Semester 1 Exam

Question 1

Cost unit (definition)

Answer 1

a measurement of output, e.g., a ton of steel, a litre of paint, a kg of sugar.

Question 2

Cost centre (definition)

Answer 2

a part of the business for which a measurement of cost is required.

Question 3

What is the difference between direct costs and indirect costs?

Answer 3

Direct costs

• can be specifically and exclusively identified with a given cost object.

Indirect costs

• cannot be specifically and exclusively identified with a given cost object.
• are assigned to cost objects on the basis of cost allocations.

Question 4

Cost allocation (definition)

Answer 4

• the process of assigning costs to cost objects that involve the use of surrogate, rather than direct measures.

Question 5

The distinction between direct and indirect costs depends on …?

Answer 5

The distinction between direct and indirect costs depends on what is identified as the cost object.

Question 6

Product costs (definition)

Answer 6

those that are identified with products and included in the stock (inventory) valuation

Question 7

Cost object (definition)

Answer 7

any activity for which a separate measurement of cost is required (e.g. cost of making a product or providing a service)

Question 8

Period costs (definition)

Not?

Treated as?

Answer 8

• not specifically related to the product and are not included in the inventory valuation.
• They are treated as expenses in the period in which they are incurred

Question 9

Figure 2.2 - Treatment of period and product costs

Answer 9

• Manufacturing cost is a product cost
• Non-manufacturing costs are period costs

When a product cost is unsold it is recorded as an asset in the balance sheet but becomes an expense when the product is sold in the profit and loss account

A period cost is recorded as an expense in the profit and loss account in the current accounting period

Question 10

Why is cost behaviour important?

Answer 10

• to predict costs and revenues at different activity levels for many decisions.

Question 11

Variable costs (definition)

Answer 11

Costs that vary in direct proportion with activity.

Question 12

Fixed costs (definition)

Answer 12

Costs that remain constant over wide range of activity

Question 13

Semi-fixed costs (definition)

Answer 13

Costs that are fixed within specified activity levels, but they eventually increase or decrease by some constant amount at critical activity levels

Question 14

Semi-variable costs (definition)

Answer 14

Costs that include both a fixed and a variable component (e.g. telephone charges)

Question 15

Variables Costs diagrams

Answer 15

Question 16

Fixed Costs diagrams

Answer 16

Question 17

Step-fixed costs diagram

Answer 17

Question 18

Sunk costs (definition)

Opportunity costs (definition)

Incremental cost (definition)

Marginal costs (definition)

Answer 18

Sunk costs

• costs that have been incurred and cannot be changed by any decision in the future

Opportunity costs

• Costs that measure the opportunity that is sacrificed when the choice of one course of action requires that an alternative course of action is given up

Incremental cost

• the difference between costs of alternative courses of action

Marginal costs

• the cost of one extra unit of output

Question 19

A cost and management accounting system should generate information for meeting the following requirements: (4)

Answer 19

• Inventory valuation for internal and external profit measurement.
• Provide relevant information to help managers make better decisions.
• Provide information for planning, control, and performance measurement.

A database should be maintained, with costs appropriately coded and classified so that relevant information can be extracted to meet each of the above requirements.

Question 20

There are three main costs that businesses incur:

Answer 20

• Materials
• Labour
• Expenses

Correctly identifying these, working out the right amount of cost and treating them correctly is critical for all
businesses

Question 21

There are two reasons why knowing the cost of inventory is vital:

Answer 21

• Value of goods ‘issued’
• Value of goods held

Question 22

Material costs – valuation

• Actual cost
• The First In First out method FIFO (what is it?)
• The Last in First out method LIFO (what is it?)
• The Weighted Average Cost method WAS (what is it?)

Answer 22

FIFO:

• assumes that the oldest items are used first, so that inventory is VALUED at the most recent prices

LIFO:

• assumes that the latest items are used first, so that inventory is valued at the oldest prices
• (this method is not allowed by IAS Inventories 2)

WAS:

• assumes no pattern of the order in which items are used, so all are VALUED at the same value, which is the average one.

Question 23

Labour costs

This can be one of the most expensive elements within the cost of unit, especially for service industries.

