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General Comments
This was the second sitting of the new P1 syllabus and candidate performance was generally
better than that achieved in the May diet. There were however still core areas of the syllabus
where candidates demonstrated a lack of understanding and preparation. It is essential that
candidates revise the entire syllabus rather than relying on particular topic areas being
included in the paper. As stated in the May 2010 Post Exam Guide, an integral part of the
revision process should be practising questions from past P1, P2 and P7 papers, including a
comparison of the candidates answer to the examiners suggested answers. It was apparent
however that many candidates had not taken this advice, even to the extent of reviewing the
May 2010 exam paper, the examiners answers and Post Exam Guide. The answers given by
many candidates in this sitting continued to demonstrate poor exam preparation, particularly
for those topics from the new areas of the syllabus.
The layouts for numerical answers once again fell short of the standard required. Candidates
place themselves at a disadvantage if they do not provide a clear layout for their workings in
numeric questions.
The quality of answers to discursive questions varied considerably between questions. Many
candidates demonstrated a clear understanding of zero based budgeting but few appeared
to understand what backflush cost accounting involves and were therefore unable to explain
why this system would be more appropriate in a JIT environment. In some questions
candidates did not provide sufficiently detailed explanations of points made; however in other
questions full explanations were given even though candidates were asked to state rather
than explain. It is essential that candidates consider the verb used in the question. The list of
verbs and their definitions is printed in every CIMA examination paper.
Candidates are again reminded of the importance of time management. The exam allows 1.8
minutes per mark and candidates should relate the time they spend on each question to the
marks available. Spending a disproportionate amount of time on sections A and B to the
detriment of section C is not effective time management. Full use should be made of the 20
minutes reading time at the beginning of the examination.
Page 1
Section A 20 marks
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION
Question 1.1
Which ONE of the following is NOT considered to be a cost of holding inventory?
A
Loss of goodwill as a result of being unable to complete customer orders due to lack of inventory
Question 1.2
The following information has been calculated for a business:
Trade receivables collection period
Trade payables payment period
54 days
67 days
If the working capital cycle is 102 days, the inventory turnover period is
A
19 days
115 days
89 days
13 days
(2 marks)
The correct answer is B
Workings
(102 + 67 - 54) = 115 days
Page 2
Question 1.3
A project requires an initial investment of $200,000. It has a life of five years and generates net cash
inflows in each of the five years of $55,000. The net present value of the project when discounted at the
companys cost of capital of 8% is $19,615.
The sensitivity of the investment decision to a change in the annual net cash inflow is:
A
35.7%
25.0%
9.8%
8.9%
(2 marks)
The correct answer is D
Workings
$19,615/$219,615 = 8.9%
Page 3
The following data are given for sub-questions 1.4 and 1.5 below
A company can choose from four mutually exclusive investment projects. The net present
value of the projects will depend on market conditions.
The table below details the net present value for each possible outcome:
Market
conditions
Projects
A
Poor
$400,000
$700,000
$450,000
$360,000
Average
$470,000
$550,000
$500,000
$400,000
Good
$600,000
$300,000
$800,000
$550,000
Question 1.4
If the company applies the maximin rule it will invest in:
Project A
Project B
Project C
Project D
(2 marks)
The correct answer is C
Workings
If the maximin rule is applied, the highest of the worst profit for each of the three projects is $450,000 i.e.
project C.
Page 4
Question 1.5
If the company applies the minimax regret rule it will invest in:
Project A
Project B
Project C
Project D
(2 marks)
The correct answer is C
Workings
Minimax Regret Table
Market Conditions
Projects
A
Poor
($300,000)
($250,000)
($340,000)
Average
($80,000)
($50,000)
($150,000)
Good
($200,000)
($500,000)
($250,000)
Page 5
Question 1.6
PJ sells goods to customers on credit. It is forecast that credit sales for July will be $36,000 and that sales
will increase by $2,000 per month for the next six months. Based on past experience PJ expects 50% of
customers to pay in the month after sale, 25% of customers to pay 2 months after sale and the remainder
to pay 3 months after sale.
PJ has a trade receivables balance outstanding at the beginning of July of $65,000.
Calculate the cash that PJ will receive from credit customers during the six month period to the end of
December.
