formation 2 examination - august 2020

NOTES: Section A - Questions 1 and 2 are compulsory. You have to answer Part A or Part B only of Question 2. Should you provide answers to both Part(s) A and B of Question 2, only the first answer to Part A for this question will be marked. Section B - You are required to answer any three out of Questions 3 to 6. Should you provide answers to all of Questions 3 to 6, only the answers for Questions 3, 4 and 5 will be marked.

TIME ALLOWED: 3 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may highlight text and write notes on the examination paper, however, you may not commence writing on the answer field until your Supervisor tells you to do so. Please read each Question carefully. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. You are reminded to pay particular attention to your communication skills and care must be taken regarding the format and literacy of your solutions. The marking system will take into account the content of your answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate.

MANAGEMENT ACCOUNTING

FORMATION 2 EXAMINATION - AUGUST 2020

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND



SECTION A

1. Bleu DAC manufactures office furniture and specialises in producing desks. This year, due to significant customer

demand, the company commenced production of a new product, a standing desk. Based on an innovative design the standing desk is constructed from sustainable beech wood only, without the need for screws or fastenings of any kind. Budgeted and actual information for the standing desks for the month of May are shown below.

Budgeted Actual Sales/production in units 3,000 2,750 Total sales revenue €840,000 €811,250 Total materials (square metres) 12,750 sq. mtrs 12,375 sq. mtrs Materials (beech wood) €153,000 €141,075 Total direct labour hours 3,750 hours 3,300 hours Total direct labour cost €60,000 €56,100 Variable production overhead cost (see Note 2) €20,625 €19,800 Fixed production overhead cost (see Note 2) €129,375 €119,790

Notes: 1. The company operates a standard absorption costing system.

2. Both variable production overhead and fixed production overhead costs are based on direct labour hours. REQUIREMENT: (a) Prepare the standard cost card for ONE standing desk. (4 marks) (b) Prepare an operating statement showing the static budget, flexed budget and actual results for the month.

(4 marks) (c) Calculate relevant variances in as much detail as the information above permits. (15 marks)

(d) For each of the direct labour variances calculated at (c) above, outline ONE reason to explain why it has occurred.

(2 marks)

[Total: 25 Marks]

ANSWER PART (A) OR PART (B) 2. (A) The managing director of XY Products DAC has recently read an article about management accounting, which

stated that ‘understanding cost classifications and cost behaviour is essential to interpreting management accounting information’. He has asked you to prepare a briefing note for distribution to the management team on the subject of cost classifications and cost behaviour.

REQUIREMENT: Prepare a briefing note: (i) Describing the main classifications of cost (direct and indirect, product and period, relevant and irrelevant) including

examples to illustrate your answer. (9 marks)

(ii) Explaining the relationship between cost behaviour and activity (volume), providing examples or diagrams to support

your answer. (5 marks)

Format and Presentation (1 mark)

[Total: 15 Marks]

OR (B) Joie DAC, a toy manufacturer pays its staff on a time basis: staff work seven and a half hours per day and are paid

an hourly rate. The managing director of Joie DAC has discovered that the company’s closest competitor pays its staff on a piece rate basis. He is keen to cut costs to increase competitiveness and is considering changing the company’s current remuneration method. You have been asked to provide more information to Joie DAC about alternative remuneration schemes.

REQUIREMENT: Draft a memorandum for the managing director of Joie DAC that: (i) Describes piece rate remuneration schemes including their related advantages and disadvantages. (5 marks)

(ii) Describes bonus or incentive schemes including their related advantages and disadvantages. (5 marks)

(iii) Briefly outlines FOUR conditions necessary for successful operation of incentive schemes. (4 marks)

Format and Presentation (1 mark)

[Total: 15 Marks]

SECTION B - ANSWER ANY THREE QUESTIONS.

3. The following multiple-choice question contains eight sections, each of which is followed by a choice of answers. Each question carries equal marks.

