Professional Bridging Examination

Transcription

1 . Professional Bridging Examination Pilot Paper Paper II Management Accounting

2 SECTION A (Total: 40 marks) Both TWO questions in this section are compulsory and MUST be answered. They are worth 40% of the total 100 marks for this examination. Question 1 ABC Industrial Ltd (ABC) manufactures several different styles of jewellery cases in the southern province of China while its headquarters are in Hong Kong. The management estimates that during the third quarter of 2002 the company will be operating at 80% of normal capacity. Because the company desires higher utilisation of plant capacity, it will consider special orders. ABC has received inquiries for special orders from two companies. The first is from Lucky Trading Ltd (LTL), which would like to market a jewellery case similar to one of ABC cases. The jewellery case would be marketed under LTL s own label. LTL has offered ABC $67.5 per jewellery case for 20,000 cases to be shipped by 1 October LTL has explicitly communicated to ABC it would not accept partial shipment of the order. The cost data for the ABC jewellery case, which would be similar to the specifications of the LTL special order, are as follows: $ Regular selling price per unit 100 Costs per unit: Raw materials 35 Direct labour, Overhead, 0.25 machine 10 Total costs per unit 75 According to the specifications provided by LTL, this special order requires less expensive raw materials, which will cost only $32.5 per case. Management has estimated that the remaining costs, labour time, and machine time will be the same as those for the ABC jewellery case. The second special order was submitted by AAT Ltd for 7,500 jewellery cases at $85 per case. These cases would be marketed under the AAT label and would have to be shipped by 1 October The AAT jewellery case is different from any jewellery case in the ABC line. Its estimated unit costs are as follows: $ Raw materials 42.5 Director labour, Overhead, 0.5 machine 20 Total costs per unit 92.5 In addition, ABC will incur $15,000 in additional set-up costs and will have to purchase a $25,000 special device to manufacture these cases; this device will be discarded once the special order is completed. 1 of 8

3 ABC manufacturing s capabilities are limited by the total machine hours available. The plant capacity under normal operations is 90,000 machine hours per year and the budgeted fixed overhead for 2002 amounts to $2.16 million. The total manufacturing overhead costs applied to production on the basis of machine hours is $40 per hour. ABC will have the entire third quarter to work on the special orders. Management does not expect any repeat sales to be generated from either special order. Company practice precludes ABC from subcontracting any portion of an order or reducing the current production volume when special orders are not expected to generate repeat sales. Required: (a) (b) (c) In order to make a decision on the special orders, provide management with a definition of the following terms: relevant cost, incremental cost, opportunity cost, and sunk cost. (4 marks) Advise ABC s management on whether the two special orders should be accepted. Your recommendation can be to accept either one, both or neither. Justify your answer and show your calculations. (13 marks) Briefly discuss the assumptions used in part (b) above and the limitations of these assumptions. (3 marks) 2 of 8

4 Question 2 The nature and role of management accounting has experienced dramatic changes in the past 20 years due to the rapid advancement and application of information technology in organisations. Information is now one of the key resources in all kinds of organisations. The quality of various information systems within organisations is critical to success since managers at all levels rely on the information generated from those systems to make business decisions on a daily basis. Recently, PBE Systems Consulting Ltd (PBE) approached your immediate supervisor, the financial controller, about implementing and upgrading new and existing information systems within your organisation to improve information availability. The financial controller does not understand some of the terms that have been mentioned by PBE in the consulting proposal it prepared two weeks after the initial meeting. Required: In order to evaluate the PBE proposal, the financial controller requires your assistance in describing and explaining the nature and characteristics of the following types of information systems: (a) Transaction processing systems (TPS) (5 marks) (b) Management information systems (MIS) (5 marks) (c) Decision support systems (DSS) (5 marks) (d) Executive information systems (EIS) (5 marks) * * END OF SECTION A * * (QUESTIONS) * * * 3 of 8

