ACCA F5 Workbook Lecture 1 Activity Base

ACCA F5 Workbook Lecture 1

Activity Based Costing

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Costs relating to set-ups

Costs relating to materials handling

Costs relating to inspection

Total production overhead

The following total activity volumes are associated with each product line for the period as

a whole:

No. of No. of movement No. of

Set ups of materials Inspections Product D 1 75 1 12 1 150

Product C

Product P

Identify the cost drivers for each of the cost categories above.

Solution

Step 1 - Pool the costs

50,000 Inspection costs

Set up costs

Total Overheads (Check)

Step 2 - Divi - Divide by Number of er of Drivers

Absorption Rate Calculation Ab on

Total Overheads

Machine Hours

Absorption Rate

2 The absorption rate to absorb o sorb overheads is $2 per machine ho ine hour.

Cost Cost Per Unit under Ab er Absorption Costing g

Item

Working

Allocated Overhead

20 10 Material Cost Per Unit

(Hrs p/unit x $2)

30 50 Labour Cost Per Unit

20 16 Total Cost Per Unit

ABC Cost Per Unit

Cost Per t Per Unit of each Prod Product

Driver

Working

Product A

Working

Product B

Set up Costs

14,000 Total Overheads ds

34,000 Total Production n

Overheads Per Unit r Unit

26.4 6.8 Materials Cost Per U st Per Unit

30 50 Labour Cost Per Un Per Unit

Comparison

Cost Per Unit

Product A

Product B

Absorption Costing

$76 ABC

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What does ABC costing link costs to?

2. Why do differences in modern production techniques mean that ABC is useful?

3. How do you calculate the cost per driver?

4. What type of cost is ABC used to allocate?

5. What can absorption costing lead to and why?

6. Give 3 advantages of ABC over absorption costing.

7. Why might the price of a product change under ABC costing?

8. Give 3 problems with ABC costing.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: Pilot Paper Q1

June 2008 Q4 June 2010 Q1

Test Your Knowledge Answers

1. What does ABC costing link costs to?

ABC links costs to the drivers or causes of those costs.

2. Why do differences in modern production techniques mean that ABC is useful?

Modern production techniques are such that many complex products with different speciﬁcations, designs etc.will come off the same production line.

Aside from costs associated with simple absorption drivers such as labour hours there will be many more costs associated with modern production lines such as set- up costs, inspection costs and materials handling costs.

ABC costing recognises these drivers in a complex manufacturing environment.

3. How do you calculate the cost per driver?

Step 1: Pool the overheads Step 2: Divide by the number of drivers

4. What type of cost is ABC used to allocate?

Just OVERHEADS!

5. What can absorption costing lead to and why?

The price may change because the cost may change. If the company uses cost plus pricing then they will change the price they charge as the cost per unit has changed.

8. Give 3 problems with ABC costing.

1. Time and cost.

2. Too much information.

3. New systems required.

4. Too complex to understand.

5. Not suitable for service industries or simple production facilities.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: Pilot Paper Q1

June 2008 Q4 June 2010 Q1

December 2010 Q4

Now do it!

Lecture 2 Life Cycle Costing

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Illustration 1

A product has a four year life-cycle. The costs in each year are shown below. Calculate the total life-cycle cost and categorise

them into each type of cost.

Product Costs

15 23 30 Service Costs

Solution

Total

R&D

300 Design

Illustration 2

Year

Development Introduction

Growth

Maturity Decline

R&D

Marketing Costs

50 40 20 4 ($ million)

Production

$3.20 Costs per Unit

10m 4m Volume

The CEO says that a price of $54 should be charged to cover costs and has produced the following schedule to support it:

Amortise R & D

50 Marketing Costs

50 Production Costs

2m x 4

Total Costs

Total Production

Cost Per Unit

Calculate the Life-Cycle cost of the product and suggest an alternative price.

Solution

Maturity Decline

R&D

Marketing Costs

50 40 20 4 ($ million)

Production Costs

$4 x 2m

$3.50 x 5m $3 x 10m $3.20 x 4m

= $8m

= $17.5m

= $30m = $12.8m

58 57.5 50 16.8 Total Life-Cycle Cost Cost ($m)

382.3 Total Production (m) (m)

21 Cost Per Unit

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What are the 5 phases of a product life cycle?

2. During what phase can the majority of cost be incurred?

3. Why might a product go into decline?

4. A product has a four year life-cycle. The costs in each year are shown below. Calculate the total life-cycle cost and categorise

them into each type of cost.

Product Costs

8 12 9 Service Costs

5. The following information is relevant to Company A:

Year

Development Introduction

Growth

Maturity Decline

R&D

Marketing Costs

70 40 30 8 ($ million)

Production

$3.20 Costs per Unit

11m 3m Volume

The CEO says that a price of $40.25 should be charged to cover costs and has produced the following schedule to support it:

Amortise R & D

75 Marketing Costs

70 Production Costs

4m x 4

Total Costs

Total Production

Cost Per Unit

Calculate the Life-Cycle cost of the product and suggest an alternative price.

