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# Fundamentals Level Skills Module, Paper F5

Section C

31 SU Co

## (a) SP (standard price per metre: \$285/095) \$300

SQ (standard quantity per dress: 22 metres/11) 2 metres
From scenario the revised price per metre (RP) is \$285, the actual price per metre (AP) is \$285 and the revised quantity
per dress (RQ) is 22 metres.
SQAP (standard quantity for actual production: 2 metres x 24,000) 48,000 metres
RQAP (revised quantity for actual production: 22 metres x 24,000) 52,800 metres
From the scenario the actual production level (AP) is 24,000 dresses and actual quantity of material bought and used (AQ)
is 54,560 metres.
Material price variances
Planning variance
(SP RP) x AQ: (\$300 \$285) x 54,560 8,184 F
Operational variance
(RP AP) x AQ: (\$285 \$285) x 54,560 0
Total price variance 8,184 F
Material usage variances
Planning variance
(SQAP RQAP) x SP: (48,000 52,800) x \$300 14,400 A
Operational variance
(RQAP AQ) x SP: (52,800 54,560) x \$300 5,280 A
Total usage variance 19,680 A
Total material variance 11,496 A
Tutorial note: These variances could have been calculated using the alternative approach as below:
Material price variances
Planning variance
(AP x RQ) x (SP RP): 24,000 x 22 metres x (\$300 \$285) 7,920 F
Operational variance
(RP AP) x AQ: 54,560 metres x (\$285 \$285) 0
Material usage variances
Planning variance
(SQ RQ) x AP x SP: 24,000 x (2 metres 22 metres) x \$300 14,400 A
Operational variance
((AP x RQ) AQ) x RP: 24,000 x 22 metres 54,560 x \$285 5,016 A
Total material variance 11,496 A

(b) AH (actual hours worked and paid): 24 x 160 hours 3,840 hours
SHAP (standard hours for actual production): (24,000 x 8)/60 3,200 hours
RHAP (revised hours for actual production): (24,000 x 10)/60 4,000 hours
From the scenario the standard rate per hour (SR) is \$12, the standard time per dress is eight minutes and the revised time
per dress is 10 minutes.
Labour efficiency variances
Planning variance
(SHAP RHAP) x SR: (3,200 4,000) x \$12 9,600 A
Operational variance
(RHAP AH) x SR: (4,000 3,840) x \$12 1,920 F
Total labour efficiency variance 7,680 A

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(c) The production manager did not have any control over the change in the design of the dress as this change was requested
by the client. Similarly, it was not his fault that the company accountant responsible for updating standard costs was off sick
and therefore unable to update the standards. Therefore, the production manager should be judged only by those variances
over which he has control, which are the operational variances.
Materials
No operational variance arose in relation to materials price, since the actual price paid was the same as the revised price. A
planning variance of \$8,184F does arise but the production manager cannot take the credit for this, as the material chosen
by GPST for the new dresses just happens to be cheaper.
As regards usage, an adverse variance of \$5,280 arose. This suggests that, even with the revised quantity of material being
taken into account, staff still used more than 22 metres on average to produce each dress. This is probably because they
had to learn a new sewing technique and they probably made some mistakes, resulting in some wastage. The manager is
responsible for this as it may have been caused by insufficient training. However, the labour efficiency variances below shed
some more light on this.
Labour
The labour efficiency operational variance was favourable, which suggests good performance by the production manager. Staff
took less than the expected revised 10 minutes per dress. However, when looked at in combination with the material usage
operational variance above, it could be inferred that staff may have rushed a little and consequently used more material than
necessary.
When both of the operational variances are looked at together, the adverse materials usage \$5,280 far outweighs the
favourable labour efficiency variance of \$1,920. Consequently, it could be concluded that, overall, the managers performance
was somewhat disappointing.

## 32 The Peoples Bank

(a) The balanced scorecard approach looks not only at the financial performance but also non-financial performance. In order to
maintain a competitive edge, organisations have to be very aware of the changing needs of their customers. In the case of
The Peoples Bank, this has involved identifying specific categories of customers which have particular needs, like SMEs in
a commercial context, or like the disabled or visually impaired in a non-commercial context. This permits these needs to be
The Peoples Bank has a vision and strategy which goes far beyond just making money. They want to help the community
and disadvantaged people and give something back to customers also. Hence, by using the balanced scorecard, performance
measures which address whether the Bank is being successful in pursuing their vision can be incorporated.
In addition, from a purely business perspective, if employees and customers are valued and internal processes are efficient,
an organisation should have more chance of achieving long-term success anyway. So, even putting aside the social objectives
The Peoples Bank has, the balanced scorecard can be useful to The Peoples Bank to measure these other aspects of future
success too.

(b) The performance of the bank will be considered under each of the headings used in the balanced scorecard:
Financial perspective
The Peoples Bank has had a year of mixed success when looking at the extent to which it has met its financial targets. Its
return on capital employed (ROCE) shows how efficiently it has used its assets to generate profit for the business. The target
for the year was 12% but it has only achieved an 11% return. The Peoples Banks interest income, however, was in fact
\$05m higher than its target, which is good. This may have been achieved by offering slightly better interest rates to customers
than competing banks, as the interest margin The Peoples Bank achieved is slightly lower than target. The most likely reason
for the under target ROCE is therefore probably the investment which The Peoples Bank has made in IT security and facilities
for the disabled and visually impaired. Whilst this may have reduced ROCE, this investment is essentially a good idea as it
helps The Peoples Bank pursue its vision and will keep customers happy. It will also, in the case of the IT security investment,
prevent the bank and its customers from losing money from fraud in the future.
The other performance measure, the amount of new lending to SMEs, is a little bit disappointing, given The Peoples Banks
stated value of making a difference to communities. The failure to meet this target may well be linked to the fact that an
insufficient number of staff were trained to provide advice to SMEs and consequently, fewer of them may have been successful
in securing additional finance.
Customer perspective
With regard to its customers, The Peoples Bank has performed well in the year. It has exceeded its target to provide mortgages
to new homeowners by 6,000. This is helping The Peoples Bank pursue its vision of helping new homeowners. It has also
managed to beat the target for customer complaints such that there are only 15 complaints for every 1,000 customers, well
below the target of 2. This may be as a result of improved processes at the bank or improved security. It is not clear what the
precise reason is but it is definitely good for The Peoples Banks reputation.
The bank has also exceeded both of its targets to help the disabled and visually impaired, which is good for its reputation and
its stated value of making services more accessible.

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Internal processes
The number of processes simplified within the bank has exceeded the target, which is good, and the success of which may
well be reflected in the lower customer complaints levels. Similarly, the investment to improve IT systems has been a success,
with only three incidences of fraud per 1,000 customers compared to the target of 10. However, perhaps because of the focus
on this part of the business, only two new services have been made available via mobile banking, instead of the target of
five, which is disappointing. Similarly, it is possible that some of the new systems have prevented the business from keeping
its CO2 emissions to their target level.
Learning and growth
The Peoples Bank has succeeded in helping the community, exceeding both of its targets relating to hours of paid volunteer
work and number of community organisations supported by volunteers or funding. These additional costs could have
contributed to the fact that the bank did not quite meet its target for ROCE.
However, the bank has not quite met its targets for helping small businesses and helping the disadvantaged. As mentioned
earlier, the shortfall in training of employees to give advice to SMEs may have had an impact on The Peoples Banks failure
to meet its target lending to SMEs. As regards the percentage of trainee positions, the target was only just missed and this
may well have been because the number of candidates applying from these areas was not as high as planned and the bank
has no control over this.
Overall, the bank has had a fairly successful year, meeting many of its targets. However, it still has some work to do in order
to meet its stated values and continue to pursue its vision.

11
Fundamentals Level Skills Module, Paper F5
Performance Management September 2016 Answers

Section A

1 C
OAR for fixed production overheads (\$72 million/96 million hours) = \$075 per hour
Total manufacturing costs (300,000 units x \$20) = \$6,000,000
Total design, depreciation and decommissioning costs = \$1,320,000
Total fixed production overheads (300,000 units x 4 hours x \$075) = \$900,000
Total life-cycle costs = \$8,220,000
Life-cycle cost per unit (\$8,220,000/300,000 units) = \$2740

2 B
Two units of Y and one unit of X would give total contribution of \$18.
Weighted average contribution per unit = \$18/3 units = \$6
Sales units to achieve target profit = (\$90,000 + \$45,000)/\$6 = 22,500

3 A
3,000 units should use 10 kg each (3,000 x 10) = 30,000 kg
3,000 units did use = 29,000 kg
Difference = 1,000 kg favourable
Valued at \$680 per kg (\$68/10 kg)
Variance = \$6,800 favourable

4 D
The tracking and summarising of critical strategic information is done by an Executive Information System (EIS).
The other three options are all likely to be potential benefits which would result from the introduction of an ERPS.

5 D
Under a system of flow cost accounting material flows are divided into three categories material, system, and delivery and
disposal.

6 C
Exam success will be a given objective of a school, so it is a measure of effectiveness.

7 B
Variance analysis is not relevant to target costing as it is a technique used for cost control at the production phase of the product
life cycle. It is a feedback control tool by nature and target costing is feedforward.
Value analysis can be used to identify where small cost reductions can be applied to close a cost gap once production commences.
Functional analysis can be used at the product design stage. It ensures that a cost gap is reached or to ensure that the product
design is one which includes only features which customers want.
Activity analysis identifies and describes activities in an organisation and evaluates their impact on operations to assess where
improvements can be made.

8 A
A memory stick is much more likely to get mislaid and compromise security than a password protected laptop. It is likely that
memory sticks could get lost or that information is left on home computers.
In the context of the scenario all the other options are good practice.

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9 A
If the values for R and N are substituted into the constraints:
Labour required = (3 x 500) + (2 x 400) = 2,300 hours which is less than what is available so there is slack.
Machine time required = (05 x 500) + (04 x 400) = 410 hours which is exactly what is available and so there is no slack.

10 B
Revised annual profit = \$190,000 + \$10,000 profit on the sale of the asset = \$200,000
Revised net assets = \$1,000,000 \$40,000 NBV + \$50,000 cash \$250,000 cash + \$250,000 asset = \$1,010,000
ROI = (\$200,000/\$1,010,000) x 100 = 198%

11 A
Throughput is determined by the bottleneck resource. Process 2 is the bottleneck as it has insufficient time to meet demand.
The only option to improve Process 2 is to improve the efficiency of the maintenance routine. All the other three options either
increase the time available on non-bottleneck resources or increase demand for an increase in supply which cannot be achieved.

12 C
An operational variance compares revised price to actual price.
20,000 kg should cost \$040 per kg at the revised price (20,000 kg x \$040) = \$8,000
20,000 kg did cost \$042 per kg (20,000 kg x \$042) = \$8,400
Variance = \$400 adverse

13 A
The material price when flexed is higher than budget whilst the external environment shows that prices are reducing. This indicates
that although suppliers lowered their prices, the manager has still overspent which indicates poor performance.
When sales volumes and prices are flexed, it can be seen that the manager has performed better.

14 D
Penetration pricing involves setting a low price when a product is first launched in order to obtain strong demand.
It is particularly useful if significant economies of scale can be achieved from a high volume of output and if demand is highly
elastic and so would respond well to low prices.

15 B
Total material budget ((1,000 units x \$10) + (2,000 units x \$20)) = \$50,000
Fixed costs related to material handling = \$100,000
OAR = \$2/\$ of material
Product B = \$2 x \$20 = \$40
Total labour budget ((1,000 units x \$5) + (2,000 units x \$20) = \$45,000
General fixed costs = \$180,000
OAR = \$4/\$ of labour
Product B = \$4 x \$20 = \$80
Total fixed overhead cost per unit of Product B (\$40 + \$80) = \$120

Section B

16 A
The maximin rule selects the maximum of the minimum outcomes for each supply level.
For Mylo the minimum outcomes are:
450 lunches \$1,170
620 lunches \$980
775 lunches \$810
960 lunches \$740
The maximum of these is at a supply level of 450 lunches.

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17 D
The minimax regret rule selects the minimum of the maximum regrets.
Demand level Supply level
450 620 775 960
\$ \$ \$ \$
450 190 360 430
620 442 217 322
775 845 403 230
960 1,326 884 481
Max regret 1,326 884 481 430
The minimum of the maximum regrets is \$430, so suggests a supply level of 960 lunches.

18 B
Expected values do not take into account the variability which could occur across a range of outcomes; a standard deviation would
need to be calculated to assess that, so Statement 2 is correct.
Expected values are particularly useful for repeated decisions where the expected value will be the long-run average, so
Statement 4 is correct.
Expected values are associated with risk-neutral decision-makers. A defensive or conservative decision-maker is risk averse, so
Statement 1 is incorrect.
Expected values will take into account the likelihood of different outcomes occurring as this is part of the calculation, so
Statement 3 is incorrect.

19 A
This requires the calculation of the value of perfect information (VOPI).
Expected value with perfect information = (015 x \$1,170) + (030 x \$1,612) + (040 x \$2,015) + (015 x \$2,496) =
\$1,83950
Expected value without perfect information would be the highest of the expected values for the supply levels = \$1,64825 (at a
supply level of 775 lunches).
The value of perfect information is the difference between the expected value with perfect information and the expected value
without perfect information = \$1,83950 \$1,64825 = \$19125, therefore \$191 to nearest whole \$.

20 D
The investments sensitivity to fixed costs is 550% ((385/70) x 100), so Statement 3 is correct.
The margin of safety is 846%. Budgeted sales are 650 units and BEP sales are 100 units (70/07), therefore the margin of safety
is 550 units which equates to 846% of the budgeted sales, so Statement 4 is therefore correct.
The investment is more sensitive to a change in sales price of 296%, so Statement 1 is incorrect.
If variable costs increased by 44%, it would still make a very small profit, so Statement 2 is incorrect.

21 D
An 80% activity level is 210,000 units.
Material and labour costs are both variable. Material is \$4 per unit and labour is \$550 per unit.
Total variable costs = \$950 x 210,000 units = \$1,995,000
Fixed costs = \$750,000
Supervision = \$175,000 as five supervisors will be required for a production level of 210,000 units.
Total annual budgeted cost allowance = \$1,995,000 + \$750,000 + \$175,000 = \$2,920,000

22 B
Variable cost per hour (\$850,000 \$450,000)/(5,000 hours 1,800 hours) = \$125 per hour
Fixed cost (\$850,000 (5,000 hours x \$125)) = \$225,000
Number of machine hours required for production = 210 batches x 14 hours = 2,940 hours
Total cost (\$225,000 + (2,940 hours x \$125)) = \$592,500, therefore \$593,000 to the nearest \$000.

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23 C
If the budget is flexed, then the effect on sales revenue of the difference between budgeted and actual sales volumes is removed
and the variance which is left is the sales price variance.

24 A
Flexible budgeting can be time-consuming to produce as splitting out semi-variable costs could be problematic, so Statement 1 is
correct.
Estimating how costs behave over different levels of activity can be difficult to predict, so Statement 2 is correct.
A flexible budget will not encourage slack compared to a fixed budget, so Statement 3 is incorrect.
It is a zero-based budget, not a flexible budget, which assesses all activities for their value to the organisation, so Statement 4 is
incorrect.

25 C
Spreadsheets can be used to change input variables and new versions of the budgets can be more quickly produced, so
Statement 1 is correct.
Sensitivity analysis is also easier to do as variables are more easily changed and manipulated to assess their impact, so
Statement 4 is correct.
A common problem of spreadsheets is that it is difficult to trace errors in a spreadsheet and data can be easily corrupted if a cell
is changed or data is input in the wrong place, so Statement 2 is incorrect.
Spreadsheets do not show qualitative factors; they show predominantly quantitative data, so Statement 3 is incorrect.

26 D
Target costing does encourage looking at customer requirements early on so that features valued by customers are included, so
Statement 2 is correct. It will also force the company to closely assess the design and is likely to be successful if costs are designed
out at this stage rather than later once production has started, so Statement 4 is correct.
Statement 1 explains a benefit of flow cost accounting. Statement 3 explains the concept of throughput accounting.

27 A
Target price is \$45 and the profit margin is 35% which results in a target cost of \$2925. The current estimated cost is \$3130
which results in a cost gap of \$205.

28 C
Using more standardised components and using its own websites for marketing will reduce processing and marketing costs.
Using cheaper materials and trainee designers will reduce costs but could impact the quality and customer perception of the
product which would impact the target price.

29 C
The change in the learning rate will increase the current estimated cost which will increase the cost gap.
The target cost will be unaffected as this is based on the target selling price and profit margin; neither of which are changing.

30 B
Services do use more labour relative to materials.
The other three statements are incorrect as uniformity is not a characteristic of services, there is no transfer of ownership and
although it is difficult to standardise a service due to the human influence, target costing can still be used.

