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No. of pages: 10

Business Level
Business Management Accounting

Instructions to candidates
(1)

Time allowed: Reading and planning 15 minutes

Writing
3 hours

(2)

Total: 100 marks

(3)

Answer all questions.

(4)

This paper consists of two sections.

Section 1: 5 questions
Section 2: 2 questions

(5)

Answers should be in the English Language, in the answer

booklet/s given to you.

(6)

Begin each answer on a separate page in the answer booklet. Submit

all workings.

K
B
2
JUNE 2015

SECTION 1
All questions are compulsory.
Total marks for Section 1 is 50 marks.
Recommended time for the section is 90 minutes.
Question 01
City Agencies (CA) is the sole agent in Sri Lanka for several multinational pharmaceutical
manufacturers. CA imports drugs and sells them to retail customers (pharmacies and
supermarkets). CAs customers vary in size and consequently the size and frequency of
their orders also vary.
The current management information system of CA, which is predominantly a financial
accounting and reporting system, produces only very little management information. It
hardly produces any product-wise or customer-wise decision support management
information. CA is therefore unaware of the costs of servicing individual customers.
The new Financial Controller, who recently joined CA, has decided to perform Customer
Profitability Analysis (CPA). He has initially planned to see the results from a sample of two
customers before deciding whether to fully introduce CPA.
The information for these two customers, and for the whole company, for the year 2014/15
is as follows:
Customer
Contribution (Rs. 000)
No. of packs sold (000)
No. of sales visits to customers
No. of orders placed by customers
No. of normal deliveries to customers
No. of urgent deliveries to customers
Activity
Sales visits to customers
Processing orders
Normal deliveries
Urgent deliveries

KB2 June 2015

AH
1,500
50
24
75
45
5

LW
810
27
12
20
15
-

Company
9,000
300
200
700
240
30

Total costs for the period

Rs. 000
1,000
1,400
2,400
1,200

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Required :
(a)
(b)

Prepare a Customer Profitability Analysis for each of the two customers.

(5 marks)
Demonstrate how CA could use this Customer Profitability Analysis to increase its
profits.
(5 marks)
(Total: 10 marks)

Question 02
Swinger Household (Pvt) Limited (SHL) manufactures and sells household consumer
goods. The market in which it operates is highly competitive. The competition comes from
other local manufacturers as well as from importers of similar items from countries such as
China and Taiwan. SHL constantly designs new products in order to maintain its market
share. The life cycle of products in the market is comparatively short as the competitors are
also engaged in constantly introducing new products or variations of existing products.
Consumers consider two main factors when buying these products: price and quality. SHL
uses a market penetration pricing policy when launching its products and is always striving
to improve its quality from the product design stage through to customer care. As a result it
has a 25% market share, and its largest competitor has a 16% market share with around
20 other companies sharing the remainder of the market.
Required:
(a)

Differentiate:

Costs of quality conformance; and

Costs of quality non-conformance.

(3 marks)

(b)

Advise how SHL should address the issues of quality conformance costs and
product selling prices in the context of consumer considerations when buying the
products.
(4 marks)

(c)

Analyse how Kaizen principles could be used by SHL to extend the life cycle of its
products.
(3 marks)
(Total: 10 marks)

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Question 03
Easyways (Pvt) Limited (EL) is a transport provider. EL is presently evaluating an offer to
transport a food item packed in boxes to a customers sales outlet. EL needs to buy a new
freezer truck for this purpose and is considering two types of trucks; Small and Large. EL is
not sure about which type of truck to buy. The volume in a small truck is 200 boxes and
that of a large truck is 300 boxes.
Daily demand of boxes in the sales outlet varies and can be either 180 boxes (with a
probability of 40%) or 270 boxes (with a probability of 60%).
Transport income is Rs. 200 per box. The variable cost of transporting one consignment of
boxes in a small truck is Rs. 20,000 and in a large truck is Rs. 30,000.
If the demand exceeds the capacity of the truck, customer will deduct Rs. 50 per box for the
shortage from the transport income of EL as a penalty to compensate the loss arising from
the short-supply (delivery).
Other daily overhead cost per small truck is Rs. 5,500 and per large truck is Rs. 8,500.
Both types of trucks can only make one trip a day.
Required:
(a)

