Performance Management (PM)

Solution pack

Sr. No. Question ACCA Exam Paper Syllabus Area Covered

1 Yumi Co Sep/Dec 2019 Budgeting and Control
2 Robinholt University Sep/Dec 2019 Performance Measurement and Control
3 Belton Park Mar/Jun 2019 Relevant Costing
4 Best Night Mar/Jun 2019 Performance Measurement and Control
5 Portable Garage Co Mar/Jun 2018 Transfer pricing | Risk and Uncertainty
6 Alka Mar/Jun 2018 CVP Analysis
7 Helot Co Sep 2016 Target Costing
8 CSC Co Sep 2016 Limiting Factors (Linear Programming)
9 Mylo Sep 2016 Risk and Uncertainty
10 Swim Co Mar/Jun 2016 Cost Volume Analysis
11 Cardio Sep/Dec 2015 CVP Analysis
12 Beckley Hill Jun 2015 Specialist Cost Accounting
13 One Stop Car Jun 2015 Performance Measurement and Control
14 Kappa Jun 2015 Variance Analysis
15 Glam Co Dec 2014 Throughput Accounting
16 Gam Jun 2014 Risk and Uncertainty
17 Duff Jun 2014 Absorption Costing and ABC
18 Newtown School Jun 2013 Budgeting and Control
19 Truffle Co Jun 2013 Variance Analysis
20 Block Jun 2013 Budgeting and Control
21 Cam Jun 2013 Lifecycle Costing and Learning Rates
22 Hair Dec 2012 CVP Analysis
23 Robber Co Jun 2012 Make or Buy Decisions
24 Universal Health Systems Jun 2012 Target Costing
25 Brace Jun 2011 Divisional Performance Assessment
26 Heat Jun 2011 Budgeting and Decision Making
27 Cement Jun 2011 Risk and Uncertainty
28 BFG Dec 2006 Decision Making Techniques
29 Preston Pilot Paper Performance Measurement and Control
 Yumi Co

Part (a) (i)

Flexed budget for Cowly restaurant

Original budget Flexed budget Actual Variance

Number of customers 1,500 1,800 1,800
$ $ $ $
Revenue 75,000 90,000 87,300 2,700 (A)
Food and drink costs (22,500) (27,000) (26,100) 900 (F)
Staff costs (31,500) (37,800) (38,250) 450 (A)
Heat, light and power (7,500) (9,000) (8,100) 900 (F)
Rent, rates and other overheads (12,000) (12,000) (12,600) 600 (A)
Profit 1,500 4,200 2,250 1,950 (A)

Notes:
Revenue: $75,000/1,500 = $50 per customer: $50 x 1,800 = $90,000
Food and drink: $22,500/1,500 = $15 per customer: $15 x 1,800 = $27,000
Staff costs: $31,500/1,500 = $21 per customer: $21 x 1,800 = $37,800
Heat, light and power: $7,500/1,500 = $5 per customer: $5 x 1,800 = $9,000

Part (a) (ii)

 In the current performance report the original budget is not flexed to adjust for the actual numbers of
customers served. Therefore, the report shows that the Cowly restaurant has overspent on all its costs.
However, the main reason for the revenue and costs variances is the fact that more customers were served.
More meaningful comparison can be done if actual numbers are compared with the flexed budget.

 Another weakness in Yumi Co’s budgetary control report is the fact that staff costs and heat, light and power
costs are assumed to be purely variable costs. It is possible that staff costs have fixed element in them
(permanent staff), similarly, hear, light and power expenses should also be classified as semi-variable costs.

Part (b)
Under an incremental budgeting approach, the current year’s budget and results are taken as the starting point
for preparing the next year’s budget. The budget is then adjusted for any expected changes, such as the impact
of inflation on costs and prices, and sales growth or decline.

The main advantage of the incremental approach is that it is a relatively straightforward. It is appropriate for
organisations operating in stable environment. The locations of Yumi Co’s restaurants are away from significant
competition, thus, it is relatively stable environment, meaning incremental budgeting is appropriate.

Similarly, Yumi Co appears to have a well-established brand with good customer base also suggests that using
an incremental approach to budgeting future revenues appears reasonable.

One of the major disadvantages of incremental budgeting is that it does not provide any incentive to make
operations more efficient or economical. The current year slack or inefficiencies are carried forward to other
years.
If the company is worried about its relatively low margins, then an approach to budgeting which challenges costs
more critically (such as zero-based budgeting or activity-based budgeting) might be more suitable.

As mentioned in part (a), whether labour costs and heat, light and power vary proportionately with the number of
customers appears debatable. If Yumi Co’s incremental budgets ignore the relationship between activities and
costs, then ultimately the budgets will provide Yumi Co’s management with little relevant information for
managing costs.

Part (c)
The current budget process is a centralised, top-down process, meaning that the managers from Yumi Co’s
restaurants do not have any opportunity to influence the budgets. In a participative approach, the managers of
each restaurant would be able to influence the figures for their restaurant, rather than having budget targets
simply imposed on them.

Involving the managers in the budgeting process should help to make the budgets more effective and realistic as
the local managers should have a greater understanding of the environment and operations.

Similarly, this will impact on the morale of the managers as, as they will take ownership of the budgets and
targets if they give inputs when setting them.

Their involvement will also help ensure that the budget figures are realistic.

However, this will be a more time-consuming exercise. The restaurant managers will have to invest their time in
budget preparations, which can have impact on the other administrative or managerial tasks they have to
perform.

For a stable environment a top-down budgeting process is suitable. A more participative approach is appropriate
for restaurants like Cowly which are facing a period of change.

Another disadvantage of participative budgeting is that managers may try to influence the budgets, therefore,
making their targets relatively easy.

Similarly, managers are more likely to highlight issues which will lead to a reduction in their budget targets,
rather than ones which increase their targets. There is a danger that the managers’ participation in the budgets
could lead to the targets becoming less challenging, which in turn could affect Yumi Co’s competitiveness.
 Robinholt University

Part (a)

1. To provide education which promotes intellectual initiative and produces confident and ambitious
graduates who have reached the highest academic standards to prepare them for success in life and
the workplace

Question 1 of the survey shows 83% of students think that the course is intellectually stimulating and the
quality of teaching is high. This has gone down by 3% since 20X5.

In the NOS survey, the percentage of graduates agreeing that the course has developed them as a person
has increased from 80% in 20X5 to 82% in 20X6. This indicates that RU is developing confident and
ambitious graduates.

However, the number of graduates achieving first class degrees in 20X6 has fallen by 8%. This infers that
the quality of teaching may have declined.

The ratio of students to academic staff has increased from 35:1 to 40:1. It appears that, although many new
students were recruited in 20X6, there were not enough new academic staff recruited. This is shown by the
fact that student numbers increased by 13% but academic staff costs only increased by 6%. As there was
presumably a pay rise in the year too, it is clear that a proportionate amount of new staff were not recruited.

This failing is also reflected by the fall in the answer to question 2 from 86% to 82%, with students being less
satisfied in 20X6.

The staff retention rate has gone down in 20X6, meaning that staff are less familiar with RU and therefore
more likely to provide a fragmented service.

In 20X5 74% of employers were happy with the graduates they recruited, this has dropped by 2%. In
addition, in 20X5 only 65% of students have managed to obtain graduate jobs within a year compared to
previous years. Given that RU has relaxed the entry requirements for students in 20X6, this may mean that
its 20X6 recruits are not as well qualified as its 20X5. This decision has meant that there has been a 23%
increase in fee income, but it compromises RU’s ability to meet its first strategic aim.

2. To provide an organised, efficient learning environment with access to cutting edge technology and
facilities

As regards premises, the money spent on maintaining these has decreased by 10% in 20X6, despite the
increased student numbers. In the NOS survey, the percentage of students satisfied with these facilities has
gone down 9%. This suggests that this aim has been neglected.

Students seem less satisfied with the way that the courses are administered now, with a fall of 9%.

Administration staff costs have only increased by 5% despite a 13% increase in student numbers. It
indicates the possibility of understaffing. This is again reflected by the fall in the staff retention rate from 90%
to 75% in 20X6.

3. To be a leader in sustainable business practices which protect the environment and support local
people
 In 20X5, RU won an environmental award for its campuses. It also took part in a food sharing initiative which
helped the local community. It has now got rid of its recycling bins and ceased to be involved in the food
share project.

RU’s spending on sustainability and community assistance has actually halved. This decline in activity is
partly attributable to staff shortages.

It appears as if this aim is being neglected in 20X6.

4. To provide attractive, innovative conference and event facilities, attracting clients both nationally
and internationally

Conference and event income has gone up by 13%. The costs have only increased by 4%, indicating good
cost control.

RU has also won an award for its conference facility and attracted a number of new clients.

Therefore, it appears that RU is focusing properly on this aim.

5. To be recognised both nationally and internationally for the scope and relevance of their research

Income from research has gone down by 13%, as have the associated costs.

A local university has won an award for their contribution to research, RU has not been successful in this
regard.

This suggests that this aim was also neglected in 20X6.

Overall satisfaction

In addition to the above, it should be considered that the overall satisfaction percentage for students has
decreased from 83% to 81%.

This could have serious implications for RU as it is the main performance indicator used both internally and
externally to assess how RU is performing.

The university needs to consider how it can improve the service it is providing in order to improve overall
satisfaction.
Calculations
2016 2015 %
$m $m increase/(decrease)
Income
Tuition fees 148 135.6 9%
Research grants 3.5 4.5 (22%)
Conferences and other events 18 16 13%
Total income 169.5 156. 1 9%

Expenditure
Academic staff costs 80.8 76.2 6%
Administration staff costs 50.4 48 5%
Premises, facilities and technology costs 7.6 8.4 (10%)
Event and conference costs 8.3 8 4%
Research grants 3.1 4 (23%)
Sustainability and community assistance 1.2 2.4 (50%)
Total expenditure 151.4 147 3%
Surplus 18.1 9.1 99%
Student numbers 27,000 24,000 13%
 Belton Park

Part (a)

Hotel

Revenue if hotel remains open

Rooms =120*$100*70%*50%*31 130,200
Extras =$20*60%*120*50%*31 22,320
152,520

Revenue if closed -

Incremental Revenue 152,520

Costs if Remain open Costs if close

Staff
- Permanent 4,500 4,500
- Temporary (unaffected by guest rates) =(120000-4500)/2 57,750
- Temporary (affected by guest rates) =(120000-4500-57750)*50/90 32,083

Maintenance 14,600 4,000

Power costs
- Fixed costs =8000+2200 10,200 10,200
- Variable Costs =20000-10200 9,800
- Variable Costs (50% increase) =(20000-10200)*50% 4,900

Security costs 13,600 13,600

Water Costs 6,450 -

153,883 32,300

Incremental costs 121,583

TOTAL Incremental cash flow if hotel remains open 30,937

 Water Park

Revenue if water park remains open

Admission =12000*48%*21*80% 96,768.00
Extras =12000*48%*12*60% 41,472.00
138,240.00

Revenue if closed -

Incremental Revenue 138,240

Costs if Remain open Costs if close

Staff
- Permanent 2,000 2,000
- Temporary =(75600-2000)*48% 35,328

Maintenance 6,000 2,000

Power costs
- Fixed costs =7000+1500 8,500 8,500
- Variable Costs =18000-8500 9,500
- Variable Costs (50% increase) =(18000-8500)*50% 4,750

Security costs 8,000 8,000

Water Costs 12,100 -

86,178 20,500

Incremental costs 65,678

TOTAL Incremental cash flow if remain open 72,562

Therefore based on the above calculations both the hotel and the water park should remain open in January due
to the fact that they both generate positive incremental cash flow.

