MANAGEMENT ACCOUNTING

Module Guide

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MANCOSA
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 This module guide,
Management Accounting(NQF Level 6)
will be used across the following programmes:

Bachelor of Business Administration

Bachelor of Commerce in Entrepreneurship

Bachelor of Commerce in Information and

Technology Management

Bachelor of Commerce in Marketing Management

Bachelor of Commerce in Project Management

Bachelor of Commerce in Retail Management

Bachelor of Commerce in Supply Chain

Management
 Management Accounting

Table of Contents
Preface 2
Unit 1: Management Accounting – An Introduction 12
Unit 2: Classification of Costs 19
Unit 3: Materials 27
Unit 4: Labour 41
Unit 5: Absorption Costing and Marginal Costing 60
Unit 6: Cost-Volume-Profit Analysis 70
Unit 7: Budgets and Budgetary Control 91
Unit 8: Standard Costing 111
Unit 9: Capital Investment Appraisal 131
Bibliography 197

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 Management Accounting

Preface
A. Welcome
Welcome to the Management Accounting (MA6) module. You are encouraged to read this overview
and module guide carefully, as it will aid you through your study journey. This module guide intends
to develop your knowledge and proficiency.

The field of Accounting is dynamic and innovative. The learning content and special features
contained in this module guide will provide you with opportunities to explore current industry
developments and theories.

As this is a distance-learning module, self-discipline and time management would need to be applied
effectively. You will have the opportunity to engage with interactive digital tools via
MANCOSAConnect to enhance your learning journey.

Through the inclusion of relevant content and industry aligned practices within the learning content,
you will develop critical thinking and problem-solving skills, empowering you as change agents for a
more sustainable world.

Please note that some special features may not have answers available, where answers are
not available this can be further discussed with your lecturer during the webinar session.

We hope you enjoy the module

-------
MANCOSA does not own or purport to own, unless explicitly stated otherwise, any
intellectual property rights in or to multimedia used or provided in the Management
Accounting guide. Such multimedia is copyrighted by the respective creators thereto and
used by MANCOSA for educational purposes only.

Should you wish to use copyrighted material from this guide for purposes of your own that
extend beyond fair dealing/use, you must obtain permission from the copyright owner.

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 Management Accounting

B. Module Overview

The Module is a 15 credit module at NQF level 6.

The purpose of this module is to provide you with a sound theoretical framework creating an
understanding and overview of the key concepts which will be used throughout this program. You
will be introduced to the concept of projects and project management. We will unpack the phases
in a project life cycle and consider the respective international standards and global trends.

C. Learning Outcomes and Associated Assessment Criteria of the Module

Module Outcomes Associated Assessment Criteria

Key elements of pre-determined costs

and management accounting systems
are identified to demonstrate an
understanding of their importance in
financial decision-making

Benefits and limitations of pre-

Understand the need for pre- determined costs and management
determined costs and management
accounting systems are evaluated to
accounting systems
assess their suitability for various
business scenarios

Pre-determined costs and management

accounting systems are applied to
solve practical business problems to
enhance financial performance and
decision-making

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 Management Accounting

Direct, indirect, fixed, and variable

costs are differentiated to demonstrate
an understanding of their unique
characteristics
Distinguish between the various key Cost category and its impact on
management accounting concepts: business performance and decision-
direct, indirect costs, fixed and variable
making is evaluated to understand the
costs
various accounting concepts

Cost classification methods are applied

to various business scenarios to
enhance cost management and
financial decision-making

Various stock valuation methods are

evaluated to demonstrate an
understanding of their unique features

Advantages and disadvantages of each

Calculate the value of stock using valuation method are compared to
different valuation methods assess their suitability for different
business scenarios

Appropriate stock valuation methods

are applied to practical business
situations to facilitate accurate stock
valuation and decision-making

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 Management Accounting

Absorption Costing and Marginal

Costing is defined and differentiated to
demonstrate an understanding of their
unique characteristics

Benefits and limitations of each costing

Apply the optimal costing methods of
method are evaluated to assess their
Absorption Costing vs Marginal costing
suitability for various business
to facilitate the costing of a product
scenarios

Optimal costing method is applied to

practical business situations to
facilitate accurate product costing and
decision-making

Key principles of Absorption Costing

are evaluated to demonstrate an
understanding of its application in
product costing

Absorption Costing on business

Analyse the Absorption Costing Method performance and decision-making is
analysed to understand the absorption
costing method

Absorption Costing is applied to

practical business scenarios to
facilitate accurate product costing and
decision-making

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 Management Accounting

Key principles of Marginal Costing are

explained to demonstrate an
understanding of its application in
product costing

Marginal Costing is analysed to

Explain and compute the Marginal demonstrate an understanding of its
Costing method
impact on business performance and
decision-making

Marginal Costing is applied to practical

business scenarios to facilitate
accurate product costing and decision-
making

Key components of Cost Volume Profit

(CVP) analysis are identified to
demonstrate an understanding of their
roles in the decision-making process

Relationships between the components

Evaluate the components of the Cost
of CVP analysis are analysed to assess
Volume Profit (CVP) analysis their impact on business profitability
and financial decision-making

CVP analysis is applied to practical

business scenarios to evaluate the
potential financial outcomes of various
decisions

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 Management Accounting

Breakeven point and its significance to

financial decision-making is defined to
understand the firms performance

Appropriate formula is applied to

Calculate the Breakeven point of a calculate the breakeven point for
firm's output various business scenarios

Breakeven point calculations are

interpreted and analysed to assess
their implications for business decision-
making and profitability

Key principles of effective budgeting

are identified to demonstrate an
understanding of their importance in
financial planning and decision-making

Describe the principles of effective Benefits and limitations of effective

budgeting budgeting for managing financial
resource are evaluated

Effective budgeting principles are

applied to practical business scenarios
to enhance financial planning and
decision-making

Cash budget is explained to

understand its importance in financial
planning

Key components of a cash budget are

Demonstrate the process of populating identified to demonstrate how they are
a Cash Budget
used in the budgeting process

Cash budget for a given business

scenario is prepared to demonstrate
proficiency in financial planning and
decision-making

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 Management Accounting

Key cost control formulae used in

standard costing are analysed to
demonstrate an understanding of their
roles in cost management

Benefits and limitations of standard

costing methods for managing costs
Apply the cost control formulae in
and improving profitability are
assessing standard costing methods evaluated to assess the standard
costing methods

Cost control formulae are applied to

practical business scenarios to assess
the effectiveness of standard costing
methods in cost management and
decision-making

Key techniques and principles used in

Capital Investment Appraisal are
identified to demonstrate an
understanding of their roles in financial
decision-making

Calculate the various techniques and Advantages and disadvantages of

principles applied, to determine the various Capital Investment Appraisal
most appropriate Capital Investment methods are compared to assess their
Appraisal method suitability for different investment
scenarios

Capital Investment Appraisal

techniques are applied to practical
business scenarios to determine the
most suitable method for investment
decision-making

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 Management Accounting

D. How to Use this Module

This Module Guide was compiled to assist you with your study journey. The purpose of the Module
Guide is to allow you the opportunity to integrate the theoretical concepts discussed within the
content of the Module Guide. We suggest that you read through the entire module guide to get an
overview of its contents. At the beginning of each Unit, you will find a list of Learning Outcomes This
outlines the main points that you should understand when you have completed the Unit/s.

This Module Guide should be studied in conjunction with the prescribed, recommended textbook(s)/
reading(s) and other relevant study material. It is important that you make your own notes as you
work through the prescribed, recommended textbook(s)/ reading(s), other relevant study material,
and the module guide. You may obtain additional reading material by utilising publications
referenced at the end module guide under the reference list and bibliography.

E. Study Material
The study material for this module includes programme handbook, this Module Guide, a list of
prescribed and recommended textbooks/readings which may be supplemented by additional
readings.

F. Prescribed Textbook
The prescribed and recommended reading(s)/textbook(s) presents a tremendous amount of material
in a simple, easy-to-learn format. You should read ahead during your course. Make a point of it to re-
read the learning content in your module textbook. This will increase your retention of important
concepts and skills. You may wish to read more widely than just the Module Guide and the
prescribed and recommended textbooks/readings, the Bibliography and Reference list provides you
with additional reading.

The prescribed and recommended textbook(s)/reading(s) for this module are:

Prescribed Reading(s)/Textbook(s)

Chadwick, L. P. (2020) Management Accounting. Custom edition for MA 6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022) Fundamentals of Cost and
Management Accounting. Ninth Edition. Durban: LexisNexis

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 Management Accounting

Recommended Reading(s)/Textbook(s)

Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green Intellectual Capital and
Environmental Management Accounting: Natural Resource Orchestration in favour of
Environmental Performance. Wliey Online library
Chadwick, L. (2020) The Essence of Management Accounting. Second Edition. United States of
America: Pearson
Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability Management
Accounting and multi-level links for sustainability - A Systematic Review. Journal of Management.
Wiley Online Library

G. Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to
help you study. It is imperative that you work through them as they also provide guidelines for
examination purposes.

~~~~~~~~~~~~~~

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 Management Accounting

Special Feature Icon Description

A Think Point allows you to apply your analytical skills to reflect

THINK POINT on the topic. You may be asked to apply a concept to your own
experience or to think of an example.

An Activity tests your knowledge on content that is highlighted

ACTIVITY within specific content areas. The purpose of an activity is to
give you an opportunity to apply what you have learned.

The readings provided should be read in order to develop your

knowledge of the content areas. If you are unable to acquire the
READINGS
suggested readings, then you may consult with any current
sources that deal with the subject.

PRACTICAL A Practical Application or an Example provides insight and

APPLICATION enhances your learning of the topic, allowing you to apply the
OR EXAMPLES theory learnt through real-life scenarios within this module

Knowledge Check Questions (KCQ) appear in the form of

KNOWLEDGE
True/False or Multiple Choice Questions throughout the module
CHECK
guide. KCQs will test your knowledge of the content areas
QUESTIONS
covered.

REVISION Revision Questions will test your understanding of module and

QUESTIONS unit outcomes.

A Case Study provides different scenarios to illustrate how

CASE STUDY
theory is practiced.

VIDEO A video Activity with links are included in your module guide
ACTIVITY along with instructions to attempt after watching the video.

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 Management Accounting

Unit
1: Management Accounting – An
Introduction

Unit 1: Management Accounting – An Introduction

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 Management Accounting

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Discuss management accounting and

1.1 What is Management Accounting? the purpose thereof

1.2 Differences in Management and Distinguish between the concepts of

Financial Accounting management and financial accounting

1.3 Management Accounting Serving the Explain the functions of management

Needs of Managers accounting

Identify and explain the reasons and

1.4 Requirements for Effective Management requirements for effective management
Accounting accounting

Identify the limitations and drawbacks

1.5 Limitations of Management Accounting of management accounting

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 Management Accounting

Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

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 Management Accounting

1.1 What is Management Accounting?

Management Accounting may be defined as the identification, analysis, interpretation and
communication of financial information that enables management to do planning and controlling
within the business as well as to make a number of management decisions. Management
Accounting is thus concerned with providing information within the business that will assist in making
informed decisions in.

1.2 Differences Between Management Accounting and Financial Accounting

Management accounting involves the use of financial information to meet the needs of managers or
internal users. Financial accounting provides financial information about the business to external
users i.e. those who not involved in the day-to-day running of the enterprise. The major differences
between the two may be tabulated as follows: order to improve the efficiency and profitability of the
business.

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 Management Accounting

1.3 Management Accounting Serving the Needs of Managers

Management Accounting serves the following functions:

It provides information for managers that enable them to make better and informed
decisions. Management requires a steady flow of information to respond to possible problems that
may be starting to develop or to be proactive in ensuring that certain problems do not occur. This
information could be in the form of reports, spreadsheets, graphs etc. It advises management about
the likely results of its intended decisions.

Management Accounting information is concerned with planning and control decisions that
managers are required to make regularly. Planning decisions relate to the setting of goals or
objectives and the formulation of policy. Control involves the comparison of actual results with
standards set e.g. actual expenditure compared to budgeted expenditure. Deviations from the
standard are analysed with a view to implementing remedial measures.

1.4 Requirements for Effective Management Accounting

Information intended for managers must be effectively and timeously communicated. The information
must also be user-friendly and understandable.

The environment in which the enterprise operates is never static and management accounting
must therefore be flexible so that it can respond to changes. The environment must be monitored
closely so that information can be updated or amended
There must be good co-operation between the management accounting section and the other
business functions. For example, the preparation of budgets requires the co-operation of all
departments in the enterprise
The management accounting department must ensure that the managers who use the
information it provides are well trained in the techniques and the processes that go into making
the information usable

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1.5 Limitations of Management Accounting

Management accounting is not an exact science. A lot of information is based on assumptions

and making judgements which are subjective
It cannot solve all financial problems or help in providing the best alternatives. It is merely one
tool amongst others that are available to help managers to make appropriate or informed
decisions

Activity 1

1. For each of the following, state whether it is concerned mainly with financial
accounting or management accounting. Place a tick in the appropriate
column

2. Tabulate 5 differences between financial accounting and management

accounting.
3. Management accounting is not required in non-profit organisations such as
welfare bodies and state clinics. Do you agree with this statement? Give
reasons for your answer.

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Answers
Activity 1.1
1. For each of the following, state whether it is concerned mainly with financial accounting or
management accounting. Place a tick in the appropriate column
Answer:

2. Tabulate 5 differences between financial accounting and management accounting.

Answer: Refer to paragraph 2.
3. Management accounting is not required in non-profit organisations such as welfare bodies
and state clinics. Do you agree with this statement? Give reasons for your answer.

Answer:

Disagree with the statement for the following reasons:

Management accounting provides information that is useful in planning, controlling and making
decisions. The elements of planning, organising and decision-making are characteristic of both
profit-making and non-profit organisations.

Non-profit organisations are also concerned with the control of income and expenditure and
therefore rely on management accounting information.

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Unit
2:
Classification of Costs

Unit 2: Classification of Costs

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 Management Accounting

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

2.1 What are Costs? Explain the concept of costs

Distinguish using examples between

2.2 Direct and Indirect Costs direct and indirect costs

Distinguish using examples between

2.3. Fixed and Variable Costs fixed and variable costs

2.4 Manufacturing Costs and Non- Explain the elements of product

Manufacturing Costs manufacturing costs

Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

20
 Management Accounting

2.1 What Are Costs?

Costs may be defined as the value of economic resources used for the production of a product or
service. Costs may be viewed as a necessity in producing a product or service. Costs may be
classified according to type e.g. direct and indirect costs as well as by behaviour e.g. fixed and
variable costs.

2.2 Direct and Indirect Costs

All costs may be categorised as direct or indirect costs. Costs are considered to be direct or indirect
to the extent to which they can be accurately traced to a cost centre. A cost centre may be defined as
any part of a business to which costs are charged e.g. a particular product or job or department.

2.2.1 Direct costs

Direct costs are costs that can be accurately identified as forming part of a cost centre. Examples of
such costs would include the materials used to make the product (direct materials) and the wages of
the employees who work with these materials (direct labour).

2.2.2 Indirect costs

Indirect costs are costs that cannot be easily traced to a particular cost centre. They may be said to
include all costs with the exception of direct costs. For example, indirect product costs include all
manufacturing costs excluding direct materials and direct labour. Costs that are shared between
different departments or products are also considered to be indirect costs e.g. common advertising
on national television that benefits two products of the same manufacturer.

2.3 Fixed and Variable Costs

Costs behave differently relative to the output. They may remain constant or they may vary. There
are no set rules to determine whether a cost is fixed or variable. It depends on the circumstances of
each case.

2.3.1 Fixed Costs

Fixed costs are those costs that remain the same irrespective of the level of output or activity.
Examples include rent and insurance. However, it must be remembered that fixed costs remain fixed
over a certain range. For example, if a factory is producing goods at full capacity and if more units

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have to be produced then additional premises would be needed resulting in additional rent expense
being incurred.

2.3.2 Variable Costs

Variable costs are those costs that change in proportion to the changes in the level of output or
activity. Examples include direct materials, direct labour and certain variable overheads e.g. packing
materials.

The classification of costs into fixed and variable costs are important in many facets of management
accounting e.g. break-even analysis. It must be remembered, though, that some costs e.g. water
contain a fixed component (a fixed monthly charge) plus a variable component (additional charged
based on usage). These costs may be termed semi-variable.

2.4 Manufacturing Costs and Non-Manufacturing Costs

Manufacturing costs consists of three elements viz. direct material, direct labour and manufacturing
overheads. Included in manufacturing overheads are indirect materials and indirect labour. Non-
manufacturing costs include marketing costs and administrative costs. All these concepts are
explained below.

2.4.1 Material

Material consists of direct material and indirect material. Direct material can be regarded as the
primary material used to manufacture a product. It forms a part of the final product and its usage
depends on the volume of production. Direct material forms one part of the primary (direct) cost of a
product.

Indirect material does not form part of the final product e.g. cleaning materials, maintenance
materials. The quantity used is not linked to the volume of production. Indirect materials form part of
manufacturing overheads.

2.4.2 Labour

Labour can also be divided into two components viz. direct labour and indirect labour. Direct labour
refers to labour that is physically applied to the manufacturing of a product and can also be easily
traced to the manufactured product. Direct labour forms part of the primary (direct) cost of a product.
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 Management Accounting

Indirect labour refers to labour costs that cannot be directly linked to a particular product. For
example, the wages of the employees who maintain and service the machines used during
manufacturing are classified as indirect labour. Indirect labour forms part of manufacturing
overheads.

2.4.3 Manufacturing Overheads

Manufacturing overheads include indirect materials, indirect labour and all other costs incurred
during the manufacturing process that cannot be directly traced to the product. In other words, in
includes all costs excluding direct material and direct labour that are incurred during the production
process. Apart from indirect materials and indirect labour, manufacturing overheads include rent (of
the factory floor space), insurance (of the factory stock and buildings), depreciation of production
machinery etc.

2.4.4 Marketing Costs

Marketing costs are costs incurred to market the product and are largely expenses incurred in
promoting sales, obtaining orders and delivery of [Link] include advertising and
commission on sales.

2.4.5 Administrative Costs

These are costs incurred during the performance of administrative duties. They include costs that
arise from departments such as finance,administration,human resources and management.
Examples include salaries of executives,legal costs,clerical costs etc.

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 Management Accounting

Activity 2.1

1. Classify the following costs as direct or indirect. Place a tick in the

appropriate column.

2. Classify the following costs as fixed or variable in terms of the level of

output. Place a tick in the appropriate column.

3. Classify the following costs as manufacturing, marketing or

administrative costs. Place a tick in the appropriate column

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 Management Accounting

Answers

Activity 2.1

1. Classify the following costs as direct or indirect. Place a tick in the appropriate column.

Answer:

2. Classify the following costs as fixed or variable in terms of the level of output. Place a tick
in the appropriate column.

Answer:

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 Management Accounting

3. Classify the following costs as manufacturing, marketing or administrative costs. Place a

tick in the appropriate column

Answer:

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 Management Accounting

Unit
3:
Materials

Unit 3: Materials

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Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Introduce topic areas covered for the

3.1 Introduction unit

Recognise the various terminology

3.2 Terminology Associated with Materials associated with materials

Enumerate the economic order quantity

3.3 Economic Order Quantity method

Evaluate materials according to the

FIFO and AVCO methods

3.4 Methods of Valuation of Materials

Discover and state what the market
price method is

State the advantages and

3.5 Inventory Pilling Versus Just In Time shortcomings/disadvantages of the just
(JIT) Inventory Policy in time (JIT) inventory policy

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 Management Accounting

Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

29
 Management Accounting

3.1 Introduction
We have learnt from the previous topic that material is an important component of the cost of
manufacturing a product. We have also learnt that material cost may be divided into direct materials
and indirect materials. There are a few other terms that we need to be familiar with:

3.2 Terminology Associated with Materials

3.2.1 Primary Material

This is another term for direct material i.e. raw materials that are used in the manufacturing process.

3.2.2 Secondary Material

This is another term for indirect material i.e. material that usually does not form part of the finished
product.

3.2.3 Work-in-Progress

This refers to raw materials that have been put into the production process but are not yet
complete. They are part of unfinished products to which a certain amount of labour and overheads
have also been applied.

3.2.4 Finished Goods

These are goods that have been completed from the raw materials that have been put into
production. These goods are now ready for sale.

3.2.5 Inventory

This refers to the stock of material (direct and indirect), work-in-progress and finished goods at any
given time.

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3.3 Economic Order Quantity

With regard to the control of materials, one of the problems that managers face is what quantity of
any item should be ordered each time. One must bear in mind that if too little is purchased, the
enterprise may run out of stock.

If too much is purchased, a lot of working capital is tied up unproductively in inventory and the cost of
holding the stock is high. Therefore, managers have to find a balance between purchasing too little
and purchasing too much

Managers need to also consider the two main costs in any purchasing order viz. the cost of
purchasing and the cost of holding the inventory. The cost of purchasing inventory includes the costs
involved in negotiations, cost of telephone and faxes, stationery, internet usage and receiving the
goods.

The cost of holding inventory include the cost of storage, loss of interest on capital tied up in
inventory, personnel costs, insurance, goods going out of fashion or becoming obsolete.

Thus one finds that if small quantities are purchased each time, the cost of purchasing will be high as
many orders need to be placed. On the other hand if larger quantities are purchased, the cost of
holding inventory becomes high.

Somewhere between these two extremes is a point where the total cost of purchasing and holding
the inventory is at a minimum. The quantity ordered at this point is the economic order quantity
(EOQ).

With regard to the control of materials, one of the problems that managers face is what quantity of
any item should be ordered each time. One must bear in mind that if too little is purchased, the
enterprise may run out of stock.

If too much is purchased, a lot of working capital is tied up unproductively in inventory and the cost of
holding the stock is high. Therefore, managers have to find a balance between purchasing too little
and purchasing too much.

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 Management Accounting

Managers need to also consider the two main costs in any purchasing order viz. the cost of
