Section A

Here we take a look at TWO Section A questions which proved to be particularly challenging for
candidates.

Example 1

A company grows different types of tea leaves and blends them together. The tea leaves are
picked by hand because too many leaves were damaged and wasted when picking machines were
used. The tea leaves are then dried and processed and any waste produced is recycled.

The company regularly tests its tea for contaminants, in line with food safety legislation. It recently
identified that one tea plantation contained high levels of contaminated soil after the use of a new
pesticide.

Identify, by selecting the relevant box in the table below, the environmental cost
classification of each of the following costs.
Cost incurred to clean
contaminated soil PREVENTION DETECTION INTERNAL EXTERNAL
FAILURE FAILURE
Staff cost for picking
leaves by hand PREVENTION DETECTION INTERNAL EXTERNAL

FAILURE FAILURE
Recycling waste cost
PREVENTION DETECTION INTERNAL EXTERNAL
FAILURE FAILURE
Cost incurred for testing
tea for contaminants PREVENTION DETECTION INTERNAL EXTERNAL
FAILURE FAILURE

Examiner’s report – PM September 2019

 What does this test?

 The classification of costs to environment cost categories.

What is the correct answer?

 The cost incurred to clean contaminated soil is an external failure cost. This is because this
cost has arisen as a result of discharging contaminants into the external environment.
 The staff cost for picking leaves by hand is a prevention cost. The picking machines
damage too many leaves which causes waste, therefore handpicking leaves prevents this
wastage.
 The recycling waste cost is an internal failure cost because it is waste which is created by
the business but is dealt with by the company so that it is not released into the
environment.
 The cost incurred for testing tea for contaminants is a detection cost as testing the tea
ensures that the company is compliant with legislation.

Example 2

A company needs 400kg of material Z to fulfil a customer order in one month’s time.

It currently has no material Z in inventory. The current purchase price of material Z is $20 per kg
and this is expected to rise to $24 per kg in one month’s time. Material Z is perishable and normally
20% of stored material is lost per month.

The company expects to have 200kg of material Y in inventory in one month’s time with no
alternative use other than to sell it for scrap for $18 per kg. The 200kg of material Y could be
converted into 200kg of material Z in one month’s time at a cost of $4 per kg. Material Y is not
perishable.

What is the total relevant cost of material Z to fulfil the customer order?

What does this test?

 The calculation of relevant costs for a decision.

What is the correct answer?

 The correct answer is $9,200

 The first step is to determine what the company’s options are and the cost of those options.
They can do the following:

1) Buy material Z now and store it for one month but the loss would need accounting for =
$20/0.8 = $25 per kg
2) Buy material Z in one month’s time = $24 per kg
3) Convert material Y into material Z in one month’s time = $18 + $4 = $22

 Based on the cost of the options the company would prefer to convert material Y into 200kg of
material Z and then for the remaining 200kg of material Z required for the order, the company
would buy it in one month’s time.

 The total relevant cost is (200kg x $22) + (200kg x $24) = $9,200

 Example 1

Which of the following statements about graphical linear programming with the objective of
maximising profit is true?

(1) If a resource constraint line does not pass through the optimum point on the graph, then the
shadow price of that resource is zero
(2) The shadow price is the maximum amount a company should pay for one more unit of a
scarce resource
(3) The slope or gradient of the objective function depends on the amount of resources
available to the organisation

A 1 only
B 1 and 2 only
C 1, 2 and 3
D 2 and 3 only

What does this test?

 The interpretation of linear programming graphs in limiting factor situations.

What is the correct answer?

 The correct answer is A

 If a resource constraint does not pass through the optimum point on the graph then its shadow
price is zero, as adding another unit of that resource will not change the optimum solution nor
the contribution earned.
 The shadow price is the maximum extra a company would pay for one more unit of scarce
resource on top of its existing cost.
 The slope or gradient of the objective function depends on the contribution earned by each
product.

Example 2

Maribela Co makes a range of products and sells them online. It uses activity-based costing to
allocate costs to its products. Its two most successful products are ABC1 and ABC2 but it makes
approximately 20 other products in its factory. The company processes and despatches 12 million
orders each year over its entire product range.

