Pilot Paper F5
Performance Management
TRIPLE Limited
(a)
Traditional cost per unit
Material
Labour ($6/hour)
Direct costs
Production overhead
($28/machine hour)
Total production cost /unit
(b)
D
$
20
3
23
C
$
12
9
21
P
$
25
6
31
42
28
84
65
49
115
ABC cost per unit
Examiners note: Each step required has been given its own sub-heading to make the procedure clear. The basic principle is
to find an overhead cost per unit of activity for each element of overhead cost. In some cases it might then be possible to find
an overhead cost per unit directly; here it is probably easier to split overheads between each product type first and then find a
cost per unit as shown.
(i)
Total overheads
These were given at $654,500
Total machine hours (needed as the driver for machining overhead)
(ii)
Product Hours/unit Production units 1,750
D
1½
C
1
1,250
P
3
7,000
Total machine hours
23,375
(iii) Analysis of total overheads and cost per unit of activity
Type of overhead Driver Set-ups
Machining
Materials handling
Inspection
Number of set ups
Machine hours
Material movements
Number of inspections
Total hours
21,125
21,250
21,000
%
35
20
15
30
100
Total overhead
$ 229,075
130,900
98,175
196,350
654,500
Level of
driver activity 670
23,375
120
1,000
Cost/driver
341.90
5.60
818.13
196.35
(iv) Total overheads by product and per unit
Product D Product C Product P Total
Overhead Activity $ Cost Activity $ Cost Activity $ Cost Activity $ Cost
Set-ups
75 25,643
115 39,319
480 164,113
670 229,075
Machining
1,125
6,300
1,250
7,000
21,000 117,600
23,375 130,900
Material Handling
12
9,817
21 17,181
87 71,177
120 98,175
Inspection
150 29,453
180 35,343
670 131,554
1,000 196,350
Total overhead cost
77,213 98,843 484,444 654,500
Units produced
Costs per unit
Cost per unit
(v)
Direct costs (from (a))
Overheads (from (iv))
750
$94.95
1,250 $79.07
D $ 23.00
94.95
C $ 21.00
79.07
P
$
31.00
69.21
117.95
100.07
100.21
7,000
$69.21
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1
Answers
(c)
Comment
The overhead costs per unit are summarised below together with volume of production.
Product
Volume
Conventional overheads
ABC overheads
D 750
$42
$95
C 1,250
$28
$79
P
7,000
$84
$69
The result of the change to Activity Based Costing is clear, the overhead cost of D and C have risen whilst that of P has
fallen.
(d)
Products D and C are relatively minor volume products but still require a fair amount of administrative time by the production
department; ie they involve a fair amount of `hassle`. This is explained by the following table of `activities per 1,000 units
produced`.
Set-ups Materials
Inspections
movements
D
100
16
200
C
92
17
144
P
69
12
96
This table highlights the problem.
–
Product P has fewer set-ups, material movements and inspections per 1,000 units than or C
–
As a consequence product P’s overhead cost per unit for these three elements has fallen
–
The machining overhead cost per unit for P is still two or three times greater than for products D or C, but because this
overhead only accounts for 20% of the total overhead this has a small effect on total cost.
–
The overall result is P’s fall in production overhead cost per unit and the rise in those figures for D and C
Pricing and Profitability
Switching to ABC can, as in this case, substantially change the costs per unit calculations. Consequently if an organisation’s
selling prices are determined by a version of cost-plus pricing then the selling prices would alter.
In this case the selling price of D and C would rise significantly, and the selling price of P would fall. This, at first glance may
be appealing however:
–
Will the markets for D and C tolerate a price rise? There could be competition to consider. Will customers be willing to pay
more for a product simply because Triple Ltd has changed its cost allocation methods?
–
Product P is a high volume product. Reducing its selling price will have a dramatic effect on revenue and contribution.
One would have to question whether such a reduction would be compensated for by increased volumes.
Alternatively, one could take the view that prices are determined by the market and therefore if Triple Ltd switches to ABC, it is
not the price that would change but the profit or margin per unit that would change.
This can change attitudes within the business. Previously high margin products (under a traditional overhead absorption
system) would be shown as less profitable. Salesmen (possibly profit motivated) can begin to push the sales of different
products seeking higher personal rewards. (Assuming commission based on profits per unit sold)
It must always be remembered that if overheads are essentially fixed then they should be ignored in business decision making.
Switching to ABC can change reported profits per unit but it is contribution per unit that is perhaps more important.
2
(a)
SIMPLY SOUP Limited
(i)
Meaning and Controllability of the variances
Material Price Variance
Indicates whether Simply Soup has paid more (adverse) or less (favourable) for its input materials than the standard
prices set for the period. For example, if a new supplier had to be found and the price paid was more than the standard
price then Simply Soup would incur an extra cost. This extra cost is the price variance.
Price variances are controllable to the extent that Simply Soup can choose its suppliers. On the other hand, vegetables
are a seasonal and weather dependent crop and therefore factors outside Simply Soups control can influence prices in
the market. The key issue is that the production manager will not control the price paid that is the job of the Purchasing
Manager.
Material Mix Variance
Considers the cost of a change in the mix of the ingredients to make soup. For example adding less butter (which is
expensive) and more stock (which is cheaper) will be a cheaper mix than the standard mix. A cheaper mix will result in
a favourable variance.
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This is in line with the comments of many who feel that ABC provides a fairer unit cost better reflecting the effort required to
make different products. This is illustrated here with product P which may take longer to make than D or C, but once production
has started the process is simple to administer. This may be due to having much longer production lines.
The recipe determines the mix. The recipe is entirely under the control of the production manager.
Material Yield Variance
This shows the productivity of the manufacturing process. If the process produces more soup than expected then the yield
will be good (favourable). At the moment 2.05 litres of input produces 1 litre of soup, if 2.05 litres of input produces more
than 1 litre of soup then the yield is favourable. Greater yield than expected can be a result of operational efficiency or a
change in mix.
The production manager controls the operational process so should be able to control the yield. Poor quality ingredients can
damage yield but the production manager should be in control of quality and reject dubious ingredients. The production
manager is also responsible for things like spillage. Higher spillage can also reduce yield.
(ii)
Production manager’s performance
The production manager has produced significant favourable cost variances. The total favourable variance has risen from
$4,226 to $10,352 in the first three months. This last figure represents approximately 7.1% of the standard monthly
spend.
The prices for materials have been rising but are probably outside the control of the production manager. The rising prices
may have put pressure on the production manager to cheapen the mix.
The mix has become cheaper. This could be seen as a cost efficient step. However, Simply Soup must question the quality
implications of this (see later).
The yield results are the most significant. The manager is getting far more out of the process than is usual. The new mix
is clearly far more productive than before. This could easily be seen as an indicator of good performance as long as the
quality is maintained.
Quality
The concern is that the production manager has sacrificed quality for lower cost and greater quantity. The sales director
has indicated that sales are falling, perhaps an indication that the customers are unhappy with the product when
compared to competitor offers. The greater yield and cheaper mix may well have produced a tasteless soup.
Overall
Overall there has to be concern about the production manager’s performance. Cost control and efficiency are important
but not at the expense of customer satisfaction and quality. We do not have figures for the extent to which sales have been
damaged and small reductions may be acceptable.
(iii) Changes to the performance management system
The performance management system needs to take account of the quality of the soup being produced and the overall
impact a decision has on the business.
Quality targets need to be agreed with the manager. These are difficult to quantify but not impossible. For example soup
consistency (thickness) is measurable. Regular tasting will indicate a fall in quality; tasters could give the soup a mark out
of 10 on taste, colour, smell etc.
The production manager should not be rewarded for producing lots of cheap soup that cannot be sold. The performance
management system should reflect the overall effect that decisions have. If the production manager’s actions have
reduced sales then sales volume variances should be allocated to the production manager as part of the performance
assessment.
(b)
Variance calculations
Material Price Variance
Mixed Vegetables:
$69,700
82,000
– 0.80
Butter:
$21,070
4,900
–4
Stock:
$58,560
122,000
– 0.50
x 82,000 = $4,100 (A)
x 4,900 = $1,470 (A)
x 122,000 = $2,440 (F)
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Cost Efficiency
Material Mix Variance
Mixed Vegetables: (82,000 – 91,712.2*) x 0.80
= $7,770 (F)
Butter:
(4,900 – 5,095.1) x 4
= $780 (F)
Stock:
(122,000 – 112,092.7) x 0.50 = $4,954 (A)
Total Mix Variance
Note: it is only the total mix variance that is a valid variance here
Total input volume = (82,000 + 4,900 + 122,000) = 208,900
* Standard mix for mixed vegetables is = $91,712.2
Note: alternate approaches are acceptable.
Material Yield Variance
[112,000 – 101,902.4] x 1.47
= $3,596 (F)
The standard inputs add up to 2.05 units (0.9+0.5+1.1). This produces 1ltr of soup. The actual inputs were 208,900 litres
and therefore the standard expected output should be
1
= 101,902.4 litres
208,900
2.05
3
BFG Limited
(a) Sales
Sales Revenue
Costs:
Direct materials (W1)
Direct Labour (W2)
Variable overhead
Rent
Net cash flow
Target cash flow
120,000 units
$1,260,000
$514,000
$315,423
$126,169
$180,000
$124,408
$130,000
The target cash flow will not be achieved
Workings:
(1) Direct material: Batches
First 200 @ $500
Second 200 @$450
Remaining 800 @$405
Total
$
100,000
90,000
324,000
514,000
(2) Direct labour
For first seven hundred batches
y = axb
y = 2,500 x 700 –0.3219
y = $303.461045
Total cost for first 700 batches = $303.461045 x 700 = $212,423
All batches after the first 700 will have the same cost as the 700th batch. To calculate the cost of the 700th batch we
need to take the cost of 699 batches from the cost of 700 batches.
For 699 batches
y=axb
y = 2,500 x 699 –0.3219
y = $303.600726
Total cost for first 699 batches = $303.600726 x 699 = $212,217
Cost of 700th batch is $212,423 - $212,217 = $206
Total cost for the 12 months of production
$212,423 + ($206 x 500) = $315,423
(3) Variable overhead is $2 per hour or 40% of direct labour
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= $14,843(F)
To calculate the learning factor BFG will have had to measure the time taken to make the first batch (500 hours) and then the
time taken to make the second batch. The learning rate measures the relationship between the average time taken between
two points as production doubles. The easiest way to measure the learning rate is when the production doubles between the
first and second batches.
At 80%
Time for first batch
Average time for two batches @80% 500 x 0.8
Total time for two batches
2 x 400
Time for second batch
800 – 500
At 90%
Time for first batch
Average time for two batches @90% 500 x 0.9
Total time for two batches
2 x 450
Time for second batch
900 – 500
500
= 400
= 800
= 300
500
= 450
= 900
= 400
The 80% learning rate reduces the time taken for the two successive batches above by a greater amount (or faster). Hence the
80% learning rate is the faster learning.
(c)
4
Possible actions to improve the net cash flows are:
–
Increase the price charged. The question states that an agreed specification has been reached, however further research
may reveal that a higher price could be tolerated by the market. Equally a form of price skimming may be possible to
improve short term net cash flow.
–
Reduce the labour cost per batch by removing unnecessary operations or processes. It may be possible to simplify the
design without damaging the ability to achieve the price stated.
–
Improve the learning rate. This may involve improving the training or the quality of people involved in the production
process. This does takes time and costs money in the short run.
–
Consider substitute materials (without damaging the product specification). Also look for new suppliers to reduce the input
cost.
–
Consider ways to reduce the level of variable overhead incurred by the product.
–
Investigate whether the production of product X could take place in existing space and hence avoid the extra rent charge.
Re-negotiate the rent charge with the landlord.
Preston Financial Services
(a)
Financial analysis
There are various financial observations that can be made from the data.
–
–
–
–
–
Turnover is up 5% – this is not very high but is at least higher than the rate of inflation indicating real growth. This is
encouraging and a sign of a growing business.
The main weakness identified in the financial results is that the net profit margin has fallen from 20% to 19.8%
suggesting that cost control may be getting worse or fee levels are being competed away.
Profit is up 3.9%. In absolute terms profits are impressive given that Richard Preston is the sole partner owning 100% of
the business.
Average cash balances are up 5% – indicating improved liquidity. Positive cash balances are always welcome in a
business.
Average debtors days are down by 3 days – indicating improved efficiency in chasing up outstanding debts. It is noticeable
that Preston’s days are lower than the industry average indicating strong working capital management. The only possible
concern may be that Richard is being particularly aggressive in chasing up outstanding debts.
Overall, with a possible concern about margins and low growth, the business looks in good shape and would appear to have
a healthy future.
(b)
Financial performance indicators will generally only give a measure of the past success of a business. There is no guarantee
that a good past financial performance will lead to a good future financial performance. Clients may leave and costs may
escalate turning past profits to losses in what can be a very short time period.
Non financial measures are often termed “indicators of future performance”. Good results in these measures can lead to a good
financial performance. For example if a business delivers good quality to its customers then this could lead to more custom at
higher prices in the future.
Specifically the information is appendix 2 relates to the non financial measures within the balanced scorecard.
Internal business processes are a measure of internal efficiency. Interestingly these measures can indicate current cost efficiency
as much as any future result
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(b)
Customer knowledge measure how well the business is dealing with its external customers. A good performance here is very
likely to lead to more custom in the future.
Innovation and learning measures that way the business develops. New products would be reflected here along with indicators
of staff retention. Again this is much more focused on the future than the present.
Measuring performance by way of non-financial means is much more likely to give an indication of the future success of a
business.
The extra non-financial information gives much greater insight into key operational issues within the business and paints a
bleaker picture for the future.
Internal business processes
Error rates
Error rates for jobs done are up from 10% to 16%, probably a result of reducing turnaround times to improve delivery on time
percentages. This is critical as users expect the accounts to be correct. Errors could lead to problems for clients with the Inland
Revenue, bankers, etc. What is worse, Richard could be sued if clients lose out because of such errors. One could say that
errors are unlikely to be revealed to clients. Businesses rarely advertise mistakes that have been made. They should of course
put mistakes right immediately.
Customer Knowledge
Client retention
The number of clients has fallen dramatically – this is alarming and indicates a high level of customer dissatisfaction. In an
accountancy practice one would normally expect a high level of repeat work – for example, tax computations will need to be
done every year. Clearly existing clients are not happy with the service provided.
Average fees
It would appear that the increase in revenue is thus due to a large increase in average fees rather than extra clients – average
fee is up from $600 to $775, an increase of 29%! This could explain the loss of clients in itself, however there could be other
reasons.
Market share
The result of the above two factors is a fall in market share from 20% to 14%. Looking at revenue figures one can estimate
the size of the market as having grown from $4.5m to $6.75m, an increase of 50%. Compared to this, Preston’s figures are
particularly worrying. The firm should be doing much better and looks to being left behind by competitors.
Learning and Growth
Non-core services
The main weakness of the firm seems to be is its lack of non-core services offered. The industry average revenue from non-core
work has increased from 25% to 30% but Richard’s figures have dropped from 5% to 4%. It would appear that most clients
are looking for their accountants to provide a wider range of products but Richard is ignoring this trend.
Employee retention
Employee turnover is up indicating that the staff are dissatisfied. Continuity of staff at a client is important to ensure a quality
product. Conservative clients may resent revealing personal financial details to a variety of different people each year. Staff
turnover is possibly a result of extra pressure to complete jobs more quickly without the satisfaction of a job well done. Also
staff may realise that the lack of range of services offered by the firm will limit their own experience and career paths
Conclusion
In conclusion, the financial results do not show the full picture. The firm has fundamental weaknesses that need to be
addressed if it is to grow into the future. At present it is being left behind by a changing industry and changing competition. It
is vital that Richard reassesses his attitude and ensures that the firm has a better fit with its business environment.
In particular he should seek to develop complementary services and reduce errors on existing work.
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(c)
Marking Scheme
1
(a)
For each product
1 mark
Total 3 marks
(b)
Total machine hours
2 marks
Cost per driver calculation
3 marks
Overheads split by product table
4 marks
Cost per unit calculation
3 marks
Total 12 marks
(c)
Explanation
4 marks
(d)
Comment on pricing, markets, customers and profitability
Total
6 marks
25 marks
2
(a)
For each variance
Explanation of meaning of variance
Brief discussion of controllability
1 mark
1 mark
(b)
Comment on cost variance
Price:
Outside Production Managers Control
Rising prices pressures
1 mark
1 mark
Mix
Cheaper mix and comment
1 mark
Yield
High yield results and comment
1 mark
Quality
Comment on quality implications
1 mark
Overall summary
1 mark
6 marks
(c)
Improvements to performance measurement system
For each sensible suggestion 2 marks
4 marks
(d)
Variance calculations
Price: 1 mark for each ingredient
3 marks
Mix: 3 marks
Yield: 3 marks
Method marks should be awarded as appropriate
Total
9 marks
25 marks
3
(a) Sales 1 marks
Direct material
2 marks
Direct labour first seven months
3 marks
last five months
3 marks
Variable overhead
1 marks
Rent
1 marks
Decision
1 marks
Total for part (a)
12 marks
(b) Second batch times 80%
2 marks
90%
2 marks
Comment on faster learning
1 marks
Total for part (b)
5 marks
(c)
Actions to improve net cash flow
(2 marks per explained idea)
Total for part (c)
Total
14
6 marks
8 marks
25 marks
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Pilot Paper F5 Performance Management
Financial commentary
Turnover growth
2 marks
Profitability
2 marks
Cash position
2 marks
Debtor management
2 marks
Total
8 marks
(b)
Future performance
General explanation with example
2 marks
Comment on each area
3 marks
Total
5 marks
(c)
Assessment of future prospects.
Internal business processes
Error rates
3 marks
Not revealed to clients
1 marks
Customer Knowledge
Retention
1 marks
Fee levels
2 marks
Market share/size
1 marks
Learning and growth
Lack of product range
2 marks
Employee retention
2 marks
Total
Total
12 marks
25 marks
15
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4
(a)
Fundamentals Level – Skills Module, Paper F5
Performance Management
Edward Limited
(a)
Target costing process
Target costing begins by specifying a product an organisation wishes to sell. This will involve extensive customer analysis,
considering which features customers value and which they do not. Ideally only those features valued by customers will be
included in the product design.
The price at which the product can be sold at is then considered. This will take in to account the competitor products and
the market conditions expected at the time that the product will be launched. Hence a heavy emphasis is placed on external
analysis before any consideration is made of the internal cost of the product.
From the above price a desired margin is deducted. This can be a gross or a net margin. This leaves the cost target. An
organisation will need to meet this target if their desired margin is to be met.
Costs for the product are then calculated and compared to the cost target mentioned above.
If it appears that this cost cannot be achieved then the difference (shortfall) is called a cost gap. This gap would have to be
closed, by some form of cost reduction, if the desired margin is to be achieved.
(b)
(c)
Benefits of adopting target costing
–
The organisation will have an early external focus to its product development. Businesses have to compete with others
(competitors) and an early consideration of this will tend to make them more successful. Traditional approaches (by
calculating the cost and then adding a margin to get a selling price) are often far too internally driven.
–
Only those features that are of value to customers will be included in the product design. Target costing at an early stage
considers carefully the product that is intended. Features that are unlikely to be valued by the customer will be excluded.
This is often insufficiently considered in cost plus methodologies.
–
Cost control will begin much earlier in the process. If it is clear at the design stage that a cost gap exists then more can
be done to close it by the design team. Traditionally, cost control takes place at the ‘cost incurring’ stage, which is often
far too late to make a significant impact on a product that is too expensive to make.
–
Costs per unit are often lower under a target costing environment. This enhances profitability. Target costing has been
shown to reduce product cost by between 20% and 40% depending on product and market conditions. In traditional
cost plus systems an organisation may not be fully aware of the constraints in the external environment until after the
production has started. Cost reduction at this point is much more difficult as many of the costs are ‘designed in’ to the
product.
–
It is often argued that target costing reduces the time taken to get a product to market. Under traditional methodologies
there are often lengthy delays whilst a team goes ‘back to the drawing board’. Target costing, because it has an early
external focus, tends to help get things right first time and this reduces the time to market.
Steps to reduce a cost gap
Review radio features
Remove features from the radio that add to cost but do not significantly add value to the product when viewed by the
customer. This should reduce cost but not the achievable selling price. This can be referred to as value engineering or value
analysis.
Team approach
Cost reduction works best when a team approach is adopted. Edward Limited should bring together members of the
marketing, design, assembly and distribution teams to allow discussion of methods to reduce costs. Open discussion and
brainstorming are useful approaches here.
Review the whole supplier chain
Each step in the supply chain should be reviewed, possibly with the aid of staff questionnaires, to identify areas of likely cost
savings. Areas which are identified by staff as being likely cost saving areas can then be focussed on by the team. For
example, the questionnaire might ask ‘are there more than five potential suppliers for this component?’ Clearly a ‘yes’ response
to this question will mean that there is the potential for tendering or price competition.
Components
Edward Limited should look at the significant costs involved in components. New suppliers could be sought or different
materials could be used. Care would be needed not to damage the perceived value of the product. Efficiency improvements
should also be possible by reducing waste or idle time that might exist. Avoid, where possible, non-standard parts in the
design.
Assembly workers
Productivity gains may be possible by changing working practices or by de-skilling the process. Automation is increasingly
common in assembly and manufacturing and Edward Limited should investigate what is possible here to reduce the costs.
The learning curve may ultimately help to close the cost gap by reducing labour costs per unit.
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1
December 2007 Answers
Clearly reducing the percentage of idle time will reduce product costs. Better management, smoother work flow and staff
incentives could all help here. Focusing on continuous improvement in production processes may help.
Overheads
Productivity increases would also help here by spreading fixed overheads over a greater number of units. Equally Edward
Limited should consider an activity based costing approach to its overhead allocation, this may reveal more favourable cost
allocations for the digital radio or ideas for reducing costs in the business.
Cost per unit and cost gap calculation
$ per unit
Component 1
$2,400
(4·10 + –––––––––– )
4,000 units
Component 2
25
100
( ––– x 0·5 x ––– )
100
98
Material – other
Assembly labour
30
100
( –– x $12·60/hr x ––– )
60
90
Variable production overhead
30
( –– x $20/hr)
60
Fixed production overhead
30
( –– x $12/hr)
60
4·70
0·128
8·10
7·00
10·00
6·00
–––––––
35·928
Total cost
Desired cost
($44 x 0·8)
35·20
–––––––
0·728
–––––––
Cost gap
Working
1.
Production overhead cost
Using a high low method
Extra overhead cost between month 1 and 2
Extra assembly hours
Variable cost per hour
$80,000
4,000
$20/hr
Monthly fixed production overhead
$700,000 – (23,000 x $20/hr)
$240,000
Annual fixed production overhead ($240,000 x 12) $2,880,000
$2,880,000
FPO absorption rate ––––––––––– =
$12/hr
240,000 hrs
2
Ties Only Limited
(a)
Financial performance of Ties Only Limited
Sales Growth
Ties Only Limited has had an excellent start to their business. From a standing start they have made $420,000 of sales and
then grown that figure by over 61% to $680,000 in the following quarter. This is impressive particularly given that we know
that the clothing industry is very competitive. Equally it is often the case that new businesses make slow starts, this does not
look to be the case here.
Gross Profit
The gross profit for the business is 52% for quarter 1 and 50% for quarter 2. We have no comparable industry data provided
so no absolute comment can be made. However, we can see the gross profit has reduced by two points in one quarter. This
is potentially serious and should not be allowed to continue.
,
The cause of this fall is unclear, price pressure from competitors is possible, who may be responding to the good start made
by the business. If Ties Only Limited is reducing its prices, this would reflect on the gross profit margin produced.
It could also be that the supply side cost figures are rising disproportionately. As the business has grown so quickly, it may
have had to resort to sourcing extra new supplies at short notice incurring higher purchase or shipping costs. These could all
reduce gross margins achieved.
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(d)
Website development
Website costs are being written off as incurred to the management accounting profit and loss account. They should be seen
as an investment in the future and unlikely to continue in the long term. Website development has been made with the future
in mind; we can assume that the future website costs will be lower than at present. Taking this into consideration the loss
made by the business does not look as serious as it first appears.
Administration costs
These are 23·9% of sales in quarter 1 and only 22·1% of sales in quarter 2. This could be good cost control, impressive
given the youth and inexperience of the management team.
Distribution costs
This is a relatively minor cost that again appears under control. Distribution costs are likely to be mainly variable (postage)
and indeed the proportion of this cost to sales is constant at 4·9%.
Launch marketing
Another cost that although in this profit and loss account is unlikely to continue at this level. Once the ‘launch’ is complete
this cost will be replaced by more general marketing of the website. Launch marketing will be more expensive than general
marketing and so the profits of the business will improve over time. This is another good sign that the results of the first two
quarters are not as bad as they seem.
Other costs
Another cost that appears under control in that it seems to have simply varied with volume.
(b)
Although the business has lost over $188,000 in the first two quarters of its life, this is not as disastrous as it looks. The
reasons for this view are:
–
–
–
New businesses rarely breakeven within six months of launch
The profits are after charging the whole of the website development costs, these costs will not be incurred in the future
Launch marketing is also deducted from the profits. This cost will not continue at such a high level in the future
The major threat concerns the fall in gross profit percentage which should be investigated.
The owners should be relatively pleased with the start that they have made. They are moving in the right direction and without
website development and launch marketing they made a profit of $47,137 in quarter 1 and $75,360 in quarter 2.
If sales continue to grow at the rate seen thus far, then the business (given its ability to control costs) is well placed to return
significant profits in the future.
The current profit (or loss) of a business does not always indicate a business’s future performance.
(c)
Non-financial indicators of success
Website hits
This is a very impressive start. A new business can often find it difficult to make an impression in the market. Growth in hits
is 25% between the two quarters. If this continued over a year the final quarter hits would be over 1·3m hits. The internet
enables new businesses to impact the market quickly.
Number of ties sold
The conversion rates are 4% for quarter 1 and 4·5% for quarter 2. Both these figures may seem low but are ahead of the
industry average data. (Industry acquired data must be carefully applied, although in this case the data seems consistent). It
appears that the business has a product that the market is interested in. Ties Only Limited are indeed looking competitive.
We can use this statistic to calculate average price achieved for the ties
Quarter 1
$420,000
–––––––––
27,631
Quarter 2
$680,000
–––––––––
38,857
= $15·20 per tie
= $17·50 per tie
This suggests that the fall in gross profit has little to do with the sales price for the ties. The problem of the falling gross profit
must lie elsewhere.
On time delivery
Clearly the business is beginning to struggle with delivery. As it expands, its systems and resources will become stretched.
Customers’ expectations will be governed by the terms on the website, but if expectations are not met then customers may
not return. More attention will have to be placed on the delivery problem.
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Also any fixed costs included in the cost (directors’ salaries are included) will be spread over greater volume. This would also
reduce the percentage of cost against sales figure. This is an example of a business gaining critical mass. The bigger it gets
the more it is able to absorb costs. Ties Only Limited may have some way to go in this regard, gaining a much greater size
than at present.
Sales returns
Returns are clearly common in this industry. Presumably, ties have to be seen and indeed worn before they are accepted as
suitable by customers. The concern here is that the business’s return rate has jumped up in quarter 2 and is now well above
the average for the industry. In other words, performance is worsening and below that of the competitors. If the business is
under pressure on delivery (as shown by the lateness of delivery) it could be that errors are being made. If wrong goods are
sent out then they will be returned by disappointed customers.
The alternative view is that the quality of the product is not what is suggested by the website. If the quality is poor then the
products could well be returned by unhappy customers.
System down time
System down time is to be avoided by internet based sellers as much as possible. If the system is down then customers
cannot access the site. This could easily lead to lost sales at that time and cause customers not to try again at later dates.
Downtime could be caused by insufficient investment at the development stage (we are told that the server was built to a
high specification) or when the site is under pressure due to peaking volumes. This second explanation is more likely in this
case.
The down time percentage has risen alarmingly and this is concerning. Ideally, we would need figures for the average
percentage down time achieved by comparable systems to be able to comment further.
The owners are likely to be disappointed given the level of initial investment they have already made. A discussion with the
website developers may well be warranted.
Summary
This new business is doing well. It is growing rapidly and ignoring non-recurring costs is profitable. It needs to focus on
delivery accuracy, speed and quality of product. It also needs to focus on a remedy for the falling gross profit margin.
Workings
1.
Gross profit
Quarter 1:
218,400
–––––––– = 52%
420,000
2.
Website conversion rates
Quarter 1: Quarter 2:
27,631
–––––––– = 4%
690,789
3.
Quarter 2:
339,320
–––––––– = 50%
680,000
38,857
–––––––– = 4·5%
863,492
Website hits growth
Between quarter 1 and quarter 2 the growth in website hits has been:
863,492
–––––––– = 1·25 = 25%
690,789
3
Spike Limited
(a)
A budget forms the basis of many performance management systems. Once set, it can be compared to the actual results of
an organisation to assess performance. A change to the budget can be allowed in some circumstances but these must be
carefully controlled if abuse is to be prevented.
Allow budget revisions when something has happened that is beyond the control of the organisation which renders the original
budget inappropriate for use as a performance management tool.
These adjustments should be approved by senior management who should attempt to take an objective and independent
view.
Disallow budget revisions for operational issues. Any item that is within the operational control of an organisation should not
be adjusted.
This type of decision is often complicated and each case should be viewed on its merits.
The direction of any variance (adverse or favourable) is not relevant in this decision.
(b)
Materials
Arguments in favour of allowing a revision
–
The nature of the problem is outside the control of the organisation. The supplier went in to liquidation; it is doubtful
that Spike Limited could have expected this or prevented it from happening.
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This is clearly concerning and an investigation is needed.
–
The buyer, knowing that budget revisions are common, is likely to see the liquidation as outside his control and hence
expect a revision to be allowed. He may see it as unjust if this is not the case and this can be demoralising.
Arguments against allowing a budget revision
–
–
There is evidence that the buyer panicked a little in response to the liquidation. He may have accepted the first offer
that became available (without negotiation) and therefore incurred more cost than was necessary.
A cheaper, more local supplier may well have been available, so it could be argued that the extra delivery cost need not
have been incurred. This could be said to have been an operational error.
Conclusion
The cause of this problem (liquidation) is outside the control of the organisation and this is the prime cause of the overspend.
Urgent problems need urgent solutions and a buyer should not be penalised in this case. A budget revision should be allowed.
Labour
–
The board made this decision, not the departmental manager. It could be argued that the extra cost on the department’s
budget is outside their control.
Arguments against allowing a budget revision
–
–
–
This decision is entirely within the control of the organisation as a whole. As such, it would fall under the definition of
an operational decision. It is not usual to allow a revision in these circumstances.
It is stated in the question that the departmental manager complained in his board report that the staff level needed
improving. It appears that he got his wish and the board could be said to have merely approved the change.
The department will have benefited from the productivity increases that may have resulted in the change of policy. If the
department takes the benefit then perhaps they should take the increased costs as well.
Conclusion
This is primarily an operational decision that the departmental manager agreed with and indeed suggested in his board report.
No budget revision should be allowed.
An alternative view is that the board made the final decision and as such the policy change was outside the direct control of
the departmental manager. In this case a budget revision would be allowed.
(c)
Total sales variances
Sales price variance = (Actual SP – Std SP) x Act sales volume
= (16·40 – 17·00) x 176,000
= $105,600 (Adverse)
Sales volume variance = (Actual sales volume – Budget sales volume) x Std contribution
= (176,000 – 180,000) x 7
= $28,000 (Adverse)
(d)
Market size and share variances
Market size variance = (Revised sales volume – budget sales volume) x Std contribution
= (160,000 – 180,000) x 7
= $140,000 (Adverse)
Market share variance = (Actual sales volume – revised sales volume) x Std contribution
= (176,000 – 160,000) x 7
= $112,000 (Favourable)
(e)
Comment on sales performance
Sales Price
The biggest issue seems to be the decision to reduce the sales price from $17·00 down to $16·40. This ‘lost’ $105,600 of
revenue on sales made compared to the standard price.
It seems likely that the business is under pressure on sales due to the increased popularity of electronic diaries. As such, they
may have felt that they had to reduce prices to sustain sales at even the level they achieved.
Volume
The analysis of sales volume into market size and share shows the usefulness of planning and operational variances. Overall,
the sales level of the business is down by 4,000 units, losing the business $28,000 of contribution or profit. This calculation
does not in itself explain how the sales department of the business has performed.
In the face of a shrinking market they seem to have performed well. The revised level of sales (allowing for the shrinking
market) is 160,000 units and the business managed to beat this level comfortably by selling 176,000 units in the period.
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Arguments in favour of allowing a revision
As mentioned above, the reducing price could have contributed to the maintenance of the sales level. Additionally, the
improved quality of support staff may have helped maintain the sales level. Equally the actions of competitors are relevant to
how the business has performed. If competitors have been active then merely maintaining sales could be seen as an
achievement.
Spike should be concerned that its market is shrinking.
(a)
(b)
Sniff should consider the following factors when making a further processing decision.
–
Incremental revenue. The new perfume, once further processed, should generate a higher price and the extra revenue
is clearly relevant to the decision.
–
Incremental costs. A decision to further process can involve more materials and labour. Care must be taken to only
include those costs that change as a result of the decision and therefore sunk costs should be ignored. Sunk costs would
include, for example, fixed overheads that would already be incurred by the business before the further process decision
was taken. The shortage of labour means that its ‘true’ cost will be higher and need to be included.
–
Impact on sales volumes. Sniff is selling a ‘highly branded’ product. Existing customers may well be happy with the
existing product. If the further processing changes the existing product too much there could be an impact on sales and
loyalty.
–
Impact on reputation. As is mentioned in the question, adding hormones to a product is not universally popular. Many
groups exist around the world that protest against the use of hormones in products. Sniff could be damaged by this
association.
–
Potential legal cases being brought regarding allergic reactions to hormones.
Production costs for 1,000 litres of the standard perfume
Aromatic oils
Diluted alcohol
10 ltrs x $18,000/ltr
990 ltrs x $20/ltr
Material cost
Labour
2,000 hrs x $15/hr
Total
Cost per litre
Sales price per litre
$
180,000
19,800
––––––––
199,800
30,000
––––––––
229,800
––––––––
229·80
399·80
Lost contribution per hour of labour used on new products
($399,800 – $199,800) ÷ 2,000 hrs = $100/hr
Incremental costs
Male version
Hormone
Supervisor
Labour
Fixed cost
Market research
2 ltr x $7,750/ltr
Sunk cost
500 hrs x $100/hr
Sunk cost
Sunk cost
Total
Female version
$
15,500
0
50,000
0
0
–––––––
65,500
–––––––
8 ltr x $12,000/ltr
Sunk cost
700 hrs x $100/hr
Sunk cost
Sunk cost
$
96,000
0
70,000
0
0
–––––––––
166,000
–––––––––
Incremental revenues
Male version
Standard
Hormone added
Incremental revenue
Net benefit/(cost)
200 ltr x $399·80/ltr
202 ltr x $750/ltr
Female version
$
79,960
151,500
––––––––
71,540
––––––––
6,040
––––––––
800 ltr x $399·80
808 ltr x $595/ltr
$
319,840
480,760
––––––––
160,920
––––––––
(5,080)
––––––––
The Male version of the product is worth further processing in that the extra revenue exceeds the extra cost by $6,040.
The Female version of the product is not worth further processing in that the extra cost exceeds the extra revenue by $5,080.
In both cases the numbers appear small. Indeed, the benefit of $6,040 may not be enough to persuade management to take
the risk of damaging the brand and the reputation of the business. To put this figure into context: the normal output generates
a contribution of $170 per litre and on normal output of about 10,000 litres this represents a monthly contribution of around
$1·7m (after allowing for labour costs).
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4
Future production decisions are a different matter. If the product proves popular, however, Sniff might expect a significant
increase in overall volumes. If Sniff could exploit this and resolve its current shortage of labour then more contribution could
be created. It is worth noting that resolving its labour shortage would substantially reduce the labour cost allocated to the
hormone added project. Equally, the prices charged for a one off experimental promotion might be different to the prices that
can be secured in the long run.
(c)
The selling price charged would have to cover the incremental costs of $166,000. For 808 litres that would mean the price
would have to be
($166,000 + $319,840)
–––––––––––––––––––––– = $601·29/ltr
808 ltrs
or about $60·13 per 100 ml.
(d)
Outsourcing involves consideration of many factors, the main ones being:
–
Cost. Outsourcing often involves a reduction in the costs of a business. Cost savings can be made if the outsourcer has
a lower cost base than, in this case, Sniff. Labour savings are common when outsourcing takes place.
–
Quality. Sniff would need to be sure that the quality of the perfume would not reduce. The fragrance must not change
at all given the product is branded. Equally Sniff should be concerned about the health and safety of its customers since
its perfume is ‘worn’ by its customers
–
Confidentiality. We are told that the blend of aromatic oils used in the production process is ‘secret. This may not remain
so if an outsourcer is employed. Strict confidentiality should be maintained and be made a contractual obligation.
–
Reliability of supply. Sniff should consider the implications of late delivery on its customers.
–
Primary Function. Sniff is apparently considering outsourcing its primary function. This is not always advisable as it
removes Sniff’s reason for existence. It is more common to outsource a secondary function, like payroll processing for
example.
–
Access to expertise. Sniff may find the outsourcer has considerable skills in fragrance manufacturing and hence could
benefit from that.
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This represents an increase of only 1·05% on the price given and so clearly there may be scope for further consideration of
this proposal.
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2007 Marking Scheme
Marks
(a)
(b)
(c)
(d)
2
(a)
Process description
Product specification
Selling price
Cost calculation
1
1
1
–––
3
–––
Benefits of target costing
Per benefit
1
–––
4
–––
Methods to reduce the cost gap
Per idea
1
–––
5
–––
Cost calculation
Component 1
Component 2
Material other
Assembly labour
Variable production overhead
High low calculation
Fixed production OAR calculation
Fixed production overhead
Cost gap identified
2
2
1
2
1
2
1
1
1
–––
13
–––
25
–––
Sales
Gross profit
Website development
Administration
Distribution
Launch marketing
Overall comment
2
3
2
2
1
2
2
–––
12
–––
Max
(b)
Future profits comment
4
–––
(c)
Website hits
Number of tie sales
Tie price calculation
On time delivery
Returns
System down time
Summary comment
2
1
2
2
2
1
1
–––
11
–––
25
–––
Max
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1
4
Marks
21/2
21/2
–––
5
–––
(a)
When adjustment allowed
When adjustment not allowed
(b)
Materials discussion
Conclusion
Labour discussion
Conclusion
3
1
3
1
–––
8
–––
(c)
Sales price variance
Sales volume variance
2
2
–––
4
–––
(d)
Market size variance
Market share variance
2
2
–––
4
–––
(e)
Comment on sales price
Comment on sales volume
2
2
–––
4
–––
25
–––
(a)
Per factor outlined
1
–––
4
–––
(b)
Hormone costs
Supervisor excluded
Direct labour
Fixed cost allocation excluded
Market research
Incremental revenue
Net benefit
Concluding comment
2
1
3
1
1
3
2
2
–––
15
–––
(c)
Breakeven calculation
2
–––
2
–––
(d)
Per factor outlined
1
–––
4
–––
25
–––
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3
Fundamentals Level – Skills Module, Paper F5
Performance Management
Chaff Co
(a)
When assessing variances it is important to consider the whole picture and the interrelationships that exist. In Chaff there
appears to be doubt about the wisdom of some of the decisions that have been made. Favourable variances have been
applauded and adverse variances criticised and the managers in charge dispute the challenge to their actions.
Purchasing manager. The purchasing manager has clearly bought a cheaper product, saving $48,000. The cause of this is
not specified and it could be due to good buying or negotiation, reductions in quality or changes in overall market conditions.
We are told the market for buying seeds is stable, so there is more likely to be an internal reason for the problem. The material
usage variance is significantly adverse, indicating much more waste than is normal has occurred in month 1. This suggests
that the quality of the seed bought was poor and as a result a $52,000 excess loss has occurred. It is possible that the waste
was caused by the labour force working poorly or too quickly and this has to be considered.
The sales price achieved is also well down on standard with the sales price variance showing an $85,000 loss of revenue
and (therefore) profit. We are told that the market for sales of brown rice is stable and so it is reasonable to presume that the
fall in sales price achieved is as a result of internal quality issues rather than general price falls. The purchasing manager of
the only ingredient may well be responsible for this fall in quality. This may have also led to a fall in the volume of sales,
another $21,000 of adverse variance.
In conclusion the purchasing manager appears mainly responsible for a loss of $110,000* taking the four variances above
together.
* ($85,000 + $52,000 + $21,000 – $48,000)
Production director. The production director has increased wage rates and this has cost an extra $15,000 in month 1.
However one could argue that this wage increase has had a motivational effect on the labour force. The labour efficiency
variance is $18,000 favourable; and so it is possible that a wage rise has encouraged the labour force to work harder.
Academic evidence suggests that this effect might only be temporary as workers get used to the new level of wages.
Equally the amount of idle time has reduced considerably, with a favourable variance of $12,000 resulting. Again it is possible
that the better motivated labour force has been more willing to work than before. Idle time can have many causes, including,
material shortages or machine breakdowns. However, we are told the machines are running well and the buyer has bought
enough rice seeds.
In conclusion the increase in the wage rate did cost more money but it may have improved morale and enhanced productivity.
The total of the three variances above is $15,000* Fav. *($18,000 + $12,000 – $15,000)
Maintenance manager. The maintenance manager has decided to delay the annual maintenance of the machines and this
has saved $8,000. This will increase profits in the short term but could have disastrous consequences later. In this case only
time will tell. If the machines breakdown before the next maintenance then lost production and sales could result.
The maintenance manager has only delayed the spend and not prevented it altogether. A saving of $8,000 as suggested by
the variance has not been made. It is also possible that the adverse variable overhead expenditure variance has been at least
partly caused by poor machine maintenance.
The variance calculated is not the saving made as it represents a timing difference only. The calculation also ignores the risks
involved.
(b)
The standard contribution is given, but could be calculated as follows (not required by the question but shown as a proof):
$
Sales price
Less:
Rice seed (1·4 Tonnes x $60/tonne)
Labour (2 hours x $20/hr)
Variable overhead (2 hours x $30/hr)
$
240
84
40
60
––––
Marginal costs of production
184
––––
56
––––
Standard contribution
The standard labour charge needs to be adjusted to reflect the cost to the business of the idle time. It is possible to adjust
the time spent per unit or the rate per hour. In both cases the adjustment would be to multiply by 10/9 – a 10% adjustment.
In the case above the rate per hour has been adjusted to $18 x 10/9 = $20/hr. (Both approaches would gain full marks.)
In order to reconcile the budget profit to the actual profit, both these profits need to be calculated and an operating statement
prepared.
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1
June 2008 Answers
Budget profit statement for month 2
$
Sales (8400u x $240/u)
Less:
Rice seed (1·4 tonnes x $60/tonne x 8,400 tonnes)
Labour (2 hours x $20/hr x 8,400 tonnes)
Variable overhead (2 hours x $30/hr x 8,400 tonnes)
$
2,016,000
705,600
336,000
504,000
––––––––
Marginal costs of production
1,545,600
––––––––––
470,400
210,000
––––––––––
260,400
––––––––––
Contribution
Less Fixed costs
Budget profit
$
Sales
Less:
Rice seed
Labour
Variable overhead
$
1,800,000
660,000
303,360
480,000
––––––––
Marginal costs of production
1,443,360
––––––––––
356,640
200,000
––––––––––
156,640
––––––––––
Contribution
Less Fixed costs
Actual profit
Operating statement for month 2
Budget contribution
Variances:
Sales price
Sales volume
$
$
Adverse
Favourable
$
470,400
120,000
22,400
––––––––
142,400
––––––––
328,000
Material price
Material usage
Labour rate
Labour efficiency
Idle time
Variable overhead efficiency
Variable overhead expenditure
60,000
48,000
18,960
20,000
15,600
30,000
30,000
––––––––
96,960
Actual contribution
Budget fixed cost
Less: Fixed cost expenditure variance
200,000
––––––––
156,640
––––––––
Actual profit
Workings for the variances in month 2
3.
4.
5.
6.
7.
28,640
––––––––
356,640
210,000
10,000
––––––––
Actual fixed cost
1.
2.
––––––––
125,600
Sales price: (225 – 240)8,000 = 120,000 Adv
Sales volume: (8,000 – 8,400)56 = 22,400 Adv
⎛ 660, 000
⎞
Material price: ⎜
– 60⎟ 12, 000 = 60, 000 Fav
⎝ 12, 000
⎠
Material usage: (12,000 – 11,200*)60 = 48,000 Adv
*(8,000 x 1·4 = 11,200)
Labour rate: (19·20 – 18)15,800 = 18,960 Adv
Labour efficiency: (15,000 – 16,000)20 = 20,000 Fav
Idle time: (800 – 1,580*)20 = 15,600 Fav
*10% of 15,800
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Actual profit for month 2.
8.
9.
⎛ 480, 000
⎞
Variable overhead expenditure: ⎜
– 30⎟ 15, 000 = 30, 000 Adv
⎝ 15, 000
⎠
Variable overhead efficiency variance: (15,000 – 16,000)30 = 30,000 Fav
Alternative calculations if standard hours adjusted for expected idle time and not the rate.
Standard cost (2 hours x 10/9) x $18 = $40 per tonne
Or 2·222 hours x $18 = $40 per tonne
Rate variance as above = 18,960 Adv
Efficiency variance: (15,000 – 16,197·77777*)18 = 21,560 Fav
* (standard time allowed less standard idle time)
Standard time is 8,000 tonnes x 2·222 hours = 17,777·777 hours
Standard idle time is 10% of 15,800 = 1,580 hours
Therefore expected working hours is 17,777·777 – 1,580 = 16,197·777 hours
(Note – there are many alternative methods of dealing with this issue, any reasonable attempt was accepted.)
2
Higgins Co
(a)
Contribution per cue
Pool cue
$
41·00
(10·80)
(9·00)
(1·20)
––––––
20·00
––––––
Selling price
Material cost at $40/kg
Craftsmen cost at $18/hr
Other Variable cost
Contribution per cue
(b)
Snooker cue
$
69·00
(10·80)
(13·50)
(4·70)
–––––––
40·00
–––––––
Formulation of the linear programming problem
Variables
Let P and S be the number of pool and snooker cues made and sold in any three month period.
Let C represent the contribution earned in any three month period
Constraints:
Craftsmen:
Ash:
Demand levels – Pool cues
– Snooker cues
Non negativity:
0·5P + 0·75S ≤ 12,000
0·27P + 0·27S ≤ 5,400
P ≤ 15,000
S ≤ 12,000
P, S ≥ 0
Objective: Higgins seeks to maximise contribution in a three month period, subject to:
20P + 40S = C
See diagram on next page
The feasible region is identified as the area inside OABCDE.
The contribution line is identified as the dotted line. Pushing the contribution line outward increases the contribution gained
(theory of iso-contribution). The contribution line last leaves the feasible region at point D which is the intersect of the skilled
labour line and the maximum demand line for S.
Solving at point D:
Maximum demand
Craftsmen
S = 12,000
0·5P + 0·75S = 12,000
(1)
(2)
Substituting S = 12,000 in equation (2)
0·5P + (0·75 x 12,000) = 12,000
0·5P + 9,000 = 12,000
0·5P = 12,000 – 9,000
0·5P = 3,000
P = 6,000
Therefore the maximum contribution is earned when 6,000 pool cues and 12,000 snooker cues are made and sold in a three
month period.
The contribution earned is
C = (20 x 6,000) + (40 x 12,000)
C = 120,000 + 480,000
C = $600,000
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Idle time: (800 – 1,580)18 = 14,040 Fav
Production schedule
P
24
Craftsmen
22
Max S
20
Max contribution
18
16
A
B
Max P
14
C
12
10
F
8
6
D
4
2
contribution
0
2
4
Ash
6
8
10
12
E
14
16
16
18
20
S
Taha Popatia - ARTT Business School - 02134523175
Feasible region = OABCDE
Optimal point at point D
(c)
Shadow prices
A shadow price is the value assigned to changes in the quantity of a scarce resource available, normally measured in terms
of contribution. If more critical scarce resource becomes available then the feasible region would tend to expand and this
means that the optimal point would tend to move outward away from the origin thus earning more contribution. It is this
increase in the contribution that is the shadow price measured on a per unit of scarce resource basis.
Management can use the shadow price as a measure of how much they would be willing to pay to gain more of a scarce
resource. It represents the maximum they should be willing to pay for more scarce resource over and above the normal price
subject to any non-financial issues that may be present.
If the availability of a non-critical scarce resource increased then the feasible region would not tend to expand and therefore
no more contribution could be earned. In this case extra non-critical scarce resource has no value and a nil shadow price.
Calculation of shadow prices:
Craftsmen: This is a critical scarce resource and if more became available then the feasible region would expand and the
optimal point would move outward thus earning more contribution. Assuming that just one more hour becomes available it
is necessary to find the new optimal point and measure the increase in contribution earned.
At point D, we re-solve based on the available craftsmen hours being one more than previously.
S = 12,000 (3)
0·5P + 0·75S = 12,001 (4)
Substituting S = 12,000 in equation (4)
0·5P + 0·75(12,000) = 12,001
0·5P + 9,000 = 12,001
0·5P = 3,001
P = 6,002
The new optimal solution would be where 12,000 snooker cues and 6,002 pool cues are made. This would earn an extra
$40 (2 x $20) in contribution.
The shadow price is therefore $40 per extra hour of craftsmen time.
(d)
Acceptability of the craftmens’ offer.
Rate of pay
The rate of pay requested (double time) is on the face of it less than the shadow price and is therefore affordable by Higgins
Co. The business would be better off by accepting the offer.
However, it is common for overtime to be paid at time and a half ($27 per hour) and Higgins would be well advised to
negotiate on this point. Higgins takes the commercial risks in this business and would therefore be justified in keeping the
majority of the rewards that come with it. Equally it is a dangerous precedent to accept the first offer and pay such a high
rate for overtime, Higgins would have to ask itself what would happen next time an overtime situation arose. It is also possible
that double time, being so generous, encourages slow working in normal time so as to gain the offer of overtime.
How many hours to buy?
The problem here is that as Higgins buys more craftsmen time, the craftsmen constraint line will move outward, changing
the shape of the feasible region. Once the craftsmen line reaches point F (see diagram) then there would be little point buying
any more hours since Higgins would then not have the materials (ash) to make more cues.
We need therefore to calculate the number of hours needed at point F.
At F
Maximum demand for S
Ash
S = 12,000 (5)
0·27P + 0·27S = 5,400 (6)
Substituting S = 12,000 in equation (6)
0·27P + 0·27(12,000) = 5,400
0·27P + 3,240 = 5,400
0·27P = 2,160
P = 8,000
Point F falls where S = 12,000 and P = 8,000
The craftsmen hours needed at this point would be given by putting the above P and S values in the craftsmen constraint
formula.
Craftsmen hours = (0·5 x 8,000) + (0·75 x 12,000)
Craftsmen hours =13,000 hours
17
Taha Popatia - ARTT Business School - 02134523175
Ash: This is a non-critical scarce resource and as such it has a shadow price of nil. Put simply we have slack (spare material)
of ash and therefore have no desire to pay more to get more of it.
Therefore Higgins should only buy 1,000 hours (13,000 – 12,000).
In general terms Higgins need only buy the number of hours that the business can use to make and sell more product. If
more ash can also be bought then more labour hours may be desirable.
Quality of work
Higgins should consider the quality of work. Overtime hours can force tiredness on craftsmen that have already worked a full
day. Tired people often produce sub-standard work. If quality is important then this could damage the reputation of the
business.
Any other feasible points would be accepted
Bridgewater Co
(a)
The divisions of Bridgewater Co have been given very specific targets to meet it is reasonable to assume that performance
will be assessed relative to them.
Sales Growth
The northwest division suffers from a slow start to the year, with falls in sales from quarter 1 to quarter 2. Overall sales growth
looks better with an average growth of 14% achieved. We don’t have quarterly budget sales to compare to but the low growth
in budget profit suggests that much slower sales growth than that actually achieved was expected. Overall the sales budget
has been exceeded, with big increases in sales in the last two quarters
The manager’s promotion could be damaged by the slow start. The ‘good news’ of better sales growth comes after the
promotion decision is taken.
Cost control – trainer costs
The division spends slightly more (as a % of sales) than budgeted on trainers. It is spending 20% as opposed to 18% on
trainers. Given the manager’s attitude towards quality it appears he is trying to employ better trainers in the hope of more
satisfied customers. This should, logically, build customer loyalty and improve local and brand reputation. This could possibly
explain the better growth in the later quarters.
Again the problem for the promotion seeking manager, investing in the future in this way damages short term performance
measures, in this case cost targets.
Cost control – room hire costs
The divisional manager is also spending more on room hire. He is spending 10% as opposed to the budgeted 9% of sales.
He could be buying poorly, hence wasting money. Alternatively he could be hiring better quality rooms to improve the learning
environment and enhance the training experience.
Again his focus on quality may be undermining his short term promotional prospects.
Profit
Annually, the divisional manager is beating the targets laid down for profit. His problem as far as his promotion is concerned
is the profit targets laid down for the first two quarters are not met.
The promotion decision comes too early for his employers to see the benefit of a quality focus made earlier in the year.
Overall, promotional prospects do not look good. The manager has not met any of his targets in the first two quarters. His
only hope is that his bosses look at future forecasts and take them in to consideration when making the decision.
(b)
Revised forecasts
Sales
less:
Trainers
Room hire
Staff training
Other costs
Software
Forecast Net profit
Original Budget profit
Q1
$’000
42·5
Q2
$’000
38·5
Q3
$’000
62·5
Q4
$’000
74·5
Total
$’000
218·0
8·0
4·0
1·5
3·0
1·8
–––––
24·2
–––––
25·0
7·2
3·6
1·5
1·7
12·0
6·0
1·0
6·0
14·4
7·2
1·0
7·0
–––––
24·5
–––––
26·0
–––––
37·5
–––––
27·0
–––––
44·9
–––––
28·0
41·6
20·8
5·0
17·7
1·8
–––––
131·1
–––––
106·0
18
Taha Popatia - ARTT Business School - 02134523175
3
Incremental effects (as a working)
Extra sales
Voucher sales
Software sales
Extra costs
Trainers
Room hire
Staff training
Software
Change in forecast Net profit
Q2
$’000
Q3
$’000
Q4
$’000
Total
$’000
2·5
2·5
2·5
10·0
2·5
12·0
10·0
22·0
2·0
1·0
2·4
1·2
+9·5
+10·9
4·4
2·2
1·0
1·8
+22·6
0·5
1·8
+0·2
0·5
+2·0
Voucher scheme
At first glance of it the voucher scheme looks a good one. The manager is confident of a reasonable volume of sales and given
that all the attendees will go on existing courses there will be no additional costs. The scheme seems to generate $10,000
of extra sales revenue in the year. One should question the assumption that no extra costs are incurred.
