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Free resources for accountancy students
P1 Management
Operational
Level
Accounting
To benefit from these notes you must watch the free lectures on the
OpenTuition website in which we explain and expand on the topics covered
You must obtain a current edition of a Revision / Exam Kit - the CIMA
approved publisher is Kaplan. It contains a great number of exam standard
questions (and answers) to practice on.
You should also use the free “Online Multiple Choice Tests” which you can find
on the OpenTuition website:
http://opentuition.com/cima/
2019 Examinations Watch free CIMA P1 lectures 1
P1 Management Accounting
1. Traditional Costing Methods 3
6. Linear Programming 25
8. Advanced Variances 33
9. Budgeting 39
Answers to Examples 73
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2019 Examinations Watch free CIMA P1 lectures 3
Chapter 1
TRADITIONAL COSTING METHODS
1. Introduction
The collective term traditional costing methods refers to:
๏ Absorption Costing
๏ Marginal costing
You will need to understand traditional costing methods in order to compare and contrast their
differences. From here you will be able to consider their strengths or weaknesses against
modern alternatives such as ABC costing.
Important to this section is the concept of marginal costing contribution which links to many
other parts of CIMA P1 syllabus for example, limited factor analysis, variance reconciliations and
cost volume profit (CVP) techniques. (see later chapters)
Exercise 1
Why do we need to obtain a cost per unit?
2019 Examinations Watch free CIMA P1 lectures 4
Overheads are allocated apportioned then absorbed across all units using a single cost driver
(usually machine or labour hours).
Suitable costing system for mass produced, homogeneous products - where overheads are largely
volume driven.
Focus is on CONTRIBUTION earned (which is not distorted by overhead costs) and can be used to
evaluate decisions relating to incremental units.
When production in the period is not equal to sales (inventory decreases or increases) there will be
a different profit figure reported under each costing system.
๏ ABSORPTION PROFIT $X
Exercise 2
Sales in period 12000 units.
Production volume 13500 units
Selling price $150
Variable costs $65 per unit
Fixed production costs per unit $30
The company above uses a marginal costing system.
Calculate the difference in reported profit under absorption costing?
2019 Examinations Watch free CIMA P1 lectures 7
Chapter 2
ACTIVITY BASED COSTING
1. Introduction
Traditional absorption costing systems share overheads across all products based on a single cost
driver (usually machine or labour hours).
Under ABC costing, overhead costs are given greater attention and visibility because they are
assigned to different products based on the extent to which each product ‘drives’ or causes that
cost.
This costing system can be relatively time-consuming and costly to implement but can be useful, if
manufacturing overhead expenditure is significant and a diverse product range exists. ABC can also
be applied to costing within service industries.
Exercise 1
Una manufactures three products: A, B, and C.
Data for the period just ended is as follows:
A B C
Production (units) 20,000 25,000 2,000
Sales price ( per unit) $20 $20 $20
Material cost (per unit) $5 $10 $10
Labour hours (per unit) 2 hours 1 hour 1 hour
(Labour is paid at the rate of $5 per hour)
Overheads for the period were as follows:
Set-up costs 90,000
Receiving 30,000
Despatch 15,000
Machining 55,000
$190,000
Cost driver data:
A B C
Machine hours per unit 2 2 2
Number of set-ups 10 13 2
Number of deliveries received 10 10 2
Number of orders despatched 20 20 20
(a) Calculate the cost (and hence profit) per unit, absorbing all the overheads on the basis
of labour hours.
(b) Calculate the cost (and hence profit) per unit absorbing the overheads using an Activity
Based Costing approach.
2019 Examinations Watch free CIMA P1 lectures 9
๏ Unit level cost – are incurred with each unit of output -e.g. power is used by factory
machines each time a unit is produced.
๏ Batch level costs –increase with each ‘batch’ of output -e.g. equipment set-up costs are
incurred each time a new batch is processed.
๏ Product Sustaining costs – this type of cost does not increase in relation to batches or units
produced but are necessary costs to support particular product types – e.g. design costs.
๏ Facility level costs – General manufacturing overheads these can not easily be traced to
production activity e.g. admin staff salaries.
Exercise 2
Explain the benefits, which can be gained from changing to a more effective costing system?
2019 Examinations Watch free CIMA P1 lectures 10
2019 Examinations Watch free CIMA P1 lectures 11
Chapter 3
LIMITING FACTOR ANALYSIS
1. Introduction
Limited Factor analysis can be used to determine optimum production levels when faced with
scarcity of a single resource (a limiting factor).
The limiting factors, in exam questions will often take the form of a shortage of a particular raw
material or an insufficient number of labour hours being available.
Management are faced with a decision of what quantities and mix of products to manufacture in
order to maximise profits given this constraint.
In a marginal costing environment, the concept of contribution can be used to plan production
in a manner which will maximise profits.
Following this, we find solutions to limiting factor scenarios in a throughput costing environment.
The marginal costing model provides information on the contribution level of all products. In the
short term, fixed costs do not change – so profits can be maximised through following a
production plan that maximises contribution.
In a situation where there is a scarcity of a particular resource, the products competing for use of
that resource can be ranked in terms of their contribution earned per unit of limited resource.
For example, a shortage of labour hours will require products to be prioritised based on those
which earn the most contribution per each scarce labour hour used.
2019 Examinations Watch free CIMA P1 lectures 12
Exercise 1
Pi plc manufactures 2 products, A and B.
The cost cards are as follows:
A B
Selling price 25 28
Materials 8 20
Labour 5 2
Other variable costs 7 2
Fixed costs 3 2
23 26
Profit $2 $2
Machine hours p.u. 2 hrs 1 hr
Maximum demand 20,000 units 10,000 units
The total hours available are 48,000.
Calculate the optimum production plan and the maximum profit using conventional limiting
factor analysis.
Goldratt refers to Throughput as a key performance measure. The main concepts of throughput
accounting are given below.
๏ Throughput is the rate at which the system generates money. It is measured in monetary
terms and links directly to profitability therefore the objective is to maximise throughput
values or throughput flow.
๏ In the short run, ALL costs (except direct materials) are viewed as being fixed. This
includes LABOUR as Fixed cost. The sum of all these production costs including labour is
called TOTAL FACTORY COSTS.
๏ The constraint on production is referred to a Bottleneck.
๏ Throughput accounting can be used in a Just-in-time environment.
2019 Examinations Watch free CIMA P1 lectures 13
4. Key formulae:
The TPAR ratio should be greater than 1 for the product to be classed as financially viable.
Priority should be given to the products which generate the highest TA ratios.
Exercise 2
Pi plc manufactures 2 products, A and B.
The cost cards are as follows:
A B
Selling price 25 28
Materials 8 20
Labour 5 2
Other variable costs 7 2
Fixed costs 3 2
23 26
Profit $2 $2
Machine hours p.u. 2 hrs 1 hr
Maximum demand 20,000 units 10,000 units
The total hours available are 48,000.
(a) Calculate the optimum production plan and the maximum profit, on the assumption
that in the short-term only material costs are variable i.e. using a throughput
accounting approach
(b) Calculate and Interpret the Throughput Accounting ratios (TPAR ratios)
(c) Suggest some business strategic reasons why management might decide NOT to
withdraw an unprofitable product from sale.
2019 Examinations Watch free CIMA P1 lectures 15
Chapter 4
ENVIRONMENTAL MANAGEMENT
ACCOUNTING
1. Introduction
Environmental management accounting (EMA) seeks to ensure that companies are fully
accounting for the environmental costs of their actions. Greater awareness of environmental costs
will equip management to make more informed decisions – ultimately the aim being to improve
corporate environmental performance.
Modern businesses can no longer ignore environmental risks and the potentially negative
consequences that poor environmental behaviour can have on their long term success. These costs
have traditionally been underrepresented or ignored by conventional accounting practices.
Globally, the pressure relating to environmental impact has intensified and companies are facing
pressure from governments, pressure groups and consumers to demonstrate commitment to
responsible environmental practice.
In this chapter we will discuss the types of environmentally related costs faced by businesses, and
describe the different methods a business may use to account for these costs.
๏ Direct costs may increase as a result of wasteful resource utilisation and additional clean-up
costs.
๏ Revenue may suffer through reputational damage. Lost sales and potential customer
boycotts will have a negative impact on sales income.
๏ Financial stability can be threatened as brand values deteriorate, lending is curbed and
insurance cover may be withdrawn.
๏ Further failure costs can take the form of fines, penalties and potentially limitless law suit
costs.
2019 Examinations Watch free CIMA P1 lectures 16
However, when accounting for total corporate environmental costs this definition needs to be
widened to include other non-conventional or hidden/intangible environmental costs that
management should be made aware of.
Environmental accounting seeks to include and increase visibility of all relevant environmentally
related costs and costs savings so they can be fully accounted for within management decision
making.
For example:
Delivery and transport costs. By emphasising these costs, a business may seek to reduce this type
of expenditure and lower their impact on the environment. Distribution methods could be
redesigned and new policies enforced relating to staff travel.
Product design costs should be considered in an effort to reduce or avoid the future
environmental costs - e.g. through reducing the overall size/weight of the finished product there
should be a positive impact on packaging and distribution expenditure.
Other costs such as the measuring, controlling and reporting of environmental data such as
pollution levels.
2019 Examinations Watch free CIMA P1 lectures 17
Environmental Prevention Costs – This relates to expenditure paid to prevent or limit the effects
of adverse environmental impact from occurring.
Internal Failure Costs are those which are borne exclusively by the business to manage and limit
the impact of hazardous waste which has been produced.
External Failure Costs are costs which have been caused by company through actions such as
hazardous waste production but which were not managed or contained and so the costs have also
been borne by the wider society.
Environmental Costs here are categorised using the quality costing framework as seen
elsewhere in the syllabus.
Similar to quality expenditure, if sufficient investment is made in the areas of prevention and
appraisal – this can reduce the potentially limitless costs that can be associated with internal
and external environmental failure.
