Performance Pillar
26 May 2010 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and Formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2010
SECTION A – 20 MARKS
[Note: The indicative time for answering this section is 36 minutes]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
Which of the following is not a symptom of overtrading?
A
Increasing levels of inventory
B
Increasing levels of trade receivables
C
Increasing levels of current liabilities
D
Increasing levels of long term borrowings
(2 marks)
1.2
The following information has been calculated for a business:
Trade receivable collection period
Raw material inventory turnover period
Work in progress inventory turnover period
Trade payables payment period
Finished goods inventory turnover period
54 days
46 days
32 days
67 days
43 days
The length of the working capital cycle is:
A
134 days
B
156 days
C
108 days
D
150 days
(2 marks)
Performance Operations
2
May 2010
1.3
A project with an initial outlay of $250,000 has a net present value of $46,000 when
discounted at the cost of capital of 8%. The present value of the receipts from sales is
$520,000.
The sensitivity of the investment decision to changes in the initial outlay is:
A
18·4%
B
$204,000
C
$270,000
D
8·8%
(2 marks)
Section A continues on the next page
TURN OVER
May 2010
3
Performance Operations
The following data are given for sub-questions 1.4 and 1.5 below
The owner of a van selling hot take-away food has to decide how many burgers to purchase
for sale at a forthcoming outdoor concert. The number of burgers sold will depend on the
weather conditions and any unsold burgers will be thrown away at the end of the day.
The table below details the profit that would be earned for each possible outcome:
Weather
1,000
Number of burgers purchased
2,000
3,000
4,000
Bad
$1,000
$0
($1,000)
($3,000)
Average
$3,000
$6,000
$7,000
$6,000
Good
$3,000
$6,000
$9,000
$12,000
1.4
If the van owner applies the maximin rule he will purchase:
A
1,000 burgers
B
2,000 burgers
C
3,000 burgers
D
4,000 burgers
(2 marks)
1.5
If the van owner applies the minimax regret rule he will purchase:
A
1,000 burgers
B
2,000 burgers
C
3,000 burgers
D
4,000 burgers
(2 marks)
1.6
JB is concerned about the increasing level of trade receivables and is considering
various options to encourage customers to pay earlier. The company offers a 30 day
payment term but customers are taking on average 65 days to pay.
One option being considered is to offer an early settlement discount of 2·5% for
customers paying within 15 days.
Calculate, to the nearest 0·1%, the effective annual interest rate to JB of offering this
discount if all customers pay within 15 days. You should assume a 365 day year and
use compound interest methodology.
(3 marks)
Performance Operations
4
May 2010
1.7
A company is considering investing in a new project. The following table shows the
project’s estimated cash inflows and cash outflows, together with their associated
probabilities. The cash inflows and cash outflows are totally independent.
Cash Inflows
$
Probability
120,000
0·30
140,000
0·45
160,000
0·25
Cash Outflows
$
Probability
50,000
0·25
60,000
0·35
70,000
0·40
Calculate the probability of net cash flows being $90,000 or greater.
(3 marks)
1.8
A $1,000 bond has a coupon rate of 8% and will repay its nominal value when it
matures in four years’ time.
The bond will be purchased today for $900 ex interest and held until maturity.
Calculate, to the nearest 0·01%, the yield to maturity for the bond based on today’s
purchase price.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be
submitted for marking.
End of Section A
Section B begins on page 6
TURN OVER
May 2010
5
Performance Operations
SECTION B – 30 MARKS
[Note: The indicative time for answering this section is 54 minutes]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
The trade receivable ledger account for customer J from 1 January to 30 April 2010
shows the following:
Debit
$
01-Jan-2010
10-Jan-2010
12-Jan-2010
18-Jan-2010
23-Jan-2010
09-Feb-2010
13-Feb-2010
05-Mar-2010
15-Mar-2010
18-Mar-2010
25-Mar-2010
01-Apr-2010
24-Apr-2010
Balance b/fwd
Invoice No. 234
Invoice No. 263
Invoice No. 297
Receipt No. 85 (Balance b/fwd + Inv No. 263)
Invoice No. 328
Credit Note No.167 (Inv No. 234)
Invoice No. 365
Invoice No. 379
Receipt No. 102 (Inv No. 297)
Invoice No. 391
Receipt No. 126 (Inv No. 328)
Invoice No. 438
Credit
$
181
92
287
217
294
63
135
232
287
71
294
145
Balance
$
125
306
398
685
468
762
699
834
1066
779
850
556
701
(i)
Prepare an age analysis of trade receivables, for customer J, at 30 April 2010 showing
the outstanding balance analysed by month.
(3 marks)
(ii)
State two benefits of preparing an age analysis of trade receivables.
(2 marks)
(Total for sub-question (a) = 5 marks)
(b)
A company, which uses the EOQ inventory management model, purchases 64,000
units of raw materials per year. The purchase price of the raw material is $10 per unit.
The cost of holding one unit in inventory is $1·20 per year. The cost of reordering and
taking delivery is $150 per order regardless of the size of the order.
Assuming that usage is predictable and spread evenly throughout the year and that
ordering and delivery are simultaneous, calculate for the raw material:
(i)
The total annual cost of holding and ordering inventory.
(3 marks)
Past experience has shown that the supplier of the raw material can be unreliable and
that the delivery period can be between one week and three weeks. If the company
wants to hold enough raw material to ensure that it never runs out, calculate for the raw
material:
(ii)
The lowest inventory level at which raw material should be reordered.
(2 marks)
(Total for sub-question (b) = 5 marks)
Performance Operations
6
May 2010
The following scenario is given for sub-questions (c) and (d)
A medium-sized manufacturing company, which operates in the electronics industry, has
employed a firm of consultants to carry out a review of the company’s planning and control
systems. The company presently uses a traditional incremental budgeting system and the
inventory management system is based on economic order quantities (EOQ) and reorder
levels. The company’s normal production patterns have changed significantly over the
previous few years as a result of increasing demand for customised products. This has
resulted in shorter production runs and difficulties with production and resource planning.
The consultants have recommended the implementation of activity based budgeting and a
manufacturing resource planning system to improve planning and resource management.
(c)
Explain how a manufacturing resource planning system would improve the planning of
purchases and production for the company.
(5 marks)
(d)
Explain the benefits for the company that could occur following the introduction of an
activity based budgeting system.
(5 marks)
(e)
The production budgets for quarters 1 and 2 for a manufacturing company are as
follows:
Production (Units)
Budgeted production costs
Direct materials
Production labour
Production overheads
Quarter 1
15,000
Quarter 2
20,000
$
180,000
155,000
210,000
$
240,000
195,000
240,000
The cost structure, which is expected to continue unchanged in quarter 3, is as follows:
(ii)
(iii)
(iv)
(v)
The variable cost elements are linear and vary in direct proportion to
volume.
There is a bulk purchase discount of 5% on materials if orders exceed
$250,000 per quarter. The discount will apply to the purchase of all
materials in that quarter.
The company operates a JIT system for material purchases.
Fixed production overheads will increase by $20,000 per quarter at
production output levels in excess of 22,000 units in a quarter.
The budgeted production volume for quarter 3 is 23,000 units.
Prepare the production cost budget for quarter 3.
(5 marks)
Section B continues on the next page
TURN OVER
May 2010
7
Performance Operations
(f)
An events management company is trying to decide whether or not to advertise an
outdoor concert. The sale of tickets is dependent on the weather. If the weather is poor
it is expected that 5,000 tickets will be sold without advertising. There is a 70% chance
that the weather will be poor. If the weather is good it is expected that 10,000 tickets
will be sold without advertising. There is a 30% chance that the weather will be good.
If the concert is advertised and the weather is poor, there is a 60% chance that the
advertising will stimulate further demand and ticket sales will increase to 7,000. If the
weather is good there is a 25% chance the advertising will stimulate demand and ticket
sales will increase to 13,000.
The profit expected, before deducting the cost of advertising, at different levels of ticket
sales are as follows:
Number of
tickets sold
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
13,000
Profit
$
(20,000)
(5,000)
35,000
55,000
70,000
90,000
115,000
130,000
150,000
The cost of advertising the concert will be $15,000.
Required:
Demonstrate, using a decision tree, whether the concert should be advertised.
(5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C begins on page 10
Performance Operations
8
May 2010
SECTION C – 50 MARKS
[Note: The indicative time for answering this section is 90 minutes]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A company manufactures a range of industrial cleaning products from its automated factory in
Western Europe. The company has recently introduced a just-in-time system for raw material
purchases.
The company uses a standard absorption costing system for planning and control purposes
although this system is now under review.
The following budget data relate to the production of one of its major products CP1 for April.
The product is manufactured by mixing two raw materials ETH1 and RXY2.
Standard cost per kg of Product CP1
Raw material input
ETH1
RXY2
Raw material cost per kg of input
Quantity
Cost/kg
Cost
0·30kg
0·70kg
$18·00
$6·00
$5·40
$4·20
$9·60
Yield
Raw materials cost per kg of output
Fixed production overheads per kg of output
Total standard cost per kg of output
96%
$10·00
$4·00
$14·00
Budget data for product CP1 for the period is detailed below:




Sales - 72,000kg
Production - 70,000kg
Opening inventory - 2,000kg of CP1 (valued at $28,000)
Selling price per kg - $20·00
Fixed production overheads - $280,000
The fixed production overhead absorption rate is based on the budgeted number of kilograms
produced.
Performance Operations
10
May 2010
Actual data for product CP1 for the period was as follows:








Sales - 71,000kg
Production - 69,000kg
Selling price per kg - $20·30
Fixed production overheads incurred - $278,000
Cost per kg of ETH1 - $18·10
Cost per kg of RXY2 - $5·80
Input of ETH1 - 22,100kg
Input of RXY2 – 47,900kg
Required:
(a)
Produce a statement that reconciles the budgeted and actual profit for
CP1 for April showing the variances in as much detail as possible.
(19 marks)
(b)
Discuss three reasons why the use of a standard costing system is
considered inappropriate in a company that operates in an advanced
manufacturing technology environment.
(6 marks)
(Total for Question Three= 25 marks)
Section C continues on the next page
TURN OVER
May 2010
11
Performance Operations
Question Four
A small regional airport is modernising its facilities in anticipation of significant growth in the
number of passengers using the airport. It is expected that the number of passengers will
increase by 10% per annum as a result of a “low cost” airline opening new routes to and from
the airport.
At present, the airport has only one food outlet selling sandwiches and other cold food and
drinks. To improve the facilities available to customers, the management of the airport is
considering opening a restaurant selling a range of hot food and drinks. The cost of fitting out
the new restaurant, which will have to be fully refurbished after four years, is estimated to be
$350,000. These assets are expected to have a residual value of $30,000 at the end of four
years.
A firm of consultants carried out an extensive study in relation to this project at a cost of
$30,000. The key findings from their report, regarding expected revenue and contribution from
the restaurant, are as follows:



Average revenue: $9·00 per customer
Average variable cost: $5·00 per customer
Demand in year 1: 500 customers per day
Future demand for the restaurant is expected to rise in line with passenger numbers.
The airport operates for 360 days per year.
Other relevant information from the consultants’ report is listed below:
1. Staffing of the new restaurant:



Number of employees (Years 1 and 2): 4
Numbers employees (Years 3 and 4): 5
Average salary per employee: $20,000 per annum
2. Overheads



The annual budgeted fixed overhead of the airport which will be apportioned to the
restaurant is $80,000.
The annual overheads apportioned to the cold food outlet will be $30,000.
The airport’s overheads are expected to increase by the following annual amounts as a
direct result of the opening of the restaurant:
o
o
o
Electricity:
Advertising:
Audit:
$40,000
$20,000
$10,000
3. Cold food outlet
The average contribution from the sale of cold food is $2·50 per customer. If the restaurant is
not opened it is expected that the cold food outlet will sell to 1,200 customers per day in the
coming year and in subsequent years the customer numbers will rise in line with passenger
numbers.
If the restaurant is opened, the consultants expect sales from the existing cold food outlet to
initially reduce by 40% in year 1 and then to increase in line with passenger numbers.
Performance Operations
12
May 2010
The airport’s Financial Director has provided the following taxation information:


Tax depreciation: 25% reducing balance per annum.
The first year’s tax depreciation allowance is used against the first year’s net cash
inflows.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid the following year.
Any taxable losses resulting from this investment can be set against profits made by the
airport company’s other business activities since the airport company is profitable.


The airport company uses a post-tax cost of capital of 8% per annum to evaluate projects of
this type. Ignore inflation.
Required:
(a)
Calculate the net present value (NPV) of the restaurant project.
(16 marks)
(b)
The Managing Director of a company has been presented with the details of three
potential investment projects. He has very little experience of project appraisal and
has asked you for help.
The project details are given below:-
Project A
Project B
Project C
Expected NPV
$150,000
$180,000
$180,000
Standard Deviation
of Expected NPV
$10,000
$50,000
$30,000
12%
12%
10%
IRR
The three projects will require the same level of initial investment. The projects are mutually
exclusive and therefore the Managing Director can only choose one of them.
Required:
Interpret the information for the Managing Director (your answer should include
an explanation of the factors he should consider when deciding which project to
undertake).
(9 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
May 2010
13
Performance Operations
PRESENT VALUE TABLE
Present value of $1, that is 1 r 
payment or receipt.
n
where r = interest rate; n = number of periods until
Periods
(n)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
1%
0.990
0.980
0.971
0.961
0.951
0.942
0.933
0.923
0.914
0.905
0.896
0.887
0.879
0.870
0.861
0.853
0.844
0.836
0.828
0.820
2%
0.980
0.961
0.942
0.924
0.906
0.888
0.871
0.853
0.837
0.820
0.804
0.788
0.773
0.758
0.743
0.728
0.714
0.700
0.686
0.673
3%
0.971
0.943
0.915
0.888
0.863
0.837
0.813
0.789
0.766
0.744
0.722
0.701
0.681
0.661
0.642
0.623
0.605
0.587
0.570
0.554
4%
0.962
0.925
0.889
0.855
0.822
0.790
0.760
0.731
0.703
0.676
0.650
0.625
0.601
0.577
0.555
0.534
0.513
0.494
0.475
0.456
Interest rates (r)
5%
6%
0.952
0.943
0.907
0.890
0.864
0.840
0.823
0.792
0.784
0.747
0.746
0705
0.711
0.665
0.677
0.627
0.645
0.592
0.614
0.558
0.585
0.527
0.557
0.497
0.530
0.469
0.505
0.442
0.481
0.417
0.458
0.394
0.436
0.371
0.416
0.350
0.396
0.331
0.377
0.312
7%
0.935
0.873
0.816
0.763
0.713
0.666
0.623
0.582
0.544
0.508
0.475
0.444
0.415
0.388
0.362
0.339
0.317
0.296
0.277
0.258
8%
0.926
0.857
0.794
0.735
0.681
0.630
0.583
0.540
0.500
0.463
0.429
0.397
0.368
0.340
0.315
0.292
0.270
0.250
0.232
0.215
9%
0.917
0.842
0.772
0.708
0.650
0.596
0.547
0.502
0.460
0.422
0.388
0.356
0.326
0.299
0.275
0.252
0.231
0.212
0.194
0.178
10%
0.909
0.826
0.751
0.683
0.621
0.564
0.513
0.467
0.424
0.386
0.350
0.319
0.290
0.263
0.239
0.218
0.198
0.180
0.164
0.149
Periods
(n)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
11%
0.901
0.812
0.731
0.659
0.593
0.535
0.482
0.434
0.391
0.352
0.317
0.286
0.258
0.232
0.209
0.188
0.170
0.153
0.138
0.124
12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
0.361
0.322
0.287
0.257
0.229
0.205
0.183
0.163
0.146
0.130
0.116
0.104
13%
0.885
0.783
0.693
0.613
0.543
0.480
0.425
0.376
0.333
0.295
0.261
0.231
0.204
0.181
0.160
0.141
0.125
0.111
0.098
0.087
14%
0.877
0.769
0.675
0.592
0.519
0.456
0.400
0.351
0.308
0.270
0.237
0.208
0.182
0.160
0.140
0.123
0.108
0.095
0.083
0.073
Interest rates (r)
15%
16%
0.870
0.862
0.756
0.743
0.658
0.641
0.572
0.552
0.497
0.476
0.432
0.410
0.376
0.354
0.327
0.305
0.284
0.263
0.247
0.227
0.215
0.195
0.187
0.168
0.163
0.145
0.141
0.125
0.123
0.108
0.107
0.093
0.093
0.080
0.081
0.069
0.070
0.060
0.061
0.051
17%
0.855
0.731
0.624
0.534
0.456
0.390
0.333
0.285
0.243
0.208
0.178
0.152
0.130
0.111
0.095
0.081
0.069
0.059
0.051
0.043
18%
0.847
0.718
0.609
0.516
0.437
0.370
0.314
0.266
0.225
0.191
0.162
0.137
0.116
0.099
0.084
0.071
0.060
0.051
0.043
0.037
19%
0.840
0.706
0.593
0.499
0.419
0.352
0.296
0.249
0.209
0.176
0.148
0.124
0.104
0.088
0.079
0.062
0.052
0.044
0.037
0.031
20%
0.833
0.694
0.579
0.482
0.402
0.335
0.279
0.233
0.194
0.162
0.135
0.112
0.093
0.078
0.065
0.054
0.045
0.038
0.031
0.026
May 2010
15
Performance Operations
Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n
years
1 (1 r )  n
r
Periods
(n)
1
2
3
4
5
1%
0.990
1.970
2.941
3.902
4.853
2%
0.980
1.942
2.884
3.808
4.713
3%
0.971
1.913
2.829
3.717
4.580
4%
0.962
1.886
2.775
3.630
4.452
Interest rates (r)
5%
6%
0.952
0.943
1.859
1.833
2.723
2.673
3.546
3.465
4.329
4.212
7%
0.935
1.808
2.624
3.387
4.100
8%
0.926
1.783
2.577
3.312
3.993
9%
0.917
1.759
2.531
3.240
3.890
10%
0.909
1.736
2.487
3.170
3.791
6
7
8
9
10
5.795
6.728
7.652
8.566
9.471
5.601
6.472
7.325
8.162
8.983
5.417
6.230
7.020
7.786
8.530
5.242
6.002
6.733
7.435
8.111
5.076
5.786
6.463
7.108
7.722
4.917
5.582
6.210
6.802
7.360
4.767
5.389
5.971
6.515
7.024
4.623
5.206
5.747
6.247
6.710
4.486
5.033
5.535
5.995
6.418
4.355
4.868
5.335
5.759
6.145
11
12
13
14
15
10.368
11.255
12.134
13.004
13.865
9.787
10.575
11.348
12.106
12.849
9.253
9.954
10.635
11.296
11.938
8.760
9.385
9.986
10.563
11.118
8.306
8.863
9.394
9.899
10.380
7.887
8.384
8.853
9.295
9.712
7.499
7.943
8.358
8.745
9.108
7.139
7.536
7.904
8.244
8.559
6.805
7.161
7.487
7.786
8.061
6.495
6.814
7.103
7.367
7.606
16
17
18
19
20
14.718
15.562
16.398
17.226
18.046
13.578
14.292
14.992
15.679
16.351
12.561
13.166
13.754
14.324
14.878
11.652
12.166
12.659
13.134
13.590
10.838
11.274
11.690
12.085
12.462
10.106
10.477
10.828
11.158
11.470
9.447
9.763
10.059
10.336
10.594
8.851
9.122
9.372
9.604
9.818
8.313
8.544
8.756
8.950
9.129
7.824
8.022
8.201
8.365
8.514
Periods
(n)
1
2
3
4
5
11%
0.901
1.713
2.444
3.102
3.696
12%
0.893
1.690
2.402
3.037
3.605
13%
0.885
1.668
2.361
2.974
3.517
14%
0.877
1.647
2.322
2.914
3.433
Interest rates (r)
15%
16%
0.870
0.862
1.626
1.605
2.283
2.246
2.855
2.798
3.352
3.274
17%
0.855
1.585
2.210
2.743
3.199
18%
0.847
1.566
2.174
2.690
3.127
19%
0.840
1.547
2.140
2.639
3.058
20%
0.833
1.528
2.106
2.589
2.991
6
7
8
9
10
4.231
4.712
5.146
5.537
5.889
4.111
4.564
4.968
5.328
5.650
3.998
4.423
4.799
5.132
5.426
3.889
4.288
4.639
4.946
5.216
3.784
4.160
4.487
4.772
5.019
3.685
4.039
4.344
4.607
4.833
3.589
3.922
4.207
4.451
4.659
3.498
3.812
4.078
4.303
4.494
3.410
3.706
3.954
4.163
4.339
3.326
3.605
3.837
4.031
4.192
11
12
13
14
15
6.207
6.492
6.750
6.982
7.191
5.938
6.194
6.424
6.628
6.811
5.687
5.918
6.122
6.302
6.462
5.453
5.660
5.842
6.002
6.142
5.234
5.421
5.583
5.724
5.847
5.029
5.197
5.342
5.468
5.575
4.836
4.988
5.118
5.229
5.324
4.656
7.793
4.910
5.008
5.092
4.486
4.611
4.715
4.802
4.876
4.327
4.439
4.533
4.611
4.675
16
17
18
19
20
7.379
7.549
7.702
7.839
7.963
6.974
7.120
7.250
7.366
7.469
6.604
6.729
6.840
6.938
7.025
6.265
6.373
6.467
6.550
6.623
5.954
6.047
6.128
6.198
6.259
5.668
5.749
5.818
5.877
5.929
5.405
5.475
5.534
5.584
5.628
5.162
5.222
5.273
5.316
5.353
4.938
4.990
5.033
5.070
5.101
4.730
4.775
4.812
4.843
4.870
Performance Operations
16
May 2010
FORMULAE
PROBABILITY
A  B = A or B.
A  B = A and B (overlap).
P(B | A) = probability of B, given A.
Rules of Addition
If A and B are mutually exclusive:
If A and B are not mutually exclusive:
P(A  B) = P(A) + P(B)
P(A  B) = P(A) + P(B) – P(A  B)
Rules of Multiplication
If A and B are independent::
If A and B are not independent:
P(A  B) = P(A) * P(B)
P(A  B) = P(A) * P(B | A)
E(X) =  (probability * payoff)
DESCRIPTIVE STATISTICS
Arithmetic Mean
x 
x
n
x
 fx
f
(frequency distribution)
Standard Deviation
SD 
( x  x ) 2
n
SD 
 fx 2
 x 2 (frequency distribution)
f
INDEX NUMBERS
Price relative = 100 * P1/P0
Price:
Quantity:
Quantity relative = 100 * Q1/Q0
P
 w   1
 Po
w




x 100
Q 
 w   1 
 Qo  x 100
w
TIME SERIES
Additive Model
Series = Trend + Seasonal + Random
Multiplicative Model
Series = Trend * Seasonal * Random
May 2010
17
Performance Operations
FINANCIAL MATHEMATICS
Compound Interest (Values and Sums)
Future Value S, of a sum of X, invested for n periods, compounded at r% interest
S = X[1 + r]n
Annuity
Present value of an annuity of £1 per annum receivable or payable for n years, commencing in one
year, discounted at r% per annum:
PV =
1
1 

1 
r  [1  r ] n 
Perpetuity
Present value of £1 per annum, payable or receivable in perpetuity, commencing in one year,
discounted at r% per annum:
PV =
1
r
LEARNING CURVE
Yx = aXb
where:
Yx = the cumulative average time per unit to produce X units;
a = the time required to produce the first unit of output;
X = the cumulative number of units;
b = the index of learning.
The exponent b is defined as the log of the learning curve improvement rate divided by log 2.
INVENTORY MANAGEMENT
Economic Order Quantity
2C o D
EOQ =
Ch
where:
Co
Ch
D
=
=
=
cost of placing an order
cost of holding one unit in inventory for one year
annual demand
Performance Operations
18
May 2010
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is D.
1.2
(54 + 46 + 32 + 43 – 67) = 108 days
The correct answer is C.
1.3
$46,000/$250,000 = 18·4%
The correct answer is A.
1.4
The lowest profit in each case is when the weather is bad. If the maximin rule is
applied, the highest profit when the weather is bad is $1,000 i.e. 1,000 burgers.
The correct answer is A.
May 2010
1
P1
1.5
Minimax Regret Table
Weather
No of burgers purchased
1,000
2000
3000
4000
Bad
$0
($1,000)
($2,000)
($4,000)
Average
($4,000)
($1,000)
$0
($1,000)
Good
($9,000)
($6,000)
($3,000)
$0
The maximum regret for 1,000 burgers is $9,000
The maximum regret for 2,000 burgers is $6,000
The maximum regret for 3,000 burgers is $3,000
The maximum regret for 4,000 burgers is $4,000
Therefore if he wants to minimise the maximum regret he will
purchase 3,000 burgers.
The correct answer is C.
1.6
Payment will be made 50 days early.
Number of compounding periods = 365/50 = 7·3
 1.00  7.3
1+ r = 

 0.975 
1 + r = 1·203
The cost of offering the discount is 20·3%
1.7
$
140,000 160,000 160,000 160,000 -
$
50,000 =
50,000 =
60,000 =
70,000 =
$
90,000
110,000
100,000
90,000
Joint probability is (0·45 x 0·25) =
Joint probability is (0·25 x 0·25) =
Joint probability is (0·25 x 0·35) =
Joint probability is (0·25 x 0·40) =
0·1125
0·0625
0·0875
0·1000
0·3625
Alternatively:
$140,000 – $50,000 = $90,000 Joint probability is (0·45 x 0·25) =
At cash inflows of $160,000, net cash flows are all greater than $90,000 therefore
probability is
0·1125
0·2500
0·3625
The probability is 36·25%
P1
2
May 2010
1.8
Interest is 80/900 i.e. 8·9% plus capital gain at maturity of $100 therefore discount
initially at 10%.
Cash flows
Discount rate
@ 10%
PV of cash
flows
$
(900·00)
198·96
737·64
36·60
$
Year 0
Year 1-3
Year 4
NPV
(900)
80
1,080
1·000
2·487
0·683
Discount rate
@ 12%
1·000
2·402
0·636
PV of cash
flows
$
(900·00)
192·16
686·88
-20·96
By interpolation:
10% + (2% (36·6/(36·6 + 20·96)) = 11·27%
May 2010
3
P1
SECTION B
Answer to Question Two
(a)
(i)
< 1 month
$
145
1- 2 months
$
438
2-3 months
$
0
>3 months
$
118
Balance
$
701
(ii)
Examiner’s note: the question asks for two benefits. Examples of points that would be
rewarded are given below.
(a)
(d)
Can be used to help decide what action should be taken about debts
that have been outstanding for longer than the specified credit period.
Provides information about the efficiency of cash collection.
Can provide information to assist in setting and monitoring collection
targets for the credit control section.
Provides information that can be used in setting a bad debt provision.
(b)
(i)
(b)
(c)
EOQ
2x 64,000x150
= 4,000
1.20
Total cost of inventory management is:
Cost of ordering inventory + cost of holding inventory
DCo ChQ 64,000 × 150 1.2 × 4,000
+
=
+
2
4,000
2
Q
= $2,400
+
$2,400
= $4,800
(ii)
One week’s usage = 64,000/52 = 1,231
Inventory reorder level = 3 x 1,231 = 3,693 units
P1
4
May 2010
(c)
The traditional approach to determine material requirements is to monitor inventories
constantly; whenever they fall to a predetermined level, a preset order is placed to
replenish them. This traditional approach (involving re-order levels and economic order
quantity calculations) originates in the pre-computer era.
A manufacturing resource planning system is a fully integrated computerised planning
approach to the management of all the company’s manufacturing resources including
inventory, labour and machine capacity. It seeks to ensure that resources are available
just before they are needed by the next stage of production or despatch. It also seeks
to ensure that resources are delivered only when required so that raw material
inventory is kept to a minimum.
The technique enables managers to track orders through the manufacturing process
and helps the purchasing and production control departments to move the right amount
of material or sub-assemblies at the right time to the right place.
The current inventory management system relies on the assumption that there is
constant demand. An MRP system begins with the setting of a master production
schedule specifying both the timing and quantity demanded of each of the finished
goods items and then works backwards to determine the resource requirements at
each stage of the production process. It aims to generate a planned schedule of
materials requirements after taking account of scheduled receipts, projected inventory
levels and items already allocated to production. The EOQ model can be used within
MRP provided that the major assumption in the EOQ model of constant demand
applies.
(d)
Under an activity based budgeting (ABB) system, resource allocation is linked to the
strategic plan and is prepared after considering alternative strategies. This approach
ensures that new activities that are required to meet the company’s strategic objectives
are included in the budget.
Under a traditional incremental budgeting system the focus is on existing resources
and operations. Adjustments are then made for changes in activity and price which
results in past inefficiencies being perpetuated. Under an activity based budgeting
system, only resources that are needed to perform activities required to meet the
budgeted production and sales volumes are included.
Activity based techniques including activity based budgeting focus on the outputs of a
process rather than the input to the process. This approach provides a clear framework
for understanding the link between costs and the level of activity. It allows the ranking
of activities and the determination of how limited resources should be allocated across
competing activities. Traditional budgeting systems present costs under functional
headings i.e. the emphasis is on the nature of the cost. The weakness of this approach
is that it gives little indication of the link between the level of activity and the cost
incurred.
The approach under a traditional system is to make arbitrary cuts in order to meet
overall financial targets. Activity based budgeting allows the identification of value
added and non-value added activities and ensures that cuts are made to non-value
added activities. ABB is also useful for review of capacity utilisation. If it is known that
the resources devoted to a particular activity are greater than those currently required
then these resources can be reduced or redeployed.
May 2010
5
P1
(e)
Production cost budget for Quarter 3
Budgeted costs
$
Direct materials
Production labour
262,200
219,000
Production overheads
278,000
759,200
Workings:
Direct materials
Production labour
Variable cost per unit = $12
Variable cost per unit
(195,000 – 155,000) / (20,000 – 15,000) = $8
Fixed cost
$155,000 – (15,000 x $8) = $35,000
Production overheads
Variable cost per unit
(240,000 – 210,000) / (20,000 – 15,000) = $6
Fixed cost
$210,000 – (15,000 x $6) = $120,000
Quarter 3
Direct material
Production labour
Production overheads
P1
23,000 units x ($12 x 0·95) = $262,200
23,000 units x $8 = $184,000 + $35,000 = $219,000
23,000 units x $6 = $138,000 + $120,000 + $20,000 = $278,000
6
May 2010
(f)
Decision tree: advertise concert or not
No Increase
40%
5,000
($35,000)
($9,800)
Increase
60%
7,000
$20,000
$8,400
10,000
$75,000
$16,875
13,000
$135,000
$10,125
Poor
70%
Advertise
No Increase
75%
Good
30%
Increase
25%
Don’t
Advertise
Poor
70%
Good
30%
$25,600
5,000
($20,000)
($14,000)
10,000
$90,000
$27,000
$13,000
Therefore the concert should be advertised.
May 2010
7
P1
SECTION C
Answer to Question Three
(a)
Reconciliation Statement
Budgeted gross profit
$
432,000
Sales price variance
Sales volume profit variance
Material price variance ETH 1
Material price variance RXY 2
Material mix variance
Material yield variance
Fixed overhead expenditure variance
Fixed overhead volume variance
Actual gross profit
21,300
6,000
2,210
9,580
13,200
18,000
2,000
4,000
457,470
F
A
A
F
A
F
F
A
Workings
Budgeted sales
Budgeted cost of sales
Budgeted gross profit
$1,440,000
$1,008,000
$432,000 (or 72,000kg x ($20 - $14))
Sales price variance = ($20·30 - $20·00) x 71,000kg = $21,300 F
Sales volume profit variance = (71,000kg – 72,000kg) x ($20 - $14) = $6,000 A
Material price variance ETH 1 = ($18·00 - $18·10) x 22,100kg = $2,210 A
Material price variance RXY 2 = ($6·00 - $5·80) x 47,900kg = $9,580 F
Material mix variance
Raw Material
ETH1
Raw Material
RXY2
Actual input
@ std mix
Kg
21,000
Actual input
@ act mix
kg
22,100
Variance
kg
Std Price
$
Variance
$
1,100 A
18·00
19,800 A
49,000
47,900
1,100 F
6·00
6,600 F
70,000
70,000
-
-
13,200 A
Material yield variance
Actual total input
Standard yield
Expected output
Actual output
Variance
Std price per kg
Variance
70,000kg
96%
67,200kg
69,000kg
1,800kg F
x $10
$18,000 F
Fixed overhead expenditure variance = ($280,000 - $278,000) = $2,000 F
Fixed overhead volume variance = (70,000 kg – 69,000kg) x $4 = $4,000 A
P1
8
May 2010
$
1,441,300
(400,010)
(277,820)
(278,000)
(28,000)
457,470
Actual sales revenue
ETH1
RXY2
Fixed o/heads incurred
Inventory movement (2,000 units x $14)
Actual gross profit
(b)
Examiner’s note: the question asks for three reasons. Examples of points that would be
rewarded are given below.
In a JIT environment measuring standard costing variances may encourage dysfunctional
behaviour. A JIT production environment relies on producing small batch sizes economically
by reducing set up times. Performance measures that benefit from large batch sizes or
producing for inventory should therefore be avoided.
In an AMT environment the major costs are those related to the production facility rather than
production volume related costs such as materials and labour which standard costing is
essentially designed to plan and control. Fixed overhead variances don’t necessarily reflect
under or overspending but may simply reflect differences in production volume. An activity
based cost management system may be more appropriate, focusing on the activities that
drive the cost.
In a total quality environment, standard costing variance measurement places an emphasis
on cost control to the detriment of quality. Cost control may be achieved at the expense of
quality and competitive advantage.
A continuous improvement environment requires a continual effort to do things better rather
than achieve an arbitrary standard based on prescribed or assumed conditions. In today’s
competitive environment cost is market driven and is subject to considerable downward
pressure. Cost management must consist of both cost maintenance and continuous cost
improvement.
In a JIT/AMT/TQM environment the workforce is usually organised into empowered, multiskilled teams controlling operations autonomously. The feedback they require is real time.
Periodic financial reports are neither meaningful nor timely enough to facilitate appropriate
control action.
May 2010
9
P1
Answer to Question Four
(a)
Restaurant:
Number of customers in Year 1
Contribution per meal
Total contribution
= (500 x 360) = 180,000
= $4
= $720,000
Cold food outlet:
Number of meals in Year 1
Contribution per meal
Total contribution
Reduction in contribution
= (1,200 x 360) = 432,000
= $2·50
= $1,080,000
= $1,080,000 x 40%
= $432,000
Cash Flows
Restaurant
contribution
Reduction in
contribution
from cold food
Salaries
Additional
overheads
Net cash flows
Year 1
720,000
Year 2
792,000
Year 3
871,200
Year 4
958,320
(432,000)
(475,200)
(522,720)
(574,992)
(80,000)
(70,000)
(80,000)
(70,000)
(100,000)
(70,000)
(100,000)
(70,000)
138,000
166,800
178,480
213,328
Year 1
138,000
(87,500)
Year 2
166,800
(65,625)
Year 3
178,480
(49,219)
Year 4
213,328
(117,656)
50,500
15,150
101,175
30,353
129,261
38,778
95,672
28,702
Taxation
Net cash flows
Tax
Depreciation
Taxable profit
Taxation @
30%
Net present value
Year 0
Net cash
(350,000)
flows
Tax
payment
Tax
payment
Net cash
(350,000)
flow after
tax
Discount
1·000
factor
Present
(350,000)
value
Year 1
138,000
(7,575)
Year 2
166,800
Year 3
178,480
Year 4
243,328
Year 5
(15,177)
(19,389)
(14,351)
( 7,575)
(15,177)
(19,389)
(14,351)
(14,351)
130,425
144,048
143,914
209,588
0·926
0·857
0·794
0·735
0·681
120,774
123,449
114,268
154,047
(9,773)
Net present value = $152,765
P1
10
May 2010
(b)
The NPV is the amount by which the present value of the future cash flows exceeds the initial
outlay. The cash flows are discounted at the rate that reflects the alternative use of the funds,
normally the company’s cost of capital. Investment decisions should be based on NPV since it
is the only appraisal method that will ensure the maximisation of shareholders’ wealth. If the
decision is based on NPV then either Project B or C should be undertaken. However NPV
does not indicate the range of outcomes that may result. While Project A has a lower
expected NPV the standard deviation of Project A is also lower and depending on the
company’s attitude to risk they may decide to undertake Project A.
The standard deviation is a measure of risk. It compares all the possible outcomes with the
expected value (or mean outcome). Project B and C have the same NPV therefore it is
possible to directly compare the standard deviations. The standard deviation for Project C is
lower than that for Project B which means that the outcomes for Project C have less
variability. Since Project A has a lower NPV than Project B and Project C it is necessary to
calculate the coefficient of variation. The coefficient of variation for Project A and Project C is
6·67% and 16·67% respectively. Therefore, in terms of achieving the expected net present
value, Project A is less risky than Project C. We would need however to see the range of
possible outcomes since in this case it is the risk of outcomes below the expected outcome
that is important.
There is however a trade-off between risk and return. The higher the risk, the higher the
potential return. The decision on which project to undertake will depend on the managing
director’s attitude to risk. If the Managing Director is risk averse he would choose Project A. If
he is risk seeking he would choose Project B as it has the potential for higher returns.
The IRR is the rate of return that equates the present value of future cash flows with the initial
outlay. It is the discount rate that will result in a net present value of zero. Project C has the
lowest IRR, however as stated above investment decisions should be based on NPV.
A limitation of Net Present Value is that it does not consider the life of the project. The longer
the project the more uncertain the cash flows are likely to be. The payback method of
investment appraisal determines how long it takes for the project to payback its initial
investment. It therefore to a certain extent copes with an uncertain future by placing more
emphasis on early cash flows.
May 2010
11
P1
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
examines candidates’ ability to prepare an age analysis of outstanding trade
receivables and to state the benefits of this process.
(b)
examines candidates’ ability to apply the EOQ formula and to calculate the cost of
holding and ordering the suggested level of stock. The ability to calculate the required
re-order level based on information regarding a supplier’s delivery times is also
examined.
(c)
examines candidates’ ability to identify and explain the benefits of a manufacturing
resource planning system in comparison to a traditional stock management system.
(d)
examines candidates’ ability to identify and explain the benefits of activity based
budgeting in comparison to a traditional budgeting system.
(e)
examines candidates’ ability to identify the cost behaviour for different cost items and
then apply this knowledge to calculate the budgeted costs for a different activity level.
The ability to apply the high-low method of cost analysis is examined.
(f)
examines candidates’ ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.
Section C – Questions Three and Four - Compulsory
Question Three examines candidates’ ability to calculate variances including both mix and
yield variances and, using these variances, to prepare a statement reconciling the budget
profit to the actual profit. The problems with using a standard costing system in an advanced
manufacturing environment are also examined.
Question Four, in part (a) of the question, examines candidates’ ability to calculate the net
present value of a project involving the identification of relevant costs and calculation of the
effect of taxation. Part (b) of the question examines candidates’ ability to evaluate three
investment project given the projects’ NPV, IRR and standard deviation.
P1
12
May 2010
Performance Pillar
Wednesday 1 September 2010
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2010
SECTION A – 20 MARKS
[Note: The indicative time for answering this section is 36 minutes]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
Which ONE of the following is NOT considered to be a cost of holding inventory?
A
Loss of goodwill as a result of being unable to complete customer orders due to lack
of inventory
B
Insurance cost of inventory
C
Storage cost of inventory
D
Interest on cash invested in inventory
(2 marks)
1.2
The following information has been calculated for a business:
Trade receivables collection period
Trade payables payment period
54 days
67 days
If the working capital cycle is 102 days, the inventory turnover period is
A
19 days
B
115 days
C
89 days
D
13 days
(2 marks)
Performance Operations
2
September 2010
1.3
A project requires an initial investment of $200,000. It has a life of five years and
generates net cash inflows in each of the five years of $55,000. The net present value
of the project when discounted at the company’s cost of capital of 8% is $19,615.
The sensitivity of the investment decision to a change in the annual net cash inflow is:
A
35.7%
B
25.0%
C
9.8%
D
8.9%
(2 marks)
Section A continues on the next page
TURN OVER
September 2010
3
Performance Operations
The following data are given for sub-questions 1.4 and 1.5 below
A company can choose from four mutually exclusive investment projects. The net present
value of the projects will depend on market conditions.
The table below details the net present value for each possible outcome:
Market
conditions
Projects
A
B
C
D
Poor
$400,000
$700,000
$450,000
$360,000
Average
$470,000
$550,000
$500,000
$400,000
Good
$600,000
$300,000
$800,000
$550,000
1.4
If the company applies the maximin rule it will invest in:
A
Project A
B
Project B
C
Project C
D
Project D
(2 marks)
1.5
If the company applies the minimax regret rule it will invest in:
A
Project A
B
Project B
C
Project C
D
Project D
(2 marks)
1.6
PJ sells goods to customers on credit. It is forecast that credit sales for July will be
$36,000 and that sales will increase by $2,000 per month for the next six months.
Based on past experience PJ expects 50% of customers to pay in the month after sale,
25% of customers to pay 2 months after sale and the remainder to pay 3 months after
sale.
PJ has a trade receivables balance outstanding at the beginning of July of $65,000.
Calculate the cash that PJ will receive from credit customers during the six month
period to the end of December.
(3 marks)
Performance Operations
4
September 2010
1.7
The estimated production volume of a new product for the first year is 2,000 units. The
management accountant has produced the following table showing the possible
production costs and their associated probabilities at this level of output.
The probabilities of the different levels of fixed production costs and variable production
costs are totally independent.
Total fixed production costs
$
Probability
80,000
0.40
130,000
0.45
160,000
0.15
Total variable production costs
$
Probability
30,000
0.25
40,000
0.35
50,000
0.40
(i)
Calculate the expected value of total production costs for the production of
2,000 units.
(ii)
Calculate the probability of total production costs for 2,000 units being $180,000
or greater.
(4 marks)
1.8
A $1,000 bond has a coupon rate of 10% per annum and will repay its face value in five
years time. Similar bonds have a yield to maturity of 8% per annum.
Calculate the current expected market value of the bond.
(3 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be
submitted for marking.
End of Section A
Section B begins on page 6
TURN OVER
September 2010
5
Performance Operations
SECTION B – 30 MARKS
[Note: The indicative time for answering this section is 54 minutes]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
JP has been offered credit terms by a supplier that will allow JP to claim a cash
discount of 2.5% if payment is made within 15 days of the date of the invoice or to pay
on normal credit terms within 45 days of the date of the invoice.
Required:
(i)
Calculate, to the nearest 0.1%, the effective annual interest rate offered to JP from
accepting the cash discount and paying within 15 days. You should assume a 365 day
year and use compound interest methodology.
(3 marks)
(ii)
State TWO other methods that the supplier could use to reduce its level of outstanding
trade receivables.
(2 marks)
(Total for sub-question (a) = 5 marks)
(b)
BB manufactures a range of electronic products. The supplier of component Y has
informed BB that it will offer a quantity discount of 1.0% if BB places an order of 10,000
components or more at any one time.
Details of component Y are as follows:
Cost per component before discount
Annual purchases
Ordering costs
Holding costs
$2.00
150,000 components
$360 per order
$3.00 per component per
annum
Required:
(i)
Calculate the total annual cost of holding and ordering inventory of component Y
using the economic order quantity and ignoring the quantity discount.
(2 marks)
(ii)
Calculate whether there is a financial benefit to BB from increasing the order size to
10,000 components in order to qualify for the 1.0% quantity discount.
(3 marks)
(Total for sub-question (b) = 5 marks)
Performance Operations
6
September 2010
(c)
Explain why a backflush cost accounting system may be considered more appropriate
than a traditional cost accounting system, in a company that operates a just-in-time
production and purchasing system.
(5 marks)
(d)
XY, a not-for-profit charity organisation which is funded by public donations, is
concerned that it is not making the best use of its available funds. It has carried out a
review of its budgeting system and is considering replacing the current system with a
zero-based budgeting system.
Required:
Explain the potential advantages AND disadvantages for the charity of a zero-based
budgeting system.
(5 marks)
(e)
QR uses an activity based budgeting (ABB) system to budget product costs. It
manufactures two products, product Q and product R. The budget details for these two
products for the forthcoming period are as follows:
Budgeted production (units)
Number of machine set ups per batch
Batch size (units)
Product Q
80,000
Product R
120,000
4
5,000
2
4,000
The total budgeted cost of setting up the machines is $74,400.
Required:
(i)
Calculate the budgeted machine set up cost per unit of product Q.
(3 marks)
(ii)
State TWO potential benefits of using an activity based budgeting system.
(2 marks)
(Total for sub-question (e) = 5 marks)
Section B continues on the next page
TURN OVER
September 2010
7
Performance Operations
(f)
A university is trying to decide whether or not to advertise a new post-graduate
degree programme. The number of students starting the programme is
dependent on economic conditions. If conditions are poor it is expected that the
programme will attract 40 students without advertising. There is a 60% chance
that economic conditions will be poor. If economic conditions are good it is
expected that the programme will attract only 20 students without advertising.
There is a 40% chance that economic conditions will be good.
If the programme is advertised and economic conditions are poor, there is a 65%
chance that the advertising will stimulate further demand and student numbers
will increase to 50. If economic conditions are good there is a 25% chance the
advertising will stimulate further demand and numbers will increase to 25
students.
The profit expected, before deducting the cost of advertising, at different levels of
student numbers are as follows:
Number
of students
15
20
25
30
35
40
45
50
Profit
$
(10,000)
15,000
40,000
65,000
90,000
115,000
140,000
165,000
The cost of advertising the programme will be $15,000.
Required:
Demonstrate, using a decision tree, whether the programme should be advertised.
(5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C begins on page 10
Performance Operations
8
September 2010
SECTION C – 50 MARKS
[Note: The indicative time for answering this section is 90 minutes]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
FX Corporation produces a single product RG. The company operates a standard absorption
costing system and a just-in-time purchasing system.
Standard production cost details per unit of product RG are:
Materials (5 kg at $20 per kg)
Labour (4 hours at $10 per hr)
Variable overheads (4 hours at $5 per hr)
Fixed overheads (4 hours at $12.50 per hr)
$
100
40
20
50
210
Fixed and variable overheads are absorbed on the basis of labour hours.
Budget data for product RG for July are detailed below:
Production and sales
Selling price
Fixed overheads
1,400 units
$250 per unit
$70,000
Actual data for product RG for July are as follows:
Production and sales
Selling price
Direct materials
Direct labour
Variable overheads
Fixed overheads
1,600 units
$240 per unit
7,300 kg costing $153,300
5,080 hours at $9 per hour
$25,400
$74,000
Required:
(a)
Produce a statement that reconciles the budgeted and actual gross profit
for product RG for July showing the variances in as much detail as
possible.
(13 marks)
Performance Operations
10
September 2010
(b)
The following details have been extracted from the company’s accounting records for
August.
Budget
800 units
4,000kg
$20.00
Output of RG
Materials
Cost per kg
Actual
890 units
4,375kg
$21.60
It has now been realised that the standard cost per kg of the material should have been
$20.90.
Calculate the following materials variances for August:
(i) The total materials cost variance.
(ii) The planning variance for materials price.
(iii) The operational variances for materials price and materials usage.
(6 marks)
(c)
Discuss THREE advantages of using a standard costing system that identifies
both planning and operational variances.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
September 2010
11
Performance Operations
Question Four
The management of a hotel is considering expanding its facilities by providing a gymnasium
and spa for the use of guests. It is expected that the additional facilities will result in an
increase in the occupancy rate of the hotel and in the rates that can be charged for each
room.
The cost of refurbishing the space, which is currently used as a library for guests, and
installing the spa is estimated to be $100,000. The cost of the gymnasium equipment is
expected to be $50,000. The gymnasium and spa will need to be refurbished and the
equipment replaced every four years. The equipment will be sold for $15,000 cash at the end
of year 4. This amount includes the effect of inflation.
The hotel’s accountants have produced a feasibility report at a cost of $10,000. The key
findings from their report, regarding occupancy rates and room rates are as follows:
•
•
•
Current occupancy rate: 80%
Number of rooms available: 40
Current average room rate per night: $250
Occupancy rates, following the opening of the gymnasium and spa, are expected to rise to
82% and the average room rate by 5%, excluding the effect of inflation.
The hotel is open for 360 days per year.
Other relevant information from the accountants’ report is listed below:
1. Staffing of the gymnasium and spa
•
•
Number of employees : 4
Average salary per employee: $30,000 per annum
2. Overheads
•
•
3.
The current budgeted overhead absorption rate for the hotel is $80 per square metre per
annum. The area required for the gymnasium and spa is 400 square metres.
The hotel’s overheads are expected to increase by $42,000 directly as a result of opening
the gymnasium and spa.
Inflation
Inflation is expected to be at a rate of 4% per annum and will apply to sales revenue,
overhead costs and staff costs. The rate of 4% will apply from Year 2 to each of the
subsequent years of the project.
4.
Taxation
The hotel’s accountants have provided the following taxation information:
•
•
•
Tax depreciation available on all costs of refurbishing, installation and equipment: 25%
reducing balance per annum.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid the following year.
Any losses resulting from this investment can be set against taxable profits made by the
company’s other business activities.
The company uses a post-tax money cost of capital of 12% per annum to evaluate projects of
this type.
Performance Operations
12
September 2010
Required:
(a)
Calculate the net present value (NPV) of the gymnasium and spa project.
(16 marks)
(b)
Calculate the post-tax money cost of capital at which the hotel would be
indifferent to accepting / rejecting the project.
(4 marks)
(c)
Discuss an alternative method for the treatment of inflation that would
result in the same NPV.
Your answer should consider the potential difficulties in using this method
when taxation is involved in the project appraisal.
(5 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
September 2010
13
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is A.
1.2
(102 + 67 - 54) = 115 days
The correct answer is B.
1.3
$19,615/$219,615 = 8.9%
The correct answer is D.
1.4
If the maximin rule is applied, the highest of the worst profit for each of the three
projects is $450,000 i.e. project C.
The correct answer is C.
September 2010
1
P1
1.5
Minimax Regret Table
Market
Conditions
Projects
A
B
C
D
Poor
($300,000)
0
($250,000)
($340,000)
Average
($80,000)
0
($50,000)
($150,000)
Good
($200,000)
($500,000)
0
($250,000)
The maximum regret for Project A is $300,000
The maximum regret for Project B is $500,000
The maximum regret for Project C is $250,000
The maximum regret for Project D is $340,000
Therefore if the company wants to minimise the maximum regret it will invest in project
C.
The correct answer is C.
1.6
Credit
sales
July
36,000
Aug
38,000
Sept
40,000
Oct
42,000
Nov
44,000
Dec
46,000
Total
246,000
Cash Collected:
$
65,000
246,000
311,000
Outstanding receivables June
Credit sales
Less receivables at 31
December
100% December credit sales
50% November credit sales
25% October credit sales
Total cash collected
(46,000)
(22,000)
(10,500)
232,500
1.7
(i)
The expected value of fixed costs is:
($80,000 x 0.40) + ($130,000 x 0.45) + ($160,000 x 0.15) = $114,500
The expected value of variable costs is:
($30,000 x 0.25) + ($40,000 x 0.35) + ($50,000 x 0.40) = $41,500
The expected value of total costs is therefore $114,500 + $41,500 = $156,000
P1
2
September 2010
(ii)
$
130,000 +
160,000 +
160,000 +
160,000 +
$
50,000 =
30,000 =
40,000 =
50,000 =
$
180,000
190,000
200,000
210,000
Joint probability is (0.45 x 0.40) =
Joint probability is (0.15 x 0.25) =
Joint probability is (0.15 x 0.35) =
Joint probability is (0.15 x 0.40) =
0.1800
0.0375
0.0525
0.0600
0.3300
Alternatively:
$130,000 + $50,000 = $180,000 Joint probability
is (0.45 x 0.40) =
At fixed costs of $160,000, total costs are all greater than
$180,000 therefore probability is =
0.1800
0.1500
0.3300
The probability is 33%.
1.8
Yield to maturity of similar bonds is 8%, therefore use 8% as the discount rate.
Year 1-5
Year 5
PV
Cashflows
$
100
1,000
Discount rate @ 8%
3.993
0.681
PV of cashflows
$
399.30
681.00
1,080.30
The expected market value of the bond is therefore $1,080.30
September 2010
3
P1
SECTION B
Answer to Question Two
(a)
(i)
Payment will be made 30 days earlier.
Number of compounding periods = 365/30 = 12.167
1 + r = 1.361
The benefit from accepting the discount is 36.1%
(ii)
Examiner’s note: the question asks for two methods. Examples of methods that would be
rewarded are given below.
a) Factoring or invoice discounting
b) Interest penalties for late payment
c) Improved credit control procedures
(b)
EOQ
2 × 150,000 × 360
= 6,000 units
3.00
Total cost of inventory management using EOQ is:
Cost of ordering inventory + cost of holding inventory
DCo ChQ 150,000 × 360 3.00 × 6,000
+
=
+
2
2
Q
6,000
P1
=
$9,000 + $9,000
=
$18,000
4
September 2010
(ii)
Total cost of inventory management using 10,000 units is:
DCo ChQ 150,000 × 360 3.00 × 10,000
+
=
+
Q
2
10,000
2
=
$5,400 + $15,000
=
$20,400
Additional inventory management cost if 10,000 components are purchased = $2,400
Value of the discount is (150,000 x $2.00) x 1% = $3,000
It is therefore worthwhile to purchase 10,000 components and take the quantity discount
(c)
Traditional cost accounting systems track the sequence of raw materials and components
moving through production. Such systems are time consuming and expensive to operate as
they require considerable documentation, such as material requisitions and time sheets, and
detailed accounting in order to maintain the job cards and inventory records.
Backflush costing delays the recording of costs until after production has been completed or
even sold. Standard costs can then be used to work backwards to 'flush' out the
manufacturing costs.
The absence of inventory in a just-in-time purchasing and production system makes choices
about inventory valuation methods unnecessary and the rapid conversion of direct materials
costs into cost of goods sold simplifies the cost accounting system.
Cost accounting is simplified in a backflush system. For example, inventory valuation is
avoided. Also, all production labour is treated as an indirect cost and is included with the other
overheads in conversion costs. This is because, in a JIT system, supplies of raw material and
production activity are only required when there is sales demand and so production labour will
be paid regardless of activity.
(d)
There are a number of advantages to the charity in the use of zero based budgeting (ZBB) as
follows:
(a)
(b)
(c)
It avoids the complacency inherent in the traditional incremental approach where
it is assumed that future activities will be very similar to current ones.
It encourages a questioning approach by focusing attention not only on the cost
of the activity but on the benefits it provides. This will force the charity managers
to articulate the benefits encouraging them to think clearly about the activities.
Preparation of the decision packages will normally require the involvement of
many employees. This involvement may produce useful ideas and promote job
satisfaction.
There are, however, a number of potential disadvantages of zero based budgeting:
(a)
The creation of decision packages and their subsequent ranking by top
management is very time consuming and costly. The charity will need to assess
whether the benefits of the system outweigh the costs involved.
September 2010
5
P1
(b)
(c)
P1
The ranking process is inherently difficult as value judgements are inevitable. In
an organisation like a charity, the decision packages are very disparate and
difficult to compare.
In applying ZBB, ‘activities’ may continue to be identified with traditional
functional departments rather than cross functional activities and thus distract
attention from the real cost-reduction issues.
6
September 2010
(e)
(i)
Number of batches
Product Q
80,000/5,000 = 16
Product R
120,000/4,000 = 30
4
2
64
60
Machine set ups
per batch
Total number of set
ups
Budgeted cost of
set ups
Budgeted cost per
set up
Total
124
$74,400
$74,400/124 = $600
Budgeted cost per unit of product Q:
Total number of set ups = 64
Total budgeted set up costs = 64 x $600 = $38,400
Budgeted set up costs per unit = $38,400/80,000 units = $0.48 per unit
(ii)
Examiner’s note: the question asks for two benefits. Examples of points that would
be rewarded are given below.
(a)
Activity based budgeting provides a clear framework for understanding the link between
costs and the level of activity.
(b)
Activity based budgeting allows the ranking of activities and the determination of how
limited resources should be allocated across competing activities.
(c)
Activity based budgeting is useful for the review of capacity utilisation. If it is known that
the resources devoted to a particular activity are above those currently required then
these resources can be reduced or redeployed.
(d)
Activity based budgeting allows the identification of value added and non-value added
activities and ensures that any budget cuts are made to non-value added activities.
September 2010
7
P1
(f)
Decision tree: advertise programme or not
No Increase
35%
40 students
$100,000
$21,000
Poor
60%
Increase
65%
Advertise
No Increase
75%
Good
40%
Increase
25%
Don’t
Advertise
Poor
60%
50 students
$150,000
$58,500
20 students
$0
$0
25 students
$25,000
$2,500
$82,000
Good
40%
40 students
$115,000
$69,000
20 students
$15,000
$6,000
$75,000
Therefore the programme should be advertised.
P1
8
September 2010
SECTION C
Answer to Question Three
(a)
Reconciliation Statement for July
$
56,000
16,000
8,000
48,000
7,300
14,000
5,080
13,200
0
6,600
4,000
10,000
85,580
Budgeted gross profit
Sales price variance
Sales volume profit variance
Budgeted gross profit from actual sales
Material price variance
Material usage variance
Labour rate variance
Labour efficiency variance
Variable overhead expenditure variance
Variable overhead efficiency variance
Fixed overhead expenditure variance
Fixed overhead volume variance
Actual gross profit
A
F
A
F
F
F
F
A
F
Workings
Budgeted sales
Budgeted cost of sales
Budgeted profit
$350,000
$294,000
$56,000 (or (1,400 x ($250 - $210))
Sales price variance = ($250 - $240) x 1,600 = $16,000 A
Sales volume profit variance = (1,600 – 1,400) x ($250 - $210) = $8,000 F
Material price variance = (7,300 x $20) - $153,300 = $7,300A
Material usage variance = ((1,600 x 5) - 7,300) x $20 = $14,000 F
Labour rate variance = 5,080 x ($10 - $9) = $5,080 F
Labour efficiency variance = (1600 x 4) – 5,080)) x $10 = $13,200 F
Variable overhead expenditure variance = (5,080 x $5) - $25,400 = 0
Variable overhead efficiency variance = ((1,600 x 4) – 5,080) x $5 = $6,600 F
Fixed overhead expenditure variance = $70,000 - $74,000 = $4,000A
Fixed overhead volume variance = ((1,600 – 1,400) x $50) = $10,000F
$
384,000
(153,300)
(45,720)
(25,400)
(74,000)
85,580
Actual sales revenue
Material cost
Labour cost
Variable overhead
Fixed overhead
Actual gross profit
September 2010
9
P1
(b)
Total material cost variance:
Budgeted material cost
Actual material cost
Material cost variance
(890 x 5kg) x $20 =
4,375kg x $21.60 =
$89,000
$94,500
$ 5,500 A
This can be analysed into planning and operational variances as follows:
Planning variance
Material price variance ((890 x 5kg) x ($20 - $20.90))
$4,005 A
Operational variances
Material price variance (4,375kg x ($20.90 – $21.60))
Material usage variance ((890 x 5kg) – 4,375) x $20.90
$3,062.50 A
$1,567.50 F
$5,500.00 A
(c)
The advantages of a standard costing system that uses planning and operational variances
are:
P1
•
The use of planning and operational variances enables management to draw a
distinction between variances caused by factors extraneous to the business and
planning errors (planning variances) and variances caused by factors that are within
the control of management (operational variances).
•
Less time is spent on investigating variances that are uncontrollable and the demotivational effect of staff being held responsible for factors that they cannot
influence is avoided.
•
Operational managers’ performance can be compared with the adjusted standards
that reflect the conditions the manager actually operated under during the reporting
period. If planning and operational variances are not distinguished, there is potential
for dysfunctional behaviour especially where the manager has been operating
efficiently and effectively and is being judged by factors he cannot control.
•
The use of planning variances allows management to assess how effective the
company’s planning process has been. Where a revision of standards is required due
to environmental changes that were not foreseeable at the time the budget was
prepared, the planning variances are uncontrollable. However standards that failed to
anticipate known market trends when they were set will reflect faulty standard setting.
It could be argued that some of the planning variances due to poor standard setting
are in fact controllable at the planning stage.
10
September 2010
Answer to Question Four
(a)
Without gymnasium and spa:
Number of available room nights per annum
Occupancy rate
Occupied room nights per annum
Average room rate
Total revenue
= (40 x 360) = 14,400
= 80%
= 11,520
= $250
= $2,880,000
With gymnasium and spa:
Occupied room nights (14,400 x 82%)
Average room rate
Total Revenue
= 11,808
= $262.50
= $3,099,600
Incremental Revenue
Incremental Costs:
= $219,600
Employees (4 x $30,000)
Overheads
= ($120,000)
= ($42,000)
Incremental cash flows in Year 1
= $57,600
Cash Flows
Taxation
Net cash flows
Tax
Depreciation
Taxable profit
Taxation @ 30%
Year 1
$
57,600
37,500
Year 2
$
59,904
28,125
Year 3
$
62,300
21,094
Year 4
$
64,792
48,281
20,100
6,030
31,779
9,534
41,206
12,362
16,511
4,953
Year 1
$
150,000
Year 2
$
112,500
Year 3
$
84,375
37,500
28,125
21,094
Year 4
$
63,281
(15,000)
48,281
Tax Depreciation
Tax WDV
Residual value
Tax
Depreciation
September 2010
11
P1
Net present value
Net cash
flows
Residual
value
Tax
payment
Tax
payment
Net cash
flow after
tax
Discount
factor
Present
value
Year 0
$
(150,000)
Year 1
$
57,600
Year 2
$
59,904
Year 3
$
62,300
Year 4
$
64,792
Year 5
$
15,000
(3,015)
(4,767)
(6,181)
(2,476)
(3,015)
(4,767)
(6,181)
(2,476)
(150,000)
54,585
52,122
51,352
71,135
(2,476)
1.000
0.893
0.797
0.712
0.636
0.567
(150,000)
48,744
41,541
36,563
45,242
(1,404)
Net present value = $20,686
(b)
The post tax money cost of capital at which the hotel will be indifferent between
accepting / rejecting the project is where the net present value is equal to zero i.e.
the IRR of the project.
If cash flows are discounted at 20%
Net cash
flow after
tax
Discount
factor
Present
value
Year 0
$
(150,000)
Year 1
$
54,585
Year 2
$
52,122
Year 3
$
51,352
Year 4
$
71,135
Year 5
$
(2,476)
1.000
0.833
0.694
0.579
0.482
0.402
(150,000)
45,469
36,173
29,732
34,287
(995)
Net present value = -$5,334
By interpolation
12% + 8% (20,686/(20,686+5,334)) = 18.36%
(c)
An alternative approach would be to express the cash flows in today’s value terms
and to discount the cash flows at the real cost of capital.
The post tax money cost of capital is 12% and inflation is 4%. The real cost of
capital can be calculated as:
P1
12
September 2010
In this case :
1.12 / 1.04 = 1.0769 -1 = 7.69%
The cash flows would be discounted at 7.69%.
There are problem however in taking this approach when there are taxation
implications. If there are any tax implications the tax cash flows would need to be
treated separately. Capital allowances are based on original cost, rather than on
replacement cost and do not change in line with changing prices. Similarly the
residual value of the equipment is stated at Year 4 values and would need to be
adjusted to present day values.
September 2010
13
P1
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
examines candidates’ ability to calculate the effective rate of interest of accepting a
cash discount and paying an invoice early. It also examines the ability to identify other
methods that a supplier could use to reduce the level of outstanding trade receivables.
(b)
examines candidates’ ability to apply the EOQ formula and to calculate the cost of
holding and ordering the suggested level of stock. The question then requires
candidates to consider whether it is worth accepting a bulk quantity discount for
ordering stock above the EOQ.
(c)
examines candidates’ ability to explain the benefits of using backflush accounting
compared to a traditional cost accounting system in a company that operates just in
time production and purchasing.
(d)
examines candidates’ ability to identify and explain the advantages and disadvantages
of zero based budgeting.
(e)
examines candidates’ ability to apply activity based budgeting to a service department.
(f)
examines candidates’ ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.
Section C – Questions Three and Four - Compulsory
Question Three examines candidates’ ability to calculate variances including both planning
and operational variances and, using these variances, to prepare a statement reconciling the
budget gross profit to the actual gross profit. The advantages of identifying both planning and
operational variances are also examined.
Question Four, in part (a) examines candidates’ ability to calculate the net present value of a
project involving the identification of relevant costs and calculation of the effect of inflation and
taxation. Part (b) of the question examines candidates’ ability to calculate the IRR of a project.
Part (c) examines the candidates understanding of the treatment of inflation in investment
appraisal.
P1
14
September 2010
Performance Pillar
24 November 2010 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2010
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
Invoice discounting is:
A
Reducing or discounting the amount owed by a customer in order to ensure payment.
B
Writing off a debt because the customer is not expected to pay.
C
Selling invoices to a finance company that then collects the cash from the customer.
D
Selling invoices to a finance company for less than their face value while continuing to
collect the cash from the customer.
(2 marks)
Performance Operations
2
November 2010
1.2
A project with a five year life requires an initial investment of $120,000 and generates a
net present value (NPV) of $50,000 at a discount rate of 10% per annum.
The project cash flows are as follows.
$000 per annum
30
10
5
Variable material cost
Variable labour cost
Incremental fixed cost
The costs and activity levels are expected to remain the same for each year of the
project.
Ignore taxation and inflation.
The sensitivity of the investment decision to changes in the variable costs is:
A
131.9%
B
44.0%
C
33.0%
D
29.3%
(2 marks)
1.3
The data in the table below has been extracted from a company’s cost accounting
records. It shows the total costs and the inflation index for the periods in which the
costs were incurred. Cost behaviour patterns are the same in both periods.
Output level
6,000 units
8,000 units
Total cost
$10,500
$13,390
Inflation index
1.05
1.03
The variable cost per unit, to the nearest $0.01, at an inflation index of 1.06 is:
A
$1.45
B
$1.59
C
$1.53
D
$1.50
(2 marks)
Section A continues on the next page
TURN OVER
November 2010
3
Performance Operations
The following data are given for sub-questions 1.4 and 1.5 below
The budgeted selling price of one of C’s range of chocolate bars was $6.00 per bar. At the
beginning of the budget period market prices of cocoa increased significantly and C decided
to increase the selling price of the chocolate bar by 10% for the whole period. C also decided
to increase the amount spent on marketing and as a result actual sales volumes increased to
15,750 bars which was 5% above the budgeted volume. The standard contribution per bar
was $2.00 however a contribution of $2.25 per bar was actually achieved.
1.4
The sales price variance for the period was:
A
$9,450 A
B
$9,450 F
C
$9,000 A
D
$9,000 F
(2 marks)
1.5
The sales volume contribution variance for the period was:
A
$1,500.00 F
B
$3,937.50 F
C
$3,750.00 F
D
$1,687.50 F
(2 marks)
1.6
H has a budgeted production for the next budget year of 12,000 units spread evenly
over the year. It expects the same production level to continue for the next two years.
Each unit uses 4kg of material.
The estimated opening raw material inventory at the start of the next budget year is
3,000kg. H’s future policy will be to hold sufficient raw material inventory at the end of
each month to cover 110% of the following month’s production.
The budgeted material cost is $8 per kg for purchases up to 49,000kg. The excess of
purchases over 49,000kg in a year will be at a cost of $7.50 per kg.
Calculate the material purchases budget for the year in $.
(3 marks)
1.7
An unquoted bond has a coupon rate of 6% per annum and will repay its face value of
$100 on its maturity in 4 years’ time. The yield to maturity on similar bonds is estimated
to be 3% per annum. The annual interest has just been paid for the current year.
Calculate the current expected market value of the bond.
(3 marks)
Performance Operations
4
November 2010
1.8
A company has to choose between three mutually exclusive projects. Market research
has shown that customers could react to the projects in three different ways depending
on their preferences. There is a 30% chance that customers will exhibit preferences 1,
a 20% chance they will exhibit preferences 2 and a 50% chance they will exhibit
preferences 3. The company uses expected value to make this type of decision.
The net present value of each of the possible outcomes is as follows:
Probability
Project A
Project B
Project C
$000
$000
$000
Preferences 1
0.3
400
800
500
Preferences 2
0.2
500
300
600
Preferences 3
0.5
700
200
400
A market research company believes it can provide perfect information about the
preferences of customers in this market.
Calculate the maximum amount that should be paid for the information from the market
research company.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be
submitted for marking.
End of Section A
Section B begins on page 6
TURN OVER
November 2010
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
Explain the stages in the budget setting process for a company that uses a zero-based
budgeting system.
(5 marks)
(b)
AP sells fruit in a market where the level of demand is uncertain. AP has to order the
fruit before the demand level is known.
The payoff table below shows the profits AP can expect depending on the level of order
that is placed and the level of demand that occurs.
Demand level
Level of order
High
Medium
Low
Good
$600
$300
$100
Average
$200
$400
$100
Poor
$(100)
$300
$200
Required:
(i) Identify which order level would be selected if AP applied:
a. the maximin decision criterion
b. the maximax decision criterion
(2 marks)
(ii) Identify, using a minimax regret table, the order level that would be selected if AP
applied the minimax regret decision criterion.
(3 marks)
(Total for sub-question (b) = 5 marks)
Performance Operations
6
November 2010
(c)
“Decision rules based on expected values assume that the decision maker is risk
neutral”.
Required:
(i)
Explain the above statement.
(2 marks)
(ii)
Describe TWO other attitudes to risk.
(3 marks)
(Total for sub-question (c) = 5 marks)
(d)
RX has a balance outstanding on its trade receivables account at the start of the year
of $83,000 after allowing for bad debts. RX forecasts sales revenue for the next year of
$492,750. All sales are on credit.
Based on past experience, RX anticipates that bad debts will represent 5% of sales for
the year. Trade receivable days at the end of the year are expected to be 60 days.
Required:
(i)
Calculate the expected receipts from customers during the year.
(3 marks)
(ii)
Describe TWO methods that RX could use to reduce the possibility of bad debts
occurring.
(2 marks)
(Total for sub-question (d) = 5 marks)
(e) A company has forecast that it will have surplus funds to invest for a 12 month period. It
is considering two investments as follows:
Investment 1
Invest in a bank deposit account that has a variable rate of interest. The current rate of
interest on the account is 1.1% per quarter.
Investment 2
Buy a 12 month fixed dated government bond. The bond has a coupon rate of 2.5%
payable every six months.
Required:
Explain the advantages AND disadvantages to the company of each of the
investments.
You should consider the return offered and the level and type of risk involved with each
investment.
You should assume that there are no other investments available and that these
investments are only available now.
(5 marks)
TURN OVER
November 2010
7
Performance Operations
(f)
An extract from WCC’s trial balance at the end of its financial year is given below:
$000
1,400
1,215
915
Sales revenue (80% on credit)
Cost of sales
Purchases of materials (95% on credit)
Inventories at end of year
Raw materials
Finished goods
Trade receivables
Trade payables
85
90
185
125
Required:
Calculate the length of WCC’s working capital cycle to the nearest 0.1 of a day.
(5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C begins on page 10
Performance Operations
8
November 2010
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A healthcare company specialises in hip, knee and shoulder replacement operations, known
as surgical procedures. As well as providing these surgical procedures the company offers
pre operation and post operation in-patient care, in a fully equipped hospital, for those
patients who will be undergoing the surgical procedures.
Surgeons are paid a fixed fee for each surgical procedure they perform and an additional
amount for any follow-up consultations. Post procedure follow-up consultations are only
undertaken if there are any complications in relation to the surgical procedure. There is no
additional fee charged to patients for any follow up consultations. All other staff are paid
annual salaries.
The company’s existing costing system uses a single overhead rate, based on revenue, to
charge the costs of support activities to the procedures. Concern has been raised about the
inaccuracy of procedure costs and the company’s accountant has initiated a project to
implement an activity-based costing (ABC) system.
The project team has collected the following data on each of the procedures.
Procedure Information
Fee charged to patients per procedure
Number of procedures per annum
Average time per procedure
Number of procedures per theatre session
In-patient days per procedure
Surgeon’s fee per procedure
% of procedures with complications
Surgeon’s fee per follow up consultation
Cost of medical supplies per procedure
Hip
Knee
Shoulder
$8,000
600
2.0 hours
2
3
$1,200
8%
$300
$400
$10,000
800
1.2 hours
1
2
$1,800
5%
$300
$200
$6,000
400
1.5 hours
4
1
$1,500
10%
$300
$300
The project team has obtained the following information about the support activities.
Activity
Cost Driver
Overheads
$000
864
Theatre preparation for each session
Number of theatre preparations
Operating theatre usage
Procedure time
1,449
Nursing and ancillary services
In-patient days
5,428
Administration
Sales revenue
1,216
Other overheads
Number of procedures
Performance Operations
10
923
November 2010
Required:
(a)
Calculate the profit per procedure for each of the three procedures,
using the current basis for charging the costs of support activities to
procedures.
(5 marks)
(b)
Calculate the profit per procedure for each of the three procedures using
activity-based costing.
(13 marks)
(c)
Discuss the ways in which the information obtained by the project team
may be of benefit to the management of the company.
(7 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
November 2010
11
Performance Operations
Question Four
A car manufacturer has been experiencing financial difficulties over the past few years. Sales
have reduced significantly as a result of the worldwide economic recession. Costs have
increased due to quality issues that led to a recall of some models of its cars.
Production volume last year was 50,000 cars and it is expected that this will increase by 4%
per annum each year for the next five years.
The company directors are concerned to improve profitability and are considering two
potential investment projects.
Project 1 – implement a new quality control process
The company has paid a consultant process engineer $50,000 to review the company’s
quality processes. The consultant recommended that the company implement a new quality
control process. The new process will require a machine costing $20,000,000. The machine is
expected to have a useful life of five years and no residual value.
It is estimated that raw material costs will be reduced by $62 per car and that both internal
and external failure costs from quality failures will be reduced by 80%.
