revision pack and ansjjwers

7/27/2019 Revision Pack and Ansjjwers

1/34

1

Revision Questions and readings

Current Issues in management Accounting

Comments

(i) There are no questions for the Balanced Scorecard in this pack. This is anew topic for 2012-13

Please use the questions from sharepoint.

(ii) Essential reading --Management Views on Real Options in Capital

Budgeting

Corresponding Author

H. Kent Baker

American University

[email protected]

Shantanu Dutta

University of Ontario Institute of [email protected]

Samir Saadi

Queens University & INSEAD

[email protected]

This article is on sharepoint. Students must understand why real options are

difficult to use in practice.

(iii) Essential reading

Using the balanced scorecard to manage performance in public

sector organizations Issues and challengesDeryl Northcott

Department of Accounting, AUT Business School,

The Auckland University of Technology, Auckland, New Zealand, and

Tuivaiti Maamora Taulapapa

Manukau Institute of Technology, Auckland, New Zealand

This article is on sharepoint. Students must understand why the BSC is difficult

to implement in the public sector.

(iv) Essential reading

Constructing a strategy map for banking institutions with key performance

indicators of the balanced scorecard

Hung-Yi Wu*

Department of Business Administration, National Chiayi University, No. 580, Xinmin

Rd., Chiayi City 60054, Taiwan

This article is on sharepoint. Students must understand the importance of causal

links between KPIs.


2/34

2

Question One May 2012

Polychemicals plc manufactures plastics used primarily in the packaging of processed

food products. The directors of the company have become aware of the increasing

environmental pressures to reduce the use of non-degradeable products in the

packaging industry and they believe that if Polychemicals can improve theirenvironmental reporting this will lead to both improved public perception of their

activities and products and to greater efficiency in their operations. In addition,

although Polychemicals has a fairly good compliance record in terms of current

environmental legislation and regulation, the company has in the past two years been

fined 1 million by a tribunal for safety breaches and 1.5 million following a court

case due to river pollution.

The existing performance measurement systems within Polychemicals focus

exclusively on financial performance. They both support financial reporting

obligations and allow monitoring of key performance measures such as earnings per

share and operating margins.

The directors of Polychemicals are currently considering a substantial capital

expenditure programme to enhance productive capacity, safety and efficiency at their

main production facility in Maidstone. This will involve demolishing certain older

sections of the plant and building on newly acquired land adjacent to the site. Overall,

the production facility will increase its land area by 20%.

Largely in response to environmental pressures, the companys Research &

Development function has developed a new derivative plastic Polysmart which is

lighter in weight and extremely malleable and so will reduce packaging materials

usage. Also Polysmart packaging will incinerate at lower temperature on disposal.

However, packaging technology is likely to continue to advance rapidly; consequently

the Polysmart product is expected to have a limited market life of five years.

The companys management accountant, Paula Wilcox, had forecast the following

information associated with Polysmart and had calculated Polychemicals traditional

performance measure of product profit for Polysmart.

All figures are ms

2013 2014 2015 2016 2017Revenue 63 69 75 82 85

Costs

Production costs 34 37 42 46 46

Marketing costs 12 10 7 7 5

Development costs 14 7 0 0 0

Product profit 3 15 26 29 34

Subsequently on investigation of the likely environmental impact of commencing the

manufacture of Polysmart, Paula was able to identify the following specific

environmental costs [previously these costs, if recognised at all, would likely havebeen treated as part of the companys general overheads].


3/34

3

All figures are ms

2013 2014 2015 2016 2017Waste liquids

filtration

3 3.5 3.8 4.8 5.3

Carbon based gasemissions

2 2.3 2.3 3 3.8

In addition, Paula focused on the costs directly associated with closing down and

recycling the production plant to be used in Polysmart production and estimated

these at 45 million in 2017.

You are required to:

(a) Identify, explain and evaluate THREE environmental accounting techniques

that can assist the directors of Polychemicals plc in their desire to improve the

environmental and strategic performance of their company.(11 marks)

(b) Discuss different cost categories that would aid transparency in environmental

reporting both internally and externally at Polychemicals plc.

(6 marks)

(c) Evaluate the costing approach traditionally used by the company to measure the

performance of the new product Polysmart compared to a lifecycle costing

approach. You should perform appropriate calculations.

(16 1/3 marks)

(Total 33 1/3 marks)


4/34

4

Question Two May 2012

Barista plc manufactures commercial coffee machines for use in cafes, restaurants and

bars. The company has over recent years built and maintained a loyal customer base

by making a high quality machine backed by a five-year warranty the terms of which

state that Barista plc will recover and repair any machine that breaks down in thewarranty period at no cost.

Barista is structured into two divisions, a Manufacturing division [which is also

responsible for sales] and a Service division.

Gill Adkins, the companys management accountant, has collected the following data

relating to the two divisions

Manufacturing Service

m mRevenue 1 320 25.5

Operating costs 741 16.5Operating profit 579 9.0

Apportioned head office costs 127 15

Profit before tax 452 7.5

Capital employed 1 941 570

Operating costs include:

Depreciation 132 4.0

The directors want to consider the position and performance of the Service Division.

The standard costs within the Service Division have been identified by Gill Adkins as:

Labour (per hour) 27

Variable divisional overhead (per hour) 18

Fixed divisional overhead (per hour) 37.5

Overheads are allocated by labour hours.

A repair takes two hours, on average, to complete.

Currently, the Service Division does two types of work. First repairs that are covered

by Barista plcs warranty and second repairs done outside warranty at the customersrequest. The Service Division is paid by the customer for the out-of-warranty repairs

while the repairs under warranty generate an annual fee of 15m, which is a recharge

from the Manufacturing Division.

The company sells on average 440,000 coffee machines a year and in the past, 9% of

these have needed a repair within the five-year warranty. Parts are charged by the

Manufacturing Division to the Service Division at cost and average 112 per repair.