Successful environmental management is now seen as an integral part of Total Quality
Management (TQM) with global companies striving for continuous improvement and
benchmarking of best environmental practices.
Exercise 1
Suggest some key performance indicators (kpis) that could be used to measure the
environmental performance of a large supermarket chain.
2019 Examinations Watch free CIMA P1 lectures 18
Chapter 5
MODERN MANUFACTURING
ENVIRONMENT
1. Introduction
Some of the techniques we cover in P1 relate to traditional systems for example, marginal and
absorption costing – whereas others such as Throughput and ABC are designed for more modern
environments.
This chapter introduces some terms and concepts that relate to modern manufacturing. These
considerations should underpin any decisions you make as a management accountant.
2. Modern Manufacturing
The following aspects should help you to compare the modern manufacturing environment to
traditional manufacturing.
๏ Level of competition
๏ Distribution networks
๏ Impact of technology
๏ Consumer power.
๏ Globalisation
๏ Product Lifecycle
๏ Product diversity
๏ Quality requirements
Exercise 1
Can you recall the features of JIT, in terms of the following areas:
(a) Level of inventory holding
(b) Supplier relationships
(c) Maintenance of machinery
(d) Empowerment of workers.
(e) Pull production flow.
(f) Quality
Exercise 2
Note down the benefits and problems of JIT.
Benefits
Drawbacks
2019 Examinations Watch free CIMA P1 lectures 21
4. Quality.
Quality may mean different things to different people. – a dictionary definition, for example,
suggests the term ‘excellence’. However, a new way at looking at quality is to focus on the user.
In this respect, ‘user satisfaction’ and ‘fitness for use’ have become modern definitions for
quality.
Full dedication from senior management is crucial for this approach to be successful - this attitude
needs to filter down and be embraced by everybody working in or with the company.
๏ Standard costing focuses on traditional financial costs (material, labour etc) whereas
TQM recognises importance of quality costs
๏ In Standard costing systems performance is appraised in terms of output and the
quantity produced. TQM recognises that its not always important how many are produced but
how well these are produced. TQM focuses on quality not quantity.
๏ Standard costs are historic backward looking. For example, variances are calculated
after they have happened. TQM suits a changing environment with a culture that strives to
move forward & adapt. Standards can soon become out of date so critics argue that
benchmarking is a more forward-thinking performance measurement tool.
๏ Performance analysis is done periodically. A key principle of TQM is ‘continuous
improvement’. This involves looking forward and constantly evaluating- not just at set periods
throughout the year.
๏ Standard costing incorporates responsibility accounting, e.g., variances are assigned to
the department managers who are seen as accountable. In contrast –TQM believes everyone
is responsible. There is a shared understanding, a high level of employee involvement and a less
formal organisational structure.
๏ Standard costing & Variance analysis can be seen as assigning blame on individual
managers or departments. TQM focus is more positive, e.g., what can we do better – not who
did what wrong…
2019 Examinations Watch free CIMA P1 lectures 24
Exercise 3
It has been argued that some of the standard costing performance measures are irrelevant in a
TQM environment.
Explain why each variance below may not be relevant in a TQM environment.
(a) Labour efficiency variance
(b) Labour price variances…
(c) Material price variance
(d) Idle time variances
2019 Examinations Watch free CIMA P1 lectures 25
Chapter 6
LINEAR PROGRAMMING
1. Introduction
Previously we dealt with scenarios, which had ONE scarce resource –we approached these using
either limiting factor analysis or throughput accounting.
Linear programming is the method for use when there are TWO or more limiting factors.
2. Linear Programming
2.1. The steps are as follows:
(1) Define the variables
(2) Formulate an equation for the objective function
(3) Formulate equations for the constraints
(4) Graph the constraints, shade the feasible region and label its vertices
(5) Plot the iso contribution line and use it to find the optimum solution.
(6) Confirm solution with simultaneous equations.
Exercise 1
Peter makes two types of chair – the ‘Executive’ and the ‘Standard’.
The data relating to each as follows:
Standard Executive
Materials 2 kg 4 kg
Labour 5 hours 6 hours
Contribution $6 $9
There is a maximum of 80 kg of material available each week and 180 labour hours per week.
Demand for ‘Standard’ chairs is unlimited, but maximum weekly demand for ‘Executive’ chairs is 10.
Find the optimal production plan, which will maximise contribution and state the
contribution value that will be generated.
2019 Examinations Watch free CIMA P1 lectures 26
Despite this, you may find that the optimum solution does not fully utilise all of the resources
available.
If the optimum solution results in using less than the maximum available of a particular resource,
then we have spare capacity of that resource known as slack.
Exercise 2
Using the information from example 1, calculate the slack for each of the constraints i.e. for
materials, for labour, and for demand for ‘Executive’ chairs.
4. Shadow prices
In business, resource shortages can often be overcome through paying a premium to obtain
additional units of scarce resource.
For example – a shortage of labour hours can usually be resolved if overtime payments are offered.
The shadow price (also known as the dual price) of a limited resource is the additional that we
would be prepared to pay, over-and-above the current resource price per unit.
This value is equal to the extra profit that would result if one extra unit of the limited resource was
available.
NB) If there is slack in the resource, then shadow price is Nil – we would not pay any additional
amount for an extra unit – because we have spare capacity already.
Exercise 3
Using the information from example 1, calculate the shadow price of each of the constraints
i.e. for materials, for labour, and for demand for ‘Executive’ chairs.
2019 Examinations Watch free CIMA P1 lectures 27
Chapter 7
STANDARD COSTING AND BASIC
VARIANCE ANALYSIS
1. Introduction
In an earlier chapter we identified that budgeting as a means of controlling the organisation.
Through comparison of budgeted figures and actuals areas can be identified that may need
corrective action. Problems can be addressed in an attempt to control future outcomes.
In this chapter we will look at the setting of standard costs, which form the basis of budget figures.
This section also requires basic variance calculations and interpretations.
Please Note:
All basic variances (calculations and interpretations) are examinable under CIMA P1
syllabus. The formulae relating to these are not included in this chapter but you should be
familiar with these from previous studies.
Advanced variances are an extension of this topic and are dealt with in the next chapter.
2. Standard costs
A Standard cost is an estimated unit cost.
The standard cost for a product (or service) is determined in advance based on expected resource
usage using expected resource prices.
Standard costing systems use these predetermined values to estimate income and expenditure
under standard conditions.
It was developed primarily for manufacturing (but can be applied to services), and was designed for
environments where there is mass production of homogenous products
The standard costs form the basis of budget totals, which can then be compared to actuals as part
of the performance management process.
2019 Examinations Watch free CIMA P1 lectures 28
The standard cost card below shows the standard costs/ prices and usage / efficiency rates that
are expected to produce one unit of product X. Any deviations from these expected rates will result
in variances (adverse or favourable)
Illustration 1
Standard cost card for Product X
$ per unit
Sales price 100
Materials (2 kg @ $20/kg ) 40
Labour (1.5 hrs @ $2/hr ) 3
Variable o/h (1.5 hrs @ $6/hr) 9
Fixed o/h (1.5 hrs @ $10/hr) 15
Standard cost of production 67
Standard profit per unit 33
2.3. McDonaldisation
Through use of predetermined products and methods on a global scale - the restaurant chain is
described as achieving efficiency, calculability, predictability and control.
However, critics argue this occurs at the expense of individuality and that cost reduction takes
priority over other important factors such as employee motivation and consumer choice
๏ Basic standard
This is a long-term standards which remain unchanged over many years. Often they are
determined at the inception of a product.
It is only really of use to show trends or improvements over time.
They are not useful measures of current performance.
๏ Current standard
This is the current attainable standard which reflects conditions actually applying in the
period under review.
They are useful when operating under abnormal conditions – eg a period of hyper inflation.
They may reduce the drive for improvement because the standards reflect up-to-date cost
environment.
2019 Examinations Watch free CIMA P1 lectures 30
3. Variance analysis
In the chapter on budgeting, we looked at the comparison between the actual results for a
period and the flexed budget. The differences between the two are referred to as variances.
* Basic variance formulae should be knowledge brought forward from previous studies.
In this section we will repeat the exercise, and then analyse them into their different components. If
we are to investigate variances properly and use them for control, then it is important that we are
able to consider the reasons for their occurrence.
Exercise 1
A company has prepared the following standard cost card:
$ per unit
Materials (4 kg at $4.50 per kg) 18
Labour (5 hrs at $5 per hr) 25
Variable overheads (5 hrs at $2 per hr) 10
$53
Budgeted selling price $75 per unit, and the budgeted fixed overheads are $130,500
The total variance that we have calculated for materials indicates that the actual expenditure on
materials was not $18 per unit. However, this could be either because we used the wrong amount
of materials (which should have been 4 kg per unit) or that we paid the wrong price (which should
have been $4.50 per kg). More likely of course, it would be a combination of the two.
We will therefore analyse this and the other variances in as much detail as possible.
Exercise 2
Using the data from example 1, analyse the variances and use them to produce on Operating
Statement reconciling the budgeted profit with the actual profit.
Exercise 3
Using data from example 1
(a) prepare the original fixed budgets using absorption costing
(b) prepare an Operating Statement using a absorption costing approach
Exercise 4
In the previous example there was a materials price variance.
Suggest possible reasons for its occurrence.
2019 Examinations Watch free CIMA P1 lectures 32
2019 Examinations Watch free CIMA P1 lectures 33
Chapter 8
ADVANCED VARIANCES
1. Introduction
In this chapter we will look at variances in further detail. This builds on the techniques and
principles of basic variances (previous chapter).
Mix and Yield variances look at the effect of altering proportions of a standard mix. In this chapter,
we will apply the techniques to material mixes – however, you should be prepared to apply this to
other scenarios such as sales mix or labour mix.
Amongst the possible reasons for a variance – it may be that the factor driving it is uncontrollable
and/or external to the organisation.
For example, adverse material price variances would usually be seen as the responsibility of the
procurement department.
