LCCI International Qualifications

Management Accounting
Level 3

Model Answers
Series 4 2008 (3024)

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Management Accounting Level 3
Series 4 2008

How to use this booklet

Model Answers have been developed by EDI to offer additional information and guidance to Centres,
teachers and candidates as they prepare for LCCI International Qualifications. The contents of this
booklet are divided into 3 elements:

(1) Questions – reproduced from the printed examination paper

(2) Model Answers – summary of the main points that the Chief Examiner expected to
see in the answers to each question in the examination paper,
plus a fully worked example or sample answer (where applicable)

(3) Helpful Hints – where appropriate, additional guidance relating to individual

questions or to examination technique

Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success.

EDI provides Model Answers to help candidates gain a general understanding of the standard
required. The general standard of model answers is one that would achieve a Distinction grade. EDI
accepts that candidates may offer other answers that could be equally valid.

© EDI 2009

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system or
transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise
without prior written permission of the Publisher. The book may not be lent, resold, hired out or
otherwise disposed of by way of trade in any form of binding or cover, other than that in which it is
published, without the prior consent of the Publisher.
QUESTION 1

Details of the three products manufactured and sold by Company B are set out below:

Product

P Q R
Selling price (£ per unit) 12.00 25.00 16.00
Variable costs (£ per unit) 6.00 16.00 10.00
Fixed costs (£ per unit) 4.50 6.50 5.30
Sales (units per period) 4,000 2,000 3,000

REQUIRED

(a) Calculate the contribution to sales ratio of each product. (3 marks)

(b) Calculate for Company B overall and based on the above sales mix:

(i) The contribution to sales ratio (4 marks)

(ii) The break-even sales revenue per period (to the nearest £ hundred) (4 marks)

(iii) The sales revenue required per period (to the nearest £ hundred) to achieve a net profit of
£20,000.
(3 marks)

(c) Draw a profit/volume (P/V) chart for Company B, based on the above sales mix and showing
sales up to £170,000 per period.
(6 marks)

(Total 20 marks)

3024/4/08/MA Page 1 of 11
MODEL ANSWER TO QUESTION 1

(a) Product contribution to sales ratios

Product P 50% [(12 – 6) ÷ 12 x 100]

Product Q 36% [(25 – 16) ÷ 25 x 100]
Product R 37.5% [(16 – 10) ÷ 16 x 100]

(b) Company B

(i) Contribution to sales ratio

Total sales £146,000 [(4,000 x 12) + (2,000 x 25) + (3,000 x 16)]

Total contribution £60,000 [(4,000 x 6) + (2,000 x 9) + (3,000 x 6)]
Contribution to sales ratio = 41.1% (60/146 x 100)

(ii) Break-even sales revenue

Total fixed costs £46,900 [(4,000 x 4.5) + (2,000 x 6.5) + (3,000 x 5.3)]
Break-even sales £114,100 (46,900 ÷ 0.411)

(iii) Required sales revenue for £20,000 net profit

£162,800 [(46,900 + 20,000) ÷ 0.411]

(c) See chart

COMPANY B: P/V CHART

30
Profit 20
£000
10

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170

10
Sales revenue £000
20
Loss
£000 30

40

50

3024/4/08/MA Page 2 of 11
QUESTION 2

Investment of £1.2 million in new machinery to expand production capacity is being considered by a
company. A residual value for the machinery of £60,000 would be expected at the end of its 6-year
life. Estimates of the incremental profit/(loss) from the investment (net of depreciation of the new
machinery on a straight-line basis) are:

£000
Year 1 (80)
Year 2 110
Year 3 160
Year 4 250
Year 5 220
Year 6 180

Discount factors at the cost of capital of 10% per annum are:

Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683
Year 5 0.621
Year 6 0.564

REQUIRED

(a) Calculate for the investment in new machinery the:

(i) Payback period (6 marks)

(ii) Average annual accounting rate of return. (5 marks)

(b) Describe the limitations of the investment appraisal methods used in part (a). (4 marks)

(c) Calculate the net present value (NPV) of the investment. (3 marks)

(d) State whether, and explain why, the investment is financially worthwhile. (2 marks)

(Total 20 marks)

3024/4/08/MA Page 3 of 11
MODEL ANSWER TO QUESTION 2

Workings

Depreciation = [(1,200,000 – 60,000) ÷ 6 = £190,000 per annum

Cash flow (£000):

Year Investment Profit/(loss) Depreciation Cash flow

0 (1,200) (1,200)
1 (80) 190 110
2 110 190 300
3 160 190 350
4 250 190 440
5 220 190 410
6 60 180 190 430

Average annual profit (£000) = [((80) + 110 + 160 + 250 + 220 + 180) ÷ 6] = 140
Average investment (£000) = [(1,200 + 60) ÷ 2] = 630

(a) (i) Payback period

Cumulative cash flow

Year 1 (1,090) (1,200 – 110)

Year 2 (790) (1,090 – 300)
Year 3 (440) (790 – 350)
Year 4 Nil (440 – 440)

The payback period is 4 years.

