Management Level Paper

P2 Performance Management
May 2013 examination
Examiners Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiners answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p2papers

The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early August at
www.cimaglobal.com/P2PEGS

SECTION A
Answer to Question One

Rationale
The question examines candidates knowledge and understanding of customer profitability
analysis and of different approaches to measuring profitability and performance.
The learning outcome tested is B1(l), analyse direct customer profitability and extend this
analysis to distribution channel profitability through the application of activity- based costing
ideas.

Suggested Approach
Candidates need to carefully read the question and using the data provided, construct a
customer profitability statement showing the profit for each customer. Candidates then need
to perform a number of calculations to measure the performance of each customer, such as
profit per order, profit per shrub. A brief discussion of the resulting figures is then required.

The Chartered Institute of Management Accountants 2013

Gross Revenue
Discounts allowed
Net Revenue
Cost of shrubs
Delivery costs
Order processing
Net profit

B
$
57,600
8,640
48,960
24,000
4,000
800
20,160

C
$
39,000
7,800
31,200
16,250
0
1,000
13,950

No. of shrubs sold

960

650

Profit per shrub sold

$21

$21.46

8
$2,520

10
$1,395

$0.35

$0.36

Number of orders
Profit per order
Profit per $1 gross revenue
Comments:

There is very little difference between the profit per $ of gross revenue from customers B and
C. Customer B earns the lower profit per shrub. This is despite the large discount given to C
for using their own transport.
The discount offered to Customer C seems generous. The discount costs the farm $7,800 in
lost revenue but only saves (based on the order frequency shown) $5,000 in delivery costs.
Why has this discount been given? Is the transport being used to full capacity and it is not
possible to make the sale unless the customer collects the shrubs themselves? Is C situated
a large distance away from the farm?
The analysis shows that B earns the higher absolute profit for the farm because of the higher
number of shrubs purchased. However C earns the highest profit per shrub.
The analysis could be used by the farm to assess the impact of the discounts it offers to the
customers. For example, what would be the impact on delivery schedules and costs of
reducing the discount offered on orders for more than 100 shrubs?
It would appear that the farm is happy to earn a profit margin of 35% and to offer incentives to
achieve that margin.

P2

May 2013

Answer to Question Two

Rationale
The question examines candidates knowledge and understanding of the learning curve and
sensitivity analysis.
The learning outcome tested is B1(e), apply learning curves to estimate time and cost for new
products and services.

Suggested Approach
Candidates needed to carefully read the question to fully appreciate what was required. In
part (i) candidates needed to calculate the maximum reduction in the labour rate that could
take place to allow the company to generate a profit of $75,000. The change needed to be
measured against the rate of $40 per labour hour.
In part (ii) candidates needed to establish by how much the learning rate could fall, and still
allow the company to generate a profit of $75,000. To fully answer the question the change
(fall) in the learning rate needed to be measured against the original 90%.

(i)
Cumulative average time for 64 units = 119.58 hours
Total time for 64 units = 119.58 *64 = 7,653.12 hours
The target profit of $75,000 is earned by 7,653.12 hours. This represents $9.80 per hour.
The hourly rate could rise by $9.80 before the profit is eroded.
The sensitivity is therefore 9.80/40.00 = 24.5%
(ii)
Total labour cost of 64 units = 7,653.12 * $40 = $306,124.8
The labour cost could rise to $306,124.8 + $75,000 = $381,124.8, before no profit is earned.
This equals $381,124.8/$40 = 9,528.12 hours
This is an average of 9,528.12/64 hours per unit = 148.88 hours per unit.
Cumulative average time for 64 units/ average time for the first unit = 148.88/225 = 0.6617
An output of 64 units represents six doublings and therefore the learning rate is the sixth root
of 0.6617
0.6617 = 0.9335

Therefore the learning rate can fall to 93.35%.

The sensitivity is therefore 3.35/90 = 3.72%

May 2013

P2

Answer to Question Three

Rationale
The question examines candidates knowledge and understanding of zero based budgeting
(ZBB) when set in a Research and Development environment.
The learning outcome tested is C3(d), discuss the criticisms of budgeting, particularly from
the advocates of beyond budgeting techniques.

Suggested Approach
Candidates needed to carefully read the question and fully understand the scenario
described. In particular, the question specifically requested candidates to discuss the
disadvantages of implementing ZBB in a Research and Development setting. Both generic
and specific disadvantages needed to be considered. A step-by-step description of the
implementation of ZBB is not required, e.g. a description of a decision package.

Zero based budgeting (ZBB) can be an effective way of allocating resources and controlling
discretionary costs. It is often thought that research and development is a discretionary cost.
However the benefits of ZBB are often viewed from the companys perspective rather than
that of the Director of a division or a budget holder.
Adopting ZBB could have major disadvantages for the Director. There are two immediate
issues that the director needs to be aware of:

it will involve a great deal of time.

it requires management and accounting expertise. The Director may not have all of
these skills.

There are four stages in the implementation of ZBB:

Activities have to be specified and evaluated

Decision packages have to be drawn up for each activity
Each package has then to be evaluated and ranked
Resources are then awarded to the preferred packages.

