cima old p1 may 2005 qp and ans

7/30/2019 CIMA Old P1 May 2005 QP and ANS

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The Chartered Institute of Management Accountants 2005

May 2005 Examinations

Managerial Level

Paper P1 - Management Accounting Performance Evaluation

Question Paper 2

Examiners Brief Guide to the Paper 21

Examiners Answers 22

The answers published here have been written by the Examiner and should provide a helpfulguide for both lecturers and students.

Published separately on the CIMA website (www.cimaglobal.com/students) from the end ofSeptember 2005 is a Post Examination Guide for this paper, which provides much valuable andcomplementary material including indicative mark information.

2005 The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may bereproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical,photocopying, recorded or otherwise, without the written permission of the publisher.
http://www.cimaglobal.com/http://www.cimaglobal.com/


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P1 2 May 2005

Management Accounting Pillar

Managerial Level Paper

P1 Management Accounting Performance Evaluation

24 May 2005 Tuesday Morning Session

Instructions to candidates

You are allowed three hours to answer this question paper.

You are allowed 20 minutes reading time before the examination begins

during which you should read the question paper, and if you wish, makeannotations on the question paper. However, you will not be allowed, underany circumstances, to open the answer book and start writing or use yourcalculator during this reading time.

You are strongly advised to carefully read the question requirement beforeattempting the question concerned. The requirements for the questions inSection C are contained in a dotted box.

Answer the ONE compulsory question in Section A. This is comprised of 19sub-questions.

Answer all SIX compulsory sub-questions in Section B.

Answer ONE of the two questions in Section C.

Maths Tables and Formulae are provided.

Write your full examination number, paper number and the examinationsubject title in the spaces provided on the front of the examination answerbook. Also write your contact ID and name in the space provided in the righthand margin and seal to close.

Tick the appropriate boxes on the front of the answer book to indicate whichquestions you have answered.

P1P

erforma

nceEvaluation


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May 2005 3 P1

SECTION A 50 MARKS

[the indicative time for answering this section is 90 minutes]

ANSWER ALL NINETEEN SUB-QUESTIONS

Question One

The following data are given for sub-questions 1.1 and 1.2 below.

Summary financial statements are given below for one division of a large divisionalisedcompany.

Summary Divisional Financial Statements for the year to 31 December

Balance sheet Income statement

000 000Non-current assets 1,500 Revenue 4,000Current assets 600 Operating costs 3,600Total assets 2,100 Operating profit 400

Interest paid 70Divisional equity 1,000 Profit before tax 330Long-term borrowings 700Current liabilities 400Total equity and liabilIties 2,100

The cost of capital for the division is estimated at 12% each year.Annual rate of interest on the long term loans is 10%.All decisions concerning the divisions capital structure are taken by central management.

1.1 The divisional Return on Investment (ROI) for the year ended 31 December is

A 190%

B 194%

C 235%

D 330%

(2 marks)

Sub-question 1.2 is on the next page

Instructions for answering Section A:

The answers to the nineteen sub-questions in Section A should ALL be written inyour answer book.

Your answers should be clearly numbered with the sub-question number then ruledoff, so that the markers know which sub-question you are answering.

For sub-questions 1.11 to 1.18 you should show your workings as marks areavailable for the method you use to answer these sub-questions.


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P1 4 May 2005

1.2 The divisional Residual Income (RI) for the year ended 31 December is

A 160,000

B 196,000

C 230,000

D 330,000(2 marks)

The following data are given for sub-questions 1.3 and 1.4 below

X40 is one of many items produced by the manufacturing division. Its standard cost is based onestimated production of 10,000 units per month. The standard cost schedule for one unit of X40shows that 2 hours of direct labour are required at 15 per labour hour. The variable overhead

rate is 6 per direct labour hour. During April, 11,000 units were produced; 24,000 direct labourhours were worked and charged; 336,000 was spent on direct labour; and 180,000 was spenton variable overheads.

1.3 The direct labour rate variance for April is

A 20,000 Favourable

B 22,000 Favourable

C 24,000 Adverse

D 24,000 Favourable

(2 marks)

1.4 The variable overhead efficiency variance for April is

A 12,000 Adverse

B 12,000 Favourable

C 15,000 Adverse

D 15,000 Favourable

(2 marks)


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May 2005 5 P1

1.5 The fixed overhead volume variance is defined as

A the difference between the budgeted value of the fixed overheads and the standard fixedoverheads absorbed by actual production.

B the difference between the standard fixed overhead cost specified for the productionachieved, and the actual fixed overhead cost incurred.

C the difference between budgeted and actual fixed overhead expenditure.

D the difference between the standard fixed overhead cost specified in the original budgetand the same volume of fixed overheads, but at the actual prices incurred.

(2 marks)

1.6 Summary results for Y Limited for March are shown below.

000 Units

Sales revenue 820Variable production costs 300Variable selling costs 105Fixed production costs 180Fixed selling costs 110Production in March 1,000Opening inventory 0Closing inventory 150

Using marginal costing, the profit for March was

A 170,000

B 185,750

C 197,000

D 229,250

(2 marks)

1.7 The CIMA definition of zero-based budgeting is set out below, with two blank sections.

Zero-based budgeting: A method of budgeting which requires each cost element___________, as though the activities to which the budget relates _______________.

Which combination of two phrases correctly completes the definition?

Blank 1 Blank 2

A to be specifically justified could be out-sourced to an external supplier

B to be set at zero could be out-sourced to an external supplier

C to be specifically justified were being undertaken for the first time

D to be set at zero were being undertaken for the first time

(2 marks)


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P1 6 May 2005

1.8 Definition A: A technique where the primary goal is to maximise throughput whilesimultaneously maintaining or decreasing inventory and operating costs.

Definition B:A system whose objective is to produce or procure products or componentsas they are required by a customer or for use, rather than for inventory.

Which of the following pairs of terms correctly matches the definitions A and B above?

