IIE Module Workbook MFAC6211

MANAGEMENT ACCOUNTING AND FINANCE

(MFAC6211)
WORKBOOK 2022
(First Edition: 2018)

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Table of Contents
Using this Guide ................................................................................................................ 6
Introduction ....................................................................................................................... 7
Module Resources ............................................................................................................ 8
Module Purpose ................................................................................................................ 8
Module Outcomes ............................................................................................................. 8
Pacer and Assessment brief Applicable to Module: MFAC6211 ....................................... 9
Assessments ................................................................................................................... 13
Learning Unit 1: An introduction to cost terms and purposes ......................................... 15
Introduction ..................................................................................................................... 15
Direct costs and indirect costs ........................................................................................ 15
Cost-behaviour ................................................................................................................ 19
Learning Unit 2: Determination of cost behaviour ........................................................... 21
Introduction ..................................................................................................................... 21
Linear cost equation ........................................................................................................ 21
High-low method ............................................................................................................. 22
Regression analysis method ........................................................................................... 23
Scattergraph method....................................................................................................... 24
Revision Exercises .......................................................................................................... 24
Learning Unit 3: Activity-Based costing systems ............................................................ 25
Introduction ..................................................................................................................... 25
Designing an ABC system .............................................................................................. 26
Traditional costing versus ABC ....................................................................................... 26
Activities .......................................................................................................................... 28
Revision Exercises .......................................................................................................... 28
Learning Unit 4: Methods of inventory valuation ............................................................. 33
Introduction ..................................................................................................................... 33
Cost of inventories .......................................................................................................... 33
The FIFO method of inventory valuation ......................................................................... 34
The weighted average method of inventory valuation ..................................................... 34
Revision Exercises .......................................................................................................... 35
Learning Unit 5: Job costing systems ............................................................................. 37
Introduction ..................................................................................................................... 37
Manufacturing cost flow through ledger accounts ........................................................... 38
Activities .......................................................................................................................... 40
Revision Exercises .......................................................................................................... 41
Learning Unit 6: Process costing systems ...................................................................... 46
Introduction ..................................................................................................................... 47
Flow of production by means of a single process ........................................................... 48
Work-in-process (WIP), equivalent units and the quantity statement ............................. 49
Losses ............................................................................................................................. 53
Production cost statement............................................................................................... 59
Allocation statements ...................................................................................................... 64

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Revision Exercises .......................................................................................................... 71

Learning Unit 7: Joint products and By-products costing systems .................................. 79
Introduction ..................................................................................................................... 79
Methods for allocating joint costs .................................................................................... 80
Accounting for by-products ............................................................................................. 86
Revision Exercises .......................................................................................................... 91
Learning Unit 8: Direct and Absorption costing ............................................................... 93
Introduction ..................................................................................................................... 93
Absorption costing versus Direct costing ........................................................................ 94
Reconciling differences between net profit ..................................................................... 99
Revision Exercises ........................................................................................................ 100
Learning Unit 9: Budgeting techniques ......................................................................... 108
Introduction ................................................................................................................... 108
Stages in the budgeting process ................................................................................... 109
The master budget ........................................................................................................ 110
Cash budgets ................................................................................................................ 110
Flexible budgets ............................................................................................................ 112
Revision Exercises ........................................................................................................ 115
Learning Unit 10: Standard costing ............................................................................... 116
Introduction ................................................................................................................... 116
Key abbreviations.......................................................................................................... 117
Material variances ......................................................................................................... 117
Labour variances........................................................................................................... 120
Variable manufacturing overhead variances ................................................................. 122
Fixed manufacturing overhead variances ..................................................................... 124
Sales variances ............................................................................................................. 125
Reconciling budgeted results with actual results .......................................................... 126
Illustrative example ....................................................................................................... 126
Revision Exercises ........................................................................................................ 128
Learning Unit 11: Relevant costing ............................................................................... 132
Introduction ................................................................................................................... 132
Relevant versus irrelevant costs ................................................................................... 133
Special pricing decisions ............................................................................................... 134
Product mix decisions when capacity constraints exist ................................................. 136
Revision Exercises ........................................................................................................ 137
Learning Unit 12: Cost-Volume-Profit (CVP) analysis (Sensitivity analysis) ................. 141
Introduction ................................................................................................................... 141
Cost-Volume-Profit analysis .......................................................................................... 142
Sensitivity analysis ........................................................................................................ 144
Effect of changes in selling prices ................................................................................. 145
Effect of changes in sales volume on profits ................................................................. 145
Effect of changes in variable costs on profits ................................................................ 146
Effect of changes in fixed costs on profits ..................................................................... 146
Intellectual Property ...................................................................................................... 152

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Using this Guide

This guide has been developed to support your use of the prescribed material for this
module. There may be occasions when the prescribed material does not provide sufficient
detail regarding a particular idea or principle. In such instances, additional detail may be
included in the guide. This guide should not, however, be used as a stand-alone textbook,
as the bulk of the information that you will need to engage with will be covered in the
prescribed material. You will not pass this module if you only use the module guide to
study from.

Various activities and revision questions are included in the learning units of this guide.
These are designed to help you to engage with the subject matter as well as to help you
prepare for your assessments.

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Introduction
Welcome to this 2nd year module in Management Accounting and Finance (MFAC6211).
The following information is useful for your understanding of the course requirements this
semester.

To introduce this module, we begin with an introduction to cost terms and behaviour in
Learning Units 1 and 2. These learning units are created to provide a sound backdrop to
management and cost accounting. Key terms and principles within these Learning Units
will be used throughout the course of the semester.

We then move on to study different costing systems, namely Activity Based Costing
(Learning Unit 3).

By this point, you will realise that the study of cost accounting, primarily deals with
Inventory. Learning Unit 4 covers basic inventory valuation methods which includes the
FIFO and Weighted Average methods (which you might remember from high school).

Next, we will cover a product costing system, Job Costing in Learning unit 5.

More advanced costing methods are studied in Learning Units 6, 7 and 8 namely Process
costing; Joint and by-products costing and Direct and absorption costing. Process Costing
and Direct and Absorption costing require an in depth understanding of valuation methods
covered in Learning Unit 4.

Budgeting and standard costing are covered in Learning Units 9 and 10. These Learning
Units introduce techniques to measure and analyse the performance of an organisation.
Standard costing has proven to be one of the more complicated sections for students. The
only way to master this section is to practise as many questions as possible, as there are
various ways of testing these topics.

The last section of this module focuses on relevant information for short-term decision
making, where you will be introduced to relevant costing (Learning Unit 11) and cost-
volume-profit analysis. (Learning Unit 12).

The content of this module is considerable, and students find great difficulty in studying
towards the exam as all topics are examinable and may be integrated. Tests and ICE
tasks during the semester will assist you with keeping up to date with the syllabus and
ensure that you are studying the content on a regular basis. This will ease the volume that
needs to be studied for the final examination. Completing work at home and tackling
homework is essential for passing this module.

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Module Resources
Prescribed Book for this Drury, C. 2020. Management and Cost Accounting. 11th ed.
Module Southern Western Cengage Learning. (PM)
ISBN: 978-1-4737-7361-5 (Hardcover)
Recommended Additional Please note that a number of additional resources and links to
Reading resources are provided throughout this module on the Learn
platform and in this workbook. You are encouraged to engage
with these as they will assist you in mastering the various
objectives of this module. They may also be useful resources
for completing any assignments. You will not, however, be
assessed under examination conditions on any additional or
recommended reading material.
Digital and Web Resources Additional digital resources are also available for this module.
Please log onto the Student Portal and follow the links to
‘Supplementary Digital Material’ to source the following.

Module Purpose
The purpose of this module is to introduce students to the field of management accounting
focusing on the analysis of data for decision making purposes. Rather than focusing on
financial performance, cost accounting focuses on the performance of the production process.
The effectiveness and efficiency of this process affects cost, which in the end determines the
selling price.
Module Outcomes
MO1 Demonstrate knowledge and understanding of the theory of costs and costing
systems.
MO2 Determine product cost in a variety of costing systems.
MO3 Apply short-term decision-making techniques to problem solving in a business
entity.

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Pacer and Assessment brief Applicable to

Module: MFAC6211
Learning Unit 1 An Introduction to Cost terms and Textbook reference
Purposes
MFAC6211 LO1:Define the different cost objects. Chapter 2 & 3
Sessions: 1 - 2 LO2:Account for manufacturing
Related Outcomes: overheads.
MO1 LO3:Classify costs in terms of cost
behaviour principles.
Learning Unit 2 Determination of Cost Behaviour Textbook reference
MFAC6211 LO1:Explain the behaviour of costs. Chapter 24
Sessions: 3 – 4 LO2:Estimate costs using different
Related Outcomes: techniques.
MO1 LO3:Estimate profits using cost-
volume profit analysis.
Learning Unit 3 Activity-Based Costing systems Textbook reference
MFAC6211 LO1: Describe the differences Chapter 11
Sessions: 5 – 9 between activity-based costing
Related Outcomes: (ABC) and the traditional
MO2 costing method.
Related Outcomes: LO2: Identify the environment which
MO2 is suitable for the
implementation of an ABC
system.
LO3: Design an ABC system with a
view to costing products.
LO4: Implement an ABC system with
a view to costing products.
Learning Unit 4 Methods of Inventory Valuation Textbook reference
MFAC6211 LO1: Determine the cost of Various supplement
Sessions: 10 – 11 inventories. sources
Related Outcomes: LO2: List the different categories of
MO2 inventory.
LO3: Value inventory on the First-in-
First-out basis.
LO4: Value inventory on the
Weighted Average basis.
Learning Unit 5 Theme: Job Costing systems Textbook reference
LO1: Identify a job costing system. Chapter 4

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MFAC6211 LO2: Record costs in a job costing

Sessions: 12 – 14 system.
LO3: Calculate the profit or loss per
job.
Learning Unit 6 Process Costing systems Textbook reference
MFAC6211 LO1: Describe the users of a process Chapter 5
Sessions: 15 – 26 costing system.
Related Outcomes: LO2: Calculate the completed units
MO2 and the equivalent units for
work-in-process (WIP).
LO3: Prepare the quantity statement
based on the weighted average
method of inventory valuation.
LO4: Prepare the quantity statement
based on the first-in-first-out
(FIFO) method of inventory
valuation.
LO5: Calculate the normal loss for a
specific period, depending on
the wastage point.
LO6: Calculate the abnormal loss for
a specific period, depending on
the wastage point.
LO7: Prepare the production cost
statement based on the
weighted average method of
inventory valuation.
LO8: Prepare the production cost
statement based on the first-in-
first-out (FIFO) method of
inventory valuation.
LO9: Prepare the allocation
statement based on the
weighted average method
inventory valuation.
LO10: Prepare the allocation
statement based on the first-in-
first-out (FIFO) method of
inventory valuation.
LO11: Record process costs in the
general ledger.
LO12: Allocate process costs in the
general ledger.

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Learning Unit 7 Joint Products and By-Products Textbook reference

costing systems
MFAC6211 LO1: Differentiate between joint and Chapter 6
Sessions: 27 – 28 by-products.
LO2: Allocate joint costs, using
different methods.
LO3: Calculate profits from the sale of
joint products.
LO4: Calculate the value of joint and
by-product inventory.
LO5: Account for by-products.
Learning Unit 8 Direct and Absorption Costing Textbook reference
MFAC6211 LO1: Identify the differences between Chapter 7
Sessions: 29 – 37 direct and absorption costing
Related Outcomes: methods.
MO2 LO2: Draft the statement of
comprehensive income
according to the absorption
costing method using different
inventory valuation methods.
LO3: Draft the statement of
comprehensive income
according to the direct costing
method using different inventory
valuation methods.
LO4: Reconcile the differences in
profit between the two costing
methods.
LO5: Identify the most appropriate
method given specific
circumstances.
Learning Unit 9 Theme: Budgeting techniques Textbook reference
MFAC6211 LO1: Describe the stages in the Chapter 15
Sessions: 38 – 39 budgeting process.
Related Outcomes: LO2: Describe the sub-budgets
MO3 included in the master budget.
LO3: Prepare a cash budget.
LO4: Prepare a flexible budget.
LO5: Describe the advantages and
disadvantages of budgeting.
Learning Unit 10 Theme: Standard Costing Textbook reference
MFAC6211 LO1: Calculate selected variances Chapter 17
Sessions: 40 – 47 using a standard costing
Related Outcomes: system.
MO3 LO2: Calculate standard cost.
LO3: Discuss reasons for variances.

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LO4: Prepare a reconciliation

between budgeted and actual
profit.
Learning Unit 11 Relevant Costing Textbook reference
MFAC6211 LO1: Identify the characteristics that Chapter 9
Sessions: 48 – 53 make information relevant.
Related Outcomes: LO2: Distinguish between relevant
MO4 and irrelevant information with
regards to a specific decision.
LO3: Identify the qualitative factors
that has an influence on a
specific decision taken.
LO4: Calculate relevant incremental
cash flows in a given scenario.
LO5: Identify the preconditions for a
special price.
LO6: Determine appropriate prices for
special orders taking into
account relevant information,
including opportunity costs.
LO7: Calculate contribution per unit of
a limiting factor identified in a
given scenario.
LO8: Determine the optimal allocation
of available resources.
LO9: Determine the optimal product
mix.
Learning Unit 12 Cost-Volume-Profit Analysis Textbook reference
(Sensitivity Analysis)
MFAC6211 LO1: Estimate profits using cost- Chapter 8
Sessions: 54 – 56 volume-profit analysis.
Related Outcomes: LO2: Use Cost-Volume-Profit
MO4 analysis to determine the
Related Outcomes: expected effect of decisions and
MO4 events on variables that affect
profit.
LO3: Use Cost-Volume-Profit
analysis to determine the
expected effect of decisions and
events on profit.
LO4: Determine the sensitivity of
profit to changes in selling
prices.

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Assessments
Integrated Curriculum Engagement (ICE)
Minimum number of ICE activities to complete 4
Weighting towards the final module mark 10%

Tests/ Examination Test 1 Test 2 Examination

Weighting 20% 20% 50%
Duration 60 minutes 60 minutes 180 minutes
Total marks 60 marks 60 marks 180 marks
Open/ closed book Closed Closed Closed
Resources required Non-programmable Non- Non-
calculator programmable programmable
calculator calculator
Learning Units covered 1–5 1–8 All learning units

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Assessment Preparation Guidelines

Format of the Assessment Preparation Hints
(The Focus/ Approach/ (How to Prepare, Resources to
Objectives) Use, etc.)
Tests and The assessments will be written with The key to passing your tests and
examinations mainly application of theory to a examinations for MFAC6211 is to
given scenario. understand the underlying principles,
but also to practise applying these
The application of theory tested in principles by doing questions. The
tests and examinations will be quantity of questions you do is not as
consistent with those questions important as the quality with which
discussed in class and resources you practice a question. You must do
available to you. each question under exam conditions
and give yourself a mark. If you did
not achieve your desired result you
need to go back to the basic
principles to see what you don’t know
and understand yet, after which you
start over again with practising
questions (follow the process above
again).

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Learning Unit 1: An introduction to cost terms and

purposes
Learning Objectives: My notes
• Define the different cost objects
• Account for manufacturing overheads
• Classify costs in terms of cost behaviour principles
Material used for this learning unit:
• Chapter 2 and 3 of the prescribed textbooks
Prescribed material used for this learning unit:
Drury, C. 2020. Management and Cost Accounting. 11th ed.
Southern Western Cengage Learning. (PM).
Study chapter 1
Study the following subsections in chapter 2:
o Cost objects
o Direct costs and indirect costs
o Period and product costs
o Cost behaviour
Study the following subsections in chapter 3:
o Assignment of direct and indirect costs
o Assigning direct costs to cost objects
o Budgeted overhead rates
o Under- and over-recovery of overheads

Introduction
This is an introductory learning unit that will prepare you for the rest of this module.
Organisations deal with different types of costs. To be able to deal effectively with costs,
you need to understand different cost terms, cost objects and the ways in which costs can
be classified. This is necessary to communicate useful information to decision makers.

Direct costs and indirect costs

Operating costs in a manufacturing company consist of manufacturing costs, which are
also called product costs, and non-manufacturing costs, which are also called period
costs.

Manufacturing costs (product costs) consist of:

• Direct material (direct cost);

• Direct labour (direct cost);
• Other direct expenses (direct cost); and
• Manufacturing overheads (indirect cost).

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Direct materials

MANUFACTURING
Direct labour
Identified as Manufacturing
forming part of the Work needed to overheads

COSTS
individual, finished convert the direct
product Indirect materials;
materials into a
Traced directly to finished product Indirect labour;
the product and
Other
manufacturing
costs

Prime Cost Conversion Cost

Manufacturing overheads includes indirect material (for example cleaning chemicals,

disposable tools), indirect labour (for example the salary of a production supervisor) and
other manufacturing costs (for example factory rental). Cleaning chemicals relating to
head office and head office salaries would form part of non-manufacturing costs as this is
not part of manufacturing.

Prime costs as indicated in the figure above are made up of direct material and direct
labour. Conversion costs are made up of direct labour and manufacturing overheads since
these are the costs incurred to convert the product from direct material into finished goods.

Non-manufacturing costs (period costs) include all other costs not classified as
manufacturing costs, for example cleaning materials and salaries as explained above.

The following diagram illustrates the difference between different types of costs, the
assignment thereof and how that then results in a cost object:

TYPE OF COST COST ASSIGNMENT COST OBJECT

Direct Costs Cost Tracing

Example: Wood
used to produce based on material
wooden tables Example: Wooden
requisition document
Tables

Indirect Costs
Example: Factory Cost Allocation
rental of factory
where tables are no requisition
produced
document

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Direct materials

The cost of direct materials can be traced directly to a product. Direct materials form part
of the physical product and can be measured by the quantity consumed by each individual
product.

Direct labour

Direct labour is the labour that can be specifically associated with the product or service,
for example the labour hours to manufacture a table. Therefore, the cost can be traced
directly to the product.

Indirect costs (Manufacturing overheads)

These costs cannot be traced directly to products or services and therefore you need to
find an allocation basis to allocate these costs to the products. Why do you do this?
Because these costs are still manufacturing costs and should form part of the cost of the
product. Even though you cannot trace them directly to the product you still need to find a
way to allocate a cost for “manufacturing overheads” to the product to cost the product
accurately to be able to set a selling price. Allocating indirect manufacturing overheads to
products are also required by IAS 2. You will learn more about this in your financial
accounting syllabus.

There are mainly two methods for determining the manufacturing overhead cost per
product: the traditional costing method and the Activity-based costing method. Activity-
based costing will be dealt with in detail in Learning Unit 3.

With the traditional costing method, the overhead cost per product is determined by
calculating a budgeted overhead rate. This is also called the recovery rate or absorption
rate or allocation rate. The following formula may be used:

𝑇𝑜𝑡𝑎𝑙 𝑏𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 =
𝑇𝑜𝑡𝑎𝑙 𝑏𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

You will then use the budgeted overhead rate and include that as your cost for
manufacturing overheads per product during the year. The total budgeted overhead
includes the total manufacturing overhead costs estimated to be incurred for the year. The
total budgeted activity level can be production units, labour hours, materials used,
machine hours, etc. Each company needs to decide which activity level would be most
appropriate when assigning overheads.

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Now, why do we use budgeted figures and not actual figures? Actual figures only become
available at the end of the year, but selling prices need to be determined during the year
based on the cost of the product. Therefore, you need to calculate the rate at the beginning
of the year to have an estimated cost for overheads as a part of the product cost. For
direct material and direct labour, it is straightforward, because you have the actual cost
per unit as you manufacture as these are directly traceable to the product. Product cost
will be made up of:

• Direct material (actual cost).

• Direct labour (actual cost).
• Other direct cost (actual cost).
• Indirect cost (manufacturing overheads) (budgeted cost).

Now how does it work? In cost of sales in the statement of comprehensive income
you will have the cost of the product multiplied by each actual unit manufactured.
Therefore, all costs will be actual costs incurred, except for overheads. Overhead
costs are calculated as budgeted cost per unit multiplied by actual units
manufactured, this is called recovered overheads. It may also be called applied
overheads or absorbed overheads or allocated overheads. In the end, you still need
to end up with actual figures in the statement of comprehensive income and
therefore need to make an adjustment in the statement of comprehensive income
for the difference between the recovered overheads and the actual overheads. This
adjustment is called under- or over recovered overheads.

If you have recovered more overheads in cost of sales than your actual overhead
cost, this means that you have recovered “too much” overheads during the year, i.e.,
your budgeted rate was too high. Therefore, due to the higher than actual overheads
included in your cost of sales, you now must reduce your expenses. If you have
recovered “less” overheads in cost of sales than your actual overhead cost incurred,
overheads were under recovered. This means that you must increase your
expenses to reach the actual overhead costs incurred.

Activity 1.1

The budgeted and actual data for ABC Limited for the year ended 28 February 20X1
were as follows:

Budgeted Actual
Manufacturing overheads 1 200 000 1 300 000
Direct labour hours 100 000 110 000
Units produced 50 000 55 000

The appropriate predetermined overhead rate is based on budgeted labour hours.

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REQUIRED

a) Calculate the under or over recovered manufacturing overhead.

b) Prepare the T-account for the manufacturing overhead account.
c) Make a journal entry for the under or over recovery for the year.

Cost-behaviour

Variable costs

Variable costs remain constant per unit. Therefore, as you produce more, your total costs
will increase and if you produce less, your total costs will decrease. Examples of variable
costs are direct material and direct labour. For example:

Number of tables produced: Variable cost per material: Total variable cost of
(A) wood (B) wood (A x B)
1 R 120 R 120
1 000 R 120 R 120 000
5 000 R 120 R 600 000

Fixed Costs

Fixed costs remain constant in total and therefore as you produce more the cost per unit
absorbed will decrease and as you produce less the cost per unit absorbed will increase.
This would mainly be manufacturing overheads, for example factory rental:

Annual total factory rental: Number of tables produced Factory rental cost per
(A) (B) unit (A / B)
R 1 000 000 10 000 R 100
R 1 000 000 20 000 R 50
R 1 000 000 100 000 R 10

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Fixed and variable cost behaviour can be presented in the following graphs:

Variable cost behaviour: Fixed cost behaviour:

Cost
increase as
Cost remains on
activity
the same level

Total cost
increase
Total cost

independent of
the activity level

Activity level Activity level

Semi-variable Costs

Semi-variable costs (also called mixed costs) includes both a variable and a fixed element,
meaning included in the total cost is both variable costs and fixed costs. Therefore, there
will be an amount that remains constant regardless of number of units produced and an
amount that varies with the number of units produces. In learning unit 2 we will learn how
to distinguish between the two elements. Semi-variable cost can be presented in the
following graph:

A portion of costs
Total cost

remain the same

and the other
portion varies with
the activity level

Activity level

Relevant range

This is the production capacity (number of units) within which the organisation normally
operates. For example, the company’s production capacity is 50 000 units. They normally
operate within 40 000 units and 45 000 units. Therefore, their relevant range would be
between 40 000 units and 45 000 units.

