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Examiners commentaries 2014

Examiners commentaries 2014


AC3097 Management accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 201314. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).

Information about the subject guide


Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2013).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refers to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements if
none are available, please use the contents list and index of the new edition to find the relevant
section.

General remarks
Learning outcomes
At the end of this course, and having completed the Essential reading and activities, you should
beable to:

critically evaluate the uses of managerial accounting information for strategic decision
making in various business contexts

select, devise and apply different types of cost allocation and explain their different roles
forsupporting strategic managerial decisions

design and prepare budgets and explain their use in strategic planning and control

design and use variances to support feedback analysis and strategic control

discuss various approaches to performance measurement and control in various types


oforganisations, and devise and evaluate simple indicators of performance

discuss the changing role of management accounting.

What are the Examiners looking for?


The AC3097 Management accounting paper follows the AC1025 Principles of accounting
paper and assumes that candidates are familiar with the subject matter and have the necessary
skills required for that course. Candidates who achieved a low pass in AC1025 Principles of
accounting may need to revise the management accounting chapters of that subject guide as part
of their preparation for this examination.The Examiners are looking for a depth of understanding of
the use of management accounting information for decision making, planning and control. They

AC3097 Management accounting

want to see an appreciation of how the information is collected and compiled and the organisational
contexts in which it is used.
Candidates should show a clear ability to identify the necessary computations and perform them
logically in order to derive answers to the questions. Where answers include calculations,
theworkings as well as the answer should be clearly presented.
Written answers should be well structured, demonstrating the ability to discuss issues and focus
onthe relevant areas where necessary. Candidates should read the whole of each question carefully
and answer exactly what is asked for. Writing general answers to specific questions will not gain
marks, but instead wastes valuable time that could be used on another question.
Management accounting is about performing the correct calculations and presenting the information
in such a way that other managers can understand it and use it in their discussions on the best
course of action. This aspect of the subject is reflected in the way that questions are set. Often
candidates are asked, in early parts of a question, for information to be calculated that is then
required for later parts of the question.

Planning your time in the examination


The time allowed for the examination is three hours and 15 minutes.
In Section A, candidates should not only look at the topic that is being examined but also make
surethey understand the way in which the question should be answered. This may help you to avoid
wasting time on a question that is too complex for you to continue with beyond the first part.At the
start of the examination it would be helpful to choose all the questions you intend to answer. While
answering one question, a different part of your brain can start marshalling ideas relevant tolater
ones, especially with written questions. Similarly, if you get stuck on a calculation question, itis
often beneficial to move on to another one, returning to the original question later. By this time
your brain may have run though new possibilities which can be tried.
Generally, candidates should not spend more than the allotted time (i.e. 45 minutes) on any
onequestion.

Format of the examination


The examination consists of two sections: Section A has questions that require the use of
calculations and comments on the numerical answers calculated. Section B has questions requiring a
written answer. Candidates must answer at least two questions from Section A, one question from
Section B and one other from either section.
The purpose of having two sections is to ensure that, in order to pass, candidates are able to
perform calculations and describe and discuss issues. The choice of answering the fourth question
from either section offers candidates the opportunity to perform to their strengths.
In order to ensure that candidates attempt the numerical parts of the questions in Section A,
therewill rarely be more than five marks allotted to comments and these will usually be related to
the calculations provided. The content of the subject guide, the textbook chapters and other
readingreferred to in the subject guide constitute the framework for working through the syllabus
against which the Examiners set the papers.

Key steps to improvement

Read the Essential and Further readings for the course.

Practise writing essays that relate to or contrast different aspects of the syllabus.

Examiners commentaries 2014

Work through numerical questions from the subject guide, the textbook and, if not fully
understood previously, from the subject guide for AC1025 Principles of accounting.
Since the paper requires at least two (and up to three) Section A questions to be answered,
it is important to practise a wide variety of numerically based questions. Even if you attend
an institution where you study with a lecturer who provides practice questions, you should
attempt the textbook questions recommended in your subject guide. The Examiners will
use these questions to gauge the appropriate level at which to set examination questions for
Section A.

Diploma for Graduates students who may not have taken AC1025 Principles of
Accounting paper may need to practise some questions from that paper and/or extra
questions at the end of each textbook chapter for AC3097 Management accounting in
order to develop their proficiency and speed in answering these types of question.

When answering questions in Section A, candidates answers should provide all of the
financial calculations requested in each part of the question. Candidates cannot rely on the
Examiners realising that they knew the answer to a previous part because they used
theinformation in a later part.

Answers to questions in Section B should be focused on the question asked. At least one
question will usually give candidates an opportunity to show initiative and relate ideas and
concepts from different parts of the syllabus.

Question spotting
Many candidates are disappointed to find that their examination performance is poorer
than they expected. This can be due to a number of different reasons and the Examiners
commentaries suggest ways of addressing common problems and improving your performance.
We want to draw your attention to one particular failing question spotting, that is,
confining your examination preparation to a few question topics which have come up in past
papers for the course. This can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in the same depth, but
you need to be aware that Examiners are free to set questions on any aspect of the syllabus.
This means that you need to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the Course information sheet in the section of the VLE dedicated
to this course. You should read the syllabus very carefully and ensure that you cover sufficient
material in preparation for the examination.
Examiners will vary the topics and questions from year to year and may well set questions that
have not appeared in past papers every topic on the syllabus is a legitimate examination
target. So although past papers can be helpful in revision, you cannot assume that topics or
specific questions that have come up in past examinations will occur again.
If you rely on a question spotting strategy, it is likely you will find yourself in
difficulties when you sit the examination paper. We strongly advise you not to
adopt this strategy.

AC3097 Management accounting

Examiners commentaries 2014


AC3097 Management accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 201314. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).

Information about the subject guide


Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2013).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refers to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements if
none are available, please use the contents list and index of the new edition to find the relevant
section.

Comments on specific questions Zone A


Candidates should answer FOUR of the following EIGHT questions: TWO from Section A, ONE
from Section B and ONE further question from either section. All questions carry equal marks.
Section A
Answer two questions and no more than one further question from this section.
Question 1
Kevin Paterson is a sports groundsman working in Sydney, Australia. After several
years working for employers, he has decided to establish his own business. For six
months each year from October to March he will concentrate on the maintenance of
cricket grounds. He intends to work eight hours a day, for six days a week, for the
26 weeks of the season; a total of 1248 hours.
From experience with several cricket clubs, he knows that the work falls into three
types: Outfield maintenance, Maintenance of the cricket square and Preparation
of pitches for specific matches. He will charge his own time at $15 per hour. There
will be variable material costs of $15 per Outfield maintenance, $12 per Square
maintenance and $9 per Pitch preparation. The fixed overheads covering insurance,
equipment and repairs will be approximately $9360 for the six month period and
will be charged to the each type of work based on Kevins labour time.
Kevin will work for several local clubs. He estimates that Outfield maintenance will
occupy eight hours, Square maintenance four hours, and Pitch preparation two
hours. After discussions with the local clubs, he plans to charge $210 per Outfield
maintenance, $110 per Square maintenance, and $70 per Pitch preparation. At
these prices he believes he can secure orders for 78 Outfield maintenances, 130

Examiners commentaries 2014

Square maintenances and 234 Pitch preparations during the season.


Required:
(a) i. Prepare a schedule to show the revenues, costs and profit of each type of
work.
ii. In view of Kevins time limitation advise him of the most financially
beneficial mix of work to be undertaken and the profit he could earn.
(10 marks)
(b) Kevin has established a good reputation during his first season. He decides to
abandon Outfield maintenance and concentrate on the more specialised Square
maintenance and Pitch preparation. He plans to hire a contractor with a high
class mower to further improve the standard of his work. The contractor
charges $15 per hour but can only work 30 hours per week for Kevin. Kevin will
still need to spend the same amount of time on each type of work as previously
estimated and his other costs will remain at the same levels as the previous year.
With this additional contractor Kevin feels he will be able to charge $150 for a
Square maintenance (which will require 2 hours of contractor time), and $90
per Pitch preparation (which will require 1 1/2 hours of contractor time).
Kevins projected orders are 260 Square maintenances, and 468 Pitch
preparations in the season.
Advise Kevin of the optimum volume and mix of work to be undertaken in this
situation and the profit he will earn based on your recommendation. Comment
on the results of your calculations in (a) and (b) above.
(10 marks)
(c) Kevin is considering using the mowing contractor more and would like him to
work an extra 2 hours per week. He is prepared to pay $23 per hour for this
extra work. Provide calculations to show whether this would be worthwhile for
Kevin.
(5 marks)

Reading for this question


Subject guide, Chapter 2.
Drury, C. Management and cost accounting. (London: Cengage, 2008) seventh edition [ISBN
9781844805662] Chapters 9 and 25. (Hereafter cited as Drury.)
Horngren, C.T., S.M. Datar and M.V. Rajan Cost accounting: a managerial emphasis. (Harlow:
Pearson Education 2012) fourteenth edition (international) [ISBN 9780273753971] Chapter 11.
(Hereafter cited as Horngren.)
Approaching the question
This limiting factors question has only one limiting factor in part (a) and two in parts (b) and (c).
(a) i. For part (a) (i) the profit for each product was requested. This involved dividing the
fixed costs by the expected (budgeted) hours available. Although the demand for
different types of work provided a figure for the number of hours Kevin could work, the
question stated the hours he was planning to work, 1,248 hours. This therefore is the
denominator needed to calculate the hourly overhead rate.
Workings calculation of overhead rate per hour: $9,360/1248 hours = $7.50 per hour.

AC3097 Management accounting

Projected unit costs and revenue by type of work:

Price charged
Projected costs
Labour @ $15 hour
Direct materials
Overheads $7.50/hour
Total cost
Profit

Outfield Mtce
$
210

Square Mtce
$
110

Pitch Preparation
$
70

120
15
60
195
15

60
12
30
102
8

30
9
15
54
16

ii. Part (a) (ii) should use the contribution per unit of each type of work, not the profit as
calculated in part (a) (i). Although in this question the profit figure would give the
correct ranking because the limiting factor is labour hours which is also the activity used
to determine the overhead rate, it is conceptually incorrect and would not lead to the
correct total profit figure because not all the available hours can be used. The
contribution can be calculated by taking the profit + fixed costs (as is done in the
answer below) or by taking price less variable costs.
Limiting factor Kevins time
Hours needed for all work
Outfield
Square
Pitch
Total hours

78 8 hrs
130 4 hrs
234 2 hrs

Hours
624
520
468
1612

Kevin has only 1,248 hours available, so 364 hours of work cannot be done and limiting
factor analysis is needed.

Contribution per unit of work


Contribution per labour hour
Ranking

Outfield
$60 + $15 = $75
$75/8 = $9.38
3rd

Square
$30 + $8 = $38
38/4 = $9.50
2nd

Pitch
$15 + $16 = $31
31/2 =15.50
1st

Most profitable work schedule


Work ranking
234 pitches
130 squares
32* outfields (balancing figure)
Total
Less fixed costs
Total income

Hours
468
520
256
1244

Contribution $
7,254
4,940
2,400
14,594
9,360
$5,234

*it is not possible to do 0.5 of an outfield maintenance.


