MANAGERIAL ACCOUNTING II

ACC3023W
DECISION MAKING USING RELEVANT INFORMATION
WEEK 1

READING REFERENCES

Drury: Management and Cost Accounting, 10th Ed, Chapter 9

MODULE CONTENT
1. MODULE OBJECTIVES…………………………………………………………………………………………….
2. GENERAL TOPIC INFORMATION (LEARNING OBJECTIVES, SAICA COMPETENCIES,
DEFINITIONS)…………………………………………………………………………………………………………
3. CLASS NOTES…………………………………………………………………………………………………………
4. LECTURE EXAMPLE………………………………………………………………………………………………..
5. TUTORIALS…………………………………………………………………………………………………………….
6. TUTORIAL SOLUTIONS……………………………………………………………………………………………
7. PRACTICE OBJECTIVE TEST……………………………………………………………………………………..

TUTORIALS
Week 1
RC01: RightFit (Pty) Ltd
RC02: All Seeing Eye (Pty) Ltd
RC03: DogMatix (Pty) Ltd*
*Unseen tutorials to be prepared

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1. MODULE OBJECTIVES

By the time you have completed this module (and once you have attempted some of the other
related modules), you should be prepared to answer questions that are similar to the ones
presented below and/or revolve around the following objectives/competencies:

1. Understand and be able to identify and explain why a cost is relevant, irrelevant, sunk
or an opportunity cost based on the scenario presented.

2. Understand how different scenarios affect what is considered relevant or irrelevant.

a) What difference does it make whether my decision is long term in nature (e.g.
add/drop a product or outsource) or short term in nature (e.g. a special order)?

b) When I am likely to see production constraints and what impact does a constraint
have on my decision.

3. Understand how to calculate the relevant cost of materials used in production where
said materials are on-hand, or not; as well as where the materials are required to be
replaced, and where not.

a) So, I know about differential costs and why they are important, but what is the
relevant cost of using materials I have on hand? Is it not a sunk cost?

4. Understand how to calculate opportunity cost when operating under constrained

conditions for the given alternatives to relieve such constraints.

a) Why do I have an opportunity cost under constrained conditions?

b) Why is the opportunity cost of foregone sales calculated as contribution margin

and not profit?

c) How do I calculate my opportunity cost when I have more than one constraint?

5. Understand how opportunity cost is affected where the constraint is a fixed versus a
variable cost.

a) Is my opportunity cost different if my constraint is a fixed or variable cost given

that contribution margin foregone is usually my opportunity cost?

6. Understand common misconceptions surrounding relevant costs.

7. List and discuss qualitative factors and risks associated with strategic decision-making.

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2. GENERAL TOPIC INFORMATION
SAICA Competency requirements
Decision making Knowledge
Level
 Criteria for relevant information 3
 Application to decisions 3
o Pricing (long term and short term pricing, relevant costing) 3
o Capacity utilisation 3
o Scenarios
o Special orders 3
o Make or buy 3
o Product mix 3
o Theory of constraints 1
o Sell or process further 3
o Product line decisions 3
o Adding / dropping parts of operation 3
o Identification of the requirement for, and the ability to apply, the following
decision-making criteria:
o Contribution per unit of limiting factor 3
o Doing linear programming is not required. The focus will be on the 1
circumstances under which linear programming would be required to
solve a multi-product, multi-constraint scenario and which elements are
required to do the programming (instruct the tool). Candidates must also
be able to interpret the results of such linear programming. In other
words, candidates are required to consider and conclude on whether
linear programming is required, but the execution thereof is excluded
from the core competencies.
 Short-term v long-term implications and relationship and integration with 3
capital budgeting
o Including an analysis on the six capitals from a short and long term 3
perspective in line with the company’s strategy
 Sensitivity analysis (application of CVP to decision making) 2
 Risk and uncertainty (in the context of management accounting and decision
making) 2

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Definitions
Differential cash flows: The cash flows that will be affected by a decision that is to be taken,
also known as incremental cash flows

Facility sustaining costs: Common costs that are incurred to support the organization as a
whole and which are normally not affected by a decision that is to be taken.

Limiting factors: Scarce resources that constrain the level of output

Opportunity costs: Costs that measure the opportunity that is sacrificed when the choice of
one course of action requires that an alternative is given up

Relevant costs and revenues: Future costs and revenues that will be changed by a particular
decision, whereas irrelevant costs and revenues will not be affected by that decision.

Sunk costs: Costs that have been incurred by a decision made in the past and that cannot be
changed by any decision that will be made into the future.

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3. CLASS NOTES

Relevant costing is a short-term decision-making tool. In the short term, capacity cannot be
altered and management must therefore make the most of what is available.

When tackling relevant costing questions always keep in mind the definition of a relevant cost:

A relevant cost is defined as: A future cash flow that will differ among alternatives.

From the above definition, the following points must be kept in mind:

• In order to meet the “future” criteria, the cost in question must not be sunk. A sunk
cost is a cost that has already been incurred (or irrevocably committed to, regardless
of the company’s future actions).

• When considering cash flow, keep in mind that some accounting expenses, such as
depreciation, are not cash flows. Also remember the cash flow can be an inflow or an
outflow.

• The cash flow must not be one that will be incurred regardless of the choice i.e. it
must differ. It is possible that there will be a cash flow for the same income or expense
in both alternatives but the rand amount could differ. In this case, it is only the
incremental amount that is relevant.

In previous sections (inventory costing, ABC and transfer pricing) it has been mentioned that
the inclusion of fixed overhead costs in the cost of a product is misleading for short-term
decisions. This is because relevant costing is a short term decision-making tool, fixed costs a
related to making capacity available, but in the short term capacity cannot be changed. Hence,
the portion of fixed costs allocated to inventory is not relevant, as the fixed cost as a whole
will be incurred in the short term, regardless of the decision made.

Determining which information is relevant to the choice of the best action to take in order to
maximise the benefit to the company, requires a clear understanding of the role of historical
costs in the decision process. Historical costs are useful in predicting the future turn of events.

Special Orders
Spare capacity often permits special, reduced price sales orders that would not affect regular
sales. In such cases, average overall unit costs do not normally serve as a proper base for
evaluating such orders. The only costs that would usually be relevant to these situations are
the variable costs that would be affected by accepting the special sales orders; because fixed
costs would usually not be affected by the decision, and would therefore be irrelevant.
However, if the decision would affect certain fixed costs immediately or in the future, they of
course should be given appropriate consideration.

On the basis of relevant cost approach, it is possible that some special orders should be
accepted at selling prices below the average unit costs that include variable costs, as well as a
portion of fixed costs. This is because the special order could still provide a positive
contribution margin and thus contribute towards covering fixed costs.

The important point is that such decisions should depend primarily on the revenues and cost
expected to be different among alternatives. This is true whether or not the financial reports

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to management also include any revenues and costs expected to be the same among
alternatives.

Consider the following example:

SJ (Pty) Ltd has budgeted output of 100 000 units. Cost estimates are as follows:

Direct Labour R 600 000 R6/ Unit

Direct Materials R 200 000 R2/ Unit
Variable Overheads R 200 000 R2/ Unit
Fixed Overheads R 400 000
Total Costs R1 400 000

The company has confirmed orders for 80 000 units at a selling price of R18/u. Should a special
order for 20 000 units at R12/u be accepted?

Thus the special order should only be accepted if the incremental revenue is at least equal to
the incremental costs.

Workings Exam technique tip: If there is a

Incremental revenue cost mentioned in the scenario,
that is not relevant, you must
Sales R12 x 20 000 R 240 000
write it down and justify why it
isn’t relevant in order to show
Incremental costs R -200 000 the examiner that you are
aware of the cost and you know
Direct materials R6 x 20 000 R 120 000 that it is not relevant.
Direct labour R2 x 20 000 R 40 000
Variable Overheads R2 x 20 000 R 40 000
Fixed Overheads Not differential R0

Incremental cash flow R 40 000

The special order should be accepted as it provides a positive incremental cash flow to the
business.

The example above is very simple because SJ (Pty) Ltd has spare capacity of 20 000 units. But
what happens if the special order received is for 30 000units? SJ (Pty) Ltd now has a shortfall
in capacity of 10 000 units and the decision will have to consider the opportunity cost of the
10 000 units of normal sales that would have to be sacrificed in order to make the entire
special order.

• An opportunity cost is the next best alternative forgone.

In the simple example above, the opportunity cost is simply the sales revenue lost. This is
because the variable costs for the 10 000 unites are simply being transferred from units for

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normal sales to units for the special order, i.e. they will be incurred regardless of the decision
made.

In most cases, the opportunity cost of lost sales will be the contribution margin forgone. I.e.
the revenue is lost but the variable costs are saved.

• Calculating opportunity costs can be made more complicated by nested decisions.

A nested decision is a decision within a decision.

For example, SJ (Pty) Ltd has material A on hand, which is no longer used in normal production.
A special order has been received that would require the use of material A. If material A is not
used in the special order, SJ could sell the material for R20 000 (selling costs of R4 000). SJ
could also convert material A into an equal quantity of material B, which would normally cost
R35 000, however the costs of this conversion would amount to R17 000. Material B is
currently being used on a limited edition product and the amount that could be produced is
exactly enough to finish off the units being produced. If the special order is accepted, revenue
of R64 000 would be generated and other variable costs of R30 500 would be incurred. Should
the special order be accepted?

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 The information above is illustrated below:

Material A Notes

Special Order Don't do the special order

This is the nested decision.

Before a decision can be
made on the special order,
Incremental the opportunity cost must be
revenue R 64 000 Sell Modify determined. This requires
Incremental analysing what the company
Other variable costs -R 30 500 revenue R 20 000 Cost saved R 35 000 would have done with
Modification material A if there had been
Opportunity cost -R 18 000 Selling Costs -R 4 000 Costs -R 17 000 no special order.
Net savings on
Net Benefit R 15 500 Net Benefit R 16 000 material B R 18 000

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Notice that, before the opportunity cost is considered, the net benefit of the special order is R33 500 (64 000
– 30 500), which appears to be better than what could be achieved on either of the alternatives if the special
order is not accepted. However, in accepting the order, R18 000 is forgone, because this is the next best
alternative, i.e. in the absence of the special order the company would have chosen to modify material A.
The net benefit of the opportunity cost is therefore only R15 500, and therefore the special order should not
be accepted.

If the other variable costs were, say, R27 000, the net benefit of the special order would be R19 000 and the
special order should be accepted.

As a final consideration, what would happen if, all else equal, SJ had double the quantity of material A on
hand? What would the opportunity cost of doing the special order be in this case? SJ would do the special
order with half of the material and with the other half, modify it to produce material B and finish off the
limited edition range. SJ is therefore forgoing R16 000, which is the net benefit of selling the other half of
material A, because in the absence of the special order, the company would have modified half and sold half.
The net benefit of the special order is now R17 500 (R64 000- 30 500-16 000). Therefore, the special order
should be accepted.

Nested decisions can also present themselves in capital budgeting questions, where the company has a
choice to make at the end of the life of the asset.

The example above considers the use of materials on a special order in the context of opportunity costs. The
following is an illustration of the thought process that should be followed when deciding what the relevant
cost of materials is:

Misconceptions and Common Errors

1) Only variable costs are relevant and all variable costs are relevant.

Not all variable costs are relevant. If a variable cost is not differential (e.g. if labour, a variable cost, is a
limited resource) then the variable cost is not relevant.

2) Fixed costs are sunk costs & fixed costs are irrelevant

No! Only costs incurred or committed to in the past are sunk costs only sunk costs are irrelevant.

Fixed costs are not always irrelevant. To identify whether the fixed cost is relevant or not you should
consider the following – are the fixed costs:

 Allocated / company-wide (probably cannot be altered by anything a division does and thus
irrelevant – but look out for specific information in the question); or
 Additional (differential and thus relevant); or
 Product specific (can be saved if a product is discontinued))

To identify whether labour is fixed or variable consider whether:

 Idle capacity exists (and is this currently paid for?)
 Is labour salaried (probably fixed cost) or casual/paid piecemeal (variable cost).

3) Depreciation is a relevant cost

No it’s not. Ever. Never, ever, ever. Depreciation is not a cash flow.

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Integrated and Discursive Aspects

Once a relevant costing calculation has been performed it is necessary to interpret the result, and consider
aspects that the relevant costing calculation doesn’t include. The following is a useful framework
summarising the aspects that should be considered. These aspects are often loosely called “qualitative
factors” – in reality these factors are mostly financial considerations that could not be quantified in the
relevant costing calculation, due uncertainty, lack of information, technical difficulty etc …

GENERAL FOCUS: PROJECT RISK

1) Strategic and long term considerations

i. Identify the company’s strategic position and implication for the company’s product and competitive
advantage (See Financial Management Readings at end of module)
ii. Porter’s 5 forces, bargaining power of suppliers, customers, competitors (re)actions, substitutes,
threat of new entrants and barriers to entry;

2) Pricing Considerations

i. Long term capacity implications (In the long term the company’s resource requirements can be altered,
and fixed costs consequently become relevant. While the opportunity may be a once off event,
consideration needs to be given to whether the decision to accept or reject this once off short term
opportunity will affect the company’s long term decision making. For instance, would acceptance of
this short term decision (which is making use of existing spare capacity) delay/defer the long term
decision to down size? Likewise, the company may not be able to alter its capacity during the timeframe
required for the initial introduction of a new product, but if the company continued to produce this
product long term, the fixed costs would be relevant, as these are differential in the long term.)
ii. Precedent may be set ito margins or prices, for repeat work for the same customer, future products,
or even the existing products, leading to a reduction in future revenue. Compare price and/or GP% to
that of existing products, and consider the appropriateness of, and risk associated with, a discounted
price – if any.

3) VAC (Volatility, accuracy and completeness) of the numbers

Relevant costing calculations are almost always forward looking, and thus necessarily based on
estimates, so are the numbers…

i. Highly sensitive to changes in price or volume? (Sensitivity analysis & CVP)

ii. Based on uncertainty in terms of more than one possible outcome? (Risk & uncertainty)
iii. Accurate (Are indirect costs accurately allocated (ABC)?
iv. Complete (Identify missing or hidden costs)

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4) Operational Considerations (Internal processing and supply chain issues)

i. Quality (immediate cost implications e.g. rework, scrap, warrantee, constraints, & long term loss of
revenue concerns (reputational risk))
ii. Quantity (implications and feasibility of operating at practical capacity on resources (employees and
equipment), and concomitant costs)
iii. On time delivery / availability (immediate cost implications e.g. penalties for delay, constraints, &
immediate and longer term loss of sales. Refer porters 5 forces.)
iv. BBEEE (relevant where the ultimate customer is government) (Own and suppliers credentials)

ID risks particular to the service/product to be outsourced and suggest ways in which the risks could
be reduced (through controls, or a SLA

5) Financing Considerations

i. Liquidity
ii. Credit risk
iii. WACC and Time value of money (NPV) considerations

6) Opportunities arising from this once off event

i. other products
ii. new customers/further work
iii. new market

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4. LECTURE EXAMPLES

Lecture Example 1:
In this scenario the financial manager is considering whether a certain component used in the production
process should be produced in-house or should be outsourced. In other words the company will purchase
the components from a supplier. The company has budgeted that it will need 8,000 components.
The following cost information is available for 8,000 units if the component is to be produced in-house:
Per unit Total R
Direct materials 12 96 000
Direct labour 8 64 000
Variable overheads 2 16 000
Fixed overheads 20 160 000
42 336 000
Fixed overheads consist of: Per unit Total R
Supervisor's salary 6 48 000
Depreciation on epuipment 4 32 000
Allocated general overhead 10 80 000
20 160 000
An outside supplier has offered to sell the component to the company at R36 per unit.

Further investigation reveals that the supervisor will be discharged and his salary will no longer be paid if the
units were to be bought from the supplier. The allocated general overheads refer to administrations costs
incurred by the company as a whole. These costs will be allocated to another segment within the company.

Timeline:

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Special orders
What is a special order?

Practical examples:

Think of what is actually happening in the business:

Understanding constraints: Introduction

What is a constraint?

2 different types of constraint:

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Lecture example 2

A company has three products in its existing product range. The company is able to work a maximum of
7,500 labour hours per month. The following information regarding these products is provided:

A B C
Cm/u 100 150 99
Labour Hr/u 4 10 9

What is the profit optimising product mix for the following two scenarios?

1. Demand (in units) 200 250 400

2. Demand (in units) 200 300 500

Solution:
A B C
Cm/u 100 150 99
Labour Hr/u 4 10 9
CM/LHr 25 15 11

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Materials

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 5. TUTORIAL QUESTIONS

MANAGEMENT ACCOUNTING II
ACC3023W
RELEVANT COSTS FOR DECISION MAKING
Tutorial Questions

TUTORIALS
Week 1
RC01: RightFit (Pty) Ltd
RC02: All Seeing Eye (Pty) Ltd
RC03: DogMatix (Pty) Ltd*

*Unseen tutorials to be prepared

RC01 (2012) (30 MARKS)

RightFit (Pty) Ltd is a Cape Town based clothing manufacturer. The company makes tracksuits for
CottonWorths Ltd, a major South African retailer. For many years, RightFit has supplied all of
CottonWorths’ tracksuit requirements, but this changed in 2012. From January of 2012,
CottonWorths has been sourcing some of their tracksuits from a cheaper Chinese manufacturer, on a
trial basis. Whereas RightFit had operated at around 100% of production capacity in the past few
years, the decision by CottonWorths meant that RightFit’s production between January and May 2012
dropped to an average of just 60% of full capacity.