Information relating to ABC1 and ABC2 is as follows:

ABC1 ABC2
Sales volume (units) 10 million 2.4 million
Average order size (units) 8 1.2

The total packing and despatching cost pool for Maribela Co is $18 million each year.
 What is the packing and despatching cost per unit of ABC1 (to two decimal places)?

A $5.54
B $0.69
C $1.50
D $0.19

What does this test?

 The calculation of activity-based costs

What is the correct answer?

 The correct answer is D

 The first step is to calculate the cost per unit of cost driver. In this question, the cost driver for
the packing and despatching cost pool is the number of orders. Therefore $18 million/12 million
orders = $1.50 per order.
 It should then be noted that the question asked for the packing and despatching cost per unit of
ABC1. There are 8 units of ABC1 in an order therefore the cost per unit is $1.50/8 units =
$0.1875, which to two decimal places is $0.19.
 If a candidate selected A then they divided $18 million by the total number of orders required for
ABC1 and ABC2 only.
 If a candidate selected B then they divided $18 million by the total number of orders required for
ABC1 and ABC2 only and then divided by 8 units.
 If a candidate selected C then they correctly calculated the cost per unit of cost driver but forgot
to divide by the order size for ABC1.

Example 1

A company makes two products with the following characteristics:

Product X Product Y
Contribution to sales ratio 0.3 0.5
Selling price per unit $3.00 $4.80
Maximum demand 8,000 units 3,000 units

Fixed costs are $9,000.

What is the minimum revenue required for production to break even?

A $20,400
B $25,800
C $29,400
D $24,000
What does this test?

 Cost-volume-profit analysis

What is the correct answer?

 The correct answer is A

 To determine the minimum revenue required to break even i.e. the break-even revenue, the
break-even point for each product needs to be calculated. To do that the contribution per
unit for each product needs to be established.
 Product X Product Y
Contribution per unit (C/S ratio x 0.3 x $3.00 = $0.90 0.5 x $4.80 = $2.40
selling price)
Break-even point (Fixed costs $9,000/$0.90 = 10,000 $9,000/$2.40 = 3,750 units
/contribution per unit) units

Maximum demand 8,000 units 3,000 units

From the table above, either 10,000 units of product X or 3,750 units of product Y need to be
produced to break-even. However, as there is a maximum demand for both products, the
break-even sales units cannot be achieved on either product. If the break-even point cannot be
achieved with only one of the products, then the combination of units of products X and Y to be
sold in order to break even needs to be determined.

To do this, the product with the highest contribution per unit would be produced first, up to its
maximum demand, to cover the fixed costs as quickly as possible. Product Y contributes $2.40
per unit, so it will be produced first, up to its maximum demand of 3,000 units, giving a total
contribution of (3,000 units x $2.40) $7,200.
Therefore sales of product Y would cover $7,200 of the fixed costs but there will be $1,800 of
fixed costs remaining, which need to be covered by sales of product X.

Production of product X will therefore be (remaining fixed costs/contribution per unit of product
X - $1,800/$0.90) = 2,000 units.

As the question asks for the minimum revenue (break-even revenue), the last step would be to
calculate the sales revenue from the production plan calculated above.

Product X sales revenue = 2,000 units x $3.00 = $6,000

Product Y sales revenue = 3,000 units x $ 4.80 = $14,400

The minimum sales revenue required to break even would therefore be $ 20,400.

 Selecting option B would have been arrived at if product X was produced first, followed by
product Y. If candidates took this approach then they could not have the ranked the
products on the basis of contribution per unit.

Product X’s contribution from sales, up to its maximum demand of 8,000 units, would be
(8,000 units x $0.90) $7,200, whereas the contribution required from product Y would be
$1,800 to cover the remaining fixed costs. 750 units ($1,800/$2.40) of product Y would
therefore have to be made.

Based on this production plan, the minimum sales revenue would be = product X (8,000
units x $3.00) + product Y (750 units x $4.80) = $25,800.