(b) Part (b) changes the problem and moves to only two types of work and the use of an
additional resource, the mower contractor. The mower contractor works on the same jobs as
Ian but does not necessarily need to work at the same time. It is first necessary to
determine whether the time needed for the demand is limited for both constraints.
Suggested answer to (b)
Square maintenance
Pitch preparation
Total
Time available

Kevins time
260 4 hrs = 1040
468 2 hrs = 936
1976
1248 hrs

Mower time
260 2 hrs = 520
468 x 1.5 hr = 702
1222
26 30 = 780 hrs

There is more work available than labour hours and mower hours so there are two limiting
factors
If the two constraints give different product preferences on contribution per limited resource
it would be necessary to use linear programming to find the optimal volume and mix of

Examiners commentaries 2014

work. However if both constraints give preference to one of the products then this can be
prioritised. The calculation below provides the required information.
Calculation of contribution per limiting factor
Square maintenance
Selling price
Labour
Materials
Mower hire
Contribution
Contribution per labour hour
Contribution per mower hour

Pitch preparation
150
(60)
(12)
(30)
48
12
24

90
(30)
(9)
(22.5)
28.5
14.25
19

Each constraint shows a different highest contribution per hour so linear programming is
required.
(c) Candidates should provide a graph with contribution line or test all corners mathematically
to determine optimal solution.
Linear programming solution:
Objective function: Maximise 48S + 28.5P where:
4S + 2P < 1248 Kevins hours
2S + 1.5p < 780 mower hours
0 < S < 260 square demand
0 < P < 468 pitch demand ..

AC3097 Management accounting

The graph shows that the intersection of Kevins hours and the mowers hours is the
optimal solution. The quantities of each type of work can be read from the graph if it is
drawn accurately, otherwise using simultaneous equations will give the correct answer.
Kevins hours and mower hours
Multiply mower hours equation 2:

Profit calculation
Square 156 $48
Pitch 312 $28.5

4S + 2P

1248

4S + 3P

1560

312

4S

1248 624

156

Kevins hours
624
624
1248

Mower hours
312
468
780

Less fixed costs


Total income

Profit calculation
7,488
8,892
16,380
9,360
$7,020

This is more profitable by $1,786 than the previous work schedule, so Kevin should proceed
with the new plan.
Alternative corners (If graph is not provided)
Mower hours and pitch demand

2S + 1.5P

780

mower hours

468

pitch demand

Multiply pitch demand by 1.

1.5P

702

2S

78

39

contribution
Squares 39 $48
Pitches 468 $28.5
Total contribution

1,872
13,338
$14,210

Labour hours and squares demand

4S + 2P

1248

labour hours

260

square demand

Multiply squares demand by 4

4S

1040

2P

208

104

Examiners commentaries 2014

Contribution
Squares 260 $48
Pitches 104 $28.5
Total contribution

12,480
2,964
$15,444

Both of these alternatives show lower contribution than calculated above, so the mix of work
shown in the first solution is optimal.
Suggested answer to (c)
Additional cost for mowing contractor $8 26 weeks 2 = $416.
New mower hours = 832.
Note: the contributions used in the objective function do not change because the extra pay
only relates to the extra 52 hours.
Linear programming solution including demand constraints: Maximise 32S + 19P $416
where:
4S + 2P = 1248 Kevins hours
2S + 1.5p = 832 Mower hours
S = 260 Square demand
P = 468 Pitch demand
The graph shows that Kevins hours and mower hours is the optimal corner
Multiply mower hours 2:

Profit calculation
Square 104 48
Pitch 416 28.5

4S + 2P

1248

4S + 3P
P

=
=

1664
416

4S

1664 1248

104

Labour hours
416
832
1248

Contractor hours
208
624
832

Less fixed costs


52 $8

Less extra pay for contractor


Total income

Profit calculation
4,992
11,856
16,848
9,360
7,488
416
$7,072

This option is slightly more profitable by $52 .


Check other corner impacted by change in hours
Mower hours and pitch demand
2S + 1.5P

832

mower hours

468

pitch demand

Multiply pitch demand by 1.5


1.5P

702

2S

130

65

Contribution
Squares 65 $48
Pitches 468 $28.5
Total contribution

3,120
13,338
$16,458

This alternative provides less contribution so is not optimal.

AC3097 Management accounting

Question 2
Modern Manufacturing Ltd makes several products and is considering its operations
for the forthcoming year. The following activity cost centres are used and the
budgeted usage on forecast production and sales is shown;
Table 1
Activity cost
centre

Cost
driver

Machine

machine
hours
hours
hours
cubic
hours

Setup
Stores handling
Stores
Administration

Total
capacity of
Cost driver
hours
100,000

Budgeted
usage of
Cost driver
hours
80,000

Activity Centre
Fixed Costs

Variable Cost
per driver

2,400,000

2,500
1,000
60,000
100,000

2,400
1,000
50,000
100,000

480,000
350,000
800,000
400,000

40
150
0
0

Required:
(a) Calculate the total cost per cost driver for each activity centre based on the
budgeted usage shown in Table 1.
(5 marks)
(b) The company is considering launching a new product and has estimated the cost
of obtaining additional capacity in each activity cost centre as shown in the
table below.
Table 2
Fixed cost changes due expanding capacity of each resource from current total
capacity would involve the following:
Activity
centre

Additional Fixed cost

Additional
yearly capacity

Machine

Buy new machine with a 5 year life 6,000,000


and no residual value

40,000 hours per


year.

Setup

Part time employee 14,000*


Full time employee 28,000*

800 hours
1,600 hours

Stores handling

Part time employee 14,000*


Full time employee 28,000*

800 hours
1,600 hours

Stores

Additional storage unit 30,000 annual rent

Administration

Part time employee 17,000*


Full time employee 34,000*

20,000 cubic
metres
800 hours
1,600 hours

project appraisal is not required use depreciation as annual cost


* Step fixed costs
After performing market research the company wishes to go ahead with a new
product in addition to its existing budgeted work shown in Table 1. The new
product will have the following characteristics:

10

Examiners commentaries 2014

Sales information:
Predicted annual demand
Selling price per motor

10,000 units
350

Cost information and resource use per motor:


Direct material per motor
Direct labour-hours per motor (rate 20 per hour)
Machine hours per motor
Number of motors per batch
Setup hours per batch
Stores use of space per motor
Handling Number of different components per motor
Handling hours per component per batch
Administration hours per unit

30
2.0 hours
4.5 hours
500
8 hours
2 cubic metres
30 components
0.2 hours
1 hour

i. Provide a statement for each of the activity centres showing:


the spare capacity available in each of the activity centres after producing
existing production.
the total cost of capacity needed to make the existing production and 10,000
units of the new product.
the revised cost per cost driver at this level of production.
(10 marks)
ii. Provide a statement of the future incremental revenues and costs which would
occur if 10,000 units of the new product were made.
(4 marks)
iii. Produce a statement of the ABC cost and profit of the new product.
(2 marks)
iv. Comment on whether the company should produce and sell the new product.
Include in your answer any other issues which the company should consider.
(4 marks)

Reading for this question


Subject guide, Chapter 6.
Drury, Chapters10, 21 and 22.
Horngren, Chapters 5 and 11.

Approaching the question


(a) The aim of this question was to explore how ABC costs change with a change in demand for
resources due to the introduction of a new product and to use both relevant cost and ABC
cost to determine the financial effect of the contemplated expansion of activity.
Existing budget
Activity cost centre

Machine hours
Setup hours
Stores handling hrs
Stores cubic metres
Administration hrs
Total

budgeted usage & cost


Budgeted
usage
80,000
2,400
1,000
50,000
100,000

Fixed
000
2400
480
350
800
400
4,430

Variable
per driver
6
40
150
0
0

Total
variable 000
480
96
150
0
0
726

Total
000
2,880
576
500
800
400
5,156

Cost per
cost driver
36
240
500
16
4

11

AC3097 Management accounting

When calculating the cost of additional resources for set-up hours, stores handling hours
and administration it was necessary to calculate how many additional staff would be needed
as these are step fixed costs. It is possible to employ part-time or full time staff as required.
(b) Calculation of new cost drivers if expansion takes place.
Activity centres

Machine
(hours)

Set up
(hours)

Total usage available


Budgeted usage
Available for new product
Needed for new product
Hours/etc to be obtained
New budgeted resources

100,000
80,000
20,000
45,000
25,000
125,000

2,500
2,400
100
160
60
2,560

Costs
Existing fixed costs
Fixed Cost of additional resources*
Variable cost of total hours
Total cost per activity centre

000
2,400
1,200
750
4,350

34.8
New
machine
depn

000
480
14
102.4
596.4

233
1 part-time
employee

Cost per cost driver


*Basis of additional cost

Stores
Handling
(hours)
1,000
1,000
0
120
120
1,120

Stores
(cubic
mtrs)
60,000
50,000
10,000
20,000
10,000
70,000

Admin
(hours)
100,000
100,000
0
10,000
10,000
110,000

000
350
14
168
532

475
1 part-time
employee
employee

000
800
30
0
830

11.86
Ne wunit
rent

000
400
221
0
621

5.64
6.5 new
employees

For incremental revenues and cost calculation, the costs of resources, other than material
and direct labour, can be calculated by subtracting the new and old total costs shown above
or provide in the following way:
Statement of forecast Incremental revenues and costs of new product and ABC
costing
Sales revenues 350 10,000
Materials 30 10,000
Labour 40 10,000
Machine (annual depreciation on new machine)
Machine variable 45,000 6
Setup hours fixed new part time employee
Set-up variable 160 40
Stores handling fixed new part time employee
Stores handling 120 150
Stores fixed 10,000 cubic metres
Stores variable 20,000 0
Administration fixed 10,000 hours/1,600 = 6.25 34,000
Total incremental cost/ABC cost
Additional relevant contribution/ABC profit

New machine
3,500,000
300,000
400,000
1,200,000
270,000
14,000
6,400
14,000
18,000
30,000
0
212,500
2,464,900
1,035,100

ABC workings

45,000 34.8

ABC
3,500,000
300,000
400,000
1,566,000

160 233

37,280

120 475

57,000

20,000 11.86

237,200
0
56,400
2,653,880
846,120

10,000 5.64

The analysis indicates that it would be worth proceeding with the new product if forecasts
are accurate.
The incremental financial analysis shows that it is very worthwhile because idle capacity is
being used. The expansion needed in administration seems quite large.
The ABC analysis which represent long run full cost at these levels of activity show profits
of 24.2% of revenue, which seems reasonable. However cost of stores seems particularly high.
Management should also consider that forward planning for subsequent years is needed as
several decisions have future consequences as discussed below.
Machining Buying the new machine can be used for the work for five years. Only 25,000
hours of the 40,000 available are needed for the new product so there would be room to
expand any of the companys products or to introduce other new products over the
machines 5 year life.
Stores The new stores facility is larger by 10,000 cubic metres per year than is needed at
present, so it might be possible to find a smaller or cheaper facility, although the proximity
to the existing operation is a priority. However if the investment in machinery goes ahead
with the plan of expanding further, renting the larger unit may be suitable.