Now, in June of 2012, RightFit is considering a big tracksuit order which it has received from EdGear
Ltd. EdGear is a “Proudly South African” company, and is CottonWorths’ biggest competitor. EdGear
has advised RightFit that, if the quality and service that it receives are of an acceptable standard, it
will seriously consider buying all of its tracksuits from RightFit in future.

As the senior management accountant at RightFit, you are asked to evaluate the EdGear order. You
know that RightFit’s results for the five months ended 31 May 2012 are as follows: (All sales have
been to CottonWorths)

Summarised Income Statement of RightFit (Pty)

for the 5 months ended 31 May 2012:

R’000 Percentage
Sales (75 000 Tracksuits at R180 each) 13,500 100%
Less Variable Costs 6,750 50%
Contribution Margin 6,750 50%
Less Fixed Costs 6,800
Net Income / (Loss) (50)

Production on the EdGear order will start on 1 July 2012, and must be completed by the end of July.
The EdGear order is for 12,000 tracksuits. RightFit’s maximum production capacity is 25,000 tracksuits
per month, and CottonWorths have already placed an order for July production of 15,000 tracksuits.

Before evaluating the EdGear order, you obtain the following additional information:

1. EdGear will pay RightFit R150 per tracksuit;

2. If RightFit accepts the EdGear order, due to a shortage of production capacity RightFit will not
be able to make and sell 2,000 units of the CottonWorths order for July. (You may assume
that all future sales revenues and costs per unit for CottonWorths orders will be as per the
above income statement. There will be no change in fixed costs in July as a result of not making
the 2,000 CottonWorths tracksuits);

3. Two weeks ago, the RightFit buyer mistakenly bought material of the wrong colour for
CottonWorths. This material cost R600,000. Luckily, the material is the exact colour and
quantity needed for the EdGear order. If not used for the Edgear order, the material can be
sold for R600,000 or returned for a credit of R600,000. However, in both cases RightFit will
have to pay transport costs of R20,000;
4. Variable costs for CottonWorths tracksuits (per the income statement above) are made up of
direct materials, direct labour, variable manufacturing overheads and variable selling
expenses. Direct material costs are R50 per tracksuit, and the rest of the variable costs of R40
per tracksuit are split between direct labour, variable manufacturing overheads, and variable
selling expenses in the ratio 7:2:1;

5. For the EdGear order, variable costs per unit (excluding material costs) will be as per the
CottonWorths costs in (4) above, adjusted as follows: Direct labour: + R2.00 per unit; Variable
manufacturing overheads: + R1.00 per unit; Variable selling expenses: No change from the
CottonWorths’ cost;
6. An additional supervisor will have to be hired for the EdGear order, at a cost of
R10 000 for July;

7. There will be no other fixed cost increases for July, although the production manager has
advised that, as the EdGear order will take up 40% of production capacity, 40% of fixed
manufacturing overheads for July should be allocated to the EdGear order. (Of the total
monthly fixed costs of R1.36 million, R0.8 million are manufacturing overheads);

8. At present, RightFit receives a rental of R12 000 per month for a spare sewing machine which
it has rented out. As this machine will be needed for the EdGear order, RightFit has arranged
to get the machine back for July, and will then rent it out again from August;

You are required to:

a. Using relevant cost principles, prepare a financial analysis of the EdGear order for RightFit
management, to help them decide whether to accept the order or not.
(18 Marks)

b. Based only on your financial analysis in (a.) above, advise RightFit management whether they
should accept the EdGear order or not, and give one good reason for your answer.
(2 Marks)

c. Mention, and briefly discuss any five factors that RightFit should take into account before
deciding to accept or reject the EdGear order. (You may mention both tactical (short-term)
and strategic (long-term) factors).
(10 Marks)
RC02 (2015) (45 MARKS)

All Seeing Eye (Pty) Ltd. (Henceforth referred to as ASE) is a company that produces various Orc
figurines that are sold as collector items to Lord of the Rings enthusiasts.

ASE’s biggest competitor, Gandalf (Pty) Ltd., has in recent times taken a considerable portion of the
figurines market share as customers have preferred to purchase figurines that resemble “the heroes”
as opposed to “the baddies” recently. In light of this the demand for the ASE’s products has been low
resulting in spare capacity in the factory.

Special Order

ASE has been approached by a company, Saruman (Pty) Ltd., to produce a special figurine to be
presented at the annual Lord of the Rings convention as a limited edition. The special figurine will be
called the “Witch-King” (this is a “baddy” in the movies) and will have to be created from scratch but
the production process will resemble some similarities to the current product offering. The details of
the Witch-King production process are detailed below:

Note.
Selling price 1 R 500

Direct material costs: R 300

- Wax 2 R 250
- Wire 3 R 10
- Moulds 4 R 40

Direct labour 5 R 100

Indirect costs: R 70
- Variable overheads 6 R 20
- Fixed Overheads 7 R 50

Total profit per Witch-King R 30

Notes:

1) Saruman has offered to pay R500 per Witch-King figurine, provided that the entire order is
completed by the end of the month (31 January 2015).

2) Each Witch-King figurine will require 1kg of Wax that will need to be moulded into the required
figurine shape.

Due to the discontinuation of an old product, the Gollum, the company has 57kgs of wax that can
be used for the special order in order to maximise the financial return. This wax is not used by the
current products offered by ASE and would have no other use other than the following:

- If the special order was not accepted then ASE could:

 o Use the wax to make hobbits. Each Hobbit would be able to be sold for R20 and
would incur no costs to manufacture other than the 100g of wax needed per
hobbit and the 0.1 hours of labour time needed to make it.
o Alternatively ASE could return the Wax for 80% of the original purchase price of
R200 per Kg.

Any excess wax needed for the special order can be purchased at R250 per kg from a local
supplier.

3) Each Figurine would require 10cm of special wire. This special wire can only be purchased from an
overseas supplier in the United States. The supplier charges $ 0.1 per cm of wire purchased.

The historic 5 year trailing R/US $ exchange rate is R10/1$. However, with the current political
unrest in South Africa, the current exchange rate is R12/1$.

4) The company will need to have moulds made for the Witch-King figurine. Each mould will only be
able to make a total of 30 figurines before it will have to be discarded. Once the order is completed
any remaining moulds will have to be destroyed as per agreement with Saruman (as this is a
Limited edition). ASE, in expectation of the order, has already incurred R25,000 in designing the
mould for the special order (This has not been taken into account in the schedule provided). Each
mould will cost the company R1,200 to make.

5) Each Witch-King will require 2.5 hours of labour time to manufacture and will be required to be
manufactured by salaried, full time employees. ASE currently has 5 full time employees who can
each work 8 hours per day. Should there be a need each employee can work a maximum of a
further 1 hour of overtime per working day. Any excess would need to be covered by cutting
existing production.

The overtime wage is calculated at 150% of the effective hourly rate. In determining this it is noted
that each employee is paid R6,400 per month.

Current production of ASE, excluding any once off or special orders, requires 675 hours per month
and this is expected to remain consistent for January 2015. Should additional hours be needed for
the special order, ASE will look to cut either the traditional Orc or Goblin figurines. The details of
each are provided below:

Traditional Orc Goblin

Selling price R 750 R 400

Direct materials: R 260 R 160

- Wax R 200 R 125
- Wire R 10 R 10
- Moulds R 50 R 25

Direct Labour R 150 R 60

Indirect costs: R 80 R 66
- Variable overheads R 30 R 16
- Fixed overheads R 50 R 50

Total profit per product R 260 R 114

6) The variable overhead rate is applied based on direct labour hours.

7) The fixed overheads include depreciation of the Moulding machines as well as factory rental. The
rate is applied based on a completed unit.

Other Information:

- You many assume that there are a total of 20 working days in January 2015.
- The order size requested by Saruman (Pty) Ltd. is 100 Witch-Kings.
- Saruman (Pty) Ltd. would usually approach Gandalf for all their special projects. However
due to the fact that Saruman has not paid for their previous order from Gandalf, they have
approached ASE in the hope of building a new business partnership.
- The decision on whether to accept the Saruman order is of high importance due to the
recent negative publicity that Saruman has faced through allegations of bribery and
corruption.

Required:

1. Calculate the financial impact for ASE of accepting the special order by Saruman (Pty.) Ltd
(30 marks)
2. Advise ASE whether they should accept the special order. In making your recommendation
discuss the qualitative issues that may be relevant
(7 marks)

Professional communication (2 marks)

*For the next question you are looking at the scenario from the perspective of Saruman (Pty) Ltd.

3. Assuming that Saruman will only be selling the special edition item (and expects to sell a total
of 100 Witch-Kings) at the Lord of the rings conference and that it will cost the company
R35 000 to have a stall and R2 000 for the 2 days in respect of salaries.

a. Calculate the number of Witch-Kings which Saruman must sell in order to break even
if each Witch-King will be sold for R950.
(3 marks)
b. Calculate the Margin of safety for Saruman and explain what this means.
(3 marks)
RC03 (2004) (UNSEEN) (35 MARKS)

DogMatix (Pty) Ltd manufactures biting robotic dogs. These robotic dogs are primarily used as
watchdogs, but also function as family pets (anti-bite software is loaded on dogs with pet
responsibilities). Sales of the robo-dogs skyrocketed 3 years ago, when the robodog featured on the
hit music single “Who let the dogs out”, and have since become the bodyguard to controversial rapper:
SnoopDoggyDog.

Atomic Kitten have been particularly impressed with the concept, but are somewhat disturbed at the
thought of a dog-squad, and would prefer a cat bodyguard. They have offered Dogmatix R5 500 000
for a team of 5 deadly Chesire Cats. As Dogmatix has spare capacity, the Atomic Kitten request is being
considered.

The junior accountant of Dogmatix (Dogbert) has prepared a cost estimate for the 5 cats:

Notes Cost

Revenue R 5,500,000

Direct Materials:
Snoopy (5kgs per cat @ R5,000 per kg x 5 Cats) N1 R 125,000
Pluto (68 meters per cat x 5 cats x R3 995) N2 R 1,358,300
Odie (100 units x 5 cats x R500 per unit) N3 R 250,000
Fluffy (70 liters per cat x 5 cats x R70) N4 R 24,500

Overheads N5 R 1,800,000

Net Profit R 1,942,200

N1 = 30 kgs of Snoopy are in stock. This material is used to manufacture the Rottweiler Robodog,
which is DogMatix’s most popular product. 10kgs of materials are required to manufacture
one Rottweiler. The contribution margin to be earned on Rottweiler is R600 000. This includes
the direct material cost of Snoopy which amounted to R50 000 for the 10 kgs. This is the
historic cost of Snoopy. There have been no price increases since this batch of Snoopy was last
purchased, and Dogmatix’s regular supplier confirms that they will be able to supply whatever
quantity of Snoopy is required by Dogmatix.

N2 = 1 873 meters of Pluto are on hand, at a historic cost of R3 995 per meter. Pluto is no longer
manufactured by the Pluto supplier, and Dogmatix will not be able to purchase any more
Pluto, ever. Dogmatix had planned to use this Pluto to make 23 Fred’s, and 20 Scoobydoos.
(The demand for Fred’s and Scoobydoo’s is limited to 23 and 20 units respectively). Once the
stocks of Pluto runs out, no further Fred’s or Scoobydoo’s can be produced. One Fred requires
34 meters of Pluto, and one Scoobydoo requires 50 meters of Pluto. The contribution margin
for one unit of Fred and one unit of Scoobydoo respectively is:
 Fred ScoobyDoo
Revenue 433,625 730,000
Variable costs: Pluto 135,830 199,750
All other variable costs 95,800 196,000
Contribution Margin 201,995 334,250
Meters of Pluto per unit 34 meters 50 meters

If Pluto was not used to produce Fed’s of ScoobyDoo’s it could be sold for scrap at a price of
R2 500 per meter.

N3 = 300 units of Odie are on hand. They were purchased for R 500 a unit last month. The supplier
increased the price per unit by 10% at the beginning of this month. The Odie material was
purchased in error. 300 units of Garfield were supposed to be purchased. This mistake was
made by a young buyer, and is understandable as Odie’s and Garfield’s are almost identical.
Dogmatix could return all the 300 units purchased for a full refund at the lower price, less a
5% handling fee. Alternatively, they could be used in the production of the Labrador RoboDog,
instead of Garfield. It would cost R25 per unit to convert the Odies into Garfields. One Garfield
costs R550.

N4 = 210 litres of Fluffy are on hand, at a historic cost of R70 per litre. The current purchase price
is now R 75 per litre. Fluffy is a lubricant which must be used by all of Robodog owners to keep
their dogs in working order. It is sold regularly to all of Dogmatix’s customers, at R100 per litre.

N5 = Overheads of R1 800 000 are made up of:

 Depreciation of R400 000 (this relates to the machinery to be used to produce the cats);
 Labour of R 500 000 (This comprises R300 000 relating to salaries of permanent staff with
spare capacity who will spend time on the order, and R200 000 relating to additional
labour that will be required to complete the order)
 Fixed factory wide overheads R250 000 (these have been allocated based on the amount
of time the order will be on the factory floor);
 R350 000 represents packaging and delivery expenses of the 5 cats.
 Supervisor’s salary of R100 000. She will spend 10% of her time supervising this order.
 Design costs of R200 000. These relate to expenses incurred in designing the robocat. The
design has been approved by Atomic Kitten.

Dogmatix offers a 1 year warranty on all robodogs (and cats). Under the warranty, Dogmatix
undertakes to bear the costs of all repairs necessary for the first year. On average 25% of all robodogs
(and cats), require repairs. If a robodog requires repairs the cost of these repairs will amount to 20%
of the selling price of the robodog (cat).

REQUIRED

Recalculate the net relevant cost / benefit of accepting the order.

Clearly indicate costs that are not relevant and briefly state why they are not relevant.
(35 Marks)
 6. TUTORIAL SOLUTIONS

MANAGEMENT ACCOUNTING II
ACC3023W
RELEVANT COSTS FOR DECISION MAKING
Tutorial Solutions

TUTORIALS

Week 1
RC01: RightFit (Pty) Ltd
RC02: All Seeing Eye (Pty) Ltd
RC03: DogMatix (Pty) Ltd*

*Unseen tutorials to be prepared

RC01 – SOLUTION
Workings:

(2) Lost contribution from CottonWorths July order:

2000 units x R180 x 50% = R180 000 [2]

(4) Variable costs per unit (Excluding direct material costs):

Direct Labour: 7/10 x R40 = R28 [1]

Variable Man. O/ Heads: 2/10 x R40 = R 8 [1]

Variable Sell. Exp: 1/10 x R40 = R 4 [1]

(5) Variable costs per unit: EdGear order (Excluding material costs)

Direct Labour: R28 + R2 = R30 [1]

Var. Man O/Heads: R8 + R1 = R 9 [1]

Var. Sell. Exp: R4 + R0 = R 4 [1]

R43

(a) Financial analysis of EdGear order:

Sales: 12 000 x R150 1 800 000 [1]

Less: Direct Material Costs (R600 000 – R20 000) 580 000 [3]

Less: Other Variable Costs (12 000 x R43) 516 000 [1]

Contribution Margin 704 000

Less CM lost on C/Worths order: 180 000 [1]

Net C/M 524 000

Less: Cost of additional supervisor 10 000 [1]

Less: Opportunity cost of sewing machine 12 000 [2]

Net Income from EdGear order 502 000 [1]

(b) RightFit should accept the EdGear order, as they make a positive net income of
R502 000 from the order. [2]

QUESTION 2 – SUGGESTED SOLUTION

(c) Tactical and Strategic factors to be considered:

• EdGear is CottonWorths’ main competitor. If RightFit accepts the EdGear order, it could
have an adverse effect on their relationship with CottonWorths. This may have negative
short term and long terms financial implications in terms of future business with
CottonWorths.

• RightFit have already accepted CottonWorths’ July order. Accepting the EdGear order will
mean that 2000 CottonWorths’ tracksuits will not be supplied in July. This could also have
an adverse effect on RightFit’s relationship with CottonWorths. CottonWorths may decide
to stop doing business with RightFit going forward which would negatively affect profit.

• There is a danger that, if RightFit accepts the EdGear order, CottonWorths may cancel their
orders for the rest of the year. If EdGear do not move their business to RightFit, RightFit
could then be in serious financial difficulties.

• RightFit should investigate the possibility of making the 2000 unit shortfall on the
CottonWorths’ July order, in June. In this way, they will not upset CottonWorths by short-
supplying their July order and risk adversely affecting RightFit’s relationship with
CottonWorths resulting in lost sales.

