P2 November 2010 Exam Solutions

SECTION A Question One


(a) Calculate planning and operating variances following the recognition of the learning curve effect. (6 marks) Flexed budget 560 4,480 $67,200 Actual output 560 3,500 $57,750 Revised flexed budget 560 1,712 (W1) $25,680

Output Direct labour hours Direct labour cost

Planning variance = flexed budget revised flexed budget Planning variance = $67,200 - $25,680 = $41,520 (F) Labour efficiency variance = (actual hours revised flexed hours) x std cost per hr Labour efficiency variance = (3,500 -1,712) x $15 = $26,820 (A) Labour rate variance = actual hours at std rate actual cost Labour rate variance = (3,500 x $15) - $57,750 = $5,250 (A) Workings (W1) Direct labour hours

Using the learning curve formula: Y = aXb Y = average time for that (X) number of units or the average cost per unit a = time for the first unit or the cost for the first unit X = the number of units you want to calculate an average time or cost for b = the index of learning (log r/log 2) a = 8 hours, b = -0.1520 Work out the average time for the first 560 units: Y = 8 x (560 to the power of 0.5146) = 3.057 hours Total time for 560 units = 3.057 x 560 = 1,712 hours


inspections and tests. Then deducting a desired level of benefit or profit for the organisation in order for the manufacture to be commercially viable. Question Two Explain. Market price to achieve desired market share TARGET COST (balancing figure) Desired profit XX (XX) XX Learning curves is an important part of a target costing strategy as it will help in reducing costs within the business. It is only applicable to those businesses that have a labour intensive operation where savings can be made through experience and efficiencies. Appraisal costs these are spent to understand how well a process has performed and corrective action is taken if needed subsequently.P2 November 2010 Exam Solutions (b) Explain the importance of learning curves in the context of Target Costing. being the price that the product should be sold for in the market. · -2- . customer surveys. In a machine intensive operation these savings are limited as machines tend produce at the same rate. (4 marks) Quality conformance costs are those costs which are spent to try to achieve a standard or target. There are two main types of quality conformance costs: · Prevention costs these are spent to try and ensure the product is made to detailed specifications and regulations. such regulations or functional specifications of a product for a customer. quality conformance costs and quality nonconformance costs and the relationship between them. and then the product be manufactured within the value left over thereby becoming the budgeted costs or target costs. product quality audits. For example training staff. with reference to CAL. For example measuring equipment. Businesses can achieve target costs once a certain level of activity has been achieved and so therefore for lessons can be learned and applied to standard costs once it is known the learning capacity of the labour force. (4 marks) Target costing is a strategy which seeks to the selling price of a product at the market price which consumers are willing to pay. supplier reviews and investment in machines.

losses or scrapping of materials and finished goods.000 x 100/98 = 20. External failure costs . repairs and replacements. There are two main types of non-conformance costs: · Internal failure costs these are quality failure costs before the products or services have been transferred to the customer.these are quality failure costs before the products or services have been transferred to the customer. (2 marks) (i) Non-conformance cost calculations Cost of replacing faulty goods for free is that we would have to supply not 20. · It is clear from the scenario that CAL from a quality perspective provides middle range quality of solar panels. product liability claims. Examples are administration of customer complaints.408. CAL is losing out on an increase of 25% in its market share due to external failure costs of poor assembly skills by staff. additional administrative costs. (4 marks) Calculate the maximum saving that could be made by implementing an inspection process for the solar panels. based on the budgeted figures and sales returns rate. administration of customer services. Therefore. -3- . For example re-inspection of goods.000 items but a further 2% in addition to this demand. as they have competitors who sell at a cheaper price but offer an inferior range of solar panels and others who sell at a higher price but offer a high quality range of solar panels.360. External costs should be avoided as they expose poor manufacturing abilities to customers. 408 items represent the free replacement which would cost CAL $45 per unit.P2 November 2010 Exam Solutions Quality non-conformance costs are quality failure costs that are needed to correct products. therefore a total of $18. immediately before the goods are delivered. as they did not meet expectations or target. (b) Assuming that CAL continues with its present systems and that the percentage of quality failings is as stated above: (i) (ii) Calculate. lost goodwill and reputation. supply 20. the total relevant costs of quality for the coming year.

