Q and As-Advanced Management Accounting - June 2010 Dec 2010 and June 2011

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ZAMBIA INSTITUTE OF CHARTERED ACCOUNTANTS

PROFESSIONAL LEVEL
P2: Advanced Management Accounting
June 2010
December 2010
June 2011
QUESTION PAPERS AND SUGGESTED SOLUTIONS
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Table of Contents
JUNE 2010 P2: ADVANCED MANAGEMENT ACCOUNTING ................................ 3
SUGGESTED SOLUTIONS ................................................................ 14
DECEMBER 2010 P2: ADVANCED MANAGEMENT ACCOUNTING .............................. 32
JUNE 2011 P2: ADVANCED MANAGEMENT ACCOUNTING .............................. 64
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CHARTERED ACCOUNTANTS EXAMINATIONS

PROFESSIONAL LEVEL

P2: ADVANCED MANAGEMENT ACCOUNTING

SERIES: JUNE 2010

TOTAL MARKS 100

TIME ALLOWED: THREE (3) HOURS

INSTRUCTIONS TO CANDIDATES
1. You have ten (10) minutes reading time. Use it to study the examination paper carefully so that
you understand what to do in each question. You will be told when to start writing.
2. There are SEVEN questions in this paper. You are required to attempt any FIVE questions. ALL
questions carry equal marks.
3. Enter your student number and your National Registration Card number on the front of the answer
booklet. Your name must NOT appear anywhere on your answer booklet.
4. Do NOT write in pencil (except for graphs and diagrams).
5. The marks shown against the requirement(s) for each question should be taken as an indication of
the expected length and depth of the answer.
6. All workings must be done in the answer booklet.
7. Present Value and Annuity Tables are attached at the end of the question paper.
8. Graph paper (if required) is provided at the end of the answer booklet.
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Question 1
Mununshi Ltd has four control periods, namely periods 1, 2, 3 and 4. It started producing and selling a
new type of toy in period 4 of 2008. Toys are produced in batches. The budgeting information for periods
1 and 2 of 2009 is as follows:
(i) All batches produced will be sold in the period of production at K2,400 per batch.
(ii) Estimated production/sales is:
Period 4 Period 1 Period 2
Period/year 2008 2009 2009
Batches 60 90 90
(iii) The labour cost of batch 1 of 2008 was K1,200,000 (at K10,000 per hour). Direct labour is subject
to a learning curve effect of 80%. The labour output rates from the commencement of production
of the product, after adjusting for learning effect, are as below:
Total Batches Produced Cumulative Average Time per Batch
30 40.14 hours
60 32.11 hours
90 28.18 hours
120 25.68 hours
150 23.90 hours
180 22.54 hours
210 21.45 hours
240 20.55 hours
All time will be paid for at K10,000 per hour.
(iv) Variable overhead is estimated at 200% of direct labour cost.
(v) Direct material is used at the rate of 200 units per batch of product for the first 40 batches of
period 4, 2008. Units materials used per batch will fall by 2% of the original level for each 40
batches thereafter due to careful usage. Materials will be bought at K18 per unit throughout
2009.
(v) Fixed costs per period are K50 million.
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Required
(i) Calculate the labour time required for the first batch. (1 mark)
(ii) Calculate the time required for the 5th to 8th batches. (3 mark)
(i) Prepare budget summary for each of the periods 1 and 2 of 2009. Total contribution earned
from the product in each period should be shown. All relevant workings should be shown.
(16 marks)
Total : 20 marks)
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Question 2
(a) The balanced scorecard has many advantages as a basis for performance measurement over
raditional management accounting views of performance management.
Required
(i) Discuss the statement above, including specific examples of quantitative measures for
each aspect of the balanced scorecard. (4 marks)
(ii) Explain three advantages of the balanced scorecard. (3 marks)
(b) Zanga Zine Plc (ZZ Plc) wishes to expand its operations and is considering investing K 90
million in a 5 year project. The project will be fully depreciated at the end of the 5 years. The
rest of the data is as follows.
K Km Km Km Km
Year: 1 2 3 4 5
Sales revenues 70 98 106.4 114.8 106.4
Materials (10.7) (15) (18) (21) (18)
Labour (21.4) (30) (36) (42) (36)
Overheads (1) (2) (2 2) (2)
Interest (11.52) (11.52) (11.52) (11.52) (11.52)
Depreciation (18) (18) (18) (18) (18)
Total profit 7.38 21.48 20.88 20.28 20.88
The following additional information is also available:
1. Cumulative investment in working capital will be as follows:
Year Kmillion
0 6
1 8
2 10
3 12
4 14
5 14
2. Elements of costs and revenue will be affected as follows:
- Materials and labour 10% increase per annum.
- Selling prices, working capital and overheads 5% increase per annum.
3. Money post tax cost of capital will be 5% per annum.
4. ZZ plc pays corporation tax on its profits at the rate of 20% - payable one year in arrears.
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5. The above cash flows have been prepared in real terms.
6. The project will qualify for tax depreciation (capital allowances) at the rate of 25% per annum
on a reducing balance basis.
Required
Evaluate the project and advise whether it is worthwhile. State clearly any assumptions that you make.
(13 marks)
Total : 20 marks
Question 3
Required
(a) Explain what you understand by management information systems (MIS) (3 marks)
(b) Three types of MIS include Decision Support Systems (DSS), Executive Information Systems
(EIS) and Expert Systems. Explain the decision support systems. (3 marks)
(c) Management accounting information should comply with a number of criteria including verifiability,
objectivity, timeless, comparability, reliability, understandability and relevance if it is to be useful in
planning, control and decision-making.
(i) Explain the meaning of each of the criteria named above and give a specific example to
illustrate each. (11 marks)
(ii) Give an explanation of how the criteria detailed in (i) might be in conflict with each other.
Giving examples to illustrate where such conflicts might arise. (3 marks)
(Total: 20 marks)
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Question 4
Katundu Transporters Ltd runs a small fleet of trucks as part of its business. The managers of the
company wish to estimate how regularly to replace the trucks. The fleet costs a total of K110,000, 000
and the company has just purchased a new fleet. Operating costs and maintenance costs increase as
the trucks get older. Estimates of these costs and the likely scrap values of the fleet at the end of various
years are presented below.
Year 1 2 3 4 5
K000 K000 K000 K000 K000
Operating costs 46,000 49,000 52,000 56,000 88,000
Maintenance costs 13,600 18,400 26,000 34,200 56,000
Scrap value 70,000 48,000 24,000 4,000 400
Katundu Transporters Ltd uses a cost of capital of 15% .
Required:
(a) Evaluate how the company should replace its trucks.
Assume all cash flows occur at the end and are after taxation (where relevant). Ignore inflation.
(8 marks)
(b) Discuss the main problems of this type of evaluation. (3 marks)
(c) (i) Distinguish between hard and soft capital rationing, explaining why a company may
deliberately choose to restrict its capital expenditure. (6 marks)
(ii) Katundu Transporters Ltd has identified four other investments but has access to only
K700 million to invest in the year to 31 December, 2010. None of the investments is
divisible and they cannot be undertaken more than once. The investments to be undertaken
in the year to 31 December 2010 are as follows:
Investment A B C D
KM KM KM KM
Capital required 200 300 280 380
NPV 112 150 136 182
Required
If there are no better investments available at this time, which investments if any should Katundu
Transport Ltd undertake? (3 marks)
(Total : 20 marks)
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Question 5
The Mwabona group operates with two divisions: Division A which is operating at full capacity and
Division B which is currently operating with spare capacity. Division A makes two products X and Y. Cost
data in relation to these two products is as follows:
Products X Y
Direct materials K40,000 per unit K30,000 per unit
Production time 4 hours 2 hours
Budget production 4,000 units 2,000 units
The variable overheads including labour of Division A are K200,000,000. These overheads vary based
on production time. Fixed overheads of Division A are budgeted at K300,000,000, and they are absorbed
based on production time. When pricing products, Division A adds 20% onto the total production cost.
The manager of Division B intends asking the manager of Division A for 1,000 units of production X
which he intends to incorporate into a new product Zed. In order to produce Zed, Division B will have
additional variable costs of K30,000. It is expected that the new product will sell for K220,000.
The managers are to meet soon to discuss the possibility of transfer of X from Division B. In informal
negotiations prices of K80,000, K140,000, K170,000 and K195,000 have been mentioned.
Required
(a) Give your views on each of the prices mentioned, recommending a price range which you
consider most appropriate. (14 marks)
(b) Explain three other factors that should be taken into account in relation to the possible transfer of
X to Division B? (6 marks)
Total: 20 marks
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Question 6
Dolly Motors Plc is motor car distributor with 57 cars. 34 of them are Corollas, 15 Camrys and 8
Carinas. The distributor at the moment has three garages requiring cars. Garage A can take 18 cars,
Garage B 18 cars and Garage C 16 cars. The cost of supplying (K000s) each car to each garage is as
follows:
Garage A Garage B Garage C
K000 K000 K000
Corollas 50 30 40
Camrys 80 40 50
Carinas 100 70 80
(a) Write out and explain the initial transportation tableau if the problem is to minimize the cost of
transporting the cars from the distributor to the garage. (6 marks)
(b) What are the main features of a problem that would lead you to solve it as a transportation
problem?
Illustrate your answer by referring to the above problem. You will need to refer to the
transportation tableau. (14 marks)
(Total 20 marks)
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Question 7
Blessings Ltd produces and sells a sweet chewing gum which requires inputs from two types of
ingredients, X and Y.
The standard cost and revenues per unit are shown below.
K per unit
Ingredient X: 2.5grams at K100 per gram 250
Ingredient Y: 1.5grams at K88 per gram 132
Labour 1.5hours x K40 per hour 60
Variable overhead 1.5hours x K28 per hour 42
Standard variable cost per unit 484
Blessing Ltd budgets to sell all bubble gums at the standard selling price of K800 per unit. Budgeted
production and sales in the quarter to 31st March 2009 were 10,000 units.
Actual results for the quarter ended 31 March 2009 were as follows.
Ingredient (gum) X: 17,500g at the total cost of K1,820,000
Ingredient (flavours) Y: 25,000g at the total cost of K2,100,000
Labour :15,000hours at the total cost of K770,000
Variable overhead at the total cost of K460,000
Actual units produced and sold were 9,000 units
Total actual revenue raised from 9,000 units was K8,910,000
The respective original prices of K100 and K88 for ingredients X and Y were too high. With the benefit of
hindsight, the more realistic prices to incorporate in the standards for ingredients X and Y should have
been K84 per gram and K76 per gram, respectively. There were no opening and closing inventory during
the quarter under review.
Required
(a) Calculate the material mix and yield variances, planning and operating variances, labour
variances, variable overhead variances and sales variances. (9marks)
(b) Prepare on operating statement reconciling the budgeted contribution to the actual contribution. (5marks)
(c) Explain the benefits of analysing variances into planning and operating, and mix and yield
variances (6 marks)
Total: 20 marks
END OF PAPER
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JUNE 2010
P2 ADVANCED MANAGEMENT ACCOUNTING
SUGGESTED SOLUTIONS
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Solution 1
(i) Labour time for the first batch
Let X be the direct labour hours
x K10,000 = K1,200,000
10,000x = K1,200,000
= 120 hours
Batch CAT Total Time Incremental Time
x Y TT
1 120 120
2 96 192
4 76.8 307.20
184.32
8 61.44 491.52
Time for 5 8 batches =184.32 hours
Budget Summary For Periods 1 and 2 of 2009
Period 1 Period 2_
Batches 90 90
K000 K000 K000 K000
Sales
(K2,400,000 90/90) 216,000 216,000
Variable Cost
Materials 86,200 82,200
Labour (W.2) 16,580 13,470
VOH (200% x
K16,580/K13470) 33,160 26,940
FOH 50,000 50,000
(185,940) (172,610)
Profit/(Loss) 30,060 43,390
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Workings
W/1:Material Cost
Period 1 Units Period Units
20 200 98% = 3,920 10 200 94% = 1,880
40 200 96% = 7680 40 200 92% = 7360
30 200 94% = 5,640 40 200 90% = 7,200

