p1 sept2014 answers

7/23/2019 P1 Sept2014 Answers

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The Chartered Institute of Management Accountants 2014

Operational Level Paper

P1 Performance OperationsSeptember 2014 examination

Examiners Answers

Note: Some of the answers that follow are fuller and more comprehensive than would beexpected from a well-prepared candidate. They have been written in this way to aid teaching,

study and revision for tutors and candidates alike.

These Examiners answers should be reviewed alongside the question paper for thisexamination which is now available on the CIMA website atwww.cimaglobal.com/p1papers

The Post Exam Guide for this examination, which includes the marking guide for eachquestion, will be published on the CIMA website by early October atwww.cimaglobal.com/P1PEGS

SECTION A

Answer to Quest ion One

Rationale

Question Oneconsists of eight objective test sub-questions. These are drawn from allsections of the syllabus. They are designed to examine breadth across the syllabus and thuscover many learning outcomes.

1.1The correct answer is B.

1.2Payment will be made 35 days early.Number of compounding periods = 365/35= 10.4291+ r = (1.00/0.98)

10.429

1+ r = 1.2345

The effective annual interest rate of the early settlement discount is 23.45%

The correct answer i s C.
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Performance Operations 2 September 2014

1.3

Material Actual input

@standard

mix (kg)

Actual input

@ actual

mix (kg)

Variance

Kg

Standard cost

$

Variance

$

A 24,400 23,000 1,400 F 2.40 3,360 F

B 36,600 38,000 1,400 A 1.30 1,820 A

61,000 61,000 1,540 F

The correct answer is A.

1.4

Weighted average standard cost(24,000kg x $2.40) + (36,000kg x $1.30) = $104,400$104,400 / 60,000 kg = $1.74 per kg

Standard kg of input per unit of output = 5kg

12,000 units output x 5kg = 60,000kg of input

Actual input = 61,000 kg

Variance = 1,000kg A

Standard cost per kg = $1.74

Variance = 1,000kg x $1.74 = $1,740 A

Or alternatively:

61,000kg should yield 61,000/5kg = 12,200 units

Actual yield = 12,000 units

Yield variance = 200 units AStandard material cost per unit = (2kg x $2.40) + (3kg x $1.30) = $8.70

Yield variance = 200 units x $8.70 = $1,740 A

The correct answer is B.

1.5

The maximum regret if 10,000 units are purchased is $180,000The maximum regret if 15,000 units are purchased is $120,000The maximum regret if 20,000 units are purchased is $70,000The maximum regret if 25,000 units are purchased is $105,000

Therefore if the manager wants to minimise the maximum regret 20,000 units will bepurchased.

The correct answer is C.


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September 2014 3 Performance Operations

1.6

Budgeted maintenance cost for August:

y = 22,000 + 0.025x2

y = 22,000 + 0.025(1,8202)

y = 22,000 + 82,810y = 104,810

Increase for inflation:

$104,810 x 1.04 = $109,002

The maintenance cost variance for August is therefore:

$109,002 - $106,500 = $2,502 Favourable

1.7

Expected cash inflow in Year 1 = ($200k x 0.2) + ($300k x 0.7) + ($360k x 0.1) = $286k

Expected cash inflow in Year 2 = ($100 x 0.6) + ($320 x 0.4) = $188k

Expected net present value

Year Cash flow Discount factor Present value

$ $

0 (300,000) 1.000 (300,000)

1 286,000 0.909 259,974

2 188,000 0.826 155,288Net present value 115,262

1.8

(i)

The discount = $1000 x 7% x 91/365 = $17.45

The issue price is therefore $1,000 - $17.45 = $982.55

(ii)

Treasury bills are negotiable instruments issued by the Government They have a maturity of less than one year, normally 91 days They have high credit quality and therefore low risk and low return They are redeemable at face value They are issued at a discount to face value There is a large and active secondary market in treasury bills


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SECTION B

Answer to Quest ion Two

(a)

Rationale

The question assesses learning outcome B1(b) explain the purposes of budgeting includingplanning, communication, co-ordination, motivation, authorisation, control and evaluation,and how these may conflict. It examines candidates ability to explain two of the purposes ofbudgeting and how these may conflict.

Suggested Approach

Candidates should clearly explain two of the stated purposes of budgeting and how thesemay conflict with each other.

Planning- Budgeting forces an organisations management to look ahead and setperformance targets. This ensures that management anticipates any future problems andgives the organisation direction. It also ensures that managers are aware of their own targetsand responsibilities and how they relate to those of other managers within the organisation.

Control- The budget acts as a control mechanism, with actual results being compared withbudget. Appropriate actions can then be taken to correct any deviations from plan.