The directors are considering amending this existing 15m internal recharge

agreement between Manufacturing and Service Divisions. There has been somediscussion of applying one of the two transfer-pricing approaches:


5/34

5

market price or cost plus

to meet the companys objectives.

Although the Service Division has the capacity to cover all of the existing workavailable, it could outsource the warranty service work, as it is usually

straightforward. It would retain the out-of-warranty service work as this is a higher

margin business. It would then begin looking for other opportunities to earn revenue

using its engineering experience.

A local domestic appliance repair firm has quoted a flat price of 300 per warranty

service repair provided that they obtain a contract for all of the warranty repairs from

Barista plc.


Prepare a report addressed to the directors of Basrista plc to:

[a] Outline the criteria for designing a transfer pricing system and

[13 marks]

[b] Evaluate the two methods discussed of calculating the transfer price between

the Service and Manufacturing Divisions of Barista plc. You should include

appropriate calculations.

(20 1/3 marks)



6/34

6

Question Three May 2012

Managers at Athena share a bonus each year. The total bonus calculation is based on

residual income. Managers have agreed that the total bonus is calculated as 10% of

the annual residual income. There is also a minimum residual income target of

500,000 before a bonus is paid. If the residual income is below 500,000 managersdo not receive a bonus. The minimum bonus is 50,000 (500,000 x 10%). There is

no upper limit for the bonus.

A majority of managers claim to be more familiar with return on investment (ROI).

Budgeted data 2011 (the company has only one product)

Product X

Production capacity (12 months) 80,000 units

Capital employed 2,500,000Annual fixed costs 1,000,000

Variable cost per unit 20.00

Required rate of return 10%

Required

(a) Based on the data in the budget what is the minimum selling price for Product

X that will give managers a bonus of 50,000?

(12 Marks)

(b) Based on the data in the budget what is the required minimum Return on

Investment that will give managers a bonus of 50,000?

(3 Marks)

(c) In 2010 the ROI was 33% and production was 75,000 units. What bonus will

be paid in 2011 if the same ROI and production is achieved in 2011? (You are

to assume that the bonus is still calculated as 10% of residual income).

(6 Marks)

(d) Identify and evaluate the weaknesses of the bonus scheme described below.

What alternative measures would you recommend and why?

Refer to the table on the following page......The first column shows the level of the

investment for a division and the second column shows the incentive bonus for a

return of investment equal to 1%. Managers can calculate their bonus by measuring

their ROI and then multiply the ROI by the incentive payment for their level of

investment in column 2. An example for the bonus payment based on a ROI of 10% is

shown in column 3.


7/34

7

Column 1 Column 2. Column 3.

Investment 1% 10%

0 - 2,000,000 1,000 10,000

3,000,000 1,125 11,2504,000,000 1,280 12,800

5,000,000 1,350 13,500

6,000,000 1,450 14,500

7,000,000 1,525 15,250

8,000,000 1,600 16,000

9,000,000 or higher 1,600 16,000

(12 Marks)

(Total 33 Marks)


8/34

8

Question Four May 2012

The recent interest in the Balanced Scorecard has reopened the debate on

organisational performance measurement.

a) Critically evaluate the arguments for using the profit measure as the all-encompassing measure of the performance of a business. (11 marks)b) Analyse the limitations and the effects, of over dependence on this profit-

measurement approach. (11 marks)

c) Evaluate the problems of using a broad range of non-financial measures for theshort and long-term control of a business.

(11 marks)

(Total: 33 Marks)


9/34

9

Question Five (May 2011)

Environmental Management Accounting (EMA) is concerned with the control of

environmental costs. However, for a company seeking to implement an effective

EMA system control is frequently not the issue, rather it is the defining, identification,and allocation of environmental costs that are the problems.

Required:

Do you agree with the above statement? Explain your answer. Your explanation

should include examples and evidence of your reading on the topic of EMA.


Question Six (May 2011)

The management accountant at a large multinational corporation (MNC) is required to

comment on the following investment opportunity.

A project will require an immediate investment of 5,000. An additional investment

of 12,000 will be required next year. Assume the cost of capital is 10%.

The initial cash flow forecast cash assumed constant cash flows for years 2-5. After

some discussion the senior managers asked the management accountant to consider

two further scenarios.

Base scenario

Probability 70%

Cash flows will be 8,000 per year for years 2-5.

Adverse scenario

Probability 30%

Cash flows will be 3,500 per year for years 2-5

At the end of the first year managers will have a better understanding of the market

conditions and will be able to forecast the cash flows with certainty.

Abandonment

Assume at the end of the first year the company can invest 12,000 or abandon the

project.

You are required to answer the following questions.

(a) Assume the managers are not confident that the actual cash flows will be as

forecast. Advise managers whether or not the value of the option to abandon is

significant and might influence a decision to accept or reject this investment.

(19 marks)


10/34

10

(b) Real Options Analysis (ROA) is a tool that managers can use to improve

decision-making. What advice would you give to managers in a MNC if they

have little experience or awareness of using ROA?

(14 1/3 marks)


Question Seven (May 2011)

(a) Explain the alternative approaches a company may adopt to determine theprice at which transfers of goods and services take place between its different

divisions or subsidiaries. (15 marks)

(b) Bibby and Bochum (B & B) plc produces a range of animal feedstuffs for theagriculture sector. The company has a divisional structure. Two of the

companys divisions are the Somerset Feeds (SF) division and the Cheshire

Inorganic Chemicals (CIC) division. The SF division sells dried cattle feed to

external customers only. The CIC divisions production includes a foodsupplement nitrate which is sold directly to outside customers, mainly other

agricultural product companies, but which is also transferred to the companys

SF division for use as an ingredient to that divisions cattle feed.

