ADVANCED MANAGEMENT ACCOUNTING TECHNIQUES

PROFESSIONAL Advanced Management
MODULE-V
Accounting
ICPAP
Institute of Certified Public Accountants of
Pakistan
Advanced Management Accounting ICPAP
Theory
Explain how technological change, globalization, and customer needs can affect
an organization and its management accounting system.
Technological change offers opportunities for new products and services and
more efficient methods of operations. Globalization forces organizations to be
more concerned about their customers and operating efficiently. Customer needs
continually change. Organization and their management accounting systems
must adapt to these changes.
Identify strategies for achieving customer value.
Customer value can be achieved through innovative product/service design,
quality, and low cost.
Describe features of organizations that promote decisions to achieve their
goals.
To achieve their goals, organizations must assign responsibilities, measure
performance, and compensate their numbers.
Explain the critical role played by management accounting in making planning
and control decisions to help managers create organizational value.
Management accounting improves planning decisions by providing decision
makers with more information to make better decisions. Management accounting
also supports control decisions by assisting in the assignment of responsibilities
and establishing performance measures to motivate individuals.
Identify the trade-offs that exist in using information for making planning and
control decisions and for external reporting.
Using the same accounting system for making planning and control decisions and
for external reporting leads to trade-offs. Employees will bias information used
for planning purposes if the information is also used as a benchmark for
measuring performance. External report will similarly be affected if also used to
evaluate performance.
Identify the roles of different types of management accountants.
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Controllers are responsible for the accounting systems within the organization.
Internal auditors monitor members of the organization to determine whether
prescribed procedures are being followed.
Recognize the role of judgement and ethics in making management accounting
choices.
The management accountant must use judgement in resolving trade-offs arising
from different uses of accounting information. This judgement should recognize
the effect of decisions on all involved parties. A code of ethics assists the
management accountant in making decisions.
Use differential costs and benefits to assist in cost/benefit analysis.
Differential analysis identifies the costs and benefits that very across alternative
decisions. Only differential costs and benefits are relevant for decisions because
all other factors are the same for each possible decision.
Identify and measure opportunity costs for making planning decisions.
Opportunity cost is defined in terms of alternative uses of a resource. The size of
the forgone opportunity of using the resource is the measure of the opportunity
cost.
Ignore sunk costs for making planning decision.
Sunk costs are costs that have already been incurred and are not relevant for
planning decisions.
Use cost/benefit analysis to make information choices.
Additional information should be gathered if the benefit of improved decision
making is greater than the cost of the information.
Determine how activity costs vary with the rate of output.
The cost of the first few units of an activity’s output tends to be quite high. At
normal production levels, the cost of additional units of ac5tivity tends to be
lower. When the activity nears capacity, the cost of additional units of activity
output tends to be higher.
Calculate marginal and average costs.
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The marginal cost is the cost of one more unit of output, which is the slope of the
total cost curve. The average cost is the total cost of the activity divided by the
number of units of output.
Approximate activity costs using variable and fixed costs.
Approximating costs by fixed and variable costs assumes that initiating the
activity has a cost, which is the fixed cost. Subsequent units of the activity output
are assumed to cost the same amount per unit, which is the variable cost per unit.
Use the account classification and high/low methods to estimate variable and
fixed costs.
The account classification method identifies fixed and variable costs by
categorizing different cost accounts. The high/low method uses the past highest
and lowest output data points to estimate fixed and variable costs.
Use regression to estimate variable and fixed costs. (Appendix)

Regression analysis uses historic outputs and costs to estimate fixed and variable
costs.
Treat products as cost objects for making product mix and pricing decisions.
Estimating the cost of a product allows managers to estimate the product’s
profitability and whether to include that product in the product mix.
Identify activities of the organization related to its different products and
services.
The organization’s activities are either directly or indirectly linked to its different
products and services.
Estimate the direct costs of a product or service.
Direct product and service costs are divided into direct labor and direct materials.
Estimates of direct labor costs can be made by estimating the labor time required
to make a product or provide a service and multiplying that labor time by the
estimated wage rate of laborers. The direct material cost is estimated by
determining the necessary parts and materials and multiplying by their respective
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prices. The labor rates and price of materials are intended to approximate the
opportunity cost of using the labor and materials.
Identify different levels of indirect product costs.
Indirect product costs are unit level if they vary by the number of units, batch
level if they vary by the number of batches, product level if they vary by the
number of products, and facility level if they vary the number and size of
facilities.
Trace indirect product costs using a cost driver.
Indirect costs are traced to products using the following steps: (1) identifying
activities, (2) estimating the cost of activities, (3) selecting the cost driver for each
activity, (4) estimating the total usage of the cost driver, (5) calculating the cost-
driver application rates, (6) and applying indirect activity costs based on usage of
the cost drivers.
Use activity-based costing to estimate the cost of a product or service.
Activity-based costing identifies activities that cause indirect costs and cost
drivers that can be sued to trace those activity costs to different products and
services. An application rate is calculated for each cost driver to apply the indirect
costs.
Recognize the advantages and problems of using activity-based costing.
Activity-based costing recognizes that indirect costs vary with different levels of
operations. Indirect costs also have different causes, and appropriate cost drivers
are chosen to reflect these differences. Activity-based costing does not adjust for
fixed opportunity costs and presumes that indirect costs vary with the usage of
the cost driver.
Use product costs for financial reporting.
Product costs in financial reports are dictated by generally accepted accounting
principles (GAAP). Whether a cost is a period or a product cost for financial
reporting purposes potentially influences shareholder wealth, management
compensation, and taxes.
Select a competitive strategy for an organization.
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The critical success factors to compete and to increase customer value include
offering innovative products and services, high-quality products and services,
and low costs.
Use activity-based management to reduce an organization’s costs without
affecting customer value.
Activity-based management identifies the non-value-added activities as areas for
potential cost reduction.
Make trade-offs in the product life cycle to reduce overall product costs.
Most costs of a product are predetermined by its design. Improved design can
reduce the cost of manufacturing, delivering, maintaining, and disposing of the
product.
Use target costing to select viable products and reduce product cost.
Target costing identifies the product opportunity first. Then a multifunctional
team determines whether and how the organization can offer the product and still
make a profit.
Estimate the costs of using different suppliers.
The cost of a supplier includes the costs of the late delivery, inspections,
unpacking, warehousing, purchasing, and quality.
Use supply chain management to operate more efficiently and reduce costs.
Supply chain management focus on relations with both suppliers and customers.
Cooperating and sharing information with both of these groups can reduce costs
for all parties.
Estimate customer profitability.
The cost of a customer includes the cost of the product or service sold plus the
cost of customer service, fright charges, and collection. These costs should be
compared with the revenues from that customer to determine customer
profitability.
Make pricing decisions that maximize organizational value.
Organizational value is maximized when price and quantity of output are chosen
at the output level at which the marginal cost equals the marginal revenue.
Explain why some organizations use cost-based pricing.
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Cost-based pricing may be used when customer value is difficult to estimate,

contract and price regulations are based on costs, and long-term customer
goodwill and competition are factors.
Balance the assignment of responsibilities the choice of performance measures,
and the compensation based on performance.
The assignment of responsibilities, the choice of performance measures, and the
compensation system should be consistent with each other and should change
simultaneously when the organizational structure changes.
Link responsibilities with individuals who have the specific knowledge to
make decisions.
Ideally, responsibilities within an organization should reside with the individual
with the best information related to the decision or with an individual in a
position to receive the information. The responsibilities should be assigned to the
person with the knowledge, or the knowledge should be transferred to the person
with the responsibility for making the decision. The method chosen depends on
the relative costs of transferring responsibilities or the knowledge.
Recognize self-interest in motivating individuals within organizations.
Individuals join organizations and work in them to better their own welfare. The
benefits each individual receives form joining the organization must exceed the
costs that individual bears. Self-interested individuals do not automatically seek
to further the organization’s goals unless incentive systems motivate such
behavior.
Identify the costs and benefits of monitoring members of an organization.
Monitoring individuals within an organization to determine whether they are
properly performing their duties is costly. Someone must observe their behavior
or measure the results of their actions. Without some monitoring, however,
individuals will not always perform their duties to benefit the organization.
Choose performance measures that reveal actions of members of an
organization.
Performance measures should reveal the actions of the individuals being
evaluated and be consistent with the organization’s goals. The measures should
not be easily manipulated by the individual being evaluated.
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Design compensation contracts based on performance measures and

responsibilities assigned.
Individuals within an organization should have compensation contracts the
motivate them to act in the organization’s best interest. The performance rewards
should be matched to and coordinated with the performance evaluation system
and the responsibilities assigned to the person. All legs of the three-legged stool
must match.
Design internal control systems by separating the planning process from the
control process.
Responsibilities associated with making planning decisions, such as initiation and
implementation, should be separated from responsibilities for control, such as
ratification and monitoring.
Identify control issues within an organization.
The purpose of control is to motivate individuals within the organization to act in
its best interests.
Use the controllability principle to choose performance measures for managers.
Managers should be evaluated based on the activities that they control.
Performance measures should reflect those controllable activities.
Identify responsibility centers based on the extent of each manager’s
responsibilities.
Managers who have responsibilities over only the input mix of their activities are
mangers of cost centers. Managers who have responsibilities over only the input
and output mix of their activities are mangers of profit centers. Managers who
have the additional responsibilities to change the size of their responsibilities
center are mangers of investment centers.
Cost-Volume-Profit Analysis:
Cost-volume-profit (CVP) analysis is a method that examines a product’s
profitability at different sales volumes. As more units of the product are sold,
both revenues and costs increase. CVP estimates the change in profit with a
change in units sold. It makes certain assumptions about revenues and product
costs to simplify the analysis.
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The first assumption is the separation of product costs into fixed and variable.
Therefore,
Total product costs = Variable costs + Fixed Costs
= (VC/units)(Q) + FC
Where
VC = Variable cost per unit
Q = Number of units produced and sold
FC = Fixed Costs
By assuming that the total product costs are either fixed or variable, capacity
constraints are not recognized. The variable cost per unit is assumed to be
constant over all levels of production. For example, suppose a cellular telephone
costs $10 a month plus $0.08 per minute. The telephone’s fixed cost is $10 and its
variable cost is $0.08 per minute.
The second assumption is that all units of the product sell for the same price.
Every customer pays the same price for the product, and the price remains the
same no matter how many units are sold. The revenues generated from the sale of
the product, therefore, are calculated as follows:
Revenues = (P)(Q)
Where
P = Sales price per unit
Under CVP, profit from the product is simply the revenues less the costs and can
be determined as follows:
Profit = Revenues – Variable costs – Fixed costs
Using the previous assumptions, the profit equation for CVP analysis can be
written as follows:
Profit = (P)(Q) – (VC/Unit)(Q) – FC
Rearranging the profit equation yields
Profit = (P-VC/Unit)(Q) – FC
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The sales price per unit minus the variable cost per unit is called the contribution
margin per unit, which is the increase in profit caused by making and selling one
additional unit of the product or service. The fixed costs do not change as
additional units are made. For example, if the contribution margin of making a
car is $5,000, selling 100 more cars will increase profit by ($5,000)(100), or
$500,000. Through the contribution margin per unit, CVP analysis is particularly
useful in estimating the short-term profit impact of selling more or fewer units.
Break-Even Analysis:-
CVP analysis also can be used for making planning decisions with longer time
horizons. In planning for an investment is a new product, information about the
number of units that must be sold to break even or have zero profit is useful. If
the organization cannot hope to sell enough units of the new product to break
even, than it should not make the investment. Break-even analysis determines
the sales level in units at which zero profit is achieved. Using variable and fixed
costs to approximate product costs, the equation solves for the number of units at
which profit equals zero:
0=(P-VC)(Q) –FC
FC = (P-VC)(Q)
FC/(P-VC) = Q
The break-even quantity is simply the fixed costs divided by the contribution
margin per unit.
Achieving a Specified Profit
The profit equation also can be sued to determine the necessary amount of a
product or service that must be produced and sold to achieve a specified target
profit. Instead of setting the profit equal to zero, the profit can be set at a specified
amount and the profit equation can be used to solve for the required number of
units produced and sold:
Profit = (P-VC)(Q) – FC
Profit + FC = (P – VC) (Q)
(Profit + FC)/(P-VC) = Q
The necessary number to achieve a certain profit is the sum of the profit and fixed
costs divided by the contribution margin per unit.
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Most firms are interested in the cash flow available after paying income taxes. An
extension of CVP analysis provides the number of units that must be sold to
achieve a specified after-tax profit.
Numerical Example:
Suppose that Laura Gonzalez, the Chicken vendor who pays $100 per day to rent
her cart, wants to make a $60 profit per day. She sells Chickens for $1 and the
variable costs of making the Chicken are $0.20 per Chicken. How many Chickens
must Laura sell per day to have a profit of $60?
Solution:-
The necessary quantity to have a profit of $60 is as follows:
(Profit + FC)/(P-VC) = ($60 + $100)/($1 - $0.20) = 200 Chickens
Graph of CVP Analysis:-
CVP analysis can be represented easily by a graph. Below figure demonstrates
“Chicken vendor” Laura Gonzalez’s CVP problem. The total cost line is in the
same form as the variable and fixed cost approximation of opportunity costs. The
chicken vendor’s fixed cost of $100 is the intercept of the vertical axis. The
variable cost of $0.20 per chicken is the slope of the total cost line. The total
revenue line is a straight line that extends from the origin. The slope of the total
revenue line is equal to the sales price of $1 per unit.
The break-even point occurs when total costs equal total revenues, which occurs
where the two lines intersect. The shaded area to the left of the break-even
number represent the expected loss if fewer chickens are produced and sold. The
shaded area to the right of the break-even number represents the expected profit
if more chickens are produced and sold. From previous Numerical Example, we
see that producing and selling 200 hot dogs a day achieves a $60 profit.
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CVP Analysis and Opportunity Costs:-

CVP analysis is used for planning purposes; therefore, the opportunity costs are
the appropriate costs to measure. The cost of using noncash resources to make the
product should reflect the alternative use of that resource. Also, if the investment
being considered involves the long-term use of cash, the planning decision should
recognize that there is an opportunity cost of using cash. If cash is borrowed, the
interest expense should be included in the analysis as a fixed cost of the product.
If the organization has available cash for a long-term investment in a product, the
investment prevents the organization from receiving interest on the cash. That
forgone interest expense of borrowed cash plus the foregone interest of available
cash used to make the investment.
Numerical Example:-
Paul McDonald is thinking about buying a farm that costs $400,000. He can
borrow $300,000 for the purchase at 10% interest but must use $100,000 of this
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own cash for the remainder. What is the annual cost of financing the investment
in the farm?
Solution:-
External financial reports in the form of an income statement would recognize
only the 10% interest on the loan (0.10)($300,000), or $30,000, annually. For CVP
analysis, however, there is a foregone opportunity of using the $100,000 cash buy
the farm. If the cash had earned 10%, the cost of financing for CVP analysis is
(0.10)($400,000), or $40,000, annually.
Problem with CVP Analysis:-
CVP analysis is simple to use. It approximates activity costs using fixed and
variable costs while the sales price and variable cost per unit are assumed
constant over all levels of output. These simplifications allow us to estimate profit
by looking at the difference between two straight lines. Most likely, however, cost
and revenue estimates are only reasonable approximations within a small range
of output levels.
Approximating costs with fixed and variable costs
We learned that fixed and variable costs only approximate cots in an intermediate
range of outputs. That range is the relevant range. At low levels of output,
product costs are likely to be less than the sum of fixed plus variable costs. Also,
as an organization nears capacity, its product costs are likely to be higher than
fixed plus variable costs. Therefore, CVP analysis should not be used at low levels
of output or at output levels near capacity.
Assuming a Constant Sales Price
In most markets, if you want to sell more units, you must lower your sales price.
Assuming that you can sell very large amounts at a constant price is unrealistic.
CVP analysis has no explicit assumption of a constraint in production or sales.
The assumption of a constant sales price is probably accurate only over a narrow
range of output levels. For example, Nike can sell only a certain number of
sneakers at $100 per pair; if it want sot sell more, it must lower the price.
Determining Optimal Quantities and Prices
CVP analysis assumes that straight lines can represent costs and revenues.
Therefore, the choices of quantity and price in CVP analysis are not determined
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by setting marginal cost equal to marginal revenue. The marginal revenue (the
slope of the revenue line) is always greater than the marginal cost (the slope of the
cost line). The slope of the two lines are not equal at any level of output. CVP
analysis suggests that profit is maximized when an infinite number of units it
produced. This result is absurd given capacity constraints and the need to make
price concessions to sell more units.
CVP Analysis and the Time Value of Money
CVP analysis is a one-period model. During a period of time, the revenues and
costs are estimated for different levels of output. Products may have a life cycle of
many years, however; to accommodate a longer product-life cycle, an assumption
could be making that each intermediate time period is identical in terms of
revenues and costs. If revenues and costs differ for different intermediate time
periods, some method of trading off profit from different periods from different
periods of time must be used. Large capital investments to make the product may
adversely affect profit early in the product life cycle but may improve it in the
latter stages of the product life cycle.
CVP Analysis and Multiple Products
CVP analysis assumes that the fixed and variable costs of each product can be
identified separately. However, most organizations provide multiple products,
and some costs frequently are common to these products. For example, a cellular
telephone manufacturer produces numerous models ranging from the
inexpensive, simple telephones to expensive, complex units. Under these
circumstances, CVP analysis is not a very good planning tool unless the multiple
products can be considered as a “basket” of goods. The basket would contain a
certain proportion of all the different goods provided by the organization and
would be treated as a single good.
For instance, a company that makes and sells bicycles and tricycles could consider
its basket of products to be two bicycles and one tricycle. The price of the basket is
the sales price of two bicycles and one tricycle. The cost of the basked includes the
fixed costs of the company plus two times the variable cost of the bicycle plus the
variable cost of the tricycle. CVP analysis then could be used for the basket of
goods because there is a single basket price and a single fixed and variable cost
for the basket. This procedure works, however, only if the proportions of different
products in the basket remain constant for all levels of output.
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Numerical Example:-
A company is considering buying a factory that assembles personal computers
and laser printers. The factory is expected to make and sell twice as many
personal computers as laser printers. The factory has annual fixed costs, such as
properly taxes and insurance, of $20 million that are not identified with either the
personal computers or the laser printers. The sales price and variable cost per unit
of the personal computer are $1,000 and $400, respectively. The sales price and
variable cost per unit of the laser printer are $800 and $300, respectively. How
many units of personal computers and laser printers must be sold to break even?
Solution:-
To solve this problem, a basket of both goods must be established. The products
are made and sold in a 2-to-1 proportion; therefore, the basket should contain two
personal computers and one laser printer. The sales revenue of this basket is
(2)($1,000/personal computer) + (1)($800/laser printer), or $2,800. The variable
cost of this basket is (2)($400/personal computer) + (1)($300/laser printer), or
$1,100. The break-even quantity of this basket is calculated as follows:
($20,000,000)/($2,800 - $1,100)= 11,765 baskets
The 11,765 baskets are equivalent to 23,530 personal computers and 11,765 laser
printers.
The limitation of CVP analysis described in this section indicates that it should be
used with care. CVP analysis has the advantage of being simple but should be
used only as a rough planning tool. It provides a manager with a low-cost
approximation of the profit effect of an investment. Whether a manager wants to
analyze the investment further depends on the cost of the analysis and the
potential benefits of more accurate information.
Explain how short-term decisions differ from strategic decisions.
Strategic decisions involve long-term planning with the opportunity to change the
existing resources of the organization; short term decisions assume that most of
the organization’s resources cannot be changed.
Estimate profit and break-even quantities using cost volume-profit analysis.
The break-even quantity is the level of output that generates zero profit and can
be estimated by dividing the fixed costs by the contribution margin per unit. The
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output level necessary to achieve a specified profit is the sum of the profit and
fixed costs divided by the contribution margin per unit.
Identify limitations of cost-volume-profit analysis.
Cost-volume-profit analysis assumes that costs can be approximated with fixed
and variable costs, and assume a constant sales price. It cannot be used to
determine optimal levels of output and price, nor does it consider the time value
of money.
Make short-term pricing decisions considering variable cost and capacity.
If an organization is operating below capacity, the marginal cost is approximated
by the variable cost. Therefore, in the short term, the variable cost should be
considered as the lower boundary in making a pricing decision.
Make decisions to add or drop products or services.

Products or services should be added if the incremental revenues are higher than
the incremental costs. Products and services should be dropped if the lost
revenues are lower than the avoidable costs.
Determine whether to make or buy a product or service.
A product or service should be purchased instead of produced if the purchase
price is lower than the cost of making it.
Determine whether to process or promote a product or service further.
A product or service should be processed further if the incremental revenue is
higher than the incremental cost. Managers that are maximizing profit prefer to
sell products with higher contribution margins if the organization is operating
below capacity.
Decide which products and services to provide when there is a constraint in the
production process.
A manager attempting to maximize profit will choose to produce more of the
product or service with the highest contribution margin per use of the scarce
resource.
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Identify and manage a bottleneck to maximize output.

A bottleneck is the limiting factor of the operating rate of an organization. It
should be managed so that it is operating at its capacity, and ways to relax the
bottleneck process should be considered.
Use extensions of cost-volume-profit analysis to make planning decision.
Break-even quantities can be expressed in terms of sales. Cost-volume-profit
analysis assists in the operating leverage decision and can be used to estimate
after-tax profit.
Use budgeting for planning purposes:
Budgeting facilitates the flow of information from the bottom up for general
planning and from the top down for coordination.
Use budgeting for control purposes.
The budget is used to allocate responsibilities to different members of the
organization and to establish performance measures, which are used to reward
managers.
Identify the conflicts that exist between planning and control in the budgeting
process.
The flow of information in the budgeting process might be inhibited or biased
because the information used for planning is often the same information used for
performance evaluation.
Describe the benefits of having both short-term and long-term budgets.
Long-term budgets are used for long-term planning. Short-term budgets are used
for both planning and control.
Explain the responsibilities implications of a line-item budget.
Line-item budgets constrain responsibilities by limiting managers’ ability to shift
resources from one use to another.
Identify the costs and benefits of budget lapsing.
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Budget lapsing constrains the manager to expend resources in the budget period.
This policy provides increased control; however, managers are not able to use
their specialized information to make more efficient decisions are frequently are
motivated to consume excess resources during the budgeted period.
Develop flexible budgets and identify when flexible budgeting should be used
instead of static budgeting.
Flexible budgeting adjusts for volume effects. If the manager cannot control
volume, the flexible budget provides more appropriate numbers for evaluating
the manager.
Explain the cost benefits of using zero-base budgeting.
Zero-base budgeting (ZBB) is costly because each line item in total must be
justified. The benefit of ZBB is the additional flow of information that might be
useful to new managers and might lead to more efficient use of resources.
Create a master budget for an organization including sales, production,
administration, capital investment, and financial budgets.
The master budget is a plan for a certain period that includes expected sales,
operating costs (production and administration), major investments and methods
to finance those investments.
Create pro forma financial statement based on data from the sales, production,
administration, capital investment, and financial budgets.
The pro forma statements include the budgeted income statement, the budgeted
cash flow statement, and the budgeted balance sheet.
Use spreadsheets to analyze monthly cash flows.