Possible disadvantages:

P2

The need to specify projects could stifle creativity. This could have a major impact on
PP and consequently the Research and Development Division.
The outcome of many projects could be difficult to forecast. Requesting funds for
projects that do not have a clearly defined commercial outcome could be problematic
given the use of decision packages within a zero based budgeting system.
The Director would have to seek approval for funding for specified projects and would
need to justify the request on a continuing basis. This loss of autonomy could be demotivating and increase pressure to achieve results.

May 2013

Answer to Question Four

Rationale
The question examines candidates knowledge and understanding of methods of dealing with
uncertainty and risk and of how these methods are linked to attitude.
The learning outcome tested is A2(d), analyse the impact of uncertainty and risk on decision
models based on CVP analysis.

Suggested Approach
Candidates needed to carefully understand the data provided, and note particularly that the
figures provided were included to assist with answering the question. Additional calculations
were not required. The requirement was quite specific and needed the four methods
requested to be linked to attitude.

Z could use any of the following three approaches to dealing with uncertainty:
Maximin: the decision maker will look at the options and choose the one that has the
highest minimum return. This type of decision maker is a pessimist and will look at the worst
outcome for each of the options and seeks to get the best of the worst.
Maximax: the decision maker will look at the options and choose the one that has the
highest return. This type of decision maker is an optimist.
Minimax Regret: the decision maker will analyse the options and choose the option so that
if it is the wrong choice the regret will not be as big as if the others had been chosen and they
were wrong. This type of decision maker seeks to minimise the post-event regret of having
made a wrong decision.
If probabilities can be assigned to the outcomes then uncertainty will become risk. It will
then be possible to calculate expected values. The decision maker will choose the outcome
that has the highest expected value. This assumes that the decision maker is risk neutral.
The expected value of an option does not give any indication of the risk associated with the
option. The risk, or spread, of the possible outcomes of each option can be measured by
calculating the standard deviation. A risk minimiser would choose the option with the lowest
standard deviation.
The trade off between risk and return can be evaluated by calculating the coefficient of
variation (standard deviation divided by expected value).

May 2013

P2

Answer to Question Five

Rationale
The question examines candidates knowledge and understanding of Beyond Budgeting
when set in the modern dynamic business environment.
The learning outcome tested is C3(c) compare and contrast traditional approaches to
budgeting with recommendations based on the balanced scorecard.

Suggested Approach
A careful read through the brief scenario was essential to understand the setting for this
Beyond Budgeting (BB) question. It was important that candidates did not simply write all
they knew about BB, and fail to relate their answer to the scenario.

Beyond Budgeting (BB) is a responsibility culture in which managers are given goals that
have been derived from benchmarks linked to competitors and world class performance. This
culture requires an adaptive approach whereby authority is devolved to managers and the
organisations structure will be a network rather than hierarchical.
The principles of BB are:

The organisation structure should have clear principles and boundaries. Everyone
should have defined areas of responsibility.
Managers should be given targets that are linked to the organisations strategy. Such
targets should be based on key performance indicators and should be part of a
balanced scorecard.
Managers should be given a high degree of freedom to make decisions. The
organisation chart should be flat.
Responsibility for decisions that generate value should be placed with front line
teams. These teams should be made responsible for managing relationships with
business partners (customers, suppliers, etc).
Information support systems should be transparent. For example, an activity based
accounting system would enable reports to be generated to show the costs/revenues
for activities which are the specific responsibility of identified managers.

It can be argued that in the modern dynamic business environment it is vital that management
can react to changes in the market and allocate resources accordingly. BB will allow this to
happen. The benefits that should accrue from the adoption of the principles of BB are faster
response times, better innovation, lower costs and improved customer and supplier loyalty. All
of these are of great importance in the modern dynamic business environment.

P2

May 2013

SECTION B
Answer to Question Six
Rationale
The question examines candidates knowledge and understanding of a limiting factor
situation to maximise company profit, aspects of linear programming and the use of Value
Analysis.
The learning outcomes tested are:
Part (a) A2(b), interpret 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 identify optimal solutions.
Part (b) A2(c), discuss the meaning of optimal solutions and how linear programming
methods can be employed for profit maximising, revenue maximising and satisfying
objectives.
Part (c) B1(g), explain how process re-engineering can be used to eliminate non valueadding activities and reduce activity costs.

Suggested Approach
Part (a)
Carefully read the question to understand clearly what is required and complete two limiting
factor calculations to identify the financial impact of making component F internally as
opposed to buying it.
Part (b)
Understand the changes to the figures in part (a) and apply linear programming skills to
construct the objective function and the constraints to be used in a linear programming model
and address the issue described in part b(ii).
Part (c)
This part required knowledge of Value Analysis in that a description of the process is
required.

