CIMA_P2_Performance Management_Specimen Papers__Ans_Nov_2009

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CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2Published November 2009

Performance Management Specimen Exam Paper1

The Examiner's Answers – Specimen Paper

P2 - Performance Management

SECTION A

Answer to Question One

Requirement (a)

The Value Chain is the concept that there is a sequence of business factors by which value isadded to an organisation’s products and services. Modern businesses cannot survive merelyby having efficient production facilities, they must also have a thorough understanding of theimportance of the relationship between all of the elements in the value chain. These include:research & development, design, manufacturing, marketing, distribution and customerservice.

The DT group currently has an internal manufacturing facility, this makes communications

between different parts of that manufacturing process relatively straight-forward, however, ifpart of this process is to be outsourced this will place as added burden on the productionmanagement to ensure that all parts of the production process operate smoothly. Aside fromcommunication difficulties, there may be different work ethics to contend with, and delays inreceiving items and quality issues may disrupt the flow of goods to customers. This will leadto difficulties in identifying where profits / contributions are being earned (and lost) within thevalue chain.

Requirement (b)

Gain sharing arrangements are based on the concept of sharing profits, however, if they areto be successful both parties must be willing to share the information necessary to determinethe extent of any gain (or loss) that has arisen.

The DT group may seek to enter a gain sharing arrangement with the suppliers of thecomponents that they have outsourced. This would require both organisations to establishsome clear targets which could include quality specifications and delivery schedules. The gainfrom lower levels of rejects and earlier delivery of components can then be determined andshared between DT and the external supplier.




Specimen Exam Paper Performance Management2

Answer to Question Two

Requirement (a)

Number of batches completed

Average time per batch

1 1,000 hours

2 900 hours4 810 hours8 729 hours

16 656 hours32 590 hours64 531 hours

It seems that the average time equals 5·3 hours per unit (i.e. 530 hours per batch after 64batches had been completed.

Requirement (b)

4 batches were produced so the average time per batch should have been 810 hours (as

shown in the answer to (a) above.

Therefore the total time should have been 4 x 810 hours = 3,240 hours.Actual hours taken were 2,500 hoursOperating efficiency difference 740 hours Favourable

By comparing the standard with the revised target time, the planning variance can beidentified:

Original standard (5·3 hours x 400 units) 2,120 hoursTime allowed per learning curve 3,240 hoursPlanning efficiency difference 1,120 hours Adverse

Each of these differences in hours is valued using the standard hourly rate of $10 per hour, sothe revised efficiency variances are:

Planning variance $11,200 AdverseOperating variance $7,400 Favourable

The rate variance remains unchanged at $ 1,000 Adverse

Requirement (c)

The analysis of the efficiency variance into planning and operational effects provides moremeaningful information because it shows the true efficiency of the operations as opposed to

an invalid application of the original target. As production has only reached four batches bythe end of August and the learning period seems to continue to around 64 batches it is clearthat the learning has not yet been completed and therefore it is unfair to measureperformance against the post learning standard. These revised calculations show that theactual learning is better than was expected whereas the original variance calculation showedthat the time taken was more than it should have been. Rather than acusing the workforce ofbeing inefficient they should be congratulated on their efficiency.





Answer to Question Three

Requirement (a)

Feedback control is the comparison of actual performance with an agreed target such as thebudget set by the Managing partner. An example would be a comparison of the fees earnedby each partner compared to those budgeted to be earned.

Feed-forward control is the comparison of a draft version of a target with a rule or objective.An example would be the comparison of the draft cash budget with the target cash balancesand the overdraft facility. As a result of this comparison it may be necessary to defer someexpenditure until a later period or reduce it so as to stay within the firm’s existing cashbalances / overdraft facility. This will lead to a second draft of the cash budget beingprepared.

Requirement (b)

One beneficial consequence of involving the other partners in the preparation of the firm’sbudgets is that they will accept ownership of their budget and accept responsibility forachieving their target. However, one adverse consequence is that since they will effectively

be setting their own targets they may be tempted to set a target that is more easily achievedthan that which would have been set by the Managing partner. This is known as the inclusionof budgetary slack.

Answer to Question Four

Requirement (a)

Calculation of cost driver rates:

Machine maintenance$100,000 / ((1,500 x 3) + (2,500 x 2) + (4,000 x 3)) = $4·65 per machine hour

Machine setups$70,000 / [{(1,500/50) x 2} + {(2,500/100) x 3} + {(4,000/500) x 1}] = $489·51 per setup

Purchasing$90,000 / [{(1,500/50) x 4} + {(2,500/100) x 4} + {(4,000/500) x 6}] = $335·82 per order

Material Handling$60,000 / [{(1,500/50) x 10} + {(2,500/100) x 5} + {(4,000/500) x 4}] = $131·29 per movement

Other Costs$80,000 / ((1,500 x 2) + (2,500 x 4) + (4,000 x 3)) = $3·20 per labour hour

Product X Y Z Batch costs:Machine setup 979 1,468·5 489·5Purchasing 1,343 1,343 2,015Material handling 1,313 656·5 525

3,635 3,468 3,029·5 Batch size 50 100 500

Unitised batch costs 72·70 34·68 6·06 Machine maintenance 13·95 9·30 6·06Other costs

Product overhead costs 93·05 56·78 29·61





Requirement (b)

Pareto Analysis is also known as the 80:20 rule. In this context it means that 80% of theproduction overhead costs are caused by 20% of the total number of causes. W has identifiedthe causes of 80% of its overhead costs (i.e. $320,000 out of the total of $400,000) and linkedthese with just four cost drivers. The remaining $80,000 is said to be caused by a number offactors.

