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2012 EDITION | Revision Question Bank

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ACCA Paper F5 | PERFORMANCE MANAGEMENT

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ACCA

PAPER F5

PERFORMANCE MANAGEMENT

REVISION QUESTION BANK

JUNE 2012

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REVISION QUESTION BANK – PERFORMANCE MANAGEMENT (F5)

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CONTENTS Question Page Answer Marks Date worked ACTIVITY BASED COSTING 1 Jola Publishing Co (ACCA J08) 1 1001 25 2 Abkaber Co (ACCA D02) 2 1003 25 3 Admer (ACCA J04) 4 1006 25 4 Spring Co (ACCA D04) 5 1009 25 DEVELOPMENTS IN MANAGEMENT ACCOUNTING 5 Edward Co (ACCA D07) 6 1012 25 6 Yam Co (ACCA J09) 7 1015 20 7 Wagrin (ACCA D08) 8 1016 25 8 Scovet (ACCA J01) 8 1019 9 9 Environmental management accounting 9 1019 20 RELEVANT COST ANALYSIS 10 Sniff Co (ACCA D07) 9 1021 25 11 Bits and Pieces (ACCA J09) 10 1024 20 12 Stay Clean (ACCA D09) 11 1025 20 COST VOLUME PROFIT ANALYSIS 13 Buttery Restaurant 12 1027 15 14 A to C Co 14 1030 20 LIMITING FACTOR DECISIONS 15 Higgins Co (ACCA J08) 15 1033 25 16 Albion Co (ACCA J03) 16 1036 25 17 Kobrin Engineers Co 17 1038 20 PRICING 18 BIL Motor Components Co (ACCA) 18 1040 20 19 Jason Grimes 19 1042 15 20 Kadok Co 19 1043 15 21 Autodes Co 20 1045 20 22 Essential aspect 21 1047 20 RISK AND UNCERTAINTY 23 Stow Health Care (ACCA PP) 22 1049 20 24 Shifters Haulage (ACCA D08) 23 1050 25 25 Decision tree 23 1052 10

PERFORMANCE MANAGEMENT (F5) – REVISION QUESTION BANK

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CONTENTS Question Page Answer Marks Date worked BUDGETING 26 Northland (ACCA J09) 24 1054 20 27 Budget behaviour (ACCA) 25 1055 20 28 ZBB (ACCA J02) 26 1057 25 29 Budgeting & costing (ACCA J05) 26 1060 25 QUANTITATIVE TECHNIQUES FOR BUDGETING

30 The Western (ACCA D09) 26 1063 20 31 Storrs Co (ACCA J03) 28 1064 25 32 South 28 1066 10 33 Henry Co (ACCA D08) 29 1067 25 34 Big Cheese Chairs (ACCA D09) 30 1069 20 BUDGETING AND STANDARD COSTING 35 Standard costing (ACCA D01) 30 1071 13 36 Information source (ACCA) 31 1072 20 BASIC VARIANCE ANALYSIS

37 Woodeezer Co (ACCA D02) 31 1074 25 38 Mermus Co (ACCA D04) 33 1076 25 39 Murgatroyd Co (ACCA D05) 33 1078 10 ADVANCED VARIANCE ANALYSIS

40 Chaff Co (ACCA J08) 34 1079 25 41 Crumbly Cakes (ACCA J09) 36 1083 20 42 AVX Co 37 1085 14 43 Milboa Co 38 1086 20 BEHAVIOURAL ASPECTS OF STANDARD COSTING 44 Spike Co (ACCA D07) 38 1088 25 45 Secure Net (ACCA D09) 39 1090 20 PERFORMANCE MEASUREMENT 46 Oliver (ACCA J09) 40 1091 20 47 Thatcher International Park (ACCA D09) 41 1094 20 FURTHER ASPECTS OF PERFORMANCE MANAGEMENT 48 Eatwell Restaurant (ACCA J02) 43 1096 20 49 Balanced Scorecard (ACCA) 43 1098 15 50 BLA Co 44 1099 20 51 AV 46 1103 20


©2012 DeVry/Becker Educational Development Corp. All rights reserved. (v)

CONTENTS Question Page Answer Marks Date worked DIVISIONAL PERFORMANCE EVALUATION

52 Bridgewater Co (ACCA J08) 48 1106 25 53 Osborne Co 49 1109 10 54 Responsibility centres (ACCA D05) 50 1110 25 55 Pace Co (ACCA D08) 51 1113 25 TRANSFER PRICING

56 Business Solutions (ACCA J02) 52 1116 20 57 Manuco Co 53 1118 13 PILOT PAPER1

1 Triple 2 2 8 25 2 Simply Soup 3 9 25 3 BFG 4 11 25 4 Preston Financial Services 5 12 25

1 Since the publication of this Pilot Paper in December 2007 the examination format has changed to

five questions of 20 marks each.


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Formulae Sheet

Learning curve

y = axb

Where y = cumulative average time per unit to produce x units a = the time taken for the first unit of output x = the cumulative number of units produced b = the index of learning (log LR/log 2) LR = the learning rate as a decimal

Regression analysis

y = a + bx

b = 22 )(∑∑∑ ∑∑−

−

xxnyxxyn

a = n

xbn

y ∑∑ −

r = ( )( ) ( )( )2222 ∑∑∑∑∑ ∑ ∑

−−

−

yynxxn

yxxyn

Demand curve

P = a – bQ

b = qualityin changepricein change

a = price when Q = 0

MR = a – 2bQ


©2012 DeVry/Becker Educational Development Corp. All rights reserved. 1

Question 1 JOLA PUBLISHING CO

Jola Publishing Co publishes two forms of book.

The company publishes a children’s book (CB), which is sold in large quantities to government-controlled schools. The book is produced in only four large production runs but goes through frequent government inspections and quality assurance checks.

The paper used is strong, designed to resist the damage that can be caused by the young children it is produced for. The book has only a few words and relies on pictures to convey meaning.

The second book is a comprehensive technical journal (TJ). It is produced in monthly production runs, 12 times a year. The paper used is of relatively poor quality and is not subject to any governmental controls and consequently only a small number of inspections are carried out. The TJ uses far more machine hours than the CB in its production.

The directors are concerned about the performance of the two books and are wondering what the impact would be of a switch to an activity based costing (ABC) approach to accounting for overheads. They currently use absorption costing, based on machine hours for all overhead calculations. They have accurately produced an analysis for the accounting year just completed as follows:

CB TJ $per unit $per unit $per unit $per unit Direct production costs Paper 0.75 0.08 Printing ink 1.45 4.47 Machine costs 1.15 1.95 3.35 6.50 Overheads 2.30 3.95 Total cost 5.65 10.45 Selling price 9.05 13.85 Margin 3.40 3.40 The main overheads involved are: Overhead % of total overhead Activity driver Property costs 75.0% Machine hours Quality control 23.0% Number of inspections Production set up costs 2.0% Number of set ups

If the overheads above were re-allocated under ABC principles then the results would be that the overhead allocation to CB would be $0.05 higher and the overhead allocated to TJ would be $0.30 lower than previously.

Required:

(a) Explain why the overhead allocations have changed in the way indicated above. (8 marks)

(b) Briefly explain the implementation problems often experienced when ABC is first introduced. (4 marks)


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(c) The directors are keen to introduce ABC for the coming year and have provided the following cost and selling price data:

(1) The paper used costs $2 per kg for a CB but the TJ paper costs only $1 per kg. The CB uses 400 gms of paper for each book, four times as much as the TJ uses.

(2) Printing ink costs $30 per litre. The CB uses one third of the printing ink of the larger TJ. The TJ uses 150 ml of printing ink per book.

(3) The CB needs six minutes of machine time to produce each book, whereas the TJ needs 10 minutes per book. The machines cost $12 per hour to run.

(4) The sales prices are to be $9.30 for the CB and $14.00 for the TJ.

As mentioned above there are three main overheads, the data for these are:

Overhead Annual cost for the coming year $

Property costs 2,160,000 Quality control 668,000 Production set up costs 52,000

––––––––– Total 2,880,000

––––––––– The CB will be inspected on 180 occasions next year, whereas the TJ will be inspected just 20 times.

Jola Publishing will produce its annual output of 1,000,000 CBs in four production runs and approximately 10,000 TJs per month in each of 12 production runs.

Required:

(i) Calculate the cost per unit and the margin for the CB and the TJ using machine hours to absorb the overheads. (5 marks)

(ii) Calculate the cost per unit and the margin for the CB and the TJ using activity based costing principles to absorb the overheads. (8 marks)

(25 marks)

Question 2 ABKABER CO

Abkaber Co assembles three types of motorcycle at the same factory: the 50 cc Sunshine, the 250 cc Roadster and the 1000 cc Fireball. It sells the motorcycles throughout the world. In response to market pressures Abkaber has invested heavily in new manufacturing technology in recent years and, as a result, has significantly reduced the size of its workforce.

Historically, the company has allocated all overhead costs using total direct labour hours, but is now considering introducing Activity Based Costing (ABC). Abkaber’s accountant has produced the following analysis:



Annual Annual direct Raw output labour Selling material (units) hours price cost ($ per unit) ($ per unit) Sunshine 2,000 200,000 4,000 400 Roadster 1,600 220,000 6,000 600 Fireball 400 80,000 8,000 900

The three cost drivers that generate overheads are:

Deliveries to retailers – the number of deliveries of motorcycles to retail showrooms;

Set-ups – the number of times the assembly line process is re-set to accommodate a production run of a different type of motorcycle;

Purchase orders – the number of purchase orders.

The annual cost driver volumes relating to each activity and for each type of motorcycle are as follows:

Number of Number of Number of deliveries set-ups purchase to retailers orders Sunshine 100 35 400 Roadster 80 40 300 Fireball 70 25 100

The annual overhead costs relating to these activities are as follows: $ Deliveries to retailers 2,400,000 Set-up costs 6,000,000 Purchase orders 3,600,000

All direct labour is paid at $5 per hour. The company holds no inventory.

At a board meeting there was some concern over the introduction of activity based costing.

The finance director argued: “I very much doubt whether selling the Fireball is viable but I am not convinced that activity based costing would tell us any more than the use of labour hours in assessing the viability of each product.”

The marketing director argued: “I am in the process of negotiating a major new contract with a motorcycle rental company for the Sunshine model. For such a big order they will not pay our normal prices but we need to at least cover our incremental costs. I am not convinced that activity based costing would achieve this as it merely averages costs for our entire production.”

The managing director argued: “I believe that activity based costing would be an improvement but it still has its problems. For instance if we carry out an activity many times surely we get better at it and costs fall rather than remain constant. Similarly, some costs are fixed and do not vary either with labour hours or any other cost driver”.

The chairman argued: “I cannot see the problem. The overall profit for the company is the same no matter which method of allocating overheads we use. It seems to make no difference to me”.



Required:

(a) Calculate the total profit on each of Abkaber Co’s three types of product using each of the following methods to attribute overheads:

(i) the existing method based on labour hours; and (ii) activity based costing. (13 marks)

(b) Write a report to the directors of Abkaber Co, as its management accountant. The report should:

(i) evaluate the labour hours and the activity based costing methods in the circumstances of Abkaber Co; and

(ii) examine the implications of activity based costing for Abkaber Co, and in so doing evaluate the issues raised by each of the directors.

Refer to your calculations in requirement (a) above where appropriate. (12 marks)

(25 marks)

Question 3 ADMER

Admer owns several home furnishing stores. In each store, consultations, if needed, are undertaken by specialists, who also visit potential customers in their homes, using specialist software to help customers realise their design objectives. Customers visit the store to make their selections from the wide range of goods offered, after which sales staff collect payment and raise a purchase order. Customers then collect their self-assembly goods from the warehouse, using the purchase order as authority to collect. Administration staff process purchase orders and also arrange consultations.

Each store operates an absorption costing system and costs other than the cost of goods sold are apportioned on the basis of sales floor area.

Results for one of Admer’s stores for the last three months are as follows:

Department Kitchens Bathrooms Dining Rooms Total $ $ $ $ Sales 210,000 112,500 440,000 762,500 Cost of goods sold 63,000 37,500 176,000 276,500 Other costs 130,250 81,406 113,968 325,624 ––––––– ––––––– ––––––– ––––––– Profit 16,750 (6,406) 150,032 160,376 ––––––– ––––––– ––––––– –––––––

The management accountant of Admer is concerned that the bathrooms department of the store has been showing a loss for some time, and is considering a proposal to close the bathrooms department in order to concentrate on the more profitable kitchens and dining rooms departments. He has found that other costs for this store for the last three months are made up of:

$ Employees Sales staff wages 64,800 12 Consultation staff wages 24,960 4 Warehouse staff wages 30,240 6 Administration staff wages 30,624 4 General overheads (light, heat, rates, etc) 175,000 ––––––– 325,624 –––––––



He has also collected the following information for the last three months:

Department Kitchens Bathrooms Dining Rooms Number of items sold 1,000 1,500 4,000 Purchase orders 1,000 900 2,500 Floor area (square metres) 16,000 10,000 14,000 Number of consultations 798 200 250

The management accountant believes that he can use this information to review the store’s performance in the last three months from an activity-based costing (ABC) perspective.

Required:

(a) Discuss the management accountant’s belief that the information provided could be used in an activity-based costing analysis. (4 marks)

(b) Explain and illustrate, using supporting calculations, how an ABC profit statement might be produced from the information provided. Clearly explain the reasons behind your choice of cost drivers. (8 marks)

(c) Evaluate and discuss the proposal to close the bathrooms department. (6 marks)

(d) Discuss the advantages and disadvantages that may arise for Admer from introducing activity-based costing in its stores. (7 marks)

(25 marks)

Question 4 SPRING CO

At a recent board meeting of Spring Co, there was a heated discussion on the need to improve financial performance. The Production Director argued that financial performance could be improved if the company replaced its existing absorption costing approach with an activity-based costing system. He argued that this would lead to better cost control and increased profit margins. The Managing Director agreed that better cost control could lead to increased profitability, but informed the meeting that he believed that performance needed to be monitored in both financial and non-financial terms. He pointed out that sales could be lost due to poor product quality or a lack of after-sales service just as easily as by asking too high a price for Spring’s products. He suggested that while the board should consider introducing activity-based costing, it should also consider ways in which the company could monitor and assess performance on a wide basis.

Required:

(a) Describe the key features of activity-based costing and discuss the advantages and disadvantages of adopting an activity-based approach to cost accumulation. (14 marks)

(b) Explain the need for the measurement of organisational and managerial performance, giving examples of the range of financial and non-financial performance measures that might be used. (11 marks)

(25 marks)



Question 5 EDWARD CO

Edward Co assembles and sells many types of radio. It is considering extending its product range to include digital radios. These radios produce a better sound quality than traditional radios and have a large number of potential additional features not possible with the previous technologies (station scanning, more choice, one touch tuning, station identification text and song identification text, etc).

A radio is produced by assembly workers assembling a variety of components. Production overheads are currently absorbed into product costs on an assembly labour hour basis.

Edward is considering a target costing approach for its new digital radio product.

Required:

(a) Briefly describe the target costing process that Edward Co should undertake. (3 marks)

(b) Explain the benefits to Edward Co of adopting a target costing approach at such an early stage in the product development process. (4 marks)

(c) Assuming a cost gap was identified in the process, outline possible steps Edward Co could take to reduce this gap. (5 marks)

(d) A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable features to Edward’s intended product. The board have agreed that the acceptable margin (after allowing for all production costs) should be 20%. Cost information for the new radio is as follows:

Component 1 (Circuit board) – these are bought in and cost $4.10 each. They are bought in batches of 4,000 and additional delivery costs are $2,400 per batch.

Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed radio. However, there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in the assembly process. Edward estimates that 2% of the purchased wire is lost in the assembly process. Wire costs $0.50 per metre to buy.

Other material – other materials cost $8.10 per radio.

Assembly labour – these are skilled people who are difficult to recruit and retain. Edward has more staff of this type than needed but is prepared to carry this extra cost in return for the security it gives the business. It takes 30 minutes to assemble a radio and the assembly workers are paid $12.60 per hour. It is estimated that 10% of hours paid to the assembly workers is for idle time.

Production Overheads – recent historic cost analysis has revealed the following production overhead data: Total production Total assembly overhead labour hours $ Month 1 620,000 19,000 Month 2 700,000 23,000 Fixed production overheads are absorbed on an assembly hour basis based on normal annual activity levels. In a typical year 240,000 assembly hours will be worked by Edward.



Required:

Calculate the expected cost per unit for the radio and identify any cost gap that might exist. (13 marks)

(25 marks)

Question 6 YAM CO

Yam Co is involved in the processing of sheet metal into products A, B and C using three processes, pressing, stretching and rolling. Like many businesses Yam faces tough price competition in what is a mature world market.

The factory has 50 production lines each of which contain the three processes: Raw material for the sheet metal is first pressed then stretched and finally rolled. The processing capacity varies for each process and the factory manager has provided the following data:

Processing time per metre in hours Product A Product B Product C Pressing 0.50 0.50 0.40 Stretching 0.25 0.40 0.25 Rolling 0.40 0.25 0.25

The factory operates for 18 hours each day for five days per week. It is closed for only two weeks of the year for holidays when maintenance is carried out. On average one hour of labour is needed for each of the 225,000 hours of factory time. Labour is paid $10 per hour.

The raw materials cost per metre is $3.00 for product A, $2.50 for product B and $1.80 for product C. Other factory costs (excluding labour and raw materials) are $18,000,000 per year. Selling prices per metre are $70 for product A, $60 for product B and $27 for product C.

Yam carries very little inventory.

Required:

(a) Identify the bottleneck process and briefly explain why this process is described as a “bottleneck”. (3 marks)

(b) Calculate the throughput accounting ratio (TPAR) for each product assuming that the bottleneck process is fully utilised. (8 marks)

(c) Assuming that the TPAR of product C is less than 1:

(i) explain how Yam could improve the TPAR of product C; (4 marks)

(ii) briefly discuss whether this supports the suggestion to cease the production of product C and briefly outline three other factors that Yam should consider before a cessation decision is taken. (5 marks)

(20 marks)



Question 7 WARGRIN

Wargrin designs, develops and sells many PC games. Games have a short lifecycle lasting around three years only. Performance of the games is measured by reference to the profits made in each of the expected three years of popularity. Wargrin accepts a net profit of 35% of turnover as reasonable. A rate of contribution (sales price less variable cost) of 75% is also considered acceptable.

Wargrin has a large centralised development department that carries out all the design work before it passes the completed game to the sales and distribution department to market and distribute the product.

Wargrin has developed a brand new game called Stealth and this has the following budgeted performance figures.

The selling price of Stealth will be a constant $30 per game. Analysis of the costs shows that at a volume of 10,000 units a total cost of $130,000 is expected. However at a volume of 14,000 units a total cost of $150,000 is expected. If volumes exceed 15,000 units the fixed costs will increase by 50%.

Stealth’s budgeted volumes are as follows: Year 1 Year 2 Year 3 Sales volume 8,000 units 16,000 units 4,000 units

In addition, marketing costs for Stealth will be $60,000 in year one and $40,000 in year two. Design and development costs are all incurred before the game is launched and has cost $300,000 for Stealth. These costs are written off to the income statement as incurred (i.e. before year 1 above).

Required:

(a) Explain the principles behind lifecycle costing and briefly state why Wargrin in particular should consider these lifecycle principles. (4 marks)

(b) Produce the budgeted results for the game “Stealth” and briefly assess the game’s expected performance, taking into account the whole lifecycle of the game. (9 marks)

(c) Explain why incremental budgeting is a common method of budgeting and outline the main problems with such an approach. (6 marks)

(d) Discuss the extent to which a meaningful standard cost can be set for games produced by Wargrin. You should consider each of the cost classifications mentioned above. (6 marks)

(25 marks)

Question 8 SCOVET

Scovet Co has identified a market for a new product D for which the following estimated information is available:

(1) Sales revenue for the years 20X2, 20X3 and 20X4 of $6m, $7m and $6m respectively. No sales are expected after 20X4. The selling price will be $10 per unit throughout the period.

(2) Contribution to sales percentage of 60% for each year.

(3) Product specific fixed costs in the years 20X2, 20X3 and 20X4 of $2.5m, $2.2m and $1.8m respectively.

(4) Capital investment of $4.5m on 1 January 20X2 with nil residual value at 31 December 20X4.

Note: Ignore taxation and the time value of money.



Required:

(a) Calculate the total profit of product D over its life. (4 marks)

(b) Calculate the cost per unit of product D, which includes absorption of all product specific costs over the life of the product. (3 marks)

(7 marks)

Question 9 ENVIRONMENTAL MANAGEMENT ACCOUNTING

(a) Explain the meaning of environmental costs. (8 marks)

(b) Explain why the management of environmental costs is becoming increasingly important to organizations. (4 marks)

(c) Explain why traditional management accounting does not enable managers of a business to manage their environmental costs. (4 marks)

(d) Explain the meaning of the term environmental management accounting, and illustrate how it can help managers to manage environmental costs more effectively. (4 marks)

(20 marks)

Question 10 SNIFF CO

Sniff Co manufactures and sells its standard perfume by blending a secret formula of aromatic oils with diluted alcohol. The oils are produced by another company following a lengthy process and are very expensive. The standard perfume is highly branded and successfully sold at a price of $39.98 per 100 millilitres (ml).

Sniff Co is considering processing some of the perfume further by adding a hormone to appeal to members of the opposite sex. The hormone to be added will be different for the male and female perfumes. Adding hormones to perfumes is not universally accepted as a good idea as some people have health concerns. On the other hand, market research carried out suggests that a premium could be charged for perfume that can “promise” the attraction of a suitor. The market research has cost $3,000.

Data has been prepared for the costs and revenues expected for the following month (a test month) assuming that a part of the company’s output will be further processed by adding the hormones.

The output selected for further processing is 1,000 litres, about a tenth of the company’s normal monthly output. Of this, 99% is made up of diluted alcohol, which costs $20 per litre. The rest is a blend of aromatic oils costing $18,000 per litre. The labour required to produce 1,000 litres of the basic perfume before any further processing is 2,000 hours at a cost of $15 per hour.

Of the output selected for further processing, 200 litres (20%) will be for male customers and 2 litres of hormone costing $7,750 per litre will then be added. The remaining 800 litres (80%) will be for female customers and 8 litres of hormone will be added, costing $12,000 per litre. In both cases the adding of the hormone adds to the overall volume of the product as there is no resulting processing loss.

Sniff Co has sufficient existing machinery to carry out the test processing.

The new processes will be supervised by one of the more experienced supervisors currently employed by Sniff Co. His current annual salary is $35,000 and it is expected that he will spend 10% of his time working on the hormone adding process during the test month. This will be split evenly between the male and female versions of the product.



Extra labour will be required to further process the perfume, with an extra 500 hours for the male version and 700 extra hours for the female version of the hormone-added product. Labour is currently fully employed, making the standard product. New labour with the required skills will not be available at short notice.

Sniff Co allocates fixed overhead at the rate of $25 per labour hour to all products for the purposes of reporting profits.

The sales prices that could be achieved as a one-off monthly promotion are:

– Male version: $75.00 per 100 ml; – Female version: $59.50 per 100 ml.

Required:

(a) Outline the financial and other factors that Sniff Co should consider when making a further processing decision.

Note: no calculations are required. (4 marks)

(b) Evaluate whether Sniff Co should experiment with the hormone adding process using the data provided. Provide a separate assessment and conclusion for the male and the female versions of the product. (15 marks)

(c) Calculate the selling price per 100 ml for the female version of the product that would ensure further processing would break even in the test month. (2 marks)

(d) Sniff Co is considering outsourcing the production of the standard perfume. Outline the main factors it should consider before making such a decision. (4 marks)

(25 marks)

Question 11 BITS AND PIECES

Bits and Pieces (B&P) operates a retail store selling spares and accessories for the car market. The store has previously only opened for six days per week for the 50 working weeks in the year, but B&P is now considering also opening on Sundays.

The sales of the business on Monday through to Saturday averages at $10,000 per day with average gross profit of 70% earned.

B&P expects that the gross profit % earned on a Sunday will be 20 percentage points lower than the average earned on the other days in the week. This is because they plan to offer substantial discounts and promotions on a Sunday to attract customers. Given the price reduction, Sunday sales revenues are expected to be 60% more than the average daily sales revenues for the other days. These Sunday sales estimates are for new customers only, with no allowance being made for those customers that may transfer from other days.

B&P buys all its goods from one supplier. This supplier gives a 5% discount on all purchases if annual spend exceeds $1,000,000.

It has been agreed to pay time and a half to sales assistants that work on Sundays. The normal hourly rate is $20 per hour. In total five sales assistants will be needed for the six hours that the store will be open on a Sunday. They will also be able to take a half-day off (four hours) during the week. Staffing levels will be allowed to reduce slightly during the week to avoid extra costs being incurred.



The staff will have to be supervised by a manager, currently employed by the company and paid an annual salary of $80,000. If he works on a Sunday he will take the equivalent time off during the week when the assistant manager is available to cover for him at no extra cost to B&P. He will also be paid a bonus of 1% of the extra sales generated on the Sunday project.

The store will have to be lit at a cost of $30 per hour and heated at a cost of $45 per hour. The heating will come on two hours before the store opens in the 25 “winter” weeks to make sure it is warm enough for customers to come in at opening time. The store is not heated in the other weeks

The rent of the store amounts to $420,000 per annum.

Required:

(a) Calculate whether the Sunday opening incremental revenue exceeds the incremental costs over a year (ignore inventory movements) and on this basis reach a conclusion as to whether Sunday opening is financially justifiable. (12 marks)

(b) Discuss whether the manager’s pay deal (time off and bonus) is likely to motivate him. (4 marks)

(c) Briefly discuss whether offering substantial price discounts and promotions on Sunday is a good suggestion. (4 marks)

(20 marks)

Question 12 STAY CLEAN

Stay Clean manufactures and sells a small range of kitchen equipment. Specifically the product range contains a dishwasher (DW), a washing machine (WM) and a tumble dryer (TD). The TD is of a rather old design and has for some time generated negative contribution. It is widely expected that in one year’s time the market for this design of TD will cease, as people switch to a washing machine that can also dry clothes after the washing cycle has completed.

Stay Clean is trying to decide whether or not to cease the production of TD now or in 12 months’ time when the new combined washing machine/drier will be ready. To help with this decision the following information has been provided:

(1) The normal selling prices, annual sales volumes and total variable costs for the three products are as follows: DW WM TD Selling price per unit $200 $350 $80 Material cost per unit $70 $100 $50 Labour cost per unit £50 $80 $40 Contribution per unit $80 $170 –$10 Annual sales 5,000 units 6,000 units 1,200 units

(2) It is thought that some of the customers that buy a TD also buy a DW and a WM. It is estimated that 5% of the sales of WM and DW will be lost if the TD ceases to be produced.

(3) All the direct labour force currently working on the TD will be made redundant immediately if TD is ceased now. This would cost $6,000 in redundancy payments. If Stay Clean waited for 12 months the existing labour force would be retained and retrained at a cost of $3,500 to enable them to produce the new washing/drying product. Recruitment and training costs of labour in 12 months’ time would be $1,200 in the event that redundancy takes place now.



(4) Stay Clean operates a just in time (JIT) policy and so all material cost would be saved on the TD for 12 months if TD production ceased now. Equally, the material costs relating to the lost sales on the WM and the DW would also be saved. However, the material supplier has a volume based discount scheme in place as follows:

Total annual expenditure ($) Discount 0–600,000 0% 600,001–800,000 1% 800,001–900,000 2% 900,001–960,000 3% 960,001 and above 5% Stay Clean uses this supplier for all its materials for all the products it manufactures. The figures given above in the cost per unit table for material cost per unit are net of any discount Stay Clean already qualifies for.

(5) The space in the factory currently used for the TD will be sublet for 12 months on a short-term lease contract if production of TD stops now. The income from that contract will be $12,000.

(6) The supervisor (currently classed as an overhead) supervises the production of all three products spending approximately 20% of his time on the TD production. He would continue to be fully employed if the TD ceases to be produced now.

Required:

(a) Calculate whether or not it is worthwhile ceasing to produce the TD now rather than waiting 12 months (ignore any adjustment to allow for the time value of money). (13 marks)

(b) Explain two pricing strategies that could be used to improve the financial position of the business in the next 12 months assuming that the TD continues to be made in that period. (4 marks)

(c) Briefly describe three issues that Stay Clean should consider if it decides to outsource the manufacture of one of its future products. (3 marks)

(20 marks)

Question 13 BUTTERY RESTAURANT

(a) The current average weekly trading results of the Buttery Restaurant are shown below.

$ $ Revenue 2,800 Operating costs: Materials 1,540 Power 280 Staff 340 Building occupancy costs 460 ——– (2,620) ——– Profit 180 ——–



The average selling price of each meal is $4. Materials and power may be regarded as a variable cost varying with the number of meals provided. Staff costs are semi-variable with a fixed cost element of $200 per week. The building occupancy costs are all fixed.

Required:

Calculate the number of meals that must be sold in order to earn a profit of $300 per week. (4 marks)

(b) The owners of the restaurant are considering expanding their business and using under-utilised space by diversifying into:

either (1) take-away food; or (2) high quality meals.

The estimated sales and costs of each proposal are shown below:

Take-away Quality meals Sales volume per week 720 meals 200 meals $ $ Average selling price per meal 1.60 6.00 Variable costs per meal 0.85 4.66 Incremental fixed costs per week 610.00 282.00

The sales estimate for both of the above proposals is rather uncertain and it is recognised that actual sales volume could be up to 20% either higher or lower than that estimated.

If either of the above proposals were implemented it has been estimated that the existing restaurant’s operations would be affected as follows:

(1) As a result of bulk purchasing material costs incurred would be reduced by 10 cents per meal. This saving would apply to all meals produced in the existing restaurant.

(2) Because more people would be aware of the existence of the restaurant it is estimated that Revenue would increase. If the “take-away food” section were opened, then for every ten take-away meals sold the existing restaurant’s sales would increase by one meal; alternatively, if the “high quality meals” section were open, then for every five such meals sold the existing restaurant’s sales would increase by one meal.

A specific effect of implementing the “take-away food” proposal would be a change in the terms of employment of the staff in the existing restaurant, the result of which would be that the staff wage of $340 per week would have to be regarded as a fixed cost.

Required:

Calculate, for each of the proposed methods of diversification:

(i) the additional profit that would be earned by the owners of the restaurant if the estimated sales were achieved (8 marks)

(ii) the sales volume at which the owners of the restaurant would earn no additional profit from the proposed diversification. (3 marks)

(15 marks)



Question 14 A TO C CO

A to C Co manufactures three products, A, B, and C. The selling price and direct cost per unit of each of these products are as follows:

Product A B C $ $ $ Selling price 10 20 30 Materials cost 6.2 7.6 20.4 Direct labour 2.0 8.0 3.0

The company uses flexible budgets based on budgeted production and sales of 3,000 units and 5,000 units per month. An extract from these budgets relating to overhead costs is as follows:

Product A B C $000 $000 $000 Total overhead costs 3,000 units 6 13 11 5,000 units 8 19 17

These include both fixed and variable overhead costs. Fixed costs represent common costs that are apportioned to each of the three products, but which are not product specific.

Required:

(a) Calculate the contribution per unit of each of the four products. (3 marks)

(b) Calculate the total fixed costs for the month. (3 marks)

Budgeted production and estimated maximum demand for each product for the following month are as follows:

Product A B C Units Units Units Budgeted sales 4,000 2,000 4,000 Maximum demand 4,100 4,600 4,100

Required:

(c) Calculate monthly break-even revenue assuming that sales of the three products are made in the budgeted mix. (4 marks)

(d) Draw a profit volume chart, showing two lines:

(i) On the assumption that sales of all products are made using the budgeted mix of products. (3 marks)

(ii) On the assumption that sales of the product with the highest contribution to sales ratio are made first, followed by the product with the second highest, and so on, with sales of each product being made up until maximum demand. (7 marks)

(20 marks)



Question 15 HIGGINS CO

Higgins Co (HC) manufactures and sells pool cues and snooker cues. The cues both use the same type of good quality wood (ash), which can be difficult to source in sufficient quantity. The supply of ash is restricted to 5,400 kg per period. Ash costs $40 per kg.

The cues are made by skilled craftsmen (highly skilled labour) who are well known for their workmanship. The skilled craftsmen take years to train and are difficult to recruit. HC’s craftsmen are generally only able to work for 12,000 hours in a period. The craftsmen are paid $18 per hour.

HC sells the cues to a large market. Demand for the cues is strong, and in any period, up to 15,000 pool cues and 12,000 snooker cues could be sold. The selling price for pool cues is $41 and the selling price for snooker cues is $69.

Manufacturing details for the two products are as follows:

Pool cues Snooker cues Craftsmen time per cue 0.5 hours 0.75 hours Ash per cue 270 g 270 g Other variable costs per cue $1.20 $4.70

HC does not keep inventory.

Required:

(a) Calculate the contribution earned from each cue. (2 marks)

(b) Determine the optimal production plan for a typical period assuming that HC is seeking to maximise the contribution earned. (You should use a linear programming graph to identify the optimal solution and accurately solve the relevant equations.) (12 marks)

(c) Some of the craftsmen have offered to work overtime, provided that they are paid double time for the extra hours over the contracted 12,000 hours. HC has estimated that up to 1,200 hours per period could be gained in this way.

Required:

(i) Explain the meaning of a shadow price (dual price) and calculate the shadow price of both the labour (craftsmen) and the materials (ash). (5 marks)

(ii) Advise HC whether to accept the craftsmen’s initial offer of working overtime, discussing the rate of pay requested, the quantity of hours and one other factor that HC should consider. (6 marks)

(25 marks)



Question 16 ALBION CO

The managers of Albion Co are reviewing the operations of the company with a view to making operational decisions for the next month. Details of some of the products manufactured by the company are given below.

Product AR2 GL3 HT4 XY5 Selling price ($/unit) 21.00 28.50 27.30 Material R2 (kg/unit) 2.0 3.0 3.0 Material R3 (kg/unit) 2.0 2.2 1.6 3.0 Direct labour (hours/unit) 0.6 1.2 1.5 1.7 Variable production overheads ($/unit) 1.10 1.30 1.10 1.40 Fixed production overheads ($/unit) 1.50 1.60 1.70 1.40 Expected demand for next month (units) 950 1,000 900

Products AR2, GL3 and HT4 are sold to customers of Albion, while Product XY5 is a component that is used in the manufacture of other products. Albion manufactures a wide range of products in addition to those detailed above.

Material R2, which is not used in any other of Albion’s products, is expected to be in short supply in the next month because of industrial action at a major producer of the material. Albion has just received a delivery of 5,500 kg of Material R2 and this is expected to be the amount held in Inventory at the start of the next month. The company does not expect to be able to obtain further supplies of Material R2 unless it pays a premium price. The normal market price is $2.50 per kg.

Material R3 is available at a price of $2.00 per kg and Albion does not expect any problems in securing supplies of this material. Direct labour is paid at a rate of $4.00 per hour.

Folam Co has recently approached Albion with an offer to supply a substitute for Product XY5 at a price of $10.20 per unit. Albion would need to pay an annual fee of $50,000 for the right to use this patented substitute.

Required:

(a) Determine the optimum production schedule for Products AR2, GL3 and HT4 for the next month, on the assumption that additional supplies of Material R2 are not purchased. (8 marks)

(b) If Albion Co decides to purchase further supplies of Material R2 to meet demand for Products AR2, GL3 and HT4, calculate the maximum price per kg that the company should pay. (3 marks)

(c) Discuss whether Albion Co should manufacture Product XY5 or buy the substitute offered by Folam Co. Your answer must be supported by appropriate calculations. (7 marks)

(d) Discuss the limitations of marginal costing (variable costing) as a basis for making short-term decisions. (7 marks)

(25 marks)



Question 17 KOBRIN ENGINEERS CO

Kobrin Engineering Co is experiencing trouble with its suppliers. The firm produces a variety of valves requiring a complex bought-in component and specially imported high-grade steel. The standard cost cards for the types of valve produced are as follows:

Valve type TW VE EC SE $ $ $ $ Steel 250 500 190 390 Bought-in component 50 50 50 50 Direct labour 60 60 50 100 Variable production costs 40 50 40 50 Fixed production costs 180 240 150 270 Selling and administration costs 145 225 120 215 Profit 35 55 30 55 _____ _____ _____ _____ Selling price 760 1,180 630 1,130 _____ _____ _____ _____

All the selling and administration costs are fixed and the same single component is used for each of the four products. Direct labour is paid $4 per standard hour and each member of the workforce is capable of producing any of the valves.

Kobrin’s major customer has ordered 30 TW, 30 EC, 20 VE and 20 SE valves for the coming month. Despite the firm’s difficulties, it is felt that these must be supplied to ensure future business. It is thought that this order represents some 10% of total demand for each valve.

Required:

Establish the best production plan for Kobrin if, in the coming month:

(a) Supplies of steel are limited to $250,000;

(b) Only 400 bought-in components are likely to be available;

(c) Labour disputes will restrict productive hours to 4,250;

(d) All four products could be sub-contracted at a cost per unit of $475, $705, $380 and $640 for TW, VE, EC and SE respectively; labour is still restricted to 4,250 hours but the major customer insists that the special order is completed by Kobrin and not sub-contracted.

Note: Each of the restrictions on production is to be treated independently. (20 marks)



Question 18 BIL MOTOR COMPONENTS CO

(a) In an attempt to win over key customers in the motor industry and to increase its market share, BIL Motor Components Co have decided to charge a price lower than their normal price for component TD463 when selling to the key customers who are being targeted. Details of component TD463’s standard costs are as follows:

Batch size 200 units Machine Machine Machine Group 1 Group 7 Group 29 Assembly Materials (per unit) 26.00 17.00 – 3.00 Labour (per unit) 2.00 1.60 0.75 1.20 Variable overheads (per unit) 0.65 0.72 0.80 0.36 Fixed overheads (per unit) 3.00 2.50 1.50 0.84 _____ _____ _____ _____ 31.65 21.82 3.05 5.40 _____ _____ _____ _____

Setting-up costs per batch of 200 units $10 $6 $4 –

Required:

Compute the lowest selling price at which one batch of 200 units could be offered, and critically evaluate the adoption of such a pricing policy. (8 marks)

(b) The company is also considering the launch of a new product, component TDX489, and have provided you with the following information:

Product TDX489 Standard cost per box $ Variable cost 6.20 Fixed cost 1.60 _____ 7.80 _____ Market research – forecast of demand

Selling price ($) 13 12 11 10 9 Demand (boxes) 5,000 6,000 7,200 11,200 13,400

The company only has enough production capacity to make 7,000 boxes. However, it would be possible to purchase product TDX489 from a sub-contractor at $7.75 per box for orders up to 5,000 boxes, and $7 per box if the orders exceed 5,000 boxes.

Required:

Prepare and present a computation that illustrates which price should be selected in order to maximise profits. (8 marks)

(c) Where production capacity is the limiting factor explain briefly the ways in which management can increase it without having to acquire more plant and machinery.

(4 marks)

(20 marks)



Question 19 JASON GRIMES

Jason Grimes’ results for the past year are as follows: $000 $000 Sales (1,000,000 units) 3,000 Less Cost of goods sold Labour 550 Materials 2,000 _____ (2,550) _____ Gross profit 450 Less Variable selling expenses (50¢ per unit) 500 Fixed overheads 250 ____ (750) ____ (300) ––––

For the coming year Jason can hire a machine for $575,000 which will cause his material usage per unit to halve. Whether the machine is hired or not, the labour cost will rise to 80¢ per unit and variable selling expenses fall to 20¢ per unit.

Jason’s demand curve is P = 5 – 00015030

,. Q, where P is the price per unit and Q is annual sales.

This gives marginal revenue of 5 – 00015060

,. Q.

Required:

Advise Jason on:

(a) whether or not to hire the machine; (b) the price to be charged to maximise profit. (15 marks)

Question 20 KADOK CO

Kadok Co manufactures a number of products, with cameras being produced in department C. The company draws up budgets for each department based on the fullest practical capacity. For the year commencing 1 January 20X9 the following budget has been formulated for department C:

$000 Direct costs: Materials 60 Labour 40 —— 100 Production overheads 100 —— 200 Administrative and marketing overheads 50 —— Full costs 250 Profit 50 —— Revenue * 300 —— * From budgeted sales of 20,000 units.



Production overheads are absorbed on the basis of 100% of direct costs. However, half are fixed, while the remainder relate to the machining of the materials. The administrative and marketing overheads are based on 25% of factory costs and do not vary within wide ranges of activity. For each department a profit margin of 20% is applied to the “full costs”, as this is felt to give a fair return on assets employed as well as to provide a reasonable reward for entrepreneurial effort. This also results in a price that appears to be fair to consumers.

Halfway through the budget period it became obvious to the management of Kadok that there was going to be a shortfall in sales that could be expected to be 25% below the forecast. At about the same time that this shortfall in sales became evident, a chain of photographic shops showed an interest in purchasing 5,000 units of a special camera that would be stripped down to bare essentials and sold under the chain’s brand name Noxid. If Kadok were to produce such a model there would obviously be a saving on the usual material and labour unit costs. The management accountant of Kadok estimated that materials costing $12,000 and labour of $8,000 would be required to produce the 5,000 cameras. As the production could take place within the firm’s existing capacity, fixed costs would not be affected.

Required:

(a) Give computations showing the price that should be quoted for the order based on the following:

(i) full cost plus pricing, on the current basis; (ii) a price that would enable the original budget profit to be attained; (iii) overheads being absorbed on a unit basis, with profit applied on the current

basis. (8 marks)

(b) Give your advice to the management of Kadok Co on a pricing policy for this quotation. Discuss any factors that you feel should be brought to the attention of management when it considers the pricing strategy for this special order. (7 marks)

(15 marks)

Question 21 AUTODES CO

Autodes Co designs, manufactures and sells a range of components for the motor car industry, selling exclusively to car manufacturers. The design team has recently developed and patented a new component for incorporation into any car. The component will greatly improve fuel consumption and reduce emissions of greenhouse gases. Initial trials have been successful and the company is now planning to launch the product. The design team believes that they are at least 24 months ahead of any of their competitors who are currently developing similar products. The product has been developed under the working title “Autolong”.

You are a consultant to the company and have been tasked with developing a pricing policy for the Autolong. You have gathered the following data for each unit:

Direct Materials: Code Quantity Price WZ954 3 gms $4.74 per gm RT429 5 gms $6.12 per gm Other $5.01 per unit Direct Labour 1.5 hours at $21 per hour

Overheads are absorbed on a direct labour hour basis, at $29 per hour.



Costs of developing the Autolong were $3,675,000. Autodes has a policy of recovering development costs in the first three years of a product’s life cycle.

Supplies of material WZ954 are limited to 180,000 gms per annum. Autodes currently uses all of its available supplies in another product, which generates a contribution of $15 per unit. Each unit of this product requires 4 gms of WZ954. (Development costs of this product have been fully recovered.)

Product prices are calculated to obtain a 25% profit margin on sales.

A market report indicates that:

– the market is reasonably price sensitive; – provided the price is not above $225, demand is expected to exceed production capacity; – introduction of the Autolong will not affect the sales volumes of other products.

The Managing Director has also asked you to comment on the suggestion of a non-executive director that the Autolong should be priced on a “more competitive basis, such as market skimming or market penetration”.

