# Paper P1 Performance Operations Post Exam Guide September 2013 Exam. General Comments

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2 Section A 20 marks ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION Question 1.1 AB is preparing its cash budget for next year. The estimated accounts payable balance at the beginning of next year is \$540,000. The budgeted purchases for next year are \$6,800,000, occurring evenly throughout the year. It is estimated that 75% of purchases will be on credit and the remainder will be for cash. The company pays for credit purchases in the month following purchase. The budgeted cash payments to suppliers next year are: A \$6,375,000 B \$6,773,333 C \$6,915,000 D \$5,215,000 (2 marks) Workings \$ Cash paid from previous period 540,000 Purchases for this budget period 6,800,000 7,340,000 Purchases not paid until next period (\$6,800,000 x 75% x 1/12) Total cash paid (425,000) 6,915,000 The correct answer is C. Question 1.2 A just-in-time (JIT) purchasing system may be defined as: A B C D A purchasing system in which the purchase of material is contracted so that the receipts and usage of material coincide. A purchasing system which is based on estimated demand for finished products. A purchasing system where the purchase of material is triggered when inventory levels reach a pre-determined re-order level. A purchasing system which minimises the sum of inventory ordering costs and inventory holding costs. (2 marks) The correct answer is A. The Chartered Institute of Management Accountants 2013 Page 2

3 The following data are given for sub-questions 1.3 and 1.4 below A company is estimating its costs based on past information. The total costs incurred by the company at different levels of output were as follows: Output (units) Total costs \$ 160,000 2,420, ,000 2,775, ,000 2,840,000 The company uses the high-low method to separate total costs into their fixed and variable elements. Ignore inflation. Question 1.3 The estimated total costs for an output of 205,000 units is: A \$2,870,000 B \$3,050,000 C \$3,064,211 D \$3,080,857 (2 marks) Workings Variable cost per unit = (\$2,840,000 \$2,420,000) / (190, ,000) = \$420,000 / 30,000 = \$14 per unit Fixed costs = \$2,840,000 (190,000 x \$14) = \$180,000 Total costs at 205,000 units = (205,000 x \$14) + \$180,000 = \$3,050,000 The correct answer is B. The Chartered Institute of Management Accountants 2013 Page 3

4 Question 1.4 The company has now established that there is a stepped increase in fixed costs of \$30,000 when output reaches 180,000 units. The estimate of total costs for an output of 175,000 units using the additional information is: A \$2,645,000 B \$2,275,000 C \$2,615,000 D \$2,630,000 (2 marks) The correct answer is C. Workings Cost before stepped increase = \$2,840,000 - \$30,000 = \$2,810,000 Variable cost per unit = (\$2,810,000 - \$2,420,000) / (190, ,000) = \$390,000 / 30,000 = \$13 Fixed costs at 190,000 units = \$2,840,000 (190,000 x \$13) = \$370,000 Total costs at 175,000 units = (175,000 x \$13) + (\$370,000 - \$30,000) = \$2,615,000 Question 1.5 A company is considering investing in a project with an expected life of four years. The project has a positive net present value of \$280,000 when cash flows are discounted at 12% per annum. The project s estimated cash flows include net cash inflows of \$320,000 for each of the four years. No tax is payable on projects of this type. The percentage decrease in the estimated annual net cash inflows that would cause the company s management to reject the project from a financial perspective is, to the nearest 0.1%: A 87.5% B 21.9% C 3.5% D 28.8% (2 marks) The correct answer is D. The Chartered Institute of Management Accountants 2013 Page 4

5 Workings Net Present Value of the project = \$280,000 Present value of the annual cash inflow = \$320,000 x = \$971,840 Sensitivity = \$280,000/\$971,840 = 28.8% Question 1.6 A bond has a coupon rate of 6% per annum and will repay its face value of \$100 on its maturity in four years time. The yield to maturity on similar bonds is 4% per annum. The annual interest has just been paid for the current year. Required: Calculate the expected market value of the bond at today s date. (3 marks) Workings Yield to maturity of similar bonds is 4% therefore use 4% as the discount rate. Year(s) Description Cash flow \$ Discount Factor (4%) Present Value \$ 1-4 Interest Redemption Market value The current expected market value of the bond is therefore \$ Or alternatively: Year(s) Description Cash flow \$ Discount Factor (4%) Present Value \$ 1-3 Interest Redemption & Interest Market value The Chartered Institute of Management Accountants 2013 Page 5

