f5 final mock answer june 2013

7/28/2019 F5 Final Mock Answer June 2013

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Paper F5

Performance Management

Final Mock Exam

June 2013 Session

Answers


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This is a blank page.The question paper begins on page 3


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Answers # 1

(a)

Logistics Managers proposal

Effect on 20X9 ROI

It will have been assumed in arriving at the 31/12/X9 net assets that the debt will have been paid.Reversing this assumption has the effect of increasing liabilities and has no effect on assets, as cash isexcluded. Thus net assets will be reduced by $90,000 (to $5,410,000).

Whether the $2,000 late payment penalty is accounted for in 20X9 or 20Y0 will depend to some extent onthe companys accounting policy. The accruals concept would, however, lean towards it being accountedfor in 20X9. Thus operating profits would be reduced by $2,000 (to $814,750).

The new ROI would thus be 814,750 5,410,000 100 = 15.06%

Thus the target will have been achieved and bonuses paid. This is, of course, no indication of improvedperformance, but simply an arithmetical anomaly arising as a result of one side of the transaction being

ignored in the calculation. In fact, the finance cost of the late payment is extremely high.

Longer term effects

There would be no quantifiable longterm effects, although relationships with the supplier may beadversely affected by the late payment.

Production managers proposal

Effect on 20X5 ROI

Assuming no depreciation charge in 20X9, net assets would be increased by the cost of the new assets,

$300,000 (to $5,800,000), and operating profits would be unaffected.

The new ROI would thus be 816,750 5,800,000 100 = 14.08%

This represents a reduction of ROI in the short term.

Longer term effects

In 20Y0 and beyond, the full impact of the cost savings and depreciation charge would be felt operatingprofits would be decreased by a net $(30,000 29,000) = $1,000. Net assets value will be increased, butthe increase will be smaller each year as the asset is depreciated.

In 20Y0, the ROI would be

816,750 (5,800,000 30,000) 100 = 14.15%

This will still not help the division to achieve its target of 15%, although it does exceed the companys costof capital and thus may be desirable overall.

But this illustrates one of the major problems with using book values for assets in performance measures as the assets get older, they appear to give better performance. This can have the effect of deterringmanagers from replacing assets even though this may be of benefit in the long term through cost savings(as above), increased productivity etc.


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Divisional Accountants proposal

Residual income (RI) is an absolute measure of performance, and is arrived at by deducting a notionalinterest charge at the companyscost of capital on the net assets. Appraising the two divisions performance forecasts under this method would have the following results:

20X9 operating Interest charge Residualprofit (10% net assets) income

$ $ $Division Aye 816,750 550,000 266,750Division Bee 203,500 92,500 111,000

In summary, RI has advantages and disadvantages over ROI as a performance measure, and both sufferfrom common valuation problems. One of these can be used as part of a package of performanceindicators market share, productivity, employee satisfaction, technological advancement, etc butneither is perfect in isolation.

The performance rankings of the two divisions are now apparently reversed. However, the RIs of the twodivisions are not directly comparable whilst Division Aye has produced nearly twice the level of RI than

that of Division Bee, the net asset base required to do this is over six times as large. RI cannot bemeaningfully used to compare investments of differing sizes, as ROI can.

One could also question the use of the companys average cost ofmoney in computing the notionalinterest charge. The two divisions have been set a target well above this may be because they areconsidered riskier than average. If 15% had been used in the computation, Division Aye would havenegative RI, whilst Division Bee has positive RI reflecting the same information as the ROI, that Aye is notachieving its target return.

The RI uses the same principles for establishing profit and asset values as the ROI, and thus shares thesame problems. As assets get older and their WDV falls, the imputed interest falls and RI rises.

However, RI can be of greater benefit than ROI in management decision making. Management may only

feel inclined to undertake new investment if doing so improves their performance measure.

For example, Division Bee currently enjoys a ROI of 22% and its manager may only consider newprojects that give a return at least as good as this (although this may depend upon the particular structureof the bonus scheme a fixed bonus provided the target of 15% is reached may not provoke such anattitude).

However, the RI measure will improve with new investment, i.e. increase, provided the investmentsreturns are at least covering the rate used in computing the notional interest (12% or 15%). This willensure that projects that are worthwhile from the companys point ofview will also be seen as such by thedivisional manager (goal congruence).

(c) Financial measures taken in isolation are unlikely to tell the whole story of a divisions or companysperformance. They must be put into context, taking account of the circumstances in which they wereachieved new products being introduced, market changes, technological changes, competitors moves,availability of resources, etc.

For example, one might question why the two divisions in Scotswood are apparently performing at suchdifferent levels. Whilst quality of management may well be a contributory factor, it is unlikely to explain adifference of over five percentage points in ROI.


