Test 2

CAT

Paper 7

Planning, Control and Performance

Management
June 2007

Test 2 4Success – Answers

To gain maximum benefit, do not refer to these

answers until you have completed the test
questions and submitted them for marking.

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CAT Paper 7 Planning, Control and Performance Management

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 Test 2

ANSWER 1
Part 1

(a) Marginal costing profit statement

£000 £000
Sales revenue 11,200
Variable cost of sales:
Production costs:
Opening stock of finished goods 420
Cost of production 6,420
Closing stock of finished goods (560)
_____
6,280
Non-production costs 710
_____
6,990
______
Contribution 4,210
Fixed overheads:
Production 2,030
Non-production 2,095
_____
4,125
______
Net profit 85
______

Workings

Opening stock of finished goods = 540 − (60,000 units × £2/unit)

Cost of production = 8,240 − 1,820
Closing stock of finished goods = 720 − (80,000 units × £2/unit)
Production fixed overheads = 1,820 (absorbed) + 210 (under-absorbed)

(b) Profit reconciliation

The profit difference of £40,000 (£125,000 − £85,000) results from the different
treatment of fixed production overheads. In absorption costing, fixed production
overheads are absorbed into the cost of stock and are subsequently charged against
profit when the goods are sold. In marginal costing, fixed production overheads are
treated as a period cost and are charged against profit when incurred.

As a consequence, absorption costing will show a profit of £40,000 higher for the
period, due to the increase in finished goods stock of 20,000 units over the period
absorbing fixed production overheads at an average £2.00 per unit.

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CAT Paper 7 Planning, Control and Performance Management

(c) Breakeven sales revenue

Breakeven sales revenue = Fixed overheads ÷ Contribution/Sales ratio

= £4,125,000 ÷ ($4,210,000/£11,200,000)
= £10,974,000
Part 2

(a) Cost adjustments

Period 1 Period 2 Period 3 Period 4

Actual costs (£) 190,760 224,020 236,100 255,600
× 1.05 × 1.04 × 1.03
× 1.04 × 1.03
× 1.03
Adjusted costs (£) 214,559
_______ 239,970
_______ 243,183
_______ 255,600
_______

(b) High-low method

£255,600 - £214,559 £41,041

= = £1.916 per unit (variable cost)
85,620 - 64,200 units 21,420 units

Fixed cost = £255,600 − (85,620 units × £1.916 per unit) = £91,552

[or £214,559 − (64,200 units × £1.916 per unit) = £91,552]

y = 91,552 + 1.916x

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 Test 2

(c) See graph below:

Scattergraph and linear cost function

260

255 x

250

245
x
240 x
Total costs (£000)

235

230

225

220

215
x

210

205

200

60 64 68 72 76 80 84 88
Output (000 units)

(d) Period 5 costs = [(87,500 units × £1.916 per unit) + £91,552] × 1.02
= £264,386

(e) Limitations

The accuracy of the function, and the resulting cost estimates, will be affected by:

• whether all costs suffer from inflation at the average rate.

• whether the high and low points are representative.
• whether the proportionately variable/fixed cost split is an accurate reflection
of cost behaviour.
• whether the function can be used outside the range of activity used to
establish it.
• whether other factors influencing cost have changed over the four year
period, eg efficiency.

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CAT Paper 7 Planning, Control and Performance Management

ANSWER 2
(a) Mission statements have several uses. Some are used for marketing purposes,
others as a means of motivating employees. They are also used to explain why the
company exists, what it is attempting to do and who it is doing it for. This final use is
important in strategic planning as it sets the long-term direction for the business. A
firm’s objectives are usually based upon its mission statement.

It is not possible to measure the performance of an organisation unless we know

what the organisation is trying to achieve. A mission statement gives an indication of
what the business is trying to achieve and therefore allows us to develop
performance measures of relevance to key stakeholders.

(b) A balanced scorecard approach to performance measurement considers various

aspects of the business performance. Kaplan and Norton suggest that performance
should be considered under the following headings:

• Financial performance
• Customer satisfaction
• Internal process efficiency
• Learning and growth

Performance is therefore considered under a variety of areas. Several advantages of

this approach are:

• Single factor financial measures can be easily manipulated by the managers.

The balanced scorecard approach which uses multiple performance
measures is less easily manipulated. Changes made in one way by
manipulation of data will often show up in another.
• Traditional accounting performance measures usually provide the symptoms
rather than the cause of problems. If return on investment has fallen, the
measure provides little clue as to why. A balanced scorecard approach will
provide much more detail as to why performance has deteriorated.
• Traditional performance measures tend to measure quantity rather than
quality. A balanced scorecard approach looks at both aspects.
• Traditional performance measures focus on short-term performance, a
balanced scorecard approach takes the long-term view.
• It is argued that ‘what gets measured gets done’. By detailing various critical
aspects of the business performance (critical success factors) and measuring
managerial performance in these areas, a balanced scorecard approach
draws managers’ attention to critical areas.