12

Examiners commentaries 2014

Question 3
Boris Bikes PLC is a U.K. company manufacturing motor scooters. It has recently
decided to build a factory in Singapore, to serve both the Singaporean and other
markets in the Far East. After the initial period of capital investment, you have
been appointed Financial Director of the Singaporean subsidiary.
The new factory is due to open in January 2015. You are aware that the first four
months of operations will be critical to its long term survival and you wish to
prepare budgets for that period. After consultation with the Boris Head Office you
discover that:
Expected sales are $2.0 million in January, $3.0 million in February, $4.0 million in
March and $5.0 million in April.
Monthly fixed expenses are expected to be:
Production overheads
Selling overheads
Administration overheads

$2,000,000
$250,000
$250,000

The budget for variable operating expenses is expected to be:


Direct Materials
Direct Wages
Production Overhead
Selling Overhead

20%
10%
5%
2%

of
of
of
of

sales
sales
sales
sales

revenue
revenue
revenue
revenue

Required:
(a) Prepare in columnar form, an operating budget for the months of January to
April showing projected income, operating expenses, and the budgeted
operating income.
(6 marks)
(b) You also establish that on 1st January 2015 Head Office will provide you with
an opening cash balance of $1.5million at, and you are concerned as to whether
this will be sufficient. On researching the timing of receipts and payments
relating to the operating budget you discover the following:
Sales Revenue will be 50% within Singapore and 50% from exports.
Singaporean customers will pay in the month following the sale, export
customers two months after the sale.
Direct Materials will be paid for in the month after their usage.
Direct Wages and Variable Production Overheads will be paid for in the month
to which they relate.
Fixed Production Overheads relate largely to the manufacturing plant which is
highly automated. They therefore include a monthly depreciation charge of $1.0
million. They also include an annual insurance premium of $2.8 million which
must be paid in January, and property taxes of $1.6 million must be paid twice
a year in March and September (a yearly total of $3.2million). The remaining
costs are due for payment in even monthly amounts throughout the year.
Variable Selling Overheads are payable in the month following the month to
which they relate.
Fixed Selling Overheads and Administration Overheads are spread evenly
throughout the year, and are payable in the month to which they relate.
A payment of $4 million is outstanding on the capital cost of the automated
plant and providing that the plant is working satisfactorily will be paid in
April.

13

AC3097 Management accounting

In setting up the Singaporean subsidiary Boris purchased more land than was
needed. A site of 2 hectares is now being sold for its cost price, of $3 million
which will be received in March.
You have established good relations with the local branch of a major bank, and
are aware that short term overdraft facilities are available. Interest will be paid
at 1% per month on the balance outstanding at the previous month end.
Prepare a cash budget for Boris Bikes (Singapore) for the months of January to
April.
(15 marks)
(c) Rather than using the short term overdraft facilities with the bank as described
above you could negotiate a formal loan of $6.0 million for one year from Boriss
subsidiary finance company. This will involve formal interest payments of
$150,000 payable quarterly.
Discuss the issues involved in this approach. Which alternative would you
recommend to your Board of Directors, and why?
(4 marks)

Reading for this question


Subject guide, Chapter 8.
Drury, Chapter 15.
Hongren, Chapter 6.

Approaching the question


(a) This question required candidates to carefully follow the information given, remembering
that the operating budget required in part (a) will be compiled on an accrual basis and the
cash budget required in part (b) will be on a cash basis. The cash may be paid for or
received in a different month from the one in which the item appears in the operating
budget.
BORIS BIKES PLC. Operating budget

Sales revenue
Budgeted costs
Direct materials
Direct wages
Production overhead Variable
Fixed
Selling Overhead Variable
Fixed
Administration overhead
Total costs
Operating income

January
000
2,000

February
000
3,000

March
000
4,000

April
000
5,000

400
200
100
2,000
40
250
250
3,240
1,240

600
300
150
2,000
60
250
250
3,610
610

800
400
200
2,000
80
250
250
3,980
20

1000
500
250
2,000
100
250
250
4,350
650

(b) Before the cash budget can be prepared it is necessary to provide workings to calculate the
impact on the cash flow of the Fixed Production Overheads. Depreciation which is included
is a non-cash expense. Some other expenses are charge in equal amounts in under the
accrual method but payments are made in specific months of the year.
All the cash receipts should be in the top section of the cash budget, followed by the cash
payments. It is therefore important to leave enough space in case you discover additional
cash receipts, later in the question. In this case it is the Land Sales which you are told
about near the end of the question.

14

Examiners commentaries 2014

Workings
Fixed production overheads
The monthly amount is 2,000,000 giving an annual budget of
Deduct depreciation which is a non-cash item 12 1,000,000
Deduct other costs which do not arise monthly:
Insurance
Local taxes (2 800,000)
Annual Fixed overhead paid for on a monthly basis

000
24,000
12,000
2,800
3,200
6,000

Therefore cash paid each month for Fixed Production overhead other than above
= 6,000,000/12

500

Cash budget

Opening cash balance b/f


Cash receipts
Sales revenue Home
Export
Land sales
Total cash inflow
Cash outflows
Direct materials
Direct wages
Production overhead Variable
Insurance
Local Taxes
Other Fixed (see above)
Selling Overhead Variable
Fixed
Administration Overhead
Capital Payment
Total cash outflow
Cash balance before overdraft interest
Overdraft Interest @ 1%
Closing cash balance c/f

January
000s
1,500

200
100
2,800
500
250
250
4,100
2,600
2,600

February
000s
2,600

March
000s
3516

April
000s
1911

1,000

2,000
1,500

1,000

1,500
1,000
3,000
5,500

400
300
150

600
400
200

800
500
250

500
40
250
250

1,600
500
60
250
250

1,890
3,490
26
3,516

3,860
1,876
35
1911

3,500

500
80
250
250
4,000
6,630
5,041
19

(c) Part (c) required you to consider not only the cost of the loan compared to the overdraft
but also that the lender is another subsidiary of the same group, whereas the bank is an
outside party.
The cash balance shows an increasing overdraft over the four months to 5,060,000. This is
due to low initial sales, a net capital outflow of 1,000,000 and prepaid insurance and local
taxes. By April the net inflow from trading activities is positive at 3,500 2,630 = 870.
Assuming that sales continue to grow, the overdraft will reduce and may be non-existent
within a few months.
However, there is a need to recognise uncertainties relating to sales projections, further
capital expenditure and further revenue expenditure e.g. on advertising.
The loan from the subsidiary is at 10% p.a. as opposed to 12% for the overdraft but is
payable for the whole year, which may result in a higher overall cost.
However the interest payments would remain within the group, so depending on the finance
companys other opportunities to lend it may be more beneficial to the group to accept the
internal loan.
A review of the cash budget to look at adjusting the timings of some of the receipts and
payments to reduce the cash deficit should be undertaken, e.g. collecting debts quicker,
defering payment for the capital equipment, paying for insurance and local taxes on a
monthly basis

15

AC3097 Management accounting

Question 4
Smart Kitchens PLC is a divisionalised company making kitchen products. The
company has three divisions, Small electrical appliances Utensils and Crockery.
Each division makes products which are sold to many retail companies.
Financial data for the three divisions for the year ended 31st March 2014 are shown
below:
Income statement for year ended 31.3.2014

Turnover
Variable costs
Contribution
Fixed costs
Research & development
Advertising
0Tangible asset Depreciation
Other fixed costs
Total fixed costs
Controllable net income
Allocated head office costs*
Divisional net income before tax
Taxation 35%
Net Income after tax

Appliances
000
18,500
(5,100)
13,400

Utensils
000
4,650
(1,470)
3,180

Crockery
000
14,500
(6,100)
8,400

Total
000
37,650
(12,670)
24,980

(300)
(200)
(3,000)
(3,400)
(6,900)
6,500
(1,850)
4,650
(1,628)
3,022

(50)
(10)
(450)
(840)
(1,350)
1,830
(465)
1,365
(478)
887

(10)
(60)
(1,600)
(730)
(2,400)
6,000
(1,450)
4,550
(1,592)
2,958

(360)
(270)
(5,050)
(4,970)
(10,650)
14,330
(3,765)
10,565
(3,698)
6,867

Summary of Financial position at 31.3.2014


Non-current assets:
Cost
Accumulated depreciation
Written down value
Net current assets
Total net assets

23,400
(5,000)
18,400
1,800
20,200

8,100
(4,750)
3,350
2,500
5,850

22,000
(15,000)
7,000
2,500
9,500

53,500
24,750
28,750
6,800
35,550

*charged on turnover ratio


Required:
(a) For each of the divisions and the company as a whole calculate:
i. Net income % and Return on Investment using both divisional controllable
net income and divisional net income before tax.
ii. Calculate the residual income for each division based on net income after tax
using an after tax capital charge of 8%.
(12 marks)
(b) i. Comment on the divisional performance shown in your results in (a).
ii. Using the more detailed information given in the table above and providing
three additional ratios which would enhance the understanding of each
divisions performance. Comment on the insights revealed.
iii. If bonuses were payable to divisional managers on the basis of the divisional
financial results, explain with reasons, how you would recommend the bonus
to be calculated.
(13 marks)

16

Examiners commentaries 2014

Reading for this question


Subject guide, Chapter 9.
Drury, Chapter 19.
Hongren, Chapter 23.

Approaching the question


(a) The requirements for part (a) were clear and required routine calculations of ratios which
are use in both financial and management accounting analysis so it was possible to obtain 12
marks just on this part. Net income % means net income as % of sales. Investment
valuation for Return on Investment calculations most commonly used is total net assets.
The Residual Income capital charge is calculated as total net assets 8%.
Appliances
4,650/18,500
= 25.1%

Utensils
1,365/4,650
= 29.4%

Crockery
4,550/14,500
= 31.4%

Total
10,565/37,650
= 28.0%

4,650/20,200
= 23%

1,365/5,850
= 23.3%

4,550/9,500
= 47.9%

= 28%

Controllable net income %

6,500/18,500
= 35.1%

1,830/4,650
= 39.4%

6,000/14,500
= 41.3%

14,330/37,650
= 38%

ROI controllable net income

6,500/20,200
= 32.2%

1,830/5,850
= 31.3%

6,000/9,500
= 63.2%

14,330/35,550
= 40.3%

Divisional net income before tax %

ROI net income before tax

Residual income (RI)


Profit after tax
Less capital charge 8% cap employed
Residual income

Appliances
3022
1616
1406

Utensils
887
468
419

Crockery
2958
760
2198

Total
6867
2844
4023

(b) Part (b) gave an opportunity to show understanding of how the measures are interpreted.
Part (bii) required you to think about how the requested financial measures can discourage
managers from investing in the future and to choose extra ratios which might highlight some
reasons for the results and that these issues could be incorporated in the calculation of
bonus requested in part (iii.)
i. The results show that the trends between the divisions are the same whichever net
income figure is used. Crockery is making the best profit margin followed by Utensils and
last, Appliances. ROI shows the same ranking but Crockery gives much better returns
than the other two divisions. Appliances and Utensils perform very similarly, with
Appliances suffering a higher allocated head office charge as this is based on sales. It can
be seen when looking at controllable income ROI that Appliances performs better than
Utensils. Using the sales basis for charging head office costs is unfair unless the benefits
provided by head office tend to correlate with sales.
Looking at Residual Income Crockery RI is huge, Appliances benefits from being the
largest division. All divisions exceed the required return.
ii. Examples of additional ratios (candidates may calculate different ratios only 3 required)
Contribution/turnover %
Asset turnover
R&D + Advertising/sales %
Depreciation/sales %

