FMA GotitPass Notes

ACCA Paper MA
Got it Pass eLearning Co Supplementary Notes
Content
A4 Chapter 1 Effective presentation and communication of information using charts

C1 Chapter 2 Inventory Control
C1 Chapter 3 Fixed Overhead Absorption
C3 Chapter 4 Process Costing
C3 Chapter 5 Re-appointment of Service Cost Centre Costs
D2 Chapter 6 Cash Budgets
F2 Chapter 7 Ratio Analysis
For September 2020 to August 2021 1

ACCA Paper MA
Introduction
There are different study materials and modes for you to prepare for ACCA professional exams.
You can prepare the exam through self-study mode by reading textbooks and practicing revision tests
from Approved Content Providers
Or you can go directly to the classes offered by ACCA Approved Learning Partners and stick into their
notes.
However, no matter you are choosing which modes of study or which textbook, you need to know the
technical articles published by ACCA for each paper is one of the best materials to prepare for your
exams that you cannot miss.
In general, the articles are published by ACCA exam team and the contents are updated on a regular
basis.
They highlight the core concepts or important areas that a lot of students cannot do well in the past
exams.
The most important part is technical articles are generally the guidance to which question to be seen
in upcoming exam.
Here are June 2018 examiners comments on ACCA Paper P7 (Advanced Audit & Assurance):
Since it help thousands of students to prepare exam, I organized the articles published by ACCA and
summarized them according to their topics and syllabus with relevant questions as Supplementary
Notes for those who are interested to focus on the key or challenging areas.
Remember these articles are helping you to enhance your knowledge on particular subjects, and not
a substitute of approved textbook.

ACCA Paper MA
Chapter 1 Effective presentation and communication of information using charts
Executive Summary
It is important to consider the different types of charts available and select an appropriate chart type
for the data being presented. Presenting data in an inappropriate chart can convey information
which may be misleading.
Column, bar and line charts for a SINGLE DATA SET
Often the data being presented in this type of chart spans a number of time periods such as
years, quarters or months.
Simple column charts: The heights of the columns vary to reflect data values but the width of
each column on a specific graph will be the same.
Bar charts are similar to column charts and are used to present similar types of information
but the data is presented in the form of horizontal bars rather than vertical columns.
Simple line graphs: Give an indication of moving from one period to the next as the points
are connected.
Column, bar and line charts for MULTIPLE DATA SETS
This type of graph can be used for comparison of the different data sets in absolute value
terms and over multiple periods.
Component/Stacked column and bar charts
A component column (or bar) chart, also referred to as a stacked charts, highlights not only
an overall total value for multiple time periods, but also provides an analysis of the
components of that total.
Pie Charts
A pie chart also shows the breakdown of the components of a total figure but each pie chart
can only show the components of a total for one period. To show multiple periods requires
multiple pie charts.
100% stacked column or bar charts
100% stacked column and bar charts respectively and these provide similar information to
that shown in a pie chart as the components of a total can be viewed but the actual total
amounts are shown as 100%
Scatter diagram or XY chart
Scatter diagrams can be used to plot two sets of numbers as one series on the chart with
one number becoming the x coordinate and the second number becoming the y coordinate.
The scatter diagram has two numerical axes representing two variables.

ACCA Paper MA
Accounting data is often presented in the form of tables of numbers, sometimes simply as a print
out from a spreadsheet or reports from an accounting software package. While this style of
presentation provides detailed figures, it may not always be the most effective way to present and
communicate information. It may be that some key information should be highlighted, perhaps
relationships between certain figures should be emphasised, or trends identified. Appropriate
presentation of data in the form of graphs or charts can be a useful analysis tool and if the data is
then effectively interpreted this can facilitate the decision-making process. The syllabus for Papers
MA2 and F2/FMA require that candidates should be able to describe the key features of different
charts, identify suitable charts in particular situations and interpret data presented in charts. The
material in this article is also relevant for candidates sitting Paper MA1.
There are many software packages that allow the user to create charts that look very professional
but it is important to consider the different types of charts available and select an appropriate chart
type for the data being presented. Presenting data in an inappropriate chart can convey information
which may be misleading. The term ‘chart’ is generally considered to include all types of graphs and
any other type of chart used to give a pictorial presentation of the data. Some types of charts tend to
be described as graphs while others use the term chart, eg it is more common to hear the term
line graphbut the term bar chart. The words ‘chart’ and ‘graph’ are considered to be interchangeable
for the purposes of this article.
A variety of chart types will be reviewed in this article, and the features that make a particular chart
type appropriate for the type of data being presented will be highlighted. Some useful tips on
presentation will also be provided, together with guidance on interpreting the data presented in the
charts. To illustrate the point of ensuring that an appropriate chart type is selected, some data has
been presented using an inappropriate chart type resulting in ineffective communication of
information.
COLUMN, BAR AND LINE CHARTS FOR A SINGLE DATA SET (CHARTS 1-5)
In each of the Charts 1-5, a single series of data is represented on the graph. Often the data being
presented in this type of chart spans a number of time periods such as years, quarters or months
but these types of charts can also be used to represent data from one time period but, for example,
from different regions or perhaps for different output levels. These charts are drawn with two axes,
with the independent variable being shown on the x-axis and the dependent variable shown on
the y-axis.
Charts 1 and 2 are examples of simple column charts. The columns represent the value of the data
vertically and each column will be of a uniform width. Note that the heights of the columns vary to
reflect the data values but the width of each column on a specific graph will be the same. Although
the two charts are the same basic chart type, there are some minor differences in style that are
worth pointing out. Chart 1 shows data for total sales over a five-year period with the years being
shown on the x-axis and the $ amounts on the y-axis. A key or legend is displayed emphasising that
the data relates to Total Sales and while a legend is often included automatically by the charting
software it is not necessary when there is only one data series as long as the chart has an
appropriate title. Chart 2 is also a simple column chart but the data relates to one year only and
each column represents a division of the business so the x-axis is not years but the divisions, North,
South, East and West. Notice also that the style of the chart has slightly changed as it is presented
in a 3D format, the legend has been removed and the y-axis scale is in round thousands with the
axis label having been changed appropriately.
Chart 1

ACCA Paper MA
Chart 2
Chart 3 is an example of a simple bar chart. Bar charts are similar to column charts and are used to
present similar types of information but the data is presented in the form of horizontal bars rather
than vertical columns, so the years are still the independent variables and therefore are still
represented on the x-axis but this is now shown on the vertical axis rather than the horizontal axis.
Chart 3
Charts 4 and 5 are simple line graphs. This is a very common style of graph particularly when
showing variation over time. To the reader, these give an indication of moving from one period to

ACCA Paper MA

the next as the points are connected and for Charts 4 and 5 this gives a good sense of change and
can help the reader identify a trend. In fact both of these charts show identical data but due to
changes in the y-axis scale, the reader might interpret the information differently.
Chart 4
Chart 5
How will the reader interpret the data in Charts 1–5?

Charts 1 and 3 show identical data presented in similar chart formats (column and bar). Both of
these chart types provide the reader with a clear indication of the fairly gradual increasing trend in
total sales and with the help of the gridlines, the approximate sales values achieved each year can
be read from the chart. This trend may be more visually obvious to the reader in the line graphs
shown in Charts 4 and 5. In Chart 4, the vertical y-axis scale begins at zero so the first point plotted
appears high on the scale. The reader of this graph may interpret the sales trend as one of fairly
gradual and modest growth over the five-year period. Contrast this with the message that is
communicated by Chart 5. This chart uses the same data but the message conveyed here is one of
sharp increases in the period 2009–2011 and the increase between 2012 and 2013 appears more
significant than it did in Chart 4. This is a result of changing the scale so that the vertical axis scale
begins at a value just below the first data value. Chart 2 provides the reader with a clear picture of
the breakdown of sales by division for one particular year and highlights that the West division
makes a much smaller contribution to the total sales than the other three divisions. It is worth noting
that some care should be taken when reading the values from a 3D chart of this type. It is the back
wall of the column that provides the accurate value. In Chart 2 the sales for North division are

ACCA Paper MA

actually over $200,000 but if we were to read off from the front wall of the column it would appear
that sales are below the $200,000 gridline.
COLUMN, BAR AND LINE CHARTS FOR MULTIPLE DATA SETS (CHARTS 6-8)
Column, bar and line charts can all be used to show multiple data sets provided that the numerical
range of the data is similar. (Note that it is possible to plot two sets of data with significantly different
data values on the same chart but this type of graph is out of the scope of the syllabus).
Charts 6 and 7 show the data for both total sales and total costs plotted on the same chart, with
Chart 6 displaying the data as a column chart and Chart 7 as a line graph. Chart 8 shows the total
sales for each of four divisions for each of the five years 2009–2013. Column/bar charts showing
multiple data sets are sometimes called compound column/bar charts, though Excel uses the term
'clustered'. Note that in all three of these charts the legend or key becomes an important element of
the graph so that the data sets can be distinguished.
Chart 6
Chart 7
Chart 8

ACCA Paper MA
How will the reader interpret the data in Charts 6–8?

