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

Section A onlyAll questions are compulsory

Note: Section B of the actual exam paper will contain four written questions

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the following questions are typical of those that will appear in Section A of the examination paper from June 2009 onwards. there will be a total of ten questions in section A.

All questions in Section A will be worth two marks each.

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.

What is the best estimate of the current cost of material x per kg?

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 marks)

2 Which of the following is the best description of a rolling budget?

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 marks)

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.

What was the division’s controllable residual income in the last year?

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 marks)

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.

What was the raw material usage variance for the period?

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 marks)



3

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’.

Which of the three e’s best describes the above measure?

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 marks)

6 The following observations have been made of total overhead cost.

Output level (units) 5,000 10,000 Total overhead cost ($) 14,000 27,000

The variable element of total overhead cost is known to increase by $1 per unit at output levels above 7,000 units.

What is the variable element of total overhead cost at an output level of 5,000 units?

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 marks)

7 The following statements have been made about linear regression analysis:

(i) It provides more accurate estimates than the high low technique. (ii) It can only be used to estimate variable cost (iii) It assumes that cost behaviour is linear. (iv) It only takes into account two observations of cost and output Which of the following statements about the use of linear regression analysis in cost estimation are true?

A (i) and (ii)

B (i) and (iii)

C (ii) and (iii)

d (iii) and (iv) (2 marks)

8 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.

how many units will be produced in the current month?

A 2,080

B 1,920 (400 + 2000 – 480)

C 2,000 (no adjustment)

d 2400 (2000 + 400) (2 marks)



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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.

What will be the percentage change in price?

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 marks)

10 Which of the following are components of a time series analysis? (i) trend (ii) Seasonal variation (iii) Cyclical variation A (i) and (ii) only

B (i) and (iii) only

C (ii) and (iii) only

d (i), (ii) and (iii) (2 marks)

end of Sample questions



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Answers



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Sample multiple Choice question paper t7 Answersplanning, Control and performance management

1 C

2 A

3 B

4 B

5 C

6 A

7 B

8 A

9 A

10 D



Planning, Controland PerformanceManagement

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 Pape

r T7

The Association of Chartered Certified Accountants



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 arebest motivated by financial incentives. The company pays a monthly bonus of 10% of profit earned in their respectivedivisions 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 someseasonal variation. The manager of the Eastern division, however, has reported significantly increased profits in May2004. The board of directors is now questioning the size of her bonus payment, particularly as she has alreadyresigned 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 absorptioncosting system.

Profit and Loss Account for the month ended30 April 2004 31 May 2004

£000 £000 £000 £000Sales 350·0 280·0Opening stock finished goods 9·0 9·0Variable production cost 200·0 400·0Absorbed fixed production cost 100·0 200·0Closing stock finished goods (9·0) (369·0)

––––– ––––––Cost of sales (300·0) (240·0)(Under)/over absorption 0·0 100·0

–––––– ––––––Gross profit 50·0 140·0

Fixed selling and administration expenses (10·0) (10·0)Variable selling and administration expenses (35·0) (28·0)

–––––– ––––––Profit before bonus 5·0 102·0Bonus (0·5) (10·2)

–––––– –––––– Net Profit 4·5 91·8

–––––– ––––––

The following information is also available1. Selling price per case of finished product was £350 in both months2. Variable production cost was £200 per case in both months3. Fixed production overheads are recovered on the basis of budgeted monthly production of 1,000 cases4. 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 May2004. (4 marks)

(b) Redraft the above profit and loss accounts on a marginal costing basis for both April and May 2004 andcalculate the bonus to be paid to the Eastern division manager in each month if the bonus was set at 10%of marginal costing profit. (12 marks)

(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 thosein the absorption costing statements;

(ii) discuss any apparent problems associated with the performance of the Eastern division in May 2004even 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 currentlyoperated. (15 marks)

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 thestatistician’s report are available.

(d) In the context of a time series analysis of sales, explain the meaning of the terms ‘trend’ and ‘seasonalvariation’. (4 marks)

(e) Use the information provided by the statistician to forecast sales in cases for the last quarter of 2004 for theWestern division. (5 marks)

(40 marks)

3 [P.T.O.

Based on linear regression analysis the quarterly trend in sales units for the Western division may berepresented by the equation:

y = 1,500 + 60xwherey = forecast sales trend in cases per quarterx = the quarter number, where the first quarter of the year 2000 = 1, the second quarter of the year2000 = 2, etc.

The average seasonal variation in sales follow an additive model with the following quarterly variations.

Quarter 1 2 3 4

Seasonal Variation (Cases) +50 –40 –60 +50

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



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2 Mortensen plc manufactures wooden toys. It uses a standard costing system to control costs. The cutting departmentcuts the shapes which are sold as toy animals. The process is very labour intensive and requires highly skilled labourto minimise the wastage of the expensive hardwood used.

The standard cost card for a set of toy animals is given below.

£Hardwood 0·1 cubic metres at £160 per cubic metre 16·00Direct labour 30 minutes at £9 per hour 14·50Fixed overhead 30 minutes at £4 per direct labour hour 12·00

––––––Total cost 22·50

––––––

Fixed overhead absorption rates are based upon budgeted monthly fixed overheads of £26,000 and a budgetedmonthly 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 forthe period were 1,800 cubic metres of hardwood at £150 per cubic metre. 8,000 direct labour hours were workedand 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 havecalculated in part (a). (10 marks)

(20 marks)



5 [P.T.O.

3 Perry plc is a large conglomerate company structured on a divisional basis. It seeks to maximise investor wealth. Headoffice avoids day to day involvement in divisional affairs and only intervenes if performance is consideredunsatisfactory. 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’smission statement is ‘To be the hotel of first choice for business users and tourists’. Although the chain has generallybeen 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 offacilities, service and catering. Over the last two years the division has invested a large amount of money inmodernising its hotels including the improvement of bedrooms and public rooms, installation of gymnasia andswimming pools and the information technology features required by business travellers. A large amount of moneyhas also been spent on staff training to improve service levels and on a television advertising campaign to promotethe improved hotels to business users.

Head office is concerned that the performance of the hotel chain appears to have declined over the last few yearsdespite this expenditure.

The following figures are available:£ million

2001 2002 2003Capital employed 50 70 90Operating profit 15 16 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 performancemeasurement. (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)



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4 Taylor Ltd manufactures a single product using a labour intensive production process. Its quality control departmenttests the final product before it leaves the factory and at present 20% of its pre-inspection output is rejected andscrapped. Scrap units have no value and cannot be reworked. Taylor builds the cost of scrapped units into the costof good production.

A standard cost card for Taylor’s product under its current production method is given below

£ per unitDirect material 3 kgs at £5 per kg 15·00Direct labour (variable) 10·00Variable overhead 5·00

––––––Cost pre-inspection per unit produced 30·00Cost of rejects 7·50

––––––Variable cost per good unit 37·50Selling price per good unit 60·00

––––––Contribution per good unit £22·50

––––––

Total fixed overheads are budgeted at £148,500 per month. Taylor currently sells 9,000 units per month. Negligiblestocks 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 wouldfall 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 managementprogramme. 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 manufacturingprocess 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 commonlycategorised under the headings of

Internal failure costsExternal failure costsAppraisal costs

and PreventionExplain the meaning of each of these terms and give one example of each type of cost in a manufacturingbusiness such as Taylor Ltd. (8 marks)

(20 marks)

End of Question Paper



Answers



9

ACCA Certified Accounting Technician Examination – Paper T7Planning, Control and Performance Management June 2004 Answers

1 (a) Number of cases produced and soldApril May

Sales (£350,000 ÷ £350) 1,000 (£280,000 ÷ £350) 1,800Production (£200,000 ÷ £200) 1,000 (£400,000 ÷ £200) 2,000

(b) Marginal costing profit statements

Profit and loss accounts for the month ended30 April 2004 31 May 2004

£000 £000 £000 £000Sales 350·0 280·0Opening stock finished goods 6·0 6·0Variable production cost 200·0 400·0Closing stock finished goods (6·0) (246·0)

–––––– ––––––Variable cost of sales (200·0) (160·0)Variable selling and administration expenses (35·0) (28·0)

–––––– ––––––Contribution 115·0 92·0Fixed production cost (100·0) (100·0)Fixed selling and Administration expenses (10·0) (10·0)

–––––– ––––––Profit before bonus 5·0 (18·0)Bonus (0·5) 0·0

––––––Net profit 4·5 (18·0)

–––––– ––––––

WorkingsApril opening stock finished goods = £9,000 ÷ £300 x £200 = £6,000April closing stock finished goods = £9,000 ÷ £300 x £200 = £6,000May closing stock finished goods = £369,000 ÷ £300 x £200 = £246,000

(c) Report

ReportTo: Board of directors Matthews LtdFrom: A Certified Accounting TechnicianSubject: Profit measurement and bonus schemeDate: Today

Differences in profit FiguresThe difference in net profit figures for May 2004 is due to a change in costing principle. Absorption costing values finishedgoods closing stock at full production cost (fixed and variable cost). In a period where finished goods stocks increase somefixed 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 offagainst 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 figureas 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.

£000Absorption costing profit 91·80LessStock increase in cases x £100 per case1,200 cases x £100 (120·00)PlusDifference in bonus payments 10·20Marginal costing profit (18·00)

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



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Bonus systems based upon absorption costing principlesThe danger of basing bonus schemes on absorption costing profit is that managers are effectively rewarded for increasingstocks. In May the manager of the Eastern division increased the reported profit figure (and her bonus) although hercontribution to the financial well-being of the company is questionable. If managers are given autonomy over production levelsthere is a danger that they ‘play the system’ to manipulate profits and boost their earnings.

Improved Bonus SystemsMany 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 financialperformance.

– Bonus payments could be based upon measures such as return on investment or residual income. This would focusmanagers’ attention upon capital invested as well as profit earned.

(d) Trend and seasonal variationIn the context of time series analysis of sales, trend refers to the general direction in which a graph of sales goes over a longinterval of time.

Seasonal variations are the identical (or almost identical) patterns which sales follow during corresponding intervals ofsuccessive periods. For example many retail businesses each year experience an increase in sales before Christmas only tosee them fall again after the Christmas period.

(e) Sales Forecast

Trendy = 1,500 + 60xy = 1,500 + (60 * 20) = 2,700

Seasonal variationLast quarter of the year = + 50

Forecast = 2,700 + 50 = 2,750 cases

2 (a) VariancesDirect Materialactual purchases at actual price 1,800m3 at £150 = £270,000

(i) Raw material price variance £18,000 FAVactual purchases at standard price 1,800m3 at £160 = £288,000actual usage at standard price 1,600m3 at £160 = £256,000

(ii) Raw material usage variance £32,000 ADVstandard usage at standard price 14,000 sets at 0·1m3 at £160 = £224,000

Direct Labouractual hours at actual rate 8,000 hours at £9·25 = £74,000

(iii) Direct labour rate variance £2,000 ADVactual hours at standard rate 8,000 hours at £9·00 = £72,000

(iv) Direct labour efficiency variance £9,000 ADVstandard hours at standard rate 14,000 sets at 0·5 hours at £9·00 = £63,000

Fixed OverheadActual fixed overheads = £23,000

(v) Fixed overhead expenditure variance £3,000 FAVBudgeted fixed overheads = £26,000

(vii) Fixed overhead capacity variance £6,000 FAVActual labour hours at standard absorption rate 8,000 hours at £4 = £32,000

(viii) Fixed overhead efficiency variance £4,000 ADVStandard labour hours at standard absorption rate

14,000 sets at 0·5 hours at £4 = £28,000capacity + efficiency = £6,000 FAV + £4,000 ADV =

(vi) Fixed overhead volume variance £2,000 FAV



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(b) Meaning and possible cause of variancesThe raw material price variance shows that wood was purchased at a lower price than standard. This saved £18,000 on thematerial purchased.

This saving could have many potential causes including a change of supplier, a fall in market prices, better price negotiationor by buying a lower grade of material. The material usage variance is £32,000 adverse showing that more material wasused than standard. Again there are many potential causes including careless use of material, pilferage, or problems resultingfrom the use of poorer quality material. The two variances could possibly be related, as the favourable price variance couldhave been achieved by buying material of an inferior quality leading to more wastage than usual. If this is the case then thedecision 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 setsthan 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 thanbudgeted we could have absorbed £6,000 more overhead than budgeted. However part of this over absorption was lost dueto inefficient labour and at standard labour hours £4,000 of this over absorption is cancelled out leading to an overall volumevariance of £2,000 favourable.

3 (a) Residual income£million

2001 2002 2003Operating profit 15 16 17Imputed interest charge£50m x 20% (10)£70m x 20% (14)£90m x 20% (18)

–––– –––– ––––Residual income 5 2 (1)

–––– –––– ––––

(b) Advantages and disadvantages of residual incomeAdvantages– 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 approachThe balanced scorecard approach seeks to measure performance under a variety of headings of financial success, customersatisfaction, 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.



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(d) CSFs and KPIsCritical Success Factor Key performance indicator

financial successInvestor wealth residual incomeCash flow achievement of cash flow targets

customer satisfactionService levels number of complaintsFacilities customer questionnaire resultsCatering customer questionnaire results

process efficiency Check-in average check-in timeFacility utilisation % utilisation of pools and gym

organisational learning and growthPenetration of business market % growth in business usageUsage of new facilities revenue from new facilities

4 (a) Break even point in good units= Monthly fixed costs

=£148,500

= –––––––––––––––– –––––––––contribution per good unit £22·5 per unit

= 6,600 units

(b) Break even point in good units for the automated process

Revised cost card £ per good unitSelling price 60·00Direct materials 15·00Direct labour 5·00Variable overhead 5·00Quality control rejects (5%) (w1) 1·32

––––––Contribution per good unit £33·68

––––––

Revised break even point =New monthly fixed costs–––––––––––––––––––––New contribution per unit

=£148,500 + £120,000

= 7,972 units–––––––––––––––––––––£33·68

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

q =£120,000

= 10,733–––––––––£11·18

(Or more directlyIncrease in fixed costs

=£120,000

––––––––––––––––––––––––––– –––––––––decrease in variable cost per unit £11·18

= 10,733 units

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



(d) Costs of qualityInternal failure costsThese 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 costsThese are discovered after the product has been delivered to customers.Examples include complaint investigation, warranty claims, cost of lost sales, product recalls etc.

Appraisal costsThese are the costs of monitoring and inspecting products before they are released to customers. Examples includemeasurement equipment, inspection and tests, test equipment expense, etc.

Prevention costsThese include investment in machinery, technology and training to reduce the number of defective products. Examples includetraining programmes, supplier reviews, field trials, cost of research into customer needs, etc.

13



15

ACCA Certified Accounting Technician Examination – Paper T7Planning, Control and Performance Management June 2004 Marking Scheme

Marks1 (a) Sales 2

Production 2–––4

(b) Sales 2Opening Stocks 2Closing Stock May 2Contribution 2Profit pre bonus 2Bonus 2

–––12

(c) Report format 1Abs and marginal approachesExplained 2Reconciliation 3(2 if bonus omitted)Sales problem 1Stock problem 2Bonus problem 22 per improved system max 4

–––15

(d) Trend 2Seasonal 2

–––4

(e) Trend 2Seasonal 1Forecast 2

–––5

–––40–––

2 (a) Raw material price 2(1 if based on usage)Raw material usage 1Labour rate 1Labour efficiency 1Fixed overhead expenditure 1Fixed overhead volume 1Fixed overhead capacity 1Fixed overhead efficiency 2

–––10

(b) Meaning and possible cause ofPrice variance 1Usage variance 1Possible interrelationship of material price and usage 2Expenditure variance 1Capacity variance 2Efficiency variance 2Volume variance 1

–––10–––20–––



16

Marks3 (a) 1 mark for each year 3

(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–––

4 (a) Method 1Break even point 1

–––2

(b) New reject cost 2New contribution 1New fixed costs 1New break even point 1

–––5

(c) Method 3Output level 2

–––5

(d) Explanations 4 x 1 4Examples 4 x 1 4

–––8

–––20–––





ADVANCED LEVEL

TUESDAY 7 DECEMBER 2004

QUESTION PAPER


ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall


Pape

r T7



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 abudgeting system. As a starting point he needs to decide on monthly production levels for the first three monthsof 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 itstwo products (shirts and shorts) per month. However, for the the first three months of 2005 production will beconstrained by a lack of direct labour. It is estimated that only 6,000 hours of direct labour will be available eachmonth.

