Examiners’ commentaries 2018
Examiners’ commentaries 2018
AC3097 Management accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 2017–18. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).
Information about the subject guide and the Essential reading
references
Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2017).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refer to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements – if
none are available, please use the contents list and index of the new edition to find the relevant
section.
General remarks
Learning outcomes
At the end of the course and having completed the Essential reading and activities you should be
able to:
•
discuss the changing role of management accounting
•
critically evaluate the uses of management accounting information for strategic decision
making in various business contexts
•
select, devise and apply different types of cost and revenue analysis and explain their
different roles for supporting operational and strategic managerial decisions
•
design and prepare budgets and explain their use in planning and control
•
design and use variances to support feedback, analysis and control
•
identify and discuss different methods of investment appraisal
•
discuss various approaches to performance measurement and control in various types of
organisations, and devise and evaluate indicators of performance.
What are the examiners looking for?
The AC3097 Management accounting paper follows the AC1025 Principles of accounting
paper and assumes that candidates are familiar with the subject matter and skills in management
accounting covered in AC1025 Principles of accounting.
1
AC3097 Management accounting
Candidates who achieved a low pass in AC1025 Principles of accounting may need to revise the
management accounting chapters of that subject guide as part of their preparation for this
examination.
The examiners are looking for a good analytical ability and depth of understanding of the use of
management accounting information for decision-making, planning and control. They want to see an
appreciation of how the information is collected and compiled and the organisational contexts in
which it is used and an understanding of how management accounting responds to changes in the
business environment.
Candidates should show a clear ability to identify the necessary computations and perform them
logically in order to derive answers to the questions. Where answers include calculations, the
workings as well as the answer should be clearly presented. Written answers should be
well-structured, demonstrating the ability to discuss issues and focus on the relevant areas where
necessary.
Candidates should read the whole of each question carefully and answer exactly what is asked for.
Writing general answers to specific questions will not gain marks, but instead wastes valuable time
that could be used on another question. Management accounting is about performing the correct
calculations and presenting the information in such a way that other managers can understand it
and use it in their discussions on the best course of action.
Planning your time in the examination
The time allowed for the examination is 3 hours and 15 minutes. In Section A, you should not only
look at the topic that is being examined but also make sure that you understand the way in which
the question should be answered. This may help you to avoid wasting time on a question that is too
complex for you to continue with beyond the first part.
At the start of the examination it would be helpful to choose all the questions you intend to answer.
While answering one question, a different part of your brain can start marshalling ideas relevant to
later ones, especially with written questions. Similarly, if you get stuck on a calculation question, it
is often beneficial to move on to another one, returning to the original question later. By this time
your brain may have run through new possibilities which can be tried.
Generally, candidates should not spend more than the allotted time (i.e. 39 minutes) on any one
question.
Format of the examination
The examination requires five questions to be answered. Each question will be worth 20 marks. The
paper consists of two sections: Section A has questions that require the use of calculations and
comments on the numerical answers calculated. Candidates must answer at least four from six
questions in Section A. Section B has questions requiring written answers. Candidates must answer
one question from two in Section B.
Key steps to improvement
•
Read the Essential reading and some of the Further reading for the course.
•
Work through numerical questions from the subject guide, the textbook and, if not fully
understood previously, from the subject guide for AC1025 Principles of accounting.
•
Practise writing essays that relate to or contrast different aspects of the syllabus.
Since the paper requires at least four Section A questions to be answered, it is important to practise
a wide variety of numerically-based questions. Even if you attend an institution where you study
2
Examiners’ commentaries 2018
with a lecturer who provides practice questions, you should still attempt the textbook questions
recommended in your subject guide. The examiners may use these questions to gauge the
appropriate level at which to set examination questions for Section A.
Diploma for Graduates candidates who may not have taken the AC1025 Principles of
accounting paper may need to practise some questions from that paper and/or extra questions at
the end of each textbook chapter for AC3097 Management accounting in order to develop their
proficiency and speed in answering these types of question.
When answering questions in Section A, candidates’ answers should provide all of the financial
calculations requested in each part of the question.
Answers to questions in Section B should focus on the question asked and show an organised
approach. Where appropriate it is useful to jot down the key issues you wish to include in your
answer before starting to write the essay. This not only helps you to write a well-constructed answer
but, if you do not finish, due to lack of time, enables some marks to be given for the ideas you have
jotted down but not had time to explain in full.
There were changes in the syllabus for 2017–18 onwards
The syllabus changes in 2017–18 were to a more analytical focus, enabling newer more advanced
management accounting analyses to be taught and incorporated in the examination paper.
The additional areas now covered in the subject guide for 2017–18 are:
•
learning curve analysis including calculations
•
decision trees
•
maximin, maximax and regret criteria
•
additional variance analyses, input mix and yield variances, sales mix variance and planning
and operational variances
•
benchmarkng
•
environmental cost management
•
the use of the Fitzgerald and Moon results and determinants framework for non-financial
data in service industries
•
issues to be considered in providing management accounting information in not-for-profit
organisations.
New theory paper
Examination of the theoretical content has been reduced in AC3097 Management accounting
but a new theory paper incorporating 50% financial accounting theory and 50% management
accounting theory will be taught and examined from 2018–19 onwards.
Examination revision strategy
Many candidates are disappointed to find that their examination performance is poorer than they
expected. This may be due to a number of reasons, but one particular failing is ‘question
spotting’, that is, confining your examination preparation to a few questions and/or topics which
have come up in past papers for the course. This can have serious consequences.
3
AC3097 Management accounting
We recognise that candidates might not cover all topics in the syllabus in the same depth, but you
need to be aware that examiners are free to set questions on any aspect of the syllabus. This
means that you need to study enough of the syllabus to enable you to answer the required number of
examination questions.
The syllabus can be found in the Course information sheet available on the VLE. You should read
the syllabus carefully and ensure that you cover sufficient material in preparation for the
examination. Examiners will vary the topics and questions from year to year and may well set
questions that have not appeared in past papers. Examination papers may legitimately include
questions on any topic in the syllabus. So, although past papers can be helpful during your revision,
you cannot assume that topics or specific questions that have come up in past examinations will
occur again.
If you rely on a question-spotting strategy, it is likely you will find yourself in difficulties
when you sit the examination. We strongly advise you not to adopt this strategy.
4
Examiners’ commentaries 2018
Examiners’ commentaries 2018
AC3097 Management accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 2017–18. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).
Information about the subject guide and the Essential reading
references
Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2017).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refer to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements – if
none are available, please use the contents list and index of the new edition to find the relevant
section.
Comments on specific questions – Zone A
Candidates should answer FIVE of the following EIGHT questions: FOUR from Section A and
ONE from Section B. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary assumptions
introduced in answering a question are to be stated.
Section A
Answer FOUR questions from this section.
Question 1
Susan’s Toys is a well-established small company run by Susan, which traditionally
has concentrated on toys for children of up to five years of age. However it has
recently developed a toy which might be suitable for older children, and it is
considering whether to manufacture and market the new product; which will be
known as ‘The Kimberly’.
As it would involve moving into a new market, and it would also involve setting up
dedicated departments to manufacture and market the product, Susan sees this as a
high risk venture. She comes to you for advice in assessing the situation and to
endeavour to quantify the risks involved.
On talking to Susan you find that she is reasonably certain of some factors. She
intends to market ‘The Kimberly’ at a price of £24 per unit. The fixed costs
relating to the new departments can be projected to be £900,000 per annum.
5
AC3097 Management accounting
However there are two particular aspects which cannot be predicted with any
certainty. They are the numbers of units that can be sold, and – as new materials
need be sourced – the unit variable costs.
You advise Susan that this might be a suitable application for a decision tree which
endeavours to quantify the uncertainties through the use of probabilities. For each
of the two factors you ask Susan to make projections of the most pessimistic case,
the most optimistic case and the most likely case.
After some consideration Susan supplies you with the following probabilities:•
For sales volume she makes a pessimistic projection of 60,000 units per annum
at a probability of 0.2, an optimistic projection of 110,000 units per annum at a
probability of 0.3, and the most likely case 95,000 units per annum at a
probability of 0.5.
•
For unit variable costs her pessimistic projection is £14.00 per unit at a
probability of 0.1, her optimistic projection is £10.00 per unit at a probability of
0.2 and the most likely £12.00 per unit at a probability of 0.7.
Required:
(a) Prepare a decision tree showing the probable expected value of a decision to
produce ‘The Kimberly’ compared with a decision not to.
(12 marks)
(b) i. Explain the meaning of probable expected value.
ii. Show the worst possible outcome; the maximin and the maximax.
iii. Explain to Susan what these figures mean in terms of how they help her
make decisions about negotiating variable cost prices and creating demand
for sales.
(6 marks)
(c) Discuss the strengths and limitations of the use of decision trees.
(2 marks)
Reading for this question
Subject guide, Chapter 9.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 12.
Approaching the question
Decisions trees show, in a single clear diagram, the different options and their expected values
based on estimates, converted into probabilities. The aggregate of these probabilities gives the
likely outcome based on the estimates. The tree itself enables users to review the probable
outcomes and consider whether changes in plans could result in a better chance of making the
desired contribution.
(a) The question specifically required a decision tree to be drawn so marks were allocated for
accurately drawing the tree, as well as calculating the expected values and the expected net
contribution towards the company’s net income. Since Susan has not yet put any actions in
place, she has not committed to pay £900,000 fixed costs, so the value of ‘do not proceed’ is
£0.
(b) It is important to be able to help a user to understand the information shown by the
decision tree. This can be done by highlighting the maximin, maximax and worst possible
case, to bring greater understanding of the possible results.
(c) It is important that users understand the usefulness and limitations of the decision tree.