1. Which of the following statements is TRUE: (a) When units sold exceed units produced variable (marginal) costing shows higher profits. (b) When units sold exceed units produced absorption costing shows higher profits. (c) When units produced are less than units sold absorption costing shows higher profits. (d) When using absorption costing there is no under or over absorbed overhead.

2. Omega LTD uses the Economic Order Quantity (EOQ) to determine the amount of inventory to purchase. The

following details have been extracted from the company’s accounting system:

Demand per quarter (in units) = 21,000 Cost of placing an order = €50 Cost to purchase one unit of product = €10 Costs of holding one unit of inventory for one year = 2% of purchase cost

The EOQ is calculated (to the nearest whole unit) as:

(a) 4,583 units (b) 2,899 units (c) 6,481 units (d) 3,241 units. 3. The process account below relates to the previous month and closing work in progress (WIP) is 60% complete.

Process Account

Units € Units €

Opening WIP 8,200 Output 867 Costs for the period 16,832 Closing WIP 45

912 25,032 912

The company uses the weighted average method of valuation. On this basis, the value of the closing work in progress for the period (to the nearest euro) is:

(a) €756 (b) €1,215 (c) €1,235 (d) €741. 4. Details relating to sales administration overhead for Gamma LTD for the first three months of the year are shown

below. Sales administration overheads include both a fixed and variable element.

January February March Sales administration overhead €237,500 €261,650 €254,750 Sales in units 65,000 72,000 70,000

Monthly fixed sales administration overhead is:

(a) €7,000 (b) €13,250 (c) €24,150 (d) €6,900.

The following information relates to questions 5, 6 and 7: On 1 January, Pharma LTD did not have any units of chemical Y in inventory. All inventory movements for chemical Y for the month of January were as follows: 4 January Purchase of 10,000 kgs at a total cost of €50,000. 11 January Issue of 4,200 kgs to production. 17 January Purchase of 8,100 kgs at a total cost of €42,120. 25 January Issue of 12,450 kgs to production. 30 January Purchase of 11,000 kgs at a total cost of €63,800. 5. On 31 January, inventory valuation using a LIFO basis (to the nearest euro) is:

(a) €73,370 (b) €73,380 (c) €71,050 (d) €72,050. 6. On 25 January, the value of the issue using a FIFO basis (to the nearest euro) is: (a) €63,870 (b) €71,340 (c) €63,580 (d) €62,740. 7. On 31 January, inventory valuation using an Average basis (to the nearest euro) is:

(a) €64,515 (b) €69,575 (c) €67,467 (d) €71,226. 8. Delta LTD produces three products, details of which are shown below.

Product X Product Y Product Z Budgeted sales for the year (units) 80,000 56,000 42,000 Contribution (per unit) €5.50 €6.00 €4.50 Labour hours (per unit) 0.50 0.50 0.25

If the company only has 70,000 labour hours available for the year and wants to maximise profits it should manufacture:

(a) 63,000 units of X, 56,000 units of Y and 42,000 units of Z. (b) 80,000 units of X, 56,000 units of Y and 8,000 units of Z. (c) 80,000 units of X and 39,000 units of Y and 42,000 units of Z. (d) 80,000 units of X, 56,000 units of Y and 42,000 units of Z.

[Total: 20 Marks]

4. Verte DAC, a food company based in Waterford, has developed a new product, a vegan superfood smoothie. The company has conducted market research to test customer response and the results have been favourable. Production of the smoothie has been streamlined so that it can be made quickly and easily. The marketing director has suggested that selling the smoothie at a two-day summer music festival would generate significant product recognition and boost demand. To assess the viability of this suggestion, the sales manager and management accountant have provided the following information:

Cost information € Per 300ml smoothie Ingredients (fruit, seeds, nut milk) 2.47 Recyclable cup 0.08 Other costs – per day Staff costs (per person) 250 Insurance 246 Festival licence fee 1,500 Market research information Average (expected) daily sales 1,700 Maximum daily production/sales 2,000

Notes: 1. The smoothie will be produced and sold in one size – 300 ml. The selling price for the smoothie will be €4.50. 2. The company will employ three staff to work on each day of the festival.

