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Question

**Alternative transfer-pricing methods** 3 methods? What does transfer price promote? (3)

Answer 1

- Market-based transfer prices. - Cost-based transfer prices. (e.g. variable manufacturing costs, manufacturing absorption costs, full product costs) - Negotiated transfer prices. Transfer price should promote goal congruence, management effort and subunit autonomy.

Answer 2

_Negotiated prices:_ - Manufacturing division may receive full cost plus a mark-up so that it makes a profit on inter-divisional transfers - Distribution division charged at opportunity cost of transfers thus motivating managers to operate at the optimum output level for the company as a whole - Profit on inter-divisional trading removed by an accounting adjustment _Reorganisation of firm:_ - If transfer pricing becomes sufficiently dysfunctional, the firm may be reorganised – organisational architecture is changed (e.g. decision rights, performance evaluation and/or rewards) - For example – divisions could be combined, reorganised as cost centres, performance and rewards could be linked to company profits (not unit profits)

Answer 3

_Repetitive Activities:_ - It works well for processes that involve repeated operations, where the input required for each unit of output can be clearly defined. _Observable Activities:_ - It's applicable to activities that can be easily monitored, allowing for standards to be established and compared against actual performance. _Defined Production Requirements:_ - This includes situations where requirements like materials and labor can be precisely specified and measured. _Industry Suitability:_ - It is commonly used in manufacturing organizations and other sectors like certain areas of the banking industry.

Answer 4

- To provide a prediction of future costs that can be used for decision-making. - To provide a challenging target that individuals are motivated to achieve. - To assist in setting budgets and evaluating performance. - To act as a control device by highlighting those activities that do not conform to plan. - To simplify the task of tracing costs to products for inventory valuation. - Provide a formal basis for assessing performance and efficiency + decision making. - Control costs through established standards and the analysis of variances. - Provide the basis for estimating e.g. quotations.

Answer 5

_Basic Standard_ - Basic standards – “a standard established for use over a long period from which a current standard can be developed”. - Standard do not change from year to year but remain static and provide a base against which to measure action. - Basic standards are not widely met in practice. _Ideal Standard_ - Standards which can be attained under the most favourable conditions, with no allowance for normal losses, waste, inefficiencies, delays and machine down time. - Standard set on assumption of maximum efficiency. - Standard will not be achieved and sustained for any significant period of time, if at all. _Attainable Standard_ - A standard which can be attained if a standard unit of work is carried out efficiently, a machine properly operated or material properly used. - Difficult but not impossible to achieve. - Allowances are made for normal losses, waste and machine downtime.

Answer 6

_Benefits of Standard Costing_ - Makes managers and employees more cost conscious - Helps to pinpoint waste/problems - Acts as a guide to areas where improvements in the area of operations can be made - Integrates management accounting and engineering functions - Setting of standards involves defining goals and reviewing roles in achieving the goals, e.g. workers will know the expectation with regard to output such as so many units per hour. _Criticisms of Standard Costing_ - Over-emphasis on price and efficiency and no consideration for quality which is a major competitive factor. - SC uses volume variance to measure the extent to which production capacity is being utilised without considering consequences of overproduction and unnecessary build up of stock. - SC provides static standards which is at odd with the philosophy of continuous improvement. - SC variance reporting system tend to create internal competition and arguments concerning who to take responsibility for adverse variances. This promotes internal conflicts rather than cooperation.

Answer 7

_Quality of Material:_ - Lower-quality materials may lead to higher waste and scrap levels, causing more material usage than anticipated. _Efficiency in Material Use:_ - Poor handling or inefficient processes can result in materials being used in excess. _Staff Supervision and Training:_ - Lack of proper supervision or inadequate training for workers might lead to errors or inefficiencies, increasing material usage. _Efficiency of Machinery/Production Methods:_ - Inefficient or faulty machinery and outdated production techniques may cause more material to be consumed. _Pilferage:_ - This refers to the small-scale theft of materials, which reduces the available stock and affects usage calculations.

