UNIVERSITY OF LONDON

PRELIMINARY EXAM 2017

MODULE CODE : AC3097

MODULE TITLE : Management Accounting
DATE OF EXAM :

TIME OF EXAM :

DURATION : _3_ hours 15 min (including 15 min reading time)

TOTAL NUMBER : 11 pages

OF PAGES
(INCLUDING
THIS PAGE)
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INSTRUCTIONS TO CANDIDATES :-

Working should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated

A calculator may be used when answering questions on this paper and must comply with
the specifications required by The University of London. The make and type of machine
must be stated clearly on the front of the answer booklet.

Candidates should answer FIVE of the following EIGHT questions: FOUR from Section A and
ONE from Section B. All question carry equal marks

DO NOT TURN OVER THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.

Candidates are strongly advised to divide their time accordingly.

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SECTION A

Answer four questions from this section.

1. Granada Ltd makes a range of its own products and works on contracts to
customer’s specification. Granada Ltd has been approached to take on a contract for
the production of 20,000 Kg of product X at a price of £500 per Kg.

The company has drawn up an estimate based on their normal absorption costing
approach to pricing as follows:

Quote for 20,000 kg of product X £000 £000

Sales 10,000
Costs:
Labour grade 1 - 2 hrs x £16 x 20,000 Kg (640)
grade 2 - 6 hrs x £7.50 x 20,000 Kg (900)
Material A - 2 x £32 x 20,000Kg (1,280)
Material B - 1 x £120 x 20,000K (2,400)
Variable Overheads 8 hrs x £12 x 20,000Kg (1,920)
Fixed overheads 8 hrs x £6 x 20,000 Kg (960) (8,100)
Net Profit on Contract 1,900

The sales manager wishes to obtain this contract but the production manager is
concerned about machine usage required. He requests you to look into the
company’s current workload and use of resources to determine if the contract should
be accepted.

You discover the following:

Grade 1 labour is highly skilled and although it is currently under-utilised in the firm it
is Granada’s policy to continue to pay Grade 1 labour in full. Acceptance of the
contract would reduce the idle time of Grade 1 labour. Idle time payments are treated
as production overheads.

Grade 2 is unskilled labour with a high turnover and is considered a variable cost.

The materials required to fulfil the contract would be drawn from materials already in
inventory.
Material A is widely used within the firm and the amounts used by this contract will
need to be replaced.
Material B was purchased to fulfil an expected order which was not completed; if
material B is not used for this contract it will be sold.

(Question continues on next page)

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For accounting purposes FIFO is used. The various values and costs for Materials A
and B are:
Book value Replacement cost Net realisable value
£ £ £
A per unit 32 60 36
B per litre 120 130 125
Variable production overheads of £12 per productive labour hour using both skilled
and unskilled labour will arise if the work is accepted.

Estimates of the year’s activity show budgeted annual fixed production overheads of
£2,400,000 and budgeted productive labour hours of 400,000.

A special machine is required for this contract. The fixed costs of running and
depreciating the machine are included in production overhead. Accepting the
contract would not cause these costs to change but using the machine time would
mean that Granada Ltd would not be able to make 10,000 units of product Y, a
product in regular demand, thus decreasing the total expected sales.

Details of Product Y’s revenues and costs are as shown below.

Per unit
Sales price £350
Labour – grade 2 4 hours
Materials – relevant variable costs £25

Granada Ltd uses full absorption job costing in order to derive a profit figure for each
contract. If the contract for X is accepted, it will be treated as a separate job for
routine costing purposes.

Required:
(a) Based on financial grounds, review the contract and the current situation at
Granada Ltd and advise the company whether or not to accept the contract.
Support your advice with calculations. (8 marks)

(b) Explain how the original absorption costing method and your results in (a) above
are used by businesses. (4 marks)

(c) i. Calculate the difference in profit revealed by the absorption costing quote and
your answer in (a) above. (1 mark)

ii. Since Granada Ltd uses a routine job costing system, accepting the contract
would mean that the difference in profit would have impacts on costs and
revenues elsewhere in the system. Draw up a schedule to explain which costs
and revenues would be affected by accepting the contract. (The total of your
schedule should be the difference in profits which you have already
calculated). (7 marks)

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2. “The Grove” is a medium priced hotel located in the suburbs of a major city. It has 250
bedrooms, a dining room, a bar and a reception hall. Its occupancy rates are high
during the working week (Monday to Thursday nights) but at the weekend (Friday to
Sunday nights) there is little activity and few overnight guests.

The directors of The Grove wish to expand the hotel and its facilities to attract weekend
guests and local residents by acquiring an adjacent site. They are confident that they
would obtain planning permission for the proposal.

The site of 10,000 square metres is available for purchase at £0.5 million. The
directors propose to build a smart facility providing a large function room for wedding
receptions, corporate dinners etc., a restaurant and bars. It is expected that a
proportion of people attending functions would book into the bedrooms in the main
hotel. There will also be a health club of swimming pool, gymnasium, sauna etc. Local
residents could take out membership of the health club at an average price of £40 per
month.