purchasing and the cost of holding the inventory. The cost of purchasing inventory includes the costs
involved in negotiations, cost of telephone and faxes, stationery, internet usage and receiving the
goods.

The cost of holding inventory include the cost of storage, loss of interest on capital tied up in
inventory, personnel costs, insurance, goods going out of fashion or becoming obsolete.

Thus one finds that if small quantities are purchased each time, the cost of purchasing will be high as
many orders need to be placed. On the other hand if larger quantities are purchased, the cost of
holding inventory becomes high.

Somewhere between these two extremes is a point where the total cost of purchasing and holding
the inventory is at a minimum. The quantity ordered at this point is the economic order quantity
(EOQ).

The economic order quantity can be calculated using the following formula:

Where:
C = cost of placing an order
U = annual usage
H = inventory (stock) holding cost per unit

Practical Applications or Example 3.1

Arlen Limited purchases 800 school bags at R60 each per annum. The bags
are sold at R80 each at a steady rate during the year. The cost of placing a
single order amounts to R20,25. Inventory holding cost amounts to R4 per
unit. Calculate the:
1. Economic Order Quanitity
2. The number of orders that should be placed each year

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 Management Accounting

Managers need to be aware that there are some limitations to the use of the basic EOQ model.
These limitations relate to its assumptions. It assumes that annual demand can be predicted
accurately. It also assumes that inventory can be purchased in single units e.g 73 but goods are
often packaged in multiples of 20 or 50 units etc. Finally, it also assumes that quantity or bulk
discounts are not available. Despite these limitations the EOQ model is still a useful tool in
managing inventory.

3.4 Methods of Valuation of Materials

The purchase price of materials is often subject to constant change. These changes could be
through the effects of inflation, shortages in supply, unstable markets etc. Materials need to be
valued for two purposes viz.

To determine the value of materials issued to production (affects cost of production)

To determine the value of the materials on hand (inventory valuation)

Various methods are used to value inventory. These include the first-in-first-out method (FIFO), last-
in-first-out method (LIFO), the weighted average cost method (AVCO) and the market price
method. The LIFO method is usually not allowed when calculating profit for tax purposes and will
therefore not be discussed.

3.4.1 First-In-First-Out Method (FIFO)

This method values material issued to production in the order in which it was received. It is based on
the premise that material that is received first is issued first (to avoid losses due to deterioration or
obsolescence). The following example explains the application of the FIFO method:

33
 Management Accounting

Practical Applications or Example 3.2

The following transactions of BNM Ltd took place during April 20.6 in respect
of a component used in production:

Required
Using the FIFO method, calculate the issue price to production and the value
of closing inventory.

3.4.2 Weighted Average Cost Method (AVCO)

When using the AVCO method, all issues of material and inventory of material are valued at the
average price. This average price is re-calculated each time materials are purchased from
suppliers. When materials are purchased the quantity and monetary value is added to the previous
stock balance and a new average unit price is available for additional issues of materials.

If prices fluctuate greatly, AVCO method provides a good option for dealing with this. For a time, all
products will be charged at a uniform rate for the same material. However, the disadvantage of this
method is that the average price may be fictitious and not be related to the market price.
34
 Management Accounting

Practical Applications or Example 3.3

The following example explains the application of the AVCO method:

Required
Refer to the information used in example 2. Using the AVCO method,
calculate the issue price to production and the value of closing inventory.

3.4.3 Market Price Method

This method uses the current market price to determine the price at which materials are issued for
production.

3.5 Inventory Piling Versus Just in Time (JIT) Inventory Policy

A business may hold stock (inventory piling or stockpiling) for various reasons. It may want to ensure
that production is uninterrupted. It is possible that future supplies may become scarce. It may be that
the prices of the materials are expected to rise shortly.

However, there are many costs that need to be borne in inventory piling. These include storage and
handling costs, financing costs, theft and obsolescence. Moreover, large amounts of working capital
may be tied up in inventory.

A modern trend among many businesses is to eliminate the need to hold inventory by applying the
just in time (JIT) inventory policy. Toyota (Pty) Ltd situated south of Durban (South Africa) uses the
JIT stock management system. The advantages to the business are that:

Inventory is kept to a minimum (thus minimising costs associated with handling, theft, insurance
and obsolescence)
The investment in inventory is kept to a minimum
Less storage facilities are required (inventory holding costs rest with the suppliers)
35
 Management Accounting

The success of the JIT inventory policy depends a lot on maintaining an excellent relationship with
suppliers. Suppliers must be informed of orders in advance and suppliers must deliver at the
appropriate times.

The downside of JIT inventory management is that if suppliers don’t deliver on time, production may
be halted and the supply of products to customers could be interrupted. Furthermore, since suppliers
are required to hold the inventory, they may compensate for this through increased prices.

Revision Questions

1. What are the consequences to a business of holding a very low a level of

inventory?
2. DNA Ltd sells 4 000 drums of grease each year. The inventory holding cost
of one drum of grease is R8. The cost of placing an order for stock is
estimated at R250.
3. Calculate the EOQ for drums of [Link] the number of orders that
should be placed per annum.(Round off calculations to the nearest whole
number.)
4. You are the newly appointed management accountant at Kelso Industries.
The company uses the EOQ model to determine the quantity of raw material
Z54 to order from REM Ltd. The following details regarding raw material Z54
are brought to your attention: Kelso Industries consumes 2 400 units of
material Z54 each working day.
It is estimated that there are 250 working days in the 20.7 financial year.

The cost of placing an order amounts to R120.

The cost of holding inventory per unit is estimated at R3,90 plus 11% of
the invoice price per unit.

The invoice price per unit is R10.

5. Calculate the EOQ for raw material Z54 for the 20.7 financial year.
6. Calculate the number of orders that should be placed during 20.7. (Round
off calculations to the nearest whole number.)

36
 Management Accounting

7. The following transactions of CAN Manufacturers took place during June

20.6 in respect of a raw material M321 used in production:

FIFO

WEIGHTED AVERAGE COST METHOD

37
 Management Accounting

Answers

Practical Application or Example 3.1

Calculate the:

1. Economic Order Quanitity

Answer:

2. The number of orders that should be placed each year

Answer:

38
 Management Accounting

Practical Application or Example 3.2

Using the FIFO method, calculate the issue price to production and the value of closing
inventory.

Answer:

39
 Management Accounting

Practical Application or Example 3.3

Refer to the information used in example 2. Using the AVCO method, calculate the issue price
to production and the value of closing inventory

Answer:

40
 Management Accounting

Unit
4:
Labour

U n i t 4 : L a b o u r

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 Management Accounting

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Introduce topic areas covered for the

4.1 Introduction unit

Categorise the administrative issues

4.2 Labour Administration and various calculations related to

labour

Recognise the employee records

4.3 Employee Records maintained for labour remuneration

Calculate the net wage or net salary of

4.4 Calculation of Net Wage or Net Salary an employee

Contrast and enumerate the various

4.5 Wage Incentive Schemes wage incentive schemes

Enumerate the allocation of the direct

4.6 Allocation of Direct Labour Costs labour costs and calculate the hourly
recovery tariff of an employee

42
 Management Accounting

Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

43
 Management Accounting

4.1 Introduction
Labour may be described as the physical and mental effort of employees in the manufacturing
process. Labour costs, as we already know, can be divided into direct labour (work that is directly
related to the production of goods) and indirect labour (work that is not directly related to the
production of goods).

Direct labour costs form part of the primary (direct) cost of production while indirect labour forms part
of the overhead costs. Labour costs can be substantial and it is therefore important for management
to exercise effective control over matters relating to employees. If management can create an
environment conducive to job satisfaction, then this should result in high levels of labour
productivity. Productivity levels need to be monitored on an on-going basis.

4.2 Labour Administration

Labour administration allows management to set standards for the manufacturing process and to
measure and compare the actual results obtained. Management can determine whether labour is
effectively employed or not. If necessary, remedial measures need to be taken.

The following matters linked to personnel administration have a bearing on labour costs:

determining the number of employees required to complete all the production tasks

Recruitment and selection process

Job analysis including job description and job specification
Work study including method study and work measurement
Training of employees including induction and in-service training
Maintaining employee records
Resignations and dismissal of employees

The number of resignations is high; this is an indication that all is not well.

Labour turnover can be calculated by using the following formula:

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 Management Accounting

Practical Applications or Example 4.1

If the number of persons who left during 20.6 was 16 out of a total staff of 80
employees, then the labour turnover will be 20%, calculated as follows:

The rate of labour turnover may also be calculated per department, per
gender group, per age group etc. Managers need to establish why employees
are leaving and analyse whether the reasons are controllable or not.
Employees may resign for many reasons including remuneration, working
conditions, relationship with manager, health reasons, promotion, working
hours, transport problems etc.
The cost of labour turnover includes all those costs mentioned above relating
to recruitment, selection, training etc.

4.3 Employee Records

It is important that proper records are kept relating to each employee. The human resources
(personnel) department will keep records relating to the employee’s date of appointment, salary
scale, leave, deductions, promotions etc. As far as labour costing is concerned, the following records
are important:

Clock cards
Job cards

4.3.1 Clock Cards

A clock card machine is a device used to determine the exact time an employee works each
day. Each employee is given a clock card. When the employee reports for duty, he/she inserts the
card into the device that records the time on it. When the employee goes off duty, he/she clocks out
and the time is once again printed.

Using the clock card, the exact number of hours worked as normal time and overtime can be
calculated. In this way, the gross wage of each employee is calculated. Computerised clocks are
used nowadays that are designed to make it difficult for employees to dishonestly clock in for another
employee.

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 Management Accounting

4.3.2 Job Cards

Job cards are used to indicate the time an employee starts a job and the time when the job is
completed. When an employee commences a new job, a new card is used. The supervisor fills in the
start time and finishing time on the job card.

The job card also indicates to the employee what job needs to be done. If the job is halted for some
reason e.g. electricity failure, an idle time card is filled.

It is important to reconcile the times reflected on the clock cards with the job cards. The times
recorded form the basis for the allocation of labour costs to the various cost centres.

4.4 Calculation of Net Wage or Net Salary

Before we go on to the calculation of net wage or net salary, let us examine some of the methods of
remunerating employees and the terminology used in labour costing.

Employees may be remunerated by using any of the following methods:

Employees may be paid a fixed salary irrespective of the number of hours worked or the quantity
of work done
Employees may be paid an hourly rate. The amount an employee earns depends on the number
of hours worked
Employees may be paid for the work that he/she has performed (piecework) and not according
to the time taken to do the work. The employer thus pays only for work that has been done
The following terms are used in connection with labour costs: Normal time refers to remuneration
employees receive for working during normal working hours (e.g. 45 hours per week)
Overtime is the remuneration employees receive for work done beyond normal working hours
Idle time refers to time that is lost because of machine breakdown, power cuts, materials not
available etc. Idle time is usually not regarded as an overhead
Gross wage is the total remuneration (normal time, overtime, bonus etc) before any deductions
are made
Net wage is the gross wage less deductions (e.g. pension, medical aid, income tax etc)
Pension fund is a fund that employees contribute to in order to receive remuneration (pension)
when they retire. The employer may also contribute to the fund on behalf of the employees
Income tax is a compulsory deduction payable to the state. The employer deducts the money
according to the “Pay As You Earn” (PAYE) system

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 Management Accounting

Unemployment insurance fund is a fund that employees contribute to in order to receive

remuneration when they become unemployed. The employer also contributes to the fund on
behalf of the employees
Medical aid fund is a fund employees contribute to in exchange for having their medical
expenses (up to certain limits) paid from the fund. The employer may also contribute to the fund
on behalf of the employees

Practical Application or Example 4.2

The following example will be used show how net wage is calculated.

4.5 Wage Incentive Schemes

Wage incentive schemes are aimed at increasing the productivity of employees and to actually
reduce total production costs. Employees are granted additional or increased remuneration if their
performance is excellent and high productivity is maintained

4.5.1 Principles of wage incentive schemes

For wage incentive schemes to be successful they should adhere to certain principles. Some of
these principles include:

The system must be fair towards the employees

Employees must be paid their bonuses as soon as possible
The system must be understandable to employees
The standards set to qualify for the bonus must be realistic
Control measures must be put in place to ensure efficiency

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 Management Accounting

4.5.2 Examples of wage incentive schemes

Straight Piecework

Piecework remuneration involves paying an employee as follows:

Units produced X rate per hour

If an employee produces more than the target set, the rate per hour may be increased for the
additional units produced.

Practical Applications or Example 4.3

John is employed by a building contractor to tile floors and walls. The

standard time to tile 4 m2 is 20 minutes. He is paid R120 per hour and the
normal working time is 9 hours per day. If he tiles more than his quota, he
receives 1,5 times his hourly rate on the additional output. He tiled 124 m2 for
the day. Calculate his earnings for the day.

Taylor’s differential piecework system

Using this system an employee is paid according to extent he/she meets the predetermined
standards set. If an employee performs below standard, he/she receives lower remuneration than an
employee whose performance is standard. Employees whose output is above standard are
compensated at a higher rate per unit.

The system works as follows:

The standard rate per unit produced is first calculated.

The following formula may be used:

Standard rate per unit = Hours worked X Rate per hour________

Standard units expected to be produced

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 Management Accounting

A premium expressed as a percentage is determined for two categories of employees viz. those that
produce less than the standard units expected and those that produce the standard units expected
or more than the standard. For example, the premium for the first category may be 85% and the
premium for the second category may be 115%.

The remuneration is then determined for each employee as follows:

Number of units produced X Standard rate per unit X Premium

While this system is meant to discourage employees from not maintaining the standard, it may be
unfair on new employees.

Practical Applications or Example 4.4

Calculate the remuneration for each employee per day using Taylor’s
differential piecework system from the information given.

4.5.3 Halsey bonus system

Using this system, the employee is rewarded for the time he/she saves. Suppose an employee
manufactures 40 units in an eight-hour day for which the standard has been set at 32 units.

The employee has saved 2 hours for the day (8 units X 15 minutes’ production time per unit = 120
minutes). (The production time per unit is 8 hours [or 480 minutes] ÷ 32 = 15 minutes). The