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 Test 2

(c) Critical success factor Key performance indicators

Financial success

Profitability Return on investment, return on sales

Operating profit margin
Actual profit compared to budgeted profit

Cash flow Operating cycle

Actual cash balance to budgeted cash balance
Critical success factor Key performance indicators

Customer satisfaction

Customer loyalty Number of regular customers

Market share

Quality of service Average waiting time

Number of customer compliments

Process efficiency

Staff scheduling Idle time

Staff to customer ratio during peak hours
Staff to customer ration during off peak hours

Food preparation Food wastage

Innovation and learning

New menu Number of new items introduced

Staff training to learn new recipe

Growth of delivery service % of sales from delivery service

(d) Benchmarking involves the exchange of information with other organisations with the
objectives of measuring and improving performance. This is not restricted to financial
information but can involve data on the efficiency of various processes and
procedures.

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CAT Paper 7 Planning, Control and Performance Management

Internal benchmarking means comparing performance between restaurants within

Goodfood. Although data would be comparable, no external comparison is being
achieved. Internal benchmarking could encourage either healthy or unhealthy rivalry
between the restaurants.

Competitive benchmarking means information is gathered about direct competitors.

For Goodfood, the assessments made by independent food critics will be a good
gauge as to where Goodfood stands in relation to its competitors. Goodfood can also
study the menu and price set by its direct competitors.

ANSWER 3
(a) Raw material usage variance = (14,000 × 0.1 × 160) − (1,600 × 160)
£32,000 (adverse)

Raw material price variance = (1,800 × 160) − (1,800 × 150)

£18,000 (favourable)

Labour efficiency variance = (14,000 × ½ × 9) − (8,000 × 9)

£9,000 (adverse)

Labour rate variance = (8,000 × 9) − (8,000 × 9.25)

£2,000 (adverse)

Fixed overhead expenditure = (13,000 × 2) − 23,000

£3,000 (favourable)

Fixed overhead volume = (13,000 × 2) − (14,000 × 2)

£2,000 (favourable)

Fixed overhead capacity = (13,000 × ½ × 4) − (8,000 × 4)

£6,000 (F)

Fixed overhead efficiency = (8,000 × 4) − (14,000 × ½ × 4)

£4,000 (adverse)

(b) The raw material price variance shows that raw material was purchased at a lower
price than standard. This saved £18,000 on the material purchased.

This saving could have many potential causes including a change of supplier, a fall in
market prices, better price negotiation or by buying a lower grade of material.

The material usage variance is £32,000 adverse showing that more material was
used than standard. Again, there are many potential causes including careless use of
material, pilferage, or problems resulting from the use of poorer quality material. The
two material variances could possibly be related, as the favourable price variance
could have been achieved by buying material of an inferior quality leading to more
wastage than usual. If this is the case then the decision to buy cheaper material was
a poor one as the material cost variance is overall £14,000 adverse.

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 Test 2

The fixed overhead expenditure variance is favourable, indicating that less has been
spent on fixed overheads than budgeted. This could be caused by price reductions or
seasonal effects.

The fixed overhead volume variance is favourable indicating an over-absorption of

overheads caused by producing more sets than budgeted. This can be considered
good news as long as the extra production can be sold.

The capacity and efficiency variances indicate the cause of this over-absorption.
Because we worked more labour hours than budgeted, we could have absorbed
£6,000 more overhead than budgeted. However, part of this over-absorption was lost
due to inefficient labour and, at standard labour hours, £4,000 of this over-absorption
is cancelled out leading to an overall volume variance of £2,000 favourable.

ANSWER 4
(a) Total relevant costs

Material K To buy 1,000 kg × £9.80 × 1.05 £10,290

To replace 2,000 kg × £9.80 × 1.05 £20,580

Material L Opportunity cost of using

200 kg × £11 £2,200

Labour Opportunity cost of using

200 units of P × (£100 − £22) £15,600
_______
Total relevant costs £48,670
_______

(b) Any variable overhead costs associated with the contract would be relevant because
they would represent additional or incremental costs caused directly by the contract.

Fixed overhead costs would only be relevant if the total fixed overhead costs of the
company increased as a direct consequence of the contract being undertaken. In that
case, the relevant amount would be the specific increase in the total fixed overhead
costs caused by the acceptance of the contract.

Arbitrary apportionments of existing fixed overhead costs would not be relevant.

Similarly, sunk and committed costs would not be relevant.

(c) Two other factors may include:

• Will accepting this one-off contract spin off more new contracts with the same
customer in the future?
• Is there a more profitable contract currently under consideration? Will
accepting this new contract displace another more profitable potential offer?

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