Hawkeshead Limited, an independent supplier to B & B plc, has now offered to

supply the SF division with an additive that is equivalent to the nitrate supplement

produced by the CIC division. Hawkeshead has a maximum spare capacity of

600,000 litres of the nitrate additive which it is willing to sell to B & B at a special

price of 5.50 per litre.

The following forecast information is available for the two divisions of B & B for

the next three month production period:

Somerset Feeds divisionProduction and sales of 3,600,000 sacks of cattle feed at a selling price of 12 per

sack (1 sack of feed is equivalent to 50kg by weight).

Variable conversion cost of the cattle feed amounts to 1.50 per sack.

Fixed costs of the division are estimated at 180,000 for the three month period.

The nitrate additive is used at the rate of 1 litre for every 4 sacks of cattle feed

produced.

Cheshire Inorganic Chemicals divisionTotal production capacity of 1,000,000 litres of the nitrate food supplement.

Variable costs amount to 5 per litre.

Fixed costs estimated at 200,000 for the three month period.

The most recent market evidence suggests that external customers to B & B are

expected to generate sales of 400,000 litres of the nitrate supplement at a selling

price of 10.50 per litre. The remaining 600,000 litres of capacity for the nitrate

could be transferred from the CIC division to the SF division for use in the cattle

feed product. Currently no other external market possibilities seem to be available

at the current selling price per litre.


11/34

11

Required:

(i) Determine the price(s) per litre at which the CIC division should offer to

transfer the food supplement nitrate to the SF division in order that the

maximum profit for B & B plc would occur if the SF divisions management

implement rational product sourcing decisions based solely on financialcriteria.

You should explain the basis on which the managers of the SF division would

make their decision using the information available. You should include all

relevant calculations. (9 marks)

(ii) The managers of the CIC division are considering the possibility of lowering

the divisions selling price for the nitrate supplement to external customers to

9.50 per litre. If implemented, this decision is expected to increase sales to

external customers to 700,000 litres for the next three month period.

For both the current selling price of 10.50 per litre and the proposed selling

price of 9.50 per litre, prepare a detailed analysis of revenue, costs and net

profit for B & B plc.

Comment upon any other factors that should be taken into consideration

before the managers of the CIC division implement the proposed price change.

(9 1/3 marks)



12/34

12

Question Eight (May 2010)

The managers at Greenwich believe the current economic uncertainty is making it

difficult to evaluate investments. The details for an investment in a new machine are

as follows:

Cost of machine 850Discount rate for this investment = 10%

Cash flows

Year 1 Year 1 Year 2 Year 2

Cash flow Probability Cash flow Probability

Scenario 1 500 0.7 400 0.2

500 0.5

600 0.3

Scenario 2 700 0.3 620 0.7

700 0.2

850 0.1

Scenario 1 is a pessimistic forecast for Year 1 and assumes that cash flows in Year 2

will be in the range of 400 - 600. Scenario 2 assumes cash flows will be higher in

Year 1 and this will result in higher cash flows in Year 2. For both scenarios the Year

2 cash flows are therefore dependent on the Year 1 cash flows.

The company does have an option to sell the machinery at the end of Year 1 for 500.


(a) Determine the value of the option to abandon for this investment and advisethe managers whether or not the investment should be approved.

(18 Marks)

(b) Identify and evaluate the problems of incorporating different types of real

options into the analysis of an investment for a new product.

(15 1/3Marks)

(Total 33 1/3 Marks)


13/34

13

Question Nine (May 2010)

A company has two divisions. Both divisions are planning for next year and have

been asked to consider investing in Product X. This product will increase total assets

by 300,000 and operating profit by 50,000.

Managers are paid an annual bonus in cash. The managers are told that Return on

Investment (ROI) must increase each year if the bonus is to be maintained. Any

decrease in ROI will reduce the bonus. Although ROI is a key component of the

bonus calculation the company also considers other quality measures in the final

calculation.

The company is also considering replacing ROI with Residual Income (RI) in the

bonus calculation. The RI calculation is based on a required rate of return of 10%.

The following data is provided:

Cost of equity 15%

Interest long term debt 10% 10%

Tax rate 30%

Required rate of return (RI) 12%

Market value equity 3,000,000

Summary data for the most recent year is as follows:

Division A Division B Total

Operating profit

300,000

400,000

700,000


Total assets

1,500,000

3,000,000

4,500,000

Current liabilities

300,000

500,000

800,000

Long term debt

2,700,000

Shareholders equity

1,000,000

Total

4,500,000

Required:

(a) Assume that only one of the divisions can invest in Product X and that ROI is

important when calculating bonuses. Evaluate which Division is likely to

accept or reject Product X. (9 marks)


14/34

14

(b) If Residual Income was used as the key component for bonus calculations

(replacing ROI) would this motivate managers to change their decision in (a)

above. (10 marks)

Question Ten (May 2009)


a) Explain the term environmental management accounting. Your answershould refer to recent academic research. [18 marks]

b) Discuss the extent to which the traditional accounting system providesinformation as to the true cost of resource usage and suggest how a more

effective measurement system might be developed by a company.

Illustrate your answer by giving appropriate examples. Your answer should

refer to recent academic research. [15 marks]

[Total 33 marks]


15/34

15

Answers to suggested revision questions

Question 1 May 2012

(a) Discussion of Environmental cost categories

Explanation and evaluation of techniques

A lifecycle view consists of considering the costs and revenues of a product over

the whole life of the product rather than one accounting period. For a production

facility, this might be taken to be the useful life of the plant and equipment. A

lifecycle view may take profit or discounted cashflow as the principal measure

of performance. This is particularly relevant for Polychemicals plc given the

planned redevelopment programme at the plant which will highlight the

decommissioning costs of such plant. This will aid future long-term investment

planning by the directors at Polychemicals.

