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CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2

Published November 2009

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 is
added to an organisation’s products and services. Modern businesses cannot survive merely
by having efficient production facilities, they must also have a thorough understanding of the
importance of the relationship between all of the elements in the value chain. These include:
research & development, design, manufacturing, marketing, distribution and customer
service.

The DT group currently has an internal manufacturing facility, this makes communications
between different parts of that manufacturing process relatively straight-forward, however, if
part of this process is to be outsourced this will place as added burden on the production
management to ensure that all parts of the production process operate smoothly. Aside from
communication difficulties, there may be different work ethics to contend with, and delays in
receiving items and quality issues may disrupt the flow of goods to customers. This will lead
to difficulties in identifying where profits / contributions are being earned (and lost) within the
value chain.

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

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

Performance Management 1 Specimen Exam Paper


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

Answer to Question Two


Requirement (a)
Number of Average time
batches completed per batch
1 1,000 hours
2 900 hours
4 810 hours
8 729 hours
16 656 hours
32 590 hours
64 531 hours

It seems that the average time equals 5·3 hours per unit (i.e. 530 hours per batch after 64
batches 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 hours
Operating efficiency difference 740 hours Favourable

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

Original standard (5·3 hours x 400 units) 2,120 hours


Time allowed per learning curve 3,240 hours
Planning efficiency difference 1,120 hours Adverse

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

Planning variance $11,200 Adverse


Operating 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 more
meaningful 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 by
the end of August and the learning period seems to continue to around 64 batches it is clear
that the learning has not yet been completed and therefore it is unfair to measure
performance against the post learning standard. These revised calculations show that the
actual learning is better than was expected whereas the original variance calculation showed
that the time taken was more than it should have been. Rather than acusing the workforce of
being inefficient they should be congratulated on their efficiency.

Specimen Exam Paper 2 Performance Management


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

Answer to Question Three


Requirement (a)
Feedback control is the comparison of actual performance with an agreed target such as the
budget set by the Managing partner. An example would be a comparison of the fees earned
by 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 balances
and the overdraft facility. As a result of this comparison it may be necessary to defer some
expenditure until a later period or reduce it so as to stay within the firm’s existing cash
balances / overdraft facility. This will lead to a second draft of the cash budget being
prepared.

Requirement (b)
One beneficial consequence of involving the other partners in the preparation of the firm’s
budgets is that they will accept ownership of their budget and accept responsibility for
achieving 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 achieved
than that which would have been set by the Managing partner. This is known as the inclusion
of 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 1,468·5 489·5
Purchasing 1,343 1,343 2,015
Material 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 6·06


Other costs

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

Performance Management 3 Specimen Exam Paper


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

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

By focusing attention on controlling these four cost causes in the future, and minimising the
costs 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 are
determined by identifying the resources expected to be required for the completion of the unit
and 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 deducting
the required profit margin to determine the cost at which the product or service must be
provided 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 taker
rather than a price maker. HJ will therefore be able to determine the selling price of its range
of plastic moulded items. HJ must then determine the profit that it wishes to achieve to make
a reasonable return on its investment in the new machinery. By deducting the profit required
from the selling price HJ will determine the target cost for its plastic moulded products. HJ will
then have to consider its production methods and the impact of any learning and experience
efficiencies that may arise to determine whether it is capable of producing the items for their
target cost.

Requirement (b)
Short term marginal cost based pricing is often necessary to enter into a new market that is
already well established and mature. However, this form of pricing is unlikely to be financially
viable in the longer term because of the need to recover the fixed costs of the business and
deliver a suitable return for the business owners.

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

Specimen Exam Paper 4 Performance Management


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

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 is
not a relevant value because the time has already been spent and is therefore a sunk
cost. The relevant value is $NIL.

