- The action of reducing the staff salaries in order to cut the cost for resolving the purpose of maximizing the owner’s wealth cannot achieve the purpose fully. Reason being, cutting down the salaries of employees may lead to maximizing of wealth and saving of cost but the management will not be able to retain its employees anymore. Instead of this, management must focus on increasing its capital investments as this is directly related to wealth maximization (Lumby & Jones, 2003).
- A general conclusion can be made about the goals of the business and its stakeholders that the business’s objective must be increasing the wealth of its shareholders and working in their best interest. Value creation should be the goal for business as well as for the shareholders.
1.2
The managers are part of the management and are responsible for the smooth functioning of the organization. They are held responsible for taking important decisions and making successful strategies. Also managers are there for planning in advance the future course of actions for the business. In order to fulfil all such duties and perform all such functions, managers required complete information about the accounts and financial performance of the company. They have the power to access the confidential financial data in order to perform their duties. This is the reason they are treated well than the other groups.
Question 2
2.1
Under historical cost concept, the price of the asset is based on its original value and the method does not takes into account the current market value of the asset. For taking decisions about the future of an asset, considering its historic cost is wrong because it does not show the true value of the company. Moreover, the concept lead to the insufficient provision for depreciation as the amount of the provision may not be sufficient enough for replacing the cost. There are other demerits also and because of such disadvantages, it will be better not to consider historic cost of the asset while taking decisions about its future (Maheshwari, 2012).
2.2
Opportunity cost: It is basically a benefit or a form of profit that is forgone by an investor, individual or a business for choosing one alternative over the other. Generally, it is not shown in the financial reports but businesses use this concept to make appropriate decisions related to relevant costs (Holtzman, 2013).
Sunk cost: It is a cost incurred by a company which cannot be recovered any longer in future. These are not considered while taking investment decision because such costs cannot be recovered. In place of these costs, relevant costs are considered. For example, cost on research and development, market research cost and many more.
Committed cost: It is similar to sunk cost to some extent and is referred as the investment made by the company which cannot be recover by any means even if the company got dissolved. For example, cost incurred on acquiring a machine and the contract of its repairs and maintenance (Kinney, Raiborn & Poznanski, 2011).
Question 3
3.1
A variable cost changes in total as and when the production level changes but per unit variable cost remains the same. Reason being, it is directly proportional to the volume of production and increases in the same ratio as the production increases. While on the other hand, the fixed cost in total remains constant at all the levels of productivity but per unit cost changes. This is due to the inverse relationship between the fixed cost and volume of production. As and when the units increases, fixed cost gets spread among them and thus the per unit cost changes.
3.2
XYZ Ltd produces three types of products for which the sales, estimated cost and production data is given below:
Fixed cost of the company are £250,000 and the limiting factor is raw material, the supply of which is limited to 50,000 kg in the period.
| Product | Chair | Table | Stools |
| Units | 7000 | 6500 | 4500 |
| Per unit data (£) | |||
| Selling Price | 100 | 150 | 110 |
| Variable Cost | |||
| Direct Material (£5 per kg) | 20 | 45 | 35 |
| Direct Labour (£3 per hour) | 10 | 20 | 15 |
| Other variable overheads | 10 | 15 | 10 |
| Total Variable cost (£) | 40 | 80 | 60 |
| Contribution per unit (£) | 60 | 70 | 50 |
| Material used per unit | 4 | 9 | 7 |
| Contribution per kg (£) | 15 | 7.78 | 7.14 |
| Production Ranking | 1st | 2nd | 3rd |
Selecting the product on the basis of highest contribution per unit will not consider the contribution of the various products in relation to their usage of limiting resource. As a result of which, this approach fails to maximize the profits.
3.3
Usually, the labour cost per unit remains constant but it changes due to the following factors:
- The change in unit labour cost is highly generated from the efficiency of the workers. An organization may pay higher to the most efficient worker according to its efficiency to work as compare to the amount paid to the less efficient worker. So, efficiency is one of the factor which for the per unit labour cost to change.
- Another factor is the pay received by the workers for their overtime. Bonus and incentive given by the organization also fluctuates the total labour cost per unit.
Question 4
4.1
As the business provide only one standard service, it is very important to distinguish between the direct and indirect cost as it will help the business to evaluate its inventory properly. Moreover, a proper accounting control of the company can be established and the prices of goods can be defined accurately (Drury, 2005).