Part (b)
Other factors that should be considered:

 The estimates used in the calculations are based on very limited historical data and therefore may not be
very reliable. This could result in even worse results if these are too optimistic.
 Belton Park Resort is a relatively new business and therefore still building up their customer base. It
would therefore be a good idea to remain open anyway even if the cash flows did not look so positive.
 If the hotel and or the water park should close this may result in the temporary staff looking for other jobs
and they could end up losing valuable staff if they do not come back when the resort reopens.
 The interdependency between the hotel and the water park should also be considered. In this case it
does not affect the decision since it has been decided to keep both open but it could be that if the water
park had to close that this would affect the hotel occupancy rate and vice versa.
 Best Night Co.

Gross Revenue

(111,890-104,976)/104,976 = 6.6% increase

This increase reflects the increase in occupancy rate and the increase in the standard room price.

Room revenue after discounts

(95,107-93,436)/93,436 = 1.8% increase

This increase is a lot lower than the gross revenue increase which means that there was an significant increase
in discounts given in order to increase occupancy rate. Occupancy rates increased by 2.8% but Net revenue
only increased by 1.8%. Therefore, even though the standard room rate was increased in 20x7 the actual
revenue per room decreased.

Considering the poor economic conditions faced in 20x7 it may have been better to keep the standard room
rates at the same price as 20x6 rather than giving so many discounts.

Additional Revenue

(24,270 – 23,185) / 23,185 = 4.6% increase

One of the benefits of increasing the occupancy rate is that there are now more guests to spend money on
additional services such as food and drink – this can be seen the increase in revenue from additional services.

Overall Total revenue increase by 2.4% which is very positive considering the tough market conditions.

Operating costs

(95,462 – 92,379)/92,379 = 3.3% increase

This is concerning that in tough economic times that operating profits have increased by more than $3 million.
This is when costs should be controlled the most. This is a cause for concern as it has resulted in operating
profit to decrease by 1.3% and should be investigated further.

However, when looking at reducing costs this should not be done at the expense of customer satisfaction as this
can have a much longer term negative effect on profits and revenues.

Return on Capital Employed

20x6 – $24.2m/$39.1m = 62%

20x7 - £23.9m/$39.5m = 60.5%
Return on capital employed reflects the value that the assets employed are generating. This has decreased
even though there has been very little or no capital investment. This is concerning.

Customer Satisfaction scores

Although reduction in profitability is a concern for Best nights sleep a bigger concern is the reduction in customer
satisfaction scores. The hotels have gone from top 10% to top 25% in just one year. This is most likely due to
the lack of investment into the hotels. This can have a much longer negative affect on the future profits and
revenues on the company.

Therefore the overall recommendation for Best Night Co would be to not defer the two year refurbishment
programme at the risk of reducing future profits even further.
 Portable Garage Co

(a) Profit Statement for current position:

Division A Division B Company
'000 '000 '000
Sales
External Sales (200,000*15)/(150,000*180) 3,000.00 27,000.00 30,000.00
Internal Sales (150,000*13) 1,950.00
4,950.00 27,000.00 30,000.00
Cost of Sales
Material - External 1,050.00 6,750.00 7,800.00
Material - internal - 1,950.00
Labour 1,400.00 5,250.00 6,650.00
Other costs 200.00 200.00
2,650.00 13,950.00 14,650.00
Contribution 2,300.00 13,050.00 15,350.00
Fixed Costs 2,200.00 5,460.00 7,660.00
Profit 100.00 7,590.00 7,690.00

(b)
Division A makes $1 additional contribution from external sales rather than internal sales. Therefore Division A
should maximise external sales first before selling any additional units within their capacity to Division B.

Div A Maximum Capacity 350

Less: External Sales. (200)
No. of units available to sell to Division B. 150

Since Division B has a maximum demand of 180,000 units, they should purchase 150,000 adaptors from
Division A as this will contribute an additional $150,000 to the bottom line of the company as a whole.

The rest of the adaptors needed to meet demand (30,000) should be purchased from the external supplier at the
same price. This will enable Division B to produce and sell an additional 30,000 adaptors at a total contributiom
of (30,000*87) $2,610,000.

(c)
In order for Division A to supply Division B with all 180,000 adaptors in order to meet their demand, Division A
will have to reduce their external sales by 30,000 to 170,000. They only have a total capacity of 350,000.

The minimum transfer price that should be charged when there is no spare capacity is:
MARGINAL COST + OPPORTUNITY COST

Therefore the Marginal cost for Dvision A's internal sales is $7 made up of labour ($4) and material ($3).

Opportunity cost is the contribution lost by not selling the items externally - $7 ($15-$3-$4-$1)

Therefore the transfer price of additional external sales = $14.

 Alka

(a) Breakeven number of occupied room nights

BE Volume = Fixed costs / Contribution per unit
Contribution per unit = $180 - $60 = $120 contribution
Fixed Costs= $600,000
BE Volume = $600,000/$120 = 5000 occupied room nights
Margin of Safety as a %
Margin of Safety % = (Budgeted sales Volume - Breakeven sales volume)/ Budgeted Sales Volume
Budgeted sales volume = 25 rooms * 365 days * 70% = 6,387
Breakeven sales volume = 5000
MOS % = (6,387 - 5,000)/5,000 = 21.72%

(b) Budgeted Profit or loss for Q1

Sales (900*$180) 162,000.00
Cost of Sales (900*$60) (54,000.00)
108,000.00
Fixed Costs (150,000.00)
Loss (42,000.00)

Even if the hotel is closed in Q1, fixed costs of $150,000 will still be incurred. This will result in lost
contribution of $108,000 and instead of just a $42,000 loss, a $150,000 loss will be made in Q1.

Not only will the hotel incur a greater loss if the hotel is closed but this could also damage the reputation of
the hotel as the regular business customers may perceive the hotel as unreliable and will book elsewhere.
Therefore the hotel should not close in Q1.

c) Project 1
2 night Theatre package Contribution:
Sales (£67.5*2 +$100) 235.00
Variable costs ($95+ $60*2) (215.00)
Contribution 20.00

BE volume = Fixed Costs/Contribution per unit = 20,000/20 = 1000 packages

The contribution per theatre package is very low and in order to breakeven and cover costs, 1,000 theatre
packages will need to be sold. Which means that in Q1 2,000 rooms will need to be occupied.

Total capacity of the hotel in Q1 = (25*365)/4 = 2,281

Hotel rooms sold in Q1 = 900
Therefore total hotel rooms available in Q1 = 1,381
Therefore there is insufficient capacity and Project 1 is not viable.
 Helot Co

1. D

Statement (1) relates to flow cost accounting, which is an environmental management accounting
technique, not target costing.

Statement (2) is correct. During the market research process which is used to identify the price that the
market would accept for a new product, customer feedback will also be obtained. Thus the company will
better understand what is important to customers using the product, including quality, cost and
timescales.

Statement (3) describes throughput accounting, not target costing.

Statement (4) is correct. If target costing is carried out before a new product is launched, and a cost gap
is identified, the design of production processes can be changed as part of the cost reduction exercise. If
target costing takes place once a product has already been launched, it may be too late to change the
production process, so target costing will have to focus more on controlling manufacturing costs.

2. A
$
Target selling price 45.00
Less required margin (35%) (15.75)
_____
Target cost 29.25
Projected cost (working) 31.30
⇒ Cost gap (the amount by which the current cost exceeds the target cost) 2.05

Working – projected costs per unit

Production costs
Direct material 3·00
Direct labour 2·50
Direct machining 5·05
Set-up 0·45
Inspection and testing 4·30

Non-production costs (taking total and dividing by 350,000 units)

Design (salaries and technology) 7.14

Marketing consultants 4.86
Distribution 4.00
_____
Projected cost 31.30

3. C

All four actions would reduce the cost, so could be used. However, using cheaper plastic (1) might
reduce the quality of the games and customers might be dissatisfied, leading to lower sales in the future.
Similarly, using trainee designers might impact the quality of the games. (Note that some companies do
 use lower grades of staff, supported by training as a means of reducing costs – however the lower
grades would not be trainees).

It could be argued that using the company’s own website for marketing might not be appropriate as this
might reach a smaller number of potential customers. However, this is probably less inappropriate than
items (1) and (3) so answer (C) is better than answer (D).

4. C

The learning rate was used in the calculation of the projected cost, not the target cost. The target cost is
not affected by the projected cost, since it is the difference between expected selling price and required
margin. Answers A and B are not therefore true.

A learning rate of 95% means that labour learns slower than a learning rate of 90%. Projected costs
would therefore be higher. This means the cost gap (the difference between the target cost and the
projected cost) would increase.

5. B

In services, ownership is not transferred to the buyer, but the buyer enjoys the use of the service.
Statement (1) is therefore not true.

Statement (2) is true. In services industries, there is not much material used, compared to the
manufacturing sector, but the service is performed using labour, so labour costs would be high relative to
material costs.

It is difficult to define a standard service but some types of service will be similar in nature, so target
costing can be used. Statement 3 is not true.

Service characteristics are intangibility, simultaneity, heterogeneity and perishability. Uniformity is not a
characteristic as this is the opposite of heterogeneity. Statement 4 is therefore not true.
 CSC Co

Solutions

(a) Shortage of Betta and optimal production plan

Shortage of Beta
Cakes Cookies Shakes
Betta – grams per unit 0.5 0.2 1.0
Demand (units) 11,200 9,800 2,500
Special contract (units) 0 0 5,000
______ ______ ______
Planned production (units) 11,200 9,800 7,500
Grams required 5,600 1,960 7,500

⇒ Total requirement of Betta = 15,060

Availability = 12,000 grams ⇒ shortage = 3,060 grams (15,060 – 12,000)

Optimum production plan

Approach – produce for Encompass health, then make products with highest contribution per gram of
Betta first:
Cakes Cookies Shakes
Contribution per unit 2.60 1.75 1.20
Betta – grams per unit 0.5 0.2 1.0
___ ___ ___
⇒ Contribution per gram 5.2 8.75 1.2
Ranking 2 1 3

Production plan – given 12,000 grams of Betta:

Betta used
(grams)
Produce 5,000 shakes for Encompass 5,000
Produce 9,800 cookies (max demand) 1,960
(9,800 x 0.2)
_____
6,960
Remaining 5,040 grams sufficient to make 10,080 cakes 5,040
______
12,000
 Profit calculation
Contribution
$
5,000 shakes for Encompass (5,000 x (1.2 – 0.2)*) 5,000
9,800 cookies (9,800 x 1.75)) 17,150
10,080 cakes (10,080 x 2.6) 26,208
_____
Total contribution 48,358
Less fixed costs 3,000
______
45,358
______

* the contribution per unit of shakes is reduced by 0.2 since the price to Encompass is $5.8, which is
$0.2 less than the normal price of $6.0.

(b) Breaching the agreement with Encompass

From a financial point of view, the agreement with Encompass should be breached. Given the shortage
of Betta, CSC would be better changing the production plan in part (a) so that it produces to meet full
demand for cakes, and then making shakes for sale in the gym, as these generate a higher contribution
per gram of Betta.

Breaching the agreement may lead to CSC losing the custom of Encompass however, and in future
months, if the supply of Betta becomes unlimited again, CSC may make higher profits overall if it can
supply Encompass in addition to the gym.

Encompass may take legal action against CSC if the agreement is breached. Also, from an ethical point
of view, it would be wrong not to honour an agreement that was made.

(Tutor note – two of these paragraphs would be sufficient to gain 4 marks. Credit would also be given of
other sensible points).

