ca proficiency 2 strategic finance and ......cap2 sfma interim assessment (january 2019) page 3 of 9...

CA PROFICIENCY 2

STRATEGIC FINANCE AND MANAGEMENT

ACCOUNTING (SFMA)

INTERIM ASSESSMENT – January 2019

PAPER AND SUGGESTED SOLUTION WITH EXAMINER’S COMMENTS

Information Note: This report contains the following documents:

Page 3: Exam paper (as sat on 12 January 2019). Page 6: Formal suggested solution with examiner’s comments. As with all examinations, the solution is a ‘suggested’ solution only. Candidates who present

alternative, valid solutions to any question will always receive the appropriate credit in an examination. This suggested solution is written to the CAP2 Competency Statement 2018/2019

CAP2 SFMA INTERIM ASSESSMENT (January 2019) of 9 CONSOLIDATED PAPER, EXAMINER’S COMMENTS AND SUGGESTED SOLUTION WRITTEN TO CAP2 COMPETENCY STATEMENT 2018/2019 © Chartered Accountants Ireland 2019

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© Chartered Accountants Ireland 2019

All references to the masculine gender within this document are intended to refer to both male and female as

appropriate.


CA Proficiency 2

STRATEGIC FINANCE & MANAGEMENT ACCOUNTING (SFMA)

INTERIM ASSESSMENT 12 January 2019: 11:00 am – 12:30 pm

INSTRUCTIONS TO CANDIDATES

1. Answer ALL questions

2. A separate answer booklet is provided and MUST BE USED BY ALL CANDIDATES.

3. Candidates should deem each monetary amount shown with the €/£ symbol to be stated in their

relevant currency.

4. All workings should be shown.

5. Answers should be illustrated with examples, where appropriate.

6. This is an OPEN BOOK exam.


CASE STUDY: HYDRATE LIMITED

Hydrate Limited (“HYDRATE”), a manufacturer of paper cups, has just introduced a new re-useable plastic

bottle named FILL AGAIN. Production and sales of the new product commenced on 1 October 2018.

HYDRATE uses standard variable (marginal) costing to report on the performance of the production

department each quarter. The standard cost card for FILL AGAIN is as follows:

Standard cost card: one unit FILL AGAIN €/£

Plastic (40 grams@ €/£ 0.06 per gram) 2.40

Labour (10 minutes@ €/£ 12 per hour) 2.00

Variable overhead (10 minutes @ €/£ 21 per hour) 3.50

Total standard variable cost per unit 7.90

Quarter four 2018 performance:

HYDRATE’s production staff, who are inexperienced at handling plastic material, have just completed the

production of 100,000 units of FILL AGAIN in the quarter ended 31 December 2018. These were produced in

two separate batches of 50,000 units each. HYDRATE planned an introductory penetration price of €/£ 10

per unit and during the quarter ended 31 December 2018 all 100,000 units were actually sold at this

budgeted price. HYDRATE’s management received the following summary statement for the quarter for the

FILL AGAIN product:

HYDRATE summary budget performance Q4 2018

FILL AGAIN €/£

Budgeted contribution 210,000

Actual contribution (negative) (235,000)

Under performance (445,000)

Management of HYDRATE are concerned about the poor performance in FILL AGAIN’s initial quarter of

production and sale. They are particularly concerned about the overtime premium paid to production staff to

work weekends to complete the batches. Management are considering either discontinuing FILL AGAIN,

which will involve job losses, or investing further to improve the new plastics production process.

You are a Financial Analyst at HYDRATE and have obtained the following statement of the detailed actual

costs incurred in the production of FILL AGAIN for the quarter ended 31 December 2018:

FILL AGAIN actual costs Q4 2018 €/£

Plastic (6,000,000 grams) 360,000

Labour (25,000 hours) 350,000

Variable overhead 525,000

2019 proposal:

Employee representatives have protested strongly that the production process is complex and requires new

materials handling skills that will have to be fine-tuned over time. They have argued that production

efficiency will improve as staff move up the learning curve. In a bid to avoid potential redundancies the

employee representatives have agreed that from 1 January 2019:

Overtime hours will be paid at normal rates, i.e. no overtime premium will be paid to staff, regardless

of the number of hours worked;


With the improved handling of plastic, the time taken to produce a unit will decrease by 2.5 minutes

from the average actual time taken in quarter four 2018.

