Management Accounting Sample Paper 2

Questions and Suggested Solutions

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NOTES TO USERS ABOUT SAMPLE PAPERS

Sample papers are published by Accounting Technicians Ireland. They are intended to provide guidance to students and their teachers regarding the style and type of question, and their suggested solutions, in our examinations. They are not intended to provide an exhaustive list of all possible questions that may be asked and both students and teachers alike are reminded to consult our published syllabus (see www.AccountingTechniciansIreland.ie) for a comprehensive list of examinable topics. There are often many possible approaches to the solution of questions in professional examinations. It should not be assumed that the approach adopted in these solutions is the only correct approach, particularly with discursive answers. Alternative answers will be marked on their own merits. This publication is copyright 2012 and may not be reproduced without permission of Accounting Technicians Ireland. ©Accounting Technicians Ireland, 2012.

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INSTRUCTIONS TO CANDIDATES In this examination paper the €/£ symbol may be understood and used by candidates in Northern Ireland to indicate the UK pound sterling and by candidates in the Republic of Ireland to indicate the Euro. Answer FIVE questions. Answer all three questions in Section A.Answer ANY Two of THREE questions in Section B. If more than the required number of questions is answered in Section B, then only the requisite number, in the order filed, will be corrected. Candidates should allocate their time carefully. All figures should be labelled, as appropriate, e.g. €,£, units etc. Answers should be illustrated with examples, where appropriate. Question 1 begins on Page 4 overleaf.

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SECTION A

Answer All Questions

Question1 The following information relates to Maimiplc’s first quarter of trading: Standard Data € / £ Selling price per unit €/£160 per unit Sales units 20,000 Direct materials per unit 4kg @ € / £2 per kg 8 per unit Direct labour per unit 8 hours @ € / £12 per hour 96 per unit

Variable overheads 20,000 units @ €/£ 18 per unit 360,000 Fixed overhead cost 400,000

Actual Results € / £ Sales units 21,000 Production units 21,000 Selling price per unit €/£175 Direct materials(total) 84,000 kg @ €/£2.10 per kg 176,400 Direct labour (total) 189,000 hours @ €/£ 11 per hour 2,079,000 Variable overhead cost 399,000 Fixed overhead cost 420,000

Required: a) Calculate:

i. the budgeted contribution per unit, and ii. the actual contribution per unit.

3 Marks b) Prepare a statement showing the original budget, the flexed budget and the actual profit.

5 Marks

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c) Calculate the following variances and use the results to reconcile the original budgeted net profit to the actual net profit:

i. Sales Price ii. Sales Volume iii. Labour Rate iv. Labour Efficiency v. Materials Price vi. Materials Usage vii. Variable Overhead Expenditure viii. Fixed Overhead Expenditure

12 Marks

Total: 20 Marks

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Question2 The following information relates toinventory of Raw material X and Work-in-progress of the only product manufactured byRasta plc. Raw Material X 01 May Material X received 800 kg @ € / £ 6.50per kg 12 May Material Xreceived 700 kg @ € / £ 8.00per kg 15 May Material Xissued to production 600 kg 20 May Material Xreceived 700 kg @ € / £ 7.50per kg 22 May Material Xissued to production 1,000 kg Work-in-Progress at 31 May 400 units which are 40% complete 200 units which are 60% complete 100 units which are 80% complete Completed finished goodsare valued at € / £ 25.80 per unit. Required: a) Prepare a statement showing the amount charged to production and the cost of the inventory of raw

materials held after each inventory transaction using each of the following methods of inventorycosting:

i. First In, First Out (FIFO) ii. Last In, First Out (LIFO) iii. Weighted Average (AVG)

12 Marks

b) Outlinethe advantages and disadvantages of each of the above 3 methods of inventory costing and suggest the circumstances when each of them would be suitable.

6 Marks

c) Calculate the value of the company’s inventory of work-in-progressat 31 May. 2 Marks

Total:20 Marks

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Question3 Weaves plc. has provided the following projected information: Year 1 Year 2

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Quarter 1 Sales units 4,000 5,000 6,000 4,000 4,000

Unit cost of production € / £ Material A 5kg @ € / £ 2 per kg 10 Material B 4 kg @ € / £ 4 per kg 16 Direct labour 15 Variable Overhead 10 51

- The selling price is expected to be € / £ 80 per unit. - The inventory at the start of quarter 1, year 1 is expected to be 500 units. - The inventory at the end of each quarter must be sufficient to satisfy 25% of the following

quarter’s projected sales volume. - Sales costs are estimated to be 2% of projected sales revenue. - Administration costs are estimated to be € / £ 5,000 per month.