Answer 8

**_Total Material Variance (Usage Variance)_** _Formula_ (Sq - Aq)Sp Where **Sq** = **Standard quantity** for actual production **Aq** = **Actual quantity** used **Sp** = **Standard price** per unit of material **_Total Material Variance (Price Variance)_** _Formula_ (Sp - Ap)Aq Where **Sp** = **Standard price** per unit of material used **Ap** = **Actual price** paid per unit of material **Aq** = Total **actual quantity** of materials purchased

Answer 9

**_Total Labour Variance (Rate Variance)_** _Formula_ (SR - AR)AH Where: - **SR = Standard rate** per hour - **AR = Actual rate** per hour - **AH = Total actual hours** for actual production **_Total Labour Variance (Efficiency Variance)_** _Formula_ (SH - AH)SR Where: - **SH** = **Total standard hours** for actual production - **AH** = **Total actual hours** for actual production - **SR** = **Standard rate** per labour hour

Answer 10

_Pay award:_ - Variances can arise from salary increases agreed upon, like those from collective bargaining or annual pay reviews. _Pay grade of labour:_ - Using workers with different skill levels or grades than originally planned can lead to cost differences. _Effect of overtime:_ - Overtime work often incurs higher rates, increasing labor costs. _Effect of bonus scheme:_ - Performance-related bonuses or incentive programs can impact overall pay rates. _Limited controllability:_ - Departmental managers generally have limited control over these factors, meaning they arise from broader organizational or external decisions.

Answer 11

_Labour Turnover:_ - Changes in the workforce can disrupt efficiency due to the time needed for new hires to adapt. _Level/Quality of Supervision:_ - Poor supervision can lead to inefficiencies, while effective oversight ensures tasks are completed optimally. _Level of Training/Grade of Labour:_ - A well-trained workforce performs more efficiently compared to those with less training or lower skill levels. _Work Methods/Quality of Machinery:_ - Outdated or poor-quality equipment and ineffective work methods can slow down productivity.

Answer 12

(SH - AH)OAR Where: - **SH** = **Standard hours** for actual production - **AH** = **Actual hours** worked - **OAR**= Standard **overhead absorption** rate (OAR x AH) - AVO Where: - **OAR** = **Std. overhead absorption** rate per hour - **AH** = **Actual hours** worked - **AVO** = Total **actual variable overheads**

Answer 13

Fixed overhead expenditure variance = **standard fixed overhead** for **budgeted output level** – **actual fixed overhead expenditure** for **actual output level** _Fixed overhead volume variance_ = (**actual** production **volume** - **budgeted** production **volume**) * **FOAR/unit** Volume variance seeks to identify the portion of total fixed overhead variance that is due to actual production being different from budgeted production. Under marginal costing system, total fixed overhead variance is the difference between the standard fixed overhead charged to production and the actual fixed overhead incurred. With an absorption costing system, an additional fixed overhead ‘volume variance’ is calculated. In addition, the sales margin variance must be expressed in unit profit margins instead of contribution margins.

Answer 14

_Sales Margin Price Variance_ _Formula:_ [(Actual selling price – standard variable cost) – (Standard selling price – standard variable cost)] x Actual sales volume The above formula can be simplified as: (AP- SP) x AQ AP: actual selling price SP: standard selling price AQ: actual sales quantity _Sales Margin Volume Variance_ Formula: (AQ – SQ) x SM AQ = Actual sales volume SQ = Standard sales volume SM = Standard contribution margin _Total Sales Margin Variance_ Identifies the combined effects of variations in selling price and volume on budgeted profit/contribution. Formula: (ASR – SCOS) – SC ASR: actual sales revenues (AP x AQ) SCOS: standard variable cost of sales (SCOS/unit x AQ) SC: budgeted contribution (SM/unit x SQ) Can be analysed into: Sales margin price variance Sales margin volume variance

Answer 15

1. Management needs to know if performance has been good or bad, a flexible budget provides a yardstick for comparison. 2. Businesses are dynamic, it's unlikely that actual trading is going to be the same as the fixed budget, comparing actual results with the fixed budget will probably be misleading. 3. To gain useful control information, it is necessary to “flex” the fixed budget to the level of activity actually achieved and compare this to the actual results.

Answer 16

By comparing like with like, flexed 15 000 units and actual 15 000 units: Labour, the overspend is £10 000 and not £35 000 Materials, there is a saving of £10 000 and not an overspend of £30 000 !! Packaging, the overspend is only £1 000 and not £6 000

Answer 17

1. Identify the objectives of the organization. 2. Identify potential strategies. 3. Evaluate alternative strategic options. 4. Select course of action. 5. Preparation of the annual budget within the context of the long-term plan. 6. Monitor actual results. 7. Respond to divergencies from plan.