Estimated internal and external failure costs per year without the new process, based on last
year’s production volume of 50,000 cars, and their associated probabilities are shown below:
Internal Failure Costs
$
Probability
300,000
50%
500,000
30%
700,000
20%
External Failure Costs
$
Probability
1,300,000
60%
1,900,000
30%
3,000,000
10%
Internal and external failure costs are expected to increase each year in line with the number
of cars produced.
The company’s accountant has calculated that this investment will result in a net present
value (NPV) of $1,338,000 and an internal rate of return of 10.5%.
Project 2 – in-house component manufacturing
The company could invest in new machinery to enable in-house manufacturing of a
component that is currently made by outside suppliers. The new machinery is expected to
cost $15,000,000 and have a useful life of five years and no residual value. Additional working
capital of $1,000,000 will also be required as a result of producing the component in-house.
The price paid to the current supplier is $370 per component. It is estimated that the in-house
variable cost of production will be $260 per component. Each car requires one component.
Fixed production costs, including machinery depreciation, are estimated to increase by
$5,000,000 per annum as a result of manufacturing the component in-house.
Depreciation is calculated on a straight line basis.
Additional Information
The company is unable to raise enough capital to carry out both projects. The company will
therefore have to choose between the two alternatives.
Taxation and inflation should be ignored.
The company uses a cost of capital of 8% per annum.
Performance Operations
12
November 2010
Required:
(a)
Calculate for Project 1 the relevant cash flows that the accountant should
have used for year 1 when appraising the project.
All workings should be shown in $000.
(6 marks)
(b) Calculate for Project 2:
(i)
(ii)
the net present value (NPV)
the internal rate of return (IRR)
All workings should be shown in $000.
(10 marks)
(c)
(d)
Advise the company directors which of the two investment projects should
be undertaken.
(4 marks)
A company is considering two alternative investment projects both of
which have a positive net present value. The projects have been ranked
on the basis of both net present value (NPV) and internal rate of return
(IRR). The result of the ranking is shown below:
NPV
IRR
Project A
st
1
nd
2
Project B
nd
2
st
1
Discuss potential reasons why the conflict between the NPV and IRR
ranking may have arisen.
(5 marks)
Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
November 2010
13
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is D.
1.2
$40,000 x 3.791 = $151,640
$50,000 / $151,640 = 0.3297 = 33.0%
The correct answer is C.
1.3
$10,500 / 1.05 = $10,000
$13,390 / 1.03 = $13,000
Using the high-low method
($13,000 – $10,000) / (8,000 – 6,000) = $ 1.50 per unit
At inflation index of 1.06 = $1.50 x 1.06 = $1.59
The correct answer is B.
1.4
The sales price variance is:
($6.60 – $6.00) x 15,750 = $9,450 Favourable
The correct answer is B.
1.5
The sales volume contribution variance is:
(15,750 – 15,000) x $2.00 = $1,500 Favourable
Budgeted sales were 15,750/1.05 = 15,000 units
The correct answer is A.
November 2010
1
P1
1.6
Materials Usage
12,000 units x 4kg = 48,000kg
Opening inventory = 3,000kg
Closing inventory = 12,000/12 x 4kg x 1.1 = 4,400kg
Material Purchases Budget (kg)
Material usage
Plus closing inventory
Less opening inventory
48,000kg
4,400kg
(3,000)kg
49,400kg
Material Purchases Budget ($)
49,000kg x $8 = $392,000
400kg x $7.50 = $3,000
Total
$395,000
1.7
Yield to maturity of similar bonds is 3%, therefore use 3% as the
discount rate.
Year(s)
Description
1-4
4
Interest
Redemption
0
Market value
Cash flow
$
6
100
Discount Factor
(3%)
3.717
0.888
Present Value
$
22.3
88.8
111.1
The current expected market value of the bond is therefore $111.10
P1
2
November 2010
1.8
Probability
Project A
Project B
Project C
$000
$000
$000
Preferences 1
0.3
400
800
500
Preferences 2
0.2
500
300
600
Preferences 3
0.5
700
200
400
570
400
470
Expected Value
Project A is the best choice (without the benefit of perfect information) as it has the highest
expected value (EV) of the NPV of $570k.
With perfect information:
If market research say preferences 1: select B and earn $800k – probability 0.3
If market research say preferences 2: select C and earn $600k – probability 0.2
If market research say preferences 3: select A and earn $700k – probability 0.5
EV (with perfect information) = ($800k x 0.3) + ($600k x 0.2) + ($700k x 0.5) = $710k
Value of perfect information is $710k – $570k = $140,000
November 2010
3
P1
SECTION B
Answer to Question Two
(a)
There are three main stages in the budget setting process in a zero based budgeting system:
Description of activities in decision packages
The activities that are being proposed are described in a decision package. There will often
be more than one decision package proposed e.g. one based on providing services at a
minimum level and others at incremental levels above the minimum.
Some of these packages will be mutually exclusive and will require management to select the
best solution to the issue involved. For example options for debt collection could be in-house
or outsourced solutions and a decision package will be needed for each.
Evaluation and ranking
Each decision package is evaluated. Its costs are compared to its benefits and net present
values or other measures calculated. The non-financial aspects are also considered as some
packages might have legal obligations attached e.g. updating accounting systems.
Management will rank each package based on the benefits to the organisation. They may
decide to reject packages even though the activity was undertaken last year. In this way the
organisation is said to be starting from a zero base with each package given due
consideration.
Allocation of resources
Once management decide which packages to accept a budget can be prepared for the
resources required. This should include costs, revenues and other resource allocations
necessary.
(b)
(i)
If AP applied the maximin decision criterion it would order at the medium level. The
worst result is a profit of $300 and this is the best “worst result”.
(ii)
If AP applied the maximax decision criterion it would order at the high level, since the
maximum return of $600 is to be gained at this level.
P1
4
November 2010
(iii)
Minimax Regret Table
Demand level
Level of order
High
Medium
Low
Good
0
$300
$500
Average
$200
0
$300
Poor
$400
0
$100
The maximum regret if AP orders at the high level is $400
The maximum regret if AP orders at the medium level is $300
The maximum regret if AP orders at the low level is $500
Therefore if AP wants to minimise the maximum regret it will order at the medium level.
(c)
(i)
Expected values represent a long-run average outcome but decisions should not be
made solely on expected values as they do not take account of the attitude to risk. In
addition to expected value decision makers should consider measures of dispersion
and the probability distribution of the outcomes of the various courses of action. A risk
neutral decision maker will tend to ignore risk and choose the course of action that
gives the highest expected value.
(ii)
A risk seeker is a decision maker that is interested in the best possible outcomes no
matter how unlikely they are to occur. They are not put off with the low probability of an
outcome but choose to focus on potential large returns instead. A risk seeker faced
with a choice between two alternatives with identical expected values will choose the
riskier investment with the highest possible outcome and ignore the downside risk.
These decision makers are often viewed as optimistic.
A risk averse decision maker is one that focuses on the poor results and seeks to
avoid high degrees of risk. A risk averse decision maker, faced with a choice between
two alternatives with identical expected values will choose the less risky alternative.
These decision makers are often viewed as pessimistic.
(d)
(i)
Trade receivable at end of the year = $492,750 / 365 x 60 = $81,000
Bad debts = ($492,750 – $81,000) x 5% = $20,587.50
Cash collected = $83,000 + $492,750 - $81,000 - $20,587.50 = $474,162.50
November 2010
5
P1
(ii)
Examiner’s note: the question asks for two methods. Examples of methods that
would be rewarded are given below.
To reduce the incidence of bad debts RX could:
•
•
•
•
•
Ensure that all new customers have a full credit rating check before the granting of credit.
This can be achieved by the use of credit rating organisations or by the taking of
references from the prospective customer.
Carry out routine credit ratings checks on existing customers, in particular the slow
payers.
Ensure that debt collection procedures are efficient in chasing up late payers.
Charge penalties for late payment or offer discounts to encourage customers to pay early.
Ensure that credit limits are allocated to customers and enforced by the credit control
department. No sales should be allowed if credit limits have been exceeded, effectively
putting the account on “stop” should this happen.
(e)
The returns given are over different time periods. We need to calculate an annual rate to
enable the investments to be compared.
4
The annual return on the deposit account is (1.011) = 1.044731 or 4.47% per annum.
The annual return on the bond is 2.5% x 2 = 5% per annum.
The deposit account has two main types of risk. Firstly, the interest rate could change and this
will introduce variability in the return, although this is likely to reflect market rates. Secondly,
after the world banking crisis in 2008/2009 it is now conceivable for a bank to fail. This
introduces another, albeit small, element of risk in that there is liquidation risk of the bank
itself.
A government bond is generally considered to be risk free. However the bonds are fixed
dated and cannot be cashed in early. Therefore the bonds lack flexibility. Although the return
is fixed, market interest rates may rise with the result that the return on the bond is below
market rates. If they are a tradable item, the bonds could be sold to another investor through
a broker. However this would incur sales costs and expose the company to price movements
which will reflect the change in market interest rates.
The choice of investment will depend on the company’s attitude to risk and whether they
prefer to have a fixed return. The bond currently offers a higher return but may not continue to
do so in the future. It also offers less risk as the return is guaranteed.
P1
6
November 2010
(f)
The number of days for each component of the working capital cycle is as follows:
Component
Calculation
Days
Raw material inventory days
85/915 x 365
33.9
Finished goods inventory days
90/1215 x 365
27.0
Receivable days
185/(0.80 x 1,400) x 365
60.3
Payables days
125/(0.95 x 915) x 365
Working capital cycle
-52.5
68.7
The working capital cycle is therefore 68.7 days.
November 2010
7
P1
SECTION C
Answer to Question Three
(a)
Hip
Knee
Shoulder
$
$
$
Fee charged to
patient
8,000
10,000
6,000
Surgeon’s fee
(1,200)
(1,800)
(1,500)
Fee for follow-up
consultations
(24)
(15)
(30)
Medical supplies
(400)
(200)
(300)
(5,200)
(6,500)
(3,900)
1,176
1,485
270
Overhead cost
Profit per procedure
Follow-up consultations working:
Hip - $300 per consultation x 8% = $24
Knee - $300 per consultation x 5% = $15
Shoulder - $300 per consultation x 10% = $30
Overhead cost workings:
Sales revenue
Hip
Knee
Shoulder
Total
$
$
$
$
$8,000 x 600 =
$4,800,000
$10,000 x 800 =
$8,000,000
$6,000 x 400 =
$2,400,000
Overheads
Overheads /
sales revenue
Cost per
procedure
P1
$15,200,000
$9,880,000
65%
$8,000 x 65%
$5,200
$10,000 x 65%
$6,500
8
$6,000 x 65%
$3,900
November 2010
(b)
Cost Driver
Theatre
preparation for
each session
Number of
theatre
preparations
Operating
theatre usage
Procedure
time
1,449
Nursing and
ancillary
services
Administration
In-patient
days
5,428
Sales
revenue
1,216
Other
overheads
Number of
procedures
Overhead cost per
procedure
Theatre preparation
for each session
Operating theatre
usage
Nursing and ancillary
services
Administration
Other overheads
Total overhead cost
per procedure
Profit per procedure
per (a) above
Add back overhead
cost per (a) above
Less overhead cost
using ABC
Profit per procedure
using ABC
(c)
No. of cost drivers
Overheads
$000
864
Activity
(600/2 + 800/1 + 400/4)
= 1,200
(600 x 2hrs) + (800 x
1.2hrs) + (400 x 1.5hrs)
= 2,760
(600 x 3) + (800 x 2)
+(400 x 1)
= 3,800
15,200,000
923
(600 + 800 + 400)
= 1,800
Cost per driver
$
$720 per theatre
preparation
$525 per hour
$1,428 per day
$0.08
per $ sales
revenue
$513 per
procedure
Hip
Knee
Shoulder
$720/2
= $360
($525 x 2)
= $1,050
($1,428 x 3)
=$4,284
(8,000 x $0.08)
= $640
$720/1
= $720
($525 x 1.2)
=$630
($1,428 x 2)
=$2,856
(10,000 x $0.08)
= $800
$720/4
= $180
($525 x 1.5)
= $788
($1,428 x 1)
=$1,428
(6,000 x$ 0.08)
= $480
$513
$513
$513
$6,847
$5,519
$3,389
Hip
Knee
Shoulder
$
$
$
1,176
1,485
270
5,200
6,500
3,900
(6,847)
(5,519)
(3,389)
(471)
2,466
781
Under an activity based costing (ABC) system the various support activities that are
involved in the process of making products or providing services are identified. The
cost drivers that cause a change to the cost of these activities are also identified and
used as the basis to attach activity costs to a particular product or service. Through the
tracing of costs to product in this way ABC establishes more accurate costs for the
product or service.
November 2010
9
P1
The identification of cost drivers provides information to management to enable them to take
actions to improve the overall profitability of the company. Cost driver analysis will provide
information to management on how costs can be controlled and managed. Variance analysis
will be more useful as it is based on more accurate costs. The establishment of more
accurate procedure costs should also help hospital managers to assess procedure profitability
and make better decisions concerning pricing and procedure mix decisions.
In the above example, the use of an ABC system has resulted in different levels of profit for
each of the procedures. It is apparent that the knee replacement procedure and the shoulder
replacement procedure are more profitable than was thought under the absorption costing
system. The shoulder replacement procedure however is making a significantly lower margin
that the knee replacement procedure. The hip replacement procedure is now shown to be
loss making. This additional information will enable management to make important decisions
regarding pricing of the procedures. The price of the knee replacement procedure could
potentially be reduced to make it more competitive and increase volumes. The price of both
the hip replacement and shoulder replacement procedures could be increased to make these
procedures more profitable. Before making any decision regarding pricing however they
would need to review market prices and consider the effect any adjustment would have on the
company’s market position. If market conditions would not allow an increase in price of both
hip and shoulder replacement procedures they could look at ways to reduce the costs of
these procedures. ABC gives more detailed information about how costs are incurred and the
potential for cost reduction by reducing activity levels. Alternatively they may want to consider
whether to discontinue the hip replacement procedures altogether and replace them with a
more profitable use of resources. This decision may not be appropriate however if part of the
marketing strategy is for the company to provide a range of complementary procedures.
An activity based costing system can be extended beyond product and service costing to a
range of cost management applications known as activity based management. These include
the identification of value added and non value added activities and performance
management in terms of measuring efficiency through cost driver rates.
P1
10
November 2010
Answer to Question Four
(a)
Project 1
Internal Failure Cost Savings:
Current Expected Value ($300k x 0.5) + ($500k x 0.3) + ($700k x 0.2) = $440k
Expected Savings Year 1 = $440k x 80% x 1.04 =$366k
External Failure Cost Savings:
Current Expected Value ($1,300k x 0.6) + ($1,900k x 0.3) + ($3,000k x 0.1) = $1,650k
Expected Savings Year 1 = $1,650k x 80% x 1.04 = $1,373k
Raw Material Cost:
Expected savings Year 1 = 50,000 x $62 x 1.04 =$3,224k
Net cash flows Year 1
$366,080 + $1,372,800 + $3,224,000 = $4,963k
(b)
Project 2
(i)
Component Costs:
Expected savings Year 1 = 50,000 x $110 x 1.04 =$5,720k
Depreciation per annum = $15,000,000 / 5 = $3,000k
Additional fixed costs (excluding depreciation) per annum = $5,000k - $3,000k $2,000k
Net Present Value
Year 0
$000
Initial
(15,000)
Investment
Working
(1,000)
capital
Cost
savings
Fixed costs
Net cash
flows
Discount
Factor @
8%
Present
value
Year 1
$000
Year 2
$000
Year 3
$000
Year 4
$000
Year 5
$000
1,000
5,720
5,949
6,187
6,434
6,691
(2,000)
(2,000)
(2,000)
(2,000)
(2,000)
(16,000)
3,720
3,949
4,187
4,434
5,691
1.000
0.926
0.857
0.794
0.735
0.681
(16,000)
3,445
3,384
3,324
3,259
3,876
Net present value = $1,288k
November 2010
11
P1
(ii)
Net cash
flows
Discount
Factor @
12%
Present
value
Year 0
$000
(16,000)
Year 1
$000
3,720
Year 2
$000
3,949
Year 3
$000
4,187
Year 4
$000
4,434
Year 5
$000
5,691
1.000
0.893
0.797
0.712
0.636
0.567
(16,000)
3,322
3,147
2,981
2,820
3,227
Net present value = - $503k
IRR
NPV at 8% = $1,288k
NPV at 12% = -$503k
By interpolation
8% + (1,288/(1,288 + 503)) x 4% =10.9%
(c)
The general rule in discount cash flow analysis where projects are mutually exclusive is that
the project with the highest net present value should be selected. In this case project 1 has a
NPV of $1,338K and project 2 has a NPV of $1,288K. Therefore on the basis on NPV alone
project 1 should be selected.
Project 2 requires an investment of $16m while project 1 requires an investment of $20m.
While project 2 has a marginally lower NPV than alternative 1, if the additional $4m of funds
can be invested in other projects with NPVs in excess of this difference, it would be
worthwhile investing in project 2.
The company directors will also have to consider the risk of the two projects and other nonfinancial factors.
(d)
The IRR measures the project return as a percentage whereas NPV measures the absolute
amount. This can result in a problem if the IRR is used to select projects where the projects
are mutually exclusive. Decisions based on IRR may result in the selection of a project with a
lower investment and a higher return, when it may be preferable to invest a greater sum
which generates a lower percentage return but produces a greater absolute amount. Where
projects are mutually exclusive NPV should be used to select projects.
Even if mutually exclusive projects have the same initial investment, NPV and IRR can give
conflicting results due to the assumption regarding the reinvestment of surplus cash flows
generated by an investment. The assumption if the NPV method is adopted is that the cash
flows generated by an investment will be reinvested at the cost of capital. The IRR method
assumes that cash flows generated by the investment will be reinvested at the IRR of the
original project. IRR may favour an investment with high early cash flows, reinvested at the
IRR, while NPV may prefer a different project with later cash flows. The NPV ranking of the
projects depends on the discount rates used. When the discount rate exceeds a certain level
the choice of projects will change and the conflict will no longer exist.
P1
12
November 2010
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
The question assesses learning outcome B3(b) apply alternative approaches to
budgeting. It examines the candidates’ ability to explain the different stages in a budget
setting process for a company that uses zero based budgeting.
(b)
The question assesses learning outcome D1(a) analyse the impact of uncertainty and
risk on decision models that may be based on relevant cash flows, learning curves,
discounting techniques etc. It examines candidates’ ability to apply various decision
making criterion to a particular decision.
(c)
The question assesses learning outcome D1(a) analyse the impact of uncertainty and
risk on decision models that may be based on relevant cash flows, learning curves,
discounting techniques etc. It examines candidates’ ability to explain the effect that a
decision maker’s attitude to risk will have on the chosen decision.
(d)
The question assesses learning outcome E1(e) analyse trade debtor and creditor
information. Part (i) of the question examines candidates’ ability to calculate expected
cash receipts from credit customers given information relating to bad debts and trade
receivable days. Part (ii) of the question examines candidates’ ability to describe
methods that a company could use to reduce the occurrence of bad debts.
(e)
The question assesses learning outcome E2(b) identify alternatives for investment of
short-term cash surpluses. It examines candidates’ ability to compare two potential
short term Investment opportunities and explain the advantages and disadvantages of
each.
(f)
The question assesses learning outcome E1(b) interpret working capital ratios for
business sectors. It examines candidates’ ability to calculate working capital ratios and
the working capital cycle.
Section C – Questions Three and Four - Compulsory
Question Three Part (a) of the question assesses learning outcome A1(a) compare and
contrast marginal (or variable), throughput and absorption accounting methods in respect of
profit reporting and stock valuation. It examines candidates’ ability to calculate the cost of a
service using a traditional method of overhead absorption. Part (b) assesses learning
outcome A1(c) discuss activity-based costing as compared with traditional marginal and
absorption costing methods, including its relative advantages and disadvantages as a system
of cost accounting. It requires candidates to be able to apply activity based costing to the
calculation of a service costs. Part (c) assesses learning outcome A1(c) discuss activitybased costing as compared with traditional marginal and absorption costing methods,
including its relative advantages and disadvantages as a system of cost accounting. It
November 2010
13
P1
examines candidates’ ability to explain the potential benefits of the information for
management decision making.
Question Four Parts (a) and (b) of the question assess learning outcomes C1(a) explain the
processes involved in making long-term decisions and C2(a) evaluate project proposals using
the techniques of investment appraisal. They examine candidates’ ability to identify relevant
costs and calculate the net present value and IRR of a project. Part (c) of the question
assesses learning outcome C2(a) evaluate project proposals using the techniques of
investment appraisal. It examines candidates’ ability to evaluate two investment projects
based on their NPV and IRR. Part d) of the question assesses learning outcome C2(c)
prioritise projects that are mutually exclusive, involve unequal lives and/or are subject to
capital rationing. It requires candidates to discuss the reasons why conflicts arise between the
ranking of projects based on their IRR and NPV.
P1
14
November 2010
Performance Pillar
Tuesday 1 March 2011
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 6.
Section B comprises 6 sub-questions and is on pages 8 to 10.
Section C comprises 2 questions and is on pages 12 to 15.
Maths tables and formulae are provided on pages 17 to 20.
The list of verbs as published in the syllabus is given for reference on page
23.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2011
SECTION A – 20 MARKS
[Note: The indicative time for answering this section is 36 minutes]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
A documentary credit is
A
A negotiable instrument, drawn by one party on another, who by signing the
document acknowledges the debt, which may be payable immediately or at some
future date.
B
A document issued by a bank on behalf of a customer authorising a person to draw
money to a specified amount from its branches or correspondents, usually in another
country, when the conditions set out in the document have been met.
C
A series of promissory notes, guaranteed by a highly rated international bank, and
purchased at a discount to face value by an exporter’s bank.
D
A form of export finance where the debt is sold to a factor, at a discount, in return for
prompt cash.
(2 marks)
Performance Operations
2
March 2011
1.2
A company is deciding which of four potential selling prices it should charge for a new
product. Market conditions are uncertain and demand may be good, average or poor.
The company has calculated the contribution that would be earned for each of the
possible outcomes and has produced a regret matrix as follows.
Regret Matrix
Demand level
Selling price
$140
$160
$180
$200
Good
$20,000
$60,000
$0
$10,000
Average
$50,000
$0
$40,000
$20,000
Poor
$0
$30,000
$20,000
$30,000
If the company applies the minimax regret criterion to make decisions, which selling
price would be chosen?
A
$140
B
$160
C
$180
D
$200
(2 marks)
Section A continues on the next page
TURN OVER
March 2011
3
Performance Operations
The following data are given for sub-questions 1.3 and 1.4 below
A company operates a standard absorption costing system. Details of budgeted and actual
figures for February are given below:
Budget
29,000
3.0
$10.00
Production (units)
Direct labour hours per unit
Direct labour cost per hour
1.3
The labour rate variance for the period was:
A
$34,800 A
B
$34,800 F
C
$29,120 A
D
$31,200 A
Actual
26,000
2.8
$10.40
(2 marks)
1.4
The labour efficiency variance for the period was:
A
$58,000 F
B
$60,320 F
C
$52,000 F
D
$54,080 F
(2 marks)
1.5
A company is deciding whether to launch a new product. The initial investment required
is $40,000. The estimated annual cash flows and their associated probabilities are
shown in the table below.
High
Medium
Low
Probability
0.20
0.50
0.30
Year 1
$20,000
$14,000
$9,000
Year 2
$24,000
$16,000
$12,000
Year 3
$18,000
$15,000
$10,000
The company’s cost of capital is 10% per annum. You should assume that all cash
flows other than the initial investment occur at the end of the year.
The expected present value of the year 1 cash flows is
A
$12,453
B
$(27,547)
C
$15,070
D
$13,700
(2 marks)
Performance Operations
4
March 2011
1.6
JB has budgeted production for the next budget year of 36,000 units. Each unit of
production requires 4 labour hours and the budgeted labour rate is $12 per hour
excluding overtime.
Idle time is expected to be 10% of total hours available i.e. including idle time. Due to
labour shortages it is expected that 20% of the hours paid, including idle time, will be
paid at an overtime rate of time and a half.
Required:
Calculate the labour cost budget for the year.
(3 marks)
1.7
An extract from a company’s trial balance at the end of its financial year is given below:
$000
2,600
1,800
1,650
220
350
260
Sales revenue (85% on credit)
Cost of sales
Purchases (90% on credit)
Inventory of finished goods
Trade receivables
Trade payables
Required:
Calculate the following working capital ratios:
(i)
(ii)
(iii)
Inventory days
Trade receivables days
Trade payables days
(3 marks)
Section A continues on the next page
TURN OVER
March 2011
5
Performance Operations
1.8
A company is preparing its annual budget and is estimating the number of units of
Product A that it will sell in each quarter of Year 2. Past experience has shown that the
trend for sales of the product is represented by the following relationship:
y = a + bx where
y = number of sales units in the quarter
a = 10,000 units
b = 3,000 units
x = the quarter number where 1 = quarter 1 of Year 1
Actual sales of Product A in Year 1 were affected by seasonal variations and were as
follows:
Quarter 1:
Quarter 2:
Quarter 3:
Quarter 4:
14,000 units
18,000 units
18,000 units
20,000 units
Required:
Calculate the expected sales of Product A (in units) for each quarter of Year 2, after
adjusting for seasonal variations using the additive model.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be
submitted for marking.
End of Section A
Section B begins on page 8
Performance Operations
6
March 2011
SECTION B – 30 MARKS
[Note: The indicative time for answering this section is 54 minutes]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
‘A zero-based budgeting system involves establishing decision packages that are then
ranked in order of their relative importance in meeting the organisation’s objectives’.
Required:
Explain the above statement and the difficulties that a not-for-profit organisation may
experience when trying to rank decision packages.
(5 marks)
(b)
A company has to decide which of three new mutually exclusive products to launch.
The directors believe that demand for the products will vary depending on competitor
reaction. There is a 30% chance that competitor reaction will be strong, a 20% chance
that competitor reaction will be normal and a 50% chance that competitor reaction will
be weak. The company uses expected value to make this type of decision.
The net present value for each of the possible outcomes is as follows:
Competitor
reaction
Product A
Product B
Product C
$000s
$000s
$000s
Strong
200
400
600
Normal
300
600
400
Weak
500
800
500
A market research company believes it can provide perfect information on potential
competitor reaction in this market.
Required:
Calculate the maximum amount that should be paid for the information from the market
research company.
(5 marks)
Performance Operations
8
March 2011
(c)
A company uses a third party delivery service to deliver goods to customers. The
current average cost per delivery is $12.50. The company is trying to decide whether to
establish an in-house delivery service. A number of factors could affect the average
total cost per delivery for the in-house delivery service. The table below shows the
possible average total costs and the probability of each one occurring:
Average total cost
$10.50
$10.70
$11.00
$12.10
$12.50
$12.60
$14.20
$15.60
$15.80
Probability
0.05
0.10
0.08
0.12
0.14
0.16
0.12
0.18
0.05
The expected value of the average total cost, based on the probability distribution
above, is $13.
Required:
Explain the decision that the company manager is likely to make, based on the
probability distribution and the current delivery cost of $12.50 per delivery, if the
manager is:
(i)
(ii)
(iii)
Risk neutral
Risk averse
Risk seeking
(5 marks)
(d)
A company is considering the use of without recourse factoring to manage its trade
receivables. It currently has a balance outstanding on trade receivables of $180,000
and annual sales revenue of $1,095,000. It anticipates that this level of sales revenue
and trade receivables will continue for at least the next year. It estimates that the use of
the factoring company will result in a reduction in credit control costs of $20,000 per
annum.
The factoring company will charge a fee of 2.5% of invoiced sales. It will give an
advance of 90% of invoiced sales and charge interest at a rate of 12% per annum.
Required:
(i)
Calculate the annual cost of factoring net of credit control cost savings.
(3 marks)
The company currently finances its accounts receivables with a bank overdraft at an
interest rate of 15% per annum.
(ii)
Calculate whether there is a financial benefit from using the factor. You should
ignore bad debts.
(2 marks)
(Total for sub-question (d) =5 marks)
TURN OVER
March 2011
9
Performance Operations
(e)
A company has surplus funds to invest for a period of 3 months. It is considering
potential investment opportunities as follows:
Investment 1
Purchase treasury bills issued by the country’s central bank. The treasury bills can be
purchased now for a period of 91 days. The purchase price is $995 per $1,000.
Investment 2
Invest in a 30 day notice bank deposit account. The account will pay a variable rate of
interest of 2.5% per annum, payable quarterly.
Required:
Explain the advantages AND disadvantages to the company of each of the
investments.
Your answer should include relevant calculations.
(5 marks)
(f)
A bond has a coupon rate of 8% and will repay its nominal value of $100 when it
matures in 6 years’ time.
The bond’s yield to maturity is 6.58%.
Required:
Explain why there may be a difference between a bond’s coupon rate and its
yield to maturity.
(5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C begins on page 12
Performance Operations
10
March 2011
SECTION C – 50 MARKS
[Note: The indicative time for answering this section is 90 minutes]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A company sells and services photocopying machines. Its sales department sells the
machines and consumables, including ink and paper, and its service department provides an
after sales service to its customers. The after sales service includes planned maintenance of
the machine and repairs in the event of a machine breakdown. Service department customers
are charged an amount per copy that differs depending on the size of the machine.
The company’s existing costing system uses a single overhead rate, based on total sales
revenue from copy charges, to charge the cost of the Service Department’s support activities
to each size of machine. The Service Manager has suggested that the copy charge should
more accurately reflect the costs involved. The company’s accountant has decided to
implement an activity-based costing system and has obtained the following information about
the support activities of the service department:
Activity
Overheads
per annum
$000
126
Cost Driver
Customer account
handling
Planned maintenance
scheduling
Unplanned maintenance
scheduling
Spare part procurement
Number of customers
Other overheads
Number of planned maintenance visits
480
Number of unplanned maintenance visits
147
Number of purchase orders
243
Number of machines
600
Total overheads
1,596
The following data have also been collected for each machine size:
Small
photocopiers
Medium
photocopiers
Large
photocopiers
$0.03
60,000
$0.04
120,000
$0.05
180,000
300
4
800
6
500
12
1
1
2
500
$100
$60
1,200
$300
$80
1,000
$400
$100
Charge per copy
Average number of copies per year per
machine
Number of machines
Planned maintenance visits per machine
per year
Unplanned maintenance visits per machine
per year
Total number of purchase orders per year
Cost of parts per maintenance visit
Labour cost per maintenance visit
Each customer has a service contract for two machines on average.
Performance Operations
12
March 2011
Required:
(a)
Calculate the annual profit per machine for each of the three sizes of
machine, using the current basis for charging the costs of support
activities to machines.
(4 marks)
(b)
Calculate the annual profit per machine for each of the three sizes of
machine using activity-based costing.
(14 marks)
(c)
Explain the potential benefits to the company of using an activity-based
costing system.
(7 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
March 2011
13
Performance Operations
Question Four
A bus operator has been experiencing a fall in passenger numbers over the past few years as
a result of intense competition from other transport providers. The company directors are
concerned to improve profit and are considering two possible alternatives.
Passenger volume last year was 20,000 passengers per day. The average fare was $2 per
passenger per day and variable costs per passenger per day were $0.50. If no investment is
made the current passenger volume, average fares and variable costs will remain the same
on current routes for the next five years. The company operates a full service for 365 days of
the year.
Project 1
The company hired a management consultant, at a cost of $50,000, to review the company’s
fare structure. The consultant recommended that the company reduce fares by 10% which
will result in a 20% increase in passenger volume in the first year. In order to maintain this
level of passenger numbers, fares will remain at the reduced rate for years 2 to 5.
The increase in passenger numbers will result in the need for four new buses costing
$250,000 each. The new buses will be depreciated on a straight line basis over their useful
life of 5 years. They will have no residual value at the end of their useful life. Other annual
fixed costs, including advertising costs, will increase by $100,000 in the first year and will
remain at that level for the life of the project. Variable costs will remain at $0.50 per
passenger per day for the life of the project.
Project 2
Increase the number of buses to enable new routes to be opened. The new buses are
expected to cost $5,000,000 in total and have a useful life of five years with no residual value.
Fixed costs, including straight line depreciation, are expected to increase by $3,500,000 in the
first year, as a result of opening the new routes. Fixed costs will remain at the higher level for
the life of the project. Additional working capital of $1,000,000 will also be required.
The passenger numbers for year 1 on the new routes are predicted as follows:
Passenger numbers per day
6,000
9,000
12,000
Probability
50%
30%
20%
It is expected that passenger numbers will increase by 3% per annum for the following four
years. The average fare per passenger for year 1 will be $2 and will remain at that level for
the life of the project. Variable costs will remain at $0.50 per passenger per day for the life of
the project.
Additional Information
Taxation and inflation should be ignored.
The company uses a cost of capital of 8% per annum.
Performance Operations
14
March 2011
Required:
(a)
(i)
Advise the management of the company which project should be
undertaken based on a financial appraisal of the projects.
You should use net present value (NPV) to appraise the projects.
(13 marks)
(ii)
Explain TWO other major factors that should be considered before a final
decision is made.
(4 marks)
(b)
Calculate the sensitivity of the choice between Project 1 and Project 2 to
a change in passenger numbers for Project 2.
(4 marks)
(c)
Company D is planning its capital investment programme for next year. It is
considering four potential projects all of which have a positive net present value. The
initial investment, internal rate of return (IRR) and net present value (NPV), based on a
cost of capital of 12%, are given below for each project.
Project
A
B
C
D
Investment
$000
50
40
20
30
NPV at 12%
$000
13.6
15.2
10.2
12.3
IRR
12.6%
10.3%
13.1%
11.2%
Funding for the company is restricted to $110,000. The projects are independent and divisible
i.e. part of a project can be undertaken.
Required:
Prioritise the projects and determine how much funding should be allocated to
each project.
(4 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
March 2011
15
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is B.
1.2
The maximum regret at a selling price of $140 is $50,000
The maximum regret at a selling price of $160 is $60,000
The maximum regret at a selling price of $180 is $40,000
The maximum regret at a selling price of $200 is $30,000
Therefore if AP wants to minimise the maximum regret it will select a selling price of
$200
The correct answer is D.
1.3
The labour rate variance is:
26,000 x 2.8 ($10.00 - $10.40) = $29,120 A
The correct answer is C.
1.4
The labour efficiency variance is:
(26,000 x (3.0 - 2.8)) x $10.00 = $52,000 F
The correct answer is C.
March 2011
1
P1
1.5
Year 1 cash flows
Probability
$20,000
$14,000
$9,000
0.20
0.50
0.30
High
Medium
Low
Expected value
Year 1
$4,000
$7,000
$2,700
$13,700
$13,700 x 0.909 = $12,453
The correct answer is A.
1.6
Labour hours for production
36,000 units x 4 hours = 144,000 hours
Idle time = 10% of total available hours, therefore total available hours need to be:
144,000 hours / 0.9 = 160,000 hours
Labour cost budget ($)
160,000 hours x 20% = 32,000 hours x ($12 x 1.50) = $576,000
160,000 hours x 80% = 128,000 hours x $12 = $1,536,000
Total labour cost budget = $2,112,000
1.7
Working capital ratio
Calculation
Days
Inventory days
220/1800 x 365
44.6
Receivables days
350/(0.85 x 2,600) x 365
57.8
Payables days
260/(0.90 x 1,650) x 365
63.9
1.8
Quarter
1
Trend sales
units
13,000
Actual sales
units
14,000
Variation
units
+1,000
2
16,000
18,000
+2,000
3
19,000
18,000
-1,000
4
22,000
20,000
-2,000
Year 2 Quarter 1 = 10,000 + (3,000 x 5) = 25,000 + 1,000 = 26,000 units
Year 2 Quarter 2 = 10,000 + (3,000 x 6) = 28,000 + 2,000 = 30,000 units
Year 2 Quarter 3 = 10,000 + (3,000 x 7) = 31,000 - 1,000 = 30,000 units
Year 2 Quarter 4 = 10,000 + (3,000 x 8) = 34,000 - 2,000 = 32,000 units
P1
2
March 2011
SECTION B
Answer to Question Two
(a)
The activities that are being proposed in a budget are described in decision packages.
There will often be more than one decision package proposed for an activity e.g. one
based on providing services at a minimum level and others at incremental levels above
the minimum.
Some of these packages will be mutually exclusive and will require management to
select the best solution to the issue involved. For example options for refuse collection
could be in-house or outsourced solutions and a decision package will be needed for
each.
Each decision package is evaluated. Its costs are compared to its benefits and net
present values or other measures calculated. The non-financial aspects are also
considered as some packages might have legal obligations attached e.g. updating
accounting systems.
Management will rank each package based on the benefits to the organisation. They
may decide to reject packages even though the activity was done last year. In this way
the organisation is said to be starting from a zero base with each package given due
consideration.
The process of ranking decision packages is inherently difficult as value judgements
are necessary. In a public sector body, for example, decision packages will relate to
very disparate activities. It is extremely difficult to formulate criteria that would allow
unambiguous ranking where decision packages, for example, related to education
services are measured against those relating to health services. It can also be difficult
to place a monetary value on the output of some of the services provided.
(b)
Competitor
reaction
Probability
Product A
expected value
Product B
Expected value
Product C
expected value
$000s
$000s
$000s
Strong
0.3
200 x 0.3 = 60
400 x 0.3 = 120
600 x 0.3 = 180
Normal
0.2
300 x 0.2 = 60
600 x 0.2 = 120
400 x 0. 2 = 80
Weak
0.5
500 x 0.5 = 250
800 x 0.5 = 400
500 x 0.5 = 250
370
640
510
Expected Value
Product B is the best choice (without the benefit of perfect information) as it has the highest
expected value (EV) of $640k.
With perfect information:
If research suggests strong competitor reaction: select C and earn $600k – probability 0.3
If research suggests normal competitor reaction: select B and earn $600k – probability 0.2
If research suggests weak competitor reaction: select B and earn $800k – probability 0.5
EV (with perfect information) = ($600k x 0.3) + ($600k x 0.2) + ($800k x 0.5) = $700k
Value of perfect information is $700k – $640k = $60k
March 2011
3
P1
(c)
(i)
A risk neutral decision maker will tend to ignore risk and choose the course of action
that gives the best expected value. The probability distribution results in an expected
value of $13 which is more than the current delivery cost of $12.50 therefore the risk
neutral decision maker will want to remain with the third party delivery service.
(ii)
A risk averse decision maker is one that focuses on the poor results and seeks to
avoid a high degree of risk. A risk averse decision maker will focus on the 51% chance
that delivery costs per unit will be higher than the current cost of $12.50. They will
ignore the fact that there is also a 35% probability that the delivery cost per unit will be
lower than the current unit cost of $12.50. A risk averse decision maker will want to
remain with the third party delivery service.
(iii)
A risk-seeker is a decision maker that is interested in the best possible outcomes no
matter how unlikely they are to occur. They are not put off by the low probability of an
outcome but choose to focus on potential large returns instead. A risk-seeker will focus
on the 23% probability that the delivery cost per unit will be $11 or lower and will want
to establish the in-house delivery service. A risk-seeker will ignore the fact that there is
a 35% chance that delivery costs per unit will be $14.20 or higher.
(d)
(i)
Annual sales revenue = $1,095,000
Factoring fee
Annual interest
$1,095,000 x 2.5%
(90% x $180,000) x 12%
Savings in credit control costs
Net cost of factoring
(ii)
= $27,375
= $19,440
$46,815
$20,000
$26,815
The company requires to borrow - $180,000 x 90% =$162,000
The cost of borrowing is therefore - $162,000 x 15% = $24,300
There is therefore no financial benefit in factoring as the cost of borrowing is less than
the cost of factoring.
(e)
The returns given are over different time periods. It is necessary to calculate a rate per
annum to enable the investments to be compared:
The annual return on the treasury bills is ($5/$995) x 365/91 = 2.02%
The annual return on the bank deposit account is 2.5%.
Treasury bills are generally considered risk free as they are guaranteed by the
government of the country of issue. However during the present economic recession it
has become evident that investment with countries that have previously been
considered financially secure are not risk free. It should be borne in mind that the
treasury bills are fixed dated and although they are negotiable this would incur costs
and expose the company to price movement which will reflect the change in market
interest rates. Although the return is fixed, if the company holds the bills for 91 days,
market interest rates may rise with the result that the return on the treasury bills may be
below market rates.
P1
4
March 2011
The deposit account has a variable interest rate which will introduce variability in the
return, although this is likely to reflect market rates. Investments in banks are generally
considered very low risk however after the world banking crisis in 2008/2009 it is now
conceivable for a bank to fail. This introduces another albeit small element of risk in
that there is liquidation risk of the bank itself. The deposit account lacks flexibility as it
requires the company to give 30 days’ notice of withdrawal or accept penalty interest
charges.
The choice of investment will depend on the company’s attitude to risk and whether
they prefer to have a fixed return. The bank deposit account currently offers a higher
return but may not continue to do so in the future.
(f)
When a bond is issued it carries a ‘coupon’ rate. This is the rate that is payable on the
face, or nominal, value of the bond. Unlike shares which are rarely issued at their
nominal value, debt is frequently issued at par, usually $100 payable for $100 nominal
value of the bond. At the time of issue, the interest rate will be fixed according to
interest rates available in the market for bonds of similar maturity i.e. the coupon rate
and the yield to maturity of the bond will be the same. As market interest rates change
during the life of the bond, so the market value of the bonds will change and the yield to
maturity, from interest and capital gain on the bond, will then differ from the coupon rate
of the bond. If market interest rates increase the market value of the bond will fall to a
level where the yield to maturity to an investor, at that point, reflects market interest
rates.
March 2011
5
P1
SECTION C
Answer to Question Three
(a)
Profit per machine
Copy charge per
machine
Small
Medium
Large
$
$
$
(60,000 x $0.03)
(120,000 x 0.04)
(180,000 x $0.05)
1,800
($100 x 5)
4,800
($300 x 7)
9,000
($400 x 14)
(500)
($60 x 5)
(2,100)
($80 x 7)
(5,600)
($100 x 14)
(300)
(560)
(1,400)
(324)
(864)
(1,620)
676
1,276
380
Cost of parts per
machine
Labour cost per
machine
Overhead cost
Profit per machine
Overhead cost workings
Sales revenue
Small
Medium
Large
Total
$
$
$
$
$1,800 x 300 =
$540,000
$4,800 x 800 =
$3,840,000
$9,000 x 500 =
$4,500,000
$8,880,000
Overheads
Overheads /
sales revenue
Cost per
machine
(b)
$1,596,000
18%
$1,800 x 18%
$324
$4,800 x 18%
$864
$9,000 x 18%
$1,620
Cost driver rates
Activity
Cost Driver
Customer
account
handling
Number of
customers
Planned
maintenance
scheduling
Number of
planned
maintenance
visits
Number of
unplanned
maintenance
visits
Number of
purchase
orders
Number of
machines
Unplanned
maintenance
scheduling
Spare part
procurement
Other
overheads
Overheads
$000
126
No. of cost drivers
(300 / 2) + (800 / 2) +
(500 / 2) =
480
800
(300 x 4) + (800 x 6) +
(500 x 12) =
147
12,000
(300 x 1) + (800 x 1) +
(500 x 2) =
243
2,100
(500 + 1,200+ 1,000) =
600
2,700
(300 + 800 + 500) =
Cost per driver
$
$157.50 per
customer
$40 per planned
maintenance
visit
$70 per
unplanned
maintenance
visit
$90 per
purchase order
$375 per
machine
1,600
P1
6
March 2011
Overhead cost per machine
Customer account
handling
Planned
maintenance
scheduling
Unplanned
maintenance
scheduling
Spare part
procurement
Other overheads
Total overhead cost
per machine
Small
Medium
Large
($157.50 / 2) =
$79
($157.50 / 2)=
$79
($157.50 / 2) =
$79
($40 x 4) =
$160
($40 x 6) =
$240
$40 x 12 =
$480
($70 x 1) =
$70
($70 x 1) =
$70
($70 x 2) =
$140
($90 x 500/300) =
$150
($90 x 1,200/800) =
$135
($90 x 1,000/500) =
$180
$375
$375
$375
$834
$899
$1,254
Small
Medium
Large
$
$
$
1,800
4,800
9,000
(800)
(2,660)
(7,000)
(834)
(899)
(1,254)
166
1,241
746
Profit per machine
Copy charge per
machine
Parts and labour per
machine
Overhead cost per
machine
Profit per machine
using ABC
(c)
The potential benefit for the company will be in the areas of planning, control and
decision making.
Planning
The implementation of an activity based costing system will allow the company to use
activity based budgeting. The activities necessary to allow a particular output level of
services can be determined and the quantity of activity cost driver can be established
for each activity. The resources required to perform that quantity of cost drivers can
then be estimated.
Control
Under an activity based costing (ABC) system the various support activities that are
involved in the process of providing services are identified. The cost drivers that cause
a change to the cost of these activities are also identified and used as the basis to
attach activity costs to the service. The identification of cost drivers provides
information to management to enable them to take actions to improve overall
profitability of the company. Cost driver analysis will provide information to
management on how costs can be controlled and managed. Variance analysis will be
more useful as it is based on more accurate costs. ABC gives more detailed
information about how costs are incurred and the potential for cost reduction by
reducing activity levels.
Decision Making
The establishment of more accurate service costs should also help managers assess
machine profitability and make better decisions concerning pricing and product mix
March 2011
7
P1
decisions. In the above example, the use of an ABC system has resulted in different
levels of profit for each machine type. It is apparent that the large machines are more
profitable than under the absorption costing system. The small machines however are
making a lower margin than was originally thought. This additional information will
enable management to make important decisions regarding pricing. The copy charge
for the large machine could potentially be reduced to make it more competitive and
increase volumes. The copy charge for the small machines could be increased to make
these machines more profitable. Before making any decision regarding pricing however
they would need to review market prices and consider the effect any adjustment would
have on the company’s market position. If market conditions would not allow an
increase in the copy charge they could look at ways to reduce the costs of these
machines. Alternatively they may want to consider whether to drop the small machines
altogether and replace them with a more profitable use of resources. This decision may
not be appropriate however if part of the marketing strategy is for the company to
provide a range of complementary products.
P1
8
March 2011
Answer to Question Four
(a)
(i)
Project 1
Current contribution = (20,000 passengers x $1.50) x 365 days = $10,950k
Revised contribution = (20,000 x 1.20 x $1.30) x 365 = $11,388k
Incremental contribution in year 1 = $11,388k - $10,950k = $438k
Incremental costs = $100k
Year
Cash flows
$000
1,000
338
0
1-5
NPV
Discount factor
1.00
3.993
Present value
$000
(1,000)
1,349.6
349.6
Project 2
Expected passenger numbers Year 1
= (6,000 x 50%) + (9,000 x 30%) + (12,000 x 20%) = 8,100
Expected contribution Year 1 = 8,100 x $1.50 x 365 days =$4,435k
Depreciation per annum = $5,000,000 / 5 = $1,000k
Additional fixed costs (excluding depreciation) per annum = $3,500k - $1,000k = $2,500k
Net Present Value
Year 0
$000
Initial
(5,000)
Investment
Working
(1,000)
capital
Expected
contribution
Fixed costs
Net cash
flows
Discount
Factor @
8%
Present
value
Net present
value
(6,000)
1.000
(6,000)
Year 1
$000
Year 2
$000
Year 3
$000
Year 4
$000
Year 5
$000
1,000
4,435
4,568
4,705
4,846
4,991
(2,500)
(2,500)
(2,500)
(2,500)
(2,500)
1,935
2,068
2,205
2,346
3,491
0.926
1,792
0.857
1,772
0.794
1,751
0.735
1,724
0.681
2,377
3,416
Project 2 has a significantly higher NPV than project 1 and if the decision was made on NPV
alone then the company should go ahead with Project 2.
(ii)
•
•
Project 2 requires a significantly higher level of investment than project 1 and the
company needs to consider whether it can raise the capital required.
There is more risk involved in Project 2. In particular the estimated passenger numbers on
the new routes is critical to the success of the project.
March 2011
9
P1
•
•
•
Project 2 is on a much larger scale and will cause many operational issues for the
company. There may be a requirement for a new depot for the buses and there will be a
substantial increase in staffing.
The level of competition and potential competitor reaction on the new routes needs to be
considered.
Project 2 will increase the company’s market share and may be important for future
growth of the company.
(b)
Expected
contribution
Discount
Factor @
8%
Present
value
Year 1
$000
4,435
Year 2
$000
4,568
Year 3
$000
4,705
Year 4
$000
4,846
Year 5
$000
4,991
0.926
0.857
0.794
0.735
0.681
4,107
3,915
3,736
3,562
3,399
Total
$000
18,719
($3,416 - $350) / $18,719 = 16.4%
Assuming that the 3% annual increase is maintained, if passenger numbers in year 1 reduce
by more than 16.4% the NPV of Project 2 will be less than that of Project 1 and therefore the
choice will be to accept Project 1. Passenger numbers in year 1 need to therefore be greater
than 6,772 (8,100 x 83.6%) for the project to be worthwhile.
(c)
The projects should be ranked on the basis of the profitability index as follows:
Project
A
B
C
D
Investment
$000
50
40
20
30
NPV at 12%
$000
13.6
15.2
10.2
12.3
Profitability
Index
1.27
1.38
1.51
1.41
Ranking
4
3
1
2
The company will select projects D, C and B which will use $90,000 of the available funding.
The remaining $20,000 can be used for part of project A.
P1
10
March 2011
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
The question assesses learning outcome B3(b) apply alternative approaches to
budgeting. It examines the candidates’ ability to explain the difficulties that a not-forprofit organisation may experience when ranking decision packages under a zero
based budgeting system.
(b)
The question assesses learning outcome D1(e) calculate the value of information. It
examines candidates’ ability to calculate the expected values of projects given a range
of outcomes and probabilities and then to calculate the value of perfect information
about the projects.
(c)
The question assesses learning outcome D1(c) analyse risk and uncertainty by
calculating expected values and standard deviations together with probability tables
and histograms.. It examines candidates’ ability to explain the likely decision that would
be made by decision makers with different attitudes to risk when given a probability
distribution of the possible outcomes.
(d)
The question assesses learning outcome E1(f) analyse the impacts of alternative
debtor and creditor policies. Part (i) of the question examines candidates’ ability to
calculate the annual cost to the company of debt factoring. Part (ii) of the question
examines candidates’ ability to calculate whether there is a financial benefit to the
company from using the factor.
(e)
The question assesses learning outcome E2(b) identify alternatives for investment of
short-term cash surpluses. It examines candidates’ ability to compare two potential
short term Investment opportunities and explain the advantages and disadvantages of
each.
(f)
The question assesses learning outcome E2(b) Identify alternatives for investment of
short-term cash surpluses. It examines candidates’ ability to explain why the coupon
rate on a bond and its yield to maturity may be different.
Section C – Questions Three and Four - Compulsory
Question Three Part (a) of the question assesses learning outcome A1(a) compare and
contrast marginal (or variable), throughput and absorption accounting methods in respect of
profit reporting and stock valuation. It examines candidates’ ability to calculate the cost of a
service using a traditional method of overhead absorption. Part (b) assesses learning
outcome A1(c) discuss activity-based costing as compared with traditional marginal and
absorption costing methods, including its relative advantages and disadvantages as a system
of cost accounting. It requires candidates to be able to apply activity based costing to the
calculation of a service costs. Part (c) assesses learning outcome A1(c) discuss activityMarch 2011
11
P1
based costing as compared with traditional marginal and absorption costing methods,
including its relative advantages and disadvantages as a system of cost accounting. It
examines candidates’ ability to explain the potential benefits of the information for
management decision making.
Question Four Parts (a)(i) of the question assesses learning outcomes C1(b) apply the
principles of relevant cash flow analysis to long run projects that continue for several years
and C2(a) evaluate project proposals using the techniques of investment appraisal. They
examine candidates’ ability to identify relevant costs and calculate the net present value of
two projects and then to advise the management of the company which project should be
undertaken. Part (a)(ii) of the question assesses learning outcome C1(g) prepare decision
support information for management, integrating financial and non-financial considerations. It
examines candidates’ ability to explain two major factors that management would need to
consider before making a final decision on the choice of project. Part (b) of the question
assesses learning outcome C1(f) Apply sensitivity analysis to cash flow parameters to identify
those to which net present value is particularly sensitive. It examines candidates’ ability to
calculate the sensitivity of the decision to a change in one variable. Part (c) of the question
assesses learning outcome C2(c) prioritise projects that are mutually exclusive, involve
unequal lives and/or are subject to capital rationing. It requires candidates to allocate
available funds to projects based on their profitability index.
P1
12
March 2011
Performance Pillar
25 May 2011 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 7.
Section C comprises 2 questions and is on pages 8 to 11.
Maths tables and formulae are provided on pages 13 to 16.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2011
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
Which of the following is NOT a feature of an agreed overdraft facility?
A
The borrower may draw funds, up to the agreed overdraft limit, as and when required.
B
Interest is payable on the total amount of the agreed overdraft limit rather than on the
amount borrowed.
C
There is no fixed repayment date for the amount borrowed.
D
The borrowing is repayable on demand.
(2 marks)
Performance Operations
2
May 2011
1.2
A marketing manager is deciding which of four potential selling prices to charge for a
new product. Market conditions are uncertain and demand may be good, average or
poor. The contribution that would be earned for each of the possible outcomes is
shown in the payoff table below:
Demand level
Selling price
$40
$60
$80
$100
Good
$50,000
$60,000
$40,000
$30,000
Average
$20,000
$30,000
$30,000
$20,000
Poor
$30,000
$30,000
$20,000
$10,000
If the manager applies the maximin criterion to make decisions, which selling price
would be chosen?
A
$40
B
$60
C
$80
D
$100
(2 marks)
1.3
A company is considering whether to develop and market a new product. The cost of
developing the product is estimated to be $150,000. There is a 70% probability that the
development will succeed and a 30% probability that the development will be
unsuccessful.
If the development is successful the product will be marketed. There is a 50% chance
that the marketing will be very successful and the product will make a profit of
$250,000. There is a 30% chance that the marketing will be reasonably successful and
the product will make a profit of $150,000 and a 20% chance that the marketing will be
unsuccessful and the product will make a loss of $80,000. The profit and loss figures
stated are after taking account of the development costs of $150,000.
The expected value of the decision to develop and market the product is:
A
$154,000
B
$4,000
C
$107,800
D
$62,800
(2 marks)
Section A continues on the next page
TURN OVER
May 2011
3
Performance Operations
The following data are given for sub-questions 1.4 and 1.5 below
A company produces three products D, E and F. The statement below shows the selling price
and product costs per unit for each product, based on a traditional absorption costing system.
Product D
$
Product E
$
Product F
$
Selling price per unit
32
28
22
Variable costs per unit
Direct material
Direct labour
Variable overhead
10
6
4
8
4
2
6
4
2
Fixed cost per unit
Fixed overhead
Total product cost
Profit per unit
9
29
3
6
20
8
6
18
4
3,000
20
4,000
25
5,000
15
Additional information:
Demand per period (units)
Time in Process A (minutes)
Each of the products is produced using Process A which has a maximum capacity of 2,500
hours per period.
1.4
If a traditional contribution approach is used, the ranking of products, in order of priority,
for the profit maximising product mix will be:
A
D, E, F
B
E, D, F
C
F, D, E
D
D, F, E
(2 marks)
1.5
If a throughput accounting approach is used, the ranking of products, in order of
priority, for the profit maximising product mix will be:
A
D, E, F
B
E, D, F
C
F, D, E
D
D, F, E
(2 marks)
Performance Operations
4
May 2011
GS has budgeted sales for the next two years of 24,000 units per annum spread evenly
throughout both years. The estimated opening inventory of finished goods at the start
of the next year is 500 units but GS now wants to maintain inventory of finished goods
equivalent to one month’s sales.
1.6
Each unit uses 2kg of material. The estimated opening raw material inventory at the
start of the next year is 300kg but GS now wants to hold sufficient raw material
inventory at the end of each month to cover the following month’s production.
The change in the policy for inventory holding for both raw materials and finished goods
will take effect in the first month of next year and will apply for the next two years.
The budgeted material cost is $12 per kg.
Required:
Calculate the material purchases budget for the next year in $.
(3 marks)
DB’s latest estimate for trade payables outstanding at the end of this year is 45 days.
Estimated purchases for this year are $474,500. DB is preparing the budget for next
year and estimates that purchases will increase by 10%.
1.7
The trade payables amount, in $, outstanding at the end of next year is estimated to be
the same as at the end of this year.
Required:
Calculate the budgeted trade payable days at the end of next year.
(3 marks)
A company is considering whether to invest in a new project. The probability
distribution of the net present value of the project is as follows:
1.8
Net present value
$2,800
$3,900
$4,900
Probability
0.25
0.40
0.35
Required:
Calculate the expected value of the net present value of the project and its standard
deviation.
(4 marks)
Note:
(Total for Section A = 20 marks)
Reminder - All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for marking.
End of Section A. Section B begins on page 6
May 2011
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
“Different budgets should be used for different purposes. The budget used for planning
purposes should be different from the budget used to set performance targets.”
Required:
Explain the above statement and the conflicts that may arise when a single budget is
used for both purposes.
(5 marks)
(b)
A company has to decide which of three mutually exclusive projects to invest in during
the next year. The directors believe that the success of the projects will vary depending
on consumer demand. There is a 20% chance that consumer demand will be above
average; a 45% chance that consumer demand will be average and a 35% chance that
consumer demand will be below average.
The net present value for each of the possible outcomes is as follows:
Consumer
demand
Project A
Project B
Project C
$000s
$000s
$000s
Above average
400
300
800
Average
500
400
600
Below average
700
600
300
A market research company believes it can provide perfect information on potential
consumer demand in this market.
Required:
Calculate, on the basis of expected value, the maximum amount that should be paid
for the information from the market research company.
(5 marks)
Performance Operations
6
May 2011
(c)
TS operates a fleet of vehicles and is considering whether to replace the vehicles on a
1, 2 or 3 year cycle.
Each vehicle costs $25,000. The operating costs per vehicle for each year and the
resale value at the end of each year are as follows:
Operating costs
Resale value
Year 1
$
5,000
18,000
Year 2
$
8,000
15,000
Year 3
$
11,000
5,000
The cost of capital is 6% per annum.
Required:
Calculate the optimum replacement cycle for the vehicles. You should assume that the
initial investment is incurred at the beginning of year 1 and that all other cash flows
arise at the end of the year.
(5 marks)
(d)
Discuss the advantages AND disadvantages of factoring as a method of managing
trade receivables.
(5 marks)
(e)
Describe the following methods of export financing:
(i)
(ii)
(iii)
Bills of exchange
Forfaiting
Documentary credits
(5 marks)
(f)
A bond has a coupon rate of 6% and will repay its nominal value of $100 when it
matures after four years.
The bond will be purchased today for $103 ex-interest and held until maturity.
Required:
Calculate, to 0.01%, the yield to maturity for the bond based on today’s
purchase price.
(5 marks)
(Total for Section B = 30 marks)
TURN OVER
May 2011
7
Performance Operations
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A company produces trays of pre-prepared meals that are sold to restaurants and food
retailers. Three varieties of meals are sold: economy, premium and deluxe.
Extracts from the budget for last year are given below:
Economy
Premium
Deluxe
Sales quantity (trays)
180,000
360,000
260,000
Selling price per tray
$2.80
$3.20
$4.49
Total sales revenue
$504,000
$1,152,000
$1,167,400
$1.00
$1.60
$2.20
Total direct material cost
$180,000
$576,000
$572,000
Direct labour cost per tray
$0.50
$0.50
$0.50
$90,000
$180,000
$130,000
Direct material cost per tray
Total direct labour cost
Overhead costs for the budget were estimated using the high-low method based on the total
overhead costs for three previous years.
Output
Total overheads
720,000 trays
$1,016,000
680,000 trays
$992,000
840,000 trays
$1,096,000
Actual results for last year were as follows:
Economy
Premium
Deluxe
Sales quantity (trays)
186,000
396,000
278,000
Selling price per tray
$2.82
$3.21
$4.50
$524,520
$1,271,160
$1,251,000
$1.10
$1.50
$2.10
Total direct material cost
$204,600
$594,000
$583,800
Direct labour cost per tray
$0.52
$0.54
$0.48
$96,720
$213,840
$133,440
$0.64
$0.66
$0.63
$119,040
$261,360
$175,140
Total sales revenue
Direct material cost per tray
Total direct labour cost
Variable overhead per tray
Total variable overheads
Actual fixed overheads: $546,000
The company operates a just-in-time system for purchasing and production and does not hold
any inventory.
Ignore inflation.
Performance Operations
8
May 2011
Required:
(a)
Calculate, for the original budget, the budgeted fixed overhead costs, the
budgeted variable overhead cost per tray and the budgeted total
overheads costs.
(3 marks)
(b)
Prepare, for last year, a budget control statement on a marginal cost basis
for the Premium product.
The statement should show the original budget, the flexed budget and the
total budget variances for sales revenue and each cost element.
(5 marks)
(c)
Discuss the benefits of flexible budgeting for planning and control
purposes.
You should use the figures calculated in (b) above to illustrate your
answer.
(6 marks)
(d)
The company has previously calculated only a sales volume variance but has
now decided that valuable management information will be provided by further
analysis of this variance.
(i)
Calculate the sales quantity contribution variance.
(3 marks)
(ii)
Calculate the sales mix contribution variance.
(3 marks)
(e)
Explain why the analysis of the sales volume variance into the sales
quantity and sales mix variances will provide valuable management
information.
Your answer should refer to the figures calculated in (d) above.
(5 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
May 2011
9
Performance Operations
Question Four
A company is considering the launch of a new 5G mobile phone. Experience from the sale of
previous models has shown that the expected life of the new model is four years and life cycle
sales will total 25,000,000 units. Sales volumes over the life cycle of the product will follow the
pattern shown below.
Year 1
Year 2
Year 3
Year 4
20%
40%
30%
10%
The company’s research and development division, which has an annual budget of
$35,000,000, has developed a prototype of the 5G phone. A further investment of
$600,000,000 in a new manufacturing facility will be required at the start of year 1 to put the
new model into production. It is expected that the new manufacturing facility will have a
residual value of $100,000,000 at the end of four years.
The new model is to be marketed initially at a premium price of $300 per unit. The price will
remain at $300 for the first year after which prices will be reduced by 20% per annum.
The 5G model will be produced exclusively in the new manufacturing facility. The total fixed
manufacturing costs will be $300,000,000 per year excluding depreciation. It is also
anticipated that a further $150,000,000 will be spent in each of years 1 and 2 and
$100,000,000 in year 3, on further development and marketing of the new model. The
variable cost per unit will be $125 and this is expected to remain the same throughout the life
of the model.
It is estimated that the launch of the new model will result in a reduction in sales of the current
4G model of 2,000,000 units in the first year after which there will no longer be a market for
the 4G model. It was never anticipated that there would be a market for the 4G model after
this period. The contribution per unit of the 4G model is $100.
The company’s financial director has provided the following taxation information:
•
•
•
Tax depreciation: 25% reducing balance per annum.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid in the following year.
Any taxable losses resulting from this investment can be set against profits made by the
company’s other business activities.
The company uses a post-tax cost of capital of 8% per annum to evaluate projects of this
type. Ignore inflation.
Performance Operations
10
May 2011
Required:
(a)
Calculate the net present value (NPV) of the project.
Workings should be shown in $millions.
(12 marks)
(b)
(i)
Calculate the internal rate of return (IRR) of the project.
(ii)
Calculate the discounted payback period of the project.
(5 marks)
(c)
Discuss the reasons why a company may want to calculate the IRR and
discounted payback period of a project even though NPV is the
theoretically superior method of investment appraisal.
(4 marks)
(d)
Explain the benefits to a company of carrying out a post-completion audit
of a project.
(4 marks)
Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 13 to 16
May 2011
11
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is B.
1.2
The minimum contribution at a selling price of $40 is $20,000
The minimum contribution at a selling price of $60 is $30,000
The minimum contribution at a selling price of $80 is $20,000
The minimum contribution at a selling price of $100 is $10,000
Therefore if the manager wants to maximise the minimum
contribution, a selling price of $60 will be selected.
The correct answer is B.
1.3
((50% x 70% x $250k) + (30% x 70% x $150k) + (20% x 70% x - $80k) + (30% x $150k)
= $62,800
The correct answer is D.
1.4
D
$12
20 mins
$0.60
nd
2
Contribution per unit
Units of limiting factor
Contribution per unit of limiting factor
Ranking
E
$14
25 mins
$0.56
rd
3
F
$10
15 mins
$0.667
st
1
The correct answer is C.
May 2011
1
P1
1.5
Throughput contribution per unit
Units of limiting factor
Throughput contribution per unit of limiting
factor
Ranking
D
$22
20 mins
$1.10
E
$20
25 mins
$0.80
st
F
$16
15 mins
$1.07
rd
1
nd
3
2
The correct answer is D.
1.6
Budgeted sales
Plus closing inventory
Less opening inventory
Budgeted production
1.7
24,000
2,000
(500)
25,500
units
units
units
units
Raw material required
Plus closing inventory
Less opening inventory
Raw material purchases
25,500 units x 2 kg
2,000 units x 2 kg
= 51,000 kg
= 4,000 kg
(300) kg
54,700 kg
Raw material purchases
budget
54,700 kg x $12
= $656,400
Trade payables outstanding at end of this year = $474,500 / 365 x 45 = $58,500
Purchases budget for next year = $474,500 x 1.1 = $521,950
Trade payable days at end of next year = $58,500 / $521,950 x 365 = 40.9 days
1.8
Deviation
from
expected
value
Squared
deviation
Weighted
amounts
345,156.25
NPV
Probability
Expected
value
$2,800
0.25
$700
-1,175
1,380,625
$3,900
0.40
$1,560
-75
5,625
$4,900
0.35
$1,715
925
855,625
$3,975
2,250
299,468.75
646,875
The expected value of the project is $3,975
The standard deviation is √646,875 = $804.29
P1
2
May 2011
SECTION B
Answer to Question Two
(a)
One of the main purposes of budgeting is planning. It will help to ensure that managers think
ahead, planning and reviewing their activities and that this is done in a co-ordinated way. It
also acts as a control mechanism, with actual results being compared against budget. In
order for the budget to fulfil these purposes it need to be based on realistically achievable
estimates.
Another purpose of a budget is to set targets to motivate managers and optimise their
performance. Evidence suggests that the existence of a defined goal or target is likely to
motivate managers and result in higher levels of performance than when no target is
established. The manager has to accept the target set for it to be effective, but the problem is
in determining the optimum degree of difficulty for the target. As the degree of difficulty
increases it has been shown that the managers’ aspiration level and performance increases
up to a point where the target is seen as impossible to achieve. Thereafter, the aspiration
level and performance of the manager declines dramatically.
This suggests that challenging targets should be established to motivate managers. However
it is unlikely that these will be suitable for planning purposes since they have a high probability
of not being achieved. There is therefore a need for two separate budgets to be produced;
however this is unlikely to be realistic in practice.
(b)
Consumer
demand
Probability
Project A
expected value
Project B
expected value
Project C
expected value
$000s
$000s
$000s
Above
average
0.20
400 x 0.2 = 80
300 x 0.2 = 60
800 x 0.2 = 160
Average
0.45
500 x 0.45 = 225
400 x 0.45 = 180
600 x 0.45 = 270
0.35
700 x 0.35 = 245
600 x 0.35 = 210
300 x 0.35 = 105
550
450
535
Below
average
Expected
value
Product A is the best choice (without the benefit of perfect information) as it has the highest
expected value (EV) of $550k.
With perfect information:
If research suggests above average consumer demand: select C and earn $800k
If research suggests average consumer demand: select C and earn $600k
If research suggests below average consumer demand: select A and earn $700k
EV (with perfect information) = ($800k x 0.2) + ($600k x 0.45) + ($700k x 0.35) = $675k
Value of perfect information is $675k – $550k = $125k
May 2011
3
P1
(c)
Year
Discount
factor
0
1
2
3
Present
value
Cumulative
discount
factor
Annualised
equivalent
1.00
0.943
0.890
0.840
Replace after Year 1
Cash
Present
flows
value
$
$
(25,000) (25,000)
13,000
12,259
Replace after Year 2
Cash
Present
flows
value
$
$
(25,000) (25,000)
(5,000)
(4,715)
7,000
6,230
Replace after Year 3
Cash
Present
flows
value
$
$
(25,000) (25,000)
(5,000)
(4,715)
(8,000)
(7,120)
(6,000)
(5,040)
(41,875)
(12,741)
(23,485)
0.943
1.833
2.673
13,511
12,812
15,666
The lowest annualised equivalent cost occurs if the vehicles are kept for 2 years. Therefore
the optimum replacement cycle is to replace the vehicles every 2 years.
(d)
Advantages
Factoring has the advantage that 80 – 85% of the cash is received immediately with the
remainder received when the client settles the debt. Factoring can also be provided on a nonrecourse basis, i.e. the factor guarantees settlement even if they are not paid by the
customers. The factor will also administer the client’s sales ledger including the assessment
of credit worthiness of the customer, invoicing and collection. The factor has considerable
expertise in all of these areas that a small business in particular may not have available.
Factoring also provides flexibility since as sales increase with the corresponding demand for
finance, so finance from this source increases. It may be a cost effective source of finance for
a company that has no assets, other than its receivables, to offer as security.
Disadvantages
Factoring has in the past been associated with financial difficulties and many companies are
reluctant to use factors for this reason. It may also be difficult, if using factoring, to raise more
traditional forms of finance except at high interest rates. The services provided by a factor are
expensive and may not be cost effective. The company will also lose the benefits of being in
personal communication with the customer. Once established with a factor, it may be difficult
for a company to withdraw from the arrangement and re-establish a sales ledger function.
(e)
(i) Bills of exchange
The bill of exchange requires the customer to pay the amount due at some fixed future date.
The supplier signs the bill and sends it to the customer, who also signs it to signify that they
agree to pay. The supplier can either, hold the bill until the due date and collect the money,
discount the bill with the bank for immediate payment or transfer the bill to their own supplier
in settlement of an amount due.
(ii) Forfaiting
The forfaiting bank buys at a discount to face value a series of promissory notes (or bills of
exchange). The promissory notes may be in any of the world’s major currencies. For
promissory notes to be eligible for forfaiting (and to provide the forfaiting bank security), the
P1
4
May 2011
notes must be guaranteed by a highly rated international bank, usually in the importers
country.
(iii) Documentary credits
A documentary credit is an undertaking that payment to the exporter will be guaranteed
provided that the exporter complies with certain specific requirements. The foreign buyer
would advise its bank (the issuing bank) to provide credit in favour of the exporter. The issuing
bank would then ask the exporters bank to advise or confirm credit to the exporter. The
issuing bank is effectively guaranteeing payment for the goods. The exporter’s bank will
provide payment to the exporter on receipt of satisfactory documentation for the goods. The
documents are sent to the issuing bank who if satisfied will reimburse the exporter’s bank and
release the documents to the foreign buyer after payment has been received. The foreign
buyer can then take delivery of the goods.
(f)
Year(s)
Description
0
1-4
4
NPV
Purchase
Interest
Redemption
Cash flow
103
6
100
Discount
factor (3%)
1.000
3.717
0.888
Present
value
$
(103.00)
22.30
88.80
8.10
Discount
factor
(6%)
1.000
3.465
0.792
Present
value
$
(103.00)
20.79
79.20
(3.01)
By interpolation
3% + (($8.10 /($8.10 + $3.01)) x 3) = 5.19%
The bond’s yield to maturity is 5.19%
May 2011
5
P1
SECTION C
Answer to Question Three
(a)
Budget fixed and variable overhead costs
High-Low Method applied to total overhead costs.
Variable costs = ($1,096,000 - $992,000) / (840,000 - 680,000) = $0.65 per tray
Budget variable costs = 800,000 x $0.65 = $520,000
Fixed costs = $1,096,000 - (840,000 x $0.65) = $550,000
(b)
Budget control statement for Premium product
Original
budget
Sales (units)
360,000
$
Sales revenue
1,152,000
Direct materials
576,000
Direct labour
180,000
Variable overheads
234,000
Contribution
162,000
Flexed
budget
396,000
$
1,267,200
633,600
198,000
257,400
178,200
Actual
396,000
$
1,271,160
594,000
213,840
261,360
201,960
Variance
$
3,960 F
39,600 F
15,840 A
3,960 A
23,760 F
Workings:
Standard
contribution
per unit
Sales revenue
Direct material
Direct labour
Variable
overhead
Contribution
$3.20
$1.60
$0.50
$0.65
Flexed
budget
396,000
trays
$
1,267,200
633,600
198,000
257,400
$0.45
178,200
(c)
A fixed budget will not provide meaningful control information when actual activity differs from
budget and variable costs are significant. If, for example, actual sales revenue is compared to
a fixed budget it is not possible to tell whether a favourable sales variance is due to an
increase in units sold or an increase in sales price. The flexed budget statement highlights
that there is a favourable sales price variance of $3,960. Similarly, if sales volumes were well
above budget, adverse variable cost variances will probably be reported, against the fixed
budget, since more variable costs have to be incurred to support the higher level of activity. In
the question, if the original budget had been used for direct materials an adverse variance of
$18,000 ($576,000 - $594,000)) would have been reported compared to the favourable
variance of $39,600 shown above. Reporting against a fixed budget tells management
nothing about the efficiency of operations. However, if a flexible budget is prepared then the
P1
6
May 2011
budget variances calculated will provide a better indication of performance since actual
results will be compared against an appropriate benchmark.
It should be noted that actual results will always be compared against the original approved
budget in the first instance. The flexed budget however provides more insight into actual
performance.