However, imagine that the increase in material costs, in this case, had been caused by a global price
rise due to scarcity. This factor is not in the control of the procurement manager.
With hindsight the original budget should’ve allowed for a higher material cost. As it stands, the
original budget is based on an incorrect/ outdated material standard cost.
By calculating planning variances, we are able to remove the effect of this incorrect standard so
we can focus on operational performance only.
It makes more sense to compare actual results with a revised budget, when the original budget
value is not valid.
The first step in these situations is to create a revised budget (sometimes called Ex post) which
will be based on the ‘revised or updated’ prices or efficiency rates.
2019 Examinations Watch free CIMA P1 lectures 34
to
To
Actual results.
Operational variances are of interest to management because they represent performance of the
business and factors influencing them should be controllable.
Exercise 1
Original budget:
Standard labour cost per unit of product is $7.
Each unit takes 0.5hours to produce at a labour rate of $14 per hour.
Budgeted production for January was 20,000 units
Actual results:
Production: 22,000 units
Actual labour worked were 11,400 hours at $15.50 per hour.
Since preparation of the budget the prevailing external labour rate has increased to $17.50
Calculate the labour rate planning variance and the labour rate operational variance.
2019 Examinations Watch free CIMA P1 lectures 35
Exercise 2
Original budget:
Budget production: 21,000 units
Standard Material cost per unit 3kg @$4 per kg
Actual results:
Production: 10,000 units
Materials: 33,000 kg for $4.20
A global shortage meant that the external price for this material was higher than budgeted and
should have been $5.20
Calculate the planning and operational material price variances.
For each of the materials we can calculate price and usage variances in the normal way, and usually
this is sufficient for our purpose.
However, suppose we were manufacturing a mixed fruit juice that contained a mixture of
strawberry juice and banana juice. To calculate usage variances for each material separately would
be of little use – if we used less strawberry juice than budgeted, we would automatically use more
banana juice. We would therefore end up with one variance favourable and one adverse, and yet
the overall effect on costs could be either favourable or adverse depending on which juice was the
most expensive.
In this situation, when the materials may be substituted for each other (or are substitutable) then
we look at all the materials together and analyse the usage variance into the following variances:
๏ Mix variance
this shows the effect on cost of changing the proportions of the mix of materials input into
the process
๏ Yield variance
This shows the difference between the actual and expected output or yield from the process
2019 Examinations Watch free CIMA P1 lectures 36
Exercise 3
The standard material cost per unit of a product is as follows:
$
Material X 2 kg @ $3 per kg 6
Material Y 1 kg @ $2 per kg 2
8
The actual production during the period was 5,000 units and the materials used were:
Material X 9,900 kg costing $27,000
Material Y 5,300 kg costing $11,000
Calculate the total materials cost variance; the materials price variance; the materials usage
variance; the mix variance; and the yield variance.
Slightly less obvious (although essentially the same approach) is the situation where sales are
‘substitutable’.
For example, suppose a company sold two types of desk which although similar had different profit
margins. Clearly the company would hope for higher sales, but they would also be interested in the
mix of sales – it would be better if customers bought more of the desks giving higher profit p.u.,
even if it were to mean selling fewer of the desks that gave lower profit p.u..
Again, in this situation, the approach used for materials may be useful.
2019 Examinations Watch free CIMA P1 lectures 37
Exercise 4
Olga plc sells three products – A, B and C.
The following table shows the budget and actual results for these products:
A B C
Budget:
Sales (units) 200 100 100
Price (p.u.) $20 $25 $30
Cost (p.u.) $17 $21 $24
Actual:
Sales (units) 180 150 170
Price (p.u.) $22 $22 $26
Cost (p.u.) $16 $18 $25
Calculate the total sales margin variance, and analyse into the sales price variance; the sales
mix variance; and the sales quantity variance.
The main reason for doing this was not just to encourage cutting the total cost of the overhead, but
also to encourage more efficient use of the overhead.
For example, we may have had an overhead cost for despatch of $100,000 and a total of 5,000
despatches. This would mean that it was costing $20 per despatch. We could reduce the cost per
despatch by either cutting the total cost (an expenditure variance) or by increasing the number of
despatches (an efficiency variance).
Exercise 5
The following information is available for a period:
Budget Actual
Production 48,000 units 50,400 units
Activity level 2,000 dispatches 2,200 dispatches
Total overhead cost of dispatching $120,000 $126,720
Calculate the total overhead variance for despatching, and analyse into the expenditure and
efficiency variances.
2019 Examinations Watch free CIMA P1 lectures 38
2019 Examinations Watch free CIMA P1 lectures 39
Chapter 9
BUDGETING
1. Introduction
Budgeting is core to management accountancy and represents a method with which to plan,
control and evaluate performance of an organisation. This syllabus area links to standard costing,
variance analysis and forecasting.
Students need to be able to explain the purposes of budgeting and discuss the different budgeting
methods and their suitability to a particular scenario. Calculations of key budget figures are
expected- as is knowledge of the usefulness of budgets as a control mechanism.
2. Budgeting Objectives
๏ Planning
๏ Communication
๏ Coordination
๏ Motivation
๏ Authorisation / Delegation
๏ Control
๏ Evaluation of performance
Exercise 1
Consider budgets you may have experienced in your workplace or elsewhere. How successful were
they at fulfilling the objectives above?
(a) Suggest how a budget might be used as a motivational tool.
(b) To what extend does a budget enable the communication of business objectives and
future plans to others in the company?
2019 Examinations Watch free CIMA P1 lectures 40
However, it could be (for example) a limit on the availability of raw materials that limits activity. In
this case Raw Materials would be the principal budget factor, and this would the first budget to be
prepared.
Sales Budget
Production Budget
Budgeted Income
Statement
Capital expenditure
Cash Budget
budget
Budgeted Statement of
Financial Position
2019 Examinations Watch free CIMA P1 lectures 41
Exercise 2
The XYZ company produces three products, X, Y, and Z. For the coming accounting period budgets
are to be prepared using the following information:
Budgeted sales
Product X 2000 units at $100 each
Product Y 4000 units at $130 each
Product Z 3000 units at $150 each
Labour
X Y Z
Standard hours per unit 4 6 8
Labour is paid at the rate of $3 per hour
๏ Fixed Budget
๏ Flexed Budget
๏ Rolling Budget
๏ Feedback Control
Explain how the above could be used in the planning, control and performance evaluation of an
organisation?
Exercise 3
A company has prepared the following fixed budget for the coming year.
Sales 10,000 units
Production 10,000 units
$
Direct materials 50,000
Direct labour 25,000
Variable overheads 12,500
Fixed overheads 10,000
$97,500
$
Direct materials 60,000
Direct labour 28,500
Variable overheads 15,000
Fixed overheads 11,000
$114,500
6. Budget Styles
๏ Top – Down (Non-participatory) – This type of budget is created and executive by senior
management. The targets set are communicated to various department managers and
imposed onto the organisation.
๏ Bottom Up (participatory) – In contrast to the above, Bottom up/ participatory budgeting
shares the decision making and control across the organisation. Middle managers and
other key staff are invited to discuss and plan targets before they are set. This consultation
process can result in more realistic budgets as well as improving the morale of the staff
involved.
Exercise 4
How are department managers likely to feel when budget figures are imposed rather than
agreed with them?
Can you suggest any arguments in favour of Top- Down Budgeting (or any problems that may arise
with Bottom Up Budget approach)?
Using your answers for part (b) -suggest circumstances when a Top-Down approach might be the
best method to follow?
2019 Examinations Watch free CIMA P1 lectures 44
7. Methods of budgeting
๏ Incremental budgeting
This approach uses prior period figures and adjusts them by an amount to cover inflation and
any other known changes.
It is the most common approach, it is reasonably quick and for stable companies it tends to
be fairly accurate.
However, one potential problem is that it can encourage errors and past inefficiencies to be
carried forward.
Incremental planning does not encourage the company to consider new ways of operating
the business. Wasteful expenditure is not questioned each year because the budgeting
process incorporates and carries this forward to next period.
For example, if we require a wages budget, we will probably ask the wages department to
produce it and they (using an incremental approach) will assume that our workers will
continue to operate as before. They will therefore simply adjust by any expected wage
increases.
As a result, the ‘plan’ for our workers stays the same as before. Nobody has been encouraged
to consider different ways of operating that may be more efficient.
7.2. Suitability
Based on your assessment of budget methods above– Comment on their suitability for different
scenarios.
Factors you might consider – Size of business, management expertise, culture, skills and attitudes,
time available, business objectives, economic climate, the type of business (manufacturing, service
industry, not for profit) etc.
2019 Examinations Watch free CIMA P1 lectures 46
2019 Examinations Watch free CIMA P1 lectures 47
Chapter 10
FORECASTING TECHNIQUES
1. Introduction
This chapter demonstrates some of the key mathematical techniques, which can be used to
prepare financial forecasts.
These are:
You are expected to be able to calculate and interpret results for all methods.
Many costs are ‘semi-variable’ and have a fixed AND a variable element.
A typical example of a semi variable cost would be a telephone bill where the customer’s total bill
comprises of a fixed monthly line rental and the cost of telephone calls on top.
The line rental is fixed and does not change throughout the period. It is known in advance and
does not change regardless of how many telephone calls are made.
The cost relating to telephone calls is classed as variable because it is determined by the usage in
the period. (i.e. it is volume driven and increases in a linear fashion)
As a management accountant, you will need to obtain accurate cost information to provide a
reliable basis for budgets and forecasts.
In addition to statutory and reporting requirements- better costing information supports better
planning as well as better decision making in areas such as product pricing.
2019 Examinations Watch free CIMA P1 lectures 48
A graph of total costs, in relation to output could look something like this:
Individually, the costs are unlikely to be useful in determining which element is fixed and which
variable.
However, our techniques of High-low and Regression analysis enable us to use this data as a basis
for estimating costs and identifying their variable and fixed elements.
2019 Examinations Watch free CIMA P1 lectures 49
3. High-low method
The high-low method is a very quick and simple approach to identifying the variable and fixed
elements of semi variable cost.
