acca f5 revision notes

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PAPer F5 revision notes

TRADITIONAL ABSORPTION v ACTIvITY BASED COSTING

A company manufactures two products: X and Y.

Information is available as follows:

(a) Product Total production Labour time per unitX 1,000 0.5 hoursY 100 1.0 hour

Total overhead: $16,500

Calculate the overhead content of each product using traditional absorption methods.

(b) The total overhead has now been broken down into:

Materials handling 4,800Production scheduling 6,500Machine-related 5,200

Product X Product YNumber of purchase orders received (total) 8 4Number of production runs (total) 3 2Number of machine operations (per unit) 2 6

Recalculate the overhead content of each product using an activity-based costing approach.

Answer

(a) Absorption ratio

Total overheads $16,500Total labour hoursX: 1,000 x 0.5 500Y: 100 x 1.0 100

600 hoursAbsorption rate = 16,500 / 600 = $27.50 per labour hour

Overhead content in products

X: 0.5 hours x 27.50 = $13.75 per unitY: 1 hour x 27.50 = $27.50 per unit

(b)

Cost driver Total X YMaterials handling Purchase orders 4,800 3,200 1,600Production scheduling Production runs 6,500 3,900 2,600Machine operations Number of operation 5,200 4,000 1,200

16,500 11,100 5,400Number of units 1,000 100Overhead cost per unit $11.10 $54



ACTIvITY BASED COSTING

* Gives fairer valuation of cost per unit

Identifies cost driver for each overhead rather than absorb all at one arbitrary rate

* Focuses attention on cost drivers

Leads to better control of overheads

BUT:

* time - consuming to identify cost drivers

* not always possible to identify a cost driver



ThROuGhPuT ACCOuNTING

A company produces 3 products, details of which are given below:

A B CSelling price 50 60 40Materials 10 15 8Labour 10 5 6Variable overheads 18 20 4Fixed overheads 5 8 10

43 48 28Profit p.u. 7 12 12Machine hours p.u. 1 hr 2 hrs 2 hrsMaximum demand 500u 500u 500u

The machine time is limited to 1,800 hours.

Determine the optimum production plan and calculate the maximum profit(a) using key factor analysis(b) using throughput accounting

Main assumptions of throughput accounting:

* in the short term, all costs except materials are fixed

* inventory levels are kept to a minimum, ideally zero.



ThROuGhPuT ACCOuNTING (ANSwER)

(a)

A B CContribution per unit $12 $20 $22Hour per unit 1 2 2Contribution per hour $12 $10 $11

(1) (3) (2)

Production plan:A 500 units x 1 500C 500 units x 2 1,000B 150 units x 2 300 (balance)

1,800

Maximum profitA 500 units x $12 6,000B 150 units x $20 3,000C 500 units x $22 11,000

Maximum contribution 20,000Less: Fixed overheads

A 500 units x $5 2,500B 500 units x $8 4,000C 500 units x $10 5,000

11,500Maximum profit $8,500

(Note: In the absence of a figure being given for fixed overheads, it is assumed that they were absorbed into product costs before knowledge of the limited time available)

(b)

A B CThroughput per unit $40 $45 $32Hour per unit 1 2 2Return per hour $40 $22.50 $16

(1) (2) (3)

Production plan:A 500 units x 1 500B 500 units x 2 1,000C 150 units x 2 300 (balance)

1,800

Maximum profitA 500 units x 40 20,000B 500 units x 45 22,500C 150 units x 32 4,800

47,300Less: Fixed costs

A 500 units x 33 16,500B 500 units x 33 16,500C 500 units x 20 10,000

43,000Maximum profit $4,300

(Note: In the absence of a figure being given for fixed overheads, it is assumed that they were absorbed into product costs before knowledge of the limited time available)



LIFE CYCLE COSTING

Consider costs and revenues over the estimated entire life of a product.

Phases of life cycle:

* Development

* Introduction

* Growth

* Maturity

* Decline

For example, might plan to have high selling price initially (high development/introduction costs, low competition), and then to have lower prices during the maturity phase (higher volume of sales, lower costs, more competition) and plan for eventual withdrawal of product (and replacement with new product) towards end of life cycle.



TARGET COSTING

1. Determine a realistic / competitive selling price.

2. Determine the profit required (e.g. required profit margin)

3. Calculate the maximum cost p.u. in order to achieve the required profit.

4. This is the target cost

5. Compare the estimated actual cost with the target cost. If higher, look for ways of achieving the target cost.



PRICING

Full cost plus:

Take full cost (i.e. including fixed overheads) and add on a percentage

Examplevariable cost of production $5 p.u.budgeted fixed costs $60,000 p.a.budgeted production 20,000 units p.a.

mark-up of 30%

Answerfixed costs p.u. = 60,000/20,000 = $3full cost = 5 + 3 = $8 p.u.selling price = $8 + 30% x $8 = $10.40 p.u.