 Selecting option C would have been arrived at if candidates calculated the maximum sales
revenue and deducted the fixed costs from it as shown below:

Maximum sales revenue = (8,000 units x $3.00) + (3,000 units x $4.80) = $38,400
Less fixed cost ($9,000)
$29,400
 $29,400

 Selecting option D meant that candidates applied the weighted average method which was
not required.

Weighted average contribution per unit

= ($0.90 x 8,000 units) + ($2.40 x 3,000 units)/11,000 units = $1.30909 per unit

The break-even point was then calculated using the weighted average contribution per unit
= $9,000/$1.30909 = 6,875 units

To calculate the sales revenue, the weighted average selling price was applied to break-
even point:
= (($3.00 x 8,000 units) + ($4.80 x 3,000 units)/11,000 units) x 6,875 units = $24,000

Example 2

A company’s board of directors were recently embarrassed when a very unhappy junior human
resources employee emailed details of their salaries to the entire company.

An investigation revealed that the human resources director had lent his username and password
to the junior employee so that routine maintenance of the human resources database could be
conducted whilst the director was on vacation. During the director’s vacation, the junior employee
had used the director’s username and password to access the board’s salary records.

Which of the following controls could have helped to prevent this breach of confidential
information?

A Monitoring the database system logs on a daily basis to see what information is being
accessed
B Building levels of access into the database so that only senior staff have access to board
records
C Keeping all the human resource records for salaries on a separate server
D Having a policy of regularly updating the passwords required to access the system

What does this test?

 The procedures necessary to ensure the security of highly confidential information.

What is the correct answer?

 The correct answer is A

 Monitoring the usage and access logs on a regular basis would have revealed that the
human resource director’s account was being accessed whilst he was on vacation and that
confidential information was being looked at and copied. This would have enabled the
company to investigate immediately and the individual could have been identified sooner,
which could have prevented the sensitive information from being divulged to everyone in
the company.

 Selecting options B, C and D would have been ineffective in this instance. Even if certain
information was restricted to only director level, or that the information the director had
access to, was on a separate server, or that the director was prompted regularly to change
passwords; none of these controls would have helped as the director had shared his
confidential account details with the junior employee.
 Here we take a look at TWO Section A questions which proved to be particularly difficult for
candidates.

Example 1

Binny Co has annual sales of $960,000 and a current ratio of 3.2:1. All of its sales are for cash
and are priced at a mark-up on cost of 50%. The average cash balance is $40,000 and the
inventory turnover period is 90 days.

Assuming 360 days in a year, what is Binny Co’s quick ratio (acid test ratio)?

A 0.64
B 0.53
C 0.80
D 1.56

What does this test?

 The calculation of financial performance indicators (FPI) for liquidity.

What is the correct answer?

 The correct answer is A

 The quick ratio = (current assets – inventory)/current liabilities. To be able to calculate this
ratio, the value of inventory, current assets and current liabilities need to be established.
 To determine the value of inventory, the cost of sales value and the inventory turnover period
need to be used. First the cost of sales has to be calculated based on the mark-up on cost of
50%. The cost of sales will be 100/150 x $960,000 = $640,000. On that basis, the inventory
value can be calculated using the inventory turnover period as 90 days/360 days x $640,000 =
$160,000.
 The current ratio = current assets/current liabilities. In Binny Co, the current ratio is 3.2:1 and
the only current assets are inventory and cash balances as all sales are on cash basis.
 From the above information, the current liabilities can be calculated.
- Current assets = $160,000 (inventory) + $40,000 (cash balance) = $200,000
- Rearranging the formula for current ratio, the current liabilities = $200,000/3.2 = $62,500
 Now we have the inventory value, current assets and current liabilities, the quick ratio can be
calculated = ($200,000 - $160,000)/$62,500 = 0.64. Alternatively the quick ratio could have
been calculated by taking the cash balance only of $40,000 and dividing by the current
liabilities.
 Choosing option B, 0.53, would have been arrived at if the inventory value had been
calculated based on the sales value of $960,000. Inventory would be 90 days/360 days x
$960,000 = $240,000. This value would then have been used in the current ratio formula as
the current assets value (forgetting to add the cash balance) to arrive at the current liabilities
figure $240,000/3.2 = $75,000. The cash balance would then be used with the current
liabilities figure to calculate the quick ratio $40,000/$75,000 = 0.53.
 Choosing option C, 0.80 would be arrived at if the cost of sales is worked out based on a
margin rather than a mark-up. Cost of sales = 50/100 x $960,000 = $480,000 and inventory =
90 days/360 days x $480,000 = $120,000. Current liabilities will be ($120,000+ $40,000)/3.2 =
$50,000 and the quick ratio will be $40,000/$50,000 = 0.80.
 Choosing option D, 1.56 would be arrived at if all the value of inventory, current assets and
current liabilities were all calculated correctly and the inverse of the correct formula was used
i.e. current liabilities/(current assets - inventory) = $62,500/$40,000 = 1.56.
 Example 2

