MANAGEMENT ACCOUNTING 278 (SAICA)

MANAGEMENT DECISION-MAKING AND CONTROL

Introduction to Management Accounting, Cost Terms and Concepts

Cost estimation and Cost behaviour

Study material

Drury - Chapters 1 & 2 (see also commentary on the PowerPoint-slides)

Drury Chapter 3 (Only p.57 – 59; p.62 – 64: p.69 – 70 excluding calculations)

The following sections of Chapter 1 in Drury fall outside the scope of Management Accounting
278:
- “Summary of the contents of the book” p. 24
- “Guidelines for using the book” p. 24 – 25

The following sections of Chapter 2 in Drury are self-study:

- “Relevant and irrelevant costs and revenues” p. 42
- “Avoidable and unavoidable costs” p. 43
- “Sunk cost” p. 43
- “Opportunity costs” p. 43 – 44
- “Incremental and marginal costs” p. 45 – 46

The following section of Chapter 2 in Drury falls outside the scope of Management Accounting
278:
- “The cost and management accounting information system” p. 47 – 48

The following sections of Chapter 3 in Drury falls outside the scope of Management
Accounting 278:
- “Inspection of the accounts” p. 59 – 60
- “Graphical or scatter graph method” p. 60 – 62
- “Tests of reliability” p. 65 – 66
- “Relevant range and non-linear cost functions” p. 67
- “A summary of the steps involved in estimating functions” p.68
- Calculations relating to the learning curve p.71 – 72
- “Estimating incremented hours and incremental cost” p. 72 – 73
- ‘Multiple regression analysis” p.73 – 74

1
SAICA Technical competencies – Learning outcomes and Minimum content

PERFORMANCE MEASUREMENT FOR MANAGEMENT AND OTHER INTERNAL USERS OF FINANCIAL

C1
INFORMATION

C1.1 Decision-making based on price setting and capacity utilization information

Level Learning Outcomes Minimum content Topic

a) Evaluate financial information · Criteria for relevant information Cost terms & classification (Nature
that is relevant to decision-making · Nature of costs of costs; Cost classification; Cost
regarding price setting and capacity o Cost classification objects)
utilisation o Cost behaviour
o Cost estimation Cost estimation & behaviour (Cost
2 o High-low behaviour; Cost estimation; High-
o Cost objects Low)

Joint & byproducts (Sell or process

further)

Specific learning outcomes

For specific learning outcomes for this topic, see your textbook, Chapters 1, 2 & 3. Please
take the abovementioned exclusions (see study material) into account.

2
CLASS EXAMPLE

COST
PER
Cost element Usage unit Price Usage UNIT =
BATCH
DIRECT COSTS

Direct material 26.12

Margarine Gram R20 per 400 gram 166 gram 8.30
Sugar Gram R10 per 250 gram 83 gram 3.32
Egg Units R2 per egg 1 egg 2.00
Cake Flour Gram R25 per kg 500 gram 12.50

Direct labour Hours R25 per hour 3.6 hours 90.00

PRIME COSTS 116.12

INDIRECT COSTS / MANUFACTURING OVERHEAD COSTS

TOTAL
COSTS NUMBER OF BATCHES
Warehouse costs 50 000.00
Indirect labour 12 000.00
Electricity 8 000.00
Cleaning 2 500.00
72 500.00 25 000.00 2.90

TOTAL MANUFACTURING COSTS 119.02

PERIOD
EXPENSES
Selling expenses 2.50
Marketing costs 4.00
Administration
costs 12.00

FULL COST 137.52

3
CALCULATOR EXAMPLE

Least squares method - CALCULATOR

Period Maintenance
M/hours
cost
X y
1 400 960
2 240 880
3 80 480
4 400 1 200
5 320 800
6 240 640
7 160 560
8 480 1 200
9 320 880
10 160 440

Steps to calculate the value for a (fixed costs), b (variable cost rate) and r (correlation
coefficient): Orange
Display
C ALL
Press to clear stats memory 0.00
∑+
Enter 400 INPUT 960 1.00
∑+
Enter 240 INPUT 880 2.00
∑+
Enter 80 INPUT 480 3.00
∑+
Enter 400 INPUT 1 200 4.00