Definition A Definition B

A Manufacturing resource planning Just-in-time

B Enterprise resource planning Material requirements planning

C Optimised production technology Enterprise resource planning

D Optimised production technology Just-in-time

(2 marks)

1.9 Division P produces plastic mouldings, all of which are used as components by DivisionQ. The cost schedule for one type of moulding item 103 is shown below.

Direct material cost per unit 300Direct labour cost per unit 400Variable overhead cost per unit 200Fixed production overhead costs each year 120,000Annual demand from Division Q is expected to be 20,000 units

Two methods of transfer pricing are being considered:

(i) Full production cost plus 40%(ii) A two-part tariff with a fixed fee of 200,000 each year

The transfer price per unit of item 103 transferred to Division Q using both of the transfer pricingmethods listed above is

(i) Full production cost plus 40% (ii) Two-part tariff

A 2100 9

B 2100 15

C 1500 19

D 1260 9

(2 marks)

Section A continues on the next page


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May 2005 7 P1

1.10 Which of the following statements is/are true?

(i) Computer-integrated manufacturing (CIM) brings together advanced manufacturingtechnology and modern quality control into a single computerised coherent system.

(ii) Flexible manufacturing systems (FMS) are simple systems with low levels of automationthat offer great flexibility through a skilled workforce working in teams.

(iii) Electronic data interchange (EDI) is primarily designed to allow the operating units in anorganisation to communicate immediately and automatically with the sales andpurchasing functions within the organisation.

A (i) only

B (i) and (ii) only

C (i) and (iii) only

D (ii) and (iii) only

(2 marks)

1.11 D Limited manufactures and sells musical instruments, and uses a standard cost system.The budget for production and sale of one particular drum for April was 600 units at aselling price of 72 each. When the sales director reviewed the results for April in thelight of the market conditions that had been experienced during the month, she believedthat D Limited should have sold 600 units of this drum at a price of 82 each. The actualsales achieved were 600 units at 86 per unit.

Calculate the following variances for this particular drum for April:

(a) Selling price planning variance(b) Selling price operating variance

(4 marks)

1.12 A plastics company operates a process in which all materials are added at the beginningof the process. At the beginning of March, the work-in-process in a plastic mouldingmachine was 200 units, which were 25% complete with respect to conversion costs.During March, 1,400 units were completed and transferred to the next process. Alsoduring March, 50 units were scrapped due to an operator error at the end of the process,although it is unusual for this to occur. At the end of March, there were 200 units inprocess, which were 50% complete with respect to conversion costs.

Using the First-in-First-out (FIFO) method, calculate the equivalent units of production for themonth of March that would be used in the computation of the cost per equivalent unit for

(a) Material costs(b) Conversion costs

(4 marks)


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P1 8 May 2005

1.13 A company has a process in which the standard mix for producing 9 litres of output is asfollows:

$40 litres of D at $9 per litre 3600

35 litres of E at $5 per litre 175025 litres of F at $2 per litre 500

5850A standard loss of 10% of inputs is expected to occur. The actual inputs for the latestperiod were:

$4,300 litres of D at $900 per litre 38,7003,600 litres of E at $550 per litre 19,8002,100 litres of F at $220 per litre 4,620

63,120

Actual output for this period was 9,100 litres.

You are required to calculate

(a) the total materials mix variance(b) the total materials yield variance

(4 marks)

Section A continues on the next page


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May 2005 9 P1

The following data are given for sub-questions 1.14 to 1.16 below

SM makes two products, Z1 and Z2. Its machines can only work on one product at a time. Thetwo products are worked on in two departments by differing grades of labour. The labourrequirements for the two products are as follow:

Minutes per unit of productZ1 Z2Department 1 12 16Department 2 20 15

There is currently a shortage of labour and the maximum times available each day inDepartments 1 and 2 are 480 minutes and 840 minutes, respectively.

The current selling prices and costs for the two products are shown below:

Z1 Z2 per unit per unit

Selling price 5000 6500

Direct materials 1000 1500Direct labour 1040 620Variable overheads 640 920Fixed overheads 1280 1840Profit per unit 1040 1620

As part of the budget-setting process, SM needs to know the optimum output levels. All outputis sold.

1.14 Calculate the maximum number of each product that could be produced each day, andidentify the limiting factor/bottleneck.

(3 marks)

1.15 Using traditional contribution analysis, calculate the profit-maximising output each day,and the contribution at this level of output.

(3 marks)

1.16 Using a throughput approach, calculate the throughput-maximising output each day, andthe throughput contribution at this level of output.

(3 marks)

1.17 A is a food processing company. The following data have been produced for one of itsprocesses for April. There were no inventories in the process at the beginning or end of

the month.

Inputs: 2,400kg at 8 per kg 19,200Process costs 4,800Transferred to packing department: 2,060kg 22,889

There is usually a loss of 10% by weight of inputs during the process. The normal lossdoes not have a sale value.

During April there was an abnormal loss that was sold for 400.

Prepare the Process Account and the Abnormal Loss Account to record the events thatoccurred in this process during April.

(4 marks)


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P1 10 May 2005

The following data are given for sub-questions 1.18 and 1.19 below

The summarised financial statements for P Limited, a potential major supplier, are shownbelow. Before a contract is signed, the financial performance of P Limited is to be reviewed.

Summary Balance Sheets for P Limited at year end

2003 2002000 000

Non-current assets 1,600 1,400Inventories 300 280Trade receivables 200 210Cash 50 10Trade payables (280) (290)Long-term borrowings (900) (800)Net assets 970 810

Share capital 600 600Retained earnings 370 210

970 810

Summary Income Statements for the years2003 2002000 000

Sales 3,000 2,500Cost of sales 1,600 1,300Operating profit 600 450

1.18 Calculate the following financial statistics for P Limited for 2003

(a) Receivables days

(b) Payables days(c) Inventory days

(3 marks)

1.19 Calculate the following financial statistics for P Limited for 2003

(a) Current ratio(b) Acid test (quick ratio)

(2 marks)

(Total for Section A = 50 marks)

End of Section A

Section B starts on the next page


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May 2005 11 P1

SECTION B 30 MARKS


ANSWER ALL SIX SUB-QUESTIONS. EACH SUB-QUESTION IS WORTH 5

MARKS

Question Two

(a) A general insurance company is about to implement a Balanced Scorecard. You arerequired to

(i) State the fourperspectives of a Balanced Scorecard; and(ii) Recommend oneperformance measure that would be appropriate for a general

insurance company, for eachof the four perspectives, and give a reason to supporteach measure. (You must recommend one measure only for each perspective.)