4.2
The statement is not true as there are some direct cost which are fixed and some indirect cost which are variable. For example, salary paid to a supervisor for producing X item is a fixed direct cost as the cost object is identifiable. Similarly, power cost at the factor which produces X item and Y item can be a variable indirect cost because as and when the production increases, the cost also increase but cannot be traceable (Drury, 2005).
4.3
Direct labour hour basis is generally used in the labour intensive cost centre where most of the overhead is covered of labour related cost. However, most of the production methods used machines also, which makes this method inappropriate and illogical. It is a logical basis only for the companies which are labour intensive (Lal, 2009).
Question 5
5.1
Following are the reasons for the non-popularity of ABC in UK:
- Absence of relevance for the firm’s business.
- Lack of support from management.
- Shortage of resources and expertise required for ABC (Al-Sayed, Abdel-Kader & Kholeif, 2008).
5.2
Principles that underpin total life cycle costing approach are:
- The basic premise of the approach is to trace the cost and revenues on the product over several years.
- Accumulating the cost and the revenue through the entire life cycle of the product.
- Principle is to focus on development cost that are incurred to individual products.
5.3
Kaizen is a Japanese term which means continuous improvement. Kaizen costing is important for the business for following reasons:
- Discover the problems at initial stage and solve them instantly.
- Reduces the wastage.
- Better utilization of employees and production capacity.
- Modification of existing procedures.
- Focusing on continuous improvements (Bragg, 2010).
5.4
Benchmarking means comparing the performance of an organization with the ones that are considered as the industry leaders. It is very beneficial for the business as it tells the management about the weak and strong point of the organization and help them in taking the correct actions for improving the performance.
Principles of benchmarking include principle of use, collaboration, reciprocity, confidentiality, preparation, leadership, communication and transparency (Rolstadås, 2012).
Question 6
Part 1
| Relevant cost for the new project | ||
| New Project | ||
| X | 20*£9 (Rep. cost) | £ 180.00 |
| Y | (200*£10) + (30*£12) | £ 2,360.00 |
| Total Cost | £ 2,540.00 |
Part 2
Peeping Tom Contract
| Component A | (30*1800) + 5% | £ 56,700.00 |
| Component B | 6*2200 | £ 13,200.00 |
| Component C | 20*1600 | 32000 |
| Less: | (40*1600)*10% | 6400 |
| £ 25,600.00 | ||
| Additional Materials | £ 2,800.00 | |
| Labour | 100*35 | |
| (£50-£15) | £ 3,500.00 | |
| Inspection Labour Hours | 50*7.99 | |
| (£6*133.33%) | £ 399.50 | |
| Minimum price | £ 102,199.50 |
Working notes:
Note 1: Component A is widely used and use on this contract required to be replaced. Therefore the original cost of the contract is irrelevant and business will be worse off if used by replacement cost on the contract.
Note 2: The disposal cost of the component B is irrelevant because if the contract is not undertaken then existing inventories must be disposed off. Whereas, if it is taken then there will be surplus component which also requires to be disposed off.
Note 3: The relevant cost for Component C will be the addition cost incurred by undertaking the contract. Thus, the relevant cost will be cost incurred on components if contract is taken less the cost incurred on same if the contract is not taken.
Note 4: The actual wages are not relevant because the workers will be employed for the same number of hours if the contract is undertaken. Therefore, there will be a loss of revenue from other activities. Also total R&D cost is not relevant.
Question 7
Given information
| April | May | |
| Sales units | 500 | 620 |
| Sales Revenue (£) | 25000 | 31000 |
| Cost (£) | 15000 | 16200 |
| Operating profit (£) | 10000 | 14800 |
Part A
| Sales price per unit | ||
| April | 25000/500 | £ 50.00 |
| May | 31000/620 | £ 50.00 |
Part B
| Increase in cost | 16200-15000 | 1200 |
| Increase in sales units | 620-500 | 120 |
| Variable cost per unit | 1200/120 | £ 10.00 |
| Part B | ||
| Increase in cost | 16200-15000 | 1200 |
| Increase in sales units | 620-500 | 120 |
| Variable cost per unit | 1200/120 | £ 10.00 |
The only reason for increase in cost is the rise in variable cost caused by higher volume
| Fixed Cost | Total cost -Variable cost | |
| April | [£15000 – (£10*500)] | £ 10,000.00 |
| May | [£16200 – (£10*620)] | £ 10,000.00 |
| Total fixed cost | £ 20,000.00 | |
| Per month | £ 10,000.00 |
Part C
| Break Even point | Fixed cost / Contribution |
| Fixed cost (per month) | £ 10,000.00 |
| Contribution | £ 40.00 |
| BEP (units per month) | 250 |
Part D
Breakeven point help the company to know about the link between the fixed cost, variable cost and sales revenue so that proper assessment and planning can be done. It also helps in assessing the risk on time as it tells about the minimum number of units to be produced and sold at which the company will be having no profit and no loss. If the company sells below BEP, then there will be a loss and if it sells above BEP then there will be a profit. This is why knowledge about BEP is very much necessary for the business.