Activity-based Costing (ABC) is a method of detailed cost allocation that, when

applied to environmental costs, distinguishes between environment-related costs

and environment-driven costs. At a chemical plant, related costs would include

those specifically attributed to an environmental cost centre such as a waste

filtration plant, while driven costs are those that are generally hidden in

overheads but relate to environmental drivers such as additional staff costs or

the shorter working life of equipment (in order to avoid excess pollution in the

later years of its working life). This will assist the directors of Polychemicals in

identifying and controlling environmental costs.

Input/output analysis considers the physical quantities input into a business

process and compares these with the output quantities with the difference being

identified as either stored or wasted in the process. These physical quantities can

be translated into monetary quantities at the end of the tracking process. Flow

cost accounting is associated with this analysis as it reflects the movement of

physical quantities through a process and will highlight priorities for efficiency

improvements.

Explanation should also be given that these techniques are not mutually

exclusive and all can assist Polychemicals directors in improving performance.

However, cost /benefit analysis will need to be undertaken for each of thesystems. This will be difficult, as benefit estimates will prove vague given the

unknown nature of the possible improvements that may accrue from using the

techniques.

The non-financial benefits will include a better public image and reduced chance

of protest by environmental groups and an improved relationship with

government, retailers and end-user customers

Additionally, ABC and input/output analysis will require significant increases in

the information that the companys management accounting systems collect and

so incur increased costs.


16/34

16

As a result, the decision to use these techniques is likely to be based on the

balance between known costs and estimated strategic benefits of non-financial

factors.

2 marks for each EMA evaluation technique

3 marks for discussion of non-financial based factors2 marks for discussion of issues / limitations of EMA approach.

[11 marks]

(b) Discussion of cost categories for environmental accounting

The companys management accountants will need to identify existing and new

cost information that is relevant to understanding Polychemicals environmental

impact.

There are conventional costs, such as raw material costs and energy costs, which

should be broadened to include the cost of waste through inefficiency. These and

other conventional costs (such as regulatory fines) are often hidden withinoverheads and therefore will not be a high priority for management control unless

they are separately reported.

There are contingent costs such as the cost of cleaning industrial sites when these

are decommissioned. These are often large sums that can have significant impact

on the shareholder value generated by a project. As these costs often occur at the

end of the project life, they can be given low priority by a management that is

driven by short-term financial measures (e.g. annual profit) and make large cash

demands that must be planned at the outset of the project.

There are relational costs such as the production of environmental information for

public reporting. This reporting will be used by environmental pressure groups

and the regulator and it will demonstrate to the public at large the importance that

Polychemicals plc attaches to environmental issues.

Finally, there are reputational costs associated with failing to address

environmental issues when consumer boycotts and adverse publicity lose sales

revenue.

2 marks for each cost category identified and discussed

up to a maximum of 6 marks

(c) Lifecycle costing

Answer should explain that a traditional analysis of the costs of Polysmart might

yield the product profit given in the original data. However, this ignores capital

costs, environmental costs and the cost of decommissioning. A lifecycle analysis

aims to capture the costs over the whole lifecycle of the product

[3 marks]

Lifecycle costing would show:

Costs

Production costs 205

Marketing costs 41

Development costs 21267


17/34

17

[4 marks]

Environmental costs

Waste liquids filtration 20.4

Carbon based gas emissions 13.4

300.8

Other costsDecommissioning costs 45

Total costs 345.8

[3 marks]

This figure should be compared to total revenues of 374m and leaves only a small

overall return on investment (surplus of 28.2m).

[2 marks]

Answer should note that the decommissioning costs are estimated at 45m in five

years. It is likely that, given the difficulty in dealing with specialised equipment and

the fact that environmental legislation may become more strict, this could easily be asignificant underestimate. This could destroy all of the added value of the product.

[2 marks]

The value of lifecycle costing often lies in the visibility it gives to costs that are

determined in the early stages of the design of the product and, in this case, it

emphasises the need to minimise the cost of decommissioning. This should be done in

the design phase of the production facility extension.

The traditional product profit analysis shows a surplus of 107m over the life of the

product as it does not capture the environmental and decommissioning costs.

Additionally, if volumes of production can be ascertained, then a cost per unit of

Polysmart could be calculated and this would assist in price setting.

[2 1/3 marks]

Total 33 1/3 marks

Notean NPV calculation would be equally appropriate solution


18/34

18

Question 2 May 2012

(a) To: Directors of Barista plc

Subject: Transfer pricing issues at Barista plc.

This report examines recent divisional performance issues. It begins by evaluating thenature of transfer prices and suitable methods of transfer pricing the work of the

Service division are reviewed.

Transfer pricing

The transfer price is the price that the Service Division would charge to the

Manufacturing Division for its warranty servicing for which it would otherwise not

receive any income. The objective of a transfer pricing system is to allow divisional

management to be assessed on the basis of divisional profit and so provide them with

motivation while retaining their autonomy.

[up to 5 marks]The transfer price should be set so that the decisions of the divisions individually are

beneficial to the company as a whole. If divisions are in different tax regimes then the

transfer price should minimise the overall company tax liability within the law.

[up to 4 marks]The general rule for goal congruent decision-making is that transfer prices should be

set with reference to the opportunity cost of sale to the selling division (Service

Division) and the opportunity cost to the buying division (Manufacturing Division).

There are different situations if there is surplus capacity or a capacity constraint in the

service division or if there is an external market for the service, since these affect the

opportunities available to the divisions.

[up to 4 marks]

[b]The two different methods of pricing the Service Divisions work are .

Market based pricingThe service division could consider an external market price since there is the

opportunity to outsource and therefore, its managers would charge 300. This would

generate a reduced divisional profit to the company of 0885m from the warranty

work as opposed to the profit from the current agreement of 4.005m. It would still

provide motivation for the Service Division to take the warranty work.