Labour costs can be worked out per hour or per unit – read the question carefully.

For example, a question could state that each unit has a labour cost of £20. Or, the question could state that each unit takes 2 hours to make and labour costs are £10 per hour

What factors can affect labour costs? (5)

Answer 23

• Wages rates paid by other businesses
• National / living wages imposed by Government
• Government incentives
• Local employment conditions – availability of unskilled and / or skilled workforce
• Employer costs above gross salaries (about 20%)

Question 24

What is the difference between relevant/avoidable costs & revenues and irrelevant/unavoidable costs & revenues

Answer 24

Relevant/ Avoidable costs and revenues:

• are changed by a future decision

Irrelevant/ unavoidable costs and revenues:

• are not changed by a future decision

Question 25

Costs incurred in a manufacturing business diagram

Answer 25

Question 26

Prime cost (definition)

Answer 26

the direct cost of a commodity in terms of the materials and labour involved in its production, excluding fixed costs

Eg. Direct materials + Direct labour = Prime cost

Question 27

Examples of production overheads (5) and non-production overheads (3)?

Answer 27

Production overheads:

• Rent and rates
• Factory power
• Factory heat and light
• Factory expenses
• Depreciation of plant

Non-production overheads:

• Selling and distribution
• Advertising
• Admin expenses (salaries of office staff and office expenses)

Question 28

Features of manufacturing, merchandising and service organisations

Answer 28

What type of materials are held by businesses will depend on the type of business

Manufacturing:

• Raw materials
• Work in progress
• Finished goods

Merchandising/retail:

• Tangible products for resale i.e. finished goods inventory

Service organisations:

• Provide a service that cannot be stored, but may have work in progress

Question 29

A cost collection system normally accounts for costs in two broad stages:

Answer 29

• Accumulates costs by classifying them into certain categories (e.g. labour, materials and
  overheads);
• Assigns costs to cost objects.

Question 30

Type of expenses diagram

Answer 30

Question 31

Graph of fixed and variable costs

Answer 31

Question 32

Separating Fixed and Variable costs

Answer 32

It is important to be able to identify the amount of fixed and variable costs. Sometimes the information is given to you but sometimes it is not.
Where total costs are known for two levels of output, the amounts of fixed and variable costs can be worked out using the ‘high/low’ method

Question 33

Separating Fixed and Variable costs

Where total costs are known for two levels of output, the amounts of fixed and variable costs can be worked out using the ‘high/low’ method.

Example of High / Low method:
- At output of 1,000 units, total costs are £7,000
- At output of 2,000 units, total costs are £9,000.

What are the fixed costs?
What is the variable cost per unit?
(Note that this only works when the variable cost per unit is constant)

Answer 33

Variable cost per unit - £2000/1000 = £2.00

For 1,000 units:

Total cost = £7,000
Variable cost = 1,000 x £2 = 2,000
Fixed cost = 5,000

Question 34

Costing systems

Going to consider the situation in manufacturing where the cost
object is a product

What are the 2 types of costing systems?

Answer 34

Job-order costing:

• Assume that there are individual products or batches of products
• The products or batches incur different costs so that there is a need to keep track of each product or batch

Process-order costing:

• Used in industries where masses of the same product are produced in a flow process

Question 35

Cost assignment methods

What happens to direct costs vs indirect costs?

Answer 35

• Direct costs - Direct tracing to - Cost Objects
• Indirect costs - go under cost allocations to either: - cause and effect allocations (the more we purchase, the more the cost will increase) or - arbitrary allocations (like direct labour hours or machine hours)

Question 36

Overhead absorption

The number of units produced can be used to work out the
overhead per unit.

But this only works if there are static units produced which
are uniform.

In most manufacturing environments, that is not the case, so
another way to allocate overheads is either: (2)

1. Firstly, the overhead absorption rate (OAR) needs to be
   found.
2. Then this can be applied to the units.

Answer 36

Arbitrary Allocations

• Based on direct labour hours or
• Based on machine hours

Question 37

OAR – Plant wide rate/blanket overhead rate

This is the ___________ of all methods and applies overheads direct to a production department.

This method is only valid for more _______ businesses who do not
have _________ departments or _________ ________.

