NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTING

MANAGEMENT AND COST ACCOUNTING II

PART 4.1
CAC 4105 MODULE
2022 ACADEMIC YEAR

Compiled by Kennedy Z Chamba – 0783 085 436

Assistant Lecturer – Department of Accounting

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 Standard Costing and Variance Analysis

Introduction

The basic principles of standard costing and variance analysis are assumed to be familiar for
all students at this stage. The initial content of this chapter amounts to a revision of the basic
principles on the topic covered in both semesters of the second year. You are thus advised to
devote adequate time to the revision of your second semester management accounting I and
II. The PART 4.1 syllabus is cumulative and hence examination questions may draw heavily
on material from second year studies.
Standard costing and variance analysis represent a particular approach to performance
evaluation. The concept that underpins them is that efficiency can be monitored by periodically
comparing actual costs incurred with standard costs for output achieved. This concept is not
valid under all circumstances. In subsequent chapters, the module goes on to explore both
the practice and limitations of standard costing.

Definitions

CIMA’s Terminology defines standard costing as follows:

Standard costing: A control technique which compares standard costs and revenues with
actual results to obtain variances which are used to stimulate improved performance.
The definition points to a very close relationship between standard costing and budgetary
control (the practice of making continuous comparison between budget and actual results).
They both compare the actual results with the expected performance to identify any variances.
The difference is that with standard costing the comparison is usually made at a unit level, that
is, the actual cost per unit is compared with the standard cost per unit. The resulting variances
may be analysed to show their causes and we will see how this is done later in this chapter.

What is a standard Cost?

A standard cost is an estimated or predetermined cost of performing an operation or producing

a good or service under normal conditions. This is a cost that should be incurred under efficient
operating conditions.
A standard cost is not the same as a budgeted cost. A budget relates to an entire activity or
operation; a standard presents the same information on a per unit basis. A standard therefore
provides cost expectations per unit of activity and a budget provides the cost expectation for
the total activity.
The standard cost may be stored on a standard cost card. The standard cost may be prepared
using either absorption costing principles or marginal costing principles. The example which
follows is based on absorption costing. Standard costs and standard prices provide the basic
unit information which is needed for valuing budgets and for determining total expenditures
and revenues.

A Standard

It is defined as a benchmark measurement of resource usage, set in defined conditions. The

definition goes on to describe a number of bases which can be used to set the standard,
including:

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 a prior period level of performance by the same organisation
the level of performance required to meet organisational objectives.
Use of the first basis indicates that management feels that performance levels in a prior period
have been acceptable. They will then use this performance level as a target and control level
for the forthcoming period. When using the second basis management is being more outward
looking, perhaps attempting to monitor their organisation’s performance against ‘the best of
the rest’. The third basis sets a performance level which will be sufficient to achieve the
objectives which the organisation has set for itself.

Ideal standard

Standards may be set at ideal levels, which make no allowance for normal losses, waste and
machine downtime. This type of ideal standard can be used if managers wish to highlight and
monitor the full cost of factors such as waste, etc., however, this type of standard will almost
always result in adverse variances since a certain amount of waste, etc., is usually
unavoidable. This can be very demotivating for individuals who feel that an adverse variance
suggests that have performed badly.

Attainable standard

Standards may also be set at attainable levels which assume efficient levels of operation, but
which include allowances for factors such as normal loss, waste and machine downtime. This
type of standard does not have the negative motivational impact that can arise with an ideal
standard because it makes some allowance for unavoidable inefficiencies. Adverse variances
will reveal whether inefficiencies have exceeded this unavoidable amount.

Basic Standard

A basic standard is one which is kept unchanged over a period of time. It is used as the basis
for preparing more up-to-date standards for control purposes. A basic standard may be used
to show the trend in costs over a period of time.

Standard costing in the modern industrial environment

There has recently been some criticism of the appropriateness of standard costing in the
modern industrial environment. The main criticisms include the following:
(a) Standard costing was developed when the business environment was more stable and
operating conditions were less prone to change. In the present dynamic environment,
such stable conditions cannot be assumed.
(b) Performance to standard used to be judged as satisfactory, but in today’s climate
constant improvement must be aimed for in order to remain competitive.
(c) The emphasis on labour variances is no longer appropriate with the increasing use of
automated production methods.
An organisation’s decision to use standard costing depends on its effectiveness in helping
managers to make the correct decisions. Standard costing may still be useful even where
the final output is not standardised. It may be possible to identify a number of standard
components and activities for which standards may be set and used effectively for planning
and control purposes. In addition, the use of demanding performance levels in standard
costs may help to encourage continuous improvement.

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What is variance analysis?

A variance is the difference between the expected standard cost and the actual cost
incurred. A unit standard cost contains detail concerning both the usage of resources and
the price to be paid for the resources. Variance analysis involves breaking down the total
variance to explain how much of it is caused by the usage of resources being different
from the standard, and how much of it is caused by the price of resources being different
from the standard.
These variances can be combined to reconcile the total cost difference revealed by the
comparison of the actual and standard cost. A variance is said to be favourable if it causes
actual profit to be greater than budget; it is said to be adverse if it causes actual profit to
be less than budget.
We are going to look at each variance and discuss the meaning of each variance, so it is
easy for you to logically deduce the formulae.
Total Direct materials variance
The direct material variance is the difference between the standard cost (SC) of materials
resulting from production activities and the actual costs (AC) incurred.

SC – AC
This variance is further broken down into:
1. Direct material price variance
This is the difference between the standard number of units (SQ) and actual number of
units (AQ) used in the production process, multiplied by the standard price per unit. This
variance is the responsibility of the production department.
(SP – AP) × AQ
2. Direct materials usage variance
This is the difference between the standard number of units (SQ) and actual number of
units (AQ) used in the production process, multiplied by the standard price per unit. This
variance is the responsibility of the production department.
(SQ – AQ) × SP
Direct materials usage variance can be further broken down into:
2.1 Raw materials mix variance
This variance should be calculated when the units being produced have two or more raw
materials that need to be mixed in certain proportions. It arises as a result of a change in
the mix/proportions of raw materials in the actual production to the mix/proportions of raw
materials in standard production. It is calculated as follows:

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 Standard
Standard
Actual mix in Variance Variance
Cost per
Mix Actual (units) $
Unit/kg
Output.
Direct material X xxx xxx xxx xxx xxx
Direct material Y xxx xxx xxx xxx xxx
Direct material Z xxx xxx xxx xxx xxx
xxx xxx xxx

2.2 Raw materials yield variance

This variance arises as a difference between the standard/expected yield and the actual
yield which has been obtained. This variance is “output based” as opposed to the materials
mix variance, which is “input based”. It is calculated as follows:

Actual Yield xxx

less: Expected yield xxx
Variance (units) xxx
x direct material price/unit xx
Variance (In $) xxx

Example 1:
GRV is a chemical processing company that produces sprays used by farmers to protect their crops.
One of these sprays is made by mixing three chemicals. The standard material cost details for 1 litre
of this spray is as follows:
$
0.4 litres of chemical A @ $30 per litre 12.00
0.3 litres of chemical B @ $20 per litre 6.00
0.5 litres of chemical C @ $15 per litre 7.50
Standard material cost of 1 litre of spray 25.50

During August GRV produced 1,000 litres of this spray using the following chemicals:
600 litres of chemical A costing $18,000
250 litres of chemical B costing $8,000
500 litres of chemical C costing $8,500

Required: Calculate the Material Mix and yield variances.

Material Mix Variance

Actual
Standard
Input
mix in Standard Cost Variance
in Variance
Actual per litre in $ $
Actual
Output.
Mix
Chemical A 600 450 150A 30 4 500 A
Chemical B 250 337.5 87.5F 20 1 750 F
Chemical C 500 562.5 62.5F 15 937.5 F
1350 1350 1 812.5 F

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Material Yield Variance

Actual Yield 1000

less: Expected yield (1350 / 1.2) 1125
Variance (units) 125 Adverse
x direct material price/unit {(0.4 x 30)+ (0.3 x 20)+ (0.5*15)} 25.5
YieldVariance (In $) 3 187 . 5 (A)

Actual usage (in kgs) 1 350

less: Expected usage (1000*0.4+1000*0.3+0.5*1000) 1 200
Variance (units) 150A
x weighted material price/litre 25.5/ 1.2 21.25
Yield Variance (In $) 3 187 .50 (A)

Total Direct labour variance

The total direct labour variance is the difference between the standard labour cost (SC) for the
actual production and the actual labour cost (AC).
SC – AC
This variance is further broken down into:
1. Direct labour rate variance
The labour rate variance measures the difference between the actual labour rate paid (AR)
and the standard rate (SR), multiplied by the number of actual hours worked (AH).
(SR – AR) × AH
2. Direct labour efficiency variance
The labour efficiency variance measures the ability to utilize labour in accordance with
expectations. The variance is useful for spotlighting those areas in the production process
that are using more labour hours than anticipated. This variance is calculated as the
difference between the actual labour hours (AH) used to produce an item and the standard
labour hours (SH) that should have been used, multiplied by the standard labour rate (SR).
(SH – AH) × SR

At this level, a distinction has to be made between labour hours worked

and labour hours paid. When calculating the labour efficiency variance
Note
labour hours worked should be used whereas when calculating the
Labour rate variance, labour hours paid should be paid.

3. Labour Idle time variance

It indicates the difference which exists between actual hours spent in active production viz
a viz actual labour hours paid. In a normal/realistic production scenario the production
process is affected by factors beyond the control of the management, e.g. machinery
breaks down. During these times production is halted but organisations have to pay full
wages in full as per the labour act. The variance is calculated by the formulae:

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 (Actual Hours Paid – Actual hours worked) x Standard labour rate

Total variable overhead variance

A total variable overhead variance is calculated in the same way as the total direct material
and labour variances. The total variable overhead variance is the difference between
standard variable overheads charged to production (SC) and actual variable overheads
incurred (AC).
SC – AC
This variance is further broken down into:
1. Variable overhead expenditure variance
To compare the actual overhead expenditure with the budgeted expenditure, we need to
“flex the budget” first. This process means changing a budget to allow for different output
levels and allows more realistic variance analysis at the end of the financial period in
question. The variable overhead expenditure variance is the difference between the
budgeted flexed variable overheads (BFVO) and actual variable overhead (AVO).
BFVO – AVO
Or
(SVOAR – AVOAR) AH
SVOAR – Standard Variable Overhead Absorption Rate
AVOAR – Actual Variable Overhead Absorption
2. Variable overhead efficiency variance
This is the difference between standard hours of output (SH) and actual hours of input
(AH) for the period multiplied by the standard variable overhead rate (SVOAR).
(SH – AH) × VOAR
Total fixed overhead variance
Fixed overhead total variance is the difference between actual (AC) and absorbed fixed
production overheads (SC) during a period. This applies where an absorption costing
system has been implemented in order to determine the foxed overhead absorption rate.
SC – AC
Since we are using an absorption costing system, an under- or over-recovery of overheads
may arise if actual output or overhead expenditure differs from budget. The total fixed
overhead variance is broken into:
1. Fixed overhead expenditure variance
This is the difference between the budgeted fixed production overhead (BFO) and the
actual fixed production overhead (AFO).
BFO – AFO
2. Volume variance

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This variance arises as a result of the difference between actual production (AP) and
budgeted production (BP), multiplied by the standard fixed overhead absorption rate
(FOAR).
Volume = (Budgeted production – Actual Production) x FOAR
The volume variance reflects that fixed costs do not change with changes in production in
the short term. The volume variance is further divided into:
2.1 Fixed Overhead Capacity Variance
This variance arises as a result of the difference Budgeted Production Hours (BH) and
Actual hours (AH), multiplied by the Standard Fixed overhead absorption rate (FOAR):
(BH – AH) x FOAR
2.2 Fixed Overhead Efficiency variance
This variance arises as a result of the difference Standard Production Hours (SH) and
Actual hours (AH), multiplied by the Standard Fixed overhead absorption rate (FOAR):
(SH – AH) x FOAR
Sales variance
These variances are used to analyse the performance of the sales function or revenue
centres. Total sales variance is calculated as the difference between actual sales revenue
(ASR) less standard variable cost of sales (SCOS) and budgeted contribution (BC).
(ASR – SCOS) – BC
Sales Price Variance
This is the difference between the actual selling price (ASP) and the standard selling price
(SSP) multiplied by the actual sales volume/quantity.
(ASP – SSP) × AV
Sales volume variance
This is the difference between the actual sales volume (AV) and the budgeted volume (BV)
multiplied by the standard contribution margin (SM).