The following costs relate to management accounting information for Kite Co for April 20X8:

Cost $
Employee time spent filling in purchase requisitions 600
Use of barcodes and scanners to record inventory 200
Storage of sales information no longer needed 400
Time taken by staff to input data into production 900
system

What were the total direct data capture costs for Kite Co for April 20X8?
A $200
B $800
C $1,700
D $2,100

What does this test?

 The identification of direct data capture costs of management accounting information.

What is the correct answer?

 The correct answer is A

 In this question, candidates must able to identify the different types of costs associated with
management accounting information and how it is collected.
 Only the cost of the use of bar coding and scanners is a direct data capture cost therefore =
$200.

Example 1

Summary financial information for one of Damon Co’s divisions for the last year is shown below:
$’000
Revenue 18,000
Variable costs (9,600)
Divisional fixed operating costs (2,760)
Apportioned head office costs (2,160)
Interest charges (200)
Tax (700)
Net profit 2,580

The average value of the division’s total assets less current liabilities for the last year was $22.8m.

Damon Co assesses the return on investment of its divisions on the basis of controllable profit.

Based on this information, what is the division’s return on investment for the last year?

A 11.3%
B 15.3%
C 20.8%
D 24.7%
What does this test?

 The calculation of a division’s return on investment

What is the correct answer?

 The correct answer is D

 ROI is calculated as operating profit/capital employed. In this case, because the company measures
the ROI on controllable costs, the figure for operating profit should exclude the apportioned head
office costs.
 Therefore, ROI = ($18,000 - $9,600 - $2,760)/$22,800 = 24.7%
 Selecting option A, means that net profit was incorrectly used to calculate ROI
 Selecting option B, suggests that the operating profit figure was used without making an adjustment
for head office costs
 Selecting option C, means that only the head office costs were added back to net profit and not the
interest and tax figures ($2,580 + $2,160)/$22,800 = 20.8%

Example 2

Farry Co has recently decided to allow its employees to have unlimited access to the internet from their
workplace computers using the company network. The reason for this decision is to allow employees to use
external information so they can perform their duties more effectively.

Which of the following are direct costs of accessing external information for Farry Co?

(1) Monetary cost of download fees

(2) Time spent by employees using search engines
(3) Payment for additional network security

A 1 and 2 only
B 1 and 3 only
C 1, 2 and 3
D 2 only

What does this test?

 The limitations of using externally generated information

What is the correct answer?

 The correct answer is B

 The question requires the distinction between direct and indirect costs of information.
 The time spent searching and analysing information on the internet has a cost but is not easily
quantifiable and is often hidden amongst other costs and seen as sunk therefore it is indirect.
 The other two costs are easily identifiable with the decision and are quantifiable and so are direct
costs.
Example 1

Vibrant Paints Co manufactures and sells paints. Business Unit A of the company makes a paint
called Micra. Micra is made using three key materials: R, S and T.

At the end of period 1, a total material cost variance of $4,900 adverse was correctly recorded for
Micra.

The following information relates to Micra for period 1:

Material Standard cost per Actual cost per litre Actual usage (litres)
litre ($) ($)
R 63 62 1,900
S 50 51 2,800
T 45 48 1,300

The standard ratio of mixing material R, material S and material T is 30:50:20.

The material price variance for Micra has been correctly calculated as $4,800 adverse.

What is the total material yield variance for Micra for period 1?

