CGA-CANADA

MANAGEMENT ACCOUNTING FUNDAMENTALS [MA1] EXAMINATION

March 2008

Marks Time: 3 Hours

Note:
Except for multiple-choice questions, all calculations must be shown to obtain full marks.

30 Question 1
Select the best answer for each of the following unrelated items. Answer each of these items in your
examination booklet by giving the number of your choice. For example, if the best answer for item (a)
is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item will
not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations.

Note:
3 marks each

a. Boomer Company has reported an operating loss of $40,000 on sales of $20,000. The contribution
margin was negative $10,000. The company has proposed the purchase of a new machine. Fixed costs
are expected to increase by $10,000 per year. However, variable costs are forecasted to be $15,000
lower than last year at the sales level of $20,000. If costs behave as predicted and the proposal is
accepted, what will the break-even sales in dollars be?
1) $ 40,000
2) $ 80,000
3) $ 160,000
4) $ 200,000

b. The INF Company and the DFL Company sell identical products at identical prices. INF has a lower
unit variable cost and a higher fixed cost relative to DFL. Currently both companies have identical
sales revenues and the same positive operating income. Which of the following statements is
incorrect?
1) Break-even sales for INF will be higher than that for DFL.
2) If sales increase at both companies, DFL will experience a higher level of net operating income
than INF.
3) The degree of operating leverage at the current level of sales for INF will be higher than that
of DFL.
4) At very high margins of safety, the advantage of INF over DFL will not be as great as it would be
at a lower margin of safety.

c. Which of the following statements concerning the approach of target costing is correct?
1) This approach is based on the observation that the firm should set its price so as to be able to
cover its costs.
2) The firm should devote resources to effectively market the product to improve profitability.
3) The firm should not expect to significantly improve profitability through cost reductions after the
product has entered production.
4) The cost of the product cannot be calculated until it has been produced.

Continued...

EMA1M08 ©CGA-Canada, 2008 Page 1 of 8

 Note:
Use the following information to answer parts (d) and (e).

At the end of April, department A at Carson Company transferred all production to finished goods
inventory. During May, the department started and fully completed 80 units. The month end work in
process (WIP) was 100% complete with respect to direct materials and 0% complete with respect to
conversion costs. Manufacturing costs for May were as follows:
Direct materials (DM) $ 12,125,000
Conversion $ 9,750,000

The cost per equivalent unit (EU) for direct materials was $97,000.

d. How many units are in the ending work in process inventory at the end of May?
1) 45
2) 80
3) 125
4) Cannot be determined without knowing if the FIFO method or the weighted-average cost method
(WACM) is used by Carson

e. What is the cost per equivalent unit for conversion costs?

1) $ 78,000.00
2) $ 121,875.00
3) $ 151,562.50
4) Cannot be determined without knowing if the FIFO method or the weighted-average cost method
is used by Carson

f. Which of the following statements regarding revenue variances is correct?

1) The sales volume variance is the difference between the actual volume of sales and the budgeted
sales volume times the budgeted sales price.
2) The sales mix variance is the difference between the actual sales mix and the budgeted sales mix
times the budgeted sales price.
3) The sales quantity variance is the actual quantity sold minus the budgeted quantity of sales times
the budgeted contribution per unit.
4) The sales mix variance plus the sales quantity variance will always be equal to the sum of the
market volume variance and the market share variance.

g. Which of the following statements about return on investment (ROI) and residual income (RI) is
correct?
1) ROI is preferred by managers because it will always lead them to increase it by taking actions that
will be consistent with their company’s strategy.
2) Using ROI to select investments will prevent managers from rejecting profitable investment
opportunities.
3) One advantage of the RI approach is that it can be used to compare the performance of 2 divisions
reliably.
4) The RI approach encourages managers to undertake investments that are profitable for the entire
company.

Continued...

EMA1M08 ©CGA-Canada, 2008 Page 2 of 8

 h. Chan Company uses a job-order costing system. The journal entry to the cost of goods sold (COGS)
account to close out the balance in the manufacturing overhead (MOH) account was a credit of
$13,460. Which of the following statements is correct?
1) The company under applied manufacturing overhead.
2) The net income for the period will decrease following the adjustment.
3) The cost of goods manufactured for the period is overstated.
4) There is a debit balance in the manufacturing overhead account.

i. Which of the following statements regarding costs in a manufacturing company is correct?