• RightFit may feel that CottonWorths are in any event going to move their business to the
Chinese supplier. In this case, it would make sense to accept the EdGear order, and to
provide the best possible quality and service in an attempt to secure their future business.

• CottonWorths may be upset to hear that EdGear are paying only R150 per tracksuit,
whereas they are paying R180 per tracksuit. This may result in CottonWorths demanding a
lower price for their products or in future no longer wanting to do business with RightFit.
• RightFit should consider offering CottonWorths a lower price on their tracksuits. The
Chinese suppliers are already cheaper, so by offering a lower price RightFit may win back all
the CottonWorths business (and still make a profit, compared to the loss they are making at
present).

• Any other acceptable factors (at the discretion of the marker).

RC02 - SOLUTION
Question 2

- Due to the tight deadline, this may impact the quality of the work and put pressure on its employees This may lead to
defective work leading to lowering the reputation of the company and future sales and profits.
- Accepting the special order will allow the company which has been struggling to make use of its available spare
capacity and to generate a return thereby improving profits.
- It must be evaluated how current customers may react to a price lower than the normal products (for a premium
product).
- Saruman has a poor reputation in the market. Being associated with a company with a negative reputation may
negatively impact ASE’s reputation which may lead to clients no longer wanting to do business with the company.
- In order to fulfil the special order the company will have to cut back on some of its normal production and not satisfy
their requirements. This may have a long term negative impact on the company as customers may find other
suppliers for their needs.
- Saruman has not paid Gandalf which may indicate the company is going through financial difficulties. This increases
the risk that Saruman may not pay ASE which will have negative cash flow implications for ASE.
- The order is currently a once off order, but by accepting it the company may open itself up to future business with the
customer which could lead to future profits.
- Other valid points

Conclusion that is justified.

 7. PRACTICE OBJECTIVE TEST

Gelatine Maniac Ltd. (“GM” or “the Company”) manufactures gelato (Italian style ice-cream).
Buster Rhymes, a famous rapper, has requested GM to produce a special flavour called Pino-
Kathleeno. Pino-Kathleeno has a hazelnut flavour gelato base with melted chocolate mixed in.
Buster has offered GM R25 000 for 200 litres of Pino-Kathleeno.

The cost per litre of Pino-Kathleeno:

Note Cost per litre of Pino-Kathleeno gelato produced
Chocolate R5
Milk R10
Electricity N1 R3
Hazelnut flavor N2 R4
Total 22

N1:
Recently GM has been affected by the increased load shedding at stage 4 and has got limited
electricity with which to produce gelato. The Company is considering purchasing a generator to
reduce downtime caused by load shedding. After taking load shedding into account, GM has 180
000 kilowatt-hours(kWh) available to use for the month, or 6000 kWhper day. A generator
would cost R4 500 and GM would then have 240 000 kWh for the month or 8000 kWh per day.

GM produce “Basic” flavours and “Fancy” flavours. The basic flavours use less electricity dueto
the simpler nature of production. Pino-Kathleeno would use the same amount of electricity as
the fancy flavours. Electricity is a fully variable cost.
Basic Fancy
CM per litre R20 R35
kWh per litre 200 kWh 300 kWh
Demand for the flavours per month 400 litres 300 litres

N2:
The exact amount of quantity Hazelnut flavour is on hand and was ordered by accident, instead
of Pecan flavor. It could be returned for R600 or it could be exchanged for the Pecanflavor which
would have cost R500.

Required:

Using relevant costing principles, what is the net benefit of accepting the order?
SUGGESTED SOLUTION

Revenue 25 000

Chocolate (5*200) -1000

Milk (10*200) -2000
Electricity
Available: 180 000
Needed:
Basic (400*200) 80 000
Fancy (300*300) 90 000
Spare 10 000

Needed for special order 60 000

Short 50 000

OC of cutting basic (250*20) -5000

OR
Buy generator -4 500
Therefore buy generator -4500

VC of electricity (3*200) -600

Flavour
Opportunity cost -600

Net benefit 16 300

Basic Fancy
CM/Lf 0.1 0.116667
Cut Basic
50000/200 = 250 l

As the net benefit is positive, the special order should be accepted.

 MANAGEMENT ACCOUNTING II (ACC3023W)

RELEVANT COSTING – WEEK 2 NOTES PRINTING

MODULE CONTENT

1. MODULE OBJECTIVES……………………………………………………………………………………………………...

2. CLASS NOTES……………………………………………………………………………………………………………………

3. ANNOTATED LECTURE EXAMPLES……………………………………………………………………………………

4. TUTORIALS……………………………………………………………………………………………………………………...

5. TUTORIAL SOLUTIONS……………………………………………………………………………………………………..

6. PRACTICE OBJECTIVE TEST……………………………………………………………………………………………….

Week 2
RC04: Champion Chicken (Pty) Ltd
RC05: Ficticorpus (Pty) Ltd
RC06: Solstice (Pty) Ltd*
*unseen tutorial question
MODULE OBJECTIVES

Key learning objective(s) for this week:

Understand how to calculate the relevant cost of materials used in production where said materials
are on-hand, or not; as well as where the materials are required to be replaced, and where not.
 2. CLASS NOTES
The illustration that follows is the thought process that should be used when deciding what the relevant cost of materials is. The lecture examples covered in
this week’s lectures cover these principles in the form of short scenarios. Students should ensure that you do not simply memorise these as rules as the
understanding behind the thought process is key to you being successful in this topic.
3. ANNOTATED LECTURE EXAMPLES

The annotated lecture examples are a supplementary resource that could be used in order to further
assist with clarifying the principles that are covered in the Voice over PowerPoint video related to the
relevant cost of materials. The annotated examples clearly outline the thought process that was
followed in determining the relevant costs under the various situations of lecture example 3.

Lecture Example 3: Materials

What is the relevant cost of material X in each of the situations below? In each situation you require
one unit of X.

Situation 1
The company needs material X for a special project. There is some of Material X on hand. It is neither
sold nor used in the ordinary course of business. Cost information regarding material X is as follows:

Original purchase price: R200

Current purchase price: R210
Current selling price: n/a

If the business did not require material X for the special project, what would it have done with the
material?

The business had no other use for the material so it would not have used it for anything. As a result we
do not forego anything by using the material in the special order. As the material had already been
purchased the cost is sunk resulting in it not meeting the criteria of a relevant cost (not a future cash
flow).

Relevant cost = 0

Situation 2
As per situation 1 above, except material X has some other uses:
A) Sell for scrap: R70
B) Use as a substitute for another material which costs R80 -> R15 modification cost will be incurred.

In this scenario the business does have some other uses for the material. If the material is not used in
the special order it would either be sold for scrap or used as a substitute. We must therefore first
determine which action the business would take using the principle of economic rationality (maximise
cash inflows, minimise cash outflows).

Option B has a net cash flow effect of R80 – R15 = R65 net cash saving. The business would therefore
prefer option A (R70) over option B (R65).
By accepting the special order, the company use the material and lose out on selling it for scrap.

The relevant cost is therefore the R70 opportunity cost of the lost sale.
Situation 3
As per situation 2 above, except material X is sold in the regular course of business.
Current Selling Price: R250.

If the special order was not accepted, what would the business have used material X for?
It would have sold the material for R250. Still ignoring the special order, what would the business have
done?

It would go on and purchase more of the material for R210 because it would want to sell more of the
material due to it generating a profit of R40. This would then continue as long as there is demand for
the material.

SP R250
Cost (R210)
Profit R40

What would now change if the special order was accepted?

It would now use one unit of material X in the special order. The business would still like to sell the
material for R250 (as it would have in the ordinary course of business even if there was not a special
order) but it is now one unit short. The business will therefore buy one unit to replace the unit used in
the special order.

The relevant cost is therefore simply the replacement cost of that one unit which is R210.

The 2 situations shown in terms of numbers:

If the special order was not If the special order was

accepted accepted
Use the unit in the special order N/A No cost as the material was
purchased before (sunk)
Replace the unit (R210)
Sell the unit R250 R250
Replace the unit (R210) (R210)
Sell the unit R250 R250
Replace the unit (R210) (R210)
The sell and replace process The sell and replace process
continues until there is no continues until there is no
longer demand longer demand

Remember, what makes a cost relevant is that it is a future differential cash flow. All of the inflows and
outflows in the green blocks are the same under the 2 situations. The only differential cost is the R210
replacement cost (orange circle)
Situation 4
As per situation 3 above, except material X in limited supply and not readily available from the
supplier.

What would the business have done if the special order was not accepted?

It would sell the unit for R250.

If the special order is accepted, material X will be used and will not be able to be sold (as the material
is in limited supply and more cannot be obtained). The company will therefore lose out on the sale and
the relevant cost will be the R250 opportunity cost.

Situation 5
As per situation 4 above, except material X is used in the regular course of business in the manufacture
of product Y. Revenue and cost information regarding product Y is as follows:

Current Selling Price: R1 450

Variable costs: R1 100
Contribution margin R350

If the special order was not accepted what would the company have done?

It would have used material X in the manufacture of product Y that earns a contribution margin of
R350.

If the special order was accepted it would have used the material and would not have been able to sell
product Y. It would therefore lose out on the contribution margin.

The variable cost of R1100 of product Y is made up of the material cost of R200 (given) and R900 (other
variable costs).

As the material has already been purchased, that cost is sunk and is therefore not relevant. The lost
contribution margin is therefore not R350 (as that assumes that the R200 cost of material X must still
be made) but is R550 (R350 + R200).

The R550 is therefore the relevant cost.

Lecture example 4: Materials only able to be acquired in batches

2 situations:
1) Materials are regularly used in the ordinary course of business
2) Materials are not regularly used in the ordinary course of business

Situation 1:

Material R is used in normal production and is purchased in batches of 75kg at R1 000 per batch.
Normal operations will require 240kg of material R and a special order will require 180kg. What is
the relevant cost?

• The material is regularly used in production

SOLUTION:
If the material is used in normal operations, the relevant cost is the cost of the incremental batches.
For example, material R is used in normal production and is purchased in batches of 75kg at R1 000
per batch. Normal operations will require 240kg of material R and a special order will require 180kg.
What is the relevant cost?

Workings

Normal production 240kg 3.6 Batches

75kg

With special order 180kg + 240kg

5.6 Batches
75kg
Incremental Batches 2 Batches

Only an additional 2 batches must be purchased, thus the relevant cost is R 2000. The temptation is
to calculate the number of whole batches that would be need for the special order in isolation i.e.
180/75 =2.4 ≈3 batches. This is not correct because normal production requires 240/75=3.6 ≈ 4
batches to be purchased, however, 0.4 of a batch is left unused. This 0.4 of a batch is added to the 2
batches purchased to arrive at the total of 2.4 batches required.
If no information had been given about the number of kilograms required for normal operations, the
relevant cost would be R1000/75 = R13.33/kg x 180kg = R2 400. It is not physically possible to buy 2.4
batches, and 3 batches will be purchased, only the cost of 2.4 batches is differential because the
assumption is that the remaining 0.6 will be used in normal production and hence, it would have been
purchased as part of another batch at some point in the future.

Situation 2:

• What if the material is not used in the ordinary course of business? If, in the example above,
material R is not used in production and any extra material can be sold for scrap at R3/kg.
What is the relevant cost?

SOLUTION:

Batches to be purchased 180/75 = 2.4 ≈ 3 x R1 000 R 3 000

Sales of extra material (3-2.4) x 75kg x R3/kg -R 135
Relevant cost R 2 865
4. TUTORIALS

The tutorials for this week cover a number of relevant costing principles and should all be attempted blind prior
to looking at any solutions. This should be the way that all your tutorials should be attempted as the learning in
management accounting is not through being able to do the calculations (which in most cases is quite easy) but
is through being able to articulate the thought process and come up with a way of solving the question in the
most efficient manner. Students should therefore feel comfortable when practicing questions to spend time
thinking of ways to solve problems instead of just making themselves comfortable with the calculations of the
final answer.

MANAGEMENT ACCOUNTING II
ACC3023W
RELEVANT COSTS FOR DECISION MAKING
Tutorial Questions

TUTORIALS

Week 2
RC04: Champion Chicken (Pty) Ltd
RC05: Ficticorpus (Pty) Ltd
RC06: Kubanda (Pty) Ltd*

*Unseen tutorials to be prepared

2
RC04 (2008) (55 MARKS)

Champion Chicken

Champion Chicken (Pty) Ltd designs and manufactures a wide range of chicken products (chicken portions,
spiced and marinated spatchcock chicken, rolled and stuffed chicken breast, stuffed crumbed chicken breasts,
chicken schnitzels etc). The company’s products are sold to large retailers, who on-sell the products to the
general public.

Rationale for launching a new product: “Chicken Pops”

Champion Chicken has noticed a slight decline in demand for its products in recent months, which the company
attributes to consumers feeling the pinch of inflation, rising interest rates, rising electricity costs and less
disposable income. Consumers are purchasing products that are less prepared (i.e. plain chicken pieces rather
than rolled and stuffed chicken breasts) which are sold at a lower price per kg, that use less electricity to cook
(i.e. purchases of products that require oven baking have reduced more significantly than products that can be
pan fried) and in many instances are moving to cheaper substitute ready-made products (e.g. frozen pies, fish
fingers, etc). The company believes it can increase sales, and win back its market by introducing a product that
is sold at a reasonable price per kg, and uses little electricity to cook. Consequently, the company is considering
launching a new product: microwaveable, self-saucing “Chicken Pops”. This argument is supported by market
research that the company has carried out, which cost R35,000.

New product design and sales quantity

Chicken Pops would comprise bite size portions of processed chicken, coated in batter that goes crispy when
micro-waved, and injected with a flavoured saline solution that not only makes the chicken moist and succulent,
but also seeps through the cracks in the crispy coating when the chicken is fully cooked. The product will also
have novelty appeal – the coating “pops” (like popcorn) when fully cooked, which causes the coating to crack.

Chicken Pops would be sold in 500g boxes. If Champion Chicken were to launch the Chicken Pops they would
need to do this immediately before the change in buying behaviour becomes more permanent, and 30,000
boxes of Chicken Pops would need to be produced over the next two month period. Previous experience has
shown that a critical mass of products needs to be available on the market in order to generate sales, and that
initial production volumes below this level have led to sales of the product not taking off, as a result of limited
shelf presence. Most existing products are usually sold in much higher quantities than this. The company would
plan to produce the minimum quantity in order to test consumers’ response to the product.

Argument regarding suggested selling price

It has been suggested that the Chicken Pops be sold to the retailers at R24 per box, which represents full cost
plus a mark-up of 20%. The recommended price of R24 per box to retailers would imply a final selling price to
consumers of R26.50 or more, once retailers had added their usual, non-negotiable margin. The price of R24
per box was determined on the basis of the costing calculation presented in the costing section on the next
page.

Usually the company marks up its products by 30% (which is similar to most manufactures in the industry), but
feels it needs to price the Chicken Pops attractively in order to lure customers back from the other products
they have begun purchasing. The sales manager has a different view: he believes that at the recommended
selling price the cash-strapped South African consumer will not regard the Chicken Pops as being affordable,
and that sales levels of 30,000 units will not be reached unless the price per box (to retailers) is R18 or lower.
At a price of R18, the final selling price to customers will remain below the R20 mark, which the sales manager
believes, is the “emotional Rubicon” that most consumers won’t cross. His argument is that as the company has

3
 spare manufacturing capacity they should “take the gap in the market, offer an attractive price, and go for the
volumes”.

Costing of new product (Chicken Pops) per 500g box

Not R’s
es
Material costs N2 7.00
Consumables and variable overheads N1 4.80
&
N2
Chicken processing labour N2 1.20
Other fixed manufacturing overheads N1 7.00
&
N2
Total Cost 20.00
20% mark up 4.00
Selling Price (to retailers) 24.00

N1 Allocation of consumables, as well as variable and fixed overheads

The company allocates consumables (cleaning agents, grease, oil etc), as well as both variable and fixed
manufacturing overheads to its products on the basis of machine hours. The company estimates that it can
produce an average of 60 boxes (500g each) of Chicken Pops per machine hour, and that production of Chicken
Pops will consume an equal amount of labour and machine time (i.e. 1 minute of labour time and 1 minute of
machine time per box). The average production level per machine hour is determined by dividing the total
number of units of product by the total amount of machine time required, including the time required to set up
and clean the machinery. The labour requirements are determined in a similar manner, and labour time includes
quality checks on 100% of the first 5% of boxes produced. The company produces all of its products in batches.
More popular products are produced in larger batch sizes.

N2 Constraints and potential implications for existing product range

Materials:
Included in the material cost above is R1.50 which represents the purchase price of 100ml of saline solution.
The company purchases this saline solution from a local manufacturer. This saline solution manufacturer is a
small BEE enterprise that the company has decided to support. In terms of an exclusivity agreement with the
supplier, Champion Chicken will not purchase saline solution from any other supplier. The supplier already
supplies 17,000 litres of saline solution per month to Champion Chicken, and is only capable of supplying an
additional 1,700 litres over the next two month period (i.e. 850 litres per month). Champion Chicken has 200
litres of saline solution on hand. The saline solution is injected into all of the chicken products that the company
currently produces, and 200ml of saline solution are injected into every 1kg of chicken (this is common practice
in the industry). (i.e. 100ml of saline would be injected into a 500g chicken product, such as chicken rolls and
chicken schnitzels).

