QUESTION ONE

a) Define marginal costing and give its limitations. (6 marks)

Marginal costing refers to a method of costing products (goods and services) in which the cost
per unit is only the variable costs. Thus, the current production and closing stocks are valued at
their variable costs only. The manufacturing fixed overheads are written off or expensed wholly
in the
period in which they are incurred.

Limitations of Marginal costing:

These arise from the assumptions of marginal costing which are:

Costs can be classified as either fixed or variable. Marginal costing does not therefore consider
the mixed costs.
Selling price is assumed constant: in reality, the selling price per unit decreases with increased
sales due to the effect of quantity discount.

Fixed costs are assumed to remain fixed within the relevant range; in reality, stepped costs
functions exist i.e. fixed costs rise to a higher level when certain critical production levels are
achieved.

Constant sales mix: or single product is assumed; in reality, organizations produce many
products and also change their product mix when circumstances dictate.

Variable costs are assumed to be constant: in reality, this is not true due to decreasing costs per
unit due to the effect of large scale production.

(b)
Required:
i).Margin of safety. (2 marks)
Solution.

Sales 24,000
Less: variable costs @ 60% x 20 million: (12,000)
Contribution: 12,000
Less: fixed costs @ 40% x 20 million (8,000)
NET PROFIT 4,000

ii).Margin of Safety = Current Sales – Break even Sales

But Break Even Sales = Fixed Costs 8,000,000
Contribution margin ratio [12,000,000/24,000,000]

B.E.S = Shs 16,000,000

Margin of Safety = 24,000,000 – 16,000,000 = Shs 8,000,000

ii). But Break Even Sales = Fixed Costs 8,000,000

Contribution margin ratio [12,000,000/24,000,000]

= Shs 16,000,000

(iii) Sales required to earn a profit of Shs 6,000,000. = Shs 16,000,000

= Fixed Costs + Target Profits = (8,000,000 + 6,000,000) = Shs 28,000,000
Contribution sales ratio (12million/24 million)

iv). In order to increase sales, the management has the following two options:

Opinion 1. Fixed coat will raise by 2,500,000

2: Variable cost to sales ratio will be 50/95 = 0.526.
Profit Statements
Option 1 Option 2
Shs ‘000’ Shs ‘000’
Sales 30,000 27,600
Variable costs (50%) (15,000) (14,526)
Contribution 15,000 13,074
Fixed costs (10,500) (8,000)
NET PROFIT 4,500 5,074

NB: Initial profit was Shs 4,000,000.

Advice to Management: decrease sales price by 5% as this will result in the highest net profit.
QUESTION TWO
(a) Briefly explain the following cost estimation methods;
i) High-low method (3 marks)
High Low Method is a mathematical technique used to determine the fixed and variable elements
of a historical cost that is partially fixed and partially variable

ii) Simple regression method. (3 marks)

Simple linear regression is a statistical method that allows us to summarize and study
relationships between two continuous (quantitative) variables. This lesson introduces the concept
and basic procedures of simple linear regression. We will also learn two measures that describe
the strength of the linear association that we find in data.

Question two (b)

Required:
i).Use the high-low method to estimate the overhead cost function. (4marks)
Highest cost (OHs) - 15,280 level of activity 1690
Lowest cost (OHs) - 9150 level of activity 834
Range = 15,280 – 9,150 = 6130 = 7.16
1690 – 834 = 856

Y = a + bx where b = 7.16
Y = 15,280
Therefore 15,280 = a + 7.16 x 1690
a = 15,280 – (7.16 x 1690)
a = 3180
Therefore Y = 3,180,000 + 7160x

ii).Use the regression method to determine the overhead cost function. (2 marks)
Y = a + bx where a = 3,709,000
b = 6487000
Therefore Y = 3,709,000 + 6487000x

ii).Compute the equivalent units of production with respect to conversion cost for the
month of November using the FIFO method. (4marks)
Completion Conversion
Conversion %
Opening stock (WIP) 1,000,000 70 700,000
Completely processed during production 500,000 100 500,000
Closing stock (WIP) 1,200,000 1,199695
Equivalent units with respect to
2,399695
conversion costs

iv).Use the regression function formulated in above to estimate the overhead cost for the
month of November. (4 marks)
Y=3,709,000+06487x where x =1125
Therefore y = 3,709,000 + 6487 x 1125 = 11,006,875

QUESTION THREE
a) List and explain the advantages of standard costing. (5 marks)

Standard costing System has the following main advantages or benefits:

The use of standard costs is a key element in a management by exception approach. If costs
remain within the standards, Managers can focus on other issues. When costs fall
significantly outside the standards, managers are alerted that there may be problems requiring
attention. This approach helps managers focus on important issues
.
Standards that are viewed as reasonable by employees can promote economy and efficiency.
They provide benchmarks that individuals can use to judge their own performance.
Standard costs can greatly simplify bookkeeping. Instead of recording actual co0sts for each
job, the standard costs for materials, labor, and overhead can be charged to jobs.

Standard costs fit naturally in an integrated system of responsibility accounting. The

standards establish what costs should be, who should be responsible for them, and what
actual costs are under control.

More useful information for managerial planning and decision making When management
develops appropriate cost standards and succeeds in controlling production costs, future
actual costs should be close to the standard. As a result, management can use standard costs
in preparing more accurate budgets and in estimating costs for bidding on jobs. A standard
cost system can be valuable for top management in planning and decision making.

More reasonable and easier inventory measurements A standard cost system provides easier
inventory valuation than an actual cost system. Under an actual cost system, unit costs for
batches of identical products may differ widely. For example, this variation can occur
because of a machine malfunction during the production of a given batch that increases the
labor and overhead charged to that batch. Under a standard cost system, the company would
not include such unusual costs in inventory. Rather, it would charge these excess costs to
variance accounts after comparing actual costs to standard costs.

Cost savings in record-keeping Although a standard cost system may seem to require more
detailed record-keeping during the accounting period than an actual cost system, the reverse
is true. For example, a system that accumulates only actual costs shows cost flows between
inventory accounts and eventually into cost of goods sold. It records these varying amounts
of actual unit costs that must be calculated during the period.
Required:
Calculate the following variances
i) Material price variance (2 marks)

Actual Quantity x Actual Price – Actual Quantity x Standard Price

= Actual Cost - Standard Cost of Actual Quantity

AB. (2500 x 175000) – [2500 x 175000-(15/100 x 17500]

(2500 x 175000) - ( 2500 x 148750) = 65,625,000

QP 2500 x 152000 – (2500 x 15200 –(15/100 15200)
380,000,000 – 37,977,200 = 342,022,800

ii) Material usage variance (2 marks)

(Actual usage - Standard usage) x Standard cost per unit

AB (2500kgs – 1400kgs) x 125 = 137500

QP (2500 - 1600 ) x 95= 85500

iii) Material mix variance (4 marks)

Standard Mix Quantity x Standard Price - Actual Quantity x Standard Price

AB. (1400kg x 125) – (2500 x 125) = -137500

QP. 1600kgs x 95) – (2500 x 95) = -85500

iv) Material yield variance (4marks)

(Actual Yield - Standard Yield) x Standard Material Cost Per Unit

AB. (2500 – 1400) x 125 = 137500

BP. (2500- 1600) x 95 = 85500
v) Material cost variance (3 marks)

MCV = (SQx SP) -(AQxAP)

AB. (1400 x 125) – 2500 x ( 125 + 0.15 x 125)

175,000 – 359775 = 184775

QP. (1600 x 95) – 2500 x (95 + 0.5 x 95)

152000 – 273125 = -121125

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