What are advantages (2) and disadvantages (3) of this method?

Answer 37

This is the simplest of all methods and applies overheads direct to a production department.

This method is only valid for more simple businesses who do not
have complex departments or multiple products.

Advantages:

• Simple to calculate,
• low cost to implement

Disadvantages:

• Arbitrary,
• simplistic,
• inaccurate

Question 38

OAR – 2 stage allocation process

This is a more complex method of allocating overheads.
Applies to both traditional methods and ABC systems

Traditional costing system: (4)

Answer 38

Stage 1

1. Assign all manufacturing overheads to production and
   service centres
2. Reallocate the costs assigned to service cost centres to
   production centres

Stage 2

3. Compute separate overhead rates for each production
   cost centre
4. Assign cost centre overheads to cost objects

Question 39

What might be used as cost centres in a traditional costing system?

What might be used as an activity cost centre in an activity-based costing system?

Answer 39

What might be used as cost centres in a traditional costing system?

• Mattress line – border added
• Building section – where fillings are added, may include tufting and tape edging.
• Delivery

What might be used as an activity cost centre in an activity-based costing system?

• Steel frame
• Adding border, hand stitching
• Building bed – adding fillings
• Tufting
• Tape Edging

Question 40

OAR – ABC (Activity Based Costing)

This is a much more complex method of allocating overheads.

It identifies activities within a business and assigns costs based on those activities. (3)

Answer 40

Stage 1

1. Activities are divided into activity cost centres.
2. The total cost associated with each activity is allocated to
   the relevant activity cost centre.

Stage 2

3. The total cost in each cost centre is then charged to output using a cost driver.

Question 41

Methods of costing (2)

Answer 41

• Direct costing = Direct cost tracing only assigns direct manufacturing costs, not fixed manufacturing costs, to products or services
• Overhead absorption costing = involves allocating production overheads to
  cost objects:

     - Plant wide / Blanket Overhead Absorption Rate – OAR based on machine hours and labour hours – different overhead allocation to the 2 jobs.
     - 2 – stage allocation process for both traditional absorption costing systems and Activity Based Costing systems

Question 42

Under or Over Absorption of overheads in absorption costing

What is the issue? (3)

Answer 42

• The OAR is based on budgeted overheads and budgeted activity e.g. number of labour hours.
• At the end of the period, we know what the actual activity was and apply the OAR to the actual activity.
• The difference between the absorbed overheads and the actual overheads is a period cost adjustment in the financial accounts. The period may be a month, quarter, or year for example.

Question 43

OAR Issues: Budgeted Overheads

There are problems in using actual overheads:

Answer 43

There is a delay in finding product costs, so essential information for decision making is not available until the end of the accounting period

• Monthly profit calculations
• Inventory valuation
• Basis for setting prices
• If this is done monthly, then fluctuations in OAR will occur

Seasonality – changes in activity, customers want to know the price

• Need to use an estimated normal product cost based on average long-run activity rather than an actual product cost
• Establish a budgeted overhead rate based on annual estimated overhead expenditure and activity

Question 44

Under and over recovery of
overheads

It is very unlikely that the actual overheads and / or production levels are the same as the budgeted overheads and production levels used to calculate the OAR

Therefore, overheads will be under or over recovered

• Under or over recovery of overhead due to the activity level being different to the budgeted activity level is called a ______ ___________ __________ ____________
• Under or over recovery of overhead due to the actual fixed overhead expenditure being different to the budget is called a _______ __________ _______________ __________
• Financial accounting regulations require that under or over recovery of overheads is treated as a ______ _____ ____________

Answer 44

It is very unlikely that the actual overheads and / or production levels are the same as the budgeted overheads and production levels used to calculate the OAR

Therefore, overheads will be under or over recovered

• Under or over recovery of overhead due to the activity level being different to the budgeted activity level is called a FIXED OVERHEAD VOLUME VARIANCE
• Under or over recovery of overhead due to the actual fixed overhead expenditure being different to the budget is called a FIXED OVERHEAD EXPENDITURE VARIANCE
• Financial accounting regulations require that under or over recovery of overheads is treated as a period cost adjustment

Question 45

Non-Manufacturing overheads

Financial accounting regulations specify that only ____________ ________ should be allocated to products.

