 144,000 Opening stock 14,000 Variable production costs 105,000 Closing stock (35,000) Cost of sales (MC basis) (84,000) Contribution 60,000 Fixed costs (30,000) Profit 30,000 (b) Complete the table below to produce a profit and loss account for the product for the month under full absorption costing (FAC) principles. £ £ Sales 144,000 Opening stock 18,000 Production costs 150,000 Closing stock (45,000) Cost of sales (FAC basis) (108,000) Profit 36,000 (c) Briefly explain why the two profit figures differ. Ans. The profits calculated by Marginal Absorption costing method is different from that calculated by Full Absorption Costing method. The difference has been occurred from the difference caused in the cost of Opening stock and closing stock. In Marginal Absorption costing method, the fixed production overheads have not been included in the cost of production. Rather, this cost has been shown separately after calculation of contribution margin. Thus, the per unit cost of production decreases. As the units of closing stock are more than the units of opening stock, the cost of sales increases and consequently, the profit decreases. In Full Absorption Costing method, the fixed production overheads are included in the cost of production. This increases the per unit cost of production. As the closing stock is more than the opening stock, the cost of sales decreases as compared to cost of sales calculated under Marginal costing Method. Consequently, the profit is greater in Full Absorption costing Method as compared to profit calculated under Marginal costing Method. Data Last month one of MPL’s products had the following process inputs: Direct materials 500 kgs at £17.20 per kg Direct labour 280 labour hours at £10.50 per hour Overheads absorbed 86 machine hours at £32 per machine hour The following information is also available: The company expects a normal loss of 5% of input. All waste is sold for £1.68 per kg. Actual output for the month was 515 kgs. There were no opening or closing stocks and all output was fully completed. 5. (a) Calculate the product’s cost per kg of normal production. Kgs £ Kgs £ Materials 500 8,600 Output 515 14,292 Labour 2,940 Overheads 2,752 14,292 Product’s cost per kg = £14,292/515 = £ 27.75 (b) Prepare the process account below for the product for last month: Description Kgs Unit cost £ Total cost £ Description Kgs Unit cost £ Total cost £ Materials 500 17.20 8,600 515 27.75 14,292 Labour 10.50 2,940 Normal Loss 25 - - Overheads 32 2,752 Abnormal Gain 40 - - 14,292 14,292 DATA Just over twelve months ago, Alpha Ltd started selling a new product, the Beta, that no one else can make or sell. A budget was prepared at the time but this was then amended to take account of revised forecasts. The original and amended budgets, and the actual results for the year to 30 November 2012, are shown below in an operating statement prepared by the previous management accountant Beta: Budgeted and actual operating results for the year to 30 November 2012 Original budget Amended budget Actual results Units £000 Units £000 Units £000 Turnover 20,000 700 22,000 770 23,000 782 Material 160 176 225 Labour 300 330 350 Production overhead 74 74 75 Cost of production 20,000 534 22,000 580 25,000 650 less closing stock nil nil nil nil 2,000 52 Cost of sales 20,000 534 22,000 580 23,000 598 Gross profit 166 190 184 General expenses 110 114 125 Operating profit 56 76 59 Nicola Brown, the managing director of Alpha Ltd, tells you that: • the only change in costs and revenues between the two budgets arose from the forecast change in volume; • material and labour are variable (or marginal) costs, production overhead is a fixed cost and general expenses is a semi-fixed cost; • both budgets assumed there would be no opening and no closing stocks. She also gives you the following information about the actual results: • the actual results have been prepared using absorption costing; • the closing stock valuation includes a proportion of production overhead; • general expenses include £71,000 which do not vary with changes in either sales or production volumes; • the balance of general expenses are selling expenses and vary with Betas sold; • the actual unit cost of material and labour has remained the same throughout the year. Nicola Brown is concerned that the actual profit for the year is less than the revised budgeted profit. She asks you to prepare an analysis showing why the two profit figures are different. 