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What are the 5 phases of a product life cycle?

Development, Introduction, Growth, Maturity, Decline.

2. During what phase can the majority of cost be incurred?

Development.

3. Why might a product go into decline?

Lack of investment in marketing & advertising. Consumer no longer interested. Newer product on the market. Consumer tastes change. Product reputation declines.

4. A product has a four year life-cycle. The costs in each year are shown below. Calculate the total life-cycle cost and

categorise them into each type of cost. Year

100 Product Costs

60 50 40 150 Marketing Costs

40 30 10 80 Distribution Costs

10 12 8 30 Customer Service Costs

8 12 9 29 Total Life-Cycl Tot -Cycle Cost

5. The following information is relevant to Company A: Year

Development Introduction

Growth

Maturity Decline

R&D

Marketing Costs

70 40 30 8 ($ million)

Production

$3.20 Costs per Unit

11m 3m Volume

The CEO says that a price of $40.25 should be charged to cover costs and has produced the following schedule to support it:

Amortise R & D

75 Marketing Costs

300 / 4

70 Production Costs

4m x 4

Total Costs

161

Total Production

Cost Per Unit

(161/4) = $40.25

Calculate the Life-Cycle cost of the product and suggest an alternative price.

Answer:

Year

Development Introduction

Growth

Maturity Decline

R&D

300

Marketing Costs

70 40 30 8 ($ million)

$3 x 11m $3.20 x 3m Costs

86 68 63 17.6 Total Life-Cycle Cost Cost

300

534.6 Total Production n

(300 + 86 + + 86 + 68 + 63 + 17 + 17.6)

(4 + 8 + 11 + 3) (4 + 8 + 3)

Lecture 3 Target Costing

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Illustration - December 2007 Q1

Edward Co assembles and sells many types of radio. It is considering extending its product range to include digital radios. These radios produce a better sound quality than traditional radios and have a large number of potential additional features not possible with the previous technologies (station scanning, more choice, one touch tuning, station identiﬁcation text and song identiﬁcation text etc).

A radio is produced by assembly workers assembling a variety of components. Production overheads are currently absorbed into product costs on an assembly labour hour basis. Edward Co is considering a target costing approach for its new digital radio product.

Required: (a) Brieﬂy describe the target costing process that Edward Co should undertake.!

! (3 marks) (b) Explain the beneﬁts to Edward Co of adopting a target costing approach at such

an early stage in the product development process. !

! (4 marks) (c) Assuming a cost gap was identiﬁed in the process, outline possible steps Edward Co could take to reduce this gap.! !

! (5 marks)

A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable features to Edward Co’s intended product. The board have agreed that the acceptable margin (after allowing for all production costs) should be 20%.

Cost information for the new radio is as follows: Component 1 (Circuit board) – these are bought in and cost $4·10 each. They are bought

in batches of 4,000 and additional delivery costs are $2,400 per batch. Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed

radio. However, there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in the assembly process. Edward Co estimates that 2% of

Total assembly labour hours Month 1!

Fixed production overheads are absorbed on an assembly hour basis based on normal annual activity levels. In a typical year 240,000 assembly hours will be worked by Edward Co.

Required: (d) Calculate the expected cost per unit for the radio and identify any cost gap that

might exist.! !

(13 marks)

Solution

(a)! Target costing process Target costing begins by specifying a product an organisation wishes to sell. This will

involve extensive customer analysis, considering which features customers value and which they do not. Ideally only those features valued by customers will be included in the product design.

The price at which the product can be sold at is then considered. This will take in to account the competitor products and the market conditions expected at the time that the product will

be launched. Hence a heavy emphasis is placed on external analysis before any consideration is made of the internal cost of the product.

From the above price a desired margin is deducted. This can be a gross or a net margin. This leaves the cost target. An organisation will need to meet this target if their desired margin is to be met.

Costs for the product are then calculated and compared to the cost target mentioned above. If it appears that this cost cannot be achieved then the difference (shortfall) is called a cost gap. This gap would have to be closed, by some form of cost reduction, if the desired margin is to

be achieved.

(b) Benefits of adopting target costing –!

The organisation will have an early external focus to its product development. Businesses have to compete with others (competitors) and an early consideration of this will tend to make them more successful. Traditional approaches (by calculating the cost and then adding a margin to get a selling price) are often far too internally driven.

Only those features that are of value to customers will be included in the product design. Target costing at an early stage considers carefully the product that is intended.

many of the costs are ‘designed in’ to the product. –!

It is often argued that target costing reduces the time taken to get a product to market. Under traditional methodologies there are often lengthy delays whilst a team goes ‘back to the drawing board’. Target costing, because it has an early external focus, tends to help get things right first time and this reduces the time to market.

(c)! Steps to reduce a cost gap Review radio features

Remove features from the radio that add to cost but do not significantly add value to the product when viewed by the customer. This should reduce cost but not the achievable selling price. This can be referred to as value engineering or value analysis.