X
17,240

X
16,440

Material price/kg K5,000 K5,000
Total Material Cost 86,200,000 K82,200,000
W.2 Labour Costs
Period 1 Period 2
Hours Hours
Total time for 150 batches Total time for 240
150 x 23.90 = 3,585 (240 x 20.55hrs) = 4,932
Total time for 60 batches Time for 150 batches
60 x 32.11 = 1,927 150 x 23.90 = 3,585
Time for 90 batches 1,658hrs 1,347
K10,000 K10,000
= K16,580,000 K13,470,000
Solution 2
The balanced scorecard consists of a variety of performance indicators both financial and non-financial.
The balanced scorecard addresses the problem identified above by focusing on four different
perspectives, as follows.
(a) The customer perspective gives rise to targets that matter to customers. Examples of measures
might include price as compared with competitors, number of favourable reviews in the press,
satisfaction levels measured on the basis of customers feedback and product ratings, or
performance in relation to areas that customers say are important, such as percentage of
deliveries on time.
(b) The internal perspective aims to improve internal processes and decision making. Examples of
measures might include length of cycle times, level of waste or idle time and trends in costs.
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(c) The innovation and learning perspective considers the businesss capacity to maintain its
competitive position through the acquisition of new skills and the development of new products.
Examples of measures might include the percentage of sales derived from new products
compared with established ones, time to market, or level of long-term investment in new product
development.
(d) The financial perspective covers traditional measures such as profitability, ROCE, cash flow,
growth and shareholder value.
Examples of measures might include the percentage of sales derived from new products
compared with established ones, time to market, or level of long-term investment in new product
development.
Advantages of this approach are as follows:
(i) It is related to the key elements of a companys strategy. It translates strategy into a clear
set of objectives. These are then further translated into a system of performance
measurements that communicate a powerful message, and provide a forward-looking,
strategic focus to everybody in the organization.
(ii) Financial, non-financial and qualitative measures are all considered and are linked together
(iii) The scorecard is balanced in the sense that managers are required to think in terms of
all four perspectives, to make sure that improvements made in one area are not made at
the expense of another.
(iv) It forces managers to look at external matters concerning the organization as well as
internal matters.
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(b) (i)
NPV MODEL KM
Year 0
Km
1
Km
2
Km
3
Km
4
Km
5
Km
6
Km
Initial cost (90)
W/capital (w.1) (6) (2) (3) (3) (3) 17
Cash profit (w.2) 15 35 36 35 36
Tax payable
(w.3)
(3) (7) (7) (7) (4)
Ne cash flow (96) 13 29 26 25 46 (4)
DF@5% 1.0 0.952 0.907 0.864 0.823 0.784 0.746
PV (96) 12 26 22 21 36 (3)
NPV = K18m
Since the project NPV is positive, the investment may be assumed to be profitable and may be increase
shareholders wealth. Hence it can be undertaken.
Workings
W.1 Incremental working capital p.a.
Km
Y0 K6 1.05
0
= 6
Y1 8 1.05
1
K6 1.05
0
= 2
Y2 10 1.05
2
8 1.05
1
= 3
Y3 12 1.05
3
10 1.05
2
= 3
Y4 14 1.05
4
12 1.05
3
= 3
Y5 14 1.05
5
14 1.05
4
= 1
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Y5 working capital release: 14 1.055 = 18 year 5 incremental w/capital
= 18 1
= 17
W.2 Cash profit and tax payable Km
Year 1 2 3 4 5 6
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Km Km Km Km Km Km
Sales
X (1.05)
n
= 74 108 123 140 136
Materials
X (x 1.1)
n
= (12) (18) (24 (31) (29)
Labour
X (1.1)
n
= (24) (36) (48) (62) (58)
Overheads
(1.05)
n
= (1) (2) (2) (2) (3)
Capital allow (22) (17) (13) (10) (28)
Cash profit 15 35 36 35 18
Tax @ 20% 3 7 7 7 4
Tax lag 3 7 7 7 4
W.3 Capital Allowances
KMillion
WDV WDA
@75% @25%
Y1 90 22
Y2 67.5 17
Y3 50.625 13
Y4 37.969 10
Y5 28.477 28( Balancing allowance)
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Working 3
Capital allowances
Year Capital allowances Km
0 Initial cost 90
1 WDA 25% K90m 22
68
2 WDA 25% K68m 17
51
3 WDA 25% K51m 13
38
4 WDA 25% K38m 10
5 Balancing allowance 28

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Solution 3
(a) Management information system is a system to convert data from internal and external sources
into information and to communicate that information, in an appropriate form, to managers at all
levels in all functions to enable them to make timely and effective decisions for planning, direct
and controlling the activities for which they are responsible. A management information system
(MIS) collects data from various sources and turns it into the type of information that managers
need to help them to run their business. An MIS cannot be bought off-the-shelf and installed
overnight. It is a combination of both informal data collection, information analysis and information
dissemination which provides an organisations managers with the information they require for
strategic, tactical and operational planning and control.
(b) Decision support systems are used by management to help make decision on poorly defined
problems (with high levels of uncertainty). They provide access to information with a wide range of
information gathering and analytical tools. Decision support systems allow managers to scan the
environment, consider a number of alternatives and evaluate them under a variety of potential
considerations. There is a major emphasis upon flexibility and user friendliness.
(c) (i) Verifiability this means that the managerial accounting information can be confirmed by
reference to documentation and schedules maintained by the company. This is especially
important when information is being used to aid decision making the decision maker will
want to be in a position to check the information being made available to him. It is also
important that the calculations used in planning and forecasting can be checked and that
the subsequent control information based on these plans (budgets) can be verified. Proper
documentation is essential to verification. Verifiability can be illustrated by reference to the
stock records that would be used in valuing material issues for cost control.
(ii) Objectivity it is highly unlikely that management accounting information will contain no
subjective bias. However, efforts should be made to ensure that such bias is kept within
acceptable limits and is appreciated during the planning and decision making process. An
example of the need for objectivity would be the setting of standard costs for labour or
materials.
(iii) Timeliness it is essential that information is produced and communicated to the
management in time for it to be used. Delays in data gathering, processing or
communication can transform potentially vital information into worthless waste paper. An
example would be material price variances which should be reported at the time of
purchase, not usage.
(iv) Comparability most information does not stand on its own. It must be in a form which
enables it to be compared with either data from previous periods or with some planned
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(budgeted) data. This is especially important for control purposes. A good example is the
use of flexible budgets to ensure that actual results are compared with the budgeted results
for that level of activity. It is also very useful to use percentages instead of absolute values
to enhance comparability.
(v) Reliability this means that the management information should be processed and
presented in such a way that the user can safely use the information while planning,
controlling or making decisions. For example, analysis using a computerized system is
likely to be more reliable than when using a manual system.
(vi) Understandability management must receive information in a style and format it finds
readily comprehensible. This means that the management accountant must be aware of the
recipients knowledge of technical accounting terms, numeracy/ literacy levels and his
personal characteristics. An example would be the use of graphs and charts instead of
tables of figures for (say) CVP analysis. Information which cannot be understood is at best
useless and at worst dangerous, resulting in poor planning and decision-making and
incorrect use of control devices.
(vii) Relevance this is the primary criterion to be met by management accounting information.
The information provided should be that which is required for the manager to plan, control
or make decisions in the current environment. Information which is relevant in one
environment, at a particular time, may not be relevant as the environment changes. An
example would be information based on marginal costing principles, giving the contribution
per unit, instead of total absorbed costs, for decisions relating to changes in activity levels.
This data may not be relevant to decisions on product pricing.
(ii) Several of the criteria could be in conflict e.g. relevant data is not always verifiable or easily
understood. The major conflict is likely to be, between timeliness and some (or all) of the
other criteria. For example it may be possible to improve the understandability of the
information but not within the period when it is considered to be timely. Some objectivity
may be lost in an effort to get the information out in time. The management accountant will
have to balance the criteria to find the optimal practical position, which is not necessarily
the optimal theoretical position for information.
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Solutions 4
(a) W.1 Cumulative PV of initial costs, maintenance and operating costs.
(K million)
Year Costs Df@15% PV Cum. PV
0 (110) 1.0 (110) (110)
1 (59.6) 0.870 (52) 162)
2 (67.4) 0.756 (51) (213)
3 (78.0) 0.658 (51) (264)
4 (90.2) 0.572 (52) (316)
5 (144) 0.497 (72) (388)
W.2 PV of scrap value (Kmillion)
Year cash flow DF@ 15% PV
1 + 70 0.870 61
2 + 48 0.756 36
3 + 24 0.658 16
4 +4 0.572 2
5 + 0.4 0.497 0
Replace every: 1 yr 2 yrs 3 yrs 4 yrs 5yrs
PV cost Km (162) (213) (264) (316) (388)
PV scrap value + 61 +36 +16 +2 0
NPV cost (101) (177) (248) (314) 388
Annuity Factor 0.870 1.626 2.283 2.855 3.352
EAC (116.1) (108.9) (108.6) (110.0) (115.8)
Advice: On financial grounds, Katundu Transporters Ltd should replace its fleet of trucks every 3 years
as this cycle has the lowest equivalent annual cost(EAC).
(b ) The solution assumes that replacements will be with identical trucks, which will incur
the same costs and generate the same revenues as vehicles retained for longer periods.
This is unlikely, as newer vehicles will be more attractive to customer, and should have less
time off the road for repairs.
The effects of inflation and taxation should not be ignored.
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Technical improvements may create cheaper running costs, particularly in maintenance
and fuel. Drivers wages may increase. The resale value of vehicles is very difficult to
estimate accurately.
( c) (i) Hard capital rationing applies when a firm is restricted from undertaking all apparently
worthwhile investment opportunities by factors external to the company, and over which it
has no control. These factors may include government monetary restrictions and the
general economic and financial climate, for example, a depressed stock market, precluding
a rights issue of ordinary shares.
Soft capital rationing applies when a company decides to limit the amount of capital
expenditure, which it is prepared to authorize. The capital budget becomes a control
variable, which the company may relax if it chooses. Segments of divisionalised companies
often have their capital budgets imposed by the main board of directors.
A company may purposely curtail its expenditure for a number of reasons:
(1) It may consider that it has insufficient depth of management expertise to exploit all
available opportunities without jeopardizing the success of both new and ongoing
operations.
(2) It may be deliberate board policy to restrict the capital budget to concentrate
managerial attention on generating the very best and most carefully thought out and
analysed proposals. In this regard, self-imposed capital rationing may be an exercise
in quality control.
(3) Many companies adopt the policy of restraining capital expenditure to the amounts
which can be generated by internal resource i.e. retained earnings and depreciation
provision (or in reality, cash flow). This reluctance to use the external capital markets
may be due to a risk-averse attitude to financial gearing, possibly because of the
operating characteristics of the industry e.g. high operating gearing in a cyclical
industry. Alternatively it may be due to reluctance to issue equity in the form of a
rights issue, for fear of diluting earnings, or in the case of an unlisted company,
reluctance to seek a quotation owing to the time and expense involved and the
dilution of ownership.
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(ii)
Feasible Combinations Total Capital required Total NPV
(Km) (Km)
A and B 500 262
A and C 480 248
A and D 580 294
B and C 580 286
B and D 680 332 * Optimal
C and D 660 318
The optimal combination is to select B and D because this combination gives the highest NPV.
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Solution 5
As Division A operates at full capacity the minimum Transfer Price(TP) is:
Marginal cost (MC) + Opportunity
cost

Therefore, Selling Price (Transfer Price) of product X
K
Materials 40,000
Variable overheads
(Including labour): 4hrs x K10,000 (w.1) 40,000
Marginal cost 80,000
Fixed overheads(. K15,0000 x 4hrs(w.2)) 60,000
Total cost per unit 140,000
Profit mark up (20% x K140,000 ) 28,000
Transfer Price = selling price 168,000
Therefore; TP = MC + Opportunity cost : K80,000 + K88,000 = K168,000
Working: W.1 Variable overhead rate
( ) ( ) 2,000 2hrs 4,000 4hrs
00 K200,000,0
+