This approach assumes a linear relationship and uses the highest and lowest data points taken
from a normal range of business activity.
Once identified – the highest and lowest activity levels and the associated total cost for each, can
be input into the following formula to obtain variable cost per unit.
Substituting total variable cost back into the total cost figures can then identify the fixed cost
element.
NB) Total Variable Cost = Variable cost per unit x Number of Units
Exercise 1
The following table shows the total costs recorded at different activity levels during the year
Output Total Cost
(units) ($)
100 40,000
400 65,000
200 45,000
700 85,000
600 70,000
500 70,000
300 50,000
Use the High-low technique to estimate variable cost per unit and fixed cost per month.
NB) It is important that data selected is representative of normal business activity. Any anomalies or
one-off occurrences that could distort the results should be removed.
2019 Examinations Watch free CIMA P1 lectures 50
4. Regression Analysis
Also known as ‘least squares’ method, this technique is also appropriate for use when costs are
believed to follow a linear relationship.
Similar to High-low method, regression analysis can be used to separate semi-variable costs into
their fixed and variable elements.
However, instead of using just two extreme points, highest and lowest, as our method previously,
this superior technique allows you to incorporate all of the data sets into your computation and
thus provides an estimate of variable and fixed costs that is based on a greater amount of historic
information.
Effectively, this recreates a line of best fit through the scattered data points.
The equation of a line and the formula needed to find ‘a’ and ‘b’ are given below:
y = a + bx
n∑ xy − ∑ x ∑ y
∑ y − b∑ x
n∑ x 2 − (∑ x )
2
n n
The method is far simpler than the formula appears and involves a logical process (see lecture).
* CIMA have confirmed that this formulae is examinable and will not be provided in the
objective test examinations.
2019 Examinations Watch free CIMA P1 lectures 51
Exercise 2
The following table shows the number of units produced each month and the total cost incurred:
Note – this will give you a slightly different answer to the high-low technique. This is because both
provide approximations only.
Once a linear expression for the data has been obtained – we are able to use this to estimate or
predict total costs ‘y’ for any given activity level x.
However, forecasting beyond the data range or applying to scenarios, which are based on different
circumstances, should be avoided.
Exercise 3
Calculate the estimated total cost for the above scenario if the forecast output level is
expected to be 650 units.
2019 Examinations Watch free CIMA P1 lectures 52
You are NOT required calculate or remember the formula for Pearson’s correlation coefficient for
CIMA P1 however you must be able to show an understanding of the results.
n∑ xy − ∑ x ∑ y
Correlation Coefficient r =
( n∑ x 2 − ( ∑ x ) )( n ∑ y − ( ∑ y ) )
2
2
2
The formula is applied to the historic data as before and can be used to determine how linear the
relationship between variables is.
The result should fall within the range of -1 to + 1 and can be interpreted as follows:
r=1 the data variables X and Y display a perfect positive linear correlation (ie costs Y
are increasing directly with output X.)
r = -1 the variables display a perfect negative linear correlation (in this case Y will
decrease for each increase in X)
Eg. If correlation coefficient r = 0.91 (close to +1) then this tells us that the two variables ( for
example, cost and output, appear to have a very strong positive linear correlation – based on the
data observations selected.
Exercise 4
Our techniques can be applied to scenarios outside management accounting.
State what type of correlation you would expect to find in examples below: i.e. positive,
negative or no correlation.
(a) Number of hours spent studying and likely exam score.
(b) Number of pages printed and ink levels in a printer.
(c) Shoe size and level of disposable income .
As before – these patterns may not be exhibited by each individual value within the data but
instead become apparent when looking a general movements across a period of time.
Histogram is a graph of time series data. Where X axis displays time period –e.g. years,
quarters, months.
You will not be required to calculate the cyclical or random components in CIMA P1
exam questions
๏ Additive model - assumes that all components are independent of each other.
TS = T + SV + C + R
๏ Multiplicative model is better for use when components are moving in line with trend (eg
seasonal variations appear to be increasing as level of trend rises).
TS = T x SV x C x R
Regression analysis can be used to estimate a trend line for a time series. The X variables in the
regression formulae will be represented by time – with period one being the first data observed.
This line can then be used as a forecasting tool.
2019 Examinations Watch free CIMA P1 lectures 54
In order to distinguish the trend from the seasonal variations, we use the method of moving
averages. This is a smoothing technique intended to reveal underlying data trends and cancel the
effect of random fluctuations.
Exercise 5
Set out below are the sales per quarter (in 000’s of units) of a company over the last 3 years.
Quarter
1 2 3 4
2000 80 87 82 90
2001 90 95 93 102
2002 105 112 103 116
Identify the trend and calculate the average seasonal variation.
In the previous example we calculated the seasonal variations using the additive model.
However, if the trend is increasing it would perhaps be more sensible to accept an increasing
seasonal variation.
The multiplicative model deals with this by measuring the seasonal variation as actual as a
percentage of trend.
Exercise 6
Using the data from example 5 together with the trend already calculated, calculate the
average seasonal variation using the multiplicative model.
6. Forecasting Considerations
Exercise 7
Discuss below the limitations of using past data as a prediction of future results.
2019 Examinations Watch free CIMA P1 lectures 55
Chapter 11
RISK AND UNCERTAINTY
It lends itself well to objective type questions and will provide the basis for further techniques
introduced in CIMA P2 and P3.
1. Introduction
Business decision-making often requires choices to be made now about future outcomes, which
are unlikely to be known with certainty.
Key decisions such as new product launches, capital investments and other opportunities are
usually made without guarantee of future results.
Risk exists where the actual outcomes of a decision may not be in line with the forecasted or
expected outcomes. This will mean that results will be different than planned or hoped for.
2. Risk vs Uncertainty
The terms risk and uncertainty are often used interchangeably but there is a technical difference:
Risk differs from uncertainty in that risk can be quantified. For example – we do not know what the
result will be from a roll of a dice – but we do know it can only be one of six possible outcomes.
Uncertainty exists when there are no such ‘well defined’ possible outcomes. The outcomes are not
known or quantifiable in the same way as risk. This means probabilities cannot be used as a basis
for predictions.
3. Risk profiles
The approach taken to decision- making may be influenced by the decision-makers attitude to risk.
A risk seeker will be interested in the best possible outcome, no matter how small the chance that
they may occur. This is described as an optimistic attitude, which may be considered reckless if
likelihood of outcomes are ignored.
Someone who is risk neutral will be concerned with the most likely or ‘average’ outcome.
A risk averse decision maker is pessimistic and selects options on the basis of the worst outcomes
occurring.
2019 Examinations Watch free CIMA P1 lectures 56
๏ Expected values
๏ Decision Rules (Maximax, maximin, minimax regret)
๏ Decision Trees
๏ Sensitivity Analysis
๏ Standard deviation
5. Expected Values
Expected Values can be obtained when in situations which have various possible outcomes for
which the probabilities of each are known.
The expected value represents a long run average result that the decision maker could expect if the
event were repeated numerous times.
EV = Σpx
Exercise 1
The outcome of a new venture has been forecast below.
Probability of $50,000 profit = 0.3
Probability of ($20,000) loss = 0.7
What is the expected value of this project?
Should the decision maker go ahead with the venture?
Expected value method is often the approach of a risk neutral decision maker. However there are
some serious limitations of this method.
2019 Examinations Watch free CIMA P1 lectures 57
6. Decision Rules
Given a range of possible outcomes (usually profits or payoffs) examination questions may ask you
to identify the decision that would be chosen by the decision making criterion below.
๏ Maximax – represents the choice of an optimist who will prefer the option
that results in the best possible returns regardless of likelihood.
๏ Maximin – this pessimistic decision maker considers the worst result of all
available options and seeks to minimise this. Therefore maximin
option will choose the option that gives the best of the worst
outcomes.
๏ Minimax Regret – this represents the choice of a ‘sore loser’. They seek to minimise
the maximum possible ‘regret’ from all the options available.
Exercise 2
John has a factory capacity of 1,200 units per month.
Units cost him $6 each to make and his normal selling price is $11 each. However, the demand per
month is uncertain and is as follows:
Demand Probability
400 0.2
500 0.3
700 0.4
900 0.1
He has been approached by a customer who is prepared to contract to a fixed quantity per month
at a price of $9 per unit. The customer is prepared to sign a contract to purchase 300, 500, 700 or
800 units per month.
The company can vary production levels during the month up to the maximum capacity, but
cannot carry forward any unsold units in inventory.
(a) Calculate all possible profits that could result from the various demand levels.
(b) Determine for what quantity John should sign the contract, under each of the following
criteria:
i) expected value
ii) maximin
iii) maximax
iv) minimax regret
(c) What is the most that John would be prepared to pay in order to obtain perfect
knowledge as to the level of demand?
2019 Examinations Watch free CIMA P1 lectures 58
7. Decision Trees
A decision tree is a diagrammatical representation of the various alternatives and outcomes. It is
relevant when using an expected value approach and where there are several decisions to be made
– it makes the options more understandable.
Exercise 3
Combi plc are having problems with one of their offices and have decided that there are three
courses of action available to them:
(a) shut down the office, raising proceeds of $5 million
(b) have an expensive refurbishment of the office costing $4,000,000
(c) have a cheaper refurbishment of the office at a cost of $2,000,000
If they do the expensive refurbishment, then a good result will yield a return of $13,500,000
whereas a poor result will yield a return of only $6,500,000.
If they alternatively decide to do the cheaper refurbishment, then a good result will yield a return of
$8,500,000 whereas a poor result will yield $4,000,000.
In either case, the probability of the refurbishment achieving a good result has been estimated to
be 2/3.
An independent company has offered to undertake market research for them in order to identify in
advance whether the result of refurbishment is likely to be good or poor. The research will cost
$200,000 and there is a 68% probability that it will indicate a good result.
Unfortunately, the research cannot be guaranteed to be accurate. However, if the research
indicates a good result, then the probability of the actual result being good is 91%.