Monthly cash flow analysis is extremely important to determine whether a cash
shortage might occur in a given month. If a cash shortage might occur in a given
month. If a cash shortage is expected, the organization can plan to find some
financing to allow it to pay its bills and continue to operate. Spreadsheets offer a
means of determining the sensitivity of cash flows to the budget estimates.
Describe the relations among common resources, indirect costs, and cost
objects.
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Common resources are resources that are used by more than one subunit or
product of an organization. Common resources generate indirect costs, which
may be allocated to the users of the common resource. The recipients of allocated
indirect costs are called cost objects.
Explain the role of allocating indirect costs for external financial reports,
income tax reports, and cost reimbursement.
For external financial reporting and income tax reports, manufacturing overhead
is traditionally allocated to products. Costs allocated to product sold on a cost
reimbursement contract provide additional revenues for the organization.
Identify reasons for cost allocation for planning purposes.
If allocated costs provide better estimates of the opportunity cost of providing a
product or service, they are valuable for planning purposes. In this case, cost
allocations communicate information to managers about the opportunity cost of
using common resources.
Identify reasons for cost allocation for control purposes.
Common cost allocation is a method for allocating scarce resources in some
organizations. It is also used for external reporting, cost reimbursement, and
motivating managers to use common resources in a manner consistent with
organizational goals. Additionally, cost allocation can be used for mutual
monitoring.
Describe how the various reasons for cost allocation can create conflict within
the organization.
Costs are allocated for external reporting, planning decisions, and control
purposes. A single cost allocation system will lead to conflict, as each reason for
cost allocation might imply a different allocation method.
Allocate indirect costs using five basic steps.
Indirect costs are allocated by (1) defining the cost objects, (2) accumulating
indirect costs in cost pools, (3) choosing an allocation base, (4) estimating an
application rate, and (5) distributing indirect costs based on usage of the
allocation base by the cost objects.
Create segment reports for the organization.
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Segment reports disclose the profit of the organization’s subunits. Their profit
reflects transfer prices and cost allocation.
Use direct, step-down, and reciprocal methods to allocate costs of service
departments that interact.
The direct method ignores any interaction of service departments. The step-down
method allocates service department costs in sequence and recognizes some of the
interaction of service departments. The reciprocal method solves simultaneous
equations (one for each service department) to account for all interactions of
service departments.
Identify different types of production systems and corresponding absorption
costing systems.
Job shops and batch manufacturers tend to use job-order cost systems, and
assembly processes and continuous flow processes tend to use process costing.
Understand a job-order cost system.
A job-order cost system is used to record the direct labor, direct material, and
overhead costs related to a particular product or batch of products. Costs are
separately accumulated on the job cost sheet while work is being performed on
the product or batch.
Identify how costs flow through different accounts.
Costs flow from raw materials, labor, and overhead accounts to work-in-process
accounts during production, to finished goods accounts upon completion of
production, and cost to cost of goods sold when sold.
Calculate over-and under absorbed overhead.
Over and under absorbed overhead occurs when the actual overhead costs are not
equal to the applied overhead costs.
Account for over and under absorbed overhead.
Over and under absorbed overhead can be (1) charged directly to cost of goods
sold, (2) prorated among work –in-process, finished goods, and cost of goods
sold, or (3) eliminated by recalculating the application rate using the actual
overhead costs and allocation base usage.
Use ABC to allocate overhead in a job-order system.
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Overhead is divided into different activity cost pools and allocated to different
products using different cost drivers and application rates for each cost pool.
Use multi-stage allocation methods and departmental cost pools to allocate

overhead.
Overhead initially is allocated to departmental cost pools and then to products
based on the department’s usage of the allocation base.
Calculate product costs using process costing.
With process costing, the production costs are divided by the number of units to
determine an average cost per unit. If there is partial completion of units during
the periods, equivalent units are used to divide into production costs.
Prepare cost of goods manufactured and cost of goods sold schedule.
The cost of goods manufactured schedule includes raw material used (beginning
raw materials + purchases – ending raw materials), direct labor, and
manufacturing overhead to determine total manufacturing costs. The cost of
goods manufactured equals the total manufacturing costs plus beginning work-
in-process less ending work-in-process. The cost of goods sold equals the cost of
goods manufactured plus the beginning goods inventory less the ending finished
goods inventory.
Identify the problems with absorption costing systems.
Absorption costing systems can cause overproduction, underutilization of
allocation bases, and misleading product costs.
Recognize the advantages and disadvantages of variable costing and use it to
generate income statement.
With variable costing, only variable costs are treated as part of the product cost.
Fixed costs are expensed in the period incurred. Variable costing reduces the
incentive to overproduce costing reduces the incentive to overproduce and
provides product costs closer to the opportunity cost when excess capacity exists.
The disadvantages include the excessive use of fixed overhead resources and the
exclusion of fixed opportunity costs in the product cost.
Identify problems in selecting the capacity of a fixed cost resource.
Page | 20
In selecting the capacity of a fixed cost resource, the organization is committing

resources for a period of time. If it sets capacity too high, it will incur excessive
fixed costs. if t sets capacity too low, it will incur additional overtime costs and
excess wear on the facilities. The organization also may lose sales. Information
about future demands for its products in critical in making the capacity decision.
Recognize the advantages and disadvantages of the practical capacity of the
organization and use it to allocate overhead.
The application rate is calculated by dividing fixed costs by the practical capacity
of the allocation base. Allocated costs include only the cost of capacity used.
Advantages include an allocated cost that is not affected by other users of the
resource and the identification of the cost of unused capacity. Disadvantages
include the incentive to overproduce and the underutilization of the allocation
base.
Describe trade-offs for decentralized managers to provide accurate information
in making a decision on the capacity of a common resource and in using it
efficiently.
When the capacity decision for a common resource is being made, decentralized
managers would like extra capacity if they were not charged for it through the
allocation of costs. however, the allocation of the fixed costs of a common
resource likely leads to underutilization of the resource, especially if significant
excess capacity exists.
Make decisions regarding the production and further processing of joint
products.
A process that produces joint products is profitable if the joint costs are less than
the sales value of all the joint products. A joint product should be processed
further if the incremental revenues exceed the incremental costs.
Describe the factors in a dynamic environment that influence an organization.
Consumer demand, technology, and global competition are factors in a dynamic
environment that lead to changes in organizations.
Describe the way an organization’s strategy is related to its structure.
An organization’s strategy determines its structure. For example, an innovative
product strategy is usually best accomplished in a decentralized organization.
Page | 21
Explain the role of management accounting in the organizational structure an

in making planning decisions.
Management accounting through budgets is used to assign responsibilities. It is
also used to measure performance and to assist in making planning decisions.
Identify major characteristics of total quality management.
Total quality management (TQM) is a philosophy that places customer
satisfaction first. Continual improvement, involved leadership, and employee
participation and empowerment are all part of TQM.
Use quality costs for making planning and control decisions.
The comparison of quality costs over time provides a benchmark to determine
whether TQM efforts are successful. Quality costs should also be used to make
planning decisions comparing different quality efforts.
Explain the philosophy of JIT processes and accounting adjustments of JIT.
The JIT philosophy is to produce to order rather than produce for inventory. To
be successful, the organization must have a short throughput time to meet
demand. JIT has no job order costs. Accounting Performance measures should be
selected to encourage faster throughput time and to discourage increased
inventory.
Create balanced scorecard to articulate the strategy of the organization.
A balanced scorecard describes objective in a cause-and-effect sequence to achieve
the organization’s strategy. Performance measures and targets are identified for
each objective.
Identify when management accounting within an organization should change.
Management accounting must continually adapt to dynamic environments and
organizations. Warning signals within the management accounting system are
dysfunctional behavior by managers and poor planning decisions.
Describe the steps of the capital budgeting process.
The steps of the capital budgeting process include initiation, ratification,
implementation, and monitoring.
Identify the opportunity cost of capital.
Page | 22
The opportunity cost of capital is the forgone opportunity of using cash, which is
the interest rate on borrowing money to replace the cash.
Estimate the payback period of an investment and identify its weaknesses in
making investment choices.
The payback period is the time required for the investment to generate cash flows
equal to the initial investment. The payback method does not consider the time
value of money or cash flows beyond the payback period.
Calculate the accounting rate of return (ROI) and identify its weaknesses in
making investment choices.
The accounting rate of return, or ROI, is the average income from a project
divided by the average investment cost. The ROI is an accounting measure and
does not consider the time value of money.
Calculate the net present value (NPV) of cash flows.
The NPV of cash flows is calculated by discounting all future cash flows to the
present and comparing the present value of the cash inflows with the present
value of the cash outflows.
Problem No 1:-
The B & O Company has one production process which yields three different
products: P, R, and T. A process cost system is used. Specific allocation of costs is
impossible for these products until the end of Department 1 where split-off
occurs. Joint products, P, R, and T are further processed in Department 2, 3 and 4,
respectively. At the split-off point the company could sell P at $4.50 at $2.75, and
T $3.20. Department 1 completed and transferred to the other departments a total
of 75,000 units at a total cost of $225,000. The ratio of units produced in
Department 1 for P, R, and T is 2:5:3, respectively.
Required: Allocate the joint costs among the three joint products based on the:
a) Market value at split-off method.
Page | 23
b) Physical output method.
Round all answers to two decimal places.
Solution:-
Total market value of each product

a) Joint cost allocation to each product = ×joint
Total market value of all products
costs
Product Ratio × Joint cost = Allocation of joint cost
P $67,500 $225,000 $ 62,569.60
$242, 625
R $103,125 $225,000 95,633.69
$242, 625
T $72, 000 $225,000 66,769.71
$242, 625
Total $225,000.00
Total market value of each product = Units produced of each product

× Units market value of each product
Total market value of all products = Sum of total market values of each
product
Product Units produced Units market Total market value
of each product value
P 15,000* $4.50 $67,500
R 37,500† $2.75 103,125
T 22,500‡ $3.20 72,000
Total market value of all products $242,625
*75,000×20%
†75,000×50%
‡75,000×30%
Output per product

b) Joint cost allocation to each product =  Joint cost
Total joint products
Page | 24
2
Product P  $225, 000  $45, 000
10*
5
Product R  $225, 000  $112,500
10*
3
Product T  $225, 000  $67,500
10*
Total $225, 000
*2:5:3=10
Problem No 2:-
The Three Stooges Production Company uses a process cost system to account for
the production of three different products: M, L, and C. The products are
considered joint products in the first department (Department 1). The products
are split off at the end of processing in Department 1. Product M needs no further
processing after the split-off point while products L and C are sent to
Departments 2A and 2B, respectively, for further processing.
The following revenue and cost information is available:
PRODUCT UNITS MARKET VALUE PER UNIT

PRODUCED AT END OF PROCESSING
M 80,000 $20
L 70,000 $30
C 90,000 $25
Department Department cost per unit

1 $12
2A $8
2B $6
Required: Allocate the joint costs of Department 1 using the net realizable value
method.
Solution:-
Page | 25
Total units produced in Department 1:
Product Units produced

M 80,000
L 70,000
C 90,000
Total 240,000
Joint costs of Department 1:
240,000 units produced × $12 per unit = $2,880,000
Additional processing costs:
Product Ratio × Joint cost Allocation of joint

= cost
M $1, 600, 000(1) $2,880,000 $ 950,103
$4,850, 000(4)
L $1,540, 000(2) $2,880,000 914,474
$4,850, 000(4)
C $1, 710, 000(3) $2,880,000 1,015,423
$4,850, 000(4)
Total $2,880,000
 Unit Market  Additional Total

  processing Hypothetical
 Produced Value of  costs of market value
 Of each Product  Costs of each product 
Product   each of each
product product
=
M (80,000 $20) $0 $1,600,000 (1)
L (70,000 $30) 560,000 1,540,000 (2)
C (90,000 $25) 540,000 1,710,000 (3)
Total $1,100,000 $4,850,000 (4)
Page | 26
Problem No 3:-
The Huffy Manufacturing Corporation uses a process cost system and presents
you with the following information:
Main products:
Units sold 20,000
Units produced 25,000
Selling price per unit $10
Marketing and administrative expenses $60,000
Total production costs in Department 1 $150,000
By product:
Units sold 900
Units produced 1,200
Selling price per unit $3
Marketing and administrative expenses $300
Additional processing costs in Department 2 $800
Expected gross profit 30%
The main products and by-product split off at the end of Department 1. The by-
product is transferred to Department 2 for additional processing. The main
products need no additional processing. No beginning or ending work-in-process
inventories exist. Ignore income taxes.
Required: Prepare income statements for the Huffy Manufacturing Corporation

under the following assumptions:
a) Net by-product income treated as other income

b) Net by-product income treated as a deduction from cost of goods sold of
the main products sold.
c) Expected value of the by-product treated as a deduction from the total
production costs using the:
1. Net realizable method
2. Reversal cost method
Solution:-
a) Net by-product income treated as other income:

Sales (main products) (20,000×$10) $200,000
Page | 27
Cost of main products sold:

Total production costs $150,000
Less: Ending inventory (5,000×6.00*) 30,000
Total cost of main product sold 120,000
Gross profit $80,000
Marketing and administrative expenses of main 60,000
products
Income from operations $20,000
Other income:
Net by-product income [$2,700† - ($300+$800)] 1,600
Net income $21,600
*150,000 ÷ 25,000 units = $6.00 per unit

†900 unit × $3 per unit = $2,700
b) Net by-product income treated as a deduction from cost of goods sold of
the main products sold:
Sales (main products) $200,000
Less: Ending inventory (see part a) 30,000
Total cost of main products sold $120,000
Less: Net by-product income (see part a) 1,600 118,400
products
Net income $21,600
c)
1. Value of the by-product produced, using the net realizable method,
threated as a deduction from total production costs:
Sales (main products) $200,000
Value of by-product produced [$3,600* - ($300 2,500
+800)]
Net production costs $147,500
Page | 28
Less: Ending inventory (5,000 × $5.90†) 29,500 118,000

products
Net income $22,000
*1,200 units produced × $3.00 per unit = $3,600

†$147,500 ÷ 25,000 per unit = $5.90 per unit
2. Value of the by-product produced, using the reversal cost method, treated
as a deduction from total products costs:
Sales:
Main product (20,000 × $10) $200,000
By-product (900×$3) 2,700 $202,700
Cost of main product and by-product sold:
Production costs:
Main product (see schedule A) $148,280
By-product (see schedule B) 2,520 $150,800
Less ending inventory:
Main product [(148,280 ÷ 25,000)×5,000] $29,656
By-product[($2,520÷1,200)×300] 630 30,286 120,514
Marketing and administrative expenses:
Main product $60,000
By-product 300 60,300
Net income $21,886
Schedule A: Production Costs of Main Product

Total production costs of Department 1 $150,000
Less joint costs applicable to by-product
produced:
Estimated revenue from by-product sales (1,200 $3,600
units produced × $3 per unit)
Less: Expected additional processing costs $800
(Department 2)
Expected gross profit by-product (30% × $3,600) 1,080 1,880 1,720
Page | 29
Production cost of main product $148,280
Schedule B: Production Costs of By-Product

Joint costs applicable to by-products (see schedule A) $1,720
Additional processing costs after split off from Department 1 800
Production costs of by-product $2,520
Problem No 4:-
Bates Corporation has decided to accumulate standard costs, in addition to actual

costs, for the next accounting period, 19X5. The following data have been
collected:
Projected production for 19X5 30,000 units

Direct materials required to produce one unit 2 tones
Price per ton of direct materials based on annual order of:
1 – 25,000 tones $200 per ton
25,001 – 50,000 tones $190 per ton
50,001 – 75,000 tons $185 per ton
Direct labor requirements
Shaping time per ton 3 hours
Welding time per unit 10 hours
Average wage rate per hour for:
Shapers $11
Welders $15
Factory overhead is applied based on direct labor hours
Budgeted variable factory overhead $120,000
Budgeted fixed factory overhead $57,600
Bates Corporation uses a process cost system to accumulate costs.
Required:
a) Calculate the following standards:

1) Direct materials price per unit
2) Direct materials efficiency per unit
3) Direct labor price per hour
Page | 30
4) Direct labor efficiency (hours) per unit

5) Variable factory overhead application rate per direct labor hour
6) Fixed factory overhead application rate per direct labor hour
b) Compute the total standard cost per unit.
Solution: - (a)
1) Direct materials price standard per unit:

Projected production (30,000 units × 2 tons per 60,000 required
unit) tons
Per unit price on the basis of an annual order $185 per ton
of 60,000 tons
2) Direct materials efficiency standard per unit:
Direct materials required to produce one unit----------- 2 tons
3) Direct labor price per hour standard:
Type of Total annual Hourly Total Annual Direct
work Hours X Rate = Labor cost
Shaping 180,000* S11 $1,980,000
Welding 300,000† 15 4,500,000
Total 480,000 $6,480,000
*3 hours per ton × 60,000 tons

†10 hours per unit × 30,000 units
Average direct labor price per hour:

$6,480,000 ÷ 480,000 = $13.50
4) Direct labor efficiency standard (hours) per unit:
Shaping per unit (3 hours × 2 tons)………..6 hours
Welding …………………………………….10 hours 16
5) Variable factory overhead application standard rate per direct labor

hour:
$120, 000  budgeted variable factory overhead 
 $.25 per direct labor hour
480, 000  expected total direct labor hours 
Page | 31
6) Fixed factory overhead application standard rate per direct labor

hour:
$57, 600  budgeted fixed factory overhead 
 $.12 per direct labor hour
480, 000  expected total direct labor hours 
b). Total standard cost per unit:
Direct materials ($185×2 tons) $370.00

Direct labor ($13.50 × 16 hours) 216.00
Factory overhead:
Variable ($.25×16 hours) 4.00
Fixed ($.12×16 hours) 1.92
Total standard cost per unit $591.92
Problem No 5:-
Handy Harold’s Hardware Supply Manufacturing Company has introduced a

new product. Since it will be produced in a new department, the first unit will
require 5 direct labor hours. Direct labor cost is $5.25 per hour.
Required:
a) Assuming a learning rate of 95%, compute the cumulative average direct

labor hours needed and the output per hour for the thirty-second unit.
b) Compute the direct labor cost and the direct labor cost per unit for each of
the cumulative units of production.
Solution:-
a)
Cumulative Cumulative Computations Total direct Output (Computations)

units of average per labor hours per direct
production unit (hours) needed labor hour
1 5.00 5.0 .20 (1÷5)
2 4.75 (5.00×.95) 9.5 .21 (2÷9.5)
4 4.513 (4.75×.95) 18.052 .22 (4÷18.052)
8 4.287 (4.513×.95) 34.296 .23 (8÷34.296)
Page | 32
16 4.073 (4.287×.95) 65.168 .25 (16÷65.168)

32 3.869 (4.073×.95) 123.808 .26 (32÷123.808)
b)
Cumulative Direct labor (Computations) Direct labor

units of cost cost per unit
production
1 $26.26 (5×$5.25) $26.25 ($26.26÷1)
2 $49.88 (9.5×$5.25) $24.94 ($49.88÷2)
4 $94.77 (18.052×$5.25) $23.69 ($94.77÷4)
8 $180.05 (34.296×$5.25) $22.51 ($180.05÷8)
16 $342.13 (65.168×$5.25) $21.38 ($342.13÷16)
32 $649.99 (123.808×$5.25) $20.31 ($64999÷32)
Problem No 6:-
The following information for 19X1 was given for the Ken-Glo Company, which
manufactures fluorescent light bulbs
Units of finished product produced 15,000 units

Direct materials quantity standards 3 units of direct materials
per unit of finished
product
Direct materials used in production 50,000 units
Direct materials purchased 60,000 units
Direct materials standard price per unit $1.25 each
Actual direct materials price per unit $1.10 each
Direct labor efficiency standard 2 direct labor hours per
unit
Actual direct labor hours worked 30,250 hours
Direct labor standard wage rate $4.20 per hour
Direct labor actual wage rate $4.50 per hour
Actual factory overhead:
Variable $114,000
Fixed $26,000
Budgeted fixed factory overhead $25,000
Standard factory overhead application rate per
Page | 33
direct labor hour:

Variable $3
Fixed 1
Total $4
Required: Calculate the following variances:
a) Direct material price variance

b) Direct materials efficiency variance
c) Direct labor efficiency variance
d) Direct labor price variance
e) Factory overhead variances under the:
1) One-factor analysis method
2) Two-factor analysis method
3) Three-factor analysis method
Solution:-
a) Direct material price variance:

(Actual unit price – Standard unit price) × Actual Quantity purchased
($1.10 - $1.25) × 60,000 = $(9,000) favorable
b) Direct material efficiency variance:
Standard quantity allowed = Standard quantity per unit × Equivalent
production
45,000 = 3 × 15,000
(Actual quantity used – Standard quantity allowed) × Standard unit price
(50,000 – 45,000) × 1.25 = $6,250 unfavorable
c) Direct labor efficiency variance:

Standard direct labor hours allowed = standard number of direct labour
hours per unit × Equivalent production
30,000 = 2 × 15,000
(Actual direct labor hours worked – Standard direct labor hours allowed) ×
Standard direct labor hourly wage rate
(30,250 – 30,000) × $4.20 = $1,050 unfavorable
d) Direct labor price variance:

Page | 34
(Actual direct labor hourly wage rate – Standard direct labor hourly wage
rate) × Actual number of direct labor hours worked
($4.50 - $4.20) × 30,250 = $9,075 unfavorable
e) Factory overhead variance:

1) One-factor analysis of factory overhead variances:
Applied FOH = Standard labor hours allowed × Standard FOH
application rate
$120,000 = 30,000 × $4
Actual FOH – Applied FOH
$140,000 - $120,000 = $20,000 unfavorable
2) Two-factor analysis of factory overhead variances:

a. Budget (controllable) variance:
Actual FOH – Budgeted FOH at standard direct labor hours
allowed
$140,000 - $115,000 = $25,000 unfavorable
Budgeted factory overhead at standard direct labor hours allowed:
Variable (30,000 × $3)…………..$90,000

Fixed (budgeted)………………. $25,000
Total…………………………… $115,000
b. Production volume (denominator or idle capacity) variance:

(Denominator direct labor hours – Standard direct labor
hours allowed) × Standard fixed FOH application rate
(25,000 – 30,000 × $1 = $(5,000) favorable
3) Thee-factor analysis of factory overhead variances:
a. Price (spending) variance:
Actual FOH – Budgeted FOH at actual direct labour hours
$140,000 - $115,750 = $24,250 unfavorable
Budgeted factory overhead at actual direct labor hours:
Variable (30,250 × 3)………….. $90,750
Fixed (budgeted)…………………25,000
Total ……………………………$115,750
Page | 35
b. Efficiency variances:
(Actual direct labor hours worked – Standard direct labor
hours allowed) × Standard FOH application rate
(30,250 – 30,000) × $3 = S750 unfavorable
c. Production volume (same as two variance method) = $(5,000)
favorable
Problem No 7:
Vogue Fashions, Inc., manufactures ladies shirts of one quality, produced in lots
to fill each special order from its customers, composed of department stores
located in various cities. Vogue sews the particular stores’ labels on the shirts. The
standard costs for a dozen shirts are:
Direct materials (24 yards @ $1.10) $26.40

Direct labor (3 hours @ $4.90 14.70
Manufacturing overhead (3 hours @$4.00) 12.00
Standard cost per dozen $53.10
During June 19X1, Vogue worked on three orders, for which the month’s job cost
records disclose the following:
Lot Units in lot Material used Hours Worked

(Dozens) (Yards)
22 1,000 24,100 2,980
23 1,700 40,440 5,130
24 1,200 28,825 2,890
The following information is also available:
1. Vogue purchased 95,000 yards of material during June at a cost of $106,400.