=
4,000 16,000
00 K200,000,0
+
=
20,000hrs
00 K200,000,0

= K10,000 / hour
W.2: Fixed overhead rate
=
20,000
K300,000
= K15,000/hour
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Identifying maximum Division B can pay for one unit of X
Maximum price payable = Marginal Revenue in Division B Marginal cost in Division B
(MRB MCB)
Or
= Selling Price Division B Marginal cost Division B (SPB MCB)
= K220,000 K30,000 (Own Costs)
Therefore; Max. Price Payable = K190,000
Some possible allowance can be made for possible savings in Div. A.
Division A managers view point (K000)
TP K80 K140 K170 K195
SP K168 K168 K168 K168
Loss/gain (K88) (K28) +K2 +K27
Division A manager will accept TPs of K170,000 and K195,000
Division B managers view point (K000)
TP K80 K140 K170 K195
SP K190 K190 K190 K190
Loss/gain +K110 K50 +K20 (+K5)
Therefore; Div. B manager would accept all prices except. Price K195,000
b) Any three factors
Saving in selling, packaging, transportation etc costs in Div. A
Forecast sales of new product
If product is transferred externally, the danger of attracting competition into market.
(Other relevant factors will be factors will be accepted on merit)
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Solution 6
(a ) The supply of cars exceeds the demand for cars. To be able to use the transportation method, it is
necessary to balance demand and supply by including in the tableau a dummy demand center to
take up the surplus capacity of four cars. The tableau therefore, consists of four columns and
three rows to represent the demand centers and supply centers. The transportation costs have
been written in the top left hand corner of each cell. The costs in the cells in the dummy column
are all zero. The dummy only uses up surplus capacity.
X22, X12, X34 are the unknown quantities that will be allocated to the cells such that the sums
in the individual rows and columns satisfy the appropriate demand and supply figures given.
The transportation method shows that for an initial feasible solution to the problem, at most only 6
(i.e. 4 + 3 1) of these unknowns will have a non-zero positive value. The value of the rest will be
zero.
( b)
Demand A B C Dummy Total
Corollas

X11

X12

X13

X14

34
Camrys

X22

X22

X23

X24

15
Carinas

X31

X32
er

X33

X34

8
Total
18

18

16

5

57
50 30

40 0
80 40 50 0
100
70 80
0
29
The classical transportation problem arises when an optimum schedule of shipments has to be
determined, e.g. three types of cars to three garages. The shipments originate at source where fixed
stockpiles of a commodity are available, e.g. 34 Corollas, 15 Camrys and 8 Carinas.
They are sent directly to their final destinations where various fixed amounts are required, e.g. 18 at A,
18 at B and 16 at C.
The total demand equals the total supply, (hence the reason for the dummy in the above problem). The
costs must, in addition, satisfy the linear objective function, so the cost of each shipment is proportional
to the amount shipped and the cost is the sum of the individual costs, i.e. total cost=50X22 + 30X22 + ,
the objective being to minimize 50X
22
+ 30X
22
+
30
Solution 7
(a) (i) Material mix variance
Actual mix Std mix
X (17,500 26,562.5) @ 100 = 906,250 F
Y (25,000 15,937.5) @ 88 = 797,500 A
42,500 42,500 108,750 F
(ii) Material yield variances
Actual in std mix std qty in std mix
X (26,562.5 22,500) @ 100 = 406,250 A
Y (15,937.5 1,500) @ 88 = 214,500 A
(iii) Planning variances
Revised std price - original std price x actual qty
X (84 100) @ 17,500 = 280,000 F
Y (76 88) @ 25,000 = 300,000 F
580,000 F
(iv) Operating variance
(Revised std price - Actual price) Actual cost
X (84 17,500) 1,820,000 = 350,000 A
Y (76 25,000) 2,100,000 = 200,000 A
550,000 A
(v) Labour rate variance
(Std rate - Actual rate) Actual hrs
(40 15,000) 770,00
170,000 A
(vi) Labour efficiency variance
(Std hrs - Actual hrs) x std rate
(9,000 1.5) 15,000) 40
60,000 A
(vii) Variable expenditure variance
(Std rate actual rate) actual hrs
(28 15,000) - 460,000
40,000 A
a.
Variable efficiency variance
(Std hrs actual hrs) std rate
(9,000 1.5) 15,000) 28
42,000 A
31
(ix) Sales price variance
(Std price actual price) actual qty
(800 8,910,000/9,000) 9,000
1,710,000 F
(x) Sales volume variance
(Budgeted qty - actual qty) std contribution
(10 ,000 9,000) (800 484)
316,000 A
(b) Reconciliation operating statement
Budgeted contribution (800 484) 3,160,000
Sales variances: volume variance 316,000 A
1,710,000 F
Price variance 4,554,000
F A
Planning variance 580,000
Operating variance 550,000
Material mix 108,750
Material yield 620,750
Labour rate 170,000
Labour efficiency 60,000
Variable ohd expenditure 40,000
Variable ohd efficiency 42,000
688,750 1,482,750 4,554,000
794,000
Actual contribution 3,760,000
(c) Analysis of variances useful for the following reasons:
(i) Responsibilities can be identified for each variance and control reporting is improved
(ii) Factors outside management control are separately identified so that they could
concentrate on the controllable factors
(iii) Motivation is improved because standards are more relevant and achievable
(iv) The standard costs become more relevant and are kept up to date with changing
circumstances.
32


PROFESSIONAL LEVEL


SERIES: DECEMBER 2010

TOTAL MARKS 100 TIME ALLOWED: THREE (3) HOURS

1. You have ten (10) minutes reading time. Use it to study the examination paper carefully so that you
understand what to do in each question. You will be told when to start writing.
7. Discount Factor tables/Present Value and Annuity Tables are attached at the end of the question
paper.
33
Question 1
The objective of the Mable health authority (a public sector organization in Zambia) is stated in its most
recent annual report as:
To serve the people of Zambia by providing high-quality healthcare within expected waiting times.
The mission statement of a large plc in a manufacturing industry is shown in its annual report as:
In everything the company does, it is committed to creating wealth, always with integrity, for its
shareholders, employees, customers and suppliers and the community in which it operates`.
Required:
(a) Discuss the four main differences between the public and private sector which have to be addressed
when determining corporate objectives. (8 marks)
(b) Describe three performance measures which could be used to assess whether or not the health
authority is meeting its current objective. (6 marks)
Note. Candidates may draw on their knowledge and experience of the public sector in Zambia
when answering this question.
(c) One of the most important elements of any decision is the specification of goals or objectives
which the decision maker seeks to achieve. It is often assumed that the goal of a company is to
maximise the shareholders wealth.
Required:
Explain any two alternative goals available to companies. (6 marks)
(Total : 20 marks)
34
Question 2
The government of the Republic of Zambia decided to sell the rights to drill for copper in the North
Western province. They have offered the rights to Kasempa Quantum Mines (KQM) Plc for K2 billion,
payable one year before the start of the first year of drilling.
The directors of KQM Plc have availed to you the following estimates relating to mining operations.
Quantity of copper Probability Annual Net Revenues
(excluding depreciation)
Strong Demand Weak Demand
High 0.3 K8 billion K2 billion
Low 0.3 K4 billion K1 billion
Zero 0.4 0 0
The selling price of copper and hence the annual revenue, depends on whether the demand for copper
is strong or weak. The directors estimate that there is a 40% probability that demand for copper will be
strong and 60% probability that it will be weak.
Exploratory drilling will be undertaken immediately after the drilling rights are acquired and will cost K1
billion payable at the time the drilling rights are paid for. If the existence of copper is revealed by the
exploratory drilling it will be extracted for ten years and KQM Plc will purchase special drilling and other
equipment at a cost of K13 billion payable at the start of the first year of drilling. It will not be necessary to
purchase the equipment if no copper is discovered. If the quantity of copper is high the equipment will
have no resale or scrap value after ten years; if it is low the equipment will have a resale value of K2
billion at the end of the period .
KQM Plc has a cost of capital of 10% per annum. Annual net revenues are receivable in cash on the last
day of the year.
Required:
(a) Describe a decision tree and the purpose it serves. (3 marks)
(b) Using a decision tree, calculate the expected net present value of purchasing the drilling rights and
advise whether or not the investment should go ahead. (12 marks)
(c) KQM Plc has five other mutually exclusive projects. The projects will each last for one year only
and their net cash inflows will be determined by the prevailing market conditions. The forecast
annual cash inflows (already discounted) and their respective probabilities are shown below :
35
Projects (Kmillion)
A B C D E
Market State Probability
Bad 0.2 1,000 800 900 720 1,200
Moderate 0.5 940 1,100 800 800 1,000
Very Good 0.3 1,100 1,140 950 840 850
Required:
(i) Evaluate the above projects and make a recommendation as to which project should be
selected. (2 marks)
(ii) Calculate the value of the perfect information about the state of the market. (3 marks)
(Total : 20 marks)
36
Question 3
(a) Mafikeng Division is part of the MCCM group. It produces a basic raw material which is then
converted in other divisions within the group. The material is also produced in other divisions within
the MCCM group and a limited quantity can be purchased from outside the group. The material is
currently charged out by the Mafikeng Division at total actual cost plus 25% profit mark-up.
(i) Explain why the current transfer pricing method used by Mafikeng Division is unlikely to lead
to the following.
Maximization of group profit.
Effective division performance measurement (4 marks)
(ii) If the supply of raw material is insufficient to meet the needs of the divisions who convert it
for sale outside, explain the procedure which should lead to a transfer pricing and
deployment policy for the basic raw material for group profit maximization. ( 4 marks)
(b) Mwanachingwala Plc operates two divisions, X and Y. Divisions X makes two products A and B.
Product A is sold on the open market for K84,000 per unit. The only outlet for product B is Division
Y.
Division Y supplies an external market and can obtain its semi-finished product, (product B) from
either Division X or an external source. Division Y currently has the opportunity to buy product B
from an external supplier for K 76,000 per unit. The operating capacity of Division X is measured in
units of output, regardless of whether product A, B or a combination of both are being
manufactured. The associated product costs are as follows:
A B
K/unit K/unit
Variable costs 4,000 70,000
Fixed costs 0,000 10,000
Total unit costs 74,000 80,000
Required:
Using the above information, discuss and advise a transfer price or transfer prices for the sale of
product B from Division X to Division Y under the following assumptions:
(i) When Division X has spare capacity and limited external demand for product A. (3 marks)
(ii) When Division X is operating at full capacity with unsatisfied external demand for product A.
(4 marks)
(c) State any Five (5) issues that you may have to take into account in international transfer pricing.
(5 marks)
(Total: 20 marks)
37
Question 4
Hi Tech Plc has developed a new product which it is expecting to sell well in hardware shops.
Development costs incurred to date amount to K50,000,000. The company has not yet decided whether
to commence production because a major company Robotics Ltd has offered K220,000,000 payable
immediately for the exclusive rights to produce and sell the new product.
The cost accountant has produced the following figures in relation to the manufacture of the new
product.
(a) The product will be sold for K75,000 per unit over the next four years. Demand for the product is
estimated at 11,000 units per year.
(b) Additional employees will have to be recruited if manufacturing commences. Recruitment costs are
expected to be K10,000,000 payable at the start of the project. At the end of the products life
redundancy costs are estimated at K 40,000,000. The labour cost is K10,000 per unit.
(c) The product can be manufactured using a machine which the company currently owns. The
machine cost K400,000,000 and has written down value of K15,000,000. The machine is no
longer in use by the company and could be sold for K80,000,000 if the product is not
manufactured. If the machine is used in the manufacture of the product it is expected to have a
scrap value of K15,000,000 at the end of the project.
(d) The new product will require 5kgs of material X per unit. Material X is regularly used by the
company and the company currently has 100,000 units of X in inventory, purchased at K8,000 per
unit. The replacement cost of material X is K10,000 per kg.
(e) Additional costs of K30,000,000 per annum will be incurred if production commences.
(f) Working capital of K60,000,000 will be required immediately.
(g) Hi Tech Plc has a cost of capital of 18%.
Required:
(i) Prepare the relevant cash flows, stating all assumptions, assuming Hi Tech Plc
manufactures the new product. (6 marks)
(ii) Calculate the net present value and advise Hi Tech Plc. (6 marks)
(iii) Calculate the internal rate of return on the project. (4 marks)
(iv) Calculate the sensitivity of the annual labour cost in relation to the project. (Show as an
absolute and a percentage amount). (4 marks)
(Total: 20 marks)
38
Question 5
(a) Business process re-engineering (BPR) has been promoted as a major management technique,
but it is also criticized as a little more than cost reduction.
Required:
(i) Explain business process re-engineering. (4 marks)
(ii) Explain five (5) main advantages and three disadvantages of business process re-
engineering programmes. (8 marks)
(b) Budgeting may be viewed as a relevant technique in facilitating the assessment of business
performance from initial planning to actual results. It will be necessary, however, to consider how to
overcome factors that may limit its effectiveness by use of activity based budgeting technique.
Required:
Highlight FOUR advantages that may be claimed for the use of activity based budgeting rather
than a traditional incremental budgeting system. (8 marks)
(Total : 20 marks )
Question 6
(a) A business enterprise needs to spend to have a quality product or provide a quality service. That
is to say, quality costs money. Quality costs may be divided into conformance and non-
conformance cost.
(Extract from a presenters handout at a joint ZICA/CIMA CPD Workshop).
Your Managing Director missed this workshop because he was overseas. However, a
complimentary copy was sent to him and wants to know more about quality related costs.
Required:
Write a report which discusses the four classical quality related costs, giving two examples under
each category. (10 marks)
(b) Red Ribbon Transport Services (RRTS) operates a car hire division. It is considering replacing a
12-seater Toyota Hiace luxury wagon. Lease or buy option is being considered. Since RRTS is a
brand and has a good company profile, the leasing divisions of leasing institutions are ready to
provide leasing funds.
Buy Option
The Toyota Hiace wagon will cost K45 million and RRTS will be entitled to 25% capital allowance
on a reducing balance basis. The bus can be scraped for K15 million at the end of three years.
Lease Option
39
An initial deposit of K3.75 million plus annual payments of K14.976 million at the end of each of the
three years will be required. Lease payments are allowable for the purpose of computing taxable
profits.
Other relevant information
(i) RRTS pays corporation tax at the rate of 30% of its profits.
(ii) RRTS pays half of its corporation tax in the year in which the profits are made and half in the
following year.
(iii) The cost of capital is 12%
Required:
Advice RRTS management as to whether it should lease or out rightly purchase the Toyota Hiace
bus. (10 marks)
(Total : 20 marks )
40
Question 7
Kalulushi Jam Products produces Kalulu jams and jam by-products by mixing four ingredients (fruit
extracts, syrups, citric acid and preservatives). These ingredients are coded as A,B, C and D. The firm
operates a system of standard costing for each batch of jam.
The standard cost data for a batch (a jar) of Kalulu jam are as follows.
A 400 kg @ K160 per kg
B 700 kg @ K100 per kg
C 99 kg @ K332 per kg
D 1 kg @ K2,000 per kg
Labour 18 hrs @ K3,250 per hour
Standard processing loss is 3%
Bad drought conditions in Zambia in the period of October to December of 2008 resulted in a low national
yield for ingredient A. As a consequence, normal prices in the trade were K190 per kg for ingredient A;
although good buying could achieve some savings. The impact of exchange rates on imports of
ingredient B has caused the price of B to increase by 20%.
The actual results for the batch were as follows.
A 428 kg @ K180 per kg
B 742 kg @ K120 per kg
C 125 kg @ K328 per kg
D 1 kg @ K950 per kg
Labour 20 hrs @ K3,000 per hour
Actual output was 1,164kg of Kalulu jam.
Required:
(a) Calculate the ingredients planning variances. (3 marks)
(b) Calculate the ingredients operating price variance and operating usage variance. (4 marks)
(c) Comment on two advantages and two disadvantages of variance analysis using planning and
operating variances.
(4 marks)
(d) Calculate the mix and yield variances. (6 marks)
(e) Calculate the total variance for the batch (3 marks)
(Total: 20 marks)
END OF PAPER
41