REQUIREMENT: (a) Based on the information provided prepare a profit statement for the two-day period. (3 marks)

(b) Prepare a break-even chart for the two-day period, clearly identifying each of the following:

(i) Total revenue line. (ii) Total cost line. (iii) Total fixed cost line. (iv) The break-even point. (v) The profit area. (vi) The margin of safety. (12 marks)

(c) Calculate how many smoothies must be sold in total if the company requires a profit of €2,500 for the two-day period.

(3 marks) (d) Describe TWO assumptions of cost-volume-profit (CVP) analysis. (2 marks)

[Total: 20 Marks] 5. Mike Sheehan set up his own business, ‘Mike’s Minibus’, a year ago to provide transport services for rural villages

Page 5

in the South West of Ireland. Mike provides transport using a 17 seat minibus. As the business has been very successful Mike is hoping to purchase another minibus and has applied for a bank loan. The loan has been approved in principle by the bank but Mike is required to prepare a cash budget for the four month period from June to September. Details of the projected revenues and expenditure for the business are presented below.

Notes:

(i) When preparing the cash budget, assume that there are 4 weeks in each month.

(ii) Mike’s Minibus expects to provide the following transport services on a weekly basis:

Number of Fare charged Average number of

return trips per return trip passengers per trip

Transport to Bingo (Note (iii)) 2 €5 17 Shopping trips to local town (Note (iv)) 4 €8 15 Airport collection/drop off (Note (iii)) 2 €50 8 Transport to events in Dublin (Note (iii)) 1 €20 15

(iii) Passengers pay cash when going to Bingo, the airport or events in Dublin.

(iv) For the shopping trips, the same passengers travel each week so Mike collects the money on a monthly basis

in arrears. During May, there were 3 shopping return trips each week to local towns; the return fare charged was €8 and there were on average 15 passengers per return trip.

(v) Running costs are €6,840 per year comprising insurance of €200 per month, motor taxation of €20 per

month and depreciation of €350 per month. (vi) In relation to fuel, Mike has a fuel card with a well-known oil company that he uses to purchase diesel. On

average, his fuel costs €500 per week. The fuel card is paid each month in arrears. (vii) To facilitate accounts and record keeping Mike intends to purchase a laptop and printer in August costing

€500 in total. (viii) Mike does some of the driving but employs another driver on a casual basis to cover the shopping trips and

transport to events in Dublin. He pays the other driver €100 per return shopping trip and €200 per return trip to Dublin. Wages are paid in the month when the transport is provided.

(ix) Mike expects his bank balance at 1 June to be €510. (x) The additional minibus that Mike wants to buy costs €35,000. The bank has approved a loan over four years

with monthly repayments of €825 commencing on 1 June. REQUIREMENT: (a) Prepare a cash budget for Mike’s Minibus on a monthly basis, for the FOUR month period commencing 1 June,

clearly showing the closing cash balance at the end of each month. (16 marks)

(b) Describe Incremental Budgeting including TWO advantages and TWO disadvantages of this method.

(4 marks)

[Total: 20 Marks] 6. Ecosport DAC manufactures sports bags from environmentally friendly bamboo fabric. The company sells the

sports bags online and last year its website was extended to allow customers to create their own designs for the outside of the sports bag. This customisation has increased overheads so that they are now a much larger percentage of the overall product cost. Consequently, the directors have decided to change from using a traditional absorption costing system to an activity based costing (ABC) system so that the company will have more accurate product costs.

When an order is placed for a sports bag the procurement clerk reserves the material and labour necessary to produce it. The design costs and machine scheduling costs both relate to the customer design choices; the more detailed the design on the sports bag the more machines that are involved and the more machine set ups that are required. The sports bags are inspected during the production process to ensure that they meet quality standards. Once produced the sports bags are finished and packaged by workers. The company calculates a selling price for the sports bag based on a mark-up on product cost of 40%.