1) All costs incurred in manufacturing the product are inventoriable.
2) The cost of direct materials (DM) used in production and the cost of direct labour (DL) are
examples of period costs since they are incurred in the period when the product is made.
3) Conversion costs are not inventoriable.
4) Only fixed costs are inventoriable costs.

j. At the end of August, there was $90,000 in inventory. At the end of September, there was $80,000 in
inventory. September cost of goods sold was $420,000. During September, $100,000 was paid to
suppliers for purchases made in August, and $10,000 was paid for purchases made prior to August.
The company pays for 80% of a month’s purchases in the month of the purchase. What is the total
amount of cash disbursements made in September for purchases?
1) $420,000
2) $438,000
3) $446,000
4) $454,000

13 Question 2
The following information relates to the sales and operations at Simmons Company:
Sales $ 200,000
Total manufacturing cost 160,000
Prime cost 80,000
Conversion cost 120,000
Contribution margin ratio 40%
Margin of safety –20%

There are no non-manufacturing variable costs and no beginning or ending inventories.

Required
2 a. Explain the meaning of the margin of safety percentage achieved by Simmons.

2 b. Calculate the break-even sales in dollars.

2 c. Calculate the contribution margin at the break-even level of sales.

7 d. Prepare a contribution margin income statement, in good form, at the current sales level of $200,000.
Note:
You must show the cost of direct materials, direct labour, and variable manufacturing overhead components of the variable cost, as
well as the break down of fixed costs into manufacturing and non-manufacturing components.

EMA1M08 ©CGA-Canada, 2008 Page 3 of 8

18 Question 3
The standard cost card for a product shows that 5 kg of direct materials and 10 hours of direct labour are
required for each unit. Both fixed and variable manufacturing overhead are applied on the basis of direct
labour-hours. The following information is available from the accounting records:

Note:
The following abbreviations are used: AP = Accounts payable; VMOH = Variable manufacturing overhead; FMOH = Fixed manufacturing
overhead; DM = Direct materials; DL = Direct labour; WIP = Work in process; CM = Contribution margin; B.E. = Break-even

Account Amount Description

1. AP Cr $1,726,000 Purchase of 95,000 kg of DM
2. DM Dr $1,615,000 Addition to DM inventory of 95,000 kg
3. VMOH control Dr $403,620 Incurrence of variable overhead
4. FMOH control Dr $515,000 Incurrence of fixed overhead
5. DM Cr $1,355,682 Issuance of DM to production
6. WIP Dr $1,360,000 Application of DM to production
7. WIP Dr $2,240,000 Application of DL to production
8. WIP Dr $400,000 Application of VMOH to production
9. WIP Dr $608,000 Application of FMOH to production
10. Budget variance Dr $2,000 Incurrence of fixed overhead budget
variance
11. Wages payable Cr $2,267,265 Wages for direct labour used

If the company had been using a normal costing system, the following would have been made:
12. VMOH control Cr $396,375 Allocation of variable manufacturing
overhead to production
Required
14 a. Based on the above information, calculate the following:
(2) i) Actual quantity of output produced
(2) ii) Direct materials quantity variance
(2) iii) Variable overhead efficiency variance
(2) iv) Direct labour rate variance
(2) v) Flexible budget fixed overhead costs
(2) vi) Budgeted fixed overhead application rate
(2) vii) Denominator level of activity

4 b. Calculate and interpret the production volume variance.

EMA1M08 ©CGA-Canada, 2008 Page 4 of 8

15 Question 4
Pearl Company specializes in making model ships for the model building hobby market. The company
broke even in 2005, as shown below. There were no beginning or ending inventories in 2005.

PEARL COMPANY
Contribution Income Statement
year ended December 31, 2005
Sales revenue (on 10,000 units) $ 360,000
Variable costs
Direct materials 90,000
Direct labour 90,000
Variable manufacturing overhead 30,000
Variable sales and administration 20,000 230,000
Contribution margin 130,000
Fixed costs
Fixed manufacturing overhead 90,000
Fixed selling and administration 40,000 130,000
Net operating income $ 0

The following information relates to sales and operations in 2006 and 2007:
1. The company’s 2006 and 2007 variable cost per unit, selling price per unit, and total fixed costs have
remained constant at the 2005 levels.
2. The sales volume in 2007 was equal to the sales volume in 2006.
3. The total cost per unit of inventory in 2006 was higher than the unit variable cost of goods sold by
$4.50.
4. There were no ending inventories in 2007.

Required
9 a. Prepare absorption costing income statements for 2006 and 2007.

6 b. Prepare a reconciliation between the absorption costing and variable costing net operating incomes.

EMA1M08 ©CGA-Canada, 2008 Page 5 of 8

 16 Question 5
Javelin Cycling Vacations Ltd. offers cycling tours in Canada and France. Each year a single tour is
offered. For 2008, the company is offering a tour of the Continental Divide. Following is an estimate of
the revenues and costs for this tour:

JAVELIN CYCLING VACATIONS LTD.