42

43

44

DECEMBER 2010
SUGGESTED SOLUTIONS
45
Solution 1
(a) A private sector organization is owned by private shareholders whereas a public sector is owned
by a government, whether national, local or international. Both sectors can have profit-making and
non-profit organizations. Most of this discussion however, is concerned with the comparison of the
profit-seeking private sector with non-profit seeking public services.
Some of the main differences between private sector and public sector organizations, which need
to be addressed when determining corporate objectives or missions, include:
(i) Public sector objectives are usually detailed in a statute or other regulatory document.
Private sector bodies will have objectives decided by their owners or by directors acting as
agents for the owners. It is easier for private sector objectives to adapt to changing
circumstances. (2 marks)
(ii) Private sector organizations will usually not survive unless they earn adequate profits for
their owners. Public services are not charged with making profits but with producing the
maximum effective high-quality output for the minimum unit cost within the allowed budget.
Other than this, the objectives of the two types of organization may be very similar, involving
consideration for the various stakeholders, such as customers, suppliers employees and the
wider community. (2 marks)
(iii) Private sector organizations nearly always have outputs which can be expressed in monetary
terms (e.g. sales value). Public service output cannot be or are not valued in monetary terms.
For example one of the outputs of the public sector hospital will be a patient with a mended
leg but the equivalent output of a private sector hospital is a patient with a mended leg and
an invoice in her/his pocket.
This difference between the two types of organization is fundamental when trying to set
objectives.
1 Private sector businesses always have a profit-based measure as one of their major
objectives. Often it will be the over-riding objective. It might be profit or return on capital
employed or shareholder value, but if the organization fails to achieve the required
financial returns for its owners, it will fail to survive.
2 Public service organizations cannot measure profit because their outputs are non-
financial. Their financial objectives are always concerned with input costs only,
whereas output objectives are set in terms of non-financial quality and efficiency
measures. (2 marks)
(iv) The sanctions on failing to meet public service objectives are weaker than private sector.
Except in extreme cases, the organization cannot be closed down and it is often more
difficult to change the management. The most severe sanction that can be imposed is to
starve the organization of cash in an attempt to force efficiency improvements.
46
(v) Until recently, public sector organizations have used cash-based accounting systems which
make it more difficult to estimate the resources used in service provision. The introduction of
cash based accounting in Zambia and other countries enables the setting of objectives and
targets which are easier to monitor against the actual out-turn and hence allows comparison
with equivalent private sector service providers. (2 marks)
(b) The health authority has as its objective the provision of high quality healthcare within expected
waiting times. This should be quantified by setting performance targets. Many performance
measures can be devised. two examples are as follows.
Waiting times
(i) Average time taken for an ambulance to arrive at the scene of an emergency.
(ii) Average time spent waiting for a particular type of non-urgent operation. (4 marks)
Quality
(iii) Percentage of successful operations for a given type of surgery.
All of these measures can be compared against the national average, or another benchmark
figure. (2 marks)
(c) Recent debate has questioned whether the maximization of shareholder wealth should or can be
the only true objective. The stakeholder theory of corporate objectives contends that many groups
of people have a stake in what the company does. Each of these groups, including workers,
managers, suppliers, customers, the local community and government, as well as shareholders
has its own objectives. Thus in practical terms, the goal of shareholder wealth maximization must
be seen as a primary objective within a whole matrix of objectives, the relative importance of which
will vary from location to location and from time to time.
Examples of non-financial objectives are:
(i) The welfare of the employees. A company might try to provide good wages and salaries,
attractive and safe working conditions, good training and career development and good
pensions. While such policies are likely to improve morale and impact favourably on financial
performance, it may be realistic to expect them to generate a positive financial return on
investment.
(ii) Fulfilment of responsibilities to suppliers. Large companies may be able to exert considerable
pressure on suppliers, both in terms of prices and payment terms. This power should not be
used unfairly. (2 marks)
(ii) Responsibilities to society. Some companies, such as Barclays Zambia Plc, take seriously their
responsibilities to society and devote resources both to initiatives in their local community and to
wider social campaigning. (2 marks)
(iii) Thus in practice, companies operate with a whole range of financial and non-financial
objectives. Although maximization of shareholder wealth may well be the primary objective, this
is likely to be constrained to some degree by the other aims of the firm. (2 marks)
47
Solution 2
(a) A decision tree is a diagram showing several possible courses of action and possible events (i.e.
state of nature) and the potential outcomes for each course of action. Each alternative course of
action or event is represented by a branch, which leads to subsidiary branches for further course of
action or possible events. Decision trees are designed to illustrate the full range of alternatives and
events that can occur, under all envisaged conditions. The value of a decision tree is that its logical
analysis of a problem enables a complete strategy to be drawn up to cover all eventualities before
a firm becomes committed to a scheme.
48
(a)

KEY:
Decision point
Outcome point
0.4
0.4
0.6
0.6

49

Workings:
High copper quantity: Kbillion
S : K8 0.4 6.145 = 19,664
W: K2 0.6 6.145 = 7,374
27,038
Low copper quantity Kbillion
S : K4 0.4 6.145 = 9,832
W: K1 0.6 6.145 = 3,687
Scrap value : K2 0.386 = 0,772
14,291

W.2 : Discount ENPV at decision node to time zero by using year 1 discount factor
Kbillion
H : 14.038 0.909 0.3 = K3,828
L : 1.291 0.909 0.3 = K0,352
Zero : 0 0.909 0.4 = K0,000
= K4,180

Kmillion
(b) (i) A (1,000 0.2 + 940 0.5 + 1,100 0.3) = K1,000
B (800 0.2 + 1,100 0.5 + 1,140 0.3) = K1,052
C (900 0.2 + 800 0.5 + 950 0.3) = K 865
D (720 0.2 + 800 0.5 + 840 0.3) = K 796
E (1,200 0.2 + 1,000 0.5 + 850 0.3) = K 995
Advice
Based on EV, project B should be undertaken because it has the Highest EV of cash inflows.

50

(ii)
Consultants Advice Project
chosen
Cashflow Probability EV
Kmillion
x p xp
Bad E 1,200 0.2 = 240
Moderate B 1,100 0.5 = 550
Very Good B 1,140 0.3 = 342
EV of cashflow with perfect information = 1,132
EV of cashflow without perfect information = 1,052
Value of perfect information = 80

51

Solution 3
(a) (i) The current transfer pricing policy is ineffective as it does not take into account the efficiency
of producing in-house rather than buying outside. Nor does it properly allocate the final profit
on sale of the goods to the various divisions.
The transfer price should be set at the variable cost of producing the goods plus the
opportunity cost. The opportunity cost is the contribution which could be earned from selling
the goods on the open market, if this is possible.
An actual cost plus approach does not send signals to managers to enhance efficiency, as
there is no incentive to control costs. The profits of the receiving divisions will be unfairly
penalised for inefficiencies in the transferring division. The poorer its performance, the
greater will be the producing division's variable costs.
The best transfer price is one which encourages the transferor division to produce enough
goods at the right price, and the transferee to purchase enough for its own requirements, so
that the incentive effect of the transfer price should be the same on both divisions.
(ii) If there is a shortage of supply which can be rectified by purchasing goods on the external
market in addition to internal production, the optimum transfer price would be the market
price of the goods.
However, in situations where there is no other source of supply the optimum transfer price
should be calculated by estimating which use of this scarce resource can generate the most
profit. A linear program is set up, with the objective to maximise contribution. The solution will
determine how much of the resource should be produced, and where it should be allocated
and thus the transfer price.
(b) (i) Division X has spare capacity and limited external demand for product A.
In this situation, the incremental cost to the company of producing product B is K70,000. It
costs Division X K76,000 to supply product B to the external market and so it cheaper by
K6,000 per unit to supply Division Y.
The transfer price needs to be fixed at a price above K70,000 both to provide some incentive
to Division X to supply Division Y and to provide some contribution towards fixed overheads.
The transfer price must be below K76,000 per unit, to encourage Division Y to buy from
Division X rather than from the external supplier.
The transfer price should therefore be set in the range above K70,000 but below K76,000 so
that both divisions, acting independently and in their own interests, would choose to buy
from, and sell, to each other.