(c) Linear programming model

(i) The line labelled C = 2.6x + 1.75y is a contribution line. All the combinations of the two products
(cakes and cookies) on this line generate a contribution of value C. Each cake generates
contribution of 2.6 while each cookie generates contribution of 1.75. It is not clear what the value
of C is for this particular line.

The area represented by OABCD is called the feasible region. This shows all the possible mixes
of output of the two products that can be made, given the limited resources.

(ii) The optimum production plan is found by drawing contribution lines that are parallel to the line
drawn. Each successive line to the right this line has a higher value of contribution. Lines are
drawn until there is only one point on the line that remains in the feasible area.
Practically the point can be found by putting a ruler over the line C = 2.6x + 1.7Y and this to the
right, keeping it parallel until it reaches the furthest point. This is actually point C on the graph.
(iii) Slack is where the optimal production plan does not use all of the available supply of a particular
resource.

In this case the optimum production point is C. Since C lies on the line representing labour, all
the labour available is being used, so there is no slack. However, point C lies below the Singa
and Betta lines, meaning that not all of the available units of Singa and Beta are being used.
There is therefore slack at this point.
 Mylo Co:
1. A

Maximin means looking at the lowest potential outcome of each decision, and choosing the one with the
highest:

Supply level Lowest outcome

450 1,170
620 980
775 810
960 740
⇒ 450 has the lowest outcome, and should be chosen if Maximin approach is adopted.

2. D

A table of regrets must be calculated. For each potential outcome (level of demand) the regret for each
decision is the difference between the best decision for that outcome, and the outcome resulting from
each decision:

Demand Outcome for best Regret Regret Regret Regret

450 620 775 960
___ ___ ___ __
450 1,170 0 190 360 430
620 1,612 442 0 217 322
775 2,015 845 403 0 230
960 2,496 1,326 884 481 0

The maximum regret from each decision is taken from the table, and the decision with the lowest
maximum regret is chosen, as follows:

Supply level Maximum regret

450 1,326
620 884
775 481
960 430

⇒ the decision to supply 960 has the lowest maximum regret, so this is the decision that would be
chosen if Minimax regret is used.

3. B

Statements (2) and (4) are true.

Use of expected values suggests a “risk neutral” approach to decision making, rather than a defensive
and conservative approach, so statement (1) is incorrect.
Expected values are calculated by taking the sum of each potential outcome multiplied by the probability
of it occurring. They do therefore take into account the likelihood of the different outcomes occurring, so
statement (3) is incorrect.

4. A
 The maximum amount that Mylo would pay for this information is the value of perfect information. This is
calculated as Expected value with perfect information minus expected value without perfect information.

Expected value with perfect information:

Each day, the HR report will correctly indicate the level of demand, so Mylo will supply the number of
meals indicated (e.g. if the report indicates that demand will be 450 meals for a particular day, Mylo will
make 450 meals and will earn profits of 1,170).

Expected value with perfect information is therefore:

Survey predicts Daily Probability Profit x

(& Mylo makes) profit Probability
450 1,170 0.15 175.5
620 1,612 0.30 483.6
775 2,015 0.40 806.0
960 2,496 0.15 374.4
______
Expected value 1,839.5

Expected value without perfect information

Mylo will calculate the expected value of each level of supply, and each day supply the same number of
meals, being the number with the highest expected value:

Supply level Expected value

450 1,170 (profit will be 1,170 for all levels of demand)

620 1,517.2 (980 ×0.15) + (1,612,× 0.3) + (1,612 × 0.4) + (1,612 × 0.15)
775 1,648.25 (810 ×0.15) + (1,395× 0.3) + (2,015 × 0.4) + (2,015 × 0.15)
960 1,586.40 (740 ×0.15) + (1,290× 0.3) + (1,785 × 0.4) + (2,496 × 0.15)

⇒ without the survey, Mylo would make 775 lunches each day. His expected value would be $1,648.25

Conclusion

Value of perfect information = expected value with perfect information – expected value without perfect
information
= 1,839.5 – 1,648.25 = 191.25. This is the maximum amount that Mylo will be prepared to pay each day.

5. D

Sensitivity of a variable refers to how much it must rise or fall by in % terms before break-even point is
reached. At breakeven point, contribution = 70, a fall of $385 from the current level.

1. Sensitivity of sales revenue (and therefore sales price) = (385 ÷ 1,300) × 100 = 29.6%

Sensitivity of sales volume = sensitivity of contribution i.e. (385÷ 455) x 100 = 84.6%
 Therefore the investment is more sensitive to a fall in sales price than to s change in sales
volume. (1) is incorrect.

2. Variable costs would need to increase by (385 ÷ 845) × 100 being a rise of 45.6%. This is more
than 44%. So statement 2 is incorrect.

3. Sensitivity to incremental fixed costs = (385 ÷ 70) × 100 = 550%. Statement 3 is correct.

4. Margin of safety = the fall in sales volume before break-even point is reached. This has already
been calculated as 84.6% in (1) above. Statement (4) is therefore true.
 SWIM Co

Solutions

1. The relevant point is where Lines A (total revenue) and Line B (Total costs) cross each other.

2.

Line A Line B

Total revenue Total costs

Line C

Fixed Costs

Explanation

 Total revenue would be zero if no athletes were trained. The only line that passes through the point 0,0
is Line A, so this must represent total revenue.
 If no athletes are trained, then total costs = fixed costs (as variable costs would also be zero). As costs
increase, fixed costs remain constant. However, in this case we are told that if the number of athlete
exceeds a certain number, then fixed costs would increase. So we would expect fixed costs to remain
 constant (a flat line) up to a certain point, then to increase to another level, after which they would remain
constant at that higher level. Line C best fits this profile.
 Line B also starts at the point where number of athletes equals zero and costs = 20,000 (Fixed costs).
However, line B increases as the number of athletes increases, which suggest it includes variable costs
too. Since it includes fixed cost and variable cost, it must represent total cost per unit.

3. $ [40,000]

At break-even point, contribution = total fixed costs = $40,000

Alternative explanation

Contribution = Revenue – Variable Costs.

When the number of athletes is 300, it can be seen from the graph that revenue is $90,000.

Variable costs is not shown on the graph. However, variable cost = total cost – fixed costs.

When the number of athletes is 300, total cost = $90,000, fixed costs are $40,000 so variable costs are
$50,000.

Contribution = 90,000 – 50,000 = 40,000.

4.
The revenue per athlete is constant throughout the
FALSE
range of data
Variable cost per athlete declines as the number of
TRUE
athletes increases above 200.
Fixed costs are initially $20,000 but increase to
$40,000 if the number of athletes increases above TRUE
200.
If the number of athletes is 200, profit of $20,000 is
FALSE
made.

The revenue line (Line A) becomes less steep if the number of athletes exceeds 400, meaning that the
price (revenue per athlete) falls at this point.

The total cost line (Line B) is less steep after 200 units are sold than it was up to 100 units, which means
the variable cost per unit is falling. (The line is steeper between 200 and 400 but this is partly due to the
increase in fixed costs per unit.

5. These are definitions that you must know.

C/S ratio Break-even point

 Contributi on per unit Fixed cost
Selling price Contributi on per unit

Break even revenue Margin of safety

Fixed cost Budgeted output - break even point

C/S ratio budgeted output
 Cardio
Part (a)

Weighted Average C/S Ratio

Weighted Average contribution to Sales Ratio (WA C/S ratio) = total contribution / total sales

Per Unit T C R
$ $ $ $ $ $
Sales $1,600 $1,800 $1,400
Material ($430) ($500) ($360)
Variable Labour 40% ($88) ($96) ($76)
Variable Overheads ($110) ($120) ($95)
Total variable costs ($628) ($716) ($531)
Contribution $972 $1,084 $869

Sales Units 420 400 380

Sales Revenue $672,000 $720,000 $532,000
Contribution $408,240 $433,600 $330,222

Total Sales Revenue = ($672,000+ $720,000+ $532,000) = $1,924,000

Total Contribution = ($408,240+ $433,600+ $330,222) = $1,172,000

WA C/S Ratio = $1,924,000/$1,172,000 = 60.92%

Part (b)

Margin of Safety

Margin of Safety = budgeted Sales – BE Sales

Budgeted Sales = $1,924,000

Total Labour Costs (420*$220) + (400*$240) + (380*$190) $260,600

Fixed Labour Costs (x60%) $156,360
Other fixed costs $55,000
Total fixed costs $211,360

Breakeven Sales Revenue = Fixed Costs/ WA C/S Ratio

= $211,360/60.92%

= $346,947

Margin of Safety = $1,924,000 - $346,947

= $1,577,053
Part (c)

Multi product BE Chart

Part (d)
BEP if products are sold in order of profitability
If more profitable items are sold first, the company will cover its fixed costs quicker. Consequently the breakeven
point will be reached earlier. Therefore fewer sales will need to be made in order to break even. Therefore the
breakeven point will be lower.

Part (e)
The limitations of CVP analysis
The limitation of CVP analysis are the unrealistic assumptions required.

i. It is assumed that fixed costs are the same in total and variable costs are the same per unit at all
levels of output.
a. Fixed costs will change if output falls or increases substantially (most fixed costs are step
costs)
b. The variable cost per unit will decrease where economies of scale are made at a higher
output volumes, but the variable cost per unit will also eventually rise when diseconomies
of scale begin to appear at even higher volumes of output. (eg: the extra cost of labout
when working overtime)
ii. It is assumed that the sales price will be constant at all levels of activity.
iii. Production and sales are assumed to be the same. Inventory levels are assumed constant.
iv. Uncertainty in the estimates of fixed costs and unit variable costs are often ignored.
 Beckley Hill

1. Cost per unit of procedure A using current method (absorption costing)

Direct costs $

Surgical time and materials 1,200

Anaesthesia time and materials 8,00

Overhead cost (working) 476

Total cost per unit 2,476

Working
Under the current methods, costs are absorbed based on the total overhead cost divided by the number of
procedures:

Total overhead costs 17,606,352

Number of procedures (A and B) 37,000 (14,600 + 22,400)

Overhead cost per procedure 475.85

 476 to the nearest $

2.
Costs Appropriate driver

Administrative costs Admin time per procedure

Nursing time Length of patient stay

Catering time Number of meals

3. (C) Each performance of Procedure B requires 48 hours @ $6 per hour = $288.

Working – cost per unit of general facility costs

Procedure A B Total

Number of procedures 14,600 22,400

Length of patient stay per procedure (hours) 24 48

Total patient stays (hours) 350,400 1,075,200 1,425,600

 Total cost of patient stay per hour = (8,553,600 ÷ 1,425,600) = $6 per hour
4.

The cost per procedure of Procedure B will be higher using activity based costing than
TRUE
under the current method of absorbing overheads.

It will definitely be beneficial for Beckley Hill to start using activity based costing. FALSE

Activity based costing makes it clear that all costs are variable. FALSE

The cost per procedure will be more accurate when calculated using activity based costing
TRUE
than when using the current method of absorbing overheads.

Commentary
It is not necessary to calculate the cost per unit to see that the cost of Procedure B would be higher under
activity based costing than under the current method. Currently overheads are absorbed on a per unit basis.
When activity based costing is used however, Procedure B would attract a greater share of overheads
because it uses more units of all drivers per procedure than Procedure A. The costs would therefore be
higher. The first statement is therefore true.

There may be benefits to setting up an activity based costing system, but there will also be costs. It is
possible that these costs exceed the benefits, so it might be better for Beckley Hill to stick to its existing
method of absorbing overheads. It is not definitely beneficial for Beckley Hill to adopt ABC.

One criticism of activity based costing is that it makes it seem as if all overhead costs are variable when in
practice they might not be. Some of the costs relating to patient stay for example will be fixed, and will not
vary with the amount of time each patient spends at the hospital. Statement 3 is therefore false.