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Section C

31 Jungle Co

Sales volumes
Since prices have remained stable year on year, it can be assumed that changes to revenue are as a result of increases or decreases
in sales volumes. Overall, revenue has increased by 15%, which is a substantial increase. In order to understand what has
happened in the business, it is necessary to consider sales by looking at each of the different categories.
Household goods
Although this was the largest category of sales for Jungle Co last year, this year it has decreased by 5% and has now been
overtaken by electronic goods. The company changed suppliers for many of its household goods during the year, buying them
instead from a country where labour was cheap. It may be that this has affected the quality of the goods, thus leading to decreased
demand.
Electronic goods
Unlike household goods, demand for electronic goods from Jungle Co has increased dramatically by 28%. This is now Jungle Cos
leading revenue generator. This is partly due to the fact that the electronic goods market has grown by 20% worldwide. However,
Jungle Co has even outperformed this, meaning that it has secured a larger segment of the market.
Cloud computing service
This area of Jungle Cos business is growing rapidly, with the company seeing a 90% increase in this revenue stream in the last
year. Once again, the company has outperformed the market, where the average growth rate is only 50%, suggesting that the
investment in the cloud technology was worthwhile.
Gold membership fees
This area of the business is relatively small but has shrunk further, with a decrease in revenue of 30%. This may be because
customers are dissatisfied with the service that they are receiving. The number of late deliveries for Gold members has increased
from 2% to 14% since Jungle Co began using its own logistics company. This has probably been at least partly responsible for
the massive increase in the number of customer complaints.
Gross profit margins
Overall, the companys gross profit margin (GPM) has increased from 37% to 42%. Whilst the GPM for electronic goods has only
increased by 1 percentage point, the margin for household goods has increased by 10 percentage points. This is therefore largely
responsible for the increase in overall GPM. This has presumably occurred because Jungle Co is now sourcing these products from
new, cheaper suppliers.
Gold membership fees constitute only a small part of Jungle Cos income, so their 2 percentage point fall in GPM has had little
impact on the overall increase in GPM. Cloud computing services, on the other hand, now make up over \$12m of Jungle Cos
sales revenue. For some reason, the GPM on these sales has fallen from 76% to 66%. This is now 14 percentage points less than
the market average gross profit margin of 80%. More information is needed to establish why this has happened. It has prevented
the overall increase in GPM being higher than it otherwise would have been.
These have increased by 60% from \$172m to \$276m. This is a substantial increase. The costs of the customer service
department are in here. Given the number of late deliveries increase from 2% to 14%, and the corresponding increase in customer
complaints from 5% to 20%, it is not surprising that the administration costs have increased. As well as being concerned about
the impact on profit of this increase of over \$1m, Jungle Co should be extremely worried about the effect on its reputation. Bad
publicity about reliable delivery could affect future business.
Distribution costs
Despite an increase in sales volumes of 15%, distribution expenses have increased by less than 2 percentage points. They have
gone down from \$016 to \$014 per \$ of revenue. Although this means that Jungle Co has been successful in terms of saving
costs, as discussed above, the damage which late deliveries are doing to the business cannot be ignored. The company needs to
urgently address the issue of late deliveries.
Net profit margin
This has increased from 19% to 25%. This means that, all in all, Jungle Co has had a successful year, with net profit having
increased from \$156m to \$238m. However, the business must address its delivery issues if its success is to continue.
Gross profit margins 31 August 20X6 31 August 20X5
Household goods 4000% 3000%
Electronic goods 3600% 3500%
Cloud computing services 6581% 7577%
Gold membership fees 9286% 9500%
Overall 4239% 3719%
Net profit margin 2515% 1895%

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Increase/decrease in revenue
Household goods 527%
Electronic goods 2828%
Cloud computing services 9018%
Gold membership fees 3000%
Total revenue increase 1499%
Increase/decrease in cost of sales
Household goods 1880%
Electronic goods 2631%
Cloud computing services 16835%
Gold membership fees 000%
Total cost of sales increase 546%
Increase in administration expenses 6047%
Increase in distribution expenses 182%
Increase in other operating expenses 2727%
Increase in costs of customer service department 12093%
([\$1,900,000 \$860,000]/\$860,000)
31 August 20X6 31 August 20X5
Customer complaints as % customers 1972% 492%
Delivery cost per \$ of revenue \$014 \$016

32 CSC Co

## (a) (Step 1) Calculate the shortage of Betta for the year

Total requirements in grams:
Cakes: grams used per cake 05
Expected demand 11,200

Total required: 5,600

Expected demand 9,800

Total required: 1,960

Shakes: grams used per shake 1
Expected demand 7,500

Total required: 7,500

Overall total required: 15,060
Less available: 12,000

Shortage: 3,060

(Step 2) Contribution per gram of Betta and ranking
Cakes Cookies Shakes Shakes (contract)
\$ \$ \$ \$
Contribution per unit 260 175 120 100
Grams of Betta per unit 05 02 1 1
\$ \$ \$ \$
Contribution per gram 520 875 120 100
Rank 2 1 3 4

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(Step 3) Optimum production plan
Product Number Grams Total Cumulative Contribution Total
to be per grams per grams per unit contribution
produced unit product
Shakes (contract) 5,000 1 5,000 5,000 100 5,000
Cookies 9,800 020 1,960 6,960 175 17,150
Cakes 10,080 05 5,040 12,000 260 26,208

Total contribution 48,358
Less fixed costs (3,000)

Profit 45,358

## (b) Breach of contract with Encompass Health (EH)

It would be bad for business if CSC Co becomes known as a supplier who cannot be relied on to stick to the terms of its
agreements. This could make future potential customers reticent to deal with them.
Even more seriously, there could be legal consequences involved in breaching the contract with EH. This would be costly and
also very damaging to CSC Cos reputation.
If CSC Co lets EH down and breaches the contract, EH may refuse to buy from them any more and future sales revenue would
therefore be lost. Just as importantly, these sales to EH are currently helping to increase the marketability of CSC Cos shakes.
This will be lost if these sales are no longer made.
Therefore, taking these factors into account, it would not be advisable to breach the contract.

(c) (i) This line is what is called the iso-contribution line and it is plotted by finding two corresponding x and y values for the
objective function. At any point along this line, the mix of cakes and cookies will provide the same total contribution,
C.
Since each cake provides a contribution of \$260 and each cookie provides a contribution of \$175, the objective
function has been defined as C = 26x + 175y. This means that the total contribution will be however many cakes
are made (represented by x) at \$260 each plus however many cookies are made (represented by y) at \$175 each.
The area 0ABCD is called the feasible region. Any point within this region could be selected and would show a feasible
mix of production of cakes and cookies. However, in order to maximise profit, the optimum production mix will be at a
point on the edge of the feasible region, not within it.
(ii) The further the iso-contribution line is moved away from the origin, 0, the greater the contribution generated will be.
Therefore, a ruler will be laid along the line, making sure it stays at exactly the same angle as the line, and the ruler will
then be moved outwards to the furthest vertex (intersection between two constraints) on the feasible region, as
represented by either point A, B, C or D. In this case, the optimum point is C, the intersection of the labour constraint
and the demand for cakes constraint.
(iii) A slack value could arise either in relation to a resource or in relation to production of a product. It means that a resource
is not being fully utilised or that there is unfulfilled demand of a product. Since the optimum point is the intersection of
the labour and the demand for cakes lines, this means that there will be three slack values. First, there will be a slack
value for cookies. This means that there will be unsatisfied demand for cookies since the optimum point does not reach
as far as the demand for cookies line on the graph. Also, there will be slack values for Betta and Singa, which means
that both of these materials are not actually the binding constraints, such that there will be more material available than
is needed.

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Fundamentals Level Skills Module, Paper F5
Performance Management March/June 2016 Sample Answers

Section B

1 (a) Batches Units Price Total Variable cost Total variable Fixed costs Total Profit
per unit revenue per unit costs cost
\$ \$ \$ \$ \$ \$ \$
1 1,000 20 20,000 1000 10,000 10,000 20,000 0
2 2,000 18 36,000 880 17,600 10,000 27,600 8,400
3 3,000 16 48,000 780 23,400 12,000 35,400 12,600
4 4,000 13 52,000 640 25,600 12,000 37,600 14,400
5 5,000 12 60,000 640 32,000 14,000 46,000 14,000
Therefore Jewel Co should import and sell four batches (4,000 units) of headphones since at this point it will make the
greatest profit: \$14,400 for the month.

(b) The algebraic model requires several assumptions to be true. First, there must be a consistent relationship between price (P)
and demand (Q), so that a demand equation can be established, usually in the form P = a bQ. Here, although there is a
clear relationship between the two, it is not a perfectly linear relationship and so more complicated techniques are required
to calculate the demand equation. It also cannot be assumed that a linear relationship will hold for all values of P and Q other
than the five given.
Similarly, there must be a clear relationship between demand and marginal cost, usually satisfied by constant variable cost
per unit and constant fixed costs. The changing variable costs per unit again complicate the issue, but it is the changes in
fixed costs which make the algebraic method less useful in Jewels case.
The algebraic model is only suitable for companies operating in a monopoly and it is not clear here whether this is the case,
but it seems unlikely, so any optimum price might become irrelevant if Jewels competitors charge significantly lower prices.
Other more general factors not considered by the algebraic model are political factors which might affect imports, social factors
which may affect customer tastes and economic factors which may affect exchange rates or customer spending power. The
reliability of the estimates themselves for sales prices, variable costs and fixed costs could also be called into question.

2 (a) The breakeven sales revenue for Swim Co is \$90,000. The companys profit, to the nearest \$10,000, if 500 athletes attend
the course is \$20,000 (\$140,000 \$120,000). (From the graph, it is clear that the precise amount will be nearer \$17,000,
i.e. \$140,000 approximately \$123,000.)

## (b) Cost structure

From the chart, it is clear that Line C represents fixed costs, Line B represents total costs and Line A represents total revenue.
Line C shows that initially, fixed costs are \$20,000 even if no athletes attend the course. This level of fixed costs remains the
same if 100 athletes attend but once the number of attendees increases above this level, fixed costs increase to \$40,000.
Line B represents total costs. If 100 athletes attend, total costs are \$40,000 (\$400 per athlete). Since \$20,000 of this relates
to fixed costs, the variable cost per athlete must be \$200. When fixed costs step up beyond this point at the level of 200
athletes, total costs obviously increase as well and Line B consequently gets much steeper. However, since there are now
200 athletes to absorb the fixed costs, the cost per athlete remains the same at \$400 per athlete (\$80,000/200), even
though fixed costs have doubled.
If 300 athletes attend the course, total cost per athlete becomes \$300 each (\$90,000/300). Since fixed costs account for
\$40,000 of this total cost, variable costs total \$50,000, i.e. \$16667 per athlete. So, economies of scale arise at this level,
as demonstrated by the fact that Line B becomes flatter.
At 400 athletes, the gradient of the total costs line is unchanged from 300 athletes which indicates that the variable costs
have remained the same. There is no further change at 500 athletes; fixed and variable costs remain steady.
Revenue structure
As regards the revenue structure, it can be seen from Line A that for 100400 athletes the price remains the same at \$300
per athlete. However, if 500 athletes attend, the price has been reduced as the total revenue line becomes flatter.
\$140,000/500 means that the price has gone down to \$280 per athlete. This was obviously necessary to increase the
number of attendees and at this point, profit is maximised.

11
3 Total sales revenue = (280,000 x \$55) + (420,000 x \$45) = \$154m + 189m = \$343m.
\$000
Less costs:
Development and design costs 5,600
Patent application costs (including \$20k) 500
Patent renewal costs 2 years 400
Opportunity cost ignore
Total material costs [(280,000 x \$16) + (420,000 x \$14)] 10,360
Total labour costs [(280,000 x \$8) + (420,000 x \$7)] 5,180
Fixed production overheads 3,800
Marketing costs (working 1) 4,680
Selling and distribution costs 1,500
Environmental costs 250

Total life cycle costs 32,270

Expected profit = \$203m
Note
The expected profit has been calculated using life cycle costing not relevant costing. Hence, the \$20,000 salary cost included in
patent costs should be included in the life cycle cost. Similarly, the opportunity cost of \$800,000 is not included using life cycle
costing whereas if relevant costing was being used to decide on a particular course of action, the opportunity cost would be
included.
Working 1
Expected marketing cost in year 1: (02 x \$22m) + (05 x \$26m) + (03 x \$29m) = \$261m
Expected marketing cost year 2: (03 x \$18m) + (04 x \$21m) + (03 x \$23m) = \$207m
Total expected marketing cost = \$468m

## 4 (a) Maximising group profit

Division L has enough capacity to supply both Division M and its external customers with component L.
Therefore, incremental cost of Division M buying externally is as follows:
Cost per unit of component L when bought from external supplier: \$37
Cost per unit for Division L of making component L: \$20.
Therefore incremental cost to group of each unit of component L being bought in by Division M rather than transferred
internally: \$17 (\$37 20).
From the groups point of view, the most profitable course of action is therefore that all 120,000 units of component L should
be transferred internally.

## (b) Calculating total group profit

Total group profits will be as follows:
Division L:
Contribution earned per transferred component = \$40 \$20 = \$20
Profit earned per component sold externally = \$40 \$24 = \$16
\$
120,000 x \$20 2,400,000
160,000 x \$16 2,560,000

4,960,000
Less fixed costs (500,000)

Profit 4,460,000

Division M:
Profit earned per component sold externally = \$27 \$1 = \$26
\$
120,000 x \$26 3,120,000
Less fixed costs (200,000)

Profit 2,920,000

Total profit 7,380,000

12
(c) Problems with current transfer price and suggested alternative
The problem is that the current transfer price of \$40 per unit is now too high. Whilst this has not been a problem before since
external suppliers were charging \$42 per unit, it is a problem now that Division M has been offered component L for
\$37 per unit. If Division M now acts in its own interests rather than the interests of the group as a whole, it will buy
component L from the external supplier rather than from Division L. This will mean that the profits of the group will fall
substantially and Division L will have significant unused capacity.
Consequently, Division L needs to reduce its price. The current price does not reflect the fact that there are no selling and
distribution costs associated with transferring internally, i.e. the cost of selling internally is \$4 less for Division L than selling
externally. So, it could reduce the price to \$36 and still make the same profit on these sales as on its external sales. This
would therefore be the suggested transfer price so that Division M is still saving \$1 per unit compared to the external price.
A transfer price of \$37 would also presumably be acceptable to Division M since this is the same as the external supplier is
offering.

## 5 (a) Basic variances

Labour rate variance
Standard cost of labour per hour = \$42/3 = \$14 per hour.
Labour rate variance = (actual hours paid x actual rate) (actual hours paid x std rate)
Actual hours paid x actual rate = \$531,930.
Actual hours paid x std rate = 37,000 x \$14 = \$518,000.
Therefore rate variance = \$531,930 \$518,000 = \$13,930 A
Labour efficiency variance
Labour efficiency variance = (actual production in std hours actual hours worked) x std rate
[(12,600 x 3) 37,000] x \$14 = \$11,200 F

## (b) Planning and operational variances

Labour rate planning variance
(Revised rate std rate) x actual hours paid = [\$1400 (\$1400 x 102)] x 37,000 = \$10,360 A.
Labour rate operational variance
Revised rate x actual hours paid = \$1428 x 37,000 = \$528,360.
Actual cost = \$531,930.
Variance = \$3,570 A.
Labour efficiency planning variance
(Standard hours for actual production revised hours for actual production) x std rate
Revised hours for each pair of gloves = 325 hours.
[37,800 (12,600 x 325)] x \$14 = \$44,100 A.
Labour efficiency operational variance
(Revised hours for actual production actual hours for actual production) x std rate
(40,950 37,000) x \$14 = \$55,300 F.

## (c) Analysis of performance

At a first glance, performance looks mixed because the total labour rate variance is adverse and the total labour efficiency
variance is favourable. However, the operational and planning variances provide a lot more detail on how these variances
have occurred.
The production manager should only be held accountable for variances which he can control. This means that he should only
be held accountable for the operational variances. When these operational variances are looked at it can be seen that the
labour rate operational variance is \$3,570 A. This means that the production manager did have to pay for some overtime in
order to meet demand but the majority of the total labour rate variance is driven by the failure to update the standard for the
pay rise that was applied at the start of the last quarter. The overtime rate would also have been impacted by that pay
increase.
Then, when the labour efficiency operational variance is looked at, it is actually \$55,300 F. This shows that the production
manager has managed his department well with workers completing production more quickly than would have been expected
when the new design change is taken into account. The total operating variances are therefore \$51,730 F and so overall
performance is good.
The adverse planning variances of \$10,360 and \$44,100 do not reflect on the performance of the production manager and
can therefore be ignored here.

13
Fundamentals Level Skills Module, Paper F5
Performance Management September/December 2015 Answers

Section B

## 1 (a) Target costing steps

Deriving a target cost
Step 1: A product or service is developed which is perceived to be needed by customers and therefore will attract adequate
sales volumes.
Step 2: A target price is then set based on the customers perceived value of the product. This will therefore be a market based
price.
Step 3: The required target operating profit per unit is then calculated. This may be based on either return on sales or return
on investment.
Step 4: The target cost is derived by subtracting the target profit from the target price.
Step 5: If there is a cost gap, attempts will be made to close the gap. Techniques such as value engineering may be
performed, which looks at every aspect of the value chain business functions with an objective of reducing costs while
satisfying customer needs.
Step 6: Negotiation with customers may take place before deciding whether to go ahead with the project.