Ensures that company covers fixed costs, BUT how to budget the level of production?Takes no account of the effect of the selling price on demand.

Marginal cost plus:

Take marginal (variable cost) and add on a percentage

ExampleVariable cost of production $5 p.u.budgeted fixed costs $60,000 p.a.budgeted production 20,000 units p.a.

mark-up of 50%

Answermarginal cost = $5 p.u.selling price = $5 + 50% x $5 = $7.50 p.u.

Avoids the problems of absorbing fixed overheads, BUT what percentage to add in order to ensure that fixed overheads are covered?

Takes no account of the effect of the selling price on demand.



ThEORETICAL PRICING

1. At a selling price of $80 p.u., the demand will be 50,000 units p.a..

For every $5 change in the selling price, the demand will change by 2,000 units.

Derive the price/demand equation.

Answer

b = 5/2,000 = 0.0025

a = 80 + (0.0025 x 50,000) = 205

P = 205 0.0025Q

2. At a selling price of $100 p.u., the demand will be 80,000 units p.a..

For every $10 change in the selling price, the demand will change by 5,000 units.

Derive the price/demand equation.

Answer

b = 10/5,000 = 0.002

a = 100 + (0.002 x 80,000) = 260

P = 260 0.002Q

3. At a selling price of $200, the demand will be 100,000 units p.a..

The demand will change by 10,000 units for every $30 change in the selling price.

The total costs will be 60,000 + 8Q

what should be the selling price p.u. to achieve maximum profit p.a.?

Answer

b = 30/10,000 = 0.003

a = 200 + (0.003 x 100,000) = 500

P = 500 0.003Q

MR = 500 0.006Q

MC = 8

For maximum profit MR = MC

500 0.006Q = 8

Q = 82,000

When Q = 82,000, P = 500 (0.003 x 82,000)

= $254 per unit



RELEvANT COSTING

* Suitable for one-off contracts.

* Calculate the future, incremental (i.e. extra), cash flows which will result from doing the contract.

Sunk costs: costs already incurred - not relevant

Opportunity costs: lost income as a result of doing the contract - are relevant

Fixed costs: only relevant if the total changes as a result of doing the contract

Examples:

1. Contract requires 200 kg of material X.

Company has 500 kg in stock, which originally cost $6 per kg..

Material X has no other use, and if not used in the contract will be scrapped for $2 per kg..

2. Contract requires 300 kg of material Y.

Company has 600 kg in stock, which originally cost $10 per kg..

Material Y is in regular use by the company has the current purchase price is $12 per kg..

3. Contract requires 50 hours of skilled labour.

The company pays skilled labour $5 per hour, and there is currently plenty of idle time.


Labour is paid $5 per hour.

There is no spare time, and the contract would have to be done in overtime.

Overtime is paid at normal rate plus 50%.


Labour is paid $5 per hour.

Labour is currently fully occupied making another product which is generating a contribution of $8 p.u.

Each unit of the other product requires 2 hours of skilled labour.

Answers1) No other use, so scrap proceeds: 200 x $2 = $4002) In regular use, so current purchase price: 300 x $12 = $3,6003) Plenty of idle time, so no extra cost: $NIL4) No spare time, so extra cost: 80 x ($5 + 50%) = $6005) Taken from other product, so rate per hour + lost contribution per hour: 100 x (5 + 8/2) = $900



uNCERTAINTY

Sales per week

Sales (units) Probability10 0.320 0.530 0.2

Selling price: $20 p.u.Cost: $10 p.u.

Any unsold units must be sold as scrap for $1 p.u. The company can contract to purchase 10, 20 or 30 units each week.

how many units should they contract for?

AnswerProfit table(a) Demand

Contract size 10 20 30

10 100 100 10020 10 200 20030 (80) 110 300

(a) Expected values

Contract size Expected value10: 10020: (0.3 x 10) + (0.7 x 200) 14330: (0.3 x (80)) + (0.5 x 110) + (0.2 x 300) 91

Contract to buy 20 units per week

(b) Maximax

Contract size Maximum10: 10020: 20030: 300 Maximum


(c) Maximin

Contract size Maximum10: 100 Maximum20: 1030: (80)


(d) Minimax Regret

Regret table

DemandContract size 10 20 30

10 0 100 20020 90 0 10030 180 90 0

Contract size Maximum regret10 20020 100 Minimum30 180




BuDGETING (1)

Incremental budgeting

Take last years figures and adjust for growth and inflation.