(5 marks)

(b) (i) Briefly explain the main features of Economic Value Added (EVA) as it would beused to assess the performance of divisions.

(2 marks)

(ii) Briefly explain how the use of EVA

to assess divisional performance might affectthe behaviour of divisional senior executives.

(3 marks)

(c) Briefly discuss threedifferent circumstances where participation in setting budgets islikely to contribute to poorperformance from managers.

(5 marks)

(d) W Limited designs and sells computer games. There are many other firms in thisindustry. For the last five years the senior management has required detailed budgets tobe produced for each year with slightly less detailed plans for the following two years.The managing director of W Limited has recently attended a seminar on budgeting andheard the Beyond Budgeting arguments that have been advanced by Hope and Fraser,among others.

You are required to

(i) Briefly describe the Beyond Budgeting approach; and(2 marks)

(ii) Advise the management of W Limited whether or not it should change its currentbudgeting system to a Beyond Budgeting approach.

(3 marks)

Sub-questions (e) and (f) are on the opposite page


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P1 12 May 2005

The following information is to be used to answer sub-questions (e) and (f)

C plc is a large company that manufactures and sells wooden garden furniture. It has threedivisions:

The Wood Division (WD) purchases logs and produces finished timber as planks or beams.Approximately two-thirds of its output is sold to the Products Division, with the remaindersold on the open market.

The Products Division(PD) manufactures wooden garden furniture. The policy of C plc isthat the PD must buy all its timber from the WD and sell all its output to the TradingDivision.

The Trading Division(TD) sells wooden garden furniture to garden centres, largesupermarkets, and similar outlets. It only sells items purchased from PD.

The current position is that all three divisions are profit centres and C plc uses Return on

Investment (ROI) measures as the primary means to assess divisional performance. Eachdivision adopts a cost-plus pricing policy for external sales and for internal transfersbetween divisions. The senior management of C plc has stated that the divisions shouldconsider themselves to be independent businesses as far as possible.

(e) For each division suggest, with reasons, the behavioural consequences that might ariseas a result of the current policy for the structure and performance evaluation of thedivisions.

(5 marks)

(f) The senior management of C plc has requested a review of the cost-plus transfer pricingpolicy that is currently used.

Suggest with reasons, an appropriate transfer pricing policy that could be used fortransfers from PD to TD, indicating any problems that may arise as a consequence of thepolicy you suggest.

(5 marks)(Total for Question Two = 30 marks)

(Total for Section B = 30 marks)

End of Section B

Section C starts on the next page


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May 2005 13 P1

SECTION C 20 MARKS


ANSWER ONEOF THE TWO QUESTIONS

Question Three

F plc supplies pharmaceutical drugs to drug stores. Although the company makes a satisfactoryreturn, the directors are concerned that some orders are profitable and others are not. Themanagement has decided to investigate a new budgeting system using activity based costingprinciples to ensure that all orders they accept are making a profit.

Each customer order is charged as follows. Customers are charged the list price of the drugsordered plus a charge for selling and distribution costs (overheads). A profit margin is alsoadded, but that does not form part of this analysis.

Currently F plc uses a simple absorption rate to absorb these overheads. The rate is calculated

based on the budgeted annual selling and distribution costs and the budgeted annual total listprice of the drugs ordered.

An analysis of customers has revealed that many customers place frequent small orders witheach order requesting a variety of drugs. The management of F plc has examined morecarefully the nature of its selling and distribution costs, and the following data have beenprepared for the budget for next year:

Total list price of drugs supplied 8mNumber of customer orders 8,000

Selling and Distribution Costs 000 Cost driverInvoice processing 280 See Note 2

Packing 220 Size of package see Note 3Delivery 180 Number of deliveries see Note 4Other overheads 200 Number of ordersTotal overheads 880

Notes:

1. Each order will be shipped in one package and will result in one delivery to the customerand one invoice (an order never results in more than one delivery).

2. Each invoice has a different line for each drug ordered. There are 28,000 invoice lineseach year. It is estimated that 25% of invoice processing costs are related to thenumber of invoices, and 75% are related to the number of invoice lines.

3. Packing costs are 32 for a large package, and 25 for a small package.

4. The delivery vehicles are always filled to capacity for each journey. The deliveryvehicles can carry either 6 large packages or 12 small packages (or appropriatecombinations of large and small packages). It is estimated that there will be 1,000delivery journeys each year, and the total delivery mileage that is specific to particularcustomers is estimated at 350,000 miles each year. 40,000 of delivery costs arerelated to loading the delivery vehicles, and the remainder of these costs are related tospecific delivery distance to customers.


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P1 14 May 2005

The management has asked for two typical orders to be costed using next years budget data,using the current method, and the proposed activity-based costing approach. Details of twotypical orders are shown below:

Order A Order B

Lines on invoice 2 8Package size small largeSpecific delivery distance 8 miles 40 milesList price of drugs supplied 1,200 900

Required:

(a) Calculate the charge for selling and distribution overheads for Order A and Order Busing:

(i) the current system; and

(ii) the activity-based costing approach. (10 marks)

(b) Write a report to the management of F plc in which you

(i) assess the strengths and weaknesses of the proposed activity-based costingapproach for F plc; and

(5 marks)

(ii) recommend actions that the management of F plc might consider in the light ofthe data produced using the activity-based-costing approach.

