Preparation paper 6

1. Edward Co assembles and sells many types of radio. It is considering extending its product range to include digital radios. These radios produce a better sound quality than traditional radios and have a large number of potential additional features not possible with the previous technologies (station scanning, more choice, one touch tuning, station identification text and song identification text etc).

   A radio is produced by assembly workers assembling a variety of components. Production overheads are currently absorbed into product costs on an assembly labour hour basis.

   Edward Co is considering a target costing approach for its new digital radio product.

   Required:

   1. Briefly describe the target costing process that Edward Co should undertake. (3 marks)
   2. Explain the benefits to Edward Co of adopting a target costing approach at such an early stage in the product development process. (4 marks)
   3. Assuming a cost gap was identified in the process, outline possible steps Edward Co could take to reduce this gap. (5 marks)

2. A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable features to Edward Co’s intended product. The board have agreed that the acceptable margin (after allowing for all production costs) should be 20%.

   Cost information for the new radio is as follows:

   • Component 1 (Circuit board) – these are bought in and cost $4.10 each. They are bought in batches of 4,000 and additional delivery costs are $2,400 per batch.
   • Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed radio. However, there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in the assembly process. Edward Co estimates that 2% of the purchased wire is lost in the assembly process. Wire costs $0.50 per metre to buy.
   • Other material – other materials cost $8.10 per radio.
   • Assembly labour – these are skilled people who are difficult to recruit and retain. Edward Co has more staff of this type than needed but is prepared to carry this extra cost in return for the security it gives the business. It takes 30 minutes to assemble a radio and the assembly workers are paid $12.60 per hour. It is estimated that 10% of hours paid to the assembly workers is for idle time.

   Production Overheads – recent historic cost analysis has revealed the following production overhead data:

   	Total production overhead ($)	Total assembly labour hours
   Month 1	620,000	19,000
   Month 2	700,000	23,000

   Fixed production overheads are absorbed on an assembly hour basis based on normal annual activity levels. In a typical year 240,000 assembly hours will be worked by Edward Co.

   Required:
   Calculate the expected cost per unit for the radio and identify any cost gap that might exist. (13 marks)

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3. Calibre Inc is a publishing firm producing magazines and weekly bulletins / newspapers. During the last financial year, its budgeted sales were 2,800 magazines more than the actual sales volume. Furthermore, actual volume of bulletins sold was 20% less than the budgeted.

   The actual selling price per magazine was 15% higher than the budgeted selling price. Actual sales were TZS 108,560,000 at the selling price per magazine of TZS 2,300 and the variable overheads incurred were TZS 81,420,000. On the other hand, total sales revenue generated from the bulletins was TZS 7,500,000 at the selling price of TZS 1,500 per bulletin. There is no change in the budgeted and actual selling prices for bulletins.

   The estimation of the proportion of variable costs has remained unchanged. Calibre has anticipated a 40% market share and the actual total industry market was 150,000 magazines and 25,000 bulletins.

   Required:
   Derive sales variances and analyze them. (8 marks)

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Bedco manufactures bed sheets and pillowcases which it supplies to a major hotel chain. It uses a just-in-time system and holds no inventories.
The standard cost for the cotton which is used to make the bed sheets and pillowcases is TZS5 per m². Each bed sheet uses 2 m² of cotton and each pillowcase uses 0.5 m². Production levels for bed sheets and pillowcases for November were as follows:

The actual cost of the cotton in November was TZS 5.80 per m². 248,000 m² of cotton was used to make the bed sheets and 95,000 m² was used to make the pillowcases.
The world commodity prices for cotton increased by 20% in the month of November. At the beginning of the month, the hotel chain made an unexpected request for an immediate design change to the pillowcases. The new design required 10% more cotton than previously. It also resulted in production delays and therefore a shortfall in production of 10,000 pillowcases in total that month.
The production manager at Bedco is responsible for all buying and any production issues which occur, although he is not responsible for the setting of standard costs.

Required:

1. Calculate the following variances for the month of November, for both bed sheets and pillow cases, and in total:
   1. Material price planning variance;
   2. Material price operational variance;
   3. Material usage planning variance;
   4. Material usage operational variance.
2. Assess the performance of the production manager for the month of November.