The materials price variance is recorded when goods are purchased. All
inventories are carried at standard cost.
2. Direct labor during June amounted to $55,000. According to payroll
records, production employees were paid $5.00 per hour.
3. Manufacturing overhead during June amounted to $45,600.
4. A total of $576,000 was budgeted for manufacturing overhead for the year
19X1, on the basis of estimated production at the plant’s normal capacity of
48,000 dozen shirts annually. Manufacturing overhead at this level
Page | 36
production is 40% fixed and 60% variable. Manufacturing overhead is

applied on the basis of direct labor hours.
5. There was no work-in-process inventory at June 1. During June, lots 22 and
23 were completed and sold for $220,000. All material was issued-for lot 24,
which was 80% complete as to direct labor.
6. Vogue uses a job order cost system to accumulate costs.
Required:
a) Compute the total standard cost of lots 22, 23, and 24 for June 19X1.
b) Compute the direct materials price variance for June 19X1.
c) For each lot product during June 19X1, compute the:
1. Direct materials efficiency (quantity) variance
2. Direct labor efficiency variance
3. Direct labor price (rate) variance
d) Compute the price, efficiency, and production volume variance for factory
overhead for June 19X1.
Solution:-
a) Total standard cost of lost 22, 23, and 24:
Lot Quantity (Dozens) Standard cost per Total standard cost

dozen
22 1,000 $53.10 $53.100
23 1,700 $53.10 $90,270
24 1,200 $47.76* $57.312
Total standard cost of production $200.682
*Standard direct materials cost $26.40

Standard direct labor costs (80% × $14.70) 11.76
Standard factory overhead costs (80% × $12.00) 9.60
Total $47.76
b) Direct material price variance

Actual unit cost of direct materials purchased:
$106,400 ÷ 95,000 yards = $1.12
$1,900 = ($1.12 - $1.10) × 95,000
Page | 37
Unfavorable
c) For each lot product during June 19X1, compute the:
1. Direct material efficiency (quantity variance)
Lot 22
Standard quantity allowed:
24 yards per dozen × 1,000 dozen = 24,000 yards
$110 = (24,100 – 24,000) ×$1.10
Unfavorable
Lot 23
$(396) = (40,440 – 40,800) ×$1.10
Favorable
Lot 24
$27.50 = (28,825 – 28,800) ×$1.10
Unfavorable
2. Direct labor efficiency variance

Lot 22
Standard hours allowed
3 hours per dozen × 1,000 dozen = 3,000
$(98) = (2,980 – 3,000) × $4.90
Favorable
Lot 23
3 hours per dozen × 1,700 dozen = 5,100
$147 = (5,130 – 5,100) × $4.90
Unfavorable
Lot 24
3 hours per dozen × 960* equivalent dozen = 2,880
Page | 38
$49 = (2,890 – 2,880) × $4.90

Unfavorable
*1,200 × 80%
3. Direct labor price (rate) variance

Lot 22
$298 = ($5.00 - $4.90) × 2,980
Unfavorable
Lot 23
$513 = ($5.00 - $4.90) × 5,130
Unfavorable
Lot 24
$289 = ($5.00 - $4.90) × 2,890
Unfavorable
d) Factory overhead variances

Total factory overhead application rate = $4.00
Variable 60% × $4.00 = $2.40
Fixed 40% × $4.00 = $1.60
Budget at 11,000* Actual Hours
Variable ($2.40 ×11,000) $26,400

Fixed ($576,000/12 × 40%) 19,200
Total for June $45,600
*2.980 + 5,130+2,890
1. Price variance
$0 = $45,600 - $46,600
2. Efficiency variance
$48 Unfavorable = (11,000 actual direct labor hours – 10,980*
standard direct labor hours) × $2.40 per direct hour
*3,000 + 5,100 + 2,880
Page | 39
3. Production volume
Expected hours for June:
144, 000 annual hours *
 12, 000
12 months
*48,000 dozen shirts annually
× 3 per direct labor hour per dozed
$1,632 Unfavorable = (12,000 denominator direct labor hours –
10,980 standard direct labor hours) × $1.60 per direct labor hour
Problem No 8:-
Stacey manufacturing Co. is interested in comparing net earnings for two periods.
The company’s operating data are as follows:
Period1 Period 2
Standard production (units) 30,000 30,000
Actual production (units) 30,000 25,000
Sales (units) 25,000 30,000
Selling price per unit $15.00 $15.00
Variable manufacturing costs per unit:
Direct materials $1.50
Direct labor $2.50
Variable factory $2.00
Total variable factory manufacturing unit cost $6.00 $6.00
Fixed factory overhead ($4 per unit) $120,000 $120,000
Selling and administrative expenses (all fixed) $50,000 $60,000
Required:-
a) Prepare a statement of earnings for both periods under the:

1. Absorption costing method
2. Direct costing method
b) Account for the difference in net earnings between the two methods.
c) Explain why net earnings are equal under the two methods for the two
periods combined.
Page | 40
d) If the firm used direct costing in its formal accounting records, what
adjustments are necessary for external reporting?
Solution:-
a) Income statement, period 1

Absorption costing
Sales (25,000 × $15) $375,000
Cost of goods sold:
Current manufacturing costs (30,000 × $10)* $300,000
Less ending inventory (5,000 × $10) 50,000
Cost of goods sold $250,000
Selling and administrative expenses 50,000
Net income $75,000
*Variable manufacturing cost ($6) + fixed factory overhead per unit ($4)
= $10
Direct costing
Sales (25,000 × $15) $375,000
Cost of goods sold:
Current manufacturing costs (30,000 × $6) $180,000
Less ending inventory (5,000 × $6) 30,000
Variable cost of goods sold $150,000
Contribution margin $225,000
Less fixed factory overhead 120,000
$105,000
Less selling and administrative expenses 50,000
Net earnings $55,000
Income statement, Period 2
Absorption Costing
Sales (30,000 × $15) $450,000

Cost of goods sold:
Beginning inventory (5,000 × $10) $50,000
Current manufacturing costs (25,000 × $10) 250,000
Less ending inventory 0
Page | 41
Cost of goods $300,000

Less under absorbed fixed factory overhead* 20,000
$130,000
Net income $70,000
*Budgeted fixed factory overhead $120,000
Applied fixed factory overhead (25,000 × $4) 100,000
Under absorbed fixed factory overhead $20,000
Direct Costing
Sales (30,000 × $15) $450,000

Cost of goods sold:
Beginning inventory (5,000 × $6) $30,000
Variable manufacturing costs (25,000 × $6) 150,000
Less ending inventory 0
Variable cost of goods sold $180,000
Contribution margin $270,000
Less fixed factory overhead 120,000
$150,000
Net income $90,000
b) The difference between the net income of period 1 of $75,000 (absorption

costing) and $55,000 (direct costing) is attributable to the $20,000 of fixed
factory overhead ($4 × 5,000 units) in the ending inventory under
absorption costing which will not be charged to the statement of income
until the next period when the units are sold.
c) Sales equals production for the two periods combined (30.000 + 25,000 =
55,000 units); therefore, the next earnings are equal under the two methods
for the two periods combined ($145,000) because there were no beginning
inventories in period 1 and no ending inventories in period 2.
d) If the firm uses direct costing in its formal accounting records, the cost of
goods sold on the income statement and the ending inventory on the
Page | 42
statement of financial position would have to be adjusted to an absorption

costing basis for external reporting.
Problem No 9:-
Cost Behavior, Relevance, and Managerial Decision Making
The XYZ Company requires 10 machines hours per unit in the Cutting
Department. The following costs are assumed to be related to the operations of a
cutting machine at a normal capacity of 10,000 units per year (with a maximum
capacity of 12,000 units per year):
Variable costs:
Electricity (10,000 × 10 MH*/unit × $5/MH) $500,000
Repairs & maintenance (10,000 units × 10 MH/unit × $2/MH)
Fixed costs:
Depreciation ($2,000,000/5 years) 400,000
Insurance 100,000
Total costs at 10,000 units $1,200,000
*MH= machine hours
Required:
a. What are the variable, fixed, and total costs per unit if the normal
production of 10,000 units per year is achieved?
b. What are the variable, fixed and total costs per unit if only 8,000 units are
produced per year?
c. What is the implication of producing less units (8,000 units) than normal
capacity (10,000 units) for managerial decision making?
d. Which costs are relevant and which costs are irrelevant to a decision to
expend production from normal capacity (10,000 units) to maximum
capacity (12,000 units)?
e. Suppose a second cutting machine, identical in every respect to the first
one, is under consideration for possible purchase. Total production for the
year is still expected to be equal to normal capacity (10,000 units) with the
first cutting machine accounting for 6,000 units and the second cutting
machine accounting for 4,000 units.
Page | 43
1. What are the total costs of operating each of the two machines?
2. What are the variable, fixed, and total costs per unit for each
machine?
3. What costs are relevant and what costs are irrelevant to the
decision to acquire a second cutting machine?
f. Under what condition would both the variable costs and fixed costs be
relevant in a decision to acquire a second cutting machine?
Solution:-
$500,000  $200,000
a) Variable cost / unit   $70 / unit
10,000 units
$400,000  $100,000
Fixed cost / unit   $50 / unit
10,000 units
Total cost/unit = $70/unit + $50/unit = $120/unit
b) Variable cost per unit = $70 per unit because, by definition, a variable
cost remains constant on a per unit basis within the relevant range.
$400,000  $100,000
Fixed cost / unit   $62.50 / unit
8,000 units
Total cost/unit = $70/unit + $62.50/unit = $132.50/unit
c) While variable cost per unit remains constant whether 8,000 or 10,000
units are produced, the fixed cost per unit increases from $50 per unit to
$62.50 per unit. For purposes of managerial decision making, a higher
fixed cost per unit will necessitate a higher a selling price per unit if, in
the long run, all costs are to be covered and a reasonable profit earned
from each unit produced and sold. If it is not possible to increase the
selling price per unit is in response to the increased fixed cost per unit,
the company will not be able to maximize its operating performance.
As a sound generalization (all other factors held constant), whenever a
company is confronted by a fixed cost, it must expand its production
and sales as much as possible so that the fixed costs can be spread over
as many units as is possible.
d) The electricity and repair and maintenance costs are relevant. They
currently equal $500,000 and $200,000, respectively, at the 10,000-unit
level. They will increase to $600,000 for electricity (12,000 units × 10 MH
× $5/MH) and $240,000 for repairs and maintenance (12,000 units × 10
Page | 44
MH/unit × $2/MH). The depreciation and insurance costs are equal to

$400,000 and $100,000, respectively, at 10,000 units and will not change
at 12,000 units. Therefore, the usual relationship between cost behavior
and relevance was applicable. That is, the variable costs were relevant
and the fixed costs were irrelevant.
e) 1.
Machine 1 Machine 2
Electricity
6,000 units × 10MH/unit × $5/MH $300,000
4,000 units × 10MH/unit × $5/MH $200,000
Repair and maintenance:
6,000 units × 10MH/unit × $2/MH 120,000
4,000 units × 10MH/unit × $2/MH $80,000
Depreciation 400,000 400,000
Insurance 100,000 100,000
Total variable and fixed costs $920,000 $780,000
2.
Variable cost per unit:
$420,000/6,000 $70.00
$280,000/4,000 units $70.00
Fixed cost per unit:
$500,000/6,000 units 83.33
$500,000/4,000 units 125.00
Total cost per unit $153.33 $195.00
3. The total variable cost of $700,000 consisting of $500,000 of electricity

and $200,000 of repairs and maintenance is an irrelevant cost. It will be
incurred whether the first cutting machine produces 10,000 units by
itself or both cutting machines produce a combined total of 10,000 units.
The total fixed cost of $500,000 consisting of $400,000 of depreciation
and $100,000 of insurance is a relevant cost. If the second cutting
machine is not purchased the $500,000 will not be incurred. It is clearly
a future cost that differs between alternative courses of action. Here is a
perfect example of a situation that runs counter to what one would
expect in terms of the usual relationship between cost behavior and
relevance. That is, the fixed cost is relevant and the variable cost is
irrelevant.
Page | 45
f) From the answer to part e3, the fixed costs are relevant if anew cutting
machine is purchased. To make the variable costs relevant, suppose the
first cutting machine was operating at maximum production capacity
(12,000 units) and the second cutting machine was being considered for
possible purchase to accommodate an anticipated amount of
production in excess of 12,000 units. If what were the case, additional
electricity and repairs and maintenance costs would have to be incurred
in order to manufacture the additional production. Thus, both the
variable and fixed costs are relevant to the decision whether or not to
purchase a second cutting machine.
Problem No 10:-
1. Woody Company, which manufactures sneakers, has enough idle capacity

available to accept a special order of 20,000 pairs of sneakers at $6.00 a pair.
The normal selling price is $10.00 a pair. Variable manufacturing costs are
$4.50 a pair, and fixed manufacturing costs are $1.50 a pair. Woody will not
incur any selling expenses as a result of the special order. What would the
effect on operating income be if the special order could be accepted
without affecting normal sales?
2. Dixon Company manufactures part 347 for use in one of its main products.
Normal annual production for part 347 is 100,000 units. The cost per 100
units is as follows:
Direct material $260

Direct labor 100
Manufacturing overhead:
Variable 120
Fixed 160
Total cost per 100 units $640
Cext Company has offered to sell Dixon all 100,000 units it will need
during the coming year for $600 per 100 units. If Dixon accepts the offer
from Cext, the facilities used to manufacture part 347 could be used in the
production of part 483. This change would save Dixon $90,000 in relevant
costs. Also, a $100,000 cost item included in the fixed factory overhead that
Page | 46
is specifically related to part 347 would be eliminated. Should Dixon

Company accept the offer from Cext Company?
3. Rice Corporation currently operates two divisions which had operating

results for the year ended December 31, 19X2, as follows:
West Division Troy Division
Sales $600,000 $300,000
Variable costs 310,000 200,000
Contribution margin $290,000 $100,000
Fixed costs for the division 110,000 70,000
Margin over direct costs $180,000 $30,000
Allocated corporate costs 90,000 45,000
Operating income (loss) $90,000 $(15,000)
Since the Troy Division also sustained an operating loss during 19X1,
Rice’s president is considering the elimination of this division. Assume that
the Troy Division’s fixed costs would be avoided if the division were
eliminated. If the Troy Division had been eliminated on January 1, 19X2,
Rice Corporation’s 19X2 operating would have been equal to what
amount?
4. The production department of Cronin Manufacturing Company must
make a product mix decision in light of a shortage of pounds of direct
materials. The following data are available for products X and Y:
Product X Product Y
Selling price per unit $12 $10
Direct materials $4 $2
Direct labor 1 3
Variable factory overhead 3 8 2 7
Contribution margin per unit $4 $3
Contribution margin ratio (CM ÷ sales) 33⅓% 30%
Number of pounds of direct materials required 2 1
per unit
Maximum sales (in units) 2,000 5,000
Determine the number of units of product X and product Y to be produced
if only 8,000 pounds of direct materials are available.
5. The Mighty Meat Company produces three joint products-hamburgers,
steak, and roast beef-from a joint process. Total joint costs are equal to
Page | 47
$43,000. Each of the three joint products can be (1) sold at the split-off point
to a competing meat company (who will complete the necessary
processing) or (2) finished by The Mighty Meat Company and sold to
retailers. Relevant costs and revenues appear below:
TOTAL
SALES TOTAL TOTAL
PRODUCT VALUE AT ADDITIONAL FINAL
SPLIT-OFF PROCESSING COSTS SALES
VALUE
Hamburger $10,000 $2,000 $14,000
Steak 14,000 3,000 20,000
Roast beef 13,000 6,000 17,000
a) Which products should be sold at the split-off point and which

products should be processed further?
b) Should The Mighty Meat Company even be in the meat processing
business?
Solution:-
1. Woody Company Accept or Reject a Special Order

Incremental revenue (20,000@ $6.00) $120,000
Incremental costs (20,000 @ $4.50) 90,000
Incremental income $30,000
2. Dixon Company Make or Buy

Make Buy
Purchase price (10,000 units × $600 per 100 $(600,000)
units)
Page | 48
Relevant cost savings from released facilities 90,000

Relevant costs to make:
Variable production costs (10,000 × $480 per $(480,000)
100 units*)
Fixed production costs† (100,000)
$(580,000) $(510,000)
Advantage to buying 70,000
$(510,000) $(510,000)
*Direct materials $260
Direct labor 100
Variable factory 120
overhead
$480
†The only relevant fixed factory overhead cost is the $100,000 that the
problem specifically tells us will be eliminated if part 347 is no longer
manufactured.
3. Rice Corporation: Elimination of Troy Division

Forgone revenue $300,000
Cost savings:
Variable costs $200,000
Fixed costs 70,000 270,000
Decrease in Rice Corporation’s operating income $30,000
if the Troy Division is eliminated
4. Cronin Manufacturing Company: Product Mix-Single Constraint

Product X Product Y
Contribution margin per unit $4 $3
Divide by pounds of direct material required per ÷2 ÷1
unit
Contribution margin per pound of direct $2 $3
materials
Maximum sales for product Y 5,000 units
Multiply by required pounds of direct materials ×1 lb/unit
per unit
Total pounds needed to produce product Y 5,000 lb
Page | 49
Total pounds available for product X (8,000 lb – 3,000 lb

5,000 lb)
Divide by required pounds per unit of product X ÷2 lb/unit
Total production of product X 1,500 units
Optimum product mix: 5,000 units of product Y
1,500 units of product X
5. The Mighty Meat Company: Sell or Process Further in Joint Costing

a)
Joint product
Hamburger Steak Roast Beef
Incremental revenue $4,000 (1) $6,000 (2) $4,000 (3)
Incremental cost 2,000 3,000 6,000
Incremental income $2,000 $3,000
Decremental income $(2,000)
Computations
(1) $14,000 (2) $20,000 (3) $17,000
-10,000 -14,000 -13,000
$4,000 $6,000 $4,000
Hamburger and steak should be processed further while roast beef should
be sold at the split-off point.
b) From part a, The Mighty Meat Company will earn revenue equal to $14,000
from hamburger and $20,000 from steak, both of which will be subject to
additional processing, and $13,000 from roast beef, which will be sold at
the split-off point. The total revenue equals $47,000. The additional
processing costs equal $2,000 for hamburger and $3,000 for steak for a total
of $5,000. However, when the $5,000 of additional processing costs are
added to the $43,000 of joint cost, the total manufacturing costs of $48,000
exceed the total revenues by $1,000. If The Mighty Meat Company cannot
either increase its revenues or decrease its costs, it should no longer be nit
he meat processing business.
Problem No 11:-
Page | 50
Maur-Shei Bakery sells only chocolate chip cookies. Each cookie sells for $ .20.
variable costs are
Flour and sugar $.02

Butter and eggs .02
Chocolate chips .04
Total fixed costs per week are
Wages (2salespeople × $25) $50

Store rent 100
$150
Required: Compute the level of sales in units necessary per week (1) to break even
and (2) to earn a profit of $250 under the following independent assumptions.
(Ignore income taxes.)
a) Given the above information.

b) The selling price is increased to $.25.
c) The cost of flour and sugar are doubled.
d) The rent is increased to $150.
e) The selling price drops to $.15.
f) The cost of chocolate chips doubles.
Solution:-
Sales = Total variable costs + Total fixed costs + Target profit
a 1 .20Q = .08Q + 150 + 0

.12Q = 150
Q = 1,250
2 .20Q = .08Q + 150 + 250
.12Q = 400
Page | 51
Q = 3,333
b 1 .25Q = .08Q + 150 + 0
.17Q = 150
Q = 882
2 .25Q = .08Q + 150 + 250
.17Q = 400
Q = 2,353
c 1 .25Q = .10Q + 150 + 0
.10Q = 150
Q = 1,500
2 .20Q = .10Q + 150 + 250
.10Q = 400
Q = 4,000
d 1 .20Q = .08Q + 200 + 0
.12Q = 200
Q = 1,667
2 .20Q = .08Q + 200 + 250
.12Q = 450
Q = 3,750
e 1 .15Q=.08Q+150+0
.07Q=450
Q=3,750
2 .15Q=.08Q+150+250
.07Q=400
Q=5,714
f 1 .20Q=.12Q+150+0
.08Q+150
Q=1,875
2 .20Q=.12Q+150+250
.08Q=400
Q=5,000
Problem No 12:-
Page | 52
The Fong Construction Company projects it will need to replace certain

equipment 5 years from now. The current cost of the equipment desired is
$100,000. Studies of historical price changes for the equipment suggests to Fond
Construction’s management that the cost of the equipment will rise by
approximately 9% per year. The firm has excess cast at this time and wants to
place money aside in order to assure it will have enough money to purchase the
equipment 5 year from now.
Required: Assuming that the Fong Construction Company can earn 7%

compounded annually after taxes on any sum it invests today, how much must be
set aside today in order to generate enough funds to purchase the equipment in 5
years?
Solution:-
The first step is to determine how much will be needed 5 years from now in order
to replace equipment that currently costs $100,000. Since Fong Construction’s
management expects the cost of the equipment of $100,000 to rise by 9% per year
compounded annually, the future value is found as follows:
FV = P(FV of $1 for 5 years at 9%)

= $100,000 (1.5386)
= $153,860
The next step is to determine how much must be set aside today in order to
generate $153,860 five years from now. The amount that must be set aside is the
present value of $153,860. Since 7% compounded annually after taxes is assumed
to be earned on any sum invested today, the amount that must be set aside today
is
PV = FV(PV of $1 five years from now at 7%)

= $153,860(.7130)
= $109,702
Thus, $107,702 must be set aside today in order to generate the funds to purchase
the equipment 5 years from now.
Page | 53
Problem No 13:-
The Tucciarone Macaroni Company is considering the acquisition of a machine so

that it can increase its production capacity. The machine will cost $50,000.
However, it will enable the company to increase cash sales by $60,000 per year for
the next 5 years. Cash operating expenses excluding taxes will also increase by
$20,000 in year 1 and are expected to increase by 10% per year thereafter. At the
end of the fifth year, it is projected that the machine can be sold to generate
proceeds of $2,000 before taxes. Presently, the Tucciarone Macaroni Company is
in the 20% marginal tax bracket. It expects to be in that bracket for the following 2
years (years 1 and 2). In year 3, 4, and 5, it expects to be in the 45% marginal tax
bracket. Depreciation for tax reporting purposes if the machine is acquired would
be as follows:
Year Depreciation
1 $7,125
2 10,450
3 9,975
4 9,975
5 9,975
$47,500
If the machine is acquired, the firm is entitled to get a 10% tax credit [which
reduces the depreciation base of the asset by half of the $5,000 tax credit, that is,
by $2,500 ($50,000 - $2,500 = $47,500)].
Required: Compute the cash flow consequences that the Tucciarone Macaroni
Company would use to determine whether to acquire the machine. (Assume that
all cash sales and cash operating expenses are recognized for tax purposes in the
year received or paid.)
Page | 54
Solution:-
Tucciarone Macaroni Company’s initial net cash outlay is equal to the cash outlay
for the machine reduced by the tax credit. Since the tax credit is assumed to be
10% of the cost of the equipment, then
Tax credit = .10($50,000)
= $5,000
Therefore, the initial net cash outlay is $45,000 ($50,000 - $5,000).
The cash flow from operations can be found by using the format.
Year
1 2 3 4 5
Additional cash receipts $60,000 $60,000 $60,000 $60,000 $62,000
Less: Additional cash outlays (20,000) (22,000) (24,200) (26,620) (29,282)
excluding taxes
Additional cash outlay for (6,575) (5,510) (11,621) (10,532) (10,234)
taxes
Cash flow $33,425 $32,490 $24,179 $22,848 $22,484
To determine additional taxes:
Year
1 2 3 4 5
Additional revenue $60,000 $60,000 $60,000 $60,000 $62,000†
recognized for tax purpose
Less: Additional operating (20,000) (22,000) (24,200) (26,620) (29,282)
expenses recognized for tax
purposes
Additional depreciation for (7,125) (10,450) (9,975) (9,975) (9,975)
tax purposes*
Additional taxable income $32,875 $27,550 $25,825 $23,405 $22,743
Marginal tax rate ×.20 ×.20 ×.45 ×.45 ×.45
Page | 55
Additional income taxes $6,575 $5,510 $11,621 $10,532 $10,234
*information given:
†The $2,000 gain is fully taxable because the assets net book value is $0.
Summary:
Initial net cash outlay $45,000

Cash flow from operation in
Year 1 $33,425
Year 2 $32,490
Year 3 $24,179
Year 4 22,848
Year 5 22,484
Problem No 14:-
The local florist sells carnations in bunches of six. The following costs are related
to one flower:
Fertilizer $.15
Utilities .50
Miscellaneous .10
The selling price of each bunch is $7.50. If the flowers are not sold at the end of
each day, they are given to the local hospital.
The probability of selling the following number of bunches was determined to be:
Number Probability
0 .03
1 .05
2 .08
3 .12
Page | 56
4 .15
5 .20
6 .17
7 .10
8 .08
9 .02
Required: Determine the expected value of profits.
Solution:-
Total costs per bunch are
Fertilizer $.15
Utilities .50
Miscellaneous .10
$.75 × 6 flowers = $4.50 per bunch
Profit per bunch = $7.50 - $4.50 = $3.00
Expected value of profit:
Demand Probability Probability