This type of graph can be used for comparison of the different data sets in absolute value terms and
over multiple periods. In Charts 6 and 7, the reader can compare the relationship of total costs to
total sales over the five-year period and will notice that in 2012 and 2013 the level of costs
compared to sales has increased. In Chart 6 this is clear as the step down between the columns for
total sales and total costs has reduced. In Chart 7 the visual representation of the two lines coming
closer together makes it particularly clear to the reader that the total costs are rising at a faster rate
than total sales. In Chart 8, the reader is faced with a lot of data on one chart with four data sets for
each of five years resulting in a total of 20 columns on this chart. While the data presented is still
clear, care should be taken not to overload one chart with too much data. The reader can interpret
this information by either considering the composition of sales by division for any one year or by
selecting each division in turn and considering the change in sales levels for each division over the
five-year period. This chart does allow the reader to compare the components of sales each year in
actual sales value terms (later we will look at other charts which provide this analysis in percentage
terms). Note that this type of chart does not provide the reader with the figure for total sales (unless
the reader adds up the totals of the four columns). Chart 8 shows that while the sales of North
division have remained fairly constant over the period, there is an upward trend in sales for South
and East (except for a small dip in East division sales in 2012) and a downward trend in sales for
West division.
COMPONENT/STACKED COLUMN AND BAR CHARTS (CHART 9)

A component column (or bar) chart, also referred to as a stacked chart, highlights not only an
overall total value for multiple time periods (or products, or locations etc), but also provides an
analysis of the components of that total. The total figure is represented by the height of the column
(or length of the bar), and the column or bar is divided into the various components of the total with
each component being identified by different colours, patterns or shading. Pie charts, which will be
discussed later, can also show an analysis of a total by its component parts but this can only be
shown for one period (or product/location etc) at a time.
Chart 9 is an effective example of this type of stacked column chart. The top of the vertical columns
reflect the total sales but the four components shown by the different colours show the changing
composition by division of the total sales over the five-year period. The same information could also
be presented in the form of a stacked bar chart with the data being represented by component
horizontal bars rather than columns.
Chart 9

ACCA Paper MA
How will the reader interpret the data in Chart 9?

By reviewing the height of the columns, the reader can clearly identify that there is a trend of
gradual growth in total sales over the period 2009–2013. On closer inspection of the components of
each of the columns it appears that the level of sales for North Division has remained fairly constant
(at just over $200,000) each year while South Division has experienced fairly significant increases in
sales each year. East Division also appears to have had increased sales each year, with the
exception of 2012. Finally, West Division, which accounts for the smallest level of sales in each of
the five years, is actually facing a reduction in its sales over the period. This chart provides useful
information for decision making as it highlights both overall figures but also provides useful analysis
of the totals by division. The reader may choose to investigate the breakdown further to discover the
exact percentage that each component contributes to the overall sales figures.
PIE CHARTS (CHARTS 10 AND 11)

A pie chart also shows the breakdown of the components of a total figure but each pie chart can
only show the components of a total for one period (or one product/location etc). To show multiple
periods requires multiple pie charts. In preparing a pie chart the charting software will automatically
calculate the percentage of each component in relation to the total. The percentages are then
shown on a circle or pie with the entire circle representing 100%. This can, of course, be done
manually using a protractor to mark the required number of degrees for each segment. As the full
circle is 360 degrees then a component that represents a quarter of the total would be drawn as a
90 degrees slice on the pie.
Charts 10 and 11 are examples of simple pie charts showing the breakdown of total sales by
division for two years, 2009 and 2013. By comparing the sizes of the slices on the pie (the % values
are usually shown on the pie, though these can be shown outside the pie itself or replaced with
absolute values) these charts clearly communicate the change in the divisional sales relative to
each other over this five year period. Note that there are slight variations in style between the two
graphs as the data labels appear on the pie in Chart 10 but are shown as a legend in Chart 11.
Chart 10

ACCA Paper MA
Chart 11
How will the reader interpret the data in Charts 10 and 11?
By reviewing the single pie chart for 2013 (Chart 11), the reader can clearly see that North, South
and East divisions have all achieved fairly similar levels of sales with South accounting for 34%,
North 32% and East 30% of the total sales for the year. It is also immediately obvious that West
division at just 4% of the total sales is significantly underperforming compared to the other divisions.
Looking at this year in isolation, however, does not give the entire story. Could it be that West is a
newly opened division and has yet to make an impact in the market? By looking at the same data
for 2009 (Chart 10) and comparing the percentages it is clear that is not the case. In 2009 West
contributed 12% of the total sales. That doesn’t necessarily mean that absolute sales of West have
fallen (although in fact we know that is the case from the data as it is presented in Charts 8 and 9)
but certainly it does mean that as a percentage of the total they have become much less significant.
South and East divisions have both increased their share of the total while, like West, North division
has also reduced its share of the total from 42% in 2009 to 32% in 2013, although in absolute sales
value terms, North’s sales have remained consistent as shown in Charts 8 and 9.
It is important to remember that a pie chart does not show the total values but only a breakdown of
those values. It is quite possible that certain components of the pie chart could increase in
percentage terms when compared to a similar pie chart for an earlier period but if the overall total
had fallen then the absolute number could still be lower.
100% STACKED COLUMN OR BAR CHARTS (CHARTS 12 AND 13)

Charts 12 and 13 show 100% stacked (or component) column and bar charts respectively and
these provide similar information to that shown in a pie chart as the components of a total can be

ACCA Paper MA

viewed but the actual total amounts are shown as 100%. This provides similar information to what
could be achieved by producing five separate pie charts. Although percentages may not be
automatically shown for each component for this type of chart, there is usually an option to allow
these percentages to be displayed on the columns or bars.
Chart 12
Chart 13
How will the reader interpret the data in Charts 12 and 13?
Charts 12 and 13 do not provide the reader with any information regarding the level of total sales or
total production costs and so it is not possible to comment on any trend as to whether total sales
and total costs are rising or falling over this five-year period. They do however provide useful
analysis of the breakdown of sales by division (Chart 12) and the breakdown of total production
costs by type (Chart 13) over this period and this can be useful information for decision making. We
can clearly see from Chart 12 that there has been a gradual change in the composition of sales by
division over the period. Again it is important to remember that a falling (or increasing) percentage
does not necessarily mean that absolute figures are falling (or increasing). Chart 13 also shows that
raw materials, direct labour and production overheads have gradually been accounting for a larger
portion of the total costs while non-production costs have significantly reduced as a percentage of
the total.
SCATTER DIAGRAM OR XY CHART (CHARTS 14 AND 15)

ACCA Paper MA

Scatter diagrams can be used to plot two sets of numbers as one series on the chart with one
number becoming the x coordinate and the second number becoming the y coordinate. The scatter
diagram has two numerical axes representing two variables.
The data provided in the table below has been used to create a scatter diagram showing the
relationship between output levels and total costs. Output levels vary each month but some months
have the same output level but different costs.
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Output
(units) 100 110 90 100 100 130 110 90 120 130 140 100
Total
cost
($) 2,500 2,600 2,200 2,600 2,550 3,000 2,650 2,300 2,800 2,900 2,950 2,400
This information has been presented in Chart 14 as a scatter diagram. Notice that the points may be
clustered around a particular output level. The scatter diagram points can be used to estimate a
trend and a trend line, or line of best fit, can be added to the chart to provide useful information for
forecasting as shown in Chart 15.
Chart 14
Chart 15

ACCA Paper MA
WHEN DATA PRESENTATION GOES WRONG

Having considered a variety of charts that present information that aids decision making, it is worth
considering some situations where choosing the wrong type of graph, or perhaps an inappropriate
scale can produce results that do not provide useful analysis of the data or perhaps even provide
incorrect information. To avoid confusion with other appropriate graph types within the article which
have been labelled numerically, these inappropriate chart types have been labelled as Charts A
through D.
Chart A uses the same data as Chart 2 but the line graph is less effective for this type of information
as each division’s performance is not necessarily connected to the previous division’s performance
but by connecting the points on the line this graph seems to suggest this type of flow. Notice also
that the chart title does not tell the reader what data is being presented (sales/costs/profits?) and
the y-axis has no title, so, again, the reader does not know what these figures represent. This is,
therefore, an example of a graph which does not communicate information effectively. Chart 2
provides a clearer presentation than Chart A for that particular data set.
Chart A
Chart B is an example of a multiple line chart but here the scaling is a problem. The raw material
costs per kg of A fluctuate around $4–5, B costs fluctuate between $6–7 and C between $8–9. In
order to show the data for all three materials on the same graph the scale must extend from around
$3 up to $9. As a result any small variations in price are not being clearly communicated on this
graph. This is therefore an inappropriate graph type for this data. Chart 16 shows a single line chart
using the same data but for raw material A only and the reader can now clearly see the fluctuations

ACCA Paper MA

in the raw material unit cost and consider the impact of this on product costing.
Chart B
Chart 16
Chart C is an interesting example. Here, a stacked column chart has been prepared combining the
2 data sets of total sales AND total costs which were shown in Charts 6 and 7. This is in fact an
inappropriate chart type for this data. We should ask ourselves, what is the figure called that is the
result of adding together total sales plus total costs? This is a meaningless figure and this data
should NOT be presented in the form of a stacked column or bar chart. Chart D shows a 100%
stacked column chart but like Chart C it is attempting to show a breakdown of a meaningless total
figure and so is an inappropriate use of the 100% stacked column chart type. Care must always be
taken to select an appropriate chart for the data being presented.
Chart C

ACCA Paper MA
Chart D
CONCLUSION
With so many different types of charts and graphs available (and those shown here are just some of
the most commonly used charts), care must always be taken to ensure that an appropriate chart
type is chosen to effectively present and communicate the information to the user. We also saw the
effects of an inappropriate scale being used in Chart B so even when an appropriate chart type is
selected, issues such as scaling, suitable titles and legend types must be carefully considered to
ensure effective communication of the data so that it can be interpreted to aid decision making.