Required:

(a) Calculate the price of the Autolong based on the current pricing policy. (8 marks)

(b) In a report to the Managing Director, comment on the non-executive director’s suggestion, and recommend an initial price for the Autolong. (12 marks)

(20 marks)

Question 22 ESSENTIAL ASPECT

An essential aspect of financial and business planning is concerned with estimating costs and revenues and deciding the optimum output and price levels. A company produces a single product and operates in a market where it has to lower the sale price of all its units if it wishes to sell more. The company’s costing and marketing departments currently use the following cost and revenue model (all output is sold in the current period):

Current Model: Total Costs = 5,000 + 0.6x Total Revenue = 20x – 0.01x2

Where x = the number of units sold

The company has recently updated its cost and revenue model to:

Total costs = 4,750 + 0.8x Total revenue = 19x – 0.009x2

The acceptability of the current model and the proposed changes as a basis for profit planning and for monitoring performance is to be reviewed.



Required:

(a) Explain the structure of the current and the revised model. (4 marks)

(b) It has been estimated that the revised model will result in an optimal output of 1,011 units being produced and sold.

(i) Suggest two alternative ways of determining this optimal level of output. (3 marks)

(ii) Discuss the extent to which adherence to this output target is a satisfactory indicator of managerial performance. (3 marks)

(c) Name and comment on cost and revenue factors which should be considered in order to improve the validity of the model as a profit forecasting model. (10 marks)

(20 marks)

Question 23 STOW HEALTH CENTRE

Stow Health Centre specialises in the provision of sports/exercise and medical/dietary advice to clients. The service is provided on a residential basis and clients stay for whatever number of days suits their needs. Budgeted estimates for the year ending 30 June 201X are as follows:

(i) The maximum capacity of the centre is 50 clients per day for 350 days in the year.

(ii) Clients will be invoiced at a fee per day. The budgeted occupancy level will vary with the client fee level per day and is estimated at different percentages of maximum capacity as follows: Occupancy as Client fee percentage of per day Occupancy level maximum capacity $180 High 90% $200 Medium 75% $220 Low 60%

(iii) Variable costs are also estimated at one of three levels per client day. The high, most likely and low levels per client day are $95, $85 and $70 respectively. The range of cost levels reflects only the possible effect of the purchase prices of goods and services.

Required:

(a) Prepare a summary which shows the budgeted contribution earned by Stow Health Centre for the year ended 30 June 201X for each of nine possible outcomes. (6 marks)

(b) State the client fee strategy for the year to 30 June 201X that will result from the use of each of the following decision rules:

(i) maximax; (ii) maximin; (iii) minimax regret.

Your answer should explain the basis of operation of each rule. Use the information from your answer to (a) as relevant and show any additional working calculations as necessary. (9 marks)



(c) The probabilities of variable cost levels occurring at the high, most likely and low levels provided in the question are estimated as 0·1, 0·6 and 0·3 respectively.

Using the information available, determine the client fee strategy that will be chosen where maximisation of expected value of contribution is used as the decision basis.

(5 marks)

(20 marks)

Question 24 SHIFTERS HAULAGE

Shifters Haulage (SH) is considering changing some of the vans it uses to transport crates for customers. The new vans come in three sizes; small, medium and large. SH is unsure about which type to buy. The capacity is 100 crates for the small van, 150 for the medium van and 200 for the large van.

Demand for crates varies and can be either 120 or 190 crates per period, with the probability of the higher demand figure being 0.6.

The sale price per crate is $10 and the variable cost $4 per crate for all van sizes subject to the fact that if the capacity of the van is greater than the demand for crates in a period then the variable cost will be lower by 10% to allow for the fact that the vans will be partly empty when transporting crates.

SH is concerned that if the demand for crates exceeds the capacity of the vans then customers will have to be turned away. SH estimates that in this case goodwill of $100 would be charged against profits per period to allow for lost future sales regardless of the number of customers that are turned away.

Depreciation charged would be $200 per period for the small, $300 for the medium and $400 for the large van.

SH has in the past been very aggressive in its decision-making, pressing ahead with rapid growth strategies. However, its managers have recently grown more cautious as the business has become more competitive.

Required:

(a) Explain the principles behind the maximax, maximin and expected value criteria that are sometimes used to make decisions in uncertain situations. (4 marks)

(b) Prepare a profits table showing the SIX possible profit figures per period. (9 marks)

(c) Using your profit table from (b) above discuss which type of van SH should buy taking into consideration the possible risk attitudes of the managers. (6 marks)

(d) Describe THREE methods other than those mentioned in (a) above, which businesses can use to analyse and assess the risk that exists in its decision-making. (6 marks)

(25 marks)

Question 25 DECISION TREE

The owner of a tourist hotel is facing a difficult decision. It is low season and, because the weather is unpredictable at this time of the year, it is difficult to predict the demand for the hotel’s facilities. If the weather is poor then there will be 200 room nights demanded for the hotel’s facilities. There is a 70% likelihood of the weather being poor. If the weather is good then there will be 600 room nights demanded for the hotel’s facilities, but there is only a 30% chance that the weather will be good.



The owner of the hotel is considering advertising some reduced prices locally or nationally in order to improve the demand during this period.

If the reduced prices are advertised locally and if the weather is poor, then there is a 60% chance that the lower prices would affect demand and would cause there to be 300 room nights demanded; but if the weather is good, then there is a 40% chance that the lower prices would affect demand and would cause there to be 800 room nights demanded.

If these lower prices were advertised nationally there is a 50% chance that these demand levels would increase to 400 room nights and 900 room nights respectively.

Expected earnings (before deducting the costs of any local or national advertising) at different levels of demand are as follows:

Room nights demanded Earnings $ 200 (35,000) 300 (15,000) 400 (5,000) 500 20,000 600 30,000 700 45,000 800 65,000 900 90,000

The costs of advertising locally and nationally are $10,000 and $25,000 respectively.

Required:

(a) Prepare a decision tree to illustrate the above problem and use this to recommend, with reasons, the best course of action for the owner of the hotel. (7 marks)

(b) Briefly discuss the limitations of using a decision tree to solve this problem. (3 marks)

(10 marks)

Question 26 NORTHLAND

Northland’s major towns and cities are maintained by local government organisations (LGO), which are funded by central government. The LGOs submit a budget each year that forms the basis of the funds received. You are provided with the following information as part of the 20X3 budget preparation:

Overheads

Overhead costs are budgeted on an incremental basis, taking the previous year’s actual expenditure and adding a set % to allow for inflation. Adjustments are also made for known changes. The details for these are:

Overhead cost category 20X2 cost ($) Known changes Inflation adjustment between 20X2 and 20X3 Property cost 120,000 None +5% Central wages 150,000 Note 1 +3% Stationery 25,000 Note 2 0%

Note 1: One new staff member will be added to the overhead team; this will cost $12,000 in 20X3. Note 2: A move towards the paperless office is expected to reduce stationery costs by 40% on the

20X2 spend.



Road repairs

In 20X3 it is expected that 2,000 metres of road will need repairing but a contingency of an extra 10% has been agreed.

In 20X2 the average cost of a road repair was $15,000 per metre repaired, but this excluded any cost effects of extreme weather conditions. The following probability estimates have been made in respect of 20X3:

Weather type predicted Probability Increase in repair cost Good 0.7 0 Poor 0.1 +10% Bad 0.2 +25%

Inflation on road repairing costs is expected to be 5% between 20X2 and 20X3.

New roads

New roads are budgeted on a zero base basis and will have to compete for funds along with other capital projects such as hospitals and schools.

Required:

(a) Calculate the overheads budget for 20X3. (3 marks)

(b) Calculate the budgets for road repairs for 20X3. (6 marks)

(c) Explain the problems associated with using expected values in budgeting by an LGO and explain why a contingency for road repairs might be needed. (8 marks)

(d) Explain the process involved for zero-based budgeting. (3 marks)

(20 marks)

Question 27 BUDGET BEHAVIOUR

For many organisations in both the private and public sectors the annual budget is the basis of much internal management information. When preparing and using budgets, however, management and the accountant must be aware of their behavioral implications.

Required:

(a) Briefly discuss four purposes of budgets. (8 marks)

(b) Explain the behavioral factors that should be taken into account and the difficulties of applying them in the process of budgeting and budgetary control. (12 marks)

(20 marks)



Question 28 ZBB

(a) Explain why zero-based budgeting might be a useful tool to employ to ensure that budgetary requirements are kept up to date. (4 marks)

(b) Describe the steps necessary to implement a zero-based budgeting system in respect of:

– questioning why expenditure needs to be incurred; – deciding which activities should be provided with a budget; and – questions to be asked when budgeted activities are to be ranked to allocate

scarce resources. (8 marks)

(c) Critically assess the use of zero-based budgeting as a tool that might be used to motivate employees. (6 marks)

(d) Explain the advantages of encouraging employee participation in budget setting. (7 marks)

(25 marks)

Question 29 BUDGETING & COSTING

Required:

(a) Discuss how costing information and principles may be applied in a not-for-profit organisation in the following areas:

(i) The selection of cost units; (ii) The use of performance measures to measure output and quality; (iii) The comparison of planned and actual performance. (10 marks)

(b) Discuss the key features of zero-based budgeting and explain how it may be applied in a not-for-profit organisation. (8 marks)

(c) Briefly discuss how activity-based budgeting might be introduced into a manufacturing organisation and the advantages that might arise from the use of activity-based budgeting in such an organisation. (7 marks)

(25 marks)

Question 30 THE WESTERN

The Western is a local government organisation responsible for waste collection from domestic households. The new management accountant of The Western has decided to introduce some new forecasting techniques to improve the accuracy of the budgeting. The next budget to be produced is for the year ended 31 December 2010.

Waste is collected by the tonne (T). The number of tonnes collected each year has been rising and by using time series analysis the new management accountant has produced the following relationship between the tonnes collected (T) and the time period in question Q (where Q is a quarter number. So Q = 1 represents quarter 1 in 2009 and Q = 2 represents quarter 2 in 2009 and so on)

T = 2,000 + 25Q



Each quarter is subject to some seasonal variation with more waste being collected in the middle quarters of each year. The adjustments required to the underlying trend prediction are:

Quarter Tonnes 1 –200 2 +250 3 +150 4 –100

Once T is predicted the new management accountant hopes to use the values to predict the variable operating costs and fixed operating costs that The Western will be subjected to in 2010. To this end he has provided the following operating cost data for 2009:

Volume of waste Total operating cost in 2009 (fixed + variable) Tonnes $000s 2,100 950 2,500 1,010 2,400 1,010 2,300 990

Inflation on the operating cost is expected to be 5% between 2009 and 2010.

The regression formula is shown on the formula sheet.

Required:

(a) Calculate the tonnes of waste to be expected in the calendar year 2010. (4 marks)

(b) Calculate the variable operating cost and fixed operating cost to be expected in 2010 using regression analysis on the 2009 data and allowing for inflation as appropriate. (10 marks)

(c) Many local government organisations operate incremental budgeting as one of their main budgeting techniques. They take a previous period’s actual spend, adjust for any known changes to operations and then add a % for expected inflation in order to set the next period’s budget.

Required:

Describe two advantages and two disadvantages of a local government organisation funded by taxpayer’s money using incremental budgeting as its main budgeting technique. (6 marks)

(20 marks)



Question 31 STORRS CO

It is mid-June and the new managing director of Storrs Co is reviewing sales forecasts for Quarter 3 of 201Z, which begins on 1 July, and for Quarter 4. The company manufactures garden furniture and experiences seasonal variations in sales, which has made forecasting difficult in the past. Sales for the last two calendar years were as follows:

Year Quarter 1 Quarter 2 Quarter 3 Quarter 4 201X $2,700,000 $3,500,000 $3,400,000 $3,000,000 201Y $3,100,000 $3,900,000 $3,600,000 $3,400,000

Sales in Quarter 1 of 201Z were $3,600,000. There is two weeks to go until the end of Quarter 2 and the managing director of Stores is confident that it will achieve sales of $4,400,000 in this quarter.

The existing sales forecasts for the two remaining quarters of the year 201Z were made by the sales director (who has been with the company for several years) during last year’s budget-setting process. These forecasts are $3,800,000 for Quarter 3 and $3,600,000 for Quarter 4. Budgets in Storrs have traditionally been prepared and agreed by the directors of the company before being implemented by junior managers.

As a basis for revising the sales forecasts for the two remaining quarters of 201Z, the management accountant of Storrs has begun to apply time series analysis in order to identify the seasonal variations in sales. He has so far calculated the following centred moving averages, using a base period of four quarters:

Year Quarter 1 Quarter 2 Quarter 3 Quarter 4 201X $3,200,000 $3,300,000 201Y $3,375,000 $3,450,000 $3,562,500 $3,687,500

Required:

(a) Using the sales information and centred moving averages provided, and assuming an additive model, forecast the sales of Storrs Co for Quarter 3 and Quarter 4 of 201Z, and comment on the sales forecasts made by the sales director.

Note: you are NOT required to use regression analysis. (8 marks)

(b) Discuss the limitations of the sales forecasting method used in part (a). (5 marks)

(c) Discuss the relative merits of top-down and bottom-up approaches to budget setting. (12 marks)

(25 marks)

Question 32 SOUTH

South has reported the following costs for the past four months:

Month Activity level (units) Total cost 1 300 $3,800 2 400 $4,000 3 150 $3,000 4 260 $3,500



Required:

(a) Using regression analysis calculate the total cost equation. (6 marks)

(b) Calculate the total cost at the following activity levels:

(i) 200 units; (ii) 500 units,

and comment on the usefulness of your equation with regard to these estimates. (4 marks)

(10 marks)

Question 33 HENRY CO

Henry Co (HC) provides skilled labour to the building trade. They have recently been asked by a builder to bid for a kitchen-fitting contract for a new development of 600 identical apartments. HC has not worked for this builder before. Cost information for the new contract is as follows:

Labour for the contract is available. HC expects that the first kitchen will take 24 man-hours to fit but thereafter the time taken will be subject to a 95% learning rate. After 200 kitchens are fitted the learning rate will stop and the time taken for the 200th kitchen will be the time taken for all the remaining kitchens. Labour costs $15 per hour.

Overheads are absorbed on a labour hour basis. HC has collected overhead information for the last four months and this is shown below:

Hours worked Overhead cost $ Month 1 9,300 115,000 Month 2 9,200 113,600 Month 3 9,400 116,000 Month 4 9,600 116,800

HC normally works around 120,000 labour hours in a year.

HC uses the high low method to analyse overheads.

The learning curve equation is y = axb, where 2Log

LogLR = –0.074

Required:

(a) Describe FIVE factors, other than the cost of labour and overheads mentioned above, that HC should take into consideration in calculating its bid. (10 marks)

(b) Calculate the total cost including all overheads for HC that it can use as a basis of the bid for the new apartment contract. (13 marks)

(c) If the second kitchen alone is expected to take 21.6 man-hours to fit demonstrate how the learning rate of 95% has been calculated. (2 marks)

(25 marks)



Question 34 BIG CHEESE CHAIRS

Big Cheese Chairs (BCC) manufactures and sells executive leather chairs. They are considering a new design of massaging chair to launch into the competitive market in which they operate.

They have carried out an investigation in the market and, using a target costing system, have targeted a competitive selling price of $120 for the chair. BCC wants a margin on selling price of 20% (ignoring any overheads).

The frame and massage mechanism will be bought in for $51 per chair and BCC will upholster it in leather and assemble it ready for despatch.

Leather costs $10 per metre and two metres are needed for a complete chair although 20% of all leather is wasted in the upholstery process.

The upholstery and assembly process will be subject to a learning effect as the workers get used to the new design. BCC estimates that the first chair will take two hours to prepare but this will be subject to a learning rate (LR) of 95%. The learning improvement will stop once 128 chairs have been made and the time for the 128th chair will be the time for all subsequent chairs. The cost of labour is $15 per hour.

The learning formula is shown on the formula sheet and at the 95% learning rate the value of b is –0.074000581.

Required:

(a) Calculate the average cost for the first 128 chairs made and identify any cost gap that may be present at that stage. (8 marks)

(b) Assuming that a cost gap for the chair exists suggest four ways in which it could be closed. (6 marks)

(c) The production manager denies any claims that a cost gap exists and has stated that the cost of the 128th chair will be low enough to yield the required margin.

Required:

Calculate the cost of the 128th chair made and state whether the target cost is being achieved on the 128th chair. (6 marks)

(20 marks)

Question 35 STANDARD COSTING

Outline the uses of standard costing and discuss the reasons why standards have to be reviewed. (13 marks)



Question 36 INFORMATION SOURCE

A major information source for many businesses is a system of standard costing and variance analysis.

Required:

(a) Describe briefly four purposes of a system of standard costing. (4 marks)

(b) Explain three different levels of performance which may be incorporated into a system of standard costing and comment on how these may relate to the purposes set out in (a) above. (6 marks)

(c) Comment on whether standard costing applies in both manufacturing and service businesses and how it may be affected by modern initiatives of continuous performance improvement and cost reduction. (4 marks)

(d) A standard costing system enables variances for direct costs, variable and fixed overheads to be extracted.

Required:

Identify and briefly discuss some of the complexities and practical problems in calculation, which may limit the usefulness of those variances. (6 marks)

(20 marks)

Question 37 WOODEEZER CO

Woodeezer Co makes quality wooden benches for both indoor and outdoor use. Results have been disappointing in recent years and a new managing director, Peter Beech, was appointed to raise production volumes. After an initial assessment Peter Beech considered that budgets had been set at levels that made it easy for employees to achieve. He argued that employees would be better motivated by setting budgets which challenged them more in terms of higher expected output.

Other than changing the overall budgeted output, Mr Beech has not yet altered any part of the standard cost card. Thus, the budgeted output and sales for the most recent month was 4,000 benches and the standard cost card below was calculated on this basis:

$ Wood 25 kg at $3.20 per kg 80.00 Labour 4 hours at $8 per hour 32.00 Variable overheads 4 hours at $4 per hour 16.00 Fixed overhead 4 hours at $16 per hour 64.00 –––––– 192.00 Selling price 220.00 –––––– Standard profit 28.00 ––––––

Overheads are absorbed on the basis of labour hours and the company uses an absorption costing system. There were no inventories at the beginning of the most recent month. Inventories are valued at standard cost.



Actual results for the month were as follows:

$ Wood 80,000 kg at $3.50 280,000 Labour 16,000 hours at $7 112,000 Variable overhead 60,000 Fixed overhead 196,000 –––––––– Total production cost (3,600 benches) 648,000 Closing Inventory (400 benches at $192) 76,800 –––––––– Cost of sales 571,200 Sales (3,200 benches) 720,000 –––––––– Actual profit 148,800 ––––––––

The average monthly production and sales for some years prior to the most recent month had been 3,400 units and budgets had previously been set at this level. Very few operating variances had historically been generated by the standard costs used.

Mr Beech has made some significant changes to the operations of the company. However, the other directors are now concerned that Mr Beech has been too ambitious in raising production targets. Mr Beech had also changed suppliers of raw materials to improve quality, increased selling prices, begun to introduce less skilled labour, and significantly reduced fixed overheads.

The finance director suggested that an absorption costing system is misleading and that a marginal costing system should be considered at some stage in the future to guide decision-making.

Required:

(a) Prepare an operating statement for the most recent month. This should show all operating variances and should reconcile budgeted and actual profit for the month for Woodeezer Co. (14 marks)

(b) In so far as the information permits, examine the impact of the operational changes made by Mr Beech on the profitability of the company. In your answer, consider each of the following:

(i) Motivation and budget setting; and (ii) Possible causes of variances. (6 marks)

(c) Re-assess the impact of your comments in part (b), using a marginal costing approach to evaluating the impact of the operational changes made by Mr Beech.

Show any relevant additional calculations to support your arguments. (5 marks)

(25 marks)



Question 38 MERMUS CO

Mermus Co is comparing budget and actual data for the last three months.

Budget Actual $ $ $ $ Sales 950,000 922,500 Cost of sales Raw materials 133,000 130,500 Direct labour 152,000 153,000 Variable production overheads 100,700 96,300 Fixed production overheads 125,400 115,300 –––––––– –––––––– 511,100 495,100 –––––––– –––––––– 438,900 427,400 –––––––– ––––––––

The budget was prepared on the basis of 95,000 units produced and sold, but actual production and sales for the three-month period were 90,000 units.

Mermus uses standard costing and absorbs fixed production overheads on a machine hour basis. A total of 28,500 standard machine hours were budgeted. A total of 27,200 machine hours were actually used in the three-month period.

Required:

(a) Prepare a revised budget at the new level of activity using a flexible budgeting approach. (4 marks)

(b) Calculate the following:

(i) Raw material total cost variance; (ii) Direct labour total cost variance; (iii) Fixed overhead efficiency variance; (iv) Fixed overhead capacity variance; (v) Fixed overhead expenditure variance. (8 marks)

(c) Suggest possible explanations for the following variances:

(i) Raw materials total cost variance; (ii) Fixed overhead efficiency variance; (iii) Fixed overhead expenditure variance. (6 marks)

(d) Explain three key purposes of a budgeting system. (7 marks)

(25 marks)

Question 39 MURGATROYD CO

Murgatroyd Co, which manufactures a single product, uses standard absorption costing. A summary of the standard product cost is as follows:

$ per unit Direct materials 15 Direct labour 20 Fixed overheads 12



Budgeted and actual production for last month was 10,000 units and 9,000 units respectively. The actual costs incurred were:

$ Direct materials 138,000 Direct labour 178,000 Fixed overheads 103,000

Required:

(a) Prepare a statement that reconciles the standard cost of actual production with its actual cost for last month and highlights the total variance for each of the three elements of cost. (4 marks)

(b) Last month 24,000 litres of direct material were purchased and used by the company. The standard allows for 2.5 litres of the material, at $6 per litre, to be used in each unit of product.

Required:

Provide an appropriate breakdown of the total direct materials cost variance included in your statement in (a). (3 marks)

(c) Explain who in the company should be involved in setting:

(i) the standard price; and (ii) the standard quantity for direct materials. (3 marks)

(10 marks)

Question 40 CHAFF CO

Chaff Co processes and sells brown rice. It buys unprocessed rice seeds and then, using a relatively simple process, removes the outer husk of the rice to produce the brown rice. This means that there is substantial loss of weight in the process. The market for the purchase of seeds and the sales of brown rice has been, and is expected to be, stable. Chaff Co uses a variance analysis system to monitor its performance.

There has been some concern about the interpretation of the variances that have been calculated in month 1.

(1) The purchasing manager is adamant, despite criticism from the production director, that he has purchased wisely and saved the company thousands of dollars in purchase costs by buying the required quantity of cheaper seeds from a new supplier.

(2) The production director is upset at being criticised for increasing the wage rates for month 1; he feels the decision was the right one, considering all the implications of the increase. Morale was poor and he felt he had to do something about it.

(3) The maintenance manager feels that saving $8,000 on fixed overhead has helped the profitability of the business. He argues that the machines’ annual maintenance can wait for another month without a problem, as the machines have been running well.



The variances for month 1 are as follows: $ Material price 48,000 Favourable Material usage 52,000 Adverse Labour rate 15,000 Adverse Labour efficiency 18,000 Favourable Labour idle time 12,000 Favourable Variable overhead expenditure 18,000 Adverse Variable overhead efficiency 30,000 Favourable Fixed overhead expenditure 8,000 Favourable Sales price 85,000 Adverse Sales volume 21,000 Adverse

Chaff Co uses labour hours to absorb the variable overhead.

Required:

(a) Comment on the performance of the purchasing manager, the production director and the maintenance manager using the variances and other information above and reach a conclusion as to whether or not they have each performed well. (9 marks)

(b) In month 2 the following data applies:

Standard costs for 1 tonne of brown rice:

– 1.4 tonnes of rice seeds are needed at a cost of $60 per tonne;

– It takes 2 labour hours of work to produce 1 tonne of brown rice and labour is normally paid $18 per hour. Idle time is expected to be 10% of hours paid; this is not reflected in the rate of $18 above;

– 2 hours of variable overhead at a cost of $30 per hour;

Standard selling price is $240 per tonne.

Standard contribution per tonne is $56 per tonne.

Budget information for month 2 is:

– Fixed costs were budgeted at $210,000 for the month – Budgeted production and sales were 8,400 tonnes

Actual results for month 2 were as follows:

– Production and sales, 8,000 tonnes; – 12,000 tonnes of rice seeds were bought and used, costing $660,000; – 15,800 labour hours were paid for, costing $303,360; – 15,000 labour hours were worked; – Variable production overhead cost $480,000; – Fixed costs were $200,000; – Sales revenue achieved was $1,800,000.

Required:

Calculate the variances for month 2 in as much detail as the information allows and reconcile the budget profit to the actual profit using marginal costing principles. You are not required to comment on the performance of the business or its managers for their performance in month 2. (16 marks)

(25 marks)



Question 41 CRUMBLY CAKES

Crumbly Cakes make cakes, which are sold directly to the public. The new production manager (a celebrity chef) has argued that the business should use only organic ingredients in its cake production. Organic ingredients are more expensive but should produce a product with an improved flavour and give health benefits for the customers. It was hoped that this would stimulate demand and enable an immediate price increase for the cakes.

Crumbly Cakes operates a responsibility-based standard costing system that allocates variances to specific individuals. The individual managers are paid a bonus only when net favourable variances are allocated to them.

The new organic cake production approach was adopted at the start of March 2009, following a decision by the new production manager. No change was made at that time to the standard costs card. The variance reports for February and March are shown below (Fav = Favourable and Adv = Adverse):

Manager responsible Allocated variances February March

Production manager $ $ Material price (total for all ingredients) 25 Fav 2,100 Adv Material mix 0 600 Adv Material yield 20 Fav 400 Fav Sales manager Sales price 40 Adv 7,000 Fav Sales contribution volume 35 Adv 3,000 Fav

The production manager is upset that he seems to have lost all hope of a bonus under the new system. The sales manager thinks the new organic cakes are excellent and is very pleased with the progress made.

Crumbly Cakes operate a JIT stock system and holds virtually no inventory.

Required:

(a) Assess the performance of the production manager and the sales manager and indicate whether the current bonus scheme is fair to those concerned. (7 marks)

(b) In April 2009 the following data applied:

Standard cost card for one cake (not adjusted for the organic ingredient change):

Ingredients Kg $ Flour 0.10 0.12 per kg Eggs 0.10 0.70 per kg Butter 0.10 1.70 per kg Sugar 0.10 0.50 per kg Total input 0.40 Normal loss (10%) (0.04) Standard weight of a cake 0.36 Standard sales price of a cake 0.85

Standard contribution per cake after all variable costs 0.35



The budget for production and sales in April was 50,000 cakes. Actual production and sales was 60,000 cakes in the month, during which the following occurred:

Ingredients used Kg $ Flour 5,700 741 Eggs 6,600 5,610 Butter 6,600 11,880 Sugar 4,578 2,747 Total input 23,478 20,978 Actual loss (1,878) Actual output of cake mixture 21,600 Actual sales price of a cake 0.99

All cakes produced must weigh 0.36 kg, as this is what is advertised.

Required:

Calculate the material price, mix and yield variances and the sales price and sales contribution volume variances for April. You are not required to make any comment on the performance of the managers. (13 marks)

(20 marks)

Question 42 AVX CO

AVX Co assembles circuit boards for use by high technology audio video companies. Due to the rapidly advancing technology in this field, AVX is constantly being challenged to learn new techniques.

AVX uses standard costing to control its costs against targets set by senior managers. The standard labour cost per batch of one particular type of circuit board (CB45) is set out below:

Direct labour – 50 hours @$10 per hour.

The following labour efficiency variances arose during the first six months of the assembly of CB45:

Batches made Efficiency and sold variance Number $ November 1 nil December 1 170.00 Favourable January 2 452.20 Favourable February 4 1089.30 Favourable March 8 1711.50 Favourable - April 16 3423.00 Favourable

An investigation has confirmed that all of the costs were as expected except that there was a learning effect in respect of the direct labour that had not been anticipated when the standard cost was set.

Required:

(a) Calculate the rates of learning that applied during the six months. (8 marks)

(b) Identify when the learning period ended and briefly discuss the implications of your findings for AVX Co. (2 marks)

(c) Explain the difference between standard costs and target costs. (4 marks)

(14 marks)



Question 43 MILBAO CO

Milbao Co makes and sells three types of electronic game for which the following budget/standard information and actual information is available for a four-week period:

Budget Standard unit data Actual Model sales Selling price Variable cost sales (units) $ $ (units) Superb 30,000 100 40 36,000 Excellent 50,000 80 25 42,000 Good 20,000 70 22 18,000

Budgeted fixed costs are $2,500,000 for the four-week period. Budgeted fixed costs should be charged to product units at an overall budgeted average cost per unit where it is relevant to do so.

Required:

(a) Calculate the sales volume variance for each model and in total for the four-week period where (i) turnover (ii) contribution and (iii) net profit is used as the variance valuation base. (10 marks)

(b) Discuss the relative merits of each of the valuation bases of the sales volume variance calculated in (a) above. (6 marks)

(c) Calculate the TOTAL sales quantity and sales mix variances for Milbao Co for the four-week period, using contribution as the valuation base. (Individual model variances are not required.) (4 marks)

(20 marks)

Question 44 SPIKE CO

Spike Co manufactures and sells good quality leather bound diaries. Each year it budgets for its profits, including detailed budgets for sales, materials and labour. If appropriate, the departmental managers are allowed to revise their budgets for planning errors.

In recent months, the managing director has become concerned about the frequency of budget revisions. At a recent board meeting he said, “There seems little point budgeting any more. Every time we have a problem the budgets are revised to leave me looking at a favourable operational variance report and at the same time a lot less profit than promised.”

Required:

(a) Describe the circumstances when a budget revision should be allowed and when it should be refused. (5 marks)

(b) Two specific situations have recently arisen, for which budget revisions were sought:

Materials

A local material supplier was forced into liquidation. Spike’s buyer managed to find another supplier, 150 miles away at short notice. This second supplier charged more for the material and a supplementary delivery charge on top. The buyer agreed to both the price and the delivery charge without negotiation. “I had no choice”, the buyer said, “The production manager was pushing me very hard to find any solution possible!” Two months later, another, more competitive, local supplier was found.

A budget revision is being sought for the two months where higher prices had to be paid.



Labour

During the early part of the year, problems had been experienced with the quality of work being produced by the support staff in the labour force. The departmental manager had complained in his board report that his team were “unreliable, inflexible and just not up to the job”.

It was therefore decided, after discussion of the board report, that something had to be done. The company changed its policy so as to recruit only top graduates from good quality universities. This has had the effect of pushing up the costs involved but increasing productivity in relation to that element of the labour force.

The support staff departmental manager has requested a budget revision to cover the extra costs involved following the change of policy.

Required:

Discuss each request for a budget revision, putting what you see as both sides of the argument and reach a conclusion as to whether a budget revision should be allowed. (8 marks)

(c) The market for leather bound diaries has been shrinking as the electronic versions become more widely available and easier to use. Spike has produced the following data relating to leather bound diary sales for the year to date:

Budget Sales volume 180,000 units Sales price $17.00 per unit Standard contribution $7.00 per unit

The total market for diaries in this period was estimated in the budget to be 1.8m units. In fact, the actual total market shrank to 1.6m units for the period under review.

Actual results for the same period Sales volume 176,000 units Sales price $16.40 per unit

Required:

(i) Calculate the total sales price and total sales volume variance. (4 marks)

(ii) Analyse the total sales volume variance into components for market size and market share. (4 marks)

(iii) Comment on the sales performance of the business. (4 marks)

(25 marks)

Question 45 SECURE NET

Secure Net (SN) manufacture security cards that restrict access to government owned buildings around the world.

The standard cost for the plastic that goes into making a card is $4 per kg and each card uses 40 gms of plastic after an allowance for waste. In November 100,000 cards were produced and sold by SN and this was well above the budgeted sales of 60,000 cards.



The actual cost of the plastic was $5.25 per kg and the production manager (who is responsible for all buying and production issues) was asked to explain the increase. He said “World oil price increases pushed up plastic prices by 20% compared to our budget and I also decided to use a different supplier who promised better quality and increased reliability for a slightly higher price. I know we have overspent but not all the increase in plastic prices is my fault”.

The actual usage of plastic per card was 35 gms per card and again the production manager had an explanation. He said “The world-wide standard size for security cards increased by 5% due to a change in the card reader technology, however, our new supplier provided much better quality of plastic and this helped to cut down on the waste.”

SN operates a just in time (JIT) system and hence carries very little inventory.

Required:

(a) Calculate the total material price and total material usage variances ignoring any possible planning error in the figures. (4 marks)

(b) Analyse the above total variances into component parts for planning and operational variances in as much detail as the information allows. (8 marks)

(c) Assess the performance of the production manager. (8 marks)

(20 marks)

Question 46 OLIVER

Oliver is the owner and manager of Oliver’s Salon, which is a quality hairdresser that experiences high levels of competition. The salon traditionally provided a range of hair services to female clients only, including cuts, colouring and straightening

A year ago, at the start of his 20X1 financial year, Oliver decided to expand his operations to include the hairdressing needs of male clients. Male hairdressing prices are lower, the work simpler (mainly haircuts only) and so the time taken per male client is much less.

The prices for the female clients were not increased during the whole of 20X0 and 20X1 and the mix of services provided for female clients in the two years was the same.

The latest financial results are as follows: 20X0 20X1 $ $ $ $ Sales 200,000 238,500 Less: Cost of sales: Hairdressing staff costs 65,000 91,000 Hair products – female 29,000 27,000 Hair products – male 8,000 ––––––– 94,000 ––––––– 126,000 –––––––– –––––––– Gross profit 106,000 112,500 Less: Expenses: Rent 10,000 10,000 Administration salaries 9,000 9,500 Electricity 7,000 8,000 Advertising 2,000 5,000 ––––––– 28,000 ––––––– 32,500 –––––––– –––––––– Profit 78,000 80,000 –––––––– ––––––––



Oliver is disappointed with his financial results. He thinks the salon is much busier than a year ago and was expecting more profit. He has noted the following extra information:

(1) Some female clients complained about the change in atmosphere following the introduction of male services, which created tension in the salon.

(2) Two new staff were recruited at the start of 20X1. The first was a junior hairdresser to support the specialist hairdressers for the female clients. She was appointed on a salary of $9,000 per annum. The second new staff member was a specialist hairdresser for the male clients. There were no increases in pay for existing staff at the start of 20X1 after a big rise at the start of 20X0 that was designed to cover two years’ worth of increases.

Oliver introduced some non-financial measures of success two years ago:

20X0 20X1 Number of complaints 12 46 Number of male client visits 0 3,425 Number of female client visits 8,000 6,800 Number of specialist hairdressers for female clients 4 5 Number of specialist hairdressers for male clients 0 1

Required:

(a) Calculate the average price for hair services per male and female client for each of the years 20X0 and 20X1. (3 marks)

(b) Assess the financial performance of the Salon using the data above. (11 marks)

(c) Analyse and comment on the non-financial performance of Oliver’s business, under the headings of quality and resource utilisation. (6 marks)

(20 marks)

Question 47 THATCHER INTERNATIONAL PARK

Thatcher International Park (TIP) is a theme park and has for many years been a successful business, which has traded profitably. About three years ago the directors decided to capitalise on their success and reduced the expenditure made on new thrill rides, reduced routine maintenance where possible (deciding instead to repair equipment when it broke down) and made a commitment to regularly increase admission prices. Once an admission price is paid customers can use any of the facilities and rides for free.

These steps increased profits considerably, enabling good dividends to be paid to the owners and bonuses to the directors. The last two years of financial results are as follows:

2008 2009 $ $ Sales 5,250,000 5,320,000 Less: Expenses: Wages 2,500,000 2,200,000 Maintenance – routine 80,000 70,000 Repairs 260,000 320,000 Directors salaries 150,000 160,000 Directors bonuses 15,000 18,000 Other costs (including depreciation) 1,200,000 1,180,000 ––––––––– ––––––––– Net profit 1,045,000 1,372,000 ––––––––– –––––––––



2008 2009 $ $ Book value of assets at start of year 13,000,000 12,000,000 Dividend paid 500,000 650,000 Number of visitors 150,000 140,000

TIP operates in a country where the average rate of inflation is around 1% per annum.

Required:

(a) Assess the financial performance of TIP using the information given above. (14 marks)

(b) During the early part of 2008 TIP employed a newly qualified management accountant. He quickly became concerned about the potential performance of TIP and to investigate his concerns he started to gather data to measure some non-financial measures of success. The data he has gathered is shown below:

Table 1

2008 2009 Hours lost due to breakdown of rides (Note) 9,000 hours 32,000 hours Average waiting time per ride 20 minutes 30 minutes Note: TIP has 50 rides of different types. It is open 360 days of the year for 10 hours each day.

Required:

Assess the quality of the service that TIP provides to its customers using Table 1 and any other relevant data and indicate the risks it is likely to face if it continues with its current policies. (6 marks)

(20 marks)



Question 48 EATWELL RESTAURANT

The owners of Eatwell Restaurant have diversified business interests and operate in a wide range of commercial areas. Since buying the restaurant in 201V they have carefully recorded the data below:

Recorded Data for Eatwell Restaurant (201W – 201Z)

201W 201X 201Y 201Z Total meals served 3,750 5,100 6,200 6,700 Regular customers attending weekly 5 11 15 26 Number of items on offer per day 4 4 7 9 Reported cases of food poisoning 4 5 7 7 Special theme evenings introduced 0 3 9 13 Annual operating hours with no customers 380 307 187 126 Proposals submitted to cater for special events 10 17 29 38 Contracts won to cater for special events 2 5 15 25 Complimentary letters from satisfied customers 0 4 3 6 Average number of customers at peak times 18 23 37 39 Average service delay at peak times (mins) 32 47 15 35 Maximum seating capacity 25 25 40 40 Weekly opening hours 36 36 40 36 Written complaints received 8 12 14 14 Idle time 570 540 465 187 New meals introduced during the year 16 8 27 11 Financial Data $ $ $ $ Average customer spend on wine 3 4 4 7 Total Revenue 83,000 124,500 137,000 185,000 Revenue from special events 2,000 13,000 25,000 55,000 Profit 11,600 21,400 43,700 57,200 Value of food wasted in preparation 1,700 1,900 3,600 1,450 Total revenue of all restaurants in locality 895,000 1,234,000 980,000 1,056,000

Required:

(a) Assess the overall performance of the business and submit your comments to the owners. They wish to compare the performance of the restaurant with their other business interests and require your comments to be grouped into the key areas of performance such as those described by Fitzgerald and Moon. (14 marks)

(b) Identify any additional information that you would consider of assistance in assessing the performance of Eatwell Restaurant in comparison with another restaurant. Give reasons for your selection and explain how they would relate to the key performance area categories used in (a). (6 marks)

(20 marks)

Question 49 BALANCED SCORECARD

Discuss the advantages that may be claimed for Kaplan and Norton’s balanced scorecard as a basis for performance measurement over traditional management accounting views of performance measurement. Your answer should include specific examples of quantitative measures for each aspect of the balanced scorecard.

(15 marks)



Question 50 BLA CO

BLA Co is a design consultancy that provides advice to clients regarding property maintenance and improvements. Three types of consultant are employed by BLA. These are:

(1) Architectural consultants who provide advice with regard to exterior building improvements.

(2) Interior design consultants who provide advice regarding interior design, and

(3) Landscape consultants who provide advice regarding landscaping of properties and garden design improvements.

BLA does not undertake building work on behalf of its clients and will only recommend contractors that undertake the three types of work when requested to do so by its clients. The following information is relevant:

(i) Each consultation, other than those detailed in notes (iv) and (v), is charged at a rate of $150 per consultation.

(ii) The consultants are each paid a fixed annual salary of $45,000. In addition they receive a bonus of 40% of the fee income generated in excess of budget. The bonus is shared equally among the consultants employed by BLA on 31 October in the year to which the bonus relates.

(iii) Other operating expenses (excluding the salaries of the consultants) were budgeted at $2,550,000 for the year to 31 October 201X. The actual amount incurred in respect of the year to 31 October 201X was $2,805,000, which excludes payments to subcontractors per note (vii) below.

(iv) In an attempt to gain new business, consultants may undertake consultations on a “no-fee” basis. Such consultations are regarded as Business Development Activity by the management of BLA.

(v) Consultants will sometimes undertake remedial consultations with clients who experience problems at the time when work commences on each client’s site. Remedial consultations are also provided on a non-chargeable (i.e. “no fee” basis).

(vi) In November 201Y, BLA purchased “state of the art” business software for use by its consultants in simulating design improvements. The software was used throughout the year by consultants who specialise in landscape and garden design. It is now planned to introduce the use of the software by the other categories of consultant in BLA.

(vii) BLA has a policy of maintaining staff at a level of 45 consultants on an on-going basis, irrespective of fluctuations in the level of demand. Also, BLA has retained links with retired consultants and will occasionally subcontract work to them at a cost of $150 per consultation, if current full-time consultants in a particular category are fully utilised. During the year ended 31 October 201X subcontractors only undertook non-chargeable client consultations.



BLA Co Sundry statistics for year ended 31 October 201X

Budget Actual Number of consultants by category: Exterior design 18 15 Interior design 18 18 Landscape & garden design 9 12 Total client enquiries: New business 67,500 84,000 Repeat business 32,400 28,000 Number of chargeable client consultations: New business 24,300 22,400 Repeat business 16,200 19,600 Mix of chargeable client consultations: Exterior design 16,200 13,830 Interior design 16,200 17,226 Landscape and garden design 8,100 10,944

Number of non-chargeable client consultations undertaken by BLA consultants:

Number of business development consultations 1,035 1,200 Number of remedial consultations 45 405

Number of non-chargeable client consultations undertaken by subcontractors: 120

Other statistics: Number of complaints 324 630

Required:

(a) Fitzgerald and Moon have suggested that business performance should be measured in a number of ways.

Using FIVE different performance indicators and the quantitative data contained above, comment on the performance of BLA Co. (15 marks)

(b) Briefly discuss THREE factors that should be considered in the determination of expected standards in a performance measurement system. (5 marks)

(20 marks)



Question 51 AV

AV is a charitable organisation, the primary objective of which is to meet the accommodation needs of persons in its locality.

BW is a profit-seeking organisation that provides rented accommodation to the public.

Income and Expenditure accounts for the most recent financial year were as follows:

AV BW $ $ Rents received 2,386,852 2,500,000 Less: Staff and management costs 450,000 620,000 Major repairs and planned maintenance 682,400 202,200 Day-to-day repairs 478,320 127,600 Sundry operating costs 305,500 235,000 Net interest payable and other similar charges 526,222 750,000 ––––––––– ––––––––– Total costs 2,442,442 1,934,800 Operating (deficit)/surplus (55,590) 565,200

Operating information in respect of the year was as follows:

(1) Property and rental information:

AV BW Size of Property Number of Rent payable Number of properties per week ($’s) properties 1 bedroom 80 40 40 2 bedrooms 160 45 80 3 bedrooms 500 50 280 4 bedrooms 160 70 nil AV had certain properties that were unoccupied during part of the year. The rents lost as a consequence of unoccupied properties amounted to $36,348. BW did not have any unoccupied properties at any time during the year.

(2) Staff salaries were payable as follows:

AV BW Number of staff Salary ($’s) per Number of staff Salary ($’s) per staff member staff member per annum per annum 2 35,000 3 50,000 2 25,000 2 35,000 3 20,000 20 20,000 18 15,000 – –



(3) Planned maintenance and major repairs undertaken:

AV BW Nature of work Number of Cost per Number of Cost per properties property properties property $ $ Miscellaneous construction work 20 1,250 – – Fitted kitchen replacements (all are the same size) 90 2,610 10 5,220 Heating upgrades/replacements 15 1,500 – – Replacement sets of windows and doors for 3-bedroomed properties 100 4,000 25 6,000 All expenditure on planned maintenance and major repairs may be regarded as revenue expenditure.