(3 marks)
Workings
Credit
sales
July
36,000
Aug
38,000
Sept
40,000
Oct
42,000
Nov
44,000
Dec
46,000
Total
246,000
Cash Collected:
Outstanding receivables June
Credit sales
$
65,000
246,000
311,000
(46,000)
(22,000)
(10,500)
232,500
Page 6
Question 1.7
The estimated production volume of a new product for the first year is 2,000 units. The management
accountant has produced the following table showing the possible production costs and their associated
probabilities at this level of output.
The probabilities of the different levels of fixed production costs and variable production costs are totally
independent.
Total fixed production costs
$
Probability
80,000
0.40
130,000
0.45
160,000
(i)
(ii)
0.15
Calculate the expected value of total production costs for the production of 2,000 units.
Calculate the probability of total production costs for 2,000 units being $180,000 or greater.
(4 marks)
Workings
(i)
The expected value of fixed costs is:
($80,000 x 0.40) + ($130,000 x 0.45) + ($160,000 x 0.15) = $114,500
The expected value of variable costs is:
($30,000 x 0.25) + ($40,000 x 0.35) + ($50,000 x 0.40) = $41,500
The expected value of total costs is therefore $114,500 + $41,500 = $156,000
(ii)
$
130,000 +
160,000 +
160,000 +
160,000 +
$
50,000 =
30,000 =
40,000 =
50,000 =
$
180,000
190,000
200,000
210,000
0.1800
0.0375
0.0525
0.0600
0.3300
Alternatively:
$130,000 + $50,000 = $180,000
Joint probability is (0.45 x 0.40) =
At fixed costs of $160,000, total costs are all greater than $180,000
therefore probability is =
0.1800
0.1500
0.3300
Page 7
Question 1.8
A $1,000 bond has a coupon rate of 10% per annum and will repay its face value in five years time.
Similar bonds have a yield to maturity of 8% per annum.
Calculate the current expected market value of the bond.
(3 marks)
(Total for Section A = 20 marks)
Workings
Yield to maturity of similar bonds is 8%, therefore use 8% as the discount rate.
Year 1-5
Year 5
PV
Cashflows
$
100
1,000
Discount rate @ 8%
3.993
0.681
PV of cashflows
$
399.30
681.00
1,080.30
Page 8
Section B 30 marks
ANSWER ALL SIX SUB-QUESTIONS.
YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE
Question 2(a)
JP has been offered credit terms by a supplier that will allow JP to claim a cash discount of 2.5% if
payment is made within 15 days of the date of the invoice or to pay on normal credit terms within 45 days
of the date of the invoice.
Required:
(i)
Calculate, to the nearest 0.1%, the effective annual interest rate offered to JP from accepting the
cash discount and paying within 15 days. You should assume a 365 day year and use compound
interest methodology.
(3 marks)
(ii)
State TWO other methods that the supplier could use to reduce its level of outstanding trade
receivables.
(2 marks)
(Total for sub-question (a) = 5 marks)
Rationale
The question examines the candidates ability to calculate the effective rate of interest of accepting a cash
discount and paying an invoice early. It also examines the ability to identify other methods that a supplier
could use to reduce the level of outstanding trade receivables.
Suggested Approach
Identify the number of days earlier that the debt will be paid. This will then be used as the
compound factor in calculating the effective rate of interest being offered by the supplier.
Recognise that the cost of the discount is 2.5% of the amount paid i.e. 97.5%.
Suggest two other methods that could be used to reduce the level of trade receivables.
Marking Guide
(i) Number of compounding periods
Marks
1 mark
1.00/0.975 or 1 + (0.025/0.975)
1 mark
1 mark
2 marks
5 marks
Page 9
Examiners comments
This question was reasonably well answered with many candidates receiving full marks. In part (b) most
candidates managed to state two other methods of reducing outstanding trade receivables however a
number failed to note the word other in the question and suggested offering an early payment discount.
Common errors
1. Failure to follow the instructions to calculate to the nearest 0.1%
2. Calculation of the number of compounding periods as 365/15
Page 10
Question 2(b)
BB manufactures a range of electronic products. The supplier of component Y has informed BB that it will
offer a quantity discount of 1.0% if BB places an order of 10,000 components or more at any one time.