This is because managers would tend to produce more goods than is necessary to meet demand. giving a net saving of $77. Total non-conformance costs = $18. This would mean holding minimum levels of raw materials as well as finished goods to meet fluctuations in demand. deterioration.000 extra lost sales. QW manufacture to specific customer order and so there is no finished goods stockpiled in the company but they do however hold 1 day s stock of raw materials to meet demand if suppliers are not able to deliver. This would result in 20.000 x $15 per unit = $75. The maximum savings will therefore be $93. The system also encourages efficient work of staff as delays may result in lost sales. This system will ensure demand is met but would lead to inefficient production and obsolete finished goods.320.360 (ii) If through an inspection it was found that some solar panels were faulty and not fit for customer consumption then the lost sale could be avoided as well as the delivery charge.360 + $75.000 = $93. administration.000 x 25% = 5.000. security and interest costs. This would give a lost contribution of 5. (5 marks) QW currently employs a form of just-in-time (JIT) whereby products should only be produced if there is an internal or external customer waiting for them. The proposed system aims to procure items to meet constant rates of production.360 less the internal costs before delivery being 408 units x $40 per unit = $16. The item would still be faulty and the only cost incurred would be internal failure costs. This is very different to the current system being JIT which aims to always hold a zero or near zero stock level. -4- . This system would also lead to other holding costs such as damage.P2 November 2010 Exam Solutions Other non-conformance costs include the lost increase of market share by 25%.040. Question Three (a) Compare and contrast QW s present production and inventory policy and practices with a traditional production system that uses constant production levels and holds inventory to meet peaks of demand.

Use QW to illustrate your discussion. Rolling budgets are good for adaptive planning. (5 marks) It is essential that a JIT system is underpinned by TQM. however it has the disadvantage of greater costs for holding greater amounts of inventory and more importantly the company moving away from a focus on quality of product resulting in the long term loss of customer goodwill and difficulties in convincing employees that quality is important. The delay may slightly less with QW as they hold 1 day s worth of raw materials but nevertheless there will be waiting time for customers. · -5- . It would have to manufacture the item again and so there will be a delay to customers who may not be happy about this. unlike annual budgets which don t get updated as the periods expire. This enables management and so enables better long term planning. This is because under a JIT system if an item is discovered by the customer as faulty then the company will not be in a position to replace immediately as it does not hold any stock. for example there is a greater chance that the budgets will be regularly updated to take account of changes within the environment the organisation is operating within if used. Question Four (a) Explain the differences between the above annual budgeting system and a rolling budget. This system has the advantage of customers not having to wait for their replacement item. once this has expired then Jan to Mar 2006 will be created and added. Rolling or continuous budgeting is when the budget is updated on a regular and frequent basis.P2 November 2010 Exam Solutions (b) Discuss the importance of a Total Quality Management (TQM) system in a just-in-time (JIT) environment. Two of the key differences between these two systems are: · Rolling budgets always provide a budget for the full period as they get updated. In a constant rate production system TQM is not as important because there would be an inventory of both raw materials and finished goods that can be used to replace the faulty item. (4 marks) An annual budgeting system is the process of using existing budgets as a guide to prepare the budget for the next 12 months which normally coincide with financial year end of the company. for example if Jan to Mar 2005 is the first three months of the yearly forecast. The method is to add a further period immediately to the budget when an earlier period has expired.

reliable and meaningful. Rolling budgets would allow regular comparison to the actual outcomes more frequent update of forecasts where necessary due to unanticipated changes in the economy. Annual budgets only get updated once a year and proves difficult for depot mangers to make decisions until the budget has been approved by management which maybe close to the year end restricting decisions being taken by depot mangers in the early part of next year. This means that it is not possible to see if the budget is being met or even if current economic circumstances have made the budget out of date and not applicable. Operational decisions and control must however be dealt with carefully as these entail the day to day actions of the company and any differences in actual performance must be noted to ensure that improvements can be made. Rolling budgets would allow frequent revisits to the strategy to ensure that it is being met and if not then the original strategy being revised. unlike annual budgets which don t get updated as the periods expire.P2 November 2010 Exam Solutions (b) Discuss how the Southern region depot manager could use a rolling budget system to address his concerns. Operational and strategic decisions cannot be taken Rolling budgets always provide a budget for the full period as they get updated and approved my management. This enables depot mangers to take decisions for the early part of next year. (6 marks) The new depot manager has two concerns that he raises about the current system: Budgets are out of date Annual budgets are set on annual basis and are not revisited on a regular basis. This would keep the budgets more accurate. Rolling budgets should not eliminate these variances by revising them as it would mean that information about inefficiencies cannot be isolated and improved. Strategic decisions and control would benefit from rolling budgets as it help to ensure that failing strategies are abandoned in favour of successful strategies. -6- .