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 finished goods or rawmaterials in the first quarter (three months) of the year. There will be no opening stocks at the beginning ofJanuary.

Estimated costs and revenues per garment are as follows:

£ per garmentshirts shorts

£ £Sales price 30 22Raw materials

Fabric at £12 per square metre (12) (6)Dyes and cotton (3) (2)

Direct labour at £8 per hour (4) (2)Fixed overheads at £4 per hour (2) (1)

–––– ––––Profit £9 £11

–––– –––––––– ––––

Required:

Calculate the number of shirts and shorts to be produced per month in the first quarter of 2005 to maximiseBowyer Ltd’s profit. (8 marks)

(c) After the first three months of 2005 direct labour will no longer be a constraint, due to recruitment of moreworkers. Building work will also be complete and the firm will once again be able to carry stock. The companyexpects to be able to sell 15,000 shirts and 20,000 shorts in April 2005. Sales volumes are expected to growat 2% per month cumulatively thereafter throughout 2005. The following additional information is available.

1. The company intends to carry a stock of finished garments sufficient to meet 40% of the next month’s sales.2. The company intends to carry sufficient raw material stock to meet the following month’s production.3. 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 consideringimposing 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 workrequired by a customer. Robertson’s accountant has compiled the following figures, together with some notes as abasis for a quotation.

£Direct materials:Bricks 200,000 at £100 per thousand 20,000 note 1

200,000 at £120 per thousand 24,000Other materials 5,000 note 2Direct labour:Skilled 3,200 hours at £12 per hour 38,400 note 3Unskilled 2,000 hours at £6 per hour 12,000 note 4Other costs:Scaffolding hire 3,500 note 5Depreciation of general purpose machinery 2,000 note 6General overheads 5,200 hours at £1 per hour 5,200 note 7Plans 2,000 note 8

––––––––Total cost 112,100Profit 22,420 note 9

––––––––Suggested price £134,520

––––––––––––––––

Notes1. 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 theyear at £100 per 1,000. The current replacement cost of this type of brick is £120 per 1,000. If the bricks instock 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 asa skilled worker for other builders at a rate of £12 per hour or spend the 800 hours completing urgently neededrepairs 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. Theseunskilled labourers are currently idle and would have sufficient spare time to complete the proposal underconsideration.

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 yardout 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 competitionfor the work.

Required:

Using relevant costing principles, calculate the lowest price that John could quote for the customer’s buildingwork. 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 ofboth 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 anabsorption costing system, and absorbs overheads on the basis of budgeted direct labour hours. On this basisthe estimated cost of its latest product, a talking electric kettle, is as follows:

£ per unitDirect material 4·50Direct labour (£12 per hour) 0·50Production overheads (£120 per hour) 5·00

–––––Production cost 10·00

––––––––––

The firm’s management accountant has suggested that more accurate product costs would be obtained if anactivity based costing (ABC) approach were used. He has collected the following information as a starting pointfor an ABC treatment of production overhead costs.

Budgeted factory overhead per annumCost Pools Cost per annum Cost Driver

£000Stores administration 5,000 Number of different componentsProduction line set ups 3,000 Number of set upsDispatch 1,000 Number of dispatchesOther overheads 3,000 Direct labour hours

–––––––Total production overhead 12,000

––––––––––––––

Estimated activity per annumCost Driver Total Activity per annumNumber of components 2,000 itemsNumber of set ups 10,000 set upsNumber of dispatches 20,000 dispatchesDirect labour hours 100,000 hours

Each talking kettle uses 10 different components and kettle manufacture will involve six production line set upsper annum. Five hundred dispatches will be required per annum. Budgeted production is 10,000 kettles perannum.

Required:

Estimate the cost of a talking kettle using an ABC approach and the cost drivers suggested by themanagement accountant. (8 marks)

(b) Birtles plc’s Finance Director supports the proposal to introduce activity based costing but argues that the firmshould consider all the costs involved in the development, production and marketing of the kettle. In addition tothe above ABC costs, £30,000 has already been spent on research and development for the talking electric kettleand he estimates that a further £5,000 will be spent on marketing the new product. There are no other costsattributable 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 secondyear 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 willearn an OVERALL 20% margin on sales over its two year life after covering ALL attributable costs outlinedabove. (8 marks)

(c) Explain what is meant by life-cycle costing. Give two reasons why a life cycle costing approach could be ofvalue to Birtles plc. (4 marks)

(20 marks)

5 [P.T.O.



4 Francis plc is a manufacturing company. It assesses managerial performance by comparing actual with budgetedresults. Due to staff shortages in the accounting department, figures for November 2004 budget reports have beenprepared by a trainee. A copy of the budget report for November 2004 for the appliances division is given below.

Budgeted Actual VarianceSales and production volumes (units) 5,000 5,500 500 F

£000 £000 £000Sales revenue 1,000 1,078 78 FDirect material (250) (286) 36 ADirect labour (150) (176) 26 AOther manufacturing costs (300) (308) 8 ADivisional fixed overhead (200) (190) 10 F

–––– –––– –––––Profit 100 118 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 herdivision’s performance. She thinks that the budget figures are inappropriate and that a flexed budget should be usedto calculate the variances. To assist in preparing a flexed budget she provides the following information:

1. Budgeted selling price is £200 per unit and actual selling price was £196 per unit.2. Direct material is a variable cost.3. Budgeted direct labour cost has a fixed element of £50,000 per month, the balance is variable.4. Other manufacturing costs are semi-variable. Budgeted cost and output for the previous two months have been

as follows:

Month October 2004 September 2004Budgeted Output (units) 4,000 3,000Budgeted Cost (£000) 210 170

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 avariance. (8 marks)

(20 marks)


6



Answers



ACCA Certified Accounting Technician Examination – Paper T7Planning, Control and Performance Management December 2004 Answers

1 (a) 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 unitShirts Shorts

£ £Selling price 30 22Variable cost 19 10

–––– ––––Contribution £11 £12

–––– –––––––– ––––

Labour hours 0·5 0·25Contribution per labour hour £22/hour £48/hourRank 2nd 1st

Shorts give most contribution per unit of the limiting factor. The sales constraint requires us to make at least one shirt forevery four shorts. We can therefore think of production being in ‘packages’ of four shorts and one shirt. Each package wouldrequire 4 x 0·25 hours + 1 x 0·5 hours = 1·5 hours

In 6,000 labour hours the company could produce

6,000= 4,000 ‘packages’–––––––––

1·5 hours

In 6,000 labour hours the company could therefore produce

6,000 hours x 4= 16,000 shorts––––––––––––––

1·5 hoursand

6,000 x 1= 4,000 shirts–––––––––

1·5 hours

(c) Functional budgets

(i) Sales BudgetsShirts Shorts

Units Price Revenue Units Price Revenue Total Revenue£ £ £ £ £

April 15,000 30 450,000 20,000 22 440,000 890,000May 15,300 30 459,000 20,400 22 448,800 907,800June 15,606 30 468,180 20,808 22 457,776 925,956

––––––– ––––––––––– ––––––– ––––––––––– –––––––––––Total 45,906 £1,377,180 61,208 £1,346,576 £2,723,756

––––––– ––––––––––– ––––––– ––––––––––– –––––––––––

9



(ii) Production Budgets

Shirts unitsApril May June

Closing stock (w1) 6,120 6,242 6,367Sales 15,000 15,300 15,606

––––––– ––––––– –––––––21,120 21,542 21,973

Less opening stock (0) (6,120) (6,242)––––––– ––––––– –––––––

Production 21,120 15,422 15,731––––––– ––––––– –––––––––––––– ––––––– –––––––

Working 1Closing stock April = 15,300 x 40% = 6,120Closing stock May = 15,606 x 40% = 6,242Closing stock June = 15,606 x 1·02 x 40% = 6,367

Shorts unitsApril May June

Closing stock (w2) 8,160 8,323 8,490Sales 20,000 20,400 20,808

––––––– ––––––– –––––––28,160 28,723 29,298


Production 28,160 20,563 20,975––––––– ––––––– –––––––––––––– ––––––– –––––––

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

(iii) Purchases

Fabric PurchasesSquare metres

April May JuneClosing stock (w3) 25,704 26,219 26,743Usage Shirts 21,120 15,422 15,731

Shorts 14,080 10,282 10,488––––––– ––––––– –––––––60,904 51,923 52,962


Purchases 60,904 26,219 26,743––––––– ––––––– –––––––––––––– ––––––– –––––––

Working 3April closing stock = May usage = 15,422 + 10,282May closing stock = June usage = 15,731 + 10,488June 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 budgetholder an opportunity to participate in the budgeting process. These budgets are then passed down to (imposed upon) budgetholders. 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 settingof 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 materialsBricks 48,000 note 1Other materials 5,000 note 2Direct labourSkilled 2,400 hours at £12 per hour + £12,000 40,800 note 3Unskilled – note 4Scaffolding hire 3,500 note 5Depreciation of general purpose machinery – note 6General overheads 10,000 note 7Plans – note 8

––––––––Total cost 107,300Profit – note 9

––––––––Minimum price £107,300

––––––––––––––––

Notes1. 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 thebest 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£ per unit

Direct material 4·50Direct labour 0·50Production overheadsComponents 10 x £2,500 ÷ 10,000 units 2·50 (working 1)Production set ups 6 x £300 ÷ 10,000 units 0·18 (working 1)Dispatches 500 x £50 ÷ 10,000 2·50 (working 1)Other 2·5 minutes ÷ 60 mins x £30 per hour 1·25 (working 2)

––––––Production cost £11·43

––––––––––––

Workings1. Cost per unit of driver activity

Cost poolStores administration £5,000,000 ÷ 2,000 components = £2,500 per componentProduction line set ups £3,000,000 ÷ 10,000 set ups = £300 per set upDispatches £1,000,000 ÷ 20,000 dispatches = £50 per dispatchOther 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 periodProduction cost (as estimated above) 20,000 x £11·43 228,600Research and development costs 30,000Marketing cost 5,000

––––––––Total cost 263,600Required profit (£263,600 ÷ 80 x 20) 65,900

––––––––Total revenue £329,500

––––––––––––––––

If first year selling price = p

Then total revenue = 10,000p + (10,000 x 0·6p).

Then p = £329,500

= £20·59––––––––––––––––––––––10,000 + (10,000 x 0·6)

(c) Life-cycle costing

No product will last forever; in time sales of all products will decline. Different costs are incurred at different stages of aproduct’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 beinvolved.

Traditional cost accounting systems do not accumulate costs over a product’s entire life but focus instead on (normally) twelvemonth 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 profitabilityof a product to be determined.

Value to Birtles plc

Birtles plc operates in a market 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 approachoffers 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 variancesWhen calculating variances it is important to compare like with like. For example, in calculating a direct materials varianceit is not sensible to compare the actual cost for making 5,500 units with the budgeted cost for making 5,000 units. Directmaterial is a variable cost; if more units are made we would expect more material to be consumed. In order to obtain a faircomparison budget figures should be adjusted for changes in volume.

Flexed budgets recognise different cost behaviour patterns and figures are adjusted for volume changes allowing faircomparisons of actual and budgeted figures.

(b) Flexed budget and variances

FlexedBudget Actual Variance

Sales units 5,500 5,500–––––– ––––––£000 £000 £000

Sales revenue (w1) 1,100 1,078 22 ADirect material (w2) (275) (286) 11 ADirect labour (w3) (160) (176) 16 AOther manufacturing costs (w4) (320) (308) 12 FDivisional fixed overhead (w5) (200) (190) 10 F

–––––– –––––– –––––Profit 145 118 27 A

–––––– –––––– ––––––––––– –––––– –––––

Workings(1) £1,000,000 ÷ 5,000 units x 5,500 units = £1,100,000(2) £250,000 ÷ 5,000 units x 5,500 units = £275,000(3) £50,000 + (£100,000 ÷ 5,000 units x 5,500 units) = £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

Variable cost per unit =Change in cost

=£(210,000 – 170,000)

–––––––––––––––– –––––––––––––––––––Change in volume (4,000 – 3,000)

= £40 per unitFixed cost (before the step up) can be calculated by substituting variable cost into either of the observations of total cost.Using 4,000 unitsTotal 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 investigationSeveral 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 labourvariance because of difficulties in working the lower grade material. These two variances would need to be consideredjointly 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) andvariances would not be surprising. Other costs such as labour are far more stable and even a small variance may indicatea problem.

5. Adverse or favourable. Adverse variances tend to attract most attention as they indicate problems; however, there is anargument 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 usuallyindicates 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 ofa 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 islittle point in investigating.

13



ACCA Certified Accounting Technician Examination – Paper T7Planning, Control and Performance Management December 2004 Marking Scheme

Marks1 (a) 2 marks per sensible advantage maximum 8

(b) Contribution per limiting factor approach 2Contributions per unit 2Contributions per labour hour 2Dealing with >25% constraint 1Correct solution 1

–––8

(c) (i) Shirts 2Shorts 2

–––4

(ii) Closing stock shirts 2Closing stock shorts 2Opening stock shirts 1Opening stock shorts 1Sales 1Production 1

–––8

(iii) Closing stock 1Opening stock 1Usage 1Purchases 1

–––4

(d) 2 marks per each approach defined 41 per each advantages max 4

–––8

–––40––––––

2 numbersbricks 2other material 1skilled labour 2unskilled 1scaffolding 1depreciation 1general overhead 1plans 1profit 1

–––11

explanationsbricks 1other material 1skilled labour 1unskilled 1scaffolding 1depreciation 1general overhead 1plans 1profit 1

–––9

–––20––––––

15



Marks3 (a) Stores administration per unit 2

Production set ups per unit 2Dispatches per unit 2Other overhead per unit 2

–––8

(b) Reward methodInclusion of production cost 1R&D cost 1Marketing cost 1Required revenue 2First year price 3

–––8

(c) Life-cycle costing explained 21 mark per reason, max 2

–––4

–––20––––––

4 (a) Comparing like with like 2Flexed budgets explained 1

–––3

(b) Flexed budget figuresSales revenue 1Direct material 1Direct labour 1Other manufacturing costs 3Fixed overhead 1Variances 1/2 each max 2

–––9

(c) 2 marks per explained factor, max 8–––20––––––

16





ADVANCED LEVEL

TUESDAY 7 JUNE 2005

QUESTION PAPER






Pape

r T7




1 McDermott plc is a manufacturer of beds. It uses a standard absorption costing system to monitor performance ofmanagers and departments. A standard absorption cost card for one of its models, the Dreamer, is given below.

£ £Selling price 250·00Production costsDirect material: 12 metres at £1·50 per metre 18·00Direct labour: 4 hours at £6·00 per hour 24·00Variable overhead: 4 hours at £15·00 per hour 60·00Fixed overhead: 4 hours at £10·00 per hour 40·00

–––––––142·00–––––––

Gross profit £108·00––––––––––––––

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 bedsDirect material (purchased and used): 16,000 metres at £1·40 per metreDirect labour (worked and paid): 5,000 hours at £6·00 per hourVariable overhead £75,500Fixed 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 followingareas:

(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 businessorganisations.

Explain FOUR problems of standard costing variance analysis in today’s business world. (8 marks)

(40 marks)

2



2 Hughes plc has recently developed a personal music player and is now considering what price to charge for the newproduct. A market research company has produced the following forecasts of demand at three potential selling prices:

Selling price £250 £350 £450Sales units per annum 10,000 8,000 6,000Fixed costs per annum £800,000 £500,000 £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 marginof 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 activitylevels between 0 and 8,000 units. (8 marks)

(c) Define target costing and explain briefly how it could be used by Hughes plc in the design, manufacture andsale of personal music players. (3 marks)

(20 marks)

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

Year Sales£ 000

2000 175,0002001 193,0252002 211,2252003 229,2502004 247,100

An index of price level movements, appropriate to Case plc’s industry for the same periods is as follows.

Year Price level index2000 1002001 1032002 1072003 1102004 1122005 (forecast) 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 pricelevels using the price level index. (5 marks)

(b) Using the graph paper provided, draw a scattergraph of total industry sales expressed in 2005 price levelsfor the period 2000 to 2004. (5 marks)

(c) Use the high-low technique to estimate a formula for industry sales expressed in 2005 price levels and usethe 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 whenforecasting its own sales. (4 marks)

(20 marks)

3 [P.T.O.