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Learning Unit 2: Determination of cost behaviour

Learning Objectives: My notes
• Explain the behaviour of costs.
• Estimate costs using different techniques.
• Estimate profits using cost-volume profit analysis.
Material used for this learning unit:
• Chapter 24 of the prescribed textbook
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 24:
o General principles applying to estimating cost
functions.
o Cost estimation methods
▪ Graphical or scattergraph method.
▪ High-low method.
▪ The least-squares method.

Introduction
In this learning unit we will look at different methods to identify the components of semi-
variable costs. You were introduced to this type of cost in the previous learning unit. The
linear cost equation will be used to forecast and project costs. The following methods are
available to identify these components:

• High-low method.
• Regression analysis method.
• Scattergraph method.

You will also learn how to perform cost-volume-profit (CVP) analysis. CVP analysis assists
in proper planning and forecasting of profits.

Linear cost equation

The linear cost equation can be used to forecast and project costs using the following
formula:

y = a + bx

Where:

y = total cost (the dependant variable)

a = total fixed costs (the intercept on the y-axis)
b = variable cost per unit of activity (the slope of the straight line).
x = activity level (normally units produced).

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A graphical representation of the linear equation is as follows:

Total cost graph

y-axis

Total
cost

a
intercept
x-axis

Activity volume

High-low method
With this method you simply select the highest and lowest observed values within the
relevant range and divide the difference in cost by the difference in activity level. By doing
this, you obtain the variable “b” in the linear cost equation, which is the variable cost per
unit. The formula for this method is as follows:

𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

𝑡ℎ𝑒 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑐𝑜𝑠𝑡𝑠 𝑎𝑡 𝑡ℎ𝑒 ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑛𝑑 𝑙𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦
=
𝑡ℎ𝑒 𝑑𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑛𝑑 𝑙𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

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Activity 2.1

ABC Limited incurred the costs as indicated below. During the six months ended June,
these costs change, but not in direct relation to the volume.

Month Number of units produced Historical cost (R)

January 105 12 500
February 135 14 050
March 120 13 800
April 110 12 900
May 95 12 850
June 125 13 950

REQUIRED

a) Use the high-low method to determine the variable cost per unit and the fixed cost
in total.
b) Formulate a linear equation that explains and predicts cost behaviour.
c) Forecast the total costs if an estimated 140 units are to be manufactured in July.

Regression analysis method

This method (also called the least squares method) is a statistical method used to
determine the relationship between the dependent (total cost) and independent (number
of units produced) variables. The following formulas may be used to solve for “a” (the total
fixed costs) and “b” (the variable cost per unit):

∑𝑦 𝑏∑𝑥
𝑎= −
𝑛 𝑛

𝑛 ∑ 𝑥𝑦 − ∑ 𝑥 ∑ 𝑦
𝑏=
𝑛 ∑ 𝑥 2 − (∑ 𝑥)²

Activity 2.2

Observation Volume Total overhead costs

(data point) (units, hours, etc.) (R)
1 2 400 19 800
2 3 600 24 500
3 2 700 21 200
4 3 200 23 000
5 3 800 26 600
6 2 300 18 000

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REQUIRED

Use the simple regression analysis method to determine the variable overhead cost per
unit and the total fixed overhead costs and define a linear equation for the cost behaviour.

Scattergraph method
With this method you plot the total costs for each activity level on a graph. Total costs will
be represented on the y-axis and the total activity level will be presented on the x-axis. A
straight line is drawn as accurately as possible in between the scattered plotted points on
the graph. The point where the line meets the y-axis represent the fixed costs whilst the
area above that represents variable costs. The more observations you have, the more
accurate your results will be. Refer to Example 24.2 in the textbook Drury 11th edition.

Revision Exercises

Revision Exercise 2.1

The following information was obtained from the books of Mabudhsa Manufacturers for
the six months ended June 20x1:

Months Units manufactured Semi-variable

manufacturing overheads
July 1 560 53 560
August 1 780 56 420
September 1 350 51 200
October 1 460 51 980
November 1 520 52 500
December 1 630 54 560

The company’s relevant range is to manufacture between 1 300 and 1 650 units per
month.

REQUIRED

a) Use the high-low method to determine the total costs to be expected in January if
1 820 units are manufactured.
b) Use the least squares method to calculate the variable cost per unit and fixed costs
in total for the financial year. Round your answers to two decimal places.

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Learning Unit 3: Activity-Based costing systems

Learning Objectives: My notes
• Describe the differences between activity-based costing
(ABC) and the traditional costing method.
• Identify the environment which is suitable for the
implementation of an ABC system.
• Design an ABC system with a view to costing products.
• Implement an ABC system with a view to costing
products.
Material used for this learning unit:
• Chapter 11 of the prescribed textbook.
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 11:
o Types of cost system
o A comparison of traditional and ABC systems
o Volume-based and non volume-based cost drivers
o Designing ABC systems
o Activity hierarchies
o Cost versus benefits considerations

Introduction
Indirect manufacturing costs (manufacturing overheads) are not as easy to identify and
measure as direct manufacturing costs. When a company has more than one product it
can become difficult to assign indirect costs to products. Traditionally this was done by
using the traditional costing system where the total manufacturing overheads were
assigned to products using only one cost driver. In the 1980’s firms started to implement
ABC systems where manufacturing overheads were now subdivided into activities of
overhead costs within the total figure and assigned to products by using different cost
drivers which are more applicable to the specific overhead type.

In this learning unit, we will look at the difference between the activity-based costing (ABC)
and traditional costing method. We will identify the environment which is suitable for the
implementation of an ABC system as well as design the ABC system with a view to costing
products. Lastly, we will look at how to implement an ABC system.

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Designing an ABC system

There are four steps involved in designing an ABC system:

STEP ONE
Identify the major activities that take place in an organisation

STEP TWO
Determine the cost driver for each major activity

STEP THREE
Create a cost centre / cost pool for each major activity

STEP FOUR
Charge costs to products based on their usage of the activity

Traditional costing versus ABC

The following example will be used to illustrate the difference between the two costing
systems:

Overhead costs
Quality control R 120 000 These are your
different costs
Packaging and shipping R 60 000 of activities
Production set-up R 70 000 within the total
O/H cost
Total cost R 250 000

Activities/Cost Drivers Product A Product B

Inspections 50 30
Machine set-ups 20 40 These are your
cost drivers
Number of units manufactured 50 000 30 000
Labour hours 30 000 20 000

Currently overheads are allocated to products based on labour hours. This information is
given for the
traditional method

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REQUIRED
a) Calculate the cost per unit for each product using the traditional costing system
b) Calculate the cost per unit for each product using ABC principles.

[Round your answer to two decimal places]

a) TRADITIONAL COSTING
Total overhead 250 000
Total number of labour hours 50 000
Overhead allocation rate per hour R5 This is the
Allocated to Product A (R5 x 30 000 hours) R 150 000 rate per
Allocated to Product B (R5 x 20 000 hours) R 100 000 HOUR and
Cost per unit for Product A NOT per unit
(R150 000 / 50 000) R3
Cost per unit for Product B
(R100 000 / 30 000) R 3.33

Total quantity of Activity per

what is “happening” product x Cost
(activity level) driver rate, i.e.
50 X R1 500 =
R75 000
b) ABC COSTING – MUCH MORE DETAILED
Total Cost Cost
Activity driver driver
Cost quantities rate Product Product
Activity Cost Driver (A) (B) (A/B) A B
Quality
control Inspections R 120 000 80 R 1 500 R 75 000 R 45 000
Packaging Units
and shipping manufactured R 60 000 80 000 R 0.75 R 37 500 R 22 500
Production Machine set-
set-up ups R 70 000 60 R 1 167 R 23 340 R 46 680

Total overhead allocated R 250 000 R 135 840 R 114 180

Number of units 50 000 30 000
Cost per unit R 2.72 R 3.81

The different
types of Calculations:
costs 50 x R 1 500 R 75 000
The reason
30 x R 1 500 R 45 000
for there 50 000 x R 0.75 R 37 500
being a cost 30 000 x R 0.75 R 22 500
20 x R 1 167 R 23 340
40 x R 1 167 R 46 680

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Activities

Activity 3.1

Solve review problem IM11.4 in the Drury textbook 11th edition.

Activity 3.2

Solve review problem IM11.5 in the Drury textbook 11th edition.

Revision Exercises

Revision Exercise 3.1

You are the management accountant at Man It (Pty) Ltd, a manufacturing company. You
attended a management accounting seminar on activity-based costing and after the
training you are confident to assist Man It with activity-based costing.

Details of four products manufactured by the company are listed below:

Products F1 G1 S1 S2
Output in units 3 000 2 500 2 700 2 000
Machine hours (per unit) 2 5 2.5 1

Production overhead for the period is as follows:

Machine department costs R 60 000

Set-up costs R 80 000
Stores receiving R 30 000
Quality control R 50 000
Material handling and dispatch R 40 000

Cost drivers to be used for ABC are listed for the overhead cost shown:

Cost Cost driver Cost driver volume

Machine department costs Machine hours ?
Set-up costs Number of production runs 32
Stores receiving Requisitions raised 50
Quality control Number of inspections 40
Material handling and dispatch Orders executed 80
REQUIRED

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a) Calculate the manufacturing overhead cost per unit for product S1 if all production
overheads are allocated on a machine hour basis instead of using ABC.
b) Calculate an activity rate for each of the five activities assuming ABC is now used.

Revision Exercise 3.2

Alpha Ltd produces two products: A and B. The enterprise produces both products with
the same equipment. Product A is a high-volume product while product B is produced in
low volumes.

Details of the costing activities, inputs and output are as follows:

Overhead cost R
Material handling 150 000
Material procurement 50 000
Set-up 150 000
Quality control 250 000
Production 600 000
Total 1 200 000

Cost driver analysis

Overhead Cost driver Product A Product B Total

Material handling Material movements 100 50 150
Material procurement No. orders 200 100 300
Set-up No. set ups 60 40 100
Quality control No. inspections 150 100 250
Production Direct labour hours 40 000 10 000 50 000
Annual output 80 000 units 20 000 units

REQUIRED

a) Calculate the overhead cost per product using an ABC system.

[Round off to two decimal places.]

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Revision Exercise 3.3

Cycle Co (Pty) Ltd manufactures two products: Cycle-Pro and Cycle-Basic. The target
market for these products is flooded with similar products and, therefore, competitiveness
and efficiency must be assured in the manufacturing process. The company requires
highly specialised machines, and the processing is time-intensive. The management of
Cycle Co (Pty) Ltd has the desire to implement activity-based costing (ABC) to improve
the costing accuracy of the products Cycle-Pro and Cycle-Basic.

A management accountant report contains the following information:

Total overheads R250 000

Total machine hours 50 000 (used for blanket rate)

Products
Cycle-Pro Cycle-Basic
Units manufactured 12 000 13 000
Direct material cost per unit R 100 R 60
Direct labour cost per unit R 60 R 40
Machine hours per unit 2.5 1.5

A time-event study indicated that overhead costs are incurred as follows:

Set-up costs 35%

Inspections 45%
Materials handling 20%

Activities in the consumption of resources were as follows:

Products
Cycle-Pro Cycle-Basic
Set-up activities 125 50
Inspections 180 70
Goods movements 200 300

REQUIRED

a) Calculate the cost per unit for Cycle-Pro and Cycle-Basic under traditional costing.
b) Calculate the cost per unit for Cycle-Pro and Cycle-Basic under activity-based
costing.

[Round your answer to two decimal places.]

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Revision Exercise 3.4

Tech (Pty) Ltd specialises in the manufacturing of hard drives (HD), USB’s and memory
cards (MC). Budgeted information for the 20X1 financial year is as follows:

Products HD USB MC Total

Revenue 4,850,000 2,680,000 1,870,000 9,400,000
Direct material 1,358,000 786,000 689,000 2,833,000
Direct labour 867,000 353,000 285,000 1,505,000
Fixed manufacturing
1,940,000 1,072,000 748,000 3,760,000
overheads
Gross profit 685,000 469,000 148,000 1,302,000

Fixed production overheads are currently absorbed based on a percentage of revenue.

Tech (Pty) Ltd is currently considering changing to an activity-based-costing (ABC)
system. The main activities and their associated cost drivers and overhead costs have
been identified as follows:

Production
overhead
Activity Cost driver costs (R)
Manufacturing scheduling Number of orders 376,000
Parts handling Number of parts 752,000
Assembly Assembly time 564,000
Software installation and testing Number of software applications 1,316,000
Packaging Number of units 752,000
Total 3,760,000

Further details have also been ascertained as follows:

HD USB MC
Budgeted production units 5,000 20,000 6,000
Average number of units per order 10 50 30
Number of parts per unit 35 20 15
Assembly time per unit (minutes) 30 20 15
Number of software applications per
unit 3 2 1

REQUIRED:

a) Calculate the total gross profit for each product using the ABC system.

Drury Adapted

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Revision Exercise 3.5

CC (Pty) Ltd manufactures three types of motorbikes: 50CC, 100CC and 250CC.
Historically, the company has allocated all manufacturing overhead costs using total direct
labour hours and is now considering introducing activity-based-costing (ABC). The
accountant has produced the following analysis.

50CC 100CC 250CC

Annual output units 1,200 800 1,000
Annual direct labour hours 130,000 96,000 74,000
Selling price per unit (Rand) 35,000 50,000 75,000
Raw material cost per unit (Rand) 4,000 6,000 8,000

The three cost drivers that generates overheads are:

Deliveries to retailers: the number of deliveries of motorcycles to retail showrooms.
Set-ups: the number of times the assembly line process is re-set to accommodate
production run of a different type of motorcycle.
Purchase orders: the number of purchase orders.
The annual cost driver volumes relating to each activity and for each type of motorcycle
are as follows:

50CC 100CC 250CC

Number of deliveries to retailers 120 60 80
Number of set-ups 40 35 45
Number of purchase orders 200 150 250

Annual costs relating to these activities are as follows:

Activity Rand
Deliveries to retailers 2,100,000
Set-up costs 4,500,000
Purchase orders 2,400,000

Direct labour is paid at a cost of R60 per hour. The company holds no stock.

REQUIRED:

a) Calculate the profit on each of CC’s three product types using each of the following
methods to allocate overheads:

1. Traditional method.
2. ABC method.
Drury Adapted

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Learning Unit 4: Methods of inventory valuation

Learning Objectives: My notes
• Determine the cost of inventories.
• List the different categories of inventory.
• Value inventory on the First-in-First-out basis.
• Value inventory on the Weighted Average basis.
Material used for this learning unit:
• Content supplemented from various sources.
• IAS2 of the International Financial Reporting Standards.
Prescribed material used for this learning unit:
• Content supplemented from various sources, including
IAS2 of the International Financial Reporting Standards.

Introduction
In this Learning unit we will look at different types of inventories and how to apply different
methods of inventory valuation. We will focus mainly on the First-in-first-out (FIFO) and
the weighted average method of inventory valuation.

When inventory is issued to production, we are issuing raw materials to the production
process for conversion into finished goods. The cost of this issue is not always simple to
determine, since inventory of the same type may be purchased at different prices during
the same period. It is because of this reason that the above methods were developed for
the valuation of inventory.

Cost of inventories
The cost of inventory includes:

• Purchase price.
• Import duties and other taxes not subsequently recoverable by the company.
• Transport.
• Handling.
• Any other costs directly attributable to the acquisition of finished goods.

Trade discounts, rebates and other similar items will be deducted from the cost of the
inventory.

In the case of a manufacturing company, conversion costs (direct labour and

manufacturing overheads) are included as part of the cost of inventory of finished goods.

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Any other costs incurred in bringing inventory to their present location and condition will
also be included in the cost of inventory.

Inventory must be measured at the lower of cost and net realisable value.

A manufacturing company will have different types of inventories, which include the
following four categories:

Work-in-process
Raw materials Consumables Finished Goods
(WIP)
•These are the •This type of •This type of •As soon as the
materials inventory is inventory product has been
purchased that normally used by includes completed in
need to be more than one conversion costs. terms of
converted into department and Raw materials manufacturing it
the finished would be an transferred to is transferred
product. indirect cost. WIP is now from WIP to
Sometimes it is recorded as a Finished Goods.
expensed rather part of WIP and This product will
than recorded as not as raw include all raw
an asset. materials materials, labour
anymore. Added and
to this would be manufacturing
the cost of overheads
conversion allocated.
charged.

The FIFO method of inventory valuation

The FIFO (First-in-first-out) method assumes that inventory items purchased or produced
first, are sold first. Therefore, the inventory at the end of the period will be valued at the
latest purchase or production price.

The weighted average method of inventory valuation

With the weighted average method, the weighted average cost of items purchased or
produced at the beginning of the period (the opening balance) and cost of items purchased
or produced during the period is determined. The average price per unit will be
recalculated every time a new purchase is made, or goods are transferred to finished
goods, or when goods are returned to the supplier. However, whenever goods are issued
to production or returned to the warehouse this will not affect the weighted average price
per unit.

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Activity 4.1

The warehouse clerk of INV Limited presents you with the following information on material
NRV007:

Date Transaction details

August
1 Opening inventory 150 units at R 120 each
5 Purchased 160 units at R 135 each
11 Issued 180 units to production
15 Purchased 200 units at R 140 each
Freight charges of R 3 000 were paid for this order
21 Returned 50 units purchased on 5 August to the supplier
26 Issued 100 units to production
31 Returned 40 excess units from factory to stores

REQUIRED

a) Calculate the value of inventory on 31 August using the FIFO method of inventory
valuation.
b) Calculate the value of inventory on 31 August using the weighted average method
of inventory valuation.

Revision Exercises

Revision Exercise 4.1

The warehouse clerk of BestEd Limited presents you with the following information on
material Sta152:

Date Transaction details

March
1 Opening inventory 250 units at R 2.30 each
4 Purchased 1 200 units at R 2.40 each
9 Issued 800 units to production
12 Purchased 600 units at R 2.50 each
Freight charges of R 300 were paid for this order
19 Returned 100 excess units from factory to stores
24 Issued 1 000 units to production
31 Returned 100 units purchased on 12 March to the supplier

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REQUIRED

a) Calculate the value of inventory on 31 March using the FIFO method of inventory
valuation.
b) Calculate the value of inventory on 31 March using the weighted average method of
inventory valuation.

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Learning Unit 5: Job costing systems

Learning Objectives: My notes
• Identify a job costing system.
• Record costs in a job costing system.
• Calculate the profit or loss per job.
Material used for this learning unit:
• Chapter 4 of the prescribed textbook.
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 4:
o Recording the purchase of raw materials.
o Recording the issue of raw materials.
o Accounting procedure for labour costs.
o Accounting procedure for manufacturing overheads.
o Non-manufacturing overheads.
o Accounting procedures for jobs completed and jobs
sold.
o Costing profit and loss account.

Introduction
A job costing system is an example of a product costing system. A product costing system
deals with the accumulation, processing and recording of costs. A job costing system is
suitable to organisations that manufacture unique products according to their client’s
specifications. These ‘jobs” are specialised and can sometimes be “once off”. A job costing
system calculates the cost of the product/job by identifying the direct material, direct labour
and manufacturing overheads used by each job. By doing this, you can set a selling price.

In this learning unit, we will look at how job costing is identified as well as recorded. We
will conclude by calculating the profit or loss per job.

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Manufacturing cost flow through ledger accounts

Input of Work-in- Finished Cost of Sales

•Raw material process Goods •Product sold
•Conversion of •Product
product takes transferred
place from WIP

With a job costing system, both sub-ledgers and the general ledger are used. A separate
sub-ledger account is created for each job. This is reconciled into the work-in-process
account.

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Direct Material (SFP) Job 1 (Sub-ledger)

Opening balance xxx Job 1 xxx Direct material xxx Finished goods xxx
Bank/creditors xxx Job 2 Material xxx Direct labour xxx
Job 3 issued xxx Manufacturing Credit
to jobs
overheads xxx total cost
xxx xxx xxx when job xxx
is finished

Direct Labour Control (SFP) Job 2 (Sub-ledger)

Bank/creditors xxx Job 1 xxx Direct material xxx
Labour
Job 3 xxx xxx xxx
charged
xxx to jobs xxx

Manufacturing Overheads Control (SFP) Job 3 (Sub-ledger)

Indirect material xxx Job 1 xxx Direct material xxx
Indirect labour xxx Job 3 Manuf xxx Direct labour xxx
O/H
Manufacturing
Bank/creditors xxx APPLIED overheads xxx
Actual O/H to jobs
incurred
xxx xxx xxx xxx

Over/under
recovered

Indirect Material Inventory (SFP) Finished Goods (SFP)

Manufacturing xxx
Bank/creditors xxx overheads xxx Job 1 Cost of sales xxx
xxx xxx xxx xxx

Credit total COST

when job is sold

Indirect Labour Control (SFP) Cost of Sales (P/L)

Manufacturing
Bank/creditors xxx overheads xxx Finished goods xxx
xxx xxx xxx xxx

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Activities

Activity 5.1

Moz Art (Pty) Ltd manufactures curios which are sold mostly to foreign tourists at border
posts entering Mozambique. Each job is unique and handmade.

The company wants you, a management accountant to help them determine the cost of
each job using the job costing system.

The following balances were extracted from the books of Moz Art (Pty) Ltd on 1 March
2019:

R
Direct material 120 000
Bank 24 500
Sales expenses 3 600

March 2019 costs have been allocated to jobs as follows:

Job Material Wages

R R
Straw Hats 18 250 12 240
Wooden Fishes 32 860 24 560
Beaded Necklaces 12 640 8 960
Colourful fabric 6 580 -

Additional information

1. Actual manufacturing costs incurred during the month are R 64 220.

2. Mark-up of 70% is added to the total of each job’s cost to arrive at the selling price
of the job.
3. Overheads are applied to production using the rate of 80% of direct material cost.
4. Job Straw Hats, Wooden Fishes and Beaded Necklaces were completed and
transferred to the finished goods account.
5. Job Straw Hats and Beaded Necklaces were sold on 31 March 2019.