Continental Divide Tour
Revenue and Expenses Forecast for 2008
Revenue $ 170,000
Expenses
Tour guide salaries1 48,000
Promotion2 12,000
Gratuities 8,000
Office and equipment insurance3 2,000
Group accident and life insurance4 7,000
Amortization 8,000
Tour support employees1 28,000
Bicycle maintenance 7,000
Customer meals 20,000
Hotel and camping costs 20,000
Administrative and office expense5 3,000
Tour coordinator salary 30,000
Total expenses 193,000
Net operating income (loss) $ (23,000)
1
Javelin will incur a cost of 5% of the salaries in severance costs when employees are terminated.
2
Promotion costs have already been incurred.
3
Office and equipment insurance is paid in advance of commencement of the tour.
4
Insurance is payable only if the tour is confirmed.
5
These expenses are for booking accommodations, arranging meals, and providing communication
services during the tour.

Required
10 a. Indicate whether the tour should be offered. Provide calculations in support of your response.

6 b. Calculate the minimum revenue required to justify offering the tour.

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 8 Question 6
During the past year, Duffy’s Garage has been losing customers to Hanlon Motor Repairs. Duffy currently
charges a labour rate of $126.75 per hour. Duffy uses a single overhead rate based on direct labour-hours
to apply overhead costs to car repair charges. Budgeted total overhead is comprised of the following:
Indirect factory wages $ 75,000
Garage equipment depreciation $ 120,000
Factory utilities $ 65,000
Factory rent $ 85,000
General administration $ 190,000

A total of 20,000 direct labour-hours has been budgeted, leading to a predetermined manufacturing
overhead application rate of $17.25 per direct labour-hour.

Duffy recently found out that Hanlon uses multiple overhead rates based on multiple overhead cost pools.
Duffy has decided to do the same. Duffy’s analysis revealed 3 different cost pools: orders, diagnostic time,
and customer service. This was based on the fact that different types of cars required differing amount of
resources for order processing, time spent for diagnosing repair problems due to the complexity of the
different equipment, and time spent answering customer questions. The following data shows the new
pools, the total driver activity, and the pool rates.

Pool Cost Activity Rate

Overall organization $ 90,000
Orders 165,000 20,500 orders $ 8.05/order
Diagnostic time 100,000 6,000 hours $16.67/hour
Customer service 180,000 10,000 hours $18.00/hour
Total $ 535,000

The following data shows anticipated driver usage by 3 categories of cars that Duffy repairs:

Car Type Categories

Asian North American European Total
Number of cars 2,000 5,000 3,000 10,000
Direct labour-hours 4,000 (20%) 10,000 (50%) 6,000 (30%) 20,000
Orders 6,000 (29%) 10,000 (49%) 4,500 (22%) 20,500
Diagnostic time 2,430 (41%) 805 (13%) 2,765 (46%) 6,000
Customer service 3,000 (30%) 2,000 (20%) 5,000 (50%) 10,000

Based on this information, Duffy has determined the overhead cost for a car by car type:

Overhead Cost per Car

Cost Method Asian North American European
Direct labour-hours $34.50 $34.50 $34.50
Multiple pools $71.40 $25.98 $57.43

Distribution of Overhead Cost by Car Type and Method of Allocation

Cost Method Asian North American European Total
Direct labour-hours $ 69,000 $172,500 $103,500 $345,000
Multiple pools $ 142,800 $129,900 $172,300 $445,000

Continued...

EMA1M08 ©CGA-Canada, 2008 Page 7 of 8

 Required
3 a. Explain what it means to allocate overhead cost based on direct labour-hours to the 3 car type
categories. No calculations are necessary.

3 b. Explain what it means to allocate overhead cost based on multiple pools to the 3 car type categories.
No calculations are necessary.

2 c. Identify 2 reasons why overhead allocation using a single overhead cost pool based on direct
labour-hours will be different from the allocation that uses the multiple overhead cost pools for
determining repair costs.

END OF EXAMINATION

100

EMA1M08 ©CGA-Canada, 2008 Page 8 of 8

 MANAGEMENT ACCOUNTING FUNDAMENTALS [MA1]
EXAMINATION

Before starting to write the examination, make sure that it is complete and that there are no
printing defects. This examination consists of 8 pages. There are 6 questions for a total of
100 marks.

READ THE QUESTIONS CAREFULLY AND ANSWER WHAT IS ASKED.

