16013319 CIMA P2 Management Accounting Decision Management Sloved Past Papers

MANAGEMENT ACCOUNTING PILLAR PAPER P2 – MANAGEMENT ACCOUNTING – DECISION MANAGEMENT

This is a Pilot Paper and is intended to be an indicative guide for tutors and students of the style and type of questions that are likely to appear in future examinations. It does not seek to cover the full range of the syllabus learning outcomes for this subject. Management Accounting Decision Management will be a three hour paper with two compulsory sections (20 marks and 30 marks respectively) and one section with a choice of questions for 50 marks.

CONTENTS

Pilot Question Paper



Section A: Eight objective test questions

Pages 2-9

Section B: Three medium answer questions

Pages 10-11

Section C: Three scenario questions

Pages 12-16

Indicative Maths Tables and Formulae

Pages 17-18

Pilot Solutions

Pages 19-32

P2 – Decision Management

MANAGERIAL LEVEL

The Chartered Institute of Management Accountants 2004 FOR FREE CIMA, ACCA & CAT RESOURCES VISIT: http://kaka-pakistani.blogspot.com

1

SECTION A – 20 MARKS ANSWER ALL EIGHT SUB-QUESTIONS

Each of the sub-questions numbered from 1.1 to 1.8 inclusive, given below, has only ONE correct answer. REQUIRED: On the indicative ANSWER SHEET, enter either your answer in the space provided where the sub-question requires a written response, or place a circle “O” around the letter that gives the correct answer to the sub-question where a list of distractors has been provided. If you wish to change your mind about an answer to such a sub-question, block out your first answer completely and then circle another letter. You will not receive marks if more than one letter is circled. Space has been provided on the four-page answer sheet for workings. If you require further space, please use the last page of your answer book and clearly indicate which question(s) these workings refer to. You must detach the answer sheet from the question paper and attach it to the front cover of your answer book before you hand it to the invigilators at the end of the examination.

Question One 1.1

The following details relate to three services provided by JHN. Service: Fee charged to customers for each unit of service Unit service costs Direct materials Direct labour Variable overhead Fixed overhead

J $ 84

H $ 122

N $ 145

12 15 12 20

23 20 16 42

22 25 20 40

All three services use the same type of direct labour which is paid at $30 per hour. In a period when the availability of the direct labour is limited, the most and least profitable use of the direct labour are: A

Most profitable H

Least profitable J

B

H

N

C

N

J

D

N

H (2 marks)

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2

Management Accounting Decision Management INDICATIVE ANSWER SHEET FOR SECTION A

Write here your full examination number:

Centre Code Hall Code Desk Number

1.1

A

B

C

D

1.2

A

B

C

D

1.3

A

B

C

D

1.4

Project:

1.5

The value of perfect information is $:

1.6

The ranking would be:

1.7

The time taken for the fourth unit is:

1.8

The impact on profits is:

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3

Space for workings for Section A

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4

Space for workings for Section A

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5

Space for workings for Section A

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6

1.2

The following equations have been taken from the plans of DX for the year ending 31 December 2005: Contribution (in dollars) = 12 x 1 + 5 x 2 + 8 x 3 2 x 1 + 3 x 2 + 4 x 3 + s1 = 12,000 kilos 6 x 1 + 4 x 2 + 3 x 3 + s2 = 8,000 machine hours 0 100 5

x1 x2 x3

2,000 500 200

where: x1, x2, and x3 are the number of units of products produced and sold, s1 is raw material still available, and s2 is machine hours still available. If an unlimited supply of raw material s1 could be obtained at the current price, the product mix that maximises the value of DX plc’s contribution is: x1 1,333 1,233 1,166 1,241

A B C D

x2 0 0 100 100

x3 0 200 200 50 (2 marks)

1.3

An organisation is considering the costs to be incurred in respect of a special order opportunity. The order would require 1,250 kgs of material D. This is a material that is readily available and regularly used by the organisation on its normal products. There are 265 kgs of material D in stock which cost $795 last week. The current market price is $3.24 per kg. Material D is normally used to make product X. Each unit of X requires 3kgs of material D, and if material D is costed at $3 per kg, each unit of X yields a contribution of $15. The relevant cost of material D to be included in the costing of the special order is nearest to:

A

$3,990

B

$4,050

C

$10,000

D

$10,300 (2 marks)

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7

The following data relate to both questions 1.4 and 1.5. (Write your answers in the space provided in the answer sheet.) TX Ltd can choose from five mutually exclusive projects. The projects will each last for one year only and their net cash inflows will be determined by the prevailing market conditions. The forecast net cash inflows and their associated probabilities are shown below. Market Conditions Probability

Poor 0·20

Good 0·50

Excellent 0·30

Project L Project M Project N Project O Project P

$000 500 400 450 360 600

$000 470 550 400 400 500

$000 550 570 475 420 425

1.4

Based on the expected value of the net cash inflows, which project should be undertaken? (Write your answer in the space provided in the answer sheet.) (2 marks)

1.5

The value of perfect information about the state of the market is calculated as: (Write your answer in the space provided in the answer sheet.) (3 marks)

1.6

An organisation manufactures four products – J, K, L and M. The products use a series of different machines but there is a common machine, X, which causes a bottleneck. The standard selling price and standard cost per unit for each product for the forthcoming year are as follows:

Selling price Cost: Direct materials Labour Variable overheads Fixed overheads Profit Machine X – minutes per unit

J £/unit 2,000

K £/unit 1,500

L £/unit 1,500

M £/unit 1,750

410 300 250 360 680 120

200 200 200 300 600 100

300 360 300 210 330 70

400 275 175 330 570 110

Direct materials is the only unit-level manufacturing cost. Using a throughput accounting approach, the ranking of the products would be: (Write your answer in the space provided in the answer sheet) (3 marks)

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8

1.7 BG has recently developed a new product. The nature of BG's work is repetitive, and it is usual for there to be an 80% learning effect when a new product is developed. The time taken for the first unit was 22 minutes. Assuming that an 80% learning effect applies, the time to be taken for the fourth unit is: (Write your answer in the space provided in the answer sheet.) (3 marks) 1.8

XJ, a manufacturing company, has two divisions: Division A and Division B. Division A produces one type of product, Prod X, which it transfers to Division B and also sells externally. Division B has been approached by another company which has offered to supply 2,500 units of Prod X for $35 each. The following details for Division A are available: $000 Sales revenue Sales to Division B @ $40 per unit External sales @ $45 per unit Less: Variable cost @ $22 per unit Fixed costs Profit

400 270 352 100 218

If Division B decides to buy from the other company, the impact of the decision on the profits of Division A and XJ, assuming external sales of Prod X cannot be increased, will be: (Write your answer in the space provided in the answer sheet.) (3 marks) (Total for Section A = 20 marks)

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9

SECTION B – 30 MARKS ANSWER ALL THREE QUESTIONS

Question Two SW is a member of the SWAL Group of companies. SW manufactures cleaning liquid using chemicals that it buys from a number of suppliers. In the past SW has used a periodic review stock control system with maximum, minimum and re-order levels to control the purchase of the chemicals and the economic order quantity model to minimise its costs. The Managing Director of SW is considering a change by introducing a Just in Time (JIT) system.

Required: As Management Accountant, prepare a report to the Managing Director that explains how a JIT system differs from the system presently being used and the extent to which its introduction would require a review of SW's quality control procedures. (10 marks) Question Three RAD Enterprises (RAD) has signed a contract with LPC to supply accounting packages. However, there has been a fire in one of the software manufacturing departments and a machine has been seriously damaged and requires urgent replacement. The replacement machine will cost £1 million and RAD is considering whether to lease or buy the machine. A lease could be arranged under which RAD would pay £300,000 per annum for four years with each payment being made annually in advance. The lease payments would be an allowable expense for taxation purposes. Corporation tax is payable at the rate of 30% of profits in two equal instalments: one in the year that profits are earned and the other in the following year. Writing-down allowances are available at 25% each year on a reducing balance basis. It is anticipated that the machine will have a useful economic life of four years, at the end of which there will be no residual value. The after-tax cost of capital is 12%.

Required: Evaluate the lease or buy considerations for acquiring the new machine from a financial viewpoint, assuming that RAD has sufficient profits to claim all available tax reliefs. (10 marks)

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10

Question Four A hyper-market now delivers to a significant number of customers that place their orders via the internet and this requires a fleet of delivery vehicles that is under the control of local management. The cost of the fleet is now significant and management is trying to determine the optimal replacement policy for the vehicle fleet. The total purchase price of the fleet is $220,000. The running costs for each year and the scrap values of the fleet at the end of each year are:

Running costs Scrap value

Year 1 $000 110 121

Year 2 $000 132 88

Year 3 $000 154 66

Year 4 $000 165 55

Year 5 $000 176 25

The hyper-market's cost of capital is 12% per annum. Ignore tax and inflation.

Required: Prepare calculations that demonstrate when the hyper-market should replace its fleet of delivery vehicles from a financial perspective. (10 marks) (Total for Section B = 30 marks)

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11

SECTION C – 50 MARKS ANSWER TWO QUESTIONS

Question Five CH Limited (Ltd) is a swimming club. Potential exists to expand the business by providing a gymnasium as part of the facilities at the club. The directors believe that this will stimulate additional membership of the club. The expansion project would require an initial expenditure of £550,000. The project is expected to have a disposal value at the end of 5 years which is equal to 10% of the initial expenditure. The following schedule reflects a recent market research survey regarding the estimated annual sales revenue from additional memberships over the project's fiveyear life: Level of demand High Medium Low

£000 800 560 448

Probability 0·25 0·50 0·25

It is expected that the contribution to sales ratio will be 55%. Additional expenditure on fixed overheads is expected to be £90,000 per annum. CH Ltd incurs a 30% tax rate on corporate profits. Corporation tax is to be paid in two equal instalments: one in the year that profits are earned and the other in the following year. CH Ltd's after-tax nominal (money) discount rate is 15·5% per annum. A uniform inflation rate of 5% per annum will apply to all costs and revenues during the life of the project. All of the values above have been expressed in terms of current prices. You can assume that all cash flows occur at the end of each year and that the initial investment does not qualify for capital allowances.

Required: (a)

Evaluate the proposed expansion from a financial perspective. (13 marks)

(b)

Calculate and then demonstrate the sensitivity of the project to changes in the expected annual contribution. (5 marks)

You have now been advised that the capital cost of the expansion will qualify for writing down allowances at the rate of 25% per annum on a reducing balance basis. Also, at the end of the project's life, a balancing charge or allowance will arise equal to the difference between the scrap proceeds and the tax written down value.

Required: (c)

Calculate the financial impact of these allowances. (7 marks) (Total = 25 marks)

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12

Question Six You have received a request from EXE to provide a quotation for the manufacture of a specialised piece of equipment. This would be a one-off order, in excess of normal budgeted production. The following cost estimate has already been prepared: Note Direct materials: Steel Brass fittings

$

10m2 @ $5.00 per m2

1 2

50 20

Direct labour: Skilled Semi-skilled

25 hours @ $8.00 per hour 10 hours @ $5.00 per hour

3 4

200 50

Overhead

35 hours @ $10.00 per hour

5

350

Estimating time

6

Administration overhead @ 20% of production cost

7

100 770 154 924

Profit @ 25% of total cost

8

Selling price

231 1,155

Notes: 1 The steel is regularly used, and has a current stock value of $5.00 per square metre. There are currently 100 square metres in stock. The steel is readily available at a price of $5.50 per square metre. 2

The brass fittings would have to be bought specifically for this job: a supplier has quoted the price of $20 for the fittings required.

3

The skilled labour is currently employed by your company and paid at a rate of $8.00 per hour. If this job were undertaken it would be necessary either to work 25 hours’ overtime, which would be paid at time plus one half, OR in order to carry out the work in normal time, reduce production of another product that earns a contribution of $13.00 per hour.

4

The semi-skilled labour currently has sufficient paid idle time to be able to complete this work.

5

The overhead absorption rate includes power costs which are directly related to machine usage. If this job were undertaken, it is estimated that the machine time required would be ten hours. The machines incur power costs of $0.75 per hour. There are no other overhead costs that can be specifically identified with this job.

6

The cost of the estimating time is that attributed to the four hours taken by the engineers to analyse the drawings and determine the cost estimate given above.

7

It is company policy to add 20% to the production cost as an allowance for administration costs associated with the jobs accepted.

8

This is the standard profit added by your company as part of its pricing policy.

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13

Required: (a)

Prepare on a relevant cost basis, the lowest cost estimate that could be used as the basis for a quotation. Explain briefly your reasons for using EACH of the values in your estimate. (12 marks)

(b)

Now that the cost estimate has been prepared, the engineers have considered the skilled labour rate and hourly power costs that have been used. They have now realised that the following alternative values may occur and they have estimated the probabilities of each value: Skilled labour $/hour Probability 10 0.3 8 0.6 7 0.1

$/hour 0.90 0.75 0.65

Power costs Probability 0.25 0.55 0.20

The following two-way data table shows the effects of these possible changes on the lowest cost estimate (all values in $): Skilled labour rate (per hour) 10 8 7

Power costs (per hour) 0.90

0.75

0.65

+76.50 +1.50 -36.00

+75.00 0.00 -37.50

+74.00 -1.00 -38.50

Required: Demonstrate and explain how the two-way data table may be used to assist the company in making a decision concerning the contract. (13 marks) (Total = 25 marks)

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14

Question Seven (a)

TQ manufactures and retails second generation mobile (cell) phones. The following details relate to one model of phone:

Budgeted selling price Budgeted variable cost Budgeted fixed cost Period Budgeted production and sales (units) Fixed overhead volume variance

$/unit 60 25 10 1 520

2 590

3 660

$1,200 (A)

$1,900 (A)

$2,600 (A)

There was no change in the level of stock during any of periods 1 to 3. The Board of Directors had expected sales to keep on growing but, instead, they appeared to have stabilised. This has led to the adverse fixed overhead volume variances. It is now the start of period 4 and the Board of Directors is concerned at the large variances that have occurred during the first three periods of the year. The Sales and Marketing Director has confirmed that the past trend of sales is likely to continue unless changes are made to the selling price of the product. Further analysis of the market for the mobile phone suggests that demand would be zero if the selling price was raised to $100 or more.

Required: (i)

Calculate the price that TQ should have charged for the phone assuming that it wished to maximise the contribution from this product. Note: If price then marginal revenue

= =

a - bx a - 2bx (7 marks)

(ii)

Calculate the difference between the contribution that would have been earned at the optimal price and the actual contribution earned during period 3, assuming the variable costs per unit were as budgeted. (3 marks)

(b)

TQ is currently developing a third generation mobile phone. It is a “state of the art” new handheld device that acts as a mobile phone, personal assistant, digital camera (pictures and video), and music player. The Board of Directors seeks your advice as to the pricing strategy that it should adopt for such a product. The company has incurred a significant level of development costs and recognises that the technology for these products is advancing rapidly and that the life cycle for the product is relatively short.

Required: Prepare a report, addressed to the Board of Directors, that discusses the alternative pricing strategies available to TQ. (15 marks) (Total = 25 marks) (Total for Section C = 50 marks)

End of question paper. Maths Tables and Formulae follow on pages 16-17

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15

INDICATIVE MATHS TABLES AND FORMULAE

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16

Formulae: Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or

Y – Y = b(X – X ),

where: b=

and or solve

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX ∑ Y = na + b ∑ X ∑ XY = a ∑ X + b ∑ X2

Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

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17

SOLUTIONS TO PILOT PAPER SECTION A Answer to Question One 1.1 Product Selling price

J $ 84

H $ 122

N $ 145

Direct materials Direct labour Variable overhead

12 15 12

23 20 16

22 25 20

Total unit variable costs

39

59

67

Unit contribution

45

63

78

Direct labour cost

15

20

25

Contribution per $1 of direct labour cost

3.00

3.15

3.12

Ranking

3rd

1st

2nd

Therefore the answer is A 1.2 If s1 is unlimited then the products must be ranked on the basis of their contribution per machine hour: x1 x2 x3

$12/6= $ 5/4= $ 8/3=

$2.00 $1.25 $2.66

Therefore, production of x3 will be maximised subject to the minimum demand constraint for x2 with the balance of resources being used to produce x1. Therefore the answer is C 1.3 The material is in regular use by the organisation and so would be replaced if it is used on the special order. The material is readily available at a price of $3.24 per kg. Therefore the relevant cost of the material is 1,250 kgs x $3.24 = $4,050 Therefore the answer is B

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18

1.4

L M N O P

(500 x 0⋅2) + (470 x 0⋅5) + (550 x 0⋅3) (400 x 0⋅2) + (550 x 0⋅5) + (570 x 0⋅3) (450 x 0⋅2) + (400 x 0⋅5) + (475 x 0⋅3) (360 x 0⋅2) + (400 x 0⋅5) + (420 x 0⋅3) (600 x 0⋅2) + (500 x 0⋅5) + (425 x 0⋅3)

EV $000 500 526 432⋅5 398 497⋅5

Ranking 2 1 4 5 3

Therefore the answer is project M 1.5 Value of perfect information Market prediction

Project

Profit

$000 Poor P 600 Good M 550 Excellent M 570 EV of profit with perfect information

Pr.

EV

0.20 0.50 0.30

$000 120 275 171 566

Less the highest EV of profit available without perfect information Value of perfect information

526 40

1.6

Selling price Direct materials Throughput Machine X (minutes) Throughput per machine (minutes)

Ranking

J £/unit 2,000 410 1,590

K £/unit 1,500 200 1,300

L £/unit 1,500 300 1,200

M £/unit 1,750 400 1,350

120

100

70

110

£1,590 120

£1,300 100

£1,200 70

£1,350 110

£13·25

£13·00

£17·14

£12·27

2nd

3rd

1st

4th

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19

1.7 Cumulative units produced 1 unit 2 units 3 units 4 units

Average time/unit Minutes 22⋅00 17⋅60 15⋅45 14⋅08

Time for nth unit Minutes 22 13⋅2 =(17⋅6 x 2) - 22 11⋅15 = ((15⋅45 x 3) - (22 + 13⋅2)) 9⋅97 = ((14⋅08 x 4) - (22 + 13⋅2 + 11⋅15))

1.8 Division A – loss in contribution = 2,500 x ($40 - $22) = $45,000 decrease. X plc will be paying ($35 - $22) = $13 per unit extra and therefore profits will reduce by $13 x 2,500 = $32,500.

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20

SECTION B Answer to Question Two Report To:

Managing Director

Subject:

JIT System

From:

Management Accountant

Introduction Further to our brief meeting, I set out below the features of a JIT system and the effects of its introduction on our quality control procedures. Findings The present stock control system is based upon the analysis of past stock movement data to establish the likely pattern of usage in the future. The use of the three control levels for maximum, minimum and re-order levels, together with the economic order quantity model, ensures that there is a level of stock of each chemical that is held as a minimum stock. This provides SW with a safety stock. JIT is based on the principle that stock is received just as it is required by production and therefore there is no safety stock. It means that, as there is no stock held, there is a significant reduction in costs in terms of storage space and other stock-related costs such as insurance. However, to be able to achieve the goal of zero stock levels, there must be knowledge of the chemical requirements and this must be communicated to the suppliers so that they may structure their production and deliveries accordingly. Quality becomes a much more significant issue when a JIT system is being used. There are two areas to consider: the quality of the chemicals that are received, and the quality of the production facility in the use of those chemicals. The chemicals that are received must be of acceptable quality when they are received, because if they are not, there is no safety stock available. As a consequence, the cleaning material production facility will be stopped until replacement chemicals are received. This would incur large costs and would not be acceptable. There needs to be a quality control check on the incoming chemicals, but this may be considered to be too late if it is done when they arrive. An alternative is to test their quality before the supplier despatches them, and this may have to be a condition of the supplier's contract. Ideally, both SW and its suppliers will build quality into their production systems rather than rely on inspecting poor quality out of the system at a post production stage. A further issue concerns the usage of the chemicals. If there are faults within the conversion process that lead to the produced cleaning material being unsatisfactory, or if there is a spillage or other loss of the chemicals in processing, there is no safety stock of chemicals that can be used. Thus, it is important to encourage an atmosphere of quality throughout the production process from handling of the chemicals, through their processing and eventual packaging for distribution to customers. There may need to be quality control checks at various stages of the production process too, but since a JIT system copes very badly with rectification of problems, the emphasis will be very much on minimising the need for such checks.

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21

Conclusion While there are potential cost savings through the use of a JIT system there are many issues that need to be considered. I should be pleased to discuss this with you further if you wish. Signed: Management Accountant

Answer to Question Three RAD Enterprises: Lease or buy considerations Purchase Ye ar 0 1 2 3 4 5

Outlay £ (1,000,000)

Tax cash flow £

(250,000) (187,500) (140,625) (421,875)

Lease Year 0 1 2 3

Capital allowances £

Payments £ (300,000) (300,000) (300,000) (300,000)

4

Tax cash flow £ 45,000 90,000 90,000 90,000 45,000

37,500 65,625 49,219 84,375 63,281

Net cash flow £ (1,000,000) 37,500 65,625 49,219 84,375 63,281

Net cash flow £ (255,000) (210,000) (210,000) (210,000)

DF £ 1⋅000 0⋅893 0⋅797 0⋅712 0⋅636 0⋅567

DF 1⋅000 0⋅893 0⋅797 0⋅712 0⋅636

45,000

PV £ 1,000,000 33,488 52,303 35,044 53,663 35,880 (789,622) PV £ (255,000) (187,530) (167,370) (149,520) 28,620 (730,800)

Therefore, leasing is the least cost option with savings of £58,822.

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22

Answer to Question Four Replacement at the end of the first year: ($220,000 x 1·00) + (($110,000 - $121,000) x 0·893) = $210,177

$210,177 Annualised equivalent cost = 0 ⋅ 893 = $235,361 Replacement at the end of the second year: ($220,000 x 1·00) + ($110,000 x 0·893) + (($132,000 - $88,000) x 0·797) = $353,298

$353,298 Annualised equivalent cost = 1 ⋅ 69 = $209,052 Replacement at the end of the third year: ($220,000 x 1·00) + ($110,000 x 0·893) + ($132,000 x 0·797) + (($154,000 - $66,000) x 0·712) = $486,090

$486,090 Annualised equivalent cost = 2 ⋅ 402 = $202,369 Replacement at the end of the fourth year: ($220,000 x 1·00) + ($110,000 x 0·893) + ($132,000 x 0·797) + ($154,000 x 0·712) + (($165,000 - $55,000) x 0·636)) = $603,042

$603,042 Annualised equivalent cost = 3 ⋅ 037 = $198,565 Replacement at the end of the fifth year: ($220,000 x 1·00) + ($110,000 x 0·893) + ($132,000 x 0·797) + ($154,000 x 0·712) + ($165,000 x 0·636) + (($176,000 - $25,000) x 0·567)) = $723,639

$723,639 Annualised equivalent cost = 3 ⋅ 605 = $200,732 The fleet should be replaced at the end of four years.

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23

SECTION C

Answer to Question Five

Requirement (a) Net Present Value Cost of capital : 10% (W1) Year 0 1 2 3 4 5 6

Total cash flow £ (550,000) 200,260 164,920 164,920 164,920 219,920 (35,340)

DF

PV £ (550,000) 182,036 136,224 123,855 112,640 136,570 (19,932) 121,393

1·000 0·909 0·826 0·751 0·683 0·621 0·564 NPV

The above NPV of £121,393, while an expedient calculation, does not allow for the inflation effect of the benefit of the lag in the payment of taxation. When this is incorporated the NPV will be slightly larger, which is even more in favour of the decision (see alternative below). Alternative Approach – the money method If candidates use the nominal discount rate, and adjust all values for inflation, this reveals a slightly different NPV result because of the time lag of taxation. Net Present Value Cost of capital :15.5% Year 0 1 2 3 4 5 6 NPV

Total cash flow £ (550,000) 210,273 183,680 192,864 202,507 282,827 (45,104)

DF

PV £ (550,000) 182,096 137,760 125,169 113,809 137,737 (18,989) 127,582

1.000 0.866 0.750 0.649 0.562 0.487 0.421

Workings for the money method Project cash Flows Contribution less fixed overhead Scrap value Total tax payable on corporate profit Net cash flow

Yr 1 £

Yr 2 £

Yr 3 £

Yr 4 £

Yr 5 £

247,380

259,749

272,736

286,373

300,692 70,195

Yr 6 £

(37,107) (76,069) (79,872) (83,866) (88,060) (45,104) 210,273 183,680 192,864 202,507 282,827 (45,104)

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24

Recommendation: The project should be undertaken as it generates a positive net present value. Workings for the real method

1.

Real discount rate

2.

Total cash flows

(1 + 0 ⋅ 155 ) −1 (1 + 0 ⋅ 05 ) = 0.10 or 10%

Expected value of annual sales Demand x £ High 800,000 Medium 560,000 Low 448,000 Expected value

P 0·25 0·50 0·25

Expected value of annual sales CS ratio Contribution Less fixed overheads Corporate profit Tax @ 30% Project cash flows Profit Scrap value Total tax payable on corporate profit Net cash flow

Px £ 200,000 280,000 112,000 592,000

£592,000 55% £325,600 £90,000 £235,600 £70,680

Year 1 £ 235,600

Year 2 £ 235,600

Year 3 £ 235,600

Year 4 £ 235,600

Year 5 £ 235,600 55,000

Year 6 £

(35,340) 200,260

(70,680) 164,920

(70,680) 164,920

(70,680) 164,920

(70,680) 219,920

(35,340) (35,340)

Requirement (b) Sensitivity of the project to changes in the expected annual contribution The net (after tax) present value of the contribution Cost of capital : 10% Year 1 2 3 4 5 6

Contribution £ 325,600 325,600 325,600 325,600 325,600

Tax payment £ (48,840) (97,680) (97,680) (97,680) (97,680) (48,840) NPV

Cash flow £ 276,760 227,920 227,920 227,920 227,920 (48,840)

DF 0·909 0·826 0·751 0·683 0·621 0·564

PV £ 251,575 188,262 171,168 155,669 141,538 (27,546) 880,666

The NPV of the project is £121,393. Therefore the PV of the contributions can fall by this amount. This means they can fall by £121,393/£880,666, that is, a sensitivity of 13·78%.

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Requirement (c) Writing Down Allowances schedule

Initial expenditure

£ 550,000

Tax saved @ 30% £

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

£

£

£

£

£

£

20,625

20,625

WDA Year 1, 25%

137,500 412,500

41,250

WDA Year 2, 25%

103,125 309,375

30,938

WDA Year 3, 25%

77,344 232,031

23,203

WDA Year 4, 25%

58,008

17,402

174,023 70,195 103,828

31,148

Sale for scrap, year 5 Balancing allowance Total tax savings Discount factor (nominal rate) Present value Total present value

15,469

15,469 11,602

11,601 8,701

8,701

20,625

36,094

27,071

20,302

15,574 24,275

15,574 15,574

0·866 17,861

0·750 27,071

0·649 17,569

0·562 11,410

0·487 11,822

0·421 6,557

92,290

The net present value for the investment will increase by £92,290 due to savings in tax arising from writing down allowances. Examiner’s Note The writing down allowances are not affected by inflation, except to the extent that the final asset value will increase.

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Answer to Question Six

Requirement (a) Note Direct materials: Steel Brass Direct labour: Skilled Semi-skilled Overhead Estimating time Administration Profit

$

1 1

55.00 20.00

2 3 4 5

300.00 – 7.50 – 382.50 – –

6 7

Lowest cost estimate

382.50

Notes (that is brief reasons for using each of the values above) 1

The steel will eventually be replaced at a cost of $5.50 per square metre, the brass is included at its future purchase cost.

2

Cost of working overtime = 25 x $8.00 x 1.5 = $300.00 Cost of substituting this order is that cash inflow of 25 x ($8.00 + $13.00) = $525.00 is lost. It is more economic to work overtime.

3

No incremental cost since there is paid idle time.

4

The power cost is based on the expected usage of power by the machine.

5

Estimating time related costs have already been incurred; they are sunk costs.

6

Administration costs are not incremental cash flows.

7

The profit mark-up is not a future cashflow.

Requirement (b) The two-way data table shows the effect of alternative combinations of three values of each of two input variables on the final outcome solution. In this question the two variables are the skilled labour rate per hour and hourly power costs and where the values of these items are as set out in part (a) of the question, there is no effect on the solution that has already been found. However, alternative combinations of the values of these input variables will cause the output value (the minimum cost price) to either increase or decrease. The table can thus be used to illustrate the range of values that may arise given the uncertainty of the values of these input variables. In this question the minimum cost price may be as low as $344.50 ($382.50 - $38.50) or as high as $459.00 ($382.50 + $76.50).

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By introducing the probability estimates as well, the likelihood of the minimum cost price being more or less than the value in the original calculation can also be determined. The combined probabilities of each combination are as follows: Skilled labour rate $ 10 10 10 8

Hourly Power cost $ 0.90 0.75 0.65 0.90

Probability 0.3 x 0.25 =0.075 0.3 x 0.55 =0.165 0.3 x 0.20 =0.060 0.6 x 0.25 =0.150

8

0.75

0.6 x 0.55 =0.330

8 7 7 7

0.65 0.90 0.75 0.65

0.6 x 0.20 =0.120 0.1 x 0.25 =0.025 0.1 x 0.55 =0.055 0.1 x 0.20 =0.020

0.45 chance that costs will be higher than those determined in part (a) 0.33 chance that the costs are as determined in part (a)

0.22 chance that costs will be lower than those determined in part (a)

By also introducing the effective results of these combinations on the minimum cost price an expected value can be determined: Skilled Labour rate $ per hour 10 10 10 8 8 8 7 7 7

Hourly Power cost $ 0.90 0.75 0.65 0.90 0.75 0.65 0.90 0.75 0.65

Sum of expected values

Probability 0.3 x 0.25 =0.075 0.3 x 0.55 =0.165 0.3 x 0.20 =0.060 0.6 x 0.25 =0.150 0.6 x 0.55 =0.330 0.6 x 0.20 =0.120 0.1 x 0.25 =0.025 0.1 x 0.55 =0.055 0.1 x 0.20 =0.020

Effect

Expected Value

$ +76.50 +75.00 +74.00 + 1.50

$ +5.7375 +12.3750 +4.4400 +0.2250

- 1.00 - 36.00 - 37.50 - 38.50

-0.1200 -0.9000 -2.0625 -0.7700 +18.925

(That is expected increase/decrease in cost compared to part (a) of the solution.) This means that the expected value of the minimum cost price is $401.43. This table can thus be used to provide the following information to the manager: If the most likely combination of skilled labour rates and hourly power costs occurs, the minimum cost price is $382.50. However, given the alternative values of these input

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28

resources the cost could be as low as $344.00 or as high as $459.00. The likelihood of the cost being more than $382.50 is 45%, whereas there is only a 22% chance of it being less than $382.50. Using an expected value approach the expected minimum cost price is $401.43. The manager may then make a decision depending upon their attitude to risk.

Answer to Question Seven

Requirement (a) The fixed overhead volume variance values the difference between the budgeted and actual production volume using the fixed overhead absorption rate per unit of $10. Therefore the differences in units represented by these values are: Period 1 2 3

Difference $1,200/$10 = 120 $1,900/$10 = 190 $2,600/$10 = 260

These can be used to determine the actual sales units by deducting the differences from the budgeted units of the corresponding period: Period 1 2 3

Budgeted units 520 590 660

Actual units 520 - 120 = 400 590 - 190 = 400 660 - 260 = 400

Since demand = zero if the price were $100 or more, and the demand at a price of $60 was 400 units, then the price equation is as follows: Price = a - bx = $100 - 40/400x = $100 - 0.1x Marginal revenue

= a - 2bx = $100 - 0.2x

Marginal cost = variable cost = $25. So to maximise profit, marginal cost equals marginal revenue: $25 $75 $75 / 0.2 375

= = = =

$100 - 0.2x 0.2x x x

Price

= = = =

$100 - 0.1x $100 - (0.1 x 375) $100 - $37.50 $62.50

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Requirement (b) REPORT To:

Board of Directors

From:

Management Accountant

Subject:

Alternative Pricing Strategies

Introduction Further to our brief meeting, I set out below the alternative pricing strategies that could be adopted for our new product. Details Price Skimming This method of pricing sets high initial prices in an attempt to exploit those sections of the market which are relatively insensitive to price changes. As TQ’s product is the first of its type it could initially set high prices to take advantage of the novelty appeal of a new product as demand would be inelastic. If this approach is used, TQ could then subsequently reduce the price to remain competitive in the market. Penetration Pricing This method sets very low prices in the initial stages of a product’s life cycle to gain rapid acceptance of the product and therefore a significant market share. If TQ used this approach it would discourage entrants into the market. Demand Based Approach With this method TQ could utilise some market research information to determine the selling price and level of demand to maximise company profits. This method, however, does pose the following drawbacks: •

it is dependent on the quality of the market research information;

•

it assumes a competitive market; that is that the actions of competitors will not impact on actual demand for the software product;

•

it is difficult to estimate the demand curve;

•

it is difficult to incorporate the effect of competition;

•

this method assumes that price is the only factor that influences the quantity demanded – other factors like quality, packaging, advertising, promotion, credit terms, after sales service are ignored;

•

the marginal cost curve for our product can only be determined after considerable analysis.

However, this method does benefit from: •

a useful insight that stresses the need for managers to think about price/demand relationships even if the relationship cannot be measured precisely;

•

a consideration of the marketplace;

•

considering only incremental costs.

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Conclusion I should be pleased to discuss these alternatives with you at the next board meeting.

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Managerial Level Paper

P2 – Management Accounting Decision Management 25 May 2005 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper You are allowed 20 minutes reading time before the examination begins during which you should read the question paper, and if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing, add or use your calculator during this reading time. You are strongly advised to carefully read the question requirement before attempting the question concerned. The requirements for the questions in Sections B and C are contained in a dotted box. Answer the ONE compulsory question in Section A. This is comprised of eight sub-questions and is on pages 2 to 5. Answer ALL THREE compulsory questions in Section B on pages 6 to 8. Answer TWO of the three questions in Section C on pages 9 to 13. Maths Tables and Formulae are provided on pages 15 to 17. These pages are detachable for ease of reference. Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

P2 – Decision Management

Management Accounting Pillar

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. TURN OVER  The Chartered Institute of Management Accountants 2005

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For sub-questions 1.6, 1.7, and 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions.

Question One 1.1

The following details relate to ready meals that are prepared by a food processing company: Ready meal

K $/meal

L $/meal

M $/meal

Selling price

5·00

3·00

4·40

Ingredients Variable conversion costs Fixed conversion costs*

2·00 1·60 0·50

1·00 0·80 0·30

1·30 1·85 0·60

Profit

0·90

0·90

0·65

10

4

8

Oven time (minutes per ready meal)

Each of the meals is prepared using a series of processes, one of which involves cooking the ingredients in a large oven. The availability of cooking time in the oven is limited and, because each of the meals requires cooking at a different oven temperature, it is not possible to cook more than one of the meals in the oven at the same time. *The fixed conversion costs are general fixed costs that are not specific to any type of ready meal. The most and least profitable use of the oven is Most profitable

Least profitable

A

Meal K

Meal L

B

Meal L

Meal M

C

Meal L

Meal K

D

Meal M

Meal L (2 marks)

P2

2

May 2005

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1.2

A company provides three different levels of customer service support for one of its software products. The following data relate to these three levels of support: Support level

Superior $ per contract 1,000

Standard $ per contract 750

Basic $ per contract 400

Annual variable costs Annual fixed costs (see note below)

450 200

250 100

180 50

Profit

350

400

170

Annual fee

Note: The total annual fixed costs are budgeted to be $1,000,000. None of these costs are specific to any type of customer service support. Assuming that the number of customer service support contracts sold are in the proportion: Superior 20%

Standard 30%

Basic 50%

The annual revenue needed to be generated to break even is closest to A

$1,690,000

B

$1,695,000

C

$1,710,000

D

$2,270,000 (2 marks)

1.3

A company is preparing a quotation for a one-month consultancy project and seeks your help in determining the relevant cost of one of the members of its project team. Currently the company employs the consultant on an annual salary of £36,000. In addition, the company provides the consultant with a company car which incurs running costs of £6,000 each year. The car will continue to be provided to the consultant whether this project is undertaken by the company or not. This consultant is fully employed on current projects and, if she were to be transferred to this new project, then an existing junior consultant would be used to cover her current work. The junior consultant would be paid a bonus of £5,000 for undertaking this additional responsibility. Another alternative that the company is considering is hiring an external consultant who has the necessary technical knowledge to work on the new consultancy project on a one month contract at a cost of £4,500.

The relevant cost to be used in preparing the quotation is A

£3,000

B

£3,500

C

£4,500

D

£5,000 (2 marks) TURN OVER

May 2005

3

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P2

1.4

A company has determined that the net present value of an investment project is $12,304 when using a 10% discount rate and $(3,216) when using a discount rate of 15%.

Calculate the Internal Rate of Return of the project to the nearest 1%. (2 marks) 1.5

A company has a nominal (money) cost of capital of 18% per annum. If inflation is 6% each year, calculate the company’s real cost of capital to the nearest 0·01%. (2 marks)

1.6

A company is considering the price that it should charge for a repeat order. Fifteen units of the product have already been made and supplied to the customer and the company has experienced an 80% learning curve so far. The first unit required 54 hours of labour to complete the manufacture, assembly and testing processes.

Assuming that the 80% learning curve continues, calculate the expected time to be taken for the 16th unit. Note: The learning index for an 80% learning curve is -0·3219. (3 marks) 1.7

A company has estimated the selling prices and variable costs of one of its products as follows: $ 40 50 60

Selling price per unit Probability 0·30 0·45 0·25

Variable cost per unit $ Probability 20 0·55 30 0·25 40 0·20

Given that the company will be able to supply 1,000 units of its product each week irrespective of the selling price, and that selling price and variable cost per unit are independent of each other, calculate the probability that the weekly contribution will exceed $20,000. (3 marks)

Section A continues on the next page

P2

4

May 2005

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1.8

A company is considering the pricing of one of its products. It has already carried out some market research with the following results: The quantity demanded at a price of $100 will be 1,000 units The quantity demanded will increase / decrease by 100 units for every $50 decrease / increase in the selling price The marginal cost of each unit is $35 Note that if Selling Price (P) = a – bx then Marginal Revenue = a – 2bx

Calculate the selling price that maximises company profit. (4 marks) (Total for Section A = 20 marks)

End of Section A

Section B starts on the next page

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5

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P2

SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS Question Two The X group is a well-established manufacturing group that operates a number of companies using similar production and inventory holding policies. All of the companies are in the same country though there are considerable distances between them. The group has traditionally operated a constant production system whereby the same volume of output is produced each week, even though the demand for the group’s products is subject to seasonal fluctuations. As a result there is always finished goods inventory in the group’s warehouses waiting for customer orders. This inventory will include a safety inventory equal to two weeks’ production. Raw material inventories are ordered from suppliers using the Economic Order Quantity (EOQ) model in conjunction with a computerised inventory control system which identifies the need to place an order when the re-order level is reached. The purchasing department is centralised for the group. On receiving a notification from the computerised inventory control system that an order is to be placed, a series of quotation enquiries are issued to prospective suppliers so that the best price and delivery terms are obtained for each order. This practice has resulted in there being a large number of suppliers to the X group. Each supplier delivers directly to the company that requires the material. The Managing Director of the X group has recently returned from a conference on World Class Manufacturing and was particularly interested in the possible use of Just In Time (JIT) within the X group.