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REQUIRED

a. Prepare the following general ledger accounts, properly balanced:

• Direct material control

• Manufacturing overhead control
• Work-in-process control
• Finished goods

b. Calculate the profit or loss of Moz Art (Pty) Ltd for the month ended 31 March 2019.

[Round off all calculations to the nearest Rand.]

Revision Exercises

Revision Exercise 5.1

Ntombi Traders (Pty) Ltd manufactures customised products for their customers. The
following information was obtained for the month of July 20X1:

Direct material control account – opening balance R 26 000

Direct materials purchased during July 20X1 R 78 000

Direct materials required by the individual jobs during the month were as follows:
R
Job A R 32 000
Job B R 27 000
Job C R 15 000

The direct wages for the month (all paid in cash) were as follows:
R
Job A (800 hours) R 16 000
Job B (990 hours) R 19 800
Job C (380 hours) R 7 600

Additional information:

• Jobs A, B and C were started in July 20X1.

• Job A was completed during July 20X1 and the customer invoiced for R75 000.
• The pre-determined manufacturing allocation rate is R15 per direct labour hour.
• Actual manufacturing overhead costs for 20X1 are R 35 000.

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REQUIRED

a) Prepare the following general ledger accounts for Ntombi Traders (Pty) Ltd for the
month July 20X1 (also balance the accounts):

i. Material control account.

ii. Salaries and wages control account.

b) Prepare the following cost ledger accounts for Ntombi Traders (Pty) Ltd for the
month July 20X1 (also balance the accounts):

i. Job A.
ii. Job B.

c) Calculate the total over/under applied overheads (all jobs) for July 20X1 and draft a
journal entry showing how this over/under application will usually be dealt with in the
company’s financial records at the end of the period.

Revision Exercise 5.2

Extreme Carts (Pty) Ltd manufactures highline go-carts according to their clients’
specifications. You have the following information available regarding March 20X1:

Job Greatone Job Meanteam

Opening WIP – 01/03/20X1 R 20 000 -
Direct material actually used R 8 000 R 18 000
Actual direct labour hours 8 employees worked 16 employees
48 hours each on the worked 36 hours
job each on the job
Budgeted direct labour hours 400 600
Actual direct labour rate per hour R 40 R 30
Variable manufacturing overhead rate per R 12 R 12
direct labour hour

Additional information:
• Total budgeted fixed overheads for March 20X1 were R 16 000. Fixed manufacturing
overheads are recovered based on direct labour hours.
• Total actual fixed overheads for March 20X1 were R 14 000. There were no other
jobs than the above two jobs being worked on or budgeted for in March 20X1.
• Job Meanteam was completed on 31 March 20X1 and immediately charged to the
client at a selling price of R 65 000.
• Job Greatone was incomplete on 31 March 20X1.
• The direct materials opening balance on 1 March 20X1 was R 15 000 and additional
materials with a cost price of R 38 000 was purchased in March 20X1.

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REQUIRED

a) Calculate the following:

i. Total profit or loss on Job Meanteam.

ii. Total inventory value on 31 March 20X1.

b) Prepare the work-in-process control account in the general ledger for March 20X1.
Balance the account properly.

Revision Exercise 5.3

Magnificent Fans (Pty) Ltd manufactures customised industrial fans and uses a job costing
system. The company wants you, a management accountant to help them determine the
cost of each fan manufactured during the month of March 20X1.

The following balances were extracted from the accounting records of Magnificent Fans
(Pty) Ltd on 1 March 20X1:
R
Direct material 210 000
Bank 189 000

The following information is available for March 20X1:

X3000 X4520 X5850

Direct material issued to jobs R120 500 R180 300 R215 600
Direct labour hours 1 100 1 600 2 100

Additional information

1. Direct material for R440 300 was purchased during the month.
2. Labour is paid at a cost of R50 per hour.
3. Manufacturing overheads are applied to production using direct labour hours.
4. Budgeted manufacturing overhead costs for March 20X1 were R360 000. Labour
hours budgeted for X3000 were 950 hours, for X4520 1 400 hours and for X5850 1
900 hours. Actual manufacturing costs incurred during the month were R372 000.
5. Magnificent Fans (Pty) Ltd applies a 30% sales margin.
6. Job X3000 and X5850 were completed and transferred to the finished goods
account.
7. Job X3000 was sold on 31 March 20X1.

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REQUIRED

Prepare the following general ledger accounts, properly balanced:

• Direct material control.

• Wages control.
• Manufacturing overhead control.
• Work-in-process control.
• Finished goods.
• Cost of sales.

Calculate the profit or loss of Magnificent Fans (Pty) Ltd for the month ended 31 March
20X1.

Revision Exercise 5.4

Bags Galore (Pty) Ltd produces customised bags and uses a job costing system. The
company wants you, a management accountant to help them determine the cost of each
bag produced during the month of March 20X1.

The following balances were extracted from the accounting records of Bags Galore (Pty)
Ltd on 1 March 20X1:

R
Direct material 25 400

The following information is available for March 20X1:

Hand Sporty Deluxe Leisure
Luxurious Galore
Direct material issued to jobs R1 200 R860 R1 850
Direct labour hours 6 8 10.5

Additional information

• Direct material for R2 300 was purchased during the month.

• Labour is paid at a cost of R60 per hour.
• Manufacturing overheads are applied to production using 60% of direct material
cost.
• Budgeted manufacturing overhead costs for March 20X1 were R2 500. Actual
manufacturing costs incurred during the month were R2 100.
• Bags Galore (Pty) Ltd applies a 60% mark-up.
• Job Hand Luxurious and Sporty Deluxe were completed during the month.
• Job Sporty Deluxe was sold on 31 March 20X1.

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REQUIRED

1. Prepare the following general ledger accounts, properly balanced:

• Direct material control.

• Manufacturing overhead control.
• Finished goods.
• Cost of sales.

2. Prepare the following cost-ledger accounts, properly balanced:

Hand Luxurious
Leisure Galore

3. Calculate the profit or loss of Bags Galore (Pty) Ltd for the month ended 31 March
20X1.

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Learning Unit 6: Process costing systems

Learning objectives: My notes
• Describe the users of a process costing system.
• Calculate the completed units and the equivalent units for
work-in-process (WIP).
• Prepare the quantity statement based on the weighted
average method of inventory valuation.
• Prepare the quantity statement based on the first-in-first-
out (FIFO) method of inventory valuation.
• Calculate the normal loss for a specific period, depending
on the wastage point.
• Calculate the abnormal loss for a specific period,
depending on the wastage point.
• Prepare the production cost statement based on the
weighted average method of inventory valuation.
• Prepare the production cost statement based on the first-
in-first-out (FIFO) method of inventory valuation.
• Prepare the allocation statement based on the weighted
average method inventory valuation.
• Prepare the allocation statement based on the first-in-
first-out (FIFO) method of inventory valuation.
• Record process costs in the general ledger.
• Allocate process costs in the general ledger.
Material used for this learning unit:
• Chapter 5 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 5:
o Process costing when all output is fully complete.
▪ No losses within the process.
▪ Normal losses within process with no scrap
value.
▪ Abnormal losses in process with no scrap
value.
o Process costing with ending work in progress
partially complete.
▪ Elements of costs with different degrees of
completion.
o Beginning and ending work in progress of
uncompleted units.
o Partially completed output and losses in process.
▪ Appendix 5.1: Losses in process and
partially completed units.

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Introduction
Certain products are produced as a part of a process, for example chemicals, medicines,
beverages, processed foods, etc. These products are produced on a continuous basis for
a general market, i.e., not for a particular client and not according to their specifications.
There is nothing unique about the product, products are produced in masses.

The challenge, which we will cover in this learning unit, is to determine the cost per product
due to units being identical and produced in masses. The purpose of a process costing
system is to help us determine the cost per unit of output to set prices, report profits
accurately and for the valuation of inventory in terms of the International Financial
Reporting Standard on Inventory (IAS 2).

In this learning unit, we will describe the users of a process costing system. We will look
at how to calculate the completed units and the equivalent units for work-in-process (WIP).
We will further prepare the quantity statement using the weighted average and first-in-first-
out (FIFO) methods of inventory valuation. Thereafter we calculate the normal loss for a
specific period, depending on the wastage point.
It is the above process that will allow us to prepare the production cost statement based
on both the weighted average method and first-in-first-out (FIFO) methods of inventory
valuation.

We will also look at the normal loss and the abnormal loss for a specific period, depending
on the wastage point. We look at how to prepare the allocation of statement based on the
weighted average and First- in- First- Out methods of inventory valuation. We will conclude
by looking at how to record and allocate costs in the general ledger.

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The following is an example of the process of how electricity is produced:

Flow of production by means of a single process

For MFAC6211 we will only be dealing with a single process. For purposes of this module,
you can also assume that material will always be added at the beginning of the process
and conversion will take place evenly throughout the process. The following figure is an
illustration of how input of material is converted to the final product of output:

Material issued, 100% of

100% of material conversion cost
cost included, 0% incurred, product
of conversion cost complete

0% Conversion process, % of completion 100%

During the conversion process the raw material is converted into the final product.
Remember that conversion cost includes labour and manufacturing overheads.
Therefore, all the components of product cost are included in the end: direct material,
direct labour, manufacturing overheads.

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Work-in-process (WIP), equivalent units and the quantity

statement
In practice, it will never be the case where all units have been started in the current period
and all units have been completed in the current period. Therefore, units for the period will
consist of the following:

• Units that have been transferred from a previous period that have been started in
that period, but were not completed in that period, therefore need to be completed
in the current period. This is called Opening WIP.
• Units that have been started and completed in the current period.
• Units that have been started in the current period, but at the end of the period have
not been completed yet. This is called Closing WIP.

The problem is that we need to calculate a cost per unit for accounting purposes; and now
we have some units that are partially completed and some units that have been completed,
but these units are not necessarily separately identifiable. To overcome this problem, a
concept called equivalent units has been introduced.

Equivalent units

When we have units that have been partially completed, we convert these units into a
comparable number of fully completed units and these units are then called equivalent
units. What this means is that if we have 1 000 units that have been 60% complete in
terms of conversion, we will have 600 completed units in terms of conversion. Therefore
600 equivalent units. If unit costs are R 20 per unit, the total cost would be R 20 x 600
units = R 12 000.

We will use the quantity statement for calculating equivalent units where we distinguish
between physical units (the incomplete units which can physically be counted) and the
equivalent units (the partially completed units converted to equivalent completed units).
When we calculate equivalent units, we also need to distinguish between the different
components of product cost (material and conversion cost) since material is added at the
beginning of the process and conversion takes place evenly throughout the process, as
noted earlier in this learning unit.

Since material is always added at the beginning of the process (when the process is 0%
complete) the equivalent units for material will always be calculated based on 100% of
completion.

Conversion (labour and overheads) takes place evenly throughout the process and
therefore if 30% of conversion has been done in the period, 30% of the units will be
equivalent to completed units.

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If units were transferred from a prior process, it must be noted that material was already
added in the previous process (at the start of the process) and that only a certain amount
of conversion still needs to be done. Therefore, if Opening WIP units were received in this
period being 40% complete, only 60% conversion needs to take place in the current period
and therefore the equivalent units in terms of conversion will be 60% of physical units.

Activity 6.1

Stay Soft (Pty) Ltd manufactures detergent in a single process and make use of a process
costing system.

The following information is available for April 20X1:

Opening WIP 80 000 units

Conversion 30% complete
New units started/put into production 300 000 units
Closing WIP 60 000 units
Conversion 60% complete

Material is added at the beginning of the process and conversion takes place evenly
throughout the process.

REQUIRED

Calculate the following:

a) The equivalent units included in opening WIP (separately for material and
conversion).
b) The production work required to complete opening WIP (in terms of equivalent
units).
c) The units completed.
d) The equivalent units included in closing WIP.

Inventory valuation methods

We need to distinguish between two inventory valuation methods: The First-in-first-out

(FIFO) and weighted average method of inventory valuation.

With the weighted average method, we add together all units to calculate a weighted
average cost per unit, whilst with the FIFO method we split the units between units
received from Opening WIP and units started and completed in the current month.

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The quantity statement

The quantity statement is used to calculate the equivalent units. The equivalent units are
based on the physical units and percentage of completion of both material and conversion.

Illustrative example 1

Fresh Fruit (Pty) Ltd manufactures fruit juice in a single process and makes use of a
process costing system.

The following information has been obtained for June 20X1:

Opening WIP (30% complete) 50 000 units

Put into production 180 000 units
Completed and transferred 200 000 units
Closing WIP 30 000 units

Additional information

• The company uses the FIFO method of inventory valuation.

• Closing WIP is 70% complete.

We received our OWIP

when it was already 30%
complete, so we just
need to finish it FROM
30% TO 100%

Opening WIP –
30% Complete

Closing WIP –
70% Complete 100%
0%
We start a product when
it is 0% complete and
We STARTED our CWIP at 0%,
when it is complete it is a
because it is NOT complete yet.
100% complete, therefore
Therefore, we START at 0% and we
the process starts at 0%
completed it UP TO 70%
and ends at 100%

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THIS STATEMENT IS ABOUT QUANTITIES!!

Quantity Statement - FIFO

Physical Units Equivalent Units
Description Material Conversion What you
Input Outputs Units % Units % still must
50 000 Opening WIP complete
This is a balancing in the
180 000 Put into Production figure: 200 000 – 50 000 current
Completed and
process
Transferred: 200 000 150 000 185 000
- Opening WIP 50 000 - 0% 35 000 70%
- Current Production 150 000 150 000 100% 150 000 100%
Closing Stock 30 000 30 000 100% 21 000 70%
230 000 230 000 180 000 206 000
Input ALWAYS equals Output
% up to where
ALWAYS 0% CWIP was
completed

The following is an illustration of how the Quantity Statement would differ should
the company make use of the weighted average method of inventory valuation:

Quantity Statement – Weighted Average

Physical Units Equivalent Units
Material Conversion
Input Description Outputs Units % ThisUnits %
line is the only
50 000 Opening WIP difference between the 2
180 000 Put into Production methods
Completed and
Transferred 200 000 200 000 100% 200 000 100%
Closing Stock 30 000 30 000 100% 21 000 70%
230 000 230 000 230 000 221 000

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Losses
Thus far we have dealt with a process costing system in an ideal situation. However, in
practice there will always be losses. Losses are units lost in the production process due
to, for example, evaporation and spillage. The input units (what was put into production)
will never be equal to the output units (units completed and transferred). These losses can
be classified as either normal or abnormal losses.

Normal versus abnormal losses

The table below is a comparison of normal losses versus abnormal losses:

Normal losses Abnormal losses

These losses are also called uncontrollable These losses are also called controllable
losses. They exist due to the nature of the losses. They are not a part of the nature of the
business. You cannot avoid or control them. business. You can avoid or control them.
They are inherent to the business and will be
there regardless.
You will set a percentage of what would be The abnormal loss are all units lost that were
expected to be the normal loss based on past not within the expected parameter of the
experience. This percentage is what the organisation. The abnormal loss units indicate
organisation deems acceptable as a loss in a ineffectiveness of the process.
normal production run. It does not indicate that
the process is ineffective.

Examples: Examples:

• Evaporation in a chemical process • Wastage due to the use of raw material

• Off-cuts of materials where clothes are of inferior quality
produced • Wastage due to employee carelessness
• Any units rejected within the • Wastage due to production interruption
acceptable parameter (estimated (due to, for example, electricity failure)
percentage of normal loss)

The “where” wastage occurs versus the “how many units” were
lost

The below is an extract from a question:

“Wastage occurs when the process is 70% complete. Normal wastage amounts to 5% of
inputs that reach the wastage point.”

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From this extract we can determine the following: The 70% is the point in the process
“where” the wastage takes place (the wastage point). This is important to know, because
in terms of conversion cost on your quantity statement you have incurred 70%, which
means that your equivalent units for the normal loss for conversion would be equal to the
physical units lost times the 70%. This is because you have been paying conversion costs
up until 70% of the process where you then lost the units, after which you no longer have
to pay conversion costs on those lost units anymore.

The 5% is used to determine the “how many units” of the normal loss. To calculate the
“how many units” of the normal loss you first need to calculate how many units were
subject to the normal loss and then times that by the 5%. This would be the physical units
of the normal loss.

From this you can conclude that the 70% would be used to calculate the equivalent units
in terms of conversion cost and the 5% would be used to calculate the physical units in
your output column.

Calculating the normal loss in units

As mentioned above, to calculate the normal and abnormal loss units you need the point
in the process where the loss occurred to determine how many units were subject to loss
point and you will need the percentage of units lost to calculate the number of physical
units lost. The point in the process where the loss occurs will then also be used to calculate
the equivalent units in terms of conversion costs for use in the quantity statement.

The below Illustrative example demonstrates the calculation of the normal loss units in
different scenarios:

Illustrative example 2

Fresh Fruit (Pty) Ltd manufactures fruit juice in a single process and makes use of a
process costing system.

The following information has been obtained for June 20X1:

Opening WIP (30% complete) 50 000 units

Put into production 180 000 units
Completed and transferred 200 000 units
Closing WIP 25 000 units

Additional information

• Closing WIP is 70% complete.

• Normal losses amount to 2% of inputs that reach the wastage point.
This is the info to
calculate the “how
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many” physical units
were lost
IIE Module Workbook MFAC6211

REQUIRED

Losses occur at the following points in the process:

This is to calculate “where” in the
a) 10%
process (the wastage point) wastage
b) 50% occurred. Therefore, to calculate
c) 100% equivalent units for conversion.

REQUIRED

Calculate the normal loss in units if losses occur as mentioned above.

a) All units that crossed the

Opening WIP – wastage point are
30% Complete subject to the 2% loss
Wastage
Occurs at
10%

Closing WIP –
100%
0% 70% Complete

Calculating the normal loss:

Total input (50 000 + 180 000) 230 000
Subtract units that did not cross the wastage point:
Opening WIP (50 000)
Units subject to loss 180 000
Normal loss @ 2% 3 600

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b)
Wastage
Opening WIP – Occurs at
All units that crossed
30% Complete 50%
the wastage point are
subject to the 2% loss

Closing WIP – 100%

0% 70% Complete

Calculating the normal loss:

Total input (50 000 + 180 000) 230 000
Subtract units that did not cross the wastage point:
All units crossed the wastage point ( -)
Units subject to loss 230 000
Normal loss @ 2% 4 600

c) All units that crossed

the wastage point are
subject to the 2% loss
Opening WIP – Wastage
30% Complete Occurs at
100%

0%
Calculating the normal loss: Closing WIP –
70% Complete
100%
Total input (50 000 + 180 000) 230 000
Subtract units that did not cross the wastage point:
Closing WIP (25 000)
Units subject to loss 205 000
Normal loss @ 2% 4 100

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Losses in the quantity statement

There will now be two-line items added in the quantity statement: Normal losses and
abnormal losses. After calculating the number of units of the normal loss as per 4.3 above,
this will be transferred to the quantity statement. Remember that the calculation of the
normal loss in 4.3 was the loss of physical units. In terms of equivalent units, you now
must use the wastage point (percentage in the process where losses occur) to calculate
the equivalent units for conversion. Equivalent units for material will still be calculated as
a 100% of physical units since all materials have been added at the beginning of the
process.

Illustrative example 3

Using the information provided in Illustrative example 2, prepare the following:

a) The quantity statement according to the FIFO method of inventory valuation if all
wastage occurs at the end of the process.
b) The quantity statement according to the weighted average method of inventory
valuation if all wastage occurs when the process is 10% complete.

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a)
Quantity Statement - FIFO - opening stock completed includes units wasted
Physical Units Equivalent Units
What you
Material Conversion
still must
Input Description Outputs Units % Units % complete in
50 000 Opening WIP the current
180 000 Put into Production This is a balancing process
Completed and figure: 200 000 – 49 000
Transferred from: 200 000
- Opening WIP 49 000 - 0% 34 300 70%
- Current Production 151 000 151 000 100% 151 000 100%
% WHERE
Normal Loss 4 100 4 100 100% 4 100 100%
wastage
Abnormal Loss 900 900 100% 900 100% occurs
Closing WIP 25 000 25 000 100% 17 500 70%
230 000 230 000 181 000 207 800

Input ALWAYS equals Output

% up to where
Our Opening WIP went CWIP was
through the wastage This is a balancing completed
ALWAYS 0%
point, THEREFORE we figure: 230 000 – 200
LOST 2% of it 000 – 4 100 – 25 000

b)
Quantity Statement – Weighted Average
Physical Units Equivalent Units
Material Conversion
Input Description Outputs Units % Units % % up to where
50 000 Opening WIP CWIP was
180 000 Put into Production completed
Completed and
Transferred 200 000 200 000 100% 200 000 100% % WHERE
Normal Loss 3 600 3 600 100% 360 10% wastage
Abnormal Loss 1 400 1 400 100% 140 10% occurs
Closing WIP 25 000 25 000 100% 17 500 70%
230 000 230 000 230 000 218 000

Input ALWAYS equals Output This line is the only difference regarding
the format between the two methods.
You now don’t have two separate line
This is a balancing items for Opening WIP and Current
figure: 230 000 – 200 production, but just one line for
000 – 3 600 – 25 000 Completed and transferred, ALWAYS
100% for BOTH material and conversion.
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Activity 6.2

Delicious Rusks (Pty) Ltd produces one product in a single process and uses a process
costing system. The following information is available for June 20X1:

Units
Work-in-process:
1 June 20X1 – 30% completed 180 000
30 June 20X1 – 80% completed 110 000
Started (put into production) in June 420 000
Completed in June 460 000

Additional information:

• Raw materials are added at the beginning of the process and conversion takes place
evenly throughout the process.
• Normal losses are estimated as 5% of units that reach the wastage point.

REQUIRED

a) Prepare the quantity statement according to the weighted average method of

inventory valuation, assuming wastage takes place when the process is 20%
complete.
b) Prepare the quantity statement according to the FIFO method of inventory valuation,
assuming wastage takes place at the end of the process.

Production cost statement

Once you have completed the quantity statement, you can now do the production cost
statement. The purpose of the production cost statement is to calculate the average cost
per unit. To do this, you need the cost incurred for the period and the equivalent units
calculated in the quantity statement. The calculation for the FIFO and weighted average
methods of inventory valuation will once again be done differently.