Details of component Y are as follows:
Cost per component before discount
Annual purchases
Ordering costs
Holding costs
$2.00
150,000 components
$360 per order
$3.00 per component per annum
Required:
(i)
Calculate the total annual cost of holding and ordering inventory of component Y using the
economic order quantity and ignoring the quantity discount.
(2 marks)
(ii)
Calculate whether there is a financial benefit to BB from increasing the order size to 10,000
components in order to qualify for the 1.0% quantity discount.
(3 marks)
(Total for sub-question (b) = 5 marks)
Rationale
The question examines candidates ability to apply the EOQ formula and to calculate the cost of holding
and ordering the suggested level of inventory. The question then requires candidates to consider whether
it is worth accepting a bulk quantity discount for placing an order greater than the EOQ.
Suggested Approach
Calculate the EOQ and then apply this figure to calculate the cost of holding and ordering
inventory.
Calculate the cost of holding and ordering inventory at the higher order level
Compare the incremental cost to the incremental benefit from the quantity discount.
Marking Guide
(i)
EOQ
Holding costs
Ordering costs
Marks
1 mark
mark
mark
(ii)
mark
mark
1 mark
1 mark
Holding costs
Ordering costs
Value of discount
Evaluation of financial benefit
5 marks
Page 11
Examiners comments
Overall the answers to this question were good. Part (i) was well done although many candidates could
not calculate holding costs and did not seem to notice that a holding cost of $450,000 was more than the
cost of the components. Many candidates struggled with part (ii), using the EOQ in this part of the answer
and failing to calculate the financial benefit.
Common errors
1. Lack of recognition that the EOQ will result in equal values for holding and ordering costs.
2. Calculating holding cost as $450,000 or $18,000.
3. Using the EOQ in part ii).
4. Careless arithmetical errors.
5. Failure to calculate the financial benefit.
Page 12
Question 2(c)
Explain why a backflush cost accounting system may be considered more appropriate than a traditional
cost accounting system, in a company that operates a just-in-time production and purchasing system.
(5 marks)
Rationale
The question examines candidates ability to explain the benefits of using backflush cost accounting
compared to a traditional cost accounting system in a company that operates just in time production and
purchasing.
Suggested Approach
A good answer will clearly identify and explain why a backflush cost accounting system is more
appropriate than a traditional cost accounting system where JIT purchasing and production is being used.
A weak answer will explain backflush costing but will not explain how this differs from a traditional costing
system and why it would be preferable where JIT purchasing and production is in operation.
Marking Guide
Up to 2 marks per valid point
Marks
Max 5 marks
5 marks
Examiners comments
This question was particularly badly answered. Many candidates explained what a JIT environment
involves but were unable to explain backflush cost accounting and why it would be more appropriate than
a traditional costing system in a JIT environment.
Common errors
1. Failure to answer the question that was asked.
2. Providing general statements rather than explaining specific points.
Page 13
Question 2(d)
XY, a not-for-profit charity organisation which is funded by public donations, is concerned that it is not
making the best use of its available funds. It has carried out a review of its budgeting system and is
considering replacing the current system with a zero-based budgeting system.
Explain the potential advantages AND disadvantages for the charity of a zero-based budgeting system.
(5 marks)
Rationale
The question examines candidates ability to identify and explain the advantages and disadvantages of
zero based budgeting.
Suggested Approach
A good answer will clearly identify and explain why zero based budgeting results in a more accurate
budget while recognising the difficulties inherent in a zero based budgeting system. A weak answer will
not clearly identify the advantages of zero based budgeting and/or not recognise the difficulties in its
implementation.
Marking Guide
Up to 2 marks per valid point
Maximum marks awarded
Marks
Max 5 marks
5 marks
Examiners comments
This question was fairly straight forward and was well answered with many candidates achieving full
marks.
Common errors
1. Providing general statements rather than explaining specific points.
2. Lack of detail in the answers.
3. Repetition of the same point a number of times.
Page 14
Question 2(e)
QR uses an activity based budgeting (ABB) system to budget product costs. It manufactures two products,
product Q and product R. The budget details for these two products for the forthcoming period are as
follows:
Product Q
80,000
Product R
120,000
4
5,000
2
4,000
Rationale
The question examines candidates ability to apply activity based budgeting to calculate budgeted product
costs.