Enter 320 INPUT 800 ∑+ 5.00

Enter 240 INPUT 640 ∑+ 6.00

Enter 160 INPUT 560 ∑+ 7.00

∑+
Enter 480 INPUT 1 200 8.00

Enter 320 INPUT 880 ∑+ 9.00

Enter 160 INPUT 440 ∑+ 10.00

Press ∑x 2 800

Press ∑y 8 040


Press ∑xy 2 540 800

Press ∑x2 928 000

Blue
4
Press 0 ŷ, m to display value of a 240.89

Press SWAP to display value of b 2.01

Orange
Key:

= shift (Oranje)

= stats (Blou)

Note: You must ALSO be able to do the formulas for the above calculations.

5
QUESTION 1

PART A
Albatross Limited is a manufacturing company who is currently busy with their budget for
the 2013 financial year, with regards to their oil consumption expense account, which is
used in their manufacturing machines. The following data was made available for the past
year (2012):

Month Machine hours Oil consumption usage

(‘000) (‘000)
R
July 34 640
Aug 30 620
Sept 34 620
Oct 39 590
Nov 42 500
Dec 32 530
Jan 26 500
Feb 26 500
March 31 530
April 35 550
May 43 580
June 48 680

Required:

Calculate the cost function for the oil consumption account by using the necessary formulas
for the following methods:
i) The hi-low method;
ii) The regression analysis method.

PART B
Mugs Limited manufactures coffee mugs. Costs for January during which 200 000 mugs were
manufactured, are as follows:

Direct materials 300 000

Direct labour 450 000
Indirect manufacturing (overhead) costs:
Indirect materials (Variable) 30 000
Indirect labour (Fixed) 54 000
Other variable costs 24 000
Other fixed costs 66 000
Selling expenses 81 000
Administrative expenses 162 000

REQUIRED

(a) Calculate the manufacturing cost per mug for January.

(b) Calculate the manufacturing cost per mug if it is estimated that 250 000 mugs will be
produced in February and that all monthly expenses will remain unchanged.

6
QUESTION 1 – SUGGESTED SOLUTION
PART A

1. i) Hi - low method:

Machine hours (‘000) Oil usage Expense (‘000)

High 48 680
Low 26 500
Dif 22 180

Variable cost: R180 000/22 000 = R 8.18

Fixed cost: R 500 000 = a + 8.18(26 000)
a = R 287 272

Cost function: y = R 287 272 + 8.18x

ii) Regression analysis:

Month Machine hours Oil usage expense

(‘000) (‘000) XY X²
X Y
July 34 640 21 760 1 156
Aug 30 620 18 600 900
Sept 34 620 21 080 1 156
Oct 39 590 23 010 1 521
Nov 42 500 21 000 1 764
Dec 32 530 16 960 1 024
Jan 26 500 13 000 676
Feb 26 500 13 000 676
March 31 530 16 430 961
April 35 550 19 250 1 225
May 43 580 24 940 1 849
June 48 680 32 640 2 304
420 6 840 241 670 15 212

Calculate b:

B = N∑XY - ∑X∑Y =
N∑X² - (∑X)²

B = 12(241 670) – (420)(6 840)

12 (15 212) – (420)²

= 2 900 040 - 2 872 800

182 544 – 176 400

= 27 240/6144
= 4.4335939

A = ∑y - b∑x = 6840/12 – 4.43(420)/12 = 414 950

N N

Y = 414 950 + 4.43x

7
PART B
(a) Manufacturing cost per unit for January:
Variable manufacturing costs based on 200 000 units: R
Direct materials 300 000
Direct labour 450 000
Indirect manufacturing costs (30 000 + 24 000) 54 000
Subtotal 804 000
Fixed manufacturing costs (54 000 + 66 000) 120 000
924 000
Cost per unit = R924 00/200 000 Units = R4,62
(b) Estimated manufacturing cost per unit for February:
Variable = R804 000/200 000 Units R4,02
Fixed = R120 000/250 000 Units R0,48
R4,50

8
QUESTION 2

The following information is supplied to you:

1. Budgeted output for the year 19 600 units

2. Standard details per unit:

Direct material: 80m2 at R10,60 per m2
Direct labour:
- Department 1: 48 hours at R15 per hour
- Department 2: 30 hours at R13,80 per hour

3. Other budgeted costs and hours for the year:

R Labour
Hours
Variable manufacturing overhead costs:
(Allocated based on direct labour hours)
Department 1 750 000 500 000
Department 2 300 000 300 000

Fixed costs: R
Manufacturing 7 840 000
(Allocated based on production units)
Selling and distribution 3 920 000
Administrative 1 960 000

REQUIRED

(a) Calculate the following per unit costs:

i) Prime cost
ii) Variable manufacturing cost
iii) Total manufacturing cost
iv) Total cost (full cost)

9
QUESTION 2 – SUGGESTED SOLUTION

a) Cost per unit:

(i) Prime cost: R
Direct material: (80 x 10,60) 848
Direct labour:
Department 1: (48 x 15) 720
Department 2: (30 x 13,80) 414
1 982

(ii) Variable manufacturing cost:

Prime cost 1 982
Variable manufacturing overhead cost:
Department 1: (750 000 ÷ 500 000 x 48 hours) 72
Department 2: (300 000 ÷ 300 000 x 30 hours) 30
2 084

(iii) Total manufacturing cost:

Variable 2 084
Fixed (7 840 000 ÷ 19 600) 400
2 484

(iv) Total cost (full cost):

Total manufacturing cost 2 484
Fixed selling and sitribution cost:
(3 920 000 ÷ 19 600) 200
Fixed administration cost: (1 960 000 ÷19 600) 100
2 784

10
QUESTION 3

Please note that the different subsections of Question 1 do not relate to one another and
that different sections must be read and answered as separate questions.

PART A (13 marks; 23 minutes)

The establishment of supermarkets and hypermarkets is an everyday phenomenon in the

South African retail industry (a hypermarket is a very large supermarket, usually larger than
3 600m² and is established on the outskirts of a town or city). These businesses sell large
quantities of groceries and other consumer goods on a self-help basis. They usually do
purchases directly from the manufacturers of products and therefore wholesalers are cut
from the purchase chain. It is operated on low profit margins and high sales quantities.
There are a reasonable number of super- and hypermarket groups in South Africa and these
stores are responsible for more than 55% of the national retail food sales.

PiekNiek Limited is a local supermarket group that was founded in 1976 with four small
shops in the Western Cape. Today the business has grown to an established, international
supermarket group and sells fresh products, groceries, general goods, clothing, liquor and
pharmaceutical supplies. PiekNiek Limited is operated on a total gross profit margin of
approximately 18% - 19% and an average net profit margin of 3% - 3.5%. Furthermore a
substantial part of the retail group’s total costs consists of fixed costs. Reasons for the
substantial amount of fixed costs are among other things the large premises which is leased
at fixed rental expenses, a large work force which manages the day-to-day activities of the
retail group and fixed technological expenses for the use of the cash registers.

It is however difficult to calculate net profit margins for individual products - this is because of
the countless costs products attract from the moment it is delivered at the inventory
warehouse until it reaches the cashiers where a sales transaction is recorded. Each of these
costs will need to be considered in order to calculate a true unit cost.

REQUIRED

a)Explain why full costs will be brought into calculation for the calculation of net profit
margins, but not for the calculation of gross profit margins. (3)

b) Discuss, with reference to the given information on PiekNiek Limited and the industry
in which they operate, why an accurate costing system is important for PiekNiek’s
internal decision-making process. (10)

11
PART B (4 marks, 7 minutes)

The opportunity to host the Soccer World Cup in South Africa gave this country the chance
to redefine perceptions of the country by the successful execution and completion of a world-
class tournament.

During the initial decision-making process regarding whether or not to have the World Cup in
South Africa the financial profitability of the tournament was considered by taking into
consideration all the estimated income and costs which would arise from this tournament. An
initial estimate of the costs was between $4 billion - $6 billion (among other things for
stadiums, security, transport and communication systems). Initial estimated income from
ticket sales and contributions from FIFA was approximately $1 billion.