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The age profile of assets used should be considered, as discussed above. Division Aye may haverecently invested in new machinery, possibly in response to technological advances. Not to do so wouldput them at a disadvantage over their competitors, and thus is for longterm benefit. The industry of themuch smaller Division Bee may be more static, requiring less asset changes.

Performance relative to the market and competitors should be considered (market share, productleadership, etc) and the degree of innovation achieved. Level of complaints received may also bemonitored.

Consider the performance of a manager labour turnover, staffmorale, managers relationships with bothsubordinates and superiors. The level of job satisfaction felt by employees at all levels is an importantconsideration in the plan for achievement of company objectives.

Answer # 2

(a)

Room AContribution per seminar = $832,000 / (8 cities x 52 weeks) = $2,000Room cost = delegate fees contribution = (100 delegates x $80) $2,000 = $6,000

Room BContribution per seminar = 2,163,200 / 8 x 52 = $5,200Room cost = (200 delegates x $80) $5,200 = $10,800

Room CContribution per seminar = $3,993,600 / (8 x 52) = $9,600Room cost = (300 delegates x $80) $9,600 = $14,400

Room DContribution per seminar = $6,656,000 / (8 x 52) = $16,000Room cost = (400 delegates x $80) $16,000 = $16,000

(b) (i)

Expected Contribution if 100 places available = $832,000

Expected Contribution if 200 places available = 1,497,000

Expected Contribution if 300 places available = 998,000

Expected Contribution if 400 places available =1,331,200

This analysis shows that Faith Co. should contract for Room B with 200 capacity as it has the highestexpected value at $1,497,600.

(ii)Limitations of the expected value approach

Expected values indicate what an outcome is likely to be in the long term with repetition. The mainlimitation is that the expected value may never actually occur. Expected values are used to support arisk-neutral attitude and ignore any variability in the range of possible outcomes. The variables involvedcan only be estimated so great care should be taken to avoid relying too heavily on educated guesses.


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(c) The minimum contribution for each decision is as follows.

Room A $832,000Room B ($1,164,000)Room C ($2,662,400)Room D ($3,328,000)

Applying a maximin approach (maximising the minimum contribution), Faith should choose RoomA.

The minimax regret rule aims to minimise the regret from making the wrong decision. The regretmatrix is shown below. The regret is calculated by taking the maximum expected contribution fromeach demandlevel (as shown in the table for (a) and deducting the contribution that would resultfrom the room sizethat was contracted for. For example, if 200 places were demanded but only 100places were contracted for, that would mean that the regret is $2,163,200 $832,000 = $1,331,200.

Regret Table:

Room size

Demand 100 200 300 400

100 0 1,996,800 3,494,400 4,160,000200 1,331,200 0 1,497,600 2,163,200400 5,824,000 4,492,800 2,662,400 0

Maximum regret 5,824,000 4,492,800 3,494,400 4,160,000

To minimise the maximum regret, Room C with 300 places needs to be contracted for.

(d) The information systems that may be introduced to reduce uncertainty in Faith Co:

A retail web site - this site should be interactive enabling customers to correspond with the customer

relationship officer to evaluate their choices and purchases. This can be backed up with the reservation ofthe room online.

Customer accounts - may be established by the company to establish the number of returningcustomers to the site and company.

Web site monitoring - the company may scan web sites of their main competitors to identify changes intheir sales items and press releases relating to their performance. This monitoring will reduce the actualdata collection which will be required by the staff working at Faith and enable them to evaluate theirperformance in relation to others. lf the industry standard increases and Faith are unaware of the changethey could find that their pcsition ls eroded, as competitors are abie to improve their margins.

Management Information System - both of the above systems will require a management informationsystem to report on the purchases made by the customers. They will then be able to analyse the numberof customers who return to buy the albums etc. and the ability to report and summarise information fromthe sales transaction will enable the organisation to obtain greater marketing information with the result oftargeting specific customers.

The organisation will need to create a number of reporting systems relating to the individual sales indifferent cities. This will enable the company to identify the profit margins on individual lines to determinetheir profitability and their overall contribution to the performance of the business.


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Executive information system (ElS) - this is a high-level information system that may be used by thestrategic managers within Faith to compare the performance of the companies in a summary format. Theinformation gathered by the MIS and other lower level information systems can be filtered into this systemto provide important information relating to the overall costs and sales.