(d)
(i)
Selling price
Direct labour
Direct material
Variable overheads
Contribution
Economy per unit
$2.80
$0.50
$1.00
$0.65
$0.65
Premium per unit
$3.20
$0.50
$1.60
$0.65
$0.45
Deluxe per unit
$4.49
$0.50
$2.20
$0.65
$1.14
Sales Quantity Contribution Variance
Economy
Premium
Deluxe
Budget sales
quantity
180,000
360,000
260,000
800,000
Actual sales at
budget mix
193,500
387,000
279,500
860,000
Difference
13,500 F
27,000 F
19,500 F
60,000
Contribution
Variance
$0.65
$0.45
$1.14
$8,775 F
$12,150F
$22,230F
$43,155F
Or alternatively:
Budget sales quantity
180,000
360,000
260,000
800,000
Economy
Premium
Deluxe
Contribution
$0.65
$0.45
$1.14
Total contribution
$117,000
$162,000
$296,400
$575,400
Weighted average contribution: $575,400 / 800,000 = $0.71925
Sales quantity contribution variance = (860,000 – 800,000) x $0.71925 = $43,155F
(ii)
Sales Mix Contribution Variance
Actual sales
quantity
Actual sales
at budget mix
Difference
Standard
186,000
193,500
7,500 F
Premium
396,000
387,000
9,000 A
Deluxe
278,000
279,500
1,500 A
Variance
from
weighted
average
contribution
per unit
($0.65 $0.71925)
($0.45 $0.71925)
($1.14 $0.71925)
Variance
$519.375 F
$2,423.25 A
$631.125 A
$2,535 A
May 2011
7
P1
Or alternatively:
Actual sales
quantity
Standard
Premium
Deluxe
186,000
396,000
278,000
Actual sales
at budget
mix
193,500
387,000
279,500
Difference
Contribution
Variance
7,500 A
9,000 F
1,500 A
$0.65
$0.45
$1.14
$4,875 A
$4,050 F
$1,710 A
$2,535 A
N.B. The analysis of the variances by product shown in the method above is not meaningful.
(e)
By analysing the sales volume variance into sales quantity and mix variances we can explain
how the sales volume variance has been affected by a change in the total quantity of sales
and a change in the relative mix of products sold. From the figures calculated in part (d) we
can say that the contribution would have been $43,155 higher if the increase in quantity sold
had been in the budgeted sales mix. The change in the sales mix however has resulted in a
reduction in profit of $2,535. The change in the sales mix has resulted in a relatively higher
proportion of sales of the Premium product which is the product that earns the lowest
contribution. This is important information for future planning and pricing purposes. An overall
increase in quantity of products sold may not result in an increase in profits if the increased
sales are from a lower margin product at the expense of products with a higher profit margin.
P1
8
May 2011
Answer to Question Four
(a)
Unit sales Year 1
Unit sales Year 2
Unit sales Year 3
Unit sales Year 4
= 25,000,000 x 20% = 5,000,000
= 25,000,000 x 40% = 10,000,000
= 25,000,000 x 30% = 7,500,000
= 25,000,000 x 10% = 2,500,000
Contribution per unit Year 1 = $300 - $125 = $175
Contribution per unit Year 2 = $240 - $125 = $115
Contribution per unit Year 3 = $192 - $125 = $67
Contribution per unit Year 4 = $153.60 - $125 = $28.60
Total contribution Year 1 = $175 x 5m = $875m
Total contribution Year 2 = $115 x 10m = $1150m
Total contribution Year 3 = $67 x 7.5m = $502.5m
Total contribution Year 4 = $28.60 x 2.5m = $71.5m
Loss of contribution from 4G model sales:Year 1 – $100 x 2m = $200m
Cash Flows
Contribution
from 5G sales
Reduction in
contribution
from 4G sales
Fixed
manufacturing
costs
Technical
improvement
and marketing
Net cash flows
Year 1
$m
875
Year 2
$m
1,150
Year 3
$m
503
Year 4
$m
72
(300)
(300)
(300)
(300)
(150)
(150)
(100)
225
700
103
(228)
Year 1
$m
225
(150)
Year 2
$m
700
(113)
Year 3
$m
103
(84)
Year 4
$m
(228)
(153)
75
(23)
587
(176)
(200)
Taxation
Net cash flows
Tax
depreciation
Taxable profit
Taxation @
30%
May 2011
9
19
(6)
(381)
114
P1
Net present value
Year 0
$m
(600)
Net cash
flows
Tax
payment
Taxable
payment
Net cash
flow after
tax
Discount
factors @
8%
Present
value
Year 1
$m
225
Year 2
$m
700
Year 3
$m
103
Year 5
$m
(3)
Year 4
$m
(228)
100
57
(12)
(88)
(11)
(88)
(3)
57
(600)
213
601
12
(74)
57
1.000
0.926
0.857
0.794
0.735
0.681
(600)
197
515
10
(54)
39
Year 0
$m
(600)
Year 1
$m
213
Year 2
$m
601
Year 3
$m
12
Year 4
$m
(74)
Year 5
$m
57
1.000
0.833
0.694
0.579
0.482
0.402
(600)
177
417
7
(36)
23
Net present value = $107m
(b)
(i)
Net cash
flows
Discount
Factor @
20%
Present
value
Net present value = $(12)m
IRR
NPV at 8% = $107m
NPV at 20% = $(12)m
By interpolation
8% + (107/(107 + 12)) x 12 =18.8%
(ii)
Discounted payback period
1 yr + ((600 – 197) / 515) x 12 = 1 yr 9 months
(c)
IRR is used in practice because users are familiar with interpreting percentage rates such as
return on capital employed, return on investment, bank rates etc. Since the IRR is expressed
as a percentage it is easy to understand. It also avoids the need to have to specify a discount
P1
10
May 2011
rate in advance. The IRR is particularly useful for indicating the excess percentage above the
cost of capital for projects that earn a positive net present value.
Discounted payback tends to be used in practice as a supplementary method of project
appraisal. Projects which return their cash outlay quicker can be seen as less risky. It can be
used at an early stage to eliminate projects that have unacceptable risk and return
characteristics. It is also seen as useful when funds are in short supply since early payback of
funds allows investment in other profitable opportunities. Discounted payback is also easy to
use and is a simple way to communicate product acceptability to managers.
(d)
Post completion audit has benefits in terms of the current project and future projects. In terms
of the current project, it enables changes to be made to over or under performing projects at
an early stage. This also makes it more likely that unsuccessful projects will be terminated.
In terms of future projects, it improves the quality of decision making as past experience is
made available to future decision makers. It encourages greater realism in predicting future
outcomes as past inaccuracies are made public. It highlights reasons for successful projects
which may be important in achieving greater benefits from future projects and in future project
selection.
May 2011
11
P1
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
This question assesses learning outcome B1(b) explain the purposes of budgeting,
including planning, communication, co-ordination, motivation, authorisation, control and
evaluation, and how these many conflict. It examines candidates’ ability to explain the
behavioural consequences of budgeting of the difficulties and conflicts that can arise.
(b)
The question assesses learning outcome D1(e) calculate the value of information. It
examines candidates’ ability to calculate the expected values of projects given a range
of outcomes and probabilities and then to calculate the value of perfect information
about the projects.
(c)
The question assesses learning outcome C1(g) prepare decision support information
for management, integrating financial and non-financial considerations. It examines
candidates’ ability to calculate the optimum replacement cycle for a product.
(d)
The question assesses learning outcome E1(f) analyse the impacts of alternative
debtor and creditor policies. It examines candidates’ ability to discuss the advantages
and disadvantages of factoring as a method of managing a company’s trade
receivables.
(e)
The question assesses learning outcome E2(c) identify appropriate methods of finance
for trading internationally. It examines candidates’ ability to describe three suggested
methods of export financing.
(f)
The question assesses learning outcome E2(d) Illustrate numerically the financial
impact of short-term funding and investment methods. It examines candidates’ ability to
calculate the yield to maturity on a bond given the current market value and the coupon
rate of the bond.
Section C – Questions Three and Four – Compulsory
Question Three The question assesses a number of learning outcomes. Part (a) assesses
learning outcome B2(b) calculate projected revenues and costs based on product/service
volumes; pricing strategies and cost structures. It examines candidates’ ability to calculate
projected overhead costs using the high – low method. Part (b) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to prepare a flexible
budget statement and calculate variances using information regarding cost behaviour. Part (c)
assesses learning outcome A1(b) Discuss a report which reconciles budget and actual profit
using absorption and/or marginal costing techniques. It examines candidates’ ability to
discuss the benefits of flexible budgeting when producing report that reconcile budget and
actual profit. Part (d) also assesses learning outcome A1(d) apply standard costing methods,
P1
12
May 2011
within costing systems, including the reconciliation of budgeted and actual profit margins. It
examines candidates’ ability to calculate sales mix and sales quantity variances. Part (e)
assesses learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead
and sales variances, distinguishing between planning and operational variances. It examines
candidates’ ability to explain why the analysis of the sales volume variance into the sales mix
and sales quantity variance provides useful management information.
Question Four Part (a) assesses learning outcomes C1(b) apply the principles of relevant
cash flow analysis to long-run projects that continue for several years and learning outcome
C2(a) evaluate project proposals using the techniques of investment appraisal. It examines
candidates’ ability to identify the relevant costs of a project and then apply discounted cash
flow analysis to calculate the net present value of the project. Part (b) also assesses learning
outcome C2(a) evaluate project proposals using the techniques of investment appraisal. It
examines candidates’ ability to calculate the IRR and discounted payback period of a project.
Part (c) assesses learning outcome C2(b) compare and contrast the alternative techniques of
investment appraisal. It examines the candidates’ ability to discuss why certain investment
appraisal techniques might be used in practice despite their theoretical disadvantages. Part
(d) assesses learning outcome C1(a) explain the process involved in making long-term
decisions. It examines candidates’ ability to explain the benefits of carrying out a postcompletion audit of a project.
May 2011
13
P1
Performance Pillar
Wednesday 31 August 2011
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2011
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
Which of the following would never be considered a feature of factoring?
A
The factoring company charges a fee for its services.
B
Interest is charged on the amount advanced to the client from the date of the advance
until the debt is settled by the client’s customer.
C
The factoring company advances a percentage of the invoice value immediately, with
the remainder being paid when the client’s customer settles the debt.
D
The borrowing is repayable over a number of years.
(2 marks)
Performance Operations
2
September 2011
1.2
A marketing manager is trying to decide which of four potential selling prices to charge
for a new product. The state of the economy is uncertain and may show signs of
recession, growth or boom. The manager has prepared a regret matrix showing the
regret for each of the possible outcomes depending on the decision made.
Regret Matrix
State of the
economy
Selling price
$40
$45
$50
$55
Boom
$10,000
$0
$20,000
$30,000
Growth
$20,000
$10,000
$0
$20,000
Recession
$0
$10,000
$20,000
$30,000
If the manager applies the minimax regret criterion to make decisions, which selling
price would be chosen?
A
$40
B
$45
C
$50
D
$55
(2 marks)
1.3
A decision maker that makes decisions using the minimax regret criterion would be
classified as:
A
Risk averse
B
Risk seeking
C
Risk neutral
D
Risk spreading
(2 marks)
Section A continues on the next page
TURN OVER
September 2011
3
Performance Operations
1.4
A company is offering its customers the choice of a cash discount of 3% for payment
within 15 days of the invoice date or paying in full within 45 days.
The effective annual interest rate of the cash discount is:
A
43.3%
B
12.5%
C
44.9%
D
24.7%
(2 marks)
1.5
AB’s estimated trade receivables outstanding at the end of this year are the equivalent
of 60 days’ credit sales. Credit sales for this year are projected to be $682,000. AB is
preparing the budget for next year and estimates that credit sales will increase by 15%.
The trade receivables amount, in $, outstanding at the end of next year is anticipated to
be the same as at the end of this year.
The budgeted trade receivable days at the end of next year, to the nearest day, will be:
A
52 days
B
69 days
C
51 days
D
60 days
(2 marks)
1.6
PJ has budgeted sales for the next two years of 144,000 units per annum spread
evenly throughout each year. The estimated closing inventory at the end of this year is
6,500 units. PJ wants to change its inventory policy so that it holds inventory equivalent
to one month’s sales. The change in inventory policy will take place at the beginning of
next year and will apply for the next two years.
Each unit produced requires 2 hours of direct labour. The budgeted direct labour rate
per hour is $15. It is anticipated that 80% of production will be paid at the budgeted rate
and the remainder will be paid at the overtime rate of time and a half. PJ treats
overtime costs as part of direct labour costs.
Required:
Calculate the direct labour cost budget for the next year.
(3 marks)
Performance Operations
4
September 2011
1.7
An investor is considering purchasing a bond with a par value of $100 and a coupon
rate of 8% payable annually. The bond is redeemable at par in 6 years’ time. Bonds
with the same level of risk have a yield to maturity of 7%.
Required:
Calculate the price the investor should pay for the bond if the first interest payment will
be paid one year after the date of purchase.
(3 marks)
1.8
FP can choose from three mutually exclusive projects. The net cash flows from the
projects will depend on market demand. All of the projects will last for only one year.
The forecast net cash flows and their associated probabilities are given below:
Market demand
Probability
Weak
0.30
Average
0.50
Good
0.20
Project A
Project B
Project C
$000
400
300
500
$000
500
350
450
$000
600
400
650
Required:
(i)
Calculate the expected value of the net cash flows from each of the THREE
projects.
(ii)
Calculate the value of perfect information regarding market demand.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
September 2011
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
Explain the advantages of management participation in budget setting and the
potential problems that may arise in the use of the resulting budget as a control
mechanism.
(5 marks)
(b)
Explain the advantages AND disadvantages of an overdraft as a method of short-term
finance for a company.
(5 marks)
(c)
A company is considering whether to develop an overseas market for its products. The
cost of developing the new market is estimated to be $250,000. There is a 70%
probability that the development of the new market will succeed and a 30% probability
that the development of the new market will fail and no further expenditure will be
incurred.
If the market development is successful the profit from the new market will depend on
prevailing exchange rates. There is a 50% chance that exchange rates will be in line
with expectations and a profit of $500,000 will be made. There is a 20% chance that
exchange rates will be favourable and a profit of $630,000 will be made and a 30%
chance that exchange rates will be adverse and a profit of $100,000 will be made.
The profit figures stated are before taking account of the development costs of
$250,000.
Required:
Demonstrate, using a decision tree, whether the company should develop an overseas
market for its products.
(5 marks)
Performance Operations
6
September 2011
(d)
ST needs to replace its fleet of delivery vans and is considering two alternative types of
van as the replacement. One of the vans has an estimated life of 4 years whilst the
other has an estimated life of 5 years. The vans will be required for the foreseeable
future.
The estimated cash flows over the life of the van are given below:
Year
0
1
2
3
4
5
Van A
$
(25,000)
(2,000)
(2,000)
(3,000)
5,000
Van B
$
(30,000)
(3,000)
(3,000)
(3,000)
(4,000)
6,000
The company’s cost of capital is 8% per annum.
Required:
Demonstrate, by calculation, which of the two vans should be purchased.
(5 marks)
(e)
When deciding where to invest short term cash surpluses, it is necessary to consider
the following two types of risk:
(i)
(ii)
Default risk
Interest rate risk
Required:
Explain what is meant by each of the TWO types of risk listed above. Your answer
should include an example of each type of risk.
(5 marks)
Section B continues on the next page
TURN OVER
September 2011
7
Performance Operations
(f)
A company manufactures two products A and B. The budget statement below was
produced using a traditional absorption costing approach. It shows the profit per unit for
each product based on the estimated sales demand for the period.
Product A
$
46
Selling price per unit
Product B
$
62
Production costs per unit:
Material costs
Labour costs
Overhead costs
18
4
8
16
10
12
Profit per unit
16
24
6,000
0.5
8,000
0.8
Additional information:
Estimated sales demand (units)
Machine hours per unit
It has now become apparent that the machine which is used to produce both products
has a maximum capacity of 8,000 hours and the estimated sales demand cannot be
met in full. Total production costs for the period, excluding direct material cost, are
$248,000. No inventories are held of either product.
Required:
(i)
Calculate the return per machine hour for each product if a throughput
accounting approach is used.
(2 marks)
(ii)
Calculate the profit for the period, using a throughput accounting approach,
assuming the company prioritises Product B.
(3 marks)
(Total for sub-question (f) = 5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 10
Performance Operations
8
September 2011
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A furniture company manufactures high quality dining room furniture that is sold to major retail
stores.
Extracts from the budget for last year are given below:
Tables
Chairs
Sideboards
Sales quantity (units)
8,000
26,000
6,000
Average selling price
$2,200
$320
$2,800
Direct material cost per unit
$1,000
$160
$1,200
$400
$60
$600
$40
$6
$60
Tables
Chairs
Sideboards
Sales quantity (units)
7,200
31,000
7,800
Average selling price
$2,400
$310
$2,500
Direct material cost per unit
$1,100
$150
$1,300
$450
$60
$600
$60
$8
$80
Direct labour cost per unit
Variable overhead cost per unit
The budgeted direct labour cost per hour was $20.
Actual results for last year were as follows:
Direct labour cost per unit
Variable overhead cost per unit
The actual direct labour cost per hour was $18.75.
Actual variable overhead cost per direct labour hour was $2.50.
The company operates a just-in-time system for purchasing and production and does not hold
any inventory.
Performance Operations
10
September 2011
Required:
(a)
Calculate the following variances for the furniture company for last year:
(i)
the sales mix contribution variance
(ii)
the sales quantity contribution variance
(3 marks)
(3 marks)
(b)
Explain the meaning of the variances calculated in (a) above.
You should refer to the figures calculated to illustrate your answer.
(5 marks)
(c)
Prepare, for sideboards only, a statement for last year on a marginal cost
basis that reconciles the budgeted contribution to the actual contribution.
The statement should show the variances in as much detail as possible.
(11 marks)
(d)
Explain THREE factors that a company would need to consider before
deciding whether to investigate a variance.
(3 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
September 2011
11
Performance Operations
Question Four
A major retail company which sells its ‘own brand’ products is deciding whether to open new
retail outlets in a rapidly expanding overseas market. Past experience from entering other
overseas markets has shown that acceptance of the brand can depend on a number of
factors and that sales in the first four years are a good indicator of the potential of the market
for the future.
Year 1 sales will depend on how readily the brand is accepted. A consultancy firm, with
experience of the overseas market, was employed at a cost of $0.5m to provide detailed
information on the market and an estimate of the likelihood of the brand being accepted. The
consultancy firm estimated that there is a 50% chance that the brand will be well received and
sales in year 1 will be $450m, there is a 20% chance that the brand will be very well received
and sales in year 1 will be $600m, and there is a 30% chance that the brand will not be well
received and sales in year 1 will be $300m. Sales are then expected to increase by $100m
each year, irrespective of sales in the first year.
An investment of $600m is required to develop and fit out the retail outlets. The costs will be
depreciated on a straight line basis over the four year period. The development and fit out
costs will be eligible for tax depreciation. It is expected that the retail outlets will have a
residual value of $400m at the end of four years. The residual value will be treated for tax
purposes as a balancing adjustment. There will also be a requirement for $60m of working
capital.
The average contribution to sales ratio is expected to be 60%. Fixed costs relating to the retail
outlets, including depreciation, are expected to be $150m per annum and will remain the
same for the four year period. It is also anticipated that a further $50m will be spent in each of
the four years on marketing the brand.
The company’s financial director has provided the following taxation information:
•
•
•
Tax depreciation: 25% reducing balance per annum.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid in the following year.
Any taxable losses resulting from this investment can be set against profits made by the
company’s other business activities.
The company uses a post-tax cost of capital of 8% per annum to evaluate projects of this
type. Ignore inflation.
Performance Operations
12
September 2011
Required:
(a)
Advise the directors of the company whether they should go ahead with
the investment from a financial perspective.
You should use net present value (NPV) as the basis of your evaluation.
Workings should be shown in $millions ($m).
(12 marks)
(b)
(i)
Calculate the sensitivity of the investment decision to a change in the
level of annual fixed cost relating to the retail outlets i.e. not including the
marketing costs.
(4 marks)
(ii)
Explain the benefits of carrying out a sensitivity analysis before making
investment decisions.
(3 marks)
(c)
(i)
Calculate the payback period of the project.
(2 marks)
(ii)
Explain the reasons why a company’s management may be interested in
the payback period of a project. You should use the scenario given above
to illustrate your answer.
(4 marks)
Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
September 2011
13
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is D.
1.2
The maximum regret at a selling price of $40 is $20,000
The maximum regret at a selling price of $45 is $10,000
The maximum regret at a selling price of $50 is $20,000
The maximum regret at a selling price of $55 is $30,000
Therefore if the manager wants to minimise the maximum regret, a
selling price of $45 will be selected.
The correct answer is B.
1.3
The correct answer is A.
1.4
Payment will be made 30 days early.
Number of compounding periods = 365/30 = 12.167
 1.00  12.167
1+ r = 

 0.97 
1+ r = 1.4486
The effective annual cost of the cash discount is 44.9%
The correct answer is C.
September 2011
1
P1
1.5
[$682,000/365] x 60 = $112,110
[$112,110 / (682,000 x 1.15)] x 365 = 52.17 days
The correct answer is A.
1.6
Budgeted sales
Plus Closing inventory
Less Opening Inventory
Budgeted Production
144,000
12,000
(6,500)
149,500
units
units
units
units
149,500 x 2 hours per unit = 299,000 hours
80% x 299,000 = 239,200 hours x $15 = $3,588,000
20% x 299,000 = 59,800 hours x $(15 x1.5) = 1,345,500
Total labour cost budget = $4,933,500
1.7
Year(s)
Description
Cash flow
$
Discount
Factor (7%)
1-6
6
PV
Interest
Redemption
8
100
4.767
0.666
Present
Value
$
38.14
66.60
104.74
The investor should pay $104.74.
1.8
(i)
Expected values ($000)
Project A ($400 x 0.3) + ($500 x 0.5) + ($600 x 0.2) = $490
Project B ($300 x 0.3) + ($350 x 0.5) + ($400 x 0.2) = $345
Project C ($500 x 0.3) + ($450 x 0.5) + ($650 x 0.2) = $505
(ii)
Value of perfect information ($000)
If weak select Project C = ($500 x 0.3) = $150
If average select Project A = ($500 x 0.5) = $250
If good select Project C = ($650 x 0.2) = $130
Value of perfect information is ($530 – $505) = $25
P1
2
September 2011
SECTION B
Answer to Question Two
(a)
One of the main purposes of budgeting is to act as a control mechanism, with actual results
being compared against budget. Another purpose of a budget is to set targets to motivate
managers and optimise their performance. The participation of managers in the budget
setting process has several advantages. Managers are more likely to be motivated to achieve
the target if they have participated in setting the target. Participation can reduce the
information asymmetry gap that can arise when targets are imposed by senior management.
Imposed targets are likely to make managers feel demotivated and alienated and result in
poor performance. Participation however can cause problems; in particular, managers may
attempt to negotiate budgets that they feel are easy to achieve which gives rise to ‘budget
padding’ or budgetary slack. They may also be tempted to ‘empire build’ because they believe
that the size of their budget reflects their importance within the organisation. This can result in
budgets that are unsuitable for control purposes.
(b)
Advantages
Flexibility: the bank will agree an overdraft limit or facility. The borrower may not require the
full facility immediately but may draw funds up to the limit as and when required. If the funds
are no longer required they can be repaid without suffering any penalty.
Minimal documentation: legal documentation is fairly minimal when arranging an overdraft.
The documents will state the maximum overdraft limit, the interest payable and the security
required.
An overdraft is seen as a relatively cheap source of finance. Banks usually charge between 2
and 5% above base rate depending on the creditworthiness and security offered by the
borrower. Savings come from the fact that interest is only paid on the daily outstanding
balance therefore a large cash inflow can offset the balance outstanding and temporarily lower
the interest payable, whilst still retaining the ability to borrow up to the overdraft limit when
required.
Disadvantages
An overdraft is strictly speaking repayable on demand.
The interest rate payable will vary depending on the perceived credit risk of the borrower.
Banks will normally expect security either in the form of a fixed charge or a
floating charge.
September 2011
3
P1
(c)
Decision tree: Develop an overseas market or not
$500,000
In-line
50%
Succeed
70%
$406,000
$630,000
Favourable
20%
Develop
$250,000
Adverse
30%
$284,200
$100,000
$34,200
Fail
30%
$0
Don’t
Develop
$0
Therefore the overseas market should be developed
P1
4
September 2011
(d)
Year
0
1
2
3
4
5
Present
Value
Cumulative
discount
factor
Annualised
equivalent
Discount
Factor @
8%
1.000
0.926
0.857
0.794
0.735
0.681
Van A
Cash Flows
Present
$
Value
$
(25,000)
(25,000)
(2,000)
(1,852)
(2,000)
(1,714)
(3,000)
(2,382)
5,000
3,675
(27,273)
Van B
Cash Flows
Present
$
value
$
(30,000)
(30,000)
(3,000)
(2,778)
(3,000)
(2,571)
(3,000)
(2,382)
(4,000)
(2,940)
6,000
4,086
(36,585)
3.312
3.993
8,234
9,162
The lowest annualised equivalent cost is for Van A therefore the company should replace its
fleet of delivery vans with Van A.
(e)
Default risk
This refers to potential doubt about the payment of interest or the eventual repayment of the
capital invested. Investments in government securities are generally considered to have very
low default risk however the recent financial crisis has shown that even investment in
government securities is not risk free. Investment in equities is generally considered high risk
and is not a suitable form of short-term investment.
Interest rate risk
This refers to the risk that market interest rates will change and the investor will be worse off.
Interest rates cannot be predicted with any degree of accuracy. Variable rate bank deposits
will leave the company vulnerable to a fall in interest rates. If the investment is in a fixed rate
term deposit, whilst the investor will receive a guaranteed return, there will be an opportunity
cost if market interest rates increase above the fixed rate.
September 2011
5
P1
(f)
(i)
Product A
$
46
(18)
28
0.5 hours
56
Selling price
Material cost
Throughput contribution
Machine hours per unit
Return per machine hour
Product B
$
62
(16)
46
0.8 hours
57.50
(ii)
Return per machine
hour
Ranking
Units produced
Machine hours
Contribution per
machine hour
Total contribution
Factory costs
Total profit
P1
Product A
Product B
$56
$57.50
2
3,200
1,600
$56
1
8,000
6,400
$57.5
$89,600
$368,000
6
Total
8,000
$457,600
$248,000
$209,600
September 2011
SECTION C
Answer to Question Three
(a)
Tables
(per unit)
$
2,200
1,000
400
40
760
Selling price
Direct material
Direct labour
Variable overheads
Contribution
Chairs
(per unit)
$
320
160
60
6
94
Sideboards
(per unit)
$
2,800
1,200
600
60
940
Sales Mix Contribution Variance
Actual Sales
Quantity
Actual Sales
at budget mix
7,200
31,000
7,800
46,000
9,200
29,900
6,900
46,000
Tables
Chairs
Sideboards
Difference
2,000 A
1,100 F
900 F
Variance from
weighted average
contribution per
unit
($760 - $354.10)
($94 - $354.10)
($940 - $354.10)
Variance
$000
811.80 A
286.11 A
527.31 F
570.60 A
Or alternatively:
Actual Sales
Quantity
Tables
Chairs
Sideboards
7,200
31,000
7,800
46,000
Difference
Actual Sales
at budget
mix
9,200
29,900
6,900
46,000
Contribution
$
Variance
$000
760
94
940
1,520 A
103.4 F
846 F
570.6 A
2,000 A
1,100 F
900 F
Sales Quantity Contribution Variance
Tables
Chairs
Sideboards
Budget Sales
Quantity
8,000
26,000
6,000
40,000
Actual Sales at
budget mix
9,200
29,900
6,900
46,000
Difference
1,200 F
3,900 F
900 F
6,000 F
Contribution
$
760
94
940
Variance
$000
912 F
366.6 F
846 F
2,124.6 F
Or alternatively:
Budget Sales Quantity
Tables
Chairs
Sideboards
8,000
26,000
6,000
40,000
Contribution
$
760
94
940
Total Contribution
$000
6,080
2,444
5,640
14,164
Weighted average contribution = $14,164k / 40,000 = $354.10
Sales quantity contribution variance = (46,000 – 40,000) x $354.10 = $2,124.6 F
September 2011
7
P1
(b)
The sales quantity contribution variance and the sales mix contribution variance explain how
the sales volume contribution variance has been affected by a change in the total quantity of
sales and a change in the relative mix of products sold. From the figures calculated for the
sales quantity contribution variance in part (a) we can say that the increase in total quantity
sold would have earned an additional contribution of $2,124,600, if the actual sales volume
had been in the budgeted sales mix. The sales mix contribution variance shows that the
change in the sales mix resulted in a reduction in profit of $570,600. The change in the sales
mix has resulted in a relatively higher proportion of sales of chairs which is the product that
earns the lowest contribution and a lower proportion of tables which earn a contribution
significantly higher than the weighted average contribution. The relative increase in the sale of
sideboards however, which has the highest unit contribution, has partially offset the switch in
mix to chairs.
(c)
Reconciliation statement for Sideboards
$000
$000
Original budget contribution
6,000 units x $940 per unit
Sales volume contribution variance
(7,800 units - 6,000 units) x $940
Budget contribution at actual level of activity
(7,800 units x $940 per unit)
Other variances:
5,640
1,692 F
7,332
Selling price variance
7,800 units x ($2,500 - $2,800)
Direct material variance
7,800 x (1,200 – 1,300)
Direct labour rate variance
((7,800 x $600) / $18.75) x ($20 - $18.75)
Direct labour efficiency variance
(7,800 x (30 hrs per unit – 32 hrs per unit)) x $20
Variable overhead expenditure variance
(7,800 x 30 hrs) x ($2 - $2.50)
Variable overhead efficiency variance
7,800 x (30 hrs per unit – 32 hrs per unit) x $2.50
Actual contribution
7,800 units x $520
2,340 A
780 A
312 F
312 A
124.8A
31.2 A
4,056
Workings:
Sales revenue
Direct material
Direct labour
Variable overhead
Contribution
P1
Standard
contribution
per unit
$
2,800
1,200
600
60
940
Flexed budget
7,800
units
$000
21,840
9,360
4,680
468
7,332
8
Actual
contribution per
unit
$
2,500
1,300
600
80
520
Total actual
contribution
$000
19,500
10,140
4,680
624
4,056
September 2011
(d)
1.
The size of the variance – costs tend to fluctuate around a norm and therefore
variances may be expected on most costs. The company will need to decide how large
a variance must be before it is considered ‘abnormal’ and worthy of investigation.
2.
The likelihood of the variance being controllable – managers may know from
experience that certain variances may not be controllable even if a lengthy investigation
is undertaken to determine their cause. Managers may argue that a material price
variance is less easily controlled than a material usage variance as it is determined by
external factors. On the other hand a material price variance may be due to the
efficiency of the purchasing department and this would only be apparent after further
investigation.
3.
The likely cost versus the potential benefits of the investigation – the cost of the
investigation would need to be weighed against the cost that would be incurred if the
variance were allowed to continue in future periods.
Other acceptable factors could be:
•
•
September 2011
The interrelationship between variances
The type of standard that was set
9
P1
Answer to Question Four
(a)
Year 1 expected sales revenue = ($450m x 50%) + ($300m x 30%) + ($600m x 20%) =
$435m
Year 2 sales revenue = $435m +100m = $535m
Year 3 sales revenue = $535m + 100m = $635m
Year 4 sales revenue = $635m + 100 = $735m
Contribution Year 1 = $435m x 60% = $261m
Contribution Year 2 = $535m x 60% = $321m
Contribution Year 3 = $635m x 60% = $381m
Contribution Year 4 = $735m x 60% = $441m
Fixed Costs
Depreciation per annum ($600m - $400m) / 4 = $50m
Fixed costs excluding depreciation = $150m - $50m = $100m
Cash Flows
Contribution
Fixed Costs
Marketing Costs
Net cash flows
Year 1
$m
261
Year 2
$m
321
Year 3
$m
381
Year 4
$m
441
(100)
(50)
111
(100)
(50)
171
(100)
(50)
231
(100)
(50)
291
Year 1
$m
111
(150)
Year 2
$m
171
(113)
Year 3
$m
231
(84)
Year 4
$m
291
147
(39)
12
58
(17)
147
(44)
438
(131)
Taxation
Net cash flows
Tax
Depreciation
Taxable profit
Taxation @ 30%
Net present value
Year 0
$m
Development
(600)
and fit out
costs
Working
(60)
capital
Net cash
flows
Tax payment
Year 1
$m
Year 2
$m
P1
Year 4
$m
400
Year 5
$m
60
111
171
231
291
6
(9)
(22)
(66)
6
(8)
(22)
(65)
168
201
663
(65)
Tax payment
Net cash flow
(660)
after tax
Discount
1.000
factors @ 8%
Present
(660)
value
Net present value = $195m
Year 3
$m
117
0.926
0.857
108
144
10
0.794
160
0.735
487
0.681
(44)
September 2011
The net present value is positive therefore on this basis the company should go ahead with
the project.
(b)
(i)
Fixed costs
Tax @ 30%
Tax
payment
Net cash
flow
Discount
Factor @
8%
Present
value
Year 1
$m
100
Year 2
$m
100
Year 3
$m
100
Year 4
$m
100
30
(15)
30
(30)
30
(30)
30
(30)
(15)
85
70
70
70
(15)
0.926
79
0.857
0.794
60
56
0.735
51
Year 5
$m
Total
$m
0.681
(10)
236
$195 / $236 = 82.6%
If fixed costs increase by more than 82.6% the NPV of the project will be negative and the
decision will be to reject the project.
(ii)
Sensitivity analysis recognises the fact that not all cash flows for a project are known with
certainty. Sensitivity analysis enables a company to determine the effect of changes to
variables on the planned outcome. Particular attention can then be paid to those variables
that are identified as being of special significance. In project appraisal, an analysis can be
made of all the key input factors to ascertain by how much each factor would need to change
before the net present value (NPV) reaches zero i.e. the indifference point. Alternatively,
specific changes can be calculated to determine the effect on NPV.
(c)
(i)
Net cash
flows
Cumulative
cash flows
Year 0
$m
(660)
Year 1
$m
117
Year 2
$m
168
Year 3
$m
201
(660)
(543)
(375)
(174)
Year 4
$m
663
Year 5
$m
(65)
Payback period
3 yrs + (174 / 663) x 12 = 3 yr 3 months
(ii)
Projects which return their cash outlay quicker can be seen as less risky. Payback is therefore
used by companies at an early stage to eliminate projects that have unacceptable risk and
return characteristics. In this case there is uncertainty surrounding the potential of the market
September 2011
11
P1
and the management may be concerned to ensure that the payback period is relatively short
in the event that it becomes necessary to withdraw from the market. Alternatively, a long
payback period may persuade management not to enter the market in the first place.
Payback is also seen as useful when funds are in short supply since early payback of funds
allows investment in other profitable opportunities. Payback is also easy to use and is a
simple way to communicate project acceptability to managers.
P1
12
September 2011
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
The question assesses learning outcome B1(b) explain the purposes of budgeting,
including planning, communication, co-ordination, motivation, authorisation, control and
evaluation, and how these many conflict. It examines candidates’ ability to explain the
behavioural consequences of budgeting and the difficulties and conflicts that can arise.
(b)
The question assesses learning outcome E2(a) identify sources of short-term funding.
It examines candidates’ ability to discuss the advantages and disadvantages of an
overdraft as a method of short term finance.
(c)
The question assesses learning outcome D1(f) apply decision trees. It examines
candidates’ ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.
(d)
The question assesses learning outcome C1(g) prepare decision support information
for management, integrating financial and non-financial considerations. It examines
candidates’ ability to compare two alternatives investments that have unequal lives.
(e)
The question assesses learning outcome E2(b) identify alternatives for investment of
short-term cash surpluses. It examines candidates’ ability to explain the risk factors that
a company needs to consider when making short term investment decisions.
(f)
The question assesses learning outcome A1(a) compare and contrast marginal (or
variable), throughput and absorption accounting methods in respect of profit reporting
and stock valuation. It examines candidates’ ability to calculate the return per machine
hour using a throughput accounting approach and calculate profit on a throughput
accounting basis.
Section C – Questions Three and Four - Compulsory
Question Three The question assesses a number of learning outcomes. Part (a) assesses
learning outcome A1(d) apply standard costing methods, within costing systems, including the
reconciliation of budgeted and actual profit margins. It examines candidates’ ability to
calculate sales mix and sales quantity variances. Part (b) assesses learning outcome A1(f)
interpret material, labour, variable overhead, fixed overhead and sales variances,
distinguishing between planning and operational variances. It examines candidates’ ability to
explain the meaning of the two variances calculated in part (a).Part (c) also assesses learning
outcome A1(d) apply standard costing methods, within costing systems, including the
reconciliation of budgeted and actual profit margins and examines candidates’ ability to
reconcile the budgeted and actual contribution for one of the products. Part (d) also assesses
learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and sales
variances, distinguishing between planning and operational variances. It examines
September 2011
13
P1
candidates’ ability to explain the factors that a company would use to determine whether a
variance was significant and required investigation.
Question Four Part (a) assesses learning outcomes C1(b) apply the principles of relevant
cash flow analysis to long-run projects that continue for several years and learning outcome
C2(a) evaluate project proposals using the techniques of investment appraisal. It examines
candidates’ ability to identify the relevant costs of a project and then apply discounted cash
flow analysis to calculate the net present value of the project. Part (b) assesses learning
outcome C1(f) apply sensitivity analysis to cash flow parameters to identify those to which net
present value is particularly sensitive. It examines candidates’ ability to calculate the
sensitivity of one variable and then to explain the benefits in carrying out sensitivity analysis.
Part (c) (i) also assesses learning outcome C2(a) evaluate project proposals using the
techniques of investment appraisal. It examines candidates’ ability to calculate the payback
period of a project. Part (c)(ii) assesses learning outcome C2(b) compare and contrast the
alternative techniques of investment appraisal. It examines the candidates’ ability to discuss
why payback might be used in practice despite its theoretical disadvantages.
P1
14
September 2011
Performance Pillar
23 November 2011 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2011
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
A decision maker who makes decisions using the maximin criterion would be classified
as:
A
Risk averse
B
Risk seeking
C
Risk neutral
D
Risk spreading
(2 marks)
1.2
A flexible budget is a budget that is
A
set prior to the control period and not subsequently changed in response to changes in
activity, costs or revenues
B
continuously updated by adding a further accounting period when the earliest
accounting period has expired
C
changed in response to changes in the level of activity
D
changed in response to changes in costs
(2 marks)
Performance Operations
2
November 2011
1.3
NG is deciding which of four potential venues should be used to stage an entertainment
event. Demand for the event may be low, medium or high depending on weather
conditions on the day. The management accountant has estimated the contribution that
would be earned for each of the possible outcomes and has produced the following
regret matrix:
Regret Matrix
Venue
Ayefield
$
Beefield
$
Ceefield
$
Deefield
$
0
200,000
300,000
450,000
Medium
330,000
110,000
0
150,000
High
810,000
590,000
480,000
0
Demand
Low
If the company applies the minimax regret criterion the venue chosen would be
A
Ayefield
B
Beefield
C
Ceefield
D
Deefield
(2 marks)
Section A continues on the next page
TURN OVER
November 2011
3
Performance Operations
The following data are given for sub-questions 1.4 and 1.5 below
JD is a retailer of storage boxes. Annual demand is 39,000 units spread evenly
throughout the year. Ordering costs are $100 per order and the cost of holding one
storage box in inventory for one year is $1.60. It takes two weeks for an order to be
delivered to JD’s premises.
1.4
The economic order quantity (EOQ) for the storage boxes is
A
1,746 units
B
2,208 units
C
2,793 units
D
1,248 units
(2 marks)
1.5
The re-order level that would ensure that JD never runs out of inventory of storage
boxes is
A
1,560 units
B
4,416 units
C
3,492 units
D
1,500 units
(2 marks)
1.6
TM’s customers all pay their invoices at the end of an agreed 30 day credit period. In
an attempt to improve cash flow, TM is considering offering all customers a 2.0%
discount for payment within 7 days.
Required:
Calculate, to the nearest 0.1%, the effective annual interest rate to TM of offering the
discount. You should assume a 365 day year and use a compound interest
methodology.
(3 marks)
1.7
PJ is considering building a warehouse on a piece of land which will be leased at an
annual cost of $4,000 in perpetuity. The lease payments will be made annually in
advance.
PJ has a cost of capital of 12% per annum.
Required:
Calculate the present value of the lease payments.
(3 marks)
Performance Operations
4
November 2011
1.8
A company has budgeted to produce 5,000 units of Product B per month. The opening
and closing inventories of Product B for next month are budgeted to be 400 units and
900 units respectively. The budgeted selling price and variable production costs per
unit for Product B are as follows:
Selling price
Direct costs
Variable production overhead costs
$ per unit
20.00
6.00
3.50
Total budgeted fixed production overheads are $29,500 per month.
The company absorbs fixed production overheads on the basis of the budgeted
number of units produced. The budgeted profit for Product B for next month, using
absorption costing, is $20,700.
Required:
(i)
Prepare a marginal costing statement which shows the budgeted profit for
Product B for next month.
(ii)
Explain, using appropriate calculations, why there is a difference between the
profit figures for the month using marginal costing and using absorption costing.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
November 2011
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
CH is a building supplies company that sells products to trade and private customers.
Budget data for each of the six months to March are given below:
Credit sales
Cash sales
Credit purchases
Other operating costs
(excluding depreciation)
Oct
$000
250
60
170
90
Nov
$000
250
60
180
90
Dec
$000
250
65
180
90
Jan
$000
260
75
200
122
Feb
$000
260
80
200
123
March
$000
280
90
200
123
80% of the value of credit sales is received in the month after sale, 10% two months
after sale and 8% three months after sale. The balance is written off as a bad debt.
75% of the value of credit purchases is paid in the month after purchase and the
remaining 25% is paid two months after purchase.
All other operating costs are paid in the month they are incurred.
CH has placed an order for four new forklift trucks that will cost $25,000 each. The
scheduled payment date is in February.
The cash balance at 1 January is estimated to be $15,000.
Required:
Prepare a cash budget for each of the THREE months of January, February and
March.
(5 marks)
Performance Operations
6
November 2011
(b)
GT is considering building a restaurant in a new retail park.
It can build either a small restaurant or a large restaurant. Since there are strict local
planning regulations, once GT has committed to the size of restaurant it cannot be
extended later.
Past experience suggests that there is a 60% chance that demand will be high and a
40% chance that demand will be low. Estimates of the net present values of the future
cash flows for GT associated with each size of restaurant are as follows:
Demand
Size of restaurant
Low
$
800,000
(1,000,000)
Small
Large
High
$
1,200,000
2,000,000
Required:
(i)
Demonstrate, using a decision tree, which course of action GT should pursue.
(3 marks)
(ii)
GT could commission a market research survey that will give an accurate prediction of
the level of demand.
Required:
Calculate the maximum price that GT should pay for the market research survey.
(2 marks)
(Total for sub-question (b) = 5 marks)
(c)
Discuss TWO sources of information that a company could use when setting credit
limits for customers.
(5 marks)
(d)
Explain THREE benefits that a company could gain from using environmental costing.
(5 marks)
November 2011
7
Performance Operations
(e)
A company is planning to launch a new product. The price at which it can sell the
product will be determined by the number of other entrants into the market. The
possible selling prices and variable costs and their respective associated probabilities
are as follows:
Selling price per unit
$
Probability
80
0·25
100
0·30
120
0·45
Variable cost per unit
$
Probability
40
0·20
60
0·55
80
0·25
Selling price and variable cost per unit are independent of each other.
Required:
(i) Calculate the probability of the contribution being greater than $39 per unit.
(3 marks)
(ii) Calculate the expected value of the contribution per unit.
(2 marks)
(Total for sub-question (e) = 5 marks)
(f)
Explain THREE benefits that organisations gain from using budgetary planning and
control systems.
(5 marks)
(Total for Section B = 30 marks)
End of section B. Section C begins on page 10
Performance Operations
8
November 2011
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
TP makes wedding cakes that are sold to specialist retail outlets which decorate the cakes
according to the customers’ specific requirements. The standard cost per unit of its most
popular cake is as follows:
$
Direct material:
Ingredient A
Ingredient B
Ingredient C
Direct labour
Variable overhead
Standard cost
4 kg at $25 per kg
3 kg at $22 per kg
2 kg at $11.50 per kg
3 hours at $12 per hour
3 hours at $8 per hour
100
66
23
36
24
249
The budgeted production for the period was 10,000 units.
Actual results for the period were as follows:
Production (units)
Direct material:
Ingredient A
Ingredient B
Ingredient C
Direct labour
Variable overhead
9,000
$
35,000 kg
28,000 kg
27,000 kg
30,000 hours
910,000
630,000
296,000
385,000
230,000
The general market prices at the time of purchase for Ingredient A and Ingredient B were $23
per kg and $20 per kg respectively.
TP operates a JIT purchasing system for ingredients and a JIT production system; therefore
there was no inventory during the period.
Performance Operations
10
November 2011
Required:
(a)
Prepare a statement which reconciles the flexed budget material cost and
the actual material cost. Your statement should include the material price
planning variances, and the operational variances including material price,
material mix and material yield.
(12 marks)
(b)
Discuss the usefulness of the planning and operational variances
calculated in part (a) for TP’s management.
(5 marks)
The budgeted selling price for the product is $400 per unit. Budgeted sales volume for
the period was 10,000 units. Actual results for the period were as follows:
Sales volume
Sales revenue
9,000 units
$3,456,000
Required:
(c)
Calculate the total sales price variance and the total sales volume
contribution variance.
(4 marks)
(d)
Explain the benefits that TP should gain from operating a JIT purchasing
system for materials.
(4 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
November 2011
11
Performance Operations
Question Four
GR is an outsourcing company that provides call centre services to a range of clients. As a
result of technical advances in telecommunication equipment, the company’s existing
telephone system is out-dated and inefficient and needs to be replaced. A technical
consultant, hired at a cost of $80,000, has prepared a report outlining two possible
replacement systems. The details of each system are as follows:
System 1
System 2
Initial investment
$600,000
$800,000
Estimated useful life
Residual value
Contribution per annum
Fixed maintenance costs per annum
Other fixed operating costs per annum
3 years
$60,000
$580,000
$20,000
$360,000
5 years
$50,000
$600,000
$40,000
$305,000
The maintenance costs are payable annually in advance. All other cash flows apart from the
initial investment should be assumed to occur at the end of each year.
Depreciation has been calculated using the straight line method and has been included in
other fixed operating costs.
The company uses a cost of capital of 12% per annum to evaluate projects of this type.
Required:
(a)
Prioritise the two systems using an annualised equivalent approach. You
should ignore taxation and inflation. Your workings should be shown in
$000.
(12 marks)
(b)
(i)
Explain the purpose of sensitivity analysis in investment appraisal.
(4 marks)
(ii)
Calculate the sensitivity of your recommendation in part (a) to changes in
the contribution generated by System 1.
(4 marks)
Performance Operations
12
November 2011
The company’s financial director has provided the following taxation information:
•
•
Tax depreciation: 25% of the reducing balance per annum, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid in the following year.
Required:
(c)
Calculate, for System 2, the tax depreciation and the resulting tax cash
flows for each year. Your workings should be shown in $000.
(5 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
November 2011
13
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is A.
1.2
The correct answer is C.
1.3
The maximum regret if the Ayefield venue is chosen is $ 810,000
The maximum regret if the Beefield venue is chosen is $ 590,000
The maximum regret if the Ceefield venue is chosen is $ 480,000
The maximum regret if the Deefield venue is chosen is $ 450,000
Therefore if NG wants to minimise the maximum regret it should stage the
entertainment event at the Deefield venue.
The correct answer is D.
1.4
EOQ =
2C o D
Ch
Where:
Co = (cost per order) = $100
D = (annual demand) = 39,000 units
Ch = (cost of holding one unit for one year) = $1.60
EOQ =
2 × 100 × 39,000
1.6
The correct answer is B.
November 2011
1
P1
1.5
JD must be certain that there is sufficient inventory available to satisfy demand
throughout the two weeks lead time. Therefore JD must place an order for storage
crates when there is the equivalent of two weeks demand in inventory.
The reorder level is therefore 39,000 x
2/
52
= 1,500 units.
The correct answer is D.
1.6
Payment will be made 23 days early.
Number of compounding periods = 365/23 = 15.86957
1+ r = (1.00/0.98)
15.86957
1+ r = 1.37797
The effective annual rate of the early settlement discount is 37.8%
1.7
The first lease payment is made in advance i.e. in Year 0
Time
0
1-∞
Present Value
Cash flow
$
(4,000)
(4,000)
Discount factor 12%
1.0000
1 / 0.12 = 8.3333
Present value
$
(4,000)
(33,333)
(37,333)
The present value of the lease payments is $37,333.
1.8
(i)
Contribution per unit = $20 – ($6.00 + $3.50) = $10.50
Number of units sold = 400 units + 5,000 units – 900 units = 4,500 units
Marginal costing statement
$
90,000
42,750
47,250
29,500
17,750
Sales revenue (4,500 x $20)
Variable costs (4,500 x $9.50)
Total contribution (4,500 x $10.50)
Fixed production overheads
Marginal costing profit
(ii)
Profit under absorption costing =
Profit under marginal costing =
Difference =
$20,700
$17,750
$ 2,950
Fixed overhead absorption rate = $29,500 / 5,000 units = $5.90 per unit
Increase in inventory = 900 units - 400 units = 500 units
Fixed overhead not charged to profit under absorption costing =
500 units x $5.90 per unit = $2,950
P1
2
November 2011
SECTION B
Answer to Question Two
(a)
January
$000
75
245
February
$000
80
253
March
$000
90
254
320
333
344
Payment for
purchases (W2)
Expenses paid
Forklift trucks
Total payments
(180)
(195)
(200)
(122)
(123)
(302)
(123)
(100)
(418)
Net cash
Opening balance
Closing balance
18
15
33
(85)
33
(52)
21
(52)
(31)
Cash sales
Receipts from credit
sales (W1)
Total receipts
(323)
Workings
(W1) Credit sales – receipts
October
November
December
January
February
Total
Total sales
$000
250
250
250
260
260
January
$000
20
25
200
February
$000
245
253
20
26
208
254
January
$000
45
135
February
$000
March
$000
20
25
208
March
$000
(W2) Credit purchases – payments
November
December
January
February
Total
November 2011
Total purchases
$000
180
180
200
200
180
3
45
150
195
50
150
200
P1
(b)
(i)
Decision tree: Build a new restaurant or not
Low
40%
Build small
$1,040,000
High
60%
$800,000
$1,200,000
$(1,000,000)
$Fail
$800,000
$1,040,000
$800
30%
Build large
Low
40%
$2,000,000
Don’t
Build
High
60%
$0
(ii)
Expected value with the survey
= (0.4 x $800,000) + (0.6 x $2,000,000)
= $320,000 + $1,200,000
= $1,520,000
Expected value without the survey
= $1,040,000 (see diagram)
Therefore maximum value of the survey = $1,520,000 - $1,040,000 = $480,000
P1
4
November 2011
(c)
Examiner’s note: the question asks for two sources. Examples of sources that would be
rewarded are given below.
Bank references
These may be provided by the customer’s bank to indicate the customer’s financial standing.
However, the law and practice of banking secrecy determines the way in which banks
respond to credit enquiries, which can render such references uninformative, particularly if the
company is experiencing financial difficulties.
Trade references
Companies already trading with the customer may be willing to provide a reference. This can
be extremely useful, providing that the companies approached are a representative sample of
all of the customer’s suppliers. Such references can be misleading, as they are usually based
on direct credit experience and contain no knowledge of the underlying financial position of
the customer.
Financial statements
The most recent financial statements of the customer can be obtained either direct from the
customer or for limited companies from Companies House. While subject to certain
limitations, past accounts can be useful in assessing the creditworthiness of the customer. In
circumstances where the credit risk appears high or substantial levels of credit are required,
the supplier may ask to see evidence of the customer’s ability to pay in accordance with
proposed payment terms. This would require access to internal future budget data.
Personal contact
A representative of the supplier might visit the business premises of the customer. Through
visiting the premises and interviewing the senior management, the representative of the
supplier should gain an impression of the efficiency and financial resources of the customer
and the integrity of its management. The management will however be keen to give the best
impression of the company and the standard of the premises and other resources will reflect
past rather than present financial standing.
Past experience
If the credit limit is being determined for an existing customer, the supplier will have access to
their past payment record. However, if it is a key supplier to the customer, the supplier should
be aware that many failing companies preserve solid payment records with key suppliers in
order to maintain supplies, but only do so at the expense of other creditors. Indeed, many
companies go into liquidation with excellent payment records with key suppliers.
November 2011
5
P1
(d)
Examiner’s note: the question asks for three benefits. Examples of points
that would be rewarded are given below.
Increased awareness of the impact of environment related activities on their financial
statements
Organisations that alter their management accounting practices to incorporate environmental
concerns will have greater awareness of the impact of environment related activities on their
financial statements. This is because conventional management accounting systems tend to
attribute many environmental costs to general overhead accounts with the result that they are
“hidden” from management.
Cost reduction
Organisations which adopt environmental cost management principles are more likely to
identify and take advantage of cost reduction and other improvement opportunities.
Improved decision making
A concern with environmental costs will also reduce the chances of employing incorrect
pricing of products and services and taking the wrong options in terms of mix and
development decisions. This in turn may lead to enhanced customer value while reducing the
risk profile attaching to investments and other decisions which have long term consequences.
Avoidance of costs of failure
A lack of concern for the environment can result in significant costs, for example the
associated costs of clean-up and financial penalties associated with environmental disasters.
Avoidance of damage to the company’s reputation
A concern with environmental costs will also reduce the risk of damage to the company’s
reputation. The well publicised Brent Spar incident that cost the oil company Shell millions of
pounds in terms of lost revenues via the resultant consumer boycott is an example of the
powerful influence that environmental concern has in today’s business environment. Shell
learned the lesson, albeit somewhat belatedly and as a result completely re-engineered their
environmental management system.
(e)
(i)
$ 80 - $40 = $40 Joint probability is 0.25 x 0.20 =
$100 - $40 = $60 Joint probability is 0.30 x 0.20 =
$100 - $60 = $40 Joint probability is 0.30 x 0.55 =
$120 - $40 = $80 Joint probability is 0.45 x 0.20 =
$120 - $60 = $60 Joint probability is 0.45 x 0.55 =
$120 - $80 = $40 Joint probability is 0.45 x 0.25 =
Alternatively:
$ 80 - $40 = $40 Joint probability is 0.25 x 0.20 =
$100 - $40 = $60 Joint probability is 0.30 x 0.20 =
$100 - $60 = $40 Joint probability is 0.30 x 0.55 =
At a selling price of $120, the contribution per
unit under all three alternatives is greater than
$40 therefore probability is
P1
6
0.05
0.06
0.165
0.09
0.2475
0.1125
0.725
0.05
0.06
0.165
0.450
0.725
November 2011
(ii)
Expected value of selling price per unit
($80 x 0.25) + ($100 x 0.30) + ($120 x 0.45) = $104
Expected value of variable cost per unit
($40 x 0.20) + ($60 x 0.55) + ($80 x 0.25) =$61
Expected value of contribution per unit = $104 - $61 = $43
(f)
Examiner’s note: the question asks for three benefits. Examples of benefits that would be
rewarded are given below.
Planning
Budgeting forces an organisation’s management to look ahead and set performance targets.
This ensures that management anticipates any future problems and gives the organisation
direction. It also ensures that managers are aware of their own targets and responsibilities
and how they relate to those of other managers within the organisation.
Control/Evaluation
The budget acts as a control mechanism, with actual results being compared with budget.
Appropriate actions can then be taken to correct any deviations from plan. The budget also
provides an internal benchmark against which performance can be evaluated. The
performance measured may be that of a department or division or of an individual manager.
Co-ordination
The budget ensures actions of different parts of the organisation are co-ordinated and
reconciled otherwise managers take actions for the benefit of their own part of organisation
that may not benefit the organisation as a whole. The budget compels managers to examine
the relationship between their own operation and other departments.
Communication
Every part of the organisation needs to be informed of plans, policies and constraints. In that
way, everyone should have a clear understanding of the part they need to play in achieving
the budget. It is through the budget that top management communicates it expectations to
lower level managers and in return lower level managers can communicate what they
consider to be achievable targets.
Motivation
Another benefit of budgeting is to set targets to motivate managers and optimise their
performance. The budget is a useful device for influencing managers’ behaviour and
motivating managers to perform in line with the organisation’s objectives. It provides a
standard which managers may be motivated to achieve. It can also encourage inefficiency
and conflict between managers particularly if the budget is imposed from above, whereby it
may act as a threat rather than as a challenge.
November 2011
7
P1
SECTION C
Answer to Question Three
(a)
Reconciliation Statement
Flexed budget material cost
(original standard)
Material price planning
variance - Ingredient A
Material price planning
variance - Ingredient B
Flexed budget material cost
(revised standard)
Material price operational
variance - Ingredient A
Material price operational
variance - Ingredient B
Material price variance
Ingredient C
Material mix variance
Material yield variance
9,000 units x $189
$1,701,000
36,000kg x ($25 - $23)
$72,000
F
27,000kg x ($22 - $20)
$54,000
F
$1,575,000
(35,000kg x $23) - $910,000
$105,000
A
(28,000kg x $20) - $630,000
$70,000
A
(27,000kg x $11.50) $296,000
See workings below
$14,500
F
$74,500
F
$175,000
A
See working below
Actual material cost
$1,836,000
Material mix variance
Actual input @
standard mix
kg
Ingredient A
40,000
Ingredient B
30,000
Ingredient C
20,000
90,000
Actual input
@ actual
mix kg
35,000
28,000
27,000
90,000
Variance
kg
Or alternatively:
Material mix variance
Actual input
@standard
mix
Ingredient A
40,000
Ingredient B
30,000
Ingredient C
20,000
90,000
Actual input
@ actual
mix kg
35,000
28,000
27,000
90,000
Variance
Kg
5,000 F
2,000 F
7,000 A
5,000
2,000
(7,000)
Standard price
$
23
20
11.50
Variance
$
115,000 F
40,000 F
80,500 A
74,500 F
Standard price
difference
$
(23 – 19.444)
(20 – 19.444)
(11.50 – 19.444)
Variance
$
17,778 F
1,111 F
55,611 F
74,500 F
Material yield variance
Standard kg per cake = 9kg
9,000 cakes x 9kg = 81,000kg
Actual usage = 90,000kg
Variance = 9,000kg A
Standard price per kg = $19.4444
Variance = 9,000 kg x $19.4444 = $175,000 A
P1
8
November 2011
Or alternatively:
90,000 kg should produce 10,000 cakes
Did produce 9,000 cakes
Yield variance = 1,000 A
Standard material cost = $175
Yield variance = 1,000 x $175 = $175,000 A
(b)
The calculation of planning and operational variances will be useful to TP for the following
reasons:
•
The use of planning and operational variances will enable TP’s management to draw a
distinction between variances caused by factors extraneous to the business and planning
errors (planning variances) and variances caused by factors that are within the control of
management (operational variances). In this case they can separate the materials price
variance caused by general price rises (planning variance) and the price variance as a
result of efficient or inefficient procurement.
•
The purchasing managers’ performance can be compared with the adjusted standards
that reflect the conditions the manager actually operated under during the reporting
period. If planning and operational variances are not distinguished, there is potential for
dysfunctional behaviour especially where the manager has been operating efficiently and
effectively and performance is being judged by factors outside the manager’s control. In
the case of TP it became evident during the period that the prevailing market prices for
materials were significantly less than those set during the budget process. It can be seen
from the reconciliation statement that the operational performance of the material buyers
was poor with large adverse operational price variances on both of the ingredients A and
B which was slightly offset by a favourable variance on ingredient C.
•
The use of planning variances will also allow TP’s management to assess how effective
the company’s planning process has been. Where a revision of standards is required due
to environmental changes that were not foreseeable at the time the budget was prepared,
the planning variances are uncontrollable. However standards that failed to anticipate
known market trends when they were set will reflect faulty standard setting. It could be
argued that some of the planning variances due to poor standard setting are in fact
controllable at the planning stage.
(c)
Total sales price variance
(9,000 units x $400) - $3,456,000 = $144,000A
Total sales volume contribution variance
(9,000 units – 10,000 units) x $151 = $151,000 A
(d)
JIT purchasing involves having an arrangement with a small number of key suppliers where
the supplier is able to provide raw materials or components on demand or with a very short
lead time. This means that the company can hold zero or very little inventory thus reducing
the costs involved with holding inventory including storage costs, insurance costs and
obsolescence costs. The costs involved with ordering inventory may however increase. The
use of a small number of suppliers should also reduce administrative costs for the company
and result in greater quantity discounts. The successful operation of a JIT purchasing system
involves the company working together with their suppliers to ensure that they can rely on
receiving supplies at the right time and at the required quality level. This should result in a
November 2011
9
P1
reduction in quality control costs for the company. Quality standards should improve resulting
in lower wastage in the production process.
P1
10
November 2011
Answer to Question Four
(a)
Other operating costs
System 1
Depreciation per annum ($600k - $60k) / 3 = $180k
Operating costs excluding depreciation = $360k - $180k = $180k
System 2
Depreciation per annum ($800k - $50k) / 5 = $150k
Operating costs excluding depreciation = $305k - $150k = $155k
Cash flows
System 1
Initial investment
Contribution
Operating costs
Maintenance costs
Residual value
Net present value
Expected life
Annuity factor/
discount factor
@12%
$000
(600)
580
(180)
(20)
60
1.00
2.402
2.402
1+ 1.690
0.712
Cumulative discount
factor
Annualised equivalent
cash flow
Operating costs
Maintenance costs
Residual value
Net present value
Expected life
$000
(600)
1,393
(432)
(54)
43
350
3 years
2.402
146
Cash flows
System 2
Initial Investment
Contribution
Present value
System 1
Annuity factor/
discount factor
@12%
$000
(800)
600
1.00
3.605
(155)
(40)
50
3.605
1+3.037
0.567
Cumulative discount
factor
Annualised equivalent
cash flow
Present Value
System 2
$000
(800)
2,163
(559)
(161)
28
671
5 years
3.605
186
System 2 has the highest annualised equivalent discounted cash flows and therefore should
be purchased.
November 2011
11
P1
(b)
(i)
Sensitivity analysis recognises the fact that not all cash inflows and cash outflows for a project
are known with certainty. Sensitivity analysis enables a company to determine the effect of
changes to variables on the planned outcome. Particular attention can then be paid to those
variables that are identified as being of special significance. In project appraisal, an analysis
can be made of all the key variables to ascertain by how much each variable would need to
change before the net present value (NPV) reaches zero i.e. the indifference point.
Alternatively, specific changes can be made to the variables to determine the effect on NPV.
(ii)
The annualised equivalent NPV for System 1 is $40k less (i.e. $186k - $146k) than for
System 2 therefore it would need to increase by more than $40k before the decision would be
to invest in System 1.
The present value of the contribution would need to increase by $40k x 2.402 = $96k. This is
an increase of $96k/$1393k = 6.9%
Alternatively, the increase would need to be $40k/$580k = 6.9%.
(c)
Year
1
2
3
4
5
6
P1
Reducing
balance
$000
800
600
450
337
253
Tax
deprecation
$000
200
150
113
84
203
Tax benefit @
30%
$000
60
45
34
25
61
12
Tax
benefit
$000
30
23
17
13
31
0
Tax
benefit
$000
0
30
22
17
12
30
Total tax
benefit
$000
30
53
39
30
43
30
November 2011
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
The question assesses learning outcome E1 (c) analyse cash-flow forecasts over a
twelve month period. It examines candidates’ ability to prepare a cash budget.
(b)
The question assesses learning outcome D1(f) apply decision trees. It examines
candidates’ ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.
(c)
The question assesses learning outcome E1(f) analyse the impact of alternative debtor
and credit policies. It examines candidates’ ability to identify potential sources of
information that can be used when assessing a customer’s credit worthiness.
(d)
The question assesses learning outcome A3(a) apply principles of environmental
costing in identifying relevant internalised costs and externalised environmental
impacts of the organisation’s activities. It examines candidates’ ability to explain the
benefits that a company could gain from using an environmental costing system.
(e)
The question assesses learning outcome D1(c) analyse risk and uncertainty by
calculating expected values and standard deviations together with probability tables
and histograms. It examines candidates’ ability to calculate the expected values of
possible outcomes using joint probabilities.
(f)
The question assesses learning outcome B1(a) explain why organisations prepares
forecast and plans. It examines candidates’ ability to identify and explain THREE
benefits of using a budgetary planning and control system.
Section C – Questions Three and Four - Compulsory
Question Three The question assesses a number of learning outcomes. Part (a) assesses
learning outcome A1(d) apply standard costing methods, within costing systems, including the
reconciliation of budgeted and actual profit margins and learning outcome A1(f) ‘
interpret material, labour, variable overhead, fixed overhead and sales variances,
distinguishing between planning and operational variances. It examines candidates’ ability to
calculate material variances including material mix and yield variances and material planning
and operational variances. Part (b) also assesses learning outcome A1(f) interpret material,
labour, variable overhead, fixed overhead and sales variances, distinguishing between
planning and operational variances. It examines candidates’ ability to discuss the usefulness
of the planning and operational variances calculated in part (a).Part (c) also assesses
learning outcome A1(d) apply standard costing methods, within costing systems, including the
reconciliation of budgeted and actual profit margins and examines candidates ability to
calculate sales price and sales volume variances. Part (d) assesses learning outcome A1(h)
explain the benefit of just-in-time manufacturing methods on cost accounting and the use of
November 2011
13
P1
‘back-flush accounting’ when work-in-progress stock is minimal. It examines candidates’
ability to explain the benefits of a JIT purchasing system for materials.
Question Four Part (a) assesses learning outcomes C1(b) apply the principles of relevant
cash flow analysis to long-run projects that continue for several years and learning outcome
C2(c) prioritise projects that are mutually exclusive, involve unequal lives and/or are subject to
capital rationing. It examines candidates’ ability to identify the relevant costs of a project and
then apply discounted cash flow analysis to calculate the net present value of the project. It
then requires candidates to prioritise the projects using and annualised equivalent method.
Part (b) assesses learning outcome C1(f) apply sensitivity analysis to cash flow parameters to
identify those to which net present value is particularly sensitive. It examines candidates’
ability to explain the benefits in carrying out sensitivity analysis and then to calculate the
sensitivity of one variable. Part (c) assesses learning outcome C1(c) calculate project cash
flows, accounting for tax and inflation, and apply perpetuities to derive ‘end of project’ value
where appropriate. It examines candidates’ ability to calculate tax depreciation and the
resulting tax cash flows for a project.
P1
14
November 2011
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
Tuesday 28 February 2012
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 9.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2012
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
A decision maker who makes decisions using the expected value criterion would be
classified as:
A
Risk averse
B
Risk seeking
C
Risk neutral
D
Risk spreading
(2 marks)
1.2
A company’s management is considering investing in a project with an expected life of
4 years. It has a positive net present value of $180,000 when cash flows are
discounted at 8% per annum. The project’s cash flows include a cash outflow of
$100,000 for each of the four years. No tax is payable on projects of this type.
The percentage increase in the annual cash outflow that would cause the company’s
management to reject the project from a financial perspective is, to the nearest 0.1%:
A
54.3%
B
45.0%
C
55.6%
D
184.0%
(2 marks)
Performance Operations
2
March 2012
1.3
PT provides expert quality assurance services on a consultancy basis. The
management of the company is unsure whether to price the services it offers at the
Deluxe, High, Standard or Low fee level. There is uncertainty regarding the mix of staff
that would be available to provide each of the services. As the staff are on different pay
scales the mix of staff would affect the variable costs of each service.
The table below details the annual contribution earned from each of the possible
outcomes.
Staffing mix
X
Y
Z
Deluxe
$135,000
$150,000
$165,000
Fee level
High
Standard
$140,000
$137,500
$160,000
$165,000
$180,000
$192,500
Low
$120,000
$160,000
$200,000
If PT applies the minimax regret criterion, the fee level it will choose is:
A
Deluxe
B
High
C
Standard
D
Low
(2 marks)
Section A continues on the next page
TURN OVER
March 2012
3
Performance Operations
The following data are given for sub-questions 1.4 and 1.5 below
FP is a retailer of office products. For one particular model of calculator there is an
annual demand of 26,000 units. Demand is predictable and spread evenly throughout
the year. Supplies are received 2 weeks after placing the order and no buffer inventory
is required.
The calculators cost $14 each. Ordering costs are $160 per order. The annual cost of
holding one calculator in inventory is estimated to be 10% of the purchase cost.
1.4
The economic order quantity (EOQ) for this model of calculator will be:
A
2,438 units
B
771 units
C
67 units
D
2,060 units
(2 marks)
1.5
FP has decided not to use the EOQ and has decided to order 2,600 calculators each
time an order is placed. The total ordering and holding costs per annum will be:
A
$5,240
B
$19,800
C
$208,014
D
$3,420
(2 marks)
1.6
State THREE ways that an accepted bill of exchange can be used by the holder.
(3 marks)
1.7
A company is considering investing $50,000 in a project which will yield $5,670 per
annum in perpetuity. The company’s cost of capital is 9% per annum.
Required:
Calculate the net present value of the project.
(3 marks)
Performance Operations
4
March 2012
1.8
PL currently earns an annual contribution of $2,880,000 from the sale of 90,000 units of
product B. Fixed costs are $800,000 per annum.
The management of PL is considering reducing the selling price per unit to $48. The
estimated levels of demand at the revised selling price and the probabilities of them
occurring are as follows:
Selling price of $48
Demand
Probability
100,000 units
0·40
120,000 units
0·60
The estimated variable costs per unit at either of the higher levels of demand and the
probabilities of them occurring are as follows:
Variable cost (per unit)
$21
$19
Probability
0·25
0·75
The level of demand and the variable cost per unit are independent of each other.
Required:
Calculate the probability that the profit will increase from its current level if the selling
price is reduced to $48.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
March 2012
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
JL is preparing its cash budget for the next three quarters. The following data have
been extracted from the operational budgets:
Sales revenue
Quarter 1
Quarter 2
Quarter 3
$500,000
$450,000
$480,000
Direct material purchases
Quarter 1
Quarter 2
Quarter 3
$138,000
$151,200
$115,600
Additional information is available as follows:
•
JL sells 20% of its goods for cash. Of the remaining sales value, 70% is received
within the same quarter as sale and 30% is received in the following quarter. It is
estimated that trade receivables will be $125,000 at the beginning of Quarter 1. No
bad debts are anticipated.
•
50% of payments for direct material purchases are made in the quarter of
purchase, with the remaining 50% in the quarter following purchase. It is estimated
that the amount owing for direct material purchases will be $60,000 at the
beginning of Quarter 1.
•
JL pays labour and overhead costs when they are incurred. It has been estimated
that labour and overhead costs in total will be $303,600 per quarter. This figure
includes depreciation of $19,600.
•
JL expects to repay a loan of $100,000 in Quarter 3.
•
The cash balance at the beginning of Quarter 1 is estimated to be $49,400 positive.
Required:
Prepare a cash budget for each of the THREE quarters.
(5 marks)
Performance Operations
6
March 2012
(b)
Explain why sensitivity analysis is useful when dealing with uncertainty in project
appraisal.
(5 marks)
(c)
TJ allows credit to customers provided that they have satisfactory trade references.
Customers however are exceeding credit terms and taking on average 55 days to pay.
In an effort to reduce the level of trade receivables, TJ is considering offering a 2%
discount to customers paying within 20 days.
Required:
(i)
Calculate, to the nearest 0·1%, the effective annual interest rate to TJ of offering
this discount. You should assume a 365 day year and use compound interest
methodology.
(3 marks)
(ii)
State TWO methods, other than asking for trade references, that TJ could use to
assess the credit worthiness of new customers.
(2 marks)
(Total for sub-question (c) = 5 marks)
(d)
Environmental costs can be categorised as ‘environmental internal failure costs’ and
‘environmental external failure costs’.
Required:
Explain what is meant by both of these categories giving TWO examples of each type
of environmental cost.
(5 marks)
Section B continues on the next page
TURN OVER
March 2012
7
Performance Operations
(e) The following details have been extracted from KL’s budget:
Selling price per unit
Variable production costs per unit
Fixed production costs per unit
$140
$45
$32
The budgeted fixed production cost per unit was based on a normal capacity of 11,000
units per month.
Actual details for the months of January and February are given below:
January
10,000
9,800
$135
$45
$350,000
Production volume (units)
Sales volume (units)
Selling price per unit
Variable production cost per unit
Total fixed production costs
February
11,500
11,200
$140
$45
$340,000
There was no closing inventory at the end of December.
Required:
(i)
Calculate the actual profit for January and February using absorption costing.
You should assume that any under / over absorption of fixed overheads is
debited / credited to the Income Statement each month.
(3 marks)
(ii)
The actual profit figure for the month of January using marginal costing was
$532,000.
Explain, using appropriate calculations, why there is a difference between the
actual profit figures for January using marginal costing and using absorption
costing.
(2 marks)
(Total for sub-question (e) = 5 marks)
Performance Operations
8
March 2012
(f) KY makes several products including Product W. KY is considering adopting an activitybased approach for setting its budget. The company’s production activities, budgeted
activity costs and cost drivers for next year are given below:
Activity
$
Cost driver
Cost driver
quantity
800
Set-up costs
200,000
No. of set-ups
Inspection/quality control
120,000
No. of quality tests
Stores receiving
252,000
No. of purchase requisitions
400
1,800
Machines are reset after each batch. Quality tests are carried out after every second
batch.
The budgeted data for Product W for next year are:
Direct materials
Direct labour
Batch size
Number of purchase requisitions
Budgeted production
$2·50 per unit
0·03 hours per unit @ $18 per hour
150 units
80
15,000 units
Required:
Calculate, using activity-based costing, the budgeted total production cost per unit for
Product W.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on the next page
TURN OVER
March 2012
9
Performance Operations
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
HR is a paint manufacturer that produces a range of paints which it sells to trade and retail
outlets.
The standard material cost for 100 litres of white paint is given below:
Raw Material
A
B
C
D
Volume
(litres)
28
27
8
42
105
Standard cost per
litre
$
1·40
1·20
3·65
2·60
Standard cost
$
39.20
32.40
29.20
109.20
210.00
During February, HR produced 7,800 litres of white paint using the following raw materials:
Raw Material
A
B
C
D
Volume
(litres)
2,800
2,700
1,000
1,900
8,400
Actual cost per litre
$
1·50
1·30
4·00
2·50
There was no opening or closing inventory of raw materials.
