Question Tag: Relevant Costs

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  • 20 Marks

MA – Mar 2024 – L2 – Q5 – Relevant cost and revenue | Decision making techniques

This question determines the optimal units for in-house production versus outsourcing based on machine hour constraints and relevant cost analysis.

Hwerema Technologies produces various components for telecom companies. The demand for these components is increasing. However, Hwerema Technologies’ production facility is restricted to 50,000 machine hours. Therefore, the company is considering whether to import certain components to make up for the shortfall in production to meet market demand. In this respect, the following information has been gathered:

Factory overheads include fixed overheads estimated at GH¢1.50 per machine hour.

Required:
a) Determine the optimal units to be produced in-house and units to be imported. (16 marks)
b) State FOUR (4) qualitative considerations relevant to make-or-buy decisions. (4 marks)

a) Optimal decision

b)

Non-financial considerations relevant to make or buy decisions

Risk of outsourcing works:

  • Suppliers may produce items to a lower standard of quality.
  • The supplier may fail to meet delivery date and the buyer may depend on the
    supplier to commit onward delivery to its buyer. In case of buying of a component,
    production process of the end-product may be held up by a lack of component.

Benefits of outsourcing work:

  •  Outsourcing work will enable the management to focus all its efforts on those
    aspects of operation the entity does best.
  • The external supplier may have specialist expertise which enables it to provide
    outsourced products more efficiently and at a cheaper price.
  • 12 Marks

MA – May 2018 – L2 – Q4a – Relevant Cost and Revenue

Evaluate whether to organize a beauty pageant in-house or outsource to a third party using cost analysis.

PieceJoz FM, a media organization, is considering hosting a two-day beauty pageant in June 2018. The show will be expensive to run and promote. There will be three cash prizes on offer for the pageant, namely:

  • 1st Place – GH¢5,000
  • 2nd Place = GH¢2,000
  • 3rd Place = GH¢1,000.

Other costs will include:

  • Three judges of the show will each be paid GH¢400 per day plus a one-off travel expense allowance of GH¢150.
  • Promotional costs of GH¢3,000 have been spent to date. A further GH¢1,000 per month will have to be incurred for the five months leading up to the pageant and GH¢4,000 in the month of the show.
  • Utility costs incurred each day of the pageant are estimated to follow the function GH¢200 + 5X where X is the number of contestants performing. The council expects 30 contestants per day.
  • Stocks of wood and steel to construct the stage. 400 metres of wood already in stock will be used. This originally cost GH¢20 per metre but will not be replaced. It was due to be sold to an employee at a price of GH¢8 per metre. 60 metres of steel that originally cost GH¢18 per metre is to be used. Steel has a scrap value of GH¢10 per metre. This steel will have to be replaced. The market price of steel has increased to GH¢15 per metre.
  • 140 labour hours to build the stage. Currently, PieceJoz FM maintenance employees are paid GH¢600 each, plus 20% employers’ costs for a 40-hour week. Two such employees will be idle for the week required to build the stage. The remaining labour will be hired in at a casual rate of GH¢10 per hour.

PieceJoz FM expects that:

  • 1,000 people will attend the beauty pageant on the first day and 2,000 on the final day.
  • Daily tickets will sell at GH¢12 per adult ticket and GH¢5 per child ticket. It is expected that ticket sales will be 40% children and 60% adult.
  • An event organizer called Magic Media has submitted a proposal to organize this program on behalf of PieceJoz FM at a fee of GH¢13,100 including utility cost of GH¢900.

Required:
a) Using the information above, advise, from a financial perspective, whether management of PieceJoz FM should organize the beauty pageant or outsource it to Magic Media.

Using Incremental Approach:

Expense GH¢
Promotion costs (GH¢1,000 x 5 months) 5,000
Month of show (Promotion) 4,000
Utility costs (2(200+30(5)) 700
Wood (400 @GH¢8) 3,200
Steel 60 @ GH¢15 900
Labour (140-80)GH¢10 600
Total 14,400
Less Outsource (13,100)
Net Gain 1,300

Using the Total Approach:

In House Outsource
GH¢ GH¢
Award Prizes (GH¢5000+GH¢2000+GH¢1000) 8,000
Judges (3(GH¢400(2 days)+ 3(150) 2,850
Promotion (GH¢1000x 5months) + GH¢4000 9,000
Utility costs (2(200+30(5)) 700
Wood (400 @ GH¢8) 3,200
Steel 60 @ GH¢15 900
Labour(140-80)GH¢10 600
Hiring fees –
Idle labour cost (6002 + 2(0.2600)) 1,440
Total 26,690

Decision:
Net Gain: GH¢1,300 when outsourced. It will therefore be prudent from a financial perspective to outsource.

  • 3 Marks

MA – Nov 2016 – L2 – Q3b – Relevant cost and revenue

Explain the concept of relevant costs and their importance in decision-making processes.

The use of relevant information is key to managerial success. Describe relevant costs to your newly appointed Managing Director who will be negotiating a new contract. (3 marks)

Relevant Costs:

Relevant costs are future cash flows that will occur as a direct consequence of a decision. These costs must satisfy the following criteria:

  1. Future Costs: They must be costs that will be incurred in the future. Past costs, also known as sunk costs, are not relevant.
  2. Cash Flows: They must involve cash flows, meaning they result in an actual financial outflow or inflow.
  3. Direct Consequence of the Decision: They must arise directly from the decision being considered. Costs that will be incurred regardless of the decision are not relevant.

Sunk costs and committed costs are not considered relevant costs in decision-making.

