a) Issues in upgrading the existing information system

i, Advantages of upgrade
a network system would allow the transmission of information both to and from
the business units and head office at Story. As such it is likely that performance
indicators, financial statistics and similar information could be rapidly gathered,
processed and disseminated. Improved communication between units and head
office should improve, leading to rapid reaction to changes both within the
organisation and the challenges of the market place. It would aslo get rid of the
problems currently experienced where some countries do to not have the most
up-to-date information on products and prices.
ii, Costs
The costs of providing a fully networked computer system, changeover costs
and the costs of future maintenance and training must be evaluated and
budgeted for. The development and implementation of security measures to
prevent fraud by unauthorised users ( who may be employees or external to the
orgnisation) have to be considered and costed. In addition, there may be a
possible need to recruit specialised staff to implement the changes to existing
information system. All of these costs are foreseeable and can be planed.
iii, Changes
Upgrading corporate information systems usually results in many unforeseen
changes to the culture of the organisaition and the working practices of staff at
all levels. For example, would greater efficiency be achieved by allowing staff
to have more flexible hours of attendance? Can costs be reduced by allowing
some staff to telecommute on a regular basis, thus allowing hot-desking to take
place? Is it likely that morale will be adversely affected by staff who may be
concerned about using new technology or staff who fear that they may lose their
jobs through the changes?
The proposed changes are unlikely to change the role and remit of management
in relation to the directing of staff, although it is likely that there will be some
impact upon organising staff tasks as new needs arise. Strategic and tactical
planning are likely to change in response to the improved, and more rapid, flow
of information that the information system will provide.
Operational decisions can be taken at lower levels of the corporate as
information becomes available becomes available more rapidly and in an
appropriate format. As well as providing a swift response to changes in the
business environment, it is possible that the organisation will, in time, evolve
into one with a flatter hierarchy. This would particularly suit the autonomous
business unit structure in Storey which already operates with devolved decision-
making. However, there is always the danger of "information overload" which
can reduce efficiency and morale within the organisation.
b) Although big data could potentially provide useful information for Story in
relation to the growth of textbook sales, there are several considerations to be
assessed.
Volume/variety - Capacity
Two of the features of big data are volume and variety. These characteristics
may mean that a larger information system capacity is required in order to
capture and store data correctly. If data is not captured and stored correctly it
can lead to misleading information and therefore incorrect decision-making.
The information derived from big data needs to be reliable.
Volume - Analytical tools
As well as having the capacity to store big data, Story will need the right
analytical tools and technologies to be able to analyse it, because it is too large
and unstructured to be analysed through traditional means.
Velocity
If the volume and variety of the data means that Story's current information
systems are not able to process it, the "velocity" aspect of big data will be
undermined. If IT teams or business analysts become burdened with increasing
requests for ad hoc analysis and one-off reports ( because the systems cannot
process the data automatically), the information and analysis from big data will
not be available for decision makers as quickly as they might want.
c) There types of MIS and how they would be used in an organisation
Types of MIS Detail
Transaction processing systems Collect, store, modify and retrieve the
(TPS) transactions of an organisation. A
transaction is an event that generates
or modifies data that is eventually
stored in an information system.
There are two types of TPS:
Batch transaction processing (BTP)
collects transaction data as a group
and processes it later, after a time
delay, as batches of identical data.
Real-time transaction processing
(RTTP) is the immediate processing
of data. It involves using a terminal or
workstation to enter data and display
results and provides instant
confirmation.
Executive information systems Give executives a straightforward
(EIS) means of access to key internal and
external data. They provide
summary-level data, captured from
the organisation’s main systems
(which might involve integrating the
executive’s desktop PC with the
organisation’s mainframe ), data

Enterprise resource planning
systems (ERP)
manipulation facilities (such as
comparison with budget or prior year
data and trend analysis) and user-
friendly presentation of data.
Integrate the key processes in an
organisation so that a single system
can serve the information needs of all
functional areas. They primarily
support business operations including
Finance, HR, Marketing and
Accounting and work in real time,
meaning that the exact status of
everything is always available to all
users. ERP systems can be deployed
at sites around the world; they can
work in multiple languages and
currencies. When they are used this
way, you can immediately see, for
example, exactly how much of a
particular part is to hand at the
warehouse in Jpan and what its value
is in yen or dollars.