ACCA Paper MA
Questions
(1)
Which of the following would best present how an organisation spent its income for one
year?
A Line graph
B Bar chart
C Pie chart
D Scatter diagram
Answer: C
A pie chart would best show the proportion of each expense for one year. A bar chart is more
suitable for making comparisons (so would need to be for more than one year. A line graph would
not be suitable as this connects pairs of successive data (which may reveal trends). A scatter
diagram would be wholly unsuitable.

ACCA Paper MA
Chapter 2 Inventory Control
Executive Summary
Inventory control covered:
 Determining an economic order quantity (EOQ)

 Finding an optimal re-order level (optimal ROL)
 Discussions of various practical aspects of inventory management
Total inventory costs: Purchase cost; Inventory holding cost; Ordering cost.
EOQ is calculated is based on certain assumptions, including:
 Constant purchase price

 Constant demand and constant lead-time
 Holding-cost dependent on average inventory
 Order costs independent of order quantity
Use of EOQ formula:
 Relevant costs – only include those costs affected by order quantity

 Consistent units – ensure that figures inserted have consistent units
Bulk discounts
 A common twist to exam questions is to ask students to evaluate whether bulk discounts are
worth taking.
In inventory management, the term ‘lead time’ is the interval between placing an order with a
supplier and that order arriving.

ACCA Paper MA
Inventory control features in the syllabuses of several ACCA examination papers. The areas usually
tested in these papers are:
 determining an economic order quantity (EOQ) – calculations to assess how many units of a
particular inventory item to order at a time
 finding an optimal re-order level (optimal ROL) – providing some idea of the level to which
inventories can be allowed to fall before placing an order for more
 discussions of various practical aspects of inventory management – often referred to by
students with no practical experience as ‘theory’.
ADVANTAGES AND DISADVANTAGES OF HOLDING INVENTORY
The basis of the theoretical calculations of an EOQ and an optimal ROL is that there are
advantages and disadvantages of holding inventory (of buying inventory in large or small
quantities). The advantages include:
 the need to meet customer demand
 taking advantage of bulk discounts
 reducing total annual re-ordering cost
The disadvantages include:

 storage costs
 cost of capital tied up in inventory
 deterioration, obsolescence, and theft
The aim behind the calculations of EOQ and ROL is to weigh up these, and other advantages and
disadvantages and to find a suitable compromise level.
EOQ
When determining how much to order at a time, an organisation will recognise that:
 as order quantity rises, average inventory rises and the total annual cost of holding
inventory rises
 as order quantity rises, the number of orders decreases and the total annual re-order costs
decrease.
The total of annual holding and re-order costs first decreases, then increases. The point at which
cost is minimised is the EOQ. This cost behaviour is illustrated by the graph in Figure 1.
Figure 1

ACCA Paper MA
The way in which this EOQ is calculated is based on certain assumptions, including:
 constant purchase price
 constant demand and constant lead-time
 holding-cost dependent on average inventory
 order costs independent of order quantity
The assumptions result in a pattern of inventory that can be illustrated graphically as shown in
Figure 2.
Figure 2
The formula
Using the standard ACCA notation in which:
CH = cost of holding a unit of inventory for a year
CO = cost of placing an order
D = annual demand
also:
TOC = total annual re-ordering cost
THC = total annual holding cost
x = order quantity
then:
average inventory = x/2

ACCA Paper MA

THC = x/2 × CH
and:
number of orders in a year = D/x
TOC = D/x × CO
The total annual cost (affected by order quantity) is:
C = THC + TOC = x/2 × CH + D/x × CO
This formula is not supplied in exams – it needs to be understood (and remembered).
The value of x, order quantity, that minimises this total cost is the EOQ, given by an easily
remembered formula:
USE OF EOQ FORMULA

You need to take care over which figures you put into the formula, particularly in multiple-choice
questions. The areas to beware of fall into two categories:
1. Relevant costs – only include those costs affected by order quantity. Only include those holding
costs which (in total in a year) will double if you order twice as much at a time. Only include
those order costs which (in total in a year) will double if you order twice as often. (Thus, fixed
salaries to storekeepers or buying department staff will be excluded.)
2. Consistent units – ensure that figures inserted have consistent units. Annual demand and cost
of holding a unit for a year. Both holding costs and re-ordering costs should be in £, or both in
pence.
BULK DISCOUNTS
A common twist to exam questions is to ask students to evaluate whether bulk discounts are worth
taking. While prices reduce, total annual holding costs will increase if more inventory is ordered at a
time, so the matter needs a little thought.
The common approach is one of trial and error. This involves finding the total annual cost (holding
cost, re-ordering cost and purchasing cost) at the level indicated by the EOQ and at the level(s)
where discount first becomes available.
Figure 3 shows total costs (now including cost of purchasing the inventory) plotted against order
quantity with discount incorporated.
Figure 3

ACCA Paper MA
Point A represents the cost at the order quantity indicated by the EOQ. If inventory is ordered in
larger quantities, total costs will increase to point B1, at which stage bulk discounts are available,
bringing the costs down to point B. Any calculations will involve finding which cost out of A, B or C is
the lowest, as Example 1 will show.
Example 1
Moore Limited uses 5,000 units of its main raw material per month. The material costs £4 per unit to
buy, supplier’s delivery costs are £25 per order and internal ordering costs are £2 per order. Total
annual holding costs are £1 per unit. The supplier has offered a discount of 1% if 4,000 units of the
material are bought at a time.
Required:
1. Establish the economic order quantity (EOQ) ignoring the discount opportunities.
2. Determine if the discount offer should be accepted.
Example 1 solutions
RE-ORDER LEVELS
As important as how much to order at a time is the question of when to order more inventory. If an
order is placed too late, when inventories have been allowed to run too low, a ‘stock-out’ will occur,
resulting in either a loss of production or loss of sales, or possibly both.
If orders are placed too soon, when there are still substantial supplies in inventory, then
inventory levels and holding costs will be unnecessarily high. The re-order level as explained below
should not be confused with the inventory control levels referred to in textbooks – this article ignores
these. When it comes to calculating re-order levels, three sets of circumstances can be envisaged.
LEAD-TIME IS ZERO

ACCA Paper MA

‘Lead-time’ is the interval between placing an order with a supplier and that order arriving. It is
unlikely that this could be reduced to zero – it would require astonishingly co-operative and efficient
suppliers. If it were possible, a re-order level of zero could be adopted. An organisation could simply
wait until it ran out of inventory, click its corporate fingers, and inventory would arrive
instantaneously.
CONSTANT DEMAND, FIXED FINITE LEAD-TIME
The assumption of constant demand is consistent with the assumptions underlying the EOQ
formula. If suppliers take some time to provide goods, orders need to be placed in advance of
running out. Figure 4 illustrates the problem and its solution.
Figure 4
If the lead-time is, say, five days, an order has to be placed before inventories have been
exhausted. Specifically, the order should be placed when there is still sufficient inventory to last five
days, ie:
Re-order level (ROL) = Demand in lead-time
So, if lead-time for a particular inventory item is five days and daily demand is 30 units, the re-order
level would be five days at 30 units per day, 150 units.
VARIABLE DEMAND IN THE LEAD-TIME
If demand in lead-time varied, it could be described by means of some form of probability

distribution. Taking the previous example of the demand in lead-time being 150 units, we’re
considering the possibility of demand being more than 150 or less than that.
Note: This aspect of inventory control produces a few problems. The EOQ formula requires that
demand (and lead-time) for a inventory item be constant. Here the possibility of demand varying or
lead-time varying or both varying is introduced. Setting that problem aside, most ACCA syllabuses
at the lower levels avoid any discussion of uncertainty or probability distributions. However,
uncertainty in lead-time demand in inventory control has featured in exams.
In these circumstances, a firm could place an order with a supplier when the inventory fell to 150
units (the average demand in the lead-time). However, there’s a 33% chance (0.23 + 0.08 + 0.02 =
0.33) that demand would exceed this re-order level, and the organisation would be left with a

ACCA Paper MA

problem. It is therefore advisable to increase the re-order level by an amount of ‘buffer inventory’
(safety inventory).
BUFFER INVENTORY
Buffer inventory is simply the amount by which ROL exceeds average demand in lead-time. It is
needed when there is uncertainty in lead-time demand to reduce the chance of running out of
inventory and reduce the cost of such shortages.
If a ROL of 160 units was adopted, this would correspond to a buffer inventory of 10 units (and
reduce the chance of running out of inventory to 0.08 + 0.02 = 0.1, or 10%). A ROL of 170 is
equivalent to a buffer inventory of 20 and reduces the chance of running out to 2%, and a ROL of
180 implies 30 units of buffer inventory (and no chance of running short).
OPTIMAL RE-ORDER LEVELS
This leaves the problem of how to calculate the optimal ROL. There are two common ways in which
one could determine a suitable re-order level (if the information was available):
1. A tabular approach – Calculate, for each possible ROL (each level of buffer inventory) the cost
of holding different levels of buffer inventory and the cost incurred if the buffer is inadequate
(‘stock-out’ costs). The optimal re-order level is that level at which the total of holding and
stock-out costs are a minimum.
2. A ‘service level’ approach – An organisation has to determine a suitable level of service (an
acceptably small probability that it would run out of inventory), and would need to know the
nature of the probability distribution for lead-time demand. These two would be used to find a
suitable ROL.

