CIMA P2 –Advanced Management Accounting

What is CIMA?

The Chartered Institute of Management Accountants (CIMA)

is a United Kingdom-based professional body offering

training and qualification in management accountancy and

related subjects, focused on accounting for business; together

with ongoing support for members.

Operational level:

P1 Management Accounting E1 Organisational Management F1 Financial Reporting and Taxation

Management level:

P2 Advanced Management Accounting E2 Project and Relationship Management F2 Advanced Financial Reporting

Strategic level:

P3 Risk Management E3 Strategic Management F3 Financial Strategy

Gateway route:

G1 Management Accountant Gateway

Certificate in business accounting

C01 Fundamentals of Management Accounting C02 Fundamentals of Financial Accounting C03 Fundamentals of Business Mathematics C04 Fundamentals of Business Economics C05 Fundamentals of Ethics, Corporate Governance

and Business Law

CIMA P2 –Advanced Management Accounting

Advanced management accounting concepts and techniques are organised around a focus on strategy to enable you contribute to an organisations’ successful navigation of mid-to long-term challenges. The module builds on Management accounting to extend your understanding of approaches such as: value chain analysis; strategic pricing; lean manufacturing; strategic issues for financing the firm; risk analysis; project appraisal techniques; performance appraisal and the balanced scorecard. You will be encouraged to take a critical approach to evaluating techniques and theories and equipped to apply them in case study settings.

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Here are some questions of Cima P2.

Question No 1:

Explain TWO reasons why the company might decide NOT to use this optimum selling price?

There are many reasons why this price may not be used (candidates are expected to explain two).• There may be inaccuracies in the demand forecasts at different prices because the model assumes that demand is driven solely by price. In fact there are many different factors that influence demand; these include advertising, competitor actions and changing fashions / tastes.• The model also assumes that the relationship between price and demand is static whereas in reality it is regularly changing.• There may be inaccuracies in the determination of the marginal cost, the assumption that marginal cost equals variable cost may itself be invalid, but even if this is acceptable then the assumption that all variable costs vary with volume is unrealistic. Some of these costs may be driven by factors other than volume. Again there is an assumption the unit variable cost is unchanging once it has been determined

Question No 2:

Explain the likely changes that will occur in the unit selling prices AND in the unit production costs, compared to the preceding stage.(ii) Maturity stages of the new product's life cycle?

Unit selling pricesThese are unlikely to be reducing any longer as the product has become established in the market place. This is a time for consolidation and while there may be occasional offers to tempt customers to buy the product the selling price is likely to be fairly constant during this period.Unit production costsDirect material costs are likely to be fairly constant in this stage. They may even increase as the quantities required diminish compared to those required in the growth stage, with the consequential loss of negotiating power.Direct labour costs are unlikely to be reducing any longer as the effect of the learning and experience curves has ended. Indeed the workers may have started working on the next product so that their attention towards this product has diminished with the result that direct labour costs may increase.Overhead costs are likely to be similar to those of the end of the growth stage as optimum batch sizes have been established and are more likely to be used in this maturity stage of the product life cycle where demand is more easily predicted.

Question No 3:

Explain how target costing could be of benefit to the company?

Target Costing is useful in a competitive market such as this where a company is not dominant in the market and is forced to accept the market price for its products or services.Thus Target Costing focuses on the achievement of a unit cost which will earn the company the financial return that it requires.The starting point for the operation of Target Costing is the unit selling price of the company's product or service. From this is deducted the required profit (to yield the company's required financial return) and the result is the target unit cost that is to be achieved. This target cost is then compared with the expected unit cost to see if the target cost is already being met or if the company needs to consider making changes which will result in a lowering of unit costs.It may be that the effects of the learning and experience curves will reduce the present cost to the level of the target cost; or it may be that the company can achieve other cost savings provided they do not diminish the quality of the product or service asperceived by the customer.If these cost savings cannot be made the company may have to lower its required return from the product or service or decide that it is not financially viable for it to sell this product or service in the market.Thus Target Costing would benefit this company by forcing it to consider its internal processes and costs and to conduct these as efficiently as possible. If despite making theseas efficient as possible the required return from the product cannot be achieved, then the company should cease to make a product that is not viable and therefore would be able to focus its resources on alternative sources of income.

Question No 4:

Explain TWO disadvantages of "total cost plus" pricing?

Total Cost Plus pricing is a pricing technique based on determining the total cost of a product or service and adding a profit percentage to that total cost to determine the selling price.In a competitive environment any cost inefficiencies or the use of too great a profit percentage will mean that the company is no longer able to compete and will start to lose its market share. As this happens and output volumes fall, then the total unit cost will rise due to the sharing of fixed costs among a smaller number of units. The total cost plus pricing formula will then result in increased selling prices thereby reducing still further the company's ability to compete.Therefore one disadvantage of this approach to pricing is that it does not consider the nature of the market and as a result can lead to loss of sales and of course profits.A second disadvantage is that the company is not motivated to save cost because if it does so this simply results in a lower selling price. Indeed if the market supports a total cost plus price then by increasing costs the size of the profit is increased!