(AV – BV) × SM
Sales volume can be further broken down into:
a. Sales margin mix variance
This variance arises when there is a change between the expected mix of sales quantities
and the actual mix of sales quantities where an organisation sells more than one product.
It is the difference between the actual volume in budgeted proportions (AVBP) and actual
volume sold (AV) multiplied by standard margin (SM).
(AVBP – AV) × SM
b. Sales margin quantity variance
This variance seeks to identify the difference between the budgeted and actual sales
volumes (holding the product mix constant). It is therefore the difference between the

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actual sales volume in budgeted proportion (AVBP) and the budgeted sales volume (BSV)
multiplied by the standard margin (SM).
(AVBP – BSV) × SM

Practice Questions

Question 1 - MATOJENI LTD

Month 1
Matojeni Ltd processes and sells brown rice. It buys unprocessed rice seeds and then,
using a relatively simple process, removes the outer husk of the rice to produce the brown
rice. This means that there is substantial loss of weight in the process. The market for the
purchase of seeds and the sales of brown rice has been, and is expected to be, stable.
Matojeni Ltd uses a variance analysis system to monitor its performance.
There has been some concern about the interpretation of the variances that have been
calculated in month 1.
1. The purchasing manager is adamant, despite criticism from the production director,
that he has purchased wisely and saved the company thousands of dollars in purchase
costs by buying the required quantity of cheaper seeds from a new supplier.
2. The production director is upset at being criticised for increasing the wage rates for
month 1; he feels the decision was the right one, considering all the implications of the
increase. Morale was poor and he felt he had to do something about it.
3. The maintenance manager feels that saving $8 000 on fixed overhead has helped the
profitability of the business. He argues that the machines’ annual maintenance can
wait for another month without a problem as the machines have been running well.
The variances for month 1 are as follows:

$
Material price Favourable 48 000
Material usage Adverse 52 000
Labour rate Adverse 15 000
Labour efficiency Favourable 18 000
Labour idle time Adverse 12 000
Variable overhead expenditure Adverse 18 000
Variable overhead efficiency Favourable 30 000
Fixed overhead expenditure Favourable 8 000
Sales price Adverse 85 000
Sales volume Adverse 21 000

Matojeni Ltd uses labour hours to absorb the variable overhead

Month 2
In month 2 the following standard data applies:

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 Standard costs for 1 tonne of brown rice:

 1,4 tonnes of rice seeds are needed at a cost of $60 per tonne
 It takes 2 labour hours of work to produce 1 tonne of brown rice and labour is
normally paid $20 per hour.
 2 hours of variable overhead at a cost of $30 per hour
 The standard selling price is $240 per tonne
 The standard contribution is $56 per tonne
Budget information for month 2 is:

 Fixed costs were budgeted at $210 000 for the month

 Budgeted production and sales were 8 400 tonnes
The actual results for month 2 were as follows:

 Actual production and sales were 8 000 tonnes

 12 000 tonnes of rice seeds were bought and used costing $660 000
 15 800 labour hours were paid for costing $303 360
 15 000 labour hours were worked
 Variable production overhead cost $480 000
 Fixed costs were $200 000
 Sales revenue achieved was $1 800 000

REQUIRED Marks

Sub- Total
total
(a) Using the variances and other relevant information above comment on
the performance of the following managers in month 1:
(i) The purchasing manager
(ii) The production director (10)
(iii) The maintenance manager (10)
Note : You are not required to comment on the performance of the
business or its managers in month 2.

(b) Calculate the variances for month 2 in as much detail as the

information above allows. 10 10

(c) Reconcile the budget profit to the actual profit using marginal costing (15) (15)
principles.
Total for Practice Question 1 35

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Solution to Practice Question 1.
(a) Using the variances and other relevant information above comment on the
performance of the following managers:
(i) The purchasing manager
 The purchasing manager has clearly bought a cheaper product, saving $48 000.
The cause of this is not specified and it could be due to good buying or negotiation,
reductions in quality or changes in overall market conditions.
 We are told the market for buying seeds is stable, so there is more likely to be an
internal reason for the problem. The material usage variance is significantly
adverse, indicating that much more waste than normal has occurred in month 1.
 This suggests that the quality of the seed bought was poor and as a result a $52
000 excess loss has occurred. It is possible that the waste was caused by the
labour force working poorly or too quickly and this has to be considered.
 The sales price achieved is also well down on standard with the sales price
variance showing an $85 000 loss of revenue and (therefore) profit.
 We are told that the market for sales of brown rice is stable and so it is reasonable
to presume that the fall in sales price achieved is as a result of internal quality
issues rather than general price falls. This may have also led to a fall in the volume
of sales, another $21 000 of adverse variance.
 In conclusion the purchasing manager appears mainly responsible for a loss of
$110 000 ($85 000 + $52 000 + $21 000 – $48 000) taking the four variances above
together.
(ii) The production director.
 The production director has increased wage rates and this has cost an extra $15
000 in month 1. However, one could argue that this wage increase has had a
motivational effect on the labour force.
 The labour efficiency variance is $18 000 favourable; and so it is possible that a
wage rise has encouraged the labour force to work harder. Academic evidence
suggests that this effect might only be temporary as workers get used to the new
level of wages.
 The plant has recorded an adverse idle time variance of $12 000. Idle time can
have many causes, including, material shortages, machine breakdowns, unclear
work instructions and poor bill of materials/assembly drawings. However, we are
told the machines are running well and the buyer has bought enough rice seeds.
This could point to a probably once – off incidence of unclear work instructions or
poor bill of materials/assembly drawings as a probable cause.
 In conclusion the increase in the wage rate did cost more money despite a marginal
improvement in morale and productivity. The total of the three variances above is
$9 000 Adverse ($18 000 – $12 000 – $15 000).
(iii) The maintenance manager.

 The maintenance manager has decided to delay the annual maintenance of the
machines and this has saved $8 000. This will increase profits in the short term but
could have disastrous consequences later.
 In this case only time will tell. If the machines breakdown before the next maintenance,
then lost production and sales could result.

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  • The maintenance manager has only delayed the expenditure and not prevented it
altogether. A saving of $8 000 as suggested by the variance has not been made. It is
also possible that the adverse variable overhead expenditure variance has been at
least partly caused by poor machine maintenance.
 The variance calculated is not the saving made as it represents a timing difference
only. The calculation also ignores the risks involved.

(b) Calculate the variances for month 2 in as much detail as the information above
allows

The status of a variance (adverse or favourable) should be clearly indicated. Where this
is not done or incorrectly done, the deduction is that the student does not understand the topic
or underlying principle. Note that the sales volume variance is expressed in terms of
contribution and that the FOH variance in this case only referred to the expenditure variance.

Sales Price Variance

Formulae (SP – AP) AQ

Variance [AP: $1 800 000 / 8 000 tonnes = $225 per tonne] ($240 – $225)8 000 t
$120 000 Adverse (1)

Sales volume

Formulae (BQ – AQ) Std Contribution/Unit

Variance (8 400 t – 8 000 t) $56
$22 400 Adverse

Direct material price

Formulae (SP – AP) AQ
Variance [AP: R660 000 / 12 000 tonnes = R55 per tonne] ($60 – $55)12 000 t
$60 000 Favourable

Direct material usage

Formulae (SQ – AQ) SP
Variance [SQ: 8 000 tonnes rice x 1,4 = 11 200 tonnes seed] (11 200 t – 12 000 t) $60
$48 000 Adverse

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 Direct labour rate

Formulae (SR – AR) AH

Variance [AR: $303 360 / 15 800 hrs = $19,20 per hour] ($20 – $19,20)15 800 hrs
$12 640 Favourable

Labour idle time

Formulae (AHP – AHW) SR

Variance (15 800 hrs – 15 000 hrs) R20
$16 000 Adverse (1)

Direct labour efficiency

Formulae (SHA – AHW) SR

Variance [SHA: 8 000 tonnes x 2 hrs = 16 000 hrs] (16 000 hrs – 15 000 hrs) $20
$20 000 Favourable

Direct labour efficiency

Formulae (SHA – AHW) SR

Variance [SHA: 8 000 tonnes x 2 hrs = 16 000 hrs] (16 000 hrs – 15 000 hrs) $20
$20 000 Favourable

Variable overhead expenditure

Formulae (SR – AR) AHW

Variance [AR: $480 000 / 15 000 hrs = $32 per hr] ($30 – $32)15 000 hrs
$30 000 Adverse

Variable overhead efficiency

Formulae (SHA – AHW) SR

Variance [SHA: 8 000 tones x 2 hrs = 16 000 hrs] (16 000 hrs – 15 000 hrs) $30
$30 000 Favourable

Fixed overhead expenditure

Formulae Budget – Actual
Variance $210 000 – $200 000
$10 000 Favourable (1)

Part C Reconcile the budget profit to the actual profit using marginal costing principles.

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 The question requires the student to prepare an operating statement using Marginal/direct
costing principles. Take note of the required formats. Students will not be awarded any
marks at this stage if a different format is used.
$
Budgeted Contribution ($ 56 x 8 400t) 470400
Sales volume contribution variance -22400
Flexible Budget Contribution (8000 x 56) 448000
Selling price varaiance -120000
328000
Vaiable Cost variances Favourable Adverse
$ $
Material Price 60000
Material usage -48000
labour rate 12640
labour idle time -16000
Labour efficiency 20000
Vaiable overhead expenditure -30000
Variable overhead efficiency 30000
Total 122640 -94000 28640
Actual contribution 356640

Budgeted fixed production overhead 210000

Fixed overhead expenditure variance -10000
Actual profit 156640

Practice Question 2 - adopted from Nust CAC 2205 – 2022 question paper.

Question 3

Malcom Reynolds Ltd makes and sells a single product, Product Q, with the following standard
specifications for materials:

Quantity Price per kg

Kg $
Direct material X 12 40
Direct material Y 8 32

It takes 20 direct labour hours to produce one unit with a standard direct labour cost of $10
per hour. The annual sales/production budget is 2 400 units evenly spread throughout the
year. The standard selling price was $1 250 per unit. The budgeted production overhead, all
fixed is $288 000 and expenditure is expected to occur evenly over the year. Absorption is
based on direct labour hours. For the month of October, the following actual information is
provided.