[2 marks]However, there would be savings if the work were kept internal to Barista plc, such as

the overhead of negotiating and managing the contract with the local appliance repairfirm. Doing the work internally would save these costs and so, a market price adjusted

down for these savings would be appropriate. There is also the danger of outsourcing

the service function in that the company loses control of a strategically important part

of its offering to customers. It is clear that the warranty is a key selling point for

Barista plc and it may not be able to control the quality of the repair work if this is

outsourced.

[3 marks]A market price will guide the Service Division to the right decision on whether to

continue to do the warranty work in-house or whether to outsource it and free capacity

for other opportunities. If external work offers a better contribution than warranty

work, the Service Division will automatically do external work. It will also measure


19/34

19

profits at market-based prices. This method will provide motivation without a price

being imposed by head office.

The volume and profitability of external work that may be available to the Service

Division should also be investigated. If this were more profitable than internal work

then this would suggest that the Service Division should prioritise this work andoutsource if there is a lack of capacity to cover the internal work. The current quote

from the outsourcer demands a minimum volume of work and so their work may need

to be repriced.

[3 marks]Cost based pricing

The work could also be charged on the basis of the cost to the service division. The

variable cost is 202 on average per repair and so the 15m contract represents a

contribution for the Division of 6 981k (based on the expected 39,600 repairs per

year). This represents a divisional profit of 4 011k.

The work could be charged at variable cost but then there would be no contribution tothe service divisions profits and so no incentive for the Service Division to do this

work. It would, therefore, prioritise external sales over internal ones.

[3 marks]If a breakeven divisional profit was desired then a price of 277 per repair should be

charged as this covers fixed overheads in the division. Although it would not

contribute to head office costs, Service Division managers would still be motivated to

perform the warranty work. Manufacturing Division managers would accept any cost

below the alternative of 300 per repair for outsourcing the work.

It may be worth comparing a cost plus approach with the existing agreement. The

service division would have to charge 380 per repair in order to make the same

divisional profit as it enjoys under the current agreement.

[2 marks]

Current pricing method

The current fixed price charge provides a contribution to the divisions fixed costs

which will incentivise the Service Division.

However, this may cause problems in quality since it is not related to the volume of

work done by service and if there were a much higher number of repairs than

expected then the service division might compromise quality in order to control costs.

[2 marks]

In conclusion of the report, the current method of transfer pricing gives a good

contribution to fixed costs in the Service Division but may not encourage bothdivisions to perform optimally from the perspective of the whole company. Further

work needs to be undertaken to investigate the possibility of obtaining an additional

stream of outside revenue for the Service Division.

Appendix:

Labour (per repair) 54

Variable divisional overhead (per repair) 36

Fixed divisional overhead (per repair) 75

Parts 112

So

Variable cost (per repair) 202Total cost (per repair) 277


20/34

20

Number of repairs per year

440,000 units where 9% need repairing every three years. Given continuous

production, this means in total 39,600 will need warranty repairs each year.

Current recharge Market

agreementpricing

000 000

Revenue 15,000 11 880

Variable costs 8 019 8 019

Contribution 6 981 3 861

Fixed costs 2 970 2 970

Divisional profit (before head office costs) 4 011 891

Cost plus price to give equivalent contribution to current recharge agreement

15m/39,600 = 378.78

to cover variable costs 5346m/39,600 = 20200

to give breakeven contribution to the division (15m4011m)/39,600 = 27700[5 1/3marks for workings]

Total 33 1/3 marks


21/34

21

Question 3 May 2012

(a)

Q- What is minimum selling price

Answer Check

Required return on

investment 2 mark 250,000 Sales 3,350,000

Add target RI2 mark 500,000 Var costs 1600000

Required profit 750,000 Contribution 1,750,000

Unit FC 1000000

Required profit 750,000 9.38 Profit 750,000

Variable costs3 mark 1,600,000 20.00

Required return on

investment 250,000

Fixed costs3 mark 1,000,000 12.50 RI 500,000Required sales2 mark 3,350,000 41.88 Bonus 50,000

Answer = 41.88 Total 12 marks

(b) 30% (750,000 / 2,500,000) Total 3 marks

(c)

What is bonus if ROI increases to 33% Check

Answer Unit Sales 3,325,000

Target profit 2 marks 825,000 11.00 Var costs 1,500,000

Variable costs2 marks 1,500,000 20.00 Contribution 1,825,000

Fixed costs1 marks 1,000,000 13.33 FC 1,000,000

Required sales1 marks 3,325,000.00 44.33 Profit 825,000

Required return on investment 250,000

RI 575,000

Bonus 57,500

Total 6 marks

(d)

Students should relate question to recent research.

Example of banking sector earns very high returns in short-term followed by

correction. Correction leads to write-offs / losses and people lose their jobs.

There is no negative pay so managers do not pay back excessive bonuses

received in the past. 3 marks

Also arbitrary nature of figures. How do we justify paying higher bonus for

managers in bigger companies. Seems to be no minimumwhat about poor

performance? 4 marks


22/34

22

Some new divisions may not yet be profitable but managers working hard to

increase future profits. They do not get bonus. Maybe reward sales growth,

sales, number of new products.3 marks

Some divisions may have very good cash flows but low profitability

example mature division. Need to reward cash generation rather than profits. 2marks

Total 33 marks

Question 4 May 2012

a. Arguments in favour of profitability: Single criterion Enables quantitative analysis

Broad performance measure Enables decentralisation Measures like ROI can be used to compare all profit making operations Bonuses based on profits can be very motivational Profit measurement well established in standard accounting practice Net result of of the success of marketing activities and control of costs Can be applied for any profit-seeking activity. Can be related to aspects of output, input and overall investment(11 marks)

b. Limitations and effects of over-dependence Profitability not main objective for all organisations Does not indicate impact of external factors Subject to manipulation Cash flow problems despite profitability Profit can encourage short-termism May motivate profit centre managers but cost centre managers may need

alternative measures.