(b) Application at C Co
Difficulties in implementation
C Co is a service company and in service companies, it is often more difficult to find a precise definition for some of the
services. In order for target costing to be useful, it is necessary to define the service being provided. C Co actually
provides a range of services to clients including specialist care wards at hospitals. This means that the definition of the
services being provided will vary. Different target costs will need to be derived for the different services provided.
C Co has two types of clients: regular clients and one-off clients. Since the service for regular clients is being repeated,
it should be relatively easy to set a target cost for these jobs. However, for the one-off jobs, there may not be any
comparative data available and therefore setting the target cost will be difficult.
Similarly, some of the work available is very specialist. For example, cleaning restaurants and kitchens after an outbreak
of food poisoning will require specialist techniques and adherence to a set of regulations with which C Co may not be
familiar. It may be difficult to establish the market price for a service like this, thus making it difficult to derive a target
cost.
Benefits to C Co
Target costing is useful in competitive markets where a company is not dominant in the market and therefore has to
accept a market price for their products. C Co is operating in a competitive market and whilst the service offered by
C Co is more specialist, it is clear from the recent drop in sales that price increases do lead to loss of customers. C Co
cannot therefore ignore the market price for cleaning services and simply pass on cost increases as it has done. Target
costing would therefore help C Co to focus on the market price of similar services provided by competitors, where this
information is available.
If after calculating a target cost C Co finds that a cost gap exists, it will then be forced to examine its internal processes
and costs more closely. It should establish why the prices of the products it uses have increased in the first place. If it
cannot achieve any reduction in these prices, it should consider whether it can source cheaper non-chemical products
from alternative suppliers. So, target costing will benefit C Co by helping it to focus on cost reduction and consequently
customer retention.
Note: More points could be made and would earn marks.

2 (a) Calculations
Bus: (04 x 067) + (032 x 08) + (028 x 082) = 7536%
Prime: (04 x 058) + (032 x 076) + (028 x 083) = 7076%
Express: (04 x 067) + (032 x 076) + (028 x 089) = 7604%

## (b) Accuracy of statement

The MDs statement says that Bus Cos customers are the most satisfied of any national bus operator. However, this is not
quite the case since, when the overall satisfaction levels are calculated, Expresss level is 7604% compared to Bus Cos
7536%. So, the first part of the MDs statement is untrue.
The MD then goes on to say that Bus Co is leading the way on what matters most to customers value for money and
punctuality. Given the weightings attached to these two criteria, it appears true to say that these are the factors which matter

11
most to customers. Similarly, it is true to say that Bus Co is leading as regards punctuality, being 4 percentage points ahead
of Prime and Express on this criterion. However, given that Express also has the same level of satisfaction as regards offering
value for money, Bus Co is only leading ahead of Prime on this criterion, not ahead of Express. Therefore, whilst it can say
that it is the leader on punctuality, it can only say that it is the joint leader on value for money.

(c) VFM
Efficiency focuses on the relationship between inputs and outputs, considering whether the maximum output is being
achieved for the resources used.
Performance measure:
Occupancy rate of buses
Utilisation rate for buses (utilisation rate = hours on the road/total hours available)
Utilisation rate for drivers
(Many others could be given too but only one was asked for.)
Effectiveness focuses on the relationship between an organisations objectives and outputs, considering whether the
objectives are being met.
Possible performance measures:
Percentage of customers satisfied with cleanliness of buses
Percentage of carbon emissions relative to target set
(Many others could be given too but only one was asked for.)

## 3 (a) Variance calculations

Mix variance
Per question, total g of materials per standard batch = 610 g.
Therefore standard quantity to produce 950 units = 950 x 610 g = 5795 kg
Per question, actual total kg of materials used to produce 950 units = 5705 kg
Material Actual quantity Actual quantity Variance Standard Variance
in standard mix in actual mix cost per kg
kg kg kg \$ \$
White flour 5705 x 450/610 = 42086 4085 1236 180 2225
Wholegrain flour 5705 x 150/610 = 14029 152 (1171) 220 (2576)
Yeast 5705 x 10/610 = 935 10 (065) 20 (13)

5705 5705 205 (1651)A

Yield variance
Material Standard quantity Actual quantity Variance Standard Variance
in standard mix in standard mix cost per kg
kg kg kg \$ \$
White flour 450/610 x 5795 = 4275 42086 664 180 1195
Wholegrain flour 150/610 x 5795 = 1425 14029 221 220 486
Yeast 10/610 x 5795 = 95 935 015 20 3

5795 5705 1981F

Alternative yield calculation
5705 kg should yield ( 061 kg) = 93525 loaves
5705 kg did yield = 950 loaves
Difference = 1475 F
Valued at standard material cost = 1475F x \$134 = \$1977F

## (b) Material yield variance

Three reasons why an adverse material yield variance may arise:
The mix may not be removed completely out of the machine, leaving some mix behind.
Since the loaves are made by hand, they may be made slightly too large, meaning that fewer loaves can be baked.
Errors or changes in the mix may cause some loaves to be sub-standard and therefore rejected by the quality inspector.
The loaves might be baked at the wrong temperature and therefore be rejected by the quality inspector.
Note: Many more reasons could be given.

12
4 (a) Weighted average C/S ratio
Weighted average contribution to sales ratio (WA C/S ratio) = total contribution/total sales revenue.
Per unit: T C R
\$ \$ \$ \$ \$ \$
Selling price 1,600 1,800 1,400
Material (430) (500) (360)
Variable labour (40%) (88) (96) (76)
Variable overheads (110) (120) (95)

Total variable costs (628) (716) (531)

Contribution 972 1,084 869

Sales units 420 400 380
Total sales revenue \$672,000 \$720,000 \$532,000
Total contribution \$408,240 \$433,600 \$330,220
WA C/S ratio = (\$408,240 + \$433,600 + \$330,220)/(\$672,000 + \$720,000 + \$532,000)
= \$1,172,060/\$1,924,000 = 6092%.

## (b) Margin of safety

Margin of safety = budgeted sales breakeven sales
Budgeted sales revenue = \$1,924,000
Fixed labour costs = {(420 x \$220) + (400 x \$240) + (380 x \$190)} x 06 = \$156,360k.
Therefore total fixed costs = \$156,360 + \$55,000 = \$211,360.
Breakeven sales revenue = fixed costs/weighted average C/S ratio
= \$211,360/6092% = \$346,947
Therefore margin of safety = \$1,924,000 \$346,947 = \$1,577,053.

13
(c) Multi-product breakeven chart

2,500

2,000
Costs and revenues \$000

1,500

Total revenue

1,000
Total costs

500

BEP

Fixed costs

0
0 200 400 600 800 1,000 1,200 1,400
Sales units

Workings
Total revenue = \$1,924,000
Total variable costs = \$1,924,000 \$1,172,060 = \$751,940
Therefore total costs = \$211,360 + \$751,940 = \$963,300

## (d) BEP if products sold in order of profitability

If the more profitable products are sold first, this means that the company will cover its fixed costs more quickly. Consequently,
the breakeven point will be reached earlier, i.e. fewer sales will need to be made in order to break even. So, the breakeven
point will be lower.

5 (a) Division F
Controllable profit = \$2,645k.
Total assets less trade payables = \$9,760k + \$2,480k \$2,960k = \$9,280k.
ROI = 285%.
Division N
Controllable profit = \$1,970k.
Total assets less trade payables = \$14,980k + \$3,260k \$1,400k = \$16,840k.
ROI = 117%.
In both calculations controllable profit has been used to reflect profit, rather than net profit. This is because the managers do
not have any control over the Head Office costs and responsibility accounting deems that managers should only be held
responsible for costs which they control. The same principle is being applied in the choice of assets figures being used. The
current assets and current liabilities figures have been taken into account in the calculation because of the fact that the
managers have full control over both of these.

14
Fundamentals Level Skills Module, Paper F5
Performance Management June 2015 Answers

Section A

1 C
Divisional profit before depreciation = \$27m x 15% = \$405,000 per annum.
Less depreciation = \$27m x 1/50 = \$54,000 per annum.
Divisional profit after depreciation = \$351,000
Imputed interest = \$27m x 7% = \$189,000
Residual income = \$162,000.

2 D
Option (ii) is not relevant since it is a common cost.

3 C
A target cost is arrived at by identifying the market price of a product and then subtracting a desired profit margin from it.

4 C
The maximum regret at each supply level is as follows:
At 325: \$142
At 350: \$90
At 375: \$82
At 400: \$120
The minimum of these is \$82 at 375, therefore the answer is C.

5 A
Statement (ii) describes an enterprise resource planning system, not an executive information system.

6 B
The method of apportioning general fixed costs is not required to calculate the break-even sales revenue.

7 C
All of the others are internal sources of information.

8 D
Statement (ii) is wrong as it reflects the common misconception that the shadow price is the maximum price which should be paid,
rather than the maximum extra over the current purchase price.
Statement (iii) is wrong but could be thought to be correct if (ii) was wrongly assumed to be correct.

9 B
\$320 \$80/(6/60) = \$2,400

10 B
ROCE can be calculated by multiplying the operating profit margin and the asset turnover.
28% x 65% = 182%

17
11 C
Labour hours per unit 1 2 11
\$ \$ \$
Profit per unit 44 51 26
Add back fixed costs 6 9 12
Contribution per unit 50 60 38
Contribution per labour hour 50 30 3455
Ranking 1st 3rd 2nd

12 B
All of the statements are false except statement (iii).

13 D
The first statement is wrong because customers are actually paying more quickly.
The second statement is wrong because inventory levels have increased.

14 A
Planning variance = (\$380 \$5) x 10,000 = \$12,000 A

15 A
The sales quantity contribution variance is calculated as follows:
Actual sales Standard sales Difference Standard Variance
units in std mix units in std mix in units contribution
Product A 16,020 15,840 180F \$12 \$2,160F
Product B 10,680 10,560 120F \$13 \$1,560F

Total \$3,720F

16 C
The learning rate was actually better than expected and only (i) could cause it to improve.

17 A
This is the correct option as environment-driven costs are allocated to general overheads, not joint cost centres.

18 A
The first statement is incorrect as the difference between actual quantity in standard mix and the actual quantity in the actual mix
is valued at the standard cost per kg, not the actual cost.
The second statement is incorrect as that is the definition of the yield variance.

19 A
Working
Opening capital employed: \$4m + \$05m = \$45m
Closing capital employed: (\$4m x 09) + (\$05 x 12) = \$36m + \$06 = \$42m
Average capital employed = \$435m
Profit after depreciation = \$12m
Therefore ROI = \$12m/\$435m = 2759%

20 A
The first statement is correct as throughput accounting discourages production for inventory purposes and is often used in a just
in time environment.
The second statement is incorrect as in throughput accounting it is the bottleneck resource which should be 100% efficient which
actually may mean unused capacity elsewhere.

18
Section B

## Annual activity per cost driver

Procedure A B Total
No. of procedures 14,600 22,400 37,000
Admin. time per procedure (hours) 14,600 33,600 48,200
Patient hours 350,400 1,075,200 1,425,600
Number of meals 14,600 89,600 104,200
Cost driver rates
Administrative costs \$1,870,160/48,200 = \$3880 per admin hour
Nursing costs \$6,215,616/1,425,600 = \$436 per patient hour
Catering costs \$966,976/104,200 = \$928 per meal
General facility costs \$8,553,600/1,425,600 = \$6 per patient hour
Overhead allocation per procedure
Procedure
A B
Administrative costs 3880 5820
Nursing costs 10464 20928
Catering costs 928 3712
General facility costs 14400 28800

29672 59260

Surgical 1,200 2,640
Anaesthesia 800 1,620

Total cost per procedure 2,29672 4,85260

(b) When activity-based costing (ABC) is used as in (a) above, the cost for Procedure A is approximately \$2,297 as compared
to the approximate \$2,476 currently calculated by BH. For Procedure B, the cost using ABC is approximately \$4,853 as
compared to the approximate current cost of \$4,736. Hence, the cost of Procedure A goes down using ABC and the cost of
Procedure B goes up. This reflects the fact that the largest proportion of the overhead costs is the nursing and general facility
costs. Both of these are driven by the number of patient hours for each procedure. Procedure B has twice as many patient
hours as Procedure A. Whilst this is not taken into account when the overheads are simply being divided by the number of
procedures and allocated to each product, it would be if ABC were adopted instead. Hence, the allocation of costs would
more fairly reflect the use of resources driving the overheads.
However, ABC can be a lot of work to implement, and whilst the comparative costs are different, they are not significantly
different. Given that ABC is costly to implement, it may be that a similar allocation in overheads can be achieved simply by
using a fairer basis to absorb the costs. If patient hours are used as the basis of absorption instead of simply dividing the
overheads by the number of procedures, the costs for Procedures A and B would be \$2,296 and \$4,853 (W1). Hence, the
same result can be achieved without going to all of the time and expense of using ABC. Therefore BH should not adopt ABC
but use this more accurate basis of absorbing overheads instead.
Working 1
\$17,606,352/1,425,600 hours = \$1235 per hour.
Therefore absorption cost for A = \$1,200 + \$800 + (24 x \$1235) = \$2,296.
Same calculation for B but with 48 hours instead.

2 Mobe Co

## From the groups perspective

For every motor sold externally, Division M generates a profit of \$80 (\$850 \$770) for the group as a whole. For every motor
which Division S has to buy from outside of the group, there is an incremental cost of \$60 per unit (\$800 [\$770 \$30]).
Therefore, from a group perspective, as many external sales should be made as possible before any internal sales are made.
Consequently, the groups current policy will need to be changed. This does, however, assume that the quality of the motors bought
from outside the group is the same as the quality of the motors made by Division M.
Division Ms total capacity is 60,000 units. Given that it can make external sales of 30,000 units, it can only supply 30,000 of
Division Ss demand for 35,000 motors. These 30,000 units should be bought from Division M since, from a group perspective,
the cost of supplying these internally is \$60 per unit cheaper than buying externally. The remaining 5,000 motors required by
Division S should then be bought in from the external supplier at \$800 per unit. .
In order to work out the transfer price which should be set for the internal sales of 30,000 motors, the perspective of both divisions
must be considered.

19
From Division Ms perspective
Division Ms only buyer for these 30,000 motors is Division S, so the lowest price it would be prepared to charge is the marginal
cost of making these units, which is \$740 per unit. However, it would ideally want to make some profit on these motors too and
would consequently expect a significantly higher price than this.
From Division Ss perspective
Division S knows that it can buy as many external motors as it needs from outside the group at a price of \$800 per unit. Therefore,
this will be the maximum price which it is prepared to pay.
Overall
Therefore, the transfer price should be set somewhere between \$740 and \$800. From the perspective of the group, the total group
profit will be the same irrespective of where in this range the transfer price is set. However, it is important that divisional managers
and staff remain motivated. Given the external sales price which Division M can achieve and the fact that Division S would have
to pay \$800 for each motor bought from outside the group, the transfer price should probably be at the higher end of the range.

3 Bokco

## (a) Planning and operational variances

Revised hours for actual production:
Cumulative time per hour for 460 units is calculated by using the learning curve formula: Y = axb
a=7
x = 460
b = 01520
Therefore y = 7 x 460 01520 = 27565054
Therefore revised time for 460 units = 1,268 hours.
Labour efficiency planning variance
(Standard hours for actual production revised hours for actual production) x std rate
= ([460 x 7] 1,268) x \$12 = \$23,424F
Labour efficiency operational variance
(Revised hours for actual production actual hours for actual production) x std rate
(1,268 1,860) x \$12 = \$7,104A

## (b) Consequences of failure to anticipate learning effect

The likely consequences are as follows:
Bokco will have hired too many temporary staff because of the fact that the new product can actually be produced more
quickly than originally thought. Given that these staff are hired on three-month contracts, Bokco will presumably have
to pay the staff for the full three months even if all of them are not needed. This will be a significant and unnecessary
cost to the business.
Since production is actually happening more quickly than anticipated, the company may well have run out of raw
materials, leading to a stop in production. Idle time is a waste of resources and costs money.
If there have been stockouts, the buying department may have incurred additional costs for expedited deliveries or may
have been forced to use more expensive suppliers. This would have made the material price variance adverse and
negatively affected the buying departments manager bonus, which would have a demotivational effect on him.
Since Bokco uses cost plus pricing for its products, the price for the product will have been set too high. This means
that sales volumes may well have been lower than they otherwise might have been, leading to lost revenue for the
company and maybe even failure of the new product launch altogether. This will continue to be the case for the next
two months unless the price review is moved forward.
The sales manager will be held responsible for the poorer sales of the product, which will probably be reflected in an
adverse sales volume variance. This means that he may lose his bonus through no fault of his own. This will have a
demotivational effect on him.
Note: Other valid points could be made too.