6. Prepare an analysis for Nicola Brown. In your analysis you should: a) calculate the following BUDGETED data: i) selling price per Beta; ii) material cost per Beta; iii) labour cost per Beta; iv) variable (or marginal) cost of general expenses per Beta; v) fixed cost of general expenses; Units £ (Total) £ (per unit of Beta) Selling price 22,000 770,000 35.00 Material cost 22,000 176,000 8.00 Labour cost 22,000 330,000 15.00 Variable cost of general expenses 22,000 43,000 1.95 Fixed cost of general expenses 71,000 b) Identify the ACTUAL production fixed costs incurred during the year; Ans: The production overhead is a fixed cost. Thus, the actual production fixed costs incurred during the year is £75,000 which is the value of actual production overheads. c) redraft the ACTUAL results for the year on a marginal costing basis; Beta: Actual operating results for the year to 30 November 2012 (on MC basis) Actual results Units £000 Turnover 23,000 782 Material 225 Labour 350 Variable cost of production 25,000 575 Beginning inventory - Ending Inventory 2,000 (46) Variable Cost of goods sold 23,000 529 Gross Contribution margin 253 Variable cost of general expenses 54 Contribution Margin 199 Less Fixed expenses: Production overhead 75 Fixed cost of general expenses 71 Total Fixed expenses (146) Operating profit 53 d) prepare a variable (or marginal) costing flexible budget statement for the year to 30 November 2012 showing: i) the actual results on a marginal costing basis; ii) the appropriate flexible budget; and iii) any variances. MARGINAL COSTING FLEXIBLE BUDGET STATEMENT FOR THE YEAR TO NOVEMBER 30, 2012 Operating Level Production Per Unit Price £ 22,000 Units (Budgeted) 25,000 Units (Actual) VARIANCE Units £ (Total) Units £ (Total) £ (Total) Turnover 34 20,000 680,000 23,000 782,000 102,000 Material 9 198,000 225,000 (27,000) Labour 14 308,000 350,000 (42,000) Variable cost of production 23 22,000 506,000 25,000 575,000 (69,000) Beginning inventory - - Ending Inventory (2,000) (46,000) (2,000) (46,000) - Variable Cost of goods sold 22,000 460,000 23,000 529,000 (69,000) Gross Contribution margin 220,000 253,000 33,000 Variable cost of general expenses 2.348 46,957 54,000 (7,043) Contribution Margin 173,043 199,000 25,957 Less Fixed expenses: Production overhead 75,000 75,000 - Fixed cost general expenses 71,000 71,000 - Total Fixed expenses (146,000) (146,000) (1,000) Operating profit 27,043 53,000 (23,000) DATA After receiving your statement comparing the actual marginal costing results with the flexible budget, Nicola Brown tells you that: • she does not understand why the budget in your statement is different from the agreed revised budget nor why some costs have changed but others have remained the same; • she does not understand why the actual results in your statement are different from the actual results in the operating statement prepared by the previous management accountant; • she is concerned that the actual sales volume was significantly different from the budgeted sales volume. 7. Write a memo to Nicola Brown. In your memo you should briefly: a) give ONE reason why the budget in your statement is different from the revised budget; b) explain why the actual results in your statement are different from the actual results given in the task data; c) explain THREE forecasting techniques Alpha Ltd can currently use to estimate the demand for Betas; d) explain ONE forecasting technique that Alpha Ltd is currently unable to use to estimate the demand for Betas. Ans: MEMORANDUM Date: December 21, 2013 To: Nicola Brown From: (Your Name) Subject: Flexible Budget for Beta This memorandum has been written to you in response to your queries regarding flexible budget of Beta for the year ending to November 2013. The flexible budget is drafted on the basis of the actual results obtained for the year ending to November 2013 regarding per unit variable cost and selling price. On the other hand, the agreed revised budget previously prepared was based on the budgeted level of output and turnover. The task data actual results are prepared using the Full Absorption costing while the marginal flexible budget was prepared while using the marginal costing method. Thus, in task data, the fixed production overheads were included in the cost of production of Beta and were also included in calculating the value of closing stock and cost of sales. On the other hand, the production overheads are separately shown in flexible budget statement, thus varying the cost of production and the value of closing stock. Beta is a new product of Alpha Ltd started just a year ago which no other company can make or sell in the market. To estimate the future demand of Beta, Alpha Ltd can use the following techniques: a. Buyer’s Opinion: The demand can be reliably estimated by taking on a survey to know the opinion of the customers about the use of Beta. This will give a good estimate whether the buyer will be willing to use the product in future or not. b. Barometric Techniques: The barometric techniques help the business to be alert regarding the changes in economic conditions of the market. The indices of economic indicators that are relevant to a product are observed to forecast the future trend of the buyer towards the product. c. Sales Force Opinion: The sales