In order to continue production of FILL AGAIN, management will also have to lease a state of the art plastics

extrusion line for a period of three years beginning on 1 January 2019. The lease cost will be €/£ 825,000

per annum, payable annually in advance. As a result:

Production will increase by 20% from annualised quarter four 2018 production rates and remain

constant throughout the life of the project;

Material usage will reduce by 8 grams per unit from quarter four 2018 actual usage and remain

constant throughout the life of the project;

You should include the following assumptions in your analysis:

All units produced will be sold at a price of €/£ 14 per unit in 2019. The sales price will increase by

€/£ 1 each year;

For 2019 the basic labour cost will remain at €/£ 12 per hour. This will increase by 5% each year

after 2019;

The cost of plastic will increase by €/£ 0.01 per gram on 1 January 2021;

The variable overhead rate will remain at quarter four 2018 levels throughout the life of the project;

FILL AGAIN will require €/£ 1,000,000 of working capital immediately. This is expected to be

returned to the business at the end of the project;

Management will continue production if the project returns a minimum Net Present Value of

€/£ 3,000,000 using a cost of capital of 10%.

Requirement:

Prepare a report for the management of HYDRATE addressing the following issues:

a) Using a standard variable (marginal) costing approach, prepare an operating statement that

reconciles the budgeted and actual contribution for the production and sale of FILL AGAIN for the

quarter ended 31 December 2018. (You should show all of your workings.) 30 marks

b)

i) Briefly explain the concept of the learning curve;

ii) Explain how you would expect the variances in part a) to change in future periods, assuming the

staff producing FILL AGAIN benefit from the learning curve. (No calculations are required);

iii) Outline TWO areas where management could use the learning curve principle, other than

variance analysis. 20 marks

c)

i) Calculate the Net Present Value (NPV) of the proposal to continue to produce FILL AGAIN and

lease the extrusion line. (You should ignore taxation and show all of your workings);

ii) Advise HYDRATE’s management, based on their stated financial criteria, whether or not to

continue production and lease the extrusion line;

iii) Identify TWO additional factors that HYDRATE’s management should consider before making a

final decision. 45 marks

Presentation 5 marks

Total 100 marks

END OF CASE


SUGGESTED SOLUTIONS

EXAMINER’S GENERAL COMMENTS

2019 saw the introduction of a simplified Interim Assessment without a pre-seen element to the case study. Overall candidates have adapted well to the new assessment format with most performing well above a passing standard and effectively carrying some “credit” into the final SFMA exam. Most well-prepared candidates attempted all parts of the requirement and the length or structure of the assessment did not give cause for concern. Candidates that had not prepared adequately for the assessment found time management a challenge. In general the standard of presentation was reasonable. Most candidates began the case with strong presentation skills but mostly failed to maintain this high standard throughout as the case progressed and time elapsed. Candidates were generally equally competent in the quantitative and discursive / qualitative elements of the paper. This is welcomed.

REPORT

TO: Management Team , HYDRATE

From: Financial Analyst, HYDRATE

Date: 12 January 2019

Subject: Financial Review of FILL AGAIN

INTRODUCTION

This report reviews the most recent actual and the likely future performance of the FILL AGAIN product.

EXAMINER’S COMMENTS ON PART A

This reasonably straight forward standard costing question was particularly well answered, with many candidates reconciling the operating statement. Those candidates that did not perform well in part a) lacked adequate preparation.


a) Past performance – Q4 2018

HYDRATE

FILL AGAIN Operating statement – Q4 2018

Detail Note Favourable Adverse

Variance Variance Total

Budgeted contribution

210,000

Variances

Direct materials – price 1 Nil

Direct materials – usage 1

(120,000)

Direct labour - rate 2

(50,000)

Direct labour – efficiency 2

(100,000)

Variable overhead – expenditure 3 Nil

Variable overhead – efficiency 3

(175,000)

Net variance Nil (445,000) (445,000)

Actual contribution (235,000)

Supporting Notes

N1) DM variances AQ AQ SQ

AP SP SP

6,000,000 6,000,000 4,000,000

0.06 0.06 0.06

360,000 360,000 240,000

NIL (120,000)

DM price v DM usage

N2) DL variances AH AH SH

AR SR SR

25,000 25,000 16,667

14 12 12

350,000 300,000 200,000

(50,000) (100,000)

Dl rate v Dl efficiency

N3) Variable overhead AH AH SH

variances AR SR SR

25,000 25,000 16,667

21 21 21

525,000 525,000 350,000

NIL (175,000)

Expenditure Efficiency


EXAMINER’S COMMENTS ON PART B

Most candidates appreciated the meaning, uses and impact of the learning curve phenomenon and how results would improve as a result.

b) The learning curve effect

i) The learning curve refers to the reduction in time that it takes to complete a repetitive manual based task.