(Units) Of Demand Profit ×profit
0 .03 $0.00 $0.00
1 .05 3.00 .15
2 .08 6.00 .48
3 .12 9.00 1.08
4 .15 12.00 1.80
5 .20 15.00 3.00
6 .17 18.00 3.06
7 .10 21.00 2.10
8 .08 24.00 1.92
9 .02 27.00 .54
1.00 $14.13
Expected value of profit = $14.13
Problem No 15:-
Page | 57
a) The following results for 19X5 were reported by Case Company’s two
investment
Investment center 1 Investment center 2
Controllable income $200, 000 $450, 000
Controllable assets $1, 000, 000 $3, 000, 000
ROI 20% 15%
The Case Company has a required rate of return equal to 12%. Upper-level
management is considering an investment proposal which should earn
$90,000 of income on $500,000 of assets. The investment proposal’s ROI
equals 18% ($90,000/$500,000). Upper level management is in the process
of choosing which of its two investment centers will be asked to initiate the
investment proposal. As far as upper-level management is concerned, it is
very excited about the project’s anticipated 18% return, which is well in
excess of the company’s 12% required rate of return. Upper-level
management would expect that both of tis investment center managers
would be equally excited. You are required to determine, first for
investment center 1 and second for investment center 2, what course of
action their mangers would take if they were confronted by upper-level
management’s proposed investment. Provide whatever data you believe to
be necessary to support each investment center manger’s position.
b) The Spacedout Company has a required rate of return equal to 10%. One of
its investment centers, a foreign subsidiary located on the moon, has been
doing very poorly and reported the following results in the year 2525:
Controllable income $4, 000
Controllable assets $100, 000
ROI 4%
The lunar subsidiary is considering an unusual investment proposal to
manufacture green cheese which should earn $600 of income on $10,000 of
assets. The investment proposal’s ROI equals 6% ($600/$10,000). As far as
upper-level management is concerned, it is totally against the project
Page | 58
because its anticipated 6% return is well below the company’s 10%

required rate of return. Upper-level management would expect that its
investment center manager would be as disenchanted with the proposal as
it is. You are required to determine for the lunar investment center what
course of action its manager would take with respect to this investment
project.
Solution:-
a) The manager of investment center 1 would, to the surprise of upper-level

management, reject the proposal on the basis of the following comparative
analysis:
ROI before Investment ROI after accepting
accepting proposal proposal
proposal
Controllable income $200, 000 $90, 000 $290,000
Controllable assets $1, 000, 000 $500, 000 $1,500,000
ROI 20% 18% 19⅓%
It is perfectly rational for investment center 1’s manager to reject an
investment proposal that would reduce his ROI from 20% to 19⅓% despite
the fact that the investment proposal is desirable from the perspective of
the company as a whole.
The manager of investment center 2 would, as expected by upper-level
management, accept the proposal on the basis of the following
comparative analysis:

proposal
Controllable income $450, 000 $90, 000 $540, 000
Controllable assets $3, 000, 000 $500, 000 $3,500, 000
ROI 15% 18% 15.43%
Page | 59
The manager of investment center 2 accepted the Case Company’s

proposal, not because he wanted to make a sacrifice for the benefit of the
company as a whole, but only because it increased his ROI from 15% to
15.43%.
The intent of part a of this problem is to demonstrate that a lack of goal
congruence can readily occur when ROI is used to evaluate the
performance of investment center managers. Investment center 1 rejected a
desirable project that would have, had it been accepted, been in the best
interest of the company as a whole.
b) The manager of the lunar investment center would, to the surprise of
upper-level management, accept the proposal on the basis of the following
comparative analysis:
proposal
Controllable income $4, 000 $600 $4, 600
Controllable assets $100, 000 $10, 000 $110, 000
ROI 4% 6% 4.18%
Once again, an investment center manager accepts a projects a project only

because it increases his ROI from 4% to 4.18%, despite the obvious fact that
upper-level management would like nothing better than to see the project
rejected.
The intent of part b of this problem is to demonstrate once again that a lack
of goal congruence can readily occur when ROI is used to evaluate the
performance of investment center mangers. An investment center manager
accepted an undesirable project that will not be in the best interests of the
company as a whole.
Problem No 16:-
Shahid Limited is engaged in manufacturing and sale of footwear. The company

sells its products through company operated retail outlets as well as through
Page | 60
distributors. The management is in the process of preparing the budget for the
year 2010-11 on the basis of following information:
i. The marketing director has provided the following annual sales

projections:
No. of units Retail price range
Men 1,200,000 Rs. 1,000 – 4,000
Women 500,000 Rs. 800 – 2,500
The previous pattern of sales indicates that 60% of units are sold at the
minimum price; 10% units are sold at the maximum price and remaining
30% at a price of Rs. 2,000 and Rs. 1,200 per footwear for men and women
respectively.
ii. It has been estimated that 30% of the units would be sold through
distributors who are offered 20% commission on retail price. The
remaining 70% will be sold through company operated retail outlets.
iii. The company operates 22 outlets all over the country. The fixed costs per
outlet are Rs. 1.2 million per month and include rent, electricity,
maintenance, salaries etc.
iv. Sales through company outlets include sales of cut size footwears which
are sold at 40% below the normal retail price and represent 5% of the total
sales of the retail outlets.
v. The company keeps a profit margin of 120% on variable cost (excluding
distributors’ commission) while calculating the retail price.
vi. Fixed costs of the factory and head office are Rs. 45 million and Rs. 15
million per month respectively.
Required:
Prepare budgeted profit and loss account for the year 2010 – 2011.
Solution:-
Price Units Amount (Rs. ‘000s)

Men Women Men Women Men Women
Page | 61
Minimum 1,000 800 720,000 300,000 720,000 240,000

Maximum 4,000 2,500 120,000 50,000 480,000 125,000
Average 2,000 1,200 360,000 150,000 720,000 180,000
Total 1,200,000 500,000 1,920,000 545,000
Rs. 000s
Sales revenue – gross (1,920,0000 + 545,000) 2,465,000
Less : Commission to distributors 20% ×30% of above 147,900
Cut size discount 40% × (5% of 70%) 34,510
182,410
Sales – net 2,282,590
Variable cost 100/220 of gross revenue 1,120,455
1,162,135
Less : Factory overheads 12 × 45m 540,000
Gross profit 622,135
Less : Admin overheads 12 ×15m 180,000
Cost of retail outlets 12 × 22 × 1.2m 316,800
496,800
Net profit 125,335
Problem No 17:-
Buraq Motors manufactures two types of cars i.e. X and Y. The production of each
type of car involves two departments. Details of production time are as follows:
Production hours per unit
Departments
Car type Assembly Finishing
Page | 62
X 120 80
Y 80 50
Contribution margin per unit of X is Rs. 150,000 and per unit of Y is Rs. 100,000.
Total capacity of assembly and finishing departments is 18,200 and 12,000 hours
per month respectively.
Required:
Calculate the shadow price per hour of capacity if 200 hours are added to the
capacity of assembly department, assuming that the capacity of finishing
department is not altered.
Solution:-
Objective function: Maximize Z = 150,000x + 100,000y
Current constraints:
120x + 80y = 18200 Eq 1 if y = 0, x ≤ 151; if x = 0,y ≤ 227
80x + 50y= 12000 Eq 2 if y = 0, x = 150; if x = 0,y = 240
x>0 and y>0
600x + 400y= 91000 Eq 3 Eq 1×5
640x + 400y 96000 Eq 4 Eq 2×8
−40x= −5000
x= 125
80x +50y= 12000 Eq 2
10000 +50y= 12000
50y= 2000
y= 40
Revised constraints
Page | 63
120x + 80y = 18400 if y = 0, x ≤ 153; if x =0,y = 230
80x + 50y= 12000 Eq 2 if y = 0, x = 150; if x =0,y = 240
x>0 and y>0
600x + 400y= 92000 Eq 3 Eq 1×5
640x + 400y 96000 Eq4 Eq2 × 8
−40x= −4000
x= 100
80x +50y= 12000 Eq 2
8000+50y= 12000
50y= 4000
y= 80
Current Options:
Production
x y Contributions
A 150 0 22,500,000
B 125 40 22,750,000
C 0 227 22,700,000
Required Options:
Production
x y Contributions
A 150 0 22,500,000
B 100 80 23,000,000
C 0 230 23,000,000
Page | 64
Shadow price for additional capacity: (23,000,000 - 22,750,000) = 250,000/200

= Rs.1, 250 per hour
Problem No 18:-
During the year ending June 30, 2011 Abdul Habib Company Limited has
planned to launch a new product which is expected to generate a profit of Rs. 9.3
million as shown below:
Rs. in ‘000’
Sales revenue (24,000 units) 51,600
Less: cost of goods sold 37,500
Gross profit 14,100
Less: operating expenses 4,800
Net profit before tax 9,300
The following additional information is available:
i. 75% of the units would be sold on 30 days credit. Credit prices would be
10% higher than the cash price. It is estimated that 70% of the customers
will settle their account within the credit term while rest of the customers
would pay within 60 days. Bad debts have been estimated @ 2% of credit
sales. All cash and credit receipts are subject to withholding tax @ 6%.
ii. 80% of the expenses forming part of cost of goods sold are variable. These
are to be paid one month in arrears.
iii. The production will require additional machinery which will be purchased
on July 1, 2010 at a cost of Rs. 60 million. The machine is expected to have a
useful life of 15 years and salvage value of Rs. 7.5 million. The company
has a policy to charge depreciation on straight line basis. The depreciation
on the machinery is included in the cost of goods sold as shown above.
iv. Variable operating expenses excluding bad debts are Rs. 105 per unit.
These are to be paid in the same month in which the sale is made.
v. 50% of the fixed costs would be paid immediately when incurred while the
remaining 50% would be paid 15 days in arrears.
vi. The management has decided to maintain finished goods stock of 1,000
units.
Page | 65
Required:
Calculate the cash requirements for the first two quarters.
Solution:-
Cash Management
Total sales Units Weight Sales Ratio

Cash sales – 25% 6,000 1.0 6,000
Credit sales – 75% 18,000 1.1 19,800
24,000 25,800
Sales Revenue (Rs. in ‘000) 51,600

Cash Selling price per unit 2,000
Credit selling price per unit 2,200
Cash Requirement 2010 -11

Particulars Qtr. 1 Qtr. 2
--- Rs. in ‘000 ---
Purchase of machinery (60,000) -
Sale receipts - -
Cash sales (2,000 × 6,000 / 4 × 94%) 2,820 2,820
Receipts from credit sales – as per working below 5,211 9,120
Cost of goods sold – variable (37,500 x 80%) /12×2 and 3 (5,000) (7,500)
Variable cost of finished stock 30,000 / 24,000 × 1,000 (1,250) -
Variable operating expenses (105 × 3 × 2,000) (630) (630)
Payment of fixed costs (457 × 2.5) / (457 × 3.0) (1,143) (1 ,372)
(59,992) 2,438
Month 1st Month 2nd

1 2 3 Qtr. 4 5 6 Qtr.
---------- Rs. in ‘000 ----------
Working for credit sales
Credit sales 3,300 3,300 3,300 3,300 3,300 3,300
Page | 66
18,000÷12×2,200)
Settlement – 70% 2,310 2,310 2,310 2,310 2,310
28% 924 924 924 924
Gross receipts 2,310 3,234 5,544 3,234 3,234 3,234 9,702
Tax @ 6% (333) (582)
Receipts net of tax 5,211 9,120
Operating expenses
Total operating expenses – given 4,800
Less: Variable cost per unit (105 × 24,000) (2,520)
Bad debt expense (2,200 × 18,000 × 2%) (792)
Fixed operating expenses 1,488
Fixed cost
Fixed factory overheads 7,500
Less: Depreciation (60m – 7.5m) / 15 (3,500)
Fixed operating overheads 1,488
5,488
Fixed cost per month 457
Problem No 19:-
Noureen Industries Limited produces and sells sports goods. The management
accountant has developed the following budget for the year ending June 30, 2011.
Budgeted Income Statement
Rs. in ‘000’
Page | 67
Sales 80,000
Variable costs 44,800
Fixed overheads 6,500
51,300
Gross profit 28,700
Selling and admin expenses:
Sales commission 8,000
Depreciation on assets 700
Fixed administrative costs 2,200
10,900
Net operating income 17,800
Finance costs (80% is fixed) 750
Net profit 17,050
The company had a policy of hiring salesmen on commission basis. The rate of
commission varied with the increase in sales. However, recently the sales team
had informed the management that they would be willing to work only if the rate
of commission is fixed at 20% irrespective of the amount of sales.
The only other alternative available to the company is to establish a full-fledged

sales department. It has been estimated that the annual cost of this department
would be as follows:
Rs. in ‘000’
Salaries – Sales Manager 1,200
– Sales persons 2,400
Advertising 1,600
Travel for promotion 1,200
Training costs 600
In addition, a commission of 5% would also be payable to the sales team.
Required:
Determine the volume of sales beyond which the company would be inclined to
establish a sales department instead of meeting the demand of the current sales
force.
Solution:-
Page | 68
Noureen Industries Limited
Contribution Margin
Increased Own sales

commission 20% department
------------Rs. in ‘000s-----------
Sales 80,000 80,000
Less: Variable expenses
Manufacturing costs 44,800 44,800
Sales commission 16,000 4,000
Finance cost 150 150
60,950 48,950
Contribution margin 19,050 31,050
Contribution margin – as % of sales 23.8 38.8
Fixed expenses
Fixed overheads 6,500 6,500
Depreciation 700 700
Fixed admin costs 2,200 2,200
Finance cost 600 600
Fixed marketing costs 7,000
10,000 17,000
Equal net income level:
Let the required sales level be x.
Net operating income with increased commission = 0.238x – 10,000
Net operating income with own sales force = 0.388x – 17,000
Both will be equal at:
0.388x – 17,000 = 0.238x – 10,000
0.15x = 7,000
x = 46,667
It would be beneficial for NIL to establish a full-fledged sales department if sales
exceed Rs. 46,667,000.
Problem No 20:-
Haji Amin (Private) Limited (HAPL) is engaged in manufacturing of spare parts.
In May 2010, the utilized production capacity of the company was 60%. The
Page | 69
management has received an order to produce 100,000 units of product M, which

will utilize 20% of the production capacity for a period of 6 months.
All the materials are added at the beginning of the process. Labour and overheads
are distributed evenly throughout the process. Inspection is conducted when the
product is 60% complete. Normal loss is equal to 5% of the units produced.
The following information is also available:
i. Materials
Each unit of product M requires 1 kg of material A and 2 kg of material B.
Material A is available in the market at a cost of Rs. 250 per kg.
Alternatively, another material C can be used, which is produced in-house
at a variable cost of Rs. 220 and is sold at a selling price of Rs. 260 per kg. C
has unlimited demand. 300,000 kgs of Material B is available in stock at a
cost of Rs. 50 per kg. 60% of the available stock is required for use in the
current production. The current market price of material B is Rs. 70 per kg.
However, the present stock available with HAPL can only be sold for Rs.
60 per kg.
ii. Labour
Each worker will take 6 hours per unit for initial 50 units. Thereafter the
average time would be reduced to 5 hours per unit. Each worker would be
hired on six months contract at the rate of Rs. 60 per hour with 200
working hours per month.
iii. Variable overheads
These are estimated at Rs. 8 per labour hour.
iv. Fixed overheads

These are estimated at Rs. 45 million per annum at 100% capacity. Some of
the facilities can be relieved, if the company does not want to work at more
than 70% capacity. As a result of relieving these facilities, the annual fixed
costs would reduce to Rs. 33.75 million. If the excess production capacity is
used to produce material C, the company can earn a contribution margin of
Rs. 200,000 per month for each 10% capacity utilization.
Required:
Compute the manufacturing cost of product M using the relevant cost approach.
Solution:-
Manufacturing cost of product B
Material A (105,000 × 250) 26,250,000
Page | 70
Material B (120,000 × 60) 7,200,000

(90,000× 70) 6,300,000 13,500,000
Labour (W-1) [60 × 200 × 6 ×448 (W-1)] 32,256,000
Variable factory overhead [200×6×448(W-1) 4,300,800
hours×8]
Fixed factory overhead (W–2) 4,425,000
Manufacturing cost of 80,731,800
product B
W-1: Labour
Total working hours per labour (200 × 6) 1,200
Units produced in first 300 hours (300/6) 50
Units produced in remaining 900 hours (900/5) 180
No. of units produced per worker 230
No. of full units 100,000
Normal loss (5,000 × 60%) 3,000
103,000
No. of workers required (103,000 / 230) 448
W-2: Fixed overheads
Savings at 70% capacity for 6 months [6/12 × (45.0 – 33.75)m] 5,625,000
Contribution from C - 10% capacity (70 – 60) for 6 months 1,200,000
A 6,825,000
Contribution from C - 40% capacity for 6 months B 4,800,000
Higher of A or B above 6,825,000
Less: contribution from C @ 20% capacity for 6 months 2,400,000
Opportunity cost of utilizing 20% capacity 4,425,000
Problem No 21:-
ABC Limited deals in a single product called HGV. It had prepared a budget for
the year ending December 31, 2009 which was based on the following key
assumptions:
Sales 504,000 units @ Rs. 430
Variable cost (40% is direct labour) Rs. 300 per unit
Fixed cost for the year (including depreciation @ 10%) Rs. 25,000,000
Page | 71
Cost of raw material per kg Rs. 56.25

Raw material consumption per unit of finished 2 kgs
product
However, the position as shown by the management accounts prepared up to

May 31, 2009 is not very encouraging and depicts the following actual results:
 105,000 units were sold @ Rs. 350 per unit.
 Average cost of raw material used amounted to Rs. 90/- per unit of
finished product.
 Other variable costs were as per the budget.
The marketing department advised the management that the failure to achieve
targeted sale is because a competitor has introduced another product which has
been very popular in the low income areas.
After due deliberations, the management has prepared a revised plan for the
remaining period of the financial year. The plan involves launching of a low
grade version of the existing product named LGV, to capture the low income
market. Salient features of the plan are as under:
i. Sales mix of HGV and LGV is expected to be in the ratio of 1:2. Sale price of
HGV would be increased to Rs. 385, whereas sale price of LGV would be
Rs. 270.
ii. A new machine will have to be purchased for Rs. 1.2 million.
iii. For LGV two different types of raw materials i.e. A and B will be used in
the ratio of 5:3. However, the total weight of raw material used shall be the
same in case of both products. Presently A is available at the rate of Rs. 25
per kg whereas B is available at the rate of Rs 45 per kg. The raw material
consumption per unit of HGV shall continue to be Rs. 90 per unit.
iv. Production of HGV is carried out by skilled workers. However, only
unskilled workers would be required for the production of LGV. The
wages of unskilled workers would be 40% lower but labour hours per unit
would be 10% higher than HGV.
v. Variable factory overhead cost per unit of LGV would be 10% lower than
HGV.
vi. Additional marketing cost would be Rs. 3 million.
Required:
Compute the sales amount and quantities for the remaining period, to achieve a
break even in 2009.
Page | 72
Solution:-
ABC Limited
Actual Jan-May 2009
Rupees
Sales (105,000x350) 36,750,000
Variable costs:
Raw materials (105,000x90) (9,450,000)
Direct labor (300 × 0.4) x 105,000 (12,600,000)
Other variable costs (300-112.50-120) x 105,000 (7,087,500)
Contribution margin 7,612,500
Revised Plan Jun-Dec 2009

LGV HGV Total
Sale price per unit 270 385.00
Variable cost:
Raw material cost
A (25x2x5/8) (31.25)
B (45x3x3/8) (45 × 3 × 2)/8 (33.75)
(65.00) (90.00)
Direct labor cost (300×0.4) (120.00)
(120 × 0.6 × 1.1) (79.20)
Factory overhead cost (300-112.5-120) (67.50)
(67.5 × 0.9) (60.75)
Total variable cost (204.95) (277.50)
Contribution margin Rs 65.05 107.50
Sales mix ratio 2 1 3
Aggregate contribution margin 130.10 107.50 237.60
Rs.
Fixed cost Jan-Dec:
Fixed cost for the year 25,000,000
Additional marketing cost 3,000,000
10% depreciation on machine cost Jun-Dec 70,000
2009
28,070,000
Contribution recovered Jan-May 2009 (7,612,500)
Required contribution for Jun-Dec 2009 20,457,500
Break even Sale quantity Jun-Dec 2009:
Page | 73
Break even quantity for:

High grade (20,457,500/237.60) 86,101
Low grade (86,101 × 2) 172,202
Break even Sale amount Jun-Dec 2009 46,494,540 33,148,885 79,643,425
Rs.
Problem No 22:-
Extract from the records of AMAX Limited are as under:
Budget Actual
---------- Rupees ----------
Sales 27,000,000 27,295,000
Variable costs:
Raw Material (7,500,000) (8,461,450)
Labour (9,375,000) (9,463,125)
Variable overheads (3,000,000) (2,974,125)
Contribution 7,125,000 6,396,300
An analysis of the above figures has revealed the following:

 Actual units sold were 3% (1,500 units) more than the budgeted sales
quantity and actual sale price was lower by Rs. 10/- per unit.
 One unit of finished product requires 3 kgs of raw material and actual raw
material price was 6% higher than the budgeted price.
 Budgeted labour cost per hour was equivalent to 150% of budgeted raw
material cost per kg.
 Production department records show that labour utilization per unit of
finished product was 1/8 hour more than the budget.
 Variable overheads varied in line with labour hours.
Required:
Compute eight relevant variances and prepare a statement reconciling budgeted
contribution with the actual contribution.
Solution:-
Sales volume margin/profit/contribution variance
= 7,125,000 / 50,000 × 1,500 = Rs. 213,750 (Fav) (W–1)
Sales Price Variance
Page | 74
= 51,500 units (Rs. 540 – Rs. 530) = Rs. 515,000 (Adv) (W–2, 3, 4)
Raw material Price variance
= (Rs. 53 -50) × 159,650 = Rs. 478,950 (Adv) (W–6, 7, 8)
Raw material quantity variance
= {159,650 – (51,500 × 3)} × 50 = Rs. 257,500 (Adv) (W–6, 8, 9)
Labour rate Variance
= (Rs 75 – Rs. 70) × 51,500 × 2.625 hours = Rs. 675,937.50 (Fav) (W–9, 10, 11, 12, 13)
Labour efficiency variance
= 1/8 hour × Rs. 75 × 51,500 = Rs. 482,812.50 (Adv) (W–2, 12)
Variable overhead efficiency variance
= 1/8 hour × (24x51,500) = 154,500 (Adv) (W–14)
Variable overhead spending / expenditure variance
(24 – 22) × 51,500 × 2.625 = Rs. 270,375 (Fav) (W–14, 15)
W-1: Budgeted Sales quantity:
1,500 / 0.03 = 50,000 units
W-2: Actual Sales quantity
50,000 + 1,500 = 51,500 units
W-3: Budgeted sale price:
27,000,000 / 50,000 = Rs. 540 per unit
W-4: Actual sale price:
540 – 10 = Rs. 530 per unit
W-5: Budgeted raw material quantity
= 50,000 units × 3 kgs = 150,000 kgs
W-6: Budgeted material price
= 7,500,000 ÷ 150,000 kgs = Rs. 50 per kg (W–5)
W-7: Actual material price
= Rs. 50 × 1.06 = Rs. 53 per kg
W-8: Total actual quantity used
= Rs. 8,461,450 ÷ Rs. 53 = 159,650 kgs
W-9: Budgeted labour cost per finished unit
= 9,375,000 ÷ 50,000 = Rs. 187.50
W-10: Budgeted labour time for one finished unit
= [(Rs. 187.5) ÷ (Rs 50 × 150%)] = 2.5 hours (W–10)
W-11: Actual labour time taken for one finished unit
= 2.5 + (1÷ 8) = 2.625 hours
W-12: Budgeted labour cost per hour
= (Rs. 187.5 ÷ 2.50 hours) = Rs. 75 per hour
Page | 75
W-13: Actual labour cost per hour

= (Rs. 9,463,125 ÷ (2.625 hours × 51,500) = Rs. 70 per hour
W-14: Budgeted variable overhead rate per hour
3,000,000 / (50,000 × 2.50) = Rs. 24 per labour hour
W-15: Actual variable overhead rate per hour

2,974,125 / (2.625 × 51,500) = Rs. 22 per labour hour
RECONCILIATION OF BUDGETED CONTRIBUTION AND ACTUAL

CONTRIBUTION
Rupees
Budgeted profit 7,125,000
Sales volume margin variance 213,750
Sale price variance (515,000)
Material price variance (478,950)
Material quantity (usage) variance (257,500)
Labour rate variance 675,937.50
Labour efficiency variance (482,812.50)
Variable overhead efficiency variance (154,500)
Variable overhead spending / expenditure variance 270,375
Actual profit 6,396,300
Problem No 23:-
Clifton Hospital is interested in an analysis of the fixed and variable cost of
supplies related to patient days of occupancy. The following actual data has been
accumulated by the management:
Month Cost of supplies Occupancy
(Rs. ‘000’) ratio (%)
December 2008 1,665 90
January 2009 1,804 93
February 2009 1,717 98
March 2009 1,735 94
April 2009 1,597 86
May 2009 1,802 99
Required:
Page | 76
Compute the variable cost of supplies per bed per day using the method of least
square, if the total number of beds in the hospital is 300.
Solution:-
Patient days Diff from Cost of Diff from Col 2 sqrd (2) x (4)
of Average Supplies Average (y) Σx2 Rs. ‘000’
occupancy (x) Rs. ‘000’ Σxy
1 2 3 4 5 6
Dec *8,370 -120 1,665 -55.0 14,400 6,600
Jan 8,649 159 1,804 84.0 25,281 13,356
Feb 8,232 -258 1,717 -3.0 66,564 774
Mar 8,742 252 1,735 15.0 63,504 3,780
Apr 7,740 -750 1,597 -123.0 562,500 92,250
May 9,207 717 1,802 82.0 514,089 58,794
Total 50,940 0 10,320 1,246,338 175,554
Average 8,490 1,720
*8370 = 300 × 90% × 31 days

Variable expenses = Σxy / Σx2
Col 6 / Col 5 = 175,554 / 1,246,338 = 0.14086
= 0.14086 × 1000 = Rs. 140.86 Variable rate per patient per day
Problem No 24:-
MMTE Limited has witnessed a significant decline in profits over the past few
years. A study has revealed that the company’s sales have been stagnant over the
years as it has been regularly increasing the price of its only product i.e. PDT.
However, since the cost of production has been rising, the company is unable to
reduce the price. The company’s budget for the next year contains the following
projections:
i. Two types of raw materials i.e. A and B will be used in the ratio of 70:30.
ii. The cost of raw materials would be Rs. 32 and Rs. 10 per kg respectively.
iii. Wastage is projected at 8% of input quantity.
iv. Labour rate has been projected at Rs. 400 for 8 working hours / day.
v. One labour hour is estimated to be consumed for 4 kgs of finished
products.
vi. Variable overheads have been budgeted at Rs. 5 per kg of input.
Page | 77
vii. Fixed overheads are estimated at Rs. 4,000,000 per annum.