162 RB Co
Top tips. In part (a) make sure you relate your discussion to the specific
circumstances of RB Co rather than just regurgitating a textbook explanation of
cost-plus pricing.
In part (b) the problem is deciding on the alternative pricing strategies to
suggest. You may have included target pricing, for example.
Part (c) is a straightforward use of the demand curve formula which you will be
given in the exam and part (d) requires a simple explanation of the total cost
function.
Part (e) requires a good understanding of price elasticity of demand, again,
applies to specific company circumstances.

a) Managing director’s pricing strategy

The managing director has adopted what is known as a full cost plus pricing
strategy which means that a profit margin (in this case, of 50%) is added to the
budgeted full cost of the product.
Given the information in the question, the selling price used by RB Co is
calculated as follows.
$
Full cost 400
50% mark up 200
Selling price 600

Disadvantages of this pricing strategy

Its focus is internal – internal costs and internal targets. It therefore takes no
account of the market conditions faced by RB Co, which is why the
company’s selling price bears little resemblance to those of its competitors. By
adopting a fixed mark-up, it does not allow the company to react to
competitors’ pricing decisions.
Absorption bases used when calculating the full cost are decided arbitrarily.
The current basis of absorption is based on the budgeted level of production,
which is lower than the current capacity. Depending on the absorption basis
used in the calculation of total cost, the strategy can produce different selling
prices.

Advantages of this pricing strategy

It is quick, cheap and relatively easy to apply. Pricing can therefore be
delegated to more junior management if necessary.
It ensures that all costs are covered and that organisation makes a profit,
provided budget figures used in the pricing calculation are reasonably accurate.
This was the case in the first two years for RB Co.
The costs of collecting market information on demand and competitor activity
are avoided.

b) Alternative pricing strategies

i) Market penetration pricing

Market penetration pricing is a policy of low prices when a product is first
launched in order to achieve high sales volumes and hence gain a significant
market share. If RB Co had adopted this strategy it might have discouraged
competitors from entering the market.
ii) Market skimming
This pricing strategy involves charging high prices when a product is
first launched and spending heavily on advertising and promotion to obtain
sales so as to exploit any price insensitivity in the market. Such as approach
would have been particularly suitable for RB’s circumstances: demand for the
software would have been relatively inelastic, customers being prepared to pay
high prices for the software given its novelty appeal. As the product moves into
later stages of its life cycle, prices can be reduced in order to remain
competitive.

c) When demand is linear the equation for the demand curve is:
P = a – bQ
Where P = the price
Q = the quantity demanded
A = the price at which demand would be nil
b = change in price/ change in quantity
a = $750
b = $10/1000 = 0.01
=> P = 750 – 0.01Q

d) Cost behaviour can be modelled using a simple linear equation of the form
y= a + bx where “a” represents the fixed costs, which for RB are
$1,200,000 (15,000*$80), and “b” represents the variable costs per unit, ie
$320(400 – 80) per unit for RB. This cost model assumes fixed costs remain
unchanged over all ranges of output and a constant unit variable cost.

e) Price elasticity of demand

Price elasticity of demand is a measure of the extent of change in market
demand for a good in response to a change in its price. It is measured as:

The change in quantity demanded, as a % of demand

The change in price, as a % of the price

Since the demand goes up when the price falls, and goes down when the price
rises, the elasticity has a negative value, but it is usual to ignore the minus sign.
The value of demand elasticity may be anything from zero to infinity.

Elastic and inelastic demand

Demand is referred to as inelastic if the absolute value is less than 1. Where
demand is inelastic, the quantity demanded falls by a smaller percentage
than the percentage increase in price.
Where demand is elastic, demand falls by a larger percentage than the
percentage rise in price. The absolute value is greater than 1.