4 Heighway Ltd is a railway company. Heighway Ltd operates a passenger railway service and is responsible for theoperation of services and the maintenance of track, signalling equipment and other facilities such as stations. In recentyears it has been criticised for providing a poor service to the travelling public in terms of punctuality, safety and thestandard of facilities offered to passengers. In the last year Heighway Ltd has invested over £20 million in newcarriages, station facilities and track maintenance programmes in an attempt to counter these criticisms. Summarisedfinancial results for Heighway Ltd for the last two years are given below.

Summarised profit and loss account for the year ended 31 December2003 2004

£ Million £ MillionSales 180·0 185·0

–––––– –––––––––––– ––––––Earnings before interest and tax 18·0 16·5Interest (3·2) (4·7)Tax (4·4) (3·5)

–––––– ––––––Earnings available to ordinary shareholders 10·4 8·3

–––––– –––––––––––– ––––––

Summarised balance sheet as at 31 December2003 2004

£m £m £m £mFixed assets (net) 100·4 120·5Current assets

Stock 5·3 5·9Debtors 2·1 2·4Cash 6·2 3·6

––––– –––––13·6 11·9

Less creditors due within one year (8·4) (9·2)Net current assets 5·2 2·7Less amounts payable after more thanone year

8% Debenture 2009 (15·0) (15·0)Bank loan (20·0) (35·0)

––––– –––––Net assets 70·6 73·2

––––– –––––

Ordinary share capital (£1 shares) 25·0 25·0Reserves 45·6 48·2

––––– –––––70·6 73·2

––––– –––––

4



Required:

(a) Calculate the following ratios for Heighway Ltd for 2003 and 2004, clearly showing your workings:

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

(b) Briefly comment on the financial performance of Heighway Ltd in 2003 and 2004 as revealed by the aboveratios 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 passengerrailway company and explain why your chosen indicators are important. (6 marks)

(20 marks)


5



Answers




1 (a) Standard costing variances

Direct materialActual usage at actual cost 16,000m x £1·40 = £22,400

Price > £1,600 FavActual usage at standard cost 16,000m x £1·50 = £24,000

Usage > £600 AdvStandard usage at standard cost 1,300 units x 12m x £1·50 = £23,400

Direct labourActual hours at actual rate 5,000 hrs x £6·00 = £30,000

Rate > £0Actual hours at standard rate 5,000 hrs x £6·00 = £30,000

Efficiency > £1,200 FavStandard hours at standard rate 1,300 units x 4 hrs x £6·00 = £31,200

Variable overheadActual hours at actual rate 5,000 hrs x £15·10 = £75,500

Expenditure > £500 AdvActual hours at standard rate 5,000 hrs x £15·00 = £75,000

Efficiency > £3,000 FavStandard hours at standard rate 1,300 units x 4 hrs x £15·00 = £78,000

Fixed overheadActual overhead = £54,600

Expenditure > £14,600 AdvBudgeted overhead 1,000 units x 4 hrs x £10·00 = £40,000

Capacity > £10,000 FavActual hours at standard rate per hour 5,000 hours x £10·00 = £50,000

Efficiency > £2,000 FavStandard overhead for actual production 1,300 units x 4 hrs x £10·00 = £52,000

Sales volumeBudgeted sales units at Standard profit margin 1,000 units x £108·00 = £108,000

> £21,600 FavActual sales units at Standard profit margin 1,200 units x £108·00 = £129,600

Sales priceActual sales at standard price 1,200 units x £250 = £300,000

> £12,000 AdvActual sales at actual price 1,200 units x £240 = £288,000

(b) Differences between standard absorption and standard marginal costing

Sales volume varianceThis variance measures the effect on profit of selling more (or less) units than budgeted. Under absorption costing this iscalculated at standard profit per unit. Note that in calculating standard profit per unit all costs, both fixed and variable, arecharged against standard selling price. Under standard marginal costing the variance is calculated at standard contributionper unit. In calculating standard contribution per unit only standard variable costs are charged against standard selling price.

Fixed overhead variancesThe 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. Ifproduction volume differs from that budgeted this can result in under or over absorption of overhead and resultant adverse orfavourable 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 overabsorption, or volume variance, occurs.

Stock valuation and its effect upon profitThe profit figures under the two systems may be different due to the different costing principles involved. Under absorptioncosting finished goods stock is valued at full production cost, which includes both fixed and variable production cost. Undera marginal costing system finished goods stock is valued at variable production cost only. This will result in differences instock valuations and possibly differences in cost of sales figures. In a period when production is greater than sales (as in themost recent month) absorption costing will show the higher profit figure as a proportion of the current period’s fixed productioncosts will be absorbed into units included in closing stock and be carried forward into the next period. This will result inabsorption 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) Standard costing systems rely on the existence of repetitive operations and homogenous output. With increasing levelsof competition and shortening product lifecycles, output is less homogenous and operations are not so repetitive.

(ii) Standard costing places much emphasis on direct labour costs. In a modern manufacturing environment labour is oftenno longer a variable cost, and represents a small proportion of total cost.

(iii) The use of labour hours in the calculation of overhead variances is also questionable as many overheads are not drivenby labour activity.

(iv) An emphasis on efficiency variances can focus management attention in the wrong areas. Just in time productionsystems are more concerned with meeting customer requirements than avoiding idle time.

(v) Material price variances may over emphasise the importance of price at the expense of quality, delivery and supplierreliability.

(vi) Variance analysis concentrates on costs and does not give sufficient attention to issues such as quality and customersatisfaction.

(vii) Variance analysis is largely aimed at manufacturing situations; large parts of modern economies are now serviceindustries.

(Note: only four criticisms were requested.)

2 (a) Budgeted profit, break-even point and margin of safety

Budgeted profitSelling Price £250 £350 £450

£ £ £Contribution (w1) 300,000 1,040,000 1,380,000Fixed costs 800,000 500,000 200,000

––––––––– –––––––––– ––––––––––Profit/(loss) (500,000) 540,000 1,180,000

––––––––– –––––––––– ––––––––––––––––––– –––––––––– ––––––––––

Break-even point in unitsFixed cost £800,000 £500,000 £200,000

––––––––––––––––– ––––––––––– –––––––––––– ––––––––––––Contribution per unit £30 per unit £130 per unit £230 per unit

= 26,667 units = 3,846 units = 870 units

Margin of safety ratio = nil 8,000 – 3,846 6,000 – 870––––––––––––– –––––––––––

8,000 6,000= 52% = 86%

working 1 £ per unit £ per unit £ per unitSelling price 250 350 450Variable cost 220 220 220

–––– –––– ––––Contribution per unit 30 130 230

10



(b) Break-even chart

ACTIVITY LEVEL

(c) Target CostingTarget costing involves setting a target cost by subtracting a desired profit margin from a competitive market price. A targetcost may be less than the planned initial cost but it is expected to be achieved by the time a product reaches its maturitystage of the product lifecyle.

To use target costing Hughes plc would firstly need to consider the product specification necessary in the current market (forexample battery life, capacity, size, etc). It would then need to decide what selling price would be necessary to achieve itsdesired market share, probably by reference to competitors’ prices. It would then need to decide upon a required profit marginon the product (this could be based upon a desired return on sales or a required return upon investment). The target costcould then be calculated by subtracting the required profit margin from the proposed selling price. Efforts could then be madeto produce the required product at the target cost. These efforts are most likely to be successful at the design stage by, forexample, reducing the number of components, using standard components,or by using different materials.

3 (a) Inflation adjustments

Year Sales £ 000

2000 175,000 x113

= 197,750–––100

2001 193,025 x113

= 211,765–––103

2002 211,225 x113

= 223,069–––107

2003 229,250 x113

= 235,502–––110

2004 247,100 x113

= 249,306–––112

11

2,800

2,600

2,400

2,200

2,000

1,800

1,600

1,400

1,200

1,000

800

600

400

200

1 2 3 4 5 6 7 8

FIXEDCOST

TOTALCOST

TOTALREVENUE

BREAK-EVEN POINT

MARGINOFSAFETY

’000 units

£’000



(b) Scatter graph of industry sales

(c) Trend Line by high-low technique

The trend in sales can be expressed in the form y = a + bxWhere y = industry sales pa in £000 (at 2005 prices)

x = the year in questiona = the interceptb = annual increments in the trend line

For ease of computation years will be denoted as follows 2000 = 02001 = 1 etc

(other approaches are acceptable, see note below)

Year Sales £000(2005 prices)

Highest year 4 249,306Lowest year 0 197,750

–– ––––––––4 51,556–– ––––––––

b =£51,556

= £12,889–––––––4

a by substitutiony = a + bx249,306 = a + 12,889 x 4249,306 = a + 51,556249,306 – 51,556 = aa = £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 uponwhich 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 valueof a, the intercept, would have been different, but the same predictions of future sales could be obtained. Full credit will begiven to other approaches.

Forecast for 2005

y = 197,750 + 12,889xy = 197,750 + 12,889 x 5y = £262,195 in 2005 prices

Industry sales expressed in 2005 prices are forecast to be £262,195,000.

12

Year

Indu

stry

Sal

es £

000 (

2005 p

rices

)300,000

250,000

200,000

150,000

100,000

50,000

0

1999 2000 2001 2002 2003 2004 2005



(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 ratios2003 2004

(i) Return on capital employed

=Profit before interest and tax

%18·0

= 17·0%16·5

= 13·4%–––––––––––––––––––––––– –––––– –––––Capital employed 105·6 123·2

(ii) Net profit margin

=Profit before interest and tax

%18·0

= 10·0%16·5

= 8·9%–––––––––––––––––––––––– –––––– –––––Sales 180·0 185·0

(iii) Asset turnover

=Sales 180·0

= 1·7 times185·0

= 1·5 times––––––––––––––– –––––– –––––Capital employed 105·6 123·2

(iv) Current ratio

=Current assets 13·6

= 1·6:111·9

= 1·3:1–––––––––––––– –––– ––––Current liabilities 8·4 9·2

(v) Capital gearing

=Long-term debt

%35·0

= 49·6%50·0

=68·3%––––––––––––– ––––– ––––Equity 70·6 73·2

Note: other sensible definitions of the above ratios are acceptable, for example capital gearing is often calculated asLong-term debt

%–––––––––––––––––––––Equity + Long-term debtThis would give figures of 33·1% and 40·6% for 2003 and 2004 respectively.

(b) Financial Performance

ProfitabilityReturn on capital employed has fallen over the two-year period. This is caused by a decrease in operating profit and anincrease in capital employed. The fall in operating profit may be caused by an increase in costs (possibly associated with thenew investments) and the increase in capital employed is clearly caused by the new investment programme. Asset turnoverhas 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 programmehas increased assets and costs (e.g. depreciation charges) but has not yet affected sales.

LiquidityThe current ratio has deteriorated. This means that the firm’s ability to meet its short-term obligations from its short-termresources has reduced. This appears to be caused by the decrease in the cash balance, which could be explained by theexpenditure on the investment programme.

Capital GearingCapital gearing has increased significantly. This appears to be due to the increase in bank loans, again, which is likely to becaused by the new investment programme. Although this is a significant increase it should not be regarded as dangerouslyhigh in a capital-intensive industry such as a railway.

13



(c) Non-financial indicators

Indicator Importance(1) % of trains on time 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




1 (a) 2 per variance max 22

(b) Sales volume variance 4Fixed overhead expenditure 1Other fixed overhead variances 2Stock valuation 2Profit computation 1

–––10

(c) 2 per point max 8–––40

2 (a) Budgeted profit 3Break-even points 3Margin of safety 3

–––9

(b) Fixed cost 1Total cost 1Sales revenue 1scaling 21 mark per useful label max 3

–––8

(c) Target Costing defined 1Use with music player 2

–––3

–––20

3 (a) 1 mark per correct adjustment max 5

(b) x-axis labelled 1y-axis labelled 1points 3

–––5

(c) ‘a’ 2‘b’ 2forecast 2

–––6

(d) 2 marks per explained point max 4–––20

4 (a) ROCE 2Net profit margin 1Asset turnover 1Current ratio 2Capital gearing 2

–––8

(b) 1 per comment and 1 per cause, max 6

(c) 1 per indicator and 1 for its importance 6–––20

15





ADVANCED LEVEL


QUESTION PAPER






Pape

r T7



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 financed by public funds. Demandfor 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 valuefor money for the taxpayer.

The finance director of the Kilkline Hospital is currently preparing budgets for the year ending 31 December 2006and 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 astandard fee from the United Kingdom government for each treatment performed; a treatment is defined as a completecourse 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 workingfull time in the department and general overheads. Variable costs relate to drugs, nursing care and patientaccommodation costs. Drugs are paid for directly by the SSD. Nursing care and accommodation services (food, bedlinen and cleaning services) are managed centrally by the hospital and charged at cost to the SSD on the basis ofnursing 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 2006Hip Knee

Replacements ReconstructionsForecast activity (number of treatments) 200 300Average length of hospital stay per treatment 18 days 15 daysNursing time per patient per day 2 hours 1·5 hours

2. Standard fee per treatment £5,000 £3,500

3. Drugs cost per treatment £480 £385

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

5. Fixed costsDoctors’ salaries for the department are forecast at £180,000 in total for 2006. General overhead costs for thesame 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 KilklineHospital? (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 ofbudgets. (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 andTWO performance indicators appropriate for a state owned hospital. (8 marks)

(iii) Give FOUR advantages of using a balanced scorecard approach. (4 marks)

(40 marks)

2 Bennett plc is a manufacturer of soft drinks. Drinks are mixed and bottled in an automated process supervised by asmall 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 brandname ‘Zoom’. The production of Zoom is more complicated than that of Bennett’s existing soft drinks, involving moreingredients, 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 costconsists entirely of direct material cost.

Bennett’s management accountant is considering how to charge overhead costs to the new product and the price atwhich 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 variableproduction cost plus a 300% mark up.

Approach 2. This would involve using a general overhead absorption rate of 400% of direct material cost. The productwould 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 willbe priced at this full cost plus a 20% margin on sales.

Activity based costing ratesOverhead item Driver rateStores administration cost £100 per ingredient used.Technician salaries £300 per mixing operation.Despatch cost £200 per customer delivery.

The 4,000 litres of Zoom used twelve different ingredients and required eight mixing operations. Ten separatedeliveries 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 threeapproaches. (8 marks)

(b) Explain why an activity based costing approach would be more useful in costing products than a traditionalabsorption costing approach, given the circumstances faced by Bennett. (6 marks)

(c) Explain two advantages and two disadvantages of cost plus pricing. (6 marks)

(20 marks)

3 [P.T.O.



3 Houchen Ltd uses a standard absorption costing system to control the manufacturing costs of its single product. Thefollowing standards have been set:

£ per unitDirect material 2 kgs at £6 per kg. 12Direct labour 1 hour at £7 per hour 7Fixed 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) Direct material price;(ii) Direct material usage;(iii) Direct labour rate;(iv) Labour idle time;(v) Direct labour efficiency;(vi) Fixed overhead expenditure;(vii) 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. (6 marks)

(20 marks)

4



4 Mabbutt plc makes four types of electrical sub-assembly: A, B, C and D. Demand and costs per unit in the comingperiod are estimated to be as follows:

Sub-assembly A B C DDemand (units) 10,000 50,000 120,000 60,000

Unit variable costs £ per unit £ per unit £ per unit £ per unitDirect labour (£4·00 per hour) 4 6 8 6Direct material 2 5 2 11Variable overhead 2 3 4 3

––– ––– ––– –––Total variable cost per unit 8 14 14 20Absorbed fixed overhead 8 12 16 12

––– ––– ––– –––Total production cost 16 26 30 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 inrecruitment, resulting in shortages of labour. Due to rapid technological change, stocks of completed sub-assembliesare never carried.

The finance director of Mabbutt plc considers the costs of the sub-assemblies to be too high and is consideringsubcontracting their manufacture. A supplier has offered to supply any quantity of A, B, C or D for £10, £16, £13and £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 andhow many should be bought in from the supplier, if Mabbutt plc expects direct labour hours in the comingperiod 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 foursub-assemblies.

Suggest four actions (other than subcontracting manufacture) the company could take to reduce the cost ofthe sub-assemblies. (8 marks)

(20 marks)


5



Answers




1 (a) The principal budget factor is the factor that limits an organisation’s performance for a given period and is usually the startingpoint in budget preparation.

In a state owned hospital, which provides free treatment to patients, it is likely to be some measure of capacity. For examplethis could be accommodation available, clinical staff time, or ultimately cash available.