Required: Write a report, addressed to the Managing Director of the X group, that explains how the adoption of JIT might affect its profitability. (10 marks)

P2

6

May 2005

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Question Three A company is considering the replacement of its delivery vehicle. It has chosen the vehicle that it will acquire but it now needs to decide whether the vehicle should be purchased or leased. The cost of the vehicle is £15,000. If the company purchases the vehicle it will be entitled to claim tax depreciation at the rate of 25% per year on a reducing balance basis. The vehicle is expected to have a trade-in value of £5,000 at the end of three years. If the company leases the vehicle, it will make an initial payment of £1,250 plus annual payments of £4,992 at the end of each of three years. The full value of each lease payment will be an allowable cost in the computation of the company’s taxable profits of the year in which the payments are made. The company pays corporation tax at the rate of 30% of its profits. 50% of the company’s corporation tax is payable in the year in which profits are made and 50% in the following year. Assume that the company has sufficient profits to obtain tax relief on its acquisition of the vehicle in accordance with the information provided above. The company’s after tax cost of capital is 15% per year. Note: Tax depreciation is not a cash cost but is allowed as a deduction in the calculation of taxable profits.

Required: Calculate whether the company should purchase or lease the vehicle and clearly state your recommendation to the company. (10 marks)

Section B continues over the page

TURN OVER

May 2005

7

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P2

Question Four Z manufactures three joint products (M, N and P) from the same common process. The following process account relates to the common process last month and is typical of the monthly results of operating this process: Common Process Account Opening work in process Materials Conversion costs: Variable Fixed

Litres 1,000 100,000

$ 5,320 250,000 100,000 180,000

101,000

Normal loss Output M Output N Output P Closing work in process Abnormal loss

535,320

Litres 10,000 25,000 15,000 45,000 800 5,200 101,000

$ 20,000 141,875 85,125 255,375 3,533 29,412 535,320

Each one of the products can be sold immediately after the common process, but each one of them can be further processed individually before being sold. The following further processing costs and selling prices per litre are expected: Product

Selling price after common process $/litre 6·25 5·20 6·80

M N P

Selling price after further processing $/litre 8·40 6·45 7·45

Further variable processing cost $/litre 1·75 0·95 0·85

Required: (a)

State the method used to apportion the common costs between the products M, N and P and comment on its acceptability. Explain why it is necessary to apportion the common costs between each of the products. (5 marks)

(b)

Evaluate the viability of the common process, and determine the optimal processing plan for each of the three products showing appropriate calculations. (5 marks) (Total for Question Four = 10 marks)

(Total for Section B = 30 marks)

End of Section B Section C starts on the next page

P2

8

May 2005

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SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE Question Five A printing company is considering investing in new equipment which has a capital cost of £3 million. The machine qualifies for tax depreciation at the rate of 25% per year on a reducing balance basis and has an expected life of five years. The residual value of the machine is expected to be £300,000 at the end of five years. An existing machine would be sold immediately for £400,000 if the new machine were to be bought. This existing machine has a tax written down value of £250,000. The existing machine generates annual revenues of £4 million and earns a contribution of 40% of sales. The new machine would reduce unit variable costs to 80% of their former value and increase output capacity by 20%. There is sufficient sales demand at the existing prices to make full use of this additional capacity. The printing company pays corporation tax on its profits at the rate of 30%, with half of the tax being payable in the year that the profit is earned and half in the following year. The company's after tax cost of capital is 14% per year.

Required: (a)

Evaluate the proposed purchase of the new printing machine from a financial perspective using appropriate calculations, and advise the company as to whether the investment is worthwhile. (15 marks)

(b)

Explain sensitivity analysis and prepare calculations to show the sensitivity of the decision to independent changes in each of the following: (i) annual contribution; (ii) rate of corporation tax on profits. (10 marks) (Total for Question Five = 25 marks)

TURN OVER May 2005

9

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P2

Question Six

(a)

The CS group is planning its annual marketing conference for its sales executives and has approached the VBJ Holiday company (VBJ) to obtain a quotation.

VBJ has been trying to win the business of the CS group for some time and is keen to provide a quotation which the CS group will find acceptable in the hope that this will lead to future contracts. The manager of VBJ has produced the following cost estimate for the conference: Coach running costs Driver costs Hotel costs General overheads Sub total

$ 2,000 3,000 5,000 2,000 12,000

Profit (30%) Total

3,600 15,600

You have considered this cost estimate but you believe that it would be more appropriate to base the quotation on relevant costs. You have therefore obtained the following further information: Coach running costs represent the fuel costs of $1,500 plus an apportionment of the annual fixed costs of operating the coach. No specific fixed costs would be incurred if the coach is used on this contract. If the contract did not go ahead, the coach would not be in use for eight out of the ten days of the conference. For the other two days a contract has already been accepted which contains a significant financial penalty clause. This contract earns a contribution of $250 per day. A replacement coach could be hired for $180 per day. Driver costs represent the salary and related employment costs of one driver for 10 days. If the driver is used on this contract the company will need to replace the driver so that VBJ can complete its existing work. The replacement driver would be hired from a recruitment agency that charges $400 per day for a suitably qualified driver. Hotel costs are the expected costs of hiring the hotel for the conference. General overheads are based upon the overhead absorption rate of VBJ and are set annually when the company prepares its budgets. The only general overhead cost that can be specifically identified with the conference is the time that has been spent in considering the costs of the conference and preparing the quotation. This amounted to $250.

Required: Prepare a statement showing the total relevant cost of the contract. Explain clearly the reasons for each of the values in your quotation and for excluding any of the costs (if appropriate). (10 marks)

Question Six continues on the opposite page P2

10

May 2005

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(b)

Now that the quotation has been prepared, it is realised that there is some uncertainty concerning the hotel cost and the fuel cost. Further investigation has shown that these costs may be higher or lower than the original estimates. Estimated costs with their associated probabilities are as follows:

Estimated hotel cost ($)

Probability %

Estimated fuel cost ($)

Probability %

4,000 5,000 6,000

20 50 30

1,200 1,500 2,000

10 50 40

The following two-way data table shows the effect on the total relevant cost of these alternative values. All figures are in $:

Fuel

$1,200 $1,500 $2,000

Hotel $5,000 –300 0 +500

$4,000 –1,300 –1,000 –500

$6,000 +700 +1,000 +1,500

Required: (i)

Explain the meaning of the above two-way data table.

(ii)

Produce and interpret a table that shows how the two-way data table may be used in conjunction with the probabilities to improve the information available to the manager of VBJ. (15 marks) (Total for Question Six = 25 marks)

Section C continues on the next page

TURN OVER

May 2005

11

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P2

Question Seven

(a)

The Q organisation is a large, worldwide respected manufacturer of consumer electrical and electronic goods. Q constantly develops new products that are in high demand as they represent the latest technology and are “must haves” for those consumers that want to own the latest consumer gadgets. Recently Q has developed a new handheld digital DVD recorder and seeks your advice as to the price it should charge for such a technologically advanced product.

Required: Explain the relevance of the product life cycle to the consideration of alternative pricing policies that might be adopted by Q. (10 marks)

(b)

Market research has discovered that the price demand relationship for the item during the initial launch phase will be as follows: Price (£) 100 80 69 62

Demand (units) 10,000 20,000 30,000 40,000

Production of the DVD recorder would occur in batches of 10,000 units, and the production director believes that 50% of the variable manufacturing cost would be affected by a learning and experience curve. This would apply to each batch produced and continue at a constant rate of learning up to a production volume of 40,000 units when the learning would be complete. Thereafter, the unit variable manufacturing cost of the product would be equal to the unit cost of the fourth batch. The production director estimates that the unit variable manufacturing cost of the first batch would be £60 (£30 of which is subject to the effect of the learning and experience curve, and £30 of which is unaffected), whereas the average unit variable manufacturing cost of all four batches would be £52·71. There are no non-manufacturing variable costs associated with the DVD recorder.

Question Seven continues on the opposite page

P2

12

May 2005

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Required: (i)

Calculate the rate of learning that is expected by the production director. (4 marks)

(ii)

Calculate the optimum price at which Q should sell the DVD recorder in order to maximise its profits during the initial launch phase of the product. (8 marks)

(iii)

Q expects that after the initial launch phase the market price will be £57 per unit. Estimated product specific fixed costs during this phase of the product’s life are expected to be £15,000 per month. During this phase of the product life cycle Q wishes to achieve a target monthly profit from the product of £30,000. Calculate the number of units that need to be sold each month during this phase in order that Q achieves this target monthly profit. (3 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of question paper Maths Tables and Formulae are on pages 15 – 17

May 2005

13

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P2

[this page is blank]

P2

14

May 2005

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PRESENT VALUE TABLE Present value of $1, that is (1+ r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

May 2005

15

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

16

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FORMULAE Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b= and or solve

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX ∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X2 Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

May 2005

17

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P2

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May 2005

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P2

Management Accounting Pillar

Managerial Level

P2 – Management Accounting – Decision Management

May 2005

Wednesday Morning Session

P2

20

May 2005

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

General Comments A high proportion of students attained good marks and many students attained excellent marks. The actual exam paper resembled the pilot paper, which resulted in students encountering no ‘surprises’ in the topics tested, in the method of testing, and in the technical aspects of the questions. It was pleasing to see an improvement in most cases in the neatness, layout and presentation of answers, and clear referencing to workings. Unfortunately it was again obvious that many students did not plan their answers, particularly to the written/discursive questions, and wrote all they knew about a particular topic without referring to the scenario in the question. This clearly demonstrated that students did not make full use of the 20 minutes planning time. The performance on question 1 (objective test questions) was generally good but a significant number of students did not respond correctly to the question. For example ‘to the nearest 1%’ is not 11.96%.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Section A – 50 marks Question 1.1 The following details relate to ready meals that are prepared by a food processing company: Ready meal

K $/meal

L $/meal

M $/meal

Selling price

5·00

3·00

4·40

Ingredients Variable conversion costs Fixed conversion costs*

2·00 1·60 0·50

1·00 0·80 0·30

1·30 1·85 0·60

Profit

0·90

0·90

0·65

10

4

8

Oven time (minutes per ready meal)

Each of the meals is prepared using a series of processes, one of which involves cooking the ingredients in a large oven. The availability of cooking time in the oven is limited and, because each of the meals requires cooking at a different oven temperature, it is not possible to cook more than one of the meals in the oven at the same time. *The fixed conversion costs are general fixed costs that are not specific to any type of ready meal. The most and least profitable use of the oven is Most profitable Meal K Meal L Meal L Meal M

A B C D

Least profitable Meal L Meal M Meal K Meal L (2 marks) The answer is C

Workings Contribution per meal Minutes Contribution per minute

K $1·40 10 $0·14

The Chartered Institute of Management Accountants

L $1·20 4 $0·30

M $1·25 8 $0·16

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 1.2 A company provides three different levels of customer service support for one of its software products. The following data relate to these three levels of support: Support level

Superior $ per contract 1,000

Standard $ per contract 750

Basic $ per contract 400

Annual variable costs Annual fixed costs (see note below)

450 200

250 100

180 50

Profit

350

400

170

Annual fee

Note: The total annual fixed costs are budgeted to be $1,000,000. None of these costs are specific to any type of customer service support. Assuming that the number of customer service support contracts sold are in the proportion: Superior 20%

Standard 30%

Basic 50%

The annual revenue needed to be generated to break even is closest to A $1,690,000 B $1,695,000 C $1,710,000 D $2,270,000 (2 marks) The answer is A Workings Contract Superior Standard Basic

Contribution $550 $500 $220

Weight 2 3 5

Contribution x Weight $1,100 $1,500 $1,100 $3,700

$1,000,000 = 270.27 packages $3,700

Each package has a sales value of $6,250 so the breakeven sales value is $1,689,188.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 1.3 A company is preparing a quotation for a one-month consultancy project and seeks your help in determining the relevant cost of one of the members of its project team. Currently the company employs the consultant on an annual salary of £36,000. In addition, the company provides the consultant with a company car which incurs running costs of £6,000 each year. The car will continue to be provided to the consultant whether this project is undertaken by the company or not. This consultant is fully employed on current projects and, if she were to be transferred to this new project, then an existing junior consultant would be used to cover her current work. The junior consultant would be paid a bonus of £5,000 for undertaking this additional responsibility. Another alternative that the company is considering is hiring an external consultant who has the necessary technical knowledge to work on the new consultancy project on a one month contract at a cost of £4,500. The relevant cost to be used in preparing the quotation is A £3,000 B £3,500 C £4,500 D £5,000 (2 marks) The answer is C Workings The lowest cost option is to hire the external consultant.

Question 1.4 A company has determined that the net present value of an investment project is $12,304 when using a 10% discount rate and $(3,216) when using a discount rate of 15%. Calculate the Internal Rate of Return of the project to the nearest 1%. (2 marks) Workings The internal rate of return of the project is 10% + [($12,304 / $15,520) x 5%] = 14%

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 1.5 A company has a nominal (money) cost of capital of 18% per annum. If inflation is 6% each year, calculate the company’s real cost of capital to the nearest 0·01%. (2 marks) Workings 1·18 / 1·06 = 1·1132 Real cost of capital = 11·32%

Question 1.6 A company is considering the price that it should charge for a repeat order. Fifteen units of the product have already been made and supplied to the customer and the company has experienced an 80% learning curve so far. The first unit required 54 hours of labour to complete the manufacture, assembly and testing processes. Assuming that the 80% learning curve continues, calculate the expected time to be taken for the 16th unit. Note: The learning index for an 80% learning curve is -0·3219. (3 marks) Workings Average time for 15 units = y = axb = 54 x 15-0·3219 = 22·584 hours Average time for 16 units = y = axb = 54 x 16-0·3219 = 22·12 hours Total time for 15 units = Total time for 16 units = Time for 16th unit =

338·76 hours 353·92 hours 15·16 hours

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 1.7 A company has estimated the selling prices and variable costs of one of its products as follows: $ 40 50 60

Selling price per unit Probability 0·30 0·45 0·25

$ 20 30 40

Variable cost per unit Probability 0·55 0·25 0·20

Given that the company will be able to supply 1,000 units of its product each week irrespective of the selling price, and that selling price and variable cost per unit are independent of each other, calculate the probability that the weekly contribution will exceed $20,000. (3 marks) Workings Weekly contribution of $20,000 if sales demand = 1,000 units equals a contribution of $20 per unit. The following combinations of selling price and variable cost per unit yield a contribution of more than $20 per unit: Selling Price $50 $60 $60

Variable Cost $20 $30 $20

Probability 0·45 x 0·55 = 0·2475 0·25 x 0·25 = 0·0625 0·25 x 0·55 = 0·1375 0·4475

Answer = 44·75%

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 1.8 A company is considering the pricing of one of its products. It has already carried out some market research with the following results: The quantity demanded at a price of $100 will be 1,000 units The quantity demanded will increase / decrease by 100 units for every $50 decrease / increase in the selling price The marginal cost of each unit is $35 Note that if Selling Price (P) = a – bx then Marginal Revenue = a – 2bx Calculate the selling price that maximises company profit. (4 marks) Workings Price at which demand = zero = $100 + ( 1000 x $50) = $600 100 P

= $600 – 0·5x

MR

= $600 – x

MC

= $35

MC

= MR

$35

= $600 – x

x

= $565

p

= $600 – $(0·5 x 565) = $317·50

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS Question 2 Write a report, addressed to the Managing Director of the X group, that explains how the adoption of JIT might affect its profitability. (10 marks) Rationale Question Two requires candidates to prepare a report that explains how the adoption of a Just in Time (JIT) approach to its manufacturing systems might affect its profitability. This requires a comparison between the existing system and JIT in order to identify the differences and how they would affect the company’s profitability. This addresses learning outcome D(ii) Evaluate the impacts of just in time production, the theory of constraints and total quality management on efficiency, inventory and cost Suggested Approach • • •

Identify the key characteristics of the existing purchasing and production system. Determine the changes that would occur as a result of implementing a JIT purchasing and production system. Explain the effect of those changes on the profitability of the company.

Marking Guide

Marks

Introduction that explains the principles of JIT, using an appropriate answer format Explanation of how the changes implemented affect profitability (up to two marks per point)

2 8

Examiner’s Comments Most students made a good attempt at this question but many simply wrote all they knew about JIT (simply a ‘brain dump’). Common Errors • Not discussing how JIT might affect profitability. • Not presenting a report (‘To’ and ‘from’ is simply not sufficient). • Not relating the answer to the scenario described in the question.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 3 Calculate whether the company should purchase or lease the vehicle and clearly state your recommendation to the company. (10 marks) Rationale Question Three requires candidates to calculate whether it is beneficial for a company to purchase or lease a vehicle. Candidates must recognise that this is a long term decision involving relevant costs and taxation and requiring the application of discounting techniques. This addresses learning outcome B(vi) Evaluate project proposals using the techniques of investment appraisal . Suggested Approach For the purchase option: • Calculate the values of tax depreciation and the years in which the depreciation allowances occur. • Calculate the tax relief and the years in which it is claimable. • Discount the tax and investment cash flows. For the lease option: • Calculate the tax saving and the years in which it occurs. • Discount the lease payments and tax savings. Recommend the lowest cost option. Marking Guide

Marks

Calculate the values of tax depreciation and the years in which they occur and the tax relief and the years in which it is claimable Discount the tax and investment cash flows for the purchase option Calculate the lease tax saving and the years in which it occurs Discount the lease payments and tax savings Recommendation

3 3 2 1 1

Examiner’s Comments This question was generally well answered. Common Errors • Calculating an incorrect figure for the balancing allowance on the purchase option. • Calculating incorrect figures for the tax savings on both the purchase and the lease option. • Showing no tax relief for the initial lease payment.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 4 (a)

State the method used to apportion the common costs between the products M, N and P and comment on its acceptability. Explain why it is necessary to apportion the common costs between each of the products. (5 marks)

(b)

Evaluate the viability of the common process, and determine the optimal processing plan for each of the three products showing appropriate calculations. (5 marks)

Rationale Question Four is divided into two parts. Part (a) requires candidates to identify the method that has been used to apportion the common costs of a process between its joint product outputs and then to comment on the acceptability of the method used. Part (b) requires candidates to evaluate the viability of the common process and to determine the optimal production plan for each of the three joint products. This addresses learning outcome A(v) Explain why joint costs must be allocated to final products for financial reporting purposes, but why this is unhelpful when decisions concerning process and product viability have to be taken Suggested Approach • • • • •

Calculate the unit cost of each litre of output and thus identify the method used to apportion the common costs. Comment on the acceptability of the apportionment method used. Explain the reasons why it is necessary to apportion the common costs. Compare the sales values of the output from the common process with the common process costs to determine its viability. Compare the incremental costs and revenues from further processing to determine the optimal processing plan for each product.

Marking Guide

Marks

Calculate the unit cost of each litre of output and thus identify the method used to apportion the common costs Comment on the acceptability of the apportionment method used Explain the reasons why it is necessary to apportion the common costs Compare the sales values of the output from the common process with the common process costs to determine its viability Compare the incremental costs and revenues from further processing to determine the optimal processing plan for each product

The Chartered Institute of Management Accountants

1 2 2 2 3

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Examiner’s Comments This question was poorly answered, particularly part (a). Only one to two per cent of candidates attempted to explain why it was necessary to apportion the common costs (for example for inventory valuation). Many students did not appreciate the simplicity of part (b). Common Errors • Misreading the question (part (a)) and answering that the method used to apportion meant absorption costing or ABC. • In part (b), putting forward a complete profitability statement showing the position ‘without further processing’ and ‘after further processing’ instead of simply comparing the incremental revenues with the incremental costs. • Either misunderstanding or totally ignoring the viability of the common process i.e. did it generate an overall profit.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE Question 5 (a)

Evaluate the proposed purchase of the new printing machine from a financial perspective using appropriate calculations, and advise the company as to whether the investment is worthwhile. (15 marks)

(b)

Explain sensitivity analysis and prepare calculations to show the sensitivity of the decision to independent changes in each of the following: (i) annual contribution; (ii) rate of corporation tax on profits. (10 marks)

Rationale Question Five is divided into two parts. Part (a) requires candidates to evaluate the proposed purchase of a new machine. Candidates must recognise that this is a long-term decision involving relevant costs and revenues as well as taxation which requires the use of discounting techniques. This addresses learning outcomes B(ii) Apply the principles of relevant cash flow analysis to long-run projects that continue for several years; and B(vi) Evaluate project proposals using the techniques of investment appraisal. Part (b) requires candidates to measure the sensitivity of two of the decision variables in the project. This addresses learning outcome B(ix) Apply sensitivity analysis to cash flow parameters to identify those to which net present value is particularly sensitive. Suggested Approach Part (a) • Determine the incremental contribution from the investment. • Determine the tax depreciation arising from the investment. • Calculate the tax cash flows arising from the project. • Discount the project cash flows and recommend acceptance. Part (b) • Explain the meaning of sensitivity analysis. • Calculate the present value of the after tax annual contribution and compare this to the net present value of the project. • Calculate the present value of the tax payments arising from the project and compare this to the net present value of the project.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Marking Guide

Marks

Part (a) Determine the incremental contribution from the investment Determine the tax depreciation arising from the investment Calculate the tax cash flows arising from the project Discount the project cash flows and recommend acceptance

5 3 4 3

Part (b) Explain the meaning of sensitivity analysis Calculate the present value of the after tax annual contribution and compare this to the net present value of the project Calculate the present value of the tax payments arising from the project and compare this to the net present value of the project

3 4 3

Examiner’s Comments Part (a) A good attempt was made by most students but the standard of layout/presentation in many cases was poor. Reference to workings was generally poor. Part (b) This was very poorly answered. Many students demonstrated that they did not have a full understanding of sensitivity analysis. Common Errors • Not appreciating that the calculations needed to reflect the ‘additional contribution’ (£896K), rather than the new contribution (£2,496K). • Phasing incorrectly both the tax relief and the tax on the incremental contribution. • Calculating an incorrect figure for the balancing charge. • Not discounting the contribution figures. • Not realising that the answer to part (a) needed to be the numerator for the sensitivity tests (the principle of the ‘own figure’ rule would have gained marks for many students).

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 6(a) Prepare a statement showing the total relevant cost of the contract. Explain clearly the reasons for each of the values in your quotation and for excluding any of the costs (if appropriate). (10 marks) Rationale Question Six is divided into two parts. Part (a) requires candidates to identify the relevant costs associated with a short-term decision making situation. This addresses learning outcome A(i) Discuss the principles of decision making including the identification of relevant cash flows and their use alongside non-quantifiable factors in making rounded judgements. In part (b) candidates are required to explain the meaning of the two-way data table provided and to produce another table showing how the two-way data table may be used with probability analysis to improve the information available to the manager. This addresses learning outcome C(iii) Analyse risk and uncertainty by calculating expected values and standard deviations together with probability tables and histograms. Suggested Approach • •

Identify the relevant costs of the proposal. Explain the reasons for including / excluding values in the quotation.

Marking Guide

Marks

Identify the relevant costs of the proposal Explain the reasons for including / excluding values in the quotation

4 6

Examiner’s Comments This was generally well answered. Common Errors • Providing poor or non-existent reasons for the inclusion or exclusion of particular figures. • Providing incorrect reasons for the inclusion or exclusion of particular figures.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 6(b) (i)

Explain the meaning of the above two-way data table.

(ii)

Produce and interpret a table that shows how the two-way data table may be used in conjunction with the probabilities to improve the information available to the manager of VBJ. (15 marks)

Rationale See 6(a). Suggested Approach • • •

Explain the two-way data table provided. Prepare a table that shows each outcome, its joint probability, and the expected value of its cost. Explain how the table prepared can be used and interpreted to improve the information available to the manager.

Marking Guide

Marks

Explain the two-way data table provided Prepare a table that shows each outcome, its joint probability, and the expected value of its cost Explain how the table prepared can be used and interpreted to improve the information available to the manager

3 6 6

Examiner’s Comments This was generally well answered. Common Errors • Providing poorly tabulated tables. • Providing an incorrect interpretation of tables. • Providing a poor description of how the information generated would be valuable to the manager receiving it. • Not relating part (a) with part (b).

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 7(a) Explain the relevance of the product life cycle to the consideration of alternative pricing policies that might be adopted by Q. (10 marks) Rationale Question 7 is divided into two parts. Part (a) requires candidates to discuss the relevance of the product life cycle to pricing policies. This addresses learning outcome D(vii) Explain the concept of life cycle costing and how life cycle costs interact with marketing strategies at each stage of the life cycle. Part (b) requires candidates to calculate the rate of learning that is expected to occur and apply this to a pricing decision before determining the required level of activity to achieve a target profit. This addresses learning outcomes A(iii) Apply an approach to pricing based on profit maximisation in imperfect markets and evaluate the financial consequences of alternative pricing strategies and D(iv) Explain and apply learning and experience curves to estimate time and cost for new products and services. Suggested Approach • •

State and briefly explain the stages of the product life cycle. For each stage of the product life cycle discuss the pricing policies that might be adopted.

Marking Guide

Marks

State and briefly explain the stages of the product life cycle For each stage of the product life cycle discuss the pricing policies that might be adopted (up to 2 marks each)

2 8

Examiner’s Comments Most students made a good attempt at this question but a large proportion did not actually answer the question (see below). Common Errors • Describing ‘life cycle costing’ as opposed to the ‘product life cycle’. • Not relating alternative pricing policies to the stages of the product life cycle. • Suggesting inappropriate pricing policies.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2005 Exam

Question 7(b) (i)

Calculate the rate of learning that is expected by the production director. (4 marks)

(ii)

Calculate the optimum price at which Q should sell the DVD recorder in order to maximise its profits during the initial launch phase of the product. (8 marks)

(iii)

Q expects that after the initial launch phase the market price will be £57 per unit. Estimated product specific fixed costs during this phase of the product’s life are expected to be £15,000 per month. During this phase of the product life cycle Q wishes to achieve a target monthly profit from the product of £30,000. Calculate the number of units that need to be sold each month during this phase in order that Q achieves this target monthly profit. (3 marks)

Rationale See 7(a). Suggested Approach • • • •

Calculate the rate of learning. Calculate the unit variable cost for each demand level. Calculate the total contribution at each demand level and identify the optimal price. Calculate the sales volume required to achieve the target profit.

Marking Guide

Marks

Calculate the rate of learning Calculate the unit variable cost for each demand level Calculate the total contribution at each demand level and identify the optimal price Calculate the sales volume required to achieve the target profit

4 5 3 3

Examiner’s Comments Too many candidates had only a basic understanding of the learning curve and appeared to have ignored this topic when preparing for the exam. Common Errors • Not using initiative by introducing their ‘own figure’ from part (i) when attempting part (ii). Marks were available, as usual, for students who took this initiative. • Applying the formula incorrectly, particularly when the quantity being produced falls outside the ‘doubling process’ (part (ii)). • Applying the learning curve effect to the full £60 (part (i) and part (ii)). • Not understanding what was required in part (iii).

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

General Comments Candidates did not perform well on this paper. Many seemed to lack knowledge of even the basic concepts of costing and management accounting. Poor and inexact expression also marred scripts. It is vital to use the correct cost accounting terminology and, if required to do so, to state the meaning clearly and precisely. For example, within a single sentence the same cost category was referred to as being both direct and variable and some scripts referred to the absorption of variable costs into product costs. The layout and presentation of answers to the discounted cash flow questions left much to be desired and because of a lack of forethought many unnecessary duplicated calculations were undertaken. Apart from 1.8, question 1 was generally quite well answered, possibly because it was the first question to be tackled by the vast majority of candidates. Judging by some of the answers to the later questions on the paper it appeared that most candidates had spent the 20 minutes reading time on question 1 alone.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Section A – 20 marks Question 1.1 A five year project has a net present value of $160,000 when it is discounted at 12%. The project includes an annual cash outflow of $50,000 for each of the five years. No tax is payable on projects of this type. The percentage increase in the value of this annual cash outflow that would make the project no longer financially viable is closest to A

64%

B

89%

C

113%

D

156% (2 marks) The answer is B

Workings Years 1 – 5 $50,000 x 3·605 = $180,250 $160,000 / $180,250 = 0·8876

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

The following data are to be used when answering questions 1.2 and 1.3 A company expects to sell 1,000 units per month of a new product but there is uncertainty as to both the unit selling price and the unit variable cost of the product. The following estimates of selling price, variable costs and their related probabilities have been made: Selling Price £ per unit Probability 20 25% 25 40% 30 35%

Unit Variable Cost £ per unit Probability 8 20% 10 50% 12 30%

There are specific fixed costs of £5,000 per month expected for the new product. Question 1.2 The expected value of monthly contribution is A

£5,890

B

£10,300

C

£10,890

D

£15,300 (2 marks) The answer is D

Workings Selling price expected value = (£20 x 25%) + (£25 x 40%) + (£30 x 35%) = Variable cost expected value = (£8 x 20%) + (£10 x 50%) + (£12 x 30%) = Expected unit contribution

£ 25·50 10·20 15·30

1,000 units x £15·30 = £15,300 Question 1.3 1.3

The probability of monthly contribution from this new product exceeding £13,500 is

A

24·5%

B

30·5%

C

63·0%

D

92·5% (2 marks) The answer is C

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Workings The total contribution must exceed £13,500, so to achieve this from a volume of 1,000 units, the unit contribution must exceed £13·50. The following combinations of selling price and variable cost and their respective combined probabilities meet this target: Selling Price £ 25 25 30 30 30

Variable cost £ 8 10 8 10 12

Probability 0·4 x 0·2 = 0·08 0·4 x 0·5 = 0·20 { { 0·35 x 1·0 = 0·35 {

Combined probability total

0·63

Question 1.4 PT has discovered that when it employs a new test engineer there is a learning curve with a 75% rate of learning that exists for the first 12 customer assignments. A new test engineer completed her first customer assignment in 6 hours. Calculate the time that she should take for her 7th assignment to the nearest 0·01 hours. Note: The index for a 75% learning curve is -0·415. (2 marks) Workings The average time for 7 assignments = 6 x 7-0·415 = 2·6757 hours Total time for 7 assignments = 7 x 2·6757 hours The average time for 6 assignments = 6 x 6-0·415 = 2·8525 hours Total time for 6 assignments = 6 x 2·8525 hours Time for the 7th assignment i.e. 1·62 hours

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18·730 hours 17·115 hours 1·615 hours

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

The following data are to be used when answering questions 1.5 and 1.6 JKL plc has $1 million available for investment. It has identified three possible investments, J, K and L, which each have a life of three years. The three year period coincides with JKL plc’s investment plans. JKL plc uses a 15% cost of capital when appraising investments of this type. Details of these investments are set out below: J $000

K $000

L $000

Initial investment

400

500

300

Net positive cashflows: Year 1 Year 2 Year 3

40 80 510

70 90 630

50 50 380

31

43

31

Net Present Value

Question 1.5 Assuming that each of the investments is divisible, they are not mutually exclusive and cannot be invested in more than once, state the optimum investment plan for JKL plc. (2 marks) Workings Profitability Index values are: J K L

31/400 = 0·0775 43/500 = 0·0860 31/300 = 0·1033

3rd 2nd 1st

Therefore the investment plan should be to invest: L in full K in full J x 50%

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Question 1.6 Calculate the Internal Rate of Return of an investment in project K to the nearest 0·01%. (3 marks) Workings The return is greater than 15% so try 20%: Year 0 1 2 3

Cashflow $000 (500) 70 90 630

Discount Factor 1·000 0·833 0·694 0·579 NPV

Present Value $000 (500·00) 58·31 62·46 364·77 (14·46)

Since the NPV is negative when the cashflows are discounted at 20%, the IRR of the project lies between 15% and 20%. The IRR = 15% + [(43/57·46) x 5] = 18·74%

Question 1.7 FH is an electronics company that has developed a new product for the video conferencing market. The product has successfully completed its testing phase and FH has now produced the first four production units. The first unit took 3 hours of labour time and the total time for the first four units was 8·3667 hours. Calculate the learning curve improvement rate (rate of learning) to the nearest 0·1%. (3 marks) Workings The average time per unit for 4 units = 8·3667 / 4 = 2·0917 hours 2·0917 / 3 = 0·6972 √0·6972 = 0·835 The rate of learning is 83·5%

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Question 1.8 A baker is trying to decide the number of batches of a particular type of bread that he should bake each day. Daily demand ranges from 10 batches to 12 batches. Each batch of bread that is baked and sold yields a positive contribution of £50, but each batch of bread baked that is not sold yields a negative contribution of £20. Assuming the baker adopts the minimax regret decision rule, calculate the number of batches of bread that he should bake each day. You must justify your answer. (4 marks) Workings Contribution table (all contribution figures in £): Sale/Demand 10 11 12 500 500 500 480 550 550 460 530 600

Make 10 11 12

Regret table (all contribution figures in £): Make 10 11 12

Sale/Demand 10 11 12 0 50 100 20 0 50 40 20 0

Maximum Regret 100 50 40

The answer is to make 12.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS Question 2 Advise the company on the optimum replacement cycle for its vehicles and state the net present value of the opportunity cost of making the wrong decision. Use a discount rate of 12% per year. All workings and assumptions should be shown. Ignore taxation. (10 marks) Rationale Question Two requires candidates to determine the optimum replacement cycle for the vehicles of a taxi company and to advise the company accordingly. The question addresses the learning outcome “Evaluate project proposals using the techniques of investment appraisal”. Suggested Approach • Identify the relevant cashflows arising from each choice of replacement cycle and ignore those that are common to both replacement cycles • Identify the timing of the relevant cashflows within the six year period • Discount the relevant cashflows using the discount factor provided • Compare the net present value of each replacement cycle and advise management to select the replacement cycle having the lowest net present cost • State the opportunity cost of the incorrect decision Marking Guide Calculation of the present value of the two-year replacement cycle Calculation of the present value of the three-year replacement cycle Compare present values, advise management and state the opportunity cost of the incorrect decision

Marks 4 4 2

Examiner’s Comments This was not answered well. The majority of candidates made the first common error listed below and some failed to gain marks from stating the best option and the opportunity cost of the incorrect decision. Presentation was often very poor. In some cases a string of unexplained figures multiplied by different discount factors were summed across the page. Common Errors • Discounting the two options over two and three years respectively and then dividing by the cumulative rate to obtain an annualised figure. This does not give the correct answer because of the inflation rates. • Providing incorrect inflation calculations. • Including non-relevant figures, namely, the initial purchase cost, the annual revenue from fares and the vehicle running costs. These items are not affected by the decision being taken.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Question 3 With reference to the above scenario (i) briefly explain absorption and marginal cost approaches to pricing; (ii) discuss the validity of the comment “any price that exceeds variable costs is better than no work”. (10 marks) Rationale Question Three requires candidates to interpret a short scenario, briefly explain absorption and marginal cost approaches to pricing and then to discuss a comment made by one of the managers concerning the acceptance of prices which are lower than full cost. This question addresses the learning outcome “Explain the particular issues that arise in pricing decisions and the conflict between marginal cost principles and the need for full recovery of all costs incurred”. Suggested Approach • Explain the difference between marginal costing and absorption costing • Explain how the two costing systems are likely to influence managers’ pricing decisions • Discuss the validity of the Managing Director’s comment in relation to both short-term and long-term pricing decisions Marking Guide Explain the difference between marginal costing and absorption costing Explain how the two costing systems are likely to influence managers’ pricing decisions Discuss the validity of the Managing Director’s comment in relation to both short-term and long-term pricing decisions

Marks 3 2 5

Examiner’s Comments Many answers did not go beyond the most basic points which would have been appropriate in a low level cost accounting exam and many did not address the specific question on pricing but instead dealt with the question in general terms. Common Errors • Providing explanations of the approaches to pricing which started with the selling price and then explained how the costs were deducted to arrive at a contribution or profit. • Providing explanations of pricing under absorption costing which discussed only fixed overheads and the absorption method and failed to mention that variable costs also had to be included in the calculation of mark-up and price. • Failing to consider the bespoke nature of the business when discussing pricing.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Question 4 Prepare a report addressed to the Management Team of PK plc that explains the changing nature of cost structures in the modern manufacturing environment and the implications for PK plc’s (i) inventory valuation (ii) short term decision making (10 marks) Note: There are 2 marks available for format and presentational style

Rationale Question Four requires candidates to interpret a short scenario and then to prepare a report that explains the changing nature of cost structures in the modern manufacturing environment and its implications for stock valuation and short-term decision making. This question addresses the learning outcome “Explain the possible conflicts between cost accounting for profit reporting and stock valuation and the convenient availability of information for decision making”. Suggested Approach • Explain traditional cost classifications for management decisions • Explain the changes in cost structure caused by the modern manufacturing environment • Explain the importance of understanding cost structures when valuing stock and making short-term decisions Marking Guide Explain traditional cost classifications and how the modern manufacturing environment has changed cost structures Explain the importance of understanding cost structures when valuing stock and making short-term decisions Report format (headings, numbered paragraphs, introduction and conclusion)

Marks 4 4 2

Examiner’s Comments This was very badly answered. Candidates did not realise that the crux of the question was how cost structures (i.e. mainly the balance between labour and overhead costs) have changed in recent times. However, most candidates made a reasonable attempt at producing the answer in a report format. Common Errors • Advising the company to eliminate inventory and use JIT. • Misunderstanding the term inventory valuation. It refers to the valuation of an item of stock and not to the total value of inventory, and so reducing the number of units of stock held does not affect the method of inventory valuation. • Basing the answer on global markets and on general changes in the environment.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE Question 5

(a)

Prepare calculations for each combination of the most likely, optimistic and pessimistic cost and revenue values to evaluate whether or not the MP Organisation should continue with the production of the film. Discuss your analysis and make a recommendation to MP. (15 marks)

(b)

Prepare notes for the management meeting that explain how probabilities can be used (i) to calculate the expected NPV; and (ii) in a simulation model to evaluate the risk of a long term decision. (10 marks) (Total for Question Five = 25 marks)

Rationale Question Five requires candidates to prepare calculations to enable them to evaluate whether or not the organisation in the scenario should continue with the production of a film in part (a) and then to discuss the use of probabilities in long term decision making in part (b). This question addresses the learning outcomes “Evaluate project proposals using the techniques of investment appraisal” and “Evaluate the impact of uncertainty and risk on decision models that may be based on CVP analysis, relevant cash flows, learning curves, discounting techniques, etc”. Suggested Approach

(a) • • • • •

Identify the relevant production costs that can be determined with certainty Identify the relevant production costs that are uncertain and calculate their three possible values Calculate the present value of the three possible values of relevant production costs Calculate the present value of the relevant non production costs Calculate the present value of the revenues that could occur at each of the three possible levels of sales demand • Prepare a table that shows the nine possible combinations of relevant revenues and relevant costs that could occur and their respective total net present values • Discuss the analysis and make a recommendation to management

(b) • Discuss the use of probabilities to evaluate decisions of this type • Discuss the use of simulation modelling to evaluate decisions of this type

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Marking Guide

Marks

(a) Calculate the present value of the three possible values of relevant production costs Calculate the present value of the relevant non production costs Calculate the present value of the revenues that could occur at each of the three possible levels of sales demand Prepare a table that shows the nine possible combinations of relevant revenues and relevant costs that could occur and their respective total net present values Discuss the analysis and make a recommendation to management

3 2 4 4 2

(b) Discuss the use of probabilities to evaluate decisions of this type Discuss the use of simulation modelling to evaluate decisions of this type

5 5

Examiner’s Comments In part (a) the method of calculation was not always properly thought out resulting in numerous unnecessary duplicated calculations. Part (b) was very badly answered and few candidates appeared to have any knowledge of simulation. Common Errors • Producing figures for only three outcomes: pessimistic, most likely and optimistic and not figures for all nine outcomes as the question required.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Question 6

(a)

State the principles of throughput accounting and the effects of using it for short-term decision making. (6 marks)

(b)

Prepare calculations to determine the production mix that will maximise the profit of QP plc during the next three months. (10 marks)

(c)

Explain the meaning of each of the values contained in the above solution. (9 marks) (Total for Question Six = 25 marks)

Rationale Question Six requires candidates to state the principles of throughput accounting in part (a), determine an optimum production mix when there is a single scarce resource in part (b) and explain the meaning of a linear programming solution in part (c). This question addresses the learning outcomes “Discuss the meaning of optimal solutions and show how linear programming methods can be employed for profit maximising, revenue maximising and satisfying objectives” and “Evaluate the impacts of just in time production, the theory of constraints and total quality management on efficiency, inventory and cost”. Suggested Approach

(a) • Explain the effect of using throughput accounting on the measurement of contribution • Explain the effect of using throughput accounting to focus on constraints and how to maximise the benefits from using scarce resources

(b) • Identify material L as the limiting factor • Calculate the contribution per kg of material L using the throughput accounting concept of contribution • Calculate the product mix that maximises the value of contribution

(c) • Explain the meaning of each of the values provided in the linear programming solution Marking Guide

Marks

(a) Explain the effect of using throughput accounting on the measurement of contribution Explain the effect of using throughput accounting to focus on constraints and how to maximise the benefits from using scarce resources

2 4

(b) Calculate the contribution per kg of material L using the throughput accounting concept of contribution Calculate the product mix that maximises the value of contribution

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5 5

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

(c) Explain the meaning of each of the values provided in the linear programming solution (1 mark each)

9

Examiner’s Comments This was extremely well answered, but it was disappointing to find that in part (b) a number of candidates failed to read the question properly and made the first error listed below. Common Errors • Including labour costs in the calculation of the contribution. • Describing production processes and bottlenecks in detail, which relates to the Theory Of Constraints rather than to throughput accounting itself.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Question 7

(a)

Prepare calculations to show the cost attributed to each client group using an activity based system of attributing costs. (7 marks)

(b)

Discuss the differences between the costs attributed using activity based costing and those attributed by the current system and advise whether the senior consultant’s suggestion should be adopted. (9 marks)

(c)

In a manufacturing environment activity based costing often classifies activities into those that are: unit; batch; product sustaining; and facility sustaining. Discuss, giving examples, how similar classifications may be applied to the use of the technique in consultancy organisations such as ZP plc. (9 marks) (Total for Question Seven = 25 marks)

Rationale Question 7 requires candidates to apply the principles of activity based costing to a marketing consultancy in part (a), to discuss the differences between an activity based approach and a traditional overhead absorption approach in part (b) and to explain in part (c) how the classification of activities in activity based costing could be used in consultancy organisations. This question addresses the learning outcomes “Apply the techniques of activity-based management in identifying cost drivers / activities and explain how process re-engineering can be used to eliminate non-value adding activities and reduce activity costs” and “Apply activity based costing ideas to analyse direct customer profitability and extend this analysis to distribution channel profitability”. Suggested Approach

(a) • Calculate the cost driver rates for the travel, accommodation and other costs based on mileage, number of overnight stays, and chargeable hours respectively • Prepare a table showing the costs attributed to each client profile using these cost driver rates

(b) • Compare activity based costs for each client profile with those determined using the present costing system • Discuss the use of activity based costing and whether or not it should be adopted by ZP plc

(c) • Identify the corresponding classifications of activities that could be used by ZP plc • Provide examples of activities within ZP plc for each of these classifications • Provide a conclusion that explains why ZP plc might improve its efficiency by adopting an activity based approach to cost analysis

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2005 Exam

Marking Guide

Marks

(a) Calculation of travel costs for each client profile Calculation of accommodation costs for each client profile Calculation of other costs for each client profile

2 2 3

(b) Comparison of costs Recognising the similarity of the costs derived by each system Discussion of cost v benefits of using ABC in this scenario Explaining wider theoretical benefits of using ABC

2 2 3 2

(c) Identify the corresponding classifications that could be used by ZP plc Provide examples of activities within ZP plc for each of these classifications Conclusion

4 4 1

Examiner’s Comments This should have been a straightforward question, but parts (a) and (c) were not answered well. Examples of the activities of a consultancy which would fit within the four activity classifications were poor and explanations for their inclusion were usually lacking. Common Errors • Failing to read the third bullet point in the question and as a consequence selecting different, and therefore incorrect, cost drivers. • Being unable to use the figures given in the question to calculate the correct cost driver rates.