4 ALG Co

## (a) Variable cost per unit

Material cost = \$2,400,000/200,000 = \$12 per unit.
Labour cost = \$1,200,000/200,000 = \$6 per unit.
Variable overhead cost using high-low method: (\$1,850,000 \$1,400,000)/(350,000 200,000) = \$3 per unit.
Therefore total variable cost per unit = \$21.
Fixed costs = \$1,400,000 (200,000 x \$3) = \$800,000

20
(b) Optimum price
Find the demand function
Demand function is P = a bx, where P = price and x = quantity, therefore find a value for a and b firstly.
B = P/Q = 2/2,000 = 0001 (ignore the minus sign as it is already reflected in the formula P = a bx.)
Therefore P = a 0001x
Find value for a by substituting in the known price and demand relationship from the question, matching p and x
accordingly.
60 = a (0001 x 250,000)
60 = a 250
310 = a
Therefore P = 310 0001x.
Identify MC
MC = \$21 calculated in (a)
State MR
MR = 310 0002x
Equate MC and MR to find x
21 = 310 0002x
0002x = 289
x = 144,500
Substitute x into demand function to find P
P = 310 (0001 x 144,500)
P = \$16550
Calculate profit
Sales revenue = 144,500 x \$16550 = \$23,914,750
Variable overheads = 144,500 x \$21 = \$3,034,500
Fixed overheads = \$800,000
Therefore profit = \$20,080,250

## (c) Market skimming

As the sales director suggests, market skimming is a strategy which initially charges high prices for the product in order to
take advantage of those buyers who want to buy it as soon as possible, and are prepared to pay high prices in order to do
so.
If certain conditions exist, the strategy could be a suitable one for ALG Co. The conditions are as follows:
Where a product is new and different, so that customers are prepared to pay high prices in order to gain the perceived
status of owning the product early. All we know about ALG Cos product is that it is innovative, so it may well meet this
condition.
Where products have a short life cycle this strategy is more likely to be used, because of the need to recover development
costs and make a profit quickly. ALG Cos product does only have a three-year life cycle, which does make it fairly short.
Where high prices in the early stages of a products life cycle are expected to generate high initial cash inflows. If this
is the case here, then skimming would be useful to help ALG Co cover the high initial development costs which it has
incurred.
Where barriers to entry exist, which deter other competitors from entering the market; as otherwise, they will be enticed
by the high prices being charged. These might include prohibitively high investment costs, patent protection or unusually
strong brand loyalty. According to the information we have been given, high development costs were involved in this
case, which would be a barrier to entry.
Where demand and sensitivity of demand to price are unknown. In ALG Cos case, market research has been carried
out to establish a price. However, this information is based on the launch of similar but not identical products, so it is
not really known just how accurate it will be.
It is not possible to say for definite whether this pricing strategy would be suitable for ALG Co, because of the limited
information available. However, it could always be launched at a higher price initially to see what demand is. It is far easier
to lower a price after launch than to raise it. The optimum pricing approach in (b) above is based on a set of assumptions
which do not hold true in the real world. Also, as the data is derived from similar but not identical products, it may not hold
true for this particular product.

21
5 (a) Main steps
1. Activities are identified by managers. Managers are then forced to consider different ways of performing the activities.
These activities are then described in what is called a decision package, which:
analyses the cost of the activity;
states its purpose;
identifies alternative methods of achieving the same purpose;
establishes performance measures for the activity;
assesses the consequence of not performing the activity at all or of performing it at different levels.
As regards this last point, the decision package may be prepared at the base level, representing the minimum level of
service or support needed to achieve the organisations objectives. Further incremental packages may then be prepared
to reflect a higher level of service or support.
2. Management will then rank all the packages in the order of decreasing benefits to the organisation. This will help
management decide what to spend and where to spend it. This ranking of the decision packages happens at numerous
levels of the organisation.
3. The resources are then allocated based on order of priority up to the spending level available.

## (b) Potential problems

At present, the LRA finds itself facing particularly difficult circumstances. The fires and the floods have meant that urgent
expenditure is now needed on schools, roads and hospitals which would not have been required if these environmental
problems had not occurred. Lesting is facing a crisis situation and the main question is therefore whether this is a good time
to introduce anything new at the LRA when it already faces so many challenges.
The introduction of ZBB in any organisation is difficult at any time because of the fact that the process requires far more skills
than, for example, incremental budgeting. Managers would definitely need some specialist training as they simply will not
have the skills which they would need in order to construct decision packages. This then would have further implications in
terms of time and cost, and, at the moment, both of these are more limited than ever for the LRA. When so many costs are
being faced by the LRA, can it really consider spending money on training staff to prepare and evaluate decision packages?
Given that the budget needs preparing imminently as the new financial year is approaching, it is really too late to start training
staff. With ZBB, the whole budgeting process becomes a lot more cumbersome as it has to be started from scratch. There is
a lot of paperwork involved and the whole process of identifying decision packages and determining their costs and benefits
is extremely time-consuming. There are often too many decision packages to evaluate and there is frequently insufficient
information for them to be ranked. The LRA provides a wide range of services and it is therefore obvious that this would be
a really lengthy and costly process to introduce. At the moment, some residents are homeless and several schools have been
damaged by fire. How can one rank one as more important than the other when both are equally important for the
community? Sometimes, the information needed in order to rank them simply will not be available, or managers will not feel
able to assimilate it properly.
Another problem with ZBB is that it can cause conflict to arise as departments compete for the resources available. Since
expenditure is urgently required for schools, roads and hospitals, it is likely that these would be ranked above expenditure on
the recycling scheme. In fact, the final phase of the scheme may well be postponed. This is likely to cause conflict between
departments as those staff and managers involved in the recycling scheme will be disappointed if the final phase has to be
postponed.

## (c) The potential benefits

ZBB will respond to changes in the economic environment since the budget starts from scratch each year and takes into
account the environment at that time. This is particularly relevant this year after the fires and the floods. Without ZBB,
adequate consideration may not be given to whether the waste management scheme should continue but, if ZBB is
used, the scheme will probably be postponed as it is unlikely to rank as high as expenditure needed for schools, housing
and hospitals.
If any of the activities or operations at LRA are wasteful, ZBB should be able to identify these and remove them. This is
particularly important now when the LRA faces so many demands on its resources.
Managers may become more motivated as they have had a key role in putting the budget together.
It encourages a more questioning attitude rather than just accepting the status quo.
Overall, it leads to a more efficient allocation of resources.
All of the organisations activities and operations are reviewed in depth.
ZBB focuses attention on outputs in relation to value for money. This is particularly important in the public sector where
the 3 Es (economy, efficiency and effectiveness) are often used to measure performance.
Note: Only three were required.

22
Fundamentals Level Skills Module, Paper F5
Performance Management December 2014 Answers

Section A

1 A
Division A: Profit = \$144m x 30% = \$432m
Imputed interest charge = \$326m x 10% = \$326m
Residual income = \$106m
Division B: Profit = 88m x 24% = \$2112m
Imputed interest charge = \$222m x 10% = \$222m
Residual income = \$(0108)m

2 D

3 A

4 B

5 C
Number of units required to make target profit = fixed costs + target profit/contribution per unit of P1.
Fixed costs = (\$12 x 10,000) + (\$1 x 12,500) \$2,500 = \$22,000.
Contribution per unit of P = \$320 + \$120 = \$440.
(\$22,000 + \$60,000)/\$440 = 18,636 units.

6 A
Product A B C D
Selling price per unit \$160 \$214 \$100 \$140
Raw material cost \$24 \$56 \$22 \$40
Direct labour cost at \$11 per hour \$66 \$88 \$33 \$22
Variable overhead cost \$24 \$18 \$24 \$18
Contribution per unit \$46 \$52 \$21 \$60

Direct labour hours per unit 6 8 3 2
Contribution per labour hour \$767 \$650 \$7 \$30
Rank 2 4 3 1
Normal monthly hours (total units x hours per unit) 1,800 1,000 720 800
If the strike goes ahead, only 2,160 labour hours will be available.
Therefore make all of D, then 1,360 hours worth of A (2,160 800 hrs).

7 B
460 400 = 60 clients
\$40,000 \$36,880 = \$3,120
VC per unit = \$3,120/60 = \$52
Therefore FC = \$40,000 (460 x \$52) = \$16,080

8 B
Increase in variable costs from buying in (2,200 units x \$40 (\$140 \$100)) = \$88,000
Less the specific fixed costs saved if A is shut down = (\$10,000)
Decrease in profit = \$78,000

9 A

17
10 B
By definition, a shadow price is the amount by which contribution will increase if an extra kg of material becomes available. 20 x
\$280 = \$56.

11 C

12 A

13 D

14 B

15 C

16 A

17 A
New profit figures before salary paid:
Good manager: \$180,000 x 13 = \$234,000
Average manager: \$180,000 x 12 = \$216,000
Poor: \$180,000 x 11 = \$198,000

EV of profits = (035 x \$234,000) + (045 x \$216,000) + (02 x \$198,000) = \$81,900 + \$97,200 + \$39,600 = \$218,700
Deduct salary cost and EV with manager = \$178,700
Therefore do not employ manager as profits will fall by \$1,300.

18 B
Set-up costs per production run = \$140,000/28 = \$5,000
Cost per inspection = \$80,000/8 = \$10,000
Other overhead costs per labour hour = \$96,000/48,000 = \$2
Overheads costs of product D:
\$
Set-up costs (15 x \$5,000) 75,000
Inspection costs (3 x \$10,000) 30,000
Other overheads (40,000 x \$2) 80,000

185,000

Overhead cost per unit = 185,000/4,000 = \$4625

19 A

20 A

18
Section B

1 Chair Co

## (a) Learning curve formula = y = axb

Cumulative average time per unit for 8 units:
Y = 12 x 8415
= 50628948 hours.
Therefore cumulative total time for 8 units = 40503158 hours.
Cumulative average time per unit for 7 units:
Y = 12 x 7415
= 53513771 hours.
Therefore cumulative total time for 7 units = 3745964 hours.
Therefore incremental time for 8th unit = 40503158 hours 3745964 hours = 3043518 hours.
Total labour cost for 8th unit =3043518 x \$15 = \$4565277
Material and overheads cost per unit = \$230
Therefore total cost per unit = \$27565277
Therefore price per unit = \$41347915

## (b) (i) Actual learning rate

Cumulative number of Cumulative total Cumulative average
seats produced hours hours per unit
1 125 125
2 ? 125 x r
4 ? 125 x r2
8 343 125 x r3
Using algebra: 343 = 8 x (125 x r3)
42875 = (125 x r3)
0343 = r3
r = 070
The learning effect was 70% as compared to the forecast rate of 75%, meaning that the labour force learnt more quickly
than anticipated.
The adjusted price charged will be lower than the original price calculated in part (a). This is because the incremental
cost of the 8th unit will be lower given the 70% learning rate, even though the first unit took 125 hours. We know this
because we are told that the cumulative time for 8 units was actually 343 hours. This is lower than the estimated
cumulative time in part (a) for 8 units of 40503158 hours and therefore, logically, the actual incremental time for the
8th unit must be lower than the estimated 3043518 hours calculated in part (a). Consequently, total cost will be lower
and price will be lower, given that this is based on cost.

2 Glam Co

## (a) Bottleneck activity

The bottleneck may have been worked out as follows:
Total salon hours = 8 x 6 x 50 = 2,400 each year. The capacity for each senior stylist must be 2,400 hours, which equates
to 2,400 cuts each year (2,400/1). Since there are three senior stylists, the total capacity is 7,200 hours or 7,200 cuts each
year. Using this method, the capacity for each activity is as follows:
Cut Treatment
Assistants 48,000 16,000
Senior stylists 7,200 4,800
Junior stylists 9,600 9,600
The bottleneck activity is clearly the work performed by the senior stylists.
The senior stylists time is called a bottleneck activity because it is the activity which prevents the salons throughput from
being higher than it is. The total number of cuts or treatments which can be completed by the salons senior stylists is less
than the number which can be completed by other staff members, considering the number of each type of staff available and
the time required by each type of staff for each client.

19
(b) TPAR
Cut Treatment
\$ \$
Selling price 60 110
Materials 060 8 (740+06)
Throughput 5940 102
Throughput per bottleneck hour 5940 68
Total salon costs per BN hour (w1) 4256 4256
TPAR 14 16
Working 1: Total salon costs
(3 x \$40,000) + (2 x \$28,000) + (2 x \$12,000) + \$106,400 = \$306,400
Therefore cost for each bottleneck hour = \$306,400/7,200 = \$4256
Note: Answers based on total salary costs were \$80,000 were also equally acceptable since the wording of question was
open to interpretation.

3 Hi Life Co

## Direct materials: Note \$

Fabric 200 m2 at \$1750 per m2 1 3,500
Wood 20 m at \$820 per m 2 164
30 m at \$850 per m 2 255
Direct labour:
Skilled 50 hours at \$24 per hour 3 1,200
Semi-skilled 300 hours at \$14 per hour 4 4,200
Factory overheads 20 hours at \$15 per hour 5 300

Total cost 9,619

1 Since the material is in regular use by HL Co, it is replacement cost which is the relevant cost for the contract.
2 30 m will have to be ordered from the alternative supplier for immediate delivery but the remaining 20 m can be used from
inventory and replaced by an order from the usual supplier at a cost of \$820 per m.
3 There is no cost for the first 150 hours of labour because there is spare capacity. The remaining 50 hours will be paid at time
and a half, which is \$16 x 15, i.e. \$24 per hour.
4 HL Co will choose to use the agency workers, who will cost \$14 per hour, since this is cheaper than paying existing
semi-skilled workers at \$18 per hour (\$12 x 15) to work overtime.
5 None of the general factory costs are incremental, so they have all been excluded. However, the supervisors overtime pay is
incremental, so has been included. The supervisors normal salary, on the other hand, has been excluded because it is not
incremental.
6 These are general overheads and are not incremental, so no value should be included for them.

4 Jamair

## (a) The four perspectives

Financial perspective this perspective is concerned with how a company looks to its shareholders. How can it create value
for them? Kaplan and Norton identified three core financial themes which will drive the business strategy: revenue growth
and mix, cost reduction and asset utilisation.
Customer perspective this considers how the organisation appears to customers. The organisation should ask itself: to
achieve our vision, how should we appear to our customers? The customer perspective should identify the customer and
market segments in which the business will compete. There is a strong link between the customer perspective and the
revenue objectives in the financial perspective. If customer objectives are achieved, revenue objectives should be too.
Internal perspective this requires the organisation to ask itself: what must we excel at to achieve our financial and customer
objectives? It must identify the internal business processes which are critical to the implementation of the organisations
strategy. These will include the innovation process, the operations process and the post-sales process.
Learning and growth perspective this requires the organisation to ask itself whether it can continue to improve and create
value. The organisation must continue to invest in its infrastructure i.e. people, systems and organisational procedures in
order to improve the capabilities which will help the other three perspectives to be achieved.

20
(b) Goals and measures
Financial perspective
Goal Performance measure
To use fewer planes to transport customers Lease costs of plane per customer
Explanation operating efficiency will be driven by getting more customers on fewer planes. This goal and measure cover the
cost side of this.
Goal Performance measure
To increase seat revenue per plane Revenue per available passenger mile
Explanation this covers the first part of achieving operating efficiency by having fewer empty seats on planes.
Customer perspective
Goal Performance measure
To ensure that flights are on time On time arrival ranking from the aviation authority
Explanation Jamair is currently number 7 in the rankings. If it becomes known as a particularly reliable airline, customers
are more likely to use it, which will ultimately increase revenue.
Goal Performance measure
To reduce the number of flights cancelled The number of flights cancelled
Explanation again, if flights are seen to be cancelled frequently by Jamair, customers will not want to use it. It needs to be
perceived as reliable by its customers.
Internal perspective
Goal Performance measure
To improve turnaround time on the ground On the ground time
Explanation less time spent on the ground means fewer planes are needed, which will reduce plane leasing costs. However,
it is important not to compromise the quality of cleaning or make errors in refuelling as a consequence of reducing on the
ground time.
Goal Performance measure
To improve the cleanliness of Jamairs planes The percentage of customers happy with the standard of the planes,
as reported in the customer satisfaction surveys.
Explanation at present, only 85% of customers are happy with the standard of cleanliness on Jamairs planes. This could
be causing loss of revenue.
Goal Performance measure
To develop the online booking system Percentage downtime.
Explanation since the company relies entirely on the booking system for customer booking of flights and check-in, it is
critical that it can deal with the growing number of customers.
Learning perspective
Goal Performance measure
To reduce the employee absentee rate The number of days absent per employee
Explanation it is critical to Jamair that its workforce is reliable as, at worse, absent staff lead to cancelled flights.
Goal Performance measure
To increase ground crew training on cleaning and Number of days training per ground crew member
refuelling procedures
Explanation if ground crew are better trained, they can reduce the number of minutes that the plane stays on the ground,
which will result in fewer planes being required and therefore lower costs. Also, if their cleaning is better, customer satisfaction
and retention will increase.
Note: Only one goal and measure were required for each perspective. In order to gain full marks, answers had to be specific
to Jamair as stated in the requirements.