5 SECTION B (Total: 60 marks) Answer THREE questions ONLY in this section. The questions are worth 60% of the total 100 marks for this examination. Question 3 HKSAR University offers an extensive continuing education programme in many cities throughout China. For the convenience of its faculty and administrative staff and also to save costs, the university operates a motor pool. The motor pool contained 25 vehicles until February 2002, when an additional automobile was acquired. The motor pool furnishes petrol, oil, and other supplies for the cars and hires one mechanic who does routine maintenance and minor repairs. Major repairs are done at a nearby commercial garage. A supervisor manages the operations. Each year the supervisor prepares an operating budget, informing university management of the funds needed to operate the pool. Depreciation on the automobiles is recorded in the budget in order to determine the cost per kilometre. The schedule below presents the annual budget approved by the university. The actual costs for March are compared with one-twelfth of the annual budget. Annual budget $ Monthly budget $ March actual $ Over (under) $ Petrol 825,000 68,750 82,000 13,250 Oil, minor repairs, parts & supplies 150,000 12,500 13, Outside repairs 27,000 2, (1,750) Insurance 48,000 4,000 4, Salaries and benefits 216,000 18,000 18,000 - Depreciation 228,000 19,000 19, ,494, , ,420 12,920 Total kilometres 1,500, , ,000 Cost per kilometre $0.996 $0.996 $0.982 Number of automobiles The annual budget was constructed based on the following assumptions. (1) There are 25 automobiles in the pool. (2) Each automobile travels 60,000 kilometres per year. (3) Each automobile travels 8 kilometres per litre of petrol. (4) Petrol costs $4.40 per litre. (5) Cost of $0.10 per kilometre for oil, minor repairs, parts and supplies. (6) Cost of $1,080 per automobile in outside repairs. 4 of 8

6 The supervisor is unhappy with the monthly report when comparing budgeted and actual costs for March; she claims it presents her performance unfairly. Her previous employer used flexible budgeting to compare actual costs with budgeted amounts. Required: (a) (b) List and describe FIVE purposes of preparing budgets in an organisation. (5 marks) Prepare a performance report that addresses the supervisor s concerns and shows the budgeted costs, actual costs, and monthly variances for March. (13 marks) (c) Discuss briefly the basis of the budgeted figure for outside repairs. (2 marks) 5 of 8

7 Question 4 Sweet Chocolate Ltd (SCL) uses standard costs and a flexible budget to control its manufacture of fine chocolates. The purchasing agent is responsible for material price variances, and the production manager is responsible for all other variances. Operating data for the past week are summarised as follows: (1) Finished units produced: 4,000 boxes of chocolates. (2) Direct material: Purchases 6,400 pounds of chocolate at $15.50 per pound; standard price is $16.00 per pound. Used 4,300 pounds. Standard allowed per box produced, 1 pound. (3) Direct labour: Actual costs 6,300 or $192,150 in total. Standard allowed per box produced, 1.5 hours. Standard rate per direct labour hour, $ (4) Variable manufacturing overhead: Actual costs $69,500. Budget formula is $10 per standard direct labour hour. Required: (a) In preparing the weekly management performance report, calculate and classify into favourable or unfavourable SCL s following variances over the past week: (i) (ii) (iii) (iv) (v) (vi) Material price variance Material usage variance Direct labour rate variance Direct labour efficiency variance Variable manufacturing overhead spending variance Variable manufacturing overhead efficiency variance (9 marks) (b) (c) (d) Comment on the statement Failure to meet material price standards is entirely the responsibility of the purchasing manager. (3 marks) Explain why the techniques for controlling overhead costs are different from those for controlling direct material costs. (3 marks) In order to reduce product costs, SCL is considering implementing an activitybased costing (ABC) system. List and describe the benefits of the ABC system. (5 marks) 6 of 8