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Managerial Level Paper

P2 – Management Accounting Decision Management 23 November 2005 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper You are allowed 20 minutes reading time before the examination begins during which you should read the question paper, and if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. Answer the ONE compulsory question in Section A. This is comprised of eight sub-questions and is on pages 2 to 4. Answer ALL THREE compulsory questions in Section B on pages 5 to 7. Answer TWO of the three questions in Section C on pages 8 to 13. Maths Tables and Formulae are provided on pages 15 to 17. These pages are detachable for ease of reference. Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

P2 – Decision Management

Management Accounting Pillar

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. TURN OVER  The Chartered Institute of Management Accountants 2005

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6, 1.7, and 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions.

Question One 1.1

A five year project has a net present value of $160,000 when it is discounted at 12%. The project includes an annual cash outflow of $50,000 for each of the five years. No tax is payable on projects of this type.

The percentage increase in the value of this annual cash outflow that would make the project no longer financially viable is closest to A

64%

B

89%

C

113%

D

156% (2 marks)

Question One continues on the opposite page

P2

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The following data are to be used when answering questions 1.2 and 1.3 A company expects to sell 1,000 units per month of a new product but there is uncertainty as to both the unit selling price and the unit variable cost of the product. The following estimates of selling price, variable costs and their related probabilities have been made: Selling Price £ per unit Probability 20 25% 25 40% 30 35%

Unit Variable Cost £ per unit Probability 8 20% 10 50% 12 30%

There are specific fixed costs of £5,000 per month expected for the new product. 1.2

The expected value of monthly contribution is

A

£5,890

B

£10,300

C

£10,890

D

£15,300 (2 marks)

1.3

The probability of monthly contribution from this new product exceeding £13,500 is

A

24·5%

B

30·5%

C

63·0%

D

92·5% (2 marks)

1.4

PT has discovered that when it employs a new test engineer there is a learning curve with a 75% rate of learning that exists for the first 12 customer assignments. A new test engineer completed her first customer assignment in 6 hours.

Calculate the time that she should take for her 7th assignment to the nearest 0·01 hours. Note: The index for a 75% learning curve is -0·415. (2 marks)

Question One continues on the next page

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P2

The following data are to be used when answering questions 1.5 and 1.6 JKL plc has $1 million available for investment. It has identified three possible investments, J, K and L, which each have a life of three years. The three year period coincides with JKL plc’s investment plans. JKL plc uses a 15% cost of capital when appraising investments of this type. Details of these investments are set out below: J $000

K $000

L $000

Initial investment

400

500

300

Net positive cashflows: Year 1 Year 2 Year 3

40 80 510

70 90 630

50 50 380

31

43

31

Net Present Value 1.5

Assuming that each of the investments is divisible, they are not mutually exclusive and cannot be invested in more than once, state the optimum investment plan for JKL plc. (2 marks)

1.6

Calculate the Internal Rate of Return of an investment in project K to the nearest 0·01%. (3 marks)

1.7

FH is an electronics company that has developed a new product for the video conferencing market. The product has successfully completed its testing phase and FH has now produced the first four production units. The first unit took 3 hours of labour time and the total time for the first four units was 8·3667 hours.

Calculate the learning curve improvement rate (rate of learning) to the nearest 0·1%. (3 marks) 1.8

A baker is trying to decide the number of batches of a particular type of bread that he should bake each day. Daily demand ranges from 10 batches to 12 batches. Each batch of bread that is baked and sold yields a positive contribution of £50, but each batch of bread baked that is not sold yields a negative contribution of £20.

Assuming the baker adopts the minimax regret decision rule, calculate the number of batches of bread that he should bake each day. You must justify your answer. (4 marks) (Total for Section A = 20 marks)

End of Section A Section B starts on the opposite page P2

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November 2005

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SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS Question Two The owner of a taxi company is considering the replacement of his vehicles. He is planning to retire in 6 years’ time and is therefore only concerned with that period of time, but cannot decide whether it is better to replace the vehicles every two years or every three years. The following data have been estimated (all values at today's price levels): Purchase cost and trade in values Taxi cost £15,000 Trade-in value of taxi: after 2 years £7,000 after 3 years £4,000 Annual costs and revenues Vehicle running cost Fares charged to customers

£20,000 per year £40,000 per year

Vehicle servicing and repair costs Vehicle servicing and repair costs depend on the age of the vehicle. In the following table year 1 represents the cost in the first year of the vehicle's ownership; year 2 represents the cost in the second year of ownership, and so on: Year 1 Year 2 Year 3

£500 £2,500 £4,000

Inflation New vehicle costs and trade in-values are expected to increase by 5% per year. Vehicle running costs and fares are expected to increase by 7% per year. Vehicle servicing and repair costs are expected to increase by 10% per year.

Required: Advise the company on the optimum replacement cycle for its vehicles and state the net present value of the opportunity cost of making the wrong decision. Use a discount rate of 12% per year. All workings and assumptions should be shown. Ignore taxation. (10 marks)

Section B continues on the next page TURN OVER

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P2

Question Three ML is an engineering company that specialises in providing engineering facilities to businesses that cannot justify operating their own facilities in-house. ML employs a number of engineers who are skilled in different engineering techniques that enable ML to provide a full range of engineering facilities to its customers. Most of the work undertaken by ML is unique to each of its customers, often requiring the manufacture of spare parts for its customers’ equipment, or the building of new equipment from customer drawings. As a result most of ML’s work is short-term, with some jobs being completed within hours while others may take a few days. To date ML has adopted a cost plus approach to setting its prices. This is based upon an absorption costing system that uses machine hours as the basis of absorbing overhead costs into individual job costs. The Managing Director is concerned that over recent months ML has been unsuccessful when quoting for work with the consequence that there has been an increase in the level of unused capacity. It has been suggested that ML should adopt an alternative approach to its pricing based on marginal costing since “any price that exceeds variable costs is better than no work”.

Required: With reference to the above scenario (i) briefly explain absorption and marginal cost approaches to pricing; (ii) discuss the validity of the comment “any price that exceeds variable costs is better than no work”. (10 marks)

Section B continues on the opposite page

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November 2005

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Question Four You are the assistant management accountant within PK plc. PK plc manufactures high quality self-assembly furniture from raw materials utilising highly skilled labour within a computercontrolled manufacturing facility. The company produces a range of furniture, and, because of the lead time to receive delivery of its raw materials, has a finished goods inventory policy of holding an average of two weeks estimated sales in inventory. Customer demand is seasonal and, as a consequence, this finished goods inventory level fluctuates throughout the year. The company also holds inventories of raw materials based upon estimates of its production requirements. An absorption costing system is used to attribute all manufacturing costs to output. Increasingly PK plc is facing competition, particularly from overseas manufacturers and its sales team have to make decisions about the extent to which it can offer price discounts in order to win customer orders.

Required: Prepare a report addressed to the Management Team of PK plc that explains the changing nature of cost structures in the modern manufacturing environment and the implications for PK plc’s (i) inventory valuation (ii) short term decision making (10 marks) Note: There are 2 marks available for format and presentational style

(Total for Section B = 30 marks)

End of Section B Section C starts on the next page

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE Question Five The MP Organisation is an independent film production company. It has a number of potential films that it is considering producing, one of which is the subject of a management meeting next week. The film which has been code named CA45 is a thriller based on a novel by a well respected author. The script has already been written at a cost of $10,000 and preliminary discussions have been held with the lead actors. The MP Organisation has incurred travel and other incidental costs of $4,000 to date. The following additional costs have been estimated in order to produce the film: Production director’s fee Set design Costumes and wardrobe Actors’ fees Musician / Songwriter for soundtrack Camera and equipment hire Actors’ travel and accommodation costs Other production costs

$000 100 10 20 50 5 20 10 5

Production of the film is estimated to take 16 weeks, and all of the above costs would be incurred during this period, though there is some uncertainty about the accuracy of these cost estimates. These cost values are those most likely to be incurred. With the exception of the payment to the production director which is a fixed fee, the other costs could be up to 10% higher or lower than the values estimated. In addition there will be advertising, promotion and marketing costs of $15,000 immediately, $10,000 in each of years 1 and 2, and then $5,000 during each of the next three years. These figures are not subject to any uncertainty. The film is expected to have a life of five years. During the first three years the film will be sold to cinemas through distributors and MP will receive 25% of the gross revenues. The film will be sold as a DVD for the remaining two years and MP will receive 100% of these revenues. The expected gross revenues are as follows: Year 1 2 3 4 5

Source Cinema Cinema Cinema DVD DVD

Gross revenue $400,000 $600,000 $450,000 $50,000 $30,000

MP’s share 25% 25% 25% 100% 100%

However it is thought that the gross revenues could vary by as much as 20% higher or lower than those stated, depending on the popularity of the film. The initial level of popularity will continue for all five years. The MP Organisation evaluates new films using a cost of capital of 15% per year.

P2

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Required: (a)

Prepare calculations for each combination of the most likely, optimistic and pessimistic cost and revenue values to evaluate whether or not the MP Organisation should continue with the production of the film. Discuss your analysis and make a recommendation to MP. (15 marks)

(b)

Prepare notes for the management meeting that explain how probabilities can be used (i) to calculate the expected NPV; and (ii) in a simulation model to evaluate the risk of a long term decision. (10 marks) (Total for Question Five = 25 marks)

Section C continues on the next page

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9

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P2

Question Six QP plc is a food processing company that produces pre-prepared meals for sale to consumers through a number of different supermarkets. The company specialises in three particular preprepared meals and has invested significantly in modern manufacturing processes to ensure a high quality product. The company is very aware of the importance of training and retaining high quality staff in all areas of the company and, in order to ensure their production employees’ commitment to the company, the employees are guaranteed a weekly salary that is equivalent to their normal working hours paid at their normal hourly rate of £7 per hour. The meals are produced in batches of 100 units. Costs and selling prices per batch are as follows: Meal

TR £/batch

PN £/batch

BE £/batch

Selling Price

340

450

270

Ingredient K (£5/kg) Ingredient L (£10/kg) Ingredient M (£15/kg)

150 70 30

120 90 75

90 40 45

Labour (£7/hour)

21

28

42

Factory costs absorbed

20

80

40

QP plc has adopted throughput accounting for its short-term decisions.

Required: (a)

(b)

State the principles of throughput accounting and the effects of using it for shortterm decision making. (6 marks)

QP plc is preparing its production plans for the next three months and has estimated the maximum demand from its customers to be as follows: TR PN BE

500 batches 400 batches 350 batches

These demand maximums are amended figures because a customer has just delayed its request for a large order and QP has unusually got some spare capacity over the next three months. However, these demand maximums do include a contract for the delivery of 50 batches of each to an important customer. If this minimum contract is not satisfied then QP plc will have to pay a substantial financial penalty for non-delivery. The Production Director is concerned at hearing news that two of the ingredients used are expected to be in short supply for the next three months. QP plc does not hold inventory of these ingredients and although there are no supply problems for ingredient K, the supplies of ingredients L and M are expected to be limited to: Ingredient L Ingredient M

P2

7,000 kilos 3,000 kilos

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The Production Director has researched the problem and found that ingredient V can be used as a direct substitute for ingredient M. It also costs the same as ingredient M. There is an unlimited supply of ingredient V.

Required: Prepare calculations to determine the production mix that will maximise the profit of QP plc during the next three months. (10 marks)

(c)

The World Health Organisation has now announced that ingredient V contains dangerously high levels of a chemical that can cause life-threatening illnesses. As a consequence it can no longer be used in the production of food.

As a result, the production director has determined the optimal solution to the company’s production mix problem using linear programming. This is set out below: Objective function value TR value PN value BE value TR slack value PN slack value BE slack value L value M value

110,714 500 357 71 0 43 279 3 28

Required: Explain the meaning of each of the values contained in the above solution. (9 marks) (Total for Question Six = 25 marks)

Section C continues on the next page

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P2

Question Seven ZP plc is a marketing consultancy that provides marketing advice and support to small and medium sized enterprises. ZP plc employs 4 full time marketing consultants who each expect to deliver 1,500 chargeable hours per year and each receive a salary of £60,000 per year. In addition the company employs 6 marketing support/administration staff whose combined total salary cost is £120,000 per year. ZP plc has estimated its other costs for the coming year as follows: £000 50 5 15 11 10

Office premises: rent, rates, heating Advertising Travel to clients Accommodation whilst visiting clients Telephone, fax, communications

ZP plc has been attributing costs to each client (and to the projects undertaken for them) by recording the chargeable hours spent on each client and using a single cost rate of £75 per chargeable hour. The same basis has been used to estimate the costs of a project when preparing a quotation for new work. ZP plc has reviewed its existing client database and determined the following three average profiles of typical clients: Client profile Chargeable hours per client Distance (Miles) to client Number of visits per client Number of clients in each profile

D 100 50 3

E 700 70 8

F 300 100 3

10

5

5

The senior consultant has been reviewing the company’s costing and pricing procedures. He suggests that the use of a single cost rate should be abandoned and, where possible, activities should be costed individually. With this is mind he has obtained the following further information: •

• •

P2

It is ZP plc’s policy that where a visit is made to a client and the distance to the client is more than 50 miles, the consultant will travel the day before the visit and stay in local accommodation so that the maximum time is available for meeting the client the following day. The cost of travel to the client is dependent on the number of miles travelled to visit the client. Other costs are facility costs – at present the senior consultant cannot identify an alternative basis to that currently being used to attribute costs to each client.

12

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Required: (a)

Prepare calculations to show the cost attributed to each client group using an activity based system of attributing costs. (7 marks)

(b)

Discuss the differences between the costs attributed using activity based costing and those attributed by the current system and advise whether the senior consultant’s suggestion should be adopted. (9 marks)

(c)

In a manufacturing environment activity based costing often classifies activities into those that are: unit; batch; product sustaining; and facility sustaining. Discuss, giving examples, how similar classifications may be applied to the use of the technique in consultancy organisations such as ZP plc. (9 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of question paper Maths Tables and Formulae are on pages 15 to 17

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P2

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P2

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PRESENT VALUE TABLE Present value of $1, that is (1+ r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

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FORMULAE Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b= and or solve

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX ∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X2 Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

November 2005

17

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P2

P2

18

November 2005

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November 2005

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P2

Management Accounting Pillar

Managerial Level

P2 – Management Accounting – Decision Management

November 2005

Wednesday Morning Session

P2

20

November 2005

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Managerial Level Paper

P2 – Management Accounting Decision Management 24 May 2006 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper You are allowed 20 minutes reading time before the examination begins during which you should read the question paper, and if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. Answer the ONE compulsory question in Section A. This is comprised of eight sub-questions and is on pages 2 to 5. Answer ALL THREE compulsory questions in Section B on pages 6 to 8. Answer TWO of the three questions in Section C on pages 10 to 15. Maths Tables and Formulae are provided on pages 17 to 19. These pages are detachable for ease of reference. Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

P2 – Decision Management

Management Accounting Pillar

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. TURN OVER  The Chartered Institute of Management Accountants 2006

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6, 1.7, and 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions.

Question One 1.1

X plc intends to use relevant costs as the basis of the selling price for a special order: the printing of a brochure. The brochure requires a particular type of paper that is not regularly used by X plc although a limited amount is in X plc’s inventory which was left over from a previous job. The cost when X plc bought this paper last year was $15 per ream and there are 100 reams in inventory. The brochure requires 250 reams. The current market price of the paper is $26 per ream, and the resale value of the paper in inventory is $10 per ream.

The relevant cost of the paper to be used in printing the brochure is A

$2,500

B

$4,900

C

$5,400

D

$6,500 (2 marks)

Section A continues on the opposite page

P2

2

May 2006

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1.2

A farmer grows potatoes for sale to wholesalers and to individual customers. The farmer currently digs up the potatoes and sells them in 20kg sacks. He is considering a decision to make a change to this current approach. He thinks that washing the potatoes and packaging them in 2kg cartons might be more attractive to some of his individual customers. Which of the following is relevant to his decision? (i) (ii) (iii) (iv)

the sales value of the dug potatoes the cost per kg of growing the potatoes the cost of washing and packaging the potatoes the sales value of the washed and packaged potatoes

A

(ii), (iii) and (iv) only

B

(i), (ii) and (iii) only

C

(i), (ii) and (iv) only

D

(i), (iii) and (iv) only (2 marks)

1.3

A company makes and sells three products, R, S, and T. Extracts from the weekly profit statements are as follows: R $ 10,000

S $ 15,000

T $ 20,000

Total $ 45,000

Variable cost of sales Fixed costs*

4,000 3,000

9,000 3,000

10,000 3,000

23,000 9,000

Profit

3,000

3,000

7,000

13,000

Sales

* general fixed costs absorbed using a unit absorption rate If the sales revenue mix of products produced and sold were to be changed to: R 20%, S 50%, T 30% then the new average contribution to sales ratio A

would be higher.

B

would be lower.

C

would remain unchanged.

D

cannot be determined without more information. (2 marks)

Section A continues on the next page

TURN OVER

May 2006

3

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P2

1.4

Z Limited is a hotel that serves cakes and gateaux in its coffee shop. An analysis of its internal costs has revealed that the variable cost of preparing its own gateaux is £5·50 per gateau compared to the price of £8·00 per gateau that would be charged by an external bakery. Z Limited employs a chef to prepare the gateaux at a salary of £1,000 per month. This chef is not able to carry out any other work in the hotel and is the only employee capable of preparing the gateaux.

Calculate the minimum monthly number of sales of gateaux at which it is worthwhile preparing the gateaux in the hotel. (2 marks)

The following data are to be used when answering questions 1.5 to 1.7 M plc is evaluating three possible investment projects and uses a 10% discount rate to determine their net present values. Investment Initial Investment Incremental cashflows Year 1 Year 2 Year 3 Year 4 Year 5*

A £000 400

B £000 450

C £000 350

100 120 140 120 100

130 130 130 130 150

50 110 130 150 100

39

55

48

Net present value

*includes £20,000 residual value for each investment project. 1.5

Calculate the payback period of investment A. (2 marks)

1.6

Calculate the discounted payback period of investment B. (3 marks)

1.7

Calculate the Internal Rate of Return (IRR) of investment C. (3 marks)

Section A continues on the opposite page

P2

4

May 2006

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1.8

A company is preparing a quotation for a new product. The time taken for the first unit of the product was 30 minutes and the company expects an 85% learning curve. The quotation is to be based on the time taken for the final unit within the learning period which is expected to end after the company has produced 200 units.

Calculate the time per unit to be used for the quotation. Note: The learning index for an 85% learning curve is -0·2345 (4 marks) (Total for Section A = 20 marks)

End of Section A Section B starts on the next page

TURN OVER

May 2006

5

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P2

SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS Question Two A manager is evaluating a three year project which has the following relevant pre-tax operating cashflows: Year Sales Costs

1 $000 4,200 2,850

2 $000 4,900 3,100

3 $000 5,300 4,150

The project requires an investment of $2m at the start of year 1 and has no residual value. The company pays corporation tax on its net relevant operating cashflows at the rate of 20%. Corporation tax is payable in the same year as the net relevant pre-tax operating cashflows arise. There is no tax depreciation available on the investment. The manager has discounted the net relevant post-tax operating cashflows using the company’s post-tax cost of capital of 7% and this results in a post-tax net present value of the project of $1·018m.

Required: (a)

Briefly explain sensitivity analysis and how the manager may use it in the evaluation of this project. (4 marks)

(b)

Calculate the sensitivity of the project to independent changes in (i) (ii)

the selling price; the cost of capital. (6 marks) (Total for Question Two = 10 marks)

Section B continues on the opposite page

P2

6

May 2006

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Question Three A firm of financial advisors has established itself by providing high quality, personalised, financial strategy advice. The firm promotes itself by sponsoring local events, advertising, client newsletters, having a flexible attitude towards the times and locations of meetings with clients and seeking new and innovative ideas to discuss with its clients. The senior manager of the firm has recently noticed that the firm’s profitability has declined, with fewer clients being interested in the firm’s new investment ideas. Indeed, many clients have admitted to not reading the firm’s newsletters. The senior manager seeks your help in restoring the firm’s profitability to its former level and believes that the techniques of Value Analysis and Functional Analysis may be appropriate.

Required: (a)

Explain the meanings of, and the differences between, Value Analysis and Functional Analysis. (4 marks)

(b)

Briefly explain the series of steps that you would take to implement Value Analysis for this organisation. (6 marks) (Total for Question Three = 10 marks)

Section B continues on the next page

TURN OVER

May 2006

7

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P2

Question Four The Managing Director of a manufacturing company based in Eastern Europe has recently returned from a conference on modern manufacturing. One of the speakers at the conference presented a paper entitled “Compliance versus Conformance – the quality control issue”. The Managing Director would like you to explain to her some of the concepts that she heard about at the conference.

Required: Prepare a report, addressed to the Managing Director, that discusses quality costs and their significance for the company. Your report should include examples of the different quality costs and their classification within a manufacturing environment. (10 marks) Note: 2 marks are available for report format

(Total for Section B = 30 marks)

End of Section B Section C starts on page 10

P2

8

May 2006

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[this page is blank]

TURN OVER

May 2006

9

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE Question Five AVX Plc assembles circuit boards for use by high technology audio video companies. Due to the rapidly advancing technology in this field, AVX Plc is constantly being challenged to learn new techniques. AVX Plc uses standard costing to control its costs against targets set by senior managers. The standard labour cost per batch of one particular type of circuit board (CB45) is set out below: Direct labour - 50 hours @ £10 /hour

£ 500

The following labour efficiency variances arose during the first six months of the assembly of CB45: Month November December January February March April

Number of batches assembled and sold 1 1 2 4 8 16

Labour Efficiency Variance (£) Nil 170·00 Favourable 452·20 Favourable 1,089·30 Favourable 1,711·50 Favourable 3,423·00 Favourable

An investigation has confirmed that all of the costs were as expected except that there was a learning effect in respect of the direct labour that had not been anticipated when the standard cost was set.

Required: (a)

(i) (ii)

Calculate the monthly rates of learning that applied during the six months; Identify when the learning period ended and briefly discuss the implications of your findings for AVX Plc. (10 marks)

AVX Plc initially priced each batch of CB45 circuit boards on the basis of its standard cost of £960 plus a mark up of 25%. Recently the company has noticed that, due to increasing competition, it is having difficulty maintaining its sales volume at this price. The Finance Director has agreed that the long run unit variable cost of the CB45 circuit board is £672·72 per batch. She has suggested that the price charged should be based on an analysis of market demand. She has discovered that at a price of £1,200 the demand is 16 batches per month, for every £20 reduction in selling price there is an increase in demand of 1 batch of CB45 circuit boards, and for every £20 increase in selling price there is a reduction in demand of 1 batch.

P2

10

May 2006

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Required: (b)

Calculate the profit maximising selling price per batch using the data supplied by the Finance Director (8 marks)

Note: If Price (P) = a-bx then Marginal Revenue (MR) = a-2bx

The Technical Director cannot understand why there is a need to change the selling price. He argues that this is a highly advanced technological product and that AVX Plc should not reduce its price as this reflects badly on the company. If anything is at fault, he argues, it is the use of Standard Costing and he has asked whether Target Costing should be used instead.

Required: (c) (i) (ii)

Explain the difference between standard costs and target costs; Explain the possible reasons why AVX Plc needs to re-consider its pricing policy now that the CB45 circuit board has been available in the market for six months. (7 marks) (Total for Question Five = 25 marks)

Section C continues on the next page

TURN OVER May 2006

11

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P2

Question Six A health clinic is reviewing its plans for the next three years. It is a not for profit organisation but it has a financial responsibility to manage its costs and to ensure that it provides a value for money service to its clients. The health clinic uses the net present value technique to appraise the financial viability of delivering the service, but it also considers other non-financial factors before making any final decisions. The present facilities, which incur an annual total cost of £300,000, are only sufficient to meet a low level of service provision so the manager is considering investing in facilities to meet potential higher levels of demand. For the purpose of evaluating this decision the possible levels of demand for the health clinic’s services have been simplified to high, medium or low. The possible demand for the services in the first year and the level of demand that could follow that specific level in the next years, and their expected probabilities, are as follows: Year 1 Low

Probability 30%

Years 2 and 3 Low Medium High

Probability 40% 60% 0%

Medium

50%

Low Medium High

30% 40% 30%

High

20%

Low Medium High

0% 30% 70%

The level of demand will be the same in years 2 and 3. The manager is considering two alternative investments in facilities: Facility A has the capacity to meet the low and medium levels of demand and requires an investment at the start of year 1 of £500,000. Thereafter it incurs annual fixed costs of £100,000 and annual variable costs depending on the level of operation. These annual variable costs are expected to be £150,000 at the low level of operation and £250,000 at the medium level of operation. Facility B has the capacity to meet all levels of demand and requires an investment at the start of year 1 of £800,000. Thereafter it incurs annual fixed costs of £200,000 and annual variable costs depending on the level of operation. These annual variable costs are expected to be £100,000 at the low level of operation, £150,000 at the medium level of operation and £200,000 at the high level of operation. Neither of these alternative investments has any residual value at the end of year 3. If the facilities of the health clinic are insufficient to meet the level of service demand that occurs, the clinic must obtain additional facilities on a yearly contract basis at the following annual costs: Level of service provision available internally Low Low Medium

Level of service provision demanded Medium High High

Annual cost of additional facilities £100,000 £250,000 £150,000

These additional facilities are not under the direct control of the health clinic manager. Note: All monetary values used throughout the question have been stated in terms of their present value. No further discounting is required. P2

12

May 2006

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Required: (a)

Prepare a decision tree to illustrate the investment decision that needs to be made by the manager of the health clinic. (Numerical values are NOT required). (6 marks)

(b)

Advise the manager of the health clinic which investment decision should be undertaken on financial grounds. (15 marks)

(c)

Briefly discuss any non-financial factors that the manager should consider before making her final investment decision. (4 marks) (Total for Question Six = 25 marks)

Section C continues on the next page

TURN OVER

May 2006

13

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P2

Question Seven GHK manufactures four products from different combinations of the same direct materials and direct labour. An extract from the flexible budgets for next quarter for each of these products is as follows: Product

G

H

J

K

Units

3,000

5,000

3,000

5,000

3,000

5,000

3,000

5,000

Revenue

$000 30

$000 50

$000 60

$000 100

$000 45

$000 75

$000 90

$000 150

9 6 6 6

15 10 10 8

12 6 24 13

20 10 40 19

4·5 13·5 22·5 11

7·5 22·5 37·5 17

18 36 9 11

30 60 15 17

Direct Material A (note 1) Direct Material B (note 2) Direct labour (note 3) Overhead (note 4) Notes 1 2 3 4

Material A was purchased some time ago at a cost of $5 per kg. There are 5,000 kgs in inventory. The costs shown in the flexible budget are based on this historical cost. The material is in regular use and currently has a replacement cost of $7 per kg. Material B is purchased as required; its expected cost is $10 per kg. The costs shown in the flexible budget are based on this expected cost. Direct labour costs are based on an hourly rate of $10 per hour. Employees work the number of hours necessary to meet production requirements. Overhead costs of each product include a specific fixed cost of $1,000 per quarter which would be avoided if the product was to be discontinued. Other fixed overhead costs are apportioned between the products but are not affected by the mix of products manufactured.

GHK has been advised by the only supplier of material B that the quantity of material B that will be available during the next quarter will be limited to 5,000 kgs. Accordingly the company is being forced to reconsider its production plan for the next quarter. GHK has already entered into contracts to supply one of its major customers with the following: 500 units of product G 1,600 units of product H 800 units of product J 400 units of product K Apart from this, the demand expected from other customers is expected to be 3,600 units of product G 3,000 units of product H 3,000 units of product J 4,000 units of product K The major customer will not accept partial delivery of the contract and if the contract with this major customer is not completed in full, then GHK will have to pay a financial penalty of $5,000.

P2

14

May 2006

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Required: (a)

For each of the four products, calculate the relevant contribution per $ of material B for the next quarter. (6 marks)

(b)

It has been determined that the optimum production plan based on the data above is to produce 4,100 units of product G, 4600 units of product H, 800 units of product J, and 2,417 units of product K. Determine the amount of financial penalty at which GHK would be indifferent between meeting the contract or paying the penalty. (5 marks)

(c)

Calculate the relevant contribution to sales ratios for each of the four products. (2 marks)

(d)

Assuming that the limiting factor restrictions no longer apply, prepare a sketch of a multi product profit volume chart by ranking the products according to your contribution to sales ratio calculations based on total market demand. Your sketch should plot the products using the highest contribution to sales ratio first. (6 marks)

(e)

Explain briefly, stating any relevant assumptions and limitations, how the multi product profit volume chart that you prepared in (d) above may be used by the manager of GHK to understand the relationships between costs, volume and profit within the business. (6 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of question paper Maths Tables and Formulae are on pages 17 to 19

TURN OVER May 2006

15

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P2

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P2

16

May 2006

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PRESENT VALUE TABLE Present value of $1, that is (1+ r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

May 2006

17

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

18

May 2006

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FORMULAE Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b= and or solve

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX ∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X2 Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

May 2006

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P2

Management Accounting Pillar

Managerial Level

P2 – Management Accounting – Decision Management

May 2006

Wednesday Morning Session

P2

24

May 2006

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

General Comments The May 2006 results showed a small improvement on November 2005, with a number of candidates displaying a high level of competence and attaining good results. Section A performance showed a noticeable improvement when compared to previous diets. However many attempts at questions in Section B, and more particularly in Section C, were disappointing, with candidates demonstrating poor application of skills within the given scenarios. The paper’s assessment strategy allows the Examiner to test a large proportion of the syllabus and, again, questions were based on the full breadth of the syllabus. Candidates are therefore reminded that they must study the whole of the published syllabus and be aware of the learning outcomes. Candidates should also ensure that they are familiar with the fundamental aspects of Management Accounting studied at Certificate level, particularly if they have been awarded exemptions from that level.

The Chartered Institute of Management Accountants

Page 1

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Section A – 20 marks Question 1.1 X plc intends to use relevant costs as the basis of the selling price for a special order: the printing of a brochure. The brochure requires a particular type of paper that is not regularly used by X plc although a limited amount is in X plc’s inventory which was left over from a previous job. The cost when X plc bought this paper last year was $15 per ream and there are 100 reams in inventory. The brochure requires 250 reams. The current market price of the paper is $26 per ream, and the resale value of the paper in inventory is $10 per ream. The relevant cost of the paper to be used in printing the brochure is A

$2,500

B

$4,900

C

$5,400

D

$6,500 (2 marks) The answer is B

Workings 100 reams @ resale value of $10 150 reams @ market price of $26

$1,000 $3,900 $4,900

Question 1.2 A farmer grows potatoes for sale to wholesalers and to individual customers. The farmer currently digs up the potatoes and sells them in 20kg sacks. He is considering a decision to make a change to this current approach. He thinks that washing the potatoes and packaging them in 2kg cartons might be more attractive to some of his individual customers. Which of the following is relevant to his decision? (i) (ii) (iii) (iv)

the sales value of the dug potatoes the cost per kg of growing the potatoes the cost of washing and packaging the potatoes the sales value of the washed and packaged potatoes

A

(ii), (iii) and (iv) only

B

(i), (ii) and (iii) only

C

(i), (ii) and (iv) only

D

(i), (iii) and (iv) only (2 marks) The answer is D

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 1.3 A company makes and sells three products, R, S, and T. Extracts from the weekly profit statements are as follows: R $ 10,000

S $ 15,000

T $ 20,000

Total $ 45,000

Variable cost of sales Fixed costs*

4,000 3,000

9,000 3,000

10,000 3,000

23,000 9,000

Profit

3,000

3,000

7,000

13,000

Sales

* general fixed costs absorbed using a unit absorption rate If the sales revenue mix of products produced and sold were to be changed to: R 20%, S 50%, T 30% then the new average contribution to sales ratio A

would be higher.

B

would be lower.

C

would remain unchanged.