(4) Day-to-day repairs information:

AV BW Classification Number of repairs Total cost Number of repairs of repair undertaken undertaken Emergency 960 $134,400 320 Urgent 1,880 $225,600 752 Non-urgent 1,020 $118,320 204 Each repair undertaken by BW costs the same irrespective of the classification of repair.

Required:

(a) Critically evaluate how the management of AV could measure the “value for money” of its service provision during the most recent financial year. (7 marks)

(b) (i) Identify TWO performance measures in relation to EACH of the following dimensions of performance measurement that could be used by the management of AV when comparing its operating performance for the most recent financial year with that of the previous year:

– flexibility: – service quality. (2 marks)

(ii) Calculate and comment on THREE performance measures relating to “cost and efficiency” that could be utilised by the management of AV when comparing its operating performance against that achieved by BW. (6 marks)

(c) Explain why differing objectives make it difficult for the management of AV to compare its operating and financial performance with that of BW, and comment briefly on additional information that would assist in the appraisal of the operating and financial performance of BW for the most recent financial year. (5 marks)

(20 marks)



Question 52 BRIDGEWATER CO

Bridgewater Co provides training courses for many of the mainstream software packages on the market.

The business has many divisions in Waterland, the one country in which it operates. The senior managers of Bridgewater Co have very clear objectives for the divisions and these are communicated to divisional managers on appointment and subsequently in quarterly and annual reviews. These are:

(1) Each quarter, sales should grow and annual sales should exceed budget; (2) Trainer (lecture staff) costs should not exceed $180 per teaching day; (3) Room hire costs should not exceed $90 per teaching day; (4) Each division should meet its budget for profit per quarter and annually.

It is known that managers will be promoted based on their ability to meet these targets. A member of the senior management is to retire after quarter 2 of the current financial year, which has just begun. The divisional managers anticipate that one of them may be promoted at the beginning of quarter 3 if their performance is good enough.

The manager of the Northwest division is concerned that his chances of promotion could be damaged by the expected performance of his division. He is a firm believer in quality and he thinks that if a business gets this right, growth and success will eventually follow.

The current quarterly forecasts, along with the original budgeted profit for the Northwest division, are as follows:

Q1 Q2 Q3 Q4 Total $000 $000 $000 $000 $000 Sales 40.0 36.0 50.0 60.0 186.0 Less: Trainers 8.0 7.2 10.0 12.0 37.2 Room hire 4.0 3.6 5.0 6.0 18.6 Staff training 1.0 1.0 1.0 1.0 4.0 Other costs 3.0 1.7 6.0 7.0 17.7 ––––– ––––– ––––– ––––– ––––– Forecast net profit 24.0 22.5 28.0 34.0 108.5 ––––– ––––– ––––– ––––– ––––– Original budgeted profit 25.0 26.0 27.0 28.0 106.0 Annual sales budget 180.0 ––––– ––––– ––––– ––––– ––––– Teaching days 40 36 50 60

Required:

(a) Assess the financial performance of the Northwest division against its targets and reach a conclusion as to the promotion prospects of the divisional manager. (8 marks)

(b) The manager of the Northwest division has been considering a few steps to improve the performance of his division.

Voucher scheme

As a sales promotion, vouchers will be sold for $125 each, a substantial discount on normal prices. These vouchers will entitle the holder to attend four training sessions on software of their choice. They can attend when they want to but are advised that one training session per quarter is sensible. The manager is confident that if the promotion took place immediately, he could sell 80 vouchers and that the customers would follow the advice given to attend one session per quarter. All voucher holders would attend planned existing courses and all will be new customers.



Software upgrade

A new important software programme has recently been launched for which there could be a market for training courses. Demonstration programs can be bought for $1,800 in quarter 1. Staff training would be needed, costing $500 in each of quarters 1 and 2 but in quarters 3 and 4 extra courses could be offered selling this training. Assuming similar class sizes and the usual sales prices, extra sales revenue amounting to 20% of normal sales are expected (measured before the voucher promotion above). The manager is keen to run these courses at the same tutorial and room standards as he normally provides. Software expenditure is written off in the income statement as incurred.

Delaying payments to trainers

The manager is considering delaying payment to the trainers. He thinks that, since his commitment to quality could cause him to miss out on a well-deserved promotion, the trainers owe him a favour. He intends to delay payment on 50% of all invoices received from the trainers in the first two quarters, paying them one month later than is usual.

Required:

(i) Revise the forecasts to take account of all three of the proposed changes. (7 marks)

(ii) Comment on each of the proposed steps and reach a conclusion as to whether, if all the proposals were taken together, the manager will improve his chances of promotion. (6 marks)

(iii) Suggest two improvements to the performance measurement system used by Bridgewater Co that would encourage a longer-term view being taken by its managers. (4 marks)

(25 marks)

Question 53 OSBORNE CO

Osborne Co is a subsidiary of Butler Co, which operates a decentralised system of management.

Group companies have control over their own working capital and make proposals to the main board for capital expenditure projects. They are appraised by reference to two measures:

(1) Return on investment, where a minimum return of 12% is expected; (2) Residual income, which must be positive.

Extracts from the accounts of Osborne for the most recent financial year yield the following information:

Statement of financial position $000 Non-current assets Land and buildings 2,000 Plant and machinery 1,200 Fixtures and fittings 300 Current assets Inventory 800 Receivables 500 Cash 100 Current liabilities Trade payables 400 Other payables 200 Long-term loan 1,000



Income statement $000 Revenue 8,500 Cost of sales 5,300 Controllable overheads 1,700 Non-controllable overheads 950 Head office recharge 700

A project, involving an investment of $840,000 financed by an increase in the company’s loan, is under discussion by the board of Osborne.

The project is expected to last three years, at the end of which there will be no scrap proceeds. Net cash flows are expected as follows:

Year Flow 1 300,000 2 600,000 3 700,000

The finance director, Mr Rhodes, says, “We must go for this project. It has a positive net present value and enhances both ROI and RI of the company”.

The managing director of Osborne, Mr Iommi, whose bonus is linked to the division achieving its targets and is due to retire at the end of year 1, is not so sure.

Required:

(a) Establish whether the company will achieve its two performance targets for the most recent financial year. (4 marks)

(b) Assuming that (with the exception of changes resulting from acceptance of the proposed project) the profitability and assets employed by Osborne Co will be constant for the foreseeable future, show why Mr Iommi might be reluctant about accepting the project. (6 marks)

(10 marks)

Question 54 RESPONSIBILITY CENTRES

(a) Identify the types of responsibility centres used in responsibility accounting and discuss how the performance of each responsibility centre type might be measured, including in your discussion examples of controllable and non-controllable factors. (12 marks)

(b) Critically discuss whether return on investment or residual income should be used to assess managerial performance in an investment centre. (13 marks)

(25 marks)



Question 55 PACE CO

Pace Co (PC) runs a large number of wholesale stores and is increasing the number of these stores all the time. It measures the performance of each store on the basis of a target return on investment (ROI) of 15%. Store managers get a bonus of 10% of their salary if their store’s annual ROI exceeds the target each year. Once a store is built there is very little further capital expenditure until a full four years have passed.

PC has a store (store W) in the west of the country. Store W has historic financial data as follows over the past four years:

20X8 20X9 20Y0 20Y1 Sales ($000) 200 200 180 170 Gross profit ($000) 80 70 63 51 Net profit ($000) 13 14 10 8 Net assets at start of year ($000) 100 80 60 40

The market in which PC operates has been growing steadily. Typically, PC’s stores generate a 40% gross profit margin.

Required:

(a) Discuss the past financial performance of store W using ROI and any other measure you feel appropriate and, using your findings, discuss whether the ROI correctly reflects Store W’s actual performance. (8 marks)

(b) Explain how a manager in store W might have been able to manipulate the results so as to gain bonuses more frequently. (4 marks)

(c) PC has another store (store S) about to open in the south of the country. It has asked you for help in calculating the gross profit, net profit and ROI it can expect over each of the next four years. The following information is provided:

Sales in the first year will be 18,000 units. Sales volume will grow at the rate of 10% for years two and three but no further growth is expected in year 4. Sales price will start at $12 per unit for the first two years but then reduce by 5% per annum for each of the next two years.

Gross profit will start at 40% but will reduce as the sales price reduces. All purchase prices on goods for resale will remain constant for the four years.

Overheads, including depreciation, will be $70,000 for the first two years rising to $80,000 in years three and four.

Store S requires an investment of $100,000 at the start of its first year of trading.

PC depreciates non-current assets at the rate of 25% of cost. No residual value is expected on these assets.

Required:

(i) Calculate (in columnar form) the revenue, gross profit, net profit and ROI of store S over each of its first four years. (9 marks)

(ii) Calculate the minimum sales volume required in year 4 (assuming all other variables remain unchanged) to earn the manager of S a bonus in that year. (4 marks)

(25 marks)



Question 56 BUSINESS SOLUTIONS

Business Solutions is a firm of management consultants, which experienced considerable business growth during the last decade. Recently the firm’s senior managers had begun to experience difficulties in managing the business, so at the end of last year the firm was reorganised and a regional divisional structure was introduced with individual profit targets being set for each of the semi-autonomous profit centres. Although North division has its own customer base that is distinct from that of its sister division South, it does occasionally call upon the services of a South consultant to assist with its projects. North has to pay a cross charge to South per consulting day. HQ determines the amount of the charge. North is free to choose whether it employs a South consultant or subcontracts the project to an external consultant. The manager of North division believes that the quality of the external consultant and the one from South division are identical and on this basis will always employ the one who is prepared to work for the lower fee.

The following information is also available:

North division is very busy and it charges its clients $1,200 per consulting day; North division pays its external consultant $500 per consulting day; The variable cost per internal consulting day is $100.

Required:

(a) Determine a possible optimal daily cross charge that should be paid by North for the services of a consultant from South in the scenarios outlined below. The charges that you select must induce both divisional managers to arrive at the same decision independently. Explain how you have determined your cross charges and state any assumptions that you think necessary.

(i) South division has spare consulting capacity; (ii) South division is fully occupied earning fees of $400 per consulting day; (iii) South division is fully occupied earning fees of $700 per consulting day.

(10 marks)

(b) Identify the possible factors that may have prompted the senior management to introduce a divisional structure last year and suggest some potential problems that may arise. (10 marks)

(20 marks)



Question 57 MANUCO CO

Manuco Co has been offered supplies of special ingredient Z at a transfer price of $15 per kg by Helpco Co, which is part of the same group of companies. Helpco processes and sells special ingredient Z to customers external to the group at $15 per kg. Helpco bases its transfer price on total cost plus 25% profit mark-up. Total cost has been estimated as 75% variable and 25% fixed.

Required:

Discuss the transfer prices at which Helpco Co should offer to transfer special ingredient Z to Manuco Co in order that group profit maximising decisions may be taken on financial grounds in each of the following situations:

(i) Helpco Co has an external market for all of its production of special ingredient Z at a selling price of $15 per kg. Internal transfers to Manuco Co would enable $1.50 per kg of variable packing cost to be avoided.

(ii) Conditions are as per (i) but Helpco Co has production capacity for 3,000 kgs of special ingredient Z for which no external market is available.

(iii) Conditions are as per (ii) but Helpco Co has an alternative use for some of its spare production capacity. This alternative use is equivalent to 2,000 kgs of special ingredient Z and would earn a contribution of $6,000.

(13 marks)



Answer 1 JOLA PUBLISHING CO

(a) Changes in overhead allocations

The first thing to point out is that the overhead allocations to the two products have not changed by that much. For example the CB has absorbed only $0.05 more overhead. The reason for such a small change is that the overheads are dominated by property costs (75% of total overhead) and the “driver” for these remains machine hours once the switch to ABC is made. Thus no difference will result from the switch to ABC in this regard.

The major effect on the cost will be for quality control. It is a major overhead (23% of total) and there is a big difference between the relative number of machine hours for each product and the number of inspections made (the ABC driver). The CB takes less time to produce than the TJ, due to the shortness of the book. It will therefore carry a smaller amount of overhead in this regard. However, given the high degree of government regulation, the CB is subject to “frequent” inspections whereas the TJ is inspected only rarely. This will mean that under ABC the CB will carry a high proportion of the quality control cost and hence change the relative cost allocations.

The production set up costs are only a small proportion of total cost and would be, therefore, unlikely to cause much of a difference in the cost allocations between the two products. However this hides the very big difference in treatment. The CB is produced in four long production runs, whereas the TJ is produced monthly in 12 production runs. The relative proportions of overhead allocated under the two overhead treatments will be very different. In this case the TJ would carry much more overhead under ABC than under a machine hours basis of overhead absorption.

(b) ABC implementation problems

There are many problems with ABC, which, despite its academic superiority, cause issues on its introduction.

Lack of understanding. ABC is not fully understood by many managers and therefore is not fully accepted as a means of cost control.

Difficulty in identifying cost drivers. In a practical context, there are frequently difficulties in identifying the appropriate drivers. For example, property costs are often significant and yet a single driver is difficult to find.

Lack of appropriate accounting records. ABC needs a new set of accounting records, this is often not immediately available and therefore resistance to change is common. The setting up of new cost pools is time consuming.

(c) Cost per unit

(i) Machine hours for overhead absorption

CB TJ $ $ Paper (400g at $2/kg) 0.80 (100g at $1/kg) 0.10 Printing (50ml at $30/litre) 1.50 (150ml at $30/litre) 4.50 Machine cost (6 mins at $12/hr) 1.20 (10 mins at $12/hr) 2.00 Overheads (6 mins at $24/hr) (W) 2.40 (10 mins at $24/hr) 4.00 ––––– ––––– Total cost 5.90 10.60 Sales price 9.30 14.00 ––––– ––––– Margin 3.40 3.40 ––––– –––––



WORKING

Overheads cost per hour

Total overhead $2,880,000 Total machine hours (1,000,000 × 6 mins) + (120,000 × 10 mins) = 7,200,000 mins Which is 120,000 hours

Cost per hour = hrs 120,000

$2,880,000 = $24/hr

(ii) ABC principles CB TJ $ $ Paper (400g at $2/kg) 0.80 (100g at $1/kg) 0.10 Printing (50ml at $30/litre) 1.50 (150ml at $30/litre) 4.50 Machine cost (6 mins at $12/hr) 1.20 (10 mins at $12/hr) 2.00 Overheads (W) 2.41 (W) 3.88 ––––– ––––– Total cost 5.91 10.48 Sales price 9.30 14.00 ––––– ––––– Margin 3.39 3.52 ––––– ––––– WORKING

ABC overheads cost per unit

Total CB TJ No of Cost/ CB TJ drivers driver $ $ $ Property costs 2,160,000 1,800,000 360,000 120,000 18/hr 1.80 3.00 Quality control 668,000 601,200 66,800 200 3,340 0.6012 0.56 Production set up 52,000 13,000 39,000 16 3,250 0.013 0.325 ––––––––– ––––––––– ––––––– ––––– ––––– Total 2,880,000 2,414,200 465,800 Cost per unit 2.41 3.88 Production level 1,000,000 120,000 ––––– ––––– Cost per unit 2.41 3.88 The above overheads have been split on the basis of the following activity levels

Driver CB TJ Property costs Machine hours 100,000 20,000 Quality control Inspections 180 20 Production set up Set ups 4 12 A cost per driver approach is also acceptable.



Answer 2 ABKABER CO

(a) Total profit

(i) Labour hours

Total overhead cost = $12,000,000 Total labour hours = 500,000 hours Overhead per labour hour = $12,000,000/500,000 = $24

Sunshine Roadster Fireball Total $ $ $ $ Direct labour ($5 per hour) 1,000,000 1,100,000 400,000 Materials (at $400/600/900) 800,000 960,000 360,000 Overheads (at $24) 4,800,000 5,280,000 1,920,000 ––––––––– ––––––––– ––––––––– Total Costs 6,600,000 7,340,000 2,680,000 ––––––––– ––––––––– ––––––––– Output (Units) 2,000 1,600 400 Cost per unit $3,300 $4,587.5 $6,700 Selling price $4,000 $6,000 $8,000 –––––––– –––––––– ––––––– Profit/(loss) per unit $700 $1,412.5 $1,300 –––––––– –––––––– ––––––– Total profit/(loss) $1,400,000 $2,260,000 $520,000 $4,180,000 –––––––– (ii) Activity-based costing

Deliveries to retailers $2,400,000/250 = $9,600 Set-ups $6,000,000/100 = $60,000 Deliveries inwards $3,600,000/800 = $4,500

Sunshine Roadster Fireball Total $ $ $ Direct labour ($5 per hour) 1,000,000 1,100,000 400,000 Materials (at $400/600/900) 800,000 960,000 360,000 Overheads: Deliveries at $9,600 960,000 768,000 672,000 Set-ups at $60,000 2,100,000 2,400,000 1,500,000 Purchase orders at $4,500 1,800,000 1,350,000 450,000 ––––––––– ––––––––– ––––––––– 6,660,000 6,578,000 3,382,000 ––––––––– ––––––––– ––––––––– Output (Units) 2,000 1,600 400 Cost per unit $3,330 $4,111.25 $8,455 Selling price $4,000 $6,000 $8,000 ––––––––– ––––––––– ––––––––– Profit/(loss) per unit $670 $1,888.75 ($455) ––––––––– ––––––––– ––––––––– Total profit/(loss) $1,340,000 $3,022,000 ($182,000) $4,180,000 –––––––––



(b) REPORT – ABKABER CO

To: Directors of Abkaber Co From: Management Accountant Subject: The Introduction of Activity Based Costing Date: June 201X

(i) Evaluation of labour hours and activity-based costing methods

Direct costs

The direct costs of labour and materials are unaffected by the use of ABC as they are directly attributable to units of output.

Notwithstanding the fact that labour is a relatively minor cost, however, the use of labour hours to allocate overheads magnifies its importance.

The labour hours allocation basis

As labour appears to be paid at a constant rate an allocation using labour cost or labour hours gives the same result.

The central concern is, however, whether there is a cause and effect relationship between overheads and labour hours. Moreover for this allocation base to be correct overheads would need to be linearly variable with labour hours. This seems unlikely on the basis of the information available.

ABC and labour hours cost allocation

ABC attempts to allocate overheads using a number of cost drivers rather than just one as with labour hours. It thus attempts to identify a series of cause and effect relationships. Moreover, those in favour of ABC argue that it is activities that generate costs, not labour hours.

While costs are likely to be caused by multiple factors, the accuracy of any ABC system will depend on both the number of factors selected and the appropriateness of each of these activities as a driver for costs. Each cost driver should be appropriate to the pool of overheads to which it relates. As noted already there should ideally be a direct cause and effect relationship between the cost driver and the relevant overhead cost pool, but this should also be a linear relationship (i.e. costs increase proportionately with the number of activities operated).

The contrast between the labour hours costing system and ABC can be seen in requirement (a). These differences can be brought out by reviewing the comments of the directors.

(ii) Implications of activity-based costing and evaluation of director issues

The Finance Director

Using the labour hours method of allocation the Fireball makes an overall profit of $520,000 but using ABC it makes a loss of $182,000. There is thus a significant difference in the levels of cost allocated and in profitability between the two methods to the extent it affects the conclusions on the Fireball’s viability.



The major reason for the difference appears to be that while labour hours are not all that significant for Fireball production, the low volumes of Fireball sales cause a relatively high amount of set-ups, deliveries and purchase processes, and this is recognised by ABC.

If the Fireball model is to continue, a review of the assembly and distribution systems may be needed in order to reduce costs.

There may, however, be other non-financial reasons to maintain the Fireball, (e.g. maintaining a wide product range and raising the reputation of the motorcycles, which may increase sales of other models).

The Marketing Director

The marketing director suggests that ABC may have a number of problems and its conclusions should not be believed unquestioningly. These problems include:

For decisions such as the closure of Fireball production or the pricing of the new motorbike rental contract, what is really needed is the incremental cost to determine a break-even position. While ABC may be closer to this concept than a labour hours allocation basis, its accuracy depends on identifying appropriate cost drivers.

The use of ABC for one-off decisions can be distinguished from its use in normal, on-going costing procedures. It is perfectly possible that while labour hours may have been used for normal costing, an incremental costing analysis would be undertaken for important one-off decisions such as the closure of Fireball production or the pricing of the new motorbike rental contract. In these circumstances the introduction of ABC in normal costing procedures may have restricted benefits.

There may be interdependencies between both costs and revenues that ABC is unlikely to capture. Where costs are truly common to more than one product then this may be difficult to capture by any given single activity.

As with labour hours allocations it is the future that matters. Any relationship between costs and activities based on historic experience and observation may be unreliable as a guide to the future.

The Managing Director

ABC normally assumes that the cost per activity is constant as the number of times the activity is repeated increases. In practice there may be a learning curve, such that costs per activity are non-linear. As a result, the marginal cost of increasing the number of activities is not the same as the average.

Also, in this case, fixed costs are included which would also mean that the marginal cost does not equal the average cost.

The MD is correct in stating that some costs do not vary with either labour hours or any cost driver, and thus do not fall easily under ABC as a method of cost attribution as there is no cause and effect relationship. Depreciation on the factory building might be one example.



The Chairman

From a narrow perspective of reporting profit it is true that the two methods give the same overall profit as is illustrated in requirement (a) at $4,180,000. There are, however, a number of qualifications to this statement:

If the company carried inventory then the method of cost allocation would, in the short term at least, affect inventory values and thus would influence profit.

If the ABC information can be relied upon, notwithstanding the above qualifications, then a decision could be taken to cease Fireball production as it generates a negative contribution of $182,000. This was not apparent from the use of labour hours; thus by the introduction of ABC and the subsequent closure decision profits would, all other things being equal, improve by $182,000.

Further Issues

The following should also be considered in evaluating ABC:

The need to develop new data capture systems, and the relevant costs of doing so; Increased and on-going analysis work; Continued evaluation of cause and effect relationships between cost drivers and cost

pools.

Answer 3 ADMER

(a) Use of information in activity-based costing (ABC) analysis

ABC is based on identifying the activities that give rise to costs and this identification does not seem to have happened in this case. Simply collecting information on different activities is not enough. A detailed analysis of business operations is needed in order to identify relationships between costs and cost drivers. There should ideally be a one-to-one relationship between cost and cost driver. To the extent that this is not so, ABC provides less useful information on product cost and for cost control.

The management accountant believes that he can use the information provided to review the store’s performance from an ABC perspective, but the relationship between “other costs” for the three-month period and the proposed cost drivers (number of items sold, purchase orders, etc.) is unclear.

If sales staff, warehouse staff, consultation staff and administration staff are on fixed salaries, their wage costs will not be linked to items sold, purchase orders or consultations. If wage costs are apportioned on to product cost using the proposed cost drivers, it is likely that better product cost information will arise, simply because the apportionment bases being used are likely to be more appropriate to retailing than floor area. But at what point does a more sophisticated absorption costing system become an ABC system?

The information provided can be used in an ABC analysis if wage costs do depend to some extent on the proposed cost drivers, for example if sales staff wages include a commission for each purchase order raised. The management accountant needs to eliminate confusion by undertaking an investigation to establish and clarify the links between costs and activities if he wishes to use ABC.



(b) Proposed cost drivers

Total number of items sold = 1,000 + 1,500 + 4,000 = 6,500 Total number of purchase orders = 1,000 + 900 + 2,500 = 4,400 Total floor area = 16,000 + 10,000 + 14,000 = 40,000 Total number of consultations = 798 + 200 + 250 = 1,248 Are sales staff wages linked to items sold or to purchase orders? If sales staff wages are linked to items sold:

Sales staff wages recovery rate = $64,800/6,500 = $9.97 per item sold If sales staff wages are linked to purchase orders: Sales staff wages recovery rate = $64,800/4,400 = $14.727 per purchase order It seems reasonable to link consultation staff wages to the number of consultations: Consultation staff wages recovery rate = $24,960/1,248 = $20.00 per consultation Warehouse staff wages could be linked to either purchase orders fulfilled or to items sold: if each item needs to be handled, items sold might be preferred; Warehouse staff wages recovery rate = $30,240/6,500 = $4.652 per item sold If warehouse staff wages are linked to purchase orders fulfilled: Warehouse staff wages recovery rate = $30,240/4,400 = $6.873 per purchase order Administration staff process purchase orders and organize consultations, but no indication is given as to whether these tasks are equally weighted. If they are, the total number of tasks = 4,400 + 1,248 = 5,648 and: Administration staff wages recovery rate = $30,624/5,648 = $5.422 per task

General overheads appear to be related to floor space, but there will be other overheads that are not space costs; these will need to be apportioned on a different basis, or even not apportioned at all. Using the information provided: General overheads absorption rate = $175,000/40,000 = $4.375 per square metre Possible ABC profit statement:

Department Kitchens Bathrooms Dining Rooms Total $ $ $ $ Sales 210,000 112,500 440,000 762,500 Cost of goods sold (63,000) (37,500) (176,000) (276,500) ––––––– ––––––– ––––––– ––––––– Variable contribution 147,000 75,000 264,000 486,000 Sales staff wages (14,727) (13,255) (36,818) (64,800) Consultation staff wages (15,960) (4,000) (5,000) (24,960) Warehouse staff wages (4,652) (6,978) (18,610) (30,240) Admin staff wages (9,749) (5,964) (14,911) (30,624) General overheads (70,000) (43,750) (61,250) (175,000) ––––––– ––––––– ––––––– ––––––– Profit 31,912 1,053 127,411 160,376 ––––––– ––––––– ––––––– ––––––– Tutorial note: Sales staff wages are apportioned using purchase orders, warehouse staff wages are apportioned using items sold, other choices are possible.



(c) Evaluation of proposal to close the bathrooms department

From the perspective of the absorption costing system currently used by the company, the bathrooms department does appear to make a loss.

When viewed from an ABC perspective, however, it may make a small profit. The department makes a contribution towards other costs and overheads of $75,000 and a profit before general overheads of $44,803. Therefore financial grounds for closure do not appear to be compelling, although there may be a need to investigate the department with a view to improving profitability.

A more detailed profitability analysis of bathroom sales might lead to greater understanding of which products were relatively profitable, which products were slow-moving and which products might be removed from sale without adversely affecting sales of other lines. Less drastic alternatives than closure might be suggested by such an analysis.

If the department were closed, it could be argued that general overheads would still need to be met and so overall profit would fall by about $45,000 in each three-month period. Overall profit could fall by more than this if some of the other costs allocated to the bathroom department remained after the closure. For example, the number of staff laid off would not correspond exactly to allocated wage costs.

However, it is unlikely the space vacated by the bathrooms department would remain unused. The remaining departments might be expanded to fill it, or it might be used for a new venture (selling carpets, for example). The key question is whether a better use exists for the space. If an alternative use is found, staff redundancies might be reduced or eliminated entirely.

A further problem is that closure of the bathrooms department could affect sales of the other departments. The store might be seen as no longer offering an adequate range of products and potential customers might prefer other stores with a greater range of home furnishings. The potential for satisfied customers to return with further business would also be reduced if the store offered a more limited range of products.

It is also unlikely that the closure decision would be made at the level of an individual store, since it carries consequences for the company as a whole. The image of the company might suffer if it were seen to be changing its product range, or if it were seen as being unable to compete with other stores selling bathrooms.

(d) Advantages and disadvantages of ABC

ABC could help Admer understand more clearly the origin of its costs. The nature of Admer’s business means that only a small number of cost drivers are likely to exist, but even given the limited information provided, the revised profit statement is likely to be more useful than treating all overhead costs as being related to floor area.

ABC can help Admer to control costs by highlighting the activities that generate them. For example, consultation staff wages are high compared to sales staff wages in the kitchen department in this store. Perhaps sales staff could be trained to provide in-store consultations and the number of home visits reduced; this could lower administration costs and reduce the cost of consultations.

It is clear that general overheads are the most significant cost other than cost of sales and existing information does not suggest ways of reducing these. However, a more detailed analysis of overheads might reveal activity-based costs that are currently aggregated. Once disaggregated, they become more amenable to understanding and control.



It is argued that ABC leads to more accurate product costs, and in order to achieve this Admer needs a more detailed analysis of sales revenue and cost based on the nature of the products sold. For example, the company might be able to classify kitchens as basic, intermediate and deluxe, and collect sales and cost data accordingly.

A key advantage claimed for ABC is that it can provide better information to aid decision-making. In this case, it could provide more appropriate information to aid managers in reaching a decision on whether to close the bathrooms department. With better or more detailed information on product cost, managers are likely to make better decisions in key areas such as product pricing and cost control.

Even after introducing ABC, however, Admer will still face the problem that some arbitrary apportionment of costs may still be required when pooling costs. The general overheads of light, heat and rates, for example, are likely to need to be treated in this way, along with the wages of administration staff. A related problem is that not all costs are generated by activities that can be measured in quantitative terms.

The management accountant of Admer should also be aware that the costs of introducing and maintaining an ABC system may exceed the benefits that such a costing system might generate. Appropriate cost drivers will need to be determined and the required information may not be available. The existing management accounting information system may therefore need to be modified to generate the required information, and perhaps new accounting software purchased or developed.

Answer 4 SPRING CO

(a) Features, advantages and disadvantages of ABC

ABC is based on the insight that activities create costs, while products consume activities. It is claimed that ABC attaches overheads to product cost in a more meaningful way than traditional absorption costing.

A key feature of ABC is that overhead costs are collected in cost pools, which correspond to a particular activity or group of activities that generate costs. A classic example of a cost pool is set-up costs for a production line. The cost of each set-up is included in the cost pool reflecting the recognition that it is set-ups that incur costs, rather than the volume of production on the production line. Set-up costs are an example of an indirect cost, and both traditional absorption costing and ABC are concerned with the allocation of indirect costs onto product cost. Traditional absorption costing assigns indirect costs or overheads to production departments and service departments and then reallocates service department overheads to production centres. ABC is likely to use, or has the potential to use, considerably more cost pools than traditional absorption costing uses production centres.

In ABC the link between cost pools and product cost is called a cost driver. A cost driver represents the extent to which a particular activity has been used by a particular product in its production. Continuing our example, an appropriate cost driver would be number of set-ups. A product that is produced in frequent short production runs would therefore incur a greater share of set-up costs than a product produced in a single production run. In traditional absorption costing, overheads are linked to product cost through overhead absorption rates such as cost per machine hour or cost per labour hour. ABC is likely to use considerably more cost drivers than traditional absorption costing uses overhead absorption rates.



The key steps in introducing an ABC system are as follows:

(1) Identify the main activities that generate costs through activity analysis; (2) Assign costs to cost pools; (3) Select appropriate cost drivers for assigning cost pool costs to products; (4) Calculate activity-based charge rates to assign the cost of activities to products.

The following benefits have been claimed for ABC:

Product costs are more accurate due to the more sophisticated analysis and assignment of overhead costs. Overhead costs are assigned on a cause-and-effect basis rather than on an ad hoc or subjective basis.

Cost behaviour is better understood due to the analysis of activities.

Cost control is facilitated through the identification and management of cost-generating activities. For example, in order to reduce set-up costs, production planning could be used to eliminate short production runs and hence reduce the number of set-ups.

Poor decisions due to inadequate cost information are less likely to occur.

As for disadvantages, identifying the main activities that generate costs in an organisation is expensive. Careful thought must also be given to the ability of existing management accounting information systems to provide the detailed activity and cost information required by an ABC system: upgrading or replacement may be needed. A further expense is the cost of training staff to use the new costing system. Once introduced, an ABC system can be significantly more expensive than a traditional absorption costing system. It is possible, therefore, that in some organisations the cost of introducing and maintaining an ABC system may exceed the benefits gained.

ABC may be most appropriate in an organisation where indirect costs are a significant proportion of total cost, or where a wide product range is maintained with a variety of different activity consumption patterns. Spring should consider the significance of indirect costs to its product costs and undertake a cost-benefit analysis before making a decision to implement an ABC system. Spring should also consider that further developments could flow from the introduction of an ABC system, for example in budgeting (activity-based budgeting) and management philosophy (activity-based management).

(b) Measurement of managerial and organisational performance

Managerial performance and organisational performance are inextricably linked, since managers are the key decision makers in an organisation and their decisions therefore determine organisational performance.

Managerial and organisational performance needs to be measured as part of the control process in an organisation. The three elements of the control process are recording or measuring actual performance or output, comparing performance with planned performance or some benchmark, and taking action to correct or modify continuing performance in order to achieve planned performance. Managerial and organisational performance can be measured in a wide variety of ways, depending on which aspect of performance, financial or non-financial, is the object of interest.



A wide variety of financial (or money) performance measures can be used to assess managerial and organisational performance. Financial performance is of interest to internal and external stakeholders who are concerned to monitor the progress and risk of their investment, the security of their employment, and so on. Examples of financial performance measures include:

Profit

Profit before interest and tax or profit after tax are usually expected to increase on an annual basis and the financial media often refer to profit when discussing managerial and organisational performance. Managers are expected to deliver increasing profits and organisations are expected to produce profit increases equal to or greater than their competitors.

Earnings per share

Earnings per share are a profit measure of interest to shareholders and the financial market, since it represents the maximum dividend per share that a company could pay. Managerial rewards could be linked in part to meeting performance targets based on earnings per share.

Cash flow

Because profit may be affected by arbitrary adjustments linked to accounting policies and because profit does not measure directly the ability to generate returns for investors, many shareholders and providers of debt finance prefer to concentrate on changes in cash flow as a means of assessing managerial and organisational performance.

Costs

A focus on managerial and organisational performance in terms of cost control or cost reduction may be especially appropriate for organisations in the public sector. Here, profitability is an inappropriate performance measure and a key objective is value for money, in terms of the drive for economy, efficiency and effectiveness.

Share price

Since one of the ways in which shareholders receive a return from their investment in a company is through capital growth, they will be interested in assessing managerial and organisational performance in terms of share price growth. If managers invest in projects with a positive net present value then, theoretically, the share price should increase to reflect the rise in corporate net present value. Conversely, organisations in which managers are believed to be poor performers will experience a share price decrease.

Measuring financial performance alone is not sufficient, since financial performance results from a range of organisational activities that must also therefore be monitored. Non-financial performance measures may be quantitative or qualitative.

An example of a quantitative performance measure is the number of complaints received from customers. An example of a qualitative performance measure is feedback from a sales representative to the effect that most customers are very happy with the after-sales service provided by the organisation.

An attempt is usually made to replace qualitative performance measures with a substitute measure that can be quantified. For example, the number of customer complaints can be used as a substitute measure of product quality or customer satisfaction. Similarly, the number of warranty claims can be used as a substitute measure of product reliability.



Modern organisations compete in terms of product quality, flexibility and reliability, customer satisfaction, and product dimensions such as after-sales care and customer loyalty. These features are captured by non-financial indicators such as number of customer complaints, number of warranty claims, and quality ratings (such as the star ratings of hotels or restaurants, or the position of an organisation in a league table).

A more balanced assessment of organisational and managerial performance will consider both financial and non-financial performance. For example, Kaplan and Norton’s Balanced Scorecard considers the customer perspective, the innovation perspective, the internal process perspective and the financial perspective, and requires the identification of quantitative and non-quantitative goals and performance measures.

Answer 5 EDWARD CO

(a) Target costing process

Target costing begins by specifying a product an organisation wishes to sell. This will involve extensive customer analysis, considering which features customers value and which they do not. Ideally only those features valued by customers will be included in the product design.

The price at which the product can be sold at is then considered. This will take in to account the competitor products and the market conditions expected at the time that the product will be launched. Hence a heavy emphasis is placed on external analysis before any consideration is made of the internal cost of the product.

From the above price a desired margin is deducted. This can be a gross or a net margin. This leaves the cost target. An organisation will need to meet this target if their desired margin is to be met.

Costs for the product are then calculated and compared to the cost target mentioned above.

If it appears that this cost cannot be achieved then the difference (shortfall) is called a cost gap. This gap would have to be closed, by some form of cost reduction, if the desired margin is to be achieved.

(b) Benefits of adopting target costing

The organisation will have an early external focus to its product development. Businesses have to compete with others (competitors) and an early consideration of this will tend to make them more successful. Traditional approaches (by calculating the cost and then adding a margin to get a selling price) are often far too internally driven.

Only those features that are of value to customers will be included in the product design. Target costing at an early stage considers carefully the product that is intended. Features that are unlikely to be valued by the customer will be excluded. This is often insufficiently considered in cost plus methodologies.

Cost control will begin much earlier in the process. If it is clear at the design stage that a cost gap exists then more can be done to close it by the design team. Traditionally, cost control takes place at the “cost incurring” stage, which is often far too late to make a significant impact on a product that is too expensive to make.



Costs per unit are often lower under a target-costing environment. This enhances profitability. Target costing has been shown to reduce product cost by between 20% and 40% depending on product and market conditions. In traditional cost plus systems an organisation may not be fully aware of the constraints in the external environment until after the production has started. Cost reduction at this point is much more difficult as many of the costs are “designed in” to the product.

It is often argued that target costing reduces the time taken to get a product to market. Under traditional methodologies there are often lengthy delays whilst a team goes “back to the drawing board”. Target costing, because it has an early external focus, tends to help get things right first time and this reduces the time to market.

(c) Steps to reduce a cost gap

Review radio features

Remove features from the radio that add to cost but do not significantly add value to the product when viewed by the customer. This should reduce cost but not the achievable selling price. This can be referred to as value engineering or value analysis.

Team approach

Cost reduction works best when a team approach is adopted. Edward should bring together members of the marketing, design, assembly and distribution teams to allow discussion of methods to reduce costs. Open discussion and brainstorming are useful approaches here.

Review the whole supplier chain

Each step in the supply chain should be reviewed, possibly with the aid of staff questionnaires, to identify areas of likely cost savings. The team can then focus on areas that are identified by staff as being likely cost saving areas. For example, the questionnaire might ask, “Are there more than five potential suppliers for this component?” Clearly a “yes” response to this question will mean that there is the potential for tendering or price competition.

Components

Edward should look at the significant costs involved in components. New suppliers could be sought or different materials could be used. Care would be needed not to damage the perceived value of the product. Efficiency improvements should also be possible by reducing waste or idle time that might exist. Avoid, where possible, non-standard parts in the design.

Assembly workers

Productivity gains may be possible by changing working practices or by de-skilling the process. Automation is increasingly common in assembly and manufacturing and Edward should investigate what is possible here to reduce the costs. The learning curve may ultimately help to close the cost gap by reducing labour costs per unit.

Clearly reducing the percentage of idle time will reduce product costs. Better management, smoother workflow and staff incentives could all help here. Focusing on continuous improvement in production processes may help.



Overheads

Productivity increases would also help here by spreading fixed overheads over a greater number of units. Equally Edward should consider an ABC approach to its overhead allocation; this may reveal more favourable cost allocations for the digital radio or ideas for reducing costs in the business.

(d) Cost per unit and cost gap calculation

$ per unit

Component 1:

+

units 000,4400,2$10.4 4.70

Component 2:

××

981005.0

10025 0.128

Material – other 8.10

Assembly labour:

××

90100/hr60.12$

6030 7.00

Variable production overhead:

× /hr20$

6030 10.00

Fixed production overhead:

× /hr12$

6030 6.00

–––––– Total cost 35.928 Desired cost: ($44 × 0.8) 35.20 –––––– Cost gap 0.728 –––––– WORKINGS

(1) Production overhead cost

Using a high low method Extra overhead cost between month 1 and 2 $80,000 Extra assembly hours 4,000 Variable cost per hour $20/hr Monthly fixed production overhead $700,000 – (23,000 × $20/hr) $240,000 Annual fixed production overhead ($240,000 × 12) $2,880,000

FPO absorption rate hrs 240,000

$2,880,000 = $12/hr



Answer 6 YAM CO

(a) The bottleneck process

The total processing hours of the factory is given but can be proven as follows: 18 hours × 5 days × 50 weeks × 50 production lines = 225,000 hours.

Given this, the production capacity for pressing must be 225,000 hours/0.5 hours per metre = 450,000 metres. Using this method the production capacity for all processes is as follows:

Product A Product B Product C Pressing 450,000 450,000 562,500 Stretching 900,000 562,500 900,000 Rolling 562,500 900,000 900,000 The bottleneck is clearly the pressing process, which has a lower capacity for each product. The other processes will probably be slowed to ensure smooth processing.

Clearly an alternative approach is simply to look at the original table for processing speed and pick out the slowest process. This is pressing. (Full marks available for that explained observation.)

(b) TPAR for each product

Product A Product B Product C Selling price 70.0 60.0 27.0 Raw materials 3.0 2.5 1.8 Throughput 67.0 57.5 25.2 Throughput per bottleneck hour* 134.0 115.0 63.0 Fixed costs per hour (W1) 90.0 90.0 90.0 TPAR 1.49 1.28 0.7 Working* 67/0.5 = 134 57.5/0.5 = 115 25.2/0.4 = 63

(1) The fixed cost per bottleneck hour can be calculated as follows:

Total fixed costs are $18,000,000 plus the labour cost. Labour costs $10 per hour for each of the 225,000 processing hours, a cost of $2,250,000.

Total fixed cost is therefore $18,000,000 + $2,250,000 = $20,250,000

Fixed cost per bottleneck hours is $20,250,000/225,000 = $90 per hour

(c) TPAR for product C

(i) Yam could improve the TPAR of product C in various ways:

Speed up the bottleneck process. By increasing the speed of the bottleneck process the rate of throughput will also increase, generating a greater rate of income for Yam if the extra production can be sold. Automation might be used or a change in the detailed processes. Investment in new machinery can also help here but the cost of that would need to be taken into account.

Increase the selling prices. It can be difficult to increase selling prices in what is said to be a competitive market. Volume of sales could be lost leaving Yam with unsold stock or idle equipment. On the other hand, a price increase may be possible given that the business appears to be selling all it can produce.



Reduce the material prices. Reducing material prices will increase the net throughput rate. Metal is available from many sources being far from a unique product. Given the industry is mature the suppliers of the raw material could be willing to negotiate on price; this could have volume or quality based conditions attached. Yam will have to be careful to protect its quality levels. Bulk buying increases stock levels and the cost of that would need to be considered.

Reduce the level of fixed costs. The fixed costs should be listed and targets for cost reduction be selected. ABC techniques can help to identify the cost drivers and with management these could be used to reduce activity levels and hence cost. Outsourcing, de-skilling or using alternative suppliers (for stationery for example) are all possible cost reduction methods.

(ii) Suggestion to cease the production of product C

A TPAR of less than one indicates that the rate at which product C generates throughput (sales revenue less material cost) is less than the rate at which Yam incurs fixed cost. So on a simple level, producing a product that incurs fixed cost faster than it generates throughput does not seem to make commercial sense. Clearly the TPAR could be improved (using the methods above) before cessation is considered any further.

However, cessation decisions involve consideration of many wider issues (only three required).

Long-term expected net cash flows from the product allowing for the timing of those cash flows (NPV) are an important factor in cessation decisions

Customer perception could be negative in that they will see a reduction in choice

Lost related sales: if product C is lost will Yam lose customers that bought it along with another product?

What use could be made of the excess capacity that is created

Throughput assumes that all costs except raw materials are fixed; this may not necessarily be the case and only avoidable fixed costs need to be taken into account for a cessation decision. If few fixed costs can be avoided then product C is making a contribution that will be lost if the product ceased.