Team approach Cost reduction works best when a team approach is adopted. Edward Limited should bring together members of the marketing, design, assembly and distribution teams to allow discussion of methods to reduce costs. Open discussion and brainstorming are useful approaches here.

Review the whole supplier chain Each step in the supply chain should be reviewed, possibly with the aid of staff questionnaires, to identify areas of likely cost savings. Areas which are identified by staff as being likely cost saving areas can then be focussed on by the team. For example, the questionnaire might ask ‘are there more than five potential suppliers for this component?’ Clearly a ‘yes’ response to this question will mean that there is the potential for tendering or price competition.

Components Edward Limited should look at the significant costs involved in components. New suppliers could be sought or different materials could be used. Care would be needed not to damage the perceived value of the product. Efficiency improvements should also be possible by reducing

Workings

Variable Cost Pe ost Per unit using the High/Low metho method

Overheads in Month 1

Overheads in Month 2

Difference 80,000 Assembly Hours in Month 1

Assembly Hours in Month 2

Difference 4,000 Variable cost per unit

Absorption Rate for Fixed Costs Absorp

Total Costs in Month 1 620,000 Total Variable Costs

380,000 Total Fixed Costs per month

(19,000 x 20)

240,000 Total Fixed Costs per year

(620,000 - 380,000)

2,880,000 Total Assembly Hours per year

(240,000 x 12)

240,000 Absorption Rate

In question

$12 per hour

0.128 Other Material

(25/100 x 0.5 x 100/98)

8.10 Assembly Labour

7 Variable Overheads

(30/60 x $12.60 x 100/90)

10 Fixed Production

(30/60 x $20 per hour)

6 Overheads

(30/60 x $12 per hour)

Total Cost 35.928 Desired Cost

35.2 Cost Gap

($44 x 0.8)

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. How do you set a target cost?

2. If the cost is too high what do we call this?

3. State 5 ways to deal with this.

4. What must you not suggest?

5. What sort of industry is Target Costing suitable for?

6. How can target costing improve performance?

7. What other costing method is Target Costing linked to?

8. How is the price of the product set in Target Costing?

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: December 2007 Q1 (Again)

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. How do you set a target cost?

1. Set a target price.

2. Establish the margin you wish to make.

3. Make sure you can cost the product to meet this.

2. If the cost is too high what do we call this?

Cost Gap.

3. State 5 ways to deal with this.

Reduce the number of components. Use standard Components. Improve labour efﬁciency. Use cheaper materials or labour. Use new technology. Cut non-value-adding activities.

4. What must you not suggest? REDUCE PRICE. (The price is set by the market).

5. What sort of industry is Target Costing suitable for?

Life Cycle Costing.

8. How is the price of the product set in Target Costing?

By undertaking market research.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: December 2007 Q1 (Again)

Now do it!

Lecture 4 Throughput Accounting

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No. Units Sold Per Day

Sales Price

Direct Materials Cost per unit

Other Factory Costs per Day

No. Hours of bottleneck used per day

Required (i) Calculate the Return Per Factory Hour.

(ii) Calculate the Throughput Accounting Ratio. (iii) Suggest how could the ratio be improved.

Solution (i)

Working

Sales Per Day

12,500 Direct Materials

Usage of bottleneck hours per d rs per day

8 Return Per Factory Hour

Working

Return Per Factory Hour 938 Total Factory Costs Per Hour

750 Throughput Accounting Ratio

(iii)

To improve the throughput accounting ratio a firm may: Increase the selling price per unit Reduce material costs per unit if possible Reduce the time on the bottleneck process Redesign the bottleneck process Invest in capacity to increase the bottleneck

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What type of manufacturing environment is Throughput Accounting suitable for?

2. Why is producing goods for inventory seen as bad?

3. What is the ‘theory of constraints’?

4. How do we calculate throughput contribution?

5. What are the 4 concepts behind Throughput Accounting?

6. What is the ‘return per factory hour’?

7. How do you calculate the Throughput Accounting Ratio?

8. What does it tell you?

9. How can you improve it?

10. State 3 other factors should be considered before ceasing production based on the THAR.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below:

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What type of manufacturing environment is Throughput Accounting suitable for?

Just In Time

2. Why is producing goods for inventory seen as bad?

It ties up cash. It increases costs eg. storage, insurance, etc. It increases the risk of obsolescence. It is an inefﬁcient use of resources.

3. What is the ‘theory of constraints’?

There are constraints within production processes called ‘bottlenecks’ that will limit the amount that a factory can produce in a certain time period.

Management should focus on these ‘bottlenecks’ to speed up production.

4. How do we calculate throughput contribution?

Sales Price less Direct Materials cost.

5. What are the 4 concepts behind Throughput Accounting?

All costs except materials are ﬁxed in the short term. Inventory is bad.

Are we making a proﬁt.

9. How can you improve it?

• Increase the selling price per unit • Reduce material costs per unit if possible • Reduce the time on the bottleneck process • Redesign the bottleneck process • Invest in capacity to increase the bottleneck

10. State 3 other factors should be considered before ceasing production based on the THAR.

Customer Perception. Long term impact on the business. Lost related sales. Excess capacity.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below:

June 2009 Q1

Lecture 5 Environmental Accounting

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Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What is environmental costing?