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 $ $
Sales (220 units) 264 000
Cost of sales
direct materials 159 000
direct wages 45 400
Fixed production overhead 23 000 227 400
Gross Profit 36 600
Administration costs 13 000
Selling and distribution costs 8 000 21 000
Net Profit 15 600

Cost of opening stocks, for each material, were at the same price per kilogram as the
purchases made during the month but there had been changes in the materials stock levels,

1-Oct 30-Oct
Kgs Kgs
Material X 680 1 180
Material Y 450 350

The number of direct labour hours worked was 4 600 hours and the total wages incurred $45
400. Work in progress stocks and finished maybe assumed to be the same at the beginning
and end of October.
Required:
a) Calculate the standard product cost for one unit of product Q showing the standard
selling price and standard gross profit margin. [5]
b) Calculate appropriate variances for the materials, labour, fixed production overhead
and sales, noting that it is company policy to calculate material price variances at the
time of issue to production. [15]
c) Prepare a statement for management reconciling the budgeted gross profit with the
actual gross profit. [5]

Solution to practice question 2

(a) Detemination of Standard Product Costs

$ $
Selling price 1250
less: Production Costs
Direct material X 12 x 40 480
Direct material Y 8 x 32 256
Direct labour 20 x 10 200
Fixed production overhead (288000/24000) = $6/hour x 20 hours 120 1056
Gross Profit / unit 194

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 (b) Calculation of variances

Material Price Variance

Formulae (SP - AP) AQ
Material X (40 - 42) 2500 (w1) $ 5 000 Adverse
Material Y (32 - 30) 1800 (w1) $ 3 600 Favourable

Material Usage Variance

Formulae (SQ - AQ) SP
Material X (2 640 - 2 500) 40 $ 5 600 Favourable
Material Y (1 760 - 1 800) 32 $ 1 280 Adverse
Total material Usage variance $ 4 320 Favourable

Material Mix Variance

Standard mix Standard

Actual Variance
in Actual Variance Cost per
Mix $
Output. Unit/kg in $

Direct material X 2 500 2 580 80 F 40 3 200 F

Direct material Y 1 800 1 720 80 A 32 2 560 A
4 300 4 300 640 F

Material Yield Variance

Actual Yield 220

less: Expected yield (4300 / 20) 215
Variance (units) 5 Favourable
x direct material price/unit {(12 x 40)+ (8 x 32)} 726
Yield Variance (In $) 3 680 (F)

Or

Actual usage (in kgs) 4 300

less: Expected usage (220*12+220*8) 4 400
Variance (units) 100F
x weighted material price/kg {(12 x 40)+ (8 x 32)}/ (8+12) 36.8
Yield Variance (In $) 3 680 (F)

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 Labour rate variance
Formulae (SR - AR) AH
(10 - 9.87) 4 600
$600 - 00 (F)

The majority of students made the mistake of rounding off the actual labour
rate. Calculations made before obtaining the final solution should be stored
Note
in the calculator. Only the final solution should be rounded off. Answers like
$598 although very close to the final solution where not marked.

Labour efficiency variance

Formulae (SH - AH) SR
(4 400 - 4 600) 10
$2 000 (A)

Fixed Production Variances

Expenditure
Formulae Budgeted - Actual
288 000/12 - 23 000
24 000 - 23 000
$ 1 000 (F)

Volume
Formulae (Budgeted Pdn - Actual Pdn) FOAR
(200 - 220) 120
$2 400 - 00 (F)

Capacity
Formulae (BH - AH) FOAR
(4 000 - 4 600) 6
$3 600 - 00 (F)
Efficiency
Formulae (SH - AH) FOAR
(4 400 - 4 600) 6
$1 200 - 00 (A)

Sales price Variance

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 Formulae (SSP - ASP) ASQ
(1 250 - 1 200) 220
$1 100 - 00 (A)
Sales Volume Variance
Formulae (SSQ - ASQ) Standard Profit
(200 - 220) 194
$3 880 - 00 (F)

Operating statement under absorption costing.

$
Budgeted profit 38 800
Sales volume profit variance 3 880
Flexed budget profit 42 680
Selling price variance (11 000)
31680
Cost variances Favourable Adverse
$ $
Material Price - Material X (5 000)
- Material Y 3 600
Material Usage Material X 5 600
Material Y (1 280)
Labour Rate 600
Labour efficeincy (2 000)
Fixed Production Expenditure 1 000
Fixed Production Capacity 3 600
Fixed production Efficiency (1 200)
Total 14400 -10480 3920
Actual Profit 35600

Nust Past Exam Paper Question – 2021 CAC 4105

QUESTION 3 – STANDARD COSTING

Bela-Bela Cleaning Products (Pvt) Ltd (‘BBCP’) is a company situated in Dulibadzimu, a town
in Beitbridge, and manufactures and distributes various cleaning products.

BBCP Soap Manufacturing Division

This division manufactures and supplies environmentally-friendly bars of soap to leisure,

nature and wildlife lodges for use in their chalets and various facilities. The bars weigh 100g
each and are sold for $5,50 each. They are sold in bags containing 10 bars of soap.

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The Soap Manufacturing Division of BBCP manufactures the soap using an entirely automated
production process. Supervision and maintenance costs fall under overhead.

The following information regarding the cost of a bag of 10 soap bars is available:

Input at standard cost:

0,30kg of Ingredient C at $38,00 per kg
0,65kg of ingredient T at $13,00 per kg
0,2kg of Ingredient A at $21,00 per kg
1,15kg

Other information:

Variable overhead: 0,25 machine hours

Fixed overhead: 0,25 machine hours
Packaging: one (1) plastic bag at $0,30 per bag

Overheads are absorbed on the basis of machine hours. BBCP uses an absorption costing
system.

The following budget information is available regarding total overhead costs (i.e. total variable
overhead cost plus total fixed overhead cost) at different production levels (based on variable
costing principles):

Total overhead cost

Production Level (fixed + variable)
Month Bags of Soap $
1 2 320 30 220
2 2 500 31 075
3 2 200 29 650

The January 2022 budget includes 600 machine hours and the production of 2 400 bags of
soap, which was the most common production level of the past two years.

The actual results for January 2022 show the following:

 2 490 bags of soap were produced.

 750 kg of ingredient C was purchased at $39,00 per kg. 730 kg was issued to
production.
 1 550 kg of ingredient T was purchased for $20 460. 1 600 kg was issued to production.
 560 kg of ingredient A was purchased at $18,50 per kg. 550 kg was issued to
production.
 Variable overhead cost of $12 864 was incurred for 640 machine hours.
 The actual fixed overhead incurred was $20 000.
 Plastic bags were purchased at $0,30 per bag. The total cost amounted to $747
Inventory of raw materials, packaging and finished goods are valued at standard cost. The
standard costs have not been changed for the past six months of 2021.

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 QUESTION 3

REQUIRED Marks

Sub- Total
total
(a) Calculate the standard cost of one bag of soap bars for Bela-Bela (5)
Cleaning Products (Pty) Ltd (BBCP) using an absorption costing basis. (5)

(b) Calculate the following standard costing variances for BBCP’s soap
division for the month of January 2022:


Material price variances for ingredients C, T and A.

Material mix and yield variances for ingredients C, T (3)
and A. (8)
 Variable overhead expenditure variance and efficiency (2) (15)
variance.
(2)
 Fixed overhead expenditure variance and volume
variance.
Total for Question 3 20

(a) Calculate the standard cost of one bag of soap bars for Bela-Bela Cleaning Products (Pvt) Ltd
using an absorption costing basis.

High-low method:
Cost at highest activity level – Cost at lowest activity level
Variable cost per unit = Units produced at highest activity level – units produced at lowest activity
level

$31 075 – $29 650 (1) r/w

Variable cost per unit = 2 500 – 2 200 (1) r/w

= $1 425 / 300 = $4,75 per bag

[$4,75 / 0,25 = $19 per hour]G3

Total variable cost for 2 500 units = 2 500 x $4,75 = $11 875 (½) c
Therefore fixed cost = $31 075 – $11 875 = $19 200 per month (½) c

Fixed overhead rate = $19 200 / 600 hrs = $32,00 per hour

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Standard cost for 1 bag (1kg) (i.e. 100g x 10 = 1kg)
$
Ingredient C 0,30kg x $38,00 /kg 11,40 (½) r/w
Ingredient T 0,65kg x $13,00 /kg 8,45 (½) r/w
Ingredient A 0,20kg x $21,00 /kg 4,20 (½) r/w

24,05
Variable overhead (0,25 hr x $19,00 /hr) 4,75 (½) r/w
Fixed overhead 0,25 hr x $32,00 /hr 8,00 (½) r/w
Packaging 1 x $0,30 0,30 (½) r/w
37,10
Available 6
Maximum 5

Part (b) Calculate the following standard costing variances for BBCP ‘s soap division for the
month of August 2015: Note: the final variance amounts must be in Rand value

Material price variances

$
Ingredient C 750kg x ($39 – $38) (750)A (1) r/w
Ingredient T 1 550kg x ($20 460/ 1550= $13,20 – $13) (310)A (1) r/w
Ingredient A 560kg x ($18,50 – $21) 1 400 F (1) r/w
340 F

Yield Variance
Actual input 2 880kg
Expected output (2 880 x 1/1,15) 2 504,348 kg
Actual output 2 490kg
Yield variance kg(negative) (2 490kg - 2 504,345kg) 14,348 kg
Yield variance ($) (14,345kg x $24,05 /kg) $345 A

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 Material mix Actual input Actual input Variance Std Variance (1)
variances in actual in std mix (kg) price $ r/w
mix (kg) (kg) $
Ingredient C 730 751,3 21,3 38,00 809,40 F
(2 880 x (0,3 / 1,15))
Ingredient T 1 600 1 627,8 27,8 13,00 361,40 F
(2 880 x (0,65 / 1,15)) (1) r/w
Ingredient A
550 500,9 (49,1) 21,00 (1 031,10)A
(2 880 x (0,2 /1,15)) (1) r/w
2 880 2 880,0 139,70 F

Variable overhead expenditure variance

[$4,75 / 0,25 = $19 per hour]

= $12 864 – (640 hrs x $19) (1) r/w
= $12 864 – $12 160
= $704 Adverse

Variable overhead efficiency variance

= [(2 490kg x 0,25 hr/kg) – 640hr] x $19 /hr (1) r/w

= (622,5 hr – 640 hr) x $19 /hr
= -17,5 hr x $19 /hr
= $332,5 Adverse

Fixed overhead expenditure variance

= $19 200 – $20 000 (1) r/w

= $800 Adverse

Fixed overhead volume variance

= (2 490kg x $8) – $19 200 OR [(2 490 – 2 400) x $8]

= $19 920 – $19 200
= $720 Favourable (1) r/w
Communication skills mark: Variance type clearly indicated (1)

Available and maximum 15

Practice Question 4

K&S LTD
K & S Ltd manufactures floor polish and liquid soaps for commercial clients. Both product lines
are sold in 10 litre containers. The company is critically aware of their trading environment and
uses a standard costing system, which is reviewed every six months. The last review was
done on 1 March 2013 for the six months ending 28 August 2013.
Floor polish division
The following standard cost was set for one 10-litre container of polish:

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 Standard Cost Unit Cost
$ $

Direct material
 5 litre policloro $3.60/litre 18
 3.5 litre oxotone $2.20/litre 7.7
 4 litre lather $0.6/litre 2.4
Direct labour: 0,24 productive hours $21.875/hr 5.25
Variable overhead: 0,24 hours 14.88
Fixed overhead: 0,24 hours 8.4
Container 5.1
Total standard cost per unit 61.73
Sales price per unit 90

Budgeted idle time of 4% was considered in detailing the above standard cost card. K & S
allocates both variable and fixed overhead costs to production on the basis of productive
labour hours. The budgeted fixed manufacturing overhead for the six months is $10 320 000.
Manufacturing activities and incurring of production cost take place evenly throughout a year.
The actual costs incurred during March 2013 amounted to:
Purchase of direct materials:
Policloro 1 100 000 litres @ $3,80 / litre
Oxotone 725 000 litres @ $2,30 / litre
Lather 830000 litres @$0,56 / litre
Labour 53800 clocked hours @ $21.50/hour(49 920)
worked hours
Variable Overhead $3 072 800
Fixed Overhead $1 689 200
Containers: 212 000 containers @ $5,10 each

The actual production for March 2013 was 210 000 units. All containers purchased were
issued. 1 000 000 litres of Policloro, 790 000 litres of Oxotone and 850 000 litres of Lather
were issued to production.