A $700 favourable
B $800 adverse
C $800 favourable
D $900 adverse

What does this test?

 The calculation of material yield variance

What is the correct answer?

 The correct answer is A

 In order to get to the answer, the relationship between variances needed to be considered.
The total material cost variance ($4900 adverse) = Material price variance ($4800 adverse)
+ material usage variance. Therefore the material usage variance is the balancing figure of
$100 adverse. The material usage variance = material mix variance + material yield
variance. We now have to calculate the material mix variance (in order to replace in the
equation above) from the information given in the question as shown in the table below:

Material Standard Actual quantity Actual Variance Standard Variance

ratio in standard quantity in (Litres) cost per ($)
mix actual mix litre ($)
(AQSM) (AQAM)
R 30% 1,800 1,900 100 A 63 6,300 A
S 50% 3,000 2,800 200 F 50 10,000 F
T 20% 1,200 1,300 100 A 45 4,500 A
Total 6,000 6,000 0 800 A
 Therefore, the material mix variance is $800 adverse. As stated above, the material usage
variance ($100 adverse) = material mix variance ($800 adverse) + material yield variance.
Therefore the material yield is
$700 Favourable (balancing figure)
 Selecting option B, $800 Adverse is the material mix. This does not answer the question
and hence this is not the correct answer.
 Selecting option C, $800 Favourable is the material mix variance but the adverse variances
were incorrectly recorded as favourable and vice versa.
 Selecting option D meant if the material mix is incorrectly calculated as $800 favourable,
then we would get the material yield as $900 Adverse. Hence, this is not the correct
answer.

Example 2

Which of the following could lead to an increase in management bonus, without benefitting
the organisation?

(1) A manager holds on to heavily depreciated assets in order to avoid heavy investment in the
period
(2) A manager in a manufacturing division uses absorption costing and builds up high levels of
inventory
(3) A sales manager changes their fixed target to a relative target based on market share

A 1 and 2 only
B 1, 2 and 3
C 1 only
D 2 and 3 only

What does this test?

 The behavioural aspects of performance management.

What is the correct answer?

 The correct answer is A

 Statement 1: holding on to heavily depreciated assets gives a low figure for ‘capital
employed’ which, in turn, gives a higher figure for ROI which could lead to bonuses for
divisional managers. However, there are likely to be higher running costs for an old
machine, making the organisation less profitable than it might be. Low depreciation
charges may also hide this but cash flow would be affected.
 Statement 2: when a manufacturing division uses absorption costing, building high
inventory levels will result in a large proportion of production overheads being carried from
one period to the next in inventory. This increases the return figure benefiting the divisional
managers if these are linked to bonuses but would only benefit the company if those units
of inventory can be sold in the following period.
 Statement 3: this is useful for the organisation as whole - by setting a relative target on
market share when the market increases, then more sales are expected in absolute terms.
This adds controllability to the organisation, since the sales manager could not be held
responsible for a rise (or a fall) in the overall market. Since this target is outside of the
control of the divisional managers, it is more likely to benefit the organisation rather than
the divisional managers
Example 1

Log Co has an operating gearing ratio of 33.33%. Its sales are currently $100m and its operating
profit is $20m.

Operating gearing is calculated by dividing fixed costs by variable costs.

What will its operating profit be its sales increases by 15%?

A $27m
B $26m
C $23m
D $21m

What does this test?

 The calculation of operating profit

What is the correct answer?

 The correct answer is B

 In order to calculate the operating profit, the total cost must be calculated first. As sales are
$100m and profit is $20m, the total cost will be $80m. Given the operational gearing is
33.33%, the fixed cost to variable cost will be in the ratio of 1:3. The fixed cost can be
calculated as ¼ x $80m=$20m and the variable cost will be $60m. Contribution will be
$40m before the increase in sales. After the 15% increase in sales the new contribution will
be 1.15 x $40m= $46m and the new operating profit will be $46m - $20m (FC)= $26m
 Selecting option A calculates the fixed cost as $80m/3=$26.67m which gives the variable
cost of $53.33m and a contribution of $46.67m. A 15% increase on this is $7m, hence
$27m
 Selecting option C meant that existing operating profit was increased by 15%
 Selecting option D meant that an increase of 33.33% of 15%= 5% x $20m= $21m

Example 2
A bank has developed a new type of account called the Gold Account. Development and
advertising costs were $50,000.