Appliances
13,400/18,500
= 72.4%
18,500/20,200
= 0.92 times
500/18,500
2.7%
3,000/18,500
16.2%

Utensils
3,180/4,650
= 68.4%
4,650/5,850
= 0.79 times
60/4,650
1.3%
450/4,650
9.6%

Crockery
8,400/14,500
= 57.9%
14,500/9,500
= 1.5 times
70/14,500
0.5%
1,600/14,500
11.0%

Total
24,980/37,650
= 66.3%
37,650/35,550
= 1.1 times
630/37,650
1.7%
5,050/37,650
13.4%

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AC3097 Management accounting

Looking at the additional ratios, although Appliances ranks lowest in the previous table,
it is making the highest contribution percentage. Appliances is spending six times as
much on R&D as Utensils and 30 times as much as Crockery. Appliances advertising is
also considerably more than the other divisions. Both of these have a big impact on
short-run profits but should help future development. Appliances fixed asset cost is
almost the same as Crockery but the assets are being depreciated more quickly and are
the least written down assets thus increasing the investment figures. On asset turnover
Crockery is highest, partly due to low fixed asset balances.
Appliances is impressive in keeping their net current assets down. Appliances achieves
the highest sales, i.e. 49% of the group total and the most controllable net profit 45% of
the total.
Utensils contribution is smallest and its assets are small. It may be that this division
could grow but might be reluctant to do so as it already has good results. For both
Utensils and Crockery the assets are getting old and the divisional managers may be
reluctant to invest in new technology if an ROI measure is used for performance
evaluation.
iii. The manager of the Appliances division would be concerned if the bonus were based
solely on financial performance calculated in (a). As the largest part of the operation it
has an important role to play.
If bonuses are to be based on financial results, they figures should give a weighting to
consider the various aspects discussed above. The head office costs should either be
disregarded or charged on an ABC basis allocated in proportion to the services provided
to each division.
An Economic Value Added approach which adjusts both the income statement and asset
values to recognise payments such as R&D, some advertising, lease investments, etc.
could be adopted. It is not possible with the limited information available to show the
effects of this approach on each division.
Another alternative would be Return on Investment using Earnings before interest,
depreciation and Amortisation (EBITDA) and for Investment using Gross fixed assets
plus net current asset.
EBITDA/(gross fixed assets + net current assets) 100
Appliances Utensils Crockery
Controllable net income
6,500
1,830
2,400
450
1,600
Add back depreciation
3,000
EBITDA
9,500
2,280
4,000
Gross fixed assets + net current assets
25,200
11,450
24,500
EBITDA/ investment
37.7%
19.9%
16.3%
This method is closer to the figures used for capital budgeting and would not be
distorted, year by year, as the assets depreciate, nor by different depreciation methods.
Using this approach Appliances is clearly the best performing division.

Section B
Answer one question and no more than one further question from this section.
General tips relating to answers in Section B
The suggested content of the answers provided in this Commentary do not represent a model
answer. Good answers should be in essay form, laying out the issues in a clear way. Similar ideas
should be grouped together and discussion should make alternative points clearly. It is not
satifactory to put down all you know about a topic in the random order in which you think of the
ideas. It is not the markers job to piece your random ideas together. You will therefore not be able
to score high marks if you answer is disorganised. It is therefore a good idea to jot down at the top
of your answer the points which you wish to include as this enables you to oder them appropriately.
The bullet points below only indicate possible content, any relevant good ideas are acceptable.

18

Examiners commentaries 2014

Question 5
(a) Describe the information contained in a Life-Cycle Budget.
(5 marks)
(b) Explain how the Life-Cycle Budget helps a company in the following areas:
i. strategic planning.
ii. capital budgeting.
iii. pricing.
iv. annual budgeting.
(20 marks)

Reading for this question


Subject guide, Chapter 4.
Drury, Chapter 21.
Hongren, Chapter 12.

Approaching the question


(a) Suggested points for an answer:
Life cycle budget information:
Focuses on one specific product
Traces all predicted revenues and costs across the entire value chain for all years of
products life from initial R&D to final customer support and decommissioning costs.
Information is compiled and the product viability assessed in total
It is also analysed by years to identify impacts on annual financial statements.
Budget assumes that revenues and cost will follow the marketing phases of introduction,
growth, maturity and decline appropriate to that product.
The exercise may also identify the timings of when costs are committed and when they
are paid for.
(b) i. Strategic planning
A company is likely to have several products at different stages of their lifecycle and can
plan to develop and introduce new products in such a way that new products are
introduced as others are declining. Producing a life cycle budget as soon as a product is
at the development stage can help with choosing which products to adopt and when to
launch them, taking into account possible competitor action and the existing products.
ii. Capital budgeting
Identifying capital costs at an early stage will help with financing. The provision of good
cost and revenue estimates throughout the products life provides information for the
capital budgeting decision.
iii. Pricing
Marketing departments will be able to produce initial estimates of price and volume from
their knowledge of the market at the different stages of the life cycle. These can be
tested against life-cycle costs to determine initial viability of the product. This may
involve target costing. As the product life proceeds, price will be constantly reviewed to
ensure that the market is being exploited and consider whether the life cycle can be
extended or must be shortened. The complete advertising and promotional activities of
the marketing package can be regularly reviewed in conjunction with price.

19

AC3097 Management accounting

iv. Annual budgeting


Life-cycle budgets for all products are amalgamated in the construction of annual
budgets, providing targets for both revenues and cost.

Question 6
The CIMA definition of Strategic Management Accounting (2005) is A form of
management accounting in which emphasis is placed on information which relates to
factors external to the firm as well as non-financial information and internally
generated information.
(a) Describe 5 aspects of external information which a company may seek to obtain
in order to develop their strategy and explain how this information would be
used.
(12 marks)
(b) Discuss the ways in which non-financial and financial measures can be used in
developing strategy and monitoring progress towards strategic goals. Include
examples in your answer. (A detailed description of the Balanced Scorecard is
not required.)
(13 marks)

Reading for this question


Subject guide, Chapter 10.
Drury, Chapter 22.
Hongren, Chapter 13.

Approaching the question


(a) Suggested points for an answer:
External information:
Total market for each product and the companys % share to decide whether it is
possible/ worthwhile to increase market share.
Whether total market is growing or shrinking, implications for companys strategy.
Determine whether competitors are using cost leadership or product differentiation, to
determine how this affects the companys pricing and marketing activities.
Monitor the economic environment to try to get ahead of the curve.
Bargaining power of customers and input suppliers.
Management accountants, working with other specialists, can use this information to
provide financial estimates of different strategic plans.
(b) Suggested points for an answer:
Financial and non-financial measures to develop strategy Company strategy
involves choosing a path from the alternatives available and regularly monitoring and
reviewing that path to determine its effectiveness and whether changes should be made.
Detailed financial reports are one way of monitoring but they are lag measures which cannot
record whether activities are continuing to build for future success. The activities needed for
current efficiency and effectiveness and future success need to be identified in detail and
measured.

20

Examiners commentaries 2014

Examples which can be drawn from the categories of the BSC (these should be
explained in full)
Customers identifying future customer needs, measuring customer satisfaction,
monitoring customer attitudes to each product (i.e. declining, growing in popularity).
Internal processes service response time, production yield, supplier delivery times.
Learning and growth employee satisfaction, percentage of workers empowered to
manage processes, employee training.

Question 7
(a) Explain why transfer prices are needed between divisions of an organisation
where each trading division is appraised using profit performance.
(7 marks)
(b) Identify the considerations in choosing a transfer pricing method to be used
under the following conditions:
i. the product being transferred has an outside market and the producing
division is working at full capacity making several different products:
ii. the product being transferred has an outside market and the producing
division has spare capacity.
iii. a product is produced using parts from different production centres none of
which has an external market for their work except the centre completing
the final product.
(18 marks)

Reading for this question


Subject guide, Chapter 9.
Drury, Chapter 20.
Hongren, Chapter 22.
Approaching the question
(a) Suggested bullet points for an answer:
Encourage co-operation between divisions.
Promote goal congruence.
Motivate managers to make good economic decisions.
Ensure divisional autonomy is not undermined.
Encourage managers to exert a high level of effort.
Help top management to evaluate the performance of sub-units.
Where sub unit trade across national borders- to reduce taxation and import duties or
facilitate the movement of cash across borders.
(b) Suggested points for an answer:
i. The product being transferred has an outside market and the producing division is
working at full capacity making several different products:
Considerations:
Does the buying division have to buy from the producing division e.g. secrecy, no
other supplier?

21

AC3097 Management accounting

If there is another supplier market price.


If there is no other supplier cost + contribution foregone by producing division in
order to make product for buying division.
ii. The product being transferred has an outside market and the producing division has
spare capacity.
Will buying division have to reduce selling price in order to increase their unit sales and
thus be able to buy more from the selling division?
If no, market price is probably the best.
If yes, then in order to make optimal decisions, the buying division needs to know the
variable costs of the end product faced by both divisions in order to make the correct
price output decisions, Therefore the price should be variable cost + proration of
contribution or dual pricing. Negotiated price is also possible.
iii. A product is produced using parts from different production centres, none of which has
an external market for their work except the centre completing the final product.
Considerations: since each of the production centres, except the last, has no alternative
source of revenue, it is inappropriate for them to be regarded as profit centres. They
should be classed as cost centres.
If a transfer price is needed in order to inform the centre completing the final product of
the costs involved, it should be based on standard cost and the cost information to the
final centre should be split between variable and fixed cost.