Evaluation - The budget also provides an internal benchmark against which performance canbe evaluated. The performance measured may be that of a department or division or of anindividual manager.

Motivation - Budgeting sets targets to motivate managers and optimise their performance.The budget is a useful device for influencing managers behaviour and motivating managersto perform in line with the organisations objectives. It provides a standard which managersmay be motivated to achieve.

The budget therefore serves a number of different purposes which may conflict with eachother. For example, the planning and motivational roles may conflict, as demanding budgetsthat may not be achieved may be appropriate to motivate managers to achieve maximumperformance but are unsuitable for planning purposes.

There is also a conflict between the planning and performance evaluation roles. For planningpurposes budgets are set in advance of the budget period based on an anticipated set ofcircumstances and/or external environment. If the circumstances that were anticipated at thetime the budget was prepared have changed then there will be a planning and performanceevaluation conflict.

There may also be a conflict between the performance evaluation and motivation purposes asthe budget can cause inefficiency and conflict between managers particularly if the budget isimposed from above, whereby it may act as a threat rather than as a challenge. Targets thatare imposed on managers are unlikely to motivate the managers to achieve them.


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(b)

Rationale

The question assesses learning outcome D1(a) analyse the impact of uncertainty and risk ondecision models that may be based on relevant cash flows, learning curves, discountingtechniques etc. It examines candidates ability to use cost volume profit analysis to identifythe sensitivity of budgeted profit figures.

Suggested Approach

Candidates should firstly determine the fixed and variable costs from the budgetedinformation given and then calculate the contribution per unit. In part (i) the break even pointcan be calculated by dividing the fixed costs by the contribution per unit. In part (ii) the marginof safety can be calculated by comparing the budgeted sales to the break even sales andexpressing the difference as a percentage of the budgeted sales. In part (iii) the effect of thechanges on the contribution per unit and the fixed costs should be calculated and then arevised break-even point should be calculated.

(i)

Contribution per unit = $24.00 - $8.60 $1.20 = $14.20

Break even point = $880,400/ $14.20 = 62,000 units

(ii)

Margin of safety = (90,000 62,000) / 90,000 = 31.1%

(iii)

Revised contribution per unit = $25.00 - $8.60 - $2.00 = $14.40Break-even point = $890,400 / $14.40 = 61,833 units


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(c)

Rationale

The question assesses learning outcome E1(g) analyse the impacts of alternative policies forstock management. It examines candidates ability to discuss the effectiveness of the EOQmodel for inventory management purposes.

Suggested Approach

Candidates should explain how the EOQ model operates and discuss its benefits andlimitations for inventory management purposes.

The economic order quantity (EOQ) is based on the assumption that demand for the period is

known and constant. Therefore the optimum order quantity will be determined by the coststhat are affected by either the quantity of inventory held or the numbers of orders placed. Ahigher quantity ordered each time will mean fewer orders each year and therefore a reductionin ordering costs. However, this will also result in higher average inventory levels whichresults in an increase in holding costs. The EOQ therefore is a trade-off between the costs ofcarrying high inventory against the costs of placing more orders. The optimum order size isthe quantity that will result in the total of the ordering and holding costs being minimised.

The EOQ model assumes a world of certainty where the usage and delivery of inventory canbe predicted accurately and management can therefore avoid stock-out costs andconcentrate on achieving the optimal balance between ordering costs and holding costs.However this is unlikely to be the case in reality for most companies. The EOQ model ignorestwo types of risk:

a) Uncertainty over the time it takes for the order to be delivered i.e. the lead time. Thelead time is neither zero as assumed by the model or necessarily predictable.

b) The rate at which inventory is used may not be constant, demand may be subject tofluctuations and the overall annual demand may be difficult to predict with accuracy.

The company can cope with these two risk elements, to a certain extent, by holding a bufferinventory. The buffer inventory level can be calculated by weighing up the cost of stock-outsand the costs of holding additional inventory. The determination of lead time and dealing withuncertainty of demand requires subjective managerial judgement as does determining thecost of stock-outs since many of the costs involved are difficult to quantify.


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(d)

Rationale

The question assesses learning outcome D1(e) calculate the value of information. It

examines candidates ability to calculate the value of perfect information where there isuncertainty regarding expected net present values.

Suggested Approach

Candidates should firstly apply the probabilities for the demand levels to calculate theexpected value of the net present value for each of the machines without perfect information.They should then select the best outcome for each of the possible demand levels and applythe probabilities to these to calculate the expected value with perfect information. The valueof perfect information can then be calculated as the difference between the expected valuewith perfect information and the best of the expected values without perfect information.