Required:
(a)
Prepare a statement that reconciles the standard material cost to the
actual material cost for February. Your statement should include the
individual material price variances, the individual material mix variances
and the total material yield variance.
(10 marks)
(b)
State THREE factors that a company would need to consider before
deciding whether to investigate a variance.
(3 marks)
Performance Operations
10
March 2012
(c)
HR uses skilled staff to operate the machinery that converts the raw materials for the
paint into the finished product. The standard direct labour hours for each 100 litres of
white paint produced are as follows:
8 direct labour hours at $24 per hour
During February, 640 direct labour hours were worked at a total cost of $16,500.
It has now been realised that a new wage rate of $26 per hour had been agreed with
the workers.
Required:
(i)
Calculate the labour rate planning variance for February.
(2 marks)
(ii)
Calculate the operational labour rate variance and the operational labour
efficiency variance for February.
(4 marks)
(d)
Explain the importance of separating variances into their planning and
operational components.
You should use the figures calculated in part (c) to illustrate your answer.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
March 2012
11
Performance Operations
Question Four
MGC is a private golf club that has seen a reduction in its membership over the past few
years. In an attempt to attract new members and retain existing members, the golf club
committee is considering building a golf driving range and an indoor swimming pool.
The project would require an initial expenditure of $600,000. The club has agreed to sell the
driving range and swimming pool for $30,000 at the end of 5 years. The expenditure will
qualify for tax depreciation.
The committee commissioned a market research survey at a cost of $40,000. The survey
estimated the increase in members from current levels as a result of the project. The results
were as follows:
Increase in
members
1,000
700
500
Probability
0·30
0·50
0·20
It is believed that the number of members will remain the same for the life of the project. The
contribution earned on membership fees received will be 55% of fee revenue in all years.
The following operating costs and revenues are expected for each year of the project. Their
values for Year 1 are:
Membership fee income
Project specific overheads
$800 per member (payable at the end of each year)
$120,000 (this figure does not include depreciation)
An inflation rate of 4% per annum will apply to these revenues and costs from Year 2 and for
the remainder of the project.
The club’s accountants have provided the following information:
•
Tax depreciation: 25% reducing balance per annum with a balancing adjustment in the
year of disposal.
•
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid in the following year.
•
Any losses resulting from this investment can be set against profits made by the
company’s other business activities.
The club uses a post-tax money cost of capital of 12% per annum to evaluate projects of this
type.
Performance Operations
12
March 2012
Required:
(a)
(i)
Evaluate the proposed expansion from a financial perspective. You
should use net present value as the basis of your evaluation and show
your workings in $000.
(12 marks)
(ii)
Explain TWO non-financial factors that the club should consider before
making a final decision.
(4 marks)
(b)
Calculate the internal rate of return (IRR) of the project.
(4 marks)
(c)
(i)
Calculate MGC’s real cost of capital.
(2 marks)
(ii)
Explain the way in which the real cost of capital may be used to calculate
the net present value of a project when the cash flows are subject to
inflation. Your answer should consider the potential difficulties in using this
method when taxation is involved in the project appraisal.
(3 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
March 2012
13
Performance Operations
Operational Level Paper
P1 –Performance Operations
Examiner’s Answers
SECTION A
Answer to Question One
1.1
The correct answer is C.
1.2
Net Present Value of the project = $180,000
Present value of the annual cash outflow = $100,000 x 3.312 = $331,200
Sensitivity = $180,000/$331,200 = 54.3%
The correct answer is A.
1.3
Regret Matrix
Staffing mix
X
Y
Z
Maximum regret
Deluxe
$5,000
$15,000
$35,000
$35,000
Fee level
Standard
0
$2,500
$5,000
0
$20,000
$7,500
$20,000
$7,500
High
Low
$20,000
$5,000
0
$20,000
The Standard fee strategy minimises the maximum regret.
The correct answer is C.
March 2012
1
P1
1.4
EOQ =
2C o D
Ch
Where:
Co = (cost per order) = $160
D = (annual demand) = 26,000 units
Ch = (cost of holding one unit for one year) = $1.40
EOQ =
2 × 160 × 26,000
1.46
The correct answer is A.
1.5
Number of orders = 26,000 / 2,600 = 10 per year
Ordering costs = 10 x $160 = $1,600
Holding costs = 2,600 x 0.5 x $1.40 = $1,820
Total ordering and holding costs = $3,420
The correct answer is D.
1.6
The holders of an accepted bill of exchange can do one of the following:
(i)
Hold the bill until the due date and collect the money
(ii)
Discount the bill with the bank for immediate payment
(iii)
Transfer the bill to a third party in settlement of an amount due.
1.7
Time
0
1-∞
Net present value
Cash flow
$
(50,000)
5,670
Discount factor 12%
1.000
1 / 0.09 = 11.111
Present value
$
(50,000)
63,000
13,000
The net present value of the project is $13,000
P1
2
March 2012
1.8
The fixed costs will remain the same therefore the contribution has to exceed
$2,880,000.
The possible outcomes and the probability of them occurring are given below:
100,000 x ($48 - $21) = $2,700,000 Joint probability is 0.40 x 0.25 = 0.10
100,000 x ($48 - $19) = $2,900,000 Joint probability is 0.40 x 0.75 = 0.30
120,000 x ($48 - $21) = $3,240,000 Joint probability is 0.60 x 0.25 = 0.15
120,000 x ($48 - $19) = $3,480,000 Joint probability is 0.60 x 0.75 = 0.45
1.00
The probability therefore that the contribution will exceed $2,880,000 is 90%.
March 2012
3
P1
SECTION B
Answer to Question Two
(a)
Quarter 1
Quarter 2
Quarter 3
$
$
$
Receipts
b/f trade receivables
125,000
20% cash sales
100,000
90,000
96,000
56% in same quarter
280,000
252,000
268,800
120,000
108,000
462,000
472,800
57,800
24% in quarter following sales
Total receipts
505,000
Payments
b/f trade payables
60,000
Materials 50% in same Quarter
69,000
75,600
69,000
75,600
284,000
284,000
284,000
Materials 50% in next Quarter
Labour and overheads
Loan repayment
Total payments
100,000
413,000
428,600
517,400
Opening balance
49,400
141,400
174,800
Net cash flow
92,000
33,400
-44,600
141,400
174,800
130,200
Closing balance
(b)
Project appraisal involves the estimation of cash flows over several years. As the cash flows
can only be estimated with varying degrees of certainty it is useful to see the impact of
changes in assumptions on project viability. Sensitivity analysis enables a company to
determine the effect of changes to variables on the planned outcome. Particular attention can
then be paid to those variables that are identified as being of special significance. In project
appraisal, an analysis can be made of all the key variables to ascertain by how much each
variable would need to change before the net present value (NPV) reaches zero i.e. the
indifference point. Alternatively, specific changes can be tested to determine the effect on
NPV.
P1
4
March 2012
(c)
(i)
The percentage cost of the discount
365/t
= [(100/(100 – d)]
365/35
-1
= [100/98]
10.43
-1
= 1.02041
= 1.2346 – 1
= 23.5%
-1
(ii)
Examiner’s note: the question asks for two methods. Examples of methods that would be
rewarded are given below.
Bank references - These may be provided by the prospective customer’s bank to indicate the
customer’s financial standing.
Financial statements - The most recent financial statements of the prospective customer can
be obtained either direct from the customer, or for limited companies, from Companies
House.
Personal contact - A representative of TJ might visit the business premises of the prospective
customer.
(d)
Environmental internal failure costs
These are costs that are incurred after hazardous materials, waste and/or other contaminants
have been produced. The costs are incurred in order to comply with both externally and
internally imposed standards. Examples include treating and disposing of toxic materials and
recycling costs.
Environmental external failure costs
These are incurred when there are failures of internal control and hazardous materials, waste
or contaminants have been introduced into the environment. Examples of costs that an
organisation has to pay include decontaminating land or cleaning a river after leakages.
Organisations may also be subject to penalties imposed by the government for these external
failures. These costs can give rise to adverse publicity. Some external failure costs may be
caused by the organisation but ‘paid’ by society.
March 2012
5
P1
(e)
(i)
January
$000
568.40
(30)
538.40
Gross profit
Over/(under) absorption of fixed overheads
Gross profit
February
$000
705.60
28
733.60
Workings:
January:
Gross profit = 9,800 units x ($135 -$45 - $32) = $568,400
Under absorption of fixed overhead
(10,000 units x $32) – $350,000 = $30,000
February:
Gross profit = 11,200 units x ($140 - $45 - $32) = $705,600
Over absorption of fixed overhead
(11,500 units x $32) - $340,000 = $28,000
(ii)
Profit using absorption costing
Profit using marginal costing
Difference
$538.40k
$532.00k
$ 6.40k
Increase in inventory in January = 200 units
Absorbed fixed overheads included in inventory under absorption costing:
200 units x $32 = $6,400
(f)
Cost driver rates
Set up costs
Inspection/quality costs
Stores receiving
$200,000 / 800 = $250 per set up
$120,000 / 400 = $300 per test
$252,000 / 1,800 = $140 per requisition
Product W cost per unit
Direct materials
$2.50
Direct labour
$0.54
Set up costs: 15,000/150 units = 100 batches x $250 = $25,000 / 15,000 units = $1.67
Inspection/ quality cost: quality tests 100/2 = 50 x $300 = $15,000 / 15,000 units = $1.00
Stores receiving costs: 80 x $140 = $11,200 / 15,000 units = $0.75
Total production costs = $2.50 + $0.54 + $1.67 + $1.00 + $0.75 = $6.46
P1
6
March 2012
SECTION C
Answer to Question Three
(a)
Reconciliation statement for February
Standard material cost
78 x $210
$16,380
Material price variance –
Raw material A
Material price variance –
Raw material B
Material price variance Raw material C
Material price variance Raw material D
Material mix variance –
Raw material A
Material mix variance –
Raw material B
Material mix variance –
Raw material C
Material mix variance –
Raw material D
Material yield variance
2,800 litres x ($1.40 - $1.50)
$280 A
2,700 litres x ($1.20 - $1.30)
$270 A
1,000 litres x ($3.65 - $4.00)
$350 A
1,900 litres x ($2.60 - $2.50)
$190 F
See workings below
$784 A
See workings below
$648 A
See workings below
$1,314 A
See workings below
$3,796 F
See working below
$420 A
Actual material cost
Material mix variance
Raw material Actual input @
standard mix
litres
A
2,240
B
2,160
C
640
D
3,360
8,400
$16,460
Actual input
@ actual
mix litres
2,800
2,700
1,000
1,900
8,400
Variance
Litres
Standard cost
$
Variance
$
560 A
540 A
360 A
1,460 F
1.40
1.20
3.65
2.60
784A
648A
1,314A
3,796F
1,050F
Actual input
@ actual
mix litres
2,800
2,700
1,000
1,900
8,400
Variance
Litres
Standard cost
differences
$
(1.40 – 2.00)
(1.20 – 2.00)
(3.65 – 2.00)
(2.60 – 2.00)
Variance
$
Or alternatively:
Material mix variance
Raw material Actual input @
standard mix
litres
A
2,240
B
2,160
C
640
D
3,360
8,400
March 2012
560 A
540 A
360 A
1,460 F
7
336F
432F
594A
876F
1,050 F
P1
NB either method of calculating the individual mix variances would be acceptable
Material yield variance
Standard input per 100 litres = 105 litres
7,800 litres x 1.05 = 8,190 litres
Actual usage = 8,400 litres
Variance = 210 litres A
Standard input cost per litre = $2.00
Variance = 210 A x $2.00 = $ 420 A
Or alternatively:
8,400 litres input should produce 8,000 litres output
Did produce 7,800 litres
Yield variance = 200 litres A
Standard output material cost per litre = $2.10
Yield variance = 200 A x $2.10 = $420 A
(b)
(i)
(ii)
(iii)
(iv)
(v)
The size of the variance
The likelihood of the variance being controllable
The likely cost versus the potential benefits of the investigation
The interrelationship between variances
The type of standard that was set
(c)
Direct labour rate planning variance
(7,800 x 0.08 hours) x ($24 - $26) = $1,248 A
Direct labour rate operational variance
(640 x $26) - $16,500 = $140 F
Direct labour efficiency operational variance
[(7,800 x 0.08) – 640] x $26 = $416 A
(d)
The calculation of planning and operational variances is important for the following reasons:
•
The use of planning and operational variances will enable management to draw a
distinction between variances caused by factors extraneous to the business and planning
errors (planning variances) and variances caused by factors that are within the control of
management (operational variances).
•
The manager’s performance can be compared with the adjusted standards that reflect the
conditions the manager actually operated under during the reporting period. If planning
and operational variances are not distinguished, there is potential for dysfunctional
behaviour especially where the manager has been operating efficiently and effectively
and performance is being affected by factors that the manager cannot control. In part c)
the labour rate variance was $1,108A however it can be clearly seen that $1,248A was a
result of a planning error and was not within the control of the operational managers.
•
The use of planning variances will also allow management to assess how effective the
company’s planning process has been. Where a revision of standards is required due to
P1
8
March 2012
environmental changes that were not foreseeable at the time the budget was prepared,
the planning variances are uncontrollable. However standards that failed to anticipate
known market trends when they were set will reflect faulty standard setting. It could be
argued that some of the planning variances due to poor standard setting are in fact
controllable at the planning stage.
March 2012
9
P1
Answer to Question Four
(a)
(i)
Expected value of increase in demand
(1,000 x 0.30) + (700 x 0.50) + (500 x 0.2) = 750 members
Contribution per member
$800 x 55% = $440
Additional contribution Year 1 = $440 x 750 = $330k
Cash Flows
Contribution
Year 1
$000
330
Year 2
$000
343
Year 3
$000
357
Year 4
$000
371
Year 5
$000
386
(120)
(125)
(130)
(135)
(140)
210
218
227
236
246
Additional
fixed costs
Net cash flows
Taxation
Year 1
$000
210
Year 2
$000
218
Year 3
$000
227
Year 4
$000
236
Year 5
$000
246
(150)
(113)
(84)
(63)
(160)
Taxable profit
60
105
143
173
86
Taxation @ 30%
18
32
43
52
26
Net cash flows
Tax depreciation
Net present value
Year 0
$000
Net cash
(600)
flows
Tax
payment
Tax
payment
Net cash
(600)
flow after
tax
Discount
1.000
factors @
12%
Present
(600)
value
Year 1
$000
210
Year 2
$000
218
Year 3
$000
227
Year 4
$000
236
Year 6
$000
(26)
Year 5
$000
246
30
(13)
(16)
(21)
(9)
(16)
(22)
(26)
(13)
201
193
190
188
237
(13)
0.893
0.797
0.712
0.636
0.567
0.507
179
154
135
120
134
(9)
Net present value = $115k
The net present value is positive therefore on this basis the company should go ahead with
the project.
P1
10
March 2012
(7)
(ii)
Two non-financials factors that could be considered are as follows:
•
The risk of the project. The cash flows used in the project appraisal are estimates and will
depend on a number of factors that are uncertain. The club will need to be aware of the
risk involved in the project.
•
The prospect of obtaining planning permission for the new facilities. The success of the
project will depend on the club obtaining planning permission for the new facilities. The
planning conditions may also have an effect on the cost involved in the project.
(b)
Net cash
flows
Discount
factor @
20%
Present
value
Year 0
$000
(600)
Year 1
$000
201
Year 2
$000
193
Year 3
$000
190
Year 4
$000
188
Year 5
$000
237
Year 6
$000
(13)
1.000
0.833
0.694
0.579
0.482
0.402
0.335
(600)
167
134
110
91
95
(4)
Net present value = $(7)k
IRR
NPV at 12% = $115k
NPV at 20% = $(7)k
By interpolation
12% + (115/(115+7)) x 8% =19.5%
(c)
(i)
The company’s real cost of capital
(ii)
An alternative approach would be to express the cash flows in today’s value terms and to
discount the cash flows at the real cost of capital. There are problems however in taking this
approach when there are tax implications. If there are tax implications the tax cash flows
would need to be treated separately. Capital allowances are based on original cost rather
than replacement cost and do not change in line with changing prices. Each tax depreciation
figure would have to be reduced by expected inflation over the relevant period to obtain a
current value. Similarly the residual value of the equipment is stated at year 5 values and
would need to be adjusted to present day values. 50% of the tax payable for any year will be
a money cash flow in the following year. This second stage payment in each year would have
to be reduced by one year’s inflation to determine its ‘real’ value in that year.
March 2012
11
P1
The Senior Examiner for P1 – Performance Operations offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination
paper.
Section A – Question One – Compulsory
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Section B – Question Two – Compulsory
Question Two has 6 sub-questions.
(a)
The question assesses learning outcome learning outcome E1(c) analyse cash-flow
forecasts over a twelve month period. It examines candidates’ ability to prepare a cash
budget.
(b)
The question assesses learning outcome D1(b) apply sensitivity analysis to both short
and long-run decisions models to identify variables that might have significant impacts
on project outcomes. It requires candidates to explain why sensitivity analysis is useful
when dealing with uncertainty in project appraisal.
(c)
The question assesses learning outcome learning outcome E1(f) analyse the impacts
of alternative debtor and credit policies. Part (i) assesses candidates’ ability to calculate
the effective annual interest rate of an early settlement discount offered to customers.
Part (ii) examines candidates’ ability to identify potential sources of information that can
be used when assessing a customer’s creditworthiness.
(d)
The question assesses learning outcome learning outcome A3(a) apply principles of
environmental costing in identifying relevant internalised costs and externalised
environmental impacts of the organisation’s activities. It examines candidates’ ability to
explain and give examples of environmental internal failure costs and environmental
external failure costs.
(e)
The question assesses learning outcome A1(b) discuss a report which reconciles
budget and actual profit using absorption and/or marginal costing techniques. Part (i)
examines candidates’ ability to calculate the profit for two periods using absorption
costing where the production volume and sales volume are different. Part (ii) requires
candidates to explain why there is a difference in profit for the period using marginal
and absorption costing.
(f)
The question assesses learning outcome B3(b) apply alternative approaches to
budgeting. It examines candidates’ ability to calculate the budgeted cost per unit of a
product using activity based costing.
Section C – Questions Three and Four - Compulsory
Question Three The question assesses a number of learning outcomes. Part (a) assesses
learning outcome A1(d) apply standard costing methods, within costing systems, including the
reconciliation of budgeted and actual profit margins. It examines candidates’ ability to
calculate material variances including material mix and yield variances. Part (b) assesses
learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and sales
variances, distinguishing between planning and operational variances. It examines
candidates’ ability to identify the factors that a company should consider before deciding
whether to investigate variances. Part (c) also assesses learning outcome A1(f) interpret
P1
12
March 2012
material, labour, variable overhead, fixed overhead and sales variances, distinguishing
between planning and operational variances. It examines candidates’ ability to calculate
planning and operational variances. Part (d) also assesses learning outcome A1(f) interpret
material, labour, variable overhead, fixed overhead and sales variances, distinguishing
between planning and operational variances. It examines candidates’ ability to explain the
importance of the planning and operational variances calculated in part (c).
Question Four In part (a) candidates should firstly calculate the flexed budget material costs
and the actual material costs for the period. They should then calculate each of the variances
for material price, material mix and material yield. They should then prepare a reconciliation
statement starting with the budgeted material cost and then showing each of the individual
variances to reconcile the budgeted material cost to actual material cost. In part (b)
candidates should use the figures calculated in part (a) to discuss the benefits of calculating
planning and operational variances.
March 2012
13
P1
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
23 May 2012 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2012
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
The term ‘budgetary slack’ refers to the:
A
Lead time between the preparation of the functional budgets and the approval of the
master budget by senior management
B
Difference between the budgeted output and the actual output
C
Difference between budgeted capacity utilisation and full capacity
D
Intentional over estimation of costs and/or under estimation of revenue in a budget
(2 marks)
1.2
Which of the following would NOT be associated with a company that is overtrading?
A
A dramatic reduction in sales revenue
B
A rapid increase in the outstanding overdraft amount
C
A rapid increase in the volume of inventory
D
A rapid increase in sales revenue
(2 marks)
Performance Operations
2
May 2012
1.3
A company has recorded the following activity levels and distribution costs for the
previous three quarters:
Quarter
1
2
3
Volume
Units
64,000
80,000
100,000
Total cost
$
200,000
240,000
290,000
What will be the distribution costs in quarter 4 if the expected level of activity is 85,000
units? You should assume that the cost behaviour pattern in the previous three
quarters will continue in quarter 4.
A
$252,500
B
$255,000
C
$254,303
D
$253,963
(2 marks)
1.4
A company has annual sales revenues of $48 million. The company earns a constant
gross margin of 40% on sales. All sales and purchases are on credit and are evenly
distributed over the year.
The following are maintained at a constant level throughout the year:
Inventory
Trade receivables
Trade payables
$8 million
$10 million
$5 million
The company’s cash operating cycle to the nearest day is:
A
99 days
B
114 days
C
89 days
D
73 days
(2 marks)
Section A continues on the next page
TURN OVER
May 2012
3
Performance Operations
1.5
A company is considering factoring as a way of managing its trade receivables. It
currently has a balance outstanding on trade receivables of $250,000. It has annual
sales revenue of $1,500,000 which occurs evenly throughout the year. Trade
receivables are expected to continue at the same level for the next year.
The factor will advance 80% of invoiced sales and will charge interest at a rate of 10%
per annum.
The interest charge for next year payable to the factor will be:
A
$25,000
B
$150,000
C
$20,000
D
$120,000
(2 marks)
1.6
A supplier has offered CB an early settlement discount of 3% if payment is made within
20 days of the invoice date. CB currently takes 58 days to pay this supplier.
Required:
Calculate, to the nearest 0.1%, the effective annual interest rate to CB of the early
settlement discount. You should assume a 365 day year and use a compound interest
methodology.
(3 marks)
1.7
A company has recently carried out a post-completion audit at the end of Year 2 of a
project that had an original investment of $100,000. It is concerned that the estimated
cash flows are not going to be achieved.
The cash flows that were forecast when the investment decision was originally taken
were as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
$
60,000
80,000
(70,000)
80,000
60,000
The data from the post-completion audit show that the net cash outflow in Year 3 will
be $90,000 and the cash inflows in Years 4 and 5 will be $60,000 and $40,000
respectively. You should assume that all cash flows with the exception of the original
investment will arise at the end of the year.
The company’s cost of capital is 12% per annum.
Required:
Demonstrate, using calculations, whether or not the project should be abandoned
immediately. You should assume that there will be no additional costs associated with
abandoning the project.
(3 marks)
Performance Operations
4
May 2012
1.8
RT is preparing the production budget for Product R and the material purchases budget
for Material T for next year. Each unit of Product R requires 6 kg of Material T.
The estimated inventory at the beginning of next year for Product R is 6,000 units and
the company wants to decrease the inventory held by 10% by the end of next year.
The estimated inventory at the beginning of next year for Material T is 60,000 kg and
due to problems with the material supplier the closing inventory at the end of next year
is to be increased to 75,000 kg.
The budgeted sales of Product R for next year are 80,000 units.
Required:
(i)
Calculate the production budget for Product R for next year.
(ii)
Calculate the material purchases budget for Material T for next year.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
May 2012
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
FG, an ink manufacturer, produces black ink by mixing three chemicals.
The standard material costs per litre of black ink are as follows:
0.50 litres of Chemical A
0.30 litres of Chemical B
0.25 litres of Chemical C
1.05
@
@
@
$0.60 per litre
$1.40 per litre
$1.00 per litre
$
0.30
0.42
0.25
0.97
Actual data for April were as follows:
Output of black ink (000s litres)
Raw materials used
3,300
Quantity (000s litres)
Cost ($000)
Chemical A
2,144
1,120
Chemical B
824
1,040
Chemical C
792
620
Required:
Calculate the following variances for April:
(i)
The total material mix variance
(ii)
The total material yield variance
(3 marks)
(2 marks)
(Total for sub-question (a) = 5 marks)
Performance Operations
6
May 2012
(b)
A capital investment project has the following estimated cash flows and present values:
Year
0
1-5
1-5
5
Initial
investment
Contribution
per annum
Fixed costs per
annum
Residual value
Cash flow
$
(100,000)
Discount factor
@ 12%
1.0
Present value
$
(100,000)
52,000
3.605
187,460
(25,000)
3.605
(90,125)
20,000
0.567
11,340
Required:
(i) Calculate the sensitivity of the investment decision to a change in the annual fixed
costs.
(3 marks)
(ii) State TWO benefits to a company of using sensitivity analysis in investment
appraisal.
(2 marks)
(Total for sub-question (b) = 5 marks)
(c)
A company currently operates from a number of different locations which have their
own purchasing departments. Senior management are now considering whether to
change to a system where all purchasing is carried out by a centralised purchasing
department.
Required:
Explain the benefits that should result from the company using a centralised
purchasing system.
(5 marks)
(d)
A company currently operates a ‘top-down’ budgeting system where senior managers
impose budgets on departmental managers. It is now considering allowing
departmental managers to participate in the setting of their own budgets.
Required:
Explain the arguments for and against the participation of departmental managers in
the preparation of their budgets.
(5 marks)
TURN OVER
May 2012
7
Performance Operations
(e)
A clothing retailer is considering which of three mutually exclusive advertising packages
to use when it launches its new range of autumn fashion. The sales revenue from the
range will depend on customer reaction to the chosen advertising package. There is a
25% chance that customer reaction will be good; a 40% chance that customer reaction
will be moderate and a 35% chance that customer reaction will be poor.
The contribution, net of advertising costs, for each of the possible outcomes is as
follows:
Customer
reaction
Package A
$000s
Package B
$000s
Package C
$000s
Good
700
900
800
Moderate
600
500
400
Poor
400
300
500
A market research company believes it can provide perfect information on potential
customer reaction to the range.
Required:
Calculate, on the basis of expected value, the maximum amount that should be paid
for the information from the market research company.
(5 marks)
(f) Explain THREE factors that a company should consider before deciding how to invest
short term cash surpluses.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 10
Performance Operations
8
May 2012
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
HB makes and sells a single product. The company operates a standard marginal costing
system and a just-in-time purchasing and production system. No inventory of raw materials or
finished goods is held.
Details of the budget and actual data for the previous period are given below.
Budget data
Standard production costs per unit:
Direct material
Direct labour
Variable overheads
8kg @ $10.80 per kg
1.25 hours @ $18.00 per hour
1.25 hours @ $6.00 per direct labour hour
$
86.40
22.50
7.50
Standard selling price: $180 per unit
Budgeted fixed production overheads: $170,000
Budgeted production and sales: 10,000 units
Actual data
Direct material: 74,000 kg @ $11.20 per kg
Direct labour: 10,800 hours @ $19.00 per hour
Variable overheads: $70,000
Actual selling price: $184 per unit
Actual fixed production overheads: $168,000
Actual production and sales: 9,000 units
Performance Operations
10
May 2012
Required:
(a)
Prepare a statement using marginal costing principles that reconciles the
budgeted profit and the actual profit. Your statement should show the
variances in as much detail as possible.
(11 marks)
(b)
(i)
Explain why the variances used to reconcile profit in a standard marginal
costing system are different from those used in a standard absorption costing
system.
(4 marks)
(ii)
Calculate the variances that would be different and any additional variances
that would be required if the reconciliation statement was prepared using
standard absorption costing.
Note: Preparation of a revised statement is not required.
(4 marks)
(c)
Explain the arguments for the use of traditional absorption costing rather
than marginal costing for profit reporting and inventory valuation.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
May 2012
11
Performance Operations
Question Four
DP is considering whether to purchase a piece of land close to a major city airport. The land
will be used to provide 600 car parking spaces. The cost of the land is $6,000,000 but further
expenditure of $2,000,000 will be required immediately to develop the land to provide access
roads and suitable surfacing for car parking. DP is planning to operate the car park for five
years after which the land will be sold for $10,000,000 at Year 5 prices. A consultant has
prepared a report detailing projected revenues and costs.
Revenues
It is estimated that the car park will operate at 75% capacity during each year of the project.
Car parking charges will depend on the prices being charged by competitors. There is a 40%
chance that the price will be $60 per week, a 25% chance the price will be $50 per week and
a 35% chance the price will be $70 per week.
DP expects that it will earn a contribution to sales ratio of 80%.
Fixed Operating Costs
DP will lease a number of vehicles to be used to transport passengers to and from the airport.
It is expected that the lease costs will be $50,000 per annum.
Staff costs are estimated to be $350,000 per annum.
The company will hire a security system at a cost of $100,000 per annum.
Inflation
All of the values above, other than the amount for the sale of the land at the end of the five
year period, have been expressed in terms of current prices. The vehicle leasing costs of
$50,000 per annum will apply throughout the five years and is not subject to inflation.
Car parking charges and variable costs are expected to increase at a rate of 5% per annum
starting in Year 1.
All fixed operating costs excluding the vehicle leasing costs are expected to increase at a
rate of 4% per annum starting in Year 1.
Other Information
The company uses net present value based on the expected values of cash flow when
evaluating projects of this type.
DP has a money cost of capital of 8% per annum.
DP’s Financial Director has provided the following taxation information:
•
•
Tax depreciation is not available on either the initial cost of the land or the
development costs.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is payable in the following year.
All cash flows apart from the initial investment of $8,000,000 should be assumed to occur at
the end of the year.
Performance Operations
12
May 2012
Required:
(a)
Evaluate the project from a financial perspective. You should use net
present value as the basis of your evaluation and show your workings in
$000.
(14 marks)
(b)
Calculate the internal rate of return (IRR) of the project.
(5 marks)
The main reason why discounted cash flow methods of investment appraisal are
considered theoretically superior is that they take account of the time value of
money.
Required:
(c)
Explain the THREE elements that determine the ‘time value of money’
and why it is important to take it into consideration when appraising
investment projects.
(6 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
May 2012
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
May 2012 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early August at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
1.1
The correct answer is D.
1.2
The correct answer is A.
1.3
Variable costs per unit
Fixed costs
=($290,000 – $200,000) / (100,000 – 64,000)
= $2.50
=$290,000 – (100,000 x $2.50)
= $40,000
At an activity level of 85,000 units, distribution costs will therefore be:
(85,000 x $2.50) + $40,000 = $252,500
May 2012
1
P1
The correct answer is A.
1.4
Accounts receivable days
(10
/48) x 365 = 76.0
Inventory days
(8/(48 x 0.6)) x 365 = 101.4
Accounts payable days
(5/(48 x 0.6)) x 365 = (63.4)
114.0
The cash operating cycle is 114 days.
The correct answer is B.
1.5
Annual interest = ($250,000 x 80%) x 10% = $20,000
The correct answer is C.
1.6
Payment will be made 38 days early.
Number of compounding periods = 365/38 = 9.60526
1+ r = (1.00/0.97)
9.60526
1+ r = 1.3399
The effective annual interest rate of the early settlement discount is 34.0%
1.7
The abandonment decision should be based on future cash flows:
Year
1
2
3
Cash flow
$
(90,000)
60,000
40,000
Discount factor
0.893
0.797
0.712
Present value
$
(80,370)
47,820
28,480
(4,070)
As the net present value of the future cash flows is negative the project should be
abandoned.
1.8
(i)
The production budget for Product R for next year will be:
Closing inventory
Plus: sales
6,000 x 0.90
Less opening inventory
Production required
P1
2
units
5,400
80,000
85,400
(6,000)
79,400
May 2012
(ii)
The purchases budget for Material T for next year will be
Closing inventory
Plus: production
79,400 units x 6 kg
Less opening inventory
Purchases required
May 2012
3
kg
75,000
476,400
551,400
(60,000)
491,400
P1
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome A1(f) interpret material, labour, variable overheads,
fixed overheads and sales variances, distinguishing between planning and operational
variances. It examines candidates’ ability to calculate material mix and material yield
variances.
Suggested Approach
In part (i) candidates should calculate the mix variance by comparing the actual quantity at
the standard mix with the actual quantity at the actual mix. The variance calculated in litres for
each of the chemicals should then by multiplied the standard cost per litre to calculate the
variance for each chemical. These should then be added together to calculate the total mix
variance. In part (ii) the standard litres of input per litre of output should be multiplied by the
actual output in litres. This should then be compared to the actual litres input. The resultant
variance in litres should be multiplied by the weighted average cost per litre of input to
calculate the yield variance.
(i)
Material mix variance
Actual input
@standard
mix
(000 litres)
Chemical A
1,791
Chemical B
1,074
Chemical C
895
3,760
Actual input
@ actual mix
(000 litres)
Variance
(000 litres)
Standard
cost
$
2,144
824
792
3,760
353 A
250 F
103 F
0.60
1.40
1.00
Variance
$000
211.8 A
350 F
103 F
241.2 F
Or alternatively:
Weighted average cost per litre of input
$0.97/1.05 litres = $0.9238
Material mix variance
Actual input
@standard mix
(000 litres)
Chemical A
1,791
Chemical B
1,074
Chemical C
895
3,760
Actual input @
actual mix
(000 litres)
2,144
824
792
3,760
Variance
(000 litres)
353
250
103
Standard cost
difference
$
(0.60 – 0.9238)
(1.40 – 0.9238)
(1.00 – 0.9238)
Variance
$000
(ii)
P1
4
May 2012
114.3 F
119.1 F
7.8 F
241.2 F
Material yield variance
Standard litres of input per litre of output = 1.05 litres
3,300k litres output x 1.05 litres = 3,465k litres input
Actual usage = 3,760k litres
Variance = 295k litres A
Standard cost per litre = $0.9238
Variance = 295k litres x $0.9238 = $272.5k A
Or alternatively:
3,760k litres should yield 3,760/1.05 = 3,580.95k litres
Actual yield = 3,300k litres
Yield variance = 280.95k litres A
Standard material cost = $0.97
Yield variance = 280.95k litres x $0.97 = $272.5k A
(b)
Rationale
The question assesses learning outcome D1(b) apply sensitivity analysis to both short and
long run decision models to identify variables that might have significant impact on project
outcomes . It examines candidates’ ability to use calculate the sensitivity of the investment
decision to a change in a variable and to identify the benefits of using sensitivity analysis in
investment appraisal.
Suggested Approach
In part (i) candidates should calculate the net present value of the investment and then
express the net present value as a percentage of the present value of the fixed costs. In part
(ii) candidates should clearly state the potential benefits that arise as a result of the use of
sensitivity analysis in investment appraisal.
(i)
If the present value of the fixed costs were to increase by more than $8,675 then the
project would cease to be viable. As a percentage increase this is:
$8,675 / $90,125 = 9.6%
(ii)
•
•
•
•
Sensitivity analysis enables a company to determine the effect of changes to
variables on the planned outcome.
Sensitivity analysis enables a company to assess the risk associated with a project.
Sensitivity analysis enables identification of variables that are of special significance.
Sensitivity analysis enables risk management strategies to be put in place to focus on
those variables of special significance.
May 2012
5
P1
(c)
Rationale
The question assesses learning outcome E1(g) analyse the impact of alternative policies for
stock management. It examines candidates’ ability to explain the benefits of a centralised
purchasing system.
Suggested Approach
Candidates should consider the potential benefits to a company of using a centralised
purchasing system compared to the current system in use and clearly explain what the
benefits are and why they arise under this system.
The advantages of a centralised purchasing system are as follows:
•
•
•
•
•
•
•
A centralised buyer is able to order in larger quantities and may be able to negotiate
bulk buying discounts.
A centralised buyer may have a wider network of suppliers than a local buyer and
should be able to ensure that the best available prices are identified.
With centralised purchasing it is easier to enforce common quality standards for
purchased materials.
Centralised purchasing should result in more efficient management of inventory. The
buyer should have access to information about the current inventory levels at all
locations in the organisation and where appropriate can arrange for inventory to be
transferred from one location to another to avoid purchasing additional quantities.
In an organisation where the operating units are all within a small geographical area it
should also be possible to operate a single centralised stores location. It should be
easier to control inventory levels within a centralised store rather than with several
localised stores.
The company should benefit from economies of scale and the reduction in
administration costs. As larger orders are being placed with suppliers it will also
reduce inventory ordering and handling costs.
Centralised purchasing should enable closer relationships with suppliers and allow
the use of JIT inventory management techniques.
(d)
Rationale
The question assesses learning outcome B1(b) explain the purposes of budgets, including
planning, communication, co-ordination, motivation, authorisation, control and evaluation. It
examines candidates’ ability to explain the benefits and problem with managers’ participation
in setting budgets.
Suggested Approach
Candidates should first consider the benefit of management participation in terms of
motivation, optimisation of performance and reducing the information asymmetry gap. The
potential problems of management participation should then be considered and the conflicts
that can arise been management participation and the use of the budget as a control
mechanism.
P1
6
May 2012
The participation of managers in the budget setting process has several advantages.
Managers are more likely to be motivated to achieve the budget if they have participated in
the budget setting process. Participation can also reduce the information asymmetry gap that
can arise when targets are imposed by senior management and should result in more realistic
budgets. Imposed budgets are likely to make managers feel demotivated and alienated and
result in poor performance.
Participation however can cause problems; in particular, managers may attempt to negotiate
budgets that they feel are easy to achieve which gives rise to ‘budget padding’ or budgetary
slack. They may also be tempted to ‘empire build’ because they believe that the size of their
budget reflects their importance within the organisation. This can result in budgets that are
unsuitable for control purposes. Manager participation is only effective if it is true participation.
Pseudo participation can be worse for motivation than no involvement at all. The involvement
of managers in the budget setting process is time consuming and the benefits of participation
would need to weighed against the cost of the resources used.
(e)
Rationale
The question assesses learning outcome D1(e) calculate the value of perfect information. It
examines candidates’ ability to calculate the value of perfect information where there is
uncertainty regarding expected cash flows.
Suggested Approach
Candidates should firstly calculate the expected value of the contribution from each package
without perfect information. They should then select the best outcome for each of the possible
customer reactions and apply the probabilities to these to calculate the expected value with
perfect information. The value of perfect information can then be calculated as the difference
between the expected value with perfect information and the best of the expected values
without perfect information.
Expected values ($000)
Package A ($700 x 0.25) + ($600 x 0.4) + ($400 x 0.35) = $555
Package B ($900 x 0.25) + ($500 x 0.4) + ($300 x 0.35) = $530
Package C ($800 x 0.25) + ($400 x 0.4) + ($500 x 0.35) = $535
Expected value of perfect information ($000)
If good select Package B = ($900 x 0.25) = $225
If moderate select Package A = ($600 x 0.4) = $240
If poor select Package C = ($500 x 0.35) = $175
Expected value of perfect information is $225 + $240 + $175 = $640
The maximum amount that should be paid is ($640k – $555k) = $85k
May 2012
7
P1
(f)
Rationale
The question assesses learning outcome E2(b) identify alternatives for investment of short
term cash surpluses. It examines candidates’ ability to explain the factors that a company
should consider before deciding how to invest short term surplus funds.
Suggested Approach
Candidates should identify three factors that companies would need to consider when
deciding to invest short tern cash surpluses. They should define each of the factors and
clearly explain why these are important in the investment decision.
Three factors that would need to be considered when deciding how to invest short term cash
surpluses are:
Maturity
A short term investment will involve investing the money for a specified period of time and
receiving interest and the payment of the capital at a specified future date. The maturity date
of the investment should be no longer than the duration of the cash surplus. If the cash is
required before the maturity of the investment and the investment is ‘cashed in’ early, there
will be the risk of loss of interest or capital value.
Risk v Return
Risk refers to the possibility that the investment might fall in value or that there may be some
doubt about the eventual payment of interest or repayment of capital. Generally a higher risk
investment will offer a higher return.
Investing in equities is high risk since the value of the equities depends on the profitability and
future prospects of the company and stock market movements. Share prices can fall by a
large amount in a short period of time therefore equities are generally regarded as an
unsuitable form of short-term investment.
Liquidity
Liquidity refers to the ease with which an investment can be ‘cashed in’ without any significant
loss of value or interest. All short-term investments are less liquid than cash in a bank current
account but some are more liquid than others. For example, many savings accounts or
deposit accounts are reasonably liquid and a depositor can withdraw cash immediately
without penalty or for the loss of only several days’ interest.
P1
8
May 2012
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate appropriate
variances to reconcile budget and actual profit under a marginal costing system. Part (b)
assesses learning outcome A1(b) discuss a report which reconciles budget and actual profit
using absorption and/or marginal costing principles. It examines candidates’ ability to explain
why the variances are different under absorption and marginal costing systems. It also
assesses learning outcome A1(d) apply standard costing methods, within costing systems,
including the reconciliation of budgeted and actual profit margins. It examines candidates’
ability to calculate the revised variances under an absorption costing system. Part (c)
assesses learning outcome A1(a) compare and contrast marginal (or variable), throughput
and absorption accounting methods in respect of profit reporting and stock valuation. It
examines candidates’ ability to explain the arguments for suing absorption costing for
inventory valuation and profit reporting purposes.
Suggested Approach
In part (a) candidates should firstly calculate the budgeted profit and the actual profit for the
period. They should then calculate each of the variances for sales, material, labour, variable
overheads and fixed overheads. They should then prepare a reconciliation statement starting
with the budgeted profit and then showing each of the individual variances to reconcile the
budgeted profit to actual profit. In part (b) candidates should clearly explain the difference that
arise when calculating variances using an absorption costing system compared to a marginal
costing system. In part (c) candidates should calculate the sales volume profit variance and
the fixed overhead volume variance. In part (d) candidates should clearly explain the reasons
why absorption costing is preferred to marginal costing for profit reporting and inventory
valuation.
May 2012
9
P1
(a)
$
Budgeted profit
$
466,000
Add back fixed production overheads
170,000
Budgeted contribution
636,000
Sales volume contribution variance
(9,000 units - 10,000 units) x $63.60
63,600 A
Standard contribution on actual sales volume
Other variances:
Selling price variance
9,000 units x ($184 - $180)
36,000 F
Cost variances:
Direct material price variance
74,000 kg x ($10.80 – $11.20)
29,600 A
Direct material usage variance
((9,000 x 8 kg) – 74,000 kg) x $10.80
21,600 A
Direct labour rate variance
10,800 x ($18.00 - $19.00)
10,800 A
Direct labour efficiency variance
((9,000 x 1.25) – 10,800) x $18.00
8,100 F
Variable overhead expenditure variance
(10,800 hours x $6) - $70,000
5,200 A
Variable overhead efficiency variance
((9,000 x 1.25) – 10,800) x $6.00
2,700 F
Fixed overhead expenditure variance
$170,000 - $168,000
2,000 F
Actual profit
384,000
Workings:
Budgeted profit for the period
Sales
Direct materials
Direct labour
Variable production overheads
Contribution
Fixed production overheads
Budgeted profit
P1
10,000 units x $180
10,000 units x $86.40
10,000 units x $22.50
10,000 units x $7.50
10,000 units x $63.60
10
$
1,800,000
864,000
225,000
75,000
(1,164,000)
636,000
(170,000)
466,000
May 2012
Actual profit for the period
Sales
Direct materials
Direct labour
Variable production overheads
Contribution
Fixed production overheads
Actual profit
9,000 units x $184
74,000 kg @ $11.20
10,800 hours @ $19
$
1,656,000
828,800
205,200
70,000
(1,104,000)
552,000
(168,000)
384,000
(b) (i)
In a standard marginal costing variance statement the sales volume contribution variance is
calculated using the standard contribution per unit. In a standard absorption costing variance
statement, standard contribution is replaced by the standard profit per unit which includes a
fixed overhead absorption rate. The difference in the variance is represented in the absorption
costing variance statement by the fixed production overhead volume variance which is
calculated as the difference in actual and budgeted volume x the fixed overhead absorption
rate. The fixed production overhead volume variance represents a part of the under absorbed
fixed overhead as a result of producing a lower volume than budgeted.
(b) (ii)
Sales volume profit variance
(9,000 units - 10,000 units) x $46.60 = $46,600 A
It would also be necessary to include a fixed production overhead volume variance as follows:
Fixed production overhead volume variance
(9,000 units – 10,000 units) x $17 = $17,000 A
(c)
The arguments used in favour of using absorption costing for profit reporting and inventory
valuation are as follows:
•
•
•
•
Fixed production overheads can be a large proportion of total production costs. It is
therefore important that these costs are included in the measurement of product costs
as they have to be recovered to make a profit.
Absorption costing follows the matching concept by carrying forward a proportion of
the fixed production overhead costs in the inventory valuation to be matched against
the sales revenue generated when the items are sold.
It is necessary to include fixed production overheads in inventory valuations for
financial statements.
It has been argued that in the longer term all costs are variable and it is appropriate
to try to identify overhead costs with the products or services that cause them.
May 2012
11
P1
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and C1(c) calculate project cash flows,
accounting for tax and inflation, and apply perpetuities to derive ‘end of project’ value where
appropriate and C2(a) evaluate project proposals using the techniques of investment
appraisal. It examines candidates’ ability to identify the relevant costs of a project and then
apply discounted cash flow analysis to calculate the net present value of the project. It also
requires candidates to calculate the effect of tax and inflation on the cash flows. Part (b) also
assesses learning outcome C2(a) evaluate project proposals using the techniques of
investment appraisal. It examines candidates’ ability to calculate the IRR of a project. Part (c)
assesses learning outcome C1(e) explain the financial consequences of dealing with long-run
projects, in particular the importance of accounting for the ‘time value of money’. It examines
candidates’ ability to explain what determines the time value of money and its importance in
appraising investment projects.
Suggested Approach
In part (a) candidates should firstly calculate the expected value of the car parking charge
and inflate this by 5% to calculate the year 1 parking charge. They should then calculate the
number of car parking spaces available each week and multiply this by the charge per week x
52 weeks to get the Year 1 revenue. The revenue should then be multiplied by 80% to get
Year 1 contribution. The Year 1 contribution should then be inflated by 5% per annum for
each year of the project. Fixed costs excluding the lease cost should also be inflated by 4%
per annum. Once the relevant cash flows for each year of the project have been identified
they should then calculate the tax payments. The net cash flows after tax should be
discounted at a discount rate of 8% to calculate the NPV of the project. In part b) the same
cash flows should then be discounted at a higher discount rate and the IRR calculated using
interpolation. In part (c) candidates should explain the three elements that determine the time
value of money and clearly explain why the time value of money is important in investment
appraisal.
(a)
Year 1 car parking charges
($60 x 40%) + ($50 x 25%) + ($70 x 35%) = $61 x 1.05 = $64.05
Year 1 sales revenue
Year 1 sales revenue = (600 x 0.75) x $64.05 x 52 weeks = $1,499k
Year 1 contribution = $1,499k x 0.8 = $1,199k
Fixed Costs
Year 1 Staff costs = $350k x 1.04 = $364k
Year 1 Security system costs = $100k x 1.04 = $104k
P1
12
May 2012
Cash Flows
Contribution
Leasing
costs
Staff costs
Security
system
costs
Net cash
flows
Year 1
$000
1,199
Year 2
$000
1,259
Year 3
$000
1,322
Year 4
$000
1,388
Year 5
$000
1,457
(50)
(50)
(50)
(50)
(50)
(364)
(104)
(379)
(108)
(394)
(112)
(409)
(117)
(426)
(122)
681
722
766
812
859
Year 1
$000
681
Year 2
$000
722
Year 3
$000
766
Year 4
$000
812
Year 5
$000
859
(204)
(217)
(230)
(244)
(258)
Taxation
Net cash
flows
Taxation @
30%
Net present value
Year 0
$000
Land
(8,000)
purchase
and
development
Net cash
flows
Tax payment
Tax payment
Year 1
$000
Year 2
$000
Year 3
$000
Year 4
$000
Year 5
$000
10,000
681
722
766
812
859
(102)
(108)
(115)
(122)
(129)
0
(102)
(109)
(115)
(122)
Net cash
(8,000)
579
512
542
575
10,608
flow after tax
Discount
1.000
0.926
0.857
0.794
0.735
0.681
factors @
8%
Present
(8,000)
536
439
430
423
7,224
value
Net present value = $971k
The project has a positive net present value and therefore should be accepted
Year 6
$000
(129)
(129)
0.630
(81)
(b)
Net cash flow after tax
Year 0
$000
(8,000)
Year 1
$000
579
Year 2
$000
512
Year 3
$000
542
Year 4
$000
575
Year 5
$000
10,608
Year 6
$000
(129)
1.000
0.893
0.797
0.712
0.636
0.567
0.507
(8,000)
517
408
386
366
6,015
(65)
Discount factors @ 12%
Present value
Net present value = -$373k
May 2012
13
P1
IRR = 8% + (($971k/($971k + $373k)) x (12% - 8%))
= 8% + 2.9%
= 10.9%
(c)
The time value of money relates to the return required by investors and has three main
elements:
Delayed Consumption
There is an opportunity cost involved with the investment of funds. Generally the value of
$1.00 now is greater than the value of $1.00 in one year’s time since investors have to give
up present consumption. An investor will give up present consumption for the potential of
higher future consumption i.e. they need to be rewarded for giving up certain current
consumption for certain future consumption.
Inflation
If there is inflation then investors also need to be compensated for the loss in purchasing
power as well as for time.
Risk
The promise of money in the future carries with it an element of risk. The payout may not take
place or the amount may be less than expected. An investor therefore needs to be
compensated for time, inflation and also risk.
The objective of investment within a company is to create value for its owners. Investors have
alternative uses for their funds and therefore have an opportunity cost if money is invested in
a corporate project. Investments therefore must generate enough cash for all investors to
receive their required returns. The use of net present value in investment appraisal
recognises the time value of money and discounts cash flows at the investors’ required rate of
return.
P1
14
May 2012
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
Wednesday 29 August 2012
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 and 7.
Section C comprises 2 questions and is on pages 8 to 11.
Maths tables and formulae are provided on pages 13 to 16.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2012
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
A company commenced business on 1 August. Total sales revenue in August was
$200,000 and is expected to increase at a rate of 2% per month. Credit sales represent
60% of total sales revenue and the remaining 40% is cash sales. The credit period
allowed is one month. Bad debts are expected to be 3% of credit sales but the
remaining credit sales customers are expected to pay on time.
The estimated receipts in September from cash and credit sales are:
A
$195,552
B
$196,400
C
$198,000
D
$201,600
(2 marks)
Performance Operations
2
September 2012
1.2
A company operates a throughput accounting system. The details per unit of Product C
are:
Selling price
Material cost
Labour cost
Overhead costs
Time on bottleneck resource
$28.50
$9.25
$6.75
$6.00
7.8 minutes
The throughput contribution per hour for Product C is:
A
$50.00
B
$122.85
C
$121.15
D
$148.08
(2 marks)
1.3
The following details have been extracted from the accounts payable records of RS.
Invoices paid in the month of purchase
Invoices paid in the first month after purchase
Invoices paid in the second month after purchase
15% of total value
65% of total value
20% of total value
The pattern of payments is expected to continue in the future and has been used to
produce RS’s cash budget for October to December.
Purchases for October to December are budgeted as follows:
October
November
December
$280,000
$250,000
$300,000
A settlement discount of 5% is taken on invoices paid in the month of purchase.
The amount budgeted to be paid to suppliers in December is:
A
$264,500
B
$261,250
C
$250,325
D
$263,500
(2 marks)
Section A continues on the next page
TURN OVER
September 2012
3
Performance Operations
1.4
The fixed production overhead volume variance can be defined as
A
the difference between the budgeted fixed production overhead cost and the standard
fixed production overhead cost absorbed by actual production.
B
the difference between the standard fixed production overhead cost absorbed by actual
production and the actual fixed overhead cost incurred.
C
the difference between the budgeted and actual fixed production overhead cost.
D
the difference between the budgeted fixed production overhead cost and the budgeted
production at the actual absorption rate incurred.
(2 marks)
1.5
A master budget comprises the
A
budgeted income statement and budgeted cash flow statement only.
B
budgeted income statement and budgeted balance sheet only.
C
budgeted income statement and budgeted capital expenditure only.
D
budgeted income statement, budgeted balance sheet and budgeted cash flow
statement only.
(2 marks)
LM operates a parcel delivery service. Last year its employees delivered 15,120
parcels and travelled 120,960 kilometres. Total costs were $194,400.
1.6
LM has estimated that 70% of its total costs are variable with activity and that 60% of
these costs vary with the number of parcels and the remainder vary with the distance
travelled.
LM is preparing its budget for the forthcoming year using an incremental budgeting
approach and has produced the following estimates:
•
•
•
All costs will be 3% higher than the previous year due to inflation
Efficiency will remain unchanged
A total of 18,360 parcels will be delivered and 128,800 kilometres will be
travelled.
Required:
Calculate the following costs to be included in the forthcoming year’s budget:
(i)
the total variable costs related to the number of parcels delivered.
(ii)
the total variable costs related to the distance travelled.
(3 marks)
Performance Operations
4
September 2012
1.7
A capital investment project has the following estimated cash flows and present values:
Year
0
1-5
1-5
5
Initial
investment
Contribution
per annum
Fixed costs per
annum
Residual value
Cash flow
$
(200,000)
Discount factor
@ 12%
1.0
Present value
$
(200,000)
108,000
3.605
389,340
(30,000)
3.605
(108,150)
30,000
0.567
17,010
Required:
Calculate the sensitivity of the investment decision to a change in the annual
contribution.
(3 marks)
1.8
DB manufactures and sells e-readers. The standard labour cost per unit of the product
is $7. Each unit takes 0.5 hours to produce at a labour rate of $14 per hour. The
budgeted production for August was 20,000 units.
The Production Director subsequently reviewed the market conditions that had been
experienced during August and determined that market labour rates were $17.50 per
hour. The actual production was 22,000 units. Actual labour hours worked were 11,400
hours at $15.50 per hour.
Required:
Calculate the following variances for August:
(i)
(ii)
(iii)
The labour rate planning variance
The labour rate operational variance
The labour efficiency operational variance
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
September 2012
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
A company’s Financial Director is deciding whether to purchase or lease two assets:
Asset 1 has a ten year life with a zero residual value. It can be purchased for $120,000.
If the asset is purchased it would be paid for in cash on the day the asset is acquired.
Alternatively, it can be leased for ten payments of $18,000 per annum payable each
year in advance.
Asset 2 has a five year life. It can be purchased for $51,000 and will have a residual
value of $20,000 after five years. If the asset is purchased it would be paid for in cash
on the day the asset is acquired. Alternatively, it can be leased for five payments of
$10,000 per annum payable each year in arrears. If leased, the asset will remain the
property of the lessor and will be returned at the end of the five year contract.
The cost of capital is 10% per annum. Ignore taxation.
Required:
Prepare calculations to show whether each of the assets should be purchased or
leased.
(5 marks)
(b)
The manager of a retail store that sells electronic goods is deciding which of three
credit agreements to offer to its customers. Past experience has shown that there are
three possible reactions to each of the agreements. The profit will depend on
customers’ reaction to the agreement on offer.
The profit for each of the possible outcomes is as follows:
Agreement A
$
Agreement B
$
Agreement C
$
Strong
52,600
44,800
64,700
Moderate
43,700
36,200
41,600
Weak
38,200
34,500
33,100
Customer reaction
Required:
(i)
Prepare a regret matrix and use it to identify the agreement that the manager
would select if the minimax regret criterion was used to make the decision.
(ii)
Describe the attitude to risk of a manager that is risk averse.
(3 marks)
(2 marks)
(Total for sub-question (b) = 5 marks)
Performance Operations
6
September 2012
(c)
Explain the disadvantages for a company of using a centralised purchasing system.
(5 marks)
(d)
Explain the limitations of incremental budgeting.
(5 marks)
The following information is given for sub-questions 2(e) and 2(f) below
GH is a manufacturer of leather goods. The company has recently won a contract to supply
CD, a major department store chain, with a range of products. The contract will require
significant investment in non-current assets and working capital. GH will raise a loan from its
bank for the investment in non-current assets but is considering alternative methods of
reducing the required investment in working capital. These methods include offering early
settlement discounts and debt factoring.
(e) CD’s normal credit term from its suppliers is 90 days. GH is considering offering an
early settlement discount of 3% for payments received within ten days in order to
reduce the working capital requirement.
Required:
(i)
Calculate, to the nearest 0.1%, the effective annual interest rate to GH of the
early settlement discount. You should assume a 365 day year and use a
compound interest methodology.
(3 marks)
(ii)
State TWO disadvantages to GH of using a bank loan to finance the additional
working capital.
(2 marks)
(Total for sub-question (e) = 5 marks)
(f)
Explain the advantages and disadvantages to GH of using debt factoring to finance the
additional working capital.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 8
TURN OVER
September 2012
7
Performance Operations
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
PQ produces two products, Product B and Product C. The company uses a standard
absorption costing system that absorbs overheads on the basis of direct labour hours. The
company operates a just-in-time purchasing and production system and no inventory of raw
materials or finished goods is held.
Standard selling prices are determined by adding a 100% mark-up to total production costs
per unit.
The following budget and actual data relate to August.
Budget data:
Production and sales
Standard production costs per unit:
Direct material ($5 per kg)
Direct labour ($7 per hour)
Variable overhead
Fixed overhead
Product B
2,200 units
Product C
1,800 units
$
25.00
14.00
3.00
8.00
$
35.00
10.50
2.25
6.00
Product B
3,000 units
$110
Product C
1,500 units
$105
Actual data:
Production and sales
Selling price per unit
Production costs:
Direct material
Direct labour
Variable overheads
Fixed overheads
$124,800 (25,600 kg)
$ 67,980 (9,140 hours)
$ 14,300
$ 27,000
The company produces a monthly variance analysis report which has previously included the
calculation of the sales volume profit variance. The new management accountant has decided
to extend this analysis and replace the sales volume profit variance with the sales mix profit
margin variance and the sales quantity profit variance.
Performance Operations
8
September 2012
Required:
(a)
Prepare a statement that reconciles the budgeted gross profit and actual gross
profit for August. The variances should be shown in as much detail as possible
including the individual sales mix profit margin variances and the individual sales
quantity profit variances.
(17 marks)
(b)
Explain the benefits to the company of separating the sales volume profit
variance into the sales mix profit margin variance and the sales quantity profit
variance. You should use the figures calculated in part (a) to illustrate your
answer.
(4 marks)
(c)
Explain TWO reasons why a standard costing system may not be considered
appropriate in a modern manufacturing environment.
(4 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
September 2012
9
Performance Operations
Question Four
EF operates tourist attractions in major capital cities. The company is considering opening a
new attraction in Eastern Europe.
The initial capital investment will be $120 million. EF plans to operate the attraction for five
years after which it will be sold to another operator at an estimated price of $50 million at
Year 5 prices.
A market research survey has estimated the following visitor numbers and associated
probabilities, revenue and operating costs:
Revenue and variable costs
Number of visitors per year
1.2 million
0.8 million
0.6 million
Probability
30%
50%
20%
It is expected that the number of visitors per year will remain constant for the life of the
project.
The entrance fee for the attraction will be $40. Each visitor is expected to spend an average
of $15 on souvenirs and $5 on refreshments.
The variable costs are estimated to be $25 per visitor. This includes the variable cost of
operating the attraction and the cost of souvenirs and refreshments.
Fixed operating costs
The company will lease the land on which the attraction is to be situated at a cost of $500,000
per annum. The lease cost will remain the same throughout the life of the project.
Maintenance costs are estimated to be $200,000 per annum.
Inflation
All of the values above, other than the amount payable by the purchaser at the end of the five
year period, have been expressed in terms of current prices. The lease cost of $500,000 per
annum will apply throughout the life of the project and is not subject to inflation.
A general rate of inflation of 4% per annum is expected to apply to all revenues and costs,
excluding the lease cost throughout the life of the project, starting in Year 1.
Other information
The company uses net present value based on the expected values of cash flow when
evaluating projects of this type.
The company has a money cost of capital of 12% per annum.
The company’s Financial Director has provided the following taxation information:
•
•
•
The initial investment will qualify for tax depreciation at 25% of the reducing balance
per annum with a balancing adjustment in the year of disposal.
The first claim for tax deprecation will be made against the profits from Year 1.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is payable in the following year.
All cash flows apart from the initial investment of $120 million should be assumed to occur at
the end of the year.
Performance Operations
10
September 2012
Required:
(a)
Evaluate the project from a financial perspective. You should use net present
value as the basis of your evaluation and show your workings in $000.
(14 marks)
(b)
(i)
Calculate the internal rate of return (IRR) of the project.
(4 marks)
(ii)
Calculate the payback period for the project. You should assume for
this purpose that all cash flows occur evenly throughout the year.
(3 marks)
(c)
Explain the difference between the real cost of capital and the money cost of
capital. You should include a numerical example to illustrate your answer.
(4 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 13 to 16
September 2012
11
Performance Operations
Operational Level Paper
P1 – Performance Operations
September 2012 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early October at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
1.1
August credit sales = 200,000 x 60% x 97% = $116,400
September cash sales = 204,000 x 40% = $81,600
Total cash received = $116,400 + $81,600 = $198,000
The correct answer is C.
1.2
Selling price – material costs = $28.50 - $9.25 = $19.25
Return per hour = ($19.25 / 7.8) x 60 = $148.08
The correct answer is D.
September 2012
1
P1
1.3
20% of October sales
65% of November sales
15% of December sales x 0.95
Total cash paid
= $ 56,000
= $162,500
= $ 42,750
= $261,250
The correct answer is B.
1.4
The correct answer is A.
1.5
The correct answer is D.
1.6
(i)
Costs that varied with number of parcels = $194,400 x 70% x 60% = $81,648
Cost per parcel last year = $81,648 /15,120 = $5.40
Parcel related cost for next year = $5.40 x 1.03 x 18,360 = $102,118
(ii)
Costs that vary with kilometres travelled = $194,400 x 70% x 40% = $54,432
Cost per km = $54,432 / 120,960 = $0.45
Distance related costs for next year = $0.45 x 1.03 x 128,800 = $59,699
1.7
The net present value of the project is $98,200.
If the present value of the contribution was to decrease by more than $98,200 then the project
would cease to be viable. As a percentage this is:
$98,200 / $389,340 = 25.2%
Which represents a decrease in the annual contribution of $108,000 x 0.252 = $27,216
1.8
(i)
The labour rate planning variance for August
(22,000 units x 0.5) x ($17.50 - $14) = $38,500 A
(ii)
The labour rate operational variance for August
11,400 hrs x ($17.50 - $15.50) = $22,800 F
P1
2
September 2012
(iii)
The labour efficiency operational variance for August
((22,000 x 0.5 hour) - 11,400 hrs) x $17.50= $7,000 A
September 2012
3
P1
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome C2(a) evaluate project proposals using the
techniques of investment appraisal. It examines candidates’ ability to calculate the present
value of leasing an asset and compare this to the cost of purchasing an asset.
Suggested Approach
For Asset 1 candidates should compare the purchase cost of the asset with the present value
of the lease cost taking into consideration that the lease payments are made in advance. For
Asset 2 candidates should calculate the purchase cost of the asset using the initial payment
and the present value of the residual value. This can then be compared to the present value
of the lease cost.
Asset 1
Present value of purchase cost = $120,000
Present value of lease cost = $18,000 + ($18,000 x 5.759) = $121,662
Asset 1 should be purchased as the present value of the purchase cost is lower.
Asset 2
Present value of purchase cost = $51,000 - ($20,000 x 0.621) = $38,580
Present value of lease cost = $10,000 x 3.791 = $37,910
Asset 2 should be leased as the present value of the lease payments is lower.
(b)
Rationale
Part (i) assesses learning outcome D1(a) analyse the impact of uncertainty and risk on
decision models that may be based on relevant cash flows, learning curves, discounting
techniques etc. It examines candidates’ ability to apply the minimax regret criterion to a
decision. Part (ii) also assesses learning outcome D1(a) analyse the impact of uncertainty
and risk on decision models that may be based on relevant cash flows, learning curves,
discounting techniques etc. It examines candidates’ ability to describe the type of manager
who is risk averse.
Suggested Approach
In part (i) candidates should prepare a regret matrix that shows the regret under each of the
possible customer reactions. They should then identify the maximum regret if each of the
agreements were chosen and then chose the agreement that minimises the maximum regret.
In part (ii) candidates should clearly describe a manager who is risk averse.
P1
4
September 2012
(i)
Regret Matrix
Customer
reaction
Agreement A
Agreement B
Agreement C
$
$
$
Strong
12,100
19,900
0
Moderate
0
7,500
2,100
Weak
0
3,700
5,100
The maximum regret if Agreement A is chosen is $12,100
The maximum regret if Agreement B is chosen is $19,900
The maximum regret if Agreement C is chosen is $5,100
To minimise the maximum regret the manager will choose Agreement C.
(ii)
A risk averse decision maker is one that focuses on the possibility of poor results and seeks
to avoid a high degree of risk. A risk averse decision maker faced with a choice between two
alternatives with identical expected values will choose the less risky alternative. These
decision makers are often viewed as pessimists.
(c)
Rationale
The question assesses learning outcome E1(g) analyse the impact of alternative policies for
stock management. It examines candidates’ ability to explain the disadvantages of using a
centralised purchasing system.
Suggested Approach
Candidates should consider the potential disadvantages to a company of using a centralised
purchasing system compared to a decentralised system and clearly explain what the
disadvantages are and why they arise under this system.
The disadvantages of a centralised purchasing system are as follows:
•
•
•
•
•
•
It may result in increased transport costs with a consequential impact on the
environment.
A centralised purchasing system is likely to be more bureaucratic and unable to
respond to inventory shortages as quickly as a local buyer.
A local buyer may be more flexible and able to respond to temporary reductions in
local prices that a central purchasing manager may be unaware of.
Local buyers may be able to develop stronger relationships with local suppliers thus
possibly ensuring greater reliability of supply and the opportunity for JIT purchasing
and reduced inventories.
Local suppliers may offer varied products thus enabling differentiation of finished
products.
The opportunity to delegate responsibility for aspects of the management of the
business and the benefits in terms of management development will not be available.
September 2012
5
P1
•
A centralised purchasing system is not appropriate where managers have been given
responsibility for the financial management of their particular operating unit. Where
this is the case the responsibility for purchasing and inventory management decisions
should also be given to the managers.
(d)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the limitations of a particular approach that managers
may use in setting budgets.
Suggested Approach
Candidates should first explain what is meant by incremental budgeting and then consider the
potential disadvantages of this approach and the problems that can arise when using this
type of budget as a control mechanism.
An incremental approach to budgeting has a number of limitations as follows:
•
•
•
•
It is based on what has happened in the past therefore the allocation of resources to
specific activities is not justified. It is assumed that the activities will continue merely
because they were undertaken in the previous year. This is inappropriate in a rapidly
changing environment.
Excessive costs included in the previous budget will be carried forward into the next
budget. An incremental system does not look at reducing waste and overspending.
Past inefficiencies will be continued as different approaches to achieving the
objectives will not be examined.
The performance targets in the budget tend not to be challenging. The approach does
not encourage managers to look for ways to improve the business.
It encourages managers to spend up to the budget as they know that if they fail to
spend the budget it is likely to be cut in the next period.
(e)
Rationale
Part (i) assesses learning outcome E1(e) analyse trade debtor and creditor information. It
examines candidates’ ability to calculate the effective annual interest rate of an early
settlement discount. Part (ii) assesses learning outcome E2(a) identify sources of short-term
funding. It examines candidates’ ability to state the advantages of loan finance as a method
of financing working capital.
Suggested Approach
In part (i) candidates should calculate how many days early the payment will be received.
They should then divide 365 days by this to calculate the compounding periods. The discount
rate should then be compounded by the number of periods to calculate the effective annual
interest rate. In part (ii) candidates should clearly state the disadvantages of using loan
finance as a method of financing working capital.
P1
6
September 2012
(i)
Payment will be received 80 days early.
Number of compounding periods = 365/80 = 4.5625
1+ r = (1.00/0.97)
4.5625
1+ r = 1.14909
The effective annual interest rate of the early settlement discount is 14.9%
(ii)
Examiners note: the question asks for TWO disadvantages. Examples of points that would be
rewarded are given below.
•
The bank will normally include additional conditions such as security in the form of
fixed/floating charges and other debt covenants. These are likely to result in reduced
financial flexibility for GH.
•
Bank loans will increase the company’s gearing ratio.
•
Interest charges on bank loans are normally based on the bank’s base rate. This
makes it harder to forecast the interest payable and exposes the business to future
increases in interest rates
•
A bank loan is generally inflexible in terms of amount and time period whereas
working capital requirements are likely to fluctuate.
September 2012
7
P1
(f)
Rationale
The question assesses learning outcome E1(f) analyse the impacts of alternative debtor and
creditor policies. It examines candidates’ ability to discuss the advantages and disadvantages
of factoring as a method of managing a company’s trade receivables.
Suggested Approach
Candidates should firstly consider the potential benefits to a company of using factoring and
then contrast with the potential disadvantages that can arise from its use.
Advantages
Factoring has the advantage that GH will received 80 – 85% of the cash immediately with the
remainder being received when the customer settles the debt thus reducing the need for
working capital financing. Factoring can also be provided on a non-recourse basis, i.e. the
factor guarantees settlement even if they are not paid by the customers. The factor will also
administer GH’s sales ledger including the assessment of credit worthiness of customer,
invoicing and collection which will result in reduced administration costs. The factor has
considerable expertise in all of these areas that a small business in particular may not have
available. Factoring also provides flexibility since as sales increase with the corresponding
demand for finance, so finance from this source increases. It may be a cost effective lender to
GH, if it has no assets, apart from its receivables, to offer as security.
Disadvantages
Factoring is sometimes associated with financial difficulties and many companies are
reluctant to use factors for this reason. GH will also lose personal communication with its
customers. The services provided by a factor are expensive and may not be cost effective. It
may be difficult for GH in the future to withdraw from the arrangement and re-establish a sales
ledger function. It may also be difficult to raise more traditional forms of finance except at high
interest rates. Debt factoring would involve factoring GH’s total sales ledger. It may be more
appropriate to use invoice discounting where only the invoices relating to this contract would
be discounted.
P1
8
September 2012
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate appropriate
variances to reconcile budget and actual profit. Part (b) assesses learning outcome A1(f)
interpret material, labour, variable overhead, fixed overhead and sales variance,
distinguishing between planning and operational variances. It examines candidates’ ability to
explain the benefits of splitting the sales volume profit variance into the sales mix profit
variance and the sales quantity profit variance. Part (c) assesses learning outcome A1(h)
explain the impact of just-in-time manufacturing methods on cost accounting and the use of
‘back-flush accounting’ when work in progress stock is minimal. It examines candidates’
ability to explain the reasons why standard costing may not be considered useful in a modern
manufacturing environment.
Suggested Approach
In part (a) candidates should firstly calculate the budgeted profit and the actual profit for the
period. They should then calculate each of the variances for sales, material, labour, variable
overheads and fixed overheads. They should then prepare a reconciliation statement starting
with the budgeted profit and then showing each of the individual variances to reconcile the
budgeted profit to actual profit. In part (b) candidates should clearly explain why it would be
useful to split the sales volume profit variance into its constituent elements using the figures
calculates in part (a) to illustrate the answer. In part (c) candidates should clearly explain the
reasons why standard costing may be not be considered useful in a modern manufacturing
environment.
September 2012
9
P1
(a)
$
$
Budgeted profit
$
206,750
Sales mix profit margin variance
(see workings below)
Product B
Product C
Sales quantity profit variance
(see workings below)
Product B
Product C
Standard profit on actual sales
26,250 F
28,219 A
1,969 A
13,750 F
12,094 F
25,844 F
23,875 F
230,625 F
Selling price variance
Product B: 3,000 units x ($110 - $100)
Product C: 1,500 units x ($105 - $107.50)
Direct material price variance
((25,600 kg x $5) – $124,800)
Direct material usage variance
((3,000 x 5 kg) + (1,500 x 7 kg)) – 25,600 kg) x $5
Direct labour rate variance
(9,140 x $7) - $67,980
Direct labour efficiency variance
((3,000 x 2hrs) + (1,500 x 1.5 hours)) – 9,140) x $7.00
Variable overhead expenditure variance
(9,140 hours x $1.50) - $14,300
Variable overhead efficiency variance
((3,000 x 2hrs) + (1,500 x 1.5 hours)) – 9,140) x $1.50
Fixed overhead expenditure variance
((2,200 x $8) + (1,800 x $6)) - $27,000
Fixed overhead volume variance
Product B: (3,000 – 2,200) x $8
Product C: (1,500 – 1,800) x $6
30,000 F
3,750 A
26,250 F
3,200 F
500 A
2,700 F
4,000 A
6,230 A
10,230 A
590 A
1,335 A
1,925 A
1,400 F
6,400 F
1,800 A
Actual profit
6,000 F
253,420
Workings:
Standard selling price per unit
Product B: $50 x 2 = $100
Product C: $53.75 x 2 = $107.50
Budgeted profit for the period
Product B
Sales (units)
2,200
Budgeted profit per unit $50
Total budgeted profit
$110,000
P1
Product C
1,800
$53.75
$96,750
10
Total
$206,750
September 2012
Actual profit for the period
$
Sales
Direct materials
Direct labour
Variable production overheads
Fixed production overheads
Total production cost
Actual profit
$
487,500
(3,000 x $110) + (1,500 x $105)
124,800
67,980
14,300
27,000
234,080
253,420
Sales mix profit margin variance
Actual sales
Actual sales
@standard
@ actual
mix
mix
(units)
(units)
Product B
2,475
3,000
Product C
2,025
1,500
4,500
4,500
Variance
(units)
525 F
525 A
Standard
profit
$
50.00
53.75
Variance
$
26,250 F
28,219 A
1,969 A
Or alternatively:
Weighted average profit per unit
$206,750 / 4,000 = $51.6875
Sales mix profit margin variance
Actual sales
Actual sales @
@standard mix
actual mix
(units)
(units)
Variance
(units)
Product B
Product C
525 F
525 A
2,475
2,025
4,500
Sales quantity profit variance
Actual sales
@standard
mix
(units)
Product B
2,475
Product C
2,025
4,500
September 2012
3,000
1,500
4,500
Budget sales
@ standard
mix
(units)
2,200
1,800
4,000
11
Variance
(units)
275 F
225 F
500 F
Standard profit
difference
$
Variance
$
(50.00 – 51.6875)
(53.75 – 51.6875)
Standard
profit
$
50.00
53.75
886 A
1083 A
1,969 A
Variance
$
13,750 F
12,094 F
25,844 F
P1
Or alternatively:
Sales quantity profit variance
Actual sales
@standard mix
(units)
Product B
Product C
2,475
2,025
4,500
Budget sales
@ std mix
(units)
2,200
1,800
4,000
Variance
(units)
275 F
225 F
500 F
Weighted average
profit per unit
$
Variance
$
51.6875
51.6875
(b)
By separating the sales volume profit variance into the quantity and mix variance, we can
explain how the sales volume is affected by a change in the total physical volume of sales
and a change in the relative mix of products. The sales quantity profit variance indicates that if
the original planned sales mix had been maintained for the actual sales volume of 4,500 units,
profits would have increased by $25,844. However because the actual sales mix was not in
accordance with the budgeted sales mix, an adverse mix variance of $1,969 occurred. The
adverse mix variance arose because there was an increase in the percentage of units sold of
Product B which has the lowest profit margin and a decrease in the percentage sold of
Product C which has the highest profit margin.