2. The cost of Direct Material A is based on 10,000 square metres valued using the
weighted 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 metre
which 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 a
minimum order size of 300 metre lengths and the remainder has no foreseeable use or
net sales revenue. Therefore the relevant cost is the cost of the minimum order of 300
lengths, i.e. 300 x $10 = $3,000

4. The cost of the components is based on the normal transfer pricing policy of $8 plus a
50% mark-up = $12 per component. 500 components x $12 = $6,000. However, this is
not the relevant cost to the M group. The relevant cost to the M group is the variable
cost of manufacturing the components plus any lost contribution from the reduction in
external sales by HK. Thus:

350 components x variable cost only = 350 x $8 = $2,800


150 components x variable cost + lost contribution = 150 x ($8 + $3) = $1,650
Total relevant cost of the components = $2,800 + $1,650 = $4,450
The external market price of $14 is not relevant because it is cheaper to manufacture
them 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 per
hour. This is not the relevant cost. The relevant cost is the lower of:

a) Recruiting engineers to do the work at $15 per hour; and


b) 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 $14
per 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 is
not 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

Performance Management 5 Specimen Exam Paper


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

work within his normal hours he will work overtime but he is not paid for this so there is
no 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. If
the 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 the
relevant cost is $2,000.

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

$220,000 / 80% of 50,000 hours = $5.50 per hour


1,000 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 costs
are incurred as a result of undertaking the project, indeed being based on an
absorption rate implies that they are not project specific and will be incurred whether
the project goes ahead or not. The relevant cost is therefore $NIL.

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

Total 93,450

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

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

(ii) The accounting system will attribute overhead costs to the project using an
absorption rate that would normally be based on the budgeted costs and activity
levels. 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 affected
by 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 them
choosing to make an internal supply in preference to their external customers. Does
this 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?

Specimen Exam Paper 6 Performance Management


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

Answer to Question Seven


Requirement (a)
The performance statement does not show the actual return on capital employed achieved by
each 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 Head
Office. However, there are a number of other factors that need to be considered in relation to
the performance report.

1. The management charges from Head Office are presumed to be non-controllable at


divisional level, it is therefore inappropriate to include them in any measure of divisional
performance.

2. The basis of valuing the Capital Employed by each division is not stated. It is assumed to
be based on the original cost of the assets less accumulated depreciation. As a consequence
older assets will have lower original costs (due to price inflation) and lower book values (due
to 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 in
Division F where fixed production costs are approximately 25% of total production costs
whereas in divisions D and E the fixed production costs are around 50% of total production
costs. This may imply that the equipment used in Divisions D and E is newer and more
automated.

Requirement (b)
The problem with negotiated transfer prices is that the results of the negotiations is as much
affected by the personalities of the managers of each division as it is by the circumstances
surrounding the transaction. If one manager has a stronger personality than another, or is a
better negotiator then this will act to the detriment of the weaker division and may not be in
the best interests of the company as a whole.

The inter-divisional trading affects the performance of all of the divisions. Assuming that the
goods sold between the divisions were similar to those that the supplying division sold into the
external 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 cost
was $32,000, a mark-up of just over 300%. If the same mark – up were applied to the internal
sale then Division D’s profits would have increased by $52,000 to $62,000 and the profits of
Division E would reduce by $52,000.

2. Goods sold by Division F


The external sales of Division F were $385,000 during the year for which the variable cost
was $221,000, a mark-up of 75%. The mark-up added to the internal sale was 67% so there
is not a significant impact on the profit reported by the divisions as a result of these internal
transactions.

Performance Management 7 Specimen Exam Paper


CIMA 2010 Chartered Management Accounting Qualification – Answers for Specimen Examination Paper P2
Published November 2009

Requirement (c)
Division D E F
$000 $000 $000
Net sales - External 130 200 385
Sales - Internal 72 0 15
Total 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-up
calculated earlier.

** These values show the variable cost to the company of these internal transactions and the
mark-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 division
would not be the same as the buying price recorded by the buying division. Typically, the
buyer would include the company variable cost as their cost and the seller would include a
value 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

Specimen Exam Paper 8 Performance Management

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