222 480 75 960 600 34.070 C $ 10.634 12.400 12.132) 14.000 / 18.434 (1.398) Total cost on old basis $725.P2 November 2010 Exam Solutions Question Five (a) Prepare calculations to show the effect on fees charged to each of these three clients of changing to the new costing system.200 300 240 2. (10 marks) Cost driver rates: Accounts preparation and advice Requesting missing information Issuing fee payment reminders Holding client meetings Travelling to clients $580.50 per reminder $60.337 40.280 B $ 8.22 per hr $30.336 (7.000 miles = $4 per mile A $ 32.530 13.955 720 375 480 0 12.195 10.695 Client Accounts preparation and advice Requesting missing information Issuing fee payment reminders Holding client meetings Travelling to clients Total costs Total costs on old basis (W1) Client fees Client fees Difference Workings (W1) new basis old basis 41.28 per hr -7- .550 15.000 / 10.204 48.000 / 250 times = $120 per request $15.000 / 250 meetings = $240 per meeting $40.055 1.000 hrs = $32.000 / 18.036 16.000 hrs = $40.084 2.000 / 400 times = $37.

Kg used 800 5.22 2 L M 400 units x 3 kg 6. L 400 1.300 1. We will work out the total amount of resources needed to meet maximum demand and then compare this to the resources that we have available to us to determine any scarce resources. (6 marks) In order to find the optimum production plan we must first establish what the scarce resource is that is restricting production to meet all demand.000 7.800 Total demand Direct labour (hours) Direct material (kg) Machine hours Direct material is the scarce resource or limiting factor as we only have available to us 6. Product Selling price Direct labour ($7 per hour) Direct material ($5 per kg) Machine hours ($10 per hour) Contribution Contribution per kg Rank in order of production Amount of material available is 6.100 1.200 kg 5.P2 November 2010 Exam Solutions SECTION B Question Six 50 MARKS (a) Prepare calculations to show.000 kg 800 kg = 5.400 Total 3. from a financial perspective. the optimum production plan for December 2010 and the contribution that would result from adopting your plan.600 800 400 M 700 1.200 kg / 9 kg = 577 units Optimum production plan Production 400 577 L M -8- .193 5.993 L $ per unit 70 (28) (10) (10) 22 22/2 = 11 1 M $ per unit 90 (14) (45) (20) 11 11/9 = 1.400 6.000 kg and we need 7.000 kg.100 kg.

250 units of product M would need: Direct labour = 2 hrs per unit x 250 units = 500 hrs Direct material = 9kg per unit x 250 units = 2.000 kg x 80%) . There is no shortfall in demand.300 hrs Direct material = (6.800 577 x $11 = $6.100 -9- . Your answer should include a proof of the five individual values highlighted in bold. The other value 0 means that we have no further units of L to make as we have reached the maximum market demand for L.147 (b) Construct the revised resource constraints and the objective function to be used to identify. (6 marks) The agreed order of 250 units of product M should be worked out separately for the resources needed to complete it first as this is a requirement. (13 marks) Product L 400 and product L other value 0 The value 400 represents the amount of L we should produce in order to maximise contribution given the resource constraints.550 1.2. therefore: Direct labour = (3.300 2.P2 November 2010 Exam Solutions Contribution from production plan L M Contribution 400 x $22 = $8.347 $15. 4L + 2M 2L + 9M 1L + 2M 2.500 hrs = 2. the revised optimum production plan for December 2010. then we can see what resources are left over to formulate our new resource constraints.250 kg Machine hours = 2 hrs per unit x 250 units = 500 hrs Resources have also been overestimated by 20% and need to be reduced before deduction of resource usage by the agreed order of 250 units of M.000 hrs x 80%) 500 hrs = 1. units.000 hrs x 80%) .100 hrs Revised resource constrains: Direct labour Direct material Machine hours Objective function: C = 22L + 11M (c) Analyse the meaning of each of the above eight values in the solution to the problem.250 kg = 2.550 kg Machine hours = (2. given the additional information above.