8 Question 5 The following information is given for Blue and Red Divisions of Colourful Co Ltd: Blue Red $ $ Sales 600, ,000 Variable cost of goods sold 200, ,000 Fixed manufacturing costs 50,000 40,000 Variable selling 30,000 5,000 Fixed administration* 20,000 4,000 Fixed selling* 50,000 30,000 Assets at cost 800, ,000 Accumulated depreciation 200, ,000 * 50% of fixed administration costs and 20% of fixed selling costs are allocated from the corporate headquarters. Required: (a) (b) (c) (d) If Colourful uses profitability to evaluate division managers, compute the net profits before taxes of both divisions that should be used for that purpose. (10 marks) If Colourful uses return on investment (ROI) to evaluate division managers and uses historical cost as the investment base, compute the ROI for Blue and Red. (4 marks) How can ROI result in sub-optimisation when it is used as a performance measure? Justify your explanation using the figures provided in the question. (4 marks) Briefly explain what distinct advantages an ROI measure may have over a residual income measure. (2 marks) 7 of 8

9 Question 6 Large Ltd is a decentralised organisation with two independent divisions, A and B. Division B purchases lumber, which it uses to make tables, chairs and other wooden furniture. Most of the lumber is purchased from Division A. Both Divisions are profit centres. Division B proposes producing a new V-style chair that will sell for $92 each. The manager is exploring the possibility of purchasing the required lumber from Division A. Production of 800 chairs is planned, using capacity in Division B that is currently idle. Division B can purchase the lumber from an outside supplier for $72 per chair. Large Ltd has a policy that internal transfers are priced at fully allocated cost. Assume the following costs for the lumber required for one chair and the production of one chair respectively: Required: Division A Division B $ $ $ Variable costs 48 Variable costs Allocated fixed costs 22 Lumber from Division A 70 Fully allocated costs 70 Division B variable costs: Manufacturing 21 Selling 6 27 Total variable costs 97 (a) (b) The directors would like to know the benefits and drawbacks of decentralisation in organisations. Identify and explain TWO benefits and TWO drawbacks. (6 marks) Assume that Division A has idle capacity and therefore would incur no additional fixed costs in producing the required lumber. (i) (ii) Would Division B buy the lumber for the chair from Division A, given the existing transfer pricing policy? Explain and justify. (4 marks) Would the company as a whole benefit if the manager decides to buy from Division A? Explain and justify. (4 marks) (c) Assume that there is no idle capacity in Division A and the lumber required for one chair can be sold to outside customers for $72. Would the company as a whole benefit if the manager decides to sell the lumber? Explain and justify. (6 marks) * * END OF EXAMINATION PAPER * * (QUESTIONS) * * * 8 of 8

10 Answers Paper II Management Accounting

11 These are suggested solutions only. Credit will be awarded to answers that adequately demonstrate the ability to solve the problems with appropriate management accounting concepts and/or techniques. SECTION A (Total: 40 marks) Answer 1(a) (1) A relevant cost in a decision is a cost that differs between alternatives. (2) An incremental cost is the change in cost that will result from some proposed action. (3) An opportunity cost is the benefit that is lost or sacrificed in rejecting some course of action. (4) A sunk cost is a cost that has already been incurred, and which cannot be changed by any future decision. (1 mark for each definition total 4 marks) Answer 1(b) Computations related to the order from LTL: Annual plant capacity 90,000 machine hours Monthly plant capacity 7,500 machine hours Estimated monthly capacity use 80% 7,500 6,000 machine hours Excess capacity per month 1,500 machine hours Period involved, third quarter 3 months Total excess capacity available 4,500 machine hours Machine hours required to produce 20,000 jewellery cases = number of cases machine hours per case = 20, = 5,000 hours (3 marks) (1 mark) The LTL order for 20,000 jewellery cases would require 5,000 machine hours, but only 4,500 machine hours are available in the third quarter. ABC does not have the necessary plant capacity in the third quarter to produce the order for 20,000 jewellery cases. The LTL order should be rejected without subcontracting. (1 mark) - 1 -

