Cost and Management Accounting

Annual requirement $D = 40{,}000$ units, $EOQ = 4{,}000$ units.

Carrying cost per unit $H = 10\% \times 20 =$ Rs 2.

$EOQ = \sqrt{\frac{2DS}{H}} \Rightarrow 4000^2 = \frac{2 \times 40{,}000 \times S}{2}$

$S = \frac{16{,}000{,}000}{40{,}000} = 400$

Ordering cost per order = Rs 400

Variable cost per unit $= 8 + 6 + 4 =$ Rs 18.

Fixed factory overhead rate $= 100{,}000/20{,}000 =$ Rs 5 per unit, so the full production cost is $18 + 5 =$ Rs 23 per unit.

Opening stock $= 20{,}000 - 19{,}000 = 1{,}000$ units (valued at Rs 23); closing stock $= 1{,}000 + 21{,}000 - 20{,}000 = 2{,}000$ units.

Income statement under absorption costing, 2079

Reconciliation without preparing the variable costing statement

The profit under absorption costing is Rs 5,000 higher because stock rose by 1,000 units, each carrying Rs 5 of fixed overhead forward.

Carrying cost per unit $C = 10\% \times 20 = \text{Rs } 2$.

$EOQ = \sqrt{\frac{2AO}{C}} \Rightarrow 600^2 = \frac{2 \times 36000 \times O}{2}$

$360000 = 36000\,O \Rightarrow O = \text{Rs } 10 \text{ per order}$

Working notes

• Variable manufacturing cost per unit $= 6 + 6 + 5 = \text{Rs } 17$.
• Fixed manufacturing overhead $= 5 \times 30{,}000 = \text{Rs } 150{,}000$ per year (Rs 5 per unit absorbed).
• Year 2: opening stock $= 25{,}000 - 23{,}000 = 2{,}000$ units; closing stock $= 2{,}000 + 25{,}000 - 26{,}000 = 1{,}000$ units.

(a) Income statement under variable costing, Year 2

(b) Profit under absorption costing

Fixed overhead in inventory changes from $2{,}000 \times 5 = 10{,}000$ to $1{,}000 \times 5 = 5{,}000$ (the same rate Rs 5 is used in both years).

$\text{Absorption profit} = 69{,}200 + (1{,}000 - 2{,}000) \times 5 = 69{,}200 - 5{,}000 = \text{Rs } 64{,}200$

(Check: Sales 780,000 less COGS $26{,}000 \times 22 = 572{,}000$, under-absorbed overhead $25{,}000$, selling expenses $118{,}800$ gives $64{,}200$.)

Two objectives of cost accounting:

1. Ascertainment of cost: to determine the cost of each product, job, process or service accurately, so that selling prices can be fixed properly.
2. Cost control: to compare actual costs with standards or budgets, find the variances and take corrective action to reduce waste and inefficiency.

Perpetual inventory system is a method of recording inventory in which the balance of every item of material or goods is updated continuously after each receipt and issue. Bin cards and stores ledger show the stock on hand at any time, so the closing stock is known without a physical count. Physical verification is done on a continuous basis, item by item, throughout the year to check the records.

A semi-variable (mixed) cost is a cost that has both a fixed and a variable component. A fixed amount is incurred even at zero activity, and beyond that the cost changes in proportion to the level of activity. It is expressed as $Y = a + bX$, where $a$ is the fixed part and $b$ the variable cost per unit. Examples are telephone bills (rental plus call charges) and electricity (minimum charge plus consumption charge).

Opportunity cost is the benefit or profit given up by choosing one alternative instead of the next best alternative, because resources are limited. It is not recorded in the books of account but is relevant for decision making.

Example: if a firm uses its own building for production instead of renting it out for Rs 50,000 a year, the Rs 50,000 rent forgone is the opportunity cost of using the building.