At the start of each of the next four years, 1000 customers are expected to open a Gold Account
and to pay the bank $300 each year that they use it. Of the 1,000 customers who open a Gold
Account, 500 are expected to close the account after one year and 500 after two years.

The bank estimates it will cost $400 per customer to administer the Gold Account in the customer’s
first year reducing to $50 per customer in the second year.

Ignoring the time value of money, what is the lifecycle profit per customer of Gold Account?

A $8.33
B $25.00
C $12.50
D $16.67

What does this test?

 The calculation of a lifecycle profit in a service industry

What is the correct answer?

 The correct answer is C

 The account runs for 4 years

 Year 1 1000 new customers
Year 2 1000 new customers 500 from year 1
Year 3 1000 new customers 500 from year 2
Year 4 1000 new customers 500 from year 3
500 from year 4
Total 4000 2000

 From the above, since customers are joining every year for the 4 years there will be a total
of 4000 customers that will cost the bank $400 per customer in the first year and 2000
customers in total that will cost $50 per customer in the second year
 Calculation of profit over the life cycle will be as follows:
First year 4000 x ($300 -$400)
Second year 2000 x ($300 - $50)
Less the development and advertising costs ($50,000)
Total Profit $50,000
Divided by 4000 customers
Lifecycle profit per customer $12.50
 Selecting option A the total profit of $50,000 is divided by 6000 customers= $8.33
 Selecting option C the development and advertising costs has been omitted-$100,000
divided by 4000 customers= $25
 Selecting option D- combines both mistakes as above- $100,000 divided by 6000
customers=$16.67

Sample Questions for Discussion

Here we take a look at two Section A questions which proved to be particularly difficult for
candidates.

Example 1
Mabel Co manufactures and sells tables and chairs in a standard mix of one table to four chairs.

The following information is available:

Product Table Chair

Variable cost per unit ($) 120 16
Contribution to sales ratio 0.4 0.6

Annual fixed costs are $100,000.

What is the break-even point in sales revenue (to the nearest hundred dollars)?

A $210,500
B $178,600
C $200,000
D $204,500
What does this test?

 The calculation of a break-even point in a multi-product situation.

What is the correct answer?

 The correct answer is D

 To calculate break even revenue in a multi-product situation requires the annual fixed costs
to be divided by the weighted average contribution to sales ratio. To do this firstly the
selling price of both products need to be determined. The selling price of a table is
calculated as the variable cost divided by 1 – the C/S ratio: $120/(1-0.4) = $200. The selling
price of a chair is $16/(1-0.6) = $40. Once the selling prices are determined the contribution
of each product can be calculated. For a table this will be $200 x 0.4 = $80 and for a chair
this will be $40 x 0.6 = $24. Now we have the selling price and contribution for both
products we can calculate the weighted average C/S ratio. Sales revenue based on the
sales mix will be (1 x $200) + (4 x $40) = $360 and contribution will be (1 x $80) + (4 x $24)
= $176; this gives a C/S ratio of 0.489. Therefore the break even revenue is
$100,000/0.489 = $204,499 and to the nearest hundred dollars is $204,500
 Selecting option A would have been based on calculating the weighted average C/S ratio
using incorrect weightings
 Selecting option C would have meant that a straight average of the product’s C/S ratios
was used
 Selection option D would have been arrived at by weighting the C/S ratios by units

Example 2
Which of the following should be categorised as environmental failure costs by an airline
company?

(1) Compensation payments to residents living close to airports for noise pollution caused by
their aircraft
(2) Air pollution due to the airline’s carbon emissions from their aircraft engines
(3) Penalties paid by the airline to the government for breaching environmental regulations

A 2 only
B 1, 2 and 3
C 1 and 3 only
D 2 and 3 only

What does this test?

 The understanding of the categorisation of environmental costs.

What is the correct answer?