Demand Probability Machine A Machine B Machine C

$000 $000 $000

High 35% 100 x 0.35 = 35 140 x 0.35 = 49 180 x 0.35 = 63

Medium 40% 150 x 0.40 = 60 160 x 0.40 = 64 140 x 0.40 = 56

Low 25% 200 x 0.25 = 50 100 x 0.25 = 25 80 x 0.25 = 20

Expected value 145 138 139

Machine A is the best choice (without the benefit of perfect information) as it has the highestexpected value (EV) of $145k.

With perfect information:If research suggests high demand: select Machine C and earn $180kIf research suggests medium demand: select Machine B and earn $160kIf research suggests low demand: select Machine A and earn $200k

EV (with perfect information) = ($180k x 0.35) + ($160k x 0.40) + ($200k x 0.25) = $177kValue of perfect information is $177k $145k = $32k

Alternatively:

Value of perfect information = (($180k - $100k) x 0.35) + (($160k - $150k) x 0.40) = $32k


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(e)

Rationale

The question assesses learning outcome E1(d) discuss measures to improve a cash forecastsituation. It examines candidates ability to explain the trade off between the cost of holdingtoo much cash and too little cash.

Suggested Approach

Candidates should clearly explain the costs involved with holding too much cash and how thisneeds to be balanced with the costs involved with holding too little cash.

There are a number of costs involved with holding too little cash which a company may incuras follows:

It may not be possible to pay suppliers on time which could lead to reluctance to supplyand eventually to liquidation;

It will not have the ability to react quickly to unexpected events e.g. competitor action,strikes etc;

It will potentially miss unexpected opportunities e.g. contracts or lucrative investments;

It may not be able to benefit from early settlement discounts from suppliers;

It is likely to incur higher cost of borrowing because unexpected cash requirementsneed to be met from temporary borrowings;

It will incur transaction costs involved with acquiring cash e.g. cost of selling securitiesor arrangement fees for overdrafts.

The costs of holding too little cash have to be balanced with the costs of holding cash i.e. theloss of interest and the loss of purchasing power as inflation erodes the value of cash.


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(f)

Rationale

The question assesses learning outcome B3(a) prepare a budget for any account in the

master budget, based on projections/forecasts and managerial targets.It examinescandidates ability to prepare a production budget and a materials usage and purchasesbudget.

Suggested Approach

In part (i) candidates should calculate the number of units required to be produced afteradjusting for the change in inventory of finished goods. In part (ii) candidates should calculatethe materials usage budget based on the production budget calculated in part (i). In part (iii)candidates should calculate the material purchases budget in kg after adjusting for thechange in materials inventory. The material purchases budget in $ can then be calculated bymultiplying the budget in kg by the price per kg of material.

(i)

Product A1 A2Sales (units) 32,000 56,000Increase / (decrease) in inventory 1,000 (2,000)Production budget (units) 33,000 54,000

(ii)

Material B3 B4A1 A2 Total A1 A2 Total

Production budget(units)

33,000 54,000 87,000 33,000 54,000 87,000

Kg per unit 8 4 4 3Material usage (kg) 264,000 216,000 480,000 132,000 162,000 294,000

(iii)

Material B3 B4Total Total

Material usage (kg) 480,000 294,000

Less: opening inventory (30,000) (20,000)Plus: closing inventory 24,000 14,700Material purchases (kg) 474,000 288,700Price per kg $1.25 $1.80Material purchases $ $592,500 $519,660


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SECTION C

Answer to Quest ion Three

Rationale

The question assesses learning outcome A1(c) discuss activity-based costing as comparedwith traditional marginal and absorption costing methods, including its relative advantagesand disadvantages as a system of cost accounting.Part (a) examines candidates ability tocalculate the cost of a product using activity based costing. Part (b) examines candidatesability to discuss the differences between the gross profit calculated under the activity basedcosting system and that calculated under the traditional absorption costing system. Part (c)examines candidates ability to explain how the information obtained using an activity basedcosting system could be used for cost management purposes.

Suggested Approach

In part (a) candidates should calculate a cost driver rate for each of the activities and thenapply this cost driver rate to calculate the overhead cost for each activity per product. Thegross profit for each product can then be calculated. In part (b) candidates should clearlyexplain the reasons for the differences between the gross profits calculated using activitybased costing and that calculated using the current absorption costing system. In part (c)candidates should clearly explain how the information from an activity based costing systemcould be used for cost management purposes.