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A company running an orchard with an adequate supply of labour presents the following requests your advice about the area to be allotted for the cultivation of various types of fruits, which would result in the maximization of the profits. The company contemplates growing Apples, Lemons, Oranges and Peaches.

The fixed costs in each season would be:

• Cultivation and growing: $56,000
• Picking: $42,000
• Administration: $84,000
• Land revenue: $18,000
• Transport: $10,000

The following limitations are also placed before you:

1. The area available is 450 acres, but out of this, 300 acres are suitable for growing only oranges and lemons the balance of 150 acres is suitable for growing any of the four fruits.
2. As the produce may be hypothecated to banks, area allocated for any fruit should be demarcated in complete acres and not in fraction of an acre.
3. The marketing strategy of the company requires the compulsory production of all the four types of fruits in a season and the minimum quantity of any one type to be 18,000 boxes.

Calculate the total profit that would accrue if your advice is accepted.

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XY Ltd. Can purchase the patent and the manufacturing rights of any one of the three products indicated below. The costs of the rights are:

At a meeting with three of XY’s directors, the management accountant stated “We are all agreed on the facts”. Each venture is a very short-term project. The fixed manufacturing and advertising costs of each venture will be:-

Sales and production will, once be known, dovetail and there will therefore be no stock build up. The sales prices and variable costs per unit are:

However, the sales volume is the crunch question. We do not know the sales level will be but we do know the various possibilities of what the sales levels could be. Product A could be a complete flop, it could sell well or it might sell very well. B is also quite variable whereas with C the range of outcomes is quite small. The various possible sales volumes and their associated probabilities are:

Based on the assumption that the above facts are all completely accurate and we agree with this all we need to do is make the decisions as to which one product to undertake. What are your views gentlemen?”

REQUIRED:

1. Calculate the expected money value of each product and on the basis of this, advise XY on the best course of action.
   (10 marks)
2. Consider only Product A for this section. The marketing manager agrees that the subjective probabilities assigned to sales levels given are as accurate as it is practical to assess, however he suggests that if a market research study was undertaken, then it would be possible to ascertain with complete accuracy exactly which of the sales levels specified would be effective i.e., it would indicate whether the sales would be zero, 2,500 or 4,000 units. This market research would cost shs. 20,000 and could be undertaken before deciding whether to purchase the patent and manufacturing rights.

   Assuming the fixed manufacturing costs are all avoidable, with no production taking place, would it be worthwhile to undertake the market research?
   (8 marks)

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Beachy Bongo has developed a new range of high-quality affordable sandals for beachwear. The sandals are based on an innovative design that protects feet from the effects of sun, salt and sand. The company has already received some sales orders for the sandals and production is due to commence next month. The management accountant has prepared the following projections for the trading year ahead:

(Production and sales of 100,000 pairs of sandals)

Notes:

1. It is assumed that the company will pay workers based on a fixed time basis i.e., hours worked regardless of output achieved.
2. The production, administration, and selling and distribution costs have been analysed and the cost behaviour is shown below:

REQUIREMENT:

1. Calculate the break-even point in units (pairs of sandals) and revenue. (5 marks)
2. Calculate the margin of safety in units (pairs of sandals) and revenue. (3 marks)
3. How many pairs of sandals must Beachy Bongo sell to make a profit of TZS 1,500,000? (3 marks)
4. Beachy Bongo is considering changing the basis of paying staff from a fixed time basis to a piece rate system. Under the new system employees will be paid TZS 4.25 per pair of sandals produced. If the company introduces this new system it will have to employ an extra production supervisor who will be paid a salary of TZS 60,000 per year.
   Assuming that the company implements the new pay system:
   1. What is the new break-even point in units (pairs of sandals)? (4 marks)
   2. How many pairs of sandals must be sold to achieve the current level of profit (i.e. TZS 1,002,500)? (2 marks)
   3. Which of the pay systems (fixed time or piece rate) would you recommend for the company? Give reasons for your answer. (3 marks)

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