Warwick Business School IB9AXO: Foundations of Financial and Management Accounting

WEEK 7 – (WORKSHOP – LECTURE 6): QUESTIONS

(a)
Explain four different ways in which costs may be classified for management accounting
purposes.

(b)

(c)

Q2: (Classification of Costs)

Richard Jackson is a painter and incurred the following costs during April 200X, when he
painted three houses. He spent £800 on paint, £100 on mineral spirits, and £80 on brushes.
He also bought two pairs of overalls for £24 each; he wears overalls only while he works.
During the first week of April, Richard placed a £20 advertisement for his business in the
Warwick Business School IB9AXO: Foundations of Financial and Management Accounting

classifieds. Richard had to hire an assistant for one of the painting jobs; he paid her £6 per
hour, and she worked for 25 hours.

Being a very methodical person, Richard kept detailed records of his mileage to and from each
painting job. His average operating cost per mile for his van is £0.50. He found a £15 receipt in
his van for a road atlas that he purchased in April, which he uses to find addresses when he is
first contacted to give an estimate on a painting job. He also had £12 in receipts for bridge
tolls (£1 per trip) for a painting job he did across the river.

Near the end of April, Richard decided to go camping, and he turned down a job on which he
had bid £2,200. He called the homeowner long-distance (at a cost of £1.60) to explain his
reasons for declining the job.

Required:

Using the following six headings (Variable, Fixed, Direct, Indirect, Period, Product), indicate
how each of the April costs incurred by Richard would be classified. Assume that the cost
object is a house-painting job. As an example, the cost of the paint used had been classified
into the following three categories: variable, direct, product.

Type of Cost Variable Fixed Direct Indirect Period Product

Q3

(a)
A company manufactures a single product which it sells for £9 per unit. The fixed costs are
£54,000 per month and the product has a variable cost of £6 per unit. The budgeted
production and sales units is 10,000 units. In a period when actual sales are £180,000, what is
the company’s margin of safety, in units?
(b)
A company has fixed costs of £60,000 per annum. It manufactures a single product which it
sells for £20 per unit. Its contribution to sales ratio is 40%. What is the company’s break-even
point in units?
Warwick Business School IB9AXO: Foundations of Financial and Management Accounting

(c)
A company’s product generates a contribution to sales ratio of 30%. Fixed costs directly
attributable to the product amount to £75,000 per month. What is the sales revenue required
to achieve a monthly profit of £15,000?
(d)
A Ltd currently provides a single service. The variable cost per unit of that service is £50. The
selling price per unit of that service is £130. The total fixed costs for the period amount to
£1,600,000. How many units of service (to the nearest whole unit) will the company need to
provide to customers to generate a profit of £250,000?

Q4

Sigma electronics has recently developed a new product. The company plans to manufacture
and sell 50,000 units per year of the new product. The following estimates have been made of
the company's costs and expenses (Other than Income taxes):

Manufacturing Costs:

Fixed (Total) £ Variable (per Unit) £

Direct Materials 47
Direct Labour 32
Manufacturing Overhead 340,000

Period Expenses:

Selling Expenses 5
Administrative Expenses 200,000

Total 540,000 84

Required:
a) What should the company establish as the sales price per unit if it sets a target of
earning an operating income of £260,000 by producing and selling 50,000 units during
the first year of operations? (Hint: First compute the required contribution margin per
unit).
b) At the unit sales price computed in part (a), how many units must the company
produce and sell to break even? (Assume all units produced are sold).
c) What will be the margin of safety (in Pounds sterling) if the company produces and sells
50,000 units at the sales price computed in part (a)? Using the margin of safety,
compute operating income at 50,000 units.
d) Assume that John, the marketing manager feels that the price of this product must be
no higher than £94 in order to ensure market penetration. Will setting the sales price at
£94 enable the Sigma company to break even, given the plans to manufacture and sell
50,000 units? Explain your answer.
Warwick Business School IB9AXO: Foundations of Financial and Management Accounting

Q5. Practice question

The Starlite company, a subsidiary of VisionTech Plc, manufactures and sells good quality LCD
monitors. The company is seen as highly innovative, producing high quality products. Starlite’s
Budget Committee, which has members drawn from all the major functions in the business, is
meeting to consider the budget for next year.

Original Projected Income Statement (6,000 units)

£ £
Sales 900,000

Less:
Materials 420,000
Labour 90,000

Manufacturing overheads 180,000

It is estimated that half of the manufacturing overheads and 70% of the selling and marketing
expenses are fixed.

The budgeted sales and production represent 80% of current production capacity. Starlite
currently has a capital employed of £600,000.

The Managing Director is not satisfied with this forecast, as he wants the return on capital
employed (ROCE) to be at least 22%.

Several alternative options are suggested during the meeting:

Option 1
The Marketing Director proposes an intensive short-term marketing campaign. Embarking
upon this additional campaign will increase the fixed selling and marketing expenditure by
£15,000. The Marketing Director predicts that this will boost sales for the coming year by 15%.
In his view, this advertising campaign can also reinforce the strong brand image of the
company.

Option 2
The Finance Director argues that in the present economic downturn, boosting marketing
expenditure is too risky. She proposes, instead, a cut in fixed marketing expenditure by
£20,000. She also recommends an alternative materials supplier whose prices are 5% lower
than those of the current supplier. In addition, she suggests a price cut of 8%, which she
predicts will increase sales to the full production capacity of the company.

Option 3
Warwick Business School IB9AXO: Foundations of Financial and Management Accounting

The Operations Director does not agree with the Finance Director on the advisability of either a
price cut or a change of supplier. He is concerned that these moves will have an impact on
both the perceived and the actual quality of the product. He also expresses his concern that
the company will not be able to sustain production output at the level either the Marketing
Director or the Finance Director are suggesting without investment in new machinery to
improve the current production system. He estimates that additional capital investment of
£160,000 will be required and fixed manufacturing overheads will increase by £20,000 per
annum. But this extra investment will pay off through improving product quality and
shortening production lead time. The variable manufacturing costs will also decrease by 10%.
The new production facility can also be used for a production of a new product which is
currently being developed.

The Managing Director has approached you to ask for your advice relating to the likely effects
(financial and non-financial) of each of the three proposals and would like you to make
recommendations on which option, if any, should be pursued.

Required:

(a) An analysis of the break-even point which highlights the profit and margin of safety at
the budgeted output and comments on the profitability of each proposal.

(b) An analysis on how risk and uncertainty can be taken into account. You need to conduct
a sensitivity analysis showing the effects on financial results if sales do not increase as
expected in option 1 and option 2.

(c) Suggestions for other factors that should be taken into account when making a final
decision, and a recommendation on which option, if any, should be pursued.