person are asked about the trend of the product in their respective areas and regions. They are also asked about their views regarding the future demand of the product. As the salespersons are in direct contact with the consumers, they may give a better opinion regarding the prospective future market of the product. Another forecasting technique is to analyze the variation in quality or price of a product manufactured by the competitor. As Alpha Ltd is the only company making and selling the product, this technique is not capable of being used as a demanding technique in the current situation. DATA Alpha Ltd makes a product called the Delta. The only use for Deltas is as part of a machine made by Global Products PLC and Global Products requires Alpha to keep a minimum closing stock of Deltas. You are the newly appointed management accountant employed by Alpha Ltd and report to Nicola Brown, the managing director. She gives you the following information. Accounting periods • Both Alpha Ltd and Global Products PLC divide the year into four-week periods. Each week consists of five days and each day comprises eight hours. Forecast demand for Deltas - first five periods of 2013 • Four-weeks ending 30 January 27 February 26 March 23 April 21 May Period 1 Period 2 Period 3 Period 4 Period 5 N0. of Deltas required 5,700 5,700 6,840 6,460 6,080 Finished Stocks and Work-in-progress • Global Products requires that closing stocks of Deltas at the end of each period must equal 3 days demand of the next period. • The opening stock of Deltas for period 1, the four weeks ending 30 January 2013, will be 1,330 Deltas. • There is no work-in-progress at any time. Material • Each Delta requires 6 litres of material. • The material is currently supplied under a long-term contract at a cost of £8.00 per litre and is made exclusively for Alpha Ltd. • The supplier of the material can only make a maximum of 34,000 litres in any four-week period and Alpha normally purchases the material in the same four-week period it is used. • Should Alpha require more than 34,000 litres in a four-week period, the supplier would be willing to supply additional material in the preceding period, providing it had spare capacity. • There is a readily available alternative source for the material but the cost is £12.00 per litre. • Before buying from the alternative source, any shortage of material in a period should be overcome, where possible, by first purchasing extra material from the supplier in the immediately preceding period. Labour • There are 78 production employees who are paid a guaranteed basic wage of £160 per 40-hour week. • Each Delta should take 2 labour-hours to make but, due to temporary technical difficulties, the workforce is only able to operate at 95 per cent efficiency in periods 1 to 4. • Any overtime incurred is payable at a rate of £6.00 per hour. 8. Nicola Brown asks you to prepare the following budgets for EACH of the periods 1 to 4: a) the production budget in Deltas, using the 3-day stock levels required by Global Products; PRODUCTION BUDGET IN DELTAS Period 1 Period 2 Period 3 Period 4 Opening Stock 1,330 855 1026 969 Production 5,225 5,871 6,783 6,403 Supplies 5,700 5,700 6,840 6,460 Closing Stock 855 1026 969 912 b) the material purchases budget in litres;   Period 1 Period 2 Period 3 Period 4   5,225 5,871 6,783 6,403   units units units units Requirement 31,350 35,226 40,698 38,418 Opening - 1,226 - - Purchases Normal 32,576 34,000 34,000 34,000 Alternative - - 6,698 4,418 Usage 31,350 35,226 34,000 34,000   6,698 4,418 Closing 1,226 - - - c) the cost of the material purchases; COST OF MATERIALS PURCHASE BUDGET   Period 1 Period 2 Period 3   5,225   5,871   6,783     units Unit cost total units Unit cost total units Unit cost total requirement 31,350     35,226     40,698     opening - - - 1,226 8 9,808 - 8 - purchases                   normal 32,576 8 260,608 34,000 8 272,000 34,000 8 272,000 alternative - 12 - - 12 - 6,698 12 80,376 usage 31,350 8 250,800 35,226 8 281,808 34,000 8 272,000               6,698 12 80,376 closing 1,226 8 9,808 - 8 - - - - COST OF MATERIALS PURCHASE BUDGET   Period 4   6,403     units Unit cost total requirement 38,418     opening -   - purchases       normal 34,000 8 272,000 alternative 4,418 12 53,016 usage 34,000 8 272,000   4,418 12 53,016 closing - 8 - d) the labour budget in hours, including any overtime hours; Normal Labour Hours available/period = Employees x Hours per week x weeks per period = 78 x 40 x 4 = 12,480 Labour Hours per Delta (@ 95% efficiency level) = 2.00/95 x 100 = 2.105 LABOUR BUDGET IN HOURS   Period 1 Period 2 Period 3 Period 4 Production 5,225 5,871 6,783 6,403 Labour hours per unit 2.105 2.105 2.105 2.105 Total Labour hours 11,000 12,360 14,280 13,480 Guaranteed wage 11,000 12,360 12,480 12,480 Overtime - - 1,800 1,000 e) the cost of the labour budget, including the cost of