(b) Income and Expenditure Account

Income and Expenditure BudgetSpecialised Surgery DepartmentYear ending 31.12.2006

Hips Knees Total£ £ £

5,000 3,500Drugs (480) (385)Nursing W1 (720) (450)Accommodation W2 (900) (750)

–––––– ––––––Contribution per treatment 2,900 1,915

Budgeted activity (number of treatments) 200 300

Total contribution W3 580,000 574,500 1,154,500Fixed CostsDoctors Salaries (180,000)General overhead (900,000)

––––––––Surplus 74,500

––––––––––––––––

Workings1. 18 days x 2 hours x £20 = £720

15 days x 1.5 hours x £20 = £4502. 18 days x £50 = £900

15 days x £50 = £7503. £2,900 x 200 = £580,000

£1,915 x 300 = £574,500

(c) Flexed Budget

Income and Expenditure BudgetSpecialised Surgery DepartmentYear ending 31.12.2006

Hips Knees Total£ £ £

Contribution per treatment 2,900 1,915Budgeted activity (number of treatments) 180 270

Total contribution 522,000 517,050 1,039,050Fixed CostsDoctors Salaries (180,000)General overhead (900,000)

––––––––Deficit (40,950)

––––––––––––––––

(d) 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’ dividedinto rows and columns. The user of the package can decide what data or information should be presented in the spreadsheetand how it should be manipulated. The advantages of using a spreadsheet package in constructing and revising budgets areas follows:

– Spreadsheets can process large amounts of data quickly. Budgeting often involves a large amount of numericalmanipulation.

– Computations are performed accurately, assuming the spreadsheet is programmed correctly and the data is inputcorrectly.

– 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



– Spreadsheets, if well constructed, facilitate ‘what if?’ analysis, that is they allow the user to test the effect of changes ininput data on budgeted results. For example the effect of a change in debtor payment days on the cash position and thebalance 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.

(e) Balanced Scorecard

(i) Explanation.A balanced scorecard approach to performance measurement seeks to measure performance under the headings offinancial 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 successBalancing income and expenditure operating surplus/deficitCost efficient operation cost per procedure

Customer satisfactionAdmission waiting time average time on waiting listProcedure success rates % of successful procedures

Number of emergency readmissionsQuality of treatment number of complaints

Process efficiencyTreatment time average length of hospital stayEmergency response time ambulance waiting time

Organisational learning and growthQuality of staff number of qualified staff employedStaff morale staff satisfaction surveys

Labour turnover/ absence rates

(only four measures were required)

2 (a) Price per litre

Variable cost plus£ per litre

Variable cost 0·20300 % mark up 0·60

–––––Selling price (£0·2 x 4) 0·80

––––––––––

Absorption cost plus£ per litre

Variable cost 0·20Overhead (400%) 0·80

–––––Production cost 1·00Margin (£1·00 x 20 ÷ 80) 0·25Selling price (£1·00 ÷ 0·8) 1·25

––––––––––

10



Activity-based costing plus£ per litre

Variable cost 0·20Stores administration (12 x £100 ÷ 4,000) 0·30Technician salaries (8 x £300 ÷ 4,000) 0·60Despatch (10 x £200 ÷ 4,000) 0·50

–––––1·60

Margin (£1·60 x 20 ÷ 80) 0·40–––––

Selling price(£1·60 ÷ 0·8) 2·00––––––––––

(b) Activity-based CostingTraditional absorption costing was developed at a time when many organisations produced only a narrow range of productsand 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 toall 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 requiringmore mixing. Activity-based costing recognises that activities cause overhead cost: the more complex the product themore likely it is to create demand for activities and hence cause overheads to be incurred. In contrast many traditionalabsorption-costing systems assume that products cause overheads in proportion to their production volumes and allocatelarge proportions of overhead to high volume products.

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

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

(c) 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 spreadmore 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 majordeterminant of prices charged.

– In companies that sell more than one product the price determined by the cost plus formula is significantly affected bythe 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 onto customers in higher prices. In a competitive market this is a dangerous attitude.

(only two advantages and two disadvantages were required)

3 (a) VariancesDirect MaterialsActual usage at actual rate £56,000

i Direct material price variance >£2,000 AActual usage at standard rate 9,000 kgs at £6·00 per kg £54,000

ii Direct material usage variance > £2,400 AStandard usage at standard rate 4,300 units x 2 kgs x £6·00 £51,600

11



Direct LabourActual hours paid at actual rate £32,800

iii Direct labour rate variance > £600 AActual hours paid at standard rate 4,600 hrs x £7·00 per hr £32,200

iv Direct labour idle time variance > £4,200 AActual hours worked at standard rate 4,000 hrs x £7·00 per hr £28,000

v Direct labour efficiency variance > £2,100 FStandard hours at standard rate 4,300 units x 1 hr x £7·00 £30,100

Fixed OverheadsActual fixed overhead £35,000

vi Fixed overhead expenditure variance > £1,000 FBudgeted fixed overhead 4,000 units x £9 per unit £36,000

vii Fixed overhead volume variance > £2,700 FStandard fixed overhead 4,300 units x £9 per unit £38,700

(b) 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 £600adverse and could be due to overtime working at premium rates, using higher grade more expensive labour or possiblyas 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, measuredat standard labour cost per hour. In this case the variance is £2,100 favourable and indicates that actual productionwas completed more quickly than standard. This could be due to a better motivated workforce, better working conditionsor more skilled labour. If the variance were due to using more highly skilled labour this would also explain the adverserate variance.

4 (a) Production plan

(i) When labour is unlimited.A B C D£ £ £ £

‘Make’ variable cost per unit 8 14 14 20‘Buy in’ cost per unit 10 16 13 25

––– ––– ––– –––Saving from making 2 2 (1) 5Decision make make buy makeProduction units 10,000 50,000 0 60,000Buy units 120,000

(ii) 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 thatoffer the biggest cost saving per scarce labour hour.

A B D£ £ £

‘Make’ variable cost per unit 8 14 20‘Buy in’ cost per unit 10 16 25

––– ––– –––Saving from making 2 2 5Labour hours per unit 1·0 hours 1·5 hours 1·5 hoursSaving per labour hour £2·00 per hour £1·33 per hour £3·33 per hourRank for making 2nd 3rd 1st

Production planMake Labour hours60,000 units of D 60,000 units x 1·5 = 90,000 hours10,000 units of A 10,000 units x 1·0 = 10,000 hours30,000 units of B 30,000 units x 1·5 = 45,000 hours

–––––––––––––145,000 hours

12



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

(b) Cost ReductionMabbutt plc could attempt to reduce the cost of the sub assemblies by one of the following actions:

– Reducing material cost by improving the efficiency of material usage, for example by reducing wastage.– Reducing material cost by attempting to negotiate lower prices with suppliers or seeking bulk buy discounts.– Value analysis could be used to find cheaper substitute materials.– Labour efficiency could be improved by changing working method (possibly by using an organisation and methods study

or a work study).– Automation involving the substitution of machinery for labour could reduce cost.– Value analysis could be used to find simpler designs leading to less production and quality control problems and hence

lower cost.– Reducing overheads by tighter budgeting and the use of activity based budgeting techniques.

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

13




1 (a) Definition 2sensible suggestion 1

–––3

(b) Contribution per unit2 for each rev and cost,max 6 if not per unit 8Total Contribution 2Profit (Fixed cost 1, Total profit 1) 2

–––12

(c) Revised total contribution 2Profit 1

–––3

(d) 2 marks per advantage, max 6

(e) (i) Balanced scorecard explained 4

(ii) 0·5 per CSF and KPI, max 8

(iii) 1 mark per advantage 4–––

16–––40

––––––

2 (a) Variable cost plusmark up 1

Absorption cost plusOverhead absorbed 2Margin 1

Acivity based cost plusStores administration 1Technician salaries 1Despatch 1Margin 1

–––8

(b) 2 marks per relevant point, max 6

(c) 1·5 marks per adv and disadv, max 6–––20

––––––

3 (a) 2 marks per variance max 14

(b) 1 mark per meaning, max 31 mark per cause, max 3

–––6

–––20

––––––

15



4 (a) (i) 1 mark per product 4

(ii) Approach 2Saving per hour 1Make and buy plan, 1 each max 5

–––12

(b) 2 marks per sensible pointmany suggestions are possible 8

–––20

––––––

16



Planning, Control

and Performance

Management


ADVANCED LEVEL

TUESDAY 6 JUNE 2006

QUESTION PAPER




This question paper must not be removed from the examination

hall





1 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 January 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

total for the year. Present your figures in £000 and work to the nearest £000). (8 marks)

(b) Tees’ management accountant believes that in addition to the above figures some other factors need 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 annum 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

Direct material Z: 2 kg at £4·00 per kg £18·00

Direct labour: 3 hours at £7·00 per hour £21·00–––––––

Standard variable cost per unit £29·00–––––––

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


£2,943 Adv

non-controllable

Actual kilograms at standard cost per kilogram price variance


Note (1) Revised standard cost per kilogram = £4·00 ×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 services 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 service 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 £’000

Passenger fares 1,200

Staff wages 600

Fuel 300

Depreciation 280

––––– 1,180–––––

Surplus 20–––––

Summarised Balance Sheet as at

31 March 2005.

£’000 £’000

Fixed assets (net) 2,000

Current assets

Stock 240

Cash 30––––270

Less creditors due within one year 60––––

Net current assets 210–––––

Total assets less liabilities 2,210–––––

Ordinary share capital (£1 shares) 2,000

Reserves 210–––––

2,210–––––

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

using the four ratios. (10 marks)

(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 (6 marks)

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

(20 marks)


6



Answers



ACCA Certified Accounting Technician Examination – Paper T7 June 2006 AnswersPlanning, Control and Performance Management

1 (a) Budgeted Profit Statement

Budgeted Profit Statement for year ending 31/12/2007 assuming Green is manufactured and sold.

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total£000 £000 £000 £000 £000

Sales revenue (w1) 1,400 1,260 1,134 1,021 4,815Variable costs (w2) (840) (756) (680) (613) (2,889)

–––––– –––––– –––––– –––––– ––––––Contribution (w3) 560 504 454 408 1,926Fixed costs (200) (200) (200) (200) (800)

–––––– –––––– –––––– –––––– ––––––Profit 360 304 254 208 1,126

–––––– –––––– –––––– –––––– ––––––

WorkingsW1Quarter 1 sales = 100,000 × £14 = £1,400,000 Quarter 2 sales = £1,400 × 90% = £1,260,000Etc

W2If contribution is 40% of sales revenue, then variable costs will be 60% of sales revenue.Quarter 1 variable cost = £1,400,000 × 60% = £840,000Quarter 2 variable cost = £1,260,000 × 60% = £756,000

W3Quarter 1 contribution £000 = £1,400,000 × 40% = £560,000Etc

Budgeted Profit Statement for year ending 31/12/2007 assuming Brace is manufactured and sold.

Quarter 1 Quarter 2 Quarter 3 Quarter 4 TotalSales units (W4) 86,000 92,000 98,000 104,000 380,000

£000 £000 £000 £000 £000Sales revenue (W5) 1,376 1,472 1,568 1,664 6,080Variable costs (W6) (860) (920) (980) (1,040) (3,800)

–––––– –––––– –––––– –––––– ––––––Contribution (W6) 516 552 588 624 2,280Fixed costs (240) (240) (240) (240) (960)

–––––– –––––– –––––– –––––– ––––––Profit 276 312 348 384 1,320

–––––– –––––– –––––– –––––– ––––––

WorkingsW4Y = 80,000 + 6,000 TQuarter 1 sales units = 80,000 + (6,000 × 1) = 86,000Quarter 2 sales units = 80,000 + (6,000 × 2) = 92,000Quarter 3 sales units = 80,000 + (6,000 × 3) = 98,000Quarter 4 sales units = 80,000 + (6,000 × 4) = 104,000

W5Quarter 1 Sales revenue = 86,000 × £16 = £1,376,000Etc

W6Variable cost per unit = Selling price – Contribution per unit = £16 – £6 = £10 per unitQuarter 1 Variable cost = 86,000 × £10 = £860,000Quarter 1 contribution = 86,000 × £6 = £516,000Etc

9



(b) Relevant Costs and revenuesReplace at Replace at Incremental1 January 1 July revenues and

2007 2007 (costs) ofeplacing

1/1/2007£ £ £

Extra profits in the year (w7) 194,000 270,000 (76,000)Sale of machinery 140,000 30,000 110,000Redundancy costs (40,000) (50,000) 10,000Wage savings (w8) 100,000 50,000 50,000

–––––––– –––––––– ––––––––Incremental Profits 394,000 300,000 94,000

–––––––– –––––––– ––––––––

ConclusionOn a relevant cost basis it is best to introduce the new product on 1 January 2007.

Explanation of figuresProfits. Replacing the Green with the Brace will result in extra profits in 2007 as revealed in the budgeted figures (part (a)).Replacing the Green later avoids low sales figures in the first quarter.Sale of Machinery. The net realiseable value of the machinery is relevant here as this is what the machinery could be soldfor. Written down value relates to unexpired historic cost, not future value.Redundancy and wage savings. Early changeover leads to lower redundancy payments and higher wage savings.

WorkingsW7 Using total profit figures for the year from (b): £1,320,000 – £1,126,000 = £194 000Using second half year profit figures from (b): £348,000 + £384,000 – £254,00 – £208,000

= £270,000W8 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 lastforever and eventually its sales will fall. The duration of the life cycle varies between products with some lasting for decadeswhilst 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 eachstage varies between products.

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 periodof 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 successfulproducts, 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 isnow strong. The market generally reaches saturation during this phase and sales growth stops. The product may be modifiedor improved as a means of sustaining demand.

10

Sales £

Introduction Growth Maturity Decline

Time



Decline. Eventually sales begin to decline and there is over-capacity amongst suppliers. Falling sales volume and reducedprices 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 highdevelopment costs are incurred prior to product launch. Credit will be given for discussion of this stage.

Importance in sales forecastingWhen forecasting sales it is important to consider the product life cycle. Rates of sales growth will vary between the differentstages of a product’s life. It is particularly important to note that growth rates enjoyed at the growth stage will not continueforever. 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 beginningof the next will occur. Some products will never get past the introductory phase (failed products), whilst others, particularlystaple food products like bread and rice appear never to reach the decline stage.

2 (a) VariancesDirect materialActual usage at actual cost 2,700 kg × £4·23 = £11,421

Price > £621 AdvActual usage at standard cost 2,700 kg × £4·00 = £10,800

Usage > £400 FavStandard usage at standard cost 1,400 units × 2kgs × £4·00 = £11,200

Direct labourActual hours at actual rate 4000 hrs × £7·50 = £30,000

Rate > £2,000 AdvActual hours at standard rate 4,000 hrs × £7·00 = £28,000

Efficiency > £1,400 FavStandard hours at standard rate 1,400 units × 3hrs × £7·00 = £29,400

Fixed overheadActual overhead = £205,000

Expenditure > £5,000 AdvBudgeted overhead = £200,000

ReconciliationStandard cost for the period £ £Variable cost (1,400 units × £29·00 per unit) 40,600Fixed cost 200,000Total standard cost –––––––– 240,600Direct material price variance 621 AdvDirect material usage variance 400 FavDirect labour rate variance 2,000 AdvDirect labour efficiency variance 1,400 FavFixed overhead expenditure variance 5,000 Adv

––––––––Total actual cost for the period 246,421

––––––––Calculation of total actual costVariable cost ((2,700 kg × £4·23) + £30,000) 41,421Fixed cost 205,000

––––––––246,421––––––––

11



(b) MemorandumTo: Production Manager, Hickman Ltd.From: A TechnicianSubject: Direct material price varianceDate: Today

The direct material price variance measures the effect of paying a different price than standard for actual materials purchasedor 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 toshop around for a good price, or failure to obtain bulk buy discounts). The analysis proposed by the management accountantattempts to split the overall price variance into controllable and non-controllable elements. This is a sensible idea as itsupports the concept of responsibility accounting, under which managers are only held accountable for items that they cancontrol.

The controllable price variance is calculated by comparing actual price with a revised standard price. The revised standardprice is the original standard price adjusted for inflation in the market price of material Z. After allowing for the effects ofinflation 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 budgetedfigure was correct.)