(a)

Tablets ConvertibleLaptops

All-in-onePCs

Total

Budgeted production per annum (units) 10,000 12,000 6,000 28,000Average number of units per order 10 6 4Number of orders 1,000 2,000 1,500 4,500Parts per unit 20 35 25Total number of parts 200,000 420,000 150,000 770,000Assembly time per unit (minutes) 20 40 30Total assembly time (minutes) 200,000 480,000 180,000 860,000Software applications per unit 2 3 4Total number of software applications 20,000 36,000 24,000 80,000

Activity Activity cost$000

Cost driver Cost driver rate

Manufacturingscheduling

162 Number of orders $162,000 / 4,500= $36 per order

Parts handling 2,464 Number of parts $2,464,000 / 770,000= $3.20 per part

Assembly 4,472 Assembly time $4,472,000 / 860,000= $5.20 per minute

Softwareinstallation &testing

2,000 Number of softwareapplications

$2,000,000 / 80,000= $25.00 per application

Packaging 1,302 Number of units $1,302,000 / 28,000= $46.50 per unit

10,400


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All-in-onePCs

Total

$000 $000 $000 $000Manufacturing

scheduling

(1,000 x $36)

36

(2,000 x $36)

72

(1,500 x $36)

54 162

Parts handling(200,000 x $3.20)

640(420,000 x $3.20)

1,344(150,000 x $3.20)

480 2,464

Assembly(200,000 x $5.20)

1,040(480,000 x $5.20)

2,496(180,000 x $5.20)

936 4,472Softwareinstallation &testing

(20,000 x $25)500

(36,000 x $25)900

(24,000 x $25)600 2,000

Packaging(10,000 x $46.50)

465(12,000 x $46.50)

558(6,000 x $46.50)

279 1,302Total productionoverhead costs 2,681 5,370 2,349 10,400


All-in-onePCs

Total

$000 $000 $000 $000Sales 3,640 12,480 9,880 26,000Direct material 800 2,800 2,200 5,800Direct labour 300 1,200 800 2,300Production overheads 2,681 5,370 2,349 10,400Gross profit (141) 3,110 4,531 7,500


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(b)

Products Tablets ConvertibleLaptops

All-in-onePCs

Current system of

absorption costing (per unit)Selling price $364 $1,040 $1,647Production overhead cost $146 $416 $659Gross profit $108 $291 $488

Gross profit % 29.8% 27.9% 29.6%

Activi ty based cos ting (per un it )Selling price $364 $1,040 $1,647Production overhead cost $268 $448 $392Gross profit $(14) $259 $755

Gross profit % (3.9%) 24.9% 45.9%

It can be seen from the figures in the table above that under the activity based costing systemthere is a completely different picture of the profitability of each of the products. Under thetraditional absorption costing system each of the products was making a very similar grossprofit margin of around 30%. However under the activity based costing system, Tablets arenow shown to be loss making and all-in-one PCs are making a significantly higher gross profitmargin, at 45.9%, than originally thought. The gross profit margin for convertible laptops hasdeclined slightly from 27.9% to 24.9%.

Under the traditional absorption costing system, production overheads were charged toproducts based on sales revenue. This meant that Tablets which has a relatively low

proportion of the total sales revenue (14%) was charged a relatively low level of fixedproduction overheads. When the activity based costing system is used and the actualconsumption of activities is considered Tablets are charged significantly more productionoverheads than before. Whilst Tablets has the lowest number of cost drivers for most of theactivities it also has a relatively lower selling price than the other products. For example theratio of parts per unit is 20:35:25 for Tablets, convertible laptops and all-in-one PCs but theratio of selling prices is 12:34:54. All-in-one PCs gross profit percentage is significantly higherunder activity based costing since whilst it has the second highest number of cost drivers forparts per unit and assembly time per unit it has the highest selling price per unit compared tothe other two products.

This information will be useful for the company when making decisions about product pricingand product mix.

(c)

The activity based costing system provides information about the various activities and thecost drivers for each activity. The information about the cost of activities enables the companyto focus on those activities with the highest costs and to determine whether they can beeliminated or performed more efficiently. Activities can be classified as value-added and non-value added. Companies can take action to reduce or eliminate the non-value addedactivities.

The information ascertained about the cost drivers will also be useful for cost controlpurposes. The company can try to reduce the number of cost drivers for each product through

process or product redesign. The cost driver rate can also be used as a measure of costefficiency.