Activity based costing will provide a more accurate product cost (or in this case cost per procedure) than
absorption costing since the costs will be absorbed based on the usage of the drivers, which reflects more
accurately the costs actually incurred in performing each procedure.

5. (C) The first three actions would all reduce the cost per performance of the procedure. The final action,
reducing the number of performances may reduce total costs, but the cost per procedure would probably
increase as some of the costs would be fixed and therefore the cost would have to be spread over a smaller
number of units.
 One Stop Car

Part (a)

1. Competitiveness
% of website hits converted into orders
MSC (9,506/14,000) = 67.9%
OSC (11,870/18,260) = 65%
This ratio shows how many customers actually book a service with MSC once they have visited their
website instead of going with their competitors.
MSC has performed better than the other OSC centres. This shows that they are more competitive.

2. Financial Performance
Gross Profit Margin
MSC ($304,200/760,500) = 40%
OSC ($328,124/$890,365
Based on the financial data presented this is the best indicator available. It shows how much revenue
exceeds the costs of the services sold.
MSC exceeds the OSC average by more than 3%. This could be due to the fact that they have a greater
ratio of junior mechanics to senior mechanics and are therefore able to keep their costs lower. This is a
good thing as long as it doesn’t compromise quality.

3. Quality of Service
% of jobs from repeat customers
MSC (1,500/9,506) = 15.68%
OSC (1,660/11,870) = 13.98%
This ratio indicates how much of their business is repeat business. This is a great indicator of quality as
customers only return if the service is good.
MSC has performed better than the OSC average by 1.8%. This shows that they have a higher quality of
service than the overall business.

4. Flexibility
Ave time taken per job
MSC (23,100/9,506) = 2.43 hours
OSC (24,800/11,870) = 2.09 hours
The time taken to complete a job is important in this business as customers often wait for their car. The
national website states that wait time is only an average of 2 hours, it is important that the service
centres are tracking this.
MSC is performing worse than average. But since they have more repeat customers and they are rated
higher than the OSC average means that the quality of the service is more important than speed.

5. Resource Utilisation
Sales per Mechanic
MSC ($760,500/12) = $63,375
OSC ($890,365/13) = $68,490
This shows how well the staff are being used to make money for the company.
MSC appears to use their staff less efficiently than the OSC average – this can be seen in the fact that
the average service time takes longer than the average. But because they get higher margins and their
quality is obviously better this is not too negative.
 6. Innovation
% revenue generated from new service packs
MSC ($66,000 + $58,000 + $54,000)/$760,000 = 23.4%
OSC ($44,000 + $42,0000)/$890,365 = 9.66%
This indicates how appealing the new service packs are to customers, the more innovative the pack, the
more appeal to customers, the more sales
MSC significantly outperformed the average – resulting in higher sales. This is a very good performance.

Part (b)

The Standards Block sets the targets for employees and management to meet. These targets must meet 3
criteria – they must be achievable, fair and encourage employees to take ownership. If the targets do not meet
these criteria then performance could suffer.

The Rewards block ensures that employees are motivated to achieve these standards. The reward schemes
should be clear, motivating and based on controllable factors.
 Kappa

Part (a)

i) Usage Variance
SQSM AQAM
Should use Did use Difference Std cost/kg Variance
kg Kg kg $ $
Alpha 1,840.00 2,200.00 (360.00) 2.00 (720.00) A
Beta 2,760.00 2,500.00 260.00 5.00 1,300.00 F
Gamma 920.00 920.00 - 1.00 -
5,520.00 5,620.00 580.00 F

(ii) Mix Variance

AQSM AQAM Difference Std cost/kg Variance

kg kg kg $ $
Alpha (4/12) 1,873.33 2,200.00 (326.67) 2.00 (653.33) A
Beta (6/12) 2,810.00 2,500.00 310.00 5.00 1,550.00 F
Gamma (2/12) 936.67 920.00 16.67 1.00 16.67 F
5,620.00 5,620.00 913.33 F

(iii) Yield Variance

SQSM AQSM Difference Std cost/kg Variance

kg kg kg $ $
Alpha 1,840.00 1,873.33 (33.33) 2.00 (66.67) A
Beta 2,760.00 2,810.00 (50.00) 5.00 (250.00) A
Gamma 920.00 936.67 (16.67) 1.00 (16.67) A
5,520.00 5,620.00 (333.33) A

Part (b)

 Material price variances are out of the control of the Production manager. Kappa Co has a purchasing
manager who is responsible for pricing and supplier contracts. Therefore including this variance in the
report would be demotivating for the production manager because he cannot control them.

 There appears to be no use of planning variances, Prices and quality of the three materials are volatile
and not identifying variances that are out of the control of the production manager can be demotivating.

 The standard mix was set by the finance department 5 years ago. These could be out of date and not in
the control of the production manager. Again this is demotivating and can result in the production
manager making decisions to obtain a favourable variance rather than a decision in the best interests of
the company.
  No commentary or feedback is given to the Production manager therefore a true picture of his
performance is lacking. Since there is no follow up on the variances it appears as though not much
importance is placed on variances, this can result in a demotivated and complacent manager.

The shortfalls of this system can be seen in the variances calculated, although the overall usage variance is
favourable this is driven by a change in mix of materials. This change in mix has lead to a lower yield in final
product and could also have impacted the quality of the final product and therefore sales revenue.
 Glam Co

1. C

Total salon hours = 8 hours × 6 days × 50 weeks = 2,400 each year.

There are three senior stylists, therefore total hours available = 7,200 each year.

Maximum capacity of stylists per year:

If only cuts are performed = 7,200 hours ÷ 1 hour per cut = 7,200

If only treatments are performed = 7,200 hours ÷ 1.5 hours per treatment = 4,800.

2. A

Throughput accounting ratio: = Return per hour of bottleneck return per hour of bottleneck.
Other costs per hour

In this question, the bottleneck is the senior stylist’s time. Other costs means all costs other than
materials. In throughput accounting, all costs are assumed to be fixed except for material costs. Other
cost per hour is given by the question as $42.56 per hour.

⇒ Throughput accounting ratios for the two services are:

Cuts = 58.5 / 42.56 = 1.37

Treatments = 67.4 / 42.56 = 1.58

Working – throughput return per hour of bottleneck

Cuts Treatments
$ $
Price per unit 60.0 110.0
Materials used per unit 1.5 8.9
____ ___
Throughput per unit 58.5 101.1
Bottleneck hours per unit
(Senior stylists time) 1 1.5
____ ____
Throughput return per hour of bottleneck 58.5 67.4
3. C

The factors which are included in the TPAR are selling price, material costs, operating expenses and
bottleneck time. Increasing the selling price and reducing costs will improve the TPAR.

Increasing the time which each service takes on the bottleneck (the senior stylists’ time) will only reduce
the number of services they can provide, so this will not improve throughput.
 Throughput accounting does not advocate the building of inventory as it is often used in a just-in-time
environment and there is no point increasing the activity prior to the bottleneck as it will just create a
build-up of work-in-progress. Neither of these will improve the rate of throughput through the process.

4. B

The existing capacity for each activity is:

Cut Treatment
Assistants 48,000 16,000
Senior stylists 7,200 4,800
Junior stylists 8,000 9,600

If another senior stylist is employed, this will mean that their available hours will be (4 × 2,400) = 9,600.

This will give them capacity to now do 9,600 cuts (9,600 hours/1 hour per cut) and 6,400 treatments
(9,600 hours/1·5 hours per treatment).

As a result, the senior stylists will still be the bottleneck activity for treatments but for cuts the bottleneck
will now be the junior stylists as they can only do 8,000 cuts compared to the senior stylists of 9,600.

5. A

The theory of constraints is focused on identifying restrictions in a process and how to manage that
restriction (commonly termed a bottleneck).

It is based on the concept of managing throughput, operating expenses and inventory.

It does use a series of focusing steps but it is not complete once the bottleneck has been overcome. In
fact it is an ongoing process of improvement, as once the bottleneck has been elevated it is probable
that another bottleneck will appear and the process will continue.

It cannot be applied to all limiting factors as some, particularly those external to the organisation, may be
out of the organisation’s control.
 Gam
Part (a)

Profit Outcomes

$35 $35 $35 $30 $30 $30

$'000 $'000 $'000 $'000 $'000 $'000
Sales
Volume 94 100 108 110 120 140
Variable cost per unit $12 $12 $11 $11 $11 $11
Contribution per unit $23 $23 $24 $19 $19 $19
Total contribution $2,162 $2,300 $2,592 $2,090 $2,280 $2,660
Fixed
Costs ($450) ($450) ($450) ($450) ($450) ($450)
Advertising costs ($970) ($970) ($970) ($900) ($900) ($900)
Profit $742 $880 $1,172 $740 $930 $1,310

Part (b)

Expected Values

Profit $742 $880 $1,172 $740 $930 $1,310

Probabililty 0.4 $0.30 0.3 0.5 0.4 0.1
EV of Profit $296.80 $264.00 $351.60 $370.00 $372.00 $131.00
Totals $912.40 $873.00

Based on the expected value, a sales price of $35 should be chosen as it gives the highest expected value of
$912,400

Part (c)

Maximin decision Rule

The maximin decision rule involves choosing the outcome that offers the least unattractive worst outcome. Ie:
choosing the outcome that maximises the minimum profit. In this case management would choose a selling price
of $35 which has a lowest possible profit of $742,000, which is better than the worst possible outcome of
$740,000 from a selling price of $30.

Part (d)

Reasons for uncertainty arising in the budgeting process

Uncertainty arises largely because of changes in the external environment over which a company will sometimes
have little control.
Reasons include:
 Customers may decide to buy more or less goods or services than originally forecast. For example, if
a major customer goes into liquidation, this has a huge effect on a company and could also cause
them to go into liquidation.
 Competitors may strengthen or emerge and take some business away from a company. On the other
hand, a competitor’s position may weaken leading to increased business for a particular company.
 Technological advances may take place which lead a company’s products or services to become
out-dated and therefore less desirable.
 The workforce may not perform as well as expected, perhaps because of time off due to illness or
maybe simply because of lack of motivation.
 Materials may increase in price because of global changes in commodity prices.
 Inflation can cause the price of all inputs to increase or decrease.
 If a company imports or exports goods or services, changes in exchange rates can cause prices to
change.
 Machines may fail to meet production schedules because of breakdown.
 Social/political unrest could affect productivity, e.g. the workforce goes on strike.
 Duff

To calculate absorption rate, divide the total overhead cost by the relevant basis.

Duff Co uses labour hours as the basis for absorption. Total labour hours expected to be used should be
calculated.

Calculation of total labour hours

Product X Y Z
Direct materials 25 28 22
Direct labour ($12 per hour) 30 36 24
Labour hours 30 / 12 = 2.5 36 / 12 = 3 24 / 12 = 2
Total hours 2.5 x 20,000 = 50,000 3 x 16,000 = 48,000 2 x 22,000 = 44,000
142,000

Overhead absorption rate = $1,377,400 / 142,000 = $9·70 per hour.

Remember:
It is better to calculate the full cost per unit using the proforma.