(5 marks)

(Total for requirement (b) = 10 marks)

(Total for Question Three = 20 marks)

Section C continues on the next page


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May 2005 15 P1

Question Four

S Limited installs complex satellite navigation systems in cars, at a very large national depot.The standard cost of an installation is shown below. The budgeted volume is 1,000 unitsinstalled each month. The operations manager is responsible for three departments, namely:purchasing, fitting and quality control. S Limited purchases navigation systems and other

equipment from different suppliers, and most items are imported. The fitting of different systemstakes differing amounts of time, but the differences are not more than 25% from the average, soa standard labour time is applied.

Standard cost of installation of one navigation system Quantity Price ()

Materials 400 1 unit 400Labour 320 20 hours 16Variable overheads 140 20 hours 7Fixed overheads 300 20 hours 15Total standard cost 1,160

The Operations Department has gathered the following information over the last few months.

There are significant difficulties in retaining skilled staff. Many have left for similar but betterpaid jobs and as a result there is a high labour turnover. Exchange rates have moved andcommentators have argued this will make exports cheaper, but S Limited has no exports andhas not benefited. Some of the fitters have complained that one large batch of systems did nothave the correct adapters and would not fit certain cars, but this was not apparent until fittingwas attempted. Rent, rates, insurance and computing facilities have risen in price noticeably.

The financial results for September to December are shown below.

Operating Statement for S Limited for September to December

September October November December 4 months

Standard cost ofactual output 1,276,000 1,276,000 1,102,000 1,044,000 4,698,000VariancesMaterials

Price 5,505F 3,354F 9,520A 10,340A 11,001AUsage 400A 7,200A 800A 16,000A 24,400A

Labour

Rate 4,200A 5,500A 23,100A 24,000A 56,800AEfficiency 16,000F 0 32,000A 32,000A 48,000A

Variable overheads

Expenditure 7,000A 2,000A 2,000F 0 7,000AEfficiency 7,000F 0 14,000A 14,000A 21,000A

Fixed overheads

Expenditure 5,000A 10,000A 20,000A 20,000A 55,000AVolume 30,000F 30,000F 15,000A 30,000A 15,000F

Actual costs 1,234,095 1,267,346 1,214,420 1,190,340 4,906,201A = adverse variance F = favourable variance


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P1 16 May 2005

Required:

(a) Prepare a report to the operations manager of S Limited commenting on theperformance of the company for the four months to 31 December. State probablecauses for the key issues you have included in your report and state the furtherinformation that would be helpful in assessing the performance of the company.

(15 marks)

(b) Prepare a short report to the operations manager of S Limited suggesting ways thatthe budgeting system could be used to increase motivation and improveperformance.

(5 marks)

(Total for Question Four = 20 marks)

(Total for Section C = 20 marks)

End of question paper

Maths Tables and Formulae follow


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May 2005 17 P1


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P1 18 May 2005

PRESENT VALUE TABLE

Present value of $1, that is ( ) nr +1 where r= interest rate; n= number of periods untilpayment or receipt.

Interest rates (r)Periods

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.9092 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.8263 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.7514 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.6835 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.6216 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.5647 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.5138 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.4679 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424

10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.38611 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.35012 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.31913 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.29014 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.26315 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239

16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.21817 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.19818 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.18019 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.16420 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Interest rates (r)Periods(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.6943 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.5794 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.4825 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.4026 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.3357 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279

8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.2339 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194

10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.16211 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.13512 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.11213 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.09314 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.07815 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.06516 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.05417 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.04518 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.03819 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.03120 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026


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May 2005 19 P1

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n

years rr n+ )(11

Interest rates (r)Periods(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909

2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.7363 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.4874 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.1705 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.3557 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.8688 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.3359 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759

10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145

11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.49512 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.81413 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.10314 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.36715 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606

16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824

17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.02218 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.20119 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.36520 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Interest rates (r)Periods(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.5283 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.1064 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.5895 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.3267 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.6058 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.8379 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031

10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192

11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.32712 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.43913 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.53314 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.61115 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675

16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.73017 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.77518 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.81219 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.84320 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870


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P1 20 May 2005

Formulae

PROBABILITYAB =A or B. A B =A and B(overlap).

P(B A) = probability of B, givenA.

Rules of AdditionIf A and Bare mutually exclusive: P(AB) = P(A) + P(B)If A and Bare not mutually exclusive: P(AB) = P(A) + P(B) P(A B)

Rules of MultiplicationIf A and Bare independent: P(AB) = P(A) * P(B)If A and Bare notindependent: P(AB) = P(A) * P(B | A)

E(X) = (probability * payoff)

Quadratic EquationsIf aX2+ bX + c =0 is the general quadratic equation, the two solutions (roots) are givenby:

a

acbbX

2

42 =

DESCRIPTIVE STATISTICSArithmetic Mean

n

xx

=

f

fxx

= (frequency distribution)

Standard Deviation

n

xxSD

2)( = 2

2

xf

fxSD

= (frequency distribution)

INDEX NUMBERSPrice relative = 100 * P1/P0 Quantity relative = 100 * Q1/Q0

Price: 100x

1

w

P

pw

o

Quantity: 100x

1

w

QQw

o

TIME SERIESAdditive Model

Series = Trend + Seasonal + Random

Multiplicative ModelSeries = Trend * Seasonal * Random


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May 2005 21 P1

LINEAR REGRESSION AND CORRELATIONThe linear regression equation of yon xis given by:

Y= a+ bX or Y- Y= b(X X)

where

b=22 )(

))((

)(Variance

)(Covariance

xxn

yxXYn

X

XY

=

and a = Y bX

or solve Y= na + b x

XY= a x + b x2

Coefficient of correlation

})(}{)({

))((

)().(

)(Covariance

2222 yynxxn

YXXYn

YVarXVar

XYr

==

R(rank) = 1 -)1(

62

2

nn

d

FINANCIAL MATHEMATICS

Compound Interest (Values and Sums)Future Value of S, of a sum of X, invested for nperiods, compounded at r% interest

S= X[1 + r]n

AnnuityPresent value of an annuity of 1 per annum receivable or payable for nyears,commencing in one year, discounted at r% per annum:

PV =

+

nrr ]1[

11

1

Perpetuity

Present value of 1 per annum, payable or receivable in perpetuity, commencing in oneyear, discounted at r% per annum:

PV =r

1


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P1 22 May 2005

The Examiner for Management Accounting Performance Evaluation offers tofuture candidates and to tutors using this booklet for study purposes, the

following background and guidance on the questions included in thisexamination paper.