(11 marks)

c. General comment on usefulness of NFIs e.g. Quality measures No. of complaints Non-productive hours System down timeProblems of NFIs

Too many measuresinformation overload. Difficult to judge which financial measures are the most important Neglect of profit criterion Some NFI difficult to measure e.g. measure of customer complaints does not

indicate that all customers who did not complain were entirely satisfied.


23/34

23

Measures may conflict with each other. If NFIs used as basis of managerial performance evaluation, areas not covered by

the measures could be ignored.

Public sectoremphasis on waiting lists and league tables may not reflect keyproblems and strategic priorities.

(11 marks)

Good answers will refer to the academic literature

(Total: 33 marks)

Question 5 May 2011

A good answer will cover the following:

Reasons for problem of environmental cost identification.Nearly all aspects of business are affected by environmental pressures, including

accounting. From an accounting perspective, the initial pressures were felt in external

reporting, including environmental disclosures in financial reports and/or the

production of separate environmental impact reports.

However, environmental issues cannot be dealt with solely through external

reporting. Environmental issues need to be managed before they can be reported on,

and this requires changes to management accounting systems.

[up to 10 marks for development of issues]

Limitations of traditional management accounting systems.In an ideal world, organisations would reflect environmental factors in their

accounting processes via the identification of the environmental costs attached to

products, processes, and services. Nevertheless, many existing conventional

accounting systems are unable to deal adequately with environmental costs and as a

result simply attribute them to general overhead accounts.

Consequently, managers are unaware of these costs, have no information with which

to manage them and have no incentive to reduce them (United Nations Division for

Sustainable Development (UNDSD), 2003)). It must be recognised that most

management accounting techniques significantly underestimate the cost of poor

environmental behaviour. Many overestimate the cost and underestimate the benefitsof improving environmental practices.

Management accounting techniques can distort and misrepresent environmental

issues, leading to managers making decisions that are bad for businesses and bad for

the environment. The most obvious example relates to energy usage. A recent UK

government publicity campaign reports that companies are spending, on average, 30%

too much on energy through inefficient practices. With good energy management, we

could reduce the environmental impact of energy production by 30% and slash 30%

of organisations' energy expenditure.

[up to 10 marks for identification of limitations]

Some possible approaches to solving the issue.


24/34

24

Frost and Wilmhurst, for example, suggest that by failing to reform management

accounting practices to incorporate environmental concerns, organisations are

unaware of the impact on profit and loss accounts and the balance sheet impact of

environment-related activities. Moreover, they miss out on identifying cost reduction

and other improvement opportunities, employ incorrect product/service pricing, mix

and development decisions.

This leads to a failure to enhance customer value, while increasing the risk profile of

investments and other decisions with long-term consequences. If management

accounting as a discipline is to contribute to improving the environmental

performance of organisations, then it has to change. Environmental Management

Accounting (EMA) is an attempt to integrate best management accounting thinking

and practice with best environmental management thinking and practice.

Identification of management accounting techniques which aid the identification and

allocation of environmental costs, namely:

input / output analysis flow cost accounting activity based costing, and life cycle costing NPV based environmental project evaluation

Each of these should be considered at least in outline.

[up to 13 1/3 marks for development of ways of dealing with environmental cost

identification and impact measurement]

total 33 1/3 marks

Question 6 May 2011

Answer (a)(i) The traditional or static NPV is calculated below. This assumes there are no

options. The project will continue for 5 years

Expected cash flows = (0.7)(8,000) + (0.3)(3,500) = 6,650 per year

Traditional NPV is positivesuggests this is a potential investment (5 marks)

(ii) Answer if we consider options- At the end of year 1

Assume cash flows are 8,000probability = 70%

3254NPV

0.101

0.1010.10

1

0.10

16650

0.101

12000-5000-NPV

0

4

0

13,359699)(8000)(3.112000-NPV

10.0110.0

110.01800012000-NPV

1

41


25/34

25

Assume cash flows are 350probability = 50%

If cash flows are 350 the NPV is negative. We would not accept a negative NPV and

so the project is cancelled. If it is cancelled the NPV = 0.

The new NPV with optionsdynamic NPV

NPV0 = -5000 + (0.7)[13359/(1+0.10)] + (0.3)[0] = 3501 (8 marks)

Note the dynamic NPV is greater than the traditional or static NPV

The difference is the value of the option to abandon - 3501-3254 = 247 (2

marks)

Commentdifficult to say value of option is significantdepends on past experienceand confidence in data. Some managers will not be sure if this helps decision. (4

marks)

(Total 19 marks)

Answer (b)

Flexibility in MNCsthis gives more opportunities to consider ROA

Flexibility is very important in MNCs. Multinational companies can move production

or operations to another country for various reasons:

Avoid government regulation

Changes in exchange rates

Tax reduction

Lower labour rates

MNC can also enter new markets to diversify and reduce risk(4 marks)

Awareness of ROA

Experience is very important. Difficult to measure awareness of real options and

whether this affects performance

Difficult to identify benefits of using advanced techniques. Additional costs may be

incurred with more staff and training. Difficult to judge quality of decisions and

relevance of existing experience to a decision.Difficult to find evidence that introducing real options analysis helped the MNC to

outperform competitors. Managers want to show that using real options analysis gives

them a competitive advantage. (4 marks)

Complexity of decisions

Some companies find it difficult to implement real optionsdecisions can be seen as

very complex.

Research - 88.6% of Fortune 1000 companies they consulted never or rarely used

ROA

Ryan PA, Ryan GP. Capital budgeting practices of the fortune

1000: how have things changed?. Journal of Business and

Management 2002;8:35564.

905-699)(3500)(3.112000-NPV

10.0110.0

110.01350012000-NPV

1

41


26/34

26

ROA cannot be described as best practice.

Managers may find it difficult to build appropriate models to analyse a problem.

