6/14/2022 STRATEGIC

MANAGEMENT
ACCOUNTING
TUTORIAL QUESTIONS

Moses Nyakuwanika [email protected]

GREAT ZIMBABWE UNIVERSITY
MOBILE NUMBER 0773475415/ 0173035562
TOPIC 1: TRADITIONAL COSTING SYSTEM VS MORDEN COSTING SYSTEM

QUESTION 1
The Mukuru Co produces three products, A, B and C, all made from the same material.
Until now, it has used traditional absorption costing to allocate overheads to its
products. The company is now considering an activity based costing system in the
hope that it will improve profitability. Information for the three products for the last year
is as follows:
A B C
Production and sales volumes (units) 15,000 12,000 18,000
Selling price per unit $7.50 $12 $13
Raw material usage (kg) per unit 2 3 4
Direct labour hours per unit 0·1 0·15 0·2
Machine hours per unit 0·5 0·7 0·9
Number of production runs per annum 16 12 8
Number of purchase orders per annum 24 28 42
Number of deliveries to retailers per annum 48 30 62

The price for raw materials remained constant throughout the year at $1·20 per kg.
Similarly, the direct labour cost for the whole workforce was $14·80 per hour. The
annual overhead costs were as follows:
$
Machine set up costs 26,550
Machine running costs 66,400
Procurement costs 48,000
Delivery costs 54,320
YOU ARE REQUIRED TO:
(a) Calculate the full cost per unit for products A, B and C under traditional absorption
costing, using direct labour hours as the basis for apportionment. (7 marks)
(b) Calculate the full cost per unit of each product using activity based costing.
(12 marks)
(c) Using your calculation from (a) and (b) above, explain how activity based costing
may help The Mukuru Co improve the profitability of each product. (6 marks)
(Total 25 marks)
QUESTION 2

Kwaedza Ltd. manufactures and sells components used in the computer hardware
industry. The company currently charge overheads to products using a plant-wide rate
based on direct labour hours. This method was introduced in 1990 when the company
was established and the company only produced one product. Since 1990, the
company has invested heavily in advanced manufacturing technologies and has
increased their product range. Kwaedza Ltd. operates in a very competitive market
and due to current economic conditions they are coming under increasing pressure by
their customers to reduce their prices. The company are considering the introduction
of an Activity Based Costing (ABC) system and has provided the following information
in relation to their three products:

Product A Product B Product C

Direct materials per unit $100 $120 $150
Direct labour hours per unit 10 hours 8 hours 9 hours
Machine hours per unit 4 hours 6 hours 3 hours
Production/sales in units 10,000 4,000 6,000

Direct labour is paid at $14 per labour hour. The company calculates selling price by
applying a mark-up on cost of 25%.

Details of the overheads of Kwaedza Ltd. are as follows:

$
Machine related costs 246,000
Set-up costs 180,000
Delivery costs 68,000
Quality related costs 64,000

Further information in relation to all three products is given as follows:

Product A Product B Product C

Number of set-ups 100 30 20
Number of deliveries 1,000 550 450
Number of inspections 200 100 100

YOU ARE REQUIRED TO:

(a) Calculate the unit production cost and unit profit using the traditional approach to
costing. (4marks)
(b) Calculate the unit production cost and unit profit based on Activity Based Costing
principles. (15 marks)
(c) Identify three reasons why Kwaedza Ltd. should implement an Activity Based
Costing system. (6 marks)
[Note: Figures to be rounded to two decimal places]
[Total: 25 Marks]
QUESTION 3
MUSHANDIKE Silverware Products Limited is a leading manufacturer of silver picture
frames. The company used a traditional costing system to allocate production
overheads to products using machine hours.

The newly appointed financial controller believes that activity based costing would
provide a better allocation of production overheads to products than the current
system. You are provided with the following total production overheads for the last
period recorded by the cost accounting system.
$
Utility costs related to machine hours 189,000
Production set up costs 120,000
Cost of ordering materials 18,000
Cost of handling materials 33,000

Details of the three models of products and relevant actual information for the last
period are also provided as follows.

Model 1 Model 2 Model 3

Number of production runs 17 25 18
Number of material orders 20 30 40
Number of material requisitions 30 100 70
Units produced 1,000 2,000 2,500
Machine hours per unit 1 1.5 2
Direct labour hours per unit ($60 per hour) 0.5 hour 1 hour 2 hours
Direct material per unit $10 $12 $15

YOU ARE REQUIRED TO:

(a) Calculate the unit production cost of each of the three products using
(i) The traditional absorption costing, and
(ii) The activity based costing approach respectively. (20 marks)
(b) Comment on the calculations in part (a) above and explain why the activity based
costing approach is superior to traditional absorption costing. (5 marks)
[Total 25 marks]
QUESTION 4
Alfresco Limited manufactures picnic tables for the Zimbabwean market. Since its
inception, it has allocated overhead costs based on labour hours. The Managing
Director is happy with this approach as he can understand the calculations and it is
relatively quick to calculate the overhead rate per labour hour. Despite this, the
accountant Mr Mufushwa is eager to adopt an activity based costing approach to
overhead allocation. Mr Mufushwa has already studied the ‘cost drivers’ of Alfresco
Limited and identified the following:

Activity: Cost Driver: Cost Pool:

Assembly costs Number of labour hours $56,000
Purchasing department Number of purchase orders $44,000
Delivery Costs Number of deliveries $42,000
Machine maintenance Machine hours $45,000

Alfresco Limited manufactures three different styles of picnic tables: ‘Round’, ‘Square’
and ‘Octagon’. Information relating to the manufacturing process is as follows:

Round Square Octagon

Direct material cost $157,500 $157,500 $210,000
No. of machine hours required 1,200 400 1,400
No. of labour hours 3,000 4,000 3,000
No. of purchase orders 3 2 6
No. of deliveries required 10 30 20
Production (units) 1,500 1,500 2,000
Selling price (mark-up on cost) 30% 30% 40%

YOU ARE REQUIRED TO:

(a) Calculate the selling price for each of the three products, using the traditional
approach to costing. (6 marks)
(b) Calculate the selling price for each of the three products, using Activity Based
Costing. (14 marks)
(c) Describe the circumstances where traditional costing systems are likely to report
distorted costs. You should include appropriate reference to your calculations
performed in parts (a) and (b) when describing such circumstances. (5 marks)

NOTE: Figures should be rounded to two decimal places. [Total: 25 marks]

QUESTION 5
Mahobo Co manufactures three products, X, Y and Z. Demand for products X and Y
is relatively elastic whilst demand for product Z is relatively inelastic. Each product
uses the same materials and the same type of direct labour but in different quantities.
For many years, the company has been using full absorption costing and absorbing
overheads on the basis of direct labour hours. Selling prices are then determined using
cost plus pricing. This is common within this industry, with most competitors applying
a standard mark-up.

Budgeted production and sales volumes for X, Y and Z for the next year are 20,000
units, 16,000 units and 22,000 units respectively.

The budgeted direct costs of the three products are shown below:

Product X Y Z
$ Per unit $ per unit $ per unit
Direct materials 25 28 22
Direct labour ($12 per hour) 30 36 24
In the next year, Mahobo Co also expects to incur indirect production costs of
$1,377,400, which are analysed as follows:

Cost pools $ Cost drivers

Machine set up costs 280,000 Number of batches
Material ordering costs 316,000 Number of purchase orders
Machine running costs 420,000 Number of machine hours
General facility costs 361,400 Number of machine hours
––––––––––
1,377,400
––––––––––

The following additional data relate to each product:

Product X Y Z
Batch size (units) 500 800 400
No of purchase orders per batch 4 5 4
Machine hours per unit 1·5 1·25 1·4

Duff Co wants to boost sales revenue in order to increase profits but its capacity to do
this is limited because of its use of cost plus pricing and the application of the standard
mark-up. The finance director has suggested using activity based costing (ABC)
instead of full absorption costing, since this will alter the cost of the products and may
therefore enable a different price to be charged.