6
Examiners’ commentaries 2018
(a) We have:
(b) i. The probable expected value is the amount expected taking into account all the
probabilities. In this case it is £229,000 per annum.
ii. The worst possible case is if demand is only 60,000 and variable costs per unit are £14.
This shows a net loss of £300,000 per annum (i.e. £600,000 − £900,000). The
probability of this is 2%.
The maximin is the largest payoff if the worst situation occurs. There are two in this
question. If the variable costs are the worst at £14 per unit the largest payoff is high
demand of 110,000 units giving a contribution of £1,100,000 and the profit £200,000.
This has an 8% probability.
If the demand is only 60,000 but the variable costs are only £10 the contribution will be
£840,000 and a loss of £60,000. There is a 4% probability of this. It is important for
Tamsin to get the best price from suppliers for the variable costs.
The maximax is the best payoff which can occur. This is where demand is at 110,000
and variable costs are only £10. It shows a contribution of £1,540,000 and a profit of
£640,000 per annum. There is a 6% probability of this.
iii. It is unlikely that the probable expected value of £229,000 net contribution will be the
actual outcome as it is based on so many estimates. The ability to make easier decisions
will soon arise as the amount of the variable cost will be ascertained fairly quickly. The
decision tree shows how important it will be to get a low price for variable cost. The
decisions will then only be the level of demand, so a new decision tree based on the
variability of demand can be calculated. The decision tree shows that ensuring high
demand is important to the success of the project.
(c) Decision trees are a useful tool where there are a whole range of uncertainties regarding the
actual outcome of a company’s best projections. The tree clearly shows the results of the
various possible outcomes. However, even the process of ‘making best case’, ‘worst case’,
and ‘most likely’ projections are highly subjective.
7
AC3097 Management accounting
Question 2
Clintons Garden Chairs produces three models of chair: a basic chair ‘The Cub’, an
armchair: ‘The Yankee’ and a lounger ‘The Giant’ to be sold in DIY stores and
garden centres.
The budget for the 2018/19 Financial Year shows following costs and revenues for
each chair:-
Clintons Selling Price
Variable Component Costs
Variable Assembly Costs
The Cub
$
38
12
3
The Yankee
$
53
17
4
The Giant
$
68
21
6
The Departmental Direct Fixed Costs are budgeted to be $975,000.
The original budget has been prepared assuming that production and sales will be
at the department’s full capacity assembly capacity. 50,000 chairs will be produced
in the proportions of The Cub 20%, The Yankee 50% and the Giant 30%.
However the latest market research considers that sales of only 45,000 chairs can be
achieved, and in the proportions of 30%, 55% and 15%.
Hilary Clinton, the Sales Director, feels that in particular, The Giant is not
competitive with similar products in the market. She is proposing to upgrade the
chair increasing the selling price to $75. For the re-designed chair the variable
component costs will be $26 per chair and the variable assembly costs $7 per chair.
She is proposing to spend $45,000 in advertising to promote the new Chair. 50,000
chairs in total will be produced in the proportions of The Cub 10%, The Yankee
55% and The Giant 35%.
Bill Clinton, the Production Director, points out that with the original forecast, the
company would be working at full assembly capacity and so overtime would be
needed to meet the new proposal. The variable assembly costs represent direct
labour paid at $18 per hour. Overtime would be paid at 150% of normal time.
Jim Jones, the accountant, wishes to calculate the contribution per normal assembly
hour for each style of chair, to inform the decision making on the price of the new
Giant and the use of production time in general.
Required:
(a) Using the information relating to the original budget for 2018/19 calculate the
net income that the company would make. Also calculate the breakeven point
for the department showing the total number of chairs needing to be sold and
the numbers of each type of chair.
(6 marks)
(b) Calculate the corresponding information as in part (a) for the projections of
sales of 45,000 chairs.
(3 marks)
(c) Assuming that the suggested changes are made to the Giant chair, that
overtime will be needed and that the anticipated sales will be achieved, calculate
the cost of overtime and the net income that the company would make.
(5 marks)
(d) Calculate the contribution per assembly hour and suggest the price which is
needed for the Giant to be as profitable as the most profitable product per
assembly hour.
(3 marks)
8
Examiners’ commentaries 2018
(e) Comment on the information you have prepared and explain how it could be
used in decision making to result in greater profitability.
(3 marks)
Reading for this question
Subject guide, Chapters 6 and 7.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 8.
Approaching the question
Because there is more than one product, the breakeven aspects of this question require an
understanding of weighted contribution per product based on the proportion of sales of each
product. Parts a and b use the same technique.
Part (c) requires careful reading of the question. The first step is to discover how much direct
labour would be needed for the original estimated sales, and the new estimated sales, so that the
overtime can be calculated. The original estimated sales units was 50,000 so this is the level at
which the company wishes to work. Some candidates assumed this quantity was 45,000 so this
was also accepted as a fair answer.
The overtime will be the extra paid per hour i.e. £6 per hour, because the original £12 is already
included in the variable costs used for calculating the contribution per product.
(a) We have:
(b) We have:
9
AC3097 Management accounting
(c) We have:
(d) We have:
(e) Part (a) gives the anticipated net income from the original sales projection and the required
breakeven. Part (b) gives a more pessimistic projection. Maybe more market research is
needed to establish which is the more likely forecast. If the original plan is no longer viable
case 2 seems to be a very poor proposition, both in terms of riskiness with higher breakeven,
and net income which is down £265,750. This is presumably why the company wishes to
upgrade the Giant. Part (c) and (d) The new proposal would make slightly more
contribution than the original budget. However, The Cub and The Yankee are making more
contribution per assembly hour. The price calculated above of £89 is considerably higher
than the proposed price. In the long run taking on more assembly workers may be advisable.
Whichever option is chosen the projections give a good yardstick against which to monitor
performance, and emphasises the importance of product mix as well as simple sales.
In the long run taking on more assembly workers may be advisable.
10
Examiners’ commentaries 2018
Question 3
Smart wheels manufactures one size of wheel hub cap in each of its production lines.
The following information relates to one production line for the most recent period.
The company uses the weighted average method to value work in process.
Each hub cap weighs 1kg but due to normal wastage requires 1.05 kg of material
input.
Opening work in progress
Materials 100% complete
Conversion 60% complete
Introduced during period:
Material
Conversion costs
Closing work in progress
Materials 100% complete
Conversion 30% complete
Total number of hub caps transferred
to finished goods
Quantities
320 hub caps:
336 kg
1,260 kg
£
£672
£2,000
£2,772
£14,500
200 hub caps
1,160 hub caps
Required:
(a) Give three uses of process costing information.
(3 marks)
(b) Calculate the cost of finished goods, the value of closing the work in progress
and the cost of the abnormal loss or gain.
(10 marks)
(c) Show the process account for the period.
(3 marks)
(d) Describe two non-financial methods by which the process might be monitored
for quality purposes.
(4 marks)
Reading for this question
Subject guide, Chapter 3.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 5.
Approaching the question
Management accounting information should always be prepared with an understanding of the
uses of the information in mind. This issue is addressed by part (a) of the question.
Part (b) is a bit like a number puzzle, as not all the information is given, some information needs
to be derived. The most important information to be calculated is the abnormal loss in order to
provide the appropriate calculations. There is also a normal loss which could be calculated.
In practice the cost of normal loss is included as part of the cost of output, so need not
necessarily be calculated. The answer can be calculated by using either Hub Caps or Kgs of
material. Some candidates assumed that the abnormal loss applied to conversion costs as well as
material costs. This approach was accepted.
Part (c) recognised that in the routine environment of continuous production there is a need for
non-financial mechanisms which can monitor activity regularly (possibly hourly) without
reference to the financial system.
11
AC3097 Management accounting
(a) The process costing information is used to calculate the full absorption cost per unit
processed. This can be used:
• to monitor cost changes,
• to inform pricing and
• to value inventory.
It is possible to monitor this using standard process costing and variance analysis.
(b) We have:
12
Examiners’ commentaries 2018
(c) Non-financial control mechanisms, for example:
• Statistical quality control charts – graphs of regular mechanical observations of
operations is used to check whether products are within pre-set limits for tolerance. The
mean and deviations of a range of the sampled items are plotted on the chart. This could
be on real time displays.
• Physical inspection of output – inspectors review the quality of regular samples taken
from the production line.
• Inspection of the production process- ensuring that each physical part of the machinery
is working properly. This can be done by regular physical inspection or by mechanical
measures which create a sound if the machine tolerances have moved.
13
AC3097 Management accounting
Question 4
Blandwell Ltd has three divisions, each of which provides Architects and
Construction Consulting Engineers in different parts of the country. The divisions
produce architectural plans, acquire planning permission, supervise construction
and use expensive testing equipment to ensure that structures are meeting the
legally required stress levels as they are constructed. Stress level testing is a new
speciality which can be performed on existing structures as well as new buildings.
The performance of the divisions for the year ended 31st December 2017 is as
follows:
14
Examiners’ commentaries 2018
The divisions are required to compile the following statistics each year:
Required:
The divisional managers receive yearly bonuses based on annual performance.
(a) Calculate the Return on Investment and residual income with a cost of capital
of 10% and the EBITDA as a percentage of sales for each division.
(6 marks)
(b) Discuss the performance of each division using the calculations from
requirement (a), the additional statistics provided and provide other
calculations you think would be useful. Include comments on the profitability of
the three methods of professional service revenue generation.
(10 marks)
(c) Briefly discuss the issues to be considered if a bonus scheme were to be
introduced which would be fair, reward current activities and encourage future
profitability.
(4 marks)
Reading for this question
Subject guide, Chapters 15 and 18.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapters 19
and 22.
