AB11 (Source 2011, Test 2) (33 marks: 40 Minutes)

Luminescence GmbH, a private company incorporated in Germany, is a preferred supplier to

the BMW Group. The company focuses exclusively on the design, manufacture and distribution
of vehicle interior and exterior lighting which BMW views as crucial to the appeal, safety and fuel
efficiency of their product. Over the past few years, Luminescence has developed numerous
technological advancements including (amongst others) the patented BMW Corona Rings and
Bi-Xenon Lights.
Towards the end of the 2010 financial year, BMW reviewed the management practices of
Luminescence and insisted that a performance incentive tool be introduced to ensure that the
2010 standards of innovation and production quality be maintained. Return on Investment (ROI)
was introduced immediately thereafter and as expected, significant improvements in profitability
and asset utilisation were realised in 2011.

BMW has voiced concerns regarding the limited innovations seen in the 2011 financial year as
well as the decreasing volumes of lighting units supplied by Luminescence. They believe the
implementation of a performance measure was left too late and not sufficiently supported. If
necessary, BMW is prepared to seek out an alternative supplier.

The financial statements of Luminescence are presented below:


Luminescence GmbH
Statement of Financial Position for the year ended 30th September 2011
Notes 2011 2010
Assets [000] [000]
Non-Current Assets
Property, Plant and Equipment N1 11 427 20 558
Land and Buildings 10 312 11 258
Intangible Assets N2 5 031 8 632
Financial Assets 1 867 2 001
Other Assets 692 645
Current Assets
Inventory 7 766 3 245
Trade Receivables 2 329 2 465
Cash and Cash Equivalents 7 432 7 500
Total Assets 46 856 56 304
Equity
Subscribed Capital 655 655
Retained Earnings 23 447 20 558
Non-Current Liabilities
Loan 14 277 27 366
Current Liabilities
Trade Payables 4 351 3 529
Provisions 1 300 1 296
Loan 2 826 2 900
Total Equity and Liability 46 856 56 304



N1 The gross replacement cost (GRC) of PPE is 18,000,000 in 2011.
N2 Intangible assets include patents, trademark and other intellectual property. Most
intangible assets such as patents are only valid for 5 years and are amortised over the
period of their useful lives.
N3 Cost of sales includes all costs required to manufacture the inventory, which includes
staff costs 5,600,000 [2010: 7,800,000], depreciation 5,500,000 [2010: 7,000,000],
operating lease expense 8,000,000 [2010: 3,200,000] and other costs.
N4 Only certain transactions are allowed to be hedged by the managers. 60% of these
losses [in 2011 and 2010] were not within the control of managers.
N5 Advisory fees are paid to the BMW Group. 200,000 is an annual fee charged to all
subsidiaries and the rest is charged based on consultation hours required from BMW.

All discretionary expenditure is expected to yield benefits evenly over the next 3 years.

In September 2011, BMW commissioned a new kind of exterior lighting system from
Luminescence. After LED technology, laser lighting is the next generation and, as a leader in the
premium segment, BMW insists that they have this technology in production by 2012. BMWs
Adaptive Laser Headlights can facilitate numerous new lighting functions for even more safety
and comfort, while contributing significantly, through its higher degree of efficiency, towards a
decrease in energy and fuel consumption which is of significant importance with the stringent
new vehicle emission and efficiency standards imposed on vehicle manufacturers.

It is estimated that demand for these laser headlight units will be 49,000 sets per year as these
will be fitted to BMWs i8 hybrid sports car. BMW is willing to pay 1,000 per set and
Luminescence requires a 20% mark-up on cost before a product is considered viable.
Luminescence is currently using the traditional costing system to allocate indirect costs to its
different products but, as can be seen below, this has resulted in a projected loss for the new
laser headlights. BMW insists Luminescence provide the group with more information regarding
its costing, which should include the effects of the production and distribution of the laser
headlights.
Luminescence GmbH
Statement of Comprehensive Income for the year ended 30th September 2011
Notes 2011 2010
[000] [000]
Revenue 60 477 110 889
Cost of Sales N3 (49 562) (92 256)
Gross Profit 12 915 18 633
Foreign Exchange Losses N4 (200) (450)
Selling, Administration Costs (589) (786)
Training and Research Costs (5 256) (12 132)
Operating Lease Expense (978) (462)
Advisory Fees N5 (500) (500)
Depreciation and Amortisation (1 900) (2 541)
Profit Before Interest and Tax 3 492 1 762
Interest Expense (855) (1 513)
Profit Before Tax 2 637 249
Tax (396) (37)
Net Profit After Tax 2 241 211



A1 Product costs relate to direct purchased-in costs of the product that is sold. These
include raw materials such as focus lenses, infrared filters, crystal pieces, radiation
emitters and glass tubes.
A2 Indirect costs are allocated to products on the basis of 45% of sales revenue.

Additional information provided to the BMW Group:
[These costs relate to all of Luminescences operations]

A3 The company budgeted to operate at 75% of practical capacity for all activities.
A4 Senior management remuneration represents 30% of the total Order Management
costs. It is expected that the senior management team is able to handle any volume of
activities in all operations and these members are considered indispensible to the
company operations of the company.
A5 For 2012, it is expected that the premises cost would amount to 450,900 at an output
of 3,470,000 units whereas the cost would be 460,000 at an output of 3,600,000 units.
As these costs relate directly to the production activities of Luminescence management
requires that they be allocated to products under the ABC system.
A6 Packing and Distribution entails packing items into protective containers and
outsourcing the distribution to DHL, where the light units will be delivered to BMWs
Munich factory on a just-in-time basis. 200,000 of this cost is expected to be fixed as
they relate to salaries, forklift rental, etc.
A7 Quality Control is done per batch, which consists of random selection of the units which
are physically checked for defects by a skilled salaried employee.