Answer 7 WARGRIN

(a) Lifecycle costing principles

Lifecycle costing is a concept that traces all costs to a product over its complete lifecycle, from design through to cessation. It recognises that for many products there are significant costs to be incurred in the early stages of its lifecycle. This is probably very true for Wargrin. The design and development of software is a long and complicated process and it is likely that the costs involved would be very significant.

The profitability of a product can then be assessed taking all costs into consideration.

It is also likely that adopting lifecycle costing would improve decision-making and cost control. The early development costs would have to be seen in the context of the expected trading results, therefore preventing a serious over spend at this stage or under-pricing at the launch point.



(b) Budgeted results for game

Year 1 Year 2 Year 3 Total $ $ $ $ Sales 240,000 480,000 120,000 840,000 Variable cost (W1) 40,000 80,000 20,000 140,000 Fixed cost (W1) 80,000 120,000 80,000 280,000 Marketing cost 60,000 40,000 100,000 –––––– ––––––– –––––– ––––––– Profit 60,000 240,000 20,000 320,000 –––––– ––––––– –––––– ––––––– On the face of it the game will generate profits in each of its three years of life. Games only have a short lifecycle, as the game players are likely to become bored of the game and move on to something new.

The pattern of sales follows a classic product lifecycle with poor levels of sales towards the end of the life of the game.

The Stealth product has generated $320,000 of profit over its three-year life measured on a traditional basis. This represents 40% of turnover – ahead of its target. Indeed it shows a positive net profit in each of its years on existence.

The contribution level is steady at around 83% indicating reasonable control and reliability of the production processes. This figure is better than the stated target.

Considering traditional performance management concepts, Wargrin is likely to be relatively happy with the game’s performance.

However, the initial design and development costs were incurred and were significant at $300,000 and are ignored in the annual profit calculations. Taking these into consideration, the game only just broke even, making a small $20,000 profit. Whether this is enough is debatable, it represents only 2.4% of sales for example. In order to properly assess the performance of a product the whole lifecycle needs to be considered.

WORKINGS

(1) Split of variable and fixed cost for Stealth

Volume Cost $ High 14,000 units 150,000 Low 10,000 units 130,000 Difference 4,000 units 20,000 Variable cost per unit = $20,000/4,000 unit = $5 per unit

Total cost = fixed cost + variable cost $150,000 = fixed cost + (14,000 × $5) $150,000 = fixed cost +$70,000 Fixed cost = $80,000 (and $120,000 if volume exceeds 15,000 units in a year)



(c) Incremental budgeting

Incremental budgeting is a process whereby this year’s budget is set by reference to last year’s actual results after an adjustment for inflation and other incremental factors. It is commonly used because:

It is quick to do and a relatively simple process.

The information is readily available, so very limited quantitative analysis is needed.

It is appropriate in some circumstances. For example, in a stable business, the amount of stationery spent in one year is unlikely to be significantly different in the next year, so taking the actual spend in year one and adding a little for inflation should be a reasonable target for the spend in the next year.

There are problems involved with incremental budgeting:

It builds on wasteful spending. If the actual figures for this year include overspends caused by some form of error then the budget for the next year would potentially include this overspend again.

It encourages organisations to spend up to the maximum allowed in the knowledge that if they don’t do this then they will not have as much to spend in the following year’s budget.

Assessing the amount of the increment can be difficult.

It is not appropriate in a rapidly changing business.

Can ignore the true (activity based) drivers of a cost leading to poor budgeting.

(d) Setting standard costs

Design and development costs: Setting a standard cost for this classification of cost would be very difficult. Presumably each game would be different and present the program writers with different challenges and hence take a varying amount of time.

Variable production cost: A game will be produced on a CD or DVD in a fairly standard format. Each CD/DVD will be identical and as a result setting a standard cost would be possible. Allowance might need to be made for waste or faulty CDs produced. Some machine time will be likely and again this should be the same for all items and therefore setting a standard would be valid.

Fixed production cost: The standard fixed production cost of a game will be the product of the time taken to produce the game and the standard fixed overhead absorption rate for the business. This brings into question whether this is “meaningful”. Allocating fixed costs to products in a standard way may not provide meaningful data. It can sometimes imply a variability (cost per unit) that is not the case and can therefore confuse non-accountants, causing poor decisions. The time per unit will be fairly standard.

Marketing costs: Games may have different target audiences and therefore require different marketing strategies. As such setting a standard may be difficult to do. It may be possible to set standards for each marketing media chosen. For example the rates for a page advert in a magazine could be set as a standard.



Answer 8 SCOVET CO

(a) Profit over the life of the product

1 Jan. 31 Dec. 31 Dec. 31 Dec. 20X2 20X2 20X3 20X4 $m $m $m $m Initial investment –4.5 Contribution (at 60%) 3.6 4.2 3.6 Fixed costs –2.5 –2.2 –1.8 ____ ____ ____ ____

Net cash flow –4.5 1.1 2.0 1.8 Net cash flow and therefore profit 0.4 million

Hence product D is viable on financial grounds since it generates positive profit over its life. .

(b) Cost per unit $ Variable cost per unit ($10 × 0.4) 4.00 Fixed cost per unit (working) 5.79 –––– Total cost per unit 9.79 –––– WORKING

Total lifecycle fixed costs per unit $m Initial investment 4.5 Fixed costs: 20X2 2.5 20X3 2.2 20X4 1.8 –––– Total product specific fixed costs 11.0 Budgeted sales units (millions) 1.9 –––– Budgeted fixed cost per unit ($) 5.79 $m Budgeted sales units: Total revenue over the life of the product 19 Budgeted units (at $10 per unit) 1.9

Answer 9 ENVIRONMENTAL MANAGEMENT ACCOUNTING

(a) Meaning of environmental costs

Various organisations have come up with different definitions of environmental cost so there is no definitive answer to the question “what is meant by environmental costs.” In most cases, the term “environmental costs” is taken to mean any costs that have relevance to the environment. The following are perhaps the most significant of these:

Costs of waste, particularly wasting scarce resources, such as energy and water. Here poor environmental behaviour costs more than good environmental behaviour.



Costs incurred to protect the environment such as investing in production processes to reduce pollution.

Costs of compliance with environmental regulations or voluntary codes. This may include employment of compliance officers, and monitoring equipment.

Costs of cleaning up pollution or contamination caused by activities. Some such costs may not become payable until operations cease (e.g. decontamination of the site on which a nuclear power station stands). However, such costs can be significant.

Image and relationship costs. The environment is an important political issue. Many organisations that have committed environmental crimes have suffered as a result of product boycotts, which have affected their bottom line. Many organisations spend huge amounts to publicise their environmental credentials.

(b) Why the management of environmental costs is becoming increasingly important

There are three main reasons why the management of environmental costs is becoming increasingly important.

(1) Increasing awareness of environmental issues means that organisations are expected to behave in an environmentally friendly way, as discussed above.

(2) Environmental costs account for a huge portion of costs for many industrial companies. As such they need to be managed.

(3) Increasing regulation by governments means that costs of non-compliance (e.g. fines) are becoming ever larger.

(c) Weakness of traditional management accounting

Traditional management accounting systems do not provide management with enough information about the impact of the organisations environmental costs. Many environmental related costs are simply included in general overheads, so management are not aware of them. Since managers are not aware of them, they have no information with which to manage them and no incentive to reduce them.

Since traditional management accounts do not provide management with an accurate view of environmental costs, management make decisions that are bad for the environment and bad for the organisation’s profits. Many organisations, for example, spend too much on energy due to inefficient practices and waste. Good energy management would reduce the waste, thus conserving a scarce resource, and reducing the costs of energy.

(d) Environmental management accounting

As with environmental costs, there is an absence of a clear definition of environmental management accounting. Many organisations have provided definitions, many of which contain much jargon and are not very clear.

Management accounting aims to provide detailed information to managers of an organisation, to help them plan and control its activities, and make decisions. Environmental management accounting is simply an extension of this, whereby information is provided to management to help them to manage the environmental costs and activities.



Environmental management accounting does not provide only financial information. The United Nations Division for Sustainable Development distinguishes between:

Physical information such as the use, flows and destinies of energy, water and materials, including waste.

Monetary information on environment related costs, earning and savings.

Environmental management accounting makes use of management accounting techniques such as activity-based costing (ABC), and life cycle costing, which can be used to manage environmental costs more effectively. In ABC, for example, the drivers that cause environmental costs to be incurred can be identified. Managers can then take steps to reduce the use of the drivers, so that the environmental costs are reduced without reducing the output of the organisation.

Environmental management accounting makes managers more aware of the costs of their environmental activities. If they are more aware, they can manage them more effectively.

Tutorial note: This solution is not the definitive solution to such a question. It has been provided to give a “general” view of the issues, without becoming too involved in the jargon of the various definitions that have been provided. As such it is probably longer than the marking scheme would warrant. The examiner stated that she would not set a whole question on environmental management accounting. Any questions on this area would appear for up to eight marks as part of a 20-mark question. The examiner also stated that she would not set numerical questions on this area.

Answer 10 SNIFF CO

(a) Financial and other factors to consider

Sniff should consider the following factors when making a further processing decision:

Incremental revenue. The new perfume, once further processed, should generate a higher price and the extra revenue is clearly relevant to the decision.

Incremental costs. A decision to further process can involve more materials and labour. Care must be taken to only include those costs that change as a result of the decision and therefore sunk costs should be ignored. Sunk costs would include, for example, fixed overheads that would already be incurred by the business before the further process decision was taken. The shortage of labour means that its “true” cost will be higher and need to be included.

Impact on sales volumes. Sniff is selling a “highly branded” product. Existing customers may well be happy with the existing product. If the further processing changes the existing product too much there could be an impact on sales and loyalty.

Impact on reputation. As is mentioned in the question, adding hormones to a product is not universally popular. Many groups exist around the world that protest against the use of hormones in products. This association could damage sniff.

Potential legal cases being brought regarding allergic reactions to hormones.



(b) Evaluation of experimenting with the hormone adding process

Production costs for 1,000 litres of the standard perfume

$ Aromatic oils 10 litres × $18,000/litre 180,000 Diluted alcohol 990 litres × $20/litre 19,800 ––––––– Material cost 199,800 Labour 2,000 hrs. × $15/hour 30,000 ––––––– Total 229,800 ––––––– Cost per litre 229·80 Sales price per litre 399·80 Lost contribution per hour of labour used on new products ($399,800 – $199,800) ÷ 2,000 hours = $100/hour Incremental costs

Male version Female version $ $ Hormone 2 litre × $7,750/litre 15,500 8 litre × $12,000/litre 96,000 Supervisor Sunk cost 0 Sunk cost 0 Labour 500 hours × $100/hour 50,000 700 hours × $100/hour 70,000 Fixed cost Sunk cost 0 Sunk cost 0 Market research Sunk cost 0 Sunk cost 0 –––––– ––––––– Total 65,500 166,000 –––––– –––––––

Incremental revenues

Male version Female version $ $ Standard 200 litre × $399.80/litre 79,960 800 litre × $399.80 319,840 Hormone added 202 litre × $750/litre 151,500 808 litre × $595/litre 480,760 –––––– ––––––– Incremental revenue 71,540 160,920 –––––– ––––––– Net benefit/(cost) 6,040 (5,080) –––––– ––––––– The Male version of the product is worth further processing in that the extra revenue exceeds the extra cost by $6,040.

The Female version of the product is not worth further processing in that the extra cost exceeds the extra revenue by $5,080.

In both cases the numbers appear small. Indeed, the benefit of $6,040 may not be enough to persuade management to take the risk of damaging the brand and the reputation of the business. To put this figure into context: the normal output generates a contribution of $170 per litre and on normal output of about 10,000 litres this represents a monthly contribution of around $1.7m (after allowing for labour costs).



Future production decisions are a different matter. If the product proves popular, however, Sniff might expect a significant increase in overall volumes. If Sniff could exploit this and resolve its current shortage of labour then more contribution could be created. It is worth noting that resolving its labour shortage would substantially reduce the labour cost allocated to the hormone added project. Equally, the prices charged for a one off experimental promotion might be different to the prices that can be secured in the long run.

(c) Selling price per 100 ml for female version of product

The selling price charged would have to cover the incremental costs of $166,000. For 808 litres that would mean the price would have to be

ltrs 808$319,840) ($166,000 + = $601.29/litre

or about $60.13 per 100 ml.

This represents an increase of only 1.05% on the price given and so clearly there may be scope for further consideration of this proposal.

(d) Outsourcing involves consideration of many factors, the main ones being:

Cost. Outsourcing often involves a reduction in the costs of a business. Cost savings can be made if the outsourcer has a lower cost base than, in this case, Sniff. Labour savings are common when outsourcing takes place.

Quality. Sniff would need to be sure that the quality of the perfume would not reduce. The fragrance must not change at all given the product is branded. Equally Sniff should be concerned about the health and safety of its customers since its perfume is “worn” by its customers

Confidentiality. The blend of aromatic oils used in the production process is secret. This may not remain so if an outsourcer is employed. Strict confidentiality should be maintained and be made a contractual obligation.

Reliability of supply. Sniff should consider the implications of late delivery on its customers.

Primary Function. Sniff is apparently considering outsourcing its primary function. This is not always advisable as it removes Sniff’s reason for existence. It is more common to outsource a secondary function, like payroll processing for example.

Access to expertise. Sniff may find the outsourcer has considerable skills in fragrance manufacturing and hence could benefit from that.



Answer 11 BITS AND PIECES

(a) Decision to open on Sundays

The decision to open on Sundays is to be based on incremental revenue and incremental costs:

$ $ Incremental revenue (W1) 800,000 Incremental costs – Cost of sales (W2) 335,000 – Staff (W3) 45,000 – Lighting (6 hours × $30 per hour × 50 days) 9,000 – Heating (8 hours × $45 per hour × 25 days) 9,000 – Manager’s bonus ($800,000 × 1% or $160 per day) 8,000 – Total ––––––– 406,000 ––––––– Net incremental revenue 394,000 ––––––– On the basis of the above it is clear that the incremental revenue exceeds the incremental costs and therefore it is financially justifiable.

WORKINGS

(1) Incremental revenue

Day Sales Gross profit Gross profit Cost of Sales $ % $ $ Average 10,000 70% Sunday (+60% of average) 16,000 50% 8,000 8,000 Annually (50 days) 800,000 400,000 400,000 Current results (300 days) 3,000,000 70·0% 2,100,000 New results 3,800,000 65·8% 2,500,000

(2) Purchasing and discount on purchasing

Extra purchasing from Sunday trading is $800,000 – $400,000 = $400,000 Current annual purchasing is $18,000 × 50 =$900,000 New annual purchasing is ($900,000 + $400,000) × 0.95 = $1,235,000 Incremental cost is $1,235,000 – $900,000 = $335,000 (a $65,000 discount)

(3) Staff costs

Staff costs on a Sunday are 5 staff × 6 hours × $20 per hour × 1.5 = $900 per day Annual cost is $900 × 50 days = $45,000

(b) Manager’s pay deal

The manager’s rewards can be summarised as follows:

Time off

This appears far from generous. The other staff are being paid time and a half and yet the manager does not appear to have this option and also is only being given time off in lieu (TOIL) at normal rates. Some managers may want their time back as TOIL so as to spend time with family or social friends; others may want the cash to spend. One would have thought some flexibility would have been sensible if the manager is to be motivated properly.



Bonus

The bonus can be calculated at $8,000 per annum (W6); on a day worked basis, this is $160 per day. This is less than that being paid to normal staff; at time and a half they earn 6 hours × $20 × 1.5 = $180 per day. It is very unlikely to be enough to keep the presumably better qualified manager happy. Indeed the bonus is dependent on the level of new sales and so there is an element of risk involved for the manager. Generally speaking higher risk for lower returns is far from motivating.

The level of sales could of course be much bigger than is currently predicted. However, given the uplift on normal average daily sales is already +60%, this is unlikely to be significant.

(c) Discounts and promotion

When new products or in this case opening times are launched then some form of market stimulant is often necessary. B&P has chosen to offer substantial discounts and promotions. There are various issues here:

Changing buying patterns: It is possible that customers might delay a purchase a day or two in order to buy on a Sunday. This would cost the business since the margin earned on Sunday is predicted to be 20% points lower than on other days.

Complaints: Customers that have already bought an item on another day might complain when they see the same product on sale for much less when they come back in for something else on a Sunday. Businesses need to be strong in this regard in that they have to retain control over their pricing policy. Studies have shown that only a small proportion of people will actually complain in this situation. More might not, though, be caught out twice and hence will change the timing of purchases (as above).

Quality: The price of an item can say something about its quality. Low prices tend to suggest poor quality and vice versa. B&P should be careful so as not to suggest that lower prices do not damage the reputation of the business as regards quality.

Answer 12 STAY CLEAN

(a) Decision to cease to produce the TD

The relevant costs of the decision to cease the manufacture of the TD are needed:

Cost or Revenue Note Amount ($) Lost revenue (1) (96,000) Saved labour cost (2) 48,000 Lost contribution from other products (3) (118,500) Redundancy and recruitment costs (4) (3,700) Supplier payments saved (5) 88,500 Sublet income 12,000 Supervisor (6) 0 ––––––– Net cash flow (69,700) –––––––

Conclusion: It is not worthwhile ceasing to produce the TD now.

Note 1: All sales of the TD will be lost for the next 12 months, this will lose revenue of 1,200 units × $80 = $96,000



Note 2: All normal labour costs will be saved at 1,200 units × $40 = $48,000

Note 3: Related product sales will be lost. This will cost the business 5% × ((5,000u × $150) + (6,000u × $270)) = $118,500 in contribution (material costs are dealt with separately below)

Note 4: If TD is ceased now, then:

Redundancy cost ($6,000) Retraining saved $3,500 Recruitment cost ($1,200) ––––––– Total cost ($3,700) Note 5: Supplier payments:

DW ($) WM ($) TD ($) Net cost Discount Gross cost ($) level ($) Current buying cost 350,000 600,000 60,000 1,010,000 5% 1,063,158 Loss of TD (60,000) (60,000) 5% (63,158) Loss of related sales at cost (17,500) (30,000) (47,500) 5% (50,000) New buying cost 921,500 3% 950,000 Difference in net cost 88,500 Note 6: There will be no saving or cost here as the supervisor will continue to be fully

employed.

An alternative approach is possible to the above problem:

Cash flow Note Amount ($) Lost contribution – TD (7) 12,000 Lost contribution – other products (8) (71,000) Redundancy and recruitment (4) (3,700) Lost discount (9) (19,000) Sublet income 12,000 Supervisor (6) 0 ––––––– Net cash flow (69,700) ––––––– Note 7: There will be a saving on the contribution lost on the TD of 1,200 units × $10 per

unit = –$12,000

Note 8: The loss of sales of other products will cost a lost contribution of 5% ((5,000 × $80) + (6,000 × $170)) = $71,000

Note 9: DW WM TD Total (net) Discount Total gross Current buying cost 350,000 600,000 60,000 1,010,000 5% 1,063,158 Saved cost (17,500 (30,000) (60,000) New buying cost 332,500 (570,000) 0 902,500 5% 950,000 921,500 3% 950,000 Lost discount (19,000)



(b) Pricing Strategies

Complementary pricing

Since the washing machine and the tumble dryer are products that tend to be used together, Stay Clean could link their sales with a complementary price. For example they could offer customers a discount on the second product bought, so if they buy (say) a TD for $80 then they can get a WM for (say) $320. Overall then Stay Clean make a positive contribution of $130 (320 + 80 – 180 – 90).

Product line pricing

All the products tend to be related to each other and used in the utility room or kitchen. Some sales will involve all three products if customers are upgrading their utility room or kitchen for example. A package price could be offered and as long as Stay Clean make a contribution on the overall deal then they will be better off.

(c) Outsourcing decision

Outsourcing requires consideration of a number of issues (only 3 required):

The cost of manufacture should be compared to cost of buying in from the outsourcer. If the outsourcer can provide the same products more cheaply then it is perhaps preferable.

The reliability of the outsourcer should be assessed. If products are delivered late then the ultimate customer could be disappointed. This could damage the goodwill or brand of the business.

The quality of work that the outsourcer produces needs to be considered. Cheaper products can often be at the expense of poor quality of materials or assembly.

The loss of control over the manufacturing process can reduce the flexibility that Stay Clean has over current production. If Stay Clean wanted, say, to change the colour of a product then at present it should be able to do that. Having contracted with an outsourcer this may be more difficult or involve penalties.

Answer 13 BUTTERY RESTAURANT

(a) Profit

Number of meals required to be sold each week to earn a profit of $300

Sales volume = unitper on Contributi

profit Required costs Fixed +

= (W2) $1.20

£300 (W1) $660 +

= 800 meals



(b) Additional profit and break-even

(i) Additional profit earned by owners of the restaurant by each proposed diversification

Take-away Quality meals Contribution per meal (W5) $0.90 $1.60 Anticipated sales volume 720 meals 200 meals $ $ Total contribution 648 320 Less Fixed costs (610) (282) —— —— Weekly profit 38 38

Add Additional profit from existing business (at current level) caused by reduction in material costs

700 meals × 10¢ (W7) 70 70

Additional weekly profits 108 108

(ii) Sales volume at which owners of the restaurant would earn no additional profit from the proposed diversification

Take-away Quality meals $ $ Incremental fixed costs 610 282 Minimum additional profit from

existing business caused by reduction in material costs

700 meals × 10¢ (70) (70) —— —— 540 212 —— ——

Contribution per meal (W5) 0.90 1.60

Break-even point 600 meals 132.5 meals

WORKINGS

(1) Fixed costs $ Staff 200 Building occupancy 460 —— 660 ——



(2) Contribution per meal $ $ Selling price 4.00 Variable costs Materials ($1,540 ÷ 700) (W3) 2.20 Power ($280 ÷ 700) (W3) 0.40 Staff ($140 ÷ 700) (W3) 0.20 —— (2.80) —— Contribution 1.20 ——

(3) Average weekly sales

$4$2,800 = 700 meals

(4) Calculation of contribution per meal in the existing restaurant if the following method of diversification were implemented

Take-away Quality meals $ $ $ $ Average selling price 4.00 4.00 Variable costs Materials (10p saving) 2.10 2.10 Power 0.40 0.40 Staff Nil 0.20 —— (2.50) —— (2.70) —— —— Contribution per meal 1.50 1.30 —— ——

(5) Calculation of contribution per meal of the two proposals

Take-away Quality meals $ $ Selling price 1.60 6.00 Incremental contribution from existing restaurant (W6) 0.15 0.26 —— —— 1.75 6.26 Variable costs (0.85) (4.66) —— —— Contribution per meal 0.90 1.60 —— ——

(6) Incremental contribution from existing restaurant as a result of proposed diversification

For take-away foods $1.50 (W4) ÷ 10 = $0.15 For high quality meals $1.30 (W4) ÷ 5 = $0.26

(7) Saving in material cost

The saving in material cost of 10¢ per meal at activity levels above 700 meals per week is included in the contribution per unit calculation in W5.



Answer 14 A TO C CO

(a) Contribution per unit

Product A B C $ $ $ Selling price 10 20 30 Less Materials cost (6.2) (7.6) (20.4) Direct labour (2.0) (8.0) (3.0) Variable overhead (1) (3) (3) (working) ––––– ––––– ––––– Contribution per unit 0.8 1.4 3.6 ––––– ––––– –––––

WORKING – calculation of variable overhead per unit

Product A B C $ $ $ Total overhead costs: For 3,000 units 6,000 13,000 11,000 For 5,000 units 8,000 19,000 17,000 –––––– –––––– –––––– Increase in total cost 2,000 6,000 6,000 Increase in output 2,000 2,000 2,000 –––––– –––––– –––––– Variable cost per unit 1 3 3 –––––– –––––– ––––––

(b) Calculation of total fixed cost

Product A B C $ $ $ Total overhead costs for 5,000 units: 8,000 19,000 17,000 Less variable portion (5,000 × 1)/(5,000 × 3) (5,000) (15,000) (15,000) –––––– –––––– –––––– Fixed portion 3,000 4,000 2,000 –––––– –––––– –––––– Total fixed costs are therefore $9,000 per month.

(c) Calculation of monthly break even revenue

Using the formula:

Break even revenue ratio C/S average Weighted

cost Fixed= =

102.0000,9$ = $88,236



WORKING – break even revenue

Weighted average C/S ratio = revenue totalBudgeted

on contributi totalBudgeted=

Product A B C Total Budgeted sales (units) 4,000 2,000 4,000 Selling price per unit 10 20 30 –––––– –––––– –––––– Budgeted revenue 40,000 40,000 120,000 200,000 –––––– –––––– –––––– ––––––– Contribution per unit 0.8 1.4 3.6 Budgeted contribution 3,200 2,800 14,400 20,400 –––––– –––––– –––––– ––––––– C/S Ratio 0.08 0.07 0.12 0.102 Weighted average C/S ratio is therefore 0.102. Tutorial note: The C/S ratios of the individual products are not required to calculate the weighted average C/S ratio. However, they are needed for the next part of the question.

(d) Profit volume charts

See the chart on the next page. The X-axis shows total revenue; the Y-axis profit.

(i) Sales in standard product mix

In order to draw this line it is sufficient to know only two points, and to draw a straight line between them:

When revenue = 0, loss = total fixed cost, = $9,000.

When revenue is as per budget, it is $200,000 (see part (c) above). Profit at this point is total contribution less fixed costs, being $20,400 – $9,000 = $11,400.

(ii) Products sold in order of C/S ratio

In this situation it is assumed that product C would be sold first, as it has the highest C/S ratio. Sales of product C would be made up until maximum demand for product C is reached, after which sales of product A would start, up to maximum demand for product A, and finally sales of product C.

The Profit volume chart will be multi gradient, as the gradient depends on the C/S ratio of the product. In order to draw the chart, it is necessary to calculate revenue and profit at each of the following points:

Zero revenue; Maximum sales of Product C only; Maximum sales of Product C and Product A; Maximum sales of all three products.

Sales revenue Contribution Fixed cost Profit Zero revenue 0 0 (9,000) (9,000) Sell 4,100 units of C 123,000 14,760 (9,000) 5,760 Sell 4,100 units of A and C 164,000 18,040 (9,000) 9,040 Sell 4,100 units of A and C and 4,600 units of B 256,000 24,480 (9,000) 15,480



75,000

88,236 123,000 164,000 200,000 256,000

(9,000)

5,760

9,040

11,400

15,480

Profit $ Line 1 – standard

sales mix

Revenue



Answer 15 HIGGINS CO

(a) Contribution per cue

Pool cue Snooker cue $ $ Selling price 41.00 69.00 Material cost at $40/kg (10.80) (10.80) Craftsmen cost at $18/hr (9.00) (13.50) Other Variable cost (1.20) (4.70) –––––– –––––– Contribution per cue 20.00 40.00 –––––– ––––––

(b) Optimal production plan

Variables

Let P and S be the number of pool and snooker cues made and sold in any three-month period.

Let C represent the contribution earned in any three-month period

Constraints

Craftsmen: 0.5P + 0.75S ≤ 12,000 Ash: 0.27P + 0.27S ≤ 5,400 Demand levels – Pool cues P ≤ 15,000 – Snooker cues S ≤ 12,000 Non-negativity: P, S ≥ 0

Objective: Higgins seeks to maximise contribution in a three month period, subject to: 20P + 40S = C

Solution

See diagram on next page. The feasible region is identified as the area inside OABCDE.

The contribution line is identified as the dotted line. Pushing the contribution line outward increases the contribution gained (theory of iso-contribution). The contribution line last leaves the feasible region at point D which is the intersection of the skilled labour line and the maximum demand line for S.

Solving at point D:

Maximum demand S = 12,000 (1) Craftsmen 0.5P + 0.75S = 12,000 (2)

Substituting S = 12,000 in equation (2)

0.5P + (0.75 × 12,000) = 12,000 0.5P + 9,000 = 12,000 0.5P = 12,000 – 9,000 0.5P = 3,000 P = 6,000



Therefore the maximum contribution is earned when 6,000 pool cues and 12,000 snooker cues are made and sold in a three-month period.

The contribution earned is:

C = (20 × 6,000) + (40 × 12,000) C = 120,000 + 480,000 C = $600,000

Graph

4 8 12 16 20 S

4

8

12

16

20

24

A B

C

D

Max P

P

Feasible region = 0ABCDE Optimal point at point D

2 6 10 14 18

2

6

10

14

18

22

0

contribution

Max S Max contribution

Craftsmen

Ash

F

E

(c) Labour cost

(i) Shadow prices

A shadow price is the value assigned to changes in the quantity of a scarce resource available, normally measured in terms of contribution. If more critical scarce resource becomes available then the feasible region would tend to expand and this means that the optimal point would tend to move outward away from the origin thus earning more contribution. This increase in the contribution is the shadow price which is measured on a per unit of scarce resource basis.



Management can use the shadow price as a measure of how much they would be willing to pay to gain more of a scarce resource. It represents the maximum they should be willing to pay for more scarce resource over and above the normal price subject to any non-financial issues that may be present.

If the availability of a non-critical scarce resource increased then the feasible region would not tend to expand and therefore no more contribution could be earned. In this case extra non-critical scarce resource has no value and a nil shadow price.

Calculation of shadow prices

Ash: This is a non-critical scarce resource and as such it has a shadow price of nil. There is “slack” (spare material) of ash and therefore no desire to pay more to get more of it.

Craftsmen: This is a critical scarce resource and if more became available then the feasible region would expand and the optimal point would move outward thus earning more contribution. Assuming that just one more hour becomes available it is necessary to find the new optimal point and measure the increase in contribution earned.

Resolving at point D based on the available craftsmen hours being one more than previously:

S = 12,000 (3) 0.5P + 0.75S = 12,001 (4)

Substituting S = 12,000 in equation (4):

0.5P + 0.75(12,000) = 12,001 0.5P + 9,000 = 12,001 0.5P = 3,001 P = 6,002

The new optimal solution would be where 12,000 snooker cues and 6,002 pool cues are made. This would earn an extra $40 (2 × $20) in contribution.

The shadow price is therefore $40 per extra hour of craftsmen time.

(ii) Acceptability of the craftsmen’s offer

Rate of pay

The rate of pay requested (double time) is on the face of it less than the shadow price and is therefore affordable by Higgins Co. The business would be better off by accepting the offer.

However, it is common for overtime to be paid at time and a half ($27 per hour) and Higgins would be well advised to negotiate on this point. Higgins takes the commercial risks in this business and would therefore be justified in keeping the majority of the rewards that come with it. Equally it is a dangerous precedent to accept the first offer and pay such a high rate for overtime, Higgins would have to ask itself what would happen next time an overtime situation arose. It is also possible that double time, being so generous, encourages slow working in normal time so as to gain the offer of overtime.

Quantity of hours to buy

The problem here is that as Higgins buys more craftsmen time, the craftsmen constraint line will move outward, changing the shape of the feasible region. Once the craftsmen line reaches point F (see diagram) then there would be little point buying any more hours since Higgins would then not have the materials (ash) to make more cues.



Calculating the number of hours needed at point F.

Maximum demand for S S = 12,000 (5) Ash 0.27P + 0.27S = 5,400 (6)

Substituting S = 12,000 in equation (6)

0.27P + 0.27(12,000) = 5,400 0.27P + 3,240 = 5,400 0.27P = 2,160 P = 8,000

Point F falls where S = 12,000 and P = 8,000

The craftsmen hours needed at this point would be given by putting the above P and S values in the craftsmen constraint formula.

Craftsmen hours = (0.5 × 8,000) + (0.75 × 12,000) Craftsmen hours = 13,000 hours

Therefore Higgins should only buy 1,000 hours (13,000 – 12,000).

In general terms Higgins need only buy the number of hours that the business can use to make and sell more products. If more ash can also be bought then more labour hours may be desirable.

Quality of work

Higgins should consider the quality of work. Overtime hours can force tiredness on craftsmen that have already worked a full day. Tired people often produce sub-standard work. If quality is important then this could damage the reputation of the business.

Tutorial note: Any other sensible points would be accepted.

Answer 16 ALBION CO

(a) Optimum production schedule

The optimum production schedule is found using limiting factor analysis.

AR2 GL3 HT4 Material R2 ($/unit) 2.5 × 2 = 5.00 2.5 × 3 = 7.50 2.5 × 3 = 7.50 Material R3 ($/unit) 2 × 2 = 4.00 2 × 2.2 = 4.40 2 × 1.6 = 3.20 Labour ($/unit) 4 × 0.6 = 2.40 4 × 1.2 = 4.80 4 × 1.5 = 6.00 Variable o/h ($/unit) 1.10 130 1.10 ––––– ––––– ––––– Variable costs ($/unit) 12.50 18.00 17.80 Selling price ($/unit) 21.00 28.50 27.30 ––––– ––––– ––––– Contribution ($/unit) 8.50 10.50 9.50 ––––– ––––– ––––– Material R2 (kg/unit) 2 3 3 Contribution ($/kg of R2) 8.5/2 = 4.25 10.5/3 = 3.50 9.5/3 = 3.17 Ranking 1 2 3



Product Demand R2 used Production Contribution units kg units $ AR2 950 1,900 950 8,075 GL3 1,000 3,000 1,000 10,500 HT4 900 600 200 1,900 –––––– ––––––– 5,500 20,475 –––––– –––––––

The optimum production schedule is 950 units of Product AR2, 1,000 units of GL3 and 200 units of HT4, giving a total contribution of $20,475. The fixed production overheads are ignored in this analysis because they are assumed not to vary with changes in the level of production.

(b) Maximum price

Further supplies of Material R2 will be used to produce additional units of Product HT4. The contribution per kg of Material R2 of Product HT4 is $3.17 and so if Albion pays 3.17 + 2.50 = $5.67 per kg for Material R2, the additional units of Product HT4 produced will make a zero contribution towards fixed costs. $5.67 is therefore the maximum price.

(c) Manufacture or buy $/unit Material R3: 3 × 2 = 6.00 Labour: 1.7 × 4 = 6.80 Variable overhead: 1.40 ––––– Variable cost of Product XY5 14.20 –––––

The substitute offered by Folam gives a saving of $4 per unit. However, Albion would also pay an annual fee of $50,000 for the right to use the substitute. The company would need to manufacture more than 50,000/4 = 12,500 units per year of Product XY5, or 1,042 units per month, in order for the offered substitute to be financially acceptable. If it needed less than 12,500 units of Product XY5 per year, it would be cheaper to manufacture the product in house. This evaluation is from a short-term perspective: in the longer term, buying in may lead to fixed cost savings and lower investment, increasing the benefits of buying in and lowering the break-even point.

Albion would also need to assure itself that the quality of the substitute was acceptable and that this quality could be maintained: the lower price offered by Folam might be associated with poorer quality than that deemed necessary by Albion. Orders for the substitute product would also need to be delivered promptly in order to avoid production hold-ups. Albion could also become dependent on Folam for supplies of the substitute product and might be vulnerable to future price increases by the supplier. Such price increases might reduce or even eliminate the cost saving of buying in.

(d) Limitations of marginal costing

Marginal costing (variable costing) treats fixed costs as a period cost, on the assumption that fixed costs do not change in the short term. The difference between selling price and variable costs is the variable contribution made by units sold towards meeting fixed costs and generating profit.

Marginal costing has traditionally been used for short-term decisions such as whether to cease production of a product, whether to make a product or buy it from a supplier, and how to allocate scarce resources in order to maximise contribution.



A major limitation with using marginal costing as the basis for making short-term decisions is the assumption that fixed costs are irrelevant to short-term decisions. In the longer term, fixed costs will change: for example, rent is usually regarded as a fixed cost and in the longer term rent might be expected to increase due to inflation. However, a change in fixed costs may be the result of a short-term decision: for example, if a product is discontinued and as a result the work of the marketing department decreases, in the longer term marketing costs would be expected to decrease.

This points to the danger of relying on a simplistic analysis of costs into fixed costs and variable costs, and of assuming that only variable costs are relevant for decision-making purposes. It is possible for a fixed cost to be a relevant cost. It is also possible for a variable cost to be irrelevant, for example in the case where a variable cost is common to two decision alternatives. If fuel costs are incurred whether a machine is leased or bought, for example, these costs are not relevant to the decision on whether to lease or buy.

Reliance on marginal costing as a basis for making short-term decisions may therefore lead to sub-optimal decisions overall for a company, as the analysis may fail to consider all relevant costs. A relevant cost is an incremental or differential cost at the whole company level. If a cost changes or is incurred, now or in the future, as a result of a decision, it is a relevant cost and should be considered when making a decision. When making short-term decisions, therefore, it is essential to adopt a whole company perspective in determining relevant costs.

When making short-term decisions, a detailed analysis of cost behaviour is therefore needed in order to determine not only variable costs and fixed costs, but relevant costs as well.

Answer 17 KOBRIN ENGINEERING CO

WORKING Product TW VE EC SE Profit 35 55 30 55 Fixed costs 325 465 270 485 ____ ____ ____ ____ Contribution 360 520 300 540 ____ ____ ____ ____

(a) Steel in short supply

Contribution $360 $520 $300 $540 Steel costs $250 $500 $190 $390 Contribution/key factor $1.44 $1.04 $1.58 $1.38 Rank 2 4 1 3

Production (units) Steel used Special order 31,000 30 20 30 20 Remaining sales of EC 51,300 270 Remaining sales of TW 67,500 270 Remaining sales of SE 70,200 180 _______ 220,000 Balance of steel on VE 30,000 60 _______ Total steel available 250,000 _______ _____ _____ _____ _____ Total production 300 80 300 200 _____ _____ _____ _____



(b) Components in short supply

Contribution $360 $520 $300 $540 Components 1 1 1 1 Contribution/key factor $360 $520 $300 $540 Rank 3 2 4 1 Product TW VE EC SE Components Production (units) Special order 100 30 20 30 20 Sales of SE 180 180 _____ 280 Remaining components 120 120 _____ Total components available 400 _____ _____ _____ _____ _____ Total production 30 140 30 200 _____ _____ _____ _____

(c) Labour in short supply

Contribution $360 $520 $300 $540 Labour hours 15 15 12.5 25 Contribution/key factor $24 $34.67 $24 $21.60 Rank 2= 1 2= 4 Hours Production (units) Special order 1,625 30 20 30 20 Remaining hours 2,625 175 _____ Total hours 4,250 _____ _____ _____ _____ _____ Total production 30 195 30 20 _____ _____ _____ _____

(d) Make or buy $ $ $ $ Contribution if made 360 520 300 540 Contribution if bought in 285 475 250 490 ____ ____ ____ ____ Extra contribution if made 75 45 50 50 ____ ____ ____ ____

÷ Labour hours 15 15 12.5 25 Extra contribution/labour hours $5 $3 $4 $2 Rank



Product TW VE EC SE Production (units) Hours Special order 1,625 30 20 30 20 Remaining hours 2,625 175 _____ Total hours 4,250 _____ _____ _____ _____ _____ Made in-house 205 20 30 20 Sub-contracted 95 180 270 180 _____ _____ _____ _____ Total made and sold 300 200 300 200 _____ _____ _____ _____

Answer 18 BIL MOTOR COMPONENTS CO

(a) Lowest selling price

←Machine Group→ Per unit 1 7 29 Assembly Total

$ $ $ $ $ Total cost 31.65 21.82 3.05 5.40 Less: Fixed overheads 3.00 2.50 1.50 0.84 _____ _____ _____ ____ 28.65 19.32 1.55 4.56 Setting 0.05 0.03 0.02 – _____ _____ _____ ____ Variable cost 28.70 19.35 1.57 4.56 54.18 _____ _____ _____ ____ _____

The lowest possible price would be that which covers the whole of the variable cost (i.e. (200 × 54.18) = $10,836 per batch of 200).

Evaluation of policy

This price would not be making any contribution towards the recovery of the fixed overheads. If the company is to make a profit, it has to recover its fixed overheads.

The selling price cannot really be set simply by reference to the variable costs. The prices at which competitors are offering the same product, plus engaging in market research should also be considered. Of particular importance is the likely reactions of competitors (e.g. if the strategy starts a price war BIL could lose more than it gains).

BIL should consider the possible impact on business if other customers of the product find out about the “special price”.

This kind of strategy takes time to introduce. It could, in fact, be a number of years before the company can charge the customer the full price.



(b) Maximising profits

For outputs and sales up to 7,000 units

$ $ $ $ $ Selling price 13.00 12.00 11.00 10.00 9.00 Less: Variable cost 6.20 6.20 6.20 6.20 6.20 _____ _____ _____ _____ _____ 6.80 5.80 4.80 3.80 2.80 _____ _____ _____ _____ _____

For outputs and sales over 7,000 units $ $ $ Selling price 11.00 10.00 9.00 Less: Bought-out finished price 7.75 7.75 7.00 _____ _____ _____ 3.25 2.25 2.00 _____ _____ _____ Selling price Volume Contribution Total units per unit contribution $ $ $ 13 5,000 6.80 34,000 ______ 12 6,000 5.80 34,800 ______ 11 7,000 4.80 33,600 200 3.25 650 _____ 34,250 ______ 10 7,000 3.80 26,600 4,200 2.25 9,450 _____ 36,050 ______ 9 7,000 2.80 19,600 6,400 2.00 12,800 _____ 32,400 ______

The price of $10 and sales of 11,200 units would maximise the profit, as illustrated above at $36,050 provided the estimates prove to be correct.

(c) Ways in which management can increase production capacity

Improving product design so that the production process can be simplified and take up less time.

Improving plant layout, production methods and production scheduling, to reduce idle time and avoid bottlenecks.

Introducing overtime working and/or “shift working”, if this has not already been done, to make more production time available.

Introducing or improving an existing incentive scheme that makes use of the standard costing system, to enhance productivity.

Buying certain components from outside suppliers rather than manufacturing them, which free machines and equipment for other purposes.

Employing sub-contracting manufacturers to produce completed products, which also frees-up production facilities.



Answer 19 JASON GRIMES

(a) Hiring the machine Without new machine With new machine Variable costs/unit $ $ Labour 0.80 0.80 Materials 2.00 1.00 Variable selling expenses 0.20 0.20 —— —— 3.00 2.00 –––– –––– Fixed costs Overheads 250,000 250,000 Machine hire – 575,000 ———– ———– 250,000 825,000 ––––––– ––––––– Extra contribution $1.00 per unit Extra fixed costs $575,000

For sales over 575,000 units the machine is worth hiring. A more definitive answer can only be given after considering the optimum activity level, as determined in (b).

(b) Maximizing profit

Profit maximised where Marginal revenue = Marginal cost

where 5 –15,0000.06Q = 3

Thus Q = 500,000

Therefore P = 5 – 15,000

500,000 0.03 × = $4

Contribution = Revenue – Variable costs = 500,000 × $(4 – 3) = $500,000 Profit = Contribution – Fixed costs = $(500,000 – 250,000) = $250,000 With machine

Profit maximised where MR = MC

where 5 – 15,0000.06Q = 2

Thus Q = 750,000

Therefore P = 5 – 15,000

750,000 0.03 × = $3.5

Contribution = 750,000 × $(3.5 – 2) = $1,125,000 Profit = $(1,125,000 – 825,000) = $300,000 Therefore (a) Hire new machine (b) Price = $3.50



Answer 20 KADOK CO

(a) Possible selling prices

(i) Full cost pricing plus, on the current basis $000 Materials 12 Labour 8 — Direct cost 20 Production overheads (100% of direct cost) 20 — Factory cost 40 Administrative and marketing overheads (25% of factory cost) 10 — Full cost 50 Profit (20% of full cost) 10 — Selling price for order 60 —

(ii) Price to maintain budgeted profit

Current budgeted profit is $50,000. If sales volume falls by 25%, profit will be:

$000 Direct costs $100,000 × 0.75 75.0 Variable overheads $50,000 × 0.75 37.5 ——– Variable cost 112.5 Fixed overheads $(50,000 + 50,000) 100.0 ——– Total cost 212.5 Profit (balancing figure) 12.5 ——– Revenue $300,000 × 0.75 225.0 ——–

For the Noxid order to generate $37,500 contribution to profit the price for the order must be:

$000 Materials 12.0 Labour 8.0 —— Direct cost 20.0 Variable overhead $12,000 × (50,000 ÷ 60,000) 10.0 —— Variable cost 30.0 Contribution 37.5 —— Selling price 67.5 ——

Variable overheads are assumed to vary with materials cost, per original budget $50/60 per $1 materials cost.



