Question Tag: Fixed Costs

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  • 1 Marks

MI – May 2016 – L1 – SA – Q11 – Cost-Volume-Profit Analysis

Calculate the number of units required to break even given the fixed costs, sales price, and marginal cost.

A company manufactures a single product with a sales price of N1,000 and a marginal cost of N650. If the fixed cost is N685,300 per annum, then the number of units required to Break Even is:

A. 1,950
B. 1,955
C. 1,958
D. 1,985
E. 1,988

Answer: C

Explanation:
The break-even point in units is calculated using the formula:

Break-Even Point = Fixed Costs/ (Sales Price−Marginal Cost)

Substitute the given values:

Break-Even Point = ≈1,958 units

Therefore, the number of units required to break even is 1,958.

  • 1 Marks

MI – May 2016 – L1 – SA – Q4 – Cost-Volume-Profit (CVP) Analysis

Identify the conditions under which total contributions equal units sold multiplied by contribution per unit.

The formula which states that total contributions equal units of sales multiplied by contribution per unit is correct if the selling price:

A. And fixed cost are constant
B. And variable cost are constant
C. Varies and variable cost is constant
D. Varies and fixed cost is constant
E. And variable cost vary

Answer: B

Explanation:

The correct answer is B (And variable cost are constant). The formula for total contribution is given as:

Total Contribution =

This formula is valid only if the contribution per unit remains constant, which means that both the selling price and the variable cost per unit must remain unchanged. If either the selling price or the variable cost varies, the contribution per unit would change, making the formula invalid.

  • 1 Marks

MI – May 2024 – L1 – SA – Q6 – Costing Techniques

Calculates the fixed cost based on total cost and activity levels.

The following data were extracted from UVW Limited for a single product V: Activity (units) Total Cost (N) 144,000 3,624,000 842,000 12,000,000 Calculate the value of fixed cost.

A. N8,376,000
B. N6,200,000
C. N3,264,000
D. N1,896,500
E. N1,896,000

Answer: E. N1,896,000

Explanation: The fixed cost is calculated using the high-low method to determine the variable and fixed components. The variable cost per unit is first identified by dividing the difference in total costs by the difference in activity levels. Once the variable cost is known, it is used to determine the fixed cost by subtracting the total variable cost from the total cost at either activity level.

  • 10 Marks

AFM – May 2019 – L3 – Q2b – International investment and financing decisions

Calculate the NPV for a multinational company planning to set up a subsidiary in Ghana and provide a recommendation for management.

A Multinational Company (MNC) is planning to set up a subsidiary company in Ghana (where hitherto it was exporting) in view of growing demand for its product and competition from other MNCs. The initial project cost (consisting of Plant and Machinery including installation) is estimated to be GH¢500 million. The net working capital requirements are estimated at GH¢50 million. The company follows the straight-line method of depreciation. Presently, the company is exporting two million units every year at a unit price of GH¢80, with variable costs per unit being GH¢40.

The Chief Finance Officer has estimated the following operating cost and other data in respect of the proposed project:
i) Variable operating cost will be GH¢20 per unit of production.
ii) Additional cash fixed cost will be GH¢30 million p.a. and the project’s share of allocated fixed cost will be GH¢3 million p.a. based on the principle of ability to share.
iii) Production capacity of the proposed project in Ghana will be 5 million units.
iv) Expected useful life of the proposed plant is five years with no salvage value.
v) Existing working capital investment for production & sale of two million units through exports was GH¢15 million.
vi) Exports of the product in the coming year will decrease to 1.5 million units if the company does not open a subsidiary in Ghana, due to competing MNCs setting up subsidiaries in Ghana.
vii) Applicable corporate income tax rate is 35%.
viii) Required rate of return for such a project is 12%.
ix) Assume that there will be no variations in the exchange rate of the two currencies and all profits will be repatriated, as there will be no withholding tax.