Easiest and most common approach, but assumes that we continue to do things the same way. (For example, if we make our products by hand, we will budget to continue to make them by hand and ignore the fact that maybe there are now machines capable of producing them.)

Zero based budgetingIgnore what currently happens.Instead, identify different solutions available, cost them out, and budget on adopting the best solution.

For example, if our product can be made by hand or made by machine, then cost out both approaches, see which is the cheaper, and budget on that basis.

Although zero based is in principle a much better approach, it is time-consuming and requires expertise.A realistic way of using a zero based approach is to apply it to one area of the business each year, and budget the other areas using an incremental approach.

Activity based budgetingUse an activity based costing approach. Budget the costs for each activity and how each activity is being used, in an attempt to ensure that each activity is being used efficiently.



BuDGETING (2)

Top-down budgetingBudget is prepared centrally and then imposed on the managers of each department

Bottom-up budgetingEach manager produces his/her budget. It is the job of central management to make sure the budgets are challenged and that different departments budgets coordinate with each other.

Bottom-up budgeting is regarded as being more motivational for managers. However the budgets do need to be challenged well otherwise there is the danger of managers introducing slack into their budgets.



BuDGETING (3)

Fixed budget The original budget based on the originally estimated levels of sales and production.The original budget profit remains the overall target of the company.

Flexed budget The budget is adjusted (or flexed) for the actual levels of sales and production. This is usually done monthly and is used for the purpose of control (compare the actual results with the flexed budget. i.e. variance analysis)

Rolling budget(continuous budgeting)

Update the budget each month and always have a budget for the next 12 months



FORECASTING

HIGH LOW METHOD

Month Sales (units)

1 23100

2 24000

3 24100

4 24800

5 25000

6 26030

7 26000

8 27100

9 27200

10 27800

11 27800

12 27500

Month Units

High 12 27500

Low 1 23100

Difference 11 4400

Change per month: 4400 / 11 = 400

Forecast for next month: 27500 + 400 = 27900 units



LEARNING CuRvES

As cumulative output doubles, the cumulative average time (labour cost) per unit falls to a fixed percentage of the previous average time (labour cost)

Example 1

First batch takes 100 hours to produce. There is a 75% learning effect.

how long will it take to produce another 7 batches.

Answer 1

Average time per batch Total time

1 1002 754 56.258 x 42.1875 = 337.5hours

Time for another 7 = 337.5 100 = 237.5 hours

Example 2

First batch takes 60 hours to produce. There is an 80% learning effect.

how long will it take to produce the 7th batch?

Answer 2

= = blog0.8

log20.3219

Average time per batch if 7 produced: 60 x 7-0.3219 = 32.07 hoursAverage time per batch if 6 produced: 60 x 6-0.3219 = 33.70 hours

Total time for 7 batches 7 x 32.07 = 224.49Total time for 6 batches 6 x 33.70 = (202.20)Time for 7th 22.29 hours

Learning curve formula: y = axb

y = average time per batch a = time for initial batch x = number of batches b = learning factor

b =log rlog 2



OPERATING STATEMENT (ABSORPTION COSTING)

Original Budget ProfitSales Volume Variance

unitsActual salesBudgeted sales

units Standard profit p.u.

Sales Price VarianceActual sales at actual S.P.

Actual sales at standard S.P

Materials Expenditure VarianceActual purchases at actual cost

Actual purchases at standard cost

Materials Usage Variancekg

Actual usageStandard usage for actual production

kg Standard cost

Labour Rate of Pay VarianceActual hours paid at actual cost

Actual hours paid at standard cost

Labour Idle Time Variancehours

Actual hours paidActual hours worked

Standard cost

Labour Efficiency Variancehours

Actual hours workedStandard hours for actual production

Standard cost

Variable Expenditure VarianceActual hours worked at actual cost

Actual hours worked at standard cost

Variable Efficiency Variancehours


Standard cost

Fixed Overhead Expenditure VarianceActual total

Budget Total

Fixed Overhead Volume Varianceunits

Actual productionBudget production

Standard cost per unit

Actual Profit



OPERATING STATEMENT (MARGINAL COSTING)Original Budget Profit

Sales volume varianceunits

Actual salesBudget sales

units Standard contribution p.u.

Sales Price variance

Actual sales at actual S.P.