By focusing attention on controlling these four cost causes in the future, and minimising thecosts of cost control, W will be controlling 80% of its production overhead costs.

Answer to Question Five

Requirement (a)

Standard costs are the estimated costs of providing one unit of goods or service. They aredetermined by identifying the resources expected to be required for the completion of the unitand the price expected to be paid for each unit of those resources.

Target costs are determined by taking the market price of a product or service and deductingthe required profit margin to determine the cost at which the product or service must beprovided in order to meet the required profit margin.

HJ is diversifying into a well established market place where it is likely to be a price takerrather than a price maker. HJ will therefore be able to determine the selling price of its rangeof plastic moulded items. HJ must then determine the profit that it wishes to achieve to makea reasonable return on its investment in the new machinery. By deducting the profit requiredfrom the selling price HJ will determine the target cost for its plastic moulded products. HJ willthen have to consider its production methods and the impact of any learning and experienceefficiencies that may arise to determine whether it is capable of producing the items for theirtarget cost.

Requirement (b)

Short term marginal cost based pricing is often necessary to enter into a new market that isalready well established and mature. However, this form of pricing is unlikely to be financiallyviable in the longer term because of the need to recover the fixed costs of the business anddeliver a suitable return for the business owners.

The difficulty lies in making the switch from one pricing model to the other without losing thecustomer base that has been built up using the marginal cost based prices. It will therefore benecessary for HJ to develop new items which have the perception of adding value to theoriginal product range so that they can be sufficiently differentiated to allow the new prices tobe introduced.





SECTION B

Answer to Question Six

Requirement (a)

1. The cost of the engineering specification is based on the time spent (i.e. 3 days)multiplied by the salary and related employment costs of $500 per day. However, this isnot a relevant value because the time has already been spent and is therefore a sunkcost. The relevant value is $NIL.

2. The cost of Direct Material A is based on 10,000 square metres valued using theweighted average basis. This can be shown to be calculated by:

10,000 square metres x $6 = $60,000

5,000 square metres x $630 = $31,500

15,000 square metres total = $91,500 = an average of $6·10 per square metre

This is not the correct valuation because the material is in regular use by PQR.Consequently its relevant cost is its cost of replacement which is $7 per square metrewhich is therefore $70,000 in total.

3. The cost of Direct Material B is based on 250 metre lengths being bought at a price of$10 per metre length. This is not the correct valuation because the sole supplier has aminimum order size of 300 metre lengths and the remainder has no foreseeable use ornet sales revenue. Therefore the relevant cost is the cost of the minimum order of 300lengths, i.e. 300 x $10 = $3,000

4. The cost of the components is based on the normal transfer pricing policy of $8 plus a50% mark-up = $12 per component. 500 components x $12 = $6,000. However, this isnot the relevant cost to the M group. The relevant cost to the M group is the variablecost of manufacturing the components plus any lost contribution from the reduction inexternal sales by HK. Thus:

350 components x variable cost only = 350 x $8 = $2,800150 components x variable cost + lost contribution = 150 x ($8 + $3) = $1,650Total relevant cost of the components = $2,800 + $1,650 = $4,450The external market price of $14 is not relevant because it is cheaper to manufacturethem internally, even if there is lost contribution caused by reduced external sales.

5. The cost of direct labour is the cost of the existing employees; 1000 hours x $12·50 perhour. This is not the relevant cost. The relevant cost is the lower of:

a) Recruiting engineers to do the work at $15 per hour; andb) Transferring the existing employees and recruiting replacements to do their work at$14 per hour.

The second of these is the lower cost option so the relevant cost is 1000 hours x $14per hour = $14,000.

6. The cost of the supervisor is based on a monthly salary of $3,500 (annual salary of$42,000 / 12 months) multiplied by 10% as the the project time estimate = $350. This isnot the relevant cost. The supervisor is already employed and will continue to be

employed whether the project goes ahead or not. If the supervisor cannot complete this





work within his normal hours he will work overtime but he is not paid for this so there isno incremental cash flow. The relevant cost is $NIL.

7. The machine hire cost is based on 5 days multiplied by a hire charge of $500 per day.However, this is not the relevant cost because there is a lower cost option available. Ifthe machine is hired for an entire month at a cost of $5,000 and then sub hired for $150

per day for 20 days (total $3,000) the net cost of this option is $2,000. Therefore therelevant cost is $2,000.