One potential concern would be that existing customers may object to the price reduction, particularly if they have already
paid a higher price for a future course. However, most customers will probably not be aware of the price difference or will not
bother complaining, those that do complain can be dealt with individually. It is common with promotions that the offer clearly
states the terms and conditions that apply. In this way the manager can protect existing sales by excluding existing sales from
the new offer.
From a promotion point of view the extra revenue and profit helps a little. If the revenue is spread evenly (as suggested) there
will be $2,500 of extra revenue and profit in each of quarter 1 and 2. Unfortunately, in both cases the manager will still fall
short of the target profit and the growth between quarter 1 and 2 will still be negative. He would need the take up rate of the
sessions to be quicker to help his promotion prospects. Manipulation of the accounting figures should be resisted
Software upgrade
A software training company must stay in touch with modern software developments. From that point of view you could argue
that this development is essential. Financially the proposal looks sound. The extra courses will generate a profit of $12,600
in this year alone, with, presumably, more courses to follow. A slower than expected take-up rate for the new course would
reduce this year’s effect.
The promotional aspects are not as good. The extra costs occur in quarter 1 and 2 but the revenue does not come in until
after the promotion decision is made. Integrity is an issue here. Personal promotional prospects must come second to sound
business decisions. The manager should show the revised forecasts to his bosses and hope this sways the decision.
Delayed payment to trainers
This is a poor idea. This will not affect profit, costs or any of the performance measures in question. It will affect cash flow
in a positive manner. However, to delay payment without agreement can damage the relationships with the trainers, upon
which he depends on for the quality of their presentations.
Overall the three proposals do improve the performance of the division. However most of the benefits accrue after quarter 2
and might therefore come too late for the promotion decision.
(d)
To encourage a longer term view more emphasis should be placed on non-financial measures of performance.
This business is dependent amongst other things on the quality of its course provision. As a result an improvement could be
to set targets for the quality of presentations given. Attendees could be asked to grade all trainers (or facilities) at the end of
sessions. This would prevent cheap but weak presenters (and poor quality rooms) being employed by managers.
Equally, the senior managers have to take account of longer periods when assessing performance. Viewing a single quarter
is too narrow and looking at the whole year is advisable. Wider issues should also be taken into consideration when making
promotional decisions. Repurchase rates could be measured for client companies for example.
4
Jola Publishing
(a)
The first thing to point out is that the overhead allocations to the two products have not changed by that much. For example
the CB has absorbed only $0·05 more overhead. The reason for such a small change is that the overheads are dominated
by property costs (75% of total overhead) and the ‘driver’ for these remains machine hours once the switch to ABC is made.
Thus no difference will result from the switch to ABC in this regard.
The major effect on the cost will be for quality control. It is a major overhead (23% of total) and there is a big difference
between the relative number of machine hours for each product and the number of inspections made (the ABC driver). The
CB takes less time to produce than the TJ, due to the shortness of the book. It will therefore carry a smaller amount of
overhead in this regard. However, given the high degree of government regulation, the CB is subject to ‘frequent’ inspections
whereas the TJ is inspected only rarely. This will mean that under ABC the CB will carry a high proportion of the quality
control cost and hence change the relative cost allocations.
19
Taha Popatia - ARTT Business School - 02134523175
(c)
Q1
$’000
The production set up costs are only a small proportion of total cost and would be, therefore, unlikely to cause much of a
difference in the cost allocations between the two products. However this hides the very big difference in treatment. The CB
is produced in four long production runs, whereas the TJ is produced monthly in 12 production runs. The relative proportions
of overhead allocated under the two overhead treatments will be very different. In this case the TJ would carry much more
overhead under ABC than under a machine hours basis of overhead absorption.
There are many problems with ABC, which, despite its academic superiority, cause issues on its introduction.
–
–
–
(c)
Lack of understanding. ABC is not fully understood by many managers and therefore is not fully accepted as a means
of cost control.
Difficulty in identifying cost drivers. In a practical context, there are frequently difficulties in identifying the appropriate
drivers. For example, property costs are often significant and yet a single driver is difficult to find.
Lack of appropriate accounting records. ABC needs a new set of accounting records, this is often not immediately
available and therefore resistance to change is common. The setting up of new cost pools is needed which is time
consuming.
Cost per unit calculation using machine hours for overhead absorption
Paper (400g at $2/kg)
Printing (50ml at $30/ltr)
Machine cost (6 mins at $12/hr)
Overheads (6 mins at $24/hr) (W1)
Total cost
Sales price
Margin
$CB
0·80
1·50
1·20
2·40
––––
5·90
9·30
––––
3·40
––––
(100g at $1/kg)
(150ml at $30/ltr)
(10 mins at $12/hr)
(10 mins at $24/hr)
$TJ
0·10
4·50
2·00
4·00
––––––
10·60
14·00
––––––
3·40
––––––
(W1) Workings for overheads:
Total overhead
$2,880,000
Total machine hours
(1,000,000 x 6 mins) + (120,000 x 10 mins) =
Which is
7,200,000 mins
120,000 hours
$2,880,000
Cost per hour = ––––––––––––– = $24/hr
120,000 hrs
Cost per unit calculations under ABC
CB
$
Paper (400g at $2/kg)
0·80
Printing (50ml at $30/ltr)
1·50
Machine cost (6 mins at $12/hr) 1·20
Overheads (W2)
2·41
––––
Total cost
5·91
Sales price
9·30
––––
Margin
3·39
––––
(100g at $1/kg)
(150ml at $30/ltr)
(10 mins at $12/hr)
(W2)
(W2) Working for ABC overheads
Property costs
Quality control
Production set up
Total
Production level
Cost per unit
Total
$
2,160,000
668,000
52,000
––––––––––
2,880,000
TJ
$
0·10
4·50
2·00
3·88
––––––
10·48
14·00
––––––
3·52
––––––
alternative:
CB
$
1,800,000
601,200
13,000
––––––––––
2,414,200
1,000,000
2·41
TJ
$
360,000
66,800
39,000
––––––––
465,800
120,000
3·88
No of drivers Cost/driver
120,000
200
16
Cost per unit
The above overheads have been split on the basis of the following activity levels
Property costs
Quality control
Production set up
Driver
Machine hours
Inspections
Set ups
CB
100,000
180
4
A cost per driver approach is also acceptable.
20
TJ
20,000
20
12
18/hr
3340
3250
CB
1·80
0·6012
0·013
–––––––
2·41
–––––––
–––––––
TJ
3·00
0·56
0·325
––––––
3·88
––––––
––––––
Taha Popatia - ARTT Business School - 02134523175
(b)
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
(b)
Assessment of each person
Buyer (poor quality, usage, sales issue)
Production director (motivation, efficiency and idle time issue)
Administration manager (short-termism, timing only)
Allow flexibility here in interpetation
Budget profit calculation
Labour
Sales
Rice seed
Variable overhead
Fixed cost
Sales price variance
Sales volume variance
Material price variance
Material usage variance
Labour rate variance
Labour efficiency variance
Idle time variance
Variable overhead expenditure variance
Variable overhead efficiency variance
Fixed overhead expenditure variance
Format
Marks
3
–––
9
–––
1
1/
2
1/
2
1/
2
1/
2
1
1
1
1
1
2
2
1
1
1
1
–––
16
–––
25
–––
21
Taha Popatia - ARTT Business School - 02134523175
1
June 2008 Marking Scheme
(a)
Selling prices
Ash costs
Craftsmen costs
Contribution identified
(b)
Assigning letters for variables
Defining ash constraint
Defining craftsmen constraint
Demand constraint – pool
Demand constraint – snooker
Non-negativity constraint
Correctly drawn diagram
Labels
Title
Ash constraint line
Craftsmen constraint line
Pool demand line
Snooker demand line
Identified feasible region
Contribution line
Identified optimal point
Solve at optimal
Calculation of contribution
Marks
1/
2
1/
2
1/
2
1/
–––2
2
–––
1/
2
1
1
1/
2
1/
2
1/
2
1/
2
1/
2
1/
2
1/
2
1/
2
1/
2
1/
2
1
1/
2
2
1
–––
12
–––
(c)
Explanation of a shadow price
Ash shadow price
Craftsmen shadow price
2
1
2
–––
5
–––
(d)
Rate of pay discussion
Quantity of hours discussion
Quantity of hours calculation
Quality (or other)
2
1
1
2
–––
6
–––
25
–––
22
Taha Popatia - ARTT Business School - 02134523175
2
4
(a)
Per target discussed
(b)
Revised forecasts
Voucher sales affect
Vista sales affect
Extra trainer cost
Extra room hire cost
Staff training increase
Software cost
Overall revised profit calculation
Marks
2
–––
8
–––
1
2
1
1
1/
2
1/
2
1
–––
7
–––
(c)
Per idea commented on
2
–––
6
–––
(d)
For each suggestion
2
–––
4
–––
25
–––
(a)
Comment on rent and rates
Comment on quality control
Comment on production set up cost
Comment on overall effect
2
2
2
2
–––
8
–––
(b)
For each explanation
2
–––
4
–––
(c)
Paper cost CB
Paper cost TJ
Printing ink cost CB
Printing ink cost TJ
Machine cost CB
Machine cost TJ
Overhead OAR
Overhead cost CB
Overhead cost TJ
Margins
1/
2
1/
2
1/
2
1/
2
1/
2
1/
2
(d)
1
1/
2
1/
2
1
–––
6 max 5
–––
11/2
11/2
11/2
11/2
11/2
1
–––
8
–––
25
–––
Split of rent and rates
Split of quality control
Split of production set up cost
Overhead cost per unit CB
Overhead cost per unit TJ
Direct cost as above
Maximum
23
Taha Popatia - ARTT Business School - 02134523175
3
Taha Popatia - ARTT Business School - 02134523175
Answers
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
Performance statistics
ROI
Bonus paid?
Sales Growth
Gross margin
Overheads
Net profit % on Sales
2005
13%
No
–
40%
$67,000
6·5%
2006
17·5%
Yes
0%
35%
$56,000
7%
2007
16·7%
Yes
–10%
35%
$53,000
5·6%
2008
20%
Yes
–5·6%
30%
$43,000
4·7%
The performance of store W can be assessed in various ways:
Sales Growth
Sales revenue growth is most unimpressive. We are told that the market in which PC operates is steadily growing and yet
store W has shrunk in terms of sales over the last four years. This could be poor volumes or poor prices achieved. Given the
reducing gross margin (see below), then a reducing sales price is likely. It is possible that W is subject to higher than normal
levels of competition.
Gross Margin
The gross margins have also shrunk. Reducing margins can result from sales price pressure or increases in the cost of sales
levels being incurred. Suppliers might have increased prices or labour could have got more expensive. The level of margin
has only reached the normal level once in the last four years. Clearly W is under performing.
Overhead Control
The one area that is impressive is the apparent ability of the business to reduce overheads as sales and margin have shrunk.
This is often difficult to do. It is possible that reducing these overheads could have contributed to the poor sales performance,
if (for example) quality has been affected, or one could say it reflects flexible management.
Net Margin
The net margin has also fallen, primarily due to falling gross margins as overheads have reduced. Clearly a disappointing
performance.
ROI
The ROI has improved in most years and has exceeded the 15% target in all but one year (year 1). This is simply due to the
reducing asset base as the stores assets have gradually been depreciated. Net profit levels have fallen overall and yet ROI has
increased.
It is hard to argue that the ROI figures properly reflect the performance of the store. The ROI will tend to increase as assets
get older and this will distort the financial performance picture. In a period of falling sales and weaker margins the manager
of W has been awarded bonuses in three out of four years. This is hard to justify.
(b)
The unethical manager would have needed to move profits out of 2006 and in to 2005. One immediate problem here is
having the information in good time to respond. The manager would have to be able to anticipate the 2005 poor result and
the improvement in 2006. It is likely that such a manager would have to gamble at the end of 2005 and make an adjustment
in the hope of a better year in 2006.
The manager need only move $2,000 of profit from 2006 to 2005 to achieve a 15% return in both years.
Possible methods of adjustment include:
Accelerate revenue: Sales made early in 2006 could be wrongly included in 2005. He could, for example, raise an invoice
before is normal, perhaps on the receipt of an order and before actual delivery. The invoice itself would not have to be sent
to the customer, merely filed until the second year had begun and delivery made.
Delay the recording of 2005 cost: A supplier’s invoice could be left unrecorded at the end of 2005, including it in 2006
expenses instead.
Understate a provision or accrual in 2005: This has the effect of moving cost from 2005 to 2006 (assuming that by the
end of 2006 the provision is correctly stated).
Manipulate accounting policy: Inventory values (for example) are easy targets for the unethical manager. If inventory in 2005
could be overstated this would have the effect of increasing 2005 profits at the expense 2006 profits.
9
Taha Popatia - ARTT Business School - 02134523175
1
December 2008 Answers
(c)
The forecast for store S is as follows:
Sales
Gross Profit
Overheads
Net Profit
Investment
ROI
W1
W2
2009 ($)
216,000
86,400
70,000
16,400
100,000
16·4%
2010 ($)
237,600
95,040
70,000
25,040
75,000
33·39%
2011 ($)
248,292
91,476
80,000
11,476
50,000
22·95%
2012 ($)
235,877
79,061
80,000
(939)
25,000
–3·8%
2009
18,000
12·00
2010
19,800a
12·00
2011
21,780b
11·40c
2012
21,780
10·83d
216,000
237,600
248,292
235,877
Sales Volume (units)
Sales Price ($)
Revenue ($)
(Volume x Price)
a: 18,000 (1·1) = 19,800
b: 19,800 (1·1) = 21,780
c: 12.00 (0·95) = 11.40
d: 11.40 (0·95) = 10.83
W2
Gross Profit
2009
2010
2011
2012
40% (given). Total gross profit = $216,000 x 0·4 = $86,400
40% (given). Total gross profit = $237,600 x 0·4 = $95,040
(40 – 5)/100(0·95) = 36·8421052%
Total gross profit = $248,292 x 0·368421052 = $91,476
(40 – 5 – 4·75)/(100(0·95)(0·95)) = 33·5180055%
Total gross profit = $235,877 x 0·335180055 = $79,061
Alternatively, given that variable costs are said to be constant over the four years, could calculate the variable cost in year one
and hold for the four years. Gross profit is then simply sales revenue less variable costs.
Variable costs in 2005:
$216,000 – 18,000 x VC = $86,400
VC per unit = $7·20
So year two gross profit will be:
$237,600 – 19,800 x 7·2 = $95,040
(d)
In order for a bonus to be paid in 2012 an ROI of 15% is needed. This implies a net profit of $25,000 x 15% = $3,750.
Adding overheads of $80,000 to this net profit means that $83,750 of gross profit is needed. At a gross profit % of 33·518%
this implies sales of $249,866.
At a price of $10·83 this suggests sales volume of 23,072 units.
2
(a)
Maximax stands for maximising the maximum return an investor might expect. An investor that subscribes to the maximax
philosophy would generally select the strategy that could give him the best possible return. He will ignore all other possible
returns and only focus on the biggest, hence this type of investor is often accused of being an optimist or a risk-taker.
Maximin stands for maximising the minimum return an investor might expect. This type of investor will focus only on the
potential minimum returns and seek to select the strategy that will give the best worst case result. This type of investor could
be said to be being cautious or pessimistic in his outlook and a risk-avoider.
Expected value averages all possible returns in a weighted average calculation.
For example if an investor could expect $100 with a 0·3 probability and $300 with a 0·7 probability then on average the
return would be:
(0·3 x $100) + (0·7 x $300) = $240
This figure would then be used as a basis of the investment decision. The principle here is that if this decision was repeated
again and again, then the investor would get the EV as a return. Its use is more questionable for use on one-off decisions.
(Note: you were not asked for a critique of this method.)
(b)
Profit calculations
Capacity
Low Demand (120)
High Demand (190)
Small Van
100
300 w1
300 w2
Medium Van
150
468 w3
500 w4
10
Large Van
200
368 w5
816 w6
Taha Popatia - ARTT Business School - 02134523175
W1
Workings
Sales
VC
Goodwill
VC adjustment
Depreciation
Profit
(c)
W1
1,000
(400)
(100)
W2
1,000
(400)
(100)
(200)
300
(200)
300
W3
1,200
(480)
48
(300)
468
W4
1,500
(600)
(100)
(300)
500
W5
1,200
(480)
W6
1,900
(760)
48
(400)
368
76
(400)
816
Which type of van to buy?
If they are more pessimistic, then they would focus on the minimum expected returns and choose the medium van as the
worst possible result is $468, which is better than the other options. We are also told that the business managers are
becoming more cautious and so a maximin criterion may be preferred by them.
Expected values could be calculated thus:
Small van
Medium van ($468 x 0·4) + ($500 x 0·6) =
Large van ($368 x 0·4) + ($816 x 0·6) =
$300
$487
$637
Given SH is considering replacing a number of vans you could argue that an EV approach has merit (not being a one-off
decision – assuming individual booking sizes are independent of each other).
The final decision lies with the managers, but, given what we know about their cautiousness, a medium sized van would
seem the logical choice. The small van could never be the correct choice.
(d)
3
(a)
Methods of uncertainty reduction:
–
Market research. This can be desk-based (secondary) or field-based (primary). Desk-based is cheap but can lack focus.
Field-based research is better in that you can target your customers and your product area, but can be time consuming
and expensive. The internet is bringing down the cost and speeding up this type of research, email is being used to
gather information quickly on the promise of free gifts etc.
–
Simulation. Computer models can be built to simulate real life scenarios. The model will predict what range of returns
an investor could expect from a given decision without having risked any actual cash. The models use random number
tables to generate possible values for the uncertainty the business is subject to. Again, computer technology is assisting
in bringing down the cost of such risk analysis.
–
Sensitivity analysis. This can be used to assess the range of values that would still give the investor a positive return.
The uncertainty may still be there, but the affect that it has on the investor’s returns will be better understood. Sensitivity
calculates the % change required in individual values before a change of decision results. If only a (say) 2% change is
required in selling price before losses result an investor may think twice before proceeding. Risk is therefore better
understood.
–
Calculation of worst and best case figures. An investor will often be interested in range. It enables a better
understanding of risk. An accountant could calculate the worst case scenario, including poor demand and high costs
whilst being sensible about it. He could also calculate best case scenarios including good sales and minimum running
costs. This analysis can often reassure an investor. The production of a probability distribution to show an investor the
range of possible results is also useful to explain risks involved. A calculation of standard deviation is also possible.
There are various issues that HC should consider in making the bid. (Only five are required for two marks each.)
Contingency allowance. HC should consider the extent to which its estimates are accurate and hence the degree of
uncertainty it is subjected to. It may be sensible to allow for these uncertainties by adding a contingency to the bid.
Competition. HC must consider which other businesses are likely to bid and recognise that the builder may be able to choose
between suppliers. Moreover, HC has not worked for this builder before, and so they will probably find the competition stiff
and the lack of reputation a problem.
Inclusion of fixed overhead. In the long run fixed overhead must be covered by sales revenue in order to make a profit. In
the short run it is often correctly argued that the level of fixed cost in a business may not be affected by a new contract and
therefore could be ignored in bid calculation. HC needs to consider to what extent the fixed costs of its business will change
if it wins this new contract. It is these incremental fixed costs that are relevant to a bid calculation.
Materials and loose tools. No allowance has been made for the use of tools and the various fixings (screws etc) that will be
needed to assemble and fit the kitchens. It is possible that most fixings would be provided with the kitchen units, but HC
should at least consider this.
Supervision of labour. The time given in the question is 24 hours to ‘fit’ the first kitchen. There seems no allowance for
supervision of the labour force. It could, of course, be included within the overhead figures but no detail is shown.
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This depends on the risk attitude of the investor. If they are optimistic about the future then the maximax criteria would suggest
that they choose the large van as this has the potentially greatest profit.
Idle time. It is common for building works to be delayed by lack of materials for example. The labour time figure needs to
reflect this.
Likelihood of repeat business. Some businesses consider it worthwhile to accept a low price for a new contract if it establishes
a reputation with a new buyer. HC could offer to do this work cheaper in the hope of more profitable work later on.
The risk of non-payment. HC may decide not to bid at all if it feels that the builder may struggle to pay.
Opportunity costs of alternate work.
Possibility of working in overtime.
Bid calculations for HC to use as a basis for the apartment contract.
Cost
Hours
Labour
Variable Overhead
Fixed Overhead
9,247
9,247
9,247
Rate per hour
(W1)
$15
$8
$4
(W2)
(W2)
Total Cost
Total
$
138,705
73,976
36,988
––––––––
249,669
––––––––
(W1)
Need to calculate the time for the 200th kitchen by taking the total time for the 199 kitchens from the total time for 200
kitchens.
For the 199 Kitchens
Using
y = axb
y = 24x199–0.074
y = 16·22169061hours
Totaltime = 16·22169061x199
Totaltime = 3,228·12hours
OR
y = axb
y = (24 x 15) x 199–0.074
y = 243·32536
Total cost = $48,421·75
OR
y = axb
y = (24 x 15) x 200–0.074
y = 243·2351198
Total cost = $48,647·02
200th cost = $225·27
For the 200 Kitchens
y = axb
y = 24x200–0.074
y = 16·21567465hours
Totaltime = 16·21567465x200
Totaltime = 3,243·13hours
The 200th Kitchen took 3,243·13 – 3,228·12 = 15·01 hours
Total time is therefore:
For first 200
For next 400
Total
3,243·13 hours
6,004·00 hours
9,247·13 hours (9,247 hours)
(15·01 hours x 400)
(W2)
The overheads need to be analysed between variable and fixed cost elements.
Taking the highest and lowest figures from the information given:
Highest
Lowest
Difference
Hours
9,600
9,200
400
Cost $
116,800
113,600
3,200
Variable cost per hours is $3,200/400hours = $8 per hour
Total cost = variable cost + fixed cost
116,800 = 9,600 x 8 + fixed cost
Fixed cost = $40,000 per month
Annual fixed cost = $40,000 x 12 = $480,000
Fixed absorption rate is $480,000/120,000 hours = $4 per hour
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(b)
(c)
A table is useful to show how the learning rate has been calculated.
Number of
Kitchens
1
2
Time for Kitchen
(hours)
24·00
21·60
Cumulative time
(hours)
24·00
45·60
Average time
(hours)
24·00
22·80
The learning rate is calculated by measuring the reduction in the average time per kitchen as cumulative production doubles
(in this case from 1 to 2).
The learning rate is therefore 22·80/24·00 or 95%
(a)
Lifecycle costing is a concept which traces all costs to a product over its complete lifecycle, from design through to cessation.
It recognises that for many products there are significant costs to be incurred in the early stages of its lifecycle. This is probably
very true for Wargrin Limited. The design and development of software is a long and complicated process and it is likely that
the costs involved would be very significant.
The profitability of a product can then be assessed taking all costs into consideration.
It is also likely that adopting lifecycle costing would improve decision-making and cost control. The early development costs
would have to be seen in the context of the expected trading results, therefore preventing a serious over spend at this stage
or under pricing at the launch point.
(b)
Budgeted results for game
Sales
Variable cost (W1)
Fixed cost (W1)
Marketing cost
Profit
Year 1 ($)
240,000
40,000
80,000
60,000
–––––––
60,000
–––––––
Year 2 ($)
480,000
80,000
120,000
40,000
––––––––
240,000
––––––––
Year 3 ($)
120,000
20,000
80,000
–––––––
20,000
–––––––
Total ($)
840,000
140,000
280,000
100,000
––––––––
320,000
––––––––
On the face of it the game will generate profits in each of its three years of life. Games only have a short lifecycle as the game
players are likely to become bored of the game and move on to something new.
The pattern of sales follows a classic product lifecycle with poor levels of sales towards the end of the life of the game.
The Stealth product has generated $320,000 of profit over its three year life measured on a traditional basis. This represents
40% of turnover – ahead of its target. Indeed it shows a positive net profit in each of its years on existence.
The contribution level is steady at around 83% indicating reasonable control and reliability of the production processes. This
figure is better than the stated target.
Considering traditional performance management concepts, Wargrin Limited is likely to be relatively happy with the game’s
performance.
However, the initial design and development costs were incurred and were significant at $300,000 and are ignored in the
annual profit calculations. Taking these into consideration, the game only just broke even, making a small $20,000 profit.
Whether this is enough is debatable, it represents only 2·4% of sales for example. In order to properly assess the performance
of a product the whole lifecycle needs to be considered.
Workings
W1 Split of variable and fixed cost for Stealth
High
Low
Difference
Volume
14,000 units
10,000 units
4,000 units
Cost $
150,000
130,000
20,000
Variable cost per unit = $20,000/4,000 unit = $5 per unit
Total cost = fixed cost + variable cost
$150,000 = fixed cost + (14,000 x $5)
$150,000 = fixed cost +$70,000
Fixed cost = $80,000 (and $120,000 if volume exceeds 15,000 units in a year.)
(c)
Incremental budgeting is a process whereby this year’s budget is set by reference to last year’s actual results after an
adjustment for inflation and other incremental factors. It is commonly used because:
–
–
–
It is quick to do and a relatively simple process.
The information is readily available, so very limited quantitative analysis is needed.
It is appropriate in some circumstances. For example, in a stable business, the amount of stationery spent in one year
is unlikely to be significantly different in the next year, so taking the actual spend in year one and adding a little for
inflation should be a reasonable target for the spend in the next year.
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4
There are problems involved with incremental budgeting:
–
–
–
–
–
Design and development costs: Setting a standard cost for this classification of cost would be very difficult. Presumably each
game would be different and present the program writers with different challenges and hence take a varying amount of time.
Variable production cost: A game will be produced on a CD or DVD in a fairly standard format. Each CD/DVD will be identical
and as a result setting a standard cost would be possible. Allowance might need to be made for waste or faulty CDs produced.
Some machine time will be likely and again this should be the same for all items and therefore setting a standard would be
valid.
Fixed production cost: The standard fixed production cost of a game will be the product of the time taken to produce the
game and the standard fixed overhead absorption rate for the business. This brings into question whether this is ‘meaningful’.
Allocating fixed costs to products in a standard way may not provide meaningful data. It can sometimes imply a variability
(cost per unit) that is not the case and can therefore confuse non-accountants, causing poor decisions. The time per unit will
be fairly standard.
Marketing costs: Games may have different target audiences and therefore require different marketing strategies. As such
setting a standard may be difficult to do. It may be possible to set standards for each marketing media chosen. For example
the rates for a page advert in a magazine could be set as a standard.
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(d)
It builds on wasteful spending. If the actual figures for this year include overspends caused by some form of error then
the budget for the next year would potentially include this overspend again.
It encourages organisations to spend up to the maximum allowed in the knowledge that if they don’t do this then they
will not have as much to spend in the following year’s budget.
Assessing the amount of the increment can be difficult.
It is not appropriate in a rapidly changing business.
Can ignore the true (activity based) drivers of a cost leading to poor budgeting.
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
Calculations of performance statistics (1/2 each max 21/2)
Sales comment
Gross margin comment
Overheads comment
Net margin comment
ROI discussion
Marks
21/2
1
1
1
1
3
–––
Max
(b)
8
Timing of decision problem
Revenue acceleration
Delay of cost
Manipulation of accounting policy
1
1
1
1
–––
4
(c)
11/2
11/2
1/
2
1/
2
1/
2
1/
2
1
2
1
–––
Sales volume
Sales price
Gross profit year 1
Gross profit year 2
Gross profit year 3
Gross profit year 4
Overhead included
Investment values
ROI calculations
9
(d)
Target net profit
Target gross profit
Target sales
Target volume
1
1
1
1
–––
4
–––
25
–––
Total
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1
December 2008 Marking Scheme
2
(a)
Marks
1
1
2
–––
Maximax explanation
Maximin explanation
Expected value explanation
4
(b)
Profit calculations
Small van sales
Small van VC
Small van goodwill or VC adjustment
Small van depreciation
Medium van – as above for small van
Large van as above for small van
1/
2
1/
2
1
1
3
3
–––
(c)
Optimist view
Pessimist view
Expected value calculation
Expected value discussion
2
2
1
1
–––
6
(d)
11/2
11/2
11/2
11/2
–––
Market Research
Simulation
Sensitivity
Range
6
–––
25
–––
Total
3
(a)
For each description
2
–––
10
(b)
Average time for 199th kitchen
Total time for 199 kitchens
Average time for 200th kitchen
Total time for 200 kitchens
200th kitchen time
Cost for first 200
Cost for next 400
Variable cost per hour
Fixed cost per month
Fixed cost per hour
Cost for variable overhead
Cost for fixed overhead
1
1
1
1
1
1
1
2
1
1
1
1
–––
13
(c)
Average time per unit
Explanation
1
1
–––
2
–––
25
–––
Total
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9
Marks
(a)
Lifecycle costing principles:
Performance assessment over whole life
Improved decision making/cost control
Relate to Wargrin
1
1
2
–––
4
(b)
Sales
Variable cost
Fixed cost
Marketing cost
Comments on profit performance (against stated targets)
Consideration of all lifecycle costs
1
1
2
1
2
2
–––
9
(c)
Why incremental budgeting common – per idea (max 3)
Problems of incremental budgets – per idea (max 3)
1
1
–––
6
(d)
11/2
–––
Discussion of each component
Max
6
–––
25
–––
Total
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4
Fundamentals Level – Skills Module, Paper F5
Performance Management
1
Yam Co
(a)
The output capacity for each process is as follows:
June 2009 Answers
The total processing hours of the factory is given but can be proven as follows:
18 hours x 5 days x 50 weeks x 50 production lines = 225,000 hours.
Given this, the production capacity for pressing must be 225,000 hours/0·5 hours per metre = 450,000 metres. Using this
method the production capacity for all processes is as follows:
Product B
450,000
562,500
900,000
Product C
562,500
900,000
900,000
The bottleneck is clearly the pressing process which has a lower capacity for each product. The other processes will probably
be slowed to ensure smooth processing.
Clearly an alternative approach is simply to look at the original table for processing speed and pick out the slowest process.
This is pressing. (full marks available for that explained observation)
(b)
TPAR for each product
Product A
70·0
3·0
67·0
134·0
90·0
1·49
Product B
60·0
2·5
57·5
115·0
90·0
1·28
Product C
27·0
1·8
25·2
63·0
90·0
0·7
67/0·5 = 134
57·5/0·5 = 115
25·2/0·4 = 63
Selling price
Raw materials
Throughput
Throughput per bottleneck hour*
Fixed costs per hour (W1)
TPAR
Working*
W1 The fixed cost per bottleneck hour can be calculated as follows:
Total fixed costs are $18,000,000 plus the labour cost. Labour costs $10 per hour for each of the 225,000 processing
hours, a cost of $2,250,000.
Total fixed cost is therefore $18,000,000 + $2,250,000 = $20,250,000
Fixed cost per bottleneck hours is $20,250,000/225,000 = $90 per hour
(c)
(i)
Yam could improve the TPAR of product C in various ways:
Speed up the bottleneck process. By increasing the speed of the bottleneck process the rate of throughput will also
increase, generating a greater rate of income for Yam if the extra production can be sold. Automation might be used or
a change in the detailed processes. Investment in new machinery can also help here but the cost of that would need to
be taken into account.
Increase the selling prices. It can be difficult to increase selling prices in what we are told is a competitive market.
Volume of sales could be lost leaving Yam with unsold stock or idle equipment. On the other hand, given the business
appears to be selling all it can produce, then a price increase may be possible.
Reduce the material prices. Reducing material prices will increase the net throughput rate. Metal is available from many
sources being far from a unique product. Given the industry is mature the suppliers of the raw material could be willing
to negotiate on price; this could have volume or quality based conditions attached. Yam will have to be careful to protect
its quality levels. Bulk buying increases stock levels and the cost of that would need to be considered.
Reduce the level of fixed costs. The fixed costs should be listed and targets for cost reduction be selected. ABC
techniques can help to identify the cost drivers and with management these could be used to reduce activity levels and
hence cost. Outsourcing, de-skilling or using alternative suppliers (for stationery for example) are all possible cost
reduction methods.
(ii)
A TPAR of less than one indicates that the rate at which product C generates throughput (sales revenue less material
cost) is less than the rate at which Yam incurs fixed cost. So on a simple level, producing a product which incurs fixed
cost faster than it generates throughput does not seem to make commercial sense. Clearly the TPAR could be improved
(using the methods above) before cessation is considered any further.
However, cessation decisions involve consideration of many wider issues (only three required).
–
–
Long-term expected net cash flows from the product allowing for the timing of those cash flows (NPV) are an
important factor in cessation decisions
Customer perception could be negative in that they will see a reduction in choice
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Product A
450,000
900,000
562,500
Pressing
Stretching
Rolling
–
–
–
Oliver’s Salon
(a)
The average price for hairdressing per client is as follows:
2008: Female clients paid $200,000 for 8,000 visits. This is an average price per visit of $200,000/8,000 = $25.
In 2009 the female hairdressing prices did not increase and the mix of sales did not change so of the total revenue $170,000
(6,800 x $25) was from female clients. This means that the balance of $68,500 ($238,500 – $170,000) was from male
clients at an average price of $20 per visit ($68,500/3,425).
(b)
Financial performance assessment
Hairdressing sales growth: Oliver’s Salon has grown significantly during the two years, with an increase of 19·25% (W1).
This is impressive in a mature industry like hairdressing.
The increase has come from the launch of the new male hairdressing with a significant contraction in the core female business
– down 15% (W1).
Hairdressing gross margin: Oliver’s hairdressing overall gross margin has reduced significantly, down from 53% to 47·2% in
2009 (W2).
There has been an increase in staff numbers for the female part of the business and this, combined with the fall in the volume
of sales from female clients, has significantly damaged margins from that customer type, with a fall from 53% to 40·5%
(W2).
The margins from male clients in 2009 are 63·5% which is better than that achieved in 2008 from the female clients. This
is probably mainly due to faster throughput, so that despite the lower average prices charged the overall margin was still quite
good.
Staff costs: The staffing levels have had to increase to accommodate the new male market and the extra levels of business.
The new hairdresser for the male clients is being paid slightly more than the previously employed staff (W3). This might
encourage dissatisfaction. The addition of a junior will clearly reduce the overall average wage bill but increases costs overall
whilst the volume of female clients is shrinking.
Advertising spend: This has increased by 150% in the year (W4). This is probably nothing to worry about as it is likely that
the launching of the new product range (males!) will have required advertising. Indeed, given the increase in sales of male
hair services it is fair to say that the money was well spent.
Rent is clearly a fixed cost and administrative expenses have gone up a mere 5·5%; these costs appear under control given
the overall volume of clients is well up on 2008.
Electricity costs have jumped 14·3% which seems a lot but is probably a cost which Oliver would find hard to control. Energy
companies are often very large organisations where competition is rarely significant. Small businesses have little choice but
to pay the going rate for energy.
Net Profit: Overall net profit has worsened to 33·5% from 39% (W8). This is primarily due to the weakening gross margin
and extra costs incurred for advertising. The advertising cost may not recur and so the net margin might improve next year.
Overall it is understandable that Oliver is disappointed with the financial results. With a 19·25% increase in overall sales he
might have expected more net profit.
(c)
Non-financial performance
Quality: The number of complaints is up by 283% (W5) and is proportionately more frequent. This seems to be due to two
main reasons. Firstly the switch away from a single gender salon has upset the existing customer base. It is possible that by
trying to appeal to more customer types Oliver is failing to meet the needs of at least one group. It may be that the quality of
hair services has not worsened but that the complaints are regarding the change towards a multi-gender business.
Secondly the wage rates paid to the new junior staff seem to be well below the wage rates of the existing staff (W3). This
implies that they are in training and could be of poorer quality. It is stated that they are in a supporting role but if not properly
supervised then mistakes could easily occur. This can easily lead to complaints from dissatisfied customers.
Resource utilisation: The main resources that Oliver has are the staff and the rented property. As far as the property is
concerned the asset is being used to a much higher degree with 27·8% more clients being serviced in the year (W6).
However, as the overall margins are lower one might argue that just focusing solely on volume misses the point on asset
utilisation.
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2
Lost related sales: if product C is lost will Yam lose customers that bought it along with another product?
What use could be made of the excess capacity that is created
Throughput assumes that all costs except raw materials are fixed; this may not necessarily be the case and only
avoidable fixed costs need to be taken into account for a cessation decision. If few fixed costs can be avoided then
product C is making a contribution that will be lost if the product ceased.
As far as the staff usage is concerned it is a mixed scene. The female specialists are producing less per member of staff than
in 2008 after the recruitment of one more staff member and a fall in volume of female clients. Each specialist served 2,000
female clients in 2008 and only 1,360 in 2009 (W9). Oliver may have been concerned with the complaints coming in and
decided to do something about service levels by increasing resources for the female clients.
The specialist dealing with male clients has produced far more treatments than those serving the females. This is probably
not unusual; we are told that the male customer requires only a simple service. Without comparative data we cannot say
whether 3,425 customers per year is good. We also cannot say that this specialist is doing ‘better’ than the others. Cutting
men’s hair is quicker to do, so more output is inevitable.
Workings:
(W1) Sales growth overall is $238,500/$200,000 or +19·25%. The female hairdressing sales has though fallen by 15%
($200,000 – $170,000)/$200,000. This is entirely reflected in volume as there was no price increase in 2009 for
female clients.
This can be analysed between the female and male clients:
2008
Sales
Less cost of sales:
Hairdressing staff costs (W3)
Hair products – female
Hair products – male
Gross profit
GP%
Female $
200,000
2009
$
Female $
170,000
Male $
68,500
(65,000)
(29,000)
(74,000)
(27,000)
(17,000)
––––––––
106,000
––––––––
53%
–––––––
69,000
–––––––
40·5%
(8,000)
–––––––
43,500
–––––––
63·5%
(W3) Staff cost growth is $91,000/$65,000 or +40%. In absolute terms average staff costs were $65,000/4 = $16,250
in 2008.
Additional staff cost $26,000 ($91,000 – $65,000) in total for two people. The junior was paid $9,000 and so the
new specialist for the male customers must have been paid $17,000
(W4) Advertising increased by $5,000/$2,000 or 150%
(W5) Number of complaints up by 46/12 or 283%. Complaints per customer visit up from 12/8,000 or 0·15% to
46/10,225 or 0·44%
(W6) Client growth is 10,225/8,000 or 27·8%
(W7) Number of female clients per specialist is 8,000/4 or 2,000 in 2008 and 6,800/5 or 1,360 in 2009. Number of male
clients per specialist is 3,425 in 2009.
(W8) Net profit is $78,000/200,000 or 39% in 2008 and $80,000/238,500 or 33·5% in 2009.
3
Crumbly Cakes
(a)
Production manager
Assessing the performance of the two managers is difficult in this situation. In a traditional sense the production manager has
seriously over spent in March following the move to organic ingredients. He has a net adverse variance against his department
of $2,300 in one month. No adjustment to the standards has been made to allow for the change to organic.
The manager has not only bought organically he has also changed the mix, increasing the input proportion of the more
expensive ingredients. This may have contributed to the increased sales of cakes.
However, the decision to go organic has seen the sales of the business improve. We are told that the taste of the cakes should
be better and that customers could perceive a health benefit. However, the production manager is allocated none of the
favourable sales variances that result. If we assume that the improved sales are entirely as a result of the production
manager’s decision to change the ingredients then the overall net favourable variance is $7,700.
The production manager did appear to be operating within the original standard in February, indicating a well performing
department. Indeed he will have earned a small bonus in that month.
Sales manager
A change to organic idea would need to be ‘sold’ to customers. It would presumably require a change of marketing and proper
communication to customers. The sales manager would probably feel he has done a good job in March. It is debatable,
however, whether he is entirely responsible for all of the favourable variances.
The move to organic certainly helped the sales manager as in February he seems to have failed to meet his targets.
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(W2) Gross margin overall is $106,000/$200,000 or 53% in 2008 and $112,500/238,500 or 47·2% in 2009.
Bonus scheme
The problem here is that the variances have to be allocated to one individual. The good sales variances have been allocated
to the sales manager when in truth the production manager’s decision to go organic appears to have been a good one and
the driver of the business success. Responsibility accounting systems struggle to cope with ‘joint’ success stories, refuting in
general a collective responsibility.
Under the current standards the production manager has seemingly no chance to make a bonus. The main problems appear
to be the out-of-date standards and the fact that all sales variances are allocated to the sales manager, despite the root cause
of the improved performance being at least in part the production manager’s decision to go organic. The system does not
appear fair.
General comments
It would appear that some sharing of the total variances is appropriate. This would be an inexact science and some negotiation
would be needed.
(b)
Variance calculations
Material price variances
Ingredient
Act price/kg
Flour
Eggs
Butter
Sugar
0·13
0·85
1·80
0·60
Std price/kg
0·12
0·70
1·70
0·50
Total
Material mix variance
Ingredient
Act mix
Flour
5,700
Eggs
6,600
Butter
6,600
Sugar
4,578
–––––––
Totals
23,478
–––––––
Std mix
5,870
5,870
5,870
5,870
–––––––
23,478
–––––––
Material yield variance
Actual yield
Standard yield (23,478/0·4)
Difference
Standard cost of a cake (W1)
Yield variance (1,305 * 0·302)
Sales price variance
Act price
Cake
0·99
Standard weight/cost of a cake
Adv or Fav
Std price
0·12
0·70
1·70
0·50
Variance
–20
511
1,241
–646
––––––
1,086
––––––
Adv or Fav
(AP – SP)
* Act Vol
Variance
8,400
Adv or Fav
Adv
Adv
Adv
Adv
Adv
Adv
60,000 cakes
58,695 cakes
1,305 cakes
$0·302
394 Fav
Std Price
Act volume
0·85
60,000
Sales volume contribution variance
Actual volume
Budget volume
Standard contribution
Variance (60,000 – 50,000) * 0·35 =
W1
Standard cost of a cake
Ingredients
Flour
Eggs
Butter
Sugar
Total input
Normal loss (10%)
Actual
(AP – SP) x AQ
quantity kg
MPV
5,700
57
6,600
990
6,600
660
4,578
458
––––––
2,165
––––––
Kg
0·10
0·10
0·10
0·10
0·40
(0·04)
–––––
0·36
60,000 cakes
50,000 cakes
0·35
$3,500 Fav
$
$0·12 per kg
$0·70 per kg
$1·70 per kg
$0·50 per kg
Cost
0·012
0·070
0·170
0·050
0·302
0·302
16
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Taha Popatia - ARTT Business School - 02134523175
One problem seems to be that the original standards were not changed following the decision to go organic. In this sense the
variances reported are not really ‘fair’. Standards should reflect achievable current targets and this is not the case here.
Bits and Pieces
(a)
The decision to open on Sundays is to be based on incremental revenue and incremental costs:
Incremental revenue
Incremental costs
–
Cost of sales
–
Staff
–
Lighting
–
Heating
–
Manager’s bonus
–
Total
Ref
W1
$
W2
W3
W4
W5
W6
335,000
45,000
9,000
9,000
8,000
$
800,000
406,000
––––––––
394,000
––––––––
Net incremental revenue
Conclusion
On the basis of the above it is clear that the incremental revenue exceeds the incremental costs and therefore it is financially
justifiable.
(W1) Incremental revenue
Day
Average
Sunday (+60% of average)
Annually (50 days)
Current results (300 days)
New results
Sales
$
10,000
16,000
800,000
3,000,000
3,800,000
Gross profit Gross profit
%
$
70%
50%
8,000
400,000
70·0%
2,100,000
65·8%
2,500,000
Cost of Sales
$
8,000
400,000
(W2) Purchasing and discount on purchasing
Extra purchasing from Sunday trading is $800,000 – $400,000 = $400,000
Current annual purchasing is $18,000 x 50 =$900,000
New annual purchasing is ($900,000 + $400,000) x 0·95 = $1,235,000
Incremental cost is $1,235,000 – $900,000 = $335,000 (a $65,000 discount)
(W3) Staff costs
Staff costs on a Sunday are 5 staff x 6 hours x $20 per hour x 1·5 = $900 per day
Annual cost is $900 x 50 days = $45,000
(W4) Lighting costs
Lighting costs are 6 hours x $30 per hour x 50 days = $9,000
(W5) Heating costs
Heating cost in winter is 8 hours x $45 per hour x 25 days = $9,000
(W6) Manager’s bonus
This is based on the incremental revenue $800,000 x 1% = $8,000 (or $160 per day)
(b)
The manager’s rewards can be summarised as follows:
Time off
This appears far from generous. The other staff are being paid time and a half and yet the manager does not appear to have
this option and also is only being given time off in lieu (TOIL) at normal rates. Some managers may want their time back as
TOIL so as to spend time with family or social friends; others may want the cash to spend. One would have thought some
flexibility would have been sensible if the manager is to be motivated properly.
Bonus
The bonus can be calculated at $8,000 per annum (W6); on a day worked basis, this is $160 per day. This is less than that
being paid to normal staff; at time and a half they earn 6 hours x $20 x 1·5 = $180 per day. It is very unlikely to be enough
to keep the presumably better qualified manager happy. Indeed the bonus is dependent on the level of new sales and so there
is an element of risk involved for the manager. Generally speaking higher risk for lower returns is far from motivating.
The level of sales could of course be much bigger than is currently predicted. However, given the uplift on normal average
daily sales is already +60%, this is unlikely to be significant.
(c)
Discounts and promotion
When new products or in this case opening times are launched then some form of market stimulant is often necessary. B&P
has chosen to offer substantial discounts and promotions. There are various issues here:
Changing buying patterns: It is possible that customers might delay a purchase a day or two in order to buy on a Sunday.
This would cost the business since the margin earned on Sunday is predicted to be 20% points lower than on other days.
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Taha Popatia - ARTT Business School - 02134523175
4
Complaints: Customers that have already bought an item on another day might complain when they see the same product
on sale for much less when they come back in for something else on a Sunday. Businesses need to be strong in this regard
in that they have to retain control over their pricing policy. Studies have shown that only a small proportion of people will
actually complain in this situation. More might not, though, be caught out twice and hence will change the timing of
purchases (as above).
Quality: The price of an item can say something about its quality. Low prices tend to suggest poor quality and vice versa.
B&P should be careful so as not to suggest that lower prices do not damage the reputation of the business as regards quality.
Northland
(a)
Overhead costs for the 2010 budget:
Property cost = $120,000 x 1·05 = $126,000
Central wages = ($150,000 x 1·03) + $12,000 = $166,500
Stationery = $25,000 x 0·6 = $15,000
(b)
The road repair budget will be based on 2,200 metres of road repairs; it is common to include a contingency in case roads
unexpectedly need repair (see part (c)).
The weather conditions could add an extra cost to the budget if poor or bad conditions exist. The adjustment needed is based
on an expected value calculation:
(0·7 x 0%) + (0·1 x 10%) + (0·2 x 25%) = 6%
Hence the budget (after allowing for a 5% inflation adjustment) will be:
2,200 x $15,000 x 1·06 x 1·05 = $36,729,000
This could be shown as:
(2,200 x 15,000 x 1·0 x 0·7) + (2,200 x 15,000 x 1·1 x 0·1) + (2,200 x 15,000 x 1·25 x 0·2) = $34,980,000
The $34,980,000 could then be adjusted for inflation at 5% to give $36,729,000 as above.
(c)
An expected value calculation used in budgeting has the following problems associated with it:
–
–
–
–
It is often difficult to estimate the probabilities associated with different (in this case) weather conditions. The weather
in one year may not reflect the weather in the following year leading to wildly inaccurate estimates and hence budgeting
errors.
It is difficult to estimate the precise monetary value attaching to each of the outcomes. ‘Bad’ weather can presumably
take many forms (extreme cold, heat or water); the effect of each of these could be difficult to assess. Whilst using
expected values it is common to group the events together and have one probability estimate. This may prove inadequate
or inaccurate.
The expected value that is calculated might not reflect the true cost leading to over or under spends on budget.
The managers will have an easy fallback position should the budgets turn out to be incorrect. It would probably be
accepted that the weather (and hence the probability of it) is outside their control and over spends could not then be
blamed on them.
A contingency is often added to a budget in the event that there is uncertainty on the likely spend. In this case there would
be much uncertainty over the level and indeed type of road repairs required. Roads could be damaged by weather conditions
(extreme cold or heat) or unexpected land movements (earthquakes). Public safety could be at risk meaning that a repair is
essential. This could result in a higher spend.
Equally the type of repair needed would vary and be unpredictable. Small holes might be simply filled in but larger holes or
cracks might involve repairs to the foundations of the road. The costs could differ considerably between the different types of
repairs.
(d)
Zero based budgeting involves three main steps:
–
Define decision packages. These are detailed descriptions of the activities to be carried out. There will be some
standardisation within the data to allow comparison with other activities (costs, time taken and so on). A cost-benefit
analysis is often carried out at this stage to ensure the most cost effective and beneficial approach to the activity is taken.
–
Evaluation and ranking of activities. Each activity is assessed; those that are perhaps part of a legal obligation become
‘must do’ activities; others may be viewed as discretionary. The LGO will have to decide which of the activities offer the
greatest value for money (VFM) or the greatest benefit for the lowest cost.
–
Allocation of resource. The budget will then be created for the accepted activities.
18
Taha Popatia - ARTT Business School - 02134523175
5
Fundamentals Level – Skills Module, Paper F5
Performance Management
1
(a)
June 2009 Marking Scheme
Marks
1
2
–––
Identification of bottleneck
Explanation
Marks
3
Sales prices (per product)
Raw material cost (per product)
Throughput per bottleneck hour (per product)
Fixed costs
Fixed cost per hour
TPAR (per product)
0·5
0·5
0·5
1·5
0·5
0·5
–––
8
(c)
(i)
Increase speed of bottleneck
Increase selling prices – difficult to do
Reduce material prices
Reduce level of fixed costs
1
1
1
1
–––
4
(ii)
Explain a TPAR
Long-term cash flows
Lost related sales
Use of spare capacity
Fixed costs
Any other reasonable factor e.g. lost contribution
2
1
1
1
1
1
–––
Maximum
5
–––
20
–––
Total
2
(a)
Average price for female customers
Average price for male customers
1
2
–––
3
(b)
Sales growth
Gross margin
Rent
Advertising spend
Staff costs
Electricity
Overall comment
2
2
1
2
2
1
1
–––
11
(c)
Quality – single gender
Quality – wage levels
Quality – other
Resource utilisation – property
Resource utilisation – staff
Resource utilisation – other
1·5
1·5
1·5
1
2
1·5
–––
Maximum
6
–––
20
–––
Total
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(b)
3
(a)
Marks
2
2
3
–––
Production manager assessment
Sales manager assessment
Bonus scheme comment
Marks
7
Price variance
Mix variance
Yield variance
Sales price variance
Sales volume variance
3
3
3
2
2
–––
13
–––
20
–––
Total
4
(a)
Existing total sales
New sales
Incremental sales
Existing purchasing
Discount allowed for
Incremental Sunday purchasing costs
Staff cost
Lighting cost
Heating cost
Manager’s bonus
1
1
1
1
1
1
1
1
1
1
–––
Maximum
(b)
12
Time off at normal rate not time and a half
Lack of flexibility
Bonus per day worked calculation and comment
Risk
1
1
1
1
–––
4
(c)
Changing customer buying pattern
Complaints risk
Quality link
2
2
2
–––
Maximum
4
–––
20
–––
Total
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(b)
(a)
Marks
1
1
1
–––
Property cost
Central wages
Stationery
Marks
3
(b)
Basic budget
Contingency included
Expected value adjustment
2
2
2
–––
6
(c)
Probability estimates difficult
Monetary values uncertain
EV not an actual value
Easy fall back for managers
Contingency
Uncertainty issue
Weather
Other outside influences
Type of repairs variable
1
1
1
1
1
1
1
1
–––
8
(d)
Explanation of ZBB process
3
–––
3
–––
20
–––
Total
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Taha Popatia - ARTT Business School - 02134523175
5
Fundamentals Level – Skills Module, Paper F5
Performance Management
1
(a)
December 2009 Answers
The total variances are as follows:
Total price variance = ($5.25 – $4)3,500kg = $4,375 Adverse
Total usage variance = (3,500 – 4,000)4 = $2,000 Favourable
This makes a total of $2,375 Adverse
(b)
The planning variances are calculated by comparing the original budget and the revised standards after adjustment for factors
outside the control of the organisation.
On this basis the revised standards would be a price of $4·80 per kg with revised usage at 42g per card.
Planning price variance = ($4·80 – $4)4,200 = $3,360 Adverse
The total planning error (variance) is $4,160 Adverse
The operational variances compare the actual spend with the revised budget figures.
Operational price variance = ($5·25 – $4·80)3,500kg = $1,575 Adverse
Operational usage variance = (3,500 – 4,200)$4·80 = $3,360 Favourable
The total operational variance is $1,785 Favourable
The method above is in line with the article previously written by the examiner and published in the ACCA student newsletter.
Other methods applied consistently would score full marks.
(c)
The production manager is subject to external pressures which appear beyond his control. The size of the security card has
to fit the reader of that card and if the industry specification changes there is nothing that he can do about that. This is, then,
a ‘planning’ error and should not form part of any assessment of his performance.
Equally if world-wide oil prices increase (and hence plastic prices) then the production manager cannot control that. This
would be allocated as a planning error and ignored in an assessment of his performance.
The performance of the production manager should be based on the operational variances (and any relevant qualitative
factors). The decision to use a new supplier ‘cost’ an extra $1,575 in price terms. On the face of it this is, at least potentially,
a poor performance. However, the manager seems to have agreed to the higher price on the promise of better quality and
reliability. If this promise was delivered then this could be seen as a good decision (and performance). The savings in waste
(partly represented by the usage variance) amount to $3,360 favourable. This would seem to suggest better quality. The fact
that the production level jumped from 60,000 to 100,000 also suggests that suppliers’ reliability was good (in that they were
able to deliver so much). The net variance position is relevant at a saving of $1,785.
It is also possible that such a large increase in volume of sales and production should have yielded a volume based discount
from suppliers. This should also be reflected in any performance assessment in that if this has not been secured it could be
seen as a poor performance.