Acquisition of the site, detailed design work and obtaining planning permission will
take one year. Construction of the health club will cost an estimated £2.5 million and
£1 million will be needed for Fixtures and Fittings. Initial marketing will cost £100,000.
Payment for these will occur by the end of the second year.

The club will open for business at the commencement of year 3. It will be actively
marketed but, the directors recognise that it will take time to build up its reputation.
They have made the following projections of activities:

Additional Club
Functions
Bedroom Bookings Membership
Operating Year 1 60 100 400
Operating Year 2 80 200 800
Operating Year 3 100 300 1200
Operating Year 4 120 400 1600
Operating Year 5 -10 150 500 2000

The directors have assumed that each function will make a contribution (over and
above the variable catering and staff costs) of £2,000. Each additional bedroom
occupied in the main hotel will make a contribution of £100. Marketing will cost
£50,000 per year. The fixed operating expenses of the function room will be £40,000
per annum and of the health club will be £200,000 per annum. For financial
accounting purposes the new building will be depreciated on a straight line basis
over 50 years and the Fixtures and Fittings will be depreciated on a straight line
basis at 10% starting from the first year of operations.

Taxation should be ignored.

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 (Question continues on next page)
Required:
(a) Prepare a cashflow for the project covering the two years of acquisition and
construction and the first 10 years of operation (As an inflow in year12, you should
bring in the land at its initial value, plus the written down value of the buildings and
fixtures and fittings). Using a 10% discount rate, calculate the Net Present Value
(NPV) of the project. Discount Factors for 10% are shown in the table below (you
should assume that all cashflows would be at the end of each year). (12 marks)

(b) Calculate the payback (in terms of approximate number of years of operation) for the
project (you should assume that all cashflows accrue evenly throughout the year).
(2 marks)

(c) Based on your answers in (a) – (b) above make reasoned recommendations on the
viability of the proposal. (3 marks)

(d) The costs and revenues used in your calculations above may not be absolutely
certain. Identify the areas which need greater certainty in order for you to be
confident of your recommendations? How would you handle the uncertainty in your
estimates? (3 marks)

Year Factor
1 1.000
2 0.909
3 0.826
4 0.751
5 0.683
6 0.621
7 0.564
8 0.513
9 0.467
10 0.424
11 0.386
12 0.350
13 0.319

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 3. Wang Consulting is a software design firm. Budgeted costs and target sales of
running the firm for the year ended 31st December 2016 are:
£M
Professional labour - fixed salaries (billable hours 1,500,000) 100
Support costs 100
Target profit 100
Total target sales 300

The current method of billing clients is to trace professional labour cost to each client
and in order to cover support costs and provide target profit to charge 300% of
professional labour cost.

The £100M support costs shown above have been analysed as follows:
£M Cost driver Budgeted use of
resource
Technicians salaries & costs 18 Technicians hours 800,000 hours
(fixed costs)
Computer running (fixed costs) 14 computer hours 2,800,000 hours
Photocopying (variable cost) 8 Photocopying (pages) 400,000,000 pages
Total identifiable support costs 40
Unidentifiable support costs(fixed 60
cost)
Total support costs 100

The firm’s data-processing can trace these costs to individual jobs. In order to charge
clients more fairly for the resources used on each contract, it has been decided to review
the effects on clients’ bills of the following method of charging:

Professional labour x 2
+ Identifiable support costs
+ Unidentifiable support costs (150% of identifiable support costs)

The firm completes many contracts each year. Estimates of resource cost or usage have
just been completed for the following two jobs:
Client 304 Client 308
Professional labour £200,000 £200,000
Technical specialists’ costs 1,000 hours 6,000 hours
Computer time 3,000 hours 15,000 hours
Photocopying 50,000 sheets 60,000 sheets

Required:
a) Calculate the contract fees which would be charged to Client 304 and Client 308 under
each of the two bases of charging described above. (7 marks)

b) Compare the answers in a) above and briefly discuss the advantages and limitations of
the two methods. (3 marks)

(Question continues on next page)

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c) Calculate the profit which will be made by the company for the year ended 31st
December 2016 using each of the two methods, if actual costs are the same as
estimated but resource use is as follows:

Professional labour 1,500,000 Billed hours

Technicians hours 750,000 hours
Computer time 3,000,000 hours
Photocopying 300,000,000 sheets (6 marks)

d) Explain why the two methods produce different results and indicate whether this would
change your recommendation on which billing method to use. (4 marks)

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4. Saunders Ltd. manufactures electrical products. It has several divisions operating as
separate profit centres. Each divisional manager has full authority over decisions
concerning the purchase and sale of their division’s products to outsiders and to other
divisions of the company. Division G currently makes a product (X12) specifically for
Division H.
Details of the operating data for product X12 for the forthcoming period are as follows:
H’s annual purchases of product X12 20,000 units
G’s variable cost per unit of product X12 £80
Transfer price of product X12 £125
Division H further enhances X12 at a variable cost of £25 and sells the resulting product
(ML1) for £180. Division H cannot increase the price of this product due to market
pressures.

