15111566 ACCA CAT Paper T7 Plan Cont and Perf Management Solved Past Papers

Certified ACCounting teChniCiAn exAminAtion

SAmple multiple ChoiCe queStionS – June 2009

Paper T7 Planning Control and Performance Management Sc A y All questions are compulsory Note: Section B of the actual exam paper will contain four written questions

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t w ss a yca  s a w aa  Sc A   aa a  J 2009 was. t w b a a   ss  sc A. A ss  Sc A w b w w aks ac.

1

Four years ago material X cost $5 per kg and the price index most appropriate to the cost of material X stood at 150. The same index now stands at 430. Wa s  bs sa   c cs  aa x  k?

2

A

$1.74 ($5 × 150 ÷ 430)

B

$9.33 ($5 × (430 – 150) ÷ 150

C

$14.33 ($5 × 430 ÷ 150)

d

$21.50 ($5 × 430 ÷ 100)

(2 aks)

Wc    w w s   bs bs sc sc  a  b? A

A budget that is continuously updated by adding a further accounting period when the earliest accounting period has expired.

B

A budget that is adjusted for known changes in volume during the accounting period.

C

A budget that, by recognising cost behaviour patterns, is designed to change as volume of activity changes.

d

A budget that is prepared by higher levels of management and then communicated to lower levels of management. (2 aks)

3

In the last year a division’s controllable return on investment was 25% and its controllable profit was $80,000. The cost of finance appropriate to the division was 18% per annum. Wa was  vs’s cab sa c   as ya? A

$5,600

$80,000 × (0.25 – 0.18)

B

$22,400

$80,000 – ($80,000 ÷ 0.25 × 0.18)

C

$74,400

$80,000 – ($80,000 × (0.25 – 0.18)

d

$76,400

$80,000 – ($80,000 × 0.25 × 0.18)) (2 aks)

4

The standard raw material cost for a unit of production is 2 kg at $4.00 per kg. Purchases for a period were 13,000 kg at an actual cost of $4.50 per kg. Raw material inventory, which are valued at standard cost, increased by $8,000 in the period. Budgeted production for the period was 6,000 units but actual production was only 5,000 units. Wa was  aw aa sa vaac   ? A

$20,000 Adverse

(5,000 × 2kg – (13,000kg + $8,000 ÷ $4.00/kg) × $4.00

B

$4,000 Adverse

(5,000 × 2kg – (13,000kg – $8,000 ÷ $4.00/kg) × $4.00

C

$4,000 Favourable

(6,000 × 2kg – (13,000kg – $8,000 ÷ $4.00/kg) × $4.00

d

$12,000 Favourable

(13,000kg – 5,000 × 2kg) × $4.00 (2 aks)

2


5

A government body uses measures based upon the ‘three Es’ to the measure value for money generated by a publicly funded hospital. It considers the most important performance measure to be ‘cost per successfully treated patient’. Wc    e’s bs scbs  abv as? A

Economy

(A measure of cost related to input)

B

Effectiveness

(A measure of output related to objectives)

C

Efficiency

(A measure of output related to input)

d

Externality

(Not one of the three Es) (2 aks)

6

The following observations have been made of total overhead cost. Output level (units) Total overhead cost ($)

5,000 14,000

10,000 27,000

The variable element of total overhead cost is known to increase by $1 per unit at output levels above 7,000 units. Wa s  vaab   a va cs a a  v  5,000 s? A

$2.00 per unit

($27,000 – $14,000 – 3,000 units × $1) ÷ (10,000 units – 5,000 units)

B

$2.60 per unit

($27,000 – $14,000) ÷ (10,000 units – 5,000 units)

C

$3.20 per unit

($27,000 – $14,000 + 3,000 units × $1) ÷ (10,000 units – 5,000 units)

d

$3.60 per unit

($27,000 – $14,000) ÷ (10,000 units – 5,000 units) + $1 (2 aks)

7

The following statements have been made about linear regression analysis: (i) (ii) (iii) (iv)

It provides more accurate estimates estimates than than the the high high low low technique. technique. It can only be used to estimate variable cost It assumes that cost behaviour is linear. linear. It only takes into account two observations of cost and output

Wc   w sas ab  s  a ss aayss  cs sa a ?

8

A

(i) and (ii)

B

(i) and (iii)

C

(ii) and (iii)

d

(iii) and (iv)

(2 aks)

A manufacturing company always carries finished goods inventory equal to 20% of the next month’s budgeted sales. Sales for the current month are 2,000 units and are budgeted to be 20% higher next month. hw ay s w b c   c ? A

2,080

B

1,920 (400 + 2000 – 480)

C

2,000 (no adjustment)

d

2400 (2000 + 400) (2 aks)

3


9

A company charges a price of $10 per unit in order to earn a 20% MARGIN on sales. It plans to change its price so as to earn a 30% MARK-UP on cost. Wa w b  ca ca  c? A

4.0 % increase

($10 × 80% × 130% – $10) ÷ $10 × 100%

B

10.0 % increase

(30% – 20%)

C

50.0% increase

(30 – 20) ÷ 20 × 100%

d

62.5 % increase

($10 ÷ 80% × 130% – $10) ÷ $10 × 100% (2 aks)

10 Wc   w a cs  a  ss aayss? () t () Sasa vaa () Cycca vaa A

(i) and (ii) only

B

(i) and (iii) only

C

(ii) and (iii) only

d

(i), (ii) and (iii) (2 aks)

e  Sa qss

4

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Answers

5


Sa m Cc qs pa t7 pa, C a pac maa

1

C

2

A

3

B

4

B

5

C

6

A

7

B

8

A

9

A

10

D

Asws

6


Planning, Control and Performance Management ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL TUESDAY 8 JUNE 2004

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

7 T r e p a P

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All FOUR questions are compulsory and MUST be attempted 1

Matthews Ltd is a small company operating in the pottery industry. Its board of directors believes that managers are best motivated by financial incentives. The company pays a monthly bonus of 10% of profit earned in their respective divisions to the divisional managers. Managers are given autonomy over production and sales matters. The company is split into four divisions. The Eastern division has faced a steady demand for its product with some seasonal variation. The manager of the Eastern division, however, has reported significantly increased profits in May 2004. The board of directors is now questioning the size of her bonus payment, particularly as she has already resigned and will leave the company in June 2004. Eastern division profit and loss accounts for the last two months are shown below. Matthews Ltd uses an absorption costing system. Profit and Loss Account for the month ended

Sales Opening stock finished goods Variable production cost Absorbed fixed production cost Closing stock finished goods Cost of sales (Under)/over absorption Gross profit

30 April 2004 £000 £000 350·0 9·0 200·0 100·0 (9·0) ––––– (300·0) 0·0 –––––– 50·0

31 May 2004 £000 £000 280·0 9·0 400·0 200·0 (369·0) –––––– (240·0) 100·0 –––––– 140·0

(10·0) (35·0) –––––– 5·0 (0·5) –––––– 4·5 ––––––

(10·0) (28·0) –––––– 102·0 (10·2) –––––– 91·8 ––––––

Fixed selling and administration expenses Variable selling and administration expenses Profit before bonus Bonus Net Profit The 1. 2. 3. 4.

following information is also available Selling price per case of finished product was £350 in both months Variable production cost was £200 per case in both months Fixed production overheads are recovered on the basis of budgeted monthly production of 1,000 cases Actual fixed production overheads were £100,000 in each month, exactly as budgeted.

Required: (a) Calculate the number of cases produced and the number of cases sold per month in both April and May (4 marks) 2004. (b) Redraft the above profit and loss accounts on a marginal costing basis for both April and May 2004 and calculate the bonus to be paid to the Eastern division manager in each month if the bonus was set at 10% (12 marks) of marginal costing profit. (c) Write a report to the board of directors of Matthews Ltd which will (i)

explain, with supporting figures, any differences between the net of bonus profit figures in (b) and those in the absorption costing statements;

(ii) discuss any apparent problems associated with the performance of the Eastern division in May 2004 even though its absorption costing profit has improved; (iii) discuss the wisdom of basing bonus payments on profits calculated on an absorption costing basis; and (iv) suggest and justify two alternative bonus schemes which might be improvements on that currently (15 marks) operated. 2


Matthews’ Western division anticipates steadily growing demand for its products, subject to some seasonal variation. Recently it has employed the services of a statistician to help forecast sales. The following extracts from the statistician’s report are available.

Based on linear regression analysis the quarterly trend in sales units for the Western division may be represented by the equation: y = 1,500 + 60x where y = forecast sales trend in cases per quarter x = the quarter number, where the first quarter of the year 2000 = 1, the second quarter of the year 2000 = 2, etc. The average seasonal variation in sales follow an additive model with the following quarterly variations. Quarter Seasonal Variation (Cases)

1

2

3

4

+50

–40

–60

+50

(Note: a quarter is a period of 3 months)

(d) In the context of a time series analysis of sales, explain the meaning of the terms ‘trend’ and ‘seasonal (4 marks) variation’. (e) Use the information provided by the statistician to forecast sales in cases for the last quarter of 2004 for the Western division. (5 marks) (40 marks)

3


[P.T.O.

2

Mortensen plc manufactures wooden toys. It uses a standard costing system to control costs. The cutting department cuts the shapes which are sold as toy animals. The process is very labour intensive and requires highly skilled labour to minimise the wastage of the expensive hardwood used. The standard cost card for a set of toy animals is given below. Hardwood Direct labour Fixed overhead

0·1 cubic metres at £160 per cubic metre 30 minutes at £9 per hour 30 minutes at £4 per direct labour hour

Total cost

£ 16·00 14·50 12·00 –––––– 22·50 ––––––

Fixed overhead absorption rates are based upon budgeted monthly fixed overheads of £26,000 and a budgeted monthly output of 13,000 sets of animals. All stocks are recorded at standard cost. In the most recent month 14,000 sets of animals were made using 1,600 cubic metres of hardwood. Purchases for the period were 1,800 cubic metres of hardwood at £150 per cubic metre. 8,000 direct labour hours were worked and paid at £9·25 per hour. Actual fixed overheads were £23,000 for the month. Required: (a) Calculate the following variances from standard cost for the most recent month: (i) Raw material price (ii) Raw material usage (iii) Labour rate (iv) Labour efficiency (v) Fixed overhead expenditure (vi) Fixed overhead volume (vii) Fixed overhead capacity (viii)Fixed overhead efficiency

(10 marks)

(b) Explain the meaning and possible causes of the raw material and fixed overhead variances you have calculated in part (a). (10 marks) (20 marks)

4


3

Perry plc is a large conglomerate company structured on a divisional basis. It seeks to maximise investor wealth. Head office avoids day to day involvement in divisional affairs and only intervenes if performance is considered unsatisfactory. Divisional performance is measured by residual income. One of Perry’s larger divisions operates a chain of high class hotels throughout the United Kingdom. The division’s mission statement is ‘To be the hotel of first choice for bu siness users and tourists’. Although the chain has generally been popular with tourists it is not proving quite so popular with business users and conference organisers. Competition in the top segment of the hotel market is fierce, with customers expecting the highest standards of facilities, service and catering. Over the last two years the division has invested a large amount of money in modernising its hotels including the improvement of bedrooms and public rooms, installation of gymnasia and swimming pools and the information technology features required by business travellers. A large amount of money has also been spent on staff training to improve service levels and on a television advertising campaign to promote the improved hotels to business users. Head office is concerned that the performance of the hotel chain appears to have declined over the last few years despite this expenditure. The following figures are available: 2001 50 15

Capital employed Operating profit

£ million 2002 70 16

2003 90 17

The cost of capital applicable to the hotel division is 20% per annum. Required: (a) Calculate the residual income for the hotel chain for each of the three years.

(3 marks)

(b) Discuss the advantages and disadvantages of residual income as a divisional performance measure. (5 marks) (c) Explain the advantages to Perry plc of a balanced scorecard approach to divisional performance measurement. (4 marks) (d) Suggest for each of the following headings two critical success factors suitable for the hotel chain: (i)

financial success;

(ii) customer satisfaction; (iii) process efficiency; (iv) organisational learning and growth. For each critical success factor suggest one key performance indicator suitable for the hotel chain. (8 marks) (20 marks)

5


[P.T.O.

4

Taylor Ltd manufactures a single product using a labour intensive production process. Its quality control department tests the final product before it leaves the factory and at present 20% of its pre-inspection output is rejected and scrapped. Scrap units have no value and cannot be reworked. Taylor builds the cost of scrapped units into the cost of good production. A standard cost card for Taylor’s product under its current production method is given below £ per unit 15·00 10·00 5·00 –––––– 30·00 7·50 –––––– 37·50 60·00 –––––– £22·50 ––––––

Direct material 3 kgs at £5 per kg Direct labour (variable) Variable overhead Cost pre-inspection per unit produced Cost of rejects Variable cost per good unit Selling price per good unit Contribution per good unit

Total fixed overheads are budgeted at £148,500 per month. Taylor currently sells 9,000 un its per month. Negligible stocks are held. Two proposals are being considered to reduce the reject rate: Proposal 1. To automate the process by hiring a machine for £120,000 per month. This would lead to a 50% reduction in labour cost per unit and the quality of the manufacturing process would improve so that reject rates would fall to 5% of pre-inspection output. Variable overhead and material cost per unit (pre-inspection) would be unchanged. Existing fixed overheads would be unchanged. Proposal 2. To continue with the present labour intensive operations and to introduce a total quality management programme. The aim of this programme would be to reduce the reject rate to zero within the coming year. Required: (a) Calculate the break even point in good units per month for the current manufacturing process.

(2 marks)

(b) Calculate the break even point in good units per month for the automated process under proposal 1. (5 marks) (c) Calculate the output level in good units per month at which proposal 1 and the current manufacturing process would have the same total cost. Comment briefly on your result. (5 marks) (d) In a total quality management programme, such as proposal 2, quality-related costs are commonly categorised under the headings of Internal failure costs External failure costs Appraisal costs and Prevention Explain the meaning of each of these terms and give one example of each type of cost in a manufacturing (8 marks) business such as Taylor Ltd. (20 marks)

End of Question Paper

6


Answers



ACCA Certified Accounting Technician Examination – Paper T7 Planning, Control and Performance Management 1

(a)

Number of cases produced and sold Sales (£350,000 ÷ £350) Production (£200,000 ÷ £200)

(b)

June 2004 Answers

April 1,000 1,000

(£280,000 ÷ £350) (£400,000 ÷ £200)

May 1,800 2,000

Marginal costing profit statements Profit and loss accounts for the month ended 30 April 2004 £000 £000 Sales 350·0 Opening stock finished goods 6·0 Variable production cost 200·0 Closing stock finished goods (6·0) –––––– Variable cost of sales (200·0) Variable selling and administration expenses (35·0) –––––– Contribution 115·0 Fixed production cost (100·0) Fixed selling and Administration expenses (10·0) –––––– Profit before bonus 5·0 Bonus (0·5) –––––– Net profit 4·5 ––––––

31 May 2004 £000 £000 280·0 6·0 400·0 (246·0) –––––– (160·0) (28·0) –––––– 92·0 (100·0) (10·0) –––––– (18·0) 0·0 (18·0) ––––––

Workings April opening stock finished goods = £9,000 ÷ £300 x £200 = £6,000 April closing stock finished goods = £9,000 ÷ £300 x £200 = £6,000 May closing stock finished goods = £369,000 ÷ £300 x £200 = £246,000 (c)

Report Report To: Board of directors Matthews Ltd From: A Certified Accounting Technician Subject: Profit measurement and bonus scheme Date: Today Differences in profit Figures The difference in net profit figures for May 2004 is due to a change in costing principle. Absorption costing values finished goods closing stock at full production cost (fixed and variable cost). In a period where finished goods stocks increase some fixed overheads are carried forward to the next period in the finished goods closing stock valuation. Marginal costing values finished goods closing stock at variable production cost only. Fixed production costs are written off against profit in the period they are incurred. Thus in a period where production is greater than sales, as in May 2004, absorption costing will show a higher profit figure as a large proportion of May’s fixed production cost is carried forward in the closing stock valuation. The statement below reconciles the two profit figures. £000 91·80

Absorption costing profit Less

Stock increase in cases x £100 per case 1,200 cases x £100

(120·00)

Plus

Difference in bonus payments Marginal costing profit

10·20 (18·00)

Problems with the performance of eastern division Although the Eastern division has increased its reported profit (under absorption costing principles) two problems have occurred. Firstly its sales have fallen leading to less contribution, and secondly the ‘profit’ has been generated by building up large stocks of finished goods. The holding costs of these goods could be high, and given Eastern’s static market there seems little reason to carry them.

9


Bonus systems based upon absorption costing principles The danger of basing bonus schemes on absorption costing profit is that managers are effectively rewarded for increasing stocks. In May the manager of the Eastern division increased the reported profit figure (and her bonus) although her contribution to the financial well-being of the company is questionable. If managers are given autonomy over production levels there is a danger that they ‘play the system’ to manipulate profits and boost their earnings. Improved Bonus Systems Many alternative bonus schemes could be adopted, examples include – Basing bonus upon contribution or marginal cost net profit. This would result in bonus varying with sales and costs, not production levels. – Bonus payments based upon non financial indicators of performance such as a balanced scorecard approach. This would focus manager’s attention on the long term success of their operations rather than short term financial performance. – Bonus payments could be based upon measures such as return on investment or residual income. This would focus managers’ attention upon capital invested as well as profit earned. (d)

Trend and seasonal variation In the context of time series analysis of sales, trend refers to the general direction in which a graph of sales goes over a long interval of time. Seasonal variations are the identical (or almost identical) patterns which sales follow during corresponding intervals of successive periods. For example many retail businesses each year experience an increase in sales before Christmas only to see them fall again after the Christmas period.

(e)

Sales Forecast Trend y = 1,500 + 60x y = 1,500 + (60 * 20) = 2,700 Seasonal variation Last quarter of the year = + 50 Forecast = 2,700 + 50 = 2,750 cases

2

(a)

Variances Direct Material actual purchases at actual price actual purchases at standard price actual usage at standard price standard usage at standard price Direct Labour actual hours at actual rate actual hours at standard rate standard hours at standard rate

1,800m3 at £150 = £270,000 (i) Raw material price variance 1,800m3 at £160 = £288,000 3 1,600m at £160 = £256,000 (ii) Raw material usage variance 14,000 sets at 0·1m3 at £160 = £224,000

8,000 hours at £9·25 = £74,000 (iii) Direct labour rate variance 8,000 hours at £9·00 = £72,000 (iv) Direct labour efficiency variance 14,000 sets at 0·5 hours at £9·00 = £63,000

£18,000 FAV

£32,000 ADV

£2,000 ADV £9,000 ADV

Fixed Overhead Actual fixed overheads

= £23,000 (v) Fixed overhead expenditure variance Budgeted fixed overheads = £26,000 (vii) Fixed overhead capacity variance Actual labour hours at standard absorption rate 8,000 hours at £4 = £32,000 (viii) Fixed overhead efficiency variance Standard labour hours at standard absorption rate 14,000 sets at 0·5 hours at £4 = £28,000 capacity + efficiency = £6,000 FAV + £4,000 ADV = (vi) Fixed overhead volume variance

£3,000 FAV £6,000 FAV £4,000 ADV

£2,000 FAV

10


(b)

Meaning and possible cause of variances The raw material price variance shows that wood was purchased at a lower price than standard. This saved £18,000 on the material purchased. This saving could have many potential causes including a change of supplier, a fall in market prices, better price negotiation or by buying a lower grade of material. The material usage variance is £32,000 adverse showing that more material was used than standard. Again there are many potential causes including careless use of material, pilferage, or problems resulting from the use of poorer quality material. The two variances could possibly be related, as the favourable price variance could have been achieved by buying material of an inferior quality leading to more wastage than usual. If this is the case then the decision to buy cheaper material was a poor one as the material cost variance is £14,000 adverse. The fixed overhead expenditure variance is favourable, indicating that less has been spent on fixed overheads than budgeted. This could be caused by price reductions or seasonal effects. The fixed overhead volume variance is favourable indicating an over absorption of overhead caused by producing more sets than budgeted. This can be considered good news as long as the extra production can be sold. The capacity and efficiency variances indicate the cause of this over absorption. Because we worked more labour hours than budgeted we could have absorbed £6,000 more overhead than budgeted. However par t of this over absorption was lost due to inefficient labour and at standard labour hours £4,000 of this over absorption is cancelled out leading to an overall volume variance of £2,000 favourable.

3

(a)

Residual income

Operating profit Imputed interest charge £50m x 20% £70m x 20% £90m x 20% Residual income

(b)

£million 2002 16

2001 15

2003 17

(10) (14) –––– 5 ––––

–––– 2 ––––

(18) –––– (1) ––––

Advantages and disadvantages of residual income Advantages – It makes divisional managers aware of the cost of financing their divisions. – It is an absolute measure of performance and not subject to the problems of relative measures such as return on investment. – In the long run it supports the net present value approach to investment appraisal (the present value of a project’s residual income equals net present value of that project). Disadvantages – In common with most other divisional performance measures, problems exist in defining controllable and traceable income and investment. – Residual income gives the symptoms not the causes of problems. If residual income falls the figures give little clue as to why. – Problems exist in comparing the performance of different sized divisions (large divisions will earn larger residual incomes simply due to their size). – Residual income when applied on a short term basis is a short term measure of performance and may lead managers to overlook projects whose payoffs are long term. This could well be the case for the hotel chain.

(c)

Advantages of a balanced scorecard approach The balanced scorecard approach seeks to measure performance under a variety of headings of financial success, customer satisfaction, process efficiency and organisational learning and growth. – It measures performance in a variety of ways, rather than relying on one figure. – Managers are unlikely to be able to distort the performance measure, bad performance is difficult to hide if multiple performance measures are used. – It takes a long-term perspective of business performance. – Success in the four key areas should lead to the long-term success of the organisation. – It is flexible, what is measured can be changed over time to reflect changing priorities. – ‘What gets measured gets done’, that is if managers know they are being appraised on various aspects of performance they will pay attention to these areas, rather than simply paying lip service to them.

11


(d)

CSFs and KPIs Critical Success Factor

Key performance indicator

Investor wealth Cash flow

residual income achievement of cash flow targets

Service levels Facilities Catering

number of complaints customer questionnaire results customer questionnaire results

Check-in Facility utilisation

average check-in time % utilisation of pools and gym

financial success

customer satisfaction

process efficiency

organisational learning and growth Penetration of business market Usage of new facilities

4

(a)

(b)

Break even point in good units = Monthly fixed costs = –––––––––––––––– contribution per good unit

% growth in business usage revenue from new facilities

=

£148,500 ––––––––– £22·5 per unit

=

6,600 units

Break even point in good units for the automated process Revised cost card Selling price Direct materials Direct labour Variable overhead Quality control rejects (5%) (w1) Contribution per good unit Revised break even point

=

=

£ per good unit 60·00 15·00 5·00 5·00 1·32 –––––– £33·68 –––––– New monthly fixed costs ––––––––––––––––––––– New contribution per unit £148,500 + £120,000 ––––––––––––––––––––– £33·68

= 7,972 units

Working 1: (£15 + £5 + £5) ÷ 0·95 x 0·05 = £1·32 per good unit (c)

Output level in good units per month at which the current process and proposal 1 have the same total monthly cost. If q = output level in good units per month, then total costs for each alternative are Current process

Total Cost = £48,500 + £37·5 q

Proposal 1

Total Cost = £148,500 + £120,000 + £26·32 q

To find the point where total cost is equal, solve the following for q £148,500 + £37·5 q = £148,500 + £120,000 + £26·32 q =

£11·18q = £120,000 £120,000 q = ––––––––– = 10,733 £11·18

(Or more directly

Increase in fixed costs ––––––––––––––––––––––––––– decrease in variable cost per unit

= =

£120,000 ––––––––– £11·18 10,733 units

Comment: This is in excess of Taylor’s current monthly sales and appears non viable.

12


(d)

Costs of quality Internal failure costs These are quality costs that are discovered before the product is delivered to the customer. Examples include rework costs, net cost of scrap, down time due to quality problems, etc. External failure costs These are discovered after the product has been delivered to customers. Examples include complaint investigation, warranty claims, cost of lost sales, product recalls etc. Appraisal costs These are the costs of monitoring and inspecting products before they are released to customers. Examples include measurement equipment, inspection and tests, test equipment expense, etc. Prevention costs These include investment in machinery, technology and training to reduce the number of defective products. Examples include training programmes, supplier reviews, field trials, cost of research into customer needs, etc.

13



ACCA Certified Accounting Technician Examination – Paper T7 Planning, Control and Performance Management

1

2

(a)

Sales Production

(b)

Sales Opening Stocks Closing Stock May Contribution Profit pre bonus Bonus

(c)

Report format Abs and marginal approaches Explained Reconciliation (2 if bonus omitted) Sales problem Stock problem Bonus problem 2 per improved system max

June 2004 Marking Scheme Marks 2 2 ––– 4 2 2 2 2 2 2 ––– 12 1 2 3 1 2 2 4 ––– 15

(d)

Trend Seasonal

2 2 ––– 4

(e)

Trend Seasonal Forecast

2 1 2 ––– 5 ––– 40 –––

(a)

Raw material price (1 if based on usage) Raw material usage Labour rate Labour efficiency Fixed overhead expenditure Fixed overhead volume Fixed overhead capacity Fixed overhead efficiency

(b)

2 1 1 1 1 1 1 2 ––– 10

Meaning and possible cause of Price variance Usage variance Possible interrelationship of material price and usage Expenditure variance Capacity variance Efficiency variance Volume variance

1 1 2 1 2 2 1 ––– 10 ––– 20 –––

15


3

4

Marks 3

(a)

1 mark for each year

(b)

1 per advantage or disadvantage max

5

(c)

1 per advantage max

4

(d)

1 per each CSF + KPI, max 2 for each heading

8 ––– 20 –––

(a)

Method Break even point

1 1 ––– 2

(b)

New New New New

2 1 1 1 ––– 5

(c)

Method Output level

3 2 ––– 5

(d)

Explanations 4 x 1 Examples 4 x 1

4 4 ––– 8 ––– 20 –––

reject cost contribution fixed costs break even point

16


Planning, Control and Performance Management ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL TUESDAY 7 DECEMBER 2004


7 T r e p a P

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall


ALL FOUR questions are compulsory and MUST be attempted 1

(a) Explain four benefits which would result from the introduction of a budgeting system by a company. (8 marks) (b) Bowyer Ltd is a small company that manufactures sports wear. Its financial director is considering setting up a budgeting system. As a starting point he needs to decide on monthly production levels for the first three months of 2005. Bowyer Ltd’s products are very popular and the firm expects to be able to sell up to 20,000 units of each of its two products (shirts and shorts) per month. However, for the the first three months of 2005 production will be constrained by a lack of di rect labour. It is estimated that only 6,000 hours of direct labour will be available each month. For sales reasons production of either of the two garments must be at least 25% of the production of the other. Because of building works in the factory Bowyer is unable to carry any month end stock of fin ished goods or raw materials in the first quarter (three months) of the year. There will be no opening stocks at the beginning of January. Estimated costs and revenues per garment are as follows: £ per garment shirts shorts £ £ 30 22

Sales price Raw materials Fabric at £12 per square metre Dyes and cotton Direct labour at £8 per hour Fixed overheads at £4 per hour

(12) (3) (4) (2) –––– £9 –––– ––––

Profit

(6) (2) (2) (1) –––– £11 –––– ––––

Required: Calculate the number of shirts and shorts to be produced per month in the first quarter of 2005 to maximise (8 marks) Bowyer Ltd’s profit. (c) After the first three months of 2005 direct labour will no longer be a constraint, due to recruitment of more workers. Building work will also be complete and the firm will once again be able to carry stock. The company expects to be able to sell 15,000 shirts and 20,000 shorts in April 2005. Sales volumes are expected to grow at 2% per month cumulatively thereafter throughout 2005. The following additional information is available. 1. 2. 3.