Actual sales at standard S.P

Materials Expenditure varianceActual purchases at actual cost

Actual purchases at standard cost

Materials usage variancekg

Actual usageStandard usage for actual production

kg Standard cost

Labour Rate of Pay varianceActual hours paid at actual cost

Actual hours paid at standard cost

Labour Idle Time variancehours

Actual hours paidActual hours worked

Standard cost

Labour Efficiency variancehours


Standard cost

variable Expenditure varianceActual hours worked at actual cost

Actual hours worked at standard cost

variable Efficiency variancehours


Standard cost

Fixed Overhead Expenditure varianceActual total

Budget TotalActual Profit



vARIANCE ANALYSIS

Budget sales and production of Product X are 600,000 units p.a. at a standard selling price of $100 p.u.The original standard costs of production were: Materials: 2 kg @ $20 per kg Labour: 1.5 hrs @ $2 per hr Variable overheads: 1.5 hrs @ $6 per hrFixed overheads were budgeted at $10.8M for the year.

Actual results for January were as follows:

Sales: 53,000 units @ $95 p.u.Production costs for 55,000 units produced: Materials (110,000 kg) $2,300,000 Labour (85,000 hrs) $180,000Variable Overheads $502,000Fixed Overheads $935,000

(a) Prepare an operating statement, reconciling actual profit with budget profit.

(Note: the companys policy is to use marginal costing)

Since preparation of the budget, the suppliers of the materials had announced a permanent price increase of 10%. As a result the manufacturing process was examined and ways were found of reducing material usage by 5% without affecting the quality of finished goods.

(b) using the additional information, analyse the total materials variance into Planning and Operational variances.



vARIANCE ANALYSIS (ANSwER A)

a) Note: Budget sales are 600,000 pa, and so budget sales for January are 600,000/12 = 50,000 unitsCost card

Materials (2 kg x $20) 40Labour (1.5 hours x $2) 3Variable o/h (1.5 hours x $6) 9Marginal cost $52

Standard contribution = 100 52 = $48 per unit

Budgeted profit:

50,000 units x $48 2,400,000Less: fixed overheads (900,000)

$1,500,000

Operating statement

Budgeted profit 1,500,000Sales volume variance (3,000 units x $48) 144,000 (F)Sales price variance (53,000 x $5) 265,000 (A)

1,379,000

Materials Expenditure VarianceActual cost 2,300,000Actual purchases at standard cost (11,000 kg x $20) 2,200,000

100,000 (A)

Materials Usage Variance kgActual usage 110,000Standard usage for actual production (55,000 x 2kg) 110,000 NIL

Labour rate of pay varianceActual cost 180,000Standard hours for actual production (85,000 hrs x 2) 170,000

10,000 (A)

Labour efficiency varianceActual hours 85,000Standard hours for actual production (55,000 hrs x 1.5) 82,500

2,500 hours x $2 5,000 (A)

Variable overheads expenditure varianceActual cost 502,000Actual hours at standard cost (85,500 hrs x $6) 510,000 8,000 (F)

Variable overheads efficiency varianceActual hours 85,000Standard hours for actual production (55,000 hrs x 1.5) 82,500

2,500 hours x $6 15,000 (A)

Fixed overheads expenditure variance(935,000 900,000) 35,000 (A)

$1,222,000



vARIANCE ANALYSIS (ANSwER B)

(b) Total materials variance

Actual total cost 2,300,000Standard cost for actual production (55,000 x $40) 2,200,000Sales price variance 100,000 (A)

Revised cost card for materialsMaterials (1.9 kg x $22) $41.80 pu

Planning variances

ExpenditureRevised std purchases at revised std cost 55,000 u x 1.9 kg = 104,500 kg x $22 2,299,000Revised std purchases at original std cost 104,500 kg x $20 2,090,000

$209,000 (A)

UsageRevised std usage at actual production (55,000 units x $1.9kg) 104,500Original std usage for actual production (55,000 x 2kg) 110,000

5,500 x$20 = $110,000 (F)

Operational variances

ExpenditureActual purchases at actual cost 2,300,000Actual purchases at revised std cost 110,000 kg x $22 2,420,000

$120,000 (F)

Usage kgActual usage 110,000Revised std usage for actual production (55,000 x 1.9kg) 104,500

5,500 x$22 = $121,000 (A)



vARIANCES

1. Always marginal costing in exam unless told otherwise, but check carefully.

2. Always show standard cost per unit (cost card) unless given in question. (Make sure you still get the marks even if you have misread something).

3. Examiner sometimes uses the word cost variance to mean total variance. (e.g. calculate for materials the cost, expenditure, and usage variances. Means expenditure and usage as normal + total variance. Do not calculate total separately, it is simply the total of expenditure + usage).

4. If more than one material, do NOT calculate mix & yield variances unless asked for. (or unless he says the materials are substitutable but he is unlikely to use these words).