6 Question 1.7 A company has annual sales revenues of \$30 million and the following working capital periods: Inventory conversion period Accounts receivable collection period Accounts payable payment period 2.5 months 2.0 months 1.5 months Required: Production costs represent 70% of sales revenue. Calculate the total amount held in working capital excluding cash and cash equivalents. Workings Inventory \$30m x 0.7 x 2.5/12 = \$4.375m Accounts receivable \$30m x 2/12 = \$5m Accounts payable \$30m x 0.7 x 1.5/12 = \$2.625m Total working capital is \$4.375m + \$5m - \$2.625m = \$6.75m The Chartered Institute of Management Accountants 2013 Page 6

7 Question 1.8 A company uses 40,000 units of a particular item of inventory each year. Demand is predictable and spread evenly throughout the year. Ordering costs are \$70 per order and the cost of holding one unit in inventory is \$1.40 per annum. Required: (i) Calculate the economic order quantity (EOQ). (2 marks) (ii) Calculate the total annual ordering and holding costs for the inventory item assuming the company uses the EOQ and no buffer inventory is held. (2 marks) (Total for sub-question 1.8 = 4 marks) Workings (i) EOQ = Where: C o (cost per order) = \$70 D = (annual demand) = 40,000 units C h = (cost of holding one unit for one year) = \$1.40 EOQ = = 2,000 units (ii) Number of orders = 40,000 / 2,000 = 20 per year Ordering costs = 20 x \$70 = \$1,400 Holding costs = 2,000 x 0.5 x \$1.40 = \$1,400 Total ordering and holding costs = \$2,800 The Chartered Institute of Management Accountants 2013 Page 7

8 Section B 30 marks ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE Question 2(a) Explain the three categories of motives for holding cash given above. (5 marks) Rationale The question assesses learning outcome E1(a) explain the importance of cash flow and working capital management. It examines candidates ability to explain a company s motives for holding cash. Suggested Approach Candidates should consider each of the three motives for holding cash and clearly explain their meaning. Marking Guide Explanation of transaction motive Explanation of precautionary motive Explanation of speculative motive Maximum marks awarded Marks per valid point Max 2 marks per motive 5 marks Examiner s comments There were a few very good answers where candidates clearly knew the motives and could provide examples of each. However many candidates had no idea and guessed at what the terms meant which was quite successful for some but not so successful for others. It was quite easy to guess that the precautionary motive is to keep cash for an unexpected event but it was then harder for candidates to expand on this. It was also harder for candidates to guess at the meaning of the speculative motive and just saying that the transaction motive was to hold cash for transactions was too vague. Common errors 1. Failure to expand on points made. 2. Giving very vague answers. The Chartered Institute of Management Accountants 2013 Page 8

9 Question 2(b) Calculate the maximum amount that should be paid for the information from the market research company. (5 marks) Rationale The question assesses learning outcome D1(e) calculate the value of information. It examines candidates ability to calculate the value of perfect information where there is uncertainty regarding expected cash flows. Suggested Approach Candidates should firstly calculate the expected value of the net present value for each project without perfect information. They should then select the best outcome from each of the possible consumer reactions and apply the probabilities to these to calculate the expected value with perfect information. The value of perfect information can then be calculated as the difference between the expected value with perfect information and the best of the expected values without perfect information. Marking Guide Calculation of expected value without perfect information Calculation of expected value with perfect information Value of perfect information Maximum marks awarded Marks 1 ½ marks 2 ½ marks 5 marks Examiner s comments There were many correct answers to this question but not enough considering how many times this has been examined. Most candidates could calculate the expected value (EV) of the three projects but many did not know what to do after that. Some candidates added the expected value of the three projects together and stated that the value of perfect information was \$1,474. The candidates who then went on to calculate the EV with perfect information generally knew how this was done. Common errors 1. Calculating the expected value of the consumer reaction rather than the expected value of the projects. 2. Comparing the total of the expected values of the projects to the total of the three best outcomes. 3. Lack of understanding of how to calculate the expected value with perfect information. The Chartered Institute of Management Accountants 2013 Page 9