Non-manufacturing costs should be assigned to products for __________-_________ (particularly cost-plus pricing).

Some non-manufacturing costs may be a ________ _____, of the product

Examples: (3)

Generally, aim to select an allocation base/_____ ______ that corresponds to the ___________ of non-manufacturing overhead

For many non-manufacturing overheads, it may be hard to determine an appropriate basis for allocation. A widely used approach is to allocate based on the product’s production costs

Answer 45

Financial accounting regulations specify that only manufacturing overheads should be allocated to products.

Non-manufacturing costs should be assigned to products for decision-making (particularly cost-plus pricing).

Some non-manufacturing costs may be a direct cost, of the product

Examples:

• Delivery costs,
• Sales commission,
• Travel costs

Generally, aim to select an allocation base/cost driver that corresponds to the causation of non-manufacturing overhead

For many non-manufacturing overheads, it may be hard to determine an appropriate basis for allocation. A widely used approach is to allocate based on the product’s production costs

Question 46

Aims of costing

One of the main aims of costing is to establish the cost of one cost unit of work, whatever the work is.

Examples of a cost unit could be:

Answer 46

• Manufacturing: per item made
• Chemical business: kilogram of chemical
• Transport company: passenger mile
• Nursing home: resident day
• University: student

Question 47

Methods of costing – job costing

Answer 47

• Job costing is used where each job can be separately identified from other jobs and costs are charged to that specific job.
• All direct costs are easy to identify, and the overheads are added on a predetermined basis, such as labour hours or machine hours.
• The overheads are allocated on a predetermined OAR basis.

Question 48

Methods of costing – continuous work – Process Costing

Answer 48

• Used where masses of similar products or services are produced in a flow process.
• In the manufacturing industry, this could be making food. In this case, process costing is the method used.
• In this situation, the total costs of the process for a given period of time are collected together and averaged per unit of output for that period.

Question 49

Marginal and absorption costing

These two costing systems are often used in cost accounting, but for different purposes:

Marginal (variable) costing – ?

Absorption costing – ?

The use of each system is dependent on the informational needs of the business:

• ‘can we afford to sell 1,000 units of our product at a discount of 20%?’ – this is _________ costing
• ‘what profit have we made this year?’ – __________ costing

Answer 49

Marginal and absorption costing
These two costing systems are often used in cost accounting, but for different purposes:

• Marginal (variable) costing – helps with short-term decision making.
• Absorption costing – is used to calculate inventory valuations and profit calculations.

The use of each system is dependent on the informational needs of the business:

• ‘can we afford to sell 1,000 units of our product at a discount of 20%?’ – this is marginal costing
• ‘what profit have we made this year?’ – absorption costing

Question 50

Marginal costing (Variable Costing)

What is marginal costing?

What are costs classified by and what is the effect of this?

What is the marginal cost of a unit usually but not always?

What does knowing this cost allow?

The contribution is:…?

Answer 50

Marginal costing is effectively the cost of producing one extra unit of output.

Cost are classified by their behaviour (variable, fixed) so that it is easy to work out the cost of producing one extra unit.

The marginal cost of a unit is usually (but not always) the total of the variable costs of producing a unit of output.

Knowing this cost allows managers to consider the contribution to the business by each unit.

The contribution is: selling price less variable cost.

Question 51

Marginal costing (4,2) vs Absorption costing (3,2)

Answer 51

Marginal costing

Variable costs:

• Variable direct materials
• Variable direct labour
• Variable direct expenses
• Variable overheads

Fixed costs:

• Fixed direct expenses
• Fixed overheads

Absorption costing

Direct costs:

• Direct materials
• Direct labour
• Direct expenses

Indirect costs:

• Variable overheads
• Fixed overheads

Question 52

Marginal costing vs Absorption costing

Main use?
How does it work?
Main focus?
Usefulness?
Limitations?

Answer 52

Marginal costing

Main use?

• To help with short term decision
  making

How does it work?

• Costs are classified as either variable or fixed
• Contribution towards fixed costs
  is calculated as selling price less
  variable costs

Main focus?

• Marginal cost
• Contribution

Usefulness?