We are only producing 194 units of M where as the maximum market demand is 700.22 contribution. Each unit of M requires 9 kg. L units produced = 400 x 1 hr per unit = 400 hrs M units produced = 194 x 2 hrs per unit = 388 hrs Total hours used = 400 + 388 = 788 hrs Hours available = 1.11 units of M could be produced from 1 kg of material. . Machine hours 312 This value represents the number of unused machine hours left at the optimal production point where contribution is maximised given current resource constraints. The other value 506 means that we have not met our maximum market demand of M by 506.10 - . therefore 0.100 hrs Hours unused = 1.P2 November 2010 Exam Solutions Product M 194 and product M other value 506 The value 194 represents the amount of M we should produce in order to maximise contribution given the resource constraints. The shadow price is maximum price you should pay above the original cost for one more extra unit of the scarce resource.11 units yield $1. Each unit of M yields a contribution of $11 and therefore 0. The proof is that if we were given 1 more kg of direct material we would use it to increase output of product M. There is a shortfall in demand of 700 units 194 units = 506 units. Labour hours 312 This value represents the number of unused labour hours left at the optimal production point where contribution is maximised given current resource constraints.100 hrs 788 hrs = 312 hrs Direct material $1. in this case being one more kg of direct material.22 This is the shadow price for direct materials as it is a scarce resource at the optimal production point where contribution is maximised given current resource constrains. We can proof this amount of unused machine hours by comparing what has been used to the total amount of machine hours available. because still has unfulfilled demand.

800 + $2. Proof: Contribution from L units = 400 x $22 = $8.134 = $10.134 Total contribution = $8.934 .11 - .934 This is the maximum contribution that can be earned given the constraints at the optimal production point.P2 November 2010 Exam Solutions Contribution $10.800 Contribution from M units = 194 x $11 = $2.

000 in 2009 and more significantly in 2010. This is because his performance is assessed on ROI. Operating costs appear to be falling over the last three years. In conclusion the improvement in ROI over the last three years is largely down to the depreciation policy rather than improved performance by the division.2% There is a very good improvement of the ROI over the last 3 years from 10% up to nearly 25%. (b) Prepare calculations to show why the manager of the S division is unlikely to go ahead with the investment.5% 62 / 256 = 24.12 - . (9 marks) Return on capital employed (ROCE) = Profit before interest and tax (PBIT) Capital employed x 100% The ROI for the three years: Year 2008 2009 2010 ROI $ 40 / 400 = 10% 56 / 320 = 17. (11 marks) The investment results in a positive NPV of $24. Ignore taxation. however from the perspective of the manger of S division it will depend on whether or not ROI of the division is improved. The gross profit has been constant at 40% and therefore indicating no change in quantity sold and prices.536 and so from a group company perspective it will be accepted by head office to go ahead.P2 November 2010 Exam Solutions Question Seven (a) Discuss the performance of the S division over the three year period. but if depreciation is removed it shows that operation costs have increased by $4. To assess this we will look at the divisional ROI if the investment is undertaken compared to the divisional ROI if the investment is not undertaken. Inflation has been removed according to the question and the figures the same for turnover and cost of sales throughout the 3 years which means there has been no increase in products sold over the last 3 years. .

800 $ 400.800) x 100% = 36.800 (W3) Other operating costs $ 98.800 ROI = ($74.P2 November 2010 Exam Solutions If investment was undertaken: Sales Cost of sales ($240.800 Capital invested at the end of the year ($256.000 x 20%) Add: New depreciation (W2) Total (W2) New depreciation and capital invested at the end of the year $ Current total NBV at the end of 2011 256.000 x 20%) Total .200 Other operating costs Less: Old depreciation ($320.000 Less: NBV of machine sold (40.200 Other operating costs Less: Depreciation ($320.800 ROI = ($86.5% Workings (W1) Other operating costs $ 98.200) Revised total NBV at the end of 2011 252.000 x 20%) Add: New depreciation ($256.000 (64.200) 86.200) 74.200 97.$51.800) x 100% = 34.3% If investment was not undertaken: Sales Cost of sales Gross profit Other operating costs (W3) Pre-tax operating profit $ 400.000 x 90%) Gross profit Other operating costs (W1) Pre-tax operating profit Capital invested at the end of the year (W2) = $252.000) 51.13 - .200) = $204.000 (85.000 216.000 316.000 .000 Less: New depreciation (316.200 85.000 240.800 / $252.000 x 20%) (63.000) 63.000 184.000 (64.000) Add: Cost of new machine 100.800 / $204.000 (97.000 160.

220) 66.420 Difference is an increase of Residual Income if investment undertaken of $8. (5 marks) Profit before interest and tax (PBIT) Capital employed x head office % interest charge Residual Income X (X) X If investment was undertaken: Pre-tax operating profits Notional capital charge ($252.380) 58.800 (20. Ignore taxation.160 .800 x 8%) Residual Income $ 86.800 x 8%) Residual Income If investment was not undertaken: Pre-tax operating profits Notional capital charge ($204.800 (16.P2 November 2010 Exam Solutions (c) Prepare calculations to show how the use of Residual Income (RI) as the performance measure would have led to a goal congruent decision by the manager of the S division in relation to the purchase of the replacement machine.580 $ 74.14 - .