(ii) Average annual accounting rate of return

22.2% [(140 ÷ 630) x 100]

(b) Both methods fail to take account of the time value of money. In addition, the payback method
ignores cash flows after the payback period is reached.

(c) Net present value

Year Cash flow Discount NPV

factor
£000 £000
0 (1,200) 1.000 (1,200)
1 110 0.909 100.0
2 300 0.826 247.8
3 350 0.751 262.9
4 440 0.683 300.5
5 410 0.621 254.6
6 430 0.564 242.5
208.3

The net present value is £208,300 positive.

(d) The investment in new machinery is financially worthwhile because the net present value is
positive when cash flows are discounted at the cost of capital.

3024/4/08/MA Page 4 of 11
QUESTION 3

Company X manufactures and sells three products that have sales and variable costs as follows:

Product B Product C Product D

Sales units per period 6,000 9,000 10,500

Selling price per unit £10.00 £7.00 £5.00
Variable costs per unit £5.80 £3.50 £2.20

The production director of Company X anticipates that there will be restricted availability of skilled
labour in the following period. The output of products per hour of skilled labour is:

Product B Product C Product D

Production units per hour 4 6 7

REQUIRED

(a) Determine, for the following period, the:

(i) number of skilled labour hours that will be required to satisfy the expected sales demand

(3 marks)

(ii) order of priority for the manufacture of the products on the assumptions that skilled labour is
the limiting factor and the objective is to maximise profit.
(6 marks)

The marketing manager of Company Y is proposing to run an advertising campaign on one of its
products, along with a promotional selling price reduction lasting for 4 weeks, to try to increase sales
and profit.

Normal weekly sales of the product are 1,400 units at £6.00 per unit, with a contribution to sales ratio
of 55%. The selling price would be reduced by 30% during the promotional period when sales of
3,000 units per week would be expected.

The supplier of the product to Company Y would reduce its own price by £0.25 per unit to support the
promotion. Company Y would incur expenses of £3,000 on the advertising campaign.

REQUIRED

(b) Calculate the expected incremental profit/(loss) from the promotion. (11 marks)

(Total 20 marks)

3024/4/08/MA Page 5 of 11
MODEL ANSWER TO QUESTION 3

(a) (i) Skilled labour hours required

Product B 1,500 (6,000 ÷ 4)

Product C 1,500 (9,000 ÷ 6)
Product D 1,500 (10,500 ÷ 7)
4,500

A total of 4,500 skilled labour hours will be required in the following period to satisfy
expected sales demand.

(ii) Order of priority for manufacture

Product B Product C Product D

Contribution per unit (10 – 5.8) (7 – 3.5) (5 – 2.2)

= £4.20 = £3.50 = £2.80

x Production units per hour x4 x6 x7

= Contribution per skilled labour hour = £16.80 = £21.00 = £19.60

Production priority 3 1 2

(b)
Existing contribution per unit £3.30 (£6.00 x 0.55)

Existing weekly contribution £4,620 (1,400 units x £3.30)

Promotional contribution per unit £1.75 [£3.30 – (£6.00 x 0.3) + £0.25]

Promotional weekly contribution £5,250 (3,000 units x £1.75)

Increased weekly contribution from promotion £630 (5,250 - £4,620)

X 4 weeks £2,520

Less cost of advertising campaign £3,000

Incremental loss from promotion (£480)

Alternative approach to answer:

Existing contribution for the 4-week period £18,480 (1,400 units x £3.30 x 4 weeks)

Expected contribution from the 4-week promotion £21,000 (3,000 units x £1.75 x 4 weeks)

Incremental contribution from promotion £2,520

Less cost of advertising campaign £3,000

Incremental loss from promotion (£480)

3024/4/08/MA Page 6 of 11
QUESTION 4

(a) Explain the balanced scorecard approach to business performance measurement. (6 marks)

A new wholesale business is planning its working capital requirements. Sales will all be on credit with
customers, on average, expected to settle their debts 30 days after sale. Suppliers of goods are
offering 45-day settlement terms and expense creditors will, on average, be settled after 10 days.

The summary forecast trading and profit and loss account for Year 1 is:

£000 £000
Sales 300
Cost of goods:
Opening stock Nil
Purchases 200
Closing stock (20) 180
Gross profit 120
Expenses 100
Net profit 20

Sales and expenses are expected to occur evenly over the year. The stock will be established at the
start of business and will then be held at the same level throughout the year.