Approaching the question
The question requirements give clear guidance on the issues to be highlighted in the answer. The
data also enables candidates to identify which division has been established the longest (as
indicated by the assets’ depreciation) and how long each division had been doing stress testing
which is obviously a growing area of work.
(a) We have:
15
AC3097 Management accounting
(b) Possible additional ratios (not specifically required by question):
Other ratios calculated by candidates will be awarded marks.
South east is the largest division (about 3 times larger than the other two based on revenue)
and possibly the oldest (based on building depreciation). It is producing the highest ROI
and RI. It has not pushed stress testing although this has the highest contribution margin as
shown by the table above. It has not grown and has lost market share in 2017. Customer
satisfaction is not as high as the other divisions. The director may need to review the
division’s activities.
Central is only just making target return on investment. It may need to look at the pricing
structure of architects work as this is lower than south east. They could also extend the
construction supervision on which the division makes a higher % contribution than the other
two divisions. It has increased the amount of stress testing. It has grown sales but not
market share. Customers are happy with the reliability.
North west appears to be the youngest division as shown by the age of the non-current
assets and this is affecting ROI & RI because of the high written down value. Depending on
competition it might be able to increase architects prices as these are making lower
contribution that the other divisions. Its main strength is stress testing which it has only
introduced this year. It has 31% of sales revenue and the highest contribution. It has grown
sales and market share and improved the % of contracts very significantly.
(c) The bonus system should reward both financial performance and potential as indicated by
non-financial measures. This could include:
• A percentage of RI earned. The south east would benefit as it is a larger division,
however it also has more responsibility. However the valuation of assets for the capital
charge needs to be considered as assets depreciate and thus automatically increase RI
over time.
• Potential should be also be rewarded by using the other BSC categories giving
weightings to the non-financial measures. For example benchmarks could be set for each
of the measures shown in the question and bonuses could be given for exceeding these
benchmarks.
• Customer measures could be the sales growth, market share and customer satisfaction
for reliability and competence.
• Internal business could measure staff turnover, training and staff satisfaction.
• Learning and growth could monitor development of new competences which could be
offered to customers, improved IT and other efficiency measures.
Question 5
The SCSO is one of four major regional symphony orchestras in England. It is a
world class orchestra, but it has a constant battle to keep its finances in order.
It has a financial year ending on 31st December. Last year (2017) it achieved a
small surplus of £200K (K = thousands of pounds sterling). However in the current
year the management feel it will barely break even. In addition a number of changes
can be anticipated for next year, (2019). You have been asked to review the SCSO
finances and to prepare a projected income and expenditure account for 2018 and a
draft budget for 2019 for both income and expenditure.
16
Examiners’ commentaries 2018
The latest projection of income for 2018 is £6,400K which comes from four broad
sources:•
Income from ticket sales. Projected (perhaps optimistically) to be £1,920K
from concerts in the orchestra’s home venue of Cunard Hall, £320K from other
UK concerts and £360K from a scheduled 4 concert European tour.
•
Grant income. From the National Arts Council £1,600K, and from South Coast
Local Authorities £600K.
•
Recording, Broadcasting and Schools Learning programmes £400K in total.
•
Donations, Legacies and other Fund Raising Schemes £1,200K.
On the Expenditure side the total projection for 2018 is also £6,400K. This is made
up of:•
Orchestra salaries £2,720K. Managerial and Support Staff £1,040K. Visiting
Conductors, Soloists and Players £960K.
•
The SCSO Centre houses the offices and rehearsal rooms and is leased. The
total cost of running the centre is £400K.
•
Current Venue Costs £920K. (UK and Europe).
•
Travel and Hotel Expenses 360K. (UK and Europe).
•
The Bank Balance at the end of 2018 is projected to be £340K.
On considering the plans for 2019 you discover the following:•
The orchestra is currently (2018) operating without a resident Principal
Conductor. The previous incumbent left last year to move to Paris. A new
Principal Conductor has now been appointed and he will take up the post at
the start of next year (2019). His gross salary of £120K, should be included in
the ‘managerial and support staff category’. However £80K can be saved from
the costs of visiting conductors.
•
Instead of the usual 4 concert European tour, a 10 concert tour of North
America is planned. This should earn an income of £800K, but concert venue
costs (UK and North America) will increase to £1,080K in total and travel
expenses (UK and North America) to £560K.
•
The longer overseas tour also means that two fewer concerts will be played in
Cunard Hall. Thus even though a small increase in ticket prices is planned,
revenue from Cunard Hall ticket sales remains at £1,920K, and other UK
concerts £320K.
•
The Arts Council grant income will remain of £1,600K, but grants from local
authorities will be reduced by one third.
•
A small increase of £20K can be expected from Recording, Broadcasting and
Schools Learning.
•
The Orchestra already has an extensive and active fund raising programme.
The maximum increase that can be assumed is £40K.
•
Both orchestra salaries, and those of other managerial support staff will rise by
4% per annum from 1st April 2019 (except for the principal conductor).
•
The SCSO Centre running costs will increase by £12K.
You also discover that the cash flow is not even throughout the year, and you decide
that a cash budget by quarter should be prepared. In particular you note:Items of income and expenditures will apply evenly throughout the year except for:
•
Half of the income from Cunard Hall concerts is from regular subscription
customers and will be received in Quarter 3.
17
AC3097 Management accounting
•
The revenue from the proposed North America Tour will not be received until
Quarter 4.
•
However the venue costs of £400K and travel expenses of £200K will need to be
paid in advance in Quarter 2.
•
The Arts Council Grant will be received in Quarter 3.
•
The lease payment on the SCSO Centre is £92K and must be paid in Quarter 1.
•
You have already noted that the salary increases apply from Quarter 2 onwards.
Required:
(a) Using the information above prepare a table showing a projected income and
expenditure account for 2018 and the draft budget for 2019.
(9 marks)
(b) Prepare a quarterly cash budget for 2019.
(8 marks)
(c) Comment on the action which should be taken as a result of the information
that your budgets reveal.
(3 marks)
Reading for this question
Subject guide, Chapter 12.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 15.
Approaching the question
This question is very wordy, which represents the sort of information a management accountant
might receive from various managers and would have to use to compile budgetary statements.
Part (a) requires a budgeted income and expenditure account for two years. The quickest way to
present this statement is to use the left hand column for narration and two columns of figures for
the two years to the right, as shown below. Having to write the narration twice for two separate
statements loses time and can make it more difficult to see the two statements together in order
to comment on the forecasts for 2019.
Part (b) requires a quarterly cash budget to highlight the peaks and troughs in cashflow over the
year. This should also be presented in columnar form. Where the instruction states that ‘Items
of income and expenditure will apply evenly throughout the year’ this means that these amounts
are divided by four and credited or charged to each period. Any additional amounts of the same
category which arises in one of the periods is charged to that period.
Part (c) requires comments on:
18
•
The deficit shown in the income and expenditure budget and actions which should be taken
to resolve this. Some candidates suggested that the American tour should be cancelled,
however looked at incrementally it makes £240,000 more than tours in the previous year.
There is also an issue of the purpose of the orchestra which is not only to, at least
break-even, but also to be recognised as a high quality international orchestra which not
only creates music for audiences and employs fine musicians but can also attract the highest
quality musicians and conductors. This is one of the differences between for profit and not
for profit organisations.
•
The cashflow problems identified in the cash budget in the first two quarters of the year.
Examiners’ commentaries 2018
(a) We have:
(b) We have:
(c) There is a budgeted loss of £225,000 projected for the 2019. The loss requires action to be
taken to plan for:
• additional fund raising efforts
• new UK venue bookings for SCSO concerts or more concerts at the same venues, for
example morning, or afternoon, perhaps aimed at schools or families
• increased ticket prices if possible without losing custom or more tickets could be sold
19
AC3097 Management accounting
• additional grants, subsidies or American companies advertising in programmes sold on
the American Tour concerts
• cutting costs, where possible e.g. visiting conductors, without reducing the standard of
the concerts.
The cash balance at the end of 2019 shows a positive £115,000. However substantial net
cash outflows are expected in Quarters 1 and 2, resulting in a cash overdraft of £1.779
million by the end of Quarter 2.
Reduced costs or additional revenues mentioned above would help.
SCSO should also consider the timing of cashflows, for example:
• changing the timing of customer subscriptions to Quarter 1 or asking for subscriptions to
be paid 50% in Quarter 1 and 50% in Quarter 3
• obtaining Arts Council funding earlier in the year or in quarterly instalments if possible.
If these suggestions to receive cash earlier cannot be implemented, the SCSO is going to
need overdraft facilities of up to $1.8.million.
Question 6
Smart Wardrobes plc make high class wardrobes in two standard sizes, the ‘narrow’
and the ‘medium’. They operate ‘on line’ and although each standard design of
wardrobe is the same size, the company offers customisation in terms of design of
doors which can have different colours or include panels of opaque glass. These
variations are performed by a small salaried team of designers and skilled
woodworkers.
3 months ago Smart Wardrobes plc started to provide a custom built wardrobe
fitting service in homes. This requires designers to measure and design the
wardrobe and after the parts have been cut to size in the factory, skilled
woodworkers install the wardrobe in the residence. This involves employing a much
bigger team of designers and skilled woodworkers on salary. The new service is also
being heavily advertised.
The variable costs of the business are the materials, variable labour (workers for
routine construction of the bookshelves are paid on an hourly basis) and delivery.
The company’s pricing practice is 100% mark-up on total variable costs per product
category to cover all fixed costs and provide net income.