Part E
| Contribution margin ratio | |
| Sales per unit | £ 50.00 |
| Variable cost per unit | £ 10.00 |
| Contribution per unit | £ 40.00 |
| Contribution margin ratio = (Contribution/sales ) | 80% |
Contribution margin basically shows the amount of sales revenue covered by variable cost. For Rennes Ltd, the contribution margin ratio is 80% which means a small fluctuation in the sales will have a big impact on the profit and loss of the business.
For example: If a company sold 500 units in May which are above BEP of 250 units then the profit will be:
| Sales (500*£50) | 25000 |
| Variable cost (500*£10) | 5000 |
| Contribution | 20000 |
| Fixed cost | 10000 |
| Profit | 10000 (250*£40 contribution each) |
Part F
| Margin of Safety | ||
| April | May | |
| Sales units | 500 | 620 |
| BEP units | 250 | 250 |
| Margin of Safety | 250 | 370 |
| MOS (%) | 50% | 60% |
Margin of Safety gives an indication of loss to the business which may occur due to change in sales. For Rennes Ltd. in order to make loss, the company have to reduce its sales by 50% in April and by 60% in May. As of now, the business is well reserved from the unexpected fall in its sales forecast.
Question 8
Part 1: Smith Ltd.
| Product | A | B | C |
| Selling price per unit (£) | 140 | 180 | 240 |
| Variable cost per unit (£) | 80 | 100 | 90 |
| Contribution per unit (£) | 60 | 80 | 150 |
| Machine time per unit | 5 | 10 | 15 |
| Contribution per limiting factor (£) | 12 | 8 | 10 |
| Ranking | 1st | 3rd | 2nd |
| Monthly demand (in units) | 90 | 100 | 80 |
Machine Hours are limited to 850 hours per month
| Combination of products | |
| Product | Total Hours |
| A = 90*5hrs | 450 |
| C = 26*15hrs | 390 |
| B = 1*10hrs | 10 |
Note: In order to maximize the profit the company must produce all the 90 units of Product A and after that due to the limited machine hours, 26 units of product C and 1 unit of Product B should be produced.
Part 2: Lorient PLC
The point where the contribution per limiting factor is equal, the products will be equally profitable.
| Contribution per unit of Product X | |
| Selling price per unit | £ 60.00 |
| Variable cost per unit | £ 30.00 |
| Contribution per unit | £ 30.00 |
| Material per unit | 9 |
| Amount of limited resource per Product X (kg) | 0.75 |
| Contribution per kg | £ 40.00 |
| Product | Y | Z |
| Use of limited resource (kg) | £12/£12 = 1 | £15/£12 = 1.25 |
| Required Contribution | 1 x 40 = £40.00 | 1.25 x 40 = £50.00 |
| Required Price | 40+15+6+12+12 = £85.00 | 50+20+3+15+16 = £ 104.00 |
Question 9
Part A
| Direct Materials | 200000 |
| Direct labour | 700000 |
| Total Overheads | |
| Power | 40000 |
| Machine maintenance and repairs | 38000 |
| Factory heat and light | 4000 |
| Lubricants | 6000 |
| Depreciation | 532000 |
| Indirect labour | 100000 |
| Total Overheads | 720000 |
| Direct labour hours | 70000 |
| Machine hours | 75000 |
| Direct Material (kg) | 16000 |
| Calculation of two feasible overhead rates | |
| Direct labour hour rate | £ 10.29 |
| Machine hours rate | £ 9.60 |
Part B
| Normal Direct labour rate per hour | £700000/70000 | £10 |
| Normal Direct Material per kg hour | £200000/16000 | £12.5 |
| Costing for the new Order (using direct labour hour basis) | ||
| Direct Material (350*12.5) | £ 4,375.00 | |
| Direct Labour (700*10) | £ 7,000.00 | |
| Overheads (700*10.29) | £ 7,200.00 | |
| Total cost | £ 18,575.00 |
| Costing for the new Order (using machine hour basis) | ||
| Direct Material (350*12.5) | £ 4,375.00 | |
| Direct Labour (700*10) | £ 7,000.00 | |
| Overheads (600*9.60) | £ 5,760.00 | |
| Total cost | £ 17,135.00 |
Part C
The decision of choosing the most preferable method depends upon the fact that whether the overhead costs are mostly covered by machine related costs or by labour related costs. It can be seen in the question that most of the overheads are related to machine cost such as depreciation, machine maintenance, power, lubricants and depreciation. So as per this machine hour basis should be preferable to treat these items and for overheads like light and heat, labour hour basis will be suitable.