The company intends to carry a stock of finished garments sufficient to meet 40% of the next month’s sales. The company intends to carry sufficient raw material stock to meet the following month’s production. The estimated variable costs and selling prices per unit for shirts and shorts are as detailed above.

Required: Prepare the following budgets on a monthly basis for each of the three months April to June 2005: (i)

A sales budget showing sales units and sales revenue for each product;

(4 marks)

(ii) A production budget (in units) for each product;

(8 marks)

(iii) A fabric purchases budget (in square metres).

(4 marks)

2


(d) The financial director has not discussed the proposed budgeting system with junior managers. He is considering imposing production and sales budgets upon them, without their involvement. Explain the following approaches to budget setting and give two advantages of each approach. (i) a ‘top down’ (or imposed) approach; and (ii) a ‘bottom up’ (or participative) approach.

(8 marks) (40 marks)

3


[P.T.O.

2

John Robertson, a self employed builder, has been asked to provide a fixed price quotation for some building work required by a customer. Robertson’s accountant has compiled the following figures, together with some notes as a basis for a quotation. £ Direct materials: Bricks 200,000 at £100 per thousand 200,000 at £120 per thousand Other materials Direct labour: Skilled 3,200 hours at £12 per hour Unskilled 2,000 hours at £6 per hour Other costs: Scaffolding hire Depreciation of general purpose machinery General overheads 5,200 hours at £1 per hour Plans Total cost Profit Suggested price

20,000 24,000 5,000

note 1 note 2

38,400 12,000

note 3 note 4

3,500 2,000 5,200 2,000 –––––––– 112,100 22,420 –––––––– £134,520 –––––––– ––––––––

note 5 note 6 note 7 note 8 note 9

Notes 1. The contract requires 400,000 bricks, 200,000 are already in stock and 200,000 will have to be bought in. This is a standard type of brick regularly used by Robertson. The 200,000 in stock were purchased earlier in the year at £100 per 1,000. The current replacement cost of this type of brick is £120 per 1,000. If the bricks in stock are not used on this job John is confident that he will be able to use them later in the year. 2. Other materials will be bought in as required; this figure represents the purchase price. 3. Robertson will need to be on site whilst the building work is performed. He therefore intends to do 800 hours of the skilled work himself. The remainder will be hired on an hourly basis. The current cost of skilled workers is £12 per hour. If John Robertson does not undertake the building work for this customer he can either work as a skilled worker for other builders at a rate of £12 per hour or spend the 800 hours completing urgently needed repairs to his own house. He has recently had a quotation of £12,000 for labour to repair his home. 4. John employs four unskilled workers on contracts guaranteeing them a 40 hour week at £6 per hour. These unskilled labourers are currently idle and would have sufficient spare time to complete the proposal under consideration. 5. This is the estimated cost of hiring scaffolding. 6. John estimates that the project will take 20 weeks to complete. This represents 20 weeks’ straight line depreciation on equipment used. If the equipment is not used on this job it will stand idle for the 20 week period. In either case its value at the end of the 20 week period will be identical. 7. This represents the rental cost of John’s storage yard. If he does not undertake the above job he can rent his yard out to a competitor who will pay him rent of £500 per week for the 20 week period. 8. This is the cost of the plans that John has already had drawn for the project. 9. John attempts to earn a mark up of 20% on cost on all work undertaken. John is surprised at the suggested price and considers it rather high. He knows that there will be a lot of competition for the work. Required: Using relevant costing principles, calculate the lowest price that John could quote for the customer’s building work. Explain your treatment of each item in the accountant’s estimate. (20 marks) Note: 11 marks are available for calculation and 9 marks for explanation.

4


3

(a) Birtles plc is a manufacturer of small domestic electrical appliances. Its market is very competitive in terms of both price and new product innovation. As a result product life cycles are short. Birtles plc’s managers are concerned about the reliability of its product costing system. It currently uses an absorption costing system, and absorbs overheads on the basis of budgeted direct labour hours. On this basis the estimated cost of its latest product, a talking electric kettle, is as follows: Direct material Direct labour (£12 per hour) Production overheads (£120 per hour) Production cost

£ per unit 4·50 0·50 5·00 ––––– 10·00 ––––– –––––

The firm’s management accountant has suggested that more accurate product costs would be obtained if an activity based costing (ABC) approach were used. He has collected the following information as a starting point for an ABC treatment of production overhead costs. Budgeted factory overhead per annum Cost Pools Cost per annum £000 Stores administration 5,000 Production line set ups 3,000 Dispatch 1,000 Other overheads 3,000 ––––––– Total production overhead 12,000 ––––––– ––––––– Estimated activity per annum Cost Driver Number of components Number of set ups Number of dispatches Direct labour hours

Cost Driver Number of different components Number of set ups Number of dispatches Direct labour hours

Total Activity per annum 2,000 items 10,000 set ups 20,000 dispatches 100,000 hours

Each talking kettle uses 10 different components and kettle manufacture will involve six production line set ups per annum. Five hundred dispatches will be required per annum. Budgeted production is 10,000 kettles per annum. Required: Estimate the cost of a talking kettle using an ABC approach and the cost drivers suggested by the management accountant. (8 marks) (b) Birtles plc’s Finance Director supports the proposal to introduce activity based costing but argues that the firm should consider all the costs involved in the development, production and marketing of the kettle. In addition to the above ABC costs, £30,000 has already been spent on research and development for the talking electric kettle and he estimates that a further £5,000 will be spent on marketing the new product. There are no other costs attributable to the new product. Total sales over its life will be 10,000 units per annum for the next two years. On past experience he knows that the firm will have to reduce the selling price of the kettle by 40% in its second year of sales in order to remain competitive. Required: Calculate the price to be charged per unit for the talking electric kettle in the first year of sales so that it will earn an OVERALL 20% margin on sales over its two year life after covering ALL attributable costs outlined (8 marks) above. (c) Explain what is meant by life-cycle costing. Give two reasons why a life cycle costing approach could be of (4 marks) value to Birtles plc. (20 marks) 5


[P.T.O.

4

Francis plc is a manufacturing company. It assesses managerial performance by comparing actual with budgeted results. Due to staff shortages in the accounting department, figures for November 2004 budget reports have been prepared by a trainee. A copy of the budget report for November 2004 for the appliances division is given below. Sales and production volumes (units) Sales revenue Direct material Direct labour Other manufacturing costs Divisional fixed overhead Profit

Budgeted 5,000

Actual 5,500

Variance 500 F

£000 1,000 (250) (150) (300) (200) –––– 100 –––– ––––

£000 1,078 (286) (176) (308) (190) –––– 118 –––– ––––

£000 78 F 36 A 26 A 8A 10 F ––––– 18 A ––––– –––––

Note: F = favourable variance A = adverse variance. The manager of the appliances division does not believe that the variances calculated give a fair assessment of her division’s performance. She thinks that the budget figures are inappropriate and that a flexed budget should be used to calculate the variances. To assist in preparing a flexed budget she provides the following information: 1. 2. 3. 4.

Budgeted selling price is £200 per unit and actual selling price was £196 per unit. Direct material is a variable cost. Budgeted direct labour cost has a fixed element of £50,000 per month, the balance is variable. Other manufacturing costs are semi-variable. Budgeted cost and output for the previous two months have been as follows: Month Budgeted Output (units) Budgeted Cost (£000)

October 2004 4,000 210

September 2004 3,000 170

There is known to be ‘step up’ of £50,000 in the fixed element of this cost for volumes in excess of 4,500 units. Required: (a) Explain why budget variances should be calculated using flexed budget figures.

(3 marks)

(b) Prepare a flexed budget for the appliances division for November 2004 and recalculate the budget variances. (9 marks) (c) Briefly discuss four factors that should be considered before deciding whether to investigate the causes of a (8 marks) variance. (20 marks)


6


Answers




(a)

December 2004 Answers

Benefits of a budgeting system. Budgeting systems are useful in the planning and control of a business. In planning they help to – Coordinate the activities of various functional areas, for example by ensuring that the production department is making the products that the sales department are trying to sell. – Ensure the best uses of scarce resources. – Communicate the organisation’s plan to managers and employees. – Force managers to plan for the coming period. In the control area they – Allocate responsibility for various aspects of the business to budget holders. – Authorise expenditure by managers. – Provide targets that can help in the motivation of managers and staff. – Allow the evaluation of managerial performance by comparing actual performance against budget. – Provide useful control information, in the form of variances, calculated by comparing actual performance with budget. – Prompt corrective action when actual results deviate from budgeted results.

(b)

Production plan £ per unit Shirts Shorts £ £ 30 22 19 10 –––– –––– £11 £12 –––– –––– –––– ––––

Selling price Variable cost Contribution Labour hours Contribution per labour hour Rank

0·5 £22/hour 2nd

0·25 £48/hour 1st

Shorts give most contribution per unit of the limiting factor. The sales constraint requires us to make at least one shirt for every four shorts. We can therefore think of production being in ‘packages’ of four shorts and one shirt. Each package would require 4 x 0·25 hours + 1 x 0·5 hours = 1·5 hours In 6,000 labour hours the company could produce 6,000 ––––––––– 1·5 hours

= 4,000 ‘packages’

In 6,000 labour hours the company could therefore produce 6,000 hours x 4 –––––––––––––– 1·5 hours

= 16,000 shorts

and 6,000 x 1 ––––––––– 1·5 hours (c)

= 4,000 shirts

Functional budgets (i)

Sales Budgets Units April May June Total

15,000 15,300 15,606 ––––––– 45,906 –––––––

Shirts Price £ 30 30 30

Revenue £ 450,000 459,000 468,180 ––––––––––– £1,377,180 –––––––––––

Units 20,000 20,400 20,808 ––––––– 61,208 –––––––

Shorts Price £ 22 22 22

Revenue £ 440,000 448,800 457,776 ––––––––––– £1,346,576 –––––––––––

Total Revenue £ 890,000 907,800 925,956 ––––––––––– £2,723,756 –––––––––––

9


(ii)

Production Budgets Shirts Closing stock (w1) Sales Less

opening stock

Production

April 6,120 15,000 ––––––– 21,120 (0) ––––––– 21,120 ––––––– –––––––

units May 6,242 15,300 ––––––– 21,542 (6,120) ––––––– 15,422 ––––––– –––––––

June 6,367 15,606 ––––––– 21,973 (6,242) ––––––– 15,731 ––––––– –––––––

Working 1 Closing stock April = 15,300 x 40% = 6,120 Closing stock May = 15,606 x 40% = 6,242 Closing stock June = 15,606 x 1·02 x 40% = 6,367 Shorts Closing stock (w2) Sales Less

opening stock

Production

April 8,160 20,000 ––––––– 28,160 (0) ––––––– 28,160 ––––––– –––––––

units May 8,323 20,400 ––––––– 28,723 (8,160) ––––––– 20,563 ––––––– –––––––

June 8,490 20,808 ––––––– 29,298 (8,323) ––––––– 20,975 ––––––– –––––––

Working 2 Closing stock April = 20,400 x 40% = 8,160 Closing stock May = 20,808 x 40% = 8,323 Closing stock June = 20,808 x 1·02 x 40% = 8,490 (iii) Purchases

Closing stock (w3) Usage Shirts Shorts Less

opening stock

Purchases

Fabric Purchases Square metres April May 25,704 26,219 21,120 15,422 14,080 10,282 ––––––– ––––––– 60,904 51,923 (0) (25,704) ––––––– ––––––– 60,904 26,219 ––––––– ––––––– ––––––– –––––––

June 26,743 15,731 10,488 ––––––– 52,962 (26,219) ––––––– 26,743 ––––––– –––––––

Working 3 April closing stock = May usage = 15,422 + 10,282 May closing stock = June usage = 15,731 + 10,488 June closing stock = July usage = (15,731 + 10,488) x 1·02 (d)

Top down and bottom up approaches to budgeting. A top down approach to budgeting involves preparation of budgets by senior managers without giving the ultimate budget holder an opportunity to participate in the budgeting process. These budgets are then passed down to (imposed upon) budget holders. This approach has the following advantages: – It gives senior management better control of the business. – It should lead to tactical decisions that are in line with the overall strategic plan (goal congruence). – It reduces the opportunity for junior managers to build ‘slack’ (padding) into budgets. – Depending upon the abilities and experience of senior and junior managers it could be argued to produce better quality decisions. – Budgets should be prepared more quickly than under other approaches. A bottom up approach to budgeting is an approach which gives all budget holders an opportunity to participate in the setting of their own budgets. This approach has the following advantages: – Budgets are based upon information from employees most familiar with the department and therefore should be more accurate. – Budget holders are likely to have more commitment to budgets they have been involved in designing. – Because of the above motivation and morale should improve. – Because of the above less budget padding should occur.

10


2

Minimum price to be quoted. £ Direct materials Bricks Other materials Direct labour Skilled 2,400 hours at £12 per hour + £12,000 Unskilled Scaffolding hire Depreciation of general purpose machinery General overheads Plans Total cost Profit Minimum price

48,000 5,000

note 1 note 2

40,800 – 3,500 – 10,000 – –––––––– 107,300 – –––––––– £107,300 –––––––– ––––––––

note 3 note 4 note 5 note 6 note 7 note 8 note 9

Notes 1. All bricks are charged at replacement cost as they are regularly used in the business and those in stock will need to be replaced at £120 per 1,000. 2. Charged at their incremental purchase price. 3. John’s labour is charged at its value in its best alternative use (its opportunity cost). If not working on the project he could earn 800 hours x £12 = £9,600 working for other builders or save £12,000 by repairing his own house. The latter is the best alternative use of his time. The remainder of the skilled labour is charged at its incremental cost of £12 per hour. 4. There is no incremental cost of using the unskilled labour on this project. 5. This is the incremental hire cost. 6. Depreciation is not an incremental cash flow. The value of the asset is not affected by the project, therefore there is no cost attached to using it. 7. The value of the yard in its best alternative use is £500 x 20 weeks = £10,000. 8. This work has already been done and its cost is sunk, therefore irrelevant. 9. As we are considering the minimum price John can quote, no profit figure is included.

3

(a)

ABC cost estimate Direct material Direct labour Production overheads Components 10 x £2,500 ÷ 10,000 units Production set ups 6 x £300 ÷ 10,000 units Dispatches 500 x £50 ÷ 10,000 Other 2·5 minutes ÷ 60 mins x £30 per hour Production cost

£ per unit 4·50 0·50 2·50 0·18 2·50 1·25 –––––– £11·43 –––––– ––––––

(working 1) (working 1) (working 1) (working 2)

Workings 1. Cost per unit of driver activity Cost pool Stores administration £5,000,000 ÷ 2,000 components = £2,500 per component Production line set ups £3,000,000 ÷ 10,000 set ups = £300 per set up Dispatches £1,000,000 ÷ 20,000 dispatches = £50 per dispatch Other overheads £3,000,000 ÷ 100,000 labour hours = £30 per hour 2.

£5 per unit ÷ £120 per hour x 60 = 2·5 minutes per unit.

11


(b)

Selling price £ Total costs over a two year period Production cost (as estimated above) 20,000 x £11·43 Research and development costs Marketing cost

228,600 30,000 5,000 –––––––– 263,600 65,900 –––––––– £329,500 –––––––– ––––––––

Total cost Required profit (£263,600 ÷ 80 x 20) Total revenue If first year selling price = p Then total revenue = 10,000p + (10,000 x 0·6p). Then p =

(c)

£329,500 –––––––––––––––––––––– 10,000 + (10,000 x 0·6)

= £20·59

Life-cycle costing No product will last forever; in time sales of all products will decline. Different costs are incurred at different stages of a product’s life. Early stages will involve research and development costs, buying in technical data, and the training of staff. Later come marketing, production, stock holding and distribution costs. Eventually retirement and disposal costs may be involved. Traditional cost accounting systems do not accumulate costs over a product’s entire life but focus instead on (normally) twelve month accounting periods. As a result the total profitability of a product over its entire life becomes difficult to determine. Life-cycle costing involves accumulating costs and revenues over a product’s entire life and hence allows the total profitability of a product to be determined. Value to Birtles plc Birtles plc operates in a mark et where new product innovation is a major competitive factor and product life cycles are short. As a result research and development costs are likely to represent a large proportion of total cost. A life-cycle costing approach offers the following advantages: 1. All costs (production and non production) will be traced to individual products over their complete life cycles and hence individual product profitability can be more accurately measured. 2. Non production costs will become more visible and the potential for their control is increased. 3. More accurate feedback on the success or failure of new products will be available.

4

(a)

Calculating variances When calculating variances it is important to compare like with like. For example, in calculating a direct materials variance it is not sensible to compare the actual cost for making 5,500 units with the budgeted cost for making 5,000 units. Direct material is a variable cost; if more units are made we would expect more material to be consumed. In order to obtain a fair comparison budget figures should be adjusted for changes in volume. Flexed budgets recognise different cost behaviour patterns and figures are adjusted for volume changes allowing fair comparisons of actual and budgeted figures.

(b)

Flexed budget and variances

Sales units Sales revenue (w1) Direct material (w2) Direct labour (w3) Other manufacturing costs (w4) Divisional fixed overhead (w5) Profit

Flexed Budget 5,500 –––––– £000 1,100 (275) (160) (320) (200) –––––– 145 –––––– ––––––

Workings (1) £1,000,000 ÷ 5,000 units x 5,500 units (2) £250,000 ÷ 5,000 units x 5,500 units (3) £50,000 + (£100,000 ÷ 5,000 units x 5,500 units)

Actual 5,500 –––––– £000 1,078 (286) (176) (308) (190) –––––– 118 –––––– ––––––

Variance £000 22 A 11 A 16 A 12 F 10 F ––––– 27 A ––––– –––––

= £1,100,000 = £275,000 = £160,000

(alternatively in workings 1–3 all variable costs could be simply increased by 10% in line with sales volume)

12


(4) Using the high low approach Change in cost £(210,000 – 170,000) Variable cost per unit = –––––––––––––––– = ––––––––––––––––––– Change in volume (4,000 – 3,000) = £40 per unit Fixed cost (before the step up) can be calculated by substituting variable cost into either of the observations of total cost. Using 4,000 units Total cost = fixed cost + variable cost £210,000 = fixed cost + (4,000 units x £40) Fixed cost = £210,000 – £160,000 = £50,000. Budgeted cost at 5,500 units = £50,000 + £50,000 step + (5,500 x £40) = £320,000 (c)

Variance investigation Several factors should be considered before deciding whether to investigate a variance. 1. Reliability of the figures. Firstly we need to be certain that the figures are accurate. Mistakes in calculating budget figures or in recording actual costs and revenues could lead to variances being reported where no problem actually occurs. 2. Materiality. The size of the variance might indicate the scale of the problem and the potential benefits from correcting the problem. 3. Possible interdependence of variances. Sometimes a variance in one area will be related to a variance in another. For example, a favourable raw material price variance from buying lower grade material may cause an adverse labour variance because of difficulties in working the lower grade material. These two variances would need to be considered jointly before making an investigation decision. 4. The inherent variability of the cost or revenue. Some costs are by nature quite volatile (for example oil prices) and variances would not be surprising. Other costs such as labour are far more stable and even a small variance may indicate a problem. 5. Adverse or favourable. Adverse variances tend to attract most attention as they indicate problems; however, there is an argument for investigating favourable variances so that we can learn from our successes. 6. Trends in variances. One adverse variance may be caused by a random event. A series of adverse variances usually indicates that the process is out of control. 7. Controllability/probability of being able to correct. If a cost or revenue is outside our control (e.g. world market price of a raw material) then there is little point in investigating its cause. 8. Costs and benefits of correction. If the cost of correcting the problem is likely to be higher than the benefit then there is little point in investigating.

13




1

(a)

2 marks per sensible advantage maximum

(b)

Contribution per limiting factor approach Contributions per unit Contributions per labour hour Dealing with >25% constraint Correct solution

December 2004 Marking Scheme Marks 8 2 2 2 1 1 ––– 8

(c)

(i)

Shirts Shorts

2 2 ––– 4

(ii)

Closing stock shirts Closing stock shorts Opening stock shirts Opening stock shorts Sales Production

2 2 1 1 1 1 ––– 8

(iii) Closing stock Opening stock Usage Purchases

1 1 1 1 ––– 4

(d)

2 marks per each approach defined 1 per each advantages max

4 4 ––– 8 ––– 40 ––– –––

2

numbers bricks other material skilled labour unskilled scaffolding depreciation general overhead plans profit

2 1 2 1 1 1 1 1 1 ––– 11

explanations bricks other material skilled labour unskilled scaffolding depreciation general overhead plans profit

1 1 1 1 1 1 1 1 1 ––– 9 ––– 20 ––– –––

15


3

(a)

Stores administration per unit Production set ups per unit Dispatches per unit Other overhead per unit

(b)

Reward method Inclusion of production cost R&D cost Marketing cost Required revenue First year price

Marks 2 2 2 2 ––– 8

1 1 1 2 3 ––– 8

(c)

Life-cycle costing explained 1 mark per reason, max

2 2 ––– 4 ––– 20 ––– –––

4

(a)

Comparing like with like Flexed budgets explained

2 1 ––– 3

(b)

Flexed budget figures Sales revenue Direct material Direct labour Other manufacturing costs Fixed overhead Variances 1/2 each max

1 1 1 3 1 2 ––– 9

(c)

2 marks per explained factor, max

8 ––– 20 ––– –––

16




7 T r e p a P




McDermott plc is a manufacturer of beds. It uses a standard absorption costing system to monitor performance of managers and departments. A standard absorption cost card for one of its models, the Dreamer, is given below. £ Selling price Production costs Direct material: 12 metres at £1·50 per metre Direct labour: 4 hours at £6·00 per hour Variable overhead: 4 hours at £15·00 per hour Fixed overhead: 4 hours at £10·00 per hour

£ 250·00

18·00 24·00 60·00 40·00 ––––––– 142·00 ––––––– £108·00 ––––––– –––––––

Gross profit Budgeted production and sales are 1,000 Dreamers per month.

Actual results for the manufacture and sale of Dreamers for the most recent month were as follows: Sales: 1,200 beds at £240 each. Production: 1,300 beds Direct material (purchased and used): 16,000 metres at £1·40 per metre Direct labour (worked and paid): 5,000 hours at £6·00 per hour Variable overhead £75,500 Fixed overheads £54,600. There were no opening stocks of finished goods. Required: (a) Calculate the following variances for the most recent month (i) Direct material price; (ii) Direct material usage; (iii) Direct labour rate; (iv) Direct labour efficiency; (v) Variable overhead expenditure; (vi) Variable overhead efficiency; (vii) Fixed overhead expenditure; (viii)Fixed overhead capacity; (ix) Fixed overhead efficiency; (x) Sales volume (in terms of profit); (xi) Sales price.

(22 marks)

(b) Explain the differences between standard absorption costing and standard marginal costing in the following areas: (i) the sales volume variance; (ii) the fixed overhead variances; (iii) stock valuation and its effect upon profit. (no further calculations are required)

(10 marks)

(c) Some authorities view traditional variance analysis as unhelpful and misleading in modern business organisations. Explain FOUR problems of standard costing variance analysis in today’s business world.


2


2

Hughes plc has recently developed a personal music player and is now considering what price to charge for the new product. A market research company has produced the following forecasts of demand at three potential selling prices: Selling price Sales units per annum Fixed costs per annum

£250 10,000 £800,000

£350 8,000 £500,000

£450 6,000 £200,000

Variable costs are forecast at £220 per unit at any activity level. Required: (a) Calculate, for each potential selling price, the budgeted profit, the break-even point in units and the margin of safety ratio (i.e. the margin of safety expressed as a percentage). (9 marks) (b) Using the graph paper provided, draw and label a break-even chart for a selling price of £350 for activity (8 marks) levels between 0 and 8,000 units. (c) Define target costing and explain briefly how it could be used by Hughes plc in the design, manufacture and (3 marks) sale of personal music players. (20 marks)

3

Case plc is preparing its budgets for the coming year and is attempting to forecast its sales. Total industry sales for this type of product for the current year and the previous four years are given below. Year

Sales £ 000 175,000 193,025 211,225 229,250 247,100

2000 2001 2002 2003 2004

An index of price level movements, appropriate to Case plc’s industry for the same periods is as follows. Year 2000 2001 2002 2003 2004 2005 (forecast)

Price level index 100 103 107 110 112 113

Assume that it is now the end of 2004. Required: (a) Restate the industry sales figures for each of the above five years (2000 to 2004) to 2005 forecast price (5 marks) levels using the price level index. (b) Using the graph paper provided, draw a scattergraph of total industry sales expressed in 2005 price levels (5 marks) for the period 2000 to 2004. (c) Use the high-low technique to estimate a formula for industry sales expressed in 2005 price levels and use the formula to forecast industry sales revenue for 2005. (6 marks) (d) Suggest TWO factors, other than past trends in industry sales, which Case plc should take into account when (4 marks) forecasting its own sales. (20 marks) 3


[P.T.O.