 To assist you in answering the examination questions, CGA-Canada includes the following glossary of terms.
Glossary of Assessment Terms
Adapted from David Palmer, Study Guide: Developing Effective Study Methods (Vancouver: CGA-Canada, 1996).
Copyright David Palmer.
Calculate Mathematically determine the amount or
number, showing formulas used and
steps taken. (Also Compute).
Compare Examine qualities or characteristics that
resemble each other. Emphasize
similarities, although differences may be
mentioned.
Contrast Compare by observing differences. Stress
the dissimilarities of qualities or
characteristics. (Also Distinguish
between)
Criticize Express your own judgment concerning
the topic or viewpoint in question.
Discuss both pros and cons.
Define Clearly state the meaning of the word or
term. Relate the meaning specifically to
the way it is used in the subject area
under discussion. Perhaps also show how
the item defined differs from items in
other classes.
Describe Provide detail on the relevant
characteristics, qualities, or events.
Design Create an outcome (e.g., a plan or
program) that incorporates the relevant
issues and information.
Determine Calculate or formulate a response that
considers the relevant qualitative and
quantitative factors.
Diagram Give a drawing, chart, plan or graphic
answer. Usually you should label a
diagram. In some cases, add a brief
explanation or description. (Also Draw)
Discuss This calls for the most complete and
detailed answer. Examine and analyze
carefully and present both pros and cons.
To discuss briefly requires you to state
in a few sentences the critical factors.
Evaluate This requires making an informed
judgment. Your judgment must be shown
to be based on knowledge and
information about the subject. (Just
stating your own ideas is not sufficient.)
Cite authorities. Cite advantages and
limitations.
Explain In explanatory answers you must clarify
the cause(s), or reasons(s). State the
“how” and “why” of the subject. Give
reasons for differences of opinions or of
results.
Identify Distinguish and specify the important
issues, factors, or items, usually based on
an evaluation or analysis of a scenario.
Illustrate Make clear by giving an example, e.g., a
figure, diagram or concrete example.
Interpret Translate, give examples of, solve, or
comment on a subject, usually making a
judgment on it.
Justify Prove or give reasons for decisions or
conclusions.
List Present an itemized series or tabulation.
Be concise. Point form is often
acceptable.
Outline This is an organized description. Give a
general overview, stating main and
supporting ideas. Use headings and
sub-headings, usually in point form. Omit
minor details.
Prove Establish that something is true by citing
evidence or giving clear logical reasons.
Recommend Propose an appropriate solution or course
of action based on an evaluation or
analysis of a scenario.
Relate Show how things are connected with each
other or how one causes another,
correlates with another, or is like another.
Review Examine a subject critically, analyzing
and commenting on the important
statements to be made about it.
State Clearly provide a position based on an
evaluation, e.g., Agree/Disagree,
Correct/Incorrect, Yes/No. (Also
Indicate)
Summarize Give the main points or facts in condensed
form, like the summary of a chapter,
omitting details and illustrations.
Trace In narrative form, describe progress,
development, or historical events from
some point of origin.
 CGA-CANADA

MANAGEMENT ACCOUNTING FUNDAMENTALS [MA1] EXAMINATION

March 2008
SUGGESTED SOLUTIONS

Marks Time: 3 Hours

30 Question 1
Note:
3 marks each

Sources/Explanations:
a. 3) Topic 4.7 (Level 1)
An operating loss of $40,000 combined with a negative margin of $10,000 translates to a fixed
cost of $30,000. Variable costs are also $30,000. The new cost structure is variable costs of
$15,000 and fixed costs of $40,000 at a sales level of $20,000. The contribution margin (CM)
becomes $5,000. Thus the CM ratio is $5,000 / $20,000 = 0.25. With fixed costs of $40,000, the
break-even sales will be $40,000 / 0.25 = $160,000.

b. 2) Topics 4.6 and 4.8 (Level 1)

c. 3) Topic 10.3 (Level 1)

The concept of target costing is based on the observation that the firm has little control over price
and that the majority of the product’s cost can be determined at the design stage. Hence by
focusing on design and development, the costs of production can be effectively controlled.
Option 1) is false because in the target costing approach, the price is set first and the costs are
engineered to ensure a desired rate of return. Options 2) and 4) are also false, because target
costing does not mention the role of marketing and the approach suggests that if a firm waits until
production to estimate product costs it will be too late.

d. 1) Topic 3.3 (Level 1)

Since beginning work in process is 0, it is not necessary to know which of FIFO or WACM is in
use. Therefore option 4) is incorrect. Dividing DM costs by the cost per EU will yield the total EU
for DM: 12,125,000 / 97,000 = 125 EU. Since 80 units were completed and transferred out and
units in ending WIP are 100% complete, ending WIP is 125 – 80 = 45.

e. 2) Topic 3.3 (Level 1)

Total EU = 80 + 0% × 45 = 80. Cost per EU = $9,750,000 / 80 = $121,875.

f. 4) Topic 8.9 (Level 1)

Option 1) is false because the use of budgeted sales price is incorrect. Option 2) is false because it
does not specify what is meant by “sales mix.” Option 3) is false because it does not adjust for the
expected sales mix. Option 4) is correct because decomposition from a market volume and share
perspective, and decomposition from a sales mix and quantity perspective are alternative
decompositions of total sales volume variance.

Continued...