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Illustrative example 4

For this example, use the quantity statements prepared in Illustrative example 3.
In addition, the following cost information is available for June 20X1:

R
WIP: 1 June 20X1
Material 120 000
Conversion 250 000
Material added during June 20X1 520 000
Labour for June 20X1 650 000
Overheads for June 20X1 320 000

REQUIRED

Prepare the following:

a) The production cost statement according to the FIFO method of inventory valuation
if all wastage occurs at the end of the process. Use the quantity statement prepared
in a) of Illustrative example 3.
b) The production cost statement according to the weighted average method of
inventory valuation if all wastage occurs when the process is 10% complete. Use
the quantity statement prepared in b) of Illustrative example 3.

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a) Production cost statement - FIFO

Total Material Conversion
Opening WIP 370 000 - -
Current Production 1 490 000 520 000 970 000
TOTAL 1 860 000 520 000 970 000

Equivalent Units 181 000 207 800

Average Cost per Unit 7.54 2.87 4.67

For FIFO these

totals will
always be ZERO
These are the units as
Cost per unit = Total Cost / per the equivalent
Equivalent units, i.e. 520 000 / statement
181 000 and 970 000 / 207 800

b) Production cost statement – Weighted Average

Total Material Conversion
Opening WIP 370 000 120 000 250 000
Current Production 1 490 000 520 000 970 000
TOTAL 1 860 000 640 000 1 220 000

Equivalent Units 230 000 218 000

Average Cost per Unit 8.38 2.78 5.60

For weighted average

these totals will
always be included
These are the units as
Cost per unit = Total Cost / per the equivalent
Equivalent units, i.e. 640 000 / statement
230 000 and 1 220 000 / 218 000

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Activity 6.3

The following quantity statement is available for Delicious Rusks (Pty) Ltd for June 20X1:

Physical Units Equivalent Units

Material Conversion
Input Description Outputs Units % Units %
180 000 Opening WIP
420 000 Put into Production
Completed and Transferred 460 000 460 000 100% 460 000 100%
Normal Loss 21 000 21 000 100% 4 200 20%
Abnormal Loss 9 000 9 000 100% 1 800 20%
Closing WIP 110 000 110 000 100% 88 000 80%
600 000 600 000 600 000 554 000

In addition, the following cost information is available for June 20X1:

R
WIP: 1 June 20X1
Material 260 000
Conversion 380 000
Material added during June 20X1 630 000
Labour for June 20X1 420 000
Overheads for June 20X1 380 000

REQUIRED

Prepare the production cost statement for June 20X1 under the assumption that Delicious
Rusks (Pty) Ltd uses the weighted average method of inventory valuation.

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Activity 6.4

The following quantity statement is available for Delicious Rusks (Pty) Ltd for June 20X1:
In addition, the following cost information is available for June 20X1:

Physical Units Equivalent Units

Output Material Conversion
Input Description s Units % Units %
180
000 Opening WIP
420
000 Put into Production
Completed and Transferred 460
from: 000
171 119
- Opening Stock 000 - 0% 700 70%
289 289 100 289 100
- Current Production 000 000 % 000 %
100 100
Normal Loss 24 500 24 500 % 24 500 %
100 100
Abnormal Loss 5 500 5 500 % 5 500 %
110 110 100
Closing WIP 000 000 % 88 000 80%
600 600 429 526
000 000 000 700

In addition, the following cost information is available for June 20X1:

R
WIP: 1 June 20X1
Material 260 000
Conversion 380 000
Material added during June 20X1 630 000
Labour for June 20X1 420 000
Overheads for June 20X1 380 000

REQUIRED

Prepare the production cost statement for June 20X1 under the assumption that Delicious
Rusks (Pty) Ltd uses the FIFO method of inventory valuation.

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Allocation statements
Ultimately, we want to value closing inventory in the financial statements. This is done in
the allocation statements. If you think back to what we have done earlier in this module,
inventory is made up of:

• Raw materials;
• Work-in-progress; and
• Finished/Completed goods.

So how is cost allocated to these accounts? To get the total cost of inventory you would
times the number of units with the cost per unit. The number of units from the quantity
statement (equivalent units) will be used and the cost per the production cost statement
will be used.

Once again there will be a difference between the weighted average method and the FIFO
method of inventory valuation. The difference would be in the structure/layout of the
allocation statement as illustrated below.

The cost allocation statement is made up of the following line items:

Line item Weighted average FIFO method

method
1 Opening WIP N/A Included
2 Current production N/A Included
3 Completed and transferred Included Included (this will only
be a total line of 1)
and 2) above)
4 Abnormal loss Included Included
5 Closing WIP Included Included

As per the above you will see that there are separate line items for Opening WIP and
Current production for the FIFO method of inventory valuation which was also the case
with the quantity statement. Basically, the line items in the allocation statement are the
line items as per the quantity statement, except that there is no line item for the normal
loss. Why is this? The normal loss is a part of the nature of the business – it is inherent
to the production process. In terms of International Financial Reporting Standards
(IFRS), normal losses should be included in inventory, therefore be allocated to the other
components of inventory. This is why we allocate the normal loss. To include it in the cost
of the other components of inventory.

Note that abnormal losses are not a part of inventory and will be treated as a period cost
in the financial statements.

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Calculating the Rand value of the normal loss

As mentioned above, the normal loss needs to be allocated to the other line items as per
the allocation statement. To do this, we need to first calculate the Rand value of the normal
loss. Now remember, in the allocation statement we are working with equivalent units and
cost per unit. The cost per unit can be obtained from the production cost statement. What
are equivalent units made up of? Units for materials and units for conversion. These units
are not necessarily the same. As per the production cost statement we also have a
different cost for material and conversion. Therefore, the Rand value of the normal loss
will be made up of a Rand value for material and a Rand value for conversion.

Illustrative example 5

For this example, use the information given in Illustrative example 3 and 4 and calculate
the following:

REQUIRED

a) Calculate the Rand value of the normal loss according to the FIFO method of
inventory valuation.
b) Calculate the Rand value of the normal loss according to the weighted average
method of inventory valuation.

a) Rand value of the normal loss = Rand value of the normal loss for material
+ Rand value of the normal loss for conversion

Rand Value of the Normal loss R

Material (4 100 units x R 2.87) 11 767
Conversion (4 100 units x R 4.67) 19 147
Total 30 914

These are the units These are the costs for

from the quantity material and These Rand values now
statement for the conversion from the need to be allocated to
normal loss line item production cost the line items per the
statement allocation statement

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b) Rand value of the normal loss = Rand value of the normal loss for material
+ Rand value of the normal loss for conversion

Rand Value of the Normal loss R

Material (3 600 units x R 2.78) 10 008
Conversion (360 units x R 5.60) 2 016
Total 12 024

These are the units These are the costs for

from the quantity material and These Rand values now
statement for the conversion from the need to be allocated to
normal loss line item production cost the line items per the
statement allocation statement

Allocation of the Rand value of the normal loss

The Rand value calculated should now be allocated to inventory as required by IFRS
(noted above). The Rand value will be allocated to the following line items for both material
and conversion:

• Completed and transferred.

• Abnormal loss.
• Closing WIP.

It is important to note that if Opening WIP or Closing WIP did not go through the wastage
point, the Rand value will not be allocated to these line items since units were not subject
to loss.

Illustrative example 6

For this example, use the information given in Illustrative example 5 (including the
information given for Illustrative examples 3 and 4).

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REQUIRED

Allocate the Rand value of the normal loss for purposes of preparing the cost allocation
statement based on the following:

a) FIFO method of inventory valuation.

b) Weighted average method of inventory valuation.

a)
Allocated to: Material Conversion Total These total
Completed and transferred 11 697 19 054 30 752 amounts are
Abnormal loss 70 93 162 going to your
Closing WIP - - - Allocation
Total cost of normal loss 11 767 19 147 30 914 Statement
Equivalent units 151 900 186 200

Note that closing WIP did not go through normal loss

Allocate the Rand value calculated
to the line items, i.e.
Check your timeline Recalculate your units with
11 767 x 151 000 / 151 900 = 11 697;
– you can only what is “left” when taking out
11 767 x 900 / 151 900 = 70;
allocate the loss to normal loss units, i.e. 0 + 151
19 147 x (34 300 + 151 000) / 186 200
units that went 000 + 900 = 151 900 (Closing
= 19 054;
through the wastage WIP did NOT go through loss)
19 147 x 900 / 186 200 = 93
point

b)
Allocated to: Material Conversion Total These total
Completed and transferred 8 841 1 853 10 694 amounts are
Abnormal loss 62 1 63 going to your
Allocation
Closing WIP 1 105 162 1 267
Statement
Total cost of normal loss 10 008 2 016 12 024
Equivalent units 226 400 217 640

Note that opening WIP did not go through normal loss

Allocate the Rand value calculated

Check your timeline – you can only Recalculate your to the line items, i.e.
allocate the loss to units that went units with what is 10 008 x 200 000 / 226 400 = 8 841;
through the wastage point. However, “left” when taking 10 008 x 1 400 / 226 400 = 62;
this is the weighted average method. If out normal loss 10 008 x 25 000 / 226 400 = 1 105;
this was the FIFO method, you would units, i.e. 200 000 + 2 016 x 200 000 / 217 640 = 1 853;
have deducted opening WIP from the 1 400 + 25 000; 200 2 016 x 140 x 217 640 = 1;
completed and transferred. 000 + 140 + 17 500. 2 016 x 17 500 / 217 640 = 162

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Preparation of the allocation statement

As mentioned earlier, the allocation statement is prepared to allocate costs to line items
of inventory. You will make use of equivalent units per the quantity statement and the cost
per unit per the production cost statement. It is important to note that these units and costs
are subdivided into material and conversion. Therefore, there will be separate line items
for costs of material and conversion underneath each section of the allocation statement.
Further to this, there will also be a line item for the normal loss as Rand value allocated
above.

Illustrative example 7

For this example, use the information given in Illustrative example 6 (including the
information given for Illustrative examples 3, 4 and 5).

REQUIRED

Prepare the allocation statements based on the following:

a) FIFO method of inventory valuation.

b) Weighted average method of inventory valuation.

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a)
Allocation Statement - FIFO

Opening WIP
Material These are your costs 120 000
for OWIP as given in
Conversion 250 000
the information
Sub-total allocated 370 000

Current period production activities

Material 151 000 x R 2.87 433 370
Conversion (151 000 + 34 300) x R 4.67 865 351
Normal loss 30 752
Sub-total allocated 1 329 473
You will have a heading
for each line as per the

Completed and transferred Costs from the 1 699 473

quantity statement,
except normal loss

production

Illustrative example 6
Abnormal loss Units from cost statement

As allocated per
the quantity
Material 900 x R 2.87 2 583
statement
Conversion 900 x R 4.67 4 203
Normal loss 162
Sub-total allocated 6 948

Closing WIP
Material 25 000 x R 2.87 71 750
Conversion 17 500 x R 4.67 81 725
Normal Loss -
Sub-total allocated 153 475

Total cost allocated There will always 1 859 896

be a rounding
Rounding difference 104
difference as we
Total cost per production cost statement round off unit cost
1 860 000

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b)

Allocation Statement - Weighted Average

Completed and transferred

Material 200 000 x R 2.78 556 000
Conversion 200 000 x R 5.60 1 120 000
10 694
You will have a heading

Normal loss
for each line as per the
quantity statement,
except normal loss

Sub-total allocated 1 686 694

Costs from the

Illustrative example 6
As allocated per
Abnormal loss production
Units from cost statement
Material 1 400 x R 2.78 3 892
the quantity
Conversion statement 140 x R 5.60 784
Normal loss 63
Sub-total allocated 4 739

Closing WIP
Material 25 000 x R 2.78 69 500
Conversion 17 500 x R 5.60 98 000
Normal Loss 1 267
Sub-total allocated 168 767
There will always
be a rounding
Total cost allocated 1 860 200
difference as we
Rounding difference round off unit cost 200
Total cost per production cost statement 1 860 000

Activity 6.5
Refer to the information in Activity 6.3.

REQUIRED

Prepare the allocation statement for June 20X1 under the assumption that Delicious
Rusks (Pty) Ltd uses the weighted average method of inventory valuation. You can
assume that wastage takes place when the process is 20% complete.

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Activity 6.6

Refer to the information in Activity 6.4.

REQUIRED

Prepare the allocation statement for June 20X1 under the assumption that Delicious
Rusks (Pty) Ltd uses the FIFO method of inventory valuation. You can assume that
wastage takes place at the end of the process.

Revision Exercises

Revision Exercise 6.1

Moca Cola (Pty) Ltd manufactures one product in a single process and uses a process
costing system. The following information is available for April 20X1.

Units
Work-in-process:
1 April 20X1 – 40% completed 250 000
30 April 20X1 – 80% completed 180 000
Put into production in April 320 000
Completed and transferred in April 360 000

Additional information:

• The company uses the weighted average method of inventory valuation.

• Raw materials are added at the beginning of the process and conversion takes place
evenly throughout the process.
• Normal losses are estimated as 3% of units that reach the wastage point. Wastage
occurs when the process is 60% complete.
• Cost information for April 20X1 was as follows:

Material Conversion
R R
Work in process (1 April 20X1) 1 460 000 840 000
Current production cost 1 790 000 1 360 000

REQUIRED

a) Prepare the quantity statement.

b) Prepare the production cost statement.
c) Prepare the cost allocation statement.

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Revision Exercise 6.2

Tear Chip (Pty) Ltd manufactures one product in a single process and uses a process
costing system. The following information is available for September 20X1.

Units
Work-in-process:
1 September 20X1 – 20% completed 36 000
30 September 20X1 – 60% completed 22 000
Put into production in September 110 000
Completed and transferred in September 105 000

Additional information:

• The company uses the FIFO method of inventory valuation.

• Raw materials are added at the beginning of the process and conversion takes place
evenly throughout the process.
• Normal losses are estimated as 10% of units that reach the wastage point. Wastage
occurs when the process is 80% complete.
• Cost information for September 20X1 was as follows:

Material Conversion
R R
Work in process (1 September 20X1) 240 000 360 000
Current production cost 520 000 880 000

REQUIRED

a) Prepare the quantity statement.

b) Prepare the production cost statement.
c) Prepare the cost allocation statement.

Revision Exercise 6.3

Magnificent Process (Pty) Ltd manufactures a single product and uses a process costing
system. The company recorded the following information for the month of August 20X1:

Units
Opening WIP (1 August) 60% complete 16 000
Closing WIP (31 August) 75% complete 18 000
New units put into production in August 20X1 70 000
Completed in August 20X1 60 000

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Additional information:

• Normal losses are estimated at 4% of units that reaches the wastage point.
• Normal losses occur when the process is 70% complete.
• Raw materials are added at the beginning of the process and conversion takes
place evenly throughout the process.

REQUIRED

a) Prepare the quantity statement for August 20X1 based on the weighted average
method of inventory valuation.
b) Assume now that losses occur when the process is 90% complete. Prepare the
quantity statement for August 20X1 based on the new wastage point and the FIFO
method of inventory valuation.

Revision Exercise 6.4

ToothBest (Pty) Ltd manufactures a single product and applies a process costing system.
Materials are added at the beginning of the process and conversion takes place evenly
throughout the process. The following information is available for the month ended
February 20X1:

Costs (R)
Units Material Conversion
Opening work-in-process 70 000 260 500 189 050
Put into production 210 000 1 010 000 620 780

Additional information:

• Normal wastage is calculated as 6 out of every 50 units of the inputs that reach the
wastage point.
• A management accountant has prepared the following quantity statement as at 28
February 20X1:

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Quantity statement for February 20X1:

Physical Units Equivalent Units

Output Material Conversion
Input Description s Units % Units %
70 000 Opening WIP
210
000 Put into Production
Completed and Transferred 180
from: 000
- Opening WIP 70 000 - 0% 21 000 30%
110 110 100 110 100
- Current Production 000 000 % 000 %
100
Normal Loss 18 000 18 000 % 7 200 40%
100
Abnormal Loss 22 000 22 000 % 8 800 40%
100
Closing WIP 60 000 60 000 % 18 000 30%
280 280
000 000 70 640 71 484

REQUIRED

a) Identify which method of inventory valuation was used by the management

accountant to prepare the quantity statement above. Motivate your answer.
b) Calculate the percentage of completion of opening WIP as at 1 February 20X1.
c) Prepare the following for February 20X1 if wastage now occurs at the end of the
process. Also assume that the company uses the weighted average method of
inventory valuation.

a. Quantity statement.
b. Production cost statement.
c. Allocation statement.

d) Explain the effect on the normal loss calculation and the remainder of the quantity
statement in (c) if the percentage of completion (opening WIP) changes to 80% and
the FIFO method of inventory valuation is applied.

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Revision Exercise 6.5

White Tooth (Pty) Ltd manufactures one type of toothpaste in a single process and
uses a process costing system. The following information is available for June 20X1.

Units
Work-in-process:
1 June 20X1 – 30% completed 80 000
30 June 20X1 – 60% completed 70 000
Put into production in June 260 000
Completed and transferred in June 240 000

Additional information:

• The company uses the weighted average method of inventory valuation.

• Raw materials are added at the beginning of the process and conversion takes place
evenly throughout the process.
• Normal losses are estimated as 4% of units that reach the wastage point. Wastage
occurs when the process is 50% complete.
• Cost information for June 20X1 was as follows:

Material Conversion
R R
Work in process (1 June 20X1) 760 000 1 010 000
Current production cost 2 890 000 3 250 000

REQUIRED

Prepare the quantity statement.

Prepare the production cost statement.
Prepare the cost allocation statement.

Revision Exercise 6.6

Yogi Drink (Pty) Ltd produces drinking yoghurt in a single process and uses a process
costing system. The following information is available for June 20X1.

Units
Work-in-process:
1 June 20X1 – 60% completed 40 000
30 June 20X1 – 80% completed 30 000
Put into production in June 120 000
Completed and transferred in June 90 000

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Additional information:

• The company uses the FIFO method of inventory valuation.

• Raw materials are added at the beginning of the process and conversion takes place
evenly throughout the process.
• Normal losses are estimated as 15% of units that reach the wastage point. Wastage
occurs when the process is 40% complete.
• Cost information for June 20X1 was as follows:

Material Conversion
R R
Work in process (1 June 20X1) 340 000 530 000
Current production cost 760 000 890 000

REQUIRED

Prepare the quantity statement.

Prepare the production cost statement.
Prepare the cost allocation statement.

Revision Exercise 6.7

The following details relate to the main process of W Limited, a chemical manufacturer:

Opening work-in-progress 2 000 litres, 40% complete

Material input 24 000 litres
Normal losses are 10% of input and are
detected at the end of the process
Output to process 2 19 500 litres
Closing work-in-progress 3 000 litres, 45% complete

The following costs were incurred:

Raw material Conversion costs

R R
Opening work-in-progress 120 600 230 800
Current production 800 420 1 056 200

Raw materials are added at the beginning of the process, conversion takes place evenly
throughout the process.

The company uses the FIFO method of inventory valuation.

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REQUIRED:

a) Prepare the following:

• Quantity statement.
• Production cost statement.
• Allocation statement.

b) Prepare the following, if the company now uses the weighted average method of
inventory valuation and that losses occur at 30% through the process:

• Quantity statement
• Production cost statement
• Allocation statement
[Drury Adapted]
Revision Exercise 6.8

A company operates several production processes involving the mixing of ingredients to

produce animal feedstuffs. One such product is mixed in two separate process operations.
The information below is of the costs incurred in, and output from, Process 2 during the
period just completed.

Costs incurred R
Opening work-in-progress raw materials costs 15 476
Opening work-in-progress conversion costs 11 564
Current period raw materials costs 470 972
Current period conversion costs 638 176

Production Units
Opening work-in-progress (50% complete) 1 200
Transfers from Process 1 112 000
Completed output 105 400
Closing work-in-progress (75% complete) 1 600

Raw materials are added at the beginning of the process, conversion takes place evenly
throughout the process.

Normal wastage occurs at 10% of the process and is expected to be 5% of input.

The company uses the FIFO method of inventory valuation.

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REQUIRED:

Prepare the following:

• Quantity statement
• Production cost statement
• Allocation statement

Prepare the following, if the company now uses the weighted average method of
inventory valuation and that losses occur at 60% through the process:

• Quantity statement.
• Production cost statement.
• Allocation statement.

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Learning Unit 7: Joint products and By-products

costing systems
Learning Objectives: My notes
• Differentiate between joint and by-products.
• Allocate joint costs, using different methods.
• Calculate profits from the sale of joint products.
• Calculate the value of joint and by-product inventory.
• Account for by-products.
Material used for this learning unit:
• Chapter 6 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 6:
o Joint products and by-products.
o Methods of allocating joint costs.
o Accounting for by-products.

Introduction
A joint process is a process where raw material is processed to a point where more than
one product is generated. These products will not be separately identifiable until the joint
process is complete. The point reached where these products are then separately
identifiable is called the split-off point. The costs incurred in the joint process are called
joint costs and will include raw materials, labour and manufacturing overheads.

You have the option to sell the products at this point, providing they have a market value
at split-off point. Or else further processing costs can be in incurred on each individual
product to obtain a final more advanced product which is then sold.

The products generated at split-off point can either be joint products or by-products. Joint
products are the products which have a significant sales value. By-products are products
that are generated due to the nature of the process and will be incidental to the production
process. The sales value of these products is insignificant, and, in some cases, there will
not be a sales value at all. In the case of a by-product not having a sales value, these will
be regarded as waste or scrap products and will need to be disposed of.

We will be looking at what is included in joint costs. Thereafter we will look at 4 different
methods that can be used to allocate joint costs to the products that have been generated
at the split-off point during the joint process. These methods are the physical standard
methods, sales value at split-off point, the net realisable value methods and the gross
profit percentage method.

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After this we will look at how to account for by-products depending on the nature of the
by-product generated in the context of the nature of the business.

The below figure is an illustration of what the process would look like from the initial input
of the product through to the final product after further processing:

Further processing cost are

incurred

Joint process costs

are incurred in the
joint process
Product 1
Product 1
(final)

Initial Product 2
Split-off Product 2
input (final)
point
product

Product 3
Product 3
(final)

Methods for allocating joint costs

Physical measures method

With this method joint costs are allocated based on the physical units of output (units
produced), for example litres, kilograms, etc. This method will only be appropriate when
output units are very similar in nature and value.