The non-controllable price variance is calculated by comparing the revised standard price with the original standard price. Itis the part of the total price variance caused by inflation, and is therefore considered non-controllable. In this case inflationin 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) RatiosReturn on capital employedOperating profit

× 100 =20

× 100 = 0·9%––––––––––––––– ––––––Capital employed 2,210

Return on sales (net margin)Operating profit

× 100 =20

× 100 = 1·7%––––––––––––––– ––––––Sales 1,200

Asset turnoverSales

=1,200

= 0·54 times––––––––––––––– ––––––Capital employed 2,210

Average cost per passenger mile= operating cost 1,180,000

= 27·3 p––––––––––––––– ––––––––––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 ratioReturn on capital employed. This ratio measures the profits earned on the long-term finance invested in the business. TheLewisville bus service is only generating an annual profit of 0·9p for every £1 invested. The equivalent figure for private buscompanies 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 servicegenerates 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 busservice incurs a cost of 27·3p per passenger mile as compared to 37·4 p for private bus companies.

Performance of the bus serviceOn first sight the Lewisville bus service appears to have performed poorly as compared to private sector bus companies. Ithas 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 usedthan 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 todraw a different conclusion. Private sector companies usually seek to maximise investor wealth. The council appears to betrying 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 operateuneconomic routes has led to a high asset turnover, implying above industry average usage of the bus service. In turn thisgreater usage of the service leads to a lower cost per passenger mile as fixed costs are spread more thinly over a larger numberof passenger miles.

Before drawing any firm conclusions it would be sensible to compare the performance of the Lewisville bus service with thatof 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 faresthan 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 perpassenger mile)

(c) Economy, Effectiveness and Efficiency.When measuring the performance of public sector organisations it is sometimes suggested that they should be assessed onthe 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 Lewisvillebus 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 theLewisville bus service it could be measured by the number of passengers carried, or the number 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 Lewisvillebus service it could be measured by cost per passenger mile travelled.

4 (a) BudgetsProduction budget 2007 Units

January February MarchSales 5,000 5,500 7,000Desired closing stock (w1) 550 700 700

–––––– –––––– ––––––5,550 6,200 7,700

Less opening stock (w2) (500) (550) (700)–––––– –––––– ––––––

Production units 5,050 5,650 7,000–––––– –––––– ––––––

Labour budget 2007January February March

Production units 5,050 5,650 7,000Hours per unit 4 4 4

HoursTotal hours 20,200 22,600 28,000Basic hours available (w3) 22,080 22,080 22,080Overtime hours needed 0 520 5,920

£ £ £Basic rate payment (w4) 176,640 176,640 176,640Overtime payment (w5) 0 6,240 71,040

–––––––– –––––––– ––––––––Total labour cost 176,640 182,880 247,680

–––––––– –––––––– ––––––––

13



WorkingsWorking 1 January closing stock = February sales × 10% = 5,500 units × 10% = 550 units etc

Working 2January opening stock = January sales × 10% = 5,000 units × 10% = 500 units etc.

Working 3138 workers × 160 hours per month = 22,080 hours

Working 4138 workers × £1,280 = £176,640

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

(b) Revised BudgetsLabour budget 2007

January February MarchHours

Basic hours available (w3) 22,080 22,080 22,080£

Basic rate payment (£)(w4) 176,640 176,640 176,640

Production budget 2007 UnitsJanuary February March

Opening stock 500 1,020 1,040Production 5,520 5,520 5,520Sales (5,000) (5,500) (6,560) (w6)

–––––– –––––– ––––––Closing stock 1,020 1,040 0

–––––– –––––– ––––––

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

14



ACCA Certified Accounting Technician Examination – Paper T7 June 2006 Marking SchemePlanning, Control and Performance Management

Marks1 (a) Green budget

Sales Revenue 2Contribution 2Profit 2

–––6

Brace budgetSales units forecast 2Sales revenue 2Contribution 2Profit 2

–––8

–––14–––

(b) Relevant cost analysisExtra profits 2Extra profit explained 1Sale of machine 2Sale of machine explained 2Redundancy cost 2Wage savings 2Wage savings and redundancy explained 2Advice 1

–––14–––

(c) Meaning of product life cyclePattern in sales over time 1Sales eventually fall 1

–––2

StagesIntroduction 1Low sales/high costs 1Growth 1Sales rise quickly 1Maturity 1Saturation/growth stops 1Decline 1Falling sales/losses 1

–––8

ImportanceRates of growth vary over the cycle 1Difficulty in predicting stages 1

–––2

–––12–––40–––

15



Marks2 (a) Variances

2 marks per variance , max 10ReconciliationFormat 1Total standard cost 1Total actual cost 1

–––13–––

(b) MemoMemo Format 1Controllable explained* 3Non-controllable explained* 3

–––7

–––* for full marks reference must be made to the price index adjustment. 20

–––

3 (a) RatiosOne mark per ratio 4

(b) Performance evaluationOne mark per ratio explained 4Simplistic interpretation of performance, max 6Performance related to objectives, max 3

–––Maximum 10

(c) 3 EsOne mark per E explained 3One mark per measure 3

–––6

–––20–––

4 (a) Production budgetClosing stocks 3Production units 3

–––6

Labour budgetBasic hours 1Overtime hours 2Basic payment 1Overtime payment 2

–––6

Labour budgetHours 1Payment 1

–––Production budget 2Production 2Closing stocks 3March sales 1

–––6

–––20–––

16





ADVANCED LEVEL


QUESTION PAPER






Pape

r T7




1 The Cruyff hotel provides accommodation and meals for tourists. There are two profit centres: accommodation andrestaurant. Rooms are sold at a nightly rate per room and guests have the option of dining in the hotel restaurant foran extra charge. In the last year the number of rooms sold has increased but overall hotel profit has fallen. The ownersof the hotel recently commissioned a consultant to introduce a system of budgetary control. Unfortunately theconsultant became ill part way through the project. As an Accounting Technician employed by the hotel, you havebeen asked to complete the consultant’s work.

The following extracts from the consultant’s notes are available.

Cruyff Hotel: profit statement week 48Budget Actual

Room Occupancy Level 80% 100% 95%£ £ £

Accommodation sales 26,880 33,600 32,000Restaurant sales 8,064 10,080 6,100

––––––– ––––––– –––––––Total sales 34,944 43,680 38,100Accommodation costs:

Laundry (1,344) (1,680) (1,603)Cleaning (3,016) (3,520) (3,980)Wages (3,000) (3,000) (2,950)

Restaurant costs:Food (4,032) (5,040) (4,950)Wages (2,000) (2,000) (2,050)

Common costs:Building maintenance (2,000) (2000) (1,950)Management salaries (1,500) (1,500) (1,500)

––––––– ––––––– –––––––Operating profit 18,052 24,940 19,117

––––––– ––––––– –––––––––––––– ––––––– –––––––

Notes1. 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; (3 marks)(ii) the fixed cost per week for cleaning. (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 budgetfigures 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-basedbudgeting. (8 marks)

(40 marks)

3 [P.T.O.



2 A large multinational company uses return on investment (ROI) to measure the performance of its divisions. Divisionalmanagers have control over divisional revenues, and are given limited control over costs. Cash, land and buildingsare 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 Divisionare given below.

Neeskens division profit and loss accountYear ended 30 September 2006

£000Sales 7,500Cash operating costs (3,600)Depreciation: land and buildings (40)Depreciation: plant and machinery (300)Apportioned head office cost (1,500)

–––––––Divisional profit 2,060

––––––––––––––

Neeskens division balance sheet as at 30 September 2005 (extract)

£000 £000Fixed assets (net book value)Land and buildings 2,000Plant and machinery 13,200

–––––––15,200

Current assetsStock 1,200Debtors 1,400Cash 500

–––––––3,100

Less creditors due within one yearTrade creditors (1,400)Net current assets 1,700

–––––––Net Assets 16,900

––––––––––––––Required:

(a) Calculate both the controllable and traceable return on investment (based upon opening investment) for theNeeskens division for the year ended 30 September 2006. (6 marks)

(b) Calculate traceable residual income (based upon opening investment) for Neeskens division for the yearended 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 differenceimportant? (6 marks)

(d) Give two advantages of residual income as a measure of divisional performance. (4 marks)

(20 marks)

4



3 (a) Rep plc is experiencing a decrease in sales for its only product. It has budgeted sales volume in the year ending30 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:

£ per unitSelling price 129Direct material 9Direct labour (note 1) 30Absorbed fixed overheads (Note 2) 40

––-Profit per unit 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 ending30 November 2007. (6 marks)

(b) The sales manager of Rep plc thinks that the fall in demand is due to aggressive pricing and intensive advertisingby 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 tothe existing budget.

2. Launch an advertising campaign. Spending £5 million on advertising is expected to increase 2007 salesunits 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 isconsidering 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 onbudgeted 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 inunits 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, andgive 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 reporteda large adverse direct material usage variance. An initial investigation has shown that the variance is caused by afaulty machine.

The production manager is trying to decide whether to close down the production line for one day to allow engineersto perform emergency maintenance work that could rectify the problem. Past experience of investigating raw materialusage variances suggests that there is a 70% chance of correcting the fault. If the emergency maintenance work isnot carried out now it is estimated that extra material costs of £60,000 per month for the next six months will beincurred. After this time the problem will definitely be corrected by scheduled maintenance work during the company’sannual shut down.

Two maintenance engineers would be required to carry out the emergency maintenance work. Maintenance engineersare paid £25,000 per annum and each engineer works for 250 days each year. There is currently surplus capacityin the maintenance department. The emergency maintenance would use parts costing £10,000. These parts wouldhave to be replaced again during the scheduled annual maintenance. Emergency maintenance would involve stoppingproduction 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 paintingcontractor 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. (8 marks)Graph paper is not required.

(20 marks)


6



Answers




1 (a) Room nights per week100% capacity: 120 rooms x 7 nights x 100% = 840 room nights per week95% capacity: 120 rooms x 7 nights x 95% = 798 room nights per week80% 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 night840 – 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

Accommodation Restaurant Total£ £ £

Sales (w1 and 2) 31,920 9,576 41,496Variable costsLaundry (w3) (1,596) (1,596)Cleaning variable (w4) (2,394) (2,394)Food (w5) (4,788) (4,788)

–––––––– ––––––– ––––––––Contribution 27,930 4,788 32,718Traceable fixed costsCleaning fixed (1,000) (1,000)Staff wages (3,000) (2,000) (5,000)

–––––––– ––––––– ––––––––Traceable profit £23,930 £2,788 26,718

–––––––– ––––––––––––––– –––––––Common costsBuilding maintenance (2,000)Management salaries (1,500)

––––––––Operating profit £23,218

––––––––––––––––

Workings.1. Accommodation sales = £33,600 x 95% = £31,9202. Restaurant sales = £10,080 x 95% = £9,5763. Laundry costs = variable cost = £1,680 x 95% = £1,5964. Total cost at 95% capacity (798 room nights) = (798 x £3) = £2,3945. Restaurant food costs = variable cost = £5,040 x 95% = £4,788

(d) Budget VariancesBudget Actual Variance

Room Occupancy Level 95% 95%£ £ £

Restaurant sales 9,576 6,100 3,476AdvRestaurant costs:

Food (4,788) (4,950) 162AdvWages (2,000) (2,050) 50AdvOperating profit £2,788 £(900) £3,688Adv

CommentsThe most significant variance is that for restaurant sales. It has several potential causes. The restaurant may not be attractingas many residents as assumed in the budget. Customers may be selecting lower price dishes (though this is not reflected inthe food cost variance), or the restaurant may be failing to charge the budgeted price for meals. Whatever the cause thisappears 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 salesvariances are caused by customers selecting lower price dishes, the food variance would be expected to be favourable. Thesmall adverse variance could be disguising significant price or wastage problems.

9



(e) Zero-based budgetingZero-based budgeting (ZBB), as its name suggests, involves preparing a budget from a zero-base. In this case the hotelmanagement would be told to assume that they had no budget allowance for particular activities and they would then berequired 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 performed by their departments. This would involve a detaileddescription of what the tasks involve, what they cost and how they contribute to organisational objectives. Decision packagesmight include alternative methods of performing tasks (for example, in-house provision or external suppliers) and differentlevels of service (using cleaning as an example, a base level package ensuring a minimum hygiene level or a superior levelof 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 inother 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 1Controllable profit = sales – cash operating costs – depreciation on plant and machinery

= £7,500 – £3,600 – £300 = £3,600

Working 2Controllable 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 3Traceable profit = sales – cash operating costs – depreciation on plant and machinery –depreciation on land and buildings

= £7,500 – £3,600 – £300 – £40= £3,560

Working 4Traceable investment = fixed assets + current assets – current liabilities

= £15,200 + 3,100 – £1,400 = £16,900

Traceable profit %Traceable ROI = ––––––––––––––––––

Traceable investment

(w3) £3,560= ––––––––––––– = 21%

(w4) £16,900

10



(b) Traceable residual income

Traceable profit 3,560Imputed interest chargeTraceable investment x 15%£16,900 x 15% (2,535)

––––––Traceable Residual income 1,025

––––––––––––

Residual income shows the return earned by a division, in excess of its required rate of return. The required rate of return isusually 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 incontrol of investment in land and buildings. In a similar way apportioned head office expenditure is not under the control ofdivisional managers. Cash and land and buildings are excluded from controllable investment as these items are controlled byhead office.

Traceable items are those that can be traced directly to the division. In the profit and loss account all items apart fromapportioned head office expenditure clearly relate to the division. All assets employed in the division can be traced to thatdivision.

The distinction is important. Controllable profit can be used to assess the performance of divisional managers. This followsthe principle of responsibility accounting, which states that managers should be assessed on the basis of items which theycan control.

Traceable profit can be used to assess the performance of a division. It is important to remember that it is possible to havepoor 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 hasseveral 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 notalways the case with return on investment where managers may reject projects that earn a return greater than the costof 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 longrun 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

Actual contribution (w1) 112·5 Actual fixed overhead (w2) (40·0)

–––––Profit 72·5

––––––––––

Budgeted profit year ending 30/11/2007

£ mBudgeted contribution (w3) 90·0Budgeted fixed overhead (40·0)

–––––Budgeted profit 50·0

––––––––––

Workings

W1 Contribution per unit= £129 – £9 – £30 = £90Actual sales units = 1 m units x 100 ÷ 80 = 1·25 m units

Contribution = £90 x 1·25 m units =£112·5 m

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

(b) (i) Revised budgeted profitsPrice Reduction £ mBudgeted contribution (w4) 100·23Budgeted fixed overhead (40·00)

––––––Budgeted profit 60·23

––––––––––––

Advertising campaign £ mBudgeted contribution (w5) 108·00Budgeted fixed overhead (45·00)

––––––Budgeted profit 63·00

––––––––––––

WorkingsW4 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 samplingThis involves dividing the total population into strata or categories (for example age groups) and then taking randomsamples 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 samplingThis involves splitting the population into convenient groups and then selecting a number of groups at random. Everyitem in the sample is then investigated. For example people travelling on particular buses could be taken asrepresentative 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 InvestigationExpected benefit of investigationSaved material costs £60,000 x 6 months x 70% = 252,000

Costs of the investigationEngineer’s salaries (irrelevant)Parts (10,000)Lost sales (160,000)Saved direct material cost 45,000Saved painting costs 7,000

–––––––––Net benefit £134,000

––––––––––––––––––

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

(b) Causes of usage variancesThere 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 chartsWhen deciding whether to investigate a variance it is important to distinguish between variances that are caused by normalrandom variation in cost (those that occur even though the process is ‘in control’) and those that are caused by genuineproblems (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) andstandards can be viewed as representing an average cost. Small variances (adverse or favourable) can often be accounted forby normal random variation that occurs around this average. Larger variances are less likely to be explained by normal randomvariation 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 theyoccur. As long as the actual cost percentage remains within the warning limits no action is taken. These small variations fromstandard are assumed to be due to normal random variation. If actual costs move outside the warning limits it indicates aneed 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) variationin cost. They are only really useful for costs where an average can be established and their use is usually restricted toefficiency rather than expenditure variances.