This is backed up by the lack of obvious quality problems since we are told that 100,000 cards were produced and sold in
the period, a huge increase on budget. The ability of a production manager to react and be flexible can often form a part of
a performance assessment.
In conclusion the manager could be said to have performed well.
2
(a)
The average cost of the first 128 chairs is as follows:
Frame and massage mechanism
Leather
Labour
2 metres x $10/mtr x 100/80
(W1)
Total
$
51·00
25·00
20·95
––––––
96·95
––––––
Target selling price is $120.
Target cost of the chair is therefore $120 x 80% = $96
The cost gap is $96·95 – $96·00 = $0·95 per chair
(W1)
The cost of the labour can be calculated using learning curve principles. The formula can be used or a tabular approach would
also give the average cost of 128 chairs. Both methods are acceptable and shown here.
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Planning Usage variance = (4,200 – 4,000)$4 = $800 Adverse
Tabulation:
Cumulative output
(units)
1
2
4
8
16
32
64
128
Average time per
unit (hrs)
2
1·9
1·805
1·71475
1·6290125
1·54756188
1·47018378
1·39667459
Total time (hrs)
Average cost per
chair at $15 per hour
178·77
20·95
Y = axb
Y = 2 x 128–0·074000581
Y = 1·396674592
The average cost per chair is 1·396674592 x $15 = $20·95
(b)
To reduce the cost gap various methods are possible (only four are needed for full marks)
–
–
–
–
–
(c)
Re-design the chair to remove unnecessary features and hence cost
Negotiate with the frame supplier for a better cost. This may be easier as the volume of sales improve as suppliers often
are willing to give discounts for bulk buying. Alternatively a different frame supplier could be found that offers a better
price. Care would be needed here to maintain the required quality
Leather can be bought from different suppliers or at a better price also. Reducing the level of waste would save on cost.
Even a small reduction in waste rates would remove much of the cost gap that exists
Improve the rate of learning by better training and supervision
Employ cheaper labour by reducing the skill level expected. Care would also be needed here not to sacrifice quality or
push up waste rates.
The cost of the 128th chair will be:
Frame and massage mechanism
Leather
Labour
Total
$
51·00
2 metres x $10/mtr x 100/80
25·00
1·29 hours x $15 per hour (W2) 19·35
––––––
95·35
––––––
Against a target cost of $96 the production manager is correct in his assertion that the required return is now being achieved.
(W2)
Using the formula, we need to calculate the cost of the first 127 chairs and deduct that cost from the cost of the first 128
chairs.
Y = axb
Y = 2 x 127–0·074000581
Y = 1·39748546
Total time is 127 x 1·39748546 = 177·48 hours
Time for the 128th chair is 178·77 – 177·48 = 1·29 hours
3
(a)
In 2010 the four quarters will be numbers 5–8, consequently the trend figures for waste to be collected will be:
Quarter 1 (Q = 5): 2,000 + 25(5) = 2,125 tonnes
Quarter 2 (Q = 6): 2,000 + 25(6) = 2,150 tonnes
Quarter 3 (Q = 7): 2,000 + 25(7) = 2,175 tonnes
Quarter 4 (Q = 8): 2,000 + 25(8) = 2,200 tonnes
Seasonal adjustments are needed thus:
Quarter 1: 2,125 – 200 = 1,925
Quarter 2: 2,150 + 250 = 2,400
Quarter 3: 2,175 + 150 = 2,325
Quarter 4: 2,200 – 100 = 2,100
Total tonnage is 1,925 + 2,400 + 2,325 + 2,100 = 8,750 tonnes for the year.
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Formula:
(b)
Regression analysis can be used to calculate the variable operating and fixed operating costs in 2009.
Tonnes (X)
2,100
2,500
2,400
2,300
9,300
Sum
Total Cost (Y)
$000’s
950
1010
1010
990
3,960
XY
X2
1,995,000
2,525,000
2,424,000
2,277,000
9,221,000
4,410,000
6,250,000
5,760,000
5,290,000
21,710,000
Y = a +bX
Where ‘a’ is fixed operating cost and ‘b’ is variable operating cost in this context.
Using the formula given:
b = (4 x 9,221,000 – 9,300 x 3,960)/(4 x 21,710,000 – (9,300)2)
a = (3,960/4) – (0·16 x 9,300/4)
a = 618 or $618,000 as the original data is in $000’s. This was the fixed operating cost in 2009.
Allowing for inflation:
The variable operating cost in 2010 will be $160 x 1·05 = $168 per tonne
The fixed operating cost in 2010 will be $618,000 x 1·05 = $648,900
(c)
Advantages of an incremental budgeting approach:
–
–
Local government organisations are often complex and incremental budgeting will be seen as a simple approach to a
budget that will take little effort.
Budget processes can be long ones, however incremental approaches do tend to be quicker than most. Complex local
government organisations can suffer from very long budget processes and incremental budgeting can alleviate this a
little.
Disadvantages of incremental budgeting:
–
–
4
(a)
Public bodies, such as local governments, will be encouraged to use up all of this year’s budget in order to ensure that
next year’s budget will be as high as possible to give themselves the flexibility they need to do whatever is needed. The
public services required can be unpredictable and so local government organisations prefer to be able to be flexible.
Overspends made in this year will be budgeted for again next year, this is hardly giving taxpayers value for money.
TIPs Financial performance can be assessed in a number of ways:
Sales growth
Sales are up about 1·3% (W1) which is a little above the rate of inflation and therefore a move in the right direction. However,
with average admission prices jumping about 8·6% (W2) and numbers of visitors falling there are clearly problems. Large
increases in admission prices reduce the value proposition for the customer, it is unlikely that the rate of increase is
sustainable or even justifiable. Indeed with volumes falling (down by 6·7%, (W6)) it appears that some customers are being
put off and price could be one of the reasons.
Maintenance and repairs
There appears to be a continuing drift away from routine maintenance with management preferring to repair equipment as
required. This does not appear to be saving any money as the combined cost of maintenance and repair is higher in 2009
than in 2008 (possible risks are dealt with in part (b)).
Directors pay
Absolute salary levels are up 6·7% (W3), well above the modest inflation rate. It appears that the shareholders are happy
with the financial performance of the business and are prepared to reward the directors accordingly. Bonus levels are also
well up. It may be that the directors have some form of profit related pay scheme and are being rewarded for the improved
profit performance. The directors are likely to be very pleased with the increases to pay.
Wages
Wages are down by 12% (W5). This may partly reflect the loss of customers (down by 6·7% (W6) if we assume that at least
part of the wages cost is variable. It could also be that the directors are reducing staff levels beyond the fall in the level of
customers to enhance short-term profit and personal bonus. Customer service and indeed safety could be compromised here.
Net profit
Net profit is up a huge 31·3% (W7) and most shareholders would be pleased with that. Net profit is a very traditional measure
of performance and most would say this was a sign of good performance.
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Taha Popatia - ARTT Business School - 02134523175
b = 0·16 or $160 per tonne as the original data is in $000’s. This was the variable operating cost per tonne for 2009.
Return on assets
The profitability can be measured relative to the asset base that is being used to generate it. This is sometimes referred to as
ROI or return on investment. The return on assets is up considerably to 11·4% from 8% (W8). This is partly due to the
significant rise in profit and partly due to the fall in asset value. We are told that TIP has cut back on new development so
the fall in asset value is probably due to depreciation being charged with little being spent during the year on assets. In this
regard it is inevitable that return on assets is up but it is more questionable whether this is a good performance. A theme park
(and thrill rides in particular) must be updated to keep customers coming back. The directors on TIP are risking the future of
the park.
Quality provision
Reliability of the rides
The hours lost has increased significantly. Equally the % of capacity lost due to breakdowns is now approaching 17·8% (W9).
This would appear to be a very high number of hours lost. This would surely increase the risk that customers are disappointed
being unable to ride. Given the fixed admission price system this is bound to irritate some customers as they have effectively
paid to ride already.
Average queuing time
Queuing will be seen by customers as dead time. They may see some waiting as inevitable and hence acceptable. However
TIP should be careful to maintain waiting times at a minimum. An increase of 10 minutes (or 50%) is likely to be noticeable
by customers and is unlikely to enhance the quality of the TIP experience for them. The increase in waiting times is probably
due to the high number of hours lost due to breakdown with customers being forced to queue for a fewer number of ride
options.
Safety
The clear reduction in maintenance could easily damage the safety record of the park and is an obvious quality issue.
Risks
If TIP continues with current policies then they will expose themselves to the following risks:
–
The lack of routine maintenance could easily lead to an accident or injury to a customer. This could lead to compensation
being paid or reputational damage
–
Increased competition. The continuous raising of admission prices increases the likelihood of a new competitor entering
the market (although there are significant barriers to entry in this market e.g. capital cost, land and so on).
–
Loss of customers. The value for money that customers see when coming to TIP is clearly reducing (higher prices, less
reliability of rides and longer queues). Regardless of the existence of competition customers could simply chose not to
come, substituting another leisure activity instead
–
Profit fall. In the end if customers’ numbers fall then so will profit. The shareholders, although well rewarded at the
moment could suffer a loss of dividend. Directors’ job security could then be threatened
Workings:
(W1) Sales growth is $5,320,000/$5,250,000 = 1·01333 or 1·3%
(W2) Average admission prices were:
2008: $5,250,000/150,000 = $35 per person
2009: $5,320,000/140,000 = $38 per person
An increase of $38/$35 = 1·0857 or 8·57%
(W3) Directors pay up by $160,000/$150,000 = 1·0667 or 6·7%
(W4) Directors bonuses levels up from $15,000/$150,000 or 10% to $18,000/$160,000 or 12·5% of turnover. This is
an increase of 3/15 or 20%
(W5) Wages are down by (1 – $2,200,000/$2,500,000) or 12%
(W6) Loss of customers is (1 – 140,000/150,000) or 6·7%
(W7) Profits up by $1,372,000/$1,045,000 = 1·3129 or 31·3%
(W8) Return on assets:
2008: $1,045,000/$13,000,000 = 1·0803 or 8·03%
2009: $1,372,000/$12,000,000 = 1·114 or 11·4%
(W9) Capacity of rides in hours is 360 days x 50 rides x 10 hours per day = 180,000
2008 lost capacity is 9,000/180,000 = 0·05 or 5%
2009 lost capacity is 32,000/180,000 = 0·177 or 17·8%
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(b)
(a)
The relevant costs of the decision to cease the manufacture of the TD are needed:
Cost or Revenue
Lost revenue
Saved labour cost
Lost contribution from other products
Redundancy and recruitment costs
Supplier payments saved
Sublet income
Supervisor
Working reference
Note 1
Note 2
Note 3
Note 4
Note 5
Note 6
Net cash flow
Amount ($)
(96,000)
48,000
(118,500)
(3,700)
88,500
12,000
0
––––––––
(69,700)
––––––––
Conclusion: It is not worthwhile ceasing to produce the TD now.
Note 1: All sales of the TD will be lost for the next 12 months, this will lose revenue of 1,200 units x $80 = $96,000
Note 2: All normal labour costs will be saved at 1,200 units x $40 = $48,000
Note 3: Related product sales will be lost.
This will cost the business 5% x ((5,000u x $150) + (6,000u x $270)) = $118,500 in contribution (material costs
are dealt with separately below)
Note 4: If TD is ceased now, then:
Redundancy cost
Retraining saved
Recruitment cost
Total cost
($6,000)
$3,500
($1,200)
––––––––
($3,700)
Note 5. Supplier payments:
Current buying cost
Loss of TD
Loss of related sales at cost
New buying cost
Difference in net cost
DW ($)
WM ($)
TD ($)
350,000
600,000
60,000
(60,000)
(17,500)
(30,000)
Net cost
Discount
($)
level
1,010,000
5%
(60,000)
5%
(47,500)
5%
921,500
3%
88,500
Gross cost
($)
1,063,158
(63,158)
(50,000)
950,000
Note 6: There will be no saving or cost here as the supervisor will continue to be fully employed.
An alternative approach is possible to the above problem:
Cash flow
Lost contribution – TD
Lost contribution – other products
Redundancy and recruitment
Lost discount
Sublet income
Supervisor
Ref
Note 7
Note 8
Note 4 above
Note 9
Note 6 above
Net cash flow
Amount ($)
12,000
(71,000)
(3,700)
(19,000)
12,000
0
––––––––
(69,700)
––––––––
Note 7: There will be a saving on the contribution lost on the TD of 1,200 units x $10 per unit = –$12,000
Note 8: The loss of sales of other products will cost a lost contribution of 5% ((5,000 x $80) + (6,000 x $170)) = $71,000
Note 9
Current buying cost
Saved cost
New buying cost
DW
350,000
(17,500
332,500
WM
600,000
(30,000)
(570,000)
Lost discount
(b)
TD
60,000
(60,000)
0
Total (net)
1,010,000
Discount
5%
Total gross
1,063,158
902,500
921,500
(19,000)
5%
3%
950,000
950,000
Complementary pricing
Since the washing machine and the tumble dryer are products that tend to be used together, Stay Clean could link their sales
with a complementary price. For example they could offer customers a discount on the second product bought, so if they buy
(say) a TD for $80 then they can get a WM for (say) $320. Overall then Stay Clean make a positive contribution of $130
(320 + 80 – 180 – 90).
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Taha Popatia - ARTT Business School - 02134523175
5
Product line pricing
All the products tend to be related to each other and used in the utility room or kitchen. Some sales will involve all three
products if customers are upgrading their utility room or kitchen for example. A package price could be offered and as long
as Stay Clean make a contribution on the overall deal then they will be better off.
Outsourcing requires consideration of a number of issues (only 3 required):
–
–
–
–
The cost of manufacture should be compared to cost of buying in from the outsourcer. If the outsourcer can provide the
same products cheaper then it is perhaps preferable
The reliability of the outsourcer should be assessed. If products are delivered late then the ultimate customer could be
disappointed. This could damage the goodwill or brand of the business.
The quality of work that the outsourcer produces needs to be considered. Cheaper products can often be at the expense
of poor quality of materials or assembly.
The loss of control over the manufacturing process can reduce the flexibility that Stay Clean has over current production.
If Stay Clean wanted, say, to change the colour of a product then at present it should be able to do that. Having
contracted with an outsourcer this may be more difficult or involve penalties.
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(c)
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2009 Marking Scheme
Marks
1
(a)
Price variance
Usage variance
2
2
–––
4
(b)
Planning price variance
Planning usage variance
Operational price variance
Operational usage variance
2
2
2
2
–––
(c)
Explanation of external problems beyond control of manager
Assessment of factors within the control of the manager
Conclusion
4
4
1
–––
Maximum
8
–––
20
–––
Total
2
(a)
Frame cost
Leather cost
Labour average time for 128 units
Labour total time for 128 units
Average cost per chair
Target cost
Cost gap
1
2
1
1
1
1
1
–––
8
(b)
Per suggestion
1·5
–––
6
(c)
Frame
Leather
Average time per unit
Total time
Time for 128th chair
Conclusion
0·5
0·5
2
1
1
1
–––
6
–––
20
–––
Total
3
(a)
Calculation of trend figures
Adjustment for seasonal variation
Total tonnage for budget
1
2
1
–––
4
(b)
Completion of table with X, Y, XY and X2
Calculation of (b)
Calculation of (a)
Allowance for inflation
4
2
2
2
–––
10
(c)
Per advantage/disadvantage
1·5
–––
6
–––
20
–––
Total
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8
Marks
4
(a)
Sales growth
Maintenance
Directors pay
Wages
Net profit
Return on assets
3
3
2
2
2
2
–––
14
Reliability of rides
Average queuing time
Each risk
2
2
1
–––
Maximum
6
–––
20
–––
Total
5
(a)
Lost revenue
Saved labour cost
Lost contribution from other products
Redundancy and recruitment cost
Supplier payments
Sublet income
Supervisor
2
2
2
2
3
1
1
–––
Maximum
(b)
13
Complementary pricing
Product line pricing
Other valid suggestions
2
2
2
–––
Maximum
(c)
4
Per issue
1
–––
3
–––
20
–––
Total
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(b)
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
Costs and quoted prices for the GC and the EX using labour hours to absorb overheads:
Materials
Labour
300hrs x $15/hr
Overheads
300hrs x $10/hr (W1)
GC $
3,500
4,500
500hrs x $15/hr
EX $
8,000
7,500
3,000
500hrs x $10/hr
–––––––
11,000
–––––––
16,500
–––––––
Total cost
Quoted price
5,000
–––––––
20,500
–––––––
30,750
–––––––
(W1). Overhead absorption rate is calculated as $400,000/40,000hrs = $10/hr
(b)
Costs and quoted prices for the GC and the EX using ABC to absorb overheads:
Materials
Labour
GC $
3,500
4,500
300hrs x $15/hr
500hrs x $15/hr
Overheads
–
Supervisor
–
Planners
–
Property
EX $
8,000
7,500
(W2)/(W3)
(W2)/(W3)
(W2)/(W3)
180
280
1,800
–––––––
10,260
–––––––
15,390
–––––––
Total cost
Quoted price
1,080
1,400
3,000
–––––––
20,980
–––––––
31,470
–––––––
(W2)
Supervisor
Planners
Property
Costs
90,000
70,000
240,000
Number of drivers
500
250
40,000
Cost per driver
180
280
6
(W3)
Cost per driver (W2)
GC
EX
(c)
Supervisor
$180
180 x 1 = 180
180 x 6 = 1,080
Planner
$280
280 x 1 = 280
280 x 5 = 1,400
Property
$6
6 x 300 = 1,800
6 x 500 = 3,000
The pricing policy is a matter for BBB to decide. They could elect to maintain the current 50% mark-up on cost and if they did
the price of the GC would fall by around 7% in line with the costs. This should make them more competitive in the market.
They could also reduce the prices by a little less than 7% (say 5%) in order to increase internal margins a little.
It is possible that the issue lies elsewhere. If the quality of the work or the reputation and reliability of the builder is questionable
then reducing prices is unlikely to improve sales. It is conceivable that BBB has a good reputation for EX but not for GC, but
more likely that a poor reputation would affect all products. Equally poor service levels or lack of flexibility in meeting customer
needs may be causing the poor sales performance. These too will not be ‘corrected’ by merely reducing prices.
It is also possible that the way salesmen discuss or sell their products for the GC is not adequate so that in some way customers
are being put off placing the work with BBB.
BBB is in competition and it perhaps needs to reflect this in its pricing more (by ‘going rate pricing’) and not seek to merely add
a mark-up to its costs.
BBB could try to penetrate the market by pricing some jobs cheaply to gain a foothold. Once this has been done the completed
EX or GC could be used to market the business to new customers.
The price of the EX would also need consideration. There is no indication of problems in the selling of the EX and so BBB could
consider pushing up their prices by around 2% in line with the cost increase. On the figures in my answer the price goes up
for a typical extension to $31,470 from $30,750 a rise of $720. This does not seem that significant and so might not lose a
significant number of sales.
The reliability and reputation of a builder is probably more important than the price that they charge for a job and so it is
possible that the success rate on job quotes may not be that price sensitive.
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1
June 2010 Answers
(d)
Marginal costs are those costs that are incurred as a consequence of the job being undertaken. In this case they would include
only the materials and the labour. If overheads are included then this is known as total absorption costing.
Overheads are for many businesses fixed by nature and hence do not vary as the number of jobs changes. In a traditional sense
any attempt to allocate costs to products (by way of labour hours for example) would be arbitrary with little true meaning being
added to the end result. The overhead absorption rate (OAR) is merely an average of these costs (over labour hours) and is
essentially meaningless. This switch (to marginal costing) would also avoid the problem of the uncertainty of budget volume.
Budget volume is needed in order to calculate the fixed cost absorption rate.
A more modern viewpoint is that activity causes costs to exist. For example, it is the existence of the need for site visits that
gives rise to the need for a supervisor and therefore, for his costs. If the activities that drive costs are identified, more costs can
then be directly traced to products, hence eradicating the need for arbitrary apportionment of many overhead costs. This has
the benefit of all costs being covered, rather than the potential shortfall that can arise if marginal cost plus pricing is used.
In the long run businesses have to cover all costs including fixed overheads in order to make a profit, whichever pricing strategy
is adopted.
2
(a)
The performance of the production director could be looked at considering each decision in turn.
The new wood supplier: The wood was certainly cheaper than the standard saving $5,100 on the standard the concern
though might be poor quality. The usage variance shows that the waste levels of wood are worse than standard. It is possible
that the lower grade labour could have contributed to the waste level but since both decisions rest with the same person
the performance consequences are the same. The overall effect of this is an adverse variance of $2,400, so taking the two
variances together it looks like a poor decision. As the new labour is trained it could be that the wood usage improves and so
we will have to wait to be sure.
The impact that the new wood might have had on sales cannot be ignored. No one department within a business can be
viewed in isolation to another. Sales are down and returns are up. This could easily be due to poor quality wood inputs. If SW
operates at the high quality end of the market then sourcing cheaper wood is risky if the quality reduces as a result.
The lower grade of labour used: SW uses traditional manual techniques and this would normally require skilled labour. The
labour was certainly paid less, saving the company $43,600 in wages. However, with adverse efficiency and idle time of a total
of $54,200 they actually cost the business money overall in the first month. The efficiency variance tells us that it took longer
to produce the bats than expected. The new labour was being trained in April 2010 and so it is possible that the situation will
improve next month. The learning curve principle would probably apply here and so we could expect the average time per bat
to be less in May 2010 than it was in April 2010.
(b)
Variance for May 2010:
Material price variance ($196,000/40,000 – 5) x 40,000 = $4,000 Fav
Material usage variance (40,000 – (19,200 x 2)) x $5/kg = $8,000 Adv
Labour rate variance ($694,000/62,000 – 12) x 62,000 = 50,000 Fav
Labour efficiency variance (61,500 – 57,600) x 12 = 46,800 Adv
Labour idle time variance 500 x 12 = 6,000 Adv
Sales price variance (68 – 65) x 18,000 = 54,000 Adv
Sales volume contribution variance (18,000 – 19,000) x 22 = 22,000 Adv
3
(a)
The optimal production mix can be found by solving the two equations given for F and T.
7W + 5L = 3,500
2W + 2L = 1,200
Multiplying the second equation by 2·5 produces:
7W + 5L = 3,500
5W + 5L = 3,000
2W = 500
W = 250
Substituting W = 250 in the fabric equation produces:
2 x 250 + 2L = 1,200
2L = 700
L = 350
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Taha Popatia - ARTT Business School - 02134523175
The marginal cost (MC) is more understandable by managers and indeed customers and a switch away from total absorption
cost (TAC) could have benefits in this way. Clearly if overheads are going to be excluded for the cost allocations then they would
still have to be covered by way of a bigger margin added to the costs. In the end all costs have to be paid for and covered by
the sales in order to show a profit.
The optimal solution is when 250 work suits are produced and 350 lounge suits are produced. The contribution gained is
$26,000:
C = 48W + 40L
C = (48 x 250) + (40 x 350)
C = 26,000
(b)
The shadow prices can be found by adding one unit to each constraint in turn.
Shadow price of T
7W + 5L = 3,501
2W + 2L = 1,200
7W + 5L = 3,501
5W + 5L = 3,000
2W = 501
W = 250·5
Substituting W = 250·5 in the fabric equation produces:
(2 x 250·5) + 2L = 1,200
2L = 1,200 – 501
L = 349·5
Contribution earned at this point would be = (48 x 250·5) + (40 x 349·5) = 26,004 which is an increase of $4.
Hence the shadow price of T is $4 per hour.
Shadow price of F
7W + 5L = 3,500
2W + 2L = 1,201
Again multiplying the second equation by 2·5 produces:
7W + 5L = 3,500·0
5W + 5L = 3,002·5
2W = 497·5
W = 248·75
Substituting W = 248·75 in the fabric equation produces:
(2 x 248·75) +2L = 1,201
2L = 1,201 – 497·5
L = 351·75
Contribution earned at this point would be = (48 x 248·75) + (40 x 351·75) = 26,010, which is an increase of $10.
Hence the shadow price of F is $10 per metre.
(c)
The shadow price represents the maximum premium above the normal rate a business should be willing to pay for more of a
scarce resource. It is equal to the increased contribution that can be gained from gaining that extra resource.
The shadow price of labour here is $4 per hour. The tailors have offered to work for $4·50 – a premium of $3·00 per hour. At
first glance the offer seems to be acceptable.
However, many businesses pay overtime at the rate of time and a half and some negotiation should be possible to create a
win/win situation. Equally some consideration should be given to the quality aspect here. If excessive extra hours are worked
then tiredness can reduce the quality of the work produced.
(d)
If maximum demand for W falls to 200 units, the constraint for W will move left to 200 on the x axis of the graph. The new
optimum point will then be at the intersection of:
W = 200 and
2W + 2L = 1,200
Solving these equations simultaneously, if:
W = 200, then (2 x 200) + 2L = 1,200
Therefore L = 400.
So, the new production plan will be to make 400L and 200W
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Again multiplying the second equation by 2·5 produces:
(a)
Price under existing policy
Steel (0·4/0·95 x $4·00)
Other materials ($3·00 x 0·9 x 0·1)
Labour (0·25 x $10)
Variable overhead (0·25 x $15)
Delivery
Total variable cost
Mark-up 30%
Transfer price
(b)
$
1·68
0·27
2·50
3·75
0·50
––––––
8·70
2·61
––––––
11·31
––––––
The only difference would be to add the fixed costs and adjust the mark-up %.
Existing total variable cost
Extra fixed cost (0·25 x $15 x 0·8)
Total cost
Mark-up 10%
Transfer price
$
8·70
3·00
––––––
11·70
1·17
––––––
12·87
––––––
The price difference is therefore 12·87 – 11·31 = $1·56 per unit
(c)
As far as the manufacturer is concerned, including fixed costs in the transfer price will have the advantage of covering all the
costs incurred. In theory this should guarantee a profit for the division (assuming the fixed overhead absorption calculations are
accurate). In essence the manufacturer is reducing the risk in his division.
The accounting for fixed costs is notoriously difficult with many approaches possible. Including fixed costs in the transfer price
invites manipulation of overhead treatment.
One of the main problems with this strategy is that a fixed cost of the business is being turned into a variable cost in the hands
of the seller (in our case the stores). This can lead to poor decision-making for the group since, although fixed costs would
normally be ignored in a decision (as unavoidable), they would be relevant to the seller because they are part of their variable
buy in price.
(d)
Degree of autonomy allowed to the stores in buying policy.
If the stores are allowed too much freedom in buying policy Hammer could lose control of its business. Brand could be
damaged if each store bought a different supplier’s shears (or other products). On the other hand, flexibility is increased and
profits could be made for the business by entrepreneurial store managers exploiting locally found bargains. However, the
current market price for shears may only be temporary (sale or special offer) and therefore not really representative of their true
market ‘value’. If this is the case, then any long-term decision to allow retail stores to buy shears from external suppliers (rather
than from Nail) would be wrong.
The question of comparability is also important. Products are rarely ‘identical’ and consequently, price differences are to be
expected. The stores could buy a slightly inferior product (claiming it is comparable) in the hope of a better margin. This could
seriously damage Hammer’s brand.
Motivation is also a factor here, however. Individual managers like a little freedom within which to operate. If they are forced
to buy what they see as an inferior product (internally) at high prices it is likely to de-motivate. Also with greater autonomy,
the performance of the stores will be easier to assess as the store managers will have control over greater elements of their
business.
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4
(a)
Bonus calculation:
Qtr to
Qtr to
Qtr to
30 June 2009 30 September 2009 31 December 2009
Staff on time?
On-time %
Bonus earned?
Members visits
Target visits
Actual visits
Bonus earned?
430/450 =
95·5%
Yes
452/480 =
94·2%
No
442/470 =
94·0%
No
460/480 =
95·8%
Yes
60% x 3,000 x
12 = 21,600
20,000
No
60% x 3,200 x
12 = 23,040
24,000
Yes
60% x 3,300 x
12 = 23,760
26,000
Yes
60% x 3,400 x
12 = 24,480
24,000
No
Qtr to
Qtr to
Qtr to
30 June 2009 30 September 2009 31 December 2009
Personal training
Target
Actual sessions
Bonus earned
Qtr to
31 March 2010
10% x 3,000
= 300
310
Yes
10% x 3,200
= 320
325
Yes
10% x 3,300
= 330
310
No
Qtr to
31 March 2010
10% x 3,400
= 340
339
No
Total
Bonus; hits’
2
2
Bonus; hits’
2
6
The bonus earned by the manager would be 6 x $400 = $2,400, which is 50% of the total bonus available.
(b)
An important principle of any target based bonus system is that the targets must be based on controllable aspects of the
manager’s role.
Staff on time
The way in which a manager manages staff can have a big bearing on whether or not an individual staff member is keen to
work and arrive on time. We are told that the local manager has the power to vary employment contracts so he should be able
to agree acceptable shift patterns with staff and reward them for compliance. In this respect the lateness of staff is controllable
by the manager.
On the other hand an individual staff member may be subject to home pressures or problems with public or other transport
meaning that even they cannot control the time of arrival at work on some days. The manager cannot control these events
either. If this problem became regular for a member of staff then the local manager could vary the contract of employment
accordingly.
Overall, lateness to work is controllable by the local manager.
Member use of facilities
The local manager controls the staff and hence the level of customer service. Good quality customer services would probably
encourage members to use the facilities more often. Equally, by maintaining the club to a high standard then the local manager
can remove another potential reason for a member not to use the facilities regularly.
On the other hand customers are influenced by many factors outside of the club. Their state of health or their own work
pressures can prevent members being able to come to the club.
Overall, the local manager can only partly control the number of member visits.
Personal training sessions
Again, the local manager controls the level of customer service and the standard of maintenance in the personal training
department. He also has control over prices so, if the bookings fall, he is able to reduce price or make special offers to
encourage use of the facilities.
On the other hand, personal training sessions may be seen as a luxury by customers and in times of financial difficulty they
are expendable by them. Personal training sessions are often available from other sources and competition can force down the
sales of the club. The manager can respond to that by improving services. He cannot, however, make significant investment in
improving the facilities without board approval.
Overall, the local manager can only partly control the number of personal training sessions booked.
(c)
There are a variety of methods that the performance data can be manipulated:
Cut off
The unethical manager could record visits in a different period than was actually the case. For example in quarter three the
target for personal training sessions was not met by 20 sessions. This was probably obvious to the manager in the last few days
of that quarter. He could have therefore recorded some sessions as having taken place in the next quarter. Indeed, only one
session would have to be moved in this way in order for the manager to meet the target in the final quarter and gain another
$400 of bonus.
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5
Reduce prices to below economic levels to encourage use
The targets that the manager is subject to are mainly volume driven. A reduction in prices would harm profitability but would
not damage the manager’s bonus potential. More sessions are bound to follow if the price is set low enough.
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(Other ideas would be acceptable including advising staff to take the day off if they were going to be late. This would damage
service levels admittedly, but would potentially gain a bonus for lateness.)
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
(b)
(c)
(d)
Marks
1
1
1
1
1
Materials
Labour
OAR
Overhead costs per unit
Price
Total
5
Materials
Labour
Overheads per unit per category (3 categories) – 1 mark each
Price
Total
0·5
0·5
3
1
5
GC reduce price by 7%
GC reduce by < 7%
Quality, reputation, reliability, sales documentation quality
EX increase price by 2%
EX hold price
Total
1
1
2
1
1
MC and TAC definitions
FC explanation of issue
Margin increase needed
Total
1
2
1
6
4
––––
20
––––
Total
2
(a)
(b)
Assessment of wood decision
Assessment of labour decision
Sales consequences
Total
2·5
2·5
2
7
MPV
MUV
LRV
LEV
LIT
SPV
SVCV
2
2
2
2
1
2
2
13
––––
20
––––
Total
3
(a)
Marks
Optimal point calculation
Contribution
3
1
4
(b)
For each shadow price
3
6
(c)
Rate discussion
Other factors e.g. tiredness, negotiation
3
3
6
(d)
Find optimum point
Solve 2 equations
Conclusion
1
2
1
4
––––
20
––––
Total
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Taha Popatia - ARTT Business School - 02134523175
1
June 2010 Marking Scheme
(a)
(b)
(c)
(d)
Marks
1
1
1
1
1
1
Steel
Other material
Labour
Variable overhead
Delivery
Mark-up
Total
6
Fixed cost
Mark-up
Total
2
2
Covers all cost
Risk
Fixed cost accounting
Converts a FC to VC
Total (max)
1
1
1
2
Market price may be temporary
Brand
Profitability
Flexibility
Control
Motivation
Performance assessment
Comparability
Total (max)
1
1
1
1
1
1
1
1
4
4
6
––––
20
––––
Total
5
(a)
(b)
(c)
Marks
Per target
Total
2
6
For each target – supporting controllability
For each target – denying controllability
Target
1·5
1·5
For each idea of manipulation up to
2·5
9
5
––––
20
––––
Total
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Taha Popatia - ARTT Business School - 02134523175
4
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
(i)
Sales price variance and sales volume variance
Sales price variance = (actual price – standard price) x actual volume
Plasma TVs
LCD TVs
Actual
price
Standard
price
Difference
$
330
290
$
350
300
$
–20
–10
Actual
volume
750
650
Sales
price
Variance
$
15,000 A
6,500 A
–––––––
21,500 A
–––––––
Sales volume contribution variance = (actual sales volume – budgeted sales volume) x standard margin
Plasma TVs
LCD TVs
(ii)
Actual
sales
volume
Budgeted
sales
volume
Difference
750
650
––––––
1,400
––––––
590
590
––––––
1,180
––––––
160
60
Standard
margin
$
190
180
Sales
volume
variance
$
30,400 F
10,800 F
–––––––
41,200 F
–––––––
Material price planning and purchasing operational variances
Material planning variance = (original target price – general market price at time of purchase) x quantity purchased
($60 – $85) x 1,400 = $35,000 A.
Material price operational variance = (general market price at time of purchase – actual price paid) x quantity purchased.
($85 – $80) x 1,400 = $7,000 F.
(iii) Labour rate and labour efficiency variances
Labour rate variance = (standard labour rate per hour – actual labour rate per hour) x actual hours worked.
Actual hours worked by temporary workers:
Total hours needed if staff were fully efficient = (750 x 2) + (650 x 1·5) = 2,475.
Permanent staff provide 2,200 hours therefore excess = 2,475 – 2,200 = 275.
However, temporary workers take twice as long, therefore hours worked = 275 x 2 = 550
Labour rate variance relates solely to temporary workers, therefore ignore permanent staff in the calculation.
Labour rate variance = ($14 – $18) x 550 = $2,200 A.
Labour efficiency variance = (standard labour hours for actual production – actual labour hours worked) x standard rate.
(275 – 550) x $14 = $3,850 A.
(b)
Explanation of planning and operational variances
Before the material price planning and operational variances were calculated, the only information available as regards
material purchasing was that there was an adverse material price variance of $28,000. The purchasing department will be
assessed on the basis of this variance, yet, on its own, it is not a reliable indicator of the purchasing department’s efficiency.
The reason it is not a reliable indicator is because market conditions can change, leading to an increase in price, and this
change in market conditions is not within the control of the purchasing department.
By analysing the materials price variance further and breaking it down into its two components – planning and operational –
the variance actually becomes a more useful assessment tool. The planning variance represents the uncontrollable element
and the operational variance represents the controllable element.
The planning variance is a really useful for providing feedback on just how skilled management are in estimating future prices.
This can be very easy in some businesses and very difficult in others.
The operational variance is more meaningful in that it measures the purchasing department’s efficiency given the market
conditions that prevailed at the time. It therefore ignores factors that the purchasing department cannot control, which in turn,
stops staff from becoming demotivated.
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Taha Popatia - ARTT Business School - 02134523175
1
December 2010 Answers
Turnover
Turnover has decreased from $72·025 million in 2009 to $66·028 million in 2010, a fall of 8·3%. However, this must be
assessed by taking into account the change in market conditions, since there has been a 20% decline in demand for accountancy
training. Given this 20% decline in the market place, AT Co’s turnover would have been expected to fall to $57·62m if it had kept
in line with market conditions. Comparing AT Co’s actual turnover to this, it’s actual turnover is 14·6% higher than expected. As
such, AT Co has performed fairly well, given market conditions.
It can also be seen from the non-financial performance indicators that 20% of students in 2010 are students who have transferred
over from alternative training providers. It is likely that they have transferred over because they have heard about the improved
service that AT Co is providing. Hence, they are most likely the reason for the increased market share that AT Co has managed to
secure in 2010.
Cost of sales
Cost of sales has decreased by 19·2% in 2010. This must be considered in relation to the decrease in turnover as well. In 2009,
cost of sales represented 72·3% of turnover and in 2010 this figure was 63·7%. This is quite a substantial decrease. The reasons
for it can be ascertained by, firstly, looking at the freelance staff costs.
In 2009, the freelance costs were $14·582m. Given that a minimum 10% reduction in fees had been requested to freelance
lecturers and the number of courses run by them was the same year on year, the expected cost for freelance lecturers in 2010 was
$13·124m. The actual costs were $12·394m. These show that a fee reduction of 15% was actually achieved. This can be seen
as a successful reduction in costs.
The expected cost of sales for 2010 before any cost cuts, was $47·738m assuming a consistent ratio of cost of sales to turnover.
The actual cost of sales was only $42·056m, $5·682m lower. Since freelance lecturer costs fell by $2·188m, this means that
other costs of sale fell by the remaining $3·494m. Staff costs are a substantial amount of this balance but since there was a pay
freeze and the average number of employees hardly changed from year to year, the decreased costs are unlikely to be related to
staff costs. The decrease is therefore most probably attributable to the introduction of online marking. AT Co expected the online
marking system to cut costs by $4m, but it is probable that the online marking did not save as much as possible, hence the
$3·494m fall. Alternatively, the saved marking costs may have been partially counteracted by an increase in some other cost
included in cost of sales.
Gross profit
As a result of the above, the gross profit margin has increased in 2010 from 27·7% to 36·3%. This is a big increase and reflects
very well on management.
Indirect expenses
–
Marketing costs: These have increased by 42·1% in 2010. Although this is quite significant, given all the improvements that
AT Co has made to the service it is providing, it is very important that potential students are made aware of exactly what the
company now offers. The increase in marketing costs has been rewarded with higher student numbers relative to the
competition in 2010 and these will hopefully continue increasing next year, since many of the benefits of marketing won’t be
felt until the next year anyway. The increase should therefore be viewed as essential expenditure rather than a cost that needs
to be reduced.
–
Property costs: These have largely stayed the same in both years.
–
Staff training: These costs have increased dramatically by over $2 million, a 163·9% increase. However, AT Co had identified
that it had a problem with staff retention, which was leading to a lower quality service being provided to students. Also, due
to the introduction of the interactive website, the electronic enrolment system and the online marking system, staff would
have needed training on these areas. If AT Co had not spent this money on essential training, the quality of service would
have deteriorated further and more staff would have left as they became increasingly dissatisfied with their jobs. Again,
therefore, this should be seen as essential expenditure.
Given that the number of student complaints has fallen dramatically in 2010 to 84 from 315, the staff training appears to
have improved the quality of service being provided to students.
–
Interactive website and the student helpline: These costs are all new this year and result from an attempt to improve the
quality of service being provided and, presumably, improve pass rates. Therefore, given the increase in the pass rate for first
time passes from 48% to 66% it can be said that these developments have probably contributed to this. Also, they have
probably played a part in attracting new students, hence improving turnover.
–
Enrolment costs have fallen dramatically by 80·9%. This huge reduction is a result of the new electronic system being
introduced. This system can certainly be seen as a success, as not only has it dramatically reduced costs but it has also
reduced the number of late enrolments from 297 to 106.
Net operating profit
This has fallen from $3·635m to $2·106m. On the face of it, this looks disappointing but it has to be remembered that AT Co has
been operating in a difficult market in 2010. It could easily have been looking at a large loss. Going forward, staff training costs
will hopefully decrease. Also, market share may increase further as word of mouth spreads about improved results and service at
AT Co. This may, in turn, lead to a need for less advertising and therefore lower marketing costs.
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Taha Popatia - ARTT Business School - 02134523175
2
It is also apparent that AT Co has provided the student website free of charge when really, it should have been charging a fee for
this. The costs of running it are too high for the service to be provided free of charge and this has had a negative impact on net
operating profit.
Note: Students would not have been expected to write all this in the time available.
1.
Turnover
Decrease in turnover = $72,025 – $66,028/$72,025 = 8·3%
Expected 2010 turnover given 20% decline in market = $72,025 x 80% = $57,620
Actual 2010 turnover CF expected = $66,028 – $57,620/$57,620 = 14·6% higher
2.
Cost of sales
Decrease in cost of sales = $42,056 – $52,078/$52,078 = 19·2%
Cost of sales as percentage of turnover: 2009 = $52,078/$72,025 = 72·3%
2010 = $42,056/$66,028 = 63·7%
Freelance staff costs: in 2009 = $41,663 x 35% = $14,582
Expected cost for 2010 = $14,582 x 90% = $13,124
Actual 2010 cost = $12,394
$12,394 – $14,582 = $2,188 decrease
$2,188/$14,582 = 15% decrease in freelancer costs
Expected cost of sales for 2010, before costs cuts, = $66,028 x 72·3% = $47,738.
Actual cost of sales = $42,056.
Difference = $5,682, of which $2,188 relates to freelancer savings and $3,494 relates to other savings.
3
3.
Gross profit margin
2009: $19,947/$72,025 = 27·7%
2010: $23,972/$66,028 = 36·3%
4.
Increase in marketing costs = $4,678 – $3,291/$3,291 = 42·1%
5.
Increase in staff training costs = $3,396 – $1,287/$1,287 = 163·9%
6.
Decrease in enrolment costs = $960 – 5,032/5,032 = 80·9%
7.
Net operating profit
Decreased from $3,635 to $2,106. This is fall of 1,529/3,635 = 42·1%
(a)
Optimum production plan
Define the variables
Let x = no. of jars of face cream to be produced
Let y = no. of bottles of body lotion to be produced
Let C = contribution
State the objective function
The objective is to maximise contribution, C
C = 9x + 8y
State the constraints
Silk powder
Silk amino acids
Skilled labour
3x + 2y ≤ 5,000
1x + 0·5y ≤ 1,600
4x + 5y ≤ 9,600
Non-negativity constraints:
x, y ≥ 0
Sales constraint:
y ≤ 2,000
Draw the graph
Silk powder
3x + 2y = 5,000
If x = 0, then 2y = 5,000, therefore y = 2,500
If y = 0, then 3x = 5,000, therefore x = 1,666·7
Silk amino acids
1x +0·5y = 1,600
If x = 0, then 0·5y = 1,600, therefore y = 3,200
If y = 0, then x = 1,600
Skilled labour
4x + 5y = 9,600
If x = 0, then 5y = 9,600, therefore y = 1,920
If y = 0, then 4x = 9,600, therefore x = 2,400
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Taha Popatia - ARTT Business School - 02134523175
Workings (Note: All workings are in $'000)
3,500
1x
3,000
+0
=
·5y
1,6
3x
2y
00
+
2,500
5,0
00
2,000
b
1,500
c
1,000
c=
9x
500
4x
d
+
+
5y
=
9,
8y
60
0
e
0 a
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
Jars of face cream
Silk powder
Silk amino acids
Skilled labour
Feasible region
Maximum sales of lotion
Iso-contribution line
Solve using iso-contribution line
If y =800 and x = 0, then if C = 9x + 8y
C = (8 x 800) = 6,400
Therefore, if y = 0, 9x = 6,400
Therefore x = 711·11
Using the iso-contribution line, the furthest vertex from the origin is point c, the intersection of the constraints for skilled labour
and silk powder.
Solving the simultaneous equations for these constraints:
4x + 5y = 9,600
x3
3x + 2y = 5,000
x4
12x + 15y = 28,800
12x + 8y = 20,000
Subtract the second one from the first one
7y = 8,800, therefore y = 1,257·14.
If y = 1,257·14 and:
4x + 5y = 9,600
Then 5 x 1,257·14 + 4x = 9,600
Therefore x= 828·58
If C = 9x + 8y
C = $7,457·22 + $10,057·12 = $17,514·34
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Taha Popatia - ARTT Business School - 02134523175
Bottles of body lotion
=
y = 2,000
(b)
Shadow prices and slack
The shadow price for silk powder can be found by solving the two simultaneous equations intersecting at point c, whilst
adding one more hour to the equation for silk powder.
4x +5y = 9,600
3x + 2y = 5,001
x3
x4
12x + 15y = 28,800
12x + 8y = 20,004
Subtract the second one from the first one
7y = 8,796, therefore y = 1,256·57
C = (9 x 829·29) + (8 x 1,256·57) = $17,516·17
Original contribution = $17,514·34
Therefore shadow price for silk powder is $1·83 per gram.
The slack for amino acids can be calculated as follows:
(828·58 x 1) + (0·5 x 1,257·14) = 1,457·15 grams used.
Available = 1,600 grams.
Therefore slack = 142·85 grams.
4
(a)
Cost per unit under full absorption costing
Total annual overhead costs:
Machine set up costs
Machine running costs
Procurement costs
Delivery costs
$
26,550
66,400
48,000
54,320
––––––––
195,270
––––––––
Overhead absorption rate:
Production volumes
Labour hours per unit
Total labour hours
A
15,000
0·1
1,500
B
12,000
0·15
1,800
C
18,000
0·2
3,600
Total
6,900
Therefore, overhead absorption rate = $195,270/6,900 = $28·30 per hour
Cost per unit:
A
$
Raw materials ($1·20 x 2/3/4kg)
2·4
Direct labour ($14·80 x 0·1/0·15/0·2hrs) 1·48
Overhead ($28·30 x 0·1/0·15/0·2 hrs)
2·83
–––––
Full cost per unit
6·71
–––––
(b)
B
$
3·6
2·22
4·25
–––––
10·07
–––––
C
$
4·8
2·96
5·66
–––––
13·42
–––––
Cost per unit using full absorption costing
Cost drivers:
Cost pools
Machine set up costs
Machine running costs
Procurement costs
Delivery costs
Cost per machine set up
Cost per machine hour
Cost per order
Cost per delivery
$
26,550
66,400
48,000
54,320
––––––––
195,270
––––––––
Cost driver
36 production runs (16 + 12 + 8)
32,100 machine hours (7,500 + 8,400 + 16,200)
94 purchase orders (24 + 28 + 42)
140 deliveries (48 + 30 + 62)
$26,550/36 = $737·50
$66,400/32,100 = $2·0685
$48,000/94 = $510·6383
$54,320/140 = $388
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Taha Popatia - ARTT Business School - 02134523175
3x + (2 x 1,256·57) = 5,001.
Therefore x = 829·29
Allocation of overheads to each product:
B
$
8,850
17,375
14,298
11,640
–––––––
52,163
–––––––
C
$
5,900
33,510
21,447
24,056
–––––––
84,913
–––––––
Number of units produced
15,000
12,000
18,000
$
3·88
$
4·35
$
4·72
A
$
2·4
1·48
3·88
–––––
7·76
–––––
B
$
3·6
2·22
4·35
––––––
10·17
––––––
C
$
4·8
2·96
4·72
––––––
12·48
––––––
Overhead cost per unit
Total cost per unit
Materials
Labour
Overheads
(c)
Total
$
26,550
66,400
48,000
54,320
––––––––
195,270
––––––––
Using activity-based costing
When comparing the full unit costs for each of the products under absorption costing as compared to ABC, the following
observations can be made:
Product A
The unit cost for product A is 16% higher under ABC as opposed to traditional absorption costing. Under ABC, it is $7·76
per unit compared to $6·71 under traditional costing. This is particularly significant given that the selling price for product A
is $7·50 per unit. This means that when the activities that give rise to the overhead costs for product A are taken into account,
product A is actually making a loss. If the company wants to improve profitability it should look to either increase the selling
price of product A or somehow reduce the costs. Delivery costs are also high, with 48 deliveries a year being made for product
A. Maybe the company could seek further efficiencies here. Also, machine set up costs are higher for product A than for any
of the other products, due to the larger number of production runs. The reason for this needs to be identified and, if possible,
the number of production runs needs to be reduced.
Product B
The difference between the activity based cost for B as opposed to the traditional cost is quite small, being only $0·10. Since
the selling price for B is $12, product B is clearly profitable whichever method of overhead allocation is used. ABC does not
really identify any areas for concern here.
Product C
The unit cost for C is 7% lower under ABC when compared to traditional costing. More importantly, while C looks like it is
making a loss under traditional costing, ABS tells a different story. The selling price for C is $13 per unit and, under ABC, it
costs $12·48 per unit. Under traditional absorption costing, C is making a loss of $0·42 per unit. Identifying the reason for
the differences in C, it is apparent that the number of production runs required to produce C is relatively low compared to the
volumes produced. This leads to a lower apportionment of the machine set up costs to C than would be given under traditional
absorption costing. Similarly, the number of product tests carried out on C is low relative to its volume.
ABC is therefore very useful in identifying that C is actually more profitable than A, because of the reasons identified above.
The company needs to look at the efficiency that seems to be achieved with C (low number of production runs less testing)
and see whether any changes can be made to A, to bring it more in line with C. Of course, this may not be possible, in which
case the company may consider whether it wishes to continue to produce A and whether it could sell higher volumes of C.
5
(a)
Difficulties in the public sector
In the public sector, the objectives of the organisation are more difficult to define in a quantifiable way than the objectives of
a private company. For example, a private company’s objectives may be to maximise profit. The meeting of this objective can
then be set out in the budget by aiming for a percentage increase in sales and perhaps the cutting of various costs. If, on the
other hand, the public sector organisation is a hospital, for example, then the objectives may be largely qualitative, such as
ensuring that all outpatients are given an appointment within eight weeks of being referred to the hospital. This is difficult to
define in a quantifiable way, and how it is actually achieved is even more difficult to define.
This leads onto the next reason why budgeting is so difficult in public sector organisations. Just as objectives are difficult to
define quantifiably, so too are the organisation’s outputs. In a private company the output can be measured in terms of sales
revenue. There is a direct relationship between the expenditure that needs to be incurred i.e. needs to be input in order to
achieve the desired level of output. In a hospital, on the other hand, it is difficult to define a quantifiable relationship between
inputs and outputs. What is more easy to compare is the relationship between how much cash is available for a particular
16
Taha Popatia - ARTT Business School - 02134523175
Machine set up costs
Machine running costs
Procurement costs
Delivery costs
A
$
11,800
15,514
12,255
18,624
–––––––
58,193
–––––––
area and how much cash is actually needed. Therefore, budgeting naturally focuses on inputs alone, rather than the
relationship between inputs and outputs.
Finally, public sector organisations are always under pressure to show that they are offering good value for money, i.e.
providing a service that is economical, efficient and effective. Therefore, they must achieve the desired results with the
minimum use of resources. This, in itself, makes the budgeting process more difficult.
(b)
Incremental and zero-based budgeting
‘Incremental budgeting’ is the term used to describe the process whereby a budget is prepared using a previous period’s
budget or actual performance as a base, with incremental amounts then being added for the new budget period.
‘Zero-based budgeting’, on the other hand, refers to a budgeting process which starts from a base of zero, with no reference
being made to the prior period’s budget or performance. Every department function is reviewed comprehensively, with all
expenditure requiring approval, rather than just the incremental expenditure requiring approval.
Stages in zero-based budgeting
Zero-based budgeting involves three main stages:
(d)
1.
Activities are identified by managers. These activities are then described in what is called a ‘decision package’. This
decision package is prepared at the base level, representing the minimum level of service or support needed to achieve
the organisation’s objectives. Further incremental packages may then be prepared to reflect a higher level of service or
support.
2.
Management will then rank all the packages in the order of decreasing benefits to the organisation. This will help
management decide what to spend and where to spend it.
3.
The resources are then allocated based on order of priority up to the spending level.
No longer a place for incremental budgeting
The view that there is no longer a place for incremental budgeting in any organisation is a rather extreme view. It is known
for encouraging slack and wasteful spending, hence the comment that it is particularly unsuitable for public sector
organisations, where cash cutbacks are being made. However, to say that there is no place for it at all is to ignore the
drawbacks of zero-based budgeting. These should not be ignored as they can make ZBB implausible in some organisations
or departments. They are as follows:
–
Departmental managers will not have the skills necessary to construct decision packages. They will need training for
this and training takes time and money.
–
In a large organisation, the number of activities will be so large that the amount of paperwork generated from ZBB will
be unmanageable.
–
Ranking the packages can be difficult, since many activities cannot be compared on the basis of purely quantitative
measures. Qualitative factors need to be incorporated but this is difficult.
–
The process of identifying decision packages, determining their purpose, costs and benefits is massively time consuming
and therefore costly.
–
Since decisions are made at budget time, managers may feel unable to react to changes that occur during the year. This
could have a detrimental effect on the business if it fails to react to emerging opportunities and threats.
It could be argued that ZBB is more suitable for public sector than for private sector organisations. This is because, firstly, it
is far easier to put activities into decision packages in organisations which undertake set definable activities. Local
government, for example, have set activities including the provision of housing, schools and local transport. Secondly, it is far
more suited to costs that are discretionary in nature or for support activities. Such costs can be found mostly in not for profit
organisations or the public sector, or in the service department of commercial operations.
Since ZBB requires all costs to be justified, it would seem inappropriate to use it for the entire budgeting process in a
commercial organisation. Why take so much time and resources justifying costs that must be incurred in order to meet basic
production needs? It makes no sense to use such a long-winded process for costs where no discretion can be exercised
anyway. Incremental budgeting is, by its nature, quick and easy to do and easily understood. These factors should not be
ignored.
In conclusion, whilst ZBB is more suited to public sector organisations, and is more likely to make cost savings in hard times
such as these, its drawbacks should not be overlooked.