The company’sbudget manual requires each of the following preliminary budgets to be prepared in advance of preparing the company’s overall budget:

(i) Sales volume and sales revenue budget (ii) Production volume andproduction cost budget (iii) Purchases budget (iv) Selling & administration overheads budget

Required: a) Describe the content of each of the preliminary budgets mentioned aboveand the relationship

between these budgets, in the context of the overall company budget. 8 Marks

b) Prepare quarterly budgets for items (i) to (iv) mentioned above and the annual budgeted statement of

Profit 12 Marks

Total: 20 Marks

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SECTION B

Answer any two of the following questions Question 4 The accounting practice where you work has been approached by Mr. Paul, a new client whose business is growing steadily, in relation to the role of the accounting function in supporting his business. Required: Prepare a report for Mr. Paul,in which you:

i. explain what management accounting is; ii. explainthe key differences between financial accounting and management accounting; and

discuss how management accounting can contribute to the effectiveness of an organisation.

Please note:Your report should include practical examples to help explain the content of the report.

Total: 20 Marks

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Question 5

Sams plc.is a manufacturing company which produces three products. The following information hasbeen provided by the company. Product

Alpha Product

Beta Product

Delta Sales units 10,000 20,000 5,000 € / £ € / £ € / £ Selling Price per unit 10 15 20 Variable Cost per unit 8 7 5 Allocated Fixed Production Overheads 22,000 44,000 35,000

General overheads of € / £ 55,000 are apportioned between the products,on the basis of sales revenue. The company has been given the opportunity to produce an enhanced version of their existing Delta product, which will be called Delta 2. The details relating to this proposed contract are as follows;

1. The proposed selling price is €/£ 16 per unit. 2. Budgeted sales volume is 1,000 units. 3. Variable costswill increase by €/£ 5 per unit, because of additional labour costs. 4. Production of each unit of Delta 2 requires 1kg of material Omega.This material is already used

in the production of product Beta. Samsplc. holds 5,000kgs of material Omega in stock. 5. Additional data relating tomaterial Omega which may be relevant is as follows:

€ / £

Purchasecost 4 per kg Replacement cost 2 per kg Net realisable value 1 per kg

6. Fixed production overheads are not expected to change.

Required: a) Prepare a statement showingthe net profit or net loss for each product line and for the company as a

whole. 6 Marks

b) Prepare a statement showing the profit / loss associated with the proposed contract.

6 Marks

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c) Prepare a memorandum to the company’s management team: - outliningthe advantages of using marginal costing for decision-making; - advising whether, on financial grounds alone, the company should undertake the

proposed contract; - outliningany non-financial factors which the company should consider in deciding

whether or not to undertake the proposed contract. 8 Marks

Total: 20 Marks

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Question 6 The following information relates to Tebplc.a manufacturing business,which is considering the introduction of a piece-work incentive scheme in one of its departments, which has 5 employees. Current Payroll Basic working week 35 hours Over-time premium 25% of normal pay grade. Normal grade A pay rate is £ / € 18 per hour. Normal grade B pay rate is £ / € 20 per hour.

Employee Normal Hours Worked

Normal Pay Grade

Normal Units Produced

1 38 A 160 2 40 A 160 3 36 B 140 4 35 B 140 5 35 B 150

Piecework Incentive Scheme Proposal Under the proposed incentive scheme, the standard time allowance would be 15 minutes per unit.The piecework rate would be based on grade Alabour rates, with a standard piecework enhancement of 6%.All employees would receive the same piecework rate. Required:

a) Outline the purpose of an incentive scheme. 4 Marks

b) Calculate the normal pay due to each employee on current payroll terms. 4 Marks

c) Calculate a standard piecework rate on the basis of the proposed incentive scheme. 4 Marks

d) Calculate the normal pay due to each employee under the terms of the proposed incentive scheme.