2. What are the 2 categories of environmental cost?

3. Give 3 examples of costs in each of the categories.

4. Who are external environmental costs imposed upon?

5. Are these costs recognised in traditional methods of costing?

6. Name 3 methods of environmental costing.

7. What are the advantages of environmental costing?

8. What are the disadvantages of environmental costing?

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: New area of the syllabus so no questions (yet!)

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What is environmental costing?

Environmental costing seeks to quantify the environmental effect of a business and treat it in the same manner as any other cost.

2. What are the 2 categories of environmental cost?

Internal & External

3. Give 3 examples of costs in each of the categories.

Internal Systems to identify costs.

Waste disposal costs. Product take back costs. Costs of regulations. Cost of permits. Decommissioning costs

External Carbon emissions

Use of energy and water.

6. Name 3 methods of environmental costing.

Environmental activity based costing. Inflow/outflow analysis. Flow cost accounting.

7. What are the advantages of environmental costing?

Creation of realistic product costs. Better pricing through an understanding of the cost. Raising awareness of the environmental impact of the firm. Integration of environmental costs into the business.

8. What are the disadvantages of environmental costing?

It takes time and money to implement. The calculation ifs difficult and and often inaccurate. Many of the costs identified are not actually borne by the firm. Some of the costs are intangible and therefore difficult to quantify. It is disadvantageous to the company to include the cost.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below:

Lecture 6 Linear Programming I

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Our Company manufactures two products, Designer Shoes and Sneakers.

The number of machine hours available for production in the month is restricted to 500.

The products require the following number of hours to produce

Machine hrs required

Designer Shoes

Sneakers

Maximum demand in the month is 150 units made up of any mix of designer shoes and trainers.

What is the optimum level of production and the profit made at that level?

Solution

Step 1 - Define the variables What can the company control?

Call one controllable item X and the other Y The number of designer shoes produced = X The number of sneakers produced = Y

Step 2 - Establish the constraints to production

Product

Machine Hours Required

X (Designer Shoes)

Y (Sneakers)

Total Machine hours available are 500 500 Any combination of X and Y must take take less than 500 hrs to produce So we can say:

(5hrs x No. Designer Shoes) + (2hrs x hrs x No. Sneakers) must be less than 500 hrs

This can be expressed as:

5X + 2Y < 500 Y < 500

Demand

Total Demand for shoes is 150 Any combination of X and Y will sell a maximum of 150 units So we can say:

No. Designer Shoes + No. Sneakers must be less than or equal to 150 units This can be expressed as:

X + Y < 150

Non-Negativity

What problem are we trying to solve - our - our objective?

Our objective is to maximise proﬁt

Product

Proﬁt

Designer Shoes

Sneakers

The objective function therefore is: Proﬁt (P) = 5 (P) = 50X + 30Y

Step 4 - Graph the Constraints For each constraint set X = 0 to ﬁnd Y and Y = 0 to ﬁnd X

For the constraint 5X + 2Y < 500 If Y = 0, then 5X = 500 and therefore X = 100 If X = 0, then 2Y = 500 and therefore Y = 250 For the constraint X + Y = < 150 If X = 0 then Y = 150 If Y = 0 then X = 150 Plot these on a graph.

Iso Proﬁt Line

This tells us which point on the graph we should produce at. It will be at the intersection of two constraints or the intersection of one of the

constraints and the axis of the graph. Choose a proﬁt level of say $2,000 and use the objective function to get 50X + 30Y =

We need to plot this on the graph so set X then Y to zero to get the points If X = 0, then 30Y = 2,000 and Y = 67 If Y = 0, then 50X = 2,000 and X = 40 Plot these on a graph and move the Iso-Proﬁt line outwards in parallel from the origin to

ﬁnd the outermost intersection and thus the optimal solution. On our graph this is at point B.

Step 6 - Find the profit at the optimum point of production

Optimum level

We can read from the graph at point B to ﬁnd the production levels of 83 sneakers and

67 designer shoes. We can also use simultaneous equations to solve the two constraints that intersect. The two constraint lines intersecting at point B are:

1) 5X + 2Y = 500 2)

X + Y = 150

Fill this into equation 2:

67 + Y = 150 Y = 83

This is of course the same answer as reading the graph.

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What sort of problems are linear programming designed to solve?

2. Give an example of a constraint that may prevent unlimited production.

3. A business has only 300 labour hours available and 400 machine hours . They produces 2 products - Digestives and Jammy Dodgers. Digestives take 3 labour hours to produce and 5 machine hours. Jammy Dodgers take 4 labour hours and 3 machine hours. Define the variables and establish the constraints.

4. If Digestives make contribution of $25 and Jammy Dodgers $37 establish the objective function.

5. Establish the points to plot the graph of the constraints established in Q3.

6. Plot the graph.

7. Draw the Iso-profit line to establish the profit maximising point.

8. Calculate the profit at that point.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: June 2008 Q2

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What sort of problems are linear programming designed to solve?