• Concept of contribution is easy to understand
• Useful for short term decision
  making

Limitations?

• Costs must be identified as either fixed or variable
• All overheads must be recovered, or a loss will be made
• Not acceptable under IAS 2
  Inventories

Absorption costing

Main use?

• To calculate profit
• To calculate inventory

How does it work?

• Overheads are charged to output through an overhead absorption rate, often based
  on labour hours or machine hours

Main focus?

• All production overheads charged to output
• Calculating profit
• Calculating inventory valuation

Usefulness?

• Acceptable under IAS 2
• Appropriate for traditional industries where overheads are charged to output based on direct labour or machine hours

Limitations?

• Not as useful for short term decision making

Question 53

Marginal costing – Contribution

• Once the contribution per unit has been established, the total contribution for the period can be established.
• The fixed costs are then ___________ , to arrive at the _________ for the period.

Answer 53

• Once the contribution per unit has been established, the total contribution for the period can be established.
• The fixed costs are then deducted, to arrive at the profit for the period.

Question 54

Advantages to a marginal costing statement (4,5)

Answer 54

• Contribution per unit is clearly identified
• Effect on changes to costs easily identified
• Effect on changes to selling price easily identified
• Helps with short-term decision making such as:

     - Break even analysis
     - Margin of safety
     - Target profit
     - Contribution sales ratio
     - Limiting factors

Question 55

Absorption costing

This method answers the question … ‘What does it cost to make one unit of output?’

The absorption cost of a unit of output is made up of:

Answer 55

This method answers the question … ‘What does it cost to make one unit of output?’

• Direct materials
• Direct labour
• Direct expenses
• Production overheads (variable and fixed)
• Absorption cost

Question 56

Absorption costing vs variable costing diagram

Answer 56

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Question 57

Marginal and absorption costing

What do they treat differently and what is the effect of this therefore?

Why is this because?

What does IAS 2 Inventories do?

What does absorption costing have to be used for?

Answer 57

Marginal and absorption costing treat fixed overheads differently; therefore, the two methods will produce different levels of profit when there is closing inventory.

This is because:

• under marginal costing the closing inventory is valued at variable production cost.
• Whereas under absorption costing, there is a share of fixed production costs in closing inventory.

IAS 2 Inventories – provides guidance for determining the cost of inventories and the subsequent recognition of the cost as an expense

Absorption costing has to be used for external reporting

Question 58

Budgets serve several purposes (6)

Answer 58

• Planning annual operations
• Coordinating activities
• Communicating plans
• Motivating managers
• Controlling activities
• Evaluating performance

Question 59

Developing budgets
Different organisations will produce budgets in different ways: (4)

Answer 59

• Participatory – managers at all levels are involved.
• Zero based budgeting – justify every figure in the budget (can be time-consuming)
• Incremental budgeting – start with prior period and adjust the figure (with percentages) (could add budgetary slack and become inaccurate)
• Rolling budgets – always have a budget for the next time period e.g. next 12 months

Question 60

Stages in the Budgeting Process

Answer 60

1. Communicate details of budget policy and guidelines to those people responsible for preparing the budget.
2. Determine the factor that restricts output.
3. Preparation of the sales budget.
4. Initial preparation of budgets.
5. Negotiation of budgets with higher management.
6. Coordination and review of budgets.
7. Final acceptance of budgets.
8. Ongoing review of the budgets.

Question 61

Types of budgets

Answer 61

• Sales
• Production including inventory levels
• Materials usage
• Materials purchase
• Labour utilisation
• Production overhead budget
• Functional budgets - eg. finance, admin
• Capital expenditure
• Cash flow
• Master, budgeted profit or loss and balance sheet

Question 62

Budgetary control

We have already looked at why budgets are produced – the main reason is for _________ ___________.
So, once the budgets are completed, what happens?
The difference between the budget figures and the actual figures can be either a favourable variance or an adverse variance. (what do these mean)

Answer 62

We have already looked at why budgets are produced – the main reason is for control purposes.

They are compared to actual figures over the period so that those responsible can understand how they are performing.