17
Taha Popatia - ARTT Business School - 02134523175
(c)
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
(b)
(i)
Sales price variance
Sales volume variance
(ii)
Purchasing planning variance
Purchasing efficiency variance
Marks
3
3
–––
6
–––
1
1
–––
2
–––
(iii) Actual hours worked
Labour rate variance
Labour efficiency variance
3
2
2
–––
7
–––
Each valid reason
1
–––
5
–––
20
–––
19
Taha Popatia - ARTT Business School - 02134523175
1
December 2010 Marking Scheme
Marks
Turnover
8·3% decrease
Actual t/o 14·6% higher
Performed well CF market conditions
Transfer of students
0.5
0.5
1
1
–––
3
–––
Max. turnover
Cost of sales
19·2% decrease
63·7% of turnover
15% fee reduction from freelance staff
Other costs of sale fell by $3·555m
Online marking did not save as much as planned
0.5
0.5
2
2
1
–––
5
–––
Max. COS
Gross profit – numbers and comment
1
Indirect expenses:
Marketing costs
42·1% increase
Increase necessary to reap benefits of developments
Benefits may take more than one year to be felt
0.5
1
0.5
Property costs – stayed the same
0.5
Staff training
163·9% increase
Necessary for staff retention
Necessary to train staff on new website etc
Without training, staff would have left
Less student complaints
0.5
1
1
1
1
Interactive website and student helpline
Attracted new students
Increase in pass rate
1
1
Enrolment costs
Fall of 80·9%
Result of electronic system being introduced
Reduced number of late enrolments
0.5
1
1
–––
9
–––
Max. Indirect expenses
Net operating profit
Fallen to $2·106
Difficult market
Staff training costs should decrease in future
Future increase in market share
Lower advertising cost in future
Charge for website
0.5
1
1
1
1
1
–––
3
–––
20
–––
Max. net operating profit
20
Taha Popatia - ARTT Business School - 02134523175
2
Marks
(a)
(b)
4
(a)
(b)
(c)
Optimum production plan
Assigning letters for variables
Defining constraint for silk powder
Defining constraint for amino acids
Defining constraint for labour
Non-negativity constraint
Sales constraint: x
Sales constraint: y
Iso-contribution line worked out
The graph:
Labels
Silk powder
Amino acids
Labour line
Demand for x line
Demand for y line
Iso-contribution line
Vertices a–e identified
Feasible region shaded
Optimum point identified
Equations solved at optimum point
Total contribution
0.5
0.5
0.5
0.5
0.5
0.5
0.5
1
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
0.5
1
3
1
–––
14
–––
Shadow prices and slack
Shadow price
Slack
4
2
–––
6
–––
20
–––
Contribution per unit
Overhead absorption rate
Cost for A
Cost for B
Cost for C
2
1
1
1
–––
5
–––
Cost under ABC
Correct cost driver rates
Correct overhead unit cost for A
Correct overhead unit cost for B
Correct overhead unit cost for C
Correct cost per unit under ABC
5
1
1
1
1
–––
9
–––
Using ABC to improve profitability
One mark per point about the Gadget Co
1
–––
6
–––
20
–––
21
Taha Popatia - ARTT Business School - 02134523175
3
Marks
(a)
Explanation
Difficulty setting objectives quantifiably
Difficulty in saying how to achieve them
Outputs difficult to measure
No relationship between inputs and outputs
Value for money issue
2
1
2
2
2
–––
5
–––
Maximum
(b)
(c)
(d)
Incremental and zero-based budgeting
Explaining ‘incremental budgeting’
Explaining ‘zero-based budgeting’
2
2
–––
4
–––
Stages involved in zero-based budgeting
Each stage
1
–––
3
–––
Discussion
Any disadvantage of inc. that supports statement (max. 3)
Incremental budgeting is quick and easy
Any disadvantage of ZBB that refutes statement (max. 3)
Easier to define decision packages in public sector
more appropriate for discretionary costs
Conclusion
Maximum
22
1
1
1
2
2
1
–––
8
–––
20
–––
Taha Popatia - ARTT Business School - 02134523175
5
Fundamentals Level – Skills Module, Paper F5
Performance Management
Cement Co
(a)
Pay off table
Prob.*
DEMAND
Weather
Good
Average
Poor
$’000
$’000
$’000
350,000
$’000
1,750 (1)
1,085 (2)
325
0·25
0·45
0·3
SUPPLY (no. of bags)
280,000
$’000
1,400
1,400
640
200,000
$’000
1,000
1,000
1,000
* The probability column is only shown so as to help in part (b) (iii)’s calculations.
Profit per bag sold in coming year = $9 – $4 = $5
Loss per bag disposed of = $4 + $0·50 = $4·50
(1) 350,000 x $5 = $1,750,000
(2) [280,000 x $5] – [70,000 x $(4·50)] = $1,085,000 etc
(b)
(i)
Maximin – identify the worst outcome for each level of supply and choose the highest of these worst outcomes.
Worst
350,000
$’000
325
SUPPLY (no. of bags)
280,000
$’000
640
200,000
$’000
1000
The highest of these is $1,000,000 therefore choose to supply only 200,000 bags to meet poor conditions.
(ii)
Maximax – identify the best outcome for each level of supply and choose the highest of these best outcomes.
SUPPLY (no. of bags)
350,000
280,000
200,000
$’000
$’000
$’000
Best
1,750
1,400
1,000
The highest of these is $1,750,000 therefore choose to supply 350,000 bags to meet good conditions.
(iii) Expected value – use the probabilities provided in order to calculate the expected value of each of the supply levels.
Good
Average
Poor
(0·25 x $1,750,000) + (0·45 x $1,085,000) + (0·30 x $325,000) = $1,023,250
(0·7 x $1,400,000) + (0·3 x $640,000) = $1,172,000
1 x $1,000,000 = $1,000,000
The expected value of producing 280,000 bags when conditions are average is the highest at $1,172,000, therefore
this supply level should be chosen.
(c)
Maximin and expected value decision rules
The ‘maximin’ decision rule looks at the worst possible outcome at each supply level and then selects the highest one of these.
It is used when the outcome cannot be assessed with any level of certainty. The decision maker therefore chooses the
outcome which is guaranteed to minimise his losses. In the process, he loses out on the opportunity of making big profits. It
is often seen as the pessimistic approach to decision-making (assuming that the worst outcome will occur) and is used by
decision makers who are risk averse. It can be used for one-off or repeated decisions.
The ‘expected value’ rule calculates the average return that will be made if a decision is repeated again and again. It does
this by weighting each of the possible outcomes with their relative probability of occurring. It is the weighted arithmetic mean
of the possible outcomes.
Since the expected value shows the long run average outcome of a decision which is repeated time and time again, it is a
useful decision rule for a risk neutral decision maker. This is because a risk neutral person neither seeks risk or avoids it; they
are happy to accept an average outcome. The problem often is, however, that this rule is often used for decisions that only
occur once. In this situation, the actual outcome is unlikely to be close to the long run average. For example, with Cement
Co, the closest actual outcome to the expected value of $1,172,000 is the outcome of $1,085,000. This is not too far away
from the expected value but many of the others are really different.
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1
June 2011 Answers
The Energy Buster
(a)
Profit
In order to ascertain the optimum price, you must use the formula P = a – bQ
Where P = price; Q = quantity; a = intersection (price at which quantity demanded will be nil); b = gradient of the demand
curve.
The approach is as follows:
(i)
Establish the demand function
b = change in price/change in quantity = $15/1,000 = 0·015.
We know that if price = $735, quantity = 1,000 units.
Establish ‘a’ by substituting these values for P, Q and b into our demand function:
735 = a – 0·015Q
15 + 735 = a
Therefore a = 750.
Demand function is therefore P = 750 – 0·015Q
(ii)
Establish marginal cost
The labour cost of the 100th unit needs to be calculated as follows:
Formula = y = axb.
a = 1·5
Therefore, if x = 100 and b= –·0740005, then y = 1·5 x 100–0·0740005 = 1·0668178
Therefore cost per unit = 1·0668178 x $8 = $8·5345
Total cost for 100 units = $853·45.
If x = 99, y = 1·5 x 99–0·0740005 = 1·0676115
Therefore cost per unit = $8·5408
Total cost for 99 = $845·55
Therefore cost of 100th unit = $853·45 – $845·55 = $7·90.
Therefore total marginal cost = $42 + $7·90 = $49·90.
Fixed overheads have been ignored as they are not part of the marginal cost.
(iii) Find profit
(1) Establish the marginal revenue function
MR = a – 2bQ
MR = 750 – 0·03Q
(2) Equate MC and MR
49·90 = 750 – 0·03Q
0·03Q = 700·1
Q = 23,337
(3) Find optimum price
P = 750 – (0·015 x 23,337)
= $399·95
(b)
(i)
Penetration pricing
With penetration pricing, a low price would initially be charged for the Energy Buster. The idea behind this is that the
price will make the product accessible to a larger number of buyers and therefore the high sales volumes will compensate
for the lower prices being charged. A large market share would be gained and possibly, the Energy Buster might become
accepted as the only industrial air conditioning unit worth buying.
The circumstances that would favour a penetration pricing policy are:
–
highly elastic demand for the Energy Buster i.e. the lower the price, the higher the demand. The preliminary
research does suggest that demand is elastic.
–
if significant economies of scale could be achieved by Heat Co, then higher sales volumes would result in sizeable
reductions in costs. This is not the case here, since learning ceases at 100 units.
–
if Heat Co was actively trying to discourage new entrants into the market. In this case, new entrants cannot enter
the market anyway, because of the patent.
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2
–
if Heat Co wished to shorten the initial period of the Energy Buster’s life cycle so as to enter the growth and maturity
stages quickly. We have no evidence that this is the case for Heat Co, although it could be.
From the above, it can be seen that this could be a suitable strategy in some respects but it is not necessarily the best
one.
Market skimming
With market skimming, high prices would initially be charged for the Energy Buster rather than low prices. This would
enable Heat Co to take advantage of the unique nature of the product, thus maximising sales from those customers who
like to have the latest technology as early as possible. The most suitable conditions for this strategy are:
–
the product is new and different. This is indeed the case with the Energy Buster.
–
the product has a short life cycle and high development costs that need to be recovered quickly. The life cycle is
fairly short and high development costs have been incurred.
–
since high prices attract competitors, there needs to be barriers to entry in order to deter competitors. In Heat Co’s
case, there is a barrier, since it has obtained a patent for the Energy Buster.
–
the strength and sensitivity of demand are unknown. Again, this is not the case here.
Once again, the Energy Buster meets only some of the conditions which would suggest that although this strategy may
be suitable the answer is not clear cut. The fact that high development costs have been incurred and the life cycle is
fairly short are fairly good reasons to adopt this strategy. Whilst we have demand curve data, we do not really know just
how reliable this data really is, in which case a skimming strategy may be a safer option.
3
Noble restaurant
(a)
Flexed budget
Number of meals
Food sales (1)
Drink sales (1)
Total revenue
Variable costs:
Staff wages (2)
Food costs (3)
Drink costs (4)
Energy costs (5)
Contribution
Fixed costs:
Manager’s and chef’s pay
Rent, rates and depreciation
1,560
$
62,400
15,600
–––––––
$
78,000
(12,672)
(7,800)
(3,120)
(4,234)
–––––––
(27,826)
–––––––
50,174
(8,600)
(4,500)
–––––––
(13,100)
–––––––
37,074
–––––––
–––––––
Operating profit
(1) Food revenue
Food revenue = 1,560 x $40 = $62,400
Drinks revenue = 1,560 x ($2·50 x 4) = $15,600.
(2) Staff wages
Average number of orders per day = 1,560/(6 days x 4 weeks) = 65 per day.
Therefore extra orders = 15 per day.
8 staff x 1·5 hours x 6 days x 4 weeks = 288 extra hours.
At $12 per hour = $3,456 extra wages.
Total flexed wages = $9,216 + $3,456 = $12,672.
(3) Food costs
Food costs = 12·5% x $62,400 = $7,800.
(4) Drink costs
Drinks costs = $15,600 x 20% = $3,120.
(5) Energy costs
Standard total hours worked = (8 x 6) x 6 days x 4 weeks = 1,152 hours.
Extra hours worked = 288 (working 2).
Total hours = 1,152 + 288 = 1,440.
At $2·94 per hour = $4,234.
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(ii)
(b)
The sales mix contribution variance measures the effect on profit of changing the mix of actual sales from the standard mix.
The sales quantity contribution variance measures the effect on profit of selling a different total quantity from the budgeted
total quantity.
The mix variance is adverse here. Since meal B generates a higher contribution than meal A, the adverse variance shows that
more of meal A must have been sold, relative to B, than budgeted. Since the quantity variance is favourable, this means that
the total quantity of meals sold (in the standard mix) was higher than expected, as evidenced by the number of meals sold
being 1,560 rather than the budgeted 1,200.
(c)
Two other variances
In addition, the total sales margin price variance for drinks sales could be split into an operational and a planning variance.
The manager is only responsible for any operational variance and any part of the sales margin variance that relates to a
planning error (i.e. the last minute decision by the owner to run the drinks promotion) should be separated out. This way, the
manager will not be held accountable for matters outside of his control.
Food sales
By running the half price drinks offer promotion, more customers have been attracted to the restaurant. Drinks have been
treated as a ‘loss leader’ i.e. sold at a low price in order to entice customers. It would therefore be relevant to calculate some
variances in relation to food sales in order to show how the drinks promotion has increased food sales. The most obvious one
to calculate would be the sales margin volume variance for food sales.
NOTE: Candidates only needed to mention two variances.
4
Brace Co
(a)
Balanced scorecard
The balanced scorecard is a strategic management technique for communicating and evaluating the achievement of the
strategy and mission of an organisation. It comprises an integrated framework of financial and non-financial performance
measures that aim to clarify, communicate and manage strategy implementation. It translates an organisation’s strategy into
objectives and performance measurements for the following four perspectives:
Financial perspective
The financial perspective considers how the organisation appears to shareholders. How can it create value for its
shareholders? Kaplan and Norton, who developed the balanced scorecard, identified three core financial themes that will drive
the business strategy: revenue growth and mix, cost reduction and asset utilisation.
Customer perspective
The customer perspective considers how the organisation appears to customers. The organisation should ask itself: ‘to achieve
our vision, how should we appear to our customers?’.
The customer perspective should identify the customer and market segments in which the business units will compete. There
is a strong link between the customer perspective and the revenue objectives in the financial perspective. If customer
objectives are achieved, revenue objectives should be too.
Internal perspective
The internal perspective requires the organisation to ask itself the question – ‘what must we excel at to achieve our financial
and customer objectives?’. It must identify the internal business processes that are critical to the implementation of the
organisation’s strategy. Kaplan and Norton identify a generic process value chain consisting of three processes: the innovation
process, the operations process and the post-sales process.
Learning and growth perspective
The learning and growth perspective requires the organisation to ask itself whether it can continue to improve and create
value.
If an organisation is to continue having loyal, satisfied customers and make good use of its resources, it must keep learning
and developing. It is critical that an organisation continues to invest in its infrastructure – i.e. people, systems and
organisational procedures – in order to provide the capabilities that will help the other three perspectives to be accomplished.
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Drink sales
As well as the price variance for drinks sales, the sales margin volume variance could be calculated. This will examine the
difference between the standard volume of sales that would ordinarily be expected for this number of customers (1,560 x
4 drinks) compared to the actual volume of drinks sold because of the drinks promotion (1,560 x 6 drinks). Since the variance
is calculated by applying the increase in volume to the standard margin, this variance will be favourable.
(b)
Divisional performance
ROI:
Division A
Net profit = $44·6m x 28% = $12·488m
ROI = $12·488m/$82·8m = 15·08%
Division B
Net profit = $21·8m x 33% = $7·194m
ROI = $7·194m/$40·6m = $17·72%
Division B
Divisional profit = $7·194m
Capital employed = $40·6m
Imputed interest charge = $40·6m x 12% = $4·872m
Residual income = $7·194 – $4·872 = $2·322m.
Comments
If a decision about whether to proceed with the investments is made based on ROI, it is possible that the manager of
Division A will reject the proposal whereas the manager of Division B will accept the proposal. This is because each division
currently has a ROI of 16% and since the Division A investment only has a ROI of 15·08%, it would bring the division’s
overall ROI down to less than it’s current level. On the other hand, since the Division B investment is higher than its current
16%, the investment would bring the division’s overall ROI up.
When you consider what would actually be best for the company as a whole, you come to the conclusion that, since both
investments have a healthy return, they should both be accepted. Hence, the fact that ROI had been used as a
decision-making tool has led to a lack of goal congruence between Division A and the company as whole. This backs up what
the new manager of Division A is saying. If they used residual income in order to aid the decision-making process, both
proposals would be accepted by the divisions since both have a healthy RI. In this case, RI helps the divisions to make
decisions that are in line with the best interests of the company. Once again, this backs up the new manager’s viewpoint.
It is important to note, however, that each of the methods has numerous advantages and disadvantages that have not been
considered here.
5
(a)
Throughput accounting ratio (TAR)
TAR is traditionally defined as: return per factory hour/cost per factory hour. In this context, we are dealing with a hospital,
so it will be: return per hospital hour/cost per hospital hour.
Since, in throughput accounting, all costs except material costs are treated as fixed costs, total hospital costs will be all the
salaries plus the general overheads:
$45,000 + $38,000 + $75,000 + $90,000 + $50,000 + $250,000 = $548,000.
Total hours of bottleneck resource, the surgeon’s time, = 40hrs x 47 weeks = 1,880 hours.
Therefore cost per hospital hour = $548,000/1,880 = $291·49.
Return per hospital hour now needs to be calculated.
Selling price per unit
Materials cost:
– injection
– anaesthetic
– dressings
Throughput per unit
Time on BNR in hours
Return per hour ($)
TAR
$
4,250
(1,000)
(45)
(5·6)
–––––––––
3,199·40
–––––––––
1·25
2,559·52
$2,559·52/$291·49
= 8·78
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Residual income:
Division A
Divisional profit = $12·488m
Capital employed = $82·8m
Imputed interest charge = $82·8m x 12% = 9·936m
Residual income = $12·488m – $9·936m = $2·552m.
(b)
Optimum production plan
A
$
8·96
2
TAR
Ranking
Name
B
A
C
Number
800
600
504
Hrs each
1
0·75
1·25
Total hours
800
450
630
––––––
1,880
––––––
––––––
B
$
9·11
1
C
$
8·78
3
T/P per hour
2,654·40
2,612·53
2,559·52
Total T/P
2,123,520
1,175,638·5
1,612,497·6
––––––––––––
4,911,656·1
––––––––––––
––––––––––––
The optimum production plan is therefore to perform the maximum number of procedures A and B (600 and 800
respectively) and perform only 504 of procedure C.
Total profit will be:
Throughput
Less total costs
Profit
(c)
$
4,911,656·1
(548,000)
––––––––––––
4,363,656·1
––––––––––––
––––––––––––
Profitability increase
At present, if the company adheres to the optimum production plan above, it will be satisfying customer demand for
procedures A and B but not for procedure C. The most obvious way to try and increase profit would be to try and exploit
demand for procedure C. There are two main factors that would need to be overcome in order for this demand to be exploited.
Firstly, another surgeon would need to be employed. Most other members of staff clearly have excess time available, because
the surgeon’s required time is at least double their required time. The recovery specialist, however, is currently used for
1,292·96 hours [(600 x 0·6) + (800 x 0·7) + (504 x 0·74)]. This staff member therefore has 587·04 spare hours available
(1,880 – 1,292·96). This is enough to carry out the additional 696 procedures of C, gvien that each one uses 0·74 hours
of the recovery specialist’s time (0·74 x 696 = 515·04).
If another surgeon was employed he would be able to meet all of the excess demand for procedure C, which would be 696
procedures (1,200 – 504).
Secondly, the other theatre would need to be equipped with the necessary equipment so that the second surgeon could
operate in it. A quick calculation will show that this cost will be more than covered even in the first year (and the theatre cost
is capital anyway, and will be benefitted from over many years).
T/P from additional 696 procedures (696 x 1·25 x $2,559·52) =
Cost of equipment
Surgeon’s fee
$
2,226,782
(750,000)
(90,000)
––––––––––
1,386,782
––––––––––
Without even taking into account future years, on the basis of one year’s throughput alone, it is worth equipping the second
theatre provided that a suitably qualified second surgeon can be found.
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Limiting factor analysis can be used to determine the optimum production plan. Each procedure first needs to be ranked
according to its TAR, then as many of each procedure should be performed as possible, starting with the most profitable
procedure first.
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2011 Marking Scheme
Marks
(a)
(b)
Pay off table
Calculation of profit
Calculation of loss
‘Demand’ label
‘Supply’ label
Weather column
Supply column – 350,000
Supply column – 280,000
Supply column – 200,000
1
1
0·5
0·5
0·5
1·5
1·5
1·5
–––
8
–––
Decision criterion
(i)
(ii)
Maximin
Selecting highest of the low
1
–––
Maximax
Selecting highest of the high
1
–––
(iii) Expected value
Calculating EV when good
Calculating EV average
Calculating EV when poor
Selecting highest
(c)
1
1
1
1
–––
4
–––
Maximin and EV
Describe maximin
Used when outcome cannot be assessed with any certainty
Risk averse/pessimistic
One-off/repeated decisions
Describe EV
Risk neutral
Repeated decisions
Maximum marks
Total marks
17
1
1
1
1
2
1
1
–––
6
–––
20
–––
–––
Taha Popatia - ARTT Business School - 02134523175
1
Marks
(a)
Profit using demand-based approach
(i)
(ii)
Establish demand function:
Find b
Find a
Write out demand function
1
1
1
–––
3
–––
Find MC:
Average cost of 100
Total cost of 100
Average cost of 99
Total cost of 99
Difference
Correct total MC excluding fixed cost
1
1
1
1
1
1
–––
6
–––
(iii) Establish MR function
Equate MC and MR to find Q
Find optimum price
(b)
1
1
1
–––
3
–––
Market based strategies
Penetration pricing
Each valid point
1
–––
4
–––
Max
Market skimming
Each valid point
1
–––
4
–––
20
–––
–––
Max
Total marks
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2
(a)
Flexed budget
Food sales
Drink sales
Total revenue
Staff wages
Food costs
Drinks costs
Energy costs
Variable costs total
Contribution
Manager’s and chef’s pay
Rent & Rates
Operating profit
(b)
Explanation of variances
Suggestions of reason for variances
(c)
Variance discussions
Each variance
1
1
1
1·5
1
1
1·5
1
1
0·5
0·5
1
–––
12
–––
2
2
–––
4
–––
2
–––
4
–––
20
–––
–––
Maximum
Total marks
4
(a)
Balanced scorecard approach
Stating what it is
Financial perspective
Customer perspective
Internal perspective
Learning and growth perspective
2
2
2
2
2
–––
10
–––
Maximum
(b)
ROI/RI
ROI for A
ROI for B
RI for A
RI for B
1
1
2
2
–––
6
–––
Maximum for ROI/RI
Comments
A rejects, B accepts under ROI
Both accept under RI
ROI produces wrong decision for company
RI produces right decision
Manager right
Other factors to consider
1
1
1
1
1
1
–––
6
–––
10
–––
20
–––
–––
Maximum for comments
Total marks
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Marks
3
Marks
(a)
(b)
(c)
TAR
Cost per hour
Return per hour – C
Ratio – C
3
2
1
–––
6
–––
Optimum production plan
Ranking
Optimum number of A
Optimum number of B
Optimum number of C
Total throughput
Less cost
Profit
1
1·5
1·5
1·5
0·5
0·5
0·5
–––
7
–––
Discussion
Demand satisfied for A & B
Unsatisfied demand for C
Calculation re recovery specialist
Would need another surgeon
Other staff have lots of idle time
Need extra theatre time
Profit calculation
Financially feasible
Each other valid point
Conclusion
1
1
2
1
1
1
1
1
1
1
–––
7
–––
20
–––
–––
Maximum
Total marks
20
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5
Taha Popatia - ARTT Business School - 02134523175
Answers
Fundamentals Level – Skills Module, Paper F5
Performance Management
T Co
(a)
Cost statement
$
Lunch
Engineers’ costs
Technical advisor
Site visits
Training costs
Handsets
Control system
Cable
Total cost
Note
1
2
3
4
5
6
7
8
0
500
480
0
125
2,184
7,600
1,300
–––––––
12,189
–––––––
Notes
Note 1: Lunch
This past cost is a ‘sunk cost’ and should therefore be excluded from the cost statement. It has already arisen and is therefore
not incremental.
Note 2: Engineers’ costs
Since one of the engineers has spare capacity, the relevant cost of his hours is Nil. This is because relevant costs must arise
as a future consequence of the decision, and since his wage will be paid regardless of whether he now works on the contract
for Push Co, it is not an incremental cost.
The situation for the other two engineers is slightly different. Their time is currently fully utilised and earning a contribution
of $5 per hour each. This is after deducting their hourly cost which, given a salary of $4,000 per month each, is $25 per
hour ($4,000/4 x 40). However, in one week’s time – when they would otherwise be idle – they can complete Contract X
and earn the contribution anyway. Therefore, the only relevant cost is the penalty of $500 that will be payable for the delay
on Contract X.
Note 3: Technical advisor
Since the advisor would have to work overtime on this contract, the relevant cost is the overtime rate of $60 ($40 x 1·5) per
hour. This would total $480 for the whole job.
Note 4: Site visits
This is a cost paid directly by Push Co to a third party. Since it is not a relevant cost for T Co, it has been excluded.
Note 5: Training costs
Since the trainer is paid a monthly salary irrespective of what work he does, this element of his cost is not relevant to the
contract, since it is not incremental. However, the commission of $125 will arise directly as a consequence of the decision
and must therefore be included.
Note 6: Handsets
Although T Co has 80 of the 120 handsets required already in inventory, they are clearly in regular use in the business.
Therefore, if the 80 are used on this contract, they will simply need to be replaced again. Consequently, the relevant cost for
both the 40 that need to be bought and the 80 already in inventory is the current purchase price of $18·20 each. 120 x
$18·20 = $2,184.
Note 7: Control system
The historic cost of Swipe 1, $5,400, is a ‘sunk’ cost and not relevant to this decision. However, since the company could
sell it for $3,000 if it did not use it for this contract, the $3,000 is an opportunity cost here. The current market price for
Swipe 1 of $5,450 is totally irrelevant to the decision as T Co has no intention of replacing Swipe 1, since it was bought in
error. In addition to the $3,000, there is a modification cost of $4,600, bringing the total cost of converting Swipe 1 to
$7,600. This is still a cheaper option than buying Swipe 2 for $10,800, therefore the company would choose to do the
modification to Swipe 1. The cost of $10,800 of a new Swipe 2 system is therefore irrelevant now.
Note 8: Cable
The cable is in regular use by T Co, therefore all 1,000 metres should be valued at the current market price of $1·30 per
metre. The $1·20 per metre is a sunk cost and not relevant.
(b)
Relevant costing principles
Relevant costs are those costs that change as a result of making a particular decision. In simple terms, a relevant cost is a
future cash flow arising as a direct consequence of a decision. In order for a cost to be relevant to a decision, it must therefore
meet all three of these criteria:
Future – any costs which have already been incurred are regarded as ‘sunk’ costs and will prevent a cost from being
considered relevant.
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1
December 2011 Answers
Cash flow – the cost must be a cash flow and not just an accounting adjustment, such as a provision for a debt or
depreciation. Also, cash flows that are the same for all alternatives are not relevant.
Direct consequence – this criteria means that the cash flow must be incremental. For example, if a cost has already been
committed to, then it will arise irrespective of whether the decision goes ahead. It will not therefore meet the ‘direct
consequence’ criteria.
Opportunity cost – this is the value of the best alternative that is foregone as a result of making a decision. In the case of the
telephone system that Push Co needs for the contract, the foregone sales proceeds of $3,000 are an example of an
opportunity cost since, by using the system for this contract, Push Co foregoes these sales proceeds.
Note: candidates would not be required to write all of this for the available marks.
The cost calculated in part (a) is a starting point only, showing the minimum cost that could be charged to the customer. If
T Co charged this price, it would be no better or worse off than if it did not carry out the work, i.e. it would make no profit
or loss. This means that T Co would not be rewarded for the risk that it takes in completing the work, unless some kind of a
mark-up is also incorporated.
Also, other costs – such as the lunch of $400 – whilst not incremental to the decision now, have been incurred. Ideally,
therefore, T Co should seek to recover them.
It could also be that, for example, in one week’s time, when the engineers are busy completing the delayed contract X, another
opportunity comes up that the company has to reject because the engineers are busy on Contract X. Therefore, with hindsight,
it would be seen that there was an opportunity cost associated with using the engineers on this work and delaying contract
X.
Furthermore, none of the business’s overheads have been considered in the cost statement and, in the long term, these would
need to be covered.
It is clear, therefore, that the relevant cost calculated in part (a) is only a starting point for T Co to use when deciding how to
price the contract. The purpose of accepting contracts is to make profit and increase shareholder wealth. This will only be
done if a price higher than the relevant cost of the contract is charged. In setting this price, however, T Co also needs to give
consideration to the fact that it hopes to attract future work from Push Co. The price needs to be attractive enough for the
customer to return in the future.
2
Bath Co
(a)
Profit statement
Division A
$’000
Division B
$’000
Company
$’000
36,000
0
–––––––
36,000
–––––––
9,600
6,000
–––––––
15,600
–––––––
45,600
(16,000)
(6,000)
(3,600)
–––––––
(25,600)
–––––––
(7,440)
–––––––
2,960
–––––––
(1,000)
0
(3,000)
–––––––
(4,000)
–––––––
(4,400)
–––––––
7,200
–––––––
Sales revenue:
External (1)
Inter-divisional transfers
Total
Variable costs:
External material costs (2)
Inter-divisional transfers (3)
Labour costs (4)
Total
Fixed costs
Profit
Workings ($’000)
(1) External sales
Div A: 80,000 x $450 = $36,000
Div B: 120,000 x $80 = $9,600
Div B: 80,000 x $75 = $6,000
(2) External material costs
Div A: 80,000 x $200 = $16,000
Div B: 200,000 x $5 = $1,000
(3) Inter-divisional transfers
Div A: 80,000 x $75 = $6,000
10
–––––––
45,600
–––––––
(17,000)
(6,600)
–––––––
(23,600)
–––––––
(11,840)
–––––––
10,160
–––––––
Taha Popatia - ARTT Business School - 02134523175
Significance of minimum price calculated
(4) Labour costs
Div A: 80,000 x $45 = $3,600
Div B: 200,000 x $15 = $3,000
Bath Co’s profit if transfer pricing is optimised
Division A
$’000
Division B
$’000
Company
$’000
36,000
14,400
1,300
–––––––
15,700
–––––––
50,400
–––––––
50,400
–––––––
(1,000)
(20,900)
(3,000)
–––––––
(4,000)
–––––––
(4,400)
–––––––
7,300
–––––––
(6,600)
–––––––
(27,500)
–––––––
(11,840)
–––––––
11,060
–––––––
Sales revenue:
External (1)
Internal sales (2)
–––––––
36,000
–––––––
Total
Variable costs:
External material costs (3)
Inter-divisional transfers (2)
Labour costs
Total
Fixed costs
Profit
(19,900)
(1,300)
(3,600)
–––––––
(24,800)
–––––––
(7,440)
–––––––
3,760
–––––––
Note: A transfer price of $65 has been used on the assumption that the company will introduce the policy discussed in (c).
Provided that the transfer price is set between the minimum of $20 (Division B’s marginal cost) and $65 (the cost to Division
A of buying from outside the group), the actual transfer price is irrelevant in this calculation. The overall profit of the company
will be the same.
Workings ($’000)
(1) External sales
Div A: 80,000 x $450 = $36,000
Div B: 180,000 x $80 = $14,400
(2) Internal sales/inter-divisional transfers
20,000 x $65 = $1,300
(3) Material costs
Div A: 60,000 x $265 + (20,000 x $200) = $19,900
Div B: 200,000 x $5 = $1,000
(c)
Issues and suitable transfer price
Divisional managers’ performance is assessed using a metric as decided by the company. This may simply be the profit for
the period, or, depending on the type of responsibility centre being used, a metric such as residual income or return on capital
employed. Whatever the metric being used, the division’s profit figure is going to affect it and divisional managers are therefore
going to be keen to maximise their individual profits. By focusing on individual decisions, divisional managers are often not
aware of the impact of their decisions on the company as a whole. This would particularly be the case where a decision which
is in the best interests of the company actually makes an individual division’s performance look worse.
The transfer pricing system in place needs to take into account the behavioural impact of the prices being charged.
Sometimes, this can mean that a ‘dual transfer pricing system’ needs to be introduced in order to ensure that divisional
managers act in the interests of the company as a whole.
It can be seen from part (b) that the best decision for the company is that:
–
Division A buys 60,000 sets of fittings from an outside supplier and buys the remaining 20,000 sets of fittings from
Division B in order to ensure that Division B is working to full capacity.
–
Division B sells as many sets of fittings as possible externally, at $80 per set. Since the maximum external demand is
180,000 units, Division B sells the remaining 20,000 sets of fittings to Division A. The minimum transfer price that
would be acceptable to Division B is its marginal cost of $20 per unit, since it has spare capacity. However, if this
transfer price is used, Division B becomes worse off than before the autonomy was given, and Division B’s manager will
not like this. As far as Division A is concerned, it will not want to pay more than the $65 that it can buy from outside
the group.
Bath Co’s policy therefore needs to ensure that, firstly, Division A’s manager is prepared to buy 20,000 sets of fittings from
Division B and secondly, Division B is prepared to sell them at $65 per set. Since it is in Division B’s best interest to work to
full capacity and the manager of Division B knows that Division A can obtain fittings for $65 per set, it should not be difficult
for B to agree to sell to A at this price. A policy of negotiated transfer prices would achieve this fairly quickly. However, the
company also needs to have a policy that divisions buy internally first, where this would be in the best interests of the overall
profitability of the company. This would ensure that Division A buys the 20,000 sets of fittings from Division B. This way, the
overall profit of the company is maximised whilst also ensuring that divisional managers do not become demotivated.
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Taha Popatia - ARTT Business School - 02134523175
(b)
(a)
Objectives of a budgetary control system
–
To compel planning
Budgeting makes sure that managers plan for the future, producing detailed plans in order to ensure the implementation
of the company’s long term plan. Budgeting makes managers look at the year ahead and consider the changes in
conditions that might take place and how to respond to those changes in conditions.
–
To co-ordinate activities
Budgeting is a method of bringing together the activities of all the different departments into a common plan. If an
advertising campaign is due to take place in a company in three months’ time, for example, it is important that the
production department know about the expected increase in sales so that they can scale up production accordingly. Each
different department may have its own ideas about what is good for the organisation. For example, the purchasing
department may want to order in bulk in order to obtain bulk quantity discounts, but the accounts department may want
to order in smaller quantities so as to preserve cash flow.
–
To communicate activities
Through the budget, top management communicates its expectations to lower level management. Each department has
a part to play in achieving the desired results of the company, and the annual budget is the means of formalising these
expectations. The whole process of budget setting, whereby information is shared between departments, facilitates this
communication process.
–
To motivate managers to perform well
The budget provides a basis for assessing how well managers and employees are performing. In this sense, it can be
motivational. However, if the budget is imposed from the top, with little or no participation from lower level management
and employees, it can have a seriously demotivational effect. This is discussed further in part (b).
–
To establish a system of control
Expenditure within any organisation needs to be controlled and the budget facilitates this. Actual results are compared
to expected results, and the reasons for any significant, unexpected differences are investigated. Sometimes the reasons
are within the control of the departmental manager and he/she must be held accountable; at other times, they are not.
–
To evaluate performance
Often, managers and employees will be awarded bonuses based on achieving budgeted results. This makes more sense
than evaluating performance by simply comparing the current year to the previous year. The future may be expected to
be very different than the past as economic conditions change. Also, events happen that may not be expected to reoccur.
For example, if weather conditions are particularly wet one year, a company making and selling umbrellas would be
expected to make higher than usual sales. It would not be fair to assess managers against these historical sales levels
in future years, where weather conditions are more normal.
(Other possible objectives include:
(b)
–
To delegate authority to budget holders
A formal budget permits budget holders to make financial decisions within the specified limits agreed, i.e. to incur
expenditure on behalf of the organisation.
–
To ensure achievement of the management’s objectives
Objectives are set not only for the organisation as a whole but also for individual targets. The budget helps to work out
how these objectives can be achieved.)
Participative budgeting
‘Participative budgeting’ refers to a budgeting process where there is some level of involvement from subordinates within the
organisation, rather than budgets just being set by the top level of management.
There are various views about whether participative budgeting is more effective than other styles. Each of the objectives from
part (a) is dealt with below, considering the extent to which participative budgeting helps to achieve this.
–
To compel planning
Participative budgeting will compel planning. Although participation can take many forms, often it will take the form of
bottom-up budgeting, whereby the participation starts at the lowest level of management and goes all the way up to the
top. If this is the case, then planning is taking place at many levels, and should be more accurate than if it simply takes
place at a high level, by individuals who are not familiar with the day to day needs of the business.
–
To co-ordinate activities
Co-ordination of activities may become more time consuming if a participative style of budgeting is used. This is
because, not only does there need to be co-ordination between departments but there also has to be co-ordination
between the different levels of management within each department. The process should be cumbersome but also
effective, with everyone knowing exactly what the plan is.
–
To communicate activities
Communication will be particularly effective with participative budgeting, although how effective depends on the extent
of the participation. If all levels of management are involved, from the bottom up, then all levels of management know
what the plan is. However, the plan may change as different departments’ budgets are reviewed together and the overall
12
Taha Popatia - ARTT Business School - 02134523175
3
–
To motivate managers to perform well
If managers play a part in setting the budget, they are more likely to think that the figures included in them are realistic.
Therefore, they are more likely to try their best to achieve them. However, it may be that managers have built budgetary
slack into their budgets, in an attempt to make themselves look good. Therefore, managers could end up performing
less well than they would do had tougher targets been set by their superiors.
–
To establish a system of control
In terms of establishing a system of control, it is largely irrelevant whether the budget setting process is a participative
one or not. What is important is that actual results are compared to expected, and differences are investigated. This
should happen irrespective of the budget setting process. Having said that, control is only really effective if the budgeted
figures are sound. As stated above, whilst they are more likely to be realistic if a participative style of budgeting is used,
the system is open to abuse in the form of budgetary slack.
–
To evaluate performance
Managers will be appraised by comparing the results that they have achieved to the budgeted results. A participative
budget will be an effective tool for this provided that participation is real rather than pseudo and provided that the
managers have not built slack into their figures, which has gone uncorrected.
Note: candidates would not be required to write all of this for the available marks.
4
(a)
Life cycle cost per unit
$
160,000
800,000
3,950,000
1,940,000
240,000
360,000
2,600,000
12,400,000
R & D costs
Product design costs
Marketing costs
Fixed production costs
Fixed distribution costs
Fixed selling costs
Administration costs
Variable manufacturing costs
(100,000 x $40 + 200,000 x $42)
Variable distribution costs
(100,000 x $4 + 200,000 x $4·50)
Variable selling costs
(100,000 x $3 + 200,000 x $3·20)
1,300,000
940,000
–––––––––––
24,690,000
–––––––––––
Total costs
Therefore cost per unit = $24,690,000/300,000 = $82·30
(b)
New life cycle cost
Total labour time for first 100 units:
y = axb
b = –0·0740005
If x = 100, then y = 0·5 x 100–0·0740005
= 0·3556 hours per unit.
Therefore total hours for 100 units = 35·56 hours
Time for 99th unit
y = 0·5 x 99–·0740005
= 0·3559 hours per unit.
Therefore total hours for 99 units = 35·23 hours.
Therefore, time for 100th unit = 35·56 hours – 35·23 hours = 0·33 hours
Total labour cost over life of product:
Year 2
100 units at 0·3556 per unit
99,900 at 0·33 hours per unit
36 hours
32,967 hours
–––––––––
33,003 hours
–––––––––
$792,072
–––––––––
at $24 per hour
13
Taha Popatia - ARTT Business School - 02134523175
budgeted profit compared to the top level management’s expectations. Hence, it may be the case that those people
involved in the initial budgets, i.e. lower level management, have to deal with their budgets being changed.
Year 3
200,000 at 0·33 per unit
66,000 hours
–––––––––
$1,716,000
–––––––––
at $26 per hour
Total revised life cycle cost
$
2,508,072
24,690,000
(3,800,000)
Therefore total labour cost
Other life cycle costs from (a)
Less labour cost included in (a)
(100,000 x 0·5 x $24) + (200,000 x 0·5 x $26)
–––––––––––
23,398,072
–––––––––––
Total revised life cycle costs
(c)
Benefits of life cycle costing
–
The visibility of ALL costs is increased, rather than just costs relating to one period. This facilitates better
decision-making.
–
Individual profitability for products is more accurate because of this. This facilitates performance appraisal and
decision-making, and means that prices can be determined with better knowledge of the true costs.
–
More accurate feedback can take place when assessing whether new products are a success or a failure, since the costs
of researching, developing and designing those products are also taken into account.
Note: Other valid benefits would also be awarded marks.
5
(a)
(i)
Usage variance
Honey
Sugar
Syrup
(ii)
Std usage for
actual output
kgs
2,020
1,515
1,010
Actual
usage
kgs
2,200
1,400
1,050
Variance
Actual qnty
std mix
kgs
2,066·67
1,550
1,033·33
Actual qnty
actual mix
kgs
2,200
1,400
1,050
Variance
kgs
(180)
115
(40)
Std cost
per kg
$
20
30
25
Variance
$
(3,600)
3,450
(1,000)
––––––
(1,150) A
––––––
Mix variance
Honey
Sugar
Syrup
kgs
(133·33)
150
(16·67)
Std cost Variance
per kg
$
$
20
(2,666·60)
30
4,500
25
(416·75)
–––––––––
1,416·65 F
–––––––––
(iii) Yield variance
Honey
Sugar
Syrup
Std quantity Actual qnty
std mix
std mix
kgs
kgs
2,020
2,066·67
1,515
1,550
1,010
1,033·33
Variance
kgs
(46·67)
(35)
(23·33)
Std cost
per kg
$
20
30
25
Variance
$
(933·40)
(1,050)
(583·25)
–––––––––
(2,566·65) A
–––––––––
The method used above is a more simple method for calculating the mix and yield variances than the one shown below.
However, in the method shown below, the individual variances for each material are also meaningful, whereas they are not
in the method shown above. Since the question only asks for the total variances, students will be given credit for either
method.
14
Taha Popatia - ARTT Business School - 02134523175
Therefore cost per unit = $23,398,072/300,000 = $77·99
(ii)
Mix variance
Honey
Sugar
Syrup
Actual qnty
std mix
kgs
2,066·67
1,550
1,033·33
Actual qnty
actual mix
kgs
2,200
1,400
1,050
Variance
kgs
(133·33)
150
(16·67)
budgeted
WAC per kg
24·44
24·44
24·44
Std cost
per kg
$
20
30
25
Difference
(4·44)
5·56
0·56
Variance
$
592·59
833·33
(9·26)
–––––––––
1,416·66 F
–––––––––
(iii) Yield variance
Actual qnty
actual mix
kgs
2,200
1,400
1,050
Variance
kgs
(180)
115
(40)
Variance
24·44
24·44
24·44
Budgeted weighted average cost
Honey
Sugar
Syrup
2,066·67
1,550
1,033·33
20
30
25
41,333·4
46,500
25,833·25
–––––––––––
4,650 113,666·65
–––––––––––
24·44
WAC = $113,666·65/4,650 kg = $24·44
(b)
(i)
Expenditure variance
Cost driver rate = $52,800/330 = $160
Expected cost therefore = 360 x $160
Actual cost
$57,600
$60,000
––––––––
$2,400 A
––––––––
Variance
(ii)
Efficiency variance
Expected no. of units per set up
264,000/330 = 800
Therefore expected no. of set ups for
320,000 = 320,000/800 =
Actual number of set ups
400
360
–––––––
40 F
–––––––
$160
–––––––
$6,400 F
–––––––
Difference
x standard rate per set up
Variance
(c)
Steps involved in activity based costing
–
–
–
–
Identify the organisation’s major activities.
Collect the costs associated with each activity into cost pools.
Identify the cost drivers i.e. those factors which give rise to the costs.
Charge the costs to the products on the basis of the cost driver.
15
$
(4,400·00)
2,811·11
(977·78)
–––––––––
(2,566·67) A
–––––––––
Taha Popatia - ARTT Business School - 02134523175
Honey
Sugar
Syrup
Std usage for
actual output
kgs
2,020
1,515
1,010
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2011 Marking Scheme
Marks
(a)
(b)
Costing statement
Lunch
Engineer costs
Technical advisor
Site visits
Training costs
Handsets
Control system
Cable
1
3
1
1
2
2
3
1
–––
14
–––
Explanation
Relevant costing
Future cost/sunk cost
Cash flow not accounting adjustment
Incremental
Committed cost
Opportunity cost
1
1
1
1
1
–––
4
–––
Maximum
Price to be charged
Doesn’t incorporate profit
Doesn’t cover all costs
Ignores fixed costs
Contract X – engineer’s time
Starting point only
Need to make a profit
Need to attract future work
1
1
1
1
1
1
1
–––
4
–––
6
–––
20
–––
–––
Maximum for price
Maximum for (b) overall
Total marks
17
Taha Popatia - ARTT Business School - 02134523175
1
Marks
(a)
(b)
(c)
Profit statement
Sales revenue:
External
Inter-divisional transfers
External material costs
Inter-divisional transfers
Labour costs
Fixed costs
Profit
1
0·5
1
0·5
1
1
1
–––
6
–––
Revised profit
External sales
Inter-divisional transfers
Material costs
Internal transfers (materials)
Labour costs
Fixed costs
Profit
1
1
2
1
1
1
1
–––
8
–––
Transfer price difficulties and policy
Each well-explained point on difficulties
1
–––
4
–––
4
–––
6
–––
20
–––
–––
Maximum
Well reasoned recommendation
Maximum for (c) overall
Total marks
3
(a)
Objectives
Each objective
1·5
–––
9
–––
Maximum
(b)
Participative style of budgeting
Explaining participative budgeting
Each objective discussed in relation to it
2
1·5
–––
11
–––
20
–––
–––
Maximum
Total marks
18
Taha Popatia - ARTT Business School - 02134523175
2
(a)
(b)
(c)
Life cycle cost
R & D costs
Product design costs
Marketing costs
Fixed production costs
Fixed distribution costs
Fixed selling costs
Administration costs
Variable manufacturing costs
Variable distribution costs
Variable selling costs
Total costs
Cost per unit (correct figure)
0·5
0·5
0·5
0·5
0·5
0·5
0·5
0·5
0·5
0·5
0·5
0·5
–––
6
–––
Revised life cycle cost
Time per unit for 100 units
Total time of 100 units
Time per unit for 99 units
Total time of 99 units
Time for 100th unit
Total labour cost year 2
Total labour cost year 3
Carry forward life cycle costs from (a)
Deduct original labour cost in (a)
Revised cost per unit
1
1
1
1
1
1
1
1
1
1
–––
10
–––
Benefits of life cycle costing
Per valid point made
1·5
–––
4
–––
20
–––
–––
Maximum
Total marks
5
(a)
(b)
(c)
Material variances
(i)
Usage variance
4
(ii)
Mix variance
4
(iii) Yield variance
4
–––
12
–––
Overhead variances
(i)
Expenditure variance
3
(ii)
Efficiency variance
3
–––
6
–––
ABC
Each step
0·5
–––
2
–––
20
–––
–––
Maximum
Total marks
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Taha Popatia - ARTT Business School - 02134523175
Marks
4
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
Keypads
$
164,000
Variable costs
Materials ($160k x 6/12) + ($160k x 1·05 x 6/12)
($116k x 1·02)
Direct labour
Machine set-up costs
($26k – $4k) x 500/400
($30k – $6k) x 500/400
Display screens
$
118,320
60,000
40,000
27,500
Attributable fixed costs
Heat and power ($64k – $20k)/($88k – $30k)
Fixed machine costs
Depreciation and insurance ($84/$96k x 40%)
Total incremental costs of making in-house
Cost of buying (80,000 x $4·10/$4·30)
Total saving from making
––––––––
231,500
30,000
––––––––
208,320
44,000
4,000
33,600
––––––––
81,600
––––––––
313,100
––––––––
––––––––
328,000
––––––––
14,900
––––––––
58,000
6,000
38,400
––––––––
102,400
––––––––
310,720
––––––––
––––––––
344,000
––––––––
33,280
––––––––
Robber Co should therefore make all of the keypads and display screens in-house
(Note: It has been assumed that the fixed set-up costs only arise if production takes place.)
(Alternative method)
Relevant costs
Keypads
$
Direct materials
($160,000/2) + $160,000/2 x 1·05
$116,000 x 1·02
Direct labour
Heat and power
$64,000 – (50% x $40,000)
$88,000 – (50% x $60,000)
Machine set up costs:
Avoidable fixed costs
Activity related costs (w1)
Avoidable depreciation and insurance costs:
40% x $84,000/$96,000
Display screens
$
164,000
40,000
118,320
60,000
44,000
58,000
Total relevant manufacturing costs
Relevant cost per unit:
Cost per unit of buying in
Incremental cost of buying in
4,000
27,500
6,000
30,000
33,600
––––––––
313,100
––––––––
3·91375
4·1
––––––––
0·18625
––––––––
38,400
––––––––
310,720
––––––––
3·884
4·3
––––––––
0·416
––––––––
As each of the components is cheaper to make in-house than to buy in, the company should continue to manufacture keypads
and display screens in-house.
Working 1
Current no. of batches produced = 80,000/500 = 160.
New no. of batches produced = 80,000/400 = 200.
Current cost per batch for keypads = ($26,000 – $4,000)/160 = $137·5.
Therefore new activity related batch cost = 200 x $137·5 = $27,500.
Current cost per batch for display screens = ($30,000 – $6,000)/160 = $150.
Therefore new activity related batch cost = 200 x $150 = $30,000.
(b)
The attributable fixed costs remain unaltered irrespective of the level of production of keypads and display screens, because
as soon as one unit of either is made, the costs rise. We know that we will make at least one unit of each component as both
are cheaper to make than buy. Therefore they are an irrelevant common cost.
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Taha Popatia - ARTT Business School - 02134523175
1
June 2012 Answers
Keypads
$
4·1
2·89
Buy
Variable cost of making ($231,500/80,000)
($208,320/80,000)
–––––
1·21
–––––
0·5
–––––
2·42
–––––
–––––
1
Saving from making per unit
Labour hour per unit
Saving from making per unit of limiting factor
Priority of making
Display screens
$
4·3
2·6
––––
1·7
––––
0·75
––––
2·27
––––
––––
2
Note 1: It is equally as acceptable to have treated the heat and power costs as variable and include them in the above. It
will not have changed the outcome and is an entirely acceptable interpretation of the scenario.
Note 2: If a production run cannot be stopped part way through, then the company would only be able to make 66,400
and would have to buy 33,600, since production takes place in batches of 400 units.
(c)
2
(a)
Non-financial factors
–
The company offering to supply the keypads and display screens is a new company. This would make it extremely risky
to rely on it for continuity of supplies. Many new businesses go out of business within the first year of being in business
and, without these two crucial components, Robber Co would be unable to meet demand for sales of control panels.
Robber Co would need to consider whether there are any other potential suppliers of the components. This would be
useful as both a price comparison now and also to establish the level of dependency that would be committed to if this
new supplier is used. If the supplier goes out of business, will any other company be able to step in? If so, at what cost?
–
The supplier has only agreed to these prices for the first two years. After this, it could put up its prices dramatically. By
this stage, Robber Co would probably be unable to begin easily making its components in house again, as it would
probably have sold off its machinery and committed to larger sales of control panels.
–
The quality of the components could not be guaranteed. If they turn out to be poor quality, this will give rise to problems
in the control panels, leading to future loss of sales and high repair costs under warranties for Robber Co. The fact that
the supplier is based overseas increases the risk of quality and continuity of supply, since it has even less control of
these than it would if it was a UK supplier.
–
Robber Co would need to establish how reliable the supplier is with meeting promises for delivery times. This kind of
information may be difficult to establish because of the fact that the supplier is a new company. Late delivery could have
a serious impact on Robber Co’s production and delivery schedule.
Deriving a target price and cost in a manufacturing company
Step 1: A product is developed that is perceived to be needed by customers and therefore will attract adequate sales volumes.
Step 2: A target price is then set based on the customers’ perceived value of the product. This will therefore be a market
based price.
Step 3: The required target operating profit per unit is then calculated. This may be based on either return on sales or return
on investment.
Step 4: The target cost is derived by subtracting the target profit from the target price.
Step 5: If there is a cost gap, attempts will be made to close the gap. Techniques such as value engineering may be
performed, which looks at every aspect of the value chain business functions, with an objective of reducing costs while
satisfying customer needs.
Step 6: Negotiation with customers may take place before deciding whether to go ahead with the project.
(b)
Four characteristics of services
–
Spontaneity: unlike goods, a service is consumed at the exact same time as it is made available. No service exists until
it is being experienced by the consumer.
–
Heterogeneity/variability: services involve people and, because people are all different, the service received may vary
depending on which person performs it. Standardisation is expected by the customer but it is difficult to maintain.
–
Intangibility: unlike goods, services cannot be physically touched.
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Taha Popatia - ARTT Business School - 02134523175
Total labour hours available = 100,000.
Make maximum keypads, i.e. 100,000, using 50,000 labour hours (100,000 x 0·5 hours)
Make 50,000/0·75 display screens, i.e. 66,666 display screens.
Therefore buy in 33,334 display screens (100,000 – 66,666).
–
Perishability: unused capacity cannot be stored for future use.
(Also acceptable characteristics are that ‘No transfer of ownership takes place when a service is provided’ and ‘service
industries rely heavily on their staff, who often have face-to-face contact with the customer, and represent the organisation’s
brand’.)
(c)
Deriving target costs
(i)
For services under the ‘payment by results’ scheme
The obvious target price is the pre-set tariff that is paid to the trust for each service. This is known with certainty and
since the trust is a not for profit organisation, there may not be any need to deduct any profit margin from the tariff.
Problems may arise because of the fact that it is already known that costs sometimes exceed the pre-set tariff. These
issues are discussed in (d).
For transplant and heart operations
For these operations, the trust is paid on the basis of its actual costs incurred. However, since the trust only has a
restricted budget for such services, it is still important that it keeps costs under control. The target cost could be based
on the average cost of these services when performed in the past, or the minimum cost that it has managed to provide
such services on before, in order to encourage cost savings. It is important that quality is not affected, however.
Note: All reasonable suggestions would be acceptable.
(d)
Difficulties for the Sickham UHS Trust in using target costing
The main difficulties for the trust are as follows:
It is difficult to find a precise definition for some of the services
In order for target costing to be useful, it is necessary to define the service being provided. Whilst the introduction of the
pre-set tariff will make this more easy for some services, as this definition can be used, for other services not covered by the
tariff, definition could be difficult.
It is difficult to decide on the correct target cost for services
For the pre-set tariff services, the obvious target cost would be the pre-set tariff. However, bearing in mind that the Trust knows
that some services can be provided at less than this and some services cannot be provided at this price at all, one has to
question whether it is right to use this as the target cost. A target cost which is unachievable could be demotivational for staff
and one which is easily met will not provide an incentive to keep costs down.