If the survey indicates a poor result, then the probability of the actual result being good is 13%.
Combi have already decided that if they do have market research, and if the research indicates a
poor result, then they will only be prepared to consider the cheaper refurbishment.
Use a decision tree to recommend what actions should be taken.
Note: In this example, the market research is not guaranteed to be accurate. This is likely to be
the case in real life and is an example of imperfect knowledge
2019 Examinations Watch free CIMA P1 lectures 59
8. Sensitivity Analysis
Sensitivity analysis can be useful to appraise a decision, where the outcome is dependent on a
number of uncertain input variables.
For example, a decision to launch a new product is likely to be based on estimated demand levels,
estimated selling price, estimated variable costs etc.
Sensitivity analyses the effect of changes made to each variable, in order to determine their effect
on the decision.
By considering the sensitivity of each input variable we can ascertain which variables are the most
critical and therefore perhaps need more work confirming our estimates.
Exercise 4
Harry is about to considering a new business opportunity.
Based on his current estimations – the opportunity looks profitable.
His forecasted sales revenue is $30,000 per year – based on 1000 units sold.
His accountant has helped him to estimate fixed costs of 15,000 p.a.
The variable costs per unit are likely to be $10 per unit.
(a) Confirm, on the basis of the above figures, that the new opportunity is worthwhile
(b) Calculate the sensitivity to change of:
i. Sales Revenue (selling price)
ii. Sales volume
iii. Total variable costs
iv. Fixed costs
(c) Comment on the results
2019 Examinations Watch free CIMA P1 lectures 60
9. Standard Deviation.
When dealing with average outcomes – such as expected values – it can be useful to have an
indication of ‘dispersion’. That being the difference between individual values within a sample
from their ‘mean’ average.
The higher the standard deviation – the more spread out the individual values will be from their
mean. High standard deviation therefore represents high risk.
For example – project A and project B both have an expected value of $40,000.
This means that project A’s profits are within ±$2000 of $40,000. Whereas Project B profits have a
difference of ±$6500 from $40,000.
∑(X–X) p
2
SD=
When calculating standard deviation where expected value is X – the method follows a columnar
format.
Exercise 5
The following are likely returns from project Z.
Return Probability
10% 0.2
15% 0.5
20% 0.3
Calculate the expected value and the standard deviation for project Z.
What is the co-efficient of variation in this case?
Standard Deviation
NB) Coefficient of variation =
MEAN
2019 Examinations Watch free CIMA P1 lectures 61
Chapter 12
RELEVANT COSTING
1. Introduction
A key part of business is decision making. This involves selecting a course of action NOW that will
affect the future.
Relevant costing is a method that is used for long term and short term decisions.
Short-term decisions concern how to make the best use of resources in the short term- they are
operational or tactical in nature. Short-term decisions are usually concern relatively low values, are
likely to be repeatable/ reversible and individually are not expected to have much impact on the
business long term.
For short term decisions we can ignore the time value of money.
Typical examples involve make-or-buy, contract pricing, acceptance of one-off orders and shut
down decisions.
2. Relevant Costing
Relevant costs refer to costs which are directly incurred (or saved) by the decision being made.
An exception to this is Opportunity costs which is the value of the next best alternative, that must
be sacrificed in order to pursue the current course of action.
Opportunity costs can only apply to limited or finite resources- otherwise no sacrifice results from
using them.
Example:
The cost of contribution lost from transferring key workers to focus on a new project would be a
relevant cost for the new project.
2019 Examinations Watch free CIMA P1 lectures 62
Always read the particulars of the question – but in general the following costs are not relevant for
decision making.
Sunk costs – These are costs, which have already been paid. Therefore they will not change as a
result of a decision and therefore are not relevant when evaluating the costs of a decision. An
example may be costs of research relating to a new product – these should not be allowed to
influence the decision to go ahead with the product because those costs have been already paid
and not change
Committed Costs – these type of costs must be paid regardless of the decision. They are usually
ongoing commitments – possibly lease or rental agreements that must be honoured by the
business in the short term.
Book Values or historic costs these costs are usually irrelevant to a decision because they are out
of date and are not a consequence of a decision being taken now.
Non- monetary costs – these are accounting valuations and estimates such as depreciation and
amortisation – these are not cash flows, so are seen as irrelevant for decision making.
Exercise 1
Identify the relevant costs from scenarios below:
(1) Your research team have spent $50,000 researching project Q during 2X14? ( Relevant / Non-
relevant)
(2) The production manager currently earns a salary of $20,000p.a. Your new project will incur
approximately $5000 p.a of overtime from him which means his salary is expected to be
$25,000 for the duration of the project. (Which is relevant cost for project here? $20,000 or
$5000 or $25,000)
(3) A decision to manufacture a new product is expected to increase fixed costs by $3000 per
month. ( Relevant / Non-relevant)
2019 Examinations Watch free CIMA P1 lectures 63
This is not a topic for which you can really learn rules. The main thing is to understand the thought
process involved and then to read questions very carefully and to state the assumptions you have
made where relevant.
Exercise 2
The managing director of Parser Ltd, a small business, is considering undertaking a one-off contract
and has asked her inexperienced accountant to advise on what costs are likely to be incurred so
that she can price at a profit. The following schedule has been prepared:
Costs for special order:
Notes $
Direct wages 1 28,500
Supervisor costs 2 11,500
General overheads 3 4,000
Machine depreciation 4 2,300
Machine overheads 5 18,000
Materials 6 34,000
98,300
Notes:
(1) Direct wages comprise the wages of two employees, particularly skilled in the labour process
for this job, who could be transferred from another department to undertake work on the
special order. They are fully occupied in their usual department and sub-contracting staff
would have to be bought-in to undertake the work left behind. Subcontracting costs would
be $32,000 for the period of the work. Different subcontractors who are skilled in the special
order techniques are available to work on the special order and their costs would amount to
$31,300.
(2) A supervisor would have to work on the special order. The cost of $11,500 is comprised of
$8,000 normal payments plus $3,500 additional bonus for working on the special order.
Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor would
lose incentive payments in his normal work amounting to $2,500. It is not anticipated that
any replacement costs relating to the supervisor’s work on other jobs would arise.
(3) General overheads comprise an apportionment of $3,000 plus an estimate of $1,000
incremental overheads.
(4) Machine depreciation represents the normal period cost based on the duration of the
contract. It is anticipated that $500 will be incurred in additional machine maintenance costs.
(5) Machine overheads (for running costs such as electricity) are charged at $3 per hour. It is
estimated that 6000 hours will be needed for the special order. The machine has 4000 hours
available capacity. The further 2000 hours required will mean an existing job is taken off the
machine resulting in a lost contribution of $2 per hour.
2019 Examinations Watch free CIMA P1 lectures 64
(6) Materials represent the purchase costs of 7,500 kg bought some time ago. The materials are
no longer used and are unlikely to be wanted in the future except on the special order. The
complete inventory of materials (amounting to 10,000 kg), or part thereof, could be sold for
$4.20 per kg. The replacement cost of material used would be $33,375.
Because the business does not have adequate funds to finance the special order, a bank overdraft
amounting to $20,000 would be required for the project duration of three months. The overdraft
would be repaid at the end of the period. The bank’s overdraft rate is 18%.
The managing director has heard that, for special orders such as this, relevant costing should be
used that also incorporates opportunity costs. She has approached you to create a revised costing
schedule based on relevant costing principles.
Adjust the schedule prepared by the accountant to a relevant cost basis, incorporating
appropriate opportunity costs.
5. Shutdown problems
This sort of question is asking for a decision as to whether or not to close part of the business.
Exercise 3
(a) A company manufactures three products, Pawns, Rooks and Bishops. The present net annual
income from these is as follows:
The company is considering whether or not to cease selling Rooks. It is felt that selling prices
cannot be raised or lowered without adversely affecting net income. $5,000 of the fixed costs
of Rooks are direct fixed costs which would be saved if production ceased. All other fixed
costs would remain the same.
(b) Suppose, however, that it were possible to use the resources released by stopping production
of Rooks to produce a new item, Crowners, which would sell for $50,000 and incur variable
costs of $30,000 and extra direct fixed costs of $6,000.
Consider whether the company should cease production and sale of Rooks under each of the
scenarios in (a) and (b) above.
2019 Examinations Watch free CIMA P1 lectures 65
Where incremental costs of manufacture are less than those of buying in, the firm should make –
assuming that there are not limited resources.
Where resources are limited, the firm should concentrate on making those products which give the
greatest saving (over buying in) per unit of the scarce resource.
To decide which products should be made and which should be bought, we calculate the saving
per unit of scarce resource from making the product rather than buying it in.
Exercise 4
The availability of Material B is limited to 8,000 kg
Product X Y Z
Demand (units) 2,000 2,500 4,000
Variable cost to make ($ per unit) 10 12 14
Buy-in price ($ per unit) 13 17 16
Kg of B required per unit 3 2 1
(included in variable cost)
Which products should the company make and which should it buy?
2019 Examinations Watch free CIMA P1 lectures 66
2019 Examinations Watch free CIMA P1 lectures 67
Chapter 13
COST VOLUME PROFIT ANALYSIS
1. Introduction
You are likely to be familiar with elements of CVP analysis from your previous studies. CIMA P1
syllabus advances this knowledge by requiring application of breakeven techniques to more
complex decision making scenarios. You will need to become familiar with Profit Volume (P/V)
analysis – and the calculation of breakeven point in a multi-product environment.
Cost-volume-profit analysis considers the relationship between costs (fixed and variable), sales
volume and levels of profit.
The techniques of CVP analysis are used in breakeven calculations, contribution/ sales ratio
analysis and can be applied to indicate the level of sales necessary to make a desired profit (target
profit) or the amount by which sales can fall before the product is loss making (margin of safety).
2. Breakeven
Breakeven point represents the minimum level of sales (revenue or volume) needed to cover total
costs (fixed and variable). At breakeven point, profit is equal to zero because our total sales income
is equal to total expenditure.