4

Heighway Ltd is a railway company. Heighway Ltd operates a passenger railway service and is responsible for the operation of services and the maintenance of track, signalling equipment and other facilities such as stations. In recent years it has been criticised for providing a poor service to the travelling public in terms of punctuality, safety and the standard of facilities offered to passengers. In the last year Heighway Ltd has invested over £20 million in new carriages, station facilities and track maintenance programmes in an attempt to counter these criticisms. Summarised financial results for Heighway Ltd for the last two years are given below. Summarised profit and loss account for the year ended 31 December 2003 £ Million Sales 180·0 –––––– –––––– Earnings before interest and tax 18·0 Interest (3·2) Tax (4·4) –––––– Earnings available to ordinary shareholders 10·4 –––––– ––––––

2004 £ Million 185·0 –––––– –––––– 16·5 (4·7) (3·5) –––––– 8·3 –––––– ––––––

Summarised balance sheet as at 31 December 2003 £m Fixed assets (net) Current assets Stock Debtors Cash creditors due within one year Net current assets Less amounts payable after more than one year 8% Debenture 2009 Bank loan Less

2004 £m 100·4

5·3 2·1 6·2 ––––– 13·6 (8·4)

£m

£m 120·5

5·9 2·4 3·6 ––––– 11·9 (9·2) 5·2

Net assets Ordinary share capital (£1 shares) Reserves

2·7

(15·0) (20·0) ––––– 70·6 –––––

(15·0) (35·0) ––––– 73·2 –––––

25·0 45·6 ––––– 70·6 –––––

25·0 48·2 ––––– 73·2 –––––

4


Required: (a) Calculate the following ratios for Heighway Ltd for 2003 and 2004, clearly showing your workings: (i) (ii) (iii) (iv) (v)

Return on capital employed (also known as return on investment) based upon closing capital employed; Net profit margin; Asset turnover; Current ratio; and Capital gearing ratio. (8 marks)

(b) Briefly comment on the financial performance of Heighway Ltd in 2003 and 2004 as revealed by the above ratios and suggest causes for any changes. (You are not required to calculate any other ratios.) (6 marks) (c) Suggest THREE non-financial indicators that could be useful in measuring the performance of a passenger railway company and explain why your chosen indicators are important. (6 marks) (20 marks)


5


Answers




(a)

Standard costing variances Direct material Actual usage at actual cost

= Price = Usage =

£22,400 > £24,000 > £23,400

16,000m x £1·40

= Rate = Efficiency =

£30,000 > £30,000 > £31,200

= Expenditure 5,000 hrs x £15·00 = Efficiency 1,300 units x 4 hrs x £15·00 =

£75,500 > £75,000 > £78,000

Standard overhead for actual production

= Expenditure 1,000 units x 4 hrs x £10·00 = Capacity 5,000 hours x £10·00 = Efficiency 1,300 units x 4 hrs x £10·00 =

£54,600 > £40,000 > £50,000 > £52,000

Sales volume Budgeted sales units at Standard profit margin

1,000 units x £108·00

Actual usage at standard cost

16,000m x £1·50

Standard usage at standard cost

1,300 units x 12m x £1·50

Direct labour Actual hours at actual rate

5,000 hrs x £6·00

Actual hours at standard rate

5,000 hrs x £6·00

Standard hours at standard rate

1,300 units x 4 hrs x £6·00

Variable overhead Actual hours at actual rate

5,000 hrs x £15·10

Actual hours at standard rate Standard hours at standard rate Fixed overhead Actual overhead Budgeted overhead Actual hours at standard rate per hour

(b)

June 2005 Answers

=

Actual sales units at Standard profit margin

1,200 units x £108·00

=

Sales price Actual sales at standard price

1,200 units x £250

=

Actual sales at actual price

1,200 units x £240

=

£1,600 Fav £600 Adv

£0 £1,200 Fav

£500 Adv £3,000 Fav

£14,600 Adv £10,000 Fav £2,000 Fav

£108,000 > £129,600

£21,600 Fav

£300,000 > £288,000

£12,000 Adv

Differences between standard absorption and standard marginal costing Sales volume variance This variance measures the effect on profit of selling more (or less) units than budgeted. Under absorption costing this is calculated at standard profit per unit. Note that in calculating standard profit per unit all costs, both fixed and variable, are charged against standard selling price. Under standard marginal costing the variance is calculated at standard contribution per unit. In calculating standard contribution per unit only standard variable costs are charged against standard selling price. Fixed overhead variances The expenditure variance (the difference between actual and budgeted expenditure) is the same under both approaches. Under absorption costing fixed overheads are charged to individual units of production via an overhead absorption rate. If production volume differs from that budgeted this can result in u nder or over absorption of overhead and resultant adverse or favourable volume variance. In turn this volume variance can be subdivided into capacity and efficiency variances. Under marginal costing, fixed overheads are not charged to individual units of production and thus no under or over absorption, or volume variance, occurs. Stock valuation and its effect upon profit The profit figures under the two systems may be different due to the different costing principles involved. Under absorption costing finished goods stock is valued at full production cost, which includes both fixed and variable production cost. Under a marginal costing system finished goods stock is valued at variable production cost only. This will result in differences in stock valuations and possibly differences in cost of sales figures. In a period when production is greater than sales (as in the most recent month) absorption costing will show the higher profit figure as a propor tion of the current period’s fixed production costs will be absorbed into units included in closing stock and be carried forward into the next period. This will result in absorption costing showing a lower cost of sales and a higher profit than marginal costing.

9


(c)

Problems of standard costing in modern business organisations

The problems of standard costing variance analysis include: (i) (ii) (iii) (iv) (v) (vi) (vii)

Standard costing systems rely on the existence of repetitive operations and homogenous output. With increasing levels of competition and shortening product lifecycles, output is less homogenous and operations are not so repetitive. Standard costing places much emphasis on direct labour costs. In a modern manufacturing environment labour is often no longer a variable cost, and represents a small proportion of total cost. The use of labour hours in the calculation of overhead variances is also questionable as many overheads are not driven by labour activity. An emphasis on efficiency variances can focus management attention in the wrong areas. Just in time production systems are more concerned with meeting customer requirements than avoiding idle time. Material price variances may over emphasise the importance of price at the expense of quality, delivery and supplier reliability. Variance analysis concentrates on costs and does not give sufficient attention to issues such as quality and customer satisfaction. Variance analysis is largely aimed at manufacturing situations; large parts of modern economies are now service industries.

(Note: only four criticisms were requested.)

2

(a)

Budgeted profit, break-even point and margin of safety Budgeted profit Selling Price Contribution (w1) Fixed costs Profit/(loss) Break-even point in units Fixed cost ––––––––––––––––– Contribution per unit Margin of safety ratio

working 1 Selling price Variable cost Contribution per unit

£250 £ 300,000 800,000 ––––––––– (500,000) ––––––––– –––––––––

£350 £ 1,040,000 500,000 –––––––––– 540,000 –––––––––– ––––––––––

£450 £ 1,380,000 200,000 –––––––––– 1,180,000 –––––––––– ––––––––––

£800,000 ––––––––––– £30 per unit = 26,667 units

£500,000 –––––––––––– £130 per unit = 3,846 units

£200,000 –––––––––––– £230 per unit = 870 units

= nil

8,000 – 3,846 ––––––––––––– 8,000 = 52%

6,000 – 870 ––––––––––– 6,000 = 86%

£ per unit 250 220 –––– 30

£ per unit 350 220 –––– 130

£ per unit 450 220 –––– 230

10


(b)

Break-even chart £’000 TOTAL REVENUE

2,800 2,600 2,400

TOTAL COST

2,200 2,000 1,800 1,600 1,400

BREAK-EVEN POINT

1,200 1,000 MARGIN OF SAFETY

800 600

FIXED COST

400 200

1

2

3

4 ’000 units

5

6

7

8

ACTIVITY LEVEL (c)

Target Costing Target costing involves setting a target cost by subtracting a desired profit margin from a competitive market price. A target cost may be less than the planned initial cost but it is expected to be achieved by the time a product reaches its maturity stage of the product lifecyle. To use target costing Hughes plc would firstly need to consider the product specification necessary in the current market (for example battery life, capacity, size, etc). It would then need to decide what selling price would be necessary to achieve its desired market share, probably by reference to competitors’ prices. It would then need to decide upon a required profit margin on the product (this could be based upon a desired return on sales or a required return upon investment). The target cost could then be calculated by subtracting the required profit margin from the proposed selling price. Efforts could then be made to produce the required product at the target cost. These efforts are most likely to be successful at the design stage by, for example, reducing the number of components, using standard components,or by using different materials.

3

(a)

Inflation adjustments Year 2000 2001 2002 2003 2004

Sales £ 000 113 175,000 x ––– = 197,750 100 113 193,025 x ––– = 211,765 103 113 211,225 x ––– = 223,069 107 113 229,250 x ––– = 235,502 110 113 247,100 x ––– = 249,306 112

11


(b)

Scatter graph of industry sales

300,000 ) s e c i r p 5 0 0 2 ( 0 0 0 £ s e l a S y r t s u d n I

250,000 200,000 150,000 100,000 50,000 0 1999

2000

2001

2002

2003

2004

2005

Year

(c)

Trend Line by high-low technique The trend in sales can be expressed in the form y = a + bx Where y = industry sales pa in £000 (at 2005 prices) x = the year in question a = the intercept b = annual increments in the trend line For ease of computation years will be denoted as follows 2000 = 0 2001 = 1 etc (other approaches are acceptable, see note below) Year Highest year Lowest year

4 0 –– 4 ––

Sales £000 (2005 prices) 249,306 197,750 –––––––– 51,556 ––––––––

£51,556 b = ––––––– = £12,889 4 a by substitution y = a + bx 249,306 = a + 12,889 x 4 249,306 = a + 51,556 249,306 – 51,556 = a a = £197,750 The trend in industry sales can be represented by the equation y = 197,750 + 12,889x Note: The value of a has little significance apart from in forecasting future sales. The value of a (the intercept) depends upon which year is taken as year 0. In this answer 2000 is taken as year 0, if another year had been taken as year zero the value of a, the intercept, would have been different, but the same predictions of future sales could be obtained. Full credit will be given to other approaches. Forecast for 2005 y = 197,750 + 12,889x y = 197,750 + 12,889 x 5 y = £262,195 in 2005 prices Industry sales expressed in 2005 prices are forecast to be £262,195,000.

12


(d)

Other factors in forecasting Case plc’s sales. Many factors could be influential including: – – – –

The price of Case plc’s product relative to the industry; a higher price may lead to a slower growth in sales. The quality of Case plc’s product relative to the industry; inferior quality may lead to lower sales growth. Market research results could give an indication of future trends in demand. Advertising and promotional expenditure relative to competitors; a lower advertising spend may lead to lower sales growth. – Other causal factors in demand such as levels of consumer income and the condition of the overall economy could be considered. Changes in these variables could affect demand. – Future trends in industry sales, sales growth seldom continues forever and an assumption of linear growth in sales is probably unrealistic. (only two factors were requested)

4

(a)

Financial ratios 2003 (i)

2004

Return on capital employed Profit before interest and tax = –––––––––––––––––––––––– % Capital employed

18·0 –––––– 105·6

= 17·0%

16·5 ––––– 123·2

= 13·4%

Net profit margin Profit before interest and tax = –––––––––––––––––––––––– % Sales

18·0 –––––– 180·0

= 10·0%

16·5 ––––– 185·0

= 8·9%

(iii) Asset turnover Sales = ––––––––––––––– Capital employed

180·0 –––––– 105·6

= 1·7 times

185·0 ––––– 123·2

= 1·5 times

(iv) Current ratio Current assets = –––––––––––––– Current liabilities

13·6 –––– 8·4

= 1·6:1

11·9 –––– 9·2

= 1·3:1

35·0 ––––– 70·6

= 49·6%

50·0 –––– 73·2

=68·3%

(ii)

(v)

Capital gearing Long-term debt = ––––––––––––– % Equity

Note: other sensible definitions of the above ratios are acceptable, for example capital gearing is often calculated as Long-term debt ––––––––––––––––––––– % Equity + Long-term debt This would give figures of 33·1% and 40·6% for 2003 and 2004 respectively. (b)

Financial Performance Profitability Return on capital employed has fallen over the two-year period. This is caused by a decrease in operating profit and an increase in capital employed. The fall in operating profit may be caused by an increase in costs (possibly associated with the new investments) and the increase in capital employed is clearly caused by the new investment programme. Asset turnover has fallen; this could be due to the new investment programme not yet having an effect on sales. Overall the explanation for the deterioration in profitability could simply be a matter of timing. In the short term the programme has increased assets and costs (e.g. depreciation charges) but has not yet affected sales. Liquidity The current ratio has deteriorated. This means that the firm’s ability to meet its short-term obligations from its short-term resources has reduced. This appears to be caused by the decrease in the cash balance, which could be explained by the expenditure on the investment programme. Capital Gearing Capital gearing has increased significantly. This appears to be due to the increase in bank loans, again, which is likely to be caused by the new investment programme. Although this is a significant increase it should not be regarded as dangerously high in a capital-intensive industry such as a railway.

13


(c)

Non-financial indicators (1)

Indicator % of trains on time

Importance Punctuality is important to travellers

(2)

% of trains cancelled

Reliability is important to travellers

(3)

Accidents per 1,000,000 passengers

Safety is vital in railway travel

(4)

Customer rating of cleanliness of facilities

Passengers require good quality service

(5)

% utilisation of rolling stock

Idle assets do not earn profits

(6)

% utilisation of staff

Idle staff do not earn profits

(7)

% of new customers

New customers are vital for growth

(8)

Employee morale

Motivated employees are vital for success in a service business

(only 3 indicators were required)

14



(a)

2 per variance max

(b)

Sales volume variance Fixed overhead expenditure Other fixed overhead variances Stock valuation Profit computation

June 2005 Marking Scheme 22

4 1 2 2 1 ––– 10

2

(c)

2 per point max

(a)

Budgeted profit Break-even points Margin of safety

8 ––– 40

3 3 3 ––– 9

(b)

Fixed cost Total cost Sales revenue scaling 1 mark per useful label max

1 1 1 2 3 ––– 8

(c)

Target Costing defined Use with music player

1 2 ––– 3 ––– 20

3

(a)

1 mark per correct adjustment max

(b)

x-axis labelled y-axis labelled points

5 1 1 3 ––– 5

(c)

‘a’ ‘b’ forecast

2 2 2 ––– 6

4

(d)

2 marks per explained point max

(a)

ROCE Net profit margin Asset turnover Current ratio Capital gearing

(b)

1 per comment and 1 per cause, max

(c)

1 per indicator and 1 for its importance

4 ––– 20

2 1 1 2 2

––– 8 6 6 ––– 20

15




7 T r e p a P



ALL FOUR questions are complusory and MUST be attempted 1

The Kilkline Hospital is a state owned hospital located in the United Kingdom. It is fi nanced by public funds. Demand for its services is enormous and long waiting lists for hospital treatment exist. The two main objectives of the Kilkline Hospital are to provide high quality healthcare to patients and to provide value for money for the taxpayer. The finance director of the Kilkline Hospital is currently preparing budgets for the year ending 31 December 2006 and asks you for assistance in preparing an income and expenditure budget for the Specialised Surgery Department (SSD). The SSD performs two types of treatment, hip replacements and knee reconstructions. The hospital receives a standard fee from the United Kingdom government for each treatment performed; a treatment is define d as a complete course of hospital care. Costs in the SSD are classified as fixed or variable. Fixed costs are made up of the salaries of the three doctors working full time in the department and general overheads. Variable costs relate to drugs, nursing care and patient accommodation costs. Drugs are paid for directly by the SSD. Nursing care and accommodation services (food, bed linen and cleaning services) are managed centrally by the hospital and charged at cost to the SSD on the basis of nursing hours used and patient accommodation days respectively. The finance director provides you with the following information: 1.

Activity forecasts for the year ending 31 December 2006

Forecast activity (number of treatments) Average length of hospital stay per treatment Nursing time per patient per day

Hip Replacements 200 18 days 2 hours

Knee Reconstructions 300 15 days 1·5 hours

£5,000

£3,500

£480

£385

2.

Standard fee per treatment

3.

Drugs cost per treatment

4.

Other variable costs Accommodation costs are estimated at £50 per patient per day for either type of treatment. Nursing time is charged to the department at £20 per hour.

5.

Fixed costs Doctors’ salaries for the department are forecast at £180,000 in total for 2006. General overhead costs for the same period are forecast at £900,000.

Required: (a) Explain the term ‘principal budget factor’. What is the principal budget factor likely to be in the Kilkline Hospital? (3 marks) (b) Prepare an income and expenditure budget for the Specialised Surgery Department for the year ending 31 December 2006. Your statement should show: (i)

the contribution PER TREATMENT (for each type of treatment);

(8 marks)

(ii) the TOTAL contribution from each of the two treatments;

(2 marks)

(iii) the surplus or deficit for the department.

(2 marks)

(c) The finance director is concerned that the forecast number of treatments may be incorrect. Required: Prepare a flexed income and expenditure budget for activity levels 10% lower than those originally forecast. (3 marks)

2


(d) Explain THREE advantages of using a computer spreadsheet package in the construction and revision of budgets. (6 marks) (e) The government has suggested that departmental performance be measured using a balanced scorecard. Required: (i)

Briefly explain what is meant by a balanced scorecard approach to performance measurement. (4 marks)

(ii) For each of the balanced scorecard’s perspectives on performance give TWO critical success factors and (8 marks) TWO performance indicators appropriate for a state owned hospital. (iii) Give FOUR advantages of using a balanced scorecard approach.


2

Bennett plc is a manufacturer of soft drinks. Drinks are mixed and bottled in an automated process supervised by a small number of technicians. The majority of production costs are fixed and are common to all of Bennett’s products. The market for soft drinks is very competitive and all of Bennett’s products face strong price competition. Bennett has recently developed a new sports energy drink, which will be sold in one-litre bottles under the brand name ‘Zoom’. The production of Zoom is more complicated than that of Bennett’s existing soft drinks, involving more ingredients, a large variety of more expensive materials and more mixing operations. The variable production cost of 4,000 litres of Zoom is £0·20 per litre, including packaging. Variable production cost consists entirely of direct material cost. Bennett’s management accountant is considering how to charge overhead costs to the new product and the price at which it should be sold. She is considering the following three approaches: Approach 1. This would involve not charging overhead to the product and pricing the new product at variable production cost plus a 300% mark up. Approach 2. This would involve using a general overhead absorption rate of 400% of direct material cost. The product would then be priced at full absorption cost plus a 20% margin on sales. Approach 3. This would involve using an activity-based costing approach to arrive at the full cost. The product will be priced at this full cost plus a 20% margin on sales. Activity based costing rates Overhead item Stores administration cost Technician salaries Despatch cost

Driver rate £100 per ingredient used. £300 per mixing operation. £200 per customer delivery.

The 4,000 litres of Zoom used twelve different ingredients and required eight mixing operations. Ten separate deliveries were required to deliver it to customers. Required: (a) Calculate the selling price per one-litre bottle of Zoom that would result from each of the above three (8 marks) approaches. (b) Explain why an activity based costing approach would be more useful in costing products than a traditional absorption costing approach, given the circumstances faced by Bennett. (6 marks) (c) Explain two advantages and two disadvantages of cost plus pricing.


3


[P.T.O.

3

Houchen Ltd uses a standard absorption costing system to control the manufacturing costs of its single product. The following standards have been set: £ per unit Direct material 2 kgs at £6 per kg. 12 Direct labour 1 hour at £7 per hour 7 Fixed overheads 9 ––– Total production cost £28 ––– ––– The fixed overhead standard cost per unit is based upon a budgeted monthly production of 4,000 units. Actual results for the most recent month were: Production 4,300 units. Direct material Cost £56,000 for 9,000 kgs. Direct labour Cost £32,800 for 4,600 hours paid. Only 4,000 hours were worked. Fixed overheads £35,000. No direct material stocks are held. Required: (a) Calculate the following variances: (i) (ii) (iii) (iv) (v) (vi) (vii)

Direct material price; Direct material usage; Direct labour rate; Labour idle time; Direct labour efficiency; Fixed overhead expenditure; Fixed overhead volume.

(14 marks)

(b) Explain the meaning and suggest one potential cause of each of the following variances: (i) Direct labour rate; (ii) Labour idle time; (iii) Direct labour efficiency.


4


4

Mabbutt plc makes four types of electrical sub-assembly: A, B, C and D. Demand and costs per unit in the coming period are estimated to be as follows: Sub-assembly Demand (units) Unit variable costs Direct labour (£4·00 per hour) Direct material Variable overhead Total variable cost per unit Absorbed fixed overhead Total production cost

A 10,000

B 50,000

£ per unit 4 2 2 ––– 8 8 ––– 16 ––– –––

£ per unit 6 5 3 ––– 14 12 ––– 26 ––– –––

C 120,000 £ per unit 8 2 4 ––– 14 16 ––– 30 ––– –––

D 60,000 £ per unit 6 11 3 ––– 20 12 ––– 32 ––– –––

Fixed overheads are absorbed on the basis of direct labour hours and represent apportioned general factory overhead. The direct labour used to build the sub-assemblies is highly skilled and Mabbutt plc sometimes has difficulties in recruitment, resulting in shortages of labour. Due to rapid technological change, stocks of completed sub-assemblies are never carried. The finance director of Mabbutt plc considers the costs of the sub-assemblies to be too high and is considering subcontracting their manufacture. A supplier has offered to supply any quantity of A, B, C or D for £10, £16, £13 and £25 per unit respectively. Mabbutt plc seeks to satisfy demand at minimum cost. Required: (a) On a purely financial basis, determine how many of each sub-assembly should be made by Mabbutt plc and how many should be bought in from the supplier, if Mabbutt plc expects direct labour hours in the coming period to be: (i)

in unlimited supply;

(4 marks)

(ii) restricted to 145,000 hours.

(8 marks)

(b) The finance director of Mabbutt plc is also considering a cost reduction campaign to reduce the cost of the four sub-assemblies. Suggest four actions (other than subcontracting manufacture) the company could take to reduce the cost of the sub-assemblies. (8 marks) (20 marks)


5


Answers




(a)


The principal budget factor is the factor that limits an organisation’s performance for a given period and is usually the starting point in budget preparation. In a state owned hospital, which provides free treatment to patients, it is likely to be some measure of capacity. For example this could be accommodation available, clinical staff time, or ultimately cash available.

(b)

Income and Expenditure Account Income and Expenditure Budget Specialised Surgery Department Year ending 31.12.2006

Drugs Nursing Accommodation

W1 W2

Contribution per treatment Budgeted activity (number of treatments) Total contribution Fixed Costs Doctors Salaries General overhead

W3

Hips £ 5,000 (480) (720) (900) –––––– 2,900

Knees £ 3,500 (385) (450) (750) –––––– 1,915

200

300

580,000

574,500

Total £

1,154,500 (180,000) (900,000) –––––––– 74,500 –––––––– ––––––––

Surplus Workings 1. 18 days x 2 hours x £20 = £720 15 days x 1.5 hours x £20 = £450 2. 18 days x £50 = £900 15 days x £50 = £750 3. £2,900 x 200 = £580,000 £1,915 x 300 = £574,500 (c)

Flexed Budget Income and Expenditure Budget Specialised Surgery Department Year ending 31.12.2006

Contribution per treatment Budgeted activity (number of treatments) Total contribution Fixed Costs Doctors Salaries General overhead

Hips £ 2,900 180

Knees £ 1,915 270

522,000

517,050

1,039,050 (180,000) (900,000) –––––––– (40,950) –––––––– ––––––––

Deficit (d)

Total £

The advantages of using a computer spreadsheet package. A spreadsheet is a general-purpose software package, the term being loosely derived from a ‘spreadsheet of paper’ divided into rows and columns. The user of the package can decide what data or information should be presented in the spreadsheet and how it should be manipulated. The advantages of using a spreadsheet package in constructing and revising budgets are as follows: – – – –

Spreadsheets can process large amounts of data quickly. Budgeting often involves a large amount of numerical manipulation. Computations are performed accurately, assuming the spreadsheet is programmed correctly and the data is input correctly. If key variables are contained in an input section alterations and amendments can be easily processed. Spreadsheets are simple to use and cheap to acquire and bring computer modelling within the reach of every day users.

9


–

– – (e)

Spreadsheets, if well constructed, facilitate ‘what if?’ analysis, that is they allow the user to test the effect of changes in input data on budgeted results. For example the effect of a change in debtor payment days on the cash position and the balance sheet could be quickly computed by a spreadsheet. They aid good presentation of results and offer facilities for the production of graphs and tables. Once set up the same model can be used each year.

Balanced Scorecard (i)

Explanation. A balanced scorecard approach to performance measurement seeks to measure performance under the headings of financial success, customer satisfaction, process efficiency and organisational learning and growth.

(ii)

Advantages. – It measures performance in a variety of ways, rather than relying on just one aspect of performance. – Managers are unlikely to be able to distort the performance measure. – Bad performance is difficult to hide if multiple performance measures are used. – It provides both leading and lagging indicators of business performance. – Success in the four key areas should lead to the long term success of the organisation. – It is flexible, what is measured can be changed over time to reflect changing priorities and strategies. – ‘what gets measured gets done’, that is if managers know they are being appraised on various aspects of performance they will pay attention to these areas, rather than simply paying lip service to them.

(iii) CSFs and KPIs Critical success factor

Key performance indicator

Financial success Balancing income and expenditure Cost efficient operation

operating surplus/deficit cost per procedure

Customer satisfaction Admission waiting time Procedure success rates Quality of treatment

average time on waiting list % of successful procedures Number of emergency readmissions number of complaints

Process efficiency Treatment time Emergency response time

average length of hospital stay ambulance waiting time

Organisational learning and growth Quality of staff Staff morale

number of qualified staff employed staff satisfaction surveys Labour turnover/ absence rates

(only four measures were required)

2

(a)

Price per litre Variable cost plus Variable cost 300 % mark up Selling price (£0·2 x 4)

£ per litre 0·20 0·60 ––––– 0·80 ––––– –––––

Absorption cost plus Variable cost Overhead (400%) Production cost Margin (£1·00 x 20 ÷ 80) Selling price (£1·00 ÷ 0·8)

£ per litre 0·20 0·80 ––––– 1·00 0·25 1·25 ––––– –––––

10


Activity-based costing plus Variable cost Stores administration (12 x £100 ÷ 4,000) Technician salaries (8 x £300 ÷ 4,000) Despatch (10 x £200 ÷ 4,000) Margin (£1·60 x 20 ÷ 80) Selling price(£1·60 ÷ 0·8) (b)

(c)

£ per litre 0·20 0·30 0·60 0·50 ––––– 1·60 0·40 ––––– 2·00 ––––– –––––

Activity-based Costing Traditional absorption costing was developed at a time when many organisations produced only a narrow range of products and when overhead costs were only a small fraction of total costs. For many companies these circumstances no longer exist, and this appears to be the case for Bennett. –

As is common in many process industries the majority of Bennett’s costs are fixed. Its fixed costs are also common to all of its products. The way in which these costs are charged to products will have a significant effect on product cost.

–

The manufacture of Zoom is more complicated than Bennett’s usual products, using more ingredients and requiring more mixing. Activity-based costing recognises that activities cause overhead cost: the more complex the product the more likely it is to create demand for activities and hence cause overheads to be incurred. In contrast many traditional absorption-costing systems assume that products cause overheads in proportion to their production volumes and allocate large proportions of overhead to high volume products.

–

Bennett’s overhead absorption rate is based upon material cost. Under this approach products with more expensive materials will be charged with more overheads even though the cost of their materials does not necessarily cause more overheads to be incurred.

–

Bennett faces strong price competition in all of its products. It is therefore important that all of its products have the most accurate costing possible in order to set competitive prices, whilst at the same time covering their costs.