SMA1M08 ©CGA-Canada, 2008 Page 1 of 8

 g. 4) Topic 8.10 (Level 1)
Option 1) is false because ROI can lead managers to take actions inconsistent with overall
strategy when attempting to increase ROI. Option 2) is false since profitable investments can
cause ROI to decline and hence cause managers to reject such investments. Option 3) is false
since RI is a poor measure for comparing divisions given its sensitivity to the size of the division.
Only option 4) is correct.

h. 3) Topics 2.2 and 2.4 (Level 1)

A credit entry to the COGS account will be offset by a debit to the MOH account, which implies
that the balance in MOH prior to closing is a credit balance, signifying overapplied overhead.
Thus options 1) and 4) are both incorrect. Since the credit entry to COGS will reduce the COGS,
net income will increase post adjustment. Thus the correct answer is option 3).

i. 1) Topics 1.7 and 1.8 (Level 2)

Manufacturing costs are product costs and only product costs are inventoriable. DL, DM are
manufacturing costs and thus not period costs. Conversion costs are all manufacturing costs and
thus inventoriable. Both fixed and variable manufacturing costs enter the cost of goods
manufactured and thus are inventoriable.

j. 2) Topic 6.7 (Level 1)

Use the inventory balance equation, Beginning inventory + Purchases – Ending inventory = Cost
of goods sold to solve for purchases. Purchases for September = $80,000 – $90,000 + $420,000 =
$410,000. Cash disbursements for September = 80% of September purchases + Disbursement for
prior period purchases = 0.8 × 410,000 + 110,000 = $438,000.

SMA1M08 ©CGA-Canada, 2008 Page 2 of 8

13 Question 2
Source: Topics 4.4 and 4.7 (Level 1)

The following relations will be used in the answer.

• Prime costs = Direct materials (DM) + Direct labour (DL)
• Conversion costs = DL + Variable manufacturing overhead (VMOH) + Fixed manufacturing overhead
(FMOH)
• Total manufacturing costs = DM + DL + FMOH + VMOH
• Contributing margin (CM) ratio = $CM / $Sales
• Margin of safety = $Sales – $Break-even sales
• Margin of safety percentage = Margin of safety / $ Sales

2 a. The margin of safety achieved is –20%. This means that current sales are 20% less than the level of
sales at which the company will break even. The firm is operating at a loss.

2 b. Break-even sales in dollars is (1 – Margin of safety %) × current sales:

Break-even sales = 1 – (–20%) × $200,000 = 1.2 × 200,000 = $240,000

2 c. The contribution margin at the break-even level of sales is CM ratio × Sales:

Contribution margin = 0.4 × $240,000 = $96,000

7 d. SIMMONS COMPANY
Contribution Income Statement
Sales $ 200,000
Variable costs
Direct materials 40,000 (Total manufacturing cost –
Conversion cost)
Direct labour 40,000 (Prime cost – Direct materials)
Variable manufacturing
Overhead 40,000 [(1 – CM ratio) × Sales – Prime costs]
Total variable costs 120,000
Contribution margin 80,000
Fixed costs
Manufacturing 40,000 (Total manufacturing cost
– Variable manufacturing cost)
Non-manufacturing 56,000 ($96,000 – $40,000)
Total fixed costs 96,000
Net operating income (loss) $ (16,000)

SMA1M08 ©CGA-Canada, 2008 Page 3 of 8

18 Question 3
Source: Topics 7.3, 8.2, and 8.3 (Level 1); Topic 7.4 (Level 2)

14 a.
(2) i) Standard price for a kg of DM = $1,615,000 / 95,000 = $17 / kg. Total quantity of DM used in
production at standard = $1,360,000 / $17 = 80,000 kg. Therefore, the quantity produced
= 80,000 kg / 5 kg per unit = 16,000 units.

(2) ii) DM quantity variance = (Actual quantity × Standard price – Standard quantity × Standard price)
= $1,355,682 – $1,360,000 = $(4,318) (favourable).

(2) iii) Entry 12 is the actual quantity of the driver (direct labour) used, valued at the standard rate per
hour. Entry 8 describes the application of variable overhead at standard (standard quantity of
driver allowed × standard rate). Therefore, the variable overhead efficiency variance is $396,375
– $400,000 = $(3,625) (favourable).

(2) iv) The direct labour rate variance is Actual hours used × (Actual wage rate – Standard wage rate) =
Actual wages – Actual hours at standard wage rate.
Entry 11 provides the actual wage bill: $2,267,265.
From entry 7, the standard wage rate is $2,240,000 / (16,000 units × 10 hrs / unit) = $14 per hour.
The actual hours are found as follows. Given that $400,000 is applied as variable overhead to
production, the standard variable overhead application rate is $400,000 / 160,000 hours = $2.50.
When this rate is applied to actual labour-hours (as in a normal costing system), one obtains
entry 11. Thus the actual quantity of driver used = $396,375 / $2.50 = 158,550 hours.
Labour rate variance = $2,267,265 – 158,550 × $14 = $2,267,265 – $2,219,700 = $47,565
unfavourable.