D

cannot be determined without more information. (2 marks) The answer is B

Workings Contribution/Sales ratios are : R 60%, S 40%, and T 50% Now = $22,000 /$45,000 = 0·489 New = (0·6 x 0·2) + (0·4 x 0·5) + (0·5 x 0·3) = 0·47

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 1.4 Z Limited is a hotel that serves cakes and gateaux in its coffee shop. An analysis of its internal costs has revealed that the variable cost of preparing its own gateaux is £5·50 per gateau compared to the price of £8·00 per gateau that would be charged by an external bakery. Z Limited employs a chef to prepare the gateaux at a salary of £1,000 per month. This chef is not able to carry out any other work in the hotel and is the only employee capable of preparing the gateaux. Calculate the minimum monthly number of sales of gateaux at which it is worthwhile preparing the gateaux in the hotel. (2 marks)

Workings Variable cost saving per gateaux = £2·50 Fixed cost = £1,000 per month Minimum quantity = £1,000 / £2·50 = 400 gateaux

The following data are to be used when answering questions 1.5 to 1.7 M plc is evaluating three possible investment projects and uses a 10% discount rate to determine their net present values. Investment Initial Investment Incremental cashflows Year 1 Year 2 Year 3 Year 4 Year 5* Net present value

A £000 400

B £000 450

C £000 350

100 120 140 120 100

130 130 130 130 150

50 110 130 150 100

39

55

48

*includes £20,000 residual value for each investment project.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 1.5 Calculate the payback period of investment A. (2 marks) Workings Year 1 2 3 4

£000 100 120 140 120

£000 to date 220 360 480

Payback period = 3 years + 40/120ths of year 4 = 3·33 years

Question 1.6 Calculate the discounted payback period of investment B. (3 marks) Workings Discounted cashflows are: Year 1 2 3 4 5

£000 130 x 0·909 130 x 0·826 130 x 0·751 130 x 0·683 130 x 0·621

£000 118·17 107·38 97·63 88·79

£000

411·97 80·73

Discounted payback occurs in year 5 and can be estimated as: 4 years plus (450 – 411·97) / 80·73 of year five = 4·47 years.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 1.7 Calculate the Internal Rate of Return (IRR) of investment C. (3 marks) Workings Discount using 20% cost of capital Year

Cashflow £000 (350) 50 110 130 150 100

0 1 2 3 4 5

Discount Factor 1·000 0·833 0·694 0·579 0·482 0·402

Present Value £000 (350) 42 76 75 72 40

NPV

(45) Discount Factor

Change

10% 20% 10%

NPV £000 48 (45) (93)

IRR = 10% + (48/93 x 10%) = 15% (approx).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 1.8 A company is preparing a quotation for a new product. The time taken for the first unit of the product was 30 minutes and the company expects an 85% learning curve. The quotation is to be based on the time taken for the final unit within the learning period which is expected to end after the company has produced 200 units. Calculate the time per unit to be used for the quotation. Note: The learning index for an 85% learning curve is -0·2345 (4 marks) Workings y = axb At 200 units: y = 30 x 200-0.2345 = 8·660 Total time = 8·660 x 200 =

1,732·00 minutes

At 199 units: y = 30 x 199-0.2345 = 8·670 Total time = 8·670 x 199 =

1,725·33 minutes

The time for the 200th unit to be used for the quotation is 6·67 minutes

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS Question 2

(a)

Briefly explain sensitivity analysis and how the manager may use it in the evaluation of this project. (4 marks)

(b)

Calculate the sensitivity of the project to independent changes in (i) (ii)

the selling price; the cost of capital. (6 marks) (Total for Question Two = 10 marks)

Rationale Question Two requires candidates to explain sensitivity analysis and to use the data provided to calculate the sensitivity of an investment project to independent changes in two of the input variables. The question addresses the learning outcome “Apply sensitivity analysis to cash flow parameters to identify those to which net present value is particularly sensitive.” Suggested Approach Read the scenario carefully Explain the meaning of sensitivity analysis Explain how sensitivity analysis could be used by the manager Calculate the sensitivity of the project to a change in the selling price Calculate the sensitivity of the project to a change in the cost of capital Marking Guide Explain the meaning of sensitivity analysis Explain how sensitivity analysis could be used by the manager Calculate the sensitivity of the project to a change in the selling price Calculate the sensitivity of the project to a change in the cost of capital

Marks 2 2 2 4

Examiner’s Comments Most candidates attempted to explain sensitivity analysis but only those who related the technique to the scenario in the question scored highly. The attempts at part (b) were relatively poor, with candidates completely ignoring the tax implication and, in some cases, the time value of money Common Errors 1. Not relating the answer to the scenario in the question; 2. Ignoring the tax implication in part (b).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 3

(a)

Explain the meanings of, and the differences between, Value Analysis and Functional Analysis. (4 marks)

(b)

Briefly explain the series of steps that you would take to implement Value Analysis for this organisation. (6 marks) (Total for Question Three = 10 marks)

Rationale Question Three requires candidates to explain the meanings of and differences between Value Analysis and Functional Analysis and then to explain the steps that would be needed to implement Value Analysis into the organisation depicted in the scenario. This question addresses the learning outcome “Compare and contrast value analysis and functional cost analysis”. Suggested Approach Read the scenario carefully Explain the meanings of Value Analysis and Functional Analysis Explain the differences between Value Analysis and Functional Analysis Explain the steps to be taken to implement Value Analysis in the context of the scenario provided Marking Guide Explain the meanings of Value Analysis and Functional Analysis Explain the differences between them Explain the steps to be taken to implement Value Analysis

Marks 2 2 6

Examiner’s Comments Many candidates read “Value Analysis” as the “Value Chain” and put forward an answer based on Porter’s model. Very few candidates attempted to explain “Functional Analysis”. Part (b) required candidates to explain the process associated with Value Analysis but attempts were poor due to problems candidates encountered in answering part (a). Common Errors A number of candidates demonstrated a complete lack of understanding of the two techniques and of the difference between them (that is, Value Analysis relates to an existing product or service whereas Functional Analysis is more commonly applied to a product or service prior to its production).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 4 Prepare a report, addressed to the Managing Director, that discusses quality costs and their significance for the company. Your report should include examples of the different quality costs and their classification within a manufacturing environment. (10 marks) Note: 2 marks are available for report format

Rationale Question Four requires candidates to prepare a report that discusses quality costs and their significance for the company depicted in the scenario. This question addresses the learning outcome “Explain the concepts of continuous improvement and Kaizen costing that are central to total quality management and prepare cost of quality reports”. Suggested Approach Identify and explain the different quality costs with examples of each Discuss the significance of those costs for the company Marking Guide Identify and explain the different quality costs with examples of each Discuss the significance of those costs for the company Report format

Marks 4 4 2

Examiner’s Comments Most candidates made a good attempt at this question. However, a number of candidates failed to take advantage of the marks that were available for presenting the answer in a report format. (To, From and a date is simply not enough for two marks). Common Errors 1. Not presenting a report; 2. Not giving relevant examples of different quality costs; 3. Not developing the price/quality relationship; 4. Not developing the relationship between incurring conformance costs and avoiding non-conformance costs.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE Question 5

(a)

(i) (ii)

Calculate the monthly rates of learning that applied during the six months; Identify when the learning period ended and briefly discuss the implications of your findings for AVX Plc. (10 marks)

(b)

Calculate the profit maximising selling price per batch using the data supplied by the Finance Director (8 marks)

(c) (i) (ii)

Explain the difference between standard costs and target costs; Explain the possible reasons why AVX Plc needs to re-consider its pricing policy now that the CB45 circuit board has been available in the market for six months. (7 marks) (Total for Question Five = 25 marks)

Rationale Question Five requires candidates to prepare calculations to enable them to determine the rate of learning that occurred in the company depicted in the scenario, when this learning ended and its implications for the company in part (a). In part (b) candidates were required to calculate the company’s profit maximising price based upon the data provided, and then in part (c) to explain the differences between standard costs and target costs and the reasons why the company needs to reconsider its pricing policy now that its product has been available for six months. This question addresses the learning outcomes “Apply an approach to pricing based on profit maximisation in imperfect markets and evaluate the financial consequences of alternative pricing strategies” and “Explain and apply learning and experience curves to estimate time and cost for new products and services” and “Explain how target costs can be derived from target prices and describe the relationship between target costs and standard costs”.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Suggested Approach (a) Calculate the actual hours for each month and to date by combining the labour efficiency variances and the standard hours Calculate the cumulative average actual hours per batch for each month Calculate the rate of learning that occurred in each month until there is no further improvement Discuss the implications of the learning effect (b) Determine the price equation Determine the marginal revenue equation Determine the optimum quantity Determine the optimum price (c) Explain standard cost and target cost and the difference between them Explain why AVX Plc needs to reconsider its pricing policy Marking Guide (a) Calculate the actual hours for each month and to date by combining the labour efficiency variances and the standard hours Calculate the cumulative average actual hours per batch for each month Calculate the rate of learning that occurred in each month until there is no further improvement Discuss the implications of the learning effect (b) Determine the price equation Determine the marginal revenue equation Determine the optimum quantity Determine the optimum price (c) Explain standard cost and target cost and the difference between them Explain why AVX Plc needs to reconsider its pricing policy

Marks 3 2 3 2 4 1 2 1 4 3

Examiner’s Comments Part (a) was very poorly answered. The majority of candidates were unable to relate the efficiency variance to the learning curve and demonstrated a lack of understanding of the basic principles of the learning curve. Part (b) was very well answered (c) (i) A surprising number of candidates were unable to explain the term ‘standard cost’. This is one of the most important and fundamental aspects of management accounting. (c) (ii) Many answers described market skimming and market penetration, rather than developing the theme put forward in c(i), that AVX Plc needed to move from a cost plus pricing technique to a target selling price technique.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam Common Errors 1. Not being able to relate variances to the learning curve; 2. Not being able to explain the terms ‘standard cost’ and ‘target cost’; 3. Providing a detailed answer discussing different methods of pricing without relating the discussion to cost implications.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 6

(a)

Prepare a decision tree to illustrate the investment decision that needs to be made by the manager of the health clinic. (Numerical values are NOT required). (6 marks)

(b)

Advise the manager of the health clinic which investment decision should be undertaken on financial grounds. (15 marks)

(c)

Briefly discuss any non-financial factors that the manager should consider before making her final investment decision. (4 marks) (Total for Question Six = 25 marks)

Rationale Question Six requires candidates to prepare a decision tree for an investment decision, advise as to which decision should be taken on financial grounds and then to discuss any non financial factors that should also be considered. This question addresses the learning outcomes “Produce decision support information for management, integrating financial and non financial considerations” and “Prepare and apply decision trees”. Suggested Approach (a) Read the scenario carefully Identify the three alternatives Identify possible year 1 outcomes and plot them Identify the outcomes for the rest of the project and plot them (b) Identify the investment needed for each of options A and B Identify the costs expected to arise for each alternative Determine the probability of each outcome Calculate the total expected cost of each investment decision Advise the manager which decision should be taken on financial grounds (c) Identify and discuss any non-financial factors that the manager should consider before making her decision

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Marking Guide (a) Identify the three alternatives Identify possible year 1 outcomes and plot them Identify the outcomes for the rest of the project and plot them (b) Identify the investment needed for each of options A and B Identify the costs expected to arise for each alternative Determine the probability of each outcome Calculate the total expected cost of each investment decision Advise the manager which decision should be taken on financial grounds

Marks 1 2 3 2 5 3 3 2

(c) Identify and discuss any non-financial factors that the manager should consider before making her decision

4

Examiner’s Comments (a) Very few good attempts were put forward, with only a small percentage of candidates displaying a good knowledge of decision trees. Some attempts were extremely poor. (b) Many different approaches were acceptable. While there were some good attempts, a number of candidates simply presented a full page of figures, with poor labelling and descriptions, and expected the marker to pick out the relevant figures. (c) Most candidates put forward ‘general’ answers and did not mention the three most important nonfinancial factors: loss of control, problems concerning quality and the possible impact on staff motivation. Common Errors 1. Demonstrating a lack of understanding of decision trees 2. Demonstrating an inability to present financial information in a clear and concise manner. 3. Ignoring the option to continue as at present

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Question 7

(a)

For each of the four products, calculate the relevant contribution per $ of material B for the next quarter. (6 marks)

(b)

It has been determined that the optimum production plan based on the data above is to produce 4,100 units of product G, 4600 units of product H, 800 units of product J, and 2,417 units of product K. Determine the amount of financial penalty at which GHK would be indifferent between meeting the contract or paying the penalty. (5 marks)

(c)

Calculate the relevant contribution to sales ratios for each of the four products. (2 marks)

(d)

Assuming that the limiting factor restrictions no longer apply, prepare a sketch of a multi product profit volume chart by ranking the products according to your contribution to sales ratio calculations based on total market demand. Your sketch should plot the products using the highest contribution to sales ratio first. (6 marks)

(e)

Explain briefly, stating any relevant assumptions and limitations, how the multi product profit volume chart that you prepared in (d) above may be used by the manager of GHK to understand the relationships between costs, volume and profit within the business. (6 marks) (Total for Question Seven = 25 marks)

Rationale Question Seven requires candidates to use relevant cost principles to calculate the relevant contributions for each of four products from the data provided in part (a), to calculate in part (b) the sensitivity of the product mix solution provided to a change in a financial penalty and in parts (c), (d) and (e) of the question to prepare a multi product profit volume chart and discuss its assumptions and limitations. This question addresses the learning outcome “Apply variable/fixed cost analysis in multiple product contexts to breakeven analysis and product mix decision making, including circumstances where there are multiple constraints and linear programming methods are needed to reach optimal solutions”.

The Chartered Institute of Management Accountants

Page 16

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2006 Exam

Suggested Approach (a) Determine the relevant product contributions Calculate the relevant contribution per $ of material B (b) Calculate the contribution from the minimum contract Calculate the contribution from the alternative use of resources Calculate the penalty value (c) Calculate the product contribution/sales ratios (d) Calculate and plot the general fixed costs Plot the products, starting with the product which earns the highest c/s ratio (e) Explain the use of the chart Marking Guide (a) Determine the relevant product contributions Calculate the relevant contribution per $ of material B (b) Calculate the contribution from the minimum contract Calculate the contribution from the alternative use of resources Calculate the penalty value (c) Calculate the product contribution/sales ratios (d) Calculate and plot the general fixed costs Plot the products, starting with the product which earns the highest c/s ratio (e) Explain the use of the chart

Marks 5 1 2 2 1 2 2 4 6

Examiner’s Comments (a) This was poorly answered. In most cases the overhead was ignored and contributions were not expressed in terms of “contribution per $ of material B”. (b) Very few completely correct answers were produced. (c) No issues to report. (d) Very few candidates were able to sketch a multi-product profit volume chart. The rules relating to graphs/sketches such as labelling and drawing lines in the correct proportions were often ignored. (e) Most answers were poor and very few related to the scenario in the question. Common Errors 1. Not following the basic principles that relate to limiting factor situations; 2. Not being able to apply the principles of limiting factors to the scenario in the question; 3. Producing charts that were poorly sketched and/or difficult to interpret, with little or no labelling of the information displayed.

The Chartered Institute of Management Accountants

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Managerial Level Paper

P2 – Management Accounting Decision Management 22 November 2006 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper, and if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. Answer the ONE compulsory question in Section A. This has eight subquestions and is on pages 2 to 5. Answer ALL THREE compulsory questions in Section B on pages 7 to 11. Answer TWO of the three questions in Section C on pages 12 to 15. Maths Tables and Formulae are provided on pages 17 to 19. These pages are detachable for ease of reference. Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

P2 – Decision Management

Management Accounting Pillar

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. TURN OVER  The Chartered Institute of Management Accountants 2006

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6, 1.7, and 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions.

Question One 1.1

A processing company operates a common process from which three different products emerge. Each of the three products can then either be sold in a market that has many buyers and sellers or further processed independently of each other in three other processes. After further processing each of the products can be sold in the same market for a higher unit selling price. Which of the following is required to determine whether or not any of the products should be further processed? (i) (ii) (iii) (iv) (v) (vi) (vii)

Total cost of the common process The basis of sharing the common process cost between the three products The total cost of each of the three additional processes The unit selling price of each product after further processing The unit selling price of each product before further processing The percentage normal loss of each further process The actual units of output of each product from the common process.

A

(iii), (iv), (vi) and (vii) only

B

(i), (ii), (iii), (iv), (vi) and (vii) only

C

(i), (ii), (v) and (vii) only

D

(iii), (iv), (v), (vi) and (vii) only (2 marks)

Section A continues on the opposite page

P2

2

November 2006

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1.2

Z plc is preparing a quotation for a one off contract to manufacture an item for a potential customer. The item is to be made of steel and the contract would require 300 kgs of steel. The steel is in regular use by Z plc and, as a consequence, the company maintains an inventory of this steel and currently has 200 kgs in inventory. The company operates a LIFO basis of inventory valuation and its most recent purchases were as follows: 20 November 2006 3 November 2006

150 kgs costing £600 250 kgs costing £1,100

The steel is easily available in the market where its current purchase price is £4·25 per kg. If the steel currently held in inventory was to be sold it could be sold for £3·50 per kg. The relevant cost of the steel to be included in the cost estimate is A

£1,050

B

£1,260

C

£1,275

D

£1,300 (2 marks)

1.3

X is considering the following five investments: Investment Initial investment Net Present Value

J $000 400 125

K $000 350 105

L $000 450 140

M $000 500 160

N $000 600 190

Investments J and L are mutually exclusive, all of the investments are divisible and none of them may be invested in more than once. The optimum investment plan for X assuming that the funding available is limited to $1m is A

$400,000 in J plus $600,000 in N.

B

$400,000 in M plus $600,000 in N.

C

$500,000 in M plus $500,000 in N.

D

$350,000 in K plus $600,000 in N plus $50,000 in M. (2 marks)

Section A continues on the next page

TURN OVER November 2006

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P2

1.4

A hospital is considering investing $80,000 in a new computer system that will reduce the amount of time taken to process a patient’s records when making an appointment. It is estimated that the cash benefit of the time saved will be $20,000 in the first year, $30,000 in the second year and $50,000 in each of the next three years. At the end of five years the computer system will be obsolete and will need to be replaced. It is not expected to have any residual value. Calculate the payback period to one decimal place of one year. (2 marks)

1.5

An investment company is considering the purchase of a commercial building at a cost of £0·85m. The property would be rented immediately to tenants at an annual rent of £80,000 payable in arrears in perpetuity. Calculate the net present value of the investment assuming that the investment company’s cost of capital is 8% per annum. Ignore taxation and inflation. (2 marks)

1.6

A bakery produces three different sized fruit pies for sale in its shops. The pies all use the same basic ingredients. Details of the selling prices and unit costs of each pie are as follows:

Selling price

Small $ per pie 3·00

Medium $ per pie 5·00

Large $ per pie 9·00

Ingredients

1·80

2·40

4·60

Direct labour Variable overhead

0·40 0·30

0·50 0·50

0·60 0·80

Weekly demand (pies)

200

500

300

Fruit (kgs per pie)

0·2

0·3

0·6

The fruit used in making the pies is imported and the bakery has been told that the amount of fruit that they will be able to buy for next week is limited to 300 kgs. The bakery has established its good name by baking its pies daily using fresh fruit, so it is not possible to buy the fruit in advance. Determine the mix of pies to be made and sold in order to maximise the bakery’s contribution for next week. (3 marks)

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November 2006

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1.7

H is launching a new product which it expects to incur a variable cost of $14 per unit. The company has completed some market research to try to determine the optimum selling price with the following results. If the price charged was to be $25 per unit then the demand would be 1,000 units each period. For every $1 increase in the selling price, demand would reduce by 100 units each period. For every $1 reduction in the selling price, the demand would increase by 100 units each period. Calculate the optimum selling price. Note: If Price (P) = a – bx; then Marginal Revenue = a – 2bx (3 marks)

1.8

A company sells three different levels of TV maintenance contract to its customers: Basic, Standard and Advanced. Selling prices, unit costs and monthly sales are as follows:

Selling price Variable cost Monthly contracts sold

Basic £ 50 30

Standard £ 100 50

Advanced £ 135 65

750

450

300

Calculate the average contribution to sales ratio of the company (i)

based on the sales mix stated above; and

(ii)

if the total number of monthly contracts sold remains the same, but equal numbers of each contract are sold. (4 marks) (Total for Section A = 20 marks)

End of Section A Section B starts on page 7

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SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS Question Two AVN designs and assembles electronic devices to allow transmission of audio / visual communications between the original source and various other locations within the same building. Many of these devices require a wired solution but the company is currently developing a wireless alternative. The company produces a number of different devices depending on the number of input sources and the number of output locations, but the technology used within each device is identical. AVN is constantly developing new devices which improve the quality of the audio / visual communications that are received at the output locations. The Managing Director recently attended a conference on world class manufacturing entitled “The extension of the value chain to include suppliers and customers” and seeks your help.

Required: Explain (i)

the components of the extended value chain; and

(ii)

how each of the components may be applied by AVN.

(3 marks) (7 marks) (Total for Question Two = 10 marks)

Section B continues on the next page

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P2

Question Three W has recently completed the development and testing of a new product which has cost $400,000. It has also bought a machine to produce the new product costing $150,000. The production machine is capable of producing 1,000 units of the product per month and is not expected to have a residual value due to its specialised nature. The company has decided that the unit selling prices it will charge will change with the cumulative numbers of units sold as follows: Cumulative sales units 0 to 2,000 2,001 to 7,000 7,001 to 14,500 14,501 to 54,500 54,501 and above

Selling price $ per unit in this band 100 80 70 60 40

Based on these selling prices, it is expected that sales demand will be as shown below: Months 1 - 10 11 - 20 21 - 30 31 - 70 71 - 80 81 - 90 91 - 100 101 - 110 Thereafter

Sales demand per month (units) 200 500 750 1,000 800 600 400 200 NIL

Unit variable costs are expected to be as follows: First 2,000 units Next 12,500 units Next 20,000 units Next 20,000 units Thereafter

$ per unit 50 40 30 25 30

W operates a Just in Time (JIT) purchasing and production system and operates its business on a cash basis. A columnar cash flow statement showing the cumulative cash flow of the product after its Introduction and Growth stages has already been completed and this is set out below: Months Number of units produced and sold Selling price per unit Unit variable cost Unit contribution Total contribution Cumulative cash flow

P2

Introduction 1-10 2,000 $100 $50 $50 $100,000 ($450,000)

8

Growth 11-30 5,000 7,500 $80 $70 $40 $40 $40 $30 $425,000 ($25,000)

November 2006

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Required: (a)

Complete the cash flow statement for each of the remaining two stages of the product’s life cycle. Do not copy the Introduction and Growth stages in your answer. Ignore the time value of money. (5 marks)

(b)

Explain, using your answer to (a) above and the data provided, the possible reasons for the changes in costs and selling prices during the life cycle of the product. (5 marks) (Total for Question Three = 10 marks)

Section B continues on the next page

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P2

Question Four You are the Assistant Management Accountant of QXY plc, a food manufacturer. The Board of Directors is concerned that its operational managers may not be fully aware of the importance of understanding the costs incurred by the business and the effect that this has on their operational decision making. In addition, the operational managers need to be aware of the implications of their pricing policy when trying to increase the volume of sales. You are scheduled to make a presentation to the operational managers tomorrow to explain to them the different costs that are incurred by the business, the results of some research that has been conducted into the implications for pricing and the importance of understanding these issues for their decision making. The diagram on the opposite page has already been prepared for the presentation.

Required: You are required to interpret the diagram and explain how it illustrates issues that the operational managers should consider when making decisions. (Note: your answer must include explanations of the Sales Revenue, Total Cost and Fixed Cost lines, and the significance of each of the activity levels labelled A, B, C, D). (10 marks)

(Total for Section B = 30 marks)

The diagram for Question Four is on the opposite page Section C starts on page 12

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Diagram for Question Four - Costs and Revenues over a range of activity levels $ Sales Revenue Total Cost

Fixed Cost

A

November 2006

B

C

D

Activity TURN OVER

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE Question Five KL manufactures three products, W, X and Y. Each product uses the same materials and the same type of direct labour but in different quantities. The company currently uses a cost plus basis to determine the selling price of its products. This is based on full cost using an overhead absorption rate per direct labour hour. However, the Managing Director is concerned that the company may be losing sales because of its approach to setting prices. He thinks that a marginal costing approach may be more appropriate, particularly since the workforce is guaranteed a minimum weekly wage and has a three month notice period.

Required: (a)

Given the Managing Director’s concern about KL’s approach to setting selling prices, discuss the advantages and disadvantages of marginal cost plus pricing AND total cost plus pricing. (6 marks)

The direct costs of the three products are shown below: Product Budgeted annual production (units) Direct materials Direct labour ($10 per hour)

W 15,000

X 24,000

Y 20,000

$ per unit 35 40

$ per unit 45 30

$ per unit 30 50

In addition to the above direct costs, KL incurs annual indirect production costs of $1,044,000.

Required: (b)

Calculate the full cost per unit of each product using KL’s current method of absorption costing. (4 marks)

Question Five continues on the opposite page

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November 2006

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An analysis of the company’s indirect production costs shows the following: Material ordering costs Machine setup costs Machine running costs General facility costs

$ 220,000 100,000 400,000 324,000

Cost driver Number of supplier orders Number of batches Number of machine hours Number of machine hours

The following additional data relate to each product: Product Machine hours per unit Batch size (units) Supplier orders per batch

W 5 500 4

X 8 400 3

Y 7 1,000 5

Required: (c)

Calculate the full cost per unit of each product using Activity Based Costing. (8 marks)

(d)

Explain how Activity Based Costing could provide information that would be relevant to the management team when it is making decisions about how to improve KL’s profitability. (7 marks) (Total for Question Five = 25 marks)

Section C continues on the next page

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P2

Question Six A theatre has a seating capacity of 500 people and is considering engaging MS and her orchestra for a concert for one night only. The fee that would be charged by MS would be $10,000. If the theatre engages MS, then this sum is payable regardless of the size of the theatre audience. Based on past experience of events of this type, the price of the theatre ticket would be $25 per person. The size of the audience for this event is uncertain, but based on past experience it is expected to be as follows: Probability 50% 30% 20%

300 people 400 people 500 people

In addition to the sale of the theatre tickets, it can be expected that members of the audience will also purchase confectionery both prior to the performance and during the interval. The contribution that this would yield to the theatre is unclear, but has been estimated as follows: Contribution from confectionery sales Contribution of $3 per person Contribution of $5 per person Contribution of $10 per person

Probability 30% 50% 20%

Required: (a)

Using expected values as the basis of your decision, advise the theatre management whether it is financially worthwhile to engage MS for the concert. (5 marks)

(b)

Prepare a two-way data table to show the profit values that could occur from deciding to engage MS for the concert. (5 marks)

(c)

Explain, using the probabilities provided and your answer to (b) above, how the two-way data table can be used by the theatre management to evaluate the financial risks of the concert, including the probability of making a profit. (9 marks)

(d)

Calculate the maximum price that the theatre management should agree to pay for perfect information relating to the size of the audience and the level of contribution from confectionery sales. (6 marks) (Total for Question Six = 25 marks)

Section C continues on the opposite page

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November 2006

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Question Seven JK plc prepares its accounts to 31 December each year. It is considering investing in a new computer controlled production facility on 1 January 2007 at a cost of £50m. This will enable JK plc to produce a new product which it expects to be able to sell for four years. At the end of this time it has been agreed to sell the new production facility for £1m cash. Sales of the product during the year ended 31 December 2007 and the next three years are expected to be as follows: Year ended 31 December Sales units (000)

2007 100

2008 105

2009 110

2010 108

Selling price, unit variable cost and fixed overhead costs (excluding depreciation) are expected to be as follows during the year ended 31 December 2007: £ 1,200

Selling price per unit Variable production cost per unit Variable selling and distribution cost per unit Fixed production cost for the year Fixed selling and distribution cost for the year Fixed administration cost for the year

750 100 4,000,000 2,000,000 1,000,000

The following rates of annual inflation are expected for each of the years 2008 - 2010: % 5 8 6 5

Selling prices Production costs Selling and distribution costs Administration costs

The company pays taxation on its profits at the rate of 30%, with half of this being payable in the year in which the profit is earned and the remainder being payable in the following year. Investments of this type qualify for tax depreciation at the rate of 25% per annum on a reducing balance basis. The Board of Directors of JK plc has agreed to use a 12% post-tax discount rate to evaluate this investment.

Required: (a)

Advise JK plc whether the investment is financially worthwhile. (17 marks)

(b)

Calculate the Internal Rate of Return of the investment. (3 marks)

(c)

Define and contrast (i) the real rate of return and (ii) the money rate of return, and explain how they would be used when calculating the net present value of a project’s cash flows. (5 marks) (Total for Question Seven = 25 marks) (Total for Section C = 50 marks)

End of question paper. Maths Tables and Formulae are on pages 17 to 19 November 2006

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November 2006

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PRESENT VALUE TABLE Present value of $1, that is (1+ r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

November 2006

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

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November 2006

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FORMULAE Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b= and or solve

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX ∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X2 Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

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P2

Management Accounting Pillar

Managerial Level

P2 – Management Accounting – Decision Management

November 2006

Wednesday Morning Session

P2

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November 2006

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

General Comments Overall a slightly higher quality of answers was presented compared with recent diets. However some of the technical aspects of the paper were poorly answered, especially the questions that related to topics that are fundamental to management accounting (for example the absorption of fixed production overheads). One of the most noticeable aspects was the inability of many candidates to put forward well constructed answers to the discursive questions. The question paper included several traditional topics, for example investment appraisal, that were well answered. However, questions on topics that may not be considered as mainstream, for example, the Value Chain, were poorly answered. The quality of writing and grammar was generally good, but it is obvious that many candidates have lost the ability to write clearly and have relied too heavily on computers to provide spelling and grammar checks to correct their work. The marking team also experienced great difficulty in marking the answers to numerical questions where candidates gave answers that were hard to follow. This unfortunately created a disadvantage for those candidates where the ‘own figure’ rules could not be applied. The performance on question one (objective test questions) showed an improvement compared with May 2006, but once again some candidates did not respond correctly to the questions for example Q.1.4 asked for the answer to ‘one decimal place of one year’. An answer of 2 years 7 months is not an answer that would gain the marks on offer.

The Chartered Institute of Management Accountants

Page 1

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Section A – 50 marks Question 1.1 A processing company operates a common process from which three different products emerge. Each of the three products can then either be sold in a market that has many buyers and sellers or further processed independently of each other in three other processes. After further processing each of the products can be sold in the same market for a higher unit selling price. Which of the following is required to determine whether or not any of the products should be further processed? (i) (ii) (iii) (iv) (v) (vi) (vii)

Total cost of the common process The basis of sharing the common process cost between the three products The total cost of each of the three additional processes The unit selling price of each product after further processing The unit selling price of each product before further processing The percentage normal loss of each further process The actual units of output of each product from the common process.

A

(iii), (iv), (vi) and (vii) only

B

(i), (ii), (iii), (iv), (vi) and (vii) only

C

(i), (ii), (v) and (vii) only

D

(iii), (iv), (v), (vi) and (vii) only (2 marks) The answer is D

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 1.2 Z plc is preparing a quotation for a one off contract to manufacture an item for a potential customer. The item is to be made of steel and the contract would require 300 kgs of steel. The steel is in regular use by Z plc and, as a consequence, the company maintains an inventory of this steel and currently has 200 kgs in inventory. The company operates a LIFO basis of inventory valuation and its most recent purchases were as follows: 20 November 2006 3 November 2006

150 kgs costing £600 250 kgs costing £1,100

The steel is easily available in the market where its current purchase price is £4·25 per kg. If the steel currently held in inventory was to be sold it could be sold for £3·50 per kg. The relevant cost of the steel to be included in the cost estimate is A

£1,050

B

£1,260

C

£1,275

D

£1,300 (2 marks) The answer is C

Workings 300 kgs @ £4·25 = £1,275

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 1.3 X is considering the following five investments: Investment Initial investment Net Present Value

J $000 400 125

K $000 350 105

L $000 450 140

M $000 500 160

N $000 600 190

Investments J and L are mutually exclusive, all of the investments are divisible and none of them may be invested in more than once. The optimum investment plan for X assuming that the funding available is limited to $1m is A

$400,000 in J plus $600,000 in N.

B

$400,000 in M plus $600,000 in N.

C

$500,000 in M plus $500,000 in N.

D

$350,000 in K plus $600,000 in N plus $50,000 in M. (2 marks) The answer is C

Workings Calculate the profitability index values of each of the investments and rank them: Investment

Profitability Index

Rank

J K L M N

0·3125 0·3000 0·3111 0·3200 0·3166

3rd 5th 4th 1st 2nd

M N

$500,000 $500,000

yielding $160,000 yielding $158,333

$1,000,000

yielding $318,333

Invest in:

Total

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 1.4 A hospital is considering investing $80,000 in a new computer system that will reduce the amount of time taken to process a patient’s records when making an appointment. It is estimated that the cash benefit of the time saved will be $20,000 in the first year, $30,000 in the second year and $50,000 in each of the next three years. At the end of five years the computer system will be obsolete and will need to be replaced. It is not expected to have any residual value. Calculate the payback period to one decimal place of one year. (2 marks)

Workings After 2 years the total inflows = After 3 years the total inflows =

$50,000 $100,000

Therefore payback occurs after 2·6 years

Question 1.5 An investment company is considering the purchase of a commercial building at a cost of £0·85m. The property would be rented immediately to tenants at an annual rent of £80,000 payable in arrears in perpetuity. Calculate the net present value of the investment assuming that the investment company’s cost of capital is 8% per annum. Ignore taxation and inflation. (2 marks)

Workings £80,000 x 1/0·08 = £1m therefore NPV = £0·15m

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 1.6 A bakery produces three different sized fruit pies for sale in its shops. The pies all use the same basic ingredients. Details of the selling prices and unit costs of each pie are as follows: Small $ per pie 3·00

Selling price

Medium $ per pie 5·00

Large $ per pie 9·00

Ingredients

1·80

2·40

4·60

Direct labour Variable overhead

0·40 0·30

0·50 0·50

0·60 0·80

Weekly demand (pies)

200

500

300

Fruit (kgs per pie)

0·2

0·3

0·6

The fruit used in making the pies is imported and the bakery has been told that the amount of fruit that they will be able to buy for next week is limited to 300 kgs. The bakery has established its good name by baking its pies daily using fresh fruit, so it is not possible to buy the fruit in advance. Determine the mix of pies to be made and sold in order to maximise the bakery’s contribution for next week. (3 marks)

Workings Small

Medium

Large

Contribution/pie

$0·50

$1·60

$3·00

Contribution/kg

$2·50

$5·33

$5·00

Ranking

3rd

1st

2nd

Make (pies)

NIL

500

250

Uses (kgs)

NIL

150

150

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 1.7 H is launching a new product which it expects to incur a variable cost of $14 per unit. The company has completed some market research to try to determine the optimum selling price with the following results. If the price charged was to be $25 per unit then the demand would be 1,000 units each period. For every $1 increase in the selling price, demand would reduce by 100 units each period. For every $1 reduction in the selling price, the demand would increase by 100 units each period. Calculate the optimum selling price. Note: If Price (P) = a – bx; then Marginal Revenue = a – 2bx (3 marks)

Workings Marginal cost (MC) = $14 Price (P) = $35 – 0·01q Marginal Revenue (MR) = $35 – 0·02q So if MC = MR then: 14 = 35 – 0·02q 0·02q = 21 q = 1,050 Price = $35 – (0·01 x 1,050) = $24·50

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 1.8 A company sells three different levels of TV maintenance contract to its customers: Basic, Standard and Advanced. Selling prices, unit costs and monthly sales are as follows:

Selling price Variable cost

Basic £ 50 30

Standard £ 100 50

Advanced £ 135 65

750

450

300

Monthly contracts sold

Calculate the average contribution to sales ratio of the company (i)

based on the sales mix stated above; and

(ii)

if the total number of monthly contracts sold remains the same, but equal numbers of each contract are sold. (4 marks)

Workings

Previous ratio: Sales Contribution

Basic £000 37·5 15

Standard £000 45 22·5

25 10

50 25

Advanced £000 40·5 21

Total £000 123 58·5

C/S ratio = 47·6% New ratio: Sales Contribution

67·5 35

142·5 70

C/S ratio = 49·1%

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS

Question 2 Explain (i)

the components of the extended value chain; and

(ii)

how each of the components may be applied by AVN.

(3 marks) (7 marks) (Total for Question Two = 10 marks)

Rationale Question Two requires candidates to explain the extended Value Chain and how it may be applied by the company in the scenario. The question addresses the learning outcome “explain the concept of the value chain and discuss the management of contribution/profit generated throughout the chain”.

Suggested Approach Read the scenario carefully to recognise the industry in which AVN operates. Apply your knowledge of the extended value chain to the scenario provided.

Marking Guide Brief explanation of the value chain and its components Apply each component to AVN: Suppliers Customers Internal components

Marks 3 2 2 3

Examiner’s Comments A significant number of candidates did not attempt this question, or made very poor attempts. In part (i) many candidates drew a diagram of the Value Chain with no accompanying notes. The question asked for candidates to ‘explain’ the Value Chain. Common Errors 1. Not relating the answer to the scenario in the question 2. Confusing ‘The Value Chain’ with Value Analysis 3. Developing answers based solely on J.I.T. 4. Not including the important role of ‘suppliers’ and ‘customers’, although the question specifically described this point.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 3

(a)

Complete the cash flow statement for each of the remaining two stages of the product’s life cycle. Do not copy the Introduction and Growth stages in your answer. Ignore the time value of money. (5 marks)

(b)

Explain, using your answer to (a) above and the data provided, the possible reasons for the changes in costs and selling prices during the life cycle of the product. (5 marks) (Total for Question Three = 10 marks)

Rationale Question Three requires candidates to complete a cash flow statement based upon the data provided for the life-cycle of a product. Candidates are then required to explain the possible reasons for the changes in costs and selling prices. This question addresses the learning outcome “explain the concept of life cycle costing and how life cycle costs interact with marketing strategies at each stage of the life cycle”.

Suggested Approach Read the question carefully and interpret the data by determining how the statement for the first two stages of the product’s life cycle have been prepared. Identify the month in which the monthly sales demand begins to fall as this is the start of the decline phase. Prepare a statement showing the results of the maturity and decline phases of the product life cycle. Explain the reasons for the changes that have occurred in this product’s life cycle.

Marking Guide Number of sales units Corresponding selling price Corresponding unit variable cost Corresponding unit contribution, total contributions and cumulative cash flows Reasons for reductions in cost Reasons for reductions in selling price

Marks 2 1 1 1 2 3

Examiner’s Comments A template was included within the question, which was aimed at assisting candidates to construct their answers. On many occasions this format was not followed. Many students were not able to identify the sales that related to the maturity and decline phases of the life cycle, which seriously reduced the marks that could be awarded. Part (b) was generally well answered. Common Errors 1. Not referring to the scenario and simply giving general answers that related to a typical product life cycle. 2. Confusing the word ‘cost’ with ‘price’. 3. Giving details of a penetration pricing approach although this was not the approach adopted by the company in question. 4. Putting forward answers that implied that high marketing and R & D costs were a reason for a high variable cost per unit.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 4 You are required to interpret the diagram and explain how it illustrates issues that the operational managers should consider when making decisions. (Note: your answer must include explanations of the Sales Revenue, Total Cost and Fixed Cost lines, and the significance of each of the activity levels labelled A, B, C, D). (10 marks)

Rationale Question Four requires candidates to interpret a breakeven chart and explain how it illustrates issues that operational managers should consider when making decisions. This question addresses the learning outcome “discuss the usefulness of dividing costs into variable and fixed components in the context of short-term decision making”.

Suggested Approach Study the diagram carefully to identify the changes in the slopes of the lines representing sales revenue, total cost and fixed cost and how these changes affect the interpretation of the gaps between these lines (representing profit and variable cost respectively). Describe the changes in the lines and their possible causes with particular emphasis on the implications of these changes for management decision making.

Marking Guide Explanation of fixed costs Explanation of variable costs Explanation of sales Explain point of profit maximisation Explain activity level A Explain activity level B Explain activity level C Explain activity level D Explain relevance to decision making

Marks 2 2 2 1 1 0.5 1 0.5 2 Max 10 marks

Examiner’s Comments Many candidates demonstrated a complete lack of understanding of a typical breakeven chart. This is a topic that is covered in paper C1 (Fundamentals of Management Accounting) and should have presented no undue problems to a well-prepared CIMA student. In many cases the answers were poorly presented and were far too general in nature. Common Errors 1. Not relating the answer to the graph. 2. Giving general answers that related to product life cycle costing and did not relate to the question. 3. Structuring answers that believed the four activity levels were four different products. 4. Not knowing that a change in the slope of the cost line and the revenue line denoted a change in the unit variable cost or the unit selling price. The change in slope does not relate to activity levels.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE

Question 5

(a)

Given the Managing Director’s concern about KL’s approach to setting selling prices, discuss the advantages and disadvantages of marginal cost plus pricing AND total cost plus pricing. (6 marks)

(b)

Calculate the full cost per unit of each product using KL’s current method of absorption costing. (4 marks)

(c)

Calculate the full cost per unit of each product using Activity Based Costing. (8 marks)

(d)

Explain how Activity Based Costing could provide information that would be relevant to the management team when it is making decisions about how to improve KL’s profitability. (7 marks) (Total for Question Five = 25 marks)

Rationale Question Five requires candidates to discuss the advantages and disadvantages of marginal cost plus pricing and total cost plus pricing in part (a). In the remainder of the question candidates were required to calculate the unit cost of the company’s products using traditional absorption costing and activity based costing and to explain how the use of activity based costing could provide information that would be relevant to the company’s management team when they are making decisions to improve the company’s profitability. This question addresses the learning outcomes “explain the particular issues that arise in pricing decisions and the conflict between marginal cost principles and the need for full recovery of all costs incurred” and “apply the techniques of activity based management in identifying cost drivers/activities and explain how process re-engineering can be used to eliminate non-value adding activities and reduce activity costs”.