REQUIRED Marks

For the Floor polish division, calculate the

(a) Material
Labour
Variances for March 2013 in as much detail as possible. (8)

Total 8

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Practice Question 5 – Sales mix and quantity variances
Famous Fishing West Coast (Pty) Ltd (FFWC), operates a fleet of specialised fishing vessels
that catch pilchards.
In catching Pilchards FFWC is governed to limit the quantity of each species of fish that may
be caught each year. This is called the Total Allowable Catch (TAC) for the year.
The TAC for pilchards has been declining over the past three years. The local and African
market for canned pilchards has, however, continued to grow. FFWC has therefore
experienced a shortage of pilchards to supply the market and maintain its market share. In the
past FFWC overcame the shortage by importing canned pilchards from Thailand and putting
their own label on the tins. This left the cannery section of their Saldanha factory with spare
capacity and seasonal cannery workers working less hours. FFWC sells all its pilchards in
400g cans. The decline in the Rand and subsequent Rand volatility presented challenges for
FFWC. During the financial year ended 31 August 2017, FFWC decided to change its strategy
by reducing the import of canned pilchards and instead importing frozen pilchards. The frozen
pilchards were then processed and canned in FFWC’s own cannery in Saldanha Bay.
The budgeted sales quantity and production costs per ton for each type of pilchard canned
for the year ended 31 August 2017 were as follows:

Sales quantity Production cost per

(tonnes) tonne
Own catch 3 600 $14 260
Imported cans 3 500 $17 200
Imported frozen pilchards 2700 $16 000

The budgeted average selling price for the year was $11,40 per 400g can of pilchards.
FFWC uses a standard absorption costing system. The budget was based on the standard
revenues and costs.
The actual results for the year ended 31 August 2017 were as follows:

Sales quantity Production cost per

(tonnes) tonne
Own catch 1 100 $13 900
Imported cans 3 400 $17 550
Imported frozen pilchards 4 800 $16 200

The actual average selling price for the year was $11,68 per 400g can of pilchards.
According to Stats SA, the compound annual growth rate in the retail price of canned pilchards
since 2008 has been 6% which is more or less in line with inflation.
FFWC does not keep any inventory of pilchards at the beginning or end of the financial year
(budget and actual).

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 QUESTION 1

REQUIRED Marks

Sub- Total
total

(a) Calculate the following variances for FFWC’s canned pilchards for
the year ended 31 August 2017:
(i) Sales price variance
4
(ii) Sales margin mix variance
6
(iii) Sales quantity variance
4
Communication skills – layout and structure
1 15

(b) Prepare a brief explanation of the reason for the difference

between the budgeted and actual sales and operating profit
(10)
figures for canned pilchards based on your calculations in part (a)

Total for Question 1 25

Practice Question 5

Air Woolies (Pty) Ltd (hereafter “the company” or “Air Woolies”) is a local company which
manufactures packaged foods and meals for supply to various airlines in South Africa as well
as airlines based in other parts of Africa. The company recently entered into sales contracts
with airlines in Botswana and Mauritius. The company claims to have “the tastiest food in thin
air” and is looking to increase their product offering. One of their main products is packaged
peanuts and raisins. This product is an age old favourite of flight passengers and Air Woolies
has received large order quantities in recent months.

Albert Walton, the financial manager of Air Woolies, has told you that he is generally pleased
with the company’s financial results. However, he wants to understand why actual results
varied from the budget. He approached you as a management accountant to look into this.
There was no opening or closing stock of raw materials or finished goods.

The following Budget was prepared for sales of packets of peanuts and raisins for the month
of November 2016:

Notes ZWL Dollars

Sales 1 225 000
Raw material: Peanuts 2 ?
Raw material: Raisins 3 (10 800)

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 Packets 4 ?
Direct labour 5 (25 000)
Variable overheads 6 (7 500)
Fixed overheads 7 (22 500)
Budgeted profit ?

Note 1:

The budgeted selling price per packet is $15. The actual selling price was $17 per packet and
actual sales amounted to 12 800 packets for the month of November.

Note 2:

Each packet weighs 50 grams and should contain 55% peanuts and 45% raisins.

The company uses a specific type of peanut and has entered into a contract to import these
peanuts from an overseas supplier at an agreed price of $4 per kilogram. The budget was
based on an expected USD exchange rate of $1: ZWL$16. The budgeted cost of peanuts for
November 2016 was USD$1 650.

Actual purchases and usage of peanuts was 385 kilograms.

The actual USD exchange rate for November was USD$1: ZWL$16.50
Note 3:

Raisins are purchased from a local supplier at a budgeted cost of $32 per kilogram. However,
the supplier charged Air Woolies a discounted price of $30 per kilogram to retain their
business.

Actual purchases and usage of raisins for the month of November was 280 kilograms.

Note 4:

Raisins and peanuts are packaged together in plastic packets which are specifically designed
to be strong yet can also be opened easily by passengers. The budgeted price is $0.60 per
packet with one packet being required for each peanut and raisin combination. Actual packet
costs amounted to $0.80 per packet and 12 880 packets were purchased and used.

Note 5:

Labourers are required for packing the required quantities of ingredients in each packet. The
budgeted labour rate is $25 per hour. It is expected that labourers will require 4 minutes to
complete each packet. Actual labour hours worked amounted to 845 hours while actual labour
costs were $23 660.

Note 6:

Allocation of variable overheads is linked to labour hours. Air Woolies budgeted on $7.50 of
variable overheads for every labour hour worked. Actual variable overheads amounted to $5
070 for November 2016.

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Note 7:

The company uses a standard absorption costing system.

Budgeted fixed overheads of $22 500 can be split between the following items:

• Rental
• Depreciation on machinery
• Electricity

Fixed overheads are allocated based on normal capacity of 15 000 packets per
month. Actual fixed overheads were made up of the following:
• Rental $11 000
• Depreciation on machinery $6 000
• Electricity $8 000

REQUIRED:

a) Determine the flexed profit for November 2016. (6)

b) Perform a reconciliation of budgeted sales to actual profit for November 2016.
Show all calculations and break variances down into as much detail as possible.
Sales volume variance should be based on selling price. (32)

c) Provide reasonable explanations for all sales variances and all direct material
variances calculated in part b above. (8)

d) Air Woolies is considering further expansion into Africa. Determine the strategic
factors and additional considerations Air Woolies should take into account relating
to their business of providing meals to airlines.

Suggested Solution

(a)

Budgeted sales = 225000/15 = 15000 units (packets) Budget

Sales (given) 225 000

Raw Materials - Peanuts (16 x $1 650) (26 400)
Raw materials - Raisins (given) (10 800)
Packets (0.60 x 15 000) (9 000)
Direct labour (given) (25 000)
Variable overheads (given) (7 500)
Fixed overheads (given) (22 500)
Budgeted profit 123 800

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 

To get to flexed = 123 800 x 12 800

/ 15 000 = 105 642.67P
Flexed profit

ALTERNATIVE:

Budgeted sales = 225 000/15 = 15 000

units (packets) Actual sales = 12 800
(given) Peanuts:
12 800 packets sold:
Each packet weighs 50 grams’ peanuts required = 12 800 x 50 grams =
640 000/1 000 = 640 kilograms’ x 55% = 352 kg of peanuts.
Raisins required = 640 kilograms’ x 45% = 288 kg of raisins
Direct labour: 4 minutes per packet
12 800 x 4 = 51 200/60 = 853,33 hours

Dollars
Sales ($15 x 12 800) 192 000 
Raw materials - Peanuts ($4 x R16 x 352) (22 528) 
Raw materials - Raisins ($32 x 288) (9 216) 
Packets (0.60 x 12 800) (7 680) 
Direct labour (853.33 x 25) could use 854 (21 333)  (rounded) or (21350)
(rounded up)
Variable overheads (7.50 x 853.33) or (7.50 (6 400  (rounded)) or ( 6 450)
x 854) (allocated on actual hours)
Fixed overheads (use allocation rate: 22 (19 200)
500/ 15 000 x 12 800)
Flexed profit 105 643P
Note: Flexed cost of sales= $192 000 – $105 643 = $86 357
Raw materials:

Peanuts:

Price variance:
Budgeted price = R16 x $4 = R64
Actual Price = R16.5 x $4 = 66
(AP-SP) x AQ
= (64-66) x 385kg = (770) A

Usage variance:

Total usage variance:

(AQ-SQ) x SP
(385-352)  x 64 = (2 112) A

Mix variance:
(AQ- AQ in standard mix) x SP
AQ in standard mix = (385 + 280) x 55% = 365.75

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 AQ = 385
(385 - 365.75) x 64= (1232) A
Yield variance:
(AQ in standard mix – SQ in standard mix) x SP
SQ in standard mix = 352 kg of peanuts
(365.75 - 352) x 64 = (880) A

Raisins:

Price variance:
(AP-SP) x AQ
(30-32) x 280kg = 560F

Usage variance:

Total usage variance:

(AQ-SQ) x SP
(280-288)  x 32 = 256F

Mix variance:
(AQ - AQ in standard mix) x SP
AQ in standard mix = (385 + 280) x 45%= 299.25
AQ = 280
(280 – 299.25) x 32 = 616F

Yield variance:
(AQ in standard mix – SQ in standard mix) x SP
SQ in standard mix = 288 kg of peanuts
(299.25 - 288) x 32 = (360) A 

Packets:

Price variance:
(AP - SP) x AQ
(0.80 - 0.60) x 12 880 = (2 576) A

Usage variance:
(AQ - SQ) x SP = (12 880 - 12 800) x 0.60 = (48) A

Direct labour:

Price variance:
(AP-SP) x AH
Actual labour rate = R23 660/845 = R28
(28 - 25) x 845 = (2535) A

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
Efficiency variance:
(AH - SH) x SP
(845- 853.33)  x 25 = 208.25 F or 208.333F

Variable overheads:
Expenditure variance:
Budgeted Flexed variable overheads (AH X SR) – Actual Costs
(AH X SR) = 845 x 7.50 = 6 338 (rounded)
6 338 – 5 070 (Actual) = 1 268F

Efficiency variance:
(SH - AH) x SP
(853.33 - 845)  x 7.50 = 62 F (rounded) or 62.5 F

Fixed overheads:

Expenditure variance:
Budgeted expenditure – Actual expenditure
Budgeted fixed overheads = 22 500
Actual Fixed overheads = (11 000+ 6 000 + 8 000) = 25 000
22 500 – 25 000 = (2 500) A
Allocated fixed overheads = 22 500/15 000= R1.50 per packet

Volume variance:
(Budgeted units – Actual units) x SP
(15 000-12 800) x 1.50 = (3 300) A

Calculation of capacity and efficiency variance:

Budgeted fixed overheads = 22 500

Capacity variance: 3 487.50A 

Labour capacity (15 000*4/60 = 1000
Standard rate per hour (22 500/1000 = 22.50)
Actual hours at standard rate per hour 19 012.50
(845 x 22.50)

Efficiency variance: 187.50F 

Fixed overheads recovered (Allocated)
(SQ x SP for actual production) 19 200
(12 800 x 1.50)
Volume variance = 22 500 - 19 200 = 3 300 adverse

Total fixed overhead variance = (2 500) + (3 300) = (5 800) A

Calculation of actual profit
Sales (12 800 x 17) 217 600(1/2)

Cost of sales: (97 844)

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 Raw materials: Peanuts (385kg x R66/kg) (25 410) (1/2)

Raw materials: Raisins (280kg x R30/kg) (8 400) (1/2)

Plastic packets: (12 880 x R0.80/packet) (10304) (1/2)

Labour: (given) (845 hours x R28) (23660)(1/2)

Variable overheads (given) (845 x 6) (5 070) (1/2)

Fixed overheads (25000)(1/2)

Actual profit 119 756 (1/2)P

(c)
The various variances can be explained as follows:

Note to students:
- When answering this type of question, where you have to explain reasons for variances,
start by identifying how many variances are actually required. This will ensure that you do not
waste time doing unnecessary variances.
- Once you have understood the required, check the mark allocation that, will guide you
concerning the extent of your discussion. The test question required four variances (sales,
peanuts, raisins and packets) for eight (8) marks, so you didn’t have to go into detail with
regards to your explanations. However, if the required had specified that you must provide as
much detail as possible or the mark allocation was larger, then you would have go into more
detail and address mix and yield (and capacity and efficiency variance where applicable).
-The starting point for actually answering all your variance explanations is to write down your
variance as well as its direction, for example, the sales price variance you would start with
-’25 600A’. This will ensure that the marker gives you marks principally even if your answer
and your explanation is wrong. However, if you do not start by listing them, you will not be
marked principally and you may end up losing many marks.

Sales variances:
The favourable sales price variance is due to a price increase of $2.00. This may be due to
the popularity of Air Woolies products or in response to higher than expected costs as the
company will want to maintain their current mark-up percentage.

The adverse sales volume variance is due to sales being lower than expected. This may be
a result of price increases or order quantities not being as large as they were in previous
months.
Max: 2
Raw materials:

Peanuts:
The adverse price variance can be attributed to fluctuations in the rand/ dollar exchange rate.
This is the only reason for the price variance as the underlying peanut price was fixed. The
ZWL dollar weakened against the US dollar. The adverse usage variance is a result of a

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higher proportion of peanuts being used per packet. Peanuts made up 57,89% of packets
produced compared to the 55% composition which was budgeted. There was also abnormal
and unexpected wastage of peanuts during the production process possibly due to poor
control.
Max: 2

Raisins:
The favourable price variance is due to an unexpected discount which was received from
suppliers.

The favourable usage variance is a result of a higher proportion of peanuts being used instead
of raisins. Raisins made up 42,11% of packets produced compared to the 45% composition
which was budgeted. Higher quantities of peanuts were possibly used due to a shortage of
raisins. 
Max: 2

Packets:
The adverse price variance is a result of packet pricing changes, possibly due to unforeseen
price increases by suppliers. Increased demand for these packets may have prompted
suppliers to increase packet prices.

The adverse usage variance is a result of wastage Changes in the quality of packaging may
have resulted in more packets breaking or being rejected during production. Is Food for
Flight using more than one supplier, with one supplier providing poor quality packaging?
Max: 2

Note to part 4 students: Discussion of reasons for variances should be specific to a

particular variance and cannot be a general discussion in total.

Direct labour:
The adverse price variance can be attributed to increased wage rate. This may be a result of
strikes or workers receiving increased wages after negotiations with trade unions.

The favourable direct labour efficiency variance can be attributed to learning curve factors
and increased efficiency not being taken into account when standards were set.

Variable overheads:
The favourable variable overhead expenditure variance is a result of actual variable
overheads being lower than those expected. Food for Flight budgeted for cost increases/
hikes which were higher than those actually incurred.

The favourable variable overhead efficiency variance is a result of labour hours being less
than expected due to increased efficiency and improved scheduling/ planning.
Fixed overheads:
The adverse fixed overheads expenditure variance is a result of budgeted fixed overheads
exceeding actual overheads. Fixed cost pricing relating to rental, depreciation and electricity
were not as high as those expected by Food for Flight. There were price increases for fixed
amounts payable relating to rental, depreciation and electricity. Even if the price of one fixed
cost was lower than standard costs, other fixed cost price hikes outweigh the benefit of any
favourable amounts.

(Need to discuss price increases/ changes relating to all fixed costs to earn mark)

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The adverse fixed overhead volume variance is due to the fact that 12 800 packets were
produced instead of the 15 000 that was budgeted. This resulted in a lower total fixed overhead
expenditure being allocated to packets as a result of production.

The adverse fixed overhead capacity variance is a result of producing fewer packets than the
15 000 packets which make up the normal capacity which Food for Flight are able to produce
through their operations.

Any other valid point.

Available: 12
Max: 8

(d)
The following additional factors and strategic considerations should be taken into account:

How will meals be transported to airlines in other parts of Africa.

Will increased order quantities and products resulting from expansion impact on employee’s
work ethic and their efficiency.

Consider whether any additional new clients can be obtained due to airlines which regularly
land in various locations in Africa.

Consider competitor’s actions regarding expansion in Africa and the impact of this on Air
Woolies market share
The company should consider any impact their production process and other operations will
have on the environment
Consider developing new airline food products in response to consumer demands in different
countries.

What impact will different exchange rates have on future financial performance? Has Food
for Flight considered the use of derivatives?

Consider laws and regulations which will need to be adhered to in countries outside
Zimbabwe.
Consider whether the company has the financial capacity to expand (1)
Consider the financial viability of the expansion into Africa (1)
Consider whether the company has the adequate knowledge and skills to thrive in the African
market (1)
Any other valid point

Semester Exercise on Standard Costing – Individual Assignment

Due date - 20 September 2022

KK biltong (hereafter ‘the company’ and ‘KK biltong’) is a Victoria Falls based biltong
manufacturer and retailer. The company is famous for its tasty biltong snack packets which
are sold at lower prices than that of competitors.

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KK biltong oversees the entire process of the manufacture of the biltong; they buy the meat
from a reputable local company. The meat is then cut into long strips and salted with a secret
recipe which gives the biltong its special and unique flavour. The spice mixture is rubbed into
the meat by hand and the salted strips are then transferred to a suitable container for further
curing.

Thereafter the meat is dried in a solar dryer for a few hours. Once dry, the biltong is sliced by
hand and packed into individual 100 gram packets. This is the only size of this product that
they sell. The biltong is then sold to retailers.

Salt and pepper are the principal ingredients used in BB’s secret spice recipe, although other
ingredients such as sugar, coriander, vinegar and Worcestershire sauce also give their biltong
its famous taste

The financial manager of KK biltong has told you that the company is very pleased with the
current state of affairs at the company. He informed you that actual sales for April 2017 were
2 000 packets more than the 20 000 packets that were expected to be sold. However, he
cannot understand why actual results for April 2017 differed so much from the budget as he
has maintained the same labour force and the same suppliers for the month of April with the
same strategic outlook as in prior months. He approached you, as a management consultant
to look into this, and presented you with the following facts and figures:

Budget – April 2017

Notes $
sales 560 000
Meat 1
Spices 2
Packaging 3
Labour 4
Overheads 5 85 000
Net Profit 112 200

1) One third of the meat weight entered into the biltong manufacturing process is lost due
to the drying process (I.e. 3 kilograms of raw meat will make 2 kilograms of biltong).
Raw meat is purchased from Flash Meat distributors for $65 per kilogram
2) One kilogram of biltong meat (after drying) should use 50 grams of the special spice
mix. KK biltong purchases the spices from Patel Spices in pre-packaged containers
which cost $140 per kilogram.
3) The branded packaging is manufactured and imported from a supplier in Botswana
who has proved to be more reliable and less expensive than local Zimbabwean
competitors. The packets cost 0.5 Botswana Pula each.
4) The company employs 25 direct labourers who are paid an hourly rate of $30. These
workers slice and spice the meat, place the pieces in the solar dryer and when dry,
package the biltong into individual packets. Management expect each worker to
complete 5 packets of biltong an hour. Each worker should work 160 hours a month in
order to meet normal production.
5) Overheads are comprised of a fixed and variable portion. Examples of overheads
include electricity used by the solar dryer, insurance and administrative salaries. In the
previous month direct labour hours totalled 3 600 and overheads were $83 000.

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 Fixed overheads are allocated on direct labour hours based on normal capacity. The April
2017 budget assumes normal capacity.

Actual – April 2017

 Although more packets were sold than anticipated, actual sales were $10 000 less
than expected.
 During April 2017 management used a more efficient drying method. Using this
method, the loss from drying only amounts to 20% of the meat entering the biltong-
making process. Flash Meat distributors increased their prices to $67 per kilogram.
 117kg spices were used during the month at total cost of $14 960.
 1% of the packets used in the month were stolen from the company’s warehouse and
had to be re-ordered from the Botswanan supplier. The price per packet in Botswanan
Pula remained the same for this order as for the previous order.
 Direct labourers were paid at the expected rate. Each worker worked for 160 hours as
expected by management.
 Variable overheads amounted to $6 per direct labour hour.
 Fixed overheads were $68 000 for the month.
 Actual profit for the month was $123 017.

Additional information

 The expected average exchange rate for April 2017 was 1 Botswana Pula = 1.38
Zimbabwe dollar. The actual average rate was 1 Botswana Pula = 1.42
Zimbabwean dollar.
 The company uses a standard absorption costing system.
 There was no opening or closing stock of any kind during April 2017.

Information for Part D only

The only other product that management sell in addition to the biltong is chilli bites. 20% of all
packets sold should be chilli bites which have a selling price of $36 per packet. Only 4 000
packets of chilli bites were actually sold during April 2017.

REQUIRED

Total

(a) Calculate the number of packets of biltong that KK biltong will need to sell in
order to break even. (12)
(b) Calculate the margin of safety percentage if the budgeted number of
packets for April 2017 was sold. (2)

(c) Reconcile budgeted contribution to actual net profit, clearly showing all (27)
variances (except for sales mix and yield variances).

(d) Using the information given for part (d), calculate in as much detail as possible, (6)
the sales volume variances for biltong and chilli bites (at a sales price level).

(e) Give reasons for the biltong sales and packaging variances. (4)

(f) List the purposes and benefits of using standard costing. (4)

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(g) Explain whether standard costing would be better suited in industries where (2)
non-repetitive activities are observed or in industries where process costing is
used. Give reasons for your answer.