Required:

(a) Calculate the budgeted full production cost per unit of each product using Duff Co’s
current method of absorption costing. All workings should be to two decimal places.
(5 marks)
(b) Calculate the budgeted full production cost per unit of each product using activity
based costing. All workings should be to two decimal places. (13 marks)
(c) Discuss the impact on the selling prices and the sales volumes OF EACH
PRODUCT which a change to activity based costing would be expected to bring
about. (7 marks)
(TOTAL MARKS: 25)
QUESTION 6
Triple Limited makes three types of gold watch – the Diva (D), the Classic (C) and the
Poser (P). A traditional product costing system is used at present; although an activity
based costing (ABC) system is being considered. Details of the three products for a
typical period are:
Hours per unit Materials
Production
Labour hours Machine hours Cost per unit units
$
Product D ½ 1½ 20 750
Product C 1½ 1 12 1,250
Product P 1 3 25 7,000
Direct labour costs $6 per hour and production overheads are absorbed on a machine
hour basis. The overhead absorption rate for the period is $28 per machine hour.'
YOU REQUIRED TO:
(a) Calculate the cost per unit for each product using traditional methods,
absorbing overheads on the basis of machine hours. (4 marks)

Total production overheads are $654,500 and further analysis shows that the total
production overheads can be divided as follows:
%
Costs relating to set-ups 35
Costs relating to machinery 20
Costs relating to materials handling 15
Costs relating to inspection 30
Total production overhead 100
The following total activity volumes are associated with each product line for the period
as a whole:
Number of Number of movements Number of
Set ups of materials
inspections
Product D 75 12 150

Product C 115 21 180

Product P 480 87 670
670 120 1,000
You are required to:
(b) Calculate the cost per unit for each product using ABC principles (work to two
decimal places). (15 marks)
(c) Explain why costs per unit calculated under ABC are often very different to costs
per unit calculated under more traditional methods. Use the information from Triple
Limited to illustrate. (6 marks)
(25 marks)
QUESTION 7
Duff Co manufactures three products, X, Y and Z. Demand for products X and Y is
relatively elastic whilst demand for product Z is relatively inelastic. Each product uses
the same materials and the same type of direct labour but in different quantities. For
many years, the company has been using full absorption costing and absorbing
overheads on the basis of direct labour hours. Selling prices are then determined using
cost plus pricing. This is common within this industry, with most competitors applying
a standard mark-up.
Budgeted production and sales volumes for X, Y and Z for the next year are 20,000
units, 16,000 units and 22,000 units respectively.
The budgeted direct costs of the three products are shown below:
Product X Y Z
$ per unit $ per unit $ per unit
Direct materials 25 28 22
Direct labour ($12 per hour) 30 36 24
In the next year, Duff Co also expects to incur indirect production costs of $1,377,400,
which are analysed as follows:
Cost pools $ Cost drivers
Machine set up costs 280,000 Number of batches
Material ordering costs 316,000 Number of purchase orders
Machine running costs 420,000 Number of machine hours
General facility costs 361,400 Number of machine hours
1,377,400
The following additional data relate to each product:
Product X Y Z
Batch size (units) 500 800 400
No of purchase orders per batch 4 5 4
Machine hours per unit 1·5 1·25 1·4
Duff Co wants to boost sales revenue in order to increase profits but its capacity to do
this is limited because of its use of cost plus pricing and the application of the standard
mark-up. The finance director has suggested using activity based costing (ABC)
instead of full absorption costing, since this will alter the cost of the products and may
therefore enable a different price to be charged.
YOU ARE REQUIRED TO:
(a) Calculate the budgeted full production cost per unit of each product using Duff
Co’s current method of absorption costing. All workings should be to two
decimal places. (5 marks)
(b) Calculate the budgeted full production cost per unit of each product using
activity based costing. All workings should be to two decimal places. (14 marks)
(c) Discuss the impact on the selling prices and the sales volumes OF EACH
PRODUCT which a change to activity based costing would be expected to bring
about. (6 marks)
(Total 25 marks)
QUESTION 8

Squash Ltd manufactures 2 products: Product S and Product T and sells these
products at a price which provides a 20% mark-up on absorption cost. Although
Squash operates in a highly competitive environment with intense price competition,
sales of Product S regularly surpass budget expectations. The sales volumes
achieved for Product T are less satisfactory and in recent years the actual sales
volume achieved for this product has consistently been below the budgeted level.

The company currently calculates absorption costs using a traditional volume based
approach in which overheads are absorbed on the basis of direct labour hours. Squash
Ltd produces 6,000 units of Product S and 4,000 units of Product T every year. The
following cost information is currently available in respect of the most recent reporting
period:
Product S Product T
Direct material cost per unit $68 $72
Direct labour cost per unit (@ $10 per hour) $30 $40

Budgeted fixed production overheads amount to $680,000 for the year.

A recent examination of production overheads led to the identification of the following

activities, activity costs and cost drivers.

Activity Cost Driver Cost Cost Driver Volumes Per Annum

Product S Product T Total
Purchasing No. of requisitions $120,000 600 200 800
Setting-up No. of set-ups $180,000 310 140 450
Machining No. of machine hrs $240,000 4,200 3,800 8,000
Quality control No. of inspections $140,000 200 150 350

YOU ARE REQUIRED TO:

a) Calculate the absorption cost per unit for Product S and for Product T using the
overhead absorption approach currently employed within Squash Ltd.
(7 marks)
b) Calculate the absorption cost per unit for Product S and for Product T if, on the
basis of the information provided above, an Activity Based Costing (ABC)
approach was adopted. (13 marks)
 c) Discuss the appropriateness of introducing ABC to Squash Ltd given the
company’s particular circumstances. (5 marks)
[Total: 25 Marks]
QUESTION 9
Admer owns several home furnishing stores. In each store, consultations, if needed,
are undertaken by specialists, who also visit potential customers in their homes, using
specialist software to help customers realize their design objectives. Customers visit
the store to make their selections from the wide range of goods offered, after which
sales staff collect payment and raise a purchase order. Customers then collect their
self-assembly goods from the warehouse, using the purchase order as authority to
collect. Administration staff process purchase orders and also arrange consultations.
Each store operates an absorption costing system and costs other than the cost of
goods sold are apportioned on the basis of sales floor area.
Results for one of Admer’s stores for the last three months are as follows:
Department Kitchens Bathrooms Dining Totals
rooms
$ $ $ $
Sales 210 000 112 500 440 000 762 500
Cost of goods sold 63 000 137 500 176 000 276 500
Other costs 130 250 81 406 113 968 325 624
Profit/(loss) 16 750 (6 406) 150 032 160 376

The management accountant of Admer is concerned that the bathrooms department

of the store has been showing a loss for some time, and is considering a proposal to
close the bathrooms department in order to concentrate on the more profitable
kitchens and dining rooms departments. He has found that other costs for this store
for the last three months are made up of:
$ Employees
Sales staff wages 164,800 12
Consultation staff wages 124,960 4
Warehouse staff wages 130,240 6
Administration staff wages 130,624 4
General overheads (light, heat, rates, etc.) 175,000
325,624
He has also collected the following information for the last three months:

Department Kitchens Bathrooms Dining rooms

Number of items sold 1,000 1,500 4,000
Purchase orders 1,000 90 2,500
Floor area (square metres) 16,000 10,000 14,000
Number of consultations 798 200 250
The management accountant believes that he can use this information to review the
store’s performance in the last three months from an activity-based costing (ABC)
perspective.
YOU ARE REQUIRED TO:
(a) Discuss the management accountant’s belief that the information provided can be
used in an activity-based costing analysis. (4 marks)
(b) Explain and illustrate, using supporting calculations, how an ABC profit statement
might be produced from the information provided. Clearly explain the reasons behind
your choice of cost drivers. (8 marks)
(c) Evaluate and discuss the proposal to close the bathrooms department. (6 marks)
(d) Discuss the advantages and disadvantages that may arise for Admer from
introducing activity-based costing in its stores. (7 marks)
(Total: 25 marks)

TOPIC 2: THROUGHPUT ACCOUNTING

QUESTION 10

Solar Systems Co (S Co) makes two types of solar panels at its manufacturing plant:
large panels for commercial customers and small panels for domestic customers. All
panels are produced using the same materials, machinery and a skilled labour force.
Production takes place for five days per week, from 7 am until 8 pm (13 hours), 50
weeks of the year. Each panel has to be cut, moulded and then assembled using a
cutting machine (Machine C), a moulding machine (Machine M) and an assembly
machine (Machine A).

As part of a government scheme to increase renewable energy sources, S Co has

guaranteed not to increase the price of small or large panels for the next three years.
It has also agreed to supply a minimum of 1,000 small panels each year to domestic
customers for this three-year period.

Due to poor productivity levels, late orders and declining profits over recent years, the
finance director has suggested the introduction of throughput accounting within the
organisation, together with a ‘Just in Time’ system of production. Material costs and
selling prices for each type of panel are shown below.

Large panels Small panels

$ $
Selling price per unit 12,600 3,800
Material costs per unit 4,300 1,160
Total factory costs, which include the cost of labour and all factory overheads, are $12
million each year at the plant.

Out of the 13 hours available for production each day, workers take a one hour lunch
break. For the remaining 12 hours, Machine C is utilized 85% of the time and Machines
M and A are utilized 90% of the time. The unproductive time arises either as a result
of routine maintenance or because of staff absenteeism, as each machine needs to
be manned by skilled workers in order for the machine to run. The skilled workers are
currently only trained to work on one type of machine each. Maintenance work is
carried out by external contractors who provide a round the clock service (that is, they
are available 24 hours a day, seven days a week), should it be required.

The following information is available for Machine M, which has been identified as the
bottleneck resource:

Large panels Small panels

Hours per unit Hours per unit
Machine M 1·4 0·6

There is currently plenty of spare capacity on Machines C and A. Maximum annual

demand for large panels and small panels is 1,800 units and 1,700 units respectively.

YOU ARE REQUIRED TO:

(a) Calculate the throughput accounting ratio for large panels and for small panels
and explain what they indicate to S Co about production of large and small
panels. (12 marks)
(b) Assume that your calculations in part (a) have shown that large panels have a
higher throughput accounting ratio than small panels.

YOU ARE REQUIRED TO:

Using throughput accounting, prepare calculations to determine the optimum

production mix and maximum profit of S Co for the next year. (7 marks)

(c) Suggest and discuss THREE ways in which S Co could try to increase its
production capacity and hence increase throughput in the next year without
making any additional investment in machinery. (6 marks)

[Total: 25 Marks]
QUESTION 11
A Co makes two products, B1 and B2. Its machines can only work on one product at
a time. The two products are worked on in two departments by differing grades of
labour. The labour requirements for the two products are as follows:
Minutes per unit of product
B1 B2
Department 1 12 16
Department 2 20 15
There is currently a shortage of labour and the maximum times available each day in
Departments 1 and 2 are 480 minutes and 840 minutes, respectively.
The current selling prices and costs for the two products are shown below:
B1 B2
$ per unit $ per unit
Selling price 50·00 65·00
Direct materials 10·00 15·00
Direct labour 10·40 6·20
Variable overheads 6·40 9·20
Fixed overheads 12·80 18·40
Profit per unit 10·40 16·20
As part of the budget-setting process, A Co needs to know the optimum output levels.
All output is sold.
(a) Calculate the maximum number of each product that could be produced each day,
and identify the limiting factor/bottleneck. (4 marks)
(b) Using traditional contribution analysis, calculate the 'profit-maximizing' output each
day, and the contribution at this level of output. (5 marks)
(c) Using a throughput approach, calculate the 'throughput-maximizing' output each
day, and the 'throughput contribution' at this level of output. (8 marks)
(d) Explain the term 'value chain costing or accounting' and the circumstances in which
its use would be appropriate. (4 marks)
(e) Discuss why any management accounting system (and a value chain costing
system in particular) may report figures for inventory value which are not the same as
those given by a traditional stock take. (4 marks)
(Total: 25 marks)
QUESTION 12
MN manufactures automated industrial trolleys, known as TRLs. Each TRL sells for
$2,000 and the material cost per unit is $600. Labour and variable overhead are
$5,500 and $8,000 per week respectively. Fixed production costs are $450,000 per
annum and marketing and administrative costs are $265,000 per annum.
The trolleys are made on three different machines. Machine X makes the four frame
panels required for each TRL. Its maximum output is 180 frame panels per week.
Machine X is old and unreliable and it breaks down from time to time. It is estimated
that, on average, between 15 and 20 hours of production are lost per month. Machine
Y can manufacture parts for 52 TRLs per week and machine Z, which is old but
reasonably reliable, can process and assemble 30 TRLs per week.
The company has recently introduced a just-in-time (JIT) system and it is company
policy to hold little work-in-progress and no finished goods inventory from week to
week. The company operates a 40-hour week, 48 weeks a year (12 months x 4 weeks)
but cannot meet demand. The demand for the next year is predicted to be as follows
and this is expected to be typical of the demand for the next four years.
Units per week Units per week
January 30 July 48
February 30 August 45
March 33 September 42
April 36 October 40
May 39 November 33
June 44 December 30

The production manager has suggested that the company replaces machine Z with
machine G which can process 45 TRLs per week. The maintenance manager is keen
to spend $100,000 on a major overhaul of machine X as he says this will make it 100%
reliable.
YOU ARE REQUIRED TO:
(a) Calculate the throughput accounting ratio for the key resource for an average
hour next year. (7 marks)

(b) Corrie produces three products, X, Y and Z. The capacity of Corrie's plant is
restricted by process alpha. Process alpha is expected to be operational for
eight hours per day and can produce 1,200 units of X per hour, 1,500 units of
Y per hour, and 600 units of Z per hour.

Selling prices and material costs for each product are as follows.

Product Selling price Material cost Throughput

Contribution
$ per unit $ per unit $ per unit
X 150 70 80
Y 120 40 80
Z 300 100 200

Conversion costs are $720,000 per day.

 YOU ARE REQUIRED TO:
(i) Calculate the profit per day if daily output achieved is 6,000 units of X,
4,500 units of Y and 1,200 units of Z.
(ii) Determine the efficiency of the bottleneck process given the output in
(a).
(iii) Calculate the TA ratio for each product.
(iv) In the absence of demand restrictions for the three products, advise
Corrie's management on the optimal production plan.
(v) State FOUR actions that management could consider to improve the TA
ratio of a particular product. (18 marks)

(25 marks)
QUESTION 13

MUSHAMBANZOU Ltd produces three products using three different machines.