Sales value at split-off point method

This method (also called the market value at split-off point method) allocates joint costs
by taking into consideration the sales value of units of output at the split-off point. The total
sales value of products generated will be used as ratio to allocate joint costs. We assume
that more costs should be allocated to products with a higher sales value.

We can only use this method if products can be sold at split-off point, i.e., they have a
market value.

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Net realisable value (NRV) at split-off point method

The NRV at split of point allocates joint costs based on the total net realisable value of
products at split-off point. The NRV of a product is calculated by using the final sales value
per product after further processing and deducting the further processing cost per product
from the final sales value. This NRV per product then needs to be multiplied by the total
number of output units to get to the total NRV for that product. This is done for each product
and then the total NRV of all products is used as the ratio in which joint costs are allocated.

Constant gross profit percentage method

This method is also called the reversal cost method. Here we want to arrive at a gross
profit per product line and therefore need to calculate what the joint cost is that needs to
be absorbed by that product line in order to arrive at the gross profit required. You will note
in the illustrative example below that you will have to work backwards to calculate what
the joint cost is that needs to be absorbed by the product line.

Illustrative example 1

R&M Butchers has provided you with the following information:

When carcasses are processed, three separate joint products are obtained, grade A meat,
grade B meat and grade C meat.

Potential selling prices per kilogram of the products at split-off point immediately after
separation are:

Grade A R 60
Grade B R 40
Grade C R 30

During the month, 120 carcasses are processed at a joint cost of R 1 680 000. The
processing of the carcasses in the joint process yielded 38 000 kg of grade A meat, 32
000 kg of grade B meat and 26 000 kg of grade C meat.

All joint products undergo further processing before they are sold as finished products.
Grade A meat is converted into fillet steak, grade B meat is converted into mince and
grade C meat is converted into brisket.

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The selling price per kilogram of joint products after further processing is:

Steak R 90
Mince R 60
Brisket R 50

Additional costs per kilogram of further processing of joint products after the split-off point
are:

Grade A (steak) R 22
Grade B (mince) R 15
Grade C (brisket) R 12

The target GP% for steak and mince are 55%. There was no opening inventory and the
total production for the month was sold. Sales and distribution costs for the month are:

Grade A (steak) R 30 000

Grade B (mince) R 20 000
Grade C (brisket) R 16 000

REQUIRED

Draft a statement of comprehensive income, showing the gross profit and gross profit
percentage if the joint cost is allocated according to the following methods:

a) The physical measures method.

b) The sales value at split-off point method if:
a. All products are sold at the split-off point
b. All products undergo further processing
c) NRV at split-off point method.
d) Constant gross profit percentage method.

Assume in all cases further processing takes place, except in b) a.

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Solution to Illustrative example 1

The easiest way to process all the above information is to draw a quick figure like the
figure illustrated earlier in this learning unit as follows: Further processing cost is
incurred

Joint process costs

are incurred in the
joint process
Grade A Steak
38 000kg (MV R60) R22 (MV R90)

Initial Mince
Split-off Grade B
input (MV R60)
point (MV R40) R15
product
32 000kg
Grade C Brisket
(MV R30) R12 (MV R50)
26 000kg
Total kgs = 96 000kg
a)
Joint
Quantity cost Cost per
produced allocated kg
Product (kilograms) Calculation R R
Grade A 38 000 38 000 / 96 000 x R1 680 000 665 000 17.50
Grade B 32 000 32 000 / 96 000 x R1 680 000 560 000 17.50
Grade C 26 000 26 000 / 96 000 x R1 680 000 455 000 17.50
Total 96 000 1 680 000

Statement of comprehensive income

Steak Mince Brisket Total
R R R R
Sales (38 000 kg x R90) (32 000 kg
x R60) (26 000 kg x R50) 3 420 000 1 920 000 1 300 000 6 640 000
Less: Cost of sales 1 501 000 1 040 000 767 000 3 308 000
Joint costs 665 000 560 000 455 000 1 680 000
Additional costs (38 000 kg x R22)
(32 000 kg x R15) (26 000 kg x
R12) 836 000 480 000 312 000 1 628 000
Gross profit 1 919 000 880 000 533 000 3 332 000
Selling & Distribution 30 000 20 000 16 000 66 000
Net profit 1 889 000 860 000 517 000 3 266 000
Gross profit % 56% 46% 41%

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b)
Joint cost Cost per
allocated kg
Product Market value Calculation R R
38 000 kg x
R60 = R2 280
Grade A 000 2 280'/4 340' x R1 680 000 882 581 27.58
32 000 kg x
R40 = R 1 280
Grade B 000 1 280'/4 340' x R1 680 000 495 484 15.48
26 000 kg x
R30 = R 780
Grade C 000 780'/4 340' x R1 680 000 301 935 11.61
Total 4 340 000 1 680 000

a.

Statement of comprehensive income

Steak Mince Brisket Total
R R R R
Sales (38 000 kg x R60) (32 000
kg x R40) (26 000 kg x R30) 2 280 000 1 280 000 780 000 4 340 000
Less: Joint costs 882 581 495 484 301 935 1 680 000
Gross profit 1 397 419 784 516 478 065 2 660 000
Selling & Distribution 30 000 20 000 16 000 66 000
Net profit 1 367 419 764 516 462 065 2 594 000
Gross profit % 61% 61% 61%

b.
Statement of comprehensive income
Steak Mince Brisket Total
R R R R
Sales (38 000 kg x R90) (32 000
kg x R60) (26 000 kg x R50) 3 420 000 1 920 000 1 300 000 6 640 000
Less: Cost of sales 1 718 581 975 484 613 935 3 308 000
Joint costs 882 581 495 484 301 935 1 680 000
Additional costs (38 000 kg x
R22) (32 000 kg x R15) (26 000
kg x R12) 836 000 480 000 312 000 1 628 000
Gross profit 1 701 419 944 516 686 065 3 332 000
Selling & Distribution 30 000 20 000 16 000 66 000
Net profit 1 671 419 924 516 670 065 3 266 000
Gross profit % 50% 49% 53%

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c)
Steak Mince Brisket Total
R R R R
3 420 1 920 1 300 6 640
Sales value (from a) 000 000 000 000
Less: Selling & Distribution 30 000 20 000 16 000 66 000
Less: Further processing costs (from 1 628
a) 836 000 480 000 312 000 000
2 554 1 420 4 946
NRV at split-off 000 000 972 000 000

Joint cost Cost per

allocated kg
Product NRV Calculation R R
Grade A 2 554 000 2 554'/4 946' x R1 680 000 867 513 22.83
Grade B 1 420 000 1 420'/4 946' x R1 680 000 482 329 15.07
Grade C 972 000 972'/4 946' x R1 680 000 330 158 12.70
Total 4 946 000 1 680 000

Statement of comprehensive income

Steak Mince Brisket Total
R R R R
Sales (38 000 kg x R90) (32 000
kg x R60) (26 000 kg x R50) 3 420 000 1 920 000 1 300 000 6 640 000
Less: Cost of sales 1 703 513 962 329 642 158 3 308 000
Joint costs 867 513 482 329 330 158 1 680 000
Additional costs (38 000 kg x
R22) (32 000 kg x R15) (26 000
kg x R12) 836 000 480 000 312 000 1 628 000
Gross profit 1 716 487 957 671 657 842 3 332 000
Selling & Distribution 30 000 20 000 16 000 66 000
Net profit 1 686 487 937 671 641 842 3 266 000
Gross profit % 50% 50% 51%

Steak Mince
R R
Sales (from a) 3 420 000 1 920 000
Less: Gross profit required (55%) 1 881 000 1 056 000
Cost of sales 1 539 000 864 000
Less: Additional costs (from a) 836 000 480 000
Joint cost absorbed 703 000 384 000

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Joint costs allocated to product Brisket will be the balance of the R 1 680 000, therefore
R1 680 000 – R 703 000 – R 384 000 = R 593 000.

Statement of comprehensive income

Steak Mince Brisket Total
R R R R
Sales (38 000 kg x R90) (32 000
kg x R60) (26 000 kg x R50) 3 420 000 1 920 000 1 300 000 6 640 000
Less: Cost of sales 1 539 000 864 000 905 000 3 308 000
Joint costs 703 000 384 000 593 000 1 680 000
Additional costs (38 000 kg x
R22) (32 000 kg x R15) (26 000
kg x R12) 836 000 480 000 312 000 1 628 000
Gross profit 1 881 000 1 056 000 395 000 3 332 000
Selling & Distribution 30 000 20 000 16 000 66 000
Net profit 1 851 000 1 036 000 379 000 3 266 000
Gross profit % 55% 55% 30%

Accounting for by-products

When accounting for by-products you need to first establish whether a regular market
exists for the product.

By-products with a regular market

If a regular market exists for the by-product the joint costs to be allocated to joint products
will be reduced by the NRV of the by-product, therefore crediting the joint costs with the
NRV of the by-product. This will occur irrespective of whether the products have been sold
in the accounting period.

Illustrative example 2

Joint & By (Pty) Ltd operates a manufacturing process that produces joint products X and
Y and by-product Z. Joint costs of the manufacturing process are R 400 000. The following
output was generated:

Product X 20 000kg
Product Y 18 000kg
Product Z 2 000kg

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By-product Z requires further processing at a cost of R2 per kg, after which it can be
sold at R10 per kg.

Accounting entries for the by-product will be as follows:

Dr By-product inventory (2 000kg x (R10 – R2) 16 000

Cr Joint process WIP account 16 000
Joint costs to be reduced by NRV of by-products

Dr Cash/Debtors (2 000kg x R10) 20 000

Cr By-product inventory 20 000
By-product sales for the period

Dr By-product inventory (2 000kg x R2) 4 000

Cr Cash/Creditors 4 000
Further processing costs incurred

By-products with no regular market

When there is no regular market for a by-product it means that they need to be disposed
of. There are two scenarios: There might be incidental sales of the by-product or disposal
costs will have to be incurred to dispose of the by-product.

Incidental sales

No regular market exists for the by-product, but there might be incidental sales. In this
case you have three options for accounting treatment:

1. Account for it as part of revenue.

2. Reduce the cost of sales of joint products.
3. Recognise it as other income.

Disposal costs incurred

If you incur disposal costs to dispose of the by-product the accounting treatment will be to
increase the joint costs to be allocated to products. Therefore, debiting the joint costs.

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Illustrative example 3

Refer to the information in Illustrative example 1. The following additional information is

provided:

When the carcasses are processed, three separate joint products are produced: grade A
meat, which is further processed into steak, grade B meat which is further processed into
mince and grade C meat which is further processed into brisket. The bones yielded from
the process represent a by-product, each carcass yielding 280 kg of bones. The selling
price of the bones at the split-off point amounts to R6 per kilogram.

During the month, 120 carcasses are processed at a joint cost of R 1 680 000. The
processing of the carcasses in the joint process yielded 38 000 kg of grade A meat, 32
000 kg of grade B meat and 26 000 kg of grade C meat.

All joint products were processed further before being sold as finished products. However,
further processing is only initiated once an order is received for the finished product. The
sales of finished products for the month were:

Steak 36 000 kg
Mince 29 000 kg
Brisket 25 000 kg

There was no opening inventory and the total production of final products for the month
was sold.

32 500 kg bones were sold this month.

Other relevant cost information is as provided in Illustrative example 1.

Company policy regarding by-products is that joint process costs are allocated based on
the physical measures method.

REQUIRED

Draft the statement of comprehensive income for the month, assuming each of the
following assumptions for the by-product (each case is independent):

a) A regular market exists for the by-product.

b) No regular market exists for the by-product and proceeds are regarded as ‘other
income’, directly in the statement of comprehensive income.
c) No regular market exists for the by-product and proceeds are regarded as ‘a
reduction of cost of sales’, directly in the statement of comprehensive income.

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Solution to Illustrative example 3

a)
Statement of comprehensive income

Sales - Joint products (1) 6 230 000

Less: Cost of sales 2 906 400
Joint costs 1 680 000
Less: Proceeds from by-products (2) (201 600)
1 478 400
Less: Closing inventory joint products (3) (99 000)
Plus: Further processing costs (4) 1 527 000
Gross profit 3 323 600
Less: Sales and distribution costs (66 000)
Net profit 3 257 600

Calculations:
Calculation 1
(R90 x 36 000kg) + (R60 x 29 000kg) + (R50 x 25 000kg) 6 230 000

Calculation 2
Sales value of bones (280kg x 120 x R6) 201 600
Less: Further processing costs -
NRV of bones 201 600
Based on production, NOT sales

Calculation 3
Allocation of joint costs:
Grade A (R 1 478 400 x 38 000 / (38 000 + 32 000 + 26 000) 585 200
Grade B (R 1 478 400 x 32 000 / (38 000 + 32 000 + 26 000) 492 800
Grade C (R 1 478 400 x 26 000 / (38 000 + 32 000 + 26 000) 400 400

Value of closing inventory:

Grade A (R 585 200 x (38 000kg - 36 000kg) / 38 000kg 30 800
Grade B (R 492 800 x (32 000kg - 29 000kg) / 32 000kg 46 200
Grade C (R 400 400 x (26 000kg - 25 000kg) / 26 000kg 15 400
92 400
Bones at NRV ((280kg x 120) - 32 500kg) x R6) 6 600
Total inventory on hand 99 000

Calculation 4
(R22 x 36 000kg) + (R15 x 29 000kg) + (R12 x 25 000kg) 1 527 000

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b)
Statement of comprehensive income
Sales - Joint products (from a) 6 230 000
Less: Cost of sales 3 102 000
Joint costs 1 680 000
Less: Closing inventory joint products (1) (105 000)
Plus: Further processing costs (from a) 1 527 000
Gross profit 3 128 000
Less: Sales and distribution costs (66 000)
Net profit 3 062 000
Plus: Income from by-products (2) 195 000
Net operating profit 3 257 000
Calculations
Calculation 1
The physical standard method is used; therefore, each unit has the same cost:
R 1 680 000 / (38 000kg + 32 000kg + 26 000kg) x 6000kg 105 000
Calculation 2
32 500kg x R6 195 000

c)
Statement of comprehensive income
Sales - Joint products (from a) 6 230 000
Less: Cost of sales 2 907 000
Joint costs 1 680 000
Less: Proceeds from by-products (from b) (195 000)
Less: Closing inventory joint products (from b) (105 000)
Plus: Further processing costs (from a) 1 527 000
Gross profit 3 323 000
Less: Sales and distribution costs (66 000)
Net profit 3 257 000

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Revision Exercises

Revision Exercise 7.1

Caffeine Pro (Pty) Ltd is the parent company of three subsidiary companies: Harvest Pro
(Pty) Ltd, Roasting Pro (Pty) Ltd and Bean Pro (Pty) Ltd. The company operates in the
coffee industry and has a holistic view on business.

Harvest Pro (Pty) Ltd consists of multiple farms with coffee plantations and the nature of
the business is the harvesting of coffee beans. The company only harvests three grades
of coffee beans as graded by the SCAA (Specialty Coffee Association of America), namely
Specialty Grade Green Coffee (Grade 1), Premium Coffee Grade (Grade 2) and Exchange
Coffee Grade (Grade 3). The company uses a joint- and by-product costing system.

During the process of harvesting coffee beans, approximately 50% of the coffee fruit is
discarded in the form of pulp and mucilage. To prevent water pollution, the pulp and
mucilage must be disposed of. It is estimated that it will cost the company R 260 000 in
the 2019 financial year to dispose of the pulp and mucilage. There is currently no other
use for these products.

The following is an estimate of the cost to be incurred for the 2019 financial year regarding
the harvesting of coffee:

Direct material R 1 020 000

Direct labour R 840 000
Transportation R 370 000
Manufacturing overheads R 680 000

At the split-off point, one tonne of coffee fruit generates 250kg of grade 1 coffee, 150kg of
grade 2 coffee and 100kg of grade 3 coffee. At this point grade 1 coffee is sold for R120
per kilogram, grade 2 coffee is sold for R80 per kilogram and grade 3 coffee is sold for
R50 per kilogram.

No further processing is done. Assume that the company had no opening or closing
inventory.

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REQUIRED:

1. Determine the joint costs for the 2019 financial year to be allocated.
2. Allocate the joint costs to the products based on the sales value at split-off point
method.
3. Discuss the accounting treatment for a by-product with incidental sales if no
regular market exists.

[Round all answers to the nearest Rand.]

Revision Exercise 7.2

WoodWorx (Pty) Ltd processes wood which is then sold to companies that manufacture
wooden furniture. The company uses a joint- and by-product costing system. A log is
typically added into the process to generate various sizes of wood that can be used in the
manufacturing of different products. At split-off point, one log generates 6m² of wood used
in tables and 4m² of wood used in chairs. Approximately 300mm² of a log can be regarded
as either saw dust or off-cuts. There is, however, a regular market for this. Bird farmers
regularly purchase saw dust and off-cuts, and they are willing to pay R50 for the saw dust
and cut-offs per log. No further processing is needed for these by-products.

Total joint costs to be allocated are estimated to be R3 000 per log.

600 logs are budgeted to be processed during the 2019 financial year. Further processing
costs are incurred after which products are then sold. The following information is
available:

Product Further processing Selling price per m²

costs per m² after further
processing
Table wood R80 R810
Chair wood R60 R440

REQUIRED:

Draft a Statement of Comprehensive Income, showing the gross profit and gross profit
margin, if the joint cost is allocated according to the net realisable value method.

Revision Exercise 7.3

Attempt Q6.16 (a-b) in Drury textbook, 11th Edition.

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Learning Unit 8: Direct and Absorption costing

Learning Objectives: My notes
• Identify the differences between direct and absorption
costing methods.
• Draft the statement of comprehensive income according to
the absorption costing method using different inventory
valuation methods.
• Draft the statement of comprehensive income according to
the direct costing method using different inventory
valuation methods.
• Reconcile the differences in profit between the two costing
methods.
• Identify the most appropriate method given specific
circumstances.
Material used for this learning unit:
• Chapter 7 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 7:
o External and internal reporting
o Variable costing
o Absorption costing
o Some arguments in support of variable costing
o Some arguments in support of absorption costing

Introduction
Until now we have looked at methods to determine product costs for purposes of inventory
valuation in terms of external reporting (IFRS). This involved allocating all production costs
to inventory and cost of sales and treating non-manufacturing costs as a period cost.
Preparing a statement of comprehensive income on these principles is called an
absorption costing system.

In this learning unit we will look at another costing system namely the direct costing system
(also called a variable costing system or a marginal costing system). This system is used
for internal reporting and analysis purposes and here we will allocate only variable
manufacturing costs to product costs for inventory valuation purposes and fixed
manufacturing costs will be treated as a period cost.

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It is important to note the difference between the two methods and the uses of the methods
respectively.

For purposes of this module, we will only deal with budgeted statements of direct and
absorption costing. The actual statements of direct and absorption costing will be dealt
with in MFAC7311.

Absorption costing versus Direct costing

Absorption costing

The following format should be used to prepare an absorption costing statement. Note that
this is similar to the statement of comprehensive income that you would prepare in
financial accounting:

Total
Sales
units

Sales
Budgeted sales units x Selling price
Cost of Sales - MANUFACTURING COSTS
Opening inventory
This is calculated like the closing balance, but
based on LAST year’s ACTUAL figures
Material
Production units

Material price x budgeted production units

Labour
Labour cost per unit x budgeted production units
Variable Overheads
Budgeted rate x budgeted number of
production units Cost includes ALL
Fixed Overheads production cost –
Budgeted fixed overheads in total material, labour,
variable AND fixed
Closing inventory overheads. Fixed
Production cost per unit x budgeted overhead cost per unit
closing stock units = BUDGETED
ALLOCATION RATE.
Note that with this method you
Gross profit calculate a GROSS PROFIT
Both fixed AND

NON-MANUFACTURING COSTS
variable

Fixed admin & salaries

Variable selling & distribution
Fixed selling & distribution

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Net profit/loss

Opening stock +
Production – Sales =
Closing stock

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Direct costing

The following format should be used to prepare a direct costing statement. Note that with
this statement we distinguish between variable and fixed costs:

Total
Sales
Sales
units

Variable Costs
Variable manufacturing costs
Opening inventory
This is calculated like the closing balance, but
based on LAST year’s ACTUAL figures
Production units

Material
Material price x budgeted production units
Labour ONLY
Labour cost per unit x budgeted production units
Variable Overheads
Variable cost
Budgeted rate x budgeted number of production
units
Closing inventory
Production cost per unit x budgeted closing stock
Sales units

units
Based on

Other variable costs

Selling & Distribution

NOT Gross Profit

Contribution

Fixed Costs
ALL Fixed
Fixed manufacturing Overheads costs
Admin
Selling & Distribution

Net profit/loss

Opening stock + Production –

Sales = Closing stock

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FIFO versus weighted average method of inventory valuation

You will remember that in learning unit 5 we dealt with inventory valuation methods. We
will apply the FIFO method and weighted average method of inventory valuation to direct
and absorption costing as well. The only line items in your statements that will be affected
will be opening and closing inventory. Everything else will remain the same for both
methods.

FIFO method of inventory valuation

If you can recall, with the FIFO method we sell the oldest inventory first. Only once the
oldest inventory has all been sold do we move on to the second oldest and so on and so
forth. How does this affect the statements? Opening inventory will be valued at the unit
cost of inventory for the prior year and closing inventory will be valued at the current
year unit cost of inventory for the current year. This is the latest available cost of
inventory for the respective years. This unit cost will then be multiplied with the number of
units in inventory to get to the value of opening and closing inventory to be included in
your statements.

Weighted average method of inventory valuation

With the weighted average method, you need to calculate the weighted average price per
unit of inventory for the year as you learned in learning unit 5. For the opening inventory it
will be based on the prior year figures and for the closing inventory it will be based on the
current year figures. This is done by adding the cost for opening inventory and units
produced during the year together and dividing this by the total of the units for opening
inventory and current production (total units available for sale during the current year).

Current year production

You can use the following table for your calculation:
cost includes ALL
production cost –
Total units Total cost material, labour,
Opening inventory overheads. Note that for
Current year production direct costing it will only
Total include variable costs
whereas for absorption
Weighted average cost costing it will also include
per unit = Total cost / fixed overheads.
Total units

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Activity 8.1

Tshabalala Co (Pty) Ltd manufactures and sells porcelain dolls. The selling price per doll
for 20X0 was R200 per doll and is expected to increase with 15% per year from 20X1.
There was no opening inventory at the beginning of 20X0.

