ACCA Certified Accounting Technician Examination - Paper T7 Planning, Control and Performance Management 1 (a) High-low technique (i)

Variable overhead cost per unit Change in variable cost Variable cost per unit = Change in units ($2,925,000 -$1,425,000) = (500,000 units - 100,000 units) $1,500,000 = 400,000 units Variable overhead cost = $375 per unit (ii) Fixed overhead cost per annum Total cost = fixed cost + variable cost By substitution into 100,000 unit budget $1,425,000 = fixed cost + (100,000 units x $375 per unit) $1,425,000 = fixed cost +$375,000 Fixed overhead cost per annum = $1,050,000. (b) Standard marginal cost card Sales price (w1) Direct materials (05 kg per unit at $120 per kg)) (w2) Direct labour (variable) (02 hours per unit at $825 per hour) Variable overhead (0125 hours per unit at $30 per hour) (w3) Contribution Working 1 $1,500,000 100,000 units Working 2 50,000 kg 100,000 units $60,000 50,000 kg $120 x 05 kg Working 3 12,500 machine hours 100,000 units $375 per unit 0125 hours per unit (c) Break-even point Contribution sales (C/S) ratio = Contribution sales = $900 $1500 = 06 Fixed costs = CS ratio $1,050,000 = = $1,750,000 06 = $1500 per unit = 05 kg per unit = $120 per kg = $06 per unit = 0125 machine hours per unit = $30 per hour

June 2008 Answers

$$
060 165 375

1500

600 900

Break-even point in revenue

Tutorial Note The break-even point in sales revenue could alternatively have been calculated by multiplying the break-even point in units by the budgeted selling price, as follows: Break-even point in units Fixed cost = Contribution per unit $1,050,000 = = 116,667 units $900 per unit

Break-even point in revenue = 116,667 units x $15 = $1,750,000

(d)

Variances (i) Sales volume Actual sales units at standard contribution Budgeted sales units at standard contribution (ii) Sales price variance Actual sales at actual price Actual sales at standard price (iii) & (iv) Direct materials price and usage variance Actual usage at actual price Actual usage at standard price Standard usage at standard price (v) & (vi) Direct labour rate and efficiency variance Actual hours at actual rate Actual hours at standard rate Standard hours at standard rate (w4) (vii) & (viii) Variable overhead rate and efficiency Actual hours at actual rate Actual hours at standard rate Standard hours at standard price (w4) (ix) Fixed overhead expenditure Actual fixed overhead Budgeted fixed overhead Working 4 Standard labour hours = 250,000 units x 02 hours per unit = 50,000 direct labour hours Standard machine hours = 250,000 units x 0125 hours per unit = 31,250 machine hours Tutorial Note Variances are often calculated by a formula and such an approach would be equally acceptable here. For example the sales volume variance could be calculated as follows: (Actual sales units budgeted sales units) x standard contribution (250,000 300,000) x $9 = $450,000 Adverse 45,000 hrs x $825 per labour hr 50,000 hrs x $825 per labour hour 125,000 kg x $120 per kg 250,000 units x $06 per unit 250,000 units x $15 per unit 250,000 units x $9 per unit = 300,000 units x $9 per units = $2,250,000 > $450,000 A $2,700,000 $4,000,000 > $250,000 Fav $3,750,000 $160,000 > $10,000 A $150,000 > 0 $150,000 $420,000 > $48,750 A $371,250 > $41,250 Fav $412,500

$924,000 > $24,000 A 30,000 x $30 per machine hr $900,000 > $37,500 Fav 31,250 machine hours x $30 per hour $937,500 $1,110,000 > $60,000 A $1,050,000

(e)

Memorandum To: Sales director Ethan From: An Accounting Technician Subject: Sales volume and price variances Date: Today I am pleased to provide you with an explanation of these two variance and the possible interrelationships between them. Sales volume variance The sales volume variance measures the effect on profit of selling more or less units than budgeted. In a standard marginal costing system this effect is measured in terms of standard contribution gained or lost. In the year ended 31 May 2008 Ethan sold 50,000 less units of the Lundegaard than was budgeted. As standard unit contribution is $9 per unit, everything else being equal this led to a profit reduction of $450,000. Sales price variance The sales price variance measures the effect on profit of selling units at a price that is higher or lower than budgeted. In the year ended 31 May 2008 Lundegaards were sold at a higher price than budgeted ($16 per unit rather than $15 per unit). On actual sales of 250,000 units, everything else being equal, this would lead to an increase in profits of $250,000. Possible interrelationships Selling price generally has an effect on sales volume. Increases in prices normally lead to a decrease in volume. This could well be the case for Lundegaards. If the increase in price is the only cause of the decrease in volume, then the decision to increase price can be seen as a bad one, resulting in a net $200,000 adverse effect on profit. Alternatively the failure to achieve budgeted sales volume could be due to other causes, for example an over optimistic sales volume in the original budget. 10