Advantages and disadvantages of cost plus pricing. Advantages – Cost plus pricing offers a simple way of pricing products. For firms with a large number of products to price it is important that pricing decisions can be safely delegated to junior management. – Cost plus pricing is sometimes seen as a way of justifying prices. Firms who use it can be seen as taking a ‘fair’ margin on cost. Cost plus arguments are commonly used as a way of justifying price increases. – The mark up charged could be varied between products (and customers) depending upon market conditions. – Basing prices on full cost plus should ensure that a company working at normal capacity will cover its fixed costs and earn a profit. Disadvantages – In its simplest form cost plus pricing fails to recognise that there is a relationship between the price charged and the quantity sold. For example a firm faced with falling demand (and hence a higher unit cost due to fixed costs being spread more thickly over a smaller number of units) would, under the logic of cost plus pricing, increase its price! – Again in its simplest form it fails to allow for competition. In many markets the price charged by competitors is a major determinant of prices charged. – In companies that sell more than one product the price determined by the cost plus formula is significantly affected by the method used to charge overhead costs to products. Arbitrary treatment of overhead will lead to arbitrary prices. – Cost plus pricing can lead to a complacent attitude to cost control and the attitude that cost increases can be passed on to customers in higher prices. In a competitive market this is a dangerous attitude. (only two advantages and two disadvantages were required)

3

(a)

Variances Direct Materials Actual usage at actual rate i Direct material price variance Actual usage at standard rate 9,000 kgs at £6·00 per kg ii Direct material usage variance Standard usage at standard rate 4,300 units x 2 kgs x £6·00

£56,000 >£2,000 A £54,000 > £2,400 A £51,600

11


Direct Labour Actual hours paid at actual rate

£32,800 > £600 A £32,200 > £4,200 A £28,000 > £2,100 F £30,100

iii Direct labour rate variance Actual hours paid at standard rate 4,600 hrs x £7·00 per hr iv Direct labour idle time variance Actual hours worked at standard rate 4,000 hrs x £7·00 per hr v Direct labour efficiency variance Standard hours at standard rate 4,300 units x 1 hr x £7·00 Fixed Overheads Actual fixed overhead vi Fixe xed d ove overh rhea ead d exp expen endi dittur ure e var variian ance ce Budgeted fixed overhead 4,000 units x £9 per unit vii Fixed overhead volume variance Standard fixed overhead 4,300 units x £9 per unit (b)

£35,000 > £1, £1,0 000 F £36,000 > £2,700 F £38,700

Meaning and potential causes of variances (i)

Direct labour rate variance. This measures the effect of paying actual labour hours at a different rate from standard. In this case the variance is £600 adverse and could be due to overtime working at premium rates, using higher grade more expensive labour or possibly as a result of a recent wage settlement.

(ii)

Idle time variance. This measures the cost (at standard rate) of having to pay wages for time at work although no actual work is being done. It is usually the result of a production stoppage and could be caused by a machine breakdown, running out of material, a shortage of customer orders or a labour dispute elsewhere in the business.

(iii) Direct labour efficiency variance. This measures the effect of working more or less than standard hours to produce the actual level of output, measured at standard labour cost per hour. In this case the variance is £2,100 favourable and indicates that actual production was completed more quickly than standard. This could be due to a better motivated workforce, better working conditions or more skilled labour. If the variance were due to using more highly skilled labour this would also explain the adverse rate variance.

4

(a)

Production plan (i)

When labour is unlimited.

‘Make’ variable cost per unit ‘Buy in’ cost per unit Saving from making Decision Production units Buy units (ii)

A £ 8 10 – –– 2 make 10,000

B £ 14 16 –– – 2 make 50,000

C £ 14 13 –– – (1) b uy 0 120,000

D £ 20 25 – –– 5 make 60,000

When labour is limited to 145,000 hours per period. C will continue to be bought outside, as it is cheaper. There is insufficient labour to make all of the other components (Hours required 10,000 + 75,000 + 90,000 = 175,000); therefore Mabbutt plc should make the components that offer the biggest cost saving per scarce labour hour.

‘Make’ variable cost per unit ‘Buy in’ cost per unit Saving from making Labour hours per unit Saving per labour hour Rank for making Production plan Make 60,000 60, 000 uni units ts of D 10,0 10 ,000 00 uni units ts of of A 30,000 30, 000 uni units ts of B

A £ 8 10 – –– 2 1·0 hours £2·00 per hour 2nd

B £ 14 16 –– – 2 1·5 hours £1·33 per hour 3rd

D £ 20 25 –– – 5 1·5 hours £3·33 per hour 1st

Labour hours 60,000 60, 000 uni units ts x 1·5 1·5 = 90,0 90,000 00 hou hours rs 10,0 10 ,000 00 uni units ts x 1·0 1·0 = 10, 10,00 000 0 hours hours 30,000 30, 000 uni units ts x 1·5 1·5 = 45,0 45,000 00 hou hours rs ––––––––––––– 145,000 hours

12


Buy 20,000 units of B (the production shortfall) 120,000 units of C (as above) (b)

Cost Reduction Mabbutt plc could attempt to reduce the cost of the sub assemblies by one of the following actions: – – – – – – –

Reducing materi Reducing material al cost cost by improvi improving ng the effic efficiency iency of material material usage usage,, for exampl example e by reducing reducing wast wastage. age. Reducing Redu cing materi material al cost cost by attempti attempting ng to negotia negotiate te lower lower prices prices with with suppli suppliers ers or seekin seeking g bulk buy buy discounts discounts.. Value anal analysi ysiss could could be use used d to find find chea cheaper per sub substi stitut tute e materi materials als.. Labour effic efficienc iencyy could be be improved improved by changi changing ng working working method method (possi (possibly bly by using using an organis organisation ation and methods methods study study or a work study). Automa Aut omatio tion n involvi involving ng the subs substit tituti ution on of machin machinery ery for labou labourr could could reduce reduce cost. cost. Value Va lue analysis analysis could be be used to find simp simpler ler designs designs leadin leading g to less less productio production n and quality quality control control proble problems ms and hence hence lower cost. Reducing Redu cing overhe overheads ads by tight tighter er budgetin budgeting g and the the use use of activi activity ty based based budgeti budgeting ng techniqu techniques. es.

Only four actions were required. The above points focus on cost reduction and value analysis. There are many other actions that could be taken, for example using standard costing to control costs, reducing stock holding costs by using JIT, JIT, using target costing, life-cycle costing etc. Any sensible, explained point will attract marks.

13



ACCA Certified Accounting Technician Examination – Paper T7 Planning, Control and Per formance Management 1

(a)

Definition sensible suggestion

December 2005 Marking Scheme

2 1 ––– 3

(b)

Contribution per unit 2 for each rev and cost, max 6 if not per unit Total Contribution Profit (Fixed cost 1, Total profit 1)

8 2 2 ––– 12

(c)

Revised total contribution Profit

2 1 ––– 3

(d)

2 marks per advantage, max

(e)

(i)

Balanced scorecard explained

4

(ii)

0·5 per CSF and KPI, max

8

(iii) 1 mark per advantage

6

4 ––– 16 ––– 40 ––– –––

2

(a)

Variable cost plus mark up

1

Absorption cost plus Overhead absorbed Margin

2 1

Acivity based cost plus Stores administration Technician salaries Despatch Margin

1 1 1 1 ––– 8

3

(b)

2 marks per relevant point, max

(c)

1·5 marks per adv and disadv, max

(a)

2 marks per variance max

(b)

1 mark per meaning, max 1 mark per cause, max

6 6 ––– 20 ––– –––

14 3 3 ––– 6 ––– 20 ––– –––

15


4

(a)

(i)

1 mark per product

4

(ii)

Approach Saving per hour Make and buy plan, 1 each max

2 1 5 ––– 12

(b)

2 marks per sensible point many suggestions are possible

8 ––– 20 ––– –––

16





The Association of Chartered Certified Accountants



Tees plc’s main product, Green, is nearing the end of its life. A replacement product, Brace, has been designed and test marketed and the company is trying to decide when to replace Green with Brace. Tees plc only has the capability to produce one of the two products at a time. Sales of Green are expected to be 100,000 units in the first quarter of 2007 and are forecast to fall after that so that each quarter’s sales will be 10% less than those of the previous quarter. Green has a selling price of £14 per unit and its contribution to sales ratio (C/S ratio) is 40%. The fixed costs of making Green in 2007 will be £200,000 per quarter. Test market results for Brace were very good and demand for similar products is growing rapidly. Tees plc believes that sales of Brace can be predicted by the following equation: Y = 80,000 + 6,000 T. Where Y = sales of Brace in units per quarter. T = time, measured in quarters. For the first quarter of 2007 (that is Januar y to March 2007), T = 1; for the second quarter of 2007, T = 2; etc. The selling price of the Brace will be £16 and its contribution per unit will be £6. Fixed costs will increase to £240,000 per quarter if Green is replaced by Brace. Required: (a) Prepare a budgeted profit statement, on a quarterly basis, for the year ending 31 December 2007 under each of the following circumstances: (i)

Tees plc continues to sell Green and does not introduce Brace in 2007.

(6 marks)

(ii) Tees plc introduces Brace and discontinues Green as from 1 January 2007. (Your budget statements should clearly identify the sales revenue, contribution and profit for each quarter, and in (8 marks) total for the year. Present your figures in £000 and work to the nearest £000). (b) Tees’ management accountant believes that in addition to the above figures some other factors ne ed to be taken into account before making a decision. He explains that to avoid disruption of the production of Tees’ other products the changeover between Green and Brace must take place on either 1 January 2007 or 1 July 2007 and that the costs of changeover will differ depending upon which date is chosen. He has collected the following information. 1.

Some of the machinery used to make the Green will no longer be required for the Brace. The written down value of this machinery will be £250,000 at 1 January 2007, and £220,000 by 1 July 2007. Its net realisable value at 1 January 2007 will be £140,000, but by 1 July 2007 it will be £30,000.

2.

Some redundancies will result from the change of products. Redundancy payments of £40,000 will be made if the changeover occurs on 1 January, but these will rise to £50,000 by 1 July. The five administration workers concerned are each paid £20,000 per annu m and will not be replaced. Their wages are not included in the costs given in part (a).

Required: Using your results from part (a) and the information given above, prepare two statements showing the incremental costs and revenues for the year ending 31 December 2007 of changing over from Green to Brace on either 1 January 2007 or 1 July 2007. Give a brief explanation of your treatment of each item and advise Tees plc of the most profitable changeover date. (14 marks) (c) Explain what is meant by the product life cycle. Describe the four stages of the product life cycle and explain its importance in sales forecasting. (12 marks) (40 marks)

2


2

Hickman Ltd uses a standard marginal costing system to control the costs of its only product. Standard costs for the product are given below. £ per unit £18·00 £21·00 ––––––– £29·00 –––––––

Direct material Z: 2 kg at £4·00 per kg Direct labour: 3 hours at £7·00 per hour Standard variable cost per unit

During the most recent period 1,400 units of the product were made using 2,700 kilograms of Z costing £4·23 per kilogram, and 4,000 direct labour hours costing a total of £30,000. Actual fixed overheads for the period were £205,000 as compared to a budgeted £200,000. No raw material stocks are carried. Required: (a) Calculate the following variances and prepare a statement reconciling actual and standard cost for the period: (i)

direct material price variance;

(ii) direct material usage variance; (iii) direct labour rate variance; (iv) direct labour efficiency variance; (v) fixed overhead expenditure variance.

(13 marks)

(b) The management accountant of Hickman proposes a more detailed analysis of the direct material price variance. He feels this is appropriate since the market price of Z has recently increased significantly due to a world shortage of this material. Since the standard price of Z was set the price index for Z has risen from 110 to 140. He suggests the following analysis: Material Z analysis of price variance Actual kilograms at actual cost per kilogram 2,700 kilograms × £4·23 per kilogram = £11,421 £2,322 Fav controllable price variance Actual kilograms at revised standard cost (1) per kilogram 2,700 kilograms × £5·09 per kilogram = £13,743

Actual kilograms at standard cost per kilogram 2,700 kilograms × £4·00 per kilogram = £10,800 Note (1) Revised standard cost per kilogram = £4·00

×

£2,943 Adv non-controllable price variance

140 –––– = £5·09. 110

Required: As an Accounting Technician working for Hickman Ltd, write a short memorandum to the production manager explaining the meaning of the controllable and non-controllable price variances calculated by the management accountant. (7 marks) (20 marks)

3


[P.T.O.

3

Lewisville is a town with a population of 100,000 people. The town council of Lewisville operates a bus service which links all parts of the town with the town centre. The service is non profit seeking and its mission statement is ‘to provide efficient, reliable and affordable public transport to all the citizens of Lewisville.’ Attempting to achieve this mission often involves operating ser vices that would be considered uneconomic by private sector bus companies, due either to the small number of passengers travelling on some routes or the low fares charged. The majority of the town council members are happy with this situation as they wish to reduce traffic congestion and air pollution on Lewisville’s roads by encouraging people to travel by bus rather than by car. However, one member of the council has recently criticised the performance of the Lewisville bus ser vice as compared to those operated by private sector bus companies in other towns. She has produced the following information: Lewisville Bus Service Summarised Income and Expenditure Account Year ending 31 March 2006 £’000 Passenger fares Staff wages Fuel Depreciation

600 300 280 –––––

Surplus

£’000 1,200

1,180 ––––– 20 –––––

Summarised Balance Sheet as at 31 March 2005. £’000 Fixed assets (net) Current assets Stock Cash

Less

£’000 2,000

240 30 –––– 270 60 ––––

creditors due within one year

Net current assets

210 ––––– 2,210 ––––– 2,000 210 ––––– 2,210 –––––

Total assets less liabilities Ordinary share capital (£1 shares) Reserves

Operating Statistics for the year ended 31 March 2006 Total passengers carried 2,400,000 passengers Total passenger miles travelled 4,320,000 passenger miles Private sector bus companies Industry average ratios Year ended 31 March 2006. Return on capital employed

10%

Return on sales (net margin)

30%

Asset turnover

0·33 times

Average cost per passenger mile

37·4p

4


Required: (a) Calculate the following ratios for the Lewisville bus service (i)

Return on capital employed (based upon opening investment);

(ii) Return on sales (net margin); (iii) Asset turnover; (iv) Average cost per passenger mile.

(4 marks)

(b) Explain the meaning of each ratio you have calculated. Discuss the performance of the Lewisville bus service (10 marks) using the four ratios. (c) Another council member suggests that the performance of the bus service should be assessed on the basis of economy, effectiveness and efficiency. Required: Explain the meaning of the following terms in the context of performance measurement and suggest a measure of each one appropriate to a bus service. (i)

Economy;

(ii) Effectiveness; (iii) Efficiency. (6 marks) (20 marks)

5


[P.T.O.

4

Rathbone plc is preparing its budgets for the coming year. It expects to be able to sell 5,000 units of its only product, the Graham, in January 2007. Sales are then expected to rise to 5,500 units in February and 7,000 units in March and then remain stable for the rest of the year. Rathbone plc aims to carry a finished goods stock at the end of each month equal to 10% of the following month’s sales. Each Graham takes four hours labour to make. Rathbone’s 138 production workers are employed on contracts that require them to work a minimum of 160 hours per month and are each paid £1,280 per month. Production workers are highly skilled and require a minimum of one year’s training. In the short term it is not possible to recruit any more production workers. Any labour hours required in excess of 160 hours per worker are made up by overtime that is paid at basic rate plus an overtime premium of 50%. Required: (a) Prepare, on a monthly basis, for the first three months of 2007 (i)

a production budget in units, showing opening and closing stocks of finished goods

(ii) a labour budget showing both hours and labour cost.

(6 marks) (6 marks)

(Assume that all production workers work at least 160 hours per month) (b) Recent pay negotiations with the workforce have proved difficult and there is a possibility that workers will refuse to work overtime in 2007. If this does occur Rathbone intends to build up stocks of the Graham to as high a level as possible from January onwards, whilst as far as is possible satisfying demand in each month. Opening stocks for January 2007 will be in line with company policy. Required: For the first three months of 2007, prepare the following monthly budgets on the assumption that the workforce refuses to work overtime: (i)

a labour budget showing both hours and labour cost.

(2 marks)

(Assume that all production workers work 160 hours per month) (ii) a production budget in units, showing opening and closing stocks of finished goods.



6


Answers



(a)

June 2006 Answers

Budgeted Profit Statement Budgeted Profit Statement for year ending 31/12/2007 assuming Green is manufactured and sold. Quarter 1 £000 1,400 (840) – – –– –– 560 (200) – – –– – – 360 – – –– – –

Sales revenue (w1) Variable costs (w2) Contribution (w3) Fixed costs Profit

Quarter 2 £000 1,260 (756) – –– – –– 504 (200) – –– – –– 304 – –– – ––

Quarter 3 £000 1,134 (680) – – –– – – 454 (200) – – –– – – 254 – – –– – –

Quarter 4 £000 1,021 (613) – –– – – – 408 (200) – –– – – – 208 – –– – – –

Total £000 4,815 (2,889) – –– – – – 1,926 (800) – –– – – – 1,126 – –– – – –

Workings W1 Quarter 1 sales = 100,000 × £14 = £1,400,000 Quarter 2 sales = £1,400 × 90% = £1,260,000 Etc W2 If contribution is 40% of sales revenue, then variable costs will be 60% of sales revenue. Quarter 1 variable cost = £1,400,000 × 60% = £840,000 Quarter 2 variable cost = £1,260,000 × 60% = £756,000 W3 Quarter 1 contribution £000 = £1,400,000 Etc

×

40% = £560,000

Budgeted Profit Statement for year ending 31/12/2007 assuming Brace is manufactured and sold. Sales units (W4) Sales revenue (W5) Variable costs (W6) Contribution (W6) Fixed costs Profit Workings W4 Y = 80,000 + 6,000 T Quarter 1 sales units = 80,000 Quarter 2 sales units = 80,000 Quarter 3 sales units = 80,000 Quarter 4 sales units = 80,000

+ + + +

Quarter 1 86,000

Quarter 2 92,000

Quarter 3 98,000

£000 1,376 (860) – – –– –– 516 (240) – – –– –– 276 – – –– – –

£000 1,472 (920) – –– – –– 552 (240) – –– – –– 312 – –– – ––

£000 1,568 (980) – – –– – – 588 (240) – – –– – – 348 – – –– – –

(6,000 (6,000 (6,000 (6,000

1) 2) × 3) × 4) × ×

= = = =

Quarter 4 104,000 £000 1,664 (1,040) – –– – – – 624 (240) – –– – – – 384 – –– – – –

Total 380,000 £000 6,080 (3,800) – –– – – – 2,280 (960) – –– – – – 1,320 – –– – – –

86,000 92,000 98,000 104,000

W5 Quarter 1 Sales revenue = 86,000 × £16 = £1,376,000 Etc W6 Variable cost per unit = Selling price – Contribution per unit = £16 – £6 = £10 per unit Quarter 1 Variable cost = 86,000 × £10 = £860,000 Quarter 1 contribution = 86,000 86,000 × £6 = £516,000 Etc

9


(b)

Relevant Costs and revenues

Extra profits in the year (w7) Sale of machiner y Redundancy costs Wage savings (w8) Incremental Profits

Replace at 1 Januar y 2007

Replace at 1 July 2007

£ 194,000 140,000 (40,000) 100,000 – – –– –– – – 394,000 – – –– –– – –

£ 270,000 30,000 (50,000) 50,000 – – –– – –– – 300,000 – – –– – –– –

Incremental revenues and (costs) of eplacing 1/1/2007 £ (76,000) 110,000 10,000 50,000 –– – –– – – – 94,000 –– – –– – – –

Conclusion On a relevant cost basis it is best to introduce the new product on 1 January 2007. Explanation of figures Profits.. Replacing the Green with the Brace will result in extra profits in 2007 as revealed in the budgeted figures (part (a)). Profits Replacing the Green later avoids low sales figures in the first quarter. Sale of Machinery. Machinery. The net realiseable value of the machinery is relevant here as this is what the machinery could be sold for. Written down value relates to unexpired historic cost, not future value. Redundancy and wage savings. savings . Early changeover leads to lower redundancy payments and higher wage savings. Workings W7 Using total profit figures for the year from (b): £1,320,000 – £1,126,000 = £194 000 Using second half year profit figures from (b): £348,000 + £384,000 – £254,00 – £208,000 = £270,000 W8 5 workers × £20,000 = £100,000 for the full year, and half of this for the half year. (c)

What is meant by the product life cycle. The product life cycle refers to the empirically observed pattern in the sales of many products over time. No product will last forever and eventually its sales will fall. The duration of the life cycle varies between products with some lasting for decades whilst others last only for a matter of months. The general shape of a product life cycle is shown in the following diagram, but it is important to note that the length of each stage varies between products.

Sales £ Introduction

Growth

Maturity

Decline

Time

Four stages of the product life cycle. Introduction.. This refers to the bringing in and the bringing on of a new product. This is usually the culmination of a period Introduction of market research and product research and development; the point at which the product or service first comes to market. Sales are usually low and costs are high due to launch expenses and design changes. Growth . This is where the product takes off and its true potential begins to become apparent. Sales rise quickly for successful Growth. products, unit costs start to decline as the firm gains experience of the product. Maturity. The product is now a familiar part of the market. Unit costs are low and profits are generally high. Competition is Maturity. now strong. The market generally reaches saturation during this phase and sales growth stops. The product may be modified or improved as a means of sustaining demand.

10


Decline. Eventually sales begin to decline and there is over-capacity amongst suppliers. Falling sales volume and reduced prices will eventually lead to losses and withdrawal of the product. Tutorial Notes: 1. Decline can sometimes be avoided by regeneration of the product. This normally involves adding new features to the product to stimulate its sales, for example adding video cameras to mobile telephones. 2.

Some textbooks refer to a development stage of the product life cycle. In this stage there are no sales and high development costs are incurred prior to product launch. Credit will be given for discussion of this stage.

Importance in sales forecasting When forecasting sales it is important to consider the product life cycle. Rates of sales growth will vary between the different stages of a product’s life. It is particularly important to note that growth rates enjoyed at the growth stage will not continue forever. All products should eventually arrive at the maturity stage. The difficulty of applying the product life cycle in sales forecasting is to know when the end of one stage and the beginning of the next will occur. Some products will never get past the introductory phase (failed products), whilst others, particularly staple food products like bread and rice appear never to reach the decline stage.

2

(a)

Variances Direct material Actual usage at actual cost 2,700 kg

£4·23

×

Actual usage at standard cost 2,700 kg

×

£4·00

Standard usage at standard cost 1,400 units Direct labour Actual hours at actual rate 4000 hrs

×

=

×

2kgs

= ×

£4·00

£7·50

Actual hours at standard rate 4,000 hrs

×

=

£7·00

Standard hours at standard rate 1,400 units

×

=

3hrs

= ×

£7·00

=

Fixed overhead Actual overhead

=

Budgeted overhead

=

Reconciliation Standard cost for the period Variable cost (1,400 units × £29·00 per unit) Fixed cost Total standard cost Direct material price variance Direct material usage variance Direct labour rate variance Direct labour efficiency variance Fixed overhead expenditure variance

£ 40,600 200,000 ––––––––

Total actual cost for the period Calculation of total actual cost Variable cost ((2,700 kg × £4·23) + £30,000) Fixed cost

£11,421 Price £10,800 Usage £11,200 £30,000 Rate £28,000 Efficiency £29,400

> £621 Adv > £400 Fav

> £2,000 Adv > £1,400 Fav

£205,000 Expenditure > £5,000 Adv £200,000 £

240,600 621 400 2,000 1,400 5,000 –––––––– 246,421 ––––––––

Adv Fav Adv Fav Adv

41,421 205,000 –––––––– 246,421 ––––––––

11


(b)

Memorandum To: Production Manager, Hickman Ltd. From: A Technician Subject: Direct material price variance Date: Today The direct material price variance measures the effect of paying a different price than standard for actual materials purchased or used. Differences between actual and standard price can be caused by events outside the control of our business (e.g. world shortages of material or exchange rate changes leading to increased prices), or events within our control (e.g. failure to shop around for a good price, or failure to obtain bulk buy discounts). The analysis proposed by the management accountant attempts to split the overall price variance into controllable and non-controllable elements. This is a sensible idea as it supports the concept of responsibility accounting, under which managers are only held accountable for items that they can control. The controllable price variance is calculated by comparing actual price with a revised standard price. The revised standard price is the original standard price adjusted for inflation in the market price of material Z. After allowing for the effects of inflation we can see that we have paid quite a low price for material Z, leading to a favourable variance, or cost saving, of £2,322. This will be considered to be to the credit of the manager who made the purchase. (Tutorial note: The use of a price index to arrive at a revised standard does, of course, assume that the original budgeted figure was correct.) The non-controllable price variance is calculated by comparing the revised standard price with the original standard price. It is the part of the total price variance caused by inflation, and is therefore considered non-controllable. In this case inflation in material Z prices resulted in extra costs of £2,943. I hope this clarifies the analysis. If you have any further queries do not hesitate to contact me.

3

(a)

Ratios Return on capital employed Operating profit 20 ––––––––––––––– × 100 = –––––– Capital employed 2,210 Return on sales (net margin) Operating profit 20 ––––––––––––––– × 100 = –––––– Sales 1,200 Asset turnover Sales ––––––––––––––– Capital employed

=

×

100

=

0·9%

×

100

=

1·7%

=

0·54 times

=

27·3 p

1,200 –––––– 2,210

Average cost per passenger mile = operating cost 1,180,000 ––––––––––––––– –––––––––– passenger miles 4,320,000

Tutorial note: the term profit is used throughout this answer; in the public sector it would normally be referred to as surplus. (b)

Meaning of each ratio Return on capital employed. This ratio measures the profits earned on the long-term finance invested in the business. The Lewisville bus service is only generating an annual profit of 0·9p for every £1 invested. The equivalent figure for private bus companies is 10p. Return on sales. This ratio measures the profitability of sales. For the Lewisville bus service 1·7p of every £1 of sales is profit. The equivalent figure for private bus companies is 30p. Asset turnover. This ratio measures a firm’s ability to generate sales from its capital employed. The Lewisville bus service generates sales of 54p for every £1 of capital employed. The equivalent figure for private bus companies is only 33p. Average cost per passenger mile. This measures the cost of transporting passengers per mile travelled. The Lewisville bus service incurs a cost of 27·3p per passenger mile as compared to 37·4 p for private bus companies. Performance of the bus service On first sight the Lewisville bus service appears to have performed poorly as compared to private sector bus companies. It has a low return on capital employed, largely due to a poor return on sales. This could be explained by the low fares charged. (See tutorial note) On the positive side its ability to generate sales is good and its buses appear to be more intensively used than private sector equivalents.

12


However, if we take into account the objectives of the council and the mission statement of the bus service it is possible to draw a different conclusion. Private sector companies usually seek to maximise investor wealth. The council appears to be trying to encourage usage of public transport in an attempt to reduce traffic congestion. To do this it charges low fares, resulting in a poor return on sales and a low return on capital employed. However, the low fares, and willingness to operate uneconomic routes has led to a high asset turnover, implying above industry average usage of the bus service. In turn this greater usage of the service leads to a lower cost per passenger mile as fixed costs are spread more thinly over a larger number of passenger miles. Before drawing any firm conclusions it would be sensible to compare the performance of the Lewisville bus service with that of bus operators pursuing similar objectives. (Tutorial note: If we compare average fare per passenger mile we can see that the Lewisville bus service charges lower fares than the private sector. Lewisville fare per passenger mile = passenger fares ÷ passenger miles = £1,200,000 ÷ 4,320,000 = 27·8p Private sector

= Average cost ÷ (1 – net margin) = 37·4p ÷ (1 – 0·3) = 53·4p.