(h) Explain to the financial manager of KK biltong the difference between (3)
calculating the meat price variance based on quantity used and on quantity
purchased in situations where these quantities differ.

Total for assignment 60

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 ABC COSTING
In traditional absorption costing overheads are charged to products using a predetermined
overhead recovery rate. This overhead absorption rate (OAR) is based upon volume of
activity. A full unit cost is computed in order to satisfy financial accounting requirements.
However, it is always stressed that full product costs, using financial accounting principles, are
not suitable for decision-making purposes. Instead decisions should be based on a decision-
relevant approach incorporating relevant/incremental cash flows. With this approach,
decisions such as introducing new products and special pricing decisions should be based on
a study of only those incremental revenues and expenses that will vary with respect to the
particular decision. This approach requires that special studies be undertaken when the need
arises. However, studies have shown that the majority of companies base their decision
making upon full product cost.
In the late 1980s Cooper and Kaplan developed a more refined approach for assigning
overheads to products and computing product cost. This new approach is called activity
based costing (ABC). It is claimed that ABC provides product-cost information that is
useful for decision-making purposes.
Traditional systems measure accurately volume-related resources that are consumed in
proportion to the number of units produced of the individual products. Such resources include
direct labour, materials, energy and machine-related costs. However, many organisational
resources exist for activities that are unrelated to physical volume. Non-volume related
activities consist of support activities such as materials handling, material procurement, set-
ups, production scheduling and first-item inspection activities. Traditional product-cost
systems, which assume that products consume all activities in proportion to their production
volumes, thus report distorted product costs.

The activity-based costing procedure

Cooper and Kaplan stated that it was the support activities that were the cause of many
overheads, for example, material handling, quality inspection, setting up machinery, material
acquisition, etc. Thus a simple three-step philosophy was developed:

 support activities cause cost;

 the products consume these activities;
 cost should, therefore, be charged on the basis of consumption of the
activities.

Method
1 Identify the organisation’s major activities.
Ideally about 30 to 50 activities should be identified. However, over time, some
large firms have been known to develop hundreds of activities. A suitable rule
of thumb is to apply the 80/20 rule: identify the 20% of activities that generate
80% of the overheads, and analyse these in detail.

2 Estimate the costs associated with performing each activity – these costs are
collected into cost pools.

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 3 Identify the factors that influence the cost pools. These are known as the cost
drivers. For example, the number of set-ups will influence the cost of setting up
machinery.
4 Calculate a cost driver rate, for example a rate per set-up, or a rate per material
requisition, or a rate per inspection. Cost driver rate = Cost pool/ Level of cost
drivers
5 Charge the overheads to the products by applying the cost driver rates to the
activity usage of the products.
To appreciate the application of this procedure it is necessary to work through an
example.

FAVOURABLE CONDITIONS FOR ABC

The purpose of moving from a traditional costing system to an activity-based system should
be based on the premise that the new information provided will lead to action that will increase
the overall profitability of the business.
This is most likely to occur when the analysis provided under the ABC system differs
significantly from that which was provided under the traditional system, which is most likely to
occur under the following conditions:

 when production overheads are high relative to direct costs, particularly direct labour;
 where there is great diversity in the product range;
 where there is considerable diversity of overhead resource input to products;
 when consumption of overhead resources is not driven primarily by volume.

Information from an ABC analysis may indicate opportunities to increase profitability in a

variety of ways, many of which are long-term. For example, an activity-based analysis may
reveal that small-batch items are relatively expensive to produce, and are therefore
unprofitable at current prices.
A number of responses to this information could be adopted. The first response might be to
consider stopping production of such items, and concentrate on the apparently more profitable
high-volume lines. Another approach would be to investigate how the production process
could be organised in such a way as to bring the cost of producing small-batch items closer to
that of producing high-volume goods.
By identifying the cost of carrying out particular activities, the new approach provides
opportunities for directing attention to matters of cost control. It can therefore be viewed as a
much longer-term technique than the word ‘costing’ in the title suggests. The establishment
of an ABC product cost may thus be considered to be the beginning of the process, rather
than an end in itself. The recent use of the term activity-based management suggests this
forward looking orientation, which is assuming increasing importance.

A summary of benefits and limitations

Benefits
1 Provides more accurate product-line costings particularly where non-volume-
related overheads are significant and a diverse product line is manufactured.

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 2 Is flexible enough to analyse costs by cost objects other than products such
as processes, areas of managerial responsibility and customers.

3 Provides a reliable indication of long-run variable product cost which is

particularly relevant to managerial decision making at a strategic level.

4 Provides meaningful financial (periodic cost driver rates) and non-financial

(periodic cost driver volumes) measures which are relevant for cost management
and performance assessment at an operational level.

5 Aids identification and understanding of cost behaviour and thus has the
potential to improve cost estimation.

6 Provides a more logical, acceptable and comprehensible basis for costing

work.

Limitations

1 Little evidence to date that ABC improves corporate profitability.

2 ABC information is historic and internally orientated and therefore lacks direct
relevance for future strategic decisions.

3 Practical problems such as cost driver selection.

4 Its novelty is questionable. It may be viewed as simply a rigorous application

of conventional costing procedures.

Practice Question 1

Gempatch Ltd manufactures three products using the same plant and processes. The
following is relevant to the September 2000 production period:

Product
Jaspis Agate Sodalite

Volume 5 500 600 7 000

Material cost per unit $50 $160 $170
Direct labour per unit 1/2 hour 2 hours 1 & 1/2 hour
Machine time per unit 1/4 hour 1 hours 1 & 1/2 hour
Labour cost per unit $30 $120 $90

The manufacturing overheads for the period can be analysed as follows:

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 $000
Machine activity 350
Set - up costs 44
Ordering costs 20
Material handling 75
Spare part administration 10
499

Currently the overheads are absorbed by the products based on machine hours at a rate of
$40 per machine hour, which gives the following overheads per product:

Jaspis $10
Agate $40
Sodalite $60

The company is at present considering a change to activity based costing. An investigation

into the manufacturing overheads activities for the period revealed the following:

Product
Total Jaspis Agate Sodalite

Number of set - ups 16 6 2 8

Number of orders 10 5 1 4
Number of material handlings 27 12 3 12
Number of spare parts 12 7 1 4

REQUIRED
(a) Contrast the features of a business that will benefit from activity based costing (ABC)
with those of a business that will not. (4)
(b) Determine the overheads per product unit for Gempatch Ltd by using ABC and briefly
comment on the differences in the overheads per unit determined with the current
system and the ABC system. Your calculations must be rounded off to two decimals.
(19)

Practice Question 2

Question 2 – Activity Based Costing (32 marks) – Unisa Adopted

Sweet Roast Limited is a producer of a variety of high grade coffee blends. The firm buys
coffee beans mainly from the Ethiopian Highlands. The coffee beans are then roasted,
blended and packaged in one kilogram bags for sale to specialist coffee houses around the
world. The major raw material in the coffee blends is the beans. The company’s automated
roasting, blending and packaging processes result in substantial overheads. Since the
company is highly automated it uses very little direct labour.

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Coffee blends from the mainly Ethiopian Highlands are very popular and sell in large volumes
while blends from Tanzania and Malawi sell in moderate volumes. The company has a mixed
pricing strategy.
The company’s budget for the coming year includes estimated production overheads of $2
200 000. The company assigns production overheads to products on the basis of direct labour
hours. The expected direct labour cost is $600 000 and the budgeted directed labour hours
are 50 000. Based on the sales budget and the material requirement budget, the company
will, during the forthcoming year, purchase and use $5 000 000 of raw materials, mostly in the
form of coffee beans.
The budgeted costs for direct materials and direct labour for one-kilogram bags for two of the
company’s coffee products are as follows:

Ethiopian Roast Malawi Roast

$ $
Direct materials (per 1 kg bag) 4,50 2,90
Direct labour (per 1 kg bag) (0,02 Hours per bag) 0,24 0,24
The company’s marketing manager is of the belief that the company’s traditional costing
system may be providing misleading cost information related to the products. She has learnt
of alternative methods of assigning manufacturing overheads to products and has collected
the following information for the total production in the company:

Budgeted
Yearly Activity
Annual
of all products
Cost pool Measure Cost
$
Purchasing Purchase orders 2 000 Orders 560 000
Material Handling Costs Number of set-ups 1 000 Setups 193 000
Quality control Number of batches 500 batches 90 000
Roasting Roasting hours 95 000 hours 1 045 000
Blending Blending hours 32 000 hours 192 000
Packaging Packaging hours 24 000 hours 120 000
Total manufacturing overhead 2 200 000
Data regarding the expected production for the two selected products is given below:

Ethiopian Roast Malawi Roast

Forecast sales and production quantities) 80 000 kg 4 000 kg

Batch size 5 000kg 500 kg
Setups 2 per batch 2 per batch
Purchase order size 20 000 kg 500 kg
Roasting, blending and packaging time per 100 kg 2,3 hours 2,3 hours

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The company holds no inventory of unroasted coffee beans at either the beginning or the end
of the financial year.

REQUIRED Marks

(a) Using direct labour hours as the base for assigning manufacturing overhead cost
to products, undertake the following:
(i) Calculate the predetermined overhead recovery rate that will be used
(1)
during the forthcoming year.
(ii) Calculate the unit product cost of one kilogram each of the Ethiopian
and Malawi roast products. (3)

(b) Using activity based costing as a basis for assigning manufacturing overhead
cost to products, undertake the following:
(i) Calculate the total amount of manufacturing overhead cost that should
(19)
be assigned to the total production of each of the roast blends for the
year.
(ii) Using the data calculated under b(i) above, compute the overhead cost
per kilogram of each of the Ethiopian and Malawi roasts.
(3)
(Work to 2 decimal places)
(iii) Calculate the unit product cost of one kilogram each of the Ethiopian
and Malawi roast products (3)

(c) In bullet point form, prepare short notes for the marketing manager on your
findings under (a) and (b) above and clearly indicate the implications to the
company of using direct labour as the base for assigning manufacturing
overheads to products. (5)

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 Practice Question 3 – UNISA Adopted

Mr Terry, believes that the traditional costing system may be providing misleading information.
He has developed an activity based analysis of the 2010 manufacturing overhead costs which
is shown in the following table:
Activity Cost Driver Cost
R'000

Materials handling Set-ups 21 300

Quality Control Batches 2 100
Baking Baking hours 10 500
Packaging time Packaging hours 4 600
Not identifiable - 5 500

The actual data regarding the 2010 production of rusks are presented below:

Buttermilk Muesli

Batch size 10 000 boxes 10 000 boxes

Set-ups 3 per batch 4 per batch
Baking time 1 hour / 100 boxes 1 hour / 100 boxes
Packaging time 0,1 hour / 100 boxes 0,1 hour / 100 boxes

REQUIRED Marks

(a) Using an activity based approach, calculate the actual manufacturing overhead
cost of buttermilk and muesli rusks for the year ended 28 February 2010.
(12)

(b) Prepare a memo to Mr Terry to briefly explain the impact of the ABC approach on (4)
the allocation of the two products’ manufacturing overhead cost.

(c) Calculate Lekker Rusks (Pty) Ltd’s Rand budgeted break-even point based on (4)
expected sales of 1 350 000 boxes buttermilk and 450 000 boxes muesli.