Cost and activity information relating to the current year is shown below.

Procurement costs €27,450 Design costs €46,860 Machine scheduling costs €24,140 Quality control and inspection costs €41,625 Sundry finishing and packaging costs €17,955 Finishing department labour hours 1,050 Number of inspections 46,250 Number of machine set ups 28,400 Total orders placed 15,250

Details relating to two orders for sports bags are as follows:

Order 14509 Order 14550 Direct materials €10.75 €10.75 Direct labour €4.50 €4.50 Number of inspections 2 4 Number of machine set ups 8 4 Finishing and labour hours 6 mins 10 mins

REQUIREMENT: (a) Calculate the total cost of each of the two orders noted above using activity based costing (ABC) to allocate

overheads. (13 marks)

(b) Using the company’s policy, compute the selling price that would be charged for the orders noted at (a) above.

(3 marks) (c) Explain the meaning of the following terms using examples, where appropriate, to support your answer:

(i) Blanket overhead rate. (ii) Under absorbed production overhead. (4 marks)

[Total: 20 Marks]

END OF PAPER

Page 7

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND



SOLUTION 1

SUGGESTED SOLUTIONS

SOLUTION 2 (A) BRIEFING NOTE (i) The main classifications of cost (direct and indirect, product and period, relevant and irrelevant) including

examples.

Direct cost: is a cost that is directly related to a product or service. A direct cost can be specifically and exclusively identified with a particular cost object, it can be accurately traced to a product or service as it can be physically identified with it. For example, for a company that makes furniture, the wood that is used to manufacture a table can be specifically and exclusively identified with the table, it may take 4 metres of wood to make each table. Direct costs comprise, direct materials, direct labour and direct expenses.

An Indirect cost: is a cost that cannot be specifically and exclusively identified with a particular cost object. For example, factory rent cannot be specifically and exclusively identified with a particular product or service. Hence, an estimate of the resources or indirect costs required for a cost object must be prepared. Indirect costs are also called overheads.

Product cost: is a cost that is identified with goods purchased or manufactured for resale. In a manufacturing company, it is a cost that is attached to the product and included in inventory valuation until the product is sold. When the product is sold the sales revenue is matched with the product cost of the goods sold. All costs involved in the manufacture of goods are considered to be product costs, for example, materials, labour, factory insurance.

A Period cost: is a cost that is not included in inventory valuation. It does not relate to the manufacture of a product i.e. it is a non-manufacturing cost. A period cost is not attached a product but instead is treated as expense and included in the income statement for the period to which it relates. For example, selling and administration expenses, distribution costs.

Relevant cost: this is a future cost that will be changed by a particular decision. It is a cost that specifically relates to a particular decision. For example, if a company is considering engaging in a particular project, which requires two new staff members to be employed if the project goes ahead but if it does not go ahead the staff members will not be employed. In this case the cost of employing the staff members is a relevant cost as it specifically relates to the decision.

An Irrelevant cost will not be affected by a particular decision; it is a cost that will be or has been incurred regardless of the decision that is now being considered. For example, assume a company purchased material costing €5,000 two years ago. If it is now considering whether to use the material to make a new product the €5,000 cost is irrelevant to the decision as the money has already been spent purchasing the material.

(9 marks) (ii) The relationship between cost behaviour and activity (volume) including examples

Costs react differently to changes in activity or volume. There are four main classifications of cost, variable, fixed, semi-variable, and semi-fixed.

Variable cost: this cost varies in direct proportion to volume or activity. For example, if a company operates a piece work wages system then its wages cost is variable, as the more output that employees produce, the higher the wages cost will be. The graph below shows the behaviour of variable cost. If there no output then there is no cost incurred however as output increases so does variable cost, in direct proportion.

Fixed cost: is a cost that remains constant over wide ranges of activity (or volume) for a specific period of time. For example, a company may rent a factory to manufacture its product at a cost of €100,000. Assume the factory has a production capacity of 500,000 units. The factory rent is a fixed cost being €100,000 as long as production is within the production capacity of 500,000 units. Even if the company does not manufacture any products the factory rent is still €100,000.