5. Remember: for cost variances we are always comparing actual costs with standard cost for actual level of production. It is worth writing down the actual level of production if you have misread, it is then obvious what you were trying to do.

6. Planning and Operational Variances

(a) Planning (or Revision) Variances

This variance cannot be corrected (or controlled) but when it is identified that it is going to occur company may decide to change plans for the future ie. feed-forward control.

(b) Operational Variances

Normally calculated monthly. It is too late to do anything about the period under review, but can use information to attempt to correct (or control) any problems for the future. ie. feedback control.



MIX & YIELD vARIANCES

Standard cost for every 8 kg of output:

A 6 kg @ $8 48B 3 kg @ $4 12

60

Actual results:Materials input A 99,000 kg at a total cost of $800,000 B 36,000 kg at a total cost of $140,000

Actual production: 130,000 kg

AnswerExpenditure Variance

Actual purchases Actual cost Actual purchases Standard costkg $ kg $

A 99,000 800,000 99,000 x $8 792,000B 36,000 140,000 36,000 x $4 144,000

$940,000 $936,000

Expenditure Variance = $4,000 (A)

Mix varianceActual total Actual mix standard cost Actual total Actual mix standard cost

kg $ kg $A 99,000 x $8 792,000 (6/9) 90,000 x $8 720,000B 36,000 x $4 144,000 (3/9) 45,000 x $4 180,000

135,000 $936,000 135,000 $900,000

Mix Variance = $36,000 (A)

Yield varianceActual total Standard mix standard cost Standard total standard mix standard cost

kg $ kg $A 90,000 x $8 720,000 97,500 x $8 780,000B 45,000 x $4 180,000 48,750 x $4 195,000

135,000 $900,000 (130,000 x 9/8) 146,250 $975,000

Yield Variance = $75,000 (F)



COST-vOLuME-PROFIT ANALYSIS MuLTIPLE PRODuCTS

A company produces and sells three products: A, Band C.The budget information for the coming year is as follows:

A B CSales (units) 5,000 6,000 8,000Selling price (p.u.) $10 $12 $15Variable cost (p.u.) $5 $8 $6Contribution (p.u.) $5 $4 $9

The total budgeted fixed overheads for the year are $50,000

(a) Calculate the CS ratio for each product individually

(b) Calculate the average CS ratio (assuming that the budget mix of production remains unchanged)

(c) Calculate the breakeven revenue (assuming that the budget mix of production remains unchanged)

(d) Construct a Pv chart (assuming that the budget mix of production remains unchanged)

Assuming that the products are produced in order of their CS ratios, contruct a table showing the cumulative revenue and cumulative profits

(e) Calculate the breakeven sales revenue on this basis

(f) Add the information to the P/v chart already produced



ENvIRONMENTAL MANAGEMENT ACCOuNTING

Note: there can be no calculations on this in the exam, and there will be a maximum of 8 marks for it as one part of a question.

Environmental costs comprise such things as electricity, water, and the disposal of waste. In addition there is the effect on the image of the company of not being environmentally friendly, although this is much harder to quantify.

For the exam you should be able to write briefly about four techniques that may be useful:

Inflow / Outflow analysis

This approach balances the quantity of resources input with the quantity that is output (either as production or as waste).

Resources include not just raw materials, but also ones such as electricity.

Measuring these in physical quantities and in monetary terms forces the business to focus on environmental costs.

Flow cost accounting

This is really inflow / outflow analysis, but concentrates on material flows in each of three categories:

Material: the resources used in storing raw materials and in production

System: the resources used in storing finished goods and in quality control

Delivery & disposal: the resources used in delivering to the customer and in disposing of any waste.

Life-cycle costing

Ensuring that environmental costs such as the disposal of waste are included in the life-cycle costs. It may be possible to design-out these costs before the product is launched.

Environmental Activity Based Costing

Environmental costs should be allocated to their own cost centres rather than simply being included in general overheads.

As with ABC in general, this focuses more attention on these costs and potentially leads to greater efficiency and cost reduction.



LIFE-CYCLE COSTING / TARGET COSTING

William plc is planning to commence production of a new product the Kate.

It is expected that demand for Kates will last for 6 years and that they will sell 1,000 units in the first year; 3,000 units in the second year; and 6,000 units per year thereafter.

The selling price will be $15 per unit, and the company wishes to achieve a mark-up of 50% on cost.