In addition to using the saline solution in the production of chicken products, the company adds flavourants to
the saline solution to produce a 500ml bottle of “Stir Fry Sauce” which the company sells to customers at R25
per 500ml bottle. The variable cost of producing the 500ml bottle of sauce is R10 per bottle, excluding the cost
of saline. 500ml of saline are required per bottle. Approximately 4,160 bottles of sauce are sold to customers
per month. Customers would purchase sauce from competitors if Champion Chicken was out of stock of these
items.

4
Availability of labour and machine hours:
Champion Chicken has determined that the company will have 400 spare machine hours over the next 2 month
period, as well as 350 spare labour hours.

The labour cost reflected in the costing calculation above applies to the permanent workforce that is responsible
for chicken processing (and is consequently regarded as a fixed cost), and has been allocated based on labour
hours per box. The company would not hire additional labour in the short term, as a significant level of training
is required. However, the existing labour force can work overtime which is paid at a premium of 50% above
normal time rates.

Any shortfall in either labour or machine hours required to make the 30,000 boxes could be sourced by reducing
sales and production levels of one of two products: stuffed chicken rolls (rolls) and standard chicken schnitzels
(schnitzels). The rolls and schnitzels are sold to the retailers at prices of R30.00 for a 500g chicken roll, and
R33.00 for 500g of chicken schnitzel, both of which reflect the company’s standard mark up of 30% on cost. 60
rolls and 80 schnitzels can be produced per machine hour. The rolls require 2 hours of labour time for every
machine hour worked, while the schnitzel requires only 1 hour of labour time to every 2 hours of machine time.

It should be noted that the chicken processing workforce is not responsible for or involved in the production of
sauce referred to under “materials” above in any way, and a separate “sauce processing” team is used to
produce sauce. Likewise, none of the machinery required to produce Chicken Pops is used in sauce production.

REQUIRED:
1. Calculate the contribution margin that is earned on a 500g Stuffed Chicken roll and on 500g of Schnitzel.
Clearly show your calculation of the fixed manufacturing overhead rate (per machine hour) and the average
labour rate (per labour hour) separately. (7 marks)

2. Based on an anticipated sales level of 30,000 boxes, calculate the minimum selling price that Champion
Chicken can charge the retailers per 500g box of Chicken Pops in order for Champion Chicken to break-even
on the introduction of the new product. (Note: You should assume a contribution margin of R15 per 500g
chicken roll and R14 per 500g of schnitzel, regardless of your answer in (1) above). (26 marks)

3. Identify and discuss the considerations that should be taken into account in determining the appropriate
price at which the Chicken Pops should be sold to the retailers, as well as any other factors that should be
considered regarding the decision to launch Chicken Pops. (16 marks)

4. Comment on Champion Chicken’s current method of overhead cost allocation. Do you believe that it is
appropriate? Why or why not?

(4 marks)
Clarity of communication, logic and presentation (2 marks)

5
RC05 (45 MARKS)
Ficticorpus (Pty) Ltd specialises in building facial- and body transformation pieces (e.g. fat suites) which are
used in the movie industry to alter actors’ appearances in minor to dramatic ways. Electronics can be used to
animate suites where necessary and fully robotic models are also built. A number of the suits built by
Ficticorpus are required to withstand gruelling stuntwork, and a number of FictiCorpus’s more technical
creations are re-produced in reasonable volumes and sold to adventure sports enthusiasts.

FictiCorpus has been approached to produce 35 bat suites for a film to be partially shot in Cape Town: Batmen
– Clone War, which is being produced by Wolf Studios, an A-list Hollywood film studio. The design team leader
has spec’ed the suites and put together a description of resource requirements and information concerning
costs and availability. The time frame for the delivery of the suites is really tight, as a result of Wolf’s
scheduling constraints and FictiCorpus will have to make a few sacrifices if they are to win the contract. Suit
requirements are described below.

Silicone latex compound

A silicone latex compound is used by FictiCorpus to form the body of most types of suits built by the team.
The compound moves in a similar fashion to loose flesh, and a more muscular appearance can be created by
the addition of inflatable sacks that can be controlled remotely (see electronic requirements below). Each bat
suit will require 7 kilogramms of compound. Approximately 400 kg’s of compound are on hand. The
compound is very expensive and FictiCorpus uses a FIFO inventory costing system to record the movement of
the compound from stocks to jobs for billing purposes. The compound is purchased in 100kg batches from
the supplier who is able to replenish FoctiCorpus’s stocks at 24 hours’ notice. The four latest invoices for latex
compound are as follows: 12 November 2005, R25 000; 20 November 2005, R25 500; 4 December 2005,
R24 900, 21 December 2005, R25 900. The supplier has indicated that the current price per batch is R25 600,
for all orders received within the next 10 working days.

Activator
An activator is added to the silicon latex compound to cause the compound to set once moulded. 200 grams
of activator are required for every 4kg’s of compound. The activator is purchased as needed at a price of R590
per kg, and again, the supplier promises 24 hour availability. 2.5kgs of the activator are on hand. The activator
has a limited shelf life and the activator on hand will expire if not used within the next few days (this activator
will expire on the day that the batsuit contract is completed). FictCorpus has no urgent use for the activator
on hand but not wanting to waste the expensive material, would have used it, together with the correct
quantity of silicone latex compound, to make an assortment of masks and gloves that would be sold through
their small retail outlet, which would generate revenue of R13 200. No other variable costs would be incurred
to make the gloves and masks. 20 labour hours would be required, but as staff have some spare capacity,
FictiCorpus doesn’t regard the labour time as a cost. (Refer to labour requirements below.)

Electric Components
110 electric nodes, 40m of wire and one transmitter/receiver unit will be required per bat suit. The wire is
easily obtainable from any electronics shop, at a cost of R2 per meter and 100meters are on hand. The nodes
and transmitters are more difficult to come by, and FictiCorpus will not be able to acquire more stocks of
either for some time. 4,200 nodes and 42 transmitters are on hand and were purchased for R10 and R200
each respectively. FictiCorpus was going to use the transmitters to make 20 remote-controlled snakes (which
are an interesting security feature if integrated into a home alarm system). Each snake requires 50 nodes and
1 transmitter unit. The contribution margin on each snake would be R1 000 per snake. 2 labour hours are
required per snake.
Each suite requires 20 inflatable sacks. These would be purchased specifically for the contract from a local
medical supplier at a cost of R100 per sack.

Evil Eyes
Each suit requires 2 evil eyes. There are exactly 72 eyes in stock. These eyes were originally purchased at a
price of R200 per eye for another contract that was cancelled before production was completed. FlexiCorpus
6
has no other use for the eyes, which cannot be returned to the supplier as they were custom made for the
cancelled job. The current purchase price is R230 per eye.

Wings
Each batsuit requires a set of base-jumping wings which must be operational from a stunt perspective.
FictiCorpus does not have sufficient time to build base-jumping wings from scratch before the delivery date
of the suits. Infact, the fastest way to source the wings is to remove them from the numerous base-jumping
suites which FictiCorpus has in inventory at their retail outlet. The wings can be removed from the base
jumping suit without damage to the suit, which means that new wings can be fixed to the suits in several
weeks’ time, when FictiCorpus will have time to model new wings. The variable cost of modelling a new set
of wings is R1 600 per set. 40 base jumping suits are in inventory. It is estimated that demand for base jumping
suits in the period before the suites can be replaced will be for 18 suits. Customers will purchase their suits
elsewhere, if FictiCorpus is out of stock. The contribution earned on a base jumping suit is R2 100.

Goat hair
120kg’s of goat hair will be purchased from a Stellenbosch farmer at a price of R200 per goat sheared. 12kgs
can be obtained from 1 goat. The hair will be moulded into the body to provide the suit with a more realistic
appearance.

Labour requirements
600 labour hours will be required to complete the 35 batsuits. Before considering the effects of the FictiCorpus
contract, only 350 hours of spare labour time (normal time) exists between the date that Wolf will give
FictiCorpus the go ahead to begin building the suits (if they win the contract) and the delivery date of the
suits. FictiCorpus’s workforce consist of 10 fulltime permanent salaried employees who are each paid (on
average) R312 000 per annum to work 40 hours per week, 52 weeks per year. Employees are contractually
committed to work overtime as and when required, and an overtime premium of 50% applies to all overtime
work, and staff could reasonably be asked to work up to 120 overtime hours in this critical period (total for all
10 employees). Part of the reason that staff have so few normal time hour available in the next week is that
other than making the radio-controlled snakes and inanimate masks and gloves described above, the
employees are also occupied with building storm sails (i.e. very small kite-surfing sails) which are selling like
hot-cakes given the gale force winds that have blown continuously throughout the current summer season.
Ficticorpus sells these sails at R5 000 each, and variable costs incurred to make these sails is R4 000 per sail.
FictiCorpus could free normal time labour hours if they purchased these sails from a kite surfing
manufacturer/retail who will sell the sails to FictCorpus at R4,500 per sail. Each sail manufactured by
FictiCorpus requires two labour hours and up to 75 sails could be purchased from the manufacturer/retailer
during this period.

Other information
FictiCorpus uses a job order costing system to charge clients, and overheads (which comprise entirely of fixed
costs) are assigned to all jobs based on labour hours at a rate of R10 per labour hour. This rate does not
include depreciation, which is charged separately. Depreciation relating to equipment and vehicles used on
this job is R1,500.

Required: Calculate the financial impact of accepting this contract. (45 MARKS)

7
RC06 (SAICA ITC - 2021) (Unseen) (45 MARKS)

Kubanda (Pty) Ltd (‘Kubanda’) was formed five years ago by a group of South African entrepreneurs
who wanted to manufacture local appliances that were affordable to the broader population of South
Africa. Kubanda produces domestic fridges, called Solarcold; this is the only product produced by the
company. Kubanda sells the Solarcold fridges to retail distributers at R4 000 per fridge. Solarcold is
labelled a ‘proudly South African product’. The company has a 30 June financial year end.

2 Production inputs and materials

The production process of the Solarcold fridges consists of a number of integrated steps that require
various materials and inputs:

2.1 The external shell of the fridge is made from inexpensive steel sheeting that currently costs R20
per square metre (m2) and which can be cut and shaped in five minutes. The external shell of a
Solarcold fridge uses 5 m2 of steel sheeting. Kubanda had 500 m2 of steel sheeting on hand on
30 June 2020 and it has ordered another 1 000 m2 from a supplier. This has not yet been
delivered and Kubanda has not yet paid for it either. All orders can be cancelled at a cancellation
fee of 10% of the purchase price.

2.2 The inner cabinet is made from high-quality thin stainless steel and each fridge uses 4,5 m2 of
stainless steel. The cost of stainless steel is currently R40 per m2. Kubanda had 2 000 m2 of
stainless steel on hand on 30 June 2020 that could be resold at only 60% of its original cost as
there is little demand for this material in the external market.

2.3 Both the inner cabinets and the external shells are sprayed with a white, quick-drying paint.
Paint, sufficient to meet one month’s production requirements, is purchased from Cha Paints, a
Durban-based paint manufacturer, at R40 470 per month. After spraying, the inner cabinet is
placed in the external shell and low-density foam is sprayed into the gap between the cabinet
and the shell to bind them together, thus forming the fridge case.

2.4 A cooling system with a high energy-efficiency rating is installed in the fridge. This feature makes
Solarcold a unique domestic fridge. Kubanda did not have the funds to patent the design of the
cooling system and therefore sources these systems from a local manufacturer, CS Ltd (‘CS’). In
terms of the agreement between Kubanda and CS, the system is specially designed to Kubanda’s
specifications and CS may not share the design or produce the systems for any other customers.

2.5 A Solarcold fridge is powered by solar energy and hence each fridge has two solar panels, an
inverter and batteries. The batteries can power the fridge for four hours once fully charged.
SolarSA (Pty) Ltd supplies the solar panels, batteries and inverters as a ‘solar set’ at a cost of R1
650 per set per fridge, which includes a delivery cost of R10 per solar set. The minimum order is
a batch of 500 solar sets. Kubanda does not currently have any solar sets on hand.

2.6 The last step in the process consists of the addition of accessories (e.g. shelves and ice trays),
after which the fridge goes through a testing process. Accessories are bought from a local
plastics producer at R100 per set per fridge.

8
 3 Production process and costs

Kubanda operates from a factory that is located in a business park in Durban. It is divided into two
separate sections: one section is used as a metal processing plant and the other section is used for the
assembly of the solar set and accessories of the fridge. The metal processing plant comprises metal
shaping and cutting as well as paint-spraying machinery. A new and unused metal processing plant
was purchased on 1 December 2018 for an amount of R2,5 million and was brought into use on the
same day. The plant has a useful life of five years and a residual value of R100 000.

Normal production in the factory is 2 850 Solarcold units per month and the monthly costs of running
the factory amount to R343 030. The breakdown of the monthly costs are as follows:

Cost description Note R

Supervisor salary 1 30 000
Plant operating staff salaries 1 120 000
Assembly staff wages 1 25 000
Maintenance and consumables 2 17 980
Rent 3 50 000
Electricity 4 100 050

Notes

1 There is one supervisor who oversees the production process and six staff members who
operate the machinery at the metal processing plant. There are two unsupervised staff
members who assemble all the components (e.g. the cooling system, solar sets and accessories)
of the fridges. The employment conditions of all the staff members provide that, if a staff
member is retrenched, he or she must receive a minimum retrenchment payment of six months’
salary.

2 The machinery in the metal processing plant requires regular maintenance checks; if its parts are
not placed correctly, or cutting edges are not sharp, there is a risk that a whole batch of materials
may be wasted. Consumables relate to welding, pop rivets and screws used in the metal
processing plant only.

3 The factory rent amounts to R50 000 per month and is allocated equally to each of the plant
and assembly sections. The lease agreement is flexible and can be altered to suit the needs of
Kubanda.

4 Each of the two factory sections uses a fixed amount of R3 000 in electricity per month and in
addition thereto, on average the manufacturing of each Solarcold unit consumes 20 kiloWatt
hours (kWh) at R1,65 per kWh.

4 Business operations

Kubanda was unable to manufacture any fridges during the full lockdown period resulting from the
Covid-19 pandemic, because fridges were classified as non-essential products. While Kubanda was able
to negotiate extended payment terms from 20 to 40 days with its suppliers, orders from customers were
being cancelled because of the economic downturn. This had a negative effect on the company’s
liquidity.

9
CS, Kubanda’s supplier of cooling systems, was also struggling with low margins on other products
because of competition from foreign suppliers. On 30 April 2020, CS notified Kubanda it was shutting
down its company because of financial difficulties and that it had 1 500 cooling systems available,
which it was willing to sell at R708 each. This amount was equal to 80% of the retail price at that time.
CS also told a Kubanda representative that it would need cash funding or a cash guarantee of R5 million
to settle its creditors if it were to wind down its other operations and produce cooling systems only.

As a result, Kubanda started searching for alternative sources of cooling systems. It approached foreign
companies. One of these was Leng, a company based in China that manufactures fridge cooling
systems for the Chinese market. Leng offered to supply Kubanda with cooling systems at R799 each,
provided that Kubanda agreed to purchase a minimum of 2 850 cooling systems per month.

5 Alternative outsourcing options

Kubanda also considered the possibility of selling its plant on 30 June 2020 for a cash injection into the
company. It could outsource parts of its production process to Metalwork AG (‘Metalwork’).
Metalwork is based in Germany and manufactures metal formworks for several industries and
companies across the world. Metalwork quoted Kubanda R350 per fridge case. It would in addition
charge delivery costs of R3 000 per batch of 1 000 fridge cases. The minimum order size would be 1
000 fridge casesand Metalwork would be able to supply up to 15 000 fridge cases per month. Time
from order to arrival would be three weeks. Kubanda would have to pay for orders upfront.

If Kubanda outsourced the metal processes of the Solarcold fridges to Metalwork, it would be able to
sell its plant for R1 740 000.

10
 Marks
QUESTION 1 – REQUIRED Sub-
Total
total
(a) Determine, with supporting calculations, whether the production of
fridge cases should be outsourced to Metalwork for financial year
ending 30 June 2021. 21

Communication skills – presentation 1 22

(b) Discuss the considerations that Kubanda needs to take into account when
deciding on its pricing of the Solarcold fridge.
8 8
(c) Evaluate Kubanda’s opportunity to purchase cooling systems from
Leng, if Kubanda is no longer able to purchase these systems from CS. No
calculation is required. 9
10
Communication skills – logical argument 1
40

0
5. TUTORIAL SOLUTIONS

MANAGEMENT ACCOUNTING II
ACC3023W
RELEVANT COSTS FOR DECISION MAKING
Tutorial Solutions

TUTORIALS

Week 2
RC04: Champion Chicken (Pty) Ltd
RC05: Ficticorpus (Pty) Ltd
RC06: Kubanda (Pty) Ltd*

*Unseen tutorials to be prepared

1
RC04 – SOLUTION

1.