Suggested Approach Briefly explain the principles of absorption costing and marginal costing and how they may both be used as the basis for cost plus pricing. Discuss the advantages and disadvantages of cost plus pricing using these methods. Calculate the unit cost of each product using traditional absorption costing and using ABC and compare the results. Explain how ABC may improve KL’s profitability by controlling costs and by encouraging decisions that reduce the activities that cause costs to be incurred.

Marking Guide (a) Briefly explain absorption costing and marginal costing Explain and justify the use of cost plus pricing

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Marks 1 1

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam Explain advantages and disadvantages of : Absorption based cost plus pricing Marginal based cost plus pricing (b) Calculate the absorption rate Use the direct costs provided Calculate the overhead cost per unit (c) Calculate the cost driver rates Calculate the overhead cost of each product by applying cost driver rates (d) Discuss the similarities and differences between unit costs Explain how using ABC can lead to cost savings Explain how ABC can lead to better cost control

2 2 2 1 1 6 2 2 3 3 Max 7 marks

Examiner’s Comments Part (a) was poorly answered and demonstrated that many candidates simply do not understand a most fundamental technique i.e. the absorption of fixed production overheads. Part (b) and (c) were generally well answered but candidates must be able to complete numerical tasks and then explain the results. It was apparent from many answers that candidates were unable to explain the principles of activity based costing. This is a worry and a matter for concern because Management Accounting is not assessed further at the Strategic Level and candidates need to be confident in their ability to apply such knowledge in practice. Common Errors 1. Demonstrating a complete lack of understanding of the word ‘absorption’. 2. Not answering the question (part a) and simply explaining that sales less marginal costs equals contribution. 3. In part (b) calculating an absorption rate per unit, as opposed to the requirement of the question, which was ‘per labour hour’. 4. In part (d) describing how ABC could be introduced to the company as opposed to responding to the question which asked how ABC could provide information that could improve profitability.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 6

(a)

Using expected values as the basis of your decision, advise the theatre management whether it is financially worthwhile to engage MS for the concert. (5 marks)

(b)

Prepare a two-way data table to show the profit values that could occur from deciding to engage MS for the concert. (5 marks)

(c)

Explain, using the probabilities provided and your answer to (b) above, how the two-way data table can be used by the theatre management to evaluate the financial risks of the concert, including the probability of making a profit. (9 marks)

(d)

Calculate the maximum price that the theatre management should agree to pay for perfect information relating to the size of the audience and the level of contribution from confectionery sales. (6 marks) (Total for Question Six = 25 marks)

Rationale Question Six requires candidates to prepare calculations by applying probabilities to the data provided. They are required to interpret the results to advise a theatre as to the financial risks associated with a proposed concert and to determine the maximum price that should be paid by the theatre company for perfect information relating to the event. This question addresses the learning outcomes “analyse risk and uncertainty by calculating expected values and standard deviations together with probability tables and histograms” and “prepare expected value tables and ascertain the value of information”.

Suggested Approach Use expected values to determine the size of the audience and the expected value of contribution in order to advise the theatre management whether or not to engage MS for the concert. Determine the nine possible combinations of audience size and confectionery contribution that could occur and present the results in a two way data table. Determine the probabilities of each of the nine outcomes and explain how the table can be used with the probabilities by the theatre management. Determine the actions of the theatre management if they had perfect information regarding the size of the audience and the confectionery contribution, and hence determine the value of that perfect information.

Marking Guide (a) Calculate expected income Calculate expected gain and advise theatre management

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Marks 3 2

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam (b) Construct an appropriate table with row and column headings Enter data values (c) Comments based on the table: Probability of profit or loss Range of possible outcomes Discussion of expected value, the skewed distribution and risk (d) Calculate the expected value with perfect information Determine the value of perfect information

2 3

2 2 5 5 1

Examiner’s Comments This was the least popular of the option questions, perhaps not being considered as a mainstream topic by candidates or providers of tuition for the paper. In many cases correct figures were not supported by meaningful explanations. Common Errors In part (b) producing a two-way table that only considered ticket sales and excluded confectionery sales. In part (b) not producing a two-way table and simply listing all the contribution values. In part (c) providing poor explanations of the two-way table, incorrect calculations of joint probabilities, and poor attempts at calculating the probability of making a profit. In part (d) not understanding what was required.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Question 7

(a)

Advise JK plc whether the investment is financially worthwhile. (17 marks)

(b)

Calculate the Internal Rate of Return of the investment. (3 marks)

(c)

Define and contrast (i) the real rate of return and (ii) the money rate of return, and explain how they would be used when calculating the net present value of a project’s cash flows. (5 marks) (Total for Question Seven = 25 marks)

Rationale Question Seven requires candidates to apply the net present value technique to the data provided to determine the financial viability of a proposed investment. Then in part (b) candidates are required to determine the Internal Rate of Return of the investment and in part (c) to define and contrast the real and money rates of return and explain how they would be used when calculating the net present value of the cash flows from a project. This question addresses the learning outcomes “calculate project cash flows, accounting for tax and inflation, and apply perpetuities to derive end of project value where appropriate” and “evaluate project proposals using the techniques of investment appraisal”.

Suggested Approach Read the scenario carefully to determine the start date of the investment and how inflation is expected to change the costs and revenues during the life of the investment. Determine the values of sales and variable costs for each year taking account of volume changes and the effects of inflation. Determine the value of fixed costs for each year taking account of the effects of inflation. Calculate the tax savings arising from the investment, and the years in which they will be received. Calculate the tax arising on the operating profits and the years in which such tax will be payable. Determine the net present value of the investment and advise the company. Calculate the Internal Rate of Return of the investment by comparing its NPV at different discount rates. Define the real and money rate of return. Explain how each of them may be used when evaluating an investment project.

Marking Guide (a) Calculate sales values Calculate variable cost values Calculate fixed cost values Correctly inflate values Tax calculations Capital cashflows Calculate NPV and advise (b) Select an appropriate discount rate Calculate IRR (c) Explain the difference between real and money rates Explain how they are used

The Chartered Institute of Management Accountants

Marks 1 2 3 3 4 1 3 1 2 2 3

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2006 Exam

Examiner’s Comments A good attempt was made by most candidates at a question that was technically more demanding than most other questions on the paper. Perhaps this is because this question conformed to a traditional pattern, which required the application of well-known and previously tested procedures. Common Errors 1. Ignoring the fixed costs 2. Not inflating the fixed costs 3. Calculating taxation based on the contribution 4. Supplying poorly presented answers 5. Supplying poor references to workings 6. Applying inflation incorrectly 7. Demonstrating an inability to distinguish between the real rate of return and the money rate of return.

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Managerial Level Paper

P2 – Management Accounting Decision Management 23 May 2007 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during the reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. ALL answers must be written in the answer book. Answers or notes written on the question paper will not be submitted for marking. Answer the ONE compulsory question in Section A. This has eight subquestions and is on pages 2 to 4. Answer ALL THREE compulsory questions in Section B on pages 6 to 9. Answer TWO of the three questions in Section C on pages 10 to 15. Maths Tables and Formulae are provided on pages 17 to 19. These pages are detachable for ease of reference. The list of verbs as published in the syllabus is given for reference on the inside back cover of this question paper. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

P2 – Decision Management

Management Accounting Pillar

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. TURN OVER  The Chartered Institute of Management Accountants 2007

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6, 1.7 and 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions.

Question One 1.1

An investment project that requires an initial investment of $500,000 has a residual value of $130,000 at the end of five years. The project’s cash flows have been discounted at the company’s cost of capital of 12% and the resulting net present value is $140,500. The profitability index of the project is closest to:

A

0·02

B

0·54

C

0·28

D

0·26 (2 marks)

1.2

A project has a net present value of $320,000. The sales revenues for the project have a total pre-discounted value of $900,000 and a total present value of $630,000 after tax. The sensitivity of the investment to changes in the value of sales is closest to:

A

$310,000

B

$580,000

C

51%

D

36% (2 marks)

P2

2

May 2007

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1.3

A company provides a number of different services to its customers from a single office. The fixed costs of the office, including staff costs, are absorbed into the company’s service costs using an absorption rate of $25 per consulting hour based on a budgeted activity level of 100,000 hours each period. Fee income and variable costs are different depending on the services provided, but the average contribution to sales ratio is 35%. The breakeven fee income each period is closest to:

A

$1,400,000

B

$11,500,000

C

$875,000

D

$7,143,000 (2 marks)

1.4

A company has recently completed the production of the first unit of a new product. The time taken for this was 12 minutes. The company expects that there will be a 75% learning rate for this product. Calculate the total time expected to produce the first four units. (2 marks)

The following data are given for sub-questions 1.5 and 1.6 below An investment project with no residual value has a net present value of $87,980 when it is discounted using a cost of capital of 10%. The annual cash flows are as follows: Year 0 1 2 3 4 5

$ (200,000) 80,000 90,000 100,000 60,000 40,000

1.5

Calculate the Accounting Rate of Return of the project using the average investment value basis. (2 marks)

1.6

Calculate the Internal Rate of Return of the project. (3 marks)

TURN OVER May 2007

3

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P2

1.7

A company manufactures three products. Each of these products use the same type of material but in different quantities. The unit selling prices, cost and profit details are as follows: Product

X $/unit

Selling price

Y $/unit

Z $/unit

23

26

28

Direct materials Direct labour Variable overhead Fixed overhead

6 8 2 4

8 6 3 5

6 8 3 6

Profit

3

4

5

The direct material used on all three products costs $10 per kg. The material available is expected to be limited to 600 kgs for the next accounting period. The maximum demand for each of the products during the next accounting period is expected to be as follows: X

240 units

Y

600 units

Z

400 units

No inventories of finished products are held. Calculate the optimum product mix for the next accounting period. (3 marks) 1.8

A company is launching a new product. Market research shows that if the selling price of the product is $100 then demand will be 1,200 units, but for every $10 increase in selling price there will be a corresponding decrease in demand of 200 units and for every $10 decrease in selling price there will be a corresponding increase in demand of 200 units. The estimated variable costs of the product are $30 per unit. There are no specific fixed costs but general fixed costs are absorbed using an absorption rate of $8 per unit. Calculate the selling price at which profit is maximised. Note: When Price = a-bx then Marginal Revenue = a-2bx (4 marks) (Total for Section A = 20 marks)

Reminder All answers to Section A must be written in your answer book. Answers to Section A written on the question paper will not be submitted for marking. End of Section A Section B starts on page 6 P2

4

May 2007

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Section B starts on the next page

TURN OVER May 2007

5

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P2

SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS Question Two A company is planning to launch a new product. It has already carried out market research at a cost of $50,000 and as a result has discovered that the market price for the product should be $50 per unit. The company estimates that 80,000 units of the product could be sold at this price before one of the company’s competitors enters the market with a superior product. At this time any unsold units of the company’s product would be of no value. The company has estimated the costs of the initial batch of the product as follows: Direct materials Direct labour ($10 per hour) Other direct costs

$000 200 250 100

Production was planned to occur in batches of 10,000 units and it was expected that an 80% learning curve would apply to the direct labour until the fourth batch was complete. Thereafter the direct labour cost per batch was expected to be constant. No changes to the direct labour rate per hour were expected. The company introduced the product at the price stated above, with production occurring in batches of 10,000 units. Direct labour was paid using the expected hourly rate of $10 and the company is now reviewing the profitability of the product. The following schedule shows the actual direct labour cost recorded: Cumulative number of batches

Actual cumulative direct labour cost $000 280 476 809 1,376

1 2 4 8

Required: (i)

Calculate the revised expected cumulative direct labour costs for the four levels of output given the actual cost of $280,000 for the first batch.

(ii)

Calculate the actual learning rate exhibited at each level of output.

(iii)

Discuss the implications of your answers to (i) and (ii) for the managers of the company. (10 marks) (Total for Question Two = 10 marks)

Section B continues on the opposite page P2

6

May 2007

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Question Three A company operates a fleet of three canal boats that provide cruises for tourists around the canals of a city. The company seeks your advice as to whether it is better to replace its boats every year, every two years or every three years. The company has provided the following data: Annual sales revenue from operating each boat Purchase cost of each boat

$ 800,000 400,000

Operating costs, which include maintenance, servicing, and similar costs are paid at the end of each year. Operating costs and end of year trade-in values vary depending on the age of the boat and are as follows for each year of the boat’s life: Year 1 2 3

Operating Costs $ 300,000 400,000 600,000

Trade-in values $ 240,000 150,000 80,000

These costs do not include depreciation or any other fixed costs of providing the tourist service. These other fixed costs are a constant $100,000 per year regardless of the age of the boat. The company uses an 8% cost of capital for its investment decisions.

Required: (a)

Produce calculations to determine the optimum replacement cycle of the boats and state clearly your recommendations. Ignore taxation. (6 marks)

The same company is also considering investing in one of three marketing campaigns to increase its profitability. All three marketing campaigns have a life of five years, require the same initial investment and have no residual value. The company has already evaluated the marketing campaigns taking into consideration the range of possible outcomes that could result from the investment. A summary of the calculations is shown below: Marketing Campaign Expected Net Present Value Standard Deviation of Net Present Value

J

K

L

$400,000

$800,000

$400,000

$35,000

$105,000

$105,000

Required: (b) (i)

Explain the meaning of the data shown above; and

(ii)

Briefly explain how the data may be used by the company when choosing between alternative investments. (4 marks) (Total for Question Three = 10 marks)

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P2

Question Four Z is one of a number of companies that produce three products for an external market. The three products, R, S and T may be bought or sold in this market. The common process account of Z for March 2007 is shown below: Inputs: Material A Material B Material C Direct labour Variable overhead Fixed cost Totals

Kg

$

1,000 2,000 1,500

3,500 2,000 3,000 6,000 2,000 1,000

4,500

17,500

Kg Normal loss Outputs: Product R Product S Product T

$

500

0

800 2,000 1,200

3,500 8,750 5,250

4,500

17,500

Z can sell products R, S or T after this common process or they can be individually further processed and sold as RZ, SZ and TZ respectively. The market prices for the products at the intermediate stage and after further processing are: Market prices per kg: R S T RZ SZ TZ

$ 3·00 5·00 3·50 6·00 5·75 6·75

The specific costs of the three individual further processes are: Process R to RZ Process S to SZ Process T to TZ

variable cost of $1·40 per kg, no fixed costs variable cost of $0·90 per kg, no fixed costs variable cost of $1·00 per kg, fixed cost of $600 per month

The question requirement is on the opposite page

P2

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Required: (a)

Produce calculations to determine whether any of the intermediate products should be further processed before being sold. Clearly state your recommendations together with any relevant assumptions that you have made. (3 marks)

(b)

Produce calculations to assess the viability of the common process:

(i)

assuming that there is an external market for products R,S and T; and

(ii)

assuming that there is not an external market for products R,S and T. State clearly your recommendations. (7 marks) (Total for Question Four =10 marks)

(Total for Section B = 30 marks)

End of Section B Section C starts on the next page

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE Question Five X operates in an economy that has almost zero inflation. Management ignores inflation when evaluating investment projects because it is so low as to be considered insignificant. X is evaluating a number of similar, alternative investments. The company uses an after tax cost of capital of 6% and has already completed the evaluation of two investments. The third investment is a new product that would be produced on a just-in-time basis and which is expected to have a life of three years. This investment requires an immediate cash outflow of $200,000, which does not qualify for tax depreciation. The expected residual value at the end of the project’s life is $50,000. A draft financial statement showing the values that are specific to this third investment for the three years is as follows: Year 1 $

Year 2 $

Year 3 $

230,000

350,000

270,000

54,000 60,000 80,000

102,000 80,000 90,000

66,000 70,000 80,000

Profit

36,000

78,000

54,000

Closing receivables Closing payables

20,000 6,000

30,000 9,000

25,000 8,000

Sales Production costs: Materials Labour Other*

*Other production costs shown above include depreciation calculated using the straight line method. The company is liable to pay corporation tax at a rate of 30% of its profits. One half of this is payable in the same year as the profit is earned, the remainder is payable in the following year.

Required: (a)

Calculate the net present value of the above investment proposal. (10 marks)

(b)

P2

Explain how the above investment project would be appraised if there were to be a change in the rate of inflation so that it became too significant to be ignored. (5 marks)

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The evaluations of the other two investments are shown below: Investment W Y

Initial investment $ 300,000 100,000

Net Present Value $ 75,000 27,000

The company only has $400,000 of funds available. All of the investment proposals are nondivisible. None of the investments may be repeated.

Required: (c)

Recommend, with supporting calculations, which of the three investment proposals should be accepted. (3 marks)

(d) (i)

Briefly explain gain sharing arrangements. (3 marks)

(ii)

Explain the reasons why X might not want to overcome its investment funding limitations by using a gain sharing arrangement. (4 marks) (Total for Question Five = 25 marks)

Section C continues on the next page

TURN OVER

May 2007

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P2

Question Six H, a printing company, uses traditional absorption costing to report its monthly profits. It is seeking to increase its business by winning work from new customers. It now has the opportunity to prepare a quotation for a large organisation that currently requires a new catalogue of its services. A technical report on the resource requirements for the catalogues has been completed at a cost of $1,000 and its details are summarised below: Production period It is expected that the total time required to print and despatch the catalogue will be one week. Material A 10,000 sheets of special printing paper will be required. This is a paper that is in regular use by H and the company has 3,400 sheets in inventory. These originally cost $1·40 per sheet but the current market price is $1·50 per sheet. The resale price of the sheets held in inventory is $1·20 per sheet. Material B This is a special ink that H will need to purchase at a cost of $8 per litre. 200 litres will be required for this catalogue but the supplier has a minimum order size of 250 litres. H does not foresee any other use for this ink, but will hold the surplus in inventory. H’s inventory policy is to review slow moving items regularly. The cost of any inventory item that has not been used for more than 6 months is accounted for as an expense of the period in which that review occurs. Direct labour Sufficient people are already employed by H to print the catalogue, but some of the printing will require overtime working due to the availability of a particular machine that is used on other work. The employees are normally paid $8 per hour, the order will require 150 hours of work and 50 of these hours will be in excess of the employees’ normal working week. A rate of $10 per hour is paid for these overtime hours. Employees are paid using an hourly rate with a guaranteed minimum wage for their normal working week. Supervision An existing supervisor will take responsibility for the catalogue in addition to her existing duties. She is not currently fully employed and receives a salary of $500 per week. Machinery Two different types of machine will be required: Machine A will print the catalogues. This is expected to take 20 hours of machine time. The running cost of machine A is $5 per hour. There is currently 30 hours of unused time on machine A per week that is being sold to other printers for $12 per hour. Machine B will be used to cut and bind the catalogues. This machine is being used to full capacity in the normal working week and this is why there is a need to work overtime. The catalogue will require 25 machine hours and these have a running cost of $4 per hour. Despatch There will be a delivery cost of $400 to transport the catalogues to the customer. Fixed overhead costs H uses a traditional absorption costing system to attribute fixed overhead costs to its work. The absorption rate that it uses is $20 per direct labour hour. Profit mark-up H applies a 30% mark-up to its costs to determine its selling prices.

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Required: (a)

In order to assist the management of H in preparing its quotation, prepare a schedule showing the relevant costs for the production of the catalogues. State clearly your reason for including or excluding each value that has been provided in the above scenario. (15 marks)

(b)

Explain how the use of relevant costs as the basis of setting a selling price may be appropriate for short-term pricing decisions but may be inappropriate for long-term pricing decisions. Your answer should also discuss the conflict between reporting profitability within a traditional absorption costing system and the use of relevant cost based pricing. (10 marks) (Total for Question Six = 25 marks)

Section C continues on the next page

TURN OVER

May 2007

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P2

Question Seven D provides a motorist rescue service to its members. At present all members pay a basic fee of $100 per year but D is considering the introduction of different fees for members depending on the data they provide when joining the service. The number of members, and therefore the fee income of D, is uncertain but the following estimates have been made: Number of members 20,000 30,000 40,000

Probability 0·3 0·5 0·2

Required: (a)

Calculate the expected annual fee income of D. (2 marks)

The operating costs to be incurred by D have been analysed between call-out costs and administration costs. These operating costs have been assumed to vary in relation to the number of members and consequently the average costs per member for next year are expected to be: Call-out cost per member for the year Administration cost per member for the year

$50 $10

Each of these operating costs may vary by plus or minus 20%. There is equal probability of these costs being as expected, 20% higher, or 20% lower. In addition D expects to incur annual fixed costs of $1,100,000.

Required: (b)

Using Expected Values, calculate the breakeven number of members. (3 marks)

(c)

Prepare a two-way data table that shows the nine possible profit values. (6 marks)

(d)

Explain the meaning of table that you have produced in (c) above and, by including appropriate probability values, how it may be used by management. (4 marks)

Now that you have presented your calculations and explanations to the Management Team of D they have questioned the validity of the assumption that costs are caused by and therefore vary in relation to the number of members. They referred to the activities that are performed by the company: • • • • • P2

Processing applications for membership; Operating the call centre that deals with logging and scheduling rescues; Providing patrol vehicles and mechanics for breakdown assistance; Recording details of the time taken to respond to members’ rescues; Recording details of the costs incurred in carrying out each rescue. 14

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The Management Team collectively agreed that your assumption that operating costs are driven by the number of members was too simplistic and that in future the Administration department should request the following information from members: • • • • • •

Member’s date of birth; Member’s address; Number of years the member has been a qualified driver; Age of vehicle; Make and model of vehicle; Average annual mileage.

Required: (e)

Explain how and why the collection of this data from members might improve the information that would be available to the Management Team. (10 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of question paper. Maths Tables and Formulae are on pages 17 to 19

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P2

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P2

16

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PRESENT VALUE TABLE Present value of $1, that is (1+ r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

May 2007

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

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May 2007

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FORMULAE Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b= and or solve

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX ∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X2 Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

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LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE 1 KNOWLEDGE What you are expected to know.

2 COMPREHENSION What you are expected to understand.

VERBS USED

DEFINITION

List State Define

Make a list of Express, fully or clearly, the details of/facts of Give the exact meaning of

Describe Distinguish Explain Identify

Communicate the key features Highlight the differences between Make clear or intelligible/State the meaning of Recognise, establish or select after consideration Use an example to describe or explain something

Illustrate 3 APPLICATION How you are expected to apply your knowledge.

Apply Calculate/compute Demonstrate Prepare Reconcile Solve Tabulate

4 ANALYSIS How are you expected to analyse the detail of what you have learned.

Analyse Categorise Compare and contrast

5 EVALUATION How are you expected to use your learning to evaluate, make decisions or recommendations.

May 2007

To put to practical use To ascertain or reckon mathematically To prove with certainty or to exhibit by practical means To make or get ready for use To make or prove consistent/compatible Find an answer to Arrange in a table

Construct Discuss Interpret Produce

Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between To build up or compile To examine in detail by argument To translate into intelligible or familiar terms To create or bring into existence

Advise Evaluate Recommend

To counsel, inform or notify To appraise or assess the value of To advise on a course of action

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P2

Management Accounting Pillar Managerial Level

P2 – Management Accounting – Decision Management

May 2007

Wednesday Morning Session

P2

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

General Comments The overall average mark was above the level achieved in previous diets, with a higher proportion of candidates attaining good marks, and some students attaining excellent marks. The paper contained questions relating to the topics that have become familiar to this paper, and should have caused no problem for a well prepared candidate. Topics such as the learning curve, investment appraisal and the two-way data table fall into this category. Whereas most candidates made solid attempts at numerical questions, many displayed a marked weakness when tacking discursive issues, especially when asked to explain the figures calculated in the numerical part of a question. For example, ‘Explain the meaning of the table you have produced in part (c)’. It was also a little disappointing to note that in some cases the questions that tested fundamental aspects of management accounting were poorly answered. This emphasises the point that students who have been awarded exemptions from papers C1 (Fundamentals of Management Accounting) and P1 (Management Accounting Performance Evaluation) need to ensure they have a good understanding of all topics included in the two syllabi before attempting the P2 examination. The quality of writing and grammar was generally good. However, many candidates presented answers that were difficult to follow and assumed the marker would understand what they meant to say, as opposed to what they actually wrote. The marking team also experienced great difficulty in marking the answers to numerical questions, where candidates did not give clear directions to workings relating to their answers. This unfortunately did not allow markers to apply the ‘own figure’ rule, which in many cases could have gained candidates additional marks. It was pleasing to note that candidates appear to be making full use of the 20 minutes planning time, especially as very few candidates appeared to encounter a time constraint problem. The performance on question 1 (objective test questions) again showed an improvement when compared to the previous two diets. It was unfortunate that some students did not take the advice given in the instructions for answering Section A, in that they did not show their workings for sub-questions 1.6, 1.7 and 1.8 for which marks could be awarded.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Section A – 50 marks Question 1.1 An investment project that requires an initial investment of $500,000 has a residual value of $130,000 at the end of five years. The project’s cash flows have been discounted at the company’s cost of capital of 12% and the resulting net present value is $140,500. The profitability index of the project is closest to:

A

0·02

B

0·54

C

0·28

D

0·26 (2 marks) The answer is C

Workings Profitability Index = $140,500 / $500,000 = 0·28

Question 1.2 A project has a net present value of $320,000. The sales revenues for the project have a total pre-discounted value of $900,000 and a total present value of $630,000 after tax. The sensitivity of the investment to changes in the value of sales is closest to: A

$310,000

B

$580,000

C

51%

D

36% (2 marks) The answer is C

Workings Sensitivity = $320,000 / $630,000 = 51%

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 1.3 A company provides a number of different services to its customers from a single office. The fixed costs of the office, including staff costs, are absorbed into the company’s service costs using an absorption rate of $25 per consulting hour based on a budgeted activity level of 100,000 hours each period. Fee income and variable costs are different depending on the services provided, but the average contribution to sales ratio is 35%. The breakeven fee income each period is closest to: A

$1,400,000

B

$11,500,000

C

$875,000

D

$7,143,000 (2 marks) The answer is D

Workings Breakeven sales value = Fixed cost / Contribution to sales ratio = $2,500,000/ 0·35 = $7,142,857

Question 1.4 A company has recently completed the production of the first unit of a new product. The time taken for this was 12 minutes. The company expects that there will be a 75% learning rate for this product. Calculate the total time expected to produce the first four units. (2 marks)

Workings Units 1 2 4

Average Time/unit (minutes) 12·00 9·00 6·75

The Chartered Institute of Management Accountants

Total time (minutes) 12·00 18·00 27·00

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

The following data are given for sub-questions 1.5 and 1.6 below An investment project with no residual value has a net present value of $87,980 when it is discounted using a cost of capital of 10%. The annual cash flows are as follows: Year 0 1 2 3 4 5

$ (200,000) 80,000 90,000 100,000 60,000 40,000

Question 1.5 Calculate the Accounting Rate of Return of the project using the average investment value basis. (2 marks)

Workings

Lifetime cash flows Lifetime depreciation Lifetime profit Average annual profit ARR

$ 370,000 200,000 170,000 34,000

= Average annual profit / Average investment value = $34,000 / $100,000 = 34%

Question 1.6 Calculate the Internal Rate of Return of the project. (3 marks)

Workings Discounting the cash flows using 20% gives: Year 0 1 2 3 4 5

Cash flow $ (200,000) 80,000 90,000 100,000 60,000 40,000

DF 1·000 0·833 0·694 0·579 0·482 0·402

PV $ (200,000) 66,640 62,460 57,900 28,920 16,080 32,000

IRR (%) = 20 + (32,000/55,980 x 10) = 26%

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 1.7 A company manufactures three products. Each of these products uses the same type of material but in different quantities. The unit selling prices, cost and profit details are as follows: Product

X $/unit

Selling price

Y $/unit

Z $/unit

23

26

28

Direct materials Direct labour Variable overhead Fixed overhead

6 8 2 4

8 6 3 5

6 8 3 6

Profit

3

4

5

The direct material used on all three products costs $10 per kg. The material available is expected to be limited to 600 kgs for the next accounting period. The maximum demand for each of the products during the next accounting period is expected to be as follows: X

240 units

Y

600 units

Z

400 units

No inventories of finished products are held. Calculate the optimum product mix for the next accounting period. (3 marks)

Workings Product Contribution / unit

X $7

Y $9

Z $11

Materials / unit (kg)

0·6

0·8

0·6

$11·67

$11·25

$18·33

Ranking

2nd

3rd

1st

Produce (units)

240

270

400

Uses (kgs)

144

216

240

Contribution / kg

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 1.8 A company is launching a new product. Market research shows that if the selling price of the product is $100 then demand will be 1,200 units, but for every $10 increase in selling price there will be a corresponding decrease in demand of 200 units and for every $10 decrease in selling price there will be a corresponding increase in demand of 200 units. The estimated variable costs of the product are $30 per unit. There are no specific fixed costs but general fixed costs are absorbed using an absorption rate of $8 per unit. Calculate the selling price at which profit is maximised. Note: When Price = a-bx then Marginal Revenue = a-2bx (4 marks)

Workings P = $160 – 0·05q MR = 160 – 0·1q MC = 30 Profit is maximised when MC = MR so 30 = 160 – 0·1q 130 = 0·1q q = 1,300 P = $160 – 0·05q Therefore P = $160 – (0·05 x 1,300) = $95

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS

Question 2 (i)

Calculate the revised expected cumulative direct labour costs for the four levels of output given the actual cost of $280,000 for the first batch.

(ii)

Calculate the actual learning rate exhibited at each level of output.

(iii)

Discuss the implications of your answers to (i) and (ii) for the managers of the company. (10 marks) (Total for Question Two = 10 marks)

Rationale Question Two This question tests candidates’ understanding of the learning curve and the effect of differences between the expected and actual initial unit/time cost, the learning rate and the length of the learning period on the eventual time/cost of units produced. This question addresses the learning outcome: Explain and apply learning and experience curves to estimate time and cost for new products and services.

Suggested Approach • Calculate the expected direct labour cost using the expected rate of learning and the expected length of the learning period based on the actual labour cost of the first batch • Compare the result of your calculations with the actual labour cost provided • Calculate the actual rate of learning shown by the actual labour cost provided • Comment on the differences between the expected learning and the actual learning that occurred and discuss the implications for profitability and pricing

Marking Guide Calculating the difference in the rate of learning Calculating the length of the learning period Identifying and commenting on the differences between the expected learning and the actual learning that occurred and discussing the implications for profitability and pricing

Marks 3 3 4

Examiner’s Comments Although part (i) was generally well answered the answers to parts (ii) and (ii) were generally poor. The majority of answers put forward by candidates for part (ii) demonstrated either a total misunderstanding of what was required, or that the candidate did not know the simple method of calculating the rate of learning, (as opposed to the formula). The majority of candidates attempting part (iii) incorrectly assumed that an 85% learning rate was an improvement on the expected rate of 80%. Common Errors 1. Not understanding the principles associated with the learning curve. 2. Calculating an incorrect actual rate of learning. 3. Not understanding that an increase in the learning curve percentage was a worsening position that could have pricing and profitability implications.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 3

(a)

Produce calculations to determine the optimum replacement cycle of the boats and state clearly your recommendations. Ignore taxation. (6 marks)

(b) (i)

Explain the meaning of the data shown above; and

(ii)

Briefly explain how the data may be used by the company when choosing between alternative investments. (4 marks) (Total for Question Three = 10 marks)

Rationale Question Three This question tests candidates’ knowledge of two specific areas of long term decision making. In part (a) candidates are required to prepare calculations to determine the optimum asset replacement cycle for a company. In part (b) candidates are required to explain the data provided and how it may be used to choose between alternative investments. This question addresses the learning outcome: Evaluate and rank projects that might be mutually exclusive, involve unequal lives and/or be subject to capital rationing.

Suggested Approach

(a)

(b)

• • • •

Identify the relevant cash flows of each replacement cycle Identify the timing of those relevant cash flows Calculate the net present value and annualised equivalent cost of each replacement cycle Make a recommendation based upon the calculations

• • •

Explain expected NPV Explain standard deviation Discuss risk v return relationship using data provided

Marking Guide (a) Selecting an appropriate solution method and using it appropriately Using relevant cash flows correctly and making an appropriate recommendation

Marks 3 3

(b) Explain expected NPV Explain standard deviation Discuss risk v return relationship using data provided

The Chartered Institute of Management Accountants

1 1 2

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Examiner’s Comments Most candidates were able to produce net present value calculations, but very few annualised the figures relating to the three cycles, with the result that a true and correct comparison could not be made. (Annualisation did not apply if a six year cash flow profile was submitted). Many candidates submitted poor layouts/ presentation of the figures, also providing poor or no links to workings. Both situations complicated the marking process and made it difficult to award marks. In part (b) many candidates could not explain, in their own words, the terms ‘net present value’ and ‘standard deviation’. This is a source of concern, especially as these topics are included in the Certificate Level syllabus. Common Errors 1. Demonstrating a complete lack of understanding of the techniques of annualising. 2. Calculating a NPV (part (a)) but not appreciating that the highest NPV, based solely on cost, is the most inferior position. 3. Demonstrating an inability to explain the terms ‘net present value’, and ‘standard deviation’. 4. Not appreciating that standard deviation figures are synonymous with the risk associated with each campaign.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 4

(a)

Produce calculations to determine whether any of the intermediate products should be further processed before being sold. Clearly state your recommendations together with any relevant assumptions that you have made. (3 marks)

(b)

Produce calculations to assess the viability of the common process: (i)

assuming that there is an external market for products R,S and T; and

(ii)

assuming that there is not an external market for products R,S and T.

State clearly your recommendations. (7 marks) (Total for Question Four =10 marks)

Rationale Question Four This question tests candidates’ ability to interpret a process account and with the other data provided to determine the viability of the process. This question addresses the learning outcome: Explain why joint costs must be allocated to final products for financial reporting purposes, but why this is unhelpful when decisions concerning process and product viability have to be taken.

Suggested Approach • Compare incremental costs and revenues for each product and make recommendations • Compare the sales value of the common process with its costs and comment on viability: • Recognising the benefits of further processing as accruing to the common process • Calculate the benefits of further processing and make a recommendation

Marking Guide Compare incremental costs and revenues for each product and make recommendations Compare the sales value of the common process with its costs and comment on viability Recognising the benefits of further processing as accruing to the common process Calculate the benefits of further processing Conclusion

Marks 3 4 1 1 1

Examiner’s Comments The majority of candidates did not appreciate the simplicity of part (a) where marks were awarded for comparing the incremental income with the incremental costs for each product. A variety of alternative methods were put forward which, while gaining the marks available, were lengthy and time consuming. Part (b) was fairly well answered, although many candidates did not fully grasp what was required and put forward the answer for b(i) as the answer for b(ii) and vice versa. Unfortunately as the requirement was quite specific the marks were not interchangeable. As already mentioned, candidates did not always provide clear directions to workings.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam Common Errors 1. Completely ignoring the fixed costs associated with product T/TZ. 2. Setting out figures, but not indicating the meaning of the figures. In addition, for parts b(ii) and b(iii) omitting to include the totals of the three products i.e. the final outcome. 3. Omitting to put forward any recommendations and instead simply leaving the markers to draw their own conclusions from the figures submitted.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE

Question 5

(a)

Calculate the net present value of the above investment proposal. (10 marks)

(b)

Explain how the above investment project would be appraised if there were to be a change in the rate of inflation so that it became too significant to be ignored. (5 marks)

(c)

Recommend, with supporting calculations, which of the three investment proposals should be accepted. (3 marks)

(d) (i)

Briefly explain gain sharing arrangements. (3 marks)

(ii)

Explain the reasons why X might not want to overcome its investment funding limitations by using a gain sharing arrangement. (4 marks) (Total for Question Five = 25 marks)

Rationale Question Five This question tests candidates’ ability in part (a) to calculate the net present value of an investment proposal from the data provided and in part (b) to discuss how their appraisal would change if inflation were at a significant level. Part (c) of the question requires candidates to choose between alternative investment opportunities, and part (d) requires candidates to explain gain sharing arrangements and why they may not be a solution to a limitation in investment funding. This question addresses the learning outcomes: Calculate project cash flows, accounting for tax and inflation, and apply perpetuities to derive “end of project” value where appropriate; and Evaluate and rank projects that might be mutually exclusive, involve unequal lives and/or be subject to capital rationing and Discuss gain sharing arrangements whereby contractors and customers benefit if contract targets for cost, delivery etc are beaten.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Suggested Approach

(a)

(b) (c)

(d)

• • • •

Identify the relevant costs and revenues of the investment proposal Convert these relevant costs and revenues into annual cash flows by adjusting for opening and closing receivables and payables Calculate the tax arising on the investment and the timing of its payment Calculate the net present value of the proposal

•

Explain how the calculations would be affected if inflation were to become significant

• •

Determine the possible combinations of projects and investments given the limited funds available for investment Calculate the NPV of each possible combination and make a recommendation

• •

Explain gain sharing arrangements Explain why X may not wish to enter into a gain sharing arrangement

Marking Guide (a) Identifying relevant costs and revenues Taxation cash flows Adjusting for receivables and payables Discounting

Marks 4 3 2 1

(b) Inflation of cash flow elements Conversion into cash flows Use of money cost of capital

2 2 1

(c) Identify possible combinations and their NPVs Recommendation

2 1

(d) (i) Explain gain sharing arrangements (ii) Explain why X plc may not wish to enter into such an arrangement

3 4

Examiner’s Comments A straightforward discounted cash flow exercise involving tax and phasing implications. In part (a) most candidates opted to completely ignore the payables and receivables figures, whereas other candidates made very poor attempts to adjust for them. In addition many candidates simply applied the taxation rate to the profit as given in the question and did not adjust for the depreciation that was included in the “other” costs figure. In part (b) many candidates appeared to understand the significance of a change in the rate of inflation but were unable to explain clearly the terms ‘money rate’ and ‘real rate’. Part (c) was generally answered well, although many candidates introduced the profitability index to rank the use of the capital available, even though the question clearly stated the proposals were non-divisible. Part (d) was generally answered quite well.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam Common Errors 1. Failing to introduce the receivables and payables balances into the cash flow statement. 2. Treating the profit given in the question as the cash flow figure i.e. failing to remove the depreciation figure from the “Other Production Costs”. 3. Not explaining correctly the difference between “money rates” and “real rates” of interest. 4. Adopting the performance index as a measure when allocating available funds.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 6

(a)

In order to assist the management of H in preparing its quotation, prepare a schedule showing the relevant costs for the production of the catalogues. State clearly your reason for including or excluding each value that has been provided in the above scenario. (15 marks)

(b)

Explain how the use of relevant costs as the basis of setting a selling price may be appropriate for short-term pricing decisions but may be inappropriate for long-term pricing decisions. Your answer should also discuss the conflict between reporting profitability within a traditional absorption costing system and the use of relevant cost based pricing. (10 marks) (Total for Question Six = 25 marks)

Rationale This question tests candidates’ ability in part (a) to interpret relevant cost data to determine the relevant cost of printing a brochure and in part (b) to explain the appropriateness of using relevant costs as the basis of pricing and the conflict that can arise when reporting profitability if a relevant cost based pricing method is used. This question addresses the learning outcomes: Discuss the principles of decision making including the identification of relevant cash flows and their use alongside non-quantifiable factors in making rounded judgements; and Explain the possible conflicts between cost accounting for profit reporting and stock valuation and the convenient availability of information for decision making; and Explain the particular issues that arise in pricing decisions and the conflict between “marginal cost” principles and the need for full recovery of all costs incurred.