21
5 Safe Soap Co

## (a) Variance calculations

Mix variance
Total kg of materials per standard batch = 025 + 06 + 05 = 135 kg
Therefore standard quantity to produce 136,000 batches = 136,000 x 135 kg = 183,600 kg
Actual total kg of materials used to produce 136,000 batches = 34,080 + 83,232 + 64,200 = 181,512 kg
Material Actual quantity Actual quantity Variance Standard cost Variance
Standard mix Actual mix per kg
kgs kgs kgs \$ \$
Lye 181,512 x 025/135 = 33,61333 34,080 (46667) 10 (4,66670)
Coconut oil 181,512 x 06/135 = 80,672 83,232 (2,560) 4 (10,240)
Shea butter 181,512 x 05/135 = 67,22667 64,200 3,02667 3 9,08001

181,512 181,512 (5,82669)A

Yield variance
Material Standard quantity Actual quantity Variance Standard cost Variance
Standard mix Standard mix per kg
kgs kgs \$ \$
Lye 025 x 136,000 = 34,000 33,61333 38667 10 3,86670
Coconut oil 06 x 136,000 = 81,600 80,672 928 4 3,712
Shea butter 05 x 136,000 = 68,000 67,22667 77333 3 2,31999

183,600 181,512 9,89869F

(b) (i) A materials mix variance will occur when the actual mix of materials used in production is different from the standard
mix. So, it is inputs which are being considered. Since the total mix variance is adverse for the Safe Soap Co, this means
that the actual mix used in September and October was more expensive than the standard mix.
A material yield variance arises because the output which was achieved is different from the output which would have
been expected from the inputs. So, whereas the mix variance focuses on inputs, the yield variance focuses on outputs.
In both September and October, the yield variance was favourable, meaning that the inputs produced a higher level of
output than one would have expected.
(ii) Whilst the mix and yield variances provide Safe Soap Co with a certain level of information, they do not necessarily
explain any quality issues which arise because of the change in mix. The consequences of the change may well have
an impact on sales volumes. In Safe Soap Cos case, the sales volume variance is adverse, meaning that sales volumes
have fallen in October. It is not known whether they also fell in September but it would be usual for the effects on sales
of the change in mix to be slightly delayed, in this case by one month, given that it is only once the customers start
receiving the slightly altered soap that they may start expressing their dissatisfaction with the product.
There may also be other reasons for the adverse sales volume variance but given the customer complaints which have
been received, the sales managers views should be taken on board.

22
Fundamentals Level Skills Module, Paper F5
Performance Management June 2014 Answers

1 (a) Full budgeted production cost per unit using absorption costing
Product X Y Z Total
Budgeted annual production (units) 20,000 16,000 22,000
Labour hours per unit 25 3 2
Total labour hours 50,000 48,000 44,000 142,000
Overhead absorption rate = \$1,377,400/142,000 = \$970 per hour.
Product X Y Z
\$ per unit \$ per unit \$ per unit
Direct materials 25 28 22
Direct labour 30 36 24
Overhead (\$970 x 25/3/2) 2425 2910 1940

Full cost per unit 7925 9310 6540

(b) Full budgeted production cost per unit using activity based costing
Product X Y Z Total
Budgeted annual production (units) 20,000 16,000 22,000
Batch size 500 800 400
Number of batches (i.e. set ups) 40 20 55 115
Number of purchase orders per batch 4 5 4
Total number of orders 160 100 220 480
Machine hours per unit 15 125 14
Total machine hours 30,000 20,000 30,800 80,800
Cost driver rates:
Cost per machine set up \$280,000/115 = \$2,43478
Cost per order \$316,000/480 = \$65833
Cost per machine hour (\$420,000 + \$361,400)/80,800 = \$967
Allocation of overheads to each product:
Product X Y Z Total
\$ \$ \$
Machine set up costs 97,391 48,696 133,913 280,000
Material ordering costs 105,333 65,833 144,834 316,000
Machine running and facility costs 290,100 193,400 297,836 781,336*

Total 492,824 307,929 576,583 1,377,336

Number of units produced 20,000 16,000 22,000
Overhead cost per unit \$2464 \$1925 \$2621
Total cost per unit: \$ per unit \$ per unit \$ per unit
Direct materials 25 28 22
Direct labour 30 36 24
Overhead 2464 1925 2621

ABC cost per unit 7964 8325 7221

*A difference of \$64 arises here as compared to the cost pool total of \$781,400 because of rounding differences. This has
been ignored.

(c) When activity based costing is used, the cost for product X is very similar to that cost calculated using full absorption costing.
This means that the price for product X is likely to remain unchanged because cost plus pricing is being used. Demand for
product X is relatively elastic but since no change in price is expected, sales volumes are likely to remain the same if ABC is
introduced.
However, the cost for product Y is almost \$10 per unit less using ABC. This means that the price of product Y will go down
if cost plus pricing is used. Given that demand for product Y is also elastic, like demand for product X, a reduced selling price
is likely to give rise to increased sales volumes.
The cost of product Z is nearly \$7 per unit more using ABC and the price of product Z will therefore go up if ABC is used.
Given that demand for product Z is relatively inelastic, this means that sales volumes would be expected to be largely
unchanged despite an increase in price.

11
2 (a) Optimum production plan
Define the variables
Let x = number of units of Xeno to be produced.
Let y = number of units of Yong to be produced.
Let C = contribution.
State the objective function
C = 30x+ 40y
State the constraints
Build time: 24x + 20y 1,800,000
Program time: 16x + 14y 1,680,000
Test time: 10x + 4y 720,000
Non-negativity constraints:
x, y 0
Sales constraints
x 85,000
y 66,000
Draw the graph
Build time:
If x = 0, y = 1,800,000/20 = 90,000
If y = 0, x = 1,800,000/24 = 75,000
Program time:
If x = 0, y = 1,680,000/14 = 120,000
If y = 0, x = 1,680,000/16 = 105,000
Test time:
If x = 0, y = 720,000/4 = 180,000
If y = 0, x = 720,000/10 = 72,000
Solve using the iso-contribution line
If y = 40,000, C = 40,000 x \$40 = \$1,600,000
If C = \$1,600,000 and y = 0, x = \$1,600,000/\$30 = 53,33333

12
200,000
Units of y

180,000

Maximum sales of x
160,000

Tes
t tim
140,000 e

120,000

100,000

80,000
Maximum sales of y
a
60,000 b
Bu
ild
tim
e

40,000 is o
-c
on
tri
bu
Pr

20,000 tio
og

n
lin
ra

e
m

c
tim
e

0
0 50,000
d 100,000 150,000 200,000
Units of x

= feasible region.

Moving the iso-contribution line out to the furthest point on the feasible region, the optimum production point is b. This is
the intersection of the build time constraint and the sales constraint for y. Solving the simultaneous equations for these two
constraints:
y = 66,000
24x + 20y = 1,800,000
24x + (20 x 66,000) = 1,800,000
24x + 1,320,000 = 1,800,000
24x = 480,000
x = 20,000
C = (20,000 x \$30) + (66,000 x \$40)
= \$600,000 + \$2,640,000 = \$3,240,000
Fixed costs = 3 x \$650,000 = \$1,950,000.
Therefore profit = \$1,290,000.

## (b) Slack resources

Test time used = (20,000 x 10)/60 + (66,000 x 4)/60 = 7,733 hours.
Therefore slack hours = 12,000 7,733= 4,267 hours.
Program time used = (20,000 x 16)/60 + (66,000 x 14)/60 = 20,733 hours.
Therefore slack hours = 28,000 20,733 = 7,267 hours.
The slack values for test time and program time mean that there are 4,267 and 7,267 hours of each respective departments
time unutilised under the optimum production plan. If possible, this time could be used by the organisation elsewhere or
subcontracted out to another company.

13
3 (a) Ratios
(i) ROCE = operating profit/capital employed x 100%
\$000 ROCE
W Co Design division 6,000/23,540 2549%
Gearbox division 3,875/32,320 1199%
C Co 7,010/82,975 845%
(ii) Asset turnover = sales/capital employed x 100%
\$000 Asset turnover
W Co Design division 14,300/23,540 061
Gearbox division 25,535/32,320 079
C Co 15,560/82,975 019
(iii) Operating profit margin = operating profit/sales x 100%
\$000 Operating profit
W Co Design division 6,000/14,300 4196%
Gearbox division 3,875/25,535 1518%
C Co 7,010/15,560 4505%
Both companies and both divisions within W Co are clearly profitable. In terms of what the different ratios tell us, ROCE tells
us the return which a company is making from its capital. The Design division of W Co is making the highest return at over
25%, more than twice that of the Gearbox division and nearly three times that of C Co. This is because the nature of a design
business is such that profits are largely derived from the people making the designs rather than from the assets. Certain assets
will obviously be necessary in order to produce the designs but it is the employees who are mostly responsible for generating
profit.
The Gearbox division and C Cos ROCE are fairly similar compared to the Design division, although when comparing the two
in isolation, the Gearbox divisions ROCE is actually over three percentage points higher than C Cos (1199% compared to
845%). This is because C Co has a substantially larger asset base than the Gearbox division.
From the asset turnover ratio, it can be seen that the Gearbox divisions assets generate a very high proportion of sales per \$
of assets (79%) compared to C Co (19%). This is partly because the Gearbox division buys its components in from C Co and
therefore does not need to have the large asset base which C Co has in order to make the components. When the unit
profitability of those sales is considered by looking at the operating profit margin, C Cos unit profitability is much higher than
the Gearbox division (45% operating profit margin as compared to 15%). The Design division, like the Gearbox division, is
also using its assets well to generate sales (asset turnover of 61%) but then, like C Co, its unit profitability is high too (42%
operating profit margin.) This is why, when the two ratios (operating profit margin and asset turnover) are combined to make
ROCE, the Design division comes out top overall because it has both high unit profitability and generates sales at a high
level compared to its asset base.
It should be noted that any comparisons between such different types of business are of limited use. It would be more useful
to have prior year figures for comparison and/or industry averages for similar businesses. This would make performance
review much more meaningful.

## (b) Transfer prices

From C Cos perspective
C Co transfers components to the Gearbox division at the same price as it sells components to the external market. However,
if C Co were not making internal sales then, given that it already satisfies 60% of external demand, it would not be able to
sell all of its current production to the external market. External sales are \$8,010,000, therefore unsatisfied external demand
is ([\$8,010,000/06] \$8,010,000) = \$5,340,000.
From C Cos perspective, of the current internal sales of \$7,550,000, \$5,340,000 could be sold externally if they were not
sold to the Gearbox division. Therefore, in order for C Co not to be any worse off from selling internally, these sales should be
made at the current price of \$5,340,000, less any reduction in costs which C Co saves from not having to sell outside the
group (perhaps lower administrative and distribution costs).
As regards the remaining internal sales of \$2,210,000 (\$7,550,000 \$5,340,000), C Co effectively has spare capacity to
meet these sales. Therefore, the minimum transfer price should be the marginal cost of producing these goods. Given that
variable costs represent 40% of revenue, this means that the marginal cost for these sales is \$884,000. This is therefore the
minimum price which C Co should charge for these sales.
In total, therefore, C Co will want to charge at least \$6,224,000 for its sales to the Gearbox division.
From the Gearbox divisions perspective
The Gearbox division will not want to pay more for the components than it could purchase them for externally. Given that it
can purchase them all for 95% of the current price, this means a maximum purchase price of \$7,172,500.
Overall
Taking into account all of the above, the transfer price for the sales should be somewhere between \$6,224,000 and
\$7,172,500.

14
4 (a) Profit outcomes
Unit contribution Sales price per unit
\$30 \$35
Up to 100,000 units \$18 \$23
Above 100,000 units \$19 \$24
Sales price \$30
Sales Unit Total Fixed Advertising Profit
volume contribution contribution costs costs
\$ \$000 \$000 \$000 \$000
120,000 19 2,280 450 900 930
110,000 19 2,090 450 900 740
140,000 19 2,660 450 900 1,310
Sales price \$35
Sales Unit Total Fixed Advertising Profit
volume contribution contribution costs costs
\$ \$000 \$000 \$000 \$000
108,000 24 2,592 450 970 1,172
100,000 23 2,300 450 970 880
94,000 23 2,162 450 970 742

## (b) Expected values

Sales price \$30
Sales Profit Probability EV of
volume profit
\$000 \$000
120,000 930 04 372
110,000 740 05 370
140,000 1,310 01 131

873

Sales price \$35
Sales Profit Probability EV of
volume profit
\$000 \$000
108,000 1,172 03 3516
100,000 880 03 264
94,000 742 04 2968

9124

If the criterion of expected value is used to make a decision as to which price to charge, then the price charged should be
\$35 per unit since the expected value of this option is the greatest.

## (c) Maximin decision rule

Under this rule, the decision-maker selects the alternative which offers the most attractive worst outcome, i.e. the alternative
which maximises the minimum profit. In the case of Gam Co, this would be the price of \$35 as the lowest profit here is
\$742,000 as compared to a lowest profit of \$740,000 at a price of \$30.

## (d) Reasons for uncertainty arising in the budgeting process

Uncertainty arises largely because of changes in the external environment over which a company will sometimes have little
control. Reasons include:
Customers may decide to buy more or less goods or services than originally forecast. For example, if a major customer
goes into liquidation, this has a huge effect on a company and could also cause them to go into liquidation.
Competitors may strengthen or emerge and take some business away from a company. On the other hand, a competitors
position may weaken leading to increased business for a particular company.
Technological advances may take place which lead a companys products or services to become out-dated and therefore
less desirable.
The workforce may not perform as well as expected, perhaps because of time off due to illness or maybe simply because
of lack of motivation.
Materials may increase in price because of global changes in commodity prices.
Inflation can cause the price of all inputs to increase or decrease.

15
If a company imports or exports goods or services, changes in exchange rates can cause prices to change.
Machines may fail to meet production schedules because of breakdown.
Social/political unrest could affect productivity, e.g. the workforce goes on strike.
Note: This list is not exhaustive, nor would candidates be expected to make all the points raised in order to score full marks.

5 (a) Variances
(i) The sales mix contribution variance
Calculated as (actual sales quantity actual sales quantity in budgeted proportions) x standard contribution per unit.
Standard contributions per valet:
Full = \$50 x 446% = \$2230 per valet
Mini = \$30 x 55% = \$1650 per valet
Actual sales quantity in budgeted proportions (ASQBP):
Full: 7,980 x (3,600/5,600) = 5,130
Mini: 7,980 x (2,000/5,600) = 2,850
Valet type AQAM AQBM Difference Standard Variance
contribution
\$ \$
Full 4,000 5,130 (1,130) 2230 25,199 A
Mini 3,980 2,850 1,130 1650 18,645 F

6,554 A

(ii) The sales quantity contribution variance
Calculated as (actual sales quantity in budgeted proportions budgeted sales quantity) x standard contribution per unit.
Valet type AQBM BQBM Difference Standard Variance
contribution
\$ \$
Full 5,130 3,600 1,530 2230 34,119 F
Mini 2,850 2,000 850 1650 14,025 F

48,144 F

(b) Description
The sales mix contribution variance
This variance measures the effect on profit of changing the mix of actual sales from the standard mix.
The sales quantity contribution variance
This variance measures the effect on profit of selling a different total quantity from the budgeted total quantity.

## (c) Sales performance of the business

The sales performance of the business has been very good over the last year, as shown by the favourable sales quantity
variance of \$48,144. Overall, total sales revenue is 33% higher than budgeted ((\$319,400 \$240,000)/\$240,000). This
is because of a higher total number of valets being performed. When you look at where the difference in sales quantity actually
is, you can see from the data provided in the question that it is the number of mini valets which is substantially higher. This
number is 99% ((3,980 2,000)/2,000) higher than budgeted, whereas the number of full valets is only 11% ((4,000
3,600)/3,600) higher. Even 11% is still positive, however.
The fact that the number of mini valets is so much higher combined with the fact that they generate a lower contribution per
unit than the full valet led to an adverse sales mix variance of \$6,554 in the year. This cannot be looked at in isolation as a
sign of poor performance; it is simply reflective of the changes which have occurred in Strappia. We are told that disposable
incomes in Strappia have decreased by 30% over the last year. This means that people have less money to spend on non-
essential expenditure such as car valeting. Consequently, they are opting for the cheaper mini valet rather than the more
expensive full valet. At the same time, we are also told that people are keeping their cars for an average of five years now as
opposed to three years. This may be leading them to take more care of them and get them valeted regularly because they
know that the car has to be kept for a longer period. Thus, the total quantity of valets is higher than budgeted, particularly
the mini valets.
Also, there is now one less competitor for Valet Co than there was a year ago, so Valet Co may have gained some of the old
competitors business. Together, all of these factors would explain the higher number of total valets being performed and in
particular, of the less expensive type of valet.
Note: Other valid points will be given full credit.

16
Fundamentals Level Skills Module, Paper F5
Performance Management December 2013 Answers

## 1 (a) Incremental revenue Less VC Net profit/(loss) Further process?

L (1,200 x 095 x \$670) (1,200 x \$05) \$348 Yes
(1,200 x \$560) = \$918 x 0.95 =\$(570)
M (1,400 x 095 x \$790) (1,400 x \$070) \$476 Yes
(1,400 x \$650) = \$1,407 x 0.95 = \$(931)
S (1,800 x 095 x \$680) (1,800 x \$080) \$(720) No
(1,800 x \$610) = \$648 x 0.95 =\$(1,368)
Process Co should further process L and M, since incremental revenue from further processing will exceed incremental costs.
However, it should not further process S as incremental costs exceed incremental revenue in Ss case.
Note: The above calculations could be done on a unit basis if preferred, still earning full marks.