REQUIRED

Financial information as well as qualitative factors must be considered during the decision-
making process. Name any long-term qualitative factors which should have been considered
when the profitability of the Soccer World Cup in South Africa was analysed. (4)

PART C (6 marks, 11 minutes)

Afrifurn Limited and Countryfurn Limited both manufacture furniture. Afrifurn Limited
classifies glue as a direct material, whereas Countryfurn Limited classifies it as an indirect
material.

Afrifurn manufactures one type of wooden table, and one type of steel table. A fair amount of
glue is used in the manufacturing of the wooden table. Countryfurn manufactures a wide
variety of wooden tables. Very little glue is used in the manufacturing of the tables, and the
cost of the glue is insignificant. In addition, the design of the manufacturing process is of
such a nature that the cost of the glue cannot easily be traced to a single product.

REQUIRED

Explain in detail why a raw material like glue can be classified as a direct raw material by
one furniture manufacturer and as an indirect raw material by another furniture
manufacturer. (6)

12
QUESTION 3 – SUGGESTED SOLUTION

PART A

a) Full cost includes all manufacturing or purchase costs PLUS all periodic expenses,
e.g. marketing costs (1). When net profit is calculated, the periodic expenses are
taken into account (deducted from gross profit as other expenses) (1) Gross profit is
however calculated by taking the costs of goods sold and the value of inventory into
account (1), which specifically excludes periodic expenses (1).

Maximum 3 marks can be earned.

b) Accurate costing systems are specifically important to PiekNiek, as a result of the

following industry-specific factors

- To allocate costs between costs of goods sold and inventory, means the
profitability of products can be determined (1). This is important so as to
determine whether or not a product must be discontinued due to the costs
exceeding the income. (1)
- In order to provide management with relevant information so that decisions
regarding the selling prices of the products can be made (1).
- To do planning - budgets cannot be compiled without the necessary accurate
cost information (1). There must also be determined how much working capital
will be needed in order to maintain sufficient inventory levels (1).
- The fact that products attract multiple (countless) costs from purchase to sale,
makes the accuracy of the costing system even more important than simply just
considering purchase prices when full cost is calculated (1).
- The business depends on large sales volumes at low prices. This means the
margin for errors or inaccurate cost apportionment is small (1). If costs are not
allocated accurately, the products which might cause losses will continue to be
sold (1). The cost of errors is therefore high.
- A large portion of the business’s costs consist of fixed costs- which means that
fixed costs or indirect costs must be allocated accurately in order to ensure that
the costs will be recovered (1).
- As result of heavy competition costs must be kept as low as possible at all times
(1) Costs cannot be managed effectively without accurate cost records (1).
- In the heavy competitive environment products and services must constantly be
improved at the lowest possible costs (1).

Maximum 9 marks can be earned.

13
PART B

Long-term qualitative factors which must be considered during the decision-making process:

- The World Cup and specifically the building of stadiums will create job
opportunities. Although theses job opportunities will only be created for the short-
term, it will contribute to the overall welfare of residents and create the
opportunity to promote workmanship.
- A positive world-image of South Africa is created- it promotes tourism, etc.
- Possible stronger police force after resources are allocated to the police force
during the preparation for the World Cup.
- Improvement in the transport system of the country - long-term benefit for all
South Africans
- Improvement of communication systems.
- World-class stadiums which will be available for future use and generating
income.

Any other valid point.

One point per factor, maximum 4 marks can be earned.

PART C

A direct raw material is traced back, while an indirect raw material is allocated. (½).
Information must be obtained in order to trace back a raw material, such as the number of
cost-objects, cost of direct raw materials per cost-object, etc. (½)

Glue can be classified as an indirect raw material cost if:

 the cost of the glue is not material and therefore not worth tracing back to every
product (1) ;
 the cost of tracing back glue to products is high in comparison to the benefit to be
obtained (1);
 a wide variety of products are manufactured in which glue is used (1);
 The design of the manufacturing process is of such a nature that the cost of the glue
cannot be easily traced back to a single product (1).

The decision whether the cost of glue will be classified as a direct raw material or indirect
raw material is therefore based on the cost-benefit principle (1).

Any other valid comment (1).