Suggested Approach

(a)

(b)

• •

Identify each cost from the scenario provided Determine the relevant value and explain the reason for its inclusion / exclusion

• • •

Discuss short term v long term pricing decisions Routine reporting using absorption costing Conflict between profitability reported and decision making

Marking Guide (a) Each relevant item Reasons for including /excluding each item

Marks 5 10

(b) Short term v long term pricing decisions Routine reporting using absorption costing Conflict between profitability reported and decision making

The Chartered Institute of Management Accountants

4 4 2

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Examiner’s Comments This was the optional question chosen by most candidates, and generally the answers for part (a) were well presented. Unfortunately the answers to part (b) were generally poor, with most candidates simply describing the characteristics of marginal costing, and not addressing the question which was in effect in two parts. Firstly, candidates were asked to explain why relevant costing is suitable for short term pricing but not suitable for long term pricing. Secondly, a discussion was requested relating to the conflict between absorption costing and relevant costing when reporting profitability. Common Errors 1. Failing to answer the question, particularly in part (a) when every item needed a comment i.e. the reason a figure was included or the reason it was excluded. 2. Failing to follow the golden rules relating to relevant costing i.e. a relevant cost is a “future cost” and it is “cash”. 3. Not answering the question, but simply putting forward general answers relating to absorption costing/marginal costing.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

Question 7

(a)

Calculate the expected annual fee income of D. (2 marks)

(b)

Using Expected Values, calculate the breakeven number of members. (3 marks)

(c)

Prepare a two-way data table that shows the nine possible profit values. (6 marks)

(d)

Explain the meaning of the table that you have produced in (c) above and, by including appropriate probability values, how it may be used by management. (4 marks)

(e)

Explain how and why the collection of this data from members might improve the information that would be available to the Management Team. (10 marks) (Total for Question Seven = 25 marks)

Rationale Question Seven This question tests candidates’ ability to analyse data to determine the expected value and the range of possible profit values that could arise for a company that provides a motorist rescue service and then to explain how the use of activity based costing might improve the information available to the Management Team. This question addresses the learning outcomes: Evaluate the impact of uncertainty and risk on decision models that may be based on CVP analysis, relevant cash flows, learning curves, discounting techniques etc; and Apply activity based costing ideas to analyse direct customer profitability and extend this analysis to distribution channel profitability.

Suggested Approach

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam

(a) (b)

(c) (d)

(e)

•

Calculate expected income value

• •

Calculate the expected contribution per member Calculate the breakeven number of members

•

Prepare the two-way data table

• •

Discuss the range of values in the table Discuss the use of probability to assist in the interpretation of the table

• • •

Discuss the use of Activity Based Costing principles and how they can be applied to the scenario Explain the need for collection and cross analysis of cost data Discuss the use of members’ data and its relevance

Marking Guide (a) Calculate expected income value

Marks 2

(b) Calculate the expected contribution per member Calculate the breakeven number of members

1 2

(c) Prepare the two-way data table: Structure Contribution values Fixed cost

1 3 2

(d) Range of values Probability interpretation

2 2

(e) Recognition of ABC Collection & cross analysis of cost data Discuss use of members’ data and its relevance

2 2 6

Examiner’s Comments Parts (a) and (b) were well answered. A large variety of answers was put forward for part (c) and many of these options successfully gained marks. However two particular aspects were crucial for full marks to be awarded: a two-way table as opposed to simply a list of figures, and profits were requested as opposed to contributions. In part (d) very few candidates put forward a meaningful explanation of the two-way data table, especially by introducing joint probability figures. Many candidates submitted lengthy answers to part (e) which were of a general nature. The main point the examiner was seeking related to the principles of Activity Based Costing and recognising that there could be many causes of cost being incurred, not simply the number of members. A good answer also needed to develop the idea that the availability of additional information from members would allow the company to recognise the costs incurred by each member and allow a fairer pricing strategy to be adopted.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2007 Exam Common Errors 1. Including contributions, as oppose to profits in the two-way table. 2. Presenting a vertical list of numbers as opposed to a traditional two-way table. 3. Failing to introduce joint probability figures to support the answers in part (d). 4. Failing to appreciate that costs can be driven by many causes and that additional data would help the company to introduce a fairer pricing structure.

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Managerial Level Paper

P2 – Management Accounting Decision Management 21 November 2007 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during the reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. ALL answers must be written in the answer book. Answers or notes written on the question paper will not be submitted for marking. Answer the ONE compulsory question in Section A. This has eight subquestions and is on pages 2 to 4. Answer ALL THREE compulsory questions in Section B on pages 5 to 7. Answer TWO of the three questions in Section C on pages 8 to 13. Maths Tables and Formulae are provided on pages 15 to 17. These pages are detachable for ease of reference. The list of verbs as published in the syllabus is given for reference on the inside back cover of this question paper. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

P2 – Decision Management

Management Accounting Pillar

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. TURN OVER © The Chartered Institute of Management Accountants 2007

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6, 1.7 and 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions.

Question One 1.1 (i)

Penetration pricing is a strategy that is often used in the decline phase of a product’s life cycle.

(ii)

In the context of quality costs, Conformance Costs are always equal to Internal Failure Costs.

Which of the above statements are correct? A

(i) only

B

(ii) only

C

Both

D

Neither (2 marks)

Section A continues on the opposite page

P2

2

November 2007

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1.2

The following details relate to Product Z:

Selling price Purchased components Labour Variable overhead Fixed overhead Time on bottleneck resource

$/unit 45·00 14·00 10·00 8·50 4·50 10 minutes

Product return per minute is A

$0·80

B

$1·25

C

$2·10

D

$3·10 (2 marks)

1.3

In the context of quality costs, customer compensation costs and test equipment running costs would be classified as: Customer compensation costs

Test equipment running costs

A

Internal Failure Costs

Prevention Costs

B

Internal Failure Costs

Appraisal Costs

C

External Failure Costs

Appraisal Costs

D

External Failure Costs

Prevention Costs

(2 marks)

1.4

A company has an annual money cost of capital of 20% and inflation is 8% per annum. Calculate the company’s annual real percentage cost of capital to 2 decimal places. (2 marks)

1.5

A project has a net present value of $683,000. The present value of the direct material cost is $825,000. Calculate the sensitivity of the project to changes in the direct material cost to 2 decimal places. (2 marks)

Section A continues on the next page TURN OVER

November 2007

3

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P2

1.6

RDE plc uses an activity based costing system to attribute overhead costs to its three products. The following budgeted data relates to the year to 31 December 2008: Product Production units (000) Batch size (000 units)

X 15 2·5

Y 25 5

Z 20 4

Machine set up costs are caused by the number of batches of each product and have been estimated to be £600,000 for the year. Calculate the machine set up costs that would be attributed to each unit of product Y. (3 marks)

1.7

A company is considering an investment of $400,000 in new machinery. The machinery is expected to yield incremental profits over the next five years as follows: Year 1 2 3 4 5

Profit ($) 175,000 225,000 340,000 165,000 125,000

Thereafter, no incremental profits are expected and the machinery will be sold. It is company policy to depreciate machinery on a straight line basis over the life of the asset. The machinery is expected to have a value of $50,000 at the end of year 5. Calculate the payback period of the investment in this machinery to the nearest 0·1 years. (3 marks)

1.8

A company has determined its activity level and is now predicting its costs for the quarter ended 31 March 2008. It has made the following predictions: Variable costs $560,000 $780,000 $950,000

Probability 0·3 0·5 0·2

Fixed costs $440,000 $640,000 $760,000

Probability 0·15 0·55 0·30

Calculate the expected value of total cost and its standard deviation. Note: SD =

Σ( x − x ) 2 n

(4 marks)

(Total for Section A = 20 marks)

Reminder All answers to Section A must be written in your answer book. Answers to Section A written on the question paper will not be submitted for marking. End of Section A. Section B starts on page 5. P2

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SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS Question Two You are the management accountant of a new small company that has developed a new product using a labour intensive production process. You have recently completed the budgets for the company for next year and, before they are approved by the Board of Directors, you have been asked to explain your calculation of the labour time required for the budgeted output. In your calculations, you anticipated that the time taken for the first unit would be 40 minutes and that a 75% learning curve would apply for the first 30 units.

Required: (a)

Explain the concept of the learning curve and why it may be relevant to the above company. (3 marks)

(b)

Calculate the expected time for the 6th unit of output. (3 marks)

(c)

Discuss the implications of the learning curve for a company adopting a penetration pricing policy. (4 marks) (Total for Question Two = 10 marks)

Note: The learning index for a 75% learning curve is −0·415

Section B continues on the next page

TURN OVER November 2007

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P2

Question Three HS manufactures components for use in computers. The business operates in a highly competitive market where there are a large number of manufacturers of similar components. HS is considering its pricing strategy for the next twelve weeks for one of its components. The Managing Director seeks your advice to determine the selling price that will maximise the profit to be made during this period. You have been given the following data: Market Demand The current selling price of the component is $1,350 and at this price the average weekly demand over the last four weeks has been 8,000 components. An analysis of the market shows that for every $50 increase in selling price the demand reduces by 1,000 components per week. Equally, for every $50 reduction in selling price the demand increases by 1,000 components per week. Costs The direct material cost of each component is $270. This price is part of a fixed price contract with the material suppliers and the contract does not expire for another year.

Production labour and conversion costs, together with other overhead costs and the corresponding output volumes, have been collected for the last four weeks and they are as follows: Week 1 2 3 4

Output volume (units) 9,400 7,600 8,500 7,300

$000 7,000 5,688 6,334 5,446

No significant changes in cost behaviour are expected over the next twelve weeks.

Required: (a)

Calculate the optimum (profit maximising) selling price of the component for the period. Note: If Price = a - bq then Marginal Revenue = a - 2bq (6 marks)

(b)

Identify and explain two reasons why it may be inappropriate for HS to use this theoretical pricing model in practice. (4 marks) (Total for Question Three = 10 marks)

P2

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Question Four The owner of a tourist hotel is facing a difficult decision. It is low season and because the weather is unpredictable at this time of the year it is difficult to predict the demand for the hotel’s facilities. If the weather is poor then there will be 200 room nights demanded for the hotel’s facilities. There is a 70% likelihood of the weather being poor. If the weather is good then there will be 600 room nights demanded for the hotel’s facilities, but there is only a 30% chance that the weather will be good. The owner of the hotel is considering advertising some reduced prices locally or nationally in order to improve the demand during this period. If the reduced prices are advertised locally and if the weather is poor, then there is a 60% chance that the lower prices would affect demand and would cause there to be 300 room nights demanded, but if the weather is good, then there is a 40% chance that the lower prices would affect demand and would cause there to be 800 room nights demanded. If these lower prices were advertised nationally there is a 50% chance that these demand levels would increase to 400 room nights and 900 room nights respectively. The earnings expected, (before deducting the costs of any local or national advertising), at different levels of demand are as follows: Room nights demanded 200 300 400 500 600 700 800 900

Earnings ($)

(35,000) (15,000) (5,000) 20,000 30,000 45,000 65,000 90,000

The costs of advertising locally and nationally are $10,000 and $25,000 respectively.

Required: (a)

Prepare a decision tree to illustrate the above problem and use this to recommend, with reasons, the best course of action for the owner of the hotel. (7 marks)

(b)

Briefly discuss the limitations of using a decision tree to solve this problem. (3 marks) (Total for Question Four =10 marks)

(Total for Section B = 30 marks)

End of Section B Section C starts on the next page TURN OVER November 2007

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE Question Five SQ manufactures and sells a range of products. Details for one of the products, product Q, are shown below. Existing Production Facility The present production facility can continue to be used to produce up to 120,000 units of product Q each year. It is estimated that the facility can be used for a further five years but annual maintenance costs will rise substantially. An analysis of the latest costs is set out below: $ per unit 50 30 25 20 10

Direct materials Direct labour Variable production overhead Fixed production overhead* Variable selling and distribution overhead**

* The fixed production overhead costs are absorbed into product costs using an absorption rate which is 25% of prime cost. These fixed overhead costs are mainly central production facility costs that are not specific to any particular product or activity and would continue to be incurred regardless of the production method used by SQ. However they also include facility maintenance costs (see above). In addition SQ incurs annual fixed non-production costs of $24 million. ** These are selling and distribution costs that are not affected by the production method that is used for the product. Proposed New Production Facility The company is considering an investment of $4 million in a new production facility for product Q. The new facility is to be operational from 1 January 2008. It will have a life of five years and at the end of its life it will have a residual value of $0·4 million. It is expected that the facility will have significant benefits. Firstly it will increase SQ’s production capacity for product Q by 30%, secondly it will reduce product Q’s direct labour and variable production overhead costs by 20% per unit and finally the savings in annual maintenance costs will be as follows: Year 2008 2009 2010 2011 2012

$000 70 80 80 110 130

You have also obtained the following further information: Demand Currently SQ produces 120,000 units of product Q each year and these sell for $150 per unit. There is significant demand for the product and SQ estimates that it could sell more units if it had the capacity to produce them. If the selling price remains unchanged, customer demand for 2008 and future years is estimated to be as shown in the following table:

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Year

Customer demand (units) 130,000 140,000 147,000 154,000 162,000

2008 2009 2010 2011 2012

Cost Structure No changes are expected to either cost structure or to cost levels other than those referred to above. Taxation SQ pays corporation tax at the rate of 30% of its taxable profits. Half of this tax is payable in the year in which the profit is earned and the other half is payable one year later. If the investment in the new production facility goes ahead on 1 January 2008 (the first day of SQ’s accounting year) it will qualify for tax depreciation at the rate of 25% per annum on a reducing balance basis. Cost of Capital SQ’s after tax cost of capital is 12% per annum.

Required: (a) (i)

Calculate the Net Present Value (NPV) of the investment in the new facility. (14 marks)

(ii)

Explain two other factors that SQ should consider before making its decision. (4 marks)

(b)

A company is thinking of investing in a new project. The details are as follows: Investment Time span Annual cash inflows Annual cash outflows Cost of capital NPV @ 10%

$15,000 3 years $30,000 $22,500 10% $3,652·50

The project does not have a residual value. Ignore taxation. (i)

Calculate the Internal Rate of Return (IRR) of the investment proposal. (3 marks)

(ii)

Calculate the sensitivity of the investment to changes in the annual cash inflows. (4 marks) (Total for Question Five = 25 marks)

Section C continues on the next page TURN OVER November 2007

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P2

Question Six DFG manufactures two products from different combinations of the same resources. Unit selling prices and unit cost details for each product are as follows: Product

D £/unit 115

G £/unit 120

Direct material A (£5 per kg) Direct material B (£3 per kg) Skilled labour (£7 per hour) Variable overhead (£2 per machine hour) Fixed overhead*

20 12 28 14 28

10 24 21 18 36

Profit

13

11

Selling price

*Fixed overhead is absorbed using an absorption rate per machine hour. It is an unavoidable central overhead cost that is not affected by the mix or volume of products produced. The maximum weekly demand for products D and G is 400 units and 450 units respectively and this is the normal weekly production volume achieved by DFG. However, for the next four weeks the achievable production level will be reduced due to a shortage of available resources. The resources that are expected to be available are as follows: Direct material A Direct material B Skilled labour Machine time

1,800kg 3,500kg 2,500 hours 6,500 machine hours

Required: (a)

Using graphical linear programming identify the weekly production schedule for products D and G that maximises the profits of DFG during the next four weeks. (15 marks)

(b)

The optimal solution to part (a) shows that the shadow prices of Skilled labour and Direct material A are as follows: Skilled labour £Nil Direct material A £5·82 Explain the relevance of these values to the management of DFG. (6 marks)

(c)

Using the graph you have drawn in part (a) explain how you would calculate by how much the selling price of Product D could rise before the optimal solution would change. Note: Assume that demand is not affected by the selling price. You are not required to perform any calculations. (4 marks) (Total for Question Six = 25 marks)

P2

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Section C continues on the next page

TURN OVER

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P2

Question Seven A small retail outlet sells four main groups of products: Basic Foods (milk, bread, etc); Newspapers & Magazines; Frozen Foods; and Canned Foods. A budgeted weekly profit statement is shown below: Basic Foods

Sales revenue

$ 800

Newspapers and Magazines $ 1,000

Frozen Foods

Canned Foods

$ 1,500

$ 2,400

Cost of sales

600

700

550

1,200

Gross margin

200

300

950

1,200

Power for freezers* Overheads**

100 100

100

200

400

Net margin

100

200

650

800

*The freezers would be emptied and switched off as necessary during redecoration. **Overhead costs comprise general costs of heating and lighting, rent and rates, and other general overhead costs. These costs are attributed to products in proportion to the floor area occupied by each product group which is as follows: Basic Foods

Floor area (m2)

50

Newspapers and Magazines 50

Frozen Foods

Canned Foods

100

200

For each product group, analysis has shown that the sales revenue achieved changes in direct proportion to the floor space allocated to the product. The owner of the retail outlet has decided that the premises need to be redecorated but is undecided as to which of the following two options would be the most profitable. Option 1 Close the retail outlet completely for four weeks while the redecoration takes place. The company that is to complete the redecoration would charge $2,500 under this option. It is expected that following the re-opening of the retail outlet there would be a loss of sales for the next 12 weeks because customers would have had to find alternative suppliers for their goods. The reduction in sales due to lost customers has been estimated to be 30% of the budgeted sales during the first four weeks of reopening; 20% during the next four weeks; and 10% during the third four weeks. In addition, in order to encourage customers to return to the retail outlet, there would be a 10% price reduction on all Basic Foods and Canned Foods for the entire 12 week period. Option 2 Continue to open the retail outlet while the redecoration takes place but with a reduced amount of floor area. The useable floor area would be reduced to 40% of that originally available. After three weeks, the retail outlet would be closed for 0·5 weeks while the goods are moved to the newly redecorated area. The retail outlet would then continue to operate using 40% of its original floor area for a further three weeks before the work was fully completed. The company that is to complete the redecoration would charge $3,500 under this option, and in addition there would be product movement costs of $1,000. The owner has determined that in order to avoid losing customers there should be no reduction in the amount of floor area given to Basic Foods and Newspapers and Magazines throughout this period. The floor area to be used by Frozen Foods and Canned Foods should be determined on the basis of their profitability per unit of P2

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area. However, the Frozen Foods are presently kept in four freezers, and therefore any reductions in floor area must be determined by complete freezer units. It may be assumed that each freezer unit incurs equal amounts of power costs.

Required: (a)

Advise the owner of the retail outlet which option to choose in order to minimise the losses that will occur as a result of the decision. All workings must be shown. (15 marks)

(b)

Explain how Activity Based Costing may be used in a retail environment to improve the decision making and profitability of the business. (10 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of question paper. Maths Tables and Formulae are on pages 15 to 17

TURN OVER

November 2007

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P2

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P2

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PRESENT VALUE TABLE Present value of $1, that is (1 + r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

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FORMULAE Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b=

Covariance ( XY )

=

n ∑ XY − ( ∑ X )( ∑ Y )

Variance ( X )

2

n ∑ X − (∑ X )

2

a= Y –bX

and or solve

∑ Y = na + b ∑ X ∑ XY = a ∑ X + b ∑ X

2

Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb

where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

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P2

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LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE 1 KNOWLEDGE What you are expected to know.

2 COMPREHENSION What you are expected to understand.

VERBS USED

DEFINITION

List State Define

Make a list of Express, fully or clearly, the details of/facts of Give the exact meaning of

Describe Distinguish Explain Identify

Communicate the key features Highlight the differences between Make clear or intelligible/State the meaning of Recognise, establish or select after consideration Use an example to describe or explain something

Illustrate 3 APPLICATION How you are expected to apply your knowledge.

Apply Calculate/compute Demonstrate Prepare Reconcile Solve Tabulate

4 ANALYSIS How you are expected to analyse the detail of what you have learned.

Analyse Categorise Compare and contrast

5 EVALUATION How you are expected to use your learning to evaluate, make decisions or recommendations.

November 2007

To put to practical use To ascertain or reckon mathematically To prove with certainty or to exhibit by practical means To make or get ready for use To make or prove consistent/compatible Find an answer to Arrange in a table

Construct Discuss Interpret Produce

Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between To build up or compile To examine in detail by argument To translate into intelligible or familiar terms To create or bring into existence

Advise Evaluate Recommend

To counsel, inform or notify To appraise or assess the value of To advise on a course of action

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P2

Management Accounting Pillar Managerial Level

P2 – Management Accounting – Decision Management

November 2007

Wednesday Morning Session

P2

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

General Comments The overall average mark was below the level achieved in the previous diet but it was encouraging to note that a significant number of candidates attained high individual marks. The paper featured questions that covered a large proportion of the syllabus and included familiar topics that should have been no surprise to candidates, especially those candidates who took the time to familiarise themselves with previous papers. Topics such as linear programming, the learning curve and investment appraisal were again examined. Unfortunately the answers put forward by many candidates demonstrated that the subject being tested was understood only at a peripheral level. It was also evident that while most candidates feel relatively comfortable when tackling numerical questions they are less able to answer discursive questions. Many candidates cannot explain, or describe, a technique they have been called upon to use, and many do not appear to appreciate what was actually required. The problem seems to be a complete lack of understanding of how to interpret a question i.e. having no understanding of the verb being used. When preparing for the examinations candidates need to know what is meant by words such as "explain", "discuss" and "identify". As in previous diets it was disappointing to note that questions that tested fundamental aspects of management accounting were poorly answered. This emphasises again the point that candidates who have been awarded exemptions from paper C1 and in some cases P1, need to ensure that they have a good understanding of the complete syllabi of both papers before attempting the P2 paper. In most cases the quality of writing was good but aspects of grammar need attention. In the majority of cases there was no clear evidence of an answer plan and many candidates presented answers that were difficult to follow. On these occasions candidates are putting themselves at a disadvantage as it is difficult to award the marks that are on offer. The marking team also experienced difficulties when marking answers to numerical questions because many candidates gave no directions to workings. On other occasions the workings could not be deciphered and sometimes the workings were simply not provided. Under these circumstances it is difficult for markers to use the ‘own figure’ rule to award marks. It was pleasing to note that very few candidates experienced time constraints, this being demonstrated by virtually every candidate attempting the required number of questions. This situation could also confirm that candidates are making full use of the 20 minutes allowed for planning.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Section A – 20 marks Question 1.1 (i)

Penetration pricing is a strategy that is often used in the decline phase of a product’s life cycle.

(ii)

In the context of quality costs, Conformance Costs are always equal to Internal Failure Costs.

Which of the above statements are correct? A

(i) only

B

(ii) only

C

Both

D

Neither (2 marks) The answer is D

Question 1.2 The following details relate to Product Z: Selling price Purchased components Labour Variable overhead Fixed overhead Time on bottleneck resource

$/unit 45·00 14·00 10·00 8·50 4·50 10 minutes

Product return per minute is A

$0·80

B

$1·25

C

$2·10

D

$3·10 (2 marks) The answer is D

Workings (Selling Price – Material Cost) / Time on bottleneck resource = ($45·00 - $14·00) / 10 minutes = $3·10

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 1.3 In the context of quality costs, customer compensation costs and test equipment running costs would be classified as: Customer compensation costs

Test equipment running costs

A

Internal Failure Costs

Prevention Costs

B

Internal Failure Costs

Appraisal Costs

C

External Failure Costs

Appraisal Costs

D

External Failure Costs

Prevention Costs

(2 marks) The answer is C

Question 1.4 A company has an annual money cost of capital of 20% and inflation is 8% per annum. Calculate the company’s annual real percentage cost of capital to 2 decimal places. (2 marks)

Workings (1+m) / (1 + i) = (1 + r) = 1·20 / 1·08 = 1·1111 Answer = 11·11%

Question 1.5 A project has a net present value of $683,000. The present value of the direct material cost is $825,000. Calculate the sensitivity of the project to changes in the direct material cost to 2 decimal places. (2 marks)

Workings $683,000 / $825,000 = 82·79%

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 1.6 RDE plc uses an activity based costing system to attribute overhead costs to its three products. The following budgeted data relates to the year to 31 December 2008: Product Production units (000) Batch size (000 units)

X 15 2·5

Y 25 5

Z 20 4

Machine set up costs are caused by the number of batches of each product and have been estimated to be £600,000 for the year. Calculate the machine set up costs that would be attributed to each unit of product Y. (3 marks)

Workings The total number of batches = (15/2·5) + (25/5) + (20/4) = 16 Cost driver rate = £600,000 / 16 = £37,500 Cost per unit = £37,500 / 5,000 = £7·50

Question 1.7 A company is considering an investment of $400,000 in new machinery. The machinery is expected to yield incremental profits over the next five years as follows: Year 1 2 3 4 5

Profit ($) 175,000 225,000 340,000 165,000 125,000

Thereafter, no incremental profits are expected and the machinery will be sold. It is company policy to depreciate machinery on a straight line basis over the life of the asset. The machinery is expected to have a value of $50,000 at the end of year 5. Calculate the payback period of the investment in this machinery to the nearest 0·1 years. (3 marks)

Workings Annual depreciation = ($400,000 - $50,000) / 5 years = $70,000 Year 1 2

Profit ($) 175,000 225,000

Depreciation ($) 70,000 70,000

Cash flow ($) 245,000 295,000

Cash flow to date ($) 245,000 540,000

Payback occurs during year 2 Payback period = [1 + (155,000/295,000)] years = 1·5 years

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 1.8 A company has determined its activity level and is now predicting its costs for the quarter ended 31 March 2008. It has made the following predictions: Variable costs $560,000 $780,000 $950,000

Probability 0·3 0·5 0·2

Fixed costs $440,000 $640,000 $760,000

Probability 0·15 0·55 0·30

Calculate the expected value of total cost and its standard deviation. (4 marks)

Workings Variable costs $000 560 560 560 780 780 780 950 950 950

Fixed costs $000 440 640 760 440 640 760 440 640 760

Total costs x $000 1,000 1,200 1,320 1,220 1,420 1,540 1,390 1,590 1,710

Totals

Probability p

px

p(x–x)2

·045 ·165 ·090 ·075 ·275 ·150 ·030 ·110 ·060

45 198 118·8 91·5 390·5 231 41·7 174·9 102·6

6,986 6,210 493 2,271 186 3,197 0 4,226 5,991

1·000

1,394

29,560

Expected value $1,394,000; Standard Deviation √29,560,000,000 = $171, 930

Examiner’s comments The average mark for this question was lower than in previous diets. Many candidates failed to gain the marks available by simply not presenting the answer as directed in the question. Questions 1.4 and 1.5 specifically asked for the answer to be shown “to 2 decimal places” but many candidates chose instead to present their answer in another format, for example a whole number, that gained no marks. When answering question 1.7 many candidates incorrectly subtracted the annual depreciation figure from the profit, rather than adding it. It was disappointing to see such a fundamental error. Common Errors 1. Failing to present an answer as directed in the question 2. Demonstrating an inability to convert an annual profit figure into a cash flow figure by adding back the correct depreciation figure.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS

Question 2

(a) (b) (c)

Explain the concept of the learning curve and why it may be relevant to the above company. (3 marks) Calculate the expected time for the 6th unit of output. (3 marks) Discuss the implications of the learning curve for a company adopting a penetration pricing policy. (4 marks) (Total for Question Two = 10 marks)

Rationale Question Two This question tests candidates’ ability to demonstrate their understanding of the learning curve and why it may be relevant to the company in the scenario, together with its implications for a company adopting a penetration pricing policy. This question addresses the learning outcome: D(iv) Explain and apply learning and experience curves to estimate time and cost for new products and services. Suggested Approach • Read the scenario carefully and identify the key factors that are relevant to the operation of a learning curve • Calculate the average time per unit for five units and six units • Calculate the total times for five units and six units • Calculate the time taken for the sixth unit • Discuss the relationship between costs, prices and profits, and the implications of the learning curve for the adoption of a penetration pricing policy Marking Guide (a) Labour intensive process so repetition Explanation of learning curve principle (b) Calculate average times Calculate total times Time for sixth unit (c) Pricing policy (e.g. using an average cost level) Losses on early units Profits on later units Deterrent to competitors

Marks 1.5 1.5 1 1 1 1 1 1 1

Examiner’s Comments Although parts (a) and (b) were generally well answered, the answers to part (c) were generally poor. Part (c) asked candidates to ‘discuss the implications of the learning curve for a company adopting a penetration pricing policy’. Unfortunately the majority of candidates simply wrote all they knew about penetration pricing and did not even consider the implications of the learning curve. Marks were not awarded for answers that did not consider the learning curve. Common Errors 1. Calculating incorrect times for the fifth and sixth units. 2. Ignoring the implications of the learning curve when formulating an answer to part (c).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 3

(a)

Calculate the optimum (profit maximising) selling price of the component for the period. Note: If Price = a - bq then Marginal Revenue = a - 2bq (6 marks)

(b)

Identify and explain two reasons why it may be inappropriate for HS to use this theoretical pricing model in practice. (4 marks) (Total for Question Three = 10 marks)

Rationale Question Three This question tests candidates’ knowledge of pricing. In part (a) candidates are required to prepare calculations to determine the profit maximising selling price. In part (b) candidates are required to identify and explain why the use of this theoretical model may be inappropriate in practice. This question addresses the learning outcome: A (iii) Apply an approach to pricing based on profit maximisation in imperfect markets and evaluate the financial consequences of alternative pricing strategies.

Suggested Approach • Read the scenario carefully to identify the key factors in determining the optimum price • Analyse the costs provided using the high & low points method to separate them into their fixed and variable components • Determine the theoretical optimum price

Marking Guide (a) Calculate marginal cost Calculate the price at zero demand Calculate q Calculate the optimum price (b) Each reason (2 X 2 marks)

Marks 1 2 2 1 4

Examiner’s Comments Both parts of this question were generally well answered. However there were two common errors. Firstly the inability of candidates to use the high-low method to calculate a variable labour and conversion cost. This is a most basic management accounting technique that appears in several areas of the syllabus (for example breakeven analysis and flexible budgets). Secondly, the answers put forward by many candidates were not ‘sensible’ in the context of the question. Common Errors 1. Demonstrating an inability to apply the high-low technique. 2. Failing to ensure that answers were sensible i.e. putting forward answers that were completely out of context to the figures in the question. 3. Failing to distinguish between “cost” and “price”

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 4

Prepare a decision tree to illustrate the above problem and use this to recommend, with reasons, the best course of action for the owner of the hotel.

(a)

(7 marks) Briefly discuss the limitations of using a decision tree to solve this problem.

(b)

(3 marks) (Total for Question Four = 10 marks)

Rationale Question Four This question tests candidates’ ability to interpret data and solve a problem using a decision tree approach. In part (b) candidates are then required to discuss the limitations of using a decision tree to solve such a problem. This question addresses the learning outcome: C(v) Prepare and apply decision trees.

Suggested Approach • • • •

Analyse the data provided to determine the possible outcomes Prepare a decision tree that summarises those outcomes Evaluate each branch of the decision tree to determine the optimal solution Discuss your recommendations and the limitations of using decision trees

Marking Guide

Marks

(a) Each branch (3 x 0.5 marks) Evaluate each branch (3 x 1 mark) Recommendation (b) Negative contributions from all options Uses expected values Expected value is an average Use may not be appropriate for this non-repeating decision Ignores range of possible outcomes

1.5 3 1.5 1 1 1 1 1 Max 3

Examiner’s Comments The answers to both parts of this question were generally poor. The decision trees put forward demonstrated clearly that many candidates were either unfamiliar with the principles associated with a decision tree, or had not practised/revised this topic. In view of the poor quality of many of the decision trees, the marking task was very difficult. On many occasions markers were unable to award marks. In part (b) most candidates did not discuss the limitations of using a decision tree as a management accounting tool, but simply discussed weather conditions and the hotel trade. Common Errors 1. Demonstrating an inability to present clear, well tabulated, decision trees. 2. Not understanding multiple probabilities. 3. Failing to provide an answer to (part b).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE

Question 5

(a) (i)

Calculate the Net Present Value (NPV) of the investment in the new facility. (14 marks)

(ii)

Explain two other factors that SQ should consider before making its decision. (4 marks)

(b)

A company is thinking of investing in a new project. The details are as follows: Investment Time span Annual cash inflows Annual cash outflows Cost of capital NPV @ 10%

$15,000 3 years $30,000 $22,500 10% $3,652·50

The project does not have a residual value. Ignore taxation. (i)

Calculate the Internal Rate of Return (IRR) of the investment proposal. (3 marks)

(ii)

Calculate the sensitivity of the investment to changes in the annual cash inflows. (4 marks) (Total for Question Five = 25 marks)

Rationale Question Five This question tests candidates’ ability in part (a) to calculate the net present value of an investment proposal from the data provided and in part (b) to calculate the internal rate of return and the sensitivity of a project to a change in one of the input variables. This question addresses the learning outcome: B(iii) Calculate project cash flows, accounting for tax and inflation, and apply perpetuities to derive “end of project” value where appropriate.

Suggested Approach • • • • • • •

Read the scenario carefully to ascertain the incremental nature of the decision being made Identify the cost and revenue changes that will occur as a result of the decision and the timing of those changes Determine the tax consequences of those incremental costs and revenues Evaluate the proposal using net present value (NPV) Discuss the practical difficulties of using NPV to evaluate investment proposals Calculate the Internal Rate of Return Analyse the sensitivity of the project outcome to changes in the forecast cash inflows

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Marking Guide (a)(i) Calculate annual cost saving on existing production Calculate additional units for each year: 2008 – 2011 2012 Calculate annual contribution from additional units Tax payable on pre tax profit Tax saving on investment Investment cash flows Discounting of cash flows (a)(ii) Each factor (2 x 2 marks) (b)(i) Calculate NPV using a different discount factor Calculate IRR (b)(ii) Calculate present value of the forecast annual cash inflows Sensitivity calculation

Marks 3 1 1 3 1 3 1 1 4 2 2 Max 3 2 2

Examiner’s Comments Part (a)(i) was a familiar investment appraisal question, similar to questions that have appeared in previous papers. The most important aspect of this question was the need to adopt an incremental approach, i.e. the impact of investing in the new facility. Unfortunately only about ten per cent of answers attempted an incremental approach. A rather disappointing point to note is the high proportion of poorly presented answers. Many answers contained figures that were difficult to read, no details were included to explain the origin of the figures and workings were either non-existent or not referred to. Marking became quite a tortuous task and on occasions it was difficult to award marks. Parts a(ii), b(i) and b(ii) were generally well answered. Common Errors 1. Not appreciating that an incremental approach was a vital aspect when answering a(i). 2. Providing poorly presented answers 3. Providing no reference to working/support details.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 6

(a)

Using graphical linear programming identify the weekly production schedule for products D and G that maximises the profits of DFG during the next four weeks. (15 marks)

(b)

The optimal solution to part (a) shows that the shadow prices of Skilled labour and Direct material A are as follows: Skilled labour £Nil Direct material A £5·82 Explain the relevance of these values to the management of DFG. (6 marks)

(c)

Using the graph you have drawn in part (a) explain how you would calculate by how much the selling price of Product D could rise before the optimal solution would change. Note: Assume that demand is not affected by the selling price. You are not required to perform any calculations. (4 marks) (Total for Question Six = 25 marks)

Rationale Question Six This question tests candidates’ ability to solve a scarce resource problem using linear programming and to interpret the solution. This question addresses the learning outcome: A(vii) Apply variable/fixed cost analysis in multiple product contexts to break-even analysis and product mix decision making, including circumstances where there are multiple constraints and linear programming methods are needed to reach “optimal” solutions.

Suggested Approach • • • • • •

Produce resource constraint equations from the data provided Determine the iso-contribution function Plot the resource constraints on a graph and identify the feasible region Determine the optimal solution using the iso-contribution function Explain the meaning of the shadow prices Explain how a change in selling price would affect the optimal solution

Marking Guide (a) Establish and plot constraints Identify iso-contribution line Identify optimal plan (b) General explanation of shadow price Shadow price of skilled labour Shadow price of material A (c) Change in contribution Change in iso-contribution line Change in plan

The Chartered Institute of Management Accountants

Marks 12 2 1 1 2 3 1 1 2

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Examiner’s Comments Overall this was a well answered question with most candidates achieving a good mark for parts (a) and (b). Many candidates chose not to use graph paper when presenting their answer to part (a). In most cases this led to inaccurate figures being put forward for the optimal solution and obviously lost marks. The answers to part (c) were generally poor. This called for an understanding of the type of graph requested, in particular, the ability to manipulate the iso-contribution line. Calculations were not required, but while figures could perhaps have supported a written answer, many students chose to put forward only numerical answers. Common Errors 1. Not using the graph paper provided. 2. Not showing all details on the graph e.g. maximum demand. 3. In part (c), putting forward calculations as opposed to answering the question, i.e. “explain how you would calculate”.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam

Question 7

(a)

Advise the owner of the retail outlet which option to choose in order to minimise the losses that will occur as a result of the decision. All workings must be shown. (15 marks)

(b)

Explain how Activity Based Costing may be used in a retail environment to improve the decision making and profitability of the business. (10 marks) (Total for Question Seven = 25 marks)

Rationale Question Seven This question tests candidates’ ability to analyse the data provided to determine the optimal solution to a closure problem and then to explain how the use of activity based costing might improve the decision making and profitability of a retail business. This question addresses the learning outcomes: A(i) Discuss the principles of decision making including the identification of relevant cash flows and their use alongside non-quantifiable factors in making rounded judgements; and D(v) Apply the techniques of activity based management in identifying cost drivers/activities and explain how process reengineering can be used to eliminate non-value adding activities and reduce activity costs.

