DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO. Performance Pillar. P1 Performance Operations. Wednesday 29 August 2012

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1 DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO Performance Pillar P1 Performance Operations Instructions to candidates Wednesday 29 August 2012 You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is all parts and/or subquestions). ALL answers must be written in the answer book. Answers written on the question paper will not be submitted for marking. You should show all workings as marks are available for the method you use. ALL QUESTIONS ARE COMPULSORY. Section A comprises 8 sub-questions and is on pages 2 to 5. Section B comprises 6 sub-questions and is on pages 6 and 7. Section C comprises 2 questions and is on pages 8 to 11. Maths tables and formulae are provided on pages 13 to 16. The list of verbs as published in the syllabus is given for reference on page 19. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. P1 Performance Operations TURN OVER The Chartered Institute of Management Accountants 2012

2 SECTION A 20 MARKS [You are advised to spend no longer than 36 minutes on this question.] ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6 to 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions. Question One 1.1 A company commenced business on 1 August. Total sales revenue in August was $200,000 and is expected to increase at a rate of 2% per month. Credit sales represent 60% of total sales revenue and the remaining 40% is cash sales. The credit period allowed is one month. Bad debts are expected to be 3% of credit sales but the remaining credit sales customers are expected to pay on time. The estimated receipts in September from cash and credit sales are: A $195,552 B $196,400 C $198,000 D $201,600 (2 marks) Performance Operations 2 September 2012

3 1.2 A company operates a throughput accounting system. The details per unit of Product C are: Selling price $28.50 Material cost $9.25 Labour cost $6.75 Overhead costs $6.00 Time on bottleneck resource 7.8 minutes The throughput contribution per hour for Product C is: A $50.00 B $ C $ D $ (2 marks) 1.3 The following details have been extracted from the accounts payable records of RS. Invoices paid in the month of purchase Invoices paid in the first month after purchase Invoices paid in the second month after purchase 15% of total value 65% of total value 20% of total value The pattern of payments is expected to continue in the future and has been used to produce RS s cash budget for October to December. Purchases for October to December are budgeted as follows: October $280,000 November $250,000 December $300,000 A settlement discount of 5% is taken on invoices paid in the month of purchase. The amount budgeted to be paid to suppliers in December is: A $264,500 B $261,250 C $250,325 D $263,500 (2 marks) Section A continues on the next page TURN OVER September Performance Operations

4 1.4 The fixed production overhead volume variance can be defined as A B C D the difference between the budgeted fixed production overhead cost and the standard fixed production overhead cost absorbed by actual production. the difference between the standard fixed production overhead cost absorbed by actual production and the actual fixed overhead cost incurred. the difference between the budgeted and actual fixed production overhead cost. the difference between the budgeted fixed production overhead cost and the budgeted production at the actual absorption rate incurred. (2 marks) 1.5 A master budget comprises the A B C D budgeted income statement and budgeted cash flow statement only. budgeted income statement and budgeted balance sheet only. budgeted income statement and budgeted capital expenditure only. budgeted income statement, budgeted balance sheet and budgeted cash flow statement only. (2 marks) 1.6 LM operates a parcel delivery service. Last year its employees delivered 15,120 parcels and travelled 120,960 kilometres. Total costs were $194,400. Required: LM has estimated that 70% of its total costs are variable with activity and that 60% of these costs vary with the number of parcels and the remainder vary with the distance travelled. LM is preparing its budget for the forthcoming year using an incremental budgeting approach and has produced the following estimates: All costs will be 3% higher than the previous year due to inflation Efficiency will remain unchanged A total of 18,360 parcels will be delivered and 128,800 kilometres will be travelled. Calculate the following costs to be included in the forthcoming year s budget: (i) (ii) the total variable costs related to the number of parcels delivered. the total variable costs related to the distance travelled. (3 marks) Performance Operations 4 September 2012