Details of the volume of sales units and total variable costs for the four product
categories for the last three months are:
Units sold
Total variable costs
Materials
Direct labour
Delivery
20
narrow
8,000
£000
320
128
240
medium
11,000
£000
577
286
370
custom built
800
£000
90
10
200
Examiners’ commentaries 2018
The fixed costs for the last three months are:
Factory rent, cleaning and supervision
Factory machinery maintenance & depreciation
Designers 16 x £12,500 each (chargeable time 390 hours per designer)
Skilled woodworkers 20 X £10,000 each (chargeable time 390 hours per
workman)
Design space rental
Administration and IT
Advertising and promotion
Total
£000
400
280
200
200
20
500
400
2,000
The company is disappointed to see that the fixed costs have soared compared with
the previous three months. They think this is due to the custom built activity and
wonder whether the pricing method for their products needs reconsidering.
The current pricing system has operated for about eight years during which time
customisation of the main products has also increased. The company decides to use
the figures for the last 3 months to analyse the use of their different resources by
products.
The following table shows the result of their investigations for the last three months.
Required:
(a) Produce an income statement for the last 3 months, using the contribution
approach, showing total sales, average sales price per unit, total variable cost
and total contribution for each product category and for the company as a
whole.
(3 marks)
(b) Allocate the fixed costs to the categories of products and calculate the net
income per category of products.
(8 marks)
(c) Comment on the current pricing method used by the company and give one
proposed alternative pricing method, showing calculations of prices under your
21
AC3097 Management accounting
method. Indicate any difficulties you foresee with using the method you have
recommended.
(5 marks)
(d) Calculate the level of any spare capacity available in the last 3 months and
indicate how this information may help when planning the budget for the next
period.
(4 marks)
Reading for this question
Subject guide, Chapters 4, 5 and 10.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapters 10
and 11.
Approaching the question
Part (a) required you to calculate the sales for each group based on 100% mark-up on total
variable costs and to put this into a contribution format income statement i.e. deducting fixed
costs from the total contribution. At this stage the allocation of fixed costs to products was not
required as the contribution approach regards all fixed costs as common to all products and that
the focus should be on improving sales volume and price.
Part (b) gave information on use of each category of the fixed resources. This enabled the use of
the ABC approach to calculate the cost allocation. When allocating fixed costs the measure to
be use must be expected usage rather than total available usage. This enables the total costs to
be allocated to products thus enabling the company to know how much of the cost of each
resource needs to be covered by each product. A few candidates showed understanding by
allocating based on total resources available and then calculated the total costs not allocated,
giving information similar to that required in part (d).
Part (c) asked you to identify that the current method of pricing was 100% on variable cost and
to observe that when the ABC approach is used the custom made products are shown to be
making a loss and are subsidised by the other products. You were then asked to suggest an
alternative pricing method. The method recommended did not necessarily have to be applied to
all the products. Since narrow and medium bookcases are profitable it might be better to just
focus on the bespoke products which are new to the market. Any realistic approach would
receive marks. Calculations illustrating the suggested method are required to earn full marks.
Discussion of testing the prices in the market or taking market price were also expected. The
suggested pricing scheme mentioned below are illustration. Only one is required.
Part (d) is the measure of spare capacity. It is most usefully stated in units of each resource but
percentages were also accepted as correct. The comments relate to the opportunity to expand
production and sales, or possibly reduce resources.
22
Examiners’ commentaries 2018
(a) The Income statement for the 3 months ended 31.3.2018 was as follows:
(b) ABC analysis of cost and net income:
(c) The biggest issues are Designers and skilled workers who spend more time on Bespoke and
more time in design room. Should this be charged to customers?
At present much of the newer resources are being used by the custom built wardrobes. This
could have an impact on the possibility for sales growth of the other products.
The standard wardrobes are earning steady but low margins. The custom built is making a
large loss.
Suggestion 1:
The ABC full cost could be used as the basis to mark-up the products. This would require a
decision on the % mark-up. Many candidates took this approach. The company would
probably choose a lower margin than the 100% used based on variable cost, as all of the
costs will be covered by the price, so a mark-up of about 20% might be appropriate, so that
the products will not be priced too high compared with competitors.
Suggestion 2:
The business has been operating for a while, so it could be presumed that the margins for
narrow and medium can be sustained so the prices of these products could remain at the
same and an appropriate mark-up be added to the ABC cost of the custom built. In order
to be profitable the bespoke could have a mark-up on full costs of perhaps 20%. This would
have meant sales figures of (300,000 + 492,000) ×1.2 = £950,400 i.e. £350,400 more than
was charged in the 3 month period.
Suggestion 3:
The labour costs of designers and skilled woodworks (which are direct but not variable)
could be added to the variable costs for all products and the 100% mark-up applied. This
would slightly affect the main products as well. For example:
23
AC3097 Management accounting
This would lead to 800,000 more sales but assumes that the company would put up the
price of narrow and medium bookshelves by a small amount. It would increase the price of
the custom built wardrobes by 65% which may be higher than the market is prepared to
pay. A lower mark-up (for example, 80%) may be more practical.
Any new approach considered would need to be tested in the market. Since the custom built
service has only been operating for three months, increasing prices might be acceptable as
the previous sales to only 800 customers could be marketed as an opening promotional sale!
The company should have tested the market before starting this new venture. It may be
that the quality they offer can be enable them to charge a higher price than competitors.
Only one recommended method is required
(d) Unused capacity:
Factory 38,000 minutes
Machines 25,000 minutes
Designers 620 hours
Woodworkers 950 hours
Design space 340 hours
(10.8%)
(16.7%)
(9.9%)
(12.2%)
(5.4%)
In the forthcoming period the information on resources available in each department, can be
used, once the estimates of sales are made, to determine whether there is sufficient capacity
to meet demand. If not plans can be made to obtain more resources/outsource activities etc.
If there is spare capacity the company should consider how to use it to be more productive
or whether some resource costs can be reduced.
Section B
Answer ONE question from this section.
Question 7
(a) Where divisions of an organisation are trading in the same country, explain the
purposes of transfer pricing.
(5 marks)
(b) Identify 3 methods of setting the transfer price and for each explain how it is
calculated, the circumstances under which it is most likely to be suitable and
any problems which arise from using the method.
(15 marks)
Reading for this question
Subject guide, Chapter 16.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 20.
24
Examiners’ commentaries 2018
Approaching the question
Where organisation create separate division in order to simplify operations decision making
systems must be introduced to ensure that divisional mangers and top management can measure
the activities and performance of each division. Where divisions trade with each other
appropriate transfer process must be set.
(a) Purposes of transfer pricing:
• promote goal congruance
• provide information to motivate divisional managers to make economic decisions in the
best interest of the division and the group
• provide information useful for evaluating the economic and managerial performance of
the division
• maintain divsional autonomy.
All points need expanding.
(b) Any thee from:
• market
• full cost / variable cost
• full cost + variable cost
• opportunity cost
• dual pricing
• marginal cost + lump sum.
Answers must cover all three aspects required by the question.
Question 8
With regard to FOUR of the management accounting terms listed below, explain
their meaning and why they are used.
i. Value chain analysis
ii. Committed (Locked in) costs
iii. Cost of quality analysis
iv. Environmental cost management
v. Customer profitability analysis
vi. Benchmarking.
(20 marks)
Reading for this question
Subject guide, Chapters 10, 17 and 18.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapters 10
and 21.
Approaching the question
The topics in this question are all areas where management accountants need to collect and
report information in different ways. This means that information systems must be detailed
enough for the information to be extracted easily and regularly.
25
AC3097 Management accounting
Brief notes:
i. Value chain analysis:
Measures the value added by each section of the value chain i.e. research and development,
design, production, marketing, distribution, customer service. It is usually easy to discover
the costs of each section but measuring value is more difficult. One way is to ask the
recipient department to estimate what they would pay for the service. Alternatively the
company can investigate the cost of buying in the resources provided by each section. The
main aim of looking along the value chain is to highlight better ways of working and
collaborating to ultimately provide a better service for present and future customers by
reducing unnecessary activities. The exercise requires a holistic understanding of the
relationships of the different sections to ensure that savings in one area do not increase costs
elsewhere.
ii. Committed (Locked in) costs:
When a new product is being designed and production processes are being planned there
may need to be new purpose built production lines or significant changes to existing
equipment. The design decisions which are made, due to the nature of the modern
production process will require costs to be incurred throughout the products life (they will
be locked in). It is therefore important that the design is not only appropriate to customers’
needs but is also made in the most efficient way. This includes efficient processes, materials
and components which have the same life or are easily replaced. This attention to detail not
only makes the product cheaper to produce and easier to repair but enhances the company’s
reputation.
iii. Cost of quality analysis:
This involves categorising operational costs into prevention, appraisal, internal failure,
(products which need to be reworked or scrapped) and external failure (products returned
after sale). Once determined the process can be reviewed to see whether additional activity
in preventing and appraising for poor quality can reduce the level of internal and external
failure.
iv. Environmental cost management:
Companies are now required to be good citizens by behaving responsibly within the society
and environment in which they operate. This includes ensuring they are keeping to all the
laws relating to the environment but also finding ways to improve their impact on the
environment. In order to make decisions in this area costs have to be collected. One
suggestion is that the costs could be analysed as:
• Environmental prevention costs – costs incurred to prevent harm and encourage good
practice.
• Environmental detection costs – ensuring that company practices conform to regulations
by inspection and testing.
• Environmental internal failure costs, where laws or good practice are not being followed.
This requires implementing activities to comply with the law or good practice.
• Environmental external failure costs are where breaches of laws have occurred and
clean-ups, compensation or other measures are needed.
v. Customer profitability analysis:
Product profitability has been practiced in firms for many years to review products which
are or are not contributing well to net income and deciding on strategic action to improve or
delete poorly performing products.
Customer profitability analysis has the same aim but focused on customers or customer
groups. The net income generated by each customer (or group of customers) is calculated.