10 Question 2(c) Explain the potential benefits for a company from using a just-in-time (JIT) production system. (5 marks) Rationale The question assesses learning outcome A1(h) explain the impact of just-in-time manufacturing methods on cost accounting and the use of back-flush accounting when work-in-progress is minimal. It examines candidates ability to explain the potential benefits to a company from using a just-in-time production system. Suggested Approach Candidates should firstly explain how a just-in-time production system operates and then clearly explain the potential benefits of this for the company. Marking Guide Explanation of benefits of JIT production Maximum marks awarded Marks per valid point 5 marks Examiner s comments This question was generally well answered and most candidates achieved at least a pass mark. Candidates generally knew what a JIT production system was and explained the reduction in inventory and the associated cost savings. However listing several different types of cost that would be saved as a result of low inventory levels did not gain further marks. Many candidates discussed special supplier relationships but some did not provide any benefits of this relationship. A few candidates also discussed TQM and the potential benefits to customers. Common errors 1. Giving very general answers. 2. Giving limited answers that only considered the benefits of low inventory levels. 3. Not explaining the benefits of particular aspects of JIT. The Chartered Institute of Management Accountants 2013 Page 10

11 Question 2(d) Calculate whether it is financially beneficial for the company to use the factor. (5 marks) Rationale The question assesses learning outcome E1(e) analyse trade debtor and creditor information. It examines candidates ability to calculate whether it is financially beneficial for a company to use a factor. Suggested Approach Candidates should firstly calculate the costs if the company uses the factor including the factoring fee, annual interest charge from the factor and the overdraft interest. They should then deduct the saving in credit control costs to arrive at the net cost of factoring. They should then calculate the cost if the company does not use factoring and compare this to the net cost of factoring. Marking Guide Cost of using factoring: Factoring fee Annual interest Overdraft interest Savings in credit control costs Cost if factoring not used: Overdraft interest Decision Maximum marks awarded Marks ½ mark ½ mark 5 marks Examiner s comments This question was not well answered. Most candidates managed to calculate the factoring fee of \$40,150 and the cost saving of \$30,000 but few candidates were able to correctly calculate the interest charge from the factor or the overdraft interest. Many candidates made an attempt to calculate the cost of factoring but then did not know what to compare it with. In some scripts it was impossible to determine whether the candidate s concluding statement was correct as the workings were poorly set out and often unlabelled. Common errors 1. Failure to correctly calculate the annual interest charge. 2. Failure to correctly calculate the overdraft interest. 3. Lack of understanding of the correct approach to the question. 4. Lack of labelling of workings. 5. Poorly laid out workings. The Chartered Institute of Management Accountants 2013 Page 11

12 Question 2(e) (i) Calculate the figures that are required to complete the pay-off table. (2 marks) (ii) Apply the minimax regret criterion to determine the number of batches that should be prepared each day. (3 (3 marks) (Total for sub-question (d) = 5 marks) Rationale The question assesses learning outcome D1(a) analyse the impact of uncertainty and risk on decision models that may be based on relevant cash flows, learning curves, discounting techniques etc. It examines candidates ability to produce a pay-off table and then use the pay-off figures to determine the decision that would be made if the minimax regret criterion is applied. Suggested Approach Candidates should firstly complete the pay-off table based on the combination of the number of batches of sandwiches prepared and the demand for sandwiches. They should then prepare a regret matrix showing the regret at each of the different levels of demand. The maximum regret at each of the different number of batches prepared can then be identified. The decision should then be based on the number of batches which will minimise the maximum regret. Marking Guide (i) Payoff table for 22 batches Payoff table for 23 batches (ii) Regret matrix Decision Maximum marks awarded Marks 2 ½ marks ½ mark 5 marks Examiner s comments This question was reasonably well answered. Most candidates could do part (i) and many could produce a regret matrix. However quite a few candidates summed the regrets in the matrix rather than determining the maximum regret. The most common incorrect approach to part (i) was where candidates added \$100 to each of the figures for the preceding demand level. Candidates who did take this approach in part (i) however were still able to earn credit for their own figures in part (ii). Common errors 1. Adding \$100 to the figures for the preceding level of demand to complete the payoff table. 2. Summing the regret figures for each number of batches prepared. 3. Choosing the number of batches with the maximum regret rather than choosing the minimum of the maximum regrets. The Chartered Institute of Management Accountants 2013 Page 12

13 Question 2(f) Explain the differences between activity based budgeting and incremental budgeting. (5 marks) Rationale The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It examines candidates ability to explain the difference between an incremental budgeting system and an activity based budgeting system. Suggested Approach Candidates should clearly explain how each of the budgeting systems operates highlighting the main differences between the two systems. Marking Guide Explanation of the differences between activity based budgeting and incremental budgeting. Maximum marks awarded Marks per valid point 5 marks Examiner s comments This question was generally well answered. Most candidates were able to highlight the differences in the budgeting process under incremental and activity based budgeting and contrast the time taken and accuracy of each of the methods. A few candidates confused activity based budgeting with zero based budgeting. Common errors 1. Lack of explanation of points made. 2. Confusing activity based budgeting and zero based budgeting. 3. Discussing activity based costing rather than activity based budgeting. The Chartered Institute of Management Accountants 2013 Page 13

15 Marking Guide Part (a) Budgeted contribution Sales quantity contribution planning variance Sales price operational variance Sales quantity contribution operational variance Sales mix contribution operational variance Actual contribution Format of reconciliation statement Part (b) The sales volume variance will enable the sales manager to identify the effect on contribution of the sales team failure to meet the revised sales budget. By separating this into a sales mix and a sales quantity variance the sales manager will be able to determine how much of the total adverse variance was due to the failure to meet the total budget sales volume and how much was due to the actual sales being in a different mix from the budget mix. Marks 2 marks 2 marks 2 marks 3 marks 2 marks per valid point The sales quantity contribution operational variance compares the actual volume sold in the budgeted mix with the budgeted volume in the budgeted mix. The budgeted figures used are the revised budget after taking account of the planning variances. The variance is adverse and indicates that if 2,000 additional units had been sold in the budgeted mix a further \$255,000 contribution would have been earned. The sales mix contribution operational variance compares the actual units sold in the budgeted mix with the actual units sold in the actual mix. The budgeted figures used are the revised budget after taking account of the planning variances. It indicates the effect that a change of mix has had on the contribution earned. The variance is adverse as sales of both the deluxe and the superfast models were lower than expected using the budgeted mix. Sales of the premium model were higher than expected under the budget mix but this model has the lowest contribution. Part (c) Enables management to separate variances caused by uncontrollable factors and planning errors from variances caused by controllable factors. In this case they can separate the sales quantity variance caused by the failure of the competitor (planning variance) from the variance as a result of efficient or inefficient selling. per valid point Managers performance can be compared with the adjusted standards that reflect the conditions under which the managers actually operated Avoids dysfunctional behaviour especially where the manager s performance is being judged according to factors outside the manager s control. Allows management to assess effectiveness of planning process. Distinguish between uncontrollable planning variances and faulty standard setting. The information used in setting the ex-post standards can be used in future budgetary planning exercises. Improvements can be made to standard setting process Maximum marks awarded 25 marks The Chartered Institute of Management Accountants 2013 Page 15

17 Question 4 (a) (b) Evaluate whether the company should go ahead with the project. You should use net present value as the basis of your evaluation. (14 marks) Calculate, using the annualised equivalent method, whether the cars should be replaced after one, two or three years. You should ignore taxation and inflation. (7 marks) (c) Explain the limitations of the annualised equivalent method for making decisions to replace non-current assets. (4 marks) (Total for Question Four = 25 marks) Rationale Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis to long-run projects that continue for several years and learning outcome C2(a) evaluate project proposals using the techniques of investment appraisal. It examines candidates ability to identify the relevant costs of a project and then apply discounted cash flow analysis to calculate the net present value of the project. Part (b) assesses learning outcome C1(g) prepare decision support information for management, integrating financial and non-financial considerations. It examines candidates ability to apply the annualised equivalent method to an asset replacement decision. Part (c) also assesses learning outcome C1(g) prepare decision support information for management, integrating financial and non-financial considerations. It examines candidates ability to explain the limitations of the annualised equivalent method for making asset replacement decisions. Suggested Approach In part (a) candidates should firstly calculate the total cost of the investment and residual value of the limousines. They should then calculate the depreciation charge for each limousine and deduct this from the fixed costs. The number of days that the limousines will be operated in each year should then be used to calculate the total contribution for each year. Candidates should then identify the other relevant cash flows for each year of the project. The tax depreciation and tax payments should then be calculated. The net cash flows after tax should be discounted at the discount rate of 12% to calculate the net present value (NPV) of the project. In part (b) candidates should calculate the NPV for a one, two and three year replacement cycle. The NPV should then be divided by the annuity factor to calculate the annualised equivalent cost. The replacement cycle with the lowest annualised equivalent cost should then be selected. In part (c) candidates should clearly explain the limitations of using the annualised equivalent method for asset replacement decisions. Marking Guide Part (a) Depreciation Fixed costs excluding depreciation Contribution years 1-5 Admin costs Tax depreciation Tax payments Initial investment/residual value Present value of cash flows Net present value of cash flows Investment decision Marks 3 marks 2 marks 2 marks The Chartered Institute of Management Accountants 2013 Page 17

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