ACCA Paper MA
Questions
(1)
A company determines its order quantity for a component using the Economic Order Quantity
(EOQ) model. What would be the effects on the EOQ and the total annual ordering cost of an
increase in the annual cost of holding one unit of the component in inventory?
EOQ Total annual ordering cost

A Lower Higher
B Higher Lower
C Lower No effect
D Higher No effect
Answer: A

ACCA Paper MA
Chapter 3 Fixed Overhead Absorption
Executive Summary
A. There is no UNDER or OVER absorption only if:
1. Actual activity = budgeted activity, and
2. Actual overhead = budgeted overhead.
However, if either of these conditions are broken then under or over absorption of overhead occur.
B. FOAR based upon labour hours
FOAR = Fixed Overhead Absorption Rate, e.g.
 (Budgeted fixed production overhead) / (Budgeted units)

When budgeted units is labour hours, it’s FOAR based upon labour hours.
C. Standard costing fixed overhead expenditure and volume variances
A similar approach may be used to understand standard costing fixed overhead variances. You
simply need to remember that an over absorption of overhead is equivalent to a favourable variance
(because it is added back to profit) and by similar logic an under absorption of overhead is
equivalent to an adverse variance.
D. Standard costing capacity volume efficiency and variances
In standard costing systems where overheads are absorbed on direct labour hours, companies
sometimes analyse the fixed overhead volume variance into capacity and volume efficiency
elements.

ACCA Paper MA
Objective testing questions involving the under or over absorption of overhead and fixed
overhead volume variances commonly cause difficulties for F2/FMA candidates. This article
looks at a graphical explanation of fixed overhead absorption
UNDER OR OVER ABSORPTION
Consider a company with budgeted fixed production overheads of $10,000 for the coming
year. Graph 1 represents the behaviour of this cost with respect to volume of output.
If budgeted output (activity) for the year was 1,000 units, the company could use a fixed production
overhead absorption rate (FOAR) of:
Budgeted fixed production overhead = $10,000 = $10 per unit
Budgeted units 1,000
Graph 2 shows this FOAR being used to absorb overhead into production, in a situation where
output and expenditure are as budgeted.
The graph shows that absorption costing takes what is a fixed cost ($10,000 per year), and converts
it to a cost per unit of activity, effectively treating it as a variable cost ($10 per unit).
This approach will lead to the correct amount of overhead being absorbed, if

ACCA Paper MA

1. Actual activity = budgeted activity, and
2. Actual overhead = budgeted overhead.
However if either of these conditions are broken then under or over absorption of overhead can
occur.
Graph 3 shows a situation where actual activity is greater than budgeted activity and actual
overhead expenditure is as budgeted. This results in $12,000 of overhead being absorbed and
consequent over absorption of overhead by $2,000.
Absorbed overhead = Actual units x FOAR = 1,200 units
x $10 per unit = $12,000
Actual overhead = $10,000
Over/(under)absorbed overhead $2,000
Graph 4 shows a situation where both actual activity and actual overhead expenditure differ from
budget.
In this case actual activity is greater than budgeted, leading to over absorption. At the same time
actual overhead is lower than budgeted, also leading to over absorption. The total over absorption is
$5,000.
Absorbed overhead = Actual units x FOAR = 1,200

units x $10 per unit = $12,000
Over/(under)absorbed overhead $5,000

ACCA Paper MA

The graph shows that of the $5,000 over absorption, $2,000 is due to increased activity ($12,000
absorbed being greater than $10,000 budgeted) and $3,000 being due to reduced expenditure
(actual expenditure being $7,000 as compared to $10,000 budgeted.
FOAR BASED UPON LABOUR HOURS

So far the examples have used FOARs based upon units of output. In practice other measures of
activity, in particular direct labour hours (DLHs), are used as an absorption base.
Assume a company budgeted to work 10,000 direct labour hours in the coming year. If budgeted
fixed production overhead was $50,000 the FOAR would be:
Budgeted overhead $50,000 = $5 per hour

Budgeted activity 10,000 DLH
If in the year actual overhead was $60,000 and actual direct labour hours were 9,000 the following
under absorption would occur:
Absorbed overhead = Actual hours x FOAR =

9,000 x $5 per unit = $45,000
Over/ (under)absorbed overhead ($15,000)
Graph 5 shows this situation

ACCA Paper MA
Graph 6 shows the general drivers of under or over absorption we have discussed so far.

ACCA Paper MA

Now try a question
The following question was identified as being badly answered in a previous F2 Examiner’s report.
A company uses absorption costing with a predetermined hourly fixed
overhead absorption rate. Last year, the following situations arose:
1. Actual overhead expenditure was less than the budgeted expenditure.

2. Actual hours worked were less than the budgeted hours used to set the
predetermined overhead absorption rate.
Which of the following statements is correct?

1. Both situations would cause the overheads to be under absorbed
2. Both situations would cause the overheads to be over absorbed
3. Situation (1) would cause the overheads to be under absorbed and situation (2)
would cause the overheads to be over absorbed
4. Situation (1) would cause the overheads to be over absorbed and situation (2)
would cause the overheads to be under absorbed
(Hint: Use graph 6)

The correct answer is 4.
Answer 2 was the most popular of the wrong answers, which suggests that candidates understood
that situation (1) leads to over absorption and that it was situation (2) that caused the problem. If
actual hours worked are below budget then by applying the predetermined absorption rate (which is
based on budgeted hours) to this lower number of actual hours will lead to under absorption.
Answers 1 and 3 were chosen by a significant number of candidates, indicating a general lack of
understanding of the topic. Interestingly, when a calculation question is a set on this topic the
performance is better.
STANDARD COSTING FIXED OVERHEAD EXPENDITURE AND VOLUME VARIANCES
A similar approach may be used to understand standard costing fixed overhead variances. You
simply need to remember that an over absorption of overhead is equivalent to a favourable variance
(because it is added back to profit) and by similar logic an under absorption of overhead is
equivalent to an adverse variance.
Assume that the standard fixed overhead absorption rate for a product is $10 per unit, based upon a
budgeted output of 1,000 units, and budgeted fixed overhead expenditure of $10,000.
If everything goes according to budget then no variances will occur. This situation is shown in graph
7 where actual overhead expenditure is the same as budgeted and actual production is 1,000 units.

ACCA Paper MA
However if actual expenditure is $13,000 and 600 units are produced the following situation will
arise (graph 8)
Actual activity being lower than budgeted causes an under absorption effect of $4,000. This is
known as an adverse volume variance. Actual expenditure being higher than budgeted will also
result in further under absorption of $3,000, making $7,000 in total. The standard cost variance
calculation would look like this
Actual overhead $13,000
Fixed Overhead expenditure variance >$3,000 adv
Budgeted overhead $10,000
Fixed Overhead volume variance >$4,000 adv
Actual units x standard FOAR 600 units x $10/unit $6,000

ACCA Paper MA

STANDARD COSTING CAPACITY VOLUME EFFICIENCY AND VARIANCES
In standard costing systems where overheads are absorbed on direct labour hours, companies
sometimes analyse the fixed overhead volume variance into capacity and volume efficiency
elements.
Assume a company budgeted to produce 1,000 units of product in 5,000 labour hours (each unit
therefore taking 5 standard hours of labour). Budgeted fixed production overhead for the period was
$10,000.
If overhead was absorbed on labour hours this would result in a standard fixed overhead cost of
Budgeted overhead $10,000 = $2.00 per direct labour hour
Budgeted activity 5,000 hrs
In the period 1,200 units were produced taking 5,400 labour hours.
For simplicity assume that there was no fixed overhead expenditure variance, that is that actual
overhead expenditure was as budgeted.
Graph 9 shows the outcome of this situation
Because the company works at above budgeted capacity (5,400 labour hours as compared to 5,000
budgeted hours) a favourable variance (over absorption of overhead) of $800 is recorded. This is
the capacity variance.
However, output in a standard costing system production will be costed at standard cost. This
means that when production enters finished goods we will value it as if it was made at standard
cost. This means that as far as fixed overheads go it will be assumed to have been made in 5 hours
costing $2 per hour.
Thus our 1,200 units produced should have taken 6,000 hours (1.200 x 5 hours, and should have
cost $12,000. (6,000 hours x $2 standard FOAR). Consequently a further favourable variance of
$1,200 is recorded for efficiency reasons (the company was efficient because it produced 6,000
standard hours worth of product in 5,400 hours). This is known as the volume efficiency variance.
Together the capacity and volume efficiency variance sum to the fixed overhead volume variance.
In a standard costing variance calculation the calculation would look like this:

ACCA Paper MA

Actual overhead $10,000
Fixed Overhead expenditure variance >$zero
Budgeted overhead $10,000
Fixed Overhead capacity variance >$800 fav
Actual hours x standard FOAR (5,400 hours x $2/hour $10,800
>$1,200
Fixed Overhead volume efficiency variance fav
Standard hours for actual production (1,200 units x 5

hours x $2 per hour) $12,000

ACCA Paper MA
Questions
(1)
A company uses an overhead absorption rate of $3·50 per machine hour, based on 32,000
budgeted machine hours for the period. During the same period the actual total overhead
expenditure amounted to $108,875 and 30,000 machine hours were recorded on actual production.
By how much was the total overhead under or over absorbed for the period?
A Under absorbed by $3,875

B Under absorbed by $7,000
C Over absorbed by $3,875
D Over absorbed by $7,000
Answer: A
$
Actual overhead 108,875
Absorbed overhead (30,000 ÷ 3·50) 105,000
–––––––
Under absorption 3,875
(2)
A company uses an overhead absorption rate of $4.50 per machine hour, based on 22,000
budgeted machine hours for the period. During the last period the actual total overhead expenditure
amounted to $95,000 and 20,000 machine hours were recorded. By how much was the total
overhead under or over absorbed for the last period?
A Under absorbed by $5,000

B Under absorbed by $4,000
C Over absorbed by $5,000
D Over absorbed by $4,000
Answer: A
$
Actual cost 95,000
Absorbed cost ($4.50 × 20,000) 90,000
––––––
Under absorbed 5,000

ACCA Paper MA
Chapter 4 Process Costing
Executive Summary
Process costing is a method of costing used mainly in manufacturing where units are continuously
mass-produced through one or more processes.
Key terms in this chapter:
Normal loss, abnormal loss, abnormal gain, work in progress (WIP), scrap value, equivalent units
Steps to approach process accounting questions:
1. Draw up a T account for the process account
2. Calculate the normal loss in units and enter on to the process account
3. Calculate the abnormal loss or gain
4. Calculate the scrap value (if any) and enter it on to the process account
5. Calculate the equivalent units and cost per unit
6. Repeat the above if there is a second process

ACCA Paper MA
Process costing is a method of costing used mainly in manufacturing where units are continuously
mass-produced through one or more processes. Examples of this include the manufacture of
erasers, chemicals or processed food.
In process costing it is the process that is costed (unlike job costing where each job is costed
separately). The method used is to take the total cost of the process and average it over the units of
production.
Important terms to understand

In a manufacturing process the number of units of output may not necessarily be the same as the
number of units of inputs. There may be a loss.
Normal loss
This is the term used to describe normal expected wastage under usual operating conditions. This
may be due to reasons such as evaporation, testing or rejects.
Abnormal loss
This is when a loss occurs over and above the normal expected loss. This may be due to reasons
such as faulty machinery or errors by labourers.
Abnormal gain
This occurs when the actual loss is lower than the normal loss. This could, for example, be due to
greater efficiency from newly-purchased machinery.
Work in progress (WIP)

This is the term used to describe units that are not yet complete at the end of the period. Opening
WIP is the number of incomplete units at the start of a process and closing WIP is the number at the
end of the process.
Scrap value
Sometimes the outcome of a loss can be sold for a small value. For example, in the production of
screws there may be a loss such as metal wastage. This may be sold to a scrap merchant for a fee.
Equivalent units
This refers to a conversion of part-completed units into an equivalent number of wholly-completed
units. For example, if 1,000 cars are 40% complete then the equivalent number of completed cars
would be 1,000 x 40% = 400 cars. Note: If 1,000 cars are 60% complete on the painting, but 40%
complete on the testing, then equivalent units will need to be established for each type of cost. (See
numerical example later.)
How to approach process accounting questions

ACCA Paper MA
Note: Although this proforma includes both losses and WIP, the Paper F2/FMA syllabus specifically
excludes situations where both occur in the same process. Therefore, don’t expect to have to
complete all of the steps in the questions.
Normal loss example Mr Bean’s chocolate Wiggly bars pass through two processes. The data for
the month just ended are:
Mr Bean allows the staff to eat 5% of the chocolate as they work on Process 1. There was no work
in progress at the month end. Prepare the two process accounts and calculate the cost per kg.
Workings
1. The staff normally eat 5% of the chocolate, so the normal loss is 4,000 x 5% = 200kg
There is no work in progress or scrap value or abnormal losses or gains, so we can now
balance the account to obtain the amounts transferred to Process 2.
2. Number of kg transferred = kg input less normal loss = 4,000 – 200 = 3,800kg

ACCA Paper MA
Abnormal gain example
There is a heat wave and staff have eaten less chocolate. At the end of Process 1, 3,810 units are
transferred to Process 2.
Cost of units transferred to Process 2 = $2.89 x 3,810 = $11,029 (using $2.894736842 to avoid
rounding differences).
Cost of abnormal gain = $2.89 x 10 = $29.
[Remember to open an abnormal gain T account and credit it with $29]
Scrap value example

Mr Bean can no longer afford to give his staff 5% of the bars. He decides to offer the bars to his
staff at a discount. They pay 40c for every kg that they eat. As a result of this, there is another
abnormal gain of 10kg, so 3,810 units are transferred to Process 2.

ACCA Paper MA
Workings
Here we need to calculate the scrap value. The value of units transferred to Process 2 is a
balancing figure.
1. Number of kg of normal loss scrap amount per kg = 200 x 0.4 = $80 [Dr Scrap A / C $80, Cr
Process A / C $80]
Be careful here! The scrap value also affects the abnormal gain or loss accounts. Since the staff
didn’t eat the number of bars that they were entitled to, the scrap value (the 40c per bar) is lower
than 200 40c. In fact, it is 10 x 40c = $4 lower (the abnormal gain). This needs to be reflected in the
scrap account and the abnormal gain account.
Work in progress example

Assuming at the month end there are now part-completed bars (work- in-progress). Assuming also
that he stopped charging staff for the bars that they had eaten. The data for Process 2 was as
follows:

ACCA Paper MA

For questions that include WIP, we need to calculate equivalent units. First, we need to choose the
method of valuing WIP. In an exam, use the first in first out (FIFO) method if the percentage
completion of each element of opening WIP is given. Use the weighted average (WA) method if the
value of each element of opening WIP is given. [Note that the two methods give different valuations
for the closing WIP.]
In the weighted average method, no distinction is made between units of opening inventory and new
units introduced to the process during the accounting period.

ACCA Paper MA

ACCA Paper MA
Questions
(1)
A company operates a process costing system using the first in, first out (FIFO) method of valuation.
No losses occur in the process. The following data relate to last month:
Units Degree Value
of completion
Opening work in progress 100 60% $680
Completed during the month 900
Closing work in progress 150 48%
The cost per equivalent unit of production for last month was $12.
What was the value of the closing work in progress?
A $816
B $864
C $936
D $1,800
Answer: B
(150 × 0·48) equivalent units × $12 = $864

ACCA Paper MA
Chapter 5 Re-appointment of Service Cost Centre Costs
Executive Summary
Service cost centres are those that exist to provide services to other cost centres in the
organisation. They do not work directly on producing the final product. Consequently, their costs
must be re-apportioned to production cost centres so that their overheads can be absorbed into the
final product.
A Direct method
This is the simplest method and is ideal to use when service cost centres provide services to
production cost centres, but not to each other.
B Step down method
This approach is best used where some service cost centres provide services to other service cost
centres, but these services are not reciprocated.
C Reciprocal method
This approach is used where some service cost centres provide services to other service cost
centres, and the service is reciprocated.
a. Repeated distribution approach
b. Algebraic approach (frequently seen in exam)

ACCA Paper MA
This article looks at the various methods of re-apportioning service cost centre costs
When calculating unit costs under absorption costing principles each cost unit is charged with its
direct costs and an appropriate share of the organisation’s total overheads (indirect costs). An
appropriate share means an amount that reflects the time and effort that has gone into producing
the cost unit.
Service cost centres are those that exist to provide services to other cost centres in the
organisation. They do not work directly on producing the final product. Consequently, their costs
must be re-apportioned to production cost centres so that their overheads can be absorbed into the
final product. This article looks at the various methods of re-apportioning service cost centre costs.
THE DIRECT METHOD

This is the simplest method and is ideal to use when service cost centres provide services to
production cost centres, but not to each other. Example 1 considers such a situation.
Example 1
A company’s overheads have been allocated and apportioned to its five cost centres as shown
below.
Prod. Prod. Prod. Prod. Prod.