Question No 5:

Discuss the motivational factors in involving functional managers in the setting of functional budgets?

If functional managers are involved in setting their own functional budget then this should have a positive motivational effect on their attempts to achieve it. These is because they will own the budget and accept it as being a fair target, seeing it as a personal failure if they do not achieve the target that they set (and therefore believed was achievable).The difficulty with involving managers in the budget setting process is that if their performance is to be measured by comparing the actual results with the budget they have set then they may be tempted to set an easy budget by building in budget slack. This will prevent them from performing as well as they might do if a harder, but fair and achievable, budget had been set by someone else.

Question No 6:

State TWO perspectives of the Balanced Scorecard and for EACH of these, recommend with reasons, ONE performance measure that could be used to measure the performance of the library?

Its customers would want to know that they can borrow the latest books and DVDs from the library so as part of the Customer perspective a measure that could be used to monitor the library's success in this area would be the number of new items that had been added to the library within a specified time period.The library would also need to measure its own efficiency of operations, particularly as it relies on government funding and donations. As part of the Internal Business perspective the library can measure its speed in obtaining new titles. Recognising demand, identifying a source, negotiating a price and placing an order all take time. The smaller the amount of time taken the better will be the customer perception and the better value for money for the library.

Question No 7:

Explain the key features of the Balanced Scorecard approach to performance measurement?

The Balanced Scorecard can be used to measure the performance of an organisation. Traditionally performance was measured only in financial terms, but it is now recognised that financial measures alone are not enough, hence the development of the Balanced Scorecard.There are different variations of the Balanced Scorecard that may be used since it facilitates internal performance measurement and thus is designed by each organisation to meet their requirements, however most Balanced Scorecards contain four perspectives. These are: Customer perspective; Internal Business perspective; Innovation & Learning perspective; Financial perspective. Each of these segments represents a different viewpoint on the operation of the organisation. Each of these contributes to the success of the organisation, in fact many argue that success in the first three of these perspectives leads to financial success. The Balanced Scorecard develops strategies into operations.

Question No 8:

Explain TWO factors that should be considered when designing divisional performance measures?

A number of factors should be considered when designing divisional performance measures. These include:• Each measure should be simple to calculate and to understand so that managers can see the effect of the decisions that they make on the measurement of their division's performance.• Each measure should be fair to the manager of the division and only include items that are within their control.

Question No 9:

Evaluate the investment from the perspective of the manager of Division E?

The investment has two effects: the increase in E's capacity by 10% and the 20% reduction in its variable cost. From Division E'sperspective the benefit of these effects is diluted due to the internal sales and the transfer pricing policy.If the capacity of Division E is increased by 10% then it will increase its external sales, but in doing so will reduce the volume ofexternal sales foregone by selling the components to Division D. Therefore the effect of the additional capacity would be totransfer an additional 10% by volume at cost. Thus there is no financial benefit to Division E.E sells 50% of its present capacity internally, and 28/70 of this is transferred to Division D at variable cost therefore any costsavings arising in respect of this proportion will be passed on to Division D due to the transfer pricing policy. The cost savingthat will accrue to Division E will therefore be limited to items sold at market value. This amounts to:Variable cost of items sold at market value = 80% x $140m = $112m per annum20% cost saving thereon = $22.4m per annumUsing the 8% annuity factor for 5 years this saving has a present value of:$22.4m x 3.993 = $89.4432mSince the capital cost of the equipment is $120m with no residual value the investment is not financially viable from Division E'sperspective.

Question No 10:

Discuss the effect of possible changes in external demand on the profits of Division E, assuming the currenttransfer pricing policy continues?

Division E has sold components to Division D without deriving any financial benefit. If Division D had bought them at market value the cost to Division D would have been $43.4m which is $15.4m greater than the current transfer price.While it may not be appropriate for Division D to pay the full market price (since Division E could not sell thesecomponents externally) it does seem unfair that all of the profit from the use of these components accrues toDivision D and therefore a transfer price that accrues some reward to Division E for the supply of the componentswould be fairer to both divisions. Any transfer price above variable cost would reduce the profits of Division Dand increase those of Division E by the same amount. For example if the difference between variable cost and market price were shared equally then the change in profit of each division would be $7.7m.If the external demand for the components were to decrease, then more of the components supplied to DivisionD would be transferred at variable cost thus lowering the profits of Division E, but increasing the profits ofDivision D. If the external demand were to increase then the opposite effect would occur until all of the internaltransfers were being made at the external selling price.

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CIMA P2 –Advanced Management Accounting