8. The overhead cost value is based on the latest annual forecast of overhead costs andcapacity levels as follows:

$220,000 / 80% of 50,000 hours = $5.50 per hour1,000 hours of skilled labour x $5.50 per hour = $5,500.

However, this is not a relevant cost. There is no indication that these overhead costsare incurred as a result of undertaking the project, indeed being based on anabsorption rate implies that they are not project specific and will be incurred whetherthe project goes ahead or not. The relevant cost is therefore $NIL.

Note $ Engineering specification 1 NILDirect material a 2 70,000Direct material B 3 3,000Components 4 4,450Direct Labour 5 14,000Supervision 6 NILMachine hire 7 2,000Overhead costs 8 NIL

Total 93,450

Requirement (b)The difference between the reported profit and that which would be expected based on therelevant cost schedule is caused by the differing nature of the accounting techniques used fordecision making compared to those used for profit reporting and inventory valuation. Forexample:

(i) The usage of material A on the project will be valued using its average cost of $6.10per square metre rather than the replacement cost of $7 per square metre.

(ii) The accounting system will attribute overhead costs to the project using anabsorption rate that would normally be based on the budgeted costs and activitylevels. This is relevant for profit reporting and is required by external reporting rules,

but is not appropriate for short term decision making as these costs are not affectedby the decision.

Requirement (c)

There are a number of non-financial factors that need to be considered, these include:

(i) Will there be any long term impact on the external market of HK as a result of themchoosing to make an internal supply in preference to their external customers. Doesthis mean that their external customers will find a permanent alternative supplier?

(ii) Will there be any conflicts between the temporary replacement workers being paid$14 per hour to do the work of employees who are currently being paid $12.50 per

hour?





Answer to Question Seven

Requirement (a)

The performance statement does not show the actual return on capital employed achieved byeach division which is:

D: 2.5% E: 10% F: 12%

It can thus be seen that only Division E achieved the target that had been set for it by HeadOffice. However, there are a number of other factors that need to be considered in relation tothe performance report.

1. The management charges from Head Office are presumed to be non-controllable atdivisional level, it is therefore inappropriate to include them in any measure of divisionalperformance.

2. The basis of valuing the Capital Employed by each division is not stated. It is assumed tobe based on the original cost of the assets less accumulated depreciation. As a consequenceolder assets will have lower original costs (due to price inflation) and lower book values (dueto more years depreciation charges). As a result comparisons between divisions may not be a

fair comparison. This may also explain the different cost structure that seems to exist inDivision F where fixed production costs are approximately 25% of total production costswhereas in divisions D and E the fixed production costs are around 50% of total productioncosts. This may imply that the equipment used in Divisions D and E is newer and moreautomated.

Requirement (b)

The problem with negotiated transfer prices is that the results of the negotiations is as muchaffected by the personalities of the managers of each division as it is by the circumstancessurrounding the transaction. If one manager has a stronger personality than another, or is abetter negotiator then this will act to the detriment of the weaker division and may not be inthe best interests of the company as a whole.

The inter-divisional trading affects the performance of all of the divisions. Assuming that thegoods sold between the divisions were similar to those that the supplying division sold into theexternal market, then the following analysis can be made.

1. Goods sold by Division D.The external sales of Division D were $130,000 during the year for which the variable costwas $32,000, a mark-up of just over 300%. If the same mark – up were applied to the internalsale then Division D’s profits would have increased by $52,000 to $62,000 and the profits ofDivision E would reduce by $52,000.

2. Goods sold by Division FThe external sales of Division F were $385,000 during the year for which the variable costwas $221,000, a mark-up of 75%. The mark-up added to the internal sale was 67% so thereis not a significant impact on the profit reported by the divisions as a result of these internaltransactions.





Requirement (c)

Division D E F $000 $000 $000

Net sales - External 130 200 385Sales - Internal 72 0 15Total sales 202 200 400

Variable production costs- External 50 35 230- Internal ** 27- Internal mark-up** 60

Fixed production costs 60 50 80

Divisional administration costs 20 17 25

Divisional profit 72 11 65

Non-controllable Head Office management charge 10 8 15

Profit 62 3 50

Capital employed 400 550 415

Return on Capital Employed (based on profit) 15·5% 0·5% 12·0%

Return on Capital Employed (based on divisional profit) 18% 2% 15·7%

* Internal sales have been valued at their equivalent external prices by applying the mark-upcalculated earlier.

** These values show the variable cost to the company of these internal transactions and themark-up that would normally apply to these transactions.

Requirement (d)

A system of dual prices would mean that the selling price recorded by the selling divisionwould not be the same as the buying price recorded by the buying division. Typically, thebuyer would include the company variable cost as their cost and the seller would include avalue closer to market value as their sales.

If this were done here, then the “Internal mark-up shown under Variable Production cost”would not appear and as a result the divisional profit of division E would have increased by$60,000 to $71,000 which would give the division a Return on Capital.

__________________________________________________________________________

The Chartered Institute of Management Accountants 2009

CIMA_P2_Performance Management_Specimen Papers__Ans_Nov_2009

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