employee will be compensated for his/her normal pay (8 hours per day) plus the additional 2 hours.

49
 Management Accounting

Practical Applications or Example 4.5

For example, Jacob’s normal wage is R32 per hour and his normal working
day is 8 [Link] has set a standard of 300 units per hour. On a
given day, Jacob produced 3 000 units within his 8-hour shift. A bonus of 50%
of the time saved is given to employees. Calculate the number of hours saved
by Jacob and his remuneration for the day.

4.6 Allocation of Direct Labour Costs

Direct labour costs are first calculated on an hourly basis and then allocated to the various cost
centres (e.g. products) in proportion to the number of hours worked. Accurate calculations are
essential to prevent under recovery or over recovery. Provision must also be made for holiday leave
and idle time. The gross salaries and wages, bonuses and the employer’s portion of fringe benefits
(e.g. pension, medical aid) must be allocated to the various cost centres.

50
 Management Accounting

Practical Applications or Example 4.6

The following information relates to an employee at MGM Ltd for the year
20.6.
Calculate the hourly recovery tariff of the employee.
Information

The following information relates to an employee at MGM Ltd for the year
20.6.
Calculate the hourly recovery tariff of the employee.
Information

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 Management Accounting

Revision Questions

1. Dube is employed by Restonic Manufacturers.

The following details relate to him for the third week of June 20.6.

Additional information
1. The income tax (PAYE) deduction is 18% of the taxable income.

2. The unemployment insurance fund deduction is 0,9% of the normal

wages. The employer contributes the same amount as the employee to
the fund.

3. The employee’s deduction for medical aid amounted to R150 for the
week. The employer contributes 1,5 times the amount the employees pay
to the fund.

4. Employees are remunerated at R24 per hour during normal working

hours.

5. Contributions to the pension fund is calculated on the normal time and is

made up as follows:

Employee’s deduction 7,5%

Employer’s contribution 11,25%
The normal working week is from Monday to Friday for 8 hours per day. Any
time worked in addition to this on weekdays and Saturdays is overtime
calculated at 1½ times normal rate.
Overtime on Sundays is remunerated at double the normal rate
Required
1. Calculate the net wage due to D. Dube for the third week of June 20.6.
2. Calculate the contributions made by Restonic Manufacturers for pension,

52
 Management Accounting

medical aid and unemployment insurance in respect of D. Dube for the week.
3. Compu Manufacturers produces a single product called Diskette A. The
basic hourly rate is R20 for all four production workers. The following is an
extract from the manufacturing records for the week ended 22 August 20.6:

Additional information
The normal working hours per week is 40

Overtime is paid at 1,5 times the normal rate

Standard production for all employees is 20 diskettes per hour

Required
Calculate the gross wage of all the employees for the week ending 22 August
20.6 using the straight piecework scheme (bonus is 1½ times the hourly rate
on the additional output).
4. Calculate the remuneration for each employee using Taylor’s differential
piecework system from the information given.
Information
Standard time allowed : 150 units per hour
Standard work day : 9 hours
Normal wage rate : R30 per hour
Premium : 80% of piecework rate if below standard
120% of piecework rate if standard or above
standard
Production of employees per day:
Tom: 1 250
Dick: 1 350
Harry: 1 500
5. Jim’s normal wage is R36 per hour and his normal working day is 9 hours.
Management has set a standard of 250 units per hour. On a given day, Jim
produced 2 500 units within his 9-hour shift. A bonus of 50% of the time saved
is given to employees (Halsey bonus system). Calculate the number of hours
saved by Jim and his remuneration for the day.
6 Manco Ltd has three employees whose basic salary is as follows:

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 Management Accounting

Each employee is entitled to 30 days’ pay vacation leave. Each employee

receives an annual bonus of 90% of the basic monthly salary payable in the
last month of the year. The employer contributes twice the amount that the
employees contribute to the pension fund. The employee’s pension deduction
is 8% of the basic salary and income tax is 18% on taxable income. The
employees work for 8 hours per day, five days per week. There are 12 public
holidays, of which 8 fall on weekdays.
Required
6.1. Calculate the net salary of each employee for the second month of the
year.
6.2. Calculate the hourly recovery tariff for each employee.
REMARKS
Annual bonus = 90% of the monthly salary

Employer’s contribution to pension fund = 16% of the basic annual

salary

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 Management Accounting

Answers

Practical Application or Example 4.2

The following information applies to Mrs J. Tladi, an employee of Dermat Ltd, who is paid
[Link] Mrs. J. Tladi’s net wage for the week. Also indicate the double entries to be
made in the books of Dermat Ltd.

Answer:

REMARKS

Gross wage = Normal wage + Overtime

Pension is calculated on normal pay (basic wage) and not on the gross wage i.e. no pension is
deducted from overtime pay
Taxable income = Gross wage – Pension deduction
Income tax (PAYE) is calculated on the taxable income and not on the gross wage.
UIF is calculated on the normal pay
Net wage = Taxable income – Other deductions

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 Management Accounting

Double entries in the books of Dermat Ltd:

The double entry relating to the calculation of the employee’s wage is:

Remarks

The double entry to pay off the liabilities is not done weekly (as shown above). Only the net wage is
paid weekly. The rest of the liabilities are settled at the end of the month. Of course the amounts in
respect of all employees are taken.

The employer’s contribution to the pension fund is calculated as follows : R900 X 6% = R54

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 Management Accounting

Practical Application or Example 4.3

John is employed by a building contractor to tile floors and [Link] standard time to tile 4
m2 is 20 [Link] is paid R120 per hour and the normal working time is 9 hours per [Link] he
tiles more than his quota, he receives 1,5 times hishourly rate on the additional [Link] tiled
124 m2 for the [Link] his earnings for the day.

Answer:

Practical Application or Example 4.4

Calculate the remuneration for each employee per day using Taylor’s differential piecework
system from the information given.

Answer:

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 Management Accounting

REMARKS

Harry is the only employee whose output (1 150 units) was below standard (1 200 units). That is
why 85% is used in calculating his remuneration.

Practical Application or Example 4.5

For example, Jacob’s normal wage is R32 per hour and his normal working day is 8 hours.
Management has set a standard of 300 units per hour. On a given day, Jacob produced 3 000
units within his 8-hour shift. A bonus of 50% of the time saved is given to employees.
Calculate the number of hours saved by Jacob and his remuneration for the day.

Answer:

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 Management Accounting

Practical Application or Example 4.6

Calculate the hourly recovery tariff of the employee.

Answer:

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 Management Accounting

Unit
5: Absorption Costing and Marginal
Costing

Unit 5: Absorption Costing and Marginal Costing

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 Management Accounting

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Introduce topic areas covered for the

5.1 Introduction unit

5.2 Difference between Marginal Costing Distinguish between absorption costing

and Absorption Costing and marginal costing

Formulate the income statements

according to both the absorption and
marginal costing methods

5.3 Preparing Income Statements According

to both the Marginal and Absorption Costing Calculate the net profit using the

Methods absorption costing and marginal

costing methods and be able to
reconcile the difference in the profits
calculated

5.4 Reconciliation of Profit Calculated Solve and reconcile the differences in

according to Marginal Costing with profit net profit between the two costing
methods
calculated according to Absorption Costing

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 Management Accounting

Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

62
 Management Accounting

5.1 Introduction
An important aspect of product costing is to calculate the manufacturing cost per unit. This is done by
dividing the total manufacturing cost for a particular period by the number of units produced during
this period. For example, if the total manufacturing costs for 30 000 units is R90 000, then the cost
per unit is R3. The availability of a unit manufacturing cost makes it easy to determine the
manufacturing costs of units sold and units on hand. This information has an impact on the
calculation of the net profit.

There are different opinions as to what should be included in the unit cost of manufacturing. Some
people favour absorption costing. Others favour marginal costing.
In absorption costing both the fixed cost and variable cost are included in the total manufacturing cost
of a product. In marginal costing only the variable cost is included in the manufacturing cost of a
product.

5.2 Difference Between Marginal Costing and Absorption Costing

In marginal costing (also called direct costing or variable costing), the manufacturing cost takes only
the variable manufacturing cost into account viz. direct material, direct labour and variable
manufacturing overheads. When marginal income is calculated all variable costs (including selling
and administrative costs) are taken into account. Fixed manufacturing overheads are considered to
be a period cost and are written off in the period in which they were incurred.

In absorption costing (also called total costing or full cost method) the manufacturing cost takes both
the variable and fixed manufacturing costs into account. Fixed manufacturing overheads are
classified as a product cost and not as a period cost (as is the case with marginal costing).

The following is a summary of product costs and period costs using both methods of costing:

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 Management Accounting

5.3 Preparing Income Statements According to Both the Marginal and Absorption Costing
Methods
The treatment of the period costs and product costs outlined above in the income statements of both
costing methods may be illustrated as follows:

The income statements can also be represented as follows:

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 Management Accounting

Income statements completed according to both costing methods will show the same net profit
provided that the number of units produced and the number of units sold are the same and that there
is no inventory on hand. If there is inventory on hand, the net profit computed for each costing
method will be different. The difference will be due to the fact that in absorption costing fixed
overheads are included in inventory valuation while in marginal costing they are treated as period
costs.

Practical Application or Example 5.1

Required:
Draft the income statement for June 20.6 using:
a. The marginal costing method
b. The absorption costing method

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 Management Accounting

There is a difference in the net profit calculated according to each costing method. This was due
to the fact that there was closing inventory on hand. Using the absorption costing method the
value of closing inventory includes both the variable and fixed manufacturing costs while with the
marginal costing method the value of closing inventory includes only the variable manufacturing
cost.
One could therefore say that the COST PRICE OF INVENTORY ON HAND is calculated
according to each of the two costing methods using the following costs:

5.4 Reconciliation of Profit Calculated According to Marginal Costing with Profit Calculated
According to Absorption Costing
In example 1 above, the difference in the net profit between the absorption costing method (R1 220
000) and the marginal costing method (R1 160 000) is R60 000. As mentioned earlier, the difference
is due to the fact that fixed manufacturing costs are included in calculating the closing inventory
using the absorption costing method. The difference in profit may be explained as follows:

This R10 per unit is included in the value of closing inventory using the absorption costing method.
Thus:
6 000 units (closing inventory) X R10 (fixed manufacturing cost per unit) = R60 000

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 Management Accounting

Revision Questions

The following information relates to the only product made by Bellini CC

during May 20.6:

Draft the income statement for May 20.6 using:

1. The Marginal Costing Method
2. The Absorption Costing Method
3. Reconcile the profit calculated according to absorption costing (in 5.1.2)
with the profit calculated according to marginal costing (in 5.1.1).
4. Draft the income statements for May 20.6 using the marginal costing
method and the absorption costing method but assume that all the goods
manufactured (9 000 units) have been sold and that there is thus no closing
inventory. Prove that the net profit calculated using both costing methods will
be the same.

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 Management Accounting

Answers

Practical Application or Example 5.1

Draft the income statement for June 20.6 using:

a. The marginal costing method

Answer:

REMARKS
Closing inventory = 30 000 (manufactured) – 24 000 (sold) = 6 000 units
Closing inventory is valued at R25 per unit calculated as follows:
Variable manufacturing cost
Number of units manufactured

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 Management Accounting

= R750 000
30 000
= R25 (variable manufacturing cost per unit)

b. The absorption costing method

Answer:

REMARKS
*Closing inventory = 30 000 (manufactured) – 24 000 (sold) = 6 000 units

*Closing inventory is valued at R35 per unit calculated as follows:

Total manufacturing cost____

Number of units manufactured

= R1 050 000
30 000
= R35 (manufacturing cost per unit)

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 Management Accounting

Unit
6: Cost-Volume-Profit
Analysis
Unit 6: Cost-Volume-Profit Analysis

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 Management Accounting

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Introduce topic areas covered for the

6.1. Introduction unit

Outline the importance of cost-volume-

profit analysis as a management
accounting tool and perform the
relevant calculations between the two
6.2. Marginal Income Statement costing methods

Classify what is meant by cost-volume-

profit analysis

Classify the concept of marginal

income and an example thereof

Calculate the break-even point of a

6.3. Cost-Volume-Profit Analysis using the firms’ output
Marginal Income Approach
Examine and calculate the break- even
value using the marginal income ratio
method

Produce a marginal income statement

that will provide the necessary
information required for cost-volume-
profit analysis
6.4. Applying the Cost-Volume-Profit
Analysis Evaluate and calculate the sales
required to attain a targeted net profit

Calculate the margin of safety

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 Management Accounting

6.5. Applying the Cost-Volume-Profit Report the effect on the cost-volume-

Analysis with changes in selling price, profit- analysis when there are changes

variable costs, fixed costs and number of in selling price, variable costs, fixed

products marketed costs and number of products marketed

Analyse the limiting Assumptions of

6.6. Limiting Assumptions of Break-Even Break-Even and Cost- Volume-Profit
and Cost- Volume-Profit Analysis Analysis

6.7. Summary of the Ratios Formulate the ratios

Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

72
 Management Accounting

6.1 Introduction
Cost-volume-profit (CVP) analysis is used to explain how profits and costs change with a change in
volume. In particular, it examines the effect on profits when there are changes in factors such as
selling price, variable costs, fixed costs, volume and the number of products marketed. CVP analysis
puts management in a better position to cope with various short-term planning decisions.

Using CVP analysis, managers would be able to get information relating to the following:

How profits are affected by a change in costs

What effect a change in sales volume will have on profit
The profit that is expected from a certain sales volume
How many units need to be sold to achieve a targeted profit
At what output of production will the income and costs be the same

6.2 Marginal Income Statement

The traditional income statement that we learnt in financial accounting does not distinguish between
fixed costs and variable costs. Consequently, its use is limited as far as management accounting is
concerned.

Cost information needs to be in a format that makes the task of management easier when doing
planning, control and decision-making. The marginal approach to drawing up an income statement
where fixed and variable costs are available is more suitable. Using this approach all expenses are
classified as fixed or variable.

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Practical Application or Example 6.1

The following is an example of a traditional income statement and a marginal

income statement:

6.3 Cost-Volume-Profit Analysis Using the Marginal Income Approach

CVP analysis is based on the marginal income approach. The marginal income statement is useful
when determining the effects of changes in selling price, cost or volume on profit. A proper
understanding of fixed and variable costs is needed for CPV analysis.

The following example will be used to illustrate the CVP analysis:

Practical Application or Example 6.2

The following is a budgeted marginal income statement of Mobeen Ltd, a

manufacturer of a single product called component X.