14




Marks1 (a) One mark for each level, max 3

(b) Method 2Variable cost 1Fixed cost 1

–––4

–––

(c) Contribution 8Traceable profit 6Total profit 2

–––16–––

(d) Two marks per variance, max 6Comments 3

–––9

–––

(e) ZBB explained 4Advantages, two each, max 4

–––8

–––40––––––

2 (a) Controllable profit 1Controllable investment 1Controllable ROI 1Traceable profit 1Traceable investment 1Traceable ROI 1

–––6

–––

(b) Imputed interest charge 1Residual income 1Explanation 2

–––4

–––

(c) Controllable explained 2Traceable explained 2Distinction 2

–––6

–––

(d) 2 per advantage, max 4–––20––––––

15



3 (a) Contribution per unit 2Total fixed costs 2Actual profit 1Budgeted profit 1

–––6

–––

(b) (i) New contribution per unit 2New fixed cost 1Budgeted profits 1

–––4

–––

(ii) Method 2Correct number of units 2

–––4

–––

(c) Each definition 2 4Advs 1 each max 2

–––6

–––20––––––

4 (a) Expected material cost savings 2Excluding engineer’s salary 1Parts 1Lost sales 1Saved material cost 1Opportunity cost labour 2Decision 1

–––9

–––

(b) 1 mark per cause, max 3–––

(c) DiagramAxes 2Warning limits 1Action (control) limits 1ExplanationIn control 2Out of control 2

–––8

–––20––––––

16





ADVANCED LEVEL

TUESDAY 5 JUNE 2007

QUESTION PAPER






Pape

r T7




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

Product A B CPer thousand metres

CostsDirect materials £120·00 £100·00 £60·00Direct labour £42·00 £42·00 £28·00

Machine hours 6·00 hrs 6·00 hrs 4·00 hrsLabour hours 0·1 hrs 0·1 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 in productionruns 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 comingperiod has been analysed as follows:

£Rates, rent, supervision, power and depreciation 26,000Set up costs 15,000Goods inwards 9,600Finished goods inspection 5,250Dispatch 9,750

––––––––Total £65,600

––––––––––––––––

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 thebudgeted price per thousand metres of each of the three products. (3 marks)

(b) The sales manager of Naceur has complained that its main competitor is undercutting its prices for products Aand 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) systemto cost products, and a cost plus pricing system with a mark-up of 20% on total activity based cost to calculateprices.

In an attempt to make Naceur’s costings more accurately reflect the usage of resources by products you haveascertained that the cost drivers for the overhead activities are as follows:

Cost Pool Cost driver Budgeted driveractivity for theperiod

Rates, rent supervision, power and depreciation machine hours 1,640Set up costs number of production runs 30Goods inwards costs Number of requisitions 120Finished goods inspection costs number of production runs 30Dispatch costs Number of sales orders 60

The number of requisitions raised by goods inwards was 40 for each product and the number of sales orderswas 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 costingapproach; (10 marks)

(iii) Using your total cost estimates from (b) (ii) and a MARK-UP of 20% on total cost, calculate the priceper thousand metres of each of the three products. Comment briefly on the causes of any changes inprices. (7 marks)

(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 toproduct costing than traditional approaches to overhead absorption. (4 marks)

(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 arebudgeted as follows:

X Y Z£/litre £/litre £/litre

Selling price 100 120 120Direct materials 20 16 21Direct labour (£12 per hour) 18 24 27Other direct expenses – 3 –Variable overhead 12 16 18Fixed overhead 6 8 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 150 litresY 40 litresZ 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 labourhours 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 beintroduced from the beginning of month 4. These controls relate to the production of product Z only, and willincur 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 needsat 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 Ltdfrom 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 whendeciding 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 upto 600,000 units of finished goods per month. If demand for warehouse space exceeds this amount in any givenmonth extra capacity can be purchased from a nearby factory for fixed payments of £30,000 for each capacityincrease of up to 40,000 additional units per month. Stock is picked from shelves by hourly paid labourers who arepaid £16 per hour and in this time are expected to pick 20 stock units. Picked units are loaded on to customervehicles by fork-lift trucks.

Budgeted costs per month throughout 2007, at two different capacity levels are as follows:

Warehouse space requiredCost element Behaviour of cost 200,000 units 500,000 units

£ £Warehouse rental Stepped fixed (see above) 160,000 160,000Stock picking costs Variable 160,000 400,000Fork-lift costs Semi variable 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 eachcost element were reported as:

Warehouse rental £284,000Stock picking costs £622,640Fork-lift costs £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 May2007.

(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 performancemeasure 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 onthe 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)


5



Answers




1 (a) Traditional absorption costing

(i) Budgeted total cost per thousand metres

Product A B CCost per thousand metres

£ £ £Direct materials 120 100 60Direct labour 42 42 28

–––– –––– ––––Prime cost 162 142 88Overhead cost (w1) 240 240 160

–––– –––– ––––Total cost 402 382 248

–––– –––– –––––––– –––– ––––

Working 1Budgeted total overhead £65,600Budgeted total machine hours = 1,640 machine hours.

Overhead absorption rate =£65,600

= £40 per machine hour.––––––––1,640 machine hours

Cost per thousand metresA = £40 x 6 hours = £240B = £40 x 6 hours = £240C = £40 x 4 hours = £160

(ii) Absorption costing

A B CPer thousand metres

£ £ £Total cost 402·00 382·00 248·00Margin (w2) 100·50 95·50 62·00

–––––––– –––––––– ––––––––Selling price £502·50 £477·50 £310·00

–––––––– –––––––– –––––––––––––––– –––––––– ––––––––

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

(b) (i) Cost driver rates

Cost pool £ Driver Driver activity Driver rateRates, rent, etc 26,000 Machine hours 1,640 hours £15·85 per machine hourSet up costs 15,000 Production runs 30 £500 per runGoods inwards 9,600 Requisitions 120 £80 per requisitionFinished goodsInspection 5,250 Production runs 30 £175 per runDispatch 9,750 Sales orders 60 £162·50 per order

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

(ii) Total cost per fabric

Product A B CCost per thousand metres

£ £ £Prime cost (as above) 162·00 142·00 88·00Overhead cost (w3) 221·77 227·10 203·40

––––––– ––––––– –––––––Total cost 383·77 369·10 291·40

––––––– ––––––– –––––––––––––– ––––––– –––––––

9



Working 3: A B COverhead per thousand metres

Rates rent etc£15·85 x 6 hours etc 95·10 95·10 63·40Set up

£500 x(120,000 ÷ 120)

50·00 50·00 50·00–––––––––––––––10,000

Goods inwards£80 x 40 ÷ 120 26·67 32·00 40·00Inspection

£175 x(120,000 ÷ 120)

17·50 17·50 17·50–––––––––––––––10,000

Dispatch

£162·50 x(120,000 ÷ 120) 32·50 32·50 32·50––––––––––––––– ––––––– ––––––– –––––––

5,000Total overhead cost 221·77 227·10 203·40

––––––– ––––––– –––––––––––––– ––––––– –––––––

(iii) Selling prices

Activity based costingA B C

Per thousand metres£ £ £

Total cost 383·77 369·10 291·40Mark up (w4) 76·75 73·82 58·28

––––––– ––––––– –––––––Selling price 460·52 442·92 349·68

––––––– ––––––– –––––––––––––– ––––––– –––––––

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 thechange 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 threeproducts. (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

X Y Z£/litre £/litre £/litre

Selling price 100 120 120Direct materials 20 16 21Direct labour 18 24 27Direct expenses – 3 –Variable overhead 12 16 18

––––––– ––––––– –––––––Contribution 50 61 54

––––––– ––––––– –––––––––––––– ––––––– –––––––Labour hours per unit (w1) 1·50 2·00 2·25Contribution per labour hour £33·33 £30·50 £24·00

––––––– ––––––– –––––––––––––– ––––––– –––––––

Rank 1 2 3

Production plan Chemical Litres Contribution Labour£ hours

Minimum requirements X 15·00 750·00 22·50Y 15·00 915·00 30·00Z 15·00 810·00 33·75

Further units X 135·00 6,750·00 202·50Y 25·00 1,525·00 50·00Z 16·11 869·94 36·25

–––––––––– –––––––Total contribution 11,619·94 375·00

––––––––––––––Fixed overheads (w2) 1,760·00

––––––––––Profit 9,859·94

––––––––––––––––––––

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 £ per monthMake current amount of Z31·11 litres x (£21 + £27 + £18) = 2,053·26Extra fixed costs = 1,000·00

–––––––––Total 3,053·26Import current amount of Z31·11 litres x £100 = (3,111·00)

–––––––––Net benefit of in house production £57·74

––––––––––––––––––

It is better to continue to produce product Z, rather than buy in.

Demand shortfallAs 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

ConclusionShilton Ltd should buy in 28·89 litres of chemical Z in month 4.

Tutorial noteImporting 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 willbe 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 724,000 units£

Warehouse rental (W1) 280,000Stock picking costs (W2) 579,200Fork-lift costs (W3) 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.

The variable cost per unit =Change in total cost

=(£400,000 – £160,000)

= £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

The variable cost per unit =Change in total cost

=(£1,100,000 – £500,000)

= £2·0 per unit––––––––––––––––– ––––––––––––––––––––––Change in volume (500,000 – 200,000)

The fixed element, by substitution:Total cost = fixed cost + variable costAt 200,000 units£500,000 = fixed cost + 200,000 x £2·0Fixed cost = £100,000.At 724,000 units total cost = £100,000 + (724,000 x £2·0) = £1,548,000.

(b) VariancesDirect picking labourActual hours at actual rate = £622,640

Rate > £42,640 AdvActual hours at standard rate 36,250 hrs x £16·00 = £580,000

Efficiency > £800 AdvFlexed budget cost = £579,200

Fork-lift costsActual cost = £1,528,822

Total variance > £19,178 FavFlexed budget cost = £1,548,000

(c) Cost centres, Profit centres and Investment centres

Cost CentresCost 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 bythe 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 centresA profit centre is any unit of an organisation to which costs and revenues can be traced so that the profitability of the unitmay be measured. The manager of a cost centre is held accountable for both costs and revenues. Profit centres can bedepartments, divisions, products or regions.

Their performance is usually measured by traceable profit, whilst the performance of profit centre managers is usuallymeasured by controllable profit.

A common difficulty is deciding which costs are traceable to the profit centre or controllable by the profit centre manager. Thisis particularly true when different profit centres share facilities and common costs.

Investment centresAn investment centre is a unit of the organisation to which costs and revenues can be traced but which also has some controlover investment decisions. The manager of an investment centre is held accountable for profit in relation to funds invested inthe 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 canbe 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 ScorecardThe balanced scorecard is an approach to performance measurement, developed by Kaplan and Norton in 1996. Rather thanassessing organisational performance from a purely financial point of view, it employs a variety of financial and non-financialindicators. 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 toinclude 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 includenumber 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 satisfactionand financial success. Measures might include the speed of innovation, the quality of after sales service or manufacturingtime.

Learning and growth: This looks at the organisation’s capacity to maintain its competitive position through the acquisition ofnew 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 measurementdevice. It can be used as a method of implementing and controlling the delivery of an organisation’s chosen strategy.

(ii) Total Quality ManagementTotal quality management (TQM) is the continuous improvement in quality, productivity and effectiveness obtained byestablishing management responsibility for processes as well as outputs. In this, every process has an identified owner andevery 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 correctingthem 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. Examplesinclude 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, performancetesting, etc.

Internal failure costs: These are costs arising within the organisation relating to a failure to achieve the specified level ofquality. 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 theorganisation. Examples would include costs of additional deliveries to the customer, cost of replacement items, lost goodwill,etc.

(iii) BenchmarkingBenchmarking involves the establishment, through data gathering, of targets and comparators, through whose use relativelevels of performance (and particularly areas of underperformance) can be identified. By the adoption of identified bestpractices 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 forthis is easy to obtain and conditions are often comparable. Learning may be limited as comparisons are only being madewithin the same company.

Competitive benchmarking. This involves comparing performance with that of direct competitors. The potential for learning isimproved but data may be difficult to obtain. For commercial reasons firms are often unwilling to divulge information to directcompetitors. The growth of benchmarking clubs and trade associations has reduced the problems of competitivebenchmarking

Functional benchmarking. Various functions in the business are compared with those recognised as the best externalpractitioners of the function. A manufacturing company could compare its invoice preparation time with that of a credit cardcompany, its delivery time with a firm of couriers etc. The potential for learning how to improve performance is very high, butcomparability 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 asmarket share and return on capital employed could be considered. Such comparisons are important in designing competitivestrategy.

13




1 (a) (i) Overhead absorption rate 2Total cost per unit 3

–––5

(ii) One per price 3–––

8

(b) (i) One per rate 5

(ii) 0·5 per overhead per product 7·5Total costs 3

–––Max 10

(iii) 1 per price 3ABC change 2Pricing change 2

–––7

–––22

(c) 2 marks per explained point 6

(d) 2 marks per explained point 4–––40

––––––

2 (a) Production mixUnit contributions 3Contribution per Unit of limiting factor 3Amounts of X, Y and Z 3Total contribution 1Fixed costs 2

–––12

(b) Make or buyMake cost 1Buy in cost 1Demand shortfall Decision 1Buy in units 1

–––4

(c) Other considerations2 per sensible factor, max 4

–––20

––––––

15



3 (a) Warehouse costs 2Picking costs 1Fork lift trucks 2

–––5

(b) 2 marks per variance 6

(c) Definitions 3Measures 3Problems 3

–––9

–––20

––––––

4 Balanced ScorecardConcept explained 2Per perspective explained, 2 each, max 8

–––10

TQMConcept explained 2Per cost explained, 2 each, max 8

–––10

BenchmarkingConcept explained 2Per type explained, 2 each, max 8

–––10

–––Max 20

––––––

16



Certified Accounting Technician Examination Advanced Level

Time allowedReading and planning: 15 minutesWriting: 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 untilinstructed by the supervisor.

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

Pape

r T7Planning, Control

and PerformanceManagement

Tuesday 4 December 2007




2


1 Torance uses a budgeting system to control the costs and revenues of its only product, the Danny. The managementaccountant 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.

$Selling price 250Direct material (4 kg at $8·00 per kg) (32)Direct labour (6 hours at $15·00 per hour) (90)

–——Contribution $128

—–—

2. Torance uses an additive time series analysis to forecast sales volume. The trend in sales and forecast seasonalvariations for 2008 are given below.

Quarter 1 2 3 4Trend (sales units) 1,200 1,300 1,400 1,500Seasonal variation (sales units) –150 +200 +300 –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’sforecast 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; (3 marks)

(ii) Production budget in units, showing opening inventory, production and closing inventory; (8 marks)

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

(iv) Labour budget in hours and cost. (4 marks)

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 ofeach approach:

(i) Rolling (or continuous) budgeting;(ii) Flexible budgeting;(iii) Zero-based budgeting. (15 marks)

(40 marks)



3 [P.T.O.

2 Nicholson sells mobile telephones. It supplies its customers with telephone handsets and wireless telephoneconnections. Customers pay an annual fee plus a monthly charge based on calls made. The company has recentlyemployed a consultant to install a balanced scorecard system of performance measurement and to benchmark theresults against those of Nicholson’s competitors. Unfortunately the consultant was called away before the work wasfinished. You have been asked to complete the work. The following data is available:

Nicholson – Operating data for the year ended 30 November 2007Sales revenue $480 millionSales attributable to new products $8 millionAverage capital employed $192 millionProfit before interest and tax $48 millionAverage number of customers 1,960,000Number of telephones returned for repair 10,000Number of bill queries 12,000Number of customer complaints 21,600Number of customers lost 117,600Average number of bill queries unresolved at the end of each day 118Average number of telephones unrepaired at the end of each day 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.

Required:

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

(i) financial success;(ii) customer satisfaction;(iii) process efficiency; and(iv) organisational learning and growth.

Note: state any assumptions that you make. (8 marks)

(20 marks)

Industry average statistics – Mobile TelephonesAnnual number of complaints per 1,000 customers 5Percentage of customers lost per annum 3%Average time to resolve billing queries 1·4 daysAverage wait for a telephone repair 2 daysPercentage of sales attributable to new products 20% Return on capital employed 15%Return on sales (net profit percentage) 5%Asset turnover 3 times



4

3 Kubrick uses a standard absorption costing system to control the cost of its only product. The flexed budget forproduction overhead for the company shows a budgeted total overhead cost of $200,000 per period when 5,000tonnes 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 fixedand $120,000 variable). The standard fixed overhead absorption rate is $24 per tonne.

Required:

(a) Using the high-low technique, calculate the following:

(i) the budgeted variable overhead per tonne; (2 marks)

(ii) the budgeted fixed overhead per period. (2 marks)

(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; (2 marks)

(ii) a favourable fixed overhead volume variance. (2 marks)

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

(20 marks)



4 The Overlook hotel is situated in a mountain holiday resort. The hotel has 50 rooms that are let for $120 per nightregardless 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 hotelrestaurant. The restaurant contribution to sales ratio is 40%.