The results enable the company to make decisions on how they relate to customers.
vi. Benchmarking:
This technique has been used for many years in many aspects of society, including
international comparisons. It aims to achieve best practice by comparison with others.
26
Examiners’ commentaries 2018
External benchmarking uses best practice from other organisations. It observes and
diagnoses areas where other organisations are more effective and learn from them. Internal
benchmarking compares activities inside the organisation. Whether internally or externally
Improving processes which lead towards better outcomes is the key.
The process can be about leaning best practice and can also be used to create targets i.e.
using the identified best practice to be the result that is expected.
Benchmarking is used in many areas of the public sector where outcomes are important but
diverse, for example a school may be measured on examination results and student
development.
27
AC3097 Management accounting
Examiners’ commentaries 2018
AC3097 Management accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 2017–18. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).
Information about the subject guide and the Essential reading
references
Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2017).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refer to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements – if
none are available, please use the contents list and index of the new edition to find the relevant
section.
Comments on specific questions – Zone B
Candidates should answer FIVE of the following EIGHT questions: FOUR from Section A and
ONE from Section B. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary assumptions
introduced in answering a question are to be stated.
Section A
Answer FOUR questions from this section.
Question 1
Motor Tyres manufactures one size of tyre in each of its production lines. The
following information relates to one production line for the most recent period. The
company uses the weighted average method for inventory valuation.
Each tyre weighs 10kg but due to normal wastage requires 11 kg of material input.
28
Examiners’ commentaries 2018
Required:
(a) Give 3 uses of process costing information.
(3 marks)
(b) Calculate the cost of finished goods, the value of the closing work in progress
and the cost of the abnormal loss or gain. And show the process account for the
period.
(13 marks)
(c) Describe two non-financial methods by which the process might be monitored
for quality purposes.
(4 marks)
Reading for this question
Subject guide, Chapter 3.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 5.
Approaching the question
Management accounting information should always be prepared with an understanding of the
uses of the information in mind. This issue is addressed by part (a) of the question.
Part (b) is a bit like a number puzzle, as not all the information is given, so some of it needs to
be derived. The most important information to be calculated is the abnormal loss. There is also
normal loss which could be calculated. The treatment of the cost of normal loss is to include it as
part of the cost of output, so depending on the method chosen, it need not necessarily be
calculated. The answer can be calculated by using either Tyres or Kgs of material. Some
candidates assumed that the abnormal loss applied to conversion costs as well as material costs.
This approach was accepted.
Part (c) recognises that in the routine environment of continuous production there is a need for
non-financial mechanisms which can monitor production regularly (possibly continuously or
hourly) without reference to the financial system.
(a) The process costing information is used to calculate the full absorption cost per unit
processed. This information can be used:
• to monitor cost changes
• to inform pricing and
• to value inventory.
It is possible to monitor this using standard process costing and variance analysis.
29
AC3097 Management accounting
(b) We have:
30
Examiners’ commentaries 2018
Non-financial control mechanisms, for example:
• Statistical quality control charts – graphs of regular mechanical observations of
operations is used to check whether products are within pre-set limits for tolerance. The
mean and deviations of a range of the sampled items are plotted on the chart. This could
be on real time displays.
• Physical inspection of output – inspectors review the quality of regular samples taken
from the production line.
• Inspection of the production process- ensuring that each physical part of the machinery
is working properly. This can be done by regular physical inspection or by mechanical
measures which create a sound if the machine tolerances have moved.
Question 2
Oak Bookcases plc makes high class bookcases in two standard sizes, the ‘low’ and
the ‘tall’. They operate ‘on line’ and although each standard design of bookcase is
the same size, the company offers customisation in terms of shaping of the shelves
and staining. These are performed by a small salaried team of designers and skilled
woodworkers.
3 months ago Oak Bookcases plc started to provide a custom made bookcase fitting
service in homes and offices. This requires designers to measure and design the
bookcase and after the parts have been cut to size in the factory, skilled
woodworkers install the bookcase in the residence. This involves employing a much
bigger team of designers and skilled woodworkers on salary. The new service is also
being heavily advertised.
The variable costs of the business are the materials, variable labour (workers for
routine construction of the shelves are paid on an hourly basis) and delivery. The
company’s pricing practice is a 100% mark-up on total variable costs per product to
cover all fixed costs and to provide net income.
Details of the volume of sales units and total variable costs for the three product
categories for the last three months are:
31
AC3097 Management accounting
The company is disappointed to see that the fixed costs have soared compared with
the previous three months. They think this is due to the custom made activity and
wonder whether the pricing method for their products needs reconsidering.
The current pricing system has operated for about eight years during which time
customisation of the main products has also increased. The company decides to use
the figures for the last 3 months to analyse the use of their different resources by
products.
The following table shows the result of their investigations for the last three months.
Required:
(a) Produce an income statement for the last 3 months, using the contribution
approach showing total sales, average sales price per unit, total variable cost and
total contribution for each product category and for the company as a whole.
(3 marks)
(b) Allocate the fixed costs to the categories of products and calculate the net
income per category of products.
(8 marks)
(c) Comment on the current pricing method used by the company and give one
proposed alternative pricing method, showing calculations of prices under your
32
Examiners’ commentaries 2018
method. Indicate any difficulties you foresee with using the method you have
recommended.
(5 marks)
(d) Calculate the level of any spare capacity available in the last 3 months and
indicate how this information may help when planning the budget for the next
period.
(4 marks)
Reading for this question
Subject guide, Chapters 4, 5 and 10.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapters 10
and 11.
Approaching the question
Part (a) required you to calculate the sales for each group based on 100% mark-up on variable
costs and to put this into a contribution format income statement i.e. deducting fixed costs from
the total contribution. At this stage the allocation of fixed costs to products was not required as
the contribution approach regards all fixed costs as common to all products and that the focus
should be on improving sales volume and price.
Part (b) gave information on use of each category of the fixed resources. This enables the use of
the ABC approach to calculate the cost allocation. When allocating fixed costs the measure to
be use must be budgeted (or in this case actual) usage rather than total available usage. This is
important as the total costs should be allocated to products, enabling the company to know the
costs of resources which need to be covered by each product. A few candidates showed
understanding by allocating costs based on total resources available and then also calculating the
value of the costs not allocated. However this is less useful than allocating based on actual usage.
Part (c) asked you to identify that the current method of pricing was 100% on variable cost and
to observe that when the ABC approach is used the custom made products are shown to be
making a loss and are subsidized by the other products. You were then asked to suggest an
alternative pricing method. The method recommended did not necessarily have to be applied to
all the products. Since Low and Tall bookcases are profitable it might be better to just focus on
the bespoke products which are new to the market. Any realistic approach would receive marks.
Calculations illustrating the method were required to earn full marks. Discussion of testing the
prices in the market or taking market price were also expected.
The suggested pricing schemes mentioned below are possible alternatives.
Part (d) is the measure of spare capacity. It is most usefully stated in units of each resource, but
percentages were also accepted as correct. The comments relate to the opportunity to expand
production and sales or possibly reduce some resources.
33
AC3097 Management accounting
(a) The Income statement for the 3 months ended 31.3.2018 was as follows:
(b) ABC analysis of cost and net income:
(c) The main costs which have expanded due to the Custom Built products are designers,
skilled workers, use of the design room and advertising. The designers and skilled workers
are direct costs (but not variable). Should these be charged directly to customers?
As some resources are being used by Custom Built, this could have an impact on the
possibility for sales growth of Low or Tall. At current prices, the Low bookshelves are
earning 18.7% net income on sales, the Tall bookshelves are earning 26.7% net income The
bespoke is making a loss.
Method of pricing (only one required – calculations required):
Suggestion 1:
The ABC full cost could be used to mark-up the products. This would require a decision on
the % mark-up. Many candidates took this approach. The company would probably choose
a lower margin than the 100% used based on variable cost, as all of the costs will be covered
by the price, so a mark-up of about 20% might be appropriate, so that the products will not
be priced too high compared with competitors.
Suggestion 2:
Since this business has been operating for a while, it is presumed that the margins for Low
and Tall can be sustained, so Low and Tall standard products could remain at the same
price and an appropriate mark-up be added to the ABC cost of the Custom Built. In order
to be profitable the Custom Built could have a mark-up on full costs of perhaps 20%. This
34
Examiners’ commentaries 2018
would have given sales figures of (340,000 + 452,000) × 1.2 = 950,400 i.e. £270,400 more
than was charged in the period. The average cost of custom built would be £2,376.
Suggestion 3:
Alternatively the design and fitting labour costs could be added to the variable costs for all
products and the 100% mark-up applied. This would slightly affect the main products as
well as Custom Built. For example:
This would lead to £800,000 more sales but assumes that the company would put up the
price of Low and Tall bookshelves as well. A lower percentage mark-up could be used, for
example 80%.
Market issues:
Any new approach considered would need to be tested in the market. Since the custom built
service has only been operating for three months, if well marketed stressing the
personalisation, increasing prices might be acceptable. The previous sales were to only 400
customers so prices may not be well known in the market and if necessary could be
marketed as an opening promotional sale!
The company should have tested the market before starting this new venture. It may be that
the quality they offer can enable them to charge a higher price than competitors at present.
(d) Unused capacity:
Designers 290 hours
Woodworkers 300 hours
Factory 23,000 minutes
Machines 19,800 minutes
Design space 340 hours
(4.6%)
(3.8%)
(7.3%)
(15.9%)
(5.4%)
In the forthcoming period the information on resources available in each department, can be
used. Once the estimates of sales are made this information can help to determine whether
there is sufficient capacity available to meet demand. If not, plans can be made to obtain
more resources/outsource activities etc.
If there is spare capacity the company should consider how to use it to be more productive
or whether some resource costs can be reduced.
