ACCT20001 Cost Management

Department of Accounting
Faculty of Business and Economics
Final Examination Paper - Semester 2, 2014


Student Number:

Examination
Details:
Reading Time Fifteen (15) minutes
Exam Duration Three (3) hours
Exam Booklet This paper has fifty-seven (57) pages

Authorised Materials: Candidates are permitted to use non-programmable calculators




Instructions to Invigilators:
Candidates ARE permitted to use pen, pencil or highlighter to annotate the questions in the
exam paper during reading time but MUST NOT commence writing in the answer space.
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This examination booklet IS NOT to be removed from the examination venue.
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Instructions to Students:
This paper consists of six (6) questions, worth 100 marks in total.
This paper represents seventy (70) % of the total assessment for this subject.
Clearly label the front page of this examination booklet with your student number.
You ARE permitted to use pen, pencil or highlighter to annotate the questions in the exam
paper during reading time but MUST NOT commence writing in the answer space.
This examination paper is not to be removed from the examination venue and must be
submitted intact.
Failure to submit this examination booklet intact with your student number clearly indicated
may result in an examination mark of ZERO (0).
Do not open this examination booklet until you are instructed to do so.



QUESTION One Two Three Four Five Six Total
MARKS 24 18 14 19 13 12 100
ACTUAL
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The following information on The Berkeley Watch Company is relevant for Questions
One, Two and Three. Where relevant, use facts on the company to justify your answers.
The Berkeley Watch Company (the company) designs, manufactures and sells highly
fashionable low-priced ladies watches via various retailers in the Australian market.
It started operations on 1 January 2013 and launched 10 different watch models during the
year. As a result of rapidly changing customer tastes, its strategy is to revamp its product line
every year. In other words, the 10 models it produced in 2013 would no longer be made
available in 2014.
The company uses process costing, the weighted average costing method and adjusted
allocation rate approach (for the end of period indirect cost adjustment). Its financial
statements are prepared in accordance with the Australian accounting standards.
Question One (24 marks)
The following contains details of its actual costs in 2013 (i.e., from 1 January 2013 – 31
December 2013) which was its first year of operation. Its top selling watch during this period
was the Professional Rockstar (PR) model.
Table 1: 2013 (Actual)
Total direct manufacturing costs for the Professional Rockstar (PR) model
Notes for 2013
Direct materials $500,000 Variable cost
Direct labour $100,000 Variable cost
Total indirect costs for the company’s overall operations
Design $ 250,000 For 2013 models
Manufacturing overhead $200,000 Fixed with respect to the
units of watches produced
Other non-manufacturing $500,000
Other information
Total PR watches produced 10,000 units
Total watches produced excluding PR watches 30,000 units
Total PR watches sold 10,000 units
Total watches sold excluding PR watches sold 30,000 units
Direct labour hours to manufacture a PR watch 0.2 hours Per unit
Weighted average direct labour hours to
manufacture a non-PR watch (i.e., a watch
from one of its other 9 models)
0.1 hours Per unit.
Weighted by the number
of units produced.
Work in progress closing inventory 0
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a) (i) The company is trying to calculate the cost of producing its different watches and
wants to ensure that indirect costs are accurately allocated to its watches for this purpose.
Briefly explain what is needed to ensure ‘an accurate allocation of indirect costs’.
(ii) Using direct labour hours to allocate all indirect costs, what is the full product cost
(also sometimes referred to as the ‘full value chain product cost’) of making a unit of the
PR watch?
[3+3marks]
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b) When it first started operations, the company had to decide between using FIFO or
weighted average costing method. What are the factors that would affect the size of the
difference in terms of the costs assigned to inventory units under the two methods?
Explain how these factors would affect this difference. [6 marks]
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c) In the company’s final production scheduling meeting for 2013, an executive suggested
that they ramp up production of PR watches during the month of December to bring the
total production to 15,000 watches in 2013. The production of the other watch models
would remain unchanged. This increased production was possible with the existing
factory capacity. The executive explained that an increase in production of PR watches
would lead to higher profits even without higher levels of sales. In the end, this
suggestion was not implemented by the company and the total units of PR watches
produced in 2013 were 10,000 units.
(i) Explain why an increase in production without a corresponding increase in sales
would generally lead to higher profits for an entity that uses absorption costing.
(ii) What would be the likely impact of the suggestion to increase the production of PR
watches be on the profit from non-PR watches? Explain. Calculations are not
necessary.
(iii)What are TWO potential adverse consequences for the company if this suggestion
was implemented? [2+2+2 = 6 marks]
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d) The following information about one of the company’s indirect cost has just been made
available to you at the end of 2013: Each of the 10 models produced in 2013 costs an
equivalent amount to design. Would this information affect the calculation of the full
product cost of each PR unit produced? Explain. [3 marks]
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e) You are told (at the end of 2013) that the company has decided to produce the same PR model which
was designed and sold in 2013 for another year, before retiring it at the end of 2014. Would this
information affect the full product cost calculation of the PR units produced in 2013? Explain.
[3 marks]
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Question Two (18 marks)
The Berkeley Watch Company (the company) is now planning for 2015. In 2015, it plans to
only make 2 models of watches: W1 and W2. Forecasts for its operations for the whole of
2015 are as follows:
Table 2: 2015 Forecasts
Information on W1 and W2
W1 W2 Notes for 2015
Total direct materials
cost
$1,200,000 $350,000 Variable cost
Total direct labour cost $240,000 $100,000 Variable cost
Total sales dollars $6,000,000 $1,000,000
Total units sold 30,000 units 10,000 units
Total units produced 30,000 units 10,000 units
Direct labour hours to
manufacture each watch
0.2 hours 0.1 hours