Premium plan is a wage incentive (bonus) system that pays a worker for the time actually taken plus a premium (bonus) for the time saved against a standard or allowed time. The two best-known forms are the Halsey plan, where the worker gets a fixed share (usually 50%) of the time saved, and the Rowan plan, where the bonus is the proportion of time saved to time allowed, applied to the time taken. The worker is always guaranteed the time-rate wage, so the plan encourages efficiency without any risk of earning less than the basic wage.

Standard time $= \dfrac{2{,}000}{15} = 133.33$ hours.

Under the Gantt task bonus scheme, a worker who completes the standard task in the standard time (output equal to standard) is paid the time wage for the standard time plus a bonus of 20% of it.

$\text{Time wage} = 133.33 \times 30 = \text{Rs } 4{,}000$

$\text{Bonus} = 20\% \times 4{,}000 = \text{Rs } 800$

Total wages = 4,000 + 800 = Rs 4,800

Total cost at normal capacity $= 5{,}000 \times 70 =$ Rs 350,000.

Variable cost $= 350{,}000 - 100{,}000 =$ Rs 250,000, so variable cost per unit $= 250{,}000/5{,}000 =$ Rs 50.

At 80% capacity, units $= 4{,}000$.

$\text{Total cost} = 4{,}000 \times 50 + 100{,}000 = \text{Rs } 300{,}000$

Fixed overhead rate $= 32{,}000/4{,}000 =$ Rs 8 per hour, so the variable overhead rate $= 20 - 8 =$ Rs 12 per hour.

Budgeted overhead for actual hours worked:

$32{,}000 + 12 \times 2{,}900 = 32{,}000 + 34{,}800 = \text{Rs } 66{,}800$

$\text{Overhead spending variance} = 66{,}800 - 65{,}000 = \text{Rs } 1{,}800 \text{ (Favourable)}$

Re-order level = maximum consumption $\times$ maximum delivery time, so maximum consumption $= 6{,}000/10 = 600$ units per day.

$\text{Maximum stock level} = ROL + ROQ - (\text{min. consumption} \times \text{min. delivery time})$

$8{,}000 = 6{,}000 + ROQ - (400 \times 6)$

$ROQ = 8{,}000 - 6{,}000 + 2{,}400 = 4{,}400$

Reorder quantity = 4,400 units

Limitations of cost-volume-profit (CVP) analysis:

1. Linearity assumption: it assumes that selling price per unit and variable cost per unit are constant, so revenue and total cost are straight lines. In practice discounts and economies of scale change them.
2. Fixed costs assumed constant: fixed cost is taken as constant over the whole range, but it rises in steps when capacity is expanded.
3. Single product or constant mix: it assumes one product or a constant sales mix, which is unrealistic for multi-product firms.
4. Production equals sales: it ignores changes in inventory.
5. Difficult cost separation: semi-variable costs are hard to split into fixed and variable parts accurately.
6. Ignores other factors: it overlooks time value of money, inflation, technology change and competitors' actions.
7. Short-term tool: the results hold only for the relevant range and a short period, so long-term decisions based on it can be wrong.

Fixed overhead rate $= 150{,}000 / 60{,}000 =$ Rs 2.50 per labour hour, so fixed overhead per unit $= 2 \times 2.50 =$ Rs 5.

Variable overhead per unit $= 8 - 5 =$ Rs 3.

Hours needed $= 25{,}000 \times 2 = 50{,}000$, which is within the 60,000 hours of capacity, so the fixed overhead does not change whether the company makes or buys. It is therefore irrelevant.

Making saves Rs 1 per unit, i.e. $500{,}000 - 475{,}000 =$ Rs 25,000 a year.

Decision: the company should make the component, because the differential cost of making (Rs 19) is lower than the purchase price (Rs 20).

Actual input $= 70 + 130 = 200$ kg; actual output $= 185$ kg.

Standard input for actual output $= 185/0.90 = 205.56$ kg. Standard mix: A $= 40\% = 82.22$ kg, B $= 60\% = 123.33$ kg.