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6.3.1 Marginal income

Marginal income is the excess of sales over the variable costs. It refers to the amounts of money
available to cover firstly the fixed costs and then to generate profits. If the fixed costs are greater than
marginal income, then a loss will result.

Practical Application or Example 6.3

If Mobeen Ltd sells only one item of component X, the income statement will
appear as follows:

For each additional unit of component X that Mobeen Ltd sells, an additional R10 marginal income
becomes available to cover the fixed costs.

The increase in the total costs as a result of an additional unit being manufactured is called marginal
costs. Marginal costs may therefore be seen as the total variable costs incurred to manufacture or
market a product.

6.3.2 Calculation of break-even point (using the marginal income method)

The volume of sales at which marginal income is equal to fixed costs is called the break-even point.
The break-even point can also be called the point of no profit and no loss. The break-even quantity is
the minimum quantity that must be sold to ensure that fixed cost are covered.

Break-even quantity can be calculated using the marginal income method as follows:

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Practical Application or Example 6.4

Using the figures from example 2, break-even quantity may be calculated as

follows:

The break-even value (i.e. break-even point in Rands) is calculated as

follows:

Practical Application or Example 6.5

Using the figures from example 2, break-even value may be calculated as

follows:

To reach break-even point during July 20.6 Mobeen Ltd needs to sell 20 000
units.
This can be proven as follows:

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6.3.3 Calculating break-even value using the marginal income ratio method

Variable costs and marginal income may be expressed as a percentage of sales. Using the figures
from example 2 (Mobeen Ltd), this can be illustrated as follows:

Marginal income ratio (also called profit volume ratio) is the percentage of marginal income to sales.

Marginal income ratio may be expressed as follows:

Practical Application or Example 6.6

The marginal income ratio for Mobeen Ltd is:

The break-even value may be calculated as follows:

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Practical Application or Example 6.7

The break-even value for Mobeen Ltd is calculated as follows:

6.4 Applying The Cost-Volume-Profit Analysis

The information contained in example 2 (Mobeen Ltd) will be used to illustrate the application of CVP
analysis. This information is reproduced below:

6.4.1 Calculation of sales required to attain a targeted net profit

Cost-profit-volume analysis may be used to determine the sales required to attain a targeted net
profit. This can be done in one of two ways. The first is as follows:

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Practical Application or Example 6.8

If Mobeen Ltd targets a net profit of R40 000 from the sale of component X,
the sales required will be as follows:

The second way of calculating the required sales for a targeted net profit is as
follows:

Practical Application or Example 6.9

The sales required by Mobeen Ltd to realise a profit of R40 000 is:

6.4.2 Margin of safety

The margin of safety is the amount by which the actual level of sales exceeds the break-even point.
It is the amount by which the sales volume may drop before losses are incurred. The margin of
safety may be expressed in value or in units:

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 Management Accounting

Practical Application or Example 6.10

The margin of safety for Mobeen Ltd is:

6.5 Applying the Cost-Volume-Profit Analysis with Changes in Selling Price, Variable Costs,
Fixed Costs and Number of Products Marketed
Thus far it has been assumed that factors such as prices, costs and volumes remained the same. We
are now going to examine the application of the cost-volume-profit analysis with changes in selling
price, variable costs, fixed costs and number of products marketed.

To illustrate this the following information from example 2 (Mobeen Ltd) will be utilized.

6.5.1. Change in selling price

Whenever enterprises increase the selling prices of their products, the result is usually a drop in
sales volume. The decrease in sales is the result of consumer reaction to the price increase. The
cost-volume-profit (CVP) analysis can be used by management to determine the level to which sales
volume can decline before this impacts negatively on its targeted profit.

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Practical Application or Example 6.11

Mobeen Ltd plans to increase the selling price of component X by 10% and
targets a profit of R40 000. Using the information from example 2 (reproduced
above), calculate the quantity of component X that must be sold (rounded off
to nearest whole number) to:
1. Break Even
2. Achieve the targeted profit

6.5.2 Change in variable cost

If management can succeed in reducing variable costs, then the number of units needed to achieve
a targeted profit will fall. This is illustrated as follows:

Practical Application or Example 6.12

Using the information from example 2, suppose Mobeen Ltd succeeds in

reducing variable costs by 10% (with the selling price remaining at R40). The
targeted profit is R40 000.
Required
1. Calculate the quantity of component X that must be sold (rounded off to
nearest whole number) to break even
2. Achieve the targeted profit

6.5.3 Change in number of products marketed

Break-even calculation becomes complicated when more than one product is marketed. As each
product has its own marginal income ratio, a sales mix is determined so that a marginal income ratio
based on the weighted average is calculated in order to determine break-even quantity and value.
This is illustrated as follows:

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Practical Application or Example 6.13

XYZ Enterprises manufactures and sells 3 different products viz. product X,

product Y and product Z. The following details apply:

Required
Calculate the break-even quantity and break-even value for each product.

6.6 Limiting Assumptions of Break-Even and Cost-Volume-Profit Analysis

The Break-Even and Cost-Volume-Profit Models Discussed Above Are Based On Some Limiting
Assumptions:

All costs are classified as either fixed or variable

Variable costs are affected only by volume
The behaviour of both sales income and expenses is linear
There is only one product
Inventories do not change a great deal from one period to the next

6.7 Summary of The Ratios

1.

2.

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3.

4.

5.

6.

7.

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Revision Questions

Complete the following sentences with the most appropriate answers.

1. The difference between sales and variable expenses is called
____________.
2. Break-even point is reached when ____________ is equal to
____________.
3. The _________is the amount by which the actual level of sales exceeds
the break-even point.
4. The break-even point will ____________ if there is an increase in fixed
costs.
5. One of the key assumptions underlying break-even analysis is that costs
are classified as either ____________ or ____________.
2. Bysan Ltd plans to manufacture a new product and the following
information is applicable

Required:
2.1 Calculate the break-even quantity
2.2 Calculate the break-even value
2.3 Calculate the break-even value using the marginal income ratio
2.4 Calculate the selling price per unit if the profit per unit is R2
3. AIM Ltd supplies component J to furniture manufacturers. The marketing
manager is of the opinion that if the selling price of component J is reduced,
sales could increase by 25%. The following information is available:

Required:
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3.1 Calculate the expected profit or loss on the marketing manager’s proposal
3.2 Calculate the number of sales units required under the proposed price to
make a profit of R60 000
3.3 Calculate the sales value required under the proposed price to make a
profit of R60 000
4. Yashik CC manufactures one product. The following details relating to the
product applies:

4.1 Calculate the marginal income ratio

4.2 Calculate the break-even quantity and break-even value
4.3 Calculate the margin of safety in terms of units and value
5. Kivi (Pty) Ltd manufactures and sells only one product. The budgeted
details for 20.7 are as follows

Required:
5.1 Calculate the budgeted profit for 20.7.
5.2 Calculate the break-even quantity and value
5.3 Suppose Kivi (Pty) Ltd wants to make provision for a 10% increase in
fixed costs and an increase in variable costs by R0,20 per unit.
Taking these increases into account, calculate the following:
5.3.1 New break-even quantity and value
5.3.2 Safety margin (in terms of value)
5.3.3 The number of units that need to be sold to earn a net profit of R400
000
6. Multi Vit Ltd has the following sales mix (fixed costs amount to R300 000):

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Required:
6.1 Calculate the total break-even value
6.2 Calculate the break-even value for each product.
(Assume that the selling price per unit of each product is the same.)

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Answers
Practical Application or Example 6.11
Mobeen Ltd plans to increase the selling price of component X by 10% and targets a profit of
R40 000. Using the information from example 2 (reproduced above), calculate the quantity of
component X that must be sold (rounded off to nearest whole number) to:

1. Break Even

Answer:

2. Achieve the targeted profit

Answer:

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Practical Application or Example 6.12

Using the information from example 2, suppose Mobeen Ltd succeeds in reducing variable
costs by 10% (with the selling price remaining at R40). The targeted profit is R40 000.

1. Calculate the quantity of component X that must be sold (rounded off to nearest whole
number) to break even

Answer:

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2. Achieve the targeted profit

Answer:

Practical Application or Example 6.13

Calculate the break-even quantity and break-even value for each product.

Answer:

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Unit
7: Budgets and
Budgetary Control
U n i t 7 : B u d g e t s a n d B u d g e t a r y C o n t r o l

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Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Introduce topic areas covered for the

7.1 Introduction unit

7.2 Concepts of Budgets and Budgetary Classify budgets and budgetary control
Control

Discuss the principles of effective

7.3 Principles of Effective Budgeting budgeting

7.4 Advantages of Budgets and Budgetary Outline the advantages of budgets and

Control budgetary control

Explain the disadvantages of budgets

7.5 Disadvantages of Budgets and budgetary control

Discover the importance of budgets

7.6 Preparation of Budgets and budgetary control and be able to

prepare the various types of budgets

Explain the processing of a zero-based

7.7 Zero-Based Budgeting budgeting balance sheet

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Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

93
 Management Accounting

7.1 Introduction
Proper planning and effective control of costs are important if an enterprise wishes to maximize
profit. Budgets and budgetary control are important management tools that assist management in
planning and cost control.

7.2 Concepts of Budgets and Budgetary Control

It is important to distinguish between these two terms as they are not the same.

7.2 1 Budgets

A budget may be described as a plan expressed in financial terms. It is the path that must be
followed from the present time to the future. A budget must reveal the plans to achieve the objective
of the enterprise for a given period.

7.2.2 Budgetary Control

As indicated above a budget is the path that an enterprise must follow to achieve its objective.
Budgetary control, on the other hand, includes measures put into place to monitor any deviations
from the path and to ensure that the objective is realised within the budgeted period. This can be
achieved by regularly comparing actual results with the budgeted targets. Budgetary control must
ensure that deviations from the plan are analysed and if necessary remedial measures are put in
place to remedy or prevent problems that may occur.

7.3 Principles of Effective Budgeting

The following principles are useful for those responsible for the budgeting process:

The objective(s) that need to be achieved must be discussed.

Those involved in the budgeting process must work in harmony and apply common sense during the
process.

They must realise that there is an inter-relationship of the various budgets

All workers, supervisors and managers whose inputs are required to draw up budgets should be
given an opportunity to participate in the budgeting process
It must be decided how to share scarce resources
A timetable should be prepared for the preparation of budgets so that they are completed well in
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advance of the budgeted period

Budgets must be flexible to allow for changes that may become necessary once they have been
implemented
The actual results and budgeted figures need to be monitored regularly to detect any deviations

7.4 Advantages of Budgets and Budgetary Control

They act as a mean to achieving the objectives of the enterprise.

Manufacturing costs can be carefully planned and controlled

Budgetary control facilitates the delegation of authority
Budgets can motivate managers and employees to better performance
Budgets can provide a basis for a system of control of employees
Budgets promote forward thinking and the identification of possible problems

7.5 Disadvantages of Budgets

Predictions cannot be totally accurate as the information used to prepare budgets is obtained from
estimates.

If targets are badly set, they may stifle the enthusiasm and flair of managers and employees
Managers may spend to the limit of their budgets, although this may be wasteful
If budget targets are set at a more difficult level than can be achieved, comparing actual results
with the budget becomes less meaningful
Budgets cannot be perfect since they have to adapt to changing circumstances

7.6 Preparation of Budgets

The main budget called the master budget is developed from the operating budget and the financial
budget. The operating budget consists of the sales budget, production budget, direct labour budget,
factory overhead budget, inventory budget, selling and administrative budget and budgeted income
statement. The financial budget consists of the cash budget and budgeted balance sheet.

For the purposes of this module, the preparation of the sales budget, cash budget, budgeted income
statement and budgeted balance sheet will be discussed.

7.6.1 Sales budget

The reliability of the sales budget is important as all other budgets are based on it. After the number
of units that may be sold is estimated, the number of units that can be produced may be determined.
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Whilst the sales budget depends a lot on previous sales figures, consideration is also given to sales
trends, future predictions and competitors. A sales budget may be described as a forecast of the
number of units the enterprise expects to sell for a predetermined period

Practical Application or Example 7.1

The following is the sales forecast (in units) of Manco Ltd that
manufactures two products viz. product X and product Y:

The selling price per unit of product X is R20 and the selling price of product
Y is R30.
All sales are on credit.
Collections from debtors are as follows:
50% is collected during the month of sale.

30% is collected in the following month.

15% is collected in the second month after the sale.

The balance is written off as bad debts at the end of the second month after
the sale.
Required
1. Prepare a sales budget for the period 1 December 20.6 to 31 January 20.7.
2. Prepare a schedule of collections from debtors for the period 1 December
20.6 to 31 January 20.7

7.6.2 Cash Budget

Once all the other budgets including the sales budget are prepared, the cash budget can be drawn
up. The cash budget shows the expected receipts and expected payments for a certain period of
time. It usually depicts the monthly cash position of the enterprise. The cash budget is prepared for
the purpose of cash planning and control. It helps in avoiding to keep cash lying idle for long periods
and identifying possible cash shortages.

Note that a cash budget only involves amounts that affect the cash balance of the enterprise.
Therefore, non-cash items such as depreciation, bad debts, discount allowed and discount received
are not included. Since budgets are used internally by an enterprise, the style may vary from
business to business.
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However, most cash budgets have the following features:

The budget period is broken down into sub-periods usually months

Receipts of cash are identified and totalled
Payments of cash are identified and totalled
The surplus (or shortfall) in cash for each month is calculated (receipts minus payments)
The closing cash balance is calculated by taking into account the cash surplus (or shortfall) and
the opening cash balance

The following example illustrates how a cash budget is prepared.

Practical Application or Examples 7.2

The following information is available for Timbuk Enterprises:

1. On 31 March 20.6 the bank account in the general ledger reflected a
debit balance of R20 000.
2. Sales figures before taking any discounts in respect of cash or credit
sales are:

3. The following discounts are given as incentives to customers:

12% on cash sales
5% on credit sales if accounts are settled after 30 days
4. Collections from debtors are expected to be as follows:
50% 30 days after the sale
30% 60 days after the sale
18% 90 days after the sale
2% written off after 90 days
5. 50% of the material purchased is bought on credit.
Creditors are usually paid as follows:
70% within the same month of the purchase
30% 30 days after the purchase.
6. Payment of overhead costs and selling and administrative costs are
delayed by one month. Selling and administrative costs are as follows:
March (actual) R6 500

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April (expected) R7 000

May (expected) R7 200
June (expected) R8 000
7. Employees involved in the production of finished goods are paid wages.
Since wages are paid on specific days, only 75% of a month’s budgeted
wages are paid in that month. The rest are paid in the following month.
8. The proprietor is expected to increase her capital contribution by R50 000
in June 20.6.
9. The production records for finished goods reveal the following:

Required
1. Prepare the debtors collection schedule for the period 01 April to 30 June
20.6.
2. Prepare a creditors payment schedule for the period 01 April to 30 June
20.6.
3. Prepare the cash budget for the period 01 April to 30 June 20.6.

7.6.3 Budgeted Income Statement and Budgeted Balance Sheet

Once the sales budget, purchases budget, production budget and expenses budget have been
prepared, the budgeted income statement can be prepared. The budgeted income statement is a
summary of the various component projections of income and expenses for the budget period.

A Budgeted Balance Sheet is prepared by starting with the balance sheet for the period just ended
and adjusting it using all the activities which are expected to take place during the budgeted period.
A budgeted balance sheet can help management to calculate a variety of ratios. It also highlights
future resources, obligations and possible unfavourable conditions.
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The following example illustrates how a budgeted (projected) income statement and balance sheet is
drawn up.

Practical Application or Examples 7.3

The following is an abridged balance sheet of KMS Manufacturers on 31

December 20.6.
KMS Manufacturers
Balance Sheet as at 31 December 20.6

Additional information
1. Costs for the year ended 31 December 20.6 are as follows:

2. The gross profit for the year ended 31 December 20.6 amounted to R80
000.
3. Budgeted sales for 20.7 are as follows:

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4. Fixed costs for 20.7 will be the same as for 20.6.

5. Variable costs will vary in the same ratio to sales as for 20.6.
6. Fixed costs include depreciation on the machinery. Depreciation is 10%
p.a. on cost. The cost price of the machinery is R200 000.
7. KMS Manufacturers plan to extend the factory during January 20.7. The
cost of the extension is expected to be R200 000 and ten monthly instalments
of R20 000 will commence on 01 February 20.7.
8. Inventory and debtors are expected to be equal to two (latest) months’
sales.
9. The amount owing to creditors is expected to equal two (latest) months’
purchases of direct materials.
10. Selling and administrative expenses are estimated to be 7% of the sales
for each quarter.
Required
1. The budgeted income statement for each quarter of 20.7.
2. The budgeted balance sheet on 31 December 20.7.

7.7 Zero-Based Budgeting

Traditional budgeting tends to concentrate on the incremental change from the previous year. The
focus is on examining what happened last year with some adjustments for any changes in factors
(like inflation) that may affect the budgeted period.

With zero-based budgeting cost estimates are built up from zero level and it rests on the philosophy
that all spending must be justified. It is not automatically accepted that if some activity was financed
this year it will be financed again in the future. A good case must be made for the allocation of scarce
resources for that activity.
The basic steps in zero-based budgeting are:

Describe each activity in the organisation in a “decision” package

Analyse, evaluate and rank the packages in order of priority on the basis of the cost-
Benefit analysis

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Resources are allocated accordingly

Zero-based budgeting forces managers to think carefully about certain activities and the way they
are undertaken. This approach should result in more effective use of resources. However, zero-
based budgeting is time-consuming and expensive to undertake. It appears to be more suited to
enterprises that do not have a profit motive

Revision Questions

The following information is available for Thandi Enterprises for 20.6.

1.

2. Credit sales is expected to be collected as follows:

60% after 30 days (A discount of 5% is allowed to debtors who pay after 30
days.)
25% after 60 days
10% after 90 days
5% is written off as bad debts.
3. Customers who buy for cash receive a 10% discount. (The sales figures
provided are before any discount.)
4. Salaries, wages and sundry expenses are settled in cash.
5. Seventy percent of all purchases are on credit and are paid one month
after the purchases.
6. Sundry expenses include depreciation of R4 000 per month.
7. The cash in the bank on 31 March was R25 200.
Required
1. Prepare a debtor’s collection schedule for the period 01 April to 31 May
20.6
2. Prepare a cash budget for the period 01 April to 31 May 20.6
The following information has been obtained from Aliwal Ltd:
Total sales figures (actual and budgeted) are:

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The abridged balance sheet on 31 March 20.6 is as follows:

Balance Sheet as at 31 March 20.6

1. Rent amounts to R240 000 per annum and is payable monthly.

2. Selling and administration expenses are estimated to be 25% of sales and
are payable in the same month as the sale.
3. The gross profit percentage on sales is 60%.
4. Depreciation on fixed assets for the year amount to R28 000.
5. Cash sales account for 20% of total sales. Credit sales (80%) are usually
collected as follows:
80% 1 month after the sale
20% 2 months after the sale.
6. Thirty percent (30%) of all purchases are for cash. The total purchases are
as follows:

7. Creditors are paid in full in the month after the purchase.

8. All other expenses are paid monthly and are expected to amount to R22
000 per month.
Required:
3. Prepare a monthly cash budget for April, May and June 20.6
4. Prepare a budgeted income statement for the 3 months ended 30 June 20

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5. Prepare a budgeted balance sheet on 30 June 20.6

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Answers

Practical Application or Example 7.1

1. Prepare a sales budget for the period 1 December 20.6 to 31 January 20.7.

Answer:

Sales Budget

2. Prepare a schedule of collections from debtors for the period 1 December 20.6 to 31
January 20.7

Answer:

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Practical Application or Example 7.2

1. Prepare the debtors collection schedule for the period 01 April to 30 June 20.6.

Answer:

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REMARKS
Collections of credit sales for each month are calculated as follows:

2. Prepare a creditors payment schedule for the period 01 April to 30 June 20.6.

Answer:

REMARKS
50% of the purchase of materials is on credit. Payments to creditors each month are calculated as
follows:

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3. Prepare the cash budget for the period 01 April to 30 June 20.6.

Answer:

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Practical Application or Examples 7.3

1. The budgeted income statement for each quarter of 20.7.

Answer:

REMARKS

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2. The budgeted balance sheet on 31 December 20.7.

Answer:

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Unit
8:
Standard Costing

U n i t 8 : S t a n d a r d C o s t i n g

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Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Classify the concept of standard

8.1 What are Standard Costs? costing

Explain the advantages of standard

8.2 Advantages of Standard Costing costing

8.3 Material Standards and Variances Compute material variances

8.4 Labour Standards and Variances Calculate the various labour variances

8.5 Manufacturing Overheads Standards Calculate the manufacturing overheads

and Variances standards and variances

8.6 Sales Variances Calculate the various sales variances

Understand and know the summary of

8.7 Summary of formulas formulae

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Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

113
 Management Accounting

8.1 Introduction
What Are Standard Costs?

A standard cost is a predetermined target cost that aims to provide a benchmark against which to
measure actual performance. Factors such as quantities, prices, rates of pay and quality are
considered in the setting of a standard.
Standards may be set for materials, labour, manufacturing overheads and selling prices. The
standard cost is determined by multiplying the standard quantity of an input by its standard price.
One of the important tasks of management is to evaluate performance by comparing actual costs
with standard costs. The difference between actual costs and standard costs is called the variance.
All variances are the result of two factors viz. price and quantity. The variance could be either
favourable or unfavourable to the enterprise.

8.2 Advantages of Standard Costing

Control is exercise over the production process through the calculation and analysis of variances
Standard cost serve as a benchmark against which actual costs can be measured.
Greater control is exercised over the various costs
The analysis of cost reports by management is facilitated
Standard costs make it easier to value inventories
The introduction of standards usually leads to greater efficiency

8.3 Material Standards and Variances

When material standards are set consideration is given to prices, quantity, quality, grades, wastages
etc. A price and a quantity standard are set for material. The standard material price is usually based
on past, present and expected future prices and also gives consideration to economic order
quantities, suppliers’ quotations and market factors. The standard material quantity specifies the
quantity required to manufacture one unit of a completed product.

Two main variances can occur with respect to material viz. a price variance and a quantity variance.

8.3.1 Material Price Variance

Two methods may be used to calculate material price variance viz. the purchase price variance and
the issue price variance.

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1. Purchase Price Variance

The purchase price variance is calculated when the material is received and occurs when the actual
price is not the same as the standard price. The purchasing department is responsible for any
material price variance that may arise e.g. incorrect calculation of discounts and delivery
costs. However, material price variances may be the result of mistakes made when the standard
price was set and unexpected price changes.

The variance is calculated by subtracting the actual cost of the quantity purchased with the standard
cost for the same quantity.

The following formula may be used to calculate purchase price variance.

2. Issue Price Variance

Issue price variance is calculated when raw materials are issued to production. It is based on the
number of units issued and used. It is the difference between the actual quantity issued at actual cost
and the actual quantity issued at standard price.

The formula to calculate issue price variance is similar to purchase price variance except that the
actual quantity (AQ) now refers to actual quantity issued instead of actual quantity purchased.

The formula for issue price variance is:

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8.3.2 Material quantity variance

This variance is the difference between the actual quantity of material used (at the standard price)
and the standard quantity of material allowed (at standard price). Assume that 2 kg of raw material is
used to manufacture one unit of a finished product. If 200 units are manufactured, then the standard
material quantity allowed is 400 kg (200 X 2 kg).

The production department is responsible for any material quantity variances that might occur e.g.
poor control over materials. However, variances may be due to faulty standards and changes in the
quality of the material supplied.

The formula to calculate the material quantity variance is:

The total material variance i.e. the total of the material price and quantity variances may be
calculated as follows

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Practical Application or Example 8.1

The standard cost of material of product C for the third quarter of 20.6 was:
4 kg per unit at R3 per kg
45 000 kg of material was purchased at R2,80 for the third quarter.
The actual production of product C for the third quarter of 20.6 was:
9 000 units which took 37 000 kg of material
Required:
In respect of material, calculate the following variances:
1. Purchase Price Varieance
2. Issue Price Variance
3. Quantity Variance
4. Total material variance for the 37 000 kg of material issued

8.4 Labour Standards and Variances

Labour standards are set in terms of rate (tariff) and efficiency (time). With respect to rate, wages
scales that have been devised for various types of labour usually form the basis of the rate
standards. Efficiency relates to how long it should take to complete a task. Efficiency standards are
set with the help of work study and in particular work measurement. Let us examine the two
variances concerning labour viz. labour rate variance and labour efficiency variance.

8.4.1 Labour Rate Variance

The labour rate variance is calculated by multiplying the difference between the standard rate and
the actual rate to the number of hours worked. Labour rate variance formula is:

The personnel manager will usually be responsible for this variance. However, the variance could be
ascribed to change to wage rates, unscheduled overtime, use of lower skilled workers with lower pay
etc.

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8.4.2 Labour Efficiency Variance

This variance is related to the time it takes to manufacture a single product. It is calculated by finding
the difference between the actual hours worked (at standard rate) and the standard time (hours)
allowed for the actual production (at standard rate).

The formula is:

The manager responsible for the supervision of labour is usually responsible for this variance.
However, this variance may be due to the quality of supervision, skill of employees, interruptions in
production etc

Practical Application or Example 8.2

Details relating to labour in the production department of AMI Ltd are as

follows:

Required:
Calculate the following:
1. Labour Rate Variance
2. Labour Efficiency Variance
3. Total Labour Variance

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8.5 Manufacturing Overheads Standards and Variances

Manufacturing overheads may be classified as fixed or variable and standards are set separately.
Variable costs (the same for each product) change in direct proportion to level of business
activity. The fixed overhead rate is calculated according to a predetermined level of business activity.

Manufacturing overhead variances may be due to equipment lying idle, absenteeism, changes in
demand, efficiency of employees, working conditions etc.

Separate variances in respect of fixed and variable manufacturing may be calculated as follows:

Variable manufacturing overheads variance

Overhead rates are often based on direct labour hours (used in this module) or machine hours.
The efficiency variance is calculated as follows:

The expenditure variance is calculated as follows:

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Practical Application or Example 8.3

The budgeted figures of GHI Manufacturers for August 20.6 are as follows:

Required
Calculate the following variable manufacturing overheads variances:
1. Efficiency Variance
2. Expenditure Variance
3. Total Variable Overheads Variance

8.5.1 Fixed manufacturing overheads variance

The total fixed overheads variance is the difference between the actual fixed overheads and the
standard fixed overheads allowed. The expenditure variance and the volume variance are the main
fixed manufacturing overheads variances.

The expenditure variance is calculated as follows:

The volume variance is calculated as follows:

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Practical Application or Example 8.4

Refer to the information provided in example 3 and calculate the following

fixed overhead variances:
1. Expenditure Variance
2. Volume Variance
3. Total Fixed Overheads Variance

8.6 Sales Variances

When one kind of product is manufactured, the sales variances will be related to the price and
quantity.

Sales price variance is calculated as follows:

Sales quantity variance is calculated as follows:

Practical Application or Example 8.5

Required to calculate the following:

1. Sales Price Variance
2. Sales Quantity Variance

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8.7 Summary of Formulas

1. Material Variances

2. Labour Variances

3. Variable Manufacturing Overheads Variance

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4. Fixed Manufacturing Overheads Variance

5. Sales Variances

Revision Questions

A standard quantity of 2 kilograms of material Z at a standard price of R4 per

kilogram is allowed for the production of one unit of product Zeplin. The cost
figures for the first quarter of 20.6 showed that 4 400 kg of material Z was
purchased at R4,20 per kg. 2 000 units of product Zeplin were produced
using 4 200 kg of material Z.
1. Required:
In respect of material, calculate the following variances:
1.1 Purchase price variance
1.2 Issue Price Variance
1.3 Quantity Variance
1.4 Total material variance for the 4 200 kg of material issued
To produce one unit of product Zeplin a standard quantity of 4 direct labour
hours at a standard rate of R6 per hour is allowed. The wage records show
that it took 2 100 hours at R5,90 per hour to produce 500 units of product
Zeplin

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2. Required
Calculate the following Labour Variances
2.1 Labour Rate Variance
2.2 Labour Efficiency Variance
2.3 Total Labour Variance
A manufacturer that manufactures product J provides the following
information for May 20.6: Budgeted figures:

3. Required:
Calculate the following variable manufacturing overheads variances:
3.1 Efficiency Variance
3.2 Expenditure Variance
3.3 Total Variable Overheads Variance
4. Required
Calculate the following fixed manufacturing overheads Variances:
4.1 Expenditure Variance