Lewisville charges lower fares per passenger mile, which may explain its higher load factor and therefore its lower cost per passenger mile) (c)

Economy, Effectiveness and Efficiency. When measuring the performance of public sector organisations it is sometimes suggested that they should be assessed on the basis of the ‘three Es’; economy, effectiveness and efficiency. Economy is an input measure and is normally based around the expenditure of the organisation. In the case of the Lewisville bus service it could be measured by total expenditure as compared to budget. Effectiveness is an output measure and looks at what the organisation achieves in terms of its objectives. In the case of the Lewisville bus service it could be measured by the number of passengers carried, or the n umber of passenger miles travelled. Efficiency is a combination of the above two measures. It considers output in relation to input. In the case of the Lewisville bus service it could be measured by cost per passenger mile travelled.

4

(a)

Budgets Production budget 2007 Sales Desired closing stock (w1)

Less

opening stock (w2)

Production units

January 5,000 550 –––––– 5,550 (500) –––––– 5,050 ––––––

Units February 5,500 700 –––––– 6,200 (550) –––––– 5,650 ––––––

March 7,000 700 –––––– 7,700 (700) –––––– 7,000 ––––––

Labour budget 2007 Production units Hours per unit

January 5,050 4

Total hours Basic hours available (w3) Overtime hours needed

Basic rate payment (w4) Overtime payment (w5) Total labour cost

20,200 22,080 0

February 5,650 4 Hours 22,600 22,080 520

March 7,000 4 28,000 22,080 5,920

£ 176,640 0 –––––––– 176,640 ––––––––

£ 176,640 6,240 –––––––– 182,880 ––––––––

£ 176,640 71,040 –––––––– 247,680 ––––––––

13


Workings Working 1 January closing stock = February sales

×

10% = 5,500 units

×

10% = 550 units etc

Working 2 January opening stock = January sales

×

10% = 5,000 units

×

10% = 500 units etc.

Working 3 138 workers

×

160 hours per month = 22,080 hours

Working 4 138 workers

×

£1,280 = £176,640

Working 5 Basic rate = £1,280 ÷ 160 hours = £8·00 per hour Overtime rate = £8·00 × 150% = £12·00 Overtime payment February = 520 hours × £12·00 = £6,240 etc. (b)

Revised Budgets Labour budget 2007 January Basic hours available (w3) Basic rate payment (£)(w4)

176,640

February Hours 22,080 £ 176,640

January 500 5,520 (5,000) –––––– 1,020 ––––––

Units February 1,020 5,520 (5,500) –––––– 1,040 ––––––

22,080

Production budget 2007 Opening stock Production Sales Closing stock

March 22,080 176,640 March 1,040 5,520 (6,560) (w6) –––––– 0 ––––––

Working 6 Rathbone can only sell available finished goods stock, 1,040 units + 5,520 units = 6,560 units

14



June 2006 Marking Scheme

Marks

1

(a)

Green budget Sales Revenue Contribution Profit

2 2 2 ––– 6

Brace budget Sales units forecast Sales revenue Contribution Profit

(b)

(c)

2 2 2 2 ––– 8 ––– 14 –––

Relevant cost analysis Extra profits Extra profit explained Sale of machine Sale of machine explained Redundancy cost Wage savings Wage savings and redundancy explained Advice

2 1 2 2 2 2 2 1 ––– 14 –––

Meaning of product life cycle Pattern in sales over time Sales eventually fall

1 1 ––– 2

Stages Introduction Low sales/high costs Growth Sales rise quickly Maturity Saturation/growth stops Decline Falling sales/losses

1 1 1 1 1 1 1 1 ––– 8

Importance Rates of growth vary over the cycle Difficulty in predicting stages

1 1 ––– 2 ––– 12 ––– 40 –––

15


Marks

2

(a)

(b)

Variances 2 marks per variance , max Reconciliation Format Total standard cost Total actual cost

10 1 1 1 ––– 13 –––

Memo Memo Format Controllable explained* Non-controllable explained*

* for full marks reference must be made to the price index adjustment.

3

(a) (b)

Ratios One mark per ratio

4

Performance evaluation One mark per ratio explained Simplistic interpretation of performance, max Performance related to objectives, max

4 6 3 ––– 10

Maximum (c)

4

(a)

1 3 3 ––– 7 ––– 20 –––

3 Es One mark per E explained One mark per measure

3 3 ––– 6 ––– 20 –––

Production budget Closing stocks Production units

3 3 ––– 6

Labour budget Basic hours Overtime hours Basic payment Overtime payment

1 2 1 2 ––– 6

Labour budget Hours Payment

1 1 ––– 2 2 3 1 ––– 6 ––– 20 –––

Production budget Production Closing stocks March sales

16




7 T r e p a P




The Cruyff hotel provides accommodation and meals for tourists. There are two profit centres: accommodation and restaurant. Rooms are sold at a nightly rate per room and guests have the option of dining in the hotel restaurant for an extra charge. In the last year the number of rooms sold has increased but overall hotel profit has fallen. The owners of the hotel recently commissioned a consultant to introduce a system of budgetary control. Unfortunately the consultant became ill part way through the project. As an Accounting Technician employed by the hotel, you have been asked to complete the consultant’s work. The following extracts from the consultant’s notes are available. Cruyff Hotel: profit statement week 48 Budget Room Occupancy Level Accommodation sales Restaurant sales Total sales Accommodation costs: Laundry Cleaning Wages Restaurant costs: Food Wages Common costs: Building maintenance Management salaries Operating profit

80% £ 26,880 8,064 ––––––– 34,944

100% £ 33,600 10,080 ––––––– 43,680

Actual 95% £ 32,000 6,100 ––––––– 38,100

(1,344) (3,016) (3,000)

(1,680) (3,520) (3,000)

(1,603) (3,980) (2,950)

(4,032) (2,000)

(5,040) (2,000)

(4,950) (2,050)

(2,000) (1,500) ––––––– 18,052 ––––––– –––––––

(2000) (1,500) ––––––– 24,940 ––––––– –––––––

(1,950) (1,500) ––––––– 19,117 ––––––– –––––––

Notes 1. The hotel has 120 rooms. The rate per night is the same for all rooms. Occupancy level is expressed as a percentage of full capacity. 2. The hotel and restaurant opens for 7 nights a week and for 52 weeks per year. 3. Budgeted restaurant sales are assumed to be a fixed percentage of accommodation sales. 4. Costs are either fixed or variable, except for cleaning, which is semi-variable.

2


Required: (a) Calculate the number of room nights sold per week for 100%, 95% and 80% occupancy levels. (3 marks) (A room night represents one room occupied for one night.) (b) Using the budgeted figures prepared by the management consultant as a basis, calculate (i) the variable cost per room-night for cleaning; (ii) the fixed cost per week for cleaning.

(3 marks) (1 mark)

(c) Prepare a flexed budgeted profit statement for the Cruyff hotel for week 48 for an occupancy level of 95%. Your statement should show (i) the budgeted contribution for each profit centre; (8 marks) (ii) the budgeted traceable profit for each profit centre; and, (6 marks) (iii) the budgeted profit for the hotel in total. (2 marks) (d) Calculate, for the restaurant only, the variances between the actual results for week 48 and the flexed budget figures you have calculated in part (c). Comment on the performance of the restaurant. (9 marks) (e) Explain how zero-based budgeting could be used to set budgets. Give two advantages of using zero-based (8 marks) budgeting. (40 marks)

3


[P.T.O.

2

A large multinational company uses return on investment (ROI) to measure the performance of its divisions. Divisional managers have control over divisional revenues, and are given limited control over costs. Cash, land and buildings are managed by group head office. Divisional managers have control over all other divisional assets and liabilities. Head office has a required rate of return of 15% for all divisions. Details of the performance of the Neeskens Division are given below. Neeskens division profit and loss account Year ended 30 September 2006 Sales Cash operating costs Depreciation: land and buildings Depreciation: plant and machinery Apportioned head office cost Divisional profit

£000 7,500 (3,600) (40) (300) (1,500) ––––––– 2,060 ––––––– ––––––– Neeskens division balance sheet as at 30 September 2005 (extract) £000

Fixed assets (net book value) Land and buildings Plant and machinery

Current assets Stock Debtors Cash

creditors due within one year Trade creditors Net current assets

£000 2,000 13,200 ––––––– 15,200

1,200 1,400 500 ––––––– 3,100

Less

(1,400) 1,700 ––––––– 16,900 ––––––– –––––––

Net Assets Required:

(a) Calculate both the controllable and traceable return on investment (based upon opening investment) for the Neeskens division for the year ended 30 September 2006. (6 marks) (b) Calculate traceable residual income (based upon opening investment) for Neeskens division for the year ended 30 September 2006 and briefly explain what it means. (4 marks) (c) Explain the difference between controllable and traceable return on investment. Why is the difference important? (6 marks) (d) Give two advantages of residual income as a measure of divisional performance.


4


3

(a) Rep plc is experiencing a decrease in sales for its only product. It has budgeted sales volume in the year ending 30 November 2007 to be 1 million units, which is 80% of sales volume for the year ended 30 November 2006. Budgeted cost and revenue per unit for the year ending 30 November 2007 are as follows: Selling price Direct material Direct labour (note 1) Absorbed fixed overheads (Note 2) Profit per unit

£ per unit 129 9 30 40 ––50 ––– –––

Notes: 1. Labour is a variable cost. 2. Fixed overheads are absorbed on the basis of budgeted direct labour hours. For the coming year sales and production are each budgeted at 1 million units. There are no variable overheads. 3. The above selling price per unit, variable costs per unit and total fixed overheads are expected to be unchanged between the two years. Required: Calculate the actual profit for the year ended 30 November 2006 and the budgeted profit for the year ending 30 November 2007. (6 marks) (b) The sales manager of Rep plc thinks that the fall in demand is due to aggressive pricing and intensive advertising by its competitors. Two actions are being considered to increase sales: 1.

Reduce price by 10%. This is expected to result in a 30% increase in sales units in 2007 as compared to the existing budget.

2.

Launch an advertising campaign. Spending £5 million on advertising is expected to increase 2007 sales units by 20% as compared to the existing budget.

The sales manager is uncertain about the increases in sales volumes associated with these two proposals and is considering conducting some market research to improve the reliability of the estimates. Required: (i)

Calculate separately the effect of the price reduction and the increase in advertising expenditure on budgeted profit for the year ending 30 November 2007; (4 marks) (ii) If the price reduction and the advertising campaign were both introduced, calculate the level of sales in units that would be required to earn a profit of £72·5 million. (4 marks) (c) Explain to the sales manager how the following sampling methods could be used in market research, and give one advantage of each method: (i) stratified random sampling; and (ii) cluster sampling. (6 marks) (20 marks)

5


[P.T.O.

4

Krol plc uses a standard costing system to control its costs. In the most recent month its cost accountant has reported a large adverse direct material usage variance. An initial investigation has shown that the variance is caused by a faulty machine. The production manager is trying to decide whether to close down the production line for one day to allow engineers to perform emergency maintenance work that could rectify the problem. Past experience of investigating raw material usage variances suggests that there is a 70% chance of correcting the fault. If the emergency maintenance work is not carried out now it is estimated that extra material costs of £60,000 per month for the next six months will be incurred. After this time the problem will definitely be corrected by scheduled maintenance work during the company’s annual shut down. Two maintenance engineers would be required to carry out the emergency maintenance work. Maintenance engineers are paid £25,000 per annum and each engineer works for 250 days each year. There is currently surplus capacity in the maintenance department. The emergency maintenance would use parts costing £10,000. These parts would have to be replaced again during the scheduled annual maintenance. Emergency maintenance would involve stopping production for a day resulting in lost production with an estimated sales value of £160,000, direct material cost of £45,000 and direct labour cost of £90,000. Direct labour would continue to be paid during the one-day stoppage. In this time the otherwise idle labour would be used to repaint the factory, saving £7,000 in outside painting contractor costs. Krol carries no finished goods stocks and is currently unable to satisfy demand for its product. Required: (a) Using relevant cost principles, calculate whether the emergency maintenance should be performed. (9 marks) (b) Suggest three potential causes of direct material usage variances.

(3 marks)

(c) Explain the role of control charts in the variance investigation decision. Note: Your answer should include a fully labelled sketch diagram of a variance control chart. Graph paper is not required.

(8 marks)

(20 marks)


6


Answers




(a)

Room nights per week 100% capacity: 120 rooms x 7 nights x 100% = 840 room nights per week 95% capacity: 120 rooms x 7 nights x 95% = 798 room nights per week 80% capacity: 120 rooms x 7 nights x 80% = 672 room nights per week

(b)

Cleaning costs £3,520 – £3,016 Variable element = –––––––––––––––––= £3 per room night 840 – 672 Fixed element by substitution: Total cost = Fixed cost + variable cost £3,520 = Fixed cost + (840 x £3 per room night) Fixed cost = £1,000

(c)

Budgeted Profit statement for 95% capacity

Sales (w1 and 2) Variable costs Laundry (w3) Cleaning variable (w4) Food (w5) Contribution Traceable fixed costs Cleaning fixed Staff wages Traceable profit

Accommodation Restaurant £ £ 31,920 9,576 (1,596) (2,394) –––––––– 27,930

(4,788) ––––––– 4,788

(1,000) (3,000) –––––––– £23,930 –––––––– ––––––––

(2,000) ––––––– £2,788 ––––––– –––––––

Common costs Building maintenance Management salaries

Total £ 41,496 (1,596) (2,394) (4,788) –––––––– 32,718 (1,000) (5,000) –––––––– 26,718

(2,000) (1,500) –––––––– £23,218 –––––––– ––––––––

Operating profit

Workings. 1. Accommodation sales = £33,600 x 95% = £31,920 2. Restaurant sales = £10,080 x 95% = £9,576 3. Laundry costs = variable cost = £1,680 x 95% = £1,596 4. Total cost at 95% capacity (798 room nights) = (798 x £3) = £2,394 5. Restaurant food costs = variable cost = £5,040 x 95% = £4,788 (d)

Budget Variances Room Occupancy Level Restaurant sales Restaurant costs: Food Wages Operating profit

Budget 95% £ 9,576

Actual 95% £ 6,100

Variance

(4,788) (2,000) £2,788

(4,950) (2,050) £(900)

162Adv 50Adv £3,688Adv

£ 3,476Adv

Comments The most significant variance is that for restaurant sales. It has several potential causes. The restaurant may not be attracting as many residents as assumed in the budget. Customers may be selecting lower price dishes (though this is not reflected in the food cost variance), or the restaurant may be failing to charge the budgeted price for meals. Whatever the cause this appears to be a major problem and a detailed investigation is needed. The other two variances relate to restaurant costs and on first sight appear relatively insignificant. However, if the sales variances are caused by customers selecting lower price dishes, the food variance would be expected to be favourable. The small adverse variance could be disguising significant price or wastage problems.

9


(e)

Zero-based budgeting Zero-based budgeting (ZBB), as its name suggests, involves preparing a budget from a zero-base. In this case the hotel management would be told to assume that they had no budget allowance for particular activities and they would then be required to justify any expenditure in order for it to be included in the budget. A ZBB exercise usually involves the following steps. Step 1. Management prepare decision packages for the tasks per formed by their depar tments. This would involve a detailed description of what the tasks involve, what they cost and how they contribute to organisational objectives. Decision packages might include alternative methods of performing tasks (for example, in-house provision or external suppliers) and different levels of service (using cleaning as an example, a base level package ensuring a minimum hygiene level or a superior level of cleaning that would give the hotel an excellent appearance). Step 2. Junior and senior managers are then asked to rank decision packages against each other and decision packages in other areas in terms of their contribution to corporate objectives. Step 3. Resources (in this case money) are then allocated to the selected decision packages. The advantages of ZBB are: – Identification and elimination of unnecessary expenditure. Activities that do not contribute toward organisational objectives will be discontinued. – Identification of wasteful expenditure. Overspending on activities will be identified and budgets will be reduced accordingly. – It challenges the status quo and encourages a questioning approach to activities and expenditure. In this way it is the ideal antidote for incremental budgeting. – The documentation that ZBB requires provides an in depth appraisal of an organisation’s activities. – It provides a plan to work to (in service departments) if more funds become available. (only two advantages were required)

2

(a)

Controllable and traceable return on investment Working 1 Controllable profit = sales – cash operating costs – depreciation on plant and machinery = £7,500 – £3,600 – £300 = £3,600 Working 2 Controllable investment = plant and machinery + stock + debtors – creditors = £13,200 + £1,200 + £1,400 – £1,400 = £14,400 Controllable profit % Controllable ROI = ––––––––––––––––––––– Controllable investment (w1) £3,600 = –––––––––––––– = 25% (w2) £14,400 Working 3 Traceable profit = sales – cash operating costs – depreciation on plant and machinery –depreciation on land and buildings = £7,500 – £3,600 – £300 – £40= £3,560 Working 4 Traceable investment = fixed assets + current assets – current liabilities = £15,200 + 3,100 – £1,400 = £16,900

Traceable ROI

Traceable profit % = –––––––––––––––––– Traceable investment (w3) £3,560 = ––––––––––––– = 21% (w4) £16,900

10


(b)

Traceable residual income Traceable profit Imputed interest charge Traceable investment x 15% £16,900 x 15% Traceable Residual income

3,560

(2,535) –––––– 1,025 –––––– ––––––

Residual income shows the return earned by a division, in excess of its required rate of return. The required rate of return is usually the division’s cost of capital. In this case residual income is positive indicating that the division is performing well. (c)

Controllable and traceable return on investment Controllable items are those that are under the control of divisional management. In the case of the Neeskens division, depreciation on land and buildings is excluded from the calculation of controllable profit as divisional managers are not in control of investment in land and buildings. In a similar way apportioned head office expenditure is not under the control of divisional managers. Cash and land and buildings are excluded from controllable investment as these items are controlled by head office. Traceable items are those that can be traced directly to the division. In the profit and loss account all items apart from apportioned head office expenditure clearly relate to the division. All assets employed in the division can be traced to that division. The distinction is important. Controllable profit can be used to assess the performance of divisional managers. This follows the principle of responsibility accounting, which states that managers should be assessed on the basis of items which they can control. Traceable profit can be used to assess the performance of a division. It is important to remember that it is possible to have poor management performance in a well performing division, and vice versa.

(d)

Advantages of residual income as a measure of divisional performance. Residual income shows the absolute surplus earned by a division in excess of its owners’ required rate of return. This has several advantages: – It facilitates comparisons between divisions of different sizes. The division with the largest residual income will be the most attractive to owners as it makes the biggest contribution to their wealth. – It avoids some of the dysfunctional aspects of return on investment. Managers whose performance is measured by residual income will want to invest in projects that offer a return greater than the division’s cost of capital. This is not always the case with return on investment where managers may reject projects that earn a return greater than the cost of capital but less than existing return on investment. – Residual income can be related to net present value (the generally accepted method of investment appraisal). In the long run companies that maximise residual income are likely to maximise net present value. (only two advantages were required)

11


3

(a)

Actual and budgeted profit. Actual profit year ended 30/11/2006 £m 112·5 (40·0) ––––– 72·5 ––––– –––––

Actual contribution (w1) Actual fixed overhead (w2) Profit

Budgeted profit year ending 30/11/2007 £m 90·0 (40·0) ––––– 50·0 ––––– –––––

Budgeted contribution (w3) Budgeted fixed overhead Budgeted profit

Workings W1

Contribution per unit= £129 – £9 – £30 = £90 Actual sales units = 1 m units x 100 ÷ 80 = 1·25 m units Contribution = £90 x 1·25 m units =£112·5 m

(b)

W2

Total fixed overheads = 1 m budgeted units x £40 per unit = £40 m Or 2 m budgeted hours x £20 per hour = £40 m.

W3

Contribution = £90 x 1 m units =£90 m

(i)

Revised budgeted profits Price Reduction Budgeted contribution (w4) Budgeted fixed overhead Budgeted profit

Advertising campaign Budgeted contribution (w5) Budgeted fixed overhead Budgeted profit

£m 100·23 (40·00) –––––– 60·23 –––––– –––––– £m 108·00 (45·00) –––––– 63·00 –––––– ––––––

Workings W4 Contribution per unit = (£129 x 0·9) – £9 – £30 = £77·1 Budgeted contribution = £77·1 x 1 m units x 1·3 = £100·23 m. W5 Budgeted contribution £90 x 1 m units x 1·2 = £108 m. (ii)

Required Sales level Target contribution £45 m + £72·5 m = –––––––––––––––––– = ––––––––––––––––– = 1·524 m units Contribution per unit £77·10 per unit

(c)

Stratified random sampling and cluster sampling (i)

Stratified random sampling This involves dividing the total population into strata or categories (for example age groups) and then taking random samples from each of the strata or categories. Advantages. – The selected sample will be representative of the population as a whole, as all strata will be represented. – Inferences can be drawn about each stratum. – Precision is increased, as variation between strata does not enter as a chance event. A random sample could miss an entire stratum.

12


(ii)

Cluster sampling This involves splitting the population into convenient groups and then selecting a number of groups at random. Every item in the sample is then investigated. For example people travelling on particular buses could be taken as representative of the travelling public in general. All the passengers on the selected buses would then be interviewed. This is a non-random sampling method. Advantages. – It is cheap to operate as the members of each cluster are all in one place, this is particularly useful if face to face interviews are required. – Useful if a sampling frame does not exist (for example if you can’t identify your potential population of customers to sample from). (only one advantage of each method was required)

4

(a)

Variance Investigation Expected benefit of investigation Saved material costs £60,000 x 6 months x 70% =

252,000

Costs of the investigation Engineer’s salaries (irrelevant) Parts Lost sales Saved direct material cost Saved painting costs

(10,000) (160,000) 45,000 7,000 ––––––––– £134,000 ––––––––– –––––––––

Net benefit

The investigation shows a net benefit of £134,000 and it should be carried out. (b)

Causes of usage variances There are many potential causes of a direct material usage variance including: – Inaccurate standard. If the standard is set badly efficient usage of materials will still result in a variance. – Inaccurate recording of actual cost. Badly recorded actual cost can result in variances being reported. – Quality of material. Material of a different quality to standard can result in favourable or adverse variances. – Variations in wastage rates due to the quality of labour or badly calibrated machinery can result in usage variances. – Theft of material can result in adverse variances. – Errors in allocating material can result in the use of the wrong material and lead to variances. (only three causes were required)

(c)

Control charts When deciding whether to investigate a variance it is important to distinguish between variances that are caused by normal random variation in cost (those that occur even though the process is ‘in control’) and those that are caused by genuine problems (often referred to as the process being ‘out of control’). Some costs are inherently variable (e.g. raw material costs where the grade of material varies from batch to batch) and standards can be viewed as representing an average cost. Small variances (adverse or favourable) can often be accounted for by normal random variation that occurs around this average. Larger variances are less likely to be explained by normal random variation and are more likely to suggest that the process is out of control. Control charts provide a visual representation of variation of actual cost around standard.

13


The above shows a variance control chart. Actual costs are plotted on the diagram as percentages of standard cost, as they occur. As long as the actual cost percentage remains within the warning limits no action is taken. These small variations from standard are assumed to be due to normal random variation. If actual costs move outside the warning limits it indicates a need for careful monitoring and outside the action limits indicates a need for corrective action. Warning and action limits can be set on the basis of experience or on the basis of a standard normal distribution. Control charts provide a useful visual representation of data and help in isolating out normal random (uncontrollable) variation in cost. They are only really useful for costs where an average can be established and their use is usually restricted to efficiency rather than expenditure variances.

14



December 2006 Marking Scheme Marks

1

2

(a)

One mark for each level, max

(b)

Method Variable cost Fixed cost

2 1 1 ––– 4 –––

(c)

Contribution Traceable profit Total profit

8 6 2 ––– 16 –––

(d)

Two marks per variance, max Comments

6 3 ––– 9 –––

(e)

ZBB explained Advantages, two each, max

4 4 ––– 8 ––– 40 ––– –––

(a)

Controllable profit Controllable investment Controllable ROI Traceable profit Traceable investment Traceable ROI

1 1 1 1 1 1 ––– 6 –––

(b)

Imputed interest charge Residual income Explanation

1 1 2 ––– 4 –––

(c)

Controllable explained Traceable explained Distinction

2 2 2 ––– 6 –––

(d)

2 per advantage, max

4 ––– 20 ––– –––

3

15


3

4

(a)

Contribution per unit Total fixed costs Actual profit Budgeted profit

2 2 1 1 ––– 6 –––

(b)

(i)

New contribution per unit New fixed cost Budgeted profits

2 1 1 ––– 4 –––

(ii)

Method Correct number of units

2 2 ––– 4 –––

(c)

Each definition 2 Advs 1 each max

4 2 ––– 6 ––– 20 ––– –––

(a)

Expected material cost savings Excluding engineer’s salary Parts Lost sales Saved material cost Opportunity cost labour Decision

2 1 1 1 1 2 1 ––– 9 –––

(b)

1 mark per cause, max

3 –––

(c)

Diagram Axes Warning limits Action (control) limits Explanation In control Out of control

2 1 1 2 2 ––– 8 ––– 20 ––– –––

16




7 T r e p a P




Naceur, a textile manufacturer, makes three products A, B and C. Budgeted cost and production information for the coming period is as follows: Product

A

B Per thousand metres

C

Costs Direct materials Direct labour Machine hours Labour hours

£120·00 £42·00 6·00 hrs 0·1 hrs

£100·00 £42·00 6·00 hrs 0·1 hrs

£60·00 £28·00 4·00 hrs 0·02 hrs

Output in thousand metres

120

100

80

The three products are manufactured using the same production technology. They are usually produced i n production runs of 10,000 metres and sold to wholesalers in batches of 5,000 metres. The company uses a cost plus pricing system and a gross margin of 20% on sales to calculate prices. Budgeted production overhead is absorbed using a machine hour rate and the budgeted overhead for the coming period has been analysed as follows: £ 26,000 15,000 9,600 5,250 9,750 –––––––– £65,600 –––––––– ––––––––

Rates, rent, supervision, power and depreciation Set up costs Goods inwards Finished goods inspection Dispatch Total Budgeted machine hours for the period are 1,640 hours. Required: (a) (i)

Calculate the budgeted total cost per thousand metres for each product, showing clearly prime cost, overhead cost and total cost; (5 marks)

(ii) Using your total cost estimates from (a) (i) and a GROSS MARGIN of 20% on sales calculate the (3 marks) budgeted price per thousand metres of each of the three products. (b) The sales manager of Naceur has complained that its main competitor is undercutting its prices for products A and B by several pounds. Naceur’s price for product C on the other hand is lower than that of the competitor. She believes these price differences are caused by their competitor using an activity-based costing (ABC) system to cost products, and a cost plus pricing system with a mark-up of 20% on total activity based cost to calculate prices. In an attempt to make Naceur’s costings more accurately reflect the usage of resources by products you have ascertained that the cost drivers for the overhead activities are as follows: Cost Pool

Cost driver

Rates, rent supervision, power and depreciation Set up costs Goods inwards costs Finished goods inspection costs Dispatch costs

machine hours number of production runs Number of requisitions number of production runs Number of sales orders

Budgeted driver activity for the period 1,64 0 30 120 30 60

The number of requisitions raised by goods inwards was 40 for each product and the number of sales orders was 60 (one order per batch sold). 2


Required: (i)

Calculate the budgeted cost driver rate for each overhead activity;

(5 marks)

(ii) Calculate the budgeted total cost per thousand metres for each product using an activity-based costing (10 marks) approach; (iii) Using your total cost estimates from (b) (ii) and a MARK-UP of 20% on total cost, calculate the price per thousand metres of each of the three products. Comment briefly on the causes of any changes in (7 marks) prices. (c) Describe three benefits which might result from the introduction of an activity based costing system. (6 marks)

(d) Describe two circumstances in which activity based costing would be a more appropriate approach to (4 marks) product costing than traditional approaches to overhead absorption. (40 marks)

3


[P.T.O.