Suggested Approach
Calculate the cost driver rate i.e. the budgeted cost per set up.
Apply this rate to product Q to calculate the total set up cost for product Q.
Calculate the set up costs per unit by dividing the total set up cost for product Q by the number of
units of product Q.
Marking Guide
(i)
Number of batches for each product
Total number of set ups
Budgeted cost per set up
Total budgeted set up costs
Budget set up costs per unit
Marks
2 marks
5 marks
mark
mark
mark
mark
1 mark
Page 15
Examiners comments
The performance in this question was particularly poor. Activity based costing is a core part of the P1
syllabus and the failure of many candidates to demonstrate the ability to apply activity based costing
techniques to a simple budgeting question was very concerning. In part (i) candidates failed to recognise the
need to calculate the cost driver rate for the whole company and then apply this to product Q. In part (ii) most
candidates related their answer to activity based costing.
Common errors
1. Calculation of cost driver rate using either the number of batches or the number of set ups per batch.
2. Calculation of budgeted set up costs per batch rather than per unit.
3. Failure to calculate the cost driver rate for the whole company.
4. Poor layout of workings.
5. Relating the answer to ABC rather than ABB.
Page 16
Question 2(f)
(f)
Profit
$
(10,000)
15,000
40,000
65,000
90,000
115,000
140,000
165,000
Required:
Demonstrate, using a decision tree, whether the programme should be advertised.
(5 marks)
Rationale
The question examines candidates ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.
Suggested Approach
A good answer will provide a clearly constructed decision tree showing the expected payoffs for each
possible outcome.
Page 17
Marking Guide
mark per payoff
Decision tree format
Decision
Marks
3 marks
1 mark
1 mark
5 marks
Examiners comments
This question clearly separated those candidates who had worked on the May exam paper from those
who had not. The question was very similar to the one asked in May and yet it was badly answered by
many candidates and a large number omitted it altogether. Many candidates seemed to think that the
decision was what the economic conditions were going to be. Other candidates misread the question and
ended up with a decision tree with only five branches instead of six and wrote a note to the examiner that
the question was incorrect. Some candidates drew the decision tree but did not calculate any figures.
Common errors
1. Drawing the decision tree on the basis that the decision was to determine the economic conditions.
2. Producing a decision tree with four or five branches rather than six.
3. Giving no figures for the decision tree.
4. Failing to state the final decision.
5. Making computational errors.
Page 18
Section C 50 marks
ANSWER BOTH THE TWO QUESTIONS
Question 3
(a)
Produce a statement that reconciles the budgeted and actual gross profit for product
RG for July showing the variances in as much detail as possible.
(13 marks)
(b)
(c)
Discuss THREE advantages of using a standard costing system that identifies both
planning and operational variances.
(6 marks)
(Total for Question Three = 25 marks)
Rationale
The question examines candidates ability to calculate variances including both planning and operational
variances and to prepare a statement reconciling the budget and actual gross profit. The advantages of
identifying both planning and operational variances are also examined.
Suggested Approach
Calculate each of the individual variances, clearly identifying whether they are adverse or
favourable
Calculate the actual profit for the period.
Produce a statement showing the budgeted profit and the individual variances reconciling to the
actual profit.
Calculate the planning and operational variances in part (b)
Explain the benefits of calculating these figures in part (c).
A good answer will calculate the variances and actual profit correctly and will produce a clear
reconciliation statement. A weak answer will contain errors in the calculation of variances, will not identify
correctly whether the variances are adverse or favourable, will not calculate the actual profit separately
and will not produce a clear reconciliation statement.
Page 19
Marking Guide
Part (a)
Marks
1 mark
3 marks
2 marks
2 marks
1 mark
3 marks
1 marks
Part (b)
(i) Materials cost variance
(ii) Material price planning variance
(iii) Material price operational variance
Material usage operational variance
1 mark
2 marks
1 mark
2 marks
Part (c)
Up to 2 marks per reason
Maximum marks awarded
6 marks
25 marks
Examiners comments
Part (a)
Candidates performed fairly well in this part of the question. The variances which caused difficulty were
the sales volume profit variance and the fixed overhead volume variance. Some candidates provided the
total fixed overhead variance rather than analysing this further to show the expenditure variance and the
volume variance.