Favourable = sales price increase = increase net profit
Adverse = cost of materials increase = decrease net profit

Question 63

Budgetary control

There can be a variety of reasons for variances:

Answer 63

• Poorly set budget
• Inaccurate cost behaviour assumptions
• Change in suppliers
• Government changes – e.g. living wage
• International changes – e.g. price of oil
• Bad management
• High wastage

Question 64

Budgetary control

So, once the budgets are completed, what happens? (2)

Answer 64

So, once the budgets are completed, what happens?

• They are compared to actual figures over the period so that those responsible can understand how they are performing.
• The difference between the budget figures and the actual figures can be either a favourable variance or an adverse variance.

Question 65

Favourable or Adverse variance (2)

Answer 65

From the perspective of Net Profit

• Favourable
• Adverse (unfavourable)

Question 66

What is a standard cost?

What is a budget? What is standard?

How do we establish standard cost?

Answer 66

• Standard costs are target costs for each operation that can be built up to produce a product standard cost.
• A budget relates to the cost for the total activity, whereas standard relates to a cost per unit of activity

Establishing standard costs: Two approaches:

• past historical records; Labour and Material usage
• engineering studies

Question 67

What does Standard Hours Produced mean?

Standard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hours
Output = 100 units of X, 200 units of Y, 300 units of Z

What is the Standard Hours Produced?

Answer 67

Standard Hours Produced

• Used to measure output where more than one product is produced.

Example

Standard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hours
Output = 100 units of X, 200 units of Y, 300 units of Z

What is the Standard Hours Produced?

(100 × 5 hours) + (200 × 2 hours) + (300 × 3 hours) = 1,800 hours

• If actual DLH are less than 1,800 the department will be efficient,
• If hours exceed 1,800 the department will be inefficient.

Note: Different activity measures and other factors (besides activity) will influence cost behaviour.
Standard Hours Produced

Question 68

Fixed and flexed budgets

What’s the difference?

• Once the flexed budget is produced…?

Answer 68

Fixed budgets remain the same irrespective of the level of activity.

A flexed budget changes with the level of activity. This is commonly used inmanufacturing businesses because if the level of activity changes, then every comparison between budget and actual will have variances – but this variance could be mainly due to activity levels being different.

• Once the flexed budget is produced, the variance analysis can be carriedout.

Note we are looking at variance analysis with a variable costing system

Question 69

Sales volume variance

What is it?
A reduction in sales volume would lead to?
An increase in sales volume would lead to?

Answer 69

This variance handles the change from original budget to flexed budget.
As the only difference between these budgets is the level of activity, this variance considersthat in one figure.

• A reduction in sales volume would lead to an adverse variance.
• An Increase in sales volume would lead to a favourable variance

Question 70

Direct labour efficiency variance

What is this?

• A reduction in the number of hours taken would lead to …?
• An increase in the number of hours taken would lead to …?

Answer 70

This variance compares the number of hours budgeted against the actual number of hours taken.

This difference is then shown at the budgeted hourly rate.

• A reduction in the number of hours taken would lead to a favourable variance.
• An increase in the number of hours taken would lead to an adverse variance

Question 71

Direct labour rate variance

What is this

• A reduction in the cost per hour would lead to …?
• An increase in the cost per hour would lead to …?

Answer 71

This variance compares the budgeted cost per hour with the actual cost per hour.

• A reduction in the cost per hour would lead to a favourable variance.
• An increase in the cost per hour would lead to an adverse variance.

Question 72

Direct material usage variance

What is this?

• A reduction in the cost per hour would lead to …?
• An increase in the cost per hour would lead to …?

Answer 72

This variance compares the quantity of materials budgeted against the actual
quantity used.
This difference is then shown at the budgeted material cost

• A reduction in the quantity of materials usedwould lead to a favourable variance.
• An increase in the quantity of materials used would lead to an adverse variance.

Question 73

Materials price variance

What is this?

• A reduction in the cost per hour would lead to …?
• An increase in the cost per hour would lead to …?

Answer 73

This variance compares the budgeted cost per unit of material with the actual cost per unit of material.

• A reduction in the cost per unit would lead to a favourable variance.
• An increase in the cost per unit would lead to an adverse variance

Question 74

Break Even Analysis

• In Marginal costing costs are classified as either ________ or ____________.
• Companies need to know how many units need to be sold to cover all the fixed costs

What is the formula for contribution?