Question 3
Industrial Electrical Components Ltd (IEC Ltd) operates in Country M but has a
division (Beetec) which operates in Country G. Beetec Division makes electronic
circuit boards for inclusion in other products. These are sold in packs of 100 circuit
boards. Beetec division sells these to external companies in Country G and to
Mantle Division which operates in Country M.
For simplicity assume that the currency is the same in each country.
Beetec Division has the following budgeted information for the next year.
35
AC3097 Management accounting
Annual Capacity
Variable cost per pack of circuit boards
Annual Fixed costs
External Demand in Country G
Mantle Division Demand
80,000 packs of circuit boards
$15
$700,000
60,000 packs of circuit boards @ $40
per pack
30,000 packs of circuit boards
Mantle Division has the following budgeted information for the next year.
The circuit boards are incorporated into components for the motor industry. Each
component requires 2 circuit boards. Components are also sold in packs of 100.
Annual Capacity
Selling price per pack of 100 components
Variable cost per pack of 100 components
(excluding price of circuit boards)
Demand for components
Annual Fixed costs
15,000 packs of components
$180
$50
15,000 packs
$500,000
Due to the international trading situation, IEC Ltd Head office has set the transfer
price for Circuit boards at variable cost +20%. The group rule on trading between
divisions is that sales to other divisions in the group must be met before external
sales are taken.
The rate of taxation is 50% in Country G and 30% in Country M.
Required:
(a) From the information provided above, show the budgeted after tax net income
of each division and the company as a whole.
(6 marks)
(b) Explain why the Head office has intervened in setting the transfer price and,
assuming that net income is part of the performance appraisal of the divisional
managers, indicate any steps which top management should take to ensure
fairness in the appraisal system.
(2 marks)
(c) It is possible that tax authorities in Country G will insist that, for taxation
purposes, the OECD arms-length approach should be taken to setting the
transfer price. IEC Ltd wish to explore the effects of the following possible
situations:
i. a market based transfer price is imposed.
ii. an opportunity cost based transfer price is imposed.
Show the impact on the net income of each Division of each of the transfer price
methods mentioned above. Comment on the results assuming that the
Divisional managers are partially rewarded by net income achievement.
(8 marks)
(d) Mantle division finds a company (Fine Boards Ltd) in country M which would
supply the circuit boards at a price of $30 per pack of 100.
Assuming that, if the tax authorities required the transfer price from Beetec to
change, Mantle would trade with Fine Boards Ltd instead of Beetec, show the
after tax income for both of the divisions and IEC Ltd as a whole and comment
on the situation.
(4 marks)
36
Examiners’ commentaries 2018
Reading for this question
Subject guide, Chapter 16.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 20.
Approaching the question
The fundamental issue faced by IED Ltd is the different taxation levels levied on businesses in
the two countries in which the divisions operate. This issue is identified in the required
calculations by focusing and commenting on the different total company net income shown by
each scenario shows the impact of the different taxation rates. Since head office stipulates a
specific transfer price to minimise total corporate tax and therefore increase total net income, the
head office should also put in place a fair mechanism for measuring divisional performance.
Comment on this issue was also expected for a good answer.
(a) Transfer price of variable cost +20%. £15 × 1.2 = £18 .
Budgeted Net Income for each division and company as a whole.
(b) The purpose of head office intervening to set a low transfer price is to decrease Beetecs net
income and increase Mantle’s net income to save on taxation at the higher rate in Country
G. From a divisional performance appraisal viewpoint this means that Beetec’s profits are
reduced and Mantle’s increased which would lead to an unfair situation for performance
appraisal. Therefore for performance appraisal purposes IEC Ltd would need to give Beetec
a notional credit and Mantle a notional charge to balance out the net incomes.
(c) Market-based price: effect on divisional and company performance.
i. The transfer price would be $40 per pack instead of $18 = $22 more.
A reduction in total net income of $132,000.
Comments:
The company as a whole would not be happy as higher taxation and lower after-tax total
net income is earned because of the different tax charges.
The Manager of Beetec will be happy because of the increased net income and the
opportunity to treat local customers in the same way as Mantle Division. Mantle will not
be happy as the net income is reduced. The company may feel that this is the transfer
price which is fair to both divisions and so would measure performance on these figures.
37
AC3097 Management accounting
ii. Opportunity cost transfer price: effect on divisional and company performance.
Assuming that the market for the Circuit boards in Country G remains at 60,000 packs
the lost opportunity cost (i.e. contribution) is10,000 × $40 − 15 =
plus the variable costs of 30,000 units × $15 =
Total
$250,000
$ 450,000
$700,000
i.e. 700,000/30,000 = £23.30 per circuit board.
This would be better than market price from a tax viewpoint as the overall change in the
tax compared with the original situation will only be:
Change in total transfer price $700,000 − 540,000 =
Additional tax for Beetec $160,000 × 0.5 =
Less tax for Mantle $160,000 × 0.3 =
Total additional tax
$160,000
$80,000
$48,000
$32,000
Or candidates may give another full calculation:
Beetec might feel that this is a rather contrived figure and would still expect a credit
from head office when considering performance appraisal.
Mantle would be more prepared to pay this price. For the company it is still worse by
£32,000 compared to the original price, however the company would be required to
follow the OECD rule but argue for this price.
(d) Mantle trades with Fine Boards Ltd:
The net income with this solution is the worst. However it frees Beetec to sell more on
the home market and if the annual capacity of 80,000 units could be sold in the home
market, Beetec could make additional net income after tax of: (20,000 × (40 − 15)) × 0.5
= $250,000 which would be the best profit for the group overall.
If the price of circuits in Country M is $30, it is possible that IEC Ltd may be able to
argue for this transfer price as market price ,to be accepted by OECD rules instead of
$40 which would save ($10 × 30,000) × 0.5 = $150,000 in tax. If Beetec continued to
trade with Mantle.
38
Examiners’ commentaries 2018
Question 4
The WMSO is a regional symphony orchestra in England. Like all world class
orchestras it has a battle to keep its finances in order. It has a financial year ending
on 31st December.
Last year (2017) it achieved a small surplus of £250K (K= thousands of pounds
sterling. In the current year (2018) the management feel it will barely break even.
In addition a number of changes can be anticipated for the next year, (2019).
You have been asked to review the WMSO finances and to provide a projected
income and expenditure account for 2018 and a draft budget for 2019 for both
income and expenditure.
The latest projection of income for 2018 is £8,000K which comes from four main
sources:•
Income from ticket sales. Projected (perhaps optimistically) to be £2,400K
from concerts in the orchestra’s home venue of Symphony Hall, £400K from
other UK concerts and £450K from a scheduled 4 concert European tour.
•
Grant income from the National Arts Council £2,000K and from West Midlands
Local Authorities £750K.
•
Recording, Broadcasting and Schools Learning programmes £500K in total.
•
Donations, Legacies and other Fund Raising Schemes £1,500K.
On the Expenditure side the total projection for 2018 is also £8,000K made up of:•
Orchestra salaries £3,400K. Managerial and Support Staff £1,300K. Visiting
Conductors, Soloists and Players £1,200K.
•
The WMSO Centre ( housing the offices and rehearsal rooms is leased). The
total cost of running the centre are £500K.
•
Current Venue Costs £1,150K. (UK and Europe).
•
Travel and Hotel Expenses £450K. (UK and Europe).
•
The Bank Balance at the end of 2018 is projected to be £425K.
On considering the plans for 2019 you discover the following:•
The orchestra is currently (2018) operating without a resident Principal
Conductor, The previous incumbent left last year move to Berlin. A new
Principal Conductor has now been appointed to start on 1st January 2019. Her
gross salary of £150K, should be included in the ‘managerial and support staff
category’. However £100K can be saved from the costs of visiting conductors
•
Instead of the usual 4 concert European tour, a 10 concert tour of North
America is planned. This should earn an income of £1,000K, but UK and North
America concert venue costs will increase to £1,350K in total and UK and
North America travel expenses to £700K.
•
The longer overseas tour also means that two fewer concerts will be played in
Symphony Hall. Thus even though a small increase in ticket prices is planned,
revenue from Symphony Hall ticket sales remains at £2,400K, and other UK
concerts £400K.
•
The Arts Council grant income will remain of £2,000K, but grants from local
authorities will be reduced by one third.
•
A small increase of £25K is expected from Recording, Broadcasting and Schools
Learning.
•
The Orchestra already has an extensive and active fund raising programme.
The maximum increase that can be assumed is £50K.
39
AC3097 Management accounting
•
Both orchestra salaries, and those of other managerial support staff will rise by
4% per annum from 1st April 2019, (except for the new principal conductor).
•
The WMSO Centre running costs will increase by £15K.
You also discover that the cash flow is not even throughout the year, and you decide
that a cash budget by quarter should be prepared for 2019. In particular you note:Items of income and expenditures will apply evenly throughout the year except for:
•
Half of the income from Symphony Hall concerts is from regular subscription
customers and will be received in Quarter 3.
•
The revenue from the proposed North America Tour will be received in Quarter
4. However the venue costs of £500K and travel expenses of £250K will need to
be paid in advance in Quarter 2.
•
The Arts Council Grant will be received in Quarter 3.
•
The lease payment on the WMSO Centre is £115K and must be paid in Quarter
1.
•
You have already noted that the salary increases apply from Quarter 2 onwards.
Required:
(a) Using the information above prepare a table showing the projected income and
expenditure account for 2018 and the draft budget for 2019.
(9 marks)
(b) Prepare a quarterly cash budget for 2019.
(8 marks)
(c) Comment on the action which should be taken as a result of the information
that your budgets reveal.
(3 marks)
Reading for this question
Subject guide, Chapter 12.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 15.