As regards the other operations, the target can be set at a level which is both achievable but feasible, so this should result in
less of an issue.
It would be difficult to use target costing for new services
The private sector initially developed the use of target costing in the service sector with the intention that it should only be
used for new services rather than existing ones. Considering the work that a hospital performs particularly, it would be difficult
to establish target costs when there is no comparative data available, unless other hospitals have already provided services
and the information can be obtained from them.
The costing systems at the Sickham UHS Trust are poor
If costs are to be analysed in depth, the analysis must be based on accurate and timely costing systems, which do not appear
to currently exist at the Sickham UHS Trust. A large part of the hospitals’ costs for services are going to be overhead costs
and these need to be allocated to services on a consistent basis. This is not currently happening.
Note: Only three difficulties were required.
3
(a)
Quarter
2010
Q3
Q4
2011
Q1
Q2
Q3
Q4
2012
Q1
Q2
Actual volume
of sales
’000 units
Centred moving
average
’000 units
Seasonal percentage
1,200
1,000
1,050
1,300
1068·75
1112·50
1162·50
1206·25
1·1228
0·8989
0·9032
1·0777
1,400
1,150
1243·75
1287·50
1·1256
0·8932
900
1,100
The average seasonal variations can now be calculated to see whether any adjustment to the percentages is required, since
they must be 4·0 in total.
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Taha Popatia - ARTT Business School - 02134523175
(ii)
Since the averages total 4·0057, each one needs to be reduced by 0·0014
2010
2011
2012
Total
Average
Rounded
Q1
Q2
1·1228
1·1256
2·2484
–––––––
1·1242
–––––––
1·1228
0·8989
0·8932
1·7921
–––––––
0·8960
–––––––
0·8946
Q3
0·9080
0·9032
Q4
1·0820
1·0777
1·8112
–––––––
0·9056
–––––––
0·9042
2·1597
–––––––
1·0799
–––––––
1·0785
4·0057
4·0001
Forecast centred moving average for Q4 of 2012 = 1,287,500 + (2 x 43,750) = 1,375,000.
Adjusted for seasonal variation = 1,375,000 x 1·0785 = 1,482,937·5 units.
Note: Other methods are equally as acceptable to answer 3(a). Candidates could have worked back from the centred moving
averages provided in the question for 2012 quarters 3 or 4 and they could also have used linear regression.
(b)
Likely impact on the staff and business
Staff
–
Since the budgeting style has been an imposed one rather than a participative one, morale amongst staff is likely to be
low, since they have not been involved in the process at all.
–
Additionally, since sales targets appear to be unachievable and staff have not received performance related bonuses,
staff are not motivated to try and achieve targets since they feel like they are impossible to achieve. Team spirit will be
low and an atmosphere of ‘doing the bare minimum’ is likely to exist.
–
Since budgets are imposed from the top down, the culture will not be one in which operational management generate
ideas, as they will feel like they are not appreciated and that their views are not taken into account.
Business
–
Since sales levels are overestimated, production volumes must also be too high. As well as this leading to high inventory
costs because actual sales are then lower than expected, since the product is also perishable, waste levels have probably
been high. These will be significant costs to the company.
4
(a)
–
Also, when customers do receive their goods, it is likely that they will be close to their expiry date, since they will have
been taken from inventory that has been held for some time. This will be frustrating for customers because products
may then perish before the end customer gets to use them. Also, it is likely that a sauce that is two months old does
not taste as good as a sauce that is only a few days old. Both of these factors may be causing damage to the company’s
reputation.
–
Too many staff are probably being employed in the business, bearing in mind that the staffing levels will be related to
forecast production volumes. One can only assume that whilst initially, production volumes relate to the forecast, as it
becomes apparent that sales are not as high as anticipated and inventory levels increase, production slows down. Staff
are probably sitting idle for some of the time, which is demotivating for them and costly to the company.
Variance calculations
Sales market share:
Revised budgeted sales
Actual sales
at std contribution per unit of $44
Sales market size
Original budgeted sales
Revised budgeted sales
at std contribution per unit of $44
900 units
960 units
–––––––
60 units
$2,640 F
1,000 units
900 units
–––––––
100 units
$4,400 A
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Taha Popatia - ARTT Business School - 02134523175
The difference of 0·0001 is due to rounding and can be ignored.
The average trend of the centred moving averages is (1,287·5 – 1,068·75)/5 = 43,750 units.
Therefore forecast centred moving average for Q3 in 2012 = 1,287,500 + 43,750 = 1,331,250.
Adjusted for seasonal variation: 1,331,250 x 0·9042 = 1,203,716·25 units.
$44 ($80 – $36)
Material price (SP – AP) x AQ
= ($3 – $3·05) x 3,648
Material usage (SQAP – AQ) x SP
(3,840 – 3,648) x $3
Labour efficiency (SHAP – AH) x SR
(1,920 – 1,824) x $10
Variable overhead efficiency (SHAP – AH) x SR
(1,920 – 1,824) x $2
Variable overhead expenditure
(AHSR – actual cost) = $3,648 – $3,283
$182 A
$576 F
$960 F
$192 F
$365 F
–––––
$151 F
–––––
Reconciliation Statement
Budgeted sales revenue
Budgeted standard variable cost
Budgeted contribution
Sales contribution variances
–
market share
–
market size
Variable cost variances
Materials
–
price
–
usage
Labour efficiency
Variable overhead
–
efficiency
–
expenditure
$
80,000
(36,000)
––––––––
44,000
2,640
(4,400)
––––––––
(182)
576
––––––––
(1,760)
––––––––
42,240
394
960
192
365
––––––––
Actual contribution
(b)
$
557
––––––––
44,151
––––––––
––––––––
TQM and standard costing
–
TQM relies on a culture of continuous improvement within an organisation. For this to succeed, the focus must be on
quality, not quantity. The cost of failing to achieve the desired level of quality must be measured in terms of internal and
external failure costs.
–
Traditional variance analysis focuses on quantity rather than quality. This could mean that, for example, lower grade
labour is used in an attempt to reduce costs. This would be totally at odds with a TQM culture, which is the basis of
the problem of the two systems running side by side.
–
A traditional standard system allocates responsibility for variances to the different departmental managers. When a TQM
system is adopted, all employees’ roles in ensuring quality are highlighted and everyone is seen as equally important in
the quality assurance process. This difference would make it difficult for the two systems to co-exist.
–
Traditional standard costing systems usually make allowances for waste. This would be totally contrary to the TQM
philosophy, which aims to eliminate all waste.
–
Continuous improvement makes the standard cost system less relevant due to regular small changes to the process.
It would seem to be the case that the two systems would struggle to co-exist at Lock Co.
5
(a)
ROI
Return on investment
= net profit/net assets
Division B
$311,000 x 12/$23,200,000 = 16·09%
Division C
$292,000 x 12/$22,600,000 = 15·5%
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Taha Popatia - ARTT Business School - 02134523175
Total
Residual income
Net profit
Less: imputed interest charge
$22·6 x 10%
$23·2m x 10%
Residual income
(c)
B
$’000
3,732
C
$’000
3,504
(2,260)
(2,320)
––––––
1,412
––––––
––––––
1,244
––––––
Performance of the two divisions
ROI
Divisions B and C have ROIs of 16·09% and 15·5% respectively, compared to the target of 20%. This suggests that the
divisions have not performed well, but the reason for this is that now, uncontrollable head office costs are being taken into
effect before calculating the ROI. The target ROI has not been reduced to reflect the change in the method being used to
calculate it. Using the old method, ROI would have been as follows:
B: ($311,000 + $155,000) x 12/$23·2m = 24·1%
C: ($292,000 + $180,000) x 12/$22·6m = 25·06%
From this it can be seen that both divisions have actually improved their performance, rather than it having become worse.
RI
From the residual income figures, it can clearly be seen that both Division B and C have performed well, with healthy RI
figures of $1·4m and $1·2m respectively, even when using net profit rather than controllable profit as bases for the
calculations. The cost of capital of the company is significantly lower than the target return on investment that the company
seeks, making the residual income figure show a more positive position.
(d)
Division B’s ROI with investment
Depreciation = 2,120,000 – 200,000/48 months = $40,000 per month.
Net profit for July = 311k + ($600k x 8·5%) – $40k = $322k
Annualised net profit: $322k x 12 = $3,864k.
Opening net assets after investment = $23,200k + $2,120 = $25,320k.
ROI = $3,864k/25,320k = 15·26%
Therefore, Division B will not proceed with the investment, since it will cause a decrease in its ROI.
If RI is calculated with the investment, the result is as follows:
B
$’000
3,864
Less: imputed interest charge
$25·32m at 10%
Residual income
(2,532)
––––––
1,332
––––––
This calculation shows that, if the investment is undertaken, RI is actually lower than without the investment. So, if either
ROI or RI is considered by Division B’s manager when deciding whether to undertake the investment, the investment will not
be undertaken. This decision will be in the best interests of the company as a whole, since the RI of the investment alone is
actually negative ($132k – $212k = $(80k)).
(e)
Behavioural issues
The staff in both divisions have been used to meeting targets and getting rewarded appropriately. Suddenly, they will find that
even though in reality divisional performance has improved, neither division is meeting its ROI target. This will purely be as
a result of the inclusion of the head office costs. The whole basis of being assessed on uncontrollable apportioned costs is
questionable in the first place. However, if it is going to be done this way, at the least the target ROI must be revised.
Staff are likely to become frustrated with a new system which is inherently unfair. This could give rise to staff organising
themselves together in order to oppose the system. At the least, they are likely to become quickly demotivated, working slower
than possible and perhaps withdrawing things like voluntary overtime. The cost to the company as a whole is likely to be
high and the situation needs to be resolved as quickly as possible.
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Taha Popatia - ARTT Business School - 02134523175
(b)
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2012 Marking Scheme
Marks
(a)
Incremental cost of buying in
Direct materials
Direct labour
Heat and power
Set-up costs
Depreciation and insurance
Total cost of making/cost per unit of making
Conclusion
1
0·5
1
3
1
0·5
1
–––
8
–––
(Method 2)
Direct materials
Direct labour
Heat and power
Avoidable fixed costs
Activity related costs (w1)
Avoidable depreciation and insurance
Total relevant cost of manufacturing/cost per unit
Conclusion
(b)
(c)
1
0·5
1
1
2
1
0·5
1
–––
8
–––
If 100,000 control panels made
Variable cost of making per unit
Saving from making
Saving per labour hour
Ranking
Make 100,000 keypads
Make 66,666 display screens
Buy 33,334 display screens
1
1
1
1
1
1
1
–––
7
–––
Non-financial factors
Per factor
1 or 2
–––
5
–––
20
–––
–––
Maximum
Total marks
17
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1
Marks
(a)
Steps
Develop product
Set target price
Set profit margin
Set target cost
Close gap
Value engineering
Negotiate
1
1
1
1
1
1
1
–––
6
–––
Maximum
(b)
Characteristics
Spontaneity
Heterogeneity
Intangibility
Perishability
Other
1
1
1
1
1
–––
4
–––
Maximum marks
(c)
(d)
Deriving target costs
(i)
Scheme target costs
2
–––
(ii)
Other services’ target costs
2
–––
Difficulties
Each difficulty explained
2
–––
6
–––
20
–––
–––
Total marks
3
(a)
(b)
Predicting sales volumes
Seasonal percentages
Average seasonal variations
Average trend of centred moving average
Forecast moving average for Q3
Adjusted for seasonal variation
Forecast moving average for Q4
Adjusted for seasonal variation
3
2
1
1
1
1
1
–––
10
–––
Likely impact
Per point discussed
2
–––
10
–––
20
–––
–––
Total marks
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Taha Popatia - ARTT Business School - 02134523175
2
Marks
(a)
(b)
Reconciliation statement
Variance calculations
Market share
Market size
Material price
Material usage
Labour efficiency
Variable overhead efficiency
Variable overhead expenditure
Reconciliation statement
1·5
1·5
1
1
1
1
1
4
–––
12
–––
TQM and standard costing
Per valid discussion point
Conclusion
2
1
–––
8
–––
20
–––
–––
Maximum marks
Total marks
5
(a)
(b)
(c)
ROI
ROI for B
ROI for C
1
1
–––
2
–––
RI calculations
RI for B
RI for C
1·5
1·5
–––
3
–––
Discussion
ROI discussion
RI discussion
Extra ROI calculation under old method
Valid conclusion drawn
2
2
1
1
–––
6
–––
Maximum marks
(d)
(e)
ROI/RI after investment
ROI calculation
RI calculation
Comments and conclusion
2
1
2
–––
5
–––
Behavioural issues
ROI of investment
Per valid point
1
–––
4
–––
20
–––
–––
Total marks
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Taha Popatia - ARTT Business School - 02134523175
4
Fundamentals Level – Skills Module, Paper F5
Performance Management
Hair Co
(a)
Weighted average contribution to sales ratio (WA C/S ratio) = total contribution/total sales revenue.
Per unit:
C
$
110
(12)
(8)
(16)
(14)
–––
60
–––
S
$
160
(28)
(22)
(34)
(20)
–––
56
–––
D
$
120
(16)
(26)
(22)
(28)
–––
28
–––
20,000
22,000
26,000
Total sales revenue
$2,200,000
$3,520,000
$3,120,000
Total contribution
$1,200,000
$1,232,000
$728,000
Selling price
Material 1
Material 2
Skilled labour
Unskilled labour
Contribution
Sales units
WA C/S ratio = $1,200,000 + $1,232,000 + $728,000/$2,200,000 + $3,520,000 + $3,120,000
= $3,160,000/$8,840,000 = 35·75%
(b)
Break-even sales revenue = fixed costs/C/S ratio
Therefore break-even sales revenue = $640,000/35·75% = $1,790,209·70.
(c)
PV chart
Calculate the individual C/S ratio for each product then rank them according to the highest one first.
Per unit:
C
$
60
110
0·55
1
Contribution
Selling price
C/S ratio
Ranking
Product
Revenue
$
0
Make C
Make S
Make D
0
2,200,000
3,520,000
3,120,000
S
$
56
160
0·35
2
Cumulative Revenue
(x axis co-ordinate)
$
0
2,200,000
5,720,000
8,840,000
Profit
$
(640,000)
1,200,000
1,232,000
728,000
11
D
$
28
120
0·23
3
Cumulative Profit
(y axis co-ordinate)
$
(640,000)
560,000
1,792,000
2,520,000
Taha Popatia - ARTT Business School - 02134523175
1
December 2012 Answers
3,000
D
2,500
2,000
S
1,000
Most profitable first
Constant mix
C
Profit $’000
500
0
0
2,000
4,000
6,000
8,000
10,000
Sales revenue $’000
–500
–1,000
(d)
From the chart above it can be seen that, if the products are sold in order of the highest ranking first, break even will take
place at a point just under $1,200,000 of sales revenue. The exact figure can be worked out by taking the fixed costs of
$640,000 and dividing them by Product C’s C/S ratio of 0·55, i.e. the exact BEP is $1,163,636. This is substantially earlier
than the break-even point which occurs if the products are all sold in a constant mix, which is $1,790,209, as calculated in
(b) above.
The reason for this is obviously because the more profitable product, C, contributes more per unit to fixed costs when being
sold on its own, than when a mix of products C, S and D are sold. The weighted average C/S ratio of all three products is
only 35·75%, compared to C’s C/S ratio of 55%. Obviously, then, break even will occur earlier if C is sold in priority.
In reality, however, the mix of sales will vary throughout the year and Hair Co can neither assume that the products are sold
in a constant mix, nor that the most profitable can be sold first.
2
Truffle Co
(a)
Basic variances
Standard cost of labour per hour = $6/0·5 = $12 per hour.
Labour rate variance = (actual hours paid x actual rate) – (actual hours paid x std rate)
Actual hours paid x std rate = $136,800/·95 = $144,000.
Therefore rate variance = $144,000 – $136,800 = $7,200 F
Labour efficiency variance = (actual production in std hours – actual hours worked) x std rate
[(20,500 x 0·5) – 12,000] x $12 = $21,000 A.
(b)
Planning and operational variances
Labour rate planning variance
(Revised rate – std rate) x actual hours paid = [$12 – ($12 x 0·95)] x 12,000 = $7,200 F.
Labour rate operational variance
There is no labour rate operational variance.
(Revised rate – actual rate) x actual hours paid = $11·40 – $11·40 x 12,000 = 0
12
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1,500
Labour efficiency planning variance
(Standard hours for actual production – revised hours for actual production) x std rate
[10,250 – (20,500 x 0·5 x 1·2)] x $12 = $24,600 A.
Labour efficiency operational variance
(Revised hours for actual production – actual hours for actual production) x std rate
(12,300 – 12,000) x $12 = $3,600 F.
(c)
Discussion
In order to assess the production manager’s performance fairly, however, only the operational variances should be taken into
account. This is because planning variances reflect differences that arise because of factors that are outside the control of the
production manager. The operational variance for the labour rate was $0, which means that the labour force were paid exactly
what was agreed at the end of October: their reduced rate of $11·40 per hour. The manager clearly did not have to pay
anyone for overtime, for example, which would have been expected to push this rate up. The rate reduction was secured by
the company and was not within the control of the production manager, so he cannot take credit for the favourable rate
planning variance of $7,200. The company is the source of this improvement.
As regards labour efficiency, the planning and operational variances give us more information about the total efficiency
variance of $21,000A. When this is broken down into its two parts, it becomes clear that the operational variance, for which
the manager does have control, is actually $3,600 favourable. This is because, when the recipe is changed as it has been
in November, the chocolates usually take 20% longer to make in the first month whilst the workers are getting used to
handling the new ingredient mix. When this is taken into account, it can therefore be seen that workers took less than the
20% extra time that they were expected to take, hence the positive operational variance. The planning variance, on the other
hand, is $24,600 adverse. This is because the standard labour time per batch was not updated in November to reflect the
fact that it would take longer to produce the truffles. The manager cannot be held responsible for this.
Overall, then, the manager has performed well, given the change in the recipe.
3
Web Co
Web Co has made three changes and introduced two incentives in an attempt to increase sales. Using the performance indicators
given in the question, it is possible to assess whether these attempts have been successful.
Total sales revenue
This has increased from $2·2 million to $2·75m, an increase of 25% (W1). This is a substantial increase, especially considering
the fact that a $10 discount has been given to all customers spending $100 or more at any one time. However, because a number
of changes and incentives have been introduced, it is not possible to assess how effective each of the individual changes/incentives
has been in increasing sales revenue without considering the other performance indicators.
Net profit margin (NPM)
This has decreased from 25% to 16·7%. In $ terms this means that net profit was $550,000 in quarter 1 and $459,250 in
quarter 2 (W2). If the 25% NPM had been maintained in quarter 2, the net profit would have been $687,500 for quarter 2. It is
therefore $228,250 lower than it would have been. This is mainly because of the $200,000 paid out for advertising and the
$20,000 paid to the consultant for the search engine work. The remaining $8,250 difference could be a result of the cost of the
$10 discounts given to customers who spent more than $100, depending on how these are accounted for. Alternatively, it could
be due to the costs of providing the Fast Track service. More information would be required on how the discounts are accounted
for (whether they are netted off sales revenue or instead included in cost of sales) and also on the cost of providing the Fast Track
service.
Whilst it is not clear how long the advert is going to run for in the fashion magazine, $200,000 does seem to be a very large cost.
This expense is largely responsible for the fall in NPM. This is discussed further under ‘number of visits to website’.
Number of visits to website
These have increased dramatically from 101,589 to 141,714, an increase of 40,125 visits (39·5% W3). The reason for this is
a combination of visitors coming through the fashion magazine’s website (28,201 visitors W5), with the remainder of the increase
most probably being due to the search engine consultants’ work. Both of these changes can therefore be said to have been effective
in improving the number of people who at least visit Web Co’s online store. However, given that the search engine consultant only
charged a fee of $20,000 compared to the $200,000 paid for magazine advertising, in relative terms, the consultant’s work
provided value for money. Web Co’s sales are not really high enough to withstand a hit of $200,000 against profit, hence the fall
in NPM.
Number of orders/customers spending more than $100
The number of orders received from customers has increased from 40,636 to 49,600, an increase of 22% (W4). This shows that,
whilst most of the 25% sales revenue increase is due to a higher number of orders, 3% of it is due to orders being of a higher
purchase value. This is also reflected in the fact that the number of customers spending more than $100 per visit has increased
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When looking at the total variances alone, it looks like the production manager has been extremely poor at controlling his
staff’s efficiency, since the labour efficiency variance is $21,000 adverse. It also looks, at a glance, like he has managed to
secure labour at a lower rate.
from 4,650 to 6,390, an increase of 1,740 orders. So, for example, If each of these 1,740 customers spent exactly $100 rather
than the $50 they might normally spend, it would easily explain the 3% increase in sales that is not due to increased order
numbers. It depends partly on how the sales discounts of $10 each are accounted for. As stated above, further information is
required on these.
An increase in the number of orders would also be expected, given that the number of visitors to the site has increased substantially.
This leads on to the next point.
Website availability
Rather than improving after the work completed by Web Co’s IT department, the website’s availability has stayed the same. This
means that the IT department’s changes to the website have not corrected the problem. Lack of availability is not good for business,
although its exact impact is difficult to ascertain. It may be that visitors have been part of the way through making a purchase only
to find that the website then becomes unavailable. More information would need to be available about aborted purchases, for
example, before any further conclusions could be drawn.
Subscribers to online newsletter
These have increased by a massive 159%. It is not clear what impact this has had on the business as we do not know whether
the level of repeat customers has increased. This information is needed. Surprisingly, it seems that there has not been an increased
cost associated with providing Fast Track delivery, as the whole fall in net profit has been accounted for, so one can only assume
that Web Co managed to offer this service without incurring any additional cost itself.
Conclusion
With the exception of the work carried out to make the system more available, all of the other measures seem to have increased
sales or, in the case of Incentive 1, increased subscribers. More information is needed in relation to a couple of areas, as noted
above. The business has therefore been responsive to changes made and incentives implemented but the cost of the advertising
was so high that, overall, profits have declined substantially. This expenditure seems too high in relation to the corresponding
increase in sales volumes.
Workings
1. Increase in sales revenue $2·75m – $2·2m/$2·2m = 25% increase.
2. NPM: 25% x $2·2m = $550,000 profit in quarter 1. 16·7% x $2·75m = $459,250 profit in quarter 2.
3. No. of visits to website: increase = 141,714 – 101,589/101,589 = 39·5%.
4. Increase in orders = 49,600 – 40,636/40,636 = 22%.
5. Customers accessing website through magazine line = 141,714 x 19·9% = 28,201.
6. Increase in subscribers to newsletter = 11,900 – 4,600/4,600 = 159%.
4
Designit
(a)
Explanation
The rolling budget outlined for Designit would be a budget covering a 12-month period and would be updated monthly.
However, instead of the 12-month period remaining static, it would always roll forward by one month. This means that, as
soon as one month has elapsed, a budget is prepared for the corresponding month one year later. For example, Designit would
begin by preparing a budget for the 12 months from 1 December 2012 to 30 November 2013, to correspond with its year
end. Then, at the end of December 2012, a budget would be prepared for the month December 2013, so that the unexpired
period covered by the budget is always 12 months.
When the budget is initially prepared for the year ending 30 November 2013, the first month is prepared in detail, with much
less detail being given to later months, where there is a greater uncertainty about the future. Then, when this first month has
elapsed and the budget for the month of December 2013 is prepared, it is also necessary to revisit and revise the budget for
January 2013, which will now be done in more detail.
Note: This answer gives more level of detail than would be required to gain full marks.
(b)
Problems
Designit only has one part-qualified accountant. He is already overworked and probably has neither the time nor the
experience to prepare rolling budgets every month. One would only expect to see monthly rolling budgets of this nature in
businesses which face rapid change. There is no evidence that this is the case for Designit. If it did decide to introduce rolling
budgets, it would probably be sufficient if they were updated on a quarterly rather than a monthly basis. If this monthly rolling
budget is going to be introduced, it is going to require a lot of input from many of the staff, meaning that they will have less
time to dedicate to other things.
The sales managers may react badly to the new budgeting and incentive system. They are used to having been set targets
that are easily achievable. With the new system, they will have to work hard all year round. They are also likely to become
frustrated with the fact that they do not know the target for the whole year in advance. Once they have hit their target for the
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Conversion rate – visitor to purchaser
The conversion rate of visitors to purchasers has gone down from 40% to 35%. This is not surprising, given the advertising on the
fashion magazine’s website. Readers of the magazine may well have clicked on the link out of curiosity and may come back and
purchase something at a later date. It may be useful to have a breakdown of the visitor to purchaser rate, showing one statistic for
visitors who have come from the online magazine and one for those who have not. This would help clarify the position.
month, they may then also be tempted to hold back further work and let it run into the next month, so that they increase the
chances of meeting next month’s target. This would not be good for the business.
(c)
Alternative incentive scheme
The issue with the current bonus scheme is that the reward system is stepped, rather than being a percentage of sales. The
first $1·5 million fee income target is too easy to reach and the second $1·5 million target is too hard to reach. Therefore,
managers are not motivated to earn additional fees once the initial $1·5 million target has been reached.
(d)
Using spreadsheets
If spreadsheets are used for budgeting, the part-qualified accountant could be rekeying large amounts of data taken from the
company’s systems. It would be very easy for him to make a mistake when he is entering his data, especially without
someone else to check his work.
Similarly, if there is any error in any of the formulae, all the numbers in the budget will be wrong. Whilst this risk already
exists because fixed budgets are being prepared on spreadsheets, the rolling budgets will be far more complex, which
increases the risk of error in the design of the model or any of the formulae.
A model can become easily corrupted simply by putting a number in the wrong cell. The accountant is unlikely to spot this
due to his lack of experience and the time pressure on him.
When spreadsheets are used, there is no audit trail that can be followed in order to check the numbers.
5
Wash Co
(a)
Transfer price using machine hours
Total overhead costs = $877,620
Total machine hours = (3,200 x 2) + (5,450) x 1 = 11,850
Overhead absorption rate = $877,620/11,850 = $74·06
Overhead cost for S = 2 x $74·06 = $148·12 and for R = 1 x $74·06 = $74·06.
Materials cost
Labour cost (at $12 per hour)
Overhead costs
Total cost
10% mark-up
Transfer price using machine hours
(b)
Product S
$
117
6
148·12
––––––
271·12
27·11
––––––
298·23
––––––
Product R
$
95
9
74·06
––––––
178·06
17·81
––––––
195·87
––––––
Transfer price using ABC
Machine set up costs: driver = number of production runs.
30 + 12 = 42.
Therefore cost per set up = $306,435/42 = $7,296·07
Machine maintenance costs: driver = machine hours: 11,850 (S= 6,400; R=5,450)
$415,105/11,850 = $35·03
Ordering costs: driver = number of purchase orders
82 + 64 = 146.
Therefore cost per order = $11,680/146 = $80
Delivery costs: driver = number of deliveries.
64 + 80 = 144.
Therefore cost per delivery = $144,400/144 = $1,002·78
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A series of constantly rising bonus rates ranging over a narrower rate of sales could be used. For example, every $500,000
of fee income could be rewarded with an additional bonus equivalent to 5% of salary. Alternatively, the bonus could be
replaced by commission, giving the managers a reward as a percentage of the fee income rather than a percentage of salary.
Currently, the company is paying out $30,000 in bonus to each of its managers each year. This is 2% of $1·5 million.
Therefore, the bonus could be that each manager earns 2% commission on all sales.
Allocation of overheads to each product:
Total overheads allocated
Number of units produced
Overhead cost per unit
Transfer price per unit:
Materials cost
Labour cost
Overhead costs
Total cost
Add 10% mark up
Transfer price under ABC
(c)
(i)
Product R
$
87,553
190,913
5,120
80,222
––––––––
363,808
––––––––
5,450
$
160·57
$
66·75
117
6
160·57
–––––––
283·57
28·36
–––––––
311·93
–––––––
95
9
66·75
–––––––
170·75
17·08
–––––––
187·83
–––––––
Product S
3,200
$
28·36
––––––––––
90,752
––––––––––
Product R
5,450
$
17·08
––––––––––
93,086
––––––––––
Product S
3,200
$
320
(311·93)
––––––––––
8·07
––––––––––
25,824
––––––––––
Product R
5,450
$
260
(187·83)
–––––––––––
72·17
–––––––––––
393,327
–––––––––––
Total
$
306,435
415,106
11,680
144,400
––––––––
877,620
––––––––
8,650
ABC monthly profit
Using ABC transfer price from part (b):
Assembly division
Production and sales
10% mark up
Profit
Retail division
Production and sales
Selling price
Cost price
Profit per unit
Total profit
(ii)
Total
183,838
––––––––
Total
419,151
––––––––
Discussion
From the various profit figures for the three bases of allocating overheads, various observations can be made.
–
There is obviously very little difference between the TOTAL profits of each division whichever method is used,
except for differences arising from rounding. In each case, the total profit made by the assembly division is
approximately $183,000 and $419,000 for the retail division. It is the reallocation of profits from R to S or S to
R that is the important factor in this situation, given that the retail division wants to reduce prices but increase sales
volumes for R.
–
As regards the assembly division, when labour hours are used to allocate overheads, there is a big difference
between the profits that each of the two products makes. When machine hours or ABC are used, this difference
becomes much smaller.
–
As regards the retail division, when labour hours are used, product S generates 76% of the profit. When this
method of allocation is then changed so that either machine hours are used or ABC is used, the main share of the
profit then moves to product R. In the case of ABC, the profit moves so much to R that S only generates a profit
per unit of $8·07 for the retail division, which is very low for a selling price of $320.
–
From the assembly division manager’s point of view, any change that results in increased sales of either R or S to
the retail division would be a good thing for the assembly division, given that both products are profitable. However,
the assembly division’s manager would probably oppose the implementation of ABC to achieve this end result
because firstly, it is complex and secondly, it is unnecessary here. The aim of this exercise is to set more accurate
transfer prices for R and S, which should mean a reduction in R’s transfer price and an increase in S’s, according
to the information given. This would then have the effect of enabling the retail division to lower its price for R and
increase sales volumes. This goal is achieved simply by changing the basis of overhead absorption from labour
hours to machine hours, without the need for activity based costing.
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Machine set-up costs
Machine maintenance costs
Ordering costs
Delivery costs
Product S
$
218,882
224,192
6,560
64,178
––––––––
513,812
––––––––
3,200
The retail manager’s view is likely to be exactly the same. If the basis of absorption is changed so that a lower
transfer price is charged, the retail division could potentially reduce their selling price for R, provided that the
increased sales volumes more than make up for the reduced margin. There is no need to get into the complexities
of ABC when the results it produces are not that different.
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–
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2012
Marks
Hair Co
(a)
Weighted average C/S ratio
Individual contributions
Total sales revenue
Total contribution
Ratio
(b)
Break-even revenue
(c)
PV chart
Individual CS ratios
Ranking
Workings for chart
Chart:
Labelling
Plotting each of six points
(d)
3
1
1
1
–––
6
–––
2
–––
1·5
1
2
0·5
4
–––
9
–––
Discussion
General comments re assumptions of CVP (max. 2 marks)
Each valid point re BEP
Total
2
1
1
–––
3
–––
20
–––
–––
Truffle Co
(a)
(b)
(c)
Rate and efficiency variances
Rate variance
Efficiency variance
2
2
–––
4
–––
Planning and operational variances
Labour rate planning variance
Labour rate operational variance
Labour efficiency planning variance
Labour efficiency operational variance
2
2
2
2
–––
8
–––
Discussion
Only operational variances controllable
No labour rate operating variance
Planning variance down to company, not manager
Labour efficiency total variance looks bad
Manager has performed well as regards efficiency
Standard for labour time was to blame
Conclusion
1
1
2
2
2
2
2
–––
8
–––
20
–––
–––
Maximum marks
Total
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1
Marks
Web Co
Calculations
Missing info
Discussion and further analysis (2–3 marks per point)
Conclusion
4
3
18
2
–––
20
–––
–––
Total
4
Designit
(a)
Explanation
Updated after one month elapsed
Always 12 months
Example given
First month in detail
Later month less detail
Need to revisit earlier months
1
1
1
1
1
1
–––
4
–––
Maximum
(b)
Problems
More time
Lack of experience
Too regular
Managers’ resistance
Work harder
Holding back work
1
1
2
2
1
2
–––
6
–––
Maximum
(c)
(d)
Simpler incentive scheme
Current target too easy
Second target too hard
Other valid point re current scheme
New scheme outlined
1
1
1
3
–––
6
–––
Using spreadsheets
Errors entering data
Rolling budgets more complex
Formulae may be wrong
Corruption of model
No audit trail
1
1
1
1
1
–––
4
–––
20
–––
–––
Maximum
Total
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3
Marks
Wash Co
(a)
(b)
(c)
Transfer price using machine hours
Calculating OAR
New TP for S
New TP for R
1
1
1
–––
3
–––
Transfer price using ABC
Identify cost drivers
Cost driver rates
Total overheads allocated
Overhead cost per unit
Total cost per unit
Transfer price per unit
1
2
2
1
1
1
–––
8
–––
ABC profit and discussion
(i)
Profit calculation
3
–––
(ii)
Each valid comment
2
–––
6
–––
20
–––
–––
Maximum marks
Total
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5
11
(a)
D
Option 2
$(360k)
$10·413m
Option 1
Decision tree
$3·591m
per annum
C
6,500 members
0·6
0·4
6,000 members
5,250 members: net
income $640 per annum
B
$3·705m
per annum
A
$3·42m
per annum
0·5
0·5
0·5
0·5
Net income $540 per annum
Net income $600 per annum
Net income $540 per annum
Net income $600 per annum
Taha Popatia - ARTT Business School - 02134523175
1
Net income $3·51m per annum
Net income $3·9m per annum
Net income $3·24m per annum
Net income $3·6m per annum
Net income $3·36m per annum
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2013 Answers
Workings
Option 1
Net income = $720 – $80 = $640 per annum.
Option 2
If costs $120 per annum, net income = $720 – $120 = $600 per annum.
If costs $180 per annum, net income = $720 – $180 = $540 per annum.
Expected value and decision:
EV at A = (0·5 x $3·6m) + (0·5 x $3·24m) = $3·42m
EV at B = (0·5 x $(3·9m) + (0·5 x $3·51m) = $3·705m
EV at C = (0·4 x $3·42m) + (0·6 x $3·705m) = $3·591m per annum
Therefore choose option 2 – expand exercise studio.
(b)
With perfect information:
If membership numbers were 6,000:
EV = $3·42m x 3 = $10·26m
Less costs of $360k = $9.9m
Therefore, with these membership numbers, GB would choose option 1 instead.
If membership numbers were 6,500:
EV = $3·705 x 3 = $11·115m
Less costs of $360k = $10·755m
In this instance, GB would choose option 2.
So, if membership numbers are 6,000, of which there is a 0·4 probability, EV will be $10·08m (option 1) and if membership
numbers are 6,500, of which there is a 0·6 probability, then EV will be $10·755m (option 2).
Therefore EV with perfect information = (0·4 x $10·08m) + (0·6 x $10·755) = $10·485m.
Without perfect information the EV is $10·413m, therefore the value of it is $72k ($10·485m – $10·413m). This represents
the maximum price that GB should be prepared to pay for the information.
(c)
The expansion decision is a one-off decision, rather than a decision that will be repeated many times. Expected values, on
the other hand, give us a long run average of the outcome that would be expected if a decision was to be repeated many
times. The actual outcome may not be very close to the expected value calculated and the technique is therefore not really
very useful here.
Also, estimating accurate probabilities is difficult because this exact situation has not arisen before.
The expected value criterion for decision-making is useful where the attitude of the investor is risk neutral. We do not know
what the management of Gym Bunnies’ attitude to risk is, which makes it difficult to say whether this criterion is a good one
to use. In a decision such as this one, it would be useful to see what the worst case scenario and best case scenario results
would be too, in order to assist decision-making.
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At D, compare EV of:
Option 1: (3 x $3·36m) = $10·08m
Option 2: ($3 x $3·591m) – $360k = $10·413m
(a)
Goals and measures
Goals
Performance Measures
Reason
Financial perspective
Increase revenue
Percentage increase in total revenue
The changes have been implemented
partly in an attempt to increase revenues,
so it is sensible to measure the extent to
which revenues have actually increased.
Increase operating profit margin
Percentage increase in operating profit
The changes have been implemented
partly in an attempt to increase operating
profit, so it is sensible to measure the
extent to which operating profit has actually
increased.
Customer perspective
Increase customer acquisition
Total sales to new customers
The fourth change (to standalone products)
was made in an attempt to attract new
customers. This measure will help to
assess whether the change has been
successful.
Reduce loss of customers
Customer churn rate
The first three of the four changes made
were made in an attempt to retain
customers. This performance measure will
help to assess whether the changes have
been successful.
Internal business perspective
Reduce number of broadband
contracts cancelled
Number of broadband contracts
cancelled
This performance measure will enable
Squarize to assess whether the improved
broadband service has resulted in a
reduction of the number of contracts
cancelled.
Increase after sales service
quality
Percentage of customer requests that
are handled with a single call
Squarize transferred its call centre back to
its home country. This measure will assess
whether that has improved the service
quality to customers as a result.
Learning and growth perspective
Increase call centre workers’ skill
levels
Number of training hours per
employee
This measure will improve the likelihood of
customers receiving an improved service. A
better public image should result, leading
to increased revenues as new customers
are attracted to the business.
Increase employees’ satisfaction
Percentage decrease in staff turnover
This measure will also help to improve
customer service, thereby improving
company image, attracting new customers
and increasing revenues in the long term.
(Other reasonable suggestions will be equally acceptable)
(b)
Pay-tv customers currently own the boxes, meaning that a certain number of customers appear to cancel their contract after
the first three months and just keep the set-top box with its free channels. Squarize may want to consider loaning the boxes
rather than selling them to the customers at the beginning of the contract.
The company only has a minimum contract period of three months. This seems very short and perhaps the company could
consider increasing it to 12 months. Unnecessary administration costs must be arising because it takes time, and therefore
money, to set up new customers. If these customers then leave three months later, the company has not had much
opportunity to earn profits from the customers generating these costs.
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2
(a)
Revised target cost
$
Manufacturing cost
Direct material (working 1)
Direct labour (working 2)
Machine costs
Quality control costs
Rework costs (working 3)
$
21·60
10·96
21
10
1·80
–––––
65·36
Product development cost
Marketing cost
25
35
–––––
Non-manufacturing costs
60
–––––––
125·36
–––––––
–––––––
Total cost
Working 1: Direct material cost
Parts to be replaced by standard parts = $40 x 0·8 = $32.
New cost of those at 45% (100% – 55%) = $14·40.
Unique irreplaceable parts: original cost = $40 x 20% = $8.
New cost $7·20
Revised direct material cost = $14·40 + $7·20 = $21·60
Working 2: Direct labour
Direct labour – cost per unit for first one hundred units:
Y = axb
45 x 100–0·152 = 22·346654 minutes
Total time for 100 units = 2,234·6654 minutes.
Time for the 100th unit:
Time for 99 units = 45 x 99–0·152
= 22·380818 minutes.
For 99 units = 2,215·701 minutes.
Therefore, time for 100th unit = 2,234·6654 – 2,215·701 = 18·9644 minutes.
Time for remaining 49,900 units = 946,323·56 minutes.
Total labour time for 50,000 units = 948,558·23 minutes.
Therefore total labour cost = 948,558·23/60 x $34·67 = $548,108·56.
Therefore average labour cost per unit = $548,108·56/50,000 = $10·96.
Note: Some rounding is acceptable and marks would still be given.
Working 3: Rework cost
Total cost = 50,000 x 10% x $18 = $90,000.
Cost per average unit = $90,000/50,000 = $1·80.
(b)
Market skimming
Market skimming is a strategy that attempts to exploit those areas of the market which are relatively insensitive to price
changes. Initially, high prices for the webcam would be charged in order to take advantage of those buyers who want to buy
it as soon as possible, and are prepared to pay high prices in order to do so.
The existence of certain conditions is likely to make the strategy a suitable one for Cam Co. These are as follows:
–
Where a product is new and different, so that customers are prepared to pay high prices in order to gain the perceived
status of owning the product early. The webcam has superior audio sound and visual quality, which does make it
different from other webcams on the market.
–
Where products have a short life cycle this strategy is more likely to be used, because of the need to recover development
costs and make a profit quickly. The webcam does only have a two year life cycle, which does make it rather short.
–
Where high prices in the early stages of a product’s life cycle are expected to generate high initial cash inflows. If this
were to be the case for the webcam, it would be particularly useful for Cam Co because of the current liquidity problems
the company is suffering. Similarly, skimming is useful to cover high initial development costs, which have been incurred
by Cam Co.
–
Where barriers to entry exist, which deter other competitors from entering the market; as otherwise, they will be enticed
by the high prices being charged. These might include prohibitively high investment costs, patent protection or unusually
strong brand loyalty. It is not clear from the information whether this is the case for Cam Co.
–
Where demand and sensitivity of demand to price are unknown. In Cam Co’s case, market research has been carried
out to establish a price based on the customers’ perceived value of the product. The suggestion therefore is that some
information is available about price and demand, although it is not clear how much information is available.
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3
It is not possible to say for definite whether this pricing strategy would be suitable for Cam Co, because of the limited
information available. However, it does seem unusual that a high-tech, cutting edge product like this should be sold at the
same price over its entire, short life cycle. Therefore, price skimming should be investigated further, presuming that this has
not already been done by Cam Co.
(a)
Sales price operational variance: (actual price – market price) x actual quantity
Commodity 3: ($40·40 – $39·10) x 25,600 = $33,280F
Sales price planning variance: (standard price – market price) x actual quantity
Commodity 3: ($41·60 – $39·10) x 25,600 = $(64,000)A
An alternative approach to the variance calculations for Commodity 3 would be as follows:
Sales price operational variance
Commodity 3
$39·10
$40·40
–––––––
$1·30F
25,600
$33,280F
Should now
Did
Difference
Actual sales quantity
Variance
Sales price planning variance
Commodity 3
$39·10
$41·60
–––––––
$2·50A
25,600
$64,000A
Should now
Should
Difference
Actual sales quantity
Variance
(b)
Sales mix variance:
(Actual sales quantity in actual mix at standard margin) – (actual sales quantity in standard mix at standard margin) =
$768,640 (w.1 & 2) – $782,006 (w.3) = $13,366 adverse.
Working 1: Standard margins per unit:
Budgeted machine hours = (30,000 x 0·2) + (28,000 x 0·6) + (26,000 x 0·8) = 43,600.
Overhead absorption rate = $174,400/43,600 = $4 per hour.
Product
Standard selling price
Variable production costs
Fixed production overheads
Standard profit margin
Commodity 1
$
30
(18)
(0·8)
––––––
11·20
––––––
Commodity 2
$
35
(28·40)
(2·4)
–––––
4·20
–––––
Commodity 3
$
41·60
(26·40)
(3·2)
–––––
12
–––––
Working 2: Actual sales quantity in actual mix at standard profit margin:
Product
Commodity 1
Commodity 2
Commodity 3
Actual quantity
in actual mix
29,800
30,400
25,600
–––––––
85,800
–––––––
Standard profit
$
$11·20
$4·20
$12
333,760
127,680
307,200
––––––––
768,640
––––––––
Working 3 Actual sales quantity in standard mix at standard profit margin:
Product
Commodity 1
Commodity 2
Commodity 3
Actual quantity in standard mix
85,800 x 30/84 = 30,643
85,800 x 28/84 = 28,600
85,800 x 26/84 = 26,557
–––––––
85,800
–––––––
Standard profit
$11·20
$4·20
$12
$
343,202
120,120
318,684
––––––––
782,006
––––––––
The sales quantity variance = (actual sales quantity in standard mix at standard margin) – (budgeted sales quantity in
standard mix at standard profit margin) = $782,006 (w.3 above) – $765,600 (w.4) = $16,406 favourable.
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4
Working 4: Budgeted sales quantity in standard mix at standard profit margin:
Product
Commodity 1
Commodity 2
Commodity 3
Standard profit
$11·20
$4·20
$12
$
336,000
117,600
312,000
––––––––
765,600
––––––––
The calculations above have shown that, as regards the sales price, there is a $23,360 favourable operational variance and
a $54,680 adverse planning variance. In total, these net off to a sales price variance of $31,320 adverse. The sales manager
can only be responsible for a variance to the extent that he controls it. Since the standard selling prices are set by a consultant,
rather than the sales manager, the sales manager can only be held responsible for the operational variance. Given that this
was a favourable variance of $23,360, it appears that he has performed well, achieving sales prices which, on average, were
higher than the market prices at the time. The consultant’s predictions, however, were rather inaccurate, and it is these that
have caused an adverse variance to occur overall in relation to sales price.
As regards sales volumes, the mix variance is $13,366 adverse and the quantity variance is $16,406 favourable, meaning
that the total volume variance is $3,040 favourable. This is because total sales volumes were higher than expected, although
it is apparent that the increased sales related to the lower margin Commodity 2, with sales of Commodity 1 and
Commodity 3 actually being lower than budget.
The total variance relating to sales is $28,280 adverse. This looks poor but, as identified above, it is due to the inaccuracy
of the sales price forecasts made by the consultant. We know that Block Co is facing tough market conditions because of the
economic recession and therefore it is not that surprising that market prices were actually a bit lower than originally
anticipated. This could be due to the recession hitting even harder in this quarter than in previous ones.
5
(a)
Budget deficit/surplus
Budgeted income:
Income from pupils registered on 1 June 2013: $724,500 (given in question)
Expected number of new joiners: (0·2 x 50) + (0·3 x 20) + (0·5 x 26) = 29
Expected income from new joiners at $900 each = $26,100
Total expected income = $750,600.
Budgeted expenditure:
Repairs and maintenance: $30,000 x 1·03 = $30,900.
Salaries: [($620,000 – $26,000)/2] + [($620,000 – $26,000 x 1·02)/2]
= $297,000 + $302,940 = $599,940.
Expected capital expenditure = (0·7 x $145,000) + (0·3 x $80,000) = $125,500.
Total expected expenditure = $756,340.
Budget deficit = $5,740.
(b)
Discussion of estimates
Advantages
–
–
–
Incremental budgeting is very easy to perform. This makes it possible for a person without any accounting training to
build a budget.
Incremental budgeting is also very quick compared to other budgeting methods.
The information required to complete it is also usually readily available.
Disadvantages
–
–
–
(c)
On the other hand, incremental budgeting encourages inefficiency because it does not question the preceding year’s
figures on which it is based. No-one asks how those figures could be reduced.
Similarly, in some organisations, it encourages slack because departmental managers may attempt to use their entire
budget up for one year, even if they do not need to, just to ensure that that cash is available again the next year.
Errors from one year are carried to the next, since the previous year’s figures are not questioned.
Zero-based budgeting (ZBB)
The three main steps involved in preparing a zero-based budget are as follows:
1.
Activities are identified by managers. Managers are then forced to consider different ways of performing the activities.
These activities are then described in what is called a ‘decision package’, which:
–
–
–
analyses the cost of the activity;
states its purpose;
identifies alternative methods of achieving the same purpose;
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(c)
Quantity
30,000
28,000
26,000
–––––––
84,000
–––––––
–
–
establishes performance measures for the activity;
assesses the consequence of not performing the activity at all or of performing it at different levels.
As regards this last point, the decision package may be prepared at the base level, representing the minimum level of
service or support needed to achieve the organisation’s objectives. Further incremental packages may then be prepared
to reflect a higher level of service or support.
Management will then rank all the packages in the order of decreasing benefits to the organisation. This will help
management decide what to spend and where to spend it. This ranking of the decision packages happens at numerous
levels of the organisation.
3.
The resources are then allocated, based on order of priority up to the spending level.
Use of ZBB at Newtown School
There is definitely a place for ZBB at Newtown School. At the moment, incremental budgeting is responsible for recurring
unexpected cash shortages, which is deterring new pupils from joining the school. Had a deficit been predicted for the year
ended 31 May 2013, perhaps $65,000 would not have been spent on improving the school gym, and then it would not
have been necessary to close the school kitchen. ZBB would be good to establish the way cash is spent on those activities
that are, to a certain extent, discretionary.
For example, although there is a need for pupils to have somewhere to eat lunch, it is not essential for children to have a
cooked meal every day. It is essential that children do have somewhere to eat though and, as a bare minimum, they would
need an area where they could eat their sandwiches and have access to fresh water. ZBB could be used to put together
decision packages which reflect the different levels of service available to the children. For example, the most basic level of
service could be the provision of an area for the children to eat a lunch brought from home. The next level would be the
provision of some cold and maybe hot food for the children, but on a self-service basis. Finally, the highest level of service
would be a restaurant for the children where they get served hot meals at tables. At Newtown School the catering manager
could prepare the decision packages and they would then be decided upon by the head teacher, who would rank them
accordingly.
Similarly, although some level of sports education is needed, the extent of the different activities offered is discretionary. ZBB
could be used to create decision packages for each of these services in order to prioritise them better than they are currently
being prioritised.
ZBB takes a long time to implement and would not be appropriate to all categories of expenditure at the school. Much of the
budgeting is very straight forward. Incremental budgeting could still be used as a starting point for essential expenditure such
as salary costs, provided that changes in staff numbers are also taken into account. There is an element of essential, recurring
expenditure in relation to repairs and maintenance too, since the costs of the checks and repairs needed to comply with health
and safety standards seem to largely stay the same each year, with an inflationary increase.
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(d)
2.
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2013 Marking Scheme
Marks
(a)
(b)
(c)
Decision tree diagram
Start with decision point
Option 1 format
Option 2 format
Expected value and decision
EV at A
EV at B
EV at C
Compare EVs at D
Recommendation that follows
0·5
0·5
5
1
1
2
1
1
–––
12
–––
Price of perfect information
EV with 6,000 members
EV with 6,500 members
Price
2
2
2
–––
6
–––
Discussion
2
–––
20
–––
–––
Total marks
2
(a)
Balanced scorecard
Identifying the four perspectives
Each goal
Each performance measure
Each reason
2
0·5
0·5
1
–––
16
–––
Maximum marks
(b)
Customer retention issue
Each point discussed – 2 marks
4
–––
4
–––
20
–––
–––
Maximum marks
Total marks
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Marks
(a)
(b)
Revised lifetime cost
Direct material cost
Direct skilled labour cost:
Cumulative average time per unit for 100 units
Cumulative total time for 100 units
Cumulative average time per unit for 99 units
Cumulative total time for 99 units
Incremental time for 100th unit
Total time for 49,900 units
Total time for 50,000 units
Total labour cost for 50,000 units
Average labour cost per unit
Machine costs
Quality control costs
Rework cost
Non-manufacturing cost
Total cost
2·5
1
0·5
1
0·5
1
0·5
0·5
0·5
0·5
0·5
0·5
1
1
0·5
–––
12
–––
Market skimming
Explanation – maximum
Discussion of each condition – maximum
Conclusion
2
2
1
–––
8
–––
20
–––
–––
Maximum marks
Total marks
4
(a)
(b)
(c)
Planning and operational variances
Operational variance
Planning variance
2
2
–––
4
–––
Mix and quantity variances
Standard profit per unit
Mix variance
Quantity variance
4
4
3
–––
11
–––
Discussion
Each valid comment
1
–––
5
–––
20
–––
–––
Total marks
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3
(a)
Budgeted income
Repairs and maintenance
Teachers’ salaries
Capital expenditure
Deficit
(b)
Advantages and Disadvantages
Two advantages
Two disadvantages
(c)
(d)
Marks
2
1
1·5
1
0·5
–––
6
–––
2
2
–––
4
–––
Zero-based budgeting
Step 1
Step 2
Step 3
2
2
2
–––
6
–––
Use of ZBB to Newtown School
Each point made
1
–––
4
–––
20
–––
–––
Maximum
Total marks
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5
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
Incremental revenue
(1,200 x 0·95 x $6·70)
– (1,200 x $5·60) = $918
Less VC
(1,200 x $0·5)
x 0.95 =$(570)
Net profit/(loss)
$348
M
(1,400 x 0·95 x $7·90)
– (1,400 x $6·50) = $1,407
(1,400 x $0·70)
x 0.95 = $(931)
$476
Yes
S
(1,800 x 0·95 x $6·80)
– (1,800 x $6·10) = $648
(1,800 x $0·80)
x 0.95 =$(1,368)
$(720)
No
L
Further process?
Yes
Process Co should further process L and M, since incremental revenue from further processing will exceed incremental costs.
However, it should not further process S as incremental costs exceed incremental revenue in S’s case.
Note: The above calculations could be done on a unit basis if preferred, still earning full marks.
(b)
The suggested transfer price being used is actual marginal cost. This means that whilst Division A would recover its variable
costs of producing products L and M, there is no profit margin built in and, therefore, unless Head Office intervenes and forces
Division A to transfer L and M to Division B, Division A will not want to transfer these products. Also, Division A will not have
the opportunity to recover any apportioned fixed costs since marginal cost does not include these. Not only would Division A
not make any profit or recovery of apportioned fixed costs from the transfers using the suggested system, it would actually
lower its overall profits if it were forced to transfer L and M for further processing rather than being allowed to sell them
externally after the split-off point. Division A’s manager would feel extremely demotivated if he/she were to be made to transfer
L and M for further processing, as it would make performance look poorer for the Division.
All of the profit from both producing L and M and further processing them into LX and MX would be gained by Division B
under the suggested system. If the criteria of return on investment (ROI) or residual income (RI) were then to be used to
assess performance, as is usual for divisional performance assessment, Division B’s ROI/RI would be seen to have increased
as a result of the further processing. Division B would then effectively be taking the credit for a large part of the work carried
out by Division A. The manager of Division B would be unlikely to complain about this as it works in favour of his Division.
Another point worth mentioning is that because actual cost would be used rather than standard cost, Division A would have
little incentive to keep its variable costs down because it would pass all of its costs on to Division B. However, given that the
suggested transfer price incorporates no profit for Division A, this point would hardly be arguable by Division B.
If Division A were told to make the transfers to Division B, their autonomy would be taken away from them. This would be
likely to have a detrimental effect on the motivation of managers since one of the primary purposes of creating a divisional
structure is to grant autonomy.
Note: Other points could be made too. A candidate would not be expected to make all of the above points in order to earn
full marks.