2

Shilton Ltd produces three chemicals X, Y and Z. The selling price and cost per litre for each of these products are budgeted as follows:

Selling price Direct materials Direct labour (£12 per hour) Other direct expenses Variable overhead Fixed overhead

X

Y

Z

£/litre

£/litre

£/litre

100 20 18 – 12 6

120 16 24 3 16 8

120 21 27 – 18 9

Notes

1.

The fixed overhead is absorbed on the basis of labour hours, based on a budget of 440 hours per month.

2.

Maximum demand for each product for month 4 is as follows: X Y Z

150 litres 40 litres 60 litres

3.

Included in the maximum demand totals is an unavoidable commitment to a major customer to supply 15 litres per month of each of the three products.

4.

During month 4 there is a shortage of labour hours that will restrict production. The total number of labour hours available is 375 hours.

5.

Shilton is able to produce and sell fractions of a litre.

Required: (a) Determine the production mix that will maximise profit in month 4 and calculate the resulting profit. (12 marks) (b) After completing the production plan you are informed that new environmental controls on pollution are to be introduced from the beginning of month 4. These controls relate to the production of product Z only, and will incur an additional fixed cost of £1,000 per month for each month that Z is manufactured. In addition you also learn that an overseas supplier will supply as many litres of chemical Z as Shilton Ltd needs at a cost of £100 per litre. Importation of Z will not incur the additional fixed pollution control costs. Required: Using the above information calculate how much chemical Z (if any) should be purchased by Shilton Ltd from the overseas supplier in month 4. (4 marks) (c) Briefly explain TWO factors, other than costs or selling price, which should be taken into consideration when deciding whether to subcontract the manufacture of chemical Z. (4 marks) (20 marks)

4


3

Maradona operates a central distribution warehouse which it classifies as a cost centre. The warehouse can stock up to 600,000 units of finished goods per month. If demand for warehouse space exceeds this amount in any given month extra capacity can be purchased from a nearby factory for fixed payments of £30,000 for each capacity increase of up to 40,000 additional units per month. Stock is picked from shelves by hourly paid labourers who are paid £16 per hour and in this time are expected to pick 20 stock units. Picked units are loaded on to customer vehicles by fork-lift trucks. Budgeted costs per month throughout 2007, at two different capacity levels are as follows: Cost element

Behaviour of cost

Warehouse rental Stock picking costs Fork-lift costs

Stepped fixed (see above) Variable Semi variable

Warehouse space required 200,000 units 500,000 units £ £ 160,000 160,000 160,000 400,000 500,000 1,100,000

During May 2007 when demand was for 724,000 units and 36,250 labour hours were worked; actual costs for each cost element were reported as: Warehouse rental Stock picking costs Fork-lift costs

£284,000 £622,640 £1,528,822

Required: (a) Prepare a flexed budget statement of warehouse costs for May 2007 for an activity level of 724,000 units. (5 marks) (b) Using the flexed budget and other information provided above calculate the following variances for May 2007. (i) Direct picking labour rate variance; (ii) Direct picking labour efficiency variance; (iii) The fork-lift total cost variance.

(6 marks)

(c) Define the terms cost centre, profit centre and investment centre. Describe one appropriate performance measure for each and state one difficulty of each of your suggested measures. (9 marks) (20 marks)

4

You are an accounting technician in the administration department of a small manufacturing company. Your manager, who is not an accountant, is about to attend a meeting and is unsure of the meaning of several items that appear on the agenda. Required: Produce notes on any TWO of the following three items to help your manager understand their meaning: (i)

The balanced scorecard and its perspectives on performance;

(ii) Total quality management (TQM) and the costs of quality; (iii) Benchmarking (including internal, competitive, functional and strategic benchmarking). Note: each of the areas you select will be worth 10 marks. (20 marks) End of Question Paper

5


Answers



(a)

June 2007 Answers

Traditional absorption costing (i)

Budgeted total cost per thousand metres Product

Direct materials Direct labour Prime cost Overhead cost (w1) Total cost

A

B C Cost per thousand metres £ £ £ 120 100 60 42 42 28 –––– –––– –––– 162 142 88 240 240 160 –––– –––– –––– 402 382 248 –––– –––– –––– –––– –––– ––––

Working 1 Budgeted total overhead £65,600 Budgeted total machine hours = 1,640 machine hours. £65,600 Overhead absorption rate = –––––––– 1,640 machine hours Cost per thousand metres A = £40 x 6 hours = £240 B = £40 x 6 hours = £240 C = £40 x 4 hours = £160

= £40 per machine hour.

(ii) Absorption costing A

Total cost Margin (w2) Selling price

£ 402·00 100·50 –––––––– £502·50 –––––––– ––––––––

B C Per thousand metres £ £ 382·00 248·00 95·50 62·00 –––––––– –––––––– £477·50 £310·00 –––––––– –––––––– –––––––– ––––––––

Working 2: Margin = £402 ÷ 0·8 x 0·2 = £100·50. (b)

(i)

Cost driver rates Cost pool Rates, rent, etc Set up costs Goods inwards Finished goods Inspection Dispatch

£ 26,000 15,000 9,600

Driver Machine hours Production runs Requisitions

Driver activity 1,640 hours 30 120

Driver rate £15·85 per machine hour £500 per run £80 per requisition

5,250 9,750

Production runs Sales orders

30 60

£175 per run £162·50 per order

Tutorial Note. Set up and inspection cost pools could be combined to save time. (ii)

Total cost per fabric Product

Prime cost (as above) Overhead cost (w3) Total cost

A

B C Cost per thousand metres £ £ £ 162·00 142·00 88·00 221·77 227·10 203·40 ––––––– ––––––– ––––––– 383·77 369·10 291·40 ––––––– ––––––– ––––––– ––––––– ––––––– –––––––

9


Working 3: Rates rent etc £15·85 x 6 hours etc Set up (120,000 ÷ 120) £500 x ––––––––––––––– 10,000 Goods inwards £80 x 40 ÷ 120 Inspection (120,000 ÷ 120) £175 x ––––––––––––––– 10,000 Dispatch (120,000 ÷ 120) £162·50 x ––––––––––––––– 5,000 Total overhead cost

A B C Overhead per thousand metres 95·10

95·10

63·40

50·00

50·00

50·00

26·67

32·00

40·00

17·50

17·50

17·50

32·50 –––––––

32·50 –––––––

32·50 –––––––

221·77 ––––––– –––––––

227·10 ––––––– –––––––

203·40 ––––––– –––––––

(iii) Selling prices Activity based costing A

Total cost Mark up (w4) Selling price

£ 383·77 76·75 ––––––– 460·52 ––––––– –––––––

B C Per thousand metres £ £ 369·10 291·40 73·82 58·28 ––––––– ––––––– 442·92 349·68 ––––––– ––––––– ––––––– –––––––

Working 4: £383·77 x 20% = £76·75 etc Comment. The use of activity based costing has resulted in lower costs for A and B, but a higher cost for C, mainly because of the change in the basis of cost allocation. This has contributed to the fall in price of A and B and the increase in price of C. The change from a 20% margin to a 20% mark up has, everything else being equal, resulted in lower prices on all three products. (20% of cost is lower than 20% of sales price). (c)

Three advantages of activity based costing. Activity based costing has the following advantages. – Unit costs calculated under ABC should more accurately reflect the activities performed and resources used to make the product. – ABC can help in distinguishing between profitable and unprofitable products and customers. – By focussing attention on cost drivers it will help managers understand and manage overhead cost. – An understanding of cost driver rates can help in budgeting overhead expenditure. – ABC concerns itself with all overhead costs, and as a consequence it has proved very useful in service industries. (only 3 advantages were required)

(d)

Circumstances in which activity based costing would be an appropriate approach to product costing. Activity based costing can be used in almost any product-costing situation. It is most useful when: – Overheads form a high proportion of total cost. – More than one product is made. – Different products result in different levels of activities and resource consumption. – Where overhead expenditure is not driven by volume of output, but by the complexity and diversity of operations. (only two circumstances were required)

10


2

(a)

Production Mix

Selling price Direct materials Direct labour Direct expenses Variable overhead Contribution Labour hours per unit (w1) Contribution per labour hour

X £/litre 100 20 18 – 12 ––––––– 50 ––––––– ––––––– 1·50 £33·33 ––––––– –––––––

Rank Production plan

Y £/litre 120 16 24 3 16 ––––––– 61 ––––––– ––––––– 2·00 £30·50 ––––––– –––––––

Z £/litre 120 21 27 – 18 ––––––– 54 ––––––– ––––––– 2·25 £24·00 ––––––– –––––––

1

2

3

Chemical

Litres

X Y Z X Y Z

15·00 15·00 15·00 135·00 25·00 16·11

Contribution £ 750·00 915·00 810·00 6,750·00 1,525·00 869·94 –––––––––– 11,619·94

Minimum requirements

Further units

Total contribution Fixed overheads (w2)

Labour hours 22·50 30·00 33·75 202·50 50·00 36·25 ––––––– 375·00 ––––––– –––––––

1,760·00 –––––––––– 9,859·94 –––––––––– ––––––––––

Profit

Working 1: For chemical X = £18 per litre ÷ £12 per hour, etc. Working 2: Fixed overhead absorption rate, based on chemical X = £12 per litre ÷ 1·5 hours per litre = £4 per litre. Total fixed overhead = 440 budgeted hours x £4 per hour = £1,760 (b)

Chemical Z Current Production Make current amount of Z 31·11 litres x (£21 + £27 + £18) Extra fixed costs

= =

Total Import current amount of Z 31·11 litres x £100

2,053·26 1,000·00 ––––––––– 3,053·26

=

(3,111·00) ––––––––– £57·74 ––––––––– –––––––––

Net benefit of in house production

£ per month

It is better to continue to produce product Z, rather than buy in. Demand shortfall As selling price exceeds the buy in cost it is worthwhile to buy in the extra litres required in month 4. Extra contribution (60 – 31·11) x (£120 – £100) = £577·80 Conclusion Shilton Ltd should buy in 28·89 litres of chemical Z in month 4. Tutorial note Importing all of product Z would only become the best alternative if demand for Z was below 29·41 litres (extra fixed cost ÷ extra variable cost per litre: £1,000 ÷ £34 per litre = 29·41 litres). In later months when labour is in free supply, all Z will be made in house. (c)

Two other factors. Before subcontracting the production of Z, Shilton Ltd should consider the following points: – Is the quality of imported Z up to requirement? – Will delivery be as required? – Will its customers be happy if they find out that an overseas supplier is producing Z for sale under Shilton’s brand? – By importing Z, Shilton Ltd is effectively exporting pollution to the overseas country. There is an ethical consideration to be made. – Will the overseas supplier eventually turn into a competitor? – How long will the contract be for, the supplier may not be required once the labour shortage ends? Note: only two factors were required.

11


3

(a)

Flexed Budget Demand Warehouse rental (W1) Stock picking costs (W2) Fork-lift costs (W3)

724,000 units £ 280,000 579,200 1,548,000 ––––––––––– £2,407,200 ––––––––––– –––––––––––

Working 1: To cope with demand 124,000 units in excess of capacity a further 160,000 units of capacity will be required. Total cost £160,000 + £120,000 = £280,000 Working 2: Stock picking costs are a variable cost. Change in total cost (£400,000 – £160,000) The variable cost per unit = ––––––––––––––––– = ––––––––––––––––––––– = £0·8 per unit Change in volume (500,000 – 200,000) (Alternatively Standard rate £16·00 per hour ÷ standard rate of 20 units per hour = £0·8 per unit) Stock picking cost at 724,000 units = 724,000 x £0·80 per unit = £579,200 Working 3 Fork-lift costs are semi variable Change in total cost (£1,100,000 – £500,000) The variable cost per unit = ––––––––––––––––– = –––––––––––––––––––––– = £2·0 per unit Change in volume (500,000 – 200,000) The fixed element, by substitution: Total cost = fixed cost + variable cost At 200,000 units £500,000 = fixed cost + 200,000 x £2·0 Fixed cost = £100,000. At 724,000 units total cost = £100,000 + (724,000 x £2·0) = £1,548,000. (b)

(c)

Variances Direct picking labour Actual hours at actual rate

=

Actual hours at standard rate 36,250 hrs x £16·00

=

Flexed budget cost

=

Fork-lift costs Actual cost

=

Flexed budget cost

=

£622,640 Rate £580,000 Efficiency £579,200

> £42,640 Adv > £800 Adv

£1,528,822 Total variance > £19,178 Fav £1,548,000

Cost centres, Profit centres and Investment centres Cost Centres Cost centres are areas of the organisation to which costs may be traced. They can be a machine, a department, a product, a project or a manager’s area of responsibility. The manager of a cost centre is held accountable for costs. The performance of cost centre managers is usually measured by comparing actual costs against budgeted costs, often by the calculation of variances. The major problem of cost based measures is that they often ignore the quality of the service provided by the cost centre. Profit centres A profit centre is any unit of an organisation to which costs and revenues can be traced so that the profitability of the unit may be measured. The manager of a cost centre is held accountable for both costs and revenues. Profit centres can be departments, divisions, products or regions. Their performance is usually measured by traceable profit, whilst the performance of profit centre managers is usually measured by controllable profit. A common difficulty is deciding which costs are traceable to the profit centre or controllable by the profit centre manager. This is particularly true when different profit centres share facilities and common costs. Investment centres An investment centre is a u nit of the organisation to which costs and revenues can be traced but which also has some control over investment decisions. The manager of an investment centre is held accountable for profit in relation to funds invested in the investment centre. Investment centres are usually large divisions or subsidiaries of the parent company. Their performance is traditionally measured by return on capital employed or residual income.

12


Similar difficulties exist to those of a profit centre and deciding which costs and revenues are traceable and controllable can be problematic. In addition defining and valuing traceable or controllable investment can prove difficult. Note: Credit will be given for any appropriate performance measure and a discussion of its limitations

4

(i)

Balanced Scorecard The balanced scorecard is an approach to performance measurement, developed by Kaplan an d Norton in 1996. Rather than assessing organisational performance from a purely financial point of view, it employs a variety of financial and non-financial indicators. The four perspectives on performance originally suggested by Kaplan and Norton are: Financial: This considers how the organisation can create value for its stakeholders. Performance measures are likely to include traditional financial measures of profitability, cash flow and sales growth. Customer: This looks at how existing and potential customers see the organisation. Performance measures could include number of customer complaints, new customers acquired, on-time deliveries, etc. Process efficiency: This considers the processes at which an organisation must excel if it is to achieve customer satisfaction and financial success. Measures might include the speed of innovation, the quality of after sales service or manufacturing time. Learning and growth: This looks at the organisation’s capacity to maintain its competitive position through the acquisition of new skills and the development of new products and services. Kaplan and Norton view the balanced scorecard as a management system rather than just a performance measurement device. It can be used as a method of implementing and controlling the delivery of an organisation’s chosen strategy.

(ii)

Total Quality Management Total quality management (TQM) is the continuous improvement in quality, productivity and effectiveness obtained by establishing management responsibility for processes as well as outputs. In this, every process has an identified owner and every person in an entity operates within a process and contributes to its improvement. One of the basic principles of TQM is that the cost of preventing mistakes is deemed to be less than the cost of correcting them once they occur. The aim should be therefore to get things right first time. The costs of quality can be categorised under four headings: Prevention costs: These represent the cost of any action taken to investigate, prevent or reduce defects or failures. Examples include training of staff, investment in more reliable machinery, development of quality control systems, etc. Appraisal costs: These are the costs of assessing the quality achieved. Examples include quality inspection, performance testing, etc. Internal failure costs: These are costs arising within the organisation relating to a failure to achieve the specified level of quality. Examples include the cost of rectification, the cost of wasted materials and labour, etc. External failure costs: These are costs arising when the failure to achieve the specified level of quality is detected outside the organisation. Examples would include costs of additional deliveries to the customer, cost of replacement items, lost goodwill, etc.

(iii) Benchmarking Benchmarking involves the establishment, through data gathering, of targets and comparators, through whose use relative levels of performance (and particularly areas of underperformance) can be identified. By the adoption of identified best practices the performance of the organisation should be improved. Four types of benchmarking are commonly recognised. Internal benchmarking. This involves the comparison of different departments or divisions within an organisation. Data for this is easy to obtain and conditions are often comparable. Learning may be limited as comparisons are only being made within the same company. Competitive benchmarking. This involves comparing performance with that of direct competitors. The potential for learning is improved but data may be difficult to obtain. For commercial reasons firms are often unwilling to divulge information to direct competitors. The growth of benchmarking clubs and trade associations has reduced the problems of competitive benchmarking Functional benchmarking. Various functions in the business are compared with those recognised as the best external practitioners of the function. A manufacturing company could compare its invoice preparation time with that of a credit card company, its delivery time with a firm of couriers etc. The potential for learning how to improve performance is very high, but comparability problems sometimes exist. (This is sometimes referred to as operational or generic benchmarking) Strategic benchmarking: This involves comparison of performance with competitors at the strategic level. Areas such as market share and return on capital employed could be considered. Such comparisons are important in designing competitive strategy.

13



(a)

(i)

Overhead absorption rate Total cost per unit


2 3 ––– 5

(ii)

One per price

3 ––– 8

(b)

(i)

One per rate

(ii)

0·5 per overhead per product Total costs

(iii) 1 per price ABC change Pricing change

5 7·5 3 ––– Max

10

3 2 2 ––– 7 ––– 22

2

(c)

2 marks per explained point

6

(d)

2 marks per explained point

4 ––– 40 ––– –––

(a)

Production mix Unit contributions Contribution per Unit of limiting factor Amounts of X, Y and Z Total contribution Fixed costs

3 3 3 1 2 ––– 12

(b)

Make or buy Make cost Buy in cost Demand shortfall Decision Buy in units

1 1 1 1 ––– 4

(c)

Other considerations 2 per sensible factor, max

4 ––– 20 ––– –––

15


3

(a)

Warehouse costs Picking costs Fork lift trucks

2 1 2 ––– 5

(b)

2 marks per variance

(c)

Definitions Measures Problems

6 3 3 3 ––– 9 ––– 20 ––– –––

4

Balanced Scorecard Concept explained Per perspective explained, 2 each, max

2 8 ––– 10

TQM Concept explained Per cost explained, 2 each, max

2 8 ––– 10

Benchmarking Concept explained Per type explained, 2 each, max

2 8 ––– 10 ––– 20 ––– –––

Max

16


Certified Accounting Technician Examination Advanced Level

Planning, Control and Performance Management Tuesday 4 December 2007

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.

7 T r e p a P

This question paper must not be removed from the examination hall.




Torance uses a budgeting system to control the costs and revenues of its only product, the Danny. The management accountant for Torance has asked for your assistance in producing the budget for the year ending 31 December 2008. He has provided you with the following information: 1.

The standard cost card for the Danny for the year ended 31 December 2008 is as follows. $ 250 (32) (90) –—— $128 —–—

Selling price Direct material (4 kg at $8·00 per kg) Direct labour (6 hours at $15·00 per hour) Contribution 2.

Torance uses an additive time series analysis to forecast sales volume. The trend in sales and forecast seasonal variations for 2008 are given below. Quarter Trend (sales units) Seasonal variation (sales units)

1 1,200 –150

2 1,300 +200

3 1,400 +300

4 1,500 –350

3.

The sales trend figures for the first two quarters of 2009 are estimated at 1,600 and 1,700 units respectively. Quarterly seasonal variations are expected to be as for 2008.

4.

It is the policy of Torance to always carry sufficient inventory of finished goods to meet 50% of the next quarter ’s forecast sales, and sufficient raw materials to meet 80% of the next quarter’s forecast production.

Required: (a) Produce the following budgets for each of the four quarters of the year ending 31 December 2008: (i)

Sales budget, showing sales units and sales revenue;

(ii) Production budget in units, showing opening inventory, production and closing inventory;

(3 marks) (8 marks)

(iii) Purchasing budget, showing opening inventory, purchases and closing inventory in kilograms and (10 marks) purchases in cost;

(4 marks)

(iv) Labour budget in hours and cost.

Note: You are not required to produce annual totals. Note: A quarter is a period of three months. (b) Explain briefly the meaning of each of the following approaches to budgeting and give TWO advantages of each approach: (i) Rolling (or continuous) budgeting; (ii) Flexible budgeting; (iii) Zero-based budgeting.


2 FOR FREE ACCA & CAT RESOURCES VISIT: http://kaka-pakistani.blogspot.com

2

Nicholson sells mobile telephones. It supplies its customers with telephone handsets and wireless telephone connections. Customers pay an annual fee plus a monthly charge based on calls made. The company has recently employed a consultant to install a balanced scorecard system of performance measurement and to benchmark the results against those of Nicholson’s competitors. Unfortunately the consultant was called away before the work was finished. You have been asked to complete the work. The following data is available: Nicholson – Operating data for the year ended 30 November 2007

Sales revenue Sales attributable to new products Average capital employed Profit before interest and tax Average number of customers Number of telephones returned for repair Number of bill queries Number of customer complaints Number of customers lost Average number of bill queries unresolved at the end of each day Average number of telephones unrepaired at the end of each day

$480 million $8 million $192 million $48 million 1,960,000 10,000 12,000 21,600 117,600 118 804

Required: (a) Calculate the following ratios and other statistics for Nicholson for the year ended 30 November 2007: (i) Return on capital employed; (ii) Return on sales (net profit percentage); (iii) Asset turnover; (iv) Annual number of complaints per thousand customers; (v) Percentage of customers lost per annum; (vi) Average time to resolve billing queries; (vii) Average wait for a telephone repair; (viii)Percentage of sales attributable to new products.

(12 marks)

(b) The following information is for the mobile phone industry for the year ended 30 November 2007. Industry average statistics – Mobile Telephones

Annual number of complaints per 1,000 customers Percentage of customers lost per annum Average time to resolve billing queries Average wait for a telephone repair Percentage of sales attributable to new products Return on capital employed Return on sales (net profit percentage) Asset turnover

5 3% 1·4 days 2 days 20% 15% 5% 3 times

Required: Using the industry average information and your answer to part (a), discuss the performance of Nicholson in the year ending 30 November 2007 under the four balanced scorecard headings of: (i) (ii) (iii) (iv)

financial success; customer satisfaction; process efficiency; and organisational learning and growth.

(8 marks)

Note: state any assumptions that you make.

(20 marks)


[P.T.O.

3

Kubrick uses a standard absorption costing system to control the cost of its only product. The flexed budget for production overhead for the company shows a budgeted total overhead cost of $200,000 per period when 5,000 tonnes are produced and $264,000 per period when 9,000 tonnes are produced. In Period 9, when the actual output was 6,500 tonnes, total actual overhead cost was $245,000 ($125,000 fixed and $120,000 variable). The standard fixed overhead absorption rate is $24 per tonne. Required: (a) Using the high-low technique, calculate the following: (i)

(2 marks)

the budgeted variable overhead per tonne;

(2 marks)

(ii) the budgeted fixed overhead per period. (b) Calculate the following: (i)

the total fixed overhead absorbed in period 9;

(2 marks)

(ii) the fixed overhead expenditure variance;

(2 marks)

(iii) the fixed overhead volume variance.

(2 marks)

(c) Explain two possible operational causes of each of the following: (i)

an adverse fixed overhead expenditure variance;

(ii) a favourable fixed overhead volume variance.

(2 marks) (2 marks)

(d) Explain the terms ‘attainable standard’ and ‘ideal standard’ and discuss which is most appropriate when (6 marks) setting operational performance standards. (20 marks)


4

The Overlook hotel is situated in a mountain holiday resort. The hotel has 50 rooms that are let for $120 per night regardless of the number of people occupying a room. The variable cost per occupied room is $18 per room night. (A room night represents one room occupied for one night.) The average number of guests per room night is 1·5. On average, each guest spends $56·00 per night in the hotel restaurant. The restaurant contribution to sales ratio is 40%. Demand for rooms is very seasonal with a peak i n July and August but a very poor demand in February and March. At present the hotel operates for 365 days a year. Management is currently reviewing figures from the early months of 2007 with a view to closing the hotel for the months of February and March of 2008. The fixed costs per month for 2007 were are as follows: Services (electricity, gas, water) Insurance Repairs and maintenance Depreciation Total

$ 23,000 12,000 25,400 24,000 ———– 84,400 ———–

Actual revenue from room rentals for the first three months of 2007 was: Sales revenue

January $115,320

February $60,480

March $62,400

Room rentals were all at the standard rate of $120 per night. Required: (a) Prepare a statement showing the number of room nights rented, sales revenue and contribution from both room rental and from the restaurant, and overall profit for each of the first three months of 2007.

(8 marks) (b) Calculate the number of room nights per month that would have needed to be let in order to break even each (3 marks) month in 2007. (c) The general manager of the hotel believes that the hotel should be closed in February and March 2008 because

it will make a loss. Required: Prepare a memorandum to the general manager stating on what basis the closure decision should be made and describing THREE items of information (qualitative or quantitative) you would require to help decide whether to close the hotel in February and March of 2008. (9 marks) (20 marks)



Answers



(a)


Quarterly Budgets (i)

Sales budget Quarter

1

2

3

4

Units

Trend (units) Seasonal variation Forecast sales (units) Forecast revenue ($) (ii)

Production budget Quarter

1,200 –150 ———— 1,050

1,300 +200 ———— 1,500

1,400 +300 ———— 1,700

1,500 –350 ———— 1,150

262,500 ———— ————

375,000 ———— ————

425,000 ———— ————

287,500 ———— ————

1

2

3

4

Units

Desired closing inventory (w1) Add sales Less opening inventory (w3) Production

750 1,050 (525 ) ——— 1,275 ——— ———

850 1,500 (750) ——— 1,600 ——— ———

575 1,700 (850) ——— 1,425 ——— ———

725 (w2) 1,150 (575) ——— 1,300 ——— ———

Working 1: next quarter sales x 50% = 1,500 x 50% = 750 units etc. Working 2: (1,600 – 150) x 50% = 725 units Working 3: this quarter sales x 50% = 1,050 x 50% = 525 units etc. (iii) Purchasing budget Quarter

1

2

3

4

Kg

Desired closing inventory (w4) Used in production (w6) Less opening inventory (w7) Purchases (kg) Costs ($) (w8)

5,120 5,100 (4,080) —–—— 6,140

4,560 6,400 (5,120) —–—— 5,840

4,160 5,700 (4,560) —–—— 5,300

5,360 (w5) 5,200 (4,160) ———– 6,400

49,120 —–—— —–——

46,720 —–—— —–——

42,400 —–—— —–——

51,200 ———– ———–

Working 4: next quarter production x 4 kg x 80% = 1,600 x 4 kg x 80% = 5,120 kg etc. Working 5: production quarter 1, 2009 = ((1,700 + 200) x 50%) + 1,450 – 725 = 1675 units.