(iii) Price absorbing overheads on a unit basis

Based on the original budget, when production overheads were $100,000 and administrative and marketing overheads $50,000, the unit overhead for the budgeted 20,000 units output would have been:

0002000050000100

,),,$( + = $7.50

Basing overhead recovery on this and assuming that when full cost is determined this way, the same profit margin (i.e. 20%) is added to the full cost, the computations for the price charged would be as follows: $000 Material 12.0 Labour 8.0 —— Direct cost 20.0 Overheads $7.5 × 5,000 37.5 —— 57.5 Profit at 20% 11.5 —— Selling price of order 69.0 ——

(b) Advice

Discussion of methods used

On first sight it may seem that a simple answer to this part of the question is to advise Kadok to select and set the highest price from those computed using the mechanisms required by the question. However, it must be obvious that there are other ways of computing even higher prices if obtaining the highest possible price from a set of calculations were to be the price objective. Why stop at the methods asked for in (a)? Why not look for those that produce even higher prices? This brings to attention the need to consider demand factors and to ask what price the market will bear. However, before discussing demand conditions further, it will be useful to make some comments about the methods dealt with in (a).

First, concerning the full price mechanism, it is frequently suggested that this procedure provides an entrepreneur with a figure of a “fair” price to charge – assuming that the profit percentage mark-up is fair for the industry concerned. However, such assumptions about fairness tend to overlook the cost classification problems that will be associated with the first two stages of the full cost price plus mechanism. Where there is difficulty in the classification and allocation of costs (e.g. between direct and indirect absorption techniques, this may cause distortions to the “fair price”). Method (iii) is a variant of the full cost plus method based on the view that it seems fairer to apportion overheads in absolute terms based on units rather than applying a percentage.

However, method (iii) overlooks the fact that units of production may not be homogeneous. The homogeneity of units in this question has been somewhat diluted because of changes in product specification. The special enquiry for unbranded cameras requires them to be stripped down to their barest essentials.



Developing methods (i) and (iii) into a marginal costing method would in fact provide the best basis of costing for an enquiry for a special order. This is because, although such an approach does not tell the price-setter what to charge as the final price, it does provide a base line for the price floor below which the good should not be sold. The price-setter can then try to ascertain the best price that can be obtained above this minimum. In method (ii) in the question, a constraint has been imposed by saying that the price set must enable the organisation to achieve its original budgeted profit figures. Such a constraint is probably unreasonable as it may cause the order to be lost, when any “contribution” that could be earned above the marginal costs would have been helpful and placed the firm in a better position than if the order had been rejected.

However, it should be noted that the presentation of data for method (ii) does show the marginal cost information.

Other factors

It might be helpful in such cases as those depicted in this question to use market intelligence to find out what the potential customer expects to make as a profit when he re-sells the goods that he buys. The manufacturing organisation should also try to find out at what price its competitors are selling comparable lines. Also, in cases where sales of the manufacturer’s brand have been reduced, it is important to try to ascertain whether sales by the photographic dealer of a cheaper house brand might affect these even more – or even whether the manufacturer would find it worthwhile to produce a stripped-down model for sale through its existing customers. Discussions should be held with the photographic chain’s purchasing officer to get the “feel” of what sort of price he expects – remembering that once a price has been sent off to him, this tends to pre-empt opportunities for negotiating prices upwards, especially if the price set was well below that which he would have been prepared to pay. If the “exploratory” price is set too high, then there is the danger that the high-priced firm will be precluded from further negotiations. When this is not the case it is likely, after bids for some products have been negotiated downwards, to mean the buyer will expect to be able to negotiate all future initial “bids” downwards, even if he would have been happy to pay the price originally asked.

All in all, it can be seen that price setting in such a situation is extremely difficult. Although the seller should know the price below which he is not prepared to fall, it is certainly worth any effort and resources expended within reason on market intelligence to ensure that the best possible price is obtained for products.

Answer 21 AUTODES CO

(a) Price based on current pricing policy $ Materials WZ954 3g at $4.74 = 14.22 RT429 5g at $6.12 = 30.60 Other materials 5.01 –––––– 49.83 Opportunity cost of using WZ954 (W1) 11.25 Labour 1.5 hours at $21 = 31.50 Overheads 1.5 hours at $29 = 43.50 Development Costs (W2) 20.42 –––––– Total cost 156.50 Plus profit (25% margin = ⅓ of cost) 52.17 –––––– Selling price 208.67 ––––––



WORKINGS

(1) Opportunity cost of WZ954

Contribution per unit of other product $15 Each unit produced requires 4g ∴ Contribution per g = $15 ÷ 4 $3.75 Each unit of Autolong uses 3g ∴ $11.25

(2) Development costs

Total of development costs $3,675,000 NB WZ954 is in short supply Maximum supply of 180,000g is sufficient for 60,000 units On maximum sales of 60,000 p.a. for three years, the impact of development costs is $3,675,000 ÷ 180,000 = $20.42 per unit

(b) Report to the managing director

To: Managing Director From: Management Consultant Ref: Pricing of Autolong Date: 5 June 20XX

Introduction

This report considers the options available to the company with regard to the initial pricing of Autolong. The report is based on the information provided by the company and the Market Report.

Pricing policy

There are a number of strategies that the company could adopt in respect of pricing. Two of these (market skimming and market penetration) have been specifically referred to by a non-executive director, while the company currently operates a policy of cost plus pricing. Before considering these in detail, it may be useful to provide an overview of the alternatives referred to by the non-executive director.

Market skimming

Essentially this strategy is used to achieve high unit profits in the early stages of a product’s life cycle. This is done by charging a high price on entry to the market and stimulating demand through advertising and promotion. As the product enters later stages of its life cycle, the price will be reduced. There are many examples of products that have been brought to market in this way, including laptop computers, digital cameras, and DVD players. The approach essentially “skims” the profit in the early stages of the life cycle before increased competition leads to lower prices.

Market penetration

This strategy is based on charging lower prices in order to achieve a high level of penetration into the market and so build market share. This allows economies of scale to be built rapidly so that unit costs can be reduced.



Application to Autodes

Using the company’s current policy, the price of the Autolong would be $209. There are two important points to note about this price. The first is that it is well below the upper price limit of $225 referred to in the market report. The second is that it is based on a significant assumption regarding the recovery of development costs.

Development costs

The company has a policy that development costs should be recovered in the first three years of a product’s life cycle. In the case of the Autolong, the fact that the supply of one of the materials (WZ954) is limited, places an upper limit of 60,000 units on the market penetration for the product. As it will be two years before our competitors bring their products to market, a shorter recovery period should be considered.

The indications are that full production capacity of 60,000 units will be sold in each of the first two years. The impact of this shorter recovery period would be that the costs of $3,675,000 would be recovered over 120,000 units. This would increase the cost of the Autolong by $10.21 to $167. When the profit margin is added the selling price will be increased by almost $14 to $223.

Recommendation

There is a two-year window during which Autodes will probably be able to sell the full production volume of the product, and also achieve full recovery of the development costs at a price of $223. Market research indicates that the maximum price that can be achieved is $225 per unit.

I would recommend a market skimming approach using a price of $223. This will give the opportunity to reduce the price by around $40 or 18% in order to respond to competitors entering the market.

Answer 22 ESSENTIAL ASPECT

(a) Structure of current and revised model

The cost model is a simple linear equation of the form y = a + bx, where a represents the fixed costs and b the variable costs per unit. Hence the current cost model has fixed costs of $5,000 and a unit variable cost of $0.6. The revised cost model reduces the fixed cost element to $4,750 but the unit variable cost rises to $0.8 Therefore, the revised model generates lower cost estimates at lower output levels, but higher cost estimates at higher output levels than the current model.

The revenue function depicts a conventional non-linear downward sloping demand curve where the company has to lower its sale price of all of its units if it wishes to sell more. The revised coefficients in the revised model result in a lower initial price (from $20 to $19) but a slower decline in price as the units sold increase. The revision in the coefficient from 0.01 to 0.009 results in the price declining at a slower rate than previously for any given change in units sold (i.e. the revised model depicts a lower price elasticity of demand). Therefore the revised model generates lower total revenue estimates at low unit sales, but greater total revenue estimates at high unit sales than the current model.



(b) Optimal output

(i) Optimal level of output

The optimal sales level could be determined by:

using differential calculus to determine the marginal cost (MC) and marginal revenue (MR) functions. Where MR = MC the optimal demand occurs. Solve the equation to find the optimal level.

by calculating the values of total revenue and total cost at all potential unit output levels and identifying where revenues exceeded costs by the greatest absolute amount.

(ii) Adherence to output target

The amended model should quantify the current efficient application of resources in the achievement of the optimum demand level. It should therefore be a measure of current efficient managerial performance. However, managerial performance should be measured in terms of identifying, quantifying and responding to changing business variables.

The model would require to be updated in order to reflect such changes. It is unlikely that the model is sufficiently sophisticated to incorporate all the variables that reflect managerial performance.

(c) Cost and revenue factors to improve validity of model

The structure of cost and revenue models frequently relies on historical information as source data – but how reliable is this for forecasting? How effective is the past as a predictor for the future? Cost and revenue relationships can alter radically over time with technological and market changes – there is a need to consider the significance and impact of these issues on long-term forecasts. The solution may be to have different models for short and long-term forecasts with more detailed and stringent accuracy requirements for the shorter-term estimates.

The cost models assume a constant fixed cost over all ranges of output – how realistic is this? Perhaps the cost model could incorporate a step cost function that increases as specific output levels are attained. Is the step cost necessarily an abrupt change or is it possible to incorporate a sliding step cost that results from capacity being temporarily expanded by short-term measures until the higher demand level is regarded as permanent.

The cost models assume that unit variable costs remain constant over all ranges of output – is this a reasonable assumption? What about the possibility of deriving economies or diseconomies of scale and hence resulting in a non-constant unit variable cost. For example, bulk purchase discounts will result in unit variable costs decreasing as output expands. These discounts may generate a downward step function in unit variable cost or even a smooth decreasing function depending on the purchase contract terms.

Are the revenue and cost forecasts based at constant prices or does an allowance for inflation need to be incorporated? This will probably depend on the length of the time horizon. What inflation factor should be used? Is RPI appropriate or is a more specific inflator required because the industry prices change at a different rate to the general economy? Indeed in certain high tech areas the forecast may be for a general decrease in prices.



The forecast price elasticity of demand incorporated into the model is critical in forecasting revenues, but how accurate can this be in a changing business environment? The model could be improved by considering the factors that determine the price elasticity of demand and incorporating the variables into the model (i.e. by making the model more sensitive to the critical issues). This will increase both the potential accuracy of the model and unfortunately, the complexity of it.

The revenue functions are extremely simple with price being the only factor in determining the units sold. The model concentrates on movements down the demand curve to influence the total revenue estimates and gives no consideration to movements in the demand curve (i.e. the other factors apart from price that influences the amount sold). The model would have greater validity if it were to incorporate other factors such as: tastes, customer income, competitors’ prices, population size and structure, advertising etc. How would these variables be incorporated into the model? Is there appropriate quantifiable data available that is suitable for inclusion?

Answer 23 STOW HEALTH CENTRE

(a) Budgeted net profit/loss outcomes for year ending 30 June 201X

Client Fee per Variable cost Contribution Total annual Days Client day per client day per client day contribution $ $ $ $ 15,750 180 95 85 1,338,750 15,750 180 85 95 1,496,250 15,750 180 70 110 1,732,500 13,125 200 95 105 1,378,125 13,125 200 85 115 1,509,375 13,125 200 70 130 1,706,250 10,500 220 95 125 1,312,500 10,500 220 85 135 1,417,500 10,500 220 70 150 1,575,000

(b) Client fee strategy based on decision rules

The maximax rule looks for the largest contribution from all outcomes. In this case the decision maker will choose a client fee of $180 per day where there is a possibility of a contribution of $1,732,500.

The maximin rule looks for the strategy that will maximise the minimum possible contribution. In this case the decision maker will choose client fee of $200 per day where the lowest contribution is $1,378,125. This is better than the worst possible outcome from client fees per day of $180 or $220 that will provide contribution of $1,338,750 and $1,312,500 respectively.

The minimax regret rule requires the choice of the strategy that will minimise the maximum regret from making the wrong decision. Regret in this context is the opportunity lost through making the wrong decision.



Using the calculations from part (a) an opportunity loss table can be created as follows:

Client fee per day strategy State of variable cost $180 $200 $220 High 39,375 0 65,625 Most likely 13,125 0 91,875 Low 0 26,250 157,500 Maximum regret 39,375 26,250 157,500 Example of the workings: at the low level of variable costs, the best strategy would be a client fee of $180. The opportunity loss from using a fee of $200 or $220 per day would be $26,250 (1,732,500 – $1,706,250) or $157,500 (1,732,500 –1,575,000) respectively.

The minimum regret strategy (client fee $200 per day) is that which minimises the maximum regret (i.e. $26,250 in the maximum regret row above).

(c) Client fee strategy

Expected value of variable cost = $95 × 0.1 + $85 × 0.6 + $70 × 0.3 = $81.50

For each client fee strategy the expected value of budget contribution for the year may be calculated:

* Fee of $180: 15,750 (180 – 81·50) = $1,551,375 * Fee of $200: 13,125 (200 – 81·50) = $1,555,312·50 * Fee of $220: 10,500 (220 – 81·50) = $1,454,250

Hence choose a client fee of $200 per day to give the maximum expected value contribution of $1,555,312.50. Note that there is virtually no difference between this and the contribution where a fee of $180 per day is used.

Answer 24 SHIFTERS HAULAGE

(a) Making decisions in uncertain situations

Maximax stands for maximising the maximum return an investor might expect. An investor that subscribes to the maximax philosophy would generally select the strategy that could give him the best possible return. He will ignore all other possible returns and only focus on the biggest; hence this type of investor is often accused of being an optimist or a risk-taker.

Maximin stands for maximising the minimum return an investor might expect. This type of investor will focus only on the potential minimum returns and seek to select the strategy that will give the best worst-case result. This type of investor could be said to be being cautious or pessimistic in his outlook and a risk-avoider.

Expected value averages all possible returns in a weighted average calculation.

For example, if an investor could expect $100 with a 0.30 probability and $300 with a 0.70 probability, then on average the return would be:

(0.3 × $100) + (0.7 × $300) = $240

This figure would then be used as a basis of the investment decision. The principle here is that if this decision was repeated again and again, then the investor would get the expected valued (EV) as a return. Its use is more questionable for use on one-off decisions.

Tutorial note: You were not asked for a critique of this method.



(b) Profit calculations

Small Van Medium Van Large Van Capacity 100 150 200 Low Demand (120) 300 W1 468 W3 368 W5 High Demand (190) 300 W2 500 W4 816 W6

WORKINGS W1 W2 W3 W4 W5 W6 Sales 1,000 1,000 1,200 1,500 1,200 1,900 Variable cost (400) (400) (480) (600) (480) (760) Goodwill (100) (100) (100) VC adjustment 48 48 76 Depreciation (200) (200) (300) (300) (400) (400) Profit 300 300 468 500 368 816

(c) Van purchase decision

The type of van to buy depends on the risk attitude of the investor. If they were optimistic about the future then the maximax criteria would suggest that they choose the large van as this has the potentially greatest profit. If they are more pessimistic, then they would focus on the minimum expected returns and choose the medium van, as the worst possible result is $468, which is better than the other options. As the business managers are becoming more cautious they may prefer a maximin criterion.

Expected values could be calculated thus:

Small van $300 Medium van ($468 × 0.4) + ($500 × 0.6) = $487 Large van ($368 × 0.4) + ($816 × 0.6) = $637 Given SH is considering replacing a number of vans you could argue that an EV approach has merit (not being a one-off decision – assuming individual booking sizes are independent of each other).

The final decision lies with the managers, but given their cautiousness, a medium-sized van would seem the logical choice. The small van could never be the correct choice.

(d) Methods of uncertainty reduction

Market research. This can be desk-based (secondary) or field-based (primary). Desk-based is cheap but can lack focus. Field-based research is better in that you can target your customers and your product area, but can be time consuming and expensive. The Internet is bringing down the cost and speeding up this type of research, email is being used to gather information quickly on the promise of free gifts etc.

Simulation. Computer models can be built to simulate real life scenarios. The model will predict what range of returns an investor could expect from a given decision without having risked any actual cash. The models use random number tables to generate possible values for the uncertainty the business is subject to. Again, computer technology is assisting in bringing down the cost of such risk analysis.

Sensitivity analysis. This can be used to assess the range of values that would still give the investor a positive return. The uncertainty may still be there, but the affect that it has on the investor’s returns will be better understood. Sensitivity calculates the % change required in individual values before a change of decision results. If only a (say) 2% change is required in selling price before losses result an investor may think twice before proceeding. Risk is therefore better understood.



Calculation of worst and best case figures. An investor will often be interested in range. It enables a better understanding of risk. An accountant could calculate the worst-case scenario, including poor demand and high costs whilst being sensible about it. He could also calculate best-case scenarios including good sales and minimum running costs. This analysis can often reassure an investor. The production of a probability distribution to show an investor the range of possible results is also useful to explain risks involved. A calculation of standard deviation is also possible.

Answer 25 DECISION TREE

(a) Decision tree

National advert

$(25,000)

No advert

$(10,000)

$0

Local advert

Weather good 0.3

Weather poor 0.7

Weather good 0.3

Weather poor 0.7

Weather good 0.3

Weather poor 0.7

Demand unchanged 0.5




Demand up 0.5

Demand up 0.5

Demand up 0.4

Demand up 0.6

600 room nights $30,000


200 room nights $(35,000)


600 room nights$30,000

200 room nights$(35,000)





$4,000

$(15,500)

$(2,900)

$(23,000)

$44,000

$(20,000)

$60,000



From decision tree:

No advert

Expected value = $(15,500)

Local advertisement

Expected value before advertising costs = $(2,900) Expected net value = $(2,900) – $10,000 = $(12,900)

Do nothing

Expected value before advertising costs = $4,000 Expected net value = $4,000 – $25,500 = $(21,000)

As it can be seen from the above, although the highest expected value before costs of advertising is with the national advertisement, once the cost of the advertising is taken into account the lowest expected net loss is for a local advert. The highest net loss is from the national advert.

The highest possible gain is from the national advert if the weather is good and the demand increases which would lead to net earnings of $65,000 after advertising costs. However the national advert could also lead to the highest net loss if the weather is poor and the demand is unaffected the potential net loss is $60,000. The possible outcomes from the local advert vary from net earnings of $55,000 to a net loss of $45,000. The national advert is therefore the most risky option as it has the greatest spread of outcomes and the option of not advertising is the least risky.

The actual decision of the owner will be dependent on his attitude to risk. However with this proviso, it is recommended that the owner take out a local advertisement as this is the option with the lowest expected net loss and is less risky that the national advert.

(b) Limitations of using a decision tree

The main limitation of using a decision tree is that it is based on probability forecasts of the outcome to enable the expected net present value to be calculated. However the calculated figure is actually an average of the possible outcomes weighted by their relative probabilities. As such, it is a hypothetical figure – in fact one or other of the outcomes must occur, not some average. If the project were carried out many times, the average results would equal the expected value. However, the technique is being applied to a project that will only be done once.

There are other problems associated with expected values. One important factor is that they ignore the decision maker’s attitude towards risk. Risk-averse decision makers will often accept considerable reductions in expected value for only small decreases in risk. Calculations of the expected net present values do not of themselves give any idea of the nature of the dispersion of possible outcomes around the expected value. As uncertainty is present, the owner needs to know more than just what the expected return would be from different options. The expected net present value does not tell us the maximum possible loss that could be incurred.

Finally, the use of expected net present values as a basis for the decision rests on the use of “subjective” probabilities that may not be valid. In this case, the decision tree is based on forecasts of the weather that are known for being difficult to estimate to any degree of accuracy.



Answer 26 NORTHLAND

(a) Overhead budget

Overhead costs for the 20X3 budget:

Property cost = $120,000 × 1.05 = $126,000 Central wages = ($150,000 × 1.03) + $12,000 = $166,500 Stationery = $25,000 × 0.6 = $15,000

(b) Budget for road repairs

The road repair budget will be based on 2,200 metres of road repairs; it is common to include a contingency in case roads unexpectedly need repair (see part (c)).

The weather conditions could add an extra cost to the budget if poor or bad conditions exist. The adjustment needed is based on an expected value calculation:

(0.7 × 0%) + (0.1 × 10%) + (0.2 × 25%) = 6%

Hence the budget (after allowing for a 5% inflation adjustment) will be:

2,200 × $15,000 × 1.06 × 1.05 = $36,729,000

This could be shown as:

(2,200 × 15,000 × 1.0 × 0.7) + (2,200 × 15,000 × 1.1 × 0.1) + (2,200 × 15,000 × 1.25 × 0.2) = $34,980,000

The $34,980,000 could then be adjusted for inflation at 5% to give $36,729,000 as above.

(c) Problems with using expected value in budgeting

An expected value calculation used in budgeting has the following problems associated with it:

It is often difficult to estimate the probabilities associated with different (in this case) weather conditions. The weather in one year may not reflect the weather in the following year leading to wildly inaccurate estimates and hence budgeting errors.

It is difficult to estimate the precise monetary value attaching to each of the outcomes. “Bad” weather can presumably take many forms (extreme cold, heat or water); the effect of each of these could be difficult to assess. Whilst using expected values it is common to group the events together and have one probability estimate. This may prove inadequate or inaccurate.

The expected value that is calculated might not reflect the true cost leading to over or under spends on budget.

The managers will have an easy fall-back position should the budgets turn out to be incorrect. It would probably be accepted that the weather (and hence the probability of it) is outside their control and over spends could not then be blamed on them.



A contingency is often added to a budget in the event that there is uncertainty on the likely spend. In this case there would be much uncertainty over the level and indeed type of road repairs required. Roads could be damaged by weather conditions (extreme cold or heat) or unexpected land movements (earthquakes). Public safety could be at risk meaning that a repair is essential. This could result in a higher spend.

Equally the type of repair needed would vary and be unpredictable. Small holes might be simply filled in but larger holes or cracks might involve repairs to the foundations of the road. The costs could differ considerably between the different types of repairs.

(d) Zero-based budgeting process

Zero based budgeting involves three main steps:

Define decision packages. These are detailed descriptions of the activities to be carried out. There will be some standardisation in the data to allow comparison with other activities (costs, time taken and so on). A cost-benefit analysis is often carried out at this stage to ensure the most cost effective and beneficial approach to the activity is taken.

Evaluation and ranking of activities. Each activity is assessed; those that are perhaps part of a legal obligation become “must do” activities; others may be viewed as discretionary. The LGO will have to decide which of the activities offer the greatest value for money (VFM) or the greatest benefit for the lowest cost.

Allocation of resource. The budget will then be created for the accepted activities.

Answer 27 BUDGET BEHAVIOUR

(a) Purposes of budgets

Planning

The budget is a major short-term planning device placing the overall direction of the company into a quarterly, monthly and, perhaps, weekly focus. It ensures that managers have thought ahead about how they will utilise resources to achieve company policy in their area.

Control

Once a budget is formulated a regular reporting system can be established so that the extent to which plans are, or are not, being met can be established. Some form of management by exception can be established so that deviations from plans are identified and reactions to the deviation developed if desirable.

Co-ordination

As organisations grow the various departments benefit from the co-ordination effect of the budget. In this role budgets ensure that no one department is out of line with the action of others. They may also hold in check anyone who is inclined to pursue his or her own desires rather than corporate objectives.

Communication

The construction of the budget can be a powerful aid to defining or clarifying the lines of horizontal or vertical communication in the enterprise. Managers should have a clearer idea of what their responsibilities are, what is expected of them, and are likely to work better with others to achieve it.



Performance evaluation

When budgets are “tailored” to a department or manager they become useful tools for evaluating how the manager or department is performing. If sales targets are met or satisfactory service provided within reasonable spending limits then bonus or promotion prospects are enhanced.

Motivation

The value of a budget is enhanced still further if it not only states expectations but also motivates managers to strive towards those expectations. This is more likely achieved if a manager has had some involvement in the budget construction, understands its implications and agrees it is fair and controllable by him/her.

(b) Behavioural factors

If budgetary control is to be successful, attention must be paid to behavioural aspects (i.e. the effect of the system on people in the organisation and vice versa). The following are some of the points that should be borne in mind:

Budget difficulty

It is generally agreed that the existence of some form of target or expected outcome is a greater motivation than no target at all. The establishment of a target, however, raises the question of the degree of difficulty or challenge of the target. If the performance standard is set too high or too low then sub-optimal performance could be the result.

The degree of budget difficulty is not easy to establish. It is influenced by the nature of the task, the organisational culture and personality factors. Some people respond positively to a difficult target others, if challenged, tend to withdraw their commitment.

Budgets and performance evaluation

The emphasis on achievement of budget targets can be increased, but also the potential for dysfunctional behaviour, if the budget is subsequently used to evaluate performance. This evaluation is frequently associated with specific rewards such as remuneration increases or improved promotion prospects. In such cases it is likely that individuals will concentrate on those items that are measured and rewarded neglecting aspects on which no measurement exists. This may result in some aspects of the job receiving inadequate attention because they are not covered by goals or targets due to the complexity of the situation or the difficulty of measurement.

Managerial style

The use of budgets in evaluation and control is also influenced by the way they are used by the superior. Different management styles of budget use have been observed, for example:

budget constrained – placing considerable emphasis on meeting budget targets;

profit conscious – where a balanced view is taken between budget targets, long-term goals and general effectiveness;

non-accounting – where accounting data is seen as relatively unimportant in the evaluation of subordinates.



The style is suggested to influence, in some cases, the superior/subordinate relationship, the degree of stress and tension involved and the likelihood of budget attainment. The style adopted and its implications are affected by the environment in which management is taking place. For example, the degree of interdependency between areas of responsibility, the uncertainty of the environment and the extent to which individuals feel they influence results are all factors to consider in relation to the management style adopted and its outcomes.

Participation

It is often suggested that participation in the budget process and discussion over how results are to be measured has benefits in terms of budget attitude and performance. Views on this point are varied however, and the personality of the individuals participating, the nature of the task (narrowly defined or flexible) and the organisation structure influence the success of participation. But a budget when carefully and appropriately established can extract a better performance from the budget holder than one in which these considerations are ignored.

Bias

Budget holders who are involved in the process from which the budget standards are set are more likely to accept them as legitimate. However, they may also be tempted to seize the opportunity to manipulate the desired performance standard in their favour. That is, they may make the performance easier to achieve and hence be able to satisfy personal goals rather than organisational goals. This is referred to as incorporating “slack” into the budget. In this context there may be a relationship between the degree of emphasis placed on the budget and the tendency of the budget holder to bias the budget content or circumvent its control.

Any organisational planning and control system has multiple objectives but primary amongst these is encouraging staff to take organisationally desirable actions. It is never possible to predict with certainty the outcomes of all behavioural interaction however it is better to be aware of the various possible behavioural implications than to be ignorant of them.

Answer 28 ZBB

(a) Usefulness

Zero-based budgeting (ZBB) is a method of budgeting that re-examines, at each budgeting exercise, whether the budgeted activity is to be funded at any level. Hence, the budgeting exercise begins at a zero or nil cost base. It is a device that is particularly useful when an organisation is unsure if its costs are at the most efficient levels. Most efficient costs are not the same as minimum levels since very low costs might impinge on service or product quality. The purpose of ZBB is to overcome inefficient forms of budgeting that might lead to slack practices that consequently consume more resources than the most effective and efficient organisations face.

(b) Steps to implement ZBB

There are a series of steps that would ordinarily be taken in order to implement an effective ZBB system.

Questioning why expenditure needs to be incurred

The development of a questioning attitude to activities that incur costs is the first step to ensuring that costs are kept to most efficient levels. It is important to recall that ZBB, in the short term, can only change costs over which the organisation has short-term control. Longer term, or period costs, can only be changed over a longer horizon. Taxes and other regulatory costs cannot be the focus of ZBB because they are difficult to influence.



Thus ZBB can be immediately effective where costs can be related to identifiable activities. The questions that might emerge in such situations are as follows:

Can costs associated with an activity be isolated? If costs cannot be identified to a particular activity to a degree that provides management with confidence that they can change the costs then there is little point in applying ZBB techniques to the cost;

An even more basic question is to ask how important the activity is to the business and what, if the costs can be identified, is the total cost saving that might result should the activity be stopped. In this respect, it is important to identify effects on costs elsewhere in the business. If the activity to be stopped absorbed fixed costs, then the fixed costs will have to be re-apportioned without absorption to the activity that is to be stopped. Moreover, there may be joint costs such that stopping one activity may have an uncertain effect on joint costs incurred with another activity;

Is the activity in question the cheapest way of providing the service or contribution to production? Thus, it is important not to ask simply if the costs relating to the activity are the most efficient, but are there alternatives that might reduce costs still further and still maintain a given level of service or production;

A more fundamental question about conducting ZBB processes is whether the benefits of employing ZBB outweigh the costs. It is important to appreciate that conducting a ZBB exercise is not a costless process if, as will inevitably be the case, management time is consumed.

Deciding which activities should be provided with a budget

Budgeted activities should be capable of being monitored and controlled. If an activity is recognised as a budget centre, and is going to be subject to a ZBB process, then it is important that management undertake the task of monitoring costs in relation to activity and taking corrective action when appropriate. Thus, if an activity consumes resources and is capable of being monitored and controlled then it should be provided with a budget. This will then make the activity subject to ZBB processes.

“Decision packages” are sometimes referred to in the context of ZBB and activities. These relate to how activities can be described when thinking about how ZBB can be used to judge an activity. There are two types of decision activity:

Mutually exclusive decisions: when ZBB assessments are made of an activity, alternative courses of action are sometimes benchmarked against existing activities. A choice is then made over which activity might be the preferable course of action. The preferred choice will involve budgeted information, but may also involve other factors such as product quality and service level provision.

Incremental decisions: ZBB assessments are often related to the level of activity in a budget centre. Thus, there will be a minimum level of activity that provides the essential level of product or service. This is often referred to as the “base” activity. Further levels of activity are then incremental and, subject to correctly identifying and isolating the variable costs related to an activity, ZBB assessments can be made separately of both the base and the incremental activities. This division might then provide management with an understanding of the degree of flexibility the organisation has.



Questions to be asked when ranking budgeted activities for scarce resources

The allocation of scarce resources is a key management task. Scarce resources will have to be allocated to the activities of a business in terms of providing appropriate labour and materials, along with any other costs related to an activity. Whilst ZBB is most often applied to support activities, the technique can also be applied to a production process.

Some sorting of ranking will have to be applied in order to determine which activities are funded by a budget against those that are not. The key question for budgeting purposes relates to:

Defining the appropriate decision package (as described above);

The importance of the activity in relation to the organisation in terms of:

Support for the organisation’s objective (e.g. maximising shareholder wealth); Support for other service or product activities;

How the ranking system is to be used:

Are all activities to be funded above a certain rank; or

Is there a scaling of funds allocated against funds requested as determined by the rank; or

Is there a combination of methods?

Essentially, a judgement has to be made by management of the benefit of the activity to the organisation. Theoretically, this is best achieved by determining deprival value. In practice, deprival values are difficult tools and some level of arbitrary judgement has to take place in which non-financial factors might play a significant role.

(c) Critical assessment of the use of ZBB

The motivation of employees is one of the most difficult tasks facing management since the problems are complex and not always referable to financial performance indicators. To the extent that employees are not responsive to financial performance indicators then ZBB is going to be less effective as a device to motivate employees.

The problem of employee motivation is one of achieving goal congruence with the organisational objectives. ZBB can be useful in this respect as a method of tackling the problem of motivating employees to achieve targeted performance when a clear understanding of the activities and their related decision packages is essential for the management tasks of monitoring and controlling an activity.

In this respect ZBB has the following advantages

It ensures that only forward-looking objectives are addressed. This limits the potential for historical abuses in budget setting to be established. Employees can be set targets that are consistent with the future objectives of the organisation.

Building “budget slack” is minimised because, in principle, the entire costs of an activity are reviewed at each budget setting stage. Employees are then set realistic targets that relate to activity levels that are the most efficient.

Managers are made to understand, as part of the ZBB process, the activity itself. This reduces tension between those who decide (management) and those who have to implement manager decisions. Claims that management do not really understand the nature of an activity are thus reduced.



ZBB encourages flexibility in employees since they know that potentially activities may be stopped. Flexibility induces goal consistency by enabling incentive schemes to reflect activity. In other words, employees are more likely to be responsive to management directives if they are aware and trust that the budget setting process encourages and supports payments that are responsive to flexibility.

(d) Advantages of encouraging employee participation in budget setting

Generally, participative budget setting will result in:

An informed budget setting process such that management are aware of the detail of budgeted activities as provided by the people who work daily in the budgeted activity;

Avoids the criticism that budgets are unrealistic;

Participation reduces the adverse effects of budget imposition when difficult management decisions have to be made (e.g. staff reduction);

Employees become aware and more involved in the management activities of the organisations. To the extent that they become more aware, then a greater understanding of the needs of the organisation as a whole is reached;

Coordination in an activity might be improved. If activities are jointly budgeted, or are part of the same process, then coordination between activities might be improved;

Budgetary slack may be reduced as management become more aware of the operational activities in an activity;

Achievable budgets are more likely to be set;

When budgets are not met management are more likely to have a deeper knowledge of the operational issues involved;

There is less risk that subordinates will undermine budgets.

Answer 29 BUDGETING & COSTING

(a) Application to not-for-profit organisations

Not-for-profit (NFP) organisations such as charities deliver services that are usually limited by the resources available to them. It may be possible neither to express their objectives in quantifiable or measurable terms, nor to measure their output in terms of the services they deliver. The financial focus in NFP organisations is therefore placed on the control of costs.

Selection of cost units

A cost unit for a NFP organisation is a unit of service for which costs are ascertained. These cost units will be used to assess the efficiency and effectiveness of the organisation. The problem for a NFP organisation is that it may not have easily identifiable cost units, and it may not be possible to identify costs with specific outputs. Once appropriate cost units have been identified, however, they can be used to provide cost control information. Examples of costs units used by an NFP organisation are patients, wards, drug treatment programmes, bed-nights and operations, which are all used by a hospital.



Use of performance measures to measure output and quality

Where output for a NFP organisation can be quantified, targets can be set and performance against these targets can be measured. In a university, for example, targets could be set in terms of the number of students graduating with a first-class degree, the number of students in a tutorial group, and the percentage of students who complete a degree course having started it. Information could easily be gathered to enable an assessment of the University’s performance compared to agreed, budgeted or imposed targets.

Measuring performance in terms of quality is not so easy. It may be possible to use a surrogate or substitute performance measure if a quality cannot be directly measured. For example, the efficiency of hospital outpatient treatment could be measured by the average length of the queue for treatment. The quality of a University course could be assessed by a composite weighting of responses to individual student questionnaires.

Comparison of planned and actual performance

It is likely that a NFP organisation will have a budget that details expected levels of income (for example from donations and investments) and expenditure (for example on staff wages, continuing programmes, fixed overheads and planned purchases). The use and application of costing principles and information here is no different than in a profit-making organisation. Planned performance can be compared to actual performance, income and cost variances calculated and investigated, and corrective action taken to remedy under-performance.

Where objectives cannot be specified in terms of quantifiable targets, costing information will serve no purpose and assessment of actual performance with planned performance will need to be undertaken from a more subjective perspective.

(b) Key features of zero-based budgeting

Zero-based budgeting requires that activities be re-evaluated as part of the budget process so that each activity, and each level of activity, can justify its consumption of the economic resources available. This is in contrast to incremental budgeting, where the current budget is increased to allow for expected future conditions. Zero-based budgeting prevents the carrying forward of past inefficiencies that can be a feature of incremental budgeting and focuses on activities rather than departments or programmes. Each activity is treated as though it was being undertaken for the first time and is required to justify its inclusion in the budget in terms of the benefit expected to be derived from its adoption.

The first step in zero-based budgeting is the formulation of decision packages. These are documents which identify and describe a given activity or group of activities in detail. The base package represents the minimum level of activity that is consistent with the achievement of organisational objectives. Incremental packages describe higher levels of activity that may be delivered if they are acceptable from a cost-benefit perspective.

Following the formulation of decision packages, they are evaluated by senior management and ranked by decreasing benefit to the budgeting organisation. Resources should then be allocated, theoretically at least, to decision packages in order of decreasing marginal utility until all resources have been allocated.

Advantages claimed for zero-based budgeting are that it eliminates the inefficiencies that can arise with incremental budgeting, that it fosters a questioning attitude towards current activities and that it focuses attention on the need to obtain value for money from the consumption of organisational resources.



Value for money is important in not-for-profit (NFP) organisations, where the profit motive found in the private sector is replaced by the need to derive the maximum benefits from limited resources available. Providers of funds to NFP organisations expect to see their cash being used wisely, with as much as possible being devoted to the achievement of organisational aims. For this reason, NFP organisations emphasise cost control and the need for economy in the selection of resources, efficiency in the consumption of resources and effectiveness in the use of resources to achieve organisational objectives (i.e. value for money).

Zero-based budgeting can therefore be applied in a NFP organisation to analyse its activities and the services it provides into decision packages, with a view to ranking them on a cost-benefit basis relative to organisational aims and objectives. In has been noted that zero-based budgeting can be applied more effectively in service-based rather than manufacturing organisations and so it may be ideally suited to a NFP organisation such as a charity.

(c) Activity-based budgeting

Activity-based budgeting (ABB) would need a detailed analysis of costs and cost drivers so as to determine which cost drivers and cost pools were to be used in the activity-based costing (ABC_ system. However, whereas ABC uses activity-based recovery rates to assign costs to cost objects, ABB begins with budgeted cost-objects and works back to the resources needed to achieve the budget.

Once the budgeted activity levels have been determined, the demand for resource-consuming activities is assessed from an organisational perspective. The resources needed to provide for these activities are then assessed and action taken to ensure that these resources are available when needed in the budget period.

The budgeted activity levels are determined in the same way as for conventional budgeting in that a sales budget and a production budget are drawn up. ABB then determines the quantity of activity cost drivers (e.g. number of purchase orders, number of set-ups) needed to support the planned sales and production. Standard cost data would be compiled that included details of the activity cost drivers required to produce a product or number of products.

The resources needed to support the budgeted quantity of activity cost drivers would then be determined (e.g. number of labour hours to process purchase orders, number of maintenance hours needed to complete set-ups). This resource need would then be matched against the available capacity (i.e. number of purchase clerks to process purchase orders) to see whether any capacity adjustments were needed.

One advantage suggested for ABB is that organisational resources are allocated more efficiently due to the detailed cost and activity information obtained by implementing an ABB system. Another advantage of ABB is that it avoids the pitfalls of incremental budgeting due to its detailed assessment of the activities and resources needed to support planned sales and production. In ABB the costs of support activities are not seen as fixed costs to be increased by annual increments, but as depending to a large extent on the planned level of activity.



Answer 30 THE WESTERN

(a) Tonnes of waste calculation

In 2010 the four quarters will be numbers 5–8, consequently the trend figures for waste to be collected will be:

Quarter 1 (Q = 5): 2,000 + 25(5) = 2,125 tonnes Quarter 2 (Q = 6): 2,000 + 25(6) = 2,150 tonnes Quarter 3 (Q = 7): 2,000 + 25(7) = 2,175 tonnes Quarter 4 (Q = 8): 2,000 + 25(8) = 2,200 tonnes

Seasonal adjustments are needed thus:

Quarter 1: 2,125 – 200 = 1,925 Quarter 2: 2,150 + 250 = 2,400 Quarter 3: 2,175 + 150 = 2,325 Quarter 4: 2,200 – 100 = 2,100

Total tonnage is 1,925 + 2,400 + 2,325 + 2,100 = 8,750 tonnes for the year.

(b) Variable and fixed operating cost

Regression analysis can be used to calculate the variable operating and fixed operating costs in 2009.

Tonnes (X) Total Cost (Y) XY X2 $000’s 2,100 950 1,995,000 4,410,000 2,500 1,010 2,525,000 6,250,000 2,400 1,010 2,424,000 5,760,000 2,300 990 2,277,000 5,290,000 Sum 9,300 3,960 9,221,000 21,710,000 Y = a +bX

Where “a” is fixed operating cost and “b” is variable operating cost in this context.

Using the formula given:

b = (4 × 9,221,000 – 9,300 × 3,960)/(4 × 21,710,000 – (9,300)2)

b = 0.16 or $160 per tonne as the original data is in $000’s. This was the variable operating cost per tonne for 2009.

a = (3,960/4) – (0.16 × 9,300/4)

a = 618 or $618,000 as the original data is in $000’s. This was the fixed operating cost in 2009.

Allowing for inflation: The variable operating cost in 2010 will be $160 × 1.05 = $168 per tonne The fixed operating cost in 2010 will be $618,000 × 1.05 = $648,900



(c) Advantages and disadvantages of incremental budgeting approach

Advantages

Local government organisations are often complex and incremental budgeting will be seen as a simple approach to a budget that will take little effort.

Budget processes can be long ones, however incremental approaches do tend to be quicker than most. Complex local government organisations can suffer from very long budget processes and incremental budgeting can alleviate this a little.

Disadvantages

Public bodies, such as local governments, will be encouraged to use up this year’s entire budget in order to ensure that next year’s budget will be as high as possible to give them the flexibility they need to do whatever is needed. The public services required can be unpredictable and so local government organisations prefer to be able to be flexible.

Overspends made in this year will be budgeted for again next year, this is hardly giving taxpayers value for money.

Answer 31 STORRS CO

(a) Sales forecast

The centred moving averages can be compared with actual sales for each quarter in order to determine the seasonal variations.

Quarter Actual Centred Seasonal Sales moving average variation $000 $000 $000 201X Q3 3,400 3,200 200 Q4 3,000 3,300 (300) 201Y Q1 3,100 3,375 (275) Q2 3,900 3,450 450 Q3 3,600 3,562.5 37.5 Q4 3,400 3,687.5 (287.5) The average seasonal variations and the residual error term can now be calculated.

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total $0000 $000 $000 $000 $000 201X 200 (300) 201Y (275) 450 37.5 (287.5) Average (275) 450 118.75 (293.75) nil Since the residual error term is nil, there is no need to net this off against the average seasonal variations. The average trend of the centred moving averages is (3,687.5 – 3,200)/5 = $97,500

The sales for Quarter 3 of 201Z can now be forecast.



Forecast centred moving average = 3,687.5 + (3 × 97.5) = $3,980,000 Forecast sales for Quarter 3 = 3,980,000 + 118,750 = $4,098,750

The sales for Quarter 4 of 201Z can now be forecast.