Exercise 1
Product X has variable costs of $2 per unit, and selling price of $6 per unit.
The fixed costs are $1,000 per year
(a) Use the above information to calculate budgeted sales revenue and budgeted costs
when planned production is 300 units per year. What is budgeted profit (or loss) at this
level?
(b) What is the breakeven point (in units)?
(c) What is C/S ratio of this product – explain the meaning?
(d) What is the breakeven revenue ($) ?
4. Margin of safety
The Margin of Safety measures the difference between budgeted sales and breakeven sales.
It can be expressed as percentage and shows the fall in budgeted sales that can be tolerated before
breakeven point is reached. This is a key measure of risk because management know that any fall
beyond breakeven point means the product will become loss making.
Exercise 2
Calculate the margin of safety % for example 1
5. Target Profit
Breakeven calculations will often ask for level of sales that is necessary to earn a target profit figure.
Exercise 3
Using example 1, calculate the sales revenue needed to generate a target profit of $320?
2019 Examinations Watch free CIMA P1 lectures 69
6. Breakeven chart
Breakeven point can be displayed and solved graphically.
Exercise 4
Draw a breakeven chart for example 1
Cost and
revenue
($)
Output (units)
7. Profit-volume chart
The profit volume chart shows the profit or loss at any level of activity. Intuitively, the greatest loss
will occur when no sales are made (sales = zero). This loss will be equal to the fixed costs. The point
will be the vertical intercept and is the starting point when creating this graph.
Exercise 5
Draw a profit-volume chart for example 1
Profit ($)
Sales units)
Loss ($)
2019 Examinations Watch free CIMA P1 lectures 70
Management are still likely to be interested in the break-even sales revenue (in order to cover the
fixed overheads), but the existence of several products makes it less certain and this is approach
through an assumption that products will be sold in a predetermined ‘budgeted’ sales mix.
The mix may be obtained from scenario’s forecast sales volumes or from indicated ratios or
percentages.
A weighted average c/s ratio is the quickest way to find the breakeven sales values for a
multiproduct scenario.
Fixed Costs
Breakeven Sales Revenue =
Weighted average C/S ratio
Exercise 6
A company produces and sells three products: C, V and P.
The budget information for the coming year is as follows:
C V P
Sales (units) 4,800 4,800 12,000
Selling price (p.u.) $5 $6 $7
Variable cost (p.u.) $3.75 $5.25 $4.35
Contribution (p.u.) $1.25 $0.75 $2.65
The total budgeted fixed overheads for the year are $8,000
(a) Calculate the CS ratio for each product individually
(b) Calculate the weighted average CS ratio (assuming that the budgeted product mix
remains unchanged)
(c) Calculate the breakeven revenue (assuming that the budgeted product mix remains
unchanged)
(d) Construct a PV chart (assuming that the budgeted product mix remains unchanged)
(e) Assume that the products are sold in order of their CS ratios, construct a table showing
the cumulative revenue and cumulative profits associated with this selling order.
(f) Add the information to the P/V chart already produced for Exercise 6 and calculate the
breakeven sales revenue on this basis
2019 Examinations Watch free CIMA P1 lectures 71
๏ The selling price per unit is assumed to remain constant at all levels of activity
๏ The variable cost per unit is assumed to remain constant at all levels of activity.
๏ It is assumed that the total fixed costs do not change across all levels of production.
๏ It is assumed that the production volume is equal to sales volume in the period (i.e. there are
no changes in the levels of inventory)
๏ It requires the budgeted product mix proportions to be known in advance and remain
unchanged.
2019 Examinations Watch free CIMA P1 lectures 72
2019 Examinations Watch free CIMA P1 lectures 73
ANSWERS TO EXAMPLES
Chapter 1
Exercise 1
Reasons why a cost per unit is required:
๏ To value inventory (SFP)
๏ To calculate cost of sales for income statement.
๏ To determine a selling price.
๏ To plan and make decisions (budgeting, forecasting)
๏ To determine the impact of management decisions on costs i.e. evaluation of a cost savings
or change in cost due to a new supplier etc.
๏ To measure performance- eg using key ratios and variance analysis.
Exercise 2
Production units > Sales units (inventory has increased).
SIAM helps us to remember when stocks increase absorption costing profit will be higher.
Absorption costing profit will be $45,000 higher than the marginal costing profit reported for that
period.
NB) The inclusion of selling price, variable cost etc are distracters and not needed to solve this
problem.
Fixed production cost per unit is another name for Overhead Absorption Rate (OAR).
Chapter 2
Exercise 1
Cost cards:
A B C
Materials 5 10 10
Labour 10 5 5
Overheads (at $2.84 per hr) 5.68 2.84 2.84
20.68 17.84 17.84
Selling price 20 20 20
Profit / Loss $(0.68) $2.16 $2.16
(b) Total A B C
Set-up costs
(Cost per set up = ) 90,000 36,000 46,800 7,200
Receiving
(Cost per delivery = ) 30,000 13,636 13,636 2,728
Despatch
(Cost per order = ) 15,000 5,000 5,000 5.000
Machining
(Cost per machine hour: ) 55,000 23,404 29,256 2,340
190,00
0 78,040 94,692 17,268
Number of units 20,000 25,000 2,000
Overheads p.u. $3.90 $3.79 $8.63
Costings:
A B C
Materials 5 10 10
Labour 10 5 5
Overheads 3.90 3.79 8.63
18.90 18.79 23.63
Selling price 20 20 20
Profit / Loss $1.10 $1.21 $(3.63)
Exercise 2
Better costing information can be used to reduce and control costs more effectively.
Chapter 3
Exercise 1
A B
Selling price 25 28
Materials 8 20
Other variable 12 4
20 24
Contribution p.u. 5 4
Machine hrs p.u. 2 1
Production
units hours
B: 10,000 × 1 hr = 10,000
A: 19,000 × 2hrs = 38,000
48,000hours
Profit
$
A: 19,000 × $5 95,000
B: 10,000 × $4 40,000
135,000
less Fixed costs:
[A: 20,000 × $3
B: 10,000 × $2] 80,000
Profit $55,000
Exercise 2
(a) A B
Selling price 25 28
Materials 8 20
Throughput p.u. $17 $8
Machine hrs p.u. 2 1
Production Plan
units hours
A: 20,000 × 2hrs = 40,000
B: 8,000 × 1hr = 8,000
48,000 hours
Profit
$
A: 20,000 × $17 340,000
B: 8,000 × $8 64,000
404,000
less “fixed” costs:
[A: 20,000 × $15
B: 10,000 × $6] 360,000
Profit $44,000
360,000
Cost per factory hour = = $7.50
$48,000
(b) Throughput accounting ratios:
8.50
A: = 1.13
7.50
8
B: = 1.07
7.50
Interpretation: Both products have a TPAR greater than 1 which means they are both
financially viable products (they return more per hour than the factory cost per hour)
However, Product A is more profitable than product B – which is why the production plan we
created prioritised resources to producing all of product A first.
(c) Management should always consider other business strategic factors before withdrawing a
product from sale. For example, product may be a vital part of the range that customers value.
Alternatively, sale price may be deliberately low due to pricing strategies such as introductory
pricing, loss leadership or a price penetration policy.
2019 Examinations Watch free CIMA P1 lectures 77
Chapter 4
Exercise 1
Suitable KPIs for a supermarket aiming to monitor their environmental performance could be as
follows:
Chapter 5
Exercise 1
(1) Level of inventory holding - Ideally inventory holding will be nil for Just in time systems.
Parts arrive just in time to be included in the production item so that many of the risks of
holding inventory (tied up cash, storage space and obsolescence) can be avoided.
(2) Supplier relationships – Suppliers become strategic partners – they need to be reliable and
able to consistently deliver small quantities exactly when required. The supplies need to
arrive quickly and be defect free - there is no allowance in JIT time frame for rejects and
reworks.
(3) Maintenance of machinery - The tight schedule of JIT production can not allow time to be
wasted through faulty machines or mechanical breakdown – therefore a proactive system of
preventative maintenance will be in place
(4) Empowerment of workers – workers are treated with full respect and trust - their ideas are
listened to and anyone on the production line has the ability to stop production if required.
They are often multi-skilled and can work cross functions
(5) Pull production flow. Factory layout is designed to minimise flow time between processes.
Because it is a Pull system – the customers orders act like a signal for production to begin.
(6) Quality There is a commitment to quality in JIT manufacturing - this links with TQM – there is
no time available for reworks or faulty products. The belief is in continuous improvement – a
company who is striving to get better.
Other features of JIT include zero waste, lean production methods, visual control systems,
standardisation of parts, high flexibility, fast throughput and short set-up times.
2019 Examinations Watch free CIMA P1 lectures 78
Exercise 2
Benefits
๏ Lower inventory holding costs.
๏ Less risk of obsolescence
๏ Lower storage costs.
๏ Greater flexibility
๏ Improved worker motivation.
๏ Better quality product.
Disadvantages
๏ Risk that supply chain failure will cause consequences in the JIT company.
๏ Relies on flexible workforce – this may not be possible
๏ Not suitable for businesses that are located in low populated areas or who are geographically
wide spread.
๏ Difficulty in switching suppliers can mean that best quotes are not always obtained on a
regular basis
Exercise 3
It has been argued that some of the standard costing performance measures are irrelevant in a
TQM environment.
๏ Labour efficiency variance –
(TQM aim to have motivated staff and empowered to work best they can at all times)
to get positive variances here –management could be encouraged to use lower cost labour – that's
against the TQM principles.
less relevant due to good relationships with suppliers so materials less variable or susceptible to
shortages.