You have been supplied with the following further information regarding unit movements:

Year Manufactured Sold Closing inventory

20X0 (Actual) 1 100 units 1 000 units ?
20X1 (Budget) 1 300 units 1 200 units ?

Margie Tshabalala, the Chief Financial Officer of Tshabalala Co (Pty) Ltd, presented you
with the following cost information. The company’s financial year end is 30 November:

R R
20X0 20X1
Variable cost per unit:
Direct material 20,00 25,00
Direct labour 6,00 7,00
Variable manufacturing overheads 5,00 5,50
Variable selling costs 1,50 1,60
Fixed costs in total:
Fixed manufacturing overheads 12 000,00 14 000,00
Fixed selling costs 21 000,00 23 000,00
Fixed administrative overheads 9 000,00 11 500,00

REQUIRED

Prepare the budgeted statement of comprehensive income for the year ended 30
November 20X1 according to:

a) The direct costing method, assuming the company uses the FIFO method of
inventory valuation.
b) The direct costing method, assuming the company uses the weighted average
method of inventory valuation.
c) The absorption costing method, assuming the company uses the FIFO method of
inventory valuation.
d) The absorption costing method, assuming the company uses the weighted average
method of inventory valuation.

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Reconciling differences between net profit

You will note that in Activity 8.1 above, there is a difference in net profit between the direct
costing method and absorption costing method even though the statement was prepared
based on the same information given. The reason for this is opening and closing inventory.
With direct costing, opening and closing inventory is valued on variable cost only, whilst
with absorption costing, fixed manufacturing costs are also included in opening and
closing inventory. You can reconcile the difference in net profits by using the following
format:

Net profit according to:

Direct costing method
Absorption costing method
Difference

Opening inventory according to:

Direct costing method
Absorption costing method
Difference

Closing inventory according to:

Direct costing method
Absorption costing method
Difference

Reconciliation in Rand value:

Opening inventory difference
Closing inventory difference
Difference in profits

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Revision Exercises

Revision Exercise 8.1

The management accountant has presented the following information for Lavida (Pty) Ltd,
which manufactured a single product type for the year ended 31 October 20X1.

Prime cost per unit R130 (20X0: R110)

Selling price per unit R210 (20X0: R190)

Overhead Costs:

• Manufacturing (variable) R50 per unit

• Manufacturing (fixed) R 160 000
• Selling and administrative (fixed) R 90 000
• Selling and administrative (variable) R2,50 per unit

Additional information:

• Lavida (Pty) Ltd manufactures 20 000 units per year.

• Units sold during 20X1 were 15 000.
• The cost structure, except for prime costs, for 20X1 remained unchanged from 20X0.
• Opening inventory value for 2 500 units calculated for IFRS purposes at 1 November
20X0 is R 420 000.
• There was no opening inventory at the beginning of the previous financial year.
• Lavida (Pty) Ltd applies the weighted average method of inventory valuation.

REQUIRED:

a) Draft the contribution statement of comprehensive income for the year ended 31
October 20X1 using the direct costing method.
b) Draft the contribution statement of comprehensive income for the year ended 31
October 20X1 using the absorption costing method.
c) Reconcile the difference in profits according to the two methods.

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Revision Exercise 8.2

The following information was extracted from the accounting records of FIFA Limited for
the year ended 31 December 20X0 and their 20X1 budget:

Actual Budget
20X0 20X1
Units:
Completed units at the beginning of the year Nil 5 000
Production for the year 30 000 32 000
Sales for the year 25 000 35 500

Costs: R R
Fixed costs:
Production 135 000 153 250
Selling and administrative 80 000 80 000
Variable cost per unit:
Production 10,15 12,00
Selling and administrative 4,00 4,00
Selling price per unit 28,00 25,00

Additional information:

The company uses the FIFO method of inventory valuation.

REQUIRED

a) Draft the contribution statement of comprehensive income for the year ended 31
December 20X1 using the direct costing method.
b) Draft the contribution statement of comprehensive income for the year ended 31
December 20X1 using the absorption costing method.
c) Reconcile the difference in profits according to the two methods.

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Revision Exercise 8.3

Cute Cars (Pty) Ltd manufactures and sells toy cars. The selling price per car for 20X0
was R50 and is expected to increase with 10% per year from 20X1. There were 2500 units
in opening inventory at the beginning of 20X0.

You have been supplied with the following further information regarding unit movements:
Year Manufactured Sold Closing inventory
20X0 (Actual) 24 000 units 23 500 units ?
20X1 (Budget) 23 000 units 25 000 units ?

The accountant presented you with the following cost information. The company’s financial
year end is 30 April:

Actual information for 20X0:

R
Manufacturing costs:
Direct material cost per unit 10.00
Direct labour cost per unit 3.00
Variable manufacturing overhead cost per unit 2.50
Fixed manufacturing overhead costs in total 80 000.00

Non-manufacturing costs:
Selling and distribution costs in total 19 750.00

Fixed administrative overheads in total 5 000.00

Additional information relating to 20X1:

• Direct material cost per unit is expected to increase with 10%.

• The current labour force is on strike and demands an increase of 11%. The
accountant expects the increase to remain at the planned 7%.
• Variable manufacturing overhead costs are expected to remain unchanged.
• The fixed manufacturing costs for 20X0 includes monthly factory rental of R3 000
which is due for annual escalation of 6% on 1 May each year.
• Selling and distribution costs include both fixed and variable costs. Total selling and
distribution costs for 20X1 are budgeted to be R20 500.
• Fixed administrative overheads are expected to increase by 6%.
• You can assume that the cost of opening inventory for 20X0 was in line with 20X0
production costs.

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REQUIRED

Prepare the budgeted statement of comprehensive income for the year ended 30 April
20X1 according to:

1. The direct costing method, assuming the company uses the FIFO method of
inventory valuation.
2. The direct costing method, assuming the company uses the weighted average
method of inventory valuation.
3. The absorption costing method, assuming the company uses the FIFO method
inventory valuation.
4. 4. The absorption costing method, assuming the company uses the weighted
average method of inventory valuation.

Revision Exercise 8.4

Magnificent Fans (Pty) Ltd manufactures and sells domestic fans. The selling price per
fan for 20X0 was R760. Due to the economic downturn the selling price is expected to
decrease with 5% in 20X1 since the company would like to try and maintain good sales
quantities. There were 3 560 fans in opening inventory at the beginning of 20X0.

You have been supplied with the following further information regarding unit movements:

Year Manufactured Sold Closing inventory

20X0 (Actual) 46 250 units 45 360 units ?
20X1 (Budget) 45 200 units 44 500 units ?

The accountant presented you with the following cost information. The company’s financial
year end is 30 June:

Actual information for 20X0:

R
Manufacturing costs:
Direct material cost per unit 160.00
Direct labour cost per unit 42.00
Variable manufacturing overhead cost per unit 22.50
Fixed manufacturing overhead costs in total 250 800.00

Non-manufacturing costs:
Variable selling and distribution costs per unit 5% of the selling price
Fixed selling and distribution costs 55 600.00
Fixed administrative overheads in total 68 000.00

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Additional information relating to 20X1:

• Direct material cost per unit is expected to increase with 12%.

• The direct labour rate per hour will increase with 3%. The company has done an
analysis on the time taken per unit and expects the employee morale to be affected
due to the low increase. They estimate that it will take 5% longer to manufacture a
fan.
• Variable manufacturing overhead costs are expected to increase in line with the time
taken per unit manufactured.
• The fixed manufacturing costs for 20X0 includes depreciation of R5 000 per month
of a machine that has been fully depreciated at the end of 20X0. The company is
not planning to replace the machine in 20X1. Other fixed manufacturing overheads
will increase with 5%.
• Fixed selling and distribution costs is expected to increase with 5%. Variable selling
and distribution costs will increase to 7% of the selling price to ensure sales
personnel maximise sales.
• Fixed administrative overheads will remain unchanged.
• You can assume that the cost of opening inventory for 20X0 was in line with 20X0
production costs.

REQUIRED

Prepare the budgeted statement of comprehensive income for the year ended 30 June
20X1 according to:

1. The direct costing method, assuming the company uses the FIFO method of
inventory valuation.
2. The direct costing method, assuming the company uses the weighted average
method of inventory valuation.
3. The absorption costing method, assuming the company uses the FIFO method of
inventory valuation.
4. The absorption costing method, assuming the company uses the weighted
average method of inventory valuation.

Revision Exercise 8.5

Roast Co (Pty) Ltd roasts coffee beans and specialise in roasting one blend of coffee only.
The company sell to coffee chains and package the beans in bags of 1 kilogram.

Currently the company reports on an absorption costing basis. The company experienced
exponential growth in the past two years and is considering implementing a direct costing
system for management accounting purposes.

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You have extracted the following actual results for the year ended 30 April 2018:

Variable costs:

Sales 125 000 bags

Sales revenue R10 000 000
Direct material R25 per kilogram
Packaging R7 per bag
Direct labour R15 per kilogram
Variable manufacturing overheads R5 per kilogram
Selling and distribution costs 5% of the selling price

Fixed costs:

Fixed manufacturing overheads R132 000

Administrative costs R156 000
Selling and distribution R 72 000

The following budgeted information for the year ended 30 April 2019 was provided:

• The selling price will be increased with 10%. Due to the increase in selling price the
sales volume is expected to decrease with 5%.
• All coffee beans are imported from Ethiopia. Due to the weakening of the Rand and
continued drought in Africa the direct material is expected to increase with 20% per
kilogram. There was no opening or closing inventory for coffee beans.
• The company has a contract with the packaging supplier. The contract ends on 31
October 2018 after which the packaging per bag will increase to R8 per unit. Sales
and production take place evenly throughout the year.
• Direct labour is expected to increase with 7%.
• Variable manufacturing overheads and variable selling and distribution costs will
remain the same as in the 2018 financial year.
• Fixed manufacturing costs will increase with 6%. This is in line with inflation.
• Due to restructuring, fixed non-manufacturing costs is expected to remain the same
as in the 2018 financial year.

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The following information regarding kilograms were extracted from the inventory system:

Details 2018 (Actual) 2019 (Budgeted)

Opening inventory (finished goods) 12 500 kg ?

Production (finished goods) 130 000 kg 115 000 kg

The value of opening inventory for the 2018 financial year was R625 000 based on the
absorption costing basis. The company uses the weighted average method of inventory
valuation. There was no opening or closing balances for work in progress.

REQUIRED

Prepare the budgeted statement of comprehensive income for the period ended 30 April
2019 based on the absorption costing method. [Round all answers to two decimal places.]

Revision Exercise 8.6

Magnificent Toys Ltd makes a toy called The Alternator 2017. The company was started
in 2016. The selling price for The Alternator 2017 in the 2017 financial year is R540. The
selling price is expected to increase next year (2018) with 10%. You have been provided
with the following information regarding the toy:

Year Manufactured Sold Closing inventory

2016 2 500 units 2 350 units ?

2017 2 760 units 2 800 units ?

2018 2 950 units 2 670 units ?

Tony Stark, the CFO, has provided you with the following information regarding the costs
of the products:

2017 2018
Variable costs per unit
Direct Material 80 83
Direct Labour 60 65
Variable manufacturing overheads 25 28
Variable selling costs 35 42

Fixed costs in total

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Fixed manufacturing overheads 65 000 68 000

Fixed selling costs 15 000 17 000
Fixed administrative overheads 22 000 26 000

The company makes use of the weighted average method of inventory valuation. You can
assume that the prior year weighted average cost per unit was R165 (variable
manufacturing costs only), the fixed cost portion worked out to be R23.55 per unit.
There was no opening or closing stock for materials or work in progress.

REQUIRED

Prepare the budgeted statement of comprehensive income for the year ended 31
December 2018 according to the direct costing method.
Reconcile the difference in profits according to the two methods if the net profit from the
absorption costing method is R900 378 and the weighted average cost per unit for the
closing inventory is R198.67.

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Learning Unit 9: Budgeting techniques

Learning Objectives: My notes
• Describe the stages in the budgeting process.
• Describe the sub-budgets included in the master budget.
• Prepare a cash budget.
• Prepare a flexible budget.
• Describe the advantages and disadvantages of budgeting.
Material used for this learning unit:
• Chapter 15 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 15:
o Stages in the budgeting process
o The multiple functions of budgets
o A detailed illustration
o Criticisms of budgeting

Introduction
A budget is an integral part of the strategic planning process. It is a short-term plan (12
months) that assists the company in attaining long term goals. The strategic planning,
budgeting and control process can be illustrated as follows:

1. Strategic planning process (setting objectives and

strategies)

2. Creating a long-term plan to implement strategies

3. Preparing the annual budget within the context of the

long-term plan

4. Monitoring actual results

5. Responding to deviations from plan

Budgets are set in monetary terms (Rand values), however, when compiling a budget,
both quantitative and qualitative factors need to be taken into consideration. In this
learning unit, we will focus on describing the stages of budgeting process and then

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describe the sub-budgets included in the master budget. We will conclude by looking at
how to prepare a cash budget.

Stages in the budgeting process

Communicating budget policy and guidelines to all parties responsible in preparing

budgets

Determining factors that retsrict production output

Preparing the sales budget

Initial preparation of sub-budgets included in the master budget

Negotiation of the budgets

Coordination and review of the budget

Final acceptance of the budget

Monitoring and review of the budget on an ongoing basis

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The master budget

In the master budget all sub-budgets that have been prepared are consolidated and the
budgeted statement of profit and loss and budgeted statement of financial position can
now be drafted. The sub-budgets included in the master budget includes the following:

Sales
budget

Departmen- Production
tal budgets budget

Direct
Selling and
Master materials
administra-
budget usage
tive budget
budget

Direct
Factory
materials
overhead
purchase
budget
budget
Direct
labour
budget

Cash budgets
The purpose of a cash budget is:

• to ensure that funds are always available to meet operational requirements, i.e.,
day-to-day cash needs;
• to ensure that the maximum cash is available; and
• that any excess cash over and above which is needed to meet the operational
requirements is invested to earn interest thereon.

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It is important to note that only cash receipts and payments are taken into consideration.
Remember that for accounting we have non-cash items, for example depreciation, credit
sales and credit purchases. These items will not form a part of your cash budget since
they are non-cash items and are used for accounting purposes. If we refer to debtors,
for example, then only the credit sales that were received in cash for that month or period
will be included in the cash budget and not the credit sales as per the accounting records.

Cash budgets can be performed for different intervals, for example monthly, quarterly,
etc. It is important though that it is done on a regular basis.

An example of the format of a cash budget would be as follows:

February March April Total

Opening balance
Receipts: This amount
Only cash
Receipts from debtors will be given
receipts
Other receipts

Payments:
Purchase of goods Only cash This is the
Payment of wages payments opening balance
for the next period
Other costs and expenses

Closing balance

Activity 9.1

The following information was provided by Budge Corp (Pty) Ltd.

1. The bank statement reflected a credit balance of R2 340 on 28 February 20X1.

2.
Actual sales Budgeted sales
December January February March April
(R) (R) (R) (R) (R)
Cash sales 7 500 6 000 7 200 7 600 6 800
Credit sales 22 000 20 000 19 500 19 000 22 000
Cash purchases 5 200 4 500 4 600 4 800 4 300
Credit purchases 11 000 10 500 9 800 8 500 10 800
Current expenses 1 180 1 280 1 320 1 300 1 200

3. Debtors pay their accounts as follows:

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• 30% after 30 days

• 50% after 60 days
• 15% after 90 days
• 5% written off after 120 days

4. Creditors are paid one month after purchases.

5. Current expenses are paid in cash, two months after they have been incurred.
6. Depreciation amounts to R 800 a month.
7. A building is rented out at R 2 000 per month. The rent is received monthly and
increases annually on 1 March by 7%.

REQUIRED

Prepare the debtors collection schedule and cash budget of Budge Corp (Pty) Ltd for
31 March 20X1.

Flexible budgets
At the beginning of the year a company compiles a budget based on budgeted costs and
budgeted production and sales volumes, called the fixed budget. This budget is compiled
for control purposes to ensure the company stays within certain parameters of spending
and to attain targets in terms of sales and production. Actual results for the year can,
however, only be obtained at the end of the year.

During and at the end of the year we are monitoring actual income and expenses versus
budgeted income and expenses and investigating any variances. When investigating
these variances, managers are mainly held responsible for variances from budgeted
compared to actual results. However, production and sales volumes are not necessarily
as budgeted. As production volumes change, variable costs are affected and will increase
and decrease as levels of production will increase and decrease. As sales volumes
change the total revenue will also be affected. If we only use the fixed budget and compare
this to actual results, it will be unfair to hold managers responsible for overspending since
increases in costs might be due to production levels and not costs.

To overcome this problem, flexible budgets have been introduced. When compiling a
flexible budget, it is taken into consideration that production and sales volumes are not as
per budget. With a flexible budget we reconstruct the fixed budget and use the budgeted
cost per unit and multiply that with actual production and sales volumes respectively.
Based on the flexible budget we can now hold managers responsible and accountable for
any overspending.
This concept is important to grasp for when we are going to do standard costing where we
will be working with budgeted costs per unit and not budgeted costs in total.

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Illustrative example

Tebogo drafted the following condensed budget for her Pottery Clay business according
to the direct costing method for April. She based her calculation on an activity level of 6
000 units.

Per unit Total

R R
Sales (6 000 units at R30 each) 30,00 180 000
Less: Variable cost 16,70 100 200
Material (12 000kg at R5,00 per kg) 10,00 60 000
Labour (600 hours at R25 per hour) 2,50 15 000
Manufacturing Overheads (600 hours at R12 per hour) 1,20 7 200
Sales commission (6 000 units at R3,00 per unit) 3,00 18 000
Contribution 13,30 79 800
Less: Fixed cost 38 500
Manufacturing 30 000
Sales and administrative 8 500
Budgeted net profit 41 300

The following were the actual results of Tebogo’s Pottery Clay, who manufactured and
sold 7 000 units.

Total
R
Sales (7 000 units at R32 each) 224 000
Less: Variable cost 118 800
Material (15 000kg at R4,50 per kg) 67 500
Labour (750 hours at R28 per hour) 21 000
Manufacturing Overheads 7 900
Sales commission (7 000 units at R3,20 per unit) 22 400
Contribution 105 200
Less: Fixed cost 40 000
Manufacturing 32 000
Sales and administrative 8 000
Actual net profit 65 200

REQUIRED

Draw up a comparison of actual results and the flexible budget based on the actual
production of 7 000 units.

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Solution to Illustrative example

Flexed
Fixed Actual budget Variance
budget (2) (1) (1) - (2)
Volume 6000 7000 7000
R R R R
Sales (1) R30 x 7 000 units 180 000 224 000 210 000 14 000 f
Less: Variable cost 100 200 118 800 100 200 18 600 f
Material (1) (12 000kg/6 000 x 7 000) x
R5 60 000 67 500 70 000 2 500 f
Labour (1) (600/6 000 x 7 000) x R25 15 000 21 000 17 500 3 500 u
Manufacturing Overheads (1) (600/6 000
x 7 000) x R12 7 200 7 900 8 400 500 f
Sales commission (1) (7 000 x R3) 18 000 22 400 21 000 1 400 u
Contribution 79 800 105 200 79 800 25 400 f
Less: Fixed cost 38 500 40 000 38 500 1 500
Manufacturing 30 000 32 000 30 000 2 000 u
Sales and administrative 8 500 8 000 8 500 500 f
Net profit 41 300 65 200 41 300 23 900 f

(f) favourable
(u) unfavourable

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Revision Exercises

Revision Exercise 9.1

Fountain View (Pty) Ltd buys and sells purified water. The company management
accountant prepared the following budgeted contribution statement for June 20X1:

R
Sales 1 600 000
Less: Variable costs 970 000
Opening inventory 130 000
Purchases 900 000
Less: Closing inventory (240 000)
Variable selling costs 30 000
Contribution 630 000
Less: Fixed costs 100 000
Production overheads 40 000
Administrative overheads 60 000

Net profit before tax 530 000

Additional information:

• The bank opening balance on 1 June 20X1 is expected to be R 160 000.

• Cash sales will amount to 60% of total sales for June. In July 20X1, cash sales as a
percentage of total sales are expected to increase to 70%.
• 70% of inventory purchased in June will be on a cash basis. All June credit
purchases will only be paid in July or August.
• The company’s total credit purchases in May amounted to R 280 000. 80% of May
credit purchases will be settled in June and the remaining balance must be settled
in July.
• Cash receipts in June in respect of credit sales of May amounted to R 220 000.
• Total depreciation amounts to R 20 000 per month and is included in the budgeted
fixed costs above.
• All other expenses in the above contribution statement will be incurred on a cash
basis.
• In June 20X1 the company is expected to settle a liability of R 48 000 in cash.

REQUIRED

Prepare a cash budget for June 20X1 and calculate the expected closing balance in the
bank account as at June 20X1. Ignore taxation.

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Learning Unit 10: Standard costing

Learning Objectives: My notes
• Calculate selected variances using a standard costing
system
• Discuss reasons for variances
• Prepare a reconciliation between budgeted and actual
profit
• Calculate standard cost
Material used for this learning unit:
• Chapter 17 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 17:
o Purposes of standard costing.
o Material variances.
▪ Material price variances.
▪ Material usage variance.
▪ Total material variance.
o Labour variances.
▪ Wage rate variance.
▪ Labour efficiency variance.
▪ Total labour variance.
o Variable overhead variances.
▪ Variable overheads expenditure variance.
▪ Variable overhead efficiency variance.
o Fixed overhead expenditure or spending variance.
o Sales variances
▪ Sales margin price variance.
o Reconciliation of budgeted and actual profit.

Introduction
Standard costing systems were introduced mainly for control purposes. Standard costing
systems allow detailed analysis of deviations from budgeted costs. The main difference
between standard costing and budgets is that with budgets we work with a budgeted cost
in total whereas with standard costing we work with a standard cost per unit.

If budgeted production is 20 000 units and standard cost per unit is R10, the budgeted
cost would be R 200 000. With a standard cost you would go one step further to determine
what the R10 is made up of. For example, 5kg of plastic at R2 per kilogram, and this is
then called a standard.
In this learning unit we will look at various variances that will in the end reconcile the
budgeted profit to the actual profit. These variances include material variances, labour

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variances, variable manufacturing overhead variances, fixed manufacturing overhead

variances and sales variances.

A variance will always be either favourable (f) or unfavourable (u).