Required:
Calculate the Net Present Value (NPV) of the proposed project in Ghana and advise management.
(10 marks)


NPV = GH¢103.2m

An alternative financial Analysis whether to set up the manufacturing units in Ghana or not may be carried using NPV technique as follows:

  • 15 Marks

MA – Nov 2017 – L2 – Q4 – Cost-volume-profit (CVP) analysis

Analyze the profit statement for two complementary products and evaluate the impact of various proposals on profit optimization.

Zumah Ltd manufactures and sells two complementary products: Hyline and Glycerin in the ratio 3:2. The result for the just ended period showed the following:

Product Hyline Glycerin
Selling price (GH¢) 20 15
Contribution/sales ratio 60% 40%
Profit/ (loss) (GH¢) 97,200 (3,600)

Joint fixed costs of GH¢180,000 are apportioned in proportion to the number of units of each product sold.

The company is in the process of preparing the budget for the coming year and is desirous of improving the performance of Glycerin. Therefore, the following proposals are being considered for implementation:

  1. Increase the price of Glycerin by 25% in expectation that the quantity demanded will reduce by 10%; or
  2. Retool the production process, which will result in a reduction of joint fixed costs by 15% and an increase in variable costs of each product by 10%; or
  3. Introduce proposals 1 and 2.

Required:

a) Determine the units of each product sold, and hence, prepare the profit statement for the just ended period.
b) Advise the management of Zumah Ltd as to which proposal to implement with a view to optimizing profits.

a) Determination of units sold and profit statement for the just-ended period:

Units Sold:

Let the total units sold be X.

Product Hyline Glycerin
Contribution/unit (GH¢) 12 6
Contribution: 60% of GH¢20 (Hyline) 12X
Contribution: 40% of GH¢15 (Glycerin) 6X
Total Contribution (GH¢) 9.60X
Fixed Costs (GH¢) 180,000
Profit (GH¢) 93,600

To find the total units sold:

9.60X−180,000=93,6009.60X – 180,000 = 93,600

X=28,500 unitsX = 28,500 \text{ units}

Thus:

  • Hyline units = 17,100 (60% of 28,500)
  • Glycerin units = 11,400 (40% of 28,500)

Profit Statement:

Product Hyline Glycerin
Contribution (GH¢) 205,200 (17,100 units @ GH¢12) 68,400 (11,400 units @ GH¢6)
Total Contribution (GH¢) 273,600
Fixed Costs (GH¢) (180,000)
Profit (GH¢) 93,600

(7 marks)

b) Evaluation of proposals and recommendation:

Proposal 1: Increase the price of Glycerin by 25%

Product Hyline Glycerin
Selling price (GH¢) 20 18.75
Variable cost/unit (GH¢) (8) (11.25)
Contribution/unit (GH¢) 12 7.50

Profit Statement:

Product Hyline Glycerin
Contribution (GH¢) 184,680 (15,390 units @ GH¢12) 76,950 (10,260 units @ GH¢7.50)
Total Contribution (GH¢) 261,630
Fixed Costs (GH¢) (180,000)
Profit (GH¢) 81,630

(3 marks)

Proposal 2: Retool production to reduce joint fixed costs by 15% and increase variable costs by 10%

Product Hyline Glycerin
Selling price (GH¢) 20 15
Variable cost/unit (GH¢) (8.8) (9.9)
Contribution/unit (GH¢) 11.20 5.10

Profit Statement:

Product Hyline Glycerin
Contribution (GH¢) 191,520 (17,100 units @ GH¢11.20) 58,140 (11,400 units @ GH¢5.10)
Total Contribution (GH¢) 249,660
Fixed Costs (GH¢) (153,000) (180,000 x 0.85)
Profit (GH¢) 96,660

(3 marks)

Proposal 3: Implement both Proposals 1 and 2

Product Hyline Glycerin
Selling price (GH¢) 20 18.75
Variable cost/unit (GH¢) (8.8) (9.90)
Contribution/unit (GH¢) 11.20 8.85

Profit Statement:

Product Hyline Glycerin
Contribution (GH¢) 172,368 (15,390 units @ GH¢11.20) 90,801 (10,260 units @ GH¢8.85)
Total Contribution (GH¢) 263,169
Fixed Costs (GH¢) (153,000)
Profit (GH¢) 110,169

Recommendation:

Implementing Proposal 3, which combines both proposals, would yield the highest incremental profit of GH¢16,569 compared to the current profit level.