(a)
Buying in the component

Contribution per unit

Skilled labour hours per unit
Contribution per skilled labour hour
Rank
Output (units)
Contribution $

D
54
1
54
2nd
2,400
129,600

E
72
1.5
48
3rd
1,000
72,000

F
35
0.5
70
1st
3,000
105,000

D
54
1
54
1st

E
72
1.5
48
3rd

F
78
1.5
52
2nd

Total

306,600

Making the component

Contribution per unit

Skilled labour hours per unit
Contribution per skilled labour hour
Rank
May 2013

Total

P2

Output (units)
Contribution $

2,400
129,600

0
0

2,000
156,000

285,600

In Month 1 the optimum production plan is to buy in the component and make 2,400, 1,000
and 3,000 units of D, E and F respectively. This will earn a profit of $156,600

(b)(i)
Objective function: Maximise 54D + 72E, where D and E are the number of units of those
products to be produced.
Subject to:
Direct materials
Skilled labour
Unskilled labour
Machine hours
Demand for D
Demand for E

3D+4E16,000
1D+1.5E5,400
1.5D+1E5,000
4D+4E19,600
D3,000
E3,000

(b)(ii)
The optimum will be at the point where the binding constraints intersect. The binding
constraints are:
1D + 1.5E = 5,400 (Equation 1)
1.5D + 1E = 5,000 (Equation 2)
Multiply equation 1 by 1.5 gives:
1.5D + 2.25E = 8,100 (Equation 3)
Equation 3 Equation 2 gives: 1.25E = 3,100 and therefore E = 2,480
Therefore by substitution into any of the equations gives D = 1,680
The resulting profit is (1,680 * $54)+(2,480 * $72) - $150,000 = $119,280.

(c)
The stages in a value analysis exercise are:

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Determine the function of the product and of each part/component in the product. The
main issue is to identify the function of each component.
Determine the costs of each part/component that makes up the function.
Develop alternative ways of performing the function of each part.
Evaluate the alternatives.
Recommend / implement the results.

May 2013

Answer to Question Seven

Rationale
The question examines candidates knowledge and understanding of transfer pricing, in
particular adopting an opportunity costing approach.
The learning outcomes tested are Part (a) & (b) D3(c), discuss the likely consequences of
different approaches to transfer pricing for divisional decision making, divisional and group
profitability, the motivation of divisional management and the autonomy of individual
divisions. Part (c) D3(d) discuss in principle the potential tax and currency management
consequences of internal transfer pricing policy.

Suggested Approach
For part (a), carefully read and understand the data provided and assemble the figures to
show the profitability of two divisions, at three different levels of output with one division
supplying to a second division. Part (b) requests candidates to consider the impact of the
receiving division deciding to purchase components externally as opposed to purchasing from
the other division. Part (c) requires an explanation of arms length pricing and the methods
that can be used to determine an arms length price.

(a)
Workings
Given the demand figures for the finished product and the components it can be seen that
both divisions will be working at full capacity. The only changes to the profits of both divisions
will be caused by the transfer prices used for the components.
S Division
External sales
15,000 @ $200
Variable costs
35,000 @ $105
Fixed costs
Loss before internal sales

$000
3,000
3,675
1,375
-2,050

R Division
Revenue
10,000 @ $800
Own variable costs 10,000 @ $250
Fixed costs
Profit before cost of components

$000
8,000
2,500
900
4,600

The transfer prices used will generate revenues for S Division and costs for R Division. The
prices used will be based on opportunity cost and these will be determined by reference to the
demand made by external customers for the components and S Divisions capacity. For
example if external demand is for 19,000 components, S will only be able to supply 15,000
and therefore there is an opportunity cost of 4,000 components at $200 each because of the
fixed capacity of 35,000 components.
External demand for components
Components transferred at $200
Components transferred at $105
Internal revenues and costs $000

May 2013

15,000
0
20,000
2,100

19,000
4,000
16,000
2,480

35,000
20,000
0
4,000

P2

Answer
S Division
External demand for components
Loss before internal sales
Internal sales
Profit

15,000
$000
-2,050
2,100
50

19,000
$000
-2,050
2,480
430

35,000
$000
-2,050
4,000
1,950

15,000
$000
4,600
2,100
2,500

19,000
$000
4,600
2,480
2,120

35,000
$000
4,600
4,000
600

15,000
$000
1,300

19,000
$000
1,300

35,000
$000
1,300

0
-1,300

380
-920

1,900
600

R Division
External demand for components
Profit before cost of components
Cost of components
Profit

(b)
External demand for components
Extra cost of external purchases
20,000*(170-105)
Extra contribution by S external
Total impact

(c)
The OECD guidelines are based on the arms length price principle, that is a price that
would have been arrived at by two unrelated companies acting independently. There are
three methods that the tax authorities can use:
1.
2.

3.

The comparable uncontrolled price method (which uses externally verified prices
of similar transactions involving unrelated companies)
The resale price method (which deducts a percentage from the selling price from
the final product to allow for profit) can be used when goods are sold on with
little further processing
The cost-plus method: an arms length gross margin is established and is applied
to the sellers manufacturing cost.

The OECD guidelines state that whenever possible the comparable uncontrolled price
method should be used and if there is no market price, preference should be given to costplus.

P2

10

May 2013