(c)
Environmental management accounting
Input/outflow analysis
This technique records material inflows and balances this with outflows on the basis that what comes in, must go out. So, if
100 kg of materials have been bought and only 80 kg of materials have been produced, for example, then the 20 kg
difference must be accounted for in some way. It may be, for example, that 10% of it has been sold as scrap and 10% of it
is waste. By accounting for outputs in this way, both in terms of physical quantities and, at the end of the process, in monetary
terms too, businesses are forced to focus on environmental costs.
Flow cost accounting
This technique uses not only material flows but also the organisational structure. It makes material flows transparent by
looking at the physical quantities involved, their costs and their value. It divides the material flows into three categories:
material, system and delivery, and disposal. The values and costs of each of these three flows are then calculated. The aim
of flow cost accounting is to reduce the quantity of materials which, as well as having a positive effect on the environment,
should have a positive effect on a business’s total costs in the long run.
Activity-based costing
ABC allocates internal costs to cost centres and cost drivers on the basis of the activities which give rise to the costs. In an
environmental accounting context, it distinguishes between environment-related costs, which can be attributed to joint cost
centres, and environment-driven costs, which tend to be hidden in general overheads.
Life cycle costing
Within the context of environmental accounting, life cycle costing is a technique which requires the full environmental
consequences, and therefore costs, arising from production of a product to be taken account of across its whole life cycle,
‘from cradle to grave’.
Note: Only two techniques were required.
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1
December 2013 Answers
(a)
Throughput accounting ratio = throughput return per factory hour/cost per factory hour.
Cost per factory hour
Total factory costs/total available hours on bottleneck resource
= $12,000,000/2,700 hours (12 x 5 x 50 x 90% hours)
= $4,444·44
Throughput return
Large panels
$
12,600
(4,300)
–––––––
8,300
1·4
$5,928·57
Selling price
Materials
Throughput per unit
Hours per unit required on Machine M
Throughput return per hour
Throughput accounting ratio
Throughput return per factory hour/cost per factory hour:
5,928·57/4,444·44
= 1·33
Small panels
$
3,800
(1,160)
––––––
2,640
0·6
$4,400
4,400/4,444·44
= 0·99
In any organisation, one would expect the throughput accounting ratio to be greater than 1. This means that the rate at which
the organisation is generating cash from sales of this product is greater than the rate at which it is incurring costs. It follows
on, then, that if the ratio is less than 1, changes need to be made quickly. Whilst the ratio for large panels is more than 1, it
is just under 1 for small panels. However, if changes are made as suggested in (c) below, this could soon be rectified.
(b)
Optimum production plan
Product
Small panels
(under contract)
Large panels
No. of units
1,000
1,500 (W.1)
Hours per unit
0.6
Total hours
600
T/P per hour
$4,400
1.4
2,100
––––––
2,700
––––––
$5,928·57
Total
Less total factory costs
Profit
Total T/P
$2,640,000
$12,449,997
–––––––––––––
$15,089,997
–––––––––––––
($12,000,000)
–––––––––––––
$3,089,997
–––––––––––––
–––––––––––––
W.1
(2,700-600)/1.4
(c)
Increasing throughput
Generally speaking, throughput can be increased by increasing sales volumes or prices on the one hand, or by cutting costs
on the other hand. In the case of S Co, it is not possible to increase sales prices as the company has guaranteed not to
increase them for three years. From our answer to (b) above, we can see that S Co has unsatisfied demand for both small
panels and large panels. There are customers out there who the company is unable to supply because of its restricted machine
capacity. Therefore, it would be worthwhile for S Co to focus on increasing production volumes and thus sales volumes.
In order to increase production volumes without making any additional capital expenditure, the company needs to focus on
how it could increase the productivity of Machine M. We are told that there is plenty of spare capacity on Machines C and
A. Some suggestions to increase Machine M’s capacity are as follows:
–
Machine M is currently only fully functional 90% of the time. This means that 300 hours of time are lost whilst the
machine is being maintained or workers are not available to man it. If the maintenance work could be carried out outside
the usual working day (i.e. either before 7 am or after 8 pm), some additional time could be freed up. This should be
possible given that we are told that the maintenance contractors work around the clock.
–
Workers could be trained to use more than one of the machines. This would then mean that, if some workers were
absent, one of the other workers could step in and work on another machine in order to keep it running. Again, this
would help to keep the lost 300 hours productive.
–
The most obvious machine time which is being lost is the one hour per day at lunchtime. This amounts to 250 lost
production hours per year. These additional 250 hours could be used to produce an extra 178 large panels (250/1·4
hours.) Large panels should be made first in preference to small panels since they generate a higher throughput per
machine hour. If workers were trained to use all three machines then, if their lunchtimes were staggered, it may be
possible to keep machine M running for the whole working day. However, even after doing this, there would still be 590
additional hours of time required on Machine M if the full market demand is going to be satisfied. Therefore, more time
needs to be made available.
–
Finally then, in order to increase productive hours on M, the working hours of the factory would need to be increased.
Either the working day could be made longer, given that workers must already be working shifts, or maybe the factory
could open for one extra day per week.
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2
(a)
Monthly costs
Month
July
August (w.1)
September
October
November (w.2)
Cumulative
number of
batches
1
2
4
8
16
Cumulative
average
hours per
batch
200
176
154·88
136·294
124·4
Cumulative
total
hours
Incremental
number of
batches
Incremental
total
hours
Actual labour
cost per
month $
200
352
619·52
1,090·352
1,990·36
1
1
2
4
8
200
152
267·52
470·832
900·008
2,400
1,824
3,210·24
5,649·60
10,800·096
Working 1: Calculations for August
Cumulative average hours per batch: 200 x 0·88 = 176 hours.
Cumulative total hours = 2 x 176 = 352 hours.
Incremental number of batches = cumulative no. of 2 batches for August less cumulative number of 1 batch for July =
1 batch.
Incremental total hours = cumulative total hours of 352 for August – 200 for July = 152 hours.
Actual labour cost = incremental total hours of 152 x $12 per hour = $1,824.
Working 2
Time for 7th batch:
Y = axb = 200 x 7–0·1844245
= 139·693 hours.
Total time for 7 batches = 139·693 x 7 = 977·851 hours.
Total time for 8 batches = 1,090·352 hours.
Therefore 8th batch took 112·501 hours (1,090·352 – 977·851)
Time for batches 9–16 = 112·501 x 8 = 900·008 hours.
Therefore cumulative average time for batches 1–16 = 1,090·352 + 900·008 = 1,990·36 hours.
Cumulative average time for 16 batches = 1,990·36/16 = 124·4 hours per batch.
Note: The labour costs for November could be arrived at quickly simply by taking the 112·501 hours for the 8th batch,
multiplying it by 8 batches and applying this number to the $12 per hour labour cost. This quick calculation is totally
sufficient to earn full marks.
(b)
Implications of end of learning period
The learning period ended at the end of October. This means that from November onwards the time taken to produce each
batch of microphones is constant. Therefore, in future, when Mic Co makes decisions about allocating its resources and
costing the microphones, it should base these decisions on the time taken to produce the 8th batch. The resource allocations
and cost data prepared for the last six months will have been inaccurate since they were based on a standard time per batch
of 200 hours.
Mic Co could try to improve its production process so that the learning period could be extended. It may be able to do this
by increasing the level of staff training provided. Alternatively, it could try and motivate staff to work harder through payment
of bonuses, although the quality of production needs to be maintained.
(c)
Involving senior staff at Mic Co in the budget setting process
Advantages
–
Since they are based on information from staff who are most familiar with the department, they are more likely to
improve the accuracy of the budget. In Mic Co’s case, the selling price could have been set more accurately and sales
may have been higher if the production manager had been consulted.
–
Staff are more likely to be motivated to achieve any targets as it is ‘their’ budget and they therefore have a sense of
ownership and commitment. The production manager at Mic Co seems resigned to the fact that he is not consulted on
budgetary matters.
–
Morale amongst staff is likely to improve as they feel that their experience and opinions are valued.
–
Knowledge from a spread of several levels of management is pooled.
–
Co-ordination is improved due to the number of departments involved in the budget setting process.
Disadvantages
–
The whole budgeting process is more time consuming and therefore costly.
–
The budgeting process may have to be started earlier than a non-participative budget would need to start because of
the length of time it takes to complete the process.
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3
Managers may try to introduce budgetary slack, i.e. making the budget easy to achieve so that they receive any
budget-based incentives.
–
Disagreements may occur between the staff involved, which may cause delays and dissatisfaction. In Mic Co’s case,
however, the fact that the production manager was not consulted has led to disagreement after the event.
–
Can support ‘empire building’ by subordinates.
Ratio analysis
Division S
Year on year
44%
36%
70%
78%
56%
61%
38%
6%
11%
9%
$102,224
$111,772
$27,000
$25,020
$129·48m
$107·75m
Increase in revenue
Increase in material costs
Increase in payroll costs
Increase in property costs
GPM in 2013
GPM in 2012
Increase in D & M costs
Increase in admin costs
NPM in 2013
NPM in 2012
Revenue per employee in 2013
Revenue per employee in 2012
Payroll cost per employee in 2013
Payroll cost per employee in 2012
Total market size ($ revenue) in 2013 (w.1)
Total market size ($ revenue) in 2012 (w.1)
Working 1 for market size
Division S 2013: $38,845m/30% = $129·48m
Division S 2012: $26,937/25% = $107·75m
Division C
Year on year
9%
25%
15%
6%
65%
67%
18%
0%
21%
22%
$104,917
$104,828
$21,000
$20,000
$80·12m
$77·61m
Division C 2013: $44,065m/55% = $80·12m
Division C 2012: $40,359m/52% = $77·61m
Note: Percentages have been calculated to the nearest 1%.
Commentary
General overview
Overall, Division S has performed well in 2013, although it has not managed to meet its objective of becoming market leader
despite its $2m advertising campaign. Since it has 30% of the market in 2013 and there are only two competitors holding 70%
of the market between them, at least one of those competitors must hold 35% or more of the market.
Revenue and market share
This has increased by a huge 44% in the last year. This compares to an increase of only 9% in Division C. However, part of the
reason that this has been achieved is because the changes in fire safety laws introduced by the government at the end of 2012
have caused the market for fire products and services to increase from $107·75m to $129·48m. Part of Division S’s success is
therefore down to increased opportunity. However, Division S has also increased its market share by a further 5 percentage points
compared to 2012. Division C has only managed a 3 percentage point increase in its market share, so this is a good result by
Division S. One can assume that this is at least partly as a result of the advertising campaign carried out by Division S. However,
this did cost a large amount, $2m, and it did not quite enable the Division to achieve its aim of becoming market leader.
Materials costs
The increase in materials costs is 36%, compared to an increase in revenue of 44%. It is difficult to say whether this is good or
bad since the increase in revenue includes revenue from services, for which no materials costs would be expected to arise. Further
information is needed on the split of revenue between products and services.
Payroll costs, revenue per employee and cost per employee
Payroll costs have increased by a massive 70% and far more than Division C’s 15% increase. This is largely due to the fact that
Division S’s employee numbers increased from 241 in 2012 to 380 in 2013. This is a really big increase in employee numbers
and has been accompanied by a fall in revenue per employee from $111,772 in 2012 to $102,224 in 2013. It is possible that
Division S over-recruited as it hoped to secure a greater level of business than it did through its advertising campaign. Division S’s
payroll cost per employee also increased from $25,020 in 2012 to $27,000 in 2013. Presumably, this is because of the fact that
there is high demand for staff skilled in this area and Division S has probably had to increase pay in order to attract the calibre of
staff which it needs.
Increase in property costs
In percentage terms, the biggest increase in costs which Division S has suffered is in relation to its property costs. They have
increased by 78%, compared to Division C’s 6% increase. It would appear that this increase is due to the increased rent charged
by Division S’s landlords on its business premises, which in turn has risen because of the increased tax charges. However, it is
not possible to quantify this precisely without further information on rent increases.
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4
–
Gross profit margin
This has actually fallen from 61% to 56%. Division C has also seen a fall in its GPM, but only a 2 percentage point fall as opposed
to Division S’s 5 percentage point fall. The reasons for Division S’s lower GPM are the higher material, payroll and property costs.
Also, Division S did not try to pass on any of its increased costs to its customers in the form of higher prices.
Distribution and marketing costs
These have increased by 38% compared to Division C’s 18%. However, when you take out the advertising costs in both years’
figures and work out the cost increase without them ($8·522m – $7·102m/$7·102m), it leaves an increase of only 20%. This
increase would be expected given the 20% increase in world fuel prices which occurred. Division S has to deliver to a wider
geographical spread of customers than Division C, so it would be expected to feel the full brunt of fuel price increases.
Net profit margin
Despite challenging cost increases in all categories, Division S has still managed to increase its NPM from 9% to 11%. However,
this is substantially lower than the NPM in Division C, which has fallen slightly but is still 21%, almost twice that in Division S.
As we have seen, Division S’s GPM is lower than Division C’s anyway and, on top of that, Division C has not suffered a big increase
in advertising costs like Division S; nor have administrative costs risen inexplicably.
Head Office
There is no information given about Head Office. If the Calana Division is also the Head Office, there could be Head Office costs
included in Calana’s figures, which would affect the comparisons being made. Further information is required here.
5
(a)
Planning and operational variances
(i)
Material Price Planning Variance (MPPV)
Sheets
Pillow cases
Total
(Standard price – revised price) x actual quantity
($5 – $6) x 248,000 = $248,000 adverse
($5 – $6) x 95,000 = $95,000 adverse
$343,000 adverse
(ii)
Material Price Operational Variance (MPOV)
Sheets
Pillow cases
Total
(Revised price – actual price) x actual quantity
($6 – $5·80) x 248,000 = $49,600 favourable
($6 – $5·80) x 95,000 = $19,000 favourable
$68,600 favourable
(iii) Material Usage Planning Variance (MUPV)
(Standard quantity for actual production – revised quantity
for actual production) x standard price
RQ for each pillow case = 0·5 m x 1·1 = 0·55 m
Sheets
Pillow cases
Total
(iv) Material Usage Operational Variance (MUOV)
(240,000 – 240,000) x $5 = 0
(90,000 – 99,000) x $5 = $45,000 adverse
$45,000 adverse
(Actual quantity – revised quantity for actual production) x
standard price
(248,000 – 240,000) x $5 = $40,000 adverse
(95,000 – 99,000) x $5 = $20,000 favourable
$20,000 adverse
Sheets
Pillow cases
Total
Note: The MPPV could be calculated using the revised quantity rather than the actual quantity. Similarly, the MUOV could
be calculated using the revised price rather than the standard price. Marks will be given where this alternative method is
used instead. However, it should be used for both the MPPV and the MUOV, otherwise the figures cannot be reconciled
back to the difference between actual spend and the budget for spend as flexed for actual production levels ($339,400
adverse).
(b)
Performance of the production manager
In total, there has been an overspend of $339,400, which looks poor. However, when the reasons for this are examined,
together with the variances calculated in (a), it is apparent that the production manager cannot be held solely responsible for
the overspend. In fact, he has had little control over the situation.
Increase in cotton price
Since cotton is used to make bed sheets and the price of this rose in the world market by 20%, the production manager’s
performance has to be looked at in light of this. Because of the increased market price, the adverse material price planning
variance is very high, since the budgeted cost of $5 per m2 was far below the actual market price of $6 per m2. The
production manager cannot be held responsible for this since he does not set the standard costs. He can only be held
responsible for any difference in price between the $6 market price and the $5·80 actual price paid. Since the $5·80 paid
per m2 is less than the market price of $6 per m2, the manager performed well, as shown by the favourable material price
operating variance of $68,600.
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Administrative costs
These have increased by 6% compared to Division C’s less than 1% increase (0% when rounded down to the nearest percent).
Further information is needed about the items included in these cost figures to explain why this increase has arisen.
Increase in amount of cotton used
Since more cotton was used for actual production than budgeted, a total adverse material usage variance of $65,000
($45,000 + $20,000) arose. However, of this, $45,000 (material usage planning variance) arose because of the request
for a change in the design of the pillowcases by Bedco’s customer. This was not within the control of the production manager
and his performance should not therefore be assessed on it. However, an adverse material usage operational variance of
$20,000 also arose; the performance of the production manager is weak here. Most of the adverse operational variance
actually related to the production of bed sheets rather than pillowcases. It is not clear why this arose but it is definitely poor.
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Bedco was also unable to produce all the pillowcases ordered by its customer in November as the order fell short by 10,000
units. If this was genuinely because of the late design change, however, it seems unfair to judge the production manager on
this.
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2013 Marking Scheme
Marks
(a)
(b)
Further processing
L
M
S
Conclusion
3
3
3
1
–––
10
–––
Issues
Per valid point – maximum
2
–––
5
–––
Maximum
(c)
Environmental accounting
Each description – maximum
3
–––
5
–––
20
–––
–––
Maximum
Total marks
2
(a)
(b)
(c)
Throughput accounting ratios
Cost per factory hour
Throughput per unit for large panels
Throughput per unit for small panels
Throughput per hour for large panels
Throughput per hour for small panels
TAR for large panels
TAR for small panels
Discussion of TAR
2
1
1
1
1
0·5
0·5
2
–––
9
–––
Optimum production plan
Optimum number of large panels
Optimum number of small panels
Total throughput
Less total factory costs
Profit
1
1
1
1
1
–––
5
–––
Increasing productivity
Each suggestion
2
–––
6
–––
20
–––
–––
Maximum
Total marks
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1
Marks
(a)
(b)
Monthly costs
Per monthly cost: July–October
November
1·5
3
–––
9
–––
End of learning period
Each point discussed – maximum
2
–––
4
–––
Maximum
(c)
Advantages and disadvantages
Each advantage
Each disadvantage
1
1
–––
7
–––
20
–––
–––
Maximum
Total marks
4
0·5 marks per calculation
Per valid piece of further information – max 2
Per comment – maximum
7
0·5
2
–––
20
–––
–––
Total marks
5
(a)
(b)
Variance calculations
MPPV
MPOV
MUPV
MUOV
3
3
3
3
–––
12
–––
Discussion
Each valid point
2
–––
8
–––
20
–––
–––
Maximum
Total marks
18
Taha Popatia - ARTT Business School - 02134523175
3
Fundamentals Level – Skills Module, Paper F5
Performance Management
(a)
Full budgeted production cost per unit using absorption costing
Product
Budgeted annual production (units)
Labour hours per unit
Total labour hours
X
20,000
2·5
50,000
Y
16,000
3
48,000
Z
22,000
2
44,000
Total
142,000
Overhead absorption rate = $1,377,400/142,000 = $9·70 per hour.
Product
Direct materials
Direct labour
Overhead ($9·70 x 2·5/3/2)
Full cost per unit
(b)
X
$ per unit
25
30
24·25
––––––
79·25
––––––
Y
$ per unit
28
36
29·10
––––––
93·10
––––––
Z
$ per unit
22
24
19·40
––––––
65·40
––––––
Full budgeted production cost per unit using activity based costing
Product
Budgeted annual production (units)
Batch size
Number of batches (i.e. set ups)
Number of purchase orders per batch
Total number of orders
Machine hours per unit
Total machine hours
X
20,000
500
40
4
160
1·5
30,000
Y
16,000
800
20
5
100
1·25
20,000
Z
22,000
400
55
4
220
1·4
30,800
Total
Cost driver rates:
Cost per machine set up
Cost per order
Cost per machine hour
$280,000/115 = $2,434·78
$316,000/480 = $658·33
($420,000 + $361,400)/80,800 = $9·67
115
480
80,800
Allocation of overheads to each product:
Product
Machine set up costs
Material ordering costs
Machine running and facility costs
Total
Number of units produced
Overhead cost per unit
Total cost per unit:
Direct materials
Direct labour
Overhead
ABC cost per unit
X
$
97,391
105,333
290,100
––––––––
492,824
––––––––
20,000
$24·64
Y
$
48,696
65,833
193,400
––––––––
307,929
––––––––
16,000
$19·25
Z
$
133,913
144,834
297,836
––––––––
576,583
––––––––
22,000
$26·21
$ per unit
25
30
24·64
––––––
79·64
––––––
$ per unit
28
36
19·25
––––––
83·25
––––––
$ per unit
22
24
26·21
––––––
72·21
––––––
Total
280,000
316,000
781,336*
––––––––––
1,377,336
––––––––––
*A difference of $64 arises here as compared to the cost pool total of $781,400 because of rounding differences. This has
been ignored.
(c)
When activity based costing is used, the cost for product X is very similar to that cost calculated using full absorption costing.
This means that the price for product X is likely to remain unchanged because cost plus pricing is being used. Demand for
product X is relatively elastic but since no change in price is expected, sales volumes are likely to remain the same if ABC is
introduced.
However, the cost for product Y is almost $10 per unit less using ABC. This means that the price of product Y will go down
if cost plus pricing is used. Given that demand for product Y is also elastic, like demand for product X, a reduced selling price
is likely to give rise to increased sales volumes.
The cost of product Z is nearly $7 per unit more using ABC and the price of product Z will therefore go up if ABC is used.
Given that demand for product Z is relatively inelastic, this means that sales volumes would be expected to be largely
unchanged despite an increase in price.
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1
June 2014 Answers
(a)
Optimum production plan
Define the variables
Let x = number of units of Xeno to be produced.
Let y = number of units of Yong to be produced.
Let C = contribution.
State the objective function
C = 30x+ 40y
State the constraints
Build time: 24x + 20y ≤ 1,800,000
Program time: 16x + 14y ≤ 1,680,000
Test time: 10x + 4y ≤ 720,000
Non-negativity constraints:
x, y ≥ 0
Sales constraints
x ≤ 85,000
y ≤ 66,000
Draw the graph
Build time:
If x = 0, y = 1,800,000/20 = 90,000
If y = 0, x = 1,800,000/24 = 75,000
Program time:
If x = 0, y = 1,680,000/14 = 120,000
If y = 0, x = 1,680,000/16 = 105,000
Test time:
If x = 0, y = 720,000/4 = 180,000
If y = 0, x = 720,000/10 = 72,000
Solve using the iso-contribution line
If y = 40,000, C = 40,000 x $40 = $1,600,000
If C = $1,600,000 and y = 0, x = $1,600,000/$30 = 53,333·33
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2
200,000
Units of y
180,000
Maximum sales of x
160,000
e
t tim
Tes
140,000
100,000
80,000
Maximum sales of y
a
ild
Bu
b
60,000
e
tim
40,000
is o
bu
tio
n
lin
e
e
50,000
c
d
tim
0
0
m
ra
og
Pr
20,000
-c
on
tri
100,000
150,000
200,000
Units of x
= feasible region.
Moving the iso-contribution line out to the furthest point on the feasible region, the optimum production point is b. This is
the intersection of the build time constraint and the sales constraint for y. Solving the simultaneous equations for these two
constraints:
y = 66,000
24x + 20y = 1,800,000
24x + (20 x 66,000) = 1,800,000
24x + 1,320,000 = 1,800,000
24x = 480,000
x = 20,000
C = (20,000 x $30) + (66,000 x $40)
= $600,000 + $2,640,000 = $3,240,000
Fixed costs = 3 x $650,000 = $1,950,000.
Therefore profit = $1,290,000.
(b)
Slack resources
Test time used = (20,000 x 10)/60 + (66,000 x 4)/60 = 7,733 hours.
Therefore slack hours = 12,000 – 7,733= 4,267 hours.
Program time used = (20,000 x 16)/60 + (66,000 x 14)/60 = 20,733 hours.
Therefore slack hours = 28,000 – 20,733 = 7,267 hours.
The slack values for test time and program time mean that there are 4,267 and 7,267 hours of each respective department’s
time unutilised under the optimum production plan. If possible, this time could be used by the organisation elsewhere or
subcontracted out to another company.
13
Taha Popatia - ARTT Business School - 02134523175
120,000
(a)
Ratios
(i)
ROCE = operating profit/capital employed x 100%
W Co
Design division
Gearbox division
C Co
(ii)
$’000
6,000/23,540
3,875/32,320
7,010/82,975
ROCE
25·49%
11·99%
8·45%
Asset turnover = sales/capital employed x 100%
W Co
Design division
Gearbox division
C Co
$’000
14,300/23,540
25,535/32,320
15,560/82,975
Asset turnover
0·61
0·79
0·19
(iii) Operating profit margin = operating profit/sales x 100%
W Co
C Co
Design division
Gearbox division
$’000
6,000/14,300
3,875/25,535
7,010/15,560
Operating profit
41·96%
15·18%
45·05%
Both companies and both divisions within W Co are clearly profitable. In terms of what the different ratios tell us, ROCE tells
us the return which a company is making from its capital. The Design division of W Co is making the highest return at over
25%, more than twice that of the Gearbox division and nearly three times that of C Co. This is because the nature of a design
business is such that profits are largely derived from the people making the designs rather than from the assets. Certain assets
will obviously be necessary in order to produce the designs but it is the employees who are mostly responsible for generating
profit.
The Gearbox division and C Co’s ROCE are fairly similar compared to the Design division, although when comparing the two
in isolation, the Gearbox division’s ROCE is actually over three percentage points higher than C Co’s (11·99% compared to
8·45%). This is because C Co has a substantially larger asset base than the Gearbox division.
From the asset turnover ratio, it can be seen that the Gearbox division’s assets generate a very high proportion of sales per $
of assets (79%) compared to C Co (19%). This is partly because the Gearbox division buys its components in from C Co and
therefore does not need to have the large asset base which C Co has in order to make the components. When the unit
profitability of those sales is considered by looking at the operating profit margin, C Co’s unit profitability is much higher than
the Gearbox division (45% operating profit margin as compared to 15%). The Design division, like the Gearbox division, is
also using its assets well to generate sales (asset turnover of 61%) but then, like C Co, its unit profitability is high too (42%
operating profit margin.) This is why, when the two ratios (operating profit margin and asset turnover) are combined to make
ROCE, the Design division comes out top overall – because it has both high unit profitability and generates sales at a high
level compared to its asset base.
It should be noted that any comparisons between such different types of business are of limited use. It would be more useful
to have prior year figures for comparison and/or industry averages for similar businesses. This would make performance
review much more meaningful.
(b)
Transfer prices
From C Co’s perspective
C Co transfers components to the Gearbox division at the same price as it sells components to the external market. However,
if C Co were not making internal sales then, given that it already satisfies 60% of external demand, it would not be able to
sell all of its current production to the external market. External sales are $8,010,000, therefore unsatisfied external demand
is ([$8,010,000/0·6] – $8,010,000) = $5,340,000.
From C Co’s perspective, of the current internal sales of $7,550,000, $5,340,000 could be sold externally if they were not
sold to the Gearbox division. Therefore, in order for C Co not to be any worse off from selling internally, these sales should be
made at the current price of $5,340,000, less any reduction in costs which C Co saves from not having to sell outside the
group (perhaps lower administrative and distribution costs).
As regards the remaining internal sales of $2,210,000 ($7,550,000 – $5,340,000), C Co effectively has spare capacity to
meet these sales. Therefore, the minimum transfer price should be the marginal cost of producing these goods. Given that
variable costs represent 40% of revenue, this means that the marginal cost for these sales is $884,000. This is therefore the
minimum price which C Co should charge for these sales.
In total, therefore, C Co will want to charge at least $6,224,000 for its sales to the Gearbox division.
From the Gearbox division’s perspective
The Gearbox division will not want to pay more for the components than it could purchase them for externally. Given that it
can purchase them all for 95% of the current price, this means a maximum purchase price of $7,172,500.
Overall
Taking into account all of the above, the transfer price for the sales should be somewhere between $6,224,000 and
$7,172,500.
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3
(a)
Profit outcomes
Unit contribution
Up to 100,000 units
Above 100,000 units
Sales price per unit
$30
$35
$18
$23
$19
$24
Sales price $30
Sales
volume
120,000
110,000
140,000
Unit
contribution
$
19
19
19
Total
contribution
$’000
2,280
2,090
2,660
Fixed
costs
$’000
450
450
450
Advertising
costs
$’000
900
900
900
Unit
contribution
$
24
23
23
Total
contribution
$’000
2,592
2,300
2,162
Fixed
costs
$’000
450
450
450
Advertising
costs
$’000
970
970
970
Profit
Probability
$’000
930
740
1,310
0·4
0·5
0·1
EV of
profit
$’000
372
370
131
––––
873
––––
Profit
Probability
$’000
1,172
880
742
0·3
0·3
0·4
Profit
$’000
930
740
1,310
Sales price $35
Sales
volume
108,000
100,000
94,000
(b)
Profit
$’000
1,172
880
742
Expected values
Sales price $30
Sales
volume
120,000
110,000
140,000
Sales price $35
Sales
volume
108,000
100,000
94,000
EV of
profit
$’000
351·6
264
296·8
––––––
912·4
––––––
If the criterion of expected value is used to make a decision as to which price to charge, then the price charged should be
$35 per unit since the expected value of this option is the greatest.
(c)
Maximin decision rule
Under this rule, the decision-maker selects the alternative which offers the most attractive worst outcome, i.e. the alternative
which maximises the minimum profit. In the case of Gam Co, this would be the price of $35 as the lowest profit here is
$742,000 as compared to a lowest profit of $740,000 at a price of $30.
(d)
Reasons for uncertainty arising in the budgeting process
Uncertainty arises largely because of changes in the external environment over which a company will sometimes have little
control. Reasons include:
–
–
–
–
–
–
Customers may decide to buy more or less goods or services than originally forecast. For example, if a major customer
goes into liquidation, this has a huge effect on a company and could also cause them to go into liquidation.
Competitors may strengthen or emerge and take some business away from a company. On the other hand, a competitor’s
position may weaken leading to increased business for a particular company.
Technological advances may take place which lead a company’s products or services to become out-dated and therefore
less desirable.
The workforce may not perform as well as expected, perhaps because of time off due to illness or maybe simply because
of lack of motivation.
Materials may increase in price because of global changes in commodity prices.
Inflation can cause the price of all inputs to increase or decrease.
15
Taha Popatia - ARTT Business School - 02134523175
4
–
–
–
If a company imports or exports goods or services, changes in exchange rates can cause prices to change.
Machines may fail to meet production schedules because of breakdown.
Social/political unrest could affect productivity, e.g. the workforce goes on strike.
Note: This list is not exhaustive, nor would candidates be expected to make all the points raised in order to score full marks.
(a)
Variances
(i)
The sales mix contribution variance
Calculated as (actual sales quantity – actual sales quantity in budgeted proportions) x standard contribution per unit.
Standard contributions per valet:
Full = $50 x 44·6% = $22·30 per valet
Mini = $30 x 55% = $16·50 per valet
Actual sales quantity in budgeted proportions (ASQBP):
Full: 7,980 x (3,600/5,600) = 5,130
Mini: 7,980 x (2,000/5,600) = 2,850
(ii)
Valet type
AQAM
AQBM
Difference
Full
Mini
4,000
3,980
5,130
2,850
(1,130)
1,130
Standard
contribution
$
22·30
16·50
Variance
$
25,199 A
18,645 F
–––––––
6,554 A
–––––––
The sales quantity contribution variance
Calculated as (actual sales quantity in budgeted proportions – budgeted sales quantity) x standard contribution per unit.
(b)
Valet type
AQBM
BQBM
Difference
Full
Mini
5,130
2,850
3,600
2,000
1,530
850
Standard
contribution
$
22·30
16·50
Variance
$
34,119 F
14,025 F
–––––––
48,144 F
–––––––
Description
The sales mix contribution variance
This variance measures the effect on profit of changing the mix of actual sales from the standard mix.
The sales quantity contribution variance
This variance measures the effect on profit of selling a different total quantity from the budgeted total quantity.
(c)
Sales performance of the business
The sales performance of the business has been very good over the last year, as shown by the favourable sales quantity
variance of $48,144. Overall, total sales revenue is 33% higher than budgeted (($319,400 – $240,000)/$240,000). This
is because of a higher total number of valets being performed. When you look at where the difference in sales quantity actually
is, you can see from the data provided in the question that it is the number of mini valets which is substantially higher. This
number is 99% ((3,980 – 2,000)/2,000) higher than budgeted, whereas the number of full valets is only 11% ((4,000 –
3,600)/3,600) higher. Even 11% is still positive, however.
The fact that the number of mini valets is so much higher combined with the fact that they generate a lower contribution per
unit than the full valet led to an adverse sales mix variance of $6,554 in the year. This cannot be looked at in isolation as a
sign of poor performance; it is simply reflective of the changes which have occurred in Strappia. We are told that disposable
incomes in Strappia have decreased by 30% over the last year. This means that people have less money to spend on nonessential expenditure such as car valeting. Consequently, they are opting for the cheaper mini valet rather than the more
expensive full valet. At the same time, we are also told that people are keeping their cars for an average of five years now as
opposed to three years. This may be leading them to take more care of them and get them valeted regularly because they
know that the car has to be kept for a longer period. Thus, the total quantity of valets is higher than budgeted, particularly
the mini valets.
Also, there is now one less competitor for Valet Co than there was a year ago, so Valet Co may have gained some of the old
competitor’s business. Together, all of these factors would explain the higher number of total valets being performed and in
particular, of the less expensive type of valet.
Note: Other valid points will be given full credit.
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Taha Popatia - ARTT Business School - 02134523175
5
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2014 Marking Scheme
Marks
(a)
(b)
(c)
Full absorption cost
Overhead absorption rate
Cost for X incl labour and materials
Cost for Y incl labour and materials
Cost for Z incl labour and materials
1·5
0·5
0·5
0·5
–––
3
–––
Activity based cost
Correct cost driver rates
Overhead unit cost for X
Overhead unit cost for Y
Overhead unit cost for Z
Adding labour and materials costs
Total cost for X
Total cost for Y
Total cost for Z
4·5
1
1
1
2
0·5
0·5
0·5
–––
11
–––
Discussion
Effect on price
Effect on sales volume
3
3
–––
6
–––
20
–––
–––
Total marks
2
(a)
(b)
Optimum production plan
Stating the objective function
Defining constraint for built time
Defining constraint for program time
Defining constraint for test time
Non-negativity constraints
Sales constraint x
Sales constraint y
Iso-contribution line worked out
The graph:
Labels
Build time line
Program time line
Test time line
Demand for x line
Demand for y line
Iso-contribution line
Feasible region identified and labelled/shaded
Optimum point identified
Equations solved at optimum point
Total contribution
Total profit
0·5
0·5
0·5
0·5
0·5
0·5
0·5
1
0·5
0·5
0·5
0·5
0·5
0·5
0·5
1
1
3
0·5
0·5
–––
14
–––
Slack values
Test time calculation
Program time calculation
Defining and identifying slack resources
Discussing implication of slack resources
1·5
1·5
1·5
1·5
–––
6
–––
20
–––
–––
Total marks
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1
Marks
(a)
(b)
Ratios
Calculating ROCE
Calculating asset turnover
Calculating operating profit margin
Per valid comment
1·5
1·5
1·5
1
–––
10
–––
Transfer pricing
Each valid comment/calculation
1 or 2
–––
10
–––
20
–––
–––
Total marks
4
(a)
(b)
(c)
(d)
Profit outcomes
Unit contribution up to 100,000 units
Unit contribution above 100,000 units
Each line of table for price of $30 (3 in total)
Each line of table for price of $35 (3 in total)
1
1
1
1
–––
8
–––
Expected values
Expected value for $30
Expected value for $35
Recommendation
1
1
1
–––
3
–––
Maximin
Explanation
Decision
2
1
–––
3
–––
Uncertainty
Each point made
1
–––
6
–––
20
–––
–––
Total marks
5
(a)
(b)
(c)
Calculations
Sales mix contribution variance
Sales quantity contribution variance
4
4
–––
8
–––
Description
One mark per description
2
–––
Discussion on sales performance
Calculations – each one, max 2
Maximum for each point made
0·5
2
–––
10
–––
20
–––
–––
Total marks
18
Taha Popatia - ARTT Business School - 02134523175
3
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2014 Answers
Section A
1
A
Division A: Profit = $14·4m x 30% = $4·32m
Imputed interest charge = $32·6m x 10% = $3·26m
Residual income = $1·06m
2
D
3
A
4
B
5
C
Number of units required to make target profit = fixed costs + target profit/contribution per unit of P1.
Fixed costs = ($1·2 x 10,000) + ($1 x 12,500) – $2,500 = $22,000.
Contribution per unit of P = $3·20 + $1·20 = $4·40.
($22,000 + $60,000)/$4·40 = 18,636 units.
6
A
Product
Selling price per unit
Raw material cost
Direct labour cost at $11 per hour
Variable overhead cost
Contribution per unit
Direct labour hours per unit
Contribution per labour hour
Rank
Normal monthly hours (total units x hours per unit)
A
$160
$24
$66
$24
$46
––––
6
$7·67
2
1,800
B
$214
$56
$88
$18
$52
––––
8
$6·50
4
1,000
C
$100
$22
$33
$24
$21
––––
3
$7
3
720
If the strike goes ahead, only 2,160 labour hours will be available.
Therefore make all of D, then 1,360 hours’ worth of A (2,160 – 800 hrs).
7
B
460 – 400 = 60 clients
$40,000 – $36,880 = $3,120
VC per unit = $3,120/60 = $52
Therefore FC = $40,000 – (460 x $52) = $16,080
8
B
Increase in variable costs from buying in (2,200 units x $40 ($140 – $100)) = $88,000
Less the specific fixed costs saved if A is shut down = ($10,000)
Decrease in profit = $78,000
9
A
17
D
$140
$40
$22
$18
$60
––––
2
$30
1
800
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Division B: Profit = 8·8m x 24% = $2·112m
Imputed interest charge = $22·2m x 10% = $2·22m
Residual income = $(0·108)m
10 B
By definition, a shadow price is the amount by which contribution will increase if an extra kg of material becomes available. 20 x
$2·80 = $56.
11 C
12 A
13 D
15 C
16 A
17 A
New profit figures before salary paid:
Good manager: $180,000 x 1·3 = $234,000
Average manager: $180,000 x 1·2 = $216,000
Poor: $180,000 x 1·1 = $198,000
EV of profits = (0·35 x $234,000) + (0·45 x $216,000) + (0·2 x $198,000) = $81,900 + $97,200 + $39,600 = $218,700
Deduct salary cost and EV with manager = $178,700
Therefore do not employ manager as profits will fall by $1,300.
18 B
Set-up costs per production run = $140,000/28 = $5,000
Cost per inspection = $80,000/8 = $10,000
Other overhead costs per labour hour = $96,000/48,000 = $2
Overheads costs of product D:
Set-up costs (15 x $5,000)
Inspection costs (3 x $10,000)
Other overheads (40,000 x $2)
$
75,000
30,000
80,000
––––––––
185,000
––––––––
Overhead cost per unit = 185,000/4,000 = $46·25
19 A
20 A
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14 B
Section B
1
Chair Co
(a)
Learning curve formula = y = axb
Cumulative average time per unit for 8 units:
Y = 12 x 8–·415
= 5·0628948 hours.
Therefore cumulative total time for 8 units = 40·503158 hours.
Cumulative average time per unit for 7 units:
Y = 12 x 7–·415
= 5·3513771 hours.
Therefore cumulative total time for 7 units = 37·45964 hours.
Total labour cost for 8th unit =3·043518 x $15 = $45·65277
Material and overheads cost per unit = $230
Therefore total cost per unit = $275·65277
Therefore price per unit = $413·47915
(b)
(i)
Actual learning rate
Cumulative number of
seats produced
1
2
4
8
Cumulative total
hours
12·5
?
?
34·3
Cumulative average
hours per unit
12·5
12·5 x r
12·5 x r2
12·5 x r3
Using algebra: 34·3 = 8 x (12·5 x r3)
4·2875 = (12·5 x r3)
0·343 = r3
r = 0·70
The learning effect was 70% as compared to the forecast rate of 75%, meaning that the labour force learnt more quickly
than anticipated.
(ii)
Adjusted price
The adjusted price charged will be lower than the original price calculated in part (a). This is because the incremental
cost of the 8th unit will be lower given the 70% learning rate, even though the first unit took 12·5 hours. We know this
because we are told that the cumulative time for 8 units was actually 34·3 hours. This is lower than the estimated
cumulative time in part (a) for 8 units of 40·503158 hours and therefore, logically, the actual incremental time for the
8th unit must be lower than the estimated 3·043518 hours calculated in part (a). Consequently, total cost will be lower
and price will be lower, given that this is based on cost.
2
Glam Co
(a)
Bottleneck activity
The bottleneck may have been worked out as follows:
Total salon hours = 8 x 6 x 50 = 2,400 each year. The capacity for each senior stylist must be 2,400 hours, which equates
to 2,400 cuts each year (2,400/1). Since there are three senior stylists, the total capacity is 7,200 hours or 7,200 cuts each
year. Using this method, the capacity for each activity is as follows:
Assistants
Senior stylists
Junior stylists
Cut
48,000
7,200
9,600
Treatment
16,000
4,800
9,600
The bottleneck activity is clearly the work performed by the senior stylists.
The senior stylists’ time is called a bottleneck activity because it is the activity which prevents the salon’s throughput from
being higher than it is. The total number of cuts or treatments which can be completed by the salon’s senior stylists is less
than the number which can be completed by other staff members, considering the number of each type of staff available and
the time required by each type of staff for each client.
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Therefore incremental time for 8th unit = 40·503158 hours – 37·45964 hours = 3·043518 hours.
(b)
TPAR
Selling price
Materials
Throughput
Throughput per bottleneck hour
Total salon costs per BN hour (w1)
TPAR
Cut
$
60
0·60
59·40
59·40
42·56
1·4
Treatment
$
110
8 (7·40+0·6)
102
68
42·56
1·6
Working 1: Total salon costs
(3 x $40,000) + (2 x $28,000) + (2 x $12,000) + $106,400 = $306,400
Therefore cost for each bottleneck hour = $306,400/7,200 = $42·56
3
Hi Life Co
Direct materials:
Fabric
Wood
Direct labour:
Skilled
Semi-skilled
Factory overheads
Administration overheads
200 m2 at $17·50 per m2
20 m at $8·20 per m
30 m at $8·50 per m
50 hours at $24 per hour
300 hours at $14 per hour
20 hours at $15 per hour
Total cost
4
Note
1
2
2
$
3,500
164
255
3
4
5
6
1,200
4,200
300
–
––––––
9,619
––––––
1
Since the material is in regular use by HL Co, it is replacement cost which is the relevant cost for the contract.
2
30 m will have to be ordered from the alternative supplier for immediate delivery but the remaining 20 m can be used from
inventory and replaced by an order from the usual supplier at a cost of $8·20 per m.
3
There is no cost for the first 150 hours of labour because there is spare capacity. The remaining 50 hours will be paid at time
and a half, which is $16 x 1·5, i.e. $24 per hour.
4
HL Co will choose to use the agency workers, who will cost $14 per hour, since this is cheaper than paying existing
semi-skilled workers at $18 per hour ($12 x 1·5) to work overtime.
5
None of the general factory costs are incremental, so they have all been excluded. However, the supervisor’s overtime pay is
incremental, so has been included. The supervisor’s normal salary, on the other hand, has been excluded because it is not
incremental.
6
These are general overheads and are not incremental, so no value should be included for them.
Jamair
(a)
The four perspectives
Financial perspective – this perspective is concerned with how a company looks to its shareholders. How can it create value
for them? Kaplan and Norton identified three core financial themes which will drive the business strategy: revenue growth
and mix, cost reduction and asset utilisation.
Customer perspective – this considers how the organisation appears to customers. The organisation should ask itself: ‘to
achieve our vision, how should we appear to our customers?’ The customer perspective should identify the customer and
market segments in which the business will compete. There is a strong link between the customer perspective and the
revenue objectives in the financial perspective. If customer objectives are achieved, revenue objectives should be too.
Internal perspective – this requires the organisation to ask itself: ‘what must we excel at to achieve our financial and customer
objectives?’ It must identify the internal business processes which are critical to the implementation of the organisation’s
strategy. These will include the innovation process, the operations process and the post-sales process.
Learning and growth perspective – this requires the organisation to ask itself whether it can continue to improve and create
value. The organisation must continue to invest in its infrastructure – i.e. people, systems and organisational procedures – in
order to improve the capabilities which will help the other three perspectives to be achieved.
20
Taha Popatia - ARTT Business School - 02134523175
Note: Answers based on total salary costs were $80,000 were also equally acceptable since the wording of question was
open to interpretation.
Goals and measures
Financial perspective
Goal
To use fewer planes to transport customers
Performance measure
Lease costs of plane per customer
Explanation – operating efficiency will be driven by getting more customers on fewer planes. This goal and measure cover the
cost side of this.
Goal
To increase seat revenue per plane
Performance measure
Revenue per available passenger mile
Explanation – this covers the first part of achieving operating efficiency – by having fewer empty seats on planes.
Customer perspective
Goal
To ensure that flights are on time
Performance measure
‘On time arrival’ ranking from the aviation authority
Explanation – Jamair is currently number 7 in the rankings. If it becomes known as a particularly reliable airline, customers
are more likely to use it, which will ultimately increase revenue.
Goal
To reduce the number of flights cancelled
Performance measure
The number of flights cancelled
Explanation – again, if flights are seen to be cancelled frequently by Jamair, customers will not want to use it. It needs to be
perceived as reliable by its customers.
Internal perspective
Goal
To improve turnaround time on the ground
Performance measure
‘On the ground’ time
Explanation – less time spent on the ground means fewer planes are needed, which will reduce plane leasing costs. However,
it is important not to compromise the quality of cleaning or make errors in refuelling as a consequence of reducing on the
ground time.
Goal
To improve the cleanliness of Jamair’s planes
Performance measure
The percentage of customers happy with the standard of the planes,
as reported in the customer satisfaction surveys.
Explanation – at present, only 85% of customers are happy with the standard of cleanliness on Jamair’s planes. This could
be causing loss of revenue.
Goal
To develop the online booking system
Performance measure
Percentage downtime.
Explanation – since the company relies entirely on the booking system for customer booking of flights and check-in, it is
critical that it can deal with the growing number of customers.
Learning perspective
Goal
To reduce the employee absentee rate
Performance measure
The number of days absent per employee
Explanation – it is critical to Jamair that its workforce is reliable as, at worse, absent staff lead to cancelled flights.
Goal
To increase ground crew training on cleaning and
refuelling procedures
Performance measure
Number of days’ training per ground crew member
Explanation – if ground crew are better trained, they can reduce the number of minutes that the plane stays on the ground,
which will result in fewer planes being required and therefore lower costs. Also, if their cleaning is better, customer satisfaction
and retention will increase.
Note: Only one goal and measure were required for each perspective. In order to gain full marks, answers had to be specific
to Jamair as stated in the requirements.
21
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(b)
Safe Soap Co
(a)
Variance calculations
Mix variance
Total kg of materials per standard batch = 0·25 + 0·6 + 0·5 = 1·35 kg
Therefore standard quantity to produce 136,000 batches = 136,000 x 1·35 kg = 183,600 kg
Actual total kg of materials used to produce 136,000 batches = 34,080 + 83,232 + 64,200 = 181,512 kg
Material
Lye
Coconut oil
Shea butter
Yield variance
Material
Lye
Coconut oil
Shea butter
(b)
(i)
Actual quantity
Standard mix
kgs
181,512 x 0·25/1·35 = 33,613·33
181,512 x 0·6/1·35 =
80,672
181,512 x 0·5/1·35 = 67,226·67
–––––––––
181,512
–––––––––
Actual quantity
Variance Standard cost
Actual mix
per kg
kgs
kgs
$
34,080
(466·67)
10
83,232
(2,560)
4
64,200
3,026·67
3
––––––––
181,512
––––––––
Standard quantity
Standard mix
0·25 x 136,000 =
0·6 x 136,000 =
0·5 x 136,000 =
Actual quantity
Standard mix
kgs
33,613·33
80,672
67,226·67
–––––––––
181,512
–––––––––
34,000
81,600
68,000
––––––––
183,600
––––––––
Variance Standard cost
per kg
kgs
$
386·67
10
928
4
773·33
3
Variance
$
(4,666·70)
(10,240)
9,080·01
–––––––––
(5,826·69)A
–––––––––
Variance
$
3,866·70
3,712
2,319·99
–––––––––
9,898·69F
–––––––––
A materials mix variance will occur when the actual mix of materials used in production is different from the standard
mix. So, it is inputs which are being considered. Since the total mix variance is adverse for the Safe Soap Co, this means
that the actual mix used in September and October was more expensive than the standard mix.
A material yield variance arises because the output which was achieved is different from the output which would have
been expected from the inputs. So, whereas the mix variance focuses on inputs, the yield variance focuses on outputs.
In both September and October, the yield variance was favourable, meaning that the inputs produced a higher level of
output than one would have expected.
(ii)
Whilst the mix and yield variances provide Safe Soap Co with a certain level of information, they do not necessarily
explain any quality issues which arise because of the change in mix. The consequences of the change may well have
an impact on sales volumes. In Safe Soap Co’s case, the sales volume variance is adverse, meaning that sales volumes
have fallen in October. It is not known whether they also fell in September but it would be usual for the effects on sales
of the change in mix to be slightly delayed, in this case by one month, given that it is only once the customers start
receiving the slightly altered soap that they may start expressing their dissatisfaction with the product.
There may also be other reasons for the adverse sales volume variance but given the customer complaints which have
been received, the sales manager’s views should be taken on board.
22
Taha Popatia - ARTT Business School - 02134523175
5
Fundamentals Level – Skills Module, Paper F5
Performance Management
December 2014 Marking Scheme
Section A
Marks
2 marks per question
40
–––
–––
1
(a)
(b)
Price
Cumulative average time per unit for 8 units
Total time for 8 units
Cumulative average time per unit for 7 units
Total time for 7 units
Incremental time for 8th unit
Cost for 8th unit
Total cost
Price
(i)
(ii)
1
0·5
1
0·5
0·5
0·5
0·5
0·5
–––
5
–––
Learning rate
Calculating learning rate
Saying whether better or worse
2·5
0·5
–––
3
–––
Effect on price
2
–––
10
–––
–––
Total marks
2
(a)
Calculation and justification of bottleneck
Explanation of bottleneck
(b)
TPAR
Throughput
Throughput per bottleneck hour
Total salon costs
Cost per hour
TPAR
3
1
–––
4
–––
1
1
1
1
2
–––
6
–––
10
–––
–––
Total marks
3
Fabric calculation
Fabric reason
Wood calculation
Wood reason
Skilled labour calculation
Skilled labour reason
Semi-skilled labour calculation
Semi-skilled labour reason
Factory overheads calculation
Factory overheads reason
Administration overheads calculation
Administration overheads reason
1
0·5
2
0·5
1
0·5
1
0·5
1
0·5
1
0·5
–––
10
–––
–––
Total marks
23
Taha Popatia - ARTT Business School - 02134523175
Section B
Marks
(a)
(b)
Perspectives
Explanation for each perspective
1·5
–––
6
–––
Goals and measures
Each goal/measure/explanation
Presentation and structure
2
1
–––
9
–––
15
–––
–––
Total marks
5
(a)
(b)
Variance calculations
Mix variance
Quantity variance
(i)
(ii)
4
4
–––
8
–––
Variances
Marks per variance explained
2
–––
4
–––
Discussion
Per valid point
1
–––
3
–––
15
–––
–––
Total marks
24
Taha Popatia - ARTT Business School - 02134523175
4
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2015 Answers
Section A
1
C
Divisional profit before depreciation = $2·7m x 15% = $405,000 per annum.
Less depreciation = $2·7m x 1/50 = $54,000 per annum.
Divisional profit after depreciation = $351,000
Imputed interest = $2·7m x 7% = $189,000
Residual income = $162,000.
D
Option (ii) is not relevant since it is a common cost.
3
C
A target cost is arrived at by identifying the market price of a product and then subtracting a desired profit margin from it.
4
C
The maximum regret at each supply level is as follows:
At 325: $142
At 350: $90
At 375: $82
At 400: $120
The minimum of these is $82 at 375, therefore the answer is C.
5
A
Statement (ii) describes an enterprise resource planning system, not an executive information system.
6
B
The method of apportioning general fixed costs is not required to calculate the break-even sales revenue.
7
C
All of the others are internal sources of information.
8
D
Statement (ii) is wrong as it reflects the common misconception that the shadow price is the maximum price which should be paid,
rather than the maximum extra over the current purchase price.
Statement (iii) is wrong but could be thought to be correct if (ii) was wrongly assumed to be correct.
9
B
$320 – $80/(6/60) = $2,400
10 B
ROCE can be calculated by multiplying the operating profit margin and the asset turnover.
28% x 65% = 18·2%
17
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2
11 C
Labour hours per unit
Profit per unit
Add back fixed costs
Contribution per unit
Contribution per labour hour
Ranking
1
2
1·1
$
44
6
50
50
1st
$
51
9
60
30
3rd
$
26
12
38
34·55
2nd
12 B
13 D
The first statement is wrong because customers are actually paying more quickly.
The second statement is wrong because inventory levels have increased.
14 A
Planning variance = ($3·80 – $5) x 10,000 = $12,000 A
15 A
The sales quantity contribution variance is calculated as follows:
Product A
Product B
Actual sales
units in std mix
16,020
10,680
Standard sales
units in std mix
15,840
10,560
Difference
in units
180F
120F
Standard
contribution
$12
$13
Total
Variance
$2,160F
$1,560F
––––––––
$3,720F
––––––––
16 C
The learning rate was actually better than expected and only (i) could cause it to improve.
17 A
This is the correct option as environment-driven costs are allocated to general overheads, not joint cost centres.
18 A
The first statement is incorrect as the difference between actual quantity in standard mix and the actual quantity in the actual mix
is valued at the standard cost per kg, not the actual cost.
The second statement is incorrect as that is the definition of the yield variance.
19 A
Working
Opening capital employed: $4m + $0·5m = $4·5m
Closing capital employed: ($4m x 0·9) + ($0·5 x 1·2) = $3·6m + $0·6 = $4·2m
Average capital employed = $4·35m
Profit after depreciation = $1·2m
Therefore ROI = $1·2m/$4·35m = 27·59%
20 A
The first statement is correct as throughput accounting discourages production for inventory purposes and is often used in a just
in time environment.
The second statement is incorrect as in throughput accounting it is the bottleneck resource which should be 100% efficient which
actually may mean unused capacity elsewhere.
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All of the statements are false except statement (iii).