(2 marks)

(Total: 15 marks)

  • 20 Marks

MA – July 2023 – L2 – Q5 – Relevant cost and revenue, Decision making techniques

Calculate the minimum price for a special order using relevant costing principles, and discuss the relevance of fixed costs in decision-making scenarios.

You are the Management Accountant for Darkoah Publishing Ltd which has been asked to send a quotation for the production of a programme for the local village fair. The work would be carried out in addition to the normal work of the company. Because of existing commitments, employees would be required to work during weekends to complete the printing of the programme. A trainee accountant has produced the following cost estimate based upon the resources required as specified by the production manager:

You are aware that considerable publicity could be obtained for the company if you are able to win this order, and the price quoted must be very competitive.

The following notes are relevant to the cost estimate above: i) The paper to be used is currently in stock at a value of GH¢5,000. It is of an unusual colour and has not been used for some time. The replacement price of the paper is GH¢8,000, whilst the scrap value of what is in stock is GH¢2,500. The production manager does not foresee any alternative use for the paper if it is not used for the village fair programme.

ii) The inks required are not held in stock. They would have to be purchased in bulk at a cost of GH¢3,000. However, only 80% of the ink purchased would be used in printing the programme. No other use is foreseen for the remainder.

iii) Skilled direct labour is currently at full capacity, but additional labour can be hired. To accommodate the printing of the programmes, 50% of the time required would be worked at weekends, for which a premium of 25% above the normal hourly rate is paid. The normal hourly rate is GH¢4.00 per hour.

iv) Unskilled labour is presently under-utilised, and at present 200 hours per week are recorded as idle time. If the printing work is carried out at a weekend, 25 unskilled labour hours would have to occur at this time, but the employees concerned would be given two hours’ time off (for which they would be paid) in lieu of each hour worked.

v) Variable overhead represents the cost of operating the printing press and binding machines.

vi) When not being used by the company, the printing press is hired to outside companies for GH¢6.00 per hour. This earns a contribution of GH¢3.00 per hour. There is unlimited demand for this facility.

vii) Fixed production costs are those incurred by and absorbed into production, using an hourly rate based on budgeted activity.

viii) The cost of the estimating department represents time that has already been incurred during discussions with the village fair committee concerning the printing of its programme.

Required: a) Prepare a revised cost estimate using a relevant cash flow approach, showing clearly the minimum price that the company should accept for the order. Give reasons for each resource valuation in your cost estimate. (17 marks)

b) Briefly discuss the statement “fixed costs are never relevant for decision making scenarios”.

(3 marks)

 

  1. Book value is irrelevant because it is a sunk cost; as there is no other use, replacement would not occur so the opportunity cost or scrap sale proceeds is relevant value.
  2. Since this involves a future cost if the work is undertaken, the purchase price should be used. Since the remaining stock has no foreseeable use it has no value so the entire purchase costs is used.
  3. Since skilled labour would work over the weekends, the full cost is relevant; 125 hours @ GH¢4/hr = GH¢500 125 hours @ GH¢5/hr = GH¢625
  4. The weekend work results in 50 hours’ time off in lieu- this, with the 75 other hours worked , totals 125 hours, which is less than the 200 hours of idle time which are already being paid for; thus there is no incremental cost.
  5. This is a future cost which will be incurred if the work is undertaken.
  6. The depreciation is a past cost and should be ignored, however the use of the press has an opportunity cost. If this work is undertaken, the press is not available for hire. The opportunity cost is the contribution which would be earned from hiring: 200 hours @ (GH¢6- GH¢3)
  7. As these costs are unaffected by the decision they should be ignored
  8. These costs are pasts or sunk costs and should be ignored.

b) Generally, the classification of costs as fixed or variable identifies those costs which changes in total when activity changes (variable costs) and those whose total remains constant (fixed costs).