Demand for rooms is very seasonal with a peak in 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 monthsof 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) 23,000Insurance 12,000Repairs and maintenance 25,400Depreciation 24,000

———–Total 84,400

———–

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

January February MarchSales revenue $115,320 $60,480 $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 bothroom 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 eachmonth in 2007. (3 marks)

(c) The general manager of the hotel believes that the hotel should be closed in February and March 2008 becauseit will make a loss.

Required:

Prepare a memorandum to the general manager stating on what basis the closure decision should be madeand describing THREE items of information (qualitative or quantitative) you would require to help decidewhether to close the hotel in February and March of 2008. (9 marks)

(20 marks)


5



Answers




1 (a) Quarterly Budgets

(i) Sales budgetQuarter 1 2 3 4

UnitsTrend (units) 1,200 1,300 1,400 1,500Seasonal variation –150 +200 +300 –350

———— ———— ———— ————Forecast sales (units) 1,050 1,500 1,700 1,150

Forecast revenue ($) 262,500 375,000 425,000 287,500———— ———— ———— ———————— ———— ———— ————

(ii) Production budgetQuarter 1 2 3 4

UnitsDesired closing inventory (w1) 750 850 575 725 (w2)Add sales 1,050 1,500 1,700 1,150Less opening inventory (w3) (525 ) (750) (850) (575)

——— ——— ——— ———Production 1,275 1,600 1,425 1,300

——— ——— ——— —————— ——— ——— ———

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

(iii) Purchasing budgetQuarter 1 2 3 4

KgDesired closing inventory (w4) 5,120 4,560 4,160 5,360 (w5)Used in production (w6) 5,100 6,400 5,700 5,200Less opening inventory (w7) (4,080) (5,120) (4,560) (4,160)

—–—— —–—— —–—— ———–Purchases (kg) 6,140 5,840 5,300 6,400

Costs ($) (w8) 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 budgetQuarter 1 2 3 4Labour (hours) (w9) 7,650 9,600 8,550 7,800

Labour ($) (w10) 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) budgetsA rolling (or continuous) budget is one which is continually updated by adding a further accounting period (a month ora quarter) when the earlier accounting period has expired. Existing budgets may also be revised at the same time toreflect 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.

9



(ii) Flexible budgetsA flexible budget is a budget, which, by recognising different cost behaviour patterns, is designed to change as volumesof 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 budgetingZero-based budgeting (ZBB), as its name suggests, involves preparing a budget from a zero-base. Budget holders aretold to assume that they had no budget allowance for particular activities and they would then be required to justify anyexpenditure 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= 25%———————————— x 100% = —––—

Capital employed $192m

Return on sales

Profit before interest and tax $48m= 10%———————————— x 100% = —––—

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———––––––––––––—–––––––––––———— = ———– = 11Average number of customers (in thousands) 1,960

Percentage of customers lost per annum

Number of customers lost 117,600———————————––— x 100% = —––—–— = 6%Average number of customers 1,960,000

Average time to resolve billing queriesAverage number of bill queries

unresolved at the end of each day 118—————————–––——––— x 365 = —––— = 3·6 days

Total bill queries 12,000Average wait for a telephone repair

Average number of telephones unrepaired at the end of each day 804

——–––––———————–––——––— x 365 = —––—– x 365 = 29·3 daysNumber 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

10



(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 isgenerating a good return on the money invested in it. This is largely explained by a return on sales of 10%, exactlydouble that of the industry average company. This could be due to higher prices, lower costs, or both. The only financialweakness apparent is that Nicholson does not enjoy as high a sales per $ of capital employed as its competitors. Overallthe 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 theindustry average company. It is often much easier to retain existing customers than to win new ones. The level ofcustomer complaints is also much higher than average. These factors will result in lost sales. They should be seen asleading 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 Nicholsonperforms badly. Telephone repair appears to take an average of nearly 30 days (as compared to a two day industryaverage). This will prove annoying to customers and will probably result in lost sales (customers cannot make callswithout telephones). Similarly delays in processing bill enquiries will eventually result in dissatisfied customers and poorfinancial 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 failingto 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 appearpoor unless improvements are made to customer service, process efficiency and innovation.

3 (a) High-low method

(i) Budgeted variable overhead per tonneUsing the high-low technique,

Change in total budgeted overheadBudgeted 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 = 264,000Variable 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 $125,000Expenditure variance > $5,000 adverse

Budgeted fixed overhead expenditure $120,000Volume variance > $36,000 favourable

Absorbed fixed overhead6,500 tonnes x $24 per tonne $156,000

11



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

(i) Adverse Expenditure VariancePotential 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 VariancePotential 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)

(d) 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 properlyoperated or material properly used. Allowances are made for normal losses, waste and machine downtime. They representwhat 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 operatingenvironment.

Operational performance standards are best based upon attainable standards. An ideal standard will normally prove to beimpossible to attain and result in large adverse variances, which will give inappropriate signals to management and possiblydamage motivation. An attainable standard is not necessarily ‘easy’, and can include a target element to encourage betterperformance, whilst at the same time resulting in variances that are useful in controlling costs and revenues.

4 (a) Profit statementJanuary February March

Rooms rented (W1) 961 504 520

$ $ $Sales:room rentals 115,320 60,480 62,400restaurant (W2) 80,724 42,336 43,680

———— ———— ————total sales 196,044 102,816 106,080

———— ———— ———————— ———— ————

Contributionroom rentals (W3) 98,022 51,408 53,040restaurant (W4) 32,290 16,934 17,472

———— ———— ————total contribution 130,312 68,342 70,512

Fixed costs (84,400) (84,400) (84,400)———— ———— ————

Profit 45,912 (16,058) (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 $84,400Break-even point = ————————–—————— = ———— = 622·4 room nights

Contribution per room night (W5) $135·60

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

12



(c) MemorandumTo General manager, Overlook hotelFrom An accounting technicianSubject: Hotel closureDate: 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 incrementalcosts 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 thesame as 2007.

– The behaviour of fixed costs during the closure period. It is unwise to assume that all fixed costs can be avoided duringthe temporary closure. Although the bulk of service costs can probably be avoided, insurance, repairs and depreciationcosts 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 variablecosts. 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 bedecommissioned, will we need to pay for security guards during the closure period, will extra cleaning be required beforereopening.

– 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 ondemand at other times of year, for example travel agents may stop recommending us if we don’t provide an all yearservice.

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



15


1 (a) Budget construction

(i) Sales units 2Sales revenue 1

–––3

(ii) Closing stock 4Opening stock 2Production 2

–––8

(iii) Closing stock 4Opening stock 2Purchases kg 2Purchase cost 2

–––10

(iv) Labour hours 2Labour cost 2

–––4

–––25

(b) Budgeting approachesMeaning 3 x 2 6Advantages 6 x 1·5 9

15–––40

––––––

2 (a) 11/2 marks per ratio/statistic 12

(b) Financial, evidence 2 conclusion 1, max 3Other, 2 marks per area, evidence 1,conclusion 1, max 6

–––Max for part b 8

–––20

––––––

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



3 (a) (i) method 1variable cost 1

–––2

(ii) Substitution approach 1Fixed overhead 1

–––2

(b) (i) actual tonnes 1absorbed overheads 1

–––2

(ii) and (iii)2 per variance 4

(c) 1 mark per cause, max 4

(d) attainable defined 2ideal defined 2discussion 2

–––20

––––––

4 (a) room nights 1·5restaurant sales 1·5rooms contribution 2restaurant contribution 2Profit 1

–––8

(b) Contribution per room night 2Break even point 1

–––3

(c) Memorandum heading 1Relevant cost basis 22 per sensible piece of

information, max 6–––

9–––

20—–—–

16









Pape



Tuesday 3 June 2008





1 Ethan uses a system of standard marginal costing to control the costs and revenues of its only product, theLundegaard. It was budgeted to manufacture and sell 300,000 units of the Lundegaard in the year ended 31 May2008. Flexed budgets for the manufacture and sale of 100,000, 300,000 and 500,000 units of the Lundegaard aregiven below, together with some explanatory notes.

Flexed Budgets for the year ended 31 May 2008.Sales and production (units) 100,000 300,000 500,000Direct material (kg) 50,000 150,000 250,000Direct labour hours 20,000 60,000 100,000Machine hours 12,500 37,500 62,500

$ $ $Sales revenue 1,500,000 4,500,000 7,500,000Direct materials 60,000 180,000 300,000Direct labour 165,000 495,000 825,000Overhead 1,425,000 2,175,000 2,925,000

–––––––––– ––––––––––– –––––––––––Profit/(loss) (150,000) 1,650,000 3,450,000

–––––––––– ––––––––––– ––––––––––––––––––––– ––––––––––– –––––––––––

Notes1. 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. Thecost 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) 250,000Direct material (kg) 125,000Direct labour hours 45,000Machine hours 30,000

$Sales revenue 4,000,000Direct materials 160,000Direct labour 420,000Variable overhead 924,000Fixed overhead 1,110,000

–––––––––––Profit 1,386,000

––––––––––––––––––––––

Required:

Calculate the following variances for the manufacture and sale of Lundegaard for the year ended 31 May2008:

(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 volumeand sales price variances and the possible interrelationships between the two variances. Use your answersfrom 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 forthe profitability of its shops. The managers have little understanding of management accounting. The conference hasbeen 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 ofwhom 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, thecompany 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 threealternative models are given below.

Model A B CSales price per unit $130 $180 $210Variable cost per unit $60 $100 $120Display space per unit 140 cm3 120 cm3 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 thecompany should sell. (4 marks)

(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. (2 marks)

(20 marks)

4



3 Showalter produces plates, which it sells in boxes, to the hotel industry. The company has sufficient work to operateat full capacity for July 2008. Thereafter, it has one further order for 80,000 boxes. After that no further orders areexpected until December when it is hoped that demand will improve. The order for 80,000 boxes represents onemonth’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 variousactivity levels are budgeted as follows:

% of full production capacity 0% 25% 100%Total direct labour cost per month $0 $250,000 $850,000

3. 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% 100%

$ $ $Indirect labour 10,000 20,000 35,000Plant and machinery depreciation 8,000 25,000 95,000

Required:

(a) For each of the two alternative production plans being considered, prepare detailed budgets showing theprime cost and total production cost for the period August to November 2008 inclusive. Use your answer torecommend 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 mightconsider before deciding upon its favoured alternative. (8 marks)

(20 marks)

5 [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 offeredto passengers, particularly with regard to flight punctuality and the courtesy of its staff. In 2008 it spent $220m onnew aeroplanes and $10m on staff training in an attempt to improve its performance. Summarised financialstatements are given below.

Summarised income statement for the year ended 31 May2007 2008$m $m

Revenue 1,800 1,850–––––– –––––––––––– ––––––

Operating profit 180 175Financing costs (32) (47)Tax expense (44) (35)

–––––– ––––––Profit for the period 104 93

–––––– –––––––––––– ––––––

Summarised statement of financial position as at 31 May2007 2008

$m $m $m $mNon-current assets (net) 1,200 1,400Current assets

Inventory 53 90Receivables 22 25Cash 64 32

–––––– ––––––1,339 1,547

–––––– –––––––––––– ––––––

Equity and reserves 585 615Long-term liabilities

8% Debenture 2009 650 650Bank loan 20 670 160 810

–––– ––––Current liabilities 84 122

–––––– ––––––Total equity and liabilities 1,339 1,547

–––––– –––––––––––– ––––––

Required:

(a) Calculate the following ratios for Brainerd for the years ending 31 May 2007 and 2008, clearly defining theratio you are calculating and showing the figures used in your calculations:

(i) Return on capital employed based upon closing capital employed;(ii) Operating margin (return on sales);(iii) Asset turnover;(iv) Current ratio; and(v) Capital gearing ratio. (10 marks)

(b) Explain the meaning of ANY THREE of the above ratios and suggest one possible cause, apparent from thequestion, of changes in performances revealed by each of your chosen ratios. (6 marks)

(c) Give TWO reasons why it would be important for Brainerd to use non-financial measures in assessing itsperformance. (4 marks)

(20 marks)


6



Answers




1 (a) High-low technique

(i) Variable overhead cost per unit

Variable cost per unit =Change in variable cost

–––––––––––––––––––––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) 15·00Direct materials (0·5 kg per unit at $1·20 per kg)) (w2) 0·60Direct labour (variable) (0·2 hours per unit at $8·25 per hour) 1·65Variable overhead (0·125 hours per unit at $30 per hour) (w3) 3·75

–––––6·00

–––––Contribution 9·00

––––––––––

Working 1 $1,500,000 ÷ 100,000 units = $15·00 per unit

Working 2 50,000 kg ÷ 100,000 units = 0·5 kg per unit$60,000 ÷ 50,000 kg = $1·20 per kg$1·20 x 0·5 kg = $0·6 per unit

Working 3 12,500 machine hours ÷ 100,000 units = 0·125 machine hours per unit$3·75 per unit ÷ 0·125 hours per unit = $30 per hour

(c) Break-even point

Contribution sales (C/S) ratio = Contribution ÷ sales= $9·00 ÷ $15·00= 0·6

Break-even point in revenue =Fixed costs–––––––––

CS ratio

=$1,050,000

= $1,750,000––––––––––0·6

Tutorial NoteThe break-even point in sales revenue could alternatively have been calculated by multiplying the break-even point in unitsby 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

9



(d) Variances

(i) Sales volumeActual sales units at standard contribution 250,000 units x $9 per unit = $2,250,000

> $450,000 ABudgeted sales units at standard contribution 300,000 units x $9 per units = $2,700,000

(ii) Sales price varianceActual sales at actual price $4,000,000

> $250,000 FavActual sales at standard price 250,000 units x $15 per unit $3,750,000

(iii) & (iv) Direct materials price and usage varianceActual usage at actual price $160,000

> $10,000 AActual usage at standard price 125,000 kg x $1·20 per kg $150,000

> 0Standard usage at standard price 250,000 units x $0·6 per unit $150,000

(v) & (vi) Direct labour rate and efficiency varianceActual hours at actual rate $420,000

> $48,750 AActual hours at standard rate 45,000 hrs x $8·25 per labour hr $371,250

> $41,250 FavStandard hours at standard rate (w4) 50,000 hrs x $8·25 per labour hour $412,500

(vii) & (viii) Variable overhead rate and efficiencyActual hours at actual rate $924,000

> $24,000 AActual hours at standard rate 30,000 x $30 per machine hr $900,000

> $37,500 FavStandard hours at standard price (w4) 31,250 machine hours x $30 per hour $937,500

(ix) Fixed overhead expenditureActual fixed overhead $1,110,000

> $60,000 ABudgeted fixed overhead $1,050,000

Working 4Standard labour hours = 250,000 units x 0·2 hours per unit = 50,000 direct labour hoursStandard machine hours = 250,000 units x 0·125 hours per unit = 31,250 machine hours

Tutorial NoteVariances are often calculated by a formula and such an approach would be equally acceptable here. For example the salesvolume 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) MemorandumTo: Sales director EthanFrom: An Accounting TechnicianSubject: Sales volume and price variancesDate: Today

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

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

Sales price varianceThe sales price variance measures the effect on profit of selling units at a price that is higher or lower than budgeted. In theyear 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 interrelationshipsSelling price generally has an effect on sales volume. Increases in prices normally lead to a decrease in volume. This couldwell be the case for Lundegaards. If the increase in price is the only cause of the decrease in volume, then the decision toincrease 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 salesvolume in the original budget.

10



2 (a) Contribution per unit of the limiting factor

Model A B C$ per unit

Sales price 130 180 210Variable cost 60 100 120

–––- –––– ––––Contribution 70 80 90

Display space per unit 140 cm3 120 cm3 160 cm3

Contribution per cm3 $0·5 $0·67 $0·56Rank 3rd 1st 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 planningand 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 aboutthe 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 gettingthe best use of these resources.

(iii) Budgets coordinate the activities of various parts of the business. They should ensure, for example, that thepurchasing 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 knowwhat 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 theircontrol.

(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 thebudget holder to spend the money.

(iv) Engage the interest and commitment of employees. Budget figures are often regarded as targets and systems thatlet employees know how badly or well they are doing against target often provide an incentive for improvedperformance.

(ii) Variable cost

A variable cost is a cost that varies in direct proportion with the volume of business activity. Examples of variable costsin 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 costsand relate to a period of time rather than activity levels. Examples of fixed costs in retailing include rent and shopmanagers’ 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 earninga profit. In retail, unit contribution will be equal to selling price less buy-in cost, less any other variable costs per unitsuch as sales commission.