Calculation of the full cost per unit using absorption costing

Product X Y Z
Direct materials 25 28 22
Direct labour ($12 per hour) 30 36 24
Overhead cost 9.7 x 2.5 = 24.25 9.7 x 3 = 29.10 9.7 x 2 = 19.40
Total cost per unit 79.25 93.10 65.40

(b)

Under activity based costing the direct labour and materials costs will remain the same. It is only the allocation of
the overheads that will change.
Summary of driver rates for each cost pool

Cost Pool $ Driver # Driver Rate

Machine setup 280,000 # of batches 115 280,000 / 115 = 2,434.78

Machine ordering 316,000 # of purchase orders 480 316,000 / 480 = 658.33

Machine running / general facility costs 420,000 # of machine hours 80,800 420,000 / 80,800 = 9.67

Calculation of total number of batches

Product X Y Z
Batch size (units) 500 800 400
Units 20,000 16,000 22,000
Batches 20,000 / 500 = 40 16,000 / 800 = 20 22,000 / 400 = 55
115

Calculation of total number of purchase orders

Product X Y Z
Batches 40 20 55
Purchase orders per batch 4 5 4
Purchase orders 4 x 40 = 160 5 x 20 = 100 4 x 55 = 220
480

Calculation of total number of machine hours

Product X Y Z
Units 20,000 16,000 22,000
Machine hours per unit 1.5 1.25 1.4
Machine hours 20,000 x 1.5 = 30,000 16,000 x 1.25 = 20,000 22,000 x 1.4 = 30,800
80,800
Note:
Machine running and general facility costs both use machine hours as a driver, so we can add the cost together
and treat it as a single cost pool.
Calculation of the full cost per unit using activity based costing

Product X Y Z

Direct materials 25 28 22
Direct labour ($12 per 30 36 24
hour)
Overhead costs:
Machine setup (2,434.78 x 40) / 20,000 = (2,434.78 x 20) / 16,000 = (2,434.78 x 55) / 22,000 =
4.87 3.04 6.09
Machine ordering (658.33 x 160) / 20,000 (658.33 x 100) / 16,000 = (658.33 x 220) / 22,000 =
=5.27 4.11 6.58
Machine running/gen 9.67 x 1.5 = 14.51 9.67 x 1.25 = 12.09 9.67 x 1.4 = 13.54
Total cost per unit 79.65 83.24 72.21
 Newtown School
Part (a)

Budget deficit/surplus
Budgeted income:
Income from pupils registered on 1 June 2013 $724,500
Income from new joiners (29(W1) x $900) $26,100
Total expected income $750,600

W1 - Expected value of new joiners: (0.2 x 50) + (0.3 x 20) + (0.5 x 26) = 29

Budgeted expenditure:
Repairs and maintenance Salaries
Prior year amount $44,000 $620,000
Less: Non-recurring items ($14,000) ($26,000)
$30,000 $594,000
Adjustments x 1.03 x 1.02/2 (for 6 months)
Budgeted amount $30,900 $599,940

Expected capital expenditure = (0·7 x $145,000) + (0·3 x $80,000) = $125,500.

Total expected expenditure = $756,340.

Budget deficit = $750,700 - $756,340 = $5,740.

Part (b)

Discussion of estimates
Incremental budgeting bases the budget on the results from the current period plus and amount for estimated
growth or inflation in the next period. This is therefore only suitable for companys that operate in a stable
environment where historical figures are a reliable guide to the future.

Advantages
1. Incremental budgeting is very easy to perform. This makes it possible for a person without any accounting
training to build a budget.
2. Incremental budgeting is also very quick compared to other budgeting methods.
3. The information required to complete it is also usually readily available.

Disadvantages
1. Incremental budgeting encourages inefficiency because it does not question the preceding year’s figures on
which it is based. No-one asks how those figures could be reduced.
2. Similarly, in some organisations, it encourages slack because departmental managers may attempt to use
their entire budget up for one year, even if they do not need to, just to ensure that that cash is available
again the next year.
3. Errors from one year are carried to the next, since the previous year’s figures are not questioned.
Part (c)
Zero-based budgeting (ZBB)

The three main steps involved in preparing a zero-based budget are as follows:

1. Activities are identified by managers. Managers are then forced to consider different ways of performing the
activities. These activities are then described in what is called a ‘decision package’, which:

i. analyses the cost of the activity;

ii. states its purpose;
iii. identifies alternative methods of achieving the same purpose;
iv. establishes performance measures for the activity;
v. assesses the consequence of not performing the activity at all or of performing it at different levels.

As regards this last point, the decision package may be prepared at the base level, representing the
minimum level of service or support needed to achieve the organisation’s objectives. Further incremental
packages may then be prepared to reflect a higher level of service or support.

2. Management will then rank all the packages in the order of decreasing benefits to the organisation. This will
help management decide what to spend and where to spend it. This ranking of the decision packages
happens at numerous levels of the organisation.

3. The resources are then allocated, based on order of priority up to the spending level.

Part (d)

Use of ZBB at Newtown School

There is definitely a place for ZBB at Newtown School. Incremental budgeting would enable the school to
distinguish between necessary and discretionary expenditure and allocate resources accordingly.

At the moment, incremental budgeting is responsible for recurring unexpected cash shortages, which is deterring
new pupils from joining the school. Had a deficit been predicted for the year ended 31 May 2013, perhaps
$65,000 would not have been spent on improving the school gym, and then it would not have been necessary to
close the school kitchen. ZBB would be good to establish the way cash is spent on those activities that are, to a
certain extent, discretionary.

For example, although there is a need for pupils to have somewhere to eat lunch, it is not essential for children
to have a cooked meal every day. It is essential that children do have somewhere to eat though and, as a bare
minimum, they would need an area where they could eat their sandwiches and have access to fresh water. ZBB
could be used to put together decision packages which reflect the different levels of service available to the
children. For example, the most basic level of service could be the provision of an area for the children to eat a
lunch brought from home. The next level would be the provision of some cold and maybe hot food for the
children, but on a self-service basis. Finally, the highest level of service would be a restaurant for the children
where they get served hot meals at tables. At Newtown School the catering manager could prepare the decision
packages and they would then be decided upon by the head teacher, who would rank them accordingly.

Similarly, although some level of sports education is needed, the extent of the different activities offered is
discretionary. ZBB could be used to create decision packages for each of these services in order to prioritise
them better than they are currently being prioritised.
ZBB takes a long time to implement and would not be appropriate to all categories of expenditure at the school.
Much of the budgeting is very straight forward. Incremental budgeting could still be used as a starting point for
essential expenditure such as salary costs, provided that changes in staff numbers are also taken into account.
There is an element of essential, recurring expenditure in relation to repairs and maintenance too, since the
costs of the checks and repairs needed to comply with health and safety standards seem to largely stay the
same each year, with an inflationary increase.
 Truffle Co

Standard cost per labour hour = $6 * 0.5 = $12

a) Labour Rate Variance

12,000 hours should have cost (12,000*$12) $144,000

12,000 hours did cost $136,800
Variance $7,200 (F)

Labour efficiency variance

Actual Production should have taken (20,500 * 0.5) 10,250 hours

Actual production did take 12,000 hours
Variance 1,750 (A)
X standard labour rate x $12
Labour efficiency variance $21,000 (A)

b) Planning & Operational Variances

Labour rate Variance

Standard rate $12

Revised rate (95%) $11.40
Variance $0.60 (F)
x Actual Hours paid 12,000
Labour rate planning variance $7,200 (F)

Revised cost of actual hours (12,000*11.40) $136,800

Actual cost $136,800
Labour rate operational variance NIL

Labour efficiency variance

Standard hours for actual production (20,500*0.5hours) 10,250 hours

Revised hours for actual production (*120%) 12,300 hours
Variance 2,050 (A)
@ original standard rate per hour x $12
Labour efficiency planning variance $24,600 (A)

20,500 batches should have taken 12,300 hours

They did take 12,000 hours
Variance 300 hours (F)
@ original standard rate X $12
Labour efficiency operational Variance $3,600 (F)
c) Performance of the production manager for the month of November

Based on the variance calculated in part (a) it would appear that the production manager did well in securing
labour at a lower rate than budgeted but that he/she was very poor at controlling the staff efficiency.

This does not give a true picture of what actually happened and therefore the variances should be split between
planning variances and operational variance. Only operational variances are in the control of the production
manager. Planning variances are as a result of inaccurate planning or faulty variances.

The labour rate variance operational variance was $0. This shows that the staff were paid the agreed upon
reduced rate of $11.40 and no overtime was paid. The production manager cannot take credit for the favourable
variance of $7,200. As this was a planning variance secured by the company.

Total labour efficiency variance = $21,000 Adverse

The planning variance is $24,600. This is due to the fact that the retailer requested the truffles be made softer
resulting in the longer time taken to produce the truffles. The standard labour time was not updated and the
production manager cannot be held responsible for this.

The operation variance on the other hand is $3,600 (F). It took the workers less than the 20% extra time
predicted to produce the truffles, resulting in a favourable operational variance. The production manager can
take credit for this favourable variance.

In conclusion the production manager performed well in November.

 Block
(a)

The sales price operational variance is the difference between the actual price of commodity 3 and the market
price of commodity 3 multiplied by the actual quantity of commodity 3 sold.

So this is: ($40·40 – $39·10) x 25,600 = $33,280F

As the commodity has been sold for a higher price than the average, the variance is favourable.

The sales price planning variance is the difference between the standard price of commodity 3 and the market
price of commodity 3 multiplied by the actual quantity of commodity 3 sold.

So this is: ($41.60 – $39·10) x 25,600 = $64,000 A

As the original standard sales price was higher than the market price the variance is adverse.

(b)

The sales mix variance compares the number of units of each commodity that should have been sold, that is as
per the standard mix, to the number of units that actually were sold. To quantify the variance in money terms we
multiply the difference in units by the standard profit per unit.

So the formula we apply is:

(Actual units sold SHOULD include - Actual units sold DID include) * Standard Profit per unit

The actual number of units sold are given directly to us in the question as 29,800, 30,400 and 25,600 for
commodity number 1, 2 & 3 respectively. This totals 85,800 actual sales units.

The total budgeted sales units were 84,000, representing a sum of 30,000 for commodity 1, 28,000 for
commodity 2 and 26,000 for commodity 3. Hence, these budgeted sales proportions represent the standard
sales mix of the 3 commodities.

So, for each of the commodities, we compare the actual units sold to the number of each that should have been
sold using the standard mix.

Sales mix variance calculation:

Commodity 1 Commodity 2 Commodity 3

Actual units sold 30,643 = 28,600 = 26,557 =

SHOULD include 85,800 x (30,000 / 84,000) 85,800 x (28,000 / 84,000) 85,800 x (26,000 / 84,000)

Actual units sold DID 29,800 30,400 25,600

include

Variance 843 1,800 957

x Standard profit per 11.2 4.2 12

unit

Mix Variance 9,442 A 7,560 F 11,484 A

Actual sales units in the standard mix calculate as 30,643 for commodity 1, being actual total sales of 85,800
multiplied by the standard mix for commodity 1 of 30,000 over 84,000.
Similarly, for commodity 2, we apply its standard mix of 28,000 over 84,000 to total actual sales of 85,800 to
generate 28,600. For commodity 3 applying a standard mix of 26k/84k means that actual sales units should
have included 26,557 units.

Comparing what actual units sold did include for each commodity to what actual units sold should have included
for each commodity generates a variance in terms of units of 843, 1,800 & 957 for commodities 1,2 and 3.

Each of these units is then valued at its standard profit per unit.

The sales price less the variable cost less the fixed cost calculates the profit of each unit.

The standard sales price and standard variable costs are provided to us in the question.

The standard fixed cost is not given. This is derived from the budgeted fixed overhead divided by the budgeted
activity. The total budgeted fixed overhead is given as $174,400. We are told that fixed production overhead is
absorbed on the basis of direct machine hours, so we will use machine hours as the activity.