Forecast centred moving average = 3,687.5 + (4 × 97.5) = $4,077,500 Forecast sales for Quarter 4 = 4,077,500 – 293,750 = $3,783,750

Both forecasts are higher than those made by the Sales Director (7.9% more for the Quarter 3 forecast and 5.1% for the Quarter 4 forecast). This may be because the Sales Director built some slack into his forecasts, or because the forecasts were made using data prior to the current year (although applying the additive model to earlier sales data does not support this).

(b) Limitations of the sales forecasting method

The additive model assumes that the trend and seasonal variations are independent of each other, and that an increasing trend is not linked to increasing seasonal variations. There is no evidence of an increasing trend in the sales of Storrs, and in such circumstances use of the additive model may be acceptable.

The model assumes that the historic pattern of the trend and the seasonal variations will continue in the future. This may not happen for a number of reasons, for example because of the occurrence of unexpected events or because of changes in consumer preferences. The forecast sales figures should be compared with the expectations and opinions of sales staff, who may have a more detailed knowledge of likely sales and market factors.

The reliability of the forecasting method is linked to the amount and accuracy of the data analysed. Since only two years of data has been considered, the forecast is unlikely to be reliable. The reliability of the forecast will also decrease as the forecasting period increases, but the forecast period here is only six months.

(c) Relative merits of top-down and bottom-up approaches

The top-down approach to budget setting implies that senior management imposes budgets. This has the advantage that budgets are more likely to support the strategic objectives of the company, and the operations of different divisions are more likely to be co-ordinated. It may be an appropriate form of budget setting in small organisations, where senior managers are likely to have a detailed knowledge of all aspects of the business, or in situations where close control of planned costs is called for, such as business start-up or difficult economic conditions. It also has the advantage of decreasing the amount of time taken, and the resources consumed, by budget preparation.

There are number of difficulties with the top-down approach that make it likely that it will not regularly be used in isolation. Staff may be de-motivated if they have not been involved in the formulation of budgets that produce targets they are expected to achieve, especially if their rewards and incentives are linked to their performance against budget. This reduction in motivation could result in strategic objectives and organisational goals being less than fully supported at the operational level, with company performance and profitability suffering as a result. Initiative and innovation could also be lost as staff simply “work to budget”, rather than making creative suggestions for improving performance that they feel are unlikely to be rewarded, or form part of future plans.



The bottom-up approach to budget setting implies that functional and other junior managers participate in the preparation of budgets. This approach is likely to lead to more realistic and more co-ordinated budgets than the top-down approach if these managers have a more detailed knowledge of the operations and markets of the organisation. It is also likely to be useful in large, established companies where the complexity of the budget-setting process calls for detailed input from lower levels of the organisation. This approach will also lead to higher levels of motivation and commitment, since managers will have contributed towards the targets against which their performance will be measured.

There are a number of difficulties with the bottom-up approach. For example, it can be more time-consuming than the top-down approach because of the larger number of participants in the budget-setting process. Participants may become dissatisfied if senior managers subsequently amend their budget proposals. Managers may introduce an element of budgetary slack into their budget estimates, giving them a “zone of comfort” in reaching budget targets. Any variances between planned and actual performance are then likely to be favourable ones. The bottom-up approach also requires detailed planning and co-ordination of the budget-setting process, perhaps supported by a budget manual.

The top-down and bottom-up approaches represent two extremes of the budget-setting process. In practice, a compromise or negotiated approach is likely to be used, with senior management reviewing and amending the budget proposals of junior or operational managers in the light of the organisation’s strategic plan, and junior or operational managers negotiating amendments to aspects of the budget they find unacceptable.

Answer 32 SOUTH

(a) Regression analysis

x y xy x2 units $000 300 3.8 1,140 90,000 400 4 1,600 160,000 150 3 450 22,500 260 3.5 910 67,600 ––––– –––– ––––– ––––––– 1,110 14.3 4,100 340,100 ––––– –––– ––––– ––––––– n = 4

b = 2(1,110) - 340,100 414.3 1,110 - 4,100 4

×××

b = 128,300

527 = 0.0041

a = 4

14.3 – 0.0041 × 4

1,110

a = 2.437

Total cost = 2.437 + 0.0041 × activity (with total cost in $000)

Total cost = 2,437 + 4.1 × activity (with total cost in $)



(b) Total cost

Total cost at 200 units = 2,437 + 4.1 × 200 = $3,257. Since the value of 200 units lies within the range of the data (i.e. interpolation) some reliance can be placed on the value generated.

Total cost at 500 units = 2,437 + 4.1 × 500 = $4,487 Since the value of 500 units lies outside the range of the data (i.e. extrapolation) very little reliance can be placed on the value generated.

Answer 33 HENRY CO

(a) Factors to consider in calculating bid

There are various issues that HC should consider in making the bid. (Only five are required for two marks each.)

Contingency allowance. HC should consider the extent to which its estimates are accurate and hence the degree of uncertainty it is subjected to. It may be sensible to allow for these uncertainties by adding a contingency to the bid.

Competition. HC must consider which other businesses are likely to bid and recognise that the builder may be able to choose between suppliers. Moreover, HC has not worked for this builder before, and so they will probably find the competition stiff and the lack of reputation a problem.

Inclusion of fixed overhead. In the long run fixed overhead must be covered by sales revenue in order to make a profit. In the short run it is often correctly argued that the level of fixed cost in a business may not be affected by a new contract and therefore could be ignored in bid calculation. HC needs to consider to what extent the fixed costs of its business will change if it wins this new contract. It is these incremental fixed costs that are relevant to a bid calculation.

Materials and loose tools. No allowance has been made for the use of tools and the various fixings (screws etc.) that will be needed to assemble and fit the kitchens. It is possible that most fixings would be provided with the kitchen units, but HC should at least consider this.

Supervision of labour. The time given in the question is 24 hours to “fit” the first kitchen. There seems to be no allowance for supervision of the labour force. It could, of course, be included in the overhead figures but no detail is shown.

Idle time. It is common for building works to be delayed by lack of materials for example. The labour time figure needs to reflect this.

Likelihood of repeat business. Some businesses consider it worthwhile to accept a low price for a new contract if it establishes a reputation with a new buyer. HC could offer to do this work cheaper in the hope of more profitable work later on.

The risk of non-payment. HC may decide not to bid at all if it feels that the builder may struggle to pay.

Opportunity costs of alternate work.

Possibility of working in overtime.



(b) Total cost

Bid calculations for HC to use as a basis for the apartment contract.

Cost Hours Rate per hour Total $ Labour 9,247 (W1) $15 138,705 Variable Overhead 9,247 $8 (W2) 73,976 Fixed Overhead 9,247 $4 (W2) 36,988 ––––––– Total Cost 249,669 ––––––– WORKINGS

(1) Learning curve effect

Need to calculate the time for the 200th kitchen by taking the total time for the 199 kitchens from the total time for 200 kitchens.

For 199 Kitchens

Using y = axb OR y = axb y = 24x199–0.074 y = (24 × 15) × 199–0.074 y = 16.22169061hours y = 243.32536 Total time = 16.22169061 × 199 Total cost = $48,421.75 Total time = 3,228·12hours For 200 Kitchens

y = axb OR y = axb y = 24x200–0.074 y = (24 × 15) × 200–0.074 y = 16.21567465hours y = 243.2351198 Total time = 16.21567465 × 200 Total cost = $48,647.02 Total time = 3,243.13hours 200th cost = $225.27 The 200th Kitchen took 3,243.13 – 3,228.12 = 15.01 hours

Total time is therefore: For first 200 3,243.13 hours For next 400 (15.01 hours × 400) 6,004.00 hours Total 9,247.13 hours (9,247 hours) (2) Analysis between variable and fixed cost elements

Taking the highest and lowest activity levels from the information given:

Hours Cost $ Highest 9,600 116,800 Lowest 9,200 113,600 Difference 400 3,200 Variable cost per hours is $3,200/400hours = $8 per hour



Total cost = variable cost + fixed cost

116,800 = 9,600 × 8 + fixed cost

Fixed cost = $40,000 per month Annual fixed cost = $40,000 × 12 = $480,000

Fixed absorption rate is $480,000/120,000 hours = $4 per hour

(c) Calculation of learning rate

A table is useful to show how the learning rate has been calculated:

Number of Time for Kitchen Cumulative time Average time Kitchens (hours) (hours) (hours) 1 24.00 24.00 24.00 2 21.60 45.60 22.80 The learning rate is calculated by measuring the reduction in the average time per kitchen as cumulative production doubles (in this case from 1 to 2).

The learning rate is therefore 22.80/24.00 or 95%.

Answer 34 BIG CHEESE CHAIRS

(a) Average cost

First 128 chairs $ Frame and massage mechanism 51.00 Leather 2 metres × $10/metre × 100/80 25.00 Labour (W1) 20.95 –––––– Total 96.95 –––––– Target selling price is $120. Target cost of the chair is therefore $120 × 80% $96 Cost gap $0.95 per chair

WORKING

(1) Labour cost

Tutorial note: This is calculated using learning curve principles. Either the formula or a tabular approach would give the average cost of 128 chairs. Both methods are acceptable.

Cumulative output Average time per Total time Average cost per (units) unit (hours) (hours) chair at $15 per hour 1 2 2 1.9 4 1.805 8 1.71475 16 1.6290125 32 1.54756188 64 1.47018378 128 1.39667459 178.77 20.95



Formula:

Y = axb Y = 2 × 128–0·074000581 Y = 1.396674592

The average cost per chair is 1.396674592 × $15 = $20.95

(b) Closing the cost gap

To reduce the cost gap various methods are possible (only four are needed for full marks):

Re-design the chair to remove unnecessary features and hence cost.

Negotiate with the frame supplier for a better cost. This may be easier as the volume of sales improve as suppliers often are willing to give discounts for bulk buying. Alternatively a different frame supplier could be found that offers a better price. Care would be needed here to maintain the required quality.

Leather can be bought from different suppliers or at a better price also. Reducing the level of waste would save on cost. Even a small reduction in waste rates would remove much of the cost gap that exists.

Improve the rate of learning by better training and supervision.

Employ cheaper labour by reducing the skill level expected. Care would also be needed here not to sacrifice quality or push up waste rates.

(c) Calculation of cost

The cost of the 128th chair will be:

$ Frame and massage mechanism 51.00 Leather 2 metres × $10/metre × 100/80 25.00 Labour 1.29 hours × $15 per hour (W2) 19.35 –––––– Total 95.35 –––––– Against a target cost of $96 the production manager is correct in his assertion that the required return is now being achieved.

WORKING

(2)

Using the formula to calculate the cost of the first 127 chairs and then deducting that cost from the cost of the first 128 chairs gives:

Y = axb Y = 2 × 127–0.074000581 Y = 1.39748546 Total time is 127 × 1.39748546 = 177.48 hours Time for the 128th chair is 178.77 – 177.48 = 1.29 hours



Answer 35 STANDARD COSTING

Standard costing has been employed for many years in situations where there is a significant degree of repetition in the production process or the service supplied. Repetition is a condition since standards presuppose that averages, as expected values, are accurate to a fair degree.

The main uses of standard costing relate to:

Valuation of inventory and costs of production for reporting purposes, either internally or for statutory reasons.

Providing an excellent management device, which enables costs to be monitored, reviewed and controlled.

Enabling exception reporting through the use of variance analysis. Exception reporting allows management to exercise control with a lower degree of effort and less time than otherwise would be the case.

Assisting in the budgeting process. Standards, once established in a business, become the common language by which performance is discussed and measured.

Evaluating managerial performance.

Motivation of staff by setting standards at levels to which staff feel able to respond. In this respect, standards have been characterised as “ideal”, “attainable”, “current”, and “basic” as a way of categorising the different ways standards may be viewed in terms of their motivational impact.

Improving efficiency. Standard setting is often viewed as a way of understanding the detail of a process through monitoring its important components. If standards are an accurate reflection of a process, then they can be used to highlight ways of improving efficiency and act as signals when the process becomes inefficient.

Once standards have been set they cannot be assumed to be accurate over long periods of time. Standards have to be reviewed to enable the benefits of standard costing to continue. In this respect, standards must change with the changing practices of an organisation. For example, in environments that continuously seek greater efficiency and reduced costs of production, standards have to change to reflect such improvements. In fact, under such circumstances, standards can very quickly become out of date. In order to review standards, they must be continually assessed to ensure that the basis of their calculation still applies. Moreover, other purposes of standards are undermined if they are not continually reviewed. Thus, for example:

The motivational impact of standards may no longer be effective if standards are out of date.

Assessment of managerial performance becomes inaccurate.

Reporting procedures are undermined.

The credibility of standards in their role in assisting with the budget setting process is called into question.

The fate of standard costing as a management tool is put at risk if management do not trust the standards. Alternative mechanisms for management control inevitably emerge which may be undesirable, untested and lack organisational approval.



Answer 36 INFORMATION SOURCE

(a) Purposes of standard costing

A standard costing system can support a wide range of management requirements. For example:

It can help in the development of budgets; standards are in effect the building blocks of periodic budgets.

If handled correctly by management the existence of an appropriately set standard can act as a target and hence become a source of employee motivation

To the extent that standards are measures of expected performance by departments or individuals standard costs are the basis for measuring performance.

Following on from the above, the variances that are derived from standard costs act as a control device by highlighting those activities that are different from plans. This signals to decision makers the need for action to take advantage of any circumstances that have produced favourable variances or minimise the repercussions of any adverse variances.

Standard costs are predicted future costs, which can be used to support decision making, for example in making pricing decisions.

In manufacturing companies a key requirement of costing is the valuation of inventory. Standard costs simplify the process of tracing costs to products for inventory valuation.

NB. The question asks for four of the above.

(b) Different levels of performance

Basic standards – such standards are left unchanged for a long period, perhaps from the inception of the product or service concerned. They may be useful in demonstrating a progression of improved performance over a period of time, but do not represent current targets. Therefore, they do not motivate, they do not result in representative unit costs and are inappropriate as predicted costs for decisions.

Ideal standards – these represent perfect performance and the most efficient operating conditions reflecting the lowest possible costs. They are a useful objective to which the firm can aspire over the long term but firms will rarely achieve this level of performance consistently. As a result adverse variances will almost always be reported, this will inevitably have an adverse effect on employee attitude and motivation. They represent budget figures which are too tight and inappropriate from which to set prices or to use directly as performance measures in most circumstances.

Currently attainable standards – these standards represent costs, which should be attained under current efficient operating conditions. They are a reasonable target and represent a likely level of future costs if operations are managed efficiently. They are a level of performance, which does not demotivate staff. They are therefore the figures that can be used to manage the current operations of a business unit. They are figures that can support planning and decision-making and as current cost levels they are appropriate for inventory valuation. It should be expected that most companies would run their systems based on these standards. The first two levels mentioned above may, on the other hand, be useful for strategic purposes, demonstrating on an ad hoc basis, how far the company has come or how far it has to go.



(c) Standard costing application

Standard costing is most suited to organisations whose activities consist of a series of common or repetitive operations. Typically, mass production manufacturing operations are indicative of its area of application. It is also possible to envisage operations in the service sector to which standard cost may apply, though this may not be costed with the same degree of accuracy of standards that apply in manufacturing. For example, hotels and restaurants often use standard recipes for food preparation; dealing with conference attendance can be like a mass production environment. Similarly, banks will have common processes for dealing with customer transactions, processing cheques etc. It is possible therefore that the principles of standard costing may be extended to service industries.

In modern manufacturing and service businesses, continuous improvement and cost reduction are topical. In order to remain competitive it is essential that businesses address the cost levels of their various operations. To do this they have to deal with the costing of operations. But the drive to “cost down” may mean in some cases that standards do not apply for long before a redesign or improvement renders them out of date. In such a setting an alternative to the use of standard costs is to compare actual costs with those of the previous operating period. As seen in (a) above, a standard costing system has a variety of purposes. It is for management to judge their various reasons for employing standard costing, and consequently whether their aims of continuous improvement and cost reduction render the system redundant.

(d) Factors which limit the usefulness of variances

Standard costing variances are a convenient way of summarising the results of an operating period by focusing on the financial impact of deviations from a budgeted result. The variances, which can be identified as to cause and responsibility, are in total the absolute difference that actual results bear to an original plan. The exercise of variance analysis is not without difficulty however, and the following is a critique of the technique, bringing out some of the practical problems.

For direct costs the traditionally adopted formula creates an analysis of price and usage variances. However, this division is only by the convention of the variance formula and the existence of joint variances influenced by a combination of price and usage could also be compiled in certain circumstances, say when remuneration is based on the results of the reported variance.

The complexity of the variance calculation can at times however, be taken too far, for example the extraction of mix, yield and price variances say in relation to materials costs can be questionable. Most of these variances can be inter-related. It is dangerous to interpret individual variances in isolation, interdependency should be recognised.

Concerning variable and fixed overheads, the level of costs is controllable against a budget and this is often a fixed budget. When activity levels change it is important to remember that the variable costs need to be flexed to allow for this. This raises the problem of which costs to flex and what measure of activity (i.e. number of units, hours of work etc.) to use as the basis of flexing. There is unlikely to be exact correlation between the measure of activity chosen (say labour hours) and the cost change, therefore care should be exercised in the interpretation of these variances. A comparison of the actual and standard activity levels facilitates the extraction of an efficiency variance in relation to variable overheads. Whether the results of such analysis reflect a more or less efficient use of variable overhead resources has been questioned.



Perhaps the variance that attracts most criticism is the fixed overhead volume variance. This variance represents the fixed overhead cost or benefit of working at a volume level below or above that that was budgeted. Though it is important to reconcile budget and actual volumes, the value applied to the volume variance does not report a meaningful cost in all circumstances. For example, as costs are fixed, by definition, extra volume, if available, is “free” up to a certain limit. In other circumstances if time is scarce then the cost of any time wasted, for example, may be far higher than the fixed overhead rate. It has been pointed out that the calculation of an overhead recovery rate per unit or per hour applied to fixed overheads may be unhelpful because it is in effect treating fixed overheads as if they were variable costs.

Tutorial note: In the latter stages of this question, especially parts (c) and (d), there is scope for slightly different content or views to be expressed than those in the outline answer. Credit will be given for points other than those stated above.

Answer 37 WOODEEZER CO

(a) Operating statement $ Budgeted profit (4,000 × $28) 112,000 Sales volume profit variance (3,200 – 4,000) $28 (22,400) A ––––––– Standard profit on actual sales 89,600 Selling price variance (225 – 220) 3,200 16,000 F ––––––– 105,600 Cost variances Favourable Adverse Material usage [(3,600 × 25) – 80,000] $3·2 32,000 Material price (3·2 – 3.5) 80,000 24,000 Labour efficiency [(4 × 3,600) – 16,000)] $8 12,800 Labour rate (8 – 7) 16,000 16,000 Var O/H efficiency [(4 × 3,600) – 16,000)] $4 6,400 Var O/H expenditure ($4 × 16,000) – 60,000 4,000 Fixed O/H expenditure (256,000 – 196,000) 60,000 Fixed O/H efficiency [(4 × 3,600) – 16,000)] $16 25,600 Fixed O/H capacity [16,000 – (4 × 4,000)] $16 nil ––––––– ––––––– 112,000 68,800 43,200 ––––––– ––––––– ––––––– Actual profit 148,800 –––––––

(b) Impact of operational changes

Motivation and budget setting

Absorption costing profit has increased by $53,600 from $95,200 (28 × 3,400) to $148,800.

It would appear that in the past an expectations budget has been set whereby the target output was set at the level that employees were expected to achieve.

Mr Beech appears to have considered the evidence that suggests that the best budget for motivating employees to maximise achievement (in this case output) is one which is difficult but credible (an aspirations budget). In maximising actual performance, however, it is normally expected that production will fall short of the budget target. This means that there is an expectation of adverse planning variances.



Explanations of variances

The sales volume variance and the sales price variance may be inter-related as an increase in price is likely to reduce demand, thus an adverse sales volume variance is consistent with a favourable sales price variance given the price increase.

Better quality materials are being purchased by Mr Beech and, given this was not foreseen at the time of the budget, it may explain a higher price resulting in an adverse materials price variance. Conversely, with better materials there may be less waste and thus it may have contributed to the favourable materials usage variance.

The lower skilled labour may account for the favourable labour rate variance but may also account for the adverse labour efficiency variance as less skilled labour may take longer to complete a given task. Also if new labour is introduced there may be an initial learning effect.

The impact of the labour efficiency variance is magnified by the variable and fixed overhead efficiency variances as they are merely linear functions of the labour efficiency variance. Their meaning is questionable however, as variable overheads seldom vary proportionately to labour hours. By definition fixed overheads do not vary with labour hours and this variance merely “balances the books” in an absorption costing system.

The fixed overhead expenditure variance is significant and requires further consideration. This is particularly the case if it involves discretionary expenditure which has been reduced but which may have a long-term impact on the business.

(c) Marginal costing

Marginal cost statement (this could be in summarised form by candidates) $ Budgeted contribution (4,000 × $92) 368,000 Sales volume variance (3,200 – 4,000) $92 (73,600) A ––––––– Standard contribution on actual sales 294,400 Sales price variance (220 – 225) 3,200 16,000 F ––––––– 310,400 Cost variances Favourable Adverse Materials usage [(3,600 × 25) – 80,000] $3.2 32,000 Materials price (3.2 – 3.5) 80,000 24,000 Labour efficiency [(4 × 3,600) – 16,000)] $8 12,800 Labour rate (8 – 7) 16,000 16,000 Var O/H efficiency [(4 × 3,600) – 16,000)] $4 6,400 Var O/H expenditure ($4 × 16,000) – 60,000 4,000 –––––– –––––– 52,000 43,200 8,800 ––––––– Actual contribution 319,200 Fixed overheads Budgeted 256,000 Expenditure variance 60,000 ––––––– (196,000) ––––––– Actual profit 123,200 –––––––



Reconciliation Absorption costing profit 148,800 Fixed costs in inventory [400 × $64] (inventory is now restated to variable cost) (25,600) ––––––– Variable costing profit 123,200 ––––––– Thus some of the “success” of Mr Beech in increasing profit arises from the fact that fixed overheads of $25,600 are not being written off in the current month but are being carried forward as part of closing inventory, notwithstanding that they are period costs and are thus sunk. Unless sales can be increased this position is unsustainable.

Nevertheless, some improvement has been made as the previous contribution was, taking the budget as the historic norm, $312,800 [3,400 × ($220 – 128)], which is lower than the $319,200 achieved by Mr Beech. The difference is, however, much lower than would be implied by the absorption costing statement.

Answer 38 MERMUS CO

(a) Revised budget using flexible budgeting

The flexed budget will be based on the actual activity level of 90,000 units.

$ $ Sales: $950,000 × 90/95 = 900,000 Cost of sales Raw materials: 133,000 × 90/95 = 126,000 Direct labour: 152,000 × 90/95 = 144,000 Variable production overheads: 100,700 × 90/95 = 95,400 Fixed production overheads: 125,400 ––––––– 490,800 ––––––– 409,200 –––––––

(b) Variance calculations

Raw materials cost total variance = 126,000 – 130,500 = $4,500 (Adverse) Direct labour cost total variance = 144,000 – 153,000 = $9,000 (Adverse) Fixed overhead absorption rate = 125,400/28,500 = $4.40 per machine hour Standard machine hours for actual production = 28,500 × 90/95 = 27,000 hours Standard fixed overhead (actual production) = 27,000 × 4.4 = $118,800 Fixed overhead absorbed on actual hours = 27,200 × 4.4 = $119,680 Fixed overhead efficiency variance = 118,800 – 119,680 = 880 (Adverse) Fixed overhead absorbed on actual hours = 27,200 × 4.4 = $119,680 Fixed overhead absorbed on budgeted hours = 28,500 × 4.4 = $125,400 Fixed overhead capacity variance = 119,680 – 125,400 = $5,720 (Adverse) Budgeted overhead expenditure = $125,400 Actual overhead expenditure = $115,300 Fixed overhead expenditure variance = 125,400 – 115,300 = $10,100 (Favourable)



(c) Variance explanations

Raw materials cost variance

The budgeted raw material cost for production of 95,000 units was $1.40 per unit (133,000/95,000) but the actual raw material cost for production of 90,000 units was $1.45 per unit (130,500/90,000). The raw material cost per unit may have increased either because more raw materials per unit were used than budgeted, or because the price per unit of raw material was higher than budgeted. Calculation of the raw material price and usage sub-variances would indicate where further explanation should be sought.

Fixed overhead efficiency variance

The fixed overhead efficiency variance measures the extent to which more or less standard hours were used for the actual production than budgeted. In this case, a total of 27,200 machine hours were actually used, when only 27,000 standard machine hours should have been used. The difference may be due to poorer production planning than expected or to machine breakdowns.

Fixed overhead expenditure variance

The fixed overhead expenditure variance measures the extent to which budgeted fixed overhead differs from actual fixed overhead. Here, actual fixed overhead is $10,100 less than budgeted. This could be due to an error in forecasting fixed production overheads such as rent and power costs, or to a decrease in fixed production overheads, such as changing to a cheaper cleaning contractor.

(d) Purposes of a budgeting system

Key purposes of a budgeting system that could be discussed include planning, co-ordination, communication, control, motivation and performance evaluation. Students were required only to discuss three key purposes.

Planning

One of the key purposes of a budgeting system is to require planning to occur. Strategic planning covers several years but a budget represents a financial plan covering a shorter period (i.e. a budget is an operational plan). Planning helps an organisation to anticipate key changes in the business environment that could potentially impact on business activities and to prepare appropriate responses. Planning also ensures that the budgeted activities of the organisation will support the achievement of the organisation’s objectives.

Co-ordination

Many organisations undertake a number of activities, which need to be co-ordinated, if the organisation is to meet its objectives. The budgeting system facilitates this co-ordination since organisational activities and the links between them are thoroughly investigated during budget preparation, and the overall coherence between the budgeted activities is reviewed before senior managers agree the master budget. Without the framework of the budgeting system, individual managers may be tempted to make decisions that are not optimal in terms of achieving organisational objectives.



Communication

The budgeting system facilitates communication in the organisation both vertically (for example between senior and junior managers) and horizontally (for example between different organisational functions). Vertical communication enables senior managers to ensure that employees at all levels understand organisational objectives. Communication also occurs at all stages of the budgetary control process, for example during budget preparation and during investigation of end-of-period variances.

Control

One of the most important purposes of a budgeting system is to facilitate cost control through the comparison of budgeted costs and actual costs. Variances between budgeted and actual costs can be investigated in order to determine the reason why actual performance has differed from what was planned. Corrective action can be introduced if necessary in order to ensure that organisational objectives are achieved. A budgeting system also facilitates management by exception, whereby only significant differences between planned and actual activity are investigated.

Motivation

The budgeting system can influence the behaviour of managers and employees, and may motivate them to improve their performance if the target represented by the budget is set at an appropriate level. An inappropriate target has the potential to be de-motivating, however, and a key factor here is the degree of participation in the budget-setting process. It has been shown that an appropriate degree of participation can have a positive motivational effect.

Performance evaluation

Managerial performance is often evaluated by the extent to which budgetary targets for which individual managers are responsible have been achieved. Managerial rewards such as bonuses or performance-related pay can also be linked to achievement of budgetary targets. Managers can also use the budget to evaluate their own performance and clarify how close they are to meeting agreed performance targets.

Answer 39 MURGATROYD CO

(a) Reconciliation of standard cost and actual cost

$ $ Standard cost of actual production 9,000 units × $(15 + 20 + 12) 423,000 Total variances: Direct materials (W1) 3,000 A Direct labour (W2) 2,000 F Fixed overheads (W3) 5,000 F ———— 4,000 F ———— Actual cost 419,000 ————



WORKINGS

(1) Materials $ Variance ($) Actual 138,000 3,000 A Standard cost of actual production (9,000 × $15) 135,000

(2) Labour

Actual 178,000 2,000 F Standard cost of actual production (9,000 × $20) 180,000

(3) Fixed overhead

Actual 103,000 5,000 F Standard cost of actual production (9,000 × $20) 108,000

(b) Direct materials cost variance

Actual quantity × actual cost 138,000 Price 6,000 F Actual quantity × standard cost 144,000 (24,000 × $6) Usage 9,000 A Standard quantity for actual production X standard cost [(as in (a)] 135,000

(c) Setting the standard price and standard quantity for direct materials

(i) Standard price

The standard price per litre is set by the person in the organisation with the specialist knowledge about the prices charged by suppliers for the raw materials used by Murgatroyd. This would be the manager responsible for purchasing (sometimes referred to as the Buying Manager or the Procurement Manager).

(ii) Standard quantity

The standard quantity per unit is set by the person in the organisation with the specialist knowledge about the product specification and the amount of each raw material that should be used in the manufacture of one unit of the product. This would be a manager in the production (manufacturing) function or technical department in Murgatroyd.

Answer 40 CHAFF CO

(a) Performance evaluation

When assessing variances it is important to consider the whole picture and the interrelationships that exist. In Chaff there appears to be doubt about the wisdom of some of the decisions that have been made. Favourable variances have been applauded and adverse variances criticised and the managers in charge dispute the challenge to their actions.



Purchasing manager. The purchasing manager has clearly bought a cheaper product, saving $48,000. The cause of this is not specified and it could be due to good buying or negotiation, reductions in quality or changes in overall market conditions. The market for buying seeds is stable so there is more likely to be an internal reason for the problem. The material usage variance is significantly adverse, indicating much more waste than is normal has occurred in month 1. This suggests that the quality of the seed bought was poor and as a result a $52,000 excess loss has occurred. It is possible that the labour force working poorly or too quickly caused the waste and this has to be considered.

The sales price achieved is also well down on standard with the sales price variance showing an $85,000 loss of revenue and (therefore) profit. The market for sales of brown rice is stable so it is reasonable to presume that the fall in sales price achieved is as a result of internal quality issues rather than general price falls. The purchasing manager of the only ingredient may well be responsible for this fall in quality. This may have also led to a fall in the volume of sales, another $21,000 of adverse variance.

In conclusion the purchasing manager appears mainly responsible for a loss of $110,000* taking the four variances above together.

* ($85,000 + $52,000 + $21,000 – $48,000)

Production director. The production director has increased wage rates and this has cost an extra $15,000 in month 1. However one could argue that this wage increase has had a motivational effect on the labour force. The labour efficiency variance is $18,000 favourable; and so it is possible that a wage rise has encouraged the labour force to work harder. Academic evidence suggests that this effect might only be temporary as workers get used to the new level of wages.

Equally the amount of idle time has reduced considerably, with a favourable variance of $12,000 resulting. Again it is possible that the better-motivated labour force has been more willing to work than before. Idle time can have many causes, including, material shortages or machine breakdowns. However, the machines are running well and the buyer has bought enough rice seeds.

In conclusion the increase in the wage rate did cost more money but it may have improved morale and enhanced productivity. The total of the three variances above is $15,000* favourable. *($18,000 + $12,000 – $15,000)

Maintenance manager. The maintenance manager has decided to delay the annual maintenance of the machines and this has saved $8,000. This will increase profits in the short term but could have disastrous consequences later. In this case only time will tell. If the machines breakdown before the next maintenance then lost production and sales could result.

The maintenance manager has only delayed the spending and has not prevented it altogether. A saving of $8,000 as suggested by the variance has not been made. It is also possible that the adverse variable overhead expenditure variance has been at least partly caused by poor machine maintenance.

The variance calculated is not the saving made as it represents a timing difference only. The calculation also ignores the risks involved.




The standard contribution is given, but could be calculated as follows (not required by the question but shown as a proof): $ $ Sales price 240 Less: Rice seed (1.4 Tonnes × $60/tonne) 84 Labour (2 hours × $20/hr) 40 Variable overhead (2 hours × $30/hr) 60 ––– Marginal costs of production 184 ––– Standard contribution 56 ––– The standard labour charge needs to be adjusted to reflect the cost to the business of the idle time. It is possible to adjust the time spent per unit or the rate per hour. In both cases the adjustment would be to multiply by 10/9 – a 10% adjustment. In the case above the rate per hour has been adjusted to $18 × 10/9 = $20/hr. (Both approaches would gain full marks.)

In order to reconcile the budget profit to the actual profit, both these profits need to be calculated and an operating statement prepared.

Budget profit statement for month 2

$ $ Sales (8400u × $240/u) 2,016,000 Less: Rice seed (1.4 tonnes × $60/tonne × 8,400 tonnes) 705,600 Labour (2 hours × $20/hr × 8,400 tonnes) 336,000 Variable overhead (2 hours × $30/hr × 8,400 tonnes) 504,000 ––––––––– Marginal costs of production 1,545,600 ––––––––– Contribution 470,400 Less Fixed costs 210,000 ––––––––– Budget profit 260,400 ––––––––– Actual profit for month 2

$ $ Sales 1,800,000 Less: Rice seed 660,000 Labour 303,360 Variable overhead 480,000 ––––––––– Marginal costs of production 1,443,360 ––––––––– Contribution 356,640 Less Fixed costs 200,000 ––––––––– Actual profit 156,640 –––––––––



Operating statement for month 2

$ $ $ Budget contribution 470,400 Variances: Adverse Favourable Sales price 120,000 Sales volume 22,400 ––––––– 142,400 ––––––– 328,000 Material price 60,000 Material usage 48,000 Labour rate 18,960 Labour efficiency 20,000 Idle time 15,600 Variable overhead efficiency 30,000 Variable overhead expenditure 30,000 –––––– ––––––– 96,960 125,600 28,640 ––––––– Actual contribution 356,640 Budget fixed cost 210,000 Less: Fixed cost expenditure variance 10,000 ––––––– Actual fixed cost 200,000 ––––––– Actual profit 156,640 –––––––

WORKINGS for the variances in month 2

1. Sales price: (225 – 240) 8,000 = 120,000 Adverse

2. Sales volume: (8,000 – 8,400) 56 = 22,400 Adverse

3. Material price:

− 60

12,000660,000 12,000 = 60,000 Favourable

4. Material usage: (12,000 – 11,200*) 60 = 48,000 Adverse *(8,000 × 1·4 = 11,200)

5. Labour rate: (19·20 – 18) 15,800 = 18,960 Adverse

6. Labour efficiency: (15,000 – 16,000) 20 = 20,000 Favourable

7. Idle time: (800 – 1,580*) 20 = 15,600 Favourable *10% of 15,800

8. Variable overhead expenditure:

− 30

15,000480,000 15,000 = 30,000 Adverse

9. Variable overhead efficiency variance: (15,000 – 16,000) 30 = 30,000 Favourable



Alternative calculations if standard hours adjusted for expected idle time and not the rate.

Standard cost (2 hours × 10/9) × $18 = $40 per tonne or 2·222 hours × $18 = $40 per tonne

Rate variance as above = 18,960 Adverse

Idle time: (800 – 1,580) 18 = 14,040 Favourable

Efficiency variance: (15,000 – 16,197.77777*) 18 = 21,560 Favourable * (standard time allowed less standard idle time) Standard time is 8,000 tonnes × 2.222 hours = 17,777.777 hours Standard idle time is 10% of 15,800 = 1,580 hours Therefore expected working hours is 17,777.777 – 1,580 = 16,197.777 hours Tutorial note: There are many alternative methods of dealing with this issue, any reasonable attempt was accepted.

Answer 41 CRUMBLY CAKES

(a) Performance evaluation

Production manager

Assessing the performance of the two managers is difficult in this situation. In a traditional sense the production manager has seriously over spent in March following the move to organic ingredients. He has a net adverse variance against his department of $2,300 in one month. No adjustment to the standards has been made to allow for the change to organic.

The manager has not only bought organically he has also changed the mix, increasing the input proportion of the more expensive ingredients. This may have contributed to the increased sales of cakes.

However, the decision to go organic has seen the sales of the business improve; the taste of the cakes should be better and customers could perceive a health benefit. However, the production manager is allocated none of the favourable sales variances that result. Assuming that the improved sales are entirely as a result of the production manager’s decision to change the ingredients, then the overall net favourable variance is $7,700.

The production manager did appear to be operating in the original standard in February, indicating a well performing department. Indeed he will have earned a small bonus in that month.

Sales manager

A change to organic idea would need to be “sold” to customers. It would presumably require a change of marketing and proper communication to customers. The sales manager would probably feel he has done a good job in March. It is debatable, however, whether he is entirely responsible for all of the favourable variances.

The move to organic certainly helped the sales manager as in February he seems to have failed to meet his targets.



Bonus scheme

The problem here is that the variances have to be allocated to one individual. The good sales variances have been allocated to the sales manager when in truth the production manager’s decision to go organic appears to have been a good one and the driver of the business success. Responsibility accounting systems struggle to cope with “joint” success stories, refuting in general a collective responsibility.

Under the current standards the production manager has seemingly no chance to make a bonus. The main problems appear to be the out-of-date standards and the fact that all sales variances are allocated to the sales manager, despite the root cause of the improved performance being at least in part the production manager’s decision to go organic. The system does not appear fair.

General comments

It would appear that some sharing of the total variances is appropriate. This would be an inexact science and some negotiation would be needed.

One problem seems to be that the original standards were not changed following the decision to go organic. In this sense the variances reported are not really “fair”. Standards should reflect achievable current targets and this is not the case here.


Material price variances

Ingredient Actual Standard Actual (AP – SP) × AQ Adv or Fav price/kg price/kg quantity kg Price variance Flour 0.13 0.12 5,700 57 Adv Eggs 0.85 0.70 6,600 990 Adv Butter 1.80 1.70 6,600 660 Adv Sugar 0.60 0.50 4,578 458 Adv –––––– Total 2,165 Adv –––––– Material mix variance

Ingredient Actual Standard Standard Variance mix mix price Adv or Fav Flour 5,700 5,870 0.12 –20 Eggs 6,600 5,870 0.70 511 Butter 6,600 5,870 1.70 1,241 Sugar 4,578 5,870 0.50 –646 –––––– –––––– –––––– Totals 23,478 23,478 1,086 Adv –––––– –––––– ––––––

Material yield variance

Actual yield 60,000 cakes Standard yield (23,478/0.4) 58,695 cakes Difference 1,305 cakes Standard cost of a cake (W1) $0.302 Yield variance (1,305 × 0.302) 394 Fav



Sales price variance

Actual Standard Actual (AP – SP) Adv or Fav Price (AP) price (SP) volume (AV) × AV Cake 0.99 0.85 60,000 8,400 Fav Sales volume contribution variance

Actual volume 60,000 cakes Budget volume 50,000 cakes Standard contribution 0.35 Variance (60,000 – 50,000) * 0.35 = $3,500 Fav WORKING

(1) Standard cost of a cake

Ingredients Kg $ Cost Flour 0.10 $0.12 per kg 0.012 Eggs 0.10 $0.70 per kg 0.070 Butter 0.10 $1.70 per kg 0.170 Sugar 0.10 $0.50 per kg 0.050 Total input 0.40 0.302 Normal loss (10%) (0.04) ––––– Standard weight/cost of a cake 0.36 0.302

Answer 42 AVX CO

(a) Calculation of learning rates

The first step in solving this problem is to calculate the actual cost of output for each period. This is done by calculating the standard cost, and then deducting favourable efficiency variances from this to find actual cost.

Standard cost Batches of output Variance Actual cost $ $ $

November 1 500 0.00 500.00 December 1 500 170.00 330.00 January 2 1,000 452.20 547.80 February 4 2,000 1089.30 910.70 March 8 4,000 1,711.50 2,288.50 April 16 8,000 3423.00 4,577.00

The next stage is to calculate the cumulative average cost each month (i.e. total costs to date since the first product was made). Cumulative average cost per unit can also be calculated:

Cumulative Cumulative Cumulative batches total cost average cost per unit $ $ $

November 1 500.00 500.00 December 2 830.00 415.00 January 4 1377.80 344.45 February 8 2,288.50 286.06 March 16 4,577.00 286.06 April 32 9,154.00 286.06



The table shows that as cumulative output doubles, from 1 to 2 units, cumulative average cost per unit falls to 83% of the average cost for the first unit. This is repeated each time cumulative output doubles until cumulative output reaches 8 batches. After this, cumulative average cost per unit remains constant, meaning that the learning rate has ceased.

The learning rate was therefore 83% for the period November to February. After this it was zero.

(b) Implications of finding for AVX

The main implication for AVX is that the standard for the period from February onwards needs to be recalculated, to take into account a learning rate. The existing standard of $500 per unit is too easy to achieve.

The second implication is that the variances calculated for the first four months should also be recalculated based on a learning rate. These revised variances show a more realistic picture to management of the actual performance.

The difficulty of this approach is that the standards should be based on a reasonable learning rate that might be expected, based on previous experiences. It would be possible to use the actual rate achieved, but if this is done, it does not question whether actual performance was what might have been expected.

(c) Differences between standard costs and target costs

A standard cost is a predetermined budgeted unit cost of a product or service, under specified working conditions. These working conditions are normally current actual working conditions – so the standard cost basically reflects what could be achieved under existing working conditions.

A target cost, on the other hand is a desired cost. It may not be achievable under current working conditions, but will require changes in production methods.

The calculation of standard costs is inwardly focussed, and does not consider prices or profits. Target costing starts with the external selling price for the product and then works backwards to calculate target cost by deducting required profits.

Standard costs are usually calculated for existing products and services. Target costs may be calculated for planned products (i.e. products that are in the design phase). This means that the design process can be changed to help achieve the target cost.

Answer 43 MILBAO CO

(a) Sales volume variances

Superb Excellent Good Total 1. Budget sales (units) 30,000 50,000 20,000 100,000 2. Actual sales (units) in standard proportions 28,800 48,000 19,200 96,000 3. Actual sales (units) 36,000 42,000 18,000 96,000 Standard unit valuations: 4. Selling price ($) 100 80 70 5. Contribution ($) 60 55 48 6. Profit ($) 35 30 23



Sales volume variance On turnover basis (1 – 3) × 4 ($) 600,000(F) 640,000(A) 140,000(A) 180,000(A) On contribution basis (1 – 3) × 5 ($) 360,000(F) 440,000(A) 96,000(A) 176,000(A) On profit basis (1 – 3) × 6 ($) 210,000(F) 240,000(A) 46,000(A) 76,000(A) Fixed cost per unit = $2,500,000/100,000 units = $25

Tutorial note: The presentation style used equates increased sales from budget as negative or favourable variances (as opposed to increased costs which are negative or adverse variances).

(b) Relative merits

The choice of turnover, contribution or net profit as the valuation basis for the sales volume variance will be affected by a number of factors:

The way in which the information is presented to management will affect the choice of valuation base (e.g. whether a standard absorption or standard marginal cost system is in operation).

In some circumstances management may prefer to think in terms of market share expressed as turnover and will wish to monitor changes in sales using turnover as the measure.

It may be argued that as an aid to decision-making the valuation base chosen should be that which most closely approximates to cash flows. The turnover basis ignores the impact of variable costs and overstates the impact of any variance. The net profit basis includes a deduction for fixed costs. This means that the cash flow impact is understated, since fixed costs are sunk and will remain unaffected by volume changes. The contribution basis is the closest approximation to the cash flow effect of a change in sales units.