Total indirect costs for the company’s overall operations
Design $60,000 W1 and W2’s design
cost are $40,000 and
$20,000 respectively
Manufacturing overhead $220,000 Fixed with respect to
volume produced.
Other non-
manufacturing
$560,000 30% is driven by the
number of watches
sold. The remaining
70% is fixed with
respect to volume
sold/produced.

Other information:
For the purposes of the following analyses, the company assumes that the proportion of units
sold between W1 and W2 remains constant in all possible scenarios.
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a) What is the weighted average contribution margin of W1 and W2? [3 marks]


























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b) What is the number of W1 and W2 watches that must be sold in order for the company to
break even? [3 marks]


























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c) The manufacturing overhead cost was initially classified as a fixed cost with respect to
the number of units produced in Table 2. Upon further investigation, the company
realised that although the $220,000 manufacturing overhead cost was correctly forecasted
for 2015, a significant portion of this overhead cost is actually batch-related. In other
words, a large portion of the manufacturing overhead cost would increase if the number
of batches produced increases. Explain the implication of this information on the units of
W1 and W2 that need to be sold to break even. Do you expect the break even units to be
higher, lower or remain the same? No calculations are necessary. [3 marks]






















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d) As per Table 2, 30% of the ‘other non-manufacturing’ cost is driven by the number of
watches sold. This 30% is due to the company’s marketing cost which is currently a
variable cost, charged by an external marketing service provider. As it reviews its
marketing cost, the company is now considering whether it should change the pricing
arrangement with the service provider without changing the nature of service it receives.
The alternative pricing arrangement that the company is considering would result in its
marketing cost becoming a fixed cost of $168,000.

(i) Which (if any) of the two (2) alternative pricing arrangements would be preferable
from the company’s perspective? Explain.
(ii) How does this decision on its marketing cost structure impact the company’s
operating leverage AND risk? [3 + 2 marks]



















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e) The forecasts provided in Table 2 have not incorporated the learning curve effects.
(i) Briefly explain what is meant by the learning curve effects. How would learning curve
effects be expected to affect break even calculations? Explain.
(ii) What are two (2) possible factors that would affect the size of the learning curve
effect at the company? [2 + 2 marks]
























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Question 3 (14 marks)
It is now approaching December 2014. The Berkeley Watch Company (the company)’s final
orders for December 2014 have just come in, resulting in the following total orders.
Orders for December, 2014:
• Watch model Space Cowboy (SC): 2,000 units
• Watch model Lift Off (LO):80 units
• Watch model Blue Velvet (BV): 500 units
Table 3: December 2014 order information
Information on the three watch models that have been ordered in December, 2014.
SC LO BV Notes for Dec. 2014
Contribution Margin $120.00 - $2.00 $90.00 Per unit

Machine Hours 0.3 1.25 0.5 Per unit
Direct Labour Hours 0.4 2.0 0.2 Per unit


Information on the capacity available in December
Total Machine
Hours available
700 hours For the month of
December
Total Labour Hours
Available
1,000 hours For the month of
December
Assume capacity cannot be increased unless otherwise mentioned.