REQUIRED

(b) Calculate the:

(i) Working capital requirements, by calculating the relevant balance sheet items (each to one
decimal place of £ thousand) as at the end of the year. (Assume that there are 365 days in
the year).
(7 marks)

(ii) Stock turnover ratio expressed both as number of times and number of days. (3 marks)

(iii) Working capital cycle (number of days). (4 marks)

(Total 20 marks)

3024/4/08/MA Page 7 of 11
MODEL ANSWER TO QUESTION 4

(a) Traditional measures of overall business performance have emphasised financial aspects and
returns. The balanced scorecard approach to performance measurement recognises that a
variety of strategic factors influence the overall financial results of a business and need to be
managed. Also strategic decisions may take some time to have the desired financial impact and
using non-financial performance measures may help to assess progress towards the desired
financial outcomes.

The contents of a balanced scorecard will vary from business to business according to the nature
of the business and to key aspects of its strategy. Most, however, include a customer
perspective, an innovation perspective and an internal efficiency perspective in addition to a
financial perspective.

(b) (i) Working capital

£000 £000
Stock 20.0
Debtors 24.7 (300 x 30/365)
44.7
Creditors:
Goods 22.2 (180 x 45/365)
Expenses 2.7 (100 x 10/365)
24.9

Working capital 19.8

(ii) Stock turnover

9 times (180 ÷ 20)

40.6 days (20/180 x 365) or (365 ÷ 9)

(iii) Working capital cycle

No. of days

Stock 40.6
Debtors 30.0
70.6

Less creditors 32.5 (24.9/280 x 365)

Net cycle 38.1 days

3024/4/08/MA Page 8 of 11
QUESTION 5

The actual production overhead costs, incurred by Company S over four periods in the manufacture of
its single product, are as follows:

Period Costs (£) Output (units)

1 41,419 10,640
2 41,204 10,210
3 44,863 10,860
4 46,352 11,380

Cost inflation in each period has been:

Period 1 2%
Period 2 3%
Period 3 5%
Period 4 2%

REQUIRED

(a) (i) Using the high/low method and Period 4 prices, analyse the production overhead costs into a
variable cost per unit and total fixed costs per period
(6 marks)

(ii) Establish an equation for the total production overhead cost, Y, in a period at Period 4
prices, based on output x.
(1 mark)

In Period 5, the budgeted output and the budgeted fixed production overheads for Company S were
11,000 units and £25,300 respectively. The standard fixed production overhead absorption rate for
Period 5 was £9.20 per direct labour hour, based on standard efficiency of 0.25 direct labour hours per
unit of product.

2,840 actual direct labour hours were worked in the manufacture of 11,200 units of the single product
in Period 5.

REQUIRED

(b) Calculate the following fixed production overhead variances for Period 5:

(i) Capacity (3 marks)

(ii) Efficiency. (3 marks)

Control ratios may be used to measure production performance as an alternative to, or in addition to,
reporting fixed production overhead efficiency, capacity and volume (activity) variances in absolute
values.

REQUIRED

(c) (i) State the formula for each of the three production control ratios (3 marks)

(ii) Explain how each ratio may be interpreted and the relationship between them. (4 marks)

(Total 20 marks)

3024/4/08/MA Page 9 of 11
MODEL ANSWER TO QUESTION 5

(a) High/low method

Using the data for Period 2 (low) and Period 4 (high), first adjust costs in Period 2 for the effect of
inflation:

Period 2 (at Period 4 prices) = £41,204 x 1.05 x 1.02

= £44,129

Variable production overhead cost per unit = £46,352 – £44,129

11,380 – 10,210 units

= £1.90 per unit

Total fixed production overhead costs = £46,352 – (11,380 units x £1.90 per unit)

= £24,730

Equation for the total production overhead cost in a period:

y = 1.9x + 24,730

(b) (i) Fixed production overhead capacity variance

[(budgeted hours – actual hours) x standard rate]

[(11,000 units x 0.25 per unit) – 2,840 hours] x £9.20 per hour

= £828 Favourable

(ii) Fixed production overhead efficiency variance

(actual hours – standard hours of output) x standard rate

[2,840 hours – (11,200 units x 0.25 per unit)] x £9.20 per hour

= £368 Adverse

(c) (i) Production control ratios (using direct labour hours)

Efficiency = standard hours of output ÷ actual hours worked

Capacity = actual hours worked ÷ budgeted hours

Volume (activity) = standard hours of output ÷ budgeted hours

3024/4/08/MA Page 10 of 11
MODEL ANSWER TO QUESTION 5 CONTINUED

(c) (ii) Efficiency ratio – a ratio > 1 (or > 100%) indicates greater efficiency than standard and vice
versa

Capacity ratio – a ratio > 1 (or > 100%) indicates more hours worked than budgeted and vice
versa

Volume ratio – a ratio > 1 (or > 100%) indicates that output has exceeded budget and vice
versa

The relationship between the ratios can be expressed as: Volume = Capacity x Efficiency

Thus the amount of output, compared with budget, is a factor of the number of hours worked
and the production efficiency during those hours.

3024/4/08/MA Page 11 of 11 © Education Development International plc 2009

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