Closing inventory quarter 4 = 1675 units x 4 kg x 80%= 5,360 kg. Working 6: production x 4 kg = 1,275 x 4 kg = 5,100 kg etc. Working 7: this quarter production x 4 kg x 80% = 1,275 x 4 kg x 80% = 4,080 kg etc. Working 8: Purchase kg x $8·00 per kg = 6,140 kg x $8·00 per kg = $49,120 etc. (iv) Labour budget Quarter

Labour (hours) (w9) Labour ($) (w10)

1

2

3

4

7,650

9,600

8,550

7,800

114,750 –––––––– ––––––––

144,000 –––––––– ––––––––

128,250 –––––––– ––––––––

117,000 –––––––– ––––––––

Working 9: this quarter’s production x 6 hours per unit = 1,275 units x 6 hours = 7,650 hours etc. Working 10: 7,650 hours at $15·00 per hour = $114,750 etc. (b)

Approaches to budgeting. (i)

Rolling (or continuous) budgets

A rolling (or continuous) budget is one which is continually updated by adding a further accounting period (a month or a quarter) when the earlier accounting period has expired. Existing budgets may also be revised at the same time to reflect new circumstances. Its advantages are: – It forces managers to reassess budgets on a regular basis and results in budgets that are up to date and realistic in the light of current events. – The budget becomes a better forecast of actual results. – The arbitrary and artificial distinction between one accounting year and the next is removed, with the result that management always have access to a plan for the next twelve months. – The workload of annual budget preparation is spread more evenly across the year.


(ii)

Flexible budgets

A flexible budget is a budget, which, by recognising different cost behaviour patterns, is designed to change as volumes of output change. Its advantages are: – It recognises that different costs behave in different ways with respect to volume. – It improves the quality of control information as it facilitates a comparison of like with like. Variances calculated against a flexed budget will give more meaningful control information than those against a fixed budget. – It allows managers to forecast revenues, costs and profits at different activity levels and forces them to think about cost behaviour. (iii) Zero-based budgeting

Zero-based budgeting (ZBB), as its name suggests, involves preparing a budget from a zero-base. Budget holders are told to assume that they had no budget allowance for particular activities and they would then be required to justify any expenditure in order for it to be included in the budget. The advantages of ZBB are: – Identification and elimination of unnecessary expenditure. Activities that do not contribute toward organisational objectives will be discontinued. – Identification of wasteful expenditure. Overspending on activities will be identified and budgets will be reduced accordingly. – It challenges the status quo and encourages a questioning approach to activities and expenditure. In this way it is the ideal antidote for incremental budgeting. – The documentation that ZBB requires provides an in depth appraisal of an organisation’s activities. – It provides a plan to work to (in service departments) if more funds become available. Note: only two advantages of each method were required.

2

(a)

Nicholson ratios and statistics. Return on capital employed

Profit before interest and tax $48m ———————————— x 100% = —––— = 25% Capital employed $192m Return on sales

Profit before interest and tax $48m ———————————— x 100% = —––— = 10% Sales revenue $480m Asset turnover

Sales revenue $480m ———————— = —––— = 2·5 times Capital employed $192m Annual number of complaints per 1,000 customers

Number of customer complaints 21,600 ———––––––––––––—–––––––––––———— = ———– = 11 Average number of customers (in thousands) 1,960 Percentage of customers lost per annum

Number of customers lost 117,600 ———————————––— x 100% = —––—–— Average number of customers 1,960,000

= 6%

Average time to resolve billing queries

Average number of bill queries unresolved at the end of each day 118 —————————–––——––— x 365 = —––— = 3·6 days Total bill queries 12,000 Average wait for a telephone repair

Average number of telephones unrepaired at the end of each day 804 ——–––––———————–––——––— x 365 = —––—– x 365 = 29·3 days Number of telephones returned for repair 10,000 Percentage of sales attributable to new products

Sales turnover attributable to new products $8m ———––––––––––––—–––––––––––———— = ———–= 1·7% Total sales turnover $480m


(b)

Discussion of performance. (i)

Financial success

Nicholson’s return on capital employed at 25% is much higher than the industry average and this indicates that it is generating a good return on the money invested in it. This is largely explained by a return on sales of 10%, exactly double that of the industry average company. This could be due to higher prices, lower costs, or both. The only financial weakness apparent is that Nicholson does not enjoy as high a sales per $ of capital employed as its competitors. Overall the company appears to have performed well financially. (ii)

Customer satisfaction

Nicholson does not perform as well as the industry average in this area. It is losing customers at twice the rate of the industry average company. It is often much easier to retain existing customers than to win new ones. The level of customer complaints is also much higher than average. These factors will result in lost sales. They should be seen as leading indicators of future financial problems. (iii) Process Efficiency

The two processes that appear in the statistics are telephone repair and bill enquiries. On both counts Nicholson performs badly. Telephone repair appears to take an average of nearly 30 days (as compared to a two day industry average). This will prove annoying to customers and will probably result in lost sales (customers cannot make calls without telephones). Similarly delays in processing bill enquiries will eventually result in dissatisfied customers and poor financial results. (iv) Organisational learning and growth

Less than 2% of Nicholson’s income comes from new products, as compared to 20% for the industry average company. In a sector characterised by changing technology and product innovation this is very poor. Failing to innovate is a failing to compete. Eventually this will result in lost sales and profits. In conclusion the company’s financial results have been good in the past year, but the prospects for the future appear poor unless improvements are made to customer service, process efficiency and innovation.

3

(a)

High-low method (i)

Budgeted variable overhead per tonne Using the high-low technique,

Change in total budgeted overhead Budgeted variable overhead per tonne = ——————————————— Change in volume ($264,000 – $200,000) = ————————————— (9,000 tonnes – 5,000 tonnes) = $16 per tonne (ii)

Budgeted fixed overhead for the period $ If total overhead at 9,000 tonnes = 264,000 Variable overhead = 9,000 tonnes x $16 per tonne = (144,000) ————– Budgeted fixed overheads $120,000 ————– ————–

(b)

Variances (i)

Total overhead absorbed in period 9

Fixed overhead absorbed

= 6,500 actual tonnes x $24 per tonne = $156,000

(ii) and (iii) Fixed overhead expenditure and volume variances

Actual fixed overhead expenditure Expenditure variance Budgeted fixed overhead expenditure Volume variance Absorbed fixed overhead 6,500 tonnes x $24 per tonne

$125,000 > $5,000 adverse $120,000 > $36,000 favourable $156,000


(c)

(d)

Two possible operational causes for each of the two variances. (i)

Adverse Expenditure Variance Potential causes of an adverse expenditure variance are – An increase in the cost of services used. – Wasteful expenditure. – A change in the type of services used.

(ii)

Favourable Volume Variance Potential causes of a favourable volume variance are – Seasonal demand leading to higher than average production levels. – Favourable labour efficiency leading to increased production. – Increased factory capacity due to the removal of a bottleneck. (only two causes of each were requested)

Attainable and ideal standards

An attainable standard is one which can be attained if a standard unit of work is carried out efficiently, a machine properly operated or material properly used. Allowances are made for normal losses, waste and machine downtime. They represent what should be achieved with a reasonable level of effort under normal operating conditions. Ideal standards are those which can be achieved under the most favourable conditions with no allowance for normal losses, waste or machine downtime. They are set on the assumption of maximum efficiency and a perfect and ideal operating environment. Operational performance standards are best based upon attainable standards. An ideal standard will normally prove to be impossible to attain and result in large adverse variances, which will give inappropriate signals to management and possibly damage motivation. An attainable standard is not necessarily ‘easy’, and can include a target element to encourage better performance, whilst at the same time resulting in variances that are useful in controlling costs and revenues.

4

(a)

Profit statement

Rooms rented (W1) Sales: room rentals restaurant (W2) total sales Contribution room rentals (W3) restaurant (W4) total contribution Fixed costs Profit

January 961

February 504

March 520

$

$

$

115,320 80,724 ———— 196,044 ———— ————

60,480 42,336 ———— 102,816 ———— ————

62,400 43,680 ———— 106,080 ———— ————

98,022 32,290 ———— 130,312

51,408 16,934 ———— 68,342

53,040 17,472 ———— 70,512

(84,400) ———— 45,912 ———— ————

(84,400) ———— (16,058) ———— ————

(84,400) ———— (13,888) ———— ————

Working 1. January room nights = $115,320 ÷ $120 per night = 961 room nights etc. Working 2. January restaurant sales = 961 room nights x 1·5 guests per room x $56 per guest = $80,724 etc. Working 3. January room rental contribution = room nights x contribution per room night = 961 x ($120 – $18) = $ 98,022 etc. Working 4. January restaurant contribution = restaurant sales x contribution sales ratio = $80,724 x 40% = $32,290 etc. (b)

Break-even point

Fixed costs $84,400 Break-even point = ————————–—————— = ———— Contribution per room night (W5) $135·60

= 622·4 room nights

Working 5. Contribution per room night = total contribution ÷ number of room nights. Using January figures $130,312 ÷ 961 = $135·60 per room night.


(c)

Memorandum To General manager, Overlook hotel From An accounting technician Subject: Hotel closure Date: Today I note your proposal to close the hotel for February and March 2008. Basis of the decision. The decision to close the hotel should be made on a relevant cost basis. That is, it should only be closed if the incremental costs of remaining open exceed the incremental revenues we could earn. Information required. To calculate the incremental costs and revenues we will need the following information. –

Budgeted prices, volumes and costs for 2008. There is no guarantee that 2008 demand conditions will be exactly the same as 2007.

–

The behaviour of fixed costs during the closure period. It is unwise to assume that all fixed costs can be avoided during the temporary closure. Although the bulk of service costs can probably be avoided, insurance, repairs and depreciation costs may well continue to be incurred.

–

A detailed analysis of budgeted service costs over the year. They are likely to vary seasonally.

–

The behaviour of variable costs during the closure period. Closure will not necessarily lead to a saving of all variable costs. For example we may need to pay staff wages during closure in order that we retain staff for when we reopen.

–

Will any incremental closure or reopening costs be incurred? For example will heating systems have to be decommissioned, will we need to pay for security guards during the closure period, will extra cleaning be required before reopening.

–

The effect of closure on demand. Temporary closure would cause difficulties for any permanent residents we may have. If they move to other hotels we may lose more than two months sales. Closure for two months may have an impact on demand at other times of year, for example travel agents may stop recommending us if we don’t provide an all year service.

I hope you find this useful. Please contact me if you wish to discuss the matter further. (Only three items of information were required)

13



(a)

December 2007 Marking Scheme

Budget construction (i)

Sales units Sales revenue

2 1 ––– 3

(ii)

Closing stock Opening stock Production

Note in parts ii, iii and iv. Look for method. Penalise errors only once.

4 2 2 ––– 8

(iii) Closing stock Opening stock Purchases kg Purchase cost

4 2 2 2 ––– 10

(iv) Labour hours Labour cost

2 2 ––– 4 ––– 25

(b)

Budgeting approaches Meaning 3 x 2 Advantages 6 x 1·5

6 9 15 ––– 40 ––– –––

2

(a)

11 / 2 marks per ratio/statistic

(b)

Financial, evidence 2 conclusion 1, max Other, 2 marks per area, evidence 1, conclusion 1, max Max for part b

12 3 6 ––– 8 ––– 20 ––– –––

15


3

(a)

(i)

method variable cost

1 1 ––– 2

(ii)

Substitution approach Fixed overhead

1 1 ––– 2

(b)

(i)

actual tonnes absorbed overheads

1 1 ––– 2

(ii) and (iii)

2 per variance (c)

1 mark per cause, max

(d)

attainable defined ideal defined discussion

4 4 2 2 2 ––– 20 ––– –––

4

(a)

room nights restaurant sales rooms contribution restaurant contribution Profit

1·5 1·5 2 2 1 ––– 8

(b)

Contribution per room night Break even point

2 1 ––– 3

(c)

Memorandum heading Relevant cost basis 2 per sensible piece of information, max

1 2 6 ––– 9 ––– 20 —– —–

16



Planning, Control and Performance Management Tuesday 3 June 2008


15 minutes 3 hours



7 T r e p a P





Ethan uses a system of standard marginal costing to control the costs and revenues of its only product, the Lundegaard. It was budgeted to manufacture and sell 300,000 units of the Lundegaard in the year ended 31 May 2008. Flexed budgets for the manufacture and sale of 100,000, 300,000 and 500,000 units of the Lundegaard are given below, together with some explanatory notes.

Flexed Budgets for the year ended 31 May 2008. Sales and production (units) Direct material (kg) Direct labour hours Machine hours

100,000

300,000

500,000

50,000 20,000 12,500

150,000 60,000 37,500

250,000 100,000 62,500

$ Sales revenue Direct materials Direct labour Overhead Profit/(loss)

1,500,000 60,000 165,000 1,425,000 –––––––––– (150,000) –––––––––– ––––––––––

$ 4,500,000 180,000 495,000 2,175,000 ––––––––––– 1,650,000 ––––––––––– –––––––––––

$ 7,500,000 300,000 825,000 2,925,000 ––––––––––– 3,450,000 ––––––––––– –––––––––––

Notes 1. Ethan carries no finished goods or raw materials inventory. 2. Direct material is a variable cost. 3. Direct labour is a variable cost. 4. Overhead is a semi variable cost. Its variable element varies with MACHINE hours. 5. Overhead is absorbed on the basis of MACHINE hours. Required: (a) Use the high-low technique to calculate: (i) Variable overhead cost per unit; (ii) Fixed overhead cost per annum.

(4 marks)

(b) Prepare a DETAILED standard marginal cost card for the Lundegaard, based upon the above budgets. The cost card should show standard marginal contribution per unit. (5 marks) (c) Calculate the contributions/sales ratio and the break-even point in sales revenue for Lundegaards. (3 marks)

2


(d) Actual performance for the year ended 31 May 2008 is given below. Sales and production (units) Direct material (kg) Direct labour hours Machine hours Sales revenue Direct materials Direct labour Variable overhead Fixed overhead Profit

250,000 125,000 45,000 30,000 $ 4,000,000 160,000 420,000 924,000 1,110,000 ––––––––––– 1,386,000 ––––––––––– –––––––––––

Required: Calculate the following variances for the manufacture and sale of Lundegaard for the year ended 31 May 2008: (i) Sales volume contribution variance; (ii) Sales price variance; (iii) Direct materials price variance; (iv) Direct materials usage variance; (v) Direct labour rate variance; (vi) Direct labour efficiency variance; (vii) Variable overhead rate variance; (viii)Variable overhead efficiency variance; and (ix) Fixed overhead expenditure variance.

(18 marks)

(e) Draft a short memorandum to the sales director of Ethan which explains the meaning of the sales volume and sales price variances and the possible interrelationships between the two variances. Use your answers from part (d) to illustrate your explanation. (10 marks) (40 marks)

3


[P.T.O.

2

Your company, an electronics retailer, has arranged a conference for its 12 regional managers who are responsible for the profitability of its shops. The managers have little understanding of management accounting. The conference has been arranged because of two recent problems in the business. 1.

The company’s recently introduced budgeting system has not proved popular with regional managers, many of whom feel it is a waste of their time.

2.

Due to the large number of products offered by manufacturers and the shortage of display space in its shops, the company has recently experienced difficulties in deciding which products it should sell.

Typical of this problem is the choice currently facing the company over which MP3 player to sell. Details of three alternative models are given below. Model

A

Sales price per unit Variable cost per unit Display space per unit

$130 $60 140 cm3

B

$180 $100 120 cm3

C

$210 $120 160 cm3

Your chief executive has asked you to prepare a brief presentation to the conference to improve financial awareness. Your company always attempts to maximise profits. Required: (a) On the basis of contribution per unit of the limiting factor, recommend which of the three MP3 players the (4 marks) company should sell. (b) Prepare notes, suitable for distribution to conference delegates, which explain the following: (i)

the benefits of operating a budgeting system;

(8 marks)

(ii) variable cost;

(1 mark)

(iii) fixed cost;

(1 mark)

(iv) contribution;

(2 marks)

(v) limiting factors; and

(2 marks)

(vi) the importance of making decisions based upon contribution per unit of the limiting factor.



3

Showalter produces plates, which it sells in boxes, to the hotel industry. The company has sufficient work to operate at full capacity for July 2008. Thereafter, it has one further order for 80,000 boxes. After that no further orders are expected until December when it is hoped that demand will improve. The order for 80,000 boxes represents one month’s operation at full production capacity. Showalter is considering two alternative production plans: EITHER (i) complete the order for 80,000 boxes by operating at full capacity in August and closing the factory for September, October and November. OR (ii) complete the order for 80,000 boxes by operating at 25% of full capacity for each of the four months of August, September, October and November. The following information is available: 1.

Direct material cost is a constant $7 per box.

2.

Direct labour is hired on a daily basis from an employment agency. Total direct labour cost per month at various activity levels are budgeted as follows: % of full production capacity Total direct labour cost per month

3.

0% $0

25% $250,000

100% $850,000

The behaviour of the cost of power is represented by the equations below, where: y = total cost of power per month in $ and x = production per month in boxes. For production of 30,000 boxes or more per month: y = 60,000 + 5x. If production falls below 30,000 boxes per month then: y = 40,000 + 6x.

4.

Overhead costs, other than power, are forecast as follows: Overhead costs per month at various activity levels % of full production capacity 0% 25% $ $ Indirect labour 10,000 20,000 Plant and machinery depreciation 8,000 25,000

100% $ 35,000 95,000

Required: (a) For each of the two alternative production plans being considered, prepare detailed budgets showing the prime cost and total production cost for the period August to November 2008 inclusive. Use your answer to recommend which alternative plan Showalter should adopt.

Note: you are not required to produce monthly budgets.

(12 marks)

(b) Suggest four factors, other than the total production cost you have calculated above, that Showalter might (8 marks) consider before deciding upon its favoured alternative. (20 marks)


[P.T.O.

4

Brainerd is a passenger airline. In 2007 it was criticised in the press for the poor quality of the service that it offered to passengers, particularly with regard to flight punctuality and the courtesy of its staff. In 2008 it spent $220m on new aeroplanes and $10m on staff training in an attempt to improve its performance. Summarised financial statements are given below. Summarised income statement for the year ended 31 May

Revenue Operating profit Financing costs Tax expense Profit for the period

2007 $m 1,800 –––––– 180 (32) (44) –––––– 104 ––––––

2008 $m 1,850 –––––– 175 (47) (35) –––––– 93 ––––––

2007 $m 1,200

2008 $m 1,400

Summarised statement of financial position as at 31 May $m

Non-current assets (net) Current assets Inventory Receivables Cash

Equity and reserves Long-term liabilities 8% Debenture 2009 Bank loan

650 20 ––––

Current liabilities

53 22 64 –––––– 1,339 ––––––

90 25 32 –––––– 1,547 ––––––

585

615

670 84 –––––– 1,339 ––––––

Total equity and liabilities

$m

650 160 ––––

810 122 –––––– 1,547 ––––––

Required: (a) Calculate the following ratios for Brainerd for the years ending 31 May 2007 and 2008, clearly defining the ratio you are calculating and showing the figures used in your calculations: (i) (ii) (iii) (iv) (v)

Return on capital employed based upon closing capital employed; Operating margin (return on sales); Asset turnover; Current ratio; and Capital gearing ratio.

(10 marks)

(b) Explain the meaning of ANY THREE of the above ratios and suggest one possible cause, apparent from the (6 marks) question, of changes in performances revealed by each of your chosen ratios. (c) Give TWO reasons why it would be important for Brainerd to use non-financial measures in assessing its (4 marks) performance. (20 marks)



Answers



(a)

June 2008 Answers

High-low technique (i)

Variable overhead cost per unit

Change in variable cost Variable cost per unit = ––––––––––––––––––––– Change in units ($2,925,000 – $1,425,000) = ––––––––––––––––––––––––––––– (500,000 units – 100,000 units) $1,500,000 = ––––––––––––– 400,000 units Variable overhead cost = $3·75 per unit (ii)

Fixed overhead cost per annum

Total cost = fixed cost + variable cost By substitution into 100,000 unit budget $1,425,000 = fixed cost + (100,000 units x $3·75 per unit) $1,425,000 = fixed cost +$375,000 Fixed overhead cost per annum = $1,050,000. (b)

Standard marginal cost card $

Sales price (w1) Direct materials (0·5 kg per unit at $1·20 per kg)) (w2) Direct labour (variable) (0·2 hours per unit at $8·25 per hour) Variable overhead (0·125 hours per unit at $30 per hour) (w3)

0·60 1·65 3·75 –––––

Contribution

(c)

$ 15·00

6·00 ––––– 9·00 ––––– –––––

Working 1 $1,500,000 ÷ 100,000 units

= $15·00 per unit

Working 2 50,000 kg ÷ 100,000 units $60,000 ÷ 50,000 kg $1·20 x 0·5 kg

= 0·5 kg per unit = $1·20 per kg = $0·6 per unit

Working 3 12,500 machine hours ÷ 100,000 units $3·75 per unit ÷ 0·125 hours per unit

= 0·125 machine hours per unit = $30 per hour

Break-even point

Contribution sales (C/S) ratio

Break-even point in revenue

= Contribution ÷ sales = $9·00 ÷ $15·00 = 0·6 Fixed costs = ––––––––– CS ratio $1,050,000 = –––––––––– = $1,750,000 0·6

Tutorial Note The break-even point in sales revenue could alternatively have been calculated by multiplying the break-even point in units by the budgeted selling price, as follows:

Break-even point in units

Fixed cost = ––––––––––––––––– Contribution per unit $1,050,000 = ––––––––––––– = 116,667 units $9·00 per unit

Break-even point in revenue = 116,667 units x $15 = $1,750,000


(d)

Variances (i)

(ii)

Sales volume

Actual sales units at standard contribution

250,000 units x $9 per unit =

Budgeted sales units at standard contribution

300,000 units x $9 per units =

$2,250,000 > $450,000 A $2,700,000

250,000 units x $15 per unit

$4,000,000 > $250,000 Fav $3,750,000

Sales price variance

Actual sales at actual price Actual sales at standard price (iii) & (iv) Direct materials price and usage variance

Actual usage at actual price Actual usage at standard price

125,000 kg x $1·20 per kg

Standard usage at standard price

250,000 units x $0·6 per unit

$160,000 > $10,000 A $150,000 >0 $150,000

(v) & (vi) Direct labour rate and efficiency variance

Actual hours at actual rate Actual hours at standard rate

45,000 hrs x $8·25 per labour hr

Standard hours at standard rate (w4)

50,000 hrs x $8·25 per labour hour

$420,000 > $48,750 A $371,250 > $41,250 Fav $412,500

(vii) & (viii) Variable overhead rate and efficiency

Actual hours at actual rate Actual hours at standard rate

30,000 x $30 per machine hr

Standard hours at standard price (w4)

31,250 machine hours x $30 per hour

$924,000 > $24,000 A $900,000 > $37,500 Fav $937,500

(ix) Fixed overhead expenditure

Actual fixed overhead

$1,110,000 > $60,000 A $1,050,000

Budgeted fixed overhead Working 4

Standard labour hours = 250,000 units x 0·2 hours per unit = 50,000 direct labour hours Standard machine hours = 250,000 units x 0·125 hours per unit = 31,250 machine hours Tutorial Note

Variances are often calculated by a formula and such an approach would be equally acceptable here. For example the sales volume variance could be calculated as follows: (Actual sales units – budgeted sales units) x standard contribution (250,000 – 300,000) x $9 = $450,000 Adverse (e)

Memorandum To: Sales director Ethan From: An Accounting Technician Subject: Sales volume and price variances Date: Today

I am pleased to provide you with an explanation of these two variance and the possible interrelationships between them. Sales volume variance

The sales volume variance measures the effect on profit of selling more or less units than budgeted. In a standard marginal costing system this effect is measured in terms of standard contribution gained or lost. In the year ended 31 May 2008 Ethan sold 50,000 less units of the Lundegaard than was budgeted. As standard unit contribution is $9 per unit, everything else being equal this led to a profit reduction of $450,000. Sales price variance

The sales price variance measures the effect on profit of selling units at a price that is higher or lower than budgeted. In the year ended 31 May 2008 Lundegaards were sold at a higher price than budgeted ($16 per unit rather than $15 per unit). On actual sales of 250,000 units, everything else being equal, this would lead to an increase in profits of $250,000. Possible interrelationships

Selling price generally has an effect on sales volume. Increases in prices normally lead to a decrease in volume. This could well be the case for Lundegaards. If the increase in price is the only cause of the decrease in volume, then the decision to increase price can be seen as a bad one, resulting in a net $200,000 adverse effect on profit. Alternatively the failure to achieve budgeted sales volume could be due to other causes, for example an over optimistic sales volume in the original budget.


2

(a)

Contribution per unit of the limiting factor Model

A

Sales price Variable cost Contribution

130 60 –––70

Display space per unit Contribution per cm3 Rank

140 cm3 $0·5 3rd

B $ per unit 180 100 –––– 80

120 cm3 $0·67 1st

C

210 120 –––– 90 160 cm3 $0·56 2nd

In terms of contribution per cm3 of display space, model B is the best choice. (b)

Delegate Notes (i)

The benefits of operating a budgeting system

A budget can be described as a financial expression of a plan of action. Budgeting systems offer benefits in planning and controlling a business. In terms of planning they (i)

Force the organisation to plan. Many managers get bogged down in day to day problems and fail to think about the future. A budgeting system forces managers to think about the future and helps it to achieve its objectives. (ii) Budgets require organisations to make decisions about the use of scarce resources and therefore help in getting the best use of these resources. (iii) Budgets coordinate the activities of various parts of the business. They should ensure, for example, that the purchasing department is buying the quantities of products that the shops want to sell. (iv) Budgets help communicate the company’s plan of action throughout the business, so that all employees know what they are trying to achieve. In terms of control they (i)

Allocate responsibility for the achievement of budget targets to budget holders, for the operations under their control. (ii) Establish a system of control over actual performance by the comparison of actual results against budgeted plans. Departures from budget can be investigated and controllable problems can be rectified. (iii) Authorise expenditure. The inclusion of an item in an approved budget is a major step towards authorising the budget holder to spend the money. (iv) Engage the interest and commitment of employees. Budget figures are often regarded as targets and systems that let employees know how badly or well they are doing against target often provide an incentive for improved performance. (ii)

Variable cost

A variable cost is a cost that varies in direct proportion with the volume of business activity. Examples of variable costs in a retail setting would be the cost of bought-in product and sales commission. (iii) Fixed cost

A fixed cost is a cost that tends to be unaffected by changes in volume of activity. Fixed costs are commonly period costs and relate to a period of time rather than activity levels. Examples of fixed costs in retailing include rent and shop managers’ salaries. (iv) Contribution

Contribution is the difference between sales price and variable cost per unit (or total revenue less total variable cost). The contribution earned per unit at first goes towards covering fixed costs and once these are covered towards earning a profit. In retail, unit contribution will be equal to selling price less buy-in cost, less any other variable costs per unit such as sales commission. (v)

Limiting factors

A limiting factor is anything that limits the activity of an organisation. Examples in retail include shortages of products to sell, labour, shelf space or customers. (vi) The importance of maximising contribution per unit of the limiting factor

In the short run fixed costs are fixed. In this situation maximising contribution will result in the maximisation of profits. Limiting factors restrict the activity of an organisation, and therefore its ability to earn contribution. We therefore need to ensure that we earn the biggest contribution possible, given any limiting factors that we face. Accordingly we should choose to sell products that give us the most contribution per unit of the limiting factor. This will result in the maximisation of contribution and profit.