12 Computations related to the order from AAT Ltd: $ $ Price offered per case 85.0 Production cost per case: Raw materials 42.5 Direct labour, 0.5 $ Overhead, 0.5 machine $16* Contribution margin per case 4.5 Number of cases 7,500 Total contribution margin 33,750 Fixed costs related to the order: Setup costs 15,000 Special device 25,000 40,000 Loss from taking the order (6,250) (6 marks) *Fixed overhead is not relevant in this case and should be omitted. Workings for overheads: Fixed overhead allocation rate per machine hour: $2,160,000 90,000 = $24 Variable overhead allocation rate: $40 $24 = $16 The AAT order should be rejected because it is unprofitable in the short run with the present price and cost structure. (1 mark) Conclusion: ABC should not accept either order. (1 mark) Answer 1(c) (1) Delivery of a partial order is not allowed. In reality, the entire order might be split and completed in the next quarter. (2) No sub-contracting is allowed. In reality, it is possible and still profitable to sub-contract part (or the whole) of the order to another manufacturer. (3) This is an one-off order which means that there will be no repeat orders in the future. In reality, we need to consider whether potential attractive orders are possible in the future, in which case a yes decision might be made. (3 marks) - 2 -

13 Answer 2(a) Transaction processing systems (TPS) are the basic business systems that serve the operational level of an organisation. A TPS is a system that performs and records the daily, routine transactions necessary to conduct the business. At the operational level, tasks, resources, and goals are predefined and highly structured. A TPS involves the updating of master file records using transaction file information. The major types of TPS in organisations include sales systems (sales order entry), production systems (material usage), accounting systems (general ledger processing), and human resources systems (payroll and employee records). These different TPS outputs may become the inputs of a management information system (MIS). (5 marks) Answer 2(b) Management information systems (MIS) serve the organisation s management, providing managers with reports and, in some cases, with on-line access to the organisation s current performance and historical records. Typically these systems are oriented almost exclusively to internal, not environmental or external, events. MIS primarily serve the functions of planning, controlling, and decision-making at the management level. Generally, these systems are dependent on underlying transaction processing systems for their data. MIS summarise and report on the company s basic operations. The basic transaction data from TPS are compressed and are usually presented in detailed reports that are produced on a regular schedule, such as daily, weekly, monthly, or yearly. (5 marks) Answer 2(c) Decision support systems (DSS) also serve the organisation s management. DSS help managers make decisions that are semi-structured, unique, or rapidly changing, and not easily specified in advance. DSS have to be responsive enough in order to correspond to changing conditions. Although DSS use internal information from TPS and MIS, they often bring in information from external sources, such as current stock prices, or competitors product prices. DSS have more analytical power than other systems, they are built explicitly with a variety of models to analyse data or they condense large amounts of data into a form in which they can be analysed by decision makers. DSS include user-friendly software and are designed so that users can work with them directly. (5 marks) Answer 2(d) Executive information systems (EIS) serve the organisation s strategic level and are used by senior executives to make decisions. EIS address unstructured decisions and create a generalised computing and communications environment rather than providing any fixed application or specific capability. EIS are designed to incorporate data about external events such as tax laws or competitors, but they also draw summarised information from internal MIS and DSS. EIS are not designed primarily to solve specific problems. They employ the most advanced graphics software and can deliver graphs and data from many sources immediately to a senior executive s office or to a boardroom. The cost of developing EIS is very high. It provides a facility for users to drill down from a summary level of information to a detailed level of data. (5 marks) * * END OF SECTION A * * (ANSWERS) * * * - 3 -