(a) Contribution per unit of the limiting factor Model Sales price Variable cost Contribution Display space per unit Contribution per cm3 Rank A 130 60 70 140 cm3 $05 3rd B $ per unit 180 100 80 120 cm3 $067 1st C 210 120 90 160 cm3 $056 2nd

In terms of contribution per cm3 of display space, model B is the best choice. (b) Delegate Notes (i) The benefits of operating a budgeting system A budget can be described as a financial expression of a plan of action. Budgeting systems offer benefits in planning and controlling a business. In terms of planning they (i) Force the organisation to plan. Many managers get bogged down in day to day problems and fail to think about the future. A budgeting system forces managers to think about the future and helps it to achieve its objectives. (ii) Budgets require organisations to make decisions about the use of scarce resources and therefore help in getting the best use of these resources. (iii) Budgets coordinate the activities of various parts of the business. They should ensure, for example, that the purchasing department is buying the quantities of products that the shops want to sell. (iv) Budgets help communicate the companys plan of action throughout the business, so that all employees know what they are trying to achieve. In terms of control they (i) Allocate responsibility for the achievement of budget targets to budget holders, for the operations under their control. (ii) Establish a system of control over actual performance by the comparison of actual results against budgeted plans. Departures from budget can be investigated and controllable problems can be rectified. (iii) Authorise expenditure. The inclusion of an item in an approved budget is a major step towards authorising the budget holder to spend the money. (iv) Engage the interest and commitment of employees. Budget figures are often regarded as targets and systems that let employees know how badly or well they are doing against target often provide an incentive for improved performance. (ii) Variable cost A variable cost is a cost that varies in direct proportion with the volume of business activity. Examples of variable costs in a retail setting would be the cost of bought-in product and sales commission. (iii) Fixed cost A fixed cost is a cost that tends to be unaffected by changes in volume of activity. Fixed costs are commonly period costs and relate to a period of time rather than activity levels. Examples of fixed costs in retailing include rent and shop managers salaries. (iv) Contribution Contribution is the difference between sales price and variable cost per unit (or total revenue less total variable cost). The contribution earned per unit at first goes towards covering fixed costs and once these are covered towards earning a profit. In retail, unit contribution will be equal to selling price less buy-in cost, less any other variable costs per unit such as sales commission. (v) Limiting factors A limiting factor is anything that limits the activity of an organisation. Examples in retail include shortages of products to sell, labour, shelf space or customers. (vi) The importance of maximising contribution per unit of the limiting factor In the short run fixed costs are fixed. In this situation maximising contribution will result in the maximisation of profits. Limiting factors restrict the activity of an organisation, and therefore its ability to earn contribution. We therefore need to ensure that we earn the biggest contribution possible, given any limiting factors that we face. Accordingly we should choose to sell products that give us the most contribution per unit of the limiting factor. This will result in the maximisation of contribution and profit.

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(a) Production cost budgets JulyOctober (Produce in one month) $$ Direct material (w1) Direct labour (w2) Prime cost Power (w3) Indirect labour (w4) Plant and machinery depreciation (w5) Alternative 1 (Produce in four months) 560,000 850,000 1,410,000 Alternative 2 560,000 1,000,000 1,560,000 640,000 80,000 100,000 2,380,000

580,000 65,000 119,000 Total production cost 2,174,000 Recommendation: On the basis of total cost alternative one is preferred. Workings Working 1 80,000 boxes x $7 per box = $560,000 Working 2 Alternative 1: 1 month x $850,000 = $850,000 Alternative 2: 4 months x $250,000 = $1,000,000 Working 3 Cost per month at: Zero output = $40,000 + ($5 x 0 boxes) = $40,000 20,000 boxes = $40,000 + ($6 x 20,000 boxes) = $160,000 80,000 boxes = $60,000 + ($5 x 80,000 boxes) = $460,000 Alternative 1: (1 month x $460,000) + (3 months x $40,000) = $580,000 Alternative 2: 4 months x $160,000 = $640,000 Working 4 Alternative 1: (1 month x $35,000) + (3 months x $10,000) = $65,000 Alternative 2: 4 months x $20,000 = $80,000 Working 5 Alternative 1: (1 month x $95,000) + (3 months x $8,000) = $119,000 Alternative 2: 4 months x $25,000 = $100,000 (b) Four factors Showalter might consider