A different approach which can be used for improving the above cost is to treat the overheads by using time based methods such as time-driven activity based costing. This method reduces the amount of data required and focus only on the two things that are unit cost of supplying the capacity and time required for completing the activity.
Question 10
Part A
Traditional full cost method of overhead absorption
| Calculating overhead recovery rate | |||
| Simon | Pumba | ||
| Labour cost per unit | |||
| Labour time per unit | 1 hour | 2 Hour | |
| Labour rate per hour | £10.00 | £ 10.00 | |
| Cost per unit | £10.00 | £20.00 | |
| Total direct labour hours | (10000*10) + (20000*20) | £500000 | |
| Overhead recovery rate | £400000/500000 | 0.8 |
| Unit costs and profit per unit | ||
| Simon | Pumba | |
| £ | £ | |
| Material cost per unit | 20 | 30 |
| Labour cost per unit | 10 | 20 |
| Overheads per unit | 8 | 16 |
| Total cost per unit | 38 | 66 |
| Selling price per unit | 50 | 90 |
| Profit per unit | 12 | 24 |
Part B
| Activity based costing method | ||||
| Activity | Cost driver | Total expected units | Total costs (£) | Unit cost per cost driver (£) |
| Quality Inspections | Number of quality inspections | 3000 | 120000 | 40 |
| Sales invoicing costs | Number of invoices issued | 4000 | 80000 | 20 |
| All other overheads | Direct Labour hours | 500000 | 200000 | 0.4 |
| Total | 400000 |
| Activity | Cost driver | Unit cost per cost driver | Expected units | ABC driven cost | ||
| Simon | Pumba | Simon | Pumba | |||
| Quality Inspections | Number of quality inspections | 40 | 200 | 2800 | 8000 | 112000 |
| Sales invoicing costs | Number of invoices issued | 20 | 500 | 3500 | 10000 | 70000 |
| All other overheads | Direct Labour hours | 0.4 | 100000 | 400000 | 40000 | 160000 |
| Total overheads | 58000 | 342000 |
| Per unit overhead cost | ||
| Simon | Pumba | |
| Total overheads | 58000 | 342000 |
| Units | 10000 | 20000 |
| Cost per unit | 5.8 | 17.1 |
| Unit costs and profit per unit | ||
| Simon | Pumba | |
| £ | £ | |
| Material cost per unit | 20 | 30 |
| Labour cost per unit | 10 | 20 |
| Overheads per unit | 5.8 | 17.1 |
| Total cost per unit | 35.8 | 67.1 |
| Selling price per unit | 50 | 90 |
| Profit per unit | 14.2 | 22.9 |
References
Al-Sayed, M., Abdel-Kader, M. G., & Kholeif, A. O. (2008). ABC diffusion in the age of digital economy: the UK experience. School of accounting, finance and management.
Bragg, S. M. (2010). Cost reduction analysis: tools and strategies (Vol. 7). New Jersey: John Wiley & Sons.
Drury, C. (2005). Management accounting for business. London: Cengage Learning EMEA.
Holtzman, M. P. (2013). Managerial accounting for dummies. Hoboken: John Wiley & Sons.
Kinney, M. R., Raiborn, C. A., & Poznanski, P. J. (2011). Cost accounting: Foundations and evolutions. Issues in Accounting Education, 26(1), 257-258.
Lal, J. (2009). Cost Accounting. New Delhi: Tata McGraw-Hill Education.
Lumby, S., & Jones, C. (2003). Corporate finance: Theory & practice. London: Cengage Learning EMEA.
Maheshwari, Y. (2012). Managerial Economics. New Delhi: PHI Learning Pvt. Ltd.
Rolstadås, A. (Ed.). (2012). Performance management: A business process benchmarking approach. Germany: Springer Science & Business Media.