4 Marks e) The company has a target production of 800 units per week for this department.

i. Calculate the total weekly cost of meeting this target using current payroll terms (assuming all employees produce equal amounts at current rates of production).

ii. Calculate the total weekly cost of meeting this target under the proposed incentive scheme.

iii. Advise the company which is the more cost-effective option. 4 Marks

Total: 20 Marks

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SUGGESTED SOLUTIONS

Solution to Question 1

a) Budgeted / Actual contribution per unit

b) Flexed Budget

Original Budget

20,000 Flexed Budget

21,000 Actual Results

21,000

€/£ €/£ €/£ €/£ €/£ €/£

Sales

3,200,000 3,360,000 3,675,000

Variable costs

Direct Materials 8.00 160,000 8.00 168,000 8.40 176,400

Direct Labour 96.00 1,920,000 96.00 2,016,000 99.00 2,079,000

Variable Overhead 18.00 360,000 18.00 378,000 19.00 399,000

Contribution 760,000 798,000 1,020,600

Fixed costs

Fixed Overhead 400,000 400,000 420,000

Net Profit 360,000 398,000 600,600

Budget Actual € / £ € / £ € / £ € / £

Selling Price per unit 160.00 175.00

Variable Costs per unit

Direct Materials 8.00 8.40

Direct Wages 96.00 99.00

Variable Overhead 18.00 19.00

122.00 126.40

Contribution per unit 38.00 48.60

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c)Variance Calculations i.Sales Price Variance

£/€ 21,000 units generated revenue of 21,000 units x £/€175 3,675,000 21,000 units should have generated revenue of 21,000 units x £/ €160 per unit 3,360,000 315,000 F or

ii. Sales Volume Variance units

Maimi actually sold 21,000

Maimi should have sold 20,000 1,000F x standard contribution per unit ( £/€ 38) €/£38,000F or

(21,000 units – 20,000 units) x € / £ 38 per unit = € / £ 38,000 Favourable

iii. Labour rate Variance

€/£

189,000 labour hours actually cost (189,000 x £/€11) 83,662

189,000 labour hoursshould have cost (189,000 x £/€12) 74,205 189,000F

or

Sales Price Variance (Actual Selling Price – Standard Selling Price) x Actual Sales Volume (€ / £ 175 – € / £ 160) x 21,000 units = € / £ 315,000 Favourable

Sales Volume Variance (Actual Sales Volume – Standard Sales Volume) x Standard Profit Margin

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vi. Labour Efficiency Variance hours

Maimi actually used 189,000

Maimi should have used (21,000 x 8 hours) 168,000 21,000A x standard cost per hour (€/£12) €/£252,000A or (Standard hours – Actual hours) x standard price (168,000 hours – 189,000 hours) x € / £ 12 per hour = € / £ 252,000 Adverse v. Materials Price Variance €/£

84,000 kg of materials actually cost (84,000 x £/€2.10) 174,400

84,000 kg of materials should have cost (84,000 x £/€2) 168,000 8,400 A or

vi.Materials Usage Variance kg

Maimi actually used 84,000

Maimi should have used (21,000 x 4 kg) 84,000 nil

Labour Rate Variance (Actual Pay Rate – Standard Pay Rate) x Actual Labour Hours (€ / £ 11 – € / £ 12) x 189,000 hours = € / £ 189,000 Favourable

Materials Price Variance (Standard Price – Actual Price) x Actual Quantity (€ / £ 2.00 per kg – € / £ 2.10 per kg) x 84,000 kg = € / £ 8,400 Adverse

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or

vii. Variable Overhead Expenditure Variance €/£

21,000 units actually cost 95,205

21,000 units should have cost (21,000 x €/£18) 74,205 21,000A or

€ / £ 420,000 – € / £ 400,000 = € / £ 20,000 Adverse

a) Reconciliation of BudgetedProfit and Actual Profit €/£ €/£

BudgetedProfit 360,000 Favourable Variances Sales Price Variance 315,000 Sales Margin Volume Variance 38,000 Labour Rate Variance 189,000 542,000 Adverse Variances Labour Efficiency Variance (252,000) Materials Price Variance (8,400) Variable Overhead Expenditure Variance (21,000) Fixed Overhead Expenditure Variance (20,000) (301,400) Actual Profit 600,600

Materials Usage Variance (Standard Quantity – Actual Quantity) x Standard Price (84,000 kg – 84,000 kg) x € / £ 2 per kg = € / £ 0