The following costs have been estimated:

Design and development: $40,000Variable production costs: $7 per unitAdditional fixed production costs: $4,000 per yearEnd of life costs: $10,000

You are required to:

(a) calculate the target cost per unit for production of Kates

(b) calculate the actual full production cost per unit for the first year and comment as to whether or not there is a cost gap

(c) calculate the lifecycle cost per unit and comment as to whether or not there is a cost gap

Answer(a) target cost = 15/1.50 = $10 per unit

(b) First year production cost:

Variable cost 7.00Fixed costs $4,000/1,000 4.00

$11

Cost gap = 11 10 = $1 per unit

(c) Life cycle cost: Total costs: 4,000 + (28,000 x 7) + (6 x 4,000) + 10,000 = $270,000

Total production

1,000 + 3,000 + (4 x 6,000) = 28,000Life cycle cost per unit = 270,000 / 28,000 = $9.64

No cost gap



DECISION TREES

Charming plc have to make a decision as to which, if either, of two machines to buy machine A or machine B.

Machine A will cost $10,000 and will last for 10 years, generating $2,000 a year if demand for the product is high, but only $1,000 a year if demand is low. If demand is low, they will be able after 5 years to scrap the machine for $1,000 or, alternatively, to invest an additional $5,000 in which case it will generate $1,500 a year for the remaining 5 years.

Machine B will cost $15,000 and will also last for 10 years, generating $4,000 a year if demand is high, or $1,000 a year if demand is low.

Neither machine has any scrap value at the end of 10 years.

For both machines, the probability of demand being high is 0.6.

Charming intend to make the decision using expected values, based on the expected net cash receipts over the life of the machines.

which (if either) of the two machines should they buy?



PERFORMANCE INDICATORS

RETURN ON CAPITALProfit before interest & tax

100%Long term capital

(ie Equity + Long Term debt)

OPERATING PROFIT MARGINOperating Profit

100%Sales

CURRENT RATIOCurrent Assets

Current liabilities

QUICK RATIOCurrent Assets Inventory

Current liabilities

EARNINGS PER SHARE (E.P.S.)Profit after interest & tax

Number of shares

P / E ratioMarket value per share

Earnings per share



RETuRN ON INvESTMENT v RESIDuAL INCOME

Division X of Y plc is currently reporting profits of $100,000 p.a. on capital employed of $800,000A new project is being considered which will cost $100,000 and is expected to generate profits of $15,000 p.a.

The target return of Y plc is 16%

(a) Should Y plc accept or reject the project?

(b) will the manager of Division X be motivated to accept the project if his performance is measured

(i) on Return on Investment? (ii) on Residual Income?

Answer(a) Return from project = 15,000/100,000 x 100% = 15% < target return of 16%, so reject

(b) Divisional manager

(i) ROI

Current ROI 100,000/800,000 x 100% = 12.5%

ROI with project: 115,000/900,000 x 100% = 12.8%

Manager motivated to accept

(ii) Current RI:

Profit 100,000Less: notional interest 16% x 800,000 (128,000)

(28,000)

RI with project

Profit 115,000Less: notional interest 16% x 900,000 (144,000)16% x 80,000 (29,000)

Manager motivated to reject



DIvISIONAL PERFORMANCE MEASuREMENT

Type of responsibility centre:

Cost centre:Manager has authority for decisions over costs (but not revenue)

Revenue centre:Manager has authority for decisions over revenue (but not costs)

Profit centre:Manager has authority for decisions over costs and revenues (but not capital investment decisions)

Investment centre:Manager has authority for decisions over costs, revenues, and new capital investment.

Controllable factors:The manager should only be assessed over those items over which he has control.

For example, if a manager is given authority to make decisions over everything except salary increases which are dictated by central management, then it would be unfair to include salaries in his performance measurement.

If (for example) it is a profit centre, then for the purposes of measuring his performance the profit of the division should be calculated ignoring salaries.



TRANSFER PRICING

OBJECTIVES:

* Goal congruence

* Performance appraisal

* Divisional autonomy

OVERALL:

* Must maximise group profit

PRACTICAL:

* T.P. often fixed by Head Office

* Problem loss of autonomy

possibility of dysfunctional decisions

APPROACh:

Allow individual managers to negotiate the transfer price

Selling division:

Minimum T.P. = Marginal cost + opportunity cost

Receiving division:

Maximum T.P. is lower of (a) external purchase price (on intermediate market)

and(b) net marginal revenue (selling price less costs of receiving division)



TRANSFER PRICING

[S = selling division; R= receiving division]

S R1. Variable production cost 15 8

Final selling price $30

2. As (1), but intermediate market exists.

S can sell intermediate market at $18; R can buy on intermediate market at $20(a) S has unlimited production capacity and there is limited demand on the intermediate market(b) S has limited production capacity and there is unlimited demand on the intermediate market

3. S has restricted capacity to make A and BR wants product A.

A BSs Variable production cost per unit 80 120Ss Intermediate market price per unit 100 150