52

Division X is operating at full capacity with unsatisfied external demand for product A.
If Division X chooses to supply Division Y rather than the external market, the opportunity
cost of such a decision must be incorporated into the transfer price. For every unit of product
B produced and sold to Division Y, Division X will lose K20,000 (K(84,000 64,000)) in
contribution due to not supplying the external market with product A. The relevant cost of
supplying B in these circumstances is therefore K90,000(70,000+ 20,000). It is therefore in
the interests of the company as a whole if Division Y sources product B externally at a
cheaper price of K76,000 per unit. Division X can therefore continue to supply external
demand at K84,000 per unit.
The company can ensure this happens if the transfer price of product B is set above
K76,000, thereby encouraging Division Y to buy externally rather than from Division X.
(c) Five issues that may have to be taken into account in international transfer pricing include:
Effect of exchange rate fluctuations
Taxation
Import duties
Repatriation of profits
Anti-dumping legislation
Competitive pressures
Foreign currency exchange controls
Minority interests

53

Solution 4
(i) Assumption/Relevant costs and Workings
1 Development costs of K50,000,000 are sunk costs and should, therefore, be excluded.
2 K220,000,000 offer is the opportunity cost of manufacturing. They should be included in the
evaluation.
3 Sales revenue of K75,000 11,000units = K825,000,000.This is a future incremental
revenue and should be included.
4 Labour: K10,000 x 11,000units = K110,000,000. The labour cost is a relevant cost because it
is specific to this product and it is incremental.
5 Original cost and written down value are irrelevant: they are sunk/past costs.
6 Scrap value (K80,000,000) of the current machine is relevant: this is the opportunity cost if
the machine is used in the manufacture of the product. Sales proceeds of K15,000,000 at the
end of the project are relevant.
7 The materials are in regular use and if used they have to be replaced. The cost of 5kg
K10,000 11,000 units = K550,000,000 is relevant. That is, the relevant cost is the current
replacement cost or current market value.
8 Working capital: this is a relevant cost and it should be included. It is assumed to be
recovered at the end of the project.
9 Redundancy and labour recruitment costs of K40,000,000 and K10,000,000, respectively,
are relevant future outflows.

54

(ii) NPV Model (Kmillion)
Year 0 1 2 3 4
Current Mach. opportunity
Cost/scrap Value) (80) 15
Manufacturing opportunity Cost (220)
Labour recruitment (10)
Working Capital (60) 60
Redundancy cost (40)
Labour (110) (110) (110) (110)
Material (550) (550) (550) (550)
Additional cost (30) (30) (30) (30)
Sales Revenue - 825 825 825 825
Net cashflow (370) 135 135 135 170
DF@ 18% 1.0 .0 0.84785 0.71861 0.60752 0.51616
PV (370) 114.0 97 82 88
NPV + K11
Advice
As the NPV is positive, on financial grounds, the manufacture of the new product should go ahead.
(iii) Internal Rate of return
Net cashflow (370) 135 135 135 170
DF@ 20% 1.0 0.833 0.694 0.579 0.482
PV (370) 112 94 78 82
NPV (4)
IRR = ( ) A% B%
P P
P
A%
+
+ = ( ) 18% - 20%
4 11
11
18% |
.
|
\
|
+
+
= 19.47%
Where:
A% = Cost of capital which gives positive NPV
B% = Cost of capital which gives negative NPV
P = Positive NPV
N = Negative NPV

55

(iv) Sensitivity of Labour Costs
Annual labour costs: K110 million p.a. for 4 years
Sensitive Factor = 100%
cost labour of PV
NPV
= 3.7%
2.690 m K110
m K11
=

Absolute = = =
2.690
11

AF
NPV
K4,089,219 per annum
Change % = 3.7% 100%
0 110,000,00
4,089,219
=

56

Solution 5
(a) (i) Business process re-engineering (BPR) is one of a number of techniques that have been
advocated to overhaul existing business processes and practices with a view to radically
improving organizational performance. It goes further than routine, automation and
rationalisaton.
BPR is not confined to manufacturing processes and has been applied to a wide range of
administrative and operational activities. In each case the idea is to ask radical questions
about why things are done in a particular way, and whether alternative methods could
achieve better results. Often the focus has been on staffing levels, the implication being that
more staff are employed than are strictly needed to achieve the desired outcome. However,
this is a by-product of the technique and is not a main purpose of BPR.
(ii) Advantages of BPR
(1) BPR revolves around customer needs and helps to give an appropriate focus to the
business and its purpose.
(2) BPR provides cost advantages that assist the organizations competitive position.
(3) BPR encourages a long-term strategic view of operational processes by asking radical
questions about how things are done and how processes could be improved.
(4) BPR helps overcome the shortsighted approaches that sometimes emerge from
excessive concentration on functional boundaries. By focusing on entire processes the
exercise can streamline activities throughout the organization.
(5) BPR can help to reduce organizational complexity by eliminating unnecessary
activities.
(ii) Disadvantages of BPR
(1) BPR is sometimes seen (incorrectly) as a means of making small improvements in
existing practices. In reality, it is a more radical approach that questions whether
existing practices make any sense in their present form.
(2) BPR is sometimes seen (incorrectly) as a single, once-for-all cost- cutting exercise. In
reality, it is not primarily concerned with cost cutting (though cost reductions often
result), and should be regarded as ongoing rather than once-for-all. This
misconception often creates hostility in the minds of staff who see the exercise as a
threat to their security.
(3) BPR requires a far-reaching and long-term commitment by management and staff.
Securing this is not an easy task, and many organizations have rejected the whole idea
as not worth the effort.

57

(b) Advantages claimed for the use of activity based budgeting include the following:
(1) Resource allocation is linked to a strategic plan for the future, prepared after considering
alternative strategies.
(2) New high priority activities are encouraged, rather than focusing on the existing planning
model. Activity based budgeting focuses on activities. This allows the identification of the
cost of each activity. It also allows the ranking of activities where financial constraints limit
the range of activities that may be achieved.
(3) There is more focus on efficiency and effectiveness and the alternative methods by which
they may be achieved. Activity based budgeting assists in the operation of a total quality
philosophy.
(4) It avoids arbitrary cuts in specific budget areas in order to meet the overall financial targets.
Non-value adding activities may be identified as those which should be eliminated.
(5) It tends to increase management commitment to the budget process. This should be
achieved since the activity analysis enables management to focus on the objectives of each
activity. Identification of primary and secondary activities and non-value added activities
should also help in motivating management in activity planning and control.
(N.B. Only four advantages are required but five advantages have been given here).

58

Solution 6
(a)
Report
To: Management Team
From: Management accountant
Date: 1 June, 2010
Ref MA/005/al/AMM
Subject: Quality Related Costs
1 Introduction
This report explains quality related costs
2 Quality costs
There are two main types of quality costs, these being cost of conformance and costs of
non-conformance. Conformance costs are further analysed into prevention costs, and
appraisal costs. Costs of non-conformance can be further analysed into internal failure costs
and external failure costs.
2.1 Prevention costs are the costs incurred prior or during production to prevent substandard or
defective product or services being produced. Examples of these include costs of quality
engineering and design or development of quality control or inspection equipment.
2.2 Appraisal costs are the costs incurred to ensure that the output produced meet required
quality standards. Examples would include acceptance testing costs and the cost of
inspection of goods inwards.
2.3 Internal failure costs are the costs arising from inadequate quality, which are identified
before the transfer of ownership from supplier to purchaser. Relevant examples include re-
inspection costs and losses due to lower selling prices from sub-quality goods.
2.4 External failure costs are the costs arising from inadequate quality discovered after the
transfer of ownership from the supplier to purchaser. Relevant examples would include
product liability costs and costs of repairing products returned from customers.
If you need further clarification, please do not hesitateto contact me.
Signed: Management Accountant

59

(b)
Purchase Option
Year 0 Year1 Year2 Year3 Year4
K000 K000 K000 K000 K000
Investment(bus) (45,000)
Capital allowance savings 1,688 2,953 2,812 1,547
Scrap value 15,000
(45,000) 1,688 2,953 17,812 1,547
Discount rate at 12% 1.000 0.893 0.797 0.712 0.636
PV (45,000) 1,507 2,354 12,682 984
NPV = K (27,473)
Working
Capital allowance savings and their timings
CA Tax at 30% Year1 Year2 Year3 Year4
K000 K000 K000 K000 K000 K000
Machine cost 45,000
Year 1 WDA at 25% (11,250) 3,375 1,688 1,687
33,750
Year 2 WDA at 25% (8,438) 2,531 1,266 1,265
25,312
Year 3
Disposal (15,000)
Balancing allowance 10,312 3,094 1,547 1,547
Tax saved 1,688 2,953 2,812 1,547

60

Lease Option
Year 0 Year1 Year2 Year3 Year4
K000 K000 K000 K000 K000
Payment (3,750) (14,976) (14,976) (14,976)
Tax relief at 30% 563 562 2,246 2,246
2,247 2,247 2,247 2,246
(3,187) (12,167) (10,483) (10,483) 2,246
Discount rate at 12% x 1.000 x 0.893 x 0.797 x 0.712 x0.636
PV (3,187) (10,865) (8,355) (7,464) 1,428
NPV = K (28,443)
Advice
On financial grounds, RRTS should purchase outrightly the new Toyota Hiace minibus because the cost
is lower.

61

Solution 7
(a) Planning price variance
K
A 400 kg K(190 160) 12,000
B 700 kg K(120 100) 14,000
planning variance 26,000 (A)
(b) (i) Operating price variance
K
A (190 180) 428 4,280 (F)
B (K120 K120) 742 -
C (332 328) 125 500 (F)
D (2,000 950) 1 1,050 (F)
operating price variance 5,830 (F)
(ii) Operating usage variance
K
A (400 428) K190 5,320 (A)
B (700 742) K120 5,040 (A)
C (99 125) K332 8,632 (A)
D (1- 1) K2,000 0
operating usage variance 18,992 (A)
(c) Advantages
(i) Standard costs are more relevant because they are kept up to date with changing
circumstances.
(ii) Motivation is improved because standards are more relevant and achievable.
(iii) Responsibilities can be readily identified for each variance and control reporting is improved.
(iv) Factors which are outside the control of management are separately identified so that they
could concentrate on the controllable factors.
Disadvantages
(i) There is a tendency to try and explain away all the variances as planning errors, so that
operating variances appear small.
(ii) It may be difficult to obtain an objective revised standard.
(iii) The work involved in updating standards regularly is considerable and time consuming.

62

(d) Ingredients Mix Variance

Std Mix
Kg

Actual mix
Kg

Variance
Kg

Std price Variance
K K
A
\
|
|
|
.
|
1,200
400

432 428 4.00 (F) 190 760 (F)
B
\
|
|
|
.
|
1,200
700

756 742 14.00 (F) 120 1,680 (F)
C
\
|
|
|
.
|
1,200
99

106.92 125 18.08 (A) 332 6,003 (A)
D

\
|
|
|
.
|
1,200
1

1.08 1 0.08 (F) 2,000 160 (F)
1,296.00 1,296.00 0 3,403 (A)
Ingredients Yield Variance
1,296 kg should have yielded : 1,296 x 97 %kg = 1,257.120 kg
1,296 kg yielded 1,164.000 kg
93.120 kg (A)
X
K167.412 per kg(W.1)
Yield Variance K15,589 (A)
Working : W.1 - Weighted Average ingredients standard cost per kg
K
A 400 K190 76,000
B 700 K120 84,000
C 99 K332 32,868
D 1 K2,000 2,000
1,200 194,868
3% loss 36 -
Output 1,164 194,868

63

Average cost per kg = K194,868 1,164 = K167.412 per kg
(e) Standard ingredient cost per batch
K
A 400K160 64,000
B 700 K100 70,000
C 99 K332 32,868
D 1 K2,000 2,000
168,868
Labour standard cost 18hrs K3,250 58,500
Total standard cost 227,368
Actual cost per batch
K
A 428 K180 77,040
B 742 K120 89,040
C 125 K328 41,000
D 1 K950 950
208,030
Labour 20hrs K3,000 = 60,000
268,030
Total variance for the batch:
Total Standard Cost K227,368
Total Actual cost K268,030
K40,662 (A)
END

64


PROFESSIONAL LEVEL


SERIES: JUNE 2011

TOTAL MARKS 100 TIME ALLOWED: THREE (3) HOURS

1. You have ten (10) minutes reading time. Use it to study the examination paper carefully so that you
understand what to do in each question. You will be told when to start writing.
7. Discount Factor tables/Present Value and Annuity Tables are attached at the end of the question
paper.