Variable Overhead Expenditure Variance Actual Cost – (Actual Units x Variable Overhead Absorption Rate Per Unit) € / £ 399,000 – (21,000 Units x € / £ 18 per unit) = € / £ 21,000 Adverse

Fixed Overhead Expenditure Variance Actual Cost – Standard Cost

Solution to Question 2

a) i First In, First Out (FIFO) Method

FIFO Method

Received Issued (charged to production)

Balance

Date Qty. kg

Value per kg

€/£

Total value €/£

Qty. kg

Value per kg

€/£

Total value € / £

Qty. kg

Value per kg

€/£

Total value €/£

01 May 800 6.50 5,200 800 6.50 5,200 12 May 700 8.00 5,600 1,500 10,800 15 May 600 6.50 3,900 900 6,900 20 May 700 7.50 5,250 1,600 12,150 22 May 200

700 100

6.50 8.00 7.50

1,300 5,600 750

7,650

600

7.50

4,500

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a) ii. Last In, First Out (LIFO)Method

LIFO Method

Received Issued (charged to production)

Balance

Date Qty. kg

Value per kg € / £

Total value € / £

Qty. kg

Value per kg € / £

Total Value € / £

Qty. kg

Value per kg € / £

Total value € / £

01 May 800 6.50 5,200 800 6.50 5,200 12 May 700 8.00 5,600 1,500 10,800 15 May 600 8.00 4,800 900 6,000 20 May 700 7.50 5,250 1,600 11,250 22 May 700

100 200

7.50 8.00 6.50

5,250 800

1,300 7,350

600

6.50

3,900

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a) iii. Weighed Average (AVG)Method

AVG Method

Received Issued (charged to production)

Balance

Date Qty. kg

Value per kg

Total Value € / £

Qty. Value per kg

Total Value € / £

Qty. kg

Value per kg

Total Value € / £

01 May 800 6.50 5,200 800 6.50 5,200 12 May 700 8.00 5,600 1,500 7.20 10,800 15 May 600 7.20 320 900 7.20 6,480 20 May 700 7.50 5,250 1,600 7.33 11,730 22 May 1,000 7.33 330 600 7.33 4,400

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b)

Method Advantages Disadvantages Most suitable use(s) First in First Out (FIFO)

1. Actual costs system – unrealised profit/ loss eliminated

2. Encourages good store-keeping practices (issuing oldest inventory first)

3. Inventory valuation comprises recent valuation

1. Not suitable in times of inflation – product costs under-stated & profits over-stated

2. Can be administratively clumsy 3. Cost comparison of batches difficult 4. Limited decision-making uses

1. Acceptable for financial accounting 2. Accepted by Tax Authorities for

taxation purposes

LastIn First Out (LIFO)

1. Actual cost system 2. Up-to-date relevant market costs charged to

production 3. Realistic costing approach useful in some

decision-making scenarios

1. Inventoryis valued at oldest prices – may distort profits

2. Not acceptable to Tax Authorities 3. Can be administratively clumsy as

purchase batches only partially charged to production

1. Used in management accounting / cost accounting, particularly in an inflationary environment

Weighted Average

1. Relatively straight-forward administratively 2. Moderates effects of price changes on

inventory valuation and production charges 3. Useful for cost-comparison exercises

1. Although realistic, not based on actual meaningful costs

1. Acceptable under financial accounting regulations and to Tax Authorities

2. most suitable in a fluctuating price environment

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c) Work in progress at 31 May Calculation of equivalent units 400 units @ 40% 160 equivalent units 200 units @ 60% 120 equivalent units 100 units @ 80% 80equivalent units 360 equivalent units @ € / £ 25.80 per unit =€ / £ 9,288

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Solution to Question 3 a) Content of named budgets and relationship between them.

(i) The sales volume / sales revenue budgetexpresses involume and value the total anticipated sales for the budget period. The sales budget may be constructed on the basis of information from specific products, market areas or by periods. The sales budget uses the sales volume projections and the expected selling price to obtain the total sales revenueby budget period.

(ii) The production volume / production cost budgetexpresses forecast production in units for each

budget period and considers inventory-holding requirements and sales budgets. The production budget is calculated by taking the budgeted sales volume and adjusting this for planned opening and closing finished goods inventory levels.The sales and the production budgets are inter-dependent and to ensure business success, these should be aligned.