5 1.7 A capital investment project has the following estimated cash flows and present values: Year Cash flow $ Discount 12% Present value $ 0 Initial (200,000) 1.0 (200,000) investment 1-5 Contribution 108, ,340 per annum 1-5 Fixed costs per (30,000) (108,150) annum 5 Residual value 30, ,010 Required: Calculate the sensitivity of the investment decision to a change in the annual contribution. (3 marks) 1.8 DB manufactures and sells e-readers. The standard labour cost per unit of the product is $7. Each unit takes 0.5 hours to produce at a labour rate of $14 per hour. The budgeted production for August was 20,000 units. Required: The Production Director subsequently reviewed the market conditions that had been experienced during August and determined that market labour rates were $17.50 per hour. The actual production was 22,000 units. Actual labour hours worked were 11,400 hours at $15.50 per hour. Calculate the following variances for August: (i) (ii) (iii) The labour rate planning variance The labour rate operational variance The labour efficiency operational variance (4 marks) (Total for Section A = 20 marks) Reminder All answers to Section A must be written in your answer book. Answers to Section A written on the question paper will not be submitted for marking. End of Section A. Section B begins on page 6 TURN OVER September Performance Operations

6 SECTION B 30 MARKS [You are advised to spend no longer than 9 minutes on each sub-question in this section.] ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE. Question Two (a) A company s Financial Director is deciding whether to purchase or lease two assets: Required: Asset 1 has a ten year life with a zero residual value. It can be purchased for $120,000. If the asset is purchased it would be paid for in cash on the day the asset is acquired. Alternatively, it can be leased for ten payments of $18,000 per annum payable each year in advance. Asset 2 has a five year life. It can be purchased for $51,000 and will have a residual value of $20,000 after five years. If the asset is purchased it would be paid for in cash on the day the asset is acquired. Alternatively, it can be leased for five payments of $10,000 per annum payable each year in arrears. If leased, the asset will remain the property of the lessor and will be returned at the end of the five year contract. The cost of capital is 10% per annum. Ignore taxation. Prepare calculations to show whether each of the assets should be purchased or leased. (5 marks) (b) The manager of a retail store that sells electronic goods is deciding which of three credit agreements to offer to its customers. Past experience has shown that there are three possible reactions to each of the agreements. The profit will depend on customers reaction to the agreement on offer. Required: The profit for each of the possible outcomes is as follows: Customer reaction Agreement A $ Agreement B $ Agreement C $ Strong 52,600 44,800 64,700 Moderate 43,700 36,200 41,600 Weak 38,200 34,500 33,100 (i) (ii) Prepare a regret matrix and use it to identify the agreement that the manager would select if the minimax regret criterion was used to make the decision. Describe the attitude to risk of a manager that is risk averse. (3 marks) (2 marks) (Total for sub-question (b) = 5 marks) Performance Operations 6 September 2012

7 (c) Explain the disadvantages for a company of using a centralised purchasing system. (5 marks) (d) Explain the limitations of incremental budgeting. (5 marks) The following information is given for sub-questions 2(e) and 2(f) below GH is a manufacturer of leather goods. The company has recently won a contract to supply CD, a major department store chain, with a range of products. The contract will require significant investment in non-current assets and working capital. GH will raise a loan from its bank for the investment in non-current assets but is considering alternative methods of reducing the required investment in working capital. These methods include offering early settlement discounts and debt factoring. (e) CD s normal credit term from its suppliers is 90 days. GH is considering offering an early settlement discount of 3% for payments received within ten days in order to reduce the working capital requirement. Required: (i) (ii) Calculate, to the nearest 0.1%, the effective annual interest rate to GH of the early settlement discount. You should assume a 365 day year and use a compound interest methodology. (3 marks) State TWO disadvantages to GH of using a bank loan to finance the additional working capital. (2 marks) (Total for sub-question (e) = 5 marks) (f) Explain the advantages and disadvantages to GH of using debt factoring to finance the additional working capital. (5 marks) (Total for Section B = 30 marks) End of Section B. Section C begins on page 8 TURN OVER September Performance Operations