Oversimplification of models is also an issue. Also difficult to get all managers to

participate in models. Many managers in MNC will find technical complexity is very

high and will also have difficulty with data unavailability for the option inputs.(6 marks)

(Total 19 marks)

Question 7 May 2011

[a] Good answer will cover the following

Criteria for an effective transfer pricing system

Criteria aim of system of transfer pricing is to ensure a group of companies overall

profits is as high as possible

Objectives of transfer pricing system

Encourage goal congruence between divisional managers, central Board, and

company shareholders

Motivate divisional managers in both the selling and the buying divisions

Promote realistic appraisal of divisional managers performance

Promote effective decision making within decisions

Preserve as much autonomy as possible for individual divisional managers.

(basically one mark for each pointalthough up to two marks for a particular point

well explained)

(5 marks)

Marginal cost

Approach which procedures optimum group profit.Buying division managers are given accurate information for decision making.

But for the selling divisions managers there could be adverse motivational issues as

no profit or contribution would be earned from internal sales. This problem could be

alleviated by transferring at standard variable cost.

(3 marks)

Opportunity costThis transfer pricing base uses market price (less any internal savings) where an

external price exists.

If no external market for the transferred product, but where there is a market for

another product using the same resources, then the contribution lost by supplying the

internal purchaser is added to the sellers variable cost to arrive at the transfer price.


27/34

27

Use of market price will motivate selling divisions managers.

Preserve autonomy of divisional managers.

Permit realistic performance appraisal but could have adverse impact on both

motivation and on the price/output decisions of purchasing division managers.

Where no external market exists, then greater influence over decisions by head office.(3 marks)

Cost plus

No encouragement to efficiency within the selling division as inefficiencies can

be passed on to buying division.

Buying division will treat transfer price as a variable cost and so reach divisional

optimisation at a lower output level.

Therefore performance appraisal and consequently motivation will be compromised.

(3 marks)

[b] [i] For B & Bplc to maximise its profit the following pricing approach should be

adopted:

The CIC division should offer to transfer the nitrate food supplement to the SF

division at marginal cost plus opportunity cost. This would apply as follows :

400000 litres at 10.50 per litre since this is the price that could be achieved from

sales to external customers of B & Bplc.

600000 litres at 5 per litre marginal cost since no alternative opportunities for

external sales exist.

Then SF division has a sales forecast of 3 600 000 sacks of feed. This will require 900

000 litres of nitrate supplement input.

Based on the pricing by CIC division indicated above, the SF division should choose

to purchase 600 000 litres of the nitrate from the CIC division at 5 per litre since this

is less than 5.50 per litre quoted by external supplier Hawkeshead.

SF division would purchase its remaining requirement of 300 000 litres of the

supplement from Hawkeshead at 5.50 per litre since this is less than the 10.50 per

litre at which the CIC division would offer to transfer its remaining outputgiven

that it can sell this amount to external customers of B & B.

[9 marks]


28/34

28

Question 8 May 2010

Answer (a)ENPV without abandonment

PV Cash flow year

1

PV Cash flow year

2

Total

PV Prob EV

Scenario

1 455 331 785 0.14

11

0

455 413 868 0.35

30

4

455 496 950 0.21

20

0

Scenario

2 636 512 1,149 0.21

24

1

636 579 1,215 0.06 73

636 702 1,339 0.03 40

0

EPV

96

8

Investmen

t

85

0

ENPV

11

8

Assuming there is an option to abandonInvestment PV cf Year 1 PV cf Year 2 NPV

Scenario 1 Option -850 455 455 59.1 Abandon

-850 455 421 26.03

No

abandon

Scenario 2 Option -850 636 455 241Abandon

-850

636 545 331

No

abandon

Value of option to abandon = 23

Probabilty NPV

Scenario 1 0.7 59.1 41.36

Scenario 2 0.3 331 99.30

ENPV 140.66

117.52

23.14

Decision is quite marginal.


29/34

29

Answer (b)Students should emphasise that real options do not replace traditional DCF analysis.

Need to help managers make optimal investment decision

Some embedded real options may lead to completely different investment decisions

compared to decision based on traditional DCF analysis.

Real options may identify investment worth considerably more.Abandonment option

High salvage values are attractive. Probability of success difficult to estimate

Useful when wanting to get out of loss making business.

Growth options

Refer to flexibility to increase scale of investment. Example add postgraduate option

for undergraduates. Students can stay with university and use exemptions from

previous study. Difficult to forecast demand.

Expansion option

Similar to growth. BT has expanded into broadband. Need to identify how many

customers buy additional products.

Investment timing optionInvest now or later. Particularly important for technology companies. Waiting may

help company avoid less profitable option. Being the first into a market is not

necessarily better. The cost is that company forgoes cash flows in early year(s)

Students should finish by discussing problem of making decision too complex. More

complexity does not mean there will be a more accurate result. Also have to think

how we get managers to provide and interpret range of probabilities! Also consider

what to do when more than one real option is identified and not all can be considered

at the same time. The real options may be seen as less reliable when complexity

increases.

Question 9 May 2010

After tax cost of debt 7.00%

WACC 11.21%


ROIBefore Product X 20.00% 13.33% 15.56%

RI - Before Product X 120,000.00 40,000.00 160,000.00

After Product X

Division A

After Before

ROI 1mark before 2 after 19.44% 20.00%

RI 1mark before 2 after 134,000 120,000.00

Division B

After Before

ROI 1mark before 2 after 13.64% 13.33%RI 1mark before 2 after 54,000 40,000


30/34

30

(a) Students use calculations to show Division A has fall in ROI if accept Product

X. Risk Bonus. Division B will increase ROI if accept Product Ximprove

Bonus. 6 marks calculation 3 marks discussion

(b) RI shows improvement for both Divisions. Better for company if either

division accepts. 6 marks calculation 4 marks discussion

Question 10 May 2009[a] A good answer will cover as a minimum the following (including 3 marks for

evidence of reading beyond the lecture material):

The global profile of environmental issues has risen significantly during the past two

decades, precipitated in part by major incidents such as the Bhopal chemical leak

(1984) and the Exxon Valdez oil spill (1989).