Cm / 500g Roll Schnitzel

Revenue 30 33 1

Thus: Profit 6.92 (30x 30/130) 7.62 (33x 30/130) 1

plus: fixed costs

Overheads 7.00 (420/60) 5.25 (420/80) 1

Labour 2.40 (72/(60/2))) 0.45 (72 / (80*2)) ) 1

Contribution margin 16.32 13.32 1

FMOH Labour

R's per box (A): 7.000 1.200

Hr's per box (B): 0.01667 0.01667

Thus R's per hour (A/B) 420.00 72.00 2

Total 7

2
2.
Marks

R's Workings
Material costs 210,000 7 x 30,000 1

Consumables and variable overheads 144,000 4.80 x 30,000 1

Opportinity costs:
Lost roll sales 90,000 100 mhrs (W1) x R900/hr (W2) 13
Lost sauce sales 7,500 500 litres (W1) x R15/ litre (W3) 4

Overtime - none required, 50 hours spare capacity -

exists 2

Other fixed manufacturing overheads and existing - Not incremental

labour force, research and design time 2

Relevant cost for 30,000 boxes 451,500 1

Relevant cost per 500g box 15.05 1

Comments in Italics are not included in the mark allocation above, 3

& must be specifically stated to have marks awarded.
28

3
Workings to Final answer presented on previous page:

W1 Constraints
Machine Labour
Saline litres Hours hours
Spare 1,900 400 350 2
(1,700 + 200)
Required -3,000 -500 -500 3
(30,000 x 0.1) (30,000 / 60) (30,000 / 60)
Short -1,100 -100 -150 1
From: (100 x 2)
Roll sales 600 100 200 3
-500 0 50 1

Sauce sales (see W3) 500 1

Total 11

W2 Cm/ lf Roll Schnitzel

Cm/500g 15.00 14.00
machine hours/ 500g 0.0167 (1/60) 0.0125 (1/80) 1
Cm/machine hour 900.00 1,120.00

labour hours/ 500g 0.0333 ( (1/60) x 2) 0.00625 ( (1/80) / 2) 2

Cm/labour hour 450.00 2,240.00

No conflict in profitability rankings, roll lower cm/lf for both constraints: 1

Thus reduce sales of rolls to get required machine hours 1
Total 5

W3 CM per litre of sauce sold:

SP 25 1
VC's 17.5 (R1.50 x 5) + 10 1
CM / 500ml 7.5
Thus R's / litre are 15 1

To obtain the necessary qty of saline for the new product for 2 months it is cheaper to 1
forego sauce sales than reduce rolls sales further.
Total 4

4
3

 The minimum price per box calculated above ignores the costs related to the use of spare capacity,
as the resources to which these costs relate are already committed to and unlikely to be altered
within the two month period. Production and sales of the 30,000 boxes would generate a positive
financial benefit at any of the selling prices suggested. (2)

 However, if Champion Chicken intends producing Chicken Pops beyond the two month period,
the price would need to be sufficient to cover the fixed costs relating to the resources used, and
provide a profit margin sufficient to cover the cost of capital on the related asset investment. (2)

 At the price that the sales manager believes will be acceptable to customers for the product being
offered, fixed costs are not covered, per the allocation provided (1). However, it should be noted
that the Chicken Pops is carrying 25% more overheads than chicken schnitzels, due to lower
production volumes (on average 60, as opposed to 80 500g portions are produced per hour) (2).
If Chicken Pops were produced in the future, in larger batch sizes (similar to the Chicken rolls), the
total cost per box of Chicken Pops could potentially decrease by R2.95 ((R4.80 + R7 ) * 2/8),
reducing the total cost per 500g box to R17.05. (4) (Note: The average number of boxes per hour
includes cleaning time which would reduce proportionately as batch sizes increased, increasing the
average number of boxes that could be produced per machine hour.)

 This price therefore provides a slim profit margin on the sales manager’s suggested price (1).

 The labour requirement per box of Chicken Pops may also be reduced in the future. Would the
amount of labour time reduce if larger quantities of the Chicken Pops were produced in the
future? (1) Does the amount of labour time currently estimated include an allowance for the fact
that staff is unfamiliar with the new product, and initial set up and production might be unusually
slow as a result? (1) If not, labour requirements may be higher than anticipated leading to further
reductions in sales levels of existing products. (1)

 The opportunity cost of lost roll sales might not be relevant – sales of this product may have
continued to decline anyway as a result of further increases in electricity costs, unless consumers
switch to gas ovens (2). However, the price of gas has also escalated recently as a result of
increased oil prices, making the switch unlikely(1).

 The price that is set now will set a precedent for future sales, and particularly if management wish
to gauge the market’s response to the new product, they need to introduce the product at what
they believe is an appropriate market price for the specific product (1). However, a selling price
that is inflated as a result of inefficiencies in the production process (small batch size due to
exploratory nature of the product) cannot be passed on to customers as this does not represent
additional value to the customer (1).

 There may be a strategic argument to set the price slightly below the optimal long term price, in
order to make it unattractive to competitors to introduce competing products. Once Champion
Chicken is satisfied that they have sufficiently established their brand in the low-watt energy
consumption market niche (and buying behaviour/brand loyalty is established), they could slowly
increase prices. (2) The entry of competitors at this point (now that better profit margins can be
achieved) will serve to reinforce the increased prices Champion Chicken now charges. (1)

5
 One matter of concern is the capacity of the outsourcer to supply sufficient quantities of saline
solution. If this is a long term constraint, then Champion Chicken would need to charge a price
that is sufficiently high to compensate for the lost sales of sauce. (2) However, as this is a non-
value added cost to customers, the higher selling price cannot be justified. Champion Chicken’s
growth opportunities should not be limited by their outsourcer. (1) Champion Chicken should
discuss expansion options with the BEE supplier, and either assist them to do so (provision of
advice, cheap finance etc) if they wish to continue using only this supplier, or Champion Chicken
should source a second supplier (2).

 Another matter of concern is that the introduction of this new product might lead to a
cannibalisation of other products that Champion Chicken produces (1).

 However, if the company does not introduce innovative new products, market share is likely to
decline anyway. This product has potential to attract more sales as electricity prices increase, and
has a novelty factor that most other products on the market don’t have. (2)

 Innovate or die! The product should be introduced. The margin does not need to be reduced too
significantly from 30%, as the saving on electricity costs should also be taken into account in
understanding the differential cost to consumers. (2)

4. Cost allocation considerations

 Allocating an equal overhead per machine hour to all products implies that overheads are incurred
equally across all different products – i.e. that the same amount of work and resources are used
per machine hour for each different product type (1). If this is not true, then products requiring
greater resources relative to the machine hours worked will be undercosted, and products
requiring less resources relative to the machine hours worked would be over costed (1).

 The majority of the variable overheads and most fixed such as power (variable), and depreciation,
maintenance and repairs, and the salaries of the machine operators, probably do vary in
proportion to machine hours and the current allocation would provide a good indication of the
true cost of producing the various product types, for the majority of variable costs (3).

 Certain of the smaller variable costs would not vary in direct proportion to machine hours, such
as consumables which is more likely a batch level cost, if these relate to cleaning of the machinery
(2).

 As the company seems to determine their sales price by applying a cost based price, the selling
price is being affected by any inaccurate cost allocation (1).

 As the company is near capacity and struggling with operational constraints that cannot easily be
altered (such as machine hours), then a more accurate costing may have implications on the

6
 company’s mix and emphasis on the product range, and allocating the variable costs accurately is
important in order to determine the correct contribution margin per product.

 As overheads represent a significant cost, it amplifies the effect of an inaccurate cost allocation
(1).

7
 RC05 – SOLUTION
Suggested Solution to RC05
R's

Price x Qty Workings

Silicone latex compound N1 256 245 (35 x 7) 62 720
Activator - to be purchased 590 9.75 (245 x (0.2/4) - 2.5) 5 753
Activator - on hand N2 13 200 - 256 x (2.5 x 4 / 0.2) = 400
Wire - to be purchased 2 1300 (40 x 35 -100) 2 600
Wire - on hand 2 100 200

Nodes and Transmitters:

13 snake sales will be lost W1, W2 1 700 13 22 100

Inflatable sacks 100 700 70 000

Eyes - 70 sunk cost -

Wings
- replacement of wings 1 600 22 = 40 - 18 (replace wings, sale not foregone) 35 200
- lost sales 3 700 13 = 35 - 22 (2100+1600) 48 100

Goat hair 200 10 2 000

Labour W3
- idle time 396 -
- overtime 225 120 =312000/(52*40)*1.5 x 120 27 000
- outsourcing 250 84 =(4500-4000)/2 x 84 21 000

Fixed overheads Not incremental -

Depreciation -

297 073

N1 - in regular use, would be replaced if used.

N2 - Here is a nested decision. Forego Sales Purchase and sell

Revenue 13 200 13 200
Costs (12 800) (14 275)
Labour - fixed - -
Silicone latex 12 800 12 800 (256 x 2.5 x 4 / 0.2)
Activator - 1 475 (2.5 x 590)
Benefit 400 (1 075)

W1 Nodes Transmitters

Qty on hand 4 200 42

Qtys required for snakes (existing prod) 1 000 a 20 a = (50 x 20)
Qty spare 3 200 22
Qty required for batsuits (3 850) (35)
Shortfall (650) (13)
Thus reduce snake production and sales 650 13
/50 /1
Check whole units (# of snakes) 13 13

Thus must cut 13 snake

8
W2 Contribution per snake lost

Contribution margin per snake 1 000

Add back sunk costs included therein 700
Financial loss per snake not produced and sold 1 700

W3 labour hours required

Currently free 350
Freed up from snakes 26
Freed up from masks and gloves 20
Total spare 396
Total for contract 600
Total required 204

3 SOURCES OF LABOUR:
Effective outsource cost per hour
Increase in cost per kite (4500 - 4000) 500
Hours per kite 2
250

Overtime cost per hour

Annual salary 312 000
annual hours 2 080
Avg hourly rate 150
x 1.5 = 2
225

Forego sale
Revenue 5 000
VC (4 000)
CM 1 000
Cost per hour 500

Max hours obtainable from kites

Max 75 kites 75
Hours per kite 2
150

W1 - alternate approach

Nodes on hand 4 200

Nodes required for Bat suits 3 850
Nodes still free for snakes 350
Nodes per snake 50
Snakes still to be made 7

Lost snake sales (in snakes) (20-7) 13

Number of nodes that had an alternate use 650

Transmitters on hand 42
Transmitters required for Bat suits 35
Transmitters still free for snakes 7
Transmitters per snake 1
Snakes still to be made 7

Lost snake sales (in snakes) (20-8) 12

Number of transmitters that had an alternate use 12
9
 6. PRACTICE OBJECTIVE TEST

Cape Chemicals recently received an order for a product which it does not normally produce. Since
the company currently has spare capacity they are considering accepting the order. Production of
this special order will require three chemicals, theolite, genatope and pestrol.

Theolite

The product will require 8 000kg of theolite. The company does not currently use theolite for any of
its existing products but has 8 000kg of theolite on hand from when it used to use it in its products.
This theolite could be sold to a competitor for R217 500. Cape Chemicals paid R30 per kilogram for
the theolite that it has on hand. Cape Chemicals could buy theolite for a current price of R36 per
kilogram.

Genatope

The product ordered will also require 1 000kg of genatope. The company currently has 8 000kg of
genatope on hand and it currently uses it in the products that it normally produces. The current
replacement cost of the genatope is R130.50 per kilogram however the cost per kilogram of the
genatope in stock is R124.50.

Pestrol

The product ordered will require 1 000 litres of pestrol. Cape Chemicals has 15 000 litres of pestrol
on hand which it purchased for R105 per litre. The supplier of pestrol has stopped importing the
product and therefore this product can no longer be purchased. Cape Chemicals currently uses 1
litre of pestrol in the manufacture of each unit of the MiTank product which they currently produce.
The MiTank usually has a selling price of R1 050 per unit and a variable of cost of R605 per unit.

REQUIRED:

Calculate the total relevant cost of the materials for the purpose of analyzing the special order
decision. (8 Marks)

10
SUGGESTED SOLUTION
Theolite Opportunity cost 217 500 (2)
Genatope:
Cost of replacing 1 000kg used in order 1 000kg x R130.50 130 500 (1)

Pestrol:
1 000 MiTanks sales foregone R1 050 x 1 000 1 050 000 (2)
Variable costs saved (R605 – R105) x 1 000 (500 000) (2)

Relevant cost of material 922 000 (1)

11
 MANAGEMENT ACCOUNTING II (ACC3023W)

RELEVANT COSTING – WEEK 3

Contents

1. MODULE OBJECTIVES.………………………………………………………………………………………………………..

2. CLASS NOTES……………………….…………………………………………………………………………………………….

3. LECTURE EXAMPLES……………………………………………………………………………………………………………

4. ANNOTATED LECTURE EXAMPLES……………………………………………………………………………………….

5. TUTORIALS……………….………………………………………………………………………………………………………...

6. TUTORIAL SOLUTIONS…………………………………………………………………………………..………………….…

7. PRACTICE OBJECTIVE TEST…………………………………………………………………………………………………..

TUTORIALS

Week 3
RC07: RoboTech (Pty) Ltd
RC08: Grinder (Pty) Ltd
RC09: Simple Packaging*

*Unseen tutorials to be prepared

12
MODULE OBJECTIVES

Key learning objective(s) for this week:

• Understand how to calculate opportunity cost when operating under constrained conditions.

o Why do I have an opportunity cost under constrained conditions?

o Why is the opportunity cost of foregone sales calculated as contribution margin and
not profit?

o How do I calculate my opportunity cost when I have more than one constraint?

• Understand how opportunity cost is affected where the constraint is a fixed versus a variable
cost.

o Is my opportunity cost different if my constraint is a fixed or variable cost given that

contribution margin foregone is usually my opportunity cost?

CLASS NOTES

In last week’s lectures we considered what the relevant costs were of materials in a special order
however materials are not the only resources that could be constrained. Labour and machine time
can also be constrained, i.e. there is not enough to fulfil normal production requirements and the
special order. The most important principle to remember is that management will always strive to
make the most economical choice i.e. obtaining the resource from the cheapest source first.

Therefore, when attempting a question that has constrained resources (limited factors), consider all
of the alternatives of freeing up the resource. These could include:

• Cutting production (which will probably free up more than one resource);

• Using overtime if labour is the constrained resource;

• Outsourcing normal production to make resources available for the special order; or

• Using a less skilled form of labour (in this case an adjustment for inefficiency is required).

Where there is more than one constrained resource that can only be obtained from cutting production
of other products, and there are multiple products to choose from, consider the following:

• The cheapest place to obtain the resource is the product that generates the least contribution
margin per unit of limited factor, thus ranking of the products is required.

• Where there is a conflict in ranking i.e. it is cheaper to get resource X from product A and
resource Y from product B, the most limited factor must be identified. The concept of most
limiting factor will be covered in PGDA. Linear programming is another method that could be
used to determine the optimal production mix if there is a conflict in rankings.

13
 Consider the following example: CAN (Pty) Ltd has received a special order for product D which is not
normally manufactured. However, the company is almost operating at full capacity and therefore
there are not enough resources to fill the order and carry on with normal operations. The special order
will require 600 direct labour hours (Lhrs) and 450 machine hours (Mhrs). The company currently has
total capacity of 10 000 Lhrs and 15000 Mhrs. Labour is unskilled and paid hourly and there is no
overtime. The company produces two other products, X and Y, which are currently utilising 9 900 Lhrs
and 14 800 Mhrs and have the following cost and revenue structures:

Notes
X Y
Selling Price R 1 500 2000
Variable costs -R 1 090 -R 1 400
Direct Material R 700 R 1 075
Direct Labour R 300 R 250 Direct Labour costs R50/Lhr
Variable overheads R 90 R 75 Variable overheads are applied at R15/Lhr
Contribution Margin R 410 R 600
Fixed overheads -R 250 -R 300 Fixed overheads are applied at R20/Mhr

Net Profit R 160 R 300

How should labour and overheads be sourced?

As mentioned earlier, it is best to analyse all the constraints together.

Workings Lhr Mhr Notes

Capacity 10 000 15 000 If there was a still a shortfall of Mhr after
Normal production -9900 -14800 enough labour was freed up, product X would
Available 100 200 be cut as that is the cheapest source of Mhr.
Special Order -600 -450
Short fall -500 -250
The surplus of machine hours does not
Sourced from: represent a cost saving as the company would
Product X 0 0 most likely have to decrease its investment in
fixed capacity in order to remove the surplus.
Product Y (100 units [W2] x 15) 500 1 500 This is a long-term decision. If, however, a
surplus of labour hours that are paid hourly
(i.e. not fixed salaried employees) is created
or an existing surplus is increased, the
incremental surplus will represent a cost
saving if those hours will not be used for
(Short fall)/surplus 0 1 250 anything else.