Relevant costs are those which are affected by a decision, and since most decisions affect activity levels, variable costs (which change when activity changes) can be seen to be relevant costs.

However, it does not automatically follow that fixed costs are not relevant. Some fixed costs may be specific to product or department and therefore may be avoidable. For example, a decision to discontinue a product will cause the product specific cost to be saved.

The general notion that fixed costs are not relevant is therefore incorrect thus each decision must be considered individually. There would be circumstances when fixed cost must be considered relevant, due to their avoidability.

  • 5 Marks

MA – May 2019 – L2 – Q2a – Cost-volume-profit (CVP) analysis

Determine the total variable cost per unit, total fixed overhead, and express the cost function based on given data.

Komosa Ltd is reviewing the selling price of its product for the coming year. A forecast of the annual costs that would be incurred by Komosa Ltd in respect of this product at differing activity levels is as follows:

Annual production (unit) 100,000 160,000 200,000
Direct materials (GH¢000) 200 320 400
Direct labour (GH¢000) 600 960 1,200
Overhead (GH¢000) 880 1,228 1,460

The cost behavior represented in the above forecast will apply for the whole range of output up to 300,000 units per annum of this product.

Required:
i) Calculate the total variable cost per unit and total fixed overhead. (4 marks)
ii) State the total cost function. (1 mark)

i) Total Variable Cost per Unit and Total Fixed Overhead:

  • Material Cost:
    GH¢ 200,000 / 100,000 units = GH¢ 2 per unit
  • Labour Cost:
    GH¢ 600,000 / 100,000 units = GH¢ 6 per unit
  • Variable overhead cost:
    Using high-low method:
    (GH¢ 1,460,000 – GH¢ 880,000) / (200,000 units – 100,000 units) = GH¢ 5.8 per unit
  • Total variable cost per unit:
    GH¢ 2 (materials) + GH¢ 6 (labour) + GH¢ 5.8 (overhead) = GH¢ 13.8 per unit
  • Fixed cost:
    Using the cost at 200,000 units:
    Total cost = GH¢ 1,460,000
    Variable cost = 200,000 units * GH¢ 13.8 = GH¢ 1,380,000
    Fixed cost = Total cost – Variable cost = GH¢ 1,460,000 – GH¢ 1,380,000 = GH¢ 300,000

(4 marks)

ii) Total Cost Function:

Total cost function: Y = GH¢ 300,000 + GH¢ 13.8x

  • 20 Marks

MA – Nov 2015 – L2 – Q3 – Decision making techniques | Relevant cost and revenue

Analyze whether to discontinue Double beds and whether to accept a new order for all bed sizes.

Obonku Limited produces Single, Double, and King-size beds for sale to hotels in West Africa. Its manufacturing plant is located in Tema and is currently operating at 100% capacity. Below is the annual output and sales for each product and the associated costs:

Product Single bed Double bed King Size bed
Units sold 5,000 units 3,500 units 4,000 units
Sales (GHS) 2,500,000 2,800,000 3,800,000
Costs:
Material cost 750,000 1,400,000 1,520,000
Labour costs 600,000 1,050,000 1,200,000
Manufacturing O’head 200,000 650,000 300,000
Administrative cost 200,000 100,000 200,000
Total cost 1,750,000 3,200,000 3,220,000
Profit/Loss 750,000 (400,000) 580,000

The Director of Obonku is of the view that the Double bed product line is not doing well and should not be produced any longer. The following additional information has been provided:

  1. 40% of the labor cost for all bed types are fixed costs.
  2. 50% of the manufacturing overhead is variable for all products.
  3. 80% of the administrative cost is fixed.

Alom Hotel Limited, situated in Elmina, has requested 80 units of each bed and is ready to procure them at the current prices. Obonku Ltd can only produce more if they increase production capacity in the short term at an additional cost of GHS 80,000.