(Total: 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)
  • 20 Marks

IMAC – MAY 2021 – L1 – Q3 – Relevant Cost and Revenue

Identifying relevant and irrelevant costs for a construction contract, and qualities and uses of management accounting information.

a) Kwame Adjei has been invited to bid for a contract to construct a place of convenience for a school at Gorlu in the Upper East Region. He has estimated the following expenses to be incurred to execute the contract.

  • Cost of concrete mixer bought at GH¢70,000 three years ago, has a written down value of GH¢52,000.
  • Stones bought six months ago at GH¢1,800 per trip currently sells at GH¢2,200 per trip. The contractor constantly uses the stones.
  • 200 bags of cement bought three months ago at GH¢40 per bag, currently sells at GH¢45 per bag.
  • Sand to be bought at GH¢900 per trip.
  • Each mason is to be paid GH¢80 per day.
  • 600 pieces of 5” blocks sells at GH¢3 per piece.

Required: i) Identify and explain TWO (2) costs that cannot be used in bidding for the contract. (4 marks)

ii) Identify and explain THREE (3) costs that can be used to bid for the contract. (6 marks)

b) Outline FIVE (5) qualities of good management accounting information system. (5 marks)

c) State and explain FIVE (5) uses of costs and management accounting information to a profit-making organisation. (5 marks)

a) i) Irrelevant costs:

  1. Cost of the concrete mixer of GH¢70,000 (Sunk cost)
  2. Written down value of concrete mixer GH¢52,000 (Sunk cost)
  3. Purchase price of stones GH¢1,800 (Historical cost)
  4. Purchase price of cement GH¢40 per bag (Historical cost)

ii) Relevant costs:

  1. Replacement cost of stones GH¢2,200 per trip (Current cost)
  2. Replacement cost of cement GH¢45 per bag (Current cost)
  3. Cost of sand GH¢900 per trip (Future cost)
  4. Cost of masons GH¢80 per day (Future cost)
  5. Cost of 600 pieces of 5” blocks GH¢3 per piece (Future cost)

b) Qualities of good management accounting information system:

  1. Completeness: Includes all necessary information.
  2. Understandability: Easily understood by users.
  3. Relevance: Pertinent to specific decisions.
  4. Reliability: Accurate and not misleading.
  5. Comparability: Prepared consistently for comparison.

c) Uses of costs and management accounting information:

  1. Ascertaining production cost per unit.
  2. Determining product selling price.
  3. Controlling and managing costs.
  4. Assessing profitability by division, activity, or unit.
  5. Identifying inefficiencies and wastages in production.
  6. Presenting relevant data for decision-making.
  7. Estimating future costs.
  • 20 Marks

IMAC – MAY 2021 – L1 – Q2 – Budgeting | Cost and Cost Behaviour | Relevant Cost and Revenue

QR activity-based budgeting system for products Q and R, and working capital calculation for a company.

a) QR uses an activity based budgeting (ABB) system to budget product cost. It manufactures two products, product Q and product R. The budget details for these two products for the forthcoming period are as follows:

Product Q Product R
Budgeted production (units) 80,000 120,000
Number of machine setups per batch 4 3
Batch size (Units) 5,000 4,000

The total budget cost of setting up the machine is GH¢74,400.

Required: i) State and explain THREE (3) objectives of budgeting. (6 marks)

ii) Calculate the budgeted machine setup cost per unit of product Q and R. (5 marks)

iii) State THREE (3) benefits and TWO (2) limitations of using an activity-based budgeting system. (5 marks)

b) A company has annual sales revenues of GH¢30 million and the following working capital periods:

Period Months
Inventory conversion period 2.5
Accounts receivable collection period 2.0
Accounts payable payment period 1.5

Production costs represent 70% of sales revenue.

Required: Calculate the total amount held in working capital excluding cash and cash equivalents. (4 marks)

a) i) Objectives of a budgetary control system:

  1. To compel planning: Budgeting ensures that managers plan for the future by producing detailed plans to implement the company’s long-term goals.
  2. To coordinate activities: Budgeting aligns the activities of different departments into a common plan, ensuring efficient resource allocation and scaling production based on anticipated changes.
  3. To communicate activities: Budgets formalize management expectations and facilitate communication between different departments.

ii) Calculation of budgeted machine setup cost per unit:

  • Number of batches for Product Q = 80,000 / 5,000 = 16
  • Number of batches for Product R = 120,000 / 4,000 = 30
  • Machine setups per batch: Product Q = 4, Product R = 3
  • Total number of setups: Product Q = 64, Product R = 90, Total = 154
  • Budgeted cost per setup = GH¢74,400 / 154 = GH¢483.12Budgeted cost per unit:
    • Product Q: (64 setups x GH¢483.12) / 80,000 units = GH¢0.39 per unit
    • Product R: (90 setups x GH¢483.12) / 120,000 units = GH¢0.36 per unit

    iii) Benefits of Activity-Based Budgeting:

    1. Clear cost-activity linkage.
    2. Better resource allocation.
    3. Enhanced capacity utilization review.

    Limitations:

    1. Time-consuming and resource-intensive.
    2. Requires expert team and sophisticated software.

    b) Working Capital Calculation:

    • Inventory: (GH¢30m x 0.7 x 2.5) / 12 = GH¢4.375m
    • Accounts receivable: (GH¢30m x 2) / 12 = GH¢5m
    • Accounts payable: (GH¢30m x 0.7 x 1.5) / 12 = GH¢2.625m
    • Total working capital = GH¢4.375m + GH¢5m – GH¢2.625m = GH¢6.75m

     

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