A consultant hired by the company has carried out a detailed study and
recommended the following measures:
 Hire a firm of Quality Assurance who would depute its expert staff to
control the ratio of wastage. The company will have to pay Re 0.5 per kg
for the inspection of material. It is expected that overall wastage would
decrease by 80%.
 It has been identified that factory workers are spending 25% more time as
compared to other manufacturing units of the industry. An incentive plan
has therefore been suggested, according to which the workers would be
entitled to share 40% of the time saved. It is expected that by implementing
the incentive plan, the workers will achieve the industry average.
 Certain improvements have been suggested in the production process and
this will result in reduction in variable overheads by 20%.
 It has been ascertained that staff performing various support functions is
underutilized. The company should therefore discontinue the services of
some members of the staff and allocate their work between the remaining
staff. As a result, fixed overheads will decrease by 25%.
Required:
Compute the amount of savings that the revised plan is expected to generate if the
required production is 2 million kgs of PDT.
Solution:-
Computation of budgeted gross profit based on:
Existing Budget based on
budget recommended
Rupees plan Rupees
Material A (2 M kgs x 70% × 48,695,652.16 (2 M kgs × 70% 45,528,455

32) / 0.92 x 32) / 0.984
Material B (2M x 30% × 10) / 6,521,739.13 (2M × 30% × 10) 6,097,561
0.92 / 0.984
Inspection cost (2M × 0.50) / 1,016,260.00
0.984
Labour Cost (15 /60 × 2M × Rs. 25,000,000.00 (Rs.25m-Rs.3m 22,000,000.00
400/8) (Note)
Page | 78
Variable (2 M × Rs. 5)/0.92 10,869,565.21 (Rs.5 x 80%) × 8,130,081.30

overhead [(2M / (1-0.016)]
Fixed Overhead 4,000,000.00 (Rs. 4,000,000– 3,000,000.00
25%)
95,086,956.50 85,772,357.30
Savings 9,314,599.20
(Note) Savings in Labour Cost:

Average labour time for industry (15 minutes /1.25) 12 Minutes
Benefits of time saving
[(15 minutes – 12 minutes) /60] × 2 M × 400/8 Rs. 5,000,000
Workers share (Rs. 5 million × 40%) Rs. 2,000,000
Savings Rs. 3,000,000
Problem No 25:-
Ahmed Sons (Pvt.) Ltd., a small sized manufacturer, is experiencing a short term
liquidity crisis. It needs Rs. 10 million by the end of next month and expects to
repay it within 6 months of the date of receipt.
The company is considering the following three alternatives:
i. Obtain short term loan at an interest of 18 percent per annum,
compounded monthly.
ii. Forego cash discount of 2% on some of its purchases. The total purchases
are approximately Rs. 12 million per month. The discount is offered for
payment within 30 days. However, if the payment is delayed beyond 90
days, it could endanger the company’s relationship with the supplier.
iii. Make arrangement with a factor who is ready to advance 75 per cent of the
value of the invoices after deduction of all factoring charges, immediately
upon receipt of the invoices. The balance shall be paid within the normal
credit period presently being availed by the customers.
The average sales are Rs. 25 million per month of which 60% are credit
sales. The company's customers pay at the end of the month following the
month in which the sales took place. This level is expected to remain
steady over the next year.
The factor shall charge interest @ 15 percent per annum on the amount of
money advanced. He shall also charge factoring fee of 2 percent.
Page | 79
The company estimates that as a result of the above arrangement, it will

save on bad debts and the cost of credit control, aggregating Rs. 200,000
per month. Moreover, the company can use any surplus funds made
available to reduce its overdraft, which is costing 1 percent per month.
Required:
Advise the company as to which of the three alternatives is cheaper.
Solution:-
Option I: Cost of short term loan per month:
Rate 18% per annum = 1.5% per month
Cost of funds for 6 months = {10,000,000 × (1.015) 6 }-10,000,000}= Rs. 934,433
Cost of funds for 1 month = 934,433 / 6 = 155,739
Option II: Cost of financing through supplies:
Opportunity cost per month = 200,000 / 9,800,000 = 2.04% / 2 = 1.02% or Rs.
102,041 per month
Option III: Cost of factoring per month:

Rupees
Credit Sale 25,000,000 × 60/100 15,000,000
Interest charges 15,000,000 × 45/30 x 75% × 1.25% 210,938
Fee 15,000,000 × 2% 300,000
Total Charges 510,938
Less : Savings in Bad debts and cost of credit control 200,000
Financial charges saving 63,641* (263,641)
247,297
Cost of funds = Rs. 303,547 per month
* Advance 75% of 15 million x 45/30 16,875,000
Less: interest charges (210,938)
Factors fees (300,000)
16,364,062
Less: requirement (10,000,000)
Overdraft reduction 6,364,062
Interest at 1% per month 63,641
Conclusion:
Option II is the cheapest option. The company should forego the cash discount
of 2% and avail credit for further 60 days.
Page | 80
Problem No 26:-
XYZ Ltd presently uses a single plant wide factory overhead rate for allocating
factory overheads to products, based on direct labour hours. A break-up of
factory overheads is as follows:
Factory overheads
Production Support 1,225,000
Others 175,000
Total cost (Rs.) 1,400,000
It now plans to use activity-based costing to determine costs of its products. The
company performs four major activities in the Production Support Department.
These activities and related costs are as follows:
Production Support Activities Rupees
Set up costs 428,750
Production control 245,000
Quality control 183,750
Materials management 367,500
Total 1,225,000
The planning department has gathered the relevant information which is given
below:
Direct Machine Inspections No. of
Production labour Batch hours hours per Material
Products in units hours per size per unit unit requisitions
unit (units) raised
Product X 10,000 2.5 125 7.50 0.2 320
Product Y 2,000 5.0 50 10.00 0.5 400
Product Z 50,000 2.8 10,000 3.00 0.1 30
The quality control department follows a policy of inspecting 5% of all production

in case of X and Y and 2% of all units of Z.
Required:
Determine the factory overhead cost per unit for Products X, Y and Z under:
a) Single factory overhead rate method.
b) Activity Based Costing.
Page | 81
Solution:-
a) .
X Y Z Total
Number of units A 10,000 2,000 50,000
Direct labour hours per unit B 2.5 5.0 2.8
Direct labour hours (A× B) C 25,000 10,000 140,000 175,000
Total factory overheads D 1,400,000
Factory overhead rate per hour (D/C) E Rs. 8
Cost per unit - single factory overhead rate 20 40 22.40
method (B × E) F
b) .
Activity based costing
Set-up costs
Batch size G 125 50 10,000
Set-ups (A ÷ G) H 80 40 5 125
Set-up costs J 274,400 137,200 17,150 428,750
Production control
Machine hours per unit K 7.5 10.0 3.0
Total machine hours (A × K) L 75,000 20,000 150,000 245,000
Production control M 75,000 20,000 150,000 245,000
Quality control Allocation
No. of inspections N 5% 5% 2%
Units inspected (A × N) P 500 100 1,000
Hours per unit inspected Q 0.2 0.5 0.1
Total inspection hours (P × Q) R 100 50 100 250
Quality control costs S 73,500 36,750 73,500 183,750
Materials management
No. of requisitions T 320 400 30 750
Material management costs U 156,800 196,000 14,700 367,500
Factory overheads – General
Allocated on the basis of direct labour hours V 25,000 10,000 140,000 175,000
Total cost (J+M+S+U+V) W 604,700 399,950 395,350 1,400,000
Factory overhead cost per unit – activity based 60.47 199.98 7.91
Page | 82
costing (W ÷ A) Rs.
Problem No 27:-
A division of Electronic Appliances Limited sold 6,000 units of refrigerators
during the year ended September 30, 2008, the sale price being Rs. 24,000 per unit.
The opening work in progress comprised of 500 units which were complete as
regards material but only 40% complete as to labour and overheads. The closing
work in progress comprised of 1200 units which were also complete as regards
material but only 50% complete as to labour and overheads. The finished goods
inventory was 800 units at the beginning of the year and 1000 units at the year
end.
The work in progress account had been debited during the year with the
following costs:
Rs. in ‘000’
Direct material 83,490
Direct labour 14,256
Variable overheads 10,890
Fixed overheads 17,490
As compared to the previous year, the costs per units have increased as follows:
Direct material 10%
Direct labour 8%
Variable overheads 10%
Fixed overheads 6%
The selling and administration costs for the year were:
Rupees
Variable cost per unit sold 1,600
Fixed costs 12,000,000
Required:
a) Compute the cost per unit, by element of cost and in total, assuming FIFO
basis.
b) Prepare profit statements on the basis of:
i. Absorption costing
ii. Marginal costing.
Solution:-
a).
Page | 83
Material Labour Variable Total Fixed Total Cost

Overheads Variable Overheads
Cost
Equivalent units
Completed units 6,200 6,200 6,200 6,200
(6,000 + 1,000 –
800)
Closing work-in- 1,200 600 600 600
progress
Opening work-in- (500) (200) (200) (200)
progress
Total equivalent 6,900 6,600 6,600 6,600
units
Total cost (Rs.) 83,490,000 14,256,000 10,890,000 108,636,000 17,490,000 126,126,000
Cost per unit (Rs.) 12,100 2,160 1,650 15,910 2,650 18,560
b).
i. Absorption costing profit statement:
Rupees
Sales (6,000 × 24,000) 144,000,000
Op WIP 6,700,000
Op finished goods (17,000 × 800) 13,600,000
Production cost 126,126,000
Closing WIP (18,396,000)
Closing finished goods stock (18,560 × 1,000) (18,560,000)
109,470,000
Gross profit 34,530,000
Less: variable selling and administration costs 9,600,000
(1,600 × 6,000)
Fixed selling and administration costs 12,000,000
21,600,000
Net profit 12,930,000
ii. Marginal costing profit statement:

Rupees
Sales 144,000,000
Op WIP 6,200,000
Op finished goods (800 x 14,500) 11,600,000
Page | 84
Variable cost of production 108,636,000

Closing WIP (16,806,000)
Closing finished goods stock (1,000 x 15,910) (15,910,000)
Variable cost of sales 93,720,000
Variable selling and administration costs (1,600 9,600,000
× 6,000)
103,320,000
Contribution 40,680,000
Less: Fixed costs (17,490 + 12,000) 29,490,000
Net profit 11,190,000
Working
Closing work-in- 14,520,000 1,296,000 990,000 16,806,000 1,590,000 18,396,000
progress (Rs.)
Cost per unit last 11,000 2,000 1,500 14,500 2,500 17,000
year
Opening work-in- 5,500,000 400,000 300,000 6,200,000 500,000 6,700,000
progress (Rs.)
Problem No 28:-
RF Ltd. has established a new division. The total cost of the property, plant and
equipment of the division is Rs. 500 million. The working capital requirements are
expected to average Rs. 100 million. The company plans to finance the division
maintaining a debt equity ratio of 70:30. The cost of debt is 10%.
Other relevant information is as under:
Annual profit before depreciation and financial charges Rs. 150 million
Life of the assets 10 years
Deprecation method Straight line
The residual value of the property, plant and equipment is estimated at Rs. 20
million. The division will start functioning from 1st January, 2009.
Required:
a) Compute the return on investment (ROI) on the basis of average net assets
employed by the division for the years 2009 and 2015.
b) Based on the results obtained above, discuss the limitations of ROI as a
measure of performance.
Page | 85
Solution:-
a) ROI = net profit / total assets (investment)
Computation of net profit
Rs. in million
Annual profit before depreciation and financial charges 150
Depreciation [(Rs. 500 M - 20 M) / 10 years] (48)
Financial Charges (Rs. 600 × 70% × 10%) (42)
60
Computation of net capital employed (mid-year) for year 2009
Rs. in million
Net Book Value at 1st January, 2009 500
Net Book Value at 31st December, 2009 [(480 × 9/10) + 20] 452
Mid-Year Value for year 2009 [(500 + 452) /2] 476
Working Capital 100
Average net capital employed 576
ROI for the year 2009 [(Rs. 60M / Rs. 576M) × 100] 10.42%
Computation of average net capital employed (mid-year) for year
2015
Rs. in million
Net Book Value at 1st January, 2015 [(480 × 4/10) + 20] 212
Net Book Value at 31st December, 2015 [(480 × 3/10) + 20] 164
Mid-Year Value for year 2015 [(212 + 164) /2] 188
Working Capital 100
Average net capital employed 288
ROI for the year 2015 [(Rs. 60 / Rs. 288) × 100] 20.83%
b) Comments on appropriateness of the result
1) ROI method focuses on short term performance whereas investment
decision should be evaluated on the life of the project.
2) Although the net profit for the years 2009 & 2015 are same but the
ROI is much higher in 2015 as compared to 2009 which shows that it
is not an appropriate ratio for comparing the performance on year to
year basis.
Problem No 29:-
Page | 86
ABC Limited is considering to set up a chemical plant to produce a specialized

chemical CP-316. Their technical consultants have examined various plants and
have recommended to install either Model A or Model Z for the project. The
specifications of the plants are as follows:
MODEL A MODEL Z
Per hour capacity 80 kgs 100 kgs
Plant cost including installation Rs. 660 million Rs. 750 million
Natural gas consumption 0.5 MMBTU / kg 0.4 MMBTU / kg
Electricity consumption 2 KWH/ kg 1.5 KWH / kg
Water consumption 5 gallons / kg 4 gallons / kg
Normal evaporation losses 15% of the input 10% of the final production
Annual operating capacity 7,500 hours 7,500 hours
Life of plant 20 years 20 years
The marketing research has indicated that there is a large gap between demand
and supply and the company can market at least one thousand tons annually.
Other relevant information is as follows:
i. .
Rupees
Sale value per kg 900
Cost of raw material per kg 400
Electricity per KWH 12
Natural gas per MMBTU 80
Water per gallon 2
ii. Other expenses at a capacity of 600 tons are as under:
Model A Model Z
Rupees in million
Direct labour 30.0 33.0
Other production overheads (60% variable) 60.0 70.0
Selling and administration (40% variable) 35.0 45.0
Production overheads include depreciation charged on straight line basis.
iii. Working capital requirements are estimated at 20% of annual sales.
iv. Debt equity ratio of 60:40 will be maintained by the company.
v. Financial charges would be 12%.
vi. Tax rate applicable to the company is 30%.
Required:
Page | 87
Prepare detailed working to conclude whether the company should purchase

Model A or Model Z.
Solution:-
Total Production Capacity
Kgs
Model A (7,500 x 80) 600,000
Model Z (7,500 x 100) 750,000
Computation of per kg cost (Model A)

Per Unit Cost Total Cost
Rupees Rupees
Raw Material Cost (400 / 0.85) 470.59 282,354,000
Natural Gas (0.5 MMBTU × Rs. 80) 40.00 24,000,000
Electricity (2 KWH × 12 Rs.) 24.00 14,400,000
Water (5 gallons × Rs. 2) 10.00 6,000,000
Plant depreciation (33,000,000 / 600,000) 55.00 33,000,000
Labour cost (30,000,000/600000) 50.00 30,000,000
Other production overhead (60,000,000 / 600) 100.00 60,000,000
749.59 449,754,000
Computation of per kg cost (Model Z)

Per Unit Cost Total Cost
Rupees Rupees
Raw Material Cost 400.00 300,000,000
Natural Gas (0.4 MMBTU × Rs. 80) 32.00 24,000,000
Electricity (1.5 KWH × 12 Rs.) 18.00 13,500,000
Water (4 gallons × Rs. 2) 8.00 6,000,000
Plant depreciation (37,500,000 / 750,000) 50.00 37,500,000
Labour cost (33,000,000/600) 55.00 41,250,000
Other production overhead (80,500,000 / 750,000) 107.33 80,500,000
670.33 502,750,000
Wastage (10/90 x 670.33) 74.48 55,860,000
744.81 558,610,000
Page | 88
Other production overheads for Model Z

Rupees
Fixed cost (40% x 70.0 million) 28,000,000
Variable cost (70 million x 60% × 75 / 60) 52,500,000
80,500,000
Selling and administration expenses for Model Z
Fixed cost (60% x 45 million) 27,000,000
Variable cost (45 million x 40% × 75 / 60) 22,500,000
49,500,000
Computation of financial charges

Rs. in million Rs. in million
Investment Size
Plant Cost 660.000 750.000
Working capital 108.000 135.000
768.000 885.000
60% Debt 460.800 531.000
Annual Financial Charges @ 12% 55.296 63.720
Profitability Analysis of Model A and Model Z

Model A Model Z
Rupees Rupees
Sales @ Rs. 900/ Kg 540,000,000 675,000,000
Cost of goods sold (449,754,000) (558,610,000)
Gross Profit 90,246,000 116,390,000
Admin and selling overheads (35,000,000) (49,500,000)
Financial Charges (55,296,000) (63,720,000)
Net Profit (50,000) 3,170,000
Tax @ 30% - (951,000)
(50,000) 2,219,000
Equity (768 × 40%) 307,200,000 (885 × 40%) 354,000,000
Return on equity (0.02) %) 0.63%
Model Z is to be preferred over Model A.
Page | 89
Problem No 30:-
a) XYZ Ltd. produces a single product which has a large market. It sells an
average of 360,000 units per month at a price of Rs.160 per unit. The
variable cost is Rs.120 per unit.
All sales are made on credit. Debtors are allowed one month to clear off the
dues. The company is thinking of extending the credit term to two months
which will help increase the sale by 25%.
Other information is as follows:
i. Raw materials constitute 60% of the variable cost.
ii. The company has a policy of maintaining 60 days stock of finished
goods and 30 days stock of raw materials. The suppliers of raw
materials allow a credit of 20 days.
iii. The company’s cost of funds is 16%.
Required:
Calculate the effect of the proposed credit policy on the profitability of the
company.
b) FGH Ltd. needs financing for its short term requirements. A factor has
offered to advance 80% of the credit bills for a fee of 2% per month plus a
commission of 4% on its trade debts which presently amount to Rs. 8
million. FGH allows a credit of 20 days to all customers. It has estimated
that it can save Rs. 600,000 per annum in Management costs and avoid bad
debts to the extent of 1% on the credit sales.
The company is also negotiating with a bank which has offered short term
loan at 18% per annum. Further, a one-time processing fee of 3% will have
to be paid.
Required:
Advise the company on the preferred mode of financing, assuming that the
financing is required for one year only.
Solution:- (a).
Existing Proposed
Assets/Liabilities level
Rupees Rupees
Debtors 360,000 x 160 57,600,000 360,000 x 160 x 1.25 x 2 144,000,000
Stocks 360,000 x 120 25,920,000 360,000 x 120 x 60% x 32,400,000
x 60% 1.25
Creditors 2/3 of above (17,280,000) 2/3 of above (21,600,000)
Finished 360,000*120*2 86,400,000 360,000 x 120 x 2 x 1.25 108,000,000
Page | 90
goods
152,640,000 262,800,000
Rupees
Increase in working capital (Rs. 262,800,000 – Rs. 2,640,000) 110,160,000
Cost of funds @ 16% of above 17,625,600
Profit margin on extra sales 360,000*0.25*40*12 43,200,000
Extra profits are more than 2.4 times the cost of funds; hence the proposed credit
policy is feasible.
(b). Cost of factoring per month
Rupees
Fee (8,000,000 x 80% x 2% 128,000
Commission (8,000,000 x 30/20 x 4%) 480,000
608,000
Less : Savings in management costs (600,000 / 12) (50,000)
Savings on bad debts (8,000,000 x 30/20 x 1%) (120,000)
438,000
Cost of short term finance from bank, per month
Rupees
Interest (8,000,000 x 0.8 x 18% / 12 ) 96,000
Processing fee (3% x 8,000,000 x 80%) 192,000
288,000
Obtaining short term loan facility is less costly and hence a better option.
Problem No 31:-
EEZ Limited produces a variety of electronic items including flat screen television
sets. All the components are imported and are assembled by a team of highly
Page | 91
skilled technicians. There are 10 employees working in this team, who work 5
days per week and 8 hours per day. Overtime is paid at double the normal rate.
A new model is produced each year. The production is carried out in batches. The
efficiency of the technicians improves with each batch but a study has not been
carried out yet to determine the extent of learning curve effect. Each batch
consists of 40 units. So far, 4 batches have been completed. The first batch
required 800 direct labour hours including overtime of 200 hours. A total of 2,312
hours have been recorded so far.
The company uses standard absorption costing. The following costs were
recorded for the initial batch:
Rupees
Direct materials 400,000
Direct labour including overtime 800,000
Special tools (Re-usable) costing 50,000
Variable overheads (per labour hour) 500
Fixed overheads (per week) 25,000
The company has been asked to bid for an order of 480 units. The order is
required to be completed in 10 weeks. Due to strong competition prevailing in the
market, the marketing director believes that the quotation is unlikely to be
accepted if it exceeds Rs. 25,000 per unit. Moreover, if the order is not accepted,
only 8 of the employees will be employed elsewhere whereas 2 employees will
remain idle for the next 6 weeks.
Required:
Recommend whether it is worth accepting this order at Rs. 25,000 per unit.
Solution:-
Computation of labour hours required
Assuming that the learning curve rate is x:
Page | 92
800 × 4 × x × x = 2312
x2 = 2312 / 3,200
x = 0.85
Cumulative average
Batches Cumulative quantity hours per unit Cumulative hours
1 40 20 800
2 80 17 1,360
4 160 14.45 2,312
8 320 12.28 3,930
16 640 10.44 6,682
Hence, additional hours for 480 units = 6,682 – 2,312 = 4,370 hours
Labour hour rate:
Rupees
600 normal hours + 200 overtime hours 800,000
600 + 200 x 2 800,000
1,000 hours 800,000
Hourly rate 800
Direct labour:
Direct
Hours labour cost
Rupees
8 workers for 10 weeks for 40 hours 3,200 @ Rs. 800 per hour 2,560,000
2 workers for 4 weeks for 40 hours 800 @ Rs. 800 per hour 256,000
Overtime 370 @ Rs. 1,600 per hour 592,000
4,370 3,408,000
Incremental cost of producing 480 units:
Amount in Rs
Direct materials (480 × 10,000) 4,800,000
Direct labour 3,408,000
Page | 93
Variable overhead (4,370 × 500) 2,185,000