3

(a)

Production cost budgets July–October

Direct material (w1) Direct labour (w2) Prime cost

Alternative 1 (Produce in one month) $ 560,000 850,000 –––––––––– 1,410,000

Power (w3) Indirect labour (w4) Plant and machinery depreciation (w5) Total production cost

Alternative 2 (Produce in four months) $ 560,000 1,000,000 –––––––––– 1,560,000

580,000 65,000 119,000 –––––––––– 2,174,000 –––––––––– ––––––––––

640,000 80,000 100,000 –––––––––– 2,380,000 –––––––––– ––––––––––

Recommendation: On the basis of total cost alternative one is preferred. Workings Working 1 80,000 boxes x $7 per box = $560,000 Working 2 Alternative 1: 1 month x $850,000 = $850,000 Alternative 2: 4 months x $250,000 = $1,000,000 Working 3 Cost per month at: Zero output = $40,000 + ($5 x 0 boxes) = $40,000 20,000 boxes = $40,000 + ($6 x 20,000 boxes) = $160,000 80,000 boxes = $60,000 + ($5 x 80,000 boxes) = $460,000 Alternative 1: (1 month x $460,000) + (3 months x $40,000) = $580,000 Alternative 2: 4 months x $160,000 = $640,000 Working 4 Alternative 1: (1 month x $35,000) + (3 months x $10,000) = $65,000 Alternative 2: 4 months x $20,000 = $80,000 Working 5 Alternative 1: (1 month x $95,000) + (3 months x $8,000) = $119,000 Alternative 2: 4 months x $25,000 = $100,000 (b)

Four factors Showalter might consider

In choosing between temporary closure and a reduced level of monthly activity Showalter might consider the following: – – – – – – – –

The required delivery date. Clearly if the plates are required in August it would be foolish to schedule their production for September. Early delivery could impress customers and lead to more business being won. Ability to cope with new orders. By completing the production in August this would leave capacity free to cope with any unexpected large orders in September. Cash flow issues: early production could lead to cash costs being incurred earlier. On the other hand early production could lead to earlier receipt of cash from customers. Morale: total closure of the factory for three months may be more demotivating than a reduced level of activity. Closure for three months could lead to agency workers finding work elsewhere and result in Showalter employing less experienced staff upon reopening. Closure for three months may have damaging effects on plant and machinery. Closure for three months may allow maintenance work to take place without disrupting production.

(Only four factors were required)


4

(a)

Ratios

(i)

Return on capital employed

Operating profit –––––––––––––– Capital employed

2007

2008

$180m ––––––––– $1,255m 14·3%

$175m ––––––––– $1,425m 12·3%

$180m ––––––––– $1,800m 10%

$175m ––––––––– $1,850m 9·5%

=

$1,800 –––––––– $1,255 1·43 x

$1,850 –––––––– $1,425 1·3 x

=

$139m –––––––– $84m 1·65

$147m –––––––– $122m 1·20

=

$670m –––––––– $585m 115%

$810m –––––––– $615m 132%

= =

(ii)

Return on sales

Operating profit ––––––––––––– Revenue

= =

(iii) Asset turnover

(iv) Current ratio

(v)

Capital gearing ratio

Revenue –––––––––––––– Capital employed

=

Current assets –––––––––––––– Current liabilities Long-term liabilities ––––––––––––––––– Total equity

Tutorial Note

The majority of these ratios may be defined in different ways. Any sensible definition will be accepted and given full credit. (b)

Meaning and potential causes of ratios Return on capital employed

This ratio shows the percentage return earned on long-term finance invested in the business. It has decreased between the two years. This is explained by both a decrease in the return on sales ratio and a decrease in the asset turnover ratio. Return on sales

This ratio shows operating profit as a percentage of sales revenue. For Brainerd in 2008, 9·5 cents of every $1 of sales was operating profit. It has decreased slightly between the two years. This could possibly be explained by a disproportionate increase in expenses (possibly caused by the cost of staff training) or a decrease in sales price (possibly caused by price cutting to counteract the recent quality problems). Lower load factors due to service quality problems could also have increased the average cost per passenger. Asset turnover

This ratio measures the ability of the firm to generate sales from the capital it has invested. Once again this has decreased between the two years. This could be explained by quality problems leading to a relative decrease in sales volume or the increased investment in n ew aircraft not being matched in the short term by increased sales volumes. Current ratio

The current ratio measures the ability of the firm to meet its short-term financial obligations (current liabilities) from cash and assets that should be converted into cash over the coming year (current assets). This ratio has deteriorated over the period in question as current liabilities have risen proportionately more than current assets. This could be due to a strain on liquidity caused by the heavy capital investment in new aircraft. Capital Gearing

The capital gearing ratio measures the amount of long-term financing provided by debt as compared to equity. It appears quite high in Brainerd, possibly due to the capital intensive nature of the industry. Capital gearing has increased over the year. This is most obviously explained by the investment in new aircraft being financed by long-term debt. (only three explanations were required) (c)

The importance of non-financial performance measures.

The use of non-financial performance measures can be justified in several ways: –

Perhaps the most important reason for the use of non-financial performance measures is that they give early warning signals of problems. For this reason they are often referred to as ‘leading indicators’. Financial performance measures are often described as ‘lagging indicators’, that is they tell the firm that something has gone wrong after it has gone


–

– – –

wrong. The use of non-financial performance measures gives a firm a chance of correcting problems before they go too far. For example, a firm might be able to cure a quality problem revealed by a high level of customer complaints before it has a damaging effect on sales and profits. Virtually all companies face increasingly competitive market places. In the face of global competition non-financial issues such as product quality, customer service, delivery, reliability and innovation have become crucial elements of competitive strategy. None of these variables are directly measurable in financial terms. Non-financial performance measures may be more understandable and relevant for non-financial staff. Financial measures in isolation can potentially be manipulated by managers. Using a range of financial and non-financial measures makes it more difficult for managers to hide bad performance. Non-financial measures can be used as a method of implementing an organisation’s chosen strategy. For example, if a firm decides to compete by offering the quickest call out times for product repair, then the effectiveness of the delivery of this strategy can be measured by a non-financial indicator such as customer waiting time.

(only two reasons were required)

14



(a)


Variable cost per unit Fixed cost per unit

2 2 ––– 4

(b)

Sales price Direct material

per per Direct labour per per Variable overhead per per Contribution

1 0·5 0·5 0·5 0·5 0·5 0·5 1 –––

kg unit hour unit hour unit

5 NB Zero for the cost card unless prepared per unit (c)

CS ratio BEP

1 2 ––– 3

(d)

(e)

Variances 2 per variance (1 for number + 1 for sign if number correct) Memo heading Volume explained Applied Price explained Applied Interrelationship explained Applied

18 1 2 1 2 1 2 1 ––– 10 ––– 40 ––– –––

2

(a)

Approach Unit contributions Contribution per unit limiting factor Decision

1 1 (0·5 if one product correct) 1 (0·5 if one product correct) 1 ––– 4

(b)

(i) (ii) (iii) (iv) (v) (vi)

8 1 1 2 2 2 –––

1 mark per benefit, max variable cost defined fixed cost defined contribution defined limiting factor defined importance explained

16 ––– 20 ––– –––

15


3

(a)

Direct materials (2 x 0·5) Direct labour (2 x 0·5) Prime cost (2 x 0·5) Power 1 month at 80,000 Power 3 months at zero Power 4 months at 20,000 Ind lab 1 month at 80,000 Ind lab 3 months at zero Ind lab 4 months at 20,000 Depn 1 month at 80,000 Depn 3 months at zero Depn 4 months at 20,000 Decision

1 1 1 1 1 2 0·5 0·5 1 0·5 0·5 1 1 ––– 12

(b)

4

2 marks per sensible factor 1 per point, 1 per expansion

(a)

1 mark per ratio (allow other sensible definitions)

(b)

1 mark per explanation 1 mark per relevant cause

8 ––– 20 ––– –––

10 3 3 ––– 6

(c)

2 marks per reason, max 1 per point, 1 per expansion

4 ––– 20 ––– –––

16



Planning, Control and Performance Management Tuesday 2 December 2008


15 minutes 3 hours



7 T r e p a P





Fenster College is a subsidiary of a large training company. It offers courses on building work, plumbing and electrics. Its major customers are local businesses, who use the courses to train their staff. Unemployed people seeking to gain skills attractive to potential employers also attend the courses. The maximum number of students on each of Fenster’s courses is limited by government safety regulations. The following information is available: Fenster College: information for the year ending 31 December 2009 Building $80

Full course fee per student per day (note 1) Maximum course size (number of students) (note 2) Percentage of students unemployed (notes 3 & 4) Direct costs Materials (per student per day) Instructors’ salaries (per class per day) (note 5) Overhead costs per annum: Heat, light and power (note 6) Depreciation (note 7) Selling and administration (note 8)

Plumbing $90

Electrics $100

40 20

30 30

25 40

$10 $300

$15 $700

$20 $500

$ 90,000 100,000 150,000

Notes 1. All courses run for 48 weeks per annum for 5 days per week. 2. Fenster’s courses are very popular and it anticipates that all courses will operate at full capacity throughout 2009. All classrooms are large enough to accommodate the maximum course sizes. 3. Unemployed students pay for their own courses and benefit from a 30% reduction on the full course fee. 4. Employed students are charged the full course fee. 5. Instructors are hired on a daily basis. 6. Heat, light and power is a semi-variable cost. The variable element is $30 per student per year. The fixed element is not traceable to any individual course. 7. Depreciation charges are a fixed cost relating to classroom equipment and college administration equipment: 20% relates to building course equipment, 30% to plumbing course equipment and 20% to electrics course equipment. The balance relates to college administation equipment. 8. Selling and administration overhead is a fixed cost for the college. 9. The head office of the large training company apportions its expenditure to colleges by a charge of 20% of college revenue. This charge is not further reapportioned to courses. Required: (a) Prepare a budgeted income statement for Fenster College for the year ending 31 December 2009. Your statement should clearly identify the profit attributable (traceable) to each course and the total profit for the (14 marks) college.


(b) Fenster College subsequently discovers that, due to emergency repairs to its premises, it will have to close its building classroom for the year ending 31 December 2009. A competitor college has some spare capacity in 2009 and can provide facilities to accommodate Fenster’s building course. It proposes to charge Fenster an all inclusive price for use of its premises in 2009 to cover room hire, heat, light and power and use of equipment. Fenster will continue to provide its own instructors and course materials. The competitor college is some distance from Fenster’s premises and no unemployed students would attend the relocated course. Fenster forecasts that the number of employed students would be unchanged. Required: Using a relevant cost approach calculate the maximum price Fenster should offer the competitor college for the hire of its classroom facilities for the year ending 31 December 2009. (10 marks) (c) Identify and explain four areas of possible concern which Fenster should investigate before transferring the building course to the competitor’s premises. (8 marks) (d) List and briefly justify four non-financial measures any college or university could use to assess its performance. (8 marks) (40 marks)

3


[P.T.O.

2

Kint Co manufactures shoes. The shoes are sold to large retailers who insist upon the highest standard of quality. The shoes have to be manufactured to precise dimensions and to be dyed to an exact colour shade. Below is a list of expenses incurred in the last month: $

Customer complaints department Finished goods inspection Shade matching Quality control system development Operative training Rework Machine maintenance Goods inwards inspection Compensation payments to customers for defective goods Pre-despatch failure analysis

3,456 3,588 1,479 5,110 1,500 8,850 850 600 4,600 3,877

Notes

$2,000 fixed costs per month required for all batches

direct costs only routine servicing

variable cost

The production director attended a course on total quality management (TQM) recently and was told that quality initiatives could save money. Required: (a) Define the following costs of quality (i) (ii) (iii) (iv)

Prevention costs; Appraisal costs; Internal failure costs; External failure costs.

(8 marks)

(b) Categorise the expenses from the month into the four categories of quality cost given in (a).

(5 marks)

(c) Failure analysis has revealed that 70% of defects can be traced to a machine in the moulding department. The

production director has found a new type of machine that is 100% reliable and will save 70% of external and internal failure costs. The machine would cost $60,000 more per year to hire than the existing machine. Running costs would remain unchanged. Additional staff costs would be $1,000 per month. Required: Calculate and recommend whether Kint Co should hire the new machine.



3

Keaton Co operates a chain of bakery shops, with each shop baking its own bread. The management accountant of Keaton Co is reviewing a proposal to open a new shop. The following estimates for the new shop are available: 1.

Standard price and variable costs

Sales price Ingredients Electricity Contribution 2.

Fixed costs per annum Bakery labour Shop labour Rent of baker y and shop

Total fixed costs per annum 3.

$ per loaf 2·00 (0·70) (0·10) ––––– 1·20 ––––– $ 20,000 16,000 30,000 ––––––– $66,000 –––––––

Budge Budgeted ted sales sales per per annum annum are are 70,0 70,000 00 loave loavess

Required: (a) Calculate Calculate the the following following figures figures for for the proposed proposed new new shop: (i) (i) (ii) (iii) (iv)

the the cont contrib ribut utio ion n to sale saless ratio; ratio; the breakbreak-even even point in sales sales revenue revenue per per annum; annum; the break-ev break-even en point in loaves sold sold per annum; annum; the margin margin of safety safety in loaves loaves per annum. annum.

(b) Using the graph graph paper paper provided, provided, draw draw and label label a break-even break-even chart for for the proposed proposed new shop. shop.

(8 marks) (6 marks)

(c) At the end of the first year of operations the new shop had sold 50,000 loaves at an average price of $2·20 per unit. Required: Calculate the sales price and sales volume contribution variances and explain the meaning of each variance. (6 marks) (20 marks)

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[P.T.O.

4

Hockney Co wishes to construct budgets for its single product for the year ending 31 December 2009. The following information is available: 1.

The stan standa dard rd cost cost card card for for 2008 2008 was was as foll follows ows Selling price Direct material (3kg at $2 per kg) Direct Labour (0·5 hour at $24 per hour) Fixe ixed ov overheads ($ ($10 pe per di direct la labour ho hour) Profit

$ per unit 30·00 6·00 12·00 5·00 ––––– $7·00 –––––

2.

The fixed overhead absorption rate rate is based based upon budgeted labour hours hours and budgeted budgeted overhead expenditure. expenditure.

3.

Budgete Budgeted d productio production n for the year year ended ended 31 Decembe Decemberr 2008 was was 50,000 50,000 units. units.

4.

Standard Standard selling selling price price will will be unchange unchanged d in 2008 2008 and 2009. 2009.

5.

Total budge budgeted ted fixed fixed overhead overheadss are expecte expected d to increase increase by 4% in 2009. 2009.

6.

Standard direct labour labour and standard direct materials materials are expected to increase in line with an industry price index of manufacturing costs. This index had an average value of 110 in 2008 and is expected to rise to an average value of 121 in 2009.

7.

Sales Sales volume volumess are forecast forecast by the the follow following ing equat equation: ion: y = 10,000 + 100x Where x = time in quarters. For quarter 1 of 2009, x = 17, for quarter 2 of 2009 x = 18 etc. y = forecast sales per quarter in units.

8.

Hockne Hockneyy Co Co carr carries ies no invent inventory ory..

Required: (a) Construct a sales sales budget for for 2009, showing sales volume volume in units and sales revenue FOR EACH QUARTER QUARTER (4 marks) of 2009. (b) Assuming that that total budgeted budgeted sales for for 2009 are 47,400 units units construct a budgeted budgeted income income statement for the year ending 31 December 2009.

Note: quarterly income statements are not required.

(7 marks)

(c) Define the following terms and explain their importance importance to budgetary budgetary planning planning or control. control. (i) Long-t Long-term erm (or (or strat strategi egic) c) planni planning; ng; (ii) (ii) Princ Principa ipall budge budgett facto factor; r; (iii) (iii) Respons Responsibil ibility ity account accounting. ing.



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Answers



(a)


Budgeted profit statement

Revenue (W1)

Building $ 721,920

Plumbing $ 589,680

Electrics $ 528,000

96,000 72,000 1,200 20,000 –––––––– 532,720 ––––––––

108,000 168,000 900 30,000 –––––––– 282,780 ––––––––

120,000 120,000 750 20,000 –––––––– 267,250 ––––––––

Total $

Less

Materials (W2) Instructors’ salaries (W3) Heat, light and power (W4) Depreciation on equipment (W5) Attributable profit Non attributable overheads Heat, light and power (W4) Administration equipment depreciation (W5) Selling and administration Apportioned head office expenditure (W6)

1,082,750 87,150 30,000 150,000 367,920 ––––––––– 447,680 ––––––––– –––––––––

College profit

Working 1 Course revenues per annum Days per year = 48 weeks x 5 days = 240 days Building = ($80 x 40 students x 80% x 240 days) + ($80 x 70% x 40 students x 20% x 240 days) = $721,920 Plumbing = ($90 x 30 students x 70% x 240 days) + ($90 x 70% x 30 students x 30% x 240 days) = $589,680 Electrics = ($100 x 25 x 60% x 240 days) + ($100 x 70% x 25 students x 40% x 240 days) = $528,000 Working 2 Materials Building $10 x 40 students x 240 days = $96,000 Plumbing $15 x 30 students x 240 days = $108,000 Electrics $20 x 25 students x 240 days = $120,000 Working 3 Instructor salaries Building $300 x 240 days = $72,000 Plumbing $700 x 240 days = $168,000 Electrics $500 x 240 days = $120,000 Working 4 Heat, light and power Building 40 students x $30 = Plumbing 30 x $30 = Electrics 25 students x $30 =

Balance = Total

$1,200 $900 $750 –––––––– $2,850 $87,150 –––––––– $90,000 –––––––– ––––––––

Working 5 Depreciation Building equipment depreciation = $100,000 x 20% = Plumbing equipment depreciation = $100,000 x 30% = Electrics equipment depreciation = $100,000 x 20% = Administation equipment depreciation (balance)

$20,000 $30,000 $20,000 $30,000 ––––––––– $100,000 ––––––––– –––––––––

Working 6 Apportioned head office expenditure Total college revenue x 20% ($721,920 + 589,680 + 528,000) x 20% = $367,920 (b)

Maximum price

Moving the building course to the competitor college as an alternative to cancelling will allow Fenster to earn some revenue it would otherwise lose, but also to incur some costs that would be saved if the building course were cancelled (materials and instruction). Fenster should pay no more than the net of these two figures. On a relevant cost basis heat, light and power, head office recharge, depreciation charges, selling and administration overheads are irrelevant as they will not change between the alternatives available.


Employed student revenue (W7) Material costs (W8) Instructors’ salaries (W3) Maximum price

$ 614,400 (76,800) (72,000) ––––––––– $465,600 ––––––––– –––––––––

Fenster should pay no more than $465,600 for the hire of the competitor college’s classroom facilities. Working 7 $80 x 40 students x 80% x 240 days = $614,400 Working 8 $10 x 40 students x 80% x 240 days = $76,800 (c)

Areas of concern

– – – – –

Will all employed building students be prepared to transfer to the new location? Will payments or fee reductions be required to reimburse existing students for extra travelling costs? Will the college incur additional costs in operating at the new location (for example staff travelling costs)? Will the competitor college take the opportunity to ‘poach’ Fenster’s building students? Will head office reduce its recharge and what impact will the decision to move the course have on college reported profit?

(only four areas of concern were required) (d)

Four non-financial measures of college performance

Non-financial measures could include: – – – – – –

Exam pass rates for examination based courses. In the long term this will measure the quality of courses (and students) and affect financial success. Student attendance rates, level of customer complaints and % of companies returning each year are all measures of course quality. Problems in any of these areas could eventually affect financial success. Classroom utilisation. This gives a measure of cost efficiency in the use of resources. Percentage of fee income coming from courses that were not operating last year. This would measure Fenster’s ability to innovate. Staff turnover could be used as a measure of staff morale. Percentage of course places filled. Low numbers could indicate poor marketing.

(only four measures were required)

2

(a)

Costs of quality Prevention costs: These represent the cost of any action taken to investigate, prevent or reduce defects or failures. Appraisal costs: These are the costs of assessing the quality achieved. Internal failure costs: These are costs arising within the organisation relating to a failure to achieve the specified level of quality. External failure costs: These are costs arising when the failure to achieve the specified level of quality is detected outside the organisation.

(b)

Analysis of costs Prevention costs Quality control devpt. Operative training Machine maintenance Shade matching Appraisal costs Finished goods inspection Goods inward inspection Internal failure costs Rework Failure analysis External failure costs Customer complaints Compensation payment

Note: Rework could also be categorised as external failure costs. Quality control development could be categorised as an appraisal cost. Shade matching could be categorised as an appraisal cost. Goods inward inspection could be categorised as a prevention cost.


(c)

Machine hire decision

Extra prevention costs per month Machine hire Training and operating

(5,000) (1,000) –––––––

Failure costs saved Rework Failure analysis Customer complaints (variable element) Compensation payment

8,850 3,877 1,456 4,600 ––––––– 18,783 –––––––

70% of $18,783 Monthly saving

(6,000)

13,148 ––––––– 7,148 ––––––– –––––––

On the basis of the above figures, Kint should hire the new machine.

3

(a)

(i)

Contribution to sales ratio

contribution per loaf Contribution to sales ratio = –––––––––––––––––– = sales price per loaf (ii)

$1·20 –––––– $2·00

= 0·60

Break-even point in sales revenue

Break even point in sales revenue

Fixed costs per annum = –––––––––––––––––––– Contribution sales ratio =

$66,000 –––––––– 0·6

= $110,000 per annum

(iii) Break-even point in units

Break-even point in units

Fixed costs per annum = –––––––––––––––––––– Contribution per loaf =

$66,000 ––––––––––––– $1·20 per loaf

= 55,000 loaves per annum or alternatively

$110,000 = –––––––––– = 55,000 loaves per annum $2 per loaf

(iv) Margin of safety

Margin of safety in loaves = Budgeted sales (loaves per annum) – break-even sales (loaves per annum) 70,000 loaves – 55,000 loaves = 15,000 loaves per annum


(b)

Break-even chart for proposed new shop

TOTAL REVENUE $000

120 TOTAL COST 110 100 80 FIXED COST

60 40 20

20

40

60

80

OUTPUT UNITS (000)

B.E.P. (c)

Sales variances Sales volume contribution variance Actual sales (loaves) x standard contribution

50,000 loaves x $1·20 = $60,000 > $24,000 Adv 70,000 loaves x $1·20 = $84,000

Budgeted sales (loaves) x standard contribution Sales price variance Actual sales (loaves) x actual price

50,000 loaves x $2·20 = $110,000 > $10,000 Fav 50,000 loaves x $2·00 = $100,000

Actual sales (loaves) x standard price

Comment Sales volume contribution variance Failure to achieve budgeted sales in loaves has resulted in (everything else being equal) a loss in contribution and profit of $24,000. Sales price variance Selling at a price of $0·20 higher than standard should lead to $10,000 extra profit at the actual sales level of 50,000 loaves.

4

(a)

Sales budget

Quarter Sales units (w1) Sales $ Working 1 Quarter 1 2009: Quarter 2 2009: Quarter 3 2009: Quarter 4 2009: (b)

1 11,700 351,000

y y y y

= = = =

10,000 10,000 10,000 10,000

+ + + +

100 100 100 100

x x x x

17 18 19 20

2 11,800 354,000

= = = =

11,700 11,800 11,900 12,000

3 11,900 357,000

4 12,000 360,000

units units units units

Budgeted income statement

Sales revenue (w2) Direct material (w3) Direct Labour (w4) Fixed overheads (w5) Profit

$ 1,422,000 312,840 625,680 260,000 –––––––– 223,480 –––––––– ––––––––

Working 2: Total sales units = (11,700 + 11,800 + 11,900 + 12,000) = 47,400 units x $30 per unit = $1,422,000


121 ––– = $312,840 110 121 Working 4: 47,400 x $12 x ––– = $625,680 110 Working 5: 2008 fixed overhead = 50,000 units x 0·5 hours per unit x $10 per hour = $250,000 2009 fixed overhead = $250,000 x 1·04 = $260,000 Working 3: 47,400 x $6 x

(c)

(i)

Long term (or strategic) planning

Long term (or strategic) planning aims to develop a match between the organisation and its environment. Many definitions of long term plans exist but most will include details of the products or services an organisation will produce, the markets it will serve, what it will achieve, and the resources required to execute the plan. Long term planning is an important precursor to budget planning as it sets the long term direction of the organisation. (ii)

Principal budget factor

The principal budget factor is the factor that limits an organisation’s performance for a given period. In most commercial organisations it is sales volume. In public sector organisations (where demand is often almost unlimited) it is usually availability of resources. It is important in budgetary planning as it is the starting point for budget preparation. Once an organisation has forecast how much product or service it can sell, it can then decide how much to produce or provide and what resources are required. (iii) Responsibility accounting

Responsibility accounting is a system of accounting that segregates revenue and costs into areas of personal responsibility in order to monitor and assess the performance of different parts of the organisation. Managers should be assigned responsibility for costs and revenues within their control. The concept of responsibility accounting is important in budgetary control as managers’ performance should only be assessed on items they are responsible for. If managers are assessed on items they are not responsible for motivation and control will suffer.



December 2008 Marking Scheme Marks

1

(a)

Revenue Materials Instructors Variable heat, light and power Depreciation Attributable profit Fixed heat, light and power Admin depreciation Apportioned head office Net profit

3 1·5 1·5 1·5 1·5 1·5 1·0 1·0 1·0 0·5 –––– 14

(b)

Approach Incremental revenue Incremental material cost Incremental instruction cost Maximum price

3 2 2 2 1 –––– 10

2

(c)

2 per area of concern, max

(d)

2 per justified measure, max

(a)

2 marks per cost defined

8

(b)

0·5 per correctly categorised cost

5

(c)

Machine hire Staffing Rework Failure analysis Variable complaints Compensation 70% adjustment Decision/recommendation

8 8 ––––

1 1 1 1 1 1 1 1 –––– 7 ––––

Maximum

3

(a)

4 x 2 marks

(b)

X axis labelled Y axis labelled Fixed cost labelled Total cost labelled Sales revenue labelled Break-even point labelled

40

20

8 1 1 1 1 1 1 –––– 6

(c)

2 per variance 1 per explanation

4 2 –––– 6 ––––

20

15


15111566 ACCA CAT Paper T7 Plan Cont and Perf Management Solved Past Papers

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