Profit maximising or cost minimising problems.

2. Give an example of a constraint that may prevent unlimited production.

Labour Hours, Machine Hours, Demand.

What can the company control?

Call one controllable item X and the other Y The number of Digestives produced = X The number of Jammy Dodgers produced = Y

Y (Jammy Dodgers)

4 3 Total Labour hours available are 3 are 300 Any combination of X and Y must must take less than 300 hrs to prod o produce So we can say:

(3hrs x No. Digestives) + (4hrs x N rs x No. Jammy Dodgers) must be st be less than 300 hrs This can be expressed as:

3X + 4Y < 300

Total Machine hours available are le are 400 Any combination of X and Y must must take less than 400 hrs to prod o produce So we can say:

(5hrs x No. Digestives) + (2hrs x N rs x No. Jammy Dodgers) must be st be less than 400 hrs This can be expressed as:

5X + 3Y < 400

We cannot produce less than one unit. Any combination of X and Y will sell a minimum of 0 units So we can say:

X can’t be less than 0 Y can’t be less than 0

This can be expressed as:

X>0 Y>0 X>0 Y>0

What problem are we trying to solve - our - our objective?

Our objective is to maximise proﬁt

Product

Proﬁt

Jammy Dodgers

The objective function therefore is: Proﬁt (P) = 2 (P) = 25X + 37Y

5. Establish the points to plot the graph of the constraints established in Q3.

For each constraint set X = 0 to ﬁnd Y and Y = 0 to ﬁnd X

For the constraint 3X + 4Y < 300 If Y = 0, then 3X = 300 and therefore X = 100 If X = 0, then 4Y = 300 and therefore Y = 75 For the constraint 5X + 3Y = < 400 If Y = 0, then 5X = 400 and therefore X = 80 If X = 0, then 3Y = 400 and therefore Y = 133 Plot these on a graph.

Iso Proﬁt Line

This tells us which point on the graph we should produce at. It will be at the intersection of two constraints or the intersection of one of the

constraints and the axis of the graph. Choose a proﬁt level of say $2,000 and use the objective function to get 25X + 37Y =

We need to plot this on the graph so set X then Y to zero to get the points If X = 0, then 37Y = 2,000 and Y = 54 If Y = 0, then 25X = 2,000 and X = 80 Plot these on a graph and move the Iso-Proﬁt line outwards in parallel from the origin to

ﬁnd the outermost intersection and thus the optimal solution. On our graph this is at point A where 3X + 4Y < 400 crosses the Y axis.

8. Calculate the profit at that point.

Proﬁt

We can read from the graph at point A to ﬁnd the production levels of 75 Jammy Dodgers and 0 Digestives.

The proﬁt at that level is (75 x $37) = $2,775

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: June 2008 Q2

Now do it!

Lecture 7 Linear Programming II

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The company producing sneakers and designer shoes in the previous illustration has calculated that a marketing campaign will increase the demand for shoes by 1 unit to 150. It is estimated that the campaign will increase overall costs by $7 per unit on average.

Should the company conduct the campaign?

Solution

Shadow Price

The constraint for demand will change to X + Y < 151 We can also use simultaneous equations to solve the two constraints again with the

new constraint. The two constraint lines intersecting at point B are:

1) 5X + 2Y = 500 2)

X + Y = 151 If we then multiply equation 2) by 2 we will be able to cancel out the Y portion of the

two equations: That gives:

1) 5X + 2Y = 500 2)

2X + 2Y = 302 Subtracting equation 2 from equation 1 we get 3X = 198 and therefore X = 66

Test Your Knowledge

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work on this area!

1. Based on the details in the Test Your Knowledge questions in the previous chapter, the workforce have agreed to work overtime for twice the normal rate of $10 per hour in order to make more labour hours available. Should the company accept the offer?

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: June 08 Q2

Now do it!

Test Your Knowledge Answers

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work on this area!

Shadow Price

The constraint for Labour will change to 3X + 4Y < 301 The intersection of the constraint and the Y axis means that X = 0 If X=0 then 4Y = 301 and Y = 75.25 Total proﬁt will be (75.25 x $37) = $2,784.25 Original Profit was $2,775 The shadow price is ($2,784.25 - $2,775) = $9.25 The company should not take up the offer as the labour hour added $9.25 in proﬁt but

cost $20 to pay the labour.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below:

Lecture 8 Demand & Costs

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A firm produces widgets and has found that for an increase in price from 35c per unit to 45c per unit demand will fall from 750,000 units to 500,000 units.

Calculate the price elasticity of demand and state whether it is elastic or inelastic.

Solution

Percentage decrease in demand (500/750 -1) x 100 33.33% Percentage increase in price

(45/35 x 100) -100 28.57% Price elasticity of demand

1.17 Price elasticity of demand is elastic as it is greater tha er than one.

ABC Ltd sells a product at $12 per unit and has demand of 16,000 units at that price. If the selling price were to be increased by $1 per unit, demand would fall by 2500 units. On the assumption that the price/demand function is linear, derive the equation relating the

selling price to demand.