The separation of the sales volume variance into the quantity and mix components
demonstrates that increasing or maximising sales volume may not be as beneficial as
promoting the sales of the most profitable mix of products.
(c)
Examiners note: the question asks for TWO reasons. Examples of points that would be
rewarded are given below.
In a JIT environment measuring standard costing variances may encourage dysfunctional
behaviour. A JIT production environment relies on producing small batch sizes economically
by reducing set up times. Performance measures that benefit from large batch sizes or
producing for inventory should therefore be avoided.
In an AMT environment the major costs are those related to the production facility rather than
production volume related costs such as materials and labour which standard costing is
essentially designed to plan and control. Fixed overhead variances do not necessarily reflect
under or overspending but may simply reflect differences in production volume. An activity
based cost management system may be more appropriate, focusing on the activities that
drive the cost.
In a total quality environment, standard costing variance measurement places an emphasis
on cost control to the detriment of quality. Cost control may be achieved at the expense of
quality and competitive advantage.
A continuous improvement environment requires a continual effort to do things better rather
than achieve an arbitrary standard based on prescribed or assumed conditions. In today’s
competitive environment cost is market driven and is subject to considerable downward
pressure. Cost management must consist of both cost maintenance and continuous cost
improvement.
In a JIT/AMT/TQM environment the workforce is usually organised into empowered, multiskilled teams controlling operations autonomously. The feedback they require is real time.
P1
12
September 2012
14,214 F
11,630 F
25,844 F
Periodic financial reports are neither meaningful nor sufficiently timely to facilitate appropriate
control action.
September 2012
13
P1
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and C1(c) calculate project cash flows,
accounting for tax and inflation, and apply perpetuities to derive ‘end of project’ value where
appropriate and C2(a) evaluate project proposals using the techniques of investment
appraisal. It examines candidates’ ability to identify the relevant costs of a project and then
apply discounted cash flow analysis to calculate the net present value of the project. It also
requires candidates to calculate the effect of tax and inflation on the cash flows. Part (b) also
assesses learning outcome C2(a) evaluate project proposals using the techniques of
investment appraisal. It examines candidates’ ability to calculate the IRR and the payback
period of a project. Part (c) assesses learning outcome C1(e) explain the financial
consequences of dealing with long-run projects, in particular the importance of accounting for
the ‘time value of money’. It examines candidates’ ability to explain what the difference
between the real cost of capital and the money cost of capital.
Suggested Approach
In part (a) candidates should firstly calculate the contribution per visitor and inflate this by 4%
to calculate the year 1 contribution per visitor. They should then calculate the expected value
of the number of visitor for year 1. They can then multiply this by the contribution per visitor to
get the Year 1 contribution. The Year 1 contribution should then be inflated by 4% per annum
for each year of the project. Maintenance costs should also be inflated by 4% per annum. The
lease costs should also be included at $500k for each year. Once the relevant cash flows for
each year of the project have been identified they should then calculate the tax depreciation
and the tax payments. The net cash flows after tax should be discounted at a discount rate of
8% to calculate the NPV of the project. In part (b) the same cash flows should then be
discounted at a higher discount rate and the IRR calculated using interpolation. The
cumulative cash flows should also be calculated to enable the calculation of the payback
period. In part (c) candidates should clearly explain the difference between the real cost of
capital and the money cost of capital.
(a)
Year 1 Contribution
Visitor numbers
Year 1 = (1.2m x 30%) + (0.8m x 50%) + (0.6m x 20%) = 880k
Contribution per visitor
Year 0 = $60 - $25 = $35
Year 1 = $35 x 1.04 = $36.40
Year 1 total contribution = $36.40 x 880k = $32,032k
Fixed Costs
Year 1 Maintenance costs = $200k x 1.04 = $208k
P1
14
September 2012
Cash Flows
Contribution
Year 1
$000
32,032
Year 2
$000
33,313
Year 3
$000
34,646
Year 4
$000
36,032
Year 5
$000
37,473
Lease costs
(500)
(500)
(500)
(500)
(500)
Maintenance
costs
Net cash flows
(208)
(216)
(225)
(234)
(243)
31,324
32,597
33,921
35,298
36,730
Taxation
Year 1
$000
31,324
Year 2
$000
32,597
Year 3
$000
33,921
Year 4
$000
35,298
Year 5
$000
36,730
Tax Depreciation
Taxable profit
(30,000)
1,324
(22,500)
10,097
(16,875)
17,046
(12,656)
22,642
12,031
48,761
Taxation @ 30%
(397)
(3,029)
(5,114)
(6,793)
(14,628)
Net cash flows
Net present value
Year 0
$000
Structure
(120,000)
cost
Net cash
0
flows
Tax payment
0
Year 1
$000
Year 2
$000
Year 3
$000
Year 4
$000
Year 5
$000
50,000
31,324
32,597
33,921
35,298
36,730
(198)
(1,514)
(2,557)
(3,396)
(7,314)
0
(199)
(1,515)
(2,557)
(3,397)
(7,314)
(120,000)
31,126
30,884
29,849
29,345
76,019
(7,314)
1.000
0.893
0.797
0.712
0.636
0.567
0.507
(120,000)
27,796
24,615
21,252
18,663
43,103
(3,708)
Tax payment
Net cash
flow after tax
Discount
factors @
12%
Present
value
Year 6
$000
Net present value = $11,721
The project has a positive net present value and therefore should be accepted
(b) (i)
Net cash flow
after tax
Discount
factors @ 20%
Present value
(120,000)
31,126
30,884
29,849
29,345
76,019
(7,314)
1.000
0.833
0.694
0.579
0.482
0.402
0.335
(120,000)
25,928
21,433
17,283
14,144
30,560
(2,450)
Net present value = -$13,102
September 2012
15
P1
By interpolation
IRR = 12% + (($11,721 / ($11,721 +$13,102)) x (20% - 12%)
IRR = 12% + 3.78%
IRR = 15.78%
(b) (ii)
Year
0
1
2
3
4
Payback period
Cash flow
(120,000)
31,126
30,884
29,849
29,345
Cumulative cash flow
(120,000)
(88,874)
(57,990)
(28,141)
1,204
= 3 yrs + ((28,141/29,345) x 12)
= 3 yrs 11.5 months
(c)
The real cost of capital is the rate of return that would be required in the absence of inflation.
If prices rise then investors will demand compensation for general inflation. If the real cost of
capital was 8% and the general rate of inflation was 4%, investors will require a return of
1.08 x 1.04 = 1.1232
Investors will be indifferent from a financial perspective as to whether they hold $1,000 now or
receive $1,123.20 in one year’s time. The money cash flow of $1,123.20 is equivalent to
$1,000 now i.e. the money rate of return is 12.32%. The money rate of return includes a
return to compensate for inflation.
P1
16
September 2012
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
21 November 2012 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2012
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
A five year investment project has a positive net present value of $320,000 when
discounted at the cost of capital of 10% per annum. The project includes annual net
cash inflows of $100,000 which occur at the end of each of the five years.
The percentage reduction in the annual net cash inflow that would result in the project
not being financially viable is:
A
31.25%
B
118.5%
C
84.4%
D
18.5%
(2 marks)
1.2
A company’s working capital cycle can be calculated as:
A
Inventory days plus accounts receivable days less accounts payable days
B
Accounts receivable days plus accounts payable days less inventory days
C
Inventory days plus accounts payable days less accounts receivable days
D
Accounts payable days plus accounts receivable days plus inventory days
(2 marks)
Performance Operations
2
November 2012
The following data are given for sub-questions 1.3 and 1.4 below
XY can choose from four mutually exclusive projects. The projects will each last for
one year and their net cash inflows will be determined by market conditions. The
forecast net cash inflows for each of the possible outcomes are shown below.
Market Conditions
Project A
Project B
Project C
Project D
Poor
$000
440
400
360
320
Average
$000
470
550
400
380
Good
$000
560
580
480
420
1.3
If the company applies the maximin criterion the project chosen would be:
A
Project A
B
Project B
C
Project C
D
Project D
(2 marks)
1.4
If the company applies the maximax criterion the project chosen would be:
A
Project A
B
Project B
C
Project C
D
Project D
(2 marks)
Section A continues on the next page
TURN OVER
November 2012
3
Performance Operations
1.5
JK has budgeted sales for next year of 24,000 units and inventory levels are expected
to remain constant throughout the year. Each unit produced will require 3 labour hours
and the budgeted labour rate will be $15 per hour. It is estimated that 10% of units
produced will be wasted.
It is expected that 15% of the total hours worked will be paid at overtime rates. 10% of
the total hours will be paid at the basic rate plus an overtime premium of 50% of the
basic rate. 5% of the total hours will be paid at the basic rate plus an overtime premium
of 100% of the basic rate.
The labour cost budget for next year is:
A
$ 1,350,000
B
$ 1,306,800
C
$ 1,188,000
D
$ 1,320,000
(2 marks)
1.6
RS reviews the financial performance of potential customers before setting a credit
limit. The summarised financial statements for PQ, a potential major customer
operating in the retail industry, are shown below.
Summary Statement of Financial Position for PQ at year end
2011
2010
$000
$000
Non-current assets
6,400
5,600
Inventories
1,200
1,120
Trade receivables
800
840
Cash
200
40
Trade payables
(1,120)
(1,160)
Non-current liabilities
(3,600)
(3,200)
Net assets
3,880
3,240
Share capital
Retained earnings
2,400
1,480
3,880
Summary Income Statement for PQ for the years
2011
$000
Sales
12,000
Cost of sales
6,400
Operating profit
2,400
2,400
840
3,240
2010
$000
10,000
5,200
1,800
Required:
Calculate the following ratios, to the nearest 0.1 days, for PQ for 2011
(i)
(ii)
(iii)
Receivables days
Payables days
Inventory days
(3 marks)
Performance Operations
4
November 2012
1.7
KL has determined from past experience that the following equation provides a reliable
estimate of its future sales volume:
y = 15,000 + 2,200x
where
y is the total sales units per quarter, and
x is the time period
KL has also derived the following set of seasonal variation index values for each
quarter using the multiplicative model:
Quarter 1
Quarter 2
Quarter 3
Quarter 4
80
110
120
90
Required:
Calculate the forecast sales units for the third quarter of year 6 using the above model
and assuming that the first quarter of year 1 is time period 1.
(3 marks)
1.8
A $100 bond has a yield to maturity of 6% per annum and is due to mature in three
years’ time. The next interest payment is due in one year’s time. Today’s market value
of the bond is $108.06.
Required:
Calculate the coupon rate on the bond.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
November 2012
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
FG is concerned that the payment record of one of its customers is extremely poor. An
extract from the trade receivable account for the customer, for the period 1 July to 31
October, is shown below:
Date
Narrative
Debit
$
01/07/2011
08/07/2011
12/07/2011
15/07/2011
23/07/2011
04/08/2011
11/08/2011
14/08/2011
05/09/2011
18/09/2011
20/09/2011
04/10/2011
16/10/2011
Balance b/fwd
Invoice No. 345
Invoice No. 423
Credit note No. C85 (Balance b/fwd)
Receipt No. R69 (Balance b/fwd and Invoice No. 345)
Invoice No. 460
Invoice No. 489
Invoice No. 558
Receipt No. R92 (Invoice No. 558)
Invoice No. 576
Invoice No. 615
Receipt No. R121 (Invoice No. 489)
Invoice No. 678
Credit
$
102
234
78
166
156
87
34
34
183
263
87
128
Balance
$
142
244
478
400
234
390
477
511
477
660
923
836
964
Required:
(i)
Prepare an aged debt analysis showing the outstanding debt of the customer
at 31 October analysed by month.
(3 marks)
The credit control department has been chasing the outstanding invoices by telephone,
email and post.
(ii)
State TWO further actions that FG may take after reviewing the information
shown in the aged debt analysis prepared in part (i).
(2 marks)
(Total for sub-question (a) = 5 marks)
Performance Operations
6
November 2012
(b)
A company has recently sold part of its trading operations and is reviewing potential
long term investment opportunities for the funds. Until a suitable opportunity is
identified the funds are being held in a bank deposit account but the company is
considering the following alternative short-term investments:
(i)
(ii)
Certificates of deposit
Bills of exchange
Required:
Describe the alternative short-term investments in terms of their risk, return and
liquidity.
(5 marks)
(c)
The following data are available for Products A, B and C:
Sales units
Selling price per unit
Variable cost per unit
Product
A
6,000
Budget
Product
B
8,400
Product
C
9,600
Product
A
6,400
Actual
Product
B
9,200
Product
C
8,700
$150
$75
$160
$90
$70
$45
$142
$69
$168
$92
$77
$48
Required:
(i)
Calculate the total sales mix contribution variance.
(ii)
Calculate the total sales quantity contribution variance.
(3 marks)
(2 marks)
(Total for sub-question (c) = 5 marks)
(d)
The managers of a hospital are in the process of preparing the annual budget for the
next financial year using incremental budgeting. The hospital’s directors are concerned
that the approach used will result in a budget that does not reflect the aims and
objectives of the hospital. They have requested that the budget should be produced
using zero based budgeting.
Required:
Explain the potential difficulties that the hospital’s managers may face when setting
budgets using zero based budgeting.
(5 marks)
Section B continues on the next page
TURN OVER
November 2012
7
Performance Operations
(e)
RS is a travel company providing daily tours of a major European capital city. The
market is highly competitive and RS has commissioned some market research to help
with the pricing decision for a new tour. The research identified the probability of three
possible market conditions and the number of tickets that would be sold each day at
three different price levels.
Market
Weak
Good
Excellent
Probability
0·3
0·5
0·2
$80
No. of tickets
80
100
150
Ticket Price
$90
No. of tickets
60
90
150
$100
No. of tickets
30
80
120
Variable costs are expected to be $20 per ticket irrespective of market conditions.
Required:
Demonstrate, using a decision tree and based on expected value, which ticket price
RS should choose.
(5 marks)
(f)
Explain the meaning of expected value and the limitations of using expected values for
decision making.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 10
Performance Operations
8
November 2012
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
GH produces three models of speedboat for sale to the retail market. GH currently operates a
standard absorption costing system. Budgeting information for next year is given below:
Model of speedboat
Sales
Direct material
Direct labour
Production overhead
Gross profit
Superior
$000
54,000
17,600
10,700
Deluxe
$000
86,400
27,400
13,400
Ultra
$000
102,000
40,200
16,600
Superior
1,000
100
Deluxe
1,200
200
Ultra
800
300
Production / sales (number of boats)
Machine hours per boat
Total
$000
242,400
85,200
40,700
69,600
46,900
The production overhead cost is absorbed using a machine hour rate.
GH is considering changing to an activity based costing system. The main activities and their
associated cost drivers and overhead cost have been identified as follows:
Activity
Cost Driver
Machining
Set up
Quality inspection
Stores receiving
Stores issue
Machine hours
Number of set ups
Number of quality inspections
Number of component deliveries
Number of issues from stores
Production overhead cost
$000
13,920
23,920
14,140
6,840
10,780
69,600
The analysis also revealed the following information:
Superior
1,000
5
10
500
4,000
Budgeted production (number of boats)
Boats per production run
Quality inspections per production run
Number of component deliveries
Number of issues from stores
Deluxe
1,200
4
20
600
5,000
Ultra
800
2
30
800
7,000
The machines are set up for each production run of each model.
Performance Operations
10
November 2012
Required:
(a)
Calculate the total gross profit for each model of speedboat:
(i) using the current absorption costing system;
(4 marks)
(ii) using the proposed activity based costing system.
(12 marks)
(b)
Explain why an activity based costing system may produce more accurate
product costs than a traditional absorption costing system.
(3 marks)
(c)
Explain the possible other benefits to the company of introducing an activity
based costing system. You should use the figures calculated in part (a) to
illustrate your answer.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
November 2012
11
Performance Operations
Question Four
JK is a profitable international pharmaceutical company that develops, produces and markets
drugs that are licensed as medication. The pharmaceutical industry has grown rapidly and
faces challenges in preventing and controlling environmental pollution. Over the past few
years there has been growing pressure on the industry from government, shareholders and
other stakeholders to improve its environmental management performance. JK has taken a
proactive approach to environmental management and has invested significant resources
introducing pollution prevention and clean manufacturing practices into its operation in order
to reduce waste and minimise negative environmental impacts. The company has used
marketing and advertising campaigns to develop an image as a company that is at the cutting
edge of ‘green’ technology.
As part of its environmental management programme, JK is considering investing in a new
system that will significantly reduce hazardous emissions and waste.
The estimates for the proposed investment are as follows:
Initial investment
$60 million
Useful life
6 years
Residual value
$12 million
Annual income from sale of recycled waste
$5 million
Annual savings in waste disposal costs
$5.5 million
Annual fixed maintenance costs per annum
$1.5 million
Other annual fixed operating costs per annum
(including depreciation)
$10.6 million
JK has experienced a number of external environmental failures over the past few years
which have resulted in total costs to JK, including government fines, of $20 million per annum.
The environmental officer has estimated that, as a direct result of this investment, future
external environmental failure costs that will be borne by JK and their associated probabilities
are as follows:
Annual external environmental
failure costs
Probability
$18 million
$12 million
$10 million
$5 million
30%
25%
35%
10%
The company uses expected value for this type of analysis.
Depreciation of the initial investment will be calculated using the straight line method and has
been included in other fixed operating costs.
The company’s financial director has provided the following taxation information:
•
•
Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid in the following year.
The company uses a cost of capital of 12% per annum to evaluate projects of this type.
Ignore inflation.
Performance Operations
12
November 2012
Required:
(a)
Evaluate the investment in the proposed system using net present value
as the basis of your evaluation. Your workings should be shown in $m to
one decimal place.
(13 marks)
(b)
(i)
Calculate the payback period for the investment.
(3 marks)
(ii)
Discuss the advantages and disadvantages of payback as a method of
investment appraisal.
(5 marks)
(c)
Explain TWO factors related to JK’s approach to environmental issues
that should be considered before making a final decision about the project.
(4 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
November 2012
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
November 2012 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early February at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
1.1
Discounted value of cash inflow = $100k x 3.791 =$379.1k
Sensitivity = $320k / $379.1k = 84.4%
The correct answer is C.
1.2
The correct answer is A.
 The Chartered Institute of Management Accountants 2012
1.3
The minimum outcome for Project A is $440k
The minimum outcome for Project B is $400k
The minimum outcome for Project C is $360k
The minimum outcome for Project D is $320k
Therefore if the company wants to maximise the minimum it will choose Project A.
The correct answer is A.
1.4
The maximum that can be achieved is $580k for Project B.
The correct answer is B.
1.5
The correct answer is D.
1.6
Receivables days = (800/12,000) x 365 = 24.3 days
Payables days = (1,120/(6,400 +1,200 - 1,120) x 365 = 63.1 days
Inventory days = (1,200/6,400) x 365 = 68.4 days
Or alternatively
Receivables days = (((800+ 840)/2)/12,000) x 365 = 24.9 days
Payables days = (((1,120 + 1,160)/2)/(6,400 +1,200 - 1,120)) x 365 = 64.2 days
Inventory days = (((1,200+ 1,120)/2)/6,400) x 365 = 66.2 days
1.7
The third quarter of Year 6 is time period 23
Expected sales volume based on the trend equation
= 15,000 + (2,200 x 23) = 65,600 units
Forecast sales volume after allowing for seasonal variation
= 65,600 x 1.2 = 78,720 units
1.8
The yield to maturity is 6% therefore the net present value of the cash flow when
discounted at 6% will be equal to zero.
Year(s)
Description
Cash flow
Discount factor (6%)
Present value
$
0
1-3
3
NPV
Purchase
Interest
Redemption
(108.06)
9
100
1.000
2.673
0.840
(108.06)
24.06
84.00
0
To achieve a NPV of zero the present value of the total interest paid has to be $24.06
therefore the annual interest payments are $9 which is a coupon rate of 9%
P1
2
November 2012
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome E1(e) analyse trade debtor and creditor information.
In part (i) it examines candidates’ ability to prepare and aged debt analysis and in part (ii) it
examines candidates’ ability to determine what action should be taken as result of the
information given in the analysis.
Suggested Approach
Candidates should firstly establish which invoices remain unpaid by netting off the receipts
and credit notes. They should then prepare a table showing the aging of the outstanding
invoices and the total outstanding balance. In part (ii) candidates should state further actions
that the company could take to recover the outstanding debt.
(a)
(i)
< 1 month
$
Invoice no.423
Invoice no.460
Invoice no.576
Invoice no.615
Invoice no.678
(ii)
1<2 months
$
2<3 months
$
3 months +
Balance
234
156
183
263
128
128
446
156
234
964
Examiner’s note: the question asks for two further actions. Examples of actions that
would be rewarded are given below.
•
•
•
They may decide to take legal action to collect the debt.
They may decide to stop further supplies to the customer.
They may decide to reduce the credit limit available to the customer.
(b)
Rationale
The question assesses learning outcome E2(b) identify alternatives for investment of shortterm cash surpluses. It examines candidates’ ability to describe two potential short term
Investment opportunities in terms of their risk, return and liquidity.
Suggested Approach
Candidates should describe each of the investment and clearly indicate the implication of the
features of the investment in terms of its risk, return and liquidity.
November 2012
3
P1
Certificates of deposit
These are securities that are issued by a bank as an acknowledgement that funds have been
deposited. Certificates of deposit are traded on the money market and so the holder can sell
them to obtain immediate cash at any time. They are therefore a suitable option in terms of
liquidity and have a low risk. Interest is paid on the deposit at a fixed rate based on current
market interest rates at the date of issue but this will reflect the low risk involved. They are
therefore subject to interest rate risk since if market rates increase they lose the opportunity
for higher rates.
They normally have maturities from three months to five years. The lower end of this time
range would be most appropriate for the company’s circumstances however because of the
marketability the upper end of this time range gives flexibility. The company however would
also be exposed to capital risk as the value of the investment changes in response to market
interest rate movements.
Bills of exchange
A bill of exchange is an unconditional order by one person/company to pay another a given
sum of money at a specified future date. These are tradeable and have a short date normally
within 180 days. There is a particularly active market in bills that are payable by top-quality
banks although it is also possible to buy bills that have been accepted by trading companies.
These would therefore be a suitable option in terms of liquidity. They are issued at a discount
to the face value with the yield on the bill dependent on the credit worthiness of the drawee
and market interest rates. They are therefore subject to interest rate risk since if market rates
increase they lose the opportunity for higher rates. They are also subject to default risk
depending on the credit worthiness of the drawee.
(c)
Rationale
The question assesses learning outcome A1(f) interpret material, labour, variable overheads,
fixed overheads and sales variances, distinguishing between planning and operational
variances. It examines candidates’ ability to calculate a sales mix contribution variance and a
sales quantity contribution variances.
Suggested Approach
In part (i) candidates should calculate the sales mix contribution variance by comparing the
actual sales quantity at the budgeted mix with the actual sales quantity at the actual mix. The
variance calculated in units for each of the products should then be multiplied the standard
contribution per unit to calculate the variance for each product. These should then be added
together to calculate the total mix variance. In part (ii) the budgeted sales quantity should be
compared to the actual sales quantity at the budgeted mix. The resultant variance in units
should be multiplied by the standard contribution per unit to calculate the sales quantity
contribution variance for each product. These should then be added together to calculate the
total sales quantity contribution variance.
P1
4
November 2012
(i) Sales Mix Contribution Variance
Actual Sales
Quantity
Product A
Product B
Product C
6,400
9,200
8,700
24,300
Or alternatively:Actual Sales
Quantity
Product A
Product B
Product C
6,400
9,200
8,700
24,300
Actual Sales
at budget
mix
6,075
8,505
9,720
24,300
Difference
Contribution
$
325 F
695 F
1,020 A
75
70
25
Actual Sales
at budget mix
Difference
6,075
8,505
9,720
24,300
325 F
695 F
1020 A
Variance
$
24,375 F
48,650 F
25,500 A
47,525 F
Variance from
weighted average
contribution per
unit
($75 - $53.25)
($70 - $53.25)
($25 - $53.25)
Variance
$
7,068.75 F
11,641.25 F
28,815 F
47,525 F
(ii) Sales Quantity Contribution Variance
Product A
Product B
Product C
Budget Sales
Quantity
6,000
8,400
9,600
24,000
Actual Sales at
budget mix
6,075
8,505
9,720
24,300
Difference
75 F
105 F
120 F
300 F
Contribution
$
75
70
25
Variance
$
5,625 F
7,350 F
3,000 F
15,975 F
Or alternatively:Budget Sales Quantity
Product A
Product B
Product C
6,000
8,400
9,600
24,000
Contribution
$
75
70
25
Total Contribution
$000
450
588
240
1,278
Weighted average contribution = $1,278k / 24,000 = $53.25
Sales quantity contribution variance = (24,300 – 24,000) x $53.25 = $15,975 F
(d)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines the candidates’ ability to explain the difficulties that a not-for-profit organisation may
experience when using a zero based budgeting system.
Suggested Approach
Candidates should clearly explain why setting budgets using zero based budgeting may be
difficult in a not-for-profit organisation.
November 2012
5
P1
The hospital has previously used an incremental budgeting system and therefore the potential
difficulties with setting a budget using a zero based budgeting system are as follows:
Zero based budgeting is extremely time consuming; the work involved in the creation of
decision packages and their ranking is considerable. The hospital may not have the resources
available to enable a full zero based budget to be prepared within the timescale required. It
may also require skills that the current management of the hospital do not possess as they
are inexperienced in this type of budgeting. As this is the first time a zero based budgeting
approach has been used it will mean that all activities carried out by the hospital will need to
be reviewed and justified.
There may be difficulty in identifying the activities undertaken by the hospital particularly if the
organisation structure is based on traditional functional departments. This may result in a
tendency to try to cut costs rather than identifying the main drivers behind costs.
The ranking process can be very difficult as value judgements are required. Widely different
activities cannot be compared on quantitative measurement alone.
(e)
Rationale
The question assesses learning outcome D1(f) apply decision trees. It examines candidates’
ability to use decision trees to evaluate a decision where there is uncertainty regarding
expected cash flows.
Suggested Approach
Candidates should firstly draw the decision tree and then using the various contribution levels
for each branch of the tree work back to calculate the expected contribution at each node.
They should then clearly indicate the most profitable decision.
Decision tree: See next page
P1
6
November 2012
80 tickets
$4,800
30%
$6,240
50%
100 tickets
$6,000
20%
Price - $80
150 tickets
$9,000
60 tickets
$4,200
30%
$6,510
Price $90
$6,510
50%
90 tickets
$6,300
20%
150 tickets
$10,500
Price - $100
30%
$5,840
50%
30 tickets
$2,400
80 tickets
$6,400
20%
120 tickets
$9,600
RS should charge a ticket price of $90.
(f)
Rationale
The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating
expected values and standard deviations together with probability tables and histograms. It
examines the candidates’ ability to explain the meaning of expected value and its limitations
when used in decision making.
Suggested Approach
Candidates should clearly explain the meaning of expected value and the limitation of its use
in decision making.
Expected value is calculated by weighting each of the possible outcomes by their associated
probability. The expected value is therefore the weighted average of the possible outcomes
based on management’s estimates of their probability.
Expected value has a number of limitations as follows:
•
•
•
•
P1
The probabilities used are usually very subjective;
The expected value is merely a weighted average if the decision is repeated several
times. It therefore has little meaning for a one off project;
The expected value gives no indication of the dispersion of possible outcomes around
the expected value i.e. the risk;
The expected value may not correspond to any of the actual possible outcomes.
8
November 2012
SECTION C
Answer to Question Three
Rationale
Part (a)(i) of the question assesses learning outcome A1(a) compare and contrast marginal
(or variable), throughput and absorption accounting methods in respect of profit reporting and
stock valuation. It examines candidates’ ability to calculate the cost of a product using a
traditional method of overhead absorption. Part (a)(ii) assesses learning outcome A1(c)
discuss activity-based costing as compared with traditional marginal and absorption costing
methods, including its relative advantages and disadvantages as a system of cost
accounting. It requires candidates to be able to apply activity based costing to the calculation
of the cost of a product. Part (b) assesses learning outcome A1(c) discuss activity-based
costing as compared with traditional marginal and absorption costing methods, including its
relative advantages and disadvantages as a system of cost accounting. It examines
candidates’ ability to explain the why activity based costing would result in more accurate
product costs compare to a traditional absorption costing system. Part (c) also assesses
learning outcome A1(c) discuss activity-based costing as compared with traditional marginal
and absorption costing methods, including its relative advantages and disadvantages as a
system of cost accounting. It examines candidates’ ability to explain other benefits to a
company of introducing an activity based costing system.
Suggested Approach
In part (a)(i) candidates should identify the direct costs for each product and then calculate
the overhead absorption rate. This rate can then be applied to each product and the gross
profit calculated. In part (a)(ii) candidates need to calculate a cost driver rate for each of the
activities and then apply this cost driver rate to calculate the overhead cost for each activity
per product. The gross profit for each product can then be recalculated. In part (b) candidates
need to clearly explain why activity based costing produces more accurate product costs. In
part (c) the potential benefits to the company of the activity based costing in the areas of
planning, decision making and control should be explained.
(a) (i)
Fixed production overheads = $69,600,000
Budgeted machine hours = (1,000 x 100) + (1,200 x 200) + (800 x 300) = 580,000
Fixed production overhead absorption rate = $69,600,000 / 580,000 = $120 per machine hour
Sales
Direct material
Direct labour
Production overhead
Gross profit
November 2012
Superior
$000
54,000
17,600
10,700
12,000
13,700
9
Deluxe
$000
86,400
27,400
13,400
28,800
16,800
Ultra
$000
102,000
40,200
16,600
28,800
16,400
P1
(a) (ii)
Cost Driver
Number of cost drivers
Machine hours
(1,000 x 100) + (1,200 x 200) + (800 x 300) = 580,000
Number of set ups
(1,000 / 5) + (1,200 /4) + (800 / 2) = 900
Number of quality
inspections
Number of component
deliveries
Number of issues from
stores
(200 x 10) + (300 x 20) + (400 x 30) = 20,000
Sales
Direct material
Direct labour
Machining
Set ups
Quality inspections
Stores receiving
Stores issuing
Gross profit
500 + 600 + 800 = 1,900
4,000 + 5,000 + 7,000 = 16,000
Superior
$000
54,000
17,600
10,700
2,400
(13,920 / 580 x 100)
5,316
(23,920 / 900 x 200)
1,414
(14,140 / 20 x 2)
1,800
(6,840 / 1,900 x 500)
2,695
(10,780 / 16 x 4)
12,075
Deluxe
$000
86,400
27,400
13,400
5,760
(13,920 / 580 x 240)
7,973
(23,920 / 900 x 300)
4,242
(14,140 / 20 x 6)
2,160
(6,840 / 1,900 x 600)
3,369
(10,780 / 16 x 5)
22,096
Ultra
$000
102,000
40,200
16,600
5,760
(13,920 /580 x 240)
10,631
(23,920 / 900 x 400)
8,484
(14,140 / 20 x 12)
2,880
(6,840 / 1,900 x 800)
4,716
(10,780 / 16 x 7)
12,729
(b)
Under an activity based costing (ABC) system the various support activities that are involved
in making products or providing services are identified. ABC recognises that there are many
different drivers of cost not just production or sales volume. The cost drivers are identified in
order to recognise a causal link between activities and costs. They are then used as the basis
to attach activity costs to a particular product or service. Through the tracing of costs to cost
objects in this way, ABC establishes more accurate costs for the product or service.
(c)
The cost drivers identified under an ABC system provide information to management to
enable them to take actions to improve the overall profitability of the company. Cost driver
analysis will provide information to management on how costs can be controlled and
managed. Variance analysis will also be more useful as it is based on more accurate product
costs. The establishment of more accurate product costs should also help managers to
assess product profitability and make better decisions concerning pricing and product mix.
Based on the existing method of absorbing production overheads, the profitability for each
model is as shown below:
P1
10
November 2012
Selling price per unit
Gross profit per unit
Gross margin
Superior
$54,000
$13,700
25.4%
Deluxe
$72,000
$14,000
19.4%
Ultra
$127,500
$20,500
16.1%
Under the ABC system the profitability for each model is significantly different as shown
below.
Selling price per unit
Gross profit per unit
Gross margin
Superior
$54,000
$12,075
22.4%
Deluxe
$72,000
$18,413
25.6%
Ultra
$127,500
$15,911
12.5%
The Ultra model is even less profitable than originally thought and the company will need to
look at ways that profitability can be improved. Cost driver analysis may give an indication of
how this might be achieved. Alternatively, depending on market conditions, the company may
have to consider increasing the price of this model. The Deluxe model under the ABC system
is more profitable than the Superior model. The company may wish to direct its marketing
efforts towards this model to increase the volume sold and the overall company profitability.
An ABC system can be extended beyond product costing to a range of cost management
applications known as activity based management. These include the identification of value
added and non value added activities and performance management in terms of measuring
efficiency through cost driver rates.
November 2012
11
P1
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and learning outcome C2(a) evaluate
project proposals using the techniques of investment appraisal. It examines candidates’
ability to identify the relevant costs of a project and then apply discounted cash flow analysis
to calculate the net present value of the project. Part (b)(i) assesses learning outcome
assesses learning outcome C2(a) evaluate project proposals using the techniques of
investment appraisal. It examines candidates’ ability to calculate the payback period of a
project. Part (b)(ii) assesses learning outcome C2(b) compare and contrast the alternative
techniques of investment appraisal. It examines the candidates’ ability to discuss the
advantages and disadvantages of payback. Part (c) assesses learning outcome C1(g)
prepare decision support information for management, integrating financial and non-financial
considerations. It examines candidates’ ability to explain two factors relating to environmental
issues that the company should consider before making a decision regarding the project.
Suggested Approach
In part (a) candidates should firstly calculate the expected future environmental failure costs
and compare this to the current level of costs to identify the future cost savings as a result of
the investment. They should then identify the other relevant cash flows for each year of the
project. The tax depreciation and tax payments should then be calculated. The net cash flows
after tax should be discounted at the discount rate of 12% to calculate the NPV of the project.
In part b)(i) the project cash flows before discounting from part a) should be used to calculate
the payback period. In part (b)(ii) candidates should then discuss the advantages and
disadvantages of payback. In part (c) candidates should clearly explain two environmental
related factors that the company should consider.
(a)
Other fixed costs
Depreciation per annum = ($60m - $12m) / 6 = $8m
Other fixed costs (excluding depreciation) per annum
= $10.6m - $8m = $2.6m
External environmental failure cost savings:
Expected future cost
($18m x 0.3) + ($12m x 0.25) + ($10m x 0.35) +($5m x 0.1) = $12.4m
Expected Savings = $20m - $12.4m = $7.6m per annum
Cash flows years 1 – 6
Income / cost savings = $5.0m + $5.5m + $7.6m = $18.1m
Fixed maintenance costs = $1.5m
Other fixed costs = $2.6m
Net cash flows = $18.1m - $1.5m - $2.6m = $14.0m
P1
12
November 2012
Taxation
Net cash
flows
Tax
Depreciation
Taxable
profit
Taxation @
30%
Year 1
$m
14
Year 2
$m
14
Year 3
$m
14
Year 4
$m
14
Year 5
$m
14
Year 6
$m
14
(15)
(11.3)
(8.4)
(6.3)
(4.8)
(2.2)
(1)
2.7
5.6
7.7
9.2
11.8
0.3
(0.8)
(1.7)
(2.3)
(2.8)
(3.5)
Net present value
Year 0
Year 1
$m
$m
Investment
(60)
/ residual
value
Net cash
14
flows
Tax
0.2
payment
Tax
payment
Net cash
(60)
14.2
flow after
tax
Discount
1.000
0.893
factors @
12%
Present
(60)
12.7
value
Net present value = -$2.5m
Year 2
$m
Year 3
$m
Year 4
$m
Year 5
$m
Year 6
Year 7
12
14
14
14
14
14
(0.4)
(0.9)
(1.2)
(1.4)
(1.8)
0.1
(0.4)
(0.8)
(1.1)
(1.4)
(1.7)
13.7
12.7
12.0
11.5
22.8
(1.7)
0.797
0.712
0.636
0.567
0.507
0.452
10.9
9.0
7.6
6.5
11.6
(0.8)
The net present value is negative therefore on this basis the company should not go ahead
with the project.
(b) (i)
Payback
Year
0
1
2
3
4
5
6
7
Cumulative cash flows
$m
(60)
(45.8)
(32.1)
(19.4)
(7.4)
4.1
26.9
25.2
Cash flows
$m
(60)
14.2
13.7
12.7
12.0
11.5
22.8
(1.7)
Payback period = 4 years + ((7.4 /11.5) x 12)
= 4 year 8 months
November 2012
13
P1
(b) (ii)
•
Payback is a simple evaluation method and is easy to understand. However its
simplicity is also one of the main criticisms of payback in that it does not take account
of the time value of money. This means that cash flows that occur in Year 1 are
assumed to have the same money value as the same cash flows occurring in Year 2.
This problem however can be overcome by calculating the payback using discounted
cash flow.
•
The method favours projects that pay back early thus recognising the importance of
liquidity for a company. Early payback of cash flow means that the funds can be
reinvested in other profitable projects sooner thus leading to increased company
growth. It does however ignore cash flows, both positive and negative, after the
payback point.
•
The method recognises the uncertainty involved with forecasting future cash flows,
particularly in a rapidly changing environment. It therefore minimises the risk
associated with long time horizons as projects that pay back early are selected in
preference to those projects that have a long payback period that may have been
acceptable using net present value. However not all risks are related to time and
payback may result in many profitable investment opportunities being overlooked
because the payback period is too long. It therefore should not be used on its own but
in combination with other investment appraisal methods such as NPV and IRR.
(c)
There are a number of environmental factors that are difficult to quantify as follows:
•
•
•
•
•
P1
The investment offers significant reduction in waste and external failure costs. The
company may place a value on these above the quantifiable cost savings particularly in
view of its commitment and previous proactive approach to minimising negative
environmental impact.
Potential impact on the company image and future sales from being seen as an
environmentally friendly company.
Potential savings in environmental costs relating to pollution and the consequential cost
to health care and the global environment.
Potential saving in future compliance costs if the government changes the compliance
levels required.
The pressure from government, shareholders and other stakeholders to improve
environmental management.
14
November 2012
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
26 February 2013 – Tuesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2013
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled
off, so that the markers know which sub-question you are answering. For multiple
choice questions, you need only write the sub-question number and the letter
of the answer option you have chosen. You do not need to start a new page for
each sub-question.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available
for the method you use to answer these sub-questions.
Question One
1.1
The correct definition of a bill of exchange is:
A
A negotiable instrument which provides evidence of a fixed-term deposit with a bank
B
A document setting out a commitment to pay a sum of money at a specified point in
time
C
A debt obligation with a long term maturity usually issued by companies and
governments
D
A legal document showing the right to receive interest and capital repayment
(2 marks)
1.2
A company has a money cost of capital of 9%. The rate of inflation is 3%.
The company’s real cost of capital is nearest to:
A
6.0%
B
12.0%
C
12.3%
D
5.8%
(2 marks)
Performance Operations
2
March 2013
The following information is given for sub-questions 1.3 and 1.4 below
The committee of a new golf club is setting the annual membership fee. The number of
members depends on the membership fee charged and economic conditions. The forecast
annual cash inflows from membership fees are shown below.
Membership level
Membership Fee
Low
Average
High
$000
$000
$000
$600
360
480
540
$800
400
440
480
$900
360
405
495
$1,000
320
380
420
1.3
If the maximin criterion is applied the fee set by the committee would be:
A
$600
B
$800
C
$900
D
$1,000
(2 marks)
1.4
If the minimax regret criterion is applied the fee set by the committee would be:
A
$600
B
$800
C
$900
D
$1,000
(2 marks)
Section A continues on the next page
TURN OVER
March 2013
3
Performance Operations
1.5
The details of four short term investments are as follows:
Investment A pays interest of 1.7% every 3 months
Investment B pays interest of 3.4% every 6 months
Investment C pays interest of 5.4% every 9 months
Investment D pays interest of 7.0% every 12 months
The investment that gives the highest effective annual rate of interest, assuming that
the interest is reinvested, is:
A
Investment A
B
Investment B
C
Investment C
D
Investment D
(2 marks)
1.6
The budgeted costs for a company at different levels of output are as follows:
Output
24,000 units
30,000 units
35,000 units
Total costs
$304,000
$352,000
$392,000
The variable cost per unit will reduce by 5% for output levels above 40,000 units. The
reduced cost per unit will apply to all units. Fixed costs will increase by $30,000 for
output levels above 38,000 units.
Required:
Calculate the budgeted total costs for an output level of 45,000 units.
(3 marks)
1.7
A $100 bond has a coupon rate of 8% per annum and is due to mature in four years
time. The next interest payment is due in one year’s time. Similar bonds have a yield to
maturity of 10%.
Required:
Calculate the expected purchase price of the bond at today’s date.
(3 marks)
Performance Operations
4
March 2013
1.8
AB is preparing its purchases budget for raw material C for the forthcoming year. The
opening inventory of raw material C is expected to be 2,000kg and the price is
expected to be $8 per kg.
Raw material C is used only in the production of Product D. Each unit of Product D
requires two kg of material C. Budgeted sales of Product D for the forthcoming year
and for the following year are 36,000 units in each year. Sales will occur evenly
throughout each year. The opening inventory is expected to be 6,000 units.
AB will implement a new inventory policy from the first month of the forthcoming year.
The closing inventory that will be required at the end of the forthcoming year is as
follows:
Raw material inventory: one month's production requirements
Finished goods inventory: one month's sales requirements
Required:
Calculate the material purchases budget for the forthcoming year.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
March 2013
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
Describe the following short term investments in terms of their risk, return and liquidity.
(i)
(ii)
Treasury bills
Bank deposit account
(5 marks)
(b)
A company is considering investing in manufacturing equipment that has a three year
life. The purchase price of the equipment is $70,000 and at the end of the three year
period it will be sold for cash of $10,000. The equipment will be used to produce 6,000
units each year of a product which earns a contribution per unit of $7. Incremental fixed
costs are expected to be $12,000 per annum.
The company has a cost of capital of 8% per annum. Ignore tax and inflation.
Required:
Calculate the sensitivity of the investment decision to a change in the cost of capital.
(5 marks)
Performance Operations
6
March 2013
(c)
A company manufactures Product P by mixing three materials. The standard material
quantity and material cost per unit of Product P are as follows:
Material W
Material X
Material Y
$
60
108
160
328
12 kg @ $5.00
18 kg @ $6.00
20 kg @ $8.00
In February, the actual mix used was as follows:
Material W
Material X
Material Y
Quantity
970 kg
1,230 kg
1,400 kg
$
4,947
7,134
11,060
The actual output was 76 units of Product P.
Required:
Calculate the following variances for February:
(i)
the total material mix variance.
(ii)
the total material yield variance.
(3 marks)
(2 marks)
(Total for sub-question (c) = 5 marks)
(d) A company’s credit control department has been continually contacting a customer by
post, email and telephone to recover an overdue debt. Despite this, the customer has
still not paid and the credit controller is considering other actions that could be taken to
recover the debt.
Required:
Discuss the advantages and disadvantages of TWO other actions that the company’s
credit control department could take in order to collect the overdue debt.
(5 marks)
Section B continues on the next page
TURN OVER
March 2013
7
Performance Operations
(e)
A company is considering introducing a new product. Market research suggests that
the selling price per unit should be $24, $25 or $26. The marketing department has
produced estimates of sales demand and their associated probabilities for each
possible selling price. These estimates are based on pessimistic, likely and optimistic
forecasts and are as follows:
Selling price
Pessimistic
Sales
demand
Units
70,000
Likely
Optimistic
$24
Probability
0.2
Sales
demand
Units
60,000
80,000
0.5
90,000
0.3
$25
Probability
$26
Probability
0.1
Sales
demand
Units
30,000
70,000
0.6
60,000
0.4
90,000
0.3
70,000
0.3
0.3
Required:
(i)
Calculate the expected value of the total sales revenue for each of the selling
prices.
(2 marks)
There is a 70% chance that the variable cost will be $8 per unit and a 30% chance that
the variable cost will be $10 per unit.
(ii)
Calculate the probability of earning a contribution of greater than
$1.1 million if the selling price is set at $25.
(3 marks)
(Total for sub-question (e) = 5 marks)
(f)
The managers of a hospital are in the process of preparing the budget for the next
financial year using incremental budgeting. The hospital’s directors are concerned
about the budgeting approach being used. They have requested that the budget should
be produced using zero based budgeting.
Required:
Explain the potential benefits for the hospital from using zero based budgeting.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 10
Performance Operations
8
March 2013
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this
section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A major company sells a range of electrical, clothing and homeware products through a chain
of department stores. The main administration functions are provided from the company’s
head office. Each department store has its own warehouse which receives goods that are
delivered from a central distribution centre.
The company currently measures profitability by product group for each store using an
absorption costing system. All overhead costs are charged to product groups based on sales
revenue. Overhead costs account for approximately one-third of total costs and the directors
are concerned about the arbitrary nature of the current method used to charge these costs to
product groups.
A consultant has been appointed to analyse the activities that are undertaken in the
department stores and to establish an activity based costing system.
The consultant has identified the following data for the latest period for each of the product
groups for the X Town store:
Product Group
Clothing
Electrical
Homeware
Sales revenue
$4,400k
$3,300k
$1,100k
Cost of sales
$2,800k
$2,300k
$600k
Number of deliveries
104
52
26
Number of pallets per delivery
50
20
10
Number of inventory items
20,000
14,000
6,000
Number of customers
2,100k
1,050k
350k
Number of requisitions
522
243
135
The consultant has also obtained the following information about the support activities:
Activity
Cost driver
Customer service
Number of customers
Warehouse receiving
Number of pallets delivered
700
Warehouse issuing
Number of requisitions
300
In-store merchandising
Number of inventory items
400
Central administration
Sales revenue
316
Performance Operations
10
Overheads
$000
1,100
March 2013
Required:
(a)
Calculate the total profit for each of the product groups:
(i)
using the current absorption costing system;
(4 marks)
(ii)
using the proposed activity based costing system.
(9 marks)
(b)
Explain how the information obtained from the activity based costing
system might be used by the management of the company.
(6 marks)
(c)
Explain the circumstances under which an activity based costing system
would produce similar product costs to those produced using a traditional
absorption costing system.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
March 2013
11
Performance Operations
Question Four
JK offers an automotive parts replacement service in over 500 depots throughout the country.
JK’s current service involves customers driving to the company’s depots where they can get
immediate replacement of tyres, exhausts and other automotive parts.
The company is considering the introduction of a mobile tyre fitting service whereby a JK van
will visit the customer and fit the new tyres. The project will require the purchase of 200 vans
to enable nationwide coverage. The fleet of vans will cost a total of $24 million to purchase
and fit out with the required equipment. The vans are expected to have a useful life of 4 years
at the end of which they will be sold for cash of $2 million in total.
Revenue and contribution
The mobile service will be available 12 hours per day for 360 days of the year. Each tyre
replacement call out is expected to last for 1½ hours including travel time between locations.
The vans are not expected to be utilised for 100% of the time but the percentage utilisation is
expected to increase over the period of the project. The expected percentage utilisation of the
vans is given below:
Year
1
2
3
4
Van utilisation
70%
80%
90%
90%
The expected value of the charge to the customer will be $180 per call out. The expected
value of the variable cost, including fuel costs, will be $120 per call out.
It is estimated that 30% of the customers using the mobile fitting service would have
otherwise travelled to the company’s depots to have their tyres fitted. The company’s depots
have sufficient available capacity to provide a service to these customers. The contribution
per customer in the company’s depots is $100.
Fixed costs
The only incremental fixed costs associated with this project relate to the vans and the
equipment.
The total annual maintenance costs for the 200 vans are expected to be $0.5 million. Other
fixed operating costs, including depreciation of the vans and the equipment, will be a total of
$8 million per annum.
Depreciation will be calculated using the straight line method.
Taxation
The company’s financial director has provided the following taxation information:
• Tax depreciation: 25% of the reducing balance per annum, with a balancing adjustment in
the year of disposal.
• Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it
arises, the balance is paid in the following year.
Other information
The company uses a cost of capital of 12% per annum to evaluate projects of this type.
Ignore inflation.
Performance Operations
12
March 2013
Required:
(a)
Evaluate the project using net present value as the basis of your evaluation.
Your workings should be shown in $ million.
(14 marks)
(b)
Explain how the following techniques could be used to assess the risk of the
project evaluated in part (a).
(i)
Probability analysis
(3 marks)
(ii)
Sensitivity analysis
(3 marks)
(c)
JK is reviewing its policy for replacement of an item of equipment that is used in
its depots. The purchase cost of the equipment is $220,000. This equipment is
essential and is continually replaced.
The following shows the operating costs for each year and the residual cash
values of the equipment, depending upon whether the equipment is replaced on
a 3 year, 4 year, or 5 year cycle. The operating costs in Year 1 and Year 2 are
$90,000 and $100,000 respectively.
Operating costs
Residual value
Year 3
$
110,000
121,000
Year 4
$
132,000
88,000
Year 5
$
154,000
66,000
Required:
Prepare calculations, using the annualised equivalent method, to determine the
optimum replacement cycle for the equipment. You should assume that the initial
investment is incurred at the beginning of Year 1 and that all other cash flows
arise at the end of the year.
You should use a cost of capital of 12% and ignore taxation and inflation
for part (c).
(5 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
March 2013
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
March 2013 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early April at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
1.1
The correct answer is B.
1.2
((1+0.09) / (1+0.03) – 1) x 100 = 5.83%
The correct answer is D.
 The Chartered Institute of Management Accountants 2013
1.3
The minimum outcome for a fee of $600 is $360k
The minimum outcome for a fee of $800 is $400k
The minimum outcome for a fee of $900 is $360k
The minimum outcome for a fee of $1,000 is $320k
Therefore if the committee wants to maximise the minimum cash inflow it will set a fee
of $800.
The correct answer is B.
1.4
A regret matrix is shown below:
Membership level
Membership fee
Low
$000
$600
Average
$000
High
$000
40
0
0
$800
0
40
60
$900
40
75
45
$1,000
80
100
120
Maximum regret if set fee of $600 is $40k
Maximum regret if set fee of $800 is $60k
Maximum regret if set fee of $900 is $75k
Maximum regret if set fee of $1,000 is $120k
To minimise the maximum regret a fee of $600 should be set.
The correct answer is A.
1.5
4
Investment A = (1.017) = 6.975%
2
Investment B = (1.034) = 6.916%
12/9
= 7.264%
Investment C = (1.054)
Investment D = 7%
The correct answer is C.
1.6
Using the high-low method to separate fixed and variable costs:
Variable cost per unit = ($392,000 - $304,000) / (35,000 – 24,000) = $8 per unit
Fixed costs = $304,000 – (24,000 x $8) = $112,000
At 45,000 units
Variable costs = 45,000 x $8 x 0.95 = $342,000
Fixed costs = $112,000 + $30,000 = $142,000
Total costs
= $484,000
P1
2
March 2013
1.7
Yield to maturity of similar bonds is 10%, therefore use 10% as the
discount rate.
Year(s)
Description
1-4
4
Interest
Redemption
0
Purchase price
Cash flow
$
8
100
Discount Factor (10%)
3.170
0.683
Present Value
$
25.36
68.30
93.66
The current expected purchase price of the bond is therefore $93.66
Alternatively:
Year(s)
Description
1-3
4
Interest
Redemption
0
Purchase price
1.8
Cash flow
$
8
108
Discount Factor (10%)
2.487
0.683
Present Value
$
19.90
73.76
93.66
Production budget for Product D
Opening inventory
Sales
Closing inventory
Production
Units
(6,000)
36,000
3,000
33,000
i.e. 36,000 / 12
Purchases budget for raw material C
Opening inventory
Production
Closing inventory
Purchases
kg
(2,000)
66,000
6,000
70,000
i.e. 33,000 x 2kg
i.e. 3,000 x 2kg
The purchases budget for raw material C is therefore:
70,000 kg x $8 per kg = $560,000
March 2013
3
P1
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome E2(b) identify alternatives for investment of shortterm cash surpluses. It examines candidates’ ability to describe two potential short-term
investment opportunities in terms of their risk, return and liquidity.
Suggested Approach
Candidates should describe each of the investments and clearly indicate the implication of
each feature of the investment in terms of its risk, return and liquidity.
Treasury Bills
These are issued by the government for terms of up to three months and therefore have
minimal capital risk as they are backed by the government. The bills are sold by tender each
week at a discount to their nominal value. They are redeemed at their nominal value giving an
implied interest rate. They are therefore subject to interest rate risk since if market rates
increase the holder loses the opportunity for higher rates.
Treasury bills are also traded on the money market and so the holder can sell them to obtain
immediate cash at any time giving excellent liquidity. If sold before maturity however the
holder would also be exposed to capital risk as the value of the investment changes in
response to market interest rate movements.
Bank Deposit Account
Bank deposit accounts are normally seen as having very low risk although in the current
economic climate it is possible for a bank to fail and be unable to repay the deposit when
required. Some deposit accounts are instant access which allows investors to withdraw their
funds without notice and without loss of interest. Others allow investors to withdraw funds
without notice but with an interest penalty. There are also accounts where notice is required
before withdrawal of funds is allowed. In view of the relatively low risk and high liquidity, the
rate of return on these accounts is very low. They are more suitable where an investor wants
to earn interest on surplus funds but places great importance on liquidity.
(b)
Rationale
The question assesses learning outcome C1(f) apply sensitivity analysis to cash flow
parameters to identify those to which net present value is particularly sensitive. It examines
candidates’ ability to calculate the sensitivity of the net present value of a project to a change
in the cost of capital.
Suggested Approach
Candidates should firstly calculate the net present value of the project when discounted at the
company’s cost of capital. They should then calculate the net present value of the project at a
higher discount rate. Interpolation should then be used to calculate the IRR of the project.
The percentage increase in the company’s cost of capital which would result in the IRR of the
project, i.e. a net present value of zero, should then be calculated.
P1
4
March 2013
Year
0
1-3
3
Initial
investment
Cash inflows
per annum
Residual value
Cash
flow
$
(70,000)
Discount
factor
@ 8%
1.000
Present
value
$
(70,000)
Discount
factor
@ 20%
1.000
Present
value
$
(70,000)
30,000
2.577
77,310
2.106
63,180
10,000
0.794
7,940
0.579
5,790
Net present
value
15,250
(1,030)
IRR by interpolation:
8% + (15,250/(15,250 + 1,030)) x (20% - 8%) = 19.2%
If the company’s cost of capital increases to more than 19.2% the investment will no longer be
viable. Thus it can increase by 140% before the investment is no longer viable.
(c)
Rationale
The question assesses learning outcome A1(f) interpret material, labour, variable overhead,
fixed overhead and sales variances, distinguishing between planning and operational
variances. It examines candidates’ ability to calculate a material mix variance and a material
yield variance.
Suggested Approach
In part (i) candidates should calculate the material mix variance by comparing the actual
material quantity in the standard mix with the actual material quantity in the actual mix. The
variance calculated in kg for each of the materials should then be multiplied by the standard
cost per kg to calculate the variance for each material. These should then be summed to
calculate the total mix variance. In part (ii) the actual units of output should be multiplied by
the standard kg of input per unit of output. This should then be compared to the actual kg of
material input. The resultant variance in kg should then be multiplied by the standard
weighted average cost per kg of input.
(i)
Material mix variance
Actual input
@standard
mix
kg
Material W
864
Material X
1,296
Material Y
1,440
3,600
March 2013
Actual input
@ actual
mix
kg
970
1,230
1,400
3,600
5
Variance
kg
Standard
cost
$
Variance
$
106 A
66 F
40 F
5.00
6.00
8.00
530 A
396 F
320 F
186 F
P1
Or alternatively:
Weighted average cost per kg of input
$328/50kg = $6.56 per kg
Material mix variance
Actual input
@standard
mix
kg
Material W
864
Material X
1,296
Material Y
1,440
3,600
Actual input
@ actual
mix
kg
970
1,230
1,400
3,600
Variance
kg
Standard cost
$
Variance
$
106 A
66 F
40 F
(5.00 – 6.56)
(6.00 – 6.56)
(8.00 – 6.56)
165.4 F
37.0 A
57.6 F
186.0 F
(ii)
Material yield variance
Standard kg of input per unit of output = 50 kg
76 units output x 50 kg = 3,800 kg input
Actual usage = 3,600 kg
Variance = 200kg F
Standard cost per kg = $6.56
Variance = 200kg x $6.56 = $1,312 F
Or alternatively:
3,600kg should yield 3,600kg/50kg = 72 units
Actual yield = 76 units
Yield variance = 4 units F
Standard material cost per unit = $328
Yield variance = 4 units x $328 = $1,312 F
(d)
Rationale
The question assesses learning outcome E1(f) analyse the impacts of alternative debtor and
creditor policies. It examines candidates’ ability to discuss the advantages and disadvantages
of different methods that could be used to collect overdue debts.
Suggested Approach
Candidates should identify two possible actions that the company could take to collect the
overdue debts and clearly explain the advantages and disadvantages of each.
Examiner’s note: the question asks for two other actions. Examples of actions that would be
rewarded are given below.
The credit control department can put the customer on the ‘stop list’ for further orders. This
can encourage rapid settlement of debts particularly if the customer has no other sources
P1
6
March 2013
of supply for the goods or services. It will avoid any further outstanding debt but may not
result in payment of the existing debt if the customer can obtain supply of goods or
services from other suppliers.
The credit control department could use a debt collection agency to collect the debt from
the customer. This should result in rapid settlement of the debt and allow the credit control
department to concentrate on other customers. It would however involve further expense
as the agency would charge a fee for the collection. The quality of service varies
considerably and the company must be careful to select an agent whose approach to the
customer does not result in damage to the company’s reputation.
The credit control department could take legal action to recover the debt. This is normally
seen as a last resort. The first step could be to send a solicitor’s letter which may prompt
payment and would avoid the need to go to court. It may not be cost effective to take court
action but it may discourage other customers from delaying payment.
(e)
Rationale
The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating
expected values and standard deviations together with probability tables and histograms. Part
(i) of the question examines candidates’ ability to calculate the expected value of sales
revenue using information about possible levels of demand and their associated probability.
Part (ii) of the question assesses candidates’ ability to use joint probabilities to calculate the
probability of achieving a particular outcome.
Suggested Approach
In part (i) candidates should calculate the expected value of the sales demand at different
selling prices and multiply the expected values by the relevant selling prices. In part (ii)
candidates should calculate the contribution that would be earned from each of the possible
combinations of sales demand and variable costs. The joint probability of each of the possible
outcomes should then be calculated. The probability of any of the outcomes over $1.1million
should then be summed.
(i)
At a selling price of $24:
(70,000 x 0.2) + (80,000 x 0.5) + (90,000 x 0.3) = 81,000 x $24 = $1,944k
At a selling price of $25:
(60,000 x 0.1) + (70,000 x 0.6) + (90,000 x 0.3) = 75,000 x $25 = $1,875k
At a selling price of $26:
(30,000 x 0.3) + (60,000 x 0.4) + (70,000 x 0.3) = 54,000 x $26 = $1,404k
(ii)
The possible outcomes and the probability of them occurring are given below:
60,000 x ($25 - $8) = $1,020k Joint probability is 0.1 x 0.7 = 0.07
70,000 x ($25 - $8) = $1,190k Joint probability is 0.6 x 0.7 = 0.42
90,000 x ($25 - $8) = $1,530k Joint probability is 0.3 x 0.7 = 0.21
60,000 x ($25 - $10) = $ 900k Joint probability is 0.1 x 0.3 = 0.03
70,000 x ($25 - $10) = $1,050k Joint probability is 0.6 x 0.3 = 0.18
90,000 x ($25 - $10) = $1,350k Joint probability is 0.3 x 0.3 = 0.09
March 2013
7
P1
The probability of achieving a contribution of greater than $1.1million is therefore
0.42 + 0.21 + 0.09 = 0.72 i.e. 72%
(f)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the benefits to a hospital from using a zero based
budgeting system.
Suggested Approach
Candidates should clearly explain why setting budgets using zero based budgeting may be
beneficial to a hospital.
A zero based budgeting (ZBB) system requires all costs to be specifically justified by the
benefits to be expected. It therefore avoids the problems of incremental budgeting where it is
assumed that the current activities will continue and that current expenditure is adding value
to customers. A ZBB approach requires all activities to be justified and prioritised before a
decision is made to allocate resources to the activity. This encourages a questioning
approach by focusing attention not only on the costs involved but on the benefits that each
activity provides. The ZBB approach requires the managers to prepare a number of
alternative decision packages for each activity at different spending levels and to rank the
decision packages in order of their contribution towards the hospital’s strategic objectives.
This process makes the managers consider alternative approaches to achieving the hospital’s
strategic objectives.
P1
8
March 2013
SECTION C
Answer to Question Three
Rationale
Part (a)(i) of the question assesses learning outcome A1(a) compare and contrast marginal
(or variable), throughput and absorption accounting methods in respect of profit reporting and
stock valuation. It examines candidates’ ability to calculate the cost of a product using a
traditional method of overhead absorption. Part (a)(ii) assesses learning outcome A1(c)
discuss activity-based costing as compared with traditional marginal and absorption costing
methods, including its relative advantages and disadvantages as a system of cost
accounting. It requires candidates to be able to apply activity based costing to the calculation
of the cost of a product group. Part (b) also assesses learning outcome A1(c) discuss activitybased costing as compared with traditional marginal and absorption costing methods,
including its relative advantages and disadvantages as a system of cost accounting. It
examines candidates’ ability to explain how companies may use the information obtained
from an activity based costing system. Part (c) also assesses learning outcome A1(c) discuss
activity-based costing as compared with traditional marginal and absorption costing methods,
including its relative advantages and disadvantages as a system of cost accounting. It
examines candidates’ ability to explain the circumstances under which an activity based
costing system would produce similar product costs to a traditional absorption costing
system.
Suggested Approach
In part (a)(i) candidates should identify the gross profit for each product group and then
calculate the overhead absorption rate. This rate can then be applied to each product group
and the total profit calculated. In part (a)(ii) candidates need to calculate a cost driver rate for
each of the activities and then apply this cost driver rate to calculate the overhead cost for
each activity per product group. The total profit for each product group can then be
recalculated. In part (b) candidates need to clearly explain how the activity based costing
information could be used by management. In part (c) the circumstances under which an
activity based costing system would produce similar product costs to a traditional absorption
costing system should be clearly explained.
(a)(i)
Clothing
Electrical
Homeware
$000
$000
$000
Revenue
4,400
3,300
1,100
Cost of sales
2,800
2,300
600
Gross profit
1,600
1,000
500
Overhead cost
1,408
1,056
352
192
(56)
148
Total profit
March 2013
9
P1
Overhead cost workings:
Food
Clothing
Homeware
Total
$000
$000
$000
$000
Sales revenue
4,400
3,300
1,100
8,800
% of total sales
revenue
50%
37.5%
12.5%
100%
Overheads cost
2,816 x 50%
1,408
2,816 x 37.5%
1,056
2,816 x 12.5%
352
2,816
(a)(ii)
Overhead
$000
Activity
Cost Driver
Customer
service
Warehouse receiving
Number of
customers
Number of pallets
delivered
Number of
requisitions
Number of inventory
items
Sales revenue
Warehouse issuing
In-store merchandising
Central administration
1,100
700
300
400
316
Activity
Customer
service
Warehouse receiving
Warehouse issuing
In-store
merchandising
Central administration
Total overheads
P1
Cost driver rate
1,100k/3,500k
= $0.314 per customer
700k/6,500
=$107.69 per pallet
300k/900
=$333.33 per requisition
400k/40,000
=$10 per inventory item
316k/8,800k
=$0.0359 per $ of sales
revenue
Overhead allocation
Clothing
Electrical
Homeware
2,100k x $0.314
$660k
5,200 x $107.69
$560k
522 x $333.33
$174k
20,000 x $10
$200k
4,400k x $0.0359
$158k
1,050k x $0.314
$330k
1,040 x $107.69
$112k
243 x $333.33
$81k
14,000 x $10
$140k
3,300k x $0.0359
$118.5k
350k x $0.314
$110k
260 x $107.69
$28k
135 x $333.33
$45k
6,000 x $10
$60k
1,100k x $0.0359
$39.5k
$1,752k
$781.5k
$282.5k
10
March 2013
Clothing
Electrical
Homeware
$000
$000
$000
Revenue
4,400
3,300
1,100
Cost of sales
2,800
2,300
600
Gross profit
1,600
1,000
500
Overhead cost
1,752
781.5
282.5
Total Profit
(152)
218.5
217.5
(b)
Using an activity based costing (ABC) system the cost drivers that cause a change to the cost
of activities are identified. These cost drivers provide information to management to enable
them to take actions to improve the overall profitability of the company. Cost driver analysis
will provide information to management about how costs can be controlled and managed.
Variance analysis will also be more useful as it is based on more accurate costs. The
establishment of more accurate product costs should also help managers to assess product
profitability and make better decisions concerning pricing and product mix.
In this example the use of an ABC system has resulted in different levels of profit for each of
the product groups. It is apparent that the Clothing product group is less profitable than
thought and that both Electrical and Homeware are more profitable using the ABC system
than using the absorption costing system. This information will enable management to make
important decisions regarding pricing of the product groups. The prices in both the Electrical
and Homeware product groups could potentially be reduced to make them more competitive
and increase volumes. The prices in the Clothing product group could be increased to make
the product group more profitable. Before making any decisions however managers would
need to review market prices and consider the effect of any adjustment on the company’s
market position. If market conditions would not allow an increase in price they could look at
ways to reduce costs of clothing in particular. ABC gives more detailed information about how
costs are incurred and the potential for cost reduction by reducing activity levels. The
company may also consider the possibility of discontinuing the clothing product group as it is
loss-making or allocating less store space to that product group.
An activity based costing system can be extended beyond product costing to a range of cost
management applications known as activity based management. These include the
identification of value added and non value added activities and performance management in
terms of measuring efficiency through cost driver rates.
(c)
Using an activity based costing (ABC) system the various support activities that are involved
in making products or providing services are identified. ABC recognises that there are many
different drivers of cost, not just production or sales volume. The cost drivers are identified in
order to recognise a causal link between activities and costs. They are then used as the basis
to attach activity costs to a particular product or service. However in some circumstances an
activity based costing system will produce similar product costs to those produced using a
traditional absorption costing system as follows:
•
•
•
•
When consumption of overheads is primarily driven by volume.
When overhead costs are low relative to direct costs.
Where there is little diversity in the product range resulting in similar overhead
resource input to all products.
Where products are not complex or where products are mass produced.
March 2013
11
P1
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and C2(a) evaluate project proposals
using the techniques of investment appraisal. It examines candidates’ ability to identify the
relevant costs of a project and then apply discounted cash flow analysis to calculate the net
present value of the project. Part (b) assesses learning outcome D1(a) analyse the impact of
uncertainty and risk on decision models that may be based on relevant cash flows, learning
curves, discounting techniques etc. It examines candidates’ ability to explain how probability
analysis and sensitivity analysis could be used to assess risk. Part (c) assesses learning
outcome C2(c) prioritise projects that are mutually exclusive, involve unequal lives and/or are
subject to capital rationing. It examines candidates’ ability to determine the optimum
replacement cycle for an item of equipment.
Suggested Approach
In part (a) candidates should firstly calculate the contribution for years 1-4 based on the
expected utilisation of the vans. The contribution forgone from the depot sales should then be
calculated. They should then identify the other relevant cash flows for each year of the
project. The tax depreciation and tax payments should then be calculated. The net cash flows
after tax should be discounted at 12% to calculate the NPV of the project. In part (b)
candidates should clearly explain how the two techniques could be used to assess the risk of
the project. In part (c) candidates should calculate the net present value for a three, four and
five year replacement cycle. The net present value should then be divided by the annuity rate
to calculate the annualised equivalent cost. The replacement cycle with the lowest annualised
equivalent cost should then be selected.
(a)
Other fixed costs
Depreciation per annum = ($24m – $2m) / 4 = $5.5m
Other fixed costs (excluding depreciation) per annum
= $8m - $5.5m = $2.5m
Contribution years 1 – 4
Van usage = 8 customers per day x 360 days = 2,880 customers
Total usage = 2,880 x 200 vans = 576k customers
Contribution per customer = $180 - $120 = $60
Year 1 = 576k x 70% = 403.2k customers x $60 = $24.2m
Year 2 = 576k x 80% = 460.8k customers x $60 = $27.6m
Year 3 = 576k x 90% = 518.4k customers x $60 = $31.1m
Year 4 = 576k x 90% = 518.4k customers x $60 = $31.1m
Contribution forgone from depot sales
Year 1 = 403.2k customers x 30% = 120.96k x $100 = $12.1m
Year 2 = 460.8k customers x 30% = 138.24k x $100 = $13.8m
Year 3 = 518.4k customers x 30% = 155.52k x $100 = $15.6m
Year 4 = 518.4k customers x 30% = 155.52k x $100 = $15.6m
P1
12
March 2013
Cash flows
Contribution
Forgone
contribution
Fixed operating
costs
Maintenance
costs
Net cash flows
Year 1
$m
24.2
Year 2
$m
27.6
Year 3
$m
31.1
Year 4
$m
31.1
(12.1)
(13.8)
(15.6)
(15.6)
(2.5)
(2.5)
(2.5)
(2.5)
(0.5)
(0.5)
(0.5)
(0.5)
9.1
10.8
12.5
12.5
Year 1
$m
9.1
(6.0)
Year 2
$m
10.8
(4.5)
Year 3
$m
12.5
(3.4)
Year 4
$m
12.5
(8.1)
3.1
0.9
6.3
1.9
9.1
2.7
4.4
1.3
Taxation
Net cash flows
Tax
depreciation
Taxable profit
Taxation @
30%
Net present value
Year 0
$m
Investment
(24.0)
/ residual
value
Net cash
flows
Tax
payment
Tax
payment
Net cash
(24.0)
flow after
tax
Discount
1.000
factors @
12%
Present
(24.0)
value
Year 1
$m
Year 2
$m
Year 3
$m
Year 4
$m
2.0
Year 5
$m
9.1
10.8
12.5
12.5
(0.5)
(1.0)
(1.4)
(0.7)
(0.4)
(0.9)
(1.3)
(0.6)
8.6
9.4
10.2
12.5
(0.6)
0.893
0.797
0.712
0.636
0.567
7.7
7.5
7.3
8.0
(0.3)
Net present value = $6.2m
The net present value is positive therefore on this basis the company should go ahead with
the project.
(b)
(i)
Probability analysis
The company can determine a range of possible outcomes for each of the cash flows in
the project, for example, a high, low and medium estimate of each cash flow could be
determined. The probability for each can then be estimated.
This can be used in several ways:
March 2013
13
P1
(i)
(ii)
(iii)
The net present value (NPV) of the project, if all high, low or medium estimates
occurred, can be calculated along with the combined probabilities of their
occurrence.
The probabilities can be combined to calculate the expected value of each cash
flow element and of the project as a whole.
The NPVs of a sample range of possible outcomes and the probability of each
NPV can be calculated. If a sufficiently large sample is taken the distribution of
outcomes can be used to calculate the standard deviation of the NPVs and the
probability of success of the project.
All, or some, of the above can be used to provide some assessment of risk and to enable
a more informed decision.
(ii)
Sensitivity analysis
Sensitivity analysis recognises the fact that most cash flows for a project are not known
with certainty. Sensitivity analysis would enable the company to determine the effect of
changes to variables on the planned outcome. For example, the company could assess
the effect of a reduction in the capacity utilisation of the vans. Particular attention can
then be paid to those variables that are identified as being of special significance. In
project appraisal, an analysis can be made of all the key variables to ascertain by how
much each variable would need to change before the net present value (NPV) reaches
zero i.e. the indifference point. In this case, the company could assess what the
percentage of customers, who would otherwise have travelled to the depot, needs to be
before the project would no longer be viable. Alternatively, specific changes can be
made to the variables to determine the effect on NPV.
(c)
Year
Discount
Factor
1
2
3
4
5
0.893
0.797
0.712
0.636
0.567
Operating
costs
$000
90
100
110
132
154
Present
value
$000
80.4
79.7
78.3
84.0
87.3
Residual
value
$000
Present
value
$000
121
88
66
86.2
56.0
37.4
Replacement at end of year 3:
($220k x 1.00) + ($160.1k) + ($78.3k) + $86.2k = $372.2k
Annualised equivalent cost = $372.2k / 2.402 = $155.0k
Replacement at end of year 4:
($220k x 1.00) + ($160.1k) + ($78.3k) + ($84.0k) + $56.0k = $486.4k
Annualised equivalent cost = $486.4k / 3.037 = $160.2k
Replacement at end of year 5:
($220k x 1.00) + ($160.1k) + ($78.3k) + ($84.0k) + ($87.3k) + $37.4k = $592.3k
Annualised equivalent cost = $592.3k / 3.605 = $164.3k
The equipment should be replaced after 3 years.