$SC = 82.22 \times 20 + 123.33 \times 30 = 1{,}644.44 + 3{,}700 = \text{Rs } 5{,}344.44$

$AC = 1{,}470 + 4{,}160 = \text{Rs } 5{,}630$

(a) Material cost variance $= SC - AC = 5{,}344.44 - 5{,}630 =$ Rs 285.56 (A)

(b) Material price variance $= (SP \times AQ) - AC$

• A: $20 \times 70 - 1{,}470 = 1{,}400 - 1{,}470 = 70$ (A)
• B: $30 \times 130 - 4{,}160 = 3{,}900 - 4{,}160 = 260$ (A)
• Total = Rs 330 (A)

(c) Material usage variance $= SP \times (SQ - AQ)$

• A: $20 \times (82.22 - 70) = 244.44$ (F)
• B: $30 \times (123.33 - 130) = 200$ (A)
• Total = Rs 44.44 (F)

(d) Material mix variance $= SP \times (RSQ - AQ)$, where the revised standard quantity of the 200 kg is A 80 kg and B 120 kg.

• A: $20 \times (80 - 70) = 200$ (F)
• B: $30 \times (120 - 130) = 300$ (A)
• Total = Rs 100 (A)

(e) Material yield variance $=$ usage $-$ mix $= 44.44 + 100 =$ Rs 144.44 (F)

Check: $330 \text{ (A)} - 44.44 \text{ (F)} = 285.56$ (A) equals the cost variance, and $100 \text{ (A)} + 144.44 \text{ (F)} = 44.44$ (F) equals the usage variance.

Apportionment of overheads (total Rs 156,000)

Overhead rate per machine hour

$\text{Department A} = \frac{93{,}055.56}{3{,}000} = \text{Rs } 31.02$

$\text{Department B} = \frac{62{,}944.44}{2{,}000} = \text{Rs } 31.47$

The statement is correct as far as it goes. Inventory management is the planning, control and supervision of materials and goods so that the right quantity is available at the right time and place at the lowest cost. Its main aim is continuous supply, because a stock-out stops production, idles workers and machines, delays deliveries and loses customers. But supply must not be secured by holding excess stock, so the objectives must be balanced.

Main objectives of inventory management

1. Uninterrupted production: keep enough material and stores so that production is not stopped for want of materials. This is the objective the statement stresses.
2. Minimum investment: avoid over-stocking, which blocks working capital and raises carrying costs such as storage, insurance, interest and obsolescence.
3. Minimum total cost: balance ordering cost against carrying cost, for example by using the Economic Order Quantity, $EOQ = \sqrt{\frac{2DS}{H}}$ where $D$ is annual demand, $S$ the ordering cost per order and $H$ the carrying cost per unit.
4. Customer service: keep finished goods so that orders are met on time.
5. Protection of materials: prevent loss by theft, pilferage, damage, deterioration and obsolescence through safe storage and proper records.
6. Purchase advantages: take quantity discounts and buy at favourable times and prices.
7. Reliable records: keep accurate stock records and carry out perpetual or periodic verification, so that the cost of materials used is known.

Techniques used to achieve the objectives

• Stock levels: re-order level, minimum level, maximum level and danger level. For example, re-order level = maximum consumption $\times$ maximum delivery time.
• EOQ and the two-bin system to fix order quantities and timing.
• ABC analysis: tight control over the few high-value items and simple control over the many low-value ones.
• Perpetual inventory and continuous stock-taking.
• Just-in-time (JIT) purchasing, to reduce stock while still avoiding shortages.

Conclusion: ensuring regular supply so that production does not stop is the primary objective of inventory management. But it must be achieved at minimum cost and minimum investment, by keeping the stock between the minimum and maximum levels.

The statement is correct. Management accounting collects, analyses and presents financial and non-financial information in a form that helps managers to plan, control and decide. Unlike financial accounting, it is internal, forward-looking and addressed to management, and it need not follow a fixed legal format.

1. Planning

Management accounting supplies the information needed to set objectives and prepare plans, using forecasts, budgets, standard costs and CVP analysis. For example, break-even analysis shows the sales a firm needs to reach a target profit, and the budget turns the plan into figures for each department.