10,393,000
Cost per unit (10,393,000/480) 21,652
Hence, quotation can be accepted at Rs 25,000 per unit.
Problem No 32:-
RS Enterprises is a family concern headed by Mr. Rameez. It is engaged in

manufacturing of a single product but under two brand names i.e. A and B. Brand
B is of high quality and over the past many years, the company has been charging
a 60% higher price as compared to brand A.
As the company has progressed, Mr. Rameez has felt the need for better planning
and control. He has compiled the following data pertaining to the year ended
November 30, 2008:
Rupees Rupees
Sales 5,522,400
Production costs:
Raw materials 2,310,000
Direct labour 777,600
Overheads 630,000 3,717,600
Gross profit 1,804,800
Selling and administration expenses 800,000
1,004,800
A B
No. of units sold 5400 3600
Labour hours required per unit 5 6
Other information is as follows:
Page | 94
i. 20% of B was sold to a corporate buyer who was given a discount of 10%.
The buyer has agreed to double the purchases in 2009 and Mr. Rameez has
agreed to increase the discount to 15%.
ii. In view of better margins in B, Mr. Rameez has decided to promote its sale
at a cost of Rs. 250,000. As a result, its sales to customers other than the
corporate customer, are expected to increase by 30%. However, the
production capacity is limited. He intends to reduce the production/sale of
A if necessary. Mr. Rameez has ascertained that 90% capacity was utilized
during the year ended November 30, 2008 whereas the time required to
produce one unit of B is 20% more than the time required to produce a unit
of A.
iii. 2.4 kgs of the same raw material is used for both brands but the process of
manufacturing B is slightly complex and 10% of all raw material is wasted
in the process. Wastage in processing A is 4%.
iv. The price of raw material have remained the same for the past many years.
However, the supplier has indicated that the price will be increased by 10%
with effect from March 1, 2009.
v. Direct labour per hour is expected to increase by 15%.
vi. 40% of production overheads are fixed. These are expected to increase by
5%. Variable overheads per unit of B are twice the variable overheads per
unit of A. For 2009, the effect of inflation on variable overheads is
estimated at 10%.
vii. Selling and administration expenses (excluding the cost of promotional
campaign on B) are expected to increase by 10%.
Required:
Prepare a profit forecast statement for the year ending November 30, 2009.
Solution:-
Computation of Sales for 2008
B B
A Normal Corporate Total
Ratio of sale price 1.00 1.60 1.44
Page | 95
Actual sale Qty 5,400.00 2,880.00 720.00

Ratio of sale value 5,400.00 4,608.00 1,036.80 11,044.80
Sales value 2,700,000.00 2,304,000.00 518,400.00 5,522,400.00
A B
Current year’s production (at 90 % capacity) 5,400.00 3,600.00
Production at full capacity 6,000.00 4,000.00
If only B is produced the company can produce 9,000 units (4,000 + 6,000 / 1.2).
Required production of B in the next year = (2,880 x 1.3) + (2 x 720) = 3744 + 1440
= 5,184 units Remaining capacity can be utilised to produce 4,579 units of A
[(9,000 - 5,184) x 1.2].
Computation of Sales for 2009
Rupees
Sales of A (4,579 x 500) 2,289,500
Sales of B (5,184 x 800) 4,147,200
6,436,700
Discount to Corporate customer (1,440 × 800 × 15%) 172,800
6,263,900
Consumption of Raw Material
Kgs
Consumption of raw material in 2008 (A: 5,400 x 2.4 / 0.96) 13,500.00
Consumption of raw material in 2008 (B: 3,600 x 2.4 / 0.90) 9,600.00
Total 23,100.00
Rupees
Price per kg of raw material ( 2,310,000 / 23,100) 100.00
Total expected consumption in 2009 (A: 4,579 x 2.4 / 0.96) 11,447.50
Total expected consumption in 2009 (B: 5,184 x 2.4 / 0.90) 13,824.00
25,271.50
Average price for 2009 ((100 x 3) + (110 x 9)) / 12 107.50
Total cost of raw material for 2009 2,716,686.25
Computation of Direct Labour
Hours
Labour hours used in 2008 (A: 5,400 × 5) 27,000
Page | 96
Labour hours used in 2008 (B: 3,600 × 6) 21,600

48,600
Labour hours forecast for 2009 (A: 4,579 × 5) 22,895

Labour hours forecast for 2009 (B: 5,184 × 6) 31,104
53,999
Increase in labour hours 5,399
Labour cost for 2009 (1.15 x (777,600 x 53,999 / 48,600) Rs. 993,582
Production overheads for 2008:
Rupees
Fixed overheads (40% x 630,000) 252,000.00
Variable overheads (630,000-252,000) 378,000.00
A B Total
Ratio of variable overheads 1.00 2.00
Total units produced 5,400.00 3,600.00
Product (units) (K) 5,400.00 7,200.00 12,600.00
Total variable overheads (Rs.) (L) 162,000.00 216,000.00 378,000.00
Per unit variable overheads (Rs.) (L /K) 30.00 60.00
Production overheads for 2009:

A B Total
Fixed overheads (1.05 x 252,000) (Rs.) 264,600.00
Per unit variable overheads (Rs.) 33.00 66.00
Total units 4,579 5,184
Total variable overheads (Rs.) 151,107.00 342,144.00 493,251.00
Total overheads (Rs.) 757,851.00
PROFIT FORECAST STATEMENT FOR 2009
Rupees
Sales 6,263,900.00
Material 2,716,686.25
Labour 993,582.00
Overheads 757,851.00 4,468,119.25
Page | 97
Gross margin 1,795,780.75
Selling and administration expenses (800,000 x 1.1) + 1,130,000.00

250,000
665,780.75
Problem No 33:-
Zain Limited operates a production unit which produces a chemical which is

commonly used in various industries. Following information has been collected to
ascertain the company’s working capital requirement:
i. Designed capacity of the plant is 150 tons per hour. However, as in the
past, it is expected that the plant will operate at 70% of the designed
capacity.
ii. The variable cost per ton of finished product would be Rs. 2,500 made up
as under:
Raw materials 62.4%
Consumables and spares 12.0%
Other processing costs 25.6%
iii. Raw material is imported on FOB basis. The supplier allows 45 days credit
from the date of shipment. However, overseas and inland transportation
and port and customs formalities take 30 days.
iv. Because of the nature of the cargo, only one ship is available in a month,
for transporting the raw material.
v. Freight, transportation and other import related variable costs of purchases
are estimated at 30% of the FOB value and are paid at the time of receipt of
goods at the plant.
vi. One ton of finished goods requires 1.25 tons of raw materials.
vii. Fixed costs are estimated at Rs. 10.584 million per month.
viii. Budgeted sales price is to be worked out so as to earn a gross profit of 20%
over sales.
Page | 98
The details of sales forecast provided by the marketing department are as

follows:
 40% sales will be made to corporate clients on 10 days credit. The
price would be 2% higher than the budgeted price.
 30% sales will be made to individual customers at budgeted price.
The goods are delivered after two days of receiving the required
amount.
 Remaining sales shall comprise of exports. The export documents
are presented in the bank within 2 days of shipment. The export
proceeds are credited in the company’s bank account after 3 days of
the date of presenting the documents. The Federal government
allows a rebate of 5% on exports and it is credited to the company’s
account on the date of realization of export proceeds.
ix. It is estimated that at any point of time the work in progress shall consist of
1,000 tons of raw material which shall be 50% complete as regards
consumables, spares and processing costs.
x. Average inventory of finished product is equal to fifteen days production.
Till last year, the company’s policy was to maintain average inventory of
30 days.
xi. Operational consumables and spares of Rs. 20 million are required to be
maintained throughout the year.
xii. Production is evenly distributed throughout the year. Except for the facts
given above, all other costs are payable after 15 days of their incurrence.
Required:
Determine the working capital requirement for the year. (Assume 30 days in each
month)
Solution:-
Page | 99
Budgeted production
Budget production is 70% of the designed capacity
(150 tons × 70% × 24 hours × 30 days × 12 months) 907,200 tons
(A) Raw material
Quantity of raw material required
(1.25 tons × 907,200 tons of finished product) 1,134,000 tons
Quantity of raw material for each shipment
(1,134,000 tons ÷ 12 of finished product) 94,500 tons
Total cost of purchases including transportation and other variable
purchase cost for each ton of product
(Rs. 2,500 × 62.4%) Rs. 1,560/ton
Per ton FOB price of raw material (Rs. 1,560 × 100 ÷ 130) ÷ 1.25 Rs. 960
Total amount to be paid to supplier for each shipment
(Rs. 960 × 94,500 tons) Rs. 90.72 mln
Credit period (45-30 days) 15 days
Trade credit: Average amount of liability (Rs. 90.72 million × 15/30) Rs. 45.36 mln
Cost of consumables, spares and processing per ton (2,500 × 37.6%) Rs. 940
(B) Inventory Rs. in 000’

Raw Material (94,500 tons ÷ 2 × Rs. 960 ×1.3) 58,968
Work in progress (1,000 × Rs. 960 × 1.3) + (1,000 × 940 × 50%) 1,718
Finished products (907,200 × 15 ÷ 30 ÷ 12) × Rs. 2,500 94,500
Spares & consumables 20,000
175,186
(C) Debtors Rupees
 Corporate clients
(40% × 945,000 tons × 10 ÷ 360 × Rs. 3,300 ×1.02) 35,343,000
 Individual clients
(30% × 945,000 tons × 2 ÷ 360 × Rs. 3,300) (5,197,500)
 Export clients
(30% × 945,000 tons × 5 ÷ 360 × Rs. 3,300 ×1.05) 13,643,438
43,788,938
Budgeted Sales quantity: Tons

Production during the year 907,200
Page | 100
Opening inventory – 1/12 of above 75,600

Closing inventory – 1/24 of the above (37,800)
Budgeted sales 945,000
Budgeted Price
Variable cost 2,500
Fixed Cost (Rs. 10.584 million ×12 ÷ 907,200 tons) 140
Total cost 2,640
Gross profit at 20% of selling price 660
Sales Price 3,300
(D) Other credit
Fixed cost (Rs. 10.584 million × 15 / 30 days) 5,292,000
Other variable cost:
940 (Rs. 2,500 – Rs. 1,560) × 907,200 × 15 /360 days 35,532,000
40,824,000
Working Capital requirement

Average value of debtors 43,788,938
Average value of inventory 175,186,000
Average value of trade credit (45,360,000)
Average value of other credit (40,824,000)
132,790,938
Problem No 34:-
Adnan Limited is a manufacturer of specialized furniture and has recently
introduced a new product. The production will commence on January 1, 2010. 200
workers have been trained to carry out the production. The complete unit will be
produced by a single worker and it would take 40 hours to produce the first unit.
The company expects a learning curve of 95% that will continue till the
production of 64 units. Thereafter, average time taken for each unit will be 28
hours.
Each worker would work for an average of 174 hours each month. They will be
paid @ Rs. 100 per hour. In addition, they will be paid a bonus equivalent to 10%
of their earnings provided they work for at least three months during the year.
The cost of material and overhead per unit has been budgeted at Rs. 10,000 and
Rs. 4,000 per unit, respectively.
Page | 101
The company’s workers are in high demand and it is estimated that 20% of the
workers would leave by the end of March 2010 whereas a further 7 workers
would retire on June 21, 2010. The management is confident that all the units
produced would be sold.
Required:
Calculate the minimum price that the company should charge if it wants to earn
gross profit margin of 20% on selling price during the year 2010.
Solution:-
Units Average Cumulative
time time
1 40.00 40
2 38.00 76
4 36.10 144
8 34.30 274
16 32.58 521
32 30.95 990
64 29.40 1,882
No. of Available Average time Production Total No. of

workers hours* per unit per worker production Hours
40 522 32.58 16 640 20,880
7 992 30.95 32 224 6,944
153 1,882 29.40 64 9,792 287,946
153 206 28.00 7 1,071 31,518
11,727 347,288
Available hours: Up to March 31 174 x 3 522
Up to June 21 174 x 5.7 992
Page | 102
Up to December 31 174 x 12 [1,882+206] 2,088
Cost of production
Units Rate Total cost
Materials 11,727 10,000 117,270,000
Labour 347,288 110 38,201,680
Overheads 11,727 4,000 46,908,000
202,379,680
Production (units) 11,727
Average cost per unit 17,258
Selling price per unit 21,573
Labour cost includes 10% bonus
Problem No 35:-
Wahid Limited established a plant to manufacture a single product ARIDE.
Standard material costs for the first year of operations were as under:
Raw Standard Price
material per kg (Rs.)
A 6.40
B 4.85
C 5.90
All the raw materials were supplied at same prices throughout the first six
months. Thereafter the prices were increased by 10%.
The company manufactured 1,320,000 units during the year ended 30 September,
2009. All purchases and the production were made evenly throughout the year.
Page | 103
Losses occurred at an even rate during the processing and are estimated at 12% of
the input quantity. The standard weight of one unit of finished product is 11.88
kgs. The ratio of input quantities of materials A, B and C is 3:2:1 respectively.
Details of ending inventory are as under:
Raw Qty (kgs) Value under FIFO % of ending inventory to
material method (Rs.) material quantity consumed
A 1,014,200 6,744,430 11
B 754,000 3,883,100 13
C 228,000 1,390,800 08
Required:
Calculate material price, usage, mix and yield variances.
Solution:-
Standard weight of one unit of finished goods 11.88 kgs
Total input of raw material required for one unit of finished product 13.50kgs
{11.88 ÷ (100% – 12%)}
Standard material input: A:6.75kgs, B:4.50kgs, C:2.25kgs
Material A B C
A Year-end inventory Given kgs 1,014,200 754,000 228,000
B Ratio of inventory to Given % 11 13 8
material consumed
C Material consumed A/B kgs 9,220,000 5,800,000 2,850,000
D Purchases during the year A+C kgs 10,234,200 6,554,000 3,078,000
E Purchases during :
Oct-Mar D/2 kgs 5,117,100 3,277,000 1,539,000
Apr-Sept D/2 kgs 5,117,100 3,277,000 1,539,000
F Value of year-end inventory Given Rs. 6,744,430 3,883,100 1,390,800
G Actual price per kg
Oct-Mar F/A Rs. 6.65 5.15 6.10
H Apr-Sept G/1.1 Rs. 6.05 4.68 5.55
J Average price Oct-Sept (G+H) Rs. 6.35 4.92 5.83
/2
K Purchases during year J*D Rs. 64,987,170 32,245,680 17,944,740
L Material consumed at actual K-F Rs. 58,242,740 28,362,580 16,553,940
Page | 104
price
M Standard price Given kg 6.40 4.85 5.90
N Standard cost CxM Rs. 59,008,000 28,130,000 16,815,000
P Price variance L – N Rs. 765,260 (232,580) 261,060
favourable/(unfavourable)
Total price variance – 793,740
Favourable
Mix variance:
Raw Actual Standard mix of Actual Standard Variances
material quantity used actual quantity used Variances price per (rupees)
(kgs) (kgs) kg
Ratio kgs
A 9,220,000 3/6 8,935,000 (285,000) 6.40 (1,824,000)
B 5,800,000 2/6 5,956,667 156,667 4.85 759,835
C 2,850,000 1/6 2,978,333 128,333 5.90 757,165
17,870,000 17,870,000 NIL (307,000)
Yield Variance:
Raw Standard mix Standard usage Variances Standard Variances
material of actual for actual output (kgs) price per Rs.
quantity used (kgs) kg
A 8,935,000 8,910,000 (25,000) 6.40 (160,000)
B 5,956,667 5,940,000 (16,667) 4.85 (80,835)
C 2,978,333 2,970,000 (8,333) 5.90 (49,165)
17,870,000 *17,820,000 (50,000) (290,000)
{Output 1.32 million units x standard input per unit 13.50 kgs(6.75 + 4.50 + 2.25kgs)}
Material usage variance (597,000)
Problem No 36:-
Sajid Industries Limited purchases a component ‘C’ from two different suppliers,
Y and Z. The price quoted by them is Rs. 90 and Rs. 87 per component
respectively. However 7% of the components supplied by Y are defective whereas
in case of Z, 11% of the components are defective. The use of such defective
Page | 105
components results in rejection of the final product. However, the final products
to be rejected are identified when the product is 60 % complete. Such units are
sold at a price of Rs. 200.
The average cost of the final product excluding the cost of component C is as
follows:
Rupees
Material (excluding the cost of the component C) 420
Labour (3 hours @ Rs 60 per hour) 180
Overheads (Rs. 40 per hour based on labour hours) 120
720
50% of the material (including the component C) is added at the start of the
production whereas the remaining material is added evenly over the production
process.
The company intends to introduce a system of inspection of the components, at
the time of purchase. The inspection would cost Rs. 20 per component. However,
even then, only 90% of the defective components would be detected at the time of
purchase whereas 10% will still go unnoticed. No payments will be made for
components which are found to be defective on inspection. The total requirement
of the components is 10,000 units.
Required:
Analyze the above data to determine which supplier should be selected and
whether the inspection should be carried out or not.
Solution:-
Cost of components without inspection:
Y Z
Total good components required (A) 10,000 10,000
Defectives expected (7/93 and 11/89 of 10,000) (B) 753 1,236
Total components to be purchased A + B = (C) 10,753 11,236
COSTS:
Purchase price of components @ 90 x (C) and 87 x (C) 967,770 977,532
Production cost of defective units:
Material cost at start - 50% of 420 × (B) 158,130 259,560
Balance processing costs {B*60% of (720-210)} 230,418 378,216
Page | 106
Sale proceeds of defectives (B) x 200 (150,600) (247,200)

Total cost of components (including defective components and 1,205,718 1,368,108
defective units produced)
Cost of components with inspection:

Y Z
Total good components required (D) 10,000 10,000
Defectives expected B ÷ 10 (E) 75 124
Total components required D + E (F) 10,075 10,124
COSTS:
Purchase price of components @ 90 x (F) and 87 x (F) 906,750 880,788
Production cost of defective units:
Material cost at start - 50% of 420 x (E) 15,750 26,040
Balance processing costs (E) * 60% of (720 -210) 22,950 37,944
Sale proceeds of defectives (E) x 200 (15,000) (24,800)
Inspection cost @ Rs. 20 per component {20 x (C)} 215,060 224,720
Total cost of components (including defective components and 1,145,510 1,144,692
defective units produced)
Conclusion: The best option is that company should buy component Z and
should carry out the inspection.
Problem No 37:-
Aftab Limited manufactures CNG kits for certain automobiles. The management
of the company foresees sudden rise in the demand of CNG kits in the next year
and they are trying to work out a strategy to meet the rising demand.
Following further information has been gathered by the management:
i. The current market demand is 650,000 units while the company’s share is
40%. The demand for the next year is projected at 1,000,000 units while the
company expects to maintain its current market share.
ii. The production capacity of the company while working 8 hours per day is
350,000 units.
iii. The selling price and average cost of production per unit for the current
year, are as follows:
Rupees
Selling Price 40,000
Page | 107
Less: Cost of production

Material 24,000
Labour (34 hours per unit) 3,400
Overheads (60% variable) 2,800 30,200
Gross Profit 9,800
iv. Since the company was working below capacity, 15% of the labour
remained idle and were paid at 10% below the normal wages. These wages
are included in fixed overheads.
v. To increase the production beyond the normal capacity, overtime will have
to be worked which is paid at twice the normal rate. Also, the fixed
overheads, other than the labour idle time, would increase by 10%.
vi. The management has negotiated with certain vendors and received the
following offers:
 A present supplier of raw material has offered bulk purchasing
discount @ 2.5%, if the total purchases during the year exceeds Rs.
9.0 billion.
 A manufacturer of CNG kits in Italy has offered to supply any
number of finished CNG kits at US$200 per unit. The landed cost of
these units in Pakistan would be Rs. 29,000 per unit.
Required:
Determine the best course of action available to the company.
Solution:-
Option 1: Manufacturing all units at own factory
350,000 units 50,000 units 400,000
units
Rate Amount Rate Amount Amount
Rs. in Rs. in Rs. in
‘000’ ‘000’ ‘000’
Material – units 24,000 8,400,000 24,000 1,200,000
Labour 3,400 1,190,000 6,800 340,000
Overheads 1,680 588,000 1,680 84,000
10,178,000 1,624,000
Existing fixed cost (260,000 x 291,200
1,120)
Page | 108
Less: Cost of idle labour (260,000 x (140,400)

3,400 x 0.15/0.85 x 90%)
150,800
Additional fixed costs (10% of 15,080
150,800)
Discount on material 2.5% of (240,000)
9.6(8.4+1.2) billion
Cost of producing 10,328,800 1,399,080 11,728,880
350,000/50,000/400,000 units
Option – 2 Produce 350,000 units locally and import 50,000 units from Italy
Rs. in ‘000’
Production of 350,000 units 10,328,800
Purchase of 50,000 units from outside @ 29,000 1,450,000
Total cost for 400,000 units 11,778,800
Option 3 Impact all (400,000) units from Italy

Purchase of 4000,000 units from outside @ 29,000 11,600,000
Add: fixed cost 150,800
Total cost 11,750,800
Decision
The company should produce 400,000 units at its own manufacturing facility.
Problem No 38:-
Rafiq Industries specializes in production of food and personal care products.
During the year 2010, the company intends to launch a new product called PQR.
The relevant details are as follows:
i. The product would be sold in 3 pack sizes and the sales have been
projected as follows:
Pack size Units
500 grams 200,000
1 kg 120,000
2 kg 90,000
ii. For producing 1 kg of output, following materials would be required:
 0.5 kg of material A which costs Rs. 300 per kg.
Page | 109
 1 kg of material B. Current stock of material B is 250,000 kgs and it was

purchased @ Rs. 100 per kg. Its current purchase price is Rs. 125 per kg.
The expiry date of the current stock is December 31, 2010. Before the expiry
date, it could be disposed of at the rate of Rs. 110 per kg.
 100,000 kgs of material B could be used in producing another product
called UVW with additional cost of Rs. 4,000,000 which could then be sold
at the rate of Rs. 160 per kg. However, both PQR & UVW are produced on
the same machine. The machine has to be worked at 100% capacity for
producing the required quantity of PQR.
iii. Cost of packing materials have been projected as under:
Pack size Cost per unit
500 grams 30
1 kg 40
2 kg 55
iv. 100 kgs of product would require 5 hours of skilled labour and 10 hours of
unskilled labour. Skilled labour is paid at Rs. 70 per hour and unskilled
labour at Rs. 45 per hour. Currently, the company has 5,000 idle hours of
skilled labour and has a policy to pay 50% for idle hours.
v. The production capacity of the factory is 2 million kgs but currently the
factory is operating at 50% capacity. Fixed overheads at 100% capacity are
Rs. 25 million. However, if the factory operates below capacity, the fixed
overheads are reduced as follows:
 by 10% at below 80% of the capacity
 by 25% at below 60% of the capacity
Required:
Calculate the sale price for each pack size of the new product assuming that the
company wants to earn a profit of 25% on the cost of the product which shall
include relevant costs only.
Solution:-
PRICING OF NEW PRODUCTS
Calculation of expected sale
Pack size Total 500 grams 1 kg 2 kg
Units (a) 200,000 120,000 90,000
Total production (Kgs.) (b) 400,000 100,000 120,000 180,000
Page | 110
Percentage of total production 100% 25% 30% 45%