The following information is available for a product for a period:

Product X Y Z
($) ($) ($)
Selling price per unit 20 15 10
Direct materials 8 5 4
Direct labour 5 3 2
Overheads 2 1 1

Estimated sale demand (unit) 310 280 250

Machine hours required per unit:

Machine 1 4 2 1
Machine 2 4 3 2
Machine 3 3 1 3

Machine capacity is limited to 2,000 hours for each machine.

Required:
(a) Calculate throughput accounting ratio and rank the products. (18 marks)
(b) Calculate the revised production schedule and the maximum profit that
the company is likely to get given that there is a bottleneck. (7 marks)
(TOTAL MARKS: 25)
TOPIC 3: TARGET COSTING

QUESTION 14

Eilat Ltd. manufactures a range of electronics products. Technical staff recently

developed a design for a new type of in-car music player which can be used to play
CDs, digital downloads, and cassette tapes. The board of the company has asked the
marketing, financial, and production directors to evaluate the design before a decision
is made as to whether to begin production of the music player.

The marketing director has suggested that $90 would be a suitable selling price for the
music player and that 6,000 units per annum would be sold at this price. Variable
selling costs would amount to $12 per unit sold.

The financial director has estimated that the new capital equipment required in order
to manufacture the music player would cost $3,000,000. The company requires an
annual return on investment (ROI) of 8% on all capital investments.

The production director has not yet finalized her estimate of the cost of manufacturing
the music player. However she has commented that the design has certain features
which are likely to add to the complexity and cost of the manufacturing process without
significantly enhancing the attractiveness of the product to potential customers.

REQUIRED:
(a) Using the data provided above, calculate the target cost of manufacturing the music
player, and explain fully the significance of this figure. (4 marks)
(b) Assume now that the production director has estimated the cost of manufacturing
the music player (using the recently-developed design) at $55 per unit and has
suggested that the company should accept a reduced ROI if necessary. Calculate the
ROI if this suggestion is accepted and comment on the production director’s
suggestion. (3 marks)
(c) It is often stated that target costing is most likely to be effective when products are
still at the design stage (i.e., before any production begins) and when comprehensive
information about cost driver rates is available from the company’s accounting system.
Explain why this is so. (3 marks)
[Total: 10 marks]
QUESTION 15
GEEWHIZZ, a manufacturer of computer games, has developed a new game called
the Action Accountant (AA). This is an interactive 3D game and is the first of its kind
to be introduced to the market. GEEWHIZZ is due to launch the AA in time for the
peak selling season.
GEEWIZZ has been using a traditional absorption costing system to calculate costs
and price its products. The new management accountant believes that this is
inappropriate for this company and is arguing for a new approach to be adopted.
As a management accountant of GEEWHIZZ, YOU ARE REQUIRED TO do the
following:
(a) Discuss how the following techniques could have been applied to the AA.
 Life cycle costing
 Target costing (7 marks)

A few months later, GEEWHIZZ is in the process of introducing another new game,
the Laughing Lawyer (LL) and has undertaken market research to find out about
customers' views on the value of the product and also to obtain a comparison with
competitors' products. The results of this research have been used to establish a target
selling price of $55 and a projected lifetime volume of 200,000 games.
Cost estimates have also been prepared based on the proposed product specification.
Manufacturing cost $
Direct material 3.21
Direct labour 4.23
Direct machinery costs 1.12
Ordering and receiving 0.23
Quality assurance 4.60
Design 19.80
Non-manufacturing costs
Marketing 8.15
Distribution 3.25
After-sales service and warranty costs 1.30
The target profit margin for the LL is 30% of the proposed selling price.
YOU ARE REQUIRED TO:
(b) Calculate the target cost of the LL and discuss the implications of the result. Explain
the limitations of target costing for GEEWIZZ. (13 marks)
(c) Briefly explain how and why market research is used by companies such as
GEEWHIZZ. (5 marks)
(Total 25 marks)
QUESTION 16
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.
YOU ARE REQUIRED TO:

(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 has
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 the purchased wire is lost in the assembly process. Wire costs
$0·50 per metre to buy.

Other material – other materials cost $8·10 per radio.

Assembly labour – these are skilled people who are difficult to recruit and retain.
Edward Co has more staff of this type than needed but is prepared to carry this extra
cost in return for the security it gives the business. It takes 30 minutes to assemble a
radio and the assembly workers are paid $12·60 per hour. It is estimated that 10% of
hours paid to the assembly workers is for idle time.

Production Overheads – recent historic cost analysis has revealed the following
production overhead data:

Total production overhead Total assembly labour hours

$
Month 1 620,000 19,000
Month 2 700,000 23,000

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.

YOU ARE REQUIRED TO:

(d) Calculate the expected cost per unit for the radio and identify any cost gap that
might exist. (13 marks)
[Total: 25 Marks]
QUESTION 17
The Universal Health System (UHS) provides the entire healthcare service to residents
in Illopia. The UHS is funded centrally through revenues from taxpayers. However, the
government is not involved in the day-to-day running of the UHS, which is largely
managed regionally by a number of self-governing trusts, such as the Sickham UHS
Trust.
The Sickham UHS Trust runs one hospital in Sickham and, like other trusts in Illopia,
receives 70% of its income largely from the UHS’ ‘payments by results’ scheme, which
was established two years ago. Under this scheme, the trust receives a pre-set tariff
(fee income) for each service it provides. If the Trust manages to provide any of its
services at a lower cost than the pre-set tariff, it is allowed to use the surplus as it
wishes. Similarly, it has to bear the cost of any deficits itself. Currently, the Trust knows
that a number of its services simply cannot be provided at the tariff paid and accepts
that these always lead to a deficit. Similarly, other services always seem to create a
surplus. This is partly because different trusts define their services and account for
overheads differently. Also, it is partly due to regional differences in costs, which are
not taken into account by the scheme, which operates on the basis that ‘one tariff fits
all’.
The remaining 30% of the Trust’s income comes from transplant and heart operations.
Since these are not covered by the scheme, the payment the Trust receives is based
on the actual costs it incurs in providing the operations. However, the Trust is not
allowed to exceed the total budget provided for these operations in any one year.
Over recent years, the Trust’s board of directors has become increasingly dissatisfied
with the financial performance of the Trust and has blamed it on poor costing systems,
leading to an inability to control costs. As a result, the finance director and his second
in command – the financial controller – have now been replaced. The board of
directors has taken this decision after complaining that ‘the Trust simply cannot sustain
the big deficit between income and spending’. The new financial controller comes from
a manufacturing background and is a great advocate of target costing, believing that
the introduction of a target costing system at the Sickham UHS Trust is the answer to
all of its problems. The new financial director is unconvinced, believing target costing
to be only really suitable in manufacturing companies.
YOU ARE REQUIRED TO:
(a) Explain the main steps involved in developing a target price and target cost for a
product in a typical manufacturing company. (8 marks)
(b) Explain four key characteristics that distinguish services from manufacturing.
(5 marks)
(c) Describe how the Sickham UHS Trust is likely, in the current circumstances, to try
to derive:
(i) A target cost for the services that it provides under the ‘payment by results’
scheme; and (3 marks)
 (ii) A target cost for transplants and heart operations. (3marks)
(d) Discuss difficulties that the Sickham UHS Trust may find in using target costing in
its service provision. (6 marks)
(Total 25 marks)
TOPIC 4: LIFE CYCLE COSTING