 The correct answer is B

 Environmental failure costs are costs incurred as a result of environmental issues being
created either internally or outside the company. These can be financial or societal costs.
Compensation, penalties and air pollution are all environmental failure costs.
 This is a good example of why covering the whole syllabus is important. Environmental
management accounting is often an area which is overlooked.
Section A
It was very pleasing to see that once again almost all candidates attempted all of the questions. Section A
questions aim to provide a broad coverage of the syllabus, and future candidates should aim to revise all areas of
the F5 syllabus, rather than attempting to question spot. The following two questions are reviewed with the aim
of giving future candidates an indication of the types of questions asked, guidance on dealing with exam
questions and to provide a technical debrief on the topics covered by the specific questions selected.

Sample Questions for Discussion

Here we take a look at two Section A questions which proved to be particularly difficult for candidates.

Example 1
A company is making product P with the following cost card:
$ $
Selling price 100
Material 25
Labour 30
Variable overheads 20
Fixed overheads 10
(85)
Profit 15

Each unit of P takes one hour to make and the available labour and machinery are fully used in its current
production of P. The company is considering making a new product, Q, but would have to divert labour and
machine use from product P.

What is the relevant total cost per hour for labour and variable overheads which should be included in the cost of
product q?

A $25
B $75
C $50
D $65
What does this test?

 The analysis of relevant cash flows for a decision.

What is the correct answer?

 The correct answer is B

 The relevant cost of diverting labour away from existing production when the resource is being used at
full capacity is the variable cost of a labour hour + opportunity cost. The opportunity cost in this case
would be the contribution of product P lost for every hour diverted away from its production. As each
unit of P takes one labour hour the opportunity cost per labour hour is $25 and the cost per labour hour
must be $30 (from the cost card). Therefore the relevant cost of labour is $55. Note that the question
asks for the total relevant cost of labour and variable overheads. As these overheads are variable they are
incurred when production happens and so are relevant and the variable overheads cost per hour is $20
(from the cost card). The total relevant cost of labour and variable overheads is $75.
 Selecting option A would have only recognised the lost contribution of product P.
 Selecting option C ignored the opportunity cost element and included only the labour and variable
overheads costs per hour.
 Selection option D included the labour and variable overheads costs per hour but used the profit of $15
as the opportunity cost instead of contribution.
 Example 2
Which of the following statements is NOT consistent with the theory of constraints?

A There is no inventory of work in progress or finished good held

B Raw materials are converted into sales as quickly as possible
C Operations prior to the bottleneck operate at the same level as the bottleneck
D Conversion costs and investment costs are kept to a minimum

What does this test?

 The understanding of the principles underpinning the theory of constraints in throughput accounting

What is the correct answer?

 The correct answer is A

 Holding no inventory of work in progress or finished goods is NOT consistent with the theory of
constraints as the theory of constraints specifies that a small amount of buffer inventory should be
maintained prior to the bottleneck activity so that the bottleneck never has to be slowed down or
delayed.
 The other three statements are all consistent with the theory of constraints.

Example 1

A company has two divisions. The divisions are identical in terms of the number and type of machines they have
and the operations they carry out. However, one division was set up four years ago and the other was set up one
year ago. Head office appraises the division using both return on investment (ROI) and residual income (RI).

Which of the following statements is correct in relation to the outcome of the appraisal for each division?

A Both ROI and RI will favour the older division

B ROI will favour the older division, but RI will treat each fairly
C RI will favour the newer division and ROI will favour the older division
D Both RI and ROI will favour the newer division

What does this test?

 The use of ROI and RI in divisional performance appraisal, and the advantages and disadvantages of both.

What is the correct answer?