Consumption of Material A (c) 200,000 50,000 60,000 90,000
(Kgs)
Cost of Material A {300 × (c)} (d) 60,000,000 15,000,000 18,000,000 27,000,000
Material B {118.125(W-1) × (a)} (e) 47,250,000 11,812,500 14,175,000 21,262,500
Packaging cost {(a) x 30, 40; 55} (f) 15,750,000 6,000,000 4,800,000 4,950,000
Labour {7.5625 (W-3) × (b)} 3,025,000 756,250 907,500 1,361,250
Fixed overheads {9.375 (W-4) x (b)} 3,750,000 937,500 1,125,000 1,687,500
Total cost 129,775,000 34,506,250 39,007,500 56,261,250
Sales (cost + 25%) 162,218,750 43,132,813 48,759,375 70,326,563
Sale price / unit 216 406 781
W-1
Material B Qty Rate Amount
Opportunity cost of 100,000 kgs (W-2) 100,000 12,000,000
Current disposal price of remaining 150,000 110 16,500,000
available material
Purchase price of additional requirement 150,000 125 18,750,000
400,000 118.125 47,250,000
W-2
Opportunity cost of 100,000 kgs
Sale Price 100,000 160 16,000,000
Less: additional cost (4,000,000)
12,000,000
Sale price if sold without processing 11,000,000
Higher of the above 12,000,000
W-3 Labour
Skilled Labour [(400,000 / 100 × 5) × 70 1,400,000
Unskilled Labour (400,000 / 100 × 10) × 45 1,800,000
Less: Skilled Labour - Idle hours now saved (5,000 × 70 /2) (175,000)
3,025,000
Cost per Kg 7.5625
Page | 111
W-4
Current fixed expenses 25,000,000 × (100-25)% = Rs. 18,750,000
Production including new product (2,000,000×50%)kgs + 400,000 kgs = 1,400,000 Kgs.
Capacity utilization after introduction of new product = 70%
Fixed expenses “ “ “ “ “ (25,000,000×90%) = 22,500,000
Additional fixed expenses on a/c of new product Rs. 3,750,000
Cost per Kg (for allocation purpose) Rs. 9.375
Problem No 39:-
Azmat Industries is engaged in manufacturing two products, X and Y. Both the
products have a high demand but the company is facing a liquidity crunch. In
view of the liberal credit policy being followed by the company the Finance
Director is of the opinion that sales of only Rs. 200 million can be financed
through the present resources. However, a credit facility of Rs. 25 million can be
obtained from local market at a mark-up of 16%. If this facility is obtained for the
whole year, the company will be in a position to increase its sale to Rs. 260
million.
The following data is available for the year ended June 30, 2008:
X Y
Direct materials per unit – Rs 300 700
Direct labour per unit – Rs. 180 150
Variable overheads per unit – Rs. 160 180
Selling price per unit – Rs. 900 1,200
Production per machine hour 8 6
The Marketing Director has informed that he has already made commitments for
the supply of 40,000 units of X and 96,000 units of Y. Total available machine
hours are 34,000.
Required:
a) Calculate the maximum profit the company can achieve if the sale is
restricted to Rs. 200 million.
Page | 112
b) Determine whether it would be feasible for the company to obtain the

credit facility.
Solution:-
(a) The company has to supply minimum sales to the customer as follows:
Unit Rate Rs.
X 40,000 900 36,000,000
Y 96,000 1,200 115,200,000
151,200,000
Further sales possible (200,000,000 – 151,200,00) 48,800,000
X Y
Contribution per unit Rs. 260 170
Contribution per hour Rs. 2,080 1,020
Contribution % on sales 29 14
X contributes more than Y.
Therefore, 48,800,000 / Rs.900 = 54,222 units of X should be produced.
Check whether this level of production can be attained in available hours:
Units Hours
Page | 113
X (40,000+ 54,222 ) 94,222 11,778
Y 96,000 16,000
27,778
Therefore, maximum contribution / profit will be as follows:
X Y Total - Rs.
Sales in unit 94,222 96,000
Contribution per unit 260 170
Total contribution 24,497,720 16,320,000 40,817,720
(b) Increase / (decrease) in profit if the loan is taken
Extra Sales of X if loan is taken (60 mln / 900) 66,667 units
Production possible in remaining hours (6,222* x 8) 49,776 units
Contribution on 49,776 units (49,776 x 260) Rs. 12,941,760
Bank charges on Rs.25 mln at 16% 4,000,000
Additional contribution if bank facility availed 8,941,760
*(34,000 – 27,778)
Problem No 40:-
Yousuf Aziz & Company has achieved significant growth over the years. The
Company is negotiating a working capital loan to finance its fast growing
Page | 114
operations. For determining the working capital requirement, the finance

manager has collected the following data for the current financial year which has
just commenced:
i. The sales will increase by 25% over the previous year’s sales of Rs. 1.0
billion. Local sales were 60% of total sales last year. The volume of local
sales will increase by 10% whereas prices will increase by 15% on the
average. The remaining growth will come from exports, all of which will
be volume driven.
ii. Cash sales to local customers will be approximately Rs. 100 million. Credit
terms for local sales are 2/10 and 1/20. It is estimated that total discounts
to the customers will amount to Rs. 6 million. The value of sales on which
2% discount will be claimed shall be twice the value on which 1% discount
will be claimed. The remaining customers will take about 30 days to make
the payments. Bad debts are expected to be 2% of credit sale.
iii. Export proceeds will be recovered on an average of 30 days.
iv. Raw materials A, B and C are used in the ratio of 3:2:1 respectively. Last
year, the raw material cost was 48% of sales. Average price of each of the
raw materials is expected to increase by 5%. Opening stocks this year were
equal to one month’s consumption of the previous year and are expected to
follow the same trend.
v. The suppliers of A and B allow credit periods of 30 and 45 days
respectively whereas 50% cash payment has to be made while placing
order for C and the balance at the time of delivery which is 15 days after
the order.
vi. Finished goods stock equal to one month’s sale, is maintained by the
company.
vii. During the previous year, labour, factory overheads and other
administrative overheads were 15%, 10% and 8% of sales value
respectively but are expected to be 16%, 12% and 10% this year. On an
average, these are paid 15 days in arrears.
Required:
Page | 115
Assuming that all transactions are evenly distributed over the year (360 days),
determine the working capital at the end of the year.
Solution:-
Computation of working capital
Rupees
Debtors:
Exports (D*30/360) (Working 1) 40,916,667
Local customers with 2% discount (F*0.98*10/360) (Working 2) 6,533,333
Local customers with 1% discount (E*0.99*20/360) (Working 2) 6,600,000
Local customers who do not avail discount (C-100,000,000-E-F-13180000)/12 23,818,333
Advance against raw material C (N x 15/360x0.5) (Working 3) 2,043,215
Closing Stock
Raw material (H) (Working 3) 48,342,000
Finished Goods (P) (Working 4) 77,508,667
Creditors - Raw material A (L x 30/360) (24,518,583)
Raw material B (M x 45/360) (24,518,583)
Labour, FOH and Admin Expenses (B x 0.38 x 15/360) (19,791,667)
136,933,382
Working 1
Page | 116
Sales in Previous year A 1,000,000,000
Sales in Current year ( A x 1.25 ) B 1,250,000,000
Local sales ( A x 60%x1.1x1.15 ) C 759,000,000
Exports (B-C) D 491,000,000
Working 2
Assume sale with 1% discount = X
Sale with 2% discount will be = 2X
Discount = 0.01X+(0.02*2X) = 0.05 X = Rs. 6,000,000
Therefore sale on which 1% discount will be given = X = 6,000,000/0.05 E 120,000,000
Therefore sale on which 2% discount will be given = 2X = 120,000,000*2 F 240,000,000
Working 3
Local sales at last year's price (1 billion * 60% * 1.1) 660,000,000
Exports as above 491,000,000
Total Sales excluding the effect of price increase G 1,151,000,000
Purchases of Raw Material
Closing stock of Raw material (G*0.48*1.05/12) H 48,342,000
Page | 117
Raw material included in cost of sales (G*0.48*1.05) I 580,104,000
Opening stock of Raw material (A*0.48/12) J (40,000,000)
Total raw material purchases K 588,446,000
Purchases of A (K*3/6) L 294,223,000
Purchases of B (K*2/6) M 196,148,667
Purchases of C (K*1/6) N 98,074,333
Working 4
Raw material as above (H) 48,342,000
Labour and factory overheads (B*28%/12) 29,166,667
P 77,508,667
Problem No 41:-
Nihal Limited manufactures a single product and uses a standard costing system.
Due to a technical fault, some of the accounting data has been lost and it will take
sometime before the issue is resolved. The management needs certain information
Page | 118
urgently. It has been able to collect the following data from the available records,
relating to the year ended March 31, 2008:
(i) The following variances have been ascertained:
Rs.
Adverse selling price variance 24,250,000
Favourable sales volume variance 2,000,000
Adverse material price variance – X 2,295,000
Favourable material price variance – Y 2,703,000
Favourable material price variance – Z 3,799,500
 The overall material yield variance is nil but consumption of X is 10%
below the budgeted quantity whereas consumption of Y is 6% in excess of
the budgeted quantity
 Labour rate variance is nil.
(ii) The budgeted sale price of Rs. 100 was 5.26% higher than actual sale price.
(iii) The standard cost data per unit of finished product is as follows:
No. of kgs Standard Cost Total Cost

X 5 3.00 15.00
Y 10 2.00 20.00
Z 15 1.80 27.00
(iv) During the year, the finished goods inventory increased by 230,000 units
whereas there was no change in the inventory levels of the raw materials.
(v) Labour costs are related to the consumption of raw materials and the standard
rates are as follows:
Re. (per kg)

Skilled labour for handling material X 1.00
Semi-skilled labour for handling material Y 0.75
Unskilled labour for handling material Z 0.10
Required:
(a) Total actual cost of each raw material consumed
Page | 119
(b) Material mix variance.

(c) Labour Cost Variance.
Solution:-
Computation of Units Sold Rupees
Actual Sales Price per unit (100 / 1.0526) 95
Sales price variance per unit (100 – 95) (A) 5
Adverse Selling Price Variance (B) 24,250,000
Units Sold during the period B/A 4,850,000
Computation of Units Manufactured
Million units
Units Sold 4.85
Increase in inventory level 0.23
Units Manufactured 5.08
(a) Actual cost of raw materials consumed (million rupees)
Mix
Standard cost Price variance Actual cost
variance*
X (5.08*15) 76.2000 2.2950 (7.6200) 70.8750
Y (5.08*20) 101.6000 (2.7030) 6.0960 104.9930
Z (5.08*27) 137.1600 (3.7995) (0.9140) 132.4465
Page | 120
314.9600 (4.2075) (2.4380) 308.3145
*See mix variance working
(b) Material mix variance
Standard mix Actual mix Difference Variance
(millions Kgs) (million Kgs) (million Kgs) (million Rs.)
X (5.08*5) 25.40 22.860 2.540 7.620
Y (5.08*10) 50.80 53.848 -3.048 -6.096
Z (5.08*15) 76.20 75.692 0.508 0.914
152.40 152.400 2.438
(c) Labour Cost Variance
Actual
Quantity Labour cost
labour at Standard
consumed variance
standard labour cost
million Kgs million Rs.
cost
skilled 22.860 22.860 25.400 2.540 Fav
semi-skilled 53.848 40.386 38.100 -2.286 Adv
unskilled 75.692 7.569 7.620 0.051 Fav
152.400 71.094 71.400 0.306
Page | 121
Problem No 42:-
Ibrahim Industrial Company produces custom made machine tools for various
industries. The prices are quoted by adding 50% mark-up on the cost of
production which includes direct material, direct labour and variable factory
overheads. The mark-up is intended to cover the non-manufacturing overheads
and earn a profit. Factory overheads are allocated on the basis of direct labour
hours.
The management has been using this system for many years but recent
experiences have shown that some customers have been dissatisfied with the
prices quoted by the company and have moved to other manufacturers. The CEO
was seriously concerned when KSL, a major client showed its concerns on the
prices quoted by the company and has asked the management accountant to carry
out a critical evaluation of the costing and pricing system.
The management accountant has devised an activity based costing system
consisting of four activity centres. The related information is as follows:
Activity Centre Basis of Allocation Budgeted Activity

Level
Activity 1 Manufacturing Direct labour hours 72,000 hours
Activity 2 Customer Service No. of days to 120 order days
complete the order
Activity 3 Order Processing Number of orders 20 orders
Activity 4 Warehousing Cost of Direct material Direct materials usage
of Rs. 40 million
The budgeted costs for the period are given below:
Description Amount (Rs.)
Direct material 40,000,000
Indirect labour 7,200,000
Other manufacturing overheads 9,000,000
Quality control 1,500,000
Administrative salaries 3,000,000
Transportation 1,260,000
79,960,000
On the basis of a careful study, the distribution of costs to activity centres has
been recommended on the following basis:
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Activity Activity Activity Activity Not Total

1 2 3 4 Allocated
Indirect labour 60% 20% NIL 20% NIL 100%
Machine-related Costs 95% NIL NIL 05% NIL 100%
Quality control 60% 40% NIL NIL NIL 100%
Transportation 10% 70% NIL 20% NIL 100%
Administrative salaries NIL NIL 20% 25% 55% 100%
The data related to the order placed by KSL is as under:

Estimated direct material cost (Rs.) 3,000,000
Direct labour (hours) 6,000
No. of days to complete the order 10
Required:
a) Calculate activity cost driver rates for each of the above activities.
b) Compute the amount of discount that can be offered to KSL on the price
that has been quoted to them, if the Activity Based Costing system is used
and the management wants to earn a minimum contribution margin of
20% of the quoted price.
Solution:-
1 2 3 4
(a) Activity Customer Order Unallocated Total

Manufactur- Ware-
process-
ing housing
service ing
Indirect labour 4,320,000 1,440,000 - 1,440,000 - 7,200,000
Other manufacturing
overheads 8,550,000 - - 450,000 - 9,000,000
Quality Control 900,000 600,000 - - - 1,500,000
Transportation 126,000 882,000 - 252,000 - 1,260,000
Admin salaries - - 600,000 750,000 1,650,000 3,000,000
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13,896,000 2,922,000 600,000 2,892,000 1,650,000 21,960,000
Budgeted activity
level 72,000 120 20 40,000,000
Cost driver rate 193.00 24,350.00 30,000.00 0.0723
per labour per order per order per Re. of

hour day processe material
d usage
(b) Order by KSL
Costs under present method
Direct material cost 3,000,000
Factory overheads (90% of direct labour) 1,350,000
5,850,000
Mark-up - 50% 2,925,000
Sale price (A) 8,775,000
Costs under ABC Method
Direct material cost 3,000,000
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Other manufacturing cost (6,000 x 193) 1,158,000
Customer service (10 x 24,350) 243,500
Order processing (1 x 30,000) 30,000
Warehousing (3,000,000 x 0.0723) 216,900
6,148,400
Margin -20% of sales price 1,537,100
Sale price (B) 7,685,500
Discount that may be allowed (A-B) 1,089,500
Problem No 43:-
Kamran Limited (KL) produces a variety of electrical appliances for industrial as
well as domestic use. The average life of the equipments is six years. According to
the terms of sale, the company has to provide free after sales service, including
parts, during the warranty period of one year. Thereafter, the services are
provided at market rates. The company has hired Ahmed Hasan Associates
(AHA) to provide these services on the following terms and conditions:
 The material required for repairs carried out during the warranty period is
provided by KL. For customers whose warranty period has expired, the
material supplied to AHA is billed at cost plus a mark-up of 15%.
 Labour and overheads incurred by AHA on services provided during the
warranty period are billed to KL at cost plus 30%.
 KL gets a share in all amounts billed to the customers after the warranty
period. 10% share is received in respect of amounts billed to industrial
customers and 15% in case of domestic customers.
The management of KL is evaluating the possibility of providing the services
directly instead of outsourcing them to AHA. On the instruction of the CEO the
management accountant has compiled the following information in respect of the
previous year:
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 20% of the services were provided to domestic customers and 80% to

industrial customers.
 20% of all services were provided during the warranty period.
 Mark-up billed to AHA amounted to Rs. 360,000.
 An amount of Rs. 990,000 was received from AHA being the KL’s share of
amount billed to the customers.
 It has been estimated that the cost of material billed by AHA, to the
customers, is determined by applying a further mark-up of 25% over the
amount billed by KL. The service charges are billed at 50% above the cost
of labour and variable overheads.
 It is estimated that the cost of labour and variable overheads will increase
by 10%, if the services are provided by KL. However, KL will not be able to
pass on this increase to the customers. Moreover, a supervisor will have to
be appointed to oversee the process, at a consolidated salary of Rs. 40,000
per month. Other fixed overheads will also increase by Rs. 60,000 per
month.
Required:
a) Compare the two options and determine whether KL should terminate the
contract with AHA and start providing the services itself.
b) What other qualitative factors should KL consider before taking a final
decision?
Solution:-
(a) EARNINGS UNDER PROPOSED OPTION
Total billing to customers (working 1) 9,000,000
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Less: Cost of raw material used after warranty period (working 3) 2,400,000
Cost of labour & variable overhead (3.8 mln + 10%) (working 2) 4,180,000
Salary of Supervisor 480,000
Increase in other fixed overheads 720,000
7,780,000
Net profit excluding cost of material used during warranty period 1,220,000
LESS: EARNINGS UNDER THE PRESENT OPTION
Mark-up earned on supply of material 360,000
Share of billing received from AHA 990,000
1,350,000
Less: Payment to AHA for services provided during warranty

period (760,000+30%) (working 2) 988,000
362,000
Net savings 858,000
Working 1
Domestic Industrial
Total
Customers Customers
Ratio of services provided by AHA A 20 80 100
Share of KL in % B 15.00% 10.00% N/A
Ratio of KL's share C (A*B) 3 8 11
Annual share received from AHA D 270,000 720,000 990,000
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Total billing by AHA E (D/B) 1,800,000 7,200,000 9,000,000
Working 2
Net recoveries from customers F (E-D) 1,530,000 6,480,000 8,010,000
Less: Recoveries in respect of material

(See working 3) G 3,450,000
Recoveries in respect of services

(labour & overheads) H (F-G) 4,560,000
Cost of labour and overhead incurred by AHA

(after warranty period) J (H*100/150) 3,040,000

(during warranty period) K (J*20/80) 760,000
Total cost of labour and overhead L(J + K) 3,800,000
Working 3
Mark-up charged by KL on material billed to AHA 360,000
Cost of material despatched (for use after warranty period) 2,400,000
2,760,000
Mark-up charged by AHA on material billed to customers (2,760,000*0.25) 690,000
Total billing in respect of material 3,450,000
Alternative Answer 6(a)
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Savings/additional revenues if services provided by KL
Mark-up charged by AHA, from the customers on cost of

material (working 1) 690,000
Mark-up charged by AHA from KL on services provided L (K*0.3)

during warranty period (working 2) 228,000
Mark-up charged by AHA, from the customers on cost of M (H-J)

labour and overhead (working 2) 1,520,000
Total 2,438,000
Less: Additional costs and decline in revenues
Increase in cost of labour and variable overheads N ((J+K)*0.1) 380,000

(working 2)
Supervisor’s salary 480,000
Increase in other fixed overheads 720,000
1,580,000
Net savings 858,000
Working 1
Mark-up charged by KL on material billed to AHA 360,000
Cost of material 129ispatched (for use after warranty period) 2,400,000
2,760,000
Mark-up charged by AHA on material billed to customers 2760000*0.25 690,000
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Total billing in respect of material 3,450,000
Working 2
Domestic Industrial
Total
Customers Customers
Ratio of services provided by AHA A 20 80 100
Share of KL in % B 15.00% 10.00% N/A
Ratio of KL’s share C (A*B) 3 8 11
Annual share received from AHA D 270,000 720,000 990,000
Total billing by AHA E (D/B) 1,800,000 7,200,000 9,000,000
Net recoveries from customers F (E-D) 1,530,000 6,480,000 8,010,000
Less: Recoveries in respect of material G (see working 1) 3,450,000
Recoveries in respect of services

(labour & overheads) H (F-G) 4,560,000
(after warranty period) J (H*100/150) 3,040,000
(during warranty period) K (J*20/80) 760,000
Total cost of materials L(J + K) 3,800,000
(b) (i) It might be beneficial for Kamran Limited (KL) to focus on core business rather
than on non-core areas like after-sale service.
(ii) Ahmed Hasan Associates (AHA) might be technically more competent at
providing these services.
(iii) KL should also consider the reliability of AHA as an outside supplier of these
services. If after-sale service is a critical component of KL’s business, it might be
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better to do it in-house.
(iv) There is a potential for KL to be inefficient in terms of cost control during parts
production since the company charges a cost-plus margin to AHA. There is not
much incentive for KL to control costs.
(v) The numbers provided by the cost accountant might be misleading since these
are predominantly direct costs of providing the service and possible effects on
other overheads may not have been considered.
Problem No 44:-
UK Limited has recently established a factory in Nawabshah which will

produce two products Mori and Naga. According to the budget for the first
year, the company would operate at normal capacity of the plant which is
50,000 units of Mori and 60,000 units of Naga. The budget prepared by the
finance department for the first year includes the following projections:
Mori Naga
Price per unit – Exports Rs. 4,000 Rs. 5,200
– Local sales Rs. 4,500 Rs. 6,000
 X type customers with 60 days credit NIL

 Y type customers with 30 days credit
10%
Discount would be allowed on local sales depending upon the credit period as
follows:
Volume of local sales is estimated at 80% of total sales. Ratio of sales to X and Y
type of customers would be 3:2 respectively.
Production costs per unit of finished products have been budgeted as under:
Mori Nag
Raw material 5 kg @ Rs. 300 per kg a
Direct labour 6 hours @ Rs. 200 per hour 710hours @ Rs. 250
kg @ Rs. 200 per
per kg
hour
*excluding ordering and holding costs of inventory
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The size of raw material orders would be 30,000 kg and 40,000 kg in

respect of Mori and Naga respectively. The company would follow a
policy of maintaining 5,000 units of inventory of finished goods of each
product and safety stocks of 10,000 kg for each raw material.
Administration expenses are fixed and are estimated at Rs. 28 million

per annum. Selling costs are estimated at Rs. 61 million of which 80%
are variable. Variable selling costs are related to local sales only. The
variable selling expenses pertaining to Naga are 40% more than selling
expenses on Mori.
Total depreciation on all assets is estimated at Rs. 3 million which has

already been incorporated in the above costs.
In addition to the above costs, the raw material holding costs are
estimated at Rs. 4 per kg per month. The annual ordering costs are
estimated at Rs. 600,000 which mostly constitute fixed expenses as the
variable costs are negligible.
Required:
Compute the break-even sales in Rupees assuming that the export orders are
confirmed and volume of local sales of Mori and Naga would maintain the ratio as per
budget.
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Problem No 45:-
Javed Ltd. is in the process of setting up a plant for production of LED

lights. The land for the plant was purchased at a cost of Rs. 100 million
whereas the plant and its installation would cost Rs. 250 million. The
annual capacity of the plant is 1.5 million LEDs.
Technical & Commercial departments of the company have forwarded the

following information:
(i) Plant would operate in a single shift of 8 hours for 25 days per month.
(ii) Cost of raw material for the LEDs is estimated at Rs. 40 per unit.
(iii) The LED holder will cost Rs. 25 per unit. It is expected that 4%
holders would be defective and would have to be sold in scrap for Rs.
2 per unit.
(iv) Average direct labour time would be 3 minutes per unit. Labour
would consist of 32 workers who would be hired on a permanent
basis and paid a salary of Rs. 20,000 per month. Other benefits and
perquisites would be 15% of the salary.
(v) Variable overheads are estimated at Rs. 480 per labour hour.
(vi) Fixed overheads are estimated at Rs. 3,800,000 per month.
The following information is based on a market survey which was conducted

recently.
(i) The current market price of an LED is Rs. 180 per unit.
(ii) It is estimated that the company can annually sell 1,240,000 units at
the above price. However, the demand is price sensitive. The
relationship between quantity demanded
(x) and sales price (SP) can be expressed as under:
SP =
273 –
0.00007
5x
Required:
Determine the optimum selling price which would maximise the company’s
profitability for
the first year of operations and calculate the optimum profit.
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Problem No 46:-
Metro Limited produces three products. Its budget for the year ending 30
June 2016 depicts the following:
Sales volume Units 840,000 660,000 520,000

Sales Rs. 140,000,000 200,000,000 250,000,000
Cost of raw material per unit of Rs. 60 110 180
production
Direct labour hours per unit 0.5 1.0 1.5
Machine hours per unit 0.1 0.2 0.3
Material requisitions to be issued per day Number 5 3 2
Inspection time per unit Minutes 12 15 20
% of units to be inspected - 1% 2% 4%
Average time taken to process a sales Hours 5 10 15
order size of the sales order
Average Units 20,000 12,000 10,000
Opening inventory Units 60,000 50,000 40,000
Closing inventory Units 20,000 90,000 120,000
Other related information is as under:
(vii) Manufacturing overheads are estimated at 50% of direct labour cost.