Suggested Approach • Read the scenario carefully and identify the impact on costs and revenues of each alternative option • Determine the costs and revenues of each option and advise the owner • Discuss the application of Activity Based Costing to the retail sector • Discuss how ABC could improve decision making and profitability for this retailer

Marking Guide (a) Each relevant cost and revenue value (8 x 2 marks) Advice (b) Categories of cost with examples ABC identifies causes of costs Examples relevant to scenario (2 x 2 marks) Improved decision making and profitability

Marks 14 Max 1 3 1 4 2

Examiner’s Comments This was the least popular optional question and in the majority of cases the answers for both parts were poor. No specific management accounting technique was required for part (a). The question simply required a candidate to assimilate the data provided and quantify the impact of choosing option 1 or option 2. A variety of approaches were available to answer the question but the majority of answers were inaccurate and provided no supporting details or workings. When marking the answers to part (b) it was disappointing to note that many candidates have lost the ability to structure a written answer. In most cases there was very little evidence of any form of an answer plan and many answers were disjointed and not cohesive. Most candidates were able to put forward a brief explanation of ABC but very few were able to relate ABC to the retail environment.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2007 Exam Common Errors 1. In part (a), adopting a poor approach and using a poor layout for answers 2. Providing no supporting details or reference to workings 3. In part (b), not using an answer plan 4. Demonstrating a poor standard of handwriting.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

General Comments The overall average mark and the percentage of candidates passing the exam were above the level achieved in the previous diet. The paper contained questions that covered a large proportion of the syllabus, and candidates who undertook a review of previous papers would have noticed a repeat of several important topics with TQM/JIT, investment appraisal, the learning curve and the principles of limiting factors, again being tested. It is important to bring to the attention of candidates a number of issues that singularly and collectively had an adverse impact on the final marks awarded. 1. Many candidates appear to be unable to interpret a question i.e. they do not understand the verb being used. When preparing for the examinations candidates need to know what is meant by such words as “identify and explain” (Q.3), “briefly discuss” (Q.3), “recommend” (Q.7). 2. Candidates are recommended to show all workings and refer to them clearly, especially when two figures have been added together and then included in a table of figures in the final answer (e.g. question 6, production and non-production costs). A mark cannot be awarded for an incorrect total figure if its make-up is not shown. 3. All candidates taking this examination, especially those who have been awarded an exemption from C1 and P1, are advised to ensure they have a good understanding of the syllabus of these two papers. 4. Candidates are advised to make full use of the 20 minutes allowed for planning. Time spent planning answers and planning the order in which to answer the questions is time well spent, especially if this reduces overall writing time and duplication of repetitive workings. 5. Candidates are also advised not to waste time rewriting the question at the start of their answer. This expends valuable time and serves no useful purpose. 6. When answering written questions some candidates submitted answers that were difficult to read. In addition, some aspects of grammar were poor. Candidates are advised to practice questions that require written answers. 7. Candidates at this level should be capable of establishing what is required and planning their answers accordingly. 8. Where required (Q2 & Q3) narrative answers should be related to the question scenario.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Section A – 20 marks Question 1.1 A project has an initial investment of $140,000 and a Net Present Value of $42,500. The present value of the sales revenue generated by the project is $385,000. The sensitivity of the investment to changes in the value of sales revenue is closest to A

36%

B

$342,500

C

89%

D

11% (2 marks) The answer is D

Workings $42,500/$385,000 = 11%

Question 1.2 A company produces three products (X, Y and Z) from a common process. Each of these products may then be further processed in separate processes, which do not incur any incremental fixed costs. When deciding whether or not to further process Product Z, the information required is: (i)

The common costs of the joint process

(ii)

The further processing costs of Product Z

(iii)

The unit selling price of Product Z at the point of separation

(iv)

The unit selling price of Product Z after further processing

(v)

The percentage losses of further processing Product Z

(vi)

The actual output of Product Z from the common process

A

(i), (ii), (iii) and (iv) only

B

(ii), (iii), (iv) and (vi) only

C

(ii), (iii), (iv), and (v) only

D

All of the above (2 marks) The answer is C

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 1.3 A company has a real cost of capital of 6⋅00% per annum and inflation is currently 4⋅00% per annum. The company’s annual money cost of capital is closest to A

10⋅24%

B

10⋅00%

C

2⋅00%

D

1⋅92% (2 marks) The answer is A

Workings 1⋅06 x 1⋅04 = 1⋅1024

The following data is to be used when answering questions 1.4 & 1.5 A company is considering investing in a new machine. The machine will cost $15,000 and has an expected life of five years with a residual value of $3,000. The machine will increase the operating cashflows of the company as follows: Year

1 2 3 4 5

Increase in operating cashflow $ 2,500 3,000 5,500 4,000 3,000

Question 1.4 Calculate the payback period of the new machine to the nearest 0⋅1 years. (2 marks)

Workings Year

1 2 3 4

Cumulative Cashflow ($) 2,500 5,500 11,000 15,000

Payback period = 4⋅0 years

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 1.5 Calculate the average Annual Accounting Rate of Return over the lifetime of the investment in the new machine. (2 marks)

Workings ARR = Average Annual Profit/Average Investment value = [(18,000 – 12,000)/5]/[(15,000 + 3,000)/2] = 13⋅3%

Question 1.6 A company is considering its costs in respect of a new product. The following tables show the predictions made by the company, together with their associated probabilities: Fixed costs $ 100,000 130,000 160,000

Probability 0⋅35 0⋅45 0⋅20

Variable costs $ 70,000 90,000 110,000

Probability 0⋅40 0⋅35 0⋅25

Calculate the expected value of total costs. (2 marks)

Workings Expected value of fixed costs: ($100,000 x 0⋅35) + ($130,000 x 0⋅45) + ($160,000 x 0⋅20) = $125,500 Expected value of variable costs: ($70,000 x 0⋅40) + ($90,000 x 0⋅35) + ($110,000 x 0⋅25) = $87,000 Expected value of total costs = $125,500 + $87,000 = $212,500

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 1.7 A company is considering the following investments for the year ending 30 June 2009: Investment W X Y Z

Capital required $ 100,000 150,000 140,000 190,000

NPV $ 56,000 75,000 68,000 91,000

None of the investments are divisible. They cannot be undertaken more than once within each year. The company has only $350,000 available to invest in the year to 30 June 2009. There are no other investments available at this time. Which investments (if any) should the company undertake? (2 marks)

Workings Possible Combinations W & X only W & Y only W & Z only X & Y only X & Z only Y & Z only

NPV ($) 131,000 124,000 147,000 143,000 166,000 Answer 159,000

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 1.8 A company is considering a short-term pricing decision to utilise some spare capacity. The item to be manufactured and sold would use 1,500kgs of raw material Q. Material Q is in regular use by the company. It currently has 1,000kgs in inventory, which was purchased last month at a cost of $4 per kg. The current replacement cost of material Q is $4⋅80 per kg and the current inventory could be sold for $4⋅30 per kg. Calculate the relevant cost of material Q for the purposes of this decision. (2 marks)

Workings 1,500 kgs x $4⋅80 = $7,200

Question 1.9 A company is considering the price of a new product. It has determined that the variable cost of making the item will be $24 per unit. Market research has indicated that if the selling price were to be $60 per unit then the demand would be 1,000 units per week. However, for every $10 per unit increase in selling price, there would be a reduction in demand by 50 units; and for every $10 reduction in selling price, there would be an increase in demand of 50 units. Calculate the optimal selling price. (4 marks) Note:

If Price P = a-bx then Marginal Revenue = a-2bx

Workings P0 = $60 + ($10 x 1,000/50) = $260 P = $260 - 0⋅2q MR = $260 - 0⋅4q MC = $24 Optimum solution: 24 236 590 P= = Note:

= = =

260 - 0⋅4q 0⋅4q q

$260 - 0⋅2q = $260 - (0⋅2 x 590) $142 P0 = price at which demand equals zero P = price q = quantity MR = marginal revenue MC = marginal cost

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Examiner’s comments It is pleasing to note that the average mark for this question was slightly higher than in previous diets. The presentation of the answers, i.e. presenting the answer as requested in the question, showed a marked improvement compared with previous experience. No individual question was ignored and there did not appear to be a particular question that was poorly answered. When answering Q.1.7 many candidates failed to note, or did not understand, the phrase ‘none of the investments are divisible’ and opted for two investments and a portion of a third investment. The topics included and tested in this question related to many important aspects of the syllabus, and were similar to questions that had appeared in previous papers. Common Errors 1. Failure to note exactly what was requested 2. Failure to show workings for question 1.9

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS

Question 2 You are the Management Accountant of XY, an engineering company that assembles components into engines for sale to the automotive industry. The company is constantly under pressure from its customers to provide more efficient engines, which are also less damaging to the environment. The company uses value chain analysis as a tool in the management of its activities. The Managing Director of XY has recently been invited to a conference to give a presentation entitled “The concept of the Value Chain and the management of profits generated throughout the chain in XY.”

Required: Prepare a report for the Managing Director explaining the points that should be covered in the presentation. (Total for Question Two = 10 marks)

Rationale This question tests candidates’ ability to demonstrate their understanding of the Value Chain. This question addresses the learning outcome: explain the concept of the value chain and discuss the management of contribution/profit generated throughout the chain.

Suggested Approach • Carefully read the scenario provided and identify the key elements of a Value Chain • Explain by a diagram or otherwise the elements of a Value Chain • Explain how value for the customer is created throughout the Value Chain, resulting in the management of profits generated throughout the chain

Marking Guide Report format Explain Value Chain Discuss contribution

Marks 2 4 4

Examiner’s Comments In most cases this question was poorly answered for several reasons: 1. A report format was requested (to, from, date, etc.) but many candidates ignored this request. 2. The answer needed to address two specific points. Firstly a description/explanation of the ‘concept of the Value Chain’ and secondly ‘the management of profits generated throughout the chain’. Most candidates were able to demonstrate a basic understanding of one of the forms of the Value Chain, some by use of a diagram. However a good answer needed to develop and explain that each link of the chain should add value in some way to generate outputs for customers and also to generate higher contribution for the company. The answer further needed to explain that a feature of any part of the Value Chain comprised the quality of the product as perceived by the customer. A large number of answers transformed the question to read ‘Write all you know about Value Analysis’, and continued to describe esteem value and utility value. This was not the question asked and such answers did not attract any marks.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam Common Errors 1. Failure to present the answer in a report format 2. Not answering the question. For example, writing about Value Analysis and Value Engineering as opposed to the Value Chain. 3. Showing no understanding of the Value Chain.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 3 A company experiences changing levels of demand, but produces a constant number of units during each quarter. The company allows inventory levels to rise and fall to satisfy the differing quarterly demand levels for its product.

Required: (a)

Identify and explain the reasons for THREE cost changes that would result if the company changed to a Just-In-Time production method for 2009. Assume there will be no inventory at the start and end of the year. (6 marks)

(b)

Briefly discuss the importance of Total Quality Management to a company that operates a Just-In-Time production method. (4 marks) (Total for Question Three = 10 marks)

Rationale This question tests candidates’ knowledge of Just In Time production. In part (a) candidates are required to explain the reasons for three additional costs / cost savings that would occur if the company were to change to a Just In Time production method. In part (b) candidates are required to discuss the importance of Total Quality Management to a company that operates a Just In Time production method. This question addresses the learning outcome: evaluate the impacts of just-in-time production, the theory of constraints and total quality management on efficiency, inventory and cost.

Suggested Approach • Carefully read the scenario to identify the key factors associated with changing to a Just In Time (JIT) production method • Explain three cost changes that will occur as a result of the introduction of JIT production • Explain the importance of quality in a JIT production method

Marking Guide (a) Resource planning Inflationary savings Inventory holding costs

Marks 2 2 2

(b) Lack of safety net Quality responsibility

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Examiner’s Comments Part (a) was generally well answered although many answers lacked imagination in that candidates put forward three valid cost reductions which all related to the same reason e.g. a reduction in inventory holding costs, lower levels of obsolescence and reduced insurance costs. These cost changes all related to a reduction in inventory. Most candidates simply treated part (b) as an extension to part (a). Their answers contained discussions/issues relating to cost implications of the introduction of JIT. The examiner however was looking for candidates to develop two particular issues. Firstly, that with the introduction of JIT there is no inventory to act as a buffer or safety net, whereby a stoppage in production would lead to delayed/lost sales. Secondly, that the company would need to adopt a philosophy of Total Quality Management so that every person in the production system takes responsibility for the quality of their own output. Common Errors 1. Lacking imagination when answering part (a). 2. Not fully understanding/appreciating what was needed for part (b). 3. Failure to develop items put forward e.g. providing a bullet point instead of a developed sentence

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 4 A company has developed a new product that it will manufacture in its workshop. The product is highly specialised and initially will be produced to order only. The product will be manufactured in batches. The estimated labour time required for the first batch is 40 hours, but due to the nature of the product and the manufacturing method to be used, it is expected that an 80% learning curve will apply.

Required: (a)

Calculate the expected time for the eighth batch. (3 marks)

(b)

When production commenced the first batch took 45 hours. The actual learning rates observed were as follows: Month 1 2 3 4

Total batches produced to date 1 2 4 8

Actual learning rate

75% 75% 90%

For each of months 2 and 4, state possible reasons why the actual learning rates differed from the expected rates. (3 marks)

(c)

The total time taken to produce the first eight batches was 182⋅25 hours. Calculate the cumulative learning rate up to the end of Month 4. (Remember that the first batch took 45 hours). (4 marks) (Total for Question Four = 10 marks)

Rationale This question tests candidates’ knowledge of learning curves. It addresses the learning outcome: explain and apply learning and experience curves to estimate time and cost for new products and services.

Suggested Approach • Calculate the average times for 8 batches and 7 batches • Calculate the total times for 8 batches and 7 batches • Calculate the time taken for the 8th batch • Compare the learning rates provided and give possible reasons for the difference • Calculate the average rate of learning by comparing the average time for the eight batches with the time for the first batch and recognising that the output doubles three times between the first and eighth batches

Marking Guide

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Marks

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam (a) Time for 8 batches Time for 7 batches Time for eighth batch

1 1 1

(b) Three reasons ( 1 mark each)

3

(c) Calculate rate of learning

4

Examiner’s Comments Part (a) was generally well answered. Part (b) was only worth three marks but the answers put forward by most candidates were poor. In fact the answers were totally incorrect. Most candidates incorrectly believed a movement in the learning curve rate from 80% to 75% was a worsening situation, and a movement up to 90% was an improvement. It is obvious from the answers put forward by many candidates that the principles relating to the learning curve have not been fully understood. Part (c) was worth four easy marks for those candidates who quickly realised that the average time for the first 8 batches of 22.78 hours was 51% of the initial time 45 hours, and that the third root of 51% was 80%. Common Errors 1. Failure to recognise that the learning curve (LC) formula was needed to answer part (a) of the question, as opposed to the ‘doubling effect’ procedure. 2. Not appreciating that an increase in the LC percentage was a worsening effect. 3. Not fully understanding the workings of the LC formula.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE

Question 5

(a)

Prepare calculations to show the most profitable course of action for the company for the next three months, assuming that there are no other suppliers of material M1, and advise the company on THREE other factors that it should consider before making its decision. (14 marks)

(b)

Calculate the maximum prices that the company should pay to obtain further supplies of material M1 from an alternative supplier, and the quantities of material M1 to which each of these prices apply. (6 marks)

The company has now become aware of a contract that it has already accepted, for the immediate delivery of 500 units of P4 at a selling price of $125 per unit. This contract has a financial penalty clause for non-delivery. This contract is in addition to the 2,000 units of estimated demand for P4 stated previously. Assume that there is no alternative supplier of material M1.

(c)

Calculate the minimum financial penalty that would change your recommendation. (5 marks)

Rationale This question tests candidates’ ability to solve a scarce resource problem involving products and components, where the components could be bought from an external supplier instead of manufacturing them internally. This question addresses the learning outcome: Apply variable/fixed cost analysis in multiple product contexts to break-even analysis and product mix decision making, including circumstances where there are multiple constraints and linear programming methods are needed to reach “optimal” solutions.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Suggested Approach • Carefully read the scenario to realise that contribution can be earned by the sale of products and also by saving costs by manufacturing components • Determine the contribution earned per square metre of the scarce material • Determine the optimum plan for the use of the material • Explain other factors that should be considered before finalising the decision • Calculate the maximum prices that should be paid for additional units of the scarce material • Determine the value of the financial penalty by comparing the contribution values under the alternative solutions

Marking Guide (a) Contribution values per square metre Ranking Optimum plan Three other factors (two marks each)

Marks 4 1 3 6

(b) Maximum prices for each level (two marks each)

6

(c) Explanation Calculation of penalty

2 3

Examiner’s Comments In part (a) the majority of candidates did not appreciate that in a question that called upon the principles associated with limiting factors, a contribution per limiting factor can be measured alongside an opportunity cost per limiting factor i.e. the buying in price compared to the variable cost to the manufacture of an item. Most candidates simply ignored components C3 and C5 and therefore earned minimal marks for part (a). Even though some candidates did not attain a good mark for part (a) the marking principle of the ‘own figure rule’ was applied so that candidates could still earn marks for parts (b) and (c). Unfortunately the attempts at these two parts of the question were generally poor. Common Errors 1. Demonstrating a complete lack of understanding of the principles associated with limiting factors and opportunity cost. 2. Failure to present clear answers. 3. Failure to appreciate that the own figure rule is applied by markers (i.e. candidates should attempt part (b) & (c) of a question even though the answer to part (a) is incorrect).

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 6

(a)

Calculate the Net Present Value (NPV) of the project (to the nearest $000). (15 marks)

(b)

Calculate the post tax money cost of capital at which H would be indifferent to accepting/rejecting the project. (4 marks)

(c)

Explain your treatment of inflation in your solution to part (a) above and describe an alternative method that would have provided the same NPV. (6 marks) (Total for Question Six = 25 marks)

Rationale This question tests candidates’ ability in part (a) to calculate the net present value of an investment proposal from the data provided, in part (b) to calculate the internal rate of return and in part (c) to explain the treatment of inflation in evaluating the proposal. This question addresses the learning outcome: Calculate project cash flows, accounting for tax and inflation, and apply perpetuities to derive “end of project” value where appropriate.

Suggested Approach • Carefully read the scenario to determine the incremental nature of the decision being made • Identify the cost and revenue changes that will occur as a result of the decision and the timing of those changes • Determine the tax consequences of those incremental costs and revenues • Evaluate the proposal using net present value • Calculate the internal rate of return • Explain the method used to include inflation in the solution to part (a) and an alternative approach that would result in the same conclusion

Marking Guide (a) Sales Production costs Non-production costs Capital values Taxation Tax depreciation Discounting Calculate NPV

Marks 2 3 2 1 2 3 1 1

(b) Selecting a lower discount rate Calculate NPV Calculate IRR

1 2 1

(c) Explanation of solution method Explanation of alternative

3 3

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Examiner’s Comments Part (a) was a familiar investment appraisal question, similar to questions that have appeared in previous papers. The most important aspect of this question related to the candidate’s ability to subject the 2008 figures to compound inflation percentages as well as apply index figures relating to growth in future years. Most candidates who chose this question made a reasonable attempt and there were some excellent, well laid out answers. Part (b) was also reasonably well answered with most candidates realising that the question called for the calculation of the Internal Rate of Return. The use of the ‘own figure rule’ was again in evidence with this part of the question. Part (c) was generally well answered. Common Errors 1. Providing poorly laid out answers with no reference to workings. 2. Providing no workings to explain how figures had been derived. 3. Using rules relating to interpolation incorrectly (part b).

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam

Question 7 (a)

Recommend which course of action the bank should take by preparing calculations to show the annual profits from: (i)

continuing with the existing bank account

(ii)

each of the two account options described above. (12 marks)

(b) (i)

Prepare a two-way data table that shows profit that would be earned by the bank for each of the NINE possible outcomes that are expected to arise as a result of the advertising campaign. (8 marks)

(ii)

State any other factors the bank should consider before making its decision and advise the bank on whether or not it should carry out the advertising campaign. (5 marks) (Total for Question Seven = 25 marks)

Rationale This question tests candidates’ ability to analyse the data provided to determine the optimal solution to a charging structure for a bank and then in part (b) to prepare and explain a two-way data table to solve a problem involving the use of advertising to increase the volume of the bank’s loan business. This question addresses the learning outcomes: Discuss the principles of decision making including the identification of relevant cash flows and their use alongside non-quantifiable factors in making rounded judgements; and evaluate the impact of uncertainty and risk on decision models that may be based on CVP analysis, relevant cash flows, learning curves, discounting techniques etc.

Suggested Approach • Carefully read the scenario and identify the implications for costs and revenues of each alternative option • Determine the costs and revenues of each option and advise the bank • Determine the net revenues of the possible outcomes of the advertising campaign • Advise the bank as to whether or not to proceed with the advertising campaign

Marking Guide (a) Calculate existing situation and two alternatives: (four marks each) Recommendation MAXIMUM 12 MARKS

Marks 12 1

(b) Structure Data values Discussion (range, risk, resources, conclusion)

2 6 5

Examiner’s Comments

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Paper P2 – Management Accounting – Decision Management Post Exam Guide May 2008 Exam This was the least popular optional question. Most candidates made a good attempt at part (a) although very few realised they needed to calculate and include a figure to represent the investment income forgone for options 1 and 2. Part (b) was well answered although some candidates were confused with the wording in the question relating to sensitivity of the number of loans, and the increase in the average loan balances. The answer to part b(ii) needed to be related to the figures in the table compared to the existing profit. Common Errors 1. Not including a figure for investment income forgone. 2. Failure to show workings for the figures submitted in the two-way table. 3. Failure to relate the ‘other factors’ to the figures shown in the two-way table.

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Managerial Level Paper

P2 – Management Accounting Decision Management 21 May 2008 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during the reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. ALL answers must be written in the answer book. Answers or notes written on the question paper will not be submitted for marking. Answer the ONE compulsory question in Section A. This has nine subquestions and is on pages 2 to 5. Answer ALL THREE compulsory questions in Section B on pages 6 to 7. Answer TWO of the three questions in Section C on pages 8 to 13. Maths Tables and Formulae are provided on pages 15 to 17. These pages are detachable for ease of reference. The list of verbs as published in the syllabus is given for reference on the inside back cover of this question paper. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered.

P2 – Decision Management

Management Accounting Pillar

TURN OVER

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL NINE SUB-QUESTIONS

Instructions for answering Section A: The answers to the nine sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-question 1.9 you should show your workings as marks are available for the method you use.

Question One 1.1

A project has an initial investment of $140,000 and a Net Present Value of $42,500. The present value of the sales revenue generated by the project is $385,000.

The sensitivity of the investment to changes in the value of sales revenue is closest to A

36%

B

$342,500

C

89%

D

11% (2 marks)

P2

2

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1.2

A company produces three products (X, Y and Z) from a common process. Each of these products may then be further processed in separate processes, which do not incur any incremental fixed costs.

When deciding whether or not to further process Product Z, the information required is: (i)

The common costs of the joint process

(ii)

The further processing costs of Product Z

(iii)

The unit selling price of Product Z at the point of separation

(iv)

The unit selling price of Product Z after further processing

(v)

The percentage losses of further processing Product Z

(vi)

The actual output of Product Z from the common process

A

(i), (ii), (iii) and (iv) only

B

(ii), (iii), (iv) and (vi) only

C

(ii), (iii), (iv), and (v) only

D

All of the above (2 marks)

1.3

A company has a real cost of capital of 6⋅00% per annum and inflation is currently 4⋅00% per annum.

The company’s annual money cost of capital is closest to A

10⋅24%

B

10⋅00%

C

2⋅00%

D

1⋅92% (2 marks)

Section A continues on the next page

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P2

The following data is to be used when answering questions 1.4 & 1.5 A company is considering investing in a new machine. The machine will cost $15,000 and has an expected life of five years with a residual value of $3,000. The machine will increase the operating cashflows of the company as follows: Year

1 2 3 4 5

1.4

Increase in operating cashflow $ 2,500 3,000 5,500 4,000 3,000

Calculate the payback period of the new machine to the nearest 0⋅1 years. (2 marks)

1.5

Calculate the average Annual Accounting Rate of Return over the lifetime of the investment in the new machine. (2 marks)

1.6

A company is considering its costs in respect of a new product. The following tables show the predictions made by the company, together with their associated probabilities: Fixed costs $ 100,000 130,000 160,000

Probability 0⋅35 0⋅45 0⋅20

Variable costs $ 70,000 90,000 110,000

Probability 0⋅40 0⋅35 0⋅25

Calculate the expected value of total costs. (2 marks)

P2

4

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1.7

A company is considering the following investments for the year ending 30 June 2009: Investment

Capital required $ 100,000 150,000 140,000 190,000

W X Y Z

NPV $ 56,000 75,000 68,000 91,000

None of the investments are divisible. They cannot be undertaken more than once within each year. The company has only $350,000 available to invest in the year to 30 June 2009. There are no other investments available at this time. Which investments (if any) should the company undertake? (2 marks)

1.8

A company is considering a short-term pricing decision to utilise some spare capacity. The item to be manufactured and sold would use 1,500kgs of raw material Q. Material Q is in regular use by the company. It currently has 1,000kgs in inventory, which was purchased last month at a cost of $4 per kg. The current replacement cost of material Q is $4⋅80 per kg and the current inventory could be sold for $4⋅30 per kg.

Calculate the relevant cost of material Q for the purposes of this decision. (2 marks)

1.9

A company is considering the price of a new product. It has determined that the variable cost of making the item will be $24 per unit. Market research has indicated that if the selling price were to be $60 per unit then the demand would be 1,000 units per week. However, for every $10 per unit increase in selling price, there would be a reduction in demand by 50 units; and for every $10 reduction in selling price, there would be an increase in demand of 50 units.

Calculate the optimal selling price. (4 marks) Note: If Price P = a-bx then Marginal Revenue = a-2bx

(Total for Section A = 20 marks)

Reminder All answers to Section A must be written in your answer book. Answers to Section A written on the question paper will not be submitted for marking End of Section A Section B starts on the next page TURN OVER May 2008

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P2

SECTION B [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS

Question Two You are the Management Accountant of XY, an engineering company that assembles components into engines for sale to the automotive industry. The company is constantly under pressure from its customers to provide more efficient engines, which are also less damaging to the environment. The company uses value chain analysis as a tool in the management of its activities. The Managing Director of XY has recently been invited to a conference to give a presentation entitled “The concept of the Value Chain and the management of profits generated throughout the chain in XY.”

Required: Prepare a report for the Managing Director explaining the points that should be covered in the presentation. (Total for Question Two = 10 marks)

Question Three A company experiences changing levels of demand, but produces a constant number of units during each quarter. The company allows inventory levels to rise and fall to satisfy the differing quarterly demand levels for its product.

Required: (a)

Identify and explain the reasons for THREE cost changes that would result if the company changed to a Just-In-Time production method for 2009. Assume there will be no inventory at the start and end of the year. (6 marks)

(b)

Briefly discuss the importance of Total Quality Management to a company that operates a Just-In-Time production method. (4 marks) (Total for Question Three = 10 marks)

P2

6

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Question Four A company has developed a new product that it will manufacture in its workshop. The product is highly specialised and initially will be produced to order only. The product will be manufactured in batches. The estimated labour time required for the first batch is 40 hours, but due to the nature of the product and the manufacturing method to be used, it is expected that an 80% learning curve will apply.

Required: (a)

Calculate the expected time for the eighth batch. (3 marks)

(b)

When production commenced the first batch took 45 hours. The actual learning rates observed were as follows: Month 1 2 3 4

Total batches produced to date 1 2 4 8

Actual learning rate

75% 75% 90%

For each of months 2 and 4, state possible reasons why the actual learning rates differed from the expected rates. (3 marks)

(c)

The total time taken to produce the first eight batches was 182⋅25 hours. Calculate the cumulative learning rate up to the end of Month 4. (Remember that the first batch took 45 hours). (4 marks) (Total for Question Four = 10 marks)

(Total for Section B = 30 marks)

End of Section B

Section C starts on page 8

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE

Question Five An engineering company manufactures a number of products and components, using a team of highly skilled workers and a variety of different metals. The current supplier has announced that the amount of M1, one of the materials it currently supplies, will be limited to 1,000 square metres in total for the next three-month period because there will be insufficient M1 to satisfy demand. The only items manufactured using M1 and their production costs and selling prices (where applicable) are shown below: Product P4 $/unit 125

Product P6 $/unit 175

Component C3 $/unit n/a

Component C5 $/unit n/a

Direct materials: M1 * M2 Direct labour Variable overhead Fixed overhead **

15 10 20 10 20

10 20 30 15 30

5 15 16 8 16

10 20 10 5 10

Total cost

75

105

60

55

Selling price

*

Material M1 is expected to be limited in supply during the next three months. These costs are based on M1 continuing to be available at a price of $20 per square metre.

**

Fixed overhead is absorbed on the basis of direct labour cost.

Products P4 and P6 are sold externally. Components C3 and C5 are used in other products made by the company. These other products do not require any further amounts of material M1. The estimated total demand for these products and components during the next three months is as follows: P4 P6 C3 C5

2,000 units 1,500 units 500 units 1,000 units

Components C3 and C5 are essential components. They would have to be bought in if they could not be made internally. They can be purchased from external suppliers for $75 and $95 per unit respectively. The bought in components are of the same quality as those manufactured by the company. The products they are used in have sufficient margins to remain financially worthwhile if C3 and C5 are bought in at these prices.

P2

8

May 2008

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Required: (a)

Prepare calculations to show the most profitable course of action for the company for the next three months, assuming that there are no other suppliers of material M1, and advise the company on THREE other factors that it should consider before making its decision. (14 marks)

(b)

Calculate the maximum prices that the company should pay to obtain further supplies of material M1 from an alternative supplier, and the quantities of material M1 to which each of these prices apply. (6 marks)

The company has now become aware of a contract that it has already accepted, for the immediate delivery of 500 units of P4 at a selling price of $125 per unit. This contract has a financial penalty clause for non-delivery. This contract is in addition to the 2,000 units of estimated demand for P4 stated previously. Assume that there is no alternative supplier of material M1.

(c)

Calculate the minimum financial penalty that would change your recommendation. (5 marks)

(Total for Question Five = 25 marks)

Section C continues on the next page

TURN OVER

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P2

Question Six H is a well-established manufacturer of household products. It produces its accounts to 31 December each year. The machinery that is currently being used to manufacture one of H’s products will have to be scrapped on 31 December 2008, because H can no longer obtain a safety certificate for it. H is considering investing $500,000 in new machinery on 1 January 2009 in order to continue manufacturing this product. If the project does not go ahead, H will no longer be able to manufacture the product. The new machinery will have sufficient production capacity to meet the expected sales demand levels for the next five years. It will have a life of five years, and at the end of that time it will be sold for $100,000. It will qualify for tax depreciation at the rate of 20% per annum on a reducing balance basis. Sales revenues and production costs for the current year, which ends on 31 December 2008, are predicted to be as follows: $000 540

Sales revenue Production costs Variable production costs Fixed overhead *

240 120 360

Fixed non-production costs

100

Profit before tax *

80

Fixed production overhead cost includes $20,000 for depreciation of the existing machinery.

Sales The following table of index numbers (2008 = 100) shows the predicted levels of sales volume.

Sales: Volume

2009

2010

2011

2012

2013

103

105

109

107

110

Assume there are no changes in the selling price other than those caused by selling price inflation, which is expected to be 4% per year. Costs Production costs are not expected to change as a result of investing in the new machinery, but production cost inflation is expected to be 5% per year. Non-production cost inflation is expected to be 3% per year. Taxation H is liable to pay tax on its profits at the rate of 30%. Half of this is payable in the year in which the profit is earned and the remainder is payable in the following year. H has a post tax money cost of capital of 14% per annum.

P2

10

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Required: (a)

Calculate the Net Present Value (NPV) of the project (to the nearest $000). (15 marks)

(b)

Calculate the post tax money cost of capital at which H would be indifferent to accepting/rejecting the project. (4 marks)

(c)

Explain your treatment of inflation in your solution to part (a) above and describe an alternative method that would have provided the same NPV. (6 marks) (Total for Question Six = 25 marks)

Section C continues on the next page

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P2

Question Seven A bank is reviewing the bank account it offers to its business customers and the charges it makes for routine transactions (for example paying into the account, writing cheques, making electronic payments and transfers). Currently, the bank’s charges to its business customers are £0⋅60 per routine transaction. The bank pays interest to the customer at 0⋅1% per year on any balance in the account. According to the bank’s records, there are currently one million business customers. Each customer makes one thousand routine transactions each year; 45% of business customers maintain an average balance of £2,000 in their account. The accounts of the other 55% of business customers are overdrawn with an average overdraft balance of £4,000. Interest on overdrawn accounts is charged at 20% per year. In addition, the bank has a number of savings account customers which, together with the bank’s business customers, result in a balance of net funds that are invested by the bank and yield an annual return by 3% per year. The bank is concerned about a growing tendency for its competitors to provide routine transactions free of charge to their business customers. As a result the bank is considering two account options: Account Option One An account that charges the business customer a fixed fee of £10 per month, with no further charges for any routine transactions. Interest would be paid to the business customer at 0⋅5% per year on any balances in the account. The bank expects that if it adopts this charging structure, it will increase the number of business customers by 5% from its present level; Account Option Two An account that does not charge the customer for any routine transactions, but pays no interest on any balances in the account. The bank expects that if it adopts this charging structure, this will increase the number of business customers by 10% from its present level. The bank does not expect the profile of new business customers to be different from existing business customers in terms of the balances in their accounts or the number of routine transactions they make. Interest will continue to be charged at 20% per year on overdrawn accounts. The bank does not expect that either of these options will result in any changes to its existing staffing or other resources. The bank also expects that if it takes no action and continues with its existing bank account that the number of business customers will fall by 20%.

Required: (a)

Recommend which course of action the bank should take by preparing calculations to show the annual profits from: (i) continuing with the existing bank account (ii) each of the two account options described above. (12 marks)

P2

12

May 2008

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The bank is also reviewing its policy with regard to small loans. Currently, the bank charges an arrangement fee of £500 per loan and interest on the average loan balance. The profit the bank makes on the interest it charges is 5% of the average loan balance. The bank’s records show that there are 200,000 small loans in issue at any one time. The average loan balance is £5,000. Market research undertaken by the bank has shown that if it were to carry out an advertising campaign that specifically targeted the small loans market, the number of loans would increase, though the amount of the increase is uncertain. It is predicted that the advertising campaign may increase the number of loans in issue at any one time to 250,000, 280,000 or 300,000. Furthermore, it is believed that the advertising campaign would increase the value of the loans. The amount of the increase is uncertain, but it is believed that the average loan balance may increase to £7,500; or that they may increase by £9,000; or that they may increase by £10,000. The expected total cost of the advertising campaign and the associated administrative costs are £112 million.

Required: (b) (i)

Prepare a two-way data table that shows profit that would be earned by the bank for each of the NINE possible outcomes that are expected to arise as a result of the advertising campaign. (8 marks)

(ii)

State any other factors the bank should consider before making its decision and advise the bank on whether or not it should carry out the advertising campaign. (5 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of Question Paper

Maths Tables and Formulae are on pages 15 to 17

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P2

[This page is blank]

P2

14

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PRESENT VALUE TABLE Present value of $1, that is (1 + r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

May 2008

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

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FORMULAE

Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b=

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX

and or solve

∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X

2

Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

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P2

[this page is blank]

P2

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LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE 1 KNOWLEDGE What you are expected to know.

2 COMPREHENSION What you are expected to understand.

VERBS USED

DEFINITION

List State Define

Make a list of Express, fully or clearly, the details of/facts of Give the exact meaning of

Describe Distinguish Explain Identify

Communicate the key features Highlight the differences between Make clear or intelligible/State the meaning of Recognise, establish or select after consideration Use an example to describe or explain something

Illustrate 3 APPLICATION How you are expected to apply your knowledge.

Apply Calculate/compute Demonstrate Prepare Reconcile Solve Tabulate

4 ANALYSIS How you are expected to analyse the detail of what you have learned.

5 EVALUATION How you are expected to use your learning to evaluate, make decisions or recommendations.

May 2008

Analyse Categorise Compare and contrast

To put to practical use To ascertain or reckon mathematically To prove with certainty or to exhibit by practical means To make or get ready for use To make or prove consistent/compatible Find an answer to Arrange in a table

Construct Discuss Interpret Produce

Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between To build up or compile To examine in detail by argument To translate into intelligible or familiar terms To create or bring into existence

Advise Evaluate Recommend

To counsel, inform or notify To appraise or assess the value of To advise on a course of action

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P2

Management Accounting Pillar

Managerial Level

P2 – Management Accounting – Decision Management

May 2008

Wednesday Morning Session

P2

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Managerial Level Paper

P2 – Management Accounting Decision Management 19 November 2008 – Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during the reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is, all parts and/or subquestions). The requirements for the questions in Sections B and C are contained in a dotted box. ALL answers must be written in the answer book. Answers or notes written on the question paper will not be submitted for marking. Answer the ONE compulsory question in Section A. This has eight subquestions and is on pages 2 to 4. Answer ALL THREE compulsory questions in Section B on pages 5 to 7. Answer TWO of the three questions in Section C on pages 8 to 13. Maths Tables and Formulae are provided on pages 15 to 17. These pages are detachable for ease of reference. The list of verbs as published in the syllabus is given for reference on the inside back cover of this question paper. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered.

P2 – Decision Management

Management Accounting Pillar

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SECTION A – 20 MARKS [the indicative time for answering this section is 36 minutes] ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6, 1.7 and 1.8 you should show your workings as marks are available for the method you use.

Question One 1.1

A company has an annual post tax money cost of capital of 18%.

If inflation is 5% per annum the company’s annual post tax real cost of capital is closest to A

12%

B

13%

C

23%

D

24% (2 marks)

1.2

A company is considering a short-term pricing decision for a contract that would utilise some material P that it has held in inventory for some time. The company does not foresee any other use for the material. The work would require 1,000 kgs of Material P. There are 800 kgs of Material P in inventory, which were bought some time ago at a cost of $3 per kg. The material held in inventory could currently be sold for $3·50 per kg. The current purchase price of Material P is $4·50 per kg.

The relevant cost of Material P for the company to use when making its pricing decision for the contract is closest to A

$3,300

B

$3,500

C

$3,700

D

$4,500 (2 marks)

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2

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1.3

The table below summarises data that have been extracted from the cost accounting records of SV Limited. The data show the cost and the inflation index relevant to the period in which the costs were incurred. Output level 3,000 units 4,000 units

Total cost £9,167 £11,760

Inflation index 1·03 1·05

The uninflated variable cost per unit of output to be used when predicting future costs is closest to A

£2·30

B

£2·59

C

£2·80

D

£2·97 (2 marks)

1.4

A company has only $700,000 available for investment during the coming year. It has identified the following four investment opportunities, all of which are divisible, and have the same life. Investment

Capital required $ 400,000 250,000 300,000 350,000

J K L M

Net Present Value $ 650,000 450,000 480,000 550,000

Calculate the correct rank order for these investments (best first). (2 marks)

1.5

A company is considering investing $100,000 in a new machine that will reduce its annual cash operating costs as follows: Year 1 2 3 4

Operating cash costs saved $000 35 45 55 30

Calculate the payback period to the nearest 0·1 years. (2 marks)

Section A continues on the next page

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P2

1.6

A company has recently launched a new product. The average time taken for the first 4 units was 24 minutes per unit and the average time taken for the first 32 units was 9·34 minutes per unit.

Calculate the rate of learning that occurred. (3 marks)

1.7

A company manufactures three products and is planning the use of its resources for the next quarter. Details of the products and their resource requirements are as follows: Product

Q

R

T

Contribution per unit

$36

$38

$44

Material A per unit (S1) Material B per unit (S2) Labour per unit (S3)

5 kgs 6 litres 4 hours

6 kgs 3 litres 5 hours

4 kgs 8 litres 6 hours

All of these resources are limited in supply. quarter are: Material A (S1) Material B (S2) Labour (S3)

The total available resources for the next 4,800 kgs 5,000 litres 3,500 hours

Prepare the initial equations for S1, S2 and S3 to be used in solving this problem using linear programming. (3 marks)

1.8

A company is considering the price of one of its products for next year. It expects that the variable cost of making the item will be $15 per unit. It has also determined that if the selling price were to be $35 per unit then the demand would be 500 units per week. However, for every $5 increase in selling price, there would be a reduction in demand of 50 units per week; and for every $5 reduction in selling price, there would be an increase in demand of 50 units per week.