Answer # 3

Define the variables

Let S represent the number of Scottie services to be providedLet L represent the number of Labrador services to be providedLet C represent contribution

Formulate the objective function

C = 7.5S + 15L

Formulate the constraints

Specialised cleaning materials 0.1S + 0.15L 60Labour time 0.5S +L 300Machine time 0.5S + 0.25L 150 Minimum number of Scotties S 25Minimum number of Labradors L 50

Plot constraints

Specialised cleaning products 0.1S + 0.15 L = 60If S=0 0.15L = 60L = 400If L = 0 0.1S = 60S = 600

Labour time 0.5S +L = 300If S=0 L = 300If L=0 0.5S = 300S = 600

Machine time 0.5S + 0.25L = 150If S=0 0.25L = 150L = 600If L=0 0.5S = 150S = 300

Plot objective function

C = 7.5S + 15L

Try C being 3,000If S=0 15L = 3,000L = 200If L=0 7.5S = 3,000S = 400

Plot the graph - NEEDS A GRAPH INSERTING TO SHOW SOLUTION


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Solve

The optimal solution is where machine hours and labour cross. Solving using simultaneous equations:

0.5S + 0.25L = 150 equation10.5S + L = 300 equation 2

Equation 2 Equation 10.75L = 150L = 200

Substitute back into equation 20.5S + 200 = 3000.5S = 100S = 200

In order to maximize contribution, Puppycare should provide 200 Scotties and 200 Labradors.

(b) Contribution maximized where 200 Scotties and 200 Labradors are provided given a contribution of:

(200 x 7.50) + (200 x 15) = 4,500.

Shadow price for machine hours:

0.5S + 0.25L = 151 equation10.5S + L = 300 equation 2

Equation 2 Equation 10.75L = 149L = 198.67

Substitute back into equation 20.5S + 198.67 = 3000.5S = 101.33S = 202.67

Optimal solution = 202.67S + 198.67L

Giving contribution of = (202.67 x 7.50) + (198.67 x 15)=4,500.075

Shadow price =4,500.075 -4,500= 7.5p

Shadow price for specialized cleaning material:

Specialised cleaning material is a non-critical constrains for Puppycare. Hence the shadow price is nill.

(c) Performance measurement in service businesses has sometimes been perceived as difficult becauseof the different characteristics of service from product. But the modern view is that if something is difficultto measure this is because it has not been clearly enough defined. Fitzgerald & Moon provide buildingblocks forstandards,rewards and dimensions for performance measurement systems in servicebusinesses.


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Standards

These are ownership, achievability and equity.

Ownership - To ensure that employees take ownership of standards, they need to participate in thebudget and standard-setting processes. They are then more likely to accept the standards, feel moremotivated as they perceive the standards to be achievable and morale is improved. The disadvantage to

participation is that it offers the opportunity for the introduction ofbudgetary slack.

Achievability - Standards need to be set high enough to ensure that there is some sense ofachievement in attaining them, but not so high that there is a demotivating effect because they areunachievable. It is management's task to find a balance between what the organisation perceives asachievable and what employees perceive as achievable.

Equity - It is vital that equity is seen to occur when applying standards for performance measurementpurposes. The performance of different business units should not be measured against the samestandards if some units have an inherent advantage unconnected with their own efforts. For example,divisions operating in different countries should not be assessed against the same standards.

Rewards

The reward structure of the performance measurement system should guide individuals to work towardsstandards. Three issues need to be considered if the performance measurement system is to operatesuccessfully: clarity, motivation and controllability.

Clarity - The organisation's objectives need to be clearly understood by those whose performance isbeing appraised ie they need to know what goals they are working towards.

Motivation - Individuals should be motivated to work in pursuit of the organisation's strategic objectives.Goal clarity and participation have been shown to contribute to higher levels of motivation to achievetargets, providing managers accept those targets. Bonuses can be used to motivate.

Controllability - Managers should have a certain level ofcontrollability for their areas of responsibility.For example they should not be held responsible for costs over which they have no control.

Dimensions

Competitive performance, focusing on factors such as sales growth and market share.

Financial performance, concentrating on profitability, capital structure and so on.

Quality of service looks at matters like reliability, courtesy and competence.

Flexibility is an apt heading for assessing the organisation's ability to deliver at the right speed, torespond to precise customer specifications, and to cope with fluctuations in demand.

Resource utilisation, not unsurprisingly, considers how efficiently resources are being utilised.This can be problematic because of the complexity of the inputs to a service and the outputs from it and

because some of the inputs are supplied by the customer (he or she brings their own hair, for example).Many measures are possible, however, for example 'number of customers per hairdresser'. Performancemeasures can be devised easily if it is known what activities are involved in the service.

Innovation is assessed in terms of both the innovation process and the success of individual innovations.