14
 The first step is to determine, how much of each resource is required.

The next step is to determine which product is the cheapest source of Lhr and Mhr:

(W1)
Workings X Y Notes
(410/(300/50)),
There is a conflict in ranking as product
CM/Lhr (600/(250/50)) 68.33 12
X is the cheapest source of Mhr but
CM/Mhr (410/(250/20), (600/(300/20) 32.8 40
product Y is the cheapest source of Lhr

Next, assess what the most limited factor (for PGDA purposes – blue text) is:

(W2)
Workings Lhr Mhr Notes
Amount required 500 250 Labour hours are the most limited
factor because for both products,
Units of production to be cut: labour requires the most production
Product X (500/6),(250/5) 84 50 to be cut. Therefore, the cheapest
Product Y (500/5), (250/15) 100 17 source of labour must be found first.
From the calculations above, product Y generates the lower CM/Labour hour therefore we will opt to
cut product Y. To free up enough labour hours I will need to drop at least 100 units of product Y.

At this point it is worthwhile to note that in a situation similar to the one given above, it is absolutely
vital that you do not double count costs/opportunity costs. Make a choice at the beginning of the
question to use the total or the incremental approach and be consistent throughout the question.
This is illustrated below:

15
Total Approach Notes

Workings
Opportunity cost -60 000 The total approach treats all of the
Product Y Sales forgone 100 x 2000 -200 000 variable costs associated with product Y
Materials saved 100 x 1075 107 500 as being saved and then included that
Direct labour saved 100 x 250 25 000 total cost of the variable costs to
Variable overheads saved 100 x 75 7 500 produce D. However, the labour is not
actually saved since 500 hours are
Production of Product D simply being shifted from product Y to
Direct Labour 600 x 50 -30 000 product D. Similarly, not all 600 of the
Variable overheads hours incurred on product D are
incurred 600 x 15 -9000 incremental; however the net effect is
that only 100 hours are actually treated
-99 000 as a cost.

Incremental Approach

Workings
Opportunity cost -92 500 The incremental approach is
Product Y Sales forgone 100 x 2000 -200 000 conceptually correct, but it can be
Materials saved 100 x 1075 107 500 tricky. This method treats only the cost
of the incremental hours, i.e. the 100
hours that were spare capacity, as
Direct labour saved 0 relevant.
Variable overheads saved 0

Production of Product D The financial impact will be the same,

Incremental Direct Labour 100 x 50 -5 000 regardless of the method used.
Incremental Variable
overheads incurred 100 x 15 -1500
-99 000

16
LECTURE EXAMPLES

Lecture example 5

1 000 labour hours are required for a special order. Labour could be obtained in the following ways:

 100 hours of idle time currently exists.

 Up to 400 hours of overtime could be worked.

 The units could be outsourced at a cost of R1 200 per unit. A maximum of 150 units of the
special project could be outsourced.

 Production of an existing product could be reduced. The existing product generates R475 in
contribution margin per labour hour, and

 2 labour hours are used to produce 1 unit for the special project.

 Labour is a fixed cost. Employees’ monthly salary equates to R100 per hour. Employees are
paid overtime at time and a half. The variable costs of producing a unit for the special project
are R500 per unit.

The relevant cost of utilising 1 000 labour hours is as follows:

Cost per hour Hours Total Cost

Total hours required: 1 000

Idle time nil -100 0

Overtime R100 x 1.5 = R150 -400 60 000

Outsource (R1 200 – R500)/2 = R350 -300 105 000

Existing Product reduced R475 1000 - 800 95 000

17
Lecture Example 6: Maximum price to pay for a limited resource

A company manufactures and sells three products.

Pure Thermal Arty

Selling Price 57 90 130
Direct Material -10 -25 -40
Direct Labour (variable) -10 -12 -20
Variable Manufacturing Overhead -7 -10 -17
Contribution Margin 30 43 53

Labour hours/unit 0.25 0.3 0.5

The company requires more labour for a special order. At the current level of production there is no
spare labour capacity. An external party has offered additional labour hours to the company at a fee.
What is the maximum fee the company should be willing to pay for the 1st additional labour hour
from the external party?

18
Lecture Example 7: implications of a constraint being a fixed or variable cost

For situation 1 and 2 below, assume that 50 labour hours are required for an order. Currently
(i.e.under the existing production plan) 10 spare labour hours exist. The remaining 40 hours can only
be obtained by reducing the production of one of two products (A or B). Labour is paid an average of
R10 per hour.

Required:

Which product should be cut back on, and what is the relevant cost of labour per hour, and in total
for the 50 hours required by the (special order etc)? First assume that labour is a fixed cost (Situation
1) and then assume that labour is a variable cost (situation 2).

Situation 1 Situation 2

Labour is a fixed cost Labour is a variable

cost

Product A B A B

Selling price 400 700 400 700

Variable costs:

Materials (180) (300) (180) (300)

Labour - - (40) (50)

Variable overheads (70) (150) (70) (150)

S&A Exp. (50) (100) (50) (100)

Cm/u 100 150 60 100

Fixed overheads per unit R240 R200 R200 R150

Labour Hr/u 4 5 4 5

19
 SOLUTION SITUATION 1 (Labour is a fixed cost):

Working 1
Product A Product B
CM/unit 100 150
LHR/unit 4 5
CM/LHR 25 30

Relevant cost
Spare labour R0
Opportunity cost R1 000 (40 hours x R25/hour)
R1 000

SOLUTION SITUATION 2 (Approach #1):

Relevant cost
Spare labour R100 (10hrsxR10/hr)
Opportunity cost R1000 (40hrs x R25/hr)

SOLUTION SITUATION 2 (Approach #2):

Working 1
Product A Product B
CM/unit 60 100
LHR/unit 4 5
CM/LHR 15 20

Relevant cost
Spare labour R500 (50 hours x R10/hour)
Opportunity cost R600 (40 hours x R15/hour)
R1 100

20
OVERHEADS

Lecture Example 7 continued:

For lecture example 7, determine the differential cash flows for variable and fixed overheads.
Overheads are allocated to product costs using labour hours.

SOLUTION SITUATION 1 (Labour is a fixed cost):

1. Fixed overheads irrelevant

2. Variable overheads – depends on the extent to which labour hours work changes.

21
SOLUTION SITUATION 2 (Approach #1):

1. Fixed overheads irrelevant

2. Variable overheads – depends on the extent to which labour hours work changes.

Adjust CM foregone for irrelevant LHRs and VOH when determining opp cost

Include incremental cost of labour and VOH

SOLUTION SITUATION 2 (Approach #2):

Do not adjust CM foregone for irrelevant LHRs and VOH when determining opp cost

Non-current assets
Equipment owned by a company has a net book value of 1 800 and has been idle for some
months. It could now be used on six months contract that is being considered. If not used on this
contract, the equipment would now be sold for a net amount of 2 000. After use on the contract,
the equipment would have no resale value and would be dismantled.
What is the relevant cost?

22
 If equipment was used in the six month contract, the company would lose out on the R2 000 net
sale amount. As a result the relevant cost is the R2 000 opportunity cost.

Lecture Example 8: Constraints Machine hours

Assume that a 40 labour hours and 40 machine hours are required for a special product, and that no
spare capacity exists for either of these resources. Thus, these hours can only be obtained by cutting
back on production of either product A or B, which have the selling prices, variable costs, and
machine and labour time requirements as presented below.

Situation 1 Situation 2

No Conflict Conflict in rankings

Product A B A B

Selling price 400 700 400 700

Variable costs:

Materials (180) (300) (180) (300)

Labour - - - -

Overheads (70) (150) (70) (150)

S&A Exp. (50) (100) (50) (100)

Cm/u 100 150 100 150

Labour Hr/u 4 5 4 5

Machine Hr/u 8 10 5 10

23
ANNOTATED LECTURE EXAMPLES

The annotated lecture examples are a supplementary resource that could be used in order to further
assist with clarifying the principles that are covered in the Lecture videos related to the relevant cost
of constrained resources. The annotated examples clearly outline the thought process that was
followed in determining the relevant costs under the various examples and situations.

Lecture example 6

1 000 labour hours are required for a special order. Labour could be obtained in the following ways:

 100 hours of idle time currently exists.

 Up to 400 hours of overtime could be worked.

 The units could be outsourced at a cost of R1 200 per unit. A maximum of 150 units of the
special project could be outsourced.

 Production of an existing product could be reduced. The existing product generates R475 in
contribution margin per labour hour, and

 2 labour hours are used to produce 1 unit for the special project.

 Labour is a fixed cost. Employees’ monthly salary equates to R100 per hour. Employees are
paid overtime at time and a half. The variable costs of producing a unit for the special project
are R500 per unit.

Calculate the relevant cost of the 1 000 labour hours:

The relevant cost of utilising 1 000 labour hours is as follows:

In order to see which labour options will be chosen first, the principle of economic rationality will be
applied (minimise cash outflows). The different sources of labour must therefore be ranked from least
expensive to most expensive to see which labour options the company would choose first.

Cost per hour Ranking Hours Total Cost

Total hours required: 1 000
Idle time nil 1 -100 0
Overtime R100 x 1.5 = R150 2 -400 60 000
Outsource* (R1 200 – R500)/2 = R350 3 -300 105 000
Existing Product reduced R475 4 1000 - 800 95 000
TOTAL R260 000

*In terms of the cost per hour of labour of outsourcing the product, we are essentially trying to isolate
what the cost of labour is that is implicit in the outsourcing cost. The total cost is R1 200 which is made

26
up of labour and other variable costs. If the other variable costs of producing the unit is R500, then the
total labour cost is R700. If each unit takes two hours, the hourly labour cost is R350 (R700/2).

Lecture Example 7: implications of a constraint being a fixed or variable cost

For situation 1 and 2 below, assume that 50 labour hours are required for an order. Currently
(i.e.under the existing production plan) 10 spare labour hours exist. The remaining 40 hours can only
be obtained by reducing the production of one of two products (A or B). Labour is paid an average of
R10 per hour.

Required:

Which product should be cut back on, and what is the relevant cost of labour per hour, and in total
for the 50 hours required by the (special order etc)? First assume that labour is a fixed cost (Situation
1) and then assume that labour is a variable cost (situation 2).

Situation 1 Situation 2
Labour is a fixed cost Labour is a variable
cost
Product A B A B

Selling price 400 700 400 700

Variable costs:
Materials (180) (300) (180) (300)
Labour - - (40) (50)
Variable overheads (70) (150) (70) (150)
S&A Exp. (50) (100) (50) (100)
Cm/u 100 150 60 100
Fixed overheads per unit R240 R200 R200 R150
Labour Hr/u 4 5 4 5

SOLUTION SITUATION 1 (Labour is a fixed cost):

We first need to assess which product generates the lowest contribution per unit of the limited
resource.
Working 1
Product A Product B
CM/unit 100 150
LHR/unit 4 5
CM/LHR 25 30
Product A therefore generates a lower contribution margin per unit of limited resource and should
therefore be dropped to free up resources for the order.

Relevant cost
Spare labour R0 (10 hours x R0/hour as labour is fixed therefore no incremental cost)

27
 Opportunity cost R1 000 (40 hours x R25/hour)
R1 000

OR
We require 50 hours. As there are 10 hours spare we only have to obtain an additional 40 labour hours.

In order to free up the 40 labour hours, how many products should you drop?
40/4 = 10 products

Therefore you will lose out on the full contribution margin for 10 products
The relevant cost is therefore 10 x 100 = R1 000

SOLUTION SITUATION 2 (Approach #1):

In this situation, labour is now a variable cost. Therefore any use of labour will incur a cost. As a result
the first 10 hours that are used incurs the variable cost of labour.

Spare labour R100 (10hrsxR10/hr)

We are still however 40 hours short. We know that we definitely are going to have to incur the labour
cost for the special order, so by cutting back on any product I will not get to save the variable cost of
labour. As a result when calculating the CM/LF of the 2 products I can add back the cost of labour
because it will not be able to be saved (product A, 60 + 40 = 100; product B, 100 + 50 = 150) and based
on the CM/LF calculation, it is in the company’s best interest to cut back on product A (CM/LF of R25
is lower than product B’s CM/LF of R30).

Therefore when we free up the 40 hours still required, we lose out on R25/labour hour. The relevant
cost for this portion is therefore:

Opportunity cost R1000 (40hrs x R25/hr)

The total relevant cost when labour is a variable cost is therefore R1 100.

SOLUTION SITUATION 2 (Approach #2):

Using approach 1, the assumption was that when you cut back on either product A or product B, you
don’t get to save the variable cost of labour which is why it was added back when calculating the
CM/LF. Under this approach, the assumption now is that you do get to save the labour cost when
cutting back on either product A or product B. We will correct this assumption later on in the
calculation.

Our first step is therefore to work out the CM/LF for the 2 products using their normal contribution
margin (i.e. now we are not adding back the variable cost of labour).

28
 Product A Product B
CM/unit 60 100
LHR/unit 4 5
CM/LHR 15 20

Based on this calculation, product A should again be cut back on. The relevant cost when cutting back
on product A is therefore:

Opportunity cost R600 (40 hours x R15/hour)

Remember when you drop a product and lose out on that contribution margin, you are essentially
saying you lose out on all the revenue but get to save on all of the variable costs. This calculation above
has therefore effectively said that you get to save the variable cost of 40 labour hours.

So this is saying you’ve lost out on all of the revenue included in the contribution margin but have saved
all of the variable costs (which includes the labour cost).

We know for the special order we will have to incur 50 labour hours. Therefore because in the previous
calculation we have said that 40 hours have been saved, the full cost of 50 labour hours must now be
incurred.

Labour R500 (50 hours x R10/hour)

The total relevant cost is therefore R1 100 (which is the same as under approach 1)

Lecture Example 7 continued:

For lecture example 7, determine the differential cash flows for variable and fixed overheads.
Overheads are allocated to product costs using labour hours.

SOLUTION SITUATION 1 (Labour is a fixed cost):

In situation 1 labour here is a fixed cost. That has no impact on the amount of labour hours that will
be used (i.e. we can use 10 or 50 labour hours but the cost will stay the same).

If we are evaluating what the relevant cost is of accepting the special order, we need to see how many
additional labour hours will be used as overheads are allocated based on labour hours. The special
order requires 50 labour hours. We therefore require an additional 10 labour hours to what we are
currently using (as we are 10 short).

The use of the 10 additional hours will have no impact on the cost of fixed overheads as these stay the
same regardless of the activity level. The 10 additional hours will however have an impact on the
variable overhead cost incurred.

The relevant cost will therefore be as follows:

29
 Product A Product B
CM/unit 100 150
LHR/unit 4 5
CM/LHR 25 30

Relevant cost
Spare labour R0 (10 hours x R0/hour as labour is fixed therefore no incremental cost)
Opportunity cost R1 000 (40 hours x R25/hour)
Fixed overhead R0
Variable overhead R875 (70/4) x 50
TOTAL R1 875

SOLUTION SITUATION 2 (Approach #1):

3. Fixed overheads irrelevant

4. Variable overheads – depends on the extent to which labour hours work changes.

Adjust CM foregone for irrelevant LHRs and VOH when determining opp cost

Include incremental cost of labour and VOH

The treatment of this is similar to what we did with labour however now in addition to labour, there is
a variable overhead cost that we also have to account for.

The adjusted CM for product A and B is therefore R170 (60 + 40 + 70) and R300 (100 + 50 + 150). This
is due to us not being able to save these costs because they will have to be incurred.

Therefore the CM/LF

Product A Product B
CM 170 300
Labour hours 4 5
CM/LF 42.50 60

Therefore we will cut back on product A

The relevant cost is therefore:

Additional labour R100 (R10 x 10)

Additional VC R175 (70/4 x 10)
Lost CM R1 700 (42.50 x 40)
Total R1 975

30
 SOLUTION SITUATION 2 (Approach #2):

Do not adjust CM foregone for irrelevant LHRs and VOH when determining opp cost

Again a similar treatment to what was done just for labour but now we also have to account for the
variable overheads (fixed overheads does not change therefore is irrelevant).

Our first step is therefore to work out the CM/LF for the 2 products using their normal contribution
margin (i.e. now we are not adding back the variable cost of labour and variable overheads).

Product A Product B
CM/unit 60 100
LHR/unit 4 5
CM/LHR 15 20

Based on this calculation, product A should again be cut back on. The relevant cost when cutting back
on product A is therefore:

Opportunity cost R600 (40 hours x R15/hour)

Now we need to account for the full labour cost and variable overhead cost:

Labour R500 (50 hours x R10/hour)

Variable OH R875 (50 hours x 70/4)

Total RC R1 975

Non-current assets
Equipment owned by a company has a net book value of 1 800 and has been idle for some months.
It could now be used on six months contract that is being considered. If not used on this contract,
the equipment would now be sold for a net amount of 2 000. After use on the contract, the
equipment would have no resale value and would be dismantled.
What is the relevant cost?
If equipment was used in the six month contract, the company would lose out on the R2 000 net sale
amount. As a result the relevant cost is the R2 000 opportunity cost.

31
Lecture Example 8: Constraints Machine hours

Assume that a 40 labour hours and 40 machine hours are required for a special product, and that no
spare capacity exists for either of these resources. Thus, these hours can only be obtained by cutting
back on production of either product A or B, which have the selling prices, variable costs, and machine
and labour time requirements as presented below.