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a) (i) Prepare a quantitative analysis that would help the company decide which watch models
it should prioritise selling for the month of December, 2014. Determine the order of
priority.
(ii) How many units of each watch model should the company sell in December, 2014?
[3 + 2 marks]
























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b) What are two (2) additional factors that the company would also need to consider when
deciding which models it should focus on selling in December 2014? [3 marks]

























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c) It turns out that the supplier of its watch-making machines is willing to lease the company
an additional machine to make watches for the whole month of December if needed. The
leased machine is able to operate for 150 hours per month. The leased machine also has
different capabilities than the company’s existing machine. As a result, the leased
machine hours required to make each of the models are as follows:
• SC: 0.3 hours per watch
• LO: 0.4 hours per watch
• BV: 1.0 hours per watch

Based on short-term quantitative factors alone, what is the lease payment that would cause
the company to breakeven i.e., be indifferent between leasing and not leasing the machine
for the month of December? [6 marks]




















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Question Four (19 marks)
Sweet Tooth (ST) Inc. makes specialty cakes that it delivers to its customers who are 4
different local supermarket chains. ST has decided to analyse the profitability of its
customers. The results of the analyses are as follows.

Table 4: Actual customer profitability for 2013
Customer A Customer B Customer C Customer D
Sales $ 100,000 300,000 200,000 400,000
Cost of goods
sold $
85,000 210,000 150,000 320,000
Gross profit $ 15,000 90,000 50,000 80,000
Customer
related non-
manufacturing
cost $
20,000 60,000 40,000 80,000
Customer profit
/ (loss) $
(5,000) 30,000 10,000 0

Notes on the customer related non- manufacturing cost
• Actual non manufacturing cost for 2013: $200,000
• Consists of the following costs:
o Delivery
o Order taking
o Sales visits
• Allocated to the different customers based on sales dollars


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a) Comment on the approach taken to calculate customer profitability in Table 4. Under
what circumstances would the customer profitability numbers calculated by ST be
reasonable / unreasonable. [3 marks]


























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b) Describe in detail an alternative approach to calculate customer profitability to the one
used in Table 4. Focus your answer on the customer related non-manufacturing costs.
Provide an example to illustrate your approach [5 marks]

























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c) ST has revised its customer profitability analysis which is detailed in Table 5 below. Its
customer related non-manufacturing cost has now been accurately allocated to the 4
different customers. Following the revised analysis, ST has decided to stop serving
Customer D as it believes this would make the company more profitable. Do you agree
that dropping Customer D would increase ST’s profitability? Explain. [4 Marks]

Table 5: Actual customer profitability for 2013 (REVISED)
Customer A Customer B Customer C Customer D
Sales $ 100,000 300,000 200,000 400,000
Cost of goods
sold $
85,000 210,000 150,000 320,000
Gross profit $ 15,000 90,000 50,000 80,000
Customer
related non-
manufacturing
expenses $
10,000 40,000 30,000 120,000
Customer profit
/ (loss) $
5,000 50,000 20,000 (40,000)















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d) ST is re-evaluating how it sets the prices for its new cakes. In particular, it is considering
the use of either cost plus or target pricing to set its long-run prices and needs your
advice. Where possible, ensure that your advice to ST is tailored to its business.

i) What should ST include in the cost base under the cost-plus pricing approach? Justify
your recommendation.

ii) Under target costing, what could ST do to ensure that the actual cost of the new cake
does not exceed its target cost?

iii) Explain the difference between locked-in vs incurred costs for ST. Is it important to
distinguish between the two concepts for ST? Explain. [2+2+ 3 marks]



















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Question Five (13 marks)
Sweet Tooth (ST) has developed cost standards for the production of its Death by Chocolate
cake. The cost standards below relate to each unit of cake.
Standard cost per cake
Chocolate: 0.5 kg at $ 5.00 per kg $2.50
Direct labour: 1 hour at $15.00 per hour $15.00
Variable manufacturing overhead: 1 hour at $30.00 per hour $30.00
Variable manufacturing overhead is applied based on direct labour hours.