Prepare a profits table showing the outcome of all options available to EL.
(4 marks)

(b)

Considering ELs risk attitude, advise on the type of truck EL should buy if it takes
the decision based on;
(i)
Expected value criterion
(ii)
Maximax criterion
(iii) Maximin criterion
(6 marks)
(Total 10 marks)

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Question 04
Electroserve (Pvt) Limited (EPL) is a divisionalised manufacturing organisation. Division B
of EPL produces table lamps for which it purchases LED bulbs from outside (At Rs.125 per
bulb) and Division A of EPL.
The LED bulbs produced by Division A are transferred at Rs. 120 each to Division B. This
price is set by adding a 20% profit mark-up to the variable cost of production. Division A
operates at its full capacity. The manager of Division A is not happy with this pricing policy
and claims that the price should be set at 10% profit mark-up on full cost.
The following additional details are provided;
The manufacture of one LED bulb consumes 2 minutes of labour at Rs. 300 per hour. Fixed
production overheads are to be absorbed to the bulbs at 200% of the labour cost.
Division A is not presently supplying the external market though it could supply any
quantity at the present market price of Rs. 125 per bulb. However, Division A would have
to spend Rs. 4 per bulb as selling and distribution costs.
EPLs ultimate objective is to maximise the profit of the whole company.
Required:
(a)

Calculate the proposed transfer price at 10% profit mark-up on full cost basis.
(2 marks)

(b) (i) Calculate the maximum transfer price that is acceptable to Division B.
(ii) Calculate the minimum transfer price that is acceptable to Division A.
(iii) Discuss the appropriateness of present and proposed transfer prices.
(5 marks)
(c)

Discuss how the dual rate pricing policy could be used to overcome transfer
pricing issues in EPL.
(3 marks)
(Total: 10 marks)

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Question 05
AB (Pvt) Limited has predicted its sales demand for each of the four quarters of 2016 as
follows:
Quarter
Sales demand (units)

1
100,000

2
110,000

3
190,000

4
140,000

The company has a normal production capacity of 135,000 units per quarter without
needing to utilise any overtime working. However, the capacity can be increased by up to
40% by working overtime.
It is current company policy to manufacture units using a constant level production system.
This means that although the company will not hold any inventory at the beginning and
end of the year (zero inventory), there are increases and decreases in the quarterly
inventory levels. On this basis the selling price, variable production overhead and
contribution for 2016 are expected to be as follows:
Selling price
Direct materials
Direct labour
Variable production overhead
Contribution

Rs. per unit

90
30
35
10
(75)
15

However, any overtime working will increase the unit direct labour cost by 20% and the
unit variable production overhead cost by 10% for those units produced during overtime
working. In addition, the company incurs a storage cost of Rs.4 per unit per quarter for
each item that is held in inventory. These costs are not included in the production costs
above.
AB is considering whether it should change the current production system to a just-in-time
(JIT) production system, but is concerned that due to the fluctuating levels of its sales
demand this may not be financially beneficial. If the company did change to a JIT
production system, no inventory would be held while the behaviour of variable production
overhead would remain unchanged.
Required:
(a)

Calculate the cost of holding inventory (based on average inventory levels in

each of the quarters) for each of the quarters and for the year in total, under the
current production system. Assume that sales occur evenly during each quarter.
(4 marks)

(b)

Evaluate on the proposal to change to a JIT production system.

(6 marks)

(Total: 10 marks)
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SECTION 2
Both questions are compulsory.
Total marks for Section 2 is 50 marks.
Recommended time for the section is 90 minutes.
Question 06
Communication Networks (Pvt) Limited (CN) manufactures and sells an electronic
component used in communication equipment. The company operates a standard marginal
costing system and a just-in-time (JIT) purchasing and production system with no
inventory of raw materials or finished goods being held.
Given below is information pertaining to the budgeted and actual results for the year ended
31 March 2015.
Extracts from the budget for the year ended 31 March 2015
Production and sales

10,000 units

Standard selling price per unit

Standard production costs per unit:
Direct material;
8 kg at Rs. 108 per kg
Direct labour;
1.25 hours at Rs. 180 per hour
Variable overheads; 1.25 hours at Rs. 60 per direct labour hour
Fixed production overheads