4.2 Volume Variance
4.3 Total Fixed Overheads Variance
The folloiwng information was provivided by GHI Manufactureres for April
20.6:

5. Required
Calculate the following:
5.1 Sales Price Variance

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5.2 Sales Quanitity Variance

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Answers

Practical Application or Example 8.1

In respect of material, calculate the following variances:

1. Purchase Price Varieance

Answer:

2. Issue Price Variance

Answer:

3. Quantity Variance

Answer:

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4. Total material variance for the 37 000 kg of material issued

Answer:

Practical Example 2

Calculate the following:

1. Labour Rate Variance

Answer:

2. Labour Efficiency Variance

Answer:

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3. Total Labour Variance

Answer:

Practical Example 3

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Practical Example 4

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Practical Example 5

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Unit
9: Capital Investment
Appraisal
Unit 9: Capital Investment Appraisal

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Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES FOR THIS UNIT

Introduce topic areas covered for the

9.1 Introduction unit

Classify the concept of present value of

9.2 Present Value of Money money

Choose techniques to evaluate capital

investment projects
9.3 Capital Investment Appraisal Using
Techniques that ignore the Time Value of
Money Outline techniques to evaluate capital
investment projects

9.4 Capital Investment Appraisal Using Explain the techniques used to

Discounted Cash Flow Methods evaluate the capital investment projects

Discuss the impact of income tax,

9.5 Influence of Income Tax, Depreciation depreciation and scrap value on the
and Scrap Value capital investment decision

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Prescribed and Recommended Reading(s)/Textbook(s)

Prescribed Reading(s)/Textbook(s)
Chadwick, L. P. (2020) Management Accounting. Custom edition for MA
6. Durban: MANCOSA

Els, G. Meyer, L. van der Walt, R. and de Wet, S.R. (2022)

Fundamentals of Cost and Management Accounting. Ninth Edition.
Durban: LexisNexis

Recommended Reading(s)/Textbook(s)
Asiaei, K. Bontis, N. and Alizadeh, R. (2022) Business Strategy. Green
Intellectual Capital and Environmental Management Accounting: Natural
Resource Orchestration in favour of Environmental Performance. Wliey
Online library

Chadwick, L. (2020) The Essence of Management Accounting. Second

Edition. United States of America: Pearson

Schaltegger, S. Christ, L. and Wenzig, L. (2022) Corporate Sustainability

Management Accounting and multi-level links for sustainability - A
Systematic Review. Journal of Management. Wiley Online Library

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9.1 Introduction
Capital investment appraisal is also known as capital budgeting. A capital budget is a financial plan
for the replacement of fixed assets. Capital investments involve large sums of money and are usually
financed from retained earnings, issue of shares or long-term borrowing. Management must be
convinced of the profitability of these capital investments before a final decision is taken because:

Large amounts of resources are usually involved

It is difficult and/or expensive to cancel an investment once it has been made

9.2 Present Value of Money

A sum of money today has a greater value than the same amount at any time in the future. This may
be due to the effects of inflation, risk and loss of interest. The present value of money is very
important in capital investment appraisal. A simple illustration of this is as follows:

Practical Application or Example 9.1

Suppose Jack decides to sell his second-hand computer to Jill. Jill makes two
proposals to Jack regarding the payment:
The first proposal is to pay R 980 immediately

The second proposal is to pay R1 100 in one year’s time

Required
Determine which proposal Jack must accept if the current rate for investments
is 10% p.a.

Present value tables

In order to eliminate the number of steps to calculate the present value of any amount, present value
tables are available. The present value of R1 can be read from the tables. Two tables (Table 1 and
Table 2) are available and appear at the end of this chapter. Table 1 shows the present value of R1
at various interest rates receivable after n years (n can represent any number). Table 2 reflects the
present value of R1 at various interest rates receivable annually for n years.

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Practical Application or Example 9.2

Use the present value tables at the end of this chapter to calculate the present
values for the following amounts at an interest rate of 12% p.a.:

Practical Application or Example 9.3

Use the present value tables at the end of this chapter to calculate the present
values for the following amounts at an interest rate of 12% p.a.:

9.3 Capital Investment Appraisal Using Techniques That Ignore the Time Value Of Money
When appraising investment decisions, net cash flows need to be calculated. Net cash flow is the
difference between the cash inflow arising from an investment and the cash outflow that it requires.
However, the minimum rate of return of an investment should be greater than the interest rate on
borrowed funds or rate of return of the enterprise (depending on the source of financing – borrowed
or own).

Also note that cash flows = profit/(loss) + depreciation

The following techniques that ignore the time value of money may be used to evaluate capital
investment projects:

Payback period
Accounting rate of return

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Payback period

9.3.1 Payback period measures the amount of time required to recover the initial cost of the
investment from the net cash inflows from the project. The general decision rule to follow is to choose
the project with a shorter payback period. The reason for this is that the shorter the payback period,
the less risky the project and the greater the liquidity. Whilst the payback method is simple and easy
to use, it does not recognise the time value of money. It also ignores the influence of cash inflows on
profitability after the payback period.

Payback period is calculated as follows if the net cash inflow is the same each year:

Practical Application or Example 9.4

FDG Ltd obtained information in respect of two machines, one of which it

intends purchasing. The following details are available:

Required
Calculate the payback period of each machine and recommend the machine
that should be chosen based on the payback period.

According to the calculation above FDG Ltd should choose machine Y since it recovers the purchase
price in a shorter time (2,14 years) than Machine X (3 years). However, the management of FDG Ltd
must also consider that machine X will be able to generate an income of R60 000 (R20 000 X 3) for
3 years after the payback period whereas machine Y will only be able to generate an income of R28
000 (for only 1 more year) after the payback period.

When the cash inflows are not even, the payback period is determined as follows:

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Practical Application or Example 9.5

Consider two projects whose cash inflows are not even. Assume that the
project costs R2 000. The net cash inflows for each year is as follows:

Required
Calculate the payback period of each machine and recommend the project
that should be selected based on the payback period

Project Y should be chosen since the payback period (2 years and 4 months) is less than that of
project X (4 years).

9.3.2 Accounting rate of return (ARR)

The accounting rate of return (ARR) measures profitability by relating the average investment to the
future annual net profit. In other words, ARR uses the average profit an investment will generate and
expresses it as a percentage of the average investment over the life of the project.

The accounting rate of return of an investment is calculated as follows:

The average investment in respect of a machine is calculated as follows:

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Using the ARR method, the project that is expected to realise a higher rate of return is chosen.

Practical Application or Example 9.6

Use the figures from example 4 to calculate the accounting rate of return.

Note: Since there is no disposal value, the average investment is R60 000 ÷ 2.

Using ARR, machine Y gives a higher rate of return and appears to be a better investment

The advantage of the ARR method is that it is easy to calculate and it recognises profitability.
However, it does not take into account the time value of money. Also it uses accounting data instead
of cash flow data

9.4 Capital Investment Appraisal Using Discounted Cash Flow Methods

Since the two methods described above do not take into account the time value of money, the
following methods are widely used to evaluate investment opportunities:

Net Present Value (NPV)

Internal Rate of Return (IRR)

9.4.1 Net Present Value (NPV)

The NPV method takes into account all the costs and benefits of each investment opportunity and
also makes provision for the timing of the costs and benefits. By applying the present value method
(discussed earlier), the present values of future cash flows are calculated using the enterprise’s
minimum rate of return.

The net present value is the difference between the present value of the projected cash inflows and
the present value of the cash outflows. If the NPV is positive, then the project is considered for
acceptance. If the NPV is negative, the project is rejected since it would not be profitable.

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Practical Application or Example 9.7

Excel Ltd has a choice of purchasing one of two machines. The following
details relate to these machines:

Required
Use the net present value method to determine which machine Excel Ltd
should purchase.

Decision: Machine A should be purchased since it has a higher net present value.

9.4.2 Internal Rate of Return (IRR)

This is the discount rate that will discount the cash flows to a net present value of zero. In other
words, the present value of cash flows minus the initial investment equals a zero NPV. The IRR
therefore indicates what a particular project is expected to earn. A project must only be considered if
the IRR exceeds the cost of capital.

The advantage of the IRR method is that it considers the time value of money and is therefore more
realistic than the accounting rate of return (ARR). However, the calculation can be difficult especially
when the cash flows are not even.
When the cash flows are not even, the trial-and-error method for calculating IRR may be
summarised as follows:

Calculate the NPV at the cost of capital rate (r1)

Check if the NPV is positive or negative
If the NPV is positive, then pick another rate (r2) higher than the cost of capital rate. (If the NPV is
negative, pick a smaller rate.) The correct IRR at which NPV = 0 lies somewhere between these

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two rates, with one rate indicating a positive NPV and the other rate indicating a negative NPV.
Calculate the NPV using r2
Use interpolation to calculate the exact rate

Practical Application or Example 9.8

Use the information in example 7 and determine which machine should be

purchased using the internal rate of return.

Alternatively, this another way of calculating the IRR for an annuity:

The following three steps may be followed:

Step 1 Calculate the payback period of the project (in years only).

Step 2 Use Table 2 (present value of a regular annuity) at the end of this module and find the two
discount factors that the figure calculated in step 1 would lie between.

Step 3 Use Interpolation to determine the precise IRR.

Solution

Machine B

Step 1

Calculate the payback period of Machine B.

Payback period = R80 000/ R22 000 = 3.6364 years

Step 2

Using present value Table 2 (at the end of this module), we notice that (using the 6 year row) 3.6364
lies between 16% and 17%.

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Step 3

First we calculate the NPV at 16% and 17%. (Always remember that one NPV will be positive and
the other negative.)

9.5 Influence of Income Tax, Depreciation and Scrap Value

Income tax has an influence on capital investment decisions. A project that may be approved on a
pre-taxation basis may be rejected on an after-tax basis. Although depreciation is not a cash outflow,
it is deducted when calculating taxable income. Scrap value has an influence on the calculation of
depreciation.

The following example illustrates the effects of income tax, depreciation and scrap value on capital
investment decisions:

Practical Application or Example 9.9

Milton Ltd is considering buying a machine and has presented the following
information:

Required
Calculate the:
1. Net Present Value (NPV)

2. Internal Rate of Return (IRR)

3. Net Present Value if the machine has a scrap value of R1 500 at the end
of 10 years

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Revision Questions

An investment has the following cash flows:

1. Requred
Calculate the following:
1.1 Payback period
1.2 Net Present Value (NPV) at 12% cost of capital
1.3 Accounting Rate of Return (ARR) (Assume that there is no depreciation)
1.4 Must the investment be considered positively or negatively? Give reasons
for your answer.
The financial manager at Rico Ltd had to choose between these two projects,
Alpha and Beta, which have the following after-tax cash inflows:

Both projects require an initial investment of R117 700.

2. Required
2.1 Calculate the payback period for each project. Which project would you
choose? Why?
2.2 Calculate the net present value (NPV) for each project, using a discount
rate of 12%. Which project would you choose? Why?
2.3 Calculate the Internal Rate of Return (IRR) for both projects. Which
project should be chosen? Why?
Mica Ltd is considering buying a machine and has presented the following
information:

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3. Required
Calculte the following:
3.1 Net Present Value (NVP)
3.2 Internal Rate of Return (IRR)
3.3 Net Present Value if the Machine has a scrap value of R10 000 at the end
of 4 years

Table 1: Present value interest factor of R1 per period at i% for n periods, PVIFA(i,n).

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The factor is zero to four decimal places

Table 2: Present value interest factor of an (ordinary) annuity of R1 per period at i% for n
periods, PVIFA(i,n).

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Answers
Practical Application or Example 9.1
Determine which proposal Jack must accept if the current rate for investments is 10% p.a.

Answer:

The two amounts cannot be compared as the amounts apply to different times (viz. present day and
one year later). Both values must therefore be converted to a common base (common date). One
way of doing this is to calculate the (future) value of R980 (first proposal) in one year’s time. This
future value can then be compared to the R1 100 (second proposal).

The second method is to use the present time as a common base. This means that the present value
of R1 100 must be calculated and this value is then compared to R980. This can be done as follows:

Future value = Present value + Interest rate

= 100% + 10%
= 110%

We can thus state

R1 100 = 110%

To calculate the present value, we multiply 110 by 100/110 (to get 100%) and do the same for R1
100 (i.e. multiply it by 100/110).

Therefore
R1 100 X 100 = 110 X 100
110 110
R1 000 = 100%

The present value of the R1 100 is therefore R1 000.

Jack should therefore accept the second proposal (present value R1 000) since it is more profitable
than the first proposal (present value R980).

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Practical Application or Example 9.2

Use the present value tables at the end of this chapter to calculate the present values for the
following amounts at an interest rate of 12% p.a.:

Answer:

Practical Application or Example 9.3

Use the present value tables at the end of this chapter to calculate the present values for the
following amounts at an interest rate of 12% p.a.:

Answer:

Instead of calculating the present value for each year, table 2 can be used since we are working with
a constant amount of R2 000 per year. Table 2 provides a quicker means of getting the answer:

R2 000 X 3,0373 = R6 075

Practical Application or Example 9.4

Calculate the payback period of each machine and recommend the machine that should be
chosen based on the payback period.

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Answer:

Practical Application or Example 9.5

Calculate the payback period of each machine and recommend the project that should be
selected based on the payback period

Answer:

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Practical Application or Example 9.6

Use the figures from example 4 to calculate the accounting rate of return.

Answer:

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Practical Application or Example 9.7

Use the net present value method to determine which machine Excel Ltd should purchase.

Answer:

Machine A

Machine B

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Practical Application or Example 9.8

Use the information in example 7 and determine which machine should be purchased using
the internal rate of return.

Answer:

Machine A
Step 1
We notice that the NPV is positive, and is far away from zero.

Step 2
We now pick a higher rate e.g. 18%. (Trial-and-error is used to obtain the higher rate)

Step 3
Interpolation:
The IRR is between 19% and 20%.

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Machine B
Step 1
We notice that the NPV is positive, and also far from zero.

Step 2
We now pick a higher rate e.g. 16%. (Trial-and-error is used to obtain the higher rate.)

Step 3
Interpolation:
The IRR is between 16% and 17%.

Decision: Machine A should be chosen since the IRR is greater.

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Practical Application or Example 9.9

Calculate the:

1. Net Present Value (NPV)

Answer:

Calculation of net present value: Machine A

2. Internal Rate of Return (IRR)

Answer:

Internal rate of return

The NPV is negative. We pick a lower rate e.g. 11%. (trial and error)