Assuming that costs and prices remain the same, you are required to:

a) Advise whether the company should shut down the production of Double beds. (10 marks)
b) Should the company accept the new order assuming Double beds will still be produced? (10 marks)

a) Calculation of Contribution that Will Be Lost if Double Bed Production Ceases:

Item GHS
Potential loss of revenue 2,800,000
Less:
– Material cost savings 1,400,000
– Variable labor cost savings (60% of 1,050,000) 630,000
– Variable manufacturing overhead savings (50% of 650,000) 325,000
– Variable administrative cost savings (20% of 100,000) 20,000
Total potential savings 2,375,000
Potential contribution to fixed costs that will be lost 425,000

Conclusion:
A contribution of GHS 425,000 will be lost if Double bed production ceases. This loss in contribution will result in a decline in profit by the same amount since fixed costs will still be incurred. Therefore, the company should continue the production of Double beds.

 

ALTERNATIVELY

 

In this case profit reduced from GHC 930,000 to GHC 505,000 a reduction of GHC425, 000

 

b) Income Statement for 80 Units of Each Product:

Item Single bed Double bed King Size bed Total
Sales (GHS) 40,000 64,000 76,000 180,000
Material Cost 12,000 32,000 30,400 74,400
Labor Cost 5,760 14,400 14,400 34,560
Manufacturing O’head 1,600 7,428.57 3,000 12,028.57
Administrative Cost 640 457.14 800 1,897.14
Total Variable Cost 20,000 54,285.71 48,600 122,885.71
Contribution 20,000 9,714.29 27,400 57,114.29
Less Incremental Fixed Costs 80,000
Loss on Order 22,885.71

Conclusion:
The order should be rejected because it will result in an incremental loss of GHS 22,885.71 unless Alom Hotel Limited is willing to pay a higher price to cover the additional costs associated with producing the extra units.

  • 20 Marks

FM – July 2023 – L2 – Q4 – Discounted cash flow | Introduction to Investment Appraisal

Compute the Net Present Value (NPV) of an investment in the cement industry and advise whether it should be undertaken, and discuss the importance of secondary markets.

a) Ntam Ghana Ltd has identified an opportunity in the Cement Industry in Ghana and decided to set up a plant to produce cement in Ghana under the brand name “Kong” in 50kg per bag. This new product has performed very well in the marketing trials carried out by the Research and Development division of the company.

The following information regarding the investment has been prepared by the Finance Manager:

  • Initial Investment (Plant Cost) = GH¢50 million
  • Working capital (At the beginning) = GH¢5 million
  • Selling price per bag (current price terms) = GH¢50
  • Variable cost per bag (current price terms) = GH¢25
  • Fixed operating cost per year (current year terms) = GH¢5 million
  • Annual Demand (current year terms) = 500,000 bags

The table below represents the forecast increases for the next 5 years:

Year Selling Price Variable Cost Fixed Operating Cost Annual Demand
1 15% 10% 10% 10%
2 18% 15% 15% 14%
3 20% 15% 15% 16%
4 15% 12% 20% 15%
5 17% 13% 18% 14%

The initial investment plant is depreciated at 20% per annum on a straight-line basis with a residual value of GH¢5 million at the end of the period. Prior discussions with Ghana Revenue Authority confirm approval for an allowable capital allowance rate on the above investment at 20% per annum. The company uses 22% as its internal cost of capital, and the Corporate tax rate for the company is 25%.

Required:
Compute the Net Present Value (NPV) and advise whether the investment should be undertaken. (15 marks)

b) Investors in the Financial Markets have the option of trading on the primary market or secondary market or both. As a professional investor in the Financial Markets, you are required to:

i) Distinguish between the Primary market and Secondary market. (2 marks)
ii) State THREE (3) reasons the secondary market is more important to investors. (3 marks)

a) Net Present Value (NPV) Calculation and Advice:

  1. Forecasted Cash Flows:

    The initial investment is depreciated 20% per annum and on straight line basis with
    a scrap value 5 million and the tax rate for Allowable capital allowance is 25%.
  2. Present Value of Cash Flows:


    NPV = (55,000,000) + 8,606,850 + 9,768,555 + 14,246,064 + 13,040,273 + 18,476,514 = GH¢9,138,256

Decision:
The NPV for the project is positive and therefore the project should be undertaken. (15 marks)

b) Primary Market vs. Secondary Market:

i) Distinction Between Primary Market and Secondary Market:

  • Primary Market: The financial market where new securities or financial instruments are issued and sold to investors for the first time. Companies raise fresh capital by issuing new shares or bonds in this market.
  • Secondary Market: The financial market where existing securities or financial instruments are traded among investors. No new capital is raised by the issuing company as the transactions are between investors.