Labour rate is Rs. 50 per hour. Manufacturing overheads represent
the cost of Production department (40%), Quality control
department (30%), Materials management department (20%) and
Engineering department (10%).
(viii) Total administration and selling expenses are budgeted at Rs. 40
million. These represent head office costs (60%) and sales
department costs (40%). Head office expenses are allocated on the
basis of sales value.
(ix) Cost of opening inventory per unit is the same as production costs
for the budget period.
(x) Units are inspected at the time of transfer to finished goods warehouse.
Required:
Prepare a product wise profit and loss account using activity based costing.
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Problem No 47:-
Royal Limited finances its working capital through running finance. Since the
company’s borrowings have reached 95% of its borrowing limit, it is negotiating
with the bankers for enhancement of the borrowing limit.
The working capital of the company as shown in its financial statements for
the year ended 31 May 2015 amounted to Rs. 3,162 million.
Debtors
1,890
1,200
Payable to suppliers of raw material (1,080)
(360)
3,162
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The details are as follows:
The company's budget for the next year contains the following projections:
(i) Sale price would increase by 5% and sales volume would increase by 20%.
(ii) Raw material prices would increase by 10% whereas labour rate
would increase by 6%.
(iii) Prices/rates of other expenses which include factory overheads and
selling/ administration expenses would increase by 8%.
(iv) The ratio of factory overhead to administration and selling expenses
is 1:3. 40% of overhead expenses and all administration and selling
expenses are fixed.
(v) Analysis of production cost reveals that the ratio of raw material
costs, labour and overheads is 5:3:2 respectively.
The company is considering to change its working capital policy as follows:

(i) Finished goods inventory turnover would reduce from 7 times to 6 times per
annum.
(ii) Raw material inventory levels would be increased from 20 days to 30 days
(iii) Credit period offered to customers would increase from 30 days to 45 days.
(iv) Policy for payment to suppliers would not be changed, however,
payment of other expenses would be delayed by 5 days. At present
the company pays all expenses in 15 days.
Required:
Determine the minimum increase in the running finance limit which the company should
seek from its bankers.
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Problem No 48:-
Adidas Limited (AL) manufactures two types of products X and Y. The

production of each product involves three departments. The relevant details are as
follows:
Annual capacity of the
Recently, AL has received a proposal whereby it would be able to increase

the production capacity of department C by 2,000 hours per month. The
additional cost associated with this facility would be Rs. 2 million per
annum.
Required:
Determine whether the company should accept the above proposal.
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Problem No 49:-
Adam Limited deals in a single product which is processed through three
production departments. The standard cost card of the first department is as under:
 Raw material: 1.25 kg @ Rs. 30 per kg

 Labour: 8 minutes per unit @ Rs. 210 per hour
 Variable factory overheads: Rs. 21 per unit
 Fixed factory overheads have been budgeted at Rs. 15 million for this
department for the production of 1.2 million units.
The company uses FIFO method for inventory valuation. All entries in
raw material, labour, factory overheads and work-in-process accounts are
recorded at standard cost and all possible variances are closed into the Cost
of Goods Sold account.
Normal loss is estimated at 5% of the output quantity.
Actual production related information of the first department, for the

period ended 31 March 2015 is as follows:
(i) There was no beginning inventory of raw material.
(ii) Raw material introduced during the period was 1,500,000 kg.
(iii) 1,650,000 kg of raw material was purchased during the period at a
total cost of Rs. 50,737,500.
(iv) 160,000 labour hours were worked during the period at a cost of Rs. 32,750,000.
(v) Actual factory overhead costs were Rs. 40 million of which 60% were variable.
(vi) Number of units in process at the start and at the end of the period
were 112,000 and 270,000 respectively.
(vii) The stage of completion of the units in process was as follows:
Opening Closing
Raw material 80% 60%
Labour 60% 45%
Factory overheads 40% 30%
(i) 950,000 units were completed and transferred out to the next department.
(ii) 44,500 units were lost when the plant had to be shut down due to a
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short circuit. These units were 90% complete as to material and 70%
complete as to labour and factory overheads.
Required:
Prepare the entries for the period ended 31 March 2015 to record the following:
(a) All entries related to material, labour and overhead on the basis of standard
cost.
(b) Accounting for abnormal loss.
(c) Transfer of material to the next department.
(d) Closure of variances
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Glossary
By-product A product of limited sales value produced simultaneously with a
product of greater value, known as main product.
Common costs: Those costs incurred to produce products simultaneously, but
each of the products could have been produced separately.
Joint costs: Costs incurred up to the point in a given process where individual
products can be identified.
Joint product costs: Common cost factors shared by joint products which are
incurred prior to separation into individual joint products.
Joint products: Individual products of significant sales value which are produced
simultaneously and which are results of a common raw material and/or a
common manufacturing process.
Split-off point: The point in the production process wherein separate products,
either joint products or by-products, emerge.
Cost of quality: The cost associated with nonconformance to quality standards. It
consists of prevention costs, appraisal costs, internal failure costs, and external
failure costs.
Direct labor efficiency standard: Predetermined performance standards in terms
of the direct labor hours that should go into the production of one finished unit.
Direct labor price (rate) standards: Predetermined wage rate per hour
Direct material efficiency (usage) standards: Predetermined specifications of the
quality of direct materials that should go into the production of one finished unit.
Page | 314
Direct materials price standards: Predetermined amount of factory overhead, per

hour, for example, that should go into the production of one finished unit:
Flexible budget: A form of budgeting that shows anticipated costs at different
activity levels.
Inspection time: The time spent to inspect the product to make sure it conforms
to production standards as it moves from one production department to the next
and before it is shipped to customers. Inspection time also includes the time it
takes to rework products that are found not to conform to specifications.
Just-in-time philosophy: Manufacturing and purchasing strategies that seek to
reduce throughput time.
Moving time: The time it takes to move the product from one production
department to the next and the time to move it to and from storage.
Nonvalue-added time: This time includes inspection time, moving time, waiting
time, and storage time. It is also referred to as waste time.
Processing time: The actual time that a product is being worked on
Quality control: A continuous system of feedback necessary for decision making
to ensure optimum product quality.
Standard costing: Costing that is concerned with cost per unit that should be
incurred; standard costing serves basically the same purpose as a budget.
Standard costs: Costs that are expected to be achieved in a particular production
process under normal conditions.
Static budget: A form of planning that shows anticipated costs at one level of
activity.
Storage time: The time that raw material and work in process remain in storage
before they are used by production department and finished products before they
are shipped to customers.
Throughput time: The time between the beginning of the production department
and finished products before they are shipped to customers.
Value-added time: Same as processing time.
Waiting or queue time: The time that the product remains in a production
department before it is worked on.
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Waste time: Same as nonvalue-added time.

Zero defects: A program designed to eliminate defects in production.
Budget (controllable) variance: Difference between actual factory overhead and
budgeted factory overhead based on standard direct labor hours allowed.
Combined price-efficiency variance: Direct material price variance per unit
multiplied by the difference between the actual quantities purchased and the
standard quantity allowed.
Direct labor efficiency variance: Difference between the actual direct labor hours
worked and the standard direct labor hours allowed multiplied by the standard
direct labor hour wage rate.
Direct labor price variance: Difference between the actual wage and the standard
wage per direct labor hour multiplied by the actual direct labor hours worked.
Direct materials efficiency variance: Difference between actual quantity of direct
materials used and standard quantity allowed multiplied by the standard unit
price.
Direct materials price variance: Difference between actual unit price and
standard unit price of direct materials purchased multiplied by the actual
quantity purchased.
Factory overhead efficiency variance: Difference between actual direct labor
hours worked and standard direct labor hours allowed multiplied by the
standard variable factory overhead application rate.
Factory overhead price (spending) variance: Difference between actual factory
overhead and budgeted factory overhead based on actual direct labor hours
worked.
Favorable variance: The result when actual costs are less than standard costs.
Production volume (denominator or idle capacity) variance: Difference between
the activity level used in the denominator for establishing the factory overhead
standard application rate and standard application rate and standard direct labor
hours allowed multiplied by the standard fixed factory overhead application rate.
Pure direct materials price variance: Difference between the direct materials price
variance per unit and the standard quantity allowed.
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Unfavorable variance: The result when actual costs are greater than standard
costs.
Variance: Difference arising when actual results do not equal standards, because
of either external or internal factors.
Disposition of variances: The end-of-period treatment of variance that results
from a standard cost system.
Immaterial or insignificant variances: Variances which don not have to be
prorated and which may be treated as period costs.
Proration of variances: Allocation of variances to the specific accounts affected.
Absorption costing: The costing method under which all direct and indirect
production costs, including fixed factory overhead, are charged to product costs.
Contribution margin: Sales less variable manufacturing, selling, and
administrative costs.
Direct costing: The costing method under which only production costs which
tend to vary with the volume of production are treated as product costs.
External reports: Formal financial statements, such as the income statement,
balance sheet, and statement of cash flows, filed with government regulatory
agencies as required, or issued to stockholders.
Fixed factory overhead: The fixed costs, such as rent, insurance, and taxes,
required to provide or maintain facilities for manufacturing.
Gross profit: Sales less cost of goods sold.
Internal reports: The various cost, operating, and financial reports that are
prepared daily, weekly, monthly, etc., for internal management in planning and
controlling operations.
Variable factory overhead: The variable costs, such as indirect materials and
indirect labor, which are indirect costs needed in production.
Accept a special order: A common decision-making problem wherein a company
must decide whether it is beneficial or not to sell on a one-time basis its product to
a specific customer at a price below the normal selling price.
Avoidable cost: A term used interchangeably with relevant cost.
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Cost of prediction error: The relevant revenue lost or relevant cost incurred
because the company chose a course of action on the basis of incorrect
information; a course of action that would not have been chosen on the basis of
correct information.
Cost-plus-fixed-fee contract: A cost-type defense contract whereby the
government will pay all costs permitted under the all costs permitted under the
contract plus a fixed fee above the costs.
Cost-plus-incentive-fee contract: A cost-type defense contract whereby the
government agrees to reimburse the contractor on the basis of a formula.
Decremental costs and revenues: A decrease in total costs and revenues when
one alternative course of action is compared to another.
Differential cost format: A format in which relevant costs and revenues are
presented for each alternative course of action.
Differential costs and revenues: Changes in total costs and revenues which are
attributable to alternative courses of action.
Elimination of a product line: A common decision making problem wherein a
company must decide whether it is beneficial or not to discontinue the
manufacture of a product line that appears, on a superficial inspection, to be
sustaining losses.
Escapable cost: A term used interchangeably with relevant cost.
Federal Procurement Regulation (FPR): Document containing the principal
regulations governing the sale of products and furnishing of services to civilian
agencies of the U.S. government.
Firm-fixed-price contract: One type of negotiated defense contract in which the
supplying contractor is given a firm price and is subject to the risk that the actual
costs to deliver the product or service will exceed the firm price.
Fixed-price incentive contract: A cost-type defense contract whereby the
government and the contractor negotiate the following: a target profit, a
maximum price, and a formula for determining the final price and profit.
Full-cost pricing: Approach to product pricing which is based on total
manufacturing costs, CG&A, and a markup.
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Incremental costs and revenues: An increase in total costs and revenues when
one alternative course of action is compared to another alternative.
Inescapable cost: A term used interchangeably with irrelevant costs.
Make or buy: A common decision-making problem wherein a company must
decide whether it is beneficial to make a needed component or buy it from an
outside supplier.
Opportunity cost format: A format in which relevant costs and revenues plus
opportunity costs are presented for a single course of action.
Product or service mix-single constraint: A common decision-making problem
wherein a company must decide which product(s) or service(s) should be offered
in light of a single scarce resource.
Relevant costs and revenues: Future costs and revenues that will differ between
or among alternative courses of action.
Relevant qualitative data: Those consequences of a decision that cannot be
measured but should still be taken into consideration, such as the impact of an
alternative course of action on employee morale.
Relevant quantitative data: Costs and revenues that should be considered by
decision makers in choosing between or among alternative courses of action.
Sell or process further in joint costing: A common decision-making problem
wherein a company must decide which of its joint products should be sold at the
split-off point or sold after additional processing.
Sunk cost: A cost incurred as a result of a past decision that is irrelevant in
decision making.
Target-return pricing: Approach to product pricing in which the markup is based
on a target return on the assets invested to produce the product.
Total cost format: A format in which relevant and irrelevant costs and revenues
are presented for each alternative course of action.
Unavoidable cost: A term used interchangeably with irrelevant cost.
Break-even point: The point, in terms of units or dollars, at which total costs
equal total revenue, and profit equals zero.
Contribution margin: Total revenue less total variable costs.
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Contribution margin per unit: Selling price per unit minus variable cost per unit.
Contribution margin ratio: Contribution margin per unit as a percentage of the
selling price.
Fixed costs: Costs which are not directly associated with production and which
remain constant for a relevant range of productive activity.
Margin of safety: The maximum percentage by which expected sales can decline
and profit can still be realized.
Mixed cost: Costs that are fixed up to a certain level of output but will vary
within certain ranges of output.
Regression analysis: A statistical technique that can be used to estimate the
relationship between cost and output.
Relevant range: The range of output over which the amount of total fixed costs
and unit variable costs remains constant.
Variable costs: Costs which are directly associated with producing a product and
which vary with the level of output.
Annuity: When the same dollar amount is to be paid or received in the future.
Annuity due: An annuity in which the first amount to be paid or received begins
immediately.
Capital budgeting decision: Decisions that involve the long-term commitment of
a firm’s resources.
Cash flow for a period: For a given period, the difference between additional
dollars received and additional dollars paid out if an investment project is
undertaken.
Cash flow from operations: As used in this chapter, a project’s cash flow for all
years except year 0. In some textbooks, cash flow from operations may mean the
cash flow for all years including year 0.
Compound interest: An investment situation in which interest is earned not only
on the principal invested but also on the previous interest earned.
Contingent projects: A project which can only be accepted if some other project is
accepted.
Dependent projects: Same as contingent projects.
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Discount rate: The interest rate used to determine the present value.
Discounted value: Same as present value.
Discounting: The process of obtaining the present value of a future value.
Independent projects: A project whose expected cash flow is independent of
another project.
Initial net cash outlay: A project’s cash flow in year 0.
Modified Accelerated Cost Recovery System (MACRS) deductions: Tax
depreciation deductions allowed under the Internal Revenue Code.
Mutually exclusive projects: Projects are said to be mutually exclusive if the
acceptance of one precludes the acceptance of any of the other projects in the
group.
Ordinary annuity: An annuity in which the first amount to be paid or received
begins one period from now.
Present value: The amount of money that must be set aside today earning a
specified rate of interest in order to have a specified dollar amount in the future.
Tax credit: Subject to specified limitations, a dollar-for-dollar reduction of the tax
liability.
Calculus: A tool of mathematics that can be used to determine the optimal value
of a mathematical function.
Coefficient of variation: A statistical measure found by dividing the standard
deviation by the expected value.
Compound event: In probability theory, an event that can be decomposed into
simple events.
Conditional probability: In probability theory, an event that can be decomposed
into simple events.
Cumulative probability distribution: A distribution function that sets out the
probability that a random variable will attain a value less than or equal to a
specific value for the random variable.
Decision criterion: The yardstick of performance employed to measure the
outcome of a decision.
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Derivative of a mathematical function: In calculus, an operation that is

performed on a mathematical function.
Descriptive models: Models that are useful in predicting the outcome of a
decision under various assumptions.
Deterministic models: Models in which there is only one outcome or
environment.
Distribution free models: Models in which more than one environment exists but
for which probabilities of occurrence cannot be assigned to the outcomes or
environments.
Expected value: The weighted average of the random variable of a probability
distribution.
Joint probability: In probability theory, the probability where more than one
event occurs simultaneously.
Management science: A specialty area in business administration that applies
quantitative techniques to analyze and solve managerial problems.
Mutually exclusive events: In probability theory, two events or outcomes which
have nothing in common.
Normal deviate: Standardization of a random variable that is normally
distributed in order to use a normal distribution table.
Normal probability distribution: A probability distribution in which the
probabilities can be determined once the expected value and standard deviation
are known. It is a commonly used probability distribution in business.
Objective probability: The approach to probability theory in which the
probability of an event is defined in terms of its relative frequency.
Opportunity loss: The difference between the best profit that could be realized if
that environment occurred and the profit that would be realized for a given
decision if that environment occurred.
Optimization models: Models that prescribe the best course of action that the
decision maker should pursue so as to achieve an objective.
Outcome matrix or outcome table: A matrix in which each cell shows the
outcome of a decision for a given state of nature or environment.
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Pay-off matrix: An outcome matrix in which the outcome for each environment is
measured as dollar profits.
Probabilistic models: Models in which alternative outcomes or environments
exist.
Probability distribution or probability function: A function in which the
possible values that a random variable can take on are assigned probabilities.
Random variable: A variable for which a probability can be associated with each
possible value that the variable can take on.
Regrets criterion: A decision criterion based on the opportunity loss.
Simple event: In probability theory, an event that cannot be decomposed into
other events.
Standard deviation: A measure of dispersion around the expected value of a
probability distribution. It is equal to the square root of the variance.
Standardized value: A procedure used to standardize a random variable that is
normally distributed so that a normal distribution table can be used.
Statistical independence: In probability theory, two events are statistically
independent if the occurrence of one does not affect the probability of the other.
Stochastic dominance rules: Rules that can be employed to determine whether
one capital investment project is more attractive than other. The rules are based
on the underlying probability distribution of the projects being compared.
Stochastic models: Same as probabilistic models.
Subjective probability: The approach to probability theory that measures
probabilities on the basis of the decision maker’s degree of belief in the likelihood
of the outcome of an event.
Value of perfect information: The difference between the expected value of a
decision assuming perfect information and the expected value of a decision
associated with the best course of action in the absence of perfect information.
Variance: A measure of dispersion around the expected value of probability
distribution. The variance is equal to the square of the standard deviation.
Page | 323
Contribution margin: The excess of sales over all variable costs, including
variable cost of goods sold, variable selling costs, and variable administrative
costs.
Cost variance: A variance due to a difference between budgeted and actual per
unit costs.
Earnings ratio: The percentage of investment center controllable income to
investment center controllable revenue (controllable income ÷ controllable
revenue).
Investment turnover: The “efficient” use of assets as measured by the
relationship between investment center controllable revenues and investment
center controllable assets (controllable revenues ÷ controllable assets).
Performance evaluation: The review process conducted by upper-level
management of the performance of a cost, profit, or investment center manager.
Residual income (RI): The investment center controllable income less investment
center controllable assets multiplied by a company’s required rate of return.
Residual income formula: Controllable income – (Controllable assets ×
Company’s required rate of return) = Residual income.
Return on investment (ROI): The investment turnover times the earnings ratio.
Return on investment formula:
Controllable revenues Controllable income

Controllable assets Controllable revenues
(Investment turnover × Earnings ratio)
Page | 324
Bibliography of Study Notes Advanced Management Accounting

1. Cost Accounting (Third Edition), by Rralph S. Poleimini Frank J. Fabozzi
Arthur H. Adelberg
2. Cost Accounting Planning & Control (Seventh Edition) by Adolph Matz, Milton
F. Usry. Published by South Western Publishing Co.
3. Past year question papers of ICMAP examinations.
4. Management Accounting Analysis and Interpretation (Third Edition) Cheryl S.
McWatters, Jerold L. Zimmerman, Dale C. Morse. Published by Irwin Megraw
Hill.
5. Advanced Management Accounting (Third Edition) By Robert S. Kaplan, Anthony
A. Atkison. Published by PHI Learning Pvt Ltd (New Delhi) India.
THE END
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PROFESSIONAL Advanced Management

Use regression to estimate variable and fixed costs. (Appendix)

Cost-based pricing may be used when customer value is difficult to estimate,

Design compensation contracts based on performance measures and

CVP Analysis and Opportunity Costs:-

Make decisions to add or drop products or services.

Identify and manage a bottleneck to maximize output.

Use spreadsheets to analyze monthly cash flows.

Use multi-stage allocation methods and departmental cost pools to allocate

In selecting the capacity of a fixed cost resource, the organization is committing

Explain the role of management accounting in the organizational structure an

a) Market value at split-off method.

b) Physical output method.

Round all answers to two decimal places.

Total market value of each product

Total market value of each product = Units produced of each product

Output per product

The following revenue and cost information is available:

PRODUCT UNITS MARKET VALUE PER UNIT

Department Department cost per unit

Total units produced in Department 1:

Product Units produced

Joint costs of Department 1:

240,000 units produced × $12 per unit = $2,880,000

Additional processing costs:

Product Ratio × Joint cost Allocation of joint

 Unit Market  Additional Total

Required: Prepare income statements for the Huffy Manufacturing Corporation

a) Net by-product income treated as other income

a) Net by-product income treated as other income:

Cost of main products sold:

*150,000 ÷ 25,000 units = $6.00 per unit

Less: Ending inventory (5,000 × $5.90†) 29,500 118,000

*1,200 units produced × $3.00 per unit = $3,600

Schedule A: Production Costs of Main Product

Production cost of main product $148,280

Schedule B: Production Costs of By-Product

Bates Corporation has decided to accumulate standard costs, in addition to actual

Projected production for 19X5 30,000 units

a) Calculate the following standards:

4) Direct labor efficiency (hours) per unit

1) Direct materials price standard per unit:

*3 hours per ton × 60,000 tons

Average direct labor price per hour:

5) Variable factory overhead application standard rate per direct labor

6) Fixed factory overhead application standard rate per direct labor

b). Total standard cost per unit:

Direct materials ($185×2 tons) $370.00

Handy Harold’s Hardware Supply Manufacturing Company has introduced a

a) Assuming a learning rate of 95%, compute the cumulative average direct

Cumulative Cumulative Computations Total direct Output (Computations)

16 4.073 (4.287×.95) 65.168 .25 (16÷65.168)

Cumulative Direct labor (Computations) Direct labor

Units of finished product produced 15,000 units

direct labor hour:

Required: Calculate the following variances:

a) Direct material price variance

a) Direct material price variance:

c) Direct labor efficiency variance:

d) Direct labor price variance:

e) Factory overhead variance:

2) Two-factor analysis of factory overhead variances: