Cost Solution

SUGGESTED SOLUTION (AC 276 TEST I)
Question 1
(a) The management accountant did not indicate to the General Manager that the income
statement he provided were based on variable costing. Even if he did this, this would
not have been of assistance to the general manager. A complete report must have
included both, variable costing and absorption costing income statements whose
differences should have been highlighted. Following from this the Management
Accountant should have explained that the increase in inventory level in year one
(where units produced are more than the units that are sold) causes absorption costing
to report higher income than what variable costing reports. This would have confirmed
to the General Manager the validity of the advice that he was given.
(b) Since variable costing income statements are available, only the absorption income
statement that follows is prepared.
ABSORPTION INCOME STATEMENTS
YEAR 1 YEAR 2
Revenue 1,530,000,000 1,600,000,000
Cost of sale 1,262,250,000 1,283,200,000
Volume variance -17,650,000 27,540,000
Adjusted costs of sale 1,244,600,000 1,310,740,000
Gross profit 285,400,000 289,260,000
Operating costs Admin.
Fixed costs 120,000,000 120,000,000
Distrib. Fixed costs 80,000,000 80,000,000
Distrib. Variable costs 61,200,000 64,000,000
141,200,000 144,000,000
Total operating costs 261,200,000 264,000,000
Operating income 24,200,000 25,260,000
(c) Comments
Table 1 below shows that in both, year one where inventory level increased, absorption
costing income is higher than variable costing income. However, in year 2 where
inventory level decreased, absorption costing is less than variable costing Income.
These income differences arise because variable costing charges total fixed production
costs to the income of the year in which this cost was incurred. Absorption costing on
the other hand transfers part of this cost, which is charged to units not sold to the
subsequent year in which these units will be sold. In order to confirm this, the income
differences are reconciled by multiplying respective inventory level changes by unit
fixed factory cost.
TBLE 1: INCOME DIFFERENCES AND THEIR RECONCILIATION

1 2 3 4
YEAR INCOME DIFFERENCES CHANGE IN INVENTORY INCOME DIFFERENCES
LEVELS EXPLAINED BY INVENTORY
LEVELS CHANGE
ABSORPTION VARIABLE INCOME PRODUCTI SALES INCREASE
COSTING COSTING DIFFERENCES ON UNITS UNITS (DECREASE)
INCOME INCOME
1 24,200,000 14,200,000 10,000,000 161,000 153,000 8,000 (8,000)(1,200) = sh10,000,000
2 25,260,000 32,400,000 -7,140,000 153,000 160,000 (7,000) (-7,000)(1,200) = -sh7,140,000
In panel 4, of Table 1, change in inventory level is multiplied by unit fixed factory
cost equal to shs.1,200 in order to reconcile.
Working 4(b)
YEAR 1 YEAR 2
W1 Fixed factory cost rate Sh.183,600,000 ÷ 146,880 unit Sh.183,600,000 ÷ 180,000 units
Sh.1,250 = sh.1,020
W2 Volume variance (146,880 – 161,000)(sh.1,250 (180,000 – 153,000)(sh.1,020)
= -17,650,000 = 27,540,000
W3 Factory absorption costs 1,071,000,000 ÷ 153,000 = 7,000 1,120,000,000 ÷ 160,000 = 7,000
Unit factory variable costs 1,250 1,020
Unit fixed factory costs 8,250 8,020
Total unit absorption costs 153,000 160,000
Unit sold 1,262,250,000 1,283,200,000
Total cost of sale ========== ==========
Question 2
(a) Break-even point in units [old machine]
Fixed costs
BEP = Unit contribution margin
Fixed costs = TZS 2,520,000,000
Unit contribution margin = 180,000 [i.e. 300,000 – 120,000]
BEPunits = 2,520,000,000
180,000
= 14,000 Units
(b) Break-even point in units (New Machine)
Fixed costs
BEPunits Unit contribution margin
Fixed costs = TZS 2,616,000,000
Unit contribution margin = 204,000 [i.e. 300,000 – 96,000]
BEPunits =2,616,000,000
204,000
= 12,824 Units
(c) Expected operating profit

Alternative 1:
Profit = Contribution – Fixed costs
New machine
Profit = 20,000(204,000) – 2,616,000,000
= 4,080,000,000 – 2,616,000,000
- TZS 1,464,000,000
Old machine
Profit = 20,000(180,000) – 2,520,000,000
= 3,600,000 – 2,520,000,000
= TZS 1,080,000,000
Comparison:
Profit:
New machine TZS 1,464,000,000
Old machine TZS 1,080,000,000
384,000,000
It is more profitable to lease the new machine.
Alternative 2:
TZS ‘000,000’
New Machine Old Machine
Sales 6,000 6,000
Less: Variable costs (1,920) (2,400)
Contribution margin 4,080 3,600
Less: Fixed Costs (2,616) (2,520)
Operating profit 1,464 1,080
(d) Advise on decision to lease the new machine or keep the old one;
Determine the level of output where both machines yield the same expected profit.
Profit equation:
Profit = Contribution – Fixed costs for both machines. Or
Profit = TR – TC
Where TC = TVC + TFC
Then; 180,000 q – 2,520,000,000 = 204,000q – 2,616,000,000
q = 4,000 units
Advice:
If expected demand is anything below 4,000 units, the company is advised to keep on
the old machine, while if the demand is anything above 4,000 units, the company
should lease the new machine. This is based on the fixed costs – variable cost
combination.
(e) Different decisions that potentially benefit from CVPO Analysis:

Candidates can come up with decisions such as:
 Pricing decision
 Accepting a particular offer (quantity or price) from a customer
 Production technique decision (variable/fixed costs combinations)
 Promotional methods to be used (advertising/price cuts) etc.
 Capacity expansion decisions
 Shut down decisions.

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SUGGESTED SOLUTION (AC 276 TEST I)

TBLE 1: INCOME DIFFERENCES AND THEIR RECONCILIATION

(a) Break-even point in units [old machine]

Fixed costs = TZS 2,520,000,000

Unit contribution margin = 180,000 [i.e. 300,000 – 120,000]

Unit contribution margin = 204,000 [i.e. 300,000 – 96,000]

(c) Expected operating profit

Profit = Contribution – Fixed costs

Then; 180,000 q – 2,520,000,000 = 204,000q – 2,616,000,000

(e) Different decisions that potentially benefit from CVPO Analysis:

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