Total 20

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 DECISION MAKING
The management accountant’s role in decision-making is to provide information relevant to a
decision. Managers use this information in preparing a quantitative analysis of the problem
under review. Qualitative factors should also be considered before a final decision is taken.
The various decisions that are discussed in the textbook, includes the following:

 Limiting factor decisions

 outsourcing versus manufacturing (example 9.4)
 deletion of a market segment
 expansion of a product range
 acceptance of once-off sales opportunities at discounted selling prices (example 9.5)
 further processing of a product (examples 9.6 & 9.7)
 acceptance of special orders requiring the use of optimisation (see chapter 8).

Relevant Cost and Revenues

Decision making involves making a choice between two or more alternatives. The decision
will be ‘rational’; profit maximising. All decisions will be made using relevant costs and
revenues.
‘Relevant costs are future cash flows arising as a direct consequence of the decision
under consideration.’
There are three elements here:
Cash flows. To evaluate a decision actual cash flows should be considered. Non-cash items
such as depreciation and inter-divisional charges should be ignored.
Future costs and revenues. This means that past costs and revenues are only useful insofar
as they provide a guide to the future. Costs already spent, known as sunk costs, are irrelevant
for decision making.
Differential costs and revenues. Only those costs and revenues that alter as a result of a
decision are relevant. Where factors are common to all the alternatives being considered they
can be ignored; only the differences are relevant.
In many short-run situations the fixed costs remain constant for each of the alternatives being
considered and thus the marginal costing approach showing sales, marginal cost and
contribution is particularly appropriate.
In the long run (and sometimes in the short run) fixed costs do change and accordingly the
differential costs must include any changes in the amount of fixed costs.
Sunk cost: The cost of resources already acquired where the total cost will be unaffected by
the choice between various alternatives. These costs have already arisen and are as a result
of a past decision. In addition, they will not be changed by a decision made in the future. Sunk
costs are irrelevant for decision making because they will remain unchanged irrespective of
which alternative is chosen.
Committed cost: Costs that are subject to a binding contract in the future and are therefore
not relevant to the decision.

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Opportunity Cost

Opportunity cost is an important concept for decision-making purposes. It is the value of the
best alternative that is foregone when a particular course of action is undertaken. It
emphasises that decisions are concerned with choices and that by choosing one plan there
may well be sacrifices elsewhere in the business.
Example 1
A company which manufactures and sells one single product is currently operating at 85% of
full capacity, producing 102,000 units per month. The current total monthly costs of
production amount to £330,000, of which £75,000 are fixed and are expected to remain
unchanged for all levels of activity up to full capacity.

A new potential customer has expressed interest in taking regular monthly delivery of 12,000
units at a price of £2.80 per unit.

All existing production is sold each month at a price of £3.25 per unit. If the new business is
accepted, existing sales are expected to fall by 2 units for every 15 units sold to the new
customer.

What is the overall increase in monthly profit which would result from accepting the new
business?

A £1,200
B £2,400
C £3,000
D £3,600

The Relevant Cost of materials

If a particular material or component is needed for a course of action the relevant cost of that
material must be considered carefully. The following decision model may be used:

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 No

Are the materials

already in stock? Cost of purchase

Yes

Yes
Will they be
replaced? Replacement cost

No

Yes
Will it be used for
other purposes? Opportunity cost of
alternative use

No

Net realisable value

The flow chart hopefully provides a useful reminder of the points that must be considered
when ascertaining the relevant cost of materials.
Do remember to apply basic logic, consider relevant cash flows, and then use a bit of common
sense!

EXAMPLE 2 – RELEVANT COST OF MATERIAL

A firm is considering undertaking a contract for a special client.

The contract requires 200 kg of material D. There is a stock of 1,000 kg, which was bought
for £10/kg last year. The current resale value is £5/kg, although to buy in any extra
kilograms would cost £17/kg. There is no other use for material D, except as a substitute
for material E, which is in constant use. Details of material E are shown below:
£/kg
Original purchase price 8
Resale value 3
Replacement cost 15
What is the relevant cost of material D?
A nil

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 B £1,000

C £2,000

D £3,000

THE RELEVANT COST OF LABOUR

Yes
Is there spare
capacity? Nil

No

Can additional Yes

labour be hired? Direct labour cost

No

Contribution foregone plus direct labour

cost

Again, remember to apply basic logic, consider relevant cash flows, and then
use a bit of common sense!

EXAMPLE 3 – RELEVANT COST OF LABOUR

100 hours of skilled labour are needed for a special contract. The staff are working at
full capacity at the moment and the workers would have to be taken off production of a
different product in order to work on the special contract. The details of the other product
are shown below:
£/unit
Selling price 60 Direct material 10
Direct labour 1 hour @ £10/hour 10
Variable overheads 15 Fixed overheads 15

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 The skilled workers’ pay-rate would not change, regardless of which product they
worked on. What would be the relevant cost?

A nil

B £1,000

C £2,500

D £3,500

Long- term decision making

The approach to answering a short-term or long-term type question is very different. Therefore,
it is very important that you identify within a scenario whether it is requiring a short run or long
run decision to be made. For short run decisions, the understanding and application of the
following concepts is very important: relevant costs, sunk costs, opportunity costs/income,
incremental costs, avoidable costs etc.

Where a long run decision is required, students must be able to use the information in the
question to evaluate whether the income from the project covers all the costs in the longterm.
Usually a net present value is required in order to do this. In the long run, most costs and
revenues are relevant, as they can be changed by a decision, however in the short-term they
may not be.

Comprehensive Example – Relevant Costing

The manager of VO Ltd has been approached by KZC Ltd to provide a quotation for the
installation of a Fibre optic uptake for their Company Internet. The inexperienced manager
of VO responded that the quote would be done on a relevant costing basis. As the
management accountant of VO ltd you have been provided with the following information.

1.The manager of VO
- Took four days to cost the requirements; this took place because of the potential order.
- Cost per day is $3 500.
2. The project would require 2 600 metres of 30 Mbps cabling, which is in regular use. There
are 1 200 metres in inventory at a cost of $9 350 per metre with the current cost being $9 700
per metre.
3. 950 metres of 50 Mbps would be required for the project. This is not regularly used and
would have to be purchased specifically for the project. The supplier with the best pricing
supplies in quantities of 1 000 m @ $12 600 / metre. The closest other price is $12 985 / metre
for the specific length required.
4. 300 metres of 100 Mbps would be required at a cost of $16 400 / metre. VO has 200 metres
in inventory at $15 900 / metre which was provisionally booked out as a sale at $16 000/metre
as it was not anticipated to be used again. The client involved would accept $50 000 as a
cancellation fee.
5. 600 complete connectivity units. VO obtains these from a group company at $7 980 each,
on which the group company makes a mark-up of 40% to cover fixed costs. They currently
have capacity to produce and deliver 370 units on demand. With effect from yesterday the
group CEO posted the following notice “It is now group policy to value all internal transfers of

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inventory at Variable cost”. The Connectivity units can also be obtained externally at a market
price of $7 980.
6. A digger machine is required for the project. VO does not have spare capacity on the
required digger machine. This machine can either be hired on a monthly basis at $100 000 for
a month or on a daily basis at $6 000 per day. A minimum of 12 days’ work will be required for
the project.
7. 3 300 man-hours of labour will be required at a rate of $100 / hour. VO has spare capacity
of 2 400 hours from existing paid workers. Workers can either be redeployed from other
projects which deliver contribution of $40 per labour hour or be paid overtime at normal
industry overtime rates of 50%.
8. 100 hours of high-skilled engineering supervision will be required at $750/hour, also the
going market rate. A normal work week entails 40 hours should an external engineer have to
be hired. One of VO’s engineers offered to work 25 hours overtime on the project without
claiming for the overtime.
9. A fixed overhead allocation of $2 million is made on all projects of this size and scope.

Required:
(a) Prepare a schedule of all relevant costs for the fibre optic project from the VO
perspective. Inclusion or exclusion of costs should be motivated.
[Round all amounts to the nearest $’000] (12 marks)
(b) Provide a brief explanation for the term Differential Costs (1 mark)

COMMON TYPES OF DECISION

1 Limiting factor decisions

2 Make or buy decisions

3 Shutdown decisions (deleting a segment)

4 Accept or reject an order decisions

5 Pricing decisions

6 Joint product and further processing decisions

Limiting factor

Also known as principal budget factor or key budget factor. It is that factor which prevents a
company from achieving the output and sales that it would like. In practice the limiting factor
is often sales demand, but in the exam it may be a shortage of labour in total or a shortage of
one particular grade of labour or a shortage of material or machine capacity or capital or
anything the Examiner fancies.

Single limiting factor

If there is a just one limiting factor then the rule is to maximise the contribution per unit of
scarce resource. The contribution per unit of each product is calculated and divided by the
amount of scarce resource each product uses. The higher the contribution per unit of scarce
resource the greater the priority that should be given to the product. Once the priorities have
been decided the scarce resource is allocated to the products in the order of the priorities until
used up.

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Example 3:
Sable Chemicals Ltd produces three chemicals X, Y and Z. The selling price and cost per litre
for each of these products are budgeted as follows:

X Y Z
$/Litre $/LITRE $/Litre
Selling price 100 120 120
Direct materials 20 16 21
Direct labour ($6 per direct labour hour) 18 24 27
Other direct expenses - 3 -
Variable overhead 12 16 18
Fixed overhead

6 8 9

Notes:

1. The fixed overhead is absorbed on the basis of labour hours, based on a

budget of 440 hours per month.

2. Maximum demand for each product for month 4 is as follows:

X = 150 litres

Y = 40 litres

Z = 60 litres

3. Included in the maximum demand totals is an unavoidable commitment to a

major customer to supply 15 litres per month of each of the three products.

4. During month 4 there is a shortage of labour hours that will restrict production.
The total number of labour hours available is 375 hours.

5. Sable is able to produce and sell fractions of a litre.

Required Marks

(a) Determine the production mix that will maximise profit in month 4 and 12
calculate the resulting profit.

(b) After completing the production plan you are informed that new 4
environmental controls on pollution are to be introduced from the
beginning of month 4. These controls relate to the production of product
Z only, and will incur an additional fixed cost of $1 000

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 per month for each month that Z is manufactured. In addition you also
learnt that an overseas supplier will supply as many litres of chemical
Z as Sable Ltd needs at a cost of $100 per litre. Importation of Z will
not incur the additional fixed pollution control costs. Using the above
information calculate how much chemical Z (if any) should be
purchased by Sable Ltd from the overseas supplier in month 4.

(c) Briefly explain FOUR factors, other than costs or selling price, which 4
should be taken into consideration when deciding whether to
subcontract the manufacture of chemical Z.

Solution

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Practice Questions

Question 1 – Adopted from NUST past question paper CAC 4105 -2021

QUESTION 4 – APPLICATION OF MARGINAL COSTING PRINCIPLES.

The Floor Cleaner Division manufactures three types of floor cleaner, namely Product
F, Product L and Product O, which are sold in 750ml bottles. Details of the products
are as follows:

F L O
Product:
$/bottle $/bottle $/bottle

Selling price 30,00 22,00 26,50

Liquid A ($16 per litre) 4,80 3,20 5,60

Liquid B ($14 per litre) 4,20 3,50 2,80
Other ingredients and packaging 5,00 3,50 4,00
Variable overhead ($140 per machine hour) 4,20 2,80 4,20
Fixed overhead ($160 per machine hour) 4,80 1,60 1,60

Manufacturing profit 7,00 7,40 8,30

The machines used in this process can only be utilised for this particular manufacturing
process. The demand for the three products for February 2022 has been estimated as
follows (excluding fixed contracts):
F L O
Bottles 1 000 2 100 1 500

In addition to the demand above, fixed contracts with lodge clients have been signed
for the following quantities for February 2022:

F L O
Bottles 400 500 460

The Floor Cleaner Division does not hold any inventory of raw materials or finished
goods.
The management of BBCP has advised that the availability of Liquid A and Liquid B
will be restricted during February 2022 to 1 800 litres of Liquid A and 1 200 litres of
Liquid B, as advised by the only local supplier of these liquids. BBCP has no intention

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of venturing into the import market for these liquids. No restrictions are expected on
any other resources.