The total budgeted machine hours is driven by the total number of units the company plans on producing. This is
30,000, 28,000 & 26,000 for commodities 1,2 & 3 respectively. The machine time spent on each unit is budgeted
to be 0.2, 0.6 & 0.8 hours respectively. Thus, total expected machine hours are 6,000 for commodity 1, 16,800
for commodity 2 and 20,800 for commodity 3, totalling 43,600 machine hours.
Substituting this back into the formula calculates an expected fixed cost per unit (or overhead absorption rate) of
$4 per machine hour.

Finally, using the $4 fixed cost per hour, we can now derive the budgeted fixed cost for each unit of the 3
commodities. Commodity 1 uses 0.20 hours per unit meaning a fixed cost of $0.80. Similarly, commodities 2 & 3
record budgeted fixed cost per unit of $2.40 and $3.20.

Calculation of the budgeted profit per unit can now be completed. Substituting the fixed cost back into our profit
calculation means a budgeted profit of $11.20, $4.20 and $12 for each of commodities 1, 2 and 3.

Transferring these budgeted profit numbers back into our sales mix variance means we can finalise this part to
the question. A sales mix variance of $9,442, $7,560 and $11,484 is calculated for our 3 commodities. Note that
the variance for commodities 1 and 3 is Adverse as less actual units were sold compared to the standard mix of
sales units. The variance for commodity 2, on the other hand, is Favourable as more actual sales of this
commodity have taken place compared to what was expected as per the standard sales mix. Combining all 3
commodities, the total sales mix variance is $13,366A.

The sales quantity variance is the difference between the budgeted sales units of each commodity and the
actual sales units of each commodity applying the standard mix. As above the variance in units will be quantified
by the standard profit of each unit.

So the formula to learn and now to apply is:

(Budgeted sales in the standard mix - Actual sales in the standard mix) * Standard profit per unit

The budgeted sales units have been provided to us in the question and are the same units we worked with in the
sales mix variance calculation. These are 30,000, 28,000 and 26,000 for the 3 commodities.

The actual sales units divided amongst the 3 commodities as per the standard mix have also been derived as
part of the sales mix calculation. These are 30,463, 28,600 and 26,557 for commodities 1, 2 & 3 respectively.

Thus, the difference in sales units is 643, 600 and 557. In each case, the actual sales in the standard mix are
higher meaning we should expect favourable variance results. These units are valued at their standard profit of
$11.20 , $4.00 and $12 to arrive at variances of $7,202, $2,520 and $6,684 for commodities 1, 2 & 3
respectively. Adding these together gives a total sales quantity variance of $16,406 F.

(c)

The total sales price variance is $31,320 A suggesting a poor business performance. However, this comprises a
sales price planning variance and a sales price operational variance. The sales manager should only be
assessed based on variances he can control. As the standard selling prices are set by a consultant and not the
sales manager, then the sales planning variance, $54,680 A, is outside the control of the sales manager. He
should be held responsible for the sales price operational variance, however, which at $23,360 F, suggests a
strong performance as actual sales prices of the 3 commodities were higher than the market average at that
time.

The sales volume variance is the sum of the sales mix and sales quantity variances (which we calculated in part
b). This totals $3,040 F (Mix 13,366 A and Quantity $16,406 F). The overall F volume variance can be explained
predominantly by commodity 2’s higher sales volume than expected.

Total sales variance (price and volume) is 28,280 A which might suggest a poor performance. However, the
inaccurate sales price forecast of the consultant coupled with the economic recession faced by Block Co helps
explain the adverse variance. Indeed, as outlined above, the performance of the sales manager must be seen as
a good one.
 Cam
Part (a)

Direct material cost

All of the parts are bespoke, however, most of the bespoke parts can be replaced for standard parts. 20% of the
parts have to be bespoke and so the remaining 80% can be replaced with 55% less costly parts. As such: 80% x
$40 x 45% = $14.40.

The irreplaceable parts make up 20% x $40 x 90% = $7.2.

So, the revised direct material cost is $14.40 + $7.2 = $21.60.

Direct labour cost

The first unit will take 45 minutes to make and then there will be an expected rate of learning of 90% up until the
100th unit. After from the 100th unit onwards, no more learning takes place and the time taken to produce each
unit will be constant.

Calculation:
Y (at the level of 100 units) = 45 x 100 -0.152 = 22.346654 minutes per unit.

Total time to produce first 100 units = 100 x 22.346654 = 2,234.6654 minutes.

Calculation:
Y ( at the level of 99 units) = 45 x 99 -0.152 = 22.380818 minutes per unit.

Total time to produce first 99 units = 99 x 22.380818 = 2,215.701 minutes.

Time taken to produce 100th unit = 2,234.6654 - 2,215.701 = 18.9644 minutes.

First 100 units 2,234.6654 minutes

Remaining 49,900 units 49,900 x 18.9644 = 946,323.56 minutes

Total 50,000 units 948,558.23 minutes

Total 50,000 units in hours 948,558.23 / 60 = 15,809.3038 hours

15,809.3038 hours x $34.67 per hour =
Total labour costs
$548,108.564
Labour cost per unit $548,108.564 / 50,000 = $10.96

Rework costs
Out of 50,000 units 10% will needs to be reworked at a cost of $18 per unit to give us a total of $90,000 (50,000
x 10% x 18 = $90,000). We then calculate the rework cost per unit by dividing 90,000 over 50,000 to give us
$1.8 per unit.
Revised target cost calculation

Part (b)

Price skimming strategy is when a company charges the highest initial price the customers will pay. Then as a
demand of the first customers is satisfied, the firm lowers a price to attract another more price-sensitive
segment.

The typical example is a technology based products such as mobile phones. When a new model enters a
market, the price is high and then a company reduces the prices to attract new customers.

The price skimming strategy may be appropriate for Cam Co due to the following reasons:
In a conclusion: price skimming strategy may be suitable for Cam Co, however, we need to understand more
about the barriers to entry before we conclude that this would be a suitable pricing strategy. Having said that it is
common for high-tech products to use this strategy as opposed to having one constant price throughout the
product.
 Hair
(a)

The first step is to calculate the contribution for each product C, S, D using the formula:

Contribution per Unit = Unit Selling Price - Unit Variable Costs

In the question, we are told the unit selling price for products C, S and D are $110, $160 and $120.

We are also given 4 types of variable costs, Material 1 and Material 2, skilled and unskilled labour.

Now, putting the values into tables, and subtracting the variable costs from the selling price for each product and
we get contribution per unit for each of the products.

To calculate the weighted average contribution to sales ratio we need to apply the following formula to all
products:

Weighted Average Contribution to Sales Ratio = Total Contribution / Total Sales

Adding the budgeted units to the table to calculate the total contribution, we take the budgeted sales volumes
and multiply by the contribution per unit.

For product C, contribution per unit is $60, multiply it by the 20K units and we get total contribution for product C
of $1.2m.

Repeating this for product S, we get $1.232m and for product D we get $728. Adding these together to get total
contribution for all products of $3.16m

To calculate the total sales we take budgeted sales volumes and multiply by the sales price per unit. For product
C, sales price per unit is $110, multiplying this by 20K units and we get total revenue for product C of $2.2m.

Repeating this for product S, we get $3.52m and for product D we get $3.12. Again, adding these together to get
total revenue for all products of $8.84m.

We then divide the contribution for all products of $3.16m by the sales of $8.84m, to get the weighted average
contribution to sales ratio of 35.75%.

Summary of calculations:
(b)

The breakeven sales revenue tells us how much sales we need to make to break even, i.e. to have zero profit.
The formula for the breakeven sales revenue is:

Breakeven Sales Revenue = Fixed Costs / Weighted Average C/S ratio

The fixed costs are expected to be $640,000 for the next year. In part (a), we calculated the weighted average
contribution to sales ratio of 35.75%. This gives us a breakeven sales revenue of$1,790,209.79.

(c)

(i)

In this part, we are assuming that we are able to sell the products in an order based on their contribution to sales
ratio. This means we will sell all of the product with the highest contribution to sales ratio first, then sell all of the
product with the second highest contribution to sales ratio, then finally sell all of the product with the lowest
contribution to sales ratio.

From part (a), we calculated the contribution per unit for products C, S and D.

To calculate the contribution to sales ratio, we divide the sales price per unit by the contribution per unit.

For product C, we take the contribution per unit of $60 and divided by C’s selling price of $110. This gives us
contribution to sales ratio of 0.55.

Repeat this for product S and D, and we get the contribution to sales ratio of 0.35 for S and 0.23 for D.

As product C has the highest contribution to sales ratio, this will be ranked first, product S will be ranked second,
and product D ranked 3rd with the lowest ratio.

The next step is to figure out, what are the dimensions and the coordinates for the multi-product profit-volume
chart. To do this we need to calculate the cumulative revenue and cumulative profit.

First, before any products are sold, we incur fixed costs of $640K, then our cumulative profit at this point is
minus $640K.

As product C is ranked first, we will start to sell all of the 20,000 units of C. In part (a), we had calculated the total
contribution and revenue from each product.

For product C, we have the total contribution of $1.2m and total revenue of $2.2m. Adding this to our table and
we get a cumulative revenue of $2.2m and cumulative profit of $560K. We get the cumulative profit of 560K, by
adding the contribution from product C, $1.2m to the previous cumulative profit of negative $640K, resulting from
the fixed costs.

Now we add the revenue and contribution from product S, which has the second highest contribution to sales
ratio. The contribution and revenue related to product S are $1.232K and $3.52m. Putting in the revenue and
contribution from product S, we get the cumulative revenue of $5.72m, by adding $3.52m to previous cumulative
revenue of $2.2m and we get the cumulative profit of $1.792m, by adding the contribution of $1.232m by the
previous cumulative profit of $560K.

Now we add the revenue and contribution from product D, the product with the lowest ranked contribution to
sales ratio. The contribution and revenue related to product D are $728K and $3.12m. Adding the revenue and
contribution from product D, we get the cumulative revenue of $8.84m and we get the umulative profit of $2.52m.

We now have the dimensions and coordinates needed to draw the profit-volume graph. Profit is will always be
on the Y, the vertical axis and revenue will always be on the ‘X’, the horizontal axis.

The cumulative revenue will be our X coordinates and the cumulative profit will be the Y coordinates. Let’s draw
the graph, the vertical Y axis needs to be able to include the total cumulative profit of $2.52m and negative
cumulative resulting from the fixed costs of $640K.

Draw the Y axis from minus $1m to $3m, and in increments of 500K. The horizontal X axis needs to be able to
include the total cumulative revenue of $8.84m. Draw the X-axis to $9m, in increments of $1m. Now, we can plot
our four points:

1. Fixed costs - Revenue is 0 and the profit is minus $640K

2. Product C - Revenue is $2.2m and the profit is $560K

3. Product S - Revenue is $5.72m and the profit is $1.792m

4. Product D -Revenue is $8.84m and the profit is $2.52m

(ii)

The assumption of constant sales mix means that the output and sales of products C, S and D are fixed in the
proportions of 20K:22K:26K mentioned in the question for all levels of activity. To draw the profit/loss line for
constant sales mix, we need join the first and last points i.e the fixed cost point to the product D point.

This indicates the average profit which will be earned from the sales of the three products in this constant sales
mix.
Multi-product profit-volume chart

(d)

Assuming that the products are sold in order of the highest contribution to sales ratio if product C is sold first,
Hair will break even at revenue of around $1.1m. We can see this where the profit/loss line meets the X axis,
assuming products are sold in order of their contribution to sales ratio. We can calculate this exactly by dividing
the fixed costs of $640K, by the contribution to sales ratio of 0.55.

Assuming that the products are sold in a constant sales mix, Hair will break even at $1,790,209.79. We can also
see this by looking at the graph, at where the profit/loss line from assuming a constant sales mix hits the X-axis.