Pricing decisions
An awareness of the concept of elasticity can assist management with pricing
decisions.
In circumstances of inelastic demand, prices should be increased because
revenues will increase and total costs will reduce ( because quantities sold will
reduce).
In circumstances of elastic demand, increases in prices will bring decreases in
revenue, and decreases in price will bring increases in revenue. Management,
therefore, has to decide whether the increase/decrease in costs will be less
than/ greater than the increase/decrease in revenue.
In situations of very elastic demand, overpricing can lead to a massive drop in
quantity sold and hence a massive drop in profits; whereas underpricing can
lead to costly stock outs and, again, a significant drop in profits. Elasticity must
therefore be reduced by creating a customer preference which is unrelated
to price (through advertising and promotional activities).
In situations of very inelastic demand, customers are not sensitive to price.
Quality, service, product mix, and location are therefore more important to
a firm’s pricing strategy.

Cost-plus pricing
Cost-plus pricing is based on the assumption that demand for the company’s
software is inelastic and prices should be increased in order to increase total
revenue and hence profit. The market research information for RB Co does not
support this view, however. It suggests that increasing prices will lead to a drop
in demand and hence a reduction in profit.

163 Belton Park Resort

Top tips. In part (a), use a clear layout, read the information carefully and make
sure you state which costs should be excluded (eg electricity $0) rather than not
mentioning them at all. It’s a good idea to practice answering numerical Section
C questions like this on a spreadsheet. Don’t forget to state whether the hotel
and water park should stay open or not.
In part (b) use your common sense to make sensible suggestions and don’t be
afraid to state the obvious.
Easy marks. There are plenty of easy marks available for the calculation in part
(a).
Examining team’s comments. Using the CBE software is key is passing
Applied Skills exams. A common mistake in part (b) was to suggest that the
resort should look at costs versus benefits, but this was done in part (a).

b) As regards the estimates calculated, these have been based on very limited
data and should be approached with caution. The calculations are based on the
first two months of opening only and, consequently, it is to say how accurate
they are likely to be. In addition, the basis of estimating the revised occupancy
rates for the hotel, for example, has not been given. If these estimates are too
optimistic, the actual results could be far worse.
The figures suggest that both the water park and the hotel stay open. Given that
this is a new business and therefore it is still building up its customer base, this
would seem like a wise decision anyway, even if the calculations had shown
that the estimated incremental cash flows were not as positive as this.
Similarly, if Belton Park were to close either the hotel or the water park, they
would invariably lose some valuable staff who might seek out other jobs after
the closure. These staff might not be available again when the hotel and water
park reopened in February.
The interdependency of the two sets of projections has not been taken into
account in the calculations either. Since the incremental cash flows suggest that
both the hotel and the water park should stay open, it is not a big problem.
However, if they had shown, for example, that the water park alone should
close, the effect that this could have on the number of hotel visitors would also
need to be taken into account. Many visitors may be attracted to the hotel
because it has a water park.
Tutorial note: There are many factors which could have been discussed here and
would be given credit.

164 Robber Co
Top tips. This question tests relevant costing within a ‘make or buy context’.
There are a number of calculations required for parts (a) and (b) so present your
answer clearly and show all of your workings to maximise your score.
Part (c) asks you to discuss non-financial factors, so do not waste time
discussing financial factors!
Easy marks. There are easy marks available in part (c) for discussing the non-
financial factors the company should consider when making a decision about
outsourcing.
Examining team’s comments. It was pleasing to see many candidates making a
decent attempt at part (a). In the suggested solution, the $4k and $6k machine
costs are treated as specific fixed costs and are therefore included in the relevant
cost of manufacturing in-house, together with the depreciation. However, it is
acceptable to assume these costs to be general fixed costs and therefore exclude
them for their manufacture cost together with the depreciation.
Part (b) produced weaker answers but many candidates were at least able to
work out the shortage of hours and the numbers of units that needs to be bought
in (without going through the process of ranking the two components), for
which they could earn nearly halt of the total marks available.
Part (c) was a straightforward knowledge requirement and the majority of
candidates scored full marks.
c) Robber Co should consider the following non-financial factors when making
a decision about outsourcing components of a high quality.
If the compenents delivered are not of the required quality Robber risks
damaging its reputation and losing sales as well as incurring high repair costs
for control panels under warranty. This is particularly significant given that the
supplier is based overseas – Robber therefore has less control over quality and
continuity of supply than if it were dealing with a locally based supplier.
Information to support the supplier’s record in meeting delivery dates may be
hard to come by, especially as the supplier is a newly established company. Late
delivery of components could disrupt Robber’s production schedule and its to
supply control panels to meet market demand.
New company
The potential supplier is a newly formed company. There is no gurantee the
company will be able to operate at the level required to supply the desired level
of componentsar the right quality.
Robber Co should consider whether there are any other potential suppliers of
the components. This would enable Robber to compare prices and get the best
deal. It could also provide the company with an alternative supplier should the
new supplier go out of business.
Pricing
The new supplier has only guaranteed the current price foe two years. After this,
the supplier could increase prices significantly. Robber Co should negotiatea
price fix for a longer period of time as part of the agreement or seek out
alternative suppliers to ensure that the company is not forced to accept a
significant increase in price at the end of the two-year period.