2. Controlling

• Actual results are compared with budgets and standards, and variances such as material, labour and overhead variances are analysed.
• Responsibility accounting makes each manager answerable for the costs and revenues under his or her control.
• Management by exception directs attention only to significant deviations, so corrective action is taken in time.

3. Decision making

It provides relevant (differential) costs and benefits for decisions such as:

• make or buy;
• accept or reject a special order;
• add or drop a product or department;
• sell at the split-off point or process further;
• fix selling prices and choose the product mix when resources are limited;
• capital budgeting (investment appraisal).

4. Other contributions

• It helps to coordinate departments through budgets and gives managers performance reports.
• It supports performance measurement through ratios, the balanced scorecard and segment profitability.
• It supports communication and motivation, since targets are known and results are reported.

Limitations: the information depends on estimates and forecasts, it is only a tool and not a substitute for management judgement, and it is costly to maintain.

Conclusion: by providing relevant information for planning, controlling and decision making, management accounting helps managers to use resources efficiently and to achieve the organization's objectives.

Assumptions: a year of 360 days (12 months of 30 days); a double room is charged at 1.5 times a single room.

(a) Operating cost statement (annual)

(b) Room charge per day

Occupied room-days, expressed in single-room equivalents:

$\text{Charge per single room per day} = \frac{3{,}048{,}000}{15{,}120} = \text{Rs } 201.59$

$\text{Charge per double room per day} = 1.5 \times 201.59 = \text{Rs } 302.38$

(i) Profit volume ratio

$P/V = \frac{\Delta \text{Profit}}{\Delta \text{Sales}} = \frac{15{,}000 - (-15{,}000)}{700{,}000 - 500{,}000} = \frac{30{,}000}{200{,}000} = 15\%$

(ii) Fixed cost

At sales of Rs 700,000: contribution $= 15\% \times 700{,}000 = 105{,}000$.

$\text{Fixed cost} = 105{,}000 - 15{,}000 = \text{Rs } 90{,}000$

(Check at Rs 500,000: $75{,}000 - 90{,}000 = -15{,}000$.)

(iii) Break-even point in Rs

$BEP = \frac{90{,}000}{0.15} = \text{Rs } 600{,}000$

(iv) Break-even point in units at selling price Rs 100:

$\frac{600{,}000}{100} = 6{,}000 \text{ units}$

(v) Sales to earn a profit after tax of Rs 30,000 (tax rate 25%):

$\text{Profit before tax} = \frac{30{,}000}{0.75} = 40{,}000$

$\text{Sales} = \frac{90{,}000 + 40{,}000}{0.15} = \text{Rs } 866{,}667$

(vi) Profit when sales are Rs 1,000,000

$0.15 \times 1{,}000{,}000 - 90{,}000 = \text{Rs } 60{,}000$

(vii) Margin of safety ratio when actual sales are Rs 900,000:

$MOS = \frac{900{,}000 - 600{,}000}{900{,}000} = 33.33\%$

Seven months' percentages add up to 100%, so the 200,000 units are spread over Chaitra to Ashwin. Monthly sales (units): Chaitra 30,000; Baisakh 40,000; Jestha 30,000; Ashad 20,000; Shrawan 20,000; Bhadra 40,000; Ashwin 20,000.

(a) Sales budget

(c) Production budget (units; closing stock = 20% of next month's sales)

Opening stock of Baisakh is 20% of Baisakh sales, i.e. 8,000 units.

(d) Material purchase budget (2 kg per unit; closing material = 50% of next month's requirement; Bhadra production is 36,000 units, so Bhadra requirement is 72,000 kg)

(e) Labour budget (2 hours $\times$ Rs 3 = Rs 6 per unit)

(f) Manufacturing overhead budget (variable Rs 3 per unit; fixed Rs 120,000 / 12 = Rs 10,000 per month)

(g) Cost of goods sold budget

Finished stock is valued at the variable manufacturing cost of Rs 29 per unit (material 20 + labour 6 + variable overhead 3), and the fixed overhead is charged in full to the month.