Section A Question One Compulsory

Question One consists of 19 objective test sub-questions. These are drawn from all sections ofthe syllabus. They are designed to examine breadth across the syllabus and thus cover manylearning outcomes.

Section B Question Two Compulsory

Question Two has 6 sub-questions.

(a) covers learning outcome C(xii) Discuss the role of non-financial performance indicators

and compare and contrast traditional approaches to budgeting with recommendationsbased on the balanced scorecard.

(b) covers learning outcome D(v) Discuss the likely behavioural consequences of the use ofperformance metrics in managing cost, profit and investment centres.

(c) covers learning outcome C(xiii) Evaluate the impact of budgetary control systems onhuman behaviour.

(d) covers learning outcome C(xiv) Evaluate the criticisms of budgeting particularly from theadvocates of the techniques that are beyond budgeting.

(e) covers learning outcome D(vi) Explain the typical consequences of divisional structure

for performance measurement as divisions compete or trade with each other.

(f) covers learning outcome D(vii) Identify the likely consequences of different approachesto transfer pricing.

Section C answer one of two questions

Question Three has two parts.

(a) covers learning outcome A(vi) Compare activity-based costing with traditionalabsorption costing methods and evaluate its potential as a system of cost accounting.

(b) covers learning outcome C(vi) Evaluate and apply alternative approaches to budgeting.

Question Four has two parts.

(a) covers learning outcome B(ii) Calculate and interpret material, labour, variableoverhead, fixed overhead and sales variances.

(b) covers learning outcome B(vi) Discuss the behavioural implications of setting standardcosts.


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May 2005 23 P1

Managerial Level Paper

P1 Management Accounting - PerformanceEvaluation

Examiners Answers

SECTION A

Answer to Question One

1.1 400 / 1700 = 235%

The correct answer is C.

1.2 400 - [1,700 x 12%] = 196,000

The correct answer is B.

1.3 Actual rate is 336,000 / 24,000 = 14 per hour

24,000 x [15-14] = 24,000 Fav

The correct answer is D.

1.4 [(11,000 x 2) - 24,000] x 6 = 12,000 Adv

The correct answer is A.

1.5 The correct answer is A.


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P1 24 May 2005

1.6 Closing inventory would be valued at 300,000 / 1,000 = 300 per unit.

Turnover 820,000Production costs [300,000 (150 x 300)] 255,000

Other costs 395,000Profit 170,000


1.7 The correct answer is C.

1.8 The correct answer is D.

1.9 Full cost

Variable cost 9Fixed cost = 120,000 /20,000 = 6Full cost 15plus 40% 6Total cost plus 21

Two-part tariff requires only variable cost of 9 for additional transfers


1.10 The correct answer is A.

1.11A - Original plan 600 x 72 = 43,200B - Revised ex post plan 600 x 82 = 49,200C - Actual results 600 x 86 = 51,600

Selling price planning variance is B A = 6,000 FavSelling price operating variance is C B = 2,400 Fav(Total variance is C A = 8,400 Fav to check)

1.12Units Material Conversion

Opening stock (200) (200) (50)Completed and transferred 1,400 1,400 1,400Abnormal loss 50 50 50Closing stock 200 200 100

Equivalent Units 1,450 1,450 1,500


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May 2005 25 P1


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P1 26 May 2005

1.13 Mix variance

Actual usage in standard proportions $D = 4,000 litres at $9 per litre 36,000E = 3,500 litres at $5 per litre 17,500F = 2,500 litres at $2 per litre 5,000

10,000 58,500 (1)

Actual usage in actual proportionsD = 4,300 litres at $9 per litre 38,700E = 3,600 litres at $5 per litre 18,000F = 2,100 litres at $2 per litre 4,200

10,000 60,900 (2)

Mix variance is (1) (2) = $2,400 Adverse

Yield variance

Standard cost of 1 litre is $58.50 / 9 = $650Expected output is 10,000 x 90% = 9,000 litresActual output = 9,100 litresYield variance is (9,100 9,000) x $6.50 = $650 Fav

1.14

Maximum no of units of Z1 Maximum no of units of Z2Dept 1 480 / 12 = 40 480 / 16 = 30Dept 2 840 / 20 = 42 840 / 15 = 56

Dept 2 has more capacity than Dept 1 for both products, therefore Dept 1 is the limiting factor orbottleneck.

1.15

Z1 Z2Variable cost 2680 3040Sales price 5000 6500Contribution 2320 3460

Calculate contribution per limiting factor (Dept 1 time)Z1 = 23.20 / 12 = 1.933 per minuteZ2 = 34.60 / 16 = 2.1625 per minuteSo maximum contribution would be to make as many Z2 as possible, that is 30 units x 34.60 =1,038


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May 2005 27 P1

1.16 Throughput or throughput contribution is sales less direct materials, soZ1 is 50 - 10 = 40Z2 is 65 - 15 = 50

Throughput per bottleneck minute is:Z1 40 / 12 = 3.333

Z2 50 / 16 = 3.125

Thus maximum throughput is by production of maximum number of Z1, that is, 40 units of Z1giving throughput contribution of 40 x 40 = 1,600

1.17Process Account

Kg Kg Input materials 2,400 19,200 Normal loss 240 -Process costs 4,800 Abnormal loss 100 1,111

Transfer to packing 2,060 22,889

2,400 24,000 2,400 24,000

Abnormal Loss Account

Process Account 1,111 Cash sale 400To Income Statement 711

1,111 1,111

1.18Receivables days 200 / 3000 x 365 = 24 days

Payables days 280 / 1600 x 365 = 64 daysInventory days 300 / 1600 x 365 = 68 days

Alternative answers for these calculations using average figures would be equally allowable.