Solution

Determine each of the componen onents of the curve

P (Price)

a (Price at which demand is zero) (16000/2500) +12

0.0004 by 1 unit)

b (Change in price required to decrease demand

Q (Quantity demanded at P) 16,000 The demand equation therefore is: 12 = 18.4 – (0.000 (0.0004 (16000))

A firm can choose to set the following prices which will lead to the following levels of demand:

Fixed Costs are $300,000 and variable costs are $15 per unit. What price should the firm charge?

Solution

Price Per Unit

20,000 Sales Revenue ($000)

800 Variable Costs ($000)

500 Fixed Costs ($000)

-300 Net Profit ($000)

200 The optimum price to charge here is $30 30

A company is able to sell 2000 units per month at a price of $100. An increase in the selling price to $110 will lead to a fall in demand to 1600 units. The variable cost per unit is $40 and the fixed costs per month are $50,000.

What is the optimum price and the maximum profit?

Solution

Determine each of the components of the dem e demand curve

b (Change in price required to decrease demand by 1 unit) Current selling price = $100 and an increase of $10 will

(10/400) $0.025 lead to a fall in demand of (2000 - 1600) 400 units.

a (Price at which demand is zero) (2000 x 0.025) + $150 100

Fill in equation MR MR = a - 2bQ

Marginal Revenue = Marginal Cost (Variable Cost Cost in question)

40 To ﬁnd optimum Q use MR = a - 2bQ

40 = 150 - (2 x 0.025Q) (2 x 0.025Q) = 110 0.05Q = 110

Q= 20 Fill into P = a - bQ

P = 150 - 0.025(2200)

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. Name the 4 types of market under economic theory.

2. How is the price elasticity of demand calculated?

3. State the demand equation.

4. State the Total Cost Equation.

5. A firm can choose to set the following prices which will lead to the following levels of demand:

Fixed Costs are $400,000 and variable costs are $17 per unit. What price should the firm charge?

6. A company is able to sell 2500 units per month at a price of $120. An increase in the selling price to $130 will lead to a fall in demand to 1800 units. The variable cost per unit is $43 and the fixed costs per month are $60,000.

What is the optimum price and the maximum profit?

If you’ve successfully answered all of the above

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. Name the 4 types of market under economic theory.

Monopoly, Monopolistic Competition, Oligopoly, Perfect Competition.

2. How is the price elasticity of demand calculated?

%Change in demand / %Change in price

3. State the demand equation.

P = a - bc

4. State the Total Cost Equation.

TC = TFC + (V. Cost per unit x Q)

5. A firm can choose to set the following prices which will lead to the following levels of demand:

Price

Demand

35,000 Sales Revenue ($000)

1,575 Variable Costs ($000)

980 Fixed Costs ($000)

-400 Net Profit ($000)

580 The optimum price to charge here is $45 45

What is the optimum price and the maximum profit?

Determine each of the components of th ts of the demand curve to deriv derive it

$0.014 demand by 1 unit) Current selling price = $120 and an increase of $10 will lead to a fall in demand of (2500 - 1800) 700 units.

b (Change in price required to decrease

a (Price at which demand is zero) (2500 x 0.014) + 120 $155

P (Price) P = 155 - 0.014(2500) 120 The demand equation therefore is: 120 = 155 - 0. 55 - 0.014(2500)

Fill in equation MR MR = a - 2bQ

Marginal Revenue = Marginal Cost (Variable Cost Cost in question)

43 To ﬁnd optimum Q use MR = a - 2bQ

43 = 155 - (2 x 0.014Q) 20

(2 x 0.014Q) = 112 0.028Q = 112

Q= 4,000 Fill into P = a - bQ

P = 155 - 0.014(4000)

Calculate total p total proﬁt

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: June 2011 Q2 (a)

Now do it!

Lecture 9 Pricing Strategy

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Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What are the downsides of full-cost plus pricing?

2. What are the benefits of marginal-cost plus pricing?

3. What are the downsides of marginal-cost plus pricing?

4. When is it appropriate to undertake a strategy of Price Skimming?

5. When is it appropriate to undertake a strategy of Penetration Pricing?

6. What are complementary products?

7. What is price discrimination?

8. What conditions must exist for price discrimination?

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: June 2011 Q2 (b)

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. What are the downsides of full-cost plus pricing?

It ignores demand in the market which may well set the price. An absorption rate is needed to absorb fixed costs.

2. What are the benefits of marginal-cost plus pricing?

It’s a quick and simple method. The mark up on products can be varied and set based on the variable cost. It makes managers aware of the concept of contribution.

3. What are the downsides of marginal-cost plus pricing?

Again, it ignores demand. The price must be set to ensure that the fixed costs are covered as they are not included in the marginal cost.

4. When is it appropriate to undertake a strategy of Price Skimming?

When the product is new and innovative. When there is high demand for the product. When the price elasticity of demand is unknown. To ensure that the cash invested in the product is recouped. When a product has a shortened life cycle.