(iii) Once the sales and production budgets have been decided, the costs of various inputs to

production should be calculated.The purchases budget calculates the raw materials required to be purchased in order to service the requirements of the production budget, after making allowance for opening and closing materials inventory.After the purchases budget has been quantified in terms of cost, the impact on payables may also be established.

(iv) The selling & administration overheads budget projects the costs in relation to selling costs and

administration overheads.It is important to consider these additional overhead costs to ensure that the overall position of the company is considered.

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b) Preparation of budgets i.Sales Budget Quarter 1 Quarter 2 Quarter 3 Quarter 4 Budgeted sales units 4,000 5,000 6,000 4,000 Budgeted selling price €/£ per unit 80 80 80 80 Budgeted sales revenue €/£ 320,000 400,000 480,000 320,000 ii.Production Budget Year 1 Year 2

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Quarter 1 units units units units units Budgeted sales 4,000 5,000 6,000 4,000 4,000 Add closing inventory 1,250 1,500 1,000 1,000 Less opening inventory 500 1,250 1,500 1,000 Budgeted production 4,750 5,250 5,500 4,000

iii. Purchases budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Budgeted production units 4,750 5,250 5,500 4,000 Material A volume (@ 5kg per unit) 23,750kg 26,250kg 27,500kg 20,000kg Material A cost (@ € / £ 2 per kg) € / £ 47,500 € / £ 52,500 € / £ 55,000 € / £ 40,000 Material B volume (@ 4kg per unit) 19,000kg 21,000kg 22,000kg 16,000kg Material B cost (@ € / £ 4 per kg) € / £ 76,000 € / £ 84,000 € / £ 88,000 € / £ 64,000

iv. Selling & administration overhead budgets Quarter 1

€ / £ Quarter 2

€ / £ Quarter 3

€ / £ Quarter 4

€ / £ Budgeted sales revenue 320,000 400,000 480,000 320,000 Sales costs (2% sales revenue) 6,400 8,000 9,600 6,400 Administration costs 15,000 15,000 15,000 15,000

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Workings Working 1: Labour budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Budgeted production units 4,750 5,250 5,500 4,000 Direct labour cost per unit€ / £ 15 15 15 15 Budgeted total directlabour cost€ / £ 71,250 78,750 82,500 60,000

Working 2: Variable Overhead Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Budgeted production units 4,750 5,250 5,500 4,000 Variable overhead per unit€ / £ 10 10 10 10 Variable overhead cost€ / £ 47,500 52,500 55,000 40,000

b) Budgeted Statement of profit

Budgeted Statement of Profit

€/£ €/£

Sales 1,520,000

Less

Opening Inventory 25,500

Production 994,500

Less Closing Inventory (51,000) 969,000

Gross Profit 551,000

Less

Sales costs 30,400

Administration costs 60,000 90,400

Net Profit 460,600

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Solution to Question 4

Role of the Accounting Function in Supporting Your Business Financial accounting can be described as‘the classification and recording of monetary transactions of an entity in accordance with established concepts, principles, accounting standards and legal requirements and presentation of a view of those transactions during, and at the end of, a reporting period’. Management accounting can be described as ‘the preparation and presentation of accounting information in such a way as to assist management in the formulation of policies and in the planning and control of the operations of the undertaking’. Financial accounting is the means by which the financial results and performance of a business, or other organisation, are reported.Financial accounts are normally required both by law and for taxation purposes and they must be prepared in accordance with accounting regulations.In business, financial accounts are usually presented in the form of a Statement ofProfit or Loss for each reporting period and a Statement of Financial Position at the end ofeach reporting period. Management accounting is the means by which the internal financial results and performance of a business, or other organization, are measured in order to effectively manage.Typical management accounting reports include Budgets, Variance Analysis Reports, Cost–Volume-Profit/ Breakeven Analysis Reports, Job Costing Reports; Overhead Apportionment Reportsand Marginalcosting & Absorption Costing Statements. The following table sets out key differences between financial accounting and management accounting:

Financial Accounting Management Accounting External reporting form Internal reporting form Must comply with legal requirements Not required by law Based on historical records Analyses past, present and future information Provides overview of performance Provides detailed analysis Prepared in accordance with accounting regulations