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Answer to Quest ion Four

Rationale

Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis

to long-run projects that continue for several years and C2(a) evaluate project proposalsusing the techniques of investment appraisal. It examines candidates ability to identify therelevant costs of a project and then apply discounted cash flow analysis to calculate the netpresent value of the project. Part (b) assesses learning outcome C1(g) prepare decisionsupport information for management, integrating financial and non-financial considerations. Itexamines candidates ability to explain other factors that the company would need to considerbefore deciding whether to go ahead with the project. Part (c) also assesses learningoutcome C2(a) evaluate project proposals using the techniques of investment appraisal. Itexamines candidates ability to calculate the internal rate of return (IRR) for the project andthe sensitivity of the investment decision to a change in the cost of capital.

Suggested Approach

In part (a) candidates should firstly calculate the number of units sold and the contributionthat would be earned from the product in each year. They should then deduct the fixed costsafter adjusting for depreciation. The contribution and fixed costs should then be adjusted forinflation from year 2 of the project. The total cost of the investment and the residual valueshould then be added to the net cash flows. The working capital should be shown as a cashoutflow in Year 0 and the additional amount required as a result of inflation, shown as a cashoutflow each year. The total working capital throughout the period of the project should thenbe shown as a cash inflow in Year 5. The tax depreciation and tax payments should then becalculated. The net cash flows after tax should then be discounted at the discount rate of 12%to calculate the net present value (NPV) of the project. In part (b) candidates should clearlyexplain two other factors that the company should consider before making a decision aboutthe investment project. In part (c)(i) candidates should discount the cash flows after tax at a

lower discount factor than 12% and then, using interpolation, calculate the internal rate ofreturn (IRR) for the project. In part (c)(ii) candidates should calculate the difference between12% and the IRR and express this as a percentage of 12%.

(a)

Contribu tion Years 1 5Year 1: 100,000 x $20 = $2,000kYear 2: 100,000 x 1.2 = 120,000 x $20 = $2,400k x 1.04 = $2,496kYear 3: 120,000 x 1.2 = 144,000 x $20 = $2,880k x 1.04

2= $3,115k

Year 4: 144,000 x 1.2 = 172,800 x $20 = $3,456k x 1.043= $3,888k

Year 5: 172,800 x 1.2 = 207,360 x $20 = $4,147k x 1.044= $4,852k

Fixed CostsDepreciation per annum = ($10m - $1.5m) / 5 = $1.7m

Fixed costs (excluding depreciation) per annum= $2.5m - $1.7m = $0.8m


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Taxation

Year 1 Year 2 Year 3 Year 4 Year 5$000 $000 $000 $000 $000

Contribution 2,000 2,496 3,115 3,888 4,852Fixed costs (800) (832) (865) (900) (936)

Net cash flows 1,200 1,664 2,250 2,988 3,916Tax depreciation (2,500) (1,875) (1,406) (1,055) (1,664)Taxable profit (1,300) (211) 844 1,933 2,252Taxation @ 30% 390 63 (253) (580) (676)

Net present value

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6$000 $000 $000 $000 $000 $000 $000

Investment/ residualvalue

(10,000) 1,500

Workingcapital

(3,000) (120) (125) (130) (135) 3,510

Net cashflows

1,200 1,664 2,250 2,988 3,916

Tax cashflow

195 32 (127) (290) (338)

Tax cashflow

195 31 (126) (290) (338)

Net cashflow aftertax

(13,000) 1,275 1,766 2,024 2,437 8,298 (338)

Discountfactors @12%

1.000 0.893 0.797 0.712 0.636 0.567 0.507

Presentvalue

(13,000) 1,139 1,408 1,441 1,550 4,705 (171)

Net present value = - $2,928kThe net present value is negative therefore the project should not go ahead.

(b)

The project is concerned with the education of children in computer science and withencouraging them to be involved in computer science at an early age. This is a new marketfor the company and may have long term benefits if children start to use full scale computersat an earlier age than normally would be expected.

Whilst the project makes a negative net present value the company may be able to improveits brand image if it is seen to be supplying relatively low cost computers to the educationmarket. The company could benefit from being involved in this project as they are being seento be concerned with the education needs of children.


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(c)

(i)

The net present value is negative at 12% therefore use a lower discount factor.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6$000 $000 $000 $000 $000 $000 $000

Net cashflow aftertax

(13,000) 1,275 1,766 2,024 2,437 8,298 (338)

Discountfactors @4%

1.000 0.962 0.925 0.889 0.855 0.822 0.790

Presentvalue

(13,000) 1,227 1,634 1,799 2,084 6,821 (267)

Net present value at 4% discount rate = $298k

By interpolation:

IRR = 4% + (($298k / ($298k + $2,928)) x 8) = 4.74%

(ii)

The cost of capital is 12%.

(12 4.74) / 12 = 61%

For the project to be accepted the cost of capital would need to reduce by 61%.

p1 sept2014 answers

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