Key abbreviations
It is important to know the following key abbreviations for the purposes of this learning
unit:

Volume (manufactured) V
Actual volume AV
Budgeted volume BV
Standard (allowed) cost SC
Actual cost AC
Price P
Standard price SP
Actual price AP
Quantity (input) Q
Standard (allowed) quantity SQ
Actual quantity AQ
Standard (hourly) rate SR
Actual (hourly) rate AR
Hours (labour or machine) H
Standard (allowed) hours SH
Actual hours AH
Favourable f
Unfavourable (also referred to as adverse) u

Material variances
The cost of material included in product cost is made up of how much you paid for the
materials and how much materials you used. When the variance from budgeted to actual
costs is analysed it would be made up of a material price variance and a material usage
variance.

Material price variance

The material price variance is the difference between what we wanted to pay for materials
and what we paid for materials.

Material usage or quantity variance

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The material usage or quantity variance compares the quantity (in kilograms/litres/metres,
etc.) that we wanted to use per unit for the actual output in units to what we actually used
for the actual output.

The following formulas can be used to calculate these variances:

This quantity is
KILOGRAMS of
Material Price Variance material used and
NOT units
produced

AP x AQ vs SP x AQ

f/u
To determine
whether this variance
This formula is f/u you would
overlaps compare PRICES –
AP vs SP

Material Usage/Quantity Variance

AQ x SP vs
SQ x SP
f/u
To determine
whether this variance SQ is the standard
(budgeted) quantity
if f/u you would
allowed per unit x actual
compare USAGE –
units produced
AQ vs SQ

Material Price Variance: (SP x AQ) - (AP x AQ) = +F / -U variance

Material Usage Variance: (*SQ x SP) - (AQ x SP) = +F / -U variance
*SQ = budgeted quantity per unit x actual units produced

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Total material variance

The total material variance can be calculated in two ways:

1) The difference between the standard material cost for actual production (SC) and
actual cost (AC); or
2) By adding up the material price variance and material usage variance.

Activity

Attempt requirements a) to c) of the Illustrative example at the end of this learning unit.

Reasons for material variances

Material price variance

The purchasing department would be responsible for this variance. Some factors would
be within their control, but they cannot always be held responsible since some factors are
not within their control.

Factors within their control:

• Quantity rebates on bulk purchases were available and they did not take advantage
thereof;
• Poor planning, which might lead to higher than budgeted prices and increased
delivery costs due to increased number of orders placed.

Factors not within their control:

• Price rises due to, for example inflation, exchange rates and fuel price increases;
• Material shortages due to unforeseen circumstances, for example fire, floods, that
lead to orders being processed at the last minute at higher prices.

Material usage or quantity variance

This variance can in most cases be controlled by the department and reasons can include:

• Employee carelessness
• Inferior quality of material
• Quality controls being either too strict or too poor
• Employees not being trained on the production process

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Labour variances
Total labour cost is derived from cost paid per hour and hours worked. Therefore, when
analysing this variance, one would have to do an analysis in terms of both rates and hours.
You would do this by calculating a labour rate variance and a labour efficiency variance.

Labour rate variance

When calculating the labour rate variance, you would compare what the company wanted
to pay for labour on an hourly basis (the set standard per hour) and what was actually paid
during the year.

Labour efficiency variance

The labour efficiency variance indicates how efficient the employees were. To measure
this, we can compare hours or minutes that were expected to be spent per unit for actual
output in units with hours or minutes that were actually spent for output in units.

The following formulas can be used to calculate these variances:

This AH is labour
Labour Rate Variance HOURS and NOT
units produced
AR x AH vs SR x AH

f/u
To determine
whether this variance
This formula
if f/u you would
overlaps
compare RATES –
AR vs SR
Labour Efficiency Variance

AH x SR vs
SH x SR
f/u
To determine
whether this variance SH is the standard
if f/u you would (budgeted) hours
compare HOURS – allowed per unit x
AH vs SH actual units produced

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Labour Rate Variance: (SR x AH) - (AR x AH) = +F / -U variance

Labour efficiency Variance: (*SH x SR) - (AH x SR) = +F / -U variance
*SH = budgeted hours per unit x actual units produced

Activity

Attempt requirements d) to f) of the Illustrative example at the end of this learning unit.

Total labour variance

The total labour variance can be calculated in two ways:

1) The difference between the standard labour cost for actual production (SC) and
actual cost (AC); or
2) By adding up the labour rate variance and labour efficiency variance.

Reasons for labour variances

Labour rate variance

The human resource department would be responsible for this variance, however there is
not much control they can have over this variance. The two most common reasons for this
variance would be:

• Wage rates could not be negotiated at the rate that the company wanted it to be.
• Workers were employed from different grades than was initially planned, for
example, workers at a higher skilled level were used.

Labour efficiency variance

This variance can be controlled by the production manager or factory supervisor. You will
see that there are similarities between the reasons for this variance and the material usage
variance. Reasons would include:

• Inferior quality of material used.

• Workers not skilled for the job to be performed.
• Unexpected idle time.
• Changes in quality standards – takes more time to ensure quality products are
produced.
• Employees not being trained on changes in the production process.

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Variable manufacturing overhead variances

The variable manufacturing overhead variance is analysed very similarly to the labour
variances. You will also use a rate variance and an efficiency variance. The reason for this
is that the variable manufacturing overheads will normally vary with labour hours worked.
Note that the same hours will be used as was used for labour, but the rate will now change.

Sometimes, however, variable manufacturing overheads do not vary with labour hours
and in that case, there will be only one variance where the standard cost (standard rate
for actual output) will be compared to the actual cost – note that this is also how you would
calculate the variance in total.

We will now look at the variances where variable manufacturing overheads vary
with labour hours:

Variable manufacturing overhead rate variance

When calculating this variance, we compare the set standard (what they wanted to pay)
to what they actually paid for the actual hours that was worked.

Variable manufacturing overhead efficiency variance

The variable manufacturing overhead efficiency variance is calculated by comparing the

standard hours or minutes allowed per unit for actual units produced to the actual hours
worked.

The following formulas can be used to calculate these variances (Note that these formulas
are the same formulas than what we used for labour, the only variable that will change, is
the rate):

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This AH is labour
Variable manufacturing overheads Rate Variance HOURS and NOT
units produced
AR x AH vs SR x AH

f/u
To determine
whether this variance
This formula
if f/u you would
overlaps
compare RATES –
AR vs SR
Variable manufacturing overheads Efficiency Variance

AH x SR vs
SH x SR
f/u
To determine
whether this variance SH is the standard
if f/u you would (budgeted) hours
compare HOURS – allowed per unit x
AH vs SH actual units produced

Variable overhead rate variance: (SR x AH) - (AR x AH) = +F / -U variance

Variable overhead efficiency Variance: (*SH x SR) - (AH x SR) = +F / -U variance
*SH = budgeted hours per unit x actual units produced

Total variable manufacturing overhead variance

The total variable manufacturing overheads variance can be calculated in two ways:

1) The difference between the standard variable manufacturing overhead cost for
actual production (SC) and actual cost (AC); or
2) By adding up the variable manufacturing overheads rate variance and variable
manufacturing overheads efficiency variance.

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Activity

Attempt requirements g) to i) of the Illustrative example at the end of this learning unit.

Reasons for variable manufacturing overhead variances

Variable manufacturing overheads rate variance

Manufacturing overheads (both fixed and variable) are made up of various line items,
including water and electricity, rent, rates and taxes, etc. All of these variances are linked
to inflation and would mostly not be within the control of the company. Due to the different
line items contained in overheads, the investigation would be much more onerous than
with the other variances.

Variable manufacturing overheads efficiency variance

Due to this variance varying with labour hours, the same reasons for the labour efficiency
variance would apply.

Fixed manufacturing overhead variances

There are several fixed manufacturing overhead variances, of which the most popular
ones are the expenditure variance and the volume variance. For purposes of MFAC6211
we will only deal with the expenditure variance.

Fixed manufacturing overhead expenditure variance

The fixed manufacturing overhead expenditure variance is the difference between the
budgeted fixed manufacturing overhead costs and the actual fixed manufacturing
overhead costs. If the company spent more than budgeted, the variance will be
unfavourable, if the company spent less than what was budgeted, the variance will be
favourable.

Budget - Actual = +F / -U variance

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Activity

Attempt requirement j) of the Illustrative example at the end of this learning unit.

Sales variances
Sales variances arise due to a difference in the price that we sold the product at compared
to what we budgeted and the difference in volume that we actually sold compared to what
we wanted to sell. There are various sales variances. For the purposes of MFAC6211 we
will only deal with the selling price variance.

Selling price variance

To calculate the selling price variance, we compare the price at which we sold the product
to the price that we wanted to sell the product for. The following formula can be used to
calculate the variance:

AP x AV vs SP x AV

f/u To determine
whether this variance
if f/u you would
compare PRICES –
AP vs SP

Selling Price Variance: (AP x AQ) - (SP x AQ) = +F / -U variance

Activity

Attempt requirement k) of the Illustrative example at the end of this learning unit.

Reasons for the selling price variance

The reasons for a selling price variance could include:

• An aggressive advertising campaign

• An increase or decrease in demand of the product
• Competition in the market

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Reconciling budgeted results with actual results

After you have calculated all variances, you can reconcile your budgeted results with your
actual results. The following format will be used to do this (Note that you start with the
budgeted profit and then add all the variances calculated to derive at the actual profit):

Budgeted profit Indicate

Variances: f/u whether
f/u
Material price variance
Material usage variance
Labour rate variance
Simply list all
Labour efficiency variance
your variances
Variable manufacturing overhead rate variance
Variable manufacturing overhead efficiency variance
Fixed manufacturing overhead expenditure variance xxx
Selling price variance
Actual profit
If (f) – add, if (u) - deduct

Activity 1

Do requirement l) of the Illustrative example at the end of this learning unit.

Illustrative example
Namib Leather (Pty) Ltd purchases leather which is cut into small strips. These strips are
then sewn together to make car seat covers. The company budget to sell these seat
covers at R 200 per cover. The budgeted profit for December 20X1 is R 280 000. Actual
profit was R 279 930,50.

The standard variable cost per seat cover is as follows:

Material leather (2 metres at R 28 per metre) R 56

Direct labour (3 hours at R 18 per hour) R 54
Variable manufacturing overheads R 30
Total standard variable cost per unit R 140

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Additional information:

• Fixed manufacturing overheads are budgeted to be R 45 000 in total.

• The company budgeted to manufacture and sell 12 000 units in December 20X1.
• Variable manufacturing overheads vary with hours worked.

Actual results for December 20X1 were as follows:

Total leather costs at R32 per metre R 658 560,00

Total labour cost (30 285 hours) R 529 987,50
Total variable manufacturing overheads R 300 522,00
Total fixed manufacturing overheads R 50 000,00

Actual units manufactured and sold for December 20X1 9 960 units
Actual selling price for December 20X1 R 210

REQUIRED

a) Calculate the material purchase price variance.

b) Calculate the material usage variance.
c) Calculate the total material variance.
d) Calculate the labour rate variance.
e) Calculate the labour efficiency variance.
f) Calculate the total labour variance.
g) Calculate the variable manufacturing overheads rate variance.
h) Calculate the variable manufacturing overheads efficiency variance.
i) Calculate the total variable manufacturing overheads variance.
j) Calculate the fixed manufacturing overheads expenditure variance.
k) Calculate the selling price variance.
l) Reconcile the budgeted profit to the actual profit for December 20X1.

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Revision Exercises

Revision Exercise 10.1

Little Giants (Pty) Ltd manufactures giant teddy bears and uses a standard costing
system. The following information is available:

Standard cost per bear is: R

Direct material: fabric (1.5m @ R200 per m) 300

Direct material: décor (0.5kg @ R12 per kg) 6
Direct material: stuffing (1kg @ R50 per kg) 50

20 hours of direct labour is required per teddy bear at a rate of R20 per hour. Variable
overhead varies with labour hours worked at a rate of R5 per hour.

Variable selling costs is budgeted as R30 000 and the selling price per teddy bear is R
900.

Actual information per bear for the financial year ended 31 December 20X1 was as follows:

Direct material: fabric 1.6 m used at a price of R180 per meter

Direct material: décor 0.4 kg used at a price of R11 per kg
Direct material: stuffing 800 grams were used and a price of R52 per
kg paid
Labour hours 22 hours per bear
Labour rate R22 per hour
Variable overhead rate variance R20 000 favourable

Actual selling price per teddy bear was R 950.

Teddy bears manufactured and sold was 1 500.

REQUIRED

a) Calculate the material price variance for materials fabric and décor.
b) Calculate the material usage variance for material stuffing.
c) Calculate the labour rate variance.
d) Calculate the labour efficiency variance.
e) Calculate the actual variable overhead rate.
f) Calculate the selling price variance.

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Revision Exercise 10.2

Cough & Co (Pty) Ltd produces cough syrup and uses a standard costing system. They
have recently accepted a contract to produce a special order of cough syrup for a potential
large future customer. The following information is available:

Standard cost per bottle of cough syrup is:

R
Direct material A (150 ml @ R 480 per litre) 72
Direct material B (60 ml @ R 150 per litre) 9
Direct material C (75 ml @ R 160 per litre) 12

12 hours of direct labour is required per bottle of cough syrup at a rate of R 30 per hour.
Variable overhead varies with labour hours worked at a rate of R 10 per hour.

Actual information for cough syrup for the financial year ended 31 August 20X1 was as
follows:

Direct material A 3 520 litres at a total cost of R 1 619 200

Direct material B 1 210 litres at a total cost of R 193 600
Direct material C 1 760 litres at a total cost of R 290 400
Labour hours 308 000 hours in total
Labour rate variance R 616 000 favourable
Variable overhead rate R 8 per hour

Bottles of cough syrup produced and sold was 22 000.

REQUIRED

a) Calculate the material price variance for materials A and B.

b) Calculate the material usage variance for material C.
c) Calculate the actual labour rate.
d) Calculate the labour efficiency variance.
e) Calculate the variable overhead rate variance.
f) Calculate the variable overhead efficiency variance.

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Revision Exercise 10.3

PCD (Pty) Ltd recently started producing paint and make use of a standard costing system.
The company has summarised the variances for October 20X1 as follows:

Selling price variance R 35 200 unfavourable

Direct material purchase price R 7 000 favourable
Direct labour rate R 5 400 unfavourable
Direct labour efficiency R 12 600 unfavourable
Variable manufacturing overhead expenditure R 4 500 unfavourable
Fixed manufacturing overhead expenditure R 5 400 favourable

Actual number of units produced and sold for the month was 22 000. Direct materials
actually purchased and used were 5 000kg.

The following data was extracted from the budget for October 20X1:

Sales volume 20 000 units

Sales revenue R 400 000
Production volume 20 000 units
Direct materials purchased and used 4 000 kg
Direct materials cost R 60 000
Direct labour hours 14 000
Direct labour cost R 420 000
Variable manufacturing overhead cost R 25 000
Fixed manufacturing overhead cost R 40 000

Variable manufacturing overhead cost varies with production.

REQUIRED:

a) Calculate the actual selling price per unit.

b) Calculate the actual purchase price per kilogram of materials.
c) Calculate the actual direct material cost.
d) Calculate the actual direct labour hours.
e) Calculate the actual direct labour cost.
f) Calculate the actual variable manufacturing overhead cost.
g) Calculate the actual fixed manufacturing overhead cost.

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Revision Exercise 10.4

Attempt Review Problem 17.23 in the Drury textbook, 11th Edition.

Revision Exercise 10.5

Attempt Question 17.10 in the Drury Student Manual, 11th Edition.

Revision Exercise 10.6

Attempt Question 17.6 in the Drury Student Manual, 11th Edition.

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Learning Unit 11: Relevant costing

Learning Objectives: My notes
• Identify the characteristics that make information relevant.
• Distinguish between relevant and irrelevant information
with regards to a specific decision.
• Identify the qualitative factors that has an influence on a
specific decision taken.
• Calculate relevant incremental cash flows in a given
scenario.
• Identify the preconditions for a special price.
• Determine appropriate prices for special orders taking into
account relevant information, including opportunity costs.
• Calculate contribution per unit of a limiting factor identified
in a given scenario.
• Determine the optimal allocation of available resources.
• Determine the optimal product mix.
Material used for this learning unit:
• Chapter 9 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 9:
o Identifying relevant costs and revenues
o Special pricing decisions
o Product mix decisions when capacity constraints
exist
o Determining the relevant costs of direct materials
o Determining the relevant costs of direct labour

Introduction
Identifying relevant costs and revenues is one of the most important functions in
management accounting. It is important to distinguish between relevant costs and
irrelevant costs as relevant costs would be included in your decision-making and irrelevant
costs will specifically be excluded. In this learning unit you will learn how to distinguish
between relevant and irrelevant costs. This is then used for decision-making in the
following circumstances:

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1. Special selling price decisions;

2. Product mix decisions when capacity constraints exist;
3. Decisions on replacement of equipment;
4. Outsourcing (make or buy) decisions;
5. Discontinuation decisions.

In MFAC6211 we will only focus on special selling price decisions and product mix
decisions when capacity constraints exist.

Relevant versus irrelevant costs

Relevant costs always need to meet the following criteria:

• It relates to the future.

• it is cash in nature.
• It is directly attributable to the decision to be taken.
• It arises as a result of the decision to be taken and will therefore not exist if this
decision will not have been an option.

You need to know the following terminology:

Term Relevant/Irrelevant Explanation

Sunk cost Irrelevant These costs have been
incurred in the past and
regardless of what decision
you take they cannot be
changed.
Committed (unavoidable) Irrelevant Even though this cost will
costs or income result in a future cash flow, it
is a result of a decision that
was taken in the past and
therefore regardless of the
decision you take, it will be
incurred/received.
Incremental costs or income Relevant These are additional costs or
income that arise because of
the decision to be taken and
is therefore a future cash flow.
Avoidable costs Relevant These costs can be avoided
because of the decision taken
and therefore result in a future
cash inflow.
Opportunity costs Relevant This is the contribution given
up because of an alternative
or option selected.

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There are two approaches that can be used when making decisions:

1. Comprehensive approach
2. Differential (Incremental) approach

Special pricing decisions

Special pricing decisions are made once-off. They can be made for both short-term and
long-term decisions. In MFAC6211 we will focus on short-term decisions only. Special
pricing decisions will be below the market price due to the company wanting it to be
competitive.

Four important factors must be considered before accepting an order:

1. The future selling price should not be affected by selling the once off order at a price
below the market price. Therefore, it is sometimes safer for the company to find a
customer outside of its normal market.
2. There should not be better opportunities awaiting due to the special pricing decision
being quoted below market price.
3. There should be spare capacity, or else opportunity cost should be taken into
consideration.
4. Because this is a short-term decision it will be assumed that fixed costs are
unavoidable.

Included in the costing of the special pricing decision will be direct material and direct
labour costs and it is therefore important to determine the relevant costs of these.

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Determining the relevant costs of direct material

To determine the relevant costs of direct material to be included in your calculation

you can make use of the following decision tree:

Are materials No Relevant Cost

already in stock? = Cost to
purchase

Yes

Are materials
used regularly
Relevant Cost Yes and replaced
= Cost to when stock runs
purchase out?

No
Do the materials
have an
alternative use /
can they be sold
if not used?
Can’t be sold or
Sold Alternative use Disposed of no alternative use
Relevant Cost = Relevant Cost =
Relevant Cost =
NRV Lost contribution Relevant Cost =
Opportunity
(Opportunity (Opportunity ZERO
Saving
Cost) Cost)

Determining the relevant costs of direct labour

To determine the relevant costs of direct labour to be included in your calculation you
can make use of the following decision tree:

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Is there spare
capacity?

Yes No

Can they work

No cost
overtime?

Yes No

Overtime cost Opportunity cost

Activity 11.1

Answer question IM9.2 in the Drury textbook, 11th edition.

Product mix decisions when capacity constraints exist

Sales demand may sometimes be greater than production capacity. Production output
may be restricted due to, for example, labour hours or availability of a material used in
your product. These would be called scarce resources and are known as limiting factors.

Due to the limiting factor’s existence we are not able to meet sales demand, because it is
not possible to produce enough units to meet the demand. The following steps can be
used to determine what product mix would maximise profit considering the capacity
constraint:

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1. Identify and calculate the limiting factor

2. Calculate the contribution per unit for each product

3. Calculate the contribution per limiting factor for each

product

4. Rank the products from the highest to lowest

contribution per limiting factor

5. Allocate the scarce resource to the products in order

of the ranking in 4) above

Activity 11.2

Answer question IM9.5 in the Drury textbook, 11th edition.

Revision Exercises

Revision Exercise 11.1

Big Foot Limited manufactures shoes and sells four different types of shoes – heels,
slippers, sneakers and boots. Management is in the process of preparing the budget for
20X1 but have noted that the demand for their shoes will not be met due to a limited
number of labour hours. The labour hours available are 8 500. The company will not be
able to acquire additional labour, but the labour hours available can be reassigned
between products as required.

The demand for each of the four products are as follows:

Heels 800 pairs

Slippers 1 200 pairs
Sneakers 2 000 pairs
Boots 800 pairs

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It takes 2 hours to manufacture one pair of heels and 1.5 hours for one pair of slippers. It
takes them 1 hour to manufacture one sneaker and twice as long to manufacture a boot.

Additional information:

• Heels are expected to sell for R200, slippers for R120, sneakers for R250 and boots
for R580.
• Variable costs per unit are budgeted as follows:

Cost Heels Slippers Sneakers Boots

Direct Labour R 40 R 20 R 40 R 80
Direct Material R 70 R 30 R 100 R 300
Overhead R 10 R 5 R 15 R 30
Selling costs R 5 R 2 R 5 R 10

• Fixed costs for the period are expected to be R320 000.

REQUIRED

a) Determine the maximum contribution that Big Foot Limited can generate with the
labour hours available to them.

Revision Exercise 11.2

Anglo (Pty) Ltd manufactures and sells two different products, Gold and Silver. The
management accountant has started preparing the budget for the 20X1 financial year and
identified the following as the only limiting factor in the production process:

Gold Silver Total

Labour hours required to meet full demand 2000 3 000 5 000
Total hours available 4 500

The company will not be able to acquire any additional labour, but the labour hours
available can be reassigned to products as required.

Additional information:
• Budgeted fixed cost for the year are R 590 000.
• Gold is expected to sell for R50 per unit and Silver for R30 per unit.
• Expected regular demand for 20X1 is 3 000 Golds and 5 000 Silvers.
• Variable costs per unit are budgeted as follows:

Gold Silver
Variable manufacturing cost R 12 R 10
Variable selling cost R 4 R 2
Total variable cost R 16 R 12

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REQUIRED:

a) Determine the sales mix that should be budgeted for the coming financial year to
maximise the budgeted profit for the company.