No formal guidelines for preparation

Normally annual time-bound requirement Can be ad-hoc in nature Financial accounting is concerned primarily with the actual historic performanceand is reported in monetary terms topresent an accurate, true and fair view of an organisation’s financial performance for a reporting period. Management accounting involves the use of internal management information systems to analyse past, present and future information to inform managementin decision-making and to assist with planning,control and decision-making.Management accounting information can be used to contribute to the effectiveness of an organisation in a number of ways, including: Planning In the planning process, management accounting helps to formulate future plans by providing information which can be used to formulate medium-term and long-term strategic plans.That information can include

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data on past performance, which can be useful as a guide for future performance.By establishing overall organisational budget procedures and timetables, management accounting will ensure co-ordination of various plans into one overall plan for the organisation as a whole. Control Management accounting aids the control process by producing performance reports which internally compare actual outcomes with planned outcomes.This highlights specific activities or aspects of organisational activities which do not conform to plan, prompting action.Management accounting can facilitate a management-by-exception approach, which frees managers from unnecessary concern with activities or aspects of operations which are adhering to plans. Decision-Making Management accounting information has a specific role to provide information for short-term and long-term decision-making purposes.For example, the decision to invest in non-current assets may be influenced by returns of a product line and efficiencies or inefficiencies in the operation of that line. Organising Management accounting, through establishing internal areas of responsibility in cost and / or revenue terms, can assist with effective performance of an organisation by identifying and developing the most-appropriate structure. Communication Management accounting aids communication by developing and maintaining an effective communication and reporting system in an organisation.For example, the establishment of a budget communicates organisational plans to managers and employees of an organisation and can ensure co-ordination between different areas as it defines what is required.Budget performance reports subsequently communicate important information on how activities are being managed against that plan. Motivation Management accounting information can have an important influence on employee motivation in an organisation.For example, standard costs can represent targets, which particular sections of the organization can be motivated to achieve, or surpass.Regular performance information can be used for motivation purposes, and can highlight areas for improvement. In large organisations the financial accounting and management accounting functions are entirely separate – however in small organisations these functions may be combined. While there are numerous differences between financialaccounting and management accounting, both form integral parts of the financial information systems of an organisation. I hope that the aboveadequately addresses your queries and I will be happy to provide further information if required.

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Solution to Question 5 Workings Working 1: Apportionment of general overheads

Alpha € / £

Beta € / £

Delta € / £

Total € /£

Sales Revenue 100,000 300,000 100,000 500,000 Apportioned general overheads

55 / 500 x 100 =11,000

55 / 500 x 300 =33,000

55 / 500 x 100 =11,000

a) Profit / Loss Statement

Product Alpha € / £

Product Beta € / £

Product Delta € / £

Company Total € / £

Sales revenue 100,000 300,000 100,000 500,000 Variable cost 80,000 140,000 25,000 245,000 Contribution 20,000 160,000 75,000 255,000 Fixed Costs Allocated fixed production overheads 22,000 44,000 35,000 101,000 Apportioned General Overheads 11,000 33,000 11,000 55,000 Net Profit / (Loss) (13,000) 83,000 29,000 99,000

b) Delta 2 Proposed Contract

€ / £ € / £ Incremental revenue Sales revenue 1,000 units x € / £ 16 per unit 16,000 Incremental Costs Variable cost € / £ 5 per unit original variable cost

+ € / £ 5 per unit additional labour cost x 1,000 units

10,000

Additional materials cost 1,000 @ € / £ 2 replacement cost 2,000 Fixed overheads Not expected to change 0 Total (12,000) Net profit 4,000