(2) v) Entry 4, with entry 10, shows that actual fixed overhead is $515,000 and the fixed overhead
budget variance is $2,000 unfavourable. Note that a debit entry for the budget variance indicates
that it is unfavourable (actual exceeds flexible budget). Therefore, the flexible budget fixed
overhead costs is $515,000 – $2,000 = $513,000.

(2) vi) The rate is found from entry 9 and from the fact that a total of 160,000 hours are used to apply
fixed overhead:
Budgeted fixed overhead application rate = $608,000 / 160,000 = $3.80

(2) vii) Denominator level of activity = Flexible budget fixed overhead / Budgeted fixed overhead
application rate.
Denominator level of activity = $513,000 / $3.80 = 135,000 hours

4 b. The production volume variance is $513,000 – $608,000 = $95,000 favourable. This is interpreted as
follows. The quantity of driver activity allowed for the actual quantity of output is greater than what
was planned (160,000 hours > 135,000 hours). This signifies that the utilization of the plant resources
was better than planned, and thus a favourable variance ensues. That is, the flexible budget anticipated
that the fixed costs would be in support of an activity level of 135,000 hours, but actually a higher
level of activity resulted leading to a higher utilization of plant resources.

SMA1M08 ©CGA-Canada, 2008 Page 4 of 8

 15 Question 4
Source: Topic 6.2 (Level 1)

First, the quantity of production in 2006 must be determined. Since the unit total product costs in inventory
are $4.50 higher than the unit variable cost of goods sold, the $4.50 must be entirely due to the fixed costs.
Since manufacturing fixed costs in 2006 are $90,000, the quantity of production must be $90,000 / $4.50 =
20,000 units.

Alternatively, total unit cost = Unit variable costs (UVC) + Unit fixed costs (UFC)
UVC = $210,000 / 10,000 = 21.00 and product cost = $21.00 + $4.50 = $25.50. Thus,
UFC = FC / Q = $4.50 = $90,000 / Q or Q = 20,000

Second, the sales volume for 2006 must be determined. Given that there are no ending inventories in 2007,
the minimum sales volume for 2006 has to be 10,000 units. The maximum sales volume cannot exceed
20,000 units. Any choice for sales units between 10,000 and 20,000 is acceptable. The final solution will
depend on the choice of units used. The solution is illustrated for sales of 10,000 units in 2006 and
20,000 units in 2006.

Alternative 1 — Sales volume in 2006 is 10,000 units

9 a. Since 2006 production is 20,000 units, there will be 10,000 units in ending inventory, which will be
sufficient to cover the 2007 sales volume of 10,000 units. No production will occur in 2007.

Nonetheless, there will still be $90,000 in fixed manufacturing costs incurred. This will be the cost of
goods manufactured for 2007.
PEARL COMPANY
Absorption Costing Income Statements
2006 2007
Sales $ 360,000 $ 360,000
Cost of goods sold
Beginning inventory 0 255,000
Cost of goods manufactured 510,000 90,000
Goods available for sale 510,000 345,000
Ending inventory (255,000) 0
Cost of goods sold 255,000 345,000
Gross margin 105,000 15,000
Selling and administrative costs — Fixed 40,000 40,000
Selling and administrative costs — Variable 20,000 20,000
Net operating income (loss) $ 45,000 $ (45,000)

Continued...

SMA1M08 ©CGA-Canada, 2008 Page 5 of 8

 6 b. Net operating income under variable costing will be $0 in both 2006 and 2007, since there is no
change in sales from 2005 to 2007, and there is no change to unit variable costs, selling price, and
total fixed costs. That is, all of the fixed costs will be expensed (as in 2005) in 2006 and 2007. The
units in inventory in 2006 will carry only the variable costs of production and administration, which
will not flow into the income statement in 2006. These costs will become the variable cost of goods
sold in 2007.

Thus the reconciliation can be set up without the need to develop variable costing income statements.

Reconciliation of Net Operating Incomes

2005 2006 2007
Variable cost — Net operating income $ 0 $ 0 $ 0
Plus fixed manufacturing overhead cost
in ending inventory 0 45,000 0
Minus fixed manufacturing overhead
cost in beginning inventory 0 0 45,000
Absorption cost — Net operating income (loss) $ 0 $ 45,000 $ (45,000)

Alternative 2 — Sales volume in 2006 is 20,000 units

9 a. In this case, the entire production is sold in 2006, and therefore in 2007 production and sales will also
be 20,000 units. Because there will be no ending inventories in either 2006 or 2007, the absorption
costing and variable costing net operating incomes will be identical and no reconciliation will be
necessary.
PEARL COMPANY
Absorption Costing Income Statements
2006 2007
Sales $ 720,000 $ 720,000
Cost of goods sold
Beginning inventory 0 0
Cost of goods manufactured 510,000 510,000
Goods available for sale 510,000 510,000
Ending inventory 0 0
Cost of goods sold 510,000 510,000
Gross margin 210,000 210,000
Selling and administrative costs — Fixed 40,000 40,000
Selling and administrative costs — Variable 40,000 40,000
Net operating income (loss) $ 130,000 $ 130,000

6 b. Since there are no inventories in 2006 or 2007, variable costing net income in 2006 and 2007 will be
identical to the absorption costing net income in 2006 and 2007.