65

Question 1
Moze Plc has identified a market for a new product at a selling price of K600 per unit. It has yet to
quantify its estimate of the volume of the market in product units.
The estimated cost structure for the product per unit is as follows:
Materials A: 8.5kg at K10 per kg
Materials B: 1.5kg (material B is a special input raw material)
Variable overheads are 60% of the selling price
Moze Plc must place an advance order for the coming year with the supplier for material B. It intends to
enter into an advance contract for material B for the coming year at one of three levels high, medium or
low which correspond to the requirements of a high, medium or low level of demand for the product.
The level of demand for the product will not be known when the advance order for material B is entered
into. A set of probabilities have been estimated by the management as to the likelihood of demand for the
product being high, medium or low. See the table below.
The amount of material B actually supplied will always be equal to the actual demand level. However,
because of the effects of unidentified volume on supplier costs;
(i) Where the advance order entered into for Material B was lower than that required for the level of
demand which is actually achieved, a discount from the original price of supply is allowed to Moze
Plc for the total quantity of material B which is purchased.
(ii) Where the advance order entered into for Material B was in excess of that required for the actual
level of demand achieved, a penalty payment( premium) in excess of the original price of supply is
payable for the total quantity of Material B which is purchased.
A summary of additional information relating to the above points is as follows:
Units Probability Advance order
High 15,000 0.3 K20.00
Medium 12,000 0.5 K24.00
Low 8,000 0.2 K28.00

66

Material B order discount or premium cost on conversion from:
Conversion discount Conversion premium (penalty)
Low to Medium K3.00
Medium to High K2.00
Low to High K4.00
Medium to Low K8.00
High to Medium K6.00
High to Low K18.00
Required:
(a) Prepare a summary which shows the total budgeted contribution earned by Moze Plc from
the new product for the coming year for each of the nine possible outcomes which may result
from the above data. (11 marks)
(b) Using figures from your answer to (a) as a relevant, indicate the advance level order size
which should be chosen for Material B and comment on the management attitude to risk
where the decision is based on each of the following criteria:
(i) Maximizing expected value (3 marks)
(ii) Maximax (3 marks)
(iii) Maximin. (3 marks)
(Total: 20 marks)

67

Question 2
Luangwa Plc operates two divisions, Petauke Division(P) which manufactures the material for the
intermediate products and Kasama Division (K) which produces the complete products for sale.
Petauke Division
The Petauke(P) division produces two separate materials, material A and material B. Both materials take
the same amount of labour time to produce a unit. Material A is sold to external customers only for K28
per unit. Division P incurs variable costs in producing this material of K18 per unit and fixed overheads
amount to K2 per unit. The budgeted production and sales of material A for June 2010 is 5,400 units.
Material B is sold to division K only. The transfer price that has been set for each unit is full cost plus
20%. This material is available externally for K52 per unit but division K has been told by management
that they must buy the material from division P. Division P incurs variable costs of K40 per unit and fixed
overheads of K16 per unit in producing material B. Budgeted production and sales for June 2010 is 4,000
units.
Division P has spare capacity.
Kasama Division
Division Kasama(K) uses material B to manufacture one unit of its final product called Tobwa. It incurs
additional processing costs of K60 per Tobwa and anticipates that it will produce and sell 4,000 Tobwas
in June 2010 for K120 each.
Required:
(a) Using the forecast information, calculate the profit for June 2010 for division P, division K and
Luangwa Plc. (5 marks)
(b) Discuss the likely reaction of division P and division K to the transfer price being set at full cost plus
20%. Recommend, with reason(s), a range for the transfer prices of material A.
(6 marks)
(c) Assuming division P is now working at full capacity, in terms of labour. Recommend, with
reason(s), a new range of transfer prices for material A. (3 marks)
(d) Luangwa Plc manufactures a state of the art baby pram for infant children. The pram is
manufactured from a rare substance which gives it superior strength and quality compared to any
other prams on the market. The marketing director believes that the fact that the pram weighs half
of the weight of all currently available travel systems and is cutting edge in terms of style, will give
the company a considerable competitive advantage. The senior management committee is now in
the process of putting together a pricing strategy.

68

Required
(i) Briefly explain what is meant by a market skimming pricing strategy and a market penetration
pricing strategy.
(ii) Discuss the relative advantages to Luangwa Plc of each approach in the context of the pram
and recommend which approach should be used. (6 marks)
(Total: 20 marks)

69

Question 3
Mukulumpe Estates produces and sells a number of different types of ground coffee. The following
standard and actual information is available for Period 1 of 2010 for one particular type of coffee, Frisco.
Budget Actual
Sales and Production 3,000 3,600
Material price per kg K800 K760
Labour price per hour K600 K660
Kgs of material 5,000 4,500
Labour hours 6,000 7,000
Additional information
The actual labour costs and material costs for Frisco are 10% higher and 5% lower, respectively, than
the original budget.
6% of the labour cost increase from the original standard is due to an underestimation of a wage award.
The remaining 4% increase is due to poor short term decision making.
3% of the material cost reduction is due to a fall in general market prices. The remaining 2% is due to
short term operational improvements.
Required:
(a) Calculate the material price, material usage, labour rate and labour efficiency variances for Frisco
for Period 1 of 2010. Where appropriate, planning and operational variances should be calculated
and a brief explanation should be given for the reasons for calculating each of these planning and
operational variances. (10 marks)
(b) The following information is available for Period 1 of 2010 for the Ricoffy, another of Mukulumpe
Estates coffee brand.
Standard material for one bottle of coffee is as follows:
Material Amount in kg Standard cost per kg
X 5 K100
Y 0.5 K300
During Period 1 of 2010 actual production of Ricoffy was 4,500 bottles. The actual materials used
are as follows:
Material Amount in kg Standard cost per kg
X 21,500 K120
Y 2,700 K320

70

Required:
Calculate the materials mix and yield variances for Ricoffy for Period 1 of 2010. Include a brief
comment on the two variances calculated. (4 marks)
(c) Discuss three reasons why the use of a standard costing system is considered inappropriate in a
company that operates in an advanced technology manufacturing environment. (6 marks)
(Total: 20 marks)

71

Question 4
Chishinga Ltd is a manufacturer of high-quality tools for those working in the engineering industry. The
mission statement of the company declares that it is dedicated to maximizing the wealth of its
shareholders and, since it was formed in 2002, the company has grown rapidly. Recently, the company
has developed a new type of circular saw and the directors of the company are now considering whether
this saw should be manufactured and sold. The following information is available to help evaluate the
viability of the new product:
(i) Costs incurred in designing and developing the new saw, which have all been paid, were
K220,000,000. These costs are to be written off in equal installments against profits generated over
the new products expected life of four years.
(ii) Sales are expected to be 18,000 saws per year over the next four years. The selling price of each
saw will be K40,000 in the first three years and K30,000 in the final year.
(iii) Variable costs are estimated to be K15,000 for each saw.
(iv) Additional fixed costs are expected to be K295,000,000 per year. This includes a charge for
depreciation of equipment used in the manufacture of the saw of K80,000,000 per year.
(v) Equipment that originally cost K800,000,000 and which has a written down value of K450,000,000
will be used to produce the new product. If the new saw is not manufactured, the equipment will be
sold immediately for K420,000,000 as it cannot be used for any other purpose. If, however, the saw
is manufactured, the equipment will be sold at the end of four years for K86,000,000.
(vi) Additional working capital of K120,000,000 will be required immediately to support the manufacture
of the new product. This will be released at the end of the life of the new product.
(vii) Chishinga Ltd is liable to pay tax on its profit at the rate of 30% and tax payable is paid one year in
arrears. Writing-down allowances are available at 25% each year on a reducing balance basis.
When applying NPV and discounted payback methods, the company uses a post tax cost of
capital of 10% and adopts a maximum discounted payback period of two years.
Required:
(a) Calculate the net present value of the new saw. (10 marks)
(b) Calculate the discounted payback period of the new saw. (2 marks)
(c) Evaluate the investment criteria adopted by the business and state, with reasons, whether
the new saw should be produced. (6 marks)
(d) Calculate by how much in percentage terms that the incremental fixed costs have to increase
before the NPV of the circular saw becomes zero. (2 marks)
(Total: 20 marks)

72

Question 5
(a) The government of the Republic of Zambia provides a free national health service for its
citizens. Public spending on health care has increased significantly over the past five years. The
government is keen to assess the benefits of such spending by looking at how well the
local district hospitals can convert the increased resources into improved outcomes.
Each local district hospital has the following objectives for 2010:
To deliver excellence for patients
- To be one of the best hospitals in the country, providing outstanding healthcare.
- To meet patient expectations by achieving waiting time targets.
- To support patient choice through a comprehensive range of services.
To deliver excellence for staff
- Ensuring a high quality working life
- Treat each other with respect, fairness and dignity
- Support the training needs and development of staff.
To deliver excellence for the national health service
- To work with other organizations to ensure the most effective local service is available within
the available financial resources.
- To lead the way in controlling costs and increasing efficiency in the use of its resources.
In the past, there have been difficulties measuring performance in this sector and, as a result,
it is felt that a more formal value for money(VFM) framework should be implemented.
Required:
(i) Discuss the performance analysis problems that may arise as a result of the local district
hospital being given a number of non-quantifiable objectives, as stated above.
(4 marks)
(ii) Explain how the government may determine if the local district hospital are effective in
providing value for money (VFM). (6 marks)
(iii) Discuss the potential conflicts that may arise as a result of the local district hospital having
multiple objectives. (4 marks)
(b) The citizens of Zambia can also pay for private healthcare. Premier Health Solutions Ltd (PHS Ltd)
owns and runs twenty private hospitals, all of which are located close to a major city. Each hospital
is treated as an investment centre.

73

Summary divisional financial statements for the year to 31 December
Statement of Financial Position Income statement
Kmillion Kmillion
Non-current assets 2,400 Revenue 7,300
Current assets 1,000 Operating costs 6,800
Total assets 3,400 Operating profit 500
Interest paid 320
Divisional equity 1,500 Profit before tax 180
Long-term borrowings 900
Current liabilities 1,000
Total equity and liabilities 3,400
The cost of capital for the division is estimated at 11% each year.
The Kitwe Memorial Hospital (one of the twenty private hospitals) has a target return on investment
(ROI) of 15%.
Required:
Calculate the divisional return on investment (ROI) and the division residual income (RI). Based on
the figures calculated, briefly comment on the performance of the hospital. (6 marks)
(Total: 20 marks)

74

Question 6
(a) It has been suggested that much of the training of management accountants is concerned with cost
control whereas the major emphasis should be on cost reduction.
Required:
(i) Distinguish between cost control and cost reduction. (4 marks)
(ii) Give three examples of cost control techniques and three examples of cost reduction
techniques. (3marks)
(b) Explain Business Process Re-engineering(BPR) and its links with Just-in Time(JIT), Total Quality
Management(TQM), Supply Chain Management(SCM) and Activity Based Costing(ABC).(9 marks)
(c) Vakudya Ltd (V Ltd) is a well established food manufacturer which makes semi-processed foods
such as chapatti, smocked sausages, pre-packed chips, etc for a fast food chain outlet called Eat
Well Restaurant. V Ltd does not have a formalized total quality management programme.
Your managing director attended a conference(organized by ZICA) in Livingstone where one of the
presenters talked about the concept of Total Quality Management(TQM) and quality related costs .
Required:
Explain four quality cost classifications, using examples relevant to the business of Vakudya Ltd.
(4 marks)
(Total: 20 marks)