(c) Total sales quantity and sales mix variances

Sales mix variance

Actual Actual sales Standard Sales mix Product sales in budgeted Difference contribution variance (units) mix (units) (units) $ $ Superb 36,000 28,800 (30%) 7,200 60 432,000 Excellent 42,000 48,000 (50%) (6,000) 55 (330,000) Good 18,000 19,200 (20%) (1,200) 48 (57,600) ––––––– ––––––– ––––––– ––––––– 96,000 96,000 0 44,400 (Fav) ––––––– ––––––– ––––––– –––––––



Sales quantity variance

Actual sales Budgeted Standard Sales quantity Product in budgeted sales Difference margin variance mix (units) (units) (units) $ $ Excellent 28,800 30,000 (1,200) 60 (72,000) Superb 48,000 50,000 (2,000) 55 (110,000) Good 19,200 20,000 (800) 48 (38,400) ––––––– ––––––– ––––––– ––––––– 96,000 100,000 (4,000) (220,400) (Adv) ––––––– ––––––– ––––––– ––––––– Answer 44 SPIKE CO

(a) Budget revisions

A budget forms the basis of many performance management systems. Once set, it can be compared to the actual results of an organisation to assess performance. A change to the budget can be allowed in some circumstances but these must be carefully controlled if abuse is to be prevented.

Allow budget revisions when something has happened that is beyond the control of the organisation that renders the original budget inappropriate for use as a performance management tool.

Senior management who should attempt to take an objective and independent view should approve these adjustments.

Disallow budget revisions for operational issues. Any item that is in the operational control of an organisation should not be adjusted.

This type of decision is often complicated and each case should be viewed on its merits.

The direction of any variance (adverse or favourable) is not relevant in this decision.

(b) Budget revision requests

Materials

Arguments in favour of allowing a revision:

The nature of the problem is outside the control of the organisation. The supplier went in to liquidation; it is doubtful that Spike could have expected this or prevented it from happening.

The buyer, knowing that budget revisions are common, is likely to see the liquidation as outside his control and hence expect a revision to be allowed. He may see it as unjust if this is not the case and this can be demoralising.

Arguments against allowing a budget revision:

There is evidence that the buyer panicked a little in response to the liquidation. He may have accepted the first offer that became available (without negotiation) and therefore incurred more cost than was necessary.



A cheaper, more local supplier may well have been available, so it could be argued that the extra delivery cost need not have been incurred. This could be said to have been an operational error.

Conclusion: The cause of this problem (liquidation) is outside the control of the organisation and is the prime cause of the overspending. Urgent problems need urgent solutions and a buyer should not be penalised in this case. A budget revision should be allowed.

Labour

Argument in favour of allowing a revision: The board made this decision, not the departmental manager. It could be argued that the extra cost on the department’s budget is outside their control.

Arguments against allowing a budget revision:

This decision is entirely within the control of the organisation as a whole. As such, it would fall under the definition of an operational decision. It is not usual to allow a revision in these circumstances.

It is stated in the question that the departmental manager complained in his board report that the staff level needed improving. It appears that he got his wish and the board could be said to have merely approved the change.

The department will have benefited from the productivity increases that may have resulted in the change of policy. If the department takes the benefit then perhaps they should take the increased costs as well.

Conclusion: This is primarily an operational decision that the departmental manager agreed with and indeed suggested in his board report. No budget revision should be allowed.

An alternative view is that the board made the final decision and as such the policy change was outside the direct control of the departmental manager. In this case a budget revision would be allowed.

(c) Sales

(i) Total sales variances

Sales price variance = (Actual SP – Standard SP) × Actual sales volume = (16.40 – 17.00) × 176,000 = $105,600 (Adverse) Sales volume variance = (Actual sales volume – Budget sales volume) × Std contribution = (176,000 – 180,000) × 7 = $28,000 (Adverse)

(ii) Market size and share variances

Market size variance = (Revised sales volume – budget sales volume) × Std contribution = (160,000 – 180,000) × 7 = $140,000 (Adverse) Market share variance = (Actual sales volume – revised sales volume) × Std contribution = (176,000 – 160,000) × 7 = $112,000 (Favourable)



(iii) Comment on sales performance

Sales price: The biggest issue seems to be the decision to reduce the sales price from $17.00 down to $16.40. This “lost” $105,600 of revenue on sales made compared to the standard price.

It seems likely that the business is under pressure on sales due to the increased popularity of electronic diaries. As such, they may have felt that they had to reduce prices to sustain sales at even the level they achieved.

Volume: The analysis of sales volume into market size and share shows the usefulness of planning and operational variances. Overall, the sales level of the business is down by 4,000 units, losing the business $28,000 of contribution or profit. This calculation does not in itself explain how the sales department of the business has performed.

In the face of a shrinking market they seem to have performed well. The revised level of sales (allowing for the shrinking market) is 160,000 units and the business managed to beat this level comfortably by selling 176,000 units in the period.

As mentioned above, the reducing price could have contributed to the maintenance of the sales level. Additionally, the improved quality of support staff may have helped maintain the sales level. Equally the actions of competitors are relevant to how the business has performed. If competitors have been active then merely maintaining sales could be seen as an achievement.

Spike should be concerned that its market is shrinking.

Answer 45 SECURE NET

(a) Material total variances

Total price variance = ($5.25 – $4) × 3,500kg = $4,375 Adverse Total usage variance = (3,500 – 4,000) × 4 = $2,000 Favourable Total $2,375 Adverse

(b) Planning and operational variances

The planning variances are calculated by comparing the original budget and the revised standards after adjustment for factors outside the control of the organisation.

On this basis the revised standards would be a price of $4·80 per kg with revised usage at 42g per card.

Planning price variance = ($4.80 – $4)4,200 = $3,360 Adverse Planning usage variance = (4,200 – 4,000) × $4 = $800 Adverse Total planning error (variance) is $4,160 Adverse

The operational variances compare the actual spend with the revised budget figures.

Operational price variance = ($5.25 – $4.80) × 3,500kg = $1,575 Adverse Operational usage variance = (3,500 – 4,200) × $4.80 = $3,360 Favourable Total operational variance is $1,785 Favourable

The method above is in line with the article previously written by the examiner and published in the ACCA student newsletter. Other methods applied consistently would score full marks.



(c) Production manager performance

The production manager is subject to external pressures which appear beyond his control. The size of the security card has to fit the reader of that card and if the industry specification changes there is nothing that he can do about that. This is, then, a “planning” error and should not form part of any assessment of his performance.

Equally if world-wide oil prices increase (and hence plastic prices) then the production manager cannot control that. This would be allocated as a planning error and ignored in an assessment of his performance.

The performance of the production manager should be based on the operational variances (and any relevant qualitative factors). The decision to use a new supplier “cost” an extra $1,575 in price terms. On the face of it this is, at least potentially, a poor performance. However, the manager seems to have agreed to the higher price on the promise of better quality and reliability. If this promise was delivered then this could be seen as a good decision (and performance). The savings in waste (partly represented by the usage variance) amount to $3,360 favourable. This would seem to suggest better quality. The fact that the production level jumped from 60,000 to 100,000 also suggests that suppliers’ reliability was good (in that they were able to deliver so much). The net variance position is relevant at a saving of $1,785.

It is also possible that such a large increase in volume of sales and production should have yielded a volume based discount from suppliers. This should also be reflected in any performance assessment in that if this has not been secured it could be seen as a poor performance.

This is backed up by the lack of obvious quality problems since 100,000 cards were produced and sold in the period; a huge increase on budget. The ability of a production manager to react and be flexible can often form a part of a performance assessment.

In conclusion the manager could be said to have performed well.

Answer 46 OLIVER

(a) Average price

The average price for hairdressing per client is as follows:

20X0: Female clients paid $200,000 for 8,000 visits. This is an average price per visit of $200,000/8,000 = $25.

In 20X1 the female hairdressing prices did not increase and the mix of sales did not change so of the total revenue $170,000 (6,800 × $25) was from female clients. This means that the balance of $68,500 ($238,500 – $170,000) was from male clients at an average price of $20 per visit ($68,500/3,425).

(b) Financial performance assessment

Hairdressing sales growth: Oliver’s Salon has grown significantly during the two years, with an increase of 19.25% (W1). This is impressive in a mature industry like hairdressing.

The increase has come from the launch of the new male hairdressing with a significant contraction in the core female business – down 15% (W1).



Hairdressing gross margin: Oliver’s hairdressing overall gross margin has reduced significantly, down from 53% to 47.2% in 20X1 (W2).

There has been an increase in staff numbers for the female part of the business and this, combined with the fall in the volume of sales from female clients, has significantly damaged margins from that customer type, with a fall from 53% to 40.5% (W2).

The margin from male clients in 20X1 is 63.5%, which is better than that achieved in 20X0 from the female clients. This is probably mainly due to faster throughput, so that despite the lower average prices charged the overall margin was still quite good.

Staff costs: The staffing levels have had to increase to accommodate the new male market and the extra levels of business. The new hairdresser for the male clients is being paid slightly more than the previously employed staff (W3). This might encourage dissatisfaction. The addition of a junior will clearly reduce the overall average wage bill but increases costs overall whilst the volume of female clients is shrinking.

Advertising spend: This has increased by 150% in the year ($5,000/$2,000). This is probably nothing to worry about, as it is likely that the launching of the new product range (males!) will have required advertising. Indeed, given the increase in sales of male hair services it is fair to say that the money was well spent.

Rent is clearly a fixed cost and administrative expenses have gone up a mere 5.5%; these costs appear under control given the overall volume of clients is well up on 20X0.

Electricity costs have jumped 14.3%, which seems a lot but is probably a cost that Oliver would find hard to control. Energy companies are often very large organisations where competition is rarely significant. Small businesses have little choice but to pay the going rate for energy.

Net Profit: Overall net profit has worsened to 33.5% from 39% (W6). This is primarily due to the weakening gross margin and extra costs incurred for advertising. The advertising cost may not recur and so the net margin might improve next year.

Overall it is understandable that Oliver is disappointed with the financial results. With a 19.25% increase in overall sales he might have expected more net profit.

(c) Non-financial performance

Quality: The number of complaints is up by 283% (W4) and is proportionately more frequent. This seems to be due to two main reasons. Firstly the switch away from a single gender salon has upset the existing customer base. It is possible that by trying to appeal to more customer types Oliver is failing to meet the needs of at least one group. It may be that the quality of hair services has not worsened but that the complaints are regarding the change towards a multi-gender business.

Secondly the wage rates paid to the new junior staff seem to be well below the wage rates of the existing staff (W3). This implies that they are in training and could be of poorer quality. It is stated that they are in a supporting role but if not properly supervised then mistakes could easily occur. This can easily lead to complaints from dissatisfied customers.

Resource utilisation: The main resources that Oliver has are the staff and the rented property. As far as the property is concerned the asset is being used to a much higher degree with 27.8% more clients being serviced in the year (10,225/8,000).



However, as the overall margins are lower one might argue that just focusing solely on volume misses the point on asset utilisation.

As far as the staff usage is concerned it is a mixed scene. The female specialists are producing less per member of staff than in 20X0 after the recruitment of one more staff member and a fall in volume of female clients. Each specialist served 2,000 female clients in 20X0 and only 1,360 in 20X1 (W7). Oliver may have been concerned with the complaints coming in and decided to do something about service levels by increasing resources for the female clients.

The specialist dealing with male clients has produced far more treatments than those serving the females. This is probably not unusual; the male customer requires only a simple service. Without comparative data it is not possible to conclude whether or not 3,425 customers per year is good. This specialist cannot be said to be doing “better” than the others. Cutting men’s hair is quicker to do, so more output is inevitable.

WORKINGS

(1)

Sales growth overall is $238,500/$200,000 or +19.25%. The female hairdressing sales has though fallen by 15% ($200,000 – $170,000)/$200,000. This is entirely reflected in volume, as there was no price increase in 20X1 for female clients.

(2)

Gross margin overall is $106,000/$200,000 or 53% in 20X0 and $112,500/238,500 or 47.2% in 20X1.

This can be analysed between the female and male clients:

20X0 20X1 Female Female Male $ $ $ Sales 200,000 170,000 68,500 Less cost of sales: Hairdressing staff costs (W3) (65,000) (74,000) (17,000) Hair products – female (29,000) (27,000) Hair products – male (8,000) –––––––– ––––––– ––––––– Gross profit 106,000 69,000 43,500 –––––––– ––––––– ––––––– GP% 53% 40.5% 63.5%

(3)

Staff cost growth is $91,000/$65,000 or +40%. In absolute terms average staff costs were $65,000/4 = $16,250 in 20X0.

Additional staff cost $26,000 ($91,000 – $65,000) in total for two people. The junior was paid $9,000 and so the new specialist for the male customers must have been paid $17,000

(4)

Number of complaints up by 46/12 or 283%. Complaints per customer visit up from 12/8,000 or 0.15% to 46/10,225 or 0.44%



(5)

Number of female clients per specialist is 8,000/4 or 2,000 in 20X0 and 6,800/5 or 1,360 in 20X1. Number of male clients per specialist is 3,425 in 20X1.

(6)

Net profit is $78,000/200,000 or 39% in 20X0 and $80,000/238,500 or 33.5% in 20X1.

Answer 47 THATCHER INTERNATIONAL PARK

(a) Financial performance

TIPs Financial performance can be assessed in a number of ways:

Sales growth

Sales are up about 1.3% (W1) which is a little above the rate of inflation and therefore a move in the right direction. However, with average admission prices jumping about 8.6% (W2) and numbers of visitors falling there are clearly problems. Large increases in admission prices reduce the value proposition for the customer; it is unlikely that the rate of increase is sustainable or even justifiable. Indeed with volumes falling (down by 6.7%, (W6)) it appears that some customers are being put off and price could be one of the reasons.

Maintenance and repairs

There appears to be a continuing drift away from routine maintenance with management preferring to repair equipment as required. This does not appear to be saving any money as the combined cost of maintenance and repair is higher in 2009 than in 2008 (possible risks are dealt with in part (b)).

Directors pay

Absolute salary levels are up 6.7% (W3), well above the modest inflation rate. It appears that the shareholders are happy with the financial performance of the business and are prepared to reward the directors accordingly. Bonus levels are also well up. It may be that the directors have some form of profit related pay scheme and are being rewarded for the improved profit performance. The directors are likely to be very pleased with the increases to pay.

Wages

Wages are down by 12% (W5). This may partly reflect the loss of customers (down by 6.7% (W6), assuming that at least part of the wages cost is variable. It could also be that the directors are reducing staff levels beyond the fall in the level of customers to enhance short-term profit and personal bonus. Customer service and indeed safety could be compromised here.

Net profit

Net profit is up a huge 31.3% (W7) and most shareholders would be pleased with that. Net profit is a very traditional measure of performance and most would say this was a sign of good performance.



Return on assets

The profitability can be measured relative to the asset base that is being used to generate it. This is sometimes referred to as ROI or return on investment. The return on assets is up considerably to 11.4% from 8% (W8). This is partly due to the significant rise in profit and partly due to the fall in asset value. TIP has cut back on new development so the fall in asset value is probably due to depreciation being charged with little being spent during the year on assets. In this regard it is inevitable that return on assets is up but it is more questionable whether this is a good performance. A theme park (and thrill rides in particular) must be updated to keep customers coming back. The directors on TIP are risking the future of the park.

(b) Quality provision

Reliability of the rides

The hours lost has increased significantly. Equally the % of capacity lost due to breakdowns is now approaching 17.8% (W9). This would appear to be a very high number of hours lost. This would surely increase the risk that customers are disappointed being unable to ride. Given the fixed admission price system this is bound to irritate some customers as they have effectively paid to ride already.

Average queuing time

Queuing will be seen by customers as dead time. They may see some waiting as inevitable and hence acceptable. However TIP should be careful to maintain waiting times at a minimum. An increase of 10 minutes (or 50%) is likely to be noticeable by customers and is unlikely to enhance the quality of the TIP experience for them. The increase in waiting times is probably due to the high number of hours lost due to breakdown with customers being forced to queue for a fewer number of ride options.

Safety

The clear reduction in maintenance could easily damage the safety record of the park and is an obvious quality issue.

Risks

If TIP continues with current policies then they will expose themselves to the following risks:

The lack of routine maintenance could easily lead to an accident or injury to a customer. This could lead to compensation being paid or reputational damage

Increased competition. The continuous raising of admission prices increases the likelihood of a new competitor entering the market, although there are significant barriers to entry in this market (e.g. capital cost, land, and so on).

Loss of customers. The value for money that customers see when coming to TIP is clearly reducing (higher prices, less reliability of rides and longer queues). Regardless of the existence of competition customers could simply chose not to come, substituting another leisure activity instead

Profit fall. In the end if customers’ numbers fall then so will profit. The shareholders, although well rewarded at the moment could suffer a loss of dividend. Directors’ job security could then be threatened



WORKINGS

(1) Sales growth is $5,320,000/$5,250,000 = 1.01333 or 1.3%

(2) Average admission prices were:

2008: $5,250,000/150,000 = $35 per person 2009: $5,320,000/140,000 = $38 per person An increase of $38/$35 = 1.0857 or 8.57%

(3) Directors pay up by $160,000/$150,000 = 1.0667 or 6.7%

(4) Directors bonuses levels up from $15,000/$150,000 or 10% to $18,000/$160,000 or 12.5% of turnover. This is an increase of 3/15 or 20%

(5) Wages are down by (1 – $2,200,000/$2,500,000) or 12%

(6) Loss of customers is (1 – 140,000/150,000) or 6.7%

(7) Profits up by $1,372,000/$1,045,000 = 1.3129 or 31.3%

(8) Return on assets:

2008: $1,045,000/$13,000,000 = 1.0803 or 8.03% 2009: $1,372,000/$12,000,000 = 1.114 or 11.4%

(9) Capacity of rides in hours is 360 days × 50 rides × 10 hours per day = 180,000

2008 lost capacity is 9,000/180,000 = 0.05 or 5% 2009 lost capacity is 32,000/180,000 = 0.177 or 17.8%

Answer 48 EATWELL RESTAURANT

(a) Overall business performance

The performance can be categorised into the following key areas: financial, competitiveness, resource utilisation, quality of service and innovation/flexibility.

Financial

Continuous turnover growth with a 123% increase over the period. Annual compound growth rate. An even faster growth in profit – approximate fivefold increase. Profits growing faster than revenue creates an increasing net profit margin from

14% in 201W to 30.9% in 201Z. This may have arisen from improved resource utilisation (see below) resulting in a gradual decrease in the ratio of fixed costs to revenues.

Competitiveness

This is concerned with market share and growing new business areas.

Market share is measured by the rate of restaurant turnover to the turnover of all restaurants in the locality. This commences with 9.2% in 201W and continually increases to 17.5% in 201Z. There is also a rapid growth in the proposals submitted for new events (10 to 38), and even more significantly, is the faster growth in contracts won. The success rate increases from 20% in 201W to 66% in 201Z. The restaurant is therefore competing increasingly successfully in this developing business area. The restaurant is becoming increasingly price competitive.



Quality of service

The increasing number of regular customers would suggest that many customers are satisfied with the total package that the restaurant offers. This may be partly due to service quality or other factors such as price competitiveness. The growth in complaints, complimentary letters, reported cases of food poisoning and the service delivery data would suggest rather a mixed situation. It is difficult to provide a definitive comment regarding the quality of service over the period, especially as the number of customers nearly doubled over the period. Even additional calculations, such as those involving key service quality data per 100 customers would not provide the basis for an overall conclusive comment.

Innovation/Flexibility

The restaurant has fared quite well in this respect considering:

the increase in the number of dishes on offer; the introduction of theme evenings; the development of the catering activities for special events.

The restaurant is prepared to try new dishes although the extent of its experimentation varies considerably from year to year. Also, the fluctuating and somewhat unsatisfactory service delays suggest that they are not managing to flex their resources adequately to meet peak demand levels.

Resource utilisation

The business activity level continually increased over the period (meals served) with a decline in non-productive time and the hours of operation with no customers. All these suggest an improvement in resource utilisation. We do not know whether the increase in seating capacity in 201Y arose from extending the floor area available or from the provision of more seating within a constant space. Although this capacity increase permitted more customers to be fed at peak times, it did result in a fluctuation in the annual number of meals served at each seat, 150 (201W), 204 (201X), 155 (201Y), 167 (201Z). A brief attempt was made in 201Y to extend the opening hours and increase the hourly utilisation of the premises.

(b) Additional information to assess performance

Financial

The value of assets required to generate the profits – to calculate the ROCE.

Details of cost categories (e.g. labour, food overheads – to assess comparative financial ratios).

Did the increase in capacity in 201Y require additional capital investment – to assess the marginal returns.

The level of business risk inherent in alternative business and the associated expected return.

Competitiveness

National trends in restaurant attendance and revenues provide broader comparisons. Data on/customer surveys of restaurants in targeted customer groups.



Quality of service

To assess various intangible factors (e.g. politeness of staff, atmosphere and décor, responsiveness to customer requests).

Food writers or expert ratings.

Innovation/Flexibility

Staff training and the potential for multi-skilled activities to provide greater operational flexibility.

The ability to cope with non-standard requests (e.g. special dietary needs and respond to customer needs).

Resource utilisation

Data on employee numbers would facilitate the calculation of business activity per employee.

Data on floor area per customer.

Answer 49 BALANCED SCORECARD

Robert Kaplan and David Norton carried out studies in several companies in the early 1990’s. The studies aimed at investigating the need to balance short-term financial performance with the drivers of long-term growth opportunities. A number of advantages of the balanced scorecard over the traditional major focus on financial performance may be suggested. These include:

Traditional measures tend to be dominated by financial accounting requirements. For example the need for inventory valuation, including WIP for Statement of financial position (Balance Sheet) purposes. Also the focus on short-term profit and ROI in order to ensure that short-term financial reporting was favourably received by stakeholders. The balanced scorecard is more broadly based. It argues that no single measure can provide a clear performance target or focus attention on critical areas of the business.

Traditional measures are mainly inward looking. The balanced scorecard is more broadly based. It is more outward looking and focuses on comparisons with competitors in order to establish best practice and ensure that change is implemented in order to achieve it. It requires a balanced presentation of both financial and non-financial measures and goals.

The balanced scorecard focuses to a greater extent than traditional measures on strategic planning for the longer term. It attempts to identify the needs and concerns of customers and the identification of new products and markets.

The balanced scorecard attempts to overcome the over-emphasis of traditional measures on the quantifiable aspects of the internal operations of a company expressed in financial terms. It also considers a range of non-financial and qualitative measures.

The balanced scorecard views the business from four different perspectives that are internal business, innovation and learning, customer and financial perspectives. The questions asked in relation to these perspectives are:

What processes must we excel at to achieve our customer and financial objectives? Can we continue to improve and create value? What do existing and new customers value from us? How do we create value for shareholders?



The balanced scorecard establishes goals for each of the four perspectives and provides measures that should assist in movement towards these goals. Its focus is both internal and external. Examples of measures that could be used are:

Internal business perspective: cycle time, unit cost analysis including cost trends and VA/NVA analysis, engineering efficiency,

Innovation and learning perspective: Time to market for new products; number of new products introduced.

Customer perspective: % sales from new products, % on time deliveries, % orders from enquiries, customer survey analysis.

Financial perspective: overall measures such as profit, sales growth, ROI; liquidity measures such as cash flow analysis; evaluation of new investment opportunities.

(Alternative relevant points and discussion would be accepted)

Answer 50 BLA CO

(a) Business performance indicators

The Fitzgerald et al framework proposes six dimensions of performance that are controlled by service industries. Their propositions include that two of these, namely financial performance and competitiveness are the “results” of actions previously taken and reflect the success of the chosen strategy. The remaining four dimensions of quality, flexibility, resource utilisation and innovation are factors that determine competitive success now and in the future. The performance of BLA Co can now be analysed under this framework.

(i) Financial performance

Summary income statement for the year ended 31 October 201X

Budget Actual $000 $000 Fee income 6,075 6,300 Costs: Consultants’ salaries 2,025 2,025 Bonus 90 Other operating costs 2,550 2,805 Subcontract payments 18 4,575 4,938 ––––– ––––– Net profit 1,500 1,362 ––––– –––––

It is clear that BLA has not performed as well as expected during the year to 31 October 201X. Whilst client income is above budget, other operating expenses reached a level that is more than 10% higher than the budget for the year, and thus it would be extremely useful to have a more detailed breakdown of other operating expenses for the year. Consultants have earned an aggregate bonus of $90,000 (42,000 – 40,500) × $150 × 40% in respect of activity above budgeted levels. Payments to subcontractors amounted to $18,000. Actual profit amounts to $1,362,000 against a budget of $1,500,000.

It would be extremely useful to see the results of the previous two years in order to assess whether there are any discernible trends in revenues and costs. The budget for the following year should be reviewed in the light of the actual performance of this year with particular reference to checking the footing of the assumptions on which it has been prepared.



(ii) Competitiveness

Competitiveness may be measured in terms of market share or sales growth and the relative success in obtaining business from enquiries made by customers. The revenue of BLA Co for the year to 31 October 201X is above budget.

Again it is desirable to see the results of recent years since it might well be the case that BLA Co has achieved steady growth which is indicative of a high level of competitiveness in future years. BLA provided 1,200 consultations on a no-fee basis with a view to gaining new business. Also, during the year BLA consultants provided 405 non-chargeable “remedial” consultations. Both of these non-chargeable activities might be viewed as initiatives to increase future levels of competitiveness.

It is useful to look at the extent to which BLA Co were successful in converting the enquiries received from both existing and new client enquiries into new business. The percentages are as follows: Budget Actual Conversion rate from enquiries New clients 36.0% 26.7% Repeat clients 50.0% 70.0% 70% of enquiries from the existing client base resulted in additional consultancy work for BLA Co. This is indicative of strong customer loyalty indicating that existing clients are satisfied with the service provided. However, the company was unable to fare as well with regard to enquiries from potential “first time” customers, only achieving a conversion ratio of 26.7%, which is approximately 74% of the intended number of “first time” clients that were budgeted for. This indicates that there is probably room for improvement in the ways in which BLA Co deals with enquiries from prospective clients. The company should review its marketing strategies with a view to improving its conversion ratio.

In absolute terms new business was approximately 7.8% below budget whereas repeat business was 21.0% above budget.

As regards the nature of the chargeable activities undertaken by the consultants it can be seen that Exterior design is 14.6% below budget, whereas Interior design and Garden design are 6.4% and 35.1% above budget.

(iii) Service quality

Quality of service is the totality of features and characteristics of the service package that bear upon its ability to satisfy client needs. Flexibility and innovation in service provision may be key determinants of service quality. To some extent the increase in the number of complaints and non-chargeable consultations associated with the remedying of those complaints is indicative of a quality problem that must be addressed. This problem needs to be investigated. BLA Co only provides advice to clients and only recommends contractors when asked to do so by clients. It would be interesting to see how many of the complaints related to recommendations made by BLA Co. Assuming consultants could have otherwise undertaken chargeable work, the revenue foregone as a consequence of the remedial consultations was $60,750. Client complaints received during the year were nearly double the budgeted level.



Also the number of remedial consultations was 405 against a budgeted level of only 45, which is exactly nine times higher than budget! Perhaps BLA Co should review and, if necessary, limit the amount of remedial consultancy provided to any one particular client. The business development consultations can be viewed as an innovative measure with a view to gaining additional business. It is noticeable that during the year ended 31st October 201X retired consultants working on a subcontract basis undertook 120 consultations, each of which was of a non-chargeable nature. It is highly unlikely that the work undertaken by the retired consultants was in nature of Business Development Activity as such work would invariably be undertaken by the consultants employed on a full-time basis by BLA Co. Moreover, given that the actual number of complaints during the year totalled 630 and that BLA consultants themselves undertook 405 remedial consultations, it would be reasonable to assume that the retired consultants undertook further remedial consultations and/or work that related to complaints from clients.

It would be extremely useful to have a detailed analysis of the client complaints. The scenario states that BLA only recommends contractors that undertake the three types of work when requested to do so by clients. In this regard it is important to recognise that a potential problem often exists where one party provides advice and another party is engaged to perform duties which relate to the provision of that advice.

(iv) Flexibility

Flexibility may relate to the company being able to cope with flexibility of volume, delivery speed or job specification. Hence, flexibility might be substantiated by looking at the mix of work undertaken by the consultants during the year. The following table gives a comparison of actual and budgeted consultations by category of consultant.

Consultations by category of consultancy service

Budget % Actual % Increase/ (decrease) Exterior Design 40.0 32.9% (7.1%) Interior Design 40.0 41.0% 1.0% Garden Design 20.0 26.1% 6.1% It is a deliberate policy of BLA Co to retain 45 consultants thereby maintaining flexibility to meet increasing demand. The delivery speed will be increased as a consequence of the retention of consultants. It would appear that a change has occurred in the mix of consultants, which may well be a response to changing market requirements. Again, it would be useful to see recent year’s statistics in order to consider trends but notably garden design looks to be a growth area hence the three new consultants recruited during the year. The mix of consultants should be such that BLA Co can cope with a range of job specifications. The fact that links have been retained with retired consultants will give an added dimension of flexibility in times of very heavy demand on its consultants.



(v) Resource utilisation

Resource utilisation measures the ratio of output achieved from those resources input. In this scenario the mean number of consultations per consultant may be used as a guide.

Average consultations per consultant

Budget Actual Increase/(decrease) Exterior Design 900 922 2.4% Interior Design 900 957 6.3% Garden Design 900 912 1.3% It is interesting to note that all categories of consultant are being utilised above budgeted levels. Consequently an aggregate bonus amounting to $90,000 was paid in respect of the year ended 31 October 201X. There are potential problems if the quality of the service provision is falling. In this regard it would be useful to have more detailed analysis of the client complaints in order to ascertain whether a large proportion relate to any one category of consultancy and/or contractor. BLA Co has adopted an innovative approach that requires consultants to undertake non-chargeable business development consultations that have at their heart the intention of generating new business. Hence in the immediate sense there is a trade-off between resource utilisation and innovation.

(vi) Innovation

Innovation should be viewed in terms of its impact on financial performance, competitiveness, service-quality, flexibility and resource utilisation in the short, medium and long term. Certainly the non-chargeable activity in terms of “business development” is an innovative feature in the business of BLA Co, as is the non-chargeable remedial consultancy provided to clients who experience problems at the commencement of building works. The acquisition of “state of the art” business software is by its very nature innovative. The result of its use is reflected in the significant increase of 35.1% above budget achieved in garden design consultations. This has probably enabled BLA Co to differentiate its services from those of its competitors and enhance its reputation. Certainly the management of BLA Co will be hoping for a similar increase in business as a consequence of the use of the software by its external and interior design consultants. The management should ensure the introduction of the software has not caused the increase in the number of complaints received.

(b) Determination of expected standards

In establishing targets, the importance of individuals taking ownership of the standards has long been established: this is often facilitated by the adoption of a budgetary system based on employee participation. This is also considered to be beneficial to the organisation since it alleviates, or at the very least reduces, many of the dysfunctional consequences associated with particular control models. In particular, managers who participate in the standard-setting process are more likely to accept the standards set, feel less job-related tension and have better relationships with their superiors and colleagues. Participation does, however, provide opportunities for the introduction of budgetary slack in order that any subsequent monitoring of activities presents a favourable outcome.

Budgets need to be realistic enough to encourage employees to perform, but not set at levels so high that they are demodulated. The challenge to management lies in finding the balance between what the company views as achievable and what the employee views as achievable as this often proves to be a source of organisational conflict.



It is important that the standards of performance measurement chosen by management facilitate a fair comparison across all similar business units and that equity is seen to prevail in measuring the performance of those units. There may be circumstances where some business units have an inherent advantage unconnected with their own deliberate initiatives. For example, some business units will be subject to higher levels of environmental uncertainty than others. In situations where higher levels of uncertainty exist, there will be a need for greater reliance to be placed on subjective judgment in appraising performance, with consequently less reliance being placed on objective, financial data. It would be inappropriate and inequitable to measure the performance of two completely different business contexts in an identical manner.

Answer 51 AV

(a) The value of money

The term “value for money” is often used to refer to economy, efficiency and effectiveness. Value for money audits can be undertaken in order to assess whether value for money has in fact been achieved. In order for such an audit to be effective the objectives of AV would need to be clearly understood by those undertaking the audit.

The management of AV could attempt to measure the value for money of its operating activities in terms of economy, efficiency and effectiveness. Economy is only concerned with inputs acquired by AV, and is achieved by obtaining those inputs at the lowest acceptable cost. For example, the prices at which with the replacement fitted kitchens are purchased ($2,610) could be compared with those obtainable from other vendors in order to assess whether the lowest acceptable cost is being achieved for the required level of quality. It is important that the management of AV realise that economy is measured by reference to quality of resource inputs. They need to recognise that the purchase of poor quality materials and inferior services represents “false economy”.

Efficiency is focussed on output, for example, maximising output for a given level of input. For example with regard to the replacement fitted kitchens, AV could use the tendering process in an attempt to maximise the number of fitted kitchens that would be installed for a given amount of money by the contractor awarded the tender. Efficiency is measured by the ratio of output to input. The ratio is not used in an absolute sense but in a relative sense and can be improved in four ways:

By increasing output for the same input; By increasing output by a greater proportion than the proportionate increase in

input; By decreasing input for the same output; and By decreasing input by a greater proportion than the decrease in output.

The denominator (input) is often measured in monetary terms whilst the numerator (output) can be measured in either monetary amounts or physical units (e.g. per property).

Effectiveness is focussed on the achievement of objectives. A not for profit organisation will invariably have a number of objectives. For example AV may have the following objectives:

To meet housing needs; To provide quality well-managed homes; To provide the services that clients want; To provide an effective care and repair service; To support the communities in which it operates.



The management of AV should be mindful that the three performance measures require individual consideration since for example, the degree to which effectiveness is achieved gives no indication about how much was spent to achieve it.

The management of AV should also recognise that these performance measures may conflict with one another. For example, during the year AV incurred expenditure amounting to $234,900 in respect of 90 replacement fitted kitchens. If AV had purchased the same replacement kitchen units as BW, then AV would only have been able to refit 45 properties ($234,900/$5,220). Hence, the efficiency ratio of inputs to outputs would have been halved. However, the purchase of replacement kitchen units at a cost of $5,220 might have resulted in a higher level of effectiveness being achieved through factors such as the longer life of the replacement kitchen units, higher quality fixtures and fittings, and enhanced aesthetic “appeal” to residents.

The management of AV should also give consideration to benchmarking against other similar charities whose primary objective is the provision of accommodation to the communities in which they operate. Benchmarking is probably the most significant recent development in measuring the performance of not-for-profit organisations. The management of charities such as AV would be far more willing to share information about performance with similar organisations for their mutual benefit, than the management of many profit-seeking organisations who often view the sharing of information as a commercial threat. For example, the management of AV could attempt to establish whether $2,610 is the “norm” in respect of the cost of a replacement fitted kitchen incurred by similar non-profit-seeking organisations.

(b) Performance Measures

(i) Performance measures for flexibility and service quality

Service quality.

The time required in order to undertake repairs of an emergency nature, after notification of the requirement by a tenant.

The friendliness of staff employed by AV could be measured via the completion of questionnaires by tenants.

Flexibility.

Mean waiting time for a house to become available to a tenant.

Mean waiting time to re-house a tenant in a different sized house after receipt of a request from a tenant.

(ii) Cost and efficiency measures

The management of AV could use the following performance measures:

Cost and efficiency AV BW (1) The mean cost, per week per house on management. $9.61 $29.81 –––––– –––––– (2) The mean cost per week, per house on general repairs. $10.22 $6.13 –––––– –––––– (3) Percentage of rent available that was collected. 98.5% 100% –––––– ––––––



Notes/comments

(1) The mean cost per week per house is calculated by dividing the amount of staff and management costs by the number of properties held by each of the respective organisations. Although the same number of staff, 25, are employed by each organisation, staff costs incurred by BW are 37.7% higher than those of AV. This could result from different pay structures and management policies regarding remuneration that are likely to be employed in a profit-seeking organisation such as BW.

(2) AV currently pays, on average, $140 for each emergency repair, $120 for each urgent repair and $116 for each non-urgent repair. BW has benefited from the fact t that each repair undertaken by BW costs the same (i.e. $100), irrespective of the classification of repair. This might be a result of a contractual arrangement with a subcontractor that each repair undertaken is charged at the same fee in return for guaranteed business volumes for the subcontractor. If this were the case, then AV would benefit from entering into such an arrangement for the supply of repair services.

(3) BW did not have any unoccupied properties at any time during the year. This would seemingly indicate a high level of demand for its properties. AV had potential gross rents receivable during the year of $2,423,200. Unoccupied properties resulted in lost revenues of $36,348, which amounted to 1.5% of gross rents receivable. Further information is required to in order to assess whether the lost revenue is attributable to “void periods” (i.e. properties becoming vacant or perhaps due to tenants who have defaulted).

Tutorial note: Other ratios and relevant comments would have been acceptable.

(c) Comparison of operating and financial performance

The primary objective of any commercial organisation such as BW is to maximise profit. Management may take a short or long-term view regarding the ways in which they seek to achieve this objective. Management may have to choose between available options, each of which might help them to achieve this objective. However, whilst many decisions may have to be made, the objective remains clear and identifiable.

The management of BW will most probably be concerned with the provision of high quality accommodation in order to generate higher revenues and profits. The management of BW are probably trying to appeal to those who are willing to pay high rents for high quality accommodation. The fact that replacement fitted kitchens and replacement windows and doors purchased by BW cost 100% and 50% respectively, more than those purchased by AV may be an indication of this.

The objectives of not-for-profit organisations such as AV can vary significantly. AV’s primary objective is “to meet the accommodation needs of persons in its locality”. This might distil down to ensuring that any person, who is in need of accommodation, is in fact provided for. The absence of a profit measure makes it more difficult to measure whether objectives are in fact being achieved. It is difficult to judge whether non-quantitative objectives such as meeting accommodation needs of people have been met. This does not mean however, that such an assessment should be placed on the “too difficult pile” and left unattended. A number of suitable measures need to be devised by the management accountant in order to assess the extent to which non-quantitative objectives have been met.



The management of AV would probably be better served in comparing the performance of their organisation with a similar non-profit seeking organisation that provides accommodation to meet the needs of society.

Additional information that would assist in appraising the performance of BW during the year includes the following:

Estimates of the financial effects of changes in demand for different levels of rents charged.

Estimates of the financial effects of changes in demand for different costs/quality levels of accommodation provision.

A detailed analysis of net interest payable – $750,000.

A detailed analysis of sundry operating costs – $235,000.

Management accounts for the current and prior years.

Budget information for the year and the two following years, if available.

It would also be useful to have details regarding the location of the properties held by BW. It is quite conceivable that the houses held by BW are situated in a sought after area. Benchmarking with a “best practice” organisation from the private sector would be of much assistance in the appraisal of the operating and financial performance of BW.

Answer 52 BRIDGEWATER CO

(a) Financial performance

The divisions of Bridgewater Co have been given very specific targets to meet it is reasonable to assume that performance will be assessed relative to them.

Sales growth

The northwest division suffers from a slow start to the year, with falls in sales from quarter 1 to quarter 2. Overall sales growth looks better with an average growth of 14% achieved. There are no quarterly budget sales to compare to but the low growth in budget profit suggests that much slower sales growth than that actually achieved was expected. Overall the sales budget has been exceeded, with big increases in sales in the last two quarters

The manager’s promotion could be damaged by the slow start. The “good news” of better sales growth comes after the promotion decision is taken.

Cost control – trainer costs

The division spends slightly more (as a % of sales) than budgeted on trainers. It is spending 20% as opposed to 18% on trainers. Given the manager’s attitude towards quality it appears he is trying to employ better trainers in the hope of more satisfied customers. This should, logically, build customer loyalty and improve local and brand reputation. This could possibly explain the better growth in the later quarters.

Again the problem for the promotion-seeking manager, investing in the future in this way damages short-term performance measures, in this case cost targets.



Cost control – room hire costs

The divisional manager is also spending more on room hire. He is spending 10% as opposed to the budgeted 9% of sales. He could be buying poorly, hence wasting money. Alternatively he could be hiring better quality rooms to improve the learning environment and enhance the training experience.

Again his focus on quality may be undermining his short-term promotional prospects.

Profit

Annually, the divisional manager is beating the targets laid down for profit. His problem as far as his promotion is concerned is the profit targets laid down for the first two quarters are not met.

The promotion decision comes too early for his employers to see the benefit of a quality focus made earlier in the year.

Overall, promotional prospects do not look good. The manager has not met any of his targets in the first two quarters. His only hope is that his bosses look at future forecasts and take them in to consideration when making the decision.

(b) Proposed changes

(i) Revised forecasts

Q1 Q2 Q3 Q4 Total $000 $000 $000 $000 $000 Sales 42.5 38.5 62.5 74.5 218.0 Less: Trainers 8.0 7.2 12.0 14.4 41.6 Room hire 4.0 3.6 6.0 7.2 20.8 Staff training 1.5 1.5 1.0 1.0 5.0 Other costs 3.0 1.7 6.0 7.0 17.7 Software 1.8 1.8 ––––– ––––– ––––– ––––– ––––– Forecast Net profit 24.2 24.5 37.5 44.9 131.1 ––––– ––––– ––––– ––––– ––––– Original Budget profit 25.0 26.0 27.0 28.0 106.0

Incremental effects (as a working)

Q1 Q2 Q3 Q4 Total $000 $000 $000 $000 $000 Extra sales Voucher sales 2.5 2.5 2.5 2.5 10.0 Software sales 10.0 12.0 22.0 Extra costs Trainers 2.0 2.4 4.4 Room hire 1.0 1.2 2.2 Staff training 0.5 0.5 1.0 Software 1.8 1.8 Change in forecast Net profit +0.2 +2.0 +9.5 +10.9 +22.6



(ii) Evaluation of proposed steps

Voucher scheme

At first glance of it the voucher scheme looks a good one. The manager is confident of a reasonable volume of sales and given that all the attendees will go on existing courses there will be no additional costs. The scheme seems to generate $10,000 of extra sales revenue in the year. One should question the assumption that no extra costs are incurred.

One potential concern would be that existing customers might object to the price reduction, particularly if they have already paid a higher price for a future course. However, most customers will probably not be aware of the price difference or will not bother complaining, those that do complain can be dealt with individually. It is common with promotions that the offer clearly states the terms and conditions that apply. In this way the manager can protect existing sales by excluding existing sales from the new offer.

From a promotion point of view the extra revenue and profit helps a little. If the revenue is spread evenly (as suggested) there will be $2,500 of extra revenue and profit in each of quarter 1 and 2. Unfortunately, in both cases the manager will still fall short of the target profit and the growth between quarter 1 and 2 will still be negative. He would need the take up rate of the sessions to be quicker to help his promotion prospects. Manipulation of the accounting figures should be resisted

Software upgrade

A software training company must stay in touch with modern software developments. From that point of view you could argue that this development is essential. Financially the proposal looks sound. The extra courses will generate a profit of $12,600 in this year alone, with, presumably, more courses to follow. A slower than expected take-up rate for the new course would reduce this year’s effect.

The promotional aspects are not as good. The extra costs occur in quarter 1 and 2 but the revenue does not come in until after the promotion decision is made. Integrity is an issue here. Personal promotional prospects must come second to sound business decisions. The manager should show the revised forecasts to his bosses and hope this sways the decision.

Delayed payment to trainers

This is a poor idea. This will not affect profit, costs or any of the performance measures in question. It will affect cash flow in a positive manner. However, to delay payment without agreement can damage the relationships with the trainers, upon which he depends on for the quality of their presentations.

Overall the three proposals do improve the performance of the division. However most of the benefits accrue after quarter 2 and might therefore come too late for the promotion decision.

(iii) Two improvements

To encourage a longer-term view more emphasis should be placed on non-financial measures of performance.