Products which are bought and used together i.e. the sale of one depends on the sale of another.

7. What is price discrimination?

Charging a different price to different customers for the same product.

8. What conditions must exist for price discrimination?

There must be identifiable segments to charge. There must be no chance of a black market. There should be no potential for a black market to become established.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

below: June 2011 Q2 (b)

Now do it!

Lecture 10 Cost/Volume/Proﬁt Analysis

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Mage Co. produces a product with the following information for next month:

Variable Cost

Fixed Costs

Budgeted Production

(i) Calculate the full cost per unit. (ii) With the recent recession, the firm is experiencing a slowdown in demand and the only

offer they have for their product is a company who will buy all 1,000 units at $57 per unit. Mage are confident that demand will pick up in the next few months. Should they accept the offer?

Solution

Variable Cost

Result if Marge take the offer Re ffer

Sales

$57,000 Variable Costs

$17,000 Fixed Costs

$20,000 Total Losses

Resul esult if Marge don’t take the offe offer

Sales Variable Cost Contribution Fixed Costs

$20,000 Total Losses

-$20,000 If Marge do not take the offer th fer they make losses of $20,000 comp 0 compared to losses of

$3,000 if they take the offer. r. This highlights the importance o nce of management understanding ding contribution (to ﬁxed costs

and proﬁt). Neither option is sustainable in le in the long term but as trading is ng is expected to improve then

accepting the smaller loss if $3, ss if $3,000 may mean the business ca ess can trade into the future until conditions improve.

Company A is producing a product with the following information:

Sales Price

Variable Cost

Fixed Costs

Budgeted Production

Required: (i) Calculate the following using ratios rather than the chart:

• Contribution to sales ratio. • Break even point in units. • Break even point in revenue. • How many units need to be sold to achieve a proﬁt of $50,000 • How much revenue is required to achieve a proﬁt of $50,000. • The margin of safety.

(ii) Draw a Break-even chart for the product based on the above information and determine where the break even point is using the chart.

Solution

Contribution to sales ratio

40% Break even point in units.

2,000 units

Company A is producing a product with the following information:

Sales Price

Variable Cost

Fixed Costs

Budgeted Production

Required: (i) Draw a Break-even chart for the product based on the above information and determine

where the break even point is using the chart. (ii)Calculate the following using ratios rather than the chart:

• Contribution to sales ratio. • Break even point in units. • Break even point in revenue. • How many units need to be sold to achieve a proﬁt of $300,000. • How much revenue is required to achieve a proﬁt of $300,000. • Margin of safety.

Solution

Contribution to sales ratio

Company B is producing 2 products with the following details being relevant:

Product X

Product Y

Sales Price

50 60 Variable Cost

30 45 Contribution Per Unit

20 15 Budgeted Sales

10,000 Total Fixed Costs are $350,000 ,000

Required: (i) Calculate the break even point in sales revenue for company B

(ii)Calculate the sales revenue required to make a proﬁt of $300,000.

Volume

Cont p/unit

Total

Sales Price Revenue

1,600,000 Average contribu ntribution/sales ratio s ratio = 550,000/1,6 0/1,600,000 = 0.344 .344

ABC produces 3 products A,B & C with the following data available:

Selling Price

Variable Cost

% of Total Sales

Fixed Costs in the period are expected to be $200,000 Budgeted sales are 100,000 units Required (i) Calculate the sales revenue required to break even (ii) Calculate the sales revenue required to make $300,000 profit (iii) Draw a Profit-Volume chart using the data in the question assuming the company

decides to sell the most profitable product first.

Solution

(i) & (ii)

Volume

Cont p/unit

Total

Sales Price Revenue

Contribution

A 20 10 200

B 50 15 750

C 30 15 450

We need to rank the products as we will show the effect if the company decides to sell the most profitable product first:

Product

Contribution to sales ratio

We then need a table to set out the figures for our graph:

Revenue Fixed Costs

Proﬁt / Loss

A 20 x $10 = $200

0 20 x $30

B 50 x $15 = $750

5,350 Graphing phing this showing one bow e bow shaped line assu ne assuming that we sell all of the of the most

C 30 x $15 = $450

30 x $75 = $2,250

profitable fitable product first and a se a second straight line ht line assuming a constant prod t product mix.

Test Your Knowledge

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. How is contribution calculated?

2. Complete the statement ‘Contribution to...........’

3. Company A is producing a product with the following information:

Sales Price

Variable Cost

Fixed Costs

Budgeted Production

Required: (i) Calculate the following using ratios:

4. Company B is producing 2 products with the following details being relevant:

(i) Calculate the break even point in sales revenue for company B (ii)Calculate the sales revenue required to make a proﬁt of $250,000.