Answer1) Transfer price: $15 $222) i) Transfer price: $15 $20 ii) Transfer price $18 $20

3) Contributions from A B A $20 p.u. B $30 p.u. Would prefer to sell B on intermediate market

Minimum Transfer price for A =

Marginal cost + Lost contribution from B80 + 30 = $110 per unit



NON-FINANCIAL PERFORMANCE MEASuRES

Quality

Flexibility

Efficiency (Resource utilisation)

Innovation

Competitiveness



vARIANCES - DIFFERENCES BETwEEN MARGINAL AND ABSORPTION COSTING

All the variances are the same in both cases, except:

Sales Volume Variance:Take difference in units between budget and actual sales, and cost out at:

Marginal costing: Standard contribution per unit

Absorption costing: Standard profit per unit

Fixed Overheads Variances

Marginal costing: Only expenditure variance

Absorption costing: Expenditure variance and volume variance (Volume Variance can be analysed into capacity and efficiency - see separate sheet)



ORIGINAL BuDGET

Standard cost of materials:8kg at $4 per kg = $32 per unitBudget production: 20,000 units

Actual results:Production 24,000 unitsMaterials: 190,000kg for $769,500

Since preparation of the budget, the price per kg had increased to $4.10 and the usage had been revised to 7.5 kg per unit.

Calculate the planning and operational variances, and analyse each into expenditure and usage variances



ORIGINAL BuDGET (ANSwER)

Flexed original budget (for 24,000 units produced):

24,000 units x $32 = $768,000

Revised budget (for 24,000 units produced):

24,000 units x $30.75 = $738,000

Actual results (for 24,000 units produced):

$769,500

Planning$30,000 (F)

Operational$31,500 (A)

AnalysisPlanning variancesExpenditure

24,000u x 7.5 kg = 180,000 kg x $4.10 = 738,000

180,000 kg x $4 = 720,000

$18,000 (A)Usage:

kg

Revised 180,000

Flexed budget (24,000u x 8 kg 192,000

12,000 x $4 = $48,000 (F)

Operational variancesExpenditure

Actual 190,000 kg 769,500

Revised 190,000 kg x $4.10 = 779,000

$9,500 (F)Usage:

kg

Actual 190,000

Revised (24,000 x 7.5 kg) 180,000

10,000 x $4.10 = $41,000 (A)



uSAGE vARIANCES

Original budget:Standard cost of materials: 10 kg at 5 per kg = $50 per unitBudget production: 10,000 units

Actual results:Production 11,000 unitsMaterials 108,900kg at $4.75 per kg

Since preparation of the budget the price per kg has changed to $4.85 and the usage to 9.5kg per unit

Calculate the planning and operational variances, and analyse each into expenditure and usage variances



uSAGE vARIANCES (ANSwER)

Flexed original budget (for 11,000 units produced):

11,000 units x $50 = $550,000

Revised budget (for 11,000 units produced):

11,000 units x $46.075 = $506,825

Actual results (for 11,000 units produced):

108,900 kg x $4.75 = $517,275

Planning$43,175 (F)

Operational$10,450 (A)

AnalysisPlanning variancesExpenditure

11,000u x 9.5 kg = 104,500 kg x $4.85 = 506,825

104,500 kg x $5 = 522,500

$15,675 (F)Usage:

kg

Revised 104,500

Flexed budget (11,000 x 10kg) 110,000

5,500 kg x $5 = $27,500 (F)

Operational variancesExpenditure

Actual 108,900 kg x $4.75 = 517,275

Revised 108,900 kg x $4.85 = 528,165

$10,890 (F)Usage:

kgActual 108,900Revised (11,000 x 9.5 kg) 104,500

4,400 kg x $4.85 = $21,340 (A)



BuSINESS SOLuTIONS

Business Solutions is a firm of management consultants which experienced considerable business growth during the last decade. By 2000 the firms senior managers were beginning to experience difficulties in managing the business.During 2001 the firm was reorganised and a regional divisional structure was introduced with individual profit targets being set for each of the semi-autonomous profit centres. Although North division has its own customer base that is distinct from that of its sister division South, it does occasionally call upon the services of a South consultant to assist with its projects. North has to pay a cross charge to South per consulting day. The amount of the charge is determined by HQ. North is free to choose whether it employs a South consultant or subcontracts the project to an external consultant. The manager of North division believes that the quality of the external consultant and the one from South division are identical and on this basis will always employ the one who is prepared to work for the lower fee.The following information is also available: North division is very busy and it charges its clients $1,200 per consulting day North division pays its external consultant $500 per consulting day The variable cost per internal consulting day is $100

Required:

(a) Determine a possible optimal daily cross charge that should be paid by North for the services of a consultant from South in the scenarios outlined below. The charges that you select must induce both divisional managers to arrive at the same decision independently. Explain how you have determined your cross charges and state any assumptions that you think necessary.