What is the formula for profit?

Answer 74

• In Marginal costing costs are classified as either fixed or variable.
• Companies need to know how many units need to be sold to cover all the fixed costs

Contribution per unit (CPU) = Selling price – variable cost

Profit = Contribution per unit x number of units sold) – Fixed costs

Question 75

Break even analysis or CVP Analysis

What does CVP stand for?

What is BEP? (2)
What is the formula for BEP?

Answer 75

C = cost of the unit
V = volume of the unit
P = profit made

Breakeven Point (BEP) is the point at which neither a profit nor a loss is made
BEP is the number of units that need to be sold to cover the fixed costs
- BEP = Fixed costs / contribution per unit

Question 76

Margin of safety

This is…?
It can be expressed as:

Answer 76

This is the amount by which the sales exceed the BEP.

It can be expressed as:

• Number of units
• Sales revenue amount
• Percentage: current output – break even output/current output x 100 = % margin of safety

Question 77

Contribution sales ratio

What is it?
How is it calculated?
What can we use it for?

What is the formula for Break even sales revenue

Answer 77

Contribution expressed as a % of the selling price.

Contribution sales ratio % = Contribution / Selling price

We can use the CS ratio to find the sales revenue at which the company breaks even, or the sales revenue to give a target profit

Break even sales revenue = Fixed cost / CS ratio

Question 78

Target profit

What is it for?
What is the formula?

Answer 78

Some companies will want (need) to make a certain amount of profit, so this can be inbuilt into the
breakeven analysis to ensure that the right amount of units are produced.

Fixed costs + target profit / CPU = number of units

Question 79

When is break even analysis used? (5)

Answer 79

• Before starting a new business
• When making changes
• To measure profits and losses
• To answer ‘what if’ questions
• To evaluate alternatives

Question 80

Limitations of break-even analysis

Answer 80

• Assumes all output is sold
• All costs and revenues can be represented by a straight line
• Fixed costs remain fixed – and not stepped
  -There is a direct relationship between revenue and cost- in some case the more that is produced the cheaper it is per unit
• Only applies to the relevant range

Question 81

Limiting factors

What are limiting factors?
Examples (5)
When they are none, what should the business focus on?
What if there are?

Answer 81

Limiting factors are those aspects of a business which affect output.

• Lack of availability of materials
• Lack of availability of labour (especially skilled)
• Lack of availability of capital resources (machinery)
• Finance
• Volume of units that can be sold

Where there are no limiting factors, company should concentrate on the product
making the highest CS ratio

However, when there are limiting factors, production should be based on the highest
contribution from each unit of the limiting factor

Question 82

Reconciliation statements

What are they used to show?
What is more complex when using standard costing?

Answer 82

Reconciliation statements can be used to show the differences between the standard cost of production and the actual cost.

Computing the differences for variable and fixed costs is more complex when using standard costing.

Question 83

Fixed costs – marginal costing

What are ignored under marginal costing?
What is the overhead variance?
Example?

Answer 83

Under marginal (variable) costing – fixed costs are ignored.

Therefore, where there is a difference between projected and actual fixed costs, the overhead variance is simply the difference between the two figures.
* i.e. Fixed Overhead Expenditure Variance

Question 84

Fixed costs – absorption costing

What is one advantage?
What is all cost estimates are reasonably accurate?
What if this doesn’t occur?

Answer 84

Under absorption costing – one advantage of standard absorption costing is that the cost for a unit will be a ‘full’ cost and will incorporate a portion of all the costs of production.

• If the actual production level is close to the projected level, and all cost estimates are reasonably accurate, then standard cost will be close to the actual full cost

However if this does not occur, fixed overhead variances will need to take into account:

• Production volumes and
• Overhead costs

Question 85

Fixed costs – absorption costing

As we know, the OAR is worked out before production is underway. The OAR is worked out so that…

• So, what happens if:
• Fixed overheads change?
• The measure (labour hours, machine hours) change?
• Volume of units produced / sold change?

Answer 85

As we know, the OAR is worked out before production is underway. The OAR is worked out so that, based on a measure, the total fixed overheads are covered by the volume of units expected to be made.