Semi-variable cost: is a cost that includes both fixed and variable elements; the fixed element represents a constant charge that is applicable and the variable element is dependent on usage or activity. An example of a semi-variable cost is electricity. There is a fixed or standing charge that is payable for the supply of electricity even if no electricity is used. There is a variable element that increases directly depending on kilowatt usage of electricity.

Semi-fixed cost: (also called a step fixed cost) is a cost that is fixed within specified activity levels and within a particular time period. An example of a semi-fixed cost is supervisor’s salary. A supervisor is paid €65,000 to supervise up to 10 staff in the factory. The staff may produce up to 100,000 units. If the company wants to increase production and hires 8 more production staff then another supervisor must be employed. In this case supervisor’s salary remains at €65,000 up to a production level of 100,000 units but when more staff are employed and production increases another supervisor is employed and supervisors’ salary increases to €130,000. As the diagram shows the fixed cost increases in steps.

Format and presentation (1 mark)

[Total: 15 Marks]

(5 marks)

SOLUTION 2 (B) MEMORANDUM

TO: Managing Director, Joie DAC FROM: CPA student RE: Alternative Remuneration Methods DATE: August 2020

Further to your recent request for information I have prepared this memorandum which describes piece rate remuneration schemes including advantages and disadvantages, describes how bonus or incentive schemes operate and presents the conditions necessary for incentive schemes to operate successfully.

(i) Piece rate remuneration schemes With piece rate remuneration schemes, staff is paid on the basis of output produced rather than hours worked. There are a number of different variations of piece rate remuneration systems including straight piece rate schemes, piece rates with guaranteed minimum pay and differential piece rate schemes.

Advantages of piece rate schemes l Each worker is paid on his/her merits and hence individual effort is encouraged. l The employer knows in advance the direct labour cost of each job and this information is very useful in

pricing or tendering for jobs. l Workers may be more careful with tools and equipment as they know that any damage to these will reduce

their earning capacity. l Companies may ensure that time wasted by employees in production is not paid for. l Any other relevant point.

Disadvantages of piece rate schemes l It may be difficult to agree an equitable rate for units produced. l Slower workers may feel disgruntled at earning a lower wage and this may lead to demotivation. l There may be an adverse effect on quality as workers try to increase their output. l There may be excessive waste of material by workers trying to work as fast as possible and while the worker

will not be paid for items scrapped there is a cost associated with these items. l Any other relevant point.

(5 marks) (ii) Bonus or incentive schemes Bonus or incentive schemes operate on the basis that a target is set and actual performance is compared with that target. If actual production is greater than the target staff is rewarded for their efficiency. Thus, staff is incentivised to work harder to increase production and their remuneration.

Advantages of bonus or incentive schemes l The scheme is simple to understand. l Encourages staff to work harder and increase their efforts. l There is usually a guaranteed minimum wage. l The employer benefits by sharing in the saving of time as it may result in a reduction in the overall cost per

unit of output and higher profits. l Bonus and incentive schemes may impact favourably on employee morale as employees are seen to receive

extra reward for extra effort. l Any other relevant point.

Disadvantages of bonus or incentive schemes l Incentives and bonuses for staff may lead to higher labour costs. l Employees may object to sharing the savings in time with the employer and it may be difficult to explain or

justify the principle to the staff. l Bonus or incentive is not as strong as for basic piece work. l Any other relevant point.

(5 marks)

(iii) FOUR Conditions necessary for incentive schemes to operate successfully

For incentive schemes to operate successfully there are a number of conditions that must be met. These include (Any FOUR of the following):

l The objectives must be clearly stated and attainable. l The scheme should be clearly communicated to all participants. l Any rules or conditions should be easy to understand and not liable to misinterpretation or manipulation. l The reward should be as nearly related to effort as possible, both in amount and time. l The standard of performance set must be reasonably attainable by the average employee. l The scheme must have the support of all relevant parties - e.g. staff, employer, and unions. l The scheme should be seen to be fair from the perspective of the employees as well as from the employer's

perspective. l Ideally bonuses or incentives should be made as near as possible to the time that they are earned so that

the link between effort and reward is very apparent. l Only employees who invest effort in securing the bonuses/incentives should receive them – employees

should not be rewarded for the work of others. l Allowances should be made for factors outside employees' control which have impinged upon their

performance. l Any other relevant point.