(b) The suggested transfer price being used is actual marginal cost. This means that whilst Division A would recover its variable
costs of producing products L and M, there is no profit margin built in and, therefore, unless Head Office intervenes and forces
Division A to transfer L and M to Division B, Division A will not want to transfer these products. Also, Division A will not have
the opportunity to recover any apportioned fixed costs since marginal cost does not include these. Not only would Division A
not make any profit or recovery of apportioned fixed costs from the transfers using the suggested system, it would actually
lower its overall profits if it were forced to transfer L and M for further processing rather than being allowed to sell them
externally after the split-off point. Division As manager would feel extremely demotivated if he/she were to be made to transfer
L and M for further processing, as it would make performance look poorer for the Division.
All of the profit from both producing L and M and further processing them into LX and MX would be gained by Division B
under the suggested system. If the criteria of return on investment (ROI) or residual income (RI) were then to be used to
assess performance, as is usual for divisional performance assessment, Division Bs ROI/RI would be seen to have increased
as a result of the further processing. Division B would then effectively be taking the credit for a large part of the work carried
out by Division A. The manager of Division B would be unlikely to complain about this as it works in favour of his Division.
Another point worth mentioning is that because actual cost would be used rather than standard cost, Division A would have
little incentive to keep its variable costs down because it would pass all of its costs on to Division B. However, given that the
suggested transfer price incorporates no profit for Division A, this point would hardly be arguable by Division B.
If Division A were told to make the transfers to Division B, their autonomy would be taken away from them. This would be
likely to have a detrimental effect on the motivation of managers since one of the primary purposes of creating a divisional
structure is to grant autonomy.
Note: Other points could be made too. A candidate would not be expected to make all of the above points in order to earn
full marks.

## (c) Environmental management accounting

Input/outflow analysis
This technique records material inflows and balances this with outflows on the basis that what comes in, must go out. So, if
100 kg of materials have been bought and only 80 kg of materials have been produced, for example, then the 20 kg
difference must be accounted for in some way. It may be, for example, that 10% of it has been sold as scrap and 10% of it
is waste. By accounting for outputs in this way, both in terms of physical quantities and, at the end of the process, in monetary
terms too, businesses are forced to focus on environmental costs.
Flow cost accounting
This technique uses not only material flows but also the organisational structure. It makes material flows transparent by
looking at the physical quantities involved, their costs and their value. It divides the material flows into three categories:
material, system and delivery, and disposal. The values and costs of each of these three flows are then calculated. The aim
of flow cost accounting is to reduce the quantity of materials which, as well as having a positive effect on the environment,
should have a positive effect on a businesss total costs in the long run.
Activity-based costing
ABC allocates internal costs to cost centres and cost drivers on the basis of the activities which give rise to the costs. In an
environmental accounting context, it distinguishes between environment-related costs, which can be attributed to joint cost
centres, and environment-driven costs, which tend to be hidden in general overheads.
Life cycle costing
Within the context of environmental accounting, life cycle costing is a technique which requires the full environmental
consequences, and therefore costs, arising from production of a product to be taken account of across its whole life cycle,
from cradle to grave.

## Note: Only two techniques were required.

11
2 (a) Throughput accounting ratio = throughput return per factory hour/cost per factory hour.
Cost per factory hour
Total factory costs/total available hours on bottleneck resource
= \$12,000,000/2,700 hours (12 x 5 x 50 x 90% hours)
= \$4,44444
Throughput return Large panels Small panels
\$ \$
Selling price 12,600 3,800
Materials (4,300) (1,160)

Throughput per unit 8,300 2,640
Hours per unit required on Machine M 14 06
Throughput return per hour \$5,92857 \$4,400
Throughput accounting ratio
Throughput return per factory hour/cost per factory hour: 5,92857/4,44444 4,400/4,44444
= 133 = 099
In any organisation, one would expect the throughput accounting ratio to be greater than 1. This means that the rate at which
the organisation is generating cash from sales of this product is greater than the rate at which it is incurring costs. It follows
on, then, that if the ratio is less than 1, changes need to be made quickly. Whilst the ratio for large panels is more than 1, it
is just under 1 for small panels. However, if changes are made as suggested in (c) below, this could soon be rectified.

## (b) Optimum production plan

Product No. of units Hours per unit Total hours T/P per hour Total T/P
Small panels 1,000 0.6 600 \$4,400 \$2,640,000
(under contract)
Large panels 1,500 (W.1) 1.4 2,100 \$5,92857 \$12,449,997

Total 2,700 \$15,089,997

Less total factory costs (\$12,000,000)

Profit \$3,089,997

W.1
(2,700-600)/1.4

## (c) Increasing throughput

Generally speaking, throughput can be increased by increasing sales volumes or prices on the one hand, or by cutting costs
on the other hand. In the case of S Co, it is not possible to increase sales prices as the company has guaranteed not to
increase them for three years. From our answer to (b) above, we can see that S Co has unsatisfied demand for both small
panels and large panels. There are customers out there who the company is unable to supply because of its restricted machine
capacity. Therefore, it would be worthwhile for S Co to focus on increasing production volumes and thus sales volumes.
In order to increase production volumes without making any additional capital expenditure, the company needs to focus on
how it could increase the productivity of Machine M. We are told that there is plenty of spare capacity on Machines C and
A. Some suggestions to increase Machine Ms capacity are as follows:
Machine M is currently only fully functional 90% of the time. This means that 300 hours of time are lost whilst the
machine is being maintained or workers are not available to man it. If the maintenance work could be carried out outside
the usual working day (i.e. either before 7 am or after 8 pm), some additional time could be freed up. This should be
possible given that we are told that the maintenance contractors work around the clock.
Workers could be trained to use more than one of the machines. This would then mean that, if some workers were
absent, one of the other workers could step in and work on another machine in order to keep it running. Again, this
would help to keep the lost 300 hours productive.
The most obvious machine time which is being lost is the one hour per day at lunchtime. This amounts to 250 lost
production hours per year. These additional 250 hours could be used to produce an extra 178 large panels (250/14
hours.) Large panels should be made first in preference to small panels since they generate a higher throughput per
machine hour. If workers were trained to use all three machines then, if their lunchtimes were staggered, it may be
possible to keep machine M running for the whole working day. However, even after doing this, there would still be 590
additional hours of time required on Machine M if the full market demand is going to be satisfied. Therefore, more time
needs to be made available.
Finally then, in order to increase productive hours on M, the working hours of the factory would need to be increased.
Either the working day could be made longer, given that workers must already be working shifts, or maybe the factory
could open for one extra day per week.

12
3 (a) Monthly costs
Month Cumulative Cumulative Cumulative Incremental Incremental Actual labour
number of average total number of total cost per
batches hours per hours batches hours month \$
batch
July 1 200 200 1 200 2,400
August (w.1) 2 176 352 1 152 1,824
September 4 15488 61952 2 26752 3,21024
October 8 136294 1,090352 4 470832 5,64960
November (w.2) 16 1244 1,99036 8 900008 10,800096
Working 1: Calculations for August
Cumulative average hours per batch: 200 x 088 = 176 hours.
Cumulative total hours = 2 x 176 = 352 hours.
Incremental number of batches = cumulative no. of 2 batches for August less cumulative number of 1 batch for July =
1 batch.
Incremental total hours = cumulative total hours of 352 for August 200 for July = 152 hours.
Actual labour cost = incremental total hours of 152 x \$12 per hour = \$1,824.
Working 2
Time for 7th batch:
Y = axb = 200 x 701844245
= 139693 hours.
Total time for 7 batches = 139693 x 7 = 977851 hours.
Total time for 8 batches = 1,090352 hours.
Therefore 8th batch took 112501 hours (1,090352 977851)
Time for batches 916 = 112501 x 8 = 900008 hours.
Therefore cumulative average time for batches 116 = 1,090352 + 900008 = 1,99036 hours.
Cumulative average time for 16 batches = 1,99036/16 = 1244 hours per batch.
Note: The labour costs for November could be arrived at quickly simply by taking the 112501 hours for the 8th batch,
multiplying it by 8 batches and applying this number to the \$12 per hour labour cost. This quick calculation is totally
sufficient to earn full marks.

## (b) Implications of end of learning period

The learning period ended at the end of October. This means that from November onwards the time taken to produce each
batch of microphones is constant. Therefore, in future, when Mic Co makes decisions about allocating its resources and
costing the microphones, it should base these decisions on the time taken to produce the 8th batch. The resource allocations
and cost data prepared for the last six months will have been inaccurate since they were based on a standard time per batch
of 200 hours.
Mic Co could try to improve its production process so that the learning period could be extended. It may be able to do this
by increasing the level of staff training provided. Alternatively, it could try and motivate staff to work harder through payment
of bonuses, although the quality of production needs to be maintained.

## (c) Involving senior staff at Mic Co in the budget setting process

Since they are based on information from staff who are most familiar with the department, they are more likely to
improve the accuracy of the budget. In Mic Cos case, the selling price could have been set more accurately and sales
may have been higher if the production manager had been consulted.
Staff are more likely to be motivated to achieve any targets as it is their budget and they therefore have a sense of
ownership and commitment. The production manager at Mic Co seems resigned to the fact that he is not consulted on
budgetary matters.
Morale amongst staff is likely to improve as they feel that their experience and opinions are valued.
Knowledge from a spread of several levels of management is pooled.
Co-ordination is improved due to the number of departments involved in the budget setting process.
The whole budgeting process is more time consuming and therefore costly.
The budgeting process may have to be started earlier than a non-participative budget would need to start because of
the length of time it takes to complete the process.

13
Managers may try to introduce budgetary slack, i.e. making the budget easy to achieve so that they receive any
budget-based incentives.
Disagreements may occur between the staff involved, which may cause delays and dissatisfaction. In Mic Cos case,
however, the fact that the production manager was not consulted has led to disagreement after the event.
Can support empire building by subordinates.

4 Ratio analysis
Division S Division C
Year on year Year on year
Increase in revenue 44% 9%
Increase in material costs 36% 25%
Increase in payroll costs 70% 15%
Increase in property costs 78% 6%
GPM in 2013 56% 65%
GPM in 2012 61% 67%
Increase in D & M costs 38% 18%
Increase in admin costs 6% 0%
NPM in 2013 11% 21%
NPM in 2012 9% 22%
Revenue per employee in 2013 \$102,224 \$104,917
Revenue per employee in 2012 \$111,772 \$104,828
Payroll cost per employee in 2013 \$27,000 \$21,000
Payroll cost per employee in 2012 \$25,020 \$20,000
Total market size (\$ revenue) in 2013 (w.1) \$12948m \$8012m
Total market size (\$ revenue) in 2012 (w.1) \$10775m \$7761m
Working 1 for market size
Division S 2013: \$38,845m/30% = \$12948m Division C 2013: \$44,065m/55% = \$8012m
Division S 2012: \$26,937/25% = \$10775m Division C 2012: \$40,359m/52% = \$7761m
Note: Percentages have been calculated to the nearest 1%.
Commentary
General overview
Overall, Division S has performed well in 2013, although it has not managed to meet its objective of becoming market leader
despite its \$2m advertising campaign. Since it has 30% of the market in 2013 and there are only two competitors holding 70%
of the market between them, at least one of those competitors must hold 35% or more of the market.
Revenue and market share
This has increased by a huge 44% in the last year. This compares to an increase of only 9% in Division C. However, part of the
reason that this has been achieved is because the changes in fire safety laws introduced by the government at the end of 2012
have caused the market for fire products and services to increase from \$10775m to \$12948m. Part of Division Ss success is
therefore down to increased opportunity. However, Division S has also increased its market share by a further 5 percentage points
compared to 2012. Division C has only managed a 3 percentage point increase in its market share, so this is a good result by
Division S. One can assume that this is at least partly as a result of the advertising campaign carried out by Division S. However,
this did cost a large amount, \$2m, and it did not quite enable the Division to achieve its aim of becoming market leader.
Materials costs
The increase in materials costs is 36%, compared to an increase in revenue of 44%. It is difficult to say whether this is good or
bad since the increase in revenue includes revenue from services, for which no materials costs would be expected to arise. Further
information is needed on the split of revenue between products and services.
Payroll costs, revenue per employee and cost per employee
Payroll costs have increased by a massive 70% and far more than Division Cs 15% increase. This is largely due to the fact that
Division Ss employee numbers increased from 241 in 2012 to 380 in 2013. This is a really big increase in employee numbers
and has been accompanied by a fall in revenue per employee from \$111,772 in 2012 to \$102,224 in 2013. It is possible that
Division S over-recruited as it hoped to secure a greater level of business than it did through its advertising campaign. Division Ss
payroll cost per employee also increased from \$25,020 in 2012 to \$27,000 in 2013. Presumably, this is because of the fact that
there is high demand for staff skilled in this area and Division S has probably had to increase pay in order to attract the calibre of
staff which it needs.
Increase in property costs
In percentage terms, the biggest increase in costs which Division S has suffered is in relation to its property costs. They have
increased by 78%, compared to Division Cs 6% increase. It would appear that this increase is due to the increased rent charged
by Division Ss landlords on its business premises, which in turn has risen because of the increased tax charges. However, it is
not possible to quantify this precisely without further information on rent increases.

14
Gross profit margin
This has actually fallen from 61% to 56%. Division C has also seen a fall in its GPM, but only a 2 percentage point fall as opposed
to Division Ss 5 percentage point fall. The reasons for Division Ss lower GPM are the higher material, payroll and property costs.
Also, Division S did not try to pass on any of its increased costs to its customers in the form of higher prices.
Distribution and marketing costs
These have increased by 38% compared to Division Cs 18%. However, when you take out the advertising costs in both years
figures and work out the cost increase without them (\$8522m \$7102m/\$7102m), it leaves an increase of only 20%. This
increase would be expected given the 20% increase in world fuel prices which occurred. Division S has to deliver to a wider
geographical spread of customers than Division C, so it would be expected to feel the full brunt of fuel price increases.
These have increased by 6% compared to Division Cs less than 1% increase (0% when rounded down to the nearest percent).
Further information is needed about the items included in these cost figures to explain why this increase has arisen.
Net profit margin
Despite challenging cost increases in all categories, Division S has still managed to increase its NPM from 9% to 11%. However,
this is substantially lower than the NPM in Division C, which has fallen slightly but is still 21%, almost twice that in Division S.
As we have seen, Division Ss GPM is lower than Division Cs anyway and, on top of that, Division C has not suffered a big increase
in advertising costs like Division S; nor have administrative costs risen inexplicably.
There is no information given about Head Office. If the Calana Division is also the Head Office, there could be Head Office costs
included in Calanas figures, which would affect the comparisons being made. Further information is required here.

## 5 (a) Planning and operational variances

(i) Material Price Planning Variance (MPPV) (Standard price revised price) x actual quantity
Sheets (\$5 \$6) x 248,000 = \$248,000 adverse
Pillow cases (\$5 \$6) x 95,000 = \$95,000 adverse
(ii) Material Price Operational Variance (MPOV) (Revised price actual price) x actual quantity
Sheets (\$6 \$580) x 248,000 = \$49,600 favourable
Pillow cases (\$6 \$580) x 95,000 = \$19,000 favourable
Total \$68,600 favourable
(iii) Material Usage Planning Variance (MUPV) (Standard quantity for actual production revised quantity
for actual production) x standard price
RQ for each pillow case = 05 m x 11 = 055 m
Sheets (240,000 240,000) x \$5 = 0
Pillow cases (90,000 99,000) x \$5 = \$45,000 adverse
(iv) Material Usage Operational Variance (MUOV) (Actual quantity revised quantity for actual production) x
standard price
Sheets (248,000 240,000) x \$5 = \$40,000 adverse
Pillow cases (95,000 99,000) x \$5 = \$20,000 favourable
Note: The MPPV could be calculated using the revised quantity rather than the actual quantity. Similarly, the MUOV could
be calculated using the revised price rather than the standard price. Marks will be given where this alternative method is
used instead. However, it should be used for both the MPPV and the MUOV, otherwise the figures cannot be reconciled
back to the difference between actual spend and the budget for spend as flexed for actual production levels (\$339,400

## (b) Performance of the production manager

In total, there has been an overspend of \$339,400, which looks poor. However, when the reasons for this are examined,
together with the variances calculated in (a), it is apparent that the production manager cannot be held solely responsible for
the overspend. In fact, he has had little control over the situation.
Increase in cotton price
Since cotton is used to make bed sheets and the price of this rose in the world market by 20%, the production managers
performance has to be looked at in light of this. Because of the increased market price, the adverse material price planning
variance is very high, since the budgeted cost of \$5 per m2 was far below the actual market price of \$6 per m2. The
production manager cannot be held responsible for this since he does not set the standard costs. He can only be held
responsible for any difference in price between the \$6 market price and the \$580 actual price paid. Since the \$580 paid
per m2 is less than the market price of \$6 per m2, the manager performed well, as shown by the favourable material price
operating variance of \$68,600.