(v) Limiting factors

A limiting factor is anything that limits the activity of an organisation. Examples in retail include shortages of productsto 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 toensure that we earn the biggest contribution possible, given any limiting factors that we face. Accordingly we shouldchoose to sell products that give us the most contribution per unit of the limiting factor. This will result in themaximisation of contribution and profit.

11



3 (a) Production cost budgets July–October

Alternative 1 Alternative 2(Produce in one month) (Produce in four months)

$ $Direct material (w1) 560,000 560,000Direct labour (w2) 850,000 1,000,000

–––––––––– ––––––––––Prime cost 1,410,000 1,560,000

Power (w3) 580,000 640,000Indirect labour (w4) 65,000 80,000Plant and machinery depreciation (w5) 119,000 100,000

–––––––––– ––––––––––Total production cost 2,174,000 2,380,000

–––––––––– –––––––––––––––––––– ––––––––––

Recommendation: On the basis of total cost alternative one is preferred.

WorkingsWorking 180,000 boxes x $7 per box = $560,000

Working 2Alternative 1: 1 month x $850,000 = $850,000Alternative 2: 4 months x $250,000 = $1,000,000

Working 3Cost per month at:Zero output = $40,000 + ($5 x 0 boxes) = $40,00020,000 boxes = $40,000 + ($6 x 20,000 boxes) = $160,00080,000 boxes = $60,000 + ($5 x 80,000 boxes) = $460,000Alternative 1: (1 month x $460,000) + (3 months x $40,000) = $580,000Alternative 2: 4 months x $160,000 = $640,000

Working 4Alternative 1: (1 month x $35,000) + (3 months x $10,000) = $65,000Alternative 2: 4 months x $20,000 = $80,000

Working 5Alternative 1: (1 month x $95,000) + (3 months x $8,000) = $119,000Alternative 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 productionfor 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)

12



4 (a) Ratios

2007 2008

(i) Return on capital employedOperating profit

=$180m $175m

–––––––––––––– ––––––––– –––––––––Capital employed $1,255m $1,425m

= 14·3% 12·3%

(ii) Return on salesOperating profit

=$180m $175m

––––––––––––– ––––––––– –––––––––Revenue $1,800m $1,850m

= 10% 9·5%

(iii) Asset turnoverRevenue

=$1,800 $1,850

–––––––––––––– –––––––– ––––––––Capital employed $1,255 $1,425

= 1·43 x 1·3 x

(iv) Current ratioCurrent assets $139m $147m–––––––––––––– –––––––– ––––––––Current liabilities $84m $122m

= 1·65 1·20

(v) Capital gearing ratioLong-term liabilities $670m $810m––––––––––––––––– –––––––– ––––––––Total equity $585m $615m

= 115% 132%

Tutorial NoteThe 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 employedThis 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 inthe asset turnover ratio.

Return on salesThis ratio shows operating profit as a percentage of sales revenue. For Brainerd in 2008, 9·5 cents of every $1 of sales wasoperating 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 therecent quality problems). Lower load factors due to service quality problems could also have increased the average cost perpassenger.

Asset turnoverThis 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 relativedecrease in sales volume or the increased investment in new aircraft not being matched in the short term by increased salesvolumes.

Current ratioThe current ratio measures the ability of the firm to meet its short-term financial obligations (current liabilities) from cash andassets 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 GearingThe capital gearing ratio measures the amount of long-term financing provided by debt as compared to equity. It appears quitehigh 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 financedby 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 warningsignals of problems. For this reason they are often referred to as ‘leading indicators’. Financial performance measuresare often described as ‘lagging indicators’, that is they tell the firm that something has gone wrong after it has gone

13



wrong. The use of non-financial performance measures gives a firm a chance of correcting problems before they go toofar. For example, a firm might be able to cure a quality problem revealed by a high level of customer complaints beforeit has a damaging effect on sales and profits.

– Virtually all companies face increasingly competitive market places. In the face of global competition non-financial issuessuch as product quality, customer service, delivery, reliability and innovation have become crucial elements ofcompetitive 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 deliveryof this strategy can be measured by a non-financial indicator such as customer waiting time.

(only two reasons were required)

14




1 (a) Variable cost per unit 2Fixed cost per unit 2

–––4

(b) Sales price 1Direct material per kg 0·5

per unit 0·5Direct labour per hour 0·5

per unit 0·5Variable overhead per hour 0·5

per unit 0·5Contribution 1

–––5

NB Zero for the cost card unless prepared per unit

(c) CS ratio 1BEP 2

–––3

(d) Variances2 per variance (1 for number + 1 for sign if number correct) 18

(e) Memo heading 1Volume explained 2Applied 1Price explained 2Applied 1Interrelationship explained 2Applied 1

–––10

–––40

––––––

2 (a) Approach 1Unit contributions 1 (0·5 if one product correct)Contribution per unit limiting factor 1 (0·5 if one product correct)Decision 1

–––4

(b) (i) 1 mark per benefit, max 8(ii) variable cost defined 1(iii) fixed cost defined 1(iv) contribution defined 2(v) limiting factor defined 2(vi) importance explained 2

–––16

–––20

––––––

15



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

–––12

(b) 2 marks per sensible factor1 per point, 1 per expansion 8

–––20

––––––

4 (a) 1 mark per ratio (allow other sensible definitions) 10

(b) 1 mark per explanation 31 mark per relevant cause 3

–––6

(c) 2 marks per reason, max1 per point, 1 per expansion 4

–––20

––––––

16









Pape



Tuesday 2 December 2008





1 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 gainskills attractive to potential employers also attend the courses. The maximum number of students on each of Fenster’scourses is limited by government safety regulations.

The following information is available:

Notes1. 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 courseequipment. 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. Yourstatement should clearly identify the profit attributable (traceable) to each course and the total profit for thecollege. (14 marks)

2

Fenster College: information for the year ending 31 December 2009

Building Plumbing ElectricsFull course fee per student per day (note 1) $80 $90 $100Maximum course size (number of students) (note 2) 40 30 25Percentage of students unemployed (notes 3 & 4) 20 30 40

Direct costsMaterials (per student per day) $10 $15 $20Instructors’ salaries (per class per day) (note 5) $300 $700 $500

Overhead costs per annum: $Heat, light and power (note 6) 90,000Depreciation (note 7) 100,000Selling and administration (note 8) 150,000



(b) Fenster College subsequently discovers that, due to emergency repairs to its premises, it will have to close itsbuilding classroom for the year ending 31 December 2009. A competitor college has some spare capacity in2009 and can provide facilities to accommodate Fenster’s building course. It proposes to charge Fenster an allinclusive 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 distancefrom Fenster’s premises and no unemployed students would attend the relocated course. Fenster forecasts thatthe number of employed students would be unchanged.

Required:

Using a relevant cost approach calculate the maximum price Fenster should offer the competitor college forthe 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 thebuilding 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 itsperformance. (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. Theshoes have to be manufactured to precise dimensions and to be dyed to an exact colour shade. Below is a list ofexpenses incurred in the last month:

$ NotesCustomer complaints department 3,456 $2,000 fixed costs per monthFinished goods inspection 3,588Shade matching 1,479 required for all batchesQuality control system development 5,110Operative training 1,500Rework 8,850 direct costs onlyMachine maintenance 850 routine servicingGoods inwards inspection 600Compensation payments to customers for defective goods 4,600Pre-despatch failure analysis 3,877 variable cost

The production director attended a course on total quality management (TQM) recently and was told that qualityinitiatives could save money.

Required:

(a) Define the following costs of quality

(i) Prevention costs;(ii) Appraisal costs;(iii) Internal failure costs;(iv) 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. Theproduction director has found a new type of machine that is 100% reliable and will save 70% of external andinternal failure costs. The machine would cost $60,000 more per year to hire than the existing machine. Runningcosts would remain unchanged. Additional staff costs would be $1,000 per month.

Required:

Calculate and recommend whether Kint Co should hire the new machine. (7 marks)

(20 marks)

4



3 Keaton Co operates a chain of bakery shops, with each shop baking its own bread. The management accountant ofKeaton 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$ per loaf

Sales price 2·00Ingredients (0·70)Electricity (0·10)

–––––Contribution 1·20

––––––––––

2. Fixed costs per annum $Bakery labour 20,000Shop labour 16,000Rent of bakery and shop 30,000

–––––––Total fixed costs per annum $66,000

––––––––––––––

3. Budgeted sales per annum are 70,000 loaves

Required:

(a) Calculate the following figures for the proposed new shop:

(i) the contribution to sales ratio;(ii) the break-even point in sales revenue per annum;(iii) the break-even point in loaves sold per annum;(iv) the margin of safety in loaves per annum. (8 marks)

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

Required:

Calculate the sales price and sales volume contribution variances and explain the meaning of each variance.(6 marks)

(20 marks)

5 [P.T.O.



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

1. The standard cost card for 2008 was as follows

$ per unitSelling price 30·00Direct material (3kg at $2 per kg) 6·00Direct Labour (0·5 hour at $24 per hour) 12·00Fixed overheads ($10 per direct labour hour) 5·00

–––––Profit $7·00

––––––––––

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

3. Budgeted production for the year ended 31 December 2008 was 50,000 units.

4. Standard selling price will be unchanged in 2008 and 2009.

5. Total budgeted fixed overheads are expected to increase by 4% in 2009.

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

7. Sales volumes are forecast by the following equation:

y = 10,000 + 100x

Wherex = 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. Hockney Co carries no inventory.

Required:

(a) Construct a sales budget for 2009, showing sales volume in units and sales revenue FOR EACH QUARTERof 2009. (4 marks)

(b) Assuming that total budgeted sales for 2009 are 47,400 units construct a budgeted income statement forthe year ending 31 December 2009.

Note: quarterly income statements are not required. (7 marks)

(c) Define the following terms and explain their importance to budgetary planning or control.

(i) Long-term (or strategic) planning;(ii) Principal budget factor;(iii) Responsibility accounting. (9 marks)

(20 marks)


6



Answers




1 (a) Budgeted profit statement

Building Plumbing Electrics Total$ $ $ $

Revenue (W1) 721,920 589,680 528,000LessMaterials (W2) 96,000 108,000 120,000Instructors’ salaries (W3) 72,000 168,000 120,000Heat, light and power (W4) 1,200 900 750Depreciation on equipment (W5) 20,000 30,000 20,000

–––––––– –––––––– ––––––––Attributable profit 532,720 282,780 267,250 1,082,750

–––––––– –––––––– ––––––––Non attributable overheadsHeat, light and power (W4) 87,150Administration equipment depreciation (W5) 30,000Selling and administration 150,000Apportioned head office expenditure (W6) 367,920

–––––––––College profit 447,680

––––––––––––––––––

Working 1 Course revenues per annumDays per year = 48 weeks x 5 days = 240 daysBuilding = ($80 x 40 students x 80% x 240 days) + ($80 x 70% x 40 students x 20% x 240 days) = $721,920Plumbing = ($90 x 30 students x 70% x 240 days) + ($90 x 70% x 30 students x 30% x 240 days) = $589,680Electrics = ($100 x 25 x 60% x 240 days) + ($100 x 70% x 25 students x 40% x 240 days) = $528,000

Working 2 MaterialsBuilding $10 x 40 students x 240 days = $96,000Plumbing $15 x 30 students x 240 days = $108,000Electrics $20 x 25 students x 240 days = $120,000

Working 3 Instructor salariesBuilding $300 x 240 days = $72,000Plumbing $700 x 240 days = $168,000Electrics $500 x 240 days = $120,000

Working 4 Heat, light and powerBuilding 40 students x $30 = $1,200Plumbing 30 x $30 = $900Electrics 25 students x $30 = $750

––––––––$2,850

Balance = $87,150––––––––

Total $90,000––––––––––––––––

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

–––––––––$100,000––––––––––––––––––

Working 6 Apportioned head office expenditureTotal 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 revenueit would otherwise lose, but also to incur some costs that would be saved if the building course were cancelled (materialsand 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 changebetween the alternatives available.

9



$Employed student revenue (W7) 614,400Material costs (W8) (76,800)Instructors’ salaries (W3) (72,000)

–––––––––Maximum price $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 ofcourse 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 ofquality.

External failure costs: These are costs arising when the failure to achieve the specified level of quality is detected outside theorganisation.

(b) Analysis of costs

Prevention costsQuality control devpt.Operative trainingMachine maintenanceShade matching

Appraisal costsFinished goods inspectionGoods inward inspection

Internal failure costsReworkFailure analysis

External failure costsCustomer complaintsCompensation 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.

10



(c) Machine hire decision

Extra prevention costs per monthMachine hire (5,000)Training and operating (1,000)

–––––––(6,000)

Failure costs savedRework 8,850Failure analysis 3,877Customer complaints (variable element) 1,456Compensation payment 4,600

–––––––18,783–––––––

70% of $18,783 13,148–––––––

Monthly saving 7,148––––––––––––––

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

3 (a) (i) Contribution to sales ratio

Contribution to sales ratio =contribution per loaf

=$1·20

= 0·60–––––––––––––––––– ––––––sales price per loaf $2·00

(ii) Break-even point in sales revenue

Break even point in sales revenue =Fixed costs per annum

––––––––––––––––––––Contribution sales ratio

=$66,000

= $110,000 per annum––––––––0·6

(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

11



(b) Break-even chart for proposed new shop

(c) Sales variances

Sales volume contribution varianceActual sales (loaves) x standard contribution 50,000 loaves x $1·20 = $60,000

> $24,000 AdvBudgeted sales (loaves) x standard contribution 70,000 loaves x $1·20 = $84,000

Sales price varianceActual sales (loaves) x actual price 50,000 loaves x $2·20 = $110,000

> $10,000 FavActual sales (loaves) x standard price 50,000 loaves x $2·00 = $100,000

CommentSales volume contribution varianceFailure to achieve budgeted sales in loaves has resulted in (everything else being equal) a loss in contribution and profit of$24,000.

Sales price varianceSelling 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 1 2 3 4Sales units (w1) 11,700 11,800 11,900 12,000Sales $ 351,000 354,000 357,000 360,000

Working 1Quarter 1 2009: y = 10,000 + 100 x 17 = 11,700 unitsQuarter 2 2009: y = 10,000 + 100 x 18 = 11,800 unitsQuarter 3 2009: y = 10,000 + 100 x 19 = 11,900 unitsQuarter 4 2009: y = 10,000 + 100 x 20 = 12,000 units

(b) Budgeted income statement

$Sales revenue (w2) 1,422,000Direct material (w3) 312,840Direct Labour (w4) 625,680Fixed overheads (w5) 260,000

––––––––Profit 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

12

20 40 60 80

20

40

60

80

100

110

120$000

OUTPUTUNITS (000)

FIXED COST

TOTAL COST

TOTAL REVENUE

B.E.P.



Working 3: 47,400 x $6 x121

= $312,840–––110

Working 4: 47,400 x $12 x121

= $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

(c) (i) Long term (or strategic) planning

Long term (or strategic) planning aims to develop a match between the organisation and its environment. Manydefinitions 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 commercialorganisations it is sales volume. In public sector organisations (where demand is often almost unlimited) it is usuallyavailability of resources.

It is important in budgetary planning as it is the starting point for budget preparation. Once an organisation has forecasthow much product or service it can sell, it can then decide how much to produce or provide and what resources arerequired.

(iii) Responsibility accounting

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

13




Marks1 (a) Revenue 3

Materials 1·5Instructors 1·5Variable heat, light and power 1·5Depreciation 1·5Attributable profit 1·5Fixed heat, light and power 1·0Admin depreciation 1·0Apportioned head office 1·0Net profit 0·5

––––14

(b) Approach 3Incremental revenue 2Incremental material cost 2Incremental instruction cost 2Maximum price 1

––––10

(c) 2 per area of concern, max 8

(d) 2 per justified measure, max 8 40––––

2 (a) 2 marks per cost defined 8

(b) 0·5 per correctly categorised cost 5

(c) Machine hire 1Staffing 1Rework 1Failure analysis 1Variable complaints 1Compensation 170% adjustment 1Decision/recommendation 1

––––Maximum 7 20

––––

3 (a) 4 x 2 marks 8

(b) X axis labelled 1Y axis labelled 1Fixed cost labelled 1Total cost labelled 1Sales revenue labelled 1Break-even point labelled 1

––––6

(c) 2 per variance 41 per explanation 2

––––6 20

––––

15



Marks4 (a) 1 mark per qtr 4

(b) Revenue 1Material 2Labour 2Fixed overhead 2

––––7

(c) Definitions, 2 each 6Importance, 2 each 6

––––Maximum 9 20

––––100––––––––

16



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