(4 marks)

If you require any further clarification or information regarding anything contained in this memorandum please feel free to contact me.

Yours sincerely, CPA student

Marks awarded for memorandum format and presentation (1 mark)

[Total: 15 Marks]

SOLUTION 3 Multiple Choice Questions – Solutions 1. Answer (a) When units sold exceed units produced variable (marginal) costing shows higher profits. 2. Answer (c) 6,481

√((2 D O)/H) D = annual demand = 21,000 x 4 = 84,000

O = €50 H = Cost of holding stock in inventory for 1 year = 2% x €10 = €0.20

=√(2x84,000x50/0.20) = 6,481

3. Answer (a) €756

Total costs incurred €25,032 Total completed units 867 Add equivalent units of closing WIP: 45 x 60% 27 Total equivalent units of output 894 Cost per equivalent unit €28 Value of closing WIP for the period 27 x €28 €756

4. Answer (b) €13,250

Sales Administration cost High activity February 72,000 units €261,650 Lowest activity January 65,000 units €237,500 Difference 7,000 units € 24,150 Variable administration overhead = €24,150/7,000 = €3.45 per unit Fixed administration overhead = €237,500 – (65,000 x €3.45) = €13,250

5. Answer (c) On 31 January inventory valuation using LIFO is €71,050

Using LIFO Balance Receipts Issues Quantity Value €

04/01 Purchase 10,000 x €5.00 10,000 50,000 11/01 Issue 4,200 x €5.00 5,800 29,000 17/01 Purchase 8,100 x €5.20 13,900 71,120 25/01 Issue 8,100 x €5.20

4,350 x €5.00 1,450 7,250 30/01 Purchase 11,000 x €5.80 12,450 71,050

6. Answer (c) On 25 January value of issue using FIFO is €63,580

Using FIFO Balance Receipts Issues Quantity Value €

04/01 Purchase 10,000 x €5.00 10,000 50,000 11/01 Issue 4,200 x €5.00 5,800 29,000 17/01 Purchase 8,100 x €5.20 13,900 71,120 25/01 Issue 5,800 x €5.00

6,650 x €5.20 = €63,580 1,450 7,540

30/01 Purchase 11,000 x €5.8 12,450 71,340

7. Answer (d) On 31 January inventory valuation using (weighted) average is €71,226

Using (Weighted) Average Receipts/ Purchase Price Value Weighted (Issues) Average

Price €04/01 Purchase 10,000 5.00 50,000 5.00 11/01 Issue (4,200) (21,000)

5,800 29,000 17/01 Purchase 8,100 5.20 42,120

13,900 71,120 5.116 25/01 Issue (12,450) (63,694)

1,450 7,426 30/01 Purchase 11,000 5.80 63,800

12,450 71,226 5.721 8. Answer (a) 63,000 units of X, 56,000 units of Y and 42,000 units of Z.

Product X Product Y Product Z Contribution per unit € 5.50 €6.00 €4.50 Labour hours per unit 0.50 0.50 0.25 Contribution per machine hour €11.00 €12.00 €18.00 Ranking 3 2 1 Manufacture as much of Z as possible: 42,000 units x 0.25 per hour = 10,500 Manufacture as much of Y as possible: 56,000 units x 0.50 per hour = 28,000

38,500 Maximum hours available 70,000 Remaining hours available 31,500 Use remaining hours to manufacture X: 31,500/0.50 = 63,000 units

[Total: 20 Marks]

SOLUTION 4

SOLUTION 5

SOLUTION 6

formation 2 examination - august 2020

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