8 SECTION C 50 MARKS [You are advised to spend no longer than 45 minutes on each question in this section.] ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE. Question Three PQ produces two products, Product B and Product C. The company uses a standard absorption costing system that absorbs overheads on the basis of direct labour hours. The company operates a just-in-time purchasing and production system and no inventory of raw materials or finished goods is held. Standard selling prices are determined by adding a 100% mark-up to total production costs per unit. The following budget and actual data relate to August. Budget data: Product B Product C Production and sales 2,200 units 1,800 units Standard production costs per unit: $ $ Direct material ($5 per kg) Direct labour ($7 per hour) Variable overhead Fixed overhead Actual data: Product B Product C Production and sales 3,000 units 1,500 units Selling price per unit $110 $105 Production costs: Direct material $124,800 (25,600 kg) Direct labour $ 67,980 (9,140 hours) Variable overheads $ 14,300 Fixed overheads $ 27,000 The company produces a monthly variance analysis report which has previously included the calculation of the sales volume profit variance. The new management accountant has decided to extend this analysis and replace the sales volume profit variance with the sales mix profit margin variance and the sales quantity profit variance. Performance Operations 8 September 2012

9 Required: (a) Prepare a statement that reconciles the budgeted gross profit and actual gross profit for August. The variances should be shown in as much detail as possible including the individual sales mix profit margin variances and the individual sales quantity profit variances. (17 marks) (b) Explain the benefits to the company of separating the sales volume profit variance into the sales mix profit margin variance and the sales quantity profit variance. You should use the figures calculated in part (a) to illustrate your answer. (4 marks) (c) Explain TWO reasons why a standard costing system may not be considered appropriate in a modern manufacturing environment. (4 marks) (Total for Question Three = 25 marks) Section C continues on the next page TURN OVER September Performance Operations

10 Question Four EF operates tourist attractions in major capital cities. The company is considering opening a new attraction in Eastern Europe. The initial capital investment will be $120 million. EF plans to operate the attraction for five years after which it will be sold to another operator at an estimated price of $50 million at Year 5 prices. A market research survey has estimated the following visitor numbers and associated probabilities, revenue and operating costs: Revenue and variable costs Number of visitors per year Probability 1.2 million 30% 0.8 million 50% 0.6 million 20% It is expected that the number of visitors per year will remain constant for the life of the project. The entrance fee for the attraction will be $40. Each visitor is expected to spend an average of $15 on souvenirs and $5 on refreshments. The variable costs are estimated to be $25 per visitor. This includes the variable cost of operating the attraction and the cost of souvenirs and refreshments. Fixed operating costs The company will lease the land on which the attraction is to be situated at a cost of $500,000 per annum. The lease cost will remain the same throughout the life of the project. Maintenance costs are estimated to be $200,000 per annum. Inflation All of the values above, other than the amount payable by the purchaser at the end of the five year period, have been expressed in terms of current prices. The lease cost of $500,000 per annum will apply throughout the life of the project and is not subject to inflation. A general rate of inflation of 4% per annum is expected to apply to all revenues and costs, excluding the lease cost throughout the life of the project, starting in Year 1. Other information The company uses net present value based on the expected values of cash flow when evaluating projects of this type. The company has a money cost of capital of 12% per annum. The company s Financial Director has provided the following taxation information: The initial investment will qualify for tax depreciation at 25% of the reducing balance per annum with a balancing adjustment in the year of disposal. The first claim for tax deprecation will be made against the profits from Year 1. Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is payable in the following year. All cash flows apart from the initial investment of $120 million should be assumed to occur at the end of the year. Performance Operations 10 September 2012