14 SECTION B (Total: 60 marks) Answer 3(a) (1) Budgets provide a means of communicating management s plans throughout the organisation. (2) Budgets force managers to think about and plan for the future. (3) The budgeting process provides a means of allocating resources to the parts of the organisation where they can be most effectively used. (4) The budgeting process can uncover potential bottlenecks before they occur. (5) Budgets coordinate the activities of the entire organisation by integrating the plans of the various parts, and help to ensure that everyone in the organisation is pulling in the same direction. (6) Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance. Answer 3(b) (Any five points with elaboration 1 mark for each point, total 5 marks) HKSAR University Motor Pool Monthly budget report March 2002 March Monthly Under actual budget (over) $ $ $ Petrol 82,000 77,000 (5,000) Oil, minor repairs, parts and supplies 13,000 14,000 1,000 Outside repairs 500 2,340 1,840 Insurance 4,160 4,160 - Salaries and benefits 18,000 18,000 - Depreciation 19,760 19,760 - Totals 137, ,260 (2,160) (5 marks) (5 marks) Number of automobiles Actual kilometres 140, ,000 - Cost per kilometre $0.982 $0.966 ($0.016) (1 mark) (1 mark) (1 mark for overall presentation) - 4 -

15 Supporting calculations for monthly budget amounts: Petrol: (140,000 km 8 km per litre) $4.40 per litre = $77,000 Oil, etc.: 140,000 km $0.10 per km = $14,000 Outside repairs: ($1,080 per auto 26 autos) 12 months = $2,340 Insurance: Annual cost for one auto = $48, autos = $1,920 per auto Annual cost for 26 autos = 26 $1,920 = $49,920 Monthly cost = $49, = $4,160 Salaries and benefits: No change, monthly cost = $216,000 annual cost 12 months = $18,000 Depreciation: Annual depreciation per auto = $228, autos = $9,120 Annual depreciation for 26 autos = $9, = $237,120 Monthly depreciation = $237, = $19,760 Answer 3(c) Outside automobile repairs are a function of the use of the automobile over its lifetime. However, these repairs occur irregularly throughout the year and over the car s life. A monthly budget figure based upon a per mile charge becomes questionable. Therefore, using one-twelfth of the estimated annual outside repair costs adjusted for the number of cars in operation during a month would appear to be more reasonable. (2 marks) - 5 -

16 Answer 4(a) Flexible budget based on standard inputs Flexible budget allowed for Cost incurred: based on actual outputs actual inputs actual inputs achieved actual prices expected prices expected prices 6,400 lbs $ ,400 lbs $16.00 = $99,200 = $102,400 6,400 $0.50 = price variance $3,200 F (1.5 marks) 4,300 lbs $ ,000 lbs $16.00 = $68,800 = $64, $16.00 = usage variance $4,800 U (1.5 marks) 6,300 hrs $ ,300 hrs $ ,000 hrs $30.00 = $192,150 = $189,000 = $180,000 6,300 $ $30.00 = rate variance, efficiency variance, $3,150 U (1.5 marks) $9,000 U (1.5 marks) Flexible budget variance, $12,150 U 6,300 hrs $ ,000 hrs $10.00 $69,500 = $63,000 = $60,000 O/H spending variance, $69,500 $63,000 = $6,500 U (1.5 marks) Flexible budget variance, $9,500 U 300 $10.00 = O/H efficiency variance, $3,000 U (1.5 marks) Answer 4(b) Failure to meet material price standards is often the responsibility of the purchasing officer, but responsibility may be shared with the production manager if he or she has frequent rush orders for materials. Of course, market conditions may be such that it is beyond the control of anyone in the company to attain the price standard. (3 marks) - 6 -

17 Answer 4 (c) Overhead control techniques are different from direct material cost control techniques because: (1) Cost drivers are generally more complex and less obvious. (2) Responsibility is split among various people. (3) A large percentage of overhead costs may be fixed or joint in nature. (3 marks) Answer 4 (d) Benefits of activity-based costing (ABC) include the following: (1) Focuses on both value-added and non-value-added activities to minimise those activities that are not adding value. (2) Highlights interrelationships among areas and activities. (3) Provides feedback on product design and opportunities for process improvements. (4) Encourages use of non-financial measures of activity and performance. (5) Provides a more appropriate means of allocating overheads to products so as to reflect the actual consumption of resources through activities. These ABC benefits should lead to cost reduction because of an improved understanding of which activities cause costs to be generated, the increased focus on controlling such activities, and the evolution of improved performance measures so that measured performance is more highly correlated with cost control. (5 marks) - 7 -