Situation 1 Situation 2
No Conflict Conflict in rankings
Product A B A B

Selling price 400 700 400 700

Variable costs:
Materials (180) (300) (180) (300)
Labour - - - -
Overheads (70) (150) (70) (150)
S&A Exp. (50) (100) (50) (100)
Cm/u 100 150 100 150

Labour Hr/u 4 5 4 5
Machine Hr/u 8 10 5 10

What is the relevant cost of accepting the special order?

Situation 1:

First we should assess to see if there is actually a constraint.

LHr MHr
Currently available 0 0
Less: Required for project -40 -40 .
Shortfall/Surplus -40 -40

We should then assess the products to see which generates the lowest CM/LF for the limited resources

CM/LF
A B
Cm/u 100 150

Labour Hr/u 4 5
CM/LHr 25 30

Machine Hr/u 8 10
CM/MHr 12.5 15

32
For both labour and machine hours, product A generates a lower CM/LF. Therefore we should drop
production of product A first to free up resources.

How many products should we cut back on?

Labour hours Machine hours

Shortfall 40 40

Hours per unit product A 4 8

Units to drop 10 5

Therefore we need to drop at least 10 units to free up labour hours as well as machine hours.

The relevant cost is therefore:

R’s Working
Opportunity cost:
Reduce production of 1000 (10 units W1 x R100/unit W2)

Remember not to double count the opportunity cost (i.e. don’t work out a relevant cost for the units
to drop to free up labour hours and then also include another relevant cost for the units to drop to
free up machine hours – this is due to machine hours being freed up when you free up the labour
hours)

Situation 2:

First we should assess to see if there is actually a constraint.

LHr MHr
Currently available 0 0
Less: Required for project -40 -40 .
Shortfall/Surplus -40 -40

We should then assess the products to see which generates the lowest CM/LF for the limited resources

A B
Cm/u 100 150

Labour Hr/u 4 5
CM/LHr 25 30

Machine Hr/u 5 10
CM/MHr 20 15

33
This calculation basically says that product A should be cut back to free up labour hours and product B
should be cut back on to free machine hours. There is therefore a conflict in rankings.

To decide which product to drop in this situation you either need to use the principle of most limited
factor (cover in PDGA) or linear programming (covered later in the year).

34
TUTORIALS

MANAGEMENT ACCOUNTING II
ACC3023W
RELEVANT COSTS FOR DECISION MAKING
Tutorial Questions

TUTORIALS

Week 3
RC07: RoboTech (Pty) Ltd
RC08: Grinder (Pty) Ltd
RC09: Simple Packaging*

*Unseen tutorials to be prepared

RC07 (2010) (50 MARKS)
RoboTech (Pty) Ltd manufactures radio-controlled cars and helicopters of various sizes and
capabilities. Their products are sold through various retailers, speciality toys stores and more
complex models are sold through hobby shops.

Special contract: Alpha Romayo replica car

RoboTech has been approached by Alpha Romayo (Alpha), an international luxury and sports
car manufacturer, with a view to producing 5,000 custom designed radio controlled cars. The
cars would be miniature replicas of Alpha’s latest sports model, the Spider, which Alpha will
award to members of its fan club at its 100th birthday celebration to be held in Verona, Italy.
Alpha has approached RoboTech, a South African radio controlled car producer, rather than a
European producer on the understanding that the South African company would be able to
offer a very attractive price. If this is not the case, then Alpha will investigate sourcing the car
from Indian manufacturers. The Alpha-replica would have to be shipped to Verona (at Alpha’s
cost) in three months’ time.

RoboTech is keen to win the order, as their own production volumes have been low for the
last two years, and are not yet showing signs of improving. However, with the recent
strengthening of the Rand, RoboTech is aware that they are not nearly as competitive cost-
wise as Alpha believes. As such, RoboTech has determined that they need to be careful not
to quote an unattractive price. Usually RoboTech would price their cars at full cost plus a mark-
up of 100%. The company’s financial manager has recommended that RoboTech determine
the relevant cost of accepting the order, and consequently the minimum amount that
RoboTech would need to charge to break even, and then decide on a suitable profit figure. To
this end, the financial manager has provided (1) A calculation of the full cost of the custom-
designed radio controlled car; and (2) Further information relating to availability of materials
and components, and other production requirements.

Full production cost

A calculation of the full production cost of 1 custom-designed Alpha Romayo replica remote
controlled car is presented in Table 1 below:

Table 1 : Full production cost of 1 custom-designed Alpha Romayo replica remote

controlled car
Notes R's
Rubber wheels N1 80
Mechanical transmission N2 150
Receiver unit N3 200
Speed Control Motor (SCMotor) N4 80
Direction Control Motor (DCMotor) N4 60

Plastic housing:
- Materials N5 25
- Moulding time N6 500
- Moulds N7 20

Handset
- Control unit N8 75
- Transmitter unit N3 130

Assembly time N9 180

 Consumables N10 120
Design costs N11 5
Total Cost N12 1,625
N1 RoboTech would use Dunlop replica wheels for this model, and has 12,000 of these
wheels on hand. These wheels are used on a number of RoboTech’s replica sports cars.
Table 1 reflects the most recent invoice price. 4 Wheels are required per car, and
RoboTech would be able to purchase more of these wheels at a price 5% above the last
invoice price. RoboTech also sells these wheels to customers, at a price of R40 per
wheel.

N2 The mechanical transmission is custom built for each design of car, and the costs
included in this line item reflect materials only. The building time is included in assembly
time.

N3 Receiver and transmitter units are purchased from reputable suppliers. The costing in
Table 1 includes the cost of the new receiver unit and transmitter unit that RoboTech
will be using in the majority of their models, going forward. RoboTech recently took the
decision to upgrade the receiver and transmitter units in all but their most basic models,
as the quality and capability of the receiver and transmitter units determines the
responsiveness of the model car and Robotech believes that it is critical for their
branding that they remain at the forefront of international trends and developments.

RoboTech has 8,000 of each the old transmitter and receiver units on hand and these
could be used on this order to reduce costs, so that RoboTech could quote a lower price.
RoboTech doesn’t believe that the vast majority of the Alpha fan club would notice the
difference, as they are not model car enthusiasts. RoboTech was going to use these
units on their basic model cars, which earn a contribution of R300 per car, currently.
These transmitter and receiver units were purchased at R170 and R100 respectively.
Once these transmitter and receiver units were used up, RoboTech would have
purchased cheaper transmitter and receiver units, which would improve the
contribution of the basic model by R50 (i.e. the basic model would earn a contribution
of R350 per car).

1 transmitter unit and 1 receiver unit is required per car (for any model).

N4 Each car will require two motors: one to control speed and the other to control
direction. Each motor is specific to the type of car, although some models can be used
on more than 1 type of model. RoboTech has 1,000 SCMotors and 6,000 DCMotors on
hand that would be suitable for the Alpha, and these are reflected in the costing above
at the last invoice price. The SCMotors are still used on two models of car that RoboTech
producers. However, the DCMotors are no longer used on any of RoboTech’s models,
as they can no longer be purchased from the supplier.

RoboTech does not sell either of the motors to customers, but does undertake to do
repairs for customers in the unusual situation that the motor breaks and needs to be
replaced. RoboTech estimates that 300 SCMotors, and 1,500 DCMotors would be
needed in repairs over the remaining life of the models that have been sold to date
which use these motors. The remaining DCMotors would have been thrown out. The
new DCMotors that are used in current production cannot be used to perform repair
work as the new motors do not fit into the shell of the old model cars. Customers are
charged R120 and R100 to replace the SCMotors and DCMotors respectively.
N5 The plastic to be used on the Alpha replica is the same as that used on all models.

N6 Moulding time relates to the time taken to mould the plastic into the shape of body of
the car. This process is machine intensive and the R500 included in the costing in Table
1 relates to the estimated overhead cost per car. Each car will require 5 hours of
moulding time and RoboTech has determined that the overheads in the moulding
department amount to R100 per machine hour. RoboTech calculated this rate per
machine hour by dividing the total overhead costs incurred in the last 12 months
(R5.5m) by the level of actual production (55,000 hours) in the moulding department.
RoboTech is not convinced that the rate of R100 per hour is accurate, when RoboTech
worked 60,500 machine hours in the moulding department in the previous 12 months,
the total overheads in the moulding department amounted to R5,61m and the effect of
inflation on moulding department overheads has been negligible across this 24 month
period.

RoboTech expects to have 23,500 spare moulding hours in total for the three month
period required to produce the Alpha-replica. If Alpha has insufficient capacity to meet
the requirements of the Alpha order, then they could reduce production of an older
model, the Toyota Hilux replica, which earns a contribution of R400 per car, and uses 3
moulding hours per car.

N7 The plastic is shaped on moulds. The moulds are built specific to each car shape, and
the useful life of 1 mould is 800 cars (i.e. 800 cars can be moulded from 1 mould,
thereafter a new mould is built.) The costs to build the models are 100% variable and
the moulding cost of R20 per car included in the costing in Table 1 was determined by
dividing the cost to build 1 mould (R16,000) by the number of cars that could be
moulded using that mould (800 cars).

N8 No control units are on hand and would be purchased as required.

N9 Assembly time relates to the labour cost associated with assembling the model car.
Labour comprises skilled, salaried employees, and is allocated at a rate of R90 per
assembly hour.

RoboTech expects to have 8,000 spare assembly hours in total for the three month
period required to produce the Alpha-replica. If Alpha has insufficient capacity to meet
the requirements of the Alpha order, then they could reduce production of the Toyota
Hilux replica, (Refer N6) which uses 1.6 assembly hours per car.

N10 Consumables relates to small parts (wiring, screw, etc.) used in the assembly process in
order to complete the model car, which individually are too low in value to be directly
traced to each car produced. Consequently, RoboTech allocates consumable costs to
cars based on assembly time, as cars that take longer to assemble also require more
consumables.

N11 This relates to the costs already incurred in developing the design of the Alpha.

N12 The full production cost of R1,625 per car would suggest a selling price of R3,250 at the
company’s usual mark up of 100%.
REQUIRED

1. Determine the minimum amount that RoboTech would have to charge for the special
order in order to break even. (34 marks)

Note: in addition to the marks allocated above, 3 marks are allocated for clarity and logical
insight, as well as layout of solution.
(3 marks)
RC08 (2018) (43 MARKS)

Grinder (Pty) Ltd (“Grinder” or “the Company”) was started by two health enthusiasts, Andrew
and Julie Hobart, in 2004. The couple noted the trend that people are becoming more health
conscious, and looked to capitalise thereon. The Company produces an innovative blender
product, called the FruitiMix, which customers can use to make smoothies, nut-butters 1, and
almond milk 2. The financial year end of the Company is 31 September, and the current date
is 1 October 2018.
Grinder started their operations by making a 600 watt (w) FruitiMix blender model. Recently,
after considering customer suggestions, the Company added a more powerful 900 watt
FruitiMix blender model. The 900w FruitiMix can break down tougher ingredients such a
wheatgrass and seeds. Grinder currently produces both models of the FruitiMix blender, the
600w Fruitimix is their most popular model.
Financial information regarding the two blender models are as follows:
Per Unit Information: Note 600w FruitiMix 900w FruitiMix
(Rand) (Rand)
Selling Price 1 580.00 2 780.00
Direct Materials:
Plastic 1 (17.60) (35.20)
Motor 2 (180.00) (400.00)
Direct Labour 3 (18.00) (36.00)
Variable Manufacturing Overheads 4 (20.00) (40.00)
Fixed Manufacturing Overheads 5 (450.00) (450.00)
Variable Selling Expenses 6 (25.00) (33.00)
Profit per unit 869.40 1 785.80

Assembly labour time per unit 3&4 6 minutes 12 minutes

Plastic moulding machine time per unit 7 9 minutes 16 minutes

Production and sales per month 1 200 600

Notes:

1. The 600w and 900w FruitiMix blenders are both made from clear plastic granules. The
plastic granules are heated and moulded to form the blender design separately for each
blender. The plastic granules are sourced from an international supplier whom sells the
granules in batches of 5 tons. Grinder purchases the plastic granules at the current purchase
price of US $5,500 per ton.

2. Each FruitiMix blender requires one motor. The only difference between the motors of
the two FruitiMix models is the wattage of the motor. The FruitiMix 600w blender and the
FruitiMix 900w blender requires a 600 watt and 900 watt motor respectively.

3. Grinder currently employs two permanent production staff members to assemble the
blenders. Each employee is paid a salary of R24 800 per month. Each employee can work a

1
A nut-butter is a spreadable food product made by grinding nuts into a paste.
2
Almond milk is a plant milk manufactured from almonds.
maximum of 8 hours per day for 5 days of the week. Overtime is not allowed for assembly
staff members of the Company.

4. Variable manufacturing overheads are allocated to the blenders on the basis of direct
labour hours. Direct labour hours are represented by the assembly labour time.

5. Fixed manufacturing overheads are allocated to the blenders on a per unit basis using
a predetermined overhead rate calculated at the beginning of the financial year. The fixed
manufacturing overheads consist of factory rental, administrative costs, the production
manager’s salary, administrative staff salaries, and depreciation of factory equipment. The
depreciation amounts to R190 000 per month. Fixed manufacturing overheads were under-
allocated to the two products by R32 650 in September 2018.

6. Variable selling expenses include packaging and shipping of the blenders.

7. The moulding machine currently has a practical capacity equivalent to 480 hours per
month for all Grinder products produced. The production manager has sufficient spare
capacity to manage the moulding machine and oversee the assembly staff.

Veggie-Chef Order:
On 1 October 2018, YoungCooks.co.za (“YoungCooks”) approached Grinder to produce the
YoungCooks-branded Veggie-Chef (a 3-in-1 vegetable processor) for sale during the December
2018 holiday period. YoungCooks is a local online kitchenware retailer, that sells YoungCooks-
branded white-labelled 3 products on their website. YoungCooks would like to add a 3-in-1
vegetable processor to their current offering.
Grinder were excited about the proposal as they had previously considered adding a vegetable
processor to their product offering. However, Grinder management cancelled the vegetable
processor idea. Because of the initial vegetable processor idea, Grinder have already
developed technical plans and a prototype 4 of the 3-in-1 vegetable processor product which
they intend to sell to YoungCooks. Grinder has spent R225 750 on research and development
relating to the processor prototype up to 30 September 2018.
YoungCooks proposal would require delivery of the Veggie-Chef from Grinder on 1 December
2018 and will pay Grinder R1 635 per unit. Depending on the success of Veggie-Chef over the
December period, YoungCooks may order the processor again in the future.
YoungCooks have indicated that they are unsure of the demand for the Veggie-Chef. However,
YoungCooks need Grinder to commit upfront as to whether they are going to produce the
product, even though the exact order numbers will depend on the success of the advertising
campaign.
Due to the uncertain demand for Veggie-Chef Grinder intend to delay production to as late as
possible, to evaluate the success of the advertising campaign. Therefore, production of the
Veggie-Chef will only occur in November so that Grinder may have greater clarity on the
expected sales of the processor. Grinder believes that there is a 40% chance that YoungCooks

3
A white label product is a product produced by a company (Company X) that another
company (Company Y) rebrands to make it appear as if they had made it.
4
A prototype is an early sample, model, or release of a product built to test a concept or
process or to potentially be replicated or learned from.
will order 240 units and a 60% they will order 600 units, depending on the intensity of the
advertising campaign.

Veggie-Chef Production:
Each Veggie-Chef processor requires 450g of clear plastic granules. Grinder currently has 6
tons of plastic granules on hand which were purchased originally for US $4,900 per ton.
It is expected that production of the Veggie-Chef processor will require 15 minutes to
assemble and 16 minutes of moulding machine time per processor. Variable selling expenses
will amount to R45 per unit.
The existing 600 watt and 900 watt motors used by Grinder are not suitable for use in the
production of Veggie-Chef. Grinder have 500 (five hundred) 1200 watt motors on hand, which
were originally purchased for the discontinued industrial-grade blender. These 1200 watt
motors were purchased for R550 each and would be suitable for use in the YoungCooks-
branded Veggie-Chef. Grinder has no plans to use these motors in any of their existing or new
products, other than the Veggie-Chef. The current purchase price of a 1200 watt motors from
the supplier is R625 each. Further, a toy manufacturer has offered to purchase up to 250 of
the 1200 watt motors that Grinder have on hand for R575 each.

Additional Information:
• If Grinder requires additional assembly labour or moulding machine time, they can
cut production of one of their existing FruitiMix products.
• The average exchange rate for November 2018 is expected to be R15.00/US$.
• Assume that there are 20 workings days per month.
• 1 tonne = 1 000 kilograms.
• 1 kilogram = 1 000 grams.

REQUIRED MARKS

1. Calculate the number of FruitiMix blenders that Grinder (Pty) Ltd were 10

required to sell in September 2018 to breakeven on a cash basis.

• For part 1 only, ignore the potential order from YoungCooks.co.za.