• So, what happens if:
• Fixed overheads change?
• The measure (labour hours, machine hours) change?
• Volume of units produced / sold change?

These changes will provide two fixed overhead variances:

• Fixed overhead expenditure variance – this is the difference in the actual amount spent on fixed overheads.
• Fixed overhead volume variance – this is the difference in the actual volume of output.

The combination of these two variances will result in an overall total fixed overhead variance.

Question 86

Fixed costs – the absorption base

Remember that fixed overheads can be apportioned uses a variety of measures. The three main ones are:

How the OAR has been worked out will change the way that the fixed overhead variances are worked out.

Answer 86

Remember that fixed overheads can be apportioned uses a variety of measures. The three main ones are:

• actual units,
• labour hours
• machine hours.

How the OAR has been worked out will change the waythat the fixed overhead variances are worked out.

Question 87

Fixed costs – sub-variances

What are the sub-divisions and what are their formulas?

Answer 87

For deeper analysis, the volume variance can also be sub-divided into efficiency variance and capacity variance.

Volume Capacity variance

• this compares the time the budgeted production should have taken with the actual hours worked.
• (actual hours taken – budgeted hours) x OAR

Volume Efficiency variance

• this compares the time the actual production should have taken with the time it actually took to make.
• (std hours for output – actual hours for output) x OAR

Question 88

The American Accounting Association define accounting as:

Answer 88

the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information

Question 89

The users of accounting information can be divided into two categories:

Answer 89

1. internal users within the organization (management accounting).
2. external parties outside the organization (financial accounting).
   (Drury, 2020)

Question 90

What’s the difference between Financial Accounting (3) and Management Accounting (3)?

Answer 90

1. Financial Accounting (not Finance):

• provide information to those external to the organisation. Shareholders would be a typical user of this information.
• mainly uses historical data and is essentially backward-looking.
• very heavily regulated and controlled by parties external to the organisation, such as the IASB.
• Financial accounting reports describe the whole of the business

2. Management Accounting:

• seeks to provide information which is for those internal to the organisation.
• Managers would be a typical user of this information.
• mainly concerned with future planning and is very forward-looking. (Key term: decision making)
• not regulated at all. (Although there are guidelines)
• Financial accounting reports describe the whole of the business

Question 91

The decision-making, planning and control process. (diagram)

Answer 91

(Drury, 2020)

Question 92

Functions of management accounting

A cost and management accounting system should generate information to meet the following: (3)

Answer 92

• allocate costs between products sold, and fully and partly completed products that are unsold.
• provide relevant information to help managers make better decisions.
• provide information for planning, control, performance measurement and continuous improvement

(Drury, 2020)

Question 93

Cost object (definition)

Answer 93

Any activity or output for which a separate measurement of costs is desired.

Question 94

2 Stages:

Classify costs into ___________ e.g., by type of ________ , by cost behaviour, then assign costs to cost objects.

Choosing an appropriate cost unit is _________ within a business as it is to this object that ___ _____ are ___________.

Answer 94

Classify costs into categories e.g., by type of expense, by cost behaviour, then assign costs to cost objects.

Choosing an appropriate cost unit is critical within a business as it is to this object that all costs are allocated.

Question 95

Stakeholders and the information they require

• Managers
• Shareholders
• Employees
• Creditors and the providers of loan capital
• Government agencies such as the Central Statistical Office

Answer 95

• Managers require information that will assist them in their decision-making and control activities; for example, information is needed on the estimated selling prices, costs, demand, competitive position and profitability of various products/services that are provided by the organization.
• Shareholders require information on the value of their investment and the income that is derived from their shareholding. Likewise, potential investors are interested in their potential returns.
• Employees require information on the ability of the firm to meet wage demands and avoid redundancies, their potential for continued employment.
• Creditors and the providers of loan capital require information on a firm’s ability to meet its financial obligations.
• Government agencies such as the Central Statistical Office collect accounting information and require such information as the details of sales activity, profits, investments, stocks (i.e. inventories), dividends paid, the proportion of profits absorbed by taxation and so on. In addition, government taxation authorities require information on the amount of profits that are subject to taxation. All this information is important for determining policies to manage the economy.