18 Answer 5(a) Blue Red $ $ Sales 600, ,000 Costs of goods sold (250,000) (190,000) Gross margin 350, ,000 Variable selling (30,000) (5,000) Fixed admin (50% traceable to division) (10,000) (2,000) Fixed selling (80% traceable to division) (40,000) (24,000) Controllable income 270,000 79,000 (5 marks) (5 marks) Answer 5(b) Blue Red $270,000 $800,000 $79,000 $600,000 = 33.75% = 13.17% (2 marks) (2 marks) Answer 5(c) Because performance measures are used to reward performance, managers use them as decision criteria when they evaluate alternative courses of action. For example, if ROI is the performance criterion, a division manager will only invest in new projects that will result in an increase in his/her division s ROI. This is sub-optimal if the overall organisation would be better off by the division manager s investment in available projects with lower ROIs. In the Blue division, assuming the division s current ROI is 33.75% as obtained in part (b) above and the division managers in Colourful are rewarded based on the divisional ROI, the manager will reject any new projects with a ROI lower than 33.75%. In other words, a new project with a 25% ROI will be rejected by the Blue division manager even though the overall organisation may benefit from taking it on. However, Red division manager will accept this new project since his or her divisional ROI will improve by investing in projects with a ROI higher than 13.17%. (4 marks) Answer 5(d) The advantage of ROI measure over residual income is that ROI facilitates a comparison of organisational sub-units of differing sizes. Because ROI is a performance measure that automatically scales for size, large and small sub-units can be compared with each other (subject to all the factors that should be considered when two units in different industries, different geographical areas, etc., are compared). (2 marks) - 8 -

19 Answer 6(a) Benefits of decentralisation include: (1) Lower-level managers may make better decisions because they have a better knowledge of local conditions. (2) Managers develop their skills so that there are more managers qualified to move up in the organisation. (3) Managers have higher status and therefore are more motivated. Drawbacks of decentralisation include: (Any two points with elaboration 1.5 marks for each point, total 3 marks) 1. Managers may make decisions that are not in the organisation s best interests because they would not consider facts that do not pertain to their own segment. 2. Managers may perform functions at the divisional level that would be less costly if centralised. 3. The cost of information needed to coordinate and control activities may increase with decentralisation. Answer 6(b)(i) (Any two points with elaboration 1.5 marks for each point, total 3 marks) Division B manager would not buy the lumber for $70 and would not produce the chairs. The division would lose $5 on each chair produced at that price: $ $ Revenue per chair 92 Division cost per chair: Lumber 70 Manufacturing 21 Selling 6 97 Division loss per chair (5) (4 marks) Answer 6(b)(ii) However, the company as a whole would benefit by $17 per chair if the chairs were produced and sold: $ $ Revenue per chair 92 Additional costs per chair: Lumber 48 Manufacturing 21 Selling 6 75 Total contribution per chair 17 (4 marks) Therefore, the policy to transfer at fully allocated costs motivates the manager to make a decision that is not in the best interests of the company as a whole

20 Answer 6(c) When there is no idle capacity in Division A, transferring lumber to Division B will represent lost sales to outside customers for Division A. Compare the total contribution from selling the lumber to the total contribution from using the lumber to build and sell the chairs: Sell lumber $ Revenue 72 Total additional costs: Variable cost of lumber 48 Total contribution margin 24 Build and sell chair $ $ Revenue 92 Total additional costs: Variable cost of lumber 48 Manufacturing 21 Selling 6 75 Total contribution margin 17 (2 marks) (3 marks) The company is $7 better off with the contribution of $24 from selling lumber rather than $17 from selling the chair. (1 mark) Another way to view this problem is that, if the lumber can be sold for $72, using it to build a chair adds $92 $72 = $20 of additional revenue. The additional costs are $21 + $6 = $27. The company is $7 worse off if it spends $27 to gain $20 in revenue. * * END OF EXAMINATION PAPER * * * * (ANSWERS) * *