In choosing between temporary closure and a reduced level of monthly activity Showalter might consider the following: The required delivery date. Clearly if the plates are required in August it would be foolish to schedule their production for September. Early delivery could impress customers and lead to more business being won. Ability to cope with new orders. By completing the production in August this would leave capacity free to cope with any unexpected large orders in September. Cash flow issues: early production could lead to cash costs being incurred earlier. On the other hand early production could lead to earlier receipt of cash from customers. Morale: total closure of the factory for three months may be more demotivating than a reduced level of activity. Closure for three months could lead to agency workers finding work elsewhere and result in Showalter employing less experienced staff upon reopening. Closure for three months may have damaging effects on plant and machinery. Closure for three months may allow maintenance work to take place without disrupting production. (Only four factors were required)

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(a) Ratios Operating profit Capital employed Operating profit Revenue Revenue Capital employed Current assets Current liabilities =165 (v) Capital gearing ratio Long-term liabilities Total equity 2007 $180m = $1,255m = 143% = = (iii) Asset turnover = =143 x (iv) Current ratio $180m $1,800m 10% $1,800 $1,255 13 x $139m $84m 120 $147m $122m $810m 132% 2008 $175m $1,425m 123% $175m $1,850m 95% $1,850 $1,425

(i)

Return on capital employed

(ii) Return on sales

$670m $585m $615m = 115%

Tutorial Note The majority of these ratios may be defined in different ways. Any sensible definition will be accepted and given full credit. (b) Meaning and potential causes of ratios Return on capital employed This ratio shows the percentage return earned on long-term finance invested in the business. It has decreased between the two years. This is explained by both a decrease in the return on sales ratio and a decrease in the asset turnover ratio. Return on sales This ratio shows operating profit as a percentage of sales revenue. For Brainerd in 2008, 95 cents of every $1 of sales was operating profit. It has decreased slightly between the two years. This could possibly be explained by a disproportionate increase in expenses (possibly caused by the cost of staff training) or a decrease in sales price (possibly caused by price cutting to counteract the recent quality problems). Lower load factors due to service quality problems could also have increased the average cost per passenger. Asset turnover This ratio measures the ability of the firm to generate sales from the capital it has invested. Once again this has decreased between the two years. This could be explained by quality problems leading to a relative decrease in sales volume or the increased investment in new aircraft not being matched in the short term by increased sales volumes. Current ratio The current ratio measures the ability of the firm to meet its short-term financial obligations (current liabilities) from cash and assets that should be converted into cash over the coming year (current assets). This ratio has deteriorated over the period in question as current liabilities have risen proportionately more than current assets. This could be due to a strain on liquidity caused by the heavy capital investment in new aircraft. Capital Gearing The capital gearing ratio measures the amount of long-term financing provided by debt as compared to equity. It appears quite high in Brainerd, possibly due to the capital intensive nature of the industry. Capital gearing has increased over the year. This is most obviously explained by the investment in new aircraft being financed by long-term debt. (only three explanations were required) (c) The importance of non-financial performance measures. The use of non-financial performance measures can be justified in several ways: Perhaps the most important reason for the use of non-financial performance measures is that they give early warning signals of problems. For this reason they are often referred to as leading indicators. Financial performance measures are often described as lagging indicators, that is they tell the firm that something has gone wrong after it has gone

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wrong. The use of non-financial performance measures gives a firm a chance of correcting problems before they go too far. For example, a firm might be able to cure a quality problem revealed by a high level of customer complaints before it has a damaging effect on sales and profits. Virtually all companies face increasingly competitive market places. In the face of global competition non-financial issues such as product quality, customer service, delivery, reliability and innovation have become crucial elements of competitive strategy. None of these variables are directly measurable in financial terms. Non-financial performance measures may be more understandable and relevant for non-financial staff. Financial measures in isolation can potentially be manipulated by managers. Using a range of financial and non-financial measures makes it more difficult for managers to hide bad performance. Non-financial measures can be used as a method of implementing an organisations chosen strategy. For example, if a firm decides to compete by offering the quickest call out times for product repair, then the effectiveness of the delivery of this strategy can be measured by a non-financial indicator such as customer waiting time. (only two reasons were required)

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