We now calculate the NPV at 10%.

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3. Net Present Value if the machine has a scrap value of R1 500 at the end of 10 years

Answer:

Net present value if the machine has a scrap value of R1 500 at the end of 10 years.

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Answers to Revision Questions

UNIT 3

1. What are the consequences to a business of holding a very low a level of inventory?

Answer:

Production may be interrupted due to shortage of raw materials

Loss of sales may result as goods cannot be provided immediately
There may be a loss of goodwill from customers due to finished stock shortages
Higher purchasing price may have to be paid in order to replenish inventory quickly
High transport costs may be incurred to replenish inventory quickly

2. DNA Ltd sells 4 000 drums of grease each year. The inventory holding cost of one drum of
grease is R8. The cost of placing an order for stock is estimated at R250.

Answer:

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3. Calculate the EOQ for drums of [Link] the number of orders that should be
placed per annum.(Round off calculations to the nearest whole number.)

Answer:

The number of orders that should be placed per annum is calculated as follows

4. You are the newly appointed management accountant at Kelso Industries. The company
uses the EOQ model to determine the quantity of raw material Z54 to order from REM Ltd. The
following details regarding raw material Z54 are brought to your attention: Kelso Industries
consumes 2 400 units of material Z54 each working day.

It is estimated that there are 250 working days in the 20.7 financial year.
The cost of placing an order amounts to R120.
The cost of holding inventory per unit is estimated at R3,90 plus 11% of the invoice price
per unit.
The invoice price per unit is R10.

Answer:

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5. Calculate the EOQ for raw material Z54 for the 20.7 financial year.

Answer:

The number of orders that should be placed per annum is calculated as follows:

6. Calculate the number of orders that should be placed during 20.7. (Round off calculations to
the nearest whole number.)

Answer:

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7. The following transactions of CAN Manufacturers took place during June 20.6 in respect of
a raw material M321 used in production:

Answer:

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UNIT 4

1. Calculate the net wage due to D. Dube for the third week of June 20.6.

Answer:

2. Calculate the contributions made by Restonic Manufacturers for pension, medical aid and
unemployment insurance in respect of D. Dube for the week.

Answer:

3. Compu Manufacturers produces a single product called Diskette A. The basic hourly rate is
R20 for all four production workers. The following is an extract from the manufacturing
records for the week ended 22 August 20.6:

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Answer:

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4. Calculate the remuneration for each employee using Taylor’s differential piecework system
from the information given.

Answer:

5. Jim’s normal wage is R36 per hour and his normal working day is 9 hours. Management has
set a standard of 250 units per hour. On a given day, Jim produced 2 500 units within his 9-
hour shift. A bonus of 50% of the time saved is given to employees (Halsey bonus system).
Calculate the number of hours saved by Jim and his remuneration for the day.

Answer:

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6.1 Calculate the net salary of each employee for the second month of the year.

Answer:

6.2 Calculate the hourly recovery tariff for each employee.

Answer:

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UNIT 5

Draft the income statement for May 20.6 using:

1. The Marginal Costing Method

Answer:

REMARKS
Variable manufacturing costs = [Direct materials cost (R90 per unit) + Direct labour cost (R180 per
unit) + Variable manufacturing overheads per unit (R90 per unit)] X number of units manufactured (9
000)
Closing inventory = 9 000 (manufactured) – 7 200 (sold) = 1 800 units
Closing inventory is valued at R360 per unit which is the variable manufacturing cost per unit as
indicated above viz. R90 + R180 + R90 = R360 per unit

2. The Absorption Costing Method

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Answer:

REMARKS
* Instead of showing fixed manufacturing costs and variable manufacturing costs as two items, one
item viz. the cost of goods manufactured could have been shown as follows:
Cost of goods manufactured (9 000 X R410)
3 690 000
Note:
Fixed manufacturing cost per unit = R450 000 = R50 per unit
9 000
Thus cost of goods manufactured per unit = R90 + R180 + R90 + R50 = R410

** Closing inventory = 30 000 (manufactured) – 24 000 (sold) = 6 000 units

Closing inventory is valued at R410 per unit calculated as above.

The effect of the two costing methods on net profit is that:

When production is greater than sales, a larger net profit will be reported using absorption costing.
When sales are greater than production, a larger net profit will be reported using marginal costing.
When sales and production are equal, the net profit will be the same under both methods
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3. Reconcile the profit calculated according to absorption costing (in 5.1.2) with the profit
calculated according to marginal costing (in 5.1.1).

Answer:

Reconciliation of profit calculated according to marginal costing with profit calculated

according to absorption costing
The difference in the net profit between the absorption costing method (R612 000) and the marginal
costing method (R522 000) is R90 000. The difference, as we already know, is due to the fact that
fixed manufacturing costs are included in calculating the closing inventory using the absorption
costing method.

The difference in profit may be explained as follows:

Another way of explaining the difference in the profits is as follows:

Calculate the fixed manufacturing cost per unit:

This R50 per unit is included in the value of closing inventory using the absorption costing method.

Thus: 1 800 units (closing inventory) X R50 (fixed manufacturing cost per unit) = R90 000

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4. Draft the income statements for May 20.6 using the marginal costing method and the
absorption costing method but assume that all the goods manufactured (9 000 units) have
been sold and that there is thus no closing inventory. Prove that the net profit calculated
using both costing methods will be the same.

Answer:

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UNIT 6

1. The difference between sales and variable expenses is called ____________.

Answer: Marginal Income

2. Break-even point is reached when ____________ is equal to ____________.

Answer: Marginal Income; Fixed Costs

3. The _________is the amount by which the actual level of sales exceeds the break-even
point.

Answer: Margin of Safety

4. The break-even point will ____________ if there is an increase in fixed costs.

Answer: Increase

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5. One of the key assumptions underlying break-even analysis is that costs are classified as
either ____________ or ____________.

Answer: Variable; Fixed

2.1 Calculate the break-even quantity

Answer:

2.2 Calculate the break-even value

Answer:

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2.3 Calculate the break-even value using the marginal income ratio

Answer:

2.4 Calculate the selling price per unit if the profit per unit is R2

Answer

Let the selling price per unit be represented by P.

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3.1 Calculate the expected profit or loss on the marketing manager’s proposal

Answer:

3.2 Calculate the number of sales units required under the proposed price to make a profit of
R60 000

Answer:

3.3 Calculate the sales value required under the proposed price to make a profit of R60 000

Answer:

4.1. Calculate the marginal income ratio

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Answer:

4.2. Calculate the break-even quantity and break-even value

Answer:

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4.3 Calculate the margin of safety in terms of units and value

Answer:

5.1 Calculate the budgeted profit for 20.7.

Answer:

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5.2 Calculate the break-even quantity and value

Answer:

5.3.1 New break-even quantity and value

Answer:

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5.3.2 Safety margin (in terms of value)

Answer:

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5.3.3 The number of units that need to be sold to earn a net profit of R400 000

Answer:

6.1 Calculate the total break-even value

Answer:

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6.2 Calculate the break-even value for each product.

Answer:

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UNIT 7

1. Prepare a debtor’s collection schedule for the period 01 April to 31 May 20.6

Answer:

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2. Prepare a cash budget for the period 01 April to 31 May 20.6

Answer:

REMARKS

Cash sales: 10% cash discount has been deducted from the figures provided
Receipts from debtors: are obtained from the debtors collection schedule
Cash purchases: is 30% of total purchases
Payments to creditors: 70% of the total purchases for March is paid in April and 70% of the total
purchases for April is paid in May
Salaries and wages: are the same amounts provided in the information
Sundry expenses: Since depreciation is a non-cash item, R4 000 per month is deducted from
sundry expenses
Cash surplus: is expected for both months as expected receipts exceed expected payments
Opening cash balance: for April is the closing cash balance for March and the opening cash
balance for May is the closing cash balance for April
Closing cash balance: is calculated using the cash surplus (shortfall) and the opening cash
balance

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3. Prepare a monthly cash budget for April, May and June 20.6

Answer:

REMARKS

Cash sales: are 20% of total sales.

Receipts from debtors: are calculated as follows:

Cash purchases and payments to creditors: The following calculations reflect the cash purchases
and payments to creditors:

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Rent: is paid monthly (R240 000 ÷12 = R20 000)

Selling and administrative expenses: are 25% of sales.
Other expenses: are paid monthly.
Opening cash balance: for April is obtained from the Balance sheet as at 31 March 20.6.

4. Prepare a budgeted income statement for the 3 months ended 30 June 20

Answer:

Budgeted income statement for the 3 months ended 30 June 20.6

REMARKS

Sales: reflects the total sales for April, May and June
Cost of sales: is 40% of sales since the gross profit percentage on sales is 60%
Rent expense: is R2 000 per month and includes rent for April, May and June
Selling and distribution: is 25% of the total sales (R1 160 000)
Depreciation: is R28 000 per annum and this translates to R7 000 every 3 months
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Other expenses: are R22 000 per month for 3 months

5. Prepare a budgeted balance sheet on 30 June 20.6

Answer:

Budgeted Balance Sheet as at 30 June 20.6

REMARKS

Plant, property and equipment: was subject to an annual depreciation of R28 000. For 3 months it
would amount to R7 000 and this is the amount by which property, plant and equipment
decreases
Inventories will remain the same as the previous month balance as all inventory sold is replaced
during the month of sale
Debtors: The amount owing by debtors includes 20% of the credit sales for May (R60 800) and
the entire credit sales for June (R288 000)
Bank: The expected bank balance at the end of June is obtained from the cash budget
Capital: increases by the expected profit as calculated in the income statement
Creditors: The amount owing to creditors will be the credit purchases for June (R100 800)

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UNIT 8

In respect of material, calculate the following variances:

8.1 Material variances

Answer:

Material purchase price variance

= (Actual price – Standard price) X Actual quantity purchased
= (R4,20 – R4,00) X 4 400
= R880 (unfavourable)

1.2 Issue Price Variance

Answer:

Material issue price variance

= (Actual price – Standard price) X Actual quantity issued
= (R4,20 – R4,00) X 4 200
= R840 (unfavourable)

1.3 Quantity Variance

Answer:

Material quantity variance

= (Actual quantity – Standard quantity) X Standard price
= (4 200 – [2 000 X 2]) X R4,00
= (4 200 – 4 000) X R4,00
= R800 (unfavourable)

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1.4 Total material variance for the 4 200 kg of material issued

Answer:

Total Material variance

= (Actual quantity X Actual price) – (Standard quantity X Standard price)
= (4 200 X R4,20) – (4 000 X R4,00)
= R17 640 – R16 000
= R1 640 (unfavourable)
or
Material issue price variance R840 (unfavourable)
Material quantity variance R800 (unfavourable)
Total material variance R1 640 (unfavourable)

Calculate the following Labour Variances

2.1 Labour Rate Variance

Answer:

Labour rate variance

= (Actual rate – Standard rate) X Actual hours worked
= (R5,90 – R6,00) X 2 100
= R210 (favourable)

2.2 Labour Efficiency Variance

Answer:

Labour efficiency variance

= (Actual time worked – Standard time allowed) X Standard rate
= (2 100 – [500 X 4]) X R6,00
= (2 100 – 2 000) X R6,00
= R600 (unfavourable)

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2.3 Total Labour Variance

Answer:

= (Actual time worked X Actual rate) – (Standard time allowed X Standard rate)
= (2 100 X R5,90) – (2 000 X R6,00)
= R12 390 – R12 000
= R390 (unfavourable)
or
Labour rate variance R210,00 (favourable)
Labour efficiency variance R600,00 (unfavourable)
Total labour variance R390,00 (unfavourable)

3.1 Efficiency Variance

Answer:

Efficiency variance
= (Actual hours – Standard hours allowed) X Standard rate
= (4 300 – [1 050 X 4*]) X (R20 000 ÷ 4 000)
= (4 300 – 4 200) X R5,00
= R500 (unfavourable)
Note: * Standard time to make 1 product is 4 hours (4 000 labour hours ÷ 1 000 units)

3.2 Expenditure Variance

Answer:

= (Actual rate – Standard rate) X Actual hours

= ([R19 135 ÷ 4 300] – [R20 000 ÷ 4 000]) X 4 300
= (R4,45 – R5,00) X 4 300
= R2 365 (favourable)

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3.3 Total Variable Overheads Variance

Answer:

= Actual amount – Standard amount

= R19 135 – ([1 050 X 4]) X R5)
= R19 135 – (4 200 X R5)
= R19 135 – R21 000
= R1 865 (favourable)
or
R500 unfavourable (efficiency variance)
R2 365 favourable (expenditure variance)
R1 865 favourable (total variance)

Calculate the following fixed manufacturing overheads Variances:

4.1 Expenditure Variance

Answer:

= Actual fixed overheads – Budgeted fixed overheads

= R49 880 – R48 000
= R1 880 (unfavourable)

4.2 Volume Variance

Answer:

= Budgeted fixed overheads – Standard fixed overheads

= R48 000 – (1 050 X 4 X R12)
= R48 000 – R50 400
=R2 400 (favourable)

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Note:
Standard fixed overheads = Number of units produced X Standard time to make 1 product
X Standard rate per hour

Standard rate per hour = Standard fixed overheads ÷ standard number of labour hours
= R48 000 ÷ 4 000
= R12

4.3 Total Fixed Overheads Variance

Answer:

= Actual fixed overheads – Standard fixed overheads

= R49 880 – (1 050 X 4 X R12)
= R49 880 – R50 400
= R520 (favourable)
or
R1 880 unfavourable (expenditure variance)
R2 400 favourable (volume variance)
R 520 favourable (total variance)

Calculate the following:

5.1 Sales Price Variance

Answer:

= (Actual selling price – Standard selling price) X Actual quantity sold

= ([R189 800 ÷ 5 200] – R36] X 5 200
= (R36,50 – R36) X 5 200
= R2 600

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5.2 Sales Quanitity Variance

Answer:

= (Actual quantity sold – Standard/Budgeted sales) X Standard selling price

= (5 200 – 5 000) X R36
= R7 200

UNIT 9

Calculate the following:

1.1 Payback period

1.2 Net Present Value (NPV) at 12% cost of capital

Answer:

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1.3 Accounting Rate of Return (ARR) (Assume that there is no depreciation)

Answer:

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1.4 Must the investment be considered positively or negatively? Give reasons for your answer.

Answer:

The investment should be considered positively because:

The payback period is only 2 ½ years.
The net present value (R8 157) is positive.
The accounting rate of return (66,67%) is higher than the cost of capital (12%).

2.1 Calculate the payback period for each project. Which project would you choose? Why?

Answer:

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2.2 Calculate the net present value (NPV) for each project, using a discount rate of 12%. Which
project would you choose? Why?

Answer:

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2.3 Calculate the Internal Rate of Return (IRR) for both projects. Which project should be
chosen? Why?

Answer:

Step 1
We notice that the NPV is positive, and above zero, but not by a large margin.
Step 2
We now pick a higher rate e.g. 13%. (Trial-and-error is used to obtain the higher rate.)

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Step 3
Interpolation:

The IRR is between 12% and 13%.

Calculte the following:

3.1 Net Present Value (NVP)

Answer:

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Table 1: Present value interest factor of R1 per period at i% for n periods, PVIFA(i,n).

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Table 2: Present value interest factor of an (ordinary) annuity of R1 per period at i% for n
periods, PVIFA(i,n).

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Bibliography
Chadwick, L. (2003) The Essence of Management Accounting. First Edition. This is the latest
edition of the textbook that is available
Chadwick, L. P. (1999) Management Accounting. Custom Edition for MA 6 MANCOSA
Els, G., Meyer, L., van der Walt, R. and de Wet, S.R. (2019) Fundamentals of Cost and
Management Accounting. Sixth Edition. Durban: LexisNexis. This is the latest edition of the
textbook that is available

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