75

Question 7
(a) Mwansabombwe Enterprises Ltd makes and sells a range of three gardening products.
Budgeted data for the next year are:
Product A B C
Sales volume (Units) 20,000 17,000 16,000
Selling price per unit K250.00 K300.00 K170.00
Direct cost per unit:
Materials K47.50 K52.75 K38.30
Labour K28.88 K32.80 K21.32
Royalties K5.00 K7.00 K4.80
Production overheads K73.92 K95.04 K42.24
Production overheads are absorbed on a machine hours basis, at a rate of K52.80 per machine
hour. 40% of overheads are estimated to be fixed.
A total of 73,000 machine hours are available for the year.
Required:
Based on the budgeted sales mix, calculate:
The number of units of each product which will be sold at the break-even point; (6 marks)
The margin of safety, expressed as a % of budgeted sales revenue. (2 marks)
(b) Kililabombwe Plc also prepared a budget for 2011 for four products. The details are as follows:
Product Sales Selling Price Per Unit Variable Cost Per Unit
(000 units) (K) (K)
W 20 40 28
X 20 80 16
Y 100 8 8.40
Z 40 20 14
Budgeted fixed overhead costs are K960,000 per annum.
Required:
(i) Prepare the profit volume graph for the four products. (6 marks)
(ii) Explain the graph to the management, comment on the results shown and state the break-
even point. (3 marks)
(iii) Briefly describe three ways in which the overall contribution to sales ratio can be improved.
(3 marks)
(Total: 20 marks)
END OF PAPER

76

77

JUNE 2011
SUGGESTED SOLUTIONS

78

Solution 1
Advance Demand for Probability Contribution Total cost Net product
order size for product
(excl. material B) (material B)
K000 K000 K000
High High 0.3 2,325 (450) 1,875
Medium 0.5 1,860 (468) 1,392
Low 0.2 1,240 (456) 784
Medium High 0.3 2,325 (495) 1,830
Medium 0.5 1,860 432) 1,428
Low 0.2 1,240 (384) 856
Low High 0.3 2,325 (540) 1,785
Medium 0.5 1,860 (450) 1,410
Low 0.2 1,240 (336) 904
Workings
(b) (i) (W1) Contribution excluding Material B
Product demand
High Medium Low
Sales (units) 15,000 12,000 8,000
K000 K000 K000
Sales revenue (at K600) 9,000 7,200 4,800
Material (at K85) (1,275) (1,020) (680)
VOH (at 60% of revenue) (5,400) (4,320) (2,880)
Contribution 2,325 1,860 1,240
(W2) Examples of workings of Material B
High advance level of order of material B and low actual requirement:
The purchase price of K20 per kg is subject to a penalty of K18 per kg. The cost of
material B is, therefore, 8,000 units x 1.5kg K38 = K456,000.
Low advance level of order of material B and medium actual requirement:
The purchase price of K28 per kg is subject to a discount of K3.00 per kg. The cost of
material B is, therefore, 12,000 units 1.5 kg K25.00 = K450,000.

79

(b) (i)
Advance Demand for Contribution Probability Total cost Net product
order size for product
K000 K000
High High 1,875 0.3 562.5
Medium 1,392 0.5 696.0
Low 784 0.2 156.8
EEVhigh = 1,415.3

Medium High 1,830 0.3 549.0
Medium 1,428 0.5 714.0
Low 856 0.2 171.2
EEVmedium = 1,434.2

Low High 1,785 0.3 535.5
Medium 1,410 0.5 705.0
Low 904 0.2 180.8
EEVlow = 1,421.3

Summary
High advanced order EV of contribution: K1,415,300
Medium advanced order EV of contribution: K1,434,200
Low advanced order EV of contribution: K1,421,300
Using the EV rule, a medium level advance order size for material B should be entered into because this
level gives the highest EV of total contribution. Managements attitude to risk is neutral.
(a) (ii) Maximax
Maximax suggests that the decision maker should look for the largest possible contribution
from all the outcomes.
Highest Total Contribution
High advanced order K1,875,000
Medium advance order K1,830,000
Low advance order K1,785,000
Using the maximax rule, a high level advance order size for material B should be entered into
because this level gives the best possible total contribution. Management attitude to risk is
risk seeking/taking.

80

(b) (iii) Maximin
Maximin suggests that the decision maker should look for the strategy which maximizes the
minimum possible contribution
Least Total Contribution
High advance order K784,800
Medium advance order K856,000
Low advance order K904,000
Based on maximin rule, a low level advance order should be entered into by management
because this level offers the best contribution out of the three worst outcomes. Management
attitude to risk is risk averse.

81

Solution 2
(a) Summary Forecast Profit for June 2010
Division P Division K Group
K K K
External Sales
(K28 5,400/K120 4000) 151,200 480,000 631,200
Internal Sales
4,000 K67.20(W.1) 268,800
420,000
Less: Costs
Transfer costs (268,800)
Own costs
Material A (K20 5,400) (108,000) (108,000)
Material B (K56 4,000) (224,000) (224,000)
Division K (K60 4,000) (240,000) (240,000)
88,000 (28,800) 59,200
(W.1) transfer price
Variable cost of B K40.0
Fixed cost of B K16.0
Full cost K56.0
+20% profit K11.2
Full cost = 67.20
(b) Division P
Division P is likely to view the transfer price of K67.20 as fair. This price ensures that all the costs
relating to producing B are recouped and that the division also earns a 20% profit.
The division may consider the 20% profit mark up as being too low since their external sales of A
earn a mark-up of 40%.
|
.
|
\
|
108,000
K43,200
However, overall division P will probably be happy with the
transfer price that has been set.
Division K
Division K is unlikely to view the transfer price as fair. The transfer price of B is K67.20 per unit but
division K could buy B externally for K52.
The high transfer price has resulted in a forecasted loss for division K in June 2010. Division K will
not want to be appraised on this loss.

82

Recommended transfer price
Maximum price the maximum price that division K will be willing to pay is K52 per unit. This is the
external market price and division K would be able to source the units at this price.
Minimum price the minimum price that division P will be willing to transfer the units of B is at K40
per unit. This is the variable cost per unit and B will want to ensure that, at a very minimum, these
costs are covered.
Range the price will be negotiated between the two divisions within the range of K40 to K52 per
unit. Division K would aim to drive the price down below the market price of K52 per unit. Division P
would aim to increase the price above K40 per unit in order to cover some of the fixed costs and
potentially allow for some profit.
The transfer price that is agreed upon should result in fair performance evaluation for both divisions
but should also result in goal congruence with the overall profits of Luangwa plc being maximized
as a result of the price set.
(c) Maximum price the maximum price will stay the same as in part (b), i.e the external market price
of K52 per unit.
Minimum price this will change as a result of full capacity within division P. If division P chooses
to make a unit of B for internal transfer, there will be an opportunity cost because they will forego
the contribution from the unit of A i.e K28-K18=K10 per unit (both units take the same labour time
to produce). Therefore the minimum price that division P will be willing to transfer the units of B is
the variable cost of K40 per unit plus the lost contribution from A of K10 per unit.
Range the transfer price will be negotiated between K50 and K52.
(d) Marketing skimming
Market skimming involves charging a high price relative to competitors. It is an attempt to exploit
those sections of the market which are relatively insensitive to price changes. Initially high prices
may be charged for the pram to take advantage of the novelty appeal of the new product when
demand is initially inelastic.
Advantages:
The main advantage is that the contribution earned per unit is high. This offers a safeguard against
an expected future increases in costs or a large fall in demand after the novelty appeal has
declined.
Once the market becomes saturated the price could be reduced to match of those of competitors in
order to attract the part of the market that has not been exploited.

83

Disadvantages:
The potential disadvantage is that the market will be restricted. It would be necessary to advertise
to promote the technological and quality advantages to potential customers which would help to
justify the higher price. This should help to make the target market segment for the pram as large
as possible. Another disadvantage is that with high prices being charged, potential competitors will
be tempted to enter the market. Barriers to entry, such as patents and brand loyalty, must be high
in order to deter those potential competitors.
Penetration Pricing
Penetration pricing is the charging of low prices will encourage people to try the pram rather than
keeping with the familiar existing product. This incentive would appear unnecessary in this case on
two counts. Firstly, the reputation of the company seems to well established with the Tobwa being
well accepted a year ago. Secondly, the pram is very advanced in terms of strength, style and
quality compared with the competition. The none-price advantage may be sufficient to encourage
people to choose this product.
The advantage of penetration pricing is that it should result in a high market share.
Disadvantages: the high market share could be a disadvantage since the high demand may result
in unfulfilled demand for the Tobwa. This could impact the companys reputation in the long run.
Another disadvantage of charging a low price is the small contribution generated on sales. It may
be necessary to charge a lower price at a later stage if a superior quality competitor comes on to
the market.
Recommended pricing strategy
In this situation the approach proposed is to charge a high price relative to competitors when the
pram is launched and a price similar to that of competitors in later years because:
- It enables a high initial contribution to be earned per pram to compensate for the higher
average cost caused by volume being lower and to aid recovery of development costs.
- It is likely to match demand with production, i.e. low at first and increasing thereafter. High
prices in the first year should prevent excess demand and waiting lists forming.
- A high initial price may make it easier to boost market share in the second year when prices
are reduced.

84

Solution 3
(a) Material price planning variance
The 3% fall in market prices results in a planning variance since operational managers could not
have controlled this fall
(W1) Revised standard material cost per Kg = K800 x 0.97= K776
K
Original budget: actual material of 4,500kg should cost XK800/kg 3,600,000
Revised budget: actual material of 4,500kg should cost X K776/kg 3,492,000
Planning variance 108,000(F)
Material price operational variance
The remaining 2% fall in material cost is due to short term operational improvements. These
improvements are under the control of Makulumpe Estates and therefore should be taken into
account as part of the operational variance.
K
Actual material of 4,500kg should cost X K776/kg (revised budgeted cost) 3,492,000
Actual material of 4,500kg did cost X K760 3,420,000
Operational variance 72,000(F)
Material usage variance
There is no need to split this variance into planning and operational variances.
(W2) standard kg of material per bottle = 5,000kg/3,000 bottles = 1.6667kg per bottle
Actual production of 3,600 bottles should use 1.6667kg per bottle (W2) 6,000
Actual production of 3,600 bottles did use 4,500
Variance 1,500( F)
1,500kg x revised standard cost per kg of K776 = K1,164,000(F)
Labour rate planning variance
6% of the increase in labour costs is due to an under-estimation of a wage award. This was due to
poor planning and should therefore be included as part of the calculation of the planning variance.
(W3) Revised standard cost of labour =K600 per hour 1.06 = K636 per hour
K
Original budget: actual labour hours of 7,000 should cost K600/hour 4,200,000
Revised budget: actual labour hours of 7,000 should cost K636/hour 4,452,000
Planning variance 252,000(A)

85

Labour rate operational variance
The remaining 4% of the labour cost increase is due to poor short term decision making. These
decisions are under the control of Mukulumpe Estates and therefore the impact should be included
in the operational variance.
K
Actual labour hours of 7,000 should cost K636/hour
(revised budgeted cost) 4,452,000
Actual labour hours of 7,000 did cost K660/hour 4,620,000
Operational variance 168,000 (A)
Labour efficiency variance: there is no need to split this variance into planning and operational
variances.
(W4) Standard labour hours per bottle = 6,000 hrs/3,000 bottles = 2 hrs per bottles
Hours
Actual production of 3,600 bottles should take 2 hours per bottle (W4) 7,200
Actual production of 3,600 bottles did take 7,000
Variance 200( F)
200( F) hours x revised standard cost per hours of K636 = K127,200(F)
(b) Material mix variance
Material Actual usage Actual usage variance Std price Variance (K)
In std mix actual mix per kg
X
|
.
|
\
|
5.5
5
22,000 21,500 500 (F) K100 50,000 (F)
Y
|
.
|
\
|
5.5
0.5
2,200 2,700 500 (A) K300 150,000 (A)
24,200 24,200 K100,000 (A)
Comment
The actual mix has used more material Y and less of material X than the standard mix. Material Y
is more expensive than material X resulting in an adverse variance.