Section B
1
(a)
Beckley Hill
Annual activity per cost driver
Procedure
No. of procedures
Admin. time per procedure (hours)
Patient hours
Number of meals
A
14,600
14,600
350,400
14,600
B
22,400
33,600
1,075,200
89,600
Total
37,000
48,200
1,425,600
104,200
Overhead allocation per procedure
Procedure
Administrative costs
Nursing costs
Catering costs
General facility costs
Add direct costs:
Surgical
Anaesthesia
Total cost per procedure
(b)
A
38·80
104·64
9·28
144·00
–––––––––
296·72
–––––––––
B
58·20
209·28
37·12
288·00
–––––––––
592·60
–––––––––
1,200
800
–––––––––
2,296·72
–––––––––
2,640
1,620
–––––––––
4,852·60
–––––––––
When activity-based costing (ABC) is used as in (a) above, the cost for Procedure A is approximately $2,297 as compared
to the approximate $2,476 currently calculated by BH. For Procedure B, the cost using ABC is approximately $4,853 as
compared to the approximate current cost of $4,736. Hence, the cost of Procedure A goes down using ABC and the cost of
Procedure B goes up. This reflects the fact that the largest proportion of the overhead costs is the nursing and general facility
costs. Both of these are driven by the number of patient hours for each procedure. Procedure B has twice as many patient
hours as Procedure A. Whilst this is not taken into account when the overheads are simply being divided by the number of
procedures and allocated to each product, it would be if ABC were adopted instead. Hence, the allocation of costs would
more fairly reflect the use of resources driving the overheads.
However, ABC can be a lot of work to implement, and whilst the comparative costs are different, they are not significantly
different. Given that ABC is costly to implement, it may be that a similar allocation in overheads can be achieved simply by
using a fairer basis to absorb the costs. If patient hours are used as the basis of absorption instead of simply dividing the
overheads by the number of procedures, the costs for Procedures A and B would be $2,296 and $4,853 (W1). Hence, the
same result can be achieved without going to all of the time and expense of using ABC. Therefore BH should not adopt ABC
but use this more accurate basis of absorbing overheads instead.
Working 1
$17,606,352/1,425,600 hours = $12·35 per hour.
Therefore absorption cost for A = $1,200 + $800 + (24 x $12·35) = $2,296.
Same calculation for B but with 48 hours instead.
2
Mobe Co
From the group’s perspective
For every motor sold externally, Division M generates a profit of $80 ($850 – $770) for the group as a whole. For every motor
which Division S has to buy from outside of the group, there is an incremental cost of $60 per unit ($800 – [$770 – $30]).
Therefore, from a group perspective, as many external sales should be made as possible before any internal sales are made.
Consequently, the group’s current policy will need to be changed. This does, however, assume that the quality of the motors bought
from outside the group is the same as the quality of the motors made by Division M.
Division M’s total capacity is 60,000 units. Given that it can make external sales of 30,000 units, it can only supply 30,000 of
Division S’s demand for 35,000 motors. These 30,000 units should be bought from Division M since, from a group perspective,
the cost of supplying these internally is $60 per unit cheaper than buying externally. The remaining 5,000 motors required by
Division S should then be bought in from the external supplier at $800 per unit. .
In order to work out the transfer price which should be set for the internal sales of 30,000 motors, the perspective of both divisions
must be considered.
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Cost driver rates
Administrative costs – $1,870,160/48,200 = $38·80 per admin hour
Nursing costs
– $6,215,616/1,425,600 = $4·36 per patient hour
Catering costs
– $966,976/104,200 = $9·28 per meal
General facility costs – $8,553,600/1,425,600 = $6 per patient hour
From Division M’s perspective
Division M’s only buyer for these 30,000 motors is Division S, so the lowest price it would be prepared to charge is the marginal
cost of making these units, which is $740 per unit. However, it would ideally want to make some profit on these motors too and
would consequently expect a significantly higher price than this.
From Division S’s perspective
Division S knows that it can buy as many external motors as it needs from outside the group at a price of $800 per unit. Therefore,
this will be the maximum price which it is prepared to pay.
3
Bokco
(a)
Planning and operational variances
Revised hours for actual production:
Cumulative time per hour for 460 units is calculated by using the learning curve formula: Y = axb
a=7
x = 460
b = –0·1520
Therefore y = 7 x 460 –0·1520 = 2·7565054
Therefore revised time for 460 units = 1,268 hours.
Labour efficiency planning variance
(Standard hours for actual production – revised hours for actual production) x std rate
= ([460 x 7] – 1,268) x $12 = $23,424F
Labour efficiency operational variance
(Revised hours for actual production – actual hours for actual production) x std rate
(1,268 – 1,860) x $12 = $7,104A
(b)
Consequences of failure to anticipate learning effect
The likely consequences are as follows:
–
Bokco will have hired too many temporary staff because of the fact that the new product can actually be produced more
quickly than originally thought. Given that these staff are hired on three-month contracts, Bokco will presumably have
to pay the staff for the full three months even if all of them are not needed. This will be a significant and unnecessary
cost to the business.
–
Since production is actually happening more quickly than anticipated, the company may well have run out of raw
materials, leading to a stop in production. Idle time is a waste of resources and costs money.
–
If there have been stockouts, the buying department may have incurred additional costs for expedited deliveries or may
have been forced to use more expensive suppliers. This would have made the material price variance adverse and
negatively affected the buying department’s manager bonus, which would have a demotivational effect on him.
–
Since Bokco uses cost plus pricing for its products, the price for the product will have been set too high. This means
that sales volumes may well have been lower than they otherwise might have been, leading to lost revenue for the
company and maybe even failure of the new product launch altogether. This will continue to be the case for the next
two months unless the price review is moved forward.
–
The sales manager will be held responsible for the poorer sales of the product, which will probably be reflected in an
adverse sales volume variance. This means that he may lose his bonus through no fault of his own. This will have a
demotivational effect on him.
Note: Other valid points could be made too.
4
ALG Co
(a)
Variable cost per unit
Material cost = $2,400,000/200,000 = $12 per unit.
Labour cost = $1,200,000/200,000 = $6 per unit.
Variable overhead cost using high-low method: ($1,850,000 – $1,400,000)/(350,000 – 200,000) = $3 per unit.
Therefore total variable cost per unit = $21.
Fixed costs = $1,400,000 – (200,000 x $3) = $800,000
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Overall
Therefore, the transfer price should be set somewhere between $740 and $800. From the perspective of the group, the total group
profit will be the same irrespective of where in this range the transfer price is set. However, it is important that divisional managers
and staff remain motivated. Given the external sales price which Division M can achieve and the fact that Division S would have
to pay $800 for each motor bought from outside the group, the transfer price should probably be at the higher end of the range.
(b)
Optimum price
Find the demand function
Demand function is P = a – bx, where P = price and x = quantity, therefore find a value for a and b firstly.
B = ∆P/∆Q = 2/2,000 = 0·001 (ignore the minus sign as it is already reflected in the formula P = a – bx.)
Therefore P = a – 0·001x
Find value for ‘a’ by substituting in the known price and demand relationship from the question, matching ‘p’ and ‘x’
accordingly.
60 = a – (0·001 x 250,000)
60 = a – 250
310 = a
Identify MC
MC = $21 calculated in (a)
State MR
MR = 310 – 0·002x
Equate MC and MR to find x
21 = 310 – 0·002x
0·002x = 289
x = 144,500
Substitute x into demand function to find P
P = 310 – (0·001 x 144,500)
P = $165·50
Calculate profit
Sales revenue = 144,500 x $165·50 = $23,914,750
Variable overheads = 144,500 x $21 = $3,034,500
Fixed overheads = $800,000
Therefore profit = $20,080,250
(c)
Market skimming
As the sales director suggests, market skimming is a strategy which initially charges high prices for the product in order to
take advantage of those buyers who want to buy it as soon as possible, and are prepared to pay high prices in order to do
so.
If certain conditions exist, the strategy could be a suitable one for ALG Co. The conditions are as follows:
–
Where a product is new and different, so that customers are prepared to pay high prices in order to gain the perceived
status of owning the product early. All we know about ALG Co’s product is that it is ‘innovative’, so it may well meet this
condition.
–
Where products have a short life cycle this strategy is more likely to be used, because of the need to recover development
costs and make a profit quickly. ALG Co’s product does only have a three-year life cycle, which does make it fairly short.
–
Where high prices in the early stages of a product’s life cycle are expected to generate high initial cash inflows. If this
is the case here, then skimming would be useful to help ALG Co cover the high initial development costs which it has
incurred.
–
Where barriers to entry exist, which deter other competitors from entering the market; as otherwise, they will be enticed
by the high prices being charged. These might include prohibitively high investment costs, patent protection or unusually
strong brand loyalty. According to the information we have been given, high development costs were involved in this
case, which would be a barrier to entry.
–
Where demand and sensitivity of demand to price are unknown. In ALG Co’s case, market research has been carried
out to establish a price. However, this information is based on the launch of similar but not identical products, so it is
not really known just how accurate it will be.
It is not possible to say for definite whether this pricing strategy would be suitable for ALG Co, because of the limited
information available. However, it could always be launched at a higher price initially to see what demand is. It is far easier
to lower a price after launch than to raise it. The optimum pricing approach in (b) above is based on a set of assumptions
which do not hold true in the real world. Also, as the data is derived from similar but not identical products, it may not hold
true for this particular product.
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Therefore P = 310 – 0·001x.
(a)
Main steps
1.
Activities are identified by managers. Managers are then forced to consider different ways of performing the activities.
These activities are then described in what is called a ‘decision package’, which:
–
–
–
–
–
analyses the cost of the activity;
states its purpose;
identifies alternative methods of achieving the same purpose;
establishes performance measures for the activity;
assesses the consequence of not performing the activity at all or of performing it at different levels.
As regards this last point, the decision package may be prepared at the base level, representing the minimum level of
service or support needed to achieve the organisation’s objectives. Further incremental packages may then be prepared
to reflect a higher level of service or support.
(b)
2.
Management will then rank all the packages in the order of decreasing benefits to the organisation. This will help
management decide what to spend and where to spend it. This ranking of the decision packages happens at numerous
levels of the organisation.
3.
The resources are then allocated based on order of priority up to the spending level available.
Potential problems
At present, the LRA finds itself facing particularly difficult circumstances. The fires and the floods have meant that urgent
expenditure is now needed on schools, roads and hospitals which would not have been required if these environmental
problems had not occurred. Lesting is facing a crisis situation and the main question is therefore whether this is a good time
to introduce anything new at the LRA when it already faces so many challenges.
The introduction of ZBB in any organisation is difficult at any time because of the fact that the process requires far more skills
than, for example, incremental budgeting. Managers would definitely need some specialist training as they simply will not
have the skills which they would need in order to construct decision packages. This then would have further implications in
terms of time and cost, and, at the moment, both of these are more limited than ever for the LRA. When so many costs are
being faced by the LRA, can it really consider spending money on training staff to prepare and evaluate decision packages?
Given that the budget needs preparing imminently as the new financial year is approaching, it is really too late to start training
staff. With ZBB, the whole budgeting process becomes a lot more cumbersome as it has to be started from scratch. There is
a lot of paperwork involved and the whole process of identifying decision packages and determining their costs and benefits
is extremely time-consuming. There are often too many decision packages to evaluate and there is frequently insufficient
information for them to be ranked. The LRA provides a wide range of services and it is therefore obvious that this would be
a really lengthy and costly process to introduce. At the moment, some residents are homeless and several schools have been
damaged by fire. How can one rank one as more important than the other when both are equally important for the
community? Sometimes, the information needed in order to rank them simply will not be available, or managers will not feel
able to assimilate it properly.
Another problem with ZBB is that it can cause conflict to arise as departments compete for the resources available. Since
expenditure is urgently required for schools, roads and hospitals, it is likely that these would be ranked above expenditure on
the recycling scheme. In fact, the final phase of the scheme may well be postponed. This is likely to cause conflict between
departments as those staff and managers involved in the recycling scheme will be disappointed if the final phase has to be
postponed.
(c)
The potential benefits
–
ZBB will respond to changes in the economic environment since the budget starts from scratch each year and takes into
account the environment at that time. This is particularly relevant this year after the fires and the floods. Without ZBB,
adequate consideration may not be given to whether the waste management scheme should continue but, if ZBB is
used, the scheme will probably be postponed as it is unlikely to rank as high as expenditure needed for schools, housing
and hospitals.
–
If any of the activities or operations at LRA are wasteful, ZBB should be able to identify these and remove them. This is
particularly important now when the LRA faces so many demands on its resources.
–
Managers may become more motivated as they have had a key role in putting the budget together.
–
It encourages a more questioning attitude rather than just accepting the status quo.
–
Overall, it leads to a more efficient allocation of resources.
–
All of the organisations activities and operations are reviewed in depth.
–
ZBB focuses attention on outputs in relation to value for money. This is particularly important in the public sector where
the 3 Es (economy, efficiency and effectiveness) are often used to measure performance.
Note: Only three were required.
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5
Fundamentals Level – Skills Module, Paper F5
Performance Management
June 2015 Marking Scheme
Section A
Marks
2 marks per question
40
–––
–––
1
(a)
(b)
ABC calculation
Correct cost driver rates
Overhead unit cost for A
Overhead unit cost for B
Total cost for A
Total cost for B
2
1·5
1·5
0·5
0·5
–––
6
–––
Discussion
Per valid point
2
–––
4
–––
10
–––
–––
Maximum
Total marks
2
Division M’s external sales generate $80 per unit
Divison S’s external purchases cost $60 per unit
Comparison of the $60 & $80
Reasoned conclusion that Div M should make 30,000 external sales
Division S should buy 5,000 units from outside
Co policy should be changed
Minimum TP from Division M’s perspective
Maximum TP from Division S’s perspective
Range of TPs discussed
Irrelevant to group which TP charged
Total marks (maximum)
3
(a)
(b)
Advanced variances
Revised labour hours
Planning variance
Operational variance
1
1
1
2
1
1
1
1
2
1
–––
10
–––
–––
1
2
2
–––
5
–––
Consequences
Maximum per point
2
–––
5
–––
10
–––
–––
Total marks
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Section B
(a)
(b)
(c)
Costs
Material cost
Labour cost
Variable overhead cost
Total variable cost
Fixed costs
0·5
0·5
1
0·5
0·5
–––
3
–––
Optimum price and profit
Find value for b
Find value for a
Identify MC (figure from (a))
State MR function with values for a and b
Equate MC and MR to find x
Substitute x in to find P
Calculate profit
1
1
0·5
0·5
1·5
1
1·5
–––
7
–––
Market skimming
Discussion of each condition – maximum 4
Criticisms of optimal pricing – maximum 2
Conclusion
1
1
1
–––
5
–––
15
–––
–––
Maximum
Total marks
5
(a)
(b)
Steps
Identification of decision packages
Rank
Allocation of resources
1
1
1
–––
3
–––
Problems
Times more difficult at minute
Need more skills and training
Less money now than ever
Too late in terms of timing now
Lots of paperwork and time
Can cause conflicts
Other valid points
2
2
2
2
2
2
2
–––
9
–––
Overall maximum
(c)
Benefits
Per point
1
–––
3
–––
15
–––
Total marks
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4
Fundamentals Level – Skills Module, Paper F5
Performance Management
September/December 2015 Answers
Section B
1
(a)
Target costing steps
Deriving a target cost
Step 1: A product or service is developed which is perceived to be needed by customers and therefore will attract adequate
sales volumes.
Step 2: A target price is then set based on the customers’ perceived value of the product. This will therefore be a market based
price.
Step 4: The target cost is derived by subtracting the target profit from the target price.
Step 5: If there is a cost gap, attempts will be made to close the gap. Techniques such as value engineering may be
performed, which looks at every aspect of the value chain business functions with an objective of reducing costs while
satisfying customer needs.
Step 6: Negotiation with customers may take place before deciding whether to go ahead with the project.
(b)
Application at C Co
Difficulties in implementation
–
C Co is a service company and in service companies, it is often more difficult to find a precise definition for some of the
services. In order for target costing to be useful, it is necessary to define the service being provided. C Co actually
provides a range of services to clients including specialist care wards at hospitals. This means that the definition of the
services being provided will vary. Different target costs will need to be derived for the different services provided.
–
C Co has two types of clients: regular clients and one-off clients. Since the service for regular clients is being repeated,
it should be relatively easy to set a target cost for these jobs. However, for the one-off jobs, there may not be any
comparative data available and therefore setting the target cost will be difficult.
–
Similarly, some of the work available is very specialist. For example, cleaning restaurants and kitchens after an outbreak
of food poisoning will require specialist techniques and adherence to a set of regulations with which C Co may not be
familiar. It may be difficult to establish the market price for a service like this, thus making it difficult to derive a target
cost.
Benefits to C Co
–
Target costing is useful in competitive markets where a company is not dominant in the market and therefore has to
accept a market price for their products. C Co is operating in a competitive market and whilst the service offered by
C Co is more specialist, it is clear from the recent drop in sales that price increases do lead to loss of customers. C Co
cannot therefore ignore the market price for cleaning services and simply pass on cost increases as it has done. Target
costing would therefore help C Co to focus on the market price of similar services provided by competitors, where this
information is available.
–
If after calculating a target cost C Co finds that a cost gap exists, it will then be forced to examine its internal processes
and costs more closely. It should establish why the prices of the products it uses have increased in the first place. If it
cannot achieve any reduction in these prices, it should consider whether it can source cheaper non-chemical products
from alternative suppliers. So, target costing will benefit C Co by helping it to focus on cost reduction and consequently
customer retention.
Note: More points could be made and would earn marks.
2
(a)
Calculations
Bus: (0·4 x 0·67) + (0·32 x 0·8) + (0·28 x 0·82) = 75·36%
Prime: (0·4 x 0·58) + (0·32 x 0·76) + (0·28 x 0·83) = 70·76%
Express: (0·4 x 0·67) + (0·32 x 0·76) + (0·28 x 0·89) = 76·04%
(b)
Accuracy of statement
The MD’s statement says that Bus Co’s customers are the most satisfied of any national bus operator. However, this is not
quite the case since, when the ‘overall satisfaction’ levels are calculated, Express’s level is 76·04% compared to Bus Co’s
75·36%. So, the first part of the MD’s statement is untrue.
The MD then goes on to say that Bus Co is leading the way on what matters most to customers – value for money and
punctuality. Given the weightings attached to these two criteria, it appears true to say that these are the factors which matter
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Taha Popatia - ARTT Business School - 02134523175
Step 3: The required target operating profit per unit is then calculated. This may be based on either return on sales or return
on investment.
most to customers. Similarly, it is true to say that Bus Co is leading as regards punctuality, being 4 percentage points ahead
of Prime and Express on this criterion. However, given that Express also has the same level of satisfaction as regards offering
value for money, Bus Co is only leading ahead of Prime on this criterion, not ahead of Express. Therefore, whilst it can say
that it is the leader on punctuality, it can only say that it is the joint leader on value for money.
(c)
VFM
‘Efficiency’ focuses on the relationship between inputs and outputs, considering whether the maximum output is being
achieved for the resources used.
Performance measure:
Occupancy rate of buses
Utilisation rate for buses (utilisation rate = hours on the road/total hours available)
Utilisation rate for drivers
‘Effectiveness’ focuses on the relationship between an organisation’s objectives and outputs, considering whether the
objectives are being met.
Possible performance measures:
Percentage of customers satisfied with cleanliness of buses
Percentage of carbon emissions relative to target set
(Many others could be given too but only one was asked for.)
3
(a)
Variance calculations
Mix variance
Per question, total g of materials per standard batch = 610 g.
Therefore standard quantity to produce 950 units = 950 x 610 g = 579·5 kg
Per question, actual total kg of materials used to produce 950 units = 570·5 kg
Material
White flour
Wholegrain flour
Yeast
Yield variance
Material
White flour
Wholegrain flour
Yeast
Actual quantity
in standard mix
kg
570·5 x 450/610 =
420·86
570·5 x 150/610 =
140·29
570·5 x 10/610 =
9·35
––––––
570·5
––––––
Actual quantity
in actual mix
kg
408·5
152
10
––––––
570·5
––––––
Variance
Standard quantity
in standard mix
kg
450/610 x 579·5 =
427·5
150/610 x 579·5 =
142·5
10/610 x 579·5 =
9·5
––––––
579·5
––––––
Actual quantity
in standard mix
kg
420·86
140·29
9·35
––––––
570·5
––––––
Variance
kg
12·36
(11·71)
(0·65)
–––––
20·5
–––––
kg
6·64
2·21
0·15
Standard
cost per kg
$
1·80
2·20
20
Variance
Standard
cost per kg
$
1·80
2·20
20
Variance
$
22·25
(25·76)
(13)
––––––
(16·51)A
––––––
$
11·95
4·86
3
––––––
19·81F
––––––
Alternative yield calculation
570·5 kg should yield (÷ 0·61 kg) = 935·25 loaves
570·5 kg did yield
= 950 loaves
Difference
= 14·75 F
Valued at standard material cost = 14·75F x $1·34 = $19·77F
(b)
Material yield variance
Three reasons why an adverse material yield variance may arise:
–
–
–
–
The mix may not be removed completely out of the machine, leaving some mix behind.
Since the loaves are made by hand, they may be made slightly too large, meaning that fewer loaves can be baked.
Errors or changes in the mix may cause some loaves to be sub-standard and therefore rejected by the quality inspector.
The loaves might be baked at the wrong temperature and therefore be rejected by the quality inspector.
Note: Many more reasons could be given.
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(Many others could be given too but only one was asked for.)
(a)
Weighted average C/S ratio
Weighted average contribution to sales ratio (WA C/S ratio) = total contribution/total sales revenue.
T
Per unit:
$
Selling price
Material
Variable labour (40%)
Variable overheads
Total variable costs
Contribution
Sales units
Total sales revenue
Total contribution
C
$
1,600
$
(430)
(88)
(110)
––––
R
$
1,800
(500)
(96)
(120)
––––
$
(360)
(76)
(95)
––––
(628)
––––––
972
––––––
(716)
––––––
1,084
––––––
(531)
––––––
869
––––––
420
$672,000
$408,240
400
$720,000
$433,600
380
$532,000
$330,220
WA C/S ratio = ($408,240 + $433,600 + $330,220)/($672,000 + $720,000 + $532,000)
= $1,172,060/$1,924,000 = 60·92%.
(b)
$
1,400
Margin of safety
Margin of safety = budgeted sales – breakeven sales
Budgeted sales revenue = $1,924,000
Fixed labour costs = {(420 x $220) + (400 x $240) + (380 x $190)} x 0·6 = $156,360k.
Therefore total fixed costs = $156,360 + $55,000 = $211,360.
Breakeven sales revenue = fixed costs/weighted average C/S ratio
= $211,360/60·92% = $346,947
Therefore margin of safety = $1,924,000 – $346,947 = $1,577,053.
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4
(c)
Multi-product breakeven chart
2,500
1,500
Total revenue
1,000
Total costs
500
BEP
Fixed costs
0
0
200
400
600
800
Sales units
1,000
1,200
1,400
Workings
Total revenue = $1,924,000
Total variable costs = $1,924,000 – $1,172,060 = $751,940
Therefore total costs = $211,360 + $751,940 = $963,300
(d)
BEP if products sold in order of profitability
If the more profitable products are sold first, this means that the company will cover its fixed costs more quickly. Consequently,
the breakeven point will be reached earlier, i.e. fewer sales will need to be made in order to break even. So, the breakeven
point will be lower.
5
(a)
Division F
Controllable profit = $2,645k.
Total assets less trade payables = $9,760k + $2,480k – $2,960k = $9,280k.
ROI = 28·5%.
Division N
Controllable profit = $1,970k.
Total assets less trade payables = $14,980k + $3,260k – $1,400k = $16,840k.
ROI = 11·7%.
In both calculations controllable profit has been used to reflect profit, rather than net profit. This is because the managers do
not have any control over the Head Office costs and responsibility accounting deems that managers should only be held
responsible for costs which they control. The same principle is being applied in the choice of assets figures being used. The
current assets and current liabilities figures have been taken into account in the calculation because of the fact that the
managers have full control over both of these.
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Costs and revenues $’000
2,000
(b)
Bonus
Bonus to be paid for each percentage point = $120,000 x 2% = $2,400.
Maximum bonus = $120,000 x 0·3 = $36,000.
Division F: ROI = 28·5% = 18 whole percentage points above minimum ROI of 10%.
18 x $2,400 = $43,200.
Therefore manager will be paid the maximum bonus of $36,000.
Division N: ROI = 11·7% = 1 whole percentage point above minimum.
Therefore bonus = $2,400.
Discussion
–
The manager of Division N will be paid a far smaller bonus than the manager of Division F. This is because of the large
asset base on which the ROI figure has been calculated. Total assets of Division N are almost double the total assets of
Division F. This is largely attributable to the fact that Division N invested $6·8m in new equipment during the year. If
this investment had not been made, net assets would have been only $10·04m and the ROI for Division N would have
been 19·62%. This would have led to the payment of a $21,600 bonus (9 x $2,400) rather than the $2,400 bonus.
Consequently, Division N’s manager is being penalised for making decisions which are in the best interests of his
division. It is very surprising that he did decide to invest, given that he knew that he would receive a lower bonus as a
result. He has acted totally in the best interests of the company. Division F’s manager, on the other hand, has benefitted
from the fact that he has made no investment even though it is badly needed. This is an example of sub-optimal decision
making.
–
Division F’s trade payables figure is much higher than Division N’s. This also plays a part in reducing the net assets
figure on which the ROI has been based. Division F’s trade payables are over double those of Division N. In part, one
would expect this because sales are over 50% higher (no purchases figure is given). However, it is clear that it is also
because of low cash levels at Division F. The fact that the manager of Division F is then being rewarded for this, even
though relationships with suppliers may be adversely affected, is again an example of sub-optimal decision making.
–
If the controllable profit margin is calculated, it is 18·24% for Division F and 22·64% for Division N. Therefore, if capital
employed is ignored, it can be seen that Division N is performing better. ROI is simply making the division’s performance
look worse because of its investment in assets. Division N’s manager is likely to feel extremely demotivated by his
comparatively small bonus and, in the future, he may choose to postpone investment in order to increase his bonus.
Managers not investing in new equipment and technology will mean that the company will not keep up with industry
changes and affect its overall future competitiveness.
–
To summarise, the use of ROI is leading to sub-optimal decision making and a lack of goal congruence, as what is good
for the managers is not good for the company and vice versa. Luckily, the manager at Division N still appears to be
acting for the benefit of the company but the other manager is not. The fact that one manager is receiving a much bigger
bonus than the other is totally unfair here and may lead to conflict in the long run. This is not good for the company,
particularly if there comes a time when the divisions need to work together.
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Taha Popatia - ARTT Business School - 02134523175
(c)
Fundamentals Level – Skills Module, Paper F5
Performance Management
September/December 2015 Marking Scheme
Section B
(a)
(b)
Target costing
Each step
1
–––
3
–––
Target costing
Benefits – per point
Difficulties – per point
1
1
–––
7
–––
10
–––
Total marks
2
(a)
Calculations
(b)
Accuracy of statement
First part untrue, Express has higher %age
Correct re what customers value
Correct re punctuality
Incorrect re leader
(c)
2
–––
1
1
1
1
–––
4
–––
Efficiency and effectiveness
Definition of efficiency
Performance measure for efficiency
Definition of effectiveness
Performance measure for effectiveness
1
1
1
1
–––
4
–––
10
–––
Total marks
3
(a)
(b)
Calculations
Mix variance
Yield variance
3·5
3·5
–––
7
–––
Reasons
Each reason
1
–––
3
–––
10
–––
Total marks
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1
Marks
Marks
(a)
(b)
(c)
(d)
Weighted average C/S ratio
Variable labour cost
Total revenue
Total contribution
WA C/S ratio
1
1
1
1
–––
4
–––
Margin of safety
Fixed costs
Breakeven sales
Margin of safety
1
1
1
–––
3
–––
Breakeven chart
Workings for chart
Plotting total cost line
Plotting total revenue line
Labelling
Correct BEP
2
1
1
1
1
–––
6
–––
Discussion
Per point
1
–––
2
–––
15
–––
Maximum
Total marks
5
(a)
(b)
(c)
ROI
Div F
Using correct profit figure
Adding up correct assets
Correct ROI
Div N
Using correct profit figure
Adding up correct assets
Correct ROI
Explaining choice of profit figure
Explaining choice of asset figure
0·5
0·5
0·5
0·5
0·5
0·5
1
1
–––
5
–––
Bonus
Calculation of the $2,400
Calculation of the maximum of $36,000
Calculation of percentage point excess for F
Calculation of the $43,600 for F, restricted
Calculation of percentage point excess for N
Calculation of the $2,400 for N
0·5
0·5
0·5
0·5
0·5
0·5
–––
3
–––
Discussion
Maximum marks per point
2
–––
7
–––
15
–––
Total marks
18
Taha Popatia - ARTT Business School - 02134523175
4
Fundamentals Level – Skills Module, Paper F5
Performance Management
March/June 2016 Sample Answers
Section B
1
(a)
Batches
Units
1
2
3
4
5
1,000
2,000
3,000
4,000
5,000
Price
per unit
$
20
18
16
13
12
Total
revenue
$
20,000
36,000
48,000
52,000
60,000
Variable cost Total variable
per unit
costs
$
$
10·00
10,000
8·80
17,600
7·80
23,400
6·40
25,600
6·40
32,000
Fixed costs
$
10,000
10,000
12,000
12,000
14,000
Total
cost
$
20,000
27,600
35,400
37,600
46,000
Profit
$
0
8,400
12,600
14,400
14,000
(b)
The algebraic model requires several assumptions to be true. First, there must be a consistent relationship between price (P)
and demand (Q), so that a demand equation can be established, usually in the form P = a – bQ. Here, although there is a
clear relationship between the two, it is not a perfectly linear relationship and so more complicated techniques are required
to calculate the demand equation. It also cannot be assumed that a linear relationship will hold for all values of P and Q other
than the five given.
Similarly, there must be a clear relationship between demand and marginal cost, usually satisfied by constant variable cost
per unit and constant fixed costs. The changing variable costs per unit again complicate the issue, but it is the changes in
fixed costs which make the algebraic method less useful in Jewel’s case.
The algebraic model is only suitable for companies operating in a monopoly and it is not clear here whether this is the case,
but it seems unlikely, so any ‘optimum’ price might become irrelevant if Jewel’s competitors charge significantly lower prices.
Other more general factors not considered by the algebraic model are political factors which might affect imports, social factors
which may affect customer tastes and economic factors which may affect exchange rates or customer spending power. The
reliability of the estimates themselves – for sales prices, variable costs and fixed costs – could also be called into question.
2
(a)
The breakeven sales revenue for Swim Co is $90,000. The company’s profit, to the nearest $10,000, if 500 athletes attend
the course is $20,000 ($140,000 – $120,000). (From the graph, it is clear that the precise amount will be nearer $17,000,
i.e. $140,000 – approximately $123,000.)
(b)
Cost structure
From the chart, it is clear that Line C represents fixed costs, Line B represents total costs and Line A represents total revenue.
Line C shows that initially, fixed costs are $20,000 even if no athletes attend the course. This level of fixed costs remains the
same if 100 athletes attend but once the number of attendees increases above this level, fixed costs increase to $40,000.
Line B represents total costs. If 100 athletes attend, total costs are $40,000 ($400 per athlete). Since $20,000 of this relates
to fixed costs, the variable cost per athlete must be $200. When fixed costs step up beyond this point at the level of 200
athletes, total costs obviously increase as well and Line B consequently gets much steeper. However, since there are now
200 athletes to absorb the fixed costs, the cost per athlete remains the same at $400 per athlete ($80,000/200), even
though fixed costs have doubled.
If 300 athletes attend the course, total cost per athlete becomes $300 each ($90,000/300). Since fixed costs account for
$40,000 of this total cost, variable costs total $50,000, i.e. $166·67 per athlete. So, economies of scale arise at this level,
as demonstrated by the fact that Line B becomes flatter.
At 400 athletes, the gradient of the total costs line is unchanged from 300 athletes which indicates that the variable costs
have remained the same. There is no further change at 500 athletes; fixed and variable costs remain steady.
Revenue structure
As regards the revenue structure, it can be seen from Line A that for 100–400 athletes the price remains the same at $300
per athlete. However, if 500 athletes attend, the price has been reduced as the total revenue line becomes flatter.
$140,000/500 means that the price has gone down to $280 per athlete. This was obviously necessary to increase the
number of attendees and at this point, profit is maximised.
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Therefore Jewel Co should import and sell four batches (4,000 units) of headphones since at this point it will make the
greatest profit: $14,400 for the month.
3
Total sales revenue = (280,000 x $55) + (420,000 x $45) = $15·4m + 18·9m = $34·3m.
$’000
Less costs:
Development and design costs
Patent application costs (including $20k)
Patent renewal costs – 2 years
Opportunity cost – ignore
Total material costs [(280,000 x $16) + (420,000 x $14)]
Total labour costs [(280,000 x $8) + (420,000 x $7)]
Fixed production overheads
Marketing costs (working 1)
Selling and distribution costs
Environmental costs
Total life cycle costs
Expected profit = $2·03m
Note
The expected profit has been calculated using life cycle costing not relevant costing. Hence, the $20,000 salary cost included in
patent costs should be included in the life cycle cost. Similarly, the opportunity cost of $800,000 is not included using life cycle
costing whereas if relevant costing was being used to decide on a particular course of action, the opportunity cost would be
included.
Working 1
Expected marketing cost in year 1: (0·2 x $2·2m) + (0·5 x $2·6m) + (0·3 x $2·9m) = $2·61m
Expected marketing cost year 2: (0·3 x $1·8m) + (0·4 x $2·1m) + (0·3 x $2·3m) = $2·07m
Total expected marketing cost = $4·68m
4
(a)
Maximising group profit
Division L has enough capacity to supply both Division M and its external customers with component L.
Therefore, incremental cost of Division M buying externally is as follows:
Cost per unit of component L when bought from external supplier: $37
Cost per unit for Division L of making component L: $20.
Therefore incremental cost to group of each unit of component L being bought in by Division M rather than transferred
internally: $17 ($37 – 20).
From the group’s point of view, the most profitable course of action is therefore that all 120,000 units of component L should
be transferred internally.
(b)
Calculating total group profit
Total group profits will be as follows:
Division L:
Contribution earned per transferred component = $40 – $20 = $20
Profit earned per component sold externally = $40 – $24 = $16
120,000 x $20
160,000 x $16
Less fixed costs
Profit
$
2,400,000
2,560,000
––––––––––
4,960,000
(500,000)
––––––––––
4,460,000
––––––––––
Division M:
Profit earned per component sold externally = $27 – $1 = $26
120,000 x $26
Less fixed costs
Profit
Total profit
$
3,120,000
(200,000)
––––––––––
2,920,000
––––––––––
7,380,000
––––––––––
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5,600
500
400
–
10,360
5,180
3,800
4,680
1,500
250
–––––––
32,270
–––––––
–––––––
(c)
Problems with current transfer price and suggested alternative
The problem is that the current transfer price of $40 per unit is now too high. Whilst this has not been a problem before since
external suppliers were charging $42 per unit, it is a problem now that Division M has been offered component L for
$37 per unit. If Division M now acts in its own interests rather than the interests of the group as a whole, it will buy
component L from the external supplier rather than from Division L. This will mean that the profits of the group will fall
substantially and Division L will have significant unused capacity.
5
(a)
Basic variances
Labour rate variance
Standard cost of labour per hour = $42/3 = $14 per hour.
Labour rate variance = (actual hours paid x actual rate) – (actual hours paid x std rate)
Actual hours paid x actual rate = $531,930.
Actual hours paid x std rate = 37,000 x $14 = $518,000.
Therefore rate variance = $531,930 – $518,000 = $13,930 A
Labour efficiency variance
Labour efficiency variance = (actual production in std hours – actual hours worked) x std rate
[(12,600 x 3) – 37,000] x $14 = $11,200 F
(b)
Planning and operational variances
Labour rate planning variance
(Revised rate – std rate) x actual hours paid = [$14·00 – ($14·00 x 1·02)] x 37,000 = $10,360 A.
Labour rate operational variance
Revised rate x actual hours paid = $14·28 x 37,000 = $528,360.
Actual cost = $531,930.
Variance = $3,570 A.
Labour efficiency planning variance
(Standard hours for actual production – revised hours for actual production) x std rate
Revised hours for each pair of gloves = 3·25 hours.
[37,800 – (12,600 x 3·25)] x $14 = $44,100 A.
Labour efficiency operational variance
(Revised hours for actual production – actual hours for actual production) x std rate
(40,950 – 37,000) x $14 = $55,300 F.
(c)
Analysis of performance
At a first glance, performance looks mixed because the total labour rate variance is adverse and the total labour efficiency
variance is favourable. However, the operational and planning variances provide a lot more detail on how these variances
have occurred.
The production manager should only be held accountable for variances which he can control. This means that he should only
be held accountable for the operational variances. When these operational variances are looked at it can be seen that the
labour rate operational variance is $3,570 A. This means that the production manager did have to pay for some overtime in
order to meet demand but the majority of the total labour rate variance is driven by the failure to update the standard for the
pay rise that was applied at the start of the last quarter. The overtime rate would also have been impacted by that pay
increase.
Then, when the labour efficiency operational variance is looked at, it is actually $55,300 F. This shows that the production
manager has managed his department well with workers completing production more quickly than would have been expected
when the new design change is taken into account. The total operating variances are therefore $51,730 F and so overall
performance is good.
The adverse planning variances of $10,360 and $44,100 do not reflect on the performance of the production manager and
can therefore be ignored here.
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Taha Popatia - ARTT Business School - 02134523175
Consequently, Division L needs to reduce its price. The current price does not reflect the fact that there are no selling and
distribution costs associated with transferring internally, i.e. the cost of selling internally is $4 less for Division L than selling
externally. So, it could reduce the price to $36 and still make the same profit on these sales as on its external sales. This
would therefore be the suggested transfer price so that Division M is still saving $1 per unit compared to the external price.
A transfer price of $37 would also presumably be acceptable to Division M since this is the same as the external supplier is
offering.
Fundamentals Level – Skills Module, Paper F5
Performance Management
March/June 2016 Sample Marking Scheme
Section B
(a)
(b)
Calculations
Figures for batch 1
Figures for batch 2
Figures for batch 3
Figures for batch 4
Figures for batch 5
Recommendation
1
1
1
1
1
1
–––
6
–––
Explanation
Per point – maximum marks
2
–––
4
–––
10
–––
Total marks
2
(a)
(b)
BEP and profit
B/E revenue
Profit
1
1
–––
2
–––
Discussion
Identifying lines
Cost structure:
Stepped fixed costs
Variable cost at 100 units
Variable cost at 200 units
Variable cost at 300 units
Variable cost at 400/500 units
Explanation of steepness of lines
Revenue structure:
Constant price to 400 athletes of $300
Decrease price to $280
1
1
1
1
1
1
2
1
1
–––
8
–––
10
–––
Maximum marks
Total marks
3
Total revenue
Design and development costs
Inclusion of full $500k patent application
Annual patent renewal costs
Exclusion of opportunity cost
Materials
Labour
Fixed production
Marketing
Selling and distribution
Environmental
Expected profit
0·5
1·5
1
0·5
1·5
0·5
0·5
0·5
2
0·5
0·5
0·5
–––
10
–––
Total marks
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Taha Popatia - ARTT Business School - 02134523175
1
Marks
Marks
(a)
(b)
(c)
Maximising group profits
Calculating incremental cost per unit
Recommendation
2
1
–––
3
–––
Profit
Profit of L
Profit of M
Total profit
3
2
1
–––
6
–––
Discussion
Transfer price is too high
Division M will not buy
Profits for group will fall
S/D costs should mean lower TP anyway
Suggested transfer price
2
1
1
2
1
–––
6
–––
15
–––
Maximum marks
Total marks
5
(a)
(b)
(c)
Basic variances
Each variance
1
–––
2
–––
Operational and planning variance
Labour rate planning
Labour rate operational
Labour efficiency planning
Labour efficiency operational
1·5
1·5
1·5
1·5
–––
6
–––
Performance
Only operational variances
Adverse op. variance
Failure to update the standard
Overtime rate impacted
Favourable efficiency variance
Good overall
1
2
1
1
2
1
–––
7
–––
15
–––
Maximum
Total marks
16
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4
Taha Popatia - ARTT Business School - 02134523175
Answers
Fundamentals Level – Skills Module, Paper F5
Performance Management
September 2016 Answers
Section A
1
C
OAR for fixed production overheads ($72 million/96 million hours) = $0·75 per hour
Total manufacturing costs (300,000 units x $20) = $6,000,000
Total design, depreciation and decommissioning costs = $1,320,000
Total fixed production overheads (300,000 units x 4 hours x $0·75) = $900,000
Total life-cycle costs = $8,220,000
2
B
Two units of Y and one unit of X would give total contribution of $18.
Weighted average contribution per unit = $18/3 units = $6
Sales units to achieve target profit = ($90,000 + $45,000)/$6 = 22,500
3
A
3,000 units should use 10 kg each (3,000 x 10) = 30,000 kg
3,000 units did use = 29,000 kg
Difference = 1,000 kg favourable
Valued at $6·80 per kg ($68/10 kg)
Variance = $6,800 favourable
4
D
The tracking and summarising of critical strategic information is done by an Executive Information System (EIS).
The other three options are all likely to be potential benefits which would result from the introduction of an ERPS.
5
D
Under a system of flow cost accounting material flows are divided into three categories – material, system, and delivery and
disposal.
6
C
Exam success will be a given objective of a school, so it is a measure of effectiveness.
7
B
Variance analysis is not relevant to target costing as it is a technique used for cost control at the production phase of the product
life cycle. It is a feedback control tool by nature and target costing is feedforward.
Value analysis can be used to identify where small cost reductions can be applied to close a cost gap once production commences.
Functional analysis can be used at the product design stage. It ensures that a cost gap is reached or to ensure that the product
design is one which includes only features which customers want.
Activity analysis identifies and describes activities in an organisation and evaluates their impact on operations to assess where
improvements can be made.
8
A
A memory stick is much more likely to get mislaid and compromise security than a password protected laptop. It is likely that
memory sticks could get lost or that information is left on home computers.
In the context of the scenario all the other options are good practice.
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Life-cycle cost per unit ($8,220,000/300,000 units) = $27·40
9
A
If the values for R and N are substituted into the constraints:
Labour required = (3 x 500) + (2 x 400) = 2,300 hours which is less than what is available so there is slack.
Machine time required = (0·5 x 500) + (0·4 x 400) = 410 hours which is exactly what is available and so there is no slack.
10 B
Revised annual profit = $190,000 + $10,000 profit on the sale of the asset = $200,000
Revised net assets = $1,000,000 – $40,000 NBV + $50,000 cash – $250,000 cash + $250,000 asset = $1,010,000
ROI = ($200,000/$1,010,000) x 100 = 19·8%
Throughput is determined by the bottleneck resource. Process 2 is the bottleneck as it has insufficient time to meet demand.
The only option to improve Process 2 is to improve the efficiency of the maintenance routine. All the other three options either
increase the time available on non-bottleneck resources or increase demand for an increase in supply which cannot be achieved.
12 C
An operational variance compares revised price to actual price.
20,000 kg should cost $0·40 per kg at the revised price (20,000 kg x $0·40) = $8,000
20,000 kg did cost $0·42 per kg (20,000 kg x $0·42) = $8,400
Variance = $400 adverse
13 A
The material price when flexed is higher than budget whilst the external environment shows that prices are reducing. This indicates
that although suppliers lowered their prices, the manager has still overspent which indicates poor performance.
When sales volumes and prices are flexed, it can be seen that the manager has performed better.
14 D
Penetration pricing involves setting a low price when a product is first launched in order to obtain strong demand.
It is particularly useful if significant economies of scale can be achieved from a high volume of output and if demand is highly
elastic and so would respond well to low prices.
15 B
Total material budget ((1,000 units x $10) + (2,000 units x $20)) = $50,000
Fixed costs related to material handling = $100,000
OAR = $2/$ of material
Product B = $2 x $20 = $40
Total labour budget ((1,000 units x $5) + (2,000 units x $20) = $45,000
General fixed costs = $180,000
OAR = $4/$ of labour
Product B = $4 x $20 = $80
Total fixed overhead cost per unit of Product B ($40 + $80) = $120
Section B
16 A
The maximin rule selects the maximum of the minimum outcomes for each supply level.
For Mylo the minimum outcomes are:
450 lunches – $1,170
620 lunches – $980
775 lunches – $810
960 lunches – $740
The maximum of these is at a supply level of 450 lunches.
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11 A
17 D
The minimax regret rule selects the minimum of the maximum regrets.
Demand level
450
$
450
620
775
960
Max regret
–
442
845
1,326
1,326
Supply level
620
775
$
$
190
360
–
217
403
–
884
481
884
481
960
$
430
322
230
–
430
The minimum of the maximum regrets is $430, so suggests a supply level of 960 lunches.
Expected values do not take into account the variability which could occur across a range of outcomes; a standard deviation would
need to be calculated to assess that, so Statement 2 is correct.
Expected values are particularly useful for repeated decisions where the expected value will be the long-run average, so
Statement 4 is correct.
Expected values are associated with risk-neutral decision-makers. A defensive or conservative decision-maker is risk averse, so
Statement 1 is incorrect.
Expected values will take into account the likelihood of different outcomes occurring as this is part of the calculation, so
Statement 3 is incorrect.
19 A
This requires the calculation of the value of perfect information (VOPI).
Expected value with perfect information = (0·15 x $1,170) + (0·30 x $1,612) + (0·40 x $2,015) + (0·15 x $2,496) =
$1,839·50
Expected value without perfect information would be the highest of the expected values for the supply levels = $1,648·25 (at a
supply level of 775 lunches).
The value of perfect information is the difference between the expected value with perfect information and the expected value
without perfect information = $1,839·50 – $1,648·25 = $191·25, therefore $191 to nearest whole $.
20 D
The investment’s sensitivity to fixed costs is 550% ((385/70) x 100), so Statement 3 is correct.
The margin of safety is 84·6%. Budgeted sales are 650 units and BEP sales are 100 units (70/0·7), therefore the margin of safety
is 550 units which equates to 84·6% of the budgeted sales, so Statement 4 is therefore correct.
The investment is more sensitive to a change in sales price of 29·6%, so Statement 1 is incorrect.
If variable costs increased by 44%, it would still make a very small profit, so Statement 2 is incorrect.
21 D
An 80% activity level is 210,000 units.
Material and labour costs are both variable. Material is $4 per unit and labour is $5·50 per unit.
Total variable costs = $9·50 x 210,000 units = $1,995,000
Fixed costs = $750,000
Supervision = $175,000 as five supervisors will be required for a production level of 210,000 units.
Total annual budgeted cost allowance = $1,995,000 + $750,000 + $175,000 = $2,920,000
22 B
Variable cost per hour ($850,000 – $450,000)/(5,000 hours – 1,800 hours) = $125 per hour
Fixed cost ($850,000 – (5,000 hours x $125)) = $225,000
Number of machine hours required for production = 210 batches x 14 hours = 2,940 hours
Total cost ($225,000 + (2,940 hours x $125)) = $592,500, therefore $593,000 to the nearest $’000.
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18 B
23 C
If the budget is flexed, then the effect on sales revenue of the difference between budgeted and actual sales volumes is removed
and the variance which is left is the sales price variance.
24 A
Flexible budgeting can be time-consuming to produce as splitting out semi-variable costs could be problematic, so Statement 1 is
correct.
Estimating how costs behave over different levels of activity can be difficult to predict, so Statement 2 is correct.
A flexible budget will not encourage slack compared to a fixed budget, so Statement 3 is incorrect.
25 C
Spreadsheets can be used to change input variables and new versions of the budgets can be more quickly produced, so
Statement 1 is correct.
Sensitivity analysis is also easier to do as variables are more easily changed and manipulated to assess their impact, so
Statement 4 is correct.
A common problem of spreadsheets is that it is difficult to trace errors in a spreadsheet and data can be easily corrupted if a cell
is changed or data is input in the wrong place, so Statement 2 is incorrect.
Spreadsheets do not show qualitative factors; they show predominantly quantitative data, so Statement 3 is incorrect.
26 D
Target costing does encourage looking at customer requirements early on so that features valued by customers are included, so
Statement 2 is correct. It will also force the company to closely assess the design and is likely to be successful if costs are designed
out at this stage rather than later once production has started, so Statement 4 is correct.
Statement 1 explains a benefit of flow cost accounting. Statement 3 explains the concept of throughput accounting.
27 A
Target price is $45 and the profit margin is 35% which results in a target cost of $29·25. The current estimated cost is $31·30
which results in a cost gap of $2·05.
28 C
Using more standardised components and using its own websites for marketing will reduce processing and marketing costs.
Using cheaper materials and trainee designers will reduce costs but could impact the quality and customer perception of the
product which would impact the target price.
29 C
The change in the learning rate will increase the current estimated cost which will increase the cost gap.
The target cost will be unaffected as this is based on the target selling price and profit margin; neither of which are changing.
30 B
Services do use more labour relative to materials.
The other three statements are incorrect as uniformity is not a characteristic of services, there is no transfer of ownership and
although it is difficult to standardise a service due to the human influence, target costing can still be used.
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It is a zero-based budget, not a flexible budget, which assesses all activities for their value to the organisation, so Statement 4 is
incorrect.
Section C
31 Jungle Co
Sales volumes
Since prices have remained stable year on year, it can be assumed that changes to revenue are as a result of increases or decreases
in sales volumes. Overall, revenue has increased by 15%, which is a substantial increase. In order to understand what has
happened in the business, it is necessary to consider sales by looking at each of the different categories.
Electronic goods
Unlike household goods, demand for electronic goods from Jungle Co has increased dramatically by 28%. This is now Jungle Co’s
leading revenue generator. This is partly due to the fact that the electronic goods market has grown by 20% worldwide. However,
Jungle Co has even outperformed this, meaning that it has secured a larger segment of the market.
Cloud computing service
This area of Jungle Co’s business is growing rapidly, with the company seeing a 90% increase in this revenue stream in the last
year. Once again, the company has outperformed the market, where the average growth rate is only 50%, suggesting that the
investment in the cloud technology was worthwhile.
Gold membership fees
This area of the business is relatively small but has shrunk further, with a decrease in revenue of 30%. This may be because
customers are dissatisfied with the service that they are receiving. The number of late deliveries for Gold members has increased
from 2% to 14% since Jungle Co began using its own logistics company. This has probably been at least partly responsible for
the massive increase in the number of customer complaints.
Gross profit margins
Overall, the company’s gross profit margin (GPM) has increased from 37% to 42%. Whilst the GPM for electronic goods has only
increased by 1 percentage point, the margin for household goods has increased by 10 percentage points. This is therefore largely
responsible for the increase in overall GPM. This has presumably occurred because Jungle Co is now sourcing these products from
new, cheaper suppliers.
Gold membership fees constitute only a small part of Jungle Co’s income, so their 2 percentage point fall in GPM has had little
impact on the overall increase in GPM. Cloud computing services, on the other hand, now make up over $12m of Jungle Co’s
sales revenue. For some reason, the GPM on these sales has fallen from 76% to 66%. This is now 14 percentage points less than
the market average gross profit margin of 80%. More information is needed to establish why this has happened. It has prevented
the overall increase in GPM being higher than it otherwise would have been.
Administration expenses/customer complaints
These have increased by 60% from $1·72m to $2·76m. This is a substantial increase. The costs of the customer service
department are in here. Given the number of late deliveries increase from 2% to 14%, and the corresponding increase in customer
complaints from 5% to 20%, it is not surprising that the administration costs have increased. As well as being concerned about
the impact on profit of this increase of over $1m, Jungle Co should be extremely worried about the effect on its reputation. Bad
publicity about reliable delivery could affect future business.
Distribution costs
Despite an increase in sales volumes of 15%, distribution expenses have increased by less than 2 percentage points. They have
gone down from $0·16 to $0·14 per $ of revenue. Although this means that Jungle Co has been successful in terms of saving
costs, as discussed above, the damage which late deliveries are doing to the business cannot be ignored. The company needs to
urgently address the issue of late deliveries.
Net profit margin
This has increased from 19% to 25%. This means that, all in all, Jungle Co has had a successful year, with net profit having
increased from $15·6m to $23·8m. However, the business must address its delivery issues if its success is to continue.
Gross profit margins
Household goods
Electronic goods
Cloud computing services
Gold membership fees
Overall
Net profit margin
31 August 20X6
40·00%
36·00%
65·81%
92·86%
42·39%
31 August 20X5
30·00%
35·00%
75·77%
95·00%
37·19%
25·15%
18·95%
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Household goods
Although this was the largest category of sales for Jungle Co last year, this year it has decreased by 5% and has now been
overtaken by electronic goods. The company changed suppliers for many of its household goods during the year, buying them
instead from a country where labour was cheap. It may be that this has affected the quality of the goods, thus leading to decreased
demand.
–5·27%
28·28%
90·18%
–30·00%
14·99%
Increase/decrease in cost of sales
Household goods
Electronic goods
Cloud computing services
Gold membership fees
Total cost of sales increase
–18·80%
26·31%
168·35%
0·00%
5·46%
Increase in administration expenses
Increase in distribution expenses
Increase in other operating expenses
Increase in costs of customer service department
([$1,900,000 – $860,000]/$860,000)
60·47%
1·82%
27·27%
120·93%
31 August 20X6
19·72%
$0·14
Customer complaints as % customers
Delivery cost per $ of revenue
31 August 20X5
4·92%
$0·16
32 CSC Co
(a)
(Step 1) Calculate the shortage of Betta for the year
Total requirements in grams:
Cakes: grams used per cake
Expected demand
0·5
11,200
–––––––
5,600
–––––––
Total required:
Cookies: grams used per cookie
Expected demand
0·20
9,800
–––––––
1,960
–––––––
Total required:
Shakes: grams used per shake
Expected demand
1
7,500
–––––––
7,500
–––––––
Total required:
Overall total required:
Less available:
15,060
12,000
–––––––
3,060
–––––––
–––––––
Shortage:
(Step 2) Contribution per gram of Betta and ranking
Contribution per unit
Grams of Betta per unit
Cakes
$
2·60
0·5
Cookies
$
1·75
0·2
Shakes
$
1·20
1
Shakes (contract)
$
1·00
1
Contribution per gram
Rank
$
5·20
2
$
8·75
1
$
1·20
3
$
1·00
4
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Increase/decrease in revenue
Household goods
Electronic goods
Cloud computing services
Gold membership fees
Total revenue increase
(Step 3) Optimum production plan
Product
Shakes (contract)
Cookies
Cakes
Number
to be
produced
5,000
9,800
10,080
Grams
per
unit
1
0·20
0·5
Total
grams per
product
5,000
1,960
5,040
Cumulative
grams
Contribution
Total
per unit contribution
5,000
6,960
12,000
Total contribution
Less fixed costs
Profit
5,000
17,150
26,208
–––––––
48,358
(3,000)
–––––––
45,358
–––––––
Breach of contract with Encompass Health (EH)
It would be bad for business if CSC Co becomes known as a supplier who cannot be relied on to stick to the terms of its
agreements. This could make future potential customers reticent to deal with them.