15
Increase in amount of cotton used
Since more cotton was used for actual production than budgeted, a total adverse material usage variance of \$65,000
(\$45,000 + \$20,000) arose. However, of this, \$45,000 (material usage planning variance) arose because of the request
for a change in the design of the pillowcases by Bedcos customer. This was not within the control of the production manager
and his performance should not therefore be assessed on it. However, an adverse material usage operational variance of
\$20,000 also arose; the performance of the production manager is weak here. Most of the adverse operational variance
actually related to the production of bed sheets rather than pillowcases. It is not clear why this arose but it is definitely poor.
Bedco was also unable to produce all the pillowcases ordered by its customer in November as the order fell short by 10,000
units. If this was genuinely because of the late design change, however, it seems unfair to judge the production manager on
this.

16
1 (a) Decision tree

## Net income \$336m per annum

Net income \$600 per annum Net income \$36m per annum
Option 1

## 5,250 members: net \$342m

income \$640 per annum
Performance Management

per annum 05
\$10413m
A
D
05

6,000 members
Net income \$540 per annum
Fundamentals Level Skills Module, Paper F5

## Option 2 Net income \$324m per annum

\$(360k)

04

C
\$3591m

11
per annum 06
Net income \$600 per annum Net income \$39m per annum

\$3705m
6,500 members
per annum 05
B
05

Net income \$540 per annum Net income \$351m per annum
Workings
Option 1
Net income = \$720 \$80 = \$640 per annum.
Option 2
If costs \$120 per annum, net income = \$720 \$120 = \$600 per annum.
If costs \$180 per annum, net income = \$720 \$180 = \$540 per annum.
Expected value and decision:
EV at A = (05 x \$36m) + (05 x \$324m) = \$342m
EV at B = (05 x \$(39m) + (05 x \$351m) = \$3705m
EV at C = (04 x \$342m) + (06 x \$3705m) = \$3591m per annum
At D, compare EV of:
Option 1: (3 x \$336m) = \$1008m
Option 2: (\$3 x \$3591m) \$360k = \$10413m
Therefore choose option 2 expand exercise studio.

## (b) With perfect information:

If membership numbers were 6,000:
EV = \$342m x 3 = \$1026m
Less costs of \$360k = \$9.9m
Therefore, with these membership numbers, GB would choose option 1 instead.
If membership numbers were 6,500:
EV = \$3705 x 3 = \$11115m
Less costs of \$360k = \$10755m
In this instance, GB would choose option 2.
So, if membership numbers are 6,000, of which there is a 04 probability, EV will be \$1008m (option 1) and if membership
numbers are 6,500, of which there is a 06 probability, then EV will be \$10755m (option 2).
Therefore EV with perfect information = (04 x \$1008m) + (06 x \$10755) = \$10485m.
Without perfect information the EV is \$10413m, therefore the value of it is \$72k (\$10485m \$10413m). This represents
the maximum price that GB should be prepared to pay for the information.

(c) The expansion decision is a one-off decision, rather than a decision that will be repeated many times. Expected values, on
the other hand, give us a long run average of the outcome that would be expected if a decision was to be repeated many
times. The actual outcome may not be very close to the expected value calculated and the technique is therefore not really
very useful here.
Also, estimating accurate probabilities is difficult because this exact situation has not arisen before.
The expected value criterion for decision-making is useful where the attitude of the investor is risk neutral. We do not know
what the management of Gym Bunnies attitude to risk is, which makes it difficult to say whether this criterion is a good one
to use. In a decision such as this one, it would be useful to see what the worst case scenario and best case scenario results
would be too, in order to assist decision-making.

12
2 (a) Goals and measures
Goals Performance Measures Reason
Financial perspective
Increase revenue Percentage increase in total revenue The changes have been implemented
partly in an attempt to increase revenues,
so it is sensible to measure the extent to
which revenues have actually increased.
Increase operating profit margin Percentage increase in operating profit The changes have been implemented
partly in an attempt to increase operating
profit, so it is sensible to measure the
extent to which operating profit has actually
increased.
Customer perspective
Increase customer acquisition Total sales to new customers The fourth change (to standalone products)
was made in an attempt to attract new
customers. This measure will help to
assess whether the change has been
successful.
Reduce loss of customers Customer churn rate The first three of the four changes made
were made in an attempt to retain
customers. This performance measure will
help to assess whether the changes have
been successful.
Reduce number of broadband Number of broadband contracts This performance measure will enable
contracts cancelled cancelled Squarize to assess whether the improved
broadband service has resulted in a
reduction of the number of contracts
cancelled.
Increase after sales service Percentage of customer requests that Squarize transferred its call centre back to
quality are handled with a single call its home country. This measure will assess
whether that has improved the service
quality to customers as a result.
Learning and growth perspective
Increase call centre workers skill Number of training hours per This measure will improve the likelihood of
levels employee customers receiving an improved service. A
better public image should result, leading
to increased revenues as new customers
are attracted to the business.
Increase employees satisfaction Percentage decrease in staff turnover This measure will also help to improve
customer service, thereby improving
company image, attracting new customers
and increasing revenues in the long term.

## (Other reasonable suggestions will be equally acceptable)

(b) Pay-tv customers currently own the boxes, meaning that a certain number of customers appear to cancel their contract after
the first three months and just keep the set-top box with its free channels. Squarize may want to consider loaning the boxes
rather than selling them to the customers at the beginning of the contract.
The company only has a minimum contract period of three months. This seems very short and perhaps the company could
consider increasing it to 12 months. Unnecessary administration costs must be arising because it takes time, and therefore
money, to set up new customers. If these customers then leave three months later, the company has not had much
opportunity to earn profits from the customers generating these costs.

13
3 (a) Revised target cost
\$ \$
Manufacturing cost
Direct material (working 1) 2160
Direct labour (working 2) 1096
Machine costs 21
Quality control costs 10
Rework costs (working 3) 180

6536
Product development cost 25
Marketing cost 35

Non-manufacturing costs 60

Total cost 12536

Working 1: Direct material cost
Parts to be replaced by standard parts = \$40 x 08 = \$32.
New cost of those at 45% (100% 55%) = \$1440.
Unique irreplaceable parts: original cost = \$40 x 20% = \$8.
New cost \$720
Revised direct material cost = \$1440 + \$720 = \$2160
Working 2: Direct labour
Direct labour cost per unit for first one hundred units:
Y = axb
45 x 1000152 = 22346654 minutes
Total time for 100 units = 2,2346654 minutes.
Time for the 100th unit:
Time for 99 units = 45 x 990152
= 22380818 minutes.
For 99 units = 2,215701 minutes.
Therefore, time for 100th unit = 2,2346654 2,215701 = 189644 minutes.
Time for remaining 49,900 units = 946,32356 minutes.
Total labour time for 50,000 units = 948,55823 minutes.
Therefore total labour cost = 948,55823/60 x \$3467 = \$548,10856.
Therefore average labour cost per unit = \$548,10856/50,000 = \$1096.
Note: Some rounding is acceptable and marks would still be given.
Working 3: Rework cost
Total cost = 50,000 x 10% x \$18 = \$90,000.
Cost per average unit = \$90,000/50,000 = \$180.

## (b) Market skimming

Market skimming is a strategy that attempts to exploit those areas of the market which are relatively insensitive to price
changes. Initially, high prices for the webcam would be charged in order to take advantage of those buyers who want to buy
it as soon as possible, and are prepared to pay high prices in order to do so.
The existence of certain conditions is likely to make the strategy a suitable one for Cam Co. These are as follows:
Where a product is new and different, so that customers are prepared to pay high prices in order to gain the perceived
status of owning the product early. The webcam has superior audio sound and visual quality, which does make it
different from other webcams on the market.
Where products have a short life cycle this strategy is more likely to be used, because of the need to recover development
costs and make a profit quickly. The webcam does only have a two year life cycle, which does make it rather short.
Where high prices in the early stages of a products life cycle are expected to generate high initial cash inflows. If this
were to be the case for the webcam, it would be particularly useful for Cam Co because of the current liquidity problems
the company is suffering. Similarly, skimming is useful to cover high initial development costs, which have been incurred
by Cam Co.
Where barriers to entry exist, which deter other competitors from entering the market; as otherwise, they will be enticed
by the high prices being charged. These might include prohibitively high investment costs, patent protection or unusually
strong brand loyalty. It is not clear from the information whether this is the case for Cam Co.
Where demand and sensitivity of demand to price are unknown. In Cam Cos case, market research has been carried
out to establish a price based on the customers perceived value of the product. The suggestion therefore is that some
information is available about price and demand, although it is not clear how much information is available.

14
It is not possible to say for definite whether this pricing strategy would be suitable for Cam Co, because of the limited
information available. However, it does seem unusual that a high-tech, cutting edge product like this should be sold at the
same price over its entire, short life cycle. Therefore, price skimming should be investigated further, presuming that this has
not already been done by Cam Co.

4 (a) Sales price operational variance: (actual price market price) x actual quantity
Commodity 3: (\$4040 \$3910) x 25,600 = \$33,280F
Sales price planning variance: (standard price market price) x actual quantity
Commodity 3: (\$4160 \$3910) x 25,600 = \$(64,000)A
An alternative approach to the variance calculations for Commodity 3 would be as follows:
Sales price operational variance
Commodity 3
Should now \$3910
Did \$4040

Difference \$130F
Actual sales quantity 25,600
Variance \$33,280F
Sales price planning variance
Commodity 3
Should now \$3910
Should \$4160

Difference \$250A
Actual sales quantity 25,600
Variance \$64,000A

## (b) Sales mix variance:

(Actual sales quantity in actual mix at standard margin) (actual sales quantity in standard mix at standard margin) =
\$768,640 (w.1 & 2) \$782,006 (w.3) = \$13,366 adverse.
Working 1: Standard margins per unit:
Budgeted machine hours = (30,000 x 02) + (28,000 x 06) + (26,000 x 08) = 43,600.
Overhead absorption rate = \$174,400/43,600 = \$4 per hour.
Product Commodity 1 Commodity 2 Commodity 3
\$ \$ \$
Standard selling price 30 35 4160
Variable production costs (18) (2840) (2640)
Fixed production overheads (08) (24) (32)

Standard profit margin 1120 420 12

Working 2: Actual sales quantity in actual mix at standard profit margin:
Product Actual quantity Standard profit \$
in actual mix
Commodity 1 29,800 \$1120 333,760
Commodity 2 30,400 \$420 127,680
Commodity 3 25,600 \$12 307,200

85,800 768,640

Working 3 Actual sales quantity in standard mix at standard profit margin:
Product Actual quantity in standard mix Standard profit \$
Commodity 1 85,800 x 30/84 = 30,643 \$1120 343,202
Commodity 2 85,800 x 28/84 = 28,600 \$420 120,120
Commodity 3 85,800 x 26/84 = 26,557 \$12 318,684

85,800 782,006

The sales quantity variance = (actual sales quantity in standard mix at standard margin) (budgeted sales quantity in
standard mix at standard profit margin) = \$782,006 (w.3 above) \$765,600 (w.4) = \$16,406 favourable.

15
Working 4: Budgeted sales quantity in standard mix at standard profit margin:
Product Quantity Standard profit \$
Commodity 1 30,000 \$1120 336,000
Commodity 2 28,000 \$420 117,600
Commodity 3 26,000 \$12 312,000

84,000 765,600

(c) The calculations above have shown that, as regards the sales price, there is a \$23,360 favourable operational variance and
a \$54,680 adverse planning variance. In total, these net off to a sales price variance of \$31,320 adverse. The sales manager
can only be responsible for a variance to the extent that he controls it. Since the standard selling prices are set by a consultant,
rather than the sales manager, the sales manager can only be held responsible for the operational variance. Given that this
was a favourable variance of \$23,360, it appears that he has performed well, achieving sales prices which, on average, were
higher than the market prices at the time. The consultants predictions, however, were rather inaccurate, and it is these that
have caused an adverse variance to occur overall in relation to sales price.
As regards sales volumes, the mix variance is \$13,366 adverse and the quantity variance is \$16,406 favourable, meaning
that the total volume variance is \$3,040 favourable. This is because total sales volumes were higher than expected, although
it is apparent that the increased sales related to the lower margin Commodity 2, with sales of Commodity 1 and
Commodity 3 actually being lower than budget.
The total variance relating to sales is \$28,280 adverse. This looks poor but, as identified above, it is due to the inaccuracy
of the sales price forecasts made by the consultant. We know that Block Co is facing tough market conditions because of the
economic recession and therefore it is not that surprising that market prices were actually a bit lower than originally
anticipated. This could be due to the recession hitting even harder in this quarter than in previous ones.

## 5 (a) Budget deficit/surplus

Budgeted income:
Income from pupils registered on 1 June 2013: \$724,500 (given in question)
Expected number of new joiners: (02 x 50) + (03 x 20) + (05 x 26) = 29
Expected income from new joiners at \$900 each = \$26,100
Total expected income = \$750,600.
Budgeted expenditure:
Repairs and maintenance: \$30,000 x 103 = \$30,900.
Salaries: [(\$620,000 \$26,000)/2] + [(\$620,000 \$26,000 x 102)/2]
= \$297,000 + \$302,940 = \$599,940.
Expected capital expenditure = (07 x \$145,000) + (03 x \$80,000) = \$125,500.
Total expected expenditure = \$756,340.
Budget deficit = \$5,740.

## (b) Discussion of estimates

Incremental budgeting is very easy to perform. This makes it possible for a person without any accounting training to
build a budget.
Incremental budgeting is also very quick compared to other budgeting methods.
The information required to complete it is also usually readily available.
On the other hand, incremental budgeting encourages inefficiency because it does not question the preceding years
figures on which it is based. No-one asks how those figures could be reduced.
Similarly, in some organisations, it encourages slack because departmental managers may attempt to use their entire
budget up for one year, even if they do not need to, just to ensure that that cash is available again the next year.
Errors from one year are carried to the next, since the previous years figures are not questioned.

## (c) Zero-based budgeting (ZBB)

The three main steps involved in preparing a zero-based budget are as follows:
1. Activities are identified by managers. Managers are then forced to consider different ways of performing the activities.
These activities are then described in what is called a decision package, which:
analyses the cost of the activity;
states its purpose;
identifies alternative methods of achieving the same purpose;

16
establishes performance measures for the activity;
assesses the consequence of not performing the activity at all or of performing it at different levels.
As regards this last point, the decision package may be prepared at the base level, representing the minimum level of
service or support needed to achieve the organisations objectives. Further incremental packages may then be prepared
to reflect a higher level of service or support.
2. Management will then rank all the packages in the order of decreasing benefits to the organisation. This will help
management decide what to spend and where to spend it. This ranking of the decision packages happens at numerous
levels of the organisation.
3. The resources are then allocated, based on order of priority up to the spending level.

## (d) Use of ZBB at Newtown School

There is definitely a place for ZBB at Newtown School. At the moment, incremental budgeting is responsible for recurring
unexpected cash shortages, which is deterring new pupils from joining the school. Had a deficit been predicted for the year
ended 31 May 2013, perhaps \$65,000 would not have been spent on improving the school gym, and then it would not
have been necessary to close the school kitchen. ZBB would be good to establish the way cash is spent on those activities
that are, to a certain extent, discretionary.
For example, although there is a need for pupils to have somewhere to eat lunch, it is not essential for children to have a
cooked meal every day. It is essential that children do have somewhere to eat though and, as a bare minimum, they would
need an area where they could eat their sandwiches and have access to fresh water. ZBB could be used to put together
decision packages which reflect the different levels of service available to the children. For example, the most basic level of
service could be the provision of an area for the children to eat a lunch brought from home. The next level would be the
provision of some cold and maybe hot food for the children, but on a self-service basis. Finally, the highest level of service
would be a restaurant for the children where they get served hot meals at tables. At Newtown School the catering manager
could prepare the decision packages and they would then be decided upon by the head teacher, who would rank them
accordingly.
Similarly, although some level of sports education is needed, the extent of the different activities offered is discretionary. ZBB
could be used to create decision packages for each of these services in order to prioritise them better than they are currently
being prioritised.
ZBB takes a long time to implement and would not be appropriate to all categories of expenditure at the school. Much of the
budgeting is very straight forward. Incremental budgeting could still be used as a starting point for essential expenditure such
as salary costs, provided that changes in staff numbers are also taken into account. There is an element of essential, recurring
expenditure in relation to repairs and maintenance too, since the costs of the checks and repairs needed to comply with health
and safety standards seem to largely stay the same each year, with an inflationary increase.