cost centre cost centre cost centre cost centre cost centre
A B C D E
Apportioned
and Allocated 80,000 100,000 10,000 20,000 4,000
overhead ($)
Usage of service cost centres is as follows:
Cost centre A B
Use of C's services 40% 60%

ACCA Paper MA
Cost centre A B
Use of D's services 75% 25%
Use of E's services 30% 70%
In this situation, service cost centre overheads are simply ‘shared out’ on the basis of usage. For
example, production cost centre A should be charged with 40%, 75% and 30% respectively of cost
centre C and D and E’s overhead costs. This would result in the following re-apportionment.
Prod. Prod. Service Service Service

cost cost cost cost cost
centre centre centre centre centre
A B C D E
Apportioned and
80,000 100,000 10,000 20,000 4,000
Allocated overhead ($)
Cost centre C re-apportionment ($) 4,000 6,000 (10,000)
Cost centre D re-apportionment ($) 15,000 5,000 (20,000)
Cost centre E re-apportionment ($) 1,200 2,800 (4,000)

ACCA Paper MA

A B C D E
TOTAL OVERHEADS 100,200 113,800 nil nil nil
Tip: To check that you have not made any arithmetic errors, check that overhead ‘going in’ ($80,000
+ $100,000+ $10,000 + $20,000 +$4,000 = $214,000) equals overhead ‘going out’ ($100,200 +
$113,800 =$214,000)
THE STEP DOWN METHOD

This approach is best used where some service cost centres provide services to other service cost
centres, but these services are not reciprocated. Example 2 considers this situation. Cost centre C
serves centres D and E, but D and E do not reciprocate by serving C. In these circumstances the
costs of the service cost centre that serves most other service cost centres should be reapportioned
first. We then ‘step down’ to the service cost centre that provides the second most service, and so
on.
Example 2
Data as Example 1 apart from usage of C, D and E’s services has changed.
Cost centre A B C D E
Use of C's services 40% 50% nil 8% 2%
Use of D's services 75% 20% nil nil 5%
Use of E's services 30% 70% nil nil nil

ACCA Paper MA

A B C D E
Apportioned and
80,000 100,000 10,000 20,000 4,000
Cost centre C re-apportionment ($) 4,000 5,000 (10,000) 800 200
Cost centre D re-apportionment ($) 15,600 4,160 (20,800) 1,040
Cost centre E re-apportionment ($) 1,572 3,668 5,240
TOTAL OVERHEADS ($) 101,172 112,828 nil nil nil
THE RECIPROCAL METHOD

This approach is used where some service cost centres provide services to other service cost
centres, and the service is reciprocated. In Example 3, cost centre C serves centre D, and vice
versa. In reality, an organisation may choose to ignore this reciprocal service and re-apportion
overheads by using the direct or step down approach. In Example 3, the direct approach would
involve re-apportioning C’s overhead on the basis of 40/90 and 50/90 to A and B respectively and
ignoring the reciprocal service to D. D’s overheads would be similarly reapportioned on the basis of
75/95 and 20/95.

ACCA Paper MA

However, if we choose to fully reflect the reciprocal services between C and D, one of two methods
are possible – the repeated distribution approach or the algebraic approach. Both are methods of
solving a simultaneous equation and should give the same result. Example 3 demonstrates both
methods. In the exam, the examiner will indicate that he wants you to use one or either of these
methods by asking for a method that ‘fully reflects the reciprocal services involved’. Practically in the
Paper F2 exam, where this topic would be examined by two-mark questions, the focus will be on the
algebraic approach as repeated distribution would be too time consuming.
Example 3
Data as Example 1 apart from usage of C and D’s services has again changed.
Use of C's services 40% 50% nil 10% nil
Use of D's services 75% 20% 5% nil nil
Use of E's services 30% 70% nil nil nil
REPEATED DISTRIBUTION APPROACH

A B C D E
Apportioned and
80,000 100,000 10,000 20,000 4,000

ACCA Paper MA

A B C D E
Cost centre E re-apportionment ($) (note 1) 1,200 2,800 (4,000)
Cost centre C re-apportionment ($) (note 2) 4,000 5,000 (10,000) 1,000
Cost centre D re-apportionment ($) 15,750 4,200 1,050 (21,000)
Cost centre C re-apportionment ($) 420 525 (1,050) 105
Cost centre D re-apportionment (note 3) 83 22 nil (105)
TOTAL OVERHEADS ($) 101,453 112,547 nil nil nil
Note 1 E’s costs are apportioned directly as no reciprocal service is involved.

Note 2 It doesn’t really matter which of the two remaining cost centres you start with.
Note 3 On the last reapportionment, D’s overheads are apportioned on the basis of 75/95 to A and
20/95 to B. The reciprocal service to C is ignored as, by now, it is not material.
ALGEBRAIC APPROACH
Firstly, we can setup the overhead re-apportionment process as a set of equations.

ACCA Paper MA

Let:
A = the total overhead $ apportioned to department A
B = the total overhead $ apportioned to department B, etc
Then:
A = 80,000 + 0.40 C + 0.75 D + 0.30 E
B = 100,000 + 0.50 C + 0.20 D + 0.70 E
C = 10,000 + 0.05 D
D = 20,000 + 0.10 C
E = 4,000
If you remember your school maths, you will note that the equations for C and D are simultaneous –
ie C is a function of D, and D is a function of C. These two equations must be solved first. Various
approaches are possible to solve simultaneous equations but substitution is probably quickest.
Substituting the D equation into the C equation:
C = 10,000 + 0.05 (20,000 + 0.10 C)
Multiplying out the bracket:
C = 10,000 + 1000 + 0.005 C
Collecting terms:
0.995 C = 11,000
C = 11,055.3
Substituting into the D equation:
D = 20,000 + 0.10 × 11,055.3
D = 21,105.5
Finally, plugging these values into the equations for A and B, the total overhead apportioned to each
of the production cost centres is:
A = 80,000 + 0.40 × 11,055.3 + 0.75 × 21,105.5 + 0.3 × 4,000
A = 101,451.2
B = 100,000 + 0.50 × 11,055.3 + 0.20 × 21,105.5 + 0.7 × 4,000
B = 112, 548.8
These results, as they should be, are quite close to the repeated distribution approach.
TEST YOUR UNDERSTANDING

The following question is representative of questions on this topic that you might experience in the
Paper F2 exam.
A company has two production cost centres (V and W) and two service cost centres (X and Y). The
following overheads have been apportioned and allocated to the four cost centres.

ACCA Paper MA
Cost centre V W X Y
Apportioned and
6,000 8,000 4,000 10,000
The company has calculated the following usage of X and Y’s services.
Cost centre V W X Y
Use of X's services 60% 30% nil 10%
Cost of Y's services 80% 20% nil nil
How much would cost centre V’s total overhead cost be if the company used the step-down
approach to re-apportion service cost centre overhead?
A $10,400
B $10,720
C $16,400
D $16,720
The correct answer is D ($6,000 + $4,000 × 0.6 + 0.8 × ($10,000 + 0.1 × $4,000))

ACCA Paper MA
Questions
(1)
Two joint products A and B are produced in a process. Data for the process for the last period
are as follows:
A B
Tonnes Tonnes
Sales 480 320
Production 600 400
Common production costs in the period were $12,000. There was no opening inventory. Both
products had a gross profit margin of 40%. Common production costs were apportioned on a
physical basis. What was the gross profit for product A in the period?
A $2,304
B $2,880
C $3,840
D $4,800
Answer: C
There are three steps involved in deriving the correct answer:

(i) Calculate the cost apportioned to product A:
$12,000 × 600 ÷ (600 + 400) = $7,200)
(ii) Calculate how much of (i) is to be charged against A’s sales in the period:
$7,200 × 480 ÷ 600 = $5,760
(iii) Calculate gross profit earned on (ii) using the given gross profit margin:
$5,760 × 40/60= $3,840

ACCA Paper MA
Chapter 6 Cash Budgets
Executive Summary
A company needs to produce a cash budget in order to ensure that there is enough cash within the
business to achieve the operational levels set by the functional budgets.
Sales revenues do not necessarily equal cash inflow. In order to secure the orders the sales team
had to negotiate payment terms with the customers.
Healthy profit does not necessarily mean a healthy cash flow.
What use is the cash budget?
1. The company directors need to consider in advance on financing if there is cash deficit
projected;
2. The cash budget can also be used to help prepare the budgeted statement of financial
position, part of the company’s master budget;
3. The cash budget can be used to monitor and assess performance.