QUESTION 18
Mambakwedza designs, develops and sells many PC games. Games have a short
lifecycle lasting around three years only. Performance of the games is measured by
reference to the profits made in each of the expected three years of popularity.
Mambakwedza accepts a net profit of 35% of turnover as reasonable. A rate of
contribution (sales price less variable cost) of 75% is also considered acceptable.
Mambakwedza has a large centralised development department which carries out all
the design work before it passes the completed game to the sales and distribution
department to market and distribute the product. Mambakwedza has developed a
brand new game called Stealth and this has the following budgeted performance
figures. The selling price of Stealth will be a constant $30 per game. Analysis of the
costs show that at a volume of 10,000 units a total cost of $130,000 is expected.
However at a volume of 14,000 units a total cost of $150,000 is expected. If volumes
exceed 15,000 units the fixed costs will increase by 50%. Stealth’s budgeted volumes
are as follows: Year 1 Year 2 Year 3 Sales volume 8,000 units 16,000 units 4,000 units
In addition, marketing costs for Stealth will be $60,000 in year one and $40,000 in year
two. Design and development costs are all incurred before the game is launched and
has cost $300,000 for Stealth. These costs are written off to the income statement as
incurred (i.e. before year 1 above).
YOU ARE REQUIRED TO:
(a) Explain the principles behind lifecycle costing and briefly state why Mambakwedza
in particular should consider these lifecycle principles. (4 marks)
(b) Produce the budgeted results for the game ‘Stealth’ and briefly assess the game’s
expected performance, taking into account the whole lifecycle of the game. (9 marks)
(c) Explain why incremental budgeting is a common method of budgeting and outline
the main problems with such an approach. (6 marks)
(d) Discuss the extent to which a meaningful standard cost can be set for games
produced by Mambakwedza. You should consider each of the cost classifications
mentioned above. (6 marks)
(Total 25 marks)
QUESTION 19

The Computing Division was launched just over a year ago, with the intention that it
would manufacture and sell small electronic devices (such as USB memory sticks and
electronic pointers) in the first instance but that operations might later extend to the
importation and customization of hardware. Because of rapid technological and market
changes, product lifecycles are short. Before launching any product, the Computing
Division carries out any necessary research and development (R & D) work and then
forecasts the product’s profitability over a three-year product lifecycle. A net profit ratio
of 10% in each year of the product lifecycle is required (before taking account of the
cost of the R & D work).

The R & D work for a new electronic pointer has just been completed at a cost of
$180,000. Variable production costs per unit are forecast as $2 in Year 1, increasing
at a rate of 10% per annum thereafter. Fixed production costs are forecast as $140,000
per annum, and step-fixed production costs each year are forecast at $50,000 per
100,000 units produced (or part thereof). The selling price per unit is forecast to be
$4.50 per unit in Year 1; it is expected to increase by 4% at the beginning of Year 2
but is not expected to increase thereafter.

In the first year, sales are forecast at 150,000 units and there will be heavy marketing
expenditure (estimated at $80,000) aimed at strengthening the market position of the
product. Sales are forecast at 210,000 units in Year 2, and marketing costs in Year 2
are expected to decrease to $70,000. As Year 3 is expected to be the final year of the
product’s lifecycle, it is forecast that marketing costs will be reduced to $10,000 and
sales will be just 100,000 units. All units are expected to be sold in the same year as
production takes place.

YOU ARE REQUIRED TO:

(a) Analyze the profitability of the new electronic pointer over its three-year product
lifecycle (by year and in total) and assess whether approval is likely to be given for the
launch of the product. (10 marks)

(b) Critically evaluate the advantages and limitations of lifecycle costing to the
Computing Division in managing potential new products, using the example of the new
electronic pointer to illustrate your answer. (8 marks)

(c) A major new initiative is planned for the Computing Division next year. The Division
plans to buy in small tablet computers from overseas manufacturers and customize
them by adding software and electrical cables which will make the tablets suitable for
retail sale in Ireland. The Division plans to commit to this type of business for the long
term. Its strategy will involve regularly providing customers with a stream of new
products (reflecting technological innovations in hardware and software capabilities)
but the plan will also involve catering for the needs of customers seeking either budget-
priced or high-spec tablets.

Advice the Division as to the potential role of the following pricing strategies in
managing the profitability of this part of the business: (i) market skimming pricing; (ii)
premium pricing; and (iii) penetration pricing. (7 marks)
[Total: 25 Marks]
QUESTION 20
Wargrin designs, develops and sells many PC games. Games have a short lifecycle
lasting around three years only. Performance of the games is measured by reference
to the profits made in each of the expected three years of popularity. Wargrin accepts
a net profit of 35% of turnover as reasonable. A rate of contribution (sales price less
variable cost) of 75% is also considered acceptable.
Wargrin has a large centralized development department which carries out all the
design work before it passes the completed game to the sales and distribution
department to market and distribute the product.
Wargrin has developed a brand new game called Stealth and this has the following
budgeted performance figures.
The selling price of Stealth will be a constant $30 per game. Analysis of the costs show
that at a volume of 10,000 units a total cost of $130,000 is expected. However at a
volume of 14,000 units a total cost of $150,000 is expected. If volumes exceed 15,000
units the fixed costs will increase by 50%.
Stealth's budgeted volumes are as follows:
Year 1 Year 2 Year 3
Sales volume 8,000 units 16,000 units 4,000 units
In addition, marketing costs for Stealth will be $60,000 in year one and $40,000 in year
two. Design and development costs are all incurred before the game is launched and
has cost $300,000 for Stealth. These costs are written off to the income statement as
incurred (i.e. before year 1 above).
YOU ARE REQUIRED TO:
(a) Explain the principles behind lifecycle costing and briefly state why Wargrin in
particular should consider these lifecycle principles. (5 marks)
(b) Produce the budgeted results for the game 'Stealth' and briefly assess the game's
expected performance, taking into account the whole lifecycle of the game. (10 marks)
(c) Explain why environmental management accounting has become so common
these days and how is this related to life cycle costing. (6 marks)
(d) Discuss the extent to which a meaningful standard cost can be set for games
produced by Wargrin. You should consider each of the cost classifications mentioned
above. (4 marks)
(Total 25 marks)
QUESTION 21
Fit Co specialises in the manufacture of a small range of hi-tech products for the fitness
market. They are currently considering the development of a new type of fitness
monitor, which would be the first of its kind in the market. It would take one year to
develop, with sales then commencing at the beginning of the second year. The product
is expected to have a life cycle of two years, before it is replaced with a technologically
superior product. The following cost estimates have been made.
 Year 1 Year 2 Year 3
Units manufactured and sold 100,000 200,000
Research and development costs $160,000
Product design costs $800,000
Marketing costs $1,200,000 $1,000,000 $1,750,000
Manufacturing costs:
Variable cost per unit $40 $42
Fixed production costs $650,000 $1,290,000
Distribution costs:
Variable cost per unit $4 $4·50
Fixed distribution costs $120,000 $120,000
Selling costs:
Variable cost per unit $3 $3·20
Fixed selling costs $180,000 $180,000
Administration costs $200,000 $900,000 $1,500,000
Note: You should ignore the time value of money.
YOU ARE REQUIRED TO:
(a) Calculate the life cycle cost per unit. (7 marks)
(b) After preparing the cost estimates above, the company realises that it has not taken
into account the effect of the learning curve on the production process. The variable
manufacturing cost per unit above, of $40 in year 2 and $42 in year 3, includes a cost
for 0·5 hours of labour. The remainder of the variable manufacturing cost is not driven
by labour hours. The year 2 cost per hour for labour is $24 and the year 3 cost is $26
per hour. Subsequently, it has now been estimated that, although the first unit is
expected to take 0·5 hours, a learning curve of 95% is expected to occur until the
100th unit has been completed.
Calculate the revised life cycle cost per unit, taking into account the effect of the
learning curve.
Note: the value of the learning co-efficient, b, is –0·0740005. (13 marks)
(c) Discuss the benefits of life cycle costing. (5 marks)
(Total 25 marks)
TRANSFER PRICING
QUESTION 22
Bath Co is a company specialising in the manufacture and sale of baths. Each bath
consists of a main unit plus a set of bath fittings. The company is split into two divisions,
A and B. Division A manufactures the bath and Division B manufactures sets of bath
fittings. Currently, all of Division A’s sales are made externally. Division B, however,
sells to Division A as well as to external customers. Both of the divisions are profit
centres.
The following data is available for Division A
Current selling price for each bath $450
Costs per bath:
Fittings from Division B $75
Other materials from external suppliers $200
Labour costs $45
Annual fixed overheads $7,440,000
Annual production and sales of baths (units) 80,000
Maximum annual market demand for baths (units) 80,000