The average time taken to carry out such a task reduces as the task is repeated to the point where steady

state is achieved i.e. where no additional time improvement can be achieved. In technical terms the

learning curve effect can be stated as “every time output is doubled the average cumulative time taken to

produce each unit reduces by a constant percentage known as the learning rate”

ii) As staff become more proficient at handling the plastic materials all the labour related adverse variances

reported for Q4 2018 should improve as more batches of FILL AGAIN are produced.

Direct Labour Efficiency and Variable Overhead Efficiency – Both these variances will improve as the

time taken to produce each bottle will reduce as staff become quicker at producing bottles and move up

the learning curve. This will reduce the time taken per unit and the resultant wage and time related

variable overhead incurred to produce each batch.

iii) Other uses of learning curve information may include:

Planning labour hour requirements;

Preparing the labour elements of functional and cash budgets;

Production planning / scheduling and determining machine utilisation rates;

Setting cost plus prices in the knowledge of more accurate unit costs;

Setting performance targets and performance related pay against steady state production times.

EXAMINER’S COMMENTS ON PART C

This NPV question was answered reasonably well. Most candidates understood and applied the concept of the time value of money and laid out the analysis in a technically correct manner. The majority of candidates appreciated the link between the actual results achieved in the previous quarter (per part a) and the proposed annualised improvements. Candidates who underperformed in part c) typically made the following errors:

Adjusting the standard costs for the proposed improvements rather than the Q4 actuals;

Using quarterly figures in the NPV calculation rather than their annualised equivalents.


c) i)

HYDRATE NPV €/£ Year 0

Year 1 2019

Year 2 2020

Year 3 2021

Sales (note 1) 6,720,000 7,200,000 7,680,000

Lease payment (825,000) (825,000) (825,000)

Plastic (note 2) (1,497,600) (1,497,600) (1,747,200)

Labour (note 3) (1,200,000) (1,260,000) (1,323,000)

Variable overhead (note 4) (2,100,000) (2,100,000) (2,100,000)

Working capital (1,000,000) 1,000,000

Net annual cashflow (1,825,000) 1,097,400 1,517,400 3,509,800

Discount rate 1 0.909 0.826 0.751

Present value (1,825,000) 997,537 1,253,372 2,635,860

Net present value 3,061,769

Note 1: Sales = 4 x 100,000 x 120% = 480,000 units x €/£ 14 ; €/£ 15 ; €/£ 16

Note 2: Material = 480,000 units x 52 grams per unit x €/£ 0.06 ; €/£ 0.07 per gram

Note 3: Labour = 480,000 units x 12.5 minutes / 60 x €/£ 12 ; €/£ 12.6 ; €/£ 13.23 per hour

Note 4: Variable overhead = 480,000 units x 12.5 minutes / 60 x €/£ 21 per hour

Commentary:

ii) The Net Present Value of €/£ 3,061,769 marginally exceeds the required €/£ 3,000,000. The

recommendation, on financial grounds, is to proceed with the project to lease the extrusion line and

continue production. However the assumptions should be reviewed carefully and HYDRATE should

consider performing sensitivity analysis on the key variables.

iii) Other factors to consider include:

1. The actual volumes achieved in Q4 2018 reflect a “penetration price” of €/£ 10. When the price is

increased to €/£ 14 and beyond, the forecast volumes of 480,000 units may be unrealistically high;

2. The employee representatives are prepared to forgo overtime premiums in the short term to protect

jobs. Once FILL AGAIN becomes profitable they will most likely expect overtime premiums to be

reinstated, leading to higher labour costs. Failure to address this issue may lead to high levels of

employee dissatisfaction and potentially industrial action;

3. The learning curve effect suggested by the employee representatives may not produce enough

efficiency improvements to deliver the 2.5 minute planned reduction in labour time. In particular, the

introduction of the new extrusion line may limit the learning curve effect if it automates some tasks;

4. Can HYDRATE retain and/or acquire sufficient staff to produce the bottle?

5. By continuing production, relationships with staff and staff representatives should improve;

6. Is the extrusion line technology tested and proven?

7. When will the learning curve effect drop off and production revert to the steady state?

8. Are there other products which could be produced and sold using the extrusion line if the FILL AGAIN

product is discontinued?

9. Is there scope for increasing the capacity of the extrusion line if required?

10. Is there allowance for early termination / increasing the duration of the lease period if required?

11. Where will the responsibility for maintaining and repairing the extrusion lie and at what cost (if any) to

HYDRATE?

END OF DOCUMENT

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