11 Required: (a) Evaluate the project from a financial perspective. You should use net present value as the basis of your evaluation and show your workings in $000. (14 marks) (b) (i) Calculate the internal rate of return (IRR) of the project. (4 marks) (ii) Calculate the payback period for the project. You should assume for this purpose that all cash flows occur evenly throughout the year. (3 marks) (c) Explain the difference between the real cost of capital and the money cost of capital. You should include a numerical example to illustrate your answer. (4 marks) (Total for Question Four = 25 marks) (Total for Section C = 50 marks) End of question paper Maths tables and formulae are on pages 13 to 16 September Performance Operations

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13 PRESENT VALUE TABLE Present value of $1, that is ( 1+ r ) n where r = interest rate; n = number of periods until payment or receipt. Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% September Performance Operations

14 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years n 1 (1+ r ) r Periods (n) Interest rates (r) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods (n) Interest rates (r) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Performance Operations 14 September 2012

15 FORMULAE PROBABILITY A B = A or B. A B = A and B (overlap). P(B A) = probability of B, given A. Rules of Addition If A and B are mutually exclusive: P(A B) = P(A) + P(B) If A and B are not mutually exclusive: P(A B) = P(A) + P(B) P(A B) Rules of Multiplication If A and B are independent:: P(A B) = P(A) * P(B) If A and B are not independent: P(A B) = P(A) * P(B A) E(X) = (probability * payoff) DESCRIPTIVE STATISTICS Arithmetic Mean x = x n fx x = (frequency distribution) f Standard Deviation INDEX NUMBERS SD = ( x x) n SD = fx x (frequency distribution) f Price relative = 100 * P 1/P 0 Quantity relative = 100 * Q 1/Q 0 P1 w P o Price: x 100 w Q1 w Q o Quantity: x 100 w TIME SERIES Additive Model Multiplicative Model Series = Trend + Seasonal + Random Series = Trend * Seasonal * Random September Performance Operations

16 FINANCIAL MATHEMATICS Compound Interest (Values and Sums) Future Value S, of a sum of X, invested for n periods, compounded at r% interest S = X[1 + r] n Annuity Present value of an annuity of $1 per annum receivable or payable for n years, commencing in one year, discounted at r% per annum: PV = r [1 + r ] n Perpetuity Present value of $1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum: PV = r 1 LEARNING CURVE Y x = ax b where: Y x = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2. INVENTORY MANAGEMENT Economic Order Quantity EOQ = 2C D where: C o = cost of placing an order C h = cost of holding one unit in inventory for one year D = annual demand C o h Performance Operations 16 September 2012

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19 LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE VERBS USED DEFINITION Level 1 - KNOWLEDGE What you are expected to know. List Make a list of State Express, fully or clearly, the details/facts of Define Give the exact meaning of Level 2 - COMPREHENSION What you are expected to understand. Describe Communicate the key features Distinguish Highlight the differences between Explain Make clear or intelligible/state the meaning or purpose of Identify Recognise, establish or select after consideration Illustrate Use an example to describe or explain something Level 3 - APPLICATION How you are expected to apply your knowledge. Level 4 - ANALYSIS How are you expected to analyse the detail of what you have learned. Level 5 - EVALUATION How are you expected to use your learning to evaluate, make decisions or recommendations. Apply Calculate Demonstrate Prepare Reconcile Solve Tabulate Analyse Categorise Compare and contrast Construct Discuss Interpret Prioritise Produce Advise Evaluate Recommend Put to practical use Ascertain or reckon mathematically Prove with certainty or to exhibit by practical means Make or get ready for use Make or prove consistent/compatible Find an answer to Arrange in a table Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between Build up or compile Examine in detail by argument Translate into intelligible or familiar terms Place in order of priority or sequence for action Create or bring into existence Counsel, inform or notify Appraise or assess the value of Advise on a course of action September Performance Operations

20 Performance Pillar Operational Level Paper P1 Performance Operations September 2012 Performance Operations 20 September 2012