Revision Exercise 11.3

Quality Cart (Pty) Ltd manufactures quality carton boxes. The company received an order
from Export Limited to design and manufacture 10 000 carton boxes. The boxes will be
completed over a period of 3 months and be ready at the end of April 20X1. Each box
requires 3 metres of paperboard and a customised label. The paperboard will need a
coating of wax, which will be 250 ml per box.

This is a box that will be manufactured according to customer specifications and therefore
will have to be designed. The current designers employed by the company will not have
the capacity to design these boxes and Quality Cart (Pty) Ltd will therefore have to
outsource this function to a designer at a total cost of R 3 000.

The paperboard will be purchased from a local supplier at R 3 per metre. They currently
pay R 10 per one litre of wax. The wax will be applied by one of their current employees
who earns a salary of R 4 500 per month.

Quality Cart currently has 8 000 labels in stock which has been purchased at R 1,50 each.
These labels were used on a product line which has been discontinued 5 months ago and
there is no future use for it. The labels will have to be disposed of at a total cost of R 2
500. The current purchase price of these labels is R 1,80.

The boxes are folded by a machine that has been purchased two years ago at a cost of R
8 000. The estimated useful life of this machine is 4 years and depreciation written off on
the straight-line method.

To meet the deadline, 2 additional casual workers will have to be employed on a contract
basis at R 3 500 each per month. These employees will be supervised, in addition to his
normal responsibilities, by the factory supervisor, who earns a salary of R 12 000 per
month.

The company pays factory rent of R 25 000 per month as per the lease agreement.

REQUIRED

Determine the minimum price that Quality Cart (Pty) Ltd should charge for the order of 10
000 carton boxes. Clearly indicate all costs that should be consider for the special order
and indicate, with reasons, why they are included or excluded.

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Revision Exercise 11.4

Attempt Question 9.5 in the Drury Student Manual, 11th Edition.

Revision Exercise 11.5

Attempt Question 9.6 in the Drury Student Manual, 11th Edition.

Revision Exercise 11.6

Attempt Question 9.7 in the Drury Student Manual, 11th Edition.

Revision Exercise 11.7

Attempt Question 9.8 (a) in the Drury Student Manual, 11th Edition.

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Learning Unit 12: Cost-Volume-Profit (CVP) analysis

(Sensitivity analysis)
Learning Objectives: My notes
• Use Cost-Volume-Profit analysis to determine the
expected effect of decisions and events on profit.
• Use Cost-Volume-Profit analysis to determine the
expected effect of decisions and events on variables that
affect profit.
• Determine the sensitivity of profit to changes in selling
prices.
• Determine the sensitivity of profit to changes in sales
volumes.
• Determine the sensitivity of profit to changes in costs.
Material used for this learning unit:
• Chapter 8 of the prescribed textbook
Prescribed material used for this learning unit:
• Drury, C. 2020. Management and Cost Accounting. 11th
ed. Southern Western Cengage Learning. (PM).
Study the following subsections in chapter 8:
• A numerical approach to cost-volume-profit analysis
• The contribution margin ratio
• Relevant range
• Margin of safety
• Constructing a break-even chart

Introduction
This learning unit consists of two topics. Cost volume profit analysis and sensitivity
analysis. Cost volume profit analysis is used as a management tool to make business
decisions. We will learn formulas and principles including the breakeven point and the
margin of safety. Sensitivity analysis will then look at the sensitivity of profits to changes
in variables such as selling prices, growth rates, variable costs and fixed costs.

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Cost-Volume-Profit analysis

Breakeven point

The breakeven point is the point where your total revenue equals your total costs,
therefore a zero profit. This can be expressed in units or in Rand value.

To calculate the breakeven point in units the following formula may be used:

𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑝𝑜𝑖𝑛𝑡 (𝑢𝑛𝑖𝑡𝑠) =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

It is important that if the breakeven point(units) is a decimal when calculating breakeven

we should round up. If you round down, you will be making a small loss.

Contribution per unit can be calculated by deducting all variable costs from your selling
price, therefore Contribution = Selling price – all variable costs per unit.

To calculate the breakeven point in Rand value the following formula may be used:

𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑝𝑜𝑖𝑛𝑡 (𝑣𝑎𝑙𝑢𝑒) =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛

Contribution margin can be calculated by dividing contribution per unit by the selling
price, or contribution in total by sales in total.

Alternatively, the breakeven point in Rand value can be calculated by multiplying the
number of breakeven units with the selling price per unit.

Target profit

In most cases companies would like to achieve a target profit. If this is the case, they need
to be able to plan what the number of units is that would have to be sold to reach the target
profit. This could be done by using the following formula:

𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑇𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡

𝑇𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

The answer to the above calculation would tell you the number of units that needs to be
sold to achieve the target profit. You will note that the formula used is very similar to the
breakeven formula. Target profit is now just added to fixed costs.

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Margin of safety

This is the amount or percentage that a company’s sales can decrease before it will incur
losses. It may be seen as the company’s safety net. It can be calculated in both units and
Rand value. To calculate this, you would use the following formulas:

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 (𝑢𝑛𝑖𝑡𝑠) = 𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑢𝑛𝑖𝑡𝑠) − 𝑏𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑠𝑎𝑙𝑒𝑠(𝑢𝑛𝑖𝑡𝑠)

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 (𝑣𝑎𝑙𝑢𝑒) = 𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑣𝑎𝑙𝑢𝑒) − 𝑏𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑠𝑎𝑙𝑒𝑠 (𝑣𝑎𝑙𝑢𝑒)

Margin of safety can also be expressed as a percentage of sales and is then called
margin of safety ratio. To calculate this, you would use the following formula:

𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑢𝑛𝑖𝑡𝑠) − 𝑏𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑠𝑎𝑙𝑒𝑠 (𝑢𝑛𝑖𝑡𝑠)

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = 𝑥 100%
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑢𝑛𝑖𝑡𝑠)

OR

𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑣𝑎𝑙𝑢𝑒) − 𝑏𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑠𝑎𝑙𝑒𝑠 (𝑣𝑎𝑙𝑢𝑒)

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = 𝑥 100%
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑣𝑎𝑙𝑢𝑒)

Activity 12.1

The following information relates to product A:

Units produced and sold: 10 000

R
Sales 200 000
Variable costs 120 000
Fixed costs 30 000

The company would like to achieve a profit of R 20 000.

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REQUIRED

Calculate the following:

a) Contribution in total and per unit

b) Contribution ratio
c) Breakeven units
d) Breakeven value
e) Target operating income/profit units to be sold to reach the profit of R 20 000
f) Margin of safety in units
g) Margin of safety ratio

Sensitivity analysis
This topic examines the sensitivity of profits to changes in variables such as selling prices,
growth rates, variable costs and fixed costs. An important assumption made in this
learning unit is that there will be no uncertainty regarding the outcome.

You will use the formulas and underlying principles covered earlier under Cost-Volume-
Profit analysis to determine, for example, the effect of changes in variables on profit,
breakeven, margin of safety and target profit. The basic format of the direct costing
statement will be used in your analysis:

Sales (made up of a selling price and number of units) xxx

Less: Variable Cost (made up of a cost and number of units) (xx)
Contribution xxx
Less: Fixed Cost (xx)
Net profit xxx

Remember that to determine sensitivity you always need to compare the one outcome
with another. You will therefore need two sets of data in your answer. The sensitivity to
change will be calculated with the same formula that you use to calculate percentage
change:

𝐿𝑎𝑡𝑒𝑠𝑡 𝑓𝑖𝑔𝑢𝑟𝑒 − 𝑂𝑙𝑑/𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑓𝑖𝑔𝑢𝑟𝑒

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 =
𝑂𝑙𝑑/𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑓𝑖𝑔𝑢𝑟𝑒

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Effect of changes in selling prices

If it is assumed that all other factors remain constant, but there is a change in the selling
price, the following will be affected:

• Revenue
• Contribution
• Profit

Activity 12.2

Sensitive (Pty) Ltd produces one type of shampoo for sensitive hair. The following
information is available for the month ended April 20X1:

Variable costs R 60 000

Fixed costs R 30 000
Profit R 60 000

There was no opening or closing inventory.

REQUIRED

a) If Sensitive (Pty) Ltd wants to increase its profit for the month by 15%, by what
percentage does the selling price per bottle of shampoo have to increase?
b) If the selling price per bottle of shampoo increase by 10%, what will the effect be on:
i. Profit (relative terms)
ii. The break-even point in units if 5 000 bottles of shampoo were sold for the
month.
iii. Margin of safety if 5 000 bottles of shampoo were sold for the month.

You can assume that no other variables changed.

Effect of changes in sales volume on profits

If it is assumed that all other factors remain constant, but there is a change in the sales
volume, the following will be affected:

• Revenue
• Variable costs
• Contribution
• Profit

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Activity 12.3

The information from Activity 12.2 will now be used again. However, the selling price
cannot be changed and consequently there will have to be an increase or decrease in
sales volume to arrive at the desired 15% increase in profit.

REQUIRED

a) Determine the percentage increase or decrease in sales volume (number of bottles

of shampoo sold) to arrive at the 15% increase in profit.
b) Assuming 5 000 bottles of shampoo were sold, determine the percentage by which
the sales volume can change before the profit will drop below R 50 000.

Effect of changes in variable costs on profits

If it is assumed that all other factors remain constant, but there is a change in the variable
cost per unit, the following will be affected:

• Variable costs
• Contribution per unit
• Contribution ratio
• Profit

Activity 12.4

The information from Activity 12.2 is still applicable, but profit can now only be increased
by decreasing variable cost per unit.

REQUIRED

a) Sensitive (Pty) Ltd still wants to increase their profit by 15% but can now only change
the variable cost per unit. Determine the percentage change necessary to arrive at
the desired profit.

Effect of changes in fixed costs on profits

If it is assumed that all other factors remain constant, but there is a change in the fixed
cost in total, the following will be affected:

• Profit

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Activity 12.5

The following information is available for Sensitive (Pty) Ltd for the month of June 20X1:

Margin of safety 250 units

Breakeven quantity 500 units
Contribution R 110 000

Fixed costs include rent of a factory building which was R 20 000 for June 20X1,
however will increase with 10% as from July 20X1 as per the rental agreement.

All other costs and selling prices will remain the same as in April 20X1.

REQUIRED

Calculate the effect that the increase in fixed costs in July 20X1 will have on:

a) Profit (in relative terms)

b) Break-even quantity (absolute and relative terms)
c) Margin of safety (absolute and relative terms)

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Revision Exercise 12.1

Tiger SA (Pty) Ltd is a transport company that outsource their services to other companies
that are not able to afford trucks to transport their goods. They are currently in the
budgeting process for the year ended 31 March 20X1 and asked your assistance with the
cost-volume-profit analysis. The following budgeted information is available:

• The charge per kilometre of goods transported, regardless of the size of the load, is
R6.50
• From experience, Tiger SA (Pty) Ltd has learned that if they drive 550 000 kilometres
per annum their total cost is R 4 960 000 and if they drive 780 000 kilometres their
total cost is R 5 696 000.
• Due to tough economic times Truck SA (Pty) Ltd budgeted to drive only 1 100 000
kilometres during the 2017 financial year. They would like to achieve a margin of
safety of 150 000 kilometres.
• The company requires a target profit of R1 500 000 per annum to satisfy the owners
of the company.

REQUIRED

a) Calculate the breakeven point in kilometres that Tiger SA (Pty) Ltd must drive to
break even for the financial year ended 31 March 20X1.
b) Calculate the breakeven value for Tiger SA (Pty) Ltd.
c) Calculate the company’s current margin of safety and indicate the percentage
increase or decrease needed to achieve their target of 150 000 kilometres.
d) Will the company reach their target profit as per the current budgeted information
provided to you?

[Round off to two decimal places. Round off to the nearest kilometre where applicable.]

Revision Exercise 12.2

Player Golf Carts (Pty) Ltd, a subsidiary of The Gary (Pty) Ltd, manufactures and supplies
golf carts. The company has been awarded a contract by Waterfall Country Club to supply
golf carts for the whole of the 20X1 financial year.

The company provided the following information for the 20X0 financial year regarding its
Fantabulous Golf Cart Range:

Total production cost if 2 000 units are produced in the year R15 000 000
Total production cost if 3 500 units are produced in the year R24 000 000

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The company manufactured and sold 450 golf carts in 20X1. The selling price per golf cart
is R12 000. The production cost structure (variable production cost per unit and fixed
production cost in total) of 20X1 is the same as in 20X0. This cost structure will remain the
same for any production quantity between 1 and 10 000 units. Ignore non-manufacturing
costs.

REQUIRED

a) Calculate the breakeven point in units (golf carts) for the Fantabulous Range for
20X1.
b) Calculate the profit or loss for 20X1 based on the sales of 450 golf carts. Clearly
indicate whether your answer is a profit or a loss.
c) Calculate the number of golf carts the company should sell in 20X1 to make a profit
of R8 000 000.

Revision Exercise 12.3

Magnificent Fans (Pty) Ltd manufactures and sells domestic fans. The selling price per
fan for 20X0 was R760. Due to the economic downturn the selling price is expected to
decrease with 5% in 20X1 since the company would like to try and maintain good sales
quantities.

The accountant presented you with the following cost information. The company’s financial
year end is 30 June:

Actual information for 20X0:

Manufacturing costs:
Direct material cost per unit R160
Direct labour cost per unit R42
Variable manufacturing overhead cost per unit R22
Fixed manufacturing overhead costs in total R250 800

Non-manufacturing costs:
Variable selling and distribution costs per unit 5% of the selling price
Fixed selling and distribution costs R55 600
Fixed administrative overheads in total R68 000

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Additional information relating to 20X1:

• Direct material cost per unit is expected to increase with 12%.

• The direct labour rate per hour will increase with 3%. The company has done an
analysis on the time taken per unit and expects the employee morale to be affected
due to the low increase. They estimate that it will take 5% longer to manufacture a
fan.
• Variable manufacturing overhead costs are expected to increase in line with the time
taken per unit manufactured.
• The fixed manufacturing costs for 20X0 includes depreciation of R5 000 per month
of a machine that has been fully depreciated at the end of 20X0. The company is
not planning to replace the machine in 20X1. Other fixed manufacturing overheads
will increase with 5%.
• Fixed selling and distribution costs is expected to increase with 5%. Variable selling
and distribution costs will increase to 7% of the selling price to ensure sales
personnel maximise sales.
• Fixed administrative overheads will remain unchanged.

REQUIRED

Calculate the budgeted breakeven units for the year ended 30 June 20X1.
Round off to two decimal places.

Revision Exercise 12.4

Cute Cars (Pty) Ltd manufactures and sells toy cars. The selling price per car for 20X0
was R50 and is expected to increase with 10% per year from 20X1.

Actual information for 20X0:

Manufacturing costs:
Direct material cost per unit R10.00
Direct labour cost per unit R3.00
Variable manufacturing overhead cost per unit R2.50
Fixed manufacturing overhead costs in total R80 000

Non-manufacturing costs:
Selling and distribution costs in total R19 750
Fixed administrative overheads in total R5 000

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Additional information relating to 20X1:

• Direct material cost per unit is expected to increase with 10%.

• The current labour force is on strike and demands an increase of 11%. The
accountant expects the increase to remain at the planned 7%.
• Variable manufacturing overhead costs are expected to remain unchanged.
• The fixed manufacturing costs for 20X0 includes monthly factory rental of R3 000
which is due for annual escalation of 6% on 1 May each year. The balance of fixed
manufacturing costs will not increase.
• Selling and distribution costs include both fixed and variable costs. Total selling and
distribution costs for 20X1 are budgeted to be R20 500. Selling and distribution costs
for 20X1 will be in line with 20X0.
• Fixed administrative overheads are expected to increase by 6%.
• Actual units sold during 20X0 were 23 500. The budgeted sales unit for 20X1 was
increased with 1 500 units from prior year.

REQUIRED

e) Calculate the budgeted breakeven units for the year ended 30 June 20X1.
Round off to two decimal places.

References
Drury, C. 2020. Management and Cost Accounting. 11th ed. Southern Western Cengage
Learning. (PM).

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Intellectual Property
Plagiarism occurs in a variety of forms. Ultimately though, it refers to the use of the words,
ideas or images of another person without acknowledging the source using the required
conventions. The IIE publishes a Quick Reference Guide that provides more detailed
guidance, but a brief description of plagiarism and referencing is included below for your
reference. It is vital that you are familiar with this information and the Intellectual Integrity
Policy before attempting any assignments.

Introduction to Referencing and Plagiarism

What is ‘Plagiarism’?

‘Plagiarism’ is the act of taking someone’s words or ideas and presenting them as your
own.

What is ‘Referencing’?

‘Referencing’ is the act of citing or giving credit to the authors of any work that you have
referred to or consulted. A ‘reference’ then refers to a citation (a credit) or the actual
information from a publication that is referred to.

Referencing is the acknowledgment of any work that is not your own, but is used by you
in an academic document. It is simply a way of giving credit to and acknowledging the
ideas and words of others.

When writing assignments, students are required to acknowledge the work, words or ideas
of others through the technique of referencing. Referencing occurs in the text at the place
where the work of others is being cited, and at the end of the document, in the bibliography.

The bibliography is a list of all the work (published and unpublished) that a writer has read
in the course of preparing a piece of writing. This includes items that are not directly cited
in the work.

A reference is required when you:

• Quote directly: when you use the exact words as they appear in the source;
• Copy directly: when you copy data, figures, tables, images, music, videos or
frameworks;
• Summarise: when you write a short account of what is in the source;
• Paraphrase: when you state the work, words and ideas of someone else in your own
words.

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It is standard practice in the academic world to recognise and respect the ownership of
ideas, known as intellectual property, through good referencing techniques. However,
there are other reasons why referencing is useful.

Good Reasons for Referencing

It is good academic practice to reference because:

• It enhances the quality of your writing;

• It demonstrates the scope, depth and breadth of your research;
• It gives structure and strength to the aims of your article or paper;
• It endorses your arguments;
• It allows readers to access source documents relating to your work, quickly and
easily.

Sources

The following would count as ‘sources’:

• Books,
• Chapters from books,
• Encyclopaedias,
• Articles,
• Journals,
• Magazines,
• Periodicals,
• Newspaper articles,
• Items from the Internet (images, videos, etc.),
• Pictures,
• Unpublished notes, articles, papers, books, manuscripts, dissertations, theses, etc.,
• Diagrams,
• Videos,
• Films,
• Music,
• Works of fiction (novels, short stories or poetry).

What You Need to Document from the Hard Copy Source You
are Using
(Not every detail will be applicable in every case. However, the following lists provide a
guide to what information is needed.)

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You need to acknowledge:

• The words or work of the author(s),

• The author(s)’s or editor(s)’s full names,
• If your source is a group/ organisation/ body, you need all the details,
• Name of the journal, periodical, magazine, book, etc.,
• Edition,
• Publisher’s name,
• Place of publication (i.e. the city of publication),
• Year of publication,
• Volume number,
• Issue number,
• Page numbers.

What You Need to Document if you are Citing Electronic

Sources

• Author(s)’s/ editor(s)’s name,

• Title of the page,
• Title of the site,
• Copyright date, or the date that the page was last updated,
• Full Internet address of page(s),
• Date you accessed/ viewed the source,
• Any other relevant information pertaining to the web page or website.

Referencing Systems
There are a number of referencing systems in use and each has its own consistent rules.
While these may differ from system-to-system, the referencing system followed needs to
be used consistently, throughout the text. Different referencing systems cannot be mixed
in the same piece of work!

A detailed guide to referencing, entitled Referencing and Plagiarism Guide is available

from your library. Please refer to it if you require further assistance.

When is Referencing Not Necessary?

This is a difficult question to answer – usually when something is ‘common knowledge’.

However, it is not always clear what ‘common knowledge’ is.

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Examples of ‘common knowledge’ are:

• Nelson Mandela was released from prison in 1990;

• The world’s largest diamond was found in South Africa;
• South Africa is divided into nine (9) provinces;
• The lion is also known as ‘The King of the Jungle’.
• 𝐸 = 𝑚𝑐 2
• The sky is blue.

Usually, all of the above examples would not be referenced. The equation 𝐸 = 𝑚𝑐 2 is
Einstein’s famous equation for calculations of total energy and has become so familiar that
it is not referenced to Einstein.

Sometimes what we think is ‘common knowledge’, is not. For example, the above
statement about the sky being blue is only partly true. The light from the sun looks white,
but it is actually made up of all the colours of the rainbow. Sunlight reaches the Earth's
atmosphere and is scattered in all directions by all the gases and particles in the air. The
smallest particles are by coincidence the same length as the wavelength of blue light. Blue
is scattered more than the other colours because it travels as shorter, smaller waves. It is
not entirely accurate then to claim that the sky is blue. It is thus generally safer to always
check your facts and try to find a reputable source for your claim.

Important Plagiarism Reminders

The IIE respects the intellectual property of other people and requires its students to be
familiar with the necessary referencing conventions. Please ensure that you seek
assistance in this regard before submitting work if you are uncertain.

If you fail to acknowledge the work or ideas of others or do so inadequately this will be
handled in terms of the Intellectual Integrity Policy (available in the library) and/ or the
Student Code of Conduct – depending on whether or not plagiarism and/ or cheating
(passing off the work of other people as your own by copying the work of other students
or copying off the Internet or from another source) is suspected.

Your campus offers individual and group training on referencing conventions – please
speak to your librarian or ADC/ Campus Co-Navigator in this regard.

Reiteration of the Declaration you have signed:

1. I have been informed about the seriousness of acts of plagiarism.

2. I understand what plagiarism is.
3. I am aware that The Independent Institute of Education (IIE) has a policy regarding
plagiarism and that it does not accept acts of plagiarism.

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4. I am aware that the Intellectual Integrity Policy and the Student Code of Conduct
prescribe the consequences of plagiarism.
5. I am aware that referencing guides are available in my student handbook or
equivalent and in the library and that following them is a requirement for successful
completion of my programme.
6. I am aware that should I require support or assistance in using referencing guides
to avoid plagiarism I may speak to the lecturers, the librarian or the campus ADC/
Campus Co-Navigator.
7. I am aware of the consequences of plagiarism.

Please ask for assistance prior to submitting work if you are at all unsure.

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