14
QUESTION 4

The following information was obtained from the accounting records of Yorkshire Limited for
the six months ending 30 June 20XX:

Number of products Total semi-variable overhead

Month
manufactured costs
R
January 180 4 000
February 200 4 150
March 190 4 100
April 170 3 800
May 205 4 200
June 185 4 050

REQUIRED:

Compute the fixed cost per month and the variable cost per product by using the following
techniques:

(a) High low method.

(b) Simple regression (least-squares technique).

15
QUESTION 4 – SUGGESTED SOLUTION

(a) High low method

Number of Total semi-
products variable costs
manufactured
R
Highest 205 4 200
Lowest 170 3 800
Difference 35 400

 Variable manufacturing overhead costs: R400/35 = R11.43 per product

Highest production:
Variable overhead costs: 205 x R11.43 = R2 343.15
Fixed overhead costs: R4 200 - 2 343.15 = R1 856.85

OR
Lowest production:
Variable overhead costs: 170 x R11.43= R1 943.10
Fixed overhead costs: R3 800 - R1 943.10 = R1 856.90

 Fixed overhead cost = R1 857 per month

 Variable overhead costs = R11.43 per product (4)

(b) CALCULATE USING YOUR CALCULATOR

Simple regression (least-squares technique)

Month Production- Semi-variable

volume overhead costs
X Y XY X2
R R
January 180 4 000 720 000 32 400
February 200 4 150 830 000 40 000
March 190 4 100 779 000 36 100
April 170 3 800 646 000 28 900
May 205 4 200 861 000 42 025
June 185 4 050 749 250 34 225
1 130 24 300 4 585 250 213 650

The two equations are – FIRSTLY CALCULATE B AND THEN B:

B = N∑XY - ∑X∑Y = 6(4 585 250) – 1 130(24 300)

N∑X² - (∑X)² 6(213 650) – (1130)²

B = R10.50

A = ∑y - b∑x = 24 300/6 – [10.50(1130)/6] = A = R2 072.50

N N

16
QUESTION 5

The management accountant in co-operation with the production- and sales manager of
Wacco Limited has gathered the following information regarding a new plant that will start
with production on 1 January 20XX:

- Production for the year 1 250 units

- Sales for the year 1 250 units
- Fixed cost for the year R18 942.00
- Variable production cost R35.00 per unit
- Semi-variable production overhead for the year R9 605.00
- Sales price per unit R65.80
- Inventory holding: material and WIP on month end Naught

Semi-variable
Month Production volume Sales budget production
overheads
Units Units R
Jan - Feb 200 200 1 535
Mrch - Apr 215 215 1 640
May - Jun 220 200 1 705
Jul - Aug 190 195 1 470
Sep - Oct 195 205 1 533
Nov - Dec 230 235 1 722
1 250 1 250 9 605

REQUIRED:

Calculate the variable- and fixed component of the semi-variable production overhead costs
by applying the following methods:

(i) High low method

(ii) Simple regression (least-squares technique) with observance of the following

calculations by the management accountant:

Production Semi-variable
volume overhead costs
X y xy x2
Months
Jan - Feb 200 1 535 307 000 40 000
Mar -Apr 215 1 640 352 600 46 225
May - Jun 220 1 705 375 100 48 400
Jul - Aug 190 1 470 279 300 36 100
Sep - Oct 195 1 533 298 935 38 025
Nov - Dec 230 1 722 396 060 52 900
1 250 9 605 2 008 995 261 650

17
QUESTION 5 – SUGGESTED SOLUTION

(i) High low method

Semi-variable production
Number of units
overheads
R
Highest (Nov - Dec) 230 1 722
Lowest (Jul - Aug) 190 1 470
40 252

 Variable overhead costs: R252

/40 = R6.30 per unit

Highest production:

Variable overhead costs : R230 x R6.30 = R1 449

Fixed overhead costs : R1 722 - R1 449 = R273

Lowest production

Variable overhead costs : 190 x R6.30 = R1 197

Fixed overhead costs : R1 470 - R1 197 = R273 for two months

ANSWER
Variable overhead costs: R6.30 per unit
Fixed overhead costs: R273 for two months

(ii) Simple regression (least-squares technique)

The two equations are – FIRSTLY CALCULATE B AND THEN A:

B = N∑XY - ∑X∑Y = 6(2 008 995) – (1250)(9605)