Rs.
1,800
864
225
75
1,700,000

Extracts from the accounting records for the year ended 31 March 2015 (actual
information)
Production and sales
Selling price
Direct material
Direct labour
Variable overheads
Fixed production overheads

KB2 June 2015

9,000 units
Rs. 1,840 per unit
74,000 kg at Rs. 112 per kg
10,800 hours at Rs. 190 per hour
Rs. 700,000
Rs. 1,680,000

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Required:
(a)

Reconcile the budgeted profit with the actual profit showing the variances in as
much detail as possible using the standard marginal costing approach.
(11 marks)

(b)

Explain why the variances used to reconcile profit in a standard marginal costing
system are different from those used in a standard absorption costing system.
(4 marks)

(c)

Calculate the variances that would be different and any additional variances that
would be required if the reconciliation statement was prepared using standard
absorption costing. (Preparation of a revised statement is not required.)
(4 marks)

(d)

Discuss the arguments in favour of the use of traditional absorption costing

rather than marginal costing for profit reporting and inventory valuation.
(6 marks)
(Total: 25 marks)

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Question 07
Auto Sort (Pvt) Limited (ASL) is an automobile repairing company which has forecasted the
following repair revenue (at present price level) for the next four years, with the existing
facilities.
Repair revenue forecast (contribution equals to 60% of repair revenue)
Year
Annual repair revenue (Rs. million)

Y1
10

Y2
12

Y3
15

Y4
17

The increase in annual repair revenue is due to the expected increase in the number of
repairs.
The management of ASL is considering an expansion plan by investing in a repair booth.
The following information is gathered and presented at the present price levels.
Investment in repair booth (based on present price levels)

The purchase price of the repair booth is Rs. 10 million. In addition, an installation cost
of Rs. 2 million is payable immediately. The repair booth can be used for the next 4
years and 30% of the purchase price could be realised at the end of fourth year by sale
of scraps. The ground concreting work required for the installation of the repair booth
was completed two months ago for which Rs. 1 million was already paid by the
company.

The maintenance cost of the repair booth is Rs. 2 million per year which will increase
with the age of the repair booth by 10% annually for the third and fourth years.

If the repair booth is used, the contribution from the present operation (repair revenue
less cost of materials for the repair) which is 60% of repair revenue, can be increased to
80%.

By using the repair booth, ASL could generate an additional repair revenue of
Rs. 5 million per annum (for Y1 = Rs. 5 million) with 80% contribution. Due to increase
in demand this revenue will increase by 10% annually for the 2nd and 3rd years and
remain at that level for the 4th year.

The repair booth will allow ASL to cut down annual labour expenses by Rs. 500,000
while increasing the annual electricity cost by Rs. 200,000.

ASL is presently paying income tax at 28% during the same year in which such
liabilities arise. ASL is eligible to claim a 33 1/3% depreciation allowance on the repair
booth and installation cost.

All figures indicated above will inflate at a uniform rate of 5% per annum. ASLs money
(nominal) after tax cost of capital is 17.6%.

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Required:
(a) Evaluate whether the investment in the repair booth is financially desirable to
ASL.
(Use the net present value (NPV) method calculated in real terms).
(11 marks)
(b) (i) Calculate the non-discounted payback period for this investment.
(ii) Explain why this method is often used by companies.
(4 marks)
(c)

Assess the maximum possible cost of capital at which the project is financially
desirable for the company.
(3 marks)

(d) It has now been informed by the supplier that production has been stopped at
present due to an operational issue, and the repair booth price is expected to be
increased in another one years time. As per the supplier, ASL can confirm the
order for a repair booth at the present price (Rs. 10 million) by advancing full
payment immediately. Otherwise, ASL can purchase it at the increased price after
one year from now. Whichever option is chosen, the repair booth will be delivered
to ASL after one year from now and the amounts of other operational cash flows
for the 4 year period will not change.
(i)

Evaluate the effect on the NPV calculated in (a) above from immediately
advancing full payment for the repair booth.
(3 marks)

(ii) Calculate the maximum revised price at which it is financially advisable for
ASL to buy the repair booth instead of advancing money.
(4 marks)
(Total: 25 marks)

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