Chapter 6
Exercise 1
Let S = number of standard chairs produced per week
E = number of executive chairs produced per week
Constraints:
Materials: 2S + 4E ≤ 80
Labour: 5S + 6E ≤ 180
Demand: E ≤ 10
Non-negativity: S ≥ 0; E ≥ 0
Objective:
Maximise C = 6S + 9E
S
40
Feasible area:
A, B, C, D, 0
A
30
B
20 C
10
D
0 10 20 30 40 E
Exercise 2
There is no spare material or labour
The spare demand for executive chairs is 5 chairs (10 – 5)
Exercise 3
(a) If there was 1 more kg of material available, then the material constraint becomes:
2S + 4E ≤ 81
Point B will still be the optimum solution, and therefore this will be when:
2S + 4E = 81 (1)
5S + 6E = 180 (2)
(1) × 2.5 5S + 10E = 202.5 (3)
(3) – (2) 4E = 22.5
E = 5.625
in (1) 2S + 22.5 = 81
2S = 58.5
C = 6S +9E
= 175.5 + 50.625
= 226.125
Shadow price of material = extra contribution
= 226.125 – 225
= $1.125 per kg
(b) If there was 1 more hour of labour available, then the labour constraint becomes: 5S + 6E ≤
181
Point B will still be the optimum solution, and therefore this will be when:
2S + 4E = 80 (1)
5S + 6E = 181 (2)
(1) × 2.5 5S + 10E = 200 (3)
(3) – (2) 4E = 19
E = 4.75
in (1) 2S + 19 = 80
2S = 61
S = 30.5
C = 6S +9E
= 183 + 42.75
= 225.75
Shadow price of labour = 225.75 – 225
= $0.75 per hour
The shadow price of demand for executive chairs is $0, because there is already spare
demand.
2019 Examinations Watch free CIMA P1 lectures 81
Chapter 7
Exercise 1
$ $ $
Sales 600,000 630,000 613,200 16,800 (A)
Materials 156,600 160,200 163,455 3,255 (A)
Labour 217,500 222,500 224,515 2,015 (A)
Variable o/h 87,000 89,000 87,348 1,652 (F)
461,100 471700 475318
Less: Inventory (37,100) (26,500) (26,500)
424,000 445,200 448,818
Contribution 176,000 184,800 (164,382)
Less: Fixed o/h (130,500) (130,500) (134,074) 3,574 (A)
Profit $45,500 $54,300 $30,308 23,992 (A)
Exercise 2
Materials
Expense variance
Actual purchases at actual cost 163,455
35,464kg
at standard cost
($4.50) 159,588
$3,867 (A)
Usage variance
kg
Actual usage 35,464
Standard usage for actual production
(8,900 u × 4kg) 35,600
136 kg
at a standard cost ($4.50) = $612 (F)
2019 Examinations Watch free CIMA P1 lectures 82
Labour
Rate of Pay variance
Operating Statement
$
Original budget profit 45,500
Sales – volume variance 8,800 (F)
54,300
Sales – price variance (16,800) (A)
Materials – expense variance (3,867) (A)
– usage variance 612 (F)
Labour – rate of pay variance 2,485 (F)
– idle time variance (6,500) (A)
– efficiency variance 2,000 (F)
Variable o/hs – expense variance 852 (F)
– efficiency variance 800 (F)
Fixed o/hs – expense variance (3,574) (A)
Actual profit $30,308
Exercise 3
Original Flexed
Actual Variances
Fixed Budget Budget
Sales (units) 8,000 8,400 8,400
Production (units) 8,700 8,900 8,900
$ $ $
Sales 600,000 630,000 613,200 16,800 (A)
Materials 156,600 160,200 163,455 3,255 (A)
Labour 217,500 222,500 224,515 2,015 (A)
Variable o/h 87,000 89,000 87,348 1,652 (F)
Fixed o/h 130,500 133,500 134,074 574 (A)
591,600 605,200 609,392
Closing inventory (47,600) (34,000) (34,000)
544,000 571,200 575,392
Profit $56,000 $58,800 $37,808 20,992 (A)
Fixed overheads
Expenditure variance
Efficiency variance
Actual hours worked 44,100
Standard hours for actual production
(8,900u × 5hrs) 44,500
400 hrs
at a standard cost ($3) = $1,200 (F)
Operating Statement
$
Original budget profit 56,000
Sales – volume variance 2,800 (F)
58,800
Sales – price variance (16,800) (A)
Materials – expense variance (3,867) (A)
– usage variance 612 (F)
Labour – rate of pay variance 2,485 (F)
– idle time variance (6,500) (A)
– efficiency variance 2,000 (F)
Variable o/hs – expense variance 852 (F)
– efficiency variance 800 (F)
Fixed o/hs – expense variance (3,574) (A)
– capacity variance 1,800 (F)
– efficiency variance 1,200 (F)
Actual profit $37,808
Exercise 4
No Answer
2019 Examinations Watch free CIMA P1 lectures 85
Chapter 8
There are different ways to calculate planning variances – however, this method is CIMA’s
preferred method – as per examiner’s article
Exercise 1
Labour rate planning variance
Actual output x revised std hours x original labour rate
22000 x 0.5 x $14 = 154000
= $38,500 ADV
Actual output x revised std hours x revised labour rate
22000 x 0.5 x $17.50 = 192500
Exercise 2
Planning material price variance
Actual output x revised std kg x original cost per kg
10,000 x 3kg x $4 = 120,000
= 36000 ADVERSE
Actual output x revised std kg x revised cost per kg
10,000 x 3kg x $5.20 = 156,000
Exercise 3
Total materials cost variance
Actual total cost (27,000 + 11,000) 38,000
Standard total cost (5,000 × $8) 40,000
Total cost variance $2,000 (F)
Materials price variance
Actual Actual Actual Standard
purchases cost purchases cost
kg $ kg $
X 9,900 27,000 9,900 29,700
Y 5,300 11,000 5,300 10,600
38,000 40,300
Price variable = 38,000 – 40,300 = $2,300 (F)
Mix variance
Actual Standard Standard Standard
purchases cost mix cost
kg $ kg $
X 9,900 29,700 (⅔) 10,133 30,399
Y 5,300 10,600 (⅓) 5,067 10,134
15,200kg 40,300 15,200 kg 40,533
Mix variance = 40,300 – 40,533 = 233 (F)
Yield variance
Standard mix Standard Standard Standard
(actual total) cost mix cost
kg $ kg $
X 10,133 30,399 10,000 30,000
Y 5,067 10,134 5,000 10,000
15,200 kg 40,533 15,000 kg 40,000
Yield variance = 40,533 – 40,000 = 533 (A)
(Usage variance = Yield variance + Mix variance = 533 (A) + 233 (F) = 300 (A))
2019 Examinations Watch free CIMA P1 lectures 87
Exercise 4
Note: throughout this answer we use standard costs because cost variances are calculated
separately in the usual way
Total sales margin variance
Budget profit:
A 200u × (20 – 17) 600
B 100u × (25 – 21) = 400
C 100u × (30 – 24) = 600
1,600
Exercise 5
Total variance:
$
Actual total expenditure 126,720
Standard cost for actual production 126,000
(50,400 × 120,000/48,000)
720 (A)
Expenditure variance:
$
Actual total expenditure 126,720
Standard cost for actual despatches 132,000
(2,200 × 120,000/2,000)
5,280 (F)
Efficiency variance:
Despatches
Actual number of despatches 2,200
Standard number of despatches for actual production 2,100
(50,400 × 2,000/48,000)
100
Variance = 100 despatches × standard cost per despatch
= 100 × 120,000/2,000 = $6,000 (A)
2019 Examinations Watch free CIMA P1 lectures 89
Chapter 9
Exercise 1
Budget Objectives Discussion
Depending on your own experiences, you may find the budgets that you have dealt with so far
were or were not effective in their purpose of planning, coordination, communication and other
goals.
If you found the budgets you have experienced were particularly poor in any of the aspects –
consider why this was the case. How might the results or the reaction of those involved be
different, if the budget process had been approached a different way?
A budget is a key internal document and underpins the foundations of the next period’s activities.
Therefore, as a management accountant the choice of budget and how successful it is
implemented will depend on your ability to consider different methods and the suitability of each,
for the organisation where you work.
(a) Budgets can be motivating if targets are challenging but achievable. Motivation can be
enhanced further by involving staff in their own target setting. Rewards such as salary
bonuses can also be linked to achievement of budgeted figures. However, when dealing
with individuals and incentivising courses of action, care must be taken to ensure that the
results are goal congruent with the aims of the company.
(b) Budgets can be used to communicate strategic aims of the owners and senior managers to
all levels of the company. The budget executes these plans by translating them into smaller
objectives. Messages on strategic direction of the company, will be transferred across the
organisation. For example, a drive for growth, quality or cost-cutting should be apparent in
the targets set. This communication should be consistent with other messages that are
conveyed across the company and elsewhere.
Exercise 2
(a) Sales budget
$
X 2,000u × $100 = 200,000
Y 4,000u × $130 = 520,000
Z 3,000u × $150 = 450,000
$1,170,000
(b) Production budget
X Y Z
Sales 2,000 4,000 3,000
Opening inventory (500) (800) (700)
Closing inventory 600 1,000 800
Production 2,100 u 4,200u 3,100u
2019 Examinations Watch free CIMA P1 lectures 90
hours
X 2,100u × 4 = 8,400
Y 4,200u × 6 = 25,200
Z 3,100u × 8 = 24,800
58,400 hours
×$3
$175,200
Exercise 3
Flexed Actual Variances
Sales 12,000u 12,000 u
Production 12,000u 12,000 u
Statement
$
Original budget contribution (10,000u × $1.25) 12,500
Sales volume variance (2,000 × $1.25) 2,500 (F)
15,000
Sales price variance 2,000 (F)
Labour variance 1,500 (F)
Actual contribution 18,500
Fixed overheads
Budget 10,000
Variance 1,000 (A) 11,000
Actual profit $7,500
Exercise 4
(a) In a Top-down budgeting system, middle managers and other employees are likely to feel
demotivated and possibly resentful of targets which are imposed from above.
Targets may be too challenging and therefore unrealistic. Targets which are too easy may
cause complacency amongst staff. NB) Targets will be discussed further in our standard
costing chapter.
There may be changes in circumstances at operational level e.g. new staff members that will
need training or individual supplier issues. These may not have been considered in the Top
Down budget.