The following data is available for Division B

Current external selling price per set of fittings $80
Current price for sales to Division A $75
Costs per set of fittings:
Materials $5
Labour costs $15
Annual fixed overheads $4,400,000
Maximum annual production and sales of sets of fittings (units) 200,000
(Including internal and external sales)
Maximum annual external demand for sets of fittings (units) 180,000
Maximum annual internal demand for sets of fittings (units) 80,000
The transfer price charged by Division B to Division A was negotiated some years ago
between the previous divisional managers, who have now both been replaced by new
managers. Head Office only allows Division A to purchase its fittings from Division B,
although the new manager of Division A believes that he could obtain fittings of the
same quality and appearance for $65 per set, if he was given the autonomy to
purchase from outside the company. Division B makes no cost savings from supplying
internally to Division A rather than selling externally.
YOU ARE REQUIRED TO:
(a) Under the current transfer pricing system, prepare a profit statement showing the
profit for each of the divisions and for Bath Co as a whole. Your sales and costs
figures should be split into external sales and inter-divisional transfers, where
appropriate. (8 marks)
(b) Head Office is considering changing the transfer pricing policy to ensure
maximisation of company profits without demotivating either of the divisional
managers. Division A will be given autonomy to buy from external suppliers and
Division B to supply external customers in priority to supplying to Division A.

Calculate the maximum profit that could be earned by Bath Co if transfer pricing
is optimised. (10 marks)

(c) Discuss the issues of encouraging divisional managers to take decisions in the
interests of the company as a whole, where transfer pricing is used. Provide a
reasoned recommendation of a policy Bath Co should adopt. (7 marks)
(Total 25 marks)
PERFOMANCE EVALUATION

QUESTION 23
(a) Brace Co is an electronics company specialising in the manufacture of home audio
equipment. Historically, the company has used solely financial performance measures
to assess the performance of the company as a whole. The company’s Managing
Director has recently heard of the ‘balanced scorecard approach’ and is keen to learn
more.
YOU ARE REQUIRED TO:
Describe the balanced scorecard approach to performance measurement. (10 marks)
(b) Brace Co is split into two divisions, A and B, each with their own cost and revenue
streams. Each of the divisions is managed by a divisional manager who has the power
to make all investment decisions within the division. The cost of capital for both
divisions is 12%. Historically, investment decisions have been made by calculating the
return on investment (ROI) of any opportunities and at present, the return on
investment of each division is 16%.
A new manager who has recently been appointed in division A has argued that using
residual income (RI) to make investment decisions would result in ‘better goal
congruence’ throughout the company.
Each division is currently considering the following separate investments:
Project for Division A Project for Division B
Capital required for investment $82·8 million $40·6 million
Sales generated by investment $44·6 million $21·8 million
Net profit margin 28% 33%
The company is seeking to maximize shareholder wealth.
YOU ARE REQUIRED TO:
Calculate both the return on investment and residual income of the new investment
for each of the two divisions. Comment on these results, taking into consideration the
manager’s views about residual income. (15 marks)
(Total 25 marks)
QUESTION 24

Tipp PLC, a large multinational company, is undertaking a review of its organizational

structure. Top management is concerned that the methods used for divisional
performance evaluation and transfer pricing may be encouraging dysfunctional
behavior by division managers.

The following sample data is available concerning two of the company’s divisions for
last year:

Division A Division B
Operating profit $152,000 $72,000
Capital invested $1,600,000 $576,000

The cost of capital is 7% for both divisions. It can be assumed that there are no intra-
company transfers between Divisions A and B.

YOU ARE REQUIRED TO:

(a) Calculate the Return On Investment (ROI) and residual income for each division.
Explain which of these two measures (ROI or residual income) gives the clearer
indication of divisional contribution to the overall success of Tipp PLC. (6 marks)

(b) Assume that ROI is used for divisional performance evaluation purposes. How
would each of the two division managers react to an additional investment opportunity
which would increase operating profit by $23,000 but would require capital investment
of $220,000? Are their reactions in the best interests of the company’s shareholders?
Justify your answer. (6 marks)

(c) At what cost of capital would the two divisions have the same residual income? (In
answering this part, ignore the additional investment opportunity in part (b) above).
(5 marks)
(d) Although there are no intra-company transfers between Divisions A and B, there
are a significant number of intracompany transfers between other divisions of Tipp
PLC. Discuss the circumstances in which it is feasible and appropriate to use external
market prices as the basis for setting transfer prices in such cases. (8 marks)
[Total: 25 marks]

QUESTION 25

Pace Company (PC) runs a large number of wholesale stores and is increasing the
number of these stores all the time. It measures the performance of each store on the
basis of a target return on investment (ROI) of 15%. Store managers get a bonus of
10% of their salary if their store’s annual ROI exceeds the target each year. Once a
store is built there is very little further capital expenditure until a full four years have
passed.

PC has a store (store W) in the west of the country. Store W has historic financial data
as follows over the past four years:

2005 2006 2007 2008

Sales ($’000) 200 200 180 170

Gross profit ($’000) 80 70 63 51

Net profit ($’000) 13 14 10 8

Net assets at start of year ($’000) 100 80 60 40

The market in which PC operates has been growing steadily. Typically, PC’s stores
generate a 40% gross profit margin.

YOU ARE REQUIRED TO:

(a) Discuss the past financial performance of store W using ROI and any other
measure you feel appropriate and, using your findings, discuss whether the ROI
correctly reflects Store W’s actual performance. (8 marks)

(b) Explain how a manager in store W might have been able to manipulate the results
so as to gain bonuses more frequently. (4 marks)

PC has another store (store S) about to open in the south of the country. It has asked
you for help in calculating the gross profit, net profit and ROI it can expect over each
of the next four years. The following information is provided:

Sales volume in the first year will be 18,000 units. Sales volume will grow at the rate
of 10% for years two and three but no further growth is expected in year 4. Sales price
will start at $12 per unit for the first two years but then reduce by 5% per annum for
each of the next two years.

Gross profit will start at 40% but will reduce as the sales price reduces. All purchase
prices on goods for resale will remain constant for the four years.
Overheads, including depreciation, will be $70,000 for the first two years rising to
$80,000 in years three and four.

Store S requires an investment of $100,000 at the start of its first year of trading.

PC depreciates non-current assets at the rate of 25% of cost. No residual value is

expected on these assets.