1.19Current ratio 550:280 196:1Quick ratio 250:280 089:1


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P1 28 May 2005

SECTION B

Answer to (a)

Kaplan & Norton devised the balanced scorecard (BSC) as a means to incorporate financial andnon-financial performance measurement in a single document or process. Four perspectives areadopted to cover the main areas of a companys activity. These are: financial shareholderperspective; customer perspective; internal business perspective; innovation and learningperspective.

For a general insurance company the following are examples of appropriate performancemeasures for each perspective. Two examples are given in this answer but only one wasrequired in the actual exam.

Customer perspective1. Percentage of repeat business as this indicates satisfaction with the policy and servicereceived from the company.2. Target data from customer satisfaction surveys, such as response cards sent to new andrenewal customers. This indicates customer satisfaction directly.

Internal business perspective1. Percentage of policies and claims issued on time, that is, within the companys stated period,for example that all policies will be despatched within 5 working days. This is a measure of thefirms ability to efficiently organise its core activities2. Number of complaints received from policyholders in relation to claims they have made.Many complaints will have been caused by failures in the core processes, such as lostpaperwork, or delays at some point in the process.

Innovation and learning perspective1. The number or percentage of new insurance products issued per year which clearly indicatesinnovation. This would need to be compared with trends or benchmarked against competitors2. Amount of hours of staff training recorded as percentage of budget and/or last year.Although this is an input measure, such measures are frequently used to indicate staffdevelopment and learning.

Financial perspective1. Meeting a key financial target such as Economic Value Added (EVA

). This is considered

one of the best financial measures of overall performance.2. Sales growth compared with previous period. Insurance companies are frequentlyconcerned with market share and so sales growth is seen as a key financial measure.

Answer to (b)

(i) EVA

attempts to modify accounting operating profit to become closer to an economicconcept of income. To do this many of the accounting conventions and adjustments arealtered, for example:

Goodwill will be amortised over its effective life R&D expenditure will be written off over its useful life Depreciation will model the decline in asset values Assets will be valued at current cost not historical cost

After this adjusted profit has been calculated, an interest rate charge is deducted to produce the

EVA. The interest rate used in EVA is usually complex and it is usually based on the CapitalAsset Pricing Model. All the above features require systems to be implemented so that the


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May 2005 29 P1

required data can be produced quickly and with minimum cost. For example, to compute EVA

a separate depreciation calculation and separate records of assets are needed. The objective

of EVA

is to better measure the true economic performance of a division.

(ii) It is argued that meeting an EVA

target will usually require managers to act in the bestinterests of the firm. In particular, EVA

is said to encourage long term decision making,

rather than decisions that maximise short-run profits. EVAproponents argue that it hasstrong motivational advantages because maximising EVA

will maximise shareholder

value. Providing incentives for managers and workers to maximise value creation forshareholders has been recognised as a significant problem for decades; this claim forEVA

has made it popular.

The adjustments that are made to accounting profit to derive EVA

are designed to minimiseany benefit that managers can obtain by manipulating accounting numbers. So, for example,there would be little gain to short run profit from failing to invest in new machinery, and at leastpart of the cost of advertising would be deferred until the benefits arose.

Some companies set EVA

targets and rewards are paid if these targets are reached. Theadjustments to operating profit remove some of the accounting choices that can be used to

manipulate profit, and so EVAprovides an incentive to produce more shareholder value.

Answer to (c)

Four circumstances where participation is likely to contribute to poorperformance include thefollowing, although only three are required in an answer:

(i) Strong evidence suggests that some personality types do not perform well in participatorysystems and for these types, being given a budget may produce higher effort levels. Forexample, Externals as defined on the basis of the locus of control variable will usuallyrespond well to imposed budgets.

(ii) Whereas in conditions of uncertainty, participation has been shown to improve results,under conditions of stability participation may result in few or no benefits. It may result inmore time and cost being expended for no benefits. This may be particularly relevant forcost centres within large organisations that have no direct link to market conditions.

(iii) Pseudo-participation - where there is a semblance of participation but no realparticipation - has been shown to produce very poor results. Individuals react stronglyagainst this pretence at participation, and effort levels are significantly reduced.

(iv) Participation may increase budget slack and thus lead to lower targets and performance.Budget slack is where the budget is deliberately set at a level that is easier than could be

achieved. There may be an increased incentive to build in budget slack if a bonus will bepaid for meeting the budget.

Answer to (d)

The Beyond Budgeting proposition is that many companies spend considerable resources onthe budgeting process that are not justified by the benefits that accrue.

In particular, the levels of technological change and market uncertainty in modern business aresuch that it is inappropriate to set budgets 15 months or more before they will apply. This mayproduce a straight-jacket that inhibits companies from taking required actions, because its not

in the budget.W Limited is in an industry where there is considerable uncertainty and it would be very difficultto predict sales three years in advance. This may indicate that detailed long-term planning and


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P1 30 May 2005

budget-setting would be of limited value. The key question is how accurately W can predict oneyear in advance. If there is a high degree of accuracy in one year planning, then the currentsystem, but with low emphasis on year two and three may be effective.

However, if the market situation is dynamic, then the beyond budgeting arguments mayindicate that budgetary control will not be effective, in fact it may limit the ability that W has to

respond to market changes. If W decides to abandon its current budgeting system, it will needother, more flexible, forms of control. These may include non-financial performance indicators,such as: time to develop new games, gross margins on games, number of new games per year,market share, and various cost control measures. W could decide to combine financial and non-financial measures into a Balanced Scorecard.

It is highly likely that some form of annual budgeting will still be needed. In particular, W willneed a cash budget, capital expenditure budget, financing budget and some forecast for profit.Many firms in similar circumstances to W have kept their traditional form of budgeting, but withtwo major changes. First, the budget is in less detail, and it focuses on overall profits not ondetailed lines within the budget. Second, the implementation of the budgetary control processmust be flexible so that changes can be incorporated as the budget year progresses.