86

Material Yield Variance
Bottles
Standard yield 24,200 kg should have yielded 5.5 = 4,400
Actual yield 24,200 kgs yielded 4,500
100 bottles (F)
X K650
= K65,000 (F)
Working: weighted average standard cost per bottle
Material X: 5kg K100 = K500
Material Y: 0.5kg K300 = K150
K650
(c) In a JIT environment measuring standard costing variances may encourage dysfunctional
behaviour. A JIT production environment relies on producing small batch sizes economically
by reducing set up times. Performance measures that benefit from large batch sizes or
producing for inventory should therefore be avoided.
In an AMT environment the major costs are those related to the production facility rather than
production volume related costs such as materials and labour which standard costing is
essentially designed to plan and control. Fixed overhead variances dont necessarily reflect
under or overspending but may simply reflect differences in production volume. An activity
based cost management system may be more appropriate, focusing on the activities that
drive the cost.
In a total quality environment, standard costing variance measurement places an emphasis
on cost control to the detriment of quality. Cost control may be achieved at the expense of
quality and competitive advantage.
A continuous improvement environment requires a continual effort to do things better rather
than achieve an arbitrary standard based on prescribed or assumed conditions. In todays
competitive environment cost is market driven and is subject to considerable downward
pressure. Cost management must consist of both cost maintenance and continuous cost
improvement.
In a JIT/AMT/TQM environment the workforce is usually organised into empowered, multi-
skilled teams controlling operations autonomously. The feedback they require is real time.
Periodic financial reports are neither meaningful nor timely enough to facilitate appropriate
control action.

87

Solution 4
(a) NPV Model K000
Year 0 1 2 3 4 5
K K K K K K
Equipment cost (420,000)
Scrap value 86,000
Working capital (120,000) 120,000
Cash profit 235,000 235,000 235,000 55,000
Tax relief (W2) 31,500 23,625 17,719 27,356
Tax payable (W1) (70,500) (70,500) (70,500) (16,500)
Net cash flows (540,000) 235,000 196,000 188,125 208,219 10,856
Discount factor
@ 10% 1.0 0.909 0.826 0.751 0.683 0.621
PV (540,000) 213,615 161,896 141,282 142,214 6,742
NPV 125,749
(b) Discounted payback
Year 0 1 2 3 4 5
K K K K K K
PV (540,000) 213,615 161,896 141,282 142,214 6,742
Cum. PV (540,000) (326,385) (164,489) (23,207) 119,007 125,749
Discounted Payback = 3 years + y ears
142,214
23,207
= 3.16 years
(a) The NPV method of investment appraisal takes into consideration all relevant cash flows relating to
a project and discounts these cash flows to take account of both risk and time value of money. It is
conceptually sound and entirely consistent with the stated mission of the business, which is to
maximize the wealth of its shareholders. The discounted payback period also discount cash flows
but ignores cash flows beyond the payback period. It is a break-even approach to appraising
investment that is not consistent with the maximization of shareholder wealth.
Using more than one method for appraising an investment opportunity runs the risk of producing
conflicting signals. In this case, the NPV is positive and so the decision rule is that the investment
project should be accepted. The discounted payback, however, is longer than the required by the
business and so the decision rule is that the investment project should be rejected.
Given that the NPV method is consistent with the stated objective of the business and that the
discounted payback method is not, the NPV method should be regarded as the primary method of
appraisal. Thus, the NPV decision rule should prevail and the investment should be accepted

88

(b) Sensitivity Factor For Incremental Fixed Costs
Sensitivity Factor =
17 215,000x 3.
125,749
100%
= 18.45%
Workings
W2 Capital Allowances
K000
WDV Tax Relief Timing
Y0 420,000 @ 30% Y1 Y2 Y3 Y4 Y5
Y1 WDA @ 25% (105,000) 31,500 31,500
315,000
Y2 WDA @ 25% (78,750) 23,625 23,625
236,250
Y3 WDA @ 25% (59,062) 17,719 17,719
177,188
Sale Proceeds (86,000)
91,188
Balancing Allowance (91,188) 27,356 27,356

W1 Cash Profit
Y1
K
Y2
K
Y3
K
Y4
K
Y5
K
Sales Revenue(K000)
[18 K40/K40/K40/K30] 720,000 720,000 720,000 540,000
Variable costs (K000)
[18 K15/K15/K15/K15] (270,000) (270,000) (270,000) (270,000)
Incremental Fixed Costs
(K000)
[K295,000 K80,000] (215,000) (215,000) (215,000) (215,000)
Cash Profits 235,000 235,000 235,000 55,000
Tax payable @ 30% 70 70 70 16
Timing (70) (70) (70) (16)

89

Solution 5
(a) The local district hospital is a not-for-profit organisation and therefore is primary objective will not
be to maximize profits. The trust will not generate revenue but instead they will have a fixed budget
for spending. The absence of revenue and of a profit objective can, however, make performance
evaluation difficult.
Many of the benefits arising as the result of the expenditure made by the local district hospital are
non-quantifiable in monetary terms. For example, it would be difficult to put a monetary figure on
patient care.
The same can be true on costs. The decisions made by the local district authority may have non-
financial cost implications. For example, a cut in the staff budget could have non-financial cost
implications with regards to patient care and employee morale.
In conclusion, any cost/benefit analysis will be judgmental. There is also a risk that if the costs or
benefits cant be quantified then they will be ignored.
(b) The local district hospital may be assessed on value for money (VMF). This combines three main
elements:
Economy
This would measure if the resources that are used are the cheapest possible for the quality
required. For example, the hospital may carry out a review of the source of drug supplies and new
hospital equipment. It may be possible to cut costs by changing the suppliers of these items whilst
still maintaining the desired level of quality.
Efficiency
This would measure if the maximum output is being achieved from the resources used. For
example, maximizing the number of patients seen by each doctor per day or maximizing the
number of operations carried out by each surgeon per week.
Effectiveness
This measure looks at whether or not the objectives are being achieved. The local district hospital
has a large number of objectives. It would review the achievement of each of these. For example,
have the waiting time targets been achieved?
(c) Unlike companies, not-for-profit organizations do not exist primarily for share holders. There will be
a number of stakeholders in the local district hospital. Each group of stakeholders will have their
own objectives and there may be conflict between these objectives. For example:
- Employees may prefer to work shorter hours but this may lead to staff shortages and as a
result, patient health could be threatened.
- Local district hospital management may push for a reduction in waiting times. However, this
may reduce the time spent on each individual patient and, as a result, the quality of their care
may deteriorate.
- Employees may want to attend training courses but this could prove to be an expensive use
of resource. In addition, the level of patient care could fall due to understaffing issues that
may arise during the time the employees are attending training.

90

- The objectives will have to be prioritized and compromise between stakeholder groups will
be required.
(d) ROI
employed Capital
tax and interest before Profit

ROI =
2,400
500
100%
= 20.8%
Capital employed is equity+ long term date= 1,500 + 900= 2,400
Or capital employed is total assets less current liabilities = 3,400-1,000=2,400
Comment: The divisions ROI exceeds target of 15%.
RI
K million
Profit 500
Imputed interest (11% 2,400) (264)
Residual income 236
Comment: Based on the positive residual income, performance will be judged as positive.

91

Solution 6
(a) (i) Cost control is the continuous comparison of actual results with those planned, both in total
and for separate sub-division and taking management action to correct adverse variances or
to exploit favourable variances.
Cost reduction is the reduction in unit cost of goods or services without impairing suitability
for the use intended. Cost reduction is not a routine process but an approach that is adopted
from time to time when management perceives the opportunity.
(ii) (1) Cost control
Budgetary control
Standard costing
Control of capital expenditure
(2) Cost reduction
Redesigning and simplifying a product
Zero based budgeting
Value for money analysis
(b) BPR involves examining business processes and making substantial changes to the way in which
an organization operates. It involves the redesign of how work is done through activities. A
business process is a series of activities that are linked together in order to achieve given
objectives. For example, material handling might be classed as a business process in which the
separate activities are scheduling production, storing materials, processing purchase orders,
inspecting materials and paying suppliers.
The aim of BPR is to improve the key business process by focusing on simplification, improved
quality, enhanced customer satisfaction and cost reduction.
In the case of material handling, the activity of processing purchase orders might be re-engineered
by integrating the production planning system with that of the supplier (an exercise in supply chain
management (or SCM) and thus sending purchase orders direct to the supplier without any
intermediate administrative activity. Joint quality control procedures might be agreed thus avoiding
the need to check incoming materials. In this manner, the cost of material procurement, receiving
holding and handing is reduced. The practical result of this exercise is that a lot of non-value
adding activities are eliminated and cost reductions are achieved. It can be seen how closely linked
BPR is to TQM, JIT, SCM and ABC.
(c) Quality costs can be classified in four ways.
(i) Prevention costs are costs of preventing and/or reducing defects and failures. V Ltd
examples include the costs of training personnel in TQM procedures and maintenance costs
of inspections equipment.
(ii) Appraisal costs are costs of appraising the level of quality achieved. Examples relevant to V
Ltd include the costs of any goods inward checks and the costs of selecting a suitable
supplier.

92

(iii) Internal failure costs. These are costs incurred in the organization due to failure to achieve
the quality specified. The defects are discovered before the goods leave the premises.
Examples appropriate to V Ltd include the costs of food scrapped due to inefficiencies in
goods inwards procedures, costs of foods lost in the process and costs of foods rejected
during any inspections process.
(iv) External Failure Costs. These are costs arising outside the organization of failure to achieve
specified quality after transfer of ownership to the customer. Examples: customer complaints,
costs of delivering and replacing returned goods, litigations costs, food poisoning costs, lost
business.

93

Solution 7
(a) (i)
Product A B C
K K K
Selling price per unit 250.00 300.00 170.00
Variable cost per unit:
Direct costs 81.38 92.55 64.42
Overheads 44.35 57.02 25.34
Contribution per unit 124.27 150.43 80.24
Sales volume (units) 20,000 17,000 16,000
Revenue K 000 5,000 5,100 2,720
% of total revenue 39.00% 39.78% 21.22%
Contribution K 000 2,485.40 2,557.3 1 1,283.84
Budgeted overheads per unit 73.92 95.04 42.24
Thus total overheads K000 1,478.4 1,615.68 675.84
Total revenue is K12,820,000
Total contribution is K6,326,550 or 49.35% of revenue
Total overheads are K3, 769 ,920 of which K 1,507,968 is fixed
Thus break-even occurs when contribution is K1, 507, 968
Break-even revenue is K1,507,968 100/49.35 or K3, 055,659
A is 39% of K3,055,659 = K1, 191,707 K250/unit = 4,767 units
B is 39.78% of K3,055,659 = K1,215,541 K300/unit = 4,052 units
C is 21.22% of K3,055,659 = K648,411 K170/unit = 3,814 units
(ii) Margin of safety =
revenue Budgeted
revenue even - Break - revenue Budgeted

=
0 K12,820,00
K3,055,659 - 0 K12,820,00

= 76.2%

94

(b) (i)
Products
W X Y Z Total
K000 K000 K000 K000 K000
Sales 800 1600 800 800 4,000
Variable costs 560 320 840 560 2,280
Contribution 240 1280 (40) 240 1,730
C/S 30% 80% (5%) 30% 43%
Ranking 2nd 1st 3rd 2nd
Profit Multiproduct P/V Graph for Products W,X,Y and Z
(ii) The products are plotted in order of their c/s ratios. The steeper the line for an individual
product the greater the c/s ratio for that product. Thus it can be seen that product X provides
the greatest contribution with respect to sales value.
It can be seen from the graph that product Y should be dropped as it provides negative
contribution.
The break-even point can be calculated using the c/s ratio of the mix. This can also be
approximately seen from the graph.
Y
B.E.P
Revenue
(K000)
4000
3200
2400
1600 800
1000
800
600
400
200
0
200
400
600
800
1000
Y
W
X
Profit
(K000)

95

Breaking Even Point Sales revenue
mix ratio C/s
Cost Fixed Total

43%
K960,000
= K2,232,558
(ii) The overall ratio could be improved by:
Increasing the selling prices
Dropping product Y
Automating the process. This would increase fixed costs but would reduce variable
costs thus increasing contribution
END

Q and As-Advanced Management Accounting - June 2010 Dec 2010 and June 2011

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