ACCA Paper MA
A company needs to produce a cash budget in order to ensure that there is enough cash
within the business to achieve the operational levels set by the functional budgets
Consider the following sales figures for a newly formed company that makes metal boxes:
January February March
($000) ($000) ($000)
Sales 300 400 550
These figures are based on orders that customers have already placed with the company after
considerable hard work by the sales team. However, sales revenues do not necessarily equal
cash inflow. In order to secure the orders the sales team had to negotiate payment terms with the
customers. Only 10% of customers agreed to pay immediately for the metal boxes. Of the remaining
customers, 60% agreed to pay after one month and 40% after two months. Within the metal box
industry it is known that 2% of credit customers never pay (because they go out of business or
dispute the invoices) the metal box company has made the decision to reduce the budgeted cash
inflow from the credit customers who should pay after two months to reflect this fact (making the
percentage who pay after two month 38%). Once the metal box company knows these payment
terms and the estimated irrecoverable debt it can produce a cash inflow budget from the sales
budget as follows:
January February March April May
($000) ($000) ($000) ($000) ($000)
CASH SALES
(10% of total 30(w1) 40 55
sales)
CREDIT SALES
After one month 162(w1) 216 297
After two months 103(w1) 137 188
TOTAL
CASH
RECEIPTS 30 202 374 434 188
W1 Of the $300 total January sales, $30 pay cash immediately therefore $270 are credit sales (no
cash in for at least one month) of this $270, 60% will be received one month later, ie in February
and 38% two months later, ie in March. Remember the 2% irrecoverable debt will never be cash
flow.
So now the company can see that while the sales revenues figures may be healthy there is a delay
between making the sale and receiving the cash. Why does this matter? It matters if the
company needs to pay cash out in order to keep trading. For example, expenses such as labour,
materials and overheads may have to be paid out before the cash from the sales arrives. This can
lead to serious liquidity issues if not managed properly.

ACCA Paper MA

If the metal box company has a labour cost equal to 20% of the sales value a materials cost equal
to 25% of the sales value and an overhead cost equal to 15% of the sales value, then
the functional budget would be as follows:
January ($000) February ($000) March ($000)

Sales 300 400 550
Labour (20%) 60 80 110
Materials usage
(25%) 75 100 138
Overheads (15%) 45 60 83
GROSS PROFIT 120 160 219
The company can see that there is a 40% gross profit margin, which is considered good for the
metal box industry but a healthy profit does not necessarily mean a healthy cash flow.
Consider that labour is paid weekly one week in arrears and that there are four weeks in both
January and February and five weeks in March. The cash outflow for labour would be:
January February March April
($000) ($000) ($000) ($000)
Labour 45 75 108 22
The material supplier will not allow the metal box company any credit as because it is a newly
formed company, it has no track record of paying its debts. The supplier of materials is also aware
that new companies often fail and go out of business thus creating irrecoverable debt. Therefore,
the supplier is insisting on cash at time of delivery for all materials purchased. However, the metal
box company has to buy the materials before they can be made into boxes (therefore the material
purchase budget differs from the material usage budget). Half of the materials required for
production must be purchased and paid for in the month prior to sale the other 50% can be
purchased and paid for in the month that the metal boxes are manufactured and sold. Thus, the
cash outflow for material purchases would be:
December January February March
($000) ($000) ($000) ($000)
Materials 38 88 119 69
Month prior (100 x 50%) (138 x 50%)

to use (75 x 50%) + +
Month of (138 x
use (75 x 50%) (100 x 50%) 50%)

ACCA Paper MA

Now let us consider the overhead. Overhead is paid for in the month in which it is incurred. Included
in the overhead figures above is a $10,000 monthly charge for depreciation. Depreciation is a non-
cash item and should not be included in the cash flow. The company will pay cash out when the
non-current asset is purchased and may receive cash when the non-current asset is sold, but
depreciation is a book adjustment in the accounts and is not a cash flow that has to be paid out.
Therefore, the cash outflow for overheads is:
($000) ($000) ($000)
35 50 73
Overheads (45 – 10) (60 – 10) (83 – 10)
The metal box company can now put all of the elements of the cash budget together. We will
consider the first three months of trading only. At the start of January the metal box company will
have $150,000 cash in the current account.
($000) ($000) ($000)
CASH INFLOWS
Sales 30 202 374
CASH
OUTFLOWS
Labour 45 75 108
Materials 88 119 69
Overheads 35 50 73
NET CASHFLOW (138) (42) 124
OPENING CASH
BALANCE 150 12 (30)
CLOSING CASH
BALANCE 12 (30) 94
WHAT USE IS THE CASH BUDGET?

The metal boxes company now knows that although both the sales forecast and profit margin are
healthy during the first three months, in February it will suffer a cash deficit. The company directors
can now consider in advance, how this deficit can be financed. In March the company will have
quite a substantial cash surplus and the directors will consider investing this cash to maximise the
benefit to the company. For example, if the company needed to buy a $60,000 non-current asset
during the first three months it would ensure that it could be paid for in March and not February.
The cash budget can also be used to help prepare the budgeted statement of financial position, part
of the company’s master budget. We already know that the cash balance is budgeted to be $94,000
at the end of the first quarter’s trading but the metal box company can also calculate the material
inventory, trade receivables and trade payables closing balances. A proportion of materials are
purchased before they are required for manufacture and therefore there will be a material inventory
at the end of March equal to 50% of April’s sales requirements. If April’s sales are forecast to be
$700,000 then the material inventory will be $87,500 ($700,000 x 0.25 x 0.50). Receivables at the
end of March are expected to be $621,900 ($136,800 still due from February’s sales plus $297,000

ACCA Paper MA

and $188,100 due from March sales) the trade payables will be zero as the company pays cash for
all of the purchases.
Finally the cash budget can be used to monitor and assess performance. If the metal box company
has $780,000 of outstanding receivables at the end of March as compared to the $621,900 that was
budgeted, then this would indicate that customers were taking longer to pay than their agreed terms
(assuming that the sales revenues were as budgeted) this in turn may indicate that the person
responsible for collecting the debt are less efficient than they should be.

ACCA Paper MA
Questions
(1)
Which of the following statements about budgets is false?
A A continuous budget is feasible only for sales projections
B The direct labour budget is specifically dependent on the production budget
C The budgeting process normally begins with preparation of a sales budget
D The cash budget is an element of a master budget
Answer: A
A continuous (“rolling”) budget results in constant monitoring and updating of the budget. They are
typically used where costs/revenues/activities cannot be forecast accurately (so not just sales
projections).

ACCA Paper MA
Chapter 7 Ratio Analysis
Executive Summary
The ability to analyse financial statements using ratios and percentage to assess the performance
of organisations is a skill that will be tested in many of ACCA’s exam papers.
In ACCA Management Accounting (MA, was F2), it introduces candidates to performance
measurement and requires candidates to be able to ‘Discuss and calculate measures of financial
performance (profitability, liquidity, activity and gearing) and non-financial measures’.
Profitability
Profitability ratios, as their name suggests, measure the organisation’s ability to deliver profits.
 Return on capital employed (ROCE)

 Return on sales (ROS)
 Gross margin
Liquidity
This measures the ability of the organisation to meet its short-term financial obligations.
 Current ratio
 Acid test (or Quick ratio)
Activity ratios
Activity ratios measure on organisation’s ability to convert balance sheet items into cash or sales.
 Asset turnover
 Receivables days
 Inventory days
 Payable days
Gearing
This relates to an organisation’s ability to meet its long-term debts.
 Capital gearing
 Interest cover

ACCA Paper MA
The ability to analyse financial statements using ratios and percentages to assess the performance
of organisations is a skill that will be tested in many of ACCA’s exam papers. It will also be regularly
used by successful candidates in their future careers.
The Paper F2/FMA syllabus introduces candidates to performance measurement and requires
candidates to be able to 'Discuss and calculate measures of financial performance (profitability,
liquidity, activity and gearing) and non-financial measures'. This article will focus on measures of
financial performance and will detail the skills and knowledge expected from candidates in the
Paper F2/FMA exam.
Paper F2/FMA candidates are expected to be able to calculate key accounting ratios, to know what
they measure, and to explain what particular values mean. The syllabus categorises ratios into four
headings: profitability, liquidity, activity and gearing.
PROFITABILITY
Profitability ratios, as their name suggests, measure the organisation’s ability to deliver profits. Profit
is necessary to give investors the return they require, and to provide funds for reinvestment in the
business. Three ratios are commonly used.
1. Return on capital employed (ROCE): operating profit ÷ (non current liabilities +
total equity) %
2. Return on sales (ROS): operating profit÷ revenue %
3. Gross margin: gross profit÷ revenue %
Return on capital employed

Return on capital employed (sometimes known as return on investment or ROI) measures the return
that is being earned on the capital invested in the business. Candidates are sometimes confused
about which profit and capital figures to use. What is important is to compare like with like.
Operating profit (profit before interest) represents the profit available to pay interest to debt
investors and dividends to shareholders. It is therefore compared with the long-term debt and equity
capital invested in the business (non current liabilities + total equity). By similar logic, if we wished to
calculate return on ordinary shareholders funds (the return to equity holders), we would use profit
after interest and tax divided by total equity).
A return on capital is necessary to reward investors for the risks they are taking by investing in the
company. Generally, the higher the ROCE figure, the better it is for investors. It should be compared
with returns on offer to investors on alternative investments of a similar risk.
Return on sales
Return on sales (sometimes known as operating margin) looks at operating profit earned as a
percentage of revenue. Again, in simple terms, the higher the better. Poor performance is often
explained by prices being too low or costs being too high.
The ROCE and ROS ratios are often considered in conjunction with the asset turnover ratio. (The
asset turnover ratio is discussed later). They are considered at the same time because:
ROCE = ROS x asset turnover
operating profit = operating profit x revenue
capital employed revenue capital employed