Approaching the question
This question is very wordy, which represents the sort of information a management accountant
might receive from various managers and would have to put into budgetary statements.
Part (a) requires a budgeted income and expenditure account for two years. The quickest way to
present this is with a left hand column for narration and two columns of figures, to the right, for
the two years, as shown below. Having to write the narration twice for two separate statements
loses time and can make it more difficult to see the two statements together in order to comment
on the forecast for 2019.
Part (b) requires a quarterly cash budget to highlight the peaks and troughs in cashflow over the
year. This should also be presented in columnar form. Where the instruction states that ‘Items
of income and expenditures will apply evenly throughout the year’ this means that these
amounts are divided by four and credited or charged to each period even if there is an additional
amount of the same category which arises in one of the periods.
40
Examiners’ commentaries 2018
Part (c) requires comments on:
•
The deficit shown in the income and expenditure budget and actions which should be taken
to resolve this. Some students suggested that the American tour should be cancelled,
however looked at incrementally it makes £100,000 more than tours in the previous year.
There is also an issue of the purpose of the orchestra which is not only to, at least
break-even, but also to be recognised as a high quality international orchestra which not
only creates music for audiences and employs fine musicians but can also attract the highest
quality musicians and conductors. This is one of the differences between for profit and not
for profit organisations.
•
The cashflow problems identified in the cash budget in the first two quarters of the year.
(a) WMSO income and expenditure projections for 2018 and budget for 2019:
41
AC3097 Management accounting
(b) We have:
(c) There is a budgeted loss of £281,000 projected for 2019. The loss requires action to be taken
to plan for increased earnings or reduced costs. For example:
• additional fund raising efforts
• additional UK venue bookings for WMSO concerts or more concerts at the same venues,
for example morning, or afternoon, perhaps aimed at schools or families.
• increased ticket prices if possible without losing custom or more tickets could be sold.
• additional grants, subsidies or American companies advertising in programmes sold on
American Tour concerts
• cutting costs, where possible for example visiting conductors, without reducing the
standard of the concerts.
The cash balance at the end of 2019 shows a positive £144,000. However substantial net
cash outflows are expected in Quarters 1 and 2, resulting in a cash overdraft of £2.225
million by the end of Quarter 2.
Reducing costs or finding additional revenues as mentioned above would help. WMSO
should also consider the timing of cashflows, for example:
• change the timing of customer subscriptions to Quarter 1 or ask for subscriptions to be
paid 50% in Quarter 1 and 50% in Quarter 3
• obtain Arts Council funding earlier in the year or in quarterly instalments if possible.
If these suggestions to receive cash earlier cannot be implemented, the WMSO is going to
need overdraft facilities of up to $2.3.million.
42
Examiners’ commentaries 2018
Question 5
Greenings Garden Chairs Ltd produces: a basic chair: ‘The Root’, an armchair:
‘The Broad’ and a lounger: ‘The Woakes’. They are sold through supermarkets,
DIY stores and garden centres.
The Budget for 2018/19 Financial Year, shows following unit costs and revenues for
each chair:-
Selling Price
Variable Component Costs
Variable Assembly Costs
Root
£
25
8
2
Broad
£
35
11
3
Woakes
£
45
14
4
The Fixed Costs are budgeted to be £650,000.
The original budget has been prepared assuming that production and sales will be
at the department’s full assembly capacity. 50,000 chairs will be produced in the
proportions of Root 20%, Broad 50% and Woakes 30%.
However the latest market research considers that sales of only 45,000 chairs can be
achieved, and in the proportions of Root 30%, Broad 55% and Woakes 15%.
Peter Greening, the Sales Director, feels that The Woakes is not competitive with
similar products in the market. He proposes to upgrade the chair and increase the
selling price to £50. For the re-designed chair the variable component costs will be
£17 per chair and the variable assembly costs will be £5 per chair. He plans to
spend £30,000 in advertising to promote the new Chair. The products can then be
sold in the proportions of Root 10%, Broad 55% and Woakes 35%.
Paul Greening, the Production Director, points out that with the original forecast,
the company would be working at full assembly capacity measured in direct labour
hours and so overtime would be needed to meet the new proposal. The variable
assembly costs represent direct labour paid at £12 per hour. Overtime would be
paid at 150% of normal time.
John Byrd, the accountant, wishes to know the contribution per assembly hour of
each of the three products to inform decisions on the price of the new Woakes and
the use of production time.
Required:
(a) Using the information relating to the original budget for 2018/19, calculate the
net income that the company would make. Also calculate the breakeven point
for the department showing the total number of chairs which need to be sold
and the numbers of each type of chair.
(6 marks)
(b) Calculate the corresponding information as in part (a) with the projection of
sales of 45,000 in the new proportions.
(3 marks)
(c) Assuming that the changes are made to The Woakes, that overtime will needed
and that the anticipated sales will be achieved, calculate the cost of overtime
and the net income that the company would make.
(5 marks)
(d) Calculate the contribution per assembly hour for each type of chair and suggest
the price which is needed for The Woakes to be as profitable as the next most
profitable product per assembly hour.
(3 marks)
43
AC3097 Management accounting
(e) Comment on the information you have prepared and explain how it could be
used in decision making to result in greater profitability.
(3 marks)
Reading for this question
Subject guide, Chapters 6 and 7.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 8.
Approaching the question
Because there is more than one product, the breakeven aspects of this question require an
understanding of weighting contribution per product based on the proportion of sales of each
product. Parts (a) and (b) use the same technique. Part (c) requires careful reading of the
question. The first step is to discover how much direct labour would be needed for the original
estimated sales, and the new estimated sales, so that the overtime can be calculated. The
original estimated sales units was 50,000 so this is the level at which the company wishes to
work. Some candidates assumed this quantity was 45,000 so this was also accepted as a fair
answer. The overtime will be the extra paid per hour i.e. £6 per hour because the original £12 is
already included in the variable costs used for calculating the contribution per product.
(a) We have:
(b) We have:
44
Examiners’ commentaries 2018
(c) We have:
Or, second approach:
Required overtime hours 15,000 − 12,917 = 2083 hours which could make (2083 × 2.4) =
5,000 units. Therefore, 35% × 12,500/17,500 = 25% will be made in normal time and 10%
in overtime.
(d) We have:
45
AC3097 Management accounting
(e) Part (a) gives the anticipated net income from the original sales projection and the required
breakeven.
Part (b) gives a more pessimistic projection and maybe more market research is needed to
establish which is more likely. If the original plan is no longer viable case 2 seems to be a
very poor proposition both in terms of riskiness with higher breakeven and profit which is
down £153,000. This is presumably why Peter Greening wishes to Upgrade the Woakes.
In part (c) the new proposal would make slightly more contribution than the original budget.
Part (d) shows, however, that Root and Broad are making more contribution per assembly
hour than Woakes. The requirement for overtime is also reducing profits. A price of £57
which would equal the contribution per hour of Broad may be too high, so a price higher
than £50 could be tested in the market. Alternatively expanding the sales of the other two
products could be considered.
Whichever option is chosen the projections give a good yardstick against which to monitor
performance, and emphasise the importance of product mix as well as simple sales. In the
long run taking on more assembly workers may be advisable.
Question 6
Tasmin’s Toys is a well-established small company run by Tasmin, which
traditionally has concentrated on toys for children of up to five years of age.
However it has recently developed a toy which might be suitable for older children,
and it is considering whether to manufacture and market the new product; which
will be known as ‘The Tabby’.
As it would involve moving into a new market, and it would also involve setting up
dedicated departments to manufacture and market the product, Tasmin sees this as
a high risk venture. She comes to you for advice in assessing the situation and to
endeavour to quantify the risks involved.
On talking to Tasmin you find that she is reasonably certain of some factors.
Tasmin intends to market ‘The Tabby’ at a price of £20 per unit. The fixed costs
relating to the new departments can be projected to be £750,000 per annum.
However there are two particular aspects which cannot be predicted with any
certainty. They are the numbers of units that can be sold, and – as new materials
need be sourced – the unit variable costs.
You advise Tasmin that this might be a suitable application for a decision tree
which endeavours to quantify the uncertainties through the use of probabilities. For
each of the two factors you ask Tasmin to make projections of the most pessimistic
case, the most optimistic case and the most likely case.
After some consideration Tasmin supplies you with the following probabilities:•
For sales volume she makes a pessimistic projection of 60,000 units per annum
at a probability of 0.2, an optimistic projection of 110,000 units per annum at a
probability of 0.3, and the most likely case 95,000 units per annum at a
probability of 0.5.
•
For unit variable costs her pessimistic projection is £12.00 per unit at a
probability of 0.1, her optimistic projection is £8.00 per unit at a probability of
0.2 and the most likely £10.00 per unit at a probability of 0.7.
Required:
(a) Prepare a decision tree showing the probable expected value of a decision to
produce ‘The Tabby’ compared with a decision not to.
(12 marks)
46
Examiners’ commentaries 2018
(b) i. Explain the meaning of probable expected value.
ii. Give the worst possible outcome, the maximin and the maximax.
iii. Explain to Tasmin what these figures mean in terms of how they help her
make decisions about negotiating variable cost and creating demand for sales.
(5 marks)
(c) Discuss the strengths and limitations of the use of decision trees.
(3 marks)
Reading for this question
Subject guide, Chapter 9.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 12.
Approaching the question
Decisions trees show in a single clear diagram the different options and their expected values
based on estimates, converted into probabilities. The aggregate of these probabilities gives the
likely outcome based on the estimates. The tree itself enables users to review the probable
outcomes and consider whether changes in plans could result in a better chance of making the
desired contribution.