Calculate the optimal selling price. Note: If Price P = a-bx then Marginal Revenue = a-2bx (4 marks)

(Total for Section A = 20 marks)

Reminder All answers to Section A must be written in your answer book. Answers to Section A written on the question paper will not be submitted for marking End of Section A. Section B starts on the next page

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4

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SECTION B – 30 MARKS [the indicative time for answering this section is 54 minutes] ANSWER ALL THREE QUESTIONS

Question Two NLM uses a common process to manufacture three joint products: X, Y and Z. The costs of operating the common process total $75,400 each month. This includes $6,800 of apportioned head office costs. The remaining costs are specific to the common process and would be avoided if it were discontinued. Common costs are apportioned to the joint products on the basis of their respective output volumes. The normal monthly output from the common process is: X Y Z

4,000 litres 5,000 litres 4,500 litres

There are a number of manufacturers of products that are identical to products X, Y and Z and as a result there is a competitive market in which these products can be bought and sold at the following prices: X Y Z

$5·00 per litre $4·50 per litre $5·50 per litre

Currently NLM uses the output from the common process as input to three separate processes where X, Y and Z are converted into SX, SY and SZ. The specific costs of these further processes (which are avoidable if the further process is discontinued) are as follows: X to SX Y to SY Z to SZ

$1·25 per litre plus $1,850 per month $1·80 per litre plus $800 per month $1·55 per litre plus $2,400 per month

The market selling prices of the further processed products are: SX SY SZ

$6·75 per litre $7·50 per litre $7·20 per litre

Required: (a)

Advise NLM as to which (if any) of the further processes should continue to be operated. State any relevant assumptions. (6 marks)

(b)

Advise NLM whether they should continue to operate the common process. State any relevant assumptions. (4 marks) (Total for Question Two = 10 marks)

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P2

Question Three

(a) A manufacturing company has developed a new product. The time taken to manufacture the first unit was 24 minutes. It is expected that an 80% learning curve will apply for the first three months of production and that by the end of that period the total number of units produced will have reached 1,024. It is then expected that the time taken for each subsequent unit will be the same as the time taken for the 1,024th unit.

Required: (i)

Calculate the expected time taken for the 8th unit. (3 marks)

(ii)

Explain two reasons why the time taken for the 1025th unit may be more than expected. (2 marks)

Note: The value of the 80% learning index is -0·3219

(b)

Explain the importance of considering the learning curve when deciding on the terms for a gain sharing arrangement with employees. (5 marks) (Total for Question Three = 10 marks)

P2

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November 2008

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Question Four You are the Management Accountant of a small engineering company, which is a member of a large engineering group. The Managing Director has recently joined the company and has little experience of the engineering sector. He has recently returned from the group’s annual management conference. The Managing Director found the seminars very useful but he is a little confused about two topics. One of the presentations discussed the use of Target Costing within the group. The Managing Director had previously thought that Target Costing would not be appropriate for an engineering group, because he thought it could only be used in an organisation that manufactured similar products. He now realises that he may be confusing Target Costing and Standard Costing. He seeks your help in explaining Target Costing and how it differs from Standard Costing. Another presentation discussed alternative investment appraisal techniques. The presenter used an example that compared three investments that were evaluated using incremental profit, accounting rate of return, payback and net present value. The presenter argued that net present value is theoretically superior to the other methods. The Managing Director seeks your help in understanding why the net present value technique is superior to the alternative investment appraisal techniques.

Required: Prepare a report to the Managing Director that

(a)

explains Target Costing and how it differs from Standard Costing; (7 marks)

(b)

explains why net present value is superior to the three other investment appraisal techniques stated above. (3 marks) (Total for Question Four = 10 marks)

(Total for Section B = 30 marks)

End of Section B

Section C starts on page 8

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P2

SECTION C – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS OUT OF THREE

Question Five A retail company has a number of individual retail outlets in different towns. Each outlet has its own manager who can make decisions about the individual retail outlet, provided these decisions are within the parameters of the overall company policy. The performance of each individual manager is measured based on the profits of the retail outlet that he or she manages. Company policy It is company policy that each of the retail outlets should stock the following categories of items for sale to customers: • • • •

Newspapers and magazines Fresh fruit and vegetables Tinned food items Frozen food items

Company policy also requires that no single category should occupy more than 40% or less than 15% of the total display space available. In addition, at their own discretion, managers are permitted to use up to 10% of the total display space available for other products that meet other localised needs. The KL Retail Outlet The following weekly sales and cost data relate to the KL retail outlet; one of the outlets owned by the company:

Newspapers and magazines Fresh fruit and vegetables Tinned food items Frozen food items Other products

Sales $000 150 130 400 200 150

Purchase costs $000 105 75 240 90 100

Display space % 25 20 30 15 10

The total display space available is 800 square metres. For each category of items for sale: • •

sales revenue is directly proportional to the floor area occupied, purchase costs are directly proportional to sales revenue.

In addition to the purchase costs of the items sold the retail outlet incurs other costs that total $280,000 per week.

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Required: (a)

Demonstrate, using the above information and appropriate calculations, how the Manager of the KL retail outlet should allocate the space available between the different categories of items for sale to customers in order to maximise his weekly profit. (7 marks)

(b) You have recently joined the retail company as its Assistant Management Accountant and, as your first project, you have been asked to compare the profitability of a number of the retail outlets. One of those within your comparison is the KL retail outlet. You have visited the KL retail outlet and have investigated the costs that are being incurred in addition to the purchase costs of the items sold. You have confirmed that typically the retail outlet incurs other costs that total $280,000 per week. Further analysis has shown that these include staff salary costs (excluding any profit-related bonus earned by the manager), staff training costs, rent, light & heat, power, equipment depreciation, point of sale software costs, stationery, telephone, inventory storage and handling costs, marketing costs and head office charges. You have discussed these other costs with the Manager of the retail outlet. The Manager of the retail outlet does not think that gross profit should be used as the basis for allocating space to items. He has suggested that some of the other costs should be attributed to the product category to which they relate rather than ignored when making the space allocation decision.

Required: Prepare a report, addressed to the manager of the KL retail outlet that explains (i) the principles of Direct Product Profitability (DPP); (ii) how these principles may be applied to his retail outlet; and (iii) how their application may improve the profits of his retail outlet. (18 marks)

(Total for Question Five = 25 marks)

Section C continues on the next page

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P2

Question Six

(a) A manufacturing company is considering its pricing policy for next year. It has already carried out some market research into the expected levels of demand for one of its products at different selling prices, with the following results: Selling Price Per unit $100 $120 $130 $150 $160 $170

Annual Demand (units) 50,000 45,000 40,000 25,000 10,000 5,000

This product is manufactured in batches of 100 units, and analysis has shown that the total production cost depends on the number of units as well as the number of batches produced each year. This analysis has produced the following formula for total cost: Z = 70x + 80y + $240,000 Where Z represents the total production cost x represents the number of units produced; and y represents the number of batches of production.

Required: (i)

Prepare calculations to identify which of the above six selling prices per unit will result in the highest annual profit from this product. (7 marks)

(ii)

Explain why your chosen selling price might not result in the highest possible annual profit from this product. (3 marks) (Total for requirement (a) = 10 marks)

(b) The company is also launching a new product to the market next year and is currently considering its pricing strategy for this new product. The product will be unlike any other product that is currently available and will considerably improve the efficiency with which garages can service motor vehicles. This unique position in the market place is expected to remain for only six months before one of the company’s competitors develops a similar product. The prototype required a substantial amount of time to develop and as a result the company is keen to recover its considerable research and development costs as soon as possible. The company has now developed its manufacturing process for this product and as a result the time taken to produce each unit is much less than was required for the first few units. This time reduction is expected to continue for a short period of time once mass production has started, but from then a constant time requirement per unit is anticipated.

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Required: (i)

Explain the alternative pricing strategies that may be adopted when launching a new product. (6 marks)

(ii)

Recommend a pricing strategy to the company for its new product and explain how the adoption of your chosen strategy would affect the sales revenue, costs and profits of this product over its life cycle. (9 marks) (Total for requirement (b) = 15 marks) (Total for Question Six = 25 marks)

Section C continues on the next page

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P2

Question Seven A restaurant company is considering further investment in order to increase its seating capacity. The company prepares its accounts to 31 December each year and, if accepted, the proposed investment would be made on 1 January 2009 and will become operational immediately. Based on the actual results for the year to date, the latest forecast income statement for the company for the year to 31 December 2008 is as follows:

Food sales Drink sales Food costs Drink costs Staff costs Other costs * Profit

£000 180 150 125 70 55 45

£000 330

295 35

*These other costs include rent, light & heat, power and administration overheads. 30% of these costs vary in proportion to the value of sales and the remainder are fixed costs. The proposed investment At present the restaurant is not able to exploit the growing demand from customers because it does not have sufficient seating capacity. The restaurant is considering the investment of £40,000 on 1 January 2009. It is expected that this will increase the seating capacity of the restaurant by 30% compared to the present level. The lease of the current business premises ends at the end of 2012. At that time the £40,000 investment will have no residual value. Of this total investment, £30,000 will qualify for 100% tax depreciation in 2009 and the remainder will qualify for 20% tax depreciation per year, commencing in 2009, calculated on a reducing balance basis. Any balancing tax charge will be made or allowance will be available at the end of 2012. Sales It is expected that the additional sales of food and drink will be proportional to the seating capacity increase and that the mix of food sales and drink sales will not change. Costs It is expected that apart from the effects of inflation (see below): •

Food costs and drink costs will continue to be the same percentages of food sales and drink sales as they are in the forecast income statement shown above.

•

Staff costs are step costs and are expected to increase by 20% from their forecast value for 2008 if there is any capacity increase.

•

The variable element of other costs is expected to increase in proportion to the capacity increase; the fixed cost element is expected to increase by £10,000 if there is any capacity increase.

Inflation Cost inflation is predicted to be 4% per annum for each of the years 2009 to 2012 whereas selling prices are only expected to increase by 3% per annum during the same period. Taxation The company pays tax on its profits at 20%. This is payable one year after the profit is earned. Cost of capital The company’s post tax money cost of capital for evaluating this investment is 8% per annum.

P2

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November 2008

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Required: (a)

Prepare calculations to show whether the investment is worthwhile assuming that the 30% increase in seating capacity is fully utilised and recommend whether the investment should proceed. (14 marks)

(b)

Calculate and interpret the Internal Rate of Return (IRR) of the proposed investment. (6 marks)

(c)

Calculate the sensitivity of your recommendation to changes in the percentage capacity utilisation. (5 marks) (Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of Question Paper

Maths Tables and Formulae are on pages 15 to 17

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P2

[This page is blank]

P2

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PRESENT VALUE TABLE Present value of $1, that is (1 + r ) payment or receipt.

−n

where r = interest rate; n = number of periods until

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820

2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673

3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554

4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456

Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312

7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258

8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215

9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178

10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149

Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124

12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104

13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087

14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073

Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051

17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043

18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037

19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031

20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026

November 2008

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P2

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

1− (1+ r ) − n r

Periods (n) 1 2 3 4 5

1% 0.990 1.970 2.941 3.902 4.853

2% 0.980 1.942 2.884 3.808 4.713

3% 0.971 1.913 2.829 3.717 4.580

4% 0.962 1.886 2.775 3.630 4.452

Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212

7% 0.935 1.808 2.624 3.387 4.100

8% 0.926 1.783 2.577 3.312 3.993

9% 0.917 1.759 2.531 3.240 3.890

10% 0.909 1.736 2.487 3.170 3.791

6 7 8 9 10

5.795 6.728 7.652 8.566 9.471

5.601 6.472 7.325 8.162 8.983

5.417 6.230 7.020 7.786 8.530

5.242 6.002 6.733 7.435 8.111

5.076 5.786 6.463 7.108 7.722

4.917 5.582 6.210 6.802 7.360

4.767 5.389 5.971 6.515 7.024

4.623 5.206 5.747 6.247 6.710

4.486 5.033 5.535 5.995 6.418

4.355 4.868 5.335 5.759 6.145

11 12 13 14 15

10.368 11.255 12.134 13.004 13.865

9.787 10.575 11.348 12.106 12.849

9.253 9.954 10.635 11.296 11.938

8.760 9.385 9.986 10.563 11.118

8.306 8.863 9.394 9.899 10.380

7.887 8.384 8.853 9.295 9.712

7.499 7.943 8.358 8.745 9.108

7.139 7.536 7.904 8.244 8.559

6.805 7.161 7.487 7.786 8.061

6.495 6.814 7.103 7.367 7.606

16 17 18 19 20

14.718 15.562 16.398 17.226 18.046

13.578 14.292 14.992 15.679 16.351

12.561 13.166 13.754 14.324 14.878

11.652 12.166 12.659 13.134 13.590

10.838 11.274 11.690 12.085 12.462

10.106 10.477 10.828 11.158 11.470

9.447 9.763 10.059 10.336 10.594

8.851 9.122 9.372 9.604 9.818

8.313 8.544 8.756 8.950 9.129

7.824 8.022 8.201 8.365 8.514

Periods (n) 1 2 3 4 5

11% 0.901 1.713 2.444 3.102 3.696

12% 0.893 1.690 2.402 3.037 3.605

13% 0.885 1.668 2.361 2.974 3.517

14% 0.877 1.647 2.322 2.914 3.433

Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274

17% 0.855 1.585 2.210 2.743 3.199

18% 0.847 1.566 2.174 2.690 3.127

19% 0.840 1.547 2.140 2.639 3.058

20% 0.833 1.528 2.106 2.589 2.991

6 7 8 9 10

4.231 4.712 5.146 5.537 5.889

4.111 4.564 4.968 5.328 5.650

3.998 4.423 4.799 5.132 5.426

3.889 4.288 4.639 4.946 5.216

3.784 4.160 4.487 4.772 5.019

3.685 4.039 4.344 4.607 4.833

3.589 3.922 4.207 4.451 4.659

3.498 3.812 4.078 4.303 4.494

3.410 3.706 3.954 4.163 4.339

3.326 3.605 3.837 4.031 4.192

11 12 13 14 15

6.207 6.492 6.750 6.982 7.191

5.938 6.194 6.424 6.628 6.811

5.687 5.918 6.122 6.302 6.462

5.453 5.660 5.842 6.002 6.142

5.234 5.421 5.583 5.724 5.847

5.029 5.197 5.342 5.468 5.575

4.836 4.988 5.118 5.229 5.324

4.656 7.793 4.910 5.008 5.092

4.486 4.611 4.715 4.802 4.876

4.327 4.439 4.533 4.611 4.675

16 17 18 19 20

7.379 7.549 7.702 7.839 7.963

6.974 7.120 7.250 7.366 7.469

6.604 6.729 6.840 6.938 7.025

6.265 6.373 6.467 6.550 6.623

5.954 6.047 6.128 6.198 6.259

5.668 5.749 5.818 5.877 5.929

5.405 5.475 5.534 5.584 5.628

5.162 5.222 5.273 5.316 5.353

4.938 4.990 5.033 5.070 5.101

4.730 4.775 4.812 4.843 4.870

P2

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November 2008

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FORMULAE

Time series Additive model: Series = Trend + Seasonal + Random Multiplicative model: Series = Trend*Seasonal*Random

Regression analysis The linear regression equation of Y on X is given by: Y = a + bX

or Y – Y = b(X – X ),

where: b=

Covariance ( XY ) Variance ( X )

=

n ∑ XY − ( ∑ X )( ∑ Y ) 2

n ∑ X − (∑ X )

2

a= Y –bX

and or solve

∑ Y = na + b ∑ X

∑ XY = a ∑ X + b ∑ X

2

Exponential Geometric

Y = abx Y = aXb

Learning curve Yx = aXb where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

November 2008

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P2

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P2

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LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE 1 KNOWLEDGE What you are expected to know.

2 COMPREHENSION What you are expected to understand.

VERBS USED

DEFINITION

List State Define

Make a list of Express, fully or clearly, the details of/facts of Give the exact meaning of

Describe Distinguish Explain Identify

Communicate the key features Highlight the differences between Make clear or intelligible/State the meaning of Recognise, establish or select after consideration Use an example to describe or explain something

Illustrate 3 APPLICATION How you are expected to apply your knowledge.

Apply Calculate/compute Demonstrate Prepare Reconcile Solve Tabulate

4 ANALYSIS How you are expected to analyse the detail of what you have learned.

5 EVALUATION How you are expected to use your learning to evaluate, make decisions or recommendations.

November 2008

Analyse Categorise Compare and contrast

To put to practical use To ascertain or reckon mathematically To prove with certainty or to exhibit by practical means To make or get ready for use To make or prove consistent/compatible Find an answer to Arrange in a table

Construct Discuss Interpret Produce

Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between To build up or compile To examine in detail by argument To translate into intelligible or familiar terms To create or bring into existence

Advise Evaluate Recommend

To counsel, inform or notify To appraise or assess the value of To advise on a course of action

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P2

Management Accounting Pillar

Managerial Level

P2 – Management Accounting – Decision Management

November 2008

Wednesday Morning Session

P2

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November 2008

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

General Comments The overall performance was disappointing across most of the paper and the pass rate reflects this level of performance. The paper included no surprises, with many topics such as the learning curve, limiting factors and investment appraisal appearing again. Candidates therefore should have been familiar with these topics and the way that they are examined. This does enforce the point made on several previous occasions that candidates should familiarise themselves with previous papers (all of which are on the CIMA website). The level of performance clearly indicates that many candidates had only a peripheral understanding of some of the topics and were not fully prepared for this exam. Questions that tested fundamental aspects of management accounting were poorly answered. This reemphasises the point made in previous Post Exam Guides that candidates who have been awarded an exemption from the Fundamentals of Management Accounting paper need to ensure that they have a good understanding of the syllabus for that paper. It is evident from the answers submitted that most candidates are more comfortable with numerical questions and less able to tackle discursive questions. The marks attained by most candidates reflect this, but many candidates put forward answers to numerical questions that were poorly presented and difficult to follow. This seriously hinders the task of the markers who on occasions were unable to award marks for unclear answers. On other occasions workings were not referenced in the answer and therefore could not be deciphered. The quality of handwriting was generally good. However in the majority of cases there was no evidence of an answer plan and many candidates’ answers were difficult to follow. Candidates must note the points below. Failure to appreciate their importance could have an adverse impact on future examination performance. 1. All candidates who plan to sit the P2 examination are advised to examine the Fundamentals of Management Accounting (C01) syllabus to ensure they have a good understanding of its content. This applies particularly to candidates who have been awarded an exemption from this fundamental paper. 2. Show all workings and refer to them clearly. 3. Make full and proper use of the 20 minutes allowed for planning (reading time). 4. Relate narrative answers to the question scenario. 5. Practice regularly using past questions, particularly questions that have appeared on recent P2 papers. 6. In particular practice questions that require written answers. 7. Ensure that the length of written answers reflects the number of marks available (refer to the Examiner’s comments on questions 3 and 4).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Section A – 20 marks Question 1.1 A company has an annual post tax money cost of capital of 18%. If inflation is 5% per annum the company’s annual post tax real cost of capital is closest to A

12%

B

13%

C

23%

D

24% (2 marks) The answer is A

Workings 1⋅18/1⋅05 = 1⋅1238

Question 1.2 A company is considering a short-term pricing decision for a contract that would utilise some material P that it has held in inventory for some time. The company does not foresee any other use for the material. The work would require 1,000 kgs of Material P. There are 800 kgs of Material P in inventory, which were bought some time ago at a cost of $3 per kg. The material held in inventory could currently be sold for $3·50 per kg. The current purchase price of Material P is $4·50 per kg. The relevant cost of Material P for the company to use when making its pricing decision for the contract is closest to A

$3,300

B

$3,500

C

$3,700

D

$4,500 (2 marks) The answer is C

Workings 800 kgs x resale price of $3⋅50 200 kgs x purchase price of $4⋅50

= $2,800 = $900

Total

= $3,700

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 1.3 The table below summarises data that have been extracted from the cost accounting records of SV Limited. The data show the cost and the inflation index relevant to the period in which the costs were incurred. Output level 3,000 units 4,000 units

Total cost £9,167 £11,760

Inflation index 1·03 1·05

The uninflated variable cost per unit of output to be used when predicting future costs is closest to A

£2·30

B

£2·59

C

£2·80

D

£2·97 (2 marks) The answer is A

Workings

Output level 3,000 units 4,000 units

Total cost £9,167 £11,760

Inflation index 1⋅03 1⋅05

Uninflated total cost £8,900 £11,200

There is a £2,300 difference in the uninflated cost for the extra 1,000 units, this equals £2⋅30 per unit.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 1.4 A company has only $700,000 available for investment during the coming year. It has identified the following four investment opportunities, all of which are divisible, and have the same life. Investment

Capital required $ 400,000 250,000 300,000 350,000

J K L M

Net Present Value $ 650,000 450,000 480,000 550,000

Calculate the correct rank order for these investments (best first). (2 marks)

Workings Investment

J K L M

Capital required $ 400,000 250,000 300,000 350,000

NPV $ 650,000 450,000 480,000 550,000

Profitability index 1⋅625 1⋅8 1⋅6 1⋅57

The rank order is K J L M

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 1.5 A company is considering investing $100,000 in a new machine that will reduce its annual cash operating costs as follows: Year 1 2 3 4

Operating cash costs saved $000 35 45 55 30

Calculate the payback period to the nearest 0·1 years. (2 marks)

Workings The cumulative operating costs saved are as follows: Year 1 2 3

Operating costs saved $000 35 80 135

Therefore payback occurs in year 3. To the nearest 0⋅1 years, the payback period is 2 full years plus 20/55 of the third year = 2⋅4 years.

Question 1.6 A company has recently launched a new product. The average time taken for the first 4 units was 24 minutes per unit and the average time taken for the first 32 units was 9·34 minutes per unit. Calculate the rate of learning that occurred. (3 marks)

Workings Output is doubled three times from 4 units to 32 units. The average time for 32 units is 38⋅917% of the average time for 4 units. The third root of the learning index is thus 0⋅3892 so the learning index is 73%.

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 1.7 A company manufactures three products and is planning the use of its resources for the next quarter. Details of the products and their resource requirements are as follows: Product

Q

R

T

Contribution per unit

$36

$38

$44

Material A per unit (S1) Material B per unit (S2) Labour per unit (S3)

5 kgs 6 litres 4 hours

6 kgs 3 litres 5 hours

4 kgs 8 litres 6 hours

All of these resources are limited in supply. The total available resources for the next quarter are: Material A (S1) Material B (S2) Labour (S3)

4,800 kgs 5,000 litres 3,500 hours

Prepare the initial equations for S1, S2 and S3 to be used in solving this problem using linear programming. (3 marks)

Workings Where q = number of units of Q, r = number of units of R and t = number of units of T. S1, S2 and S3 are unutilsed material A, material B and labour respectively. 5q + 6r + 4t + 1S1 = 4,800 6q + 3r + 8t + 1S2 = 5,000 4q + 5r + 6t +1S3 = 3,500

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 1.8 A company is considering the price of one of its products for next year. It expects that the variable cost of making the item will be $15 per unit. It has also determined that if the selling price were to be $35 per unit then the demand would be 500 units per week. However, for every $5 increase in selling price, there would be a reduction in demand of 50 units per week; and for every $5 reduction in selling price, there would be an increase in demand of 50 units per week. Calculate the optimal selling price. Note: If Price P = a-bx then Marginal Revenue = a-2bx (4 marks)

Workings For demand to equal zero there needs to be 10 x $5 increase in selling price, that is the price at which demand = zero is $35 + $50 = $85 Price = $85 - 0⋅1x Marginal revenue = $85 - 0⋅2x Marginal cost = $15 Equating marginal cost and marginal revenue: 15 = 85 - 0⋅2x 0⋅2x = 70 x = 350 If x = 350 then Price = $85 - (0⋅1 x 350) = $50

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Examiner’s comments The average mark for Section A was slightly higher than that achieved in previous diets, with a number of candidates attaining full marks. In the majority of cases the presentation of the answers was better than in previous diets. No particular question was ignored but some questions were answered better than others. Question 1.4: many candidates did not answer this question, which required candidates to simply rank order the investments. However, many candidates went further and allocated the available money which was not called for. Question 1.5: the question specifically asked for the payback period to be stated to the nearest 0.1 years. Many candidates chose instead to put forward other variations e.g. 2 years 3 months, 2 years 4½ months which did not gain all the marks that were available. Question 1.7: the data in the question clearly showed that there were three products. Therefore a simplex approach was needed to answer the question (as opposed to a graph). The equations needed to include the slack variables which many candidates omitted. Many candidates failed to appreciate or realise that if a slack variable is included an equal sign is required rather than an inequality sign. Many candidates also stated the objective function which was not requested. Common Errors 1. Failure to answer the question (e.g. Q1.7) 2. Failure to present the answer in the form requested in the question (e.g. Q1.5) 3. Failure to show workings which could have gained marks (e.g. Q1.8)

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Section B – 30 marks ANSWER ALL THREE QUESTIONS

Question 2

(a)

Advise NLM as to which (if any) of the further processes should continue to be operated. State any relevant assumptions. (6 marks)

(b)

Advise NLM whether they should continue to operate the common process. State any relevant assumptions. (4 marks) (Total for Question Two = 10 marks)

Rationale This question tests candidates’ ability to demonstrate their understanding of relevant costs and revenues when deciding whether or not to continue operating separate processes within a joint product environment. This question addresses the learning outcome: A(v) Explain why joint costs must be allocated to final products for financial reporting purposes, but why this is unhelpful when decisions concerning process and product viability have to be taken.

Suggested Approach

(a)

(b)

• For each product - Identify the incremental contribution per litre - Multiply by the number of litres - Subtract the incremental fixed cost to arrive at the incremental profit of loss • State any relevant assumptions • •

•

Identify the relevant costs of the common process Compare this figure with the total market values of common process outputs to arrive at a surplus or deficit State any relevant assumptions

Marking Guide Calculate the incremental profit or loss for each product State recommendation and assumptions Calculate overall deficit of common process with recommendation

The Chartered Institute of Management Accountants

Marks 3 marks 3 marks 4 marks

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Examiner’s Comments In many cases this question was poorly answered. A large percentage of candidates were unable to demonstrate a good understanding of process costing, in particular that an incremental approach was required in part (a). The simplest and quickest approach is shown in the Examiner’s answers, but many other more time consuming methods were acceptable. Regardless of which method was chosen, candidates needed to quantify the effect of further processing i.e. the before and after position. Many candidates made poor attempts to do this, and many others put forward unclear answers. Very few candidates presented meaningful assumptions or assumptions that related to the scenario. The answers put forward to part (b) clearly demonstrated that the question had been completely misunderstood by many candidates. The question described a common process which yielded three products. Many candidates suggested the common process should be operated for only one or two of the products. As with part (a) the assumptions put forward were extremely weak. Common Errors 1. Not understanding the question requirements. 2. Using poor layouts for the answer. 3. Providing poor descriptions/labels to figures. 4. Stating weak, unrelated assumptions.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 3

(a) (i)

Calculate the expected time taken for the 8th unit. (3 marks)

(ii)

Explain two reasons why the time taken for the 1025th unit may be more than expected. (2 marks)

Note: The value of the 80% learning index is -0·3219

(b)

Explain the importance of considering the learning curve when deciding on the terms for a gain sharing arrangement with employees. (5 marks) (Total for Question Three = 10 marks)

Rationale This question tests candidates’ knowledge of the learning curve and its relevance to gain sharing arrangements with employees. This question addresses the learning outcomes: D(iv) Explain and apply learning and experience curves to estimate time and cost for new products and services and D(ix) Discuss gain sharing arrangements whereby contractors and customers benefit if contract targets for cost, delivery etc, are beaten.

Suggested Approach

(a)

• •

(b)

•

•

Calculate the total time for 7 units and 8 units then subtract one from the other to arrive at the time for the eighth unit Put forward suitable reasons for time being greater than expected

Explain gain sharing in the context of the question Comment on the importance of the learning curve in relation to gain sharing arrangements

Marking Guide (a) Calculate the time for the eighth unit Identify reasons why the time may be different from that expected

Marks 3 marks 2 marks

(b) Explain gain sharing Explain the importance of the Learning Curve in relation to gain sharing

2 marks 3 marks

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Examiner’s Comments Parts a(i) and (ii) were generally answered well, although some candidates displayed poor exam technique and wrote a full page when answering part a (ii) which was worth only two marks. Part (b) was poorly answered. The question clearly requested candidates to explain the importance of the learning curve when considering a gain sharing arrangement with employees. Many candidates described a gain sharing arrangement with other parties such as suppliers and contractors. They also ignored completely the impact of the learning curve, i.e. that if it is not taken into consideration this could favour the employee or the employer, depending on the target production time agreed. Common Errors 1. Failing to relate the answer to the scenario in the question. 2. Completely ignoring a major part of the question (part b). 3. Not recognising the mark value of a question, or part of a question (part a (ii)).

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 4 Prepare a report to the Managing Director that

(a)

explains Target Costing and how it differs from Standard Costing; (7 marks)

(b)

explains why net present value is superior to the three other investment appraisal techniques stated above. (3 marks) (Total for Question Four = 10 marks)

Rationale This question tests candidates’ ability in part (a) to distinguish between target costing and standard costing. This part of the question addresses the learning outcome: D(vi) Explain how target costs can be derived from target prices and describe the relationship between target costs and standard costs. In part (b) candidates were required to explain why net present value is a superior technique compared with other investment appraisal techniques. This part of the question addresses the learning outcome: B(vii)Compare, contrast and evaluate the alternative techniques of investment appraisal.

Suggested Approach Explain target costing, then explain standard costing and finally show how they differ Explain the favourable characteristics of net present value to show how this technique is superior to the other techniques

(a) (b)

Marking Guide (a) Present a report format Explain target costing Explain standard costing Compare the two techniques

Marks 1 mark 2 marks 2 marks 2 marks

(b) Explain why NPV is superior to other techniques

3 marks

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Examiner’s Comments In most cases both parts of this question were poorly answered. The majority of candidates did not plan or compose their responses, and put forward rambling and incoherent answers. A report format was requested (to, from, introduction, conclusion etc.) but many candidates either ignored this request or put forward reports that simply started with “Dear Sir” and closed with “Yours Sincerely” (similar comments apply to candidate responses to question 5(b)). In part (a) most candidates were able to describe target costing but very few were able to define or describe standard costing. This is a most worrying situation as standard costing is one of the most important topics in the management accounting syllabus. Most candidates simply described how a percentage could be added to a standard cost to derive a selling price. Very few candidates were able to compare the two techniques to demonstrate that they were completely different, in that target costing is a costing system with an external bias that relates to the customer and the market price of a product or service, whereas standard costing is a planning and control mechanism. Most candidates simply assumed that this was a question about pricing. The answers to part (b) were also poor. Candidates were in effect asked to explain why NPV is superior to other techniques. For example it considers the timing of cash flows, it considers all inflows and outflows and it recognises the opportunity cost of money. Most candidates chose to comment on the weaknesses of the other three techniques which was not the main thrust of the question. Common Errors 1. Being unable to define standard costing. 2. Not answering the question i.e. inability to compare two techniques (part (a)). 3. Not answering the question (part (b)), as described above. 4. Failing to use a report format. 5. Submitting lengthy answers that were disproportional to the marks available (part (b)).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Section C – 50 marks ANSWER TWO QUESTIONS OUT OF THREE

Question 5

(a)

Demonstrate, using the above information and appropriate calculations, how the Manager of the KL retail outlet should allocate the space available between the different categories of items for sale to customers in order to maximise his weekly profit. (7 marks)

(b)

Prepare a report, addressed to the manager of the KL retail outlet that explains (i) the principles of Direct Product Profitability (DPP); (ii) how these principles may be applied to his retail outlet; and (iii) how their application may improve the profits of his retail outlet. (18 marks) (Total for Question Five = 25 marks)

Rationale This question tests candidates’ ability to analyse the data provided to determine the optimum use of space available in a retail outlet and then to explain how the use of activity based costing might improve the information available to the manager. This question addresses the learning outcomes: A(vii) Apply variable/fixed cost analysis in multiple product contexts to breakeven analysis and product mix decision making, including circumstances where there are multiple constraints and linear programming methods are needed to reach optimal solutions; and D(x) Apply activity based costing ideas to analyse direct customer profitability and extend this analysis to distribution channel profitability.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Suggested Approach

(a)

• •

Calculate the contribution per % of floor area and rank by category Allocate the available space while recognising the stipulated minimum requirements Make a recommendation based on the calculations

• •

Explain the principles of DPP Discuss how these principles can be applied to the retail outlet Explain how profitability could be improved with the application of DPP

•

(b)

•

Marking Guide (a) Calculate contribution per unit of limiting factor and rank the results Allocate the available space Put forward the necessary advice

Marks 3 marks 3 marks 1 mark

(b) Explain three significant principles Discuss the application of these principles Identify how profit could be improved

6 marks 6 marks 6 marks

Examiner’s Comments Very few candidates attempted this question. Part (a) was simply a basic limiting factor question with display space being the limiting factor. A reallocation of the available space was the main requirement, but only a few candidates took notice of this detail in the question, especially that the manager was not required to allocate any space to “other products”. Part (b) was poorly answered. Only a few candidates submitted worthwhile attempts to explain DPP, in particular how it relates closely to Activity Based Costing and applies specifically to the retail trade. Some candidates were able to describe DPP but did not relate their answers to the question scenario. The overall quality of written answers was poor, with many candidates appearing to have no answer plan. It was particularly disappointing to note that many candidates did not know the difference between allocation and apportionment. Common Errors 1. Demonstrating poor application of limiting factor principles (e.g. ranking according to contributions without considering the limiting factor). 2. Not answering the question and not proposing a reallocation of the available space (part a). 3. Demonstrating a lack of planning and not using a clear structure for answering the discursive part of the question (part b).

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 6

(a) (i) Prepare calculations to identify which of the above six selling prices per unit will result in the highest annual profit from this product. (7 marks) (ii) Explain why your chosen selling price might not result in the highest possible annual profit from this product. (3 marks) (Total for requirement (a) = 10 marks)

(b) (i) Explain the alternative pricing strategies that may be adopted when launching a new product. (6 marks) (ii) Recommend a pricing strategy to the company for its new product and explain how the adoption of your chosen strategy would affect the sales revenue, costs and profits of this product over its life cycle. (9 marks) (Total for requirement (b) = 15 marks) (Total for Question Six = 25 marks)

Rationale This question tests candidates’ ability in part (a) to interpret relevant data to determine the most profitable selling price from those provided and to explain why this might not be the optimal selling price, and in part (b) to explain alternative pricing strategies for a new product and recommend the strategy to be used by the company in the scenario provided. This question addresses the learning outcomes: A(iii) Apply an approach to pricing based on profit maximisation in imperfect markets and evaluate the financial consequences of alternative pricing strategies.

Suggested Approach

(a)

(b)

• • •

Calculate the profit at each level of demand, using the formula provided to determine the cost Make a recommendation based on the levels of profit Put forward reasons why this might not result in the highest possible profit

• •

Describe the pricing strategies that are most suitable for this scenario Recommend a suitable pricing strategy and relate the stages of this strategy to the product life cycle

Marking Guide (a) Calculate a profit for each level of demand Make a recommendation Explain why this might not result in the highest profit

The Chartered Institute of Management Accountants

Marks 6 marks 1 mark 3 marks

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

(b) Explain alternative pricing strategies Select an appropriate strategy and show how this strategy relates to: Sales revenue Costs Profits

6 marks 3 marks 3 marks 3 marks

Examiner’s Comments Part (a) was well answered by most candidates. Part b(i) was generally well answered but a large percentage of candidates suggested pricing techniques that did not relate to the scenario. In part b(ii) the question requirement provided candidates with a format for answering this question, that is how the proposed strategy would affect the sales revenue, costs and profits over the life cycle of the product. Many candidates chose to ignore this suggested answer structure and discussed instead the stages of pricing when using a market skimming approach. Common Errors 1. Putting forward answers that did not relate to the question scenario (part b(i)). 2. Changing the thrust of the question and converting it to a pricing question (part b(ii)). 3. Presenting poorly laid out written answers. 4. Using poor handwriting.

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Question 7

(a)

Prepare calculations to show whether the investment is worthwhile assuming that the 30% increase in seating capacity is fully utilised and recommend whether the investment should proceed. (14 marks)

(b)

Calculate and interpret the Internal Rate of Return (IRR) of the proposed investment. (6 marks)

(c)

Calculate the sensitivity of your recommendation to changes in the percentage capacity utilisation. (5 marks) (Total for Question Seven = 25 marks)

Rationale This question tests candidates’ ability in part (a) to calculate the net present value of an investment proposal from the data provided and in parts (b) and (c) to calculate the Internal Rate of Return of the proposal and the sensitivity of their solution to changes in the decision variables. This question addresses the learning outcomes: B(iii) Calculate project cash flows, accounting for tax and inflation, and apply perpetuities to derive “end of project” value where appropriate; and B(vi) Evaluate project proposals using the techniques of investment appraisal and C(ii) Apply sensitivity analysis on both short and long run decision models to identify variables that might have significant impacts on project outcomes.

Suggested Approach

(a)

• • • •

Prepare calculations for each year, on an incremental basis, for each item of sales and costs, incorporating the relevant levels of inflation Calculate the tax on profits and the tax saved on investments Calculate the net present value using the money cost of capital provided Make a recommendation based upon the calculations

(b)

Calculate and interpret the internal rate of return

(c)

Calculate the level of sensitivity related to the change in capacity utilisation

Marking Guide (a) Calculate revised sales figures Calculate cost figures Calculate tax on profits Calculate tax saved on investment Generate NPV figures Make a recommendation

Marks 2 marks 8 marks 2 marks 2 marks 1 mark 1 mark max 14

(b) Calculate the IRR Interpret the IRR

3 marks 3 marks

(c) Generate variables, subject to tax and discounting Calculate sensitivity

3 marks 2 marks

The Chartered Institute of Management Accountants

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Paper P2 – Management Accounting – Decision Management Post Exam Guide November 2008 Exam

Examiner’s Comments Part (a) was a familiar investment appraisal question that was similar to questions that have appeared in recent papers. Unfortunately the question was poorly answered. The majority of candidates did not adopt an incremental approach, resulting in poor marks. In addition, the presentation and neatness of answers was well below the standard expected of management accounting students. In many cases workings were not referred to and were difficult to decipher. In part (b) most candidates were able to submit an IRR calculation (albeit using their own figures) but only a small percentage of candidates attempted to interpret the IRR, thus limiting their potential mark to three out of the six marks available. Part (c) was answered by only a few candidates and generally the attempts were extremely poor. Common Errors 1. Failing to use an incremental approach (part (a)). 2. Offering poorly presented answers. 3. Providing no workings to explain how figures have been derived (all parts).

The Chartered Institute of Management Accountants

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