YOU ARE REQUIRED TO:

(c) Calculate (in columnar form) the revenue, gross profit, net profit and ROI of store
S over each of its first four years. (9 marks)

(d) Calculate the minimum sales volume required in year 4 (assuming all other
variables remain unchanged) to earn the manager of S a bonus in that year. (4 marks)

(Total 25 marks)

TOPIC: ENVIRONMENTAL MANAGEMENT ACCOUNTING

QUESTION 26
Process Co is becoming increasingly concerned that environmental costs may be
increasing within the company. However, the company has not yet developed a
structured way for accounting for these costs. It has heard of a number of different
management accounting techniques which can be used to account for environmental
costs, including ‘material flow cost accounting’, ‘environmental activity-based costing’
and ‘life cycle costing’.
YOU ARE REQUIRED TO:
Describe these techniques in the context of environmental management accounting.
(100 marks)

MATHEMATICAL APPROACHES TO COST ESTIMATION

QUESTION 27

A sales representative provided the following information about the kilometers

travelled per month and the corresponding maintenance cost of his vehicle:

Month kilometers travelled per month maintenance cost per

month

February 3 400 850

March 3 750 900
April 4 450 1 150
May 4 800 1 250
June 5 350 1 200
July 5 100 1 400
August 6 450 1 500
September 6 050 1 450
October 5 800 1 500
November 5 250 1 300

YOU ARE REQUIRED TO:

(a) Draw a scatter diagram for this data and comment on any relationship
observed?
(4 marks)
(b) Using the scatter diagram drawn above for the period February- November
estimate a regression equation or model for this data. (3 marks)

(c) Estimate the regression model or equation mathematical using the least-
squares method. (4 marks)

(d) Evaluate the regression equation in terms of its likely reliability for forecasting
by calculating:
i. The Coefficient of Determination, (8 marks)
ii. The Standard Error of the Estimate, and (3 marks)
iii. The Standard Error of the Coefficient. (3 marks)
[Total: 25 Marks]

TOPIC: DECISION MAKING

QUESTION 28
Bits and Pieces (B&P) operates a retail store selling spares and accessories for the
car market. The store has previously only opened for six days per week for the 50
working weeks in the year, but B&P is now considering also opening on Sundays.
The sales of the business on Monday through to Saturday averages at $10,000 per
day with average gross profit of 70% earned.
B&P expects that the gross profit % earned on a Sunday will be 20 percentage points
lower than the average earned on the other days in the week. This is because they
plan to offer substantial discounts and promotions on a Sunday to attract customers.
Given the price reduction, Sunday sales revenues are expected to be 60% more than
the average daily sales revenues for the other days. These Sunday sales estimates
are for new customers only, with no allowance being made for those customers that
may transfer from other days.
B&P buys all its goods from one supplier. This supplier gives a 5% discount on all
purchases if annual spend exceeds $1,000,000.
It has been agreed to pay time and a half to sales assistants that work on Sundays.
The normal hourly rate is $20 per hour. In total five sales assistants will be needed for
the six hours that the store will be open on a Sunday. They will also be able to take a
half-day off (four hours) during the week. Staffing levels will be allowed to reduce
slightly during the week to avoid extra costs being incurred.
The staff will have to be supervised by a manager, currently employed by the company
and paid an annual salary of $80,000. If he works on a Sunday he will take the
equivalent time off during the week when the assistant manager is available to cover
for him at no extra cost to B&P. He will also be paid a bonus of 1% of the extra sales
generated on the Sunday project.
The store will have to be lit at a cost of $30 per hour and heated at a cost of $45 per
hour. The heating will come on two hours before the store opens in the 25 ‘winter’
weeks to make sure it is warm enough for customers to come in at opening time. The
store is not heated in the other weeks
The rent of the store amounts to $420,000 per annum.
YOU ARE REQUIRED TO:
(a) Calculate whether the Sunday opening incremental revenue exceeds the
incremental costs over a year (ignore inventory movements) and on this basis reach
a conclusion as to whether Sunday opening is financially justifiable. (15 marks)
(b) Discuss whether the manager’s pay deal (time off and bonus) is likely to motivate
him. (5 marks)
(c) Briefly discuss whether offering substantial price discounts and promotions on
Sunday is a good suggestion. (5 marks)
(Total 25 marks)
QUESTION 29
Regina Ltd. manufactures a wide range of specialized electrical products. The
company is structured along divisional lines.

“Division A” manufactures a specialized motor. Monthly production is 30,000 units and

the marginal cost of production is $140 per unit. Half of all output is sold to external
customers at a price of $200 per unit. The remaining output is sold within Regina Ltd.
to “Division B”. In accordance with the company’s rules, these internal transfers are
made at the same price per unit as sales to external customers (i.e $200).

“Division B” uses the motor as a component in the manufacture of an industrial heater,

which is sold to external customers at a price of $350 per unit. (One motor is required
for each heater). “Division B” incurs a marginal cost of $100 per unit, in addition to the
transfer price paid for the motor.
A potential new customer (Quebec Ltd.) has offered to purchase 7,500 units per month
of the industrial heater from “Division B” at a special contract price of $275 each.
“Division B” has sufficient spare production capacity to produce these additional
heaters.

YOU ARE REQUIRED TO:

(a) Assume that “Division A” has sufficient spare production capacity to enable it to
produce the additional motors required by “Division B” to enable it to fulfil the Quebec
Ltd. contract.
In these circumstances, explain:
 Whether it would be in the best interests of Regina Ltd. to accept the Quebec
Ltd. contract, and
 Whether the existing transfer pricing arrangements motivate the division
managers to take the decisions which are in the best interests of Regina Ltd.
as a whole. (9 marks)

(b) Now assume that “Division A” has no spare production capacity. If “Division A”
were to produce the additional motors required by “Division B” to enable it to fulfil the
Quebec Ltd. contract, then “Division A” would reduce its sales of motors to external
customers.

Explain how your answer to part (a) would differ in these circumstances. (9 marks)

(c) Critically evaluate the transfer pricing arrangements in Regina Ltd., using your
answers to parts (a) and (b) to illustrate your answer. (7 marks)
[Total: 25 marks]
QUESTION 30
Damascus Ltd. operates three retail stores. The stores are located in close proximity
to each other but are operated separately because they deal in different types of
products. The following are summary income and expenditure accounts for the three
stores for last month, produced by the company’s internal accounting system:

Hardware Interiors Gardening

Store Store Store

Sales $360,000 $625,000 $535,000

Less: Cost of goods sold $202,000 $320,000 $288,900
Gross profit $158,000 $305,000 $246,100
OTHER COSTS:
Salespersons’ salaries $36,000 $45,000 $42,000
Salaries of store managers &
Deputy Managers $12,000 $16,000 $11,000
Depreciation of store fixtures $6,200 $8,000 $7,800
Store rent $40,000 $65,000 $50,000
Store lighting & heating $10,200 $19,000 $17,000
Local radio advertising costs $20,000 $34,000 $33,000
Share of newspaper advertising costs of
Damascus Ltd. $5,040 $8,750 $7,490
Share of head office salaries & expenses $20,160 $35,000 $29,960
Depreciation of delivery vehicles $1,400 $1,400 $1,400
Salaries of delivery vehicle crews $3,000 $3,000 $3,000
Employee fringe benefits $14,232 $19,800 $17,192
Net profit (loss) ($10,232) $50,050 $26,258
The managing director of Damascus Ltd. has suggested that the hardware store
should be shut down because it has reported losses for several successive months.
However the management accountant has warned of the need for careful analysis
before any decision is made, and has assembled the following additional information:

1. If the hardware store were closed then all salespersons, managers and deputy
managers employed in that store would be laid off. The only exception would be one
manager who currently earns $7,000 per month and who would be transferred to
Damascus Ltd.’s head office where she would work as an analyst and would continue
to be paid her existing salary. If the hardware store were not closed then head office
would recruit a new analyst who would be paid $5,000 per month.

2. If the hardware store were closed then all of its fixtures would be transferred for use
in the company’s other stores.

3. The hardware store is located in a building which the company has leased for some
years. The lease will expire shortly. The company must decide within the next three
months whether or not to renew the lease for another ten year term.