N∑X² - (∑X)² 6(261 650) – (1250)²

B = R6.44865

A = ∑y - b∑x = 9605/6 – [6.4486(1250)/6]

N N

A = R257.36

18
QUESTION 6

Runners World Proprietary Limited (‘RW’) manufactures a range of sportswear and gadgets.
One of its products is running socks, which is manufactured in the Socks Division. The
following communication recently took place between the managing director of RW, Matthew
Roberts, and the manager of the Socks Division, Christel Gevana:

From: [email protected]
To: [email protected]
Date: 8 June 2022, 8:10
Subject: Poorer than expected performance of the Sock Division

Dear Christel,

It has come to my attention that your division is not financially performing as well as
expected. At this stage the underperformance is still regarded as small but seeing that the
product (socks) trades in a highly competitive market, with very small profit margins and
high sales quantities, I believe we should take corrective action as soon as possible.
Please let me know your thoughts on the matter so we can strategise accordingly.

Regards,
Matthew Roberts

From: [email protected]
To: [email protected]
Date: 8 June 2022, 08:55
RE: Poorer than expected performance of Sock Division

Dear Matthew,

Yes, the financial information of my division shows that we are just not covering our costs,
even though our pricing policy is to determine the selling price per pair of socks by adding
a 0.95 percent profit markup on total variable product (manufacturing) cost per pair of
socks.

I believe our problem lies with the accuracy of our costing information, especially with our
analysis of the cost behaviour of our maintenance department’s costs. The maintenance
department only renders maintenance services to our production department’s machinery.
Currently, we use the high-low method to distinguish between fixed and variable
maintenance costs for planning and decision-making purposes. I have asked the senior
accountant to assist us in analysing the behaviour of the maintenance cost by using the
least squares method – a more statistical method of analysing cost behaviour than the
high-low method.

I will send you feedback as soon as I have more information.

Regards,
Christel Gevana

19
Christel provided the senior accountant with the following information regarding the
maintenance department (you may assume this information is correct):

Annual total production units (i.e.,

Year Total annual maintenance cost
total number of pairs of socks)
2014 30 000 R397 500
2015 36 000 R453 000
2016 24 000 R333 000
2017 27 000 R360 000
2018 39 000 R543 000
2019 33 000 R442 500
2020 48 000 R606 000
2021 45 000 R600 000

Extract from notes to the above table:

Σ (total maintenance cost x annual production units) = R137 812 500 000
Σ (total maintenance cost)2 = R1 821 595 500 000
Σ (annual production units)2 = R10 440 000 000

Marks
QUESTION 2 – REQUIRED Sub- Total
total
(a) Given the Sock Division’s pricing policy, discuss in detail how
the maintenance costs ought to be treated in relation to each
pair of socks when determining a selling price per pair of socks.
Structure your discussion as follows:
- the classification (in detail) and cost behaviour of
maintenance cost in relation to each pair of socks; and
- the statement made by Christel Gevana regarding using
the least squares method rather than the high-low
method to estimate cost behaviour.

No calculations are required.

9 9
(b) Establish the equation which will allow Christel Gevana to
predict annual total maintenance cost for a given level of
production units using the least squares method. 4 4
Total 13

20
QUESTION 6 – SUGGESTED SOLUTION

a)

Background/explanatory information to the solution:

- In this scenario, the cost object is a pair of socks.
- The selling price policy of the Sock division requires that only product
(manufacturing) costs, which are also variable in nature in relation to each pair of
socks, are considered when a selling price is determined (i.e., these are the costs to
which a profit markup of 0.95 percent will be added).
- Therefore, firstly, it needs be determined whether maintenance costs can be
classified as a product cost for pairs of sock (product cost which can be further
classified as either direct or indirect) and secondly, what portion of maintenance is
fixed and/or variable, using either the high-low method or the least squares
regression method.

Classification:
 Since the maintenance is rendered to the production department in which socks are
manufactured, the overhead costs can be regarded as a product (manufacturing)
cost-item (in comparison to a non-manufacturing) .
 Maintenance costs cannot be specifically and exclusively traced to each pair of socks
(and it also won’t be economically viable to do so) . Therefore, maintenance cost
should be classified as indirect product costs (or overhead costs) in relation to pairs
of socks .