Question 8
Choose five of the terms/techniques listed below, and for each one:
i. Explain the meaning of the term/technique.
ii. Drawing on your experience of management accounting, give two examples of
its application and the context in which it is used.
iii. Provide a brief discussion of some of the practical limitations of the
term/technique of which users should be aware.
(a) Principal Budget Factor.
(b) Job Costing
(c) Marginal Cost
(d) Ratio Analysis
(e) Direct Material Mix Variance
(f ) Internal Rate of Return
(g) Margin of Safety
(h) Zero Based Budget
(25 marks)

Reading for this question


Subject guide: several chapters material can be found from list of contents.
Drury: use index
Hongren: use index

22

Examiners commentaries 2014

Approaching the question


(a) Principal Budget Factor
Definition factor which informs the preparation of the budget and may limit the extent of
activity.
Examples sales forecast and mix, expansion plan, production capacity.
Limitations may be difficult to determine one factor, in which case priorities must be
decided.
(b) Job Costing
Definition a system of assigning costs to products or services that is used in situations
where many different products are made or services provided.
Examples car repairs, professional legal firm.
Limitations may be difficult to trace all resources used to each product/service. Tracing
fixed costs requires the determination of an allocation basis, estimate of total work which
will be done during the period and estimate of total cost in order to calculate overhead rates
to be charged to each job. Usually requires cost+ pricing which may not be competitive.
(c) Marginal Cost
Definition the additional cost of one extra unit of output.
Examples used in decision making, e.g. break-even, contribution per limiting factor.
Limitations may be difficult to identify behaviour of all cost and therefore determine the
true marginal cost.
(d) Ratio Analysis
Definition the calculation of meaningfully related figures from financial or management
accounting reports to enable different aspect to be meaningfully compared.
Examples common ratios used in relation to financial report include profit margin ratios,
liquidity ratios, e.g. current ratio, gearing ratio. From management accounting contribution
percentage, through-put percentages, percentage of defects, percentage of completed units.
Limitations can lead to wrong conclusions if data is non-comparable.
(e) Direct Material Mix Variance
Definition the variance which arises due to a different mix of products being produced or
sold than budgeted.
Example. budget: product A= 60%, product B = 40%; actual: product A = 45%, product
B = 55%. Can arise in any organisation where more than one product or service is provided.
It can mean that although the production or sales volume is as expected, due to the change
in mix the cost or profitability is different as the different products have different costs or
contributions.
Limitations may not be well understood by some managers.
(f) Internal Rate of Return
Definition the technique used to make capital investment decisions which takes account of
the time value of money. It is the discount rate at which the net present value is zero.
Example appraisal of the profitability of the purchase of a capital item which lasts for
more than one year and generates revenues or leads to cost savings.
Limitations may be difficult to estimate future cash flows which arise relating to the
project.
(g) Margin of Safety
Definition the amount by which sales can decrease before a loss occurs.
Example used in any organisation where break-even analysis can be used.
Limitations may risk employees thinking that it is safe to operate near to break-even.

23

AC3097 Management accounting

(h) Zero Based Budget


Definition a budgeting approach where projected expenditure for existing activities starts
from base zero rather than last years budget. Forcing managers to justify all budget
expenditure.
Example usually used in cost centres where it is difficult to estimate output. Often used in
public sector organisations.
Limitations very time consuming so not usually used for all departments each year.

24

Examiners commentaries 2014

Examiners commentaries 2014


AC3097 Management accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 201314. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).

Information about the subject guide


Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2013).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refers to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements if
none are available, please use the contents list and index of the new edition to find the relevant
section.

Comments on specific questions Zone B


Candidates should answer FOUR of the following EIGHT questions: TWO from Section A, ONE
from Section B and ONE further question from either section. All questions carry equal marks.
Section A
Answer two questions and no more than one further question from this section.
Question 1
Ian Ball is a sports groundsman. After several years working for employers, he has
decided to establish his own business. For six months each year from April to
September he will concentrate on the maintenance of cricket grounds. He intends to
work 8 hours a day, for 6 days a week, for the 26 weeks of the season; a total of 1248
hours.
From experience with several cricket clubs, he knows that the work falls into three
types, Outfield Maintenance, Maintenance of the cricket square and Preparation
of pitches for specific matches. He will charge his own time at 10 per hour. There
will be variable material costs of 10 per Outfield maintenance, 8 per Cricket
square maintenance and 6 per Pitch preparation. The fixed overheads covering
insurance, equipment and repairs will be approximately 6240 for the six month
period and will be charged to each type of work based on Ians labour time.
Ian will work for several local clubs. He estimates that Outfield maintenance will
occupy eight hours, Square maintenance, four hours, and Pitch preparation two
hours. After discussions with the local clubs, he plans to charge 140 per Outfield
maintenance, 75 per Square maintenance, and 45 per Pitch preparation. At these
prices he can secure orders for 78 Outfield maintenances, 130 Square maintenances

25

AC3097 Management accounting

and 234 Pitch preparations during the season.


Required:
(a) i. Prepare a schedule to show the revenues, costs and profit of each type of
work.
ii. In view of Ians time limitation advise him of the most financially beneficial
mix of work to be undertaken and the profit he will earn with your advice.
(10 marks)
(b) Ian has established a good reputation during his first season. He decides to
abandon Outfield maintenance and concentrate on the more specialised Square
maintenance and Pitch preparation. He plans to hire a contractor with a high
class mower to further improve the standard of his work. The contractor
charges 10 per hour but can only work 30 hours per week for Ian. Ian will still
need to spend the same amount of time on each type of work as previously
estimated. Ians other costs will remain at the same levels as the previous year.
With this additional contractor Ian feels he will be able to charge 100 for a
Square maintenance (which will require 2 hours of contractor time), and 50
per Pitch preparation (which will require 1 1/2 hours of contractor time). Ians
projected orders are 260 Square maintenances, and 468 Pitch preparations in
the season.
Advise Ian of the optimum volume and mix of work to be undertaken in this
situation and the profit he will earn based on your recommendation. Comment
on the results of your calculations in (a) and (b) above.
(10 marks)
(c) Ian is considering using more of the mowing contractors time and would like
him to work an extra 2 hours per week. Ian is prepared to pay 15 per hour for
this extra work. Calculate and advise on whether this plan would benefit Ian.
(5 marks)

Reading for this question


Subject guide, Chapter 2.
Drury, C. Management and cost accounting. (London: Cengage, 2008) seventh edition [ISBN
9781844805662] Chapters 9 and 25. (Hereafter cited as Drury.)
Horngren, C.T., S.M. Datar and M.V. Rajan Cost accounting: a managerial emphasis. (Harlow:
Pearson Education 2012) fourteenth edition (international) [ISBN 9780273753971] Chapter 11.
(Hereafter cited as Horngren.)

Approaching the question


This limiting factors question has only one limiting factor in part (a) and two in parts (b) and (c).
(a) i. For part (a) (i) the profit for each product was requested. This involved dividing the
fixed costs by the expected (budgeted) hours available. Although the demand for
different types work provided figures for the number of hours of work available to Ian,
the question stated the hours he planned to work, 1248 hours. This therefore is the
denominator needed to calculate the hourly overhead rate.
Workings calculation of overhead rate per hour: 6240/1248 hours = 5 per hour.

26

Examiners commentaries 2014

Projected unit revenues, costs and profit by type of work:

Price Charged
Costs Labour @ 10 hour
Direct Materials
Overheads 5/hour
Total Cost
Profit

Outfield Mtce

140
80
10
40
130
10

Square Mtce

75
40
8
20
68
7

Pitch Prep

45
20
6
10
36
9

(ii.) Part (a) (ii) should use the contribution per unit of each type of work, not the profit as
calculated in part (ai). Although the profit figure would give the correct ranking in this
case, because the limiting factor is labour hours which is also the activity used to
determine the overhead rate, it is conceptually incorrect and would not lead to the
correct total profit figure because not all the available hours can be used. The
contribution can be calculated by taking the profit + fixed costs (as is done in the
answer below) or by taking price less variable costs.
Hours needed for all work
Outfield 78 8 hrs
Square 130 4 hrs
Pitch 234 2 hrs
Total hours

Hours
624
520
468
1612

Ian has only 1248 hours available, so 364 hours of work cannot be done so limiting factor
analysis is needed.
Ranking of work by contribution per limiting factor
Contribution type of work (10 + 40) = 50 (7 +10) = 27
Contribution labour hour
50/8 = 6.25
27/4 = 6.75
Ranking
3rd
2nd

(9+10) = 19
19/2 = 9.50
1st

Most profitable work schedule


Work ranking
234 Pitches
130 Squares
32* outfields (balancing figure)
Total
Less fixed costs
Total profit

Hours
486
520
256
1244

Contribution
4,446
3,510
1,600
9,556
6,240
3,316

*it is not possible to do 0.5 of an outfield maintenance.


(b) Part (b) changes the problem and moves to only two types of work and the use of an
additional resource, the mower contractor. The mower contractor works on the same jobs as
Ian but does not necessarily need to work at the same time. It is first necessary to
determine whether the time needed for the demand is limited for both constraints.
Analysis of hours required for available work
Square maintenance
Pitch preparation
Total
Time available

Ians (Labour) hours


260 4 hrs = 1,040
468 2 hrs = 936
1,976
1,248

Mower hours
260 2hrs = 520
468 1.5 hr = 702
1,222
26 30 = 780 hrs

There is more work available than labour hours and mower hours so there are two limiting
factors
If the two constraints give different product preferences on contribution per limited resource,
it would be necessary to use linear programming to find the optimal volume and mix of
work. However if both constraints give preference to one of the products then this can be
prioritised. The calculation below provides the required information.

27

AC3097 Management accounting

Contribution per hour of each limited resource


Selling price
Labour
Materials
Mower hire
Contribution
Contribution per labour hour
Contribution per mower hour

Square maintenance
100
(40)
(8)
(20)
32
32/4 = 8
32/2 = 16

Pitch preparation
50
(20)
(6)
(15)
9
9/2 = 4.50
9/1.5 = 6

Since the contribution per hour for both constraints is higher for square maintenance the
demand for that service should be met in full.
Most profitable work schedule
260 square maintenance 32
104 pitch preparation
Time available
Total contribution
Less fixed costs
Total Profit

Labour hours
1040
208
1248
1248

Mower hours
520
156
676
780

Contribution
8320
936

9256
6240
3016

It can be seen that not all the mower contractor hours are needed, so presumably the
contractor will only do 676 hours for Ian. The contribution is lower by 300 than the work
schedule in part (a). If Ian Ball wishes to make the new way of working more profitable, he
should either work more hours, find more square maintenance work or put up the prices,
particularly of pitch preparation.
(c) Since there is currently too much mower time for the most profitable schedule it would not
be useful for the mower contractor to work more hours. It will only be beneficial if Ian is
also prepared to work more hours to do pitch preparations.
Ian could work more hours so that the mower contractor could work the original 780 hours.
There are (780 676) 104 mower hours already available. This would enable (104/1.5) 69
more pitch preparations to be done and Ian would need to work 138 more hours, resulting in
(69 9) = 621 extra contribution, a total contribution 9,877 which is higher than the
previous plan by 321. Ian would also earn (138 10) = 1380 extra wages giving total
improvement of 1701.
If the mower contractor did work 52 additional hours on (52/1.5) 34 Pitch preparations this
would mean that Ian would need to work another (34 2) = 68 hours.
The contribution per additional pitch preparation would be 9 7.50 = 1.50. The total
additional contribution would be 1.50 34 = 51 and Ian would earn (68 10) = 680
providing an extra 731.
Some candidates used the linear programming approach and marks were awarded to correct
solutions using this approach. However, it will have taken more time.
(b) Alternative suggested answer to part (b) most profitable work schedule if linear
programming is used:
Objective function: Maximise 32S + 9P subject to the constraints:
4S + P < 1248 Ians hours
2S + 1.5P < 780 mower hours
0 < S < 260 square demand
0 < P < 468 pitch demand.
Candidates should provide a graph with contribution line or test all corners mathematically
to determine optimal solution.

28

Examiners commentaries 2014

Testing all corners


Mower hours & Ians hours
4S + 2P

1248

Ians hours

2S + 1.5P

780

mower hours

4S + 3P

1560

4S + 2P

1248.