4. Because the three stores carry very different product ranges, there are separate
local radio advertising campaigns for each store. However, the company places
"general purpose" advertisements in the newspapers to publicize the company name,
and the costs of such advertising are allocated among the three stores in proportion
to sales revenues.

5. Head office salaries and expenses are also allocated among the three stores in
proportion to sales revenues.

6. Because the stores are located in close proximity to each other, they share a single
set of delivery vehicles and crew. No vehicles would be disposed of if the hardware
store were closed, but one crew member (whose salary is $2,000 per month) would
be laid off because of the reduced work load.

7. The reduced workload due to the closure of the hardware store would also lead to
the laying off of one administrative staff member at head office. This staff member is
paid $3,500 per month.

8. The company incurs employee fringe benefits costs amounting to 20% of all
salaries.

YOU ARE REQUIRED TO:

(a) Prepare calculations to indicate the increase or decrease in the short run monthly
profit of Damascus Ltd. which would result from the closure of the hardware store.
State and justify any assumptions which you make (14 marks)

(b) The manager of the hardware store has been summoned to make a presentation
to the managing director, in which she must justify the argument that it makes good
business sense in the long run for Damascus Ltd. to continue to operate the hardware
store. She has devoted a lot of effort to developing the business of the hardware store,
and believes that it can be very profitable in the long run, but she recognizes that the
managing director will not be easy to convince.

Explain three management accounting techniques which would be significantly useful

to the manager of the hardware store in making this presentation. In your answer,
explain fully the usefulness of your chosen techniques for this purpose.
(11 marks)
[Total: 25 marks]
QUESTION 31
Hammer is a large garden equipment supplier with retail stores throughout Zimbabwe.
Many of the products it sells are bought in from outside suppliers but some are
currently manufactured by Hammer’s own manufacturing division ‘Nail’.
The prices (a transfer price) that Nail charges to the retail stores are set by head office
and have been the subject of some discussion. The current policy is for Nail to
calculate the total variable cost of production and delivery and add 30% for profit. Nail
argues that all costs should be taken into consideration, offering to reduce the mark-
up on costs to 10% in this case. The retail stores are unhappy with the current pricing
policy arguing that it results in prices that are often higher than comparable products
available on the market.
Nail has provided the following information to enable a price comparison to be made
of the two possible pricing policies for one of its products.
Garden shears
Steel: the shears have 0·4kg of high quality steel in the final product. The
manufacturing process loses 5% of all steel put in. Steel costs $4,000 per tonne (1
tonne = 1,000kg)
Other materials: Other materials are bought in and have a list price of $3 per kg
although Hammer secures a 10% volume discount on all purchases. The shears
require 0·1kg of these materials.
The labour time to produce shears is 0·25 hours per unit and labour costs $10 per
hour.
Variable overheads are absorbed at the rate of 150% of labour rates and fixed
overheads are 80% of the variable overheads.
Delivery is made by an outsourced distributor that charges Nail $0·50 per garden
shear for delivery.
YOU ARE REQUIRED TO:
(a) Calculate the price that Nail would charge for the garden shears under the existing
policy of variable cost plus 30%. (8 marks)
(b) Calculate the increase or decrease in price if the pricing policy switched to total
cost plus 10%. (5 marks)
(c) Discuss whether or not including fixed costs in a transfer price is a sensible policy.
 (5 marks)
(d) Discuss whether the retail stores should be allowed to buy in from outside
suppliers if the prices are cheaper than those charged by Nail. (7 marks)
(Total 25 marks)

LEARNING CURVE THEORY

QUESTION 32

Paida manufacturers expects a learning curve of 85% on the manufacture of a newly

introduced product of which only one unit has been manufactured to date and which
took 120 hours to manufacture. The estimate of 85% is based on the learning curve
achieved on a similar product. It is also envisaged that the learning curve will last until
sixty-four units have been manufactured.

REQUIRED:
(a) Determine the total cumulative time at each doubling of units, up to a level of
sixty-four units. (6 marks)
(b) Make a projection of the time required for the manufacture of units seventeen
to thirty-two. (5 marks)
(c) Make a projection of the time required for the manufacture of units thirty-three
to sixty-four. (4 marks)
[Total: 15 marks]
QUESTION 33
Velo Racers has designed a radical new concept in racing bikes with the intention of
selling them to professional racing teams. The estimated cost and selling price of the
first bike to be manufactured and assembled is as follows.
$
Materials 1,000
Assembly labour (50 hours at $10 per hour) 500
Fixed overheads (200% of assembly labour) 1,000
Profit (20% of total cost) 500
Selling price 3,000
Velo Racers plans to sell all bikes at a total cost plus 20% and the material cost per
bike will remain constant irrespective of the number sold.
Velo Racers' management expects the assembly time to gradually improve with
experience and has estimated an 80% learning curve for the first 16 bikes, after which
a steady state production time will apply with the labour time per bike after the first 16
bikes being equal to the time for the 16th bike.
A racing club has approached the company and asked for the following quotations.
1 If we were to purchase the first bike assembled, and immediately put in an order for
the second, what would be the price of the second bike?
2 If we waited until you had sold two bikes to another team, and then ordered the third
and fourth bikes to be assembled, what would be the average price of the third and
fourth bikes?
3 If we decided to immediately equip our racing team with the new bike, what would
be the price per bike if we placed an order for the first eight to be assembled?
4 If we decided to buy 20 bikes in total, what would be the price of the entire order?
YOU ARE REQUIRED TO:
(a) Explain Learning Curve Theory, circumstances where its use is appropriate, and
in particular the concept of cumulative average time. (5 marks)
(b) Provide detailed price quotations for each of the four enquires outlined above.
(12 marks)
(c) Identify the major areas within management accounting where learning curve
theory is likely to affect Velo Racers and suggest potential limitations of this theory.
(8 marks)
(Total: 25 marks)
QUESTION 34
Big Masvingo Chairs (BMC) manufactures and sells executive leather chairs. They are
considering a new design of massaging chair to launch into the competitive
Zimbabwean market in which they operate.
They have carried out an investigation in the market and using a target costing system
have targeted a competitive selling price of $120 for the chair. BMC wants a margin
on selling price of 20% (ignoring any overheads).
The frame and massage mechanism will be bought in for $51 per chair and BMC will
upholster it in leather and assemble it ready for despatch.
Leather costs $10 per metre and two metres are needed for a complete chair although
20% of all leather is wasted in the upholstery process.
The upholstery and assembly process will be subject to a learning effect as the
workers get used to the new design. BMC estimates that the first chair will take two
hours to prepare but this will be subject to a learning rate (LR) of 95%. The learning
improvement will stop once 128 chairs have been made and the time for the 128th
chair will be the time for all subsequent chairs. The cost of labour is $15 per hour.
The learning formula is shown on the formula sheet and at the 95% learning rate the
value of b is –0·074000581.
You are required to:
(a) Calculate the average cost for the first 128 chairs made and identify any cost gap
that may be present at that stage. (10 marks)
(b) Assuming that a cost gap for the chair exists suggest four ways in which it could
be closed. (7 marks)
The production manager denies any claims that a cost gap exists and has stated that
the cost of the 128th chair will be low enough to yield the required margin.
(c) Calculate the cost of the 128th chair made and state whether the target cost is
being achieved on the 128th chair. (8 marks)
(Total 25 marks)

FORMULAE SHEET
1. Learning curve

𝑌 = 𝑎𝑥 𝑏
Where y = average cost per batch
a = cost of first batch
x = total number of batches produced
b = learning factor (log LR/log 2)
LR = the learning rate as a decimal