Answer 18

- planning - annual operations - control - by having a plan to compare to - performance evaluation - managers’ performance - coordinating activities of all budget centres - motivation - communication - of policies and targets by every manager for that part of the plan

Answer 19

1. Identify the budgeting period (usually a year divided into quarters or monthly). 2. Budgets may be continuous (rolling forward by one month when one actual month elapses so that there is always 12 months of budget data). 3. Communicating expectations to managers, and managers should be fully involved. 4. Determine the limiting factor for the organisation, (usually sales). 5. Sales budget will depend on the sales forecast. The sales forecast will consider the economy, industry factors, market competition, market issues and other factors likely to influence demand. 6. Initial preparation of various budgets 7. Negotiation of budgets 8. Coordination and review of budgets 9. Final acceptance of the budgets 10. Budget review

Answer 20

1. _Determine the budget period:_ - Decide the timeframe the budget will cover—whether it's monthly, quarterly, or annually. 2. _Identify the limiting factor:_ - Pinpoint the constraints that might affect budget outcomes, such as limited resources, market conditions, or production capacity. 3. _Prepare the functional budgets:_ - Create detailed budgets for individual departments or functions, like sales, production, and marketing. 4. _Prepare the master budget:_ - Combine all the functional budgets into a comprehensive summary that reflects the organization's overall financial plan. 5. _Obtain approval:_ - Submit the finalized budgets to the budget committee or management for review and official approval.

Answer 21

Each budget produced serves some particular purpose and is known as a functional budget 1. _Sales Budget:_ - Focuses on quantities, prices, and values of products or services to project revenue. 2. _Production Budget:_ - Includes information on production quantities, costs, stock levels, and how the plant's capacity is utilized. 3. _Purchasing Budget:_ - Deals with procurement planning to ensure materials and supplies are available when needed. 4. _Direct Labour Budget:_ - Outlines labor costs and workforce requirements based on production needs. 5. _Administrative Expenses Budget:_ - Covers overheads related to administrative functions, such as office costs and management expenses.

Answer 22

_Benefits of Budgeting_ * A vehicle for communication of plans * The process forces managers to think ahead and draw up formal plans * The process acts as a means of allocating organisational resources * Highlights the potential problem areas * Coordinates and integrates the activities of the whole organisation * Serves as a benchmark for evaluating performance _Limitations of Budgeting_ * In today’s fast paced environment budgeting is sometimes not the best tool. Some companies are instead using rolling forecasts and KPI’s (key performance indicators) * Changes to the organisation’s circumstances are often not updated quickly enough * Encourages rigid planning and incremental thinking * Time consuming to construct * Produces inadequate variance reports leaving ‘how’ and ‘why’ questions unanswered * Focuses too much on short term and ignores shareholder value drivers * Meets only the lower targets, doesn’t try and improve them * Behavioural implications such as spending up to budget level in order to protect next years budget * Achieving the budget becomes the focus even though it may not be desirable

Answer 23

- Monitor cashflow and financing requirements - Control over income and expenditure streams in line with budget - Monthly management reporting of variances - Planning for significant cashflows - Co-ordinate levels of working capital around cashflow for company liquidity

Answer 24

Costs: - Materials are expected to cost £50,000 in August and September and £55,000 thereafter. - Wages are normally £20,000 a month, however in the run up to Christmas overtime means that October is expected to be 10% higher than normal, November 25%, December 50%. In January the Wage bill will be 10% higher as we pay overtime to store unsold trees in long term storage. - Rent is expected to remain constant at £10,000 a month. Incidental (Other) expenses normally are about £10,000, however in October and January these will be 10% higher and in November 10% lower. - During October an old machine will need to be replaced costing £100,000. In the November edition of a tabloid newspaper the business intends to take out a large advertisement cost £50,000. In January a £150,000 tax bill will need to be paid. At the beginning of August the Cash Balance was +£50,000. The sales in July was £90,000.

Answer 25

1. **Transactions Motive** - People hold cash to cover day-to-day expenses like groceries, transport, and bills. - ensures liquidity for routine purchases without the need for constant bank transactions. 2. **Precautionary Motive** - Cash is kept aside for unexpected situations, such as medical emergencies or sudden repairs. - It acts as a financial safety net when unforeseen costs arise. 3. **Speculative Motive** - Some prefer holding cash to take advantage of future investment opportunities. - When markets fluctuate, having liquid funds allows quick investment decisions to maximize returns.

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