SMA1M08 ©CGA-Canada, 2008 Page 6 of 8

 16 Question 5
Source: Topic 9.2 (Level 1)

10 a. This is a shutdown or operate decision. There are several ways to set up the solution.

Cost of not offering the tour

Severance costs $ 3,800

Profit (loss) of operating the tour:

Promotion costs are irrelevant. Insurance on the office and equipment is paid before the tour is
planned and thus have also been incurred. Amortization is not a cash flow, thus the original net
operating loss should be adjusted as follows:
Revised net operating income = ($23,000) + $12,000 + 8,000 + 2,000 = ($1,000)

The loss from operating is less than the cost of shutting down: the advantage of offering the tour
is $2,800.

Alternative solution:
This approach compares the revenue and expenses under each choice.

With Tour (A) Without Tour (B) Difference (A – B)

Revenue $ 170,000 $ 0 $ 170,000
Expenses
Tour guide salaries 48,000 2,400 45,600
Promotion Sunk Sunk Sunk
Gratuities 8,000 0 8,000
Insurance, office Sunk 0 Sunk
Insurance, group 7,000 0 7,000
Tour support staff 28,000 1,400 26,600
Bicycle maintenance 7,000 0 7,000
Customer meals 20,000 0 20,000
Hotel and camping costs 20,000 0 20,000
Administrative and office expenses 3,000 0 3,000
Tour coordinator salary 30,000 0 30,000
Net Operating Income $ (1,000) $ (3,800) $ 2,800

6 b. From part a), the cost of shutting down exceeds the cost of operating by $3,800 – $1,000 = $2,800;
thus if revenue was to decline by more than $2,800, it would be best to shut down. Therefore,
minimum sales revenue required to offer the tour must be greater than $170,000 – $2,800 = $167,200.

SMA1M08 ©CGA-Canada, 2008 Page 7 of 8

8 Question 6
Source: Topic 5.1 (Level 1); Topic 5.2 (Level 2)

3 a. If overhead cost is allocated using direct labour-hours (DLH), it means that management believes that
North American cars should bear the 50% of the overhead burden and that this would accurately
reflect the contribution of this type of cars to total overhead costs. Similarly, it would be thought that
the Asian cars contribute and should bear 20% of the total overhead burden, and European cars should
absorb 30% of the burden. On a per car basis, every car is allocated the same cost of $34.50. This
indicates that when multiple products are produced, a per car allocation rate by itself will not convey
the complete information.

3 b. Moving to multiple pools means that overhead costs are driven by batch level activities such as orders,
time spent on diagnosis, and customer service. There is also recognition of a component of cost that is
independent of any activity base — the organization level cost. The overhead cost burden to assign to
each car type will be different than when it was determined using direct labour-hours. For example,
owners of European cars apparently impose a greater burden on customer service activity, perhaps due
to the complexity of these cars. If owners of such cars are more demanding, this might also explain the
relatively high consumption of service time. As another example, it may be argued that the time to
diagnose a problem does not have to be related to the time taken to fix the problem. These aspects will
go unrecognized in a single pool system based on DLH. Therefore, repair charges, including a charge
for the overhead, are likely distorted when DLH is used instead of multiple activity drivers.

2 c. One reason for a difference to exist between the 2 methods of allocation is the use of multiple
overhead pools. That is, activity cost pools lead to the allocation of all of the non-organization level
overhead costs, including non-manufacturing overhead, to the products. The use of direct labour-hours
in a traditional cost allocation system will ignore the non-manufacturing overhead costs.

A second difference will be that the relative consumption of each activity driver such as orders,
diagnostic time, and customer service time is different from the consumption of direct labour-hours
for the 3 car types. In other words, the data show that the incidence of overhead activity driver use
when 3 activity pools are used is different than when only direct labour-hours are considered.

END OF SOLUTIONS

100

SMA1M08 ©CGA-Canada, 2008 Page 8 of 8

 CGA-CANADA

MANAGEMENT ACCOUNTING FUNDAMENTALS [MA1] EXAMINATION

March 2008
EXAMINER’S COMMENTS

General Comments
Performance on this examination, overall, was unsatisfactory. Performance on Questions 1 and 2 was
unsatisfactory. Students found Question 3 on variances and standard costing the most difficult and
performance on this question was poor. Students also had difficulty with Question 4. Performance on
Questions 5 and 6 was satisfactory. In general, students appeared to have had difficulty with the style and
format of some of the questions on this examination, especially Questions 3 and 4.Students are advised to
use previous examination and assignment formats only as a guide to some of the possible ways they can be
tested; they are urged to consider the learning objectives and the competencies specified in the
examination blueprint when reviewing the content of the past examinations and assignments. Too much
reliance on past examination or assignment formats can hamper a student’s ability to apply the course
concepts in new settings and contexts.