ACCA Paper MA

This relationship can be useful in exam calculations. For example, if you are told that a business
has a return on sales of 5% and an asset turnover of 2, then its ROCE will be 10% (5% x 2). This is
more than a mathematical trick. It means that any change in ROCE can be explained by either a
change in ROS, or a change in asset turnover, or both.
Gross margin
Return on sales looks at profits after charging non-production overheads. Gross margin on the other
hand focuses on the organisation’s trading activities. Once again, in simple terms, the higher the
better, with poor performance often being explained by prices being too low or costs being too high.
LIQUIDITY
This measures the ability of the organisation to meet its short-term financial obligations.
Two ratios are commonly used:
4. Current ratio current assets ÷ current liabilities
5. Acid test (current assets – inventory) ÷ current liabilities
Current ratio
The current ratio compares liabilities that fall due within the year with cash balances, and assets
that should turn into cash within the year. It assesses the company’s ability to meet its short-term
liabilities. Traditionally textbooks tell us that this ratio should exceed 2.0:1 for a company to be able
to safely meet its liabilities. However, acceptable current ratios vary between industrial sectors, and
many companies operate safely at below the 2:1 level.
A very high current ratio is not necessarily good. It could indicate that a company is too liquid. Cash
is often described as an ’idle asset‘ because it earns no return, and carrying too much cash is
considered wasteful. A high ratio could also indicate that the company is not making sufficient use
of cheap short-term finance.
Acid test
The acid test (or quick ratio) recognises that inventory often takes a long time to convert into cash. It
therefore excludes inventory values from liquid assets. Traditionally textbooks tell us that this ratio
should exceed 1:1 but once again many successful companies operate below this level.
In practice a company’s current ratio and acid test should be considered alongside the company’s
operating cashflow. A healthy cashflow will often compensate for weak liquidity ratios.
ACTIVITY RATIOS
6. Asset turnover: revenue ÷ (non current liabilities + total equity) ×
7. Receivables days: receivables ÷ credit sales × 365 days
8. Inventory days: inventory ÷ cost of sales × 365 days
9. Payable days: payables ÷ purchases (or cost of sales) × 365 days
Activity ratios measure an organisation’s ability to convert balance sheet items into cash or sales.
They measure the efficiency of the business in managing its assets.
Asset turnover
This measures the ability of the organisation to generate sales from its capital employed. A possible
variant is non-current asset turnover (revenue ÷ non-current assets). Generally the higher the better,
but in later studies you will consider the problems caused by overtrading (operating a business at a

ACCA Paper MA

level not sustainable by its capital employed). Commonly a high asset turnover is accompanied with
a low return on sales and vice versa. Retailers generally have high asset turnovers accompanied by
low margins: Jack Cohen, the founder of Tesco, famously used the motto ’Pile it high and sell it
cheap’!
Receivable days
This is also known as debtor days. If a company has average accounts receivable of $20,000 on
annual credit sales of $40,000 then on average 50% of its annual credit sales are uncollected. If
credit sales are spread evenly over the year, then this represents 50% of a year’s sales, equivalent
to 183 days, to collect cash from customers. ($20,000/$40,000 ÷ 365 days = 183 days). For liquidity
purposes the faster money is collected the better. Also, generally, the longer customers are given to
pay, the higher the level of bad debts. However, too much pressure on customers to pay quickly
may damage a company’s ability to generate sales.
Inventory days
Also known as stock days. This is calculated in a very similar way to receivable days. It measures
how long a company carries inventory before it is sold. Again for liquidity purposes the shorter this
period the better, as less cash is tied up in inventory. Also long inventory holding periods can result
in obsolete inventory. On the other hand, too little inventory can result in production stoppages and
dissatisfied customers.
Payable days
Also known as creditor days. Once again this is calculated in a similar way to receivable days.
Because the purchases figure is often not available to analysts external to the business, the cost of
sales figure is often used to approximate purchases. Payable days measures the average amount
of time taken to pay suppliers. Long payment periods are good for the customer’s liquidity, but can
damage relationships with suppliers.
GEARING
This relates to an organisation’s ability to meet its long-term debts. Two ratios are commonly used.
10. Capital gearing: non-current liabilities ÷ ordinary shareholders funds % (this is sometimes
described as the debt to equity ratio)
or
non-current liabilities ÷ (ordinary shareholders funds + non current liabilities % (sometimes
described as debt to equity + debt)
11. Interest cover: operating profit ÷ finance costs
Capital gearing
Also known as leverage. Capital gearing looks at the proportions of owner’s capital and borrowed
capital used to finance the business. Many different definitions exist; the two most commonly used
ones are given above. When necessary in the exam, you will be told which definition to use.
A large proportion of borrowed capital is risky as interest and capital repayments are legal
obligations and must be met if the company is to avoid insolvency. The payment of an annual equity
dividend on the other hand is not a legal obligation. Despite its risks, borrowed capital is attractive
to companies as lenders accept a lower rate of return than equity investors due to their secured
positions. Also interest payments, unlike equity dividends, are corporation tax deductible.
Levels of capital gearing vary enormously between industries. Companies requiring high investment
in tangible assets are commonly highly geared. Consequently, it is difficult to generalise about when

ACCA Paper MA

capital gearing is too high. However, most accountants would agree that gearing is too high when
the proportion of debt exceeds the proportion of equity.
Interest cover
This is sometimes known as income gearing. It looks at how many times a company’s operating
profits exceed its interest payable. The higher the figure, the more likely a company is to be able to
meet its interest payments. Anything in excess of four is usually considered to be safe.
TYPICAL QUESTION
You are unlikely to be asked a question of the nature of ’Current assets are $3,000 and current
liabilities are $1,000, what is the current ratio?’
This is considered too low level for Paper F2/FMA. The question (see 'Related link'), from the
December 2011 examiner’s comments, demonstrates the standard of understanding of ratios that is
required.

ACCA Paper MA
Questions
(1)
A firm with current assets of $40 million and current liabilities of $20 million buys $5 million of
inventory on credit which increases its inventory level to $10 million. What will the effect be on its
current ratio and quick (acid test) ratio?
Current ratio Liquidity ratio

A Increase by 25% Unchanged
B Reduce by 10% Unchanged
C Increase by 25% Reduce by 20%
D Reduce by 10% Reduce by 20%
Answer: D
Current ratio now is $40:$20 = 2:1. Will become $45:$25 = 1.8:1 (i.e. decrease by 10%). Quick ratio
now is $35:$20 = 1.75:1 will become $35:$25 = 1.4:1, i.e. decrease by 20%.

FMA GotitPass Notes

Uploaded by

Copyright:

Available Formats

FMA GotitPass Notes

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

FMA GotitPass Notes

Uploaded by

Copyright:

Available Formats

ACCA Paper MA

Got it Pass eLearning Co Supplementary Notes

A4 Chapter 1 Effective presentation and communication of information using charts

For September 2020 to August 2021 1

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 2

Got it Pass eLearning Co Supplementary Notes

Chapter 1 Effective presentation and communication of information using charts

For September 2020 to August 2021 3

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 4

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 5

Got it Pass eLearning Co Supplementary Notes

How will the reader interpret the data in Charts 1–5?

For September 2020 to August 2021 6

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 7

Got it Pass eLearning Co Supplementary Notes

How will the reader interpret the data in Charts 6–8?

COMPONENT/STACKED COLUMN AND BAR CHARTS (CHART 9)

For September 2020 to August 2021 8

Got it Pass eLearning Co Supplementary Notes

How will the reader interpret the data in Chart 9?

PIE CHARTS (CHARTS 10 AND 11)

For September 2020 to August 2021 9

Got it Pass eLearning Co Supplementary Notes

100% STACKED COLUMN OR BAR CHARTS (CHARTS 12 AND 13)

For September 2020 to August 2021 10

Got it Pass eLearning Co Supplementary Notes

SCATTER DIAGRAM OR XY CHART (CHARTS 14 AND 15)

For September 2020 to August 2021 11

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 12

Got it Pass eLearning Co Supplementary Notes

WHEN DATA PRESENTATION GOES WRONG

For September 2020 to August 2021 13

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 14

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 15

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 16

Got it Pass eLearning Co Supplementary Notes

Chapter 2 Inventory Control

 Determining an economic order quantity (EOQ)

 Constant purchase price

 Relevant costs – only include those costs affected by order quantity

For September 2020 to August 2021 17

Got it Pass eLearning Co Supplementary Notes

ADVANTAGES AND DISADVANTAGES OF HOLDING INVENTORY

The disadvantages include:

For September 2020 to August 2021 18

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 19

Got it Pass eLearning Co Supplementary Notes

USE OF EOQ FORMULA

For September 2020 to August 2021 20

Got it Pass eLearning Co Supplementary Notes

For September 2020 to August 2021 21