 The correct answer is A

 ROI is calculated as (divisional profit/capital employed) x 100%
 RI is calculated as divisional profit – (capital employed x cost of capital)
 To see how ROI and RI would treat each division, it’s a fair assumption to assume they’re both
generating the same profit (as they’re virtually identical).
 Both divisions have the same assets – however the older division will have suffered more depreciation,
as it is three years older – reducing its capital employed.
 Looking at both calculations, the smaller capital employed will give the older division an artificially high
ROI compared to the newer division.
 Likewise, the ‘imputed interest’ (capital employed x cost of capital) for the older division will be smaller.
Both divisions use the overall company’s cost of capital, thus giving the older division a higher RI than
the newer division.
 If in doubt with questions like this, make up some numbers. If they both generate profits of $100k, but
the older division’s assets have a NBV of $500k compared to the newer division’s $2,000k (for
example), this gives ROI of 20% and 5% respectively. Similarly, if you use a cost of capital of 10%
(keeping the numbers simple), this gives RI of $50k and ($100k) – both clearly favouring the older
division.
Example 2

An education department has a statutory obligation to report on the number of students on site throughout the
day. In order to produce this information, a swipe card system has been introduced.

The following table details the costs of the swipe card system in its first year:

$ Notes
Purchase price of the swipe system (vendor list price) 100,000 Invoiced and paid
Installation costs of the system (negotiated with 20,000 Invoiced and paid
vendor)

Pre-launch testing costs (in-house) 17,000 Salaries time spent on testing
Cost per 100 swipe cards 5,000 1,000 cards purchased in the first year
Apportionment of the technology insurance cost 9,000 Fixed cost
Salary of clerk employed to collate and distribute swipe 36,000 Fixed cost
card system information

What is the indirect cost of producing the information required in the first year of the swipe card system?

A $62,000
B $45,000
C $36,000
D $9,000

What does this test?

 Indirect vs direct costs of information

What is the correct answer?

 The correct answer is D

 There are two types of costs of producing information in this case – direct and indirect. A direct cost can
be completely attributed to obtaining the information. An indirect cost is required in order to produce the
information, but can’t be completely attributed to it.
 In this example, only the apportionment of the technology insurance cost is indirect – all of the others
are solely related to producing the information.

Example
A company has started production of a new product and has found that the first 10 units of
production took 120 hours. The next 30 units produced took a further 150 hours.

What was the learning rate?

A. 75.00%

B. 56.25%

C. 66.70%

D. 80.00%
The answer to the question is A: 75.00% and can be calculated several ways. One approach is
shown below:

We know that every time cumulative output doubles, the cumulative average time per unit or batch
falls to a fixed percentage of its previous level. Here, the cumulative average time for the first 10
units (1 batch) was 120 hours. Since the incremental time for the next 30 units (3 batches) was
150 hours, the cumulative total for all 40 units (4 batches) is 270 hours (120 + 150.) This means
that the cumulative average time per batch is 67.5 hours (270/4).
 In this question, cumulative output doubled twice: once from 10 to 20 units and once more from 20
to 40. So, the learning effect has taken place twice. So, expressing this as an equation and then
solving to find r:
67.5 = 120 x r2.
67.5/120 = r2
0.5625=r2
=r
0.75 = r
Therefore, the learning rate is 75%.

Question To make a special order, labour will have to be transferred from the production of Product
X, which earns a contribution of $24 per unit made. Each unit of Product X requires 0.5 hours of
labour, which is paid at $24 per hour.

The special order will require 100 hours of labour and 500 hours of machine time. The variable cost of
running the machine is $30 per hour.

What are the total relevant costs for labour and machine time that should be included in the cost of
the special order?

A $22,200
B $10,200
C $19,800
D $17,400

The answer to the question is A. This is calculated as follows:-

Labour: direct cost = 100 x $24 = $2,400
Lost contribution = 100/0.5 x $24 = $4,800
Machine cost = 500 x $30 = $15,000
Total cost = $22,200

This type of relevant costing question usually causes a problem for candidates as it tests the concept of
opportunity costs. The contribution from product X will be lost because of this special order.
Consequently, the full cost of this lost contribution PLUS the direct labour cost must be included. The
most common error which candidates make is excluding the direct labour cost as they think that this is
irrelevant. It is relevant as it would have been charged to product X in arriving at product X’s
contribution; therefore instead, it must be charged to the special contract.

Candidates who had excluded the direct labour cost would have erroneously chosen option C,
£19,800.
Candidates who dealt with the labour cost correctly but then misread the number of machine hours
incorrectly as 100 would have chosen option B ($2,400+$4,800+$3,000). Candidates who failed to
include the lost contribution would have selected answer D ($2,400+$15,000).