This business is dependent amongst other things on the quality of its course provision. As a result an improvement could be to set targets for the quality of presentations given. Attendees could be asked to grade all trainers (or facilities) at the end of sessions. This would prevent cheap but weak presenters (and poor quality rooms) being employed by managers.



Equally, the senior managers have to take account of longer periods when assessing performance. Viewing a single quarter is too narrow and looking at the whole year is advisable. Wider issues should also be taken into consideration when making promotional decisions. Repurchase rates could be measured for client companies for example.

Answer 53 OSBORNE CO

(a) Performance targets

(i) Divisional return on investment

employed capital Traceableprofit Traceable

Traceable profit = 8.5m – 5.3m – 1.7m – 0.95m = 0.55m

Capital employed = 2m + 1.2m + 0.3m + 0.8m + 0.5m + 0.1m – 0.4m – 0.2m = 4.3m

Therefore ROI = 3.4

55.0 = 12.8%

(ii) Divisional residual income (assuming an imputed interest rate of 12%)

$m Traceable profit 0.550 Imputed interest (12% × 4.3m) (0.516) ——— 0.034 ———

Thus both targets have been achieved.

(b) Mr Iommi

Given that Mr Iommi is due to retire after the project’s first year, he will only consider the effect on ROI and RI for the first year.

The effect during year 1 on the company’s profit and capital is as follows:

$ Profit Cash flow from project 300,000 Depreciation (840,000 ÷ 3) (280,000) ——–— Increase in profit 20,000 ——–— Capital employed after one-year increase in capital employed will be the NBV of the investment = 840,000 – 280,000 560,000 ——–—

New ROI 0.56 4.30.02 0.55

++ 11.7%



$m New RI Traceable profit (0.55 + 0.02) 0.570 Imputed interest (12% × 4.86) (0.583) ——— (0.013) ——— Hence neither target is achieved nor would Mr Iommi not receive his bonus for 2000

Over the whole life of the project average net profit is

⅓ × [(300,000 + 600,000 + 700,000) – 840,000] = $253,333

Thus ROI for the project calculated as

yearfirst of endat assetsNet

profit annual Average = 000,560333,253 × 100% = 45.2%

and RI for the project in global terms = 253,333 – (12% × 840,000) = $152,533

If the project were considered over its entire life it would be acceptable under both appraisal measures.

Consequently, Mr Iommi is acting dysfunctionally by not accepting the project. However, this is understandable given that Mr Iommi is concerned with short-term results rather than long-term, due to his intention to retire in a year. What has caused the difference in attitudes towards the project is the fact that the high profits occur after the first year of the project’s life.

Answer 54 RESPONSIBILITY CENTRE

(a) Responsibility centres

A responsibility centre is part of an organisation for whose activities a manager is deemed to be responsible. The type of responsibility centre depends on the type of activities for which responsibility is carried.

Cost centre

A cost centre or expense centre can be defined as a responsibility centre where a manager is accountable only for costs that are under his control. It is a production or service location for which costs can be identified or accumulated prior to allocation to cost units. Cost centres may be either standard cost centres, where output can be measured and the input needed for a given output can be specified, or discretionary cost centres, where output cannot be measured easily and the relationship between inputs and outputs cannot be specified1. An example of a standard cost centre is a production unit in a factory, while an example of a discretionary cost centre is a health and safety department in a university. A cost centre manager is responsible for the cost of inputs to the organisation. The performance of the manager of a cost centre can be assessed by comparing actual performance with budgeted targets for price, usage and efficiency.

1 Drury, C. (2004) Management and Cost Accounting, 6th edition, pp.653–4



Revenue centre

A revenue centre is a responsibility centre where a manager is accountable solely for the revenue generation that is under his control. An example would be a sales team with a target geographical area that is under the control of a sales manager. The manager would have no responsibility for the production cost of the items his team is selling, but has responsibility for meeting sales targets in terms of sales volume, sales revenue or market share. A revenue centre manager has responsibility for the revenue generated by outputs from the organisation. The performance of the manager of a revenue centre can be assessed by comparing actual performance with budgeted targets for price, mix and volume.

Profit centre

A profit centre is a combination of a cost centre and a revenue centre where a manager has responsibility for both production costs and revenue generation. The degree of responsibility carried by a manager can be higher with a profit centre than with a cost centre or a revenue centre, and the manager may be responsible for purchasing, production planning, product mix and pricing decisions. The performance of the manager of a profit centre is unlikely to be assessed on the fine detail of cost and revenue data but by the extent to which agreed targets for overall cost, revenue and profit have been achieved.

Investment centre

With an investment centre, the manager of a profit centre is given additional responsibility for investment decisions regarding working capital and the purchase and replacement of fixed assets. The manager of an investment centre is likely to be assessed with an aggregate measure that links periodic profit to the assets employed in the period to generate that profit. An example of such an aggregate measure is return on capital employed.

Controllable and non-controllable factors

It is a cardinal principle of responsibility accounting that managers can only be assessed on the cash flows that are under their control. If a manager has no control over a cash flow he cannot influence its size or timing and so cannot be held responsible if either of these values changes. The performance of the manager of a cost centre can thus only be assessed on the controllable costs over which he exercises control. In the case of a production cost centre, the manager may be able to control material usage but could have no influence over the price at which materials are bought by the purchasing department. For the production cost centre manager, material usage is a controllable factor whereas material purchase price is not.

With a revenue centre, a sales manager can be held responsible for generating revenue against agreed sales volume targets but may have no control over the selling price of his products as this is determined by market conditions. In this case sales volume is a controllable factor whereas selling price is not.

The manager of a profit centre will have control of operating costs but will not be able to influence the financing costs arising from investment decisions. The manager may thus have responsibility for operating profit but his performance should not be assessed on profit before tax since interest charges are outside of his control.

The manager of an investment centre could have his performance assessed on profit before tax, but the profit on which he is assessed should exclude non-controllable elements such as overhead costs that he cannot influence, for example allocated head office charges.



(b) Assessing managerial performance

While it is possible to assess the performance of an investment centre such as a division in a company on the basis of the profit it generates, considering profit alone and taking no account of the assets used to generate the profit will provide an incomplete picture of performance. Comparing profit between profit centres is also misleading if assets employed are ignored. Assessment of the performance of an investment centre will usually therefore include a performance measure that relates profit to assets employed. Two such measures are return on investment (ROI) and residual income (RI).

Return on investment expresses controllable profit as a percentage of capital employed. It is thus a relative, rather than an absolute, performance measure and is both widely used and understood. Controllable profit means that non-controllable factors are excluded as far as possible from the profit used in calculating ROI since these will diminish the usefulness of the calculated measure in assessing managerial performance.

Because ROI is a relative measure, it can be used to compare performance between investment centres. ROI also offers a way of assessing the past investment decisions made by an investment centre, since it is measured after these investment decisions have been made. It can thus be used to check that the performance predicted by investment appraisal decisions is in fact being achieved post implementation.

Since ROI assesses investment centre managerial performance on the basis of controllable profit generated, managers will be keen to maximise this as far as possible. The desire to maximise controllable profit can be assisted by the use of performance related pay and similar incentive schemes. But if performance is assessed using ROI, investment centre managers will be as keen to minimise capital employed, as they will be to maximise controllable profit. While this can encourage managers to dispose of obsolete equipment and minimise working capital, it can also lead to sub-optimal decisions for the company as a whole.

If managers are assessed using ROI, there will be a disincentive to invest in projects with a ROI that is less than the current ROI of the investment centre. However, these projects should be accepted if the project ROI is greater than the company’s cost of capital. In this case, the decision not to invest will not be consistent with the overall objective of maximising shareholder wealth.

A similar problem arises with asset disposal decisions. Here, a manager assessed using ROI may choose to retain assets with a low written down value since these assets will generate a higher ROI than new, more expensive assets that could be more economical and efficient. This problem highlights the way in which short-term concerns can outweigh longer-term interests when ROI is used to assess managerial performance. It should be noted that ROI could simply increase due to ageing assets rather than from the actions of managers charged with increasing it.

Residual income has been suggested as a way of overcoming some of the perceived shortcomings of ROI as a managerial performance measure. Residual income (RI) is defined as controllable profit less a cost of capital charge on controllable investment. RI is therefore an absolute, rather than a relative, performance measure, which means that comparisons between investment centres cannot be made directly.



The advantage of RI as a performance measure is that the cost of capital charge (or imputed interest charge) is made by reference to the company’s cost of capital, so that a positive residual income arises if an existing or proposed investment generates a return greater than the required minimum. Investment centre managers assessed on the basis of RI will therefore choose to accept all projects with a positive RI, increasing the company’s overall return. Sub-optimal investment decisions should therefore be reduced or eliminated using RI. Investment centre managers will also be discouraged from retaining ageing and inefficient assets, since replacing such assets by more efficient ones is likely to lead to an increase in residual income.

Overall, it is felt that return on investment is an unsatisfactory way of assessing managerial performance as far as an investment centre is concerned, and that residual income should be used instead. Despite this, ROI appears in practice to be preferred to RI1.

Answer 55 PACE CO

(a) Performance statistics

20X8 20X9 20Z0 20Z1 ROI 13% 17.5% 16.7% 20% Bonus paid? No Yes Yes Yes Sales Growth – 0% –10% –5.6% Gross margin 40% 35% 35% 30% Overheads $67,000 $56,000 $53,000 $43,000 Net profit % on Sales 6.5% 7% 5.6% 4.7% The performance of store W can be assessed in various ways:

Sales growth

Sales revenue growth is most unimpressive. The market in which PC operates is steadily growing and yet store W has shrunk in terms of sales over the last four years. This could be poor volumes or poor prices achieved. Given the reducing gross margin (see below), then a reducing sales price is likely. It is possible that W is subject to higher than normal levels of competition.

Gross margin

The gross margins have also shrunk. Reducing margins can result from sales price pressure or increases in the cost of sales levels being incurred. Suppliers might have increased prices or labour could have got more expensive. The level of margin has only reached the normal level once in the last four years. Clearly W is under performing.

Overhead control

The one area that is impressive is the apparent ability of the business to reduce overheads as sales and margin have shrunk. This is often difficult to do. It is possible that reducing these overheads could have contributed to the poor sales performance, if (for example) quality has been affected, or one could say it reflects flexible management.

Net margin

The net margin has also fallen, primarily due to falling gross margins as overheads have reduced. Clearly, this is a disappointing performance.

1 Drury, C. (2004) Management and Cost Accounting, 6th edition, p.847



ROI

The ROI has improved in most years and has exceeded the 15% target in all but one year 20X8. This is simply due to the reducing asset base as the stores assets have gradually been depreciated. Net profit levels have fallen overall and yet ROI has increased.

It is hard to argue that the ROI figures properly reflect the performance of the store. The ROI will tend to increase as assets get older and this will distort the financial performance picture. In a period of falling sales and weaker margins the manager of W has been awarded bonuses in three out of four years. This is hard to justify.

(b) Manipulation of financial results

The unethical manager would have needed to move profits out of 20X9 and in to 20X8. One immediate problem here is having the information in good time to respond. The manager would have to be able to anticipate the 20X8 poor results and the improvement in 20X9. It is likely that such a manager would have to gamble at the end of 20X8 and make an adjustment in the hope of a better year in 20X9.

The manager need only move $2,000 of profit from 20X9 to 20X8 to achieve a 15% return in both years.

Possible methods of adjustment include:

Accelerate revenue: Sales made early in 20X9 could be wrongly included in 20X8. He could, for example, raise an invoice before it is normal, perhaps on the receipt of an order and before actual delivery. The invoice itself would not have to be sent to the customer, merely filed until the second year had begun and delivery made.

Delay the recording of 20X8 costs: A supplier’s invoice could be left unrecorded at the end of 20X8, including it in 20X9 expenses instead.

Understate a provision or accrual in 20X8: This has the effect of moving cost from 20X8 to 20X9 (assuming that by the end of 20X9 the provision is correctly stated).

Manipulate accounting policy: Inventory values (for example) are easy targets for the unethical manager. If inventory in 20X8 could be overstated this would have the effect of increasing 20X8 profits at the expense 20X9 profits.

(c) Store S

(i) Financial forecast Year 1 Year 2 Year 3 Year 4 $ $ $ $ Sales (W1) 216,000 237,600 248,292 235,877 Gross profit (W2) 86,400 95,040 91,476 79,061 Overheads 70,000 70,000 80,000 80,000 Net profit 16,400 25,040 11,476 (939) Investment 100,000 75,000 50,000 25,000 ROI 16.4% 33.39% 22.95% –3.8%



WORKINGS

(1) Sales Year 1 Year 2 Year 3 Year 4 Sales volume (units) 18,000 19,800a 21,780b 21,780 Sales price ($) 12·00 12·00 11·40c 10·83d Revenue ($) 216,000 237,600 248,292 235,877 a: 18,000 (1.1) = 19,800 b: 19,800 (1.1) = 21,780 c: 12.00 (0.95) = 11.40 d: 11.40 (0.95) = 10.83

(2) Gross profit

Year 1 40% (given). Total gross profit = $216,000 × 0.4 = $86,400 Year 2 40% (given). Total gross profit = $237,600 × 0.4 = $95,040 Year 3 (40 – 5)/(100 × 0·95) = 36.8421052% Total gross profit = $248,292 × 0.368421052 = $91,476 Year 4 (40 – 5 – 4·75)/(100 × 0.952) = 33.5180055% Total gross profit = $235,877 × 0.335180055 = $79,061

Alternatively, given that variable costs are said to be constant over the four years, you could calculate the variable cost in year one and hold for the four years. Gross profit is then simply sales revenue less variable costs.

Variable costs in year one:

$216,000 – (18,000 × unit VC) = $86,400 VC per unit = $7.20 So year two’s gross profit will be: $237,600 – 19,800 × 7.2 = $95,040

(ii) Minimum sales volume

In order for a bonus to be paid in year four a ROI of 15% is needed. This implies a net profit of $25,000 × 15% = $3,750.

Adding overheads of $80,000 to this net profit means that $83,750 of gross profit is needed. At a gross profit % of 33.518% this implies sales of $249,866.

At a price of $10.83, this suggests sales volume of 23,072 units.



Answer 56 BUSINESS SOLUTIONS

(a) Optimal daily cross charge

(i) Spare capacity

If North uses the external consultant, the daily contribution to the company is $1,200 – $500 = $700. If North uses a consultant from South the daily contribution to the company is $1,200 – $100 = $1,100. Therefore the cross charge rate should be set on a level where both North and South will perceive that they will benefit – above $100 and below $500 – say $300.

(ii) Full capacity – $400 a day

If North uses the external consultant, the total contribution for one day’s consultancy in both North and South divisions would be:

Income Variable cost North 1,200 500 South 400 100 ––––– ––––– 1,600 – 600 = $1,000 –––––– If the South consultant goes to North, then the total contribution would be:

$1200 – $100 = $1,100

Therefore it is best if North employs the South consultant – by setting the cross charge above $400 and below $500, say $450, both parties will benefit and agree to the transaction.

(iii) Full capacity – $700 a day

If the North uses the South Consultant, the total contribution will be:

$1200 – $100 = $1,100

If North employs the external consultant, the total contribution will be:

Income Variable cost North 1,200 500 South 700 100 ––––– ––––– 1,900 – 600 = $1,300 –––––– The lost contribution of the work in South ($600) exceeds the incremental cost ($400) of the external consultant undertaking the work.

The company therefore needs to set a cross charge that discourages a consultant going North (i.e. above $500 but below $700).



Assumptions

The objective of the company is to maximise contribution in the short run (not long run considerations)

The long term business consequences of rejecting work in the South (Scenario ii) can be ignored

The divisional managers’ behaviour and responses determined only by short-term sectional (divisional) financial performance measurement.

Access to all the decision-making data that the separate divisions use.

(b) Reasons for re-organisation

The need to have local knowledge applied specifically to local decisions

A divisional company offers the opportunity to make decentralised speedy decisions – especially with a rapidly changing environment

It permits senior managers to concentrate on global strategic issues – detailed operational activities are dealt with separately by those most suitable

It permits junior managers to experience broader decision making and can be used as part of their development programme

Local semi-autonomous decision making is likely to be a motivating factor for managers (less central control)

A divisional structure may reduce the complexity and cost of the communication systems in an unitary hierarchical structure

Suggested problems

The senior management may have difficulty in “letting go” – permitting decision to be made locally

Senior management may become involved in resolving disputes between the divisions

The divisions might eventually compete against each other to the detriment of the entire company

Some divisional decisions may not be in the best interests of the entire company (problems of local optimality v global optimality) – ensuring goal congruence

The potential waste from the duplication of functions



Answer 57 MANUCO CO

The general rule of transfer pricing to assist in profit maximising decisions is to set transfer price equal to marginal cost plus net opportunity cost to the group.

Applying this rule to the three situations:

(i) External market

Since Helpco Co has an external market, which is the opportunity foregone, the relevant transfer price would be the external selling price of $15 per kg. This will be adjusted to allow for the $1.50 per kg avoided on internal transfers due to packing costs not required:

The transfer price should be $15 – $ 1.50 = $13.50 per kg.

(ii) No external market

In this situation Helpco Co has no alternative opportunity for 3,000kg of its production of special ingredient Z. It should, therefore, offer to transfer this quantity at marginal cost. This is variable cost less packing costs avoided = $9 – $1.50 = $7.50 per kg.

Total cost = $15 × 80% = $12 Variable cost = $12 × 75%= $9)

The remaining amount of special ingredient Z should be offered to Manuco Co at the adjusted selling price of $13.50 per kg as in (i) above.

(iii) Alternative use for some production capacity

Helpco Co has an alternative use for some of its production capacity that will yield a contribution equivalent to $3 per kg of special ingredient Z ($6,000/2,000kg). The balance of its spare capacity (1,000kg) has no opportunity cost and should still be offered at marginal cost.

Helpco Co should offer to transfer:

2,000kg at $7.50 + $3 = $10.50 per kg; 1,000kg at $7.50 per kg; and the balance of requirements at $13.50 per kg.

Performance Management

Time allowed Reading and planning: 15 minutesWriting: 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.

This question paper must not be removed from the examination hall.

Fundamentals Pilot Paper – Skills module

Pape

r F5

The Association of Chartered Certified Accountants

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Answer ALL FOUR questions

1 Triple Limited makes three types of gold watch – the Diva (D), the Classic (C) and the Poser (P). A traditional product costing system is used at present; although an activity based costing (ABC) system is being considered. Details of the three products for a typical period are:

Hoursperunit Materials Production Labourhours Machinehours Costperunit($) Units Product D ½ 1½ 20 1,750 Product C 1½ 1 12 1,250 Product P 1 3 25 7,000

Direct labour costs $6 per hour and production overheads are absorbed on a machine hour basis. The overhead absorption rate for the period is $28 per machine hour.

Required:

(a) Calculate the cost per unit for each product using traditional methods, absorbing overheads on the basis of machine hours. (3 marks)

Total production overheads are $654,500 and further analysis shows that the total production overheads can be divided as follows:

% Costs relating to set-ups 35 Costs relating to machinery 20 Costs relating to materials handling 15 Costs relating to inspection 30 Total production overhead 100

The following total activity volumes are associated with each product line for the period as a whole:

Numberof Numberofmovements Numberof Setups ofmaterials inspections Product D 175 112 1,150 Product C 115 121 1,180 Product P 480 187 1,670 670 120 1,000 Required:

(b) Calculate the cost per unit for each product using ABC principles (work to two decimal places). (12 marks)

(c) Explain why costs per unit calculated under ABC are often very different to costs per unit calculated under more traditional methods. Use the information from Triple Limited to illustrate. (4 marks)

(d) Discuss the implications of a switch to ABC on pricing and profitability. (6 marks)

(25 marks)

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2 Simply Soup Limited manufactures and sells soups in a JIT environment. Soup is made in a manufacturing process by mixing liquidised vegetables, melted butter and stock (stock in this context is a liquid used in making soups). They operate a standard costing and variances system to control its manufacturing processes. At the beginning of the current financial year they employed a new production manager to oversee the manufacturing process and to work alongside the purchasing manager. The production manager will be rewarded by a salary and a bonus based on the directly attributable variances involved in the manufacturing process

After three months of work there is doubt about the performance of the new production manager. On the one hand, the cost variances look on the whole favourable, but the sales director has indicated that sales are significantly down and the overall profitability is decreasing.

The table below shows the variance analysis results for the first three months of the manager’s work.

Table1

F = Favourable. A = Adverse Month1 Month2 Month3 Material Price Variance $300 (F) $900 (A) $2,200 (A) Material Mix Variance $1,800 (F) $2,253 (F) $2,800 (F) Material Yield Variance $2,126 (F) $5,844 (F) $9,752 (F) Total Variance $4,226 (F) $7,197 (F) $10,352 (F)

The actual level of activity was broadly the same in each month and the standard monthly material total cost was approximately $145,000.

The standard cost card is as follows for the period under review $ 0.90 litres of liquidised vegetables @ $0.80/ltr = 0.72 0.05 litres of melted butter @$4/ltr 0.20 1.10 litres of stock @ $0.50/ltr 0.55

Total cost to produce 1 litre of soup 1.47

Required:

(a) Using the information in table 1:

(i) Explain the meaning of each type of variances above (price, mix and yield but excluding the total variance) and briefly discuss to what extent each type of variance is controllable by the production manager.

(6 marks)

(ii) Evaluate the performance of the production manager considering both the cost variance results above and the sales director’s comments. (6 marks)

(iii) Outline two suggestions how the performance management system might be changed to better reflect the performance of the production manager. (4 marks)

(b) The board has asked that the variances be calculated for Month 4. In Month 4 the production department data is as follows:

ActualresultsforMonth4 Liquidised vegetables: Bought 82,000 litres costing $69,700 Melted butter: Bought 4,900 litres costing $21,070 Stock: Bought 122,000 litres costing $58,560

Actual production was 112,000 litres of soup

Required:

Calculate the material price, mix and yield variances for Month 4. You are not required to comment on the performance that the calculations imply. Round variances to the nearest $. (9 marks)

(25 marks)

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3 BFG Limited is investigating the financial viability of a new product the S-pro. The S-pro is a short-life product for which a market has been identified at an agreed design specification. The product will only have a life of 12 months.

The following estimated information is available in respect of S-pro:

1. Sales should be 120,000 in the year in batches of 100 units. An average selling price of $1,050 per batch of 100 units is expected. All sales are for cash.

2. An 80% learning curve will apply for the first 700 batches after which a steady state production time will apply, with the labour time per batch after the first 700 batches being equal to the time for the 700th batch. The cost of the first batch was measured at $2,500. This was for 500 hours at $5 per hour.

3. Variable overhead is estimated at $2 per labour hour.

4. Direct material will be $500 per batch of S-pro for the first 200 batches produced. The second 200 batches will cost 90% of the cost per batch of the first 200 batches. All batches from then on will cost 90% of the batch cost for each of the second 200 batches. All purchases are made for cash

5. S-pro will require additional space to be rented. These directly attributable fixed costs will be $15,000 per month.

A target net cash flow of $130,000 is required in order for this project to be acceptable.

Note: The learning curve formula is given on the formulae sheet. At the learning rate of 0.8 (80%), the learning factor (b) is equal to -0.3219.

Required:

(a) Prepare detailed calculations to show whether product S-pro will provide the target net cash flow. (12 marks)

(b) Calculate what length of time then second batch will take if the actual rate of learning is: (i) 80%; (ii) 90%.

Explain which rate shows the faster learning. (5 marks)

(c) Suggest specific actions that BFG could take to improve the net cash flow calculated above. (8 marks)

(25 marks)

5

4 The following information relates to Preston Financial Services, an accounting practice. The business specialises in providing accounting and taxation work for dentists and doctors. In the main the clients are wealthy, self-employed and have an average age of 52.

The business was founded by and is wholly owned by Richard Preston, a dominant and aggressive sole practitioner. He feels that promotion of new products to his clients would be likely to upset the conservative nature of his dentists and doctors and, as a result, the business has been managed with similar products year on year.

You have been provided with financial information relating to the practice in appendix 1. In appendix 2, you have been provided with non-financial information which is based on the balanced scorecard format.

Appendix1:Financialinformation Currentyear Previousyear Turnover ($’000) 945 900 Net profit ($’000) 187 180 Average cash balances ($’000) 21 20 Average debtor / trade receivables days (industry average 30 days) 18 days 22 days Inflation rate (%) 3 3

Appendix2:BalancedScorecard(extract) InternalBusinessProcesses Currentyear Previousyear Error rates in jobs done 16% 10% Average job completion time 7 weeks 10 weeks

CustomerKnowledge Currentyear Previousyear Number of customers 1220 1500 Average fee levels ($) 775 600 Market Share 14% 20%

LearningandGrowth Currentyear Previousyear Percentage of revenue from non-core work 4% 5% Industry average of the proportion of revenue from non-core work in accounting practices 30% 25% Employee retention rate. 60% 80%

Notes

1. Error rates measure the number of jobs with mistakes made by staff as a proportion of the number of clients serviced

2. Core work is defined as being accountancy and taxation. Non-core work is defined primarily as pension advice and business consultancy. Non core work is traditionally high margin work

Required:

(a) Using the information in appendix 1 only, comment on the financial performance of the business (briefly consider growth, profitability, liquidity and credit management). (8 marks)

(b) Explain why non financial information, such as the type shown in appendix 2, is likely to give a better indication of the likely future success of the business than the financial information given in appendix 1. (5 marks)

(c) Using the data given in appendix 2 comment on the performance of the business. Include comments on internal business processes, customer knowledge and learning/growth, separately, and provide a concluding comment on the overall performance of the business. (12 marks)

(25 marks)

End of Question paper

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Formulae Sheet

Learning curve

Y = axb

Where y = average cost per batch a = cost of first batch x = total number of batches produced b = learning factor (log LR/log 2) LR = the learning rate as a decimal

Regression analysis

Demand curve

P = a – bQ b = change in price change in quantity

a = price when Q = 0

y=a+bx

b=n∑xy-∑x∑yn∑x -(∑x)

a=∑yn

-b∑xn

r=n∑xy

2 2

--∑x∑y

n∑x -(∑x) )(n∑y -(∑y) )2 2 2 2

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Pilot Paper F5 AnswersPerformance Management

1 TRIPLELimited

(a) Traditional cost per unit D C P $ $ $ Material 20 12 25 Labour ($6/hour) 3 9 6 Direct costs 23 21 31 Production overhead ($28/machine hour) 42 28 84 Total production cost /unit 65 49 115

(b) ABC cost per unit

Examinersnote: Each step required has been given its own sub-heading to make the procedure clear. The basic principle is to find an overhead cost per unit of activity for each element of overhead cost. In some cases it might then be possible to find an overhead cost per unit directly; here it is probably easier to split overheads between each product type first and then find a cost per unit as shown.

(i) Total overheads

These were given at $654,500

(ii) Total machine hours (needed as the driver for machining overhead)

Product Hours/unit Productionunits Totalhours D 1½ 1,750 21,125 C 1 1,250 21,250 P 3 7,000 21,000 Total machine hours 23,375 (iii) Analysis of total overheads and cost per unit of activity

Typeofoverhead Driver % Totaloverhead Levelof Cost/driver $ driveractivity Set-ups Number of set ups 35 229,075 670 341.90 Machining Machine hours 20 130,900 23,375 5.60 Materials handling Material movements 15 98,175 120 818.13 Inspection Number of inspections 30 196,350 1,000 196.35 100 654,500

(iv) Total overheads by product and per unit

ProductD ProductC ProductP Total Overhead Activity $CostActivity $CostActivity $Cost Activity $Cost Set-ups 75 25,643 115 39,319 480 164,113 670 229,075 Machining 1,125 6,300 1,250 7,000 21,000 117,600 23,375 130,900 Material Handling 12 9,817 21 17,181 87 71,177 120 98,175 Inspection 150 29,453 180 35,343 670 131,554 1,000 196,350 Total overhead cost 77,213 98,843 484,444 654,500

Units produced 750 1,250 7,000 Costs per unit $94.95 $79.07 $69.21

(v) Cost per unit D C P $ $ $ Direct costs (from (a)) 23.00 21.00 31.00 Overheads (from (iv)) 94.95 79.07 69.21 117.95 100.07 100.21

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(c) Comment

The overhead costs per unit are summarised below together with volume of production.

Product D C P Volume 750 1,250 7,000 Conventional overheads $42 $28 $84 ABC overheads $95 $79 $69

The result of the change to Activity Based Costing is clear, the overhead cost of D and C have risen whilst that of P has fallen.

This is in line with the comments of many who feel that ABC provides a fairer unit cost better reflecting the effort required to make different products. This is illustrated here with product P which may take longer to make than D or C, but once production has started the process is simple to administer. This may be due to having much longer production lines.

Products D and C are relatively minor volume products but still require a fair amount of administrative time by the production department; ie they involve a fair amount of `hassle`. This is explained by the following table of `activities per 1,000 units produced`.

Set-ups Materials Inspections movements D 100 16 200 C 92 17 144 P 69 12 96

This table highlights the problem. – Product P has fewer set-ups, material movements and inspections per 1,000 units than or C– As a consequence product P’s overhead cost per unit for these three elements has fallen– The machining overhead cost per unit for P is still two or three times greater than for products D or C, but because this

overhead only accounts for 20% of the total overhead this has a small effect on total cost.– The overall result is P’s fall in production overhead cost per unit and the rise in those figures for D and C

(d) Pricing and Profitability

Switching to ABC can, as in this case, substantially change the costs per unit calculations. Consequently if an organisation’s selling prices are determined by a version of cost-plus pricing then the selling prices would alter.

In this case the selling price of D and C would rise significantly, and the selling price of P would fall. This, at first glance may be appealing however:

– Will the markets for D and C tolerate a price rise? There could be competition to consider. Will customers be willing to pay more for a product simply because Triple Ltd has changed its cost allocation methods?

– Product P is a high volume product. Reducing its selling price will have a dramatic effect on revenue and contribution. One would have to question whether such a reduction would be compensated for by increased volumes.

Alternatively, one could take the view that prices are determined by the market and therefore if Triple Ltd switches to ABC, it is not the price that would change but the profit or margin per unit that would change.

This can change attitudes within the business. Previously high margin products (under a traditional overhead absorption system) would be shown as less profitable. Salesmen (possibly profit motivated) can begin to push the sales of different products seeking higher personal rewards. (Assuming commission based on profits per unit sold)

It must always be remembered that if overheads are essentially fixed then they should be ignored in business decision making. Switching to ABC can change reported profits per unit but it is contribution per unit that is perhaps more important.

2 (a) SIMPLY SOUP Limited

(i) Meaning and Controllability of the variances

MaterialPriceVariance

Indicates whether Simply Soup has paid more (adverse) or less (favourable) for its input materials than the standard prices set for the period. For example, if a new supplier had to be found and the price paid was more than the standard price then Simply Soup would incur an extra cost. This extra cost is the price variance.

Price variances are controllable to the extent that Simply Soup can choose its suppliers. On the other hand, vegetables are a seasonal and weather dependent crop and therefore factors outside Simply Soups control can influence prices in the market. The key issue is that the production manager will not control the price paid that is the job of the Purchasing Manager.

MaterialMixVariance

Considers the cost of a change in the mix of the ingredients to make soup. For example adding less butter (which is expensive) and more stock (which is cheaper) will be a cheaper mix than the standard mix. A cheaper mix will result in a favourable variance.

10

$69,70082,000

$21,0704,900

$58,560122,000

The recipe determines the mix. The recipe is entirely under the control of the production manager.

MaterialYieldVariance

This shows the productivity of the manufacturing process. If the process produces more soup than expected then the yield will be good (favourable). At the moment 2.05 litres of input produces 1 litre of soup, if 2.05 litres of input produces more than 1 litre of soup then the yield is favourable. Greater yield than expected can be a result of operational efficiency or a change in mix.

The production manager controls the operational process so should be able to control the yield. Poor quality ingredients can damage yield but the production manager should be in control of quality and reject dubious ingredients. The production manager is also responsible for things like spillage. Higher spillage can also reduce yield.

(ii) Production manager’s performance

CostEfficiency

The production manager has produced significant favourable cost variances. The total favourable variance has risen from $4,226 to $10,352 in the first three months. This last figure represents approximately 7.1% of the standard monthly spend.

The prices for materials have been rising but are probably outside the control of the production manager. The rising prices may have put pressure on the production manager to cheapen the mix.

The mix has become cheaper. This could be seen as a cost efficient step. However, Simply Soup must question the quality implications of this (see later).

The yield results are the most significant. The manager is getting far more out of the process than is usual. The new mix is clearly far more productive than before. This could easily be seen as an indicator of good performance as long as the quality is maintained.

Quality

The concern is that the production manager has sacrificed quality for lower cost and greater quantity. The sales director has indicated that sales are falling, perhaps an indication that the customers are unhappy with the product when compared to competitor offers. The greater yield and cheaper mix may well have produced a tasteless soup.

Overall

Overall there has to be concern about the production manager’s performance. Cost control and efficiency are important but not at the expense of customer satisfaction and quality. We do not have figures for the extent to which sales have been damaged and small reductions may be acceptable.

(iii) Changes to the performance management system

The performance management system needs to take account of the quality of the soup being produced and the overall impact a decision has on the business.

Quality targets need to be agreed with the manager. These are difficult to quantify but not impossible. For example soup consistency (thickness) is measurable. Regular tasting will indicate a fall in quality; tasters could give the soup a mark out of 10 on taste, colour, smell etc.

The production manager should not be rewarded for producing lots of cheap soup that cannot be sold. The performance management system should reflect the overall effect that decisions have. If the production manager’s actions have reduced sales then sales volume variances should be allocated to the production manager as part of the performance assessment.


MaterialPriceVariance

Mixed Vegetables: – 0.80 x 82,000 = $4,100 (A)

Butter: – 4 x 4,900 = $1,470 (A)

Stock: – 0.50 x 122,000 = $2,440 (F)

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MaterialMixVariance

Mixed Vegetables: (82,000 – 91,712.2*) x 0.80 = $7,770 (F)

Butter: (4,900 – 5,095.1) x 4 = $780 (F)

Stock: (122,000 – 112,092.7) x 0.50 = $4,954 (A)

Total Mix Variance = $3,596 (F)

Note: it is only the total mix variance that is a valid variance here Total input volume = (82,000 + 4,900 + 122,000) = 208,900

* Standard mix for mixed vegetables is = $91,712.2

Note: alternate approaches are acceptable.

MaterialYieldVariance [112,000 – 101,902.4] x 1.47 = $14,843(F)

The standard inputs add up to 2.05 units (0.9+0.5+1.1). This produces 1ltr of soup. The actual inputs were 208,900 litres and therefore the standard expected output should be

1 208,900 = 101,902.4 litres 2.05

3 BFGLimited

(a) Sales 120,000 units Sales Revenue $1,260,000 Costs: Direct materials (W1) $514,000 Direct Labour (W2) $315,423 Variable overhead $126,169 Rent $180,000 Net cash flow $124,408 Target cash flow $130,000

The target cash flow will not be achieved

Workings:

(1) Direct material: Batches $ First 200 @ $500 100,000 Second 200 @$450 90,000 Remaining 800 @$405 324,000 Total 514,000

(2) Direct labour

For first seven hundred batches y = axb

y = 2,500 x 700 –0.3219

y = $303.461045

Total cost for first 700 batches = $303.461045 x 700 = $212,423

All batches after the first 700 will have the same cost as the 700th batch. To calculate the cost of the 700th batch we need to take the cost of 699 batches from the cost of 700 batches.

For 699 batches y = a x b y = 2,500 x 699 –0.3219

y = $303.600726 Total cost for first 699 batches = $303.600726 x 699 = $212,217

Cost of 700th batch is $212,423 - $212,217 = $206

Total cost for the 12 months of production

$212,423 + ($206 x 500) = $315,423

(3) Variable overhead is $2 per hour or 40% of direct labour

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(b) To calculate the learning factor BFG will have had to measure the time taken to make the first batch (500 hours) and then the time taken to make the second batch. The learning rate measures the relationship between the average time taken between two points as production doubles. The easiest way to measure the learning rate is when the production doubles between the first and second batches.

At 80%

Time for first batch 500 Average time for two batches @80% 500 x 0.8 = 400 Total time for two batches 2 x 400 = 800 Time for second batch 800 – 500 = 300

At 90%

Time for first batch 500 Average time for two batches @90% 500 x 0.9 = 450 Total time for two batches 2 x 450 = 900 Time for second batch 900 – 500 = 400

The 80% learning rate reduces the time taken for the two successive batches above by a greater amount (or faster). Hence the 80% learning rate is the faster learning.

(c) Possible actions to improve the net cash flows are:

– Increase the price charged. The question states that an agreed specification has been reached, however further research may reveal that a higher price could be tolerated by the market. Equally a form of price skimming may be possible to improve short term net cash flow.

– Reduce the labour cost per batch by removing unnecessary operations or processes. It may be possible to simplify the design without damaging the ability to achieve the price stated.

– Improve the learning rate. This may involve improving the training or the quality of people involved in the production process. This does takes time and costs money in the short run.

– Consider substitute materials (without damaging the product specification). Also look for new suppliers to reduce the input cost.

– Consider ways to reduce the level of variable overhead incurred by the product.

– Investigate whether the production of product X could take place in existing space and hence avoid the extra rent charge. Re-negotiate the rent charge with the landlord.

4 Preston Financial Services

(a) Financial analysis

There are various financial observations that can be made from the data.

– Turnover is up 5% – this is not very high but is at least higher than the rate of inflation indicating real growth. This is encouraging and a sign of a growing business.

– The main weakness identified in the financial results is that the net profit margin has fallen from 20% to 19.8% suggesting that cost control may be getting worse or fee levels are being competed away.

– Profit is up 3.9%. In absolute terms profits are impressive given that Richard Preston is the sole partner owning 100% of the business.

– Average cashbalances are up 5% – indicating improved liquidity. Positive cash balances are always welcome in a business.

– Average debtorsdays are down by 3 days – indicating improved efficiency in chasing up outstanding debts. It is noticeable that Preston’s days are lower than the industry average indicating strong working capital management. The only possible concern may be that Richard is being particularly aggressive in chasing up outstanding debts.

Overall, with a possible concern about margins and low growth, the business looks in good shape and would appear to have a healthy future.

(b) Financial performance indicators will generally only give a measure of the past success of a business. There is no guarantee that a good past financial performance will lead to a good future financial performance. Clients may leave and costs may escalate turning past profits to losses in what can be a very short time period.

Non financial measures are often termed “indicators of future performance”. Good results in these measures can lead to a good financial performance. For example if a business delivers good quality to its customers then this could lead to more custom at higher prices in the future.

Specifically the information is appendix 2 relates to the non financial measures within the balanced scorecard.

Internal business processes are a measure of internal efficiency. Interestingly these measures can indicate current cost efficiency as much as any future result

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Customer knowledge measure how well the business is dealing with its external customers. A good performance here is very likely to lead to more custom in the future.

Innovation and learning measures that way the business develops. New products would be reflected here along with indicators of staff retention. Again this is much more focused on the future than the present.

Measuring performance by way of non-financial means is much more likely to give an indication of the future success of a business.

(c) The extra non-financial information gives much greater insight into key operational issues within the business and paints a bleaker picture for the future.

Internalbusinessprocesses

Error rates Error rates for jobs done are up from 10% to 16%, probably a result of reducing turnaround times to improve delivery on time

percentages. This is critical as users expect the accounts to be correct. Errors could lead to problems for clients with the Inland Revenue, bankers, etc. What is worse, Richard could be sued if clients lose out because of such errors. One could say that errors are unlikely to be revealed to clients. Businesses rarely advertise mistakes that have been made. They should of course put mistakes right immediately.

CustomerKnowledge

Client retention The number of clients has fallen dramatically – this is alarming and indicates a high level of customer dissatisfaction. In an

accountancy practice one would normally expect a high level of repeat work – for example, tax computations will need to be done every year. Clearly existing clients are not happy with the service provided.

Average fees It would appear that the increase in revenue is thus due to a large increase in average fees rather than extra clients – average

fee is up from $600 to $775, an increase of 29%! This could explain the loss of clients in itself, however there could be other reasons.

Market share The result of the above two factors is a fall in market share from 20% to 14%. Looking at revenue figures one can estimate

the size of the market as having grown from $4.5m to $6.75m, an increase of 50%. Compared to this, Preston’s figures are particularly worrying. The firm should be doing much better and looks to being left behind by competitors.

LearningandGrowth

Non-core services The main weakness of the firm seems to be is its lack of non-core services offered. The industry average revenue from non-core

work has increased from 25% to 30% but Richard’s figures have dropped from 5% to 4%. It would appear that most clients are looking for their accountants to provide a wider range of products but Richard is ignoring this trend.

Employee retention Employee turnover is up indicating that the staff are dissatisfied. Continuity of staff at a client is important to ensure a quality

product. Conservative clients may resent revealing personal financial details to a variety of different people each year. Staff turnover is possibly a result of extra pressure to complete jobs more quickly without the satisfaction of a job well done. Also staff may realise that the lack of range of services offered by the firm will limit their own experience and career paths

Conclusion In conclusion, the financial results do not show the full picture. The firm has fundamental weaknesses that need to be

addressed if it is to grow into the future. At present it is being left behind by a changing industry and changing competition. It is vital that Richard reassesses his attitude and ensures that the firm has a better fit with its business environment.

In particular he should seek to develop complementary services and reduce errors on existing work.

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Pilot Paper F5 Marking SchemePerformance Management

1 (a) For each product 1 mark Total 3 marks

(b) Total machine hours 2 marks Cost per driver calculation 3 marks Overheads split by product table 4 marks Cost per unit calculation 3 marks Total 12 marks

(c) Explanation 4 marks

(d) Comment on pricing, markets, customers and profitability 6 marks Total 25marks

2 (a) For each variance Explanation of meaning of variance 1 mark Brief discussion of controllability 1 mark 6 marks

(b) Comment on cost variance Price: Outside Production Managers Control 1 mark Rising prices pressures 1 mark

Mix Cheaper mix and comment 1 mark

Yield High yield results and comment 1 mark

Quality Comment on quality implications 1 mark

Overall summary 1 mark 6 marks

(c) Improvements to performance measurement system For each sensible suggestion 2 marks 4 marks

(d) Variance calculations Price: 1 mark for each ingredient 3 marks Mix: 3 marks Yield: 3 marks Method marks should be awarded as appropriate 9 marks Total 25marks

3 (a) Sales 1 marks Direct material 2 marks Direct labour first seven months 3 marks last five months 3 marks Variable overhead 1 marks Rent 1 marks Decision 1 marks Total for part (a) 12 marks

(b) Second batch times 80% 2 marks 90% 2 marks Comment on faster learning 1 marks Total for part (b) 5 marks

(c) Actions to improve net cash flow (2 marks per explained idea) 8 marks Total for part (c) Total 25marks

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4 (a) Financial commentary Turnover growth 2 marks Profitability 2 marks Cash position 2 marks Debtor management 2 marks Total 8 marks

(b) Future performance General explanation with example 2 marks Comment on each area 3 marks Total 5 marks

(c) Assessment of future prospects. Internal business processes Error rates 3 marks Not revealed to clients 1 marks Customer Knowledge Retention 1 marks Fee levels 2 marks Market share/size 1 marks Learning and growth Lack of product range 2 marks Employee retention 2 marks Total 12 marks Total 25marks

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This ACCA Revision Question Bank which has undergone a Quality Assurance review by ACCA includes:

• Past examination questions, updated where relevant

• Model answers and suggested solutions

• Tutorial notes

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