165 Gam Co
Top tips. Part (a) is straightforward provided you read the information carefully
and use a clear layout and workings. Make sure you make a recommendation in
your answer in part (b). Know the difference between maximin, minimax and
maximax for part (c).
Examining team’s comments. This was a very well answered question. Where
mistakes were made it was through inaccurate reading of the question,
incorrectly applying probabilities to profit figures (part (b)), or failure to
recommend which option Gam Co would choose (part (b)). In part (c), some
candidates mixed up maximin eith minimax regret or maximax and
consequently gave the wrong explanation and recommendation.

c) Maximin decision rule

The maximin decision rule involves choosing the outcome the offers the least
unattractive worst outcome, in this instance choosing the outcomr which
maximise the minimum profit. Management would therefore choose a selling
price of $35, which has a lowest possible profit of $742,000. This is better than
the worst possible outcome from a selling price of $30, which would provide a
profit $740,000.
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. Reason 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 competitor’s position may weaken
leading to increased business for a particular company.
+ Technological advances may take place which lead a company’s
products or services to become out-dated simply 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.
+ If a company imports or exports goods or services, changes in exchange
rates can cause prices to change.
+ Machine may fail unrest could affect productivity, eg the workforce
goes on strike.
+ Social/ political unrest could affect productivity, eg 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.

166 Cardio Co
Top tips. Part (a) and part (b) are fairly straightforward. Part (c) requires
knowledge of breakeven charts but even if you think you can’t remember how
to do a breakeven chart, it is worth writing down some workings for yourself to
see if they match the graph. Recognising the chart and knowing what the axes
were was worth so don’t miss this easy point. For part (e) yor needed to think of
the assumptions of CVP analysis. Assumptions are often the limitations in
accounting techiques.
Examining team’s comments. In part (a) some students added the individual
contribution/unit and divided by the sum of the individual selling prices. This
does not given the correct weighting, answered with many answers giving a PV
chart instead of breakeven chart. In part (d) most students did not pick up the
‘explain’ mark – that fixed costs would be covered quicker by the higher C/S
ratio.

d) BEP if products sold in order of profitability

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

e) The limitations of CVP analysis are unrealistic assumptions required

i) It is assumed that fixed costs are the same in total and variable costs are
the same per unit at all level of output. This assumption is a great simplification.
+ Fixed costs will change if output falls or increases substantially ( most
fixed costs are step costs).
+ The variable cost per unit will decrease where economies of sale are
made at higher output volumes, but the variable cost per unit will also
eventually rise when diseconomies of scale begin to appear at even higher
volume output (for example, the extra cost of labour in overtime working).
The assumption is only correct within a normal range or relevant range of
output. It is generally assumed that both the budgeted output and the breakeven
point lie within this relevant range.
ii) It is assumed that prices will be constant at all levels of activity. This may
not be true, especially at higher volumes of output, where the price may have to
be reduced to win the extra sales.
iii) Production and sales are assumed to be the same, so that the
consequences of any increase in inventory levels or of ‘de-stocking’ are
ignored.
iv) Uncertainty in the estimates of fixed costs and unit variable costs is often
ignored.