Presentation and communication: clarity of workings & layout 1

2. Evaluate whether Grinder (Pty) Ltd should accept the Veggie-Chef proposal 31

from YoungCooks.co.za. by calculating the overall expected financial impact.

• Your answer should include a calculation of the relevant cost of the

Veggie-Chef order for each of the two order quantities (240 and 600

units) separately, as well as the overall expected financial impact.

Presentation and communication: clarity of workings & layout

TOTAL 43
RC09 (2019) (UNSEEN) (IGNORE VAT & TAXATION) (44 MARKS)

Simple Packaging (Pty) Ltd (“SP” or “the Company”) is a packaging manufacturer based in Cape
Town. The Company specialises in producing responsibly-sourced, sustainable packaging
solutions. At the heart of SP’s vision is a self-sustaining world. In line with this vision, SP
encourages retailers to promote non-plastic packaging for products sold in store and for the
bags that customers use to take their purchases home. The current date is 31 January 2019.

SP was started by Bonolo Zondo, a qualified CA(SA), after he spent time in Hawaii volunteering
to help clean up the Great Pacific garbage patch 5. During this time, he witnessed the massive
burden that single-use plastic has become on our environment and oceans. This lead Bonolo
to conceptualise SP in a bid to reduce the use and circulation of single-use plastics and to raise
awareness of the global plastic pollution problem.

SP has a very successful manufacturing facility in Epping that produces two (2) products;
namely the paper-based packaging (‘paper bags’) and the rolls of ‘recycled plastic packaging’.
These two products are sold to retailers and manufacturers as packaging solutions for their
products. Financial information regarding these two products is as follows:

Paper bags Recycled plastic packaging

(per bag) (per metre)
Selling price R5 R4
Paper pulp* R1.28 -
Glue* R1.74 -
Consumables* R0.55 R1.59
Labour cost (refer to 3) ? ?
Allocated fixed overheads R1.15 R1.15

Labour time 0.72 mins, OR 0.78 mins, OR

(0.012 hrs) (0.013 hrs)
Machine time 1.68 mins, OR 2.1 mins, OR
(0.028 hrs) (0.035 hrs)
Paint (in litres) 0.02 -

Total demand per month 8 000 bags 20 000 metres

* These costs are deemed to be variable in nature.

SP is currently looking to expand its sustainable packaging products through alternate

materials. The alternate sustainable material being considered is hemp 6. Hemp is fast
becoming the choice sustainable raw material globally as it grows quickly and is adaptable for
numerous purposes.

To evaluate whether hemp is suitable for long-term packaging production, SP is considering a

once-off order to manufacture branded, limited-edition hemp bags. The hemp bags are

5
The Great Pacific Garbage patch is the largest accumulation of plastic in the ocean in the world, and is situated off
the West Coast of the United States of America.
6
Hemp is a sustainable plant, the fibres of which can be used to make a variety of products, including building
material, plastic, paper, and jewellery.
available for customers to use instead of the conventional plastic-based bags at the upcoming
International Vegan 7 Food Festival in Cape Town.

Manufacturing of hemp bags for the festival:

The Vegan Food Festival has offered SP a lump-sum of R62 500 for 6 600 hemp bags. The
hemp bags would need to be manufactured during February to ensure they are available for
the festival occurring on 2nd March 2019. The following resources will be required to
manufacture the hemp bags:

1. Hemp
Hemp can currently only be sourced from France, China, and Chile. Based on the current
seasonal conditions it is only possible to source the hemp from Chile on such short notice.
Bonolo has incurred international telephone costs of R3 042 in an attempt to contact suppliers
in Chile. When an appropriate supplier was finally contacted, they indicated that hemp prices
are quoted in US Dollars, and the current price of hemp is $215 per tonne. Hemp can only be
purchased by the tonne.

The supplier however indicated that if Bonolo can deposit the cash into a separate private
Swiss bank account, the price can be reduced by 20% as the supplier would not add the
mandatory taxes to the cost. SP has estimated that each kilogram of hemp would yield three
(3) bags.

2. Machine hours
The production machines currently used for all existing packaging products are suitable to use
in the production of hemp bags. The hemp fibres are more refined than the pulp fibres used
to make paper bags. Therefore, the hemp bags will use one seventh of the machine hours per
bag compared to paper bags. The machines are currently operating at full capacity based on
the existing production.

3. Labour
Each hemp bag will require 0.13 labour hours. The existing manufacturing workers are able to
produce hemp bags. Nine workers are currently employed by SP, one of which is the factory
supervisor. Each employee earns a salary of R12 600 per month. The supervisor oversees the
production process and has spare capacity to oversee any additional production.

The production employees in the paper bag manufacturing facility can work seven (7) hours a
day, and there are only 20 working days each month. Further, each employee can only work
an additional one hour overtime for each working day available at 125% of the normal hourly
rate.

SP can also train the current admin assistant to assist in the paper bag production. Training
would cost R7 500 immediately and the trained admin assistant would be available for the full
month of February. The trained admin assistant will earn the same as the current production
employees. A new admin assistant would be required to replace the existing admin assistant
who earned R10 300.

7The Vegan movement is one that looks at consumers living a more sustainable life style,
mainly through their dietary choices in consuming no meat products, but also in their other
consumption choices.
 4. Cleaning Solution
A special cleaning solution is required to clean the hemp. SP estimates that 40 litres of the
cleaning solution is required for the quantity of hemp required to produce the 6 600 hemp
bags. Fortunately, SP has 31 litres of the cleaning solution on hand that they had purchased
for R30 per a litre in September 2018. The cleaning solution on hand is suitable for use in the
cleaning of hemp.

This cleaning solution is readily available from the supplier, although prices have increased by
R5 a litre since September 2018. This price is only available to SP, due to SP’s good relationship
with the supplier and the supplier supporting SP’s vision of a self-sustaining world.

If the cleaning solution on hand is not used in the cleaning of hemp fibres, SP could return the
solution to the supplier and get a refund of the original price paid less 10%. It will cost R300
to transport this solution back to the supplier. Otherwise, SP could sell this cleaning solution
to another manufacturer at R34 a litre. SP would not have to incur the transport costs to get
the solution to the other manufacturer.

5. Paint
The branding of the hemp bags will be identical to the branding used on the paper bags, and
follow the same production process. The branding is applied with green paint that is screen
printed onto either bag product. The green paint required for the hemp bags is the same as
that used for the paper bags. The green paint is available from the supplier at the current
purchase price of R26 per litre.

Additional Information:

• Current exchange rate $1 = R13.10

• 1 litre = 1 000ml
• 1 tonne = 1 000kg
• SP will consider cutting an existing product if necessary to accept the special order of
hemp bags.
• The hemp bags production must be completed in one month (February 2019).

REQUIRED MARKS
1. Determine whether Simple Packaging (Pty) Ltd should accept the 30
special order to produce the hemp bags for the International Vegan
Food Festival.

Presentation and Communication: Layout & Clarity of workings

1
2. Discuss the qualitative factors Simple Packaging (Pty) Ltd should 12
consider before accepting the special order.

Presentation and Communication: Communication 1

TOTAL 44
 TUTORIAL SOLUTIONS

MANAGEMENT ACCOUNTING II
ACC3023W
RELEVANT COSTS FOR DECISION MAKING
Tutorial Solutions

TUTORIALS

Week 3
RC07: RoboTech (Pty) Ltd
RC08: Grinder (Pty) Ltd
RC09: Simple Packaging*

*Unseen tutorials to be prepared

 RC07 – SOLUTION
R's Workings Marks:

Variable Costs

Rubber wheels 420000 (5000units x R80 x 1.05) 2

Mechanical transmission 750000 (5000 units x R150) 1

Receiver unit - Sunk Cost 1

Speed Control Motor

(SCMotor) 400000 (5000 x R80) 1

Direction Control Motor

(DCMotor) 50000 (500 x R100) 3

(4500 x - ) Sunk cost 1

Plastic housing:

- Materials 125000 (5000 x 25) 1

- Molding time (variable (5000units x 5hrs x R20) *(Hi-lo

portion) 500000 calc) 4

Handset

- Control unit 375000 (5000 x R75) 1

- Tranmitter unit - Sunk Cost 1

Assembly time

Variable overheads and

consumables 600000 (5000 x R120) 1

Design costs

- car design - Sunk Cost 2

Step Cost - Moulds

manufactured
 - building and testing [5000units/800 = 6.25moulds] (7
moulds 112000 moulds x R16 000) 2

Fixed Costs

- Moulding time (fixed

Portion) -
Fixed costs -- not incremental 2

- Assembly time -

Opportunity Cost

(5000 units x [R570 - 350])

- lost CM for RU and TU 1100000 **(check) 6

- lost Hilux Sales 500000 (1250 units cut x R400) 4

Total Cost 4932000 1

Internal consistency and no double

counting. 2

36

No. Of Units 5000

R
Cost per Unit 986.40

* Mixed Cost: (Hi-lo) Moulding Time

Cost

At activity of 60 500 MHRS 5 610 000

At activity of 55 000 MHRS 5 500 000

Change in Costs 110 000 a

Change in Activity 5500 b

Variable Rate per Unit R 20 (a/b)

** New Receiver unit (RU) 200

New Transmitter Unit (TU) 130

Total Cost for RU&TU (per unit) 330

 Cost of using old stock (CM lost) (R570
- R350)*** 220 

Therefore: use old stock rather to reduce the quoted price

by R110 per unit

*** Current CM (incl. Sunk costs) 300

Sunk Costs:

- TU 170

- RU 100

CM foregone 570

CM earned 350

Incremental CM lost 220

Moulding Assembly
Constraints: Time Time

Spare Capacity 23 500 8 000

Required for Spec. Order -25 000 (5000units x 5hrs) -10 000 (5000units x 2hrs)

Short -1 500 -2 000

Cut Hilux Sales (1250 units) 3 750 (1250 x 3hrs) 2 000 (2000hrs/1.6 = 1250)

Spare 2 250 0

Reject Special Order Accept Special Order

Contribution Earned: Contribution Earned:

(8000 x R570) 4 560 000 (3000 x R570) 1710000

(5000 x R350) 1750000

4 560 000 3460000

Incremental Cost 1 100 000

RC08

QUESTION 1 Marks

1 Breakeven calculation

Fixed costs:
Production staff salaries R24 800 x 2 49 600
Fixed overheads R450 x (600 + 1 200) 810 000
Under allocated overheads 32 650
Depreciation not a cash cost, therefore remove -190 000
702 250

Contribution margin 600w FM 900w FM

Sales 1 580.00 2 780.00
Variable Costs -242.60 -508.20
Plastic 17.60 35.20
Motors 180.00 400.00
Variable Overheads 20.00 40.00
Variable Selling Expenses 25.00 33.00
Contribution Margin per Unit 1 337.40 2 271.80

Batch ratio 2.00 1.00

CM per batch 2 674.80 2 271.80
4 946.60

Breakeven batches Fixed costs 702 250

CM per batch 4 946.60

= 141.97 batches

Breakeven units 283.93 600w FM

141.97 900w FM

ROUND UP UNITS 284.00 600w FM

142.00 900w FM
1 Calculate the Financial Impact
240 600

Revenue No. units x 1 635 392 400.00 981 000.00

Direct Materials:
Plastic [(450g / 1 000g) x ($5 500 x R15 / 1 000 kg) x No. units] -8 910.00 -22 275.00
Motors On hand 250 units - -
Acquire (100 x R625) -62 500.00
Lost sales (250 x R575) -143 750.00

Variable Manufacturing Overheads [(R40 (900w FM) x 15min/12min) x No. units] -12 000.00 -30 000.00
or [(R20 (600w FM) x 15min/6min) x No. units]
Variable Selling Expenses [R45 x No. units] -10 800.00 -27 000.00
Fixed overheads & labour Not Incremental
Research and Design Sunk

Opportunity cost of lost sales

Lost CM on 900w FM [350/100 units x R2271.80/unit] - -795 130.00

Financial Impact 360 690.00 -99 655.00

40% 60%
Expected Value 84 483.00
Therefore Fruit Grinders should accept the special order

Working 1: (which product to cut) 600w FM 900w FM

Contribution Margin per Unit (from part 1) 1 337.40 2 271.80
Assembly time per unit 6 12
Moulding time per unit 9 16
Production 1 200 600

CM/Assembly minute 222.90 189.32

CM/moulding minute 148.60 141.99

Therefore cut 900w FruitiMix

Working 2:
Assembly time Moulding time
Total Available [60mins x 8hrs x 20 days x 2] 19 200 28 800 [480 hours x 60 mins]
Existing production [1200 x 6min + 600 x 12min] -14 400 -20 400 [1200 x 9min + 600 x 12min]
Spare per month 4 800 8 400

Special Order (240 units) [20 units x 15 mins] -3 600 -3 840 [20 units x 16 mins]
Spare / (Short) 1 200 4 560

Special Order (600 units) [600 units x 15 mins] -9 000 -9 600 [600 units x 16 mins]
Spare / (Short) -4 200 -1 200
Cut 900w FM 4 200 5 600
Spare / (Short) - 4 400

No of units to be cut: [4 200 / 12 min] -350.0 -75.0 [1 200 / 16 min]

Therefore cut 350

Total available
Max 31
 6. PRACTICE OBJECTIVE TEST

RELEVANT COSTING OBJECTIVE TEST (10 Marks: 12 Minutes)

Select one option as an answer as there is only one correct answer. Please show all workings, no
marks will be awarded for no workings:

1. An organisation is considering the costs to be incurred in respect of a special order

opportunity.

The order would require 1,150 kgs of material D. This is a material that is readily available and
regularly used by the organisation on its normal products. There are 265 kgs of material D in stock
which cost R 795 last week. The current market price is R3.50 per kg.

Material D is normally used to make product X. each unit of X requires 3kgs of material D, and if
material D is costed as R 3 per kg, each unit of X yields a contribution of R15.

The relevant cost of material D to be included in the costing of the special order is nearest to:

A : R4,025

B : R4,050

C : R15,000

D : R10,300

[2 marks]

2. A Company has been asked to quote for a special contract. The following information is
available on the labour required for the contract:

The special contract would require 200 hours of labour. However, the labourers, who are each paid
R15 per hour, are working at full capacity. There is a shortage of labour in the market and therefore
the labour required to undertake this special contract would have to be taken from another contract
Z, which currently utilises 500 hours of labour and generates R5,000 worth of contribution. If the
labour was taken from contract Z, then the whole of contract Z would have to be delayed, and such
delay would invoke a penalty fee of R1, 000.

A : R1, 000

B: R3,000

C: R2,500

D: R4,000

[ 2 Marks ]
 3. Tholukuthini provides a single service to its customer. An analysis of its budget for the year
ending 31 December 20X5 shows that in period 3, when the budgeted activity was 6,570
service units with a sales value of R72 each, the margin of safety was 21.015 %.

The budgeted contribution to sales ratio of the service is 35 %.

Budgeted fixed costs in period 3 were nearest to:

A : R115,000

B: R131,000

C: R145,000

D: R157,000

4. Which of the following statements are correct?

i) A cost driver is may factor that causes a change on the cost of an activity

ii) Fixed overheads are allocated taking into account Actual capacity

iii) Traditional absorption costing tends to under allocate overheads costs to low-volume
products.

A : i) and iii) only

B: ii) and iii only

C: i), ii) and iii)

D: i) only

[1 Mark]

5. H Ltd has in stock 15,000 kg of M, a raw material which is bought for R3/kg five years ago,
for a product line which was discontinued four years ago.

At present, M has no use in its existing state but could be sold as scrap for R1 per kg. One of the
company’s current products (HN) requires 4kg of a raw material which is available for R 5 per kg. M
can be modified at a cost of R0.90 per kg so that it may be used as a substitute for this material.
However, after modification, 5 kg of M is required for every unit of HN to be produced.

H Ltd has now received an invitation to tender for a product which could use M in its present state.

The relevant cost per kg of M to be included in the cost estimate for the tender is:

A: R 0.90
B: R1
C: R3.1
D: R3.25
[3 Marks]
SOLUTION

Question 1
Answer: A

The material is in regular use by the business and the replacement cost is thus the
relevant cost

Question 2
Answer : D

Labour is in short supply so there is an opportunity cost. The contribution from

Contract Z will stillbe earned but will be delayed. The relevant cost is therefore the
wages earned plus the penalty fee.

(15 X 200 ) + ( 1,000) = 4,000

Question 3
Answer: B

If the margin of safety budgeted in period 3 is 21.015 %, then the breakeven

number of units inthe period is:

6570 –( 6570 X 21.015 % ) = 5, 189 units

At this level, contribution is equal to the level of

fixed costs.Contribution at this volume is:

5,189 X 35 % X 72 = 130, 763

So fixed costs are 130 ,763 ( nearest to 131,00 )

 Question 4
Answer: A

Question 5
Answer: C

Replacement material cost saved (4kg @ R 5) 20.00 �

�
Less further processing cost (R0.90 * 5kg) (4.50) �
�
Value of M in current use, for each unit made 15.50

Therefore opportunity cost of using M on the job being tendered for = 15.50 /5 = R3.1 per
kg