Cost behaviour:
 However, only the variable portion of manufacturing costs, i.e., only the portion of
maintenance cost that varies directly in relation to the number of production units, ought
to be included for the purpose of this company’s selling price determination (definition
of variable cost).
 Maintenance cost (or the portion thereof) that remains constant regardless of the
number of production units is a fixed costs and will be excluded from the cost
information for the purpose of selling price determination (definition of fixed cost).

Cost estimation:
 Different methods, with different accuracy levels, could be used to estimate cost
behaviour, for example the high-low method and the least squares method.

High-low method:
o The high-low method consists of selecting the periods of highest and lowest activity
levels and comparing the changes in costs that result from the two levels, ignoring
all cost observations other than the observations for the highest and lowest activity
levels.
o Unfortunately, cost observations at the extreme ranges of activity level are not
always typical of normal operating conditions and therefore may reflect abnormal
rather than normal cost relationships.
o The use of the high-low method is ostensibly much easier than using the least
square method, the former which renders less accurate results. 

Least squares method:

o The least square method is a mathematical method of determining the regression
line of best fit, considering all cost observations.
o Hence, this method is regarded superior, in terms of accuracy, to the high-low
method. 

21
Christel Geneva’s statement:
 It is submitted that, based on the industry conditions in which the Socks Division trades,
more accurate cost information is required, suggesting the use of the more complex, yet
more accurate, least squares method to determine cost relationships and behaviour
rather than the high-low method is justified. This is substantiated by the following
industry conditions:
o The business depends on large sales volumes at low profit markup percentages
(0.95% on variable manufacturing costs). This means the margin for errors or
inaccurate cost assignment is small. If costs are not assigned accurately, the
selling prices may be uncompetitive (too high) or socks are sold at (too low) selling
prices, which might cause losses for RW.  The cost of errors is therefore high,
necessitating accurate cost assignment.
o As a result of heavy competition in the sport socks industry, costs must be always
kept as low as possible. Costs cannot be managed effectively without accurate
cost records.
Maximum 9 marks

b)

Cost estimation equation:

y = a + bx,
where y = total cost; a = total fixed cost; b = variable cost per unit of activity level; x = activity
level (total units).

Least squares method:

Students can make use of the formulae and manually solve ‘a’ and ‘b’ or make use of their
financial calculators:

∑x = 282 000 ½
∑y = 3 735 000 ½

B = n∑xy - ∑x∑y ½
n∑x² - (∑x)²
B = [(8 x 137 812.5) – (282 x 3 735)] / [(8 x 10 440) - (282) 2]
B = 49 230 / 3 996
B = 12.3198...
B = 12.32 ½m

A = ∑y – ½ B(∑x)
n n
A = (3 735 / 8) – (12.32 x 282) / 8
A = 466.88 – 434.27
A = 32.60135 (rounded off to nearest thousand, thus R32 601.35) ½m

Thus, y = R32 601.35 + 12.32x m

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CALCULATOR METHOD

Steps to calculate the value for a (fixed costs), b (variable cost rate) and r (correlation
coefficient): Orange
Display
C ALL
Press to clear stats memory 0.00

Enter 30 000 INPUT 397 500 ∑+ 1

Enter 36 000 INPUT 453 000 ∑+ 2

Enter 24 000 INPUT 333 000 ∑+ 3

Enter 27 000 INPUT 360 000 ∑+ 4


Enter 39 000 INPUT 543 000 ∑+ 5

Enter 33 000 INPUT 442 500 ∑+ 6

Enter 48 000 INPUT 606 000 ∑+ 7

Enter 45 000 INPUT 600 000 ∑+ 8

Press ∑x 282 000 ½m

Press ∑y 3 735 000½m



Press ∑xy 137 812 500 (given)

Press ∑x2 10 440 000 000 (given)

Blue

Press 0 ŷ, m to display value of a 32 601.135½m

Press SWAP to display value of b 12.32½m

Orange
Key:

= shift (Orange)

= stats (Blue)

Thus, y = R32 601.35 + 12.32x m

Notes: Students are not penalised for rounding differences.

4 marks

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