Specific Comments
Question 1 Multiple choice (Levels 1 and 2)
This question covered a broad range of topics. Performance on this question was unsatisfactory. Part (f)
(revenue variances) posed the greatest difficulty for the students.

Question 2 Cost-volume profit analysis, cost classifications, variable income costing income statements
(Level 1)
Performance on this question was unsatisfactory. Students had difficulty applying the definition of margin
of safety. Some students erroneously referred to the concept of safety stock in inventory management.
Many did not recognize that the parts of this question were sequenced to lead them to be able to prepare
the variable costing income statement in part (d). Instead, these students attempted each part
independently. For example, contribution margin at the break-even point is also the total fixed costs over a
relevant range of volume of output and sales. Many students also had difficulty in applying the concept of
prime cost and conversion cost.

Question 3 Standard cost and variables (Level 1)

Students had difficulty with all parts of this question. Although the format of the presentation of the
information was different from what students have seen before, the information itself, which required
students to demonstrate their understanding of the use of standard costs when accumulating costs of
manufacture, should have been familiar. The main idea behind this question was that when costs are
“applied” or when quantities are issued they are done so at standard costs and quantities. When costs are
“incurred,” they reflect actual quantities and prices. Students did not demonstrate a good understanding of
the concept of the production volume variance and its calculation in part (b). Very few students provided a
definition of the concept in part (b). Also some students did not realise that parts (a) (v), (vi), and (viii)
were calculations of the components of the production volume variance.

Continued...

©CGA-Canada, 2007
 Question 4 Absorption costing and variable costing approaches (Level 1)
Performance on this question was unsatisfactory. The calculation of the production for 2006 and deciding
the sales volume for 2006 and 2007 were two key aspects of this question. Students had difficulty using
the information on total fixed costs and the unit fixed costs, which was given in the form of the difference
between total unit cost and unit variable costs, to calculate the production volume (20,000 units). Sales
volume information was not provided. Any value between 10,000 and 20,000 was acceptable. Many
students chose 10,000 and several chose 20,000. Regardless of the actual number chosen for sales, it was
critical to account for beginning and ending inventories when determining the cost of goods manufactured
and the cost of goods sold when setting up the absorption income statement. Using the proper format here
would have made the reconciliation easy to make. Most students did not do this satisfactorily.

Common errors included preparing variable costing income statements even though the question required
an absorption costing statement; assuming that sales and production was equal to 10,000 units and yet
showing positive inventories in one year and none in the next; and increasing the total cost of manufacture
in 2006 and reducing the total cost of manufacture in 2007 while keeping sales and production constant.
The most common error in part (b) was that the reconciliation attempted was not consistent with the
calculations from part (a).

Question 5 Relevant cost analysis (Operate or shutdown decision) (Level 1)

This question was answered satisfactorily for the most part. Common difficulties included problems
distinguishing sunk costs, common costs, and irrelevant costs. The correct answer could be arrived at
using a variety of different approaches and students employed most of these. Several students attempted to
answer the question by determining the direct costs of only one option: costs of not offering the tour or the
costs of offering the tour, and thus did not compare the costs of two options. Even if the analysis of one
option results in a loss, it will be preferable if the loss is less than the alternative option.

Some students did not recognize that amortization is not a cash flow item; it is a common cost, and as such
it will net out in any cost comparison between the options and therefore it also an irrelevant cost. Another
error was to include the severance costs as part of the option to offer the tour; these costs are incurred only
if the tour is abandoned, which would necessitate letting employees go. If the tour does go ahead, no
severance is incurred because at the end of the tour the employee contracts will have been fulfilled. In
part (b), a common error was interpreting the question as requiring a break-even calculation. Students who
made this error did not recognize that the question was asking for the sales revenue that would make
offering the tour justifiable. If the decision was to reject the tour, the sales revenue needs to increase, but
only by the amount of the difference in the losses between the two options. This illustrates the need to read
carefully the required of the question.

Question 6 Comparison of ABC and traditional approaches to overhead cost allocation (Level 2)
This question was answered satisfactorily. A common error here was to simply describe the process of
each approach. Such a response does not recognize that all of the computations have already been made
and the results of each approach are available. Students should focus on the results of each allocation
approach and explain their meaning. On average, students demonstrated a good general understanding of
the differences between the two approaches, but were not very successful in relating that understanding to
the specific situation described in the problem.

MA1M08 ©CGA-Canada, 2008