(2 marks)

ii) Three Reasons Why the Secondary Market is More Important to Investors:

  • Liquidity: Secondary markets provide liquidity to investors by allowing them to buy and sell securities easily.
  • Price Discovery: Through the continuous trading in the secondary market, the fair value of securities is established based on supply and demand.
  • Benchmark for Valuation: The prices in the secondary market serve as a benchmark for the valuation of securities and new issues in the primary market.

(3 marks)

  • 20 Marks

IMAC – NOV 2021 – L1 – Q3 – Cost and Cost Behaviour | Marginal Costing and Absorption Costing

Explanation of different cost classifications and advantages of marginal costing over absorption costing.

a) Costs may be classified in various ways according to their nature and the information needs of management.

Required:
Explain the following pairs of costs:
i) Direct and Indirect Costs (3 marks)
ii) Fixed and Variable Costs (3 marks)
iii) Controllable and Non-controllable Costs (3 marks)
iv) Production and Non-production Costs (3 marks)
v) Relevant and Irrelevant costs (3 marks)

b) QQQ Ltd has been reporting using an absorption costing technique. However, at a management retreat attended by the Cost and Management Accountant, they discussed the information usefulness of marginal costing reports for short-term decision making extensively.

Required:
Outline FIVE (5) advantages of a marginal costing system of reporting compared to absorption costing system for consideration by the management of QQQ Ltd. (5 marks)

 

a) i) Direct and Indirect Costs:

  • Direct costs can be directly identified with a specific cost unit or cost center. Examples include direct materials, direct labour, and direct expenses. The total of direct costs is known as the prime cost.
  • Indirect costs cannot be directly identified with a specific cost unit or cost center. Examples include indirect materials, indirect labour, and indirect expenses. The total of indirect costs is known as overheads.

ii) Fixed and Variable Costs:

  • Fixed costs are incurred for an accounting period and remain constant in total within certain activity levels.
  • Variable costs vary in total in direct proportion with the level of activity.

iii) Controllable and Non-controllable Costs:

  • Controllable costs can be influenced by a given level of managerial authority and are within the domain of that managerial authority and responsibility.
  • Non-controllable costs cannot be influenced by a given level of managerial authority and are usually determined by higher levels of managerial authority and shared among lower levels.

iv) Production and Non-production Costs:

  • Production costs relate to the manufacture of a product or the provision of a service and are included in the cost of sales. Examples include direct materials, direct labour, direct expenses, and production overheads.
  • Non-production costs are not directly associated with the production of the business’s output and are charged to the statement of profit or loss as expenses for the period they are incurred. Examples include administrative, selling, and finance costs.

v) Relevant and Irrelevant Costs:

  • Relevant costs make a difference in decision making, are generally incremental, futuristic in nature, and involve cash outlays.
  • Irrelevant costs do not vary with a given decision under consideration and do not impact the decision. They are usually sunk or past costs that have already been incurred or fixed costs that must be incurred regardless of the decision.

b) Advantages of marginal costing over absorption costing:

  1. It discourages stock build-up.
  2. There is no under or over absorption of overheads, and hence no adjustment is required in the statement of profit or loss.
  3. Fixed costs are treated as period costs and charged in full to the period under consideration.
  4. Marginal costing is useful in short-term decision-making processes.
  5. It is simple to operate.
  6. Separating costs into fixed and variable facilitates cost control. (Any 5 points @ 1 mark each = 5 marks)

Take control of your business data with insight and in-depth understanding by taking this course. 

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