For the forthcoming period Division G is planning to increase all its product prices by 20%
due to cost pressures which threaten its ability to meet Head Office target returns. It will
increase the price of Component X12 to £150. Division H is thinking of moving its custom
to another manufacturer who will supply X12 for £135 per unit.

Required:
(a) Calculate the impact of the change in the transfer price of product X12 to £150 on the
profits of each division and the company as a whole. (6 marks)

(b) If there are no alternative uses for the internal facilities at Division G, what price would you
recommend? (4 marks)

(c) The internal facilities of Division G, if not used to produce the 20,000 units of X12, would
be used for other production operations resulting in annual cash-operating savings of
£1,300,000. Explain the trading arrangement and transfer price of X12 which would be
most suitable in ensuring that both managers, acting in their divisions’ best interests also
take actions that are in the best interest of the whole company. (6 marks)

(d) Discuss the importance of “Goal Congruence” in setting transfer prices. (4 marks)

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5. Gadgets Ltd has three production divisions in different parts of the country. The
divisional financial reports on a historical cost basis for the year ended 31st
December 2016 for each division are as follows:

Division E F G
£000 £000 £000
Income Statement
Revenues 500 700 1120
Less: operating expenses 294 412 770
straight-line depreciation 120 168 160
Net Income 86 120 190

Statement of Financial Position

Non-current Assets Cost 1,200 840 1,600
Accumulated depreciation 720 672 160
Net book value 480 168 1,440
Net Current Assets 250 200 300
Net total assets 730 368 1,740
Divisions fixed assets acquired when price index was 140 160 170

Price index at 31.12.16 = 180

The company appraises the divisions using three measures: Return on net total
assets, Net total asset turnover and Net profit percentage.

Required:
(a) Using the historical cost approach to asset valuation, calculate the three measures
indicated above for each division and discuss the performance of the divisions as
revealed by the calculations. (6 marks)

(b) The manager of Division G feels that the method of assets valuation is unfair
and requests that a current cost accounting approach be applied to fixed asset
valuation and depreciation charges. It is agreed that the net current assets figures
represent current values but the price index should be used to revalue the fixed
assets. For each of the divisions, calculate the three measures calculated in (a) but
using current cost accounting. Discuss the performance of the divisions as revealed
by the calculations. (9 marks)

(c) Briefly explain which of the methods in (a) and (b) above seems fairer for
evaluation purposes. (5 marks)

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6. Oakwood Stables specialises in boarding thoroughbred breeding mares and their
foals. Customers bring their breeding mares to Oakwood for delivery of their foals
and postnatal care of the mare and foal.

Oakwood has prepared a master budget for the financial year end 31.9.2017
detailed by quarters. They have prepared the performance report for the first quarter
as shown below:

OAKWOOD STABLES Performance Report for 3 months ended 31.12.2016

Budget Standard Master Actual Variance*

(per Mare per Day) Budget Net income
Number of mares 60 52 8 (U)
Number of boarding days 5520 4732 788 (U)
£ £ £ £
Revenues £25.00 £138,000 £104,900 £33,100 (U)
Less variable expenses
Feed & supplies 5.00 27,600 26,098 1502 (F)
Veterinary fees 3.00 16,560 14,709 1851 (F)
Blacksmith fees 0.30 1,656 1,369 287 (F)
Total variable expenses 8.30 45,816 42,176 3,640 (F)
Contribution margin 16.70 92,184 62,724 29,460 (U)

Less fixed expenses

Depreciation & insurance 14,000 14,000 0
Rates, light and heat 3,000 3,200 200 (U)
Repairs & maintenance 11,000 10,400 600 (F)
Labour 22,000 21,800 200 (F)
Total fixed expenses 50,000 49,400 600 (F)
Net income 42,184 13,324 28,860 (U)
*F = Favourable
U = Unfavourable

John Oaks the proprietor is concerned about the very low profit for the quarter. He
realises that it is due to a drop in the number of mares cared for. He is pleased to see
that all his costs except one show favourable variances but feels that with such good
cost savings he should have made a better profit. He knows that Feed and Supplies
costs per item have increased 5% on the figures used in the budget but veterinary rates
have stayed the same. He has negotiated a discount of 8% with the blacksmith since
preparing the budget.

Required:
Using any calculations you consider appropriate, provide a revised financial report, and
a brief written report to John Oaks on the financial performance of the stables for the
quarter. (20 marks)

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Section B: Answer ONE Question from this section.

7 Quality management requires the identification of financial and non-financial indicators

of quality.

(a) Explain the categories and measures of quality (both financial and non-financial)
which can be collected to monitor quality. (16 marks)

(b) Describe the ways in which the information can be used by companies. (4 marks)

8 With regard to four of the management accounting terms listed below:

a) Give definitions and explain their meaning

b) Give examples of their applications

(i) Cost centre.

(ii) Opportunity cost.
(iii) Throughput contribution.
(iv) Break-even chart.
(v) Process costing. (20 marks)

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