P1
14
March 2013
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
22 May 2013 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 and 7.
Section C comprises 2 questions and is on pages 8 to 11.
Maths tables and formulae are provided on pages 13 to 16.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2013
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
AB is preparing its cash budget for next year. The accounts receivable at the beginning of
next year are expected to be $460,000. The budgeted sales are $5,400,000 and will occur
evenly throughout the year. 80% of the budgeted sales will be on credit and the remainder
will be cash sales. Credit customers pay in the month following sale.
The budgeted cash receipts from customers next year are:
A
$5,040,000
B
$5,410,000
C
$5,500,000
D
$4,420,000
(2 marks)
Performance Operations
2
May 2013
The following data are given for sub-questions 1.2 and 1.3 below
A company is estimating future sales using time-series analysis. The following trend equation
has been derived from actual sales data for Year 1:
y = 22,000 + 800x
where y is the total sales units for the quarter, and
x is the time period (Quarter 1 of Year 1 is time period 1)
The following set of seasonal variation index values has been derived using a multiplicative
model and based on Year 1 actual sales:
Quarter 1
Quarter 2
Quarter 3
Quarter 4
70
90
130
110
1.2
Using the above multiplicative time series model, sales for Year 2 Quarter 3 would be
estimated as:
A
35,880 units
B
40,040 units
C
27,600 units
D
27,730 units
(2 marks)
1.3
Using an additive time series model, the amount of the seasonal variation for Quarter 2
would be:
A
- 2,680
B
- 2,360
C
+ 2,680
D
+ 2,360
(2 marks)
Section A continues on the next page
TURN OVER
May 2013
3
Performance Operations
1.4
Which ONE of the following transactions will affect the overall amount of working capital:
A
Receipt of the full amount of cash from a trade receivable
B
Payment of an account payable
C
Sale of a non-current asset on credit at its net book value
D
Purchase of inventory on credit
(2 marks)
1.5
CD uses factoring to manage its trade receivables. The factor advances 80% of invoiced
sales and charges interest at a rate of 12% per annum. CD has estimated sales revenue
for next year of $2,190,000. The average time for the factor to receive payment from
customers is 50 days.
The estimated interest charge for next year payable to the factor will be:
A
$28,800
B
$262,800
C
$210,240
D
$36,000
(2 marks)
1.6
The table below shows the possible outcomes, the probability of their occurrence and the
expected value of the net present value for Project A:
Net present value
$2 million
$3 million
$4 million
Probability
30%
20%
50%
Expected value
$0.6 million
$0.6 million
$2.0 million
$3.2 million
Required:
Calculate the standard deviation of the net present value for Project A.
Note:
(3 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
Performance Operations
4
May 2013
1.7
A company has a maximum of $80 million available for investment and seven
independent projects in which it could invest as follows:
Project
Investment
$ million
10.0
40.0
20.0
40.0
50.0
20.0
20.0
A
B
C
D
E
F
G
Net present value
$ million
4.20
6.10
8.50
13.70
3.80
4.90
4.33
None of the projects can be carried out more than once. Each project is divisible therefore
investment in part of a project can be undertaken.
Required:
Prioritise the projects and determine the maximum net present value that can be
achieved from the $80 million investment.
(3 marks)
1.8
A company is considering a project which requires the purchase of a van to be used to
deliver sandwiches to office workers. The van will cost $40,000 and have a maximum life
of 3 years. It is difficult to estimate how successful the project is likely to be. The company
has the option to abandon the project after 1 or 2 years when the van would still have a
resale value.
The estimated cash inflows for the project are as follows:
Year
1
2
3
Operating
net cash
inflows
$
16,800
18,000
24,000
Resale value
of van
$
24,800
16,000
0
The company’s cost of capital is 12% per annum. Ignore tax and inflation.
Required:
Calculate the net present value of the project:
(i)
(ii)
(iii)
If operated for 3 years;
If abandoned after 2 years;
If abandoned after 1 year.
(4 marks)
(Total for Section A = 20 marks)
End of Section A. Section B begins on page 6
TURN OVER
May 2013
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
Explain what is meant by an aggressive policy in respect of the level of investment in,
and financing of, working capital.
(5 marks)
(b)
Compare and contrast the economic order quantity (EOQ) model and a just-in-time (JIT)
approach to inventory management.
(5 marks)
(c)
A company is estimating the future profit from a new product. For each of the variables,
the amount and the probability of the occurrence is given below:
Number of units sold
100,000
80,000
Probability
40%
60%
Contribution per unit
$7
$5
Probability
50%
50%
Fixed costs
$400,000
$500,000
Probability
30%
70%
Required:
(i)
Prepare a table which shows all the possible outcomes, their associated probability
and the expected value of the profit from the new product.
(ii)
Calculate the probability of the new product achieving each of the following:
•
•
•
a profit;
a loss;
break-even.
(5 marks)
Section B continues on the opposite page
Performance Operations
6
May 2013
(d)
EF manufactures and sells a single product.
Budgeted details for April
Selling price per unit
Variable production costs per unit
Fixed production overheads per unit
Budgeted gross profit per unit
$8.00
$2.00
$2.50
$3.50
EF operates a standard absorption costing system. A predetermined absorption rate is
used for fixed production overheads and is based on normal capacity of 20,000 units per
month.
Actual details for April
Units produced
Units sold
Selling price per unit
Variable costs per unit
Fixed production overheads
23,000
21,000
$8.00
$2.00
$52,000
Inventory at the end of March was 1,000 units. Any under / over absorption of fixed
overheads is debited / credited to the Income Statement each month.
Required:
(i)
Calculate the gross profit for April using absorption costing.
(2 marks)
(ii)
Reconcile the absorption costing profit for the month of April with the profit using
marginal costing.
(3 marks)
(Total for sub-question (d) = 5 marks)
(e) A bond has a coupon rate of 8% and will repay its nominal value of $100 when it matures
in five years’ time.
The bond will be purchased today for $106 ex-interest and held until maturity. The
next interest payment is due in one year’s time.
Required:
Calculate, to 0.01%, the yield to maturity for the bond based on today’s purchase
price.
(5 marks)
(f)
Explain the potential benefits for a company from using activity based budgeting
compared to incremental budgeting.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 8
TURN OVER
May 2013
7
Performance Operations
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
GH manufactures and sells a single product. The company uses a just-in-time purchasing and
production system and as a result holds no inventory of raw materials or finished goods.
The standard selling price and standard variable costs of the product are as follows:
Selling price per unit
$
400
Variable costs per unit:
8kg of material @ $20 per kg
6 hours of labour @ $14 per hour
160
84
The following information is available for April:
(i)
Budgeted production and sales were 2,500 units. Actual production and sales were
2,850 units at a selling price of $385.
(ii)
Actual usage of material was 24,900 kg at $18 per kg.
(iii)
18,800 hours were worked and paid for at a rate of $15.50 per hour.
Required:
(a)
Prepare a statement that reconciles the budgeted contribution with the actual
contribution. Your statement should show the variances in as much detail as
possible.
(11 marks)
Performance Operations
8
May 2013
The management accountant has decided that it would be more useful to show separately
the variances that relate to planning differences and those that relate to operational
changes. The following additional information is available:
The material normally used was unavailable throughout April and the company had to use
a substitute material. Due to the nature of the substitute material it was expected that
9.25kg of material would be required per unit of the product. The cost of the substitute
material was expected to be $20 per kg.
(b)
Prepare calculations that show the total material usage variance separated
into planning and operational variances.
(4 marks)
(c)
Explain why planning and operational variances provide better information
for planning and control purposes.
(6 marks)
(d)
Explain TWO factors that a company should consider before deciding
whether to investigate a variance.
(4 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
May 2013
9
Performance Operations
Question Four
JK is considering whether to tender for a franchise to operate a government owned rail network.
Under the terms of the franchise agreement JK would have to make a fixed annual payment to
the government and would also be required to make significant investments to maintain and
develop the rail network’s infrastructure. JK would be entitled to the profits from operating the rail
network for the period of the franchise.
The franchise is for a period of six years after which it will be put out to tender again.
Passenger numbers and fares
Passenger numbers in Year 1 are estimated to be 170 million and will increase at a rate of 3%
per annum. Rail fares in Year 1 will be $10.00 per passenger and future price increases will be
restricted under the franchise agreement to the rate of inflation. JK plans to implement the full
fare increase each year of the franchise agreement. Inflation over the six year period of the
franchise is expected to be 4% per annum.
Capital investment
JK plans to make a total capital investment of $700 million in two instalments. This will involve
introducing high speed trains, updating the existing train carriages and improving facilities at
railway stations. An investment of $400 million will be made at the start of the franchise. The
remaining $300 million investment will be made at the beginning of Year 4. At the end of the
franchise the equipment is expected to have a residual value of $100 million at Year 6 prices.
Both instalments of the capital investment will become eligible for tax depreciation when they are
incurred.
There will also be a requirement for working capital of $80 million at the start of the franchise
period. The requirement for working capital will not be affected by inflation.
Costs
The estimated annual costs, at Year 1 prices, over the franchise period are as follows:
Salary costs
Fixed maintenance costs
Payment to the government
Other fixed operating costs
(excluding depreciation)
$400 million
$80 million
$1,000 million
$240 million
The annual payment to the government will remain at Year 1 prices throughout the period of the
franchise. All the other costs listed above will increase at the same rate of inflation as the
passenger fares.
Taxation
JK’s financial director has provided the following taxation information:
•
•
•
Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
JK has sufficient taxable profits from other parts of its business to enable the offset of any
taxable losses.
Other information
A cost of capital of 12% per annum is used to evaluate projects of this type.
Performance Operations
10
May 2013
Required:
(a)
Evaluate whether JK should tender for the rail franchise. You should use net
present value as the basis of your evaluation. Total revenue, total costs and
tax benefits / charges per annum should each be rounded to the nearest
$million. Ignore any costs to be incurred in the tendering process.
(14 marks)
(b)
Calculate the sensitivity of the decision to tender to a change in passenger
numbers.
(6 marks)
(c)
Explain the benefits of carrying out a sensitivity analysis before making
investment decisions. You should use the figures calculated in (b) above to
illustrate your answer.
(5 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 13 to 16
May 2013
11
Performance Operations
Operational Level Paper
P1 – Performance Operations
May 2013 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early August at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of eight objective test sub-questions. These are drawn from all
sections of the syllabus. They are designed to examine breadth across the syllabus and thus
cover many learning outcomes.
1.1
Cash received from previous period
Sales for this budget period
Credit sales not paid until next period
($5,400,000 x 80% x 1/12)
Total cash received
$
460,000
5,400,000
5,860,000
(360,000)
5,500,000
The correct answer is C.
 The Chartered Institute of Management Accountants 2013
1.2
Year 2, quarter 3 is period 7
Trend sales
= 22,000 + 800 (7)
= 27,600 units
Adjusted for seasonal variations = 27,600 x 1.30 = 35,880 units
The correct answer is A.
1.3
Trend sales for quarter 2 year 1
= 22,000 x 800(2)
= 23,600 units
Actual sales for quarter 2 year 1
= 23,600 x 90%
= 21,240 units
Seasonal variation using additive model
= 21,240 – 23,600
= - 2,360
The correct answer is B.
1.4
The correct answer is C.
1.5
80% of invoiced sales
Outstanding trade receivables
Interest at 12% per annum
= $2,190,000 x 80% = $1,752,000
= $1,752,000 x 50/365
= $240,000
= $240,000 x 12%
= $28,800
The correct answer is A.
1.6
NPV
Probability
$m
Deviation from
expected
value
Squared
deviation
Weighted
amounts
$m
$m
$m
2
30%
-1.2
1.44
0.432,
3
20%
-0.2
0.04
0.008
4
50%
0.8
0.64
0.320
0.760
The standard deviation is √0.760 = 0.871780 i.e. $871,780
P1
2
May 2013
1.7
Project
Investment
A
B
C
D
E
F
G
$ million
10.0
40.0
20.0
40.0
50.0
20.0
20.0
Project
Investment
C
A
D
F
$ million
20.0
10.0
40.0
10.0
80.0
Net present
value
$ million
4.20
6.10
8.50
13.70
3.80
4.90
4.33
Net present
value
$ million
8.50
4.20
13.70
2.45
28.85
Profitability
index
Ranking
0.4200
0.1525
0.4250
0.3425
0.0760
0.2450
0.2165
2
6
1
3
7
4
5
Ranking
1
2
3
4
The maximum net present value is $28.85million
1.8
(i)
Year
0
1
2
3
NPV
(ii)
Year
0
1
2
NPV
(iii)
Year
0
1
NPV
May 2013
If operated for 3 years
Cash flow
$
(40,000)
16,800
18,000
24,000
Discount factors
1.000
0.893
0.797
0.712
Present value
$
(40,000)
15,002
14,346
17,088
6,436
If abandoned after 2 years
Cash flow
$
(40,000)
16,800
34,000
Discount factors
1.000
0.893
0.797
Present value
$
(40,000)
15,002
27,098
2,100
If abandoned after 1 year
Cash flow
$
(40,000)
41,600
Discount factors
1.000
0.893
3
Present value
$
(40,000)
37,149
(2,851)
P1
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome E1(a) explain the importance of cash flow and
working capital management. It examines candidates’ ability to explain the meaning of an
aggressive policy in respect of the investment in and financing of working capital.
Suggested Approach
Candidates should clearly explain what is meant by an aggressive policy for both the
investment in and the financing of working capital.
Investment in working capital is normally in inventory, accounts receivable and cash or highly
liquid, short-term assets. These are partly financed by accounts payable and overdraft. In
conditions of uncertainty, companies must hold some minimum level of cash and inventory.
With an aggressive working capital investment policy, a company would hold minimal safety
inventories. Such a policy would minimise costs but it could reduce sales as the company
could not respond rapidly to changes in demand. Generally, the expected return is higher
under an aggressive policy but the risks are also greater. In cash management, an aggressive
policy involves holding low levels of cash which would expose the company to the risk that
they could not meet payments when they become due. In the case of accounts receivable
and account payable, an aggressive policy would mean low levels of receivables in relation to
sales and high levels of accounts payable.
Working capital financing policy decisions involve the determination of the mix of long-term
versus short-term debt. Since the yield curve is usually upward sloping, short-term debt
typically costs less than long-term debt. With an aggressive working capital financing policy,
the company finances part of its permanent asset base with short term debt. This policy
generally provides the highest expected return but it is very risky due to the frequent need to
refinance or if the company relied on an overdraft, the risk of withdrawal of that facility at short
notice.
(b)
Rationale
The question assesses learning outcome E1(g) analyse the impact of alternative policies for
stock management. It examines candidates’ ability to compare and contrast the economic
order quantity model and a JIT approach to inventory management.
Suggested Approach
Candidates should clearly explain how both systems operate and highlight the differences
between the two approaches.
The economic order quantity (EOQ) is based on the assumption that demand for the period is
known and constant. Therefore the optimum order quantity will be determined by the costs
that are affected by either the quantity of inventory held or the numbers of orders placed. A
P1
4
May 2013
higher quantity ordered each time will mean fewer orders each year and therefore a reduction
in ordering costs. However, this will also result in higher average inventory levels which
results in an increase in holding costs. The EOQ therefore is a trade-off between the cost of
carrying high inventory against the cost of placing more orders. The optimum order size is the
quantity that will result in the total of the ordering and holding costs being minimised.
In contrast, a just in time (JIT) inventory management system is based on actual demand
rather than an estimated demand level. It seeks to ensure the delivery of materials
immediately before their use. By ensuring that production and purchases are timed to
coincide with demand the determination of economic order quantities and re-order points is
no longer required. JIT purchasing involves having an arrangement with a small number of
key suppliers where the supplier is able to provide raw materials or components on demand
or with a very short lead time. This means that the company can hold zero or very little
inventory thus reducing the costs involved with holding inventory including storage costs,
insurance costs and obsolescence costs. The costs involved with ordering inventory may
however increase since JIT results in more frequent deliveries from suppliers. This contrasts
with an EOQ system where the amount of inventory held is determined by the EOQ formula
which aims to balance the costs of holding and ordering inventory. The use of a small number
of suppliers however should also reduce administrative costs for the company and may result
in greater quantity discounts. The successful operation of a JIT purchasing system involves
the company working together with their suppliers to ensure that they can rely on receiving
supplies at the right time and at the required quality level. This should also result in a
reduction in quality control costs for the company. Quality standards should also improve
resulting in lower wastage in the production process and hence reduced wastage costs.
(c)
Rationale
The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating
expected values and standard deviations together with probability tables and histograms. It
examines candidates’ ability to calculate the expected values of possible outcomes using joint
probabilities.
Suggested Approach
Candidates should firstly calculate the profit for each of the combinations of number of units
sold, contribution and fixed costs. They should then calculate the joint probability of these
outcomes and multiply the profit by the joint probability to calculate the expected value. In
part (ii) they should sum the probabilities of the outcomes which give a profit, loss and breakeven.
May 2013
5
P1
(i)
Number of
units
sold
100,000
Contribution
per unit
Profit
$
Joint Probability
$7
Fixed
costs
$
400,000
300,000
100,000
$7
500,000
200,000
100,000
$5
400,000
100,000
100,000
$5
500,000
0
80,000
$7
400,000
160,000
80,000
$7
500,000
60,000
80,000
$5
400,000
0
80,000
$5
500,000
(100,000)
0.06
(0.4 x 0.5 x 0.3)
0.14
(0.4 x 0.5 x 0.7)
0.06
(0.4 x 0.5 x 0.3)
0.14
(0.4 x 0.5 x 0.7)
0.09
(0.6 x 0.5 x 0.3)
0.21
(0.6 x 0.5 x 0.7)
0.09
(0.6 x 0.5 x 0.3)
0.21
(0.6 x 0.5 x 0.7)
1.00
Expected
value
$
18,000
28,000
6,000
0
14,400
12,600
0
(21,000)
58,000
(ii)
The probability of a profit is 56% ((0.06 + 0.14 + 0.06 + 0.09 + 0.21) x 100%)
The probability of a loss is 21% (0.21 x 100%)
The probability of break-even is 23% ((0.14 + 0.09) x 100%)
(d)
Rationale
The question assesses learning outcome A1(b) discuss a report which reconciles budget and
actual profit using absorption and/or marginal costing techniques. Part (i) examines
candidates’ ability to calculate the profit for a period using absorption costing where the
production volume and sales volume are different. Part (ii) requires candidates to reconcile
the difference in profit for the period using marginal and absorption costing.
Suggested Approach
(i)
Candidates should firstly calculate the gross profit per unit based on the budgeted fixed
overhead absorption rate. This should then be multiplied by the number of units sold.
The under/over absorption should then be calculated based on the number of units
produced multiplied by the fixed overhead absorption rate, less the actual overhead
incurred. Overheads under absorbed should be deducted from the gross profit and over
absorbed overhead should be added back to the gross profit.
(ii) Candidates should calculate the difference between the absorption costing profit for
April calculated in (i) and the marginal costing profit. The difference should then be
reconciled by taking the movement in inventory multiplied by the budgeted fixed
overhead absorption rate.
P1
6
May 2013
(i)
Absorption costing profit:
21,000 units x $3.50 per unit
Plus: over absorption of fixed overheads
(23,000 units x $2.50) – ($52,000)
(ii)
$
73,500
5,500
79,000
Marginal costing profit:
$
126,000
52,000
74,000
Contribution (21,000 units x $6)
Fixed production overheads
Difference in profit is $5,000
Opening inventory
Closing inventory
Inventory increase
1,000 units
3,000 units
2,000 units
Fixed overhead absorption rate = $2.50 per unit
Difference in profit = 2,000 units x $2.50 = $5,000
Inventory increased, therefore the absorption costing profit is $5,000 higher than the marginal
costing profit.
(e)
Rationale
The question assesses learning outcome E2(d) illustrate numerically the financial impact of
short-term funding and investment methods. It examines candidates’ ability to calculate the
yield to maturity on a bond given the current market value and the coupon rate of the bond.
Suggested Approach
Candidates should identify the cash flows if the bond was purchased today and then held
until maturity. They should then discount the cash flow using two different discount rates to
derive a positive and a negative net present value. Candidates should then use interpolation
to calculate the internal rate of return of the cash flows.
Year(s)
Description
Cash flow
0
1-5
5
NPV
Purchase
Interest
Redemption
$
(106)
8
100
Discount
factor
(6%)
1.000
4.212
0.747
Present
value
$
(106.00)
33.70
74.70
2.40
Discount
factor
(8%)
1.000
3.993
0.681
Present
Value
$
(106.00)
31.94
68.10
(5.96)
By interpolation
6% + (($2.40 /($2.40 + $5.96)) x 2) = 6.57%
The bond’s yield to maturity is 6.57%
May 2013
7
P1
(f)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the potential benefits of using an activity-based
budgeting system rather than an incremental budgeting system.
Suggested Approach
Candidates should clearly explain how each of the budgeting systems operates highlighting
the potential benefits of using an activity-based budgeting system.
Incremental budgeting is based on what has happened in the past therefore the allocation of
resources to specific activities is not justified. It is assumed that activities will continue merely
because they were undertaken in the previous year. The result of this is that excessive costs
included in the previous budget will be carried forward into the next budget.
Under an activity based budgeting system, resource allocation is linked to the strategic plan
and is prepared after considering alternative strategies. This approach ensures that new
activities that are required to meet the company’s strategic objectives are included in the
budget.
Activity based techniques, including activity based budgeting, focus on the outputs of a
process rather than the inputs to the process. In contrast an incremental budgeting system
focuses on the inputs to the process. An activity based approach provides a clear framework
for understanding the link between costs and the level of activity. It allows the ranking of
activities and the determination of how limited resources should be allocated over competing
activities.
The focus on activities and the drivers of the cost of these activities enables a more informed
and accurate budget to be set. Variance analysis will also be more useful and therefore it will
ensure greater control of overhead costs which are an increasingly large proportion of total
product costs.
Activity based budgeting allows the identification of value added and non-value added
activities and ensures that cuts are made to non-value added activities. Under an incremental
budget the tendency is to make cuts across the board. Activity based budgeting is also useful
for the review of capacity utilisation. If it is known that the resources devoted to a particular
activity are greater than those currently required then these resources can be reduced or
redeployed.
P1
8
May 2013
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate variances to
enable the reconciliation of budgeted and actual contribution. Part (b), (c) and (d) assess
learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and
sales variances, distinguishing between planning and operational variances. Part (b)
examines candidates’ ability to separate variances into their planning and operational
elements. Part (c) examines candidates’ ability to explain the importance of planning and
operational variances. Part (d) examines candidates’ ability to interpret variances,
considering factors such as their possible interrelationship and significance.
Suggested Approach
In part (a) candidates should firstly calculate the budgeted contribution and the actual
contribution for the period. They should then calculate each of the variances for sales,
material and labour. They should then prepare a reconciliation statement starting with the
budgeted contribution and adding the favourable sales volume contribution variance to
calculate a revised standard contribution. They should then show each of the individual
variances to reconcile this standard contribution to the actual contribution. In part (b)
candidates should calculate the material usage planning variance and the material usage
operational variance. In part (c) candidates should clearly explain why calculating planning
and operational variances gives better information for planning and control purposes. In part
(d) candidates should explain two factors that should be taken into account before beginning
the process of investigating a variance.
(a)
Statement to reconcile budget and actual contribution for April
$
$
Budgeted contribution
390,000
Sales volume contribution variance
(2,850 units - 2,500 units) x $156
54,600 F
Standard contribution on actual sales volume
Other variances:
Selling price variance
2,850 units x ($385 - $400)
Cost variances:
Direct material price variance
24,900 kg x ($20.00 – $18.00)
Direct material usage variance
((2,850 x 8 kg) – 24,900 kg) x $20.00
Direct labour rate variance
18,800 x ($14.00 - $15.50)
Direct labour efficiency variance
((2,850 x 6hr) – 18,800) x $14.00
Actual contribution
May 2013
444,600
42,750 A
49,800 F
42,000 A
28,200 A
23,800 A
357,650
9
P1
Workings:
Budgeted contribution for the period
Budgeted Contribution
$
390,000
2,500 units x $156
Actual contribution for the period
$
Sales
Direct materials
Direct labour
Actual Contribution
2,850 units x $385
24,900 kg @ $18
18,800 hours @ $15.50
$
1,097,250
448,200
291,400
357,650
(b)
$
Direct material usage planning variance
(2,850 x (8kg – 9.25kg)) x $20
Direct material usage operational variance
((2,850 x 9.25 kg) – 24,900 kg) x $20.00
Total direct material usage variance
$
71,250 A
29,250 F
42,000 A
(c)
The calculation of planning and operational variances is useful for the following reasons:
P1
•
The use of planning and operational variances will enable management to draw a
distinction between variances caused by factors uncontrollable by the business and
planning errors (planning variances) and variances caused by factors that are within
the control of management (operational variances). In this case they can separate the
materials usage variance caused by the substitute material (planning variance) and
the variance as a result of efficient or inefficient production.
•
The managers’ performance can be compared with the adjusted standards that
reflect the conditions the manager actually operated under during the reporting
period. If planning and operational variances are not distinguished, there is potential
for dysfunctional behaviour especially where the manager has been operating
efficiently and effectively and performance is being judged according to factors
outside the manager’s control.
•
The use of planning variances will also allow management to assess how effective
the company’s planning process has been. Where a revision of standards is required
due to environmental changes that were not foreseeable at the time the budget was
prepared, the planning variances are uncontrollable. However standards that failed to
anticipate known market trends when they were set will reflect faulty standard setting.
It could be argued that some of the planning variances due to poor standard setting
are in fact controllable at the planning stage.
•
The information used in setting the ex-post standards can be used in future budget
periods. The planning variances may also indicate problems in the standard setting
process and the reasons for this can be identified and improvement made to the
process.
10
May 2013
(d)
The size of the variance
It is not possible to budget with complete accuracy therefore a company will need to decide
how large a variance needs to be before it is considered abnormal and worthy of
investigation.
The likelihood of the variance being controllable
Some variances particularly those that arise as a result of external factors may be
uncontrollable and therefore the costs of the investigation would result in no benefit to the
company.
The likely cost versus the potential benefits of the investigation
The company will need to weigh up the costs of the investigation versus the benefit from
avoiding the variance occurring in the future.
The interrelationship between variances
A favourable variance in one area may result in an adverse variance in another area. For
example, the decision to use lower quality material may result in a favourable material price
variance but an adverse material usage variance.
May 2013
11
P1
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and learning outcome C2(a) evaluate
project proposals using the techniques of investment appraisal. It examines candidates’
ability to identify the relevant costs of a project and then apply discounted cash flow analysis
to calculate the net present value of the project. Part (b) assesses learning outcome C1(f)
apply sensitivity analysis to cash flow parameters to identify those to which net present value
is particularly sensitive. It examines candidates’ ability to calculate the sensitivity of net
present value to a change in passenger numbers. Part (c) assesses learning outcome D1(a)
analyse the impact of uncertainty and risk on decision models that may be based on relevant
cash flows, learning curves, discounting techniques, etc. It examines candidates’ ability to
explain the benefits of using sensitivity analysis in project appraisal.
Suggested Approach
In part (a) candidates should firstly calculate the passenger numbers for each year and the
passenger fare for each year after applying the inflation rate. These can then be multiplied
together to derive the total cash inflow each year. They should then deduct the payment to
the government and the other fixed costs after adjusting these for inflation. The tax
depreciation and tax payments should then be calculated. The total cost of the investment,
the residual value and the working capital cash outflows and inflows should be added to the
net cash flows. The net cash flows after tax should then be discounted at the discount rate of
12% to calculate the net present value (NPV) of the project. In part (b) candidates should take
the cash inflows from passenger fares and adjust these for tax. The cash inflows after tax
should then be discounted at the discount rate of 12% to calculate the present value of the
passenger revenue. The sensitivity of the net present value to a change in passenger
numbers can then be calculated by dividing the NPV of the project by the present value of the
passenger revenue. In part (c) candidates should clearly explain the benefits of carrying out a
sensitivity analysis before making investment decisions.
(a)
Cash inflows years 1-6
Year 1
Passenger
170.0
numbers
(millions)
Passenger
$10
fares
Total cash
$1,700m
inflow
Year 2
175.1
Year 3
180.4
Year 4
185.8
Year 5
191.3
Year 6
197.1
$10.40
$10.82
$11.25
$11.70
$12.17
$1,821m
$1,952m
$2,090m
$2,238m
$2,399m
Cash flows
Total cash
inflow
Payment to
government
Other fixed
costs
Net cash flow
P1
Year 1
$m
1,700
Year 2
$m
1,821
Year 3
$m
1,952
Year 4
$m
2,090
Year 5
$m
2,238
Year 6
$m
2,399
(1,000)
(1,000)
(1,000)
(1,000)
(1,000)
(1,000)
(720)
(749)
(779)
(810)
(842)
(876)
(20)
72
173
280
396
523
12
May 2013
Taxation Depreciation
Year 1
$m
Tax written down
400
value
Tax depreciation
(100)
Year 2
$m
300
Year 3
$m
225
Year 4
$m
469
Year 5
$m
352
Year 6
$m
264
(75)
(56)
(117)
(88)
(164)
Taxation
Net cash flows
Tax
Depreciation
Taxable profit
Taxation @
30%
Year 1
$m
(20)
(100)
Year 2
$m
72
(75)
Year 3
$m
173
(56)
Year 4
$m
280
(117)
Year 5
$m
396
(88)
Year 6
$m
523
(164)
(120)
36
(3)
1
117
(35)
163
(49)
308
(92)
359
(108)
Net present value
Year 0
Investment /
residual
value
Working
capital
Net cash
flows
Tax
payment
Tax
payment
Net cash
flow after
tax
Discount
factors @
12%
Present
value
$m
(400)
Year 1
Year 2
$m
$m
Year
3
$m
(300)
Year 4
$m
Year
5
$m
(80)
Year
6
$m
100
Year
7
$m
80
0
(20)
72
173
280
396
523
0
18
1
(18)
(25)
(46)
(54)
0
0
18
0
(17)
(24)
(46)
(54)
(480)
(2)
91
(145)
238
326
603
(54)
1.000
0.893
0.797
0.712
0.636
0.567
0.507
0.452
(480)
(2)
73
(103)
151
185
306
(24)
Net present value = $106m
The net present value is positive therefore on this basis the company should go ahead with
the tender.
May 2013
13
P1
(b)
Total cash
flow from
passenger
revenue
Taxation
@30%
Tax
payment
Tax
payment
Net cash
flow after
taxation
Discount
factor
Present
value
Year 1
$m
1,700
Year 2
$m
1,821
Year 3
$m
1,952
Year 4
$m
2,090
Year 5
$m
2,238
Year 6
$m
2,399
Year 7
$m
(510)
(546)
(586)
(627)
(671)
(720)
(255)
(273)
(293)
(314)
(336)
(360)
(255)
(273)
(293)
(313)
(335)
(360)
1,445
1,293
1,386
1,483
1,589
1,704
(360)
0.893
0.797
0.712
0.636
0.567
0.507
0.452
1,290
1,031
987
943
901
864
(163)
Present value of revenue = $5,853
Sensitivity of the proposed investment to a change in passenger numbers is therefore:
$106m / $5,853m = 1.8%
(c)
Sensitivity analysis recognises the fact that not all cash flows for a project are known with
certainty. Sensitivity analysis enables a company to determine the effect of changes to
variables on the planned outcome. Particular attention can then be paid to those variables
that are identified as being of special significance. In project appraisal, an analysis can be
made of all the key input factors to ascertain by how much each factor would need to change
before the net present value (NPV) reaches zero i.e. the indifference point. Alternatively,
specific changes can be calculated to determine the effect on NPV. In this case the project is
highly sensitive to a change in passenger numbers. A 1.8% change in the passenger
numbers would result in the project no longer being viable. The company may decide that this
is too high a risk to take and not tender for the franchise.
P1
14
May 2013
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO SO
Performance Pillar
Wednesday 28 August 2013
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 7.
Section C comprises 2 questions and is on pages 8 to 11.
Maths tables and formulae are provided on pages 13 to 16.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2013
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
AB is preparing its cash budget for next year. The estimated accounts payable balance at
the beginning of next year is $540,000. The budgeted purchases for next year are
$6,800,000, occurring evenly throughout the year. It is estimated that 75% of purchases
will be on credit and the remainder will be for cash. The company pays for credit
purchases in the month following purchase.
The budgeted cash payments to suppliers next year are:
A
$6,375,000
B
$6,773,333
C
$6,915,000
D
$5,215,000
(2 marks)
1.2
A just-in-time (JIT) purchasing system may be defined as:
A
A purchasing system in which the purchase of material is contracted so that the receipts
and usage of material coincide.
B
A purchasing system which is based on estimated demand for finished products.
C
A purchasing system where the purchase of material is triggered when inventory levels
reach a pre-determined re-order level.
D
A purchasing system which minimises the sum of inventory ordering costs and inventory
holding costs.
(2 marks)
Performance Operations
2
September 2013
The following data are given for sub-questions 1.3 and 1.4 below
A company is estimating its costs based on past information. The total costs incurred by the
company at different levels of output were as follows:
Output
(units)
160,000
185,000
190,000
Total costs
$
2,420,000
2,775,000
2,840,000
The company uses the high-low method to separate total costs into their fixed and variable
elements. Ignore inflation.
1.3
The estimated total costs for an output of 205,000 units is:
A
$2,870,000
B
$3,050,000
C
$3,064,211
D
$3,080,857
(2 marks)
1.4
The company has now established that there is a stepped increase in fixed costs of
$30,000 when output reaches 180,000 units.
The estimate of total costs for an output of 175,000 units using the additional information
is:
A
$2,645,000
B
$2,275,000
C
$2,615,000
D
$2,630,000
(2 marks)
Section A continues on the next page
TURN OVER
September 2013
3
Performance Operations
1.5
A company is considering investing in a project with an expected life of four years. The
project has a positive net present value of $280,000 when cash flows are discounted at
12% per annum. The project’s estimated cash flows include net cash inflows of $320,000
for each of the four years. No tax is payable on projects of this type.
The percentage decrease in the estimated annual net cash inflows that would cause the
company’s management to reject the project from a financial perspective is, to the nearest
0.1%:
A
87.5%
B
21.9%
C
3.5%
D
28.8%
(2 marks)
1.6
A bond has a coupon rate of 6% per annum and will repay its face value of $100 on its
maturity in four years’ time. The yield to maturity on similar bonds is 4% per annum. The
annual interest has just been paid for the current year.
Required:
Calculate the expected market value of the bond at today’s date.
(3 marks)
1.7
A company has annual sales revenues of $30 million and the following working capital
periods:
Inventory conversion period
Accounts receivable collection period
Accounts payable payment period
2.5 months
2.0 months
1.5 months
Production costs represent 70% of sales revenue.
Required:
Calculate the total amount held in working capital excluding cash and cash equivalents.
(3 marks)
Performance Operations
4
September 2013
1.8
A company uses 40,000 units of a particular item of inventory each year. Demand is
predictable and spread evenly throughout the year. Ordering costs are $70 per order and
the cost of holding one unit in inventory is $1.40 per annum.
Required:
(i)
Calculate the economic order quantity (EOQ).
(2 marks)
(ii)
Calculate the total annual ordering and holding costs for the inventory item
assuming the company uses the EOQ and no buffer inventory is held.
(2 marks)
(Total for sub-question 1.8 = 4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
September 2013
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
A company, when deciding its cash management policy, has to balance the costs of
holding insufficient cash with the costs of holding cash. The motives for holding cash can
be categorised as follows:



Transaction motive
Precautionary motive
Speculative motive
Required:
Explain the three categories of motives for holding cash given above.
(5 marks)
(b)
A company has to decide which of three mutually exclusive projects to undertake. The
directors believe that success of the projects will depend on consumer reaction. There is a
25% chance that consumer reaction will be strong, a 40% chance that consumer reaction
will be good and a 35% chance that consumer reaction will be weak. The company uses
expected value to make this type of decision.
The net present value for each of the possible outcomes is as follows:
Consumer reaction
Project A
Project B
Project C
$000s
$000s
$000s
1,000
1,600
1,200
Good
250
300
375
Weak
200
140
100
Strong
A market research company believes it can provide perfect information on consumer
reaction.
Required:
Calculate the maximum amount that should be paid for the information from the market
research company.
(5 marks)
(c)
Explain the potential benefits for a company from using a just-in-time (JIT) production
system.
(5 marks)
Performance Operations
6
September 2013
(d)
CD has annual sales revenue of $2,007,500 and trade receivables of $330,000 which
represent 60 days’ sales based on a 365 day year. Sales and trade receivables are
expected to continue at the same level for the next year. CD pays interest on its overdraft
at a rate of 10% per annum.
CD is considering the use of non-recourse factoring to manage its trade receivables. The
factor will pay 80% of the trade receivable when a credit sale is made and the remaining
20% when the cash is received from the customer. It is estimated that, as a result of the
factor’s expertise, cash will be received from customers in 50 days. The factor will charge
interest at a rate of 12% per annum on cash advanced and a fee of 2% of annual sales
revenue. CD estimates that credit control costs will be reduced by $30,000 each year if
the factor is used.
Required:
Calculate whether it is financially beneficial for the company to use the factor.
(5 marks)
(e)
A supplier of pre-packed sandwiches is trying to decide how many batches of sandwiches
should be prepared for each day. Any sandwiches prepared and not sold are thrown away
at the end of the day.
Each batch of sandwiches can be sold for $100 and has a variable cost of $40. It is
estimated that demand will be 20, 21, 22 or 23 batches each day and therefore a
minimum of 20 batches and a maximum of 23 batches will be prepared per day.
The management accountant has started to produce a pay-off table showing the
contribution for the possible outcomes as follows:
Demand
20 batches
21 batches
22 batches
23 batches
20 batches
$1,200
$1,200
Number of batches prepared
21 batches
22 batches
$1,160
$1,120
$1,260
$1,220
23 batches
$1,080
$1,180
Required:
(i)
Calculate the figures that are required to complete the pay-off table.
(2 marks)
(ii)
Apply the minimax regret criterion to determine the number of batches that
should be prepared each day.
(3 (3 marks)
(Total for sub-question (d) = 5 marks)
(f)
Explain the differences between activity based budgeting and incremental budgeting.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 8
September 2013
7
Performance Operations
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
DE is a distributor of three models of Tablet PCs (Premium, Deluxe and Superfast) to retailers.
The details of the sales volume budget, standard selling prices and standard variable costs for
each model for July were as follows:
Sales volume budget
Premium
Deluxe
Superfast
7,000 units
5,000 units
8,000 units
Premium
$ per unit
400
300
Standard selling price
Standard variable cost
Deluxe
$ per unit
450
320
Superfast
$ per unit
500
350
At the end of July the senior management of the company decided that the impact of the failure
of a major competitor had been underestimated and produced a revised sales volume budget as
follows:
Revised sales volume budget
Premium
Deluxe
Superfast
9,800 units
7,000 units
11,200 units
Actual results for July
Sales volume (units)
Selling price per unit
Variable cost per unit
Performance Operations
Premium
11,000
$410
$300
8
Deluxe
6,000
$440
$320
Superfast
9,000
$520
$350
September 2013
Required:
(a)
Prepare a statement that reconciles the original budgeted contribution with
the actual contribution for July, including planning and operational variances.
Your statement should show the variances in as much detail as possible for
each individual model, and in total.
(13 marks)
(b)
Explain why separating the sales volume variance into a sales mix and a
sales quantity variance will provide useful information for the company’s
sales manager. You should use the variances calculated in (a) to illustrate
your answer.
(6 marks)
(c)
Explain why separating variances into their planning and operational
components provides better information for planning and control purposes.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
September 2013
9
Performance Operations
Question Four
A car rental company is considering setting up a division to provide chauffeur driven limousines
for weddings and other events. The proposed investment will include the purchase of a fleet of
20 limousines at a cost of $200,000 each. It is estimated that the limousines will have a useful
life of five years and a resale value of $30,000 each at the end of their useful life. The company
uses the straight line method of depreciation.
Revenue and variable costs
Each limousine will be hired to customers for $800 per day. The variable costs, including fuel,
cleaning and the chauffeur’s wages, will be $300 per day. The limousines will be available for
hire 350 days of the year. A market specialist was hired at a cost of $20,000 to estimate the
demand for the limousines in Year 1. The market specialist estimated that each limousine will be
hired for 260 days in Year 1 and that the number of days’ hire will increase by 10 days each year
for the remaining life of the project.
Fixed costs
Each limousine will incur fixed costs, including maintenance and depreciation, of $45,000 a year.
The administration of the division is expected to cost $300,000 each year. The garaging of the
limousines will not require any additional investment but will utilise existing facilities for which
there is no other use. The head office will charge the division an annual fee of 10% of sales
revenue for the use of these facilities.
Taxation
The company’s financial director has provided the following taxation information:


Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal. The limousines will be eligible for tax depreciation.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
Other information
Ignore inflation.
The company uses a cost of capital of 12% per annum to evaluate projects of this type.
Performance Operations
10
September 2013
Required:
(a)
Evaluate whether the company should go ahead with the project. You should
use net present value as the basis of your evaluation.
(14 marks)
The company is also carrying out a review of its existing car rental business. The
company is deciding whether it should replace the cars that it uses after one, two or
three years. The cars will not be kept longer than three years due to the higher risk
of breakdowns.
The estimated relevant cash flows for the three possible options for each car can be
obtained from the following information:
Year
0
1
2
3
Cash
outflows
$
(30,000)
(1,500)
(2,700)
(3,600)
Residual
Value
$
21,000
15,000
9,000
The company uses a cost of capital of 12% for decisions of this type.
Required:
(b)
Calculate, using the annualised equivalent method, whether the cars should
be replaced after one, two or three years. You should ignore taxation and
inflation.
.
(7 marks)
(c)
Explain the limitations of the annualised equivalent method for making
decisions to replace non-current assets.
(4 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 13 to 16
September 2013
11
Performance Operations
Operational Level Paper
P1 – Performance Operations
September 2013 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early October at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of eight objective test sub-questions. These are drawn from all
sections of the syllabus. They are designed to examine breadth across the syllabus and thus
cover many learning outcomes.
1.1
Cash paid from previous period
Purchases for this budget period
Purchases not paid until next period
($6,800,000 x 75% x 1/12)
Total cash paid
$
540,000
6,800,000
7,340,000
(425,000)
6,915,000
The correct answer is C.
1.2
The correct answer is A.
 The Chartered Institute of Management Accountants 2012
1.3
Variable cost per unit
= ($2,840,000 – $2,420,000) / (190,000 – 160,000)
= $420,000 / 30,000
= $14 per unit
Fixed costs
= $2,840,000 – (190,000 x $14)
= $180,000
Total costs at 205,000 units
= (205,000 x $14) + $180,000
= $3,050,000
The correct answer is B.
1.4
Cost before stepped increase = $2,840,000 - $30,000 = $2,810,000
Variable cost per unit = ($2,810,000 - $2,420,000) / (190,000 – 160,000)
= $390,000 / 30,000
= $13
Fixed costs at 190,000 units = $2,840,000 – (190,000 x $13)
= $370,000
Total costs at 175,000 units = (175,000 x $13) + ($370,000 - $30,000)
= $2,615,000
The correct answer is C.
1.5
Net Present Value of the project = $280,000
Present value of the annual cash inflow = $320,000 x 3.037 = $971,840
Sensitivity = $280,000/$971,840 = 28.8%
The correct answer is D.
1.6
Yield to maturity of similar bonds is 4% therefore use 4% as the discount rate.
Year(s)
Description
1-4
4
0
Interest
Redemption
Market value
Cash flow
$
6
100
Discount Factor
(4%)
3.630
0.855
Present Value
$
21.78
85.50
107.28
The current expected market value of the bond is therefore $107.28
Or alternatively:
P1
Year(s)
Description
1-3
4
0
Interest
Redemption & Interest
Market value
Cash flow
$
6
106
2
Discount Factor
(4%)
2.775
0.855
Present Value
$
16.65
90.63
107.28
September 2013
1.7
Inventory
Accounts receivable
Accounts payable
$30m x 0.7 x 2.5/12 = $4.375m
$30m x 2/12 = $5m
$30m x 0.7 x 1.5/12 = $2.625m
Total working capital is $4.375m + $5m - $2.625m = $6.75m
1.8
(i)
EOQ =
Where:
Co (cost per order) = $70
D = (annual demand) = 40,000 units
Ch = (cost of holding one unit for one year) = $1.40
EOQ =
= 2,000 units
(ii)
Number of orders = 40,000 / 2,000 = 20 per year
Ordering costs = 20 x $70 = $1,400
Holding costs = 2,000 x 0.5 x $1.40 = $1,400
Total ordering and holding costs = $2,800
September 2013
3
P1
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome E1(a) explain the importance of cash flow and
working capital management. It examines candidates’ ability to explain a company’s motives
for holding cash.
Suggested Approach
Candidates should consider each of the three motives for holding cash and clearly explain
their meaning.
Transaction motive
Cash is needed to pay salaries, buy material and non-current assets, pay interest and
dividends and for a number of other day-to-day transactions. It is necessary to hold some
cash as the daily cash inflows do not normally match the cash outflows and a ‘buffer’ amount
of cash is required to enable operations to continue. This is particularly important in seasonal
businesses or in businesses where long credit periods are given to customers.
Precautionary motive
Cash flow forecasting is subject to error and uncertainty. Future cash flows can vary from
those originally forecast for a variety of reasons e.g. lower sales demand or failure of a major
customer. The inability of a business to meet payments when they fall due may result in loss
of settlement discounts, damaged relations with suppliers or staff, bank charges or possibly
liquidation. The more vulnerable cash flows are to unpredictable changes the greater the cash
balance needed to act as a safety margin.
Speculative motive
The availability of cash means that a company can potentially invest in unexpected profitable
opportunities, for example, to take advantage of unexpected discounts offered for cash
payments for materials.
(b)
Rationale
The question assesses learning outcome D1(e) calculate the value of information. It
examines candidates’ ability to calculate the value of perfect information where there is
uncertainty regarding expected cash flows.
Suggested Approach
Candidates should firstly calculate the expected value of the net present value for each
project without perfect information. They should then select the best outcome from each of
the possible consumer reactions and apply the probabilities to these to calculate the expected
value with perfect information. The value of perfect information can then be calculated as the
difference between the expected value with perfect information and the best of the expected
values without perfect information.
P1
4
September 2013
Project A
expected value
Project B
expected value
Project C
expected value
$000s
$000s
$000s
Strong
250
400
300
Good
100
120
150
Weak
70
49
35
Expected value
420
569
485
Consumer reaction
Project B is the best choice (without the benefit of perfect information) as it has the highest
expected value (EV) of $569k.
With perfect information:
If research reveals strong consumer reaction: select B – expected value $400k
If research reveals good consumer reaction: select C – expected value $150k
If research reveals weak consumer reaction: select A – expected value $70k
EV (with perfect information) = $400 + $150 + $70 = $620k
Value of perfect information is $620k – $569k = $51k
(c)
Rationale
The question assesses learning outcome A1(h) explain the impact of just-in-time
manufacturing methods on cost accounting and the use of ‘back-flush accounting’ when
work-in-progress is minimal. It examines candidates’ ability to explain the potential benefits to
a company from using a just-in-time production system.
Suggested Approach
Candidates should firstly explain how a just-in-time production system operates and then
clearly explain the potential benefits of this for the company.
A just-in-time (JIT) production system is based on actual demand. JIT production aims to
produce the right parts or finished goods at the right time only when they are needed. A JIT
production system is a pull system where parts or goods move through the production system
based on demand.
The use of a JIT production system should result in the following benefits:
•
•
•
•
Low levels of work in progress and finished goods and consequently a reduction in the
costs involved in holding inventory.
The elimination of waste which is defined as anything that does not add value to the
product.
The elimination of any non-value added activities including inspections, movement of
materials and part-completed work and storage of inventory. This involves moving from
a batch production functional factory layout to a cellular flow line manufacturing system
to avoid move times and queue times.
An increase in quality since low quality materials will result in disruption to the
production process, increased inspection time and wastage.
September 2013
5
P1
JIT production techniques can also lead to JIT purchasing whereby the delivery of materials
immediately precede their use. This will bring the following additional benefits:
•
•
•
Low levels of raw materials and of the costs involved with holding raw materials.
A reduction in quality control costs for the company as a result of the close
relationships with a small number of suppliers.
An increase in quality standards resulting in lower wastage in the production process
and hence reduced wastage costs.
(d)
Rationale
The question assesses learning outcome E1(e) analyse trade debtor and creditor information.
It examines candidates’ ability to calculate whether it is financially beneficial for a company to
use a factor.
Suggested Approach
Candidates should firstly calculate the costs if the company uses the factor including the
factoring fee, annual interest charge from the factor and the overdraft interest. They should
then deduct the saving in credit control costs to arrive at the net cost of factoring. They should
then calculate the cost if the company does not use factoring and compare this to the net cost
of factoring.
If the company uses factoring:
Factoring fee
Annual interest
Overdraft interest
$2,007,500 x 2%
((80% x $2,007,500) x 50/365) x 12%
((20% x $2,007,500) x 50/365) x 10%
= $40,150
= $26,400
= $ 5,500
$72,050
$30,000
$42,050
Savings in credit control costs
Net cost of factoring
If the company does not use factoring:
The company requires to borrow - $330,000
The cost of borrowing is therefore - $330,000 x 10% = $33,000
There is therefore no financial benefit in factoring as the cost of borrowing is
less than the cost of factoring.
(e)
Rationale
The question assesses learning outcome D1(a) analyse the impact of uncertainty and risk on
decision models that may be based on relevant cash flows, learning curves, discounting
techniques etc. It examines candidates’ ability to produce a pay-off table and then use the
pay-off figures to determine the decision that would be made if the minimax regret criterion is
P1
6
September 2013
applied.
Suggested Approach
Candidates should firstly complete the pay-off table based on the combination of the number
of batches of sandwiches prepared and the demand for sandwiches. They should then
prepare a regret matrix showing the regret at each of the different levels of demand. The
maximum regret at each of the different number of batches prepared can then be identified.
The decision should then be based on the number of batches which will minimise the
maximum regret.
September 2013
7
P1
(i)
Demand
20 batches
21 batches
22 batches
23 batches
20 batches
$1,200
$1,200
$1,200
$1,200
Number of batches prepared
21 batches
22 batches
$1,160
$1,120
$1,260
$1,220
$1,260
$1,320
$1,260
$1,320
23 batches
$1,080
$1,180
$1,280
$1,380
20 batches
0
$60
$120
$180
$180
Number of batches prepared
21 batches
22 batches
$40
$80
0
$40
$60
$0
$120
$60
$120
$80
23 batches
$120
$80
$40
$0
$120
(ii)
Demand
20 batches
21 batches
22 batches
23 batches
Maximum regret
To minimise the maximum regret the company should produce 22 batches.
(f)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the difference between an incremental budgeting
system and an activity based budgeting system.
Suggested Approach
Candidates should clearly explain how each of the budgeting systems operates highlighting
the main differences between the two systems.
An incremental budget is normally based on the previous year’s budget for a responsibility
centre which is then adjusted for any expected changes e.g. changes in level of activity or
changes to operations. The different elements of the budget will also be adjusted for inflation.
A key aspect of the incremental budgeting approach is that it builds upon the previous budget
and assumes that the activities required in the previous year will continue in the next year.
The effect of this is that any previous inefficiencies are perpetuated.
Activity based budgeting (ABB) aims to manage costs more effectively by authorising the
supply of only those resources that are needed to perform activities required to meet the
budgeted production, sales volume or service levels. Cost objects i.e. products or services
are the starting point. The necessary activities required will be determined by the different
types of products or services that will be produced / sold. The cost driver for each activity will
be identified and the volume of cost drivers required for each activity combined with the cost
driver rate will then be used to estimate the resources required. The activity based budget
approach will also enable the identification of non-value added activities which can be
reduced or eliminated.
P1
8
September 2013
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate sales
variances including sales mix and sales quantity variances. It also assesses learning
outcome A1(f) interpret material, labour, variable overhead, fixed overhead and sales
variances, distinguishing between planning and operational variances. It examines
candidates’ ability to separate variances into their planning and operational elements. Part (b)
also assesses learning outcome A1(f) interpret material, labour, variable overhead, fixed
overhead and sales variances, distinguishing between planning and operational variances. It
examines candidates’ ability to explain why it is useful to separate the sale volume variance
into a sales mix variance and a sales quantity variance. Part (c) also assesses learning
outcome A1(f) interpret material, labour, variable overhead, fixed overhead and sales
variances, distinguishing between planning and operational variances. It examines
candidates’ ability to explain the importance of planning and operational variances.
Suggested Approach
In part (a) candidates should firstly calculate the budgeted contribution and the actual
contribution for the period. They should then calculate each of the variances for sales price,
sales quantity and sales mix showing separately the sales quantity planning variance and
sales quantity operational variance. They should then prepare a reconciliation statement
starting with the budgeted contribution, adding the sales quantity contribution planning
variance to calculate a revised contribution and then showing each of the individual variances
to reconcile the budgeted contribution to actual contribution. In part (b) candidates should
use the figures calculated in part (a) to discuss the benefits of separating the sales volume
variance into a sales mix and sales quantity variance. In part (c) candidates should clearly
explain why calculating planning and operational variances gives better information for
planning and control purposes.
(a)
Reconciliation statement
$
Budgeted contribution
2,550,000
Sales quantity contribution planning variance
- Premium
- Deluxe
- Superfast
280,000 F
260,000 F
480,000 F
Revised budget contribution
1,020,000 F
3,570,000
Operational variances:
Sales quantity contribution operational variance
- Premium
- Deluxe
- Superfast
Sales mix contribution operational variance
- Premium
- Deluxe
- Superfast
September 2013
$
9
70,000 A
65,000 A
120,000 A
255,000 A
190,000 F
65,000 A
210,000 A
85,000 A
P1
Sales price operational variance
- Premium
- Deluxe
- Superfast
Actual contribution
110,000 F
60,000 A
180,000 F
230,000 F
3,460,000
Original budgeted contribution for the period
$
Premium 7,000 units x $100
700,000
Deluxe
5,000 units x $130
650,000
Superfast 8,000 units x $150 1,200,000
2,550,000
Sales quantity contribution planning variance
Difference
Revised
Original
budget
budget
units
units
@ original
@ original
budget mix
budget mix
Premium
7,000
9,800
2,800 F
Deluxe
5,000
7,000
2,000 F
Superfast
8,000
11,200
3,200 F
20,000
28,000
Variance
$
Standard
contribution
$
100
130
150
280,000 F
260,000 F
480,000 F
1,020,000 F
Revised budget contribution
Premium
Deluxe
Superfast
9,800 units x $100
7,000 units x $130
11,200 units x $150
$
980,000
910,000
1,680,000
3,570,000
Sales quantity contribution operational variance
Actual units
Difference
Revised budget
@ budget mix
units
@ budget mix
Premium
9,800
9,100
700 A
Deluxe
7,000
6,500
500 A
Superfast
11,200
10,400
800 A
28,000
26,000
Sales mix contribution operational variance
Actual units
Actual units
@ budget mix
@ actual mix
Premium
Deluxe
Superfast
P1
9,100
6,500
10,400
26,000
11,000
6,000
9,000
26,000
10
Difference
1,900 F
500 A
1,400 A
Standard
contribution
$
100
130
150
Variance
$
Standard
contribution
$
100
130
150
Variance
$
70,000 A
65,000 A
120,000 A
255,000 A
190,000 F
65,000 A
210,000 A
85,000 A
September 2013
Or alternatively
Weighted average contribution per unit = $3,570,000 / $28,000 = $127.50
Sales mix contribution operational variance
Actual units
Actual units
Difference
@ budget mix @ actual mix
Premium
Deluxe
Superfast
9,100
6,500
10,400
26,000
11,000
6,000
9,000
26,000
1,900
500
1,400
Sales price operational variance
Actual
Standard
selling price
selling price
Premium
$400
$410
Deluxe
$450
$440
Superfast
$500
$520
Weighted average
contribution less
standard contribution
$
(127.50 – 100)
(127.50 – 130)
(127.50 – 150)
Difference
$10 F
$10 A
$20 F
Actual units
sold
11,000
6,000
9,000
26,000
Variance
$
52,250 A
1,250 A
31,500 A
85,000 A
Variance
$
110,000 F
60,000 A
180,000 F
230,000 F
Actual contribution for the period
Premium
Deluxe
Superfast
11,000 units x $110
6,000 units x $120
9,000 units x $170
September 2013
$
1,210,000
720,000
1,530,000
3,460,000
11
P1
(b)
The sales volume variance will enable the sales manager to identify the effect on contribution
of the sales team’s failure to meet the revised sales budget. By separating this into a sales
mix and a sales quantity variance the sales manager will be able to determine how much of
the total adverse variance was due to the failure to meet the total budget sales quantity and
how much was due to the actual sales being at a different mix from the budget mix.
The sales quantity contribution operational variance compares the actual volume sold at the
budgeted mix with the budgeted volume at the budgeted mix. The budgeted figures used are
the revised budget after taking account of the planning variances. The variance is adverse
and indicates that if 2,000 additional units had been sold at the budgeted mix a further
$255,000 contribution would have been earned.
The sales mix contribution operational variance compares the actual units sold at the
budgeted mix with the actual units sold at the actual mix. The budgeted figures used are the
revised budget after taking account of the planning variances. It indicates the effect that a
change of mix has had on the contribution earned. The variance is adverse as sales of both
the deluxe and the superfast models were lower than expected using the budgeted mix. Sales
of the premium model were higher than expected under the budget mix but this model has the
lowest contribution.
(c)
Planning and operational variances provide better information for planning and control
purposes for the following reasons:
•
The use of planning and operational variances will enable management to draw a
distinction between variances caused by factors outside the control of the business and
planning errors (planning variances) and variances caused by factors that are within the
control of management (operational variances). In this case they can separate the sales
quantity contribution variance to show the variance caused by inaccurate planning as a
result of not considering the impact of the competitor’s failure on sales volume (planning
variance) and the operational variance as a result of efficient or inefficient selling.
•
The managers’ performance can be compared with the adjusted standards that reflect the
conditions the manager actually operated under during the reporting period. If planning
and operational variances are not distinguished, there is potential for dysfunctional
behaviour especially where the manager has been operating efficiently and effectively
and performance is being judged by factors outside the manager’s control.
•
The use of planning variances will also allow management to assess how effective the
company’s planning process has been. Where a revision of the budget is required due to
changes that were not foreseeable at the time the budget was prepared, the planning
variances are uncontrollable. However budgets that failed to anticipate foreseeable
market trends when they were set will reflect faulty planning. It could be argued that some
of the planning variances are in fact controllable at the planning stage.
•
The information used in setting the ex-post standards can be used in future budget
periods. The planning variances may also indicate problems in the standard setting
process and the reasons for this can be identified and improvement made to the process.
P1
12
September 2013
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and learning outcome C2(a) evaluate
project proposals using the techniques of investment appraisal. It examines candidates’
ability to identify the relevant costs of a project and then apply discounted cash flow analysis
to calculate the net present value of the project. Part (b) assesses learning outcome C1(g)
prepare decision support information for management, integrating financial and non-financial
considerations. It examines candidates’ ability to apply the annualised equivalent method to
an asset replacement decision. Part (c) also assesses learning outcome C1(g) prepare
decision support information for management, integrating financial and non-financial
considerations. It examines candidates’ ability to explain the limitations of the annualised
equivalent method for making asset replacement decisions.
Suggested Approach
In part (a) candidates should firstly calculate the total cost of the investment and residual
value of the limousines. They should then calculate the depreciation charge for each
limousine and deduct this from the fixed costs. The number of days that the limousines will be
operated in each year should then be used to calculate the total contribution for each year.
Candidates should then identify the other relevant cash flows for each year of the project. The
tax depreciation and tax payments should then be calculated. The net cash flows after tax
should be discounted at the discount rate of 12% to calculate the net present value (NPV) of
the project. In part (b) candidates should calculate the NPV for a one, two and three year
replacement cycle. The NPV should then be divided by the annuity factor to calculate the
annualised equivalent cost. The replacement cycle with the lowest annualised equivalent cost
should then be selected. In part (c) candidates should clearly explain the limitations of using
the annualised equivalent method for asset replacement decisions.
(a)
Investment costs
$200k per limousine x 20 = $4,000,000
Residual value = $30k x 20 = $600,000
Fixed costs
Depreciation per limousine per annum = ($200k – $30k) / 5 = $34k
Administration costs = $300k
Other fixed costs (excluding depreciation) per annum
$45k - $34k = $11k per limousine
$11k x 20 = $220k
The head office charge is not a relevant cost.
Contribution years 1 – 5
Contribution per limousine per day = $800 - $300 = $500
Total contribution per day = $500 x 20 = $10,000
Year 1 = 260 days
Year 2 = 260 days + 10 days = 270 days
Year 3 = 270 days + 10 days = 280 days
Year 4 = 280 days + 10 days = 290 days
September 2013
13
P1
Year 5 = 290 days + 10 days = 300 days
Total contribution
Year 1 = 260 days x $10,000 = $2,600,000
Year 2 = 270 days x $10,000 = $2,700,000
Year 3 = 280 days x $10,000 = $2,800,000
Year 4 = 290 days x $10,000 = $2,900,000
Year 5 = 300 days x $10,000 = $3,000,000
Cash flows
Contribution
Other fixed
operating costs
Administration
costs
Net cash flows
Year 1
$k
2,600
Year 2
$k
2,700
Year 3
$k
2,800
Year 4
$k
2,900
Year 5
$k
3,000
(220)
(220)
(220)
(220)
(220)
(300)
(300)
(300)
(300)
(300)
2,080
2,180
2,280
2,380
2,480
Taxation
Net cash
flows
Tax
Depreciation
Taxable
profit
Taxation @
30%
Year 1
Year 2
Year 3
Year 4
Year 5
$k
2,080
$k
2,180
$k
2,280
$k
2,380
$k
2,480
(1,000)
(750)
(563)
(422)
(665)
1,080
1,430
1,717
1,958
1,815
324
429
515
587
545
Net present value
Year 0
Year 1
$k
$k
Investment (4,000)
/ residual
value
Net cash
2,080
flows
Tax
(162)
payment
Tax
payment
Net cash
(4,000)
1,918
flow after
tax
Discount
1.000
0.893
factors @
12%
Present
(4,000)
1,713
value
Net present value = $2,887k
Year 2
$k
Year 3
$k
Year 4
$k
Year 5
$k
600
Year 6
$k
2,180
2,280
2,380
2,480
(215)
(258)
(294)
(273)
(162)
(214)
(257)
(293)
(272)
1,803
1,808
1,829
2,514
(272)
0.797
0.712
0.636
0.567
0.507
1,437
1,287
1,163
1,425
(138)
The net present value is positive therefore on this basis the company should go ahead with
the project.
P1
14
September 2013
(b)
Year
0
1
2
3
Net
present
value
Cumulative
discount
factor
Annualised
equivalent
Discount
Factor
@12%
1.00
0.893
0.797
0.712
Replace after Year 1
Cash
Present
flows
value
$
$
(30,000) (30,000)
19,500
17,414
Replace after Year 2
Cash
Present
flows
value
$
$
(30,000) (30,000)
(1,500)
(1,340)
12,300
9,803
Replace after Year 3
Cash
Present
flows
value
$
$
(30,000)
(30,000)
(1,500)
(1,340)
(2,700)
(2,152)
5,400
3,845
(12,586)
(21,537)
(29,647)
0.893
1.690
2.402
(14,094)
(12,744)
(12,343)
The lowest annualised equivalent cost occurs if the vehicles are kept for three years.
Therefore the optimum replacement cycle is to replace the vehicles every three years.
(c)
The annualised equivalent method assumes that the company replaces the assets with an
identical asset each time. This however ignores changing technology and the necessary
requirement to replace assets with a more up to date model which may be more efficient and
have different functions. The method also ignores the effect of inflation which may differ for
each of the different variables. This may mean that the optimal replacement period will vary
over time. The external environment is uncertain and therefore companies cannot predict with
accuracy the environment that they will face in the future. It may not be necessary to replace
the assets in the future as they may no longer be required.
September 2013
15
P1
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO
Performance Pillar
20 November 2013 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2013
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
It is estimated that at the end of this year AB will have trade payables outstanding of
$547,800. This represents 55 days of purchases based on a 365 day year. All purchases
are on credit and are spread evenly each year.
AB is preparing the budget for next year and estimates that annual purchases will
increase by 15%.
The trade payables days are expected to change from 55 days to 50 days due to several
suppliers offering early settlement discounts.
The budgeted trade payables outstanding at the end of next year will be:
A
$629,970
B
$498,000
C
$692,967
D
$572,700
(2 marks)
Performance Operations
2
November 2013
1.2
BC had trade receivables of $242,000 at the start of the year. BC forecasts that the sales
revenue for the year will be $1,500,000. All sales are on credit.
Trade receivable days at the end of the year are expected to be 60 days based on a 365
day year.
The expected receipts from customers during the year are closest to:
A
$1,495,425
B
$1,742,000
C
$ 1,253,425
D
$ 1,504,575
(2 marks)
1.3
A decision maker who makes decisions using the maximax decision criterion would be
described as:
A
Pessimistic
B
Optimistic
C
A bad loser
D
Cautious
(2 marks)
Section A continues on the next page
TURN OVER
November 2013
3
Performance Operations
1.4
PQ is purchasing the lease on a property which has an annual lease payment of $300 in
perpetuity. The lease payments will be paid annually in advance.
PQ has a cost of capital of 12% per annum.
The present value of the lease payments is:
A
$2,500
B
$2,800
C
$3,600
D
$3,900
(2 marks)
1.5
RS is a retailer of pet products. A dog basket that it sells has an annual demand of
15,000 units. Demand is spread evenly throughout the year.
RS pays its supplier $60 for each basket. Ordering costs are $150 per order and the
annual cost of holding one basket in inventory is estimated to be $6.
The economic order quantity (EOQ) for the dog basket to the nearest unit is:
A
612 units
B
173 units
C
866 units
D
1,025 units
(2 marks)
1.6
A bond has a coupon rate of 8.5% per annum. The next interest payment will be made in
one year’s time. The bond will repay the par value of $100 when it matures in seven
years’ time.
Required:
Calculate the expected current market price of the bond if yields to maturity on similar
bonds are 7% per annum.
(3 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
Performance Operations
4
November 2013
1.7
A company is considering an investment project that has a life of four years and requires
an initial investment of $800,000. Net cash inflows are estimated to be $281,000 per year.
The project has a positive net present value of $53,397 when discounted at 12% per
annum. Ignore tax and inflation.
Required:
Calculate, to the nearest 1%, the maximum discount rate at which the project will be
financially viable.
(3 marks)
1.8
A company normally pays its supplier 50 days after the invoice date. The supplier has
offered the company a 2% early settlement discount if the invoice is paid within 10 days of
the invoice date. The company pays 11% per annum on its overdraft which will be used to
fund the early settlement.
Required:
Calculate whether the company should accept the early settlement discount.
(4 marks)
(Total for Section A = 20 marks)
End of Section A. Section B begins on page 6
TURN OVER
November 2013
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
‘Public sector organisations are often judged by their economy, efficiency and
effectiveness. Consequently they should use an approach to budgeting other than
incremental budgeting.’
Required:
Explain ONE advantage and TWO disadvantages of public sector organisations using
incremental budgeting.
(5 marks)
(b)
EF manufactures and sells three products, X, Y and Z. The following production overhead
costs are budgeted for next year:
Activity
Set up
Material handling
Inspection
Total production overheads
$
560,000
242,000
386,000
1,188,000
Budgeted details for each of the products for next year are as follows:
Product X
10,000
100
2
16,530
1,188
Production units
Batch size
Number of set ups per batch
Number of material movements
Number of inspections
Product Y
16,000
200
3
20,938
1,782
Product Z
18,000
300
6
17,632
2,430
Required:
Calculate the total budgeted production overhead cost for each product using activity
based budgeting.
(5 marks)
Section B continues on the opposite page
Performance Operations
6
November 2013
The following data are given for sub-questions (c) and (d) below
A company produces grit for use on public roads during icy conditions. The grit has to be
produced in advance of the winter season. The level of demand depends on weather
conditions. Any excess production has to be disposed of as it will deteriorate before the
following winter. The company has received the following weather predictions and
associated demand for next winter.
Weather conditions
Severe
Normal
Mild
Demand
72,000 tonnes
54,000 tonnes
38,000 tonnes
The company needs to determine the quantity of grit to produce for the next winter
season. It can only produce 40,000, 60,000 or 80,000 tonnes and cannot change the
quantity once production has begun
One tonne of grit has a selling price of $150 and costs $70 to produce. Any unsold grit will
need to be disposed of at a cost of $20 per tonne.
Required:
(c)
Prepare a payoff table showing the profits for production quantities of 40,000 tonnes,
60,000 tonnes and 80,000 tonnes.
(5 marks)
(d)
It has now been estimated that the probabilities of the weather conditions are 30%, 50%
and 20% for severe, normal and mild weather respectively.
(i)
Calculate the profit that would be earned if the decision about the production quantity was
based on the expected value of demand.
(3 marks)
(ii)
Describe the attitude to risk of a decision maker who makes decisions using the expected
value decision rule.
(2 marks)
(Total for sub-question (d) = 5 marks)
(e) Environmental management is considered to be one of the most important issues facing
companies today. An effective environmental costing system will not only support a
company’s environmental management but may also improve the financial performance of
the organisation.
Required:
Explain THREE ways in which an environmental costing system can lead to improved
financial performance.
(5 marks)
Section B continues on the next page
TURN OVER
November 2013
7
Performance Operations
(f) A company is considering five investment projects as follows:
Project
A
B
C
D
E
Investment
$
12,000
8,000
20,000
16,000
14,000
Profitability Index
0.20
0.05
0.60
0.40
0.30
The company has $40,000 available for investment. Projects C and D are mutually
exclusive. All projects can be undertaken only once and are divisible.
Required:
Calculate the maximum net present value (NPV) that can be earned from the projects given
that there is only $40,000 available for investment.
(5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C begins on page 10
Performance Operations
8
November 2013
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
GH manufactures a product using skilled labour and high quality materials. The company
operates a standard costing system and a just-in-time (JIT) purchasing and production system.
The standard selling price and variable costs for one unit of the product are as follows:
Selling price
Materials (2 kg @ $10 per kg)
Labour (3 hours @ $24 per hour)
$
136
20
72
The budgeted sales for October were 38,000 units.
Actual results for October were as follows:
Production and sales
Selling price
36,000 units
$134 per unit
Materials
Labour
76,000 kg costing $754,000
114,000 hours paid costing $2,656,000
Required:
(a)
Prepare a statement that reconciles the budgeted contribution with the actual
contribution for October. Your statement should show the variances in as much
detail as possible.
(10 marks)
At a recent Board meeting the Management Accountant presented a statement showing the
variances for the previous quarter in total as follows:
Variance
Material price variance
Material usage variance
Labour rate variance
Labour efficiency variance
Sales volume contribution variance
Sales price variance
Performance Operations
$
$
15,300 F
22,500 A
130,800 F
146,400 A
182,600 A
134,000 A
10
November 2013
The Production Director explained to the Board that, in an attempt to reduce costs, he made a
decision at the start of the three month period to adjust the labour mix by replacing some of the
skilled labour with semi-skilled labour and to reduce the quality of the materials used. The
standard costs were not adjusted to reflect these changes.
The Sales Director stated that the sales team were being forced to reduce the selling price due
to concerns expressed by customers about the quality of the product. There had also been a
large increase in customer complaints and returns of faulty products.
Required:
(b)
Discuss the performance of the Production Director using the information
given in the variance statement above.
(8 marks)
The Management Accountant has provided more detailed information regarding the
labour mix.
The labour cost shown in the original standard cost was made up as follows:
Skilled labour
Semi-skilled labour
1.8 hours @ $30 per hour
1.2 hours @ $15 per hour
3.0 hours
$54
$18
$72
The actual mix of labour used in October was as follows:
Skilled labour
Semi-skilled labour
64,000 hours costing $1,750,000
50,000 hours costing $906,000
The Management Accountant has decided to undertake further variance analysis using the more
detailed information.
Required:
(c)
Calculate the following variances for October, taking account of the more
detailed information regarding the labour mix:
(i)
(ii)
(iii)
The total labour efficiency variance
The total labour mix variance
The total labour yield variance
(7 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
November 2013
11
Performance Operations
Question Four
JK manufactures high quality tablet PCs using just-in-time (JIT) production methods. The market
has grown significantly over the past few years and is expected to continue to grow. JK is
planning to launch a new model the ‘Supertab’. The introduction of the Supertab will have no
impact on sales of existing models as it is expected to appeal to a different segment of the
market.
The company has already spent $2 million marketing the new model but will require a further
investment of $20 million in production equipment. The project has a life of five years at the end
of which the equipment will have a residual value of $5 million. Depreciation is calculated using
the straight line method. It is expected that the total capital investment will be eligible for tax
depreciation.
Sales and production of the Supertab over its lifecycle are expected to be:
Year 1
Year 2
Year 3
Year 4
Year 5
50,000 units
60,000 units
75,000 units
30,000 units
30,000 units
The selling price in Year 1 and Year 2 will be $500 per unit. The selling price will be reduced to
$400 in Year 3 and will remain at this level for the remainder of the project.
The total variable cost of the Supertab, including labour, materials and variable overhead costs
is estimated to be $200 per unit and this is expected to remain constant throughout the life of the
project. Each unit is estimated to take 1.25 machine hours to produce. Fixed overheads are
charged to products using an absorption rate of $120 per machine hour. The additional fixed
overheads expected to be incurred directly as a result of increasing the production capacity is $8
million per annum including depreciation charges.
Additional working capital of $6 million will be required at the start of the project.
Taxation
JK’s Financial Director has provided the following taxation information:
•
•
•
Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
JK has sufficient taxable profits from other parts of its business to enable the offset of any
pre-tax losses on this project.
Other information
A cost of capital of 12% per annum is used to evaluate projects of this type. Ignore inflation.
Performance Operations
12
November 2013
Required:
(a)
Evaluate whether JK should introduce the new model. You should use net
present value (NPV) as the basis of your evaluation. Workings should be
rounded to the nearest $0.1 million.