Even more seriously, there could be legal consequences involved in breaching the contract with EH. This would be costly and
also very damaging to CSC Co’s reputation.
If CSC Co lets EH down and breaches the contract, EH may refuse to buy from them any more and future sales revenue would
therefore be lost. Just as importantly, these sales to EH are currently helping to increase the marketability of CSC Co’s shakes.
This will be lost if these sales are no longer made.
Therefore, taking these factors into account, it would not be advisable to breach the contract.
(c)
(i)
This line is what is called the ‘iso-contribution line’ and it is plotted by finding two corresponding x and y values for the
‘objective function’. At any point along this line, the mix of cakes and cookies will provide the same total contribution,
‘C’.
Since each cake provides a contribution of $2·60 and each cookie provides a contribution of $1·75, the objective
function has been defined as ‘C = 2·6x + 1·75y’. This means that the total contribution will be however many cakes
are made (represented by ‘x’) at $2·60 each plus however many cookies are made (represented by ‘y’) at $1·75 each.
The area 0ABCD is called the ‘feasible region’. Any point within this region could be selected and would show a feasible
mix of production of cakes and cookies. However, in order to maximise profit, the optimum production mix will be at a
point on the edge of the feasible region, not within it.
(ii)
The further the iso-contribution line is moved away from the origin, 0, the greater the contribution generated will be.
Therefore, a ruler will be laid along the line, making sure it stays at exactly the same angle as the line, and the ruler will
then be moved outwards to the furthest vertex (intersection between two constraints) on the feasible region, as
represented by either point A, B, C or D. In this case, the optimum point is ‘C’, the intersection of the ‘labour’ constraint
and the ‘demand for cakes’ constraint.
(iii) A ‘slack’ value could arise either in relation to a resource or in relation to production of a product. It means that a resource
is not being fully utilised or that there is unfulfilled demand of a product. Since the optimum point is the intersection of
the labour and the demand for cakes lines, this means that there will be three slack values. First, there will be a slack
value for cookies. This means that there will be unsatisfied demand for cookies since the optimum point does not reach
as far as the ‘demand for cookies’ line on the graph. Also, there will be slack values for Betta and Singa, which means
that both of these materials are not actually the binding constraints, such that there will be more material available than
is needed.
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(b)
1·00
1·75
2·60
Fundamentals Level – Skills Module, Paper F5
Performance Management
September 2016 Marking Scheme
Section A
Marks
Each question is worth 2 marks
30
–––
Section B
30
–––
Each question is worth 2 marks
Section C
Sales volumes (up to 2 marks per revenue stream)
COS and gross margins
Administration expenses/customer complaints
Distribution costs/late deliveries
Net profit margin
8
5
3
2
2
–––
20
–––
32 CSC
(a)
Calculating shortage of Betta
Contribution per gram of Betta
Ranking
Optimum production plan
Profit
1·5
1
0·5
2
1
–––
6
–––
(b)
Each valid point
1
–––
4
–––
Maximum
(c)
(i)
Identification and explanation of the iso-contribution line
Identification and explanation of the feasible region
2
2
–––
4
–––
(ii)
Explaining how to use line for identification of optimum point
Identification of optimum point
1·5
0·5
–––
2
–––
(iii) Explaining what slack values are
Identifying Betta as slack
Identifying Singa as slack
Identifying slack demand for cookies
1
1
1
1
–––
4
–––
20
–––
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31 Jungle Co
Taha Popatia - ARTT Business School - 02134523175
Answers
Fundamentals Level – Skills Module, Paper F5
Performance Management
March/June 2017 Sample Answers
Section C
31 SU Co
(a)
SP (standard price per metre: $2·85/0·95)
$3·00
SQ (standard quantity per dress: 2·2 metres/1·1)
2 metres
SQAP (standard quantity for actual production: 2 metres x 24,000)
48,000 metres
RQAP (revised quantity for actual production: 2·2 metres x 24,000)
52,800 metres
From the scenario the actual production level (AP) is 24,000 dresses and actual quantity of material bought and used (AQ)
is 54,560 metres.
Material price variances
Planning variance
(SP – RP) x AQ: ($3·00 – $2·85) x 54,560
8,184 F
Operational variance
(RP – AP) x AQ: ($2·85 – $2·85) x 54,560
0
Total price variance
8,184 F
Material usage variances
Planning variance
(SQAP – RQAP) x SP: (48,000 – 52,800) x $3·00
14,400 A
Operational variance
(RQAP – AQ) x SP: (52,800 – 54,560) x $3·00
5,280 A
Total usage variance
19,680 A
Total material variance
11,496 A
Tutorial note: These variances could have been calculated using the alternative approach as below:
Material price variances
Planning variance
(AP x RQ) x (SP – RP): 24,000 x 2·2 metres x ($3·00 – $2·85)
Operational variance
(RP – AP) x AQ: 54,560 metres x ($2·85 – $2·85)
7,920 F
0
Material usage variances
(b)
Planning variance
(SQ – RQ) x AP x SP: 24,000 x (2 metres – 2·2 metres) x $3·00
14,400 A
Operational variance
((AP x RQ) – AQ) x RP: 24,000 x 2·2 metres – 54,560 x $2·85
5,016 A
Total material variance
11,496 A
AH (actual hours worked and paid): 24 x 160 hours
SHAP (standard hours for actual production): (24,000 x 8)/60
RHAP (revised hours for actual production): (24,000 x 10)/60
3,840 hours
3,200 hours
4,000 hours
From the scenario the standard rate per hour (SR) is $12, the standard time per dress is eight minutes and the revised time
per dress is 10 minutes.
Labour efficiency variances
Planning variance
(SHAP – RHAP) x SR: (3,200 – 4,000) x $12
9,600 A
Operational variance
(RHAP – AH) x SR: (4,000 – 3,840) x $12
1,920 F
Total labour efficiency variance
7,680 A
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From scenario the revised price per metre (RP) is $2·85, the actual price per metre (AP) is $2·85 and the revised quantity
per dress (RQ) is 2·2 metres.
(c)
The production manager did not have any control over the change in the design of the dress as this change was requested
by the client. Similarly, it was not his fault that the company accountant responsible for updating standard costs was off sick
and therefore unable to update the standards. Therefore, the production manager should be judged only by those variances
over which he has control, which are the operational variances.
Materials
No operational variance arose in relation to materials price, since the actual price paid was the same as the revised price. A
planning variance of $8,184F does arise but the production manager cannot take the credit for this, as the material chosen
by GPST for the new dresses just happens to be cheaper.
Labour
The labour efficiency operational variance was favourable, which suggests good performance by the production manager. Staff
took less than the expected revised 10 minutes per dress. However, when looked at in combination with the material usage
operational variance above, it could be inferred that staff may have rushed a little and consequently used more material than
necessary.
When both of the operational variances are looked at together, the adverse materials usage $5,280 far outweighs the
favourable labour efficiency variance of $1,920. Consequently, it could be concluded that, overall, the manager’s performance
was somewhat disappointing.
32 The People’s Bank
(a)
The balanced scorecard approach looks not only at the financial performance but also non-financial performance. In order to
maintain a competitive edge, organisations have to be very aware of the changing needs of their customers. In the case of
The People’s Bank, this has involved identifying specific categories of customers which have particular needs, like SMEs in
a commercial context, or like the disabled or visually impaired in a non-commercial context. This permits these needs to be
addressed.
The People’s Bank has a vision and strategy which goes far beyond just making money. They want to help the community
and disadvantaged people and give something back to customers also. Hence, by using the balanced scorecard, performance
measures which address whether the Bank is being successful in pursuing their vision can be incorporated.
In addition, from a purely business perspective, if employees and customers are valued and internal processes are efficient,
an organisation should have more chance of achieving long-term success anyway. So, even putting aside the social objectives
The People’s Bank has, the balanced scorecard can be useful to The People’s Bank to measure these other aspects of future
success too.
(b)
The performance of the bank will be considered under each of the headings used in the balanced scorecard:
Financial perspective
The People’s Bank has had a year of mixed success when looking at the extent to which it has met its financial targets. Its
return on capital employed (ROCE) shows how efficiently it has used its assets to generate profit for the business. The target
for the year was 12% but it has only achieved an 11% return. The People’s Bank’s interest income, however, was in fact
$0·5m higher than its target, which is good. This may have been achieved by offering slightly better interest rates to customers
than competing banks, as the interest margin The People’s Bank achieved is slightly lower than target. The most likely reason
for the under target ROCE is therefore probably the investment which The People’s Bank has made in IT security and facilities
for the disabled and visually impaired. Whilst this may have reduced ROCE, this investment is essentially a good idea as it
helps The People’s Bank pursue its vision and will keep customers happy. It will also, in the case of the IT security investment,
prevent the bank and its customers from losing money from fraud in the future.
The other performance measure, the amount of new lending to SMEs, is a little bit disappointing, given The People’s Bank’s
stated value of making a difference to communities. The failure to meet this target may well be linked to the fact that an
insufficient number of staff were trained to provide advice to SMEs and consequently, fewer of them may have been successful
in securing additional finance.
Customer perspective
With regard to its customers, The People’s Bank has performed well in the year. It has exceeded its target to provide mortgages
to new homeowners by 6,000. This is helping The People’s Bank pursue its vision of helping new homeowners. It has also
managed to beat the target for customer complaints such that there are only 1·5 complaints for every 1,000 customers, well
below the target of 2. This may be as a result of improved processes at the bank or improved security. It is not clear what the
precise reason is but it is definitely good for The People’s Bank’s reputation.
The bank has also exceeded both of its targets to help the disabled and visually impaired, which is good for its reputation and
its stated value of making services more accessible.
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As regards usage, an adverse variance of $5,280 arose. This suggests that, even with the revised quantity of material being
taken into account, staff still used more than 2·2 metres on average to produce each dress. This is probably because they
had to learn a new sewing technique and they probably made some mistakes, resulting in some wastage. The manager is
responsible for this as it may have been caused by insufficient training. However, the labour efficiency variances below shed
some more light on this.
Internal processes
The number of processes simplified within the bank has exceeded the target, which is good, and the success of which may
well be reflected in the lower customer complaints levels. Similarly, the investment to improve IT systems has been a success,
with only three incidences of fraud per 1,000 customers compared to the target of 10. However, perhaps because of the focus
on this part of the business, only two new services have been made available via mobile banking, instead of the target of
five, which is disappointing. Similarly, it is possible that some of the new systems have prevented the business from keeping
its CO2 emissions to their target level.
However, the bank has not quite met its targets for helping small businesses and helping the disadvantaged. As mentioned
earlier, the shortfall in training of employees to give advice to SMEs may have had an impact on The People’s Bank’s failure
to meet its target lending to SMEs. As regards the percentage of trainee positions, the target was only just missed and this
may well have been because the number of candidates applying from these areas was not as high as planned and the bank
has no control over this.
Overall, the bank has had a fairly successful year, meeting many of its targets. However, it still has some work to do in order
to meet its stated values and continue to pursue its vision.
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Learning and growth
The People’s Bank has succeeded in helping the community, exceeding both of its targets relating to hours of paid volunteer
work and number of community organisations supported by volunteers or funding. These additional costs could have
contributed to the fact that the bank did not quite meet its target for ROCE.
Fundamentals Level – Skills Module, Paper F5
Performance Management
March/June 2017 Sample Marking Scheme
Section C
Maximum marks
Marks awarded
(a)
Standard price
Standard quantity
SQAP
RQAP
Price planning variance
Usage planning variance
Usage op variance
1
0·5
0·5
0·5
1·5
1·5
1·5
–––
7
–––
(b)
Actual hours
SHAP
RHAP
Planning variance
Operating variance
1
0·5
0·5
1·5
1·5
–––
5
–––
(c)
Controllability
Variances/performance
Other/conclusion
1
6
1
–––
8
–––
20
–––
32 The People’s Bank
(a)
Discussion
4
–––
(b)
Financial
Customer
Internal
Learning
4
4
4
4
–––
16
–––
20
–––
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31 SU Co
F5 Examiner’s commentary on
March/June 2017sample questions
Question 31
This was a fairly typical variances question, in a similar style to long variances questions from previous sittings.
Unfortunately it is a topic which candidates regularly find difficult, as was the case here. As a result, I shall go
into some detail about how best to approach this type of question.
As with any long question, it is good practice to read the first couple of lines of the scenario to find out what sort
of business we are looking at, before looking at the requirement(s) to establish the topic being tested.
In this case we are told about two companies – the School Uniform Company (SU) and one of its customers, the
Girls’ Private School Trust (GPST).
The first requirement is to “Calculate the material variances in as much detail as the information allows for the
month of February.” It is clear then, that we need to know material variances. The question is not specific
however, and we don’t know which variances are required – this is one of the key skills that are being tested.
There are several variances we might be able to calculate here – the “basic” price and usage variances and the
more advanced planning and operational variances or mix and yield. We won’t know which until we read the
scenario in more detail.
The second requirement is more specific – to “Calculate the labour efficiency variances in as much detail… for
the month of February.” This is more of a clue – the labour efficiency variance is again the “basic” variance. The
only detail we could go into is either to calculate planning and operating variances, or productive efficiency and
idle time variances. Again though, we will need to read the scenario to determine which we can calculate – the
fact that this part of the question carries 5 marks should rule out the possibility that only the basic variance is
required.
The final requirement is to “assess the performance of the production manager for the month of February.” The
fact that we are calculating variances means that it’s very likely that we can use these to assess the manager’s
performance, however it’s essential to read the scenario to determine what they can and cannot control, so that
we assess their performance fairly. There may also be details in the scenario about decisions the manager has
made, and we can use those to assess performance too.
Now that we know what the requirements are, we can actively read the scenario to find the details we need. We
know that materials and labour variances are involved, so should be on the lookout for information about both
standard and actual usage and prices for material, and rates and hours for labour.
Reading through, the second paragraph gives us detail about materials for our product (a spring/summer dress).
We are told some very important information – firstly that the design has changed, and now requires more
material than previously – the standard cost card will need to be revised to allow for this, and any usage variance
should be analysed between the planning variance caused by the change in design, and the operational variance
which we can use to assess the production manager. Secondly, a new material is being used, which is cheaper
than the previous material. It is worth noting here that the new material was chosen by GPST – a customer of
SU, therefore this decision was not made by the production manager. This is crucial for two reasons – firstly this
Examiner’s commentary – F5 sample questions March/June 2017
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This commentary has been written to accompany the published sample questions and answers and is written
based on the observations of markers. The aim is to provide constructive guidance for future candidates and their
tutors, giving insight into what the marking team is looking for, and flagging pitfalls encountered by candidates
who sat these questions.
The next paragraph gives details about labour time, which we know we will need to calculate our efficiency
variance. Again, the change in design has had an effect on time taken – the new design will take 2 minutes
longer to make. Again, this will cause a planning variance – the original standard will need to be revised to allow
for this extra time, as the production manager should not be criticised for the change in design, which was not
their decision. We are also told that there was no idle time, ruling out any idle time variances.
Next we are given budgeted and actual production. Actual production levels are essential in working out
variances, as they compare actual figures to the flexed budget (based on actual production). The budgeted
production figure is less important here, although it could be noted that actual production was 20% under
budget, which may have a knock-on effect on profits. It is worth noting that the most common error when
calculating variances of this type is to use budgeted production to calculate standard usage. For example, taking
the basic materials usage variance –many candidates write this as:
ie the difference between the actual quantity of material at the standard price, and the standard quantity of
material at the standard price. It is the SQ that causes the problems – it means the standard (expected) quantity
of material to make ACTUAL production. So in our case, actual production was 24,000 units – the original
standard amount per unit was 2m, so SQ would be 2m*24,000=48,000m. Similarly, the revised standard
quantity would be 2.2*24,000=52,800m. You would never use the budgeted quantity to calculate standard
usage, as you’re comparing it to the actual quantity of material used to make ACTUAL production.
In the final paragraph, we are told that the production manager is responsible for purchasing and production
issues. This means that they can be have some control over the materials price variance, as well as materials
usage and labour efficiency variances, so we can use these to assess their performance.
Finally, we are told that the standard cost card has not been updated to reflect the changes in the design. This
confirms that we need to calculate planning and operational variances, as discussed throughout – comparing
actual performance to the standard cost card for the old design will lead to some variances which are not
controllable by the production manager.
In answering parts (a) and (b) it’s obviously essential to know the variances calculations. It was clear that most
did – the main reason scores were low on both parts were that only the basic variances were calculated. Whilst
some credit could be given for this, there were 12 marks available in total – for 6 variances – materials price
(planning and operational), materials usage (planning and operational) and labour efficiency (planning and
operational). Calculating just the 3 basic variances would not score a passing mark.
Coupled with that, it was much easier to score well on part (c) if you had already determined what was
controllable and what was not. Easy marks could be gained here for explaining that the materials usage and
Examiner’s commentary – F5 sample questions March/June 2017
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cannot be used to assess the production manager’s performance for part (c) and secondly an uncontrollable
change from the original standard means that we should split our materials price variance into planning and
operational components – the 5% reduction in price constitutes the planning variance.
When assessing performance it is also useful to give a conclusion. This should be in line with your previous
findings – using total operational variance here would be a useful yardstick.
Question 32
This was a performance assessment question, involving the use of the balanced scorecard. Performance on
this question was reasonably strong, although poor exam technique in addressing the specific requirement
did let some candidates down.
Part (a) was a short requirement asking why the balanced scorecard would be more useful to the People’s
Bank than using solely financial performance measures. Although there were only four marks available, it
did highlight some candidates’ weakness in not being able to use the information in the scenario to help
them answer the question. Most were able to identify the generic point that the balanced scorecard gives a
more rounded view by looking at a wider range of performance measures (financial and non-financial) as
well as internal and external factors. However, the scenario gives us more help and shows us how
important these non-financial factors are to the bank – the 3 values given highlight this. If their
performance was assessed purely on profit they would never strive to meet those values, or looking at it
another way they might be judged to have failed by spending money on improving customer accessibility or
simplifying their processes.
Part (b) was a more traditional performance assessment question. However, exam technique was crucial
here. The note in the requirement says to use each of the four headings of the balanced scorecard to
structure your answer. Candidates who ignored this found it much harder to score well on this question, as
it was harder to see how their points corresponded to the perspectives of the balanced scorecard. It was
pleasing to see though, that the majority did use the headings suggested (which were given in the
scenario). Similarly, the requirement specifically asked candidates to use the bank’s vision and values to
assess performance. Therefore, a sensible approach would be to take each perspective, use the
performance measures given and details in the scenario to see how they link to the bank’s vision and
values. The other key skill in these questions is to identify linkages between measures – cause and effect
relationships.
For example on the Financial perspective we can see that new lending to SMEs was significantly (10%)
down on target. The first point you should make is that this is not in line with the bank’s third value – to
support SMEs. This alone will be given credit, and similar points should be made for each heading, however
even more credit can be given if you go on to say that the drop in new lending to SMEs is due to the fact
Examiner’s commentary – F5 sample questions March/June 2017
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labour efficiency planning variances were due to the change in design, and therefore not controllable, and the
materials price planning variance was due to GPST’s decision to change the material – again, not controllable.
You could then look at the operational variances and, based on whether they were adverse or favourable, decide
whether the production manager had performed well or not. Remember that in many cases the variances have
some interconnectivity. For example here, the operational labour efficiency variance was favourable, showing that
the workers worked faster than expected. However the operational material usage variance was adverse, meaning
that more material was used to make the actual production of 24,000 dresses than expected. This could have
been because the workers were rushing, and therefore more material was wasted. Identifying possible cause and
effect relationships like this will lead to a lot of credit being given.
Finally, a long discussion question like this should finish with a brief, overall conclusion. This should be in
line with your findings – sometimes it will be very clear that performance has been good or bad, otherwise
you might have to say something like “with the exception of the financial perspective, The People’s Bank
has performed well in meeting its vision.”
Examiner’s commentary – F5 sample questions March/June 2017
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that fewer colleagues have been trained to provide advice to SMEs (under learning and growth). Other
similar linkages could be that fewer complaints were made than expected, possibly due to more simplified
processes or fewer incidences of fraud. These points do not require a great deal of technical knowledge,
but require candidates to analyse the information given quickly and understand how they affect one
another.
Taha Popatia - ARTT Business School - 02134523175
Answers
Fundamentals Level – Skills Module, Paper F5
Performance Management
September/December 2017 Sample Answers
31 TR Co
Step 1: Establish the demand function
b = change in price/change in quantity
b = $2/5,000 units = 0·0004
The maximum demand for Parapain is 1,000,000 units, so where P = 0, Q = 1,000,000, so ‘a’ is established by substituting
these values for P and Q into the demand function:
0 = a – (0·0004 x 1,000,000)
0 = a – 400
Therefore a = 400
Demand function is therefore: P = 400 – 0·0004Q
Step 2: Establish the marginal cost
Total
$
50
150
6·6039
2
208·6039
Material Z
500 g x $0·10
Material Y
300 g x $0·50
Labour
Working 1
Machine running cost
(20/60) x $6·00
Total marginal cost per batch
Note: Fixed overheads have been ignored as they are not part of the marginal cost.
The marginal cost will now be rounded down to $208·60 per batch.
Working 1: Labour
The labour cost of the 1,000th unit needs to be calculated as follows as this is the basis TR Co will determine the price for
Parapain:
Learning curve formula: Y = aXb
‘a’ is the cost for the first batch: 5 hours x $18 = $90
If X = 1,000 batches and b = –0·321928, then
Y = 90 x 1,000–0·321928 = 9·7377411
Total cost for 1,000 batches = $9,737·7411
If X = 999 batches, then
Y = 90 x 999–0·321928 = 9·7408781
Total cost for 999 batches = $9,731·1372
Therefore the cost of the 1,000 batches ($9,737·7411 – $9,731·1372) = $6·6039
Step 3: Establish the marginal revenue function: MR = a – 2bQ
Equate MC and MR and insert the values for ‘a’ and ‘b’ from the demand function in step 1.
208·60 = 400 – (2 x 0·0004 x Q)
Step 4: Solve the MR function to determine optimum quantity, Q
208·60 = 400 – 0·0008Q
0·0008Q = 191·4
Q = 239,250 batches
Step 5: Insert the value of Q from step 4 into the demand function determined in step 1 and calculate the optimum price
P = 400 – (0·0004 x 239,250)
P = $304·30
Step 6: Calculate profit
$
72,803,775
(49,907,550)
(500,000)
–––––––––––
22,396,225
–––––––––––
Revenue (239,250 batches x $304·30)
Variable costs (239,250 batches x $208·60)
Fixed costs (250,000 batches x $2)
Profit
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(a)
Market penetration pricing
With penetration pricing, a low price would initially be charged for the anti-malaria drug. The ideology behind this is that the
price will make the product accessible to a larger number of buyers and therefore the high sales will compensate for the lower
prices being charged. The anti-malaria drug would rapidly become accepted as the only drug worth buying, i.e. it would gain
rapid acceptance in the marketplace.
The circumstances which would favour a penetration pricing policy are:
–
Highly elastic demand for the anti-malaria drug, i.e. the lower the price, the higher the demand. There is no evidence that
this is the case.
–
If significant economies of scale could be achieved by TR Co so that higher sales volumes would result in sizeable
reductions in costs. It cannot be determined if this is the case here.
–
If TR Co was actively trying to discourage new entrants into the market, however in this case, new entrants cannot enter
the market anyway due to the patent.
–
If TR Co wished to shorten the initial period of the drug’s life-cycle so as to enter the growth and maturity stages quickly
but there is no evidence the company wish to do this.
Market skimming pricing
With market skimming, high charges would initially be charged for the anti-malaria drug rather than low prices. This would
enable TR Co to take advantage of the unique nature of the product. The most suitable conditions for this strategy are:
–
The product has a short life cycle and high development costs which need to be recovered. There is no information about
the drug’s life cycle but development costs have been high.
–
Since high prices attract competitors, there needs to be barriers to entry if competitors are to be deterred. In TR Co’s case
it has a patent for the drug and also the high development costs could act as a barrier.
–
Where high prices in the early stages of a product’s life cycle are expected to generate high initial cash flows, this will help
TR Co recover the high development costs it has incurred.
Recommendation
Given the unique nature of the drug and the barriers to entry, a market skimming pricing strategy would appear to be the far
more suitable pricing strategy. Also, whilst there is demand curve data, it is unknown how reliable this data is, in which case
a skimming strategy may be the safer option.
32 Sports Co
(a)
(i)
Return on investment = controllable profit/average divisional net assets
Controllable profit
C
$’000
Net profit
1,455
Add back depreciation on non-controllable assets
49·5
Add back Head Office costs
620
––––––––
Controllable profit
2,124·5
––––––––
E
$’000
3,950
138
700
––––––
4,788
––––––
Average divisional net assets
Opening assets
Closing assets
Average assets
$’000
13,000
9,000
11,000
$’000
24,000
30,000
27,000
ROI
19·3%
17·7%
(ii)
Whilst Division C has exceeded the target ROI, Division E has not. If controllable profit in relation to revenue is considered,
Division C’s margin is 56% compared to Division E’s margin of 57%, so Division E is actually performing slightly better.
However, Division E has a larger asset base than Division C too, hence the fact that Division C has a higher ROI.
Since Division E appears to be a much larger division and is involved in sports equipment manufacturing, then it could
be expected to have more assets. Division E’s assets have gone up partly because it made substantial additions to plant
and machinery. This means that as well as increasing the average assets figure, the additions will have been depreciated
during the year, thus leading to lower profits. This may potentially have had a large impact on profits since Division E uses
the reducing balance method of depreciation, meaning that more depreciation is charged in the early years.
Based on the ROI results, the manager of Division C will get a bonus and the manager of Division E will not. This will
have a negative impact on the motivation level of the manager of Division E and may discourage him from making future
investments, unless a change in the performance measure used is adopted.
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(b)
C
$’000
2,124·5
(1,320)
–––––––
804·5
–––––––
E
$’000
4,788
(3,240)
––––––
1,548
––––––
From the residual income results, it can clearly be seen that both divisions have performed well, with healthy RI figures of
between $0·8m and $1·55m. The cost of capital of Sports Co is significantly lower than the target return on investment
which the company seeks, making the residual income figure show a more positive position.
(ii)
Advantages
The use of RI should encourage managers to make new investments, if the investment adds to the RI figure. A new
investment can add to RI but reduce ROI and in such a situation measuring performance with RI would not result in the
dysfunctional behaviour which has already been seen at Sports Co. Instead, RI will lead to decisions which are in the best
interests of the company as a whole being made.
Since an imputed interest charge is deducted from profits when measuring the performance of the division, managers are
made more aware of the cost of assets under their control. This is a benefit as it can discourage wasteful spending.
Alternative costs of capital can be applied to divisions and investments to account for different levels of risk. This can allow
more informed decision-making.
Disadvantages
RI does not facilitate comparisons between divisions since the RI is driven by the size of divisions and their investments.
This can clearly be seen in Sports Co where the RI of Division E is almost twice that of Division C, which will be related
to Division E being a much larger division.
RI is also based on accounting measures of profit and capital employed which may be subject to manipulation so as, for
example, to obtain a bonus payment. In this way it suffers from the same problems as ROI.
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(b) (i)
Controllable profit
Less: imputed charge on assets at 12%
Residual income
Fundamentals Level – Skills Module, Paper F5
Performance Management
September/December 2017 Sample Marking Scheme
Maximum marks
31 (a) Demand function
Marginal cost/batch
Labour 1,000th batch
Establishing MR function
Solve MR to find Q
Use demand function and Q to find P
Contribution based on P and Q
Deduction of fixed costs
Profit
1·5
2·5
3·5
0·5
1
1
1
0·5
0·5
–––
12
–––
(b) Penetration pricing
Skimming pricing
Other relevant comments/recommendation
3
3
2
–––
8
–––
20
–––
32 (a) (i) Net profit
Add back depreciation
Add back HO costs
Controllable profit
Average assets
ROI
1
1
1
1
1
1
–––
6
–––
(ii)
6
–––
Discussion
(b) (i) Controllable profit
Imputed interest
RI
Comment
1
1
1
1
–––
4
–––
(ii)
4
–––
20
–––
Advantages/disadvantages
11
Marks awarded
Taha Popatia - ARTT Business School - 02134523175
Section C
F5 Examiner’s commentary on
September/December 2017 sample
questions
This was a question mostly from the pricing area of the syllabus, although knowledge of learning curves
was also tested. Part (a) required application of the MR=MC optimum price method, and part (b)
required discussion of market skimming and penetration. Probably due to its technical nature, answers
to part (a) were mixed, whereas candidates were generally able to score well in part (b).
Taking each requirement in turn:
(a) Calculate the optimum (profit-maximising) selling price for Parapain and the resulting annual
profit which TR Co will make from charging this price.
It is important to read each requirement very carefully, to determine exactly what we need to do. Often,
as is the case here, two (or more) things are asked for so it’s essential that you cover all requirements.
Firstly then, calculate the optimum selling price. There are two methods to find an optimum price in the
syllabus, the tabular approach, and the MR=MC method.
The tabular approach is where we are given all possible prices and details of costs and volumes at each
price. We then simply calculate the profit at each possible price to find the price with the highest profit.
MR=MC is a method where we follow several algebraic steps to determine a theoretical optimum price.
In questions of this type, the scenario will tell you which method to use. If you’re given possible prices
and demands, then use the tabular method. If you’re given information about how changes in price will
affect demand, it’s MR=MC.
There’s also a big clue in this question, the note in the requirement that if P = a – bQ, then
MR = a – 2bQ. This is from the MR=MC method, so we should be using that. If you would like to see
an example question using the tabular approach, see Question 1 on the March/June 2016 Sample
Questions on the ACCA website.
The MR=MC method often scares students when they first see it, especially those who struggle with
mathematics. However, the steps required are consistent, and practice is the key to getting over any
initial confusion. To give a bit of background, the theory behind the model is that profit is maximised
when Marginal Cost = Marginal Revenue, i.e. MC=MR. We are trying to find a profit maximising price,
so we need to find the price where MC=MR. What are these things? Marginal cost is the cost of making
one more unit of our product. If we make one more unit of our product, our costs will increase by the
variable cost per unit, so this is the marginal cost (ignoring any complications like stepped fixed costs or
variable cost/unit changing). Marginal revenue is slightly more complicated; by definition it is the
revenue earned from selling one more unit. That might suggest that this is the selling price – sell one
more unit and earn the selling price. However, in order to sell one more unit, you’d have to reduce the
Examiner’s commentary – F5 September/December 2017
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Question 31
1. Find the demand equation P=a-bQ
The demand equation shows how price, P and demand, Q are linked. The assumption (and therefore
limitation) of this model is that price and demand have a (negative) linear relationship. This means that
an increase in price will lead to a predictable decrease in demand, and vice versa. We can deal with the
calculations later, but for now let’s carry on with the steps.
2. Find Marginal Revenue, MR
This follows directly on from step 1, where we find a and b in P = a – bQ, so MR = a – 2bQ, as per the
note.
3. Find Marginal Cost, MC
As already mentioned, this is the variable cost per unit.
4. Profit is maximised when MC=MR
As we know MC, and MR is a function of Q, we can solve this equation to find the profit-maximising
demand.
5. Find optimum P
As we now know Q, we can find P using P = a – bQ.
This may still seem a bit of a mystery, and it’s easier to explain with some numbers. However,
knowledge of these steps makes it easier to find the required information from the scenario – firstly we
know we need information on how changes in price affect demand to find the demand equation in step
1. Secondly, we need information on variable cost per unit.
The second paragraph of the scenario is key for this method. We are told that for a $2 decrease in price,
demand would increase by 5,000 – i.e. information about how changes in price will affect demand. We
are also told that maximum demand is one million.
We are then given important information about costs – two different materials, variable running costs
and fixed costs. Finally, we are told that labour time per batch is subject to an 80% learning curve, and
that all pricing decisions will be based on the time taken to produce the 1,000th unit. As this is a pricing
decision, we must therefore use the time for the 1,000th unit.
Examiner’s commentary – F5 September/December 2017
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selling price, so it’s more complicated than that. Fortunately, we don’t need to worry about this
complication, as the note mentioned above defines MR for us. This allows us to follow these steps to
find where MC=MR, and therefore the optimum price:
1. Find the demand equation P = a – bQ
We need to calculate ‘a’ and ‘b’ to find the demand equation. Going against alphabetical convention, it is
usual to calculate b first. We are told that b = change in price/change in demand. From the scenario, a
change in price of $2 will give a change in demand of 5,000. Therefore:
B = 2/5,000 = 0·0004 (or leave as a fraction)
a is defined as ‘the price at which demand is zero’. This is less helpful, but now that we know b, our
equation is starting to take form:
P = a – 0.0004Q
To calculate a, we just need an existing price and demand. If we put them into the equation, we can
find a. Previous questions have given information like ‘the current price is $150 and demand is 40,000
(say), which is what you would use to calculate a. This one is slightly different – we are told that
maximum demand is 1 million. Maximum demand would be achieved at a price of 0, so that is the
price/demand combination we would use:
0 = a – (0·0004 x 1,000,000)
0 = a – 400
a = 400
Virtually all candidates were able to calculate b, but many struggled with a. The best advice I can give
here is don’t give up! As this is the first step, there are still many marks to come – even if you calculate
a incorrectly, if your method following that is correct, you will still pick up most of the marks. This is
where the Section C questions differ from A and B – you may not get the answer 100% correct but will
still pick up marks for correct technique – you could even put a note saying ‘I assume a is 100,’ for
example.
Anyway, we now know that P = 400 – 0.0004Q. So for any given demand, we can calculate the price
required.
2. Find Marginal Revenue, MR
You can write this straight down: MR = 400 – 0.0008Q, doubling the value of b.
Examiner’s commentary – F5 September/December 2017
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The order you approach the various steps is up to you – many candidates calculated the learning curve
aspects first, which is absolutely fine. For clarity though, this report will follow the steps in the order
already given.
3. Find Marginal Cost, MC
Item
Material Z Material Y Machine time Labour Total Working
500 x $0·10 300 x $0·50 (20/60) x $6/hr Time of 1,000th batch x $18/hr $
50 150 2 ? ?
The labour cost will require further work, as discussed we need to know that we need the cost of
batch 1000. This is a commonly used method, and was well attempted, so just to show the workings:
1,000 batches 5*1,000^0·321928 =
0·54099 0·54099*1,000 = 540·9860 Average time/batch y = ax^b Total time for all batches Time for 1,000th batch (difference) 999 batches 5*999^0·321928 =
0·5412 0·5412*999 =
540·6191 540·9860 – 540·6191 = 0.3669hours
One small point to note here; when calculating y, the average time per batch using the learning curve
formula, you then need to multiply this by the number of batches. It is important not to round this
number too early, as it can make a big difference to your final answer. Simply take the number in your
calculator and multiply it by the number of batches without clearing the value to avoid this.
We can now complete our MC working:
Item
Material Z Material Y Machine time Labour Total Working
500 x $0·10 300 x $0·50 (20/60) x $6/hr 0·3669 x $18/hr $
50 150 2 6·60 208·60
Note that writing out all of the variable costs in this way makes it easier to follow the answer – we got to
the point where I didn’t know one of the values (labour cost), but calculated this separately and then
filled in the final value.
Examiner’s commentary – F5 September/December 2017
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Reading the scenario, we can identify the variable costs:
4. Profit is maximised when MC=MR
208·60 = 400 – 0·0008Q – this gives us an equation with one unknown, Q – so rearrange
208·60 – 400 = –0·0008Q – subtract 400 from both sides
–194·4 = –0·0008Q
–194·4/–0·0008 = Q – divide through by –0·0008
Q = 239,250
What this tells us is that a demand of 239,250 will maximise our profit – nearly there!
5. Find optimum P
We know from step 1 that P = 400 – 0.0004Q, and Q = 239,250, so:
P = 400 – (0.0004 x 239,250)
P = 304·3
Our profit maximising price is $304.30
After all of this work, you might be tempted to think you’ve finished and move on BUT it’s always a good
idea to double check the requirement. We were asked to find the profit maximising price AND the
resulting annual profit. This is actually the most straightforward part of the question. Usually the
quickest way to get to profit is total contribution – fixed costs, and we have all of that information:
Contribution/unit Total contribution Fixed cost Profit Selling price – VC/unit Contribution/unit x demand FC/unit x budgeted demand Contribution-fixed cost 304·3 – 208·6 95·7 x 239,350 2 x 250,000 95·7 22,905,795 (500,000) 22,405,795
It is worth persevering this far to pick up these easy marks. Having said that, the most common error
was to multiply the fixed cost per unit of $2 by the new demand. Remember, fixed costs are fixed, so
don’t change with demand. If we budgeted for $500,000 fixed costs at a demand of 250,000 units,
we’d budget for $500,000 at a demand of 239,350.
On to part (b)
(b) Discuss and recommend whether market penetration or market skimming would be the most
suitable pricing strategy for TR Co when launching the new anti-malaria drug.
The verbs used in the requirements are particularly important for written questions such as this. Here,
we are asked to discuss and recommend. Discuss implies some depth – advantages and disadvantages
are often a good start. We’re asked to discuss their suitability for pricing the drug, so need to look at
Examiner’s commentary – F5 September/December 2017
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Now we have everything we need:
Substituting in what we know MR=MC:
This requirement was well answered, and the model answer goes into lots of detail about the suitability
or otherwise of each method, so I won’t add more to that. Reading through it, or looking at the scenario,
you can see that virtually all of the arguments are in favour of market skimming. It is worth mentioning
from an exam technique point of view that many candidates spotted this – recommending skimming and
talking in depth about why it was suitable. Unfortunately they didn’t mention penetration at all, which
meant that their answer could not be given full credit. It’s important to discuss all aspects of the
requirement to gain full credit. Use of headings to structure your answer will help avoid this problem –
on reading that requirement you can immediately split it into 3 headings – Penetration, Skimming and
Recommendation. Ensure that you cover all 3 to maximise your marks.
Question 32
Sports Co was a typical divisional performance measurement question, asking candidates to calculate
return on investment (ROI) and residual income (RI), as well as some discursive aspects.
The calculations were performed well – virtually all candidates were able to calculate ROI and RI.
However, marks were still a little varied as only stronger candidates were able to make the necessary
adjustments to profit to allow for controllability. In questions of this type, it’s especially important to look
in the scenario for clues about anything which the divisional managers can’t control. Here, we’re
specifically told in the notes that a proportion of the depreciation costs are not controlled by the
divisional managers, and that head office recharges are included in fixed costs. These will not be
controllable, so should be added back to profit.
Once controllable profit and average net assets have been calculated for (a), the same figures should be
used in the calculation of RI in (b), making (b)(i) a relatively straightforward question, and candidates
scored well accordingly.
Performance in the discursive aspects was less strong. Looking at the requirement for (a)(ii) in detail,
we’re asked to discuss the two divisions’ performance, including the ROI difference. However, there is a
second part – to explain the impact this ROI difference could have on the manager of the worst
performing division.
Again, from an exam technique point of view it’s easy to get bogged down in the detail of the
performance management part, and forget about the second part. With a fairly open requirement like
‘discuss the performance,’ candidates can often spend too long looking at irrelevant or unnecessary
comparisons. This is where reading the scenario carefully is so useful.
Examiner’s commentary – F5 September/December 2017
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whether they should/shouldn’t be used. It’s also important that we recommend which one to use, based
on our discussion.
Divisional managers make decisions about investments
Target ROI is 18%
Bonus awarded for meeting this
Division E made $2m investment
There are other points, but this is only a 6 mark question, so let’s not get carried away. Looking at those,
we can easily look at our calculations and comment:
Did managers meet target?
Will they get a bonus?
Large investment will increase net assets so reduce ROI
Other points such as the difference between the businesses can also be used to explain the different
ROIs, but don’t forget to discuss the behavioural aspects – the manager will be demotivated, and may try
to manipulate the figures by not investing. These are textbook points, but can be applied to this
scenario.
Finally, (b)(ii) looks like a simple advantages/disadvantages of RI question. However, scores on this
were fairly low – the main reason because candidates did not address the Explain part of the
requirement. Many candidates simply stated several advantages/disadvantages of RI, without explaining
them. For example, one common advantage given was ‘RI reduces dysfunctional decision making.’ This
does not explain the advantage – a ‘because’ comes in handy here. ‘RI reduces dysfunctional decision
making because it uses the whole company’s cost of capital, so positive RI projects for the company
would also be accepted by the division.’ That extra couple of seconds making sure that you have
addressed the requirement properly will pay dividends.
Examiner’s commentary – F5 September/December 2017
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To score well in a performance assessment question, you need to add value to your discussion, rather
than bland comments like ‘E did better than C.’ Some key points from the scenario:
Taha Popatia - ARTT Business School - 02134523175
Answers
Fundamentals Level – Skills Module, Paper F5
Performance Management
March/June 2018 Sample Answers
Section C
31 Portable Garage Co
Profit statement for current position:
Division B
$’000
Sales revenue:
External sales (150,000 x $180/200,000 x $15)
27,000
Internal transferred sales (150,000 x $13)
–––––––
Total revenue
27,000
–––––––
Variable costs:
External material costs
6,750
Internal transferred costs
1,950
Labour costs
5,250
Other costs of external sales
–––––––
Total variable costs
13,950
–––––––
Contribution
13,050
Less fixed costs
5,460
–––––––
Profit
7,590
–––––––
(b)
(c)
Division A
$’000
PGC Co
$’000
3,000
1,950
––––––
4,950
––––––
30,000
–––––––
30,000
–––––––
1,050
7,800
1,400
200
––––––
2,650
––––––
2,300
2,200
––––––
100
––––––
6,650
200
–––––––
14,650
–––––––
15,350
7,660
–––––––
7,690
–––––––
If Division B can buy adaptors from outside the group at $13 per unit, then the optimum position is for Division A to sell as
many adaptors as possible to external customers at $15 each and then sell the remainder to Division B at a price to be agreed
between them.
This would mean that Division A continues to sell Division B 150,000 adaptors but Division B then buys the remaining
30,000 adaptors from an external supplier. This is because the contribution per unit for Division A’s external sales is $7 ($15
– $3 – $4 – $1). This means that for every external sale it loses, it forfeits $7 for the group. However, the incremental cost for
the group of Division B buying adaptors from outside the group is only $6 ($13 external cost less the $7 cost of making them
in-house). So, it makes sense for Division A to satisfy its external sales first before selling internally.
In order for Division A to supply Division B with 180,000 adaptors, it would have to reduce its external sales from 200,000
units to 170,000. This is because it only has enough spare capacity to supply Division B with 150,000 units at present after
it has supplied adaptors to its external customers.
The minimum transfer price in situations where there is no spare capacity is marginal cost plus opportunity cost. In this case,
contribution is lost by not selling 30,000 units to the external customers. As the marginal cost for Division A’s internal sales is
$7 ($4 + $3) and the contribution per unit for external sales is $7 per unit ($15 – $3 – $4 – $1), the transfer price for the
additional 30,000 units would need to be $14.
32 The Alka Hotel
(a)
Breakeven point (in occupied room nights) = Fixed cost/contribution per room
$600,000/($180 – $60) = 5,000 occupied room nights
Margin of safety = (Budgeted room occupancy – breakeven room occupancy)/budgeted room occupancy
Total rooms available per annum: 365 days x 25 rooms = 9,125 rooms
Budgeted occupancy level: 9,125 x 70% = 6,387·5 rooms
Margin of safety: (6,387·5 – 5,000)/6,387·5 = 21·72%
(b)
Profit or loss for Q1
$
108,000
(150,000)
––––––––
(42,000)
––––––––
Contribution (900 rooms x $120)
Fixed costs (($600,000/12) x 3)
Loss
The Alka Hotel should not close in Q1. The fixed costs will still be incurred and closure would result in lost contribution of
$108,000. This in turn would result in a decrease in annual profits of $108,000. In addition, the hotel could lose customers
at other times of the year, particularly their regular business customers, who may perceive the hotel as being unreliable.
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Taha Popatia - ARTT Business School - 02134523175
(a)
(c)
Contribution/sales ratio of Project 1
Sales value of two room nights (2 x $67·50)
Sales value of a pair of theatre tickets
Variable cost of two room nights (2 x $60)
Variable cost of a pair of theatre tickets
Contribution
C/S ratio (20/235)
Breakeven point in revenue ($20,000/0·0851)
$
135
100
––––
235
(120)
(95)
––––
20
––––
8·51%
$235,000
Alternatively:
Contribution per theatre package sold
Breakeven point in theatre packages ($20,000/$20)
Breakeven point in revenue (1,000 x $235)
The unit contribution per theatre package is low and it requires a large number of sales to break even. Each theatre package
would require two room nights to be sold which would mean 2,000 room nights needed in Q1 to break even. The available
rooms for Q1 are only 2,281·25 (9,125/4) and the Alka Hotel has already sold 900 rooms, so there is insufficient capacity.
Based on this, Project 1 is not viable at the quoted prices.
(d)
$20
1,000
$235,000
Project 2 will cause the fixed costs of the hotel to rise from $600,000 per annum to $800,000 per annum for the hotel and
restaurant combined. This is an annual increase of $200,000.
Revenue per occupied room will rise from $180 to $250 ($2,000,000/8,000 rooms) which reflects the extra guest expenditure
in the restaurant.
The total cost predicted at a level of 8,000 occupied rooms is $1,560,000 which means the variable costs must be $760,000
($1,560,000 – $800,000 fixed costs). This is a variable cost per occupied room of $95 which is an increase of $35. This
reflects the variable costs of the restaurant.
As a result of these changes, the breakeven point has increased from 5,000 to 5,161 occupied rooms so the hotel needs to
sell more room nights to cover costs.
However, budgeted occupancy is now 7,300 occupied room nights which gives 80% occupancy (7,300/9,125). This gives
a margin of safety of 2,139 occupied room nights or 29%. This is an increase on the current position and the hotel’s position
appears safer. At 7,300 occupied room nights the Alka Hotel’s budgeted profit is $331,500 (7,300 x ($250 – $95) –
$800,000.
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Taha Popatia - ARTT Business School - 02134523175
Fundamentals Level – Skills Module, Paper F5
Performance Management
March/June 2018 Sample Marking Scheme
Section C
Maximum marks
Marks awarded
(a) External sales – A/B
Internal sales – A
External materials – A/B
Internal costs – B
Labour costs – A/B
Other costs – A
Fixed costs
Profit – A/B
PGC Co figures
1
0·5
1
0·5
1
1
0·5
1
2·5
–––
9
–––
(b) External cont of $7 – A
Incremental cost of $6
External sales first – A
150,000 from A/30,000 externally
Approach
1
1
1
1
2
–––
6
–––
(c) Minimum transfer price (marginal cost + opportunity cost)
Opportunity cost – lost contribution $7
Add marginal cost for transfer price of $14
Approach
1
1
1
2
–––
5
–––
20
–––
32 The Alka Hotel
(a) Contribution
BEP
Total rooms available
Budgeted occupancy
Margin of safety %
0·5
1
1
0·5
1
–––
4
–––
(b) Profit/loss
Recommendation
Explanation
1·5
0·5
2
–––
4
–––
(c) C/S ratio
BEP $ revenue
Recommendation
Explanation
1
0·5
0·5
2
–––
4
–––
(d) Calculations
Commentary
4
4
–––
8
–––
20
–––
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Taha Popatia - ARTT Business School - 02134523175
31 Portable Garage Co
This commentary has been written to accompany the published sample questions and answers and
is written based on the observations of markers. The aim is to provide constructive guidance for future
candidates and their tutors, giving insight into what the marking team is looking for, and highlighting
common issues encountered by candidates who sat these questions.
Portable Garage Co
This was a fairly typical transfer pricing question, testing candidates’ understanding of how internal sales
affect different divisions’ profit figures, then moving on to more advanced understanding of the effect of
transfer pricing on the group as a whole, as well as the individual divisions.
Requirement (a) was well attempted by most candidates, which you would expect to be the case as it
involves some relatively simple calculations. The model answer doesn’t require any further explanation, but
some common mistakes were:
Layout
When asked to calculate profit for two or more divisions, as we are here, a columnar approach is by far the
best method. Unfortunately the majority of candidates chose to calculate the profits for each division
separately, writing out each cost/revenue separately.
Whilst this approach would be given full credit, it is time-consuming, and time is a scarce resource in any
exam.
Not answering the full requirement
Possibly as a result of poor layout, many candidates failed to perform perhaps the simplest task of the
requirement – add up the two divisions’ figures to show PGC’s results. I cannot stress enough how important
it is to address every aspect of a requirement, and this is no exception.
Of those who did give a figure for PGC, many just gave the total profit. While this was given some credit, full
credit could not be given – the requirement asked for a profit statement, which would be expected to show
the breakdown of different revenue and cost types.
Using incorrect volumes
Perhaps as a result of being under time pressure and rushing, the most common technical mistake was to
use incorrect sales volumes, for either division. We are told that B’s maximum demand is 200,000, for
example, but they only produce 150,000. It’s important to read the scenario carefully, and make notes of
the key figures.
Missing key information
The most commonly missed piece of information was the $1 ‘other’ variable cost on external sales for
Division A. Omitting this figure can only be as a result of not reading the scenario carefully enough. This
omission was not as important as some of the errors already mentioned, but it was an otherwise
straightforward mark that many candidates were not awarded.
Requirement (b) was the most poorly answered part of this question. Judging by the answers given, most
Examiner’s commentary – F5 sample questions March/June 2018
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F5 Examiner’s commentary on
March/June 2018 sample questions
Many candidates discussed this from the point of view of each division. The buying division, B, doesn’t really
care where they get the components from – they cost $13 either way (ignoring quality differences, etc). The
selling division makes $7 contribution from an external sale, but only $6 from an internal sale, therefore will
want to sell externally. This is true, and many answers came to the (correct) conclusion that A should
continue to sell its 150,000 spare capacity to B, but the remaining 30,000 should be bought by B from the
external source. Although this conclusion is correct, it could not be awarded full marks due to the lack of
group focus. From the group’s perspective, the internal transfer price is irrelevant (which is easy to see from
the answer to (a) – it cancels out). The group has to make a decision here – would they rather B bought the
components from A, meaning that A misses out on 30,000 external sales, or would they rather keep those
sales, and have B buy the components externally.
Once you’ve identified that those are the only things to consider, this becomes a relatively simple make v buy
question. If A supplies the extra 30,000 units to B, the group loses out on the $7/unit external contribution A
would have received. If B buys them for $13/unit, this costs PGC an extra $6 (variable cost of production is
$7, and $13 - $7 = $6) per unit. PGC would rather pay an extra $6 per unit than lose out on $7
contribution, so B should buy internally.
Finally, requirement (c) asked for the minimum transfer price for any extra adaptors supplied by Division A.
This put candidates back on more familiar ground – most were able to identify that the minimum price is the
lowest price that the selling division would accept. Many remembered that the minimum transfer price =
marginal cost + opportunity cost. Unfortunately, few were able to apply this knowledge to the scenario.
Firstly, as the requirement states that this would be for any additional adaptors supplied above the current
level, Division A does not have spare capacity to produce those units. Therefore, any additional units would
mean that A would give up on external sales – this is where the opportunity cost arises. A significant minority
of candidates stated that the opportunity cost was nil, as A has spare capacity. As mentioned earlier, reading
the requirement and scenario carefully can help prevent these errors.
The opportunity cost, therefore, is the contribution A would lose out on from its external sales. As mentioned
earlier, this is $7 – occasionally $8 was given as an answer due to the omission of the extra external variable
cost of $1, but this would still be a strong answer. Once the opportunity cost is identified, the minimum
transfer price is then simply the variable cost + $7 = $14.
Finding this transfer price doesn’t involve any complicated calculations, but it is important to address the
requirement – calculate and discuss. Many candidates could not be awarded full marks because they simply
gave the answer $14, with no explanation.
(Note that the $14 can also be reached by adjusting the external price of $15 by the $1 external cost. Full
credit was given for this method.)
Examiner’s commentary – F5 sample questions March/June 2018
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candidates failed to recognise that the key to this question was considering what was best for the group. The
requirement says that the new policy will ensure the optimisation of group profits, so we need to look from
their perspective.
The Alka Hotel
This question was centred on CVP analysis, although there was some decision-making and analysis to
perform. It was generally well attempted, but really high scores were rare due to lack of depth to the answers
to part (d).
Requirement (b) was also generally well answered, although full marks were far rarer due to a lack of
awareness of what our decision should be based on. Most were able to calculate the loss of $42,000.
Unfortunately the most common answer given was to close in Q1, to prevent making this loss. Essentially
this is a relevant costing issue – if we close in Q1, do we prevent the whole loss? A little bit more care would
lead us to realise that the fixed costs are just that – fixed. If we close in Q1 we lose the contribution of
$108,000, but the fixed costs remain. We could discuss if any of the fixed costs COULD be saved, but by
that point we’ve done enough to realise that with the information given, closing the hotel is a bad idea.
Answer to requirement (c) became a bit more muddled. There was more information to deal with, so this is
understandable, although it was pleasing to note that many candidates picked up marks through application
of their knowledge, even if they had misunderstood some of the information given. The contribution per
package, or C/S ratio was often incorrectly calculated, but breakeven revenue was still obtained, along with
sensible discussion. Recommendations should follow from the results, so it was possible to come to a
different conclusion to the suggested answer and still be given credit. It was again pleasing to see so many
responses here considering the low contribution of this package, and how unlikely it would be to improve
results.
As already mentioned, answers to requirement (d) often let candidates down. Interpretation of the breakeven
chart was usually performed well – candidates were able to calculate important figures such as selling price
and variable costs (and therefore contribution per unit). Stronger answers were able to analyse these in terms
of the effect the new restaurant would have, and also whether it seemed to be a good idea or not. For
example, many candidates were able to identify the new margin of safety, and would gain some credit for
this. However, better answers would then discuss whether the hotel’s position was better or worse – showing
an understanding of what margin of safety means to a business. A conclusion, whilst not essential, could
also give weight to an answer – overall, does it seem like a good idea or not?
Examiner’s commentary – F5 sample questions March/June 2018
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Responses to requirement (a) were usually very good, with a significant proportion of candidates picking up
full marks. It was clear that this topic, and the formulas required, had been covered by most candidates as
part of their studies.