17
Fundamentals Level Skills Module, Paper F5
Performance Management December 2012 Answers

1 Hair Co

(a) Weighted average contribution to sales ratio (WA C/S ratio) = total contribution/total sales revenue.
Per unit: C S D
\$ \$ \$
Selling price 110 160 120
Material 1 (12) (28) (16)
Material 2 (8) (22) (26)
Skilled labour (16) (34) (22)
Unskilled labour (14) (20) (28)

Contribution 60 56 28

Sales units 20,000 22,000 26,000
Total sales revenue \$2,200,000 \$3,520,000 \$3,120,000
Total contribution \$1,200,000 \$1,232,000 \$728,000
WA C/S ratio = \$1,200,000 + \$1,232,000 + \$728,000/\$2,200,000 + \$3,520,000 + \$3,120,000
= \$3,160,000/\$8,840,000 = 3575%

## (b) Break-even sales revenue = fixed costs/C/S ratio

Therefore break-even sales revenue = \$640,000/3575% = \$1,790,20970.

(c) PV chart
Calculate the individual C/S ratio for each product then rank them according to the highest one first.
Per unit: C S D
\$ \$ \$
Contribution 60 56 28
Selling price 110 160 120
C/S ratio 055 035 023
Ranking 1 2 3
Product Revenue Cumulative Revenue Profit Cumulative Profit
(x axis co-ordinate) (y axis co-ordinate)
\$ \$ \$ \$
0 0 0 (640,000) (640,000)
Make C 2,200,000 2,200,000 1,200,000 560,000
Make S 3,520,000 5,720,000 1,232,000 1,792,000
Make D 3,120,000 8,840,000 728,000 2,520,000

11
3,000

D
2,500

2,000
S

1,500

## 1,000 Most profitable first

Constant mix
C
500
Profit \$000

0
0 2,000 4,000 6,000 8,000 10,000
Sales revenue \$000
500

1,000

(d) From the chart above it can be seen that, if the products are sold in order of the highest ranking first, break even will take
place at a point just under \$1,200,000 of sales revenue. The exact figure can be worked out by taking the fixed costs of
\$640,000 and dividing them by Product Cs C/S ratio of 055, i.e. the exact BEP is \$1,163,636. This is substantially earlier
than the break-even point which occurs if the products are all sold in a constant mix, which is \$1,790,209, as calculated in
(b) above.
The reason for this is obviously because the more profitable product, C, contributes more per unit to fixed costs when being
sold on its own, than when a mix of products C, S and D are sold. The weighted average C/S ratio of all three products is
only 3575%, compared to Cs C/S ratio of 55%. Obviously, then, break even will occur earlier if C is sold in priority.
In reality, however, the mix of sales will vary throughout the year and Hair Co can neither assume that the products are sold
in a constant mix, nor that the most profitable can be sold first.

2 Truffle Co

## (a) Basic variances

Standard cost of labour per hour = \$6/05 = \$12 per hour.
Labour rate variance = (actual hours paid x actual rate) (actual hours paid x std rate)
Actual hours paid x std rate = \$136,800/95 = \$144,000.
Therefore rate variance = \$144,000 \$136,800 = \$7,200 F
Labour efficiency variance = (actual production in std hours actual hours worked) x std rate
[(20,500 x 05) 12,000] x \$12 = \$21,000 A.

## (b) Planning and operational variances

Labour rate planning variance
(Revised rate std rate) x actual hours paid = [\$12 (\$12 x 095)] x 12,000 = \$7,200 F.
Labour rate operational variance
There is no labour rate operational variance.
(Revised rate actual rate) x actual hours paid = \$1140 \$1140 x 12,000 = 0

12
Labour efficiency planning variance
(Standard hours for actual production revised hours for actual production) x std rate
[10,250 (20,500 x 05 x 12)] x \$12 = \$24,600 A.
Labour efficiency operational variance
(Revised hours for actual production actual hours for actual production) x std rate
(12,300 12,000) x \$12 = \$3,600 F.

(c) Discussion
When looking at the total variances alone, it looks like the production manager has been extremely poor at controlling his
staffs efficiency, since the labour efficiency variance is \$21,000 adverse. It also looks, at a glance, like he has managed to
secure labour at a lower rate.
In order to assess the production managers performance fairly, however, only the operational variances should be taken into
account. This is because planning variances reflect differences that arise because of factors that are outside the control of the
production manager. The operational variance for the labour rate was \$0, which means that the labour force were paid exactly
what was agreed at the end of October: their reduced rate of \$1140 per hour. The manager clearly did not have to pay
anyone for overtime, for example, which would have been expected to push this rate up. The rate reduction was secured by
the company and was not within the control of the production manager, so he cannot take credit for the favourable rate
planning variance of \$7,200. The company is the source of this improvement.
As regards labour efficiency, the planning and operational variances give us more information about the total efficiency
variance of \$21,000A. When this is broken down into its two parts, it becomes clear that the operational variance, for which
the manager does have control, is actually \$3,600 favourable. This is because, when the recipe is changed as it has been
in November, the chocolates usually take 20% longer to make in the first month whilst the workers are getting used to
handling the new ingredient mix. When this is taken into account, it can therefore be seen that workers took less than the
20% extra time that they were expected to take, hence the positive operational variance. The planning variance, on the other
hand, is \$24,600 adverse. This is because the standard labour time per batch was not updated in November to reflect the
fact that it would take longer to produce the truffles. The manager cannot be held responsible for this.
Overall, then, the manager has performed well, given the change in the recipe.

3 Web Co

Web Co has made three changes and introduced two incentives in an attempt to increase sales. Using the performance indicators
given in the question, it is possible to assess whether these attempts have been successful.
Total sales revenue
This has increased from \$22 million to \$275m, an increase of 25% (W1). This is a substantial increase, especially considering
the fact that a \$10 discount has been given to all customers spending \$100 or more at any one time. However, because a number
of changes and incentives have been introduced, it is not possible to assess how effective each of the individual changes/incentives
has been in increasing sales revenue without considering the other performance indicators.
Net profit margin (NPM)
This has decreased from 25% to 167%. In \$ terms this means that net profit was \$550,000 in quarter 1 and \$459,250 in
quarter 2 (W2). If the 25% NPM had been maintained in quarter 2, the net profit would have been \$687,500 for quarter 2. It is
therefore \$228,250 lower than it would have been. This is mainly because of the \$200,000 paid out for advertising and the
\$20,000 paid to the consultant for the search engine work. The remaining \$8,250 difference could be a result of the cost of the
\$10 discounts given to customers who spent more than \$100, depending on how these are accounted for. Alternatively, it could
be due to the costs of providing the Fast Track service. More information would be required on how the discounts are accounted
for (whether they are netted off sales revenue or instead included in cost of sales) and also on the cost of providing the Fast Track
service.
Whilst it is not clear how long the advert is going to run for in the fashion magazine, \$200,000 does seem to be a very large cost.
This expense is largely responsible for the fall in NPM. This is discussed further under number of visits to website.
Number of visits to website
These have increased dramatically from 101,589 to 141,714, an increase of 40,125 visits (395% W3). The reason for this is
a combination of visitors coming through the fashion magazines website (28,201 visitors W5), with the remainder of the increase
most probably being due to the search engine consultants work. Both of these changes can therefore be said to have been effective
in improving the number of people who at least visit Web Cos online store. However, given that the search engine consultant only
charged a fee of \$20,000 compared to the \$200,000 paid for magazine advertising, in relative terms, the consultants work
provided value for money. Web Cos sales are not really high enough to withstand a hit of \$200,000 against profit, hence the fall
in NPM.
Number of orders/customers spending more than \$100
The number of orders received from customers has increased from 40,636 to 49,600, an increase of 22% (W4). This shows that,
whilst most of the 25% sales revenue increase is due to a higher number of orders, 3% of it is due to orders being of a higher
purchase value. This is also reflected in the fact that the number of customers spending more than \$100 per visit has increased

13
from 4,650 to 6,390, an increase of 1,740 orders. So, for example, If each of these 1,740 customers spent exactly \$100 rather
than the \$50 they might normally spend, it would easily explain the 3% increase in sales that is not due to increased order
numbers. It depends partly on how the sales discounts of \$10 each are accounted for. As stated above, further information is
required on these.
An increase in the number of orders would also be expected, given that the number of visitors to the site has increased substantially.
This leads on to the next point.
Conversion rate visitor to purchaser
The conversion rate of visitors to purchasers has gone down from 40% to 35%. This is not surprising, given the advertising on the
fashion magazines website. Readers of the magazine may well have clicked on the link out of curiosity and may come back and
purchase something at a later date. It may be useful to have a breakdown of the visitor to purchaser rate, showing one statistic for
visitors who have come from the online magazine and one for those who have not. This would help clarify the position.
Website availability
Rather than improving after the work completed by Web Cos IT department, the websites availability has stayed the same. This
means that the IT departments changes to the website have not corrected the problem. Lack of availability is not good for business,
although its exact impact is difficult to ascertain. It may be that visitors have been part of the way through making a purchase only
to find that the website then becomes unavailable. More information would need to be available about aborted purchases, for
example, before any further conclusions could be drawn.
Subscribers to online newsletter
These have increased by a massive 159%. It is not clear what impact this has had on the business as we do not know whether
the level of repeat customers has increased. This information is needed. Surprisingly, it seems that there has not been an increased
cost associated with providing Fast Track delivery, as the whole fall in net profit has been accounted for, so one can only assume
that Web Co managed to offer this service without incurring any additional cost itself.
Conclusion
With the exception of the work carried out to make the system more available, all of the other measures seem to have increased
sales or, in the case of Incentive 1, increased subscribers. More information is needed in relation to a couple of areas, as noted
above. The business has therefore been responsive to changes made and incentives implemented but the cost of the advertising
was so high that, overall, profits have declined substantially. This expenditure seems too high in relation to the corresponding
increase in sales volumes.
Workings
1. Increase in sales revenue \$275m \$22m/\$22m = 25% increase.
2. NPM: 25% x \$22m = \$550,000 profit in quarter 1. 167% x \$275m = \$459,250 profit in quarter 2.
3. No. of visits to website: increase = 141,714 101,589/101,589 = 395%.
4. Increase in orders = 49,600 40,636/40,636 = 22%.
5. Customers accessing website through magazine line = 141,714 x 199% = 28,201.
6. Increase in subscribers to newsletter = 11,900 4,600/4,600 = 159%.

4 Designit

(a) Explanation
The rolling budget outlined for Designit would be a budget covering a 12-month period and would be updated monthly.
However, instead of the 12-month period remaining static, it would always roll forward by one month. This means that, as
soon as one month has elapsed, a budget is prepared for the corresponding month one year later. For example, Designit would
begin by preparing a budget for the 12 months from 1 December 2012 to 30 November 2013, to correspond with its year
end. Then, at the end of December 2012, a budget would be prepared for the month December 2013, so that the unexpired
period covered by the budget is always 12 months.
When the budget is initially prepared for the year ending 30 November 2013, the first month is prepared in detail, with much
less detail being given to later months, where there is a greater uncertainty about the future. Then, when this first month has
elapsed and the budget for the month of December 2013 is prepared, it is also necessary to revisit and revise the budget for
January 2013, which will now be done in more detail.
Note: This answer gives more level of detail than would be required to gain full marks.

(b) Problems
Designit only has one part-qualified accountant. He is already overworked and probably has neither the time nor the
experience to prepare rolling budgets every month. One would only expect to see monthly rolling budgets of this nature in
businesses which face rapid change. There is no evidence that this is the case for Designit. If it did decide to introduce rolling
budgets, it would probably be sufficient if they were updated on a quarterly rather than a monthly basis. If this monthly rolling
budget is going to be introduced, it is going to require a lot of input from many of the staff, meaning that they will have less
time to dedicate to other things.
The sales managers may react badly to the new budgeting and incentive system. They are used to having been set targets
that are easily achievable. With the new system, they will have to work hard all year round. They are also likely to become
frustrated with the fact that they do not know the target for the whole year in advance. Once they have hit their target for the

14
month, they may then also be tempted to hold back further work and let it run into the next month, so that they increase the
chances of meeting next months target. This would not be good for the business.

## (c) Alternative incentive scheme

The issue with the current bonus scheme is that the reward system is stepped, rather than being a percentage of sales. The
first \$15 million fee income target is too easy to reach and the second \$15 million target is too hard to reach. Therefore,
managers are not motivated to earn additional fees once the initial \$15 million target has been reached.
A series of constantly rising bonus rates ranging over a narrower rate of sales could be used. For example, every \$500,000
of fee income could be rewarded with an additional bonus equivalent to 5% of salary. Alternatively, the bonus could be
replaced by commission, giving the managers a reward as a percentage of the fee income rather than a percentage of salary.
Currently, the company is paying out \$30,000 in bonus to each of its managers each year. This is 2% of \$15 million.
Therefore, the bonus could be that each manager earns 2% commission on all sales.

## (d) Using spreadsheets

If spreadsheets are used for budgeting, the part-qualified accountant could be rekeying large amounts of data taken from the
companys systems. It would be very easy for him to make a mistake when he is entering his data, especially without
someone else to check his work.
Similarly, if there is any error in any of the formulae, all the numbers in the budget will be wrong. Whilst this risk already
exists because fixed budgets are being prepared on spreadsheets, the rolling budgets will be far more complex, which
increases the risk of error in the design of the model or any of the formulae.
A model can become easily corrupted simply by putting a number in the wrong cell. The accountant is unlikely to spot this
due to his lack of experience and the time pressure on him.
When spreadsheets are used, there is no audit trail that can be followed in order to check the numbers.

5 Wash Co

## (a) Transfer price using machine hours

Total overhead costs = \$877,620
Total machine hours = (3,200 x 2) + (5,450) x 1 = 11,850
Overhead absorption rate = \$877,620/11,850 = \$7406
Overhead cost for S = 2 x \$7406 = \$14812 and for R = 1 x \$7406 = \$7406.
Product S Product R
\$ \$
Materials cost 117 95
Labour cost (at \$12 per hour) 6 9
Overhead costs 14812 7406

Total cost 27112 17806
10% mark-up 2711 1781

Transfer price using machine hours 29823 19587

## (b) Transfer price using ABC

Machine set up costs: driver = number of production runs.
30 + 12 = 42.
Therefore cost per set up = \$306,435/42 = \$7,29607
Machine maintenance costs: driver = machine hours: 11,850 (S= 6,400; R=5,450)
\$415,105/11,850 = \$3503
Ordering costs: driver = number of purchase orders
82 + 64 = 146.
Therefore cost per order = \$11,680/146 = \$80
Delivery costs: driver = number of deliveries.
64 + 80 = 144.
Therefore cost per delivery = \$144,400/144 = \$1,00278

15
Allocation of overheads to each product:
Product S Product R Total
\$ \$ \$
Machine set-up costs 218,882 87,553 306,435
Machine maintenance costs 224,192 190,913 415,106
Ordering costs 6,560 5,120 11,680
Delivery costs 64,178 80,222 144,400

Total overheads allocated 513,812 363,808 877,620

Number of units produced 3,200 5,450 8,650
\$ \$
Overhead cost per unit 16057 6675
Transfer price per unit:
Materials cost 117 95
Labour cost 6 9
Overhead costs 16057 6675

Total cost 28357 17075
Add 10% mark up 2836 1708

Transfer price under ABC 31193 18783

## (c) (i) ABC monthly profit

Using ABC transfer price from part (b):
Assembly division Product S Product R Total
Production and sales 3,200 5,450
\$ \$
10% mark up 2836 1708

Profit 90,752 93,086 183,838

Retail division Product S Product R Total
Production and sales 3,200 5,450
\$ \$
Selling price 320 260
Cost price (31193) (18783)

Profit per unit 807 7217

Total profit 25,824 393,327 419,151

(ii) Discussion
From the various profit figures for the three bases of allocating overheads, various observations can be made.
There is obviously very little difference between the TOTAL profits of each division whichever method is used,
except for differences arising from rounding. In each case, the total profit made by the assembly division is
approximately \$183,000 and \$419,000 for the retail division. It is the reallocation of profits from R to S or S to
R that is the important factor in this situation, given that the retail division wants to reduce prices but increase sales
volumes for R.
As regards the assembly division, when labour hours are used to allocate overheads, there is a big difference
between the profits that each of the two products makes. When machine hours or ABC are used, this difference
becomes much smaller.
As regards the retail division, when labour hours are used, product S generates 76% of the profit. When this
method of allocation is then changed so that either machine hours are used or ABC is used, the main share of the
profit then moves to product R. In the case of ABC, the profit moves so much to R that S only generates a profit
per unit of \$807 for the retail division, which is very low for a selling price of \$320.
From the assembly division managers point of view, any change that results in increased sales of either R or S to
the retail division would be a good thing for the assembly division, given that both products are profitable. However,
the assembly divisions manager would probably oppose the implementation of ABC to achieve this end result
because firstly, it is complex and secondly, it is unnecessary here. The aim of this exercise is to set more accurate
transfer prices for R and S, which should mean a reduction in Rs transfer price and an increase in Ss, according
to the information given. This would then have the effect of enabling the retail division to lower its price for R and
increase sales volumes. This goal is achieved simply by changing the basis of overhead absorption from labour
hours to machine hours, without the need for activity based costing.

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The retail managers view is likely to be exactly the same. If the basis of absorption is changed so that a lower
transfer price is charged, the retail division could potentially reduce their selling price for R, provided that the
increased sales volumes more than make up for the reduced margin. There is no need to get into the complexities
of ABC when the results it produces are not that different.

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