any overtime. Guaranteed basic wage/ hour (£) = Guaranteed basic wage per week/ Hours per week = £ 160 / 40 = £ 4.00 per hour LABOUR COST BUDGET (£)   Period 1 Period 2 Period 3   Units and Hours Cost per Hour (£) Total Cost (£) Units and Hours Cost per Hour (£) Total Cost (£) Units and Hours Cost per Hour (£) Total Cost (£) Production 5,225     5,871     6,783     Labour hours per unit 2.105     2.105     2.105     Total Labour hours 11,000     12,360     14,280     Basic Wage 11,000 4.00 44,000 12,360 4.00 49,440 12,480 4.00 49,920 Overtime - 6.00 - - 6.00 - 1,800 6.00 10,800 Total 11,000   44,000 12,360   49,440 14,280   63,600 LABOUR COST BUDGET (£)   Period 4   Units and Hours Cost per Hour (£) Total Cost (£) Production 6,403     Labour hours per unit 2.105     Total Labour hours 13,480     Normal 12,480 4.00 49,920 Overtime 1,000 6.00 6,000 Total 13,480   55,920 DATA On receiving your budgets, Nicola Brown, the managing director, tells you that: • she is concerned about the cost of the planned overtime and the extra cost of purchasing materials from the alternative source; • the minimum demand in any four-week period is forecast to be 5,700 Deltas; She also believes that some immediate and longer-term cost savings are possible if Delta stocks at the end of each period were sometimes more than the 3-days required by Global Products. 9. Write a memo to Nicola Brown. In your memo, you should: a) use the budget information prepared in task 7 to identify ONE immediate possible cost saving proposal other than reducing the 3-day stock requirement imposed by Global Products; b) calculate the value of the cost savings in the proposal identified in part a); c) use the forecast of demand for Deltas to show whether or not: i) the need to obtain material supplies from the alternative supplier is a short-term problem; and ii) the need for overtime payments is also a short-term problem; d) suggest TWO cost savings which may be possible in the longer term. MEMORANDUM Date: December 21, 2013 To: Nicola Brown From: (Your Name) Subject: Flexible Budget for Beta This memorandum has been written to you in response to your queries regarding flexible budget of Beta for the year ending to November 2013. One immediate possible cost saving proposal is to increase the efficiency of labour by removing temporary technical difficulties. If the efficiency is improved to 100%, time will be saved in producing required units of Deltas. LABOUR COST BUDGET £   Period 1 Period 2 Period 3   Units Cost per Hour (£) Total Cost (£) Units Cost per Hour (£) Total Cost (£) Units Cost per Hour (£) Total Cost (£) Production 5,225     5,871     6,783     Labour hours per unit 2.000     2.000     2.000     Total Labour hours 10,450     11,742     13,566     Basic wage 10,450 4.00 41,800 11,742 4.00 46,968 12,480 4.00 49,920 Overtime - 6.00 - - 6.00 - 1,086 6.00 6,516 Total 10,450   41,800 11,742   46,968 13,566   56,436 Total (at 95% efficiency) 11,000   44,000 12,360   49,440 14,280   60,720 Cost Saving     2,200     2,472     4,284 LABOUR COST BUDGET £         Period 4   Units Cost per Hour (£) Total Cost (£) Production 6,403     Labour hours per unit 2.000     Total Labour hours 12,806     Basic wage 12,806 4.00 51,224 Overtime - 6.00 - Total 12,806   51,224 Total (at 95% efficiency) 13,480   55,920 Cost Saving     4,696 Total cost saving is £ 13,652 The minimum demand of Deltas is expected to be 5,700 Deltas. Material per Delta is 6 liters. Thus, the minimum material required will be 34,200 liters. The normal purchase per period is 34,000 liters. Thus, the material will require to be purchased from alternative source in long-term. Thus, it appear to be a long-term problem. The labour hours required for 5,700 Deltas production is 11,400 hours. The normal labour hours available are 12,480 hours. Thus, it appear to be a short-term production if the requirements of Deltas decreases and reaches to 6,240 Deltas which is probable to occur if Deltas continue to decrease. Long-term cost saving is possible in the following ways: 1. By increasing the labour work force, the normal wage hours available for production will be increased. Thus, the payment of overtime may be saved and will keep the wage level to £ 4.00 per hour. 2. Another long-term cost saving is to make possible increased supplies by the supplier. This will make it possible not to purchase materials from alternative supplier and will keep the cost of materials used to £ 8.00 per liter. References 1. Adolph, M. and Milton, F., 1980. Cost Accounting Planning and Control. Philippines: South- Western Publishing Co. 2. Gupta, R. Advantages and Disadvantages of First-in-First out Method (FIFO). [e- book] PreserveArticles.com. Available at: [Accessed 22 December 2013]. 3. Caplan, D. Management Accounting: Concepts and Techniques. [e- book] College of Business. Available at: [Accessed 22 December 2013]. Read More