Check: 110,000 units sold $\times$ 29 + fixed overhead 40,000 = Rs 3,230,000.

(h) Why organizations prepare functional budgets

1. Planning: each function (sales, production, purchase, labour, overhead) gets a detailed plan in line with the organization's objectives.
2. Coordination: the production budget is based on sales and the purchase budget on production, so departments work together without shortages or surplus.
3. Control: actual results are compared with the budgets, and variances are investigated.
4. Resource planning: they show the materials, labour, machine time and cash needed in advance.
5. Motivation and responsibility: managers have clear targets and are held responsible for their budgets.
6. Basis for the master budget: the functional budgets are combined into the master budget (budgeted income statement, balance sheet and cash budget), which supports decisions.

Using the high-low method:

$\text{Variable cost per unit} = \frac{1800-1200}{500-200} = \frac{600}{300} = \text{Rs } 2$

$\text{Fixed cost} = 1200 - (200 \times 2) = \text{Rs } 800$

$\text{Total cost for 600 units} = 800 + (600 \times 2) = \text{Rs } 2000$

Time wages $= 18 \times 20 = \text{Rs } 360$.

Under Halsey (50% sharing), bonus $= 380 - 360 = \text{Rs } 20$.

$20 = 50\% \times (\text{time saved} \times 20) \Rightarrow \text{time saved} = 2 \text{ hours}$

So standard (allowed) time $= 18 + 2 = 20$ hours.

Rowan bonus:

$\frac{\text{Time saved}}{\text{Time allowed}} \times \text{Time taken} \times \text{Rate} = \frac{2}{20} \times 18 \times 20 = \text{Rs } 36$

$\text{Total wages under Rowan Plan} = 360 + 36 = \text{Rs } 396$

Electricity is apportioned on light points (140 : 160 = 7 : 8) and depreciation on asset values (200000 : 400000 = 1 : 2).

Management accounting is the process of identifying, measuring, analysing and reporting financial and non-financial information for the internal use of management. Unlike financial accounting, which reports to outsiders such as shareholders and creditors, its purpose is to help managers plan, control and make decisions. Hence the statement is true.

The information is useful to management in the following ways:

1. Planning: budgets, forecasts and profit plans are prepared from cost and revenue data.
2. Decision making: relevant costs and cost-volume-profit analysis help in decisions such as make or buy, accepting a special order, pricing, and product mix.
3. Control: standard costing, variance analysis and responsibility accounting compare actual with planned performance and show where action is needed.
4. Performance evaluation: divisional and managerial performance is judged using segment reports and ratios.
5. Coordination and communication: reports pass information between departments and levels of management.

It is not bound by accounting standards, it is future oriented, may use non-monetary data and is prepared at the frequency management needs. So all its information is directed to the needs of management.

Working notes

• Capacity: 25,000 DMH; each unit needs 0.25 DMH, so full capacity $= 100{,}000$ units.
• Present use: $70{,}000 \times 0.25 = 17{,}500$ DMH. Spare capacity $= 7{,}500$ DMH $= 30{,}000$ units.
• The offer of 40,000 units needs $10{,}000$ DMH, so $2{,}500$ DMH (10,000 units) must be taken from regular production and sales.
• Fixed overhead per DMH $= 200{,}000 / 25{,}000 = \text{Rs } 8$, i.e. Rs 2 per unit. Variable overhead per unit $= 5 - 2 = \text{Rs } 3$.
• Variable cost per unit $= 8 + 6 + 3 = \text{Rs } 17$. Regular contribution $= 20 - 17 = \text{Rs } 3$ per unit.

(a) Differential cost analysis

Fixed costs are unchanged and irrelevant. The offer price (Rs 16) is below the variable cost (Rs 17) and it also displaces regular sales, so the company should not accept the offer.

(b) Opportunity cost

If the offer is accepted, 10,000 regular units are given up, so the opportunity cost is the lost contribution of $10{,}000 \times 3 = \text{Rs } 30{,}000$.