Scenario (i)

South division has spare consulting capacity.

Scenario (ii)

South division is fully occupied earning fees of $400 per consulting day.

Scenario (iii)

South division is fully occupied earning fees of $700 per consulting day. (10 marks)

(b) Identify the possible factors that may have prompted the senior management to introduce a divisional structure in 2001 and suggest some potential problems that may arise. (10 marks)

(20 marks)



BuSINESS SOLuTIONS (ANSwER)

(a) Scenario (i)If North uses the external consultant, the daily contribution to the company is $1,200 $500 = $700. If North uses a consultant from South the daily contribution to the company is $1,200 $100 = $1,100. Therefore the cross charge rate should be set on a level where both North and South will perceive that they will benefit above $100 and below $500 say $300.

Scenario (ii)If North uses the external consultant, the total contribution for one days consultancy in both North and South divisions would be:

Income VCNorth 1,200 500South 400 100

1,600 600= $1,000If the South consultant goes to North, then the total contribution would be:

$1200 $100 = $1,100

Therefore it is best if North employs the South consultant by setting the cross charge above $400 and below $500, say $450, both parties will benefit and agree to the transaction.

Scenario (iii)If the North uses the South Consultant, the total contribution will be:

$1200 $100 = $1,100

If North employs the external consultant, the total contribution will be:

Income VCNorth 1,200 500South 700 100

1,900 600= $1,300The lost contribution of the work in South ($600) exceeds the incremental cost ($400) of the external consultant undertaking the work.

The company therefore needs to set a cross charge that discourages a consultant going North i.e. above $500 but below $700

Assumptions: the objective of the company is to maximise contribution in the short run (not long run considerations) the long term business consequences of rejecting work in the South (Scenario ii) can be ignored the divisional managers behaviour and responses determined only by short term sectional (divisional) financial performance

measurement. access to all the decision making data that the separate divisions use.

(b) Reasons for re-organisation the need to have local knowledge applied specifically to local decisions a divisional company offers the opportunity to make decentralised speedy decisions especially with a rapidly changing

environment it permits senior managers to concentrate on global strategic issues detailed operational activities are dealt with separately

by those most suitable it permits junior managers to experience broader decision making and can be used as part of their development programme local semi-autonomous decision making is likely to be a motivating factor for managers (less central control) a divisional structure may reduce the complexity and cost of the communication systems within an unitary hierarchical

structureSuggested problems the senior management may have difficulty in letting go permitting decision to be made locally senior management may become involved in resolving disputes between the divisions the divisions might eventually compete against each other to the detriment of the entire company some divisional decisions may not be in the best interests of the entire company (problems of local optimality v global

optimality) ensuring goal congruence the potential waste from the duplication of functions



hOw TO PASS ACCA EXAMS !!!!

1 Attempt every question

2 Attempt every part of every question (attempt does not mean finish even just copying a relevant formula from the formula sheet will get a mark and could make

the difference between 49 and 50)

3 Help the marker start each new question on a new sheet of paper

4 Start each part of a question on a new sheet of paper. If you can only write one line for part (a) of a question, leave the rest of the page blank you might think of something else later to add.

5 Help the marker be neat! You will get marks for the correct approach even if your calculations are wrong provided the marker can see what you have done.

6 Always write something for a written part never write nothing! Anything sensible will almost certainly get you 1 mark, which could be the difference between passing and failing. There is no negative marking, and so even if you are wrong you will not lose marks.

7 Allocate your time between questions and parts of questions. Spending an hour on one part of one question will certainly mean you will fail because you will not have enough time for other questions.

8 In a calculation question, no one figure can be worth more than 3 or 4 marks (if it is it will be a separate part of the question). If you find yourself spending too long on one figure then leave it there will be plenty more marks available in the same time.

9 Help the marker in essay parts of questions put each separate point on a new line. If you string points one after the other, there is the danger of the marker missing some of them. Do make each point into a sentence never write one-word answers.

10 Read the requirements first do not start worrying about the figures in the body of the question until you know what it is you are trying to do!

11 Remember the pass mark is 50%. Aim to get 50% on every part of every question as fast as you can by going for the easy bits first. Once you feel you have got half the marks then you can spend more time on the harder bits.

12 Allocate your time and attempt every part of every question.

13 Allocate your time and attempt every part of every question.

acca f5 revision notes

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