Multiple mower hours 2

Contribution
Squares 156 32
Pitches 312 9
Total contribution

312

4S

1248 (2 312)

156.

2S + 1.5P

780

mower hours

468

pitch demand

1.5P

702

2S

78

39.

4,992
2,808
7,700

Mower hours & pitch demand

Multiple pitch demand 1.5

29

AC3097 Management accounting

Contribution
Squares 39 32
Pitches 468 9
Total contribution

1,248
4,212
5,460

Ians hours & square demand


4S + 2P

1248

labour hours

260

square demand

Multiple squares demand 4

Contribution
Squares 260 32
Pitches 104 9
Total contribution

4S

1040

2P

208

104

8,320
936
9,256

Ians hours and square demand are optimal giving a profit of 9,256 6,240 = 3,016.
The contribution is lower by 300 than the work schedule in part (a). If Ian Ball wishes to
make the new way of working more profitable, he should either, work more hours, find more
square maintenance work or put up the prices particularly of pitch preparation.
(c) Alternative suggested answer to (c) if linear programming is used:
Note: the contributions used in the objective function do not change as the extra pay only
relates to 52 hours.
Additional cost for mowing contractor 26 weeks 2 5 = 260.
New mower hours = 780 + 52 =832.
Linear programming equations:
Objective function: maximise 32S + 9P 260 subject to the constraints:
4S + 2P = 1248 labour hours
2S + 1.5p = 832 mower hours
S = 260 square demand
P = 468 pitch demand.
See graph above shows extra mower hours outside feasible region.
Leading to the conclusion that labour hours and squares demand is still the best. Extending
mower hours does not result in higher contribution because Ians time is the main constraint.
This is proved by testing all corners.
Mower hours & labour hours
4S + 2P

1248

2S + 1.5P

832

labour hours

4S + 3P

1664

4S + 2P

1248

416

4S

1664 (3 416)

104

mower hours

Multiple mower hours 2

30

Examiners commentaries 2014

Contribution
Squares 104 32
Pitches 419 9
Total
Less mower pay 52 5
Total

3,328
3,744
7,072
260
6,812

Mower hours & pitch demand


2S + 1.5P

832

mower hours

468

pitch demand

1.5P

702

2S

130

65

Multiple pitch demand 1.5

Contribution
Squares 65 32
Pitches 48 9
Total
Less mower pay 52 5
Total

2,080
4,212
6,292
260
6,032

Labor hours & square demand


4S + 2P

1248

labour hours

260

square demand

Multiple squares demand 4

Contribution
Squares 260 32
Pitches 104 9
Total

4S

1040

2P

208

104

8,320
936
9,256

Question 2
Francis Hollande S.A. is a French Company manufacturing motor scooters. It has
recently decided to build a factory in the U.K., to serve the U.K. and some overseas
markets. After the initial period of capital investment, you have been appointed
Financial Director of the U.K. subsidiary.
The new factory is due to start operations on 1st January 2015. You are aware that
the first four months of operations will be critical to its long term survival and wish
to prepare budgets for that period. After consultation with the Hollande Head
Office you discover that:
Expected sales are 1.0million in January, 1.5 million in February, 2.0 million in
March and 2.5 million in April.

31

AC3097 Management accounting

Monthly fixed expenses will be:


Production overheads
Selling overheads
Administration overheads

1,000,000
125,000
125,000

Variable operating expenses will be:


Direct Materials
Direct Wages
Production Overhead
Selling Overhead

20% of sales revenue


10% of sales revenue
5% of sales revenue
2% of sales revenue

Required:
(a) Prepare in columnar form an operating budget for each of the months of
January to April 2015 showing projected monthly revenues, operating expenses,
and operating income.
(6 marks)
(b) You establish that on 1st January 2015 head office will provide you with an
opening cash balance of 750,000, and you are concerned as to whether this will
be sufficient. On researching the timing of receipts and payments relating to the
operating budget you discover the following:
Sales Revenue will be 50% from UK sales, and 50% from exports. UK
customers will pay in the month following the sale, export customers two
months after the sale.
Direct Materials will be paid for in the month after their usage.
Direct Wages and Variable Production Overheads will be paid for in the month
to which they relate.
Fixed Production Overheads relate largely to the highly automated
manufacturing plant. They therefore include a monthly depreciation charge of
500,000. They also include an annual insurance premium of 1,400,000 which
must be paid in January, and payments of 800,000 in local authority taxes
which must be made twice a year in March and September (a yearly total of
1,600,000). The remaining costs are due for payment in even monthly amounts
throughout the year.
Variable Selling Overheads are payable in the month following the month to
which they relate.
Fixed Selling Overheads and Administration Overheads are spread evenly
throughout the year, and are payable in the month to which they relate.
A payment of 2 million is outstanding on the capital cost of the automated
plant. It will be paid in April 2015 if the plant is working satisfactorily.
In setting up the British subsidiary Hollande purchased more land than was
needed. A site of 2 hectares is now being sold (at its cost price) for 1,500,000.
Cash from this sale is expected to be received in March 2015.
You have established good relations with the local branch of a major French
bank, and you are aware that short term overdraft facilities are available.
Interest will be paid at 1% per month on the balance outstanding at the
previous month end.
Prepare a cash budget for Hollande (UK) for the months of January to April
2015.
(15 marks)

32

Examiners commentaries 2014

(c) Rather than using the short term overdraft facilities with the bank as described
above you could negotiate a formal loan of 3,000,000 for one year from
Hollandes subsidiary finance company. This would involve formal interest
payments of 75,000 payable quarterly.
Discuss the issues involved in this alternative. What alternative would you
recommend to your Board of Directors, and why?
(4 marks)
Reading for this question
Subject guide, Chapter 8.
Drury, Chapter 15
Horngren, Chapter 6.
Approaching the question
This question required candidates to carefully follow the information given in the question and to
remember that the operating budget required in part (a) will be compiled on an accrual basis and
the cash budget required in part (b) will be on a cash basis. Therefore the cash may be paid for
or received in a different month from the one in which the item appears in the operating budget.
(a) Francis Hollande S.A. Operating Budget
January February March April
000
000
000 000
1,500
2,000
2,500
Sales revenue
1,000
Production costs
Direct materials
200
300
400
500
Direct wages
100
150
200
250
Production overhead Variable
50
75
100
125
Fixed
1,000
1,000
1,000
1,000
Selling overhead Variable
20
30
40
50
Fixed
125
125
125
125
Administration overhead
125
125
125
125
Total costs
1,620
1,805
1,990
2,175
Operating Income ()
620
305
10
325
(b) Before the cash budget can be prepared it is necessary to provide workings to calculate the
impact on the cash flow of the Fixed Production Overheads. Depreciation is included which
is a non-cash expense. Some other payments are paid for in specific months but charged
equally to each month.under the accrual method.
All the cash receipts should be in the top section of the cash budget, followed by the cash
payments. It is therefore important to leave enough space in case you discover additional
cash receipts, which you hadnt noticed, later in the question. In this case it is the Land
Sales which you are told about near the end of the question.
Workings
The monthly amount is 1,000,000 giving an annual budget of
Deduct depreciation which is a non-cash item 12 500,000
Deduct other costs which do not arise monthly:
Insurance
Local taxes (2 800,000)
Annual fixed overhead paid for on a monthly basis
Therefore cash paid each month for Fixed Production Overhead
other than above

000
12,000
6,000
1,400
1,600
3,000
250
= 3,000,000/12

33

AC3097 Management accounting

Francis Hollande S.A Cash Budget


Opening cash balance b/f
Cash receipts Sales revenue Home
Export
Land Sales
Total cash Inflow
Cash payments
Direct materials
Direct wages
Production overhead Variable
Insurance
Local taxes
Other fixed (see above)
Selling overhead Variable
Fixed
Administration overhead
Capital payment
Total cash outflow
Cash balance before interest
Overdraft interest @ 1%
Closing cash balance c/f

January
000
750

100
50
1,400
250
125
125
2,050
1,300
1,300

February
000
1,300
500

April
000
955
1,000
750

500

March
000
1758
750
500
1,500
2,750

200
150
75

300
200
100

400
250
125

250
20
125
125

800
250
30
125
125

945
1,745
13
1,758

1,930
938
17
955

1,750

250
40
125
125
2,000
3,315
2,520
10
2,530

(c) Part (c) required you to consider not only the cost of the loan compared to the overdraft
but also that the lender is another subsidiary of the same group, whereas the bank is an
outside party.
The cash balance shows an increasing overdraft over the four months to 2,530,000. This is
due to low initial sales, a net capital outflow of 500,000 and prepaid insurance and local
taxes. By April the net inflow from trading activities is positive at 1750 1315 = 435
(the next payment of local taxes of 800 is due in September). Assuming that sales continue
to grow, the overdraft will reduce and may be non-existent within a few months.
However, there is a need to recognise uncertainties relating to sales projections, further
capital expenditure and further revenue expenditure (e.g. on advertising).
The loan from the subsidiary is at 10% p.a. as opposed to 12% for the overdraft but is
payable for the whole year, which may result in a higher overall cost.
However, the interest payments would remain within the group, so depending on the finance
companys other opportunities to lend, it may be more beneficial to the group to accept the
internal loan.
A review of the cash budget to look at adjusting the timings of some of the receipts and
payments to reduce the cash deficit should be undertaken (e.g. collecting debts quicker,
deferring payment for the capital equipment, paying for insurance on a monthly basis).