QUESTION 4

REQUIRED Marks

Sub- Total
total

(a) Calculate the optimum product mix to maximise BBCP’s floor

cleaner division’s profit for February 2022. Also calculate the
(18) (18)
number of bottles of product that cannot be supplied due to the
shortage of Liquid A and/or Liquid B.

(b) Briefly list BBCP’s major risks in terms of liquids A and B and then
explain why, in your opinion, it is reasonable for BBCP to import
these liquids.
(7) (7)
[Risks: 3 marks, import acquisition 4 marks]

Total for Question 4 25

Examiner Comments – the question was poorly and disappointingly done with a lot of
students exhibiting a very poor foundation or background of management accounting
techniques. Some students failed to interpret the requirements of the question and could not
tell the question required them to apply Limiting factor concepts.

Question 2 – Adopted from NUST past question paper CAC 4105 -2021

QUESTION 2 – DECISION MAKING PART A - relevant costing

The Bulawayo City Council is hosting a cultural day for schools in the City at ZITF
Grounds and has asked Hotdog to prepare a quote to provide each child with a
food package consisting of: One Easy-dog Hotdog, One Soft drink, One Health
bar. For the tender, the MD will assume a price for the Easy-dog of $12,50 from
the Supply Division. The MD is eager to get the contract as there are many of these
events country wide and he had a few ideas to maximise his profit:

• 350 children are expected to attend. As Hotdog wants to promote its

brand, it said it will provide 10% additional packages at cost to cover for any
additional children attending as well as free delivery.
• Soft drinks will have to be acquired. The current market price is $5,50
each. There are currently 150 cans in inventory which was acquired at $5,20
to send to the franchise-holders.

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 • Hotdog plans to provide an all-in-one parcel to the children by packing
everything into a polystyrene box. Since this differs from their normal
inventory, it will have to be acquired from a new supplier. There is however
a minimum order quantity of 400 at 50c per box
• The health bars are also not sold at the stores and will have to be
acquired at $4,50 each. The minimum order quantity is 2 000 bars. The MD
suggested that they sell the rest of the bars at their Bulawayo stalls as an
experiment.
• For packing and quality control of the parcel, workers will have to work
overtime. The MD will have to work 20 additional hours to prepare the
tender. His currently hourly rate is $450. Three wage earners who normally
earn $35/hour will work 4 hours’ overtime each for two days. The overtime
rate is calculated at 1,5 times the normal wage rate. The Supply division are
expected to work 10 hours’ overtime in preparation of the Easy-dogs. These
employees earn the same wage rates as the other wage labourers. Hotdog
subscribes to the Basic Conditions of Labour/Employment act.
• The MD has found that this will be the ideal time to buy a new delivery
vehicle he was planning on for a while now to help with operations at a cost
of $285 000. ZIMRA has allowed an annual 20% wear and tear deduction.
• Fixed overhead is allocated at a rate of $20 per labour hour.
• Variable overhead is expected at $2,50 per parcel. The MD expects a
20% mark-up on relevant cost.

QUESTION 2

REQUIRED Marks

Sub- Total
total

(a) Calculate the expected selling price per food package for the
special order linked to the Cultural Day on a relevant costing
basis. Clearly show the relevant cost value for each of the items.
Explain each relevant value you have evaluated and why the (8)
values you have excluded are not relevant.
Discuss whether it is likely that the municipality will accept the
deal. (2) (10)

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Practice Question 3

SHEPS Ltd is involved in the design and manufacture of train engines. The company has just
received an enquiry about the possibility of supplying 30 engines to a privatised transport
company NRAZ. The finance director of NRAZ has informed SHEPS Ltd that they have just
received quotes from other manufactures of train engines and that the most reasonable quote
was $145 000 per engine. The management accountant has provided you with the following
details relating to the costs involved in the construction of the train engines:
1. Each engine will require 12 litres of oil. The company has 300 litres of oil in stock and
if the oil is not used it will be disposed immediately. The cost of disposal is $1, 850.
The original purchase price of the oil in stock was $340 per litre. The replacement cost
is $350 per litre of oil.
2. Each engine will also require 15 sheets of alloy steel. The purchase price of a sheet
of steel is $3, 800 for all purchases up to and including 300 sheets. The supplier has
agreed to offer a discount of 10% on the purchase price on all purchases over 300
sheets.
3. Additionally, each engine will require 1 slab of cast iron and this type of iron is used
regularly by SHEPS Ltd. The company holds 22 of these slabs in the warehouse at
present. These slabs of cast iron cost $3,415 per slab.
4. The construction of the engines will require a combination of skilled and unskilled
labour. Each engine will require 35 skilled labour hours and 10 unskilled labour hours.
The skilled labourers are paid $180 per hour and the unskilled labourers are paid 55%
of the skilled labour hourly rate. If this contract does not go ahead there will be 300
skilled labour idle hours and he company is reluctant to make redundancies due to
continued loyalty towards its staff. The unskilled labour will have to be hired in for the
contract.
5. The project will require a project manager to oversee the work. SHEPS Ltd currently
employs a manager with the necessary experience who will be transferred to the
proposed project should it go ahead. This manager currently earns $78,000 per
annum. Due to the size of this project SHEPS Ltd has agreed to pay him an additionally
5% of his current salary. The project manager will then be replaced by a less
experienced manager who will be paid an annual salary of $65,000.
6. Variable overheads are absorbed at rate of $102 per skilled labour hour.
7. Fixed overheads will increase from their current level of $1,360,000 to $2,175,000 if
the project to produce engines is undertaken.
8. In order to assess the practicalities of taking on this project SHEPS Ltd employed a
company to research the availability of materials and experienced labour. This
research cost $11,000 and $4,000 is still outstanding. If SHEPS takes on the project
future research into safety issues will be required at a cost of $5,500.

Required:
(a) Provide a brief explanation for each of the following terms:
i. Sunk costs
ii. Committed costs
iii. Incremental cost
iv. Relevant cost
(b) Using relevant costing principles, determine whether or not SHEPS Ltd should
undertake the contract. Your answer must include an explanation for the inclusion for
the inclusion or exclusion of each of the points from points 1 to 8 above.

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(c) List

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 METHODS OF COST DETERMINATION (DIRECT AND ABSORPTION
COSTING)

The most important objective of product costing is to allocate the total manufacturing cost
incurred during a certain period to the total number of units manufactured during that period,
in order to calculate the manufacturing cost per unit. The manufacturing cost per unit is
therefore calculated simply by dividing the total manufacturing cost for a certain period by the
number of units manufactured during the period in question,
When the unit cost is known, this makes it easier to calculate the allocation of manufacturing
cost to units that are still in stock and to units that have been sold. This information is required
to calculate the net profit of the enterprise for the period, which is one of the most important
goals of cost accounting.
There are two divergent schools of thought on what should be included in unit cost. Some
people prefer absorption or full costing, but others favour direct or variable costing (also known
as MARGINAL COSTING).
The concept of absorption costing is taken to include both fixed and variable cost as integral
parts of the total manufacturing cost of a product. The concept of direct costing, on the other
hand, includes only the variable cost in the manufacturing cost of a product.
THE USES OF DIRECT AND ABSORPTION COSTING
Direct costing is also known as variable costing or marginal costing. Only variable
manufacturing cost, namely direct materials, direct labour and variable manufacturing
overheads, are taken into account when manufacturing cost is calculated in total or per unit.
All variable costs are taken into account, however, when marginal income is calculated. Fixed
manufacturing overheads are written off against income as period cost for the period in which
they are incurred.
According to the absorption costing method fixed manufacturing cost are included in the cost
of a product. The product therefore “absorbs” both variable and fixed manufacturing cost. The
larger the number of units of a product which are manufactured the lower the unit cost because
the same amount of fixed cost is divided among a larger number of products. When absorption
costing is applied, fixed cost are recovered on the basis of the number of units of a product
manufactured during the period.
When the number of units produced and the number of units sold are the same, that is when
there is no stock on hand, income statements drafted according to direct and absorption
costing methods will show the same net profit. If there is stock on hand, the difference in net
profit shown in income statements drafted according to the two methods can be reconciled by
taking into account the difference between opening and closing stock according to the two
approaches.
Information casg

Practice Questions

Question 1– UNISA Adopted

Lekker Rusks (Pvt) Ltd is a processor and distributor of the old South African favourite, rusks.
The owner Mr Biscuit, uses his grandmother’s secret family recipe to manufacture and
package rusks for resale.

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Lekker Rusks currently offers two types of rusks, buttermilk and muesli, both which are
processed and sold in 1kg boxes.
Budgeted Data for the 28 February 2010, year-end are as follows:
Buttermilk Muesli Company

Units sold(boxes) 1 500 000 700 000

Per Unit (dollars) $ $ $

Sales price 38,5 55
Direct materials 12 15,5

Cost in Total (Dollars)

Manufacturing Overheads Fixed 45 000 000
Manufacturing Labour Fixed 25 000 000
Admin Salaries Fixed 777 000
Sales and Distribution Fixed and variable 8 280 000

Mr Kuda, the management accountant, provided the following information in respect of the
actual figures for the year ended 28 February 2010:

Sales $/unit 39 57
Materials $/unit 12,7 15
Manufacturing Overheads $ 44 000 000
Manufacturing Labour $ 24 000 000
Admin Salaries $ 777 000
Sales and distribution $ 8 000 000
Inventory - 1 March 09 ($) 2 000 000 1 485 000
Inventory - 28 February 2010 ? ?

No inventory of raw materials or work in process are held.

All baked rusks are packaged and taken into inventory.
Assume that there are no expired goods on hand. i.e. all inventory have been sold before
expiry date and thus nothing should be written off.
1. Assume that the budgeted closing inventory = actual closing inventory (per above quantity
schedule).
2. The inventory on 1 March 2009 includes fixed manufacturing overhead and fixed
manufacturing labour.

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 3. Manufacturing labour and fixed overheads are based on normal capacity of 1 000 000 hours
per year.
For the year ending 28 February 2010 the following information is applicable:

Buttermilk Muesli

Budgeted labour hours 450 000 550 000

Actual labour hours 460 000 555 000

4. Admin salaries and sales and distribution costs are divided on a 50/50 basis between the
two products.
$3 000 000 of the budgeted sales and distribution costs are fixed and the actual fixed costs
equalled the budgeted fixed costs.
5. There is no difference between budgeted and actual depreciation.

REQUIRED Marks

(a) Prepare an income statement for the year ended 28 February 2010 on the
absorption costing basis.
(20)
Show as much detail as possible and round all calculations off to 3 decimals.

(b) Calculate Lekker Rusks (Pty) Ltd’s Rand budgeted break-even point based on (5)
expected sales of 1 350 000 boxes buttermilk and 450 000 boxes muesli.

Total 25

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