These events received worldwide media attention and increased concerns over major

issues such as global warming, depletion of non-renewable resources, and loss of

natural habitats.

This has led to a general questioning of business practices and numerous calls for

change.

Businesses have become increasingly aware of the environmental implications of their

operations, products and services. Environmental risks cannot be ignored, they are

now as much a part of running a successful business as product design, marketing,

and sound financial management.

Poor environmental behaviour may have a real adverse impact on the business and itsfinances. Punishment includes fines, increased liability to environmental taxes, loss in

value of land, destruction of brand values, loss of sales, consumer boycotts, inability

to secure finance, loss of insurance cover, contingent liabilities, law suits, and damage

to corporate image.

EMA is the generation and analysis of both financial and non-financial information in

order to support internal environmental management processes. It is complementary

to the conventional financial management accounting approach, with the aim to

develop appropriate mechanisms that assist in the identification and allocation of

environment-related costs The major areas for the application for EMA are:

in the assessment of annual environmental costs/expenditures product pricing budgeting investment appraisal calculating costs

and

savings of environmental projects, or setting quantified performance targets.EMA is as wide-ranging in its scope, techniques and focus as normal management

accounting. There is still no precision in the terminology associated with EMA'. EMA

viewed as being an application of conventional accounting that is concerned with the

environmentally-induced impacts of companies, measured in monetary units, andcompany-related impacts on environmental systems, expressed in physical units.


31/34

31

EMA can be viewed as a part of the environmental accounting framework and is

defined as 'using monetary and physical information for internal management use'.

[18 marks]

[b] Environmental Review of Conventional Management Accounting

A good answer will cover as a minimum the following (including 3 marks for


Nearly all aspects of business are affected by environmental pressures, including



production of separate environ However, environmental issues cannot be dealt with

solely through external reporting. Environmental issues need to be managed before

they can be reported on, and this requires changes to management accounting

systems.

In an ideal world, organisations would reflect environmental factors in their


products, processes, and services. Nevertheless, many existing conventional

accounting systems are unable to deal adequately with environmental costs and as a






environmental behaviour. Many overestimate the cost and underestimate the benefits

of improving environmental practices.








Frost and Wilmhurst suggest that by failing to reform management accounting

practices to incorporate environmental concerns, organisations are unaware of the

impact on profit and loss accounts and the balance sheet impact of environment-

related activities. Moreover, they miss out on identifying cost reduction and other

improvement opportunities, employ incorrect product/service pricing, mix and

development decisions.





Accounting (EMA) is an attempt to integrate best management accounting thinkingand practice with best environmental management thinking and practice.


32/34

32

[15 marks]

Total 33 marks

[a] A good answer will cover as a minimum the following (including 3 marks for


The global profile of environmental issues has risen significantly during the past two

decades, precipitated in part by major incidents such as the Bhopal chemical leak(1984) and the Exxon Valdez oil spill (1989).

These events received worldwide media attention and increased concerns over major

issues such as global warming, depletion of non-renewable resources, and loss of

natural habitats.

This has led to a general questioning of business practices and numerous calls for

change.

Businesses have become increasingly aware of the environmental implications of their

operations, products and services. Environmental risks cannot be ignored, they are

now as much a part of running a successful business as product design, marketing,

and sound financial management.

Poor environmental behaviour may have a real adverse impact on the business and its

finances. Punishment includes fines, increased liability to environmental taxes, loss in

value of land, destruction of brand values, loss of sales, consumer boycotts, inability

to secure finance, loss of insurance cover, contingent liabilities, law suits, and damage

to corporate image.

EMA is the generation and analysis of both financial and non-financial information in

order to support internal environmental management processes. It is complementary

to the conventional financial management accounting approach, with the aim to

develop appropriate mechanisms that assist in the identification and allocation of

environment-related costs The major areas for the application for EMA are:

in the assessment of annual environmental costs/expenditures product pricing budgeting investment appraisal calculating costs

and

savings of environmental projects, or setting quantified performance targets.

EMA is as wide-ranging in its scope, techniques and focus as normal managementaccounting. There is still no precision in the terminology associated with EMA'. EMA

viewed as being an application of conventional accounting that is concerned with the

environmentally-induced impacts of companies, measured in monetary units, and

company-related impacts on environmental systems, expressed in physical units.

EMA can be viewed as a part of the environmental accounting framework and is

defined as 'using monetary and physical information for internal management use'.

[18 marks]


33/34

33

[b] Environmental Review of Conventional Management AccountingA good answer will cover as a minimum the following (including 3 marks for

evidence of reading beyond the lecture material):Nearly all aspects of business are affected by environmental pressures, including



production of separate environ However, environmental issues cannot be dealt with

solely through external reporting. Environmental issues need to be managed before

they can be reported on, and this requires changes to management accounting

systems.

In an ideal world, organisations would reflect environmental factors in their


products, processes, and services. Nevertheless, many existing conventionalaccounting systems are unable to deal adequately with environmental costs and as a






environmental behaviour. Many overestimate the cost and underestimate the benefits

of improving environmental practices.








Frost and Wilmhurst suggest that by failing to reform management accounting

practices to incorporate environmental concerns, organisations are unaware of the

impact on profit and loss accounts and the balance sheet impact of environment-related activities. Moreover, they miss out on identifying cost reduction and other

improvement opportunities, employ incorrect product/service pricing, mix and

development decisions.





Accounting (EMA) is an attempt to integrate best management accounting thinking

and practice with best environmental management thinking and practice.

[15 marks]

Total 33 marks


34/34

revision pack and ansjjwers

Documents