This is considerably higher than assuming products are sold in order of contribution to sales ratio. This is
because the contribution to sales ratio for product C 0.55 is higher than the weighted average C/S ratio of
0.3575, calculated in part (a) and, therefore, contributes more to fixed costs.

However, in reality both assumptions are unrealistic and the sales mix will vary throughout the year.
 ROBBER Co:

Solutions

(a) Make or buy decision

Relevant costs of making in house Keypads Display screens

Direct materials $ $
(½ × $160,000) + (½ × $160,000 × 1·05) 164,000
$116,000 × 1·02 118,320
Direct labour 40,000 60,000
Heat and power
$64,000 – (50% × $40,000) 44,000
$88,000 – (50% × $60,000) 58,000
Machine set up costs:
Avoidable fixed costs 4,000 6,000
Activity related costs (W) 27,500 30,000
Avoidable depreciation and insurance costs:
40% × $84,000/$96,000 33,600 38,400
––––––– –––––––
Total relevant manufacturing costs 313,100 310,720
––––––– –––––––
––––––– –––––––
Cost of buying in (4.10 / 4.3 × 80,000) 328,000 344,000
––––––– –––––––

As each of the components is cheaper to make in-house than to buy in, the company should continue to
manufacture keypads and display screens in-house.

WORKING – Calculation of Variable and Fixed machine costs

Keypads Display screens
$ $
Total costs – current year 26,000 30,000
Fixed portion (given in note (4) (4,000) (6,000)
______ _______
Total variable costs – current year 22,000 24,000
No. of batches – current year (80,000 ÷ 500) 160 24,000
______ ______
⇒ Variable cost per batch 137.5 150

In the following year, smaller batch size of 400 units will be used, therefore:

Number of batches (80,000 ÷ 400) 200 200

⇒ total variable costs 27,500 30000
______ ______
(b) Make or buy – higher production level

We know from part (a) that it is cheaper to make both products in house than to buy externally. However,
labour time is now limited, meaning that some units will have to be bought from the external supplier.

The approach is to calculate how much costs are saved per labour hour for each product where the
goods are made in house, and to prioritise making the product that produces the higher savings per
hour.
For the purposes of calculating savings per unit, only variable costs are relevant, as fixed costs will be
incurred anyway (since there will be some production of both products in house).

Keypads Display screens

$ $
Cost per unit of buying externally 4·1 4·3

Variable cost per unit of making in house (working) 2.89 2.6

–––––– ––––––
Saving from making per unit 1·21 1·7
Labour hour per unit 0·5 0·75
Saving from making per unit labour hour 2·42 2·27
–––––– ––––––
Priority of making 1 2

Production plan

Total labour hours available = 100,000.

Make maximum keypads (i.e. 100,000) using 50,000 labour hours (100,000 × 0·5 hours)

Make 50,000 ÷ 0·75 display screens (i.e. 66,666 display screens).

Therefore buy in 33,334 display screens (100,000 – 66,666).

Working – variable costs per unit (taken from Part (a))

Keypads Display screens

$ $
Direct materials 164,000 118,320
Direct labour 40,000 60,000
Heat and power
Machine set up costs: (activity related only) 27,500 30,000
______ ______
Total variable costs of producing 80,000 units each 231,500 208,320
⇒ cost per unit (total÷ 80,000) $2.89 $2.60
(c) Non-financial factors

The company offering to supply the keypads and display screens is a new company. Many new
businesses fail within the first year of starting and without these two crucial components, Robber would
be unable to meet demand for sales of control panels.

The supplier has only agreed to these prices for the first two years. After this, it could put up its prices
dramatically. It might be difficult for Robber to begin making its components in house again.

The quality of the components could not be guaranteed. If they turn out to be poor quality, this will give
rise to problems in the control panels, leading to future loss of sales and high repair costs under
warranties for Robber.

Tutorial note: The key word in the requirement for part (c) was discussed. This means you need to write
more detail about each point you made, rather than just listing factors. You would gain at least two marks
for a well discussed point, so the answer above would be more than enough to get the five marks
available for this part.
Other relevant points would also gain credit.
 Universal Health Systems
(a)

In a manufacturing company, target costing applies to a particular product so we begin in step 1 by specifying a
product that the company wishes to sell. This will involve an analysis of the market and a determination of what
product features are of interest to customers.

In step 2 the price at which the product will be sold is considered. This will be a market driven price based on
what a customer is willing to pay for the product or their perceived value of that product. This is referred to as the
target price.

The company then in step 3 calculates the profit that is required from the sale of this product. This profit is
usually determined by what the company investors may deem to be an acceptable return on their investment.
This can be referred to as the required profit or the target profit.

In step 4 we determine the target cost. This is calculated by subtracting the required profit (as we have
discussed in step 3) from the product selling price (seen in step 2). The target cost represents the lowest
acceptable cost of the product. If the estimated costs of that same product are greater than the target cost then a
cost gap exists.

In step 5 this cost gap needs to be closed meaning a review of the costs incurred during the product’s design
and production stages. It is important, however, that the quality of the product is not impaired as a result of any
cost reductions.

Finally, in step 6, if a cost gap still exists the company could consider negotiating with customers in order to
determine whether the manufacture of the product proceeds.

(b)

Four characteristics of services:

Spontaneity: Unlike manufactured goods, a service is consumed at the exact same time that it is produced or
made available. Or in other words, the service does not exist until the point where it is experienced by the
customer.

Perishability: Because the service is consumed immediately then it is perishable. Hence, unlike a manufactured
good, a service cannot be stored or placed in inventory.

Intangible: A service cannot be seen or touched, hence it is intangible. This obviously differs to a manufactured
product which has physical substance and can be seen and touched.

Unique: As a service involves people and typically human interaction, then no two services can ever be seen to
be homogenous. While standardisation of a service may be expected by the customer, this is very difficult to
provide.

Unlike a manufactured product, there is no transfer of ownership when a service is provided.

Also, services industries rely heavily on their staff who have interaction with customers and are representative of
the company’s brand.
(c)

(i)

UHS receives a pre-set income for each service. So, this could be representative of the target price.

As the UHS Trust is a not-for-profit organisation there may not be need to deduct a profit margin from the target
price. However, as alluded to in the scenario given costs have been exceeding income perhaps a profit margin
could be justified. Deducting a profit margin from the target price calculates the target cost.

(ii)

The UHS trust is paid for transplants and operations on the basis of actual costs incurred. In the absence of a
required profit margin the target cost could be based on this actual cost, perhaps using an average cost of past
transplants and operations. In order to encourage cost savings, the target cost could also be based on the
minimum cost incurred for such services in the past. Any effort to reduce costs should not dilute the quality of the
service.

(d)

Target costing applies to a particular product or service. So it is necessary for UHS Trust to have a clear view or
definition of the service. Currently, different trusts define their services differently. UHS Trust seems to split their
services between pre-set tariff services and other services. Establishing a clear definition of each service could
prove to be difficult.

Calculating a target cost could be difficult. Some of the services have a fixed or pre-set tariff so the obvious
target cost would be this fixed tariff. However, we are also told that some services are provided for at a cost
above and below this amount. Hence there is no obvious cost to use as a target. Also, setting a target cost that
is unrealistically low would only serve to demotivate staff. Similarly, a target cost that is seen to be high will not
encourage cost reduction.

We are told that the Trust costing systems are poor. Deriving a target cost requires an in-depth understanding
and analysis of costs associated with each service.
It also requires that overheads or indirect costs are allocated to services on a reasonable and consistent basis.
This would prove very difficult given a sub-standard costing system.
 Brace
The balanced scorecard is a management technique for assessing and communicating the performance of the
business. It focuses on both financial and non-financial performance indicators and provides a link between an
organisation’s strategy and its short-term operations and performance measurements. It does this across four
perspectives:

1) Financial Perspective

The financial perspective considers how the organisation can create value for its shareholders. The
organisation might focus on increasing revenues, reducing costs or utilising its assets more efficiently. Its
performance here might be measured in terms of increased net profit margin or perhaps increased return
on investment.

2) Customer Perspective

The customer perspective considers how the organisation appears to customers. The aim of the
organisation is to achieve total customer satisfaction. A link exists between the customer perspective
and the financial perspective in that a happy customer today should mean increased revenue and profits
in the future. The organisation’s performance here might be assessed by a reduction in the number of
customer complaints or an increase in the number of customer visits.

3) Internal Perspective

The organisation must identify the internal business processes that are critical to the implementation of
its strategy. In other words, the aim here is for the efficiency of its operations in order to achieve the
customer and the financial objectives. Performance assessment of from an internal perspective could be
in terms of reducing staff turnover or the number of mistakes or perhaps increasing the organisation’s IT
capability.

4) Innovation Perspective

The aim of the organisation here is constant learning and growth. The organisation must continue to
develop and provide capabilities that will achieve the internal, customer and financial objectives. For
example, increasing staff training or enhancing research and development expenditure might result in
fewer staff mistakes (internal perspective), hence increasing customer satisfaction (customer
perspective) which in turn increases the organisation’s profit (financial perspective).

(b)

Assessment of divisional performance can be based on the return on its investment. This is calculated as the net
profit of that investment divided by the investment cost.

So for Division A, the net profit can be calculated as the sales of 44.6m multiplied by the net profit margin of 28%
giving a profit of 12.49m. The capital required has been given to us as $82.8m meaning a return on investment
of 15.08% for Division A.

Similarly, for Division B, net profit of $7.19m is derived from the net profit margin of 33% multiplied by the sales
revenue of 21.8m. When expressed as a % of the investment required of 40.60m a return on investment of
17.72% is calculated.
The residual income is calculated as the profit minus the imputed interest charge. The imputed interest charge
represents the minimum acceptable return to the investors, calculated as the investment cost multiplied by the
company’s cost of capital. Generally, if the residual income is positive the investment is acceptable to the
Division.

So, for Division A, the profit of $12.49m is the same as that calculated in the return on investment calculation.
The imputed interest charge of $8.84m is calculated as the company’s cost of capital of 12% multiplied by the
necessary investment of $82.8m. The residual income for Division A’s investment is 2.55m positive.

For Division B residual income of 2.32 positive is also calculated based on the profit of 7.19 less the imputed
interest charge of 4.87. The imputed interest charge here is also indicative of the minimum return required by
investors of 12% on B’s investment of $40.6.

Using return on investment as a basis for making a decision, a division will only deem a project or an investment
to be acceptable if it increases its return on investment. Each division currently has the ROI of 16% meaning
Division A’s investment would be rejected given a 15.08% ROI. If it were accepted then Division A’s overall ROI
would fall below its current level of 16%.

Division B, however, would accept the investment as the expected 17.72% ROI exceeds the current ROI of 16%
meaning overall ROI would increase.

Given the cost of capital for both divisions is 12% it can be argued that both investments should be accepted as
it would benefit the company as a whole. Hence the decision of Division A is not in the best interests of the
company. This supports the view of the sales manager that using ROI as a decision-making tool can lead to a
lack of goal congruence between the divisions and the company.

