Performance Management

PART 3 FRIDAY 8 DECEMBER 2006

QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A BOTH questions are compulsory and MUST be answered TWO questions ONLY to be answered

Section B

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

Paper 3.3

Section A BOTH questions are compulsory and MUST be attempted 1 Wonderland plc, which is based in Robynland, owns Cinola Island which is located off the coast of Robynland. On Cinola Island, Wonderland plc operates a circus and zoological gardens (zoo) both of which are open for 365 days per annum. The circus, which is widely regarded as the best in the world, can accommodate a maximum of 14,000 visitors per day. The zoological gardens, which opened on 1 December 1999, can accommodate a maximum of 20,000 visitors per day. Visitors travel to and from Cinola Island using petrol-driven ferries owned by Wonderland plc. There is no other mode of transport to and from Cinola Island. The following information is available in respect of the year ended 30 November 2006 and the year ending 30 November 2007. (1) The zoo and circus were open on each day of the year. The circus performed once per day and was always operated at maximum capacity. (2) Three types of ticket were sold as follows: Ticket type Z C ZC Admission to: Zoo Circus Zoo and Circus

The total of admissions to the zoo was 6,570,000. The total of admissions to the circus was 5,110,000. These totals include 4,380,000 type ZC tickets. (3) Admission fees per visitor were as follows: Category Adults Children and Senior citizens Zoo only 40 20 Circus only 40 20

Visitors who purchased ticket type ZC received a discount of 25% on the cost of separately purchasing a type Z and a type C ticket. Each ticket type was valid for one day only. (4) The visitor mix for all ticket types was as follows: Adults Children and senior citizens 40% 60%

(5) In addition to any admission fees payable, visitors paid a transport fee for the return journey to and from Cinola Island. The total transport fees received amounted to 25,550,000 of which 15,330,000 was attributable to the zoo, the remainder being attributable to the circus. (6) The management of Wonderland plc categorises all operating costs, including those relating to the operation of its petrol-driven ferries, as fixed costs. These were as follows: Zoo 130m Circus 100m

Note: The petrol-driven ferries were fully depreciated as at 1 December 2006. (7) Wonderland plc received an annual fee of 10 million from an International media group under a fixed-term contract of three years duration. The contract commenced on 1 December 2005 and relates to the rights to televise programmes which were filmed in the zoo and therefore the fee should be regarded as relating to the zoo. (8) Admission fees to the zoo and circus will be increased by 5% with effect from 1 December 2006. Transport fees will remain unchanged. (9) It is anticipated that all operating costs will increase by 4% per annum due to the impact of inflation during the year ending 30 November 2007. (10) The management of Wonderland plc expect that the number of visitors, visitor mix and ticket mix will remain unchanged during the year ending 30 November 2007. (11) Ignore taxation.

Required: (a) Prepare the budgeted profit and loss account for Wonderland plc for the year ending 30 November 2007. (9 marks) (b) Calculate the percentage of maximum capacity at which the zoo will break even during the year ending 30 November 2007. You should assume that 50% of the revenue from sales of ticket type ZC is attributable to the zoo. (7 marks) (c) The management of Wonderland plc are concerned regarding the extent to which fluctuations in zoo revenues will impact upon the total profitability of Wonderland plc during the year ending 30 November 2007. They are not concerned about fluctuations in circus revenues and are confident that it will remain at maximum capacity throughout the year. However, because Robynland has experienced considerable fluctuations in the rate of inflation during recent years, the management of Wonderland plc are also concerned regarding the impact upon profitability of any variation in the rate of inflation from the 4% allowed for, as per Note (9). The management of Wonderland plc have obtained the following forecasts regarding zoo revenues and the possible rates of inflation in respect of the year ending 30 November 2007. Zoo revenues Increase by 10% No change Decrease by 10% Probability 025 050 025 Inflation 2% 4% 8% Probability 030 040 030

Note: Transport revenues relating to the zoo would increase or decrease by the same percentage as zoo revenues. Required: (i) Using the above information, prepare a summary in an appropriate format which shows: (1) the range of possible company net profit or loss outcomes (2) the combined probability of each potential outcome (3) the expected value of net profit for the year. (ii) Calculate the probability of the net profit being less than 75 million.

(10 marks) (2 marks)

(d) The management of Wonderland plc have become concerned about the increased level of operating costs associated with its petrol-driven ferries and have made a strategic decision to dispose of these. They are now considering entering into a contract with the Newman Steamship Company (NSC), a shipping organisation based in Robynland. The contract would entail NSC providing transport to and from Cinola Island for all visitors to the zoo and circus. As a result of negotiations with NSC, the directors of Wonderland plc are considering two options whereby NSC will become responsible for the transportation of visitors to and from Cinola Island with effect from 1 December 2007 or 1 December 2008. Additional information is available as follows: (1) NSC would require Wonderland plc to pay for the necessary modifications to their steamships in order that they would satisfy marine regulations with regard to passenger transportation. The only firm which could undertake this work is currently working to full capacity and would require a payment of 2,450,000 in order to undertake the work necessary so that the ferries could be in operation by 1 December 2007. The same firm would require a payment of 1,725,000 in order to make the necessary modifications so that the ferries could be in operation by 1 December 2008. The government of Robynland would be willing to pay a grant of 8% towards the cost of getting the ferries into operation by 1 December 2007, but would not be willing to pay a grant in respect of any later date. (2) On 1 December 2002 Wonderland plc paid 500,000 to the Port Licencing Authority of Robynland. This payment was for a licence which entitles Wonderland plc to use all harbour facilities in Robynland during the five-year period ending 30 November 2007. The licence could be renewed on 1 December 2007 at a cost of 150,000 per annum.

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(3) Redundancy payments would need to be paid in respect of loss of employment. These would amount to 1,200,000 if the contract with NSC commenced on 1 December 2007. This amount would reduce to 750,000 if the contract commenced on 1 December 2008. (4) Wonderland plc has a contract for the provision of petrol for its ferries which is due to expire on 30 November 2008. Early termination of the contract would incur a penalty charge of 76,000. An emergency reserve stock of petrol held by Wonderland plc, which cannot be used after 30 November 2007 due to marine regulations regarding the age of fuel, could be sold for 55,000 on 1 December 2007 but not on any date thereafter. (5) The ferries could be sold for 3,300,000 on 1 December 2007. If retained after 1 December 2007 the ferries would require servicing during the year ending 30 November 2008 which would incur costs amounting to 150,000. The resale value of the ferries on 1 December 2008 would be 2,900,000. (6) Stock of consumable items which originally cost 150,000 could be sold on 1 December 2007 for 110,000 and on 1 December 2008 for 50,000. Required: (i) On purely financial grounds, advise whether the management of Wonderland plc should enter into a contract with NSC with effect from 1 December 2007 or 1 December 2008. You may ignore the time value of money. (9 marks) (4 marks)

(ii) Briefly discuss FOUR non-financial factors which might influence the above decision.

(e) Briefly discuss FOUR initiatives that management might consider in order to further enhance profitability. (4 marks) (45 marks)

The Information Technology division (IT) of the RJ Business Consulting Group provides consulting services to its clients as well as to other divisions within the group. Consultants always work in teams of two on every consulting day. Each consulting day is charged to external clients at 750 which represents cost plus 150% profit mark up. The total cost per consulting day has been estimated as being 80% variable and 20% fixed. The director of the Human Resources (HR) division of RJ Business Consulting Group has requested the services of two teams of consultants from the IT division on five days per week for a period of 48 weeks, and has suggested that she meets with the director of the IT division in order to negotiate a transfer price. The director of the IT division has responded by stating that he is aware of the limitations of using negotiated transfer prices and intends to charge the HR division 750 per consulting day. The IT division always uses state of the art video-conferencing equipment on all internal consultations which would reduce the variable costs by 50 per consulting day. Note: this equipment can only be used when providing internal consultations. Required: (a) Calculate and discuss the transfer prices per consulting day at which the IT division should provide consulting services to the HR division in order to ensure that the profit of the RJ Business Consulting Group is maximised in each of the following situations: (i) Every pair of consultants in the IT division is 100% utilised during the required 48-week period in providing consulting services to external clients, i.e. there is no spare capacity.

(ii) There is one team of consultants who, being free from other commitments, would be available to undertake the provision of services to the HR division during the required 48-week period. All other teams of consultants would be 100% utilised in providing consulting services to external clients. (iii) A major client has offered to pay the IT division 264,000 for the services of two teams of consultants during the required 48-week period. (12 marks) (b) Briefly explain THREE limitations of negotiated transfer prices. (3 marks) (15 marks)

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Section B TWO questions ONLY to be attempted 3 Vision plc is a reputable manufacturer of a specialist range of optical and photographic equipment. At present, marketing activities are confined to its home market in Blinkland. The directors wish to achieve a net profit per annum of 150 million by the year ending 30 November 2009. The following information is available: Note 1: The most recent forecast covering the three year period ending 30 November 2009, based on sales of products which were in existence at 1 December 2006 to existing customers, is as follows: Year ending 30 November: Turnover Net Profit 2007 m 1000 400 2008 m 1050 420 2009 m 1100 440

Note 2: Vision plc manufactures a range of products within its three divisions, as follows: Division Astronomy Medical This division manufactures telescopic equipment which is sold via mail order to private individuals. This division manufactures microscopes and associated equipment which are sold to hospitals and schools in Blinkland. Outdoor pursuits This division manufactures a range of cameras and binoculars which are sold via mail order to private individuals. Note 3: The following became effective on 1 December 2006: (i) The company created a new division called the Oceanic division which manufactures cameras suitable for underwater use. These are sold to clubs and societies that engage in scuba diving activities. Sales revenue is forecast to be 5 million in the first year of operation with an anticipated doubling of sales volume during each of the next two years of operation. Variable costs are forecast at 40% of sales revenue in the first year of operation and are expected to reduce to 35% and 30% during each of the next two years respectively. Fixed overheads are forecast at 1 million in the first year of operation and are expected to increase by 10% per annum during each of the next two years.

(ii) The company purchased the Sound and vision chain of camera shops comprising a total of 30 retail outlets within Blinkland. Each of the 20 out of town outlets is forecast to make a profit of 750,000 and each of the 10 city outlets is forecast to make a profit of 1 million during the year ending 30 November 2007. It is anticipated that profits of out of town and city outlets will increase by 8% and 4% per annum respectively during each of the next two years. (iii) The company purchased Racquets Ltd, a well-established manufacturer of tennis, badminton and squash racquets. Racquets Ltd made a profit of 15 million during the year ended 30 November 2006 and profit is expected to increase by 1 million per annum during each of the next three years. (iv) A new camera known as the Birdcam-V was launched. This camera will allow bird-watching activities to take place during the night, irrespective of prevailing noise and weather conditions. The Birdcam-V is the only camera on the market which has special noise and weather filtering capabilities and has an expected life of three years. The marketing director has estimated that at a selling price of 600 per unit, a total of 85,000 units per annum would be sold during the year ending 30 November 2007 and that each increase or decrease in the selling price of 10 will cause quantity demanded to decrease or increase by 1,000 units. The variable cost per unit is expected to remain constant at 180. Development costs amounting to 45,967,500 are to be written off evenly over the expected life of the Birdcam-V. The directors of Vision plc have agreed to adopt the combination of selling price and output that will maximise profit earned from sales of the BirdcamV.

Required: (a) Calculate the profit gap that is forecast to exist at 30 November 2009. (b) (i) (10 marks)

Explain how the use of Ansoffs product-market matrix might assist the management of Vision plc to reduce the profit-gap that is forecast to exist at 30 November 2009. (3 marks)

(ii) Explain how the existing product range and the actions per Note (3) would feature in Ansoffs product-market matrix. (7 marks) (20 marks)

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Our Timbers Ltd is a market leader in the supply of timber-based products to the construction industry. The company has two divisions, namely the RP division which manufactures products used in the construction of residential properties and the IP division which manufactures products used in construction of industrial properties. The following information is available in respect of the three year period ended 30 November 2006: (1) (i) Net Assets as at 30 November were as follows: 2006 000 75,600 64,400 140,000 19,200 2005 000 64,800 55,200 120,000 18,000 2004 000 54,000 56,000 110,000

Fixed Assets (net book value) Net Current Assets Net Assets Fixed Assets acquired during year

Note: No disposals of fixed assets took place during the above periods. (ii) The total capital employed of Our Timbers Ltd was invested in the divisions during each year as follows: Division RP IP % of total capital employed 40 60

(iii) Depreciation is charged at 10% per annum on a reducing balance basis. (2) Operating cash flows were as follows: Division RP IP 2006 m 144 200 2005 m 131 180

(3) Each division has a target rate of return of 225% on average capital employed throughout each year. Divisional managers are eligible to receive an annual bonus amounting to 10% of annual salary if the target rate of return is achieved. Required: (a) (i) Calculate the return on the average capital employed by each of the divisions during the years ended 30 November 2005 and 30 November 2006. (6 marks)

(ii) Comment briefly on how divisional managers might respond to the results achieved and ONE potential problem that might be experienced by Our Timbers Ltd. (2 marks) (b) Until 30 November 2006 the company outsourced its entire sales administration and would have incurred service costs amounting to 3,855,000 and 4,895,000 in respect of divisions RP and IP during the year ending 30 November 2007. However, a strategic decision was taken to establish an in-house division known as the Sales division which would be dedicated to servicing the needs of divisions RP and IP and therefore would not provide any service whatsoever to any other party. The sales division became operational on 1 December 2006. (1) Budgeted information in respect of the year ending 30 November 2007 is as follows: Division Average capital employed Profit before service costs RP m 52 12 IP m 78 16 Sales m 9

(2) The management accountant has prepared a detailed analysis of the budget of the sales division for the year ending 30 November 2007 which is as follows: Total 000 4,100 900 1,000 1,000 7,000 Quotation Order preparation processing 000 000 1,400 1,500 50 350 200 400 150 150 1,800 2,400 Quotations 1,022,000 Sales orders 817,600 Invoice generation 000 250 250 50 50 600 Invoices 511,000 Customer Management visits costs 000 000 200 750 200 50 50 300 350 300 800 1,400 Visits 2,500

Salaries Consumable items IT costs Sundry operating costs Total Cost driver Activity volume

(3) The estimated usage of the Sales division by the RP and IP divisions is as follows: Division Number Number Number Number of of of of quotations prepared sales orders processed invoices generated customer visits RP 255,500 204,400 102,200 2,000 IP 766,500 613,200 408,800 500

(4) The company owns tree plantations from which it satisfies 100% of its requirement for timber during each year. The managing director of Our Timbers Ltd has proposed that all services provided by the Sales division to the RP and IP divisions during the year ending 30 November 2007 should be invoiced on the basis of cost plus 30% with all costs, other than management costs, split according to the estimated usage data detailed in note (3) above. Management costs would be shared equally between divisions RP and IP. Required: (i) Evaluate the proposal of the managing director and comment on its likely acceptance by the managers of the three divisions. (9 marks)

(ii) Comment briefly on the use of its own tree plantations as a source of raw materials by Our Timbers Ltd. (3 marks) (20 marks)

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A management accounting focus for performance management in an organisation may incorporate the following: (1) the determination and quantification of objectives and strategies (2) the measurement of the results of the strategies implemented and of the achievement of the results through a number of determinants (3) the application of business change techniques, in the improvement of those determinants. Required: (a) Discuss the meaning and inter-relationship of the terms (shown in bold type) in the above statement. Your answer should incorporate examples that may be used to illustrate each term in BOTH profit-seeking organisations and not-for-profit organisations in order to highlight any differences between the two types of organisation. (14 marks) (b) Provide an example that illustrates a structured application of the terms contained in the above statement in respect of a profit-seeking organisation OR a not-for-profit organisation of your own choice. (6 marks) (20 marks)

End of Question Paper

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