(12 marks)
(b)
Calculate for the Supertab project:
(i)
the internal rate of return (IRR)
(4 marks)
(ii)
the discounted payback period
(3 marks)
JK could outsource the production of the Supertab to an overseas manufacturer.
The accountant has presented figures to show that the NPV of the project based
on outsourcing the production is $0.3 million higher than the NPV of in-house
production.
(c)
Explain THREE non-financial factors that JK would need to consider before
deciding whether to outsource production.
(6 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
November 2013
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
November 2013 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early February at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of eight objective test sub-questions. These are drawn from all
sections of the syllabus. They are designed to examine breadth across the syllabus and thus
cover many learning outcomes.
1.1
Annual purchases this year = $547,800/55 x 365 =$3,635,400
Annual purchases next year = $3,635,400 x 1.15 = $4,180,710
Trade payables outstanding = $4,180,710 x 50/365 = $572,700
The correct answer is D.
 The Chartered Institute of Management Accountants 2013
1.2
Sales revenue for the year
Plus cash received from last year
Less trade receivables at end of year ($1,500,000/365 x 60)
Cash received from customers
$
$1,500,000
$242,000
($246,575)
$1,495,425
The correct answer is A.
1.3
The correct answer is B.
1.4
The first lease payment is paid in advance i.e. in Year 0
Time
0
1-∞
Present Value
Cash flow
$
300
300
Discount factor 12%
1.0000
1 / 0.12 = 8.3333
Present value
$
300
2,500
2,800
The present value of the lease payments is $2,800.
The correct answer is B.
1.5
2C o D
EOQ =
Ch
Where:
Co = (cost per order) = $150
D = (annual demand) = 15,000 units
Ch = (cost of holding one unit for one year) = $6.00
EOQ =
2 × 150 × 15,000
6
= 866
The correct answer is C.
1.6
Yield to maturity of similar bonds is 7%, therefore use 7% as the discount rate.
Year(s)
Description
1-7
7
Interest
Redemption
0
Market value
Cash flow
$
8.50
100
Discount Factor
(7%)
5.389
0.623
Present Value
$
45.81
62.30
108.11
The current expected market value of the bond is therefore $108.11
P1
2
November 2013
1.7
It is necessary to find the annuity factor where the initial investment will be equal to the
net cash inflows.
$281,000 x four year annuity factor = $800,000
Four year annuity factor = $800,000/$281,000 = 2.847
The four year annuity factor for 15% = 2.855
The four year annuity factor for 16% = 2.798
The maximum discount rate at which the project will be financially viable is therefore
15%.
Alternatively:
Using a 20% discount rate
Year
Cash flow
$
(800,000)
281,000
0
1-4
Discount factor
Present value
$
(800,000)
727,509
(72,491)
1.000
2.589
Using interpolation:
12% + (53,397/(53,397+72,491)) x 8%
12% + 3.39% = 15.39%
To the nearest 1%, the discount rate is 15%
1.8
Payment will be made 40 days early.
Number of compounding periods = 365/40 = 9.125
1+ r = (1.00/0.98)
9.125
1+ r = 1.20244
The effective annual rate of the early settlement discount is 20.24%
The cost of the overdraft is 11% per annum, therefore the company should accept the
early settlement discount.
Alternatively:
th
If payment is made on the 10 day the discount is worth $10,000 x 0.02 = $200
th
Saving on overdraft interest if payment is made on the 50 day:
365
√(1+0.11) -1 = 0.000285959
The daily interest rate =
40
40 days interest = (1 + 0.000285959) – 1
= 0.01150237
= $9,800 x 0.01150237
= $112.72
th
Therefore pay on the 10 day and accept the early settlement discount.
November 2013
3
P1
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the advantages and disadvantages of incremental
budgeting.
Suggested Approach
Candidates should clearly explain one advantage and two disadvantages of incremental
budgeting in public sector organisations.
Advantage
An incremental approach is much easier and quicker to implement than other forms of
budgeting approaches e.g. zero based budgeting. Public sector organisations tend to be fairly
complex and in many cases outputs cannot be measured in monetary terms therefore the link
between inputs and outputs is difficult to establish. An incremental approach can therefore
provide a cost effective approach to budgeting.
Disadvantages
Under an incremental approach to budgeting, existing operations and the current budgeted
allowance for these existing activities are taken as the base level for preparing the budget.
The base level is then adjusted for known changes and inflation. The main disadvantage of
this is that the cost of past activities becomes fixed and any inefficiencies or wastage is
perpetuated.
The incremental approach means that budget holders in public sector organisations will be
encouraged to use up this year’s budget to ensure that next year’s budget will be as high as
possible. Any overspends in the current year will be included in the budget for the following
year.
For both these reasons the incremental approach does not encourage managers in public
sector organisations to look at the efficiency and effectiveness of activities undertaken and
how taxpayers can be given value for money.
(b)
Rationale
The question assesses learning outcome B2(b) calculate projected revenues and costs
based on product/service volumes, pricing strategies and cost structures. It examines
candidates’ ability to calculate budgeted product costs using activity based budgeting.
Suggested Approach
Candidates should firstly identify the cost driver for each of the activities and the number of
cost drivers for each product and in total. They should then use the cost driver information to
charge the overhead costs to each product.
P1
4
November 2013
Number of set ups
Production units
Batch size
Number of batches
Number of set ups per batch
Total number of set ups
Set up costs
Material handling
costs
Inspection costs
Product X
10,000
100
100
2
200
Product Y
16,000
200
80
3
240
Product Z
18,000
300
60
6
360
Product X
Product Y
Product Z
Total
$140,000
$168,000
$252,000
$560,000
(200/800 x
$560,000)
$72,600
(240/800 x
$560,000)
$91,960
(360/800 x
$560,000)
$77,440
$242,000
(16,530/55,100
x $242,000)
$84,920
(20,938/55,100
x $242,000)
$127,380
(17,632/55,100
x $242,000)
$173,700
$386,000
(1,188/5,400
x $386,000)
$297,520
(1,782/5,400
x $386,000)
$387,340
(2,430/5,400
x $386,000)
$503,140
$1,188,000
(c)
Rationale
The question assesses learning outcome D1(d) prepare expected value tables. It examines
candidates’ ability to prepare a payoff table showing the possible profit at different levels of
demand and production.
Suggested Approach
Candidates should firstly calculate the profit per tonne of production sold and the cost per
tonne of production unsold. They should then calculate the profit for each of the combinations
of levels of demand and production quantities.
November 2013
5
P1
Profit per tonne of production sold = $150 - $70 = $80
Cost per tonne of production unsold = $70 + $20 = $90
Production
Demand
72,000 tonnes
54,000 tonnes
38,000 tonnes
80,000 tonnes
60,000 tonnes
40,000 tonnes
$
$
$
5,040,000
4,800,000
3,200,000
(72,000 x $80) –
(8,000 x $90)
(60,000 x $80)
(40,000 x $80)
1,980,000
3,780,000
3,200,000
(54,000 x $80) (26,000 x $90)
(54,000 x $80) –
(6,000 x $90)
(40,000 x $80)
(740,000)
1,060,000
2,860,000
(38,000 x $80) –
(42,000 x $90)
(38,000 x $80) –
(22,000 x $90)
(38,000 x $80) –
(2,000 x $90)
(d)
Rationale
Part (i) of the question assesses learning outcome D1(c) analyse risk and uncertainty by
calculating expected values and standard deviations together with probability tables and
histograms. Part (ii) of the question assesses learning outcome D1(a) analyse the impact of
uncertainty and risk on decision models that may be based on relevant cash flows, learning
curves, discounting techniques etc. Part (i) examines candidates’ ability to calculate the
expected demand and the resultant profit if the decision on production quantity was based on
the expected demand. Part (ii) requires candidates to describe the attitude to risk of a
decision maker who makes decisions using the expected value decision rule.
Suggested Approach
(i)
Candidates should firstly apply the probabilities for the weather conditions to calculate
the expected value of demand. They should then establish the production quantity that
would be required to meet the expected demand. They should then calculate the profit
that would be earned from this combination of demand and production quantity.
(ii)
Candidates should clearly describe the attitude to risk of a decision maker who applies
the expected value decision rule.
(i)
If the expected value decision rule is used the company would need to apply the
probabilities given for each of the weather conditions to calculate the expected value of
the demand.
Expected value of demand =
(72,000 x 30%) + (54,000 x 50%) + (38,000 x 20%) = 56,200
If the expected value of demand is 56,200 the company will produce 60,000 tonnes.
P1
6
November 2013
The profit will be:
(56,200 x $80) - (3,800 x $90) = $4,154,000
(ii)
A decision maker who uses the expected value rule is considered to be risk neutral. A
risk neutral person is a person who is indifferent to risk. A person making a decision
using the expected value rule would be indifferent between two alternatives that have
the same expected values even when they have different dispersions.
(e)
Rationale
The question assesses learning outcome A3(a) apply principles of environmental costing in
identifying relevant internalised costs and externalised environmental impacts of the
organisation’s activities. It examines candidates’ ability to explain the ways in which an
environmental costing system can lead to improved financial performance.
Suggested Approach
Candidates should clearly explain three ways in which an environmental costing system may
lead to improved financial performance.
Examiner’s note: the question asks for three ways. Examples of points that would be
rewarded are given below.
Cost reduction
Organisations that have an effective environmental costing system are more likely to identify
and take advantage of cost reduction and other improvement opportunities. Cost reductions
will arise as a result of reduction in wastage and disposal costs. Organisations that are aware
of environmental costs have benefited from additional revenues as a result of recycling waste.
Increased revenues
An awareness of the extent of environmental costs may result in the production of products
that meet the environmental needs of or concerns of customers. This can result in an
improved company image which can lead to increased sales. It may also be possible to sell
these products at a premium price.
Improved decision making
An awareness of environmental costs will also reduce the chances of employing incorrect
pricing of products and services and taking the wrong options in terms of mix and
development decisions. This in turn may lead to enhanced customer value while reducing the
risk profile attaching to investments and other decisions which have long term consequences.
Avoidance of costs of failure
A lack of awareness of environmental costs can result in environmental failures and significant
additional costs, for example the associated costs of clean-up and financial penalties
associated with environmental disasters. The well publicised BP oil spill in the Gulf of Mexico
has so far cost the oil company billions of dollars in penalties and fines.
November 2013
7
P1
(f)
Rationale
The question assesses learning outcome C2(c) prioritise projects that are mutually exclusive,
involve unequal lives and/or are subject to capital rationing. It examines candidates’ ability to
prioritise projects where some of the projects are mutually exclusive and where there is
capital rationing.
Suggested Approach
Candidates should firstly rank the projects based on the profitability index taking into account
that projects C and D are mutually exclusive. They should then allocate the available funds
based on the ranking taking into account that the projects are divisible. They should then use
the profitability index to calculate the net present value of the projects and the maximum net
present value that can be earned from the projects.
Project
Investment
Profitability Index
A
B
C
D
E
$
12,000
8,000
20,000
16,000
14,000
0.20
0.05
0.60
0.40
0.30
Net present
value
$
2,400
400
12,000
6,400
4,200
Ranking
3
4
1
n/a
2
The projects should be invested in as follows:
Project
C
E
A (x 50%)
Investment
$
20,000
14,000
6,000
40,000
Net present value
$
12,000
4,200
1,200
17,400
Ranking
1
2
3
The maximum net present value that can be earned is $17,400.
P1
8
November 2013
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate variances to
enable the reconciliation of budgeted and actual contribution margins. Part (b) assesses
learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and
sales variances, distinguishing between planning and operational variances. It examines
candidates’ ability to discuss the reasons why the variances may have arisen and the
possible interrelationship between the variances. Part (c) also assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margin. It examines candidates’ ability to calculate labour mix and
yield variances.
Suggested Approach
In part (a) candidates should firstly calculate the budgeted contribution and the actual
contribution for the period. They should then calculate each of the variances for sales,
material and labour. They should then prepare a reconciliation statement starting with the
budgeted contribution, adjusting for the sales volume contribution variance to calculate a
revised contribution and then showing each of the individual variances to reconcile the
budgeted contribution to actual contribution. In part (b) candidates should discuss the effect
that the production director’s decision has had on the company performance as shown by the
variances. In part (c) candidates should calculate the total labour efficiency variance, mix
variance and yield variance using the further information available about the labour mix.
(a)
Reconciliation statement
$
Budgeted contribution
(38,000 x $44)
1,672,000
Sales volume contribution variance
(36,000 units - 38,000 units) x $44
88,000 A
Standard contribution on actual sales volume
Sales price variance
36,000 units x ($134 - $136)
Material price variance
((76,000 kg x $10) – $754,000)
Material usage variance
((36,000 x 2 kg) – 76,000 kg) x $10
Labour rate variance
((114,000 x $24) - $2,656,000)
Labour efficiency variance
((36,000 x 3 hrs) – 114,000) x $24
1,584,000
72,000 A
6,000 F
40,000 A
80,000 F
144,000 A
1,414,000
Actual contribution
November 2013
$
9
P1
Workings:
Actual contribution for the period
Sales
Direct materials
Direct labour
$
4,824,000
36,000 units x $134
754,000
2,656,000
(3,410,000)
1,414,000
Actual contribution
(b)
The Production Director’s decisions may have contributed to the total material cost variance of
$7,200A and the total labour cost variance of $15,600A. The material price variance is
favourable due to the purchase of reduced quality materials. However, this has probably
contributed to the adverse material usage variance from additional wastage of the material
due to its poorer quality and also because the labour force will be unfamiliar with handling the
new material. The decision to use lower skilled labour has resulted in a favourable labour rate
variance but this has been outweighed by the adverse labour efficiency variance. There could
be a number of reasons for the adverse labour efficiency variance. The labour force will be
less familiar with the material and therefore slower when working with it but also the less
skilled labour would be expected to take longer due to their lack of experience and skills.
It could be argued that the Production Director is also responsible for the adverse sales
variances. According to the Sales Director the sales price variance reflects the need to reduce
selling prices as a result of customer dissatisfaction with the quality of the product. The
adverse sales volume variance will at least partly be a result of the customer dissatisfaction
and the amount of returned products.
The decision will also have resulted in an increase in administration costs relating to the
handling of customer complaints and other costs in dealing with the faulty products. These
additional costs are not reflected in the production cost variances that have been analysed.
(c)
(i)
Labour efficiency variance
Skilled labour
((36,000 x 1.8 hours) – 64,000) x $30 = $ 24,000 F
Unskilled labour ((36,000 x 1.2 hours) – 50,000) x $15 = $102,000 A
$ 78,000 A
Total efficiency variance
(ii)
Labour mix variance
Actual hours
@standard
mix
Skilled labour
Semi-skilled
labour
P1
Actual hours
@ actual mix
Variance
(hours)
Standard
cost
$
68,400
45,600
64,000
50,000
4,400 F
4,400 A
30
15
114,000
114,000
0
10
Variance
$
132,000 F
66,000 A
66,000 F
November 2013
Or alternatively:
Weighted average cost per hour of input
$72/3 hours = $24 per hour
Labour mix variance
Actual hours
@standard mix
Skilled labour
Semi-skilled
labour
Actual hours
@ actual mix
Variance
(hours)
68,400
45,600
64,000
50,000
4,400
4,400
114,000
114,000
Standard cost
$
Variance
$
(30 – 24)
(15 – 24)
26,400 F
39,600 F
66,000 F
(iii) Labour yield variance
Standard hours of input per unit of output = 3 hours
36,000 units output x 3 hours = 108,000 hours of input
Actual hours = 114,000 hours
Variance = 6,000 hours A
Standard cost per hour = $24
Variance = 6,000 hours x $24 = $144,000 A
Or alternatively:
114,000 hours should yield 114,000/3hours = 38,000 units
Actual yield = 36,000 units
Yield variance = 2,000 units A
Standard labour cost per unit = $72
Yield variance = 2,000 units x $72= $144,000 A
November 2013
11
P1
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and learning outcome C2(a) evaluate
project proposals using the techniques of investment appraisal. It examines candidates’
ability to identify the relevant costs of a project and then apply discounted cash flow analysis
to calculate the net present value of the project. Part (b) also assesses learning outcome
C2(a) evaluate project proposals using the techniques of investment appraisal. It examines
candidates’ ability to calculate the internal rate of return (IRR) and the discounted payback
period for the project. Part (c) assesses learning outcome C1(g) prepare decision support
information for management, integrating financial and non-financial considerations. It
examines candidates’ ability to explain non-financial factors that a company would need to
consider before deciding whether to outsource the production of the product.
Suggested Approach
In part (a) candidates should firstly calculate the contribution for each year of the project.
They should then deduct the fixed costs after adjusting these for depreciation. The tax
depreciation and tax payments should then be calculated. The total cost of the investment,
the residual value and the working capital cash outflows and inflows should be added to the
net cash flows. The net cash flows after tax should then be discounted at the discount rate of
12% to calculate the net present value (NPV) of the project. In part (b)(i) candidates should
use the cash flows calculated in part (a) and discount these at a higher discount rate to get a
negative NPV. They should then use interpolation to calculate the IRR of the project. In part
(b)(ii) candidates should use the discounted cash flows calculated in part (a) to calculate the
cumulative discounted cash flows at the end of each year and the discounted payback period
of the project. In part (c) candidates should clearly explain three non-financial factors that the
company should consider before deciding whether to outsource production.
(a)
Fixed costs
Depreciation per annum = ($20m - $5m) / 5 = $3m
Fixed costs (excluding depreciation) per annum
= $8m - $3m = $5m
Contribution Years 1 – 5
Year 1: 50,000 units x ($500 - $200) = $15,000,000
Year 2: 60,000 units x ($500 - $200) = $18,000,000
Year 3: 75,000 units x ($400 - $200) = $15,000,000
Year 4: 30,000 units x ($400 - $200) = $ 6,000,000
Year 5: 30,000,units x ($400 - $200) = $ 6,000,000
P1
12
November 2013
Taxation
Contribution
Year 1
$m
15
Year 2
$m
18
Year 3
$m
15
Year 4
$m
6
Year 5
$m
6
(5)
10
(5)
13
(5)
10
(5)
1
(5)
1
(5)
(3.8)
(2.8)
(2.1)
(1.3)
5
9.2
7.2
(1.1)
(0.3)
(1.5)
(2.8)
(2.2)
0.3
0.1
Year 0
$m
(20)
Year 1
$m
Year 2
$m
Year 3
$m
Year 4
$m
Fixed costs
Net cash
flows
Tax
Depreciation
Taxable
profit
Taxation @
30%
Net present value
Investment /
residual value
Working
(6)
capital
Net cash flows
Tax payment
Tax payment
Net cash flow
(26)
after tax
Discount
1.000
factors @ 12%
Present value
(26)
Net present value = $3.2m
Year 5
$m
5
6
10
(0.8)
9.2
13
(1.4)
(0.7)
10.9
10
(1.1)
(1.4)
7.5
1
0.2
(1.1)
0.1
1
0.1
0.1
12.2
0.893
0.797
0.712
0.636
0.567
8.2
8.7
5.3
0.1
6.9
The net present value is positive therefore on this basis JK should go ahead with the
introduction of the new model.
(b)(i)
Year 0
$m
(26)
Net cash flow
after tax
Discount
1.000
factors @ 20%
Present value
(26)
Net present value = -$1.5m
Year 1
$m
9.2
Year 2
$m
10.9
Year 3
$m
7.5
Year 4
$m
0.1
Year 5
$m
12.2
0.833
0.694
0.579
0.482
0.402
7.7
7.6
4.3
0.0
4.9
By interpolation:
IRR = 12% + ((3.2 / (3.2+1.5)) x 8%)
= 12% + 5.4% = 17.4%
November 2013
13
P1
(ii)
Discounted Payback
Year
Discounted cash flows
$m
0
(26)
1
8.2
2
8.7
3
5.3
4
0.1
5
6.9
Cumulative cash flows
$m
(26)
(17.8)
(9.1)
(3.8)
(3.7)
3.2
Discounted Payback period = 4 years + ((3.7 /6.9) x 12)
= 4 years 6 months
(c)
Examiner’s note: the question asks for three factors. Examples of points that would be
rewarded are given below.
Quality: can the outsourcing company produce the same quality of product as JK’s other
models? JK has a reputation for high quality and this reputation could easily be destroyed if
the outsourcing company are unable to produce the new model to the same quality standard.
Reliability: can the outsourcing company be relied on to deliver the products when required by
JK’s customers? This may especially be a potential problem as the outsourcing company is
based overseas and if the product is only for the home market. This may result in the need to
maintain high stocks of the product and if the outsourcing company is unable to meet the
delivery schedule result in lost sales for this model and potentially in lost sales for JK’s other
models.
Management control: the company would need to manage the relationship with the
outsourcing company. The fact that the outsourcing company is based overseas may make
the relationship more difficult to manage. This may involve some additional costs that have
not been considered in the net present value calculations.
Financial strength of the outsourcing company: JK is reliant on the outsourcing company
being able to provide the new model for at least the period of the outsourcing contract.
P1
14
November 2013
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.
Performance Pillar
Tuesday 25 February 2014
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2014
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION.
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
AB is preparing its cash budget for the next quarter.
Which of the following items should NOT be included in the cash budget?
A
Payment of tax due on last year’s profits
B
Gain on the disposal of a piece of machinery
C
Repayment of the capital amount of a loan
D
Receipt of interest from short term investments
(2 marks)
1.2
A company has a real cost of capital of 6% per annum and inflation is 3% per annum.
The company’s money cost of capital per annum is:
A
9.00%
B
2.91%
C
3.00%
D
9.18%
(2 marks)
Performance Operations
2
March 2014
The following information is given for sub-questions 1.3 and 1.4 below
RS has recently introduced an activity based costing system. RS manufactures two products,
details of which are given below:
Budgeted production
per annum (units)
Batch size (units)
Machine set-ups per
batch
Processing time per
unit (minutes)
Product R
80,000
Product S
60,000
100
3
50
3
3
5
The budgeted annual costs for two activities are as follows:
Machine set-up
Processing
$180,000
$108,000
1.3
The budgeted processing cost per unit of Product R is:
A
$0.20
B
$0.51
C
$0.60
D
$0.45
(2 marks)
1.4
The budgeted machine set-up cost per unit of Product S is:
A
$150
B
$1.80
C
$1.50
D
$30
(2 marks)
Section A continues on the next page
TURN OVER
March 2014
3
Performance Operations
1.5
An investment project requires an initial investment of $500,000 and has a residual value
of $130,000 at the end of five years. The net present value of the project is $140,500 after
discounting at the company’s cost of capital of 12% per annum.
The profitability index of the project is:
A
0.38
B
0.54
C
0.28
D
0.26
(2 marks)
1.6
EF sells personal computers on which it gives a one year warranty. EF is estimating the
cost of warranty claims for next year.
If all products under warranty need minor repairs the total cost is estimated to be $2
million. If all products under warranty need major repairs it would cost $6 million. If all
products under warranty need to be replaced it would cost $10 million.
Based on past experience EF has estimated that 80% of products under warranty will
require no repairs, 15% will require minor repairs, 3% will require major repairs and 2%
will need to be replaced.
Required:
Calculate the expected value of the cost of warranty claims for next year.
(3 marks)
1.7
JK’s trade receivables outstanding at the end of this year are expected to be 55 days.
Credit sales for this year are expected to be $862,860 spread evenly throughout the year.
JK is preparing the budget for next year and estimates that credit sales will increase by
5%.
The trade receivables amount, in $, outstanding at the end of next year is estimated to be
the same as at the end of this year.
Required:
Calculate the budgeted trade receivable days at the end of next year. Your answer
should be rounded to two decimal places of a day.
(3 marks)
Performance Operations
4
March 2014
1.8
A marketing manager is deciding which of four potential selling prices to charge for a new
product. The market for the product is uncertain and reaction from competitors may be
strong, medium or weak. The manager has prepared a payoff table showing the forecast
profit for each of the possible outcomes.
Competitor
Reaction
Selling price
$80
$90
$100
$110
Strong
$70,000
$80,000
$70,000
$75,000
Medium
$50,000
$60,000
$70,000
$80,000
Weak
$90,000
$100,000
$90,000
$80,000
Required:
(i)
Identify the selling price that would be chosen if the manager applies the maximin
criterion to make the decision.
(ii)
Identify, using a regret matrix, the selling price that would be chosen if the manager
applies the minimax regret criterion to make the decision.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
March 2014
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
“Public sector organisations are responsible for taxpayers’ money therefore they should
no longer be allowed to use incremental budgeting but should instead use a zero based
budgeting system”.
Required:
Explain TWO advantages and ONE disadvantage of public sector organisations using
zero based budgeting.
(5 marks)
(b)
A company has to decide which of three mutually exclusive projects to invest in next year.
The directors believe that the success of the projects will vary depending on economic
conditions. There is a 30% chance that conditions will be good, a 20% chance that
conditions will be fair and a 50% chance that conditions will be poor. The company uses
expected value to make this type of decision.
The net present value for each of the possible outcomes is as follows:
Economic
Conditions
Project A
Project B
Project C
$000
$000
$000
Good
700
800
700
Fair
400
500
600
Poor
300
400
500
A firm of economic analysts believes it can provide perfect information on economic
conditions.
Required:
Calculate the maximum amount that should be paid for the information from the firm of
economic analysts.
(5 marks)
Performance Operations
6
March 2014
(c)
A company is concerned about its cash flow position. It has reviewed its trade receivable
days and is considering offering an early settlement discount. The company currently
receives payments from customers on average 65 days after the invoice date. The
company’s current credit terms are 30 days after the invoice date. The company is
considering offering a 2% early settlement discount for payment within 20 days of the
invoice date.
Required:
(i)
Calculate the effective annual interest rate of the early settlement discount. You
should use compound interest methodology and assume a 365 day year.
(3 marks)
(ii)
State TWO other methods that could be used to reduce the trade receivable
days.
(2 marks)
(Total for sub-question (c) = 5 marks)
(d)
PR is a retailer of bicycles. The most popular children’s bicycle has an annual demand of
30,000 units. Demand is predictable and spread evenly throughout the year.
The bicycles are purchased by PR for $200 each. Ordering costs are $150 per order and
the annual cost of holding one bicycle in inventory is $25.
Required:
(i)
Calculate the economic order quantity (EOQ) for the children’s bicycle.
(2 marks)
(ii)
Calculate the total annual ordering and holding costs for the bicycle assuming the
company purchases the EOQ, does not hold any buffer inventory and the lead
time is zero.
(3 marks)
(Total for sub-question (d) = 5 marks)
(e) “Environmental costing is an important part of a company’s environmental management
system. Management needs to be aware of the extent of environmental costs if these are
to be effectively managed”.
Required:
Explain THREE benefits that may arise for a company that uses an environmental costing
system.
(5 marks)
Section B continues on the next page
TURN OVER
March 2014
7
Performance Operations
(f)
ST is considering investing in a bill of exchange which has a face value of $1,000 and 91
days to maturity. The issue price of the bill is based on a discount yield of 6% per annum.
(i)
Calculate the issue price of the bill assuming a 365 day year.
(3 marks)
(ii)
State TWO ways in which an accepted bill of exchange can be used by the holder.
(2 marks)
(Total for sub-question (f) = 5 marks)
(Total for Section B = 30 marks)
End of Section B. Section C starts on page 10
Performance Operations
8
March 2014
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
GH manufactures and sells a single product. The company operates a standard absorption
costing system and absorbs overheads on the basis of direct labour hours.
The standard selling price and standard costs for one unit of the product are as follows:
$
per unit
300
Selling price
Direct material
Direct labour
Variable production overheads
Fixed production overheads
15 metres @ $9 per metre
5 hours @ $12 per hour
5 hours @ $6 per hour
5 hours @ $3 per hour
Gross profit
135
60
30
15
60
The budgeted production and sales for February were 1,000 units. The fixed overhead
absorption rate has been calculated based on budgeted production for the month.
Actual results for February were as follows:
Production
Sales
Selling price
1,400 units
1,200 units
$306 per unit
Direct materials
Direct labour
Variable production overheads
Fixed production overheads
22,000 metres @ $12 per metre
6,800 hours @ $15 per hour
$33,000
$18,000
No materials inventories are held.
Required:
(a)
Prepare a statement that reconciles the budgeted gross profit with the actual gross
profit for February. Your statement should show the variances in as much detail as
possible.
(13 marks)
Performance Operations
10
March 2014
The Production Director when questioned about the variances explained that, in an attempt to
improve the quality of the product, better quality material was used and some of the semi-skilled
labour was replaced with skilled labour. The Production Director believed that the improvement
in the quality of the product would enable the company to increase the price of the product and
would also result in increased sales volumes.
Required:
(b)
Discuss, using the variances calculated in part (a), the effect on
performance of the decisions taken by the Production Director.
(6 marks)
(c)
Explain why a standard costing system may not be considered appropriate
in a modern manufacturing environment.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
March 2014
11
Performance Operations
Question Four
LM is a supermarket chain that operates 500 stores. The company’s sales have fallen behind its
competitors as it currently does not offer its customers an online shopping service.
It is considering a proposal to establish an online shopping service using the technology of PQ,
an existing online retailer.
Sales revenue and gross profit
The number of customers using the online delivery service in the first five years is estimated to
be as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
100,000 customers per week
120,000 customers per week
150,000 customers per week
160,000 customers per week
170,000 customers per week
Customers are expected to spend an average of $200 per week. Delivery to customers will be
free of charge. The expected gross profit margin is 20% of selling price.
Loss of existing in-store sales
It is estimated that 30% of customers purchasing online would have purchased in store if the
online facility was not available. The sales revenue per customer and gross profit margin on
on-line sales will be same as that for in-store sales.
Capital expenditure
LM will purchase a fleet of delivery vehicles costing $15 million. The vehicles will have a useful
life of five years and will be depreciated on a straight line basis. They will have no residual value
at the end of the five year period. The vehicles will be eligible for tax depreciation.
Contract with the online retailer
The contract with PQ will be for an initial period of 5 years. LM will pay $340 million to buy one of
PQ’s existing warehouses. LM will also invest $90 million to expand the facility. The expanded
warehouse will then be leased back to PQ for five years for a fee of $20 million per annum. The
cost of purchasing the warehouse and the expansion costs will not be eligible for tax
depreciation. The warehouse will have a realisable value of $350 million at the end of the five
year period.
LM will pay 1% of gross profit from the online business to PQ. LM will also pay a fee of $30
million per annum to license the technology and as a contribution towards PQ's research and
development costs.
Other operating costs
The online operation will result in additional costs in the first year of $60 million, including
delivery costs but excluding depreciation. This amount will rise by $5 million each year as the
customer numbers increase.
Taxation
LM’s Financial Director has provided the following taxation information:
• Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
• Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
• LM has sufficient taxable profits from other parts of its business to enable the offset of any
pre-tax losses on this project.
Other information
•
A cost of capital of 12% per annum is used to evaluate projects of this type.
•
Ignore inflation.
Performance Operations
12
March 2014
Required:
(a)
Evaluate whether LM should go ahead with the proposal to establish an online shopping service. You should use net present value as the basis of your
evaluation. Your workings should be rounded to the nearest $million.
(14 marks)
(b)
Explain TWO other factors that LM should consider before deciding whether
to go ahead with the contract.
(4 marks)
(c)
LM is concerned that replacing the delivery vehicles every five years will
result in breakdowns and customer complaints. It is therefore considering
whether to replace the vehicles on a one, two or three year cycle. The
proposed contract with the online retailer expires after five years however at
the end of this period LM will continue to operate the online business. The
delivery vehicles will therefore require to be continually replaced.
Each vehicle costs $25,000. The operating costs per vehicle for each year
and the resale value at the end of each year are estimated as follows:
Operating costs
Resale value
Year 1
$
6,000
16,000
Year 2
$
8,000
10,000
Year 3
$
12,000
4,000
Required:
Calculate, using the annualised equivalent method, whether the vehicles
should be replaced on a one, two or three year cycle. You should assume
that the initial investment is incurred at the beginning of year 1 and that all
other cash flows arise at the end of the year. Ignore taxation and inflation
and use a cost of capital of 12%.
(7 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
March 2014
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
March 2014 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early April at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of eight objective test sub-questions. These are drawn from all
sections of the syllabus. They are designed to examine breadth across the syllabus and thus
cover many learning outcomes.
1.1
The correct answer is B.
1.2
(1 + r) x (1 + i) = (1 + m)
(1 + 0.06) x (1 + 0.03) = 1.0918
(1 + m) = 1.0918
m = 0.0918
m = 9.18%
The correct answer is D.
 The Chartered Institute of Management Accountants 2014
1.3
Budgeted production
per annum (units)
Number of batches
Number of machine
set-ups
Total processing time
(minutes)
Product R
80,000
Product S
60,000
Total
140,000
800
2,400
1,200
3,600
2,000
6,000
240,000
300,000
540,000
Cost driver rate = $108,000 / 540,000 = $0.20
Total processing costs = $0.20 x 240,000 = $48,000
Processing costs per unit = $48,000 / 80,000 = $0.60
The correct answer is C.
1.4
Cost driver rate = $180,000 / 6,000 = $30 per set up
Total set-up costs = $30 x 3,600 = $108,000
Set up cost per unit =$108,000 / 60,000 = $1.80
The correct answer is B.
1.5
The profitability index
= net present value of the investment / initial investment
= $140,500 / $500,000
= 0.281
The correct answer is C.
1.6
The expected value of cost of the warranty claims is:
$2,000,000 x 15% =
$6,000,000 x 3% =
$10,000,000 x 2% =
Performance Operations
$300,000
$180,000
$200,000
$680,000
2
March 2014
1.7
Trade receivable at the end of this year = $862,860 x 55/365 = $130,020
Credit sales for next year = $862,860 x 1.05 = $906,003
Trade receivable days at end of next year = $130,020 / $906,003 x 365 = 52.38 days
1.8
(i)
The minimum profit at a selling price of $80 is $50,000
The minimum profit at a selling price of $90 is $60,000
The minimum profit at a selling price of $100 is $70,000
The minimum profit at a selling price of $110 is $75,000
Therefore if the manager wants to maximise the minimum profit a selling price of $110 would
be chosen.
(ii)
A regret matrix can be produced as follows:
Competitor
Reaction
Selling price
$80
$90
$100
$110
Strong
$10,000
$0
$10,000
$5,000
Medium
$30,000
$20,000
$10,000
$0
Weak
$10,000
$0
$10,000
$20,000
Maximum regret
$30,000
$20,000
$10,000
$20,000
Therefore if the manager wants to minimise the maximum regret a selling price of $100 would
be chosen.
March 2014
3
Performance Operations
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the advantages and disadvantages of zero based
budgeting.
Suggested Approach
Candidates should clearly explain two advantages and one disadvantage of zero based
budgeting in the scenario described.
Examiner’s note: the question asks for two advantages and one disadvantage. Examples of
points that would be rewarded are given below.
Advantages
a)
It avoids the complacency inherent in the traditional incremental approach where it is
assumed that future activities will be very similar to current ones.
b)
It encourages a questioning approach by focusing attention not only on the cost of the
activity but on the benefits is provides. This will force the public sector managers to
articulate the benefits encouraging them to think clearly about the activities.
c)
Preparation of decision packages will normally require the involvement of many
employees. This involvement may produce many ideas and promote job satisfaction.
Disadvantage
a)
The creation of decision packages and their subsequent ranking is very time consuming
and costly. The public sector organisation will need to assess whether the benefits of
the system outweigh the costs involved.
b)
The ranking process is very difficult and value judgements are inevitable. In a public
sector organisation the decision packages are very disparate and difficult to compare.
c)
In applying ZBB ‘activities’ may continue to be identified with traditional functional
departments rather than cross functional activities and thus distract attention from the
real cost-reduction issues.
Performance Operations
4
March 2014
(b)
Rationale
The question assesses learning outcome D1(e) calculate the value of information. It
examines candidates’ ability to calculate the value of perfect information where there is
uncertainty regarding expected cash flows.
Suggested Approach
Candidates should firstly apply the probabilities for the economic conditions to calculate the
expected value of the net present value (NPV) for each of the projects without perfect
information. They should then select the best outcome for each of the possible economic
conditions and apply the probabilities to these to calculate the expected value with perfect
information. The value of perfect information can then be calculated as the difference
between the expected value with perfect information and the best of the expected values
without perfect information.
Economic
Conditions
Project A
Project B
Project C
$000
$000
$000
Good (30%)
700
800
700
Fair (20%)
400
500
600
Poor (50%)
300
400
500
Expected values ($000)
Project A ($700 x 0.3) + ($400 x 0.2) + ($300 x 0.5) = $440
Project B ($800 x 0.3) + ($500 x 0.2) + ($400 x 0.5) = $540
Project C ($700 x 0.3) + ($600 x 0.2) + ($500 x 0.5) = $580
On the basis of expected value Project C would be chosen.
Expected value with perfect information ($000)
If good select Project B = ($800 x 0.3) = $240
If fair select Project C = ($600 x 0.2) = $120
If poor select Project C = ($500 x 0.5) = $250
Expected value with perfect information is $240 + $120 + $250 = $610
The maximum amount that should be paid is ($610k – $580k) = $30k
March 2014
5
Performance Operations
(c)
Rationale
Part (i) assesses learning outcome E1(e) analyse trade debtor and creditor information. It
examines candidates’ ability to calculate the effective annual interest rate of an early
settlement discount. Part (ii) assesses learning outcome E1(f) analyse the impacts of
alternative debtor and creditor policies. It examines candidates’ ability to identify methods that
could be used to reduce a company’s trade receivable days.
Suggested Approach
In part (i) candidates should calculate how many days early the payment will be received.
They should then divide 365 days by this to calculate the number of compounding periods.
The discount rate should then be compounded by the number of periods to calculate the
effective annual interest rate. In part (ii) candidates should clearly state two methods that
could be used to reduce a company’s trade receivable days.
(i)
Payment will be made 45 days early.
Number of compounding periods = 365/45= 8.111
1+ r = (1.00/0.98)
8.111
1+ r = 1.17805
The effective annual interest rate of the early settlement discount is 17.81%
(ii)
Examiner’s note: the question asks for two methods. Examples of methods that would be
rewarded are given below.
a)
b)
c)
Interest penalties for late payment
Improved credit control procedures
Reduce the credit terms
Performance Operations
6
March 2014
(d)
Rationale
The question assesses learning outcome E1(g) analyse the impacts of alternative policies for
stock management. Part (i) examines candidates’ ability to calculate the economic order
quantity (EOQ) for a product. Part (ii) requires candidates to calculate the total inventory
holding and ordering costs if the company uses the EOQ.
Suggested Approach
In part (i) candidates should apply the formula for the EOQ given in the question paper to the
figures given in the question in order to calculate the EOQ. In part (ii) candidates should firstly
calculate the total number of orders that would be required if the EOQ was used. This can
then be multiplied by the ordering costs per order to calculate the total ordering costs. In
order to calculate the holding costs the EOQ should be divided by two to calculate the
average inventory held. This should then be multiplied by the holding cost per unit to
calculate the total holding costs. The total ordering cost and total holding costs can then be
added together.
(i)
EOQ =
2C o D
Ch
Where:
Co (cost per order) = $150
D = (annual demand) = 30,000 units
Ch = (cost of holding one unit for one year) = $25
EOQ =
2 × 150 × 30, 000
25
= 600 units
(ii)
Number of orders = 30,000 / 600 = 50 per year
Ordering costs = 50 x $150 = $7,500
Holding costs = 600 x 0.5 x $25 = $7,500
Total ordering and holding costs = $15,000
March 2014
7
Performance Operations
(e)
Rationale
The question assesses learning outcome A3(a) apply principles of environmental costing in
identifying relevant internalised costs and externalised environmental impacts of the
organisation’s activities. It examines candidates’ ability to explain the benefits to a company
from using an environmental costing system.
Suggested Approach
Candidates should clearly explain three benefits that may arise for a company that uses an
environmental costing system.
Examiner’s note: the question asks for three benefits. Examples of points that would be
rewarded are given below.
Increased awareness of the impact of environment related activities on their financial
statements
Organisations that use an environmental costing system will have greater awareness of the
impact of environment related activities on their financial statements. This is because
conventional management accounting systems tend to attribute many environmental costs to
general overhead accounts with the result that they are “hidden” from management.
Cost control / reduction
Organisations which adopt environmental cost management principles are more likely to
identify and take advantage of cost reduction and other improvement opportunities. Identifying
and monitoring the usage and cost of resources such as water, electricity and fuel will result
in better control of the cost of these resources and identification of potential for cost reduction.
More accurate product costs / improved decision making
A good environmental costing system will produce more accurate product costs. This will
reduce the chances of employing incorrect pricing of products and services and taking the
wrong options in terms of mix and development decisions. Lack of cost information can result
in the cross subsidisation of environmentally damaging products.
Environmental risk management
Improved environmental cost information will enable environmental considerations to form
part of investment decisions. The likelihood and impact of environmental risks can also be
assessed.
Performance Operations
8
March 2014
(f)
Rationale
Part (i) of the question assesses learning outcome E2(d) illustrate numerically the financial
impact of short-term funding and investment methods. Part (ii) assesses learning outcome
E2(b) identify alternatives for investment of short-term cash surpluses. Part (i) examines
candidates’ ability to calculate the issue price of a bill of exchange. Part (ii) requires
candidates to state two ways in which an accepted bill of exchange can be used by the
holder.
Suggested Approach
In part (i) candidates should calculate the discount on the bill by multiplying the face value by
the discount yield for 91 days. The discount on the bill should then be subtracted from the
face value to calculate the issue price. In part (ii) candidates should clearly state two ways in
which an accepted bill of exchange can be used by the holder.
(i)
If the discount yield is 6% then the discount on the bill will be:
$1,000 x 0.06 x 91/365 = $14.96
The issue price of the bill is therefore:
$1,000 - $14.96 = $985.04
(ii)
Examiner’s note: the question asks for two ways. Examples of points that would be rewarded
are given below.
The holder of an accepted bill of exchange can do one of the following:
(i)
Hold the bill until the due date and collect the money
(ii)
Discount the bill with the bank for immediate payment
(iii)
Transfer the bill to a third party in settlement of an amount due.
March 2014
9
Performance Operations
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate appropriate
variances to enable the reconciliation of budgeted and actual profit. Part (b) assesses
learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and
sales variances, distinguishing between planning and operational variances. It examines
candidates’ ability to discuss the reasons the variances may have arisen and the possible
interrelationship between the variances. Part (c) assesses learning outcome A1(h) explain
the impact of just-in-time manufacturing methods on cost accounting and the use of ‘backflush accounting’ when work in progress stock is minimal. It examines candidates’ ability to
explain the reasons why standard costing may not be considered useful in a modern
manufacturing environment.
Suggested Approach
In part (a) candidates should firstly calculate the budgeted profit and the actual profit for the
period. They should then calculate each of the variances for sales, material, labour and
production overheads. They should then prepare a reconciliation statement starting with the
budgeted profit and then showing each of the individual variances to reconcile the budgeted
profit to actual profit. In part (b) candidates should discuss the effect that the Production
Director’s decision has had on the company performance as shown by the variances.
In part (c) candidates should clearly explain the reasons why standard costing may not be
considered useful in a modern manufacturing environment.
Performance Operations
10
March 2014
(a) (i) Reconciliation statement for February
$
$
Budgeted gross profit
60,000
(1,000 units x $60)
Sales volume profit variance
12,000 F
(1,200 units - 1,000 units) x $60
Sales price variance
7,200 F
1,200 units x ($306 - $300)
Direct material price variance
66,000 A
22,000 mtrs x ($9 - $12)
Direct material usage variance
9,000 A
((1,400 x 15 mtrs) – 22,000 mtrs) x $9
Direct labour rate variance
20,400 A
6,800 hours x ($12 - $15)
Direct labour efficiency variance
2,400 F
((1,400 x 5 hrs) – 6,800) x $12
Variable overhead expenditure variance
7,800 F
(6,800 x $6) – $33,000
Variable overhead efficiency variance
1,200 F
((1,400 x 5 hrs) – 6,800) x $6
Fixed overhead expenditure variance
3,000 A
(1,000 x $15) - $18,000
Fixed overhead volume variance
6,000 F
((1,400 – 1,000 x 5 hrs) x $3)
Actual gross profit /(loss)
(1,800)
Workings:
Actual gross profit for the period
Sales
Direct materials
Direct labour
Variable production overheads
Fixed production overheads
Closing stock
Actual gross profit
1,200 units x $306
22,000 metres x $12
6,800 hours x $15
200 units x $240
$
367,200
264,000
102,000
33,000
18,000
(48,000)
(1,800)
(b)
The Production Director’s decision has resulted in a favourable sales volume variance of
$12,000 and a favourable sales price variance of $7,200 F which may at least partly be as a
result of the improved quality of the product. However, the favourable sales variances have
been achieved at a very high cost in terms of material and labour.
The Production Director’s decision has resulted in a total material cost variance of $75,000 A
and a total labour cost variance of $18,000 A. The material price variance is adverse due to
the purchase of higher quality materials. However, there is also an adverse material usage
variance which may be because the labour force was unfamiliar with handling the new
material. The decision to use higher skilled labour has resulted in an adverse labour rate
variance which has been only partially offset by a favourable labour efficiency variance.
March 2014
11
Performance Operations
(c)
In a JIT environment measuring standard costing variances may encourage dysfunctional
behaviour. A JIT production environment relies on producing small batch sizes economically
by reducing set up times. Performance measures that benefit from large batch sizes or
producing for inventory should therefore be avoided.
In an AMT environment the major costs are those related to the production facility rather than
production volume related costs such as materials and labour, which standard costing is
essentially designed to plan and control. Fixed overhead variances don’t necessarily reflect
under or overspending but may simply reflect differences in production volume. An activity
based cost management system may be more appropriate, focusing on the activities that
drive the cost.
In a total quality environment, standard costing variance measurement places an emphasis
on cost control to the detriment of quality. Cost control may be achieved at the expense of
quality and competitive advantage.
A continuous improvement environment requires a continual effort to do things better rather
than achieve an arbitrary standard based on prescribed or assumed conditions. In today’s
competitive environment cost is market driven and is subject to considerable downward
pressure. Cost management must consist of both cost maintenance and continuous cost
improvement.
In a JIT/AMT/TQM environment the workforce is usually organised into empowered, multiskilled teams controlling operations autonomously. The feedback they require is real time.
Periodic financial reports are neither meaningful nor timely enough to facilitate appropriate
control action.
Performance Operations
12
March 2014
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and C2(a) evaluate project proposals
using the techniques of investment appraisal. It examines candidates’ ability to identify the
relevant costs of a project and then apply discounted cash flow analysis to calculate the net
present value of the project. Part (b) assesses learning outcome C1(g) prepare decision
support information for management, integrating financial and non-financial considerations. It
examines candidates’ ability to explain other factors that the company would need to consider
before deciding whether to go ahead with the project. Part (c) assesses learning outcome
C2(c) prioritise projects that are mutually exclusive, involve unequal lives and/or are subject
to capital rationing. It examines candidates’ ability to determine the optimum replacement
cycle for a company’s non-current assets.
Suggested Approach
In part (a) candidates should firstly calculate the gross profit that would be earned in each
year from the online shopping service and deduct the lost profit from existing in-store sales.
They should then deduct the payments to PQ and the other operating costs and add on the
lease income. The tax depreciation and tax payments should then be calculated. The total
cost of the investment, the residual value should be added to the net cash flows. The net
cash flows after tax should then be discounted at the discount rate of 12% to calculate the net
present value (NPV) of the project. In part (b) candidates should clearly explain two other
factors that the company would need to consider before deciding whether to go ahead with
the project. In part (c) candidates should calculate the NPV of the cash flows under each of
the three alternatives. They should then divide the NPV by the appropriate annuity factor to
calculate the annualised equivalent cost. The optimum replacement cycle can then be
selected as the alternative with the lowest annualised equivalent cost.
(a)
Gross profit Years 1 – 5
Year 1: 100,000 customers x 52 weeks x $200 = $1,040m x 20% = $208m
Year 2: 120,000 customers x 52 weeks x $200 = $1,248m x 20% = $250m
Year 3: 150,000 customers x 52 weeks x $200 = $1,560m x 20% = $312m
Year 4: 160,000 customers x 52 weeks x $200 = $1,664m x 20% = $333m
Year 5: 170,000 customers x 52 weeks x $200 = $1,768m x 20% = $354m
Taxation
Gross profit
Lost profit from
existing sales
Other operating
costs
Lease income
Fee to PQ
Fee to PQ
Net cash flows
Tax depreciation
Taxable profit
Taxation @ 30%
March 2014
Year 1
$m
208
(62)
Year 2
$m
250
(75)
Year 3
$m
312
(94)
Year 4
$m
333
(100)
Year 5
$m
354
(106)
(60)
(65)
(70)
(75)
(80)
20
(30)
(2)
74
(4)
70
21
20
(30)
(3)
97
(3)
94
28
20
(30)
(3)
135
(2)
133
40
20
(30)
(3)
145
(2)
143
43
20
(30)
(4)
154
(4)
150
45
13
Performance Operations
Net present value
Year 0
$m
(445)
Year 1
$m
Year 2
$m
Year 3
$m
Year 4
$m
Year 5
$m
350
Investment
/ residual
value
Net cash
74
97
135
145
154
flows
Tax
(11)
(14)
(20)
(22)
(23)
payment
Tax
(10)
(14)
(20)
(21)
payment
Net cash
(445)
63
73
101
103
460
flow after
tax
Discount
1.000
0.893
0.797
0.712
0.636
0.567
factors @
12%
Present
(445)
56
58
72
66
261
value
Net present value = $57m
The net present value is positive therefore the project should go ahead.
Year 6
$m
(22)
(22)
0.507
(11)
(b)
Two other factors that the company would need to consider are:
Quality/ reliability: can the online retailer provide the quality and reliability of service that LM’s
customers will expect?
Financial strength of PQ: LM is reliant on PQ being able to provide the IT technology and
delivery service to its customers for at least the five year period of the contract.
(c)
Year
0
1
2
3
Net
present
value
Cumulative
discount
factor
Annualised
equivalent
Discount
Factor
@12%
1.000
0.893
0.797
0.712
Replace after Year 1
Cash
Present
flows
value
$
$
(25,000) (25,000)
10,000
8,930
Replace after Year 2
Cash
Present
flows
value
$
$
(25,000) (25,000)
(6,000)
(5,358)
2,000
1,594
Replace after Year 3
Cash
Present
flows
value
$
$
(25,000)
(25,000)
(6,000)
(5,358)
(8,000)
(6,376)
(8,000)
(5,696)
(42,430)
(16,070)
(28,764)
0.893
1.690
2.402
(17,996)
(17,020)
(17,664)
The lowest annualised equivalent cost occurs if the vehicles are kept for two years. Therefore
the optimum replacement cycle is to replace the vehicles every two years.
Performance Operations
14
March 2014
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.
Performance Pillar
21 May 2014 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2014
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
In finance, a bond is described as:
A
A negotiable instrument offering a fixed rate of interest over a fixed period of time and with
a fixed redemption value.
B
A negotiable instrument which provides evidence of a fixed term deposit with a bank.
Maturity is normally within 90 days but can be longer.
C
A document which sets out a commitment to pay a sum of money at a specified point in
time.
D
An unsecured short term loan note issued by companies and generally maturing within a
period of up to one year.
(2 marks)
1.2
A Treasury bill with a face value of $1,000 and 91 days to maturity has an issue price of
$985.04.
The discount yield for the Treasury bill, assuming there are 365 days in the year, is:
A
1.50%
B
6.09%
C
6.00%
D
1.52%
(2 marks)
Performance Operations
2
May 2014
The following information is given for sub-questions 1.3 and 1.4 below
A company manufactures Product Y using a single raw material which is used exclusively in the
manufacture of Product Y. It operates a JIT purchasing system and there is no inventory of raw
materials. The following data relate to the production of Product Y for April.
Budgeted production
Standard material cost per unit
11,000 units
3kg per unit @ $4 per kg
Actual production
Material purchased and used
10,000 units
32,000 kg @ $4.80 per kg
It has now been decided that the standard price for the raw material should have been $5 per
kg.
1.3
The material price planning variance for April is:
A
$6,000 Adverse
B
$30,000 Adverse
C
$32,000 Adverse
D
$33,000 Adverse
(2 marks)
1.4
The material price operational variance for April is:
A
$6,000 Favourable
B
$30,000 Adverse
C
$6,400 Favourable
D
$32,000 Adverse
(2 marks)
Section A continues on the next page
TURN OVER
May 2014
3
Performance Operations
1.5
The table below shows the output, total costs and the cost inflation index for a business in
two periods. Cost behaviour patterns were the same in both periods.
Output level
12,000 units
16,000 units
Total cost
$21,000
$26,780
Inflation index
1.05
1.03
The variable cost per unit at an inflation index of 1.08 will be:
A
$1.56
B
$1.45
C
$1.50
D
$1.62
(2 marks)
1.6
A company is considering the launch of a new product which it estimates has a 75%
chance of success if no marketing is undertaken. The company believes that if it
undertakes a marketing campaign costing $50,000 the probability of success of the
product will increase to 90%.
If successful, the product will make a profit of $300,000, before marketing costs. However,
if it is unsuccessful, the product will make a loss of $80,000 before marketing costs.
Required:
Calculate whether it is worthwhile for the company to undertake the marketing campaign.
(3 marks)
1.7
A company is planning to launch a new product. The price at which it will sell the product
will be determined by the level of competition in the market which is currently uncertain.
The possible selling prices and variable costs and their respective associated probabilities
are as follows:
$
60
64
68
Selling price per unit
Probability
0·30
0·25
0·45
Variable cost per unit
$
Probability
20
0·25
24
0·40
26
0·35
Selling price and variable cost per unit are independent of each other.
Required:
Calculate the probability of the contribution per unit being equal to or greater than $40.
(3 marks)
Performance Operations
4
May 2014
1.8
A project requires an initial investment of $150,000 and has an expected life of five years.
The required rate of return on the project is 12% per annum.
The project’s estimated cash flows each year are as follows:
$000
101
30
5
Sales revenue
Variable costs
Incremental fixed costs
The selling price, costs and activity levels are expected to remain the same for each year
of the project.
Ignore taxation and inflation.
Required:
Calculate the percentage change in the selling price that would result in the project being
rejected.
(4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A
Section B begins on page 6
TURN OVER
May 2014
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
A company uses a top-down approach to budgeting. Budgets are imposed by senior
management and budget holders are not given the opportunity to participate in the budget
setting process.
Required:
Explain ONE advantage and TWO disadvantages to the company of using this top-down
budgeting approach.
(5 marks)
(b)
XY has developed two new products, Product X and Product Y, but has insufficient
resources to launch both products. The success of the products will depend on the extent
of competitor reaction. There is a 20% chance that competitors will take no action, a 50%
chance that they will launch a similar product and a 30% chance that they will launch a
better product.
The profit/loss that will be earned by each of the products depending on the extent of
competitor reaction is as follows:
Competitor reaction
No action
Launch a similar product
Launch a better product
Product X
$540,000
$320,000
($150,000)
Product Y
$620,000
$380,000
($200,000)
Another option for XY would be to launch neither product. If it chooses this course of
action there is a 60% chance that competitors will take no action and there will be no
effect on the company’s profit. There is a 40% chance that competitors will launch a new
product and company profits will reduce by $100,000.
Required:
Demonstrate, using a decision tree and based on expected value, the best course of
action for the company.
(5 marks)
(c)
Discuss the potential benefits for a company from using a just-in-time (JIT) purchasing
system.
(5 marks)
Performance Operations
6
May 2014
(d)
JS has decided to purchase t-shirts and print them with a logo to commemorate a major
international sporting event.
Sales
The commemorative t-shirts will be sold for $10 each and predicted sales are as follows:
July
August
September
9,000 t-shirts
18,000 t-shirts
22,500 t-shirts
One third of sales will be for cash. The remainder will be on credit with the customer
paying the month after sale.
Purchases
The t-shirts will cost $6 each and will be purchased in the month prior to sale. It is
expected that 10% of the t-shirts purchased will be damaged during the printing process
and will not be suitable for sale. The supplier has offered two months credit.
Capital investment
To print the t-shirts with the logo of the sporting event will require the purchase of a
machine costing $30,000. The machine will be bought at the start of the project and paid
for in August. The machine will have a five-year useful life but no expected residual value.
The machine will be used elsewhere in the business at the end of this project.
Expenses
Expenses, excluding advertising, of $20,000 per month will be incurred each month and
paid in the month incurred. Advertising costs of $5,000 per month will be incurred in each
of the months July, August and September and will be paid one month in arrears.
Required:
Produce a cash budget for the project for each of the three months July, August and
September.
(5 marks)
(e)
(i)
Explain why it is important for a business to prepare a cash budget.
(2 marks)
(ii)
State THREE ways, other than borrowing, of improving the cash flow position of a
business.
(3 marks)
(Total for sub-question (e) = 5 marks)
Section B continues on the next page
TURN OVER
May 2014
7
Performance Operations
(f)
A company has a highly seasonal business with the result that its borrowing requirement
fluctuates significantly throughout the year. There are two alternative ways of funding its
short-term borrowing requirement as follows:
1)
The company’s bank has offered a $400,000 overdraft facility at an annual
interest rate of 12% per annum.
2)
The company can take a $400,000 one year loan at an interest rate of 10% per
st
annum. The loan would be taken out on 1 January. Any surplus funds can be
deposited to earn 4% per annum.
The monthly borrowing requirements for the forthcoming year are as follows:
Month
$000
Jan
280
Feb
370
March
0
Apr
370
May
400
Jun
0
Jul
280
Aug
280
Sep
0
Oct
370
Nov
400
Dec
400
The borrowing requirement will apply for the whole of each month.
Required:
(i)
Calculate the net cost of each alternative for the forthcoming year. You should
assume that each month is of equal length and that there are no fees payable.
(3 marks)
(ii)
State TWO advantages of using an overdraft to fund short-term cash deficits.
(2 marks)
(Total for sub-question (f) = 5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C begins on page 10
Performance Operations
8
May 2014
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
MS manufactures three types of skincare product for sale to retailers. MS currently operates a
standard absorption costing system. Budgeted information for next year is given below:
Products
Sales
Direct material
Direct labour
Fixed production overheads
Gross profit
Production and sales (units)
Anti-ageing
Cream
$000
60,000
11,800
3,700
Facial
Masks
$000
38,000
6,200
2,400
Collagen
Fillers
$000
22,000
4,000
1,900
Anti-ageing
Cream
1,000,000
Facial
Masks
1,200,000
Collagen
Fillers
600,000
Total
$000
120,000
22,000
8,000
15,400
74,600
Fixed production overheads are absorbed using a direct material cost percentage rate.
The management accountant of MS is proposing changing to an activity based costing system.
The main activities and their associated cost drivers and overhead cost have been identified as
follows:
Activity
Cost Driver
Machine set up
Quality inspection
Processing
Purchasing
Packaging
Number of set ups
Number of quality inspections
Processing time
Number of purchase orders
Number of units of product
Production overhead cost
$000
3,600
1,200
6,500
1,800
2,300
15,400
Further details have been ascertained as follows:
Batch size (units)
Machine set-ups per batch
Purchase orders per batch
Processing time per unit (minutes)
Quality inspections per batch
Performance Operations
Anti-ageing
Cream
1,000
3
2
2
1
10
Facial
Masks
2,000
3
2
3
1
Collagen
Fillers
1,500
4
1
4
1
May 2014
Required:
(a)
Calculate for each product:
(i)
the total fixed production overhead costs using the current absorption
costing system;
(2 marks)
(ii)
the total gross profit using the proposed activity based costing system.
(13 marks)
The management accountant is reviewing the company’s performance for the last quarter
of this year. The budgeted standard costs for this year differ from those given in the
scenario above for next year.
Budget and actual data for the last quarter of this year include:
Sales (units)
Gross profit per
unit
(b)
Anti-ageing
Cream
Budget
Actual
240,000
250,000
$34.00
$33.20
Facial
Masks
Budget
Actual
280,000
260,000
$20.00
$20.60
Collagen
Fillers
Budget
Actual
120,000
140,000
$22.00
$20.20
Calculate the following variances for the last quarter:
(i) Sales mix gross profit variance
(3 marks)
(ii) Sales quantity gross profit variance
(2 marks)
(c)
Explain the meaning of the sales mix gross profit variance and why its calculation
provides useful information for the company. You should use the figures calculated
in part (b) to illustrate your answer.
(5 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
May 2014
11
Performance Operations
Question Four
QR, a major international cosmetics company, is considering investing in the production and
sale of facial masks. The market for facial masks is growing rapidly and is expected to continue
to grow over the next five years. Market intelligence suggests that the total market size in Year 1
will be 50 million units. The company expects the market size to grow at a rate of 10% per
annum. The investment is to be evaluated over a five year life at which point it is expected that
product innovations will result in a replacement product.
QR’s estimated market share for each of the next five years after the investment is as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
20%
25%
30%
30%
35%
QR has spent $25 million developing the product. Investment of $500 million in a new
manufacturing facility will be required at the beginning of Year 1. The manufacturing facility will
have an estimated residual value of $120 million at the end of five years. The manufacturing
facility will be depreciated using the straight line method. The project will also require an
investment in working capital of $30 million at the beginning of the project.
The selling price of the facial mask will be $30 per unit and the variable cost per unit will be $10.
The selling price and the variable cost per unit are expected to remain the same throughout the
life of the product.
The new manufacturing facility will be used exclusively for the manufacture of facial masks. The
total fixed manufacturing costs will be $200 million per year including depreciation. It is
anticipated that $50 million per year will be spent in years 1 and 2 and $80 million per year in
years 3, 4 and 5 on technical improvements and marketing the new product.
Taxation
QR’s Financial Director has provided the following taxation information:
•
•
•
Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
QR has sufficient taxable profits from other parts of its business to enable the offset of any
pre-tax losses.
Other information
•
A cost of capital of 12% per annum is used to evaluate projects of this type.
•
Ignore inflation.
Performance Operations
12
May 2014
Required:
(a)
Evaluate whether QR should go ahead with the investment. You should use
net present value as the basis of your evaluation. Your workings should be
rounded to the nearest $ million.
(13 marks)
(b)
Explain why discounted cash flow techniques should be used when
evaluating a long-term investment project.
(6 marks)
(c)
Explain the benefits of carrying out a post completion audit of a long-term
investment project.
(6 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
May 2014
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
May 2014 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early August at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
1.1
The correct answer is A.
1.2
The discount for 91 days = $1,000 - $985.04 = $14.96
The annual discount = $14.96 / 91 x 365 = $60
$60 / $1,000 = 6%
The correct answer is C.
 The Chartered Institute of Management Accountants 2014
1.3
(10,000 units x 3 kg) x ($4 - $5) = $30,000 A
The correct answer is B.
1.4
32,000 kg x ($5 - $4.80) = $6,400 F
The correct answer is C.
1.5
If inflation is removed from the costs
$21,000 / 1.05 = $20,000
$26,780 / 1.03 = $26,000
The variable cost per unit = ($26,000 - $20,000) / (16,000 – 12,000) = $1.50
At an inflation index of 1.08 = $1.50 x 1.08 = $1.62
The correct answer is D.
1.6
Expected value of profit with marketing campaign
($300,000 x 0.90) + (-$80,000 x 0.1) = $262,000 - $50,000 = $212,000
Expected value of profit without marketing campaign
($300,000 x 0.75) + (-$80,000 x 0.25) = $205,000
It is therefore worthwhile for the company to undertake the marketing campaign as the
increase in the expected value of profit is $7,000
1.7
$60 - $20 = $40 Joint probability is 0.30 x 0.25 = 0.0750
$64 - $20 = $44 Joint probability is 0.25 x 0.25 = 0.0625
$64 - $24 = $40 Joint probability is 0.25 x 0.40 = 0.1000
$68 - $20 = $48 Joint probability is 0.45 x 0.25 = 0.1125
$68 - $24 = $44 Joint probability is 0.45 x 0.40 = 0.1800
$68 - $26 = $42 Joint probability is 0.45 x 0.35 = 0.1575
0.6875
Alternatively:$60 - $20 = $40 Joint probability is 0.30 x 0.25 = 0.0750
$64 - $20 = $44 Joint probability is 0.25 x 0.25 = 0.0625
$64 - $24 = $40 Joint probability is 0.25 x 0.40 = 0.1000
At a selling price of $68, the contribution per
unit under all three alternatives is greater than
$40 therefore probability is
= 0.4500
0.6875
Performance Operations
2
May 2014
1.8
Net cash flows per annum = $101,000 - $30,000 - $5,000 = $66,000
PV of net cash flows = $66,000 x 3.605 = $237,930
Net present value = $237,930 - $150,000 = $87,930
The PV of the sales revenue = $101,000 x 3.605 = $364,105
The percentage change in the selling price that will result in the project being rejected is:
$87,930 / $364,105 = 24.15%
End of Section A. Section B begins on page 4
May 2014
3
Performance Operations
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates’ ability to explain the advantages and disadvantages of a top-down
approach to budgeting.
Suggested Approach
Candidates should clearly explain one advantage and two disadvantages of a top-down
approach to budgeting.
Examiner’s note: the question asks for one advantage and two disadvantages. Examples that
would be rewarded are given below:
Advantages
•
Top-down budgeting avoids the problem of managers attempting to negotiate budgets
that they feel are easy to achieve which gives rise to ‘budget padding’ or budgetary
slack.
•
It also avoids the problem of managers trying to ‘empire build’ because they believe
that the size of their budget reflects their importance within the organisation. This can
result in budgets that are unsuitable for control purposes.
•
The involvement of managers in the budget setting process is time consuming. Topdown budgets can be produced much more quickly.
•
Top-down budgeting avoids pseudo-participation which can be especially demotivating
for managers.
Disadvantage
•
Imposed targets are likely to make managers feel demotivated and alienated and result
in poor performance. Managers are more likely to be motivated to achieve the target if
they have participated in setting the target.
•
Senior management are not involved in the day to day operation of the business.
Participation by managers can reduce the information asymmetry gap that can arise
when targets are imposed by senior management and should result in more realistic
budgets.
•
The use of a top-down budgeting approach will result in the absence of communication
between managers at all levels throughout the organisation.
Performance Operations
4
May 2014
(b)
Rationale
The question assesses learning outcome D1(f) apply decision trees.
It examines candidates’ ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.
Suggested Approach
Candidates should firstly draw the decision tree and then using the profit/loss and
probabilities given for each branch of the tree work back to calculate the expected profit/loss
at each node. They should then clearly indicate the most profitable decision.
May 2014
5
Performance Operations
$540,000
No action
20%
$223,000
Similar
50%
Better
30%
Product X
No action
20%
$254,000
Product Y
$254,000
Similar
50%
$320,000
($150,000)
$ 620,000
$ 380,000
Better
30%
No
Product
($200,000)
No action
60%
$0
($40,000)
New
product
40%
($100,000)
The company should launch Product Y
Performance Operations
6
May 2014
(c)
Rationale
The question assesses learning outcome E1(g) analyse the impacts of alternative policies for
stock management. It examines candidates’ ability to discuss the potential benefits for a
company from using a JIT purchasing system.
Suggested Approach
Candidates should explain how a JIT purchasing system operates and the potential benefits
that may arise from the use of the system. Candidates should also consider the pre-requisites
for achieving the benefits from a JIT purchasing system.
The successful operation of a JIT purchasing system relies on having an arrangement with a
small number of key suppliers where the supplier is able to provide raw materials or
components on demand or with a very short lead time. This allows the company to hold zero
or very little inventory thus reducing the costs involved with holding inventory including
storage costs, insurance costs and obsolescence costs. The costs involved with ordering
inventory may however increase.
The use of a small number of suppliers should also reduce administrative costs for the
company and may result in greater quantity discounts.
A JIT purchasing system involves the company working together with their suppliers to ensure
that they can rely on receiving supplies at the right time and at the required quality level. This
should result in a reduction in quality control costs for the company. Quality standards should
also improve resulting in lower wastage in the production process. However, close cooperation with suppliers is essential thus suppliers are not selected on the basis of price
alone. Their performance in terms of quality and the ability to deliver as needed and their
commitment to JIT purchasing are also of vital importance.
May 2014
7
Performance Operations
(d)
Rationale
The question assesses learning outcome B3(a) prepare a budget for any account in the
master budget, based on projections/forecasts and managerial targets. It examines
candidates’ ability to prepare a cash budget based on information given about the timing of
cash flows.
Suggested Approach
Candidates should firstly prepare a format for the cash budget with months along the top and
receipts and payments down the side. They should then work out the timing of the cash flows
for each of the items. The cash receipts and cash payments should be totalled and the net
cash flow for each month should be calculated. The opening cash balance and closing cash
balance for each month can then be calculated.
July
August
September
$
$
$
30,000
60,000
75,000
0
60,000
120,000
30,000
120,000
195,000
Purchases
0
60,000
120,000
Machinery
0
30,000
0
Expenses
20,000
20,000
20,000
0
5,000
5,000
20,000
115,000
145,000
0
10,000
15,000
Net cash flow
10,000
5,000
50,000
Closing balance
10,000
15,000
65,000
Receipts
1/3 cash sales
2/3 credit sales
Total receipts
Payments
Advertising
Total payments
Opening balance
Performance Operations
8
May 2014
(e)
Rationale
Part (i) of the question assesses learning outcomes E1(a) explain the importance of cash flow
and working capital management. Part (ii) assesses learning outcome E1(d) discuss
measures to improve a cash forecast situation. Part (i) examines candidates’ ability to explain
why it is important for a business to prepare a cash budget. Part (ii) requires candidates to
state three ways of improving the cash flow position of a business.
Suggested Approach
In part (i) candidates should clearly explain the benefits to the company of cash budgeting. In
part (ii) candidates should state three methods that could be used to improve the cash flow
position of a business.
(i)
The objective of a cash budget is to ensure that sufficient cash is available to meet the level
of operations in the various functional and capital budgets. Cash deficits can be identified in
advance and steps taken to ensure that sources of finance will be available to cover any
deficits. Cash budgets can also help a company to avoid cash surpluses by enabling
management to take actions in advance to invest the surplus cash in short-term or long-term
investments as appropriate. The overall aim should be to manage the cash of the company to
ensure that cash is available when required and that the maximum benefit is gained from the
use of any idle funds.
(ii)
Examiner’s note: the question asks for three methods. Examples that would be rewarded are
given below:
•
•
•
•
•
•
•
Using different forms of financing for capital expenditure e.g. leasing rather than
purchasing outright.
Selling short-term investments.
Postponing non-essential capital expenditure.
Disposing of non-current assets that are no longer required.
Reducing inventory levels by using, for example, JIT purchasing.
Reducing the time taken to collect receivables by e.g. offering early settlement
discounts, reducing credit terms or factoring the debt.
Delaying the payment of payables.
May 2014
9
Performance Operations
(f)
Rationale
Part (i) of the question assesses learning outcome E2(d) illustrate numerically the financial
impact of short-term funding and investment methods. Part (ii) assesses learning outcome
E2(a) identify sources of short-term funding. Part (i) examines candidates’ ability to calculate
the cost of two alternative methods of funding a company’s short-term borrowing requirement.
Part (ii) requires candidates to state two advantages of using an overdraft to fund short-term
cash deficits.
Suggested Approach
In part (i) candidates should calculate the cost of the overdraft based on the balance
outstanding each month. They should then calculate the annual interest cost of the loan net
of the interest receivable on the unused portion. In part (ii) candidates should clearly state two
advantages of using an overdraft to fund short-term cash deficits.
(i)
Interest on the overdraft
$370,000 x 3/12 x 0.12 = $11,100
$280,000 x 3/12 x 0.12 = $ 8,400
$400,000 x 3/12 x 0.12 = $12,000
$31,500
Interest on loan
$400,000 x 0.10
= $40,000
Less interest receivable
$400,000 x 3/12 x 0.04 =
$120,000 x 3/12 x 0.04 =
$30,000 x 3/12 x 0.04 =
($4,000)
($1,200)
($300)
$34,500
The overdraft is therefore the cheaper alternative.
(ii)
Examiner’s note: the question asks for two advantages. Examples that would be
rewarded are given below:
•
Flexibility: the bank will agree an overdraft limit or facility. The borrower may not require
the full facility immediately but may draw funds up to the limit as and when required. If
the funds are no longer required they can be repaid without suffering any penalty.
Minimal documentation: legal documentation is fairly minimal when arranging an
overdraft. The documents will state the maximum overdraft limit, the interest payable
and the security required.
An overdraft is seen as a relatively cheap source of finance. Banks usually charge
between 2% and 5% above base rate depending on the borrower’s creditworthiness
and security offered by the borrower. Savings come from the fact that interest is only
paid on the daily outstanding balance. Therefore a large cash inflow can offset the
balance outstanding and temporarily lower the interest payable, whilst still retaining the
ability to borrow up to the overdraft limit when required.
•
•
Performance Operations
10
May 2014
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) of the question assesses
learning outcome A1(c) discuss activity-based costing as compared with traditional marginal
and absorption costing methods, including its relative advantages and disadvantages as a
system of cost accounting. It examines candidates’ ability to calculate the cost of a product
using both traditional absorption costing and activity based costing. Part (b) assesses
learning outcome A1(d) apply standard costing methods, within costing systems, including
the reconciliation of budgeted and actual profit margins. It examines candidates’ ability to
calculate a sales mix gross profit variance and a sales quantity gross profit variance. Part (c)
assesses learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead
and sales variances, distinguishing between planning and operational variances. It examines
candidates’ ability to explain the meaning of a sales mix gross profit variance and why it is
useful to calculate the variance.