Question 3
The Harold Wilson Memorial Hospital (HWMH) is located in a medium sized town
within the wider county of Gaitskill. In order to respond to population changes, the
provision of hospital services across the entire county is being reviewed. It is clear
that, during the next year, more services will be moved to the HWMH.
Within a general hospital a laundry is a vital service. It is not known what the
actual demand for laundry services will be, but it will certainly be higher than the
current level. Senior hospital management have asked you to consider alternatives
which can cope with three demand levels: i.e. 275,000 pieces, 350,000 pieces and
425,000 pieces of laundry per year. You have been asked to review the provision of
laundry resources and to evaluate three alternatives which are being considered, one
of which would be adopted in a years time:

34

Examiners commentaries 2014

Alternative (i)
Continue with the Current HWMH operation, an old laundry plant on the hospital
site. It handles 200,000 pieces of laundry a year but has a capacity of 250,000 pieces.
However, it is not capable of further expansion. When necessary it uses a local
laundry (Blacks Ltd) to contract out any excess laundry at 2.00 per piece.
The current budget for the HWMH laundry operation, for its current activity level
of 200,000 pieces, is as follows:

Power and supplies (variable)


Direct Labour (10 staff )
Plant maintenance (semi variable)
Laundry manager
General site overheads

000
20
150
15
30
75
290

An increase in activity to the maximum of 250,000 pieces would require the


employment of 2 additional staff members on the direct labour team and additional
plant maintenance of 2,000.
Alternative (ii)
Contract out the laundry provision to a private sector provider. One local firm
(Whites Ltd) has provided a particularly competitive quotation, but is specifying a
minimum workload of 300,000 pieces per annum and a three year contract.
If the hospital moves wholly to contracting out to Whites Ltd there will be an
annual fixed charge of 200,000 and a variable element of 0.30 per piece (subject
to the minimum level of 300,000 pieces). The laundry manager will remain in post
and 2, 3 or 4 staff (for the lower, middle and higher levels of activity) will be needed
to organise collection and distribution of laundry, etc. Correspondingly 8, 7 or 6 of
the current 10 staff will be made redundant and will each receive redundancy pay.
The lump sum of redundancy pay for each staff member willl be equivalent an
annual cost of 1,000.
Alternative (iii)
Another private sector provider would build a new, modern laundry plant on the
hospital site. The company would require a ten year lease to be signed. It can build
the plant within a year which would have capacity to handle up to 450,000 pieces a
year.
If this option were chosen the annual leasing cost would be 175,000. 6 staff (plus
the laundry manager) would be needed to operate the plant (the other 4 staff being
declared redundant). The variable cost element would be 15p per piece and the
hospital would be responsible for plant maintenance of 50,000 per annum.
Required:
(a) Set out in tabular form the relevant annual operating costs for the current plant
at the current level of activity and for the three possible alternatives, at 275,000
pieces, 350,000 pieces and 425,000 pieces a year.
(15 marks)
(b) After examining the population changes in more detail the hospital senior
management have assessed the probability of the workload as follows:

35

AC3097 Management accounting

Workload
275,000 pieces per annum
350,000 pieces per annum
425,000 pieces per annum

Probability
20%,
50%
30%

Prepare a decision tree showing all the options and incorporating the relevant
probabilities.
(6 marks)
(c) Discuss the issues involved. What would be your recommendation to the
hospital management board, and why?
(4 marks)

Reading for this question


Subject guide, Chapter 2 .
Drury, Chapter 9.
Horngren, Chapter 11.

Approaching the question


This question requires the identification of the costs which will be incurred with each alternative
situation but ignoring costs which do not change. Since in part (b) probabilities must be applied
for each level of laundry and comparisons must be made between the alternative ways of meeting
the laundry needs, it is not possible to get the right answer by just including incremental changes
at each level of laundry within each alternative.
Most candidates understood this and used the correct approach to part (a).
200

275

350

425

000
20
150
15

000
25
180
17
50
272

000
25
180
17
200
422

000
25
180
17
350
572

Contracting out
Fixed Charge
Variable Charge @ 30p/piece (Minimum 300 pieces)
Direct Labour
Redundancy Charge
Total relevant cost

200
90
30
8
328

200
105
45
7
357

200
128
60
6
394

New Leased Plant


Leasing Charge
Variable Charge @ 15p/piece
Direct Labour
Redundancy Charge
Plant Maintenance
Total relevant cost

175
41
90
4
50
360

175
53
90
4
50
372

175
64
90
4
50
383

Activity; 000 Pieces per annum


Relevant operating costs
Current Plant
Power & Supplies @ 10p/piece (max 250,000 pieces)
Direct Labour (max 12 staff)
Plant Maintenance
Contracting Out Excess @ 2.00/piece
Total relevant cost

(a)

185

Note: Laundry manager and general site expenses should be excluded as they apply to all
options.

36

Examiners commentaries 2014

(b)

(c) Alternative 1
Retaining the present plant is the worst option as above 250,000 pieces it is very expensive
per piece to outsource at 2 compared to 0.30 for alternative (b). So even a small
expansion generates higher costs. As seen from the decision tree, taking the full range of
possible options, it is the most expensive.
Alternative 2
The contracting out option has the lowest weighted average expected value and is preferred
at the two lower quantities. In addition it is only a commitment for three years, so is
attractive during a period when the level of activity is unclear but may be resolved during
that time. However, after three years it might not be possible to renew on such favourable
terms. There may also be issues of the quality and reliability of the service to be considered.
Alternative 3
The possibility of a new laundry is very attractive if more work is expected as it keeps all
processes under the control of the hospital and logistically it is more sound that using a
laundry off site.
It is not much more expensive than alternative (b) and creates good provision for the
foreseeable future.
The board needs to consider both alternative (b) and alternative (c) in the light of its other
planned developments to meet the predicted additional new services.
It may be preferred to use alternative (b) for the three years of the contract and after that
time, if the activity reaches the highest level, it might be possible to commit to the new
leased plant.

Question 4
Growwell PLC is a divisionalised company making baby care products. The
company has three divisions, Toiletries, Baby food and Baby equipment. Each
division makes products which are sold to many retail companies.

37

AC3097 Management accounting

Financial data for the three divisions for the year ended 31st March 2014 are shown
below:
Income statement for year ended 31.3.2014

Turnover
Variable costs
Contribution
Fixed costs
Research & development
Advertising
Tangible asset Depreciation
Amortisation of goodwill
Other fixed costs
Total fixed costs
Controllable net income
Allocated head office costs*
Net income before tax
Taxation 35%
Net Income after tax

Toiletries
000
2,900
(1,220)
1,680

Baby food
000
2,900
(980)
1,920

Baby equipment
000
5,700
(1,700)
4,000

Total
000
11,500
(3,900)
7,600

(5)
(15)
(400)

(5)
(15)
(300)

(460)
(880)
800
(303)
497
(174)
323

(380)
(700)
1,220
(303)
917
(321)
596

(50)
(20)
(1,200)
(20)
(1,210)
(2,500)
1,500
(594)
906
(317)
589

(60)
(50)
(1,900)
(20)
(2,050)
(4,080)
3,520
(1,200)
2,320
(812)
1,508

5,400
(2,500)
2,900
1,000
3.900

7,800
(2,000)
5,800
600
6,400

17,100
(7,000)
10,100
2,100
12,200

Summary of Financial position at 31.3.2014


Non-current assets:
Cost
4,400
Accumulated depreciation
(3,000)
Written down value
1,400
Net current assets
500
Total net assets
1,900
*charged on turnover ratio
Required:

(a) For each of the divisions and the company as a whole calculate:
i. Net income % and Return on Investment using divisional net income before
tax and divisional controllable net income.
ii. Calculate the residual income for each division based on net income after tax
using an after tax capital charge of 8%.
(12 marks)
(b) i. Comment on the divisional performance shown in your results in (a).
ii. Using the more detailed information given in the table above and providing
three additional ratios which would enhance the understanding of each
divisions performance. Comment on the insights revealed.
iii. If bonuses were payable to divisional managers on the basis of the divisional
financial results, explain with reasons, how you would recommend the bonus
to be calculated.
(13 marks)
Reading for this question
Subject guide, Chapter 9.
Drury, Chapter 19.
Horngren, Chapter 23.

38

Examiners commentaries 2014

Approaching the question


(a) The requirements for part (a) were clear and required routine calculations of ratios which
are use in both financial and management accounting analysis so it was possible to obtain 12
marks just on this part. Net income % means net income as % of sales. The Investment
Valuation for Return on Investment most commonly used is total net assets. The Residual
Income capital charge is calculated as total net assets 8%.
Toiletries
497/2,900
= 17.1%

Baby food
917/2,900
= 31.6%

Baby equipment
906/5,700
= 15.9%

Total group
2,320/11,500
= 20.2%

ROI net income before tax

497/1,900
= 26.2%

917/3,900
23.5%

906/6,400
14.2%

2,320/12,200
= 19%

Controllable net income %

800/2,900
= 27.6%

1,220/2,900
= 42.0%

1,500/5,700
= 26.3%

3,520/11,500
= 30.6%

ROI controllable net income

800/1,900
= 42.1%

1,220/3,900
= 31.3%

1,500/6,400
= 23.4%

3,520/12,200
= 28.9%

Division net income before tax %

Residual Income
Profit after tax
Less capital charge 8%
Residual Income

Toiletries
323
152
171

Baby food
596
312
284

Baby equipment
589
512
77

Total group
1508
976
532

(b) Part (b) gave an opportunity to show understanding of how the measures are interpreted.
Part (b) (ii) required you to think about how the requested financial measures can
discourage managers from investing in the future and to choose extra ratios which might
highlight some reasons for the results and that these issues could be incorporated in the
calculation of bonus requested in part (iii.).
i. Commenting purely on the results calculated it can be seen that the trends between the
divisions are the same whichever profit figure is used. Baby food is making the best
profit margin followed by Toiletries and last Baby equipment. However, the ROI ranks
Toiletries as the most profitable, closely followed by Baby food with Baby equipment
making a much lower return. This ROI difference between Toiletries and Baby
equipment is highest where net income before tax is used as Baby equipment carries the
highest head office costs because of the higher sales. Using this basis for charging head
office costs is unfair unless the benefits provided by head office tend to correlate with
sales. Baby equipment has the highest sales and the highest investment.
Looking at RI, Baby food RI is better than Toiletries and Baby equipment looks very
poor. All divisions are exceeding the required return.
ii. Possible additional ratios to provide insights (only 3 ratios required)
Toiletries
1680/2,900
= 57.9%

Baby food
1,920/2,900
= 66.2%

Baby equipment
4,000/5,700
= 70.2%

Total group
7,600/11,500
= 66.1%

2,900/1,900
= 1.53

2,900/3,900
= 0.74

5,700/6,400
= 0.89

11,500/12,200
= 0.94

R&D + Advertising/sales %

20/2,900
= 0.6%

20/2,900
0.6%

70/5,700
1.2%

110/11,500
= 1%

Depn+ amortisation/sales %

400/2900
= 13.9%

300/2,900
= 10.3%

1,200/5,700
= 21%

110/11,500
= 16.5%

Contribution/turnover %

Asset turnover

The wider picture shows that although Baby equipment ranks lowest in the above table,
it is making the highest contribution percentage and the highest value of contribution.
It has higher R&D, advertising, depreciation and amortisation costs. It has the highest
costs of fixed assets and the least depreciated. The amortisation of goodwill indicates
that it has taken over another company. Having younger assets than the other two
divisions increases the investment figures, partly explaining the low ranking on this

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AC3097 Management accounting

factor. Baby equipment makes the most sales, 48% of the total and the most controllable
net profit, 43% of the total.
The Baby food and Toiletries divisions have the same sales but the Baby food division
has lower costs throughout, leading to good performance.
On asset turnover, Toiletries is highest partly due to old assets resulting in low fixed
asset balances.
Inspecting fixed costs gives insight into how much each division is spending on investing
in the future. Toiletries contribution is smallest and its assets are the oldest. This
division could grow but might be reluctant to do so as it already has good results. The
division may need to replace assets soon which will affect their ROI.
iii. The manager of the Baby equipment division would be concerned if the bonus were
based purely on ROI or RI performance. This divisions short-term performance suffers
due to its greater spending in R&D, advertising and goodwill, which have reduced the
profits but are investments in future success. Comparing divisions using written down
value of assets penalises divisions which have new, less depreciated assets and
discourages replacement of aging assets. Baby equipment is the largest part of the
operation and has an important role to play.
If bonuses are to be based on financial results they should give a weighting to the various
aspects discussed above. The head office costs should either be disregarded or charged on
an ABC basis measuring the proportion of services provided to each division.
An Economic Value Added approach which adjusted both the income statement and
asset values to recognise payments such as R&D, some advertising, lease investments etc
could be adopted. It is not possible with the limited information available to show the
effects of this approach on each division.
Another alternative would be Return on Investment using Earnings before interest,
depreciation and Amortisation (EBITDA) and for Investment using Gross fixed assets
plus net current assets.
EBITDA*/(gross fixed assets + net current assets) 100.
Controllable net income
Add back depreciation and amortisation
EBITDA
Gross fixed assets + net current assets
EBITDA/ investment

Toiletries
800
400
1,200
4,900
24.5%

Baby food
1,220
300
1,520
6,400
23.8%

Baby equipment
1,500
1,220
2,720
8,400
32.4%

This method is closer to the figures used for capital budgeting and would not be
distorted, year by year, as the assets depreciate, nor by different depreciation methods.