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c) MEMORANDUM

To: Management Team

From: Student

Date: x/ x/ xx

Re:(i) Marginal costing for decision making (ii) Proposed Contract – financial decision & non-financial factors Marginal costing for decision making Marginal costing focuses on separating variable costs and fixed costs and assists in focusing on relevant costs to provide more relevant information.Marginal costing recognises that,as fixed costs are committed and cannot be avoided, they are largely irrelevant to many decision-making situations. Marginal costing avoids arbitrary allocations, apportionments and the use of pre-determined overhead absorption rates, which can be misleading in decision-making scenarios. Profit calculations are not dependent upon changes in inventory levels.Holding inventory is normal in most businesses (other than service businesses), where production is at a different rate to sales.Differing costing approaches will result in different inventory valuations.This can result in differing profit figures when the inventory level changes during a reporting period.Marginal costing charges fixed costs to the period in which they are incurred and does not incorporate fixed costs in inventory costs, which results in profits reported relative to sales. A marginal cost represents the most relevant cost for short-term tactical decisions, such as pricing.In a scenario where a manager is seeking to make the best use of resources, as fixed costs are treated as committed and unchanging, so the marginal cost, sales revenue and contribution are the key issues.In these circumstances, the selection of the alternative which maximises contribution is the correct decision rule. Where sales volumes are declining but production volume is sustained, marginal costing provides an early profit warning, as opposed to other methods such as absorption costing. Proposed Contract – financial decision On financial grounds alone, it makes sense to proceed with the proposed contract, as the calculations show that doing so contributes to profit.

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Proposed Contract – non-financial factors

Other considerations which the company should consider before accepting this contract include:

• Impact on other existing Delta sales and customers;

• Impact on other product revenues and costs;

• Consideration of overhead cost drivers to identify cost allocations, particularly general overheads;

• Consideration of variable and fixed costs split;

• Other uses and returns for product omega;

• Future potential contracts from the same source.

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Solution to Question 6 a) Incentive schemes are a means of remuneration which relate payment to output.The aims of

such schemes are to benefit employees by providing an opportunity to increase earnings, while encouraging performance and providing for increased productivity, which may result in reduced cost per unit. Incentive Schemes can be based upon individual performance or aimed at incentivising groups of employees.Incentive schemes should be based on efficient working methods following comprehensive work studies and may be financial or non-financial in nature.

b) Normal pay on current payroll terms

Employee Calculation

€ / £ Employee 1 35 hours @ € / £ 18 630.00 3 hours @ (€ / £ 18+25%) 67.50 697.50 Employee 2 35 hours @ € / £ 18 630.00 5 hours @ (€ / £ 18+25%) 112.50 742.50 Employee 3 35 hours @ € / £ 20 700.00 1 hour @ (€ / £ 20+25%) 25.00 725.00 Employee 4 35 hours @ € / £ 20 700.00 Employee 5 35 hours @ € / £ 20 700.00

c) Standard piecework rate

Standard Weekly Pay (Grade A) 630.00 Standard Weekly Production 35 hours = 2,100 minutes / 15

140 units

Basic Piecework Rate € / £ 4.50 per unit

Incentive Element 6% 0.27 Standard Incentive Piecework Rate € / £ 4.77

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d) Normal pay under the proposed incentive scheme

Employee Calculation Result

€ / £ Employee 1 160 units x € / £ 4.77 763.20 Employee 2 160 units x € / £ 4.77 763.20 Employee 3 140 units x € / £ 4.77 667.80 Employee 4 140 units x € / £ 4.77 667.80 Employee 5 150 units x € / £ 4.77 715.50

e) i. Cost of producing 800 units under current payroll terms

Employee Calculation Result

€ / £ Employee 1 35 hours @ € / £ 18 630.00 3 hours @ (€ / £ 18+25%) 67.50 697.50 Employee 2 35 hours @ € / £ 18 630.00 5 hours @ (€ / £ 18+25%) 112.50 742.50 Employee 3 35 hours @ € / £ 20 700.00 6.13 hours @ (€ / £ 20+25%) 153.25 853.25 Employee 4 35 hours @ € / £ 20 700.00 5 hours @ (€ / £ 20+25%) 125.00 825.00 Employee 5 35 hours @ € / £ 20 700.00 2.29 hours @ (€ / £ 20+25%) 57.25 757.25

Total Weekly Cost 3,875.50

ii. Cost of producing 800 units under Incentive Scheme proposal 800 pieces @ € / £ 4.77 = € / £ 3,816.00 Incentive Scheme = more cost-effective option

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Workings Target average production 800 units / 5 employees = 160 units/ week Current Average Production Rate Time required for target Employee 1 160 units/ 38 hours = 4.21 units per hour 38 hours Employee 2 160 units / 40 hours = 4.00 units per hour 40 hours Employee 3 140 units / 36 hours = 3.89 units per hour 41.13 hours Employee 4 140 units / 35 hours = 4.00 units per hour 40 hours Employee 5 150 units / 35 hours = 4.29 units per hour 37.29 hours