Indeed using residual income as a basis for making a decision would result in the investments in Division A and
Division B being accepted given that residual income for both investments is positive. Accepting both would be
in the best interests of the company meaning divisional and company goal congruence would be achieved. This
is consistent with the views of the new sales manager.
 Heat
(a)

(i) Demand equation

P = a - bQ

P - the price

a - the price at which demand is zero

Q - the quantity demanded

Change in price
b=
Change in quantity

Using the information given in the scenario, we can calculate b:

b = = 15 / 15,000 = 0.015

We are also told that if the company set the price at $735, only 1,000 units would be demanded. Therefore:

735 = a - 0.015 * (1000)

735 = a - 15

a = 750

Now we can establish the demand equation:

P = 750 - 0.015Q

(ii) Learning curve

Y = axb

Y - the cumulative average time per unit to produce x units

a - the time taken for the first unit of output

x - the cumulative number of units

b - the index of learning (logLR / log2)

LR - the learning rate as a decimal

Using the note from the scenario, we can establish the following values:

a = 1.5
b = -0.0740005 = log 95 / log 2

Now we need to figure out how long does it take to produce the 100th unit:

Y = the cumulative average time per unit to produce x units

Y100 = the cumulative average time per unit to produce 100 units

Total time for 100 units = Y100 * 100 units

Y99 = the cumulative average time per unit to produce 99 units

Total time for 99 units = Y99 * 99 units

th
Y100 * 100 units - Y 99 * 99 units = time per 100 unit

As we have values for a and b, we can calculate the time to produce 100th unit:

Y = axb

a = 1.5 a = 1.5
b = -0.0740005 b = -0.0740005 x = 100 x = 99

Y100 = 1.5 * (100) -0.0740005 = 1.066818 Y99 = 1.5 * (99) -0.0740005 = 1.067612
Total time for 100 units = 1.066818 * 100 units = Total time for 99 units = 1.067612 * 99 units = 106.6818
hours = 105.6936 hours

Time for 100th unit = Total time for 100 units - Total time for 99 units = 106.6818 - 105.6936 = 0.9882

Labour cost for 100th unit = 0.9882 * 8 = $7.91

The marginal cost is the cost of producing one more unit. To produce one more unit we just have to pay variable
cost as fixed costs have already been paid for. We are told that direct materials are $42 per unit. Therefore:

$
Direct materials 42
Labour 7.91
Marginal cost 49.91

(iii) Optimum Price / Quantity

Profits are maximised when marginal cost equals marginal revenue:

MR = a - 2bQ

Marginal cost = $49.41

a = 750
b = 0.015

49.91 = 750 - 2 * (0.015) * Q

0.3Q = 700.09

Q = 23,336 units

In part (i) we established the demand equation:

P = 750 - 0.015 * Q

Q = 23,336 units

P = 750 - 0.015 * (23,336)

P = $399.96

Optimum price = $399.96

Optimum quantity = 23,336 units

 Cement
(a)

Pay off table

Supply

350,000 280,000 200,000

Weather Probability
$’000 $’000 $’000

Good $’000 0.25 1,750 (1) 1,400 (2) 1,000

Average $’000 0.45 1,085 1,400 1,000

Demand
Poor $’000 0.3 325 640 (3) 1,000

We are told that if a bag of cement is produced and sold then this will generate a profit of $5, being $9 of sales
less $4 of cost.

However, if a bag is produced and not sold then the loss to the company is the $4 production cost plus the $0.50
disposal cost of each bag, equalling $4.50 per unsold bag.

(1) So, if for example, the weather is good (meaning customer demand is 350,000) and the company also
produces 350,000, then a profit of $1,750,000 will be generated.

(2) Let’s look at another scenario. If for example, the weather is good (meaning customer demand is 350,000)
and the company only produces 280,000, then profit will be limited to $1,400,000 (being 280,000 * $5 profit)

(3) However, if customer demand were only 200,000 (due to poor weather) and company production was
280,000 then the company would have unsold bags of cement of 80,000. Thus, profit generated would be
$640,000 - calculated as $1m (being 200k bags sold for $5 profit) less $360,000 of costs (being 80k unsold bags
at a cost of $4.50)

The remaining 6 calculations work in a similar fashion.

(b)

The maximin approach to decision making means we should assume the worst possible outcome (in this case
the lowest profit) for each of the 3 production levels and then choose the best of these.

So, at a production level of 350k, the lowest profit is $325k; at a production level of 280k, the lowest profit is
$640k, while when producing 200k bags of cement the lowest possible profit is $1 million. The best of these
possible profits is $1m meaning the company should choose to produce 200,000 bags of cement.

The maximax approach to decision making means we should choose the best outcome (or highest profit) for
each of the 3 production levels and then choose the best of these.

So, at a production level of 350k, the highest possible profit is $1,750k; at a production level of 280k the highest
profit is $1,400, while at a production level of 200k bags of cement the highest possible profit is $1 million. The
best of these possible profits is $1,750k meaning, according to the maximax decision making rule, the company
should choose to produce 350,000 bags of cement.

Using the expected value approach to decision making, we apply the probabilities (which are given to us in the
question) to the profits (as calculated in the pay off table) so as to calculate the expected value (profit) of each of
the company’s production levels.

So, if the company chooses to produce 350,000 bags of cement, it could make a profit of $1.75m if the weather
is good, $1.085m is the weather is average or $325k if the weather is poor. The probability of each of these
weather conditions (or profits) arising is 25%, 45% and 30% respectively.
We multiply each possible profit by the probability of that profit arising. To calculate the expected profit at this
production level we then add these results together.

Hence at a production level of 350,000 we add: (25% x $1,750,000) + (45% x $1,085,000) + (30% x $325,000) =
$1,023,250

At a production level of 280,000 we add (25% x $1,400,000) + (45% x $1,400,000) + (30% x $640,000) =
$1,172,000

At a production level of 200,000 we add (25% x $1,000,000) + (45% x $1,000,000) + (30% x $1,000,000) =
$1,000,000

The company will then choose the highest expected profit of $1,172,000, thus deciding upon a production level
of 280,000 bags.

(c)

In the maximin approach to decision making the decision maker does not have certainty as to the outcome. He
assumes the worst possible outcome will arise in each situation. The best of these outcomes is then chosen.
This is seen as a pessimistic approach to decision making and is used by a decision maker who is risk averse.

The expected value approach to decision making calculates the long-term weighted average value given a
range of possible values and their related probabilities. It assumes the decision will have to be made again and
again and thus, by calculating an average, can be seen as a risk neutral approach to decision making. Expected
values should not, therefore, be applied to one-off decisions.
 BFG
Part (a)

S-Pro success in achieving target net cash flow

Sales 120,000 units
Sales Revenue $1,260,000
Costs:
Direct materials (W1) $514,000
Direct Labour (W2) $315,423
Variable overhead $126,169
Rent $180,000
–––––––––
Net cash flow $124,408
–––––––––
Target cash flow $130,000

The target cash flow will not be achieved

Workings

(1) Direct material: Batches

$
First 200 @ $500 100,000
Second 200 @$450 90,000
Remaining 800 @$405 324,000
–––––––––
Total 514,000
–––––––––

(2) Direct labour

For first seven hundred batches y = axb
y = 2,500 × 700–0.3219
y = $303.461045
Total cost for first 700 batches = $303.461045 × 700 = $212,423

All batches after the first 700 will have the same cost as the 700th batch. To calculate the cost of the 700th
batch we need to take the cost of 699 batches from the cost of 700 batches.

For 699 batches y = axb

y = 2,500 × 699–0.3219
y = $303.600726

Total cost for first 699 batches = $303.600726 × 699 = $212,217

Cost of 700th batch is $212,423 – $212,217 = $206
Total cost for the 12 months of production
$212,423 + ($206 × 500) = $315,423

(3) Variable overhead is $2 per hour or 40% of direct labour

Part (b)

Effect of learning rate

To calculate the learning factor BFG will have had to measure the time taken to make the first batch (500 hours)
and then the time taken to make the second batch. The learning rate measures the relationship between the
average time taken between two points as production doubles. The easiest way to measure the learning rate is
when the production doubles between the first and second batches.

At 80%
Time for first batch 500
Average time for two batches @80% 500 × 0.8 = 400
Total time for two batches 2 × 400 = 800
Time for second batch 800 – 500 = 300

At 90%
Time for first batch 500
Average time for two batches @90% 500 × 0.9 = 450
Total time for two batches 2 × 450 = 900
Time for second batch 900 – 500 = 400

The 80% learning rate reduces the time taken for the two successive batches above by a greater amount (or
faster). Hence the 80% learning rate is the faster learning.

Part (c)

Possible actions to improve the net cash flows are:

 Increase the price charged. The question states that an agreed specification has been reached, however
further research may reveal that a higher price could be tolerated by the market. Equally a form of price
skimming may be possible to improve short term net cash flow.

 Reduce the labour cost per batch by removing unnecessary operations or processes. It may be possible to
simplify the design without damaging the ability to achieve the price stated.

 Improve the learning rate. This may involve improving the training or the quality of people involved in the
production process. This does takes time and costs money in the short run.

 Consider substitute materials (without damaging the product specification). Also look for new suppliers to
reduce the input cost.

 Consider ways to reduce the level of variable overhead incurred by the product.

 Investigate whether the production of product X could take place in existing space and hence avoid the extra
rent charge. Re-negotiate the rent charge with the landlord.
 Preston

Part (a) - Financial analysis

Revenue increased by 5% from the previous year to the current year. It can be seen that average fee levels
rose by 29% but the number of clients fell from 1500 to 1229. This loss of clients is a concern, as it suggests that
clients are either not happy with the services or find the increase in fees to much.

The net profit margin has fallen from 20% to 19.8% suggesting that cost control may be getting worse. This is
particularly surprising given the increase in fee levels.

Profit is up 3.9%. This is higher than inflation. In absolute terms profits are impressive given that Richard
Preston is the sole partner owning 100% of the business.

Average cash balances are up 5% – indicating improved liquidity. Positive cash balances are always welcome
in a business.

Average receivables days are down by 3 days – indicating improved efficiency in chasing up outstanding debts.
It is noticeable that Preston’s days are lower than the industry average indicating strong working capital
management.

Overall, while profits and revenues have risen, we would expect higher growth in these, given the high increase
in fees.

Workings
945  900
1. Increase in revenue – previous to current year = 900 × 100 = 5%

775  600
2 Increase in average fees = 600 × 100 = 29%

3. Net profit margin

Current year Previous year
netprofit 187 180
= revenue × 100 945 × 100 900 × 100

19.8% 20.0%

Part (b) - Non financial performance

Internal business processes

Error rates
Error rates for jobs done are up from 10% to 16%. This is very bad as users expect the accounts to be correct.
Errors could lead to problems for clients with the tax authorities, bankers, etc. The increase in error rates might
be due to pressure to increase jobs quicker, as the completion time has fallen from 10 weeks to 7 weeks.
However, job completion time should not be reduced so quickly if it leads to errors.

Customer Knowledge
Client retention
The number of clients has fallen dramatically – this is alarming and indicates a high level of customer
dissatisfaction. In an accountancy practice one would normally expect a high level of repeat work – for example,
tax computations will need to be done every year. Clearly existing clients are not happy with the service
provided.

Market share
The result of the above two factors is a fall in market share from 20% to 14%. The firm should be doing much
better and looks to being left behind by competitors.

Learning and Growth

Non-core services
The main weakness of the firm seems to be is its lack of non-core services offered. The industry average
revenue from non-core work has increased from 25% to 30% but Richard’s figures have dropped from 5% to
4%. It would appear that most clients are looking for their accountants to provide a wider range of products but
Richard is ignoring this trend.

Employee retention
Employee turnover is up indicating that the staff are dissatisfied. Continuity of staff at a client is important to
ensure a quality product. Conservative clients may resent revealing personal financial details to a variety of
different people each year. Staff turnover is possibly a result of extra pressure to complete jobs more quickly
without the satisfaction of a job well done. Also staff may realise that the lack of range of services offered by the
firm will limit their own experience and career paths

Conclusion
In conclusion, the financial results do not show the full picture. The firm has fundamental weaknesses that need
to be addressed if it is to grow into the future. At present it is being left behind by a changing industry and
changing competition. It is vital that Richard reassesses his attitude and ensures that the firm has a better fit with
its business environment.

In particular he should seek to develop complementary services and reduce errors on existing work.