Section B
Answer one question and no more than one further question from this section.
General tips relating to answers in Section B
The suggested content of the answers provided in this Commentary do not represent a model
answer. Good answers should be in essay form, laying out the issues in a clear way. Similar ideas
should be grouped together and discussion should make alternative points clearly. It is not
satifactory to put down all you know about a topic in the random order in which you think of the
ideas. It is not the markers job to piece your random ideas together. You will therefore not be able
to score high marks if you answer is disorganised. It is therefore a good idea to jot down at the top
of your answer the points which you wish to include as this enables you to oder them appropriately.
The bullet points below only indicate possible content, any relevant good ideas are acceptable.

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Examiners commentaries 2014

Question 5
(a) Describe the four levels (cost hierarchies) which can be used to trace costs to
products using the ABC approach. You should include examples of the costs
which would be included at each level.
(10 marks)
(b) In relation to the following situations explain how ABC information can be used
and the issues which decision makers should consider when using the costs for
these purposes:
i. Long-run pricing decisions
ii. Product mix decisions
iii. Dropping a product
iv. Cost reduction and process improvement
v. Planning and managing activities.
(15 marks)
Reading for this question
Subject guide, Chapter 6.
Drury, Chapter 11.
Horngren, Chapter 5.
Approaching the question
(a) The 4 levels are:
Unit level costs activities performed on each individual unit (e.g. machine operation
costs such as energy, machine depreciation)
Batch level costs activities relating to a batch of unit (e.g. set up, material handling,
quality inspection, placing purchase orders, receiving materials, paying purchase
invoices).
Product (service) activities relating to each product type (e.g. sustaining costs
product research & development, design costs, making engineering changes, product
marketing).
Facility sustaining all activities not included in categories above (e.g. top management
compensation, rent, property taxes, security). (Difficult to find causal link so some
companies do not allocate these.)
(b) Candidates should have a clear idea of how ABC costs are calculated and the relevant costs
needed for each situation.
i. Long-run pricing decisions
ABC costs are very relevant for this purpose as all costs must be covered in the long run
and the ABC approach measures resource use accurately. This enables management to
consider what long run prices are acceptable. The ABC costs can also contribute to the
information required for life cycle costing and will inform selling prices, strategy etc.
ii. Product mix decisions
In all relevant cost decisions the actual impact on all costs and revenues must be
identified in detail. Since many ABC costs are fixed, using them on the assumption that
they are short-term variable could lead to the wrong decisions. However, because the
ABC analysis identifies the resource use of each product/product line this gives valuable
information for use in decision analysis by highlighting scarce resources which need to be
taken into account in determining limiting factors. If short-run variable costs for each
resource can be identified, it will enable a more accurate measure of contribution per
product unit to be calculated.

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AC3097 Management accounting

iii. Dropping a product


As in the product mix decision above, it is important to determine contributions made
by the product which appears to be performing poorly and therefore may be a candidate
to be dropped. ABC may identify the variable elements of overhead costs and more
clearly highlight the resources which would be made available for other uses if the
product were dropped. The contributions which would be generated by the new uses of
these resources compared to the contributions forgone by the product being dropped
should be compared. Using full ABC cost for this type of decision would be incorrect.
iv. Cost reduction and process improvement
ABC, by identifying resource use, can help considerably in determining the sorts of costs
which can be reduced by more effective use of resources. For process improvement the
information can be used to compare the resource efficiencies and related costs which will
arise in different departments.
v. Planning and managing activities
ABC informs Activity Based Budgeting and is therefore an excellent basis for budget
preparation and variance analysis, which can drill down to many of the real causes of
problems. Activities can be better managed due to the detailed information available.

Question 6
(a) Explain the role of budgeting in setting and monitoring performance.
(15 marks)
(b) Discuss how management style can affect managers attitudes to innovation in
the execution of their role.
(10 marks)

Reading for this question


Subject guide, Chapter 8.
Drury, Chapters 15 and 16.
Horngren, Chapter 6 and 8.

Approaching the question


(a) Budget setting
Closely linked to strategy and long-term planning.
Provides financial information which informs strategic decision alternatives.
Working with managers from all levels of the organisation assists with:

planning, including looking at different scenarios and enabling choices of direction


co-ordinating activities to ensure the smooth running of processes
encouraging communication across departmental boundaries
providing targets and motivating focused activity
involving many managers in the decision process
avoiding budgetary slack by creating good trust and dialogue between managers and
top management.

Monitoring performance
Performance should be regularly monitored by comparing actual financial performance
against budget with the use of variance analysis. There can be daily or weekly reporting, or
managers can access information when needed with the use of on-line reporting systems.

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Examiners commentaries 2014

Monitoring activity:
Breaks down revenues and expenditure in appropriate ways to discover reasons for
differences.
Encourages managers to respond by making alterations to their activities if they are
deviating from plan.
May require revised budgets if external circumstances or internal changes indicate that
the existing plan cannot be met or new opportunities have arisen.
Requires good management supervision to deter managers of responsibility centres from
becoming department centred in finding ways to meet their budget or taking short-run
decisions which lead to poor long-term outcomes.
Should include guidelines for managers to share decision making where their activities
and issues impact on other managers decisions.
Variance analysis is often used as part of a managers performance measurement. This
should be done in a holistic way perhaps using the Balanced Scorecard or similar method.
(b) The question assumes that managers are in higher management roles where innovative
choices are possible. Since the activities required to meet goals are left to the discretion of
the manager s/he is largely appraised on results.
A management style which focuses on results controls and rigid adherence to agreed
budget targets will encourage the building of budgetary slack and aim to meet the
budget even if the manager knows this is detrimental to the company or future
performance. New possible ways of working will not be considered
Managers may be demotivated by poor design of the responsibility system which means
each manager does not have full decision-making responsibility over all the aspects which
have been delegated to them.
Where there is considerable task uncertainty, appraisal needs to include much wider
parameters, opportunities for discussion of reasons for deviating from budget and a
supportive, trusting and encouraging environment.

Question 7
When making long-run pricing decisions Horngren et al (2012) suggest that both
market based and cost based approaches should be used.
(a) Describe both of these approaches (including the information which is required
and how it is obtained) and explain why each is important.
(15 marks)
(b) Describe how the two approaches are incorporated into target costing.
(10 marks)

Reading for this question


Subject guide, Chapter 4.
Drury, Chapters 10 and 21.
Horngren, Chapter12.

Approaching the question


(a) Definition of market based approaches what market will bear, cannot sell above market
price.

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AC3097 Management accounting

Companies need information on:


competitors prices
own market share and positioning
elastic or inelastic demand
customer preferences.
Competitors prices are regarded as benchmarks and companies may attempt to create a
distinctive product which can be sold at a higher price than competitors or a basic product
at a lower price. Information on customer preferences is needed.
Products will not sell if the price set is not acceptable to the customer but market
imperfections may be able to be exploited.
Definition of cost based approaches full cost, including share of fixed costs; in long run all
costs must be covered and profit made.
Companies need information on:
fixed and variable elements of cost
future changes in prices of inputs
demand which enables a company to estimate whether they can use fixed resources to
capacity
ABC analysis may be useful in companies with complex use of resources.
Answers should discuss the danger of not being aware of market and just adding a mark-up
onto cost leading to death spiral.
Answers should also include discussion of relevant cost based pricing for short run decisions.
Both aspects are important since business cannot continue if you cannot sell or can only sell
at a price below cost and thus cannot make profits.
(b) Target costing brief description of method bringing out:
Market research activity starts before design.
Design and price are informed by consumer preferences and features.
Target cost is determined by target price minus target profit per unit based on an
estimated output.
Quality is matched to consumer requirement and any aspects not required are eliminated.
Product costs are checked against target cost and inputs reviewed to reduce cost further
if necessary by reverse engineering and value analysis.
Market research on finished prototype is conducted.
Product reviewed again after market research.
Product may have a defined lifecycle so changes in price and volume at different stages may
also be considered.
Links with market based pricing
Care in defining product features to meet customer needs and customer perception of
price (target price).
Awareness of competitor prices and features.
Links with cost based pricing and cost reduction
Care in design to exclude non-value added items thus keeping costs down.
Awareness of locked-in costs.
Inclusion of all costs (including long-run fixed e.g. depreciation) in calculating full cost.
Value engineering to reduce costs.

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Examiners commentaries 2014

Question 8
(a) Explain why it is important for businesses to understand the behaviour of their
costs.
(5 marks)
(b) Describe four different cost estimation methods and for each method discuss its
limitations and the circumstances when you would recommend its use.
(16 marks)
(c) Explain the learning curve and discuss its relevance in standard setting.
(4 marks)

Reading for this question


Subject guide, Chapter 3.
Drury, Chapters 8 and 23.
Horngren, Chapters 2 and 10.

Approaching the question


(a) Suggested points for an answer:
Cost behaviour can be loosely classified as variable with output, fixed irrespective of
output, step-fixed or semi variable.
Most decisions which relate to using cost information for planning, decision making and
control require knowledge of the behaviour of cost.
Without this information product and departmental costs cannot be correctly estimated
at different levels of activity.
Modelling the effects of different decisions is constrained, creating budgets and
performance reports to reflect actual activity cannot be realistically or fairly achieved.
(b) Suggested points for an answer:
Possible methods:
industrial engineering
conference
account analysis
quantitative analysis (e.g. high-low method, linear regression).
Answers should provide:
detailed description
problems associated with each method (limitations)
circumstances where it can be used.
(c) Suggested points for an answer:
The learning curve:
Arises in situations where new methods of working must be learned (e.g. a new product
to be made, a change in the service to be provided, or change in processes due to
different equipment or logistical layout).
Recognises and measures how labour costs and costs dependent on labour hours reduce
due to employee learning. It is not related to new employees learning, but to new
processes or products which require a new activity to be learned by all employees
involved.

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AC3097 Management accounting

Uses a mathematical approach based on an estimate of the rate at which work will get
quicker.
It is important for standard setting to use the estimated time before learning as standard
will lead to overstated hours, production scheduling inaccuracies and thus idle machine
time. It may also affect wage payment and distort cash flow. It can appear that workers are
working more efficiently than expected.
If the standard at the end of the learning is used from the beginning the converse of the
above outcomes will arise.
The correct method to set standards is to adjust the standards as learning takes place.

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