5. ABC produces 3 products A,B & C with the following data available:

Selling Price

Variable Cost

% of Total Sales

Fixed Costs in the period are expected to be $500,000 Budgeted sales are 200,000 units

Required (i) Calculate the sales revenue required to break even (ii)Calculate the sales revenue required to make $400,000 profit (iii)Show the points to plot on a Profit-Volume chart using the data in the question

assuming the company decides to sell the most profitable product first.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below:

New area of the syllabus so no questions (yet!)

Test Your Knowledge Answers

If you can’t answer all of the questions below without looking at the answer then you need to do some more

work on this area!

1. How is contribution calculated?

Sales Price less variable cost of production.

2. Complete the statement ‘Contribution to...........’

.....fixed costs and profit’

3. Company A is producing a product with the following information:

Sales Price

Variable Cost

Fixed Costs

Budgeted Production

Required: (i) Calculate the following using ratios:

• Contribution to sales ratio. • Break even point in units. • Break even point in revenue.

Contribution to sales ratio

47% Break even point in units.

2,143 units Break even point in revenue.

$159,574 How many units need to be sold to

3,571 units achieve a proﬁt of $50,000

$265,957 achieve a proﬁt of $300,000.

How much revenue is required to

The margin of safety.

(8,000 - 2,143)

5,857 units

4. Company B is producing 2 products with the following details being relevant:

Product X

Product Y

Sales Price

40 75 Variable Cost

20 52 Contribution Per Unit

20 23 Budgeted Sales

120,000 Total Fixed Costs are $500,000 ,000

Required: (i) Calculate the break even point in sales revenue for company B

Volume

Cont p/unit

Total

Sales Price Revenue

11,000,000 Average contribu ntribution/sales ratio s ratio = 3,760,000/1 000/11,000,000 = 0.3 = 0.34 Break-even poin point = (500,000 / 0 00 / 0.34) = $1,470, ,470,588 To make $250,00 50,000 proﬁt = (500 = (500,000 + 250,000 0,000) / 0.34 = $2,20 $2,205,882

Selling Price

Variable Cost

% of Total Sales

Fixed Costs in the period are expected to be $500,000 Budgeted sales are 200,000 units Required (i) Calculate the sales revenue required to break even (ii) Calculate the sales revenue required to make $400,000 profit (iii) Show the points to plot on a Profit-Volume chart using the data in the question

assuming the company decides to sell the most profitable product first.

Solution (i) & (ii)

Volume

Cont p/unit

Total

Sales Price Revenue

85 525 Average contribu ntribution/sales ratio s ratio = (85/525) = 0 5) = 0.16

We need to rank the products as we will show the effect if the company decides to sell the most profitable product first:

Product Contribution to sales ratio

We then need a table to set out the figures for our graph:

Revenue Fixed Costs

Proﬁt / Loss

-500,000

B 100,000 x $8 =

C 40,000 x $15 =

A 60,000 x $5 =

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions

Lecture 11 Relevant Costing

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ABC Co. is considering a project to produce a one-off run of products for a customer. They can employ non-skilled staff at short notice who are paid $8 per hour and are not currently needed elsewhere in the business. The production run will also use skilled labour who are currently employed on another project which creates contribution of $35 per hour for the business. The skilled labour are paid $20 per hour.

The production run will take: 500 hours of unskilled labour.

200 hours of skilled labour. (i) What is the relevant cost of labour for inclusion in the evaluation of the project by ABC?

(ii) If the unskilled labour was employed by ABC on contract guaranteeing them work for the 500 hours in any area of the factory then what would the labour cost be?

Solution

(i)

Working

Unskilled Labour

4,000 Skilled Labour

(500 x 8)

4,000 Opportunity cost of skilled labour

Total Cost of Labour Tota

Laddy Co. is considering undertaking a one-off building project. The project will use 2 different types of window, standard and decorative. Standard windows currently cost $40 each and the project will require 20,000 of these.

Decorative brick currently costs $120 each and the project will require 2,000 of these. Laddy has 7,000 standard windows in stock which cost $30 when they were purchased 3

months ago. These are used in all projects undertaken by Laddy and there are 3 other projects in progress at the moment.

Laddy has 300 decorative windows in stock which cost $150 when they were purchased. They do not expect to use the decorative type on future projects and could sell any that they have for their current cost price less 10% as some are damaged.

What is the total relevant cost of the windows for consideration of the project?

Solution

Working

280,000 Standard Windows not in Stock

Standard Windows in Stock

Used regularly so 7,000 x 40

520,000 Decorative windows in Stock

(20,000 - 7,000) x 40

32,400 Decorative windows not in Stock

(120 x 0.9) x 300

(2,000 - 300) x 120

Total Cost of Windows 1,036,400

A builder has been asked to quote for a job and has the following information available about the costs:

Item

Detail

Direct Materials Bricks

200,000 at $100 per thousand.

Note 1

200,000 at $120 per thousand.

Other Materials

Note 2 Direct Labour Skilled

Note 3 Unskilled

3,200 hrs at $12 per hour

Note 4 Other Costs Scaffolding hire

2,000 hrs at $6 per hour

Note 5 Depreciation of general neral purpose machinery

Note 6 General overheads 5,200 hrs at $1 per hour