Luminescences weighted average cost of capital is 9.6%. The current corporate tax rate
in Germany is 15%. All answers and workings must be done in Euros.



Notes [000]
Sales 49,000
Product Costs A1 (26,950)
Indirect Costs A2 (23,520)
Product Loss (1,470)
Luminescence Profitability Analysis - BMW Adaptive Laser Headlights
Activity Cost Driver
Budgeted Total
Cost for 2012
Budgeted
Activity Level
for 2012 [A3]
Notes [000] [000]
Order Management A4 No. of Orders 3 000 60
Premises A5 No. of Units 453 3 500
Packing and Distribution A6 No. of Batches 443 330
Quality Control A7 No. of Batches 45 330
Luminescence Costing Analysis - Indirect Costs
Budgeted 2012 Activities Levels - BMW Adaptive Laser Headlights
No. of Orders 100
No. of Units 49,000
No. of Batches 4,500



Required

1. Is it suitable for Luminescence to implement an ABC system? (3)

2. Discuss whether Luminescences criterion of a 20% mark-up for project acceptance is
appropriate? If not, what should such a decision be based upon? (3)

3. Given the activity based information presented, re-perform the profitability analysis for the
laser headlights. (20)

4. What other considerations should be taken into account by Luminescence when deciding
whether or not they should be producing and distributing the laser headlights for BMW?
(5)

Professional Communication: format and presentation (2)
































Suggested Solution AB11

Part B
Question 4
It depends,

1. The company produces several different lighting products that are diverse (both
internal and external lighting solutions) and complex. It is likely these consume
very different amounts of resources and allocation based on the percentage of
revenue earned is unlikely to be accurate, ABC would likely be more so.
(1)

2. Indirect overheads do not appear to be a substantial portion of total costs i.e.
3,696 (total indirect overheads) vs. 58,985 (total costs per 2011 income
statement). As such the cost of maintaining an ABC system is substantial and
may outweigh the benefit. (2)

3. Luminescence uses a 20% mark-up on cost for all products currently produced,
it is unlikely that ABC will cause 'profitable' products to become unprofitable
given the extent of this mark-up and the relatively small amount of indirect
costs. The value of ABC is thus doubtful. (1)

4. As Luminescene REQUIRES a 20% mark-up on cost for all products, incorrect
cost allocation may result in the rejection (as seen in the case of Laser lights) of
otherwise acceptable projects. (1)



Maximum (3)














Description Costs Activity Level Rate / Activity Usage Cost
[000] [000]
Order Management 2 100.00 80.00 26.25 100.00 2 625.00 1
Premises - Variable - - 0.07 49 000.00 3 430.00
Premises - Fixed 208.00 4 667 0.04 49 000.00 2 184.00
Package and Distribution - Fixed 200.00 440.00 0.45 4 500.00 2 045.45
Package and Distribution - Variable 243.00 330.00 0.74 4 500.00 3 313.64
Quality Control 45.00 440.00 0.10 4 500.00 460.23
14 058.32
3 Marks 4 Marks 2 Marks 2 Marks 11
Profitability Analysis
Sales 49 000 000.00 1 Given
Product Costs (26 950 000.00) 1 Given
Indirect Costs (14 058.32) 1 Carry-through
Profitability Analysis 22 035 941.68 1 Total
Hi-Lo Calculation
= Change in cost / Change in activity
= 460,000 - 450,900 9 100 1
= 3,600,000 - 3,470,000 130 000 1
0.07 Variable per unit & 208 000 Fixed 2
TOTAL 20
Mark Allocation
Correct denominator level of activity (fixed = practical, variable = budgeted) 4 If used budgeted for ALL = just 2 marks i.e. for variable
Correct fixed and variable split 3 If no indication of thought of variable / fixed = 0
Calculating rate per activity 2
Multiplying rate per activity by laser headlight usage 2
Order management calculation (70% relevant) 1
Hi-Lo 4
Profitibility analysis 4
Maximum 20
BMW Adaptive Laser Headlights
Question 5
No,

There is no indication of why 20% is considered necessary. It would appear an
arbitrary acceptance criteria. (1)

Project acceptance should be based on whether the project is value creating or not
i.e. whether the ROI exceeds the WACC and a positive NPV is generated.
(2)


Question 6





Please note that there were various assumptions that could have been made regarding
the Premises costs and Package and Distribution costs and alternative solutions based
on the reasonable assumptions were awarded full marks, these include:
Premises only 208 being the fixed costs would be relevant for costing purposes and
there would be no variable costs.
Package and Distribution the full 443 would be regarded as fixed cost with no variable
costs OR 2,000 would be regarded as fixed costs with no variable costs OR 2,000 being
the fixed costs with 2,430 being the variable costs.


Question 7
1. Luminescence is a preferred supplier to BMW. It is likely BMW accounts for the
majority of Luminescence's revenue and this reliance on BMW should be
considered when setting the price of a new product required by BMW. (2)

2. Luminescence would appear to have spare capacity (budgeted operations at 75% of
practical) and additional profitable projects (like this one) should be considered on a
relevant costing basis (fixed costs are unlikely to be relevant - unless a repeat
order).
(2)

3. Laser lights will be a technological breakthrough and will likely re-establish
Luminescence's superiority in innovation. This is crucial to maintaining their BMW
relationship. It is also likely to attract additional customers.
(2)
Any other valid points (1)
Maximum (5)
Professional Communication: Format and presentation (2)