Standard data (input 1000 kg, loss 10%, so standard output $= 900$ kg)

Actual: X $350 \times 8 = 2{,}800$; Y $650 \times 11 = 7{,}150$; total $1{,}000$ kg, Rs 9,950. Actual output $= 950$ kg.

Standard cost for actual output $= 9{,}700 \times \dfrac{950}{900} = \text{Rs } 10{,}238.89$. Standard quantity for actual output: X $= 316.67$ kg; Y $= 738.89$ kg.

1. Material cost variance

$= 10{,}238.89 - 9{,}950 = \text{Rs } 288.89 \text{ (F)}$

2. Material price variance $= AQ(SP - AP)$

• X: $350 \times (9-8) = 350$ (F)
• Y: $650 \times (10-11) = 650$ (A)
• Total $= \text{Rs } 300$ (A)

3. Material usage variance $= SP(SQ - AQ)$

• X: $9 \times (316.67 - 350) = 300$ (A)
• Y: $10 \times (738.89 - 650) = 888.89$ (F)
• Total $= \text{Rs } 588.89$ (F)

4. Material mix variance $= SP(\text{RSQ} - AQ)$, where the revised standard quantity is 1,000 kg in the ratio 3 : 7 (X 300, Y 700)

• X: $9 \times (300-350) = 450$ (A)
• Y: $10 \times (700-650) = 500$ (F)
• Total $= \text{Rs } 50$ (F)

5. Material yield variance $= (\text{Actual yield} - \text{Std yield}) \times \text{Std cost per kg output}$

$= (950 - 900) \times \frac{9{,}700}{900} = \text{Rs } 538.89 \text{ (F)}$

Check: Usage $= 50 + 538.89 = 588.89$ (F); Cost $= 588.89 - 300 = 288.89$ (F).

Assumptions: cost of goods sold $= 60\%$ of sales (gross profit 40%); closing stock of each month $=$ next month's cost of sales; depreciation is $10\%$ p.a. on fixed assets (including the furniture bought on 1 January); the bank loan is taken at the beginning of January when needed, interest ($1\%$ per month) is paid only on the loan repaid, and there is no income tax.

(a) Merchandise purchase budget (Rs)

(b) Selling and administrative expenses budget (Rs)

Cash payment of selling expenses is in the same month; administrative expenses are paid in the following month (January pays 75,000 for December, February pays 67,500, March pays 75,000).

(c) Cash budget (Rs)

Collections: cash sales 20%; credit sales 80%, collected 50% in the month, 30% next month, 20% in the month after.

Interest: February repayment $68{,}000 \times 1\% \times 2 = 1{,}360 \approx 1{,}400$; March repayment $40{,}000 \times 1\% \times 3 = 1{,}200$. Loan outstanding at the end of March $= 120{,}000 - 68{,}000 - 40{,}000 = 12{,}000$.

(d) Budgeted income statement, January to March (Rs)

(e) Budgeted balance sheet at 31 March (Rs)

Accounts receivable $= 50\%$ of March credit sales $(180{,}000)$ $+ 20\%$ of February credit sales $(80{,}000) = 260{,}000$.

(f) Total fixed and variable costs (January to March)

Variable costs: cost of goods sold 840,000 + selling 140,000 + administrative 210,000 $=$ Rs 1,190,000 (85% of sales). Fixed costs: depreciation 7,500 + interest 2,600 $=$ Rs 10,100.

(g) Breakeven sales

$\text{P/V ratio} = \frac{1{,}400{,}000 - 1{,}190{,}000}{1{,}400{,}000} = 15\%$

$\text{Breakeven sales} = \frac{10{,}100}{0.15} = \text{Rs } 67{,}333$

(h) Sales for an after-tax profit of Rs 42,000

$\text{Profit before tax} = \frac{42{,}000}{1-0.30} = \text{Rs } 60{,}000$

$\text{Required sales} = \frac{10{,}100 + 60{,}000}{0.15} = \text{Rs } 467{,}333$