As a consequence, department managers may view the budget as irrelevant and feel further
demotivated by the lack of senior management understanding.
(b) Despite the drawbacks in terms of employee morale, top down budgeting is much quicker.
The consultation process for participatory budgeting is likely to be time consuming. Further
problems may arise if department managers have little budget setting experience and can
not appreciate company wide factors. The occurrence of conflicts between management
regarding targets will make the budgeting process even longer and more difficult to
manage.
(c) Participatory Budgeting is usually the preferred method for a modern business
environment. It is particularly suitable to Just in time environments which encourage staff
participation and knowledge sharing as part of the employee culture. However, there may
be occasions when Top Down imposed budget style is suitable.
For example, when a budget must be planned and implemented very quickly- in a take-over/
acquisition situation, the top down approach may be more suitable.
If the company is very large or geographically widespread – full consultation may not be
possible – alternatively a very small company may not have department heads or middle
management with which to consult – so the budget targets are better communicated from
top-down.
Top down budgeting may be used when departmental resistance is expected but no
negotiation or compromise is possible. For example – extreme cost cutting measures are not
going to be popular and so may have to be enforced to ensure business survival.
2019 Examinations Watch free CIMA P1 lectures 92
Chapter 10
Exercise 1
u $
High 700 85,000
Low 100 40,000
600u $45,000
45,000
Variable cost = = $75
600
For high:
Exercise 2
x y xy x2 y2
1 40 40 1 1,600
4 65 260 16 4,225
2 45 90 4 2,025
7 85 595 49 7,225
6 70 420 36 4,900
5 70 350 25 4,900
3 50 150 9 2,500
28 425 1,905 140 27,375
Σx Σy Σxy Σx2 Σy2
n∑ xy−∑ x ∑ y
b= 2
n∑ x 2 −(∑ x )
7×1,905−28×425
=
7×140−282
1, 435
= = 7.321
196
a=
∑ y − b∑ x
n n
425 7.321×28
= − = 31.430
7 7
y = 31.430 + 73.21x
2019 Examinations Watch free CIMA P1 lectures 93
Exercise 3
y =31,430 + 73.21(650)
y = $79,016
Exercise 4
Number of hours spent studying and Exam results [positive correlation expected]
Number of pages printed and ink levels in a printer. [Negatively correlated]
Shoe size and level of disposable income [No correlation]
Exercise 5
Moving Trend Seasonal % variation
Average Variation
2000 1 80
2 87 84.75
3 82 87.25 86 -4 95.3
4 90 89.25 88.25 + 1.75 102.0
2001 1 90 92 90.62 - 0.62 99.3
2 95 95 93.5 +1.5 101.6
3 93 98.75 96.87 - 3.87 96.0
4 102 103 100.87 +1.13 101.1
2002 1 105 105.5 104.25 +0.75 100.7
2 112 109 107.25 +4.75 104.4
3 103
4 116
1 2 3 4
2000 - - -4 + 1.75
2001 - 0.62 + 1.5 - 3.87 + 1.13
2002 + 0.95 + 4.75 - -
Total + 0.13 + 6.25 - 7.87 + 2.88
Averages + 0.06 + 3.12 - 3.93 + 1.44
Exercise 6
1 2 3 4
2000 - - 95.3 102.0
2001 99.3 101.6 96.0 101.1
2002 100.7 104.4 - -
Total 200 206 191.3 203.1
Averages 100% 103% 95.6% 101.5%
2019 Examinations Watch free CIMA P1 lectures 94
Exercise 7
Discussion could include:
Too few data observations reduces the reliability of using data as a forecast.
Consider other factors that may influence future results (PEST factors).
Conclusion
As a management accountant techniques, which can analyse past data and use them to forecast
future results, can be very useful.
However, these methods should always be applied carefully – considering the points discussed
above – in addition to application of good judgment and management expertise.
Chapter 11
Exercise 1
(a) The expected value will be ( 0.3*50,000) + (0.7 * -20,000) = $1000.
In the long run they should end up with an average profit of $1000.
(b) On the basis of EV alone - the decision maker can accept the project.
However, the actual result of the venture may be loss making. The principle of expected values is
designed for experiments that are due to be repeated multiple times – therefore using this
technique to appraise a one-off venture may not be appropriate.
Exercise 2
Demand
(a) Contract size 400u 500u 700u 900u
300u 2,900 3,400 4,400 5,400
500u 3,500 4,000 5,000 5,000
700u 4,100 4,600 4,600 4,600
800u 4,400 4,400 4,400 4,400
Exercise 3
13.5M
5M
2/3
od
Go
A
)
(4M
t
shu
ive
ens
exp Bad
⅓ 6.5M
1
(2M 8.5M
)
che
ap 2/3 13.5M
d
Goo .91
0
B od
Go
C
Bad
Market ⅓ 4M
)
research e (4M Bad
(0.2M) e nsiv 0.0
exp 9
6.5M
Good result
2
F 0.68 (2M 8.5M
che
)
d 0.91
Ba ap Goo
0.3 d re D
shut
2 sul
t
Bad
0.0
9
3 5M 4M
ch
eap
(2M
) .13 8.5M
o od0
shu
G
E
t
5M Ba
d0
.87
4M
Expected values:
Exercise 4
Sensitivity Analysis
Sensitivity Analysis
Sales revenue
5000
x 16.6%
30,000
Fixed costs
5,000
x 100 = 33.3%
15,000
Interpretation.
If the total variable costs were to rise by more than 50% of the current estimated figure then the
project will become loss making.
All sensitivity calculations assume the other variables of the project are held constant.
Exercise 5
2019 Examinations Watch free CIMA P1 lectures 98
The coefficient of variation is 3.5/15.5 = 0.2258 which is 22.6% ( This % gives an indication of
relative magnitude of variation in the data).
Chapter 12
Exercise 1
(1) Your research team have spent $50,000 researching project Q during 2X14? (Non-relevant)
(2) The production manager currently earns a salary of $20,000p.a. Your new project will incur
approximately $5000 p.a of overtime from him which means his salary is expected to be
$25,000 for the duration of the project. (Which is relevant cost for project here? $5000 )
(3) A decision to manufacture a new product is expected to increase fixed costs by $3000 per
month. ( Relevant )
Exercise 2
Revised costs for special order:
Notes $
Subcontractor costs 1 31,300
Supervisor costs 2 1,000
General overheads 3 1,000
Machine maintenance 4 500
Machine overheads 5 22,000
Materials 6 31,500
Interest costs 7 900
88,200
Notes:
1. The choice lies between the two subcontractor costs that have to be employed because
of the shortage of existing labour. The minimum cost is to have subcontractors
employed who are skilled in the special process.
2. Only the difference between the bonus and the incentive payment represents an
additional cost that arises due to the special order. Fixed salary costs do not change.
3. Only incremental costs are relevant.
4. Depreciation is a period cost and is not related to the special order. Additional
maintenance costs are relevant.
2019 Examinations Watch free CIMA P1 lectures 99
5. The relevant costs are the variable overheads ($3 × 6000 hours) that will be incurred,
plus the displacement costs of $2 × 2000 hours making a total of $22,000.
6. Since the materials are no longer used the replacement cost is irrelevant. The historic
cost of $34,000 is a sunk cost. The relevant cost is the lost sale value of the inventory
used in the special order which is: 7,500 kg × $4.20 per kg = $31,500.
7. Full opportunity costing will also allow for imputed interest costs on the incremental
loan. The correct interest rate is the overdraft rate since this represents the incremental
cost the company will pay. Simple interest charges for three months are therefore:
(3/12) × $20,000 × 18% = $900.
Exercise 3
(a) Lost contribution from Rooks (15,000)
Save fixed overheads 5,000
Net loss from ceasing Rooks 10,000
Exercise 3
X Y Z
Buy-in price 13 17 16
Cost to make 10 12 14
Saving (p.u.) $3 $5 $2
Kg of B 3 2 1
Z BUY 1,000
X BUY 2,000
Chapter 13
Exercise 1
$
Selling price 6
Variable costs 2
Contribution 4
(a) $
Total contribution (300u × $4) 1,200
Fixed costs (1,000)
Profit $200
(c) C/S Ratio is 4/6 = 0.66 (This tells us that 66% of selling price is contribution)
1,000
If used formula with C/ S ratio – result is approx the same as above = 1,515
0.66
Approx $1500
2019 Examinations Watch free CIMA P1 lectures 101
Exercise 2
Margin of safety
300 – 250
Margin of safety = × 100 = 16.67%
300
Exercise 3
Contribution 4
C/S ratio = = = 0.67
Sales 6
$
Target profit 320
Fixed overheads 1,000
Target contribution $1,320
Sales revenue required = Target contribution ÷ C/S ratio = 1320 ÷ 4/6 = $1,980
Exercise 4
Cost & revenue
($)
3,000 Total
revenue
}
2,000 Total cost
variable
cost
}
1,000
fixed cost
Exercise 5
Profit
($)
1,000
breakeven
(250 units)
1,000
Exercise 6
(a) CS ratios:
= $136,800
= $41,400
(Alternatively, the average CS ratio may be calculated by taking the weighted average of the
individual CS ratios, weighting by the budgeted sales revenues.)
= 8000/0.303
= $26,400
2019 Examinations Watch free CIMA P1 lectures 103
Profit ($)
+ 40,000
+ 30,000
+ 20,000
+ 10,000 P
– 10,000
Cumulative Cumulative
Sales Profit
P (12,000 × 7 =) 84,000 ((12,000 × 2.65) – 8000) 23,800
C (4,800 × 5 = 24,000) 108,000 (4,800 × 1.25 = 6000) 29,800
V (4,800 × 6 = 28,800) 136,800 (4,800 × 0.75 = 3600) 33,400
(f) If selling products in the order of highest contribution (P then C then V) Product P’s sales
alone will achieve breakeven. This means breakeven point from this selling strategy will be =
8000/0.379 = $21,108 of product P.