Suggested Approach
In part (a)(i) candidates should identify the direct material costs for each product and then
calculate the overhead absorption rate. This rate can then be applied to each product and the
total overhead cost calculated. In part (a)(ii) candidates need to calculate a cost driver rate for
each of the activities and then apply this cost driver rate to calculate the overhead cost for
each activity per product. The gross profit for each product can then be recalculated. In part
(b)(i) candidates should calculate the sales mix gross profit variance by comparing the actual
sales quantity at the budgeted mix with the actual sales quantity at the actual mix. The
variance calculated in units for each of the products should then be multiplied by the standard
gross profit per unit to calculate the variance for each product. These should then be added
together to calculate the total mix variance. In part (b)(ii) the budgeted sales quantity should
be compared to the actual sales quantity at the budgeted mix. The resultant variance in units
should be multiplied by the standard gross profit per unit to calculate the sales quantity gross
profit variance for each product. These should then be added together to calculate the total
sales quantity gross profit variance. In part (c) candidates should clearly explain the meaning
of the sales mix gross profit variance and why it is useful for a company to calculate this
variance.
(a)
(i)
Fixed production overheads = $15,400,000
Budgeted material cost = $22,000,000
Fixed production overhead absorption rate = $15,400,000 / 22,000,000 = 70%
Fixed production overhead
May 2014
Anti-ageing
cream
$000
Facial masks
8,260
11
Total
$000
Collagen
fillers
$000
4,340
2,800
15,400
$000
Performance Operations
(ii)
Budgeted production per annum (units)
Batch size (units)
Number of batches
Number of machine set-ups
Number of purchase orders
Processing time (minutes)
Activity
Machine set up
Activity cost
$000
3,600
Quality inspection
1,200
Processing
6,500
Purchasing
1,800
Packaging
2,300
Anti-ageing
Cream
1,000,000
1,000
1,000
3,000
2,000
2,000,000
Facial
Masks
1,200,000
2,000
600
1,800
1,200
3,600,000
Cost driver
Number of machine
set ups
Number of quality
inspections
Processing time
Number of
purchase orders
Number of units
Collagen
Fillers
600,000
1,500
400
1,600
400
2,400,000
Cost driver rate
$3,600,000 / 6,400
= $562.50 per set-up
$1,200,000 / 2,000
= $600 per inspection
$6,500,000 / 8,000,000
= $0.8125 per minute
$1,800,000 / 3,600
= $500 per purchase order
$2,300,000 / 2,800,000
= $0.821 per unit
15,400
Sales
Direct material
Direct labour
Machine set ups
Quality
inspections
Processing
Purchasing
Packaging
Anti-ageing
Cream
$000
60,000
11,800
3,700
(3,000 x $562.50)
1,688
(1,000 x $600)
600
(2,000,000 x
$0.8125)
1,625
(2,000 x $500)
1,000
(1,000,000 x $0.821)
821
Facial
Masks
$000
38,000
6,200
2,400
(1,800 x $562.50)
1,012
(600 x $600)
360
(3,600,000 x
$0.8125)
2,925
(1,200 x $500)
600
(1,200,000 x $0.821)
986
Collagen
Fillers
$000
22,000
4,000
1,900
(1,600 x $562.50)
900
(400 x $600)
240
(2,400,000 x
$0.8125)
1,950
(400 x $500)
200
(600,000 x $0.821)
493
38,766
23,517
12,317
Total
$000
120,000
22,000
8,000
3,600
1,200
6,500
1,800
2,300
Gross profit
Performance Operations
12
74,600
May 2014
(b)
(i)
Sales Mix Gross Profit Variance:
Anti-ageing cream
Facial masks
Collagen fillers
Actual
Sales
quantity
(units)
250,000
260,000
140,000
650,000
Actual
Sales at
budget mix
(units)
243,750
284,375
121,875
650,000
Difference
(units)
Budget
sales
Quantity
(units)
240,000
280,000
120,000
640,000
Standard
gross profit
$
Total profit
$000
6,250 F
24,375 A
18,125 F
Standard
gross profit
$
34.00
20.00
22.00
Variance
$
212,500 F
487,500 A
398,750 F
123,750 F
Or alternatively:
Anti-ageing cream
Facial masks
Collagen fillers
34
20
22
8,160
5,600
2,640
16,400
Weighted average gross profit = $16,400k / 640,000 = $25.625
Anti-ageing cream
Facial masks
Collagen fillers
Actual
sales
quantity
(units)
250,000
260,000
140,000
650,000
Actual
sales at
budget mix
(units)
243,750
284,375
121,875
650,000
Difference
(units)
6,250 F
24,375 A
18,125 F
Variance from
weighted
average gross
profit per unit
($34 - $25.625)
($20 - $25.625)
($22 - $25.625)
Variance
$
52,344 F
137,109 F
65,703 A
123,750 F
(ii)
Sales Quantity Gross Profit Variance
Anti-ageing cream
Facial masks
Collagen fillers
Budget
sales
quantity
(units)
240,000
280,000
120,000
Actual
sales at
budget mix
(units)
243,750
284,375
121,875
640,000
650,000
Difference
(units)
3,750 F
4,375 F
1,875 F
Standard
gross profit
$
34
20
22
Variance
$
127,500 F
87,500 F
41,250 F
256,250 F
Or alternatively:
Sales quantity gross profit variance = (650,000 – 640,000) x $25.625 = $256,250 F
May 2014
13
Performance Operations
(c)
The sales mix gross profit variance identifies the effect on profit of a change in the mix of
product sales. It compares the actual quantity of products sold at the budgeted mix with the
actual mix of products sold. From the figures calculated in part (b) we can see that the change
in the sales mix has resulted in an increase in profit of $123,750. The change in the sales mix
has resulted in a relatively higher proportion of sales of the anti-ageing cream and collagen
fillers which are the products that earn the highest profit per unit and a lower proportion of
sales of facial masks which have a relatively lower profit per unit. This is important information
for future planning and pricing purposes. An overall increase in quantity of products sold may
not result in an increase in profits if the increased sales are from a lower margin product at
the expense of products with a higher profit margin.
Performance Operations
14
May 2014
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and C2(a) evaluate project proposals
using the techniques of investment appraisal. It examines candidates’ ability to identify the
relevant costs of a project and then apply discounted cash flow analysis to calculate the net
present value of the project. Part (b) assesses learning outcome C1(e) explain the financial
consequences of dealing with long-run projects, in particular the importance of accounting for
the ‘time value of money’. It examines candidates’ ability to explain why discounted cash flow
techniques should be used when evaluating a long-term investment project. Part (c)
assesses learning outcome C1(a) explain the processes involved in making long-term
decisions. It examines candidates’ ability to explain the benefits of carrying out a postcompletion audit of a long-term investment project.
Suggested Approach
In part (a) candidates should firstly calculate the number of units sold and the contribution
that would be earned from the product in each year. They should then deduct the fixed costs
after adjusting for depreciation. The tax depreciation and tax payments should then be
calculated. The total cost of the investment and the residual value should then be added to
the net cash flows. The net cash flows after tax should then be discounted at the discount
rate of 12% to calculate the net present value of the project. In part (b) candidates should
clearly explain why it is necessary to adjust cash flows to account for the time value of
money. In part (c) candidates should clearly explain the potential benefits to a company of
carrying out a post-completion audit of a long-term investment project.
(a)
Contribution Years 1 – 5
Year 1: 50 million x 20% x $20 = $200 million
Year 2: 50 million x 1.1 = 55 million x 25% x $20 = $275 million
Year 3: 55 million x 1.1 = 60.5 million x 30% x $20 = $363 million
Year 4: 60.5 million x 1.1 = 66.55 million x 30% x $20 = $399 million
Year 5: 66.55 million x 1.1 = 73.21 million x 35% x $20 = $512 million
Fixed Costs
Depreciation per annum = ($500m - $120m) / 5 = $76m
Fixed costs (excluding depreciation) per annum
= $200m - $76m = $124m
Taxation
Contribution
Fixed operating
costs
Advertising
Net cash flows
Tax depreciation
Taxable profit
Taxation @ 30%
May 2014
Year 1
$m
200
(124)
Year 2
$m
275
(124)
Year 3
$m
363
(124)
Year 4
$m
399
(124)
Year 5
$m
512
(124)
(50)
26
(125)
(99)
30
(50)
101
(94)
7
(2)
(80)
159
(70)
89
(27)
(80)
195
(53)
142
(43)
(80)
308
(38)
270
(81)
15
Performance Operations
Net present value
Investment
/ residual
value
Working
capital
Net cash
flows
Tax
payment
Tax
payment
Net cash
flow after
tax
Discount
factors @
12%
Present
value
Year 0
$m
(500)
Year 1
$m
Year 2
$m
Year 3
$m
Year 4
$m
(30)
Year 5
$m
120
Year 6
$m
30
26
101
159
195
308
15
(1)
(13)
(21)
(40)
15
(1)
(14)
(22)
(41)
(530)
41
115
145
160
396
(41)
1.000
0.893
0.797
0.712
0.636
0.567
0.507
(530)
37
92
103
102
225
(21)
Net present value = $8m
The net present value is positive therefore the project should go ahead.
(b)
Discounted cash flow techniques are used in investment appraisal in recognition of the fact
that money has a time value. It reflects the fact that the value of $1.00 now is greater than the
value of $1.00 in one year’s time. This is because if there is inflation then more can be
purchased now than at some time in the future. Alternatively the money can be invested to
gain interest or borrowings can be reduced. The rate of interest on the investment reflects
both inflation and the risk involved in the investment.
The use of net present value in investment appraisal recognises the time value of money and
discounts cash flows at the investors’ required rate of return. This means that future cash
flows are reduced in value in order to reflect their value if they were received today i.e. to
express them in present value terms.
(c)
Post completion audit has benefits in terms of the current project and future projects. In terms
of the current project, it enables changes to be made to over or under performing projects at
an early stage. This also makes it more likely that unsuccessful projects will be terminated.
In terms of future projects, it improves the quality of decision making as past experience is
made available to future decision makers. It encourages greater realism in predicting future
outcomes as past inaccuracies are made public. It highlights reasons for successful projects
which may be important in achieving greater benefits from future projects and in future project
selection.
Performance Operations
16
May 2014
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.
Performance Pillar
Wednesday 27 August 2014
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 8.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2014
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
A certificate of deposit is best described as:
A
A debt instrument which offers a fixed rate of interest over a fixed period of time and with
a fixed redemption value.
B
A negotiable instrument which provides evidence of a fixed term deposit with a bank.
C
A document which sets out a commitment to deposit a sum of money at a specified point
in time.
D
A certificate which shows ownership of part of the share capital of a company.
(2 marks)
1.2
A company is considering offering its customers an early settlement discount. The
company currently receives payments from customers on average 65 days after the
invoice date. The company is considering offering a 2% early settlement discount for
payment within 30 days of the invoice date.
The effective annual interest rate of the early settlement discount using compound interest
methodology and assuming a 365 day year is:
A
22.94%
B
20.86%
C
23.45%
D
27.85%
(2 marks)
Performance Operations
2
September 2014
The following information is given for sub-questions 1.3 and 1.4 below
A company produces a product that requires two materials, Material A and Material B. Details of
the material quantities and costs for August are given in the table below.
Quantity (kg)
Cost per kg
Material A
Budget
Actual
24,000
23,000
$2.40
$2.30
Material B
Budget
Actual
36,000
38,000
$1.30
$1.38
Budgeted and actual output of the product for August was 12,000 units.
1.3
The material mix variance for August is:
A
$1,540 Favourable
B
$1,540 Adverse
C
$1,288 Favourable
D
$1,288 Adverse
(2 marks)
1.4
The material yield variance for August is:
A
$200 Adverse
B
$1,740 Adverse
C
$200 Favourable
D
$1,740 Favourable
(2 marks)
Section A continues on the next page
TURN OVER
September 2014
3
Performance Operations
1.5
A purchasing manager is deciding how many units of a product to purchase for the winter
season. The demand for the product is uncertain. The purchasing manager has prepared
a regret matrix showing the regret based on the contribution that each of the possible
outcomes would earn.
Regret Matrix
Quantity purchased (units)
Demand
10,000
15,000
20,000
25,000
10,000
$0
$35,000
$70,000
$105,000
15,000
$21,000
$0
$32,000
$62,000
20,000
$120,000
$26,000
$0
$33,000
25,000
$180,000
$120,000
$22,000
$0
If the manager applies the minimax regret criterion to make decisions, which quantity
would be purchased?
A
10,000 units
B
15,000 units
C
20,000 units
D
25,000 units
(2 marks)
1.6
A company budgets maintenance costs by analysing past data and then adjusting for
inflation.
The relationship between the monthly maintenance costs and activity levels, before
adjusting for inflation, was determined to be:
2
y = 22,000 + 0.025x
where y = total monthly maintenance costs ($) and
x = machine hours
An inflation rate of 4% was then applied to the above formula to determine the budgeted
costs for August.
In August the actual machine hours were 1,820 and the actual maintenance cost incurred
was $106,500.
Required:
Calculate the maintenance cost variance for August.
(3 marks)
Performance Operations
4
September 2014
1.7
A company is considering an investment project for which the possible cash inflows and
their respective probabilities are given in the table below:
Year 1
Cash inflow
$000
200
300
360
Year 2
Probability
Cash inflow
$000
100
320
0.2
0.7
0.1
Probability
0.6
0.4
The cash flows for Year 1 and Year 2 are independent. The initial cash outflow for the
project is $300,000. The company’s cost of capital is 10% per annum. Ignore tax and
inflation.
Required:
Calculate the expected value of the net present value of the project.
(3 marks)
1.8
A Treasury bill with 91 days to maturity and a face value of $1,000 is issued at a discount
yield of 7% per annum.
Required:
(i)
Calculate the issue price of the Treasury bill, to the nearest $0.01, assuming there
are 365 days in the year.
(2 marks)
(ii)
State FOUR features of a Treasury bill.
(2 marks)
(Total for sub-question 1.8 = 4 marks)
(Total for Section A = 20 marks)
Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be submitted for
marking.
End of Section A. Section B begins on page 6
TURN OVER
September 2014
5
Performance Operations
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
Budgeting has a number of different purposes including:
Planning;
Control;
Performance evaluation;
Motivation.
Required:
Explain TWO of the above purposes of budgeting and how the two purposes that you
have explained could conflict with each other.
(5 marks)
(b)
A company manufactures a single product. Budget and standard cost details for next year
include:
Selling price per unit
Variable production cost per unit
Fixed production costs
Fixed selling and distribution costs
Sales commission
Sales
$24.00
$8.60
$650,000
$230,400
5% of selling price
90,000 units
Required:
(i)
(ii)
Calculate the break-even point in units.
Calculate the percentage by which the budgeted sales can fall before the
company begins to make a loss.
The marketing manager has suggested that the selling price per unit can be increased to
$25.00 if the sales commission is increased to 8% of selling price and a further $10,000 is
spent on advertising.
(iii)
Calculate the revised break-even point based on the marketing manager’s
suggestion.
(5 marks)
(c)
Discuss the effectiveness of the economic order quantity (EOQ) model for inventory
management purposes.
(5 marks)
Performance Operations
6
September 2014
(d)
A company has to decide which of three machines to purchase to manufacture a product.
Each machine has the same purchase price but the operating costs of the machines
differ. Machine A has low fixed costs and high variable costs; Machine B has average
fixed costs and average variable costs whilst Machine C has high fixed costs and low
variable costs. Machine A would consequently be preferable if demand was low and
Machine C would be preferable if demand was high. There is a 35% chance that demand
will be high, a 40% chance that demand will be medium and a 25% chance that demand
will be low. The company uses expected value to make this type of decision.
The estimated net present values for each of the possible outcomes are as follows:
Demand
Machine A
Machine B
Machine C
$
$
$
High
100,000
140,000
180,000
Medium
150,000
160,000
140,000
Low
200,000
100,000
80,000
A market research company believes it can provide perfect information on product demand.
Required:
Calculate the maximum amount that should be paid for the information from the market
research company.
(5 marks)
(e)
When deciding how much cash to hold for operating purposes, a company needs to strike
a balance between the cost of holding too little cash and the cost of holding too much
cash.
Required:
Explain the costs involved in the ‘cash trade-off’ described above.
(5 marks)
Section B continues on the next page
TURN OVER
September 2014
7
Performance Operations
(f)
A company produces two products, A1 and A2 that are sold to retailers. The budgeted
sales volumes for the next quarter are as follows:
Product
A1
A2
Units
32,000
56,000
The inventory of finished goods is budgeted to increase by 1,000 units of A1 and
decrease by 2,000 units of A2 by the end of the quarter.
Materials B3 and B4 are used in the production of both products. The quantities required
of each material to produce one unit of the finished product and the purchase prices are
shown in the table below:
A1
A2
Purchase price per kg
Budgeted opening inventory
B3
8 kg
4 kg
$1.25
30,000 kg
B4
4 kg
3 kg
$1.80
20,000 kg
The company plans to hold inventory of raw materials, at the end of the quarter, of 5% of
the quarter’s material usage budget.
Required:
Prepare the following budgets for the quarter:
(i)
(ii)
(iii)
The production budget (in units)
The material usage budget (in kg)
The material purchases budget (in kg and $)
(5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C starts on page 10
Performance Operations
8
September 2014
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
FG specialises in the manufacture of tablets, laptops and desktop PCs. FG currently operates a
standard absorption costing system. Budgeted information for next year is given below:
Products
Tablets
Laptops
$000
3,640
800
300
1,456
1,084
$000
12,480
2,800
1,200
4,992
3,488
Sales revenue
Direct material
Direct labour
Fixed production overheads
Gross profit
Desktop
PCs
$000
9,880
2,200
800
3,952
2,928
Total
$000
26,000
5,800
2,300
10,400
7,500
Fixed production overheads are currently absorbed based on a percentage of sales revenue.
FG is considering changing to an activity based costing system. The main activities and their
associated cost drivers and overhead cost have been identified as follows:
Activity
Cost Driver
Manufacturing scheduling
Parts handling
Assembly
Software installation & testing
Packaging
Number of orders
Number of parts
Assembly time
Number of software applications
Number of units
Production overhead cost
$000
162
2,464
4,472
2,000
1,302
10,400
Further details have also been ascertained as follows:
Budgeted production for next year (units)
Average number of units per order
Number of parts per unit
Assembly time per unit (minutes)
Number of software applications per unit
Performance Operations
Tablets
Laptops
Desktop
PCs
10,000
10
20
20
2
12,000
6
35
40
3
6,000
4
25
30
4
10
September 2014
Required:
(a)
Calculate the total gross profit for each product using the proposed activity
based costing system.
(13 marks)
(b)
Discuss the differences between the gross profit figures calculated in Part
(a) compared with those calculated under the current absorption costing
system.
(8 marks)
(c)
Explain how the information obtained from the activity based costing system
could be used for cost management purposes.
(4 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
September 2014
11
Performance Operations
Question Four
PT is a major international computer manufacturing company. It is considering investing in the
production of micro-computers. These computers will be targeted at the education market with
the specific aim of encouraging children to learn computer science at an early age.
Sales of the micro-computers are expected to be 100,000 units in Year 1 and then to increase at
the rate of 20% per annum for the remainder of the project life. The project has a life of five
years.
The company’s research and development division has already spent $250,000 in developing
the product. A further investment of $10 million in a new manufacturing facility will be required at
the beginning of Year 1. It is expected that the new manufacturing facility could be sold for cash
of $1.5 million, at Year 5 prices, at the end of the life of the project. The manufacturing facility
will be depreciated over 5 years using the straight line method.
The project will also require an investment of $3 million in working capital at the beginning of the
project. The amount of the investment in working capital is expected to increase by the rate of
inflation each year.
The selling price of the new product in Year 1 will be $45 and the variable cost per unit will be
$25. The selling price and the variable cost per unit are expected to increase by the rate of
inflation each year.
The micro-computers will be exclusively produced in the new manufacturing facility. The total
fixed costs in Year 1 will be $2.5 million including depreciation. The fixed costs are expected to
increase thereafter by the rate of inflation each year.
Taxation
PT’s Financial Director has provided the following taxation information:
•
•
•
Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
PT has sufficient taxable profits from other parts of its business to enable the offset of any
pre-tax losses.
Other information
•
A cost of capital of 12% per annum is used to evaluate projects of this type.
•
Inflation is expected to be 4% per annum throughout the life of the project.
Performance Operations
12
September 2014
Required:
(a)
Evaluate whether PT should go ahead with the investment project. You
should use net present value as the basis of your evaluation. Your workings
should be rounded to the nearest $000.
(14 marks)
(b)
Explain TWO other factors that the company should consider before making
a final decision about the investment project.
(4 marks)
(c)
Calculate the following for the investment project:
(i) The internal rate of return (IRR);
(5 marks)
(ii) The increase or decrease in the cost of capital, expressed as a percentage of
the original cost of capital, which would change the decision about whether to
accept or reject the project.
(2 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
September 2014
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
September 2014 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early October at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of eight objective test sub-questions. These are drawn from all
sections of the syllabus. They are designed to examine breadth across the syllabus and thus
cover many learning outcomes.
1.1
The correct answer is B.
1.2
Payment will be made 35 days early.
Number of compounding periods = 365/35= 10.429
10.429
1+ r = (1.00/0.98)
1+ r = 1.2345
The effective annual interest rate of the early settlement discount is 23.45%
The correct answer is C.
 The Chartered Institute of Management Accountants 2014
1.3
Material
A
B
Actual input
@standard
mix (kg)
24,400
36,600
61,000
Actual input
@ actual
mix (kg)
23,000
38,000
61,000
Variance
Kg
Standard cost
$
Variance
$
1,400 F
1,400 A
2.40
1.30
3,360 F
1,820 A
1,540 F
The correct answer is A.
1.4
Weighted average standard cost
(24,000kg x $2.40) + (36,000kg x $1.30) = $104,400
$104,400 / 60,000 kg = $1.74 per kg
Standard kg of input per unit of output = 5kg
12,000 units output x 5kg = 60,000kg of input
Actual input = 61,000 kg
Variance = 1,000kg A
Standard cost per kg = $1.74
Variance = 1,000kg x $1.74 = $1,740 A
Or alternatively:
61,000kg should yield 61,000/5kg = 12,200 units
Actual yield = 12,000 units
Yield variance = 200 units A
Standard material cost per unit = (2kg x $2.40) + (3kg x $1.30) = $8.70
Yield variance = 200 units x $8.70 = $1,740 A
The correct answer is B.
1.5
The maximum regret if 10,000 units are purchased is $180,000
The maximum regret if 15,000 units are purchased is $120,000
The maximum regret if 20,000 units are purchased is $70,000
The maximum regret if 25,000 units are purchased is $105,000
Therefore if the manager wants to minimise the maximum regret 20,000 units will be
purchased.
The correct answer is C.
Performance Operations
2
September 2014
1.6
Budgeted maintenance cost for August:
2
y = 22,000 + 0.025x
2
y = 22,000 + 0.025(1,820 )
y = 22,000 + 82,810
y = 104,810
Increase for inflation:
$104,810 x 1.04 = $109,002
The maintenance cost variance for August is therefore:
$109,002 - $106,500 = $2,502 Favourable
1.7
Expected cash inflow in Year 1 = ($200k x 0.2) + ($300k x 0.7) + ($360k x 0.1) = $286k
Expected cash inflow in Year 2 = ($100 x 0.6) + ($320 x 0.4) = $188k
Expected net present value
Year
0
1
2
Net present value
Cash flow
$
(300,000)
286,000
188,000
Discount factor
Present value
$
(300,000)
259,974
155,288
115,262
1.000
0.909
0.826
1.8
(i)
The discount = $1000 x 7% x 91/365 = $17.45
The issue price is therefore $1,000 - $17.45 = $982.55
(ii)
•
•
•
•
•
•
Treasury bills are negotiable instruments issued by the Government
They have a maturity of less than one year, normally 91 days
They have high credit quality and therefore low risk and low return
They are redeemable at face value
They are issued at a discount to face value
There is a large and active secondary market in treasury bills
September 2014
3
Performance Operations
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome B1(b) explain the purposes of budgeting including
planning, communication, co-ordination, motivation, authorisation, control and evaluation,
and how these may conflict. It examines candidates’ ability to explain two of the purposes of
budgeting and how these may conflict.
Suggested Approach
Candidates should clearly explain two of the stated purposes of budgeting and how these
may conflict with each other.
Planning - Budgeting forces an organisation’s management to look ahead and set
performance targets. This ensures that management anticipates any future problems and
gives the organisation direction. It also ensures that managers are aware of their own targets
and responsibilities and how they relate to those of other managers within the organisation.
Control - The budget acts as a control mechanism, with actual results being compared with
budget. Appropriate actions can then be taken to correct any deviations from plan.
Evaluation - The budget also provides an internal benchmark against which performance can
be evaluated. The performance measured may be that of a department or division or of an
individual manager.
Motivation - Budgeting sets targets to motivate managers and optimise their performance.
The budget is a useful device for influencing managers’ behaviour and motivating managers
to perform in line with the organisation’s objectives. It provides a standard which managers
may be motivated to achieve.
The budget therefore serves a number of different purposes which may conflict with each
other. For example, the planning and motivational roles may conflict, as demanding budgets
that may not be achieved may be appropriate to motivate managers to achieve maximum
performance but are unsuitable for planning purposes.
There is also a conflict between the planning and performance evaluation roles. For planning
purposes budgets are set in advance of the budget period based on an anticipated set of
circumstances and/or external environment. If the circumstances that were anticipated at the
time the budget was prepared have changed then there will be a planning and performance
evaluation conflict.
There may also be a conflict between the performance evaluation and motivation purposes as
the budget can cause inefficiency and conflict between managers particularly if the budget is
imposed from above, whereby it may act as a threat rather than as a challenge. Targets that
are imposed on managers are unlikely to motivate the managers to achieve them.
Performance Operations
4
September 2014
(b)
Rationale
The question assesses learning outcome D1(a) analyse the impact of uncertainty and risk on
decision models that may be based on relevant cash flows, learning curves, discounting
techniques etc. It examines candidates’ ability to use cost volume profit analysis to identify
the sensitivity of budgeted profit figures.
Suggested Approach
Candidates should firstly determine the fixed and variable costs from the budgeted
information given and then calculate the contribution per unit. In part (i) the break even point
can be calculated by dividing the fixed costs by the contribution per unit. In part (ii) the margin
of safety can be calculated by comparing the budgeted sales to the break even sales and
expressing the difference as a percentage of the budgeted sales. In part (iii) the effect of the
changes on the contribution per unit and the fixed costs should be calculated and then a
revised break-even point should be calculated.
(i)
Contribution per unit = $24.00 - $8.60 – $1.20 = $14.20
Break even point = $880,400/ $14.20 = 62,000 units
(ii)
Margin of safety = (90,000 – 62,000) / 90,000 = 31.1%
(iii)
Revised contribution per unit = $25.00 - $8.60 - $2.00 = $14.40
Break-even point = $890,400 / $14.40 = 61,833 units
September 2014
5
Performance Operations
(c)
Rationale
The question assesses learning outcome E1(g) analyse the impacts of alternative policies for
stock management. It examines candidates’ ability to discuss the effectiveness of the EOQ
model for inventory management purposes.
Suggested Approach
Candidates should explain how the EOQ model operates and discuss its benefits and
limitations for inventory management purposes.
The economic order quantity (EOQ) is based on the assumption that demand for the period is
known and constant. Therefore the optimum order quantity will be determined by the costs
that are affected by either the quantity of inventory held or the numbers of orders placed. A
higher quantity ordered each time will mean fewer orders each year and therefore a reduction
in ordering costs. However, this will also result in higher average inventory levels which
results in an increase in holding costs. The EOQ therefore is a trade-off between the costs of
carrying high inventory against the costs of placing more orders. The optimum order size is
the quantity that will result in the total of the ordering and holding costs being minimised.
The EOQ model assumes a world of certainty where the usage and delivery of inventory can
be predicted accurately and management can therefore avoid stock-out costs and
concentrate on achieving the optimal balance between ordering costs and holding costs.
However this is unlikely to be the case in reality for most companies. The EOQ model ignores
two types of risk:
a)
Uncertainty over the time it takes for the order to be delivered i.e. the lead time. The
lead time is neither zero as assumed by the model or necessarily predictable.
b)
The rate at which inventory is used may not be constant, demand may be subject to
fluctuations and the overall annual demand may be difficult to predict with accuracy.
The company can cope with these two risk elements, to a certain extent, by holding a buffer
inventory. The buffer inventory level can be calculated by weighing up the cost of stock-outs
and the costs of holding additional inventory. The determination of lead time and dealing with
uncertainty of demand requires subjective managerial judgement as does determining the
cost of stock-outs since many of the costs involved are difficult to quantify.
Performance Operations
6
September 2014
(d)
Rationale
The question assesses learning outcome D1(e) calculate the value of information. It
examines candidates’ ability to calculate the value of perfect information where there is
uncertainty regarding expected net present values.
Suggested Approach
Candidates should firstly apply the probabilities for the demand levels to calculate the
expected value of the net present value for each of the machines without perfect information.
They should then select the best outcome for each of the possible demand levels and apply
the probabilities to these to calculate the expected value with perfect information. The value
of perfect information can then be calculated as the difference between the expected value
with perfect information and the best of the expected values without perfect information.
Demand
Probability
Machine A
Machine B
Machine C
$000
$000
$000
High
35%
100 x 0.35 = 35
140 x 0.35 = 49
180 x 0.35 = 63
Medium
40%
150 x 0.40 = 60
160 x 0.40 = 64
140 x 0.40 = 56
Low
25%
200 x 0.25 = 50
100 x 0.25 = 25
80 x 0.25 = 20
145
138
139
Expected value
Machine A is the best choice (without the benefit of perfect information) as it has the highest
expected value (EV) of $145k.
With perfect information:
If research suggests high demand: select Machine C and earn $180k
If research suggests medium demand: select Machine B and earn $160k
If research suggests low demand: select Machine A and earn $200k
EV (with perfect information) = ($180k x 0.35) + ($160k x 0.40) + ($200k x 0.25) = $177k
Value of perfect information is $177k – $145k = $32k
Alternatively:
Value of perfect information = (($180k - $100k) x 0.35) + (($160k - $150k) x 0.40) = $32k
September 2014
7
Performance Operations
(e)
Rationale
The question assesses learning outcome E1(d) discuss measures to improve a cash forecast
situation. It examines candidates’ ability to explain the trade off between the cost of holding
too much cash and too little cash.
Suggested Approach
Candidates should clearly explain the costs involved with holding too much cash and how this
needs to be balanced with the costs involved with holding too little cash.
There are a number of costs involved with holding too little cash which a company may incur
as follows:
•
It may not be possible to pay suppliers on time which could lead to reluctance to supply
and eventually to liquidation;
•
It will not have the ability to react quickly to unexpected events e.g. competitor action,
strikes etc;
•
It will potentially miss unexpected opportunities e.g. contracts or lucrative investments;
•
It may not be able to benefit from early settlement discounts from suppliers;
•
It is likely to incur higher cost of borrowing because unexpected cash requirements
need to be met from temporary borrowings;
•
It will incur transaction costs involved with acquiring cash e.g. cost of selling securities
or arrangement fees for overdrafts.
The costs of holding too little cash have to be balanced with the costs of holding cash i.e. the
loss of interest and the loss of purchasing power as inflation erodes the value of cash.
Performance Operations
8
September 2014
(f)
Rationale
The question assesses learning outcome B3(a) prepare a budget for any account in the
master budget, based on projections/forecasts and managerial targets. It examines
candidates’ ability to prepare a production budget and a materials usage and purchases
budget.
Suggested Approach
In part (i) candidates should calculate the number of units required to be produced after
adjusting for the change in inventory of finished goods. In part (ii) candidates should calculate
the materials usage budget based on the production budget calculated in part (i). In part (iii)
candidates should calculate the material purchases budget in kg after adjusting for the
change in materials inventory. The material purchases budget in $ can then be calculated by
multiplying the budget in kg by the price per kg of material.
(i)
Product
Sales (units)
Increase / (decrease) in inventory
Production budget (units)
A1
32,000
1,000
33,000
A2
56,000
(2,000)
54,000
(ii)
Material
Production budget
(units)
Kg per unit
Material usage (kg)
A1
33,000
B3
A2
54,000
Total
87,000
A1
33,000
B4
A2
54,000
Total
87,000
8
264,000
4
216,000
480,000
4
132,000
3
162,000
294,000
(iii)
Material
B3
Total
480,000
(30,000)
24,000
474,000
$1.25
$592,500
Material usage (kg)
Less: opening inventory
Plus: closing inventory
Material purchases (kg)
Price per kg
Material purchases $
September 2014
9
B4
Total
294,000
(20,000)
14,700
288,700
$1.80
$519,660
Performance Operations
SECTION C
Answer to Question Three
Rationale
The question assesses learning outcome A1(c) discuss activity-based costing as compared
with traditional marginal and absorption costing methods, including its relative advantages
and disadvantages as a system of cost accounting. Part (a) examines candidates’ ability to
calculate the cost of a product using activity based costing. Part (b) examines candidates’
ability to discuss the differences between the gross profit calculated under the activity based
costing system and that calculated under the traditional absorption costing system. Part (c)
examines candidates’ ability to explain how the information obtained using an activity based
costing system could be used for cost management purposes.
Suggested Approach
In part (a) candidates should calculate a cost driver rate for each of the activities and then
apply this cost driver rate to calculate the overhead cost for each activity per product. The
gross profit for each product can then be calculated. In part (b) candidates should clearly
explain the reasons for the differences between the gross profits calculated using activity
based costing and that calculated using the current absorption costing system. In part (c)
candidates should clearly explain how the information from an activity based costing system
could be used for cost management purposes.
(a)
Budgeted production per annum (units)
Average number of units per order
Number of orders
Parts per unit
Total number of parts
Assembly time per unit (minutes)
Total assembly time (minutes)
Software applications per unit
Total number of software applications
Activity
Manufacturing
scheduling
Parts handling
Activity cost
$000
162
Tablets
Convertible
Laptops
10,000
10
1,000
20
200,000
20
200,000
2
20,000
12,000
6
2,000
35
420,000
40
480,000
3
36,000
Cost driver
Number of orders
2,464
Number of parts
Assembly
4,472
Assembly time
Software
installation &
testing
Packaging
2,000
Number of software
applications
1,302
Number of units
All-inone
PCs
Total
6,000
4
1,500
25
150,000
30
180,000
4
24,000
28,000
4,500
770,000
860,000
80,000
Cost driver rate
$162,000 / 4,500
= $36 per order
$2,464,000 / 770,000
= $3.20 per part
$4,472,000 / 860,000
= $5.20 per minute
$2,000,000 / 80,000
= $25.00 per application
$1,302,000 / 28,000
= $46.50 per unit
10,400
Performance Operations
10
September 2014
Manufacturing
scheduling
Parts handling
Assembly
Software
installation &
testing
Packaging
Total production
overhead costs
Sales
Direct material
Direct labour
Production overheads
Gross profit
September 2014
Tablets
Convertible
Laptops
All-in-one
PCs
Total
$000
(1,000 x $36)
36
(200,000 x $3.20)
640
(200,000 x $5.20)
1,040
$000
(2,000 x $36)
72
(420,000 x $3.20)
1,344
(480,000 x $5.20)
2,496
$000
(1,500 x $36)
54
(150,000 x $3.20)
480
(180,000 x $5.20)
936
$000
(20,000 x $25)
500
(10,000 x $46.50)
465
(36,000 x $25)
900
(12,000 x $46.50)
558
(24,000 x $25)
600
(6,000 x $46.50)
279
2,681
5,370
2,349
2,464
4,472
2,000
1,302
10,400
Tablets
Convertible
Laptops
All-in-one
PCs
Total
$000
3,640
800
300
2,681
(141)
$000
12,480
2,800
1,200
5,370
3,110
$000
9,880
2,200
800
2,349
4,531
$000
26,000
5,800
2,300
10,400
7,500
11
162
Performance Operations
(b)
Products
Tablets
Convertible
Laptops
All-in-one
PCs
$364
$146
$108
$1,040
$416
$291
$1,647
$659
$488
Gross profit %
29.8%
27.9%
29.6%
Activity based costing (per unit)
Selling price
Production overhead cost
Gross profit
$364
$268
$(14)
$1,040
$448
$259
$1,647
$392
$755
(3.9%)
24.9%
45.9%
Current system of
absorption costing (per unit)
Selling price
Production overhead cost
Gross profit
Gross profit %
It can be seen from the figures in the table above that under the activity based costing system
there is a completely different picture of the profitability of each of the products. Under the
traditional absorption costing system each of the products was making a very similar gross
profit margin of around 30%. However under the activity based costing system, Tablets are
now shown to be loss making and all-in-one PCs are making a significantly higher gross profit
margin, at 45.9%, than originally thought. The gross profit margin for convertible laptops has
declined slightly from 27.9% to 24.9%.
Under the traditional absorption costing system, production overheads were charged to
products based on sales revenue. This meant that Tablets which has a relatively low
proportion of the total sales revenue (14%) was charged a relatively low level of fixed
production overheads. When the activity based costing system is used and the actual
consumption of activities is considered Tablets are charged significantly more production
overheads than before. Whilst Tablets has the lowest number of cost drivers for most of the
activities it also has a relatively lower selling price than the other products. For example the
ratio of parts per unit is 20:35:25 for Tablets, convertible laptops and all-in-one PCs but the
ratio of selling prices is 12:34:54. All-in-one PCs gross profit percentage is significantly higher
under activity based costing since whilst it has the second highest number of cost drivers for
parts per unit and assembly time per unit it has the highest selling price per unit compared to
the other two products.
This information will be useful for the company when making decisions about product pricing
and product mix.
(c)
The activity based costing system provides information about the various activities and the
cost drivers for each activity. The information about the cost of activities enables the company
to focus on those activities with the highest costs and to determine whether they can be
eliminated or performed more efficiently. Activities can be classified as value-added and nonvalue added. Companies can take action to reduce or eliminate the non-value added
activities.
The information ascertained about the cost drivers will also be useful for cost control
purposes. The company can try to reduce the number of cost drivers for each product through
process or product redesign. The cost driver rate can also be used as a measure of cost
efficiency.
Performance Operations
12
September 2014
Answer to Question Four
Rationale
Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and C2(a) evaluate project proposals
using the techniques of investment appraisal. It examines candidates’ ability to identify the
relevant costs of a project and then apply discounted cash flow analysis to calculate the net
present value of the project. Part (b) assesses learning outcome C1(g) prepare decision
support information for management, integrating financial and non-financial considerations. It
examines candidates’ ability to explain other factors that the company would need to consider
before deciding whether to go ahead with the project. Part (c) also assesses learning
outcome C2(a) evaluate project proposals using the techniques of investment appraisal. It
examines candidates’ ability to calculate the internal rate of return (IRR) for the project and
the sensitivity of the investment decision to a change in the cost of capital.
Suggested Approach
In part (a) candidates should firstly calculate the number of units sold and the contribution
that would be earned from the product in each year. They should then deduct the fixed costs
after adjusting for depreciation. The contribution and fixed costs should then be adjusted for
inflation from year 2 of the project. The total cost of the investment and the residual value
should then be added to the net cash flows. The working capital should be shown as a cash
outflow in Year 0 and the additional amount required as a result of inflation, shown as a cash
outflow each year. The total working capital throughout the period of the project should then
be shown as a cash inflow in Year 5. The tax depreciation and tax payments should then be
calculated. The net cash flows after tax should then be discounted at the discount rate of 12%
to calculate the net present value (NPV) of the project. In part (b) candidates should clearly
explain two other factors that the company should consider before making a decision about
the investment project. In part (c)(i) candidates should discount the cash flows after tax at a
lower discount factor than 12% and then, using interpolation, calculate the internal rate of
return (IRR) for the project. In part (c)(ii) candidates should calculate the difference between
12% and the IRR and express this as a percentage of 12%.
(a)
Contribution Years 1 – 5
Year 1: 100,000 x $20 = $2,000k
Year 2: 100,000 x 1.2 = 120,000 x $20 = $2,400k x 1.04 = $2,496k
2
Year 3: 120,000 x 1.2 = 144,000 x $20 = $2,880k x 1.04 = $3,115k
3
Year 4: 144,000 x 1.2 = 172,800 x $20 = $3,456k x 1.04 = $3,888k
4
Year 5: 172,800 x 1.2 = 207,360 x $20 = $4,147k x 1.04 = $4,852k
Fixed Costs
Depreciation per annum = ($10m - $1.5m) / 5 = $1.7m
Fixed costs (excluding depreciation) per annum
= $2.5m - $1.7m = $0.8m
September 2014
13
Performance Operations
Taxation
Contribution
Fixed costs
Net cash flows
Tax depreciation
Taxable profit
Taxation @ 30%
Year 1
$000
2,000
(800)
1,200
(2,500)
(1,300)
390
Year 2
$000
2,496
(832)
1,664
(1,875)
(211)
63
Year 3
$000
3,115
(865)
2,250
(1,406)
844
(253)
Year 4
$000
3,888
(900)
2,988
(1,055)
1,933
(580)
Year 5
$000
4,852
(936)
3,916
(1,664)
2,252
(676)
Net present value
Investment
/ residual
value
Working
capital
Net cash
flows
Tax cash
flow
Tax cash
flow
Net cash
flow after
tax
Discount
factors @
12%
Present
value
Year 0
$000
(10,000)
Year 1
$000
Year 2
$000
Year 3
$000
Year 4
$000
Year 5
$000
1,500
Year 6
$000
(3,000)
(120)
(125)
(130)
(135)
3,510
1,200
1,664
2,250
2,988
3,916
195
32
(127)
(290)
(338)
195
31
(126)
(290)
(338)
(13,000)
1,275
1,766
2,024
2,437
8,298
(338)
1.000
0.893
0.797
0.712
0.636
0.567
0.507
(13,000)
1,139
1,408
1,441
1,550
4,705
(171)
Net present value = - $2,928k
The net present value is negative therefore the project should not go ahead.
(b)
The project is concerned with the education of children in computer science and with
encouraging them to be involved in computer science at an early age. This is a new market
for the company and may have long term benefits if children start to use full scale computers
at an earlier age than normally would be expected.
Whilst the project makes a negative net present value the company may be able to improve
its brand image if it is seen to be supplying relatively low cost computers to the education
market. The company could benefit from being involved in this project as they are being seen
to be concerned with the education needs of children.
Performance Operations
14
September 2014
(c)
(i)
The net present value is negative at 12% therefore use a lower discount factor.
Net cash
flow after
tax
Discount
factors @
4%
Present
value
Year 0
$000
(13,000)
Year 1
$000
1,275
Year 2
$000
1,766
Year 3
$000
2,024
Year 4
$000
2,437
Year 5
$000
8,298
Year 6
$000
(338)
1.000
0.962
0.925
0.889
0.855
0.822
0.790
(13,000)
1,227
1,634
1,799
2,084
6,821
(267)
Net present value at 4% discount rate = $298k
By interpolation:
IRR = 4% + (($298k / ($298k + $2,928)) x 8) = 4.74%
(ii)
The cost of capital is 12%.
(12 – 4.74) / 12 = 61%
For the project to be accepted the cost of capital would need to reduce by 61%.
September 2014
15
Performance Operations
DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.
Performance Pillar
19 November 2014 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during this reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be written in the answer book. Answers written on the
question paper will not be submitted for marking.
You should show all workings as marks are available for the method you use.
ALL QUESTIONS ARE COMPULSORY.
Section A comprises 8 sub-questions and is on pages 2 to 5.
Section B comprises 6 sub-questions and is on pages 6 to 9.
Section C comprises 2 questions and is on pages 10 to 13.
Maths tables and formulae are provided on pages 15 to 18.
The list of verbs as published in the syllabus is given for reference on page
19.
Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.
Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.
P1 – Performance Operations
P1 – Performance Operations
TURN OVER
 The Chartered Institute of Management Accountants 2014
SECTION A – 20 MARKS
[You are advised to spend no longer than 36 minutes on this question.]
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Instructions for answering Section A:
The answers to the eight sub-questions in Section A should ALL be written in your
answer book.
Your answers should be clearly numbered with the sub-question number then ruled off,
so that the markers know which sub-question you are answering. For multiple choice
questions, you need only write the sub-question number and the letter of the
answer option you have chosen. You do not need to start a new page for each subquestion.
For sub-questions 1.6 to 1.8 you should show your workings as marks are available for
the method you use to answer these sub-questions.
Question One
1.1
The economic order quantity is the order quantity which results in:
A
the lowest cost of ordering inventory.
B
the highest discount from suppliers.
C
the lowest combined total costs of ordering and holding inventory.
D
the lowest cost of holding inventory.
(2 marks)
1.2
A decision maker using the maximin decision criterion will:
A
assume that uncertainty can be ignored and will select the option with the highest
expected value.
B
assume that he/she will regret not having selected another option and will therefore
minimise the possible regret under this assumption.
C
assume that the worst outcome will occur and will select the option that will give the
highest return from the worst outcome possible under each option.
D
assume that the best outcome will occur and will select the option that will give the highest
return from the best outcome possible under each option.
(2 marks)
Performance Operations
2
November 2014
1.3
A company uses an activity based costing system. The company manufactures three
products, details of which are given below:
Annual production (units)
Batch size (units)
Number of inspections per batch
Product X
160,000
100
3
Product Y
200,000
50
4
Product Z
100,000
25
6
Annual inspection costs are $150,000.
The inspection cost per unit of Product Y is closest to:
A
$0.23
B
$0.33
C
$13.39
D
$0.27
(2 marks)
1.4
A company uses a standard costing system. The company’s sales budget for the latest
period includes 1,500 units of a product with a selling price of $400 per unit. The product
has a budgeted contribution to sales ratio of 30%. Actual sales for the period were 1,630
units at a selling price of $390 per unit. The actual contribution to sales ratio was 28%.
The sales volume contribution variance for the product for the latest period is:
A
$15,600 F
B
$52,000 F
C
$14,560 F
D
$14,196 F
(2 marks)
1.5
A company’s budget for the next period shows that it would breakeven at sales revenue of
$800,000 and fixed costs of $320,000.
The sales revenue needed to achieve a profit of $200,000 in the next period would be:
A
$1,000,000
B
$1,300,000
C
$1,320,000
D
$866,667
(2 marks)
TURN OVER
November 2014
3
Performance Operations
1.6
A company’s managers are considering investing in a project that has an expected life of
five years. The project is expected to generate a positive net present value of $240,000
when cash flows are discounted at 12% per annum. The project’s expected cash flows
include a cash inflow of $120,000 in each of the five years. No tax is payable on projects
of this type.
Required:
Calculate the percentage decrease, to the nearest 0.1%, in the annual cash inflow that
would cause the managers to reject the project from a financial perspective.
(2 marks)
1.7
A company’s sales revenue for the year just ended was $28 million. The company earned
a gross margin of 40% on sales. All sales and purchases were on credit.
The following balances have been extracted from the year end accounts:
Inventory
Accounts receivable
Accounts payable
$4 million
$6 million
$3 million
Required:
Calculate, to the nearest day, the company’s cash operating cycle based on the year end
figures.
(4 marks)
1.8
A company is preparing its annual budget and is estimating the number of units of Product
W that it will sell in each quarter of year 2. Past experience has shown that the trend for
sales of the product is represented by the following relationship:
y = a + bx where:
y = number of sales units in the quarter
a = 15,000
b = 3,000
x = the quarter number where 1 = quarter 1 of year 1
Actual sales of Product W in year 1 were affected by seasonal variations and were as
follows:
Quarter 1:
Quarter 2:
Quarter 3:
Quarter 4:
20,250 units
19,425 units
25,200 units
24,300 units
Required:
Calculate the expected unit sales of Product W for each quarter of year 2, after adjusting
for seasonal variations using the multiplicative model.
(4 marks)
(Total for Section A = 20 marks)
Performance Operations
4
November 2014
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a)
A company, which operates from a number of different locations, uses a system of
centralised purchasing. The directors of the company are considering whether to change
to a system of decentralised purchasing.
Required:
Explain the benefits that may result from the company using a decentralised purchasing
system.
(5 marks)
(b)
A company has annual credit sales of $25 million. The company’s credit terms are 30
days from the invoice date but the average settlement period for trade receivables is 60
days. The company is currently reviewing its credit policy.
The credit controller has proposed a change to the company’s credit policy as follows:
(i) Implement stricter credit control procedures at a cost of $30,000 per year.
and
(ii) Offer customers a 2.5% discount if they pay within 30 days.
It is estimated that, as a result of the proposed change to the credit policy, 60% of
customers, by sales value, would pay at the end of the 30 day period. The remainder
would take, on average, 50 days to pay. It is not anticipated that the change to the credit
policy will result in a reduction in sales revenue.
The company finances its trade receivables by a bank overdraft which has an interest rate
of 14% per annum.
Required:
Calculate the net annual cost if the credit controller’s proposed change to the credit policy
is adopted.
(5 marks)
Section B continues on the opposite page
Performance Operations
6
November 2014
(c)
FG is preparing its cash budgets for January, February and March.
Budgeted data are as follows:
November
December
January
February
Sales (units)
750
800
800
850
900
Production (units)
800
800
850
900
950
$48,000
$48,000
$51,000
$54,000
$56,000
$20,000
$20,000
$20,000
$20,000
$20,000
Direct labour and variable
overheads incurred
Fixed overheads incurred
(excluding depreciation)
March
The selling price per unit is $200. The purchase price per kg of raw material is $25. Each
unit of finished product requires 2 kg of raw materials which are purchased on credit in the
month before they are used in production. Suppliers of raw materials are paid one month
after purchase.
All sales are on credit. 80% of customers, by sales value, pay one month after sale and the
remainder pay two months after sale.
The direct labour cost, variable overheads and fixed overheads are paid in the month in
which they are incurred.
Machinery costing $100,000 will be delivered in February and paid for in March.
Depreciation, including that on the new machinery, is as follows:
Machinery and equipment
Motor vehicles
$3,500 per month
$800 per month
The opening cash balance at 1 January is estimated to be $15,000.
Required:
Prepare a cash budget for each of the three months January, February and March.
(5 marks)
TURN OVER
November 2014
7
Performance Operations
(d)
A company has surplus funds to invest for a period of three months. It is considering two
alternative types of investment:
Investment 1
Purchase treasury bills issued by the home country’s central bank.
Investment 2
Arrange a money market deposit through a bank.
Required:
Compare and contrast the two alternative types of investment in terms of their risk,
return and liquidity.
(5 marks)
The following information is required for sub-questions (e) and (f)
The manager of a tourist attraction is considering whether to open on 1 January, a day when the
attraction has, in previous years, been closed. The attraction has a daily capacity of 1,000
visitors. If the attraction opens for business on that day it will incur additional specific fixed costs
of $30,000.
The contribution from the sale of tickets would be $25 per visitor. The number of visitors is
uncertain but based on past experience it is expected to be as follows:
Probability
50%
30%
20%
800 visitors
900 visitors
1,000 visitors
It is expected that visitors will also purchase souvenirs and refreshments. The contribution which
would be made from these sales has been estimated as follows:
Probability
35%
40%
25%
$8 per visitor
$10 per visitor
$12 per visitor
(e)
Calculate whether it is worthwhile opening the tourist attraction on 1 January. You should
use expected value as the basis of your analysis.
(5 marks)
Performance Operations
8
November 2014
(f)
(i) Prepare a two way data table to show the contribution to general fixed overheads for
each of the nine possible outcomes.
(3 marks)
(ii) Calculate the probability of making a positive contribution to general fixed overheads by
opening on 1 January.
(2 marks)
(Total for sub-question (f) = 5 marks)
(Total for Section B = 30 marks)
End of Section B
Section C begins on page 10
TURN OVER
November 2014
9
Performance Operations
SECTION C – 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]
ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS
WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS
ARE AVAILABLE FOR THE METHOD YOU USE.
Question Three
A company manufactures and sells a single product. The company operates a standard
marginal costing system that enables the reporting of planning and operational variances.
The original standard contribution per unit of the product for October, which was used to
establish the budgeted contribution for the month, was as follows:
Selling price
Direct material
Direct labour
Contribution
1.5 kg @ $10 per kg
2 hours @ $15 per hour
$
60
(15)
(30)
15
Other information for October
•
Sales and production quantities:
Budgeted sales and production
Actual sales and production
40,000 units
42,000 units
•
A change in the product specification was implemented at the start of October which
required 20% additional material for each unit. The standard cost shown above was not
revised to reflect this change.
•
Actual direct material purchased and used was 78,000 kg at $9.90 per kg.
•
The labour rate shown in the standard cost above was over estimated. The correct standard
labour rate for the grade of labour required was $14.60 per hour. The actual rate paid was
$15.20 per hour and actual hours worked were 86,000 hours.
•
The actual selling price per unit was $62.
•
There was no opening inventory of raw materials or finished goods.
Performance Operations
10
November 2014
Required:
(a)
Prepare a statement for October that reconciles the budgeted contribution
with the actual contribution. Your statement should show the variances in as
much detail as possible.
(13 marks)
(b)
Discuss the performance of the company for October. Your discussion
should give one possible reason for each of the operational variances
calculated in part (a).
(6 marks)
(c)
Explain why separating variances into their planning and operational
elements should improve performance management.
(6 marks)
(Total for Question Three = 25 marks)
Section C continues on the next page
TURN OVER
November 2014
11
Performance Operations
Question Four
ST operates in a highly competitive market and is considering introducing a new product to
expand its current range. The new product will require the purchase of a specialised machine
costing $825,000. The machine has a useful life of four years and is expected to have a scrap
value at the end of Year 4 of $45,000. The company uses the straight line method of
depreciation. The machine would be used exclusively for the new product.
Due to a shortage of space in the factory, investment in the new machine would necessitate the
disposal, for $23,000, of an existing machine which has a net book value of $34,000. This
machine, if retained for a further year, would have earned a contribution of $90,000 before being
scrapped for nil value. The machine had a zero tax written down value and therefore there will
be no effect on tax depreciation arising from the disposal of the machine.
The company employed the services of a consultant, at a cost of $29,000, to determine the
demand for the new product. The consultant’s estimated demand is given below:
Year 1
Year 2
Year 3
Year 4
18,000 units
24,000 units
26,000 units
22,000 units
The new product is expected to earn a contribution of $30 per unit.
Fixed costs of $380,000 per annum, including depreciation of the new machine, will arise as a
direct result of the manufacture of the new product.
Taxation
ST’s Financial Director has provided the following taxation information:
•
•
•
Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in
the year of disposal.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
ST has sufficient taxable profits from other parts of its business to enable the offset of any
pre-tax losses on this project.
Other information
A cost of capital of 12% per annum is used to evaluate projects of this type. Ignore inflation.
Performance Operations
12
November 2014
Required:
(a) Evaluate whether ST should introduce the new product. You should use net
present value (NPV) as the basis of your evaluation.
(14 marks)
A company is deciding which of two alternative machines (X and Y) to purchase.
The useful lives for machines X and Y are two years and three years
respectively. The cash flows associated with each of the machines are given in
the table below:
Year
0
1
2
3
$000
$000
$000
$000
Machine X
(200)
200
230
Machine Y
(240)
200
230
240
Each of the machines would be replaced at the end of its useful life by an
identical machine. You should assume that the cash flows for the future
replacements of machines X and Y are the same as those in the table above.
The company’s cost of capital is 12% per annum.
Required:
(b) Calculate, using the annualised equivalent method, whether the company
should purchase machine X or machine Y.
(5 marks)
(c) Explain the limitations of using the annualised equivalent method when making
investment decisions.
(6 marks)
(Total for Question Four = 25 marks)
(Total for Section C = 50 marks)
End of question paper
Maths tables and formulae are on pages 15 to 18
November 2014
13
Performance Operations
Operational Level Paper
P1 – Performance Operations
November 2014 examination
Examiner’s Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiner’s answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early February at
www.cimaglobal.com/P1PEGS
SECTION A
Answer to Question One
Rationale
Question One consists of eight objective test sub-questions. These are drawn from all
sections of the syllabus. They are designed to examine breadth across the syllabus and thus
cover many learning outcomes.
1.1
The correct answer is C.
1.2
The correct answer is C.
 The Chartered Institute of Management Accountants 2013
1.3
Annual production
Batch size (units)
Number of batches
Number of inspections per batch
Total number of inspections
Product X
160,000
100
1,600
3
4,800
Product Y
200,000
50
4,000
4
16,000
Product Z
100,000
25
4,000
6
24,000
Total
44,800
Cost driver rate = $150,000 / 44,800 = $3.35 per inspection
Cost per unit of Product Y = ($3.35 x 16,000) / 200,000 = $0.27
The correct answer is D.
1.4
(Actual sales volume –budgeted sales volume) x standard contribution per unit
(1,630 – 1,500) x ($400 x 0.3) = $15,600 F
The correct answer is A.
1.5
At the breakeven point, contribution is equal to fixed costs therefore the contribution to
sales ratio is $320,000 / $800,000 i.e. 40%
To earn a profit of $200,000 the required contribution is equal to the fixed costs plus the
required profit
($320,000 + $200,000) / 0.40 = $1,300,000
The correct answer is B.
1.6
Net present value of the project = $240,000
Present value of the annual cash outflow = $120,000 x 3.605 = $432,600
$240,000/$432,600 = 55.5%
The managers would reject the project if the annual cash flows decrease by more than
55.5%.
1.7
Days
= 78.2
Accounts receivable days
((6/28) x 365)
Inventory days
(4/(28 x 0.6)) x 365 = 86.9
Accounts payable days
(3/(28 x 0.6)) x 365 = (65.2)
99,9
The cash operating cycle is 100 days.
Performance Operations
2
November 2014
1.8
Quarter
Actual sales
units
20,250
Variation
1
Trend sales
units
18,000
2
21,000
19,425
-7.5%
3
24,000
25,200
+5.0%
4
27,000
24,300
-10.0%
+12.5%
Forecast sales
Year 2 Quarter 1 = 15,000 + (3,000 x 5) = 30,000 + 12.5% = 33,750 units
Year 2 Quarter 2 = 15,000 + (3,000 x 6) = 33,000 - 7.5% = 30,525 units
Year 2 Quarter 3 = 15,000 + (3,000 x 7) = 36,000 + 5.0% = 37,800 units
Year 2 Quarter 4 = 15,000 + (3,000 x 8) = 39,000 - 10.0% = 35,100 units
November 2014
3
Performance Operations
SECTION B
Answer to Question Two
(a)
Rationale
The question assesses learning outcome E1(g) analyse the impacts of alternative policies for
stock management. It examines candidates’ ability to explain the benefits of a decentralised
purchasing system.
Suggested Approach
Candidates should consider the potential benefits to a company of using a decentralised
purchasing system compared to the current system and explain clearly what the benefits are
and why they arise under this system.
The benefits of a decentralised purchasing system are as follows:
•
•
•
•
•
•
•
It may result in reduced transport costs with a consequential impact on the
environment.
A decentralised purchasing system is likely to be less bureaucratic and able to
respond quickly to inventory shortages.
A local buyer may be more flexible and able to respond to temporary reductions in
local prices that a central buying manager may be unaware of.
Local buyers may be able to develop stronger relationships with local suppliers thus
possibly ensuring greater reliability of supply and the opportunity for JIT purchasing
and reduced levels of inventory.
Local suppliers may offer varied products thus enabling differentiation of finished
products.
The opportunity is available to delegate responsibility for aspects of the management
of the business and there may be benefits in terms of management development.
Managers who have been given responsibility for the financial management of their
particular operating unit will be able to make decisions regarding purchasing and
inventory management.
Performance Operations
4
November 2014
(b)
Rationale
Part (i) assesses learning outcome E1(f) analyse the impacts of alternative debtor and
creditor policies. It examines candidates’ ability to calculate the net cost of a change to a
company’s credit policy.
Suggested Approach
Candidates should first calculate the change in the level of investment in trade receivables if
the early settlement discount is offered. The benefit of this, in terms of the reduction in
overdraft interest, can then be calculated. This should then be compared to the cost of the
cash discount offered and the additional credit control costs.
Current level of investment in trade receivables
($25 million x 60/365)
$000
Proposed level of investment in trade receivables
($15 million x 30/365)
($10 million x 50/365)
$000
4,110
(1,233)
(1,370)
(2,603)
1,507
Reduction in trade receivables
The reduction in overdraft interest as a result of the reduction in trade receivables will be
$1,507,000 x 14% = $210,980
Cost of cash discount offered ($25m x 60% x 2.5%)
Additional credit control costs
Interest charge savings
Net cost of change in policy
375
30
405
(211)
194*
Or alternatively:
Current cost of investment in trade receivables:
$000
$25m x 60/365 x 14%
$000
575
Cost if proposed policy implemented:
Cash discounts ($25m x 60% x 2.5%)
Cost of investment in trade receivables
$15m x 30/365 x 14%
$10m x 50/365 x 14%
Credit control costs
Net cost of change in policy
375
173
192
30
770
195*
*Rounding differences only
November 2014
5
Performance Operations
(c)
Rationale
The question assesses learning outcome B3(a) prepare a budget for any account in the
master budget, based on projections/forecasts and managerial targets. It examines
candidates’ ability to prepare a cash budget based on information about the timing of cash
flows.
Suggested Approach
Candidates should first prepare a format for the cash budget with months along the top and
receipts and payments down the side. They should then work out the timing of the cash flows
for each of the items. The cash receipts and cash payments should be summed and the net
cash flow for each month should be calculated. The opening cash balance and closing cash
balance for each month can then be calculated.
Cash budget
January
February
March
$
$
$
80% credit sales
128,000
128,000
136,000
20% credit sales
30,000
32,000
32,000
158,000
160,000
168,000
Purchases
42,500
45,000
47,500
Labour & overheads
71,000
74,000
Receipts
Total receipts
Payments
Machinery
Total payments
76,000
100,000
113,500
119,000
223,500
Opening balance
15,000
59,500
100,500
Net cash flow
44,500
41,000
(55,500)
Closing balance
59,500
100,500
45,000
Performance Operations
6
November 2014
(d)
Rationale
The question assesses learning outcome E2(b) identify alternatives for investment of shortterm cash surpluses. It examines candidates’ ability to compare and contrast two short term
investment opportunities in terms of their risk, return and liquidity.
Suggested Approach
Candidates should describe each of the investments and indicate clearly how each of them
compares in terms of their risk, return and liquidity.
Treasury bills
These are issued by the government for terms of up to three months and therefore have
minimal capital risk as they are backed by the government. The bills are sold by tender each
week at a discount to their nominal value. They are redeemed at their nominal value giving an
implied interest rate. They are therefore subject to interest rate risk since if market rates
increase the holder loses the opportunity to earn higher rates.
Treasury bills are also traded on the money market and so the holder can sell them to obtain
immediate cash at any time giving excellent liquidity. However if sold before maturity the
holder would also be exposed to capital risk as the value of the bill changes in response to
market interest rate movements.
Money market deposit
A money market deposit is riskier than an investment in treasury bills however as the money
market is used largely by banks and other financial institutions the risk is relatively low. The
return on money market deposits will be higher than the return on treasury bills. Similar to
treasury bills, the deposit is subject to interest rate risk. Money invested in a money market
deposit cannot be withdrawn until the deposit matures and is therefore less liquid than
treasury bills. However the investment can be made for very short periods of time.
November 2014
7
Performance Operations
(e)
Rationale
The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating
expected values and standard deviations together with probability tables and histograms. It
examines candidates’ ability to calculate the expected value of a decision.
Suggested Approach
Candidates should first calculate the expected value of the number of visitors and the
expected value of the contribution from sales of souvenirs and refreshments. The total
contribution can then be calculated and the specific fixed costs deducted from this to
calculate the expected contribution towards general fixed overheads.
Expected value of number of visitors:
= (800 x 0.5) + (900 x 0.3) + (1,000 x 0.2) = 870
Expected value of contribution from sales of souvenirs and refreshments:
= ($8 x 0.35) + ($10 x 0.40) + ($12 x 0.25) = $9.80
Expected contribution to general overheads:
Contribution = ($25 + $9.80) x 870
Less specific fixed costs
Additional contribution
Performance Operations
=
$30,276
$30,000
$ 276
8
November 2014
(f)
Rationale
Part (i) of the question assesses learning outcome D1(d) prepare expected value tables. It
examines candidates’ ability to prepare a two way data table. Part (ii) of the question
assesses learning outcome D1(c) analyse risk and uncertainty by calculating expected values
and standard deviations together with probability tables and histograms. It examines
candidates’ ability to determine the probability of a particular outcome using joint probabilities.
Suggested Approach
In part (i) candidates should calculate the contribution to general fixed overheads, for each of
the possible outcomes, by multiplying the number of visitors by the selling price of the ticket
plus the contribution from the sales of souvenirs and refreshments. The specific fixed costs
should then be deducted from the total contribution. The figures should then be presented in
the form of a two way data table.
In part (ii) candidates should calculate the joint probability of each of the possible outcomes
that produce a positive contribution. The total probability of making a positive contribution can
then be calculated.
(i)
The contribution to general fixed overheads for each of the combinations is shown in the two
way data table below:
Contribution
$8 per visitor
$10 per visitor
$12 per visitor
800 visitors
($3,600)
($2,000)
($400)
900 visitors
($300)
$1,500
$3,300
1,000 visitors
$3,000
$5,000
$7,000
(ii)
The joint probabilities of the combinations are shown in the table below:
$8 per visitor
$10 per visitor
$12 per visitor
800 visitors
(0.50 x 0.35) = 0.175
(0.50 x 0.40) = 0.200
(0.50 x 0.25) = 0.125
900 visitors
(0.30 x 0.35) = 0.105
(0.30 x 0.40) = 0.120
(0.30 x 0.25) = 0.075
1,000 visitors
(0.20 x 0.35) = 0.070
(0.20 x 0.40) = 0.080
(0.20 x 0.25) = 0.050
The probability of making a positive contribution to general fixed overheads is:
0.120 + 0.075 + 0.070 + 0.080 + 0.050 = 0.395 or 39.5%
November 2014
9
Performance Operations
SECTION C
Answer to Question Three
Rationale
The question assesses a number of learning outcomes. Part (a) assesses learning outcome
A1(d) apply standard costing methods, within costing systems, including the reconciliation of
budgeted and actual profit margins. It examines candidates’ ability to calculate variances to
enable the reconciliation of budgeted and actual contribution margins. Part (b) assesses
learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and
sales variances, distinguishing between planning and operational variances. It examines
candidates’ ability to discuss the company’s performance and the reasons why the variances
may have arisen. Part (c) also assesses learning outcome A1(f) interpret material, labour,
variable overhead, fixed overhead and sales variances, distinguishing between planning and
operational variances. It examines candidates’ ability to explain the importance of planning
and operational variances.
Suggested Approach
In part (a) candidates should first calculate the budgeted contribution and the actual
contribution for the period. They should then prepare a reconciliation statement starting with
the budgeted contribution, adjusting for the sales volume contribution variance to calculate a
revised contribution and then adjusting for the planning variances. They should then calculate
each of the individual operational variances to reconcile the budgeted contribution to actual
contribution. In part (b) candidates should discuss the company’s performance in general
terms and then identify a possible reason for each of the operational variances as shown by
the variances calculated in part (a). In part (c) candidates should explain clearly the potential
benefits to a company, in terms of planning and control, of reporting planning and operational
variances.
Performance Operations
10
November 2014
(a)
Reconciliation statement for October
$
Budgeted contribution
(40,000 units x $15)
Sales volume contribution operational variance
((42,000 – 40,000) x $15.00)
Standard contribution at actual sales volume
(42,000 units x $15)
Planning variances:
Material usage variance
126,000 A
(42,000 units x ($15.00 - $18.00))
Labour rate variance
33,600 F
((42,000 units x 2hrs) x ($15.00 - $14.60))
Revised standard contribution
$
600,000
30,000 F
630,000
92,400 A
537,600
Operational variances:
Sales price variance
(($62 - $60) x 42,000)
Material price variance
(78,000 x ($10.00 - $9.90))
Material usage variance
(((42,000 x 1.8 kg) – 78,000) x $10)
Labour rate variance
(($14.60 - $15.20) x 86,000)
Labour efficiency variance
(((42,000 x 2 hours) – 86,000) x $14.60)
84,000 F
7,800 F
24,000 A
51,600 A
29,200 A
13,000 A
524,600
Actual contribution
Workings:
Actual contribution for October
Sales
42,000 units x $62
Less production costs:
Direct materials
78,000 x $9.90
Direct labour
86,000 x $15.20
Actual contribution
November 2014
$
2,604,000
(772,200)
(1,307,200)
524,600
11
Performance Operations
(b)
The original budgeted contribution of $600,000 was reduced by $92,400 as a result of the
planning changes. The main contributor to the planning variances was the change in the
material specification. It is not clear why the specification was changed – perhaps the
company hoped to increase the price of the product or maybe there was a lack of availability
of an existing material.
The sales volume and sales price variances were both favourable. The sales price variance
was $84,000 F which may be a result of the change to material specification which has
improved the quality of the product and thus allowed an increase in price. The increase in
sales volume could be for the same reason. It is arguable that at least part of these variances
would be more appropriately treated as planning variances.
The material price variance was also favourable which could be explained by suppliers
offering a bulk purchase discount due to the increase in the amount of materials purchased as
a result of the specification change. The material usage variance was adverse which may be
because the labour force was not familiar with the different materials and this resulted in more
wastage than was originally expected.
The labour rate and the labour efficiency variances were both adverse which could also be
explained by the change in specification. Depending on how the company classifies an
overtime premium, the labour rate variance may be a result of the need to work overtime as
the work was taking longer because of the new material used. If the labour were not
accustomed to using the material they may have taken longer to handle it and required more
time to produce each unit. Alternatively the variance could be a result of using a different mix
of labour from that originally planned.
(c)
Standards are normally based on the anticipated environment. It could be argued that if the
environment is significantly different from the expected environment, actual performance
should be compared with a standard that takes account of these changed conditions. This
would provide a more meaningful measure of managerial performance.
The planning variance may not be controllable but does provide some useful information to
managers on the accuracy of their planning and could help to improve the accuracy of future
plans.
Operational variances are considered to be controllable and hence they provide a better
measure of the operating efficiency. In practice, however, there may be problems with
managers trying to suggest that adverse variances have all arisen due to planning errors.
Performance Operations
12
November 2014
Answer to Question Four
Rationale
Part (a) assesses learning outcome C1(b) apply the principles of relevant cash flow analysis
to long-run projects that continue for several years and learning outcome C2(a) evaluate
project proposals using the techniques of investment appraisal. It examines candidates’
ability to identify the relevant cash flows of a project and then apply discounted cash flow
analysis to calculate the net present value of the project. Part (b) assesses learning outcome
C2(c) prioritise projects that are mutually exclusive, involve unequal lives and/or are subject
to capital rationing. It examines candidates’ ability to apply the annualised equivalent method
to choose between two machines which have different useful lives. Part (c) also assesses
learning outcome C2(c) prioritise projects that are mutually exclusive, involve unequal lives
and/or are subject to capital rationing. It examines candidates’ ability to explain the limitations
of using the annualised equivalent method when making investment decisions.
Suggested Approach
In part (a) candidates should first calculate the contribution for each year of the project. They
should then deduct the fixed costs after adjusting these for depreciation. The foregone
contribution from the existing machine should also be deducted from the cash flows. The tax
depreciation and tax payments should then be calculated. The total cost of the investment,
the residual value and the sales proceeds from the existing machine should be added to the
net cash flows. The net cash flows after tax should then be discounted at the discount rate of
12% to calculate the net present value (NPV) of the project. In part (b) candidates should
calculate the net present value for each of the machines using the company’s cost of capital.
They should then calculate the annualised equivalent by dividing the net present value of the
machine by the appropriate cumulative discount factor. The machine with the highest
annualised equivalent net present value should then be selected. In part (c) candidates
should explain clearly the limitations of using the annualised equivalent method in investment
appraisal.
(a)
Fixed costs
Depreciation per annum = ($825k - $45k) / 4 = $195k
Fixed costs (excluding depreciation) per annum
= $380k - $195k = $185k
Contribution Years 1 – 4
Year 1: 18,000 units x $30 = $540,000
Year 2: 24,000 units x $30 = $720,000
Year 3: 26,000 units x $30 = $780,000
Year 4: 22,000 units x $30 = $660,000
Taxation
Contribution
Fixed costs
Lost contribution
Net cash flows
Tax depreciation
Taxable profit
Taxation @ 30%
November 2014
Year 1
$000
540
(185)
(90)
265
(206)
59
(18)
13
Year 2
$000
720
(185)
Year 3
$000
780
(185)
Year 4
$000
660
(185)
535
(155)
380
(114)
595
(116)
479
(144)
475
(303)
172
(52)
Performance Operations
Tax depreciation
Investment / WDV
Tax depreciation
Balancing allowance / (charge)
Total tax depreciation
Year 1
$000
825
206
0
206
Year 2
$000
619
155
0
155
Year 3
$000
464
116
0
116
Year 4
$000
348
87
216
303
Total
$000
780
Net present value
Investment / residual value
Sales proceeds from existing machine
Net cash flows
Tax payment
Tax payment
Net cash flow after tax
Discount factors @ 12%
Present value
Net present value = $386k
Year 0
$000
(825)
23
(802)
(802)
1.000
(802)
Year 1
$000
Year 2
$000
Year 3
$000
Year 4
$000
45
265
(9)
535
(57)
(9)
469
0.797
374
595
(72)
(57)
466
0.712
332
475
(26)
(72)
422
0.636
268
256
0.893
229
Year 5
$000
(26)
(26)
0.567
(15)
The net present value is positive therefore on this basis ST should go ahead with the
introduction of the new product.
(b)
Year
0
1
2
3
Net
present
value
Cumulative
discount
factor
Annualised
equivalent
Discount
factor
@12%
1.000
0.893
0.797
0.712
Machine X
Cash
Present
flows
value
$000
$000
(200)
(200)
200
179
230
183
162
Machine Y
Cash
Present
flows
value
$000
$000
(240)
(240)
200
179
230
183
240
171
293
1.690
2.402
96
122
The higher annualised equivalent net present value occurs if machine Y is purchased and
replaced every three years.
Performance Operations
14
November 2014
(c)
The annualised equivalent method assumes that the company replaces the assets with an
identical asset each time. However this ignores changing technology and the necessary
requirement to replace assets with a more up to date model which may be more efficient and
have different functions. The method also ignores the effect of inflation which may differ for
each of the different variables. This may mean that the optimal replacement period will vary
over time. The external environment is uncertain and therefore companies cannot predict with
accuracy the environment in which they will be operating in the future. It may not be
necessary to replace the assets in the future as they may no longer be required.
November 2014
15
Performance Operations