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
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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
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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
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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
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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