These dimensions can be divided into two sets. The results (measured by financial performance and competitiveness) The determinants (the remainder)


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Answer # 4

Sales Volume profit varianceTV DVD AC

Budgeted sales 800 units 600 units 300 unitsActual sales 560 units 1,260 units 250 units

Sales volume variance in units 240 units (A) 660 units (F) 50 units (A)Standard profit margin per unit $5 $3 $4

Sales volume variance in $ $1,200 (A) $1,980 (F) $200 (A)

Total sales volume variance = $580 (F)

Sales Mix profit variance

Total quantity sold (560 + 1,260 + 250) = 2,070Budgeted total quantity (800 + 600 + 300) = 1,700

Standard Mix Actual Profit

on actual sales sales per unit $

TV (800/1700) x 2070 560 5 2071 (A)

DVD (600/1700) x 2070 1260 3 1588 (F)

AC (300/1700) x 2070 250 4 461 (A)

Total 944 (A)

Sales Quantity profit variance

Budgeted Standard Mix Profit

sales on actual sales per unit $

TV 800 (800/1700) x 2070 5 871 (F)

DVD 600 (600/1700) x 2070 3 392 (F)

AC 300 (300/1700) x 2070 4 261 (F)

Total 1524 (F)

If an organisation uses standard marginal costing instead of standard absorption costing then standardcontribution rather than standard profit margin is used in the calculations.

(b) The favourable sales volume variance indicates that a potential increase in profit was achieved as aresult of the change in sales volume compared with the budgeted volume.

The sales mix variance is adverse due to the fact that more of the less profitable product was sold thanbudgeted.

Profit would have been $944 higher if the 2,070 units had been sold in the budgeted mix of TV 8: DVD 6:AC 3.


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The favourable sales quantity variance of $1,524 is the difference in profit because sales volumes ofproducts were higher than budgeted, possibly due to effective marketing campaigns.

(c) Maximising profits

Selling price 12 11 10 9Demand 6,000 7,200 11,200 13,400

Sales Revenue 72,000 79,200 112,000 120,600

Variable cost (in house) 37,200 43,400 43,400 43,400Subcontractor cost - 1,550 32,550 44,800Fixed cost 11,200 11,200 11,200 11,200

_____ _____ _____ _____Profit 23,600 23,050 24,850 21,200

The price of $10 and sales of 11,200 units would maximise the profit, as illustrated above at $24,850provided the estimates prove to be correct.

(d) Environmental Management Accounting Try yourself


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Answer # 5

(a) Learning curve theory can be used in budgeting to:

- Calculate the marginal (incremental) cost of making extra units of a product.

- Quote selling prices for a contract, where prices are calculated at cost plus a percentage mark-up forprofit. An awareness of the learning curve can make all the difference between winning contracts andlosing them, or between making profits and selling at a loss-making price.

- Prepare realistic production budgets and more efficient production schedules.

- Prepare realistic standard costs for cost control purposes.

(b)$

Direct material cost (W1) 631,200

Direct labour cost (W2)

(35435.94 x 10) 354,359.4

Variable overhead(35435.94 x 3) 106,307.8

Fixed cost (11000 x 18) 198,000-------------

Total Cost 1,289,867.2

Profit Mark-up 25% 322,466.8

Selling Price 1,612,334

Selling Price per unit 1,151.67

Workings

(W1) Direct material cost = (300 x 600) + (300 x 600 x 80%) + (800 x 600 x 80% x 80%)

(W2) Direct labour hour

Cumulative average time per unit to produce 900 units = 500 x 900 -0.4150= 29.7139 hour

Cumulative total labour hour to produce 900 units = 900 x 29.7139 = 26742.4919 hour

Cumulative average time per unit to produce 899 units = 500 x 899 -0.4150= 29.7276 hour

Cumulative total labour hour to produce 899 units = 899 x 29.7276 = 26725.1052 hour

Time to produce 900th unit = 26742.4919 - 26725.1052 = 17.3869 hour

Total time to produce 1400 units = 26742.4919 + 500 x 17.3869 = 35435.94 hour


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(c) Limitations of using learning curve in modern manufacturing environment Try yourself

(d)

Life cycle costing tracks and accumulates costs and revenues attributable to each product over theentire product life cycle.

Every product goes through a life cycle in Metallica Ltd.

Development - The product has a research and development stage where costs are incurred but norevenue is generated.

Introduction - The product is introduced to the market. Potential customers will be unaware of theproduct or service, and the organisation may have to spend further on advertising to bring the product orservice to the attention of the market.

Growth - The product gains a bigger market as demand builds up. Sales revenues increase and theproduct begins to make a profit.

Maturity - Eventually, the growth in demand for the product will slow down and it will enter a period ofrelative maturity. It will continue to be profitable. The product may be modified or improved, as a means ofsustaining its demand.

Decline -At some stage, the market will have bought enough of the product and it will therefore reach'saturation point'. Demand will start to fall. Eventually it will become a loss-maker and this is the timewhen the organisation should decide to stop selling the product or service.

The level of sales and profits earned over a life cycle can be illustrated diagrammatically.

f5 final mock answer june 2013

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