The actual results for the Death By Chocolate Cake for October, 2014 were as follows:
Number of cakes produced: 160
Direct labour hours incurred: 180 hours
Kilograms of chocolate purchased: 90 kg
Kilograms of chocolate used in production: 80kg
Cost of chocolate purchased: $500
Direct labour cost: $3,060
Variable manufacturing overhead cost: $5,000

a) Compute the chocolate quantity (or efficiency) variance for October. Indicate whether the
variance is favourable or unfavourable. Briefly interpret the variance. [2 marks]











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b) Compute the chocolate price variance for October. Indicate whether the variance is
favourable or unfavourable. Briefly interpret the variance. [2 marks]

























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c) Compute the direct labour rate variance for October. Indicate whether the variance is
favourable or unfavourable. Briefly interpret the variance. [2 marks]

























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d) Compute the direct labour efficiency variance for October. Indicate whether the variance is
favourable or unfavourable. Briefly interpret the variance. [2 marks]

























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e) Compute the variable manufacturing overhead rate (or spending) variance for October.
Indicate whether the variance is favourable or unfavourable. Briefly interpret the variance.
[2 marks]

























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f) ST is trying to find the right person(s) within the firm to hold accountable for the chocolate
quantity (or efficiency) variance and chocolate price variance. What advice would you give
ST on this matter? [ 3 marks]

























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Question Six (12 marks)
Jamie Lin has recently been made managing partner of Insight & Company (IC), a
management consultancy which serves clients in Australia. IC provides advice to its clients
on a wide range of areas including the formulation of strategy, cost reduction and revenue
generation initiatives. IC’s sole source of revenues is from the consulting fee it charges its
clients. The fee for each client project is determined by the size of the IC consulting team
assigned to the project and the duration of the project.
2013 was a very challenging year for IC. The public sector which was an important source of
revenues had significantly reduced its use of consulting services following cuts to its budget.
This in turn had led to various changes in IC’s operations. For example, it had decided to
reduce its consultant salary cost by outsourcing its data analysis and desktop research to
external service providers based in Asia. More changes in its operations are expected going
forward.
One of Jamie’s many tasks is to re-evaluate the use of budgets at IC. Currently, IC uses
budgets for the following purposes:
• To ensure the company’s strategy is implemented effectively. For example, when IC
decided to diversify its client base by serving mining clients in Western Australia in 2014,
this was reflected in the budget where funds were set aside to cover the cost of opening a
new office in Perth. A limit of $1 million was decided to be the maximum amount to be
spent on the new office. This would be IC’s first new office opening in 15 years.

• To evaluate performance. For example, the newly hired head of the Perth office Steven
Orr, who had extensive experience in the mining industry was made accountable for
achieving the $2 million revenue budget for the Perth office in 2014. This amount was
included in IC’s overall revenue budget and was decided following discussions between
Steven and Jamie.

• To motivate staff: For example, if Steven Orr achieved the $2 million revenue budget, he
would receive a substantial bonus payment from IC.

• To coordinate the different departments within IC. For example, during the budgeting
process, the HR department became aware about the plan to open a new office in Perth.
This allowed them to incorporate the hiring of additional consultants with mining
experience for the new office and adjust their budget for salaries upwards by $500,000.
This $500,000 amount was a hard limit (i.e., non negotiable) as IC was trying to reduce
its overall cost of operations.


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a) Highlight three (3) possible issues/challenges that may arise as a result of how the budget
is used at IC. Refer to facts provided in the question to justify your answer. [ 6 marks]


























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b) How would you classify the Perth office in terms of type of responsibility centre? Explain.
[2 marks]

























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c) IC has started its budgeting cycle for 2015. One of the first things it does is to develop the
revenue budget for its Perth office. What are four (4) pieces of information /forecasts that
would help IC develop the revenue budget for its Perth office? [4 marks]

























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[Additional writing space. Please label answers clearly]



























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[End of Exam Paper]
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