In part (a) the question specifically requires a decision tree to be drawn so marks were allocated
for accurately drawing the tree, as well as calculating the expected values and the expected net
contribution towards the company’s net income. Since Tasmin has not yet put any actions in
place, she has not committed to pay £900,000 fixed costs, so the value of ‘do not proceed’ is £0.
In (b) it is important to be able to help a user to understand the information shown by the
decision tree. This can be done by highlighting the worst possible case, the maximin and the
maximax, to bring greater understanding of the possible results.
In (c) it is important that users understand the usefulness and limitations of the decision tree.
(a) We have:
47
AC3097 Management accounting
(b) i. The probable expected value is the sum of the weighted probabilities On the expected
probabilities, the decision tree shows that The Tabby should bring in a net contribution
(i.e. after charging fixed expenses) of £193,000 per annum.
ii. Worst possible outcome is if demand is only 60,000 and variable costs per unit are £12.
This shows a net loss of £270,000 per annum (i.e. £480,000 − £750,000). (The
probability of this is 2%.)
The maximin is the largest payoff if the worst situation occurs. There are two in this
question. If the variable costs are the worst at £12 per unit the largest payoff is high
demand of 110,000 units giving a contribution of £880,000 and the profit £130,000. (The
probability of this is 3%.)
If the demand is worst at only 60,000 but the variable costs are £8 the contribution will
be £720,000 and a loss of £30,000. It is important for Tamsin to get the best price for
the variable costs. (The probability of this is 4%.)
The maximax is the best payoff which can occur. This is where demand is at 110,000
and variable costs are only £8. It shows a contribution of £1,320,000 and a profit of
£570,000 per annum. (The probability of this is 6%.)
iii. It is unlikely that the probable expected value of £193,000 will be the actual outcome as
it is based on so many estimates. The ability to make easier decisions will arise when the
amount of the variable cost can be ascertained. The decisions will then only be the level
of demand, so a new decision tree based on the variability of demand can be calculated.
Ensuring high demand is more important to making high profits than the change in
variable costs.
(c) Decision trees are a useful tool where there are a whole range of uncertainties regarding the
actual outcome of a companys best projections. The tree shows the results of different mixes
of probabilities. However even the process of ‘making best case’, ‘worst case’, and ‘most
likely’ projections is highly subjective.
Section B
Answer ONE question from this section.
Question 7
(a) Describe the reasons for the development of the use non-financial perfomance
indicators.
(5 marks)
(b) Discuss the importance of strategic alignment when developing performance
indicators.
(3 marks)
(c) Explain the design of the Balanced Scorecard and how the parts are
interconnected. Give examples of measures which might be included in each of
the four perspectives.
(12 marks)
Reading for this question
Subject guide, Chapter 18.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapter 22.
Approaching the question
This topic relates to ensuring that companies are focusing on the long-term as well as current
performance. This is important for all the investors in the company – shareholders, lenders,
employees and customers.
48
Examiners’ commentaries 2018
(a) If non-financial measures are not used in conjunction with financial measure it is likely that:
• the focus of many managers will be on improving annual net income since this is often
recognised for bonuses, promotion and possibly comparison of performance with other
divisions (league tables).
• managers will be discouraged from investing in the future such as spending on new fixed
assets, R&D and product development, internal efficiency, staff training, customer
service.
So in order to encourage managers to make decisions which invest in the future, companies
introduce non-financial indicators which make visible the activites which the company
wishes managers to focus on.
(b) Strategic alignment is important when developing performance indicators because mangers
focus on what is measured so if the measures do not lead in the right direction the company
will not meet their targets.
• Before inplementing non-financial measures care must be taken to ensure that the
indicators encourage managers to focus on activities which move the business towards
their strategic goals.
• Strategic maps can be drawn to indicate the activites which should be encouraged in
each area.
(c) Explain the four perspectives of the Balanced Scorecard: financial focus, customer
focus,internal business processes focus, and learning and growth focus.
• Explain how they are designed and Interconnected (can draw a diagram of
interconnectedness with narration).
• Give examples of each perspective.
Question 8
With regard to FOUR of the management accounting terms listed below:
(a) Explain their meaning.
(b) Give examples of their applications
i. Rolling budgets
ii. Standard costs
iii. Planning and operational variances
iv. Mix and yield variances
v. Variance investigation
vi. Management by exception
(20 marks)
Reading for this question
Subject guide, Chapters 12 and 13.
Drury, C. Management and Cost Accounting, Cengage Learning 9th Edition (Drury) Chapters
15, 17 and 18.
Approaching the question
All these terms relate to aspects of the budgetary process. In order to achieve good marks both
parts of the question should be answered. Only four topics are required.
49
AC3097 Management accounting
i. Rolling budgets.
(a) Some businesses face many uncertainties. Due to these uncertainties creating a budget
for 12 months is not possible and would be a waste of time. These companies create the
budget for the length of time over which they feel they have enough knowledge to make
it a realistic guide and challenge, possibly three months. In order to ensure that the
business continues to plan ahead, at the end of each month the next months budget is
prepared, so that there is always a budget for 3 months to guide activities. Depending on
the circumstances some companies may prepare a budget for a year, broken into 3
monthly periods instead of monthly periods. The first 3 months will then be created in
detail and later periods will be estimated monthly in detail during or after the first
month and so on. In both approaches there are always three months detailed budget
available (or whatever period is feasible).
(b) Examples: Companies in volatile markets which do not know in what aspect of their
work they will be operating in three months’ time. Companies where the availability of
resources, for example materials or staff are very unpredictable. For example, film
production companies. Freelance workers.
ii. Standard costs.
(a) These are the costs estimated at the beginning of a budget period. They are based on
the quantities of material, labour hours and machine hours which have been estimated
by engineering methods or past records, if necessary are adjusted for expected changes to
the product or procedure. They represent practical standards which can be expected to
be met. Once the quantities are known the prices for materials and labour which are
expected to be paid in the forthcoming period are used to create the standard cost. If
the company uses full absorption standard costing the production hours for each process
and the cost of running each process for a period will be estimated. The production costs
are divided by the production hours to give a rate per hour. The fixed costs of each
process is then allocated to each product using the usage of the resource required for
that product. The total of standard material, standard labour and standard overhead
are summed to create the standard cost for each product. In each reporting period the
quantity of each of the products produced is multiplied by the appropriate standard to
give the flexed budget for that period.
(b) Examples: production companies making several/many standard products. Service
companies offering specific standardised services, for example tyre replacement.
iii. Planning and operational variances.
(a) Companies may face significant changes in the trading environment which affects the
company’s performance. This mostly impacts on sales prices, for example gains or falls
due to market conditions and input prices, for example shortage of material or staff thus
increasing prices. The manager should do everything possible to mitigate these effects.
However the manager should not be held accountable for activities outside his/her
control. The planning and operational variances are used to calculate the effect of the
uncontrollable activity on the department’s performance. It breaks down the price
variance into the controllable and uncontrollable elements. The same approach can be
used for other uncontrollable events, for example power failure.
(b) Example based on unexpected change in market price. The standard price of material is
£4 per metre. The actual price of similar materials has increased to £7 per metre
however due to good relationships with the supplier the company has been able to buy
1,000 metres at £6 per metre.
The normal price variance would be original standard − actual price) × quantity, i.e.
(4 − 6) × 1000 = −£2,000.
The planning variance is (original standard − general market price) × quantity, i.e.
(4 − 7) × 1, 000 = −£3,000.
The operational variance is (general market price − price paid), i.e.
(7 − 6) × 1000 = £1,000.
The manager can then feel that the variances show that s/he has bought wisely in a
difficult market whereas the original variance showed poor performance.
50
Examiners’ commentaries 2018
iv. Mix and yield variances.
(a) These are sub variances which explain in more detail the impact of changes in:
∗ the sales mix of products with different contributions, resulting in changed
contribution for the same level of sales units.
∗ relating to production where several different materials are inputted (possibly fluids
or chemicals) and the result of the production will result in a standard yield. The mix
and yield variances together explain the usage variance. It may sometimes be better
to use a different mix of ingredients if it is cheaper and produces the same yield.
(b) Examples: Sales mix is calculated by:
(Actual sales quantity − Actual sales quantity in budgeted proportions) × standard
contribution.
Material mix variances are calculated by:
(Actual usage in standard proportions − actual usage in actual proportions) × standard
cost.
Material yield variances are calculated by:
(actual yield − standard yield from material input) × standard cost per unit of output.
v. Variance investigation.
(a) Companies produce variance analyses at regular intervals (usually at least monthly
although with good IT provision they could be reported more frequently, depending on
management requirements). In many cases the manager will know why a variance has
occurred because s/he was involved in the decision making and may not be surprised.
Nevertheless quantifying the activities which the manger thinks is the reason for the
variance may show that there are other activities affecting the variance. Surprise
variances which may have arisen, due to a number of reasons, need to be investigated to
determine why they have occurred in order to learn and adjust activities or processes, if
it is a factor which may appear again. A manager’s superior may also wish to know the
reasons for any large variances and wish them to be explained in detail. Sometimes an
event may affect several costs or revenues and the aggregate impact of the event should
be investigated and calculated.
Some companies set a standard amount of the variance (for example, 10% of total cost)
over which investigation should be done.
(b) Examples: actions leading to large variance which need investigating may be:
∗ a production breakdown which requires repair, reduces efficiency and loses sales
∗ a drop in sales of a particular branch (may be discover to be due to a pop-up shop
operating nearby).
vi. Management by exception.
(a) Regular reporting and variance analysis enables management by exception. The manager
will look into the areas where reports show that things are different from what was
expected. Inefficiency or problems can be addressed. Where activities are operating as
expected no intervention is needed. This is important in using managerial time
effectively.
(b) Examples:
∗ Large and continuous adverse yield variance from a process.
∗ Increase in cost of sickness absences in a particular branch.
51