Part (b)
This part was less well answered. Few candidates were able to calculate a materials cost variance and
many calculated a price variance instead. The planning variance was seldom calculated correctly and the
operational usage variance caused a lot of difficulty. Overall there was evidence of a lack of knowledge in
this area.
Part (c)
This part was poorly answered. Most candidates discussed standard costing systems without reference to
planning and operational variances. When planning and operational variances were considered there was
a lack of detail in the points made.
Common errors
Part (a)
1. Incorrect labelling of variances.
2. Confusion over the calculation and labelling of the fixed overhead variances.
3. Use of incorrect variance signs (adverse/favourable) for the direction of variances, especially with the
fixed overhead variances.
4. Incorrect calculation of the sales volume profit variance.
5. Not providing a reconciliation statement.
Part (b)
1. Calculation of a material price variance rather than a materials cost variance.
2. Calculation of the material planning variance using actual quantity.
3. Incorrect calculation of the material usage variance.
Part (c)
1. Not answering the question that was asked.
Lack of detail in the answers.
The Chartered Institute of Management Accountants
Page 20
Question 4
(a) Calculate the net present value (NPV) of the gymnasium and spa project.
(16 marks)
(b)
Calculate the post-tax money cost of capital at which the hotel would be indifferent to
accepting / rejecting the project.
(4 marks)
(c)
Discuss an alternative method for the treatment of inflation that would result in the
same NPV.
Your answer should consider the potential difficulties in using this method when
taxation is involved in the project appraisal.
(5 marks)
Rationale
Part (a) of the question examines candidates ability to calculate the net present value of a project
involving the identification of relevant costs and the calculation of the effect of inflation and taxation. Part
(b) examines candidates ability to calculate the IRR of a project. Part (c) examines the candidates
understanding of the treatment of inflation in investment appraisal.
Suggested Approach
In part (a) firstly identify the incremental cash flows of the project then calculate the tax effect of
the cash flows taking account of the timing of the tax payments.
Discount the resultant net cash flows at the companys cost of capital.
In part (b) calculate the IRR of the project.
In part (c) calculate the real discount rate which could be applied to cash flows that were not
adjusted for inflation.
Also demonstrate appreciation of the problem involved with this approach where there are tax
implications of the appraisal.
Page 21
Marking Guide
Part (a)
Marks
Current revenue
Future projected revenue
Incremental revenue
Employee costs
Overhead costs
Adjusting net cash flows for inflation
Residual value
Tax calculations and phasing of cash flows
Discounting cash flows
3 marks
2 marks
1 mark
1 mark
1 mark
1 mark
1 mark
4 marks
2 marks
Part (b)
Recognising need for an IRR calculation
Calculating NPV at higher/lower discount rate
Calculating IRR
1 mark
2 marks
1 mark
Part (c)
Explanation of alternative approach
Formula to calculate real cost of capital
Calculation of real cost of capital
Explanation of problems where taxation is involved
1 mark
1 mark
1 mark
Up to 2 marks
Examiners comments
Part (a)
This part of the question was reasonably well answered although many candidates did not seem to
recognise that only the incremental revenue was relevant. Similarly many candidates included the
absorbed fixed overheads as a relevant cash flow. Most candidates were able to calculate the tax
depreciation for years 1-3 but often calculated the balancing figure for year 4 incorrectly.
Part (b)
Candidates that recognised the need for an IRR calculation scored well in this part of the question but
many candidates did not understand what was required. Some candidates gave the answer to part c)
instead.
Part (c)
This part of the question was omitted by many candidates. Those who did attempt it were usually able to
give the formula to calculate the real cost of capital but many did not then go on to calculate it.
Explanations given for the difficulties in using this method when taxation is involved were vague and did
not demonstrate any clear understanding.
Common errors
Part (a)
1. Failure to calculate incremental revenue.
2. Inclusion of non-relevant costs in the cash flows.
3. Omission of the residual value from the cash flows.
4. Use of 365 days in the calculation of revenue.
5. Incorrect calculation of Year 4 tax depreciation.
6. Incorrect phasing of the benefit from the tax depreciation.
Part (b)
1. Failure to recognise the need to calculate the project IRR.
Page 22
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