Answer to (e)

The senior management of C plc states that the three divisions should see themselves asindependent businesses as far as possible. However, the primary issue is that they are highlyrelated and dependent on each other.

The WD sells approximately two-thirds of its output to the PD. Thus the profits of WD and PDdepend crucially on the cost-plus transfer price. Further, with only one third of output being soldto external customers, these internal transfers will significantly affect the ROI measure that isused to assess performance. This may lead to a variety of behavioural problems, including:

Attempts to manipulate internal pricing procedures, particularly by increasing costs; Lack of effort and incentive to control costs; Lack of effort in selling to external customers as the consequences may be small in

relation to internal transfers; Short-term decisions may be made at the expense of long run profits.

PD must sell all its output to the TD and buy all its timber from WD. Thus the problemsmentioned for WD apply even more so to PD. It has little control over its business activities andthus cannot really be considered an independent business. The additional behaviouralconsequences for PD include:

The major emphasis for PD should be quality and technical efficiency. Control throughROI is likely to divert attention away from this at best, and at worst may conflict with this

aim. For example not replacing machinery because it would worsen ROI. PD needs to work very closely with WD and TD and being structured as a separateprofit centre may inhibit this (maybe a cost centre would be more appropriate?)

TD sells to the final market, and thus its sales revenue is not unduly affected by the structure ofC. Its major costs are determined by internal transfers, so its ROI is not a good measure ofperformance, just as for the other two divisions. Other behavioural consequences include:

Problems with motivation if the transfer costs from PD mean that overall profit and ROIis low.

Frustration if the management of TD believes it could substantially increase sales andROI by having a wider product range.


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May 2005 31 P1

Answer to (f)

In general transfer prices should reflect market prices. There is much theory and evidence thatsuch prices will minimise possible adverse behavioural consequences. Where market-basedprices are not possible, all transfer prices have potential problems. Many of the transfer pricetheories attempt to determine transfer prices that are similar to what a market price might be.

Transfer from PD to TDHere there is a good case that PD is not actually a profit centre. It has no control over thevolume of its output, and cannot buy or sell outside C plc. On pure economic criteria, PD shouldbecome a cost centre and transfer its output to TD at cost. In economic terms there aretheoretical arguments that this transfer price should be marginal cost. To achieve this theperformance measurement and reward system for PD would have to be changed as marginalcost transfers will always produce losses in the supplying division. In practice, it is more likelythat the transfer would be at full cost, or a standard cost. If this were the case, the performancetarget for PD would be to break even. TD would probably be receiving these products at belowmarket price. This may lead to lower final prices and higher demand. Care would be needed asthis higher output could lead to either increased or decreased profits.It may be possible to accurately estimate a market-based price. If that were the case it would be

possible to operate the current structure. From the limited evidence it is unlikely that market-based prices would be reliably available.


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P1 32 May 2005

SECTION C

Answer to Question Three

(a)

(i) Current system

880,000 / 8m = 11% of list price of drugs suppliedThus Order A will have a charge of 1,200 x 011 = 132Order B will have a charge of 900 x 011 = 99

(ii) Proposed systemCost driver rates

Invoice costs

Charge per invoice= 70,000 / 8,000 = 875 per invoiceCharge per invoice line = 210,000 / 28,000 = 750 per lineDelivery costsCharge per delivery trip = 40,000 / 1,000 = 40 per tripSo for large package = 40 / 6 = 667For small package = 40 / 12 = 333Charge per delivery mile = 140,000 / 350,000 = 040 per mileOther overheads allocated by orders(this is not a genuine cost driver)200,000 / 8,000 = 25 per order

Overhead costs Order A Order B Invoice costs 1 x 875 = 875 1 x 875 = 8752 x 750 = 1500 8 x 750 = 6000

Packing 2500 3200Delivery 1 x 333 = 333 1 x 667 = 667

8 x 040 = 320 40 x 040 = 1600Other overhead costs 2500 2500Total charge for overheads 8028 14842

(b)

Report to the Management of F plc on the Implications of Implementing an Activity-BasedCosting Approach.

From A.CandidateDate MayThis report covers two issues: (i) an assessment of the strengths and weaknesses of theproposed activity-based costing approach, and (ii) recommendations for action the Managementof F plc might take.

(i) All budgeting systems have strengths and weaknesses, and these are in part related tothe specific circumstances of the company. For F the following are relevant.

Strengths include:

Better understanding of the cost structure and what is driving costs. Ability to set prices that relate to the actual resources consumed, which should result in

few or no loss-making orders being accepted.


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May 2005 33 P1

Highlights where costs are being incurred which should lead to action to reduceactivities that have high costs.

Prices could be defended if challenged by customers. Out-sourcing decisions can be analysed more easily.

Weaknesses might include:

The costs may exceed benefits. The activity data is still very aggregated and may not be detailed enough to reveal

important cost behaviour, for example the high cost of the longest distance categorymight be distorted by some very long deliveries.

There are still arbitrary elements in the ABC system, particularly other overhead costswhich means care must be taken with the data.

(ii) The following recommendations could be made to the directors of F plc.

The present policy is cost based. This approach is simple and relatively cheap to operate.However, such a policy is unlikely to be optimal, and will only be viable where the company is

able to sell all its output. Thus, assuming that price is not closely linked to demand, a pricingpolicy that does no more than simply recover overheads and produce a profit may be deemedsatisfactory. In this case, although the current charge for overheads is simple and cheap tocalculate, it does not reflect the actual costs incurred by each order.

The new activity-based costing (ABC) system produces a measure of cost that better reflectsthe resources that have been used. This new ABC system produces very different costs to theprevious system. However, the new costing system used, although a very simple version ofABC, is probably too complex for a pricing system.

As the first step in a review it would be instructive to check whether some orders are actuallylosing money. The activity-based cost analysis indicates that orders with many differentproducts and those delivered over a long distance are expensive, in comparison with orders fora larger volume of few products with shorter delivery distances.

F will need to develop a pricing structure that would enable some of the key cost drivers to bereflected in the prices charged, and to let customers know the charge in advance.

Another possible strategy would be to stop accepting long distance orders by imposing adistance limit. It might be possible to out-source long distance deliveries, possibly along with ahigh charge for the long distance band in the charging table, as mentioned above.

The costs based on the number of items on the invoice become very high when multipleproducts are ordered. This needs careful review. Would better systems using newertechnology reduce these invoice costs this is highly likely.


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P1 34 May 2005

Answer to Question Four

(a)

Report to the operations manager of S Limited on performance for the period September toDecember

From A.CandidateDate December

Four months is not a long period to recognise trends, but it is much better than a single month.The trends and significant features for this period include:

Output has fallen distinctly during the period. There are probably seasonal factors here. It islikely that more of these systems will be sold in Summer than in early Winter. It is also possiblethese differences are expected variations around the 1000 units per month budget? Were theresome specially large contracts in September and October? This is not directly the responsibilityof the operations manager but it will affect the operating results.

Material usage (efficiency) has varied over the four months, with October and December beingpoor. This is not related to volume, and so other explanations must be sought. One batch ofsystems has been more difficult to install and sometimes require additional or replacementparts. It would be important to ascertain whether other problems of material efficiency are linkedto certain systems, certain fitters, or specific stages of the installation process.

Material price the buying in cost of the basic systems has risen over the four months. Itappears that part of this increase has been the result of exchange movements. It would beimportant to quantify this effect. It would also be important to ascertain whether there arealternative sources. Have purchasing staff been active in seeking alternative sources? It mightbe possible to increase prices to reflect the rising cost, although this may be limited by itscompetitors or the firms strategy, for example, to keep prices competitive to build market share.

The labour rate is higher than standard for all months and is deteriorating further. This clearlyneeds investigation. The most likely cause appears to be problems with keeping skilled staffand average labour rates may have risen to help retain staff. This may also have been causedby bad budgeting, or there may have been unexpected pay rises. As volumes have fallenduring the months when hourly labour rates have risen, this rise is unlikely to have been causedby overtime payments.

More worrying than the rate variances are the labour efficiency variances that are alsodeteriorating. This may indicate that the cause of the higher wage rates is not the use of ahigher proportion of skilled workers at higher wage rates. The problems with high staff turnovermay have resulted in more staff learning the job and taking more time. Another possible causeis that fitters are taking longer on each vehicle as the monthly volumes are decreasing. Thiswould indicate that labour is not actually a variable cost, although standard costing systems

usually assume that it will be. Another explanation to be explored is whether the batch with theincorrect adapters has led to increased labour time being used. It might be that the averagelabour time is not as expected, purely as a consequence of the 25% variation that is known tooccur.

For variable overheads only the total variable overhead variance has any real meaning. Thisalso shows poor performance in November and December. This might indicate that variableoverheads are not fully variable and as volumes fall, the variable overheads fall proportionatelyless.

A similar deteriorating pattern is seen with the fixed overhead spending variance. It is usuallyimpossible to ascertain the causes of this without detailed investigation, as many different itemsof cost are included in this category. In this case it is clear that some of the main fixed costshave risen during the period, and these increases may not have been budgeted. It is importantto enquire whether there has been effective control of costs by the department managers,


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although it also important to distinguish those costs where these managers have little control,such as: rent, rates, insurance.

Overall there seems to be a worsening of operating performance in November and December,with no obvious cause apparent in the data. The total adverse variance is only 4.4% of the totalstandard cost and may not in itself require detailed investigation. However, this total includes

some individual variances that are much larger in percentage terms, and these do needinvestigation. There are hints that lower volumes may be playing a part, and also hints that costcontrol needs to be tighter. As always, detailed questions will have to be asked to ensure thatthe causes of rising costs are understood. It may then be possible to manage these costs andreduce future costs.

The points above mention detailed additional information that would be helpful in assessing theperformance for this period. There is other more general further information that would behelpful, including: departmental information, market data, operating and quality data in physicalunits, and details of the nature of the standards.

(b)

Report to the operations manager

Subject: Ways to increase motivation and improve performanceFrom A. CandidateDate December

Motivation and performance improvement are complex subjects. Many aspects of the firminteract to produce the overall motivation for each individual employee. It is possible to use thebudgeting system to increase motivation and improve performance. The following are possiblemeans to achieve this in S Limited:

Set budgets with the participation of managers. It may be possible do this inconjunction with an initiative to establish teams of fitters that have some autonomy over

how they organise their work. There is evidence that this approach frequently producesimproved results, but this is not guaranteed.

Attempt to achieve acceptance of the standards in the budget. Participation is seen asone way to do this. Other approaches are through consultation and clear explanation tostaff.

Give clear and rapid feedback to the first-line managers and supervisors/team leaders.There is strong evidence that this improves motivation as people are keen to know howwell they are doing and this reinforces any motivation to perform well.

Link with appropriate incentives. It may be beneficial to introduce some incentivescheme linked to achieving the budget, but note that too strong a link will lead to gamingbehaviour. There is good evidence that incentives can improve performance, but alsomuch evidence that where this emphasis is strong obtaining the reward becomes the

objective and this may be achieved without making overall long run improvements inperformance. For S Limited it would be very damaging for budgets to be met at the costof damaging customer satisfaction.

Encourage interchange between departments and teams, possibly by company-wideincentives not department-based incentives. This is particularly important where realimprovements can best be achieved through improved cooperation.

It may be important to note clearly the controllable and non-controllable elements withinthe budget. For example, the batch of systems that were difficult to fit was not the resultof a decision by the fitters. There are strong arguments that managers